Peoples Community Bancorp 10-K 2008
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
x Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2007
o Transition report pursuant to Section 13 or 15(d) of the Securities and Exchange Act of 1934
Commission File No.: 000-29949
PEOPLES COMMUNITY BANCORP, INC.
(Exact Name of Registrant as Specified in Its Charter)
(Registrants Telephone Number, Including Area Code)
Securities registered under Section 12(b) of the Exchange Act:
Securities registered under Section 12(g) of the Exchange Act:
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes o No x
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes o No x
Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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 o
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 Registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o Accelerated filer o Non-accelerated filer o Smaller reporting company x
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x
As of June 30, 2007, the aggregate value of the 3,904,422 shares of Common Stock of the Registrant issued and outstanding on such date, which excludes 934,542 shares held directly or indirectly by all directors and executives officers of the Registrant and the Registrants Employee Stock Ownership Plan (ESOP) as a group, was approximately $63.8 million. This figure is based on the closing sales price of $16.34 per share of the Registrants Common Stock on June 30, 2007. Although directors and executive officers and the ESOP were assumed to be affiliates of the Registrant for purposes of this calculation, the classification is not to be interpreted as an admission of such status.
Number of shares of Common Stock outstanding as of April 14, 2008: 4,838,964
TABLE OF CONTENTS
Peoples Community Bancorp, Inc. (Peoples or the Company) was organized in December 1999 at the direction of the Board of Directors of The Peoples Building, Loan and Savings Company, presently Peoples Community Bank (the Bank), for the purpose of holding all of the capital stock of the Bank and in order to facilitate the conversion of the Bank from an Ohio-chartered mutual savings and loan association to a federally-chartered stock savings bank. (Unless the context otherwise requires, reference to Peoples includes the Bank). Peoples assets consist primarily of the outstanding shares of common stock of the Bank. Peoples has no significant liabilities other than junior subordinated debentures issued in fiscal 2005 and $17.5 million of debt currently outstanding as of April 14, 2008 under a line of credit which is secured by the outstanding shares of common stock of the Bank. The management of Peoples and the Bank are substantially identical and Peoples neither owns nor leases any property but instead uses the premises, equipment and furniture of the Bank. At December 31, 2007, the Company had $887.4 million in total assets, $735.2 million in deposits, $77.6 million in borrowings (excluding subordinated debentures) and $53.6 million of stockholders equity. The Companys principal executive office is located at 6100 West Chester Road, West Chester, Ohio 45069. The Companys telephone number is (513) 870-3530.
The Bank is a federally-chartered stock savings bank that was originally organized in 1889. The Bank conducts its business from nineteen full service offices in Hamilton, Warren and Butler counties in Southwest Ohio and Dearborn and Ohio Counties in Southeast Indiana. The Bank is primarily engaged in attracting deposits from the general public and using those funds to originate loans and invest in securities. The Banks primary lending emphasis has been, and continues to be, loans secured by first liens on single-family (one- to four-units) residential properties located in its local market.
As a result of acquisitions and internal growth, the Company grew from $416.0 million in total assets as of September 30, 2001 to a high of $1.0 billion in total assets as of December 31, 2005. Between the completion of the public offering in March 2000 and December 31, 2005, the Company acquired five financial institutions with aggregate total assets as of the time of acquisition of $428.5 million. Also, in September 2003, the Company purchased $32.8 million in loans and assumed $55.6 million in deposits in connection with the acquisition of two branch offices from another financial institution. The Company supplemented this growth from acquisitions with loan generation secured primarily by real estate in its market area. Total gross loans increased from $419.5 million at September 30, 2001 to $851.3 million at December 31, 2005. In addition, since September 30, 2000, the Company expanded its franchise through the opening of six full service branch offices. These new branch offices, as well as acquired branch offices, have expanded the Companys market presence. The Companys loan growth has been funded in part by deposits. The Company has placed an emphasis on deposit generation both internally and through whole bank and branch acquisitions. Deposits have increased from $233.1 million at September 30, 2001 to $735.2 million at December 31, 2007.
However, beginning in early 2007, the Company began to reduce all aspects of its lending exposure due in large part to the downturn in the local economy, and, in particular, values of residential and residential development properties. At December 31, 2007, total gross loans amounted to $704.0 million, a decrease of $240.7 million or 25.5% compared to $944.7 million of loans at December 31, 2005. In addition, in an attempt to address such slowdown and the resulting decrease in the value of its collateral, the Company charged-off $13.1 million of loans in 2006 and $18.3 million of loans in 2007, and provided $17.5 million and $32.8 million during 2006 and 2007, respectively, to the allowance for losses on loans. As a result, the allowance for loan losses to total gross loans at December 31, 2007 amounted to 4.9%. Further, beginning in 2006, the Company revised its underwriting standards to place an increased focus on cash flow analysis, tightened its credit standards and provided additional resources to the resolution of its classified assets.
The actions taken by the Company during 2006 and 2007, discussed above, and the continued recessionary forces in the local economy have had a significant adverse impact on the Companys financial condition and results of operations. For 2006 and 2007, net losses amounted to $4.1 million and $33.3 million, respectively, and stockholders equity decreased from $86.0 million or 8.36% of total assets at December 31, 2005 to $53.6 million or 6.04% of total assets at December 31, 2007. Further, the level of the Companys non-performing assets has and will continue to negatively impact the Companys interest rate spread, interest income, provision for losses on loans and net earnings or loss. Non-performing assets totaled $32.8 million, $26.1 million and $18.9 million at December 31, 2007, 2006 and 2005, respectively. While the Bank has devoted and will continue to devote substantial management resources toward the resolution of all delinquent and non-performing assets, no assurance can be made that managements efforts will be successful.
The Banks primary federal regulator, the Office of Thrift Supervision (OTS) has, in light of the Companys recent losses and levels of nonperforming assets, imposed certain operations restrictions on the Company and the Bank, many of which had previously been taken by the Company and the Bank. On April 2, 2008, the Company and the Bank each consented to the terms of Cease and Desist Orders issued by the OTS (the Orders). The Company attached copies of the Orders to a Current Report on Form 8-K filed with the Securities and Exchange Commission on April 3, 2008.
The Orders require the Company and the Bank to, among other things, file with the OTS within proscribed time periods updated business plans, which specifically incorporate the requirements set forth in the Orders and comments contained in the most recently completed examinations of the Company and the Bank. On a quarterly basis, the Bank and the Company will be required to compare the projected operating results from the business plans with the actual results. The results of this variance analysis are to be submitted to the OTS within the proscribed time periods. In addition, the Orders require that the Company and the Bank receive the permission of the OTS prior to (i) making or declaring any dividends or payments on their outstanding securities; (ii) adding or replacing a director or hiring a senior executive officer; and (iii) making any golden parachute payments to any institution-affiliated party. Pursuant to the Order issued to the Company, the Company must also receive the permission of the OTS prior to increasing its debt position and before any repurchase of its securities.
The Order issued to the Bank also requires the Bank to take or refrain from certain actions, including (i) not making any new loans or issuing new lines of credit for land acquisition or development, speculative residential construction, commercial and multi-family construction, acquisition or retention of commercial property, and non-owner occupied one- to four-family residential property; (ii) engaging an independent consultant to conduct a loan portfolio review for the purpose of determining asset quality and the appropriateness of the Banks asset classification process related to loan relationships that equal or exceed $4.0 million; (iii) establishing a plan for reducing adversely classified assets; (iv) reviewing and, where appropriate, adjusting the Banks allowance for loan and lease losses methodology; (v) limiting asset growth during each calendar quarter to an amount not to exceed net interest credited on deposit liabilities; and (vi) establishing an Oversight Committee of the Banks Board of Directors comprised of independent outside directors. In an effort to proactively address the downturn in the local real estate market, the Bank had previously curtailed or ceased the lending activities restricted in the Orders.
Management of the Company and the Bank is working diligently to resolve the issues associated with the Companys nonperforming assets and to provide the information or take the actions required by the Orders. Concurrently, management and the Board of Directors are considering all strategic alternatives available to the Company and the Bank. As required, the Company and the Bank have filed a consolidated business plan with the OTS covering operations through 2010. The Companys business plan contemplates, among other things, a consolidation of the Companys operations through branch sales and a reduction in adversely classified assets through loan resolutions, repayments, sales and charge-offs. Branch sale transactions would decrease the Companys assets and liabilities, generate additional capital, generate taxable income, and reduce general, administrative and other expense. In addition, the Bank would dividend funds to the Company to provide liquidity to service the Companys debt, provided that approval would be received from the OTS. The business plan was submitted by the Company to the OTS on April 7, 2008 and is subject to review and approval by the OTS.
The report of the Companys independent registered accounting firm contains an explanatory paragraph as to the Companys ability to continue as a going concern primarily due to the Companys current lack of liquidity to repay its $17.5 million obligation under an outstanding line of credit due June 30, 2008. The line of credit is secured by all outstanding shares of common stock of the Bank. Although the Bank exceeds all of its capital requirements and is considered well capitalized at December 31, 2007, the Orders prohibit the Bank from paying cash dividends to the Company without the prior consent of the OTS and the Company will only be able to rely upon existing cash and cash equivalents as sources of its liquidity. Without the ability to rely on dividends from the Bank, the Company will require funds from other capital sources to meet its obligations such as restructuring the current line of credit or replacing the current line of credit. The Company was not in compliance with one of the loan covenants at December 31, 2007 and the lender has the ability to accelerate all outstanding amounts upon notice and the passage of 30 days. The Company is currently negotiating with the lender regarding a waiver of default, and a modification and/or extension of the line of credit.
In light of the matters discussed above, the Company established a $4.4 million valuation allowance of deferred federal income taxes, thus decreasing the tax benefit recorded during the year by the Company. Generally, the losses incurred in 2006 and 2007 resulted in deferred federal income taxes or deferred tax assets which may be utilized against current period earnings, carried back against prior years earnings or utilized to the extent of managements estimate of future taxable income. The valuation allowance was established since the Companys current liquidity position may impair the Companys ability to generate future taxable income, and therefore, impair its ability to realize all benefits of the deferred tax asset.
Current OTS capital standards require savings institutions to satisfy three different capital requirements. Under these standards, savings institutions must maintain tangible capital equal to at least 1.5% of adjusted total assets, core capital equal to at least 4.0% of adjusted total assets and total capital equal to at least 8.0% of risk-weighted assets. At December 31, 2007, the Bank exceeded all of such capital requirements, with tangible, core and risk-based capital ratios of 7.0%, 7.0% and 11.4%, respectively. Further, at such date, the Bank was deemed a well capitalized institution under the regulatory framework for prompt correction action purposes.
The Bank is subject to examination and comprehensive regulation by the OTS, which is the Banks chartering authority and primary federal regulator. The Bank is also regulated by the Federal Deposit Insurance Corporation (the FDIC), administrator of the Deposit Insurance Fund. The Bank is a member of the Federal Home Loan Bank (the FHLB) of Cincinnati, which is one of the 12 regional banks comprising the FHLB System.
As previously announced, the Board of Directors of the Company adopted an amendment to Article VI of the Companys Bylaws to change the Companys fiscal year end from September 30, to December 31, effective retroactively to January 1, 2006, in order to increase operational efficiency. As a result, the consolidated statements of financial condition compares December 31, 2007 to December 31, 2006, while the consolidated statements of operations, the consolidated statements of comprehensive income (loss), and the consolidated statements of cash flow reflect, as applicable, the twelve month periods ended December 31, 2007 and December 31, 2006, the three month period ended December 31, 2005, and the twelve month period ended September 30, 2005.
General. At December 31, 2007, the net loan portfolio of Peoples totaled $634.4 million, representing approximately 71.5% of total assets at that date. Historically, the principal lending activity of Peoples has been the origination of residential and nonresidential real estate loans. At December 31, 2007, residential loans (including construction loans secured by residential real estate) amounted to $525.9 million, or 74.7% of the gross loan portfolio. Nonresidential real estate and land loans totaled $129.0 million, or 18.3% of the gross loan
portfolio and nonresidential construction loans amounted to $12.4 million, or 1.8% of the gross loan portfolio as of December 31, 2007. Further, commercial loans amounted to $20.0 million, or 2.8% of the gross loan portfolio at December 31, 2007 and consumer loans amounted to $16.8 million, or 2.4% of the gross loan portfolio at such time. The Company curtailed its acquisition and development lending, one- to four-family residential investment lending, and unsecured commercial lending beginning in early 2007 due in large part to the downturn in the local housing market, the increase in the Banks nonaccrual loans and charge-offs, and to realign the portfolio due to loan concentrations. Further, as discussed above, the Bank is currently prohibited from making any new loans or issuing new lines of credit for the following purposes:
· Land acquisition or development
· Speculative residential construction
· Commercial and multi-family construction
· Acquisition or retention of commercial property, and
· Non-owner occupied one- to four-family property.
A savings institution generally may not make loans to one borrower and related entities in an amount which exceeds 15% of its unimpaired capital and surplus. However, loans in an amount equal to an additional 10% of unimpaired capital and surplus may be made to a borrower if the loans are fully secured by readily marketable securities. At December 31, 2007, Peoples regulatory limit on loans-to-one borrower was $13.7 million. All of Peoples five largest loans or groups of loans-to-one borrower, amounting to $12.9 million, $11.9 million, $9.7 million, $9.0 million and $8.8 million at December 31, 2007 were performing in accordance with their terms at such date.
Loan Portfolio Composition. The following table sets forth the composition of Peoples loans at the dates indicated.
Origination of Loans. The lending activities of Peoples are subject to the written underwriting standards and loan origination procedures established by the Board of Directors and management. Loan originations are obtained through a variety of sources, including referrals from real estate brokers, builders and existing customers. Written loan applications are taken by loan officers. Loan processors obtain or procure credit reports, appraisals and other documentation involved with a loan. Property valuations are performed by independent outside appraisers approved by the Board of Directors of Peoples. The Banks underwriting standards primarily focuses on the borrowers cash flow capacity to service the loan and to a lesser extent, the collateral value. This represents a transition from underwriting standards primarily based on collateral value, which are generally used by thrifts, to underwriting standards more widely used by banks.
Under the real estate lending policy of Peoples, a title opinion must be obtained for each real estate loan. Peoples also requires fire and extended coverage casualty insurance, in order to protect the properties securing its real estate loans. Borrowers must also obtain flood insurance policies when the property is in a flood hazard area as designated by the Department of Housing and Urban Development. Peoples does not require borrowers to advance funds to an escrow account for the payment of real estate taxes or hazard insurance premiums.
Peoples loan approval process is intended to assess the borrowers ability to repay the loan, the viability of the loan and the adequacy of the value of the collateral that will secure the loan. The Board of Directors has granted authority to approve secured loans as follows: loans up to $500,000 must be approved by two senior executive officers; loans between $500,000 and $1.0 million must be approved by three senior officers and loans greater than $1.0 million must be approved by the Board of Directors or the executive committee of the Board of Directors.
Unsecured loans up to $500,000 require approval by three senior executive officers and those greater than $500,000, individually or in the aggregate, must be approved by the Board of Directors or the executive committee of the Board of Directors. The executive committee ratifies all approvals and presents its report on a monthly basis for the Board of Directors review and approval.
Activity in Loans. The following table shows the activity in Peoples loans during the periods indicated.
(1) Undisbursed portions of loans in process totaled $33.7 million, $62.0 million, $77.1 million, $72.9 million, $59.0 million, and $55.3 million at December 31, 2007, 2006 and 2005, and September 30, 2005, 2004, and 2003, respectively.
(2) Includes loan participations sold of $4.9 million, $5.1 million, $1.1 million, $5.0 million, and $10.2 million in fiscal 2007, 2006, 2005, 2004 and 2003, respectively. There were no loan participations sold for the three months ended December 31, 2005. For fiscal 2007, 2006 and 2005, includes whole loans sold of $27.1 million, $29.5 million and $6.7 million, respectively, and for the three months ended December 31, 2005, includes whole loans sold of $3.5 million. The reduction in total loans resulting from sales of loans and loan participations in fiscal 2007 and 2006, the three months ended December 31, 2005, and fiscal 2005, 2004, and 2003 were offset (increased) by increases (decreases) in undisbursed loans in process, and other net items totaling approximately $(27.1) million, $(13.9) million, $5.7 million, $13.0 million, $5.3 million, and $16.1 million, respectively.
The significant repayments of $269.4 million, $366.5 million, $263.7 million, $236.4 million and $247.1 million during fiscal 2007, 2006, 2005, 2004, and 2003 respectively, were primarily due to the repayment of short-term construction loans and land development loans as well as the refinancing activity related to adjustable-rate single-family residential loans that were set to reprice in the current year.
Charge-offs of $18.3 million during fiscal 2007 consisted primarily of $8.5 million in loans secured by one- to four-family residential real estate (including $7.4 million of non-owner occupied investment property), $4.7 million in loans secured by multi-family residential real estate, $844,000 in construction loans, $1.3 million in loans secured by commercial real estate and land, and $2.9 million in commercial and consumer loans. The increase in charged-off loans was primarily due to both (i) real estate investors and developers experiencing cash flow difficulties and (ii) the downturn in the local economy. See Asset Quality.
Although federal laws and regulations permit savings institutions to originate and purchase loans secured by real estate located throughout the United States, Peoples generally confines its lending activity to its primary market area of Warren, Butler and Hamilton Counties in Ohio and Dearborn and Ohio Counties in Indiana. Subject to its loans-to-one borrower limitation, Peoples is permitted to invest without limitation in residential mortgage loans and up to 400% of its capital in loans secured by non-residential or commercial real estate. Peoples may also invest in secured and unsecured consumer loans in an amount not exceeding 35% of total assets. This 35% limitation may be exceeded for certain types of consumer loans. In addition, Peoples may invest up to 10% of its total assets in secured and unsecured loans for commercial, corporate, business or agricultural purposes. At December 31, 2007, Peoples was within each of the above lending limits. Notwithstanding the foregoing, Peoples lending activities are significantly restricted due to the requirements of the Orders. See Business General.
One- to Four-Family Residential Real Estate Loans. The primary real estate lending activity of Peoples continues to be the origination of loans secured by residential real estate. At December 31, 2007, $312.0 million, or 49.2% of the net loan portfolio of Peoples consisted of conventional one- to four-family residential loans, compared to $343.3 million, or 42.3% at December 31, 2006 and $341.2 million or 40.1% of the net loan portfolio at December 31, 2005. Owner occupied residential real estate loans are not restricted by the Orders.
The loan-to-value ratio, maturity and other provisions of the loans made by Peoples generally have reflected Peoples policy of making less than the maximum loan permissible under applicable regulations, in accordance with sound lending practices, market conditions and underwriting standards established by Peoples. Peoples lending policies on one- to four-family residential mortgage loans generally limit the loan-to-value ratio to 80% of the lesser of the appraised value or purchase price of the property. Residential mortgage loans are amortized on a monthly basis with principal and interest due each month. The loans generally include due-on-sale clauses.
The residential mortgage loans originated by Peoples consist of fixed rate and adjustable rate loans. Presently, the single-family fixed-rate residential mortgage loans originated by Peoples have terms of up to 30 years. In addition, Peoples originates adjustable-rate mortgage loans on which the interest rate adjusts every one, three or five years based upon the one-year or three-year rate on T-bills plus a specified margin. During fiscal 2004, Peoples introduced a five year fixed rate balloon product and a five year fixed rate product which adjusts on an annual basis thereafter based on the one-year rate on the T-bill. At December 31, 2007, $157.6 million, or 50.5% of our single-family residential loans were fixed rate and $154.4 million, or 49.5% were adjustable rate. Most of Peoples single-family loans in 2007 were originated for its portfolio, and some of these loans did not conform to Fannie Mae and Freddie Mac requirements and therefore, could not be sold in the secondary market.
Peoples non-owner occupied residential mortgage loans have been originated primarily to investors and builders, and have been made on substantially the same terms as owner occupied residential real estate loans. In 2007, the Company curtailed its one- to four-family residential lending to investors, due in large part to the downturn in the local housing market, the increase in the Banks nonaccrual loans and charge-offs, and to realign the portfolio due to loan concentrations. As previously stated, Peoples is currently prohibited from originating such loans. See Business General.
Multi-family Residential Loans. Peoples has also originated multi-family (over four units) residential loans. Peoples multi-family loans are primarily secured by apartment buildings or apartments being converted to condominium units. The multi-family residential mortgage loans of Peoples have been underwritten on substantially the same basis as its nonresidential real estate loans, discussed below, although loan-to-value ratios are generally limited to 80%. At December 31, 2007, Peoples had $82.2 million in multi-family residential mortgage loans, which amounted to 12.9% of Peoples net loan portfolio, compared to $122.2 million, or 15.0% of Peoples net loan portfolio at December 31, 2006. As previously stated, Peoples is currently prohibited from originating such loans. See Business General.
Nonresidential Real Estate and Land Loans. Peoples nonresidential real estate and land loan portfolio primarily consists of loans secured by land for development purposes, professional offices, small retail centers, warehouses and building lots located within Peoples primary market area. Nonresidential real estate and land loans amounted to $129.0 million, or 20.3% of the net loan portfolio at December 31, 2007. This compares to $140.9 million, or 17.3% at December 31, 2006. As previously stated, Peoples is currently prohibited from originating such loans. See Business General.
Nonresidential real estate loans originated by Peoples typically have a loan-to-value ratio of 75% or less and generally have higher interest rates than single-family residential mortgage loans with similar terms and structure. The maximum original term of Peoples nonresidential real estate loans is 25 years. Decisions to lend are based on the economic viability of the property and the creditworthiness of the borrower. Creditworthiness is determined by considering the character, experience, management and financial strength of the borrower, and the ability of the property to generate adequate funds to cover both operating expenses and debt services. In evaluating whether to make a nonresidential real estate loan, Peoples places primary emphasis on the ratio of net cash flow to debt service on the property and generally requires a ratio of cash flow to debt service of at least 120%, computed after deduction for a vacancy factor and property expenses as Peoples deems appropriate.
The land loans of Peoples generally are secured by single-family residential lots or undeveloped land being held for residential development. Lot loans generally have a loan-to-value ratio of 80% or less (on an undeveloped basis) and are typically interest only loans with one-year maturities. Loans originated on developed land generally have a loan to value ratio of 75% or less with interest only over either a one or two year term. Land loans secured by single-family residential lots are structured similar to undeveloped land with a loan-to-value ratio of 80% or less.
Nonresidential real estate lending is generally considered to involve a higher degree of risk than one- to four-family residential lending. Such lending typically involves large loan balances concentrated in a single borrower or groups of related borrowers for rental or business properties. In addition, the payment experience on loans secured by income-producing properties is typically dependent on the success of the operation of the related project and thus is typically affected by adverse conditions in the real estate market and in the economy. Peoples generally attempts to mitigate the risks associated with its nonresidential real estate lending by, among other things, lending primarily in its market area and using reasonable loan-to-value ratios in the underwriting process.
Land development and acquisition loans involve significant additional risks when compared with loans on existing residential properties. These loans may involve larger loan balances to single borrowers, and the payment experience may be dependent on the successful development of the land and the sale of the lots. These risks can be significantly impacted by supply and demand conditions as well as local economic conditions. In early 2007, the Bank curtailed new origination of land development and acquisition loans based on the downturn in the local housing market, the increase in the Banks nonaccrual loans and charge-offs, and to realign the portfolio due to loan concentrations. As previously stated, Peoples is currently prohibited from originating such loans. See Business General.
Construction Loans. At December 31, 2007, Peoples had approximately $144.2 million, or 22.7% of the net loan portfolio, in construction loans, compared to $234.8 million, or 28.9% of the total loan portfolio at December 31, 2006. Of this amount at December 31, 2007, $131.8 million, or 91.4%, consisted of residential construction loans and $12.4 million, or 8.6%, consisted of nonresidential construction loans. The construction loans of Peoples have been comprised of loans made to builders on a pre-sold basis, as well as to builders for homes on an unsold or speculative basis.
Peoples construction loans to builders have generally been made with a term not to exceed twelve months. Interest-only payments are required during the construction period, which is typically twelve months. Peoples generally limits the number of unsold homes under construction to its builders. This number is dependent on the financial strength of the builder, marketability of the property and the Banks experience with and present exposure to the builder. In addition, loans made to borrowers to construct their personal residences are originated at one closing as a construction/permanent loan.
Peoples has also originated loans for the construction of nonresidential real estate such as small office buildings and warehouses. These loans are typically originated as construction/permanent loans with interest only payments during the construction period and converting to a permanent loan at the end of the construction period. These loans are generally made with a construction term of 12 months. The loan to value ratio is generally limited to 75% on these loans on an as completed basis.
Prior to making a commitment to fund a construction loan, Peoples requires an appraisal of the property. Peoples also generally requires third party inspections of each project prior to disbursement of funds. Loan proceeds are then disbursed based on a percentage of completion.
Construction lending is generally considered to involve a higher degree of risk of loss than long-term financing on improved, owner-occupied real estate because of the uncertainties of construction, including the possibility of costs exceeding the initial estimates and the need to obtain a tenant or purchaser if the property will not be owner-occupied. Peoples generally attempts to mitigate the risks associated with construction lending by, among other things, primarily lending in its market area, using conservative underwriting guidelines, and monitoring the construction process.
Peoples is currently prohibited from originating speculative residential construction loans, multi-family residential construction loans and commercial construction loans. See Business General.
Commercial Loans. Peoples commercial loans consist primarily of secured and unsecured lines of credit predominantly to builders and developers for working capital purposes, and to a lesser extent, loans secured by business equipment. At December 31, 2007, commercial loans amounted to $20.0 million, or 3.2% of Peoples net loan portfolio, compared to $30.9 million, or 3.8% of the net loan portfolio at December 31, 2006. In early 2007, the Bank curtailed new origination of commercial unsecured loans in recognition of the downturn in the local housing market and the increase in the Banks nonaccrual loans and charge-offs. As previously stated, Peoples is currently prohibited from originating such loans. See Business General.
Consumer Loans. Peoples consumer and other loans consist of loans secured by deposit accounts, automobiles and stock. At December 31, 2007, consumer and other loans amounted to $16.8 million, or 2.6% of Peoples net loan portfolio, compared to $23.0 million, or 2.9% of Peoples net loan portfolio as of December 31, 2006.
Loan Origination and Other Fees. In addition to interest earned on loans, Peoples receives loan origination fees or points for originating loans. Loan points are a percentage of the principal amount of the mortgage loan and are charged to the borrower in connection with the origination of the loan. In accordance with Statement of Financial Accounting Standards No. 91, loan origination fees and certain related direct loan origination costs are offset, and the resulting net amount is deferred and amortized as interest income over the contractual life of the related loans as an adjustment to the yield of such loans. Peoples had $1.5 million and $2.3 million of deferred loan fees at December 31, 2007 and December 31, 2006, respectively.
Contractual Principal Repayments and Interest Rates. The following table sets forth scheduled contractual amortization of Peoples loans at December 31, 2007 as well as the dollar amount of such loans which are scheduled to mature after one year which have fixed or adjustable interest rates. Demand loans, loans having no schedule of repayments and no stated maturity and overdraft loans are reported as due in one year or less.
Scheduled contractual maturities of loans do not necessarily reflect the actual expected term of the loan portfolio. The average life of mortgage loans is substantially less than their average contractual terms because of prepayments. The average life of mortgage loans tends to increase when current mortgage loan rates are higher than rates on existing mortgage loans and, conversely, decrease when rates on current mortgage loans are lower than existing mortgage loan rates (due to refinancing of adjustable-rate and fixed-rate loans at lower rates). Under the latter circumstance, the weighted-average yield on loans decreases as higher yielding loans are repaid or refinanced at lower rates.
General. Peoples mails delinquent notices to borrowers when a borrower fails to make a required payment within 15 days of the date due. Additional notices begin when a loan becomes 30 days past due. If a loan becomes 90 days past due, Peoples refers it to an attorney to commence foreclosure. In many cases, deficiencies are cured promptly. While Peoples generally prefers to work with borrowers to resolve such problems, Peoples will institute foreclosure or other collection proceedings when necessary to minimize any potential loss.
Loans are placed on non-accrual status when management believes the probability of collection of interest is insufficient to warrant further accrual. When a loan is placed on non-accrual status, previously accrued but unpaid interest is deducted from interest income. As a matter of policy, Peoples generally discontinues the accrual of interest income when the loan becomes 90 days past due as to principal or interest, and if collection of the interest is questionable.
Real estate acquired by Peoples as a result of foreclosure or by deed-in-lieu of foreclosure is classified as real estate owned until sold. Peoples had real estate owned of $6.9 million and $333,000 at December 31, 2007 and December 31, 2006, respectively. At December 31, 2007, approximately $5.1 million of real estate owned consisted of a residential development for multi-family residences and condominiums in a northern Cincinnati suburb.
At December 31, 2007, the Company had $25.9 million of non-performing loans. If the current downturn in the local economy continues and borrowers are not able to meet their debt service obligations, the Company may experience a continued migration of non-performing loans to real estate owned.
Delinquent Loans. The following tables set forth information concerning delinquent loans at the dates indicated, in dollar amounts and as a percentage of each category of Peoples loan portfolio. The amounts presented represent the total outstanding principal balances of the related loans, rather than the actual payment amounts which are past due.
Non-Performing Assets. The following table sets forth information with respect to non-performing assets identified by Peoples, including non-accrual loans and other real estate owned.
Nonperforming assets totaled $32.8 million, $26.1 million, and $18.9 million at December 31, 2007, 2006 and 2005, respectively. Nonperforming assets at December 31, 2007 consisted of $4.8 million of loans secured by single-family residential real estate, $5.2 million of loans secured by multi-family residential real estate, $10.6 million of loans secured by nonresidential real estate and land, $4.6 million in construction loans, $562,000 of commercial and consumer loans, and $6.9 million in foreclosed real estate. Of the $25.9 million of nonperforming loans at December 31, 2007, approximately $1.6 million were less than 30 days past due. Over the past two years, the Bank has revised its methods of reviewing loans for potential weaknesses, which includes a strong emphasis on cash flow analysis. The Banks management continues to take this proactive approach, in addition to aggressively pursuing the collection and resolution of all delinquent and nonperforming loans. The increase in nonperforming loans was due in large part to the downturn in the local housing market and resultant cash flow issues faced by local property investors.
At December 31, 2007, non-accrual loans secured by one- to four-family residential real estate consisted of $1.9 million in owner-occupied residences with an average balance of $69,000, and $2.9 million in non-owner occupied residential real estate with an average balance of $71,000. Three borrowers represented $1.9 million of the non-owner occupied one- four-family residential non-accrual loans. Non-accrual loans secured by multi-family residential real estate amounted to $5.2 million with an average balance of $435,000. Two borrowers represented $3.9 million of the multi-family residential non-accrual loans, with the largest borrower owing $2.8 million.
Nonresidential real estate and land secured non-accrual loans totaled $10.1 million at December 31, 2007. The average balance of these 25 loans was $403,000. Approximately $6.3 million of the nonresidential real estate and land secured non-accrual loans were loan acquisition and development loans, with the largest borrower owing $3.8 million. Loans secured by building lots included in the nonresidential real estate secured non-accrual loans totaled $990,000 at December 31, 2007, and were primarily comprised of 3 borrowers, with the largest borrower owing $783,000. Twelve nonresidential real estate secured non-accrual loans totaling $2.8 million were secured by commercial real estate, with the largest borrower owing $933,000.
Non-accrual construction loans totaled $4.6 million at December 31, 2007, with an average balance of $244,000. Approximately $3.8 million of these construction loans are secured by one-to four-family residential real estate. Commercial and consumer non-accrual loans totaled $545,000, with $503,000 of these loans being unsecured.
If the $25.3 million of non-accruing loans of Peoples had been current in accordance with their terms during fiscal 2007, the gross income on such loans would have been approximately $2.8 million. A total of approximately $913,000 of interest income was actually recorded by Peoples on such loans in the fiscal year ended December 31, 2007.
Classified Assets. Federal regulations require that each insured savings institution classify its assets on a regular basis. In addition, in connection with examinations of insured institutions, federal examiners have authority to identify problem assets and, if appropriate, classify them. There are three classifications for problem assets: substandard, doubtful and loss. Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a higher possibility of loss. An asset classified loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. Another category designated special mention also must be established and maintained for assets which do not currently expose an insured institution to a sufficient degree of risk to warrant classification as substandard, doubtful or loss. Assets classified as substandard or doubtful may require the institution to establish general allowances for loan losses. If an asset or portion thereof is classified loss, the insured institution must either establish specific allowances for loan losses in the amount of 100% of the portion of the asset classified loss, or charge-off such amount. General loss allowances established to cover possible losses related to assets classified substandard or doubtful may be included in determining an institutions regulatory capital, while specific valuation allowances for loan losses do not qualify as regulatory capital. Federal examiners may disagree with an insured institutions classifications and amounts reserved.
The following table sets forth information with respect to classified assets as identified by Peoples, at the dates indicated.
Peoples total classified assets at December 31, 2007 amounted to $40.6 million, with no assets classified doubtful or loss. It was managements opinion that as of December 31, 2007, no loans exhibited characteristics to warrant a doubtful classification, while loans classified loss were charged off in full. The largest classified loan at December 31, 2007 was a $3.8 million loan secured by a land development project. The remaining $36.8 million of classified assets at December 31, 2007 consisted of approximately $4.4 million secured by non-owner occupied residential real estate, $1.9 million secured by owner-occupied residential real estate, $5.6 million secured by multi-family residential real estate, $4.6 million in residential construction loans, $11.9 million in loans secured by nonresidential real estate and land, $1.4 million of commercial and consumer loans, and $6.9 million of foreclosed real estate. The real estate owned consisted of $5.5 million of land and land development, $546,000 of single-family residential real estate, and $393,000 of multi-family real estate.
Approximately $43.1 million of loans were categorized as special mention by the Bank as of December 31, 2007, compared to $31.6 million at December 31, 2006. Although these loans are not deemed classified, these loans have potential weaknesses that deserve managements close attention. If left uncorrected, these potential weaknesses may, at some future date, result in the deterioration of the repayment prospects for the credit or the Banks credit position. Concerns may lie with cash flow, liquidity, leverage, collateral or industry conditions. Over the past two years, the Bank has revised its methods of reviewing loans for potential weaknesses, which includes a strong emphasis on cash flow analysis. The Banks management believes that this proactive approach has resulted in earlier detection of loans with potential exposure. The Banks management has also increased its monitoring of these loans and is working proactively with borrowers to remediate and mitigate risk associated with these loans.
Allowance for Loan Losses. The allocation of the allowance for loan losses based on particular types of loans was as follows:
The allowance for loan losses is maintained by management at a level considered sufficient to cover estimated losses inherent in the existing portfolio based on prior loan loss experience, known risks in the portfolio, adverse situations that may affect the borrowers ability to repay, the estimated value of any underlying collateral, general economic conditions, and other factors and estimates which are subject to change over time.
A quarterly analysis of the allowance for loan loss requirements includes general allocations based on the type of collateral securing the loan. In the analysis, loans determined to have a higher risk, such as land development loans, non-owner occupied residential real estate loans, and unsecured commercial loans, will have higher allowance requirements. Additional allowance requirements are allocated to criticized assets, based on the classified status of the loan. For example, loans classified substandard require higher loan loss allowances as compared to loans classified special mention. No special allowances are provided for concentration of loans to one borrower, unless management becomes aware of a potential problem with collectibility. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that should be charged-off.
Peoples increased its allowance for loan losses by recording a $24.5 million provision for losses on loans in the fourth quarter of 2007 and a total of $32.8 million for fiscal year 2007 based on the current level of non-performing, classified and criticized loans. The level of these loans is primarily due to delinquent loans in the Banks non-owner occupied (investment property) residential loan portfolio and its acquisition, development, and construction loan portfolio. The delinquencies in these portfolios are due primarily to the continuing downturn in the local economy and resultant cash flow issues faced by local property investors and developers.
At the beginning of 2007, the Company curtailed its acquisition and development lending, one- to four-family residential investment lending, and unsecured commercial lending. While management believes that it determines the size of the allowance based on the best information available at the time, the allowance will need to be adjusted as circumstances change and assumptions are updated. Future adjustments to the allowance could significantly affect future net earnings.
The following table sets forth the activity in the allowance for loan losses during the periods indicated.
Peoples has authority to invest in various types of securities, including mortgage-backed securities, United States Treasury obligations, securities of various federal agencies and of state and municipal governments, certificates of deposit at federally-insured banks and savings institutions, certain bankers acceptances and federal funds. Each large purchase of an investment security is approved by the Board of Directors.
The investment policy of Peoples is designed to maintain adequate liquidity, manage investment assets in conjunction with interest rate risk and maximize stability through diversification. Excess funds not utilized to meet loan demand are typically invested using the guidelines of the investment policy to seek the maximum return with minimal risk. All investments are approved to be held as Available for sale or Held to maturity. Peoples does not maintain any investments as Trading or Held to Maturity. Peoples transacts all investment activity through a select group of securities dealers approved by the Board of Directors.
The following table sets forth information regarding the carrying value and fair value of Peoples securities at the dates indicated.
The following table sets forth the activity in Peoples aggregate securities portfolio during the periods indicated.
(1) Includes increases in Federal Home Loan Bank stock, other stock investments, and mutual funds from purchases and dividends.
(2) At December 31, 2007, 2006 and 2005, and September 30, 2005, $78.2 million or 95.9%, $67.3 million or 94.8%, $85.8 million or 97.9%, and $199.6 million or 91.1%, respectively, of Peoples securities portfolio consisted of adjustable-rate securities .
The following table sets forth certain information regarding the maturities of Peoples security portfolio at December 31, 2007.
Mortgage-backed securities represent a participation interest in a pool of one- to four-family or multi-family mortgages. The mortgage originators use intermediaries (generally U.S. Government agencies and government-sponsored enterprises) to pool and repackage the participation interests in the form of securities, with investors receiving the principal and interest payments on the mortgages. Such U.S. Government agencies and government-sponsored enterprises guarantee the payment of principal and interest to investors.
Mortgage-backed securities are typically issued with stated principal amounts, and the securities are backed by pools of mortgages that have loans with interest rates that are within a range and have varying maturities. The underlying pool of mortgages, i.e., fixed-rate or adjustable-rate, as well as prepayment risk, are passed on to the certificate holder. The life of a mortgage-backed pass-through security approximates the life of the underlying mortgages.
The mortgage-backed securities of Peoples may consist of Government National Mortgage Association (Ginnie Mae), Federal Home Loan Mortgage Corporation (FHLMC) and Federal National Mortgage Association (FNMA) securities. Ginnie Mae is a government agency within the Department of Housing and Urban Development which is intended to help finance government-assisted housing programs. Ginnie Mae securities are backed by loans insured by the Federal Housing Administration, or guaranteed by the Veterans Administration, and the timely payment of principal and interest on Ginnie Mae securities are guaranteed by Ginnie Mae and backed by the full faith and credit of the U.S. Government.
Mortgage-backed securities generally yield less than the loans which underlie such securities because of their payment guarantees or credit enhancements which offer nominal credit risk. In addition, mortgage-backed securities are more liquid than individual mortgage loans and may be used to collateralize borrowings or other obligations of Peoples. At December 31, 2007, Peoples had mortgage-backed securities with a fair value totaling $63.3 million.
General. Deposits are the primary source of Peoples funds for lending and other investment purposes. In addition to deposits, principal and interest payments on loans and mortgage-backed securities are a source of funds. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows are significantly influenced by general interest rates, competition from other financial entities, and money market conditions. Borrowings may also be used on a short-term basis to compensate for reductions in the availability of funds from other sources and on a longer-term basis for general business purposes.
Deposits. Deposits are attracted by the Bank principally from within its primary market area. Deposit account terms vary, with the principal differences being the minimum balance required, the time periods the funds must remain on deposit and the interest rate. The Bank offers traditional passbook savings accounts, money market accounts, checking accounts and certificates of deposit.
The Bank obtains deposits primarily from residents of its primary market areas of southwestern Ohio and southeastern Indiana. The Bank does not solicit deposits from outside its primary market area or pay fees to brokers to solicit funds for deposit.
Interest rates paid, maturity terms, service fees and withdrawal penalties are established on a periodic basis. Management determines the rates and terms based on rates paid by competitors, the need for funds or liquidity, growth goals and federal and state regulations.
The following table sets forth the activity in Peoples deposits during the periods indicated.