Hills Bancorporation
Form 10-k
December 31, 2001
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-k
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2001. Commission File Number 0-12668.
HILLS BANCORPORATION
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(Exact name of Registrant as specified in its charter)
Iowa 42-1208067
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(State or Other Jurisdiction of (IRS Employer Identification No.)
Incorporation or Organization)
131 Main Street, Hills, Iowa 52235
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(Address of principal executive offices)
Registrant's telephone number, including area code: (319) 679-2291
Securities Registered pursuant to Section 12 (b) of the Act: None
Securities Registered pursuant to Section 12 (g) of the Act:
No par value common stock
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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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Registrant S-K (229.405 of this chapter) is not contained herein, and will
not be contained to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [X]
While it is difficult to determine the market value of shares owned by
nonaffiliates (within the meaning of such term under the applicable regulations
of the Securities and Exchange Commission), the Registrant estimates that the
aggregate market value of the Registrant's common stock held by nonaffiliates on
March 15, 2002 (based upon reports of beneficial ownership that approximately
82% of the shares are so owned by nonaffiliates and upon information
communicated informally to the Registrant by various purchasers and sellers that
the sale price for the common stock is generally $82 per share) was
$100,763,000.
The number of shares outstanding of the Registrant's common stock as of March
15, 2002 is 1,498,558 shares of no par value common stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement dated March 22, 2002 for the Annual Meeting of
the Shareholders of the Registrant to be held April 15, 2002 (the Proxy
Statement) are incorporated by reference in Part III of this Form 10-K.
EXHIBIT INDEX
The exhibits index is on Page 72.
Part I
Item 1. Business
GENERAL
Hills Bancorporation (the "Company") is a holding company principally engaged,
through its subsidiary bank, in the business of banking. The Company was
incorporated December 12, 1982 and all operations are conducted within the state
of Iowa. The Company became owner of 100% of the outstanding stock of Hills Bank
and Trust Company, Hills, Iowa ("Hills Bank and Trust" or the "Bank") as of
January 23, 1984 when stockholders of Hills Bank and Trust exchanged their
shares for shares of the Company. Effective July 1, 1996, the Company formed a
new subsidiary, Hills Bank, which acquired for cash all the outstanding shares
of a bank in Lisbon, Iowa. Subsequently an office of Hills Bank was opened in
Mount Vernon, Iowa, a community that is contiguous in Lisbon. Effective November
17, 2000, Hills Bank was merged into Hills Bank and Trust.
On September 20, 1996, another subsidiary, Hills Bank Kalona, acquired cash and
other assets and assumed the deposits of the Kalona, Iowa office of Boatmen's
Bank Iowa, N.A., Kalona, Iowa (Washington County) is approximately 20 miles
south of Iowa City. Kalona has a population of approximately 2,000 people.
Kalona is primarily an agricultural community, but is located within easy
driving distance for employment in Iowa City and Coralville (combined population
87,000) and Washington, Iowa (population 7,300). Effective October 26, 2001,
Hills Bank Kalona was merged into Hills Bank and Trust.
The Bank primarily serves the communities of Iowa City, Coralville, Hills and
North Liberty, located near Interstate 80 and Interstate 380 in Eastern Iowa.
These communities have a combined population of approximately 80,000 and Johnson
County, Iowa has a population of approximately 106,000. The University of Iowa
in Iowa City has over 27,000 students and 23,000 full and part-time employees,
including employees of The University of Iowa Hospitals and Clinics. Johnson
County, Iowa has had one of the strongest economies in Iowa and has had
substantial economic growth in the past ten years.
The Bank also operates offices in the Linn County, Iowa communities of Lisbon,
Mount Vernon and Cedar Rapids, Iowa. Lisbon has a population of approximately
1,500 and Mount Vernon, located two miles from Lisbon, has a population of
3,700. Both communities are strong economically and are within easy commuting
distances to Cedar Rapids and Iowa City, Iowa. Mount Vernon is the home of
Cornell College, which has approximately 1,200 students. Cedar Rapids has a
metropolitan population of approximately 180,000 and is located approximately 10
miles west of Lisbon, Iowa and approximately 25 miles north of Iowa City on
Interstate 380. The larger employers in the Cedar Rapids area are Rockwell
Collins with approximately 6,300 employees and Amana Appliances with
approximately 2,950 employees. Other major employers include Cedar Rapids
Community Schools (about 2,475 employees), St. Luke's Hospital (about 2,250
employees) and McLeod USA (approximately 2,000 employees). There are several
additional employers in Cedar Rapids having from 1,000 to 2,000 employees each.
The Bank is an all full-service commercial bank extending its services to
individuals, business, governmental units and institutional customers primarily
in the communities of Hills, Iowa City, Cedar Rapids, Coralville, North Liberty,
Lisbon, Mount Vernon and Kalona. This area includes all of Johnson County and
parts of Linn and Washington counties. The Bank is actively engaged in all areas
of commercial banking, including acceptance of demand, savings and time
deposits; making commercial, real estate, agricultural and consumer loans;
maintaining night and safe deposit facilities; and performing collection,
exchange and other banking services tailored for individual customers. The Bank
administers estates, personal trusts, and pension plans and provides farm
management and investment advisory and custodial services for individuals,
corporations and nonprofit organizations. The Bank makes commercial and
agricultural loans, real estate loans, automobile, installment and other
consumer loans. In addition, the Bank earns substantial fees from originating
mortgages that are sold in the secondary residential real estate market without
mortgage servicing rights being retained.
The Bank has an established formal loan origination policy. In general, the loan
origination policy requires individual lenders to reduce the risk of credit loss
to the Bank by requiring that, among other things, minimum loan to value ratios
be maintained, evidence of appropriate levels of insurance be carried by
borrowers and documenting appropriate types and amounts of collateral and
sources of expected payment.
The Bank's business is not seasonal, except that loan origination fees are
normally higher during the spring and summer months. Management believes that
the Bank has not undertaken any significant new services during the current year
that might exceed the limits of its human resources and data processing
capabilities.
The Company does not engage in any business activities apart from its ownership
of the Bank and, therefore, does not encounter any competition for its services
other than as described above for the Bank.
The Company and the Bank have undertaken no material research activities during
the last three years relating to research and development activities.
The Company had no employees as of December 31, 2001 and the Bank had 265
regular and 101 part-time employees.
COMPETITION
The financial services industry is highly competitive. The Bank must compete
with financial services providers, such as banks, savings and loan associations,
credit unions, finance companies, mortgage banking companies, insurance
companies and money market and mutual fund companies. It also faces increased
competition from nonbanking institutions such as brokerage houses and insurance
companies, as well as from financial services subsidiaries of commercial and
manufacturing companies. Many of these competitors enjoy the benefits of fewer
regulatory constraints and lower cost structures.
Effective March 13, 2000, securities firms and insurance companies that elect to
become financial holding companies may acquire banks and other financial
institutions. This may significantly change the competitive environment in which
the Company conducts business. The financial services industry is also likely to
become more competitive as further technological advances enable more companies
to provide financial services. These technological advances may diminish the
importance of depository institutions and other financial intermediaries in the
transfer of funds between parties.
The Company does not engage in any business activities apart from its ownership
of the Bank and, therefore, does not encounter any competition for its services
other than as described above for the Bank.
The Company and the Bank have undertaken no material research activities during
the last three years relating to research and development activities.
The Company had no employees as of December 31, 2001 and the Bank had 265
regular and 101 part-time employees.
The Bank is in direct competition for loans and deposits and financial services
with a number of other banks in Johnson County, Iowa. A comparison of deposits
in Johnson County is as follows:
Deposits
June 30,
2001
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(In Millions)
Hills Bank and Trust Company ................................ $557
Branches of largest competing regional bank ................. 245
Largest competing independent bank .......................... 321
Largest competing credit union .............................. 202
In Linn County, Iowa, the June 30, 2001 deposits of the Bank totaled $70 million
out of total deposits of $2,512 million.
THE ECONOMY
The Bank's primary trade territory is Johnson County, Iowa. Recent employment
data indicates that the total employment in the county is approximately 45,000,
of which 23,000 employees work for the University of Iowa or the University of
Iowa Hospitals and Clinics. Other larger sectors of the economy are health care
(two other hospitals employ 2,500), educational testing and data processing (two
employers employ 2,300), governmental (city, county and schools employ 2,600)
and retail and service sectors. The University of Iowa's impact on the local
economy has been to maintain employment levels because of record enrollments at
the University of Iowa and to stabilize unemployment at approximately 2.1% for
the past four years.
The State of Iowa has recently seen decreasing tax revenues while spending has
increased, and the Iowa legislature has required the University to reduce
spending in the year ending June 30, 2002 with further reductions expected for
the year ending June 2003. So far, the University has reacted to its budget
constraints without significant lay-offs and has announced that it intends to
reduce employment, when necessary, through attrition. However, salary increases
at the University are expected to be minimal in the next year.
The Bank also serves a number of smaller communities in Johnson, Linn and
Washington counties that are more dependent upon the agricultural economy, which
has historically been affected by commodity prices and weather. However, the
Bank's total agricultural loans comprise only about 5% of the Bank's total
loans.
The Bank also competes in Linn County, Iowa where it holds approximately 3% of
the county's total deposits. Linn County, with a population of approximately
180,000, has a much higher dependence on manufacturing and its largest employer
is Rockwell Collins, with about 6,300 employees. Other employment sectors
include telecommunications with McLeod USA and MCI employing approximately 5,000
total employees. Several of Linn County's larger employers have recently reduced
employment, including McLeod USA, which is operating in bankruptcy, Rockwell
Collins, and Amana Appliances, which has been acquired by Maytag.
SUPERVISION AND REGULATION
Financial institutions and their holding companies are extensively regulated
under federal and state law. As a result, the growth and earnings performance of
the Company can be affected not only by management decisions and general
economic conditions but also by the requirements of applicable state and federal
statutes and regulations and the policies of various governmental regulatory
authorities, including the Iowa Superintendent of Banking (the
"Superintendent"), the Board of Governors of the Federal Reserve System (the
"Federal Reserve"), the Federal Deposit Insurance Corporation (the "FDIC"), the
Internal Revenue Service and state taxing authorities and the Securities and
Exchange Commission (the "SEC"). The effect of applicable statues, regulations
and regulatory policies can be significant and cannot be predicted with a high
degree of certainty.
Federal and state laws and regulations generally applicable to financial
institutions, such as the Company and its subsidiary Bank, regulate, among other
things, the scope of business, investments, reserves against deposits, capital
levels relative to operations, the nature and amount of collateral for loans,
the establishment of branches, mergers, consolidations and dividends. The system
of supervision and regulation applicable to the Company and its subsidiary Bank
establishes a comprehensive framework for their respective operations and is
intended primarily for the protection of the FDIC's deposit insurance funds and
the depositors, rather than the stockholders, of financial institutions.
The following is a summary of the material elements of the regulatory framework
that applies to the Company and its subsidiary Bank. It does not describe all of
the statutes, regulations and regulatory policies that apply, nor does it
restate all of the requirements of the statutes, regulations and regulatory
policies that are described. As such, the following is qualified in its entirety
by reference to the applicable statutes, regulations and regulatory policies.
Any change in applicable law, regulations or regulatory policies may have a
material effect on the business of the Company and its subsidiary Bank.
Recent Regulatory Developments
The Gramm-Leach-Bliley Act, also known as the Financial Services Modernization
Act (the "Act"), was enacted on November 12, 1999. The Act allows eligible bank
holding companies to engage in a wider range of nonbanking activities and grants
them greater authority to engage in securities and insurance activities. Under
the Act, an eligible bank holding company that elects to become a financial
holding company may engage in any activity that the Federal Reserve, in
consultation with the Secretary of the Treasury, determines by regulation or
order is financial in nature, incidental to any such financial activity, or
complementary to any such financial activity and does not pose a substantial
risk to the safety or soundness of depository institutions or the financial
system generally. A financial service corporation can engage in a number of
financial activities including insurance and securities underwriting and other
agency activities, merchant banking and insurance company portfolio investment
activities. Activities that are ancillary to financial activities are also
allowed. Additionally, the Act amends the federal securities laws to incorporate
functional regulation of bank securities and activities and provides for the
functional regulation of insurance activities by establishing which insurance
products banks and bank subsidiaries may provide as principal. National banks
are also authorized by the Act to engage, through "financial subsidiaries," in
certain activity that is permissible for financial holding companies (as
described above) and certain activity that the Secretary of the Treasury, in
consultation with the Federal Reserve, determines is financial in nature or
incidental to any such financial activity.
Various bank regulatory agencies have issued regulations as mandated by the Act.
During June 2000, all of the federal bank regulatory agencies jointly issued
regulations implementing the privacy provisions of the Act. In addition, the
Federal Reserve issued interim regulations establishing procedures for bank
holding companies to elect to become financial holding companies and listing the
financial activities permissible for financial holding companies, as well as
describing the extent to which financial holding companies may engage in
securities and merchant banking activities. The Federal Reserve has issued an
interim regulation regarding the parameters under which state member banks may
establish and maintain financial subsidiaries. At this time, it is not possible
to predict the impact the Act and its implementing regulations may have on the
Company. As of the date of this filing, the Company has not applied for or
received approval to operate as a financial holding company. In addition, the
Bank has not applied for or received approval to establish financial
subsidiaries.
Furthermore, the Act provides reform in the Federal Home Loan Bank area by
providing that banks with less than $500 million in assets may use long-term
advances for loans to small businesses, small farms and small agri-businesses
and replaces the current $300 million funding formula for the REFCORP
obligations of the Federal Home Loan Banks to twenty percent (20%) of the Bank's
annual earnings.
In the area of privacy, the Act requires clear disclosure by all financial
institutions of their privacy policy regarding the sharing of nonpublic
information with both affiliates and third parties. Further, the Act requires a
notice to consumers and an opportunity to "opt out" of sharing of nonpublic
personal information with nonaffiliated third parties subject to certain limited
exceptions. The Act also provides reform in the area of ATMs, Community
Reinvestment Community Banks and Deposit Production Offices. Specifically, the
Act requires ATM operators who impose a fee for use of an ATM by a noncustomer
to post a notice on the machine that a fee will be charged and on the screen
that a fee will be charged and the amount of the fee, and further requires a
notice when ATM cards are issued that surcharges may be imposed by other parties
when transactions are initiated from ATMs not operated by the card issuer. The
Act also clarifies that nothing in the act repeals any provision of the
Continuity Reinvestment Act ("CRA"); however, the Act requires full disclosure
of all CRA agreements and grants regulatory relief regarding the frequency of
CRA exams to small banks and savings and loans (those with no more than $250
million in assets). In the community bank area, the Act allows community banks
all the powers as a matter of right that large institutions have accumulated on
an ad hoc basis, including the ability to underwrite municipal bonds in several
years. Finally, the Act expands the prohibition of deposit production offices
contained in the Riegle-Neal Interstate bill to include all branches of an
out-of-state bank holding company.
Regulation of the Company
General. The Company, as the sole shareholder of the Bank, is a bank holding
company. As a bank holding company, the Company is registered with, and is
subject to regulation by, the Federal Reserve under the Bank Holding Company
Act, as amended (the "BHCA"). In accordance with the Federal Reserve policy, the
Company is expected to act as a source of financial strength to the Bank and to
commit resources to support the Bank in circumstances where the Company might
not otherwise do so. Under the BHCA, the Company is subject to periodic
examination by the Federal Reserve. The Company is also required to file with
the Federal Reserve periodic reports of the Company's operations and such
additional information regarding the Company and its subsidiaries as the Federal
Reserve may require.
Investments and Activities. Under the BHCA, a bank holding company must obtain
Federal Reserve approval before: (i) acquiring, directly or indirectly,
ownership or control of any voting shares of another bank or bank holding
company if, after the acquisition, it would own or control more than 5% of the
shares of the other bank or bank holding company (unless it already owns or
controls the majority of such shares), (ii) acquiring all or substantially all
of the assets of another bank or (iii) merging or consolidating with another
bank holding company. Subject to certain conditions (including certain deposit
concentration limits established by the BHCA), the Federal Reserve may allow a
bank holding company to acquire banks located in any state of the United States
without regard to whether the acquisition is prohibited by the law of the state
in which the target bank is located. On approving interstate acquisitions,
however, the Federal Reserve is required to give effect to applicable state law
limitations on the aggregate amount of deposits that may be held by the
acquiring bank holding company and its insured depository institution affiliates
in the state in which the target bank is located (provided that those limits do
not discriminate against out-of-state depository institutions or their holding
companies) and state laws which require that the target bank have been in
existence for a minimum period of time (not to exceed five years) before being
acquired by an out-of-state bank holding company.
The BHCA also generally prohibits the Company from acquiring direct or indirect
ownership or control of more than 5% of the voting shares of any company which
is not a bank and from engaging in any business other than that of banking,
managing and controlling banks or furnishing services to banks and their
subsidiaries. This general prohibition is subject to a number of exceptions. The
principal exception allows bank holding companies to engage in, and to own
shares of companies engaged in, certain businesses found by the Federal Reserve
to be "so closely related to banking . . . as to be a proper incident thereto."
Under current regulations of the Federal Reserve, the Company either directly or
through nonbank subsidiaries would be permitted to engage in a variety of
banking-related businesses, including the operation of a thrift, sales and
consumer finance, equipment leasing, the operation of a computer service bureau
(including software development) and mortgage banking and brokerage. The BHCA
generally does not place territorial restrictions on the domestic activities of
nonbank subsidiaries of bank holding companies.
Federal law also prohibits any person from acquiring "control" of a bank holding
company without prior notice to the appropriate federal bank regulator.
"Control" is defined in certain cases as the acquisition of 10% or more of the
outstanding shares of a bank or a bank holding company depending on the
circumstances surrounding the acquisition.
Regulatory Capital Requirements
Regulatory guidelines define capital and spell out the minimum acceptable
capital levels for banks. The purpose of these guidelines is to increase
depositor protection and to reduce deposit insurance fund losses. Currently, the
three federal banking agencies use as "risk-based" approach to gauge bank
capital. Under this approach, the agencies define what is to be included in bank
capital and establish the minimum capital a bank must have to protect it,
primarily from the inherent risk in its asset holdings.
Risk-based capital guidelines divide capital into core and supplemental capital.
Core or Tier I capital is similar to what is normally thought of as capital in
other businesses. It consists primarily of common and certain preferred stock,
surplus and undivided profits. Bank holding companies are required to maintain
these minimum levels of capital in accordance with Federal Reserve capital
adequacy guidelines. If capital falls below minimum guideline levels, a bank
holding company, among other things, may be denied approval to acquire or
establish additional banks or nonbank businesses. Total capital consists
primarily of Tier 1 capital plus certain other debt and equity instruments which
do not qualify as Tier 1 capital and a portion of the company's allowance for
loan and lease losses. Supplemental or Tier 2 capital consists, within certain
specified limits, of such things as the allowance for loan losses, hybrid
capital instruments and subordinated debt. These supplemental items are often
forms of debt that are subordinate to claims of depositors and the FDIC. As
such, they provide depositor protection and are included in bank capital. The
sum of Tier 1 and Tier 2 capital, less certain deductions, represents a bank's
total capital. In the capital guidelines, Tier 1 capital must constitute at
least 50% of a bank's total capital. Thus, the use of Tier 2 capital is limited
by the "hard" equity in a bank's capital structure.
As part of their capital adequacy assessment, the regulatory agencies convert a
bank's assets, including off-balance sheet items, to risk-equivalent assets. The
purpose of this conversion is to quantify the relative risk, primarily credit
risk, in these assets and to determine the minimum capital necessary to
compensate for this risk. For example, assets that pose little risk, such as
cash held at the bank's offices and U. S. government securities, are weighted
zero, meaning that no capital support is required for these assets. Assets that
pose greater risk are weighted at 20%, 50% or 100% of their dollar value,
indicating the level of capital support they require. Except for banks with
large "off-balance sheet" asset positions, risk weighting will nearly always
lower total assets requiring capital support. However, even if a bank held
nothing but cash and U.S. securities, it would still be required to maintain
capital support for these assets. The reason is that banks face more than credit
risk (e.g., market risk), and these other risks require that capital be kept at
some minimum level to protect the bank and its depositors.
The Federal Reserve's capital guidelines establish the following minimum
regulatory capital requirements for bank holding companies: a risk-based
requirement expressed as a percentage of total risk-weighted assets, and a
leverage requirement expressed as a percentage of total assets. The risk-based
requirement consists of a minimum ratio of total capital to total risk-weighted
assets of 8%, at least one-half of which must be Tier 1 capital. The leverage
requirement consisted of a minimum ratio of Tier 1 capital to total assets of 3%
for the most highly rated companies, with a minimum requirement of 4% for all
others.
The risk-based and leverage standards described above are minimum requirements.
Higher capital levels will be required if warranted by the particular
circumstances or risk profiles of individual banking organizations. For example,
the Federal Reserve's capital guidelines contemplate that additional capital may
be required to take adequate account of, among other things, interest rate risk,
or the risks posed by concentration of credit, nontraditional activities or
securities trading activities. Further, any banking organization experiencing or
anticipating significant growth would be expected to maintain capital ratios
(i.e., Tier 1 capital less all intangible assets), well above the minimum
levels. Current Federal Reserve requirements for a well capitalized organization
experiencing significant growth are a minimum of leverage capital of 5%, a Tier
1 capital of 6% and total risk-based capital of 10%. As of December 31, 2001,
the Company had regulatory capital in excess of the Federal Reserve's minimum
and well-capitalized definition requirements, with a leverage ratio of 8.86%,
with total Tier 1 risk-based capital ratio of 13.47% and a total risk-based
capital of 14.72%.
Dividends. The Iowa Business Corporation Act ("IBCA") allows the Company to pay
dividends only out of its surplus (as defined and computed in accordance with
the provision of the IBCA) or if the Company has no such surplus, out of its net
profits for the fiscal year in which the dividend is declared and/or the
preceding fiscal year. Additionally, the Federal Reserve has issued a policy
statement with regard to the payment of cash dividends by bank holding
companies. The policy statement provides that a bank holding company should not
pay cash dividends which exceed its net income or which can only be funded in
ways that weaken the bank holding company's financial health, such as by
borrowing. The Federal Reserve also possesses enforcement powers over bank
holding companies and their nonbank subsidiaries to prevent or remedy actions
that represent unsafe or unsound practices or violations of applicable statutes
and regulations. Among these powers is the ability to proscribe the payment of
dividends by banks and bank holding companies.
Federal Securities Regulation. The Company's common stock is registered with the
SEC under the Securities Exchange Act of 1934, as amended (the "Exchange Act").
Consequently, the Company is subject to the information, proxy solicitation,
insider trading and other restrictions and requirements of the SEC under the
Exchange Act.
Regulation of the Bank
General. The Bank is an Iowa-chartered bank, the deposit accounts of which are
insured by the FDIC's Bank Insurance Fund ("BIF"). As an Iowa-chartered, FDIC
insured bank, the Bank is subject to the examination, supervision, reporting and
enforcement requirements of the Superintendent, as the chartering authority for
Iowa banks, and the FDIC, as administrator of the BIF.
Deposit Insurance. As an FDIC-insured institution, the Bank is required to pay
deposit insurance premium assessments to the FDIC. The FDIC has adopted a
risk-based assessment system under which all insured depository institutions are
placed into one of nine categories and assessed insurance premiums based upon
their respective levels of capital and results of supervisory evaluations.
Institutions classified as well-capitalized (as defined by the FDIC) and
considered healthy, pay the lowest premium while institutions that are less than
adequately capitalized (as defined by the FDIC) and considered of substantial
supervisory concern, pay the highest premium. Risk classification of all insured
institutions is made by the FDIC for each semi-annual assessment period. The
Bank is currently paying the minimum assessment under the FDIC's risk assessment
system.
The FDIC may terminate the deposit insurance of any insured depository
institution if the FDIC determines, after a hearing, that the institution (i)
has engaged in or is engaging in unsafe or unsound practices, (ii) is in an
unsafe or unsound condition to continue operations or (iii) has violated any
applicable law, regulation, order, or any condition imposed in writing by, or
written agreement with, the FDIC. The FDIC may also suspend deposit insurance
temporarily during the hearing process for a permanent termination of insurance
if the institution has no tangible capital. Management of the Company is not
aware of any activity or condition that could result in termination of the
deposit insurance of the Bank.
Capital Requirements. 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. One of the most significant
standards of operation of state banks is the six and one-half percent (6-1/2%)
primary capital to total assets ratio generally required by the Superintendent.
In certain instances, the Superintendent may mandate higher capital, but the
Superintendent has not imposed such a requirement on the Bank. The
Superintendent defines the term "primary capital" to mean the sum of
stockholders' equity and the allowance for loan losses less any intangible
assets. In determining the primary capital ratio, the Superintendent uses the
total assets as of the date of computation. At December 31, 2001, the primary
capital to total assets ratio of the Bank exceeded the ratio required by the
Superintendent.
Capital adequacy for banks took on an added dimension with the establishment of
a formal system of prompt corrective action under the Federal Deposit Insurance
Corporation Improvement Act of 1991 (FDICIA). This system uses bank capital
levels to trigger supervisory actions designed to quickly correct banking
problems. Capital adequacy zones are used by the federal banking agencies to
trigger these actions. The ratios and the definition of "adequate capital"
(refer to line two in the table) are the same as those used by the agencies in
their capital adequacy guidelines.
Federal law provides the federal banking regulators of the Bank with broad power
to take prompt corrective action to resolve the problems of undercapitalized
banking institutions. The extent of the regulators' powers depends on whether
the institution in question is "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized" or "critically
undercapitalized," in each case as defined by regulation. Under prompt
corrective action, banks that are inadequately capitalized face a variety of
mandatory and discretionary supervisory actions. For example, "undercapitalized
banks" must restrict asset growth, obtain prior approval for business expansion,
and have an approved plan to restore capital. "Critically undercapitalized
banks" must be placed in receivership or conservatorship within 90 days unless
some other action would result in lower long-term costs to the deposit insurance
fund.
Depending upon the capital category to which an institution is assigned, the
regulators' corrective powers include: requiring the institution to submit a
capital restoration plan; limiting the institution's asset growth and
restricting its activities; requiring the institution to issue additional
capital stock (including additional voting stock) or to be acquired; restricting
transactions between the institution and its affiliates; restricting the
interest rate the institution may pay on deposits; ordering a new election of
directors of the institution; requiring that senior executive officers or
directors be dismissed; prohibiting the institution from accepting deposits from
correspondent banks; requiring the institution to divest certain subsidiaries;
prohibiting the payment of principal or interest on subordinated debt; and
ultimately, appointing a receiver for the institution. As of December 31, 2001,
the Bank was well capitalized, as defined by FDIC regulations.
Supervisory Assessments. All Iowa banks are required to pay supervisory
assessments to the Iowa Superintendent of Banking to fund the operations of the
Superintendent for their examination and supervision. During the fiscal year
ended December 31, 2001, the Bank paid supervisory assessments to the
Superintendent totaling $9,679.
Dividends. The Iowa Banking Act provides that an Iowa bank may not pay dividends
in an amount greater than its undivided profits.
The payment of dividends by any financial institution or its holding company is
affected by the requirement to maintain adequate capital pursuant to applicable
capital adequacy guidelines and regulations, and a financial institution
generally is prohibited from paying any dividends if, following payment thereof,
the institution would be undercapitalized. As described above, the Bank exceeded
its minimum capital requirements under applicable guidelines as of December 31,
2001. Notwithstanding the availability of funds for dividends; however, the
Superintendent may prohibit the payment of any dividends by the Bank if the
Superintendent determines such payment would constitute an unsafe or unsound
practice.
Insider Transactions. The Bank is subject to certain restrictions imposed by
federal law on extensions of credit to the Company and its subsidiaries, on
investments in the stock or other securities of the Company and its subsidiaries
and the acceptance of the stock or other securities of the Company or its
subsidiaries as collateral for loans. Certain limitations and reporting
requirements are also placed on extensions of credit by the Bank to its
directors and officers, to directors and officers of the Company and its
subsidiaries, to principal stockholders of the Company, and to "related
interests" of such directors, officers and principal stockholders. In addition,
federal law and regulations may affect the terms upon which any person becoming
a director or officer of the Company or one of its subsidiaries or a principal
stockholder of the Company may obtain credit from banks with which the Bank
maintains a correspondent relationship.
Safety and Soundness Standards. The federal banking agencies have adopted
guidelines that establish operational and managerial standards to promote the
safety and soundness of federally insured depository institutions. The
guidelines set forth standards for internal controls, information systems,
internal audit systems, loan documentation, credit underwriting, interest rate
exposure, asset growth, compensation, fees and benefits, asset quality and
earnings.
In general, the safety and soundness guidelines prescribe the goals to be
achieved in each area, and each institution is responsible for establishing its
own procedures to achieve those goals. If an institution fails to comply with
any of the standards set forth in the guidelines, the institution's primary
federal regulator may require the institution to submit a plan for achieving and
maintaining compliance. If an institution fails to submit an acceptable
compliance plan, or fails in any material respect to implement a compliance plan
that has been accepted by its primary federal regulator, the regulator is
required to issue an order directing the institution to cure the deficiency.
Until the deficiency cited in the regulator's order is cured, the regulator may
restrict the institution's rate of growth, require the institution to increase
its capital, restrict the rates the institution pays on deposits or require the
institution to take any action the regulator deems appropriate under the
circumstances. Noncompliance with the standards established by the safety and
soundness guidelines may also constitute grounds for other enforcement action by
the federal banking regulators, including cease and desist order and civil money
penalty assessments.
Branching Authority. Historically, Iowa's intrastate branching statutes have
been rather restrictive when compared with those of other states. Iowa's
intrastate branching statutes were relaxed in recent legislation that became
effective on February 21, 2001 (the "2001 Amendment"). The 2001 Amendment allows
Iowa banks to move towards statewide branching by allowing every Iowa bank with
the approval of its primary regulator, to establish three new bank offices
anywhere in Iowa during the next three years. The three offices are in addition
to those offices allowed within certain restricted geographic areas under prior
Iowa law. Effective July 1, 2004, the 2001 Amendment repeals all limitations on
bank office location and effectively allows statewide branching. After that
date, banks will be allowed to establish an unlimited number of offices in any
location in Iowa subject only to regulator's approval.
Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
(the "Riegle-Neal Act"), both state and national banks are allowed to establish
interstate branch networks through acquisitions of other banks, subject to
certain conditions, including certain limitations on the aggregate amount of
deposits that may be held by the surviving bank and all of its insured
depository institution affiliates. The establishment of new interstate branches
or the acquisition of individual branches of a bank in another state (rather
than the acquisition of an out-of-state bank in its entirety) is allowed by the
Riegle-Neal Act only if specifically authorized by state law. The legislation
allowed individual states to "opt-out" of certain provisions of the Riegle-Neal
Act by enacting appropriate legislation prior to June 1, 1997. Iowa permits
interstate bank mergers, subject to certain restrictions, including a
prohibition against interstate mergers involving an Iowa bank that has been in
existence and continuous operation for fewer than five years.
State Bank Activities. Under federal law and FDIC regulations, FDIC insured
state banks are prohibited, subject to certain exceptions, from making or
retaining equity investments of a type, or in an amount, that are not
permissible for a national bank. Federal law and FDIC regulations also prohibit
FDIC insured state banks and their subsidiaries, subject to certain exceptions,
from engaging as principal in any activity that is not permitted for a national
bank or its subsidiary, respectively, unless the Bank meets, and continues to
meet, its minimum regulatory capital requirements and the FDIC determines the
activity would not pose a significant risk to the deposit insurance fund of
which the Bank is a member. These restrictions have not had, and are not
currently expected to have, a material impact on the operations of the Bank.
CONSOLIDATED STATISTICAL INFORMATION
The following consolidated statistical information reflects selected balances
and operations of the Company and the Bank for the periods indicated.
The following tables show (1) average balances of assets, liabilities and
stockholders' equity, (2) interest income and expense on a tax equivalent basis,
(3) interest rates and interest differential and (4) changes in interest income
and expense.
AVERAGE BALANCES
(Average Daily Basis)
December 31,
------------------------------
2001 2000 1999
------------------------------
(In Thousands)
------------------------------
ASSETS
Cash and due from banks ..................... $ 24,493 $ 20,347 $ 16,863
Taxable securities .......................... 132,227 121,499 119,856
Nontaxable securities ....................... 42,783 38,026 34,699
Federal funds sold .......................... 29,551 11,358 9,796
Loans, net .................................. 646,196 600,215 508,293
Property and equipment, net ................. 18,889 13,675 11,633
Other assets ................................ 19,575 16,129 17,249
------------------------------
$913,714 $821,249 $718,389
==============================
LIABILITIES AND STOCKHOLDERS' EQUITY
Noninterest-bearing demand deposits ........... $ 78,687 $ 69,246 $ 62,317
Interest-bearing demand deposits .............. 76,366 66,090 57,017
Savings deposits .............................. 169,561 154,121 152,507
Time deposits ................................. 357,882 309,565 274,507
Securities sold under agreements to repurchase 17,444 14,665 12,139
FHLB borrowings ............................... 123,211 128,043 86,880
Other liabilities ............................. 5,924 5,569 4,659
Redeemable common stock held by
Employee Stock Ownership Plan ............... 11,872 11,251 10,127
Stockholders' equity .......................... 72,767 62,699 58,236
------------------------------
$913,714 $821,249 $718,389
==============================
INTEREST INCOME AND EXPENSE
Year Ended December 31,
---------------------------
2001 2000 1999
---------------------------
(In Thousands)
Income:
Loans (1) ...................................... $53,121 $50,267 $42,107
Taxable securities ............................. 7,670 7,481 7,167
Nontaxable securities (1) ...................... 2,924 2,624 2,373
Federal funds sold ............................. 1,132 698 455
---------------------------
Total interest income .................... 64,847 61,070 52,102
---------------------------
Expense:
Interest-bearing demand deposits ............... 1,412 1,566 1,175
Savings deposits ............................... 4,611 5,615 4,769
Time deposits .................................. 20,611 17,690 14,882
Securities sold under agreements to repurchase . 617 699 517
FHLB borrowings ................................ 7,184 7,494 4,970
---------------------------
Total interest expense ................... 34,435 33,064 26,313
---------------------------
Net interest income ...................... $30,412 $28,006 $25,789
===========================
(1) Presented on a tax equivalent basis using a federal tax rate of 34% and
state tax rates of 5%.
INTEREST RATES AND INTEREST DIFFERENTIAL
Year Ended December 31,
- --------------------------------------------------------------------------------
2001 2000 1999
- --------------------------------------------------------------------------------
Average yields:
Loans (1) ......................................... 8.20% 8.34% 8.25%
Loans (tax equivalent basis) ...................... 8.22 8.37 8.28
Taxable securities ................................ 5.80 6.15 5.98
Nontaxable securities ............................. 4.51 4.55 4.51
Nontaxable securities (tax equivalent basis) ...... 6.83 6.90 6.84
Federal funds sold ................................ 3.85 6.15 4.64
Interest-bearing demand deposits .................. 1.85 2.37 2.06
Savings deposits .................................. 2.72 3.64 3.13
Time deposits ..................................... 5.76 5.71 5.42
Securities sold under agreements to repurchase .... 3.53 4.77 4.26
FHLB borrowings ................................... 5.83 5.85 5.72
Yield on average interest-earning assets .......... 7.62 7.92 7.75
Rate on average interest-bearing liabilities ...... 4.63 4.92 4.51
Net interest spread (2) ........................... 2.99 3.00 3.24
Net interest margin (3) ........................... 3.58 3.62 3.83
(1) Nonaccruing loans are not significant and have been included in the average
loan balances for purposes of this computation.
(2) Net interest spread is the difference between the yield on average
interest-earning assets and the yield on average interest-paying
liabilities stated on a tax equivalent basis using a federal and state tax
rate of 34% and 5%, respectively, for the three years presented.
(3) Net interest margin is net interest income, on a tax equivalent basis,
divided by average interest-earning assets.
CHANGES IN INTEREST INCOME AND EXPENSE
Changes Due Changes Due Total
To Volume To Rates Changes
----------------------------------
(In Thousands)
Year ended December 31, 2001:
Change in interest income:
Loans ........................................ $ 3,763 $ (920) $ 2,843
Taxable securities ........................... 637 (440) 197
Nontaxable securities ........................ 325 (27) 298
Federal funds sold ........................... 779 (340) 439
-------------------------------
5,504 (1,727) 3,777
-------------------------------
Change in interest expense:
Interest-bearing demand deposits ............. 221 (375) (154)
Savings deposits ............................. 520 (1,524) (1,004)
Time deposits ................................ 2,767 154 2,921
Securities sold under agreements to repurchase 120 (202) (82)
FHLB borrowings .............................. (284) (26) (310)
-------------------------------
3,344 (1,973) 1,371
-------------------------------
Change in net interest income .................. $ 2,160 $ 246 $ 2,406
===============================
Year ended December 31, 2000:
Change in interest income:
Loans ........................................ $ 7,697 $ 463 $ 8,160
Taxable securities ........................... 102 212 314
Nontaxable securities ........................ 230 21 251
Federal funds sold ........................... 80 163 243
-------------------------------
8,109 859 8,968
-------------------------------
Change in interest expense:
Interest-bearing demand deposits ............. 201 190 391
Savings deposits ............................. 52 794 846
Time deposits ................................ 1,979 829 2,808
Securities sold under agreements to repurchase 116 66 182
FHLB borrowings .............................. 2,408 116 2,524
-------------------------------
4,756 1,995 6,751
-------------------------------
Change in net interest income .................. $ 3,353 $(1,136) $ 2,217
===============================
Rate volume variances are allocated on a consistent basis using the absolute
values of changes in volume compared to the absolute values of the changes in
rates. Loan fees included in interest income are not material. Interest on
nontaxable securities and loans is shown at tax equivalent amounts.
LOANS
The following table shows the composition of loans (before deducting the
allowance for loan losses) as of December 31 for each of the last five years.
December 31,
----------------------------------------------------
2001 2000 1999 1998 1997
----------------------------------------------------
(In Thousands)
Agricultural ............ $ 34,304 $ 28,560 $ 27,302 $ 32,318 $ 27,636
Commercial and financial 44,363 37,832 36,848 39,438 33,616
Real estate, construction 40,430 38,184 40,879 28,476 8,157
Real estate, mortgage ... 538,832 499,010 439,072 338,871 332,655
Loans to individuals .... 34,713 33,715 31,030 30,664 28,707
Total ........... $692,642 $637,301 $575,131 $469,767 $430,771
There were no foreign loans outstanding for any of the years presented
MATURITY DISTRIBUTION OF LOANS
The following table shows the principal payments due on loans as of December 31,
2001:
Amount One Year One To Over Five
Of Loans Or Less (1) Five Years Years
---------------------------------------------
(In Thousands)
Commercial, financial and agricultural $ 78,667 $ 38,669 $ 32,788 $ 7,210
Real estate, construction and mortgage 579,262 73,683 214,261 291,318
Other ................................ 34,713 12,783 21,401 529
--------------------------------------------
$692,642 $125,135 $268,450 $299,057
============================================
Interest rates on loans are as follows:
Fixed rate ............................ $380,184 $ 86,789 $259,490 $ 33,905
Variable rate ......................... 312,458 38,346 8,960 265,152
--------------------------------------------
$692,642 $125,135 $268,450 $299,057
============================================
<FN>
(1) A significant portion of the commercial loans are due in one year or
less. A significant percentage of the notes are re-evaluated prior to
their maturity and are likely to be extended.
</FN>
NONACCRUAL, PAST DUE AND RESTRUCTURED LOANS
The following table summarizes the Company's nonaccrual, past due, restructured
and impaired loans as of December 31 for each of the years presented:
2001 2000 1999 1998 1997
-----------------------------------------------
(In Thousands)
Nonaccrual loans ............. $ 1,001 $ 618 $ -- $ 12 $ --
Accruing loans past due
90 days or more ............ 2,921 2,143 1,320 945 954
Restructured loans ........... -- -- -- -- --
Impaired loans ............... 11,288 11,068 9,265 8,956 9,556
The Company does not have a significant amount of loans that are past due less
than 90 days on which there are serious doubts as to the ability of the
borrowers to comply with the loan repayment terms.
Loans are placed on non-accrual status when management believes the collection
of future interest is not reasonably assured. Interest income was not materially
affected by this classification.
The Company has no individual borrower or borrowers engaged in the same or
similar industry exceeding 10% of total loans. The Company has no other
interest-bearing assets, other than loans, that meet the nonaccrual, past due,
restructured or potential problem loan criteria.
Specific allowance for losses on impaired loans are established if the loan
balances exceed the net present value of the future cash flows or the fair value
of the collateral if the loan is collateral dependent.
SUMMARY OF LOAN LOSS EXPERIENCE
The following table summarizes the Bank's loan loss experience for each of the
last five years:
Year Ended December 31,
---------------------------------------------------
2001 2000 1999 1998 1997
---------------------------------------------------
(In Thousands)
Allowance for loan losses
at beginning of year ............. $10,428 $ 9,750 $ 8,856 $ 8,010 $ 7,311
---------------------------------------------------
Charge-offs:
Agriculture ...................... 35 26 60 4 197
Commercial and financial ......... 1,225 522 181 431 326
Real estate, mortgage ............ 557 254 104 132 215
Loans to individuals ............. 724 372 418 401 390
---------------------------------------------------
2,541 1,174 763 968 1,128
---------------------------------------------------
Recoveries:
Agriculture ...................... 72 153 157 125 65
Commercial and financial ......... 289 276 260 256 195
Real estate, mortgage ............ 362 118 30 100 377
Loans to individuals ............. 416 357 310 417 142
---------------------------------------------------
1,139 904 757 898 779
---------------------------------------------------
Net charge-offs .................... 1,402 270 6 70 349
---------------------------------------------------
Provision for loan losses (1) ...... 924 948 900 916 1,048
---------------------------------------------------
Allowance for loan losses
at end of year ................... $ 9,950 $10,428 $ 9,750 $ 8,856 $ 8,010
===================================================
Ratio of net charge-offs during year
to average loans outstanding ..... 0.22% 0.04% 0.00% 0.02% 0.09%
====================================================
The allowance for loan losses has not been allocated by type of loan. Management
regularly reviews the loan portfolio and does not expect any unusual material
amount to be charged off during 2002 that would be significantly different than
the years ended December 31, 2001, 2000, 1999, 1998 and 1997.
(1) For financial reporting purposes, management regularly reviews the loan
portfolio and determines a provision for loan losses based upon the impact
of economic conditions on the borrowers' ability to repay, past collection
experience, the risk characteristics of loan portfolio and such other
factors that deserve current recognition. The growth of the loan portfolio
is a significant element in the determination of the provision for loan
losses.
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
The Bank regularly reviews a substantial portion of the loans in the portfolio
and assesses whether the loans are impaired. If the loans are impaired, the Bank
determines if a specific allowance is appropriate. Loans for which there are no
specific allowances are classified into one or more risk categories. Based upon
the risk category assigned, the Banks allocate a percentage, as determined by
management, for a required allowance needed. The percentage begins with
historical loss experience factors, which are then adjusted for current economic
factors. The risk categories are compared to the risk categories used by federal
and state regulatory agencies as follows:
(1) Pass
(2) Watch
(3) Substandard
In addition, the Bank's management also reviews and, where determined necessary,
provides allowances based upon reviews of specific borrowers and provides
general allowances for areas that management believes are of higher credit risk
(agricultural loans and constructed model real estate homes as of December 31,
2001).
The following table presents the allowance for estimated loan losses on loans by
type of loans and the percentage in each category to total loans as of December
31, 2001:
% Of Loans
Amount To Total Loans
-------------------------
(In Thousands)
Agriculture .................................. $1,032 4.95%
Commercial ................................... 1,714 6.40
Real estate, construction .................... 770 5.84
Real estate .................................. 5,722 77.79
Consumer ..................................... 712 5.01
--------------------
$9,950 100.00%
====================
Prior to December 31, 2001, the allowance for loan losses was allocated by risk
category and not by type of loan. The components of the allowance for loan loss,
by risk category, as of December 31, 2000 is as follows:
(In Thousands)
Pass ..................................................... $ 1,316
Watch .................................................... 3,471
Substandard .............................................. 2,521
Specific allowances ...................................... 3,120
-------
$10,428
=======
Anticipated charge-offs of the above categories are not determinable at December
31, 2001; however, management does not believe there are any categories of loans
where future charge-offs are likely to be higher than the allowances provided.
INVESTMENT SECURITIES
The following tables show the carrying value of the investment securities which
are principally held by the Bank as of December 31, 2001, 2000 and 1999 and the
maturities and weighted average yield of the investment securities as of
December 31, 2001:
December 31,
----------------------------
2001 2000 1999
(In Thousands)
Carrying value:
U. S. Treasury securities ................... $ 12,073 $ 18,318 $ 19,470
Obligations of other U. S. Government
agencies and corporations ................. 123,165 95,036 94,302
Obligations of state and political
subdivisions .............................. 46,913 39,923 36,496
------------------------------
$182,151 $153,277 $150,268
==============================
December 31, 2001
------------------------------
Weighted
Carrying Average
Value Yield
------------------------------
(In Thousands)
Type and maturity grouping:
U. S. Treasury maturities:
Within 1 year ............................ $ 5,644 6.09%
From 1 to 5 years ........................ 6,429 6.35%
--------
12,073
--------
Obligations of other U. S. Government
agencies and corporations, maturities:
Within 1 year .............................. 19,859 5.82%
From 1 to 5 years .......................... 103,306 5.62
-------
123,165
-------
Obligations of state and political
subdivisions, maturities:
Within 1 year .............................. 4,744 7.17%
From 1 to 5 years .......................... 25,506 6.44
From 5 to 10 years ......................... 16,437 6.84
Over 10 years .............................. 226 8.22
--------
46,913
--------
Total ................................ $182,151
========
INVESTMENT SECURITIES
As of December 31, 2001, there were no investment securities, exceeding 10% of
stockholders' equity, other than securities of the U. S. Government and U. S.
Government agencies and corporations.
The weighted average yield is based on the amortized cost of the investment
securities. The yields are computed on a tax-equivalent basis using a federal
tax rate of 34% and a state tax rate of 5%.
DEPOSITS
The following tables show the amount of average deposits and rates paid on such
deposits for the years ended December 31, 2001, 2000 and 1999 and the
composition of the certificates of deposit issued in denominations in excess of
$100,000 as of December 31, 2001:
December 31,
------------------------------------------------------
2001 Rate 2000 Rate 1999 Rate
------------------------------------------------------
Average noninterest-bearing deposits $ 78,687 0.00% $ 69,246 0.00% $ 62,317 0.00%
Average interest-bearing demand
deposits ......................... 76,366 1.85 66,090 2.37 57,017 2.06
Average savings deposits ........... 169,561 2.72 154,121 3.64 152,507 3.13
Average time deposits .............. 357,882 5.76 309,565 5.71 274,507 5.42
$682,496 $599,022 $546,348
Time certificates issued in amounts
of $100,000 or more as of
December 31, 2001 with ........... Amount Rate
maturity in: ----------------
3 months or less ................. $ 5,777 4.50%
3 through 6 months ............... 8,149 4.85
6 through 12 months .............. 26,329 5.79
Over 12 months ................... 15,262 5.76
--------
$ 55,517
========
There were no deposits in foreign banking offices.
RETURN ON STOCKHOLDERS' EQUITY AND ASSETS
The following table presents the return on average assets, return on average
stockholders' equity, the dividend payout ratio and average stockholders' equity
to average assets ratio for the years ended December 31, 2001, 2000 and 1999:
December 31,
----------------------
2001 2000 1999
----------------------
Return on average assets ............................ 1.11% 1.14% 1.18%
Return on average stockholders' equity .............. 13.94 14.94 14.54
Dividend payout ratio ............................... 23.58 23.18 22.56
Average stockholders' equity to average assets ratio 7.96 7.63 8.11
SHORT-TERM BORROWINGS
The following table shows outstanding balances, weighted average interest rates
at year end, maximum month-end balances, average month-end balances and weighted
average interest rates of federal funds purchased and securities sold under
agreements to repurchase during 2001, 2000 and 1999:
2001 2000 1999
-----------------------------
(Amounts In Thousands)
-----------------------------
Outstanding balance as of December 31 ......... $22,409 $16,561 $26,714
Weighted average interest rate at year end .... 2.36% 4.80% 4.28%
Maximum month-end balance ..................... 22,711 16,678 27,815
Average month-end balance ..................... 17,444 14,665 12,139
Weighted average interest rate for the year ... 3.53% 4.77% 4.26%
FEDERAL HOME LOAN BANK BORROWINGS
The following table shows outstanding balances, weighted average interest rates
at year end, maximum month-end balances, average month-end balances and weighted
average interest rates during 2001, 2000 and 1999:
2001 2000 1999
---------------------------------
Outstanding balance as of December 31 ...... $137,637 $120,668 $108,700
Weighted average interest rate at year end . 5.57% 5.79% 5.66%
Maximum month-end balance .................. 137,637 148,700 108,700
Average month-end balance .................. 123,211 128,043 86,880
Weighted average interest rate for the year 5.83% 5.85% 5.72%
PART I
Item 2. Properties
The Company's office and the main bank of the Bank are located at 131 Main
Street, Hills, Iowa. This is a brick building containing approximately 45,000
square feet. A portion of the building was built in 1977, a two-story addition
was completed in 1984, and in February 2001, the Bank completed a two-story
brick addition. With the completion of the 2001 addition, all bank processing
and administrative systems, including trust, were consolidated in Hills, Iowa. A
majority of these operations were located previously in the Coralville office
and sixty-five full-time and part-time employees relocated.
The other offices of Hills Bank and Trust are as follows:
1. Iowa City office located at 1401 South Gilbert Street is a one-story brick
building containing approximately 15,400 square feet. The branch has five
drive-up teller lanes and a drive-up, 24-hour automatic teller machine. The
Bank's trust department customer service representatives are located here.
This building was constructed in 1982 and has been expanded several times,
most recently in 1998.
2. Coralville office is a two-story building built in 1972 and expanded in
2001 that contains approximately 23,000 square
3. A 2,800 square foot branch bank in North Liberty, Iowa was opened for
business in 1986. This office is a full-service
4. The Bank leases an office at 132 East Washington Street in downtown Iowa
City with approximately 2,500 square feet. The
5. In December 2001, the Bank opened a new East Side office location at 2621
Muscatine Avenue, Iowa City. The office is a
6. The Lisbon office is a two-story brick building in Lisbon, Iowa with
approximately 3,000 square feet of banking retail
7. The Mount Vernon office opened in February 1998 with the completion of a
full-service, 4,200 square foot office, with
8. In February 2000, the Bank opened a 2,900 square foot branch office in
downtown Cedar Rapids that is leased. In April
9. The Kalona office is a 6,400 square foot building that contains a walk-up
24-hour automatic teller machine and one drive-up lane. This is an older
building that was remodeled in late 1998.
10. In October 2001, the Bank began construction in Cedar Rapids on a second
branch office. The new 7,200 square foot, one-story building will have
three drive-up lanes and a drive-up automatic teller machine. The location
is on Williams Boulevard in Southwest Cedar Rapids.
All of the properties owned by the Bank are free and clear of any mortgages or
other encumbrances of any type.
Item 3. Legal Proceedings
There are no material pending legal proceedings.
Neither the Company nor the Bank hold any properties that are the subject of
hazardous waste clean-up investigations.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders for the three months
ended December 31, 2001.
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters
There is no established trading market for the Company's common stock. Its stock
is not listed with any exchange or quoted in an automated quotation system of a
registered securities association, nor is there any broker/dealer acting as a
market maker for its stock. A bid and ask price is quoted in an Iowa City local
paper and the quotes are provided by a local broker. The Company's stock is not
actively traded. As of March 15, 2002, the Company had 1,309 stockholders.
Based on the Company's stock transfer records and information informally
provided to the Company, its stock trading transactions have been as follows:
- -------------------------------------------------------------------------------
Number High Low
Of Shares Number Of Selling Selling
Year Traded Transactions Price Price
- -------------------------------------------------------------------------------
2001 9,273 28 $ 82.00 $ 77.00
2000 14,187 16 77.00 70.00
1999 6,415 22 70.00 58.00
The Company paid aggregate annual cash dividends in 2001, 2000 and 1999 of
$2,392,000, $2,171,000 and $1,910,000, respectively, or $1.60 per share in 2001,
$1.45 per share in 2000 and $1.30 per share in 1999. In January 2002, the
Company declared and paid a dividend of $1.75 per share totaling $2,622,000. The
decision to declare any such cash dividends in the future and the amount thereof
rests within the discretion of the Board of Directors and will remain subject
to, among other things, certain regulatory restrictions imposed on the payment
of dividends by the Bank, and the future earnings, capital requirements and
financial condition of the Company.
As of December 31, 2001, stock option information is as follows:
Number of shares that would be issued if all options were exercised 29,179
Weighted average price of options outstanding $ 44.98
Number of additional shares that could be granted 55,600
There are no stock option plans that have not been approved by the stockholders.
PART II
Item 6. Selected Financial Data
CONSOLIDATED FIVE-YEAR STATISTICAL SUMMARY
2001 2000 1999 1998 1997
-----------------------------------------------------------------
YEAR-END TOTALS
Total assets .................... $ 976,105 $ 875,750 $ 773,966 $ 689,787 $ 603,102
Investment securities ........... 189,960 161,066 156,198 149,350 138,064
Federal funds sold .............. 29,428 28,065 206 36,811 2,447
Loans, net ...................... 682,692 626,873 565,381 460,911 422,761
Deposits ........................ 720,018 652,706 562,086 534,151 479,770
Federal Home Loan Bank borrowings 137,637 120,668 108,700 75,732 50,764
Redeemable common stock ......... 12,194 11,550 10,953 9,301 7,682
Stockholders' equity ............ 78,155 68,524 60,264 56,452 51,500
EARNINGS
Interest income ................. $ 63,718 $ 59,992 $ 51,121 $ 47,289 $ 42,743
Interest expense ................ 34,435 33,064 26,313 25,254 22,502
Provision for loan losses ....... 924 948 900 916 1,048
Other income .................... 9,257 7,514 6,437 5,811 5,938
Other expenses .................. 22,859 20,069 18,309 16,438 15,500
Applicable income taxes ......... 4,613 4,059 3,570 3,006 2,545
Net income ...................... 10,144 9,366 8,466 7,486 7,086
PER SHARE
Net income:
Basic ......................... $ 6.78 $ 6.26 $ 5.70 $ 5.10 $ 4.83
Diluted ....................... 6.72 6.21 5.66 5.02 4.78
Cash dividends .................. 1.60 1.45 1.30 1.20 1.05
Book value as of December 31 .... 52.15 45.82 40.29 38.42 35.08
Increase (decrease) in book value
due to:
ESOP obligation ............... (8.14) (7.72) (7.32) (6.33) (5.23)
Accumulated other
comprehensive income ........ 2.02 0.47 (0.66) 0.81 0.33
SELECTED RATIOS
Return on average assets ........ 1.11% 1.14% 1.18% 1.17% 1.24%
Return on average equity ........ 13.94 14.94 14.54 14.12 14.62
Net interest margin ............. 3.58 3.62 3.83 3.81 3.93
Average stockholders' equity to
average total assets .......... 7.96 7.63 8.11 8.25 8.47
Dividend payout ratio ........... 23.58 23.18 22.56 23.52 21.69
PART II
Item 7. Management's Discussion and Analysis of Financial Condition
And Results of Operations
Special Note Regarding Forward-Looking Statements
The discussion following contains certain forward-looking statements with
respect to the financial condition, the results of operations and business of
the Company. These statements involve certain risks and uncertainties, which are
often inherent in the ongoing operation of financial institutions such as the
Company's subsidiary bank.
Forward-looking statements discuss matters that are not facts and are typically
identified by the words "believe," "expect," "anticipate," "target," "goal,"
"objective," "intend," "estimate," "will," "can," "would," "should," "could,"
"may" and similar expressions. They discuss expectations about the future and
are not guarantees. Forward-looking statements speak only as of the date they
are made, and the Company undertakes no obligation to update them to reflect
changes that occur after the date they are made.
There are several factors - many of which are beyond the control of the Company
or its subsidiary Bank - that could cause results to differ significantly from
expectations. Some of these factors are described below. There are factors other
than those described below that could cause results to differ from expectations.
Any factor described below could by itself, or together with one or more other
factors, adversely affect the business, earnings and/or financial condition of
the Company and its subsidiary Bank.
The risks involved in the operations and strategies of the Company and its
subsidiary Bank include competition from other financial institutions, changes
in interest rates, changes in economic or market conditions as well as events
and trends affecting specific assets, the effect of credit quality and market
perceptions of value on the fair values of financial instruments and regulatory
factors. These risks, which are not inclusive, cannot be accurately estimated.
For example, a financial institution may accept deposits at fixed interest
rates, at different times and for different terms, and lend funds at fixed
interest rates, at different times and for different terms. In doing so, it
accepts the risk that its cost of funds may rise while the use of those funds
may be at a fixed rate. Similarly, although market rates of interest may
decline, the financial institution may have committed by virtue of the term of a
deposit, to pay what essentially becomes an above-market rate.
Loans, and the allowance for loan losses, carry the risk that borrowers will not
repay all funds in a timely manner, as well as the risk of total loss. The
collateral pledged as security for loans may or may not have the value that has
been attributed to it. The loan loss reserve, while believed to be adequate, may
prove inadequate if one or more large-balance borrowers, or numerous mid-balance
borrowers, or a combination of both, experience financial difficulty for a
variety of reasons. These reasons may relate to the financial circumstances of
an individual borrower, or may be caused by negative economic circumstances at
the local, regional, national or international level that are beyond the control
of the borrowers or the lender.
Because the business of banking is of a highly regulated nature, the decisions
of governmental entities can have a major effect on operating results. Changes
to statutes, regulations or regulatory policies, including changes in
interpretation or implementation of statutes, regulations or policies, could
have substantial and unpredictable effects including increasing the ability of
nonbanks to offer competing financial services and products.
PART II
Item 7. Management's Discussion and Analysis of Financial Condition
And Results of Operations
The Bank's success depends, in part, on its ability to attract and retain key
people. Competition for the best people - in particular individuals with
technology experience - is intense. The Bank may not be able to hire
well-qualified people or pay them enough to keep them.
All of these uncertainties, as well as others, are present in the operations and
business of the Company, and stockholders are cautioned that the Company's
actual results may differ materially from those included in the forward-looking
statements.
Critical Accounting Policies
The Company's most critical accounting policies that affect net income are the
accrual of interest income and expense and providing an appropriate allowance
for loan losses. Interest is accrued at the stated rate on the outstanding
balances of all interest earning assets and interest-bearing liabilities. The
Company discontinues accruing interest income on certain loans at the point
there is reasonable doubt about the borrower's ability to make all the principal
and interest payments. The allowance for loan losses and the provision for loan
losses charged to expense is affected by the Bank's quarterly review of the loan
portfolio, the Bank's identification of impaired loans for which specific
allowances may be provided and the allowances on all other loans. The allowance
is affected, among other things, by loan delinquency rates, local economic
conditions and the estimated fair value of collateral on loans.
Other critical policies that affect the Company's balance sheet are the fair
value of investment securities available-for-sale and the Company's maximum cash
obligation related to its obligation to redeem common stock held by the ESOP.
Financial Position
Year End Amounts (In Thousands) 2001 2000 1999 1998 1997
- -----------------------------------------------------------------------------------------
Loans, net of allowance for losses $682,692 $626,873 $565,381 $460,911 $422,761
Investment securities ............ 189,960 161,066 156,198 149,350 138,064
Deposits ......................... 720,018 652,706 562,086 534,151 479,770
Federal Home Loan Bank borrowings 137,637 120,668 108,700 75,732 50,764
Stockholders' equity ............. 78,155 68,524 60,264 56,452 51,500
Total assets ..................... 976,105 875,750 773,966 689,787 603,102
In 2001, total assets grew $100.4 million, slightly below the record growth of
$101.8 million for 2000. The percentage increase in total assets was 11.46% in
2001, compared to 13.15% in 2000. Asset growth for both years was primarily
reflected in higher loan balances and investment securities.
In 2001, net loans increased by $55.8 million, including $42.1 million in real
estate loans. For the year 2000, net loans increased $61.5 million, and $60
million of the increase was attributable to real estate mortgage loans.
Declining interest rates in 2001 and stable interest rates in 2000 have helped
housing starts and new real estate development projects in the Bank's trade
territory.
Deposits increased $67.3 million, or 10.31 % in 2001 compared to an increase of
16.12% in 2000. After several years of slower deposit growth, the past two years
have seen substantial deposit growth. In 2001, the increase in net deposits
resulted from uncertainties in the stock market that led a number of investors
to move their funds to bank deposits. In addition, the addition and renovation
of branch banks helped bring new customers to the Bank. In 2001 and 2000, the
Company has also borrowed from the Federal Home Loan Bank, and such borrowings
increased by a net $17 million in 2001 and $12 million in 2000. The advances
were used to fund loan growth and lock in low interest rates.
Components of Diluted Earnings Per Share
2001 2000 1999
------------------------------------
Net interest income ..................... $ 19.40 $ 17.85 $ 16.59
Provision for loan losses ............... (0.61) (0.63) (0.60)
Noninterest income ...................... 6.13 4.98 4.30
Noninterest expense ..................... (15.14) (13.30) (12.24)
------------------------------------
Income before income taxes ...... 9.78 8.90 8.05
Income tax expense ...................... (3.06) (2.69) (2.39)
------------------------------------
Net income ...................... $ 6.72 $ 6.21 $ 5.66
====================================
Net income for 2001 reached a record high of $10,144,000, or diluted earnings
per share of $6.72. The rate of increase in earnings in 2001 slowed slightly
from 2000 results. For 2001, diluted earnings per share increased $.51 per
share, while 2000 results had increased $.55 per share. For the year ended
December 31, 2000, net income increased by $900,000 from the 1999 results. Net
interest income for 2000 was $2.1 million higher than 1999. For both 2001 and
2000, the Company's net interest income has benefited from substantial growth in
average earning assets and a stable net interest margin.
The Company consistently benefited from a high quality loan portfolio and a
strong local economy. Because the loan portfolio is concentrated in well-secured
real estate loans, the Bank has not needed higher provisions for loan losses.
Net Interest Income
Net interest income is the excess of the interest and fees received on
interest-earning assets over the interest expense of the interest-bearing
liabilities. The measure is shown on a tax-equivalent basis to make the interest
earned on taxable and nontaxable assets more comparable.
Net interest income on a tax-equivalent basis changed in 2001 as follows:
Change In Change In Increase (Decrease)
Average Average Volume Rate Net
Balance Rate Changes Changes Change
-------------------------------------------------------
Interest income:
Loans, net ........................................ $ 45,981 (0.15)% $ 3,763 $ (920) $ 2,843
Taxable securities ................................ 10,728 (0.35) 637 (440) 197
Nontaxable securities ............................. 4,757 (0.07) 325 (27) 298
Federal funds sold ................................ 18,193 (2.30) 779 (340) 439
-------- -------------------------------
$ 79,659 5,504 (1,727) 3,777
-------- -------------------------------
Interest expense:
Interest-bearing demand deposits .................. $ 10,276 (0.15)% 221 (375) (154)
Savings deposits .................................. 15,440 (0.92) 520 (1,524) (1,004)
Time deposits ..................................... 48,317 0.05 2,767 154 2,921
Federal funds purchased and securities
sold under agreements to repurchase ............. 2,779 (1.24) 120 (202) (82)
FHLB borrowings ................................... (4,832) (0.02) (284) (26) (310)
-------- --------------------------------
$ 71,980 3,344 (1,973) 1,371
======== --------------------------------
Change in net interest income ....................... $ 2,160 $ 246 $ 2,406
================================
Net interest income changes for 2000 were as follows:
Change In Effect Of Effect Of
Average Volume Rate Net
Balance Changes Changes Change
-------------------------------------------
Interest-earning assets ........... $98,454 $ 8,109 $ 859 $ 8,968
Interest-bearing liabilities ...... 89,434 4,756 1,995 6,751
------------------------------------------
Change in net interest income ..... $ 3,353 $(1,136) $ 2,217
==========================================
A summary of the net interest spread and margin is as follows:
(Tax Equivalent Basis) 2001 2000 1999
- --------------------------------------------------------------------------------
Yield on average interest-earning assets ............... 7.62% 7.92% 7.75%
Rate on average interest-bearing liabilities ........... 4.63 4.92 4.51
---------------------
Net interest spread .................................... 2.99 3.00 3.24
Effect of noninterest-bearing funds .................... 0.59 0.62 0.59
---------------------
Net interest margin (tax equivalent interest income
divided by average interest-earning assets) .......... 3.58% 3.62% 3.83%
=====================
Provision For Loan Losses
The provision for loan losses totaled $924,000, $948,000 and $900,000 for 2001,
2000 and 1999, respectively. Charge-offs, net of recoveries, were $1,402,000,
$270,000 for 2000 and $6,000 for 2001, 2000 and 1999, respectively. Although net
charge-offs for 2001 increased from the prior two years, the charge-offs related
to loans that had previously been classified and the losses had been accrued in
prior years.
The allowance for loan losses totaled $9,950,000 at December 31, 2001 compared
to $10,428,000 at December 31, 2000. The percentage of the allowance to
outstanding loans was 1.44% and 1.64% at December 31, 2001 and 2000,
respectively.
Agricultural loans totaled $34,304,000 and $28,560,000 at December 31, 2001 and
2000, respectively. Management has assessed the risks for agricultural loans
higher than other loans due to unpredictable commodity prices, the effects of
weather on crops and uncertainties regarding government support programs.
Therefore, the allowance for loan losses includes general and specific reserves
for these loans.
Loan concentrations, quality and credit terms had no significant changes from
2000 to 2001. Therefore, the 2001 allowance for loan losses was not materially
different than the 2000 allowance. In 2001, the Bank refined the methodology
used to compute the allowance for loan losses, primarily by applying loss rates
to several risk categories of loans instead of more general populations. The
estimated loss rates used in 2001 increased slightly because there were several
early indicators of an economic slowdown in the area. The primary indicator in
Johnson County is the tightening of the budget for the University of Iowa and
the possibility of staffing cutbacks and wage constraints.
The allowance for loan losses is sensitive to the underlying collateral value of
real estate, especially in Johnson County, Iowa. Real estate values are affected
by the inventory of unsold properties, vacancy rates for residential rental
units, the supply and demand for commercial and retail space and overall
employment and retail sales. Overbuilding in the area could lower the fair value
of properties and affect the allowance for loan losses. Likewise, sharply higher
interest rates could affect the ability of some borrowers to make scheduled
interest and principal payments.
The University of Iowa has a dominant economic effect on the economy of the
Bank's primary trade area, Johnson County, Iowa, and in 2001 and 2000, the
University has helped the local economy remain strong even when the national
economy has experienced weaknesses. However, in recent months the economy of the
state of Iowa has weakened to the point that the University has recently
suffered modest budget cuts and for its fiscal year beginning July 1, 2002 the
University is anticipating more significant budget constraints. The possible
effects on the local economy cannot be predicted, but are likely to weaken the
economy in future years.
The above factors could, but are not reasonably expected, to have a material
effect on the allowance for loan losses.
Other Income
Dollars Per Share, Based on Weighted
Average Diluted Shares Outstanding 2001 2000 1999
- --------------------------------------------------------------------------------
Real estate origination fees ................. $ 0.77 $ 0.21 $ 0.39
Trust fees ................................... 1.59 1.58 1.36
Deposit account charges and fees ............. 2.06 1.70 1.47
Other fees and charges ....................... 1.71 1.49 1.29
Investment securities gains (losses) ......... -- -- (0.21)
-------------------------------
$ 6.13 $ 4.98 $ 4.30
===============================
In 2001, the Company's total other income increased $1,743,000 compared to the
prior year. Real estate origination fee revenue for 2001 made up $849,000 of the
increase from the prior year because of reduced interest rates that enabled many
borrowers to re-finance at lower interest rates. In addition, the increase in
customer deposit accounts, along with changes in the fee structure, accounted
for a $542,000 increase in deposit account charges and fees. Trust fees in 2001
were virtually unchanged from 2000 because new trust accounts provided fees that
offset the decline in asset related trust fees affected by the stock market.
Total other income reached a record high of $6.13 per share in 2001.
Total other income increased $1,077,000 for the year ended December 31, 2000
compared to the same period in 1999. Loan origination fees for the year 2000
were $276,000 less than 1999 as a result of higher interest rates in 2000 that
slowed re-financings. Trust fees, deposit account charges and other fees
increased $1,038,000 for 2000 and resulted from volume increases in trust assets
and deposit accounts. During 1999, the Company had a reduction of other income
of $315,000, which represented investment securities losses taken to replace
lower yielding securities with higher yielding securities of similar risk and
maturity. For the year 2000, no gains and losses on sale of investment
securities occurred.
Other Expenses
Dollars Per Share, Based on Weighted
Average Diluted Shares Outstanding 2001 2000 1999
- --------------------------------------------------------------------------------
Salaries and employees benefits ............ $ 7.86 $ 7.06 $ 6.56
Occupancy .................................. 1.21 0.94 0.84
Furniture and equipment .................... 1.86 1.43 1.26
Office supplies and postage ................ 0.79 0.75 0.74
Other ...................................... 3.42 3.12 2.84
---------------------------------
$ 15.14 $ 13.30 $ 12.24
=================================
Total other expenses increased $2,790,000 in 2001. Occupancy expenses increased
$409,000 in 2001, up sharply from $1,417,000 in 2000. The increase was primarily
related to the opening and use of the Bank's 31,000 square foot operations area
in early 2001 and the Coralville expansion. Salary and employee benefits
increased $1,212,000 in 2001 and were primarily related to an increase in new
employees at various locations and higher employee benefit costs. The new
operations center in Hills and the Coralville expansion accounted for most of
the increase in occupancy and furniture and equipment related expenses and
depreciation.
Other expenses increased $1,760,000 in 2000. Of the increase, salaries and
benefits accounted for $844,000, occupancy and furniture and equipment expense
$431,000 and all other expenses $485,000. The salaries and employee benefits
increased as a direct result of salary adjustments in the first quarter of 2000
and furniture and equipment related expenses. The Iowa City eastside location of
Hills Bank and Trust Company opened in June 1999 and the Cedar Rapids office
opened in February 2000. The two new locations also accounted for a portion of
the increase in occupancy expense and other expense increases were in marketing
and business promotion. Also during 2000, the Bank introduced an on-line banking
product and incurred increased product promotion expense.
Income Taxes
Income tax expense was $4,613,000, $4,059,000 and $3,570,000 for the years ended
December 31, 2001, 2000 and 1999, respectively. The corresponding percentage of
income taxes compared to income before income taxes is 31.26% in 2001, 30.23% in
2000 and 29.66% in 1999.
Impact of Recently Issued Accounting Standards
In July 2001, the Financial Accounting Standards Board issued Statement 141,
"Business Combinations" and Statement 142, "Goodwill and Other Intangible
Assets." Statement 141 eliminates the pooling method for accounting for business
combinations, requires that intangible assets that meet certain criteria be
reported separately from goodwill and requires negative goodwill arising from a
business combination to be recorded as an extraordinary gain. Statement 142
eliminates the amortization of goodwill and other intangibles that are
determined to have an indefinite life, and requires, at a minimum, annual
impairment tests for goodwill and other intangible assets that are determined to
have an indefinite life. For the Company, the provisions of the Statements are
effective January 1, 2002.
Implementation of Statement 141 will have no immediate impact on the Company's
financial statements. Implementation of Statement 142 is not expected to have a
material effect on the Company's financial statements in 2002.
The Financial Accounting Standards Board has issued Statement 143, "Accounting
for Asset Retirement Obligations" and Statement 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." Statement 143 requires that the
fair value of liability for an asset retirement obligation be recognized in the
period in which it is incurred if a reasonable estimate of fair value can be
made. The associated asset retirement costs are capitalized as part of the
carrying amount of the long-lived asset. Statement 144 supersedes FASB Statement
121 and the accounting and reporting provisions of APB Opinion No. 30. Statement
144 establishes a single accounting model for long-lived assets to be disposed
of by sale which includes measuring a long-lived asset classified as held for
sale at the lower of its carrying amount or its fair value less costs to sell
and to cease depreciation/amortization. For the Company, the provisions of
Statement 143 and 144 are effective January 1, 2003, and January 1, 2002,
respectively. Implementation of the Statements is not expected to have a
material impact on the Company's financial statements.
Interest Rate Sensitivity and Liquidity Analysis
At December 31, 2001, the Company's interest rate sensitivity report is as
follows (in thousands):
Repricing Days
Maturities ----------------------------------------------- More Than
Immediately 2-30 31-90 91-180 181-365 One Year Total
-------------------------------------------------------------------------------------
Earning assets:
Federal funds sold $ 29,428 $ -- $ -- $ -- $ -- $ -- $ 29,428
Investment
securities ...... -- 1,135 5,085 7,409 15,787 160,544 189,960
Loans ............. -- 60,706 21,674 30,121 55,916 524,225 692,642
-------------------------------------------------------------------------------------
Total ....... 29,428 61,841 26,759 37,530 71,703 684,769 912,030
-------------------------------------------------------------------------------------
Sources of funds:
Interest-bearing
checking and
savings accounts 56,815 -- -- -- -- 203,565 260,380
Certificates of
deposit ......... -- 13,177 19,483 58,380 150,822 125,597 367,459
Other borrowings -
FHLB ............ -- 30,000 10,000 10,000 10,000 77,637 137,637
Repurchase
agreements and
federal funds ... 22,409 -- -- -- -- -- 22,409
-------------------------------------------------------------------------------------
79,224 43,177 29,483 68,380 160,822 406,799 787,885
Other sources,
primarily
noninterest-
bearing ........... -- -- -- -- -- 92,179 92,179
-------------------------------------------------------------------------------------
Total sources 79,224 43,177 29,483 68,380 160,822 498,978 880,064
-------------------------------------------------------------------------------------
Repricing
differences ....... $ (49,796) $ 18,664 $ (2,724) $ (30,850) $ (89,119) $ 185,791 $ 31,966
=====================================================================================
A portion of the interest-bearing checking, savings and money market accounts
has been included in the above table as maturing immediately based upon
management's estimate using a financial model and the rest of these deposits are
shown as more than 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 their callable dates because they may be
called if interest rates rise over current rates.
Inflation
Inflation has an impact on the growth of total assets and has resulted in the
need to increase equity capital to maintain an appropriate equity to asset
ratio. The results of operations have been affected by inflation, but the effect
has been minimal.
Liquidity and Capital Resources
On an unconsolidated basis, the Company had cash balances of $1,655,000 as of
December 31, 2001. In 2001, the holding company received dividends of $2,392,000
from its subsidiary bank and used those funds to pay dividends to its
stockholders of $2,392,000.
As of December 31, 2001 and 2000, stockholders' equity, before deducting for the
maximum cash obligation related to ESOP, was $90,349,000 and $80,074,000,
respectively. This measure of equity as a percent of total assets was 9.26% at
December 31, 2001 and 9.14% at December 31, 2000. As of December 31, 2001, total
equity was 8.01% of assets compared to 7.82% of assets at the prior year end.
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 total
approximately $7,015,000 as of December 31, 2001.
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, 2001, 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 weighing 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.
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. One of the most significant
standards of operation of state banks is the six and one-half percent (6 1/2%)
primary capital to total assets ratio generally required by the Superintendent.
In certain instances, the Superintendent may mandate higher capital, but the
Superintendent has not imposed such a requirement on the Bank. The
Superintendent defines the term "primary capital" to mean the sum of
stockholders' equity and the allowance for loan losses less any intangible
assets. In determining the primary capital ratio, the Superintendent uses the
total assets as of the date of computation. At December 31, 2001, the primary
capital to total assets ratio of the Bank exceeded the ratio required by the
Superintendent.
The actual amounts and capital ratios as of December 31, 2001 and the minimum
regulatory requirements for the Company and the Bank are presented below (in
thousands):
To Be Well
For Capital Capitalized Under
Adequacy Prompt Corrective
Actual Purposes Action Provisions
---------------------------------------------------
Amount Ratio Ratio Ratio
---------------------------------------------------
As of December 31, 2001:
Company:
Total risk based capital ....... $92,725 14.72% 8.00% 10.00%
Tier 1 risk based capital ...... 84,827 13.47 4.00 6.00
Leverage ratio ................. 8.86 3.00 5.00
Bank:
Total risk based capital ....... 89,690 14.34 8.00 10.00
Tier 1 risk based capital ...... 82,103 13.09 4.00 6.00
Leverage ratio ................. 8.71 3.00 5.00
The Bank is classified as "well capitalized" by FDIC capital guidelines.
On a consolidated basis, 2001 cash flows from operations provided $13,778,000,
net increases in deposits provided $67,312,000 and Federal Home Loan Bank
borrowings provided $17,000,000. These cash flows were invested in net loans of
$56,743,000, net securities of $25,377,000 and net federal funds sold of
$1,363,000. In addition, $6,710,000 was used to purchase property and equipment.
At December 31, 2001, the Bank had total outstanding loan commitments and unused
portions of lines of credit totaling $117,609,000. Management believes that its
liquidity levels are sufficient, 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.
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.
As of December 31, 2001, the Bank estimates that 2002 additional construction
expenditures for the new office on Williams Boulevard in Cedar Rapids, Iowa, to
be completed in 2002 will total $893,000 and will not require outside financing.
Related Party Transactions
The Bank's primary transactions with related parties are the loans 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, 2001 and 2000, loan balances to
related individuals and businesses totaled $24,440,000 and $13,297,000,
respectively. Deposits from related parties totaled $5,884,000 and $4,825,000 as
of December 31, 2001 and 2000, 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.
PART II
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
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 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.
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
result from an increase in the Company's cost of funds that would not be
immediately offset by an increase in its yield on earning assets that would tend
to reduce net interest income. 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.
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.
2002 2003 2004 2005 2006 Thereafter Total Fair Value
--------------------------------------------------------------------------------------------------------------
Assets:
Loans, fixed:
Balance ....... $ 5,530 $ 46,101 $ 91,060 $ 37,564 $ 84,766 $ 35,163 $ 300,184 $376,829
Average
interest rate 8.01% 8.33% 7.62% 7.95% 7.20% 7.00% 7.67%
Loans, variable:
Balance ......... $ 27,300 $ 1,136 $ 3,486 $ 1,728 $ 2,610 $ 276,198 $ 312,458 $312,458
Average
interest rate . 7.03% 7.48% 6.98% 7.42% 7.33% 7.45% 7.40%
Investments (1):
Balance ......... $ 58,594 $ 33,586 $ 47,335 $ 46,506 $ 7,927 $ 25,440 $ 219,388 $219,694
Average
interest rate 3.92% 6.13% 5.93% 5.43% 5.82% 5.83% 5.30%
Liabilities:
Liquid
deposits (2):
Balance ....... $ 260,380 $ -- $ -- $ -- $ -- $ -- $ 260,380 $260,380
Average
interest rate 1.59% 0.00% 0.00% 0.00% 0.00% 0.00% 1.59%
Deposits,
certificates:
Balance ......... $ 241,862 $ 77,702 $ 32,865 $ 6,812 $ 8,218 $ -- $ 367,459 $376,384
Average
interest rate . 5.32% 5.46% 5.82% 5.34% 5.11% 0.00% 5.39%
<FN>
(1) Includes all available-for-sale investments, held-to-maturity investments,
federal funds and Federal Home Loan Bank stock.
(2) Includes passbook accounts, NOW accounts, Super NOW accounts and money
market funds.
</FN>
Item 8. Financial Statements and Supplementary Data
The financial statements and supplementary data are included on Pages 39 through
67.
Independent Auditor's Report
To the Board of Directors and Stockholders
Hills Bancorporation
Hills, Iowa
We have audited the accompanying consolidated balance sheets of Hills
Bancorporation and subsidiary as of December 31, 2001 and 2000, and the related
consolidated statements of income, comprehensive income, stockholders' equity
and cash flows for the years ended December 31, 2001, 2000 and 1999. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
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, 2001 and 2000, and the results of their
operations and their cash flows for the years ended December 31, 2001, 2000 and
1999 in conformity with accounting principles generally accepted in the United
States of America.
/s/ McGladrey & Pullen, LLP
Iowa City, Iowa
February 7, 2002
HILLS BANCORPORATION
CONSOLIDATED BALANCE SHEETS
December 31, 2001 and 2000
(In Thousands, Except Shares)
ASSETS 2001 2000
- ----------------------------------------------------------------------------------------
Cash and due from banks (Note 9) ................................. $ 37,070 $ 25,669
Investment securities (Note 2):
Available for sale (amortized cost 2001 $165,515; 2000 $136,661) 170,311 137,768
Held to maturity (fair value 2001 $12,146; 2000 $15,676) ....... 11,840 15,509
Stock of Federal Home Loan Bank .................................. 7,809 7,789
Federal funds sold ............................................... 29,428 28,065
Loans, net of allowance for loan losses 2001 $9,950; 2000 $10,428
(Notes 3, 6 and 10) ............................................ 682,692 626,873
Property and equipment, net (Note 4) ............................. 20,997 16,499
Accrued interest receivable ...................................... 7,257 7,522
Deferred income taxes (Note 8) ................................... 1,873 3,286
Other assets ..................................................... 6,828 6,770
-------------------
$976,105 $875,750
===================
LIABILITIES AND STOCKHOLDERS' EQUITY
- ----------------------------------------------------------------------------------------
Liabilities
Noninterest-bearing deposits ................................... $ 92,179 $ 76,087
Interest-bearing deposits (Note 5) ............................. 627,839 576,619
-------------------
Total deposits ........................................... 720,018 652,706
Securities sold under agreements to repurchase ................. 22,409 16,561
Federal Home Loan Bank borrowings (Note 6) ..................... 137,637 120,668
Accrued interest payable ....................................... 2,683 2,865
Other liabilities .............................................. 3,009 2,876
-------------------
885,756 795,676
-------------------
Commitments and Contingencies (Notes 7 and 13)
Redeemable Common Stock Held By Employee Stock
Ownership Plan (ESOP) (Note 7) ................................. 12,194 11,550
-------------------
Stockholders' Equity (Note 9)
Capital stock, no par value; authorized 10,000,000 shares;
issued 2001 1,498,558 shares; 2000 1,495,483 shares .......... 10,397 10,197
Retained earnings .............................................. 76,931 69,179
Accumulated other comprehensive income ......................... 3,021 698
-------------------
90,349 80,074
Less maximum cash obligation related to ESOP shares (Note 7) ... 12,194 11,550
-------------------
78,155 68,524
-------------------
$976,105 $875,750
===================
See Notes to Financial Statements.
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2001, 2000 and 1999
(In Thousands, Except Per Share Amounts)
2001 2000 1999
- --------------------------------------------------------------------------------------------
Interest income:
Loans, including fees ................................... $ 52,986 $ 50,081 $ 41,933
Investment securities:
Taxable ............................................... 7,670 7,481 7,167
Nontaxable ............................................ 1,930 1,732 1,566
Federal funds sold ...................................... 1,132 698 455
------------------------------
Total interest income ............................. 63,718 59,992 51,121
------------------------------
Interest expense:
Deposits ................................................ 26,634 24,871 20,826
Securities sold under agreements to repurchase .......... 617 699 517
FHLB borrowings ......................................... 7,184 7,494 4,970
------------------------------
Total interest expense ............................ 34,435 33,064 26,313
------------------------------
Net interest income ............................... 29,283 26,928 24,808
Provision for loan losses (Note 3) ........................ 924 948 900
------------------------------
Net interest income after provision for loan losses 28,359 25,980 23,908
------------------------------
Other income:
Loan origination fees ................................... 1,165 316 592
Trust fees .............................................. 2,399 2,388 2,029
Deposit account charges and fees ........................ 3,108 2,566 2,203
Other fees and charges .................................. 2,585 2,244 1,928
Net (losses) on sale of investment securities (Note 2) . -- -- (315)
------------------------------
9,257 7,514 6,437
------------------------------
Other expenses:
Salaries and employee benefits .......................... 11,863 10,651 9,807
Occupancy ............................................... 1,826 1,417 1,249
Furniture and equipment ................................. 2,807 2,156 1,893
Office supplies and postage ............................. 1,198 1,128 1,111
Other ................................................... 5,165 4,717 4,249
------------------------------
22,859 20,069 18,309
------------------------------
Income before income taxes ........................ 14,757 13,425 12,036
Federal and state income taxes (Note 8) ................... 4,613 4,059 3,570
------------------------------
Net income ........................................ $ 10,144 $ 9,366 $ 8,466
==============================
Earnings per share:
Basic ................................................... $ 6.78 $ 6.26 $ 5.70
Diluted ................................................. 6.72 6.21 5.66
See Notes to Financial Statements.
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years Ended December 31, 2001, 2000 and 1999
(In Thousands)
2001 2000 1999
- --------------------------------------------------------------------------------------------
Net income ................................................... $10,144 $ 9,366 $ 8,466
---------------------------
Other comprehensive income, net of income taxes:
Unrealized holding gains (losses) arising during the year,
net of income taxes 2001 $1,366; 2000 $983; 1999 $(1,385) 2,323 1,679 (2,364)
Reclassification adjustments for net (gains) losses realized
in net income, net of income taxes 2001 none;
2000 none; 1999 $116 ..................................... -- -- 198
---------------------------
Other comprehensive income (loss) .................... 2,323 1,679 (2,166)
---------------------------
Comprehensive income ................................. $12,467 $11,045 $ 6,300
===========================
See Notes to Financial Statements.
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Notes 7 and 9)
Years Ended December 31, 2001, 2000 and 1999
(In Thousands, Except Share Amounts)
Maximum
Cash
Accumulated Obligation
Other Related
Capital Retained Comprehensive To ESOP
Stock Earnings Income (Loss) Shares Total
- ---------------------------------------------------------------------------------------------
Balance, December 31, 1998 ....... $ 9,140 $ 55,428 $ 1,185 $ (9,301) $ 56,452
Issuance of 26,665 shares of
common stock ................. 752 -- -- -- 752
Redemption of 167 shares
of common stock .............. (8) -- -- -- (8)
Change related to ESOP shares .. -- -- -- (1,652) (1,652)
Net income ..................... -- 8,466 -- -- 8,466
Income tax benefit related to
stock based compensation ..... 330 -- -- -- 330
Cash dividends ($1.30 per share) -- (1,910) -- -- (1,910)
Other comprehensive
income (loss) ................ -- -- (2,166) -- (2,166)
--------------------------------------------------------
Balance, December 31, 1999 ....... 10,214 61,984 (981) (10,953) 60,264
Redemption of 458 shares
of common stock .............. (23) -- -- -- (23)
Change related to ESOP shares .. -- -- -- (597) (597)
Net income ..................... -- 9,366 -- -- 9,366
Income tax benefit related to
stock based compensation ..... 6 -- -- -- 6
Cash dividends ($1.45 per share) -- (2,171) -- -- (2,171)
Other comprehensive income ..... -- -- 1,679 -- 1,679
--------------------------------------------------------
Balance, December 31, 2000 ....... 10,197 69,179 698 (11,550) 68,524
Issuance of 3,233 shares of
common stock ................. 165 -- -- -- 165
Redemption of 158 shares
of common stock .............. (8) -- -- -- (8)
Change related to ESOP shares .. -- -- -- (644) (644)
Net income ..................... -- 10,144 -- -- 10,144
Income tax benefit related to ..
stock based compensation ..... 43 -- -- -- 43
Cash dividends ($1.60 per share) -- (2,392) -- -- (2,392)
Other comprehensive income ..... -- -- 2,323 -- 2,323
--------------------------------------------------------
Balance, December 31, 2001 ....... $ 10,397 $ 76,931 $ 3,021 $(12,194) $ 78,155
========================================================
See Notes to Financial Statements.
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2001, 2000 and 1999
(In Thousands)
2001 2000 1999
- -------------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities
Net income .................................................... $ 10,144 $ 9,366 $ 8,466
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation ................................................ 2,212 1,648 1,484
Amortization ................................................ 301 261 261
Provision for loan losses ................................... 924 948 900
Net losses on sale of investment securities ................. -- -- 315
Compensation paid by issuance of common stock ............... 121 -- 94
Deferred income taxes ....................................... 47 (315) (847)
(Increase) decrease in accrued interest receivable .......... 266 (1,146) (491)
Amortization of bond discount ............................... 171 39 339
(Increase) in other assets .................................. (359) 1,409 (1,329)
Increase (decrease) in accrued interest and other liabilities (49) 492 1,652
-----------------------------------
Net cash provided by operating activities ............... 13,778 12,702 10,844
-----------------------------------
Cash Flows from Investing Activities
Proceeds from maturities of investment securities:
Available for sale .......................................... 47,282 27,115 29,278
Held to maturity ............................................ 3,668 2,798 2,862
Proceeds from sales of available-for-sale securities .......... -- -- 17,013
Purchases of investment securities available for sale ......... (76,327) (32,158) (60,090)
Federal funds sold, net ....................................... (1,363) (27,859) 36,605
Loans made to customers, net of collections ................... (56,743) (62,440) (105,370)
Purchases of property and equipment ........................... (6,710) (6,501) (1,937)
-----------------------------------
Net cash (used in) investing activities ................. (90,193) (99,045) (81,639)
-----------------------------------
Cash Flows from Financing Activities
Net increase in deposits ...................................... 67,312 90,620 27,935
Net increase (decrease) in federal funds purchased and
securities sold under agreements to repurchase .............. 5,848 (10,153) 16,160
Borrowings from FHLB .......................................... 17,000 40,000 50,000
Payments on FHLB borrowings ................................... (31) (28,032) (17,032)
Stock options exercised ....................................... 44 -- 650
Income tax benefits related to stock based compensation ....... 43 6 330
Redemption of common stock .................................... (8) (23) --
Dividends paid ................................................ (2,392) (2,171) (1,910)
-----------------------------------
Net cash provided by financing activities ............... 87,816 90,247 76,133
-----------------------------------
(Continued)
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Years Ended December 31, 2001, 2000 and 1999
(In Thousands)
2001 2000 1999
- --------------------------------------------------------------------------------
Increase in cash and due from banks ...... $11,401 $ 3,904 $ 5,338
Cash and due from banks:
Beginning ...................................... 25,669 21,765 16,427
---------------------------
Ending ......................................... $37,070 $25,669 $21,765
===========================
Supplemental Disclosures
Cash payments for:
Interest paid to depositors and others ....... $26,884 $24,046 $20,824
Interest paid on other obligations ........... 8,504 8,193 5,487
Income taxes ................................. 4,974 4,424 3,755
Noncash financing activities:
Increase in maximum cash obligation related to
ESOP shares ................................ $ 644 $ 597 $ 1,652
See Notes to Financial Statements.
HILLS BANCORPORATION
NOTES TO 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 and Cedar Rapids, 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.
Accounting estimates: The preparation of 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 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 stock-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, 2001 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.
Investment securities: Held-to-maturity securities consist solely of debt
securities, which the Company has the positive intent and ability to hold to
maturity and are stated at amortized cost.
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, 2001 and 2000.
Stock of the Federal Home Loan Bank is carried at cost.
Premiums and discounts on debt securities are amortized over the contractual
lives 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.
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.
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 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.
Loans are considered impaired when, based on current information and events, it
is probable the Bank will not be able to collect all amounts due. The portion of
the allowance for loan losses applicable to impaired 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 impaired 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 impaired 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 statement of income as
collected or incurred. Compared to the net deferral method, this practice had no
significant effect on income.
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.
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.
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 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.
Intangible assets: Intangible assets consist principally of goodwill, which
represents the excess of cost over fair value of net assets acquired in business
combinations of two banks in 1996 accounted for under the purchase method.
Goodwill is amortized on a straight-line basis over the estimated period to be
benefited, 15 years. The carrying value of goodwill is reviewed periodically for
impairment. Goodwill totaled $2,500,000 and $2,760,000, net of accumulated
amortization of $1,398,000 and $1,137,000, respectively, as of December 31, 2001
and 2000, respectively, and is included in other assets.
Stock options: Compensation expense for stock issued through stock option and
award plans is accounted for using the intrinsic value based method of
accounting prescribed by APB Opinion No. 25, "Accounting for Stock Issued to
Employees." Under this method, compensation is 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, is charged to
expense over the periods of service.
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.
Trust assets: Trust assets, other than cash deposits, held by the Bank in
fiduciary or agency capacities for its customers are not included in these
statements since they are not assets of the Company.
Earnings per share: Basic per-share amounts are computed by dividing net income
(the numerator) by the weighted-average number of common shares outstanding (the
denominator). Diluted per share amounts assume the conversion, exercise or
issuance of all potential common stock equivalents unless the effect is to
reduce the loss or increase the income per common share from continuing
operations.
Following is a reconciliation of the denominator:
Year Ended December 31,
------------------------------------
2001 2000 1999
------------------------------------
Weighted average number of shares ................ $1,497,064 $1,495,906 $1,483,540
Potential number of dilutive shares .............. 12,432 12,875 11,784
Total shares to compute diluted earnings per share $1,509,496 $1,508,781 $1,495,324
There are no potentially dilutive securities that have not been included in the
determination of diluted shares.
Statement of cash flows: For purposes of reporting cash flows, cash and due from
banks includes cash on hand and amounts due from banks (including cash items in
process of clearing). Cash flows from loans originated by the Bank, deposits and
federal funds purchased and securities sold under agreements to repurchase are
reported net.
Recently issued accounting standards: Recently issued accounting standards are
not expected to materially affect the Company's financial statements.
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 11
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
believed to be significant. Unfunded loan commitments are not valued since
the loans are generally priced at market at the time of funding.
Cash and due from banks and federal funds sold: The carrying amounts reported
in the balance sheet 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. The carrying amount of accrued
interest receivable approximates its fair value.
Deposit liabilities: The fair values of demand deposits equal their carrying
amounts, which represent the amount payable on demand. The carrying amounts for
variable-rate, fixed-term money market accounts and certificates of deposit are
estimated using a discounted cash flow calculation that applies interest rates
currently being offered on certificates to a schedule of aggregated expected
monthly maturities on time deposits.
Short-term borrowings: The carrying amounts of federal funds sold 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 carrying amount of accrued interest payable
approximates its fair value. Note 2.
Investment Securities
The amortized cost and fair value of investment securities available for sale
are as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
--------------------------------------------
(Amounts In Thousands)
December 31, 2001:
U. S. Treasury .................. $ 11,549 $ 524 $ -- $ 12,073
U. S. Government agencies and
corporations .................. 119,308 3,887 (30) 123,165
State and political subdivisions 34,658 544 (129) 35,073
--------------------------------------------
Total ..................... $165,515 $ 4,955 $ (159) $170,311
============================================
December 31, 2000:
U. S. Treasury .................. $ 18,070 $ 249 $ (1) $ 18,318
U. S. Government agencies and
corporations .................. 94,439 720 (123) 95,036
State and political subdivisions 24,152 331 (69) 24,414
--------------------------------------------
Total ..................... $136,661 $ 1,300 $ (193) $137,768
============================================
The amortized cost and fair value of debt securities held to maturity are as
follows:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
------------------------------------------
(Amounts In Thousands)
December 31, 2001:
State and political subdivisions ... $11,840 $ 306 $ -- $12,146
=========================================
December 31, 2000:
State and political subdivisions ... $15,509 $ 168 $ (1) $15,676
=========================================
The contractual maturity distribution of investment securities as of December
31, 2001 is summarized as follows:
Available For Sale Held To Maturity
------------------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
------------------------------------------
(Amounts In Thousands)
Due in one year or less .............. $ 26,680 $ 27,193 $ 3,053 $ 3,090
Due after one year through five years 122,597 126,643 8,599 8,855
Due after five years through ten years 16,038 16,273 163 174
Due over ten years ................... 200 202 25 27
-----------------------------------------
Total ........................ $165,515 $170,311 $ 11,840 $ 12,146
=========================================
As of December 31, 2001, investment securities with a carrying value of
$44,782,000 were pledged to collateralize public and trust deposits, short-term
borrowings and for other purposes, as required or permitted by law.
Net gains or losses from the sale of investment securities were as follows:
Year Ended December 31,
------------------------------
2001 2000 1999
------------------------------
(Amounts In Thousands)
Gross gains ............................... $ -- $ -- $ 4
Gross (losses) ............................ -- -- (319)
-----------------------------
Net (losses) ...................... $ -- $ -- $ (315)
=============================
Note 3. Loans
The composition of loans is as follows:
December 31,
-------------------------
2001 2000
-------------------------
(Amounts In Thousands)
Agricultural ................................. $ 34,304 $ 28,560
Commercial and financial ..................... 44,363 37,832
Real estate:
Construction ............................... 40,430 38,184
Mortgage ................................... 538,832 499,010
Loans to individuals ......................... 34,713 33,715
-------------------------
692,642 637,301
Less allowance for loan losses ............... 9,950 10,428
-------------------------
$682,692 $626,873
=========================
Changes in the allowance for loan losses are as follows:
Year Ended December 31,
-------------------------------------
2001 2000 1999
-------------------------------------
(Amounts In Thousands)
Balance, beginning ................... $ 10,428 $ 9,750 $ 8,856
Provision charged to expenses ...... 924 948 900
Recoveries ......................... 1,139 904 757
Loans charged off .................. (2,541) (1,174) (763)
-------------------------------------
Balance, ending ...................... $ 9,950 $ 10,428 $ 9,750
=====================================
Information about impaired loans as of and for the years ended December 31, 2001
and 2000 is as follows:
2001 2000
----------------------
(Amounts In Thousands)
Loans receivable for which there is a related allowance for loan losses $ 4,417 $ --
Loans receivable for which there is no related allowance for loan losses 6,871 11,068
-----------------
Total impaired loans ........................................... $11,288 $11,068
=================
Related allowance for credit losses .................................... $ 897 $ --
Average balance ........................................................ 11,200 10,409
Interest income recognized ............................................. 962 977
Note 4. Property and Equipment
The major classes of property and equipment and the total accumulated
depreciation are as follows:
December 31,
-----------------------
2001 2000
-----------------------
(Amounts In Thousands)
Land ........................................... $ 3,715 $ 3,080
Buildings and improvements ..................... 15,844 12,664
Furniture and equipment ........................ 16,834 13,939
-----------------------
36,393 29,683
Less accumulated depreciation .................. 15,396 13,184
-----------------------
Net .................................... $20,997 $16,499
=======================
Note 5. Interest-Bearing Deposits
A summary of these deposits is as follows:
December 31,
--------------------------
2001 2000
--------------------------
(Amounts In Thousands)
NOW and other demand ....................... $ 84,480 $ 70,980
Savings .................................... 175,900 161,603
Time, $100,000 and over .................... 55,517 46,653
Other time ................................. 311,942 297,383
--------------------------
$627,839 $576,619
==========================
Note 6. Federal Home Loan Bank Borrowings
As of December 31, 2001 and 2000, the borrowings were as follows:
2001 2000
--------------------------
(Effective interest rates as of December 31, 2001) (In Thousands)
Due 2005, 3.72% ............................ $ 4,350 $ 10,000
Due 2006, 4.08% ............................ 12,750 --
Due 2008, 5.22% to 6.00% ................... 50,000 40,100
Due 2009, 5.66% to 6.04% ................... 30,537 30,568
Due 2010, 5.77% to 6.61% ................... 40,000 40,000
--------------------------
$137,637 $120,668
==========================
Approximately $120,000,000 of the borrowings are callable at various dates
through 2005.
The borrowings are collateralized by 1-4 family mortgage loans with an aggregate
face amount of $165,165,000. As of December 31, 2001, the Company held Federal
Home Loan Bank stock with a cost of $7,809,000.
Note 7. 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
$79,000, $70,000 and $64,000 for the years ended December 31, 2001, 2000 and
1999, 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 traded, a sponsor must reflect the maximum cash
obligation related to those securities outside of stockholders' equity. As of
December 31, 2001, 148,713 shares held by the ESOP, at a fair value of $82 per
share, had been reclassified from stockholders' equity to liabilities.
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 $636,000, $562,000 and
$509,000 for the years ended December 31, 2001, 2000 and 1999, respectively.
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 stock awards. Under the plan, the aggregate number of
options and shares granted cannot exceed 66,000 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. Directors may
exercise options immediately and officers' rights under the plan vest over a
five-year period from the date of the grant. No compensation expense has been
charged to expense using the intrinsic value based method as prescribed by APB
No. 25. Had compensation expense been determined based on the grant date fair
values of the awards, as prescribed by SFAS No. 123, reported net income and
earnings per share would have been as follows:
Years Ended December 31,
------------------------------------
2001 2000 1999
------------------------------------
Pro forma net income (in thousands) .... $ 10,131 $ 9,361 $ 8,461
Pro forma earnings per share:
Basic ................................ 6.77 6.26 5.70
Diluted .............................. 6.71 6.21 5.66
The fair value of each grant is established at the grant date using the
Black-Scholes option-pricing model with the following weighted average
assumptions for 2001 grants: Dividend rate 2.19%; risk-free interest rate of
4.40% and an expected life of 10 years. There were no grants in 2000 or 1999.
Weighted
Average
Number Exercise
Of Shares Price
----------------------------
Balance, December 31, 1999 ................... 20,462 $ 27.15
Exercised .................................. -- --
---------------------------
Balance, December 31, 2000 ................... 20,462 27.15
Granted* ................................... 10,400 77.00
Exercised .................................. (1,683) 26.17
---------------------------
Balance, December 31, 2001 ................... 29,179 $ 44.98
===========================
* The weighted average fair value of these options was $15 per share.
Other pertinent information related to the options outstanding at December 31,
2001 is as follows:
Remaining
Exercise Number Contractual Number
Price Outstanding Life Exercisable
- --------------------------------------------------------------
$ 25.33 12,330 15 Months 12,330
26.17 4,394 18 Months 4,394
41.00 2,055 63 Months 2,055
77.00 10,400 113 months -
------ ------
29,179 18,779
====== ======
As of December 31, 2001, 55,600 options were available for future grants.
The committee is also authorized to grant awards of common stock, and if
authorized the issuance of 1,550, none and 1,587 shares of common stock to a
group of employees in 2001, 2000 and 1999, respectively.
Note 8. Income Taxes
Income taxes for the years ended December 31, 2001, 2000 and 1999 are summarized
as follows:
2001 2000 1999
-----------------------------------------
(Amounts In Thousands)
Current:
Federal .................... $ 3,819 $ 3,648 $ 3,707
State ...................... 747 726 710
Deferred ..................... 47 (315) (847)
-----------------------------------------
$ 4,613 $ 4,059 $ 3,570
=========================================
Deferred income tax liabilities and assets arose from the following temporary
differences:
December 31,
--------------------------
2001 2000 1999
--------------------------
(Amounts In Thousands)
Deferred income tax assets:
Allowance for loan losses ...................... $3,693 $3,860 $3,597
Unrealized losses on investment securities ..... -- -- 574
Deferred compensation .......................... 530 433 311
Certain accrued expenses ....................... 276 198 190
Other .......................................... 91 90 112
--------------------------
Gross deferred tax assets ................ 4,590 4,581 4,784
--------------------------
Deferred income tax liabilities:
Property and equipment ......................... 773 750 700
FHLB dividends ................................. 130 130 130
Unrealized gains on investment securities ...... 1,775 409 --
Other .......................................... 39 6 --
--------------------------
Gross deferred tax liabilities ........... 2,717 1,295 830
--------------------------
Net deferred income tax asset ............ $1,873 $3,286 $3,954
==========================
The net change in the deferred income taxes for the years ended December 31,
2001, 2000 and 1999 is reflected in the financial statements as follows:
Year Ended December 31,
---------------------------------
2001 2000 1999
---------------------------------
(Amounts In Thousands)
Statement of income ...................... $ 47 $ (315) $ (847)
Statement of stockholders' equity ........ 1,366 983 (1,269)
---------------------------------
$ 1,413 $ 668 $(2,116)
=================================
The income tax provisions for the years ended December 31, 2001, 2000 and 1999
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:
2001 2000 1999
% Of % Of % Of
Pretax Pretax Pretax
Amount Income Amount Income Amount Income
--------------------------------------------------------
(Amounts In Thousands)
Expected provision $ 5,165 35.0% $ 4,699 35.0% $ 4,213 35.0%
Tax-exempt interest (745) (5.0) (712) (5.3) (647) (5.3)
Interest expense
limitation ...... 143 1.0 111 1.0 120 1.0
State income taxes,
net of federal
income tax
benefit ......... 493 3.3 479 3.6 468 3.9
Income tax credits (345) (2.3) (345) (2.6) (345) (2.9)
Other ............. (98) (0.7) (173) (1.3) (239) (2.0)
-------------------------------------------------------
$ 4,613 31.3% $ 4,059 30.4% $ 3,570 29.7%
=======================================================
Note 9. Regulatory Capital Requirements, Restrictions on Subsidiary Dividends
and Cash Restrictions
Federal regulatory agencies have adopted various capital standards for financial
institutions, including risk-based capital standards. The primary objectives of
the risk-based capital framework are to provide a more consistent system for
comparing capital positions of financial institutions and to take into account
the different risks among financial institutions' assets and off-balance sheet
items.
Risk-based capital standards include requirements for a minimum Tier 1 capital
to assets ratio (leverage ratio). In addition, regulatory agencies consider the
published capital levels as minimum levels and may require a financial
institution to maintain capital at higher levels.
The actual amounts and capital ratios as of December 31, 2001, with the minimum
regulatory requirements for the Company and Bank are presented below (amounts in
thousands):
To Be Well
For Capital Capitalized Under
Adequacy Prompt Corrective
Actual Purposes Action Provisions
--------------------------------------------------
Amount Ratio Ratio Ratio
---------------------------------------------------
As of December 31, 2001:
Company:
Total risk based capital ....... $92,725 14.72% 8.00% 10.00%
Tier 1 risk based capital ...... 84,827 13.47 4.00 6.00
Leverage ratio ................. 8.86 3.00 5.00
Bank:
Total risk based capital ....... 89,690 14.34 8.00 10.00
Tier 1 risk based capital ...... 82,103 13.09 4.00 6.00
Leverage ratio ................. 8.71 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 $7,015,000 as of December 31, 2001 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 $11,998,000 and $9,662,000 as of December
31, 2001 and 2000, respectively.
Note 10. 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, 2001 and 2000:
Year Ended December 31,
-----------------------------
2001 2000
-----------------------------
(Amounts In Thousands)
Balance, beginning ..................... $ 13,297 $ 10,733
Advances ............................. 15,445 8,725
Collections .......................... (4,302) (6,161)
-----------------------------
Balance, ending ........................ $ 24,440 $ 13,297
=============================
Deposits from related parties are accepted subject to the same interest rates
and terms as those from nonrelated parties.
Note 11. Fair Value of Financial Instruments
The carrying value and estimated fair values of the Company's financial
instruments as of December 31, 2001 and 2000 are as follows:
2001 2000
-------------------- --------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------------------------------------------
(Amounts In Thousands)
Cash and due from banks ...................................... $ 37,070 $ 37,070 $ 25,669 $ 25,669
Federal funds sold ........................................... 29,428 29,428 28,065 28,065
Investment securities ........................................ 189,960 190,266 161,066 161,233
Loans ........................................................ 682,692 679,337 626,873 624,450
Accrued interest receivable .................................. 7,257 7,257 7,522 7,522
Deposits ..................................................... 720,018 728,943 652,706 659,327
Federal funds purchased and securities
sold under agreements to repurchase ........................ 22,409 22,409 16,561 16,561
Borrowings from Federal Home Loan
Bank ....................................................... 137,637 137,371 120,668 121,325
Accrued interest payable ..................................... 2,683 2,683 2,865 2,865
Face Amount Face Amount
----------- -----------
Off-balance sheet instruments:
Loan commitments ........................................... $117,609 $ -- $ 91,060 $ --
Letters of credit .......................................... 12,569 -- 10,993 --
Note 12. Parent Company Only Financial Information
Following is condensed financial information of the Company (parent company
only):
CONDENSED BALANCE SHEETS
December 31, 2001 and 2000
(Amounts In Thousands)
ASSETS 2001 2000
- --------------------------------------------------------------------------------
Cash ................................................... $ 1,655 $ 1,583
Investment securities available for sale ............... 520 499
Investment in subsidiary bank .......................... 87,837 77,711
Other assets ........................................... 572 529
-------------------
Total assets ................................... $90,584 $80,322
===================
LIABILITIES AND STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------------
Liabilities ............................................ $ 235 $ 248
-------------------
Redeemable common stock held by ESOP ................... 12,194 11,550
-------------------
Stockholders' equity:
Capital stock ........................................ 10,397 10,197
Retained earnings .................................... 76,931 69,179
Accumulated other comprehensive income ............... 3,021 698
-------------------
90,349 80,074
Less maximum cash obligation related to ESOP shares .... 12,194 11,550
-------------------
Total stockholders' equity ..................... 78,155 68,524
-------------------
Total liabilities and stockholders' equity ..... $90,584 $80,322
===================
CONDENSED STATEMENTS OF INCOME
Years Ended December 31, 2001, 2000 and 1999
(Amounts In Thousands)
2001 2000 1999
---------------------------------
Interest on investment securities ........... $ 32 $ 30 $ 16
Dividends received from subsidiary .......... 2,392 2,170 1,911
Other expenses .............................. (112) (119) (121)
---------------------------------
Income before income taxes and equity
in subsidiary's undistributed income 2,312 2,081 1,806
Income tax benefit .......................... 29 43 37
---------------------------------
2,341 2,124 1,843
Equity in subsidiary's undistributed income . 7,803 7,242 6,623
---------------------------------
Net income .......................... $ 10,144 $ 9,366 $ 8,466
=================================
CONDENSED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2001, 2000 and 1999
(Amounts In Thousands)
2001 2000 1999
--------------------------------
Cash flows from operating activities:
Net income ...................................... $ 10,144 $ 9,366 $ 8,466
Noncash items included in net income:
Undistributed earnings of subsidiary .......... (7,803) (7,242) (6,623)
(Increase) decrease in other assets ........... (43) 304 (180)
Increase (decrease) in liabilities ............ (13) (76) 90
--------------------------------
Net cash provided by operating activities . 2,285 2,352 1,753
--------------------------------
Cash flows from investing activities:
Proceeds from maturities of investment securities 250 -- 303
Purchase of investment securities ............... (271) -- (499)
--------------------------------
Net cash (used in) investing activities ... (21) -- (196)
--------------------------------
Cash flows from financing activities:
Stock issued (redeemed) ......................... 157 (23) 744
Income tax benefits related to stock based
compensation .................................. 43 6 330
Dividends paid .................................. (2,392) (2,171) (1,910)
--------------------------------
Net cash (used in) financing activities ... (2,192) (2,188) (836)
--------------------------------
Increase in cash .......................... 72 164 721
Cash balance:
Beginning ....................................... 1,583 1,419 698
--------------------------------
Ending .......................................... $ 1,655 $ 1,583 $ 1,419
================================
Note 13. 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
$17,417,000. The concentrations of credit by type of loan are set forth in Note
3. 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, 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 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 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, 2001 and 2000
is as follows:
2001 2000
----------------------
(Amounts In Thousands)
Firm loan commitments and unused portion of lines
of credit:
Home equity loans ................................... $ 5,819 $ 4,693
Credit card participations .......................... 14,050 12,639
Commercial, real estate and home construction ....... 44,880 33,562
Commercial lines .................................... 52,860 40,166
Outstanding letters of credit ......................... 12,569 10,993
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.
Outstanding letters of credit are the conditional commitments issued by the Bank
to guarantee the performance of a customer to a third party and collateralize
the customer's borrowing arrangement with other creditors. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan facilities to customers. Collateral held varies as specified
above and is required in instances which the Bank deems it necessary.
Note 14. Quarterly Results of Operations (unaudited, in thousands, except per
share amounts)
Quarter Ended
-----------------------------------------------
March June September December Year
-----------------------------------------------
2001:
Total interest income ...... $15,752 $15,931 $16,032 $16,003 $63,718
Net interest income after
provisions for loan losses 6,527 6,923 7,298 7,611 28,359
Net income ................. 2,307 2,534 2,680 2,623 10,144
Basic earnings per share ... 1.54 1.69 1.79 1.76 6.78
Diluted earnings per share . 1.53 1.68 1.77 1.74 6.72
2000:
Total interest income ...... $14,059 $14,651 $15,300 $15,982 $59,992
Net interest income after
provisions for loan losses 6,294 6,496 6,511 6,679 25,980
Net income ................. 2,204 2,399 2,336 2,427 9,366
Basic earnings per share ... 1.47 1.60 1.56 1.63 6.26
Diluted earnings per share . 1.46 1.59 1.55 1.61 6.21
Part II
Item 9. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure
None
Part III
Item 10. Directors and Executive Officers of the Registrant
Information concerning directors is contained in the Registrant's Proxy
Statement under the heading "Information Concerning Nominees for Election as
Directors" and "Information Concerning Directors Other Than Nominees," which
sections are incorporated herein by this reference.
The following table sets forth the name, age and principal occupation of the
Executive Officers of the Registrant and Executive Officers of the Bank. All
officers of the Registrant and the Bank are elected annually for one-year terms
of office.
Year First
Elected
Position With Registrant Or Bank And Officer Of
Principal Occupation And Employment Registrant
Name Age During The Past Five Years (Bank)
- -------------------------------------------------------------------------------------------------------------------
Dwight O. Seegmiller 49 Director of Registrant and Bank; President, Registrant and Bank 1986 (1975)
Willis M. Bywater 63 Director of Registrant and Bank; Chairman of the Board, Bank; 1997
Vice President of the Registrant; Executive Officer and Shareholder
of Economy Advertising Company
James G. Pratt 53 Treasurer of Registrant; Senior Vice President from January 1986 1985 (1982)
to present
Thomas J. Cilek 55 Secretary of Registrant; Senior Vice President of Bank from 1988 (1986)
August 1986 to present
Item 11. Executive Compensation
Information required by this item is contained in the Registrant's Proxy
Statement under the heading "Executive Compensation and Benefits," which section
is incorporated herein by this reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information required by this item is contained in the Registrant's Proxy
Statement under the heading "Security Ownership of Certain Beneficial Owners and
Management" and "Report on Executive Compensation," which sections are
incorporated herein by this reference.
Item 13. Certain Relationships and Related Transactions
Information required by this item is contained in the Registrant's Proxy
Statement under the heading "Loans To and Certain Other Transactions With
Executive Officers and Directors," which section is incorporated herein by this
reference.
Part IV
Item 14. Exhibits, Financial Statements, Schedules and Reports on Form 8-K
Form 10-K
Reference
---------
(a) 1. Financial Statements
Independent auditor's report on the financial statements
Consolidated balance sheets as of December 31, 2001 and 2000
Consolidated statements of income for the years ended
December 31, 2001, 2000 and 1999
Consolidated statements of comprehensive income for the
years ended December 31, 2001, 2000 and 1999
Consolidated statements of stockholders' equity for the years
ended December 31, 2001, 2000 and 1999
Consolidated statements of cash flows for the years ended
December 31, 2001, 2000 and 1999
Notes to financial statements
(a) 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
Exhibit 3 - Articles of Incorporation and Bylaws filed as Exhibit 3 of
Form 10-K for the year ended December 31, 1993 are incorporated by
reference.
Exhibit 10(a) - 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.
Exhibit 10(b) - 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.
Exhibit 10(c) - 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.
Exhibit 10(d) - Material contract (2000 Stock Option and Incentive
Plan) filed as Exhibit 10(d) in Form 10-K for the year ended December
31, 2000 is incorporated by reference.
Exhibit 11 - Statement Re Computation of Basic and Diluted Earnings Per
Share is attached on Page 73.
Exhibit 21 - Subsidiaries of the Registrant is attached on Page 74.
Exhibit 23 - Consent of Accountants is attached on Page 75.
(b) Reports on Form 8-K:
The Registrant filed no reports on Form 8-K for the three months ended
December 31, 2001.
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.
HILLS BANCORPORATION
Date March 25, 2002 By /s/ Dwight O. Seegmiller
--------------------------- -----------------------------------
Dwight O. Seegmiller, Director
and President
Date March 25, 2002 By /s/ James G. Pratt
--------------------------- -----------------------------------
James G. Pratt, 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.
Date March 25, 2002 By /s/ Willis M. Bywater
---------------------------- -----------------------------------
Willis M. Bywater, Director
Date March 25, 2002 By /s/ Thomas J. Gill
---------------------------- -----------------------------------
Thomas J. Gill, Director
Date March 25, 2002 By /s/ Donald H. Gringer
---------------------------- -----------------------------------
Donald H. Gringer, Director
Date March 25, 2002 By /s/ Michael E. Hodge
--------------------------- -----------------------------------
Michael E. Hodge, Director
Date March 25, 2002 By /s/ Richard W. Oberman
--------------------------- -----------------------------------
Richard W. Oberman, Director
Date March 25, 2002 By /s/ Theodore H. Pacha
--------------------------- -----------------------------------
Theodore H. Pacha, Director
Date March 25, 2002 By /s/ Ann M. Rhodes
---------------------------- -----------------------------------
Ann M. Rhodes, Director
Date March 25, 2002 By /s/ Ronald E. Stutsman
----------------------------- -----------------------------------
Ronald E. Stutsman, Director
Date March 25, 2002 By /s/ Sheldon E. Yoder
---------------------------- -----------------------------------
Sheldon E. Yoder, Director
HILLS BANCORPORATION
ANNUAL REPORT ON FORM 10-K FOR THE
FISCAL YEAR ENDED DECEMBER 31, 2001
EXHIBIT INDEX
Page Number
In The Sequential
Exhibit Numbering System
Number Description For 2001 Form 10-K
- -------------------------------------------------------------------------------------------------------
11 Statement Re Computation of Basic and Diluted Earnings Per Share
21 Subsidiary of the Registrant
23 Consent of Independent Certified Public Accountants