FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 (Mark One) (X) Quarterly Report Pursuant to Section 13 or 15(d) of THE SECURITIES EXCHANGE ACT of 1934 For the quarterly period ended September 30, 2002 or ( ) Transition Report Pursuant to Section 13 or 15(d) of THE SECURITIES EXCHANGE ACT OF 1934 For the transaction period from to Commission File Number 1-13253 THE PEOPLES HOLDING COMPANY ------------------------------------------------------- (Exact name of the registrant as specified in its charter) MISSISSIPPI -------------------------------------------------------------- (State or other jurisdiction of incorporation or organization) 64-0676974 --------------------------------------- (I.R.S. Employer Identification Number) 209 Troy Street, P. O. Box 709, Tupelo, Mississippi 38802-0709 ------------------------------------------------------------ (Address of principal executive offices) (Zip code) Registrant's telephone number including area code 662-680-1001 Indicate by check 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 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 the number of shares outstanding of each of the issuer's classes of common stock, as to the latest practicable date. Common stock, $5 Par Value, 5,574,733 shares outstanding as of November 14, 2002 1
THE PEOPLES HOLDING COMPANY INDEX PART I. FINANCIAL INFORMATION PAGE Item 1. Condensed Consolidated Financial Statements (Unaudited) Condensed Consolidated Balance Sheets - September 30, 2002 and December 31, 2001............. 3 Condensed Consolidated Statements of Income - Three Months and Nine Months Ended September 30, 2002 and 2001.... 4 Condensed Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2002 and 2001........ 5 Notes to Condensed Consolidated Financial Statements...... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.................. 8 Item 3. Quantitative and Qualitative Disclosures About Market Risk.................................... 16 Item 4. Controls and Procedures .................................. 16 PART II. OTHER INFORMATION Item 1. Legal Proceedings........................................ 17 Item 6. Exhibits and Reports on Form 8-K......................... 17 Signatures................................................... 18 Certification of Chief Executive Officer .................... 19 Certification of Chief Financial Officer .................... 20 2
PART I. FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS <TABLE> <CAPTION> THE PEOPLES HOLDING COMPANY AND SUBSIDIARY CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except share data) SEPTEMBER 30 DECEMBER 31 2002 2001 ------------ ------------ (Unaudited) (Note 1) <S> <C> <C> Assets Cash and due from banks .................. $ 49,570 $ 41,475 Federal funds sold ....................... 7,000 Interest-bearing balances with banks ..... 392 22,937 ---------- ---------- Cash and cash equivalents ... 49,962 71,412 Securities available-for-sale ............ 326,344 277,293 Loans, net of unearned income ............ 855,415 827,696 Allowance for loan losses ............. (12,299) (11,354) ---------- ---------- Net loans ................... 843,116 816,342 Premises and equipment, net .............. 29,124 28,346 Other assets ............................. 58,094 61,334 ---------- ---------- Total assets .................... $ 1,306,640 $ 1,254,727 ========== ========== Liabilities Deposits: Noninterest-bearing ................... $ 164,848 $ 145,690 Interest-bearing ...................... 925,548 917,365 ---------- ---------- Total deposits .............. 1,090,396 1,063,055 Treasury tax and loan note account ....... 9,459 6,181 Advances from the Federal Home Loan Bank . 58,136 41,145 Other liabilities ........................ 18,090 20,764 ---------- ---------- Total liabilities ........... 1,176,081 1,131,145 Shareholders' equity Common Stock, $5 par value - 15,000,000 shares authorized, 6,212,284 shares issued; 5,575,433 and 5,704,680 shares outstanding at September 30, 2002 and December 31, 2001, respectively ........ 31,061 31,061 Treasury stock, at cost .................. (17,529) (12,856) Additional paid-in capital ............... 39,864 39,850 Retained earnings ........................ 70,869 63,391 Accumulated other comprehensive income ... 6,294 2,136 ---------- ---------- Total shareholders' equity .. 130,559 123,582 ---------- ---------- Total liabilities and shareholders' equity ......... $ 1,306,640 $ 1,254,727 ========== ========== </TABLE> See Notes to Condensed Consolidated Financial Statements 3
<TABLE> <CAPTION> THE PEOPLES HOLDING COMPANY AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF INCOME (in thousands, except share data) NINE MONTHS ENDED SEPTEMBER 30 THREE MONTHS ENDED SEPTEMBER 30 2002 2001 2002 2001 (Unaudited) (Unaudited) <S> <C> <C> <C> <C> Interest income Loans ................................... $ 46,027 $ 53,919 $ 15,363 $ 17,773 Securities: Taxable ............................ 9,892 9,380 3,251 3,030 Tax-exempt ......................... 3,011 3,004 1,019 991 Other ................................... 277 669 74 83 --------- --------- --------- --------- Total interest income .............. 59,207 66,972 19,707 21,877 Interest expense Deposits ................................ 18,567 31,276 5,940 9,548 Borrowings ............................. 1,797 1,090 614 359 --------- --------- --------- --------- Total interest expense ............. 20,364 32,366 6,554 9,907 --------- --------- --------- --------- Net interest income ................ 38,843 34,606 13,153 11,970 Provision for loan losses ..................... 3,325 3,475 1,125 1,225 --------- --------- --------- --------- Net interest income after provision for loan losses ...... 35,518 31,131 12,028 10,745 Noninterest income Service charges on deposit accounts ..... 9,220 8,569 3,220 2,961 Fees and commissions .................... 6,731 5,406 2,456 1,905 Trust revenue ........................... 680 660 218 130 Securities gains ........................ 30 87 22 42 Other ................................... 3,583 3,026 1,069 1,134 --------- --------- --------- --------- Total noninterest income ........... 20,244 17,748 6,985 6,172 Noninterest expense Salaries and employee benefits .......... 21,609 19,285 7,290 6,862 Data processing ......................... 2,838 2,629 957 902 Net occupancy ........................... 2,368 2,402 784 797 Equipment ............................... 2,386 2,195 792 733 Other ................................... 8,265 7,792 2,819 2,579 --------- --------- --------- --------- Total noninterest expense .......... 37,466 34,303 12,642 11,873 --------- --------- --------- --------- Income before taxes and cumulative effect of accounting change ...................... 18,296 14,576 6,371 5,044 Income taxes .................................. 5,198 3,845 1,827 1,202 --------- --------- --------- --------- Income before cumulative effect of accounting change .... 13,098 10,731 4,544 3,842 Cumulative effect of accounting change ........ (1,300) --------- --------- --------- --------- Net income ......................... $ 11,798 $ 10,731 $ 4,544 $ 3,842 ========= ========= ========= ========= Basic and diluted earnings per share: Income before cumulative effect of accounting change .................... $ 2.33 $ 1.81 $ 0.81 $ 0.66 Cumulative effect of accounting change ... (0.23) --------- --------- --------- --------- Net income ............................... $ 2.10 $ 1.81 $ 0.81 $ 0.66 ========= ========= ========= ========= Weighted average shares outstanding .......... 5,620,891 5,925,326 5,591,462 5,793,822 Weighted average shares outstanding - diluted . 5,625,348 5,925,326 5,597,362 5,793,822 See Notes to Condensed Consolidated Financial Statements </TABLE> 4
<TABLE> <CAPTION> THE PEOPLES HOLDING COMPANY AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands, except share data) NINE MONTHS ENDED SEPTEMBER 30 2002 2001 ---- ---- (Unaudited) <S> <C> <C> Operating activities Net cash provided (used) by operating activities .......... $ 18,999 $ (1,572) Investing activities Purchases of securities available-for-sale ................. (160,133) (71,398) Proceeds from sales of securities available-for-sale ................. 43,770 13,208 Proceeds from calls/maturities of securities available-for-sale ...... 73,369 58,214 Net increase in loans ................... (33,178) (16,136) Proceeds from sales of premises and equipment ...................... 324 33 Purchases of premises and equipment ..... (3,217) (1,023) ---------- ---------- Net cash used in investing activities .................... (79,065) (17,102) Financing activities Net increase in noninterest-bearing deposits ........ 19,158 28,969 Net increase in interest-bearing deposits ........... 8,183 12,025 Net increase in short-term borrowings ............... 3,278 2,128 Proceeds from other borrowings .......... 24,248 6,000 Repayments of other borrowings .......... (7,257) (1,522) Acquisition of treasury stock ........... (4,673) (7,471) Cash dividends paid ..................... (4,321) (4,193) ---------- ---------- Net cash provided by financing activities ................... 38,616 35,936 ---------- ---------- (Decrease) increase in cash and cash equivalents ......... (21,450) 17,262 Cash and cash equivalents at beginning of period ............... 71,412 56,817 ---------- ---------- Cash and cash equivalents at end of period ..................... $ 49,962 $ 74,079 ============ ============ Supplemental disclosures: Non-cash transactions: Transfer of loans to other real estate .. $ 3,079 $ 2,104 Transfer of premises and equipment to other assets ......................... 181 ============ ============ </TABLE> See Notes to Condensed Consolidated Financial Statements 5
THE PEOPLES HOLDING COMPANY AND SUBSIDIARY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 2002 (in thousands, except share data) Note 1 Basis of Presentation The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the nine-month period ended September 30, 2002 are not necessarily indicative of the results that may be expected for the year ended December 31, 2002. For further information, refer to the consolidated financial statements and footnotes thereto included in The Peoples Holding Company and Subsidiary's annual report on Form 10-K for the year ended December 31, 2001. For purposes of this quarterly report on Form 10-Q, the term "Company" refers to The Peoples Holding Company and the term "Bank" refers to The Peoples Bank and Trust Company. Note 2 Other Accounting Pronouncements In October 2002, the Financial Accounting Standards Board (FASB) issued Statement No. No. 147, "Acquisitions of Certain Financial Institutions." The statement addresses the financial accounting and reporting for the acquisition of all or part of a financial institution, and is effective for any such activities initiated after October 1, 2002. The adoption of this statement is not anticipated to have a material effect on our financial position or results of operations. In the first quarter of 2002, the Company completed the transitional impairment test required by Financial Accounting Standards Board (FASB) Statement No. 142, "Goodwill and Intangible Assets." As a result of this test, the Company recorded a goodwill impairment charge of $1,300 as a cumulative effect of a change in accounting principle. The Company identified its reporting units as banking operations and insurance operations for purposes of measuring impairment of goodwill. The impairment was specific to the insurance subsidiary. The fair value of the insurance reporting unit was estimated using the expected present value of future cash flows. The insurance subsidiary acquisition was a tax-free exchange; therefore, there was no tax offset to the impairment cost booked. As of September 30, 2002 -------------------------------- Gross Carrying Accumulated Amount Amortization -------------- -------------- Amortized intangible assets: Core deposit intangible assets .. $ 507 $ (365) Other intangible assets ......... 3,282 (1,986) ---------- ---------- Total ........................... $ 3,789 $ (2,351) ========== ========== Unamortized goodwill $ 7,190 $ (2,142) ========== ========== 6
Note 2 Other Accounting Pronouncements (continued) Aggregate amortization expense: For the period ended September 30, 2002 .. $ 370 Estimated amortization expense in future years: For the year ended December 31, 2002 ..... $ 493 For the year ended December 31, 2003 ..... 493 For the year ended December 31, 2004 ..... 423 For the year ended December 31, 2005 ..... 399 For the year ended December 31, 2006 ..... 0 The changes in the carrying amount of intangible assets for the nine months ended September 30, 2002, are as follows: Other Goodwill Intangibles ----------- ----------- Balance as of January 1, 2002 .............. $ 6,348 $ 1,808 Impairment losses ........................ (1,300) Amortization expense ..................... (370) ----------- ----------- Balance as of September 30, 2002 ........... $ 5,048 $ 1,438 =========== =========== The table below presents net income for the prior periods as reported as well as adjusted for the exclusion of goodwill amortization and the cumulative effect of the transitional impairment. <TABLE> <CAPTION> Nine Months Three Months Nine Months Three Months Ended Ended Year Ended Ended Ended September 30, September 30, December 31, September 30, September 30, 2002 2002 2001 2001 2001 ------------- ------------- ------------ ------------- ------------- <S> <C> <C> <C> <C> <C> Reported net income ................. $ 11,798 $ 4,544 $ 14,587 $ 10,731 $ 3,842 Goodwill amortization, net of tax ... 407 306 102 Transitional impairment ............. 1,300 ---------- ---------- ----------- ---------- ---------- Core net income ..................... $ 13,098 $ 4,544 $ 14,994 $ 11,037 $ 3,944 ========== ========== =========== ========== ========== Basic and diluted earnings per share: Reported net income ................. $ 2.10 $ 0.81 $ 2.48 $ 1.81 $ 0.66 Goodwill amortization, net of tax ... 0.07 0.05 0.02 Transitional impairment ............. 0.23 ---------- ---------- ----------- ---------- ---------- Core net income ..................... $ 2.33 $ 0.81 $ 2.55 $ 1.86 $ 0.68 ========== ========== =========== ========== ========== </TABLE> Note 3 Comprehensive Income For the nine month periods ended September 30, 2002 and 2001, total comprehensive income was $15,956 and $15,301, respectively. For the quarters ended September 30, 2002 and 2001, total comprehensive income amounted to $6,543 and $5,613, respectively. Total comprehensive income consists of net income and the change in the unrealized gain (loss) on securities available for sale. 7
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (in thousands, except share data) This Form 10-Q may contain, or incorporate by reference, statements which may constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Prospective investors are cautioned that any such forward-looking statements are not guarantees for future performance and involve risks and uncertainties, and that actual results may differ materially from those contemplated by such forward-looking statements. Important factors currently known to management that could cause actual results to differ materially from those in forward-looking statements include significant fluctuations in interest rates, inflation, economic recession, significant changes in the federal and state legal and regulatory environment, significant underperformance in our portfolio of outstanding loans, and competition in our markets. We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time. Financial Condition Total assets of The Peoples Holding Company increased from $1,254,727 on December 31, 2001, to $1,306,640 on September 30, 2002, or 4.14% for the nine month period. As a result of weak loan demand and continued payoffs in our sales finance portfolio, most of the growth in assets occurred in the investment portfolio, which increased from $277,293 on December 31, 2001, to $326,344 on September 30, 2002. Federal funds sold and interest bearing bank balances decreased $29,545 from the beginning of the year as funds were shifted to the investment portfolio. We invested $35,417 in various securities this quarter. Purchases included mortgage-backed securities, U.S. government agency securities, and municipal securities. The majority (57%) of the purchases during the third quarter continued to be in the mortgage-backed sector because of the cash flow provided by the principal and interest payback each month. This cash flow provides a higher reinvestment opportunity that will be advantageous when rates begin to rise. Last year, we changed our investment policy, eliminating the minimum requirement of 18% of the portfolio being invested in Treasury securities. We have steadily replaced investments in Treasury securities since that time with investments in other sectors in order to enhance yield. All Treasury securities had matured at September 30, 2002. This represented a decrease of approximately $15,000 since December 31, 2001, and approximately $23,000 since September 30, 2001. Loan balances have increased $27,719, from $827,696 at December 31, 2001, to $855,415 at September 30, 2002. Loans increased $19,626 during the third quarter. Most of this growth began in late August and continued during September. We made a strategic decision to curtail our sales finance division in July 2000. At the time of the curtailment, this portfolio was approximately $32 million and has since decreased to approximately $8.5 million. The purpose of the decision was twofold - to reduce risk and to enhance yield. The sales finance portfolio decreased approximately $6,500 since December 31, 2001. 8
The majority of our loan growth in the third quarter was in real estate loans, particularly in commercial and residential loans. Approximately 71% of the portfolio is comprised of loans secured by real estate. We have experienced declines in retail consumer loans and in commercial, financial and agricultural loans. With 0% financing being offered by automobile makers, we have experienced a decline in our new automobile financing. Used automobile financing is also down primarily because of the implementation of tighter credit standards. The average loan to deposit ratios were 75.21% and 76.68% at September 30, 2002, and December 31, 2001, respectively. The actual loan to deposit ratios were 78.45% and 77.86% at September 30, 2002, and December 31, 2001, respectively. We are committed to increasing loan volume and recognize that doing so is imperative for maintaining net interest margin. We have also recognized that the sluggish economy has impacted our ability to expand loan volume; however, we have taken action to improve loan volume by adding several seasoned commercial lenders to assist in attracting and pricing commercial business. Total deposits for the first nine months of 2002 increased from $1,063,055 on December 31, 2001, to $1,090,396 on September 30, 2002, or an increase of 2.57%. The majority of our growth has been in noninterest bearing demand accounts and public fund interest bearing demand deposits. Our average noninterest bearing demand deposit accounts as a percent of total average deposits have increased from 13.53% at December 31, 2001 to 13.84% at September 30, 2002. With the growth in transaction and money market accounts, the Bank is benefitting from a lower percentage of time deposits to total deposits (on average) this year. Those ratios were 51.21% and 54.48% for September 30, 2002 and December 31, 2001, respectively. Other borrowed funds have increased $20,269 from year end. Of the increase, $16,991 was due to additional funds borrowed from the Federal Home Loan Bank (FHLB). We minimize rate risk by funding loans with FHLB borrowings having similar terms, locking in fixed rates based on a spread over the FHLB note rates. The equity capital to total assets ratios were 9.99% and 9.85% at September 30, 2002, and December 31, 2001, respectively. Capital increased $6,977, or 5.65%, from December 31, 2001, to September 30, 2002. There were a number of factors contributing to the increase in capital. Normal transactions such as net income and unrealized portfolio gains contributed to the increase in capital, offset by dividends and the purchase of treasury stock. The increase in the unrealized gains on the investment portfolio was due primarily to market conditions. Cash dividends declared were $.25 per share in the first quarter and $.26 per share in the second and third quarters of 2002. We have continued to purchase treasury stock, purchasing 129,247 shares at an average cost of $36.07 per share over the nine month period ending September 30, 2002. We purchased 31,441 shares during the third quarter of 2002. 9
Results of Operations Our core net income for the nine month period ended September 30, 2002, was $13,098. This represented an increase of $2,061, or 18.67% over comparable core net income for the nine month period ended September 30, 2001. Core net income for the nine month period ending September 30, 2001 was $11,037. For the three month periods ended September 30, 2002 and 2001, core net income was $4,544 and $3,944, respectively. Core earnings per share for the nine month period ended September 30, 2002 were $2.33, an increase of 25.27% from $1.86 for the comparable period a year ago. The increase in core net income for the three and nine month periods ended September 30, 2002, compared to the same periods of 2001 resulted from usual and customary deposit gathering and lending operations and increases in noninterest income for sales of other products such as insurance. The annualized core return on average assets on the same basis for the three month periods ending September 30, 2002 and 2001, was 1.38% and 1.28%, respectively, and for the nine month periods ending September 30, 2002 and 2001 was 1.33% and 1.18%, respectively. Core net income is defined as income before the effect of the change in accounting principle and excluding goodwill amortization for all periods. Net Interest Income Net interest income, the difference between interest earned on assets and the cost of interest-bearing liabilities, is the largest component of our net income. The primary concerns in managing net interest income are the mix and the repricing of rate-sensitive assets and liabilities. Net interest income has improved due to loan growth, risk based pricing of loans, and a shift in the deposit mix from time deposits to transaction and money market accounts. Net interest income for the nine month periods ending September 30, 2002 and 2001 was $38,843 and $34,606, respectively, while earning assets for the same periods averaged $1,176,926 and $1,116,677, respectively.Net interest income for the three month periods ending September 30, 2002 and 2001 was $13,153 and $11,970, respectively, while earning assets for the same periods averaged $1,184,723 and $1,110,881, respectively. The bank's repricing position was favorable under the falling interest rate environment in which we have been operating recently. This, combined with our repricing strategy and mix change in both assets and liabilities, increased net interest margin. <TABLE> <CAPTION> Three Months ending Nine Months ending Three Months ending September 30, September 30, December 31, 2002 2001 2002 2001 2001 -------- -------- ------- ------- ------------ <S> <C> <C> <C> <C> <C> Net interest margin .. 4.68% 4.58% 4.67% 4,44% 4.54% </TABLE> 10
Provision for Loan Losses The provision for loan losses charged to operating expense is an amount which, in the judgment of management, is necessary to maintain the allowance for loan losses at a level that is adequate to meet the inherent risks of losses on our current portfolio of loans. The appropriate level of the allowance is based on a quarterly analysis of the loan portfolio including consideration of such factors as the risk rating of individual credits, size and diversity of the portfolio, economic conditions, prior loss experience, and the results of periodic credit reviews by internal loan review and regulators. The loan loss provision totaled $3,325 and $3,475, respectively for the nine month periods ending September 30, 2002 and 2001. The tables below present pertinent data and ratios. <TABLE> <CAPTION> Loans and Credit Quality Nonperforming Net Charge-offs Loans* Loans Nine Months Ended September 30 September 30 September 30 ------------------ ------------------ ------------------ 2002 2001 2002 2001 2002 2001 -------- -------- -------- -------- -------- -------- <S> <C> <C> <C> <C> <C> <C> Commercial, financial, agricultural ... $148,791 $152,621 $ 1,707 $ 535 $ 528 $ 749 Real estate - construction ............ 36,480 33,067 103 96 25 Real estate - mortgage ................ 572,283 528,718 1,990 3,957 1,200 1,086 Consumer .............................. 97,861 112,635 271 522 556 985 -------- -------- -------- -------- -------- -------- $855,415 $827,041 $ 3,968 $ 5,117 $ 2,380 $ 2,845 ======== ======== ======== ======== ======== ======== * Net of unearned income. </TABLE> <TABLE> <CAPTION> Allowance for Loan Losses 2002 2001 ------------------------------- ------------------------------------------ 3rd 2nd 1st 4th 3rd 2nd 1st Quarter Quarter Quarter Quarter Quarter Quarter Quarter --------- --------- --------- --------- --------- --------- --------- <S> <C> <C> <C> <C> <C> <C> <C> Balance at beginning of period ............. $ 11,658 $ 11,811 $ 11,354 $ 11,166 $ 11,403 $ 11,067 $ 10,536 Loans charged off .......................... 573 1,310 985 1,196 1,534 870 702 Recoveries of loans previously charged off . 89 82 317 69 72 81 108 --------- --------- --------- --------- --------- --------- --------- Net Charge-offs ....................... 484 1,228 668 1,127 1,462 789 594 Provision for loan losses .................. 1,125 1,075 1,125 1,315 1,225 1,125 1,125 --------- --------- --------- --------- --------- --------- --------- Balance at end of year ..................... $ 12,299 $ 11,658 $ 11,811 $ 11,354 $ 11,166 $ 11,403 $ 11,067 ========= ========= ========= ========= ========= ========= ========= Allowance for loan losses to total loans ... 1.44% 1.39% 1.44% 1.37% 1.35% 1.39% 1.36% Reserve coverage ratio ..................... 309.95 317.57 207.25 178.65 218.20 191.62 143.34 Net charge-offs to total loans ............. 0.06 0.15 0.08 0.14 0.18 0.10 0.07 Nonperforming loans to total loans ......... 0.46 0.44 0.70 0.77 0.62 0.73 0.95 </TABLE> 11
Noninterest Income Noninterest income, excluding gains from the sales of securities, was $20,214 for the nine month period ending September 30, 2002, compared to $17,661 for the same period in 2001, or an increase of 14.46%. Approximately 63% of the increase in noninterest income was attributable to usual and customary loan and deposit services. Income derived from the mortgage loan business continued to be strong for the first nine months of 2002. Another significant portion of the increase was due to the income booked as the result of Bank Owned Life Insurance (BOLI) purchased on key management personnel in May 2001. The additional income derived from BOLI of approximately $511 has been used to offset rising benefits cost, primarily health and life insurance. We continued to place emphasis on sales of insurance and alternative financial instruments. We implemented an insurance integration plan in 2001 aimed at improving our cross-selling between the bank and the insurance company. As a result, our insurance commission income increased $351 over the nine month period reported in 2001, making up 14% of the total increase in noninterest income. A secondary, yet significant, benefit resulting from the implementation of the insurance integration plan was an improvement in contingency income of $90. Contingency income is a bonus received from the insurance underwriters and is based both on commission income and claims experience on our customers during the previous year. For the three month periods ended September 30, 2002 and 2001, noninterest income, excluding gains from the sales of securities, was $6,963 and $6,130, respectively. Approximately 72% of this increase was due to customary loan and deposit services. The increase in noninterest income derived from insurance commissions is approximately $158, making up 19% of the increase over the third quarter of 2001. Income generated from alternative financial products (annuities and mutual funds) was down this quarter, largely attributable to the economy and uncertainties in the market. We continue to work our business plan, which is directed toward increasing the number of services per client for our existing client base as well as increasing our affluent client base. Noninterest Expense Noninterest expense was $37,466 for the nine month period ended September 30, 2002, compared to $34,303 for the same period in 2001, an increase of $3,163, or 9.22%. Core noninterest expense was $37,466 for the nine month period ending September 30, 2002 compared to $33,879 for the same period in 2001, an increase of $3,587, or 10.59%. Core noninterest expense excludes amortization expense associated with all intangible assets that are no longer amortized as the result of adoption of FASB Statement No 142 "Goodwill and Intangible Assets". The increase in core noninterest expense, excluding increases in health and life insurance cost and performance based reward (PBR) plan cost was 6.92%. One significant factor contributing to the increase was health and life insurance cost which was approximately 17%, or $598, of the change in core noninterest expense. This increase was due to the rising cost of health care as well as higher claims experienced this year. Our Company has a PBR plan which allows for an incentive payment to employees based on improvement in net income over an established baseline. This cost is linked to performance and increases as performance improves. The increase for incentive cost for the nine month period was $645, or 18% of the total increase in core noninterest expenses. Since a significant amount of the improvement in earnings for 2001 occurred in the last half of the year, we recorded 73% of the total incentive cost during the third and fourth quarters. 12
Other factors contributing to the increase in expense include depreciation, maintenance contract and computer processing costs associated with technological enhancements made during the last year. We installed a teller platform system in 2001, and upgraded our deposit platform system and portions of our loan system, particularly the credit scoring module, this year. In addition, we upgraded data storage to a robotic DVD device which provides near on-line access to data (check images) and purchased software to enhance read rates in item processing. During the fourth quarter of 2002, we will be implementing a new loan platform system. These upgrades have enhanced productivity, reduced losses for the bank, and provided better service for our clients. We have noted improvement in both cash short and fraud/forgery losses as a result of the teller platform and deposit platform systems. Finally, in recognition of the sophistication of hackers and the damage that can be done by such individuals, information security has been enhanced through software, hardware, and retention of services by experts in that field. It has been, and will continue to be, our practice to seek technological improvements, evaluate the benefit to us and our clients, and to progress with implementation of such if a cost/benefit analysis justifies it. This practice is directly influenced by our vision to be the financial services advisor and provider of choice in the communities we serve. For the three month periods ending September 30, 2002 and 2001, noninterest expense was $12,642 and $11,873, respectively, an increase of $769, or 6.48%. For the three month periods ending September 30, 2002 and 2001, core noninterest expense was $12,642 and $11,732, respectively, an increase of $910, or 7.76%. Health and life insurance expense was $75 less than the third quarter last year due to the decrease in claims paid during the quarter. Salary cost was $222, or 4.93%, higher than last year. During 2002, employee evaluation reviews were changed from each employee's anniversary date to March. All employees are now reviewed in March and merit/cost of living raises are given in April. Insurance commission expense increased $44 over last year. This cost is directly linked to the increase in insurance commission income. The cost of the PBR plan increased $60. Computer depreciation, maintenance contracts and computer processing cost increased $84, or approximately 11% of the increase in core noninterest expense, due to the previously discussed technological enhancements. Offsetting the higher cost associated with the enhancements are decreases in fraud/forgery losses of approximately $28. We also incurred additional expense related to consulting engagements intended to improve efficiency and profitability. Although expenses increased, we have significantly improved our efficiency ratio. The growth in noninterest income has been a key factor in the improvement of our efficiency ratio. Nine Months Ended Three Months Ended September 30 September 30 ----------------- ------------------ 2002 2001 2002 2001 ------ ------ ------ ------ Efficiency ratio ..... 60.99% 62.50% 60.44% 62.63% 13
Income tax expense was $5,198 for the nine month period ended September 30, 2002, (with an effective tax rate of 28.41%) compared to $3,845 (with an effective tax rate of 26.38%) for the same period in 2001. The increase in the effective tax rate this year was due in part to less tax-free interest income. Income tax expense was $1,827 and $1,202 for the three month periods ending September 30, 2002 and 2001 respectively. The effective tax rate for the third quarters of 2002 and 2001 were 28.68% and 23.83%, respectively. Liquidity Risk Liquidity management is the ability to meet the cash flow requirements of customers who may be either depositors wishing to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. Core deposits are a major source of funds used to meet cash flow needs. Maintaining the ability to acquire these funds as needed in a variety of money markets is a key to assuring liquidity. When evaluating the movement of these funds even during times of large interest rate changes, it is apparent that we continue to attract deposits that can be used to meet cash flow needs. Management continues to monitor the liquidity and potentially volatile liabilities ratios to ensure compliance with Asset-Liability Committee targets. These targets are set to ensure that we meet the liquidity requirements deemed necessary by management and regulators. Another source available for meeting our liquidity needs is available-for-sale securities. The available-for-sale portfolio is composed of securities with a readily available market that can be used to convert to cash if the need arises. Other sources available for meeting liquidity needs include federal funds sold and interest bearing balances with the FHLB. In addition, we may obtain advances from the FHLB or the Federal Reserve Bank. Funds obtained from the FHLB are used primarily to match-fund real estate loans in order to minimize interest rate risk, and may be used to meet day to day liquidity needs. Capital Resources We are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. Our capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require us to maintain minimum balances and ratios. All banks are required to have core capital (Tier I) of at least 4% of risk-weighted assets (as defined), 4% of average assets (as defined), and total capital of 8% of risk-weighted assets (as defined). As of September 30, 2002, we met all capital adequacy requirements to which we are subject. 14
As of September 30, 2002, the most recent notification from the Federal Deposit Insurance Corporation (FDIC) categorized us as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, we must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios of 10%, 6%, and 5%, respectively. In the opinion of management, there are no conditions or events since the last notification that have changed the institution's category. The Bank's actual capital amounts and applicable ratios are as follows and do not differ materially from that of the Company. Actual Amount Ratio ------ ----- As of September 30, 2002 Total Capital .................... $ 127,806 14.6% (to Risk Weighted Assets) Tier I Capital ................... $ 116,879 13.4% (to Risk Weighted Assets) Tier I Capital ................... $ 116,879 9.0% (to Adjusted Average Assets) As of December 31, 2001 Total Capital .................... $ 122,162 14.5% (to Risk Weighted Assets) Tier I Capital ................... $ 111,622 13.3% (to Risk Weighted Assets) Tier I Capital ................... $ 111,622 9.1% (to Adjusted Average Assets) Management recognizes the importance of maintaining a strong capital base. As the above ratios indicate, we continue to exceed the requirements for a well capitalized bank. Management also recognizes the importance of managing capital to maximize performance. Our quarterly dividend to shareholders, which is currently $0.26 per share of common stock, has increased for sixteen consecutive years. Our dividend payout ratio was 36.80% at September 30, 2002. We continue to repurchase shares of our common stock in accordance with our strategic plan. We Purchased 220,556 of our common stock through a tender offer which was initiated April 16,2001 and expired May 15, 2001. Since then, we have purchased an additional 247,135 under our stock repurchase plan. On October 15, 2002 our Board of Directors authorized the repurchase of up to 278,771 additional shares, or approximately 5%, of our common stock outstanding September 30, 2002. Along with earnings, unrealized gains on securities available for sale have contributed to the increase in capital. Under the current rate environment, unrealized gains on securities available for sale increased from $2,136 on December 31, 2001, to $6,294 on September 30, 2002, or 294.66% for the nine month period. Book value per share was $23.42 and $21.66 at September 30, 2002 and December 31, 2001, respectively. The annualized core return on average equity for the three month periods ending September 30, 2002 and 2001, was 14.00% and 12.68%, respectively, and for the nine month periods ending September 30, 2002 and 2001 was 13.80% and 11.68%, respectively. Our capital policy is to evaluate future needs based on growth, earnings trends and anticipated acquisitions. 15
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK There have been no significant changes to our disclosure on quantitative and qualitative disclosures about market risk since December 31, 2001. For additional information, see our Form 10-K for the year ended December 31, 2001. Item 4. CONTROLS AND PROCEDURES Based on their evaluation as of a date within 90 days prior to the filing of this quarterly report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended) are effective for timely alerting them to material information required to be included in our periodic SEC reports. Subsequent to the date of their evaluation, there have been no significant changes in our internal controls or in other factors that could significantly affect internal controls, including any corrective actions with regard to significant deficiencies and material weaknesses. 16
PART II. OTHER INFORMATION Item 1. LEGAL PROCEEDINGS There have been no material proceedings against us during the quarter ending September 30, 2002. Item 6.(a) EXHIBITS Exhibit No. and Description 3.1 Articles of Incorporation and Articles of Amendment to Articles of Incoorporation (filed as Exhibit 3.1 to the Company's Registration Statement on Form S-4 filed on February 17, 1999, as amended, and incorporated herin by reference, Commission File No. 333-72507 3.2 By-laws of the Company (as amended March 1, 2001) 10.1 Executive Deferred Compensation Plan A 10.2 Executive Deferred Compensation Plan B 10.3 Directors' Deferred Fee Plan A 10.4 Directors' Deferred Fee Plan B 10.5 Chief Executive Officer Employee Agreement 99.1 Statement of the Chief Executive Officer and the Chief Financial Officer (b) REPORTS ON FORM 8-K On July 18, 2002, we filed on Form 8-K our Second Quarter 2002 Earnings Press Release. 17
SIGNATURES Pursuant to the requirements 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. THE PEOPLES HOLDING COMPANY --------------------------- Registrant DATE: November 14, 2002 /s/ E. Robinson McGraw --------------------------- E. Robinson McGraw President & Chief Executive Officer 18
CERTIFICATION OF CHIEF EXECUTIVE OFFICER I, E. Robinson McGraw, certify that: 1. I have reviewed this quarterly report on Form 10-Q of The Peoples Holding Company; 2. Based on my knowledge, this quarterly 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 quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly 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 quarterly report; 4. The registrant's other certifying officers 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 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 quarterly report (the "Evaluation Date"); and c) presented in this quarterly 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 officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): 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 officers and I have indicated in this quarterly report whether 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: November 14, 2002 /s/ E. Robinson McGraw --------------------------- E. Robinson McGraw President & Chief Executive Officer 19
CERTIFICATION OF CHIEF FINANCIAL OFFICER I, Stuart R. Johnson, certify that: 1. I have reviewed this quarterly report on Form 10-Q of The Peoples Holding Company; 2. Based on my knowledge, this quarterly 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 quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly 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 quarterly report; 4. The registrant's other certifying officers 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 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 quarterly report (the "Evaluation Date"); and c) presented in this quarterly 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 officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): 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 officers and I have indicated in this quarterly report whether 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: November 14, 2002 /s/ Stuart R. Johnson --------------------------- Stuart R. Johnson Executive Vice President & Chief Executive Officer 20