The allowance for loan losses totaled $19,710,000 at December 31, 2007 compared to $17,850,000 at December 31, 2006. The percentage of the allowance to outstanding loans was 1.44% and 1.38% at December 31, 2007 and 2006, respectively. The percentage increase was due to loan growth and an increase in the amount of “problem” or “watch” loans as a percentage of total loans outstanding. The allowance was based on management’s consideration of a number of factors, including composition of the loan portfolio, loans with higher credit risks (primarily agriculture loans and spec real estate construction) and overall increases in Net Loans outstanding. The methodology used in 2007 is consistent with the methodology used in the prior years.
Agricultural loans totaled $60,004,000 and $49,223,000 at December 31, 2007 and 2006, respectively. The level of agriculture loans during the last five years compared to total loans has varied from a high of 4.37% in 2007 to a low of 3.78% in 2005. Management has assessed the risks for agricultural loans to be higher than other loans due to unpredictable commodity prices, the effects of weather on crops and uncertainties regarding government support programs. In particular, loans that are in the swine production segment continue to be of major concern as prices for hogs are subject to severe fluctuations.
Non-performing loans increased by $24.9 million from December 31, 2006 to December 31, 2007. Non-performing loans were 2.88% of loans as of December 31, 2007 and 1.13% as of December 31, 2006. Non-performing loans, which are considered impaired, include any loan that has been placed on nonaccrual status. Non-performing loans also include loans that, based on management’s evaluation of current information and events, the Bank expects to be unable to collect in full according to the contractual terms of the original loan agreement. These loans are also considered impaired loans. This increase in non-performing loans is due primarily to the deterioration in credit quality of eight borrower relationships that have an aggregate balance of approximately $33.5 million as of December 31, 2007.
The University of Iowa, because of its 25,200 employees and because of its total budget in Johnson County, has a tremendous impact on the economy of the Bank’s primary trade area. In 2007 and 2006, the University of Iowa helped Johnson County’s economy remain strong. The economy of the state of Iowa has recovered from recent weakness, but the University continues to have budget limitations. For its fiscal year beginning July 1, 2007, the University expects continued budget constraints. The possible effects on the local economy cannot be predicted, but such budget limitations may weaken the economy in future years.
The other income of the Company was $15,984,000 in 2007 compared to $14,611,000 in 2006. The increase of $1,373,000 was the result of a combination of factors discussed below. In 2006, the total other income increased $1,803,000 from 2005. The amount of the net gain on sale of secondary market mortgage loans in each year can vary significantly. The gain was $934,000 in 2007, $859,000 in 2006 and $1,074,000 in 2005. The number of loans sold in 2007 was approximately 112% of the volume in 2006 and 105% of the activity experienced in 2005. The fee per loan in 2006 was approximately 3% higher than the fee per loan in 2007 which was offset by the volume of loans sold. The volume of activity in these types of loans is directly related to the level of interest rates. In 2005 and 2006, rates did not drop sufficiently to make it feasible for a large volume of refinancing to occur. In 2007, secondary market rates were favorable resulting in the increase in the volume of loans sold. The servicing of the loans sold into the secondary market is not retained by the Company so these loans do not provide an ongoing stream of income.
Trust fees increased $505,000 to $3,928,000 in 2007. Trust fees increased $433,000 in 2006. As of December 31, 2007, the Bank’s Trust Department had $963 million in assets under management compared to $857 million and $787 million at December 31, 2006 and 2005, respectively. Trust fees are based on total assets under management. The trust assets that are the most volatile are those that are held in common stocks, which amount to approximately 52.5% of assets under management. In 2007 and 2006, the market value of such common stock increased. In 2005, the market value was stable. The Dow Jones Industrial Average increased over 6% in 2007 and over 16% in 2006. This average decreased less than 1% in 2005.
| Item 7. | Management’s Discussion and Analysis of Financial Condition And Results of Operation (Continued) |
Service charges and fees increased $934,000 in 2007 to $7,861,000 from $6,927,000 in 2006. Such charges and fees include fees on deposit accounts and credit card processing fees on merchant accounts. Service fees on deposit accounts increased $428,000 in 2007 compared to the prior year as a result of fee income strategies. Service charge income on savings deposits increased $53,000 due to a change in the related fee structure and minimum balance requirements. Debit card interchange fees increased $293,000, point of sale (POS) interchange income increased $116,000 and credit card merchant fees increased $63,000. These increases were due to volume changes in debit and credit card usage. Debit card interchange income was reduced by $50,000 due to the reserve for Visa. This reserve is related to the Bank’s contingent liability, as a member of Visa, Inc. (“Visa”), for the Bank’s portion of settlement payments arising from the expected settlement by Visa of its litigation with American Express Company and Discover Financial Services.
Rental revenue on tax credit real estate decreased $96,000 in 2007 due to adjustment recorded upon the receipt of the 2006 audited financial statements for the tax credit properties. Other noninterest income was $2,576,000 in 2007 and $2,621,000 in 2006. The primary reason for the decrease in other noninterest income was a one-time $79,000 sales tax refund received in 2006.
Service charges and fees increased by $1,023,000 from 2005 to 2006, resulting in total fees of $6,927,000 in 2006. Service fees on deposit accounts increased $729,000 in 2006 compared to 2005 due to fee income strategies. In addition, debit card interchange fees increased $225,000 and point of sale (POS) interchange income increased $134,000. Total other income was partially offset by $234,000 in investment securities losses in 2005.
Other Expenses
Total other expenses were $36,150,000 and $34,364,000 for the years ended December 31, 2007 and 2006, respectively. The increase is $1,786,000 or 5.20% in 2007 and $1,503,000 or 4.57% in 2006. Salaries and employee benefits, the largest component of non-interest expense, increased $885,000 in 2007, a 4.79% change. This increase includes $657,000 in direct salaries, a 4.80% increase which resulted from annual pay adjustments. Another component of salaries and employee benefits expense is profit sharing plan expense which totaled $1,180,000 in 2007. This expense increase $75,000, or 6.80% over 2006 and includes the Company’s contributions to its Profit Sharing and ESOP plans. (See Note 8 to the Consolidated Financial Statements.) The majority of the increase is due to growth in the underlying salary base for eligible employees. Medical expenses included with salaries and benefits increased to $1,633,000 from $1,523,000 in 2006. Increases in premiums and in the number of employees covered resulted in the higher expense in 2007.
Occupancy expense increased $122,000 with increases of $44,000 in property taxes and $32,000 in utilities in 2007. Occupancy expense also includes costs related to building maintenance and upkeep. This expense increased $50,000 in 2007 due to a full year of maintenance for the Wellman location (opened in September 2006) and higher snow removal expense.
In 2007, furniture and equipment expense included depreciation expense of $1,670,000 and $1,251,000 in equipment and software maintenance contracts. These expenses one year ago were $1,817,000 for depreciation and $1,069,000 for the maintenance contracts. The increase in maintenance contract expense in 2007 is due to a full year of expense related to various maintenance agreements entered into in 2006. Also, maintenance expense related to the Company’s core processing system increased 20% to $356,000 in 2007.
Outside services increased $366,000 in 2007 to $5,254,000 as of December 31, 2007 compared to the same period in 2006. Outside services include professional fees, courier services and ATM fees, and processing charges for the merchant credit card program, retail credit cards and other data processing services. Professional fees increased $160,000 from 2006 to a total of $1,632,000 for 2007. In 2007, professional fees included $25,000 in additional internal audit projects and $10,000 in loan review services, both of which are outsourced to third party service providers. Attorney’s fees increased $49,000 over 2006 due in part to increased activity related to costs of collection efforts and repossession activity. Credit card, debit card and merchant card processing expenses increased $190,000 due to the volume of transactions in 2007. Data processing expense also increased $44,000 due to a growth in the volume of transactions from 2006 to 2007.
Page 44 of 97
| Item 7. | Management’s Discussion and Analysis of Financial Condition And Results of Operation (Continued) |
Other noninterest expense was $1,558,000 for the year ended December 31, 2007, an increase of $313,000 over the same period in 2006. Other noninterest expense includes fraud losses related to customer credit and debit cards and other deposit accounts. This expense increased $75,000 in 2007 due to increased incidents of unauthorized use of customer credit and debit cards. Also, $35,000 was recovered in 2006 related to charges expensed in 2005, reducing the 2006 expense when compared to 2007.
Other noninterest expenses also include $243,000 related to unauthorized activities by an officer of the Bank in a Bank internal account. The officer has not been employed since October 3, 2007, the date the discovery was made. The Company conducted an internal investigation with assistance from third party fraud auditors and its internal audit department. The scope of the Company’s internal investigation was extensive and included transactions, accounts, and other matters involving the former employee. The Company has also cooperated fully with an investigation conducted by the U.S. Attorney’s Office and the Federal Bureau of Investigation. The internal and external investigations have shown that no customer accounts were affected. The expense represented the portion of the improper transactions remaining in the Company’s assets as of October 3, 2007. The former employee was indicted on February 12, 2008 for allegedly misappropriating approximately $559,000. The difference of $316,000 was recognized mainly through other noninterest expenses over a seven year period. The Company maintains its insurance policies covering officer or employee dishonesty that may cover a portion of the loss, subject to the applicable deductible of $150,000. The Company expects to finalize its insurance claim in April 2008. Because the Company has already recognized the loss resulting from the former employee’s alleged actions, if the former employee makes restitution or the Company receives insurance proceeds, the Company will record those payments as income in the period received.
Total other expenses were $32,861,000 for the year ended December 31, 2005. The increase in expenses in 2006 was $1,503,000. This included an increase of $918,000 in salaries and benefits, which was the direct result of salary adjustments for 2006 and an addition of twelve employees in 2006. Compensation expense related to the officers’ deferred compensation plan and costs associated with restricted common stock awarded to various officers decreased $199,000 in 2006. This decrease is primarily the result of the change in the appraised value of the Company’s common stock. Effective June 30, 2005, as a result of the Company’s program to repurchase up to a total of 750,000 shares of the Company’s common stock, the Company began obtaining a quarterly independent appraisal of the shares of stock. Previously, the Company was obtaining an independent appraisal of the shares of stock on an annual basis for the Company’s ESOP. Due to the 2005 Stock Repurchase Program, no marketability discount was given on the new quarterly appraisals and the result was the removal by the independent appraiser of a 10% minority interest adjustment. The appraisal value of the stock based on the latest appraisal is $50.00 per share, which resulted in a per share increase of $3.50 for 2006. This compares to a $9.50 per share increase in 2005. The final appraisal for each quarter will be completed approximately forty days after each quarter end and sixty days after year-end.
Medical expenses included with salaries and benefits increased from $1.2 million to $1.5 million in 2006. Occupancy expense increased $67,000 due to property taxes and utilities. Furniture and equipment expense was $111,000 higher in 2006 when compared to 2005 as a result of the costs related to equipment and software maintenance contracts. Advertising and business development expenses decreased $58,000 in 2006. This change was due in part to a $68,000 decrease in the redemption of scorecard points awarded for credit card charges. In addition, there was a decrease in outside services of $111,000. 2005 included consulting fees for a income strategy of $226,000 which was not incurred in 2006. Credit card, debit card and merchant card processing expense increased $81,000.
Income Taxes
Income tax expense was $7,138,000, $6,933,000 and $6,684,000 for the years ended December 31, 2007, 2006 and 2005, respectively. Income taxes as a percentage of income before income taxes were 30.66% in 2007, 30.82% in 2006 and 30.54% in 2005. The amount of tax credits were $566,000, $566,000 and $678,000 for 2007, 2006 and 2005, respectively. In 2005, the final tax credits were taken on one tax credit property. The decrease in tax credits in 2006 reflects credits for one remaining tax credit property. In 2007, the Company invested in a fourth tax credit property. Credits related to this new property will be approximately $1.5 million and are expected to be recognized in 2008 and future years.
Page 45 of 97
| Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operation (Continued) |
Impact of Recently Issued Accounting Standards
In March 2006, the FASB issued FASB Statement No. 156 (“FAS 156”),Accounting for Servicing of Financial Assets and amendment of FASB Statement No. 140 (“FAS 140”), Accounting for Transfers and Extinguishment of Liabilities. FAS 156 requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. The Company elected the fair value measurement method with changes in fair value reflected in earnings for subsequent measurements. FAS 156 was effective for the Company as of January 1, 2007. The adoption of this statement had no effect on the Company’s consolidated financial statements.
In July 2006, the FASB issued FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes. FIN 48 requires that the Company recognize in its financial statements, the impact of a tax position if that position is more likely than not of being sustained on audit based on the technical merits of the position. The provisions of FIN 48 were effective as of January 1, 2007. The adoption of the Interpretation did not have a significant effect on the Company’s consolidated financial statements. See Note 9 to the Consolidated Financial Statements.
In September 2006, the FASB issued FASB Statement No. 157,Fair Value Measurements. The Statement provides a single definition of fair value, a framework for measuring fair value and expanded disclosures concerning fair value. Previously, different definitions of fair value were contained in various accounting pronouncements that prescribe fair value as the relevant measure of value, except FAS 123R and related interpretation and pronouncements that require or permit measurement similar to fair value but are not intended to measure fair value. The Statement is effective for financial statements issued for year beginning after November 15, 2007. The adoption of this Statement will not have a significant effect on the Company’s consolidated financial statements.
In February 2007, the FASB issued FASB Statement No. 159,The Fair Value Option for Financial Assets and Financial Liabilties – Including an Amendment of FASB Statement No. 115 (“FAS 159”). FAS 159 permits companies to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The objective of FAS 159 is to provide opportunities to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply hedge accounting provisions. FAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. The Statement is effective for financial statements issued for the year beginning after November 15, 2007. The adoption of this Statement will not have a significant effect on the Company’s consolidated financial statements.
In November 2007, the SEC issued Staff Accounting Bulletin No. 109,Written Loan Commitments Recorded at Fair Value Through Earnings (“SAB 109”). SAB 109 provides interpretive guidance on the accounting for written loan commitments recorded at fair value through earnings under generally accepted accounting principles. SAB 109 revises and rescinds portions of Staff Accounting Bulletin No. 105,Application of Accounting Principles to Loan Commitments. The SEC staff belief is that the expected net future cash flows related to the associated servicing of a loan should be included in the measurement of derivative and other written loan commitments that are accounted for at fair value through earnings. SAB 109 is effective for financial statements issued for the year beginning after December 15, 2007. The adoption of SAB 109 will not have a significant effect on the Company’s consolidated financial statements.
In December 2007, the FASB issued FASB Statement No. 141 (revised),Business Combinations(“FAS 141R”). The standard changes the accounting for business combinations including the measurement of acquirer shares issued in consideration for a business combination, the recognition of contingent consideration, the accounting for pre-acquisition gain and loss contingencies, the recognition of capitalized in-process research and development, the accounting for acquisition-related restructuring cost accruals, the treatment of acquisition related transaction costs and the recognition of changes in the acquirer’s income tax valuation allowance. FAS 141R is effective for financial statements issued for the year beginning after December 15, 2008. The adoption of this Statement will not have a significant effect on the Company’s consolidated financial statements.
Page 46 of 97
| Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operation (Continued) |
In December 2007, the FASB issued FASB Statement No. 160,Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 (“FAS 160”). The standard changes the accounting for noncontrolling (minority) interests in consolidated financial statements including the requirements to classify noncontrolling interests as a component of consolidated stockholders’ equity, and the elimination of “minority interest” accounting in results of operations with earnings attributable to noncontrolling interests reported as part of consolidated earnings. Additionally, FAS 160 revises the accounting for both increases and decreases in a parent’s controlling ownership interest. FAS 160 is effective for financial statements issued for the year beginning after December 15, 2008. The adoption of this Statement will not have a significant effect on the Company’s consolidated financial statements.
Interest Rate Sensitivity and Liquidity Analysis
At December 31, 2007, the Company’s interest rate sensitivity report is as follows (amounts in thousands):
| Repricing
Maturities
Immediately
| Days
| More Than
One Year
| Total
|
|---|
| 2-30
| 31-90
| 91-180
| 181-365
|
|---|
| | | | | | | | |
|---|
| | | | | | | |
|---|
| | | | | | | |
|---|
| Earning assets: | | | | | | | | | | | | | | | | | | | | | | | |
| Investment | | |
| securities | | | $ | - | | $ | 4,465 | | $ | 7,690 | | $ | 10,765 | | $ | 22,635 | | $ | 168,213 | | $ | 213,768 | |
| Loans | | | | 7,508 | | | 174,413 | | | 48,461 | | | 83,405 | | | 148,636 | | | 916,678 | | | 1,379,101 | |
|
|
|
|
|
|
|
|
| Total | | | | 7,508 | | | 178,878 | | | 56,151 | | | 94,170 | | | 171,271 | | | 1,084,891 | | | 1,592,869 | |
|
|
|
|
|
|
|
|
| Sources of funds: | | |
| Interest-bearing | | |
| checking and | | |
| savings accounts | | | | 150,739 | | | - | | | - | | | - | | | - | | | 269,137 | | | 419,876 | |
| Certificates of | | |
| deposit | | | | - | | | 34,101 | | | 99,891 | | | 157,889 | | | 169,249 | | | 108,701 | | | 569,831 | |
| Other borrowings - | | |
| FHLB | | | | - | | | - | | | 10,000 | | | 10,000 | | | 348 | | | 245,000 | | | 265,348 | |
| Federal funds and | | |
| repurchase | | |
| agreements | | | | 87,076 | | | - | | | - | | | - | | | - | | | - | | | 87,076 | |
|
|
|
|
|
|
|
|
| | | | | 237,815 | | | 34,101 | | | 109,891 | | | 167,889 | | | 169,597 | | | 622,838 | | | 1,342,131 | |
| Other sources, | | |
| primarily | | |
| noninterest- | | |
| bearing | | | | - | | | - | | | - | | | - | | | - | | | 154,219 | | | 154,219 | |
|
|
|
|
|
|
|
|
| Total sources | | | | 237,815 | | | 34,101 | | | 109,891 | | | 167,889 | | | 169,597 | | | 777,057 | | | 1,496,350 | |
|
|
|
|
|
|
|
|
| Interest | | |
| Rate Gap | | | $ | (230,307 | ) | $ | 144,777 | | $ | (53,740 | ) | $ | (73,719 | ) | $ | 1,674 | | $ | 307,834 | | $ | 96,519 | |
|
|
|
|
|
|
|
|
| Cumulative Interest | | |
| Rate Gap | | |
| at December 31, 2007 | | | $ | (230,307 | ) | $ | (85,530 | ) | $ | (139,270 | ) | $ | (212,989 | ) | $ | (211,315 | ) | $ | 96,519 | | | | |
|
|
|
|
|
|
| |
Page 47 of 97
| Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operation (Continued) |
The table set forth above includes the portion of the balances in interest-bearing checking, savings and money market accounts that management has estimated to mature within one year. The classifications are used because the Bank’s historical data indicates that these have been very stable deposits without much interest rate fluctuation. Historically, these accounts would not need to be adjusted upward as quickly in a period of rate increases so the interest risk exposure would be less than the re-pricing schedule indicates. The FHLB borrowings are classified based on either their due date or if they are callable on their most likely call date based on the interest rate.
Effects of Inflation
The consolidated financial statements and the accompanying notes have been prepared in accordance with generally accepted accounting principles. These principles require the measurement of financial position and operating results in terms of historical dollar amounts without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Company’s operations. Unlike industrial companies, nearly all of the assets and liabilities of the Company are monetary in nature. As a result, interest rates have a more significant impact in the Company’s performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services. In the current economic environment, liquidity and interest rate adjustments are features of the Company’s asset/liability management, which are important to the maintenance of acceptable performance levels. The Company attempts to maintain a balance between monetary assets and monetary liabilities, over time, to offset the potential effects of changing interest rates.
Liquidity and Capital Resources
On an unconsolidated basis, the Company had cash balances of $257,000 as of December 31, 2007. In 2007, the Company received dividends of $4,376,000 from its subsidiary Bank and used those funds to pay dividends to its stockholders of $3,873,000.
The ability of the Company to pay dividends to its shareholders is dependent upon the earnings and capital adequacy of its subsidiary Bank, which affects the Bank’s dividends to the Company. The Bank is subject to certain statutory and regulatory restrictions on the amount it may pay in dividends. In order to maintain acceptable capital ratios in the subsidiary Bank, certain of its retained earnings are not available for the payment of dividends. Retained earnings available for the payment of dividends to the Company totaled approximately $19,427,000, $16,254,000 and $13,720,000 as of December 31, 2007, 2006 and 2005, respectively. As of December 31, 2007 and 2006, stockholders’ equity, before deducting for the maximum cash obligation related to the ESOP, was $152,895,000 and $139,579,000, respectively. This measure of stockholders’ equity as a percent of total assets was 9.20% at December 31, 2007 and 9.00% at December 31, 2006. As of December 31, 2007, total equity was 7.87% of assets compared to 7.65% of assets at the prior year end.
The Company and the Bank are subject to the Federal Deposit Insurance Corporation Improvement Act of 1991, and the Bank is subject to Prompt Corrective Action Rules as determined and enforced by the Federal Reserve. These regulations establish minimum capital requirements that member banks must maintain.
As of December 31, 2007, risk-based capital standards require 8% of risk-weighted assets. At least half of that 8% must consist of Tier I core capital (common stockholders’ equity, non-cumulative perpetual preferred stock and minority interest in the equity accounts of consolidated subsidiaries), and the remainder may be Tier II supplementary capital (perpetual debt, intermediate-term preferred stock, cumulative perpetual, long-term and convertible preferred stock, and loan loss reserve up to a maximum of 1.25% of risk-weighted assets). Total risk-weighted assets are determined by weighting the assets according to their risk characteristics. Certain off-balance sheet items (such as standby letters of credit and firm loan commitments) are multiplied by “credit conversion factors” to translate them into balance sheet equivalents before assigning them risk weightings. Any bank having a capital ratio less than the 8% minimum required level must, within 60 days, submit to the Federal Reserve a plan describing the means and schedule by which the Bank shall achieve the applicable minimum capital ratios.
Page 48 of 97
| Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operation (Continued) |
The Bank is an insured state bank, incorporated under the laws of the state of Iowa. As such, the Bank is subject to regulation, supervision and periodic examination by the Superintendent of Banking of the State of Iowa (the “Superintendent”). Among the requirements and restrictions imposed upon state banks by the Superintendent are the requirements to maintain reserves against deposits, restrictions on the nature and amount of loans which may be made by state banks, and restrictions relating to investments, opening of bank offices and other activities of state banks. Changes in the capital structure of state banks are also approved by the Superintendent. State banks must have a Tier 1 risk-based leverage ratio of 6.5% plus a fully funded loan loss reserve. In certain circumstances, the Superintendent may mandate higher capital, but the Superintendent has not imposed such a requirement on the Bank. In determining the Tier 1 risk-based leverage ratio, the Superintendent uses total equity capital without unrealized securities gains and the allowance for loan losses less any intangible assets. At December 31, 2007, the Tier 1 risk-based leverage ratio of the Bank was 9.17% and exceeded the ratio required by the Superintendent.
The actual amounts of risk-based capital and risk-based capital ratios as of December 31, 2007 and the minimum regulatory requirements for the Company and the Bank are presented below (amounts in thousands):
| Actual
| For Capital
Adequacy
Purposes
| To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
|
|---|
| Amount
| Ratio
| Ratio
| Ratio
|
|---|
| | | | | |
|---|
| | | | |
|---|
| | | | |
|---|
| As of December 31, 2007: | | | | | | | | | | | | | | |
| Company: | | |
| Total risk-based capital | | | $ | 165,254 | | | 13.37 | % | | 8.00 | % | | 10.00 | % |
| Tier 1 risk-based capital | | | | 149,749 | | | 12.11 | | | 4.00 | | | 6.00 | |
| Leverage ratio | | | | 149,749 | | | 9.18 | | | 3.00 | | | 5.00 | |
| Bank: | | |
| Total risk-based capital | | | | 165,024 | | | 13.36 | | | 8.00 | | | 10.00 | |
| Tier 1 risk-based capital | | | | 149,532 | | | 12.11 | | | 4.00 | | | 6.00 | |
| Leverage ratio | | | | 149,532 | | | 9.17 | | | 3.00 | | | 5.00 | |
The Bank is classified as “well capitalized” by FDIC capital guidelines.
On a consolidated basis, 2007 cash flows from operations provided $19,344,000 and net increases in deposits provided $36,517,000. These cash flows were invested in Net Loans of $76,901,000 and net securities purchased of $19,996,000. Also, net borrowings from the FHLB increased by $29,969,000 to assist in the funding of the Bank’s increased loan demand. In addition, $1,408,000 was used to purchase property and equipment.
At December 31, 2007, the Bank had total outstanding loan commitments and unused portions of lines of credit totaling $237,138,000 (see Note 14 to the Consolidated Financial Statements). Management believes that its liquidity levels are sufficient at this time, but the Bank may increase its liquidity by limiting the growth of its assets, by selling more loans in the secondary market or selling portions of loans to other banks through participation agreements. It may also obtain additional funds from the Federal Home Loan Bank (FHLB). The Bank as of December 31, 2007 can obtain an additional $184 million from the FHLB based on the current real estate mortgage loans held. In addition, the Bank has arranged $99 million of credit lines at three banks. The borrowings under these credit lines would be secured by the Bank’s investment securities.
While the Bank has off-balance sheet commitments to fund additional borrowings of customers, it does not use other off-balance-sheet financial instruments, including interest rate swaps, as part of its asset and liability management. Contractual commitments to fund loans are met from the proceeds of federal funds sold or investment securities and additional borrowings. Many of the contractual commitments to extend credit will not be funded because they represent the credit limits on credit cards and home equity lines of credits.
Page 49 of 97
| Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operation (Continued) |
Contractual Obligations and Commitments
As disclosed in Note 14 to the Consolidated Financial Statements, the Company has certain obligations and commitments to make future payments under contracts. The following table summarizes significant contractual obligations and other commitments as of December 31, 2007:
| Payments Due By Period
|
|---|
| (Amounts In Thousands)
|
|---|
| Total
| Less Than
One Year
| One -
Three Years
| Three -
Five Years
| More Than
Five Years
|
|---|
| | | | | | |
|---|
| | | | | |
|---|
| Contractual obligations: | | | | | | | | | | | | | | | | | |
| Long-term debt obligations | | | $ | 265,348 | | $ | 20,348 | | $ | 80,000 | | $ | 105,000 | | $ | 60,000 | |
| Operating lease obligations | | | | 1,176 | | | 209 | | | 424 | | | 333 | | | 210 | |
|
| |
| |
| |
| |
| |
| Total contractual obligations: | | | $ | 266,524 | | $ | 20,557 | | $ | 80,424 | | $ | 105,333 | | $ | 60,210 | |
|
| |
| |
| |
| |
| |
| | | |
| Other commitments: | | |
| Lines of credit | | | $ | 237,138 | | $ | 183,006 | | $ | 49,952 | | $ | 4,078 | | $ | 102 | |
| Standby letters of credit | | | | 10,961 | | | 10,961 | | | - | | | - | | | - | |
|
| |
| |
| |
| |
| |
| Total other commitments | | | $ | 248,099 | | $ | 193,967 | | $ | 49,952 | | $ | 4,078 | | $ | 102 | |
|
| |
| |
| |
| |
| |
| Item 7A. | Quantitative and Qualitative Disclosures About Market Risk |
Related Party Transactions
The Bank’s primary transactions with related parties are the loan and deposit relationships it maintains with officers, directors and entities related to these individuals. The Bank makes loans to related parties under substantially the same interest rates, terms and collateral as those prevailing for comparable transactions with unrelated persons. In addition, these parties may maintain deposit account relationships with the Bank that also are on the same terms as with unrelated persons. As of December 31, 2007 and 2006, loan balances to related individuals and businesses totaled $36,683,000 and $32,638,000, respectively. Deposits from these related parties totaled $11,416,000 and $7,512,000 as of December 31, 2007 and 2006, respectively.
Commitments and Trends
The Company and the Bank have no material commitments or plans that will materially affect liquidity or capital resources. Property and equipment may be acquired in cash purchases, or they may be financed if favorable terms are available.
Market Risk Exposures
The Company’s primary market risk exposure is to changes in interest rates. The Company’s asset/liability management, or its management of interest rate risk, is focused primarily on evaluating and managing net interest income given various risk criteria. Factors beyond the Company’s control, such as market interest rates and competition, may also have an impact on the Company’s interest income and interest expense. In the absence of other factors, the Company’s overall yield on interest-earning assets will increase as will its cost of funds on its interest-bearing liabilities when market interest rates increase over an extended period of time. Inversely, the Company’s yields and cost of funds will decrease when market rates decline. The Company is able to manage these swings to some extent by attempting to control the maturity or rate adjustments of its interest-earning assets and interest-bearing liabilities over given periods of time.
Page 50 of 97
| Item 7A. | Quantitative and Qualitative Disclosures About Market Risk (Continued) |
The Bank maintains an asset/liability committee, which meets at least quarterly to review the interest rate sensitivity position and to review various strategies as to interest rate risk management. In addition, the Bank uses a simulation model to review various assumptions relating to interest rate movement. The model attempts to limit rate risk even if it appears the Bank’s asset and liability maturities are perfectly matched and a favorable interest margin is present.
In order to minimize the potential effects of adverse material and prolonged increases or decreases in market interest rates on the Company’s operations, management has implemented an asset/liability program designed to mitigate the Company’s interest rate sensitivity. The program emphasizes the origination of adjustable rate loans, which are held in the portfolio, the investment of excess cash in short or intermediate term interest-earning assets, and the solicitation of passbook or transaction deposit accounts, which are less sensitive to changes in interest rates and can be re-priced rapidly.
Based on the data following, net interest income should decline with instantaneous increases in interest rates while net interest income should increase with instantaneous declines in interest rates. Generally, during periods of increasing interest rates, the Company’s interest rate sensitive liabilities would re-price faster than its interest rate sensitive assets causing a decline in the Company’s interest rate spread and margin. This would tend to reduce net interest income because the resulting increase in the Company’s cost of funds would not be immediately offset by an increase in its yield on earning assets. In times of decreasing interest rates, fixed rate assets could increase in value and the lag in re-pricing of interest rate sensitive assets could be expected to have a positive effect on the Company’s net interest income.
Page 51 of 97
| Item 7A. | Quantitative and Qualitative Disclosures About Market Risk (Continued) |
The following table, which presents principal cash flows and related weighted average interest rates by expected maturity dates, provides information about the Company’s loans, investment securities and deposits that are sensitive to changes in interest rates.
| 2008
| 2009
| 2010
| 2011
| 2012
| Thereafter
| Total
| Fair Value
|
|---|
| (Amounts In Thousands) |
|---|
| | | | | | | | | |
|---|
| | | | | | | | |
|---|
| | | | | | | | |
|---|
| Assets: | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Loans, fixed: | | |
| Balance | | | $ | 190,689 | | $ | 95,797 | | $ | 129,455 | | $ | 82,278 | | $ | 109,325 | | $ | 63,174 | | $ | 670,718 | | $ | 624,547 | |
| Average | | |
| interest rate | | | | 6.65 | % | | 6.34 | % | | 6.54 | % | | 7.12 | % | | 7.16 | % | | 5.77 | % | | 6.64 | % | | | |
| | | |
| Loans, variable: | | |
| Balance | | | $ | 247,131 | | $ | 115,500 | | $ | 116,943 | | $ | 126,691 | | $ | 87,731 | | $ | 7,595 | | $ | 701,591 | | $ | 691,515 | |
| Average | | |
| interest rate | | | | 7.04 | % | | 6.36 | % | | 6.06 | % | | 6.24 | % | | 6.94 | % | | 6.50 | % | | 6.60 | % | | | |
| | | |
| Investments (1): | | |
| Balance | | | $ | 59,659 | | $ | 37,172 | | $ | 18,663 | | $ | 24,956 | | $ | 24,814 | | $ | 48,504 | | $ | 213,768 | | $ | 213,768 | |
| Average | | |
| interest rate | | | | 4.03 | % | | 4.52 | % | | 4.66 | % | | 4.87 | % | | 4.83 | % | | 5.60 | % | | 4.72 | % | | | |
| | | |
| Liabilities: | | |
| Liquid | | |
| deposits (2): | | |
| Balance | | | $ | 419,876 | | $ | - | | $ | - | | $ | - | | $ | - | | $ | - | | $ | 419,876 | | $ | 419,876 | |
| Average | | |
| interest rate | | | | 1.81 | % | | 0.00 | % | | 0.00 | % | | 0.00 | % | | 0.00 | % | | 0.00 | % | | 1.81 | % | | | |
| | | |
| Deposits, | | |
| certificates: | | |
| Balance | | | $ | 461,130 | | $ | 43,772 | | $ | 53,395 | | $ | 9,950 | | $ | 1,584 | | $ | - | | $ | 569,831 | | $ | 569,831 | |
| Average | | |
| interest rate | | | | 4.77 | % | | 3.98 | % | | 4.61 | % | | 4.46 | % | | 4.54 | % | | 0.00 | % | | 4.69 | % | | | |
| (1) | Includes all available-for-sale investments, federal funds and Federal Home Loan Bank stock. |
| (2) | Includes passbook accounts, NOW accounts, Super NOW accounts and money market funds. |
Page 52 of 97
Item 8. Consolidated Financial Statements and Supplementary Data
The consolidated financial statements and supplementary data are included on Pages 54 through 86.
Page 53 of 97
 | KPMG LLP
2500 Ruan Center
666 Grand Avenue
Des Moines, IA 50309 |
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Hills Bancorporation:
We have audited the accompanying consolidated balance sheets of Hills Bancorporation and subsidiary as of December 31, 2007 and 2006, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2007. We also have audited Hills Bancorporation’s internal control over financial reporting as of December 31, 2007, based on criteria established inInternal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Hills Bancorporation’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying management’s report on internal control over financial reporting. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall consolidated financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Hills Bancorporation and subsidiary as of December 31, 2007 and 2006, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2007, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, Hills Bancorporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established inInternal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
/s/ KPMG LLP
March 11, 2008
Page 54 of 97
HILLS BANCORPORATION
CONSOLIDATED BALANCE SHEETS
December 31, 2007 and 2006
(Amounts In Thousands, Except Shares)
| | |
|---|
| | |
|---|
| | |
|---|
| | |
|---|
| | |
|---|
| ASSETS | | | | 2007 | | | 2006 | |
|
|
|
| Cash and cash equivalents (Note 10) | | | $ | 32,383 | | $ | 23,397 | |
| Investment securities (Notes 2 and 6): | | |
Available for sale at fair value (amortized cost 2007 $198,551;
2006 $180,106) | | | | 199,599 | | | 178,057 | |
| Held to maturity at amortized cost (fair value 2007 none; 2006 $177) | | | | - | | | 170 | |
| Stock of Federal Home Loan Bank | | | | 14,169 | | | 12,757 | |
| Loans held for sale | | | | 6,792 | | | 3,808 | |
Loans, net of allowance for loan losses (2007 $19,710; 2006 $17,850)
(Notes 3, 7 and 11) | | | | 1,352,599 | | | 1,279,227 | |
| Property and equipment, net (Note 4) | | | | 21,220 | | | 22,061 | |
| Tax credit real estate | | | | 8,803 | | | 7,111 | |
| Accrued interest receivable | | | | 11,391 | | | 10,292 | |
| Deferred income taxes, net (Note 9) | | | | 7,731 | | | 7,613 | |
| Goodwill | | | | 2,500 | | | 2,500 | |
| Other assets | | | | 3,911 | | | 4,240 | |
|
|
|
| | | | $ | 1,661,098 | | $ | 1,551,233 | |
|
|
|
| LIABILITIES AND STOCKHOLDERS' EQUITY | | |
|
|
|
| Liabilities | | |
| Noninterest-bearing deposits | | | $ | 154,219 | | $ | 143,274 | |
| Interest-bearing deposits (Note 5) | | | | 989,707 | | | 964,135 | |
|
|
|
| Total deposits | | | | 1,143,926 | | | 1,107,409 | |
| Short-term borrowings (Note 6) | | | | 87,076 | | | 59,063 | |
| Federal Home Loan Bank borrowings (Note 7) | | | | 265,348 | | | 235,379 | |
| Accrued interest payable | | | | 3,227 | | | 3,500 | |
| Other liabilities | | | | 8,626 | | | 6,303 | |
|
|
|
| | | | | 1,508,203 | | | 1,411,654 | |
|
|
|
| Commitments and Contingencies (Notes 8 and 14) | | |
| | | |
| Redeemable Common Stock Held By Employee Stock | | |
| Ownership Plan (ESOP) (Note 8) | | | | 22,205 | | | 20,940 | |
|
|
|
| | | |
| Stockholders' Equity (Note 10) | | |
| Capital stock, no par value; authorized 10,000,000 shares; | | |
| issued 2007 4,583,520 shares; 2006 4,571,659 shares | | | | - | | | - | |
| Paid in capital | | | | 12,823 | | | 12,364 | |
| Retained earnings | | | | 144,122 | | | 131,852 | |
| Accumulated other comprehensive income (loss) | | | | 647 | | | (1,265 | ) |
| Treasury stock at cost (2007 93,413 shares; 2006 67,921 shares) | | | | (4,697 | ) | | (3,372 | ) |
|
|
|
| | | | | 152,895 | | | 139,579 | |
| Less maximum cash obligation related to ESOP shares (Note 8) | | | | 22,205 | | | 20,940 | |
|
|
|
| | | | | 130,690 | | | 118,639 | |
|
|
|
| | | | $ | 1,661,098 | | $ | 1,551,233 | |
|
|
|
See Notes to Consolidated Financial Statements.
Page 55 of 97
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2007, 2006 and 2005
(Amounts In Thousands, Except Per Share Amounts)
| 2007 | 2006 | 2005 |
|---|
| | | |
|---|
| | | |
|---|
| | | |
|---|
|
|
|
|
| Interest income: | | | | | | | | | | | |
| Loans, including fees | | | $ | 88,743 | | $ | 80,240 | | $ | 66,688 | |
| Investment securities: | | |
| Taxable | | | | 4,706 | | | 4,438 | | | 4,795 | |
| Nontaxable | | | | 3,154 | | | 2,900 | | | 2,685 | |
| Federal funds sold | | | | 325 | | | 40 | | | 235 | |
|
|
|
|
| Total interest income | | | | 96,928 | | | 87,618 | | | 74,403 | |
|
|
|
|
| Interest expense: | | |
| Deposits | | | | 35,277 | | | 27,841 | | | 19,665 | |
| Short-term borrowings | | | | 2,151 | | | 2,801 | | | 749 | |
| FHLB borrowings | | | | 12,524 | | | 11,720 | | | 9,949 | |
|
|
|
|
| Total interest expense | | | | 49,952 | | | 42,362 | | | 30,363 | |
|
|
|
|
| Net interest income | | | | 46,976 | | | 45,256 | | | 44,040 | |
| Provision for loan losses (Note 3) | | | | 3,529 | | | 3,011 | | | 2,101 | |
|
|
|
|
| Net interest income after provision for loan losses | | | | 43,447 | | | 42,245 | | | 41,939 | |
|
|
|
|
| Other income: | | |
| Net gain on sale of loans | | | | 934 | | | 859 | | | 1,074 | |
| Net losses on sale of investment securities | | | | - | | | - | | | (234 | ) |
| Trust fees | | | | 3,928 | | | 3,423 | | | 2,990 | |
| Service charges and fees | | | | 7,861 | | | 6,927 | | | 5,904 | |
| Rental revenue on tax credit real estate | | | | 685 | | | 781 | | | 742 | |
| Other noninterest income | | | | 2,576 | | | 2,621 | | | 2,332 | |
|
|
|
|
| | | | | 15,984 | | | 14,611 | | | 12,808 | |
|
|
|
|
| Other expenses: | | |
| Salaries and employee benefits | | | | 19,353 | | | 18,468 | | | 17,089 | |
| Occupancy | | | | 2,344 | | | 2,222 | | | 2,155 | |
| Furniture and equipment | | | | 3,482 | | | 3,443 | | | 3,332 | |
| Office supplies and postage | | | | 1,329 | | | 1,297 | | | 1,161 | |
| Advertising and business development | | | | 1,859 | | | 1,843 | | | 1,901 | |
| Outside services | | | | 5,254 | | | 4,888 | | | 4,999 | |
| Rental expenses on tax credit real estate | | | | 971 | | | 958 | | | 955 | |
| Other noninterest expenses | | | | 1,558 | | | 1,245 | | | 1,269 | |
|
|
|
|
| | | | | 36,150 | | | 34,364 | | | 32,861 | |
|
|
|
|
| Income before income taxes | | | | 23,281 | | | 22,492 | | | 21,886 | |
| Income taxes (Note 9) | | | | 7,138 | | | 6,933 | | | 6,684 | |
|
|
|
|
| Net income | | | $ | 16,143 | | $ | 15,559 | | $ | 15,202 | |
|
|
|
|
| | | |
| Earnings per share: | | |
| Basic | | | $ | 3.59 | | $ | 3.42 | | $ | 3.34 | |
| Diluted | | | | 3.57 | | | 3.39 | | | 3.32 | |
See Notes to Consolidated Financial Statements.
Page 56 of 97
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years Ended December 31, 2007, 2006 and 2005
(Amounts In Thousands)
| 2007 | 2006 | 2005 |
|---|
| | | |
|---|
| | | |
|---|
| | | |
|---|
| | | |
|---|
|
|
|
|
| | | | | | | | | | | | |
| Net income | | | $ | 16,143 | | $ | 15,559 | | $ | 15,202 | |
| | | |
| Other comprehensive income (loss), | | |
| Unrealized gains (losses) on securities: | | |
| Unrealized holding gains (losses) arising during the year, | | |
| net of income taxes 2007 $1,185; 2006 $320; 2005 ($1,443) | | | | 1,912 | | | 518 | | | (2,503 | ) |
| | | |
| Less: reclassification adjustment for losses included in net | | |
| income, net of income taxes | | | | - | | | - | | | 144 | |
|
|
|
|
| | | |
| Other comprehensive income (loss) | | | | 1,912 | | | 518 | | | (2,359 | ) |
|
|
|
|
| | | |
| Comprehensive income | | | $ | 18,055 | | $ | 16,077 | | $ | 12,843 | |
|
|
|
|
See Notes to Consolidated Financial Statements.
Page 57 of 97
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 2007, 2006 and 2005
(Amounts In Thousands, Except Share Amounts)
| Paid In
Capital | Retained
Earnings | Accumulated
Other
Comprehensive
Income (Loss) | Maximum
Cash
Obligation
Related
To ESOP
Shares | Treasury
Stock | Total |
|---|
| | | | | | |
|---|
| | | | | | |
|---|
| | | | | | |
|---|
| | | | | | |
|---|
|
|
|
|
|
|
|
| | | | | | | | | | | | | | | | | | | | | |
| Balance, December 31, 2004 | | | $ | 11,364 | | $ | 108,199 | | $ | 576 | | $ | (16,336 | ) | $ | - | | $ | 103,803 | |
|
|
|
|
|
|
|
| Issuance of 14,882 shares of | | |
| common stock | | | | 619 | | | - | | | - | | | - | | | - | | | 619 | |
| Forfeiture of 901 shares | | |
| of common stock | | | | (29 | ) | | - | | | - | | | - | | | - | | | (29 | ) |
| Change related to ESOP shares | | | | - | | | - | | | - | | | (4,298 | ) | | - | | | (4,298 | ) |
| Net income | | | | - | | | 15,202 | | | - | | | - | | | - | | | 15,202 | |
| Income tax benefit related to | | |
| share-based compensation | | | | 16 | | | - | | | - | | | - | | | - | | | 16 | |
| Cash dividends ($.75 per share) | | | | - | | | (3,412 | ) | | - | | | - | | | - | | | (3,412 | ) |
| Purchase of 1,400 shares | | |
| of common stock | | | | - | | | - | | | - | | | - | | | (63 | ) | | (63 | ) |
| Other comprehensive (loss) | | | | - | | | - | | | (2,359 | ) | | - | | | - | | | (2,359 | ) |
|
|
|
|
|
|
|
| Balance, December 31, 2005 | | | $ | 11,970 | | $ | 119,989 | | $ | (1,783 | ) | $ | (20,634 | ) | $ | (63 | ) | $ | 109,479 | |
|
|
|
|
|
|
|
| Issuance of 9,715 shares of | | |
| common stock | | | | 346 | | | - | | | - | | | - | | | - | | | 346 | |
| Forfeiture of 1,693 shares | | |
| of common stock | | | | (63 | ) | | - | | | - | | | - | | | - | | | (63 | ) |
| Share-based compensation | | | | 44 | | | | | | | | | | | | | | | 44 | |
| Income tax benefit related to | | |
| share-based compensation | | | | 67 | | | - | | | - | | | - | | | - | | | 67 | |
| Change related to ESOP shares | | | | - | | | - | | | - | | | (306 | ) | | - | | | (306 | ) |
| Net income | | | | - | | | 15,559 | | | - | | | - | | | - | | | 15,559 | |
| Cash dividends ($.81 per share) | | | | - | | | (3,696 | ) | | - | | | - | | | - | | | (3,696 | ) |
| Purchase of 66,521 shares | | |
| of common stock | | | | - | | | - | | | - | | | - | | | (3,309 | ) | | (3,309 | ) |
| Other comprehensive income | | | | - | | | - | | | 518 | | | - | | | - | | | 518 | |
|
|
|
|
|
|
|
| Balance, December 31, 2006 | | | $ | 12,364 | | $ | 131,852 | | $ | (1,265 | ) | $ | (20,940 | ) | $ | (3,372 | ) | $ | 118,639 | |
|
|
|
|
|
|
|
| Issuance of 13,030 shares of | | |
| common stock | | | | 326 | | | - | | | - | | | - | | | - | | | 326 | |
| Forfeiture of 1,169 shares | | |
| of common stock | | | | (54 | ) | | - | | | - | | | - | | | - | | | (54 | ) |
| Share-based compensation | | | | 42 | | | - | | | - | | | - | | | - | | | 42 | |
| Income tax benefit related to | | |
| share-based compensation | | | | 145 | | | - | | | - | | | - | | | - | | | 145 | |
| Change related to ESOP shares | | | | - | | | - | | | - | | | (1,265 | ) | | - | | | (1,265 | ) |
| Net income | | | | - | | | 16,143 | | | - | | | - | | | - | | | 16,143 | |
| Cash dividends ($.86 per share) | | | | - | | | (3,873 | ) | | - | | | - | | | - | | | (3,873 | ) |
| Purchase of 25,492 shares | | |
| of common stock | | | | - | | | - | | | - | | | - | | | (1,325 | ) | | (1,325 | ) |
| Other comprehensive income | | | | - | | | - | | | 1,912 | | | - | | | - | | | 1,912 | |
|
|
|
|
|
|
|
| Balance, December 31, 2007 | | | $ | 12,823 | | $ | 144,122 | | $ | 647 | | $ | (22,205 | ) | $ | (4,697 | ) | $ | 130,690 | |
|
|
|
|
|
|
|
See Notes to Consolidated Financial Statements.
Page 58 of 97
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2007, 2006 and 2005
(Amounts In Thousands)
| 2007 | 2006 | 2005 |
|---|
| | | |
|---|
| | | |
|---|
| | | |
|---|
| | | |
|---|
|
|
|
|
| Cash Flows from Operating Activities | | | | | | | | | | | |
| Net income | | | $ | 16,143 | | $ | 15,559 | | $ | 15,202 | |
| Adjustments to reconcile net income to net cash and cash | | |
| equivalents provided by operating activities: | | |
| Depreciation | | | | 2,249 | | | 2,403 | | | 2,418 | |
| Provision for loan losses | | | | 3,529 | | | 3,011 | | | 2,101 | |
| Net losses on sale of investment securities | | | | - | | | - | | | 234 | |
| Share-based compensation | | | | 42 | | | 44 | | | - | |
| Compensation expensed through issuance of common stock | | | | 133 | | | 207 | | | 590 | |
| Excess tax benefits related to share-based compensation | | | | (145 | ) | | (67 | ) | | (16 | ) |
| Forfeiture of common stock | | | | (54 | ) | | (63 | ) | | (29 | ) |
| Provision for deferred income taxes | | | | (1,303 | ) | | (1,114 | ) | | (870 | ) |
| Increase in accrued interest receivable | | | | (1,099 | ) | | (1,673 | ) | | (1,270 | ) |
| Amortization of discount on investment securities, net | | | | 310 | | | 504 | | | 810 | |
| (Increase) decrease in other assets | | | | 474 | | | 303 | | | (1,353 | ) |
| Increase in accrued interest and other liabilities | | | | 2,049 | | | 379 | | | 1,878 | |
| Loans originated for sale | | | | (114,169 | ) | | (104,286 | ) | | (113,565 | ) |
| Proceeds on sales of loans | | | | 112,119 | | | 102,039 | | | 117,845 | |
| Net gain on sales of loans | | | | (934 | ) | | (859 | ) | | (1,074 | ) |
|
|
|
|
Net cash and cash equivalents provided by operating
activities | | | | 19,344 | | | 16,387 | | | 22,901 | |
|
|
|
|
| | | |
| Cash Flows from Investing Activities | | |
| Proceeds from maturities of investment securities: | | |
| Available for sale | | | | 36,592 | | | 40,270 | | | 56,394 | |
| Held to maturity | | | | 170 | | | 45 | | | 4,785 | |
| Proceeds from sales of investment securities available for sale | | | | - | | | - | | | 10,465 | |
| Purchases of investment securities available for sale | | | | (56,758 | ) | | (21,964 | ) | | (67,475 | ) |
| Loans made to customers, net of collections | | | | (76,901 | ) | | (140,522 | ) | | (145,586 | ) |
| Purchases of property and equipment | | | | (1,408 | ) | | (2,199 | ) | | (2,869 | ) |
| Investment in tax credit real estate, net | | | | (1,692 | ) | | 484 | | | 415 | |
|
|
|
|
| Net cash used in investing activities | | | | (99,997 | ) | | (123,886 | ) | | (143,871 | ) |
|
|
|
|
(Continued)
Page 59 of 97
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Years Ended December 31, 2007, 2006 and 2005
(Amounts In Thousands)
| 2007 | 2006 | 2005 |
|---|
| | | |
|---|
| | | |
|---|
| | | |
|---|
| | | |
|---|
|
|
|
|
| Cash Flows from Financing Activities | | | | | | | | | | | |
| Net increase in deposits | | | | 36,517 | | | 70,995 | | | 79,178 | |
| Net (increase) decrease in short-term borrowings | | | | 28,013 | | | 24,526 | | | (3,448 | ) |
| Borrowings from FHLB | | | | 60,000 | | | 45,000 | | | 60,000 | |
| Payments on FHLB borrowings | | | | (30,031 | ) | | (32,782 | ) | | (4,381 | ) |
| Borrowings from FRB | | | | 9 | | | - | | | - | |
| Payments on FRB borrowings | | | | (9 | ) | | - | | | - | |
| Stock options exercised | | | | 193 | | | 139 | | | 28 | |
| Excess tax benefits related to share-based compensation | | | | 145 | | | 67 | | | 16 | |
| Purchase of treasury stock | | | | (1,325 | ) | | (3,309 | ) | | (63 | ) |
| Dividends paid | | | | (3,873 | ) | | (3,696 | ) | | (3,412 | ) |
|
|
|
|
| Net cash provided by financing activities | | | | 89,639 | | | 100,940 | | | 127,918 | |
|
|
|
|
| | | |
| Increase (decrease) in cash and cash equivalents | | | $ | 8,986 | | $ | (6,559 | ) | $ | 6,948 | |
| | | |
| Cash and cash equivalents: | | |
| Beginning of year | | | | 23,397 | | | 29,956 | | | 23,008 | |
|
|
|
|
| End of year | | | $ | 32,383 | | $ | 23,397 | | $ | 29,956 | |
|
|
|
|
| | | |
| Supplemental Disclosures | | |
| Cash payments for: | | |
| Interest paid to depositors | | | $ | 35,550 | | $ | 26,654 | | $ | 18,984 | |
| Interest paid on other obligations | | | | 14,675 | | | 14,521 | | | 10,698 | |
| Income taxes | | | | 7,877 | | | 8,193 | | | 6,770 | |
| | | |
| Noncash financing activities: | | |
| Increase in maximum cash obligation related to | | |
| ESOP shares | | | $ | 1,265 | | $ | 306 | | $ | 4,298 | |
See Notes to Consolidated Financial Statements.
Page 60 of 97
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| Note 1. | Nature of Activities and Significant Accounting Policies |
Nature of activities: Hills Bancorporation (the “Company”) is a holding company engaged in the business of commercial banking. The Company’s subsidiary is Hills Bank and Trust Company, Hills, Iowa (the “Bank”), which is wholly-owned. The Bank is a full-service commercial bank extending its services to individuals, businesses, governmental units and institutional customers primarily in the communities of Hills, Iowa City, Coralville, North Liberty, Lisbon, Mount Vernon, Kalona, Wellman, Cedar Rapids and Marion, Iowa.
The Bank competes with other financial institutions and nonfinancial institutions providing similar financial products. Although the loan activity of the Bank is diversified with commercial and agricultural loans, real estate loans, automobile, installment and other consumer loans, the Bank’s credit is concentrated in real estate loans. All of the Company’s operations are considered to be one reportable operating segment.
Accounting estimates: The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Certain significant estimates: The allowance for loan losses, fair values of securities and other financial instruments, and share-based compensation expense involves certain significant estimates made by management. These estimates are reviewed by management routinely and it is reasonably possible that circumstances that exist at December 31, 2007 may change in the near-term future and that the effect could be material to the consolidated financial statements.
Principles of consolidation: The consolidated financial statements include the accounts of the Company and its subsidiary. All significant intercompany balances and transactions have been eliminated in consolidation.
Revenue recognition: Interest income on loans and investment securities is recognized on the accrual method. Loan origination fees are recognized when the loans are sold. Trust fees, deposit account service charges and other fees are recognized when the services are provided or when customers use the services.
Investment securities: Held-to-maturity securities consisted solely of debt securities, which the Company had the positive intent and ability to hold to maturity and were stated at amortized cost. There are no held-to-maturity securities as of December 31, 2007.
Available-for-sale securities consist of debt securities not classified as trading or held to maturity. Available-for-sale securities are stated at fair value, and unrealized holding gains and losses, net of the related deferred tax effect, are reported as a separate component of stockholders’ equity. There were no trading securities as of December 31, 2007 and 2006.
Stock of the Federal Home Loan Bank is carried at cost.
Premiums on debt securities are amortized over the earliest of the call date or the maturity date and discounts on debt securities are accreted over the period to maturity of those securities. The method of amortization results in a constant effective yield on those securities (the interest method). Realized gains and losses on investment securities are included in income, determined on the basis of the cost of the specific securities sold.
Unrealized losses judged to be other than temporary are charged to operations for both securities available for sale and securities held to maturity, and a new cost basis of the securities is established.
Page 61 of 97
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| Note 1. | Nature of Activities and Significant Accounting Policies (Continued) |
Loans: Loans are stated at the amount of unpaid principal, reduced by the allowance for loan losses. Interest income is accrued on the unpaid balances as earned.
Loans held for sale are stated at the lower of aggregate cost or estimated fair value. Loans are sold on a non-recourse basis with servicing released and gains and losses are recognized based on the difference between sales proceeds and the carrying value of the loan.
The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance when management believes the collectability of principal is unlikely. The allowance for loan losses is maintained at a level considered adequate to provide for probable losses that can be reasonably anticipated. The allowance is increased by provisions charged to expense and is reduced by net charge-offs. The Bank makes continuous reviews of the loan portfolio and considers current economic conditions, historical loss experience, review of specific problem loans and other factors in determining the adequacy of the allowance. Management classifies loans within the following industry standard categories: watch, substandard and loss.
Loans are considered non-performing when, based on current information and events, it is probable the Bank will not be able to collect all amounts due. A non-performing loan includes any loan that has been placed on nonaccrual status. They also include loans based on current information and events that it is likely the Bank will be unable to collect all amounts due according to the contractual terms of the original loan agreement. The portion of the allowance for loan losses applicable to non-performing loans has been computed based on the present value of the estimated future cash flows of interest and principal discounted at the loans effective interest rate or on the fair value of the collateral for collateral dependent loans. The entire change in present value of expected cash flows of non-performing loans or of collateral value is reported as bad debt expense in the same manner in which impairment initially was recognized or as a reduction in the amount of bad debt expense that otherwise would be reported. Interest income on nonaccrual loans is recognized on the cash basis.
The accrual of interest income on loans is discontinued when, in the opinion of management, there is reasonable doubt as to the borrower’s ability to meet payments of interest or principal when they become due.
Loan fees and origination costs are reflected in the consolidated statements of income as collected or incurred. Compared to the net deferral method, this practice had no significant effect on income in any of the years presented.
Transfers of financial assets: Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.
Page 62 of 97
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| Note 1. | Nature of Activities and Significant Accounting Policies (Continued) |
Credit related financial instruments: In the ordinary course of business, the Company has entered into commitments to extend credit, including commitments under credit card arrangements, commercial letters of credit and standby letters of credit. Such financial instruments are recorded when they are funded.
Tax credit real estate: Tax credit real estate represents two multi-family rental properties, an assisted living rental property and a multi-tenant rental property for persons with disabilities, all which are affordable housing projects as of December 31, 2007. The Bank has a 99% limited partnership interest in each limited partnership. The investment in each was completed after the projects had been developed by the general partner. The properties are recorded at cost less accumulated depreciation. The Company evaluates the recoverability of the carrying value on a regular basis. If the recoverability was determined to be in doubt, a valuation allowance would be established by way of a charge to expense. Depreciation expense is provided on a straight-line basis over the estimated useful life of the assets. Expenditures for normal repairs and maintenance are charged to expense as incurred.
The financial condition, results of operations and cash flows of each limited partnership is consolidated in the Company’s consolidated financial statements. The operations of the properties are not expected to contribute significantly to the Company’s income before income taxes. However, the properties do contribute in the form of income tax credits, which lowers the Company’s effective tax rate. Once established, the credits on each property last for ten years and are passed through from the limited partnerships to the Bank and reduces the consolidated federal tax liability of the Company.
Property and equipment: Property and equipment is stated at cost less accumulated depreciation. Depreciation is computed using primarily declining-balance methods over the estimated useful lives of 7-40 years for buildings and improvements and 3-10 years for furniture and equipment.
Deferred income taxes: Deferred income taxes are provided under the asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and net operating loss, and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. Beginning with the adoption of FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes (FIN 48) as of January 1, 2007, the Company recognizes the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. Prior to the adoption of FIN 48, the Company recognized the effect of income tax positions only if such positions were probable of being sustained. Interest and penalties on unrecognized tax benefits are classified as an other noninterest expense. As of December 31, 2007, the Company had no material unrecognized tax benefits.
Goodwill: Goodwill represents the excess of cost over the fair value of the net assets acquired, and is not subject to amortization, but requires, at a minimum, annual impairment tests for intangibles that are determined to have an indefinite life.
Other real estate: Other real estate represents property acquired through foreclosures and settlements of loans. Property acquired is carried at the lower of the principal amount of the loan outstanding at the time of acquisition, plus any acquisition costs, or the estimated fair value of the property, less disposal costs. Subsequent write downs estimated on the basis of later valuations, gains or losses on sales and net expenses incurred in maintaining such properties are charged to other non-interest expense. Other real estate is included in other assets and totaled $473,000 and $801,000 as of 2007 and 2006, respectively.
Page 63 of 97
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| Note 1. | Nature of Activities and Significant Accounting Policies (Continued) |
Earning per share: Basic earnings per share is computed using the weighted average number of actual common shares outstanding during the period. Diluted earnings per share reflects the potential dilution that would occur from the exercise of common stock options outstanding. The following table presents calculations of earnings per share:
| Year Ended December 31, |
|---|
| 2007
| 2006
| 2005
|
|---|
| (Amounts In Thousands) |
|---|
| | | | |
|---|
| | | |
|---|
Computation of weighted average number of basic and
diluted shares: | | | | | | | | | | | |
| Common shares outstanding at the beginning of the year | | | | 4,503,738 | | | 4,562,237 | | | 4,549,656 | |
Weighted average number of net shares issued
(redeemed) | | | | (4,158 | ) | | (6,215 | ) | | 4,165 | |
|
|
|
|
| Weighted average shares outstanding (basic) | | | | 4,499,580 | | | 4,556,022 | | | 4,553,821 | |
| Weighted average of potential dilutive shares | | |
attributable to stock options granted, computed under
the treasury stock method | | | | 19,495 | | | 25,581 | | | 22,354 | |
|
|
|
|
| Weighted average number of shares (diluted) | | | | 4,519,075 | | | 4,581,603 | | | 4,576,175 | |
|
|
|
|
| | | |
| Net income (In Thousands) | | | $ | 16,143 | | $ | 15,559 | | $ | 15,202 | |
|
|
|
|
| | | |
| Earnings per share: | | |
| Basic | | | $ | 3.59 | | $ | 3.42 | | $ | 3.34 | |
|
|
|
|
| Diluted | | | $ | 3.57 | | $ | 3.39 | | $ | 3.32 | |
|
|
|
|
Stock awards and options: For the years ended December 31, 2007 and 2006, compensation expense for stock issued through the stock award plan is accounted for using the fair value method prescribed by Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (FAS 123R). Under this method, compensation expense is measured and recognized for all stock-based awards made to employees and directors based on the fair value of each option as of the date of the grant.
For the year ended December 31, 2005, compensation expense for stock issued through the stock award plan was accounted for using the intrinsic value based method of accounting prescribed by APB Opinion No. 25, “Accounting for Stock Issues to Employees.” Under this method, compensation was measured as the difference between the estimated fair value of the stock at the date of award less the amount required to be paid for the stock. The difference, if any, was amortized straight line to expense over the vesting period of five years of service. No share-based employee compensation cost was recognized in 2005 because all options granted under the plan had an exercise price equal to the market value of the underlying common stock on the date of grant. See Note 8 to the Consolidated Financial Statements for a tabular presentation of the reconciliation between net income, basic earnings per share and diluted earnings per share as reported in the consolidated financial statements and as the information would have been reported (pro forma) if the Company has chosen to implement the fair value based method for all options.
Common stock held by ESOP: The Company’s maximum cash obligation related to these shares is classified outside stockholders’ equity because the shares are not readily traded and could be put to the Company for cash.
Page 64 of 97
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| Note 1. | Nature of Activities and Significant Accounting Policies (Continued) |
Fair value of financial instruments: In cases where quoted market prices are not available, fair values of financial instruments are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Certain financial instruments and all nonfinancial instruments are excluded from fair value disclosure. Accordingly, the aggregate fair value amounts presented in Note 12 to the Consolidated Financial Statements do not represent the underlying value of the Company.
The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:
| | Off-balance sheet instruments: Fair values for outstanding letters of credit are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of the outstanding letters of credit is not significant. Unfunded loan commitments are not valued since the loans are generally priced at market at the time of funding. |
| | Cash and cash equivalents: The carrying amounts reported in the consolidated balance sheets for cash and short-term instruments approximate their fair values. |
| | Investment securities: Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. |
| | Loans receivable: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for other loans are determined using estimated future cash flows, discounted at the interest rates currently being offered for loans with similar terms to borrowers with similar credit quality. |
| | Accrued interest receivable: The fair value of accrued interest receivable equals the amount receivable due to the current nature of the amounts receivable. |
| | Deposit liabilities: The fair value of demand deposits, savings accounts and certain money market account deposits is the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. If the fair value of the fixed maturity certificates of deposits is calculated at less than the carrying amount, the carrying value of these deposits is reported as the fair value. |
| | Short-term borrowings: The carrying amounts of federal funds purchased and securities sold under agreements to repurchase approximate their fair values. |
| | Long-term borrowings: The fair values of the Bank’s long-term borrowings (other than deposits) are estimated using discounted cash flow analyses, based on the Bank’s current incremental borrowing rates for similar types of borrowing arrangements. |
| | Accrued interest payable: The fair value of accrued interest payable equals the amount payable due to the current nature of the amounts payable. |
Reclassifications: Certain prior year amounts may be reclassified to conform to the current year presentation.
Page 65 of 97
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| Note 2. | Investment Securities |
Investment Securities Available For Sale:
Investment securities have been classified in the consolidated balance sheets according to management’s intent. The Company had no securities designated as trading in its portfolio at December 31, 2007 or 2006. The carrying amount of available-for-sale securities and their approximate fair values were as follows December 31 (in thousands):
| Amortized
Cost
| Gross
Unrealized
Gains
| Gross
Unrealized
(Losses)
| Estimated
Fair
Value
|
|---|
| | | | | |
|---|
| | | | |
|---|
| | | | |
|---|
| | | | |
|---|
| December 31, 2007: | | | | | | | | | | | | | | |
| Other securities (FHLB, FHLMC and FNMA) | | | $ | 104,041 | | $ | 1,070 | | $ | (146 | ) | $ | 104,965 | |
| State and political subdivisions | | | | 94,510 | | | 426 | | | (302 | ) | | 94,634 | |
|
|
|
|
|
| Total | | | $ | 198,551 | | $ | 1,496 | | $ | (448 | ) | $ | 199,599 | |
|
|
|
|
|
| | | | | | | | | | | | | | | |
| December 31, 2006: | | |
| Other securities (FHLB, FHLMC and FNMA) | | | $ | 95,554 | | $ | 3 | | $ | (1,489 | ) | $ | 94,068 | |
| State and political subdivisions | | | | 84,552 | | | 257 | | | (820 | ) | | 83,989 | |
|
|
|
|
|
| Total | | | $ | 180,106 | | $ | 260 | | $ | (2,309 | ) | $ | 178,057 | |
|
|
|
|
|
The amortized cost and estimated fair market value of available-for-sale securities classified according to their contractual maturities at December 31, 2007, were as follows (in thousands):
| Amortized
Cost
| Fair
Value
|
|---|
| | | |
|---|
| | |
|---|
| | |
|---|
| | |
|---|
| Due in one year or less | | | $ | 45,576 | | $ | 45,490 | |
| Due after one year through five years | | | | 104,846 | | | 105,605 | |
| Due after five years through ten years | | | | 46,718 | | | 47,082 | |
| Due over ten years | | | | 1,411 | | | 1,422 | |
|
|
|
| Total | | | $ | 198,551 | | $ | 199,599 | |
|
|
|
As of December 31, 2007, investment securities with a carrying value of $87,076,000 were pledged to collateralize public deposits, short-term borrowings and for other purposes, as required or permitted by law.
Page 66 of 97
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| Note 2. | Investment Securities (Continued) |
Sales proceeds and gross realized gains and losses on available-for-sale securities were as follows for the years ended December 31 (in thousands):
| 2007
| 2006
| 2005
|
|---|
| | | | |
|---|
| | | |
|---|
| | | |
|---|
| | | |
|---|
| Sales proceeds | | | $ | - | | $ | - | | $ | 10,465 | |
| Gross realized gains | | | | - | | | - | | | - | |
| Gross realized losses | | | | - | | | - | | | (234 | ) |
The following table shows the Company’s investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2007 and 2006 (in thousands):
| Less than 12 months
| | 12 months or more
| | Total
|
|---|
2007
Description
of Securities | #
| Fair Value
| Unrealized
Loss
| %
| | #
| Fair Value
| Unrealized
Loss
| %
| | #
| Fair Value
| Unrealized
Loss
| %
|
|---|
| | | | | | | | | | | | | | | |
|---|
| | | | | | | | | | | | | | |
|---|
| | | | | | | | | | | | | | |
|---|
| Other securities | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(FHLB, FHLMC and
FNMA) | | | | 3 | | $ | 6,571 | | $ | (29 | ) | | 0.44 | % | | | 16 | | $ | 36,391 | | $ | (117 | ) | | 0.32 | % | | | 19 | | $ | 42,962 | | $ | (146 | ) | | 0.34 | % |
| State and municipal bonds | | | | 41 | | | 10,892 | | | (41 | ) | | 0.38 | % | | | 159 | | | 32,069 | | | (261 | ) | | 0.81 | % | | | 200 | | | 42,961 | | | (302 | ) | | 0.70 | % |
|
|
|
|
| |
|
|
|
| |
|
|
|
|
| Total temporarily | | |
| impaired securities | | | | 44 | | $ | 17,463 | | $ | (70 | ) | | 0.40 | % | | | 175 | | $ | 68,460 | | $ | (378 | ) | | 0.55 | % | | | 219 | | $ | 85,923 | | $ | (448 | ) | | 0.52 | % |
|
|
|
|
| |
|
|
|
| |
|
|
|
|
| Less than 12 months
| | 12 months or more
| | Total
|
|---|
2006
Description
of Securities | #
| Fair Value
| Unrealized
Loss
| %
| | #
| Fair Value
| Unrealized
Loss
| %
| | #
| Fair Value
| Unrealized
Loss
| %
|
|---|
| | | | | | | | | | | | | | | |
|---|
| | | | | | | | | | | | | | |
|---|
| | | | | | | | | | | | | | |
|---|
| Other securities | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(FHLB, FHLMC
and FNMA) | | | | 1 | | $ | 3,529 | | $ | (10 | ) | | 0.28 | % | | | 38 | | $ | 87,538 | | $ | (1,479 | ) | | 1.69 | % | | | 39 | | $ | 91,067 | | $ | (1,489 | ) | | 1.64 | % |
| | | |
| State and municipal bonds | | | | 52 | | | 9,431 | | | (36 | ) | | 0.38 | % | | | 209 | | | 41,396 | | | (784 | ) | | 1.89 | % | | | 261 | | | 50,827 | | | (820 | ) | | 1.61 | % |
|
|
|
|
| |
|
|
|
| |
|
|
|
|
| | | |
| Total temporarily | | |
| impaired securities | | | | 53 | | $ | 12,960 | | $ | (46 | ) | | 0.35 | % | | | 247 | | $ | 128,934 | | $ | (2,263 | ) | | 1.76 | % | | | 300 | | $ | 141,894 | | $ | (2,309 | ) | | 1.63 | % |
|
|
|
|
| |
|
|
|
| |
|
|
|
|
The Company considered the following information in reaching the conclusion that the impairments disclosed in the table above are temporary and not other-than-temporary impairments. The nature of the investments with gross unrealized losses as of December 31, 2007 was as follows: other securities (19 positions issued and guaranteed by FNMA, FHLB, or FHLMC); and state and municipal bonds (53 issues are local issues, nonrated and 147 issues are A1 or better rated, general obligation bonds). Therefore, none of the impairments in the above table was due to the deterioration in the credit quality of any of the issues that might result in the non-collection of contractual principal and interest. The cause of the impairments is due to changes in interest rates. The Company has not recognized any unrealized loss in income because management has the intent and ability to hold the securities for the foreseeable future.
Page 67 of 97
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| Note 2. | Investment Securities (Continued) |
Investment Securities Held to Maturity:
At December 31, 2007, there were no investment securities held to maturity.
| | Amortized
Cost
| Gross
Unrealized
Gains
| Gross
Unrealized
(Losses)
| Fair
Value
|
|---|
| | (Amounts In Thousands) |
|---|
| | | | | |
|---|
| | | | | |
|---|
| | | | | |
|---|
| December 31, 2006: | | | | | | | | | | | | | | |
| State and political subdivisions | | | $ | 170 | | $ | 7 | | $ | - | | $ | 177 | |
| |
|
|
|
|
The composition of loans is as follows:
| | December 31,
|
|---|
| | 2007
| 2006
| 2005
|
|---|
| | (Amounts In Thousands) |
|---|
| | | | |
|---|
| | | | |
|---|
| Agricultural | | | $ | 60,004 | | $ | 49,223 | | $ | 43,730 | |
| Commercial and financial | | | | 132,070 | | | 118,339 | | | 91,501 | |
| Real estate: | | |
| Construction | | | | 123,144 | | | 114,199 | | | 83,456 | |
| Mortgage | | | | 1,020,802 | | | 983,489 | | | 906,188 | |
| Loans to individuals | | | | 36,289 | | | 31,827 | | | 32,201 | |
| |
|
|
|
| | | | | 1,372,309 | | | 1,297,077 | | | 1,157,076 | |
| Less allowance for loan losses | | | | 19,710 | | | 17,850 | | | 15,360 | |
| |
|
|
|
| | | | $ | 1,352,599 | | $ | 1,279,227 | | $ | 1,141,716 | |
| |
|
|
|
Changes in the allowance for loan losses are as follows:
| | Year Ended December 31, |
|---|
| | 2007
| 2006
| 2005
|
|---|
| | (Amounts In Thousands) |
|---|
| | | | |
|---|
| | | | |
|---|
| Balance, beginning | | | $ | 17,850 | | $ | 15,360 | | $ | 13,790 | |
| Provision charged to expense | | | | 3,529 | | | 3,011 | | | 2,101 | |
| Recoveries | | | | 1,249 | | | 1,352 | | | 1,644 | |
| Loans charged off | | | | (2,918 | ) | | (1,873 | ) | | (2,175 | ) |
| |
|
|
|
| Balance, ending | | | $ | 19,710 | | $ | 17,850 | | $ | 15,360 | |
| |
|
|
|
Page 68 of 97
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Information about impaired and nonaccrual loans as of and for the years ended December 31, 2007, 2006 and 2005 are as follows:
| 2007
| 2006
| 2005
|
|---|
| (Amounts In Thousands) |
|---|
| | | | |
|---|
| | | |
|---|
| | | |
|---|
Impaired loans receivable for which there is a related allowance
for loan losses | | | $ | 4,950 | | $ | 947 | | $ | 586 | |
Impaired loans receivable for which there is no related allowance
for loan losses | | | | 34,633 | | | 13,734 | | | 16,016 | |
|
|
|
|
| Total | | | $ | 39,583 | | $ | 14,681 | | $ | 16,602 | |
|
|
|
|
| | | |
| Related allowance for credit losses on impaired loans | | | $ | 355 | | $ | 292 | | $ | 66 | |
| Average balance of impaired loans | | | | 32,246 | | | 15,722 | | | 16,334 | |
| Nonaccrual loans (included as impaired loans) | | | | 4,948 | | | 879 | | | 175 | |
| Loans past due ninety days or more and still accruing | | | | 6,019 | | | 4,983 | | | 1,910 | |
| Interest income recognized on impaired loans | | | | 2,554 | | | 1,212 | | | 1,147 | |
| Interest income forfeited on non-accrual loans | | | | 279 | | | 34 | | | 19 | |
The increase in impaired loans is due primarily to the deterioration in credit quality of eight borrower relationships that have an aggregate balance of approximately $33.5 million as of December 31, 2007.
| Note 4. | Property and Equipment |
The major classes of property and equipment and the total accumulated depreciation are as follows:
| December 31,
|
|---|
| 2007
| 2006
| 2005
|
|---|
| (Amounts In Thousands) |
|---|
| | | | |
|---|
| | | |
|---|
| Land | | | $ | 4,846 | | $ | 4,648 | | $ | 4,404 | |
| Buildings and improvements | | | | 19,178 | | | 18,929 | | | 18,856 | |
| Furniture and equipment | | | | 26,687 | | | 25,726 | | | 23,844 | |
|
|
|
|
| | | | | 50,711 | | | 49,303 | | | 47,104 | |
| Less accumulated depreciation | | | | 29,491 | | | 27,242 | | | 24,839 | |
|
|
|
|
| Net | | | $ | 21,220 | | $ | 22,061 | | $ | 22,265 | |
|
|
|
|
Page 69 of 97
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| Note 5. | Interest-Bearing Deposits |
A summary of these deposits is as follows:
| December 31, |
|---|
| 2007
| 2006
|
|---|
| (Amounts In Thousands) |
|---|
| | | |
|---|
| | |
|---|
| NOW and other demand | | | $ | 164,531 | | $ | 138,862 | |
| Savings | | | | 255,345 | | | 248,714 | |
| Time, $100,000 and over | | | | 131,159 | | | 149,452 | |
| Other time | | | | 438,672 | | | 427,107 | |
|
|
|
| | | | $ | 989,707 | | $ | 964,135 | |
|
|
|
Time deposits have a maturity as follows:
| December 31, |
|---|
| 2007
| 2006
| |
|---|
| (Amounts In Thousands) |
|---|
| | | |
|---|
| | |
|---|
| Due in one year or less | | | $ | 461,130 | | $ | 447,351 | |
| Due after one year through two years | | | | 43,772 | | | 76,637 | |
| Due after two years through three years | | | | 53,395 | | | 28,379 | |
| Due after three years through four years | | | | 9,950 | | | 17,423 | |
| Due over four years | | | | 1,584 | | | 6,769 | |
|
| |
| |
| | | | $ | 569,831 | | $ | 576,559 | |
|
| |
| |
| Note 6. | Short-Term Borrowings |
The following table sets forth selected information for short-term borrowings (borrowings with a maturity of less than one year):
| December 31, |
|---|
| 2007
| 2006
|
|---|
| (Amounts In Thousands) |
|---|
| | | |
|---|
| | |
|---|
| Federal funds purchased, secured by other securities (FHLB, FHLMC and FNMA) | | | $ | 39,675 | | $ | 10,670 | |
| Repurchase agreements with customers, renewable daily, interest payable | | |
| monthly, secured by other securities (FHLB, FHLMC and FNMA) | | | | 43,886 | | | 43,503 | |
| Repurchase agreements with customers, interest fixed, maturities of less | | |
| than one year, secured by other securities (FHLB, FHLMC and FNMA) | | | | 3,515 | | | 4,890 | |
|
| |
| |
| | | | $ | 87,076 | | $ | 59,063 | |
|
| |
| |
The weighted average interest rate on short-term borrowings outstanding as of December 31, 2007 and 2006 was 3.90% and 4.40%, respectively.
Customer repurchase agreements are used by the Bank to acquire funds from customers where the customer is required or desires to have their funds supported by collateral consisting of investment securities. The repurchase agreement is a commitment to sell these securities to a customer at a certain price and repurchase them at a future date at that same price plus interest accrued at an agreed upon rate. The Bank uses customer repurchase agreements in its liquidity plan as well as an accommodation to customers. At December 31, 2007, $47.4 million of securities sold under repurchase agreements with a weighted average interest rate of 3.47%, maturing in 2008, were collateralized by investment securities having an amortized cost of $47.4 million.
Page 70 of 97
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| Note 7. | Federal Home Loan Bank Borrowings |
As of December 31, 2007 and 2006, the borrowings were as follows:
| | 2007
| 2006
|
|---|
| (Effective interest rates as of December 31, 2007) | (Amounts In Thousands) |
|---|
| | | |
|---|
| | | |
|---|
| | | |
|---|
| Due 2007 | | | $ | - | | $ | 20,000 | |
| Due 2008, 5.38% to 6.00% | | | | 20,348 | | | 30,379 | |
| Due 2009, 5.66% to 6.22% | | | | 40,000 | | | 40,000 | |
| Due 2010, 5.77% to 6.61% | | | | 40,000 | | | 40,000 | |
| Due 2015, 3.70% to 4.56% | | | | 60,000 | | | 60,000 | |
| Due 2016, 4.46% to 4.69% | | | | 45,000 | | | 45,000 | |
| Due 2017, 4.09% to 4.89% | | | | 60,000 | | | - | |
| |
|
|
| | | | $ | 265,348 | | $ | 235,379 | |
| |
|
|
$265 million of the borrowings were callable with $130 million callable in the first quarter of 2008. The advances are unlikely to be called unless rates would move significantly upwards.
The advances from the FHLB are collateralized by the Company’s investment in FHLB stock of $14,169,000 and $12,757,000 at December 31, 2007 and 2006, respectively. Additional collateral is provided by the Company’s 1-4 family mortgage loans totaling $318,417,000 at December 31, 2007 and $282,455,000 at December 31, 2006.
| Note 8. | Employee Benefit Plans |
The Company has an Employee Stock Ownership Plan (the “ESOP”) to which it makes discretionary cash contributions. The Company’s contribution to the ESOP totaled $131,000, $123,000 and $115,000 for the years ended December 31, 2007, 2006 and 2005, respectively.
In the event a terminated plan participant desires to sell his or her shares of the Company stock, or for certain employees who elect to diversify their account balances, the Company may be required to purchase the shares from the participant at their fair value. To the extent that shares of common stock held by the ESOP are not readily tradable, a sponsor must reflect the maximum cash obligation related to those securities outside of stockholders’ equity. Effective June 30, 2005, as a result of the Company’s program to repurchase up to a total of 750,000 shares of the Company’s common stock, the Company began obtaining a quarterly independent appraisal of the shares of stock. Previously, the Company was obtaining an independent appraisal of the shares of stock on an annual basis for the Company’s ESOP. As of December 31, 2007 and 2006, the shares held by the ESOP, fair value and maximum cash obligation were as follows:
| 2007
| 2006
|
|---|
| | | |
|---|
| | |
|---|
| | |
|---|
| | |
|---|
| Shares held by the ESOP | | | | 418,959 | | | 418,788 | |
|
| |
| |
| Fair value per share | | | $ | 53.00 | | $ | 50.00 | |
|
| |
| |
| Maximum cash obligation | | | $ | 22,205,000 | | $ | 20,940,000 | |
|
| |
| |
Page 71 of 97
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| Note 8. | Employee Benefit Plans (Continued) |
The Company has a profit-sharing plan with a 401(k) feature, which provides for discretionary annual contributions in amounts to be determined by the Board of Directors. The profit-sharing contribution totaled $1,049,000, $983,000, and $905,000 for the years ended December 31, 2007, 2006 and 2005, respectively. The Company’s made matching contributions under its 401(k) plan of $111,000 in 2007, $105,000 in 2006 and $98,200 in 2005 and is included in salaries and employee benefits.
The Company provides a deferred compensation program for executive officers. This program allows executive officers to elect to defer a portion of their salaried compensation for payment by the Company at a subsequent date. The executive officers can defer up to 30% of their base compensation and up to 100% of any bonus into the deferral plan. Any amount so deferred is credited to the executive officer’s deferred compensation account and converted to units equivalent in value to the fair market value of a share of stock in Hills Bancorporation. The “stock units” are book entry only and do not represent an actual purchase of stock. The executive officer’s account is adjusted each year for dividends paid and the change in the market value of Hills Bancorporation stock. The deferrals and earnings grow tax deferred until withdrawn from the plan. Earnings credited to the individual’s accounts are recorded as compensation expense when earned. The deferred compensation liability is recorded in other liabilities and totals $2.8 million and $2.5 million at December 31, 2007 and 2006, respectively. Expense related to the deferred compensation plan was $198,000, $213,000 and $491,000 for 2007, 2006 and 2005, respectively and is included in salaries and employee benefits expense.
The Company has a Stock Option and Incentive Plan for certain key employees and directors whereby shares of common stock have been reserved for awards in the form of stock options or restricted stock awards. Under the plan, the aggregate number of options and shares granted cannot exceed 198,000 shares. A Stock Option Committee may grant options at prices equal to the fair value of the stock at the date of the grant. Options expire 10 years from the date of the grant. Director options granted on or before December 31, 2006 may be exercised immediately. Director options granted on or after January 1, 2007, and officers’ rights under the plan vest over a five-year period from the date of the grant. Prior to January 1, 2006, the Company accounted for the stock options under the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25,Accounting for Stock Issued to Employees.
On January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004),Share-Based Payment(FAS 123R), which requires the measurement and recognition of compensation expense for all stock-based awards made to employees and Directors. The Company adopted FAS 123R using the modified prospective transition method. The Consolidated Financial Statements as of and for year ended December 31, 2007 reflect the impact of FAS 123R and include $42,000 of share-based compensation expense. Share-based compensation expense was $44,000 in 2006. In accordance with the modified prospective transition method, the Consolidated Financial Statements for prior periods have not been restated.
Page 72 of 97
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| Note 8. | Employee Benefit Plans (Continued) |
The results for the years ended December 31, 2007 and 2006 are not directly comparable to the same period in 2005. Prior to the adoption of FAS 123R, the Company applied the existing accounting rules under APB Opinion No. 25, which provided that no compensation expense was charged for options granted at an exercise price equal to the market value of the underlying common stock on the date of the grant. If the fair value recognition provisions of FAS 123R had been applied to share-based compensation for the year ended December 31, 2005, the Company’s pro forma net income and earnings per share would have been as follows:
| | |
|---|
| | |
|---|
| | |
|---|
| | |
|---|
| | |
|---|
| Net income: | | | | | |
| As reported | | | $ | 15,202 | |
| Deduct total share-based employee compensation expense determined | | |
| under fair value based method for all awards, net of related tax effects | | | | (84 | ) |
| |
| |
| Pro forma | | | $ | 15,118 | |
| |
| |
| | | |
| Basic earnings per share: | | |
| As reported | | | $ | 3.34 | |
| Pro forma | | | $ | 3.32 | |
| | | |
| Diluted earnings per share: | | |
| As reported | | | $ | 3.32 | |
| Pro forma | | | $ | 3.30 | |
A summary of the stock options are as follows:
| Number of Shares
| Weighted-Average
Exercise Price
| Weighted-Average
Remaining Contractual
Term (Years)
| Aggregate
Intrinsic Value
(In Thousands)
|
|---|
| | | | |
|---|
| | | | |
|---|
| | | | |
|---|
| | | | |
|---|
| Balance, December 31, 2004 | | | | 63,753 | | $ | 26.64 | | | | | | | |
| Granted | | | | - | | | - | | | | | | | |
| Exercised | | | | (1,134 | ) | | 24.33 | | | | | | | |
|
| | | | | | | |
| Balance, December 31, 2005 | | | | 62,619 | | | 26.69 | | | | | | | |
| Granted | | | | - | | | - | | | | | | | |
| Exercised | | | | (5,424 | ) | | 25.62 | | | | | | | |
|
| | | | | | | |
| Balance, December 31, 2006 | | | | 57,195 | | | 26.79 | | | 4.88 | | $ | 1,532 | |
| Granted | | | | 4,580 | | | 52.00 | | | | | | | |
| Exercised | | | | (10,410 | ) | | 18.55 | | | | | | | |
| Forfeited | | | | (3,000 | ) | | 25.67 | | | | | | | |
|
| | | | | | | |
| Balance, December 31, 2007 | | | | 48,365 | | | 31.02 | | | 5.05 | | $ | 1,500 | |
|
| | | | | | | |
The weighted-average fair value of options granted in 2007 was $16.98 per share. The intrinsic value of options exercised was $193,000 and $139,000 for 2007 and 2006, respectively.
Page 73 of 97
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| Note 8. | Employee Benefit Plans (Continued) |
The fair value of each option is estimated as of the date of grant using a Black Scholes option pricing model. The expected lives of options granted incorporate historical employee exercise behavior. The risk-free rate for periods that coincide with the expected life of the options is based on the annual 10 year interest rate swap rate as published by the Federal Reserve Bank. Expected volatility is based on volatility levels of the Company’s peer’s common stock as the Company’s stock has limited trading activity. Expected dividend yield was based on historical dividend rates. Significant assumptions include:
| | 2007
|
|---|
| | |
|---|
| | |
|---|
| | |
|---|
| | |
|---|
| Risk-free interest rate | | | | 5.21 | % |
| Expected option life | | | | 7.5 years | |
| Expected volatility | | | | 25.33 | % |
| Expected dividends | | | | 1.69 | % |
Other pertinent information related to the options outstanding at December 31, 2007 is as follows:
| Exercise Price
| Number Outstanding
| Remaining Contractual Life
| Number Exercisable
|
|---|
| | | | |
|---|
| | | | |
|---|
| | | | |
|---|
| | | | |
|---|
| $ | 25.67 | | | 19,105 | | | 41 Months | | | 19,105 | |
| | 25.00 | | | 200 | | | 36 Months | | | 200 | |
| | 29.33 | | | 15,600 | | | 60 Months | | | 15,600 | |
| | 33.67 | | | 3,000 | | | 72 Months | | | - | |
| | 34.50 | | | 2,940 | | | 76 Months | | | 2,940 | |
| | 36.25 | | | 2,940 | | | 81 Months | | | 2,940 | |
| | 52.00 | | | 4,580 | | | 113 Months | | | - | |
| | |
| | | |
| |
| | | | | 48,365 | | | | | | 40,785 | |
| | |
| | | |
| |
As of December 31, 2007, the outstanding options have a weighted-average exercise price of $31.02 per share and a weighted average remaining contractual term of 5.05 years. The intrinsic value of all options outstanding was $1,500,000 as of December 31, 2007.
As of December 31, 2007, there was $73,100 in unrecognized compensation cost for stock options granted under the plan. This cost is expected to be recognized over a weighted-average period of 3.02 years.
As of December 31, 2007, the vested options totaled 40,785 shares with a weighted-average exercise price of $28.47 per share and a weighted-average remaining contractual term of 4.49 years. The intrinsic value for the vested options was $1,161,000. The fair value of the 15,100 options vested during 2007 was $123,000. The fair value of the 31,200 options vested in 2006 was $248,000.
As of December 31, 2007, 110,950 shares were available for stock options and awards. The committee is also authorized to grant awards of restricted common stock, and it authorized the issuance of 2,192 shares of common stock in 2007, 4,291 in 2006 and 13,748 in 2005 to certain employees. The vesting period for these awards is five years and the Bank amortizes the expense on a straight line basis during the vesting period. The expense relating to these awards for the years ended December 31, 2007, 2006 and 2005 was $166,000, $149,000 and $70,000, respectively.
Page 74 of 97
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Income taxes for the years ended December 31, 2007, 2006 and 2005 are summarized as follows:
| 2007
| 2006
| 2005
|
|---|
| (Amounts In Thousands) |
|---|
| | | | |
|---|
| | | |
|---|
| | | |
|---|
| Current: | | | | | | | | | | | |
| Federal | | | $ | 7,091 | | $ | 6,771 | | $ | 6,335 | |
| State | | | | 1,350 | | | 1,276 | | | 1,219 | |
| Deferred: | | |
| Federal | | | | (1,133 | ) | | (968 | ) | | (756 | ) |
| State | | | | (170 | ) | | (146 | ) | | (114 | ) |
|
|
|
|
| | | | $ | 7,138 | | $ | 6,933 | | $ | 6,684 | |
|
|
|
|
Temporary differences between the amounts reported in the consolidated financial statements and the tax basis of assets and liabilities result in deferred taxes. Deferred tax assets and liabilities at December 31, 2007 and 2006 were as follows:
| | December 31,
|
|---|
| | 2007
| 2006
|
|---|
| | (Amounts In Thousands) |
|---|
| | | |
|---|
| | | |
|---|
| Deferred income tax assets: | | | | | | | | |
| Allowance for loan losses | | | $ | 7,539 | | $ | 6,827 | |
| Deferred compensation | | | | 1,647 | | | 1,440 | |
| Accrued expenses | | | | 379 | | | 281 | |
| Unrealized losses on investment securities | | | | - | | | 784 | |
| Interest on nonaccrual loans | | | | 107 | | | - | |
| State net operating loss | | | | 341 | | | 314 | |
| Other | | | | - | | | 13 | |
| |
|
|
| Gross deferred tax assets | | | | 10,013 | | | 9,659 | |
| Valuation allowance | | | | (341 | ) | | (314 | ) |
| |
|
|
| Deferred tax asset, net of valuation allowance | | | | 9,672 | | | 9,345 | |
| |
|
|
| Deferred income tax liabilities: | | |
| Property and equipment | | | | 904 | | | 1,005 | |
| FHLB dividends | | | | 132 | | | 132 | |
| Prepaid expenses | | | | 78 | | | 277 | |
| Unrealized gains on investment securities | | | | 401 | | | - | |
| Goodwill | | | | 382 | | | 318 | |
| Other | | | | 44 | | | - | |
| |
|
|
| Gross deferred tax liabilities | | | | 1,941 | | | 1,732 | |
| |
|
|
| Net deferred income tax assets | | | $ | 7,731 | | $ | 7,613 | |
| |
|
|
Page 75 of 97
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| Note 9. | Income Taxes (Continued) |
The Company has recorded a deferred tax asset for the future tax benefits of Iowa net operating loss carry-forwards. The net operating loss carry-forwards are generated by the parent company largely from its investment in tax credit real estate properties. The parent company is required to file a separate Iowa tax return and cannot be consolidated with the Bank. The net operating loss carry-forwards will expire, if not utilized, between 2007 and 2022. The Company has recorded a valuation allowance to reduce the net operating loss carry-forwards. At December 31, 2007 and 2006, the Company believes it is more likely than not that the Iowa net operating loss carry-forwards will not be realized. The increase in net operating loss carry-forward in 2007 compared to 2006 reflects the additional Iowa income tax net operating loss generated during 2007 less any expiring carry-forward. A valuation allowance related to the remaining deferred tax assets has not been provided because management believes it is more likely than not that the results of future operations will generate sufficient taxable income to realize the deferred tax assets.
The valuation allowance increased by $28,000 and $27,000 for each of the years ended December 31, 2007 and 2006, respectively.
The net change in the deferred income taxes for the years ended December 31, 2007, 2006 and 2005 is reflected in the consolidated financial statements as follows:
| | Year Ended December 31,
|
|---|
| | 2007
| 2006
| 2005
|
|---|
| | (Amounts In Thousands) |
|---|
| | | | |
|---|
| | | | |
|---|
| Consolidated statements of income | | | $ | 1,303 | | $ | 1,114 | | $ | 870 | |
| Consolidated statements of stockholders' equity | | | | (1,185 | ) | | (320 | ) | | 1,443 | |
| |
|
|
|
| | | | $ | 118 | | $ | 794 | | $ | 2,313 | |
| |
|
|
|
Income tax expense for the years ended December 31, 2007, 2006 and 2005 are less than the amounts computed by applying the maximum effective federal income tax rate to the income before income taxes because of the following items:
| 2007
| 2006
| 2005
|
|---|
| Amount
| % Of
Pretax
Income
| Amount
| % Of
Pretax
Income
| Amount
| % Of
Pretax
Income
|
|---|
| (Amounts In Thousands) |
|---|
| | | | | | | |
|---|
| | | | | | |
|---|
| Expected tax expense | | | $ | 8,148 | | | 35.0 | % | $ | 7,872 | | | 35.0 | % | $ | 7,660 | | | 35.0 | % |
| Tax-exempt interest | | | | (1,230 | ) | | (5.2 | ) | | (1,114 | ) | | (5.0 | ) | | (1,026 | ) | | (4.7 | ) |
| Interest expense | | |
| limitation | | | | 212 | | | 0.9 | | | 185 | | | 0.8 | | | 130 | | | 0.6 | |
| State income taxes, | | |
| net of federal income tax benefit | | | | 767 | | | 3.3 | | | 735 | | | 3.3 | | | 718 | | | 3.3 | |
| Income tax credits | | | | (566 | ) | | (2.4 | ) | | (566 | ) | | (2.5 | ) | | (679 | ) | | (3.1 | ) |
| Other | | | | (193 | ) | | (0.9 | ) | | (179 | ) | | (0.8 | ) | | (119 | ) | | (0.6 | ) |
|
|
|
|
|
|
|
| | | | $ | 7,138 | | | 30.7 | % | $ | 6,933 | | | 30.8 | % | $ | 6,684 | | | 30.5 | % |
|
|
|
|
|
|
|
Page 76 of 97
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| Note 9. | Income Taxes (Continued) |
Federal income tax expense for the years ended December 31, 2007 and 2006 was computed using the consolidated effective federal tax rate. The Company also recognized income tax expense pertaining to state franchise taxes payable individually by the subsidiary bank. On January 1, 2007, the Company adopted FIN 48,Accounting for Uncertainty in Income Taxes. The evaluation was performed for those tax years which remain open to audit. The Company files a consolidated tax return for federal purposes and separate tax returns for the State of Iowa purposes. The tax years ended December 31, 2006, 2005 and 2004, remain subject to examination by the Internal Revenue Service. For state tax purposes, the tax years ended December 31, 2006, 2005 and 2004, remain open for examination. As a result of the implementation of FIN 48, the Company did not recognize any increase or decrease for unrecognized tax benefits. There were no material unrecognized tax benefits on January 1, 2007 and December 31, 2007. No interest or penalties on these unrecognized tax benefits has been recorded. As of December 31, 2007, the Company does not anticipate any significant increase or decrease in unrecognized tax benefits during the next twelve months.
| Note 10. | Regulatory Capital Requirements, Restrictions on Subsidiary Dividends and CashRestrictions |
The Company and the Bank are subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial results. Under capital adequacy guidelines and the regulatory frameworks for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. Capital amounts and classifications of the Company and the Bank are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by the regulations to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the tables that follow) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes that, as of December 31, 2007 and 2006, the Company and the Bank met all capital adequacy requirements to which they are subject.
As of December 31, 2007, the most recent notifications from the Federal Reserve System categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table that follows. There are no conditions or events since that notification that management believes have changed the institution’s category.
Page 77 of 97
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| Note 10. | Regulatory Capital Requirements, Restrictions on Subsidiary Dividends and Cash Restrictions (Continued) |
The actual amounts and capital ratios as of December 31, 2007 and 2006, with the minimum regulatory requirements for the Company and Bank are presented below (amounts in thousands):
| Actual
| For Capital
Adequacy
Purposes
| To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
|
|---|
| Amount
| Ratio
| Ratio
| Ratio
|
|---|
| | | | | |
|---|
| | | | |
|---|
| | | | |
|---|
| As of December 31, 2007: | | | | | | | | | | | | | | |
| Company: | | |
| Total risk-based capital | | | $ | 165,254 | | | 13.37 | % | | 8.00 | % | | 10.00 | % |
| Tier 1 risk-based capital | | | | 149,749 | | | 12.11 | | | 4.00 | | | 6.00 | |
| Leverage ratio | | | | 149,749 | | | 9.18 | | | 3.00 | | | 5.00 | |
| Bank: | | |
| Total risk-based capital | | | | 165,024 | | | 13.36 | | | 8.00 | | | 10.00 | |
| Tier 1 risk-based capital | | | | 149,532 | | | 12.11 | | | 4.00 | | | 6.00 | |
| Leverage ratio | | | | 149,532 | | | 9.17 | | | 3.00 | | | 5.00 | |
| Actual
| For Capital
Adequacy
Purposes
| To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
|
|---|
| Amount
| Ratio
| Ratio
| Ratio
|
|---|
| | | | | |
|---|
| | | | |
|---|
| | | | |
|---|
| As of December 31, 2006: | | | | | | | | | | | | | | |
| Company: | | |
| Total risk-based capital | | | $ | 152,737 | | | 13.31 | % | | 8.00 | % | | 10.00 | % |
| Tier 1 risk-based capital | | | | 138,344 | | | 12.05 | | | 4.00 | | | 6.00 | |
| Leverage ratio | | | | 138,344 | | | 9.00 | | | 3.00 | | | 5.00 | |
| Bank: | | |
| Total risk-based capital | | | | 151,983 | | | 13.25 | | | 8.00 | | | 10.00 | |
| Tier 1 risk-based capital | | | | 137,599 | | | 11.99 | | | 4.00 | | | 6.00 | |
| Leverage ratio | | | | 137,599 | | | 8.95 | | | 3.00 | | | 5.00 | |
The ability of the Company to pay dividends to its stockholders is dependent upon dividends paid by the Bank. The Bank is subject to certain statutory and regulatory restrictions on the amount it may pay in dividends. To maintain acceptable capital ratios in the Bank, certain of its retained earnings are not available for the payment of dividends. To maintain a ratio of capital to assets of 8%, retained earnings of $19,427,000 as of December 31, 2007 are available for the payment of dividends to the Company.
The Bank is required to maintain reserve balances in cash or with the Federal Reserve Bank. Reserve balances totaled $2,436,000 and $1,914,000 as of December 31, 2007 and 2006, respectively.
Page 78 of 97
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| Note 11. | Related Party Transactions |
Certain directors of the Company and the Bank and companies with which the directors are affiliated and certain principal officers are customers of, and have banking transactions with, the Bank in the ordinary course of business. Such indebtedness has been incurred on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons.
The following is an analysis of the changes in the loans to related parties during the years ended December 31, 2007 and 2006:
| Year Ended December 31,
|
|---|
| 2007
| 2006
|
|---|
| (Amounts In Thousands) |
|---|
| | | |
|---|
| | |
|---|
| Balance, beginning | | | $ | 32,638 | | $ | 38,951 | |
| Advances | | | | 50,042 | | | 50,087 | |
| Collections | | | | (44,544 | ) | | (56,400 | ) |
|
|
|
| Balance, ending | | | $ | 38,136 | | $ | 32,638 | |
|
|
|
Deposits from related parties are accepted subject to the same interest rates and terms as those from nonrelated parties.
Page 79 of 97
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| Note 12. | Fair Value of Financial Instruments |
The carrying value and estimated fair values of the Company’s financial instruments as of December 31, 2007 and 2006 are as follows:
| 2007
| 2006
|
|---|
| Carrying
Amount
| Estimated
Fair Value
| Carrying
Amount
| Estimated
Fair Value
|
|---|
| (Amounts In Thousands) |
|---|
| | | | | |
|---|
| | | | |
|---|
| Cash and due from banks | | | $ | 32,383 | | $ | 32,383 | | $ | 23,397 | | $ | 23,397 | |
| Investment securities | | | | 213,768 | | | 213,768 | | | 190,984 | | | 190,991 | |
| Loans | | | | 1,359,391 | | | 1,316,062 | | | 1,283,035 | | | 1,214,320 | |
| Accrued interest receivable | | | | 11,391 | | | 11,391 | | | 10,292 | | | 10,292 | |
| Deposits | | | | 1,143,926 | | | 1,143,926 | | | 1,107,409 | | | 1,107,409 | |
| Federal funds purchased and securities | | |
| sold under agreements to repurchase | | | | 87,076 | | | 87,076 | | | 59,063 | | | 59,063 | |
| Borrowings from Federal Home Loan | | |
| Bank | | | | 265,348 | | | 232,191 | | | 235,379 | | | 195,208 | |
| Accrued interest payable | | | | 3,227 | | | 3,227 | | | 3,500 | | | 3,500 | |
| Face Amount
| | Face Amount
| |
|---|
| | | | | |
|---|
| | | | |
|---|
| | | | |
|---|
| | | | |
|---|
| Off-balance sheet instruments: | | | | | | | | | | | | | | |
| Loan commitments | | | $ | 237,138 | | $ | - | | $ | 200,786 | | $ | - | |
| Letters of credit | | | | 10,961 | | | - | | | 10,107 | | | - | |
Page 80 of 97
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| Note 13. | Parent Company Only Financial Information |
Following is condensed financial information of the Company (parent company only):
CONDENSED BALANCE SHEETS
December 31, 2007 and 2006
(Amounts In Thousands)
ASSETS
| 2007
| 2006
|
|---|
| | | |
|---|
| | |
|---|
| | |
|---|
| | |
|---|
| Cash at subsidiary bank | | | $ | 257 | | $ | 983 | |
| Investment in subsidiary bank | | | | 152,679 | | | 138,834 | |
| Other assets | | | | 1,029 | | | 668 | |
|
|
|
| Total assets | | | $ | 153,965 | | $ | 140,485 | |
|
|
|
| | | |
| LIABILITIES AND STOCKHOLDERS' EQUITY | | |
|
|
|
| | | |
| Liabilities | | | $ | 1,070 | | $ | 906 | |
|
|
|
| Redeemable common stock held by ESOP | | | | 22,205 | | | 20,940 | |
|
|
|
| Stockholders' equity: | | |
| Capital stock | | | | 12,823 | | | 12,364 | |
| Retained earnings | | | | 144,122 | | | 131,852 | |
| Accumulated other comprehensive income (loss) | | | | 647 | | | (1,265 | ) |
| Treasury stock at cost | | | | (4,697 | ) | | (3,372 | ) |
|
|
|
| | | | | 152,895 | | | 139,579 | |
| Less maximum cash obligation related to ESOP shares | | | | 22,205 | | | 20,940 | |
|
|
|
| Total stockholders' equity | | | | 130,690 | | | 118,639 | |
|
|
|
| Total liabilities and stockholders' equity | | | $ | 153,965 | | $ | 140,485 | |
|
|
|
Page 81 of 97
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| Note 13. | Parent Company Only Financial Information (Continued) |
CONDENSED STATEMENTS OF INCOME
Years Ended December 31, 2007, 2006 and 2005
(Amounts In Thousands)
| 2007
| 2006
| 2005
|
|---|
| | | | |
|---|
| | | |
|---|
| | | |
|---|
| | | |
|---|
| Interest on checking account and investment securities | | | $ | 18 | | $ | 160 | | $ | 81 | |
| Dividends received from subsidiary | | | | 4,376 | | | 3,696 | | | 3,413 | |
| Other expenses | | | | (273 | ) | | (265 | ) | | (291 | ) |
|
|
|
|
| Income before income tax benefit and | | |
| equity in undistributed income of subsidiary | | | | 4,121 | | | 3,591 | | | 3,203 | |
| Income tax benefit | | | | 89 | | | 37 | | | 71 | |
|
|
|
|
| | | | | 4,210 | | | 3,628 | | | 3,274 | |
| Equity in undistributed income of subsidiary | | | | 11,933 | | | 11,931 | | | 11,928 | |
|
|
|
|
| Net income | | | $ | 16,143 | | $ | 15,559 | | $ | 15,202 | |
|
|
|
|
Page 82 of 97
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| Note 13. | Parent Company Only Financial Information (Continued) |
CONDENSED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2007, 2006 and 2005
(Amounts In Thousands)
| 2007
| 2006
| 2005
|
|---|
| | | | |
|---|
| | | |
|---|
| | | |
|---|
| | | |
|---|
| Cash flows from operating activities: | | | | | | | | | | | |
| Net income | | | $ | 16,143 | | $ | 15,559 | | $ | 15,202 | |
| Noncash items included in net income: | | |
| Equity in undistributed income of subsidiary | | | | (11,933 | ) | | (11,931 | ) | | (11,928 | ) |
| Share-based compensation | | | | 42 | | | 44 | | | - | |
| Compensation expensed through issuance of common stock | | | | 133 | | | 207 | | | 590 | |
| Excess tax benefits related to share-based compensation | | | | (145 | ) | | (67 | ) | | (16 | ) |
| Forfeiture of common stock | | | | (54 | ) | | (63 | ) | | (29 | ) |
| Increase in other assets | | | | (216 | ) | | (48 | ) | | (68 | ) |
| Increase in liabilities | | | | 164 | | | 147 | | | 223 | |
|
|
|
|
| Net cash provided by operating activities | | | | 4,134 | | | 3,848 | | | 3,974 | |
|
|
|
|
| Cash flows from investing activities: | | |
| Proceeds from maturities of investment securities | | | | - | | | - | | | 500 | |
|
|
|
|
| Net cash provided by investing activities | | | | - | | | - | | | 500 | |
|
|
|
|
| Cash flows from financing activities: | | |
| Stock options exercised | | | | 193 | | | 139 | | | 28 | |
| Excess tax benefits related to share-based | | |
| compensation | | | | 145 | | | 67 | | | 16 | |
| Purchase of treasury stock | | | | (1,325 | ) | | (3,309 | ) | | (63 | ) |
| Dividends paid | | | | (3,873 | ) | | (3,696 | ) | | (3,412 | ) |
|
|
|
|
| Net cash used in financing activities | | | | (4,860 | ) | | (6,799 | ) | | (3,431 | ) |
|
|
|
|
| (Decrease) increase in cash | | | | (726 | ) | | (2,951 | ) | | 1,043 | |
| Cash balance: | | |
| Beginning | | | | 983 | | | 3,934 | | | 2,891 | |
|
|
|
|
| Ending | | | $ | 257 | | $ | 983 | | $ | 3,934 | |
|
|
|
|
Page 83 of 97
HILLS BANCORPORATION
NOTES TOCONSOLIDATED FINANCIAL STATEMENTS
| Note 14. | Commitments and Contingencies |
Concentrations of credit risk: The Bank’s loans, commitments to extend credit, unused lines of credit and outstanding letters of credit have been granted to customers within the Bank’s market area. Investments in securities issued by state and political subdivisions within the state of Iowa totaled approximately $24,489,000. The concentrations of credit by type of loan are set forth in Note 3 to the Consolidated Financial Statements. Outstanding letters of credit were granted primarily to commercial borrowers. Although the Bank has a diversified loan portfolio, a substantial portion of its debtors’ ability to honor their contracts is dependent upon the economic conditions in Johnson County and Linn County, Iowa.
Contingencies: In the normal course of business, the Company and Bank are involved in various legal proceedings. In the opinion of management, any liability resulting from such proceedings would not have a material adverse effect on the accompanying consolidated financial statements.
Financial instruments with off-balance sheet risk: The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, credit card participations and standby letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets.
The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, credit card participations and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. A summary of the Bank’s commitments at December 31, 2007 and 2006 is as follows:
| 2007
| 2006
|
|---|
| (Amounts In Thousands) |
|---|
| | | |
|---|
| | |
|---|
| | |
|---|
| Firm loan commitments and unused portion of lines of credit: | | | | | | | | |
| Home equity loans | | | $ | 21,152 | | $ | 18,796 | |
| Credit card participations | | | | 30,737 | | | 28,091 | |
| Commercial, real estate and home construction | | | | 94,769 | | | 83,699 | |
| Commercial lines | | | | 90,480 | | | 70,200 | |
| Outstanding letters of credit | | | | 10,961 | | | 10,107 | |
Page 84 of 97
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| Note 14. | Commitments and Contingencies (Continued) |
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the party. Collateral held varies, but may include accounts receivable, crops, livestock, inventory, property and equipment, residential real estate and income-producing commercial properties. Credit card participations are the unused portion of the holders’ credit limits. Such amounts represent the maximum amount of additional unsecured borrowings.
Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements and, generally, have terms of one year, or less. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The Bank holds collateral, which may include accounts receivable, inventory, property, equipment, and income-producing properties, supporting those commitments if deemed necessary. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Bank would be required to fund the commitment. The maximum potential amount of future payments the Bank could be required to make is represented by the contractual amount shown in the summary above. If the commitment is funded the Bank would be entitled to seek recovery from the customer. At December 31, 2007 and 2006 no amounts have been recorded as liabilities for the Bank’s potential obligations under these guarantees.
Lease commitments: The Company leases certain facilities under operating leases. The minimum future rental commitments as of December 31, 2007 for all non-cancelable leases relating to Bank premises were as follows:
Year ending December 31:
| (Amounts In Thousands)
|
|---|
| |
|---|
| |
|---|
| |
|---|
| |
|---|
| | 2008 | | | 209 | |
| | 2009 | | | 211 | |
| | 2010 | | | 213 | |
| | 2011 | | | 175 | |
| | 2012 | | | 158 | |
| | Thereafter | | | 210 | |
|
|
| | | | $ | 1,176 | |
|
|
Page 85 of 97
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| Note 15. | Quarterly Results of Operations (unaudited, amounts in thousands, except per share amounts) |
| Quarter Ended
|
|---|
| March
| June
| September
| December
| Year
|
|---|
| | | | | | |
|---|
| | | | | |
|---|
| | | | | |
|---|
| 2007 | | | | | | | | | | | | | | | | | |
| Interest income | | | $ | 23,284 | | $ | 24,008 | | $ | 24,724 | | $ | 24,912 | | $ | 96,928 | |
| Interest expense | | | | 11,966 | | | 12,396 | | | 12,698 | | | 12,892 | | | 49,952 | |
|
|
|
|
|
|
| Net interest income | | | $ | 11,318 | | $ | 11,612 | | $ | 12,026 | | $ | 12,020 | | $ | 46,976 | |
| Provision for loan losses | | | | 532 | | | 954 | | | 1,270 | | | 773 | | | 3,529 | |
| Other income | | | | 3,629 | | | 4,136 | | | 4,217 | | | 4,002 | | | 15,984 | |
| Other expense | | | | 8,612 | | | 8,921 | | | 9,070 | | | 9,547 | | | 36,150 | |
|
|
|
|
|
|
| Income before income taxes | | | $ | 5,803 | | $ | 5,873 | | $ | 5,903 | | $ | 5,702 | | | 23,281 | |
| Income taxes | | | | 1,798 | | | 1,806 | | | 1,814 | | | 1,720 | | | 7,138 | |
|
|
|
|
|
|
| Net income | | | $ | 4,005 | | $ | 4,067 | | $ | 4,089 | | $ | 3,982 | | $ | 16,143 | |
|
|
|
|
|
|
| | | |
| Basic earnings per share | | | $ | 0.89 | | $ | 0.90 | | $ | 0.91 | | $ | 0.89 | | $ | 3.59 | |
| Diluted earnings per share | | | | 0.88 | | | 0.90 | | | 0.90 | | | 0.89 | | | 3.57 | |
| | | |
| 2006 | | |
| Interest income | | | $ | 20,229 | | $ | 21,594 | | $ | 22,620 | | $ | 23,175 | | $ | 87,618 | |
| Interest expense | | | | 9,164 | | | 10,177 | | | 11,143 | | | 11,878 | | | 42,362 | |
|
|
|
|
|
|
| Net interest income | | | $ | 11,065 | | $ | 11,417 | | $ | 11,477 | | $ | 11,297 | | $ | 45,256 | |
| Provision for loan losses | | | | 655 | | | 1,054 | | | 433 | | | 869 | | | 3,011 | |
| Other income | | | | 3,455 | | | 3,772 | | | 3,756 | | | 3,628 | | | 14,611 | |
| Other expense | | | | 8,122 | | | 8,674 | | | 8,516 | | | 9,052 | | | 34,364 | |
|
|
|
|
|
|
| Income before income taxes | | | $ | 5,743 | | $ | 5,461 | | $ | 6,284 | | $ | 5,004 | | $ | 22,492 | |
| Income taxes | | | | 1,794 | | | 1,671 | | | 1,991 | | | 1,477 | | | 6,933 | |
|
|
|
|
|
|
| Net income | | | $ | 3,949 | | $ | 3,790 | | $ | 4,293 | | $ | 3,527 | | $ | 15,559 | |
|
|
|
|
|
|
| | | |
| Basic earnings per share | | | $ | 0.87 | | $ | 0.83 | | $ | 0.94 | | $ | 0.78 | | $ | 3.42 | |
| Diluted earnings per share | | | | 0.86 | | | 0.83 | | | 0.93 | | | 0.77 | | | 3.39 | |
Page 86 of 97
PART II
| Item 9. | Changes In and Disagreements with Accountants on Accounting and Financial Disclosure |
None.
| Item 9A. | Controls and Procedures |
Disclosure Controls and Procedures
As of the end of the period covered by this report, the Company carried out an evaluation under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective.
Management’s Report on Internal Control Over Financial Reporting
The Company’s management is responsible for establishing and maintaining an adequate system of internal control over financial reporting (as defined in Rule 13a-15(f) and Rule 15d-15(f) under the Securities Exchange Act of 1934). Internal control over financial reporting of the Company includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the Company’s consolidated financial statements. Important features of the Company’s system of internal control over financial reporting include the adoption and implementation of written policies and procedures, careful selection and training of financial management personnel, a continuing management commitment to the integrity of the system and through examinations by an internal audit function that coordinates its activities with the Company’s Independent Registered Public Accounting Firm.
All internal control systems, no matter how well designed, have inherent limitations, including the possibility of human error and the circumvention of overriding controls. Accordingly, even effective internal control can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of internal control may vary over time.
The Company’s management conducted an evaluation of the effectiveness of the Company’s internal controls over financial reporting as of December 31, 2007. Management’s assessment is based on the criteria described in “Internal Control – Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, the Company’s management concluded that the Company maintained effective internal control over financial reporting as of December 31, 2007.
There was no change in the Company’s internal control over financial reporting during the most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
The Company’s independent registered public accounting firm, that audited the consolidated financial statements included in this annual report, has issued a report on the Company’s internal control over financial reporting as of December 31, 2007.
Page 87 of 97
| Item 9B. | Other Information |
Not applicable
PART III
| Item 10. | Directors, Executive Officers and Corporate Governance |
The information required by Item 10 of Part III is presented under the items entitled “Certain Information Regarding Directors and Executive Officers” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the Company’s Definitive Proxy Statement dated March 21, 2008 for the Annual Meeting of Stockholders on April 21, 2008. Such information is incorporated herein by reference.
The Company has a Code of Ethics in place for the Chief Executive Officer and Chief Financial Officer. A copy of the Company’s Code of Ethics will be provided free of charge, upon written request to:
| | James G. Pratt
Treasurer
Hills Bancorporation
131 Main Street
Hills, Iowa 52235 |
| Item 11. | Executive Compensation |
The information required by Item 11 of Part III is presented under the item entitled “Executive Compensation and Benefits” in the Company’s Definitive Proxy Statement for the Annual Meeting of Stockholders on April 21, 2008. Such information is incorporated herein by reference.
| Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
The information required by Item 12 is presented under the item entitled “Security Ownership of Principal Stockholders and Management” and “Report on Executive Compensation,” in the Company’s Definitive Proxy Statement for the Annual Meeting of Stockholders on April 21, 2008. Such information is incorporated herein by reference.
| Item 13. | Certain Relationships and Related Transactions, and Director Independence |
The information required by Item 13 of Part III is presented under the item entitled “Loans to and Certain Other Transactions with Executive Officers and Directors” in the Company’s Definitive Proxy Statement for the Annual Meeting of Stockholders on April 21, 2008. Such information is incorporated herein by reference.
| Item 14. | Principal Accounting Fees and Services |
Information required by this item is contained in the Registrant’s Proxy Statement dated March 21, 2008, under the heading “Independent Auditors – Audit and Other Fees,” which section is incorporated herein by this reference.
Page 88 of 97
PART IV
| Item 15. | Exhibits, Financial Statement Schedules |
| | | Form 10-K
Reference
|
|---|
| | | | |
|---|
| | | |
|---|
| | | |
|---|
| | | |
|---|
| (a) | 1. | Financial Statements | |
| |
| |
| | | Independent registered public accounting firm's report on the financial statements | 54 |
| | | Consolidated balance sheets as of December 31, 2007 and 2006 | 55 |
| | | Consolidated statements of income for the years ended
December 31, 2007, 2006, and 2005 | 56 |
| | | Consolidated statements of comprehensive income for the years ended
December 31, 2007, 2006 and 2005 | 57 |
| | | Consolidated statements of stockholders' equity for the years ended
December 31, 2007, 2006 and 2005 | 58 |
| | | Consolidated statements of cash flows for the years ended
December 31, 2007, 2006 and 2005 | 59 |
| | | Notes to financial statements | 61 |
| |
| | 2. | Financial Statements Schedules |
| |
| | | All schedules are omitted because they are not applicable or not required, or because the required information is included in the consolidated financial statements or notes thereto. | |
| |
| (a) | 3. | Exhibits | |
| |
| | 3.1 | Articles of Incorporation filed as Exhibit 3 of Form 10-K for the year ended December 31, 1993 are incorporated by reference. | |
| |
| | 3.2 | By-Laws filed as Exhibit 3 of Form 10-K for the year ended December 31, 1993 are incorporated by reference. | |
| |
| | 10.1 | Material Contract (Employee Stock Ownership Plan) filed as Exhibit 10(a) in Form 10-K for the year ended December 31, 1993 is incorporated by reference. | |
| |
| | 10.2 | Material Contract (1993 Stock Incentive Plan) filed as Exhibit 10(b) in Form 10-K for the year ended December 31, 1993 is incorporated by reference. | |
| |
| | 10.3 | Material Contract (1995 Deferred Compensation Plans) filed as Exhibit 10(c) in Form 10-K for the year ended December 31, 1995 is incorporated by reference. | |
| |
| | 10.4 | Material Contract (2000 Stock Option and Incentive Plan) filed as Exhibit A to the Hills Bancorporation Proxy Statement dated March 23, 2001 is incorporated by reference. | |
| |
| | 11 | Statement Regarding Computation of Basic and Diluted Earnings Per Share on Page 92. | |
| |
| | 21 | Subsidiary of the Registrant is Attached on Page 93. | |
| |
| | 23 | Consent of Independent Registered Public Accounting Firm is Attached on Page 94.
KPMG LLP | |
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| | 31 | Certifications under Section 302 of the Sarbanes-Oxley Act of 2002 on Pages 95 - 96. | |
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| | 32 | Certifications under Section 906 of the Sarbanes-Oxley Act of 2002 on Page 97. | |
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| (b) | | Reports on Form 8-K: | |
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| | | The Registrant filed no reports on Form 8-K for the three months ended December 31, 2007. | |
Page 89 of 97
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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| | HILLS BANCORPORATION |
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| Date: March 11, 2008 | By: /s/ Dwight O. Seegmiller |
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| | Dwight O. Seegmiller, Director, President and Chief Executive Officer |
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| Date: March 11, 2008 | By: /s/ James G. Pratt |
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| | James G. Pratt, Secretary, Treasurer and Chief Accounting Officer |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
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| | DIRECTORS OF THE REGISTRANT |
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| Date: March 11, 2008 | By: /s/ Willis M. Bywater |
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| | Willis M. Bywater, Director |
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| Date: March 11, 2008 | By: /s/ Michael S. Donovan |
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| | Michael S. Donovan, Director |
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| Date: March 11, 2008 | By: /s/ Thomas J. Gill |
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| | Thomas J. Gill, Director |
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| Date: March 11, 2008 | By: /s/ Michael E. Hodge |
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| | Michael E. Hodge, Director |
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| Date: March 11, 2008 | By: /s/ James A. Nowak |
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| | James A. Nowak, Director |
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| Date: March 11, 2008 | By: /s/ Richard W. Oberman |
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| | Richard W. Oberman, Director |
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| Date: March 11, 2008 | By: /s/ Theodore H. Pacha |
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| | Theodore H. Pacha, Director |
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| Date: March 11, 2008 | By: /s/ John W. Phelan |
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| | John W. Phelan, Director |
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| Date: March 11, 2008 | By: /s/ Ann M. Rhodes |
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| | Ann M. Rhodes, Director |
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| Date: March 11, 2008 | By: /s/ Ronald E. Stutsman |
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| | Ronald E. Stutsman, Director |
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| Date: March 11, 2008 | By: /s/ Sheldon E. Yoder |
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| | Sheldon E. Yoder, Director |
Page 90 of 97
HILLS BANCORPORATION
ANNUAL REPORT OF FORM 10-K FOR THE
FISCAL YEAR ENDED DECEMBER 31, 2007
Page 91 of 97
