UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1997 COMMISSION FILE NUMBER: 0-13368 FIRST MID-ILLINOIS BANCSHARES, INC. (Exact name of Registrant as specified in its charter) DELAWARE 37-1103704 (State or other jurisdiction of (I.R.S. employer identification No.) incorporation or organization) 1515 CHARLESTON AVENUE, MATTOON, ILLINOIS 61938 (Address and Zip Code of Principal Executive Offices) (217) 234-7454 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, PAR VALUE $4.00 PER SHARE (Title of class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] As of October 31, 1997, 1,955,881 common shares, $4.00 par value, were outstanding. PART I ITEM 1. FINANCIAL STATEMENTS CONSOLIDATED BALANCE SHEETS September 30, DECEMBER 31, (In thousands, except share data) (unaudited) 1997 1996 ASSETS Cash and due from banks: Non-interest bearing $ 19,700 $ 20,158 Interest bearing 474 453 Federal funds sold 4,050 6,500 Cash and cash equivalents 24,224 27,111 Interest bearing deposits with other financial institutions 99 99 Investment securities: Available-for-sale, at fair value 111,708 114,027 Held-to-maturity, at amortized cost (estimated fair value of $3,501 and $3,491 at September 30, 1997 and December 31, 1996, respectively) 3,490 3,481 Loans 362,943 348,217 Less allowance for loan losses 2,633 2,684 Net loans 360,310 345,533 Premises and equipment, net 12,290 10,735 Intangible assets 8,928 5,472 Other assets 9,776 8,939 TOTAL ASSETS $ 530,825 $ 515,397 LIABILITIES AND STOCKHOLDERS' EQUITY Deposits: Non-interest bearing $ 52,605 $ 55,044 Interest bearing 403,484 358,632 Total deposits 456,089 413,676 Securities sold under agreements to repurchase 9,190 18,360 Federal Home Loan Bank advances 10,000 32,426 Long-term debt 6,450 6,200 Other liabilities 4,527 4,831 TOTAL LIABILITIES 486,256 475,493 Stockholders' Equity Series A convertible preferred stock; no par value; authorized 1,000,000 shares; issued 620 shares with stated value of $5,000 per share 3,100 3,100 Common stock, $4 par value; authorized 6,000,000 shares in 1997 and 2,000,000 shares in 1996; issued 1,952,471 shares in 1997 and 1,885,632 shares in 1996 7,810 3,771 Additional paid-in-capital 6,643 5,463 Retained earnings 26,815 27,578 Net unrealized gain on available-for-sale investment securities, net of tax 225 16 Less treasury stock at cost, 4,000 shares (24) (24) TOTAL STOCKHOLDERS' EQUITY 44,569 39,904 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $530,825 $515,397 See accompanying notes to consolidated financial statements. CONSOLIDATED STATEMENTS OF INCOME For the nine months ended September 30, 1997 and 1996 (In thousands, except per share data) (unaudited) 1997 1996 INTEREST INCOME: Interest and fees on loans $22,363 $20,443 Interest on investment securities 5,631 5,623 Interest on federal funds sold 122 148 Interest on deposits with other financial institutions 73 54 Total interest income 28,189 26,268 INTEREST EXPENSE: Interest on deposits 12,629 11,409 Interest on securities sold under agreements to repurchase 394 393 Interest on Federal Home Loan Bank advances 881 909 Interest on federal funds purchased 25 40 Interest on long-term debt 341 359 Total interest expense 14,270 13,110 Net interest income 13,919 13,158 Provision for loan losses 460 36 Net interest income after provision for loan losses 13,459 13,122 OTHER INCOME: Trust revenues 1,212 900 Brokerage revenues 346 272 Service charges 1,326 1,293 Securities (losses), net (6) (10) Mortgage banking revenue 291 299 Other 736 743 Total other income 3,905 3,497 OTHER EXPENSE: Salaries and employee benefits 5,868 5,890 Occupancy, furniture and equipment, net 2,099 1,775 Federal deposit insurance premiums 12 964 Amortization of intangible assets 518 411 Stationary and supplies 478 397 Legal and professional fees 619 611 Marketing and promotion 397 376 Other 1,644 1,474 Total other expense 11,635 11,898 Income before income taxes 5,729 4,721 Income taxes 2,040 1,663 Net income $ 3,689 $ 3,058 Per common share data: Primary earnings per share $ 1.81 $ 1.55 Fully diluted earnings per share 1.70 1.47 See accompanying notes to consolidated financial statements. CONSOLIDATED STATEMENTS OF INCOME For the three months ended September 30, 1997 and 1996 (In thousands, except per share data) (unaudited) 1997 1996 INTEREST INCOME: Interest and fees on loans $ 7,662 $ 7,217 Interest on investment securities 1,851 1,900 Interest on federal funds sold 44 60 Interest on deposits with other financial institutions 50 26 Total interest income 9,607 9,203 INTEREST EXPENSE: Interest on deposits 4,489 3,841 Interest on securities sold under agreements to repurchase 111 133 Interest on Federal Home Loan Bank advances 182 532 Interest on federal funds purchased 10 11 Interest on long-term debt 117 130 Total interest expense 4,909 4,647 Net interest income 4,698 4,556 Provision for loan losses 210 36 Net interest income after provision for loan losses 4,488 4,520 OTHER INCOME: Trust revenues 338 248 Brokerage revenues 126 112 Service charges 465 444 Securities (losses), net - (28) Mortgage banking revenue 122 103 Other 245 195 Total other income 1,296 1,074 OTHER EXPENSE: Salaries and employee benefits 1,950 2,004 Occupancy, furniture and equipment, net 741 621 Federal deposit insurance premiums 27 827 Amortization of intangible assets 179 137 Stationary and supplies 179 155 Legal and professional fees 234 194 Marketing and promotion 108 121 Other 518 501 Total other expense 3,936 4,560 Income before income taxes 1,848 1,034 Income taxes 663 345 Net income $ 1,185 $ 689 Per common share data: Primary earnings per share $ .57 $ .33 Fully diluted earnings per share .54 .33 See accompanying notes to consolidated financial statements. CONSOLIDATED STATEMENTS OF CASH FLOWS For the nine months ended September 30, 1997 and 1996 (In thousands) (unaudited) 1997 1996 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 3,689 $ 3,058 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 460 36 Depreciation, amortization and accretion, net 1,366 945 Loss on sale of securities, net 6 10 Gain on sale of loans held for sale, net (212) (211) Origination of mortgage loans held for sale (17,437) (14,443) Proceeds from sale of mortgage loans held for sale 17,298 11,315 (Increase) in other assets (973) (2,015) Increase (decrease) in other liabilities (283) 3,367 Net cash provided by operating activities 3,914 2,062 CASH FLOWS FROM INVESTING ACTIVITIES: Capitalization of mortgage servicing rights (62) (118) Purchases of premises and equipment (1,097) (1,390) Net increase in loans (14,426) (37,867) Proceeds from sales of: Securities available-for-sale 9,983 24,753 Proceeds from maturities of: Securities available-for-sale 19,650 20,014 Securities held-to-maturity 155 40 Purchases of: Securities available-for-sale (26,958) (46,103) Securities held-to-maturity (170) (80) Cash of acquired branch 22,416 - Net cash provided by (used in) investing activities 9,491 (40,751) CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in deposits 14,657 13,437 Decrease in securities sold under agreements to repurchase (9,170) (2,735) Increase (decrease) in Federal Home Loan Bank advances (22,426) 28,726 Repayment of long-term debt (750) (750) Proceeds from long-term debt 1,000 - Proceeds from issuance of common stock 838 998 Dividends paid on preferred stock (16) (16) Dividends paid on common stock (425) (436) Net cash provided by (used in) financing activities (16,292) 45,724 Increase (decrease) in cash and cash equivalents (2,887) 7,035 Cash and cash equivalents at beginning of period 27,111 23,295 Cash and cash equivalents at end of period $24,224 $30,330 ADDITIONAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid during the period for: Interest $14,623 $13,070 Income taxes 2,285 1,755 Loans transferred to real estate owned 579 290 Dividends reinvested in common shares 529 462 See accompanying notes to consolidated financial statements. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The unaudited consolidated financial statements include the accounts of First Mid-Illinois Bancshares, Inc. ("Registrant") and its wholly owned subsidiaries: First Mid-Illinois Bank & Trust, N.A. ("First Mid Bank"); Heartland Savings Bank ("Heartland"); and Mid-Illinois Data Services, Inc. ("MIDS"). All significant intercompany balances and transactions have been eliminated in consolidation. The financial information reflects all adjustments which, in the opinion of management, are necessary to present a fair statement of the results of the interim periods ended September 30, 1997 and 1996, and all such adjustments are of a normal recurring nature. The results of the interim periods ended September 30, 1997, are not necessarily indicative of the results expected for the year ending December 31, 1997. During the fourth quarter of 1997, the Registrant plans to merge two of its wholly owned bank subsidiaries, Heartland and First Mid Bank, with First Mid Bank being the surviving entity. This merger will enable customers of both banking subsidiaries access to a wider array of real estate loan products and other financial services and will result in reduced costs of product and services distributions. The unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information required by generally accepted accounting principles for complete financial statements and related footnote disclosures. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Registrant's 1996 Form 10-K. YEAR 2000 COMPLIANCE The Registrant utilizes and is dependent upon data processing systems and software to conduct its business. The data processing systems and software include those developed and maintained by the Registrant's third-party data processing vendor and purchased software which is run on in-house computer networks. In 1997, the Registrant initiated a review and assessment of all hardware and software to confirm that it will function properly in the year 2000. To date, those vendors which have been contacted have indicated that their hardware or software is or will be Year 2000 compliant by the end of 1998. The Registrant anticipated that year 2000 compliance will increase its data processing expenses in 1998, although management does not believe that such costs will have a material impact on overall 1998 financial performance. EARNINGS PER SHARE A 2-for-1 common stock split was distributed on June 5, 1997, in the form of a 100% stock dividend for the stockholders of record on May 22, 1997. Accordingly, information with respect to shares of common stock and earnings per share have been restated in all periods presented to fully reflect the stock split. Earnings per share of common stock have been determined by dividing net income for the period by the weighted average number of common shares outstanding. Income for primary earnings per common share is adjusted for dividends attributable to preferred stock. Fully diluted earnings per share data is computed by using the weighted average number of common shares outstanding, increased by the assumed conversion of the convertible preferred stock. The weighted average number of common equivalent shares used in calculating earnings per share were as follows: THREE MONTHS ENDED NINE MONTHS ENDED September 30, September 30, 1997 1996 1997 1996 Primary 1,945,720 1,869,384 1,919,264 1,828,800 Fully diluted 2,196,324 2,119,988 2,169,868 2,079,404 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis is intended to provide a better understanding of the consolidated financial condition and results of operations of the Registrant and its subsidiaries for the three month and nine month periods ended September 30, 1997 and 1996. This discussion and analysis should be read in conjunction with the consolidated financial statements appearing elsewhere in this Form 10-Q. SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 This report contains certain forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The Registrant intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Reform Act of 1995, and is including this statement for purposes of these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Registrant, are generally identifiable by use of the words "believe," "expect," "intend," "anticipate," "estimate," "project," or similar expressions. The Registrant's ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse affect on the operations and future prospects of the Registrant and the subsidiaries include, but are not limited to, changes in: interest rates, general economic conditions, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Registrant's market area and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Further information concerning the Registrant and its business, including additional factors that could materially affect the Registrant's financial results, is included in the Registrant's filings with the securities and Exchange Commission. 1997 ACQUISITION During the first quarter of 1997, the Registrant acquired the Charleston, Illinois branch location and the deposit base of First of America Bank. This cash acquisition added approximately $28 million to total deposits, $.5 million to loans, $1.3 million to premises and equipment and $3.8 million to intangible assets. OVERVIEW Net income for the three month period ended September 30, 1997, increased to $1,185,000, up 72% from $689,000 earned in the same quarter of 1996. On a fully diluted basis, earnings per share for the quarterly period increased $.21 per share to $.54 as compared to $.33 per share earned in the third quarter of 1996. An increase of $142,000 in net interest income together with higher levels of non interest income, primarily from trust and brokerage activities, and a reduction in the amount of non interest expense, primarily attributable to FDIC deposit insurance premiums, contributed to increased profitability. The change in deposit insurance premiums was due to a $758,000 one-time charge to record the effect of a special assessment associated with the recapitalization of the Savings Association Insurance Fund. A summary of the factors which contributed to the changes in quarterly net income follows (in thousands): TABLE 1-A EFFECT ON QUARTERLY EARNINGS 1997 VS 1996 Increase in net interest income $ 142 Increase in provision for loan losses (174) Increase in other income, including securities transactions 222 Decrease in other expenses 624 Increase in income taxes (318) Increase in net income $ 496 Net income for the nine month period ended September 30, 1997 increased to $3,689,000, up 20.6% from $3,058,000 earned in the nine month period ended September 30, 1996. On a fully diluted basis, earnings per share for the period increased $.23 per share to $1.70 as compared to $1.47 per share earned in the same period of 1996. An increase of $761,000 in net interest income together with higher levels of non interest income, primarily from trust and brokerage activities, and a reduction in the amount of non interest expense, primarily attributable to deposit insurance premiums, contributed to increased profitability. The Registrant provided $460,000 for possible loan losses during the first nine months, whereas only $36,000 was provided for possible loan losses during the same nine month period of 1996. Increased equipment, supplies and other non interest expenses associated with recent technology investments also reduced the income of the first nine months of 1997. A summary of the factors which contributed to the changes in year-to-date net income follows (in thousands): TABLE 1-B EFFECT ON YEAR-TO-DATE EARNINGS 1997 VS 1996 Increase in net interest income $ 761 Increase in provision for loan losses (424) Increase in other income, including securities transactions 408 Decrease in other expenses 263 Increase in income taxes (377) Increase in net income $ 631 The Registrant's annualized return on average total assets increased to .94% for the nine months ended September 30, 1997 as compared to .85% for the year ended December 31, 1996. Return on average total equity and return on average common equity increased to 11.71% and 11.90%, respectively for the nine month period ended September 30, 1997 as compared to 11.03% and 11.18% for the year ended December 31, 1996. Average total equity to average assets increased to 8.02% for the nine months ended September 30, 1997 compared to 7.69% for the year ended December 31, 1996. NET INTEREST INCOME The largest source of operating revenue for the Registrant is net interest income. Net interest income represents the difference between total interest income earned on earning assets and total interest expense paid on interest- bearing liabilities. The amount of interest income is dependent upon many factors including the volume and mix of earning assets, the general level of interest rates and the dynamics of changes in interest rates. The cost of funds necessary to support earning assets varies with the volume and mix of interest-bearing liabilities and the rates paid to attract and retain such funds. For purposes of the following discussion and analysis, the interest earned on tax-exempt securities is adjusted to an amount comparable to interest subject to normal income taxes. The adjustment is referred to as the tax equivalent ("TE") adjustment. The Registrant's average balances, interest income and expense and rates earned or paid for major balance sheet categories are set forth in the following table (dollars in thousands): TABLE 2 DISTRIBUTION OF CONSOLIDATED ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY - INTEREST, RATES AND NET YIELDS NINE MONTH PERIOD ENDED YEAR ENDED SEPTEMBER 30, 1997 (ANNUALIZED)(4) DECEMBER 31, 1996 AVERAGE AVERAGE AVERAGE AVERAGE BALANCE INTEREST(4) RATE BALANCE INTEREST RATE ASSETS Interest bearing deposits $ 1,878 $ 97 5.18% $ 1,264 $ 65 5.14% Federal funds sold 3,028 163 5.37 3,403 180 5.29 Investment securities Taxable 108,383 6,808 6.28 111,640 6,858 6.14 Tax-exempt(1) 12,975 1,061 8.17 11,442 953 8.33 Loans (2)(3) 353,357 29,817 8.44 326,302 27,827 8.53 Total earning assets 479,621 37,946 7.91 454,051 35,883 7.90 Cash and due from banks 18,249 17,051 Premises and equipment 11,762 9,864 Other assets 16,682 12,854 Allowance for loan losses (2,658) (2,762) Total assets $ 523,656 $ 491,058 LIABILITIES AND STOCKHOLDERS' EQUITY Interest Bearing Deposits Demand deposits $ 123,524 $ 3,592 2.91% $ 110,708 $ 3,085 2.79% Savings deposits 39,157 1,029 2.63 39,364 1,069 2.72 Time deposits 223,559 12,217 5.46 204,362 11,156 5.46 Securities sold under agreements to repurchase 11,545 525 4.55 12,411 574 4.62 FHLB advances 20,028 1,176 5.87 23,920 1,405 5.87 Federal funds purchased 644 33 5.18 800 44 5.50 Long-term debt 6,630 455 6.86 6,819 472 6.92 Total interest bearing 425,087 19,027 4.48 398,384 17,805 4.47 liabilities Demand deposits 52,068 50,789 Other liabilities 4,491 4,102 Stockholders' equity 42,010 37,783 Total liabilities & equity $ 523,656 $ 491,058 Net interest income (TE) $ 18,919 $ 18,078 Net interest spread 3.43% 3.43% Impact of non-interest bearing funds .51% .55% Net yield on interest earning assets (TE) 3.94% 3.98% (1) Interest income and rates are presented on a tax equivalent basis ("TE") assuming a federal income tax rate of 34%. (2) Loan fees are included in interest income and are not material. (3) Nonaccrual loans have been included in the average balances. (4) 1997 interest income and expense amounts have been annualized based on results through September 30, 1997. The annualized amounts are not necessarily indicative of the actual amounts that are expected or that will occur for the year ending December 31, 1997. Changes in net interest income may also be analyzed by segregating the volume and rate components of interest income and interest expense. The following table summarizes the approximate relative contribution of changes in average volume and interest rates to changes in net interest income (TE) for the past year (in thousands): TABLE 3 ANALYSIS OF CHANGES IN INTEREST INCOME AND INTEREST EXPENSE 1997 COMPARED TO 1996 INCREASE - (DECREASE)(5) TOTAL RATE/ CHANGE VOLUME RATE VOLUME(4) EARNING ASSETS: Interest bearing deposits $ 32 $ 31 $ 1 $ - Federal funds sold (17) (20) 3 - Investment securities: Taxable (50) (200) 155 (5) Tax-exempt (1) 108 128 (18) (2) Loans (2)(3) 1,990 2,307 (293) (24) Total interest income 2,063 2,246 (152) (31) Interest-Bearing Liabilities Interest-bearing deposits Demand deposits 507 357 134 16 Savings deposits (40) (6) (34) - Time deposits 1,061 1,049 11 1 Securities sold under agreements to repurchase (49) (40) (9) - FHLB advances (229) (229) - - Federal funds purchased (11) (9) (3) 1 Long-term debt (17) (13) (4) - Total interest expense 1,222 1,109 95 18 Net interest income $ 841 $ 1,137 $ (247) $ (49) (1) Interest income and rates are presented on a tax equivalent basis, assuming a federal income tax rate of 34%. (2) Loan fees are included in interest income and are not material. (3) Nonaccrual loans are not material and have been included in the average balances. (4) The changes in rate/volume are computed on a consistent basis by multiplying the change in rates with the change in volume. (5) 1997 interest income and expense amounts have been annualized based on results through September 30, 1997. The annualized amounts are not necessarily indicative of the actual amounts that are expected or that will occur for the year ending December 31, 1997. On an annualized tax equivalent basis, net interest income increased $841,000, or 4.7% for 1997, compared to an annualized increase of $804,000, or 4.8% for the same period of 1996. As set forth in Table 3, the improvement in net interest income was due to the increase in the volume of earning assets and interest-bearing liabilities, partially offset by the effect of changes in interest rates. In 1997, average earning assets increased by $25,570,000, or 5.6%, and average interest-bearing liabilities increased by $26,703,000, or 6.7%, compared with 1996 (Table 2). The higher volumes of earning assets and interest-bearings liabilities were primarily the result of strong loan growth in 1996 and 1997. As a percentage of average earning assets, average loans increased from 71.2% on September 30, 1996, to 73.7% on September 30, 1997, and average securities decreased from 27.6% to 25.3% for the same periods of time. PROVISION FOR LOAN LOSSES The provision for loan losses in the third quarter of 1997 was $210,000 and $36,000 for the same period of 1996. For the nine month period ended September 30, 1997, the provision for loan losses was $460,000 and $36,000 for the same period of 1996. This was primarily in response to the increase in the loan portfolio and charge offs during 1997. For information on loan loss experience and nonperforming loans, see the "Nonperforming Loans" and "Loan Quality and Allowance for Loan Losses" sections later in this document. OTHER INCOME An important source of the Registrant's revenue is derived from other income. The following table sets forth the major components of other income for the nine months ended September 30, 1997 and 1996 (in thousands): TABLE 4-A YEAR-TO-DATE OTHER INCOME NINE MONTHS ENDED 1997 1996 $ CHANGE Trust $ 1,212 $ 900 $ 312 Brokerage 346 272 74 Securities (losses) (6) (10) 4 Service charges 1,326 1,293 33 Mortgage banking 291 299 (8) Other 736 743 (7) Total other income $ 3,905 $ 3,497 $ 408 The Registrant's other income increased to $3,905,000 in the first nine months of 1997 as compared to $3,497,000 in the first nine months of 1996. Trust revenues increased to $1,212,000 in the first nine months of 1997 as compared to $900,000 for the same period of 1996. Trust assets increased to $302,589,000 at September 30, 1997 from $223,117,000 at December 31, 1996 and $213,950,000 at September 30, 1996. During 1997, increased revenues were primarily due to an increase in fees generated on retirement plans and farm agencies under management as well as the increase in trust assets. Revenues from brokerage and annuity sales increased by $74,000 in the first nine months of 1997 as compared to the same period in 1996. This increase was attributable to the more favorable market conditions during 1997 for the variable rate annuities and the special fixed rate annuity programs provided to customers. There were net securities losses of $6,000 in the first nine months of 1997 as compared to $10,000 in net securities losses in the same period of 1996. Service charges amounted to $1,326,000 in the first nine months of 1997 as compared to $1,293,000 in the first nine months of 1996. The increase of $33,000 or 2.6% in service charges in 1997 as compared to 1996 was primarily due to an increase in the activity of overdraft accounts. Heartland originates loans for its own portfolio and for sale to others. Mortgage banking income from loans originated and subsequently sold into the secondary market amounted to $291,000 in the first nine months of 1997 as compared to $299,000 for the same period of 1996. Included in 1997 and 1996 mortgage banking income was the amount of the mortgage servicing rights recorded on loans originated and sold into the secondary market with servicing retained amounting to $48,000 and $8,000 for the nine month periods ended September 30, 1997 and 1996, respectively. In 1997, the volume of loans sold by Heartland was $17.0 million, representing 260 loans as compared to $12.7 million representing 211 loans during the first nine months of 1996. The following table sets forth the major components of other income for the three months ended September 30, 1997 and 1996 (in thousands): TABLE 4-B QUARTERLY OTHER INCOME THREE MONTHS ENDED 1997 1996 $ CHANGE Trust $ 338 $ 248 $ 90 Brokerage 126 112 14 Securities (losses) - (28) 28 Service charges 465 444 21 Mortgage banking 122 103 19 Other 245 195 50 Total other income $ 1,296 $ 1,074 $ 222 The Registrant's other income increased to $1,296,000 in the third quarter of 1997 as compared to $1,074,000 in the third quarter of 1996. Trust revenues increased to $338,000 in the third quarter of 1997 as compared to $248,000 in the third quarter of 1996. Trust assets increased to $302,589,000 at September 30, 1997 from $223,117,000 at December 31, 1996 and $213,950,000 at September 30, 1996. During the third quarter of 1997 as compared to the same quarter of 1996, increased revenues were primarily due to an increase in fees generated on retirement plans and farm agencies under management and the increase in trust assets. Revenues from brokerage and annuity sales increased by $14,000 in the third quarter of 1997 as compared to the same period in 1996. There were no securities gains or losses in the third quarter of 1997 as compared to $28,000 in net securities losses in the third quarter of 1996. Service charges amounted to $465,000 in the third quarter of 1997 as compared to $444,000 in the third quarter of 1996. The increase of $21,000 or 4.7% in service charges in 1997 as compared to 1996 was primarily due to an increase in the activity of overdraft accounts. OTHER EXPENSE The major categories of other expense include salaries and employee benefits, occupancy and equipment expenses and other operating expenses associated with day-to-day operations. The following table sets forth the major components of other expense for the first nine months of 1997 and 1996 (in thousands): TABLE 5-A YEAR-TO-DATE OTHER EXPENSE NINE MONTHS ENDED 1997 1996 $ CHANGE Salaries and benefits $ 5,868 $ 5,890 $ (22) Occupancy, furniture & equipment 2,099 1,775 324 FDIC premiums 12 964 (952) Amortization of intangibles 518 411 107 Stationary and supplies 478 397 81 Legal and professional fees 619 611 8 Marketing and promotion 397 376 21 Other operating expenses 1,644 1,474 170 Total other expense $11,635 $11,898 $ (263) The Registrant's non-interest expense amounted to $11,635,000 in the first nine months of 1997 as compared to $11,898,000 in the first nine months of 1996. Salaries and employee benefits, the largest component of other expense, remained constant at $5,868,000 in the first nine months of 1997 as compared to $5,890,000 in the first nine months of 1996. At September 30, 1997, the number of full-time equivalent ("FTE") employees totaled 264 compared to 254 at September 30, 1996. Occupancy, furniture and equipment expense increased to $2,099,000 in the first nine months of 1997 as compared to $1,775,000 in the first nine months of 1996. The 18.3% increase was primarily due to the increase in depreciation expense recorded on the technology equipment put into service at the beginning of 1997. This included items relating to document imaging, report imaging, home banking and wide-area network projects. The net amount of FDIC premiums recorded in the first nine months of 1997 includes a refund of $69,000 on the 1996 assessments of the Savings Association Insurance Fund ("SAIF"). During the first nine months of 1996, the Registrant recorded premium expense of $206,000 and a one-time special SAIF assessment of $758,000, as required by federal legislation, to increase the balance of the SAIF. A lower premium rate in effect beginning in 1997 helped to reduce overall deposit insurance. Amortization of intangible assets increased 26.0% when comparing the first nine months of 1997 and 1996. This net increase was primarily the result of an increase of $159,000 during the second and third quarters of 1997 in association with the acquisition by the Registrant of the Charleston branch. Core deposit premium and goodwill generated from this transaction amounted to $3.8 million, which will be amortized over 7 and 15 years, respectively. During the first nine months of 1997, various categories of other operating expenses were impacted by the implementation of several large technology projects including imaging of customer checks and statements and the establishment of a wide-area network, along with new products being introduced such as PC banking. The following table sets forth the major components of other expense for the third quarter of 1997 and 1996 (in thousands): TABLE 5-B QUARTERLY OTHER EXPENSE THREE MONTHS ENDED 1997 1996 $ CHANGE Salaries and benefits $ 1,950 $ 2,004 $ (54) Occupancy, furniture & equipment 741 621 120 FDIC premiums 27 827 (800) Amortization of intangibles 179 137 42 Stationary and supplies 179 155 24 Legal and professional fees 234 194 40 Marketing and promotion 108 121 (13) Other operating expenses 518 501 17 Total other expense $ 3,936 $ 4,560 $ (624) The Registrant's non-interest expense amounted to $3,936,000 in the third quarter of 1997 as compared to $4,560,000 in the third quarter of 1996. Salaries and employee benefits, the largest component of other expense, decreased slightly from $1,950,000 in the third quarter of 1997 as compared to $2,004,000 in the third quarter of 1996. This slight decrease was primarily due to insurance expense. Occupancy, furniture and equipment expense increased to $741,000 in the third quarter of 1997 as compared to $621,000 in the third quarter of 1996. The 19.3% increase was primarily due to the increase in depreciation expense recorded on the technology equipment placed into service at the beginning of 1997. This included items relating to document imaging, report imaging, home banking and wide-area network projects. FDIC premiums recorded in the third quarter of 1997 decreased to $27,000 from $69,000 in the third quarter of 1996. The Registrant also recorded a one-time special SAIF assessment of $758,000 during the third quarter of 1996. Amortization of intangible assets increased 30.7% when comparing the third quarters of 1997 and 1996. This increase in expenses resulted from the March 1997, acquisition of the Charleston, Illinois branch. Core deposit premium and goodwill generated from this transaction amounted to $3.8 million, and is being amortized over 7 and 15 years, respectively. INCOME TAXES Total income tax expense amounted to $2,040,000 in the first nine months of 1997 as compared to $1,663,000 in the first nine months of 1996. The total tax expense included state income tax expense of $173,000 and $152,000 for the first nine months of 1997 and 1996, respectively. Effective tax rates were 35.6% and 35.2% respectively, for the first nine months of 1997 and 1996. ANALYSIS OF BALANCE SHEETS SECURITIES The Registrant's overall investment goal is to maximize earnings while maintaining liquidity in securities having minimal credit risk. The types and maturities of securities purchased are primarily based on the Registrant's current and projected liquidity and interest rate sensitivity positions. The following table sets forth the amortized cost of the securities at September 30, 1997 and December 31, 1996 (in thousands): TABLE 6 INVESTMENT PORTFOLIO SEPTEMBER 30, DECEMBER 31, 1997 1996 % OF % OF AMOUNT TOTAL AMOUNT TOTAL U.S. Treasury securities and obligations of U.S. Government Agencies and corporations $ 76,986 67% $ 86,518 74% Obligations of states and political subdivisions 13,418 12 11,398 10 Mortgage-backed securities 21,901 19 15,283 13 Other securities 2,552 2 4,285 3 Total securities $114,857 100% $117,484 100% At September 30, 1997 the Registrant's investment portfolio showed an increase in mortgage-backed securities and municipal securities. The amortized cost, gross unrealized gains and losses and estimated fair values for available-for-sale and held-to-maturity securities by major security type at September 30, 1997 and December 31, 1996 were as follows (in thousands): TABLE 7 INVESTMENTS AT AMORTIZED COST / ESTIMATED FAIR VALUE GROSS GROSS ESTIMATED AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE September 30, 1997 AVAILABLE-FOR-SALE: U.S. Treasury securities and obligations of U.S. Government Agencies and corporations $ 76,986 $ 202 $ (252) $ 76,936 Obligations of states and political subdivisions 9,928 325 (1) 10,252 Mortgage-backed securities 21,901 150 (83) 21,968 Federal Home Loan Bank stock 2,115 - - 2,115 Other securities 437 - - 437 Total available-for-sale $111,367 $ 677 $ (336) $111,708 HELD-TO-MATURITY: Obligations of states and political subdivisions $ 3,490 $ 31 $ (20) $ 3,501 DECEMBER 31, 1996 AVAILABLE-FOR-SALE: U.S. Treasury securities and obligations of U.S. Government Agencies and corporations $ 86,518 $ 342 $ (585) $ 86,275 Obligations of states and political subdivisions 7,917 249 (3) 8,163 Mortgage-backed securities 15,283 103 (82) 15,304 Federal Home Loan Bank stock 3,878 - - 3,878 Other securities 407 - - 407 Total available-for-sale $114,003 $ 694 $ (670) $114,027 HELD-TO-MATURITY: Obligations of states and political subdivisions $ 3,481 $ 28 $ (18) $ 3,491 The following table indicates the expected maturities of investment securities classified as available-for-sale and held-to-maturity, presented at amortized cost, at September 30, 1997 (dollars in thousands) and the weighted average yield for each range of maturities. Mortgage backed securities are aged according to their weighted average life. All other securities are shown at their contractual maturity. TABLE 8 INVESTMENT MATURITY SCHEDULE ONE AFTER 1 AFTER 5 AFTER YEAR THROUGH THROUGH TEN OR LESS 5 YEARS 10 YEARS YEARS TOTAL AVAILABLE-FOR-SALE: U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 10,803 $ 50,121 $ 15,564 $ 498 $ 76,986 Obligations of state and political subdivisions 709 4,668 749 3,802 9,928 Mortgage-backed securities 2,137 9,230 2,966 7,568 21,901 Other securities - - - 2,552 2,552 Total Investments $ 13,649 $ 64,019 $ 19,279 $ 14,420 $111,367 Weighted average yield 5.80% 6.32% 6.39% 6.39% 6.28% Full tax equivalent yield 5.93% 6.54% 6.51% 7.26% 6.55% HELD-TO-MATURITY: Obligations of state and political subdivisions $ 700 $ 1,972 $ 353 $ 465 $ 3,490 Weighted average yield 4.70% 5.09% 5.73% 5.74% 5.16% Full tax equivalent yield 7.12% 7.71% 8.69% 8.70% 7.82% The weighted average yields are calculated on the basis of the cost and effective yields weighted for the scheduled maturity of each security. Full tax equivalent yields have been calculated using a 34% tax rate. With the exception of obligations of the U.S. Treasury and other U.S. Government agencies and corporations, there were no investment securities of any single issuer the book value of which exceeded 10% of stockholders' equity at September 30, 1997. Proceeds from sales of investment securities and realized gains and losses were as follows during the nine months ended September 30, 1997 and the year ended December 31, 1996 (in thousands): TABLE 9 PROCEEDS FROM SALES September 30, 1997 December 31, 1996 Proceeds from sales $9,983 $31,667 Gains 20 155 Losses 26 164 LOANS The loan portfolio (net of unearned discount) is the largest category of the Registrant's earning assets. The following table summarizes the composition of the loan portfolio at September 30, 1997 and December 31, 1996 (in thousands): TABLE 10 COMPOSITION OF LOANS September 30, December 31, 1997 1996 Commercial, financial and agricultural $74,342 $ 75,028 Real estate - mortgage 257,317 241,240 Installment 30,184 30,423 Other 1,100 1,526 Total loans $362,943 $348,217 At September 30, 1997, the Registrant had loan concentrations in agricultural industries of 13.3% of outstanding loans, remaining unchanged since December 31, 1996. The Registrant had no further industry loan concentrations in excess of 10% of outstanding loans. TABLE 11 LOAN MATURITY DISTRIBUTION AND INTEREST RATE SENSITIVITY The following table presents the balance of loans outstanding as of September 30, 1997, by maturities (dollars in thousands): MATURITY (1) OVER 1 ONE YEAR THROUGH OVER OR LESS(2) 5 YEARS 5 YEARS TOTAL Commercial, financial and agricultural $52,454 $ 19,700 $ 2,189 $ 74,342 Real estate - mortgage 43,013 138,518 75,786 257,317 Installment 6,315 22,838 1,032 30,184 Other 210 488 402 1,100 Total loans $101,992 $178,544 $79,409 $362,943 (1) Based on scheduled principal repayments. (2) Includes demand loans, past due loans and overdrafts. As of September 30, 1997, loans with maturities over one year consisted of $214,163,000 in fixed rate loans and $43,790,000 in variable rate loans. The loan maturities noted above are based on the contractual provisions of the individual loans. The Registrant has no general policy regarding rollovers and borrower requests, which are handled on a case by case basis. NONPERFORMING LOANS Nonperforming loans include: (a) loans accounted for on a nonaccrual basis; (b) accruing loans contractually past due 90 days or more as to interest or principal payments; and loans not included in (a) and (b) above which are defined as "troubled debt restructurings". The following table presents information concerning the aggregate amount of nonperforming loans (in thousands): TABLE 12 NONPERFORMING LOANS September 30, December 31, 1997 1996 Nonaccrual loans $ 990 $ 790 Loans past due ninety days or more and still accruing 287 575 Restructured loans which are performing in accordance with revised terms 360 580 Interest income for the nine months ended September 30, 1997 that would have been reported if nonaccrual and restructured loans had been performing totaled $136,000. Interest income that was included in income for the same period totaled $26,000. The Registrant's policy generally is to discontinue the accrual of interest income on any loan for which principal or interest is 90 days past due and when, in the opinion of management, there is reasonable doubt as to the timely collectibility of interest or principal. Nonaccrual loans are returned to accrual status when, in the opinion of management, the financial position of the borrower indicates there is no longer any reasonable doubt as to the timely collectibility of interest or principal. LOAN QUALITY AND ALLOWANCE FOR LOAN LOSSES The allowance for loan losses represents management's estimate of the reserve necessary to adequately cover losses that could ultimately be realized from current loan exposures. The provision for loan losses is the charge against current earnings that is determined by management as the amount needed to maintain an adequate allowance for loan losses. In determining the adequacy of the allowance for loan losses, and therefore the provision to be charged to current earnings, management relies predominantly on a disciplined credit review and approval process which extends to the full range of the Registrant's credit exposure. The review process is directed by overall lending policy and is intended to identify, at the earliest possible stage, borrowers who might be facing financial difficulty. Once identified, the magnitude of exposure to individual borrowers is quantified in the form of specific allocations of the allowance for loan losses. Collateral values are considered by management in the determination of such specific allocations. Additional factors considered by management in evaluating the overall adequacy of the allowance include historical net loan losses, the level and composition of nonaccrual, past due and renegotiated loans and the current and anticipated economic conditions in the region where the Registrant operates. In addition to the aforementioned considerations, management also considers the loan loss experience of other banks, thrifts and financial services holding companies. Management recognizes that there are risk factors which are inherent in the Registrant's loan portfolio. All financial institutions face risk factors in their loan portfolios because risk exposure is a function of the business. The Registrant's operations (and therefore its loans) are concentrated in east central Illinois, an area where agriculture is the dominant industry. Accordingly, lending and other business relationships with agriculture-based businesses are critical to the Registrant's success. At September 30, 1997, the Registrant's loan portfolio included $48.1 million of loans to borrowers whose businesses are directly related to agriculture. The balance increased $1.7 million from $46.4 million at December 31, 1996. In addition to agricultural lending, the Registrant has historically had substantial residential mortgage lending activity in and around east central Illinois. Residential mortgage loans amounted to $187.9 million or 51.8% of total loans at September 30, 1997. At December 31, 1996, these loans amounted to $172.3 million or 49.5% of total loans. TABLE 13 ALLOWANCE FOR LOAN LOSSES Loan loss experiences are summarized as follows (dollars in thousands): NINE MONTHS ENDED YEAR ENDED September 30, DECEMBER 31, 1997 1996 Average loans outstanding, net of unearned income $353,357 $326,302 Allowance-beginning of year 2,684 2,814 Charge-offs: Commercial, financial and agricultural 354 238 Real estate-mortgage 67 6 Installment 115 131 Total charge-offs 536 375 Recoveries: Commercial, financial and agricultural 10 53 Real estate-mortgage - - Installment 15 45 Total recoveries 25 98 Net charge-offs 511 277 Provision for loan losses 460 147 Allowance-end of period $2,633 $ 2,684 Ratio of net charge-offs to average loans .14% .08% Ratio of allowance for loan losses to loans outstanding (less unearned interest at end of period) .73% .77% Ratio of allowance for loan losses to nonperforming loans 160.8% 138.0% The Registrant minimizes credit risk by adhering to sound underwriting and credit review policies. These policies are reviewed at least annually, and changes are approved by the board of directors. Senior management is actively involved in business development efforts and the maintenance and monitoring of credit underwriting and approval. The loan review system and controls are designed to identify, monitor and address asset quality problems in an accurate and timely manner. On a monthly basis, the board of directors reviews the status of problem loans. In addition to internal policies and controls, regulatory authorities periodically review asset quality and the overall adequacy of the allowance for loan losses. During the first nine months of 1997, the Registrant had net charge-offs of $511,000. Of this amount, $358,000 was attributable to losses on four specific commercial borrowers with the remainder generally being the result of personal bankruptcies. During the third quarter, management also identified an additional borrower with a loss potential of $240,000. This was placed on nonaccrual status during September, 1997. The aforementioned matters together with the Registrant's general expectations for future growth in the loan portfolio resulted in an increase in the provision for loan losses to $460,000 during the first nine months of 1997 as compared to $147,000 during the year ended December 31, 1996. At September 30, 1997, the allowance was $2,633,000, or .73% of total loans, and 160.8% of nonperforming loans. On December 31, 1996, the allowance for loan losses amounted to $2,684,000, or .77% of total loans, and 138% of nonperforming loans. The allowance for loan losses, in management's judgment, would be allocated as follows to cover potential loan losses (in thousands): TABLE 14 ALLOCATION OF ALLOWANCE FOR LOAN LOSSES September 30, 1997 DECEMBER 31, 1996 ALLOWANCE % OF ALLOWANCE % OF FOR LOANS FOR LOANS LOAN TO TOTAL LOAN TO TOTAL LOSSES LOANS LOSSES LOANS Commercial, financial and agricultural $ 1,644 20.5% $ 1,854 21.5% Real estate-mortgage 320 70.9 434 69.3 Installment 206 8.3 152 8.7 Other - .3 - .5 Total allocated 2,170 2,440 Unallocated 463 N/A 244 N/A Allowance at end of reported period $2,633 $100.0% $ 2,684 100.0% The allowance is allocated to the individual loan categories by a specific reserve for all classified loans plus a percentage of loans not classified based on historical losses. DEPOSITS Funding the Registrant's earning assets is substantially provided by a combination of consumer, commercial and public fund deposits. The Registrant continues to focus its strategies and emphasis on retail core deposits, the major component of funding sources. The following table sets forth the average deposits and weighted average rates at September 30, 1997 and December 31, 1996 (dollars in thousands): TABLE 15 COMPOSITION OF DEPOSITS PERIOD ENDED PERIOD ENDED SEPTEMBER 30, 1997 DECEMBER 31, 1996 WEIGHTED WEIGHTED AVERAGE AVERAGE AMOUNT RATE AMOUNT RATE Demand deposits: Non-interest bearing $ 52,068 - $ 50,789 - Interest bearing 123,524 2.91% 110,708 2.79% Savings 39,157 2.63 39,364 2.72 Time deposits 223,559 5.46 204,362 5.46 Total average deposits $438,308 3.84% $405,223 3.78% The following table sets forth the maturity of time deposits of $100,000 or more (in thousands): TABLE 16 MATURITY DISTRIBUTION OF TIME DEPOSITS OF $100,000 OR MORE September 30, December 31, 1997 1996 3 months or less $ 16,224 $ 20,658 Over 3 through 6 months 17,011 7,322 Over 6 through 12 months 9,603 6,897 Over 12 months 9,240 5,893 Total $ 52,078 $ 40,770 OTHER BORROWINGS Other borrowings consist of securities sold under agreements to repurchase, Federal Home Loan Bank advances, and federal funds purchased. Information relating to other borrowings for the periods ended September 30, 1997 and December 31, 1996 is presented below (in thousands): TABLE 17 SCHEDULE OF OTHER BORROWINGS SEPTEMBER 30, DECEMBER 31, 1997 1996 End of Period: Securities sold under agreements to repurchase $9,190 $18,360 Federal Home Loan Bank advances: Overnight - 19,733 Fixed term - due in one year or less 3,000 11,693 Fixed term - due after one year 7,000 1,000 Total $19,190 $50,786 Average interest rate at end of period 5.21% 5.91% Maximum Outstanding at Any Month-end Securities sold under agreements to repurchase $17,710 $18,860 Federal Home Loan Bank advances: Overnight 23,733 23,083 Fixed term - due in one year or less 16,000 20,693 Fixed term - due after one year 9,000 7,500 Federal funds purchased - 6,500 Averages for the Year Securities sold under agreements to repurchase $11,545 $12,411 Federal Home Loan Bank advances: Overnight 9,269 8,136 Fixed term - due in one year or less 3,982 9,352 Fixed term - due after one year 6,777 6,432 Federal funds purchased 644 800 Average interest rate during the year 5.38% 5.45% Securities sold under agreements to repurchase primarily represent borrowings originated as part of cash management services offered to corporate customers. The remaining balance of securities sold under agreements to repurchase represents term repurchase agreements with the State of Illinois. Federal Home Loan Bank advances represent borrowings by the Bank Subsidiaries to fund loan demand. INTEREST RATE SENSITIVITY The Registrant seeks to maximize its net interest margin within an acceptable level of interest rate risk. Interest rate risk can be defined as the amount of forecasted net interest income that may be gained or lost due to favorable or unfavorable movements in interest rates. Interest rate risk, or sensitivity, arises when the maturity or repricing characteristics of assets differ significantly from the maturity or repricing characteristics of liabilities. The Registrant monitors its interest rate sensitivity position to maintain a balance between rate sensitive assets and rate sensitive liabilities. This balance serves to limit the adverse effects of changes in interest rates. The Registrant's asset/liability management committee oversees the interest rate sensitivity position and directs the overall allocation of funds in an effort to maintain a cumulative one-year gap to earning assets ratio of less than 30% of total earning assets. In the banking industry, a traditional measurement of interest rate sensitivity is known as "gap" analysis, which measures the cumulative differences between the amounts of assets and liabilities maturing or repricing at various intervals. The following table sets forth the amounts of interest- earning assets and interest-bearing liabilities outstanding at September 30, 1997, which are anticipated by the Registrant to reprice or mature in each of the future time periods shown. Except for savings and N.O.W. accounts the amounts of assets and liabilities shown which reprice or mature during a particular period are based upon the contractual terms of the asset or liability. Regular savings accounts are assumed to be withdrawn over a 60 month period and NOW accounts were assumed to be withdrawn over an 18 month period. The two deposit types collectively totaled $120 million at September 30, 1997. Management believes that these assumptions approximate actual experience and considers them reasonable, although the actual amortization and repayment of assets and liabilities may vary substantially. TABLE 18 GAP TABLE (In thousands) NUMBER OF MONTHS UNTIL NEXT REPRICING OPPORTUNITY INTEREST EARNING ASSETS: 0-1 1-3 3-6 6-12 12+ Deposits with other financial institutions $ 573 $ - $ - $ - $ - Federal funds sold 4,050 - - - - Taxable investment securities 24,610 11,510 7,467 15,237 42,894 Nontaxable investment securities - 620 727 315 11,814 Loans 47,222 14,047 33,085 34,115 234,474 Total $ 76,455 $ 26,177 $ 41,279 $ 49,667 $289,182 INTEREST BEARING LIABILITIES: Savings and N.O.W. accounts (1) 5,168 10,336 15,504 31,007 58,108 Money market accounts 49,288 - - - - Other time deposits 25,880 29,163 60,349 46,315 72,365 Other borrowings 9,190 3,000 - 1,000 6,000 Long-term debt 6,450 - - - - Total $ 95,976 $ 42,499 $ 75,853 $ 78,322 $136,473 Periodic GAP $(19,521) $(16,322) $(34,574) $ (28,655) $152,709 Cumulative GAP $(19,521) $(35,843) $(70,417) $(99,072) $ 53,637 GAP as a % of interest earning assets: Periodic (4.0%) (3.4%) (7.2%) (5.9%) 31.6% Cumulative (4.0%) (7.4%) (14.6%) (20.5%) 11.1% (1) Historically the Registrant's NOW accounts and savings deposits have been relatively insensitive to interest rate changes. However, the Registrant considers a portion of these deposits to be rate sensitive based on historical trends and management's expectations. At September 30, 1997, the table above reflects that the Registrant was liability sensitive due to the level of interest bearing demand deposits and savings deposits which are generally subject to immediate withdrawal and may be repriced at any time. As such, the effect of an increase in the prime rate of 100 basis points would decrease net interest income by approximately $520,000 in 90 days and $1,168,000 in 12 months assuming no management intervention. A fall in the interest rates would have the opposite effect for the same period. In analyzing interest rate sensitivity, the Registrant considers these differences and incorporates other assumptions and factors, such as balance sheet growth and prepayments, to better measure interest rate risk. Certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as ARM loans, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. Further, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the table. Finally, the ability of many borrowers to service their debt may decrease in the event of an interest rate increase. Interest rate sensitivity using a static GAP analysis basis is only one of several measurements of the impact of interest rate changes on net interest income used by the Registrant. Its actual usefulness in assessing the effect of changes in interest rates varies with the constant changes which occur in the composition of the Registrant's earning assets and interest bearing liabilities. For this reason, the Registrant uses financial models to project interest income under various rate scenarios and various assumptions relative to the prepayments, reinvestment and roll overs of assets and liabilities. CAPITAL RESOURCES At September 30, 1997, the Registrant's stockholders' equity amounted to $44,569,000, a $4,665,000 or 11.7% increase from the $39,904,000 balance as of December 31, 1996. Year to date, net income contributed $3,689,000 to equity before $215,000 of dividends to preferred stockholders. Common stock dividends declared during this same period of 1997 amounted to $385,000. The change in net unrealized gain on available-for-sale investment securities increased stockholders' equity by $209,000, net of tax. During 1996, the Registrant began issuing Company common stock as part of a deferred compensation plan for its directors and certain senior officers and as an investment option under the Registrant's 401-K (First Retirement and Savings Plan) for its employees. During the first nine months of 1997, 7,867 shares were issued pursuant to the Deferred Compensation Plan and 33,537 shares were issued pursuant to the First Retirement and Savings Plan. In late 1994, the Registrant implemented a Dividend Reinvestment Plan whereby common and preferred stockholders could elect to have their cash dividends automatically reinvested into newly-issued common shares of the Registrant. This plan became effective with the January, 1995 common stock dividend. Of the $971,000 in common and preferred stock dividends paid during the first nine months of 1997, $529,000 or 54.5% was reinvested into shares of common stock of the Registrant through the Dividend Reinvestment Plan. This resulted in an additional 27,435 shares of common stock being issued during the first nine months of 1997. The Registrant is subject to various regulatory capital requirements administered by the federal banking agencies. Bank holding companies follow minimum regulatory requirements established by the Federal Reserve Board, First Mid Bank follows similar minimum regulatory requirements established for national banks by the Office of the Comptroller of the Currency and Heartland is regulated by the FDIC and the Office of the Commissioner of Banks & Real Estate. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary action by regulators that, if undertaken, could have a direct material effect on the Registrant's financial statements. Quantitative measures established by each regulatory agency to ensure capital adequacy require the reporting institutions to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital to risk- weighted assets, and of Tier 1 capital to average assets. Management believes, as of September 30, 1997, that all capital adequacy requirements have been met. As of September 30, 1997, the most recent notification from the primary regulators categorized the Registrant, First Mid Bank and Heartland as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios must be maintained as set forth in the table. There are no conditions or events since that notification that management believes have changed these categories. TABLE 19 CAPITAL RATIOS TO BE WELL CAPITALIZED UNDER FOR CAPITAL PROMPT CORRECTIVE ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO September 30, 1997 Total Capital (to risk-weighted assets) Registrant $38,230 11.74% $26,046 > 8.00% $32,558 > 10.00% First Mid Bank 33,755 11.99 22,516 > 8.00 28,145 > 10.00 Heartland 7,513 17.66 3,404 > 8.00 4,255 > 10.00 Tier 1 Capital (to risk-weighted assets) Registrant 35,597 10.93 13,023 > 4.00 19,535 > 6.00 First Mid Bank 31,147 11.18 11,258 > 4.00 16,887 > 6.00 Heartland 7,164 16.84 1,702 > 4.00 2,553 > 6.00 Tier 1 Capital (to average assets) Registrant 35,597 6.91 20,619 > 4.00 25,774 > 5.00 First Mid Bank 31,147 7.26 17,333 > 4.00 21,666 > 5.00 Heartland 7,164 8.07 3,553 > 4.00 4,441 > 5.00 LIQUIDITY Liquidity represents the ability of the Registrant and its subsidiaries to meet the requirements of customers for loans and deposit withdrawals. Liquidity management focuses on the ability to obtain funds economically for these purposes and to maintain assets which may be converted into cash at minimal costs. Management monitors its expected liquidity requirements carefully, focusing primarily on cash flows from operating, investing and financing activities. EFFECTS OF INFLATION Unlike industrial companies, virtually all of the assets and liabilities of the Registrant are monetary in nature. As a result, interest rates have a more significant impact on the Registrant's performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or experience the same magnitude of changes as goods and services, since such prices are effected by inflation. In the current economic environment, liquidity and interest rate adjustments are features of the Registrant's assets and liabilities which are important to the maintenance of acceptable performance levels. The Registrant attempts to maintain a balance between monetary assets and monetary liabilities, over time, to offset these potential effects. FUTURE ACCOUNTING CHANGES In June 1996, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities" ("SFAS 125"). SFAS 125, among other things, applies a "financial-components approach" that focuses on control, whereby an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes assets when control has been surrendered, and derecognizes liabilities when extinguished. SFAS 125 provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. SFAS 125 is effective for transactions occurring after December 31, 1996; however SFAS 127, issued in December 1996, deferred the effective date of certain elements of SFAS 125 for one year. The Registrant adopted SFAS 125 during the first quarter of 1997, without any significant impact on its consolidated financial condition or results of operations. In February 1997, FASB issued SFAS No. 128, "Earnings Per Share" ("SFAS 128"). SFAS 128 supersedes APB Opinion No. 15, "Earnings Per Share" ("APB #15") and specifies the computations, presentation, and disclosure requirements for earnings per share ("EPS") for entities with publicly held common stock or potential common stock. SFAS 128 was issued to simplify the computation of EPS and to make the U.S. standard more compatible with the EPS standards of other countries and that of the International Accounting Standards Committee. It replaces the presentation of primary EPS with a presentation of basic EPS and fully diluted EPS with diluted EPS. It also requires dual presentation of basic and diluted EPS on the face of the income statement for all entities with complex capital structures and requires a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. Basic EPS, unlike primary EPS, excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Diluted EPS is computed similarly to fully diluted EPS under APB #15. SFAS 128 is effective for financial statements for both interim and annual periods ending after December 15, 1997. Earlier application is not permitted (although pro forma EPS disclosure in the footnotes for periods prior to required adoption is permitted). After adoption, all prior-period EPS data presented shall be restated to conform with SFAS 128. The Registrant does not expect adoption of SFAS 128 to have a significant impact on its financial statements. In February, 1997, FASB issued SFAS No. 129, "Disclosure of Information about Capital Structure", which is effective for financial statements for periods ending after December 15, 1997. This statement lists required disclosures about capital structure that had been included in a number of previously existing separate statements and opinions. The Registrant does not expect adoption of SFAS 129 to have a significant impact on its financial statements. In June 1997, FASB issued SFAS No. 130, "Reporting Comprehensive Income", which is effective for fiscal years beginning after December 15, 1997. This statement establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general purpose financial statements. This statement requires that all items that are required in a financial statement that is displayed with the same prominence as other financial statements. In June 1997, FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information", which is effective for fiscal years beginning after December 31, 1997. This statement establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to stockholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. PART II--OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Since the Bank Subsidiaries act as depositories of funds, each is named from time to time as a defendant in law suits (such as garnishment proceedings) involving claims to the ownership of funds in particular accounts. Management believes that all such litigation as well as other pending legal proceedings constitute ordinary routine litigation incidental to the business of the Bank Subsidiaries and that such litigation will not materially adversely affect the Registrant's consolidated financial condition. In addition to the normal legal proceedings referred to above, the Registrant, on behalf of Heartland, filed a complaint on December 5, 1995, against the U.S. Government which is now pending in the U.S. Court of Federal Claims in Washington D.C. This complaint relates to Heartland's interest as successor to Mattoon Federal Savings and Loan Association which incurred a significant amount of supervisory goodwill when it acquired Urbana Federal Savings and Loan in 1982. The complaint alleges that the Government breached its contractual obligations when, in 1989, it issued new rules which eliminated supervisory goodwill from inclusion in regulatory capital. In January 1997, the U.S. Court of Federal Claims denied the Government's motion to dismiss this supervisory goodwill complaint. The Government had taken the position that the complaint, as well as the complaints of a number of other parties, should be prohibited from moving forward on statute of limitation grounds. At this time it is too early to tell whether Heartland will ultimately prevail in the suit and if so, what damages may be recovered. ITEM 2. CHANGES IN SECURITIES None ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. TEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, AND REPORTS ON FORM 8-K. (a)(3) -- Exhibits (a)(3) -- The exhibits required by Item 601 of Regulation S-K and filed herewith are listed in the exhibit Index which follows the Signature Page and immediately precedes the exhibits filed. (b) Reports on Form 8-K There were no reports on Form 8-K filed by the Registrant during the quarter ended September 30, 1997. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized on this 12th day of November, 1997. FIRST MID-ILLINOIS BANCSHARES, INC. (Registrant) /s/ Daniel E. Marvin, Jr. *-------------------------------------* Daniel E. Marvin, Jr. President and Chief Executive Officer /s/ William S. Rowland *-------------------------------------* William S. Rowland Chief Financial Officer Dated: November 12, 1997 *---------------------* EXHIBIT INDEX TO FORM 10-Q EXHIBIT NUMBER DESCRIPTION AND FILING OR INCORPORATION REFERENCE 3.1 RESTATED CERTIFICATE OF INCORPORATION AND AMENDMENT TO RESTATED CERTIFICATE OF INCORPORATION OF FIRST MID-ILLINOIS BANCSHARES, INC. Exhibit 3(a) to First Mid-Illinois Bancshares, Inc.'s Annual Report on Form 10-K for the year ended December 31, 1987 (File No. 0-13688) 3.2 RESTATED BYLAWS OF FIRST MID-ILLINOIS BANCSHARES, INC. Exhibit 3(b) to First Mid-Illinois Bancshares, Inc.'s Annual Report on Form 10-K for the year ended December 31, 1987 (File No 0-13368) 11.1 STATEMENT RE: COMPUTATION OF EARNINGS PER SHARE (Filed herewith) 27.1 FINANCIAL DATA SCHEDULE (Filed herewith)