PEOPLES BANCORP INC annual report, FY2017

Peoples Bancorp Inc. — FY2017 Form 10-K

Business context and reporting period. Peoples Bancorp is an Ohio-based financial holding company operating principally through Peoples Bank, with community banking as its sole reportable segment. It provides banking, insurance, investment and trust services across Ohio, West Virginia and Kentucky. This summary covers the fiscal year ended December 31, 2017; fourth-quarter results are noted separately. Financial amounts below are in U.S. dollars.

Key financial results

Metric	FY2017	FY2016
Total interest income	$126.5 million	$115.4 million
Net interest income	$113.4 million	$104.9 million
Total non-interest income	$55.6 million	$50.9 million
Total revenue (net interest income plus non-interest income)	$169.0 million	$155.7 million
Provision for loan losses	$3.8 million	$3.5 million
Non-interest expense	$108.0 million	$106.9 million
Net income	$38.5 million	$31.2 million
Diluted earnings per share	$2.10	$1.71

Net income rose approximately 23%, while revenue grew about 9%. Management reported positive operating leverage, with revenue growth of 6% on its stated measure outpacing expense growth of 1%.
Net interest margin increased to 3.62% from 3.54%. Management attributed improvement chiefly to loan growth and higher yields on variable-rate loans as rates rose.
The efficiency ratio improved to 62.20% from 65.13% (lower is better). Return on average assets was 1.10%, versus 0.94%.
Net cash provided by operating activities was $60.8 million, compared with $60.3 million. Investing activities used $162.7 million, principally reflecting loan growth and securities activity; financing activities provided $107.9 million. Cash and cash equivalents ended the year at $72.2 million, up $6.0 million.
Total assets were $3.58 billion, up 4%; loans were $2.36 billion, up 6%. Total deposits were $2.73 billion, up $220.6 million. Total borrowings declined to $353.5 million from $450.8 million.
Stockholders’ equity was $458.6 million. Peoples’ common equity Tier 1, total risk-based capital and leverage ratios were 13.45%, 14.62% and 9.90%, respectively; management reported capital substantially above “well capitalized” requirements.
Asset quality improved on several measures: nonperforming loans were 0.73% of loans, down from 1.13%; nonperforming assets were 0.49% of assets, down from 0.75%. The allowance was $18.8 million, or 0.80% of loans, versus 0.83%. Net charge-offs increased to $3.4 million from $1.9 million (0.15% versus 0.09% of average loans).
Dividends declared were $0.84 per share for 2017, up from $0.64. In January 2018, the company declared a quarterly dividend of $0.26 per share, an 18% increase over the fourth-quarter 2017 dividend.

Fourth-quarter performance and material changes

Fourth-quarter 2017 net income was $9.0 million and diluted EPS was $0.49, compared with $7.4 million and $0.41 in fourth-quarter 2016.
Fourth-quarter net interest income was $29.1 million, versus $26.7 million a year earlier. The quarter included a $0.8 million investment securities gain; full-year gains were $3.0 million, primarily from the sale of available-for-sale equity securities.
Consumer indirect lending expanded materially: year-end balances rose 35% to $340.4 million and grew to 14.5% of loans, from 11.4%. Commercial loans were 57.2% of total loans.
Non-interest expense increased modestly year over year. Higher salaries and benefits, incentive compensation, medical costs and $0.2 million of pension settlement expense were partly offset by lower professional, communications and intangible-amortization costs and the absence of 2016 core-system conversion expenses.
Six branches were closed in 2017. Two small insurance-related acquisitions were completed; management said they did not materially affect results.
Non-interest-bearing deposits fell $178.4 million, while interest-bearing demand deposits rose $314.4 million, partly reflecting customer migration to new deposit products. Brokered CDs rose to $159.6 million from $38.8 million.

Outlook, risks and unusual items

2018 outlook: Excluding the pending ASB acquisition, management expected loan balances to grow 5%–7%, fee-based revenue to grow 2%–4%, and total expenses to grow 2%–4%. It projected a 3.60% net interest margin, a 61%–63% efficiency ratio and positive operating leverage. Management expected net charge-offs to normalize within its long-term historical range of 0.20%–0.30% of average loans. These are management expectations, not guarantees.
ASB merger: The proposed acquisition, expected to close in the second quarter of 2018 subject to approvals and other conditions, would add six branches. ASB reported $288.3 million in assets, $247.2 million in net loans and $203.2 million in deposits at year-end 2017. Peoples estimated one-time 2018 acquisition costs of approximately $8.2 million and projected earnings accretion of $0.06–$0.07 per share in 2018 and $0.13–$0.15 in 2019, excluding those costs. Consideration could be stock or cash, with cash limited to 15% of total consideration.
Tax legislation: The Tax Cuts and Jobs Act reduced the federal corporate tax rate to 21%. Peoples recorded a $0.9 million write-down of net deferred tax assets in 2017. It expected an approximately $3 million after-tax reduction to retained earnings upon adoption of new revenue-recognition guidance in 2018; the filing characterized its analysis as preliminary.
Equity investment accounting: Beginning in 2018, market-value changes on equity securities would flow through earnings rather than accumulated other comprehensive income. The year-end portfolio had a fair value of $7.8 million and net unrealized gains of $6.4 million, creating potential earnings volatility.
Interest-rate and funding risks: Management said the balance sheet was positioned to benefit from rising rates, but warned that a flattening yield curve could constrain that benefit. Deposit competition, wholesale funding access, loan demand and changing rates may affect margins and liquidity. Year-end liquidity coverage ratios were 1.7 times for forecast sources versus uses and 7.1 times including contingent sources; both were within policy limits.
Credit and other risks: Risks include commercial real estate and commercial borrower exposures, indirect consumer loan growth, collateral values, economic weakness in local markets, cyber incidents and dependence on third-party providers, regulatory changes, acquisition integration, and potential future increases in the allowance under the expected-loss CECL standard scheduled for 2020. The company reported no material pending legal proceedings, and management believed existing proceedings would not materially affect its financial position, results or liquidity.
Ernst & Young issued unqualified opinions on the consolidated financial statements and internal control over financial reporting. Management also concluded disclosure controls and internal controls were effective as of year-end.

Important facts for investors to verify

Whether ASB received shareholder and regulatory approvals, closed on schedule, and achieved the disclosed cost and accretion expectations.
Whether 2018 loan growth, margin, fee revenue, expense growth and credit-loss outcomes tracked management’s stated ranges.
How the growth and performance of indirect consumer lending affected delinquencies, charge-offs and reserve adequacy.
Whether deposit mix changes and increased brokered CDs affected funding costs, liquidity and deposit stability.
The actual earnings impact of equity-security market-value changes, the new revenue-recognition standard and the tax-law remeasurement.
Any material subsequent developments in credit quality, interest-rate exposure, litigation, cybersecurity or third-party service-provider risk.