**Exhibit 13**

** **

 

**2007 ANNUAL REPORT**

 

**TO STOCKHOLDERS**

 

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**TABLE OFCONTENTS**

 
|                                                                                       | **Page**   |
|--------------------------------------------------------------------------------------------|------------|
|                                                                                       | ** ** |
| President’s Letter to Stockholders                                                    | 1          |
|                                                                                       |       |
| Business  of Peoples Community Bancorp, Inc                                                | 2          |
|                                                                                       |       |
| Market  Price of Peoples Community Bancorp Common Shares andRelated Stockholder Matters    | 3          |
|                                                                                       |       |
| Selected  Consolidated Financial and Other Data                                            | 4          |
|                                                                                       |       |
| Management’s  Discussion and Analysis of Financial Conditionand Results of Operations | 6          |
|                                                                                       |       |
| Consolidated  Financial Statements:                                                        |       |
|                                                                                       |       |
| Report of Independent Registered  Public Accounting Firm                                   | 26         |
|                                                                                       |       |
| Consolidated Statements of Financial  Condition                                            | 27         |
|                                                                                       |       |
| Consolidated Statements of Operations                                                      | 28         |
|                                                                                       |       |
| Consolidated Statements of Comprehensive  Income (Loss)                                    | 29         |
|                                                                                       |       |
| Consolidated Statements of Stockholders’  Equity                                      | 30         |
|                                                                                       |       |
| Consolidated Statements of Cash Flows                                                      | 32         |
|                                                                                       |       |
| Notes to Consolidated Financial Statements                                                 | 34         |
|                                                                                       |       |
| Directors  and Executive Officers                                                          | 71         |
|                                                                                       |       |
| Banking  Locations and Stockholder Information                                             | 72         |

 

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Dear Fellow Shareholders:

 

This past year presenteda challenging national banking environment and proved even more difficult inour greater Cincinnati market area.  Ouroperations were significantly impacted by the recessionary forces in the localeconomy, the decrease in real estate values and the associated cash flowdifficulties faced by many of our real estate investor and developercustomers.  Although we believe we havebeen proactive in, among other things, curtailing or ceasing all aspects of ourlending operations and tightening our credit standards, the level of ournonperforming assets and related loan charge-offs and provisions for losses onloans were the primary factors in our net losses of $4.1 million and $33.3million for 2006 and 2007, respectively. We are very disappointed with these results and are working diligentlyto resolve the issues associated with our nonperforming assets and return theCompany to profitability. Despite the issues confronting the Company over thelast two years, at December 31, 2007, its wholly-owned subsidiary, PeoplesCommunity Bank, continued to exceed all of the regulatory capital requirementsapplicable to it and was also deemed a well capitalized institution.

 

This annual report tostockholders includes a detailed discussion of our financial condition and theimpact of our nonperforming assets and recent losses on our results ofoperations.  We strongly urge you to readthis annual report in its entirety to fully understand the challenges faced byPeoples Community 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 committedto maximizing shareholder value and will not preclude any feasible strategicalternative to do so.  We appreciate yoursupport and patience as we work through these challenging times.

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

 

1

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**BUSINESS OF PEOPLES COMMUNITY BANCORP, INC.**

 

Peoples CommunityBancorp, Inc., a Maryland corporation (the “Company”), is a registeredsavings and loan holding company which owns all of the outstanding commonshares of Peoples Community Bank (“Peoples” or the “Bank”), a federally charteredsavings bank.  The Company was formed in December 1999in connection with the mutual to stock conversion of the Bank, and the sale of1,190,000 shares of common stock to depositors and members of thecommunity.  The Bank conducts itsbusiness from nineteen full service offices in Hamilton, Warren and Butlercounties in Southwest Ohio and Dearborn and Ohio Counties in Southeast Indiana. The funds for the Bank’s lending and investment activities are primarilyprovided by deposits and borrowings.  At December 31,2007, the Company had $887.4 million in total assets, $735.2 million indeposits, $77.6 million in borrowings (excluding subordinated debentures) and$53.6 million of stockholders’ equity. The Company’s principal executive office is located at 6100 West ChesterRoad, P.O. Box 1130, West Chester, Ohio 45071-1130.  The Company’s telephone number is (513)870-3530.

 

The Company is subject to regulation, supervision and examination bythe Office of Thrift Supervision (the “OTS”). Peoples is subject to regulation, supervision and examination by the OTSas its primary federal regulator and the Federal Deposit Insurance Corporation(the “FDIC”), which administers the Deposit Insurance Fund. The FDIC insuresdeposits in Peoples up to applicable limits.

 

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**MARKET PRICE OF PEOPLES COMMUNITYBANCORP COMMON SHARES**

**AND RELATED STOCKHOLDERMATTERS**

 

The Company’s common shares are currently listedon the Nasdaq Global Market (“Nasdaq”) under the symbol “PCBI.”  Presented below are the high and low tradingprices for the Company’s common shares for the three years ended December 31,2007.  Such prices do not include retailfinancial markups, markdowns or commissions. Information relating to prices has been obtained from Nasdaq.  The Company suspended the payment of aquarterly cash dividend effective for the quarter ended December 31,2007.  No assurance can be given as to ifor when the Company may resume such payments.

 
| **Fiscal 2007**     | ** ** | **High** | ** ** | **Low** | ** ** | **Dividends** | ** ** |
|--------------------------|------------|----------|------------|---------|------------|---------------|------------|
|                     |       |     |       |    |       |          |       |
| Quarter ended:           |       |     |       |    |       |          |       |
| December 31,  2007  |       | $        | 18.00      |    | $          | 13.52         |       | $ | — |   |
| September 30,  2007 |       | 18.38    |       | 14.71   |       | .15           |       |
| June 30,  2007      |       | 16.93    |       | 14.47   |       | .15           |       |
| March 31,  2007     |       | 18.43    |       | 16.80   |       | .15           |       |
|                          |            |          |            |         |            |               |            |  |  |  |

 
| **Fiscal 2006**     | ** ** | **High** | ** ** | **Low** | ** ** | **Dividends** | ** ** |
|--------------------------|------------|----------|------------|---------|------------|---------------|------------|
|                     |       |     |       |    |       |          |       |
| Quarter ended:           |       |     |       |    |       |          |       |
| December 31,  2006  |       | $        | 19.60      |    | $          | 16.35         |       | $ | .15 |   |
| September 30,  2006 |       | 19.85    |       | 17.25   |       | .15           |       |
| June 30,  2006      |       | 20.95    |       | 18.50   |       | .15           |       |
| March 31,  2006     |       | 21.83    |       | 19.91   |       | .15           |       |
|                          |            |          |            |         |            |               |            |  |  |  |

 

As of April 7, 2008, the Company had4,838,964 common shares outstanding held of record by approximately 1,030stockholders.  The number of stockholdersdoes not reflect the number of persons or entities who may hold stock innominee or “street” name through brokerage firms or others.

 

3

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**SELECTED CONSOLIDATED FINANCIALAND OTHER DATA**

 

The following selected consolidated financial and otherdata does not purport to be complete and is qualified in its entirety byreference to the more detailed financial information, including theConsolidated Financial Statements and related notes, appearing elsewhereherein.

 
| **Selected Consolidated Financial**                      | ** ** | **At December 31,** | ** ** | **At September 30,** | ** ** |
|--------------------------------------------------------------------|------------|-------------------------------|------------|--------------------------------|------------|
| **Condition Data: ****(1)**                              | ** ** | **2007**                      | ** ** | **2006**                       | ** ** | **2005** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                         |       |                          |       |                           |       | **(In thousands)** |   |   |   |   |   |   |   |
| ** **                                                         |       |                          |       |                           |       |   |   |   |   |   |   |   |   |
| Total assets                                                       |       | $                             | 887,426    |                           | $          | 1,028,079 |   | $ | 1,040,912 |   | $ | 1,006,654 |   | $ | 889,121 |   | $ | 738,683 |   |
| Cash and cash  equivalents                                         |       | 86,614                        |       | 57,459                         |       | 21,558 |   | 17,061 |   | 14,430 |   | 10,244 |   |
| Investment  securities available for sale                          |       | 4,237                         |       | 4,230                          |       | 3,458 |   | 7,650 |   | 1,069 |   | 2,156 |   |
| Mortgage-backed  securities available for sale                     |       | 63,335                        |       | 52,669                         |       | 71,024 |   | 199,716 |   | 228,085 |   | 133,828 |   |
| Loans  receivable, net                                             |       | 634,421                       |       | 812,578                        |       | 851,270 |   | 704,714 |   | 599,466 |   | 554,351 |   |
| Deposits                                                           |       | 735,212                       |       | 755,261                        |       | 726,629 |   | 612,199 |   | 472,436 |   | 455,900 |   |
| Advances from  the Federal Home Loan Bank and other borrowed money |       | 77,628                        |       | 156,885                        |       | 221,483 |   | 301,920 |   | 324,500 |   | 232,400 |   |
| Stockholders’  equity (2)                                     |       | 53,565                        |       | 87,616                         |       | 86,047 |   | 86,700 |   | 75,775 |   | 46,699 |   |
|                                                                    |            |                               |            |                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
|                                                     | ** ** | ** **                                                         | ** **  | ** **            | ** ** | **Three Months**                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------------------------|-------------|-----------------------|------------|---------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                               | ** ** | **Year Ended**                                                | ** **  | **Ended**             | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Selected Consolidated Operating**            | ** ** | **December 31,**                                              | ** **  | **December 31,** | ** ** | **Year Ended September 30,** | ** ** |
| **Data:**** (1)**                                   | ** ** | **2007**                                                           | ** **  | **2006**              | ** ** | **2005**                                    | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|                                                     | ** ** | **(In thousands, except per share data)** | ** **  |
| ** **                                               |       |                                                               |        |                  |       |                                        |       |       |       |       |       |       |       |
| Interest income                                          |       | $                                                                  | 60,233      |                  | $          | 65,475                                      |       | $          | 14,402     |       | $          | 47,748     |       | $ | 40,171 |   | $ | 37,169 |   |
| Interest expense                                         |       | 36,460                                                             |        | 36,485                |       | 8,155                                       |       | 26,204     |       | 19,813     |       | 18,072     |       |
| Net interest  income                                     |       | 23,773                                                             |        | 28,990                |       | 6,247                                       |       | 21,544     |       | 20,358     |       | 19,097     |       |
| Provision for  losses on loans                           |       | 32,800                                                             |        | 17,450                |       | 900                                         |       | 3,600      |       | 3,600      |       | 4,198      |       |
| Net interest  income after provision for losses on loans |       | (9,027                                                             | )           | 11,540                |       | 5,347                                       |       | 17,944     |       | 16,758     |       | 14,899     |       |
| Other income                                             |       | 3,932                                                              |        | 3,213                 |       | (764                                        | )          | 2,114      |       | 1,181      |       | 1,251      |       |
| Goodwill  impairment                                     |       | 11,397                                                             |        | —                |       | —                                      |       | —     |       | —     |       | —     |       |
| General,  administrative and other expense               |       | 21,774                                                             |        | 21,122                |       | 4,530                                       |       | 15,827     |       | 13,750     |       | 10,504     |       |
|                                                     |       |                                                               |        |                  |       |                                        |       |       |       |       |       |       |       |
| Earnings (loss)  before income taxes                     |       | (38,266                                                            | )           | (6,369                | )          | 53                                          |       | 4,231      |       | 4,189      |       | 5,646      |       |
| Federal income  taxes (benefits)                         |       | (4,933                                                             | )           | (2,308                | )          | (34                                         | )          | 1,375      |       | 1,320      |       | 1,922      |       |
| Net earnings  (loss)                                     | ** ** | **$**                                                              | **(33,333** | **)**                 | **$**      | **(4,061**                                  | **)**      | **$**      | **87**     | ** ** | **$**      | **2,856**  | ** ** | **$** | **2,869** | ** ** | **$** | **3,724** | ** ** |
| Earnings (loss)  per share                               |       |                                                               |        |                  |       |                                        |       |       |       |       |       |       |       |
| Basic                                                    | ** ** | **$**                                                              | **(6.97**   | **)**                 | **$**      | **(0.88**                                   | **)**      | **$**      | **0.02**   | ** ** | **$**      | **0.73**   | ** ** | **$** | **0.92** | ** ** | **$** | **1.51** | ** ** |
| Diluted                                                  | ** ** | **$**                                                              | **(6.97**   | **)**                 | **$**      | **(0.88**                                   | **)**      | **$**      | **0.02**   | ** ** | **$**      | **0.72**   | ** ** | **$** | **0.91** | ** ** | **$** | **1.48** | ** ** |

 

(See footnotes on next page)

 

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| ** **                                                               | ** ** | ** **                       | ** ** | ** **            | ** ** | **At or for the**            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------|------------|-----------------------|------------|---------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                                               | ** ** | **At or for the** | ** ** | **Three Months** | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                               | ** ** | **Year Ended**              | ** ** | **Ended**             | ** ** | **At or for the**            | ** ** |
| ** **                                                               | ** ** | **December 31,**            | ** ** | **December 31,** | ** ** | **year ended September 30,** | ** ** |
| **Key Operating Ratios:**** (1)**                         | ** ** | **2007**                         | ** ** | **2006**              | ** ** | **2005**                                    | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
| ** **                                                               | ** ** | ** **                       | ** ** | ** **            | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Performance  Ratios: (1)**                                             |       |                             |       |                  |       |                                        |       |       |       |       |       |       |       |
| Return on  average assets                                                |       | (3.44                            | )%         | (0.38                 | )%         | .03                                         | %          | .30        | %          | .34        | %          | .59        | %          |
| Return on  average equity                                                |       | (38.32                           | )          | (4.48                 | )          | .40                                         |       | 3.65       |       | 4.97       |       | 8.28       |       |
| Average  interest-earning assets to average interest-bearing liabilities |       | 103.71                           |       | 104.02                |       | 104.00                                      |       | 106.63     |       | 104.82     |       | 105.83     |       |
| Interest rate  spread (2)                                                |       | 2.53                             |       | 2.84                  |       | 2.49                                        |       | 2.25       |       | 2.40       |       | 2.96       |       |
| Net interest  margin (2)                                                 |       | 2.68                             |       | 3.00                  |       | 2.63                                        |       | 2.45       |       | 2.52       |       | 3.13       |       |
| General,  administrative and other expense to average assets             |       | 3.42                             |       | 1.99                  |       | 1.78                                        |       | 1.69       |       | 1.61       |       | 1.65       |       |
| Dividend payout  ratio                                                   |       | n/a                              |       | n/a                   |       | 750.00                                      |       | 82.19      |       | 32.61      |       | n/a        |       |
|                                                                     |       |                             |       |                  |       |                                        |       |       |       |       |       |       |       |
| **Asset  Quality Ratios:**                                               |       |                             |       |                  |       |                                        |       |       |       |       |       |       |       |
| Nonperforming  assets to total assets at end of period (3)               |       | 3.70                             | %          | 2.54                  | %          | 1.82                                        | %          | 2.07       | %          | .71        | %          | 1.16       | %          |
| Allowance for  loan losses to nonperforming loans at end of period       |       | 133.05                           |       | 71.20                 |       | 71.67                                       |       | 66.32      |       | 182.87     |       | 134.15     |       |
| Allowance for  loan losses to total loans at end of period               |       | 4.90                             |       | 2.05                  |       | 1.42                                        |       | 1.72       |       | 1.64       |       | 1.57       |       |
|                                                                     |       |                             |       |                  |       |                                        |       |       |       |       |       |       |       |
| **Capital  and Other Ratios:**                                           |       |                             |       |                  |       |                                        |       |       |       |       |       |       |       |
| Average  stockholders’ equity to average assets                     |       | 8.97                             | %          | 8.54                  | %          | 8.55                                        | %          | 8.35       | %          | 6.77       | %          | 7.07       | %          |
| Tangible  stockholders’ equity to tangible assets                   |       | 5.48                             |       | 7.12                  |       | 8.07                                        |       | 9.75       |       | 8.38       |       | 7.51       |       |
| Tier 1 capital  to risk-weighted assets (4)                              |       | 10.06                            |       | 11.32                 |       | 10.86                                       |       | 13.37      |       | 12.52      |       | 10.85      |       |

 

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(1)                                 Allratios are based on average monthly balances during the respective periodsprior to the fiscal year ended September 30, 2004.  With respect to the fiscal year ended September 30,2005 and later, all ratios are based on average daily balances.

 

(2)                                  Interestrate spread represents the difference between the weighted-average yield oninterest-earning assets and the weighted-average cost of interest-bearingliabilities.  Net interest marginrepresents net interest income as a percentage of average interest-earningassets.

 

(3)                                  Nonperformingassets consist of non-accrual loans, loans past due 90 days or more and stillaccruing interest and real estate acquired through foreclosure or bydeed-in-lieu thereof.

 

(4)                                  Thisregulatory capital ratio represents the capital ratio of the Bank.

 

5

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**

**AND RESULTS OF OPERATION**

 

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

###### ** **

As a result of acquisitions and internal growth, the Company grew from$416.0 million in total assets as of September 30, 2001 to a high of $1.0billion in total assets as of December 31, 2005.  Between the completion of the public offeringin March 2000 and December 31, 2005, the Company acquired fivefinancial institutions with aggregate total assets as of the time ofacquisition of $428.5 million.  Also, in September 2003,the Company purchased $32.8 million in loans and assumed $55.6 million indeposits in connection with the acquisition of two branch offices from anotherfinancial institution.  The Companysupplemented this growth from acquisitions with loan generation securedprimarily by real estate in its market area. Total gross loans increased from $419.5 million at September 30,2001 to $851.3 million at December 31, 2005.    In addition, since September 30, 2000,the Company expanded its franchise through the opening of six full servicebranch offices. These new branch offices, as well as acquired branch offices,have expanded the Company’s market presence. The Company’s loan growth has been funded in part by deposits.  The Company has placed an emphasis on depositgeneration both internally and through whole bank and branch acquisitions.  Deposits have increased from $233.1 millionat September 30, 2001 to $735.2 million at December 31, 2007.

 

However,beginning in early 2007, the Company began to reduce all aspects of its lendingexposure due in large part to the downturn in the local economy, and, inparticular, values of residential and residential development properties. At December 31,2007, total gross loans amounted to $704.0 million, a decrease of $240.7million or 25.5% compared to $944.7 million of loans at December 31,2005.  In addition, in an attempt toaddress such slowdown and the resulting decrease in the value of its collateral,the Company charged-off $13.1 million of loans in 2006 and $18.3 million ofloans in 2007, and provided $17.5 million and $32.8 million during 2006 and2007, respectively, to the allowance for losses on loans.  As a result, the allowance for loan losses tototal gross loans at December 31, 2007 amounted to 4.9%.  Further, beginning in 2006, the Companyrevised its underwriting standards to place an increased focus on cash flowanalysis, tightened its credit standards and provided additional resources tothe resolution of its classified assets.

 

Theactions taken by the Company during 2006 and 2007, discussed above, and thecontinued recessionary forces in the local economy have had a significantadverse impact on the Company’s financial condition and results ofoperations.  For 2006 and 2007, netlosses amounted to $4.1 million and $33.3 million, respectively, andstockholders’ equity decreased from $86.0 million or 8.36% of total assets at December 31,2005 to $53.6 million or 6.04% of total assets at December 31, 2007.  Further, the level of the Company’snon-performing assets has and will continue to negatively impact the Company’sinterest rate spread, interest income, provision for losses on loans and netearnings or loss.  Non-performing assetstotaled $32.8 million, $26.1 million and $18.9 million at December 31,2007, 2006 and 2005, respectively.  Whilethe Bank has devoted and will continue to devote substantial managementresources toward the resolution of all delinquent and non-performing assets, noassurance can be made that management’s efforts will be successful.

 

TheBank’s primary federal regulator, OTS has, in light of the Company’s 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 Cease and DesistOrders issued by the OTS (the “Orders”). The Company attached copies of the Orders to a Current Report on Form 8-Kfiled with the Securities and Exchange Commission on April 3, 2008.

 

TheOrders require the Company and the Bank to, among other things, file with theOTS within proscribed 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 Bank

 

6

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andthe Company will be required to compare the projected operating results fromthe business plans with the actual results. The results of this varianceanalysis are to be submitted to the OTS within the proscribed time periods. Inaddition, the Orders require that the Company and the Bank receive 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 or refrain from certainactions, including (i) not making any new loans or issuing new lines ofcredit for land acquisition or development, speculative residentialconstruction, commercial and multi-family construction, acquisition orretention of commercial property, and non-owner occupied one- to four-familyresidential property; (ii) engaging an independent consultant to conduct aloan portfolio 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 of independentoutside directors.  In an effort toproactively address the downturn in the local real estate market, the Bank hadpreviously curtailed or ceased the lending activities restricted in the Orders.

 

Management of the Company and the Bank isworking diligently to resolve the issues associated with the Company’snonperforming assets and to provide the information or take the actionsrequired by the Orders.  Concurrently,management and the Board of Directors are considering all strategicalternatives available to the Company and the Bank.  As required, the Company and the Bank havefiled a consolidated business plan with the OTS covering operations through2010.  The Company’s business plancontemplates, among other things, a consolidation of the Company’s operationsthrough branch sales and a reduction in adversely classified assets throughloan resolutions, repayments, sales and charge-offs.  Branch sale transactions would decrease theCompany’s assets and liabilities, improve capital ratios, generate taxableincome, and reduce general, administrative and other expense.  In addition, the Bank would dividend funds tothe Company to provide liquidity to service the Company’s debt, provided thatapproval would be received from the OTS. The business plan was submitted by theCompany to the OTS on April 7, 2008 and is subject to review and approvalby the OTS.

 

The report of the Company’s independentregistered public accounting firm contains an explanatory paragraph as to theCompany’s ability to continue as a going concern primarily due to the Company’scurrent lack of liquidity to repay its $17.5 million obligation under anoutstanding line of credit due June 30, 2008.  The line of credit is secured by alloutstanding shares of common stock of the Bank. Although the Bank exceeds all of its capital requirements and isconsidered well capitalized at December 31, 2007, the Orders prohibit theBank from paying cash dividends to the Company without the prior consent of theOTS and the Company will only be able to rely upon existing cash and cashequivalents as sources of its liquidity. Without the ability to rely on dividends from the Bank, the Company willrequire funds from other capital sources to meet its obligations such asrestructuring the current line of credit or replacing the current line ofcredit.  The Company was not incompliance with one of the loan covenants at December 31, 2007 and thelender has the ability to accelerate all outstanding amounts upon notice andthe passage of 30 days. The Company is currently negotiating with the lenderregarding a waiver of default, and a modification and/or extension of the lineof credit.

 

7

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**Overview and Recent Regulatory Matters**(continued)

 

In light of the matters discussed on the previous page, the Companyestablished a $4.4 million valuation allowance of deferred federal incometaxes, thus decreasing the tax benefit recorded during the year by theCompany.  Generally, the losses incurredin 2006 and 2007 resulted in deferred federal income taxes or deferred taxassets which may be utilized against current period earnings, carried backagainst prior years’ earnings or utilized to the extent of management’sestimate of future taxable income.  Thevaluation allowance was established since the Company’s current liquidityposition may impair the Company’s ability to generate future taxable income,and therefore, impair its ability to realize all benefits of the deferred taxasset.

 

Current OTS capital standards require savingsinstitutions to satisfy three different 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. At December 31, 2007, the Bank exceeded all of such capitalrequirements, with tangible, core and risk-based capital ratios of 7.0%, 7.0%and 11.4%, respectively.  Further, atsuch date, the Bank was deemed a well capitalized institution under theregulatory framework for prompt correction action purposes.

 

The Bank is subject to examination andcomprehensive regulation by the OTS, which is the Bank’s chartering authorityand primary federal regulator.  The Bankis also regulated by the FDIC, administrator of the Deposit InsuranceFund.  The Bank is a member of theFederal Home Loan Bank (the “FHLB”) of Cincinnati, which is one of the 12regional banks comprising the FHLB System.

 

8

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**PEOPLES COMMUNITY BANCORP, INC.**

 

###### **General**

###### ** **

The Company’s profitability depends primarilyon 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.  The Company’s profitability also depends, toa lesser extent, on the level of other income, the provision for losses onloans, general, administrative and other expenses and federal incometaxes.  The Company’s operations andprofitability are subject to changes in interest rates, applicable statutes andregulations and general economic conditions, as well as other factors beyondmanagement’s control.

 

Aspreviously announced, the Board of Directors of the Company adopted anamendment to Article VI of the Company’s Bylaws to change the Company’sfiscal year end from September 30, to December 31, effectiveretroactively to January 1, 2006, in order to increase operational efficiency.  As a result, the consolidated statements offinancial condition compares December 31, 2007 to December 31, 2006,while the consolidated statements of operations, the consolidated statements ofcomprehensive income (loss), and the consolidated statements of cash flowreflect, as applicable, the twelve month period ended December 31,2007, the twelve month period ended December 31, 2006, the three monthperiod ended December 31, 2005, and the twelve month period ended September 30,2005. Further, for purposes of this section, the discussion of changes infinancial condition compares December 31, 2007 to December 31, 2006and the discussion of results of operations compares the year ended December 31,2007 to the year ended December 31, 2006 as well as the year ended December 31,2006 to the year ended September 30, 2005.

 

**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 the Company’s consolidated financial statements, whichare prepared 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, sensitivity of the estimates to changes in economic conditions, andwhether alternative accounting methods may be utilized under US GAAP.  Material estimates that are particularlysusceptible to significant change in the near term relate to the determinationof the allowance for loan losses, valuation allowance of deferred income taxes,and goodwill impairment.  Actual resultscould differ from those estimates.

 

**Allowance for Loan Losses.**  The procedures for assessingthe adequacy of the allowance for loan losses reflect management’s evaluationof credit risk after 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 may affecta 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.

 

9

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**Valuation Allowance of Deferred Income Taxes. **TheCompany accounts for federal income taxes in accordance with the provisions ofSFAS No. 109, “Accounting for Income Taxes.”  Pursuant to the provisions of SFAS No. 109,a deferred tax liability or deferred tax asset is computed by applying thecurrent statutory tax rates to net taxable or deductible differences betweenthe tax basis of an asset or liability and its reported amount in theconsolidated financial statements that will result in taxable or deductibleamounts in future periods.  Deferred taxassets are recorded only to the extent that the amount of net deductibletemporary differences or carryforward attributes may be utilized againstcurrent period earnings, carried back against prior years’ earnings, offsetagainst taxable temporary differences reversing in future periods, or utilizedto the extent of management’s estimate of future taxable income.  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.

 

**Goodwill.**  The Company has developed procedures to testgoodwill for impairment on an annual basis using September 30 financialdata.  The evaluation of possibleimpairment is outsourced to a third party. This evaluation is based on the analysis set forth below.

 

The test involves assigning tangible assets and liabilities, identifiedintangible assets and goodwill of the Bank (which is the Company’s reportingunit as defined under SFAS No. 142) and comparing the fair value of thisreporting unit to its carrying value including goodwill.  The value is determined assuming a freelynegotiated transaction between a willing buyer and a willing seller, neither beingunder any compulsion to buy or sell and both having reasonable knowledge ofrelevant facts.  The third party selectedby management 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; (2) thediscounted cash flow approach and (3) the trading price method. Theapplication of the valuation techniques takes into account the reporting unit’soperating history, the current market environment and future prospects.  As of the most recent evaluation, the onlyreporting unit carrying goodwill is the Bank.

 

If the fair value of a reporting unit exceeds its carrying amount,goodwill of the reporting unit is considered not impaired and no second step isrequired.  If the fair value does notexceed the carrying amount, a second test is required to measure the amount ofgoodwill impairment.  The second test ofthe overall goodwill impairment compares the implied fair value of thereporting unit goodwill with the carrying amount of the goodwill.  The impairment loss shall equal the excess ofcarrying value over fair value.  Anyimpairment loss would require an immediate charge to earnings.  The Bank recorded goodwill totaling $23.9million in conjunction with acquisitions of other financial institutions overthe past five years.  Following anupdated valuation in the fourth quarter of 2007 by an independent third party,the Bank incurred a non-cash impairment charge of $11.4 million for thewritedown of goodwill.   This impairmentis primarily attributable to lower market valuations for financial institutionsin the latter part of 2007, the weakening of the credit market in the secondhalf of 2007, the decline in real estate values, particularly in the Cincinnatiregion, and the net losses recorded by the Bank and Company for the past sixquarters.

 

After each testing period, the third party compiles a summary of thetest that is then provided to the audit committee for review.

 

10

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**Forward-LookingStatements 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.

 

11

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# **AVERAGE BALANCES, NET INTEREST INCOME, YIELDS EARNED AND RATES PAID**

 

The following table presents for the periods indicated the total dollaramount of interest income from average interest-earning assets and theresultant yields, as well as interest expense on average interest-bearingliabilities, expressed both in dollars and rates, and the net interest margin.

 
| ** **                                                               | ** ** | **Year ended**             | ** **  |
|--------------------------------------------------------------------------|------------|---------------------------------|-------------|
| ** **                                                               | ** ** | **December 31, 2007** | ** **  | **December 31, 2006** | ** ** | **September 30, 2005** | ** ** |
| ** **                                                               | ** ** | **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)                                                    |       | $                               | 751,917     |   | 53,390 |   | 7.10 | % | $ | 870,327 |   | 61,096 |   | 7.02 | % | $ | 655,256 |   | $ | 41,628 |   | 6.35 | % |
| Mortgage-backed securities                                               |       | 49,427                          |        | 2,394 |   | 4.84 |   | 60,474 |   | 2,467 |   | 4.08 |   | 204,500 |   | 5,292 |   | 2.59 |   |
| Investment  securities (2)                                               |       | 18,150                          |        | 1,100 |   | 6.06 |   | 17,473 |   | 951 |   | 5.44 |   | 13,992 |   | 664 |   | 4.75 |   |
| Interest-earning  deposits                                               |       | 64,965                          |        | 3,349 |   | 5.16 |   | 18,206 |   | 961 |   | 5.28 |   | 5,327 |   | 164 |   | 3.08 |   |
|                                                                     |       |                            |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  interest-earning assets                                           |       | 884,459                         |        | 60,233 |   | 6.81 |   | 966,480 |   | 65,475 |   | 6.77 |   | 879,075 |   | 47,748 |   | 5.43 |   |
|                                                                     |       |                            |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Non-interest-earning  assets                                             |       | 85,652                          |        |   |   |   |   | 93,635 |   |   |   |   |   | 57,477 |   |   |   |   |   |
|                                                                     |       |                            |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total assets                                                             | ** ** | **$**                           | **970,111** | ** ** | ** ** | ** ** | ** ** |   | **$** | **1,060,115** |   |   |   |   |   | **$** | **936,552** |   |   |   |   |   |
|                                                                     |       |                            |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                                           |       |                            |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Savings and  checking accounts                                           |       | $                               | 193,845     |   | 5,430 |   | 2.80 |   | $ | 230,353 |   | 6,162 |   | 2.65 |   | $ | 190,901 |   | 4,250 |   | 2.23 |   |
| Money market  deposit accounts                                           |       | 20,097                          |        | 396 |   | 1.97 |   | 20,303 |   | 395 |   | 1.92 |   | 25,019 |   | 306 |   | 1.22 |   |
| Certificates of  deposit                                                 |       | 506,294                         |        | 24,202 |   | 4.78 |   | 478,148 |   | 20,682 |   | 4.30 |   | 295,636 |   | 10,671 |   | 3.61 |   |
| FHLB advances and  other borrowings                                      |       | 117,546                         |        | 5,341 |   | 4.54 |   | 173,622 |   | 7,163 |   | 4.13 |   | 296,527 |   | 9,934 |   | 3.35 |   |
| Subordinated  debentures                                                 |       | 15,000                          |        | 1,091 |   | 7.27 |   | 26,740 |   | 2,083 |   | 7.79 |   | 16,299 |   | 1,043 |   | 6.40 |   |
|                                                                     |       |                            |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total interest-bearing  liabilities                                      |       | 852,782                         |        | 36,460 |   | 4.28 |   | 929,166 |   | 36,485 |   | 3.93 |   | 824,382 |   | 26,204 |   | 3.18 |   |
|                                                                     |       |                            |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Non-interest-bearing  liabilities                                        |       | 30,346                          |        |   |   |   |   | 40,384 |   |   |   |   |   | 33,933 |   |   |   |   |   |
|                                                                     |       |                            |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total liabilities                                                        |       | 883,128                         |        |   |   |   |   | 969,550 |   |   |   |   |   | 858,315 |   |   |   |   |   |
|                                                                     |       |                            |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Stockholders’  equity                                               |       | 86,983                          |        |   |   |   |   | 90,565 |   |   |   |   |   | 78,237 |   |   |   |   |   |
|                                                                     |       |                            |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total liabilities  and stockholders’ equity                         | ** ** | **$**                           | **970,111** | ** ** | ** ** | ** ** | ** ** |   | **$** | **1,060,115** |   |   |   |   |   | **$** | **936,552** |   |   |   |   |   |
|                                                                     |       |                            |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest  income                                                     | ** ** | ** **                      | ** **  | **$** | **23,733** | ** ** | ** ** |   |   |   | **$** | **28,990** |   |   |   |   |   | **$** | **21,544** |   |   |   |
|                                                                     |       |                            |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest rate  spread                                                    | ** ** | ** **                      | ** **  | ** ** | ** ** | **2.53** | **%** |   |   |   |   | **2.84** | **%** |   |   |   |   | **2.25** | % |
|                                                                     |       |                            |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest  margin (3)                                                 | ** ** | ** **                      | ** **  | ** ** | ** ** | **2.69** | **%** |   |   |   |   | **3.00** | **%** |   |   |   |   | **2.45** | % |
|                                                                     |       |                            |        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Average  interest-earning assets to average interest-bearing liabilities | ** ** | ** **                      | ** **  | ** ** | ** ** | **103.71** | **%** |   |   |   |   | **104.02** | **%** |   |   |   |   | **106.63** | % |
|                                                                          |            |                                 |             |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)                                  Includesnon-accruing loans.

 

(2)                                  IncludesFederal Home Loan Bank and Federal Home Loan Mortgage Corp. stock and otherequity securities.

 

(3)                                  Equalsnet interest income divided by average interest-earning assets.

 

12

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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 affected theCompany’s 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, 2006 to** | ** ** | **December 31, 2005 to** | ** ** |
|-------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|
| ** **                          | ** ** | **December 31, 2007**         | ** ** | **December 31, 2006**         | ** ** |
| ** **                          | ** ** | **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                    |       | $                                       | 705        |                                    | $          | (8,411 | ) | $ | (7,706 | ) | $ | 4,698 |   | $ | 14,770 |   | $ | 19,468 |   |
| Mortgage-backed  securities         |       | (3,776                                  | )          | 3,703                                   |       | (73 | ) | 12,599 |   | (15,424 | ) | (2,825 | ) |
| Investment  securities (1)          |       | 111                                     |       | 38                                      |       | 149 |   | 105 |   | 182 |   | 287 |   |
| Interest-earning  deposits          |       | (21                                     | )          | 2,409                                   |       | 2,388 |   | 182 |   | 615 |   | 797 |   |
| Total  interest-earning assets      |       | (2,981                                  | )          | (2,261                                  | )          | (5,242 | ) | 17,584 |   | 143 |   | 17,727 |   |
|                                |       |                                    |       |                                    |       |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:      |       |                                    |       |                                    |       |   |   |   |   |   |   |   |   |
| Savings and  checking accounts      |       | 407                                     |       | (1,139                                  | )          | (732 | ) | 912 |   | 1,000 |   | 1,912 |   |
| Money market  deposit accounts      |       | 2                                       |       | (1                                      | )          | 1 |   | 133 |   | (44 | ) | 89 |   |
| Certificates of  deposit            |       | 2,305                                   |       | 1,215                                   |       | 3,520 |   | 2,367 |   | 7,644 |   | 10,011 |   |
| FHLB advances  and other borrowings |       | 809                                     |       | (2,631                                  | )          | (1,822 | ) | 3,552 |   | (6,323 | ) | (2,771 | ) |
| Subordinated  debentures            |       | (150                                    | )          | (842                                    | )          | (992 | ) | 152 |   | 888 |   | 1,040 |   |
| Total  interest-bearing liabilities |       | 3,373                                   |       | (3,398                                  | )          | (25 | ) | 7,116 |   | 3,165 |   | 10,281 |   |
|                                |       |                                    |       |                                    |       |   |   |   |   |   |   |   |   |
| Increase in net  interest income    | ** ** | **$**                                   | **(6,354** | **)**                                   | **$**      | **1,137** | ** ** | **$** | **(5,217** | **)** | **$** | **10,468** | ** ** | **$** | **(3,022** | **)** | **$** | **7,446** | ** ** |

 

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(1)           Includes FHLB stockand certificates of deposit at other institutions.

 

13

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**Discussion of Financial Condition Changes from December 31,2006 to December 31, 2007**

 

At December 31, 2007, the Company’stotal assets amounted to $887.4 million, a decrease of $140.7 million, or13.7%, compared to total assets at December 31, 2006.  The decrease in assets was comprisedprimarily of a $178.2 million net decrease in loans receivable and a decreasein goodwill of $11.4 million, partially offset by an increase of $29.2 millionin cash and cash equivalents, an increase in real estate acquired byforeclosure of $6.6 million, and an increase of $5.7 million in deferredfederal income tax.

 

Liquid assets (i.e. cash and interest-bearing deposits) totaled $86.6million at December 31, 2007, an increase of $29.2 million, or 50.7%,compared to the amount at December 31, 2006.  The increase in liquid assets as of December 31,2007 was primarily due to curtailed lending and the low yield on alternativeinvestments.  Approximately $67.0 millionwas invested in fed funds with a yield of 3.03% on December 31, 2007.

 

Investment securities totaled $67.6 millionat December 31, 2007, an increase of $10.7 million, or 18.8%, from theamount at December 31, 2006.  Theincrease was comprised primarily of $29.8 million in purchases, partiallyoffset by  $19.3 million of sales andrepayments during the period.

 

Loans receivable totaled $634.4 million at December 31,2007, a decrease of $178.2 million, or 21.9%, over December 31, 2006levels. Loan disbursements amounted to $162.4 million during fiscal 2007, whichwere offset by principal repayments of $269.4 million and loans andparticipations sold totaling $32.0 million. Between 2001 and 2005, the Bank placed an increasing emphasis onmulti-family residential loans, nonresidential real estate and land loans,construction loans, unsecured commercial loans and consumer loans.  However, due in large part to the downturn inthe local economy, and, in particular, values of residential and residentialdevelopment properties, as well as a significant increase in total non-performingloans, the Company, beginning in late 2006, began to reduce all aspects of itslending exposure.  In addition, asdiscussed below, in an attempt to address such slowdown in the local economyand the resulting decrease in the value of its collateral, the Companycharged-off $13.1 million and $18.3 million of loans in 2006 and 2007,respectively.

 

The allowance for loan losses totaled $34.5million at December 31, 2007, an increase of $16.1 million, or 87.8%compared to the allowance at December 31, 2006.  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, $32.8 million was added to the allowance through the provisionfor losses on loans during fiscal 2007.  Approximately $18.3 million of loans were charged-off during theyear.  The charged-off loans werecomprised of $8.5 million in loans secured by one- to four-family residentialreal estate (including $7.4 million of non-owner occupied investment property),$4.7 million in loans secured by multi-family residential real estate, $844,000in construction loans, $1.3 million in loans secured by commercial real estateand land, and $2.9 million in commercial and consumer loans.  The increase in charged-off loans wasprimarily due to real estate investors and developers experiencing cash flowdifficulties and the downturn in the local economy.

 

The allowance for loan losses represented4.9% and 2.1% of total loans at December 31, 2007 and 2006,respectively.  The allowance for loanlosses represented 133.0% and 71.2% of nonperforming loans at December 31,2007 and 2006, respectively. Nonperforming assets totaled $32.8 million and $26.1 million at December 31,2007 and 2006, respectively. Nonperforming assets at December 31, 2007 consisted of $4.8 millionof loans secured by one- to four-family residential real estate, $5.2 millionof  loans secured  by multi-family residential real estate, $10.6 million of loans secured bynonresidential real estate and land, $4.7 million in construction loans,$563,000 in commercial and consumer loans, and $6.9 million in foreclosed realestate.  The Bank’s management continuesto aggressively pursue the collection and resolution of all delinquent andnonperforming loans.

 

14

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**Discussion of Financial Condition Changes FromDecember 31, 2006 to December 31, 2007** (continued)

 

At December 31, 2007, non-accrual loanssecured by one- to four-family residential real estate consisted of $1.9million in owner-occupied residences with an average balance of $69,000, and$2.9 million in non-owner occupied residences with an average balance of$71,000.  Three borrowers represented$1.9 million of the non-owner occupied one- to four-family residentialnon-accrual loans.

 

Non-accrual loans secured by multi-familyresidential real estate amounted to $5.2 million at December 31, 2007,with an average balance of $435,000.  Twoborrowers represented $3.9 million of this total, with the largest borrowerowing $2.8 million.    Commercial realestate and land secured non-accrual loans totaled $10.1 million at December 31,2007.  The average balance of these 25loans was $403,000.  Three borrowersrepresented $6.3 million of the non-accrual loans secured by commercial realestate and land, with the largest borrower owing $3.8 million.

 

Non-accrual construction loans totaled $4.6million at December 31, 2007, with an average balance of $244,000.  Approximately $3.8 million of theseconstruction loans are secured by one- to four-family residential realestate.  Commercial and consumernon-accrual loans totaled $546,000, with $512,000 of these loans beingunsecured.

 

Management has considered these loanconcentrations as a part of its overall evaluation of the adequacy of the Bank’sallowance for loan losses.  Althoughmanagement believes that its allowance for loan losses at December 31,2007 was appropriate based upon the available facts and circumstances at suchtime, there can be no assurance that additions to such allowance will not benecessary in future periods, which would adversely affect the Bank’s results ofoperations.

 

Goodwill decreasedfrom $23.9 million at December 31, 2006 to $12.5 million at December 31,2007, a decrease of $11.4 million, or 47.7%. The Bank recordeda goodwill impairment of $11.4 million as of December 31, 2007, primarilydue to lower market valuations for financial institutions in the latter part of2007, the weakening of the credit market in the second half of 2007, thedecline in real estate values, particularly in the Cincinnati region, and thenet losses recorded by the Bank and the Company for the past six quarters.

 

Deposits totaled $735.2 million at December 31,2007, a decrease of $20.0 million, or 2.7%, over the total at December 31,2006.  Total demand, transaction andsavings deposits decreased by $32.6 million, or 12.7%, to $223.4 million at December 31,2007, while total certificates of deposit increased by $12.5 million, or 2.5%,to $511.8 million at December 31, 2007. During the first three quarters of fiscal year 2007, the Bank utilizedcompetitive pricing strategies on certificates of deposits, which includedadvertised specials rates.  In late 2007,due to the cost of funds and the Bank’s interest margin compression, managementcontinued itsconcentration on growing demand and savings deposits.

 

Advances from the Federal Home Loan Bank andother borrowings totaled $77.6 million at December 31, 2007, a decrease of$79.3 million, or 50.5%, compared to December 31, 2006 totals.  During fiscal year 2007, $100.0 million infixed-rate convertible FHLB advances were paid in full on their conversion datewith no penalty through the use of available cash and proceeds from bothmortgage-backed security repayments and loan sales and payments.  In the fourth quarter of 2007, the Bank tookadvantage of a fixed rate advance special with FHLB for $25.0 million.  This special offering provides a fixed rateof interest of 3.45% for a minimum of 3 months and a maximum of 10 years.  After the first three months and quarterlythereafter, the FHLB has the option to require the borrower to prepay theadvance without a fee or allow the advance to remain at the original contractedfixed rate.

 

Stockholders’ equity totaled $53.6 million atDecember 31, 2007, a decrease of $34.1 million, or 38.9%, compared to theamount at December 31, 2006.  Thedecrease resulted primarily from net losses of $33.3 million, which included $11.4million in goodwill impairment, and dividends paid on common stock totaling$2.1 million, which were partially offset by the amortization of stock benefitplans totaling $1.1 million, a $176,000 increase in net unrealized gains onavailable for sale securities, and $180,000 adjustment due to theimplementation of FIN 48 on January 1, 2007.

 

15

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

 

# **General**

 

The Company recorded a net loss of $33.3million for the fiscal year ended December 31, 2007, compared to a netloss of $4.1 million for the fiscal 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, the Company recorded a $5.2 million, or 18.0%, decrease in netinterest income, partially offset by an increase of $720,000, or 22.4%, inother income and a $2.6 million increase in tax benefits.

 

# **Net Interest Income**

 

Total interest income amounted to $60.2million for the fiscal year ended December 31, 2007, a $5.2 million, or8.0%, decrease over the fiscal year ended December 31, 2006.  The decrease was due to an $82.0 million, or8.5%, decrease in average interest-earning assets, partially offset by a fourbasis point increase in the average yield for the year ended December 31,2007 compared to the year ended December 31, 2006.

 

Interest income on loans totaled $53.4 millionfor the fiscal 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 to a $118.4million, or 13.6%, decrease in the average portfolio balance outstanding forthe year ended December 31, 2007 compared to the year ended December 31,2006, partially offset by an eight basis point increase in the weighted-averageyield to 7.10% for fiscal 2007. The decrease in the average balance wasprimarily due to loan sales of $32.0 million, and loan repayments totaling$269.4 million, partially offset by loan disbursements of $162.4 million.  As previously stated, the Bank, beginning inlate 2006, began to reduce all aspects of its lending exposure in response tothe downturn in the local real estate market. The increase in the Bank’s yield reflects a moderate upward shift inmarket rates and the corresponding impact on adjustable-rate loans, primarilyin the first two quarters of the fiscal year.

 

Interest income on mortgage-backed securitiestotaled $2.4 million for fiscal 2007, a decrease of $73,000, or 3.0%, comparedto the year ended December 31, 2006, due to a $11.0 million, or 18.3%,decrease in the average balance outstanding for the year ended December 31,2007 compared to the year ended December 31, 2006, partially offset by a76 basis point increase in the weighted-average yield. The decrease in theaverage balance of the mortgage-backed securities portfolio was primarily dueto approximately $19.3 million in repayments, partially offset by a purchase inthe fourth quarter of approximately $29.8 million.  Interest income on investment securities andinterest-bearing deposits totaled $4.4 million, an increase of $2.5 million,due primarily to a $47.4 million increase in the average balance of the relatedassets for the year ended December 31, 2007 compared to the year ended December 31,2006.  The increase in interest-bearingdeposits was primarily due to curtailed lending and the low yield onalternative 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 fiscal year ended December 31, 2007, an increase of $2.8million, 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 fiscal 2007, partially offset by a decrease of $8.6 million, or 1.2%,in the average 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 strongly competitive Cincinnati market place.

 

Interest expense on borrowings totaled $6.4million for fiscal 2007, a decrease of $2.8 million, or 30.4%, compared to theyear ended 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 fiscal2007.  During fiscal year 2007, $100.0million in fixed-rate convertible FHLB advances were paid in full on theirconversion date with no penalty through the use of available cash and proceedsfrom both mortgage-backed security repayments and loan sales and payments.

 

16

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**Comparison of Results of Operations for the FiscalYears Ended December 31, 2007 and December 31, 2006**(continued)

 

**Net Interest Income**(continued)

 

As a result of the foregoing changes ininterest income and interest expense, net interest income decreased by $5.2million, or 18.0%, during the fiscal year ended December 31, 2007,compared to fiscal year ended December 31, 2006.  The interest rate spread amounted to 2.53%for fiscal 2007 compared to 2.84% for the year ended December 31,2006.  The net interest margin totaled2.69% and 3.00% for the fiscal years ended December 31, 2007 and 2006,respectively.

 

# **Provision for Losses on Loans**

 

A provision for losses on loans is charged toearnings to bring the total allowance for loan losses to a level consideredappropriate by management based on historical loss experience, the volume andtype of lending conducted by the Bank, the status of past due principal andinterest payments, general economic conditions, particularly as such conditionsrelate to the Bank’s market area, and other factors related to thecollectibility of the Bank’s loan portfolio. After considering the above factors, management recorded a provision forlosses on loans of $24.5 million in the fourth quarter of 2007, resulting in atotal of $32.8 million for the fiscal year ended December 31, 2007,compared to $17.5 million for the fiscal year ended December 31,2006.  The large provision in the fourthquarter of 2007 reflects higher probable credit losses on primarily non-owneroccupied residential loans and land development loans.  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.

 

The provisions recorded during the fiscal2007 and 2006 periods were predicated on higher non-performing, classified andcriticized assets for the years, as well as significant charge-offs during bothfiscal years.  The increase in such loansis primarily due to delinquent loans in the Bank’s non-owner occupied(investment property) residential loan portfolio and its acquisition,development, and construction loan portfolio. The delinquencies in these portfolios are due primarily to the residualeffects of the deterioration in the local real estate market and resultant cashflow issues faced by local property investors and developers.  The downturn in the local economy has alsoresulted in deterioration in other sectors of the portfolio, includingmulti-family residential loans and commercial loans. There can be no assurancethat the allowance for loan losses will be sufficient to cover losses onnonperforming loans in the future.

 

# **Other Income**

 

Other income totaled $3.9 million for thefiscal year ended December 31, 2007, an increase 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 fiscal year 2007 compared to a net loss of $59,000recorded during fiscal 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 depositfees.  These increases were partiallyoffset by a decrease in the gain on sale of securities of $47,000 during fiscalyear 2007.

 

# **General, Administrative and OtherExpense**

 

General, administrative and other expense totaled $33.2 million for thefiscal year ended December 31, 2007, an increase of $12.0 million, or57.0%, compared to the fiscal year ended December 31, 2006.  This increase resulted primarily from agoodwill non-cash impairment charge of $11.4 million recorded in the fourthquarter of 2007 by the Bank following an updated valuation by an independentthird party.  This impairment isprimarily attributable to lower market valuations for financial institutions inthe latter part of 2007, the weakening of the credit market in the second halfof 2007, the decline in real estate values, particularly in the Cincinnatiregion, and the net losses recorded by the Bank and Company for the past sixquarters.

 

17

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**Comparison of Results of Operations for the FiscalYears Ended December 31, 2007 and December 31, 2006**(continued)

 

**General, Administrative and Other Expense**(continued)

 

Excludingthe goodwill impairment, general, administrative and other expense increased$652,000, or 3.1%. The Company 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 fiscal year ended December 31,2006.  During the fourth quarter of 2007,the Company recorded approximately $508,000 in ESOP expense for the release ofapproximately 32,383 ESOP shares for employee allocation.  Thisoccurred in conjunction with the decision to terminate the ESOP by September 30,2008 and record associated expenses in 2008 to release all remainingunallocated shares.

 

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**

 

The Company recorded a credit provision forfederal income taxes totaling $4.9 million for the fiscal year ended December 31,2007 compared to a credit provision of $2.3 million for the fiscal year ended December 31,2006.  The income tax benefit for bothyears was due to net losses incurred in 2006 and 2007.  A valuation allowance against deferred taxassets of approximately $4.4 million was recorded in the fourth quarter of2007.

 

**Comparison of Results of Operations for the FiscalYears Ended December 31, 2006 and September 30, 2005**

 

# **General**

 

The inclusion of the accounts of AmericanState Bank, Peoples Federal Savings Bank, and Mercantile Savings Bank, whichthe Company acquired in June 2005, December 2005, and June 2006,respectively, in transactions accounted for using the purchase method ofaccounting, contributed to the increases in the level of income and expenseduring the fiscal year ended December 31, 2006, compared to the year endedSeptember 30, 2005.  In accordancewith the purchase method of accounting, the consolidated statement of earningsfor the fiscal year ended September 30, 2005 was not restated for theacquisition.

 

The Company recorded a net loss of $4.1million for the fiscal year ended December 31, 2006, compared to netearnings of $2.9 million for the fiscal year ended September 30,2005.  The net loss was primarily due toan increase in the provision for losses on loans of $13.9 million, and anincrease of $5.3 million, or 33.5%,  ingeneral, administrative and other expense, partially offset by a $7.4 million,or 34.6%, increase in net interest income, an increase of $1.1 million, or52.0%, in other income, and a $3.7 million decrease in provision for federalincome taxes.

 

# **Net Interest Income**

 

Total interest income amounted to $65.5million for the fiscal year ended December 31, 2006, a $17.7 million, or37.1%, increase over the fiscal year ended September 30, 2005.  The increase was due to an $87.4 million, or9.9%, increase in average interest-earning assets, coupled with a 134 basispoint increase in the average yield for the year ended December 31, 2006compared to the year ended September 30, 2005.

 

Interest income on loans totaled $61.1million for the fiscal year ended December 31, 2006, an increase of $19.5million, or 46.8%, from the year ended September 30, 2005.  This increase was primarily due to a $215.1million, or 32.8%, increase in the average portfolio balance outstanding forthe year ended December 31, 2006 compared to the

 

18

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**Comparison of Results of Operations for the FiscalYears Ended December 31, 2006 and September 30, 2005**(continued)

 

**Net Interest Income**(continued)

 

year ended September 30, 2005, coupledwith a 67 basis point increase in the weighted-average yield to 7.02% forfiscal 2006.  The increase in the averagebalance was primarily due to $122.6 million and $38.0 million in loans obtainedin the acquisition of Peoples Federal and Mercantile, respectively, in fiscal2006, coupled with continued strong loan origination activity, particularlywith respect to single-family residential loans, construction loans, andnonresidential real estate and land loans. The increase in the Bank’s yield reflects a moderate upward shift inmarket rates and the corresponding impact on adjustable-rate loans as well asnew originations in higher yielding loan products.

 

Interest income on mortgage-backed securitiestotaled $2.5 million for fiscal 2006, a decrease of $2.8 million, or 53.4%,compared to the year ended September 30, 2005, due to a $144.0 million, or70.4%, decrease in the average balance outstanding for the year ended December 31,2006 compared to the year ended September 30, 2005, partially offset by a149 basis point increase in the weighted-average yield. The decrease in theaverage balances of the mortgage-backed securities was primarily due toapproximately $108.9 million of securities sold in the three months ended December 31,2005, in order to restructure a portion of the securities portfolio, repayhigher rate short-term advances and manage balance sheet growth.  Interest income on investment securities andinterest-bearing deposits totaled $1.9 million, an increase of $1.1 million, or130.9%, due primarily to a $16.4 million, or 84.7%, increase in the averagebalance of  the related assets,  in conjunction with a 107 basis pointincrease in the weighted-average yield for the year ended December 31,2006 compared to the year ended September 30, 2005.  The increase in interest-bearing deposits isprimarily due to future cash flow requirements and the current favorableinterest rate environment for short-term investments.   The increase in the weighted-average yieldsof the mortgage-backed securities, investment securities and interest-bearingdeposits was due to an increase in market rates and the repricing ofadjustable-rate securities held in the portfolio.

 

Interest expense on deposits totaled $27.2million for the fiscal year ended December 31, 2006, an increase of $12.0million, or 78.9%, over the $15.2 million recorded in the year ended September 30,2005.  The increase was due primarily toa $217.1 million, or 42.5%, increase in the average balance of depositsoutstanding for the year ended December 31, 2006 compared to the yearended September 30, 2005, coupled with increase in the weighted-averagecost of deposits of 76 basis points, to 3.74% for fiscal 2006.  The increase in the average balance wasprimarily due to $88.7 million and $48.7 million in deposits obtained in theacquisitions of Peoples Federal and Mercantile, respectively, in fiscal 2006,in addition to continued marketing efforts. The increase in the average cost of deposits was primarily due to theincrease in market interest rates, as well as advertised special rates oncertificates of deposits throughout the year.

 

Interest expense on borrowings totaled $9.2million for fiscal 2006, a decrease of $1.7 million, or 15.8%, compared to theyear ended September 30, 2005, due primarily to a $122.5 million decreasein the average balance of borrowings outstanding, partially offset by a 111basis point increase in the average cost of borrowings for fiscal 2006.  During the three months ended December 31,2005, the Bank repaid approximately $100.0 million of short-term advances at aweighted average rate of 4.27%, using the proceeds from the sale of investmentsecurities with a weighted average rate of 3.16%.  The increase in the average cost ofborrowings was due primarily to the increase in interest rates on overnightadjustable-rate advances from the Federal Home Loan Bank, which the Bankutilized primarily to manage daily cash flow.

 

As a result of the foregoing changes ininterest income and interest expense, net interest income increased by $7.4million, or 34.6%, during the fiscal year ended December 31, 2006,compared to fiscal year ended September 30, 2005.  The interest rate spread amounted to 2.84%for fiscal 2006 compared to 2.25% for the year ended September 30,2005.  The net interest margin totaled3.00% and 2.45% for the fiscal years ended December 31, 2006 and September 30,2005, respectively.

 

19

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**Comparison of Results of Operations for the FiscalYears Ended December 31, 2006 and September 30, 2005**(continued)

 

# **Provision for Losses on Loans**

 

A provision for losses on loans is charged toearnings to bring the total allowance for loan losses to a level consideredappropriate by management based on historical loss experience, the volume andtype of lending conducted by the Bank, the status of past due principal andinterest payments, general economic conditions, particularly as such conditionsrelate to the Bank’s market area, and other factors related to thecollectibility of the Bank’s loan portfolio. After considering the above factors, management recorded a provision forlosses on loans totaling $17.5 million and $3.6 million for the fiscal yearsended December 31, 2006 and September 30, 2005, respectively.  The provision recorded during the fiscal 2006period was predicated on higher non-performing, classified and criticizedassets for the fiscal year 2006, as well as significant charge-offs during2006.  The increase in such loans isprimarily due to delinquent loans in the Bank’s non-owner occupied (investmentproperty) residential loan portfolio and its acquisition, development, andconstruction loan portfolio.  Thedelinquencies in these portfolios are due primarily to moderate downturn in thelocal economy and resultant cash flow issues faced by local property investorsand developers.  There can be noassurance that the allowance for loan losses will be sufficient to cover losseson nonperforming loans in the future.

 

# **Other Income**

 

Other income totaled $3.2 million for thefiscal year ended December 31, 2006, an increase of $1.1 million, or52.0%, compared to the year ended September 30, 2005.  The increase was due primarily to a $1.2 million,or 95.4%, increase in other operating income, and an increase of $527,000 inincome from bank-owned life insurance. In fiscal 2006, the Company recognized twelve months of income frombank-owned life insurance which it acquired at the end of June 2005,compared to three months of income recognized during the twelve months ended September 30,2005.  The increase in other operatingincome resulted primarily from an increase of approximately $652,000 in feesgenerated from the growth in deposit accounts and $111,000 in loan servicingfees relating to the loan servicing portfolio obtained in the acquisition ofMercantile in June 2006.  Theseincreases were partially offset by a decrease in the gain on sale of securitiesof $641,000, or 86.5%.

 

# **General, Administrative and OtherExpense**

 

General, administrative and other expense totaled $21.1 million for thefiscal year ended December 31, 2006, an increase of $5.3 million, or33.5%, compared to the fiscal year ended September 30, 2005.  This increase resulted primarily from a $1.8million, or 22.1%, increase in employee compensation and benefits, a $926,000,or 35.9%, increase in occupancy and equipment expense, a $102,000, or 11.7%,increase in franchise tax, a $1.5 million increase in amortization of intangibles,an $839,000, or 27.0%, increase in other operating expense, and an $88,000, or9.6%, increase in data processing expense.

 

TheBank employed approximately 217 and 169 full-time employees as of December 31,2006 and September 30, 2005, respectively. A total of 23 full-time employees were added in conjunction with theacquisitions of Peoples Federal in December 2005 and Mercantile in June 2006.  The increase in employee compensation andbenefits was also due to the increase in staffing levels to support growth inthe overall infrastructure of the Company, as well as normal merit increasesand increases in other employee benefit costs.

 

Theincrease in occupancy and equipment expense primarily reflects increaseddepreciation and maintenance costs associated with the three offices inSoutheast Indiana acquired with the purchase of American State Bank in June 2005,the three offices in Southeast Indiana acquired with the purchase of PeoplesFederal Savings Bank in December 2005 and the one office in Cincinnatiacquired with the purchase of Mercantile Savings Bank in June 2006. The increase in franchise taxes reflectsthe continued growth of the equity in the Bank. The increase in amortization of intangibles was due to the additionalcore deposit intangibles recorded in conjunction with the acquisitions ofAmerican State in June 2005, Peoples Federal in December 2005 andMercantile in June 2006.  Theincrease in other

 

20

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**Comparison of Results of Operations for the FiscalYears Ended December 31, 2006 and September 30, 2005**(continued)

 

**General, Administrative and Other Expense**(continued)

 

operatingexpense was primarily due to increased loan collection expenses ofapproximately $310,000, and an increase in other operating costs associatedwith the Bank’s overall growth for the year ended December 31, 2006compared to the year ended September 30, 2005.

 

# **Federal Income Taxes**

 

The Company recorded a credit provision forfederal income taxes totaling $2.3 million for the fiscal year ended December 31,2006, compared to a provision of $1.4 million for fiscal year ended September 30,2005.  The effective tax rate was 32.4%for the fiscal year ended September 30, 2005.

 

**Results of Operations for the Three Months Ended December 31,2005**

 

Net earnings amounted to $87,000 for thethree months ended December 31, 2005. Net interest income for the three-months totaled $6.2 million andfederal income tax benefits totaled $34,000, which were substantially offset by$900,000 in provision for losses on loans, $4.5 million in general,administrative and other expenses, and a $764,000 loss in other income.

 

Approximately $1.4 million in securitieslosses was recorded in the three-months ended December 31, 2005.  The Company sold certain investmentsecurities in order to (i) restructure a portion of its securitiesportfolio, (ii) repay higher rate short-term advances and (iii) managebalance sheet growth.  To implement thisrestructuring, the Company sold $108.9 million of investment securities, ofwhich $108.4 million consisted of adjustable-rate mortgage-backed securitieswith a weighted average interest yield of 3.16%.  The Company used a significant portion ofsuch proceeds to repay $100.0 million of short-term advances with a weightedaverage rate of 4.27%.  The restructuringwas also undertaken to manage the Company’s growth in light of the acquisitionof PFS Bancorp in December 2005.

 

**Exposure to Changes in Interest Rates**

 

The Company’s ability to maintain netinterest income depends upon its ability to earn a higher yield oninterest-earning assets than the rates paid on deposits and borrowings.  The Bank’s ability to maintain a positivespread between the interest earned on assets and the interest paid on depositsand borrowings can be adversely affected when market rates of interestfluctuate.  Historically, long-term,fixed-rate mortgage loans made up a significant portion of Peoples’interest-earning assets.  A predominanceof long-term fixed-rate loans would make Peoples particularly susceptible tothe risk of changing interest rates, particularly in a rising rateenvironment.  However, during fiscal2000, the Bank began to emphasize the origination of adjustable-rate mortgage (“ARM”)loans and shorter-term loans such as non-residential real estate loans,construction loans, commercial loans and consumer loans, in an effort toimprove its interest rate risk position. As a result, at December 31, 2007, approximately $288.9 million, or41.0%, of the Company’s loan portfolio consisted of loans with fixed-rates ofinterest and approximately $415.1 million, or 59.0%, had adjustable-rates ofinterest.  Further, nonresidential realestate and land loans, construction loans, commercial loans and consumer loanstotaled $309.9 million or 44.0% of the total loan portfolio at December 31,2007 compared to $203.6 million or 36.6% of the total loan portfolio at September 30,2002.  These loans typically have higherrates and/or shorter terms to maturity compared to single-family residentialmortgage loans.

 

21

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**Fourth Quarter Review**

 

Net loss for the fourth quarter of 2007 was $31.5 million, or $6.57loss per share, compared to a net loss for the third quarter of 2007 of $1.4million and $2.3 million for the fourth quarter of 2006.  Net interest income for the  fourth quarter of 2007 decreased $1.1 million,or 18.4%, compared to the third quarter of 2007, primarily due to a decrease of40 basis points in the net interest margin to 2.17% for the fourth quarter of2007.

 

Management recorded a provision for losses onloans of $24.5 million in the fourth quarter of 2007, compared to $4.1 millionin the third quarter of 2007.  The largerprovision in the fourth quarter reflects higher probable credit losses onprimarily non-owner occupied residential loans and land development loans, as aresult of continuing forces in the local economy and a significant downturn inthe real estate market.  Nonperformingassets at September 30, 2007 totaled $20.4 million, compared to $32.8million at December 31, 2007, while classified assets increased from $31.3million at September 30, 2007 to $40.6 million at December 31, 2007.

 

Other income totaled approximately $1.2million for the fourth quarter of 2007, compared to $749,000 for the thirdquarter of 2007.  The increase wasprimarily attributed to approximately $100,000 in recoveries received on loanscharged-off by a financial institution prior to its acquisition by the Company,$100,000 received as a property improvement easement, and increases in otherdeposit and loan fee income.

 

General,administrative and other expenses recorded during the fourth quarter of 2007totaled $5.3 million, an increase of $277,000, or 5.5%, compared to the thirdquarter of 2007, and a decrease of $418,000, or 7.3%, and a decrease of$325,000, or 5.8%, from the first and second quarter of 2007,respectively.  InDecember 2007, the Bank recorded approximately $508,000 in compensationexpense for the release of approximately 32,383 ESOP shares for employeeallocation.  This occurred in conjunctionwith the decision to terminate the ESOP by September 30, 2008 and recordassociated expenses in 2008 to release all unallocated shares.

 

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.   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.

 

In the fourth quarter of 2007, the Company recorded a valuationallowance of deferred income tax in the amount of  $4.4 million based principally on uncertaintyabout the Company’s ability to generate sufficient future taxable income torealize all of the related temporary differences.  The Company believes that it will realize theremaining net deferred tax assets through taxable income resulting from plannedprofitable sale of branches of the Bank within the next twelve months.  The expense for recording the valuationallowance is a non-cash item, and the recording of this expense does not implythat the Company owes additional income taxes. This resulted in a total tax benefit of $3.7 million for the fourthquarter of 2007.

 

22

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**Quantitative Analysis**

 

TheOTS provides a quarterly report on the potential impact of interest ratechanges upon the market value of portfolio equity.  Management reviews the quarterly reports fromthe OTS that show the impact of changing interest rates on net portfoliovalue.  Net portfolio value (“NPV”) isthe difference between incoming and outgoing discounted cash flows from assets,liabilities, and off-balance sheet contracts. The application of the methodology attempts to quantify interest raterisk and the change in NPV which would result from a theoretical 100, 200 and300 basis point increase in market interest rates and a theoretical 100 and 200basis point decrease in market interest rates.

 

The following tables presentthe Bank’s net portfolio value as of December 31, 2007 and December 31,2006, as calculated by the OTS, based on information provided to the OTS by theBank.

 
| **December 31, 2007** | ** ** |
|---------------------------------|------------|
| ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Change in** | ** ** |
| **Change in**              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Net Portfolio** | ** ** | **Net Portfolio** | ** ** |
| **Interest Rates**         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Value as a% of** | ** ** | **Value as a% of** | ** ** |
| **In Basis Points**   | ** ** | ** ** | ** ** | **Net Portfolio** | ** ** | ** ** | ** ** | **Portfolio Value** | ** ** | **Portfolio Value** | ** ** |
| **(Rate Shock)**           | ** ** | **Amount** | ** ** | **Value $ Change** | ** ** | **% Change** | ** ** | **of Assets** | ** ** | **of Assets** | ** ** |
|                            |       | **(Dollars in thousands)** |   |   |   |   |   |   |   |
|                            |       |   |   |   |   |   |   |   |   |   |   |
| 300bp                           |       | $ | 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 | ) |
| 0                               |       | 94,637 |   | — |   | — |   | 10.53 |   | — |   |
| (100)                           |       | 95,789 |   | 1,153 |   | 1 |   | 10.59 |   | 6 |   |
| (200)                           |       | 94,408 |   | (228 | ) | — |   | 10.39 |   | (14 | ) |
|                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |

 
| **December 31, 2006** | ** ** |
|---------------------------------|------------|
| ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Change in** | ** ** |
| **Change in**              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Net Portfolio** | ** ** | **Net Portfolio** | ** ** |
| **Interest Rates**         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Value as a% of** | ** ** | **Value as a% of** | ** ** |
| **In Basis Points**   | ** ** | ** ** | ** ** | **Net Portfolio** | ** ** | ** ** | ** ** | **Portfolio Value** | ** ** | **Portfolio Value** | ** ** |
| **(Rate Shock)**           | ** ** | **Amount** | ** ** | **Value $ Change** | ** ** | **% Change** | ** ** | **of Assets** | ** ** | **of Assets** | ** ** |
| ** **                      | ** ** | **(Dollars in thousands)** | ** ** | ** ** |
|                            |       |   |   |   |   |   |   |   |   |   |   |
| 300bp                           |       | $ | 93,611 |   | $ | (26,697 | ) | (22 | )% | 9.46 | % | (231 | )bp |
| 200                             |       | 104,620 |   | (15,688 | ) | (13 | ) | 10.44 |   | (133 | ) |
| 100                             |       | 113,622 |   | (6,685 | ) | (6 | ) | 11.22 |   | (55 | ) |
| 0                               |       | 120,308 |   | — |   | — |   | 11.77 |   | — |   |
| (100)                           |       | 123,615 |   | 3,307 |   | 3 |   | 12.00 |   | 23 |   |
| (200)                           |       | 122,663 |   | 2,355 |   | 2 |   | 11.82 |   | 5 |   |
|                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

As shown by the 2007 tableabove, a 100 basis point increase in interest rates would result in a decreasein the Bank’s net portfolio value based on OTS calculations as of December 31,2007.  A 200 and 300 basis point increasewould result in larger decreases in net portfolio value. Conversely, the 2007table indicates an increase in net portfolio value at a 100 basis pointdecrease in interest rates, and a slight decrease in net portfolio value at a200 basis point decrease in interest rates. The instantaneous shock as indicated in the tables is subject toperiodic interest rate adjustments and caps as dictated by the underlyingnotes.

 

23

----

 

**Quantitative Analysis** (continued)

 

The Bank’s fixed-rate loanshelp its profitability if interest rates are stable or declining, since theseloans have yields that exceed its cost of funds.  However, if interest rates increase, the Bankwould have to pay more on its deposits and new borrowings, which wouldadversely affect its interest rate spread. Historically, the Bank has been able to maintain relatively stablelevels of net interest income despite the interest rate risk inherent in its operations.  The Bank attempts to mitigate potentialexposure to interest rate risk by:

 

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

 

(2)                                  Originating home equity lines of credit withinterest rates that adjust monthly based on an index;

 

(3)                                  Purchasing adjustable-rate mortgage-backedsecurities;

 

(4)                                  Utilizing fixed-rate longer-term advancesoffered by the Federal Home Loan Bank; and

 

(5)                                  Developing a strongcore deposit base.

 

**Liquidityand Capital Resources**

 

Peoples, like otherfinancial institutions, is required under applicable federal regulations tomaintain sufficient funds to meet deposit withdrawals, loan commitments andexpenses.  Liquid assets consist of cashand interest-bearing deposits in other financial institutions, investments andmortgage-backed securities.  Managementmonitors and assesses liquidity needs daily in order to meet depositwithdrawals, loan commitments and expenses.

 

The primary sources of funds includedeposits, principal and interest repayments on loans and on mortgage-backedsecurities and borrowings.  The Bank’sfirst preference is to fund liquidity needs with core deposits, if available,in the marketplace.  Core depositsinclude noninterest-bearing and interest-bearing retail deposits.  Other funding sources include Federal HomeLoan Bank advances.

 

Liquid assets as of December 31, 2007,included cash and deposits in other financial institutions totaling $86.6million, in addition to investment securities and mortgage-backed securitiesavailable for sale at a total market value of $67.6 million.  These liquid assets as well as the ability toborrow funds, sell loan participations and attract deposits through localpricing or through brokers will allow the Bank to meet its obligations andcommitments as indicated in the table below. Any future excess liquidity generated via operations will be utilized torepay borrowings or purchase investment and mortgage-backed securities.

 

The Company is a thrift holding company andits sources of funds are limited.  Cashavailable to pay dividends to stockholders of the Company and to service thedebt of the Company is largely dependent on the receipt of dividends from theBank.  Without an additional capitalinfusion as well as possibly a restructuring of existing debt obligations,current cash flows and capital resources of the Company will be insufficient tofund the Company’s operating expenses and to meet its debt service obligationson the junior subordinated debentures beginning in August, 2008 or, moreimportantly, to pay off the $17.5 million line of credit which is due on June 30,2008.  Since the Orders prohibit the Bankfrom paying cash dividends without the prior written consent of the OTS, theCompany will only be able to rely upon****existing cash and cash equivalents****as the sources of its liquidity.  Without the ability to rely on dividends fromthe Bank, the Company will require funds from other funding sources to meet itsobligations such as restructuring the current line of credit or replacing thecurrent line of credit.  Any increase inthe Company’s outstanding indebtedness will also require OTS approval.

 

24

----

 

**Liquidity and Capital Resources** (continued)

 

The Company is actively evaluating various funding strategies to meetits obligations, including restructuring its outstanding debt and sellingbranch offices.  The Company cannotprovide assurance that it will succeed in accomplishing any restructuring ofits existing debt or selling branches before its capital resources aredepleted.  Failure to restructure theCompany’s debt obligations or to sell branches will have a material adverseeffect on, and impair, the Company’s business, financial condition and abilityto operate as a going concern.

 

The following table sets forth informationregarding the Company’s obligations and commitments to make future paymentsunder contract as of December 31, 2007.

 
| ** **                                                     | ** ** | **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 |   | $ | 77 |   | $ | 6 |   | $ | 198 |   |
| Advances from  the Federal Home Loan Bank and other borrowings |       | 18,497                                    |        | 2,938 |   | 1,964 |   | 54,229 |   | 77,628 |   |
| Subordinated  debentures                                       |       | —                                    |        | — |   | — |   | 15,464 |   | 15,464 |   |
| Certificates of  deposit                                       |       | 406,005                                   |        | 77,865 |   | 27,925 |   | 2 |   | 511,797 |   |
|                                                           |       |                                      |        |   |   |   |   |   |   |   |   |
| Amount of  commitments expiring per period                     |       |                                      |        |   |   |   |   |   |   |   |   |
| Commitments to  originate loans:                               |       |                                      |        |   |   |   |   |   |   |   |   |
| Consumer lines  of credit                                      |       | 29,538                                    |        | — |   | — |   | — |   | 29,538 |   |
| Commercial lines  of credit                                    |       | 2,393                                     |        | — |   | — |   | — |   | 2,393 |   |
| One-to-four  family and multi-family loans                     |       | 143                                       |        | — |   | — |   | — |   | 143 |   |
| Commitments to  fund commercial or other:                      |       |                                      |        |   |   |   |   |   |   |   |   |
| Letters of  credit                                             |       | 5,868                                     |        | — |   | — |   | — |   | 5,868 |   |
|                                                           |       |                                      |        |   |   |   |   |   |   |   |   |
| Total  contractual obligations                                 | ** ** | **$**                                     | **462,482** | ** ** | **$** | **80,880** | ** ** | **$** | **29,966** | ** ** | **$** | **69,695** | ** ** | **$** | **643,039** | ** ** |

 

The Bank is required tomaintain regulatory capital sufficient to meet tangible, core and risk-basedcapital ratios of at least 1.5%, 4.0% and 8.0%, respectively.  At December 31, 2007, the Bank exceededeach of the capital requirements with tangible, core and risk-based capitalratios of 7.0%, 7.0% and 11.4%, respectively.

 

**Impact of Inflation and Changing Prices**

 

The consolidated financialstatements and related financial data presented herein regarding the Companyhave been prepared in accordance with accounting principles generally acceptedin the United States of America, which generally require the measurement offinancial position and operating results in terms of historical dollars,without considering changes in relative purchasing power over time due toinflation.  Unlike most industrialcompanies, virtually all of the Company’s assets and liabilities are monetaryin nature.  As a result, interest ratesgenerally have a more significant impact on the Company’s performance than doesthe effect of inflation.  Interest ratesdo not necessarily move in the same direction or in the same magnitude as theprices of goods and services, since such prices are affected by inflation to alarger extent than interest rates.

 

25

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**Report of Independent RegisteredPublic Accounting Firm**

 

Audit Committee, Board of Directors andStockholders

Peoples Community Bancorp, Inc.

West Chester, Ohio

 

We have audited the accompanying consolidatedstatements of financial condition of Peoples Community Bancorp, Inc. as ofDecember 31, 2007 and 2006, and the related consolidated statements ofoperations, comprehensive income (loss), stockholders’ equity and cash flowsfor each of the years ended December 31, 2007 and 2006, the three-monthperiod ended December 31, 2005 and for the year ended September 30,2005. The Company’s management is responsible for these financial statements.Our responsibility is to express an opinion on these financial statements basedon our audits.

 

We conducted our audits in accordance withthe standards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audits to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement. The Company is not required to have, nor were we engagedto perform, an audit of its internal control over financial reporting. Ouraudits included consideration of internal control over financial reporting as abasis for designing auditing procedures that are appropriate in thecircumstances, but not forthe purpose of expressing an opinion on the effectiveness of the Company’sinternal control over financial reporting. Accordingly, we express no suchopinion. Our audits also includedexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements, assessing the accounting principles used andsignificant estimates made by management and evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

 

In our opinion, the consolidated financialstatements referred to above present fairly, in all material respects, thefinancial position of Peoples Community Bancorp, Inc. as ofDecember 31, 2007 and 2006, and the results of its operations and its cashflows for the years ended December 31, 2007 and 2006, the three-monthperiod ended December 31, 2005, and for the year ended September 30,2005, in conformity with accounting principles generally accepted in the UnitedStates of America.

 

The accompanying financial statements havebeen prepared assuming the Company will continue as a going concern. Asdiscussed in Note P, the Company has suffered recurring losses from operationsand will operate under restrictions set forth by the formal agreements with theCompany’s and Bank’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 in regards to these matters are alsodescribed in Note P. The financial statements do not include any adjustmentsthat might result from the outcome of this uncertainty.

 

 

Cincinnati, Ohio

April 15, 2008

 
|        | 312 Walnut Street,  Suite 3000   Cincinnati, OH 45202-4025   513  621-8300   Fax 513 621-8345 |  |
|-------------|--------------------------------------------------------------------------------------------------------------------------------------------|--|
| **bkd.com** |                                                                                                                                            |

 

26

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**CONSOLIDATED STATEMENTS OFFINANCIAL CONDITION**

 

December 31,2007 and 2006

(In thousands, exceptshare data)

 
| ** **                                                                                                                                              | ** ** | **2007** | ** **  | **2006**   | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|-------------|------------|------------|
| **ASSETS**                                                                                                                                              |       |     |        |       |       |
| Cash and due  from banks                                                                                                                                |       | $        | 16,117      |       | $          | 26,272 |   |
| Federal funds sold                                                                                                                                      |       | 67,000   |        | 25,000     |       |
| Interest-bearing  deposits in other financial institutions                                                                                              |       | 3,497    |        | 6,187      |       |
| Cash and cash  equivalents                                                                                                                              |       | 86,614   |        | 57,459     |       |
|                                                                                                                                                    |       |     |        |       |       |
| Securities  designated as available for sale                                                                                                            |       | 67,572   |        | 56,899     |       |
| Loans receivable  - net                                                                                                                                 |       | 634,421  |        | 812,578    |       |
| Office premises  and equipment                                                                                                                          |       | 27,795   |        | 27,879     |       |
| Real estate held  for sale                                                                                                                              |       | 510      |        | —     |       |
| Real estate  acquired through foreclosure                                                                                                               |       | 6,915    |        | 333        |       |
| Federal Home  Loan Bank stock                                                                                                                           |       | 14,024   |        | 14,024     |       |
| Accrued interest  receivable                                                                                                                            |       | 4,295    |        | 5,461      |       |
| Bank-owned life  insurance                                                                                                                              |       | 17,812   |        | 17,093     |       |
| Prepaid expenses  and other assets                                                                                                                      |       | 1,906    |        | 3,404      |       |
| Goodwill                                                                                                                                                |       | 12,514   |        | 23,911     |       |
| Intangible  assets                                                                                                                                      |       | 4,232    |        | 5,903      |       |
| Deferred federal  income taxes                                                                                                                          |       | 8,816    |        | 3,135      |       |
|                                                                                                                                                    |       |     |        |       |       |
| Total assets                                                                                                                                            | ** ** | **$**    | **887,426** | ** ** | **$**      | **1,028,079** | ** ** |
|                                                                                                                                                    |       |     |        |       |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                           |       |     |        |       |       |
|                                                                                                                                                    |       |     |        |       |       |
| Deposits                                                                                                                                                |       | $        | 735,212     |       | $          | 755,261 |   |
| Advances from  the Federal Home Loan Bank and other borrowings                                                                                          |       | 77,628   |        | 156,885    |       |
| Subordinated  debentures                                                                                                                                |       | 15,464   |        | 15,464     |       |
| Accrued interest  payable                                                                                                                               |       | 382      |        | 577        |       |
| Other  liabilities                                                                                                                                      |       | 5,175    |        | 12,276     |       |
| Total  liabilities                                                                                                                                      |       | 833,861  |        | 940,463    |       |
|                                                                                                                                                    |       |     |        |       |       |
| Commitments and  contingent liabilities                                                                                                                 |       | —   |        | —     |       |
|                                                                                                                                                    |       |     |        |       |       |
| Stockholders’  equity                                                                                                                              |       |     |        |       |       |
| Common stock -  15,000,000 shares of $.01 par value authorized; 4,838,964 and 4,829,699  shares issued at December 31, 2007 and 2006, respectively |       | 48       |        | 48         |       |
| Additional  paid-in capital                                                                                                                             |       | 71,136   |        | 70,987     |       |
| Retained  earnings (deficit)                                                                                                                            |       | (17,364  | )           | 17,929     |       |
| Shares acquired  by stock benefit plan                                                                                                                  |       | (295     | )           | (1,212     | )          |
| Accumulated  comprehensive income (loss)                                                                                                                |       | 40       |        | (136       | )          |
| Total  stockholders’ equity                                                                                                                        |       | 53,565   |        | 87,616     |       |
|                                                                                                                                                    |       |     |        |       |       |
| Total  liabilities and stockholders’ equity                                                                                                        | ** ** | **$**    | **887,426** | ** ** | **$**      | **1,028,079** | ** ** |

 

Theaccompanying notes are an integral part of these statements.

 

27

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**CONSOLIDATED STATEMENTS OFOPERATIONS**

 

 (In thousands, except share data)

 
| ** **                                               | ** ** | **For Years**    | ** **  | **For Three Months** | ** ** | **For Year**      | ** ** |
|----------------------------------------------------------|------------|-----------------------|-------------|--------------------------------|------------|------------------------|------------|
| ** **                                               | ** ** | **Ended**             | ** **  | **Ended**                      | ** ** | **Ended**              | ** ** |
| ** **                                               | ** ** | **December 31,** | ** **  | **December 31,**          | ** ** | **September 30,** | ** ** |
| ** **                                               | ** ** | **2007**              | ** **  | **2006**                       | ** ** | **2005**               | ** ** | **2005** | ** ** |
|                                                     |       |                  |        |                           |       |                   |       |   |   |
| Interest income                                          |       |                  |        |                           |       |                   |       |   |   |
| Loans                                                    |       | $                     | 53,390      |                           | $          | 61,096                 |       | $ | 12,620 |   | $ | 41,628 |   |
| Mortgage-backed  securities                              |       | 2,394                 |        | 2,467                          |       | 1,463                  |       | 5,292 |   |
| Investment  securities                                   |       | 1,100                 |        | 951                            |       | 245                    |       | 664 |   |
| Interest-bearing  deposits and other                     |       | 3,349                 |        | 961                            |       | 74                     |       | 164 |   |
| Total interest  income                                   |       | 60,233                |        | 65,475                         |       | 14,402                 |       | 47,748 |   |
|                                                     |       |                  |        |                           |       |                   |       |   |   |
| Interest expense                                         |       |                  |        |                           |       |                   |       |   |   |
| Deposits                                                 |       | 30,028                |        | 27,239                         |       | 5,111                  |       | 15,226 |   |
| Borrowings                                               |       | 6,432                 |        | 9,246                          |       | 3,044                  |       | 10,978 |   |
| Total interest  expense                                  |       | 36,460                |        | 36,485                         |       | 8,155                  |       | 26,204 |   |
|                                                     |       |                  |        |                           |       |                   |       |   |   |
| Net interest  income                                     |       | 23,773                |        | 28,990                         |       | 6,247                  |       | 21,544 |   |
|                                                     |       |                  |        |                           |       |                   |       |   |   |
| Provision for  losses on loans                           |       | 32,800                |        | 17,450                         |       | 900                    |       | 3,600 |   |
|                                                     |       |                  |        |                           |       |                   |       |   |   |
| Net interest  income after provision for losses on loans |       | (9,027                | )           | 11,540                         |       | 5,347                  |       | 17,944 |   |
|                                                     |       |                  |        |                           |       |                   |       |   |   |
| Other income                                             |       |                  |        |                           |       |                   |       |   |   |
| Gain (loss) on  sale of investment securities            |       | 53                    |        | 100                            |       | (1,407                 | )          | 741 |   |
| Gain (loss) on  sale of branch premises and equipment    |       | —                |        | (21                            | )          | 4                      |       | (58 | ) |
| Gain on sale of  loans                                   |       | 326                   |        | 9                              |       | —                 |       | — |   |
| Loss on sale of  foreclosed real estate                  |       | (81                   | )           | (47                            | )          | (19                    | )          | — |   |
| Income from  bank-owned life insurance                   |       | 719                   |        | 685                            |       | 162                    |       | 158 |   |
| Other operating                                          |       | 2,915                 |        | 2,487                          |       | 496                    |       | 1,273 |   |
| Total other  income                                      |       | 3,932                 |        | 3,213                          |       | (764                   | )          | 2,114 |   |
|                                                     |       |                  |        |                           |       |                   |       |   |   |
| General,  administrative and other expense               |       |                  |        |                           |       |                   |       |   |   |
| Employee  compensation and benefits                      |       | 9,988                 |        | 10,058                         |       | 2,343                  |       | 8,235 |   |
| Occupancy and  equipment                                 |       | 3,487                 |        | 3,505                          |       | 728                    |       | 2,579 |   |
| Franchise taxes                                          |       | 1,020                 |        | 975                            |       | 240                    |       | 873 |   |
| Data processing                                          |       | 1,217                 |        | 1,004                          |       | 201                    |       | 916 |   |
| Amortization of  intangibles                             |       | 1,838                 |        | 1,633                          |       | 116                    |       | 116 |   |
| Goodwill  impairment                                     |       | 11,397                |        | —                         |       | —                 |       | — |   |
| Other operating                                          |       | 4,224                 |        | 3,947                          |       | 902                    |       | 3,108 |   |
| Total general,  administrative and other expense         |       | 33,171                |        | 21,122                         |       | 4,530                  |       | 15,827 |   |
|                                                     |       |                  |        |                           |       |                   |       |   |   |
| Earnings (loss)  before income taxes                     |       | (38,266               | )           | (6,369                         | )          | 53                     |       | 4,231 |   |
|                                                     |       |                  |        |                           |       |                   |       |   |   |
| Federal income  taxes (benefits)                         |       |                  |        |                           |       |                   |       |   |   |
| Current                                                  |       | 774                   |        | (817                           | )          | 493                    |       | 1,945 |   |
| Deferred                                                 |       | (5,707                | )           | (1,491                         | )          | (527                   | )          | (570 | ) |
| Total federal  income taxes (benefits)                   |       | (4,933                | )           | (2,308                         | )          | (34                    | )          | 1,375 |   |
|                                                     |       |                  |        |                           |       |                   |       |   |   |
| Net earnings  (loss)                                     | ** ** | **$**                 | **(33,333** | **)**                          | **$**      | **(4,061**             | **)**      | **$** | **87** | ** ** | **$** | **2,856** | ** ** |
|                                                     |       |                  |        |                           |       |                   |       |   |   |
| Earnings (Loss)  per share                               |       |                  |        |                           |       |                   |       |   |   |
|                                                     |       |                  |        |                           |       |                   |       |   |   |
| Basic                                                    | ** ** | **$**                 | **(6.97**   | **)**                          | **$**      | **(.88**               | **)**      | **$** | **.02** | ** ** | **$** | **.73** | ** ** |
| Diluted                                                  | ** ** | **$**                 | **(6.97**   | **)**                          | **$**      | **(.88**               | **)**      | **$** | **.02** | ** ** | **$** | **.72** | ** ** |

 

Theaccompanying notes are an integral part of these statements.

 

28

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**CONSOLIDATEDSTATEMENTS OF COMPREHENSIVE INCOME (LOSS)**

 

(In thousands)

 
| ** **                                                                                                                                                                                                                                                                                                                        | ** ** | **For Years**    | ** **  | **For Three Months** | ** ** | **For Year**      | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|-------------|--------------------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                        | ** ** | **Ended**             | ** **  | **Ended**                      | ** ** | **Ended**              | ** ** |
| ** **                                                                                                                                                                                                                                                                                                                        | ** ** | **December 31,** | ** **  | **December 31,**          | ** ** | **September 30,** | ** ** |
| ** **                                                                                                                                                                                                                                                                                                                        | ** ** | **2007**              | ** **  | **2006**                       | ** ** | **2005**               | ** ** | **2005** | ** ** |
|                                                                                                                                                                                                                                                                                                                              |       |                  |        |                           |       |                   |       |   |   |
| Net earnings  (loss)                                                                                                                                                                                                                                                                                                              |       | $                     | (33,333     | )                              | $          | (4,061                 | )          | $ | 87 |   | $ | 2,856 |   |
|                                                                                                                                                                                                                                                                                                                              |       |                  |        |                           |       |                   |       |   |   |
| Other  comprehensive income (loss), net of tax:                                                                                                                                                                                                                                                                                   |       |                  |        |                           |       |                   |       |   |   |
| Unrealized  holding gains (losses) on securities during the period, net of tax effects  (benefits) of $109, $120, $(576), and $365 in fiscal years ended  December 31, 2007, and December 31, 2006, three months ended December 31,  2005, and fiscal year ended September 30, 2005, respectively             |       | 211                   |        | 234                            |       | (1,119                 | )          | 708 |   |
|                                                                                                                                                                                                                                                                                                                              |       |                  |        |                           |       |                   |       |   |   |
| Reclassification  adjustment for realized losses (gains) included in earnings, net of tax (effects)  benefits of $(18), $(34), $478, and $(252) in fiscal years ended  December 31, 2007 and December 31, 2006, three months ended December 31,  2005, and fiscal year ended September 30, 2005, respectively |       | (35                   | )           | (66                            | )          | 929                    |       | (489 | ) |
|                                                                                                                                                                                                                                                                                                                              |       |                  |        |                           |       |                   |       |   |   |
| Comprehensive  income (loss)                                                                                                                                                                                                                                                                                                      | ** ** | **$**                 | **(33,157** | **)**                          | **$**      | **(3,893**             | **)**      | **$** | **(103** | **)** | **$** | **3,075** | ** ** |
|                                                                                                                                                                                                                                                                                                                              |       |                  |        |                           |       |                   |       |   |   |
| Accumulated  comprehensive income (loss)                                                                                                                                                                                                                                                                                          | ** ** | **$**                 | **40**      | ** **                     | **$**      | **(136**               | **)**      | **$** | **(304** | **)** | **$** | **(114** | **)** |

 

29

----

 

**PEOPLES COMMUNITY BANCORP, INC.**

 

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**

 

(Inthousands)

 
| ** **                                                                                     | ** ** | ** ** | ** ** | ** **     | ** ** | ** **    | ** ** | ** **   | ** ** | **Unrealized**     | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------------------------------|------------|------------|------------|----------------|------------|---------------|------------|--------------|------------|--------------------|------------|------------|------------|
| ** **                                                                                     | ** ** | ** ** | ** ** | ** **     | ** ** | ** **    | ** ** | **Shares**   | ** ** | **gains (losses)** | ** ** | ** ** | ** ** |
| ** **                                                                                     | ** ** | ** ** | ** ** | ** **     | ** ** | ** **    | ** ** | **acquired** | ** ** | **on securities**  | ** ** | ** ** | ** ** |
| ** **                                                                                     | ** ** | ** ** | ** ** | **Additional** | ** ** | **Retained**  | ** ** | **by stock** | ** ** | **designated**     | ** ** | ** ** | ** ** |
| ** **                                                                                     | ** ** | **Common** | ** ** | **paid-in**    | ** ** | **earnings**  | ** ** | **benefit**  | ** ** | **as available**   | ** ** | ** ** | ** ** |
| ** **                                                                                     | ** ** | **stock**  | ** ** | **capital**    | ** ** | **(deficit)** | ** ** | **plan**     | ** ** | **for sale**       | ** ** | **Total**  | ** ** |
|                                                                                           |       |       |       |           |       |          |       |         |       |               |       |       |       |
| Balance at  October 1, 2004                                                               |       | $          | 39         |           | $          | 51,901        |       | $            | 24,891     |               | $          | (723       | )          | $ | (333 | ) | $ | 75,775 |   |
|                                                                                           |       |       |       |           |       |          |       |         |       |               |       |       |       |
| Amortization  expense of stock benefit plans                                                   |       | —     |       | 392            |       | —        |       | 221          |       | —             |       | 613        |       |
| Compensation  expense relating to vested stock options                                         |       | —     |       | 184            |       | —        |       | —       |       | —             |       | 184        |       |
| Issuance of  common shares                                                                     |       | 5          |       | 10,245         |       | —        |       | (962         | )          | —             |       | 9,288      |       |
| Exercise of  stock options                                                                     |       | —     |       | 150            |       | —        |       | —       |       | —             |       | 150        |       |
| Net earnings for  the year ended September 30, 2005                                       |       | —     |       | —         |       | 2,856         |       | —       |       | —             |       | 2,856      |       |
| Dividends paid  of $.60 per common share                                                       |       | —     |       | —         |       | (2,385        | )          | —       |       | —             |       | (2,385     | )          |
| Unrealized gains  on securities designated as available for sale, net of related tax effects   |       | —     |       | —         |       | —        |       | —       |       | 219                |       | 219        |       |
|                                                                                           |       |       |       |           |       |          |       |         |       |               |       |       |       |
| Balance at  September 30, 2005                                                            |       | $          | 44         |           | $          | 62,872        |       | $            | 25,362     |               | $          | (1,464     | )          | $ | (114 | ) | $ | 86,700 |   |
|                                                                                           |       |       |       |           |       |          |       |         |       |               |       |       |       |
| Amortization  expense of stock benefit plans                                                   |       | —     |       | —         |       | —        |       | 41           |       | —             |       | 41         |       |
| Compensation  expense relating to vested stock options                                         |       | —     |       | 53             |       | —        |       | —       |       | —             |       | 53         |       |
| Exercise of  stock options                                                                     |       | —     |       | 20             |       | —        |       | —       |       | —             |       | 20         |       |
| Net earnings for  the three months ended December 31, 2005                                |       | —     |       | —         |       | 87            |       | —       |       | —             |       | 87         |       |
| Dividends paid  of $.15 per common share                                                       |       | —     |       | —         |       | (664          | )          | —       |       | —             |       | (664       | )          |
| Unrealized  losses on securities designated as available for sale, net of related tax  effects |       | —     |       | —         |       | —        |       | —       |       | (190               | )          | (190       | )          |
|                                                                                           |       |       |       |           |       |          |       |         |       |               |       |       |       |
| Balance at  December 31, 2005                                                             |       | $          | 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 (balance carried forward)                                   |       | $          | 48         |           | $          | 70,987        |       | $            | 17,929     |               | $          | (1,212     | )          | $ | (136 | ) | $ | 87,616 |   |

 

The accompanying notes are an integral part ofthese statements.

 

30

----

 
| ** **                                                                                   | ** ** | ** ** | ** ** | ** **     | ** ** | ** **    | ** ** | ** **   | ** ** | **Unrealized**          | ** ** | ** ** | ** ** |
|----------------------------------------------------------------------------------------------|------------|------------|------------|----------------|------------|---------------|------------|--------------|------------|-------------------------|------------|------------|------------|
| ** **                                                                                   | ** ** | ** ** | ** ** | ** **     | ** ** | ** **    | ** ** | **Shares**   | ** ** | **gains (losses)** | ** ** | ** ** | ** ** |
| ** **                                                                                   | ** ** | ** ** | ** ** | ** **     | ** ** | ** **    |       | **acquired** |       | **on securities**  |       |       |       |
| ** **                                                                                   | ** ** | ** ** | ** ** | **Additional** | ** ** | **Retained**  | ** ** | **by stock** | ** ** | **designated**          | ** ** | ** ** | ** ** |
| ** **                                                                                   | ** ** | **Common** | ** ** | **paid-in**    | ** ** | **earnings**  | ** ** | **benefit**  | ** ** | **as available**        | ** ** | ** ** | ** ** |
| ** **                                                                                   | ** ** | **stock**  | ** ** | **capital**    | ** ** | **(deficit)** | ** ** | **plan**     | ** ** | **for sale**            | ** ** | **Total**  | ** ** |
| ** **                                                                                   | ** ** | ** ** | ** ** | ** **     | ** ** | ** **    | ** ** | ** **   | ** ** | ** **              | ** ** | ** ** | ** ** |
| Balance at  December 31, 2006 (balance brought forward)                                 |       | $          | 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 |   |

 

Theaccompanying notes are an integral part of these statements.

 

31

----

 

**PEOPLES COMMUNITY BANCORP, INC.**

 

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(In thousands)

 
| ** **                                                                                                    | ** ** | **For Years**    | ** ** | **For Three Months** | ** ** | **For Year**      | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|--------------------------------|------------|------------------------|------------|
| ** **                                                                                                    | ** ** | **Ended**             | ** ** | **Ended**                      | ** ** | **Ended**              | ** ** |
| ** **                                                                                                    | ** ** | **December 31,** | ** ** | **December 31,**          | ** ** | **September 30,** | ** ** |
| ** **                                                                                                    | ** ** | **2007**              | ** ** | **2006**                       | ** ** | **2005**               | ** ** | **2005** | ** ** |
| Cash flows  provided by (used in) operating activities:                                                       |       |                  |       |                           |       |                   |       |   |   |
| Net earnings  (loss) for the year                                                                             |       | $                     | (33,333    | )                              | $          | (4,061                 | )          | $ | 87 |   | $ | 2,856 |   |
| Adjustments to  reconcile net earnings to net cash provided by (used in) operating  activities:               |       |                  |       |                           |       |                   |       |   |   |
| Amortization of  premiums and discounts on securities                                                         |       | 90                    |       | 628                            |       | 247                    |       | 1,768 |   |
| Amortization of  deferred loan origination fees & premiums                                           |       | (131                  | )          | (948                           | )          | (413                   | )          | (1,630 | ) |
| Amortization of  premiums and discounts on deposits                                                           |       | (16                   | )          | (424                           | )          | —                 |       | — |   |
| Amortization of  premiums and discounts on borrowings                                                         |       | 104                   |       | 159                            |       | (404                   | )          | — |   |
| Expense of stock  benefit plans                                                                               |       | 1,059                 |       | 616                            |       | 94                     |       | 797 |   |
| Amortization of  other intangible assets                                                                      |       | 1,671                 |       | 1,633                          |       | 116                    |       | 116 |   |
| Amortization of  mortgage servicing rights                                                                    |       | 165                   |       | 101                            |       | —                 |       | — |   |
| Goodwill  impairment                                                                                          |       | 11,397                |       | —                         |       | —                 |       | — |   |
| Depreciation                                                                                                  |       | 1,348                 |       | 1,407                          |       | 340                    |       | 1,116 |   |
| Provision for  losses on loans                                                                                |       | 32,800                |       | 17,450                         |       | 900                    |       | 3,600 |   |
| Investment  securities dividends                                                                              |       | (52                   | )          | (57                            | )          | (12                    | )          | (46 | ) |
| Federal Home  Loan Bank stock dividends                                                                       |       | —                |       | (664                           | )          | (165                   | )          | (510 | ) |
| Income from  bank-owned life insurance                                                                        |       | (719                  | )          | (685                           | )          | (162                   | )          | (158 | ) |
| Undistributed  income from investment in Columbia                                                             |       | —                |       | (172                           | )          | (48                    | )          | (95 | ) |
| Loss (gain) on  sale of securities                                                                            |       | (53                   | )          | (100                           | )          | 1,407                  |       | (741 | ) |
| Loss (gain) on  sale of branch premises and equipment                                                         |       | —                |       | 21                             |       | (4                     | )          | 58 |   |
| Gain on sale of  loans                                                                                        |       | (326                  | )          | (9                             | )          | —                 |       | (93 | ) |
| Gain on sale of  real estate                                                                                  |       | (32                   | )          | (9                             | )          | —                 |       | — |   |
| Loss on sale of  foreclosed real estate                                                                       |       | 113                   |       | 56                             |       | 18                     |       | 33 |   |
| Proceeds from  sale of loans in the secondary market                                                          |       | 1,688                 |       | 831                            |       | —                 |       | 6,714 |   |
| Loans originated  for sale in the secondary market                                                            |       | (1,663                | )          | (822                           | )          | —                 |       | (6,543 | ) |
| Increase  (decrease) in cash, due to changes in:                                                              |       |                  |       |                           |       |                   |       |   |   |
| Accrued interest  receivable                                                                                  |       | 1,166                 |       | (56                            | )          | (7                     | )          | (882 | ) |
| Prepaid expenses  and other assets                                                                            |       | (3,235                | )          | (770                           | )          | 3,170                  |       | 580 |   |
| Accrued interest  payable and other liabilities                                                               |       | (8,288                | )          | 4,981                          |       | (967                   | )          | 2,062 |   |
| Net cash  provided by operating activities                                                                    |       | 3,753                 |       | 19,106                         |       | 4,197                  |       | 9,002 |   |
|                                                                                                          |       |                  |       |                           |       |                   |       |   |   |
| Cash flows  provided by (used in) investing activities:                                                       |       |                  |       |                           |       |                   |       |   |   |
| Purchase of investment  in Columbia                                                                           |       | —                |       | —                         |       | —                 |       | (2,524 | ) |
| Sale of  investment in Columbia                                                                               |       | —                |       | 2,856                          |       | —                 |       | — |   |
| Purchase of  bank-owned life insurance                                                                        |       | —                |       | —                         |       | —                 |       | (15,000 | ) |
| Purchases of  investment securities and mortgage-backed securities                                            |       | (29,801               | )          | —                         |       |                   |       | (88,111 | ) |
| Proceeds from  sale of investment securities and mortgage-backed securities designated as  available for sale |       | 61                    |       | 1,635                          |       | 108,865                |       | 41,919 |   |
| Principal  repayments on investment securities and mortgage-backed securities                                 |       | 19,349                |       | 22,425                         |       | 22,482                 |       | 76,510 |   |
| Proceeds from  sale of loans and loan participations                                                          |       | 32,000                |       | 34,635                         |       | 3,490                  |       | 1,055 |   |
| Principal  repayments (disbursements) on loans – net                                                     |       | 106,929               |       | 24,885                         |       | (27,889                | )          | (73,387 | ) |
| Purchase of  office premises and equipment                                                                    |       | (1,774                | )          | (4,035                         | )          | (640                   | )          | (6,880 | ) |
| Proceeds from  sale of branch premises and equipment                                                          |       | —                |       | 15                             |       | 4                      |       | 565 |   |
| Redemption of  Federal Home Loan Bank stock                                                                   |       | —                |       | 473                            |       | —                 |       | — |   |
| Proceeds from  sale of real estate acquired through foreclosure                                               |       | 165                   |       | 830                            |       | —                 |       | 880 |   |
| Cash received in  acquisition of Mercantile Financial Corporation.- net                                       |       | —                |       | 11,123                         |       | —                 |       | — |   |
| Cash paid in acquisition  of PFS Bancorp, Inc. – net                                                |       | —                |       | —                         |       | (30,008                | )          | — |   |
| Cash received in  acquisition of American State Corporation – net                                        |       | —                |       | —                         |       | —                 |       | 8,349 |   |
|                                                                                                          |       |                  |       |                           |       |                   |       |   |   |
| Net cash  provided by (used in) investing activities                                                          |       | 126,929               |       | _94,842                        |       | 76,304                 |       | (56,624 | ) |
| Net cash  provided by (used in) operating and investing activities (balance carried  forward)                 |       | $                     | 130,682    |                           | $          | 113,948                |       | $ | 80,501 |   | $ | (47,622 | ) |

 

Theaccompanying notes are an integral part of these statements.

 

32

----

 
| ** **                                                                                    | ** ** | **For Years**    | ** ** | **For Three Months** | ** ** | **For Year**      | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-----------------------|------------|--------------------------------|------------|------------------------|------------|
| ** **                                                                                    | ** ** | **Ended**             | ** ** | **Ended**                      | ** ** | **Ended**              | ** ** |
| ** **                                                                                    | ** ** | **December 31,** | ** ** | **December 31,**          | ** ** | **September 30,** | ** ** |
| ** **                                                                                    | ** ** | **2007**              | ** ** | **2006**                       | ** ** | **2005**               | ** ** | **2005** | ** ** |
|                                                                                          |       |                  |       |                           |       |                   |       |   |   |
| Net cash  provided by (used in) operating and investing activities (balance brought  forward) |       | $                     | 130,682    |                           | $          | 113,948                |       | $ | 80,501 |   | $ | (47,622 | ) |
|                                                                                          |       |                  |       |                           |       |                   |       |   |   |   |   |   |   |
| Cash flows  provided by (used in) financing activities:                                       |       |                  |       |                           |       |                   |       |   |   |
| Net increase  (decrease) in deposit accounts                                                  |       | (20,033               | )          | (19,627                        | )          | 25,740                 |       | 81,768 |   |
| Proceeds from  Federal Home Loan Bank advances and other borrowings                           |       | 29,550                |       | 97,500                         |       | 49,900                 |       | 213,000 |   |
| Repayment of  Federal Home Loan Bank advances and other borrowings                            |       | (108,911              | )          | (140,284                       | )          | (151,000               | )          | (267,032 | ) |
| Proceeds from  issuance of subordinated debentures                                            |       | —                |       | —                         |       | —                 |       | 15,464 |   |
| Redemption of  subordinated debentures                                                        |       | —                |       | (12,887                        | )          | —                 |       | — |   |
| Proceeds from  issuance of common stock                                                       |       | —                |       | —                         |       | —                 |       | 10,250 |   |
| Dividends paid  on common stock                                                               |       | (2,140                | )          | (2,795                         | )          | (664                   | )          | (2,385 | ) |
| Proceeds from  exercise of stock options                                                      |       | 7                     |       | 46                             |       | 20                     |       | 150 |   |
| Shares acquired  by ESOP                                                                      |       | —                |       | —                         |       | —                 |       | (962 | ) |
| Net cash  provided by (used in) financing activities                                          |       | (101,527              | )          | (78,047                        | )          | (76,004                | )          | 50,253 |   |
|                                                                                          |       |                  |       |                           |       |                   |       |   |   |
| Net increase in  cash and cash equivalents                                                    |       | 29,155                |       | 35,901                         |       | 4,497                  |       | 2,631 |   |
|                                                                                          |       |                  |       |                           |       |                   |       |   |   |
| Cash and cash  equivalents at beginning of period                                             |       | 57,459                |       | 21,558                         |       | 17,061                 |       | 14,430 |   |
|                                                                                          |       |                  |       |                           |       |                   |       |   |   |
| Cash and cash  equivalents at end of period                                                   | ** ** | **$**                 | **86,614** | ** **                     | **$**      | **57,459**             | ** ** | **$** | **21,558** | ** ** | **$** | **17,061** | ** ** |
|                                                                                          | ** ** | ** **            | ** ** | ** **                     | ** ** | ** **             | ** ** | ** ** | ** ** |
| Supplemental  disclosure of cash flow information:                                            |       |                  |       |                           |       |                   |       |   |   |
| Cash paid during  the year for:                                                               |       |                  |       |                           |       |                   |       |   |   |
| Federal income  taxes                                                                         | ** ** | **$**                 | **—** | ** **                     | **$**      | **380**                | ** ** | **$** | **500** | ** ** | **$** | **1,200** | ** ** |
|                                                                                          | ** ** | ** **            | ** ** | ** **                     | ** ** | ** **             | ** ** | ** ** | ** ** |
| Interest on  deposits and borrowings                                                          | ** ** | **$**                 | **36,655** | ** **                     | **$**      | **36,608**             | ** ** | **$** | **8,300** | ** ** | **$** | **25,587** | ** ** |
|                                                                                          | ** ** | ** **            | ** ** | ** **                     | ** ** | ** **             | ** ** | ** ** | ** ** |
| Supplemental disclosure  of noncash investing activities:                                     |       |                  |       |                           |       |                   |       |   |   |
| Transfers from  loans to real estate acquired through foreclosure                             |       | **$**                 | **6,860**  | ** **                     | **$**      | **1,008**              | ** ** | **$** | **—** | ** ** | **$** | **1,854** |   |
|                                                                                          |       | ** **            | ** ** | ** **                     | ** ** | ** **             | ** ** | ** ** |   |
| Loans disbursed  to facilitate sale of real estate acquired through foreclosure               |       | **$**                 | **—** | ** **                     | **$**      | **—**             | ** ** | **$** | **—** | ** ** | **$** | **1,276** |   |
|                                                                                          |       | ** **            | ** ** | ** **                     | ** ** | ** **             | ** ** | ** ** |   |
| Loans disbursed  to facilitate sale of real estate                                            | ** ** | **$**                 | **—** | ** **                     | **$**      | **308**                | ** ** | **$** | **—** | ** ** | **$** | **—** |   |
|                                                                                          | ** ** | ** **            | ** ** | ** **                     | ** ** | ** **             | ** ** | ** ** |   |
| Common stock  issued in acquisition of Mercantile Financial Corp.                             |       | **$**                 | **—** | ** **                     | **$**      | **7,595**              | ** ** | **$** | **—** | ** ** | **$** | **—** |   |

 

Theaccompanying notes are an integral part of these statements.

 

33

----

 

**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

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

 

Peoples Community Bancorp, Inc. (“theCompany”) is a registered savings and loan holding company whose activities areprimarily limited to holding the stock of Peoples Community Bank (“Peoples” orthe “Bank”).  The Company conducts ageneral banking business in southwestern Ohio and southeastern Indiana which consistsof attracting deposits from the general public and primarily applying thosefunds to the origination of loans for residential, consumer and nonresidentialpurposes.  The Company’s profitability issignificantly dependent on net interest income, which is the difference betweeninterest income generated from interest-earning assets (i.e. loans andinvestments) and the interest expense paid on interest-bearing liabilities(i.e. customer deposits and borrowed funds). Net interest income is affected by the relative amount ofinterest-earning assets and interest-bearing liabilities and the interestreceived or paid on these balances.  Thelevel of interest rates paid or received by the Company can be significantly influencedby a number of factors, such as governmental monetary policy, that are outsideof management’s control.

 

The Company has entered into a number ofacquisitions, divestitures and other material financial transactions during theyears covered by these financial statements.

 

On January 14,2005, Peoples Community Bancorp acquired 69,925 shares of Columbia Bancorp, Inc.(“Columbia”), Cincinnati, Ohio, a privately held bank holding company for anaggregate purchase price of $2.5 million. These shares represented approximately 38% of Columbia’s issued andoutstanding common stock.  At this point,Peoples Community Bancorp, Inc. became a bank holding company.

 

On June 10, 2005, the Companyacquired American State Corporation, the parent company of American State Bank(“American”) with three branch offices in the Southeast Indiana communities ofLawrenceburg, Aurora and Bright.  TheBank paid $4.79 in cash for each of the 1,469,062 outstanding common shares ofAmerican.  American’s outstandingpreferred stock was redeemed for cash at par value, totaling $700,000.   The expansion in this Southeast Indianacommunity further enhanced Peoples Community Bank’s ability to increase itsmarket share and scale of operations, as well as expand its distributionnetwork within the greater Cincinnati area.

 

On August 11, 2005,the Company completed a private placement of 500,000 shares of its common stockwith certain institutional investors and directors and officers. The netproceeds of $10.3 million were utilized to supplement the Company’s capital andalso served as an additional source to fund the Company’s growth strategy andfor general corporate purposes.

 

On December 16, 2005, the Companyacquired PFS Bancorp, Inc. (“PFS”), the parent company of Peoples FederalSavings Bank (“Peoples Federal”).  PeoplesFederal operated three offices in the Southeast Indiana communities of Aurora,Rising Sun, and Vevay.  The Company paid$23.00 in cash for each of the outstanding 1,473,728 shares of PFS, resultingin aggregate merger consideration of approximately $32.8 million.  The acquisition was accounted for using thepurchase method of accounting.

 

On June 9, 2006, theCompany acquired Mercantile Financial Corporation (“Mercantile”) and PeoplesCommunity Bank (“Bank”) acquired Mercantile Savings Bank which operated onebranch office in Cincinnati, Ohio.  TheBank paid $34.78 in cash and exchanged 43.10 shares of stock for each of theoutstanding common shares of Mercantile, resulting in aggregate mergerconsideration of approximately

 

34

----

 

**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

**NOTE A -SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES** (continued)

 

$9.3 million, includingacquisition costs.  This acquisitioncomplemented the Bank’s market area, and increased its market share.

 

On August 25, 2006, the Board ofDirectors approved a change of the Company’s and the Bank’s fiscal year endfrom September 30 to December 31, retroactive to January 1,2006, in order to increase operational efficiency.

 

On December 29,2006, the Company sold its 69,925 shares of Columbia for an aggregate salesprice of $2.9 million.  In conjunctionwith this divesture, the Company converted its charter to a registered savingsand loan holding company.

 

The consolidated financial informationpresented herein has been prepared in accordance with accounting principlesgenerally accepted in the United States of America (“U.S. GAAP”) and generalaccounting practices 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 the Company’ssignificant accounting policies which have been consistently applied in the preparationof the accompanying consolidated financial statements.

 

1. Principles of Consolidation

 

The accompanying consolidated financialstatements include the accounts of the Company and the Bank, it’s wholly-ownedsubsidiary, and American State Advisory Group Corp., a wholly-owned subsidiaryof the Bank.  All significantinter-company items have been eliminated. American State Advisory Group Corp. was established as an operatingsubsidiary of the Bank to hold title, manage, and sell a portion of the Bank’sother real etate owned.  At December 31,2007, American State Advisory Group Corp. held $6.4 million in real estateacquired through foreclosure.  In December 2003,FASB issued a revision to FIN 46 to clarify certain provisions that affectedthe accounting for trust preferred securities. As a result of the provisions in FIN 46, Peoples Bancorp Capital Trust Iwas deconsolidated as of June 30, 2004, with the Company accounting forits investment in Peoples Community Bancorp Capital Trust I as an asset, itssubordinated debentures as debt, and the interest paid thereon as interestexpense.  The Company had previouslyclassified the trust preferred securities as debt, but eliminated its commonstock investment.  The subordinateddebentures issued by Peoples Bancorp Capital Trust I were redeemed on December 8,2006, resulting in Peoples Bancorp Capital Trust I being dissolved.  The investment in Peoples Community BancorpCapital Trust II is accounted for using provisions of FIN 46 as revised by theFASB.

 

2. Investment Securities and Mortgage-Backed Securities

 

The Company accounts for investments indebt and equity securities as held-to-maturity, trading, or available forsale.  Securities classified asheld-to-maturity are carried at cost only if the Company has the positiveintent and ability to hold these securities to maturity. Securities designatedas available for sale are carried at fair value with resulting unrealized gainsor losses recorded to stockholders’ equity.

 

35

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

**NOTE A -SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES** (continued)

 

2. Investment Securities and Mortgage-Backed Securities (continued)

 

Realized gains and losses on sales ofsecurities are recognized using the specific identification method.  Amortization of premiums and accretion ofdiscounts are recorded on a principal pay-down method based on the estimated durationof 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-porfolio 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.

 

The Company 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.

 

TheCompany assesses the impairment of the capitalized mortgage servicing rightsbased on fair value.  Changes in fairvalue are included in earnings in the period the change occurs.  The mortgage servicing rights recorded byPeoples 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 from loans, net of direct origination costs, as deferred items,and amortizes such amounts to interest income using the level-yield method,giving effect to actual loan prepayments. Loan origination costs are limited to the direct costs of originating aloan, i.e., principally direct personnel costs. Fees received for loan commitments that are expected to be drawn upon,based on Peoples’ experience with similar commitments, are deferred andamortized over the life of the loan using the level-yield method.  Fees for other loan commitments are deferredand amortized over the loan commitment period on a straight-line basis.

 

36

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

**NOTE A -SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES** (continued)

 

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 loansbased upon the present value of expected future cash flows discounted at theloan’s effective interest rate or, as an alternative, at the loan’s observablemarket price 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 estate acquiredthrough foreclosure, net of rental income, are charged against earnings asincurred.

 

37

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

**NOTE A -SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES** (continued)

 

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, Inc.  In December 2006, the Company sold itsinvestment in Columbia for an aggregate sales price of $2.9 million.

 

9.  Goodwill

 

Goodwill is tested annually for impairment,  if the implied fair value of goodwill islower than its carrying amount, a goodwill impairment is indicated and goodwillis written down to its implied fair value. Subsequent increases in goodwill value are not recognized in thefinancial statements.  The Bank selectedan independent third party to evaluate the unamortized goodwill balance as of December 31,2007, and subsequently recorded an impairment of $11.4 million, which reducedthe goodwill balance on its books to $12.5 million from $23.9 million.   The impairment of goodwill is primarilyattributable to lower market valuations for financial institutions in thelatter part of 2007, the weakening of the credit market in the second half of2007, the decline in real estate values, particularly in the Cincinnati region,and the net losses recorded by the Bank and Company for the past six 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 were 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 June 2005, December 2005, and June 2006,the Bank acquired American, Peoples Federal and Mercantile resulting ingoodwill of approximately $3.9 million, $9.9 million, and $4.0 million, respectively.  The changes in the carrying amount ofgoodwill for the years ended December 31, 2007 and December 31, 2006,the three-month period ended December 31, 2005 and the year ended September 30,2005 are summarized below.

 
| ** **                                        | ** ** | ** **                    | ** ** | ** **            | ** ** | **For Three Months** | ** ** | ** ** | ** ** |
|---------------------------------------------------|------------|-------------------------------|------------|-----------------------|------------|--------------------------------|------------|------------|------------|
| ** **                                        | ** ** | **For Years Ended** | ** ** | **Ended**             | ** ** | **For Year Ended**   | ** ** |
| ** **                                        | ** ** | **December 31,**         | ** ** | **December 31,** | ** ** | **September 30,**         | ** ** |
| ** **                                        | ** ** | **2007**                      | ** ** | **2006**              | ** ** | **2005**                       | ** ** | **2005**   | ** ** |
| ** **                                        | ** ** | **(In thousands)**            | ** ** |
| ** **                                        | ** ** | ** **                    | ** ** |
| Balance at  beginning of period                   |       | $                             | 23,911     |                  | $          | 20,282                         |       | $          | 10,028     |   | $ | 6,089 |   |
| Purchase of  American                             |       | —                        |       | —                |       | —                         |       | 3,939      |       |
| Purchase of  Peoples Federal and final adjustment |       | —                        |       | (334                  | )          | 10,254                         |       | —     |       |
| Purchase of  Mercantile                           |       | —                        |       | 3,963                 |       | —                         |       | —     |       |
| Impairment                                        |       | (11,397                       | )          | —                |       | —                         |       | —     |       |
| Balance at end  of period                         |       | $                             | 12,514     |                  | $          | 23,911                         |       | $          | 20,282     |   | $ | 10,028 |   |

 

38

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

**NOTE A -SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES** (continued)

 

10. Other Intangible Assets

 

In June 2005, the Bank recorded $1.9million of core deposit intangibles in conjunction with the acquisition ofAmerican. In December 2005, the Bank recorded $3.7 million in core depositintangibles in conjunction with the acquisition of PFS., and recorded $2.2million in core deposit intangibles in conjunction with the acquisition ofMercantile in June 2006.

 

The core deposit intangibles are beingamortized on an accelerated basis over an original period of seven years.  The carrying basis and accumulatedamortization of core deposit intangibles at December 31, 2007 and 2006were:

 
| ** **                | ** ** | **2007**           | ** ** | **2006**   | ** ** |
|---------------------------|------------|--------------------|------------|------------|------------|
| ** **                | ** ** | **(in thousands)** | ** ** |
| ** **                | ** ** | ** **         | ** ** | ** ** | ** ** |
| Core deposits             |       |               |       |       |       |
| Gross carrying  amount    |       | $                  | 7,768      |       | $          | 7,768 |   |
| Accumulated  amortization |       | 3,536              |       | 1,865      |       |
|                           |            |                    |            |            |            |  |  |

 

Amortization expense for the years ended December 31,2007 and December 31, 2006, the three-month period ending December 31,2005 and the year ended September 30, 2005 was $1.7 million, $1.6 million,$116,000 and $116,000, respectively.  Thefollowing table summarizes the Bank’s current estimates for future amortizationexpense of the core deposit intangible

 
| ** **           | ** ** | **(In thousands)** | ** ** |
|----------------------|------------|-------------------------|------------|
| ** **           | ** ** | ** **              | ** ** |
| 2008                 |       | $                       | 1,393      |   |
| 2009                 |       | $                       | 1,116      |   |
| 2010                 |       | $                       | 839        |   |
| 2011                 |       | $                       | 561        |   |
| 2012 and  thereafter |       | $                       | 323        |   |

 

11. Loan Servicing

 

In conjunction with its acquisition ofMercantile, the Company 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 $72.1 and $81.1 million at December 31, 2007and December 31, 2006, respectively.

 

Inconjunction with its acquisition of Mercantile, the Bank acquired $926,000 inmortgage servicing rights. The balance and fair value of mortgage servicing rightsas of December 31, 2007 was $659,000. The Bank recorded amortization related to mortgage servicing rightstotaling $167,000 and $101,000 for the fiscal years ended December 31,2007 and December 31, 2006, respectively.

 

39

----

 

**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

**NOTE A -SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES** (continued)

 

12. Federal Income Taxes

 

The Company accounts for federal incometaxes in accordance with the provisions of SFAS No. 109, “Accounting forIncome Taxes.”  Pursuant to theprovisions of SFAS No. 109, a deferred tax liability or deferred tax assetis computed by applying the current statutory tax rates to net taxable ordeductible differences between the tax basis of an asset or liability and itsreported amount in the consolidated financial statements that will result intaxable 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 current period earnings, carried backagainst prior years’ earnings, offset against taxable temporary differencesreversing in future periods, or utilized to the extent of management’s estimateof future taxable income.  A valuationallowance is provided for deferred tax assets to the extent that the value ofnet deductible temporary differences and carryforward attributes exceedsmanagement’s estimates of taxes payable on future taxable income.  Deferred tax liabilities are provided on thetotal amount of net temporary differences taxable in the future.

 

13. Unrecognized Tax Benefits

 

The Company adopted FIN 48 at thebeginning of fiscal year 2007 which resulted in a reclassification of $1.3million in deferred tax liability and the establishment of a $1.1 millionunrecognized tax liability related to federal income tax matters.  The following table reflects the change inthe balance of the unrecognized tax liability for the fiscal year ended December 31,2007.

 
| ** **                                                  | ** ** | **(in thousands)** | ** ** |
|-------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                  | ** ** | ** **              | ** ** |
| Balance at  January 1, 2007                            |       | $                       | 1,112      |   |
| Decrease based  on position taken during the current period |       | (87                     | )          |
|                                                        |       |                    |       |
| Balance at  December 31, 2007                          |       | $                       | 1,025      |   |

 

Peoples’ federal income tax returns for thetax years ended 2007 and 2006 are open under the statute of limitations and aresubject to review by the IRS.  Variouscompanies that the Bank has acquired remain under the statute of limitations bythe IRS for the years ended 2004 through 2007.

 

14. 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 and total vesting for all participants.  The balance of the accrued liability was $1.7million and $1.4 million, as of December 31, 2007 and 2006,respectively.  The provision for director’sretirement expense totaled $504,000, $94,000, and $19,000 for the fiscal yearsended December 31, 2007, December 31, 2006, and September 30,2005, respectively.  There was noprovision recorded for the three months ended December 31, 2005.  A higher provision was recorded in fiscalyear 2007 due to a decrease in the discount rate, which is utilized incalculating the present value of the benefits.

 

40

----

 

**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

**NOTE A -SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES** (continued)

 

14.  Benefit Plans (continued)

 

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 expense 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 $656,000, $207,000, $43,000, and  $261,000 for the fiscal years ended December 31,2007 and December 31, 2006, the three-month period ended December 31,2005 and the fiscal year ended September 30, 2005, 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 Three Months** | ** ** | ** ** | ** ** |
|--------------------------------------------------------------------------|------------|-------------------------------|------------|-----------------------|------------|--------------------------------|------------|------------|------------|
| ** **                                                               | ** ** | **For Years Ended** | ** ** | **Ended**             | ** ** | **For Year Ended**   | ** ** |
| ** **                                                               | ** ** | **December 31,**         | ** ** | **December 31,** | ** ** | **September 30,**         | ** ** |
| ** **                                                               | ** ** | **2007**                      | ** ** | **2006**              | ** ** | **2005**                       | ** ** | **2005**   | ** ** |
|                                                                     |       |                          |       |                  |       |                           |       |       |       |
| Allocated shares                                                         |       | 101,954                       |       | 96,542                |       | 98,921                         |       | 99,013     |       |
| Shares committed  to be released                                         |       | 34,258                        |       | 1,875                 |       | 1,875                          |       | —     |       |
| Unearned shares                                                          |       | 12,297                        |       | 54,211                |       | 63,754                         |       | 65,629     |       |
|                                                                     |       |                          |       |                  |       |                           |       |       |       |
| Total ESOP  shares                                                       |       | 148,509                       |       | 152,628               |       | 164,550                        |       | 164,642    |       |
|                                                                     |       |                          |       |                  |       |                           |       |       |       |
| Fair value of  unearned shares at end of period (expressed in thousands) |       | $                             | 172        |                  | $          | 976                            |       | $          | 1,288      |   | $ | 1,401 |   |
|                                                                          |            |                               |            |                       |            |                                |            |            |            |  |  |  |  |

 

41

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

 

**NOTE A -SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES** (continued)

 

15. Share-Based Compensation Plans

 

Effective October 1, 2005, theCompany adopted the fair value recognition provisions of Statement of FinancialAccounting Standards (SFAS) No. 123R, Share-Based Payment.  The adoption of this Statement had nomaterial impact on the Company’s financial statement as the Company waspreviously accounting for stock compensation under Statement of FinancialAccounting Standards No. 123.  BothStatements utilize the fair value method at grant date for stock compensationand expense such cost against additional paid-in capital in its ConsolidatedStatement of Financial Condition.

 

The Bank has two share-based compensationplans, which are described below.  Thecompensation cost that has been charged against income for those plans was$276,000, $341,000, $138,000, and $507,000 for the fiscal years ended December 31,2007 and December 31, 2006, the three months ended December 31, 2005and for the fiscal year ended September 30, 2005, respectively.  The total income tax benefit recognized inthe income statement for share-based compensation arrangements was $94,000,$70,000 $47,000, and $172,000 for the fiscal years ended December 31, 2007and December 31, 2006, the three months ended December 31, 2005, andfor the fiscal year ended September 30, 2005, 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 150,000of authorized but unissued shares of common stock at fair value at the date ofgrant.  As of December 31, 2007,88,910 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 onmanagement’s discretion.

 

The Bank accounts for the plans using afair value-based 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.

 

42

----

 

**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

**NOTE A -SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES** (continued)

 

15. Share-Based Compensation Plans (continued)

 
| ** **                   | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Expected  volatility         |       | 24.8       | %          | 17.3       | %          | 19.5       | %          |
|                         |       |       |       |       |       |       |       |
| Weighted average  volatility |       | 24.8       | %          | 17.3       | %          | 19.5       | %          |
|                         |       |       |       |       |       |       |       |
| Expected  dividends          |       | 3.0        | %          | 3.0        | %          | 3.0        | %          |
|                         |       |       |       |       |       |       |       |
| Expected term  (in years)    |       | 10         |       | 10         |       | 10         |       |
|                         |       |       |       |       |       |       |       |
| Risk-free rate               |       | 5.0        | %          | 5.2        | %          | 4.0        | %          |

 

A summary of the status of the Plan as ofand for the fiscal year ended December 31, 2007 is presented below:

 
| ** **                                                    | ** ** | ** **  | ** ** | **Weighted-Average**    | ** ** | **Weighted-Average**           | ** ** | **Aggregate**            | ** ** |
|---------------------------------------------------------------|------------|-------------|------------|-------------------------|------------|--------------------------------|------------|--------------------------|------------|
| ** **                                                    | ** ** | **Shares**  | ** ** | **Exercise Price** | ** ** | **Remaining Contractual** | ** ** | **Intrinsic Value** | ** ** |
| ** **                                                    | ** ** | ** **  | ** ** | ** **              | ** ** | **Term (in years)**  | ** ** | **($000)**               | ** ** |
| Outstanding at January 1, 2007                           |       | 228,723     |       | $                       | 18.63      |                           |       |                     |       |   |
| Granted                                                       |       | 43,722      |       | 16.34                   |       |                           |       |                     |       |
| Exercised                                                     |       | 520         |       | 14.00                   |       |                           |       |                     |       |
| Forfeited & expired                                  |       | 19,764      |       | 20.77                   |       |                           |       |                     |       |
|                                                          |       |        |       |                    |       |                           |       |                     |       |
| Outstanding at  December 31, 2007                        | ** ** | **252,161** | ** ** | **$**                   | **18.08**  | ** **                     | **6.46**   | ** **               | **$**      | **3** | ** ** |
|                                                          |       |        |       |                    |       |                           |       |                     |       |
| Options exercisable at December 31, 2007                 | ** ** | **142,317** | ** ** | **$**                   | **17.54**  | ** **                     | **4.85**   | ** **               | **$**      | **3** | ** ** |
|                                                          |       |        |       |                    |       |                           |       |                     |       |
| Weighted-average fair value of options granted  during period |       |        |       | **$**                   | **4.05**   |                           |       |                     |       |   |

 

The weighted-average grant-date fair value of options granted duringthe years ended December 31, 2007, December 31, 2006, and September 30,2005 was $4.05, $4.52, and $4.17, respectively. There were no options granted during the three-month period ended December 31,2005.  The total intrinsic value ofoptions exercised during the years ended December 31, 2007, December 31,2006 and September 30, 2005 was $1,000, $19,000 and $82,000,respectively.  There were no optionsexercised during the three months ended December 31, 2005.

 

43

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

**NOTE A -SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES** (continued)

 

15.  Share-Based Compensation Plans(continued)

 

The Company also has a 2001 ManagementRecognition Plan (“2001 MRP”) which provides for awards of up to 79,109 sharesof the Company’s common stock to members of the Board of Directors, managementand employees.  As of December 31,2007, 73,650 shares have been awarded, net of forfeitures, from the 2001 MRP tomembers of the Board of Directors, management and employees.  Common shares awarded to outside members ofthe Board of Directors were fully expensed when granted, while shares awardedto members of management and employees have vested or will vest over a fiveyear period beginning with the date of the award.  Shares awarded under the MRP are distributedfrom previously authorized but unissued shares.

 

In 2004, the stockholders approved a 2004Management Recognition Plan (“2004 MRP”) which provides for awards of anadditional 60,000 shares of the Company’s common stock to management andemployees.  As of December 31, 2007,3,568 shares have been awarded, net of forfeitures, from the 2004 MRP.  Total shares vested and distributed to recipientsthrough December 31, 2007 under both plans totaled 62,734 shares.

** **
| ** **                           | ** ** | ** ** | ** ** | **Weighted-Average** | ** ** |
|--------------------------------------|------------|------------|------------|----------------------|------------|
| ** **                           | ** ** | ** ** | ** ** | **Grant Date**  | ** ** |
| ** **                           | ** ** | **Shares** | ** ** | **Fair Value**  | ** ** |
|                                 |       |       |       |                 |       |
| Nonvested at  January 31, 2007  |       | 31,564     |       | $                    | 20.90      |   |
| Granted                              |       | —     |       | —               |       |
| Vested                               |       | 8,714      |       | 21.19                |       |
| Forfeited                            |       | 7,199      |       | 20.73                |       |
|                                 |       |       |       |                 |       |
| Nonvested at  December 31, 2007 | ** ** | **15,651** | ** ** | **$**                | **20.81**  | ** ** |

 

As of December 31,2007, there was $575,000 of total unrecognized compensation cost related to theshare-based compensation plans.  The costis expected to be recognized over a weighted-average period of 1.95 years.   The total fair value of shares vested duringthe years ended December 31, 2007, December 31, 2006, and September 30,2005 was $330,000, $268,000, and $267,000, respectively.   There were no shares vested during thethree-month period ended December 31, 2005.

 

44

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

**NOTE A -SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES** (continued)

 

16. Earnings Per Share

 

Diluted earnings pershare is computed taking into consideration common shares outstanding anddilutive potential common shares to be issued under the Company’s stock optionplan.  There is no adjustment to netearnings (loss) for the calculation of diluted earnings per share.  The computations were as follows:

 
| ** **                                            | ** ** | ** **                    | ** ** | ** **            | ** ** | **For Three Months** | ** ** | ** **    | ** ** |
|-------------------------------------------------------|------------|-------------------------------|------------|-----------------------|------------|--------------------------------|------------|---------------|------------|
| ** **                                            | ** ** | **For Years Ended** | ** ** | **Ended**             | ** ** | **For Year Ended**   | ** ** |
| ** **                                            | ** ** | **December 31,**         | ** ** | **December 31,** | ** ** | **September 30,**         | ** ** |
| ** **                                            | ** ** | **2007**                      | ** ** | **2006**              | ** ** | **2005**                       | ** ** | **2005**      | ** ** |
| ** **                                            | ** ** | ** **                    | ** ** | ** **            | ** ** | ** **                     | ** ** | ** **    | ** ** |
| Weighted-average  common shares outstanding (basic)   |       | 4,783,610                     |       | 4,591,802             |       | 4,358,840                      |       | 3,920,398     |       |
| Dilutive effect  of assumed exercise of stock options |       | —                        |       | —                |       | 27,257                         |       | 38,741        |       |
| Weighted-average  common shares outstanding (diluted) | ** ** | **4,783,610**                 | ** ** | **4,591,802**         | ** ** | **4,386,097**                  | ** ** | **3,959,139** | ** ** |

 

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, 2007 and 2006 due to the net loss recorded forthese periods.  Options to purchase46,417 and 48,746 shares of common stock and MRP awards of 13,543 and 14,486shares at a weighted-average price of $23.21 were outstanding at December 31,2005 and September 30, 2005, respectively, but were excluded from thecomputation of diluted earnings per share for the period because the exerciseprice was greater than the average market price of the common shares.

 

17.  Fair Value of Financial Instruments

 

SFAS No. 107, “Disclosures AboutFair Value of Financial Instruments,” requires disclosure of the fair value offinancial instruments, both assets and liabilities whether or not recognized inthe consolidated statement of financial condition, for which it is practicableto estimate that value.  For financialinstruments where quoted market prices are not available, fair values are basedon estimates using present value and other valuation methods.

 

The methods used are greatly affected bythe assumptions applied, including the discount rate and estimates of futurecash flows.  Therefore, the fair valuespresented may not represent amounts that could be realized in an exchange forcertain financial instruments.

 

The following methods and assumptionswere used by the Company in estimating its fair value disclosures for financialinstruments at December 31, 2007 and 2006:

 

Cash and cash equivalents: The carrying amounts presented in the consolidated statements offinancial condition for cash and cash equivalents are deemed to approximatefair value.

 

45

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

**NOTE A -SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES** (continued)

 

17.  Fair Value of Financial Instruments(continued)

 

Investment and mortgage-backed securities: For investment and mortgage-backed securities, fair value is deemed toequal the quoted market price.

 

Loans receivable:  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. The fair values for the resultant loan categories were computed viadiscounted cash flow analysis, using current interest rates offered for loanswith similar terms to borrowers of similar credit quality.  For consumer and other loans, fair valueswere deemed to equal the historic carrying values.  The historical carrying amount of accruedinterest on loans is deemed to approximate fair value.

 

Loans held for sale:  Loansoriginated and intended for sale in the secondary market are carried at thelower of cost or fair value.  When theBank decides to sell loans not previously classified as held for sale, suchloans are transferred into a held-for-sale classification, and the recordedloan values are adjusted to the lower of cost or fair value.

 

Federal Home Loan Bankstock:  The carrying amount presented in theconsolidated statements of financial condition is deemed to approximate fairvalue.

 

Deposits:  The fairvalue of checking accounts, savings accounts, money market demand and escrowdeposits is deemed to approximate the amount payable on demand.  Fair values for fixed-rate certificates ofdeposit have been estimated using a discounted cash flow calculation using theinterest rates currently offered 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.

 

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

 

Subordinated debentures:  The fairvalue of the Company’s subordinated debentures has been estimated usingdiscounted cash flow analysis, based on the interest rates currently offeredfor instruments of similar remaining maturities.

 

Commitments to extendcredit:  For fixed-rate and adjustable-rate loancommitments, the fair value estimate considers the difference between currentlevels of interest rates and committed rates. At December 31, 2007 and 2006, the difference between the fairvalue and notional amount of loan commitments was not material.

 

Accrued Interest:   The carrying amount presented in theconsolidated statements of financial condition is deemed to approximate fairvalue.

 

46

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

**NOTE A -SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES** (continued)

 

17. Fair Value of Financial Instruments (continued)

 

Based on the foregoing methods andassumptions, the carrying value and fair value of the Company’s financialinstruments at December 31 are as follows:

 
| ** **                                                     | ** ** | **2007**                | ** ** | **2006**  | ** ** |
|----------------------------------------------------------------|------------|-------------------------|------------|-----------|------------|
| ** **                                                     | ** ** | **Carrying**            | ** ** | **Fair**  | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| ** **                                                     | ** ** | **value**               | ** ** | **value** | ** ** | **value** | ** ** | **value** | ** ** |
| ** **                                                     | ** ** | **(In thousands)** | ** ** |
| Financial assets                                               |       |                    |       |      |       |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                                     |       | $                       | 86,614     |      | $          | 86,614 |   | $ | 57,459 |   | $ | 57,459 |   |
| Investment  securities                                         |       | 4,237                   |       | 4,237     |       | 4,230 |   | 4,230 |   |
| Mortgage-backed  securities                                    |       | 63,335                  |       | 63,335    |       | 52,669 |   | 52,669 |   |
| Loans receivable                                               |       | 634,421                 |       | 638,128   |       | 812,578 |   | 815,357 |   |
| Accrued interest  receivable                                   |       | 4,295                   |       | 4,295     |       | 5,461 |   | 5,461 |   |
| Federal Home  Loan Bank stock                                  |       | 14,024                  |       | 14,024    |       | 14,024 |   | 14,024 |   |
|                                                           |       |                    |       |      |       |   |   |   |   |
| Financial  liabilities                                         |       |                    |       |      |       |   |   |   |   |
| Deposits                                                       |       | $                       | 735,212    |      | $          | 740,184 |   | $ | 755,261 |   | $ | 753,745 |   |
| Advances from  the Federal Home Loan Bank and other borrowings |       | 77,628                  |       | 79,182    |       | 156,885 |   | 155,609 |   |
| Accrued interest  payable                                      |       | 382                     |       | 382       |       | 577 |   | 577 |   |
| Subordinated  debentures                                       |       | 15,464                  |       | 15,464    |       | 15,464 |   | 15,464 |   |

 

18.  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, 2007 and 2006.

 

19. 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.

 

20.  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, 2007 was $2.3 million.

 

21.  Reclassifications

 

Certain prior year amounts have beenreclassified to conform to the 2007 consolidated financial statementpresentation.

 

47

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

**NOTE A -SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES** (continued)

 

22.    Effects of Recent AccountingPronouncements

 

In March 2006, theFASB issued Statement of Financial Accounting Standards No. 156,Accounting for Servicing of Financial Assets: an amendment of FASB Statement No. 140(FAS 140 and FAS 156).  FAS 140establishes, among other things, the accounting for all separately recognizedservicing assets and servicing liabilities. This Statement amends FAS 140 to require that all separately recognizedservicing assets and servicing liabilities be initially measured at fair value,if practicable.  This Statement permits,but does not require, the subsequent measurement of separately recognizedservicing assets and servicing liabilities at fair value.  Under this Statement, an entity can electsubsequent fair value measurement to account for its separately recognizedservicing assets and servicing liabilities. Adoption of this Statement is required as of the beginning of the firstfiscal year that begins after September 15, 2006.  The Company’s adoption of FAS 156 effective January 1,2007 did not have a material impact on the financial position and results ofoperations of the Company.

 

In July 2006, theFASB issued FASB Interpretation No. 48, Accounting for Uncertainty inIncome Taxes – an interpretation of FASB Statement No. 109 (FIN 48), whichclarifies the accounting for uncertainty in tax positions.  This Interpretation requires that the Companyrecognize in the financial statements, the impact of a tax position, if thatposition is more likely than not of being sustained on audit, based on thetechnical merits of the position.  The adoption ofFIN 48 at the beginning of the 2007 fiscal year resulted in reclassification of$1.3 million in deferred tax liabilities and the establishment of a$1.1 million unrecognized tax liability related to federal income taxmatters, resulting in a $180,000 increase to the beginning balance of retainedearnings as of January 1, 2007. There was no impact on the results ofoperations of the Company. The unrecognized tax liability decreased $87,000during the twelve months ended December 31, 2007 based on a change in theposition taken by the Company. The Company has not accrued any interest andpenalties related to these uncertain tax positions. During 2007 the InternalRevenue Service (IRS) completed audits on the Company’s tax years ended December 31,2004 and 2005, while the year ending December 31, 2006 is currently opento audit under the statute of limitations. Various companies that the Bank hasacquired remain under the statute of limitations by the IRS for the yearsending December 31, 2004 through 2007.

 

In September 2006, the Emerging Issues Tax Force (EITF) reached aconsensus on Issue No. 06-4, Accounting for Deferred Compensation andPostretirement Benefit Aspects of Endorsement of Split-Dollar Life InsuranceArrangements. The consensus requires the recognition of a liability related tothe postretirement benefits covered by an endorsement split-dollar lifeinsurance arrangement. If the policy holder has agreed to maintain theinsurance policy in force for the employee’s benefit during his or herretirement, then the liability recognized during the employee’s active serviceperiod should be based on the future cost of insurance to be incurred duringthe employee’s retirement. Alternatively, if the policyholder has agreed to provide the employeewith a death benefit, then the liability for the future death benefit should berecognized by following the guidance in Statement 106 or Option 12, asappropriate. This approach requires the policyholder to gain a clearunderstanding of the benefit being provided by the policyholder to its employeegiven that it is this benefit that is being recognized as a liability. Thisconsensus is applicable in fiscal years beginning after December 15,2007.  The Company has determined thatthe adoption of Issue No. 06-4 will have an immaterial impact on thefinanacial position of the Company.

 

48

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

**NOTE A -SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES** (continued)

 

22.  Effects of Recent AccountingPronouncements  (continued)

 

In September 2006,the FASB issued Statement of Financial Accounting Standard No. 157, FairValue Measurement (FAS 157).  TheStatement enhances existing guidance for measuring assets and liabilities usingfair value.  Prior to the issuance ofthis Statement, guidance for applying fair value was incorporated in severalaccounting pronouncements.  FAS 157provides a single definition of fair value, together with a framework formeasuring it, and requires additional disclosure about the use of fair value tomeasure assets and liabilities.  TheStatement also emphasizes that fair value is a market-based measurement, not anentity-specific measurement, and sets out a fair value hierarchy with thehighest priority being quoted prices in active markets.  Under the Statement, fair value measurementsare disclosed by level within that hierarchy. While FAS 157 does not add any new fair value measurements, it doeschange current practice.  Changes topractice include: (1) a requirement for an entity to include its owncredit standing in the measurement of its liabilities; (2) a modificationof the transaction price presumption; (3) a prohibition on the use ofblock discounts when valuing large blocks of securities for broker-dealers andinvestment companies; and (4) a requirement to adjust the value ofrestricted stock for the effect of the restriction even if the restrictionlapses within one year.  This Statementis effective for financial statements issued for fiscal years beginning after November 15,2007, and interim period within those fiscal years.  The Company believes the impact of adoptingFAS 157 on its financial statements will be minimal.

 

In February 2007,the FASB issued Statement No. 159, The Fair Value Option for FinancialAssets and Financial Liabilities – Including an amendment of FASB Statement No. 115(“SFAS 159”).  SFAS 159 permits entitiesto choose to measure many financial instructions and certain other items atfair value.  Unrealized gains and losseson items for which the fair value option has been elected will be recognized inearnings at each subsequent reporting date. SFAS 159 is effective as of the beginning of an entity’s first fiscalyear that begins after November 15, 2007 and is not expected to have amaterial impact on the Company’s financial condition or results of operations.

 

In December 2007,the FASB issued Statement No. 141 (R) Business Combinations.  This Statement establishes principals andrequirements for how the acquirer of a business recognizes and measures in itsfinancial statements the identifiable assets acquired, the liabilities assumed,and any noncontrolling interest in the acquirer.  The Statement also provides guidance for recognizingand measuring the goodwill acquired in the business combination and determineswhat information to disclose to enable users of the financial statements toevaluate the nature and financial effects of the business combination.  The guidance will become effective as of thebeginning of a company’s fiscal year beginning after December 15,2008.  Early adoption is prohibited.

 

In December 2007,the FASB issued Statement No. 160, Noncontrolling Interests inConsolidated Financial Statements – an amendment of ARB No. 51.  This Statement amends ARB No. 51 toestablish accounting and reporting standards for the noncontrolling interest ina subsidiary and for the deconsolidation of a subsidiary.  It clarifies that a noncontrolling interestin a subsidiary is an ownership interest in the consolidated entity and isreported as equity in the consolidated financial statements.  This Statement applies to all for profitentities that prepare consolidated financial statements, but affects only thoseentities that have an outstanding noncontrolling interest in subsidiaries orthat deconsolidate a subsidiary.  Sincethe Company has no noncontrolling interests in subsidiaries, the impact ofadopting SFAS No. 160 on January 1, 2009 is not anticipated to have amaterial impact on the Company’s financial statements.

 

49

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

**NOTE B -INVESTMENTS AND MORTGAGE-BACKED SECURITIES**

 

The amortized cost, gross unrealizedgains, gross unrealized losses and estimated fair values of securities at December 31,2007 and 2006, are summarized as follows:

 
| ** **                        | ** ** | **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** |   |

** **
| ** **                        | ** ** | **2006**                | ** ** |
|-----------------------------------|------------|-------------------------|------------|
| ** **                        | ** ** | ** **              | ** ** | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                        | ** ** | **Amortized**           | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                        | ** ** | **Cost**                | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| ** **                        | ** ** | **(In thousands)** | ** ** |
| Available for sale:     |       |                    |       |   |   |   |   |   |   |
|                              |       |                    |       |   |   |   |   |   |   |
| US Government  agency obligations |       | $                       | 1,966      |   | $ | 11 |   | $ | 12 |   | $ | 1,965 |   |
| Municipal  securities             |       | 1,114                   |       | 11 |   | 14 |   | 1,111 |   |
| Mutual funds                      |       | 1,199                   |       | — |   | 53 |   | 1,146 |   |
| Mortgage-backed  securities       |       | 52,818                  |       | 134 |   | 283 |   | 52,669 |   |
| Other securities                  |       | 7                       |       | 1 |   | — |   | 8 |   |
| ** **                        | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |   |
| ** **                        | ** ** | **$**                   | **57,104** | ** ** | **$** | **157** | ** ** | **$** | **362** | ** ** | **$** | **56,899** |   |

 

Theamortized cost and fair value of available-for-sale securities at December 31,2007, by contractual maturity, are shown below. There were no held-to-maturity securities at December 31,2007.  Expected maturities will differfrom contractual maturities because issuers may have the right to call orprepay obligations with or without call or prepayment penalties.

 
| ** **                  | ** ** | **Available-for-sale**  | ** ** |
|-----------------------------|------------|-------------------------|------------|
| ** **                  | ** ** | **Amortized**           | ** ** | **Fair** | ** ** |
| ** **                  | ** ** | **Cost**                | ** ** | **Value** | ** ** |
| ** **                  | ** ** | **(In Thousands)** | ** ** |
|                        |       |                    |       |   |   |
| Within one year             |       | $                       | 24         |   | $ | 23 |   |
| One to five  years          |       | 1,131                   |       | 1,150 |   |
| Five to ten  years          |       | 627                     |       | 638 |   |
| After ten years             |       | 1,219                   |       | 1,216 |   |
|                        |       | 3,001                   |       | 3,027 |   |
|                        |       |                    |       |   |   |
| Mortgage-backed  securities |       | 63,258                  |       | 63,335 |   |
| Mutual funds                |       | 1,251                   |       | 1,210 |   |
|                        |       |                    |       |   |   |
| Totals                      |       | $                       | 67,510     |   | $ | 67,572 |   |

 

50

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

**NOTE B -INVESTMENTS AND MORTGAGE-BACKED SECURITIES** (continued)

 

Proceeds fromthe sale of investment securities during fiscal year 2007 amounted to $61,000,with gains of $53,000 and a related tax effect of $18,000.  In conjunction with the purchase ofMercantile in June 2006, the Company acquired $7.4 million in investmentsecurities which were designated as available for sale.  Proceeds from the sale of investmentsecurities during fiscal year 2006 amounted to $1.6 million, with gross gainsof $126,000 and gross losses of $26,000, for a net realized gain totaling$100,000 and a related tax effect of $34,000. During the three-month period ended December 31, 2005, the Banksold $108.9 million in investment securities and recorded gross losses of $1.4million and a related tax effect of $478,000. During the year ended September 30, 2005, the Bank sold $41.9million of investment securities with gross gains of $741,000 and a related taxeffect of $252,000.

 

At December 31, 2007, People’s had$10.0 million of mortgage-backed securities pledged to secure public depositsand $13.1 million of mortgage-backed securities pledged to secure advances fromthe Federal Home Loan Bank.  At December 31,2006, People’s had $10.7 million of mortgage-backed securities pledged tosecure public deposits, and $35.7 million of mortgage-backed securities pledgedto secure advances from the Federal 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 these investmentsat December 31, 2007 and 2006, was $20.6 million and $31.1 million, respectively,which approximated 30.4% and 54.8% of the Company’s investment portfolio.  These declines primarily resulted from recentincreases in market rates.  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 thesesecurities become other than temporary, the cost basis of the investment willbe reduced and the resulting loss recognized in net earnings in the period inwhich the other-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, 2007 and 2006.

 
| ** **                             | ** ** | **2007**                               | ** ** |
|----------------------------------------|------------|----------------------------------------|------------|
| ** **                             | ** ** | **Less than 12 months** | ** ** | **12 Months or Longer** | ** ** | **Total** | ** ** |
| **Description**                        | ** ** | **Number of**                     | ** ** | **Fair** | ** ** | **Unrealized** | ** ** | **Number of** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| **of Securities**                 | ** ** | **Investments**                        | ** ** | **Value** | ** ** | **Losses** | ** ** | **Investments** | ** ** | **Value** | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
| ** **                             |       | **(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** |   |

 

51

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

**NOTE B -INVESTMENTS AND MORTGAGE-BACKED SECURITIES** (continued)

 
| ** **                             | ** ** | **2006**                               | ** ** |
|----------------------------------------|------------|----------------------------------------|------------|
| ** **                             | ** ** | **Less than 12 months** | ** ** | **12 Months or Longer** | ** ** | **Total** | ** ** |
| **Description**                        | ** ** | **Number of**                     | ** ** | **Fair** | ** ** | **Unrealized** | ** ** | **Number of** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| **of Securities**                 | ** ** | **Investments**                        | ** ** | **Value** | ** ** | **Losses** | ** ** | **Investments** | ** ** | **Value** | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
| **(In  Thousands)**                    |       |
|                                   |       |                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| US Government agency  obligations      |       | —                                 |       | $ | — |   | $ | — |   | 2 |   | $ | 980 |   | $ | 12 |   | $ | 980 |   | $ | 12 |   |
| Municipal  securities                  |       | —                                 |       | — |   | — |   | 3 |   | 423 |   | 14 |   | 423 |   | 14 |   |
| Mutual funds                           |       | —                                 |       | — |   | — |   | 2 |   | 1,146 |   | 53 |   | 1,146 |   | 53 |   |
| Mortgage-backed  securities            |       | 3                                      |       | 592 |   | 1 |   | 7 |   | 27,971 |   | 282 |   | 28,563 |   | 283 |   |
|                                   |
|                                   |       |                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  temporarily impaired securities | ** ** | **3**                                  | ** ** | **$** | **592** | ** ** | **$** | **1** | ** ** | **14** | ** ** | **$** | **30,520** | ** ** | **$** | **361** | ** ** | **$** | **31,112** | ** ** | **$** | **362** |   |

 

On January 24,2008, the Bank sold approximately $28.9 million in mortgage-backed securitiesdue to the favorable market conditions. In conjunction with the sale, the Bank recorded a $483,000 gain on saleand a related tax effect of approximately $164,000.

 

**NOTE C -LOANS RECEIVABLE**

 

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

 
| ** **                               | ** ** | **2007**                | ** **  | **2006**   | ** ** |
|------------------------------------------|------------|-------------------------|-------------|------------|------------|
| ** **                               | ** ** | **(In thousands)** | ** **  |
| ** **                               | ** ** | ** **              | ** **  |
| Residential real  estate                 |       |                    |        |       |       |
| One-to  four-family                      |       | $                       | 311,968     |       | $          | 343,346 |   |
| Multifamily                              |       | 82,176                  |        | 122,221    |       |
| Construction                             |       | 131,777                 |        | 104,764    |       |
| Nonresidential  real estate and land     |       | 128,955                 |        | 140,909    |       |
| Nonresidential  real estate construction |       | 12,394                  |        | 130,066    |       |
| Commercial                               |       | 20,012                  |        | 30,933     |       |
| Consumer and  other                      |       | 16,758                  |        | 23,022     |       |
| Total loans  receivable                  |       | 704,040                 |        | 895,261    |       |
|                                     |       |                    |        |       |       |
| Less:                                    |       |                    |        |       |       |
| Undisbursed  portion of loans in process |       | 33,661                  |        | 62,042     |       |
| Deferred loan  origination fees          |       | 1,459                   |        | 2,272      |       |
| Allowance for  loan losses               |       | 34,499                  |        | 18,369     |       |
|                                     | ** ** | ** **              | ** **  | ** ** | ** ** |
| Loans receivable  – net             | ** ** | **$**                   | **634,421** | ** ** | **$**      | **812,578** | ** ** |

 

52

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

**NOTE C -LOANS RECEIVABLE**(continued)

 

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 $725,000and $886,000 at December 31, 2007 and 2006, respectively.  During the fiscal year ended December 31,2007, there was one loan renewed to executive officers and directors for$200,000.  During the fiscal year ended December 31,2006, there was one loan originated to executive officers and directors for$275,000.   During the fiscal years endedDecember 31, 2007 and December 31, 2006, principal repayments ofapproximately $361,000 and $92,000, respectively, were received from executiveofficers and directors

 

**NOTE D -ALLOWANCE FOR LOAN LOSSES**

 

The activity in theallowance for loan losses is summarized as follows the fiscal years ended December 31,2007 and 2006, the three-month period ended December 31, 2005 and thefiscal year ended September 30, 2005:

 
| ** **                                 | ** ** | ** **                    | ** ** | ** **            | ** ** | **For Three Months** | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|-------------------------------|------------|-----------------------|------------|--------------------------------|------------|------------|------------|
| ** **                                 | ** ** | **For Years Ended** | ** ** | **Ended**             | ** ** | **For Year Ended**   | ** ** |
| ** **                                 | ** ** | **December 31,**         | ** ** | **December 31,** | ** ** | **September 30,**         | ** ** |
| ** **                                 | ** ** | **2007**                      | ** ** | **2006**              | ** ** | **2005**                       | ** ** | **2005**   | ** ** |
| ** **                                 | ** ** | **(In thousands)**       | ** ** |
| Balance at  beginning of period            |       | $                             | 18,369     |                  | $          | 13,444                         |       | $          | 13,697     |   | $ | 11,025 |   |
| Increase from  Peoples Federal acquisition |       | —                        |       | —                |       | 907                            |       | —     |       |
| Increase from  Mercantile acquisition      |       | —                        |       | 302                   |       | —                         |       | —     |       |
| Provision for  losses on loans             |       | 32,800                        |       | 17,450                |       | 900                            |       | 3,600      |       |
| Charge-off of  loans                       |       | (18,284                       | )          | (13,103               | )          | (2,206                         | )          | (1,081     | )          |
| Recoveries                                 |       | 1,614                         |       | 276                   |       | 146                            |       | 153        |       |
|                                       | ** ** | ** **                    | ** ** | ** **            | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Balance at end  of period                  | ** ** | **$**                         | **34,499** | ** **            | **$**      | **18,369**                     | ** ** | **$**      | **13,444** | ** ** | **$** | **13,697** | ** ** |

 

At December 31,2007, December 31, 2006, December 31, 2005, and September 30,2005 non-accruing loans amounted to $25.3 million, $24.1 million, $18.8million, and $19.4 million, respectively. At December 31, 2007, loans greater than 90 days delinquent andstill accruing totaled $613,000 and were deemed to be in process of collectionof both principal and interest.  At December 31,2006 loans greater than 90 days delinquent and still accruing totaled $1.7million and were deemed to be in process of collection of both principal andinterest. There were no loans greater than 90 days delinquent and stillaccruing at December 31, 2005. Interest income which would have been recognized if such non-accruingloans had performed pursuant to contractual terms totaled approximately $1.8million, $1.4 million, $161,000, and $1.1 million for the fiscal years ended December 31,2007 and 2006, the three-month period ended December 31, 2005 and thefiscal year ended September 30, 2005, respectively.

 

53

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

**NOTE D -ALLOWANCE FOR LOAN LOSSES**(continued)

 

Information with respect to the Bank’simpaired loans at and for the years ended December 31, 2007 and 2006 is asfollows:

 
| ** **                                                    | ** ** | **2007**                | ** ** | **2006**   | ** ** |
|---------------------------------------------------------------|------------|-------------------------|------------|------------|------------|
| ** **                                                    | ** ** | **(In thousands)** | ** ** |
|                                                          |       |                    |       |       |       |
| Impaired loans  with related allowance                        |       | $                       | 23,368     |       | $          | 15,327 |   |
| Impaired loans  with no related allowance                     |       | —                  |       | 5,201      |       |
| Total impaired  loans                                         | ** ** | **$**                   | **23,368** | ** ** | **$**      | **20,528** | ** ** |
| Allowance for  losses on impaired loans                       | ** ** | **$**                   | **5,777**  | ** ** | **$**      | **2,115** | ** ** |
|                                                          | ** ** | ** **              | ** ** | ** ** | ** ** |
| Average recorded  investment in impaired loans                | ** ** | **$**                   | **16,530** | ** ** | **$**      | **16,297** | ** ** |
|                                                          | ** ** | ** **              | ** ** | ** ** | ** ** |
| Interest income  recognized on impaired loans                 | ** ** | **$**                   | **913**    | ** ** | **$**      | **861** | ** ** |
|                                                          | ** ** | ** **              | ** ** | ** ** | ** ** |
| Interest income  recognized on a cash basis on impaired loans | ** ** | **$**                   | **910**    | ** ** | **$**      | **847** | ** ** |

 
| The allowance for impaired loans is included in the  Bank’s overall allowance for loan losses. |   |   |
|-----------------------------------------------------------------------------------------------------|--------|--------|

** **

**NOTE E -OFFICE PREMISES AND EQUIPMENT**

 

Office premises and equipment arecomprised of the following at December 31:

 
| ** **                         | ** ** | **2007**                | ** ** | **2006**   | ** ** |
|------------------------------------|------------|-------------------------|------------|------------|------------|
| ** **                         | ** ** | **(In thousands)** | ** ** |
|                               |       |                    |       |       |       |
| Land and  improvements             |       | $                       | 9,862      |       | $          | 9,855 |   |
| Office buildings  and improvements |       | 17,991                  |       | 15,323     |       |
| Construction in  progress          |       | 586                     |       | 1,957      |       |
| Furniture,  fixtures and equipment |       | 6,883                   |       | 6,414      |       |
|                               |       | 35,322                  |       | 33,549     |       |
|                               |       |                    |       |       |       |
| Less accumulated  depreciation     |       | 7,017                   |       | 5,670      |       |
| ** **                         | ** ** | ** **              |       | ** ** |       |
| ** **                         | ** ** | **$**                   | **28,305** |       | **$**      | **27,879** |   |

 

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 fiscal year 2007 wasapproximately $76,000.

 

54

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

**NOTE F -DEPOSITS**

 

Deposits consist of the following majorclassifications at December 31:

 
| ** **                                       | ** ** | **2007**                | ** **  | **2006**   | ** ** |
|--------------------------------------------------|------------|-------------------------|-------------|------------|------------|
| ** **                                       | ** ** | **(In thousands)** | ** **  |
|                                             |       |                    |        |       |       |
| Non-interest  bearing checking accounts          |       | $                       | 21,936      |       | $          | 21,967 |   |
| Checking  accounts                               |       | 50,686                  |        | 55,114     |       |
| Savings accounts                                 |       | 131,728                 |        | 158,025    |       |
| Money market  demand deposit                     |       | 19,065                  |        | 20,863     |       |
| Total demand,  transaction and passbook deposits |       | 223,415                 |        | 255,969    |       |
|                                             |       |                    |        |       |       |
| Certificates of  deposit:                        |       |                    |        |       |       |
| Original  maturities of:                         |       |                    |        |       |       |
| Less than 12  months                             |       | 272,986                 |        | 227,290    |       |
| 12 months to 36  months                          |       | 85,174                  |        | 99,998     |       |
| More than 36  months                             |       | 66,676                  |        | 83,507     |       |
| Individual  retirement accounts                  |       | 86,961                  |        | 88,497     |       |
|                                             |       |                    |        |       |       |
| Total  certificates of deposit                   |       | 511,797                 |        | 499,292    |       |
|                                             |       |                    |        |       |       |
| Total deposits                                   | ** ** | **$**                   | **735,212** | ** ** | **$**      | **755,261** | ** ** |

 

AtDecember 31, 2007 and 2006, Peoples had certificate of deposit accountswith balances greater than $100,000 totaling $152.4 million and $131.9 million,respectively.

 

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

 
| ** **           | ** ** | **2007**            | ** **  |
|----------------------|------------|---------------------|-------------|
|                 |       | **(In  thousands)** |        |
|                 |       |                |        |
| One year or less     |       | $                   | 406,005     |   |
| One to two years     |       | 44,377              |        |
| Two to three  years  |       | 33,488              |        |
| Three to four  years |       | 15,111              |        |
| Four to five  years  |       | 12,814              |        |
| Five to six  years   |       | 2                   |        |
| ** **           |       | ** **          |        |
| ** **           |       | **$**               | **511,797** | ** ** |

 

55

----

 

**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

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

 

Advances from theFederal Home Loan Bank, collateralized at December 31, 2007 by pledges ofcertain residential mortgage loans totaling $283.7 million, certain mortgagebacked securities totaling $13.1 million, and Peoples’ investment in FederalHome Loan Bank stock, are summarized as follows:

 
| ** **                     | ** ** | **Maturing Fiscal**     | ** ** | ** **                           | ** ** |
|--------------------------------|------------|------------------------------|------------|--------------------------------------|------------|
| **Interest Rate**         | ** ** | **Year Ending in** | ** ** | **(Dollars in thousands)** | ** ** |
| ** **                     | ** ** | ** **                   | ** ** | ** **                           | ** ** |
| 4.30%                          |       | 2008                         |       | $                                    | 1,997      |   |
| 3.73%                          |       | 2009                         |       | 2,938                                |       |
| 7.65%                          |       | 2011                         |       | 2                                    |       |
| 4.53%                          |       | 2012                         |       | 1,962                                |       |
| 4.78%                          |       | 2015                         |       | 1,959                                |       |
| 4.07%                          |       | 2016                         |       | 25,000                               |       |
| 3.45%                          |       | 2017                         |       | 25,000                               |       |
| 5.60%                          |       | 2018                         |       | 66                                   |       |
| 5.60% - 6.61%                  |       | 2019                         |       | 2,204                                |       |
| ** **                     |       |                         |       | ** **                           |       |
| ** **                     |       |                         |       | **$**                                | 61,128     |   |
| ** **                     |       |                         |       | ** **                           |       |
| Weighted-average interest rate | ** ** | ** **                   |       | 3.91                                 | %          |

 

**NOTE H -OTHER BORROWED MONEY**

 

The Company has a $17.5million line of credit with another financial institution, with interestpayable at daily LIBOR plus 200 basis points or prime less 50 basis pointsbased on the selection made by the Company. The Company had a balance of $16.5 million at December 31, 2007 ata rate of 7.24%.  This line of creditexpires in the second quarter of fiscal 2008. The loan is secured by the outstanding shares of the Bank.  The loan agreement contains certain financialcovenants which, if not complied with, could allow the lender to acceleraterepayment of the loan.   As of December 31,2007, the Company was not in compliance with one of the loan covenants andthe lender has the ability to accelerate all outstanding amounts upon noticeand the passage of 30 days. The Company is currently negotiating with thelender regarding a waiver of default, and a modification and/or extension ofthe line of credit.

 

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

 

Infiscal 2002, a Delaware trust owned by the Company (the “Trust I”), issued$12.5 million of mandatorily redeemable debt securities.  The debt securities issued by the Trust Iwere included in the Company’s regulatory capital, specifically as a componentof Tier I capital.  The subordinateddebentures were the sole assets of the Trust I, and the Company owned all ofthe common securities of the Trust I. Interest payments on the debt securities were made semi-annually at anannual variable interest rate equal to the six-month LIBOR rate plus 375 basispoints, or equal to 8.42% at December 31, 2005 and were reported as acomponent of interest expense on borrowings. Theses subordinated debentures were redeemed in December 2006 withno penalty.  The funds to redeem thedebentures were obtained through an advance on the Company’s line of credit withanother financial institution.

 

56

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

**NOTEI - GUARANTEED PREFFERED BENEFICIAL INTERESTS IN JUNIOR SUBORDINATED DEBENTURES **(continued)

 

In June 2005, the Company formed a second wholly owned trust (the “TrustII”), which issued $15.0 million of mandatorily redeemable debt securities.These debt securities are included as a component of Tier I capital forregulatory capital purposes.  Thesubordinated debentures are the sole assets of the Trust II, and the Companyowns all of the common securities of the Trust II.  Interest payments on the debt securities aremade quarterly at an annual variable interest rate equal to the three-monthLIBOR rate plus 175 basis points, or equal to 7.11% at December 31, 2006and 6.74% at December 31, 2007, and are reported as a component ofinterest expense on borrowings.   The netproceeds received by the Company from the sale of the debt securities were usedfor general 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 to financialinstruments with off-balance-sheet risk in the normal course of business tomeet the financing needs of its customers, including commitments to extendcredit.  Such commitments involve, tovarying 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 to credit loss in theevent of nonperformance by the other party to the financial instrument forcommitments to extend credit is represented by the contractual notional amountof those instruments.  Peoples uses thesame credit policies in making commitments and conditional obligations as thoseutilized for on-balance-sheet instruments.

 

At December 31, 2007, Peoples hadcommitments to originate fixed rate loans totaling $143,000. Additionally,Peoples had adjustable-rate commitments for unused lines of credit under homeequity loans totaling $29.0 million, adjustable-rate commitments for unusedcommercial lines of credit totaling $2.4 million, and fixed-rate commitmentsfor unused consumer overdraft protection lines totaling $537,000.  Management believes that such loan commitmentsare able to be funded through normal cash flow from operations.  Additionally, Peoples had standby letters ofcredit for customers totaling $5.9 million at December 31, 2007.  From time to time balances with correspondentbanks may exceed the FDIC $100,000 insurable limit.

 

At December 31, 2006, Peoples hadcommitments to originate loans totaling $5.0 million of which $716,000 werefixed rate and $4.3 million were adjustable rate. Additionally, Peoples hadadjustable-rate commitments for unused lines of credit under home equity loanstotaling $25.2 million, adjustable-rate commitments for unused commercial linesof credit totaling $5.1 million, and fixed-rate commitments for unused consumeroverdraft protection lines totaling $504,000. Additionally, Peoples had fixed-rate standby letters of credit forcustomers totaling $5.8 million at December 31, 2006.

 

57

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

**NOTE J —COMMITMENTS** (continued)

 

Commitments to extend credit areagreements to lend to a customer as long as there is no violation of anycondition 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 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 of the counterparty. Collateral on loans may vary but the preponderance of loans grantedgenerally include a mortgage interest in real estate as security.

 

Peoples hasalso entered into lease agreements for office premises under operating leaseswhich expire at various dates through 2013. Rent expense totaled $68,000,$128,000, $16,000 and $37,000 for the fiscal years ended December 31, 2007and 2006, the three-month period ended December 31, 2005 and the fiscalyear ended September 30, 2005, respectively. The following tablesummarizes minimum payments due under lease agreements by year.

 
| **Year ending**  | ** ** | ** **                           | ** ** |
|-----------------------|------------|--------------------------------------|------------|
| **December 31,** | ** ** | **(Dollars in thousands)** | ** ** |
|                  |       |                                 |       |
| 2008                  |       | $                                    | 38         |   |
| 2009                  |       | 38                                   |       |
| 2010                  |       | 38                                   |       |
| 2011                  |       | 38                                   |       |
| 2012                  |       | 38                                   |       |
| 2013                  |       | 6                                    |       |
|                  |       |                                 |       |
| ** **            |       | **$**                                | **196**    |   |

** **

**NOTE K -FEDERAL INCOME TAXES**

 

Federal income taxes differ from theamounts computed at the statutory corporate tax rate for the fiscal years endedDecember 31, 2007 and 2006, the three-month period ended December 31,2005 and fiscal year ended September 30, 2005 as follows:

 
| ** **                                                  | ** ** | ** **              | ** ** | ** **            | ** ** | **For Three Months** | ** ** | ** ** | ** ** |
|-------------------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|--------------------------------|------------|------------|------------|
| ** **                                                  | ** ** | **Years Ended**    | ** ** | **Ended**             | ** ** | **For Year Ended**   | ** ** |
| ** **                                                  | ** ** | **December 31,**   | ** ** | **December 31,** | ** ** | **September 30,**         | ** ** |
| ** **                                                  | ** ** | **2007**                | ** ** | **2006**              | ** ** | **2005**                       | ** ** | **2005**   | ** ** |
| ** **                                                  | ** ** | **(In thousands)** | ** ** |
|                                                        |       |                    |       |                  |       |                           |       |       |       |
| Federal income  taxes at statutory rate                     |       | $                       | (13,010    | )                     | $          | (2,165                         | )          | $          | 18         |   | $ | 1,439 |   |
| Increase  (decrease)in taxes resulting from:                |       |                    |       |                  |       |                           |       |       |       |
| Goodwill  impairment                                        |       | 3,875                   |       | —                |       | —                         |       | —     |       |
| Bank owned life  insurance undistributed earnings           |       | (244                    | )          | (233                  | )          | (55                            | )          | (54        | )          |
| Tax exempt  interest on municipal securities                |       | (15                     | )          | (15                   | )          | (4                             | )          | (5         | )          |
| Valuation  allowance                                        |       | (4,400                  | )          | —                |       | —                         |       | —     |       |
| Other                                                       |       | 61                      |       | 105                   |       | 7                              |       | (5         | )          |
|                                                        |       |                    |       |                  |       |                           |       |       |       |
| Federal income  taxes per consolidated financial statements |       | $                       | (4,933     | )                     | $          | (2,308                         | )          | $          | (34        | ) | $ | 1,375 |   |
|                                                        | ** ** | ** **              | ** ** | ** **            | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Effective tax  rate                                         | ** ** | **n/a**                 | ** ** | **n/a**               | ** ** | **n/a**                        | ** ** | **32.4**   | **%**      |

 

58

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

**NOTE K -FEDERAL INCOME TAXES**(continued)

 

The composition of the Company’s net deferred tax asset at December 31is as follows:

 
| ** **                                                         | ** ** | **2007**                | ** ** | **2006**   | ** ** |
|--------------------------------------------------------------------|------------|-------------------------|------------|------------|------------|
| ** **                                                         | ** ** | **(In thousands)** | ** ** |
| Taxes (payable)  refundable on temporary                           |       |                    |       |       |       |
| differences at  estimated corporate tax rate:                      |       |                    |       |       |       |
| Deferred tax  assets:                                              |       |                    |       |       |       |
| General loan  loss allowance                                       |       | $                       | 11,730     |       | $          | 6,245 |   |
| Deferred  compensation                                             |       | 576                     |       | 476        |       |
| Charitable  contributions                                          |       | 60                      |       | 37         |       |
| Stock benefit  plans                                               |       | 32                      |       | 252        |       |
| Deferred loan  origination fees                                    |       | 496                     |       | 772        |       |
| Net operating loss  carryforwards                                  |       | 3,859                   |       | 1,188      |       |
| Nonaccrual  interest                                               |       | 190                     |       | 293        |       |
| Unrealized  losses on securities designated as available for sale  |       | —                  |       | 70         |       |
| Other                                                              |       | 962                     |       | —     |       |
| Total deferred  tax assets                                         |       | 17,905                  |       | 9,333      |       |
| Deferred tax  liabilities:                                         |       |                    |       |       |       |
| Federal Home Loan  Bank stock dividends                            |       | (1,919                  | )          | (1,919     | )          |
| Unrealized  losses on securities designated as available for sale  |       | (21                     | )          | —     |       |
| Book/tax  depreciation differences                                 |       | (113                    | )          | (398       | )          |
| Mortgage  servicing rights                                         |       | (224                    | )          | (281       | )          |
| Core deposit  intangible and other purchase accounting adjustments |       | (2,199                  | )          | (3,255     | )          |
| Other                                                              |       | (213                    | )          | _(345      | )          |
| Total deferred  tax liabilities                                    |       | (4,689                  | )          | (6,198     | )          |
| Valuation  allowance                                               |       | (4,400                  | )          | —     |       |
| Net deferred tax  asset                                            | ** ** | **$**                   | **8,816**  | ** ** | **$**      | **3,135** | ** ** |

 

During 2007, the Company recorded a valuation allowance of $4.4 millionbased principally on uncertainty about the Company’s ability to generatesufficient future taxable income to realize all of the related temporarydifferences.  The Company believes thatit will realize the remaining net deferred tax assets through taxable incomeresulting from the planned profitable sale of branches of the Bank within thenext twelve months.  The expense forrecording the valuation allowance is a non-cash item, and the recording of thisexpense does not imply that the Company owes additional income taxes.  Management will continue to review the taxcriteria related to the recognition of deferred tax assets.

 

As of December 31, 2007, the Company had approximately $11.4million of net operating loss carry forward available to offset future federaltaxable income.  The net operating losscarry forward expires in 2025.

 

59

----

 

**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

**NOTE K -FEDERAL INCOME TAXES**(continued)

 

Prior to fiscal 1997, Peoples was alloweda special bad debt deduction based on a percentage of earnings, generallylimited to 8% of otherwise taxable income and subject to certain limitationsbased on aggregate loans and savings account balances at the end of theyear.  This deduction totaledapproximately $4.9 million as of December 31, 2007.  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 to various regulatorycapital requirements administered by the federal banking agencies.  Failure to meet minimum capital requirementscan initiate certain mandatory – and possibly additional discretionary –actions by regulators that, if undertaken, could have a direct material effecton the Bank’s financial statements.  Under capital adequacy guidelines and the regulatory framework forprompt corrective action, the Bank must meet specific capital guidelines thatinvolve quantitative measures of the bank’s assets, liabilities, and certainoff-balance sheet items as calculated under regulatory accountingpractices.  The Bank’s capital amountsand classification are also subject to qualitative judgments by the regulatorsabout components, risk weightings, and other factors.

 

Quantitative measuresestablished by regulation to ensure capital adequacy require the Bank tomaintain minimum amounts and ratios (set forth in the table below) of total andTier 1 capital (as defined in the regulation) to risk-weighted assets (asdefined), and of Tier 1 capital (as defined) to adjusted total assets (asdefined).  During fiscal 2007, the Bankwas notified by the OTS that it was categorized as “well-capitalized” under theregulatory framework for prompt corrective action.  To be categorized as “well-capitalized” theBank must maintain minimum capital ratios as set forth in the followingtables.  There are no conditions orevents since that notification that management believes have changed the Bank’scategory.

 

Peoples Community Bancorp, as a savingsinstitution holding company at December 31, 2007 and 2006, is not subjectto regulatory capital requirements separate from those of the Bank.

 
| ** **                           | ** ** | **As of December 31, 2007** | ** ** |
|--------------------------------------|------------|-------------------------------------------------|------------|
| ** **                           | ** ** | ** **                                      | ** ** | ** ** | ** ** | **Adequately** | ** ** | **Well** | ** ** |
| ** **                           | ** ** | **Actual**                                      | ** ** | **Capitalized** | ** ** | **Capitalized** | ** ** |
| **Peoples Community Bank** | ** ** | **Amount**                                      | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| ** **                           | ** ** | **(Dollars in thousands)**            | ** ** |
| **Total  Capital**                   |       |                                            |       |   |   |   |   |   |   |   |   |   |   |
| **(to  Risk Weighted Assets):**      |       | $                                               | 68,335     |   | 11.4 | % | 3$48,102 |   | 38.0 | % | 3$60,127 |   | 310.0 | % |
| ** **                           |       |                                            |       |   |   |   |   |   |   |   |   |   |   |
| **Tier 1  Capital**                  |       |                                            |       |   |   |   |   |   |   |   |   |   |   |
| **(to  Risk-Weighted Assets):**      |       | $                                               | 60,486     |   | 10.1 | % | 3$24,051 |   | 34.0 | % | 3$36,076 |   | 3  6.0 | % |
| ** **                           |       |                                            |       |   |   |   |   |   |   |   |   |   |   |
| **Tier 1  Capital**                  |       |                                            |       |   |   |   |   |   |   |   |   |   |   |
| **(to  Adjusted Total Assets):**     |       | $                                               | 60,486     |   | 7.0 | % | 3$34,500 |   | 34.0 | % | 3$43,125 |   | 3  5.0 | % |

 

60

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

**NOTE L -CAPITAL REQUIREMENTS AND REGULATORY MATTERS**(continued)

 

 
| ** **                           | ** ** | **As of December 31, 2006** | ** ** |
|--------------------------------------|------------|-------------------------------------------------|------------|
| ** **                           | ** ** | ** **                                      | ** ** | ** ** | ** ** | **Adequately** | ** ** | **Well** | ** ** |
| ** **                           | ** ** | **Actual**                                      | ** ** | **Capitalized** | ** ** | **Capitalized** | ** ** |
| **Peoples Community Bank** | ** ** | **Amount**                                      | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| ** **                           | ** ** | **(Dollars in thousands)**            | ** ** |
| **Total  Capital**                   |       |                                            |       |   |   |   |   |   |   |   |   |   |   |
| **(to  Risk Weighted Assets):**      |       | $                                               | 94,390     |   | 12.6 | % | 3$59,983 |   | 38.0 | % | 3$74,979 |   | 310.0 | % |
| ** **                           |       |                                            |       |   |   |   |   |   |   |   |   |   |   |
| **Tier 1  Capital**                  |       |                                            |       |   |   |   |   |   |   |   |   |   |   |
| **(to  Risk-Weighted Assets):**      |       | $                                               | 84,906     |   | 11.3 | % | 3$29,991 |   | 34.0 | % | 3$44,987 |   | 3  6.0 | % |
| ** **                           |       |                                            |       |   |   |   |   |   |   |   |   |   |   |
| **Tier 1  Capital**                  |       |                                            |       |   |   |   |   |   |   |   |   |   |   |
| **(to Adjusted  Total Assets):**     |       | $                                               | 84,906     |   | 8.5 | % | 3$39,949 |   | 34.0 | % | 3$49,936 |   | 3  5.0 | % |

 

The recessionary forces in the local economy have continued to impactthe Company’s operations and have resulted in the imposition of certainrestrictions on such operations by the Bank’s primary federal regulator, theOTS.  On April 2, 2008, the Companyand the Bank each consented to the terms of Cease and Desist Orders issued bythe OTS (the “Orders”).  The Companyattached copies of the Orders to a Current Report on Form 8-K filed withthe Securities and Exchange Commission on April 3, 2008.

 

The Orders require the Company and the Bank to, among other things,file with the OTS within proscribed time periods updated business plans, whichspecifically incorporate the requirements set forth in the Orders and commentscontained in the most recently completed examinations of the Company and theBank. On a quarterly basis, the Bank and the Company will be required tocompare the projected operating results from the business plans with the actualresults. The results of this variance analysis are to be submitted to the OTSwithin the proscribed time periods. In addition, the Orders require that theCompany and the Bank receive the permission of the OTS prior to (i) makingor declaring any dividends or payments on their outstanding securities; (ii) addingor replacing a director or hiring a senior executive officer; and (iii) makingany golden parachute payments to any institution-affiliated party. Pursuant tothe Order issued to the Company, the Company must also receive the permissionof the OTS prior to increasing its debt position and before any repurchase ofits securities.

 

TheOrder issued to the Bank also requires the Bank to take or refrain from certainactions, including (i) not making any new loans or issuing new lines ofcredit for land acquisition or development, speculative residentialconstruction, commercial and multi-family construction, acquisition orretention of commercial property, and non-owner occupied one- to four-familyresidential property; (ii) engaging an independent consultant to conduct aloan portfolio 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.

 

61

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

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

 

The following condensed financial statements summarize the financialposition of Peoples Community Bancorp, Inc. as of December 31, 2007and 2006, and the results of its operations and its cash flows for the fiscalyears ended December 31, 2007 and 2006, the three-month period ended December 31,2005 and the fiscal year ended September 30, 2005.

 

**PEOPLES COMMUNITY BANCORP, INC.**

**STATEMENTSOF FINANCIAL CONDITION**

December 31,2007 and 2006

(In thousands)

 
| ** **                                                                                    | ** ** | **2007**   | ** ** | **2006**   | ** ** |
|-----------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| **ASSETS**                                                                                    |       |       |       |       |       |
| ** **                                                                                    |       |       |       |       |       |
| Cash and cash  equivalents                                                                    |       | $          | 145        |       | $          | 191 |   |
| Loan receivable  from Bank                                                                    |       | 1,001      |       | 1,212      |       |
| Investment in  Peoples Community Bank                                                         |       | 85,091     |       | 114,617    |       |
| Prepaid and  deferred federal income taxes and other assets                                   |       | 464        |       | 1,156      |       |
|                                                                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total assets                                                                                  | ** ** | **$**      | **86,701** | ** ** | **$**      | **117,176** | ** ** |
| ** **                                                                                    |       |       |       |       |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                |       |       |       |       |       |
| ** **                                                                                    |       |       |       |       |       |
| Loan payable                                                                                  |       | $          | 16,500     |       | $          | 12,700 |   |
| Accrued expenses  and other liabilities                                                       |       | 146        |       | 122        |       |
| Accounts payable  to subsidiary                                                               |       | 1,026      |       | 1,274      |       |
| Subordinated  debentures                                                                      |       | 15,464     |       | 15,464     |       |
| Total  liabilities                                                                            |       | 33,136     |       | 29,560     |       |
|                                                                                          |       |       |       |       |       |
| Stockholders’  equity                                                                    |       |       |       |       |       |
| Common stock and  additional paid-in capital                                                  |       | 70,889     |       | 69,823     |       |
| Retained  earnings (deficit)                                                                  |       | (17,364    | )          | 17,929     |       |
| Unrealized gains  (losses) on securities designated as available for sale, net of tax effects |       | 40         |       | (136       | )          |
| Total  stockholders’ equity                                                              |       | 53,565     |       | 87,616     |       |
|                                                                                          |       |       |       |       |       |
| Total  liabilities and stockholders’ equity                                              | ** ** | **$**      | **86,701** | ** ** | **$**      | **117,176** | ** ** |

 

62

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

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

 

**PEOPLESCOMMUNITY BANCORP, INC.**

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

#####  

| ** **                                                                 | ** ** | **For Years**    | ** **  | **For Three Months** | ** ** | **For Year**      | ** ** |
|----------------------------------------------------------------------------|------------|-----------------------|-------------|--------------------------------|------------|------------------------|------------|
| ** **                                                                 | ** ** | **Ended**             | ** **  | **Ended**                      | ** ** | **Ended**              | ** ** |
| ** **                                                                 | ** ** | **December 31,** | ** **  | **December 31,**          | ** ** | **September 30,** | ** ** |
| ** **                                                                 | ** ** | **2007**              | ** **  | **2006**                       | ** ** | **2005**               | ** ** | **2005** | ** ** |
| ** **                                                                 | ** ** | ** **            | ** **  | **(In thousands) **       | ** ** | ** **             | ** ** |
| ** **                                                                 | ** ** | ** **            | ** **  | ** **                     | ** ** | ** **             | ** ** | ** ** | ** ** |
| Income                                                                     |       |                  |        |                           |       |                   |       |   |   |
| Dividends from  subsidiaries                                               |       | $                     | —      |                           | $          | —                 |       | $ | — |   | $ | — |   |
| Other income                                                               |       | 56                    |        | 73                             |       | 39                     |       | 55 |   |
| Total income                                                               |       | 56                    |        | 73                             |       | 39                     |       | 55 |   |
|                                                                       |       |                  |        |                           |       |                   |       |   |   |
| Expenses                                                                   |       |                  |        |                           |       |                   |       |   |   |
| Interest expense                                                           |       | 2,236                 |        | 2,186                          |       | 463                    |       | 1,043 |   |
| Other expenses                                                             |       | 178                   |        | 252                            |       | 73                     |       | 270 |   |
| Total expenses                                                             |       | 2,414                 |        | 2,438                          |       | 536                    |       | 1,313 |   |
|                                                                       |       |                  |        |                           |       |                   |       |   |   |
| Loss before  income tax and equity in undistributed income of subsidiaries |       | (2,358                | )           | (2,365                         | )          | (497                   | )          | (1,258 | ) |
|                                                                       |       |                  |        |                           |       |                   |       |   |   |
| Income tax  benefit                                                        |       | —                |        | (693                           | )          | (146                   | )          | (408 | ) |
|                                                                       |       |                  |        |                           |       |                   |       |   |   |
| Loss before  equity in undistributed income of subsidiaries                |       | (2,358                | )           | (1,672                         | )          | (351                   | )          | (850 | ) |
|                                                                       |       |                  |        |                           |       |                   |       |   |   |
| Equity in  undistributed income (loss) of subsidiaries                     |       | (30,975               | )           | (2,389                         | )          | 438                    |       | 3,706 |   |
|                                                                       |       |                  |        |                           |       |                   |       |   |   |
| Net income  (loss)                                                         | ** ** | **$**                 | **(33,333** | **)**                          | **$**      | **(4,061**             | **)**      | **$** | **87** | ** ** | **$** | **2,856** | ** ** |

 

63

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

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

 

**PEOPLES COMMUNITY BANCORP, INC.**

**STATEMENTS OF CASH FLOWS**

 (In thousands)

 
| ** **                                                 | ** ** | **For Years**    | ** ** | **For Three Months** | ** ** | **For Year**      | ** ** |
|------------------------------------------------------------|------------|-----------------------|------------|--------------------------------|------------|------------------------|------------|
| ** **                                                 | ** ** | **Ended**             | ** ** | **Ended**                      | ** ** | **Ended**              | ** ** |
| ** **                                                 | ** ** | **December 31,** | ** ** | **December 31,**          | ** ** | **September 30,** | ** ** |
| ** **                                                 | ** ** | **2007**              | ** ** | **2006**                       | ** ** | **2005**               | ** ** | **2005** | ** ** |
| Operating  Activies                                        |       |                  |       |                           |       |                   |       |   |   |
| Net earnings  (losses)                                     |       | $                     | (33,333    | )                              | $          | (4,061                 | )          | $ | 87 |   | $ | 2,856 |   |
| Items not  requiring (providing) cash                      |       |                  |       |                           |       |                   |       |   |   |
| Undistributed  losses (earnings) of Peoples Community Bank |       | 30,975                |       | 2,561                          |       | (373                   | )          | (3,691 | ) |
| Undistributed  earnings of Columbia                        |       | —                |       | (172                           | )          | (65                    | )          | (95 | ) |
| Gain on sale of  securities                                |       | —                |       | (6                             | )          | —                 |       | — |   |
| Increase  (decrease) in cash due to changes in:            |       |                  |       |                           |       |                   |       |   |   |
| Other assets                                               |       | 110                   |       | 1,229                          |       | (146                   | )          | (793 | ) |
| Other  liabilities                                         |       | 324                   |       | (214                           | )          | (258                   | )          | 143 |   |
|                                                       |       |                  |       |                           |       |                   |       |   |   |
| Net cash used in  operating activities                     |       | (1,924                | )          | (663                           | )          | (755                   | )          | (1,580 | ) |
|                                                       |       |                  |       |                           |       |                   |       |   |   |
| Investing Activities                                       |       |                  |       |                           |       |                   |       |   |   |
| Proceeds from  repayment of loan to ESOP                   |       | 211                   |       | 211                            |       | 41                     |       | 221 |   |
| Proceeds from  sale of investment securities               |       | —                |       | 126                            |       |                   |       |   |   |
| Purchase of  interest in Columbia                          |       | —                |       | —                         |       | —                 |       | (2,524 | ) |
| Sale of interest  in Columbia                              |       | —                |       | 2,856                          |       | —                 |       | — |   |
| Loan disbursed  to ESOP                                    |       | —                |       | —                         |       | —                 |       | (962 | ) |
| Cash paid in  acquisition of Mercantile - net              |       | —                |       | (364                           | )          | —                 |       | — |   |
| Contribution to  Peoples Community Bank                    |       | —                |       | —                         |       | —                 |       | (25,250 | ) |
|                                                       |       |                  |       |                           |       |                   |       |   |   |
| Net cash  provided by (used in) investing activities       |       | 211                   |       | 2,829                          |       | 41                     |       | (28,515 | ) |
|                                                       |       |                  |       |                           |       |                   |       |   |   |
| Financing  Activities                                      |       |                  |       |                           |       |                   |       |   |   |
| Proceeds from  borrowings                                  |       | 4,550                 |       | 16,500                         |       | —                 |       | — |   |
| Repayment of  borrowings                                   |       | (750                  | )          | (3,800                         | )          | —                 |       | — |   |
| Dividends paid  on common stock                            |       | (2,140                | )          | (2,795                         | )          | (664                   | )          | (2,419 | ) |
| Proceeds from  issuance of common stock-net                |       | —                |       | —                         |       | —                 |       | 10,250 |   |
| Proceeds from  exercise of stock options                   |       | 7                     |       | 46                             |       | 20                     |       | 150 |   |
| Proceeds from  issuance of subordinated debentures         |       | —                |       | —                         |       | —                 |       | 15,464 |   |
| Redemption of  subordinated debentures                     |       | —                |       | (12,887                        | )          | —                 |       | — |   |
|                                                       |       |                  |       |                           |       |                   |       |   |   |
| Net cash  provided by (used in) financing activities       |       | 1,667                 |       | (2,936                         | )          | (644                   | )          | 23,445 |   |
|                                                       |       |                  |       |                           |       |                   |       |   |   |
| Net decrease in  cash and cash equivalents                 |       | (46                   | )          | (770                           | )          | (1,358                 | )          | (6,650 | ) |
|                                                       |       |                  |       |                           |       |                   |       |   |   |
| Cash and cash  equivalents at beginning of year            |       | 191                   |       | 961                            |       | 2,319                  |       | 8,969 |   |
|                                                       |       |                  |       |                           |       |                   |       |   |   |
| Cash and cash  equivalents at end of year                  | ** ** | **$**                 | **145**    | ** **                     | **$**      | **191**                | ** ** | **$** | **961** | ** ** | **$** | **2,319** | ** ** |

 

64

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

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

 

The Bank is subject toregulations imposed by the OTS regarding the amount of capital distributionspayable by the Bank to the Company. Generally, the Bank’s payment of dividends is limited, without prior OTSapproval, to net earnings for the current calendar year plus the two precedingcalendar years, less capital distributions paid over the comparable timeperiod.  Insured institutions arerequired to file an application with the OTS for capital distributions inexcess of this limitation. The Orders specifically prohibit the Bank frompaying dividends to the Company without the prior approval of the OTS.

 

**NOTE N -BUSINESS COMBINATIONS**

 

On June 10, 2005, the Company acquiredAmerican, included $38.4 million in loans receivable, $1.3 million in fixedassets, and $58.0 million in deposits. Goodwill and other intangible assets ofapproximately $5.8 million was recorded in the acquisition.

 

On December 16, 2005, the Company acquiredPFS, which included $122.6 million in loans receivable, $1.0 million in fixedassets, and $88.7 million in deposits. Goodwill and other intangible assets of approximately $14.0 million wasrecorded in this acquisition.

 

On June 9, 2006, the Company acquired Mercantile and the Bank acquiredMercantile Savings Bank which operated one branch office in Cincinnati,Ohio.  The acquisition included $38.0million in loans receivable and $48.7 million in deposits.  Goodwill and other intangible assets ofapproximately $6.2 million were recorded in the acquisition.

 

Eachof the foregoing acquisitions focused on increasing the Company’s market shareand scale of operations, as well as expanding its distribution network withinits primary market area.  The results ofoperations of each of these acquisitions have been included in the consolidatedfinancial statements as of their acquisition date.

 

Presentedon the next page are the estimated fair values of the assets acquired andliabilities assumed from the acquisitions in the fiscal year ended September 30,2005, the three-month period ended December 31, 2005 and the fiscal yearended December 31, 2006.

 

65

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

**NOTE N -BUSINESS COMBINATIONS** (continued)

 
| ** **                     | ** ** | **American State**     | ** ** | **PFS Bancorp**            | ** ** | **Mercantile**             | ** ** |
|--------------------------------|------------|-----------------------------|------------|---------------------------------|------------|----------------------------|------------|
| ** **                     | ** ** | **June 10, 2005** | ** ** | **December 16, 2005** | ** ** | **June 9, 2006** | ** ** |
| ** **                     | ** ** | ** **                  | ** ** | **(in thousands)**         | ** ** | ** **                 | ** ** |
|                           |       |                        |       |                            |       |                       |       |
| Cash and  investments          |       | $                           | 16,086     |                            | $          | 2,740                      |       | $ | 12,913 |   |
| Investment  securities         |       | 9,699                       |       | 1,480                           |       | 7,407                      |       |
| Loans                          |       | 38,358                      |       | 122,643                         |       | 38,030                     |       |
| Office premises  and equipment |       | 1,277                       |       | 1,020                           |       | —                     |       |
| Core deposits                  |       | 1,859                       |       | 3,703                           |       | 2,206                      |       |
| Goodwill                       |       | 3,939                       |       | 9,919                           |       | 3,963                      |       |
| Other assets                   |       | 1,910                       |       | 2,484                           |       | 2,560                      |       |
|                           |       |                        |       |                            |       |                       |       |
| Total assets  acquired         |       | 73,128                      |       | 143,989                         |       | 67,079                     |       |
|                           |       |                        |       |                            |       |                       |       |
| Deposits                       |       | 57,995                      |       | 88,690                          |       | 48,683                     |       |
| Borrowings                     |       | 5,601                       |       | 21,067                          |       | 6,378                      |       |
| Other  liabilities             |       | 1,475                       |       | 1,341                           |       | 2,633                      |       |
|                           |       |                        |       |                            |       |                       |       |
| Total  liabilities             |       | 65,071                      |       | 111,098                         |       | 57,694                     |       |
|                           |       |                        |       |                            |       |                       |       |
| Net assets  acquired           |       | $                           | 8,057      |                            | $          | 32,891                     |       | $ | 9,385 |   |

 

Presented below arepro-forma condensed consolidated statements of earnings which have beenprepared as if the American State transaction had been consummated as of thebeginning of the fiscal year ended September 30, 2005; the PFS Bancorptransaction had been consummated at the beginning of the fiscal year ended September 30,2005 and the three-month period ended December 31, 2005; and theMercantile transaction had  beenconsummated at the beginning of the fiscal year ended September 30, 2005and the three-month period ended December 31, 2005 and the fiscal yearended December 31, 2006.

 
| ** **                                 | ** ** | **Fiscal Year   Ended   December 31,** | ** ** | **Three Months   Ended   December 31,** | ** ** | **Fiscal Year   Ended   September 30,** | ** ** |
|--------------------------------------------|------------|------------------------------------------------------------|------------|-------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                 | ** ** | **2006**                                                   | ** ** | **2005**                                                    | ** ** | **2005**                                                    | ** ** |
| ** **                                 | ** ** | ** **                                                 | ** ** | **(in thousands)**                                     | ** ** | ** **                                                  | ** ** |
|                                       |       |                                                       |       |                                                        |       |                                                        |       |
| Total interest  income                     |       | $                                                          | 66,720     |                                                        | $          | 16,075                                                      |       | $ | 57,537 |   |
| Total interest  expense                    |       | 37,017                                                     |       | 9,281                                                       |       | 30,507                                                      |       |
| Net interest  income                       |       | 29,703                                                     |       | 6,794                                                       |       | 27,030                                                      |       |
|                                       |       |                                                       |       |                                                        |       |                                                        |       |
| Provision for  losses on loans             |       | 17,450                                                     |       | 916                                                         |       | 5,844                                                       |       |
| Other income                               |       | 3,471                                                      |       | 753                                                         |       | 3,527                                                       |       |
| General,  administrative and other expense |       | 22,532                                                     |       | 7,528                                                       |       | 25,169                                                      |       |
| Loss before  income taxes                  |       | (6,808                                                     | )          | (897                                                        | )          | (456                                                        | )          |
|                                       |       |                                                       |       |                                                        |       |                                                        |       |
| Federal income  tax benefits               |       | (2,314                                                     | )          | (305                                                        | )          | (155                                                        | )          |
| Net loss                                   |       | $                                                          | (4,494     | )                                                           | $          | (592                                                        | )          | $ | (301 | ) |
|                                       |       |                                                       |       |                                                        |       |                                                        |       |
| Pro-forma basic  loss per share            |       | $                                                          | (0.94      | )                                                           | $          | (0.12                                                       | )          | $ | (0.07 | ) |
| Pro-forma  diluted loss per share          |       | $                                                          | (0.94      | )                                                           | $          | (0.12                                                       | )          | $ | (0.07 | ) |

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

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

 

The following table summarizes the Company’squarterly results for the fiscal years ended December 31, 2007 and December 31,2006.  Certain amounts, as previouslyreported, have been reclassified to conform to the 2007 presentation.

 
| ** **                                 | ** ** | **Three Months Ended**                                   | ** ** |
|--------------------------------------------|------------|--------------------------------------------------------------------|------------|
|                                       | ** ** | **March 31,**                                                 | ** ** | **June 30,** | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                                 | ** ** | **(In thousands, except per share data)** | ** ** |
| 2007:                                      |       |                                                               |       |   |   |   |   |   |   |
|                                       |       |                                                               |       |   |   |   |   |   |   |
| 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 | ) |
| Federal income  tax benefit                |       | (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** | **)** |

 
| ** **                                 | ** ** | **Three Months Ended**                    | ** ** |
|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                 | ** ** | **March 31,**                        | ** ** | **June 30,** | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                                 | ** ** | **(In thousands, except per share data)** | ** ** |
| 2006:                                      |       |                                      |       |   |   |   |   |   |   |
| ** **                                 |       |                                      |       |   |   |   |   |   |   |
| Total interest  income                     |       | $                                         | 15,954     |   | $ | 16,726 |   | $ | 16,716 |   | $ | 16,079 |   |
| Total interest  expense                    |       | 8,500                                     |       | 9,045 |   | 9,474 |   | 9,466 |   |
|                                       |       |                                      |       |   |   |   |   |   |   |
| Net interest  income                       |       | 7,454                                     |       | 7,681 |   | 7,242 |   | 6,613 |   |
| Provision for  losses on loans             |       | 1,200                                     |       | 1,500 |   | 8,550 |   | 6,200 |   |
| Gain (loss) on  sale of assets             |       | (44                                       | )          | (23 | ) | 126 |   | (18 | ) |
| Other income                               |       | 626                                       |       | 716 |   | 862 |   | 968 |   |
| General,  administrative and other expense |       | 5,171                                     |       | 5,394 |   | 5,694 |   | 4,863 |   |
|                                       |       |                                      |       |   |   |   |   |   |   |
| Earnings (loss)  before income taxes       |       | 1,665                                     |       | 1,480 |   | (6,014 | ) | (3,500 | ) |
| Federal income  taxes (benefit)            |       | 511                                       |       | 449 |   | (2,105 | ) | (1,163 | ) |
|                                       |       |                                      |       |   |   |   |   |   |   |
| Net earnings  (loss)                       | ** ** | **$**                                     | **1,154**  | ** ** | **$** | **1,031** | ** ** | **$** | **(3,909** | **)** | **$** | **(2,337** | **)** |
|                                       | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Earnings (loss)  per share                 |       |                                      |       |   |   |   |   |   |   |
| Basic                                      | ** ** | **$**                                     | **.26**    | ** ** | **$** | **.23** | ** ** | **$** | **(.82** | **)** | **$** | **(.49** | **)** |
| Diluted                                    | ** ** | **$**                                     | **.26**    | ** ** | **$** | **.23** | ** ** | **$** | **(.82** | **)** | **$** | **(.49** | **)** |

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

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

 

Net loss for the fourth quarter of 2007 was $31.5 million, or $6.57loss per share, compared to a net loss for the third quarter of 2007 of $1.4million and $2.3 million for the fourth quarter of 2006.  Net interest income for the quarter decreased$1.1 million, or 18.4%, compared to the third quarter of 2007, primarily due toa decrease of 40 basis points in the net interest margin to 2.17% for thefourth quarter of 2007.

 

Management recorded a provision for losses onloans of $24.5 million in the fourth quarter of 2007, compared to $4.1 millionin the third quarter of 2007.  The largerprovision in the fourth quarter reflects higher probable credit losses onprimarily non-owner occupied residential loans and land development loans, as aresult of continuing recessionary forces in the local economy and a significantdownturn in the real estate market.  Nonperformingassets at September 30, 2007 totaled $20.4 million, compared to $32.8million at December 31, 2007, while classified assets increased from $31.3million at September 30, 2007 to $40.6 million at December 31, 2007.

 

Other income totaled approximately $1.2million for the fourth quarter of 2007, compared to $749,000 for the thirdquarter of 2007.  The increase wasprimarily attributed to approximately $100,000 in recoveries received on loanscharged-off by a financial institution prior to its acquisition by the Company,$100,000 received as a property improvement easement, and increases in otherdeposit and loan fee income.

 

General,administrative and other expenses recorded during the fourth quarter of 2007totaled $5.3 million, an increase of $277,000, or 5.5%, compared to the thirdquarter of 2007, and a decrease of $418,000, or 7.3%, and a decrease of$325,000, or 5.8%, from the first and second quarter of 2007,respectively.  InDecember 2007, the Bank recorded approximately $508,000 in compensationexpense for the release of approximately 32,383 ESOP shares for employeeallocation.  This occurred in conjunctionwith the decision to terminate the ESOP by September 30, 2008 and recordassociated expenses in 2008 to release all unallocated shares.

 

The Bank recorded goodwill totaling $23.9million in conjunction with acquisitions of other financial institutions overthe past five years.  Following anupdated valuation in the fourth quarter of 2007 by an independent third party,the Bank incurred a non-cash impairment charge of $11.4 million for thewritedown of goodwill.   This impairmentis primarily attributable to lower market valuations for financial institutionsin the latter part of 2007, the weakening of the credit market in the secondhalf of 2007, the decline in real estate values, particularly in the Cincinnatiregion, and the net losses recorded by the Bank and Company for the past sixquarters.

 

In the fourth quarter of 2007, the Company recorded a valuationallowance of deferred income tax in the amount of  $4.4 million based principally on uncertaintyabout the Company’s ability to generate sufficient future taxable income torealize all of the related temporary differences.  The Company believes that it will realize theremaining net deferred tax assets through taxable income resulting from theplanned profitable sale of branches of the Bank within the next twelvemonths.  The expense for recording thevaluation allowance is a non-cash item, and the recording of this expense doesnot imply that the Company owes additional income taxes.  This resulted in a total tax benefit of $3.7million for the fourth quarter of 2007.

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

**NOTE P –OPERATING AND LIQUIDITY MATTERS**

 

Beginning in early 2007, the Company began to reduce all aspects of itslending exposure due in large part to the downturn in the local economy, and,in particular, values of residential and residential development properties.Further, beginning in 2006, the Company revised its underwriting standards toplace an increased focus on cash flow analysis, tightened its credit standardsand provided additional resources to the resolution of its classifiedassets.  Actions taken by the Companyduring 2006 and 2007,  includingsignificant charge-offs and provisions for loan losses, as well as thecontinued recessionary forces in the local economy have had a significantadverse impact on the Company’s financial condition and results ofoperations.  For 2006 and 2007, netlosses recorded by the Company amounted to $4.1 million and $33.3 million,respectively.

 

TheBank’s primary federal regulator, the OTS has, in light of the Company’s 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 proscribed 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 outstanding securities; (ii) addingor replacing a director or hiring a senior executive officer; and (iii) makingany golden parachute payments to any institution-affiliated party. Pursuant tothe Order issued to the Company, the Company must also receive the permissionof the OTS prior to increasing its debt position and before any repurchase ofits securities.

 

The Company currently lacksliquidity to continue as a going concern primarily due to the Company’s currentlack of liquidity to repay its $17.5 million obligation under an outstandingline of credit due June 30, 2008. The line of credit is secured by all outstanding shares of common stockof the Bank.  Although the Bank exceedsall of its capital requirements and is considered well capitalized at December 31,2007, the Orders prohibit the Bank from paying cash dividends to the Companywithout the prior consent of the OTS and the Company will only be able to relyupon existing cash and cash equivalents as sources of its liquidity.  Without the ability to rely on dividends fromthe Bank, the Company will require funds from other funding sources to meet itsobligations such as restructuring the current line of credit or replacing thecurrent line of credit.  The Company wasnot in compliance with one of the loan covenants at December 31, 2007 andthe lender has the ability to accelerate all outstanding amounts upon noticeand the passage of 30 days. The Company is currently negotiating with thelender regarding a waiver of default, and a modification and/or extension ofthe line of credit.

 

Management of the Companyand the Bank is working diligently to resolve the issues associated with theCompany’s nonperforming assets and to provide the information or take theactions required by the Orders. Concurrently, management and the Board of Directors are considering allstrategic alternatives available to the Company and the Bank. As required, theCompany and the Bank have filed a consolidated business plan with the OTScovering operations through 2010.  TheCompany’s business plan contemplates, among other things, a consolidation ofthe Company’s operations through branch sales and a reduction in adverselyclassified assets through loan resolutions, repayments, sales andcharge-offs.  Branch sale transactionswould decrease the Company’s assets and liabilities, improve capital ratios,generate taxable income, and reduce general, administrative and otherexpense.  In addition, the Bank woulddividend funds to the Company to provide liquidity to service the Company’sdebt, provided that approval would be received from the OTS. The business planwas submitted by the Company to the OTS on April 7, 2008 and is subject toreview and approval by the OTS.

 

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**PEOPLES COMMUNITY BANCORP, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)**

 

**NOTE P –OPERATING AND LIQUIDITY MATTERS**  (continued)

 

There are no assurances that the measures set forth in the 3-yearbusiness plan will successfully improve the condition of the Company and resultin the termination of the Orders from the OTS. The economic factors of the greater Cincinnati area and the duration ofthe downturn in the local real estate market will have a significant impact onthe implementation of the business plan. In addition, while these measures are designed to improve the conditionof the Company, there are no assurances that such measures will successfullyenable the Company to continue as a going concern.  Although not currently planned, the realizationof assets in other than the ordinary course of business in order to meetliquidity needs could incur losses not reflected in these financial statements.

 

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**PEOPLESCOMMUNITY BANCORP, INC.**

 

**DIRECTORSAND EXECUTIVE OFFICERS**

 

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

 

**DIRECTORS**

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

 

**EXECUTIVE OFFICERS**

 
| Jerry D.  Williams                                      | Thomas J. Noe                                     |
|---------------------------------------------------------|---------------------------------------------------|
| *President  and Chief Executive Officer*                | *Treasurer  and Executive Vice President*         |
|                                                    |                                              |
| Teresa A. O’Quinn                                  | Lori M. Henn                                      |
| *Chief  Financial Officer and Executive Vice President* | *Compliance  Officer and Senior Vice President*   |
|                                                    |                                              |
| Fred L.  Darlington                                     | Stephen P. Wood                                   |
| *General Counsel, Senior Vice President and*            | *Chief Lending Officer and Senior Vice President* |
| *Corporate  Secretary*                                  |                                              |
|                                                    |                                              |
| Rick Wade                                               | Jerry Gore                                        |
| *Chief  Operations Officer and Senior Vice President*   | *Director  of Retail Banking and*                 |
| * *                                                | *Senior Vice President*                           |
|                                                    |                                              |
| Joan Woodward                                           |                                              |
| *Senior  Vice President, Human Resources*               |                                              |

 

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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  Drive  West 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 128  Cleves, Ohio 45002               |       | 1101 Columbus AvenueLebanon, Ohio 45036             |       | 5797 South State Route 48  Maineville, 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           |       | 3200 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 will be held on May 28, 2008 at10:00 a.m., Eastern Time, at the Company’s Voice of America location, 7615Voice of America Centre Drive, West Chester, Ohio  45069.

 

**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, P. O. Box 1130, West Chester, Ohio  45071. Stockholdersneeding assistance with stock records, transfers or lost certificates, pleasecontact Peoples Community Bancorp’s transfer agent, Registrar and TransferCompany.

 

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