Table of Contents

 

 

**2008ANNUAL REPORT**

 

**TOSTOCKHOLDERS**

 

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Table ofContents

 

**TABLE OF CONTENTS**

 
| ** **                                                                                           | **Page** |
|------------------------------------------------------------------------------------------------------|----------|
|                                                                                                 |     |
| President’s  Letter to Stockholders                                                             | 1        |
|                                                                                                 |     |
| Business  of Peoples Community Bancorp, Inc                                                          | 2        |
|                                                                                                 |     |
| Market  Price of Peoples Community Bancorp, Inc. Common Shares and Related  Stockholder Matters | 3        |
|                                                                                                 |     |
| Selected  Consolidated Financial and Other Data                                                      | 4        |
|                                                                                                 |     |
| Management’s Discussion and Analysis of Financial  Condition and Results of  Operations         | 6        |
|                                                                                                 |     |
| Consolidated  Financial Statements:                                                                  |     |
|                                                                                                 |     |
| Reports of  Registered Independent Public Accounting Firms                                           | 25       |
| Consolidated Statements of Financial Condition                                                       | 27       |
| Consolidated Statements of Operations                                                                | 28       |
| Consolidated Statements of Comprehensive Income (Loss)                                               | 29       |
| Consolidated Statements of Stockholders’ Equity  (Deficit)                                      | 30       |
| Consolidated Statements of Cash Flows                                                                | 31       |
| Notes to Consolidated Financial Statements                                                           | 33       |
|                                                                                                 |     |
| Directors and Executive Officers                                                                     | 66       |
|                                                                                                 |     |
| Banking  Locations and Stockholder Information                                                       | 67       |

 

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DearFellow Stockholders:

 

The extremely difficultbanking environment and troubling economic atmosphere in 2007 deepenedconsiderably in 2008. The weakening economy negatively impacted real estatevalues, job retention and the ability of homeowners and other borrowers to makepayments on their loans.  Management isacutely aware of the severe conditions as the Company suffered a loss of $68.5million for 2008.  This loss wasprimarily due to provisions for loan losses of $41.5 million goodwillimpairment of $12.5 million and adverse tax consequences of $6.9 million.  Although we began to curtail our lendingactivity in early 2007 and have worked diligently with our borrowers to modifyor restructure their debt obligations, asset quality continued to deterioratenationally and, to a greater extent, locally.

 

In order to combat theserecessionary forces we have significantly downsized and sought out strategictransactions to preserve stockholder value. Due in large part to the reduction of our loan portfolio, total assetshave decreased from $887.4 million at December 31, 2007 to $712.4 millionat December 31, 2008. In addition, we will continue to pursue the sale ofbranch offices to reduce assets and liabilities, generate a deposit premium andincrease capital.

 

This annual report tostockholders includes a detailed discussion of our financial condition, theimpact of these troubling economic times on our results of operations and ourincreased regulatory oversight and restrictions.  We strongly urge you to read this annualreport in its entirety to fully understand the challenges faced by PeoplesCommunity Bancorp and the commitment of management to devote all of itsresources to resolving these issues.

 

Our directors and many ofour employees have aligned their interest with yours by investing in PeoplesCommunity Bancorp, Inc.  We are verydisappointed with our recent losses and the loss in value to all of us asstockholders.  We are aware of the verydifficult struggle before us and remain committed to meeting this challenge.

 

 
|   | Sincerely,                             |
|--------|----------------------------------------|
|   |                                   |
|   |                                   |
|   | Jerry  D. Williams                     |
|   | President  and Chief Executive Officer |

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**BUSINESS OFPEOPLES COMMUNITY BANCORP, INC.**

 

Peoples CommunityBancorp, Inc., a Maryland corporation (“Peoples” or the “Company”), is aregistered savings and loan holding company which owns all of the outstandingcommon shares of Peoples Community Bank (the “Bank”), a federally charteredsavings bank.  Unless thecontext otherwise requires, reference to Peoples includes the Bank.  Peoples wasformed in December 1999 in connection with the mutual to stock conversionof the Bank, and the sale of 1,190,000 shares of common stock to depositors andmembers of the community.  The Bankconducts its business from nineteen full service offices in Hamilton, Warrenand Butler counties in Southwest Ohio and Dearborn and Ohio counties inSoutheast Indiana.  The funds for theBank’s lending and investment activities are primarily provided by deposits andborrowings.  At December 31, 2008,Peoples had $712.4 million in total assets, $630.2 million in deposits, $76.5million in borrowings (excluding subordinated debentures) and $14.8 million instockholders’ deficit.  Peoples’ principalexecutive office is located at 6100 West Chester Road, West Chester, Ohio45069.  Peoples’ telephone number is(513) 870-3530.

 

Peoples is subject to regulation, supervision and examination by theOffice of Thrift Supervision (the “OTS”). The Bank is subject to regulation, supervision and examination by theOTS as its primary federal regulator and the Federal Deposit InsuranceCorporation (the “FDIC”), which administers the Deposit Insurance Fund. TheFDIC insures deposits in the Bank up to applicable limits.  The Bank is a member of the Federal Home LoanBank (the “FHLB”) of Cincinnati, which is one of the 12 regional bankscomprising the FHLB System.

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**MARKET PRICE OF PEOPLESCOMMUNITY BANCORP, INC. COMMON SHARES AND RELATED STOCKHOLDER MATTERS**

 

TheCompany’s common shares are currently listed on the Nasdaq Global Market (“Nasdaq”)under the symbol “PCBI.”  However, byletter dated April 17, 2009, Nasdaq informed the Company that it no longercomplies with Nasdaq’s listing rules since it did not timely file its Form 10-Kfor the year ended December 31, 2008. Under the listing rules, the Company has 60 calendar days to submit aplan to regain compliance, which typically consists of filing the delinquentreport.  Although the Company submittedthe Form 10-K for the year ended December 31, 2008 within such 60 dayperiod, no assurances may be given that Nasdaq will accept such plan or thatthe Company’s common stock will continue to be listed on Nasdaq.

 

Presentedbelow are the high and low trading prices for the Company’s common shares forthe three years ended December 31, 2008. Such prices do not include retail financial markups, markdowns orcommissions.  Information relating toprices has been obtained from Nasdaq. The Company suspended the payment of a quarterly cash dividend effectivefor the quarter ended December 31, 2007.  In addition, the Company does not have anycurrent intention or ability to pay dividends.

 
| **2008**                 | ** ** | **High** | ** ** | **Low** | ** ** | **Dividends** | ** ** |
|--------------------------|------------|----------|------------|---------|------------|---------------|------------|
|                     |       |     |       |    |       |          |       |
| Quarter ended:           |       |     |       |    |       |          |       |
| December 31,  2008  |       | $        | 1.45       |    | $          | 0.18          |       | $ | — |   |
| September 30,  2008 |       | 2.28     |       | 0.90    |       | —        |       |
| June 30,  2008      |       | 4.40     |       | 2.00    |       | —        |       |
| March 31,  2008     |       | 15.19    |       | 3.87    |       | —        |       |
|                          |            |          |            |         |            |               |            |  |  |  |

 
| **2007**                 | ** ** | **High** | ** ** | **Low** | ** ** | **Dividends** | ** ** |
|--------------------------|------------|----------|------------|---------|------------|---------------|------------|
|                     |       |     |       |    |       |          |       |
| Quarter ended:           |       |     |       |    |       |          |       |
| December 31,  2007  |       | $        | 18.00      |    | $          | 13.52         |       | $ | — |   |
| September 30,  2007 |       | 18.38    |       | 14.71   |       | 0.15          |       |
| June 30,  2007      |       | 16.93    |       | 14.47   |       | 0.15          |       |
| March 31,  2007     |       | 18.43    |       | 16.80   |       | 0.15          |       |
|                          |            |          |            |         |            |               |            |  |  |  |

 
| **2006**                 | ** ** | **High** | ** ** | **Low** | ** ** | **Dividends** | ** ** |
|--------------------------|------------|----------|------------|---------|------------|---------------|------------|
|                     |       |     |       |    |       |          |       |
| Quarter ended:           |       |     |       |    |       |          |       |
| December 31,  2006  |       | $        | 19.60      |    | $          | 16.35         |       | $ | 0.15 |   |
| September 30,  2006 |       | 19.85    |       | 17.25   |       | 0.15          |       |
| June 30,  2006      |       | 20.95    |       | 18.50   |       | 0.15          |       |
| March 31,  2006     |       | 21.83    |       | 19.91   |       | 0.15          |       |
|                          |            |          |            |         |            |               |            |  |  |  |

 

As of April 15, 2009, the Company had4,844,489 common shares outstanding held of record by approximately 1,010stockholders.  The number of stockholdersdoes not reflect the number of persons or entities who may hold stock in nomineeor “street” names through brokerage firms or others.

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**SELECTED CONSOLIDATED FINANCIALAND OTHER DATA**

 

Thefollowing selected consolidated financial and other data does not purport to becomplete and is qualified in its entirety by reference to the more detailedfinancial information, including the Consolidated Financial Statements andrelated notes, appearing elsewhere herein. Peoples changed its fiscal year end from September 30 to December 31effective January 1, 2006.

 
| **Selected Consolidated Financial**                                | ** ** | **At December 31,** | ** ** | **At September 30,** | ** ** |
|--------------------------------------------------------------------|------------|-------------------------------|------------|--------------------------------|------------|
| **Condition Data:**                                                | ** ** | **2008**                      | ** ** | **2007**                       | ** ** | **2006** | ** ** | **2005** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                         | ** ** | **(in thousands)**       | ** ** |
| Total assets                                                       |       | $                             | 712,415    |                           | $          | 887,426 |   | $ | 1,028,079 |   | $ | 1,040,912 |   | $ | 1,006,654 |   | $ | 889,121 |   |
| Cash and cash  equivalents                                         |       | 72,015                        |       | 86,614                         |       | 57,459 |   | 21,558 |   | 17,061 |   | 14,430 |   |
| Securities  available for sale                                     |       | 100,952                       |       | 67,572                         |       | 56,899 |   | 74,482 |   | 207,366 |   | 229,154 |   |
| Loans  receivable, net                                             |       | 461,861                       |       | 634,421                        |       | 812,578 |   | 851,270 |   | 704,714 |   | 599,466 |   |
| Deposits                                                           |       | 630,198                       |       | 735,212                        |       | 755,261 |   | 726,629 |   | 612,199 |   | 472,436 |   |
| Advances from  the Federal Home Loan Bank and other borrowed money |       | 76,507                        |       | 77,628                         |       | 156,885 |   | 221,483 |   | 301,920 |   | 324,500 |   |
| Stockholders’  equity (deficit)                               |       | (14,845                       | )          | 53,565                         |       | 87,616 |   | 86,047 |   | 86,700 |   | 75,775 |   |
|                                                                    |            |                               |            |                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

** **

 

** **
| ** **                                                      | ** ** | ** **                                                         | ** **  | ** **            | ** ** | ** **             | ** ** | **Three Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------------------------------------|-------------|-----------------------|------------|------------------------|------------|-----------------------|------------|------------|------------|------------|------------|
| ** **                                                      | ** ** | **Year Ended**                                                | ** **  | **Ended**             | ** ** | **Year Ended**    | ** ** |
| **Selected  Consolidated Operating**                            | ** ** | **December 31,**                                              | ** **  | **December 31,** | ** ** | **September 30,** | ** ** |
| **Data:  (1)**                                                  | ** ** | **2008**                                                           | ** **  | **2007**              | ** ** | **2006**               | ** ** | **2005**              | ** ** | **2005**   | ** ** | **2004**   | ** ** |
| ** **                                                      | ** ** | **(In thousands, except per share data)** | ** **  |
| Interest income                                                 |       | $                                                                  | 40,237      |                  | $          | 60,233                 |       | $                     | 65,475     |       | $          | 14,402     |       | $ | 47,748 |   | $ | 40,171 |   |
| Interest expense                                                |       | 26,237                                                             |        | 36,460                |       | 36,485                 |       | 8,155                 |       | 26,204     |       | 19,813     |       |
| Net interest  income                                            |       | 14,000                                                             |        | 23,773                |       | 28,990                 |       | 6,247                 |       | 21,544     |       | 20,358     |       |
|                                                            |       |                                                               |        |                  |       |                   |       |                  |       |       |       |       |       |
| Provision for  losses on loans                                  |       | 41,477                                                             |        | 32,800                |       | 17,450                 |       | 900                   |       | 3,600      |       | 3,600      |       |
| Net interest  income (loss) after provision for losses on loans |       | (27,477                                                            | )           | (9,027                | )          | 11,540                 |       | 5,347                 |       | 17,944     |       | 16,758     |       |
| Other income  (loss)                                            |       | (286                                                               | )           | 3,932                 |       | 3,213                  |       | (764                  | )          | 2,114      |       | 1,181      |       |
| Goodwill  impairment                                            |       | 12,514                                                             |        | 11,397                |       | —                 |       | —                |       | —     |       | —     |       |
| General,  administrative and other expense                      |       | 21,333                                                             |        | 21,774                |       | 21,122                 |       | 4,530                 |       | 15,827     |       | 13,750     |       |
|                                                            |       |                                                               |        |                  |       |                   |       |                  |       |       |       |       |       |
| Earnings (loss)  before income taxes                            |       | (61,610                                                            | )           | (38,266               | )          | (6,369                 | )          | 53                    |       | 4,231      |       | 4,189      |       |
| Federal income  taxes (benefits)                                |       | 6,905                                                              |        | (4,933                | )          | (2,308                 | )          | (34                   | )          | 1,375      |       | 1,320      |       |
| Net earnings  (loss)                                            | ** ** | **$**                                                              | **(68,515** | **)**                 | **$**      | **(33,333**            | **)**      | **$**                 | **(4,061** | **)**      | **$**      | **87**     | ** ** | **$** | **2,856** | ** ** | **$** | **2,869** | ** ** |
|                                                            |       |                                                               |        |                  |       |                   |       |                  |       |       |       |       |       |
| Earnings (loss)  per share                                      |       |                                                               |        |                  |       |                   |       |                  |       |       |       |       |       |
| Basic                                                           | ** ** | **$**                                                              | **(14.17**  | **)**                 | **$**      | **(6.97**              | **)**      | **$**                 | **(0.88**  | **)**      | **$**      | **0.02**   | ** ** | **$** | **0.73** | ** ** | **$** | **0.92** | ** ** |
| Diluted                                                         | ** ** | **$**                                                              | **(14.17**  | **)**                 | **$**      | **(6.97**              | **)**      | **$**                 | **(0.88**  | **)**      | **$**      | **0.02**   | ** ** | **$** | **0.72** | ** ** | **$** | **0.91** | ** ** |

 

(Seefootnotes on next page)

 

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| ** **                                                               | ** ** | ** **                       | ** ** | ** **            | ** ** | ** **                       | ** ** | **At or for the** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------|------------|-----------------------|------------|----------------------------------|------------|----------------------------------|------------|------------|------------|------------|------------|
| ** **                                                               | ** ** | **At or for the** | ** ** | **Three Months** | ** ** | **At or for the** | ** ** |
| ** **                                                               | ** ** | **Year Ended**              | ** ** | **Ended**             | ** ** | **Year Ended**              | ** ** |
| ** **                                                               | ** ** | **December 31,**            | ** ** | **December 31,** | ** ** | **September 30,**           | ** ** |
| **Key  Operating Ratios: (1)**                                           | ** ** | **2008**                         | ** ** | **2007**              | ** ** | **2006**                         | ** ** | **2005**                         | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|                                                                     |       |                             |       |                  |       |                             |       |                             |       |       |       |       |       |
| **Performance  Ratios: (1)**                                             |       |                             |       |                  |       |                             |       |                             |       |       |       |       |       |
| Return on  average assets                                                |       | (8.62                            | )%         | (3.44                 | )%         | (0.38                            | )%         | 0.03                             | %          | 0.30       | %          | 0.34       | %          |
| Return on  average equity                                                |       | (183.59                          | )          | (38.32                | )          | (4.48                            | )          | 0.40                             |       | 3.65       |       | 4.97       |       |
| Average  interest-earning assets to average interest-bearing liabilities |       | 101.75                           |       | 103.71                |       | 104.02                           |       | 104.00                           |       | 106.63     |       | 104.82     |       |
| Interest rate  spread (2)                                                |       | 1.82                             |       | 2.53                  |       | 2.84                             |       | 2.49                             |       | 2.25       |       | 2.40       |       |
| Net interest  margin (2)                                                 |       | 1.88                             |       | 2.68                  |       | 3.00                             |       | 2.63                             |       | 2.45       |       | 2.52       |       |
| General,  administrative and other expense to average assets             |       | 4.26                             |       | 3.42                  |       | 1.99                             |       | 1.78                             |       | 1.69       |       | 1.61       |       |
| Dividend payout  ratio                                                   |       | n/a                              |       | n/a                   |       | n/a                              |       | 750.00                           |       | 82.19      |       | 32.61      |       |
|                                                                     |       |                             |       |                  |       |                             |       |                             |       |       |       |       |       |
| **Asset  Quality Ratios:**                                               |       |                             |       |                  |       |                             |       |                             |       |       |       |       |       |
| Nonperforming  assets to total assets at end of period (3)               |       | 7.48                             | %          | 3.70                  | %          | 2.54                             | %          | 1.82                             | %          | 2.07       | %          | 0.71       | %          |
| Allowance for  loan losses to nonperforming loans at end of period       |       | 66.59                            |       | 133.05                |       | 71.20                            |       | 71.67                            |       | 66.32      |       | 182.87     |       |
| Allowance for  loan losses to total loans at end of period               |       | 5.40                             |       | 4.90                  |       | 2.05                             |       | 1.42                             |       | 1.72       |       | 1.64       |       |
|                                                                     |       |                             |       |                  |       |                             |       |                             |       |       |       |       |       |
| **Capital  and Other Ratios:**                                           |       |                             |       |                  |       |                             |       |                             |       |       |       |       |       |
| Average  stockholders’ equity to average assets                     |       | 4.70                             | %          | 8.97                  | %          | 8.54                             | %          | 8.55                             | %          | 8.35       | %          | 6.77       | %          |
| Tangible  stockholders’ equity to tangible assets                   |       | (0.23                            | )          | 5.48                  |       | 7.12                             |       | 8.07                             |       | 9.75       |       | 8.38       |       |
| Tier 1 capital  to risk-weighted assets (4)                              |       | 3.50                             |       | 10.06                 |       | 11.32                            |       | 10.86                            |       | 13.37      |       | 12.52      |       |

 

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(1)                                  All ratios are based on average monthlybalances for the fiscal year ended September 30, 2004.  With respect to the fiscal years ended September 30,2005 or later, all ratios are based on average daily balances.

 

(2)                                  Interest rate spread represents thedifference between the weighted-average yield on interest-earning assets andthe weighted-average cost of interest-bearing liabilities.  Net interest margin represents net interestincome as a percentage of average interest-earning assets.

 

(3)                                  Nonperforming assets consist ofnon-accrual loans, loans past due 90 days or more and still accruing interestand real estate acquired through foreclosure or by deed-in-lieu thereof.

 

(4)                                  This regulatory capital ratio representsthe capital ratio of the Bank.  At December 31,2008, the Bank did not meet two of the three capital requirements imposed bythe OTS.  In addition, at such date, theBank was deemed a significantly undercapitalized institution under theregulatory framework for prompt corrective action.  For further explanation of the Bank’s capitalrequirements and related consequences of its classification as significantlyundercapitalized, see “Overview and Recent Regulatory Matters” herein.

 

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###### **Table of Contents**

 

**PEOPLES COMMUNITY BANCORP, INC.**

 

**MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**

**AND RESULTSOF OPERATIONS**

 

###### **Overview and RecentRegulatory Matters**

###### ** **

***Operations. ***As a result of acquisitionsand internal growth, Peoples 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 2000and December 31, 2005, Peoples acquired five financial institutions withaggregate total assets as of the time of acquisition of $428.5 million. Also, in September 2003, Peoples purchased $32.8 million in loans andassumed $55.6 million in deposits in connection with the acquisition of twobranch offices from another financial institution.  Peoples supplementedthis growth due to acquisitions with loan generation secured primarily by realestate in its market area.  Total gross loans increased from $419.5million at September 30, 2001 to $944.7 million at December 31,2005.  In addition, since September 30, 2000, Peoples expandedits franchise through the opening of six full service branch offices. These newbranch offices, as well as acquired branch offices, have expanded Peoples’market presence.  Peoples’ loan growth was funded in part bydeposits.  Peoples placed an emphasis on deposit generation bothinternally and through whole bank and branch acquisitions.  Depositsincreased from $233.1 million at September 30, 2001 to $755.3 million at December 31,2006.

 

Beginning in early 2007, however, Peoplesbegan to reduce all aspects of its lending exposure due in large part to thedownturn in the local economy and, in particular, values of residential andresidential development properties. At December 31, 2008, total grossloans amounted to $531.4 million, a decrease of $413.3 million or 43.8%compared to $944.7 million of loans at December 31, 2005.  In addition, to address such slowdown and theresulting decrease in the value of its collateral, Peoples charged off $18.3million of loans in 2007 and $47.8 million of loans in 2008, and provided $32.8million and $41.5 million during 2007 and 2008, respectively, to the allowancefor loan losses.  As a result, theallowance for loan losses to total gross loans at December 31, 2008amounted to 5.4%.  Further, beginning in2006, Peoples revised its underwriting standards to place an increased focus oncash flow analysis, tightened its credit standards and provided additionalresources to the resolution of its classified assets.

 

Despite the actions taken by Peoples during2006, 2007 and 2008, discussed above, the continued recessionary forces in thelocal economy have had a significant adverse impact on Peoples’ financialcondition and results of operations.  For2007 and 2008, net losses amounted to $33.3 million and $68.5 million,respectively, and stockholders’ equity decreased from $53.6 million or 6.04% oftotal assets at December 31, 2007 to a deficit of $14.8 million at December 31,2008.  Further, the level ofnon-performing assets has and will continue to negatively impact Peoples’interest rate spread, interest income, provision for losses on loans and netearnings or loss.  Non-performing assetstotaled $26.1 million, $32.8 million and $53.3 million at December 31,2006, 2007 and 2008, respectively.  WhilePeoples has devoted and will continue to devote substantial resources towardthe resolution of all delinquent and non-performing assets, no assurance can bemade that these efforts will be successful.

 

***RegulatoryEnforcement Actions. ***The OTS is theprimary federal regulator of Peoples Community Bank.  In light of Peoples’ losses in 2007 and 2006and levels of nonperforming assets, the OTS has imposed certain operationsrestrictions on the Company and the Bank, many of which had previously beentaken by the Company and the Bank. On April 2, 2008, the Company and theBank each consented to the terms of Cease and Desist Orders issued by the OTS(the “Orders”).  The Company attachedcopies of the Orders to a Current Report on Form 8-K filed with theSecurities and Exchange Commission on April 3, 2008.

 

The Orders require the Company and the Bankto, among other things, file with the OTS within prescribed time periodsupdated business plans, which specifically incorporate the requirements setforth in the Orders and comments contained in the most recently completedexaminations of the Company and the Bank. On a quarterly basis, the Company andthe Bank are required to compare the projected operating results from thebusiness plans with the actual results. The results of this variance analysisare to be submitted to the OTS within the prescribed time periods. In addition,the Orders require that the Company and the Bank receive the permission of theOTS prior to (i) making or declaring any dividends or payments on theiroutstanding securities; (ii) adding or replacing a director or hiring anexecutive officer; and (iii) making any golden parachute payments to anyinstitution-affiliated party. Pursuant to the 

 

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Order issued to the Company, the Company mustalso receive the permission of the OTS prior to increasing its debt positionand before any repurchase of its securities.

 

The Order issued to the Bank also requiresthe Bank to take or refrain from certain actions, including (i) not makingany new loans or issuing new lines of credit for land acquisition ordevelopment, speculative residential construction, commercial and multi-familyconstruction, acquisition or retention of commercial property, and non-owneroccupied one-to-four-family residential property; (ii) engaging anindependent consultant to conduct a loan portfolio review for the purpose ofdetermining asset quality and the appropriateness of the Bank’s assetclassification process related to loan relationships that equal or exceed $4.0million; (iii) establishing a plan for reducing adversely classifiedassets; (iv) reviewing and, where appropriate, adjusting the Bank’sallowance for loan and lease losses methodology; (v) limiting asset growthduring each calendar quarter to an amount not to exceed net interest creditedon deposit liabilities; and (vi) establishing an Oversight Committee ofthe Bank’s Board of Directors comprised of independent outside directors. In an effort to proactively address the downturn in the local real estatemarket, the Bank had previously curtailed or ceased the lending activitiesrestricted in the Orders.

 

During 2008, management of Peoples workeddiligently to resolve the issues associated with the Bank’s nonperformingassets and to provide the information or take the actions required by theOrders.  Concurrently, management and theBoard of Directors considered all strategic alternatives available to theCompany and the Bank.  As required,Peoples has filed a consolidated business plan with the OTS covering operationsthrough 2010.  Peoples’ business plancontemplates, among other things, a consolidation of its operations throughbranch sales and a reduction in adversely classified assets through loanresolutions, repayments, sales and charge-offs. Branch sale transactions would decrease Peoples’ assets and liabilities,improve capital ratios, generate income, and reduce general, administrative andother expense.  Despite management’sefforts, the extremely difficult economic conditions have continued tonegatively impact real estate values and the ability of borrowers to service orrepay their loans.  As a result, Peopleshas continued to incur significant losses which has severely impactedstockholders’ equity and the related regulatory capital of the Bank.

 

Banking regulations require savingsinstitutions to satisfy several capital requirements.  Under these standards, savings institutionsmust 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 capitalequal to at least 8.0% of risk-weighted assets. Due to continued losses during 2008, at December 31, 2008, the Bankdid not meet two of these capital requirements, with tangible, core andrisk-based capital ratios of 2.2%, 2.2% and 4.8%, respectively.  Further, at such date, the Bank was deemed asignificantly undercapitalized institution under the regulatory framework forprompt corrective action.  As a result,the Bank was notified by the OTS by letter dated April 13, 2009 (the “Notice”),that it is subject to certain restrictions and requirements, including therequirement to file a capital restoration plan by April 30, 2009 todemonstrate the ability of the Bank to return to an adequately capitalizedstatus by June 15, 2009 (the “Capital Plan”).

 

On April 28, 2009, the Bank consented toan Amended Order to Cease and Desist (the “Amended Order”) issued by the OTS.The Amended Order became effective on April 29, 2009.  The AmendedOrder supplements and amends the previously issued Cease and Desist Orderissued by the OTS against the Bank on April 2, 2008.  The Amended Order requires that the Bankachieve by July 14, 2009 and maintain: (i) a Tier 1 (Core) CapitalRatio of at least eight percent (8%); and (ii) a Total Risk-Based CapitalRatio of at least twelve percent (12%). The Amended Order also requires the Bank to file with the OTS a writtencontingency plan by May 14, 2009 that will be implemented by the Bank inthe event it becomes critically undercapitalized (the “Contingency Plan”). The Contingency Plan will require that the Bank achieve one of the followingresults: (i) a merger with or acquisition by another federally insuredinstitution or holding company thereof, or (ii) a voluntary liquidationby, among other things, filing the appropriate applications with OTS inconformity with federal laws and regulations.  The Contingency Plan willbe implemented if the Bank becomes critically undercapitalized or uponnotification by the OTS.  In addition,the Amended Order requires the Bank to refrain from certain actions, including:(i) accepting, renewing or rolling over any brokered deposit; (ii) actingas a deposit broker; or (iii) soliciting deposits by offering an effectiveyield on insured deposits that exceeds the limitation provided by OTSregulations.

 

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On April 30, 2009, the Bank filed its Thrift FinancialReport for the quarter ended March 31, 2009. This report reflected the Bank’s capital under the framework for promptcorrective action at the “critically undercapitalized” level.  The Bank’s total risk-based capital, Tier 1risk-based capital and tier 1 leverage capital were 4.15%, 2.82% and 1.81%,respectively.  The Bank’s ratio oftangible equity to tangible assets was 1.81%. As a result, the Bank is subject to numerous operational restrictionsand requirements.

 

In addition to the other operational restrictions imposed by theOrders, the Bank may not, without the prior written consent of the FDIC:

 

·                  Enter into anymaterial transactions other than in the usual course of business, including anyinvestment, expansion, acquisition, sale of assets, or similar action withrespect to which the Bank is required to give notice to OTS;

·                  Extend creditfor any highly leveraged transaction;

·                  Amend itscharter or bylaws, except to the extent necessary to carry out any otherrequirement of any law, regulation, or order;

·                  Make anymaterial change in accounting methods;

·                  Engage in anycovered transaction;

·                  Pay excessivecompensation or bonuses; or

·                  Make paymentson subordinated debt.

 

The Company and the Bank are currently innegotiations concerning a transaction to sell certain branches of the Bank (the“Branch Transaction”), the proposed results of which are the basis for the Bank’sCapital Plan, as filed with the OTS on April 30, 2009, as required by theNotice.  The Bank intends to negotiateand enter into the Branch Transaction in order to reduce assets andliabilities, generate a deposit premium and return the Bank to an adequatelycapitalized status. The Company cannot provide assurance that an agreementrelated to the Branch Transaction will be entered into or consummated or thatthe Bank’s Capital Plan will be acceptable to the OTS.  If the Bank’s Capital Plan is not approved bythe OTS or the Bank cannot enter into and consummate a transaction to returnthe Bank to an adequately capitalized status on a timely basis, the Companywill not be able to continue as a going concern.

 

***Report ofIndependent Registered Public Accounting Firm. ***The report of the Company’s independent registeredpublic accounting firm for the year ended December 31, 2007, contained anexplanatory paragraph as to the Company’s ability to continue as a goingconcern primarily due to the Company’s current lack of liquidity to repay itsobligation under an outstanding line of credit with Integra Bank, N.A. (“Integra”).  The line of credit is secured by alloutstanding shares of common stock of the Bank. The Orders prohibit the Bankfrom paying cash dividends to the Company without the prior consent of the OTSand the Company will be able to rely upon only a limited amount of existingcash and cash equivalents for its liquidity. Without the ability to rely ondividends from the Bank, the Company will require funds from other capitalsources to meet its obligations such as restructuring or replacing the line ofcredit.  Peoples is actively evaluatingvarious funding strategies to meet its obligations, including restructuring itsoutstanding debt and selling branch offices. Any increase in the Company’s outstanding indebtedness will also requireOTS approval.  The Company cannot provideassurance that it will succeed in obtaining funds to meet its financialobligations.  Failure to do so will havea material adverse effect on, and impair the Company’s business, financialcondition and ability to operate as a going concern.

 

The report of the Company’s independentregistered public accounting firm for the year ended December 31, 2008,also contained an explanatory paragraph as to the Company’s ability to continueas a going concern. Reasons cited include the Bank’s low level of capital,exposure to significant regulatory sanctions and significant losses fromoperations.

 

***Default on Lineof Credit and Termination of Strategic Transaction. ***As of December 31,2007, the Company was not in compliance with certain covenants of its line ofcredit with Integra.  On June 30,2008, the loan matured and was due in full. Effective July 24, 2008, the Company entered into a forbearanceagreement with Integra 

 

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regarding its $17.5 million line of credit.The forbearance was negotiated in order to extend the repayment period andallow the Company to structure a transaction which would result in repayment ofthe $17.5 million line of credit.

 

On September 12, 2008, the Companyentered into a purchase and assumption agreement (“Agreement”) with a buyer anda third party.  The Agreement providedfor the purchase of a substantial portion of the Bank’s assets, as well as theassumption of the Bank’s deposits and certain other liabilities.  The Company or the buyer could terminate theAgreement if the closing of the transactions did not occur on or before December 31,2008.  By letter dated December 29, 2008, the buyer terminated itsobligations under the Agreement pursuant to Section 25(f) of theAgreement.

 

On December 31, 2008, the Company andthe third party entered into the First Amendment (“Amendment”) to the Agreementto extend the Company’s and third party’s obligations under the Agreement to January 31,2009.  The Company and the third party reaffirmed their respectiverepresentations and warranties and acknowledged that the third party willrequire another financial institution acceptable to the Office of ThriftSupervision to perform its or their obligations under the Agreement.  No agreement was reached by January 31,2009.

 

On December 31, 2008, the Company andIntegra extended the forbearance period to January 31, 2009.  The forbearance period has expired and theCompany is in default on its line of credit with Integra.  This matter remains unresolved.

 

***Establishment ofValuation Allowance. ***In light of thematters discussed above, the Company established a valuation allowance ofdeferred federal income taxes of approximately $4.4 million in 2007.  As of December 31, 2008 the allowancehad been increased to $27.2 million. Generally, the losses incurred in 2006, 2007 and 2008 resulted indeferred federal income taxes or deferred tax assets which may be appliedagainst current period earnings, carried back against prior years’ earnings orused to the extent of management’s estimate of future taxable income.  The valuation allowance was established sincethe Company’s current circumstances might impair the Company’s ability togenerate future taxable income and therefore impair its ability to realize allbenefits of the deferred tax asset.

 

**General**

 

Peoples’ operations are influenced primarilyby net interest income, which is the difference between interest and dividendincome on interest-earning assets, principally loans, mortgage-backedsecurities, investment securities and interest-earning deposits in otherfinancial institutions; and interest expense, principally on interest-bearingdeposits and borrowings from the Federal Home Loan Bank.  Net interest income is dependent upon thelevel of interest rates and the extent to which such rates are changing.  Peoples’ operations are also dependent on thelevel of other income, the provision for losses on loans, general,administrative and other expenses and federal income taxes.  The provision for losses on loans has had asignificant impact on People’s operations in 2006, 2007 and 2008.  Peoples’ operations are also subject tochanges in interest rates, applicable statutes and regulations and generaleconomic conditions, as well as other factors beyond management’s control.

 

**Critical Accounting Policies**

 

The “Management’s Discussion and Analysis of Financial Condition andResults of Operations,” as well as disclosures found elsewhere in this annualreport, are based upon Peoples’ consolidated financial statements, which areprepared in accordance with generally accepted accounting principles in theUnited States (“US GAAP”).  Thepreparation of these financial statements requires management to make estimatesand judgments that affect the reported amounts of assets, liabilities, revenuesand expenses.  Several factors areconsidered in determining whether or not a policy is critical in thepreparation of financial statements. These factors include, among other things, whether the estimates aresignificant to the financial statements, the nature of the estimates, theability to readily validate the estimates with other information, includingthird parties or available prices,  sensitivityof the estimates to changes in economic 

 

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conditions, and whether alternative accounting methods may be utilizedunder US GAAP.  Material estimates thatare particularly susceptible to significant change in the near term relate tothe determination of the allowance for loan losses, valuation allowance ofdeferred income taxes and goodwill impairment. Actual results could differ from those estimates.

 

**Allowance for Loan Losses.**  The procedures for assessing the adequacy ofthe allowance for loan losses reflect management’s evaluation of credit riskafter consideration of all information available.  In developing this assessment, managementmust rely on estimates and exercise judgment regarding matters where theultimate outcome is unknown, such as economic factors, developments affectingcompanies in specific industries and issues with respect to singleborrowers.  Depending on changes incircumstances, future assessments of credit risk may yield materially differentresults, which may require an increase or a decrease in the allowance for loanlosses.

 

The allowance is regularly reviewed by management to determine whetherthe amount is considered adequate to absorb probable losses.  This evaluation includes specific lossestimates on certain individually reviewed loans, statistical loss estimatesfor loan pools that are based on historical loss experience, and general lossestimates that are based  upon the size,quality, and  concentration  characteristics  of the various loan  portfolios, adverse situations that mayaffect a borrower’s ability to repay, and current economic and industryconditions.   Also considered as part ofthat judgment is a review of the Bank’s trends in delinquencies and loanlosses, as well as trends in delinquencies and losses for the region and othereconomic factors.

 

**Valuation Allowance of Deferred Income Taxes. **Peoplesaccounts for federal income taxes in accordance with the provisions of SFAS No. 109,“Accounting for Income Taxes.”  Pursuantto the provisions of SFAS No. 109, a deferred tax liability or deferredtax asset is computed by applying the current statutory tax rates to nettaxable or deductible differences between the tax basis of an asset orliability and its reported amount in the consolidated financial statements thatwill result in taxable or deductible amounts in future periods.  Deferred tax assets are recorded only to theextent that the amount of net deductible temporary differences or carryforwardattributes may be utilized against future taxable income.  A valuation allowance is provided for netdeferred tax assets to the extent that the value of net temporary differences and carryforward attributesexceeds management’s estimates of taxes payable on future taxable income.

 

**Goodwill.**  Peoples hasdeveloped procedures to test goodwill for impairment on an annual basis using September 30financial data and more frequently if an event occurs or circumstances changethat would more likely than not reduce the fair value of a reporting unit belowits carrying amount. The evaluation of possible impairment is outsourced to athird party. This evaluation is based on the analysis set forth below.

 

Thetest involves estimating the fair value of tangible assets and liabilities,identified intangible assets and goodwill of the Bank (which is the Company’sreporting unit as defined under FAS 142) and comparing the fair value ofthis reporting unit to its carrying value including goodwill. The value isdetermined assuming a freely negotiated transaction between a willing buyer anda willing seller, neither being under any compulsion to buy or sell and bothhaving reasonable knowledge of relevant facts. The third party selected bymanagement utilizes the following common approaches to valuing businesscombination transactions involving financial institutions to derive the fairvalue of the reporting unit: (1) the comparable transactions approachwhich is specifically based on earnings, book value, assets and deposit premiummultiples received in recent sales of comparable bank franchises; and (2) thediscounted cash flow approach. The application of the valuation techniquestakes into account the reporting unit’s operating history, the current marketenvironment and future prospects. If the fair value of a reporting unitexceeds its carrying amount, goodwill of the reporting unit is considered notimpaired and no second step is required. If the fair value does not exceedthe carrying amount, a second test is required to measure the amount ofgoodwill impairment. The second test of the overall goodwill impairmentcompares the implied fair value of the reporting unit goodwill with thecarrying amount of the goodwill. The impairment loss shall equal theexcess of carrying value over 

 

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fairvalue. Any impairment loss would require an immediate charge to earnings.After each testing period, the third party compiles a summary of the test thatis then provided to the audit committee for review.

 

Peoplesevaluated the goodwill balance as of September 30, 2007 and June 30,2008.  As a result of these evaluations,Peoples recorded impairment charges of $11.4 million and $12.5 millionrespectively, which eliminated the goodwill on its books. The impairment ofgoodwill was primarily attributable to lower market valuations for financialinstitutions, the weakening of the credit market, the decline in real estatevalues, particularly in the Cincinnati region, and the net losses recorded byPeoples from 2006 to 2008.

 

**Forward-Looking Statements Are Subject to Change**

 

Certain statements are made in this documentas to what management expects may happen in the future.  These statements usually contain the words “believe,”“estimate,” “project,” “expect,” “anticipate,” “intend” or similarexpressions.  Because these statementslook to the future, they are based on management’s current expectations andbeliefs.  Actual results or events maydiffer materially from those reflected in the forward-looking statements.

 

Management’s current expectations and beliefsas to future events are subject to change at any time, and no assurances can beprovided that the future events will actually occur.  All forward-looking statements in thisdocument are based on information available to us on the date this document isfiled.  We do not intend to, and assumeno responsibility for, updating any forward-looking statements that may be madeby us or on our behalf in this document or otherwise.

 

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**Average Balances, Net Interest Income, Yields Earned and Rates Paid**

 

The following table presents for the periodsindicated the total dollar amount of interest income from averageinterest-earning assets and the resultant yields, as well as interest expenseon average interest-bearing liabilities, expressed both in dollars and rates,and the net interest margin.

 
| ** **                                                               | ** ** | **For the Year Ended** | ** **  |
|--------------------------------------------------------------------------|------------|---------------------------------------|-------------|
| ** **                                                               | ** ** | **December 31, 2008**       | ** **  | **December 31, 2007** | ** ** | **December 31, 2006** | ** ** |
| ** **                                                               | ** ** | **Average**                           | ** **  | **Interest** | ** ** | ** ** | ** ** | **Average** | ** ** | **Interest** | ** ** | ** ** | ** ** | **Average** | ** ** | **Interest** | ** ** | ** ** | ** ** |
| ** **                                                               | ** ** | **outstanding**                       | ** **  | **earned/** | ** ** | **Yield/** | ** ** | **outstanding** | ** ** | **earned/** | ** ** | **Yield/** | ** ** | **outstanding** | ** ** | **earned/** | ** ** | **Yield/** | ** ** |
| ** **                                                               | ** ** | **balance**                           | ** **  | **paid** | ** ** | **rate** | ** ** | **balance** | ** ** | **paid** | ** ** | **rate** | ** ** | **balance** | ** ** | **paid** | ** ** | **rate** | ** ** |
| ** **                                                               | ** ** | **(Dollars in thousands)**  | ** **  |
| Interest-earning  assets:                                                |       |                                  |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans receivable (1)                                                |       | $                                     | 594,991     |   | 35,446 |   | 5.96 | % | $ | 751,917 |   | 53,390 |   | 7.10 | % | $ | 870,327 |   | 61,096 |   | 7.02 | % |
| Mortgage-backed securities                                               |       | 29,321                                |        | 1,430 |   | 4.88 |   | 49,427 |   | 2,394 |   | 4.84 |   | 60,474 |   | 2,467 |   | 4.08 |   |
| Investment  securities (2)                                               |       | 40,088                                |        | 1,773 |   | 4.42 |   | 18,150 |   | 1,100 |   | 6.06 |   | 17,473 |   | 951 |   | 5.44 |   |
| Interest-earning  deposits                                               |       | 80,648                                |        | 1,588 |   | 1.97 |   | 64,965 |   | 3,349 |   | 5.16 |   | 18,206 |   | 961 |   | 5.28 |   |
|                                                                     |       |                                  |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  interest-earning assets                                           |       | 745,048                               |        | 40,237 |   | 5.40 |   | 884,459 |   | 60,233 |   | 6.81 |   | 966,480 |   | 65,475 |   | 6.77 |   |
|                                                                     |       |                                  |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Non-interest-earning  assets                                             |       | 49,680                                |        |   |   |   |   | 85,652 |   |   |   |   |   | 93,635 |   |   |   |   |   |
|                                                                     |       |                                  |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total assets                                                             | ** ** | **$**                                 | **794,728** |   |   |   |   | ** ** | **$** | **970,111** |   |   |   |   | ** ** | **$** | **1,060,115** |   |   |   |   |   |
|                                                                     | ** ** | ** **                            |        |   |   |   | ** ** | ** ** |   |   |   |   | ** ** | ** ** |   |   |   |   |   |
| Interest-bearing  liabilities:                                           |       |                                  |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Savings and  checking accounts                                           |       | $                                     | 79,365      |   | 919 |   | 1.16 |   | $ | 69,133 |   | 1,472 |   | 2.13 |   | $ | 103,865 |   | 1,137 |   | 1.09 |   |
| Money market  deposit accounts                                           |       | 95,605                                |        | 2,538 |   | 2.65 |   | 144,809 |   | 4,354 |   | 3.01 |   | 146,791 |   | 5,420 |   | 3.69 |   |
| Certificates of  deposit                                                 |       | 465,491                               |        | 18,594 |   | 3.99 |   | 506,294 |   | 24,202 |   | 4.78 |   | 478,148 |   | 20,682 |   | 4.33 |   |
| FHLB advances  and other borrowings                                      |       | 76,789                                |        | 3,429 |   | 4.47 |   | 117,546 |   | 5,341 |   | 4.54 |   | 173,622 |   | 7,163 |   | 4.13 |   |
| Subordinated  debentures                                                 |       | 15,000                                |        | 757 |   | 5.05 |   | 15,000 |   | 1,091 |   | 7.27 |   | 26,740 |   | 2,083 |   | 7.79 |   |
|                                                                     |       |                                  |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities                                      |       | 732,250                               |        | 26,237 |   | 3.58 |   | 852,782 |   | 36,460 |   | 4.28 |   | 929,166 |   | 36,485 |   | 3.93 |   |
|                                                                     |       |                                  |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Non-interest-bearing  liabilities                                        |       | 25,159                                |        |   |   |   |   | 30,346 |   |   |   |   |   | 40,384 |   |   |   |   |   |
|                                                                     |       |                                  |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  liabilities                                                       |       | 757,409                               |        |   |   |   |   | 883,128 |   |   |   |   |   | 969,550 |   |   |   |   |   |
|                                                                     |       |                                  |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Stockholders’  equity                                               |       | 37,319                                |        |   |   |   |   | 86,983 |   |   |   |   |   | 90,565 |   |   |   |   |   |
|                                                                     |       |                                  |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  liabilities and stockholders’ equity                         |       | **$**                                 | **794,728** | ** ** | ** ** | ** ** | ** ** | ** ** | **$** | **970,111** | ** ** | ** ** | ** ** | ** ** | ** ** | **$** | **1,060,115** | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                                                     |       | ** **                            |        |   |   |   |   | ** ** |   |   |   |   |   | ** ** |   |   |   |   |   |
| Net interest  income                                                     |       |                                  | ** **  | **$** | **14,000** |   |   |   |   | ** ** | **$** | **23,773** |   |   |   |   | ** ** | **$** | **28,990** |   |   |   |
|                                                                     |       |                                  | ** **  | ** ** |   |   |   |   | ** ** | ** ** |   |   |   |   | ** ** | ** ** |   |   |   |
| Interest rate  spread                                                    |       |                                  |        |   | ** ** | **1.82** | **%** |   |   |   | ** ** | **2.53** | **%** |   |   |   | ** ** | **2.84** | **%** |
|                                                                     |       |                                  |        |   | ** ** | ** ** | ** ** |   |   |   | ** ** | ** ** | ** ** |   |   |   | ** ** | ** ** | ** ** |
| Net interest  margin (3)                                                 |       |                                  |        |   | ** ** | **1.88** | **%** | ** ** | ** ** | ** ** | ** ** | **2.69** | **%** | ** ** | ** ** | ** ** | ** ** | **3.00** | **%** |
|                                                                     |       |                                  |        |   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Average  interest-earning assets to average interest-bearing liabilities |       |                                  |        |   |   | **101.75** | **%** |   |   |   |   | **103.71** | **%** |   |   |   |   | **104.02** | **%** |
|                                                                          |            |                                       |             |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)                                  Includes non-accruing loans.

 

(2)                                  Includes Federal Home Loan Bank stock.

 

(3)                                  Equals net interest income divided byaverage interest-earning assets.

 

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# **Rate/Volume Analysis**

#  

The following table shows the extent to which changes in interest ratesand changes in volume of interest-related assets and liabilities affectedPeoples’ interest income and expense during the periods indicated.  For each category of interest-earning assetsand interest-bearing liabilities, information is provided on changesattributable to (i) changes in volume (change in volume multiplied byprior year rate), and (ii) changes in rate (change in rate multiplied byprior year volume).  The combined effectof changes in both rate and volume has been allocated proportionately to thechange due to rate and the change due to volume.

 
| ** **                                  | ** ** | **December 31, 2007 to** | ** ** | **December 31, 2006 to** | ** ** |
|---------------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|
| ** **                                  | ** ** | **December 31, 2008**         | ** ** | **December 31, 2007**         | ** ** |
| ** **                                  | ** ** | **Increase (Decrease)**            | ** ** | **Increase (Decrease)**            | ** ** |
| ** **                                  | ** ** | **Due to Changes In**    | ** ** | **Due to Changes In**    | ** ** |
| ** **                                  | ** ** | **Rate**                                | ** ** | **Volume**                              | ** ** | **Total** | ** ** | **Rate** | ** ** | **Volume** | ** ** | **Total** | ** ** |
| ** **                                  | ** ** | **(In thousands)**                 | ** ** |
| Interest-earning  assets:                   |       |                                    |       |                                    |       |   |   |   |   |   |   |   |   |
| Loans receivable                            |       | $                                       | (7,814     | )                                       | $          | (10,130 | ) | $ | (17,944 | ) | $ | 705 |   | $ | (8,411 | ) | $ | (7,706 | ) |
| Mortgage-backed  securities                 |       | 17                                      |       | (981                                    | )          | (964 | ) | (3,776 | ) | 3,703 |   | (73 | ) |
| Investment  securities (1)                  |       | 64                                      |       | (134                                    | )          | (70 | ) | 111 |   | 38 |   | 149 |   |
| Interest-earning  deposits                  |       | (2,260                                  | )          | 1,242                                   |       | (1,018 | ) | (21 | ) | 2,409 |   | 2,388 |   |
| Total  interest-earning assets              |       | (9,993                                  | )          | (10,003                                 | )          | (19,996 | ) | (2,981 | ) | (2,261 | ) | (5,242 | ) |
|                                        |       |                                    |       |                                    |       |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:              |       |                                    |       |                                    |       |   |   |   |   |   |   |   |   |
| Savings and  checking accounts              |       | (819                                    | )          | 266                                     |       | (553 | ) | (1,127 | ) | 395 |   | (732 | ) |
| Money market  deposit accounts              |       | (465                                    | )          | (1351                                   | )          | (1,816 | ) | 1 |   | — |   | 1 |   |
| Certificates of  deposit                    |       | (3,763                                  | )          | (1,845                                  | )          | (5,608 | ) | 2,305 |   | 1,215 |   | 3,520 |   |
| FHLB advances  and other borrowings         |       | (89                                     | )          | (1,822                                  | )          | (1,911 | ) | 809 |   | (2,631 | ) | (1,822 | ) |
| Subordinated  debentures                    |       | (335                                    | )          | —                                  |       | (335 | ) | (150 | ) | (842 | ) | (992 | ) |
| Total  interest-bearing liabilities         |       | (5,471                                  | )          | (4,752                                  | )          | (10,223 | ) | 1,838 |   | (1,863 | ) | (25 | ) |
|                                        |       |                                    |       |                                    |       |   |   |   |   |   |   |   |   |
| Increase  (decrease) in net interest income | ** ** | **$**                                   | **(4,522** | **)**                                   | **$**      | **(5,251** | **)** | **$** | **(9,773** | **)** | **$** | **(4,819** | **)** | **$** | **(398** | **)** | **$** | **(5,217** | **)** |

 

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(1)           Includes FHLB stock.

 

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**Discussion of Financial Condition Changes from December 31,2007 to December 31, 2008**

 

AtDecember 31, 2008, Peoples’ total assets amounted to $712.4 million, adecrease of $175.0 million, or 19.7%, compared to total assets at December 31,2007.  The decrease in assets wascomprised primarily of a $172.6 million net decrease in loans receivable, adecrease in goodwill of $12.5 million, a decrease of $14.6 million in cash andcash equivalents, and the elimination of $8.8 million in deferred incometaxes.  The decreases were partiallyoffset by an increase of $33.4 million in securities designated as availablefor sale.

 

Liquid assets (i.e. cash and interest-bearing deposits) totaled $72.0million at December 31, 2008, a decrease of $14.6 million, or 16.9%,compared to the amount at December 31, 2007.  The decrease in liquid assets as of December 31,2008 was primarily due to the purchase of securities available for sale inorder to increase yields.  Approximately$60.9 million was invested in interest bearing deposits in other financialinstitutions with a yield of 2.93% at December 31, 2008.

 

Investmentsecurities totaled $101.0 million at December 31, 2008, an increase of$33.4 million, or 49.4%, from the amount at December 31, 2007.  The increase was comprised primarily of $81.6million in purchases, partially offset by $48.1 million of sales and repayments during the period.

 

Loansreceivable totaled $461.9 million at December 31, 2008, a decrease of$172.6 million, or 27.2%, over December 31, 2007 levels. Loandisbursements amounted to $48.3 million during 2008, which were offset byprincipal repayments of $143.8 million and loan sales and participations soldtotaling $28.4 million.  Between 2001 and2005, Peoples placed an increasing emphasis on multi-family residential loans,nonresidential real estate and land loans, construction loans, unsecuredcommercial loans and consumer loans. However, due in large part to the downturn in the local economy, and, inparticular, values of residential and residential development properties, aswell as a significant increase in total non-performing loans, Peoples,beginning in late 2006, began to reduce all aspects of its lendingexposure.  In addition, as discussedbelow, Peoples charged off $47.8 million and $18.3 million of loans in 2008 and2007, respectively.

 

The allowance for loan losses totaled $28.7million at December 31, 2008, a decrease of $5.8 million, or 16.8%compared to the allowance at December 31, 2007.  Due primarily to the significant downturn inthe local real estate market, an increase in internally classified loans,significant charge-offs during the year, and the relative credit risk of theloan portfolio, $41.5 million was added to the allowance through the provisionfor losses on loans during 2008.  Approximately $47.8 million of loans were charged-off during theyear.  The charged-off loans werecomprised of $6.7 million in loans secured by one-to-four-family residentialreal estate, $9.3 million in loans secured by multi-family residential realestate, $8.8 million in construction loans, $18.9 million in loans secured bycommercial real estate and land, and $4.0 million in commercial and consumerloans.  The increase in charged-off loanswas primarily due to real estate investors and developers experiencing cash flowdifficulties and the downturn in the local economy.

 

Theallowance for loan losses represented 5.4% and 4.9% of total loans at December 31,2008 and 2007, respectively.  Theallowance for loan losses represented 66.6% and 133.1% of nonperforming loansat December 31, 2008 and 2007, respectively.  Nonperforming assets totaled $53.3 millionand $32.8 million at December 31, 2008 and 2007, respectively.  Nonperforming assets at December 31,2008 consisted of $6.6 million of loans secured by one-to-four-familyresidential real estate, $7.1 million of loans secured by multi-familyresidential real estate, $25.2 million of loans secured by nonresidential realestate and land, $3.9 million in construction loans, $381,000 in commercial andconsumer loans, and $10.2 million in foreclosed real estate.  The Bank’s management continues toaggressively pursue the collection and resolution of all delinquent andnonperforming loans.

 

AtDecember 31, 2008, non-accrual loans secured by one-to-four-familyresidential real estate consisted of $4.5 million in owner-occupied residenceswith an average balance of $161,000 and $2.1 million in non-owner occupiedresidences with an average balance of $114,000.

 

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Non-accrual loans secured by multi-familyresidential real estate amounted to $7.1 million at December 31, 2008,with an average balance of $787,000.  Oneborrower represented $5.3 million of this total.  Non-residential real estate and land securednon-accrual loans totaled $25.2 million at December 31, 2008.  The average balance of these loans was$647,000.  Three borrowers represented$7.8 million of the non-accrual loans secured by non-residential real estateand land, with the largest borrower representing $3.9 million.

 

Non-accrual construction loans totaled $3.9million at December 31, 2008, with an average balance of $241,000.  Commercial and consumer non-accrual loanstotaled $381,000, with $3,000 of these loans being unsecured.

 

Managementhas considered these loan concentrations as a part of its overall evaluation ofthe adequacy of Peoples’ allowance for loan losses.  Although management believes that itsallowance for loan losses at December 31, 2008 was appropriate based uponthe available facts and circumstances at such time, there can be no assurancethat additions to such allowance will not be necessary in future periods, whichwould continue to adversely affect Peoples’ results of operations.

 

Peoplesrecorded a goodwill impairment of $12.5 million as of June 30, 2008,primarily due to lower market valuations for financial institutions, theweakening of the credit market, the decline in real estate values, particularlyin the Cincinnati region, and the net losses recorded by Peoples.

 

Depositstotaled $630.2 million at December 31, 2008, a decrease of $105.0 million,or 14.3%, over the total at December 31, 2007.  Total demand, transaction and savingsdeposits decreased by $21.2 million, or 9.5%, to $202.2 million at December 31,2008, while total certificates of deposit decreased by $83.8 million, or 16.4%,to $428.0 million at December 31, 2008. During the first three quarters of 2007, Peoples utilized competitivepricing strategies on certificates of deposits, which included advertisedspecial rates.  In late 2007, due to thecost of funds and interest margin compression, management shifted its focus todemand and savings deposits.  Due to theanticipated decline in loan balances, deposits were priced to providecontrolled runoff throughout 2008.

 

Advancesfrom the Federal Home Loan Bank and other borrowings totaled $76.5 million at December 31,2008, a decrease of $1.1 million, or 1.4%, compared to December 31, 2007totals.  In the fourth quarter of 2007,Peoples took advantage of a fixed rate advance special with FHLB for $25.0million.  This special offering providesa fixed rate of interest of 3.45% for a minimum of 3 months and a maximum of 10years.  After the first three months andquarterly thereafter, the FHLB has the option to require the borrower to prepaythe advance without a fee or allow the advance to remain at the originalcontracted fixed rate.

 

Stockholders’deficit totaled $14.8 million at December 31, 2008, a decrease of $68.4million compared to stockholders’ equity at December 31, 2007.  The decrease resulted primarily from netlosses of $68.5 million, which included $41.5 million in provision for losseson loans and $12.5 million in goodwill impairment.

 

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**Comparisonof Results of Operations for the Years Ended December 31, 2008 and December 31,2007**

 

# **General**

#  

Peoples recorded a net loss of $68.5 millionfor the year ended December 31, 2008, compared to a net loss of $33.3million for the year ended December 31, 2007.  The higher net loss was primarily due to a$9.8 million decrease in net interest income, a $4.2 million, or 107.2%,decrease in other income, an $11.8 million increase in income tax expense, andan $8.7 million increase in provision for loan losses.

 

# **Net Interest Income**

#  

Totalinterest income amounted to $40.2 million for the year ended December 31,2008, a $20.0 million, or 33.2%, decrease over the year ended December 31,2007.  The decrease was due to a $139.4million, or 15.8%, decrease in average interest-earning assets and a 141 basispoint decrease in the average yield on interest earning assets for the yearended December 31, 2008 compared to the year ended December 31, 2007.

 

Interestincome on loans totaled $35.4 million for the year ended December 31,2008, a decrease of $17.9 million, or 33.6%, from the year ended December 31,2007.  This decrease was primarily due toa $156.9 million, or 20.9%, decrease in the average portfolio balanceoutstanding for the year ended December 31, 2008 compared to the yearended December 31, 2007 and a 114 basis point decrease in theweighted-average yield to 5.96% for 2008. The decrease in the average balancewas primarily due to loan sales of $28.4 million, and loan repayments totaling$143.8 million, partially offset by loan disbursements of $48.3 million.  As previously stated, the Bank, beginning inlate 2006, reduced all aspects of its lending exposure in response to thedownturn in the local real estate market. The decrease in the Bank’s yield reflects a downward shift in marketrates and the corresponding impact on adjustable-rate loans.

 

Interestincome on mortgage-backed securities totaled $1.4 million for 2008, a decreaseof $964,000, or 40.3%, compared to the year ended December 31, 2007.  The decrease in interest income is due to a$20.1 million, or 40.7%, decrease in the average balance outstanding for theyear ended December 31, 2008 compared to the year ended December 31,2007. The decrease in the average balance of the mortgage-backed securitiesportfolio was primarily due to approximately $10.9 million in repayments, and asale in the first quarter of approximately $28.8 million.  Interest income on investment securities andinterest-bearing deposits totaled $3.4 million, an increase of $1.1 million,due primarily to a $37.6 million increase in the average balance of the relatedassets for the year ended December 31, 2008 compared to the year ended December 31,2007, partially offset by a 257 basis point decrease in the weighted averageyield to 2.78% for 2008.  The increase ininterest-bearing deposits was primarily due to curtailed lending.

 

Interest expense on deposits totaled $22.1million for the year ended December 31, 2008, a decrease of $8.0 million,or 26.6%, over the $30.0 million recorded for the year ended December 31,2007.  The decrease was due primarily toa decrease of $79.8 million, or 11.1%, in the average balance of depositsoutstanding for the year ended December 31, 2008 compared to the yearended December 31, 2007 and a decrease in the weighted-average cost ofdeposits of 73 basis points, to 3.44% for 2008. The decrease in the average cost of deposits was primarily due to thedecrease in market interest rates.  Thedecrease in the average balance of deposits was primarily due to pricing byPeoples at levels intended to provide controlled runoff throughout 2008.

 

Interest expense on borrowings totaled $4.2million for 2008, a decrease of $2.2 million, or 34.9%, compared to the yearended December 31, 2007, due primarily to a $40.8 million, or 30.7%,decrease in the average balance of borrowings outstanding and a 29 basis pointdecrease in the average cost of borrowings for 2008.

 

Asa result of the changes in interest income and interest expense, net interestincome decreased by $9.8 million, or 41.1%, during the year ended December 31,2008, compared to the year ended December 31, 2007.  The interest rate 

 

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spreadamounted to 1.82% for 2008 compared to 2.53% for the year ended December 31,2007.  The net interest margin totaled1.88% and 2.69% for the years ended December 31, 2008 and 2007,respectively.

 

# **Provision for Losses on Loans**

#  

Aprovision for losses on loans is charged to earnings to bring the totalallowance for loan losses to a level considered appropriate by management basedon historical loss experience, the volume and type of lending conducted by theBank, the status of past due principal and interest payments, general economicconditions, particularly as such conditions relate to the Bank’s market area,and other factors related to the collectibility of the Bank’s loanportfolio.  After considering the abovefactors, management recorded a provision for losses on loans of $41.5 millionfor the year ended December 31, 2008, compared to $32.8 million for theyear ended December 31, 2007.

 

Theprovisions recorded during 2008 and 2007 were predicated on highernon-performing, classified and criticized assets for the years, as well assignificant charge-offs during both years. The increase in delinquent loans in Peoples’ non-owner-occupied(investment property) residential loan portfolio and its acquisition,development, and construction loan portfolio contributed to the increasedprovisions.  The delinquencies in theseportfolios are due primarily to the residual effects of the deterioration inthe local real estate market and resultant cash flow issues faced by localproperty investors and developers.  Thedownturn in the local economy has also resulted in deterioration in other sectorsof the portfolio, including multi-family residential loans and commercialloans. There can be no assurance that the allowance for loan losses will besufficient to cover losses on loans in the future.

 

# **Other Income (Loss)**

#  

Otherincome (loss) totaled $(286,000) for the year ended December 31, 2008, adecrease of $4.2 million, compared to the year ended December 31,2007.  The decrease was due primarily toa $4.2 million decrease in gain on sale of loans.

 

# **General, Administrative and OtherExpense**

#  

General,administrative and other expense totaled $33.8 million for the year ended December 31,2008; an increase of $676,000, or 2.0%, compared to the year ended December 31,2007.  Peoples recorded goodwill non-cashimpairment charges of $12.5 million in 2008, compared to $11.4 million recordedin 2007.  The charge was made by Peoplesfollowing a valuation by an independent third party.  This impairment is primarily attributable tolower market valuations for financial institutions, the weakening of the creditmarket, the decline in real estate values, particularly in the Cincinnatiregion, and the net losses recorded by Peoples during 2006, 2007 and 2008.  Peoples recorded a $2.0 million, or 48.2%,increase in other operating expense, partially offset by a $437,000, or 42.8%,decrease in franchise tax, a $445,000, or 24.2%, decrease in amortization ofintangibles, a $357,000, or 10.2% decrease in occupancy and equipment, and a$1.3 million, or 12.6%, decrease in employee compensation and benefits expensedue to a decrease in the number of employees. The increase in other operating expenses was due primarily to anincrease in legal and collection fees recorded as well as an increase in FDICinsurance paid during the year ended December 31, 2008.

 

# **Federal Income Taxes**

#  

Peoplesrecorded an expense for federal income taxes totaling $6.9 million for the yearended December 31, 2008 compared to an income tax benefit $4.9 million forthe year ended December 31, 2007. The income tax benefit for 2007 was due to net losses incurred in2007.  A valuation allowance againstdeferred tax assets of approximately $4.4 million was recorded in the fourthquarter of 2007; an additional $22.8 million was added to the valuationallowance in year 2008.  Generally, thelosses incurred in 2006, 2007 and 2008 resulted in tax losses and deferred taxassets which may be used to the extent of future taxable income.  The valuation allowance was established sincePeoples’ current position impairs the Company’s ability to generate futuretaxable income and therefore impairs its ability to realize all benefits of thedeferred tax asset.

 

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**Comparison of Results of Operations for the Years Ended December 31,2007 and December 31, 2006**

 

# **General**

#  

Peoples recorded a net loss of $33.3 millionfor the year ended December 31, 2007, compared to a net loss of $4.1million for the year ended December 31, 2006.  The higher net loss was primarily due to anincrease of $15.4 million, or 88.0% in provision for loan losses and goodwillimpairment of $11.4 million.  Inaddition, Peoples recorded a $5.2 million, or 18.0%, decrease in net interestincome, partially offset by an increase of $720,000, or 22.4%, in other incomeand a $2.6 million increase in tax benefits.

 

# **Net Interest Income**

#  

Totalinterest income amounted to $60.2 million for the year ended December 31,2007, a $5.2 million, or 8.0%, decrease over the year ended December 31,2006.  The decrease was due to an $82.0million, or 8.5%, decrease in average interest-earning assets, partially offsetby a four basis point increase in the average yield for the year ended December 31,2007 compared to the year ended December 31, 2006.

 

Interestincome on loans totaled $53.4 million for the year ended December 31,2007, a decrease of $7.7 million, or 12.6%, from the year ended December 31,2006.  This decrease was primarily due toa $118.4 million, or 13.6%, decrease in the average portfolio balanceoutstanding for the year ended December 31, 2007 compared to the yearended December 31, 2006, partially offset by an eight basis point increasein the weighted-average yield to 7.10% for 2007. The decrease in the averagebalance was primarily due to loan sales of $32.0 million, and loan repaymentstotaling $269.4 million, partially offset by loan disbursements of $162.4million.  As previously stated,  beginning in late 2006, Peoples began toreduce all aspects of its lending exposure in response to the downturn in thelocal real estate market.  The increasein Peoples’ yield reflects a moderate upward shift in market rates and thecorresponding impact on adjustable-rate loans, primarily in the first twoquarters of the year.

 

Interestincome on mortgage-backed securities totaled $2.4 million for 2007, a decreaseof $73,000, or 3.0%, compared to the year ended December 31, 2006, due toa $11.0 million, or 18.3%, decrease in the average balance outstanding for theyear ended December 31, 2007 compared to the year ended December 31,2006, partially offset by a 76 basis point increase in the weighted-averageyield. The decrease in the average balance of the mortgage-backed securitiesportfolio was primarily due to approximately $19.3 million in repayments,partially offset by a purchase in the fourth quarter of approximately $29.8million.  Interest income on investmentsecurities and interest-bearing deposits totaled $4.4 million, an increase of$2.5 million, due primarily to a $47.4 million increase in the average balanceof the related assets for the year ended December 31, 2007 compared to theyear ended December 31, 2006.  Theincrease in interest-bearing deposits was primarily due to curtailed lendingand the low yield on alternative investments. At December 31, 2007,federal funds sold totaled $67.0 million, compared to $25.0 million at December 31,2006.

 

Interest expense on deposits totaled $30.0million for the year ended December 31, 2007, an increase of $2.8 million,or 10.2%, over the $27.2 million recorded for the year ended December 31,2006.  The increase was due primarily toan increase in the weighted-average cost of deposits of 43 basis points, to4.17% for 2007, partially offset by a decrease of $8.6 million, or 1.2%, in theaverage balance of deposits outstanding for the year ended December 31,2007 compared to the year ended December 31, 2006.  The increase in the average cost of depositswas primarily due to the increase in market interest rates, as well asadvertised special rates on certificates of deposits throughout the year.  The decrease in the average balance ofdeposits was primarily due to the competitive Cincinnati market place.

 

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Interest expense on borrowings totaled $6.4million for 2007, a decrease of $2.8 million, or 30.4%, compared to the yearended December 31, 2006, due primarily to a $67.8 million, or 33.8%,decrease in the average balance of borrowings outstanding, partially offset bya 24 basis point increase in the average cost of borrowings for 2007.  During 2007, $100.0 million in fixed-rateconvertible FHLB advances were paid in full on their conversion date with nopenalty through the use of available cash and proceeds from bothmortgage-backed security repayments and loan sales and payments.

 

Asa result of the foregoing changes in interest income and interest expense, netinterest income decreased by $5.2 million, or 18.0%, during the year ended December 31,2007, compared to year ended December 31, 2006.  The interest rate spread amounted to 2.53%for 2007 compared to 2.84% for the year ended December 31, 2006.  The net interest margin totaled 2.69% and3.00% for the years ended December 31, 2007 and 2006, respectively.

 

# **Provision for Losses on Loans**

#  

Aprovision for losses on loans is charged to earnings to bring the totalallowance for loan losses to a level considered appropriate by management basedon historical loss experience, the volume and type of lending conducted by theBank, the status of past due principal and interest payments, general economicconditions, particularly as such conditions relate to the Bank’s market area,and other factors related to the collectibility of the Bank’s loanportfolio.  After considering the abovefactors, management recorded a provision for losses on loans of $24.5 millionin the fourth quarter of 2007, resulting in a total of $32.8 million for theyear ended December 31, 2007, compared to $17.5 million for the year endedDecember 31, 2006.  The largeprovision in the fourth quarter of 2007 reflects higher probable credit losseson primarily non-owner occupied residential loans and land developmentloans.  Nonperforming assets at September 30,2007 totaled $20.4 million, compared to $32.8 million at December 31,2007, while classified assets increased from $31.3 million at September 30,2007 to $40.6 million at December 31, 2007.

 

Theprovisions recorded during the 2007 and 2006 periods were predicated on highernon-performing, classified and criticized assets for the years, as well assignificant charge-offs during both years. The increase in such loans is primarily due to delinquent loans in theBank’s non-owner occupied (investment property) residential loan portfolio andits acquisition, development, and construction loan portfolio.  The delinquencies in these portfolios are dueprimarily to the residual effects of the deterioration in the local real estatemarket and resultant cash flow issues faced by local property investors anddevelopers.  The downturn in the localeconomy has also resulted in deterioration in other sectors of the portfolio,including multi-family residential loans and commercial loans. There can be noassurance that the allowance for loan losses will be sufficient to cover losseson nonperforming loans in the future.

 

# **Other Income**

#  

Otherincome totaled $3.9 million for the year ended December 31, 2007, anincrease of $719,000, or 22.4%, compared to the year ended December 31, 2006.  The increase was due primarily to a $428,000,or 17.2%, increase in other operating income, an increase of $33,000, or 4.8%,in income from bank-owned life insurance, and a $247,000 net gain on sale ofloans recorded during year 2007 compared to a net loss of $59,000 recordedduring year 2006 on the sale of loans and real estate.  The increase in other operating incomeresulted primarily from an increase of approximately $289,000 in deposit fees.  These increases were partially offset by adecrease in the gain on sale of securities of $47,000 during year 2007.

 

# **General, Administrative and OtherExpense**

#  

General,administrative and other expense totaled $33.2 million for the year ended December 31,2007, an increase of $12.0 million, or 57.0%, compared to the year ended December 31,2006.  This increase resulted primarilyfrom goodwill non-cash impairment charges of $11.4 million recorded in thefourth quarter of 2007 by the Bank following 

 

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anupdated valuation by an independent third party.  This impairment is primarily attributable tolower market valuations for financial institutions in the latter part of 2007,the weakening of the credit market in the second half of 2007, the decline inreal estate values, particularly in the Cincinnati region, and the net lossesrecorded by the Bank and Company for the past six quarters.

 

Excluding thegoodwill impairment, general, administrative and other expense increased$652,000, or 3.1%. Peoples recorded a $277,000, or 7.0%, increase in otheroperating expense, a $45,000, or 4.6%, increase in franchise tax, a $205,000,or 12.6%, increase in amortization of intangibles, and a $213,000, or 21.2%,increase in data processing expense. Employee compensation and benefits expense and occupancy and equipmentexpense remained relatively constant compared to the year ended December 31,2006.  During the fourth quarter of 2007,Peoples recorded approximately $508,000 in ESOP expense for the release of32,383 ESOP shares for employee allocation. This occurred inconjunction with the decision to terminate the ESOP by September 30, 2008and record associated expenses in 2008 to release all remaining unallocatedshares.

 

The increase in other operating expenses was due primarily to anincrease in legal and collection fees recorded during the year ended December 31,2007.  Data processing expenses increasedprimarily due to an increase in services utilized by customers and an overallprice increase.

 

# **Federal Income Taxes**

#  

Peoplesrecorded a credit provision for federal income taxes totaling $4.9 million forthe year ended December 31, 2007 compared to a credit provision of $2.3million for the year ended December 31, 2006.  The income tax benefit for both years was dueto net losses incurred in 2006 and 2007. A valuation allowance against deferred tax assets of approximately $4.4million was recorded in the fourth quarter of 2007.

 

**Exposure to Changes in Interest Rates**

 

Peoples’ability to maintain net interest income depends upon its ability to earn ahigher yield on interest-earning assets than the rates paid on deposits andborrowings.  The Bank’s ability tomaintain a positive spread between the interest earned on assets and theinterest paid on deposits and borrowings can be adversely affected when marketrates of interest fluctuate. Historically, long-term, fixed-rate mortgage loans made up a significantportion of Peoples’ interest-earning assets. A predominance of long-term fixed-rate loans would make Peoplesparticularly susceptible to the risk of changing interest rates, particularlyin a rising rate environment.  However,during fiscal 2000, the Bank began to emphasize the origination ofadjustable-rate mortgage (“ARM”) loans and shorter-term loans such asnon-residential real estate loans, construction loans, commercial loans andconsumer loans, in an effort to improve its interest rate risk position.  As a result, at December 31, 2008,approximately $219.0 million, or 47.4%, of Peoples’ loan portfolio consisted ofloans with fixed-rates of interest and approximately $242.9 million, or 52.6%,had adjustable-rates of interest. Further, nonresidential real estate and land loans, construction loans,commercial loans and consumer loans totaled $175.6 million or 33.0% of thetotal loan portfolio at December 31, 2008. These loans typically have higher rates and/or shorter terms to maturitycompared to single-family residential mortgage loans.

 

**Quantitative Analysis**

 

The OTSprovides a quarterly report on the potential impact of interest rate changesupon the net portfolio value (“NPV”) of the Bank.  Management reviews the quarterly reports fromthe OTS that show the impact of changing interest rates on NPV.  Net portfolio value is the difference betweenincoming and outgoing discounted cash flows from assets, liabilities, andoff-balance sheet contracts.  The applicationof the methodology attempts to quantify interest rate risk and the change inNPV which would result from a theoretical increase or decrease in marketinterest rates.

 

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The following tables present the Bank’s net portfolio value as of December 31,2008 and December 31, 2007, based on information provided to the OTS bythe Bank.

 
| **December 31, 2008** | ** ** |
|---------------------------------|------------|
| ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Change in** | ** ** |
| ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **NPV as a** | ** ** |
| ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **NPV as a** | ** ** | **Percentage of** | ** ** |
| **Change in**              | ** ** | ** ** | ** ** | **Change in** | ** ** | **Percentage** | ** ** | **Percentage of** | ** ** | **the Present** | ** ** |
| **Interest Rates**         | ** ** | **NPV** | ** ** | **NPV** | ** ** | **Change in** | ** ** | **the Present** | ** ** | **Value of Assets** | ** ** |
| **(In basis points)** | ** ** | **(In thousands)** | ** ** | **(In thousands)** | ** ** | **NPV** | ** ** | **Value of Assets** | ** ** | **(In basis points)** | ** ** |
|                            |       |   |   |   |   |   |   |   |   |   |   |
| +300                            | bp         | $ | 10,136 |   | $ | 516 |   | +5 | % | 1.42 | % | +10 | bp |
| +200                            |       | 12,651 |   | 3,031 |   | +32 |   | 1.76 |   | +44 |   |
| +100                            |       | 12,340 |   | 2,720 |   | +28 |   | 1.71 |   | +38 |   |
| +50                             |       | 11,133 |   | 1,513 |   | +16 |   | 1.53 |   | +21 |   |
| 0                               |       | 9,620 |   | — |   | — |   | 1.32 |   | — |   |
| -50                             |       | 6,975 |   | -2,645 |   | -27 |   | 0.96 |   | -36 |   |
| -100                            |       | 4,143 |   | -5,477 |   | -57 |   | 0.57 |   | -75 |   |
|                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |

 
| **December 31, 2007** | ** ** |
|---------------------------------|------------|
| ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Change in** | ** ** |
| ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **NPV as a** | ** ** |
| ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **NPV as a** | ** ** | **Percentage of** | ** ** |
| **Change in**              | ** ** | ** ** | ** ** | **Change in** | ** ** | **Percentage** | ** ** | **Percentage of** | ** ** | **the Present** | ** ** |
| **Interest Rates**         | ** ** | **NPV** | ** ** | **NPV** | ** ** | **Change in** | ** ** | **the Present** | ** ** | **Value of Assets** | ** ** |
| **(In basis points)** | ** ** | **(In thousands)** | ** ** | **(In thousands)** | ** ** | **NPV** | ** ** | **Value of Assets** | ** ** | **(In basis points)** | ** ** |
|                            |       |   |   |   |   |   |   |   |   |   |   |
| +300                            | bp         | $ | 74,391 |   | $ | -20,246 |   | -21 | % | 8.54 | % | -199 | bp |
| +200                            |       | 83,308 |   | -11,329 |   | -12 |   | 9.45 |   | -108 |   |
| +100                            |       | 90,606 |   | -4,030 |   | -4 |   | 10.17 |   | -37 |   |
| +50                             |       | 92,980 |   | -1,657 |   | -2 |   | 10.39 |   | -14 |   |
| 0                               |       | 94,637 |   | — |   | — |   | 10.53 |   | — |   |
| -50                             |       | 95,428 |   | 791 |   | 1 |   | 10.59 |   | 5 |   |
| -100                            |       | 95,789 |   | 1,153 |   | 1 |   | 10.59 |   | 6 |   |
|                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

As shown by the 2008 table above, an increase in market interest rateswould result in an increase in the Bank’s net portfolio value as of December 31,2008.  Conversely, the 2008 tableindicates a decrease in market interest rates would result in a decrease in theBank’s net portfolio value as of December 31, 2008.  The instantaneous shock as indicated in thetables is subject to periodic interest rate adjustments and caps as dictated bythe underlying notes.

 

The Bank’s fixed-rate loans help its profitability if interest ratesare stable or declining, since these loans have yields that exceed its cost offunds.  However, if interest ratesincrease, the Bank would have to pay more on its deposits and new borrowings,which would adversely affect its interest rate spread against fixed rateloans.  Historically, the Bank has beenable to maintain relatively stable levels of net interest income despite theinterest rate risk inherent in its operations.

 

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The Bank attempts to mitigate potential exposure to interest rate riskby:

 

1)              Originating one-year and three-yearadjustable-rate mortgage loans;

2)              Originating home equitylines of credit with interest rates that adjust monthly based on an index;

3)              Purchasing adjustable-ratemortgage-backed securities;

4)              Utilizing fixed-ratelonger-term advances offered by the Federal Home Loan Bank; and

5)              Developinga strong core deposit base.

 

As of December 31, 2008, the estimated percentage change in NPVfor declining rate scenarios is in excess of the limits established in the Bank’sAsset/Liability Management policy. Similarly, the Bank’s NPV as a percentage of the present value of assetshas fallen below Bank policy minimums for all rate scenarios illustrated in theDecember 31, 2008 table above.  Thiscondition is primarily due to the decrease in the Bank’s capital.

 

**Liquidity and Capital Resources**

 

The Bank, like other financial institutions, is required underapplicable federal regulations to maintain sufficient funds to meet depositwithdrawals, loan commitments and expenses. Liquid assets consist of cash and interest-bearing deposits in otherfinancial institutions, investments and mortgage-backed securities.  Management monitors and assesses liquidityneeds daily in order to meet deposit withdrawals, loan commitments andexpenses.

 

Theprimary sources of funds include deposits, principal and interest repayments onloans and on mortgage-backed securities and borrowings.  The Bank’s first preference is to fundliquidity needs with core deposits in its local market.  Core deposits include noninterest-bearing andinterest-bearing retail deposits.  Otherfunding sources include Federal Home Loan Bank advances.

 

Liquidassets as of December 31, 2008, included cash and deposits in otherfinancial institutions totaling $72.0 million, in addition to investmentsecurities and mortgage-backed securities available for sale at a total marketvalue of $101.0 million.  These liquidassets as well as the ability to borrow funds, sell loan participations andattract deposits through local pricing or through brokers will allow the Bankto meet its obligations and commitments as indicated in the table below.  Any future excess liquidity generated viaoperations will be utilized to repay borrowings or purchase investment andmortgage-backed securities.

 

TheCompany is a thrift holding company and its sources of funds are limited.  Cash available to pay dividends tostockholders of the Company and to service the debt of the Company is largelydependent on the receipt of dividends from the Bank.  The Orders prohibit the Bank from paying cashdividends to the Company without the prior written consent of the OTS.  The Company has no expectation that the OTSwill permit such dividends from the Bank. Further, current cash flows and capital resources of the Company havebeen insufficient to fund the Company’s operating expenses and to meet its debtservice obligations on the junior subordinated debentures or to pay off the$17.5 million line of credit which was due on June 30, 2008.  Peoples is actively evaluating variousfunding strategies to meet its obligations, including restructuring itsoutstanding debt and selling branch offices. See “Overview and Recent Regulatory Matters” beginning on page 6herein.  Any increase in the Company’soutstanding indebtedness will also require OTS approval.  The Company cannot provide assurance that itwill succeed in obtaining funds to meet its financial obligations.  Failure to do so will have a material adverseeffect on, and impair Peoples’ business, financial condition and ability tooperate as a going concern.

 

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The following table sets forth information regarding Peoples’obligations and commitments to make future payments under contract as of December 31,2008.

 
| ** **                                                                 | ** ** | **Payments due by period** | ** **  |
|----------------------------------------------------------------------------|------------|-------------------------------------------|-------------|
| ** **                                                                 | ** ** | **Less**                                  | ** **  | ** ** | ** ** | ** ** | ** ** | **More** | ** ** | ** ** | ** ** |
| ** **                                                                 | ** ** | **than**                                  | ** **  | **1-3** | ** ** | **3-5** | ** ** | **than** | ** ** | ** ** | ** ** |
| ** **                                                                 | ** ** | **1 year**                                | ** **  | **years** | ** ** | **years** | ** ** | **5 years** | ** ** | **Total** | ** ** |
| ** **                                                                 | ** ** | **(In thousands)**                   | ** **  |
|                                                                       |       |                                      |        |   |   |   |   |   |   |   |   |
| Contractual  obligations:                                                  |       |                                      |        |   |   |   |   |   |   |   |   |
| Operating lease  obligations                                               |       | $                                         | 38          |   | $ | 77 |   | $ | 45 |   | $ | — |   | $ | 160 |   |
| Advances from  the Federal Home Loan Bank and other borrowings             |       | 20,472                                    |        | 2 |   | 1,971 |   | 54,062 |   | 76,507 |   |
| Subordinated  debentures                                                   |       | —                                    |        | — |   | — |   | 15,464 |   | 15,464 |   |
| Certificates of  deposit                                                   |       | 304,468                                   |        | 84,613 |   | 38,901 |   | — |   | 427,982 |   |
|                                                                       |       |                                      |        |   |   |   |   |   |   |   |   |
| Amount of  commitments expiring per period Commitments to originate loans: |       |                                      |        |   |   |   |   |   |   |   |   |
| Consumer lines  of credit                                                  |       | 519                                       |        | — |   | — |   | — |   | 519 |   |
| Commercial lines  of credit                                                |       | 511                                       |        | — |   | — |   | — |   | 511 |   |
| One-to-four  family and multi-family loans                                 |       | 23,303                                    |        | — |   | — |   | — |   | 23,303 |   |
| Commitments to  fund commercial or other:                                  |       |                                      |        |   |   |   |   |   |   |   |   |
| Letters of  credit                                                         |       | 5,723                                     |        | — |   | — |   | — |   | 5,723 |   |
|                                                                       |       |                                      |        |   |   |   |   |   |   |   |   |
| Total  contractual obligations                                             | ** ** | **$**                                     | **355,034** | ** ** | **$** | **84,692** | ** ** | **$** | **40,917** | ** ** | **$** | **69,526** | ** ** | **$** | **550,169** | ** ** |
|                                                                            |            |                                           |             |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

TheBank is required to maintain regulatory capital sufficient to meet tangible,core and risk-based capital ratios of at least 1.5%, 4.0% and 8.0%,respectively.  At December 31, 2008,the Bank did not meet two of its capital requirements with tangible, core andrisk-based capital ratios of 2.3%, 2.3% and 4.8%, respectively.  In addition, at such date, the Bank wasdeemed a significantly undercapitalized institution under the framework forprompt corrective action.  On April 30,2009, the Bank filed its Thrift Financial Report for the quarter ended March31, 2009. This report reflected the Bank’s capital under the framework forprompt corrective action at the “critically undercapitalized” level.  As a result, the Bank is subject to numerousoperational restrictions and requirements, including the requirement to file acapital restoration plan to return to an adequately capitalized status.  The Company and the Bank are currently innegotiations concerning a transaction to sell certain branches of the Bank, theproposed results of which are the basis for the Bank’s capital restorationplan, as filed with the OTS on April 30, 2009.  The Bank intends to negotiate and enter untoa transaction to sell certain branches in order to reduce assets andliabilities, generate a deposit premium and return the Bank to an adequatelycapitalized status.  The Company cannotprovide assurance that such a transaction will be entered into or consummatedor that the Bank’s capital restoration plan will be acceptable to the OTS.  If the Bank’s capital plan is not approved bythe OTS or the Bank cannot enter into and consummate a transaction to returnthe Bank to an adequately capitalized status on a timely basis, the Companywill not be able to continue as a going concern.

 

Fora further discussion of the Company’s and the Bank’s regulatory enforcement actions,see “Overview and Recent Regulatory Matters” beginning on page 6 herein.

 

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**Impact of Inflation and Changing Prices**

 

The consolidated financial statements andrelated financial data presented herein regarding Peoples have been prepared inaccordance with accounting principles generally accepted in the United Statesof America, which generally require the measurement of financial position andoperating results in terms of historical dollars, without considering changesin relative purchasing power over time due to inflation.  Unlike most industrial companies, virtually allof Peoples’ assets and liabilities are monetary in nature.  As a result, interest rates generally have amore significant impact on Peoples’ performance than does the effect ofinflation.  Interest rates do notnecessarily move in the same direction or in the same magnitude as the pricesof goods and services, since such prices are affected by inflation to a largerextent than interest rates.

 

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**Report ofIndependent Registered Public Accounting Firm**

 

Tothe Board of Directors and Stockholders

PeoplesCommunity Bancorp, Inc.

 

Wehave audited the accompanying consolidated statement of financial condition ofPeoples Community Bancorp, Inc. as of December 31, 2008, and therelated consolidated statements of operations, comprehensive income (loss),stockholders’ equity, and cash flows for the year then ended.  These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audit.

 

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements.  An audit alsoincludes assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statementpresentation. We believe that our audit provides a reasonable basis for ouropinion.

 

Inour opinion, the financial statements referred to above present fairly, in allmaterial respects, the consolidated financial position of Peoples CommunityBancorp, Inc. as of December 31, 2008 and the consolidated results ofits operations and its cash flows for the year then ended, in conformity withaccounting principles generally accepted in the United States of America.

 

Theaccompanying financial statements have been prepared assuming the Company willcontinue as a going concern. As discussed in Note L to the financial statements,at December 31, 2008, the Company’s wholly-owned Bank, Peoples CommunityBank, is considered to be significantly undercapitalized. The Bank is requiredto file a capital restoration plan with the Office of Thrift Supervision (OTS)outlining its plans for attaining the required levels of regulatory capital.Failure to meet the capital requirements and capital targets included in thecapital plan would expose the Bank to significant regulatory sanctions.  The Company also has suffered significantlosses from operations. These matters raise substantial doubt about the abilityof the Company to continue as a going concern. Management’s plans in regard tothese matters are described in Note P. The accompanying financial statements donot include any adjustments that might result from the outcome of thisuncertainty.

 

 

April 30,2009

Columbus,Ohio

 

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|  | 312 Walnut Street, Suite 3000  Cincinnati, OH 45202-4025  513.621.8300 Fax 513.621.8345 **www.bkd.com** |
|--|---------------------------------------------------------------------------------------------------------|

 

**Report of Independent Registered Public Accounting Firm**

 

AuditCommittee, Board of Directors and Stockholders

PeoplesCommunity Bancorp, Inc.

WestChester, Ohio

 

Wehave audited the accompanying consolidated statement of financial condition ofPeoples Community Bancorp, Inc. as of December 31, 2007, and therelated consolidated statements of operations,comprehensive income (loss), stockholders’equity and cash flows for each of the years ended December 31, 2007 and2006. The Company’s management is responsible for these financial statements.Our responsibility is to express an opinion on these financial statements basedon our audits.

 

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audits to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. The Company is notrequired to have, nor were we engaged to perform, an audit of its internalcontrol over financial reporting. Our audits included consideration of internalcontrol over financial reporting as a basis for designing auditing proceduresthat are appropriate in the circumstances, but not for the purpose of expressing an opinion on theeffectiveness of the Company’s internal control over financial reporting.Accordingly, we express no such opinion. Our audits also includedexamining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements, assessing the accounting principlesused and significant estimates made by management and evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

 

Inour opinion, the consolidated financial statements referred to above present fairly,in all material respects, the financial position of Peoples Community Bancorp,Inc. as of December 31, 2007, and the results of its operations and itscash flows for the years ended December 31, 2007 and 2006, in conformitywith accounting principles generally accepted in the United States of America.

 

Theaccompanying financial statements have been preparedassuming the Company will continue as a going concern. As discussed in Note P,the Company has suffered recurring losses from operations and will operateunder restrictions set forth by theformal agreements with the Company’s andBank’s federal regulators, which result in uncertainty about the Company’sability to meet obligations coming due in 2008. These factors raise substantialdoubt about its ability to continue as a going concern. Management’s plans inregards to these matters are also described in Note P. The financial statementsdo not include any adjustments that might result from the outcomeof this uncertainty.

 
|                 | /s/**BKD,****LLP** |
|----------------------|--------------------|
|                 | ** **         |
| Cincinnati,  Ohio    |               |
| April 15,  2008 |               |

 
| **** |  |
|------|--|

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION**

 

(In thousands, except share data)

 
| ** **                                                                                                                                                                                   | ** ** | **For Years Ended December 31,** | ** **  |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|-------------|
| ** **                                                                                                                                                                                   | ** ** | **2008**                                             | ** **  | **2007** | ** ** |
| **ASSETS**                                                                                                                                                                                   |       |                                                 |        |   |   |
| ** **                                                                                                                                                                                   |       |                                                 |        |   |   |
| Cash and due  from banks                                                                                                                                                                     |       | $                                                    | 11,133      |   | $ | 16,117 |   |
| Federal funds  sold                                                                                                                                                                          |       | —                                               |        | 67,000 |   |
| Interest-bearing  deposits in other financial institutions                                                                                                                                   |       | 60,882                                               |        | 3,497 |   |
| Cash and cash  equivalents                                                                                                                                                                   |       | 72,015                                               |        | 86,614 |   |
|                                                                                                                                                                                         |       |                                                 |        |   |   |
| Securities  designated as available for sale                                                                                                                                                 |       | 100,952                                              |        | 67,572 |   |
| Loans receivable  - net                                                                                                                                                                      |       | 461,861                                              |        | 634,421 |   |
| Office premises  and equipment                                                                                                                                                               |       | 26,671                                               |        | 27,795 |   |
| Real estate held  for sale                                                                                                                                                                   |       | 510                                                  |        | 510 |   |
| Real estate  acquired through foreclosure                                                                                                                                                    |       | 10,176                                               |        | 6,915 |   |
| Federal Home  Loan Bank stock                                                                                                                                                                |       | 14,549                                               |        | 14,024 |   |
| Accrued interest  receivable                                                                                                                                                                 |       | 2,941                                                |        | 4,295 |   |
| Bank-owned life  insurance                                                                                                                                                                   |       | 18,566                                               |        | 17,812 |   |
| Prepaid expenses  and other assets                                                                                                                                                           |       | 1,336                                                |        | 1,906 |   |
| Goodwill                                                                                                                                                                                     |       | —                                               |        | 12,514 |   |
| Intangible  assets                                                                                                                                                                           |       | 2,838                                                |        | 4,232 |   |
| Deferred federal  income taxes                                                                                                                                                               |       | —                                               |        | 8,816 |   |
| ** **                                                                                                                                                                                   | ** ** | ** **                                           | ** **  | ** ** | ** ** |
| Total assets                                                                                                                                                                                 | ** ** | **$**                                                | **712,415** | ** ** | **$** | **887,426** | ** ** |
|                                                                                                                                                                                         | ** ** | ** **                                           | ** **  | ** ** | ** ** |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY (DEFICIT)**                                                                                                                                     |       |                                                 |        |   |   |
| ** **                                                                                                                                                                                   |       |                                                 |        |   |   |
| Deposits                                                                                                                                                                                     |       | $                                                    | 630,198     |   | $ | 735,212 |   |
| Advances from  the Federal Home Loan Bank and other borrowings                                                                                                                               |       | 76,507                                               |        | 77,628 |   |
| Subordinated  debentures                                                                                                                                                                     |       | 15,464                                               |        | 15,464 |   |
| Accrued interest  payable                                                                                                                                                                    |       | 1,022                                                |        | 382 |   |
| Other  liabilities                                                                                                                                                                           |       | 4,069                                                |        | 5,175 |   |
| Total  liabilities                                                                                                                                                                           |       | 727,260                                              |        | 833,861 |   |
|                                                                                                                                                                                         |       |                                                 |        |   |   |
| Commitments and  contingent liabilities                                                                                                                                                      |       | —                                               |        | — |   |
|                                                                                                                                                                                         |       |                                                 |        |   |   |
| Stockholders’  equity (deficit) Common stock - 15,000,000 shares of $.01 par value  authorized; 4,844,489 and 4,838,964 shares issued at December 31, 2008  and 2007, respectively |       | 48                                                   |        | 48 |   |
| Additional  paid-in capital                                                                                                                                                                  |       | 71,345                                               |        | 71,136 |   |
| Accumulated  deficit                                                                                                                                                                         |       | (85,879                                              | )           | (17,364 | ) |
| Shares acquired  by stock benefit plan                                                                                                                                                       |       | —                                               |        | (295 | ) |
| Accumulated  comprehensive income (loss)                                                                                                                                                     |       | (359                                                 | )           | 40 |   |
| Total  stockholders’ equity (deficit)                                                                                                                                                   |       | (14,845                                              | )           | 53,565 |   |
|                                                                                                                                                                                         |       |                                                 |        |   |   |
| Total  liabilities and stockholders’ equity (deficit)                                                                                                                                   | ** ** | **$**                                                | **712,415** | ** ** | **$** | **887,426** | ** ** |

 

The accompanying notes are an integral part ofthese statements.

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**CONSOLIDATED STATEMENTS OF OPERATIONS**

 

(In thousands, except share data)

 
| ** **                                                      | ** ** | **For Years Ended December 31,** | ** **  |
|-----------------------------------------------------------------|------------|------------------------------------------------------|-------------|
|                                                            |       | **2008**                                             |        | **2007** | ** ** | **2006** |   |
| Interest income                                                 |       |                                                 |        |   |   |   |   |
| Loans                                                           |       | $                                                    | 35,446      |   | $ | 53,390 |   | $ | 61,096 |   |
| Mortgage-backed  securities                                     |       | 1,430                                                |        | 2,394 |   | 2,467 |   |
| Investment  securities                                          |       | 1,030                                                |        | 1,100 |   | 951 |   |
| Interest-bearing  deposits and other                            |       | 2,331                                                |        | 3,349 |   | 961 |   |
| Total interest  income                                          |       | 40,237                                               |        | 60,233 |   | 65,475 |   |
|                                                            |       |                                                 |        |   |   |   |   |
| Interest expense                                                |       |                                                 |        |   |   |   |   |
| Deposits                                                        |       | 22,051                                               |        | 30,028 |   | 27,239 |   |
| Borrowings                                                      |       | 4,186                                                |        | 6,432 |   | 9,246 |   |
| Total interest  expense                                         |       | 26,237                                               |        | 36,460 |   | 36,485 |   |
|                                                            |       |                                                 |        |   |   |   |   |
| Net interest  income                                            |       | 14,000                                               |        | 23,773 |   | 28,990 |   |
|                                                            |       |                                                 |        |   |   |   |   |
| Provision for  losses on loans                                  |       | 41,477                                               |        | 32,800 |   | 17,450 |   |
|                                                            |       |                                                 |        |   |   |   |   |
| Net interest  income (loss) after provision for losses on loans |       | (27,477                                              | )           | (9,027 | ) | 11,540 |   |
|                                                            |       |                                                 |        |   |   |   |   |
| Other income                                                    |       |                                                 |        |   |   |   |   |
| Gain (loss) on  sale of investment securities                   |       | 558                                                  |        | 53 |   | 100 |   |
| Gain (loss) on  sale of branch premises and equipment           |       | —                                               |        | — |   | (21 | ) |
| Gain (loss) on  sale of loans                                   |       | (3,855                                               | )           | 326 |   | 9 |   |
| Gain (loss) on  sale of foreclosed real estate                  |       | 4                                                    |        | (81 | ) | (47 | ) |
| Income from  bank-owned life insurance                          |       | 754                                                  |        | 719 |   | 685 |   |
| Other operating                                                 |       | 2,253                                                |        | 2,915 |   | 2,487 |   |
| Total other  income (loss)                                      |       | (286                                                 | )           | 3,932 |   | 3,213 |   |
|                                                            |       |                                                 |        |   |   |   |   |
| General,  administrative and other expense                      |       |                                                 |        |   |   |   |   |
| Employee  compensation and benefits                             |       | 8,727                                                |        | 9,988 |   | 10,058 |   |
| Occupancy and  equipment                                        |       | 3,130                                                |        | 3,487 |   | 3,505 |   |
| Franchise taxes                                                 |       | 583                                                  |        | 1,020 |   | 975 |   |
| Data processing                                                 |       | 1,240                                                |        | 1,217 |   | 1,004 |   |
| Amortization of  intangibles                                    |       | 1,394                                                |        | 1,838 |   | 1,633 |   |
| Goodwill  impairment                                            |       | 12,514                                               |        | 11,397 |   | — |   |
| Other operating                                                 |       | 6,259                                                |        | 4,224 |   | 3,947 |   |
| Total general,  administrative and other expense                |       | 33,847                                               |        | 33,171 |   | 21,122 |   |
|                                                            |       |                                                 |        |   |   |   |   |
| Loss before  income taxes                                       |       | (61,610                                              | )           | (38,266 | ) | (6,369 | ) |
|                                                            |       |                                                 |        |   |   |   |   |
| Federal income  taxes (benefits)                                |       |                                                 |        |   |   |   |   |
| Current                                                         |       | —                                               |        | 774 |   | (817 | ) |
| Deferred                                                        |       | 6,905                                                |        | (5,707 | ) | (1,491 | ) |
| Total federal  income taxes (benefits)                          |       | 6,905                                                |        | (4,933 | ) | (2,308 | ) |
|                                                            |       |                                                 |        |   |   |   |   |
| Net loss                                                        | ** ** | **$**                                                | **(68,515** | **)** | **$** | **(33,333** | **)** | **$** | **(4,061** | **)** |
|                                                            | ** ** | ** **                                           | ** **  | ** ** | ** ** | ** ** | ** ** |
| Loss per share                                                  |       |                                                 |        |   |   |   |   |
| Basic                                                           | ** ** | **$**                                                | **(14.17**  | **)** | **$** | **(6.97** | **)** | **$** | **(.88** | **)** |
| Diluted                                                         | ** ** | **$**                                                | **(14.17**  | **)** | **$** | **(6.97** | **)** | **$** | **(.88** | **)** |

 

The accompanying notes are an integral part ofthese statements.

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**CONSOLIDATED STATEMENTS OFCOMPREHENSIVE INCOME (LOSS)**

 

(In thousands)

 
| ** **                                                                                                                                                                                                | ** ** | **For Years Ended December 31,** | ** **  |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|-------------|
| ** **                                                                                                                                                                                                | ** ** | **2008**                                             | ** **  | **2007** | ** ** | **2006** | ** ** |
|                                                                                                                                                                                                      |       |                                                 |        |   |   |   |   |
| Net loss                                                                                                                                                                                                  |       | $                                                    | (68,515     | ) | $ | (33,333 | ) | $ | (4,061 | ) |
|                                                                                                                                                                                                      |       |                                                 |        |   |   |   |   |
| Other  comprehensive income (loss), net of tax:                                                                                                                                                           |       |                                                 |        |   |   |   |   |
| Unrealized  holding gains (losses) on securities during the period, net of tax effects  (benefits) of $0, $109, and $120 in years ended December 31, 2008, 2007,  and 2006 respectively              |       | 159                                                  |        | 211 |   | 234 |   |
|                                                                                                                                                                                                      |       |                                                 |        |   |   |   |   |
| Reclassification  adjustment for realized losses (gains) included in earnings, net of tax (effects)  benefits of $0, $(18), and $(34) in years ended December 31, 2008, 2007,  and 2006 respectively |       | (558                                                 | )           | (35 | ) | (66 | ) |
|                                                                                                                                                                                                      |       |                                                 |        |   |   |   |   |
| Comprehensive  income (loss)                                                                                                                                                                              | ** ** | **$**                                                | **(68,914** | **)** | **$** | **(33,157** | **)** | **$** | **(3,893** | **)** |
|                                                                                                                                                                                                      | ** ** | ** **                                           | ** **  | ** ** | ** ** | ** ** | ** ** |
| Accumulated  comprehensive income (loss)                                                                                                                                                                  | ** ** | **$**                                                | **(359**    | **)** | **$** | **40** | ** ** | **$** | **(136** | **)** |

 

The accompanying notes are an integral part ofthese statements.

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**CONSOLIDATED STATEMENTS OFSTOCKHOLDERS’ EQUITY (DEFICIT)**

 

(Inthousands)

 
| ** **                                                                                     | ** ** | ** ** | ** ** | ** **     | ** ** | ** **    | ** ** | **Shares**        | ** ** | ** **             | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------------------------------|------------|------------|------------|----------------|------------|---------------|------------|-------------------|------------|------------------------|------------|------------|------------|
| ** **                                                                                     | ** ** | ** ** | ** ** | ** **     | ** ** | ** **    | ** ** | **acquired**      | ** ** | **Accumulated**        | ** ** | ** ** | ** ** |
| ** **                                                                                     | ** ** | ** ** | ** ** | **Additional** | ** ** | **Retained**  | ** ** | **by stock** | ** ** | **Other**              | ** ** | ** ** | ** ** |
| ** **                                                                                     | ** ** | **Common** | ** ** | **paid-in**    | ** ** | **earnings**  | ** ** | **benefit**       | ** ** | **Comprehensive**      | ** ** | ** ** | ** ** |
| ** **                                                                                     | ** ** | **stock**  | ** ** | **capital**    | ** ** | **(deficit)** | ** ** | **plan**          | ** ** | **Income (Loss)** | ** ** | **Total**  | ** ** |
|                                                                                           |       |       |       |           |       |          |       |              |       |                   |       |       |       |
| Balance at  January 1, 2006                                                               |       | $          | 44         |           | $          | 62,945        |       | $                 | 24,785     |                   | $          | (1,423     | )          | $ | (304 | ) | $ | 86,047 |   |
|                                                                                           |       |       |       |           |       |          |       |              |       |                   |       |       |       |
| Amortization  expense of stock benefit plans                                                   |       | —     |       | 235            |       | —        |       | 211               |       | —                 |       | 446        |       |
| Compensation  expense relating to vested stock options                                         |       | —     |       | 170            |       | —        |       | —            |       | —                 |       | 170        |       |
| Exercise of  stock options                                                                     |       | —     |       | 46             |       | —        |       | —            |       | —                 |       | 46         |       |
| Issuance of  common shares                                                                     |       | 4          |       | 7,591          |       | —        |       | —            |       | —                 |       | 7,595      |       |
| Net losses for  the year ended December 31, 2006                                          |       | —     |       | —         |       | (4,061        | )          | —            |       | —                 |       | (4,061     | )          |
| Dividends paid  of $.60 per common share                                                       |       | —     |       | —         |       | (2,795        | )          | —            |       | —                 |       | (2,795     | )          |
| Unrealized  losses on securities designated as available for sale, net of related tax  effects |       | —     |       | —         |       | —        |       | —            |       | 168                    |       | 168        |       |
|                                                                                           |       |       |       |           |       |          |       |              |       |                   |       |       |       |
| Balance at  December 31, 2006                                                             |       | $          | 48         |           | $          | 70,987        |       | $                 | 17,929     |                   | $          | (1,212     | )          | $ | (136 | ) | $ | 87,616 |   |
|                                                                                           |       |       |       |           |       |          |       |              |       |                   |       |       |       |
| Amortization  expense of stock benefit plans                                                   |       | —     |       | 5              |       | —        |       | 917               |       | —                 |       | 922        |       |
| Compensation  expense relating to vested stock options                                         |       | —     |       | 137            |       | —        |       | —            |       | —                 |       | 137        |       |
| Adjustment  related to FIN 48                                                                  |       | —     |       | —         |       | 180           |       | —            |       | —                 |       | 180        |       |
| Exercise of  stock options                                                                     |       | —     |       | 7              |       | —        |       | —            |       | —                 |       | 7          |       |
| Net losses for  the year ended December 31, 2007                                          |       | —     |       | —         |       | (33,333       | )          | —            |       | —                 |       | (33,933    | )          |
| Dividends paid  of $.45 per common share                                                       |       | —     |       | —         |       | (2,140        | )          | —            |       | —                 |       | (2,140     | )          |
| Unrealized gains  on securities designated as available for sale, net of related tax effects   |       | —     |       | —         |       | —        |       | —            |       | 176                    |       | 176        |       |
|                                                                                           |       |       |       |           |       |          |       |              |       |                   |       |       |       |
| Balance at  December 31, 2007                                                             |       | $          | 48         |           | $          | 71,136        |       | $                 | (17,364    | )                      | $          | (295       | )          | $ | 40 |   | $ | 53,565 |   |
|                                                                                           |       |       |       |           |       |          |       |              |       |                   |       |       |       |
| Amortization  expense of stock benefit plans                                                   |       | —     |       | 84             |       | —        |       | 295               |       | —                 |       | 379        |       |
| Compensation  expense relating to vested stock options                                         |       | —     |       | 125            |       | —        |       | —            |       | —                 |       | 125        |       |
| Net losses for the  year ended December 31, 2008                                          |       | —     |       | —         |       | (68,515       | )          | —            |       | —                 |       | (68,515    | )          |
| Unrealized gains  on securities designated as available for sale, net of related tax effects   |       | —     |       | —         |       | —        |       | —            |       | (399                   | )          | (399       | )          |
|                                                                                           |       |       |       |           |       |          |       |              |       |                   |       |       |       |
| Balance at  December 31, 2008                                                             |       | $          | 48         |           | $          | 71,345        |       | $                 | (85,879    | )                      | $          | —     |       | $ | (359 | ) | $ | (14,845 | ) |

 

Theaccompanying notes are an integral part of these statements.

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**CONSOLIDATED STATEMENTS OFCASH FLOWS**

 

(In thousands)

 
| ** **                                                                                                    | ** ** | **For Years Ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                                                    | ** ** | **2008**                                        | ** ** | **2007** | ** ** | **2006** | ** ** |
| Cash flows  provided by (used in) operating activities:                                                       |       |                                            |       |   |   |   |   |
| Net loss for the  year                                                                                        |       | $                                               | (68,515    | ) | $ | (33,333 | ) | $ | (4,061 | ) |
| Adjustments to  reconcile net loss to net cash provided by (used in) operating activities:                    |       |                                            |       |   |   |   |   |
| Amortization of  premiums and discounts on securities                                                         |       | (167                                            | )          | 90 |   | 628 |   |
| Amortization of  deferred loan origination fees & premiums                                           |       | 1,040                                           |       | (131 | ) | (948 | ) |
| Amortization of  premiums and discounts on deposits                                                           |       | —                                          |       | (16 | ) | (424 | ) |
| Amortization of  premiums and discounts on borrowings                                                         |       | 38                                              |       | 104 |   | 159 |   |
| Expense of stock  benefit plans                                                                               |       | 504                                             |       | 1,059 |   | 616 |   |
| Amortization of  other intangible assets                                                                      |       | 1,394                                           |       | 1,671 |   | 1,633 |   |
| Amortization of  mortgage servicing rights                                                                    |       | 165                                             |       | 165 |   | 101 |   |
| Goodwill  impairment                                                                                          |       | 12,514                                          |       | 11,397 |   | — |   |
| Depreciation                                                                                                  |       | 1,131                                           |       | 1,348 |   | 1,407 |   |
| Provision for  losses on loans                                                                                |       | 41,477                                          |       | 32,800 |   | 17,450 |   |
| Investment  securities dividends                                                                              |       | (57                                             | )          | (52 | ) | (57 | ) |
| Federal Home  Loan Bank stock dividends                                                                       |       | (525                                            | )          | — |   | (664 | ) |
| Income from  bank-owned life insurance                                                                        |       | (754                                            | )          | (719 | ) | (685 | ) |
| Undistributed  income from investment in Columbia                                                             |       | —                                          |       | — |   | (172 | ) |
| Loss (gain) on  sale of securities                                                                            |       | (558                                            | )          | (53 | ) | (100 | ) |
| Loss (gain) on  sale of branch premises and equipment                                                         |       | —                                          |       | — |   | 21 |   |
| Loss (gain) on  sale of loans                                                                                 |       | 3,855                                           |       | (326 | ) | (9 | ) |
| Gain on sale of  real estate                                                                                  |       | —                                          |       | (32 | ) | (9 | ) |
| Loss (gain)on  sale of foreclosed real estate                                                                 |       | (4                                              | )          | 113 |   | 56 |   |
| Write down of  real estate acquired through foreclosure                                                       |       | 130                                             |       | — |   | — |   |
| Proceeds from  sale of loans in the secondary market                                                          |       | 28,312                                          |       | 1,688 |   | 831 |   |
| Loans originated  for sale in the secondary market                                                            |       | (3,505                                          | )          | (1,663 | ) | (822 | ) |
| Increase (decrease)  in cash, due to changes in:                                                              |       |                                            |       |   |   |   |   |
| Accrued interest  receivable                                                                                  |       | 1,354                                           |       | 1,166 |   | (56 | ) |
| Prepaid expenses  and other assets                                                                            |       | 9,242                                           |       | (3,235 | ) | (770 | ) |
| Accrued interest  payable and other liabilities                                                               |       | (466                                            | )          | (8,288 | ) | 4,981 |   |
| Net cash  provided by operating activities                                                                    |       | 26,605                                          |       | 3,753 |   | 19,106 |   |
|                                                                                                          |       |                                            |       |   |   |   |   |
| Cash flows  provided by (used in) investing activities:                                                       |       |                                            |       |   |   |   |   |
| Sale of  investment in Columbia                                                                               |       | —                                          |       | — |   | 2,856 |   |
| Purchases of  investment securities and mortgage-backed securities                                            |       | (81,635                                         | )          | (29,801 | ) | — |   |
| Proceeds from  sale of investment securities and mortgage-backed securities designated as  available for sale |       | 29,444                                          |       | 61 |   | 1,635 |   |
| Principal  repayments on investment securities and mortgage-backed securities                                 |       | 19,173                                          |       | 19,349 |   | 22,425 |   |
| Proceeds from  sale of loans and loan participations                                                          |       | 69                                              |       | 32,000 |   | 34,635 |   |
| Principal  repayments (disbursements) on loans — net                                                     |       | 95,502                                          |       | 106,929 |   | 24,885 |   |
| Purchase of  office premises and equipment                                                                    |       | (11                                             | )          | (1,774 | ) | (4,035 | ) |
| Proceeds from  sale of branch premises and equipment                                                          |       | 4                                               |       | — |   | 15 |   |
| Redemption of  Federal Home Loan Bank stock                                                                   |       | —                                          |       | — |   | 473 |   |
| Proceeds from  sale of real estate acquired through foreclosure                                               |       | 2,423                                           |       | 165 |   | 830 |   |
| Cash received in  acquisition of Mercantile Financial Corporation - net                                       |       | —                                          |       | — |   | 11,123 |   |
|                                                                                                          |       |                                            |       |   |   |   |   |
| Net cash  provided by investing activities                                                                    |       | 64,969                                          |       | 126,929 |   | 94,842 |   |
|                                                                                                          |       |                                            |       |   |   |   |   |
| Net cash  provided by (used in) operating and investing activities (balance carried  forward)                 |       | $                                               | 91,574     |   | $ | 130,682 |   | $ | 113,948 |   |

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

 

(In thousands)

 
| ** **                                                                                    | ** ** | **For Years Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                    | ** ** | **2008**                                             | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net cash  provided by (used in) operating and investing activities (balance brought  forward) |       | $                                                    | 91,574     |   | $ | 130,682 |   | $ | 113,948 |   |
|                                                                                          |       |                                                 |       |   |   |   |   |
| Cash flows  provided by (used in) financing activities:                                       |       |                                                 |       |   |   |   |   |
| Net increase  (decrease) in deposit accounts                                                  |       | (105,014                                             | )          | (20,033 | ) | (19,627 | ) |
| Proceeds from  Federal Home Loan Bank advances and other borrowings                           |       | 1,000                                                |       | 29,550 |   | 97,500 |   |
| Repayment of  Federal Home Loan Bank advances and other borrowings                            |       | (2,159                                               | )          | (108,911 | ) | (140,284 | ) |
| Redemption of  subordinated debentures                                                        |       | —                                               |       | — |   | (12,887 | ) |
| Dividends paid  on common stock                                                               |       | —                                               |       | (2,140 | ) | (2,795 | ) |
| Proceeds from  exercise of stock options                                                      |       | —                                               |       | 7 |   | 46 |   |
| Shares acquired  by ESOP                                                                      |       | —                                               |       | — |   | — |   |
| Net cash used in  financing activities                                                        |       | (106,173                                             | )          | (101,527 | ) | (78,047 | ) |
|                                                                                          |       |                                                 |       |   |   |   |   |
| Net increase  (decrease) in cash and cash equivalents                                         |       | (14,599                                              | )          | 29,155 |   | 35,901 |   |
|                                                                                          |       |                                                 |       |   |   |   |   |
| Cash and cash  equivalents at beginning of period                                             |       | 86,614                                               |       | 7,459 |   | 1,558 |   |
|                                                                                          | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash and cash  equivalents at end of period                                                   | ** ** | **$**                                                | **72,015** | ** ** | **$** | **86,614** | ** ** | **$** | **57,459** | ** ** |
|                                                                                          |       |                                                 |       |   |   |   |   |
| Supplemental  disclosure of cash flow information:                                            |       |                                                 |       |   |   |   |   |
| Cash paid during  the year for:                                                               |       |                                                 |       |   |   |   |   |
| Federal income  taxes                                                                         | ** ** | **$**                                                | **—** | ** ** | **$** | **—** | ** ** | **$** | **380** | ** ** |
|                                                                                          | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest on  deposits and borrowings                                                          | ** ** | **$**                                                | **25,598** | ** ** | **$** | **36,655** | ** ** | **$** | **36,608** | ** ** |
|                                                                                          |       |                                                 |       |   |   |   |   |
| Supplemental  disclosure of noncash investing activities:                                     |       |                                                 |       |   |   |   |   |
| Transfers from  loans to real estate acquired through foreclosure                             | ** ** | **$**                                                | **5,810**  | ** ** | **$** | **6,860** | ** ** | **$** | **1,008** | ** ** |
|                                                                                          |       |                                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Loans disbursed  to facilitate sale of real estate                                            |       | $                                                    | —     | ** ** | **$** | **—** | ** ** | **$** | **308** | ** ** |
|                                                                                          | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Common stock  issued in acquisition of Mercantile Financial Corp.                             | ** ** | **$**                                                | **—** | ** ** | **$** | **—** | ** ** | **$** | **7,595** | ** ** |

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**NOTE A -SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

Peoples Community Bancorp, Inc. is a registeredsavings and loan holding company whose activities are primarily limited toholding the stock of Peoples Community Bank. Peoples conducts a general banking business in southwestern Ohio andsoutheastern Indiana which consists of attracting deposits from the generalpublic and primarily applying those funds to the origination of loans forresidential, consumer and nonresidential purposes.  Peoples’ profitability is significantlydependent on net interest income, which is the difference between interestincome generated from interest-earning assets (i.e. loans and investments) andthe interest expense paid on interest-bearing liabilities (i.e. customerdeposits and borrowed funds).  Netinterest income is affected by the relative amount of interest-earning assetsand interest-bearing liabilities and the interest received or paid on thesebalances.  The level of interest ratespaid or received by Peoples can be significantly influenced by a number offactors, such as governmental monetary policy, that are outside of management’scontrol.

 

On June 9, 2006, theCompany acquired Mercantile Financial Corporation (“Mercantile”) and the Bankacquired Mercantile Savings Bank which operated one branch office inCincinnati, Ohio.  The Bank paid $34.78in cash and exchanged 43.10 shares of stock for each of the outstanding commonshares of Mercantile,resulting in aggregate merger consideration of approximately $9.3 million,including acquisition costs.  Thisacquisition complemented the Bank’s market area, and increased its marketshare.

 

On August 25, 2006, the Board of Directorsapproved a change of the Company’s and the Bank’s fiscal year end from September 30to December 31, retroactive to January 1, 2006, in order to increaseoperational efficiency.

 

On December 29, 2006,the Company sold its 69,925 shares of Columbia Bancorp, Inc. for anaggregate sales price of $2.9 million. In conjunction with this divesture, the Company converted its charter toa registered savings and loan holding company.

 

The consolidated financial information presentedherein has been prepared in accordance with accounting principles generallyaccepted in the United States of America (“U.S. GAAP”) and general accountingpractices within the financial services industry.  In preparing consolidated financialstatements in accordance with U.S. GAAP, management is required to makeestimates and assumptions that affect the reported amounts of assets andliabilities and the disclosure of contingent assets and liabilities at the dateof the financial statements and revenues and expenses during the reportingperiod.  Actual results could differ fromsuch estimates.

 

The following is a summary of Peoples’ significantaccounting policies which have been consistently applied in the preparation ofthe accompanying consolidated financial statements.

 

1.  Principlesof Consolidation

 

The accompanying consolidated financial statementsinclude the accounts of the Company and the Bank, its wholly-owned subsidiary,and American State Advisory Group Corp., a wholly-owned subsidiary of theBank.  All significant inter-companyitems have been eliminated.  AmericanState Advisory Group Corp. was established as an operating subsidiary of theBank to hold title, manage, and sell a portion of the Bank’s other real estateowned.  In accordance with FIN 46,Peoples Bancorp Capital Trust II is not consolidated with Peoples’ financialstatements.  The Company accounts for itsinvestment in Peoples Community Bancorp Capital Trust II as an asset, itssubordinated debentures as debt, and the interest paid thereon as interestexpense.

 

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**PEOPLES COMMUNITY BANCORP, INC.**

** **

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

2.  InvestmentSecurities and Mortgage-Backed Securities

 

Peoples accounts for investments in debt and equitysecurities as held-to-maturity, trading, or available for sale.  Securities classified as held-to-maturity arecarried at cost only if Peoples has the positive intent and ability to holdthese securities to maturity. Securities designated as available for sale arecarried at fair value with resulting unrealized gains or losses recorded tostockholders’ equity.  Realized gains andlosses on sales of securities are recognized using the specific identificationmethod.  Amortization of premiums andaccretion of discounts are recorded on a principal pay-down method based on theestimated duration of the underlying security.

 

3. Loans Receivable

 

Loansreceivable are stated at the principal amount outstanding, adjusted fordeferred loan origination fees and the allowance for loan losses.  Interest is accrued as earned unless thecollectibility of the loan is in doubt. Uncollectible interest on loans that are contractually past due ischarged off, or an allowance is established based on management’s periodicevaluation.  The allowance is establishedby a charge to interest income equal to all interest previously accrued.  Income is subsequently recognized only to theextent that cash payments are received until, in management’s judgment, theborrower’s ability to make periodic interest and principal payments hasreturned to normal.  In this case theloan is returned to accrual status.  Ifthe ultimate collectibility of principal is in doubt, in whole or in part, allpayments received on nonaccrual loans are applied to reduce principal untilsuch doubt is eliminated.

 

Loans originated and intended for sale in thesecondary market are carried at the lower of cost or fair value.  Mortgage loans held-in-portfolio are recordedat their cost, adjusted for the amortization of net deferred costs and forcredit losses inherent in the portfolio. When the Bank decides to sell loans not previously classified as heldfor sale, such loans are transferred into a held-for-sale classification, andthe recorded loan values are adjusted to the lower of cost or fair value.

 

Peoples recognizes asseparate assets, rights to service mortgage loans for others, regardless of howthose servicing rights are acquired.  Aninstitution that acquires mortgage servicing rights through either the purchaseor origination of mortgage loans and sells those loans with servicing rightsretained must allocate some of the cost of the loans to mortgage servicingrights.

 

Peoplesassesses the impairment of the capitalized mortgage servicing rights based onfair value.  Changes in fair value areincluded in earnings in the period the change occurs.  The mortgage servicing rights recorded by theBank were segregated into pools for valuation purposes, using as poolingcriteria the loan term and coupon rate. Once pooled, each grouping of loans was evaluated on a discountedearnings basis to determine the present value of future earnings that apurchaser could expect to realize from each portfolio.  Earnings were projected from a variety ofsources, including loan servicing fees, interest earned on float, net interestearned on escrows, miscellaneous income, and costs to service the loans.  The present value of future earnings is the “economic”value for the pool, i.e., the net realizable present value to an acquirer ofthe acquired servicing.

 

4. Loan Origination Fees

 

Peoples accounts for loan originationfees received, net of certain direct loan origination costs, over the life ofthe related loan as an adjustment of yield. Loan origination costs are limited to the direct costs of originating aloan, principally direct personnel costs. The net origination fee/cost for most loans is amortized using theinterest rate method, whereas the net origination fee/cost for demand loans andrevolving lines of credit or similar arrangements is amortized on astraight-line basis.

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

5. Allowance for Loan Losses

 

It is Peoples’ policy to providevaluation allowances for estimated losses on loans based on past lossexperience, trends in the level of delinquent and problem loans, adversesituations that may affect the borrower’s ability to repay, the estimated valueof any underlying collateral and current economic conditions in the primary lending area.  When the collection of a loan becomesdoubtful, or otherwise troubled, Peoples records a loan charge-off equal to thedifference between the fair value of the property securing the loan and theloan’s carrying value.  Major loans(including development projects) and major lending areas are reviewedperiodically to determine potential problems at an early date.  The allowance for loan losses is increased bycharges to earnings and decreased by charge-offs (net of recoveries).

 

Peoples accounts for impaired loans basedupon the present value of expected future cash flows discounted at the loan’seffective interest rate or, as an alternative, at the loan’s observable marketprice or fair value of the collateral. Peoples’ current procedures for evaluating impaired loans result incarrying such loans at the lower of cost or fair value.

 

A loan is defined as impaired when, basedon current information and events, it is probable that a creditor will beunable to collect all amounts due according to the contractual terms of theloan agreement.  The Bank considers itsinvestment in one-to-four family residential loans and consumer loans to behomogeneous and therefore excluded from separate identification for evaluationof impairment.  With respect to Peoples’investment in multi-family, nonresidential real estate and land loans, and itsevaluation of impairment thereof, such loans are collateral dependent, and as aresult, are carried as a practical expedient at the lower of cost or fairvalue.  With respect to the Bank’sinvestment in unsecured commercial lines of credit, impairment is measuredbased upon the present value of expected future cash flows.

 

It is Peoples’ policy to charge offconsumer unsecured credits that are more than ninety days delinquent.  Similarly, collateral dependent loans whichare more than ninety days delinquent are considered to constitute more than aminimum delay in repayment and are evaluated for impairment at that time.

 

6.   Office Premises and Equipment

 

Office premises and equipment areoriginally recorded at cost and include expenditures which extend the usefullives of existing assets.  Maintenance,repairs and minor renewals are expensed as incurred.  For financial reporting, depreciation andamortization are provided on the straight-line and accelerated methods over theuseful lives of the assets, estimated to be forty to fifty years for buildings,ten to fifty years for building improvements, and three to ten years forfurniture and equipment.  An acceleratedmethod is used for tax reporting purposes.

 

7.  Real Estate Acquired Through Foreclosure

 

Real estate acquired through foreclosureis carried at fair value less estimated selling expenses at the date ofacquisition.  Real estate loss provisionsare recorded if the properties’ fair value subsequently declines below theamount determined at the recording date. In determining the fair value at acquisition, costs relating todevelopment and improvement of property are capitalized.  Costs relating to holding real estateacquired through foreclosure, net of rental income, are charged againstearnings as incurred.

 

8.   Investment in Columbia Bancorp, Inc.

 

In January 2005, the Companyacquired 69,925 shares of Columbia Bancorp, Inc., Cincinnati, Ohio, aprivately held bank holding company for an aggregate purchase price of $2.5million.  These shares representedapproximately 38% of Columbia’s issued and outstanding common stock.  The investment was carried at cost, adjustedfor the Company’s equity in the undistributed income of Columbia Bancorp, 

 

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**PEOPLES COMMUNITY BANCORP, INC.**

** **

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

Inc. In December 2006, the Company sold its investment in Columbia foran aggregate sales price of $2.9 million.

 

9.   Goodwill

 

Goodwill is tested annually forimpairment,  if the implied fair value ofgoodwill is lower than its carrying amount, a goodwill impairment is indicatedand goodwill is written down to its implied fair value.  Subsequent increases in goodwill value arenot recognized in the financial statements. Peoples selected an independent third party to evaluate the unamortizedgoodwill balance as of December 31, 2007, and subsequently recorded animpairment of $11.4 million, which reduced the goodwill balance on its books to$12.5 million from $23.9 million.  Another evaluation was done as of June 30, 2008, and the remaininggoodwill was eliminated.  The impairmentof goodwill is primarily attributable to lower market valuations for financialinstitutions in the latter part of 2007 and first half of 2008, the weakeningof the credit market, the decline in real estate values, particularly in theCincinnati region, and the net losses recorded by the Bank and Company for thepast ten quarters.

 

The goodwill impairment charge was computedby determining the fair value of the Bank on a controlling interest basis.  The fair value of the Bank was considered tobe the amount at which the Bank could be sold in a current transaction betweenwilling parties, that is, other than a forced liquidation sale.  Both the comparable transaction and thetrading price methods were utilized to determine the fair value of theBank.  Because the Bank has severalcharacteristics of a commercial bank, including a significant commercial realestate and commercial business loan portfolio, both thrift and banktransactions were utilized for the comparable transaction method.  Each of the two methods was given a 50%weighting to determine the fair value of the Bank.  The computed fair value of the Bank was foundto be less than its carrying value.  As aresult, management computed the amount of the goodwill impairment charge neededto reduce the carrying value of the Bank to its fair value.

 

In December 2005 and June 2006,Peoples acquired Peoples Federal and Mercantile resulting in goodwill ofapproximately $9.9 million and $4.0 million, respectively.  The changes in the carrying amount ofgoodwill for the years ended December 31, 2008, 2007 and 2006 aresummarized below.

 
| ** **                                       | ** ** | **For Years Ended December 31,** | ** ** |
|--------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                       | ** ** | **2008**                                             | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                       | ** ** | **(In thousands)**                              | ** ** |
|                                             |       |                                                 |       |   |   |   |   |
| Balance at  beginning of period                  |       | $                                                    | 12,514     |   | $ | 23,911 |   | $ | 20,282 |   |
| Final adjustment  to purchase of Peoples Federal |       | —                                               |       | — |   | (334 | ) |
| Purchase of  Mercantile                          |       | —                                               |       | — |   | 3,963 |   |
| Impairment                                       |       | (12,514                                              | )          | (11,397 | ) | — |   |
| Balance at end  of period                        |       | $                                                    | —     |   | $ | 12,514 |   | $ | 23,911 |   |

 

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**PEOPLES COMMUNITY BANCORP, INC.**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

10. Other Intangible Assets

 

In June 2006, Peoples recorded $2.2million in core deposit intangibles in conjunction with the acquisition ofMercantile.  The core deposit intangiblesare being amortized on an accelerated basis over an original period of sevenyears.  The carrying basis andaccumulated amortization of core deposit intangibles at December 31, 2008and 2007 were:

 
| ** **                | ** ** | **2008**                | ** ** | **2007** | ** ** |
|---------------------------|------------|-------------------------|------------|----------|------------|
| ** **                | ** ** | **(In thousands)** | ** ** |
|                      |       |                    |       |     |       |
| Core deposit  intangibles |       |                    |       |     |       |
| Gross carrying  amount    |       | $                       | 7,768      |     | $          | 7,768 |   |
| Accumulated  amortization |       | 4,930                   |       | 3,536    |       |
|                           |            |                         |            |          |            |  |  |

 

Amortization expense for the years ended December 31,2008, 2007, and 2006, was $1.4 million, $1.7 million, and $1.6 million,respectively.  The following tablesummarizes the Bank’s current estimates for future amortization expense of thecore deposit intangible

 
| (In thousands)  |
|----------------------|
|                 |   |   |   |
| 2009                 |   | $ | 1,116 |   |
| 2010                 |   | 838 |   |
| 2011                 |   | 561 |   |
| 2012                 |   | 284 |   |
| 2013 and  thereafter |   | 39 |   |
|                      |  |  |  |  |

 

11. Loan Servicing

 

In conjunction with its acquisition ofMercantile, Peoples obtained approximately $86.7 million of residentialmortgage loans serviced for Freddie Mac and Fannie Mae.  Mortgage loans serviced for others are notincluded in the accompanying consolidated balance sheets.  The unpaid principal balance of mortgageloans serviced for others was $63.0 million and $72.1 million at December 31,2008 and December 31, 2007, respectively.

 

In conjunction with its acquisition ofMercantile, the Bank acquired $926,000 in mortgage servicing rights. Thebalance and fair value of mortgage servicing rights as of December 31,2008 was $494,000.  The Bank recordedamortization related to mortgage servicing rights totaling $165,000, $167,000,and 101,000 for the years ended December 31, 2008, 2007, and 2006,respectively.

 

12. Federal Income Taxes

 

Peoples accounts for federal income taxesin accordance with the provisions of SFAS No. 109, “Accounting for IncomeTaxes.”  Pursuant to the provisions ofSFAS No. 109, a deferred tax liability or deferred tax asset is computedby applying the current statutory tax rates to net taxable or deductibledifferences between the tax basis of an asset or liability and its reportedamount in the consolidated financial statements that will result in taxable ordeductible amounts in future periods. Deferred tax assets are recorded only to the extent that the amount ofnet deductible temporary differences or carryforward attributes may be utilizedagainst current period earnings, carried back against prior years’ earnings,offset against taxable temporary differences reversing in future periods, orutilized to the extent of management’s estimate of future taxable income.  Peoples adopted FIN 48 at the beginning of2007 which resulted in a reclassification of $1.3 million in deferred taxliability and the establishment of a $1.1 million unrecognized tax liabilityrelated to federal income tax matters. The net result was an increase to retained earnings of $180,000effective January 1, 2007.

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

A valuation allowance is provided fordeferred tax assets to the extent that the value of net deductible temporarydifferences and carryforward attributes exceeds management’s estimates of taxespayable on future taxable income. Deferred tax liabilities are provided on the total amount of nettemporary differences taxable in the future.

 

Peoples’ federal income taxreturns for the tax years ended 2007 and 2008 are open under the statute oflimitations and are subject to review by the IRS.  Various companies that the Bank has acquiredremain under the statute of limitations by the IRS for the years ended 2005through 2007.

 

13. Benefit Plans

 

Peoples’ has a noncontributory unfundedretirement plan that covers all members of its Board of Directors.  Peoples’ policy is to maintain an accruedliability equal to the present value of benefits computed using a predeterminedannual benefit amount at retirement.  Theplan provides for immediate vesting for all participants.  The balance of the accrued liability was $1.7million and $1.7 million, as of December 31, 2008 and 2007,respectively.  The provision fordirectors’ retirement expense totaled $85,000, $504,000, and $94,000 for theyears ended December 31, 2008, 2007 and 2006, respectively.  A higher provision was recorded in 2007 dueto a decrease in the discount rate, which is utilized in calculating thepresent value of the benefits.

 

The Bank has an Employee Stock OwnershipPlan (“ESOP”) which provides retirement benefits for substantially allfull-time employees who have completed one year of service. The Bank makesannual contributions to the ESOP equal to the ESOP’s debt service lessdividends received by the ESOP on unallocated shares.  Shares in the ESOP were acquired using fundsprovided by a loan from the Company and accordingly the cost of those shares isshown as a reduction of stockholders’ equity. Shares are released to participants proportionately as the loan isrepaid. Dividends on allocated shares are recorded as dividends and charged toretained earnings.  Dividends onunallocated shares are used to repay the loan and are treated as compensationexpense.  Compensation expense isrecorded equal to the fair market value of the stock for shares committed to bereleased. The Bank accounts for the ESOP in accordance with Statement ofPosition (“SOP”) 93-6, “Employers’ Accounting for Employee Stock OwnershipPlans.”  SOP 93-6 requires thatcompensation expenses recorded by employers equal the fair value of ESOP sharesallocated to participants during a given fiscal year.  In April 2004, the Bank added 35,000shares to the ESOP plan in connection with its secondary stock offering at atotal value of $700,000.  In March 2005,an additional 40,000 shares were acquired and added to the ESOP plan at a totalvalue of approximately $962,000.  Expenserecognized related to the ESOP totaled $295,000, $656,000, and $207,000 for theyears ended December 31, 2008, 2007, and 2006, respectively.  In December 2007, the Bank recordedapproximately $508,000 in compensation expense for the release of approximately32,383 ESOP shares for employee allocation. This occurred in conjunction with the decision to terminate the ESOP by September 30,2008 and record associated expenses in 2008 to release all unallocated shares.

 
| ** **                                                               | ** ** | **For Years Ended December 31,** | ** ** |
|--------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                               | ** ** | **2008**                                             | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                                     |       |                                                 |       |   |   |   |   |
| Allocated shares                                                    |       | 146,760                                              |       | 101,954 |   | 96,542 |   |
| Shares committed  to be released                                         |       | —                                               |       | 34,258 |   | 1,875 |   |
| Unearned shares                                                          |       | —                                               |       | 12,297 |   | 54,211 |   |
| Total ESOP  shares                                                       |       | 146,760                                              |       | 148,509 |   | 152,628 |   |
| Fair value of  unearned shares at end of period (expressed in thousands) |       | $                                                    | —     |   | $ | 172 |   | $ | 976 |   |
|                                                                          |            |                                                      |            |  |  |  |  |  |  |  |

 

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**PEOPLES COMMUNITY BANCORP, INC.**

** **

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

14. Share-Based Compensation Plans

 

Effective October 1, 2005, Peoplesadopted the fair value recognition provisions of Statement of Financial AccountingStandards (SFAS) No. 123R, Share-Based Payment.  The adoption of this Statement had nomaterial impact on Peoples’ financial statement as Peoples was previouslyaccounting for stock compensation under Statement of Financial AccountingStandards No. 123.  Both Statementsutilize the fair value method at grant date for stock compensation and expensesuch cost against additional paid-in capital in its Consolidated Statement ofFinancial Condition.

 

The Bank has two share-based compensationplans, which are described below.  Thecompensation cost that has been charged against income for those plans was$228,000, $276,000, $341,000, for the years ended December 31, 2008, 2007,and 2006, respectively.

 

During fiscal2001, the Board of Directors adopted the Peoples Community Bancorp, Inc.Stock Option and Incentive Plan (the “2001 Plan”) that provides for theissuance of 197,773 of authorized but unissued shares of common stock at fairvalue at the date of grant.  Through December 31,2007, the Company had granted all options under the 2001 Plan.  The 2004 Stock Option and Incentive Plan (the“2004 Plan”), as approved by stockholders, provides for the issuance of 150,000authorized but unissued shares of common stock at fair value at the date ofgrant.  As of December 31, 2008,111,140 options, net of forfeitures, had been granted under the 2004 Plan.  All option awards are granted with anexercise price equal to the market price of the Company’s stock at the date ofgrant. Options under both plans have a 10-year term.

 

Both plansprovide that one-fifth of the options granted become exercisable on each of thefirst five anniversaries of the date of grant. The remaining shares in theplans may be granted to employees in increments of 20% per year based on management’sdiscretion.

 

The Bank accounts for the plans using afair-value method for valuing stock-based compensation, which measurescompensation cost at the grant date based on the fair value of the award.  Compensation is then recognized over theservice period, which is usually the vesting period.

 

The fair value of the option grants areestimated on the date of grant using the modified Black-Scholes options-pricingmodel that uses the assumptions noted in the following table. The objective ofthe measurement process is to estimate the fair value of options based on thestock price at the grant date, to which employees will become entitled whenthey have rendered the requisite service and satisfy all other conditionsnecessary to earn the right to benefit from the options. In deriving the fairvalue of the stock options through the Black-Scholes model, the stock price atthe grant date is reduced by the value of any dividends to be paid during thelife of the option, since the options do not give holders the benefit ofdividends paid before exercise. The expected life of all options is 10 years.The risk-free rate for the expected term of the option is the constant maturityyield on a U.S. Government obligation, with a term equal to the expected lifeof the options at the grant date.

 
| ** **                | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|----------|------------|
|                      |       |     |       |     |       |     |       |
| Expected  volatility      |       | 37.0     | %          | 24.8     | %          | 17.3     | %          |
|                      |       |     |       |     |       |     |       |
| Expected  dividends       |       | 0.0      | %          | 3.0      | %          | 3.0      | %          |
|                      |       |     |       |     |       |     |       |
| Expected term  (in years) |       | 10       |       | 10       |       | 10       |       |
|                      |       |     |       |     |       |     |       |
| Risk-free rate            |       | 4.0      | %          | 5.0      | %          | 5.2      | %          |

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

A summary of the status of the Plans asof and for the year ended December 31, 2008 is presented below:

 
| ** **                                                    | ** ** | ** **  | ** ** | ** **              | ** ** | **Weighted-Average**           | ** ** | **Aggregate**            | ** ** |
|---------------------------------------------------------------|------------|-------------|------------|-------------------------|------------|--------------------------------|------------|--------------------------|------------|
| ** **                                                    | ** ** | ** **  | ** ** | **Weighted-Average**    | ** ** | **Remaining Contractual** | ** ** | **Intrinsic Value** | ** ** |
| ** **                                                    | ** ** | **Shares**  | ** ** | **Exercise Price** | ** ** | **Term (In years)**  | ** ** | **(In thousands)**  | ** ** |
| Outstanding at January 1, 2008                           |       | 252,161     |       | $                       | 18.08      |                           |       |                     |       |   |
| Granted                                                       |       | 43,722      |       | 2.24                    |       |                           |       |                     |       |
| Exercised                                                     |       | —      |       | 0.00                    |       |                           |       |                     |       |
| Forfeited                                                     |       | 24,892      |       | 15.30                   |       |                           |       |                     |       |
| Expired                                                       |       | 12,661      |       | 19.98                   |       |                           |       |                     |       |
|                                                          | ** ** | ** **  | ** ** | ** **              | ** ** | ** **                     | ** ** | ** **               | ** ** |
| Outstanding at  December 31, 2008                        | ** ** | **258,330** | ** ** | **$**                   | **15.55**  | ** **                     | **6.12**   | ** **               | **$**      | **—** | ** ** |
|                                                          |       |        |       |                    |       |                           |       |                     |       |
| Options exercisable at December 31, 2008                 | ** ** | **156,586** | ** ** | **$**                   | **17.68**  | ** **                     | **4.35**   | ** **               | **$**      | **—** | ** ** |
|                                                          |       |        |       |                    |       |                           |       |                     |       |
| Weighted-average fair value of options granted  during period |       |        |       | **$**                   | **1.24**   |                           |       |                     |       |   |

 

The weighted-average grant-date fair value of options granted duringthe years ended December 31, 2008, 2007, and 2006 was $1.24, $4.05, and$4.52, respectively.  There were nooptions exercised during the year ended December 31, 2008.  The total intrinsic value of optionsexercised during the years ended December 31, 2007 and 2006 was $1,000,and $19,000, respectively.

 

The Companyalso has a 2001 Management Recognition Plan (“2001 MRP”) which provides forawards of up to 79,109 shares of the Company’s common stock to members of theBoard of Directors, management and employees. As of December 31, 2008, 72,259 shares have been awarded, net offorfeitures, from the 2001 MRP to members of the Board of Directors, managementand employees.  Common shares awarded tooutside members of the Board of Directors were fully expensed when granted,while shares awarded to members of management and employees have vested or willvest over a five year period beginning with the date of the award.  Shares awarded under the MRP are distributedfrom previously authorized but unissued shares.

 

In 2004, thestockholders approved a 2004 Management Recognition Plan (“2004 MRP”) whichprovides for awards of an additional 60,000 sharesof the Company’s common stock to management and employees.  As of December 31, 2008, 2,435 shareshave been awarded, net of forfeitures, from the 2004 MRP.  Total shares vested and distributed to recipientsthrough December 31, 2008 under both plans totaled 68,290 shares.

 

A summary ofthe status of the Plans as of and for the year ended December 31, 2008 ispresented below:

** **
| ** **                           | ** ** | ** ** | ** ** | **Weighted-Average** | ** ** |
|--------------------------------------|------------|------------|------------|----------------------|------------|
| ** **                           | ** ** | ** ** | ** ** | **Grant Date**  | ** ** |
| ** **                           | ** ** | **Shares** | ** ** | **Fair Value**  | ** ** |
|                                 |       |       |       |                 |       |
| Nonvested at  January 1, 2008   |       | 15,651     |       | $                    | 20.81      |   |
| Granted                              |       | —     |       | —               |       |
| Vested                               |       | 5,556      |       | 21.38                |       |
| Forfeited                            |       | 1,698      |       | 20.93                |       |
|                                 |       |       |       |                 |       |
| Nonvested at  December 31, 2008 | ** ** | **8,397**  | ** ** | **$**                | **20.40**  | ** ** |

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

As of December 31, 2008, there was $425,000 of total unrecognizedcompensation cost related to the MRP and stock option plans.  The cost is expected to be recognized over aweighted-average period of 1.65 years.  The total fair value of shares vested during the years ended December 31,2008, 2007, and 2006 was $249,000, $330,000, and $268,000, respectively.

 

15.  Earnings Per Share

 

Dilutedearnings per share is computed taking into consideration common sharesoutstanding and dilutive potential common shares to be issued under the Company’sstock option plan.  There is noadjustment to net earnings (loss) for the calculation of diluted earnings pershare.  The computations were as follows:

 
| ** **                                            | ** ** | **For Years Ended December 31,** | ** ** |
|-------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                            | ** ** | **2008**                                             | ** ** | **2007** | ** ** | **2006** | ** ** |
| Weighted-average  common shares outstanding (basic)   |       | 4,833,351                                            |       | 4,783,610 |   | 4,591,802 |   |
| Dilutive effect  of assumed exercise of stock options |       | —                                               |       | — |   | — |   |
| Weighted-average  common shares outstanding (diluted) | ** ** | **4,833,351**                                        | ** ** | **4,783,610** | ** ** | **4,591,802** | ** ** |

 

Basic earnings per share for each period presentedis based upon the weighted-average shares outstanding during the year lessunallocated ESOP shares. Options to purchase shares of common stock and MRPawards were excluded from the computation of diluted earnings per share for theyears ended December 31, 2008, 2007, and 2006 due to the net loss recordedfor these periods.

 

16.  FairValue of Financial Instruments

 

SFASNo. 107, “Disclosures About Fair Value of Financial Instruments,” requiresdisclosure of the fair value of financial instruments, both assets andliabilities whether or not recognized in the consolidated statement offinancial condition, for which it is practicable to estimate that value.  For financial instruments where quoted marketprices are not available, fair values are based on estimates using presentvalue and other valuation methods.

 

Themethods used are greatly affected by the assumptions applied, including thediscount rate and estimates of future cash flows.  Therefore, the fair values presented may notrepresent amounts that could be realized in an exchange for certain financialinstruments.

 

Thefollowing methods and assumptions were used by Peoples in estimating its fairvalue disclosures for financial instruments at December 31, 2008 and 2007:

 

Cashand cash equivalents:  Thecarrying amounts presented in the consolidated statements of financialcondition for cash and cash equivalents are deemed to approximate fair value.

 

Investmentand mortgage-backed securities:  For investment and mortgage-backedsecurities, fair value is deemed to equal the quoted market price.

 

Loansreceivable:  The loanportfolio has been segregated into categories with similar characteristics,such as one-to-four-family residential, multi-family residential,nonresidential real estate and unsecured commercial loans.  These loan categories were further delineatedinto fixed-rate and adjustable-rate loans. 

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

The fair values for theresultant loan categories were computed via discounted cash flow analysis,using current interest rates offered for loans with similar terms to borrowersof similar credit quality.  For consumerand other loans, fair values were deemed to equal the historic carryingvalues.  The historic carrying amount ofaccrued interest on loans is deemed to approximate fair value.

 

Federal Home Loan Bank stock: The carrying amount presented in the consolidated statements of financialcondition is deemed to approximate fair value.

 

Deposits:  The fair value of checking accounts, savingsaccounts, money market demand deposits and escrow deposits is deemed toapproximate the amount payable on demand. Fair values for fixed-rate certificates of deposit have been estimatedusing a discounted cash flow calculation using the interest rates currentlyoffered for deposits of similar remaining maturities.

 

Advances from the Federal Home Loan Bank: The fair value of these advances is estimated using the rates currentlyoffered for similar advances of similar remaining maturities.

 

Otherborrowed money:  The fairvalue of other borrowed money is estimated using the rates currently offeredfor similar borrowings of similar remaining maturities.

 

Subordinateddebentures:  The fairvalue of Peoples’ subordinated debentures has been estimated using discountedcash flow analysis, based on the interest rates currently offered forinstruments of similar remaining maturities.

 

Commitments to extend credit: For fixed-rate and adjustable-rate loan commitments, the fair valueestimate considers the difference between current levels of interest rates andcommitted rates.  At December 31,2008 and 2007, the difference between the fair value and notional amount ofloan commitments was not material.

 

AccruedInterest:   The carrying amount presented in theconsolidated statements of financial condition is deemed to approximate fairvalue.  Basedon the foregoing methods and assumptions, the carrying value and fair value ofPeoples’ financial instruments at December 31 are as follows:

 
| ** **                                                     | ** ** | **2008**                | ** ** | **2007**  | ** ** |
|----------------------------------------------------------------|------------|-------------------------|------------|-----------|------------|
| ** **                                                     | ** ** | **Carrying**            | ** ** | **Fair**  | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| ** **                                                     | ** ** | **value**               | ** ** | **value** | ** ** | **value** | ** ** | **value** | ** ** |
| ** **                                                     | ** ** | **(In thousands)** | ** ** |
| Financial assets                                               |       |                    |       |      |       |   |   |   |   |
| Cash and cash  equivalents                                     |       | $                       | 72,015     |      | $          | 72,015 |   | $ | 86,614 |   | $ | 86,614 |   |
| Investment  securities                                         |       | 77,968                  |       | 77,968    |       | 4,237 |   | 4,237 |   |
| Mortgage-backed  securities                                    |       | 22,984                  |       | 22,984    |       | 63,335 |   | 63,335 |   |
| Loans receivable                                               |       | 461,861                 |       | 470,464   |       | 634,421 |   | 638,128 |   |
| Accrued interest  receivable                                   |       | 2,941                   |       | 2,941     |       | 4,295 |   | 4,295 |   |
| Federal Home  Loan Bank stock                                  |       | 14,549                  |       | 14,549    |       | 14,024 |   | 14,024 |   |
|                                                           |       |                    |       |      |       |   |   |   |   |
| Financial  liabilities                                         |       |                    |       |      |       |   |   |   |   |
| Deposits                                                       |       | $                       | 630,198    |      | $          | 646,553 |   | $ | 735,212 |   | $ | 740,184 |   |
| Advances from  the Federal Home Loan Bank and other borrowings |       | 76,507                  |       | 83,495    |       | 77,628 |   | 79,182 |   |
| Accrued interest  payable                                      |       | 1,022                   |       | 1,022     |       | 382 |   | 382 |   |
| Subordinated  debentures                                       |       | 15,464                  |       | 15,464    |       | 15,464 |   | 15,464 |   |

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

Effective January 1,2008, Peoples adopted FASB Statement No. 157, Fair Value Measurements (“FAS157”). FAS 157 defines fair value, establishes a framework for measuring fairvalue and expands disclosures about fair value measurements. FAS 157 has beenapplied prospectively as of the beginning of the year.

 

FAS 157 defines fair valueas the price that would be received to sell an asset or paid to transfer aliability in an orderly transaction between market participants at themeasurement date. FAS 157 also establishes a fair value hierarchy whichrequires an entity to maximize the use of observable inputs and minimize theuse of unobservable inputs when measuring fair value.

 

The standard describes threelevels of inputs that may be used to measure fair value:

 
| Level 1 | Quoted  prices in active markets for identical assets or liabilities.                                                                                                                                                                                                                                      |
|--------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |                                                                                                                                                                                                                                                                                                       |
| Level 2 | Observable  inputs other than Level 1 prices, such as quoted prices for similar assets or  liabilities; quoted prices in markets that are not active; or other inputs  that are observable or can be corroborated by observable market data for  substantially the full term of the assets or liabilities. |
|         |                                                                                                                                                                                                                                                                                                       |
| Level 3 | Unobservable  inputs that are supported by little or no market activity and that are  significant to the fair value of the assets or liabilities.                                                                                                                                                          |

 

Following is a descriptionof the valuation methodologies used for instruments measured at fair valueon              a recurring basis and recognized inthe accompanying balance sheet, as well as the general classification of suchinstruments pursuant to the valuation hierarchy.

 

*Available-for-salesecurities*. Where quoted market prices are available in anactive market, securities are classified within Level 1 of the valuationhierarchy. If quoted market prices are not available, then fair values areestimated by using pricing models, quoted prices of securities with similarcharacteristics or discounted cash flow. In certain cases where Level 1 orLevel 2 inputs are not available, securities are classified within Level 3 ofthe hierarchy.

 

The following table presentsthe fair value measurements of assets recognized in the accompanying  balance sheet measured at fair value on arecurring basis and the level within the FAS 157 fair value hierarchy in whichthe fair value measurements fall at December 31, 2008:

 
| ** **                     | ** ** | ** **          | ** ** | **Fair Value Measurements Using  (in thousands)**                               | ** ** |
|--------------------------------|------------|---------------------|------------|-----------------------------------------------------------------------------------------------------|------------|
| ** **                     | ** ** | **Fair Value** | ** ** | **Quoted Prices in  Active Markets  for Identical Assets  (Level 1)** | ** ** | **Significant Other  Observable Inputs  (Level 2)** | ** ** | **Significant  Unobservable  Inputs  (Level 3)** | ** ** |
| Available-for-sale  securities |       | $                   | 100,952    |                                                                                                | $          | 1,255 |   | $ | 99,697 |   | $ | 0 |   |
|                                |            |                     |            |                                                                                                     |            |  |  |  |  |  |  |  |  |

 

*Impaired Loans.* Loans for which it isprobable Peoples will not collect all principal and interest due according tocontractual terms are measured for impairment in accordance with the provisionsof Financial Accounting Standard No. 114, Accounting by Creditors forImpairment of a Loan. Allowable methods for estimating fair value include usingthe fair value of the collateral for collateral dependent loans, or where aloan is determined not to be collateral dependent, using the discounted cashflow method. If the impaired loan is collateral dependent, then the fair valuemethod of measuring the amount of impairment is utilized. This method utilizesa recent appraisal or other valuations of the collateral and applies a discountfactor to the value based on Peoples’ estimate of holding cost and othereconomic factors, such as estimated cash flow generated from the property.

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

The following table presentsthe fair value measurements of assets measured at fair value on a nonrecurringbasis and the level within the FAS 157 fair value hierarchy in which the fairvalue measurements fell at December 31, 2008.

 
| ** **     | ** ** | ** **          | ** ** | **Fair Value Measurements Using  (in thousands)**                     | ** ** |
|----------------|------------|---------------------|------------|-----------------------------------------------------------------------|------------|
| ** **     | ** ** | **Fair Value** | ** ** | **Quoted Prices in  Active Markets  for Identical Assets  (Level 1)** | ** ** | **Significant Other  Observable Inputs  (Level 2)** | ** ** | **Significant  Unobservable  Inputs  (Level 3)** | ** ** |
| Impaired loans |       | $                   | 38,400     |                                                                  | $          | 0 |   | $ | 0 |   | $ | 38,400 |   |
|                |            |                     |            |                                                                       |            |  |  |  |  |  |  |  |  |

 

The fair value of theimpaired loans of $38.4 million does not have any specific reserves against it.Of the $38.4 million of impaired loans at December 31, 2008, there werecharge offs related to these loans of $27.3 million. Loans totaling $18.4million that were impaired at December 31, 2007, were no longer impairedat December 31, 2008.

 

17.  Capitalization

 

The Company’s authorized capital stockincludes 1,000,000 shares of $.01 per share par value voting preferredstock.  No preferred shares were issuedat December 31, 2008 and 2007.

 

18. Cash and Cash Equivalents

 

For purposes of reporting cash flows,cash and cash equivalents include cash and due from banks and interest-bearingdeposits in other financial institutions with original maturities of threemonths or less.

 

19.  Restriction on Cash and Due From Banks

 

The Bank is required tomaintain reserve funds in cash or in deposits with Federal Reserve Bank orFederal Home Loan Bank.  The reserverequired at December 31, 2008 and 2007 was $1.0 million and $2.3 million,respectively.

 

20.  Reclassifications

 

Certain prior year amounts have beenreclassified to conform to the 2008 consolidated financial statementpresentation.

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**NOTE B - INVESTMENTS AND MORTGAGE-BACKEDSECURITIES**

 

The amortized cost, gross unrealizedgains, gross unrealized losses and estimated fair values of securities at December 31,2008 and 2007, are summarized as follows:

 
| ** **                        | ** ** | **2008**                | ** **  |
|-----------------------------------|------------|-------------------------|-------------|
| ** **                        | ** ** | ** **              | ** **  | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                        | ** ** | **Amortized**           | ** **  | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                        | ** ** | **Cost**                | ** **  | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| ** **                        | ** ** | **(In thousands)** | ** **  |
| **Available for sale:** |       |                    |        |   |   |   |   |   |   |
| US Government  agency obligations |       | $                       | 75,497      |   | $ | 290 |   | $ | — |   | $ | 75,787 |   |
| Municipal  securities             |       | 943                     |        | 21 |   | 39 |   | 925 |   |
| Mutual funds                      |       | 1,309                   |        | — |   | 54 |   | 1,255 |   |
| Mortgage-backed  securities       |       | 23,562                  |        | 13 |   | 590 |   | 22,985 |   |
| ** **                        | ** ** | ** **              | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** |   |
| ** **                        | ** ** | **$**                   | **101,311** | ** ** | **$** | **324** | ** ** | **$** | **683** | ** ** | **$** | **100,952** |   |

 
| ** **                        | ** ** | **2007**                | ** ** |
|-----------------------------------|------------|-------------------------|------------|
| ** **                        | ** ** | ** **              | ** ** | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                        | ** ** | **Amortized**           | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                        | ** ** | **Cost**                | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| ** **                        | ** ** | **(In thousands)** | ** ** |
| **Available for sale:** |       |                    |       |   |   |   |   |   |   |
| US Government  agency obligations |       | $                       | 1,974      |   | $ | 19 |   | $ | — |   | $ | 1,993 |   |
| Municipal  securities             |       | 1,027                   |       | 14 |   | 7 |   | 1,034 |   |
| Mutual funds                      |       | 1,251                   |       | — |   | 41 |   | 1,210 |   |
| Mortgage-backed  securities       |       | 63,258                  |       | 196 |   | 119 |   | 63,335 |   |
| ** **                        | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |   |
| ** **                        | ** ** | **$**                   | **67,510** | ** ** | **$** | **229** | ** ** | **$** | **167** | ** ** | **$** | **67,572** |   |

 

The amortizedcost and fair value of available-for-sale securities at December 31, 2008,by contractual maturity, are shown below. There were no held-to-maturity securities at December 31,2008.  Expected maturities will differfrom contractual maturities because issuers may have the right to call orprepay obligations with or without call or prepayment penalties.

 

| ** **                  | ** ** | **Amortized**           | ** ** | **Fair**  | ** ** |
|-----------------------------|------------|-------------------------|------------|-----------|------------|
| ** **                  | ** ** | **Cost**                | ** ** | **Value** | ** ** |
| ** **                  | ** ** | **(In Thousands)** | ** ** |
|                        |       |                    |       |      |       |   |   |
| Within one year             |       | $                       | 75,025     |      | $          | 75,310 |   |
| One to five  years          |       | 166                     |       | 170       |       |
| Five to ten  years          |       | 529                     |       | 531       |       |
| After ten years             |       | 720                     |       | 701       |       |
|                        |       | 76,440                  |       | 76,712    |       |
|                        |       |                    |       |      |       |
| Mortgage-backed  securities |       | 23,562                  |       | 22,985    |       |
| Mutual funds                |       | 1,309                   |       | 1,255     |       |
|                        |       |                    |       |      |       |
| Totals                      |       | $                       | 101,311    |      | $          | 100,952 |   |

 

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**PEOPLES COMMUNITY BANCORP, INC.**

** **

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

Proceeds fromthe sale of investment securities during 2008 amounted to $29.4 million, withgains of $558,000.  Proceeds from thesale of investment securities during 2007 amounted to $61,000, with gains of$53,000 and a related tax effect of $18,000. Proceeds from the sale of investment securities during 2006 amounted to$1.6 million, with gross gains of $126,000 and gross losses of $26,000, for anet realized gain totaling $100,000 and a related tax effect of $34,000.

 

At December 31, 2008, Peoples had$1.5 million of mortgage-backed securities pledged to secure public depositsand $9.4 million of mortgage-backed securities and $25.0 million of agenciespledged to secure advances from the Federal Home Loan Bank.  At December 31, 2007, Peoples had $10.0million of mortgage-backed securities pledged to secure public deposits, and$13.1 million of mortgage-backed securities pledged to secure advances from theFederal Home Loan Bank.

 

Certain investments in debt andmarketable equity securities are reported in the financial statements at anamount less than their historical cost. As indicated in the following tables, the total fair value of theseinvestments at December 31, 2008 and 2007, was $23.8 million and $20.6million, respectively, which approximated 23.6% and 30.4% of Peoples’investment portfolio.  Based on anevaluation of the available evidence, including recent changes in market rates,credit rating information and information obtained from regulatory filings,management believes the declines in fair value for these securities aretemporary.

 

Should the impairment of any of these securitiesbecome other than temporary, the cost basis of the investment will be reducedand the resulting loss recognized in net earnings in the period in which theother-than-temporary impairment is identified.

 

The following tables reflect theinvestments’ gross unrealized loses and fair value, aggregated by investmentcategory and length of time that individual securities have been in acontinuous unrealized loss position at December 31, 2008 and 2007.

 

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**PEOPLES COMMUNITY BANCORP, INC.**

** **

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**2008**

 
| ** **                             | ** ** | **Less than 12 months**              | ** ** | **12 Months or Longer** | ** ** | **Total**      | ** ** |
|----------------------------------------|------------|--------------------------------------|------------|-------------------------|------------|----------------|------------|
| **Investment**                         | ** ** | **Number of**                        | ** ** | **Fair**                | ** ** | **Unrealized** | ** ** | **Number of** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| **Category**                           | ** ** | **Investments**                      | ** ** | **Value**               | ** ** | **Losses**     | ** ** | **Investments** | ** ** | **Value** | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
| ** **                             | ** ** | **(Dollars in thousands)** | ** ** |
| US Government agency  obligations      |       | —                               |       | $                       | —     |           | $          | — |   | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Municipal securities                   |       | 2                                    |       | 170                     |       | 14             |       | 1 |   | 198 |   | 25 |   | 368 |   | 39 |   |
| Mutual funds                           |       | —                               |       | —                  |       | —         |       | 2 |   | 1,255 |   | 54 |   | 1,255 |   | 54 |   |
| Mortgage-backed securities             |       | 16                                   |       | 10,679                  |       | 206            |       | 7 |   | 11,537 |   | 384 |   | 22,216 |   | 590 |   |
|                                   |       |                                 |       |                    |       |           |       |   |   |   |   |   |   |   |   |   |   |
| Total  temporarily impaired securities |       | **18**                               | ** ** | **$**                   | **10,849** | ** **     | **$**      | **220** | ** ** | **10** | ** ** | **$** | **12,990** | ** ** | **$** | **463** | ** ** | **$** | **23,839** | ** ** | **$** | **683** | ** ** |

 

**2007**

 
| ** **                             | ** ** | **Less  than 12 months**             |       | **12  Months or Longer** |       | **Total**      |       |
|----------------------------------------|------------|--------------------------------------|------------|--------------------------|------------|----------------|------------|
| **Investment**                         | ** ** | **Number  of**                       | ** ** | **Fair**                 | ** ** | **Unrealized** | ** ** | **Number  of** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** |   |
| **Category**                           | ** ** | **Investments**                      | ** ** | **Value**                | ** ** | **Losses**     | ** ** | **Investments** | ** ** | **Value** | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** |   |
|                                   |       | **(Dollars in thousands)** |       |
| US Government agency  obligations      |       | —                               |       | $                        | —     |           | $          | — |   | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — | ** ** |
| Municipal  securities                  |       | —                               |       | —                   |       | —         |       | 3 |   | 410 |   | 7 |   | 410 |   | 7 | ** ** |
| Mutual funds                           |       | —                               |       | —                   |       | —         |       | 2 |   | 1,210 |   | 41 |   | 1,210 |   | 41 | ** ** |
| Mortgage-backed securities             |       | 8                                    |       | 18,647                   |       | 97             |       | 1 |   | 296 |   | 22 |   | 18,943 |   | 119 | ** ** |
|                                   |       |                                 |       |                     |       |           |       |   |   |   |   |   |   |   |   |   | ** ** |
| Total  temporarily impaired securities |       | **8**                                | ** ** | **$**                    | **18,647** | ** **     | **$**      | **97** | ** ** | **6** | ** ** | **$** | **1,916** | ** ** | **$** | **70** | ** ** | **$** | **20,563** | ** ** | **$** | **167** | ** ** |

 

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**PEOPLES COMMUNITY BANCORP, INC.**

** **

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**NOTE C -LOANS RECEIVABLE**

 

The composition of the loan portfolio at December 31is summarized as follows:

 
| ** **                               | ** ** | **2008**           | ** **  | **2007**   | ** ** |
|------------------------------------------|------------|--------------------|-------------|------------|------------|
| ** **                               | ** ** | **(In thousands)** | ** **  |
| Residential real  estate                 |       |               |        |       |       |
| One-to-four-family                       |       | $                  | 300,340     |       | $          | 311,968 |   |
| Multifamily                              |       | 55,502             |        | 82,176     |       |
| Construction                             |       | 69,930             |        | 131,777    |       |
| Nonresidential  real estate and land     |       | 75,251             |        | 128,955    |       |
| Nonresidential  real estate construction |       | 9,294              |        | 12,394     |       |
| Commercial                               |       | 8,082              |        | 20,012     |       |
| Consumer and  other                      |       | 13,029             |        | 16,758     |       |
| Total loans  receivable                  |       | 531,428            |        | 704,040    |       |
|                                     |       |               |        |       |       |
| Less:                                    |       |               |        |       |       |
| Undisbursed  portion of loans in process |       | 40,110             |        | 33,661     |       |
| Deferred loan  origination fees          |       | 752                |        | 1,459      |       |
| Allowance for  loan losses               |       | 28,705             |        | 34,499     |       |
|                                     |       |               |        |       |       |
| Loans receivable  – net             | ** ** | **$**              | **461,861** | ** ** | **$**      | **634,421** | ** ** |

 

Inthe ordinary course of business, Peoples has granted loans to some of itsdirectors, officers and their related business interests.  All loans to related parties have been madeon substantially the same terms as those prevailing at the time for unrelatedthird parties.  The aggregate dollaramount of loans to executive officers and directors was approximately $620,000and $725,000 at December 31, 2008 and 2007, respectively.  During the year ended December 31, 2008,there were no loans originated to executive officers and directors.  During the year ended December 31, 2007,there was one loan renewed to executive officers and directors for$200,000.  During the year ended December 31,2008, principal repayments of approximately $117,000 were received fromexecutive officers and directors.

 

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**PEOPLES COMMUNITY BANCORP, INC.**

** **

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**NOTE D -ALLOWANCE FOR LOAN LOSSES**

 

The activity in theallowance for loan losses is summarized as follows for the years ended December 31,2008, 2007, and 2006:

 
| ** **                      | ** ** | **For Years Ended December 31,** | ** ** |
|---------------------------------|------------|---------------------------------------|------------|
| ** **                      | ** ** | **2008**                              | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                      | ** ** | **(In thousands)**                    | ** ** |
| ** **                      | ** ** | ** **                            | ** ** |
| Balance at  beginning of period |       | $                                     | 34,499     |   | $ | 18,369 |   | $ | 13,444 |   |
| Increase due to  acquisition    |       | —                                |       | — |   | 302 |   |
| Provision for  losses on loans  |       | 41,477                                |       | 32,800 |   | 17,450 |   |
| Charge off of  loans            |       | (47,765                               | )          | (18,284 | ) | (13,103 | ) |
| Recoveries                      |       | 494                                   |       | 1,614 |   | 276 |   |
|                            |       |                                  |       |   |   |   |   |
| Balance at end  of period       | ** ** | **$**                                 | **28,705** | ** ** | **$** | **34,499** | ** ** | **$** | **18,369** | ** ** |

 

At December 31,2008 and 2007, non-accruing loans amounted to $43.1 million and $25.3 million,respectively.  At December 31, 2008,there were no loans greater than 90 days delinquent and still accruing.  At December 31, 2007 loans greater than90 days delinquent and still accruing totaled $613,000 and were deemed to be inprocess of collection of both principal and interest.  Interest income which would have beenrecognized if such non-accruing loans had performed pursuant to contractualterms totaled approximately $1.5 million, $1.8 million, $1.4 million, for theyears ended December 31, 2008, 2007, ad 2006, respectively.

 

Information with respectto the Bank’s impaired loans at December 31, 2008 and 2007 and for thethree years ended December 31, 2008, is as follows:

 
| ** **                                | ** ** | **2008**           | ** ** | **2007** | ** ** |
|-------------------------------------------|------------|--------------------|------------|----------|------------|
| ** **                                | ** ** | **(In thousands)** | ** ** |
| Impaired loans  with related allowance    |       | $                  | —     |     | $          | 23,368 |   |
| Impaired loans  with no related allowance |       | 38,400             |       | —   |       |
| Total impaired  loans                     |       | $                  | 38,400     |     | $          | 23,368 |   |
|                                      |       |               |       |     |       |
| Allowance for  losses on impaired loans   |       | $                  | —     |     | $          | 5,777 |   |

 
| ** **                                                    | ** ** | **2008**           | ** ** | **2007** | ** ** | **2006** | ** ** |
|---------------------------------------------------------------|------------|--------------------|------------|----------|------------|----------|------------|
| ** **                                                    | ** ** | **(In thousands)** | ** ** |
| Average recorded  investment in impaired loans                |       | $                  | 35,367     |     | $          | 16,530   |       | $ | 16,297 |   |
| Interest income  recognized on impaired loans                 |       | $                  | 37         |     | $          | 913      |       | $ | 861 |   |
| Interest income  recognized on a cash basis on impaired loans |       | $                  | 37         |     | $          | 910      |       | $ | 847 |   |

 

Theallowance for impaired loans is included in the Bank’s overall allowance forloan losses.

 

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**PEOPLES COMMUNITY BANCORP, INC.**

** **

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**NOTE E -OFFICE PREMISES AND EQUIPMENT**

 

Office premises andequipment are comprised of the following at December 31:

 
| ** **                         | ** ** | **2008**           | ** ** | **2007**   | ** ** |
|------------------------------------|------------|--------------------|------------|------------|------------|
| ** **                         | ** ** | **(In thousands)** | ** ** |
| ** **                         | ** ** | ** **         | ** ** | ** ** | ** ** |
| Land and  improvements             |       | $                  | 10,448     |       | $          | 10,448 |   |
| Office buildings  and improvements |       | 17,991             |       | 17,991     |       |
| Furniture,  fixtures and equipment |       | 6,888              |       | 6,883      |       |
|                               |       | 35,327             |       | 35,322     |       |
|                               |       |               |       |       |       |
| Less accumulated  depreciation     |       | 8,146              |       | 7,017      |       |
|                               |       |               |       |       |       |
|                               | ** ** | **$**              | **27,181** | ** ** | **$**      | **28,305** | ** ** |

 

Included aboveis approximately $510,000 of real estate held for sale.  Construction was completed on a new branchoffice in Montgomery in February, 2007, at a total cost of $1.2 million.  Construction was also completed on therebuilding of a branch office on Importing Street in Aurora, Indiana at a totalcost of approximately $1.8 million. Capitalized interest on construction during year 2007 was approximately$76,000.

 

**NOTE F -DEPOSITS**

 

Deposits consist of thefollowing major classifications at December 31:

 
| ** **                                       | ** ** | **2008**           | ** **  | **2007**   | ** ** |
|--------------------------------------------------|------------|--------------------|-------------|------------|------------|
| ** **                                       | ** ** | **(In thousands)** | ** **  |
| ** **                                       | ** ** | ** **         | ** **  | ** ** | ** ** |
| Non-interest  bearing checking accounts          |       | $                  | 15,897      |       | $          | 21,936 |   |
| Checking  accounts                               |       | 36,693             |        | 50,686     |       |
| Savings accounts                                 |       | 20,382             |        | 29,256     |       |
| Money market demand  deposit                     |       | 129,244            |        | 121,537    |       |
| Total demand,  transaction and passbook deposits |       | 202,216            |        | 223,415    |       |
|                                             |       |               |        |       |       |
| Certificates of  deposit:                        |       |               |        |       |       |
| Original  maturities of:                         |       |               |        |       |       |
| Less than 12  months                             |       | 207,513            |        | 272,986    |       |
| 12 months to 36  months                          |       | 79,922             |        | 85,174     |       |
| More than 36  months                             |       | 62,022             |        | 66,676     |       |
| Individual  retirement accounts                  |       | 78,525             |        | 86,961     |       |
|                                             |       |               |        |       |       |
| Total  certificates of deposit                   |       | 427,982            |        | 511,797    |       |
|                                             |       |               |        |       |       |
| Total deposits                                   | ** ** | **$**              | **630,198** | ** ** | **$**      | **735,212** | ** ** |

 

AtDecember 31, 2008 and 2007, Peoples had certificate of deposit accountswith balances greater than $100,000 totaling $106.9 million and $152.4 million,respectively.

 

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**PEOPLES COMMUNITY BANCORP, INC.**

** **

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

Maturitiesof outstanding certificates of deposit are summarized as follows at December 31:

 
| ** **           | ** ** | **2008**           | ** **  |
|----------------------|------------|--------------------|-------------|
| ** **           | ** ** | **(In thousands)** | ** **  |
| ** **           | ** ** | ** **         | ** **  |
| One year or less     |       | $                  | 304,468     |   |
| One to two years     |       | 69,001             |        |
| Two to three  years  |       | 15,612             |        |
| Three to four  years |       | 32,611             |        |
| Four to five  years  |       | 6,290              |        |
| Five to six  years   |       | —             |        |
|                 | ** ** | **$**              | **427,982** | ** ** |

 

**NOTE G - ADVANCES FROM THE FEDERAL HOME LOAN BANK**

 

Advancesfrom the Federal Home Loan Bank, collateralized at December 31, 2008 bypledges of certain residential mortgage loans totaling $259.3 million, certainmortgage backed securities and agencies totaling $34.4 million, and Peoples’investment in Federal Home Loan Bank stock, are summarized as follows:

 
| ** **                      | ** ** | **Maturing** | ** ** | ** **         | ** ** |
|---------------------------------|------------|--------------|------------|--------------------|------------|
| **Interest  Rate**              | ** ** | **In Year**  | ** ** | **Amount**         | ** ** |
| ** **                      | ** ** | ** **   | ** ** | **(In thousands)** | ** ** |
| 3.73%                           |       | 2009         |       | 2,972              |       |
| 7.65%                           |       | 2011         |       | 2                  |       |
| 4.53%                           |       | 2012         |       | 1,971              |       |
| 4.78%                           |       | 2015         |       | 1,965              |       |
| 4.07%                           |       | 2016         |       | 25,000             |       |
| 3.45%                           |       | 2017         |       | 25,000             |       |
| 5.60%                           |       | 2018         |       | 55                 |       |
| 5.60% - 6.61%                   |       | 2019         |       | 2,042              |       |
|                            | ** ** | ** **   |       | **$**              | **59,007** |   |
|                            | ** ** | ** **   |       | ** **         |       |
| Weighted-average  interest rate |       | 3.90         | %          |
|                                 |            |              |            |                    |            |  |

 

**NOTE H -OTHER BORROWED MONEY**

 

TheCompany has a $17.5 million line of credit with Integra.  At December 31, 2008 and 2007, theoutstanding balance was $17.5 million and $16.5 million, respectively.  At December 31, 2007, the Company wasnot in compliance with certain loan covenants and the lender had the ability toaccelerate all outstanding amounts upon notice. The line of credit matured June 30, 2008.  Effective July 24, 2008, the Companyentered into a forbearance agreement to extend the repayment period and allowthe Company to structure a transaction which would result in repayment of theline of credit in full.  On December 31,2008, the Company and Integra extended the forbearance period to January 31,2009.  The forbearance period has expiredand the Company is in default on its line of credit with Integra.  This matter remains unresolved.

 

AtDecember 31, 2008, interest was calculated at the prime rate plus 300basis points. The effective interest rate at December 31, 2008 was6.25%.  During the forbearance period,interest is payable monthly at the prime rate (3.25% at December 31,2008); when the loan principal and initial interest is paid in full, under theforbearance terms, the remainder of the interest is due.  Interest accrued and not paid related to theline of

 

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**PEOPLES COMMUNITY BANCORP, INC.**

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**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

credittotaled $264,000 at December 31, 2008 and is included in accrued interestpayable in the consolidated statement of financial condition. At December 31,2007, interest was payable at daily LIBOR plus 200 basis points or prime less50 basis points based on the selection made by the Company. The effectiveinterest rate at December 31, 2007 was 7.24%.

 

**NOTEI - GUARANTEED PREFFERED BENEFICIAL INTERESTS IN JUNIOR SUBORDINATED DEBENTURES**

 

In June 2005,the Company formed a wholly owned Delaware trust (the “Trust II”), which issued$15.0 million of mandatorily redeemable debt securities. These debt securitiesare included as a component of Tier I capital for regulatory capitalpurposes.  The subordinated debenturesare the sole assets of the Trust II, and the Company owns all of the commonsecurities of the Trust II.  Interestpayments on the debt securities are scheduled to be made quarterly at an annualvariable interest rate equal to the three-month LIBOR rate plus 175 basispoints, or equal to 3.74% at December 31, 2008 and 7.11% at December 31,2007, and are reported as a component of interest expense on borrowings.   On May 23, 2008, the Company gavenotice to the trustee that it has elected to exercise its right to deferpayments of interest beginning with its June 15, 2008 payment.  Interest accrued and not paid related to theTrust II totaled $544,000 at December 31, 2008, and is included in accruedinterest payable in the consolidated statement of financial condition.

 

The net proceedsreceived by the Company from the sale of the debt securities were used forgeneral corporate purposes.  Thesubordinated debentures mature in 2035, but can be redeemed through priorapproval by the OTS in any June, September, December or March beginningin 2010.

 

**NOTE J -COMMITMENTS**

 

Peoples’ is a party tofinancial instruments with off-balance-sheet risk in the normal course ofbusiness to meet the financing needs of its customers, including commitments toextend credit.  Such commitments involve,to varying degrees, elements of credit and interest-rate risk in excess of theamount recognized in the consolidated statement of financial condition.  The contract or notional amounts of thecommitments reflect the extent of Peoples’ involvement in such financialinstruments.

 

Peoples’ exposure tocredit loss in the event of nonperformance by the other party to the financialinstrument for commitments to extend credit is represented by the contractualnotional amount of those instruments. Peoples uses the same credit policies in making commitments andconditional obligations as those utilized for on-balance-sheet instruments.

 

The following arecommitments Peoples had as of December 31, 2008:

 
| ** **                      | ** ** | **2008**           | ** ** | **2007**   | ** ** |
|---------------------------------|------------|--------------------|------------|------------|------------|
| ** **                      | ** ** | **(In thousands)** | ** ** |
| ** **                      | ** ** | ** **         | ** ** | ** ** | ** ** |
| Commitments to  originate loans |       | $                  | 50         |       | $          | 143 |   |
| Unused lines of  credit         |       | 24,283             |       | 31,931     |       |
| Unused letters  of credit       |       | 5,723              |       | 5,868      |       |
| Unused balances  of loans       |       | 16,727             |       | 34,497     |       |
|                                 |            |                    |            |            |            |  |  |

 

Commitments to extendcredit are agreements to lend to a customer as long as there is no violation ofany condition established in the contract. Commitments generally have fixed expiration dates or other terminationclauses and may require payment of a fee. Since many of the commitments may expire without

 

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**PEOPLES COMMUNITY BANCORP, INC.**

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**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

being drawn upon, thetotal commitment amounts do not necessarily represent future cashrequirements.  Peoples evaluates eachcustomer’s creditworthiness on a case-by-case basis.  The amount of collateral obtained, if it isdeemed necessary by Peoples upon extension of credit, is based on management’scredit evaluation.  Collateral on loansmay vary but the preponderance of loans granted generally include a mortgageinterest in real estate as security.

 

Peopleshas also entered into lease agreements for office premises under operatingleases which expire at various dates through 2013. Rent expense totaled $38,000,$68,000, and $128,000, for the years ended December 31, 2008, 2007, and2006, respectively. The following table summarizes minimum payments due underlease agreements by year as of December 31, 2008.

 
| **Year ending**       | ** ** | ** **         | ** ** |
|-----------------------|------------|--------------------|------------|
| **December 31,** | ** ** | **Amount**         | ** ** |
| ** **            | ** ** | **(in thousands)** | ** ** |
| 2009                  |       | $                  | 38         |   |
| 2010                  |       | 38                 |       |
| 2011                  |       | 38                 |       |
| 2012                  |       | 38                 |       |
| 2013                  |       | 6                  |       |
| Thereafter            |       | —             |       |
|                  |       | $                  | 160        |   |

 

**NOTE K -FEDERAL INCOME TAXES**

 

Federal income taxesdiffer from the amounts computed at the statutory corporate tax rate for theyears ended December 31, 2008, 2007, and 2006 as follows:

 
| ** **                                                  | ** ** | **For Years Ended December 31,** | ** ** |
|-------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                  | ** ** | **2008**                              | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                                  | ** ** | **(In thousands)**                    | ** ** |
| ** **                                                  | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Federal income  taxes at statutory rate                     |       | $                                     | (23,295    | ) | $ | (13,010 | ) | $ | (2,165 | ) |
| Increase  (decrease)in taxes resulting from:                |       |                                  |       |   |   |   |   |
| Goodwill  impairment                                        |       | 4,255                                 |       | 3,875 |   | — |   |
| Bank owned life  insurance undistributed earnings           |       | (256                                  | )          | (244 | ) | (233 | ) |
| Tax exempt  interest on municipal securities                |       | (99                                   | )          | (15 | ) | (15 | ) |
| Valuation  allowance                                        |       | 22,809                                |       | 4,400 |   | — |   |
| Other                                                       |       | 3,491                                 |       | 61 |   | 105 |   |
| Federal income  taxes per consolidated financial statements |       | $                                     | 6,905      |   | $ | (4,933 | ) | $ | (2,308 | ) |
|                                                        |       |                                  |       |   |   |   |   |
| Effective tax rate                                          |       | n/a                                   |       | n/a |   | n/a |   |

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

The composition ofPeoples’ net deferred tax asset at December 31 is as follows:

 
| ** **                                                                            | ** ** | **2008**                | ** ** | **2007**   | ** ** |
|---------------------------------------------------------------------------------------|------------|-------------------------|------------|------------|------------|
| ** **                                                                            | ** ** | **(In thousands)** | ** ** |
| Taxes (payable)  refundable on temporary differences at estimated corporate tax rate: |       |                    |       |       |       |
| Deferred tax  assets:                                                                 |       |                    |       |       |       |
| General loan  loss allowance                                                          |       | $                       | 9,760      |       | $          | 11,730 |   |
| Deferred  compensation                                                                |       | 583                     |       | 576        |       |
| Charitable  contributions                                                             |       | 60                      |       | 60         |       |
| Stock benefit  plans                                                                  |       | 27                      |       | 32         |       |
| Deferred loan  origination fees                                                       |       | 256                     |       | 496        |       |
| Net operating  loss carryforwards                                                     |       | 19,294                  |       | 3,859      |       |
| Nonaccrual  interest                                                                  |       | 428                     |       | 190        |       |
| Other                                                                                 |       | 971                     |       | 962        |       |
| Total deferred  tax assets                                                            |       | 31,379                  |       | 17,905     |       |
|                                                                                  |       |                    |       |       |       |
| Deferred tax  liabilities:                                                            |       |                    |       |       |       |
| Federal Home  Loan Bank stock dividends                                               |       | (2,159                  | )          | (1,919     | )          |
| Unrealized  losses on securities designated as available for sale                     |       | —                  |       | (21        | )          |
| Book/tax  depreciation differences                                                    |       | (113                    | )          | (113       | )          |
| Mortgage  servicing rights                                                            |       | (168                    | )          | (224       | )          |
| Core deposit  intangible and other purchase accounting adjustments                    |       | (1,730                  | )          | (2,199     | )          |
| Other                                                                                 |       | —                  |       | (213       | )          |
| Total deferred  tax liabilities                                                       |       | (4,170                  | )          | (4,689     | )          |
| Valuation  allowance                                                                  |       | (27,209                 | )          | (4,400     | )          |
| Net deferred tax  asset                                                               | ** ** | **$**                   | **—** | ** ** | **$**      | **8,816** | ** ** |

 

At December 31,2008, Peoples had a valuation allowance of $27.2 million based principally onuncertainty about Peoples’ ability to generate sufficient future taxable incometo realize all of the related temporary differences.  The expense for recording the valuation allowanceis a non-cash item, and the recording of this expense does not imply thatPeoples owes additional income taxes.

 

As of December 31,2008, Peoples had approximately $60.2 million of net operating loss carryforward available to offset future federal taxable income.  The net operating loss carry forward expiresin 2025.

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

Prior to fiscal 1997,Peoples was allowed a special bad debt deduction based on a percentage ofearnings, generally limited to 8% of otherwise taxable income and subject tocertain limitations based on aggregate loans and savings account balances atthe end of the year.  This deductiontotaled approximately $4.9 million as of December 31, 2008.  If the amounts that qualified as deductionsfor federal income tax purposes are later used for purposes other than for baddebt losses, including distributions in liquidation, such distributions will besubject to federal income taxes at the then current corporate income taxrate.  The approximate amount of theunrecognized deferred tax liability relating to the cumulative bad debtdeduction is $1.4 million.

 

**NOTE L -CAPITAL REQUIREMENTS AND REGULATORY MATTERS**

 

The Bank is subject tovarious regulatory capital requirements administered by the federal bankingagencies.  Failure to meet minimumcapital requirements can initiate certain mandatory — and possibly additionaldiscretionary — actions by regulators that, if undertaken, could have a directmaterial effect on the Bank’s financial statements.   Under capital adequacy guidelines and theregulatory framework for prompt corrective action, the Bank must meet specificcapital guidelines that involve quantitative measures of the Bank’s assets,liabilities, and certain off-balance sheet items as calculated under regulatoryaccounting practices.  The Bank’s capitalamounts and classification are also subject to qualitative judgments by theregulators about components, risk weightings, and other factors.

 

Quantitativemeasures established by regulation to ensure capital adequacy require the Bankto maintain minimum amounts and ratios (set forth in the table below) of totaland Tier 1 capital (as defined in the regulation) to risk-weighted assets (asdefined), and of Tier 1 capital (as defined) to adjusted total assets (asdefined).  As of December 31, 2008,the Bank was categorized as “significantly undercapitalized” under theregulatory framework for prompt corrective action.  This categorization is based on the capitalratios as set forth in the following tables.

 

OnApril 13, 2009, Peoples was notified by the OTS of certain promptcorrective actions that Peoples is required to take.  These requirements include submitting to theOTS a capital restoration plan by April 30, 2009 and achieving certaincapital levels by June 15, 2009. The Bank’s capital restoration plan to be submitted to the OTS willconsist of selling branches in order to reduce assets and liabilities, generatea deposit premium and return the Bank to an adequately capitalized status.  The Company cannot provide assurance that itscapital restoration plan will be acceptable to the OTS.  If the Bank’s capital plan is not approved bythe OTS or the Bank cannot enter into and consummate a transaction to returnthe Bank to an adequately capitalized status on a timely basis, the Companywill not be able to continue as a going concern.

 

PeoplesCommunity Bancorp, as a savingsinstitution holding company at December 31, 2008 and 2007, is not subjectto regulatory capital requirements separate from those of the Bank.

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**As of December 31,2008**

 
| ** **             | ** ** | **Actual**       | ** ** | **Critically  Undercapitalized** | ** ** | **Significantly  Undercapitalized** | ** ** | **Undercapitalized** | ** ** | **Adequately  Capitalized** | ** ** | **Well  Capitalized** | ** ** |
|------------------------|------------|------------------|------------|----------------------------------|------------|-------------------------------------|------------|----------------------|------------|-----------------------------|------------|-----------------------|------------|
| ** **             | ** ** | **Ratio/Amount** | ** ** | **Ratio/Amount**                 | ** ** | **Ratio/Amount**                    | ** ** | **Ratio/Amount**     | ** ** | **Ratio/Amount**            | ** ** | **Ratio/Amount**      | ** ** |
|                   |       |             |       |                             |       |                                |       |                 |       |                        |       |                  |       |
| Total Capital to       |       | 4.8%             |       |                             |       | <6.0%                            |       | <8.0%             |       | 38.0%                  |       | 310.0%           |       |
| Risk Weighted  Assets  |       | $21,785          |       |                             |       | <$27,150                         |       | <$36,200          |       | 3$36,200               |       | 3$45,250         |       |
|                   |       |             |       |                             |       |                                |       |                 |       |                        |       |                  |       |
| Tier 1 Capital  to     |       | 3.5%             |       |                             |       | <3.0%                            |       | <4.0%             |       | 34.0%                  |       | 36.0%            |       |
| Risk-Weighted  Assets  |       | $15,844          |       |                             |       | <$13,575                         |       | <$18,100          |       | 3$18,100               |       | 3$27,150         |       |
|                   |       |             |       |                             |       |                                |       |                 |       |                        |       |                  |       |
| Tier 1 Capital  to     |       | 2.2%             |       |                             |       | <3.0%                            |       | <4.0%             |       | 34.0%                  |       | 3 5.0%           |       |
| Adjusted Total  Assets |       | $15,844          |       |                             |       | <$21,283                         |       | <$28,378          |       | 3$28,378               |       | 3$35,472         |       |
|                   |       |             |       |                             |       |                                |       |                 |       |                        |       |                  |       |
| Tangible Equity  to    |       | 2.2%             |       | <2%                           |       |                                |       |                 |       |                        |       |                  |       |
| Tangible Assets        |       | $15,844          |       | <$14,189                      |       |                                |       |                 |       |                        |       |                  |       |

** **

**As of December 31, 2007**

** **
| ** **             | ** ** | **Actual**       | ** ** | **Critically  Undercapitalized** | ** ** | **Significantly  Undercapitalized** | ** ** | **Undercapitalized** | ** ** | **Adequately  Capitalized** | ** ** | **Well  Capitalized** | ** ** |
|------------------------|------------|------------------|------------|----------------------------------|------------|-------------------------------------|------------|----------------------|------------|-----------------------------|------------|-----------------------|------------|
| ** **             | ** ** | **Ratio/Amount** | ** ** | **Ratio/Amount**                 | ** ** | **Ratio/Amount**                    | ** ** | **Ratio/Amount**     | ** ** | **Ratio/Amount**            | ** ** | **Ratio/Amount**      | ** ** |
|                   |       |             |       |                             |       |                                |       |                 |       |                        |       |                  |       |
| Total Capital to       |       | 11.4%            |       |                             |       | <6.0%                            |       | <8.0%             |       | 38.0%                  |       | 310.0%           |       |
| Risk Weighted  Assets  |       | $68,335          |       |                             |       |                                |       |                 |       | 3$48,102               |       | 3$60,127         |       |
|                   |       |             |       |                             |       |                                |       |                 |       |                        |       |                  |       |
| Tier 1 Capital  to     |       | 10.1%            |       |                             |       | <3.0%                            |       | <4.0%             |       | 34.0%                  |       | 3 6.0%           |       |
| Risk-Weighted  Assets  |       | $60,486          |       |                             |       |                                |       |                 |       | 3$24,051               |       | 3$36,076         |       |
|                   |       |             |       |                             |       |                                |       |                 |       |                        |       |                  |       |
| Tier 1 Capital  to     |       | 7.0%             |       |                             |       | <3.0%                            |       | <4.0%             |       | 34.0%                  |       | 3 5.0%           |       |
| Adjusted Total  Assets |       | $60,486          |       |                             |       |                                |       |                 |       | 3$34,500               |       | 3$43,125         |       |
|                   |       |             |       |                             |       |                                |       |                 |       |                        |       |                  |       |
| Tangible Equity  to    |       | 7.0%             |       | <2%                           |       |                                |       |                 |       |                        |       |                  |       |
| Tangible Assets        |       | $60,486          |       |                             |       |                                |       |                 |       |                        |       |                  |       |

 

Therecessionary forces in the local economy have continued to impact Peoples’operations and have resulted in the imposition of certain restrictions on suchoperations by the Bank’s primary federal regulator, the OTS.  On April 2, 2008, the Company and theBank each consented to the terms of Cease and Desist Orders issued by the OTS(the “Orders”).  The Company attachedcopies of the Orders to a Current Report on Form 8-K filed with theSecurities and Exchange Commission on April 3, 2008.

 

TheOrders require the Company and the Bank to, among other things, file with theOTS within prescribed time periods updated business plans, which specificallyincorporate the requirements set forth in the Orders and comments contained inthe most recently completed examinations of the Company and the Bank. On aquarterly basis, the Company and the Bank will be required to compare theprojected operating results from the business plans with the actual results.The results of this variance analysis are to be submitted to the OTS within theprescribed time periods. In addition, the Orders require that the Company andthe Bank receive

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

thepermission of the OTS prior to (i) making or declaring any dividends orpayments on their outstanding securities; (ii) adding or replacing adirector or hiring a senior executive officer; and (iii) making any goldenparachute payments to any institution-affiliated party. Pursuant to the Orderissued to the Company, the Company must also receive the permission of the OTSprior to increasing its debt position and before any repurchase of itssecurities.

 

TheOrder issued to the Bank also requires the Bank to take certain actions,including (i) not making any new loans or issuing new lines of credit forland acquisition or development, speculative residential construction,commercial and multi-family construction, acquisition or retention ofcommercial property, and non-owner occupied one-to-four-family residentialproperty; (ii) engaging an independent consultant to conduct a loanportfolio review for the purpose of determining asset quality and theappropriateness of the Bank’s asset classification process related to loanrelationships that equal or exceed $4.0 million; (iii) establishing a planfor reducing adversely classified assets; (iv) reviewing and, whereappropriate, adjusting the Bank’s allowance for loan and lease lossesmethodology; (v) limiting asset growth during each calendar quarter to anamount not to exceed net interest credited on deposit liabilities; and (vi) establishingan Oversight Committee of the Bank’s Board of Directors comprised ofindependent outside directors.  In aneffort to proactively address the downturn in the local real estate market, theBank had previously curtailed or ceased the lending activities restricted inthe Orders.

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**NOTE M -CONDENSED FINANCIAL STATEMENTS OF PEOPLES COMMUNITY BANCORP, INC.**

 

The followingcondensed financial statements summarize the financial position of PeoplesCommunity Bancorp, Inc. as of December 31, 2008 and 2007, and theresults of its operations and its cash flows for the years ended December 31,2008, 2007, and 2006.

 

## **PEOPLES COMMUNITY BANCORP, INC.**

**STATEMENTSOF FINANCIAL CONDITION**

December 31,2008 and 2007

(In thousands)

 
| ** **                                                 | ** ** | **2008**   | ** ** | **2007**   | ** ** |
|------------------------------------------------------------|------------|------------|------------|------------|------------|
| **ASSETS**                                                 |       |       |       |       |       |
|                                                       |       |       |       |       |       |
| Cash and cash  equivalents                                 |       | $          | 262        |       | $          | 145 |   |
| Loan receivable  from Bank                                 |       | —     |       | 1,001      |       |
| Investment in  Peoples Community Bank                      |       | 18,389     |       | 85,091     |       |
| Investment in  Peoples Bancorp Capital Trust II            |       | 464        |       | 464        |       |
|                                                       | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total assets                                               | ** ** | **$**      | **19,115** | ** ** | **$**      | **86,701** | ** ** |
|                                                       | ** ** | ** ** | ** ** | ** ** | ** ** |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY (DEFICIT)**   |       |       |       |       |       |
|                                                       |       |       |       |       |       |
| Loan payable                                               |       | $          | 17,500     |       | $          | 16,500 |   |
| Accrued expenses  and other liabilities                    |       | 983        |       | 146        |       |
| Accounts payable  to subsidiary                            |       | 13         |       | 1,026      |       |
| Subordinated  debentures                                   |       | 15,464     |       | 15,464     |       |
| Total  liabilities                                         |       | 33,960     |       | 33,136     |       |
|                                                       |       |       |       |       |       |
| Stockholders’  equity                                 |       |       |       |       |       |
| Common stock and  additional paid-in capital               |       | 71,393     |       | 70,889     |       |
| Accumulated  deficit                                       |       | (85,879    | )          | (17,364    | )          |
| Accumulated  other comprehensive income (loss)             |       | (359       | )          | 40         |       |
| Total  stockholders’ equity (deficit)                 |       | (14,845    | )          | 53,565     |       |
|                                                       | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total  liabilities and stockholders’ equity (deficit) | ** ** | **$**      | **19,115** | ** ** | **$**      | **86,701** | ** ** |

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**PEOPLESCOMMUNITY BANCORP, INC.**

##### **STATEMENTS OF OPERATIONS**

#####  

| ** **                                                               | ** ** | **For Years Ended December 31,** | ** **  |
|--------------------------------------------------------------------------|------------|------------------------------------------------------|-------------|
| ** **                                                               | ** ** | **2008**                                             | ** **  | **2007** | ** ** | **2006** | ** ** |
| ** **                                                               | ** ** | **(In thousands)**                              | ** **  |
|                                                                     |       |                                                 |        |   |   |   |   |
| Income                                                                   |       |                                                 |        |   |   |   |   |
| Dividends from  subsidiaries                                             |       | $                                                    | —      |   | $ | — |   | $ | — |   |
| Other income                                                             |       | 17                                                   |        | 56 |   | 73 |   |
| Total income                                                             |       | 17                                                   |        | 56 |   | 73 |   |
|                                                                     |       |                                                 |        |   |   |   |   |
| Expenses                                                                 |       |                                                 |        |   |   |   |   |
| Interest expense                                                         |       | 1,824                                                |        | 2,236 |   | 2,186 |   |
| Other expenses                                                           |       | 100                                                  |        | 178 |   | 252 |   |
| Total expenses                                                           |       | 1,924                                                |        | 2,414 |   | 2,438 |   |
|                                                                     |       |                                                 |        |   |   |   |   |
| Loss before  income tax and equity in undistributed income of subsidiary |       | (1,907                                               | )           | (2,358 | ) | (2,365 | ) |
| Income tax  benefit                                                      |       | (200                                                 | )           | — |   | (693 | ) |
| Loss before  equity in undistributed income of subsidiary                |       | (1,707                                               | )           | (2,358 | ) | (1,672 | ) |
| Equity in  undistributed loss of subsidiary                              |       | (66,808                                              | )           | (30,975 | ) | (2,389 | ) |
|                                                                     | ** ** | ** **                                           | ** **  | ** ** | ** ** | ** ** | ** ** |
| Net loss                                                                 | ** ** | **$**                                                | **(68,515** | **)** | **$** | **(33,333** | **)** | **$** | **(4,061** | **)** |

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**PEOPLES COMMUNITY BANCORP, INC.**

**STATEMENTS OF CASH FLOWS**

(In thousands)

 
| ** **                                           | ** ** | **For Years Ended December 31,** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                           | ** ** | **2008**                                             | ** ** | **2007** | ** ** | **2006** | ** ** |
| Operating  Activities                                |       |                                                 |       |   |   |   |   |
| Net loss                                             |       | $                                                    | (68,515    | ) | $ | (33,333 | ) | $ | (4,061 | ) |
| Items not  requiring (providing) cash                |       |                                                 |       |   |   |   |   |
| Undistributed  losses of subsidiary                  |       | 66,808                                               |       | 30,975 |   | 2,561 |   |
| Undistributed  earnings of Columbia                  |       | —                                               |       | — |   | (172 | ) |
| Gain on sale of  securities                          |       | —                                               |       | — |   | (6 | ) |
| Increase  (decrease) in cash due to changes in:      |       |                                                 |       |   |   |   |   |
| Other assets                                         |       | —                                               |       | 110 |   | 1,229 |   |
| Other  liabilities                                   |       | 824                                                  |       | 324 |   | (214 | ) |
|                                                 |       |                                                 |       |   |   |   |   |
| Net cash used in  operating activities               |       | (883                                                 | )          | (1,924 | ) | (663 | ) |
|                                                 |       |                                                 |       |   |   |   |   |
| Investing  Activities                                |       |                                                 |       |   |   |   |   |
| Proceeds from  repayment of loan to ESOP             |       | —                                               |       | 211 |   | 211 |   |
| Proceeds from  sale of investment securities         |       |                                                 |       | — |   | 126 |   |
| Sale of interest  in Columbia                        |       | —                                               |       | — |   | 2,856 |   |
|                                                 |       |                                                 |       |   |   |   |   |
| Cash paid in  acquisition of Mercantile - net        |       | —                                               |       | — |   | (364 | ) |
|                                                 |       |                                                 |       |   |   |   |   |
| Net cash  provided by investing activities           |       | —                                               |       | 211 |   | 2,829 |   |
| Financing  Activities                                |       |                                                 |       |   |   |   |   |
| Proceeds from  borrowings                            |       | 1,000                                                |       | 4,550 |   | 16,500 |   |
| Repayment of  borrowings                             |       | —                                               |       | (750 | ) | (3,800 | ) |
| Dividends paid  on common stock                      |       | —                                               |       | (2,140 | ) | (2,795 | ) |
|                                                 |       |                                                 |       |   |   |   |   |
| Proceeds from  exercise of stock options             |       | —                                               |       | 7 |   | 46 |   |
|                                                 |       |                                                 |       |   |   |   |   |
| Redemption of  subordinated debentures               |       | —                                               |       | — |   | (12,887 | ) |
|                                                 |       |                                                 |       |   |   |   |   |
| Net cash  provided by (used in) financing activities |       | 1,000                                                |       | 1,667 |   | (2,936 | ) |
|                                                 |       |                                                 |       |   |   |   |   |
| Net increase (decrease) in cash and cash equivalents |       | 117                                                  |       | (46 | ) | (770 | ) |
|                                                 |       |                                                 |       |   |   |   |   |
| Cash and cash equivalents at beginning of year       |       | 145                                                  |       | 191 |   | 961 |   |
|                                                 |       |                                                 |       |   |   |   |   |
| Cash and cash equivalents at end of year             | ** ** | **$**                                                | **262**    | ** ** | **$** | **145** | ** ** | **$** | **191** | ** ** |

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

The Bank is subject to regulations imposed by the OTSregarding the amount of capital distributions payable by the Bank to theCompany.  Generally, the Bank’s paymentof dividends is limited, without prior OTS approval, to net earnings for thecurrent calendar year plus the two preceding calendar years, less capitaldistributions paid over the comparable time period.  Insured institutions are required to file anapplication with the OTS for capital distributions in excess of thislimitation. The Orders specifically prohibit the Bank from paying dividends tothe Company without the prior approval of the OTS.

 

**NOTE N -BUSINESS COMBINATIONS**

 

On June 9, 2006, theCompany acquired Mercantile and the Bank acquired Mercantile Savings Bank whichoperated one branch office in Cincinnati, Ohio. The acquisition included $38.0 million in loans receivable and $48.7million in deposits.  Goodwill and otherintangible assets of approximately $6.2 million were recorded in theacquisition.

 

Thisacquisition focused on increasing Peoples’ market share and scale ofoperations, as well as expanding its distribution network within its primarymarket area.  The results of operationsof this acquisition have been included in the consolidated financial statementsas of the acquisition date.

 

Presentedbelow are the estimated fair values of the assets acquired and liabilitiesassumed from the acquisition in the year ended December 31, 2006.

 
| ** **                     | ** ** | **Mercantile**             | ** ** |
|--------------------------------|------------|----------------------------|------------|
| ** **                     | ** ** | **June 9, 2006** | ** ** |
| ** **                     | ** ** | **(in thousands)**    | ** ** |
|                           |       |                       |       |
| Cash and  investments          |       | $                          | 12,913     |   |
| Investment  securities         |       | 7,407                      |       |
| Loans                          |       | 38,030                     |       |
| Office premises  and equipment |       | —                     |       |
| Core deposits  premium         |       | 2,206                      |       |
| Goodwill                       |       | 3,963                      |       |
| Other assets                   |       | 2,560                      |       |
|                           |       |                       |       |
| Total assets  acquired         |       | 67,079                     |       |
|                           |       |                       |       |
| Deposits                       |       | 48,683                     |       |
| Borrowings                     |       | 6,378                      |       |
| Other  liabilities             |       | 2,633                      |       |
|                           |       |                       |       |
| Total  liabilities             |       | 57,694                     |       |
|                           |       |                       |       |
| Net assets  acquired           |       | $                          | 9,385      |   |

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

Presented below are pro-forma condensed consolidated statements ofearnings which have been prepared as if the Mercantile transaction had  been consummated at the beginning of the yearended December 31, 2006.

 
| ** **                                 | ** ** | **Year   Ended   December 31,** | ** ** |
|--------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                 | ** ** | **2006**                                       | ** ** |
| ** **                                 | ** ** | ** **                                     | ** ** |
| Total interest  income                     |       | $                                              | 66,720     |   |
| Total interest  expense                    |       | 37,017                                         |       |
| Net interest  income                       |       | 29,703                                         |       |
|                                       |       |                                           |       |
| Provision for  losses on loans             |       | 17,450                                         |       |
| Other income                               |       | 3,471                                          |       |
| General,  administrative and other expense |       | 22,532                                         |       |
| Loss before  income taxes                  |       | (6,808                                         | )          |
|                                       |       |                                           |       |
| Federal income  tax benefits               |       | (2,314                                         | )          |
| Net loss                                   |       | $                                              | (4,494     | ) |
|                                       |       |                                           |       |
| Pro-forma basic  loss per share            |       | $                                              | (0.94      | ) |
| Pro-forma  diluted loss per share          |       | $                                              | (0.94      | ) |

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE O -QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)**

 

The following table summarizes Peoples’quarterly results for the years ended December 31, 2008 and December 31,2007.  Certain amounts, as previouslyreported, have been reclassified to conform to the 2008 presentation.

 
| ** **                                 | ** ** | **Three Months Ended**                                   | ** ** |
|--------------------------------------------|------------|--------------------------------------------------------------------|------------|
| **2008:**                                  | ** ** | **March 31,**                                                 | ** ** | **June 30,** | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                                 | ** ** | **(In thousands, except per share data)** | ** ** |
| ** **                                 |       |                                                               |       |   |   |   |   |   |   |
| Total interest  income                     |       | $                                                                  | 11,929     |   | $ | 10,685 |   | $ | 9,216 |   | $ | 8,407 |   |
| Total interest  expense                    |       | 7,983                                                              |       | 5,806 |   | 5,866 |   | 6,582 |   |
|                                       |       |                                                               |       |   |   |   |   |   |   |
| Net interest  income                       |       | 3,946                                                              |       | 4,879 |   | 3,350 |   | 1,825 |   |
| Provision for  losses on loans             |       | 1,800                                                              |       | 1,800 |   | 16,604 |   | 21,273 |   |
| Gain (loss) on  sale of assets             |       | 503                                                                |       | 34 |   | (3,883 | ) | 53 |   |
| Other income                               |       | 799                                                                |       | 728 |   | 735 |   | 745 |   |
| General,  administrative and other expense |       | 5,230                                                              |       | 5,485 |   | 5,994 |   | 4,624 |   |
| Goodwill  impairment                       |       | —                                                             |       | 12,514 |   | — |   | — |   |
|                                       |       |                                                               |       |   |   |   |   |   |   |
| Loss before  income taxes                  |       | (1,782                                                             | )          | (14,158 | ) | (22,396 | ) | (23,274 | ) |
| Federal income  taxes (benefits)           |       | (657                                                               | )          | (558 | ) | 9,790 |   | (1,670 | ) |
|                                       |       |                                                               |       |   |   |   |   |   |   |
| Net loss                                   | ** ** | **$**                                                              | **(1,125** | **)** | **$** | **(13,600** | **)** | **$** | **(32,186** | **)** | **$** | **(21,604** | **)** |
|                                       | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Loss per share                             |       |                                                               |       |   |   |   |   |   |   |
| Basic                                      | ** ** | **$**                                                              | **(.23**   | **)** | **$** | **(2.82** | **)** | **$** | **(6.66** | **)** | **$** | **(4.46** | **)** |
| Diluted                                    | ** ** | **$**                                                              | **(.23**   | **)** | **$** | **(2.82** | **)** | **$** | **(6.66** | **)** | **$** | **(4.46** | **)** |

 
| ** **                                 | ** ** | **Three Months Ended**                                   | ** ** |
|--------------------------------------------|------------|--------------------------------------------------------------------|------------|
| **2007:**                                  | ** ** | **March 31,**                                                 | ** ** | **June 30,** | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                                 | ** ** | **(In thousands, except per share data)** | ** ** |
| ** **                                 |       |                                                               |       |   |   |   |   |   |   |
| Total interest  income                     |       | $                                                                  | 16,089     |   | $ | 15,943 |   | $ | 14,935 |   | $ | 13,266 |   |
| Total interest  expense                    |       | 9,288                                                              |       | 9,591 |   | 9,091 |   | 8,490 |   |
|                                       |       |                                                               |       |   |   |   |   |   |   |
| Net interest  income                       |       | 6,801                                                              |       | 6,352 |   | 5,844 |   | 4,776 |   |
| Provision for  losses on loans             |       | 2,100                                                              |       | 2,100 |   | 4,100 |   | 24,500 |   |
| Gain (loss) on  sale of assets             |       | (4                                                                 | )          | (45 | ) | 301 |   | 46 |   |
| Other income                               |       | 785                                                                |       | 917 |   | 749 |   | 1,183 |   |
| General,  administrative and other expense |       | 5,745                                                              |       | 5,652 |   | 5,050 |   | 5,327 |   |
| Goodwill  impairment                       |       | —                                                             |       | — |   | — |   | 11,397 |   |
|                                       |       |                                                               |       |   |   |   |   |   |   |
| Loss before  income taxes                  |       | (263                                                               | )          | (528 | ) | (2,256 | ) | (35,219 | ) |
| Benefits                                   |       | (137                                                               | )          | (233 | ) | (817 | ) | (3,746 | ) |
|                                       |       |                                                               |       |   |   |   |   |   |   |
| Net loss                                   | ** ** | **$**                                                              | **(126**   | **)** | **$** | **(295** | **)** | **$** | **(1,439** | **)** | **$** | **(31,473** | **)** |
|                                       | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Loss per share                             |       |                                                               |       |   |   |   |   |   |   |
| Basic                                      | ** ** | **$**                                                              | **(.03**   | **)** | **$** | **(.06** | **)** | **$** | **(.30** | **)** | **$** | **(6.57** | **)** |
| Diluted                                    | ** ** | **$**                                                              | **(.03**   | **)** | **$** | **(.06** | **)** | **$** | **(.30** | **)** | **$** | **(6.57** | **)** |

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

Net loss for thefourth quarter of 2008 was $21.6 million, or $4.46 loss per share, compared toa net loss for the third quarter of 2008 of $32.2 million and $31.5 million forthe fourth quarter of 2007.  Net interestincome for the fourth quarter of 2008 decreased $1.5 million, or 45.5%,compared to the third quarter of 2008, primarily due to a decrease of 63 basispoints in the net interest margin to 1.24% for the fourth quarter of 2008.

 

Management recorded a provision for losses on loans of $21.3 million inthe fourth quarter of 2008, compared to $16.6 million in the third quarter of2008.  The larger provision in the fourthquarter reflects loans that were identified as having specific losses andcharging them down to their net realizable value.  Nonperforming assets at September 30,2008 totaled $33.5 million, compared to $53.3 million at December 31,2008, while classified assets increased from $80.6 million at September 30,2008 to $114.1 million at December 31, 2008.

 

General,administrative and other expenses recorded during the fourth quarter of 2008totaled $4.6 million, a decrease of $1.4 million, or 22.9%, compared to thethird quarter of 2008, and a decrease of $607,000, or 11.6%, and a decrease of$861,000, or 15.7%, from the first and second quarter of 2008, respectively.

 

The Bank recorded goodwill totaling $23.9 million in conjunction withacquisitions of other financial institutions over the past five years.  Following an updated valuation in the fourthquarter of 2007 by an independent third party, the Bank incurred a non-cashimpairment charge of $11.4 million for the writedown of goodwill.   An updated valuation was performed in thesecond quarter of 2008 which resulted in a non-cash impairment charge of $12.5million, which eliminated the goodwill on the books of the Bank.  This impairment was primarily attributable tolower market valuations for financial institutions in the latter part of 2007and first half of 2008, the weakening of the credit market, the decline in realestate values, particularly in the Cincinnati region, and the net lossesrecorded by the Bank and Company.

 

In the fourthquarter of 2007, Peoples recorded a valuation allowance of deferred income taxin the amount of $4.4 million based principally on uncertainty about itsability to generate sufficient future taxable income to realize all of therelated temporary differences.  Peoplesrecorded an additional $22.8 million to this valuation allowance in 2008.  The expense for recording the valuationallowance is a non-cash item, and the recording of this expense does not implythat Peoples owes additional income taxes.

 

**NOTE P —OPERATING AND LIQUIDITY MATTERS**

 

Beginningin early 2007, Peoples began to reduce all aspects of its lending exposure duein large part to the downturn in the local economy, and, in particular, valuesof residential and residential development properties. Further, beginning in2006, Peoples revised its underwriting standards to place an increased focus oncash flow analysis, tightened its credit standards and provided additionalresources to the resolution of its classified assets.  Despite actions taken by Peoples during 2007and 2008, the continued recessionary forces in the local economy have had asignificant adverse impact on Peoples’ financial condition and results ofoperations.  For 2007 and 2008, netlosses recorded by Peoples amounted to $33.3 million and $68.5 million,respectively.

 

TheBank’s primary federal regulator, the OTS has, in light of Peoples’ recentlosses and levels of nonperforming assets, imposed certain operationsrestrictions on the Company and the Bank, many of which had previously beentaken by the Company and the Bank.  On April 2,2008, the Company and the Bank each consented to the terms of the Orders.  The Orders require the Company and the Bankto, among other things, file with the OTS within prescribed time periodsupdated business plans, which specifically incorporate the requirements setforth in the Orders and comments contained in the most recently completedexaminations of the Company and the Bank. In addition, the Orders require thatthe Company and the Bank receive the permission of the OTS prior to (i) makingor declaring any dividends or payments on their 

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

outstandingsecurities; (ii) adding or replacing a director or hiring a seniorexecutive officer; and (iii) making any golden parachute payments to anyinstitution-affiliated party. Pursuant to the Order issued to the Company, theCompany must also receive the permission of the OTS prior to increasing itsdebt position and before any repurchase of its securities.

 

TheCompany currently lacks the ability to continue as a going concern, primarilydue to the Company’s current lack of liquidity to repay its $17.5 millionobligation under an outstanding line of credit with Integra, which was due andpayable June 30, 2008.  The line ofcredit is secured by all outstanding shares of common stock of the Bank.  The Orders prohibit the Bank from paying cashdividends to the Company without the prior consent of the OTS.  Without this consent, the Company has onlyexisting cash and cash equivalents as its source of liquidity.  Absent the ability to rely on dividends fromthe Bank, the Company will require funds from other funding sources to meet itsobligations, such as restructuring or replacing the existing line ofcredit.  Effective July 24, 2008,the Company entered into a forbearance agreement with Integra regarding its$17.5 million line of credit. The forbearance was negotiated in order to extendthe repayment period and allow the Company to structure a transaction whichwould result in repayment of the $17.5 million line of credit.

 

OnDecember 31, 2008, the Company and Integra extended the forbearance periodto January 31, 2009.  Theforbearance period has expired and the Company is in default on its line ofcredit with Integra.  This matter remainsunresolved.

 

Management of the Companyand the Bank is working diligently to resolve the issues associated with theirnonperforming assets and to provide the information or take the actionsrequired by the Orders.  Concurrently,management and the Board of Directors are considering all strategic alternativesavailable to the Company and the Bank. As required, the Company and the Bankhave filed a consolidated business plan with the OTS covering operationsthrough 2010.  Peoples’ business plancontemplates, among other things, a consolidation of Peoples’ operationsthrough branch sales and a reduction in adversely classified assets throughloan resolutions, repayments, sales and charge-offs.  Branch sale transactions would decreasePeoples’ assets and liabilities, improve capital ratios, and reduce general,administrative and other expense.  Inaddition, the Bank would dividend funds to the Company to provide liquidity toservice the Company’s debt, provided that approval would be received from theOTS.

 

There are noassurances that the measures set forth in the 3-year business plan willsuccessfully improve the condition of Peoples and result in the termination ofthe Orders from the OTS.  The economicfactors of the greater Cincinnati area and the duration of the downturn in thelocal real estate market will have a significant impact on the implementationof the business plan.  In addition, whilethese measures are designed to improve the condition of Peoples, there are noassurances that such measures will successfully enable Peoples to continue as agoing concern.  Although not currentlyplanned, the liquidation of assets in other than the ordinary course ofbusiness in order to meet liquidity needs could result in losses not reflectedin these financial statements.

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**DIRECTORSAND EXECUTIVE OFFICERS**

 

**PEOPLESCOMMUNITY BANCORP, INC. AND PEOPLES COMMUNITY BANK**

 

**DIRECTORS**

 
| Donald L. Hawke                                                   |     | Thomas J. Noe                                  |
|-------------------------------------------------------------------|----------|------------------------------------------------|
| *Retired*                                                         | * * | *CFO,  Treasurer and Executive Vice President* |
| * *                                                          | * * | * *                                       |
| Jerry D.  Williams                                                |     | John E. Rathkamp                               |
| *President  and Chief Executive Officer*                          | * * | *Retired*                                      |
| * *                                                          | * * | * *                                       |
| John L. Buchanan                                                  |     | Nicholas N.  Nelson                            |
| *President  of Buchanan’s Power Equipment Center, Inc.* | * * | *County  Auditor, Warren County, Ohio*         |
|                                                              |     |                                           |
| * *                                                          |     |                                           |
| James R.  VanDeGrift                                              |     |                                           |
| *Trustee,  Turtlecreek Township, Lebanon, Ohio*                   |     |                                           |

 

**EXECUTIVE & SENIOR OFFICERS**

 
| Jerry D.  Williams                                       |     | Thomas J. Noe                                           |
|----------------------------------------------------------|----------|---------------------------------------------------------|
| *President  and Chief Executive Officer*                 | * * | *CFO,  Treasurer and Executive Vice President*          |
| * *                                                 | * * | * *                                                |
| Fred L.  Darlington                                      |     | Jerry Gore                                              |
| *Interim  Chief Lending Officer, General Counsel,*       | * * | *Director  of Retail Banking and Senior Vice President* |
| *Corporate Secretary and**Senior Vice President*         | * * |                                                    |
| * *                                                 | * * | * *                                                |
| Lori M. Henn                                             |     | Rick Wade                                               |
| *Compliance  Officer and Senior Vice President*          | * * | *Chief  Operations Officer and Senior Vice President*   |
| * *                                                 | * * | * *                                                |
| Joan Woodward                                            |     |                                                    |
| *Director  of Human Resources and Senior Vice President* |     |                                                    |

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**BANKINGLOCATIONS AND STOCKHOLDER INFORMATION**

 

**BANKINGLOCATIONS**

 

Peoples Community Bancorp, Inc.is a Maryland-incorporated savings and loan holding company conducting businessthrough its wholly-owned subsidiary, Peoples Community Bank.  Peoples Community Bank is afederally-chartered, DIF-insured stock savings bank operating through nineteenoffices in Hamilton, Warren, and Butler counties in southwest Ohio and Dearbornand Ohio counties in southeast Indiana.

 
| ** **                                           | ** ** | **Main Office**                                     | ** ** | ** **                                              |
|------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------------|
| ** **                                           | ** ** | ** **                                          | ** ** | ** **                                              |
|                                                 |       | 6100 West Chester RoadWest Chester, Ohio 45069      |       |                                                    |
|                                                 |       |                                                |       |                                                    |
| ** **                                           | ** ** | **Branch Offices in Ohio**                          |       |                                                    |
| ** **                                           | ** ** | ** **                                          |       |                                                    |
| 7615 Voice of America  DriveWest Chester, Ohio 45069 |       | 11 South BroadwayLebanon, Ohio 45036                |       | 4825 Marburg AvenueCincinnati, Ohio 45209               |
|                                                 |       |                                                |       |                                                    |
| 5712 Bridgetown RoadCincinnati, Ohio 45248           |       | 6570 Harrison AvenueCincinnati, Ohio 45247          |       | 7522 Hamilton AvenueCincinnati, Ohio 45231              |
|                                                 |       |                                                |       |                                                    |
| 4100 State Route 128Cleves, Ohio 45002               |       | 1101 Columbus AvenueLebanon, Ohio 45036             |       | 5797 South State Route 48Maineville, Ohio 45039         |
|                                                 |       |                                                |       |                                                    |
| 8350 Arbor Square DriveMason, Ohio 45040             |       | 3530 Springdale RoadCincinnati, Ohio 45251          |       | 7200 Blue Ash RoadCincinnati, Ohio 45236                |
|                                                 |       |                                                |       |                                                    |
| 9360 Montgomery Road   Cincinnati, Ohio 45242        |       |                                                |       | 6945 South Liberty Drive   Liberty Township, Ohio 45044 |
|                                                 |       |                                                |       |                                                    |
| ** **                                           | ** ** | **Branch Offices in Indiana**                       |       |                                                    |
| ** **                                           | ** ** | ** **                                          |       |                                                    |
| 131 Walnut StreetLawrenceburg, Indiana 47025         |       | 320 Importing StreetAurora, Indiana 47001           |       | 24128 State Line RoadBright, Indiana 47025              |
|                                                 |       |                                                |       |                                                    |
|                                                 |       | 330 Industrial Access RoadRising Sun, Indiana 47040 |       |                                                    |

 

**ANNUALMEETING**

 

The annual meeting ofstockholders of Peoples Community Bancorp, Inc. for 2009 has not beenscheduled.  The Company presently intendsto hold the annual meeting in June 2009. The date, time and location will be announced by press release and othermeans of public dissemination.

 

**TRANSFERAGENT/REGISTRAR**

 

Registrar andTransfer Company

10 Commerce Drive

Cranford, NewJersey 07016

(908) 272-8511

 

**STOCKHOLDERREQUESTS**

 

Requests for annualreports, quarterly reports and related stockholder literature should bedirected to Thomas J. Noe, Treasurer, Peoples Community Bancorp, Inc.,6100 West Chester Road, West Chester, Ohio 45069.

 

Stockholdersneeding assistance with stock records, transfers or lost certificates, pleasecontact Peoples Community Bancorp’s transfer agent, Registrar and TransferCompany.

 

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