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, 2002.
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]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act) Yes [ X ] No [ ]
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 17, 2003 (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 $88 per share) was
$108,316,000.
The number of shares outstanding of the Registrant's common stock as of March
17, 2003 is 1,501,054 shares of no par value common stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement dated March 24, 2003 for the Annual Meeting of
the Shareholders of the Registrant to be held April 21, 2003 (the Proxy
Statement) are incorporated by reference in Part III of this Form 10-K.
EXHIBIT INDEX
The exhibits index is on Page 74.
1
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 to 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.. The office is located in Kalona, Iowa (Washington County) which
is approximately 20 miles south of Iowa City. Kalona has a population of
approximately 2,300 people. Kalona is primarily an agricultural community, but
is located within easy driving distance for employment in Iowa City, Coralville
and North Liberty (combined population 85,000) and Washington, Iowa (population
7,000). 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 86,000 and Johnson
County, Iowa has a population of approximately 111,000. The University of Iowa
in Iowa City has over 29,700 students and 23,600 full and part-time employees,
including employees of The University of Iowa Hospitals and Clinics. Other
principal employers in Johnson County include the following:
Employer Type of Business Employees
- ------------------------------------------------------------------------------------------------------------
Iowa City Community School District Education 1,300
NCS Pearson Corporation Information Service - Computers 1,250
Hy-Vee Food Stores Grocery Stores 1,200
Mercy Hospital Health Care 1,200
Veterans Administration Medical Center Health Care 1,200
American College Testing Program Educational Testing Service 1,100
Lear Corporation Automotive Products Manufacturing 900
Rockwell Collins Electronic Manufacturing 800
Oral B Laboratories Consumer Products 730
Proctor & Gamble Consumer Products 580
City of Iowa City City Government 580
2
The Bank also operates offices in the Linn County, Iowa communities of Lisbon,
Mount Vernon and Cedar Rapids, Iowa. In addition, the Bank opened its twelfth
office location on February 10, 2003 in Marion, Iowa, a community that is
adjacent to Cedar Rapids, in Linn County. Lisbon has a population of
approximately 1,900 and Mount Vernon, located two miles from Lisbon, has a
population of 3,800. 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 1,000 students. Cedar
Rapids has a metropolitan population of approximately 154,000, including 27,000
from Marion and is located approximately 10 miles west of Lisbon, Iowa and
approximately 25 miles north of Iowa City on Interstate 380. The total
population of Linn County is approximately 192,000.The largest employer in the
Cedar Rapids area is Rockwell Collins, manufacturer of communications
instruments, with about 7,100 employees. Other large employers in the Cedar
Rapids area and their approximate number of employees are as follows:
Employer Type of Business Employees
- ------------------------------------------------------------------------------------------------------------
MCI WorldCom., Inc Telecommunications 2,900
Cedar Rapids Community Schools Education 2,750
Hy-Vee Food Stores Grocery Stores 2,400
AEGON USA, Inc. Insurance 2,400
St. Luke's Hospital Health Care 2,400
Maytag Appliances, Amana Iowa Household Appliances 2,300
Mercy Medical Center Health Care 2,000
McLeod*USA Telecommunications 1,650
Alliant Energy Electric Utility 1,650
City of Cedar Rapids City Government 1,500
Kirkwood Community College Education 1,325
Quaker Oats Company Cereals and Chemicals 1,275
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, Cedar Rapids, Coralville,
North Liberty, Lisbon, Mount Vernon, Kalona and Marion. 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 attempts to reduce the risk of credit loss to the Bank by
requiring that, among other things, maintenance of minimum loan to value ratios,
evidence of appropriate levels of insurance carried by borrowers and
documentation of 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, 2002 and the Bank had 285
regular and 109 part-time employees.
3
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 Bank is in direct competition for loans and deposits and financial services
with a number of other banks and credit unions in Johnson and Linn County. A
comparison of deposits in the two counties are as follows:
Deposits as of June 2002
(In Millions)
Johnson Linn
County County
Hills Bank and Trust Company ....................... $ 611 $ 89
Branches of largest competing regional bank ........ 234 591
Largest competing independent bank ................. 345 331
Largest competing credit union ..................... 219 278
Total Market in County ............................. 1,713 3,099
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 68,500,
of which 23,600 employees work for the University of Iowa or the University of
Iowa Hospitals and Clinics. Other larger sectors of the economy are indicated
above in the employment table of large employers. 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 2.0% for the past five years. Johnson County, Iowa has had one of
the strongest economies in Iowa and has had substantial economic growth in the
past ten years. The largest segment of the employed population is employed in
management, professional or related occupations.
The State of Iowa continues to collect decreasing tax revenues while spending
continues to increase, and the Iowa legislature has required the University of
Iowa to reduce spending in the last two fiscal years. The University has reacted
to its budget constraints without significant lay-offs and has continued to
review and reduce employment, when necessary, through attrition. However, salary
increases at the University have been minimal.
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
192,000, has a much higher dependence on manufacturing than Johnson County. Linn
County has an employment labor force of 114,300 and similar to Johnson County
has an unemployment rate of about 2%. Overall the economy in both Johnson and
Linn County has not been adversely affected by the slow down in the national
economy. It is expected that at some point the local economy will be adversely
affected if the national economy remains sluggish.
4
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
applicable 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 activities that are permissible for financial holding companies (as
described above) and certain activities that the Secretary of the Treasury, in
consultation with the Federal Reserve, determines are 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.
5
Furthermore, the Act provides reform in transactions with the Federal Home Loan
Bank 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 by replacing the current $300 million funding formula for
the refinance corporation ("REFCORP") obligations of the Federal Home Loan Bank
to permit such obligations to equal twenty percent (20%) of the Federal Home
Loan Bank's annual earnings.
In the area of privacy, the Act requires clear disclosure by all financial
institutions of their privacy policies 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 reforms laws that regulate ATMs, Community
Reinvestment 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 both on the machine 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
reduces the frequency of CRA exams for small banks and savings and loans (those
with no more than $250 million in assets). 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 the future.
Finally, the Act expands the prohibition of deposit production offices contained
in the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the
"Riegle-Neal Act") 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"). 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.
Source of Strength Policy. According to Federal Reserve Board policy,
bank/financial holding companies are expected to act as a source of financial
strength to each subsidiary bank and to commit resources to support each such
subsidiary. This support may be required at times when a bank/financial holding
company may not be able to provide support. Similarly, under the cross-guarantee
provisions of the Federal Deposit Insurance Act, in the event of a loss suffered
or anticipated by the FDIC - either as a result of default of a banking or
thrift subsidiary of a bank/financial holding company such as the Company or
related to FDIC assistance provided to a subsidiary in danger of default - the
other banking subsidiaries of such bank/financial holding company may be
assessed for the FDIC's loss, subject to certain exceptions.
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.
6
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 a "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 primarily to protect
it from the risk inherent 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
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. 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 banks maintain
minimum levels of capital to protect the banks and their 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 consists 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.
7
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 minimum requirements for a well capitalized
organization experiencing significant growth are a leverage ratio of 5%, a Tier
1 risk-based capital ratio of 6% and total risk-based capital ratio of 10%. As
of December 31, 2002, the Company had regulatory capital in excess of the
Federal Reserve's minimum and well-capitalized definition requirements, with a
leverage ratio of 8.64%, with total Tier 1 risk-based capital ratio of 12.93%
and a total risk-based capital ratio of 14.19%.
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 of Banking of the State of Iowa
(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.
8
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, and restrictions
relating to investments, opening of bank offices and other activities of state
banks. Changes in the capital structure of state banks are also approved by the
Superintendent. State banks normally must have a primary capital to total assets
ratio of six and one-half percent (6 1/2 %). 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, 2002, 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" 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, 2002,
the Bank was well capitalized, as defined by FDIC regulations.
Community Investment and Consumer Protection Laws. In the connection with its
lending activities, the Bank is subject to a variety of federal laws designed to
protect borrowers and promote lending to various sectors of the economy and
population. Included among these are the Federal Home Mortgage Disclosure Act,
Real Estate Settlement Procedures Act, Truth-in-Lending Act, Equal Credit
Opportunity Act, Fair Credit Reporting Act and Community Reinvestment Act.
The Community Reinvestment Act requires insured institutions to define the
communities that they serve, identify the credit needs of those communities and
adopt and implement a "Community Reinvestment Act Statement" pursuant to which
they offer credit products and take other actions that respond to the credit
needs of the community. The responsible federal banking regulator must conduct
regular Community Reinvestment Act examinations of insured financial
institutions and assign to them a Community Reinvestment Act rating of
"outstanding," "satisfactory," "needs improvement" and "unsatisfactory." In
2002, the Community Reinvestment Act rating of the Company's banking subsidiary
was either "outstanding" or "satisfactory."
Supervisory Assessments. All Iowa banks are required to pay supervisory
assessments to the Superintendent to fund the Superintendent's examination and
supervision operations. During the fiscal year ended December 31, 2002, the Bank
paid supervisory assessments to the Superintendent totaling $7,952, for the
period ending June 30, 2002. Effective July 1, 2002 the Superintendent has
changed the method of computation of the supervisory assessment from billing for
each state examination completed based on an hourly rate, to billing on an
annual basis based on the assets of the bank, the expected hours needed to
conduct examinations of that size bank and an additional amount if more work is
required. It is expected that the Bank's total assessment on an annual basis
will be $100,000. This would be an amount similar to the current assessment in a
year in which a state examination would have been completed. For fiscal 2002 the
assessment total was $40,547.
9
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,
2002. 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 orders 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 regulatory approval.
Under 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.
10
Miscellaneous. The Bank is subject to certain restrictions on loans to the
Company or its non-bank subsidiaries, on investments in the stock or securities
thereof, on the taking of such stock or securities as collateral for loans to
any borrower, and on the issuance of a guarantee or letter of credit on behalf
of the Company or its non-banking subsidiaries. The Bank is also subject to
certain restrictions on most types of transactions with the Company or its
non-bank subsidiaries, requiring that the terms of such transactions be
substantially equivalent to terms of similar transactions with non-affiliated
firms.
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.
Regulatory Enforcement Authority. The enforcement powers available to federal
and state banking regulators are substantial and include, among other things,
the ability to assess civil money penalties, to issue cease-and-desist or
removal orders and to initiate injunctive actions against banking organizations
and institutions-affiliated parties, as defined. In general, these enforcement
actions may be initiated for violations of laws and regulations and unsafe or
unsound practices. Other actions or inactions may provide the basis for
enforcement action, including misleading or untimely reports filed with
regulatory authorities.
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,
------------------------------------
2002 2001 2000
------------------------------------
(Amounts In Thousands)
ASSETS
Cash and due from banks ...................... $ 27,815 $ 24,493 $ 20,347
Taxable securities ........................... 143,422 132,227 121,499
Nontaxable securities ........................ 56,369 42,783 38,026
Federal funds sold ........................... 34,827 29,551 11,358
Loans, net ................................... 733,822 646,196 600,215
Property and equipment, net .................. 21,598 18,889 13,675
Other assets ................................. 21,650 19,575 16,129
------------------------------------
$1,039,503 $ 913,714 $ 821,249
====================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Noninterest-bearing demand deposits .......... $ 92,145 $ 78,687 $ 69,246
Interest-bearing demand deposits ............. 96,054 76,366 66,090
Savings deposits ............................. 194,230 169,561 154,121
Time deposits ................................ 381,973 357,882 309,565
Securities sold under agreements to repurchase 21,240 17,444 14,665
FHLB borrowings .............................. 153,543 123,211 128,043
Other liabilities ............................ 6,173 5,924 5,569
Redeemable common stock held by
Employee Stock Ownership Plan .............. 12,572 11,872 11,251
Stockholders' equity ......................... 81,573 72,767 62,699
------------------------------------
$1,039,503 $ 913,714 $ 821,249
====================================
11
INTEREST INCOME AND EXPENSE
Year Ended December 31,
---------------------------
2002 2001 2000
---------------------------
(Amounts In Thousands)
Income:
Loans (1) ...................................... $54,491 $53,121 $50,267
Taxable securities ............................. 7,412 7,670 7,481
Nontaxable securities (1) ...................... 3,433 2,924 2,624
Federal funds sold ............................. 520 1,132 698
---------------------------
Total interest income .................... 65,856 64,847 61,070
---------------------------
Expense:
Interest-bearing demand deposits ............... 1,094 1,412 1,566
Savings deposits ............................... 2,900 4,611 5,615
Time deposits .................................. 18,300 20,611 17,690
Securities sold under agreements to repurchase . 375 617 699
FHLB borrowings ................................ 8,472 7,184 7,494
---------------------------
Total interest expense ................... 31,141 34,435 33,064
---------------------------
Net interest income ...................... $34,715 $30,412 $28,006
===========================
(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,
----------------------
2002 2001 2000
----------------------
Average yields:
Loans (1) ......................................... 7.41% 8.20% 8.34%
Loans (tax equivalent basis) ...................... 7.43 8.22 8.37
Taxable securities ................................ 5.17 5.80 6.15
Nontaxable securities ............................. 4.02 4.51 4.55
Nontaxable securities (tax equivalent basis) ...... 6.09 6.83 6.90
Federal funds sold ................................ 1.49 3.85 6.15
Interest-bearing demand deposits .................. 1.14 1.85 2.37
Savings deposits .................................. 1.49 2.72 3.64
Time deposits ..................................... 4.79 5.76 5.71
Securities sold under agreements to repurchase .... 1.79 3.53 4.77
FHLB borrowings ................................... 5.52 5.83 5.85
Yield on average interest-earning assets .......... 6.80 7.62 7.92
Rate on average interest-bearing liabilities ...... 3.68 4.63 4.92
Net interest spread (2) ........................... 3.12 2.99 3.00
Net interest margin (3) ........................... 3.58 3.58 3.62
(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.
12
CHANGES IN INTEREST INCOME AND EXPENSE
Changes Due Changes Due Total
To Volume To Rates Changes
----------------------------------
(Amounts In Thousands)
Year ended December 31, 2002:
Change in interest income:
Loans ........................................ $ 6,777 $(5,407) $ 1,370
Taxable securities ........................... 617 (875) (258)
Nont axable securities ....................... 852 (343) 509
Federal funds sold ........................... 177 (789) (612)
---------------------------------
8,423 (7,414) 1,009
---------------------------------
Change in interest expense:
Interest-bearing demand deposits ............. 308 (626) (318)
Savings deposits ............................. 598 (2,309) (1,711)
Time deposits ................................ 1,321 (3,638) (2,317)
Securities sold under agreements to repurchase 114 (350) (236)
FHLB borrowings .............................. 1,687 (399) 1,288
---------------------------------
4,028 (7,322) (3,294)
---------------------------------
Change in net interest income .................. $ 4,395 $ (92) $ 4,303
=================================
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
=================================
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,
----------------------------------------------------
2002 2001 2000 1999 1998
----------------------------------------------------
(Amounts In Thousands)
Agricultural ............ $ 37,937 $ 34,304 $ 28,560 $ 27,302 $ 32,318
Commercial and financial 46,828 44,363 37,832 36,848 39,438
Real estate, construction 47,201 40,430 38,184 40,879 28,476
Real estate, mortgage ... 628,110 538,832 499,010 439,072 338,871
Loans to individuals .... 32,906 34,713 33,715 31,030 30,664
----------------------------------------------------
Total ........... $792,982 $692,642 $637,301 $575,131 $469,767
====================================================
13
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,
2002:
Amount One Year One To Over Five
Of Loans Or Less (1) Five Years Years
--------------------------------------------
(Amounts In Thousands)
Commercial, financial and agricultural $ 84,765 $ 46,961 $ 33,574 $ 4,230
Real estate, construction and mortgage 675,311 82,051 216,792 376,468
Other ................................ 32,906 15,328 17,230 348
--------------------------------------------
$792,982 $144,340 $267,596 $381,046
============================================
The types of interest rates applicable to these principal payments are shown
below:
Amount One Year One To Over Five
Of Loans Or Less (1) Five Years Years
--------------------------------------------------
(Amounts In Thousands)
Fixed rate ............. $385,085 $ 92,665 $253,985 $ 38,435
Variable rate .......... 407,897 51,675 13,611 342,611
--------------------------------------------------
$792,982 $144,340 $267,596 $381,046
==================================================
(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.
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:
2002 2001 2000 1999 1998
-----------------------------------------------
(Amounts In Thousands)
Nonaccrual loans ............. $ 1,538 $ 1,001 $ 618 $ -- $ 12
Accruing loans past due
90 days or more ............ 2,516 2,921 2,143 1,320 945
Restructured loans ........... -- -- -- -- --
Impaired loans ............... 16,261 11,288 11,068 9,265 8,956
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.
Impaired loans increased as of December 31, 2002 from December 31, 2001 by
$4,973,000. The increase was primarily related to swine production loans of
$3,212,000 and other agricultural loans that are impaired which increased
$1,543,000.
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.
14
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,
---------------------------------------------------
2002 2001 2000 1999 1998
---------------------------------------------------
(Amounts In Thousands)
Allowance for loan losses
at beginning of year ............. $ 9,950 $10,428 $ 9,750 $ 8,856 $ 8,010
---------------------------------------------------
Charge-offs:
Agriculture ...................... 33 35 26 60 4
Commercial and financial ......... 562 1,225 522 181 431
Real estate, mortgage ............ 390 557 254 104 132
Loans to individuals ............. 803 724 372 418 401
---------------------------------------------------
1,788 2,541 1,174 763 968
---------------------------------------------------
Recoveries:
Agriculture ...................... 116 72 153 157 125
Commercial and financial ......... 371 289 276 260 256
Real estate, mortgage ............ 402 362 118 30 100
Loans to individuals ............. 625 416 357 310 417
---------------------------------------------------
1,514 1,139 904 757 898
---------------------------------------------------
Net charge-offs .................... 274 1,402 270 6 70
---------------------------------------------------
Provision for loan losses (1) ...... 2,449 924 948 900 916
---------------------------------------------------
Allowance for loan losses
at end of year ................... $12,125 $ 9,950 $10,428 $ 9,750 $ 8,856
===================================================
Ratio of net charge-offs during year
to average loans outstanding ..... 0.04% 0.22% 0.04% 0.00% 0.02%
===================================================
<FN>
(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 the 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. It is not expected at this time that the provision for loan losses
will have material increases in 2003 related to agricultural loans,
primarily swine production. However the Company will continue to evaluate
the loan portfolio on a quarterly basis.
</FN>
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 Bank allocates 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.
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,
2002).
15
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, 2002 and 2001:
2002 2001
---------------------------------------------------
% Of Loans % Of Loans
Amount To Total Loans Amount To Total Loans
---------------------------------------------------
(In Thousands) (In Thousands)
Agriculture ...................... $ 2,219 4.78% $ 1,032 4.95%
Commercial ....................... 1,374 5.91 1,714 6.40
Real estate, construction ........ 975 5.95 770 5.84
Real estate ...................... 6,638 79.21 5,722 77.80
Consumer ......................... 919 4.15 712 5.01
-----------------------------------------------
$12,125 100.00% $ 9,950 100.00%
===============================================
In reviewing the allocation of the allowance for loan losses changes between
2002 and 2001 in the various risk categories of loans, the largest change is in
the agriculture area that increased $1,187,000. This change is principally due
to swine production loans, and an increase in the volume of loans that are now
classified as watch or potential watch increasing $3.3 million. In addition,
substandard loans relating to swine production increased to $4.9 million at
December 31, 2002 from $1.4 million at December 31, 2001. Hog prices while
averaging $44.50 and $46.57 per hundred weight in 2000 and 2001 dropped to an
average of $34.34 in 2002, with the average breakeven in the industry being
approximately $40.00 per hundred weight loan loss exposure exists in these types
of loans.
The other large change in the allowance occurred for real estate loans. Net real
estate mortgage loans outstanding increased from $538.8 million at December 31,
2001 to $628.1 million at December 31, 2002. The allowance related to 1 to 4
family real estate loan risk category increased $625,000 and the commercial real
estate loan allocation increased $471,000. The loss rate allocation for these
types of loans increased slightly between years as past due loans over 90 days
and nonperforming 1 to 4 family loans at December 31, 2002 were $2.3 million.
Approximately $520,000 of the increases for these loans were due to the net
increases in loans of $89.3 million between years.
Anticipated charge-offs of the above categories are not determinable at December
31, 2002; 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, 2002, 2001 and 2000 and the
maturities and weighted average yield of the investment securities as of
December 31, 2002:
December 31,
------------------------------
2002 2001 2000
------------------------------
(Amounts In Thousands)
Carrying value:
U. S. Treasury securities ..................... $ 6,365 $ 12,073 $ 18,318
Obligations of other U. S. Government
agencies and corporations ..................... 134,936 123,165 95,036
Obligations of state and political subdivisions 64,528 46,913 39,923
------------------------------
$205,829 $182,151 $153,277
==============================
16
December 31, 2002
-------------------------
Weighted
Carrying Average
Value Yield
-------------------------
(Amounts In Thousands)
Type and maturity grouping:
U. S. Treasury maturities:
Within 1 year .......................................................... $ 2,018 5.82%
From 1 to 5 years ...................................................... 4,347 6.60
--------
6,365
--------
Obligations of other U. S. Government agencies and corporations, maturities:
Within 1 year ............................................................ 32,744 5.31%
From 1 to 5 years ........................................................ 102,192 4.70
--------
134,936
--------
Obligations of state and political subdivisions, maturities:
Within 1 year ............................................................ 12,507 4.35%
From 1 to 5 years ........................................................ 31,824 5.92
From 5 to 10 years ....................................................... 19,697 5.94
Over 10 years ............................................................ 500 6.26
--------
64,528
--------
Total .............................................................. $205,829
========
INVESTMENT SECURITIES
As of December 31, 2002, 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, 2002, 2001 and 2000 and the
composition of the certificates of deposit issued in denominations in excess of
$100,000 as of December 31, 2002:
December 31,
-----------------------------------------------------------
2002 Rate 2001 Rate 2000 Rate
-----------------------------------------------------------
Average noninterest-bearing deposits $ 92,145 0.00% $ 78,687 0.00% $ 69,246 0.00%
Average interest-bearing demand
deposits ......................... 96,054 1.14 76,366 1.85 66,090 2.37
Average savings deposits ........... 194,230 1.49 169,561 2.72 154,121 3.64
Average time deposits .............. 381,973 4.79 357,882 5.76 309,565 5.71
-------- -------- --------
$764,402 $682,496 $599,022
======== ======== ========
Time certificates issued in amounts
of $100,000 or more as of Amount Rate
December 31, 2002 with -----------------
maturity in:
3 months or less ................. $ 11,589 4.29%
3 through 6 months ............... 7,779 3.73
6 through 12 months .............. 11,168 3.23
Over 12 months ................... 30,000 4.11
--------
$ 60,536
========
17
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, 2002, 2001 and 2000:
December 31,
------------------------
2002 2001 2000
------------------------
Return on average assets ............................ 1.10% 1.11% 1.14%
Return on average stockholders' equity .............. 14.05 13.94 14.94
Dividend payout ratio ............................... 22.87 23.58 23.18
Average stockholders' equity to average assets ratio 7.85 7.96 7.63
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 during 2002, 2001 and 2000:
2002 2001 2000
------------------------------
(Amounts In Thousands)
Outstanding balance as of December 31 ......... $20,798 $22,409 $16,561
Weighted average interest rate at year end .... 1.52% 2.36% 4.80%
Maximum month-end balance ..................... 28,882 22,711 16,678
Average month-end balance ..................... 21,240 17,444 14,665
Weighted average interest rate for the year ... 1.79% 3.53% 4.77%
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 2002, 2001 and 2000:
2002 2001 2000
---------------------------------
(Amounts In Thousands)
Outstanding balance as of December 31 ...... $167,606 $137,637 $120,668
Weighted average interest rate at year end . 5.35% 5.57% 5.79%
Maximum month-end balance .................. 167,637 137,637 148,700
Average month-end balance .................. 153,543 123,211 128,043
Weighted average interest rate for the year 5.52% 5.83% 5.85%
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, the Bank completed a two-story brick addition in February
2001. 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 previously were located in the Bank's Coralville
office. As a result of the consolidation, sixty-five full-time and part-time
employees were relocated.
The other offices of Hills Bank and Trust are as follows:
1. The 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. The Coralville office is a two-story building built in 1972 and expanded in
2001 that contains approximately 23,000
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
18
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 March of 2002, Hills Bank opened its eleventh office, and the second
office location in the Cedar Rapids market. The new 11. In August of 2002,
Hills Bank and Trust Company began an extensive remodeling of property
located at 800 11th Street in Marion, Iowa. The office is a two-story
building having approximately 8,400 square feet with three drive-up lanes
and a drive-up ATM. The full service office opened on February 10, 2003.
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, 2002.
19
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 17, 2003, the Company had 1,366 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
- -------------------------------------------------------------------
2002 16,917 22 $ 88.00 $ 82.00
2001 9,273 28 82.00 77.00
2000 14,187 16 77.00 70.00
The Company paid aggregate annual cash dividends in 2002, 2001 and 2000 of
$2,622,000, $2,392,000 and $2,171,000, respectively, or $1.75 per share in 2002,
$1.60 per share in 2001 and $1.45 per share in 2000. In January 2003, the
Company declared and paid a dividend of $1.90 per share totaling $2,852,000. 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, 2002, stock option information is as follows:
Number of shares that would be issued if all options were exercised 27,815
Weighted average price of options outstanding $ 46.99
Number of additional shares that could be granted 53,156
There are no stock option plans that have not been approved by the stockholders.
20
PART II
Item 6. Selected Financial Data
CONSOLIDATED FIVE-YEAR STATISTICAL SUMMARY
2002 2001 2000 1999 1998
---------------------------------------------------------------------------
YEAR-END TOTALS (Amounts in Thousands)
Total assets ....................... $ 1,098,547 $ 976,105 $ 875,750 $ 773,966 $ 689,787
Investment securities .............. 214,211 189,960 161,066 156,198 149,350
Federal funds sold ................. 32,514 29,428 28,065 206 36,811
Loans, net ......................... 780,857 682,692 626,873 565,381 460,911
Deposits ........................... 802,321 720,018 652,706 562,086 534,151
Federal Home Loan Bank borrowings .. 167,606 137,637 120,668 108,700 75,732
Redeemable common stock ............ 12,951 12,194 11,550 10,953 9,301
Stockholders' equity ............... 88,084 78,155 68,524 60,264 56,452
EARNINGS (Amounts in Thousands)
Interest income .................... $ 64,561 $ 63,718 $ 59,992 $ 51,121 $ 47,289
Interest expense ................... 31,141 34,435 33,064 26,313 25,254
Provision for loan losses .......... 2,449 924 948 900 916
Other income ....................... 10,230 9,257 7,514 6,437 5,811
Other expenses ..................... 24,615 22,859 20,069 18,309 16,438
Applicable income taxes ............ 5,122 4,613 4,059 3,570 3,006
Net income ......................... 11,464 10,144 9,366 8,466 7,486
PER SHARE Net income:
Basic .............................. $ 7.65 $ 6.78 $ 6.26 $ 5.70 $ 5.10
Diluted ............................ 7.58 6.72 6.21 5.66 5.02
Cash dividends ..................... 1.75 1.60 1.45 1.30 1.20
Book value as of December 31 ....... 58.68 52.15 45.82 40.29 38.42
Increase (decrease) in book value
due to:
ESOP obligation .................... (8.63) (8.14) (7.72) (7.32) (6.33)
Accumulated other
comprehensive income ............. 3.15 2.02 0.47 (0.66) 0.81
SELECTED RATIOS
Return on average assets ........... 1.10% 1.11% 1.14% 1.18% 1.17%
Return on average equity ........... 14.05 13.94 14.94 14.54 14.12
Net interest margin ................ 3.58 3.58 3.62 3.83 3.81
Average stockholders' equity to
average total assets .............. 7.85 7.96 7.63 8.11 8.25
Dividend payout ratio .............. 22.87 23.58 23.18 22.56 23.52
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.
21
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.
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 financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America. The financial
information contained within these statements is, to a significant extent,
financial information that is based on approximate measures of the financial
effects of transactions and events that have already occurred. Based on its
consideration of accounting policies that involve the most complex and
subjective decisions and assessments, management has identified its most
critical accounting policy to be related to the allowance for loan losses. The
Company's allowance for loan loss methodology incorporates a variety of risk
considerations, both quantitative and qualitative in establishing an allowance
for loan loss that management believes is appropriate at each reporting date.
Quantitative factors include the Company's historical loss experience,
delinquency and charge-off trends, collateral values, changes in nonperforming
loans, and other factors. Quantitative factors also incorporate known
information about individual loans, including borrowers' sensitivity to interest
rate movements. Qualitative factors include the general economic environment in
the Company's markets, including economic conditions throughout the Midwest and
in particular, the state of certain industries. Size and complexity of
individual credits in relation to loan structure, existing loan policies and
pace of portfolio growth are other qualitative factors that are considered in
the methodology. As the Company adds new products and increases the complexity
of its loan portfolio, it will enhance its methodology accordingly. This
discussion and analysis should be read in conjunction with the Company's
financial statements and the accompanying notes presented elsewhere herein, as
well as the portion of this Management's Discussion and Analysis section
entitled "Financial Condition - Allowance for Loan Losses". Although management
believes the levels of the allowance as of both December 31, 2002 and 2001 were
adequate to absorb losses inherent in the loan portfolio, a decline in local
economic conditions, or other factors, could result in increasing losses that
cannot be reasonably predicted at this time.
22
The Company's other critical accounting policies that affect net income are the
accrual of interest income and expense. 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
when there is reasonable doubt about the borrower's ability to make all the
principal and interest payments. 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 (Amounts
In Thousands) 2002 2001 2000 1999 1998
- ---------------------------------------------------------------------------------------------------
Loans, net of allowance for losses $ 780,857 $ 682,692 $ 626,873 $ 565,381 $ 460,911
Investment securities ............ 214,211 189,960 161,066 156,198 149,350
Deposits ......................... 802,321 720,018 652,706 562,086 534,151
Federal Home Loan Bank borrowings 167,606 137,637 120,668 108,700 75,732
Stockholders' equity ............. 88,084 78,155 68,524 60,264 56,452
Total assets ..................... 1,098,547 976,105 875,750 773,966 689,787
In 2002, total assets grew $122.4 million, ahead of the record growth of $101.8
million for 2000. The percentage increase in total assets was 12.54% in 2002,
compared to 11.46% in 2001. Asset growth for both years was primarily reflected
in higher loan balances and investment securities.
In 2002, net loans increased by $98.2 million, including $96.0 million in real
estate loans. For the year 2001, net loans increased $55.8 million, and $42.1
million of the increase was attributable to real estate mortgage loans.
Declining interest rates in both 2002 and 2001 with forty year lows have helped
housing starts and new real estate development projects in the Bank's trade
territory.
Deposits increased $82.3 million, or 11.43 % in 2002 compared to an increase of
10.31% in 2001. After several years of slower deposit growth, the past two years
have seen substantial deposit growth. In 2002, the increase in net deposits
resulted from continued uncertainties in the stock market that has led investors
to move their funds to bank deposits. The addition and renovation of branch
banks has assisted in bringing new customers to the Bank with two recent
additions in Cedar Rapids, Iowa, one established in 2000 and the other in early
2002. In 2002 and 2001, the Company has also borrowed from the Federal Home Loan
Bank, and such borrowings increased by a net $30 million in 2002 and $17 million
in 2001. The advances were used to fund loan growth and lock in low interest
rates.
Components of Diluted Earnings Per Share
2002 2001 2000
-----------------------------------
Net interest income ..................... $ 22.11 $ 19.40 $ 17.85
Provision for loan losses ............... (1.62) (0.61) (0.63)
Noninterest income ...................... 6.77 6.13 4.98
Noninterest expense ..................... (16.29) (15.14) (13.30)
-----------------------------------
Income before income taxes ...... 10.97 9.78 8.90
Income tax expense ...................... (3.39) (3.06) (2.69)
-----------------------------------
Net income ...................... $ 7.58 $ 6.72 $ 6.21
===================================
Net income for 2002 reached a record high of $11,464,000, or diluted earnings
per share of $7.58. The rate of increase in earnings in 2002 is 13.01% compared
to 8.31% in 2001. For 2002, diluted earnings per share increased $.86 per share,
while 2001 results had increased $.51 per share. For the year ended December 31,
2001, net income increased by $778,000 from the 2000 results. For both 2002 and
2001, the Company's net interest income has benefited from substantial growth in
average earning assets and a stable net interest margin.
The Company has 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.
However, in 2002 the provision for loan losses was substantially higher than in
2001 and 2000 and is discussed in the provision for loan losses section.
23
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 2002 as follows:
Increase (Decrease)
Change In Change In -----------------------------
Average Average Volume Rate Net
Balance Rate Changes Changes Change
----------------------------------------------------
(Amounts In Thousands)
Interest income:
Loans, net ........................... $ 87,626 (0.79)% $ 6,777 $(5,407) $ 1,370
Taxable securities ................... 11,195 (0.63) 617 (875) $ (258)
Nontaxable securities ................ 13,586 (0.74) 852 (343) $ 509
Federal funds sold ................... 5,276 (2.36) 177 (789) $ (612)
---------------------------------------------------
$117,683 $ 8,423 $(7,414) $ 1,009
-------- -----------------------------
Interest expense:
Interest-bearing demand deposits ..... $19,688 (0.71)% 308 (626) (318)
Savings deposits ..................... 24,669 (1.23) 598 (2,309) (1,711)
Time deposits ........................ 24,091 (0.97) 1,321 (3,638) (2,317)
Federal funds purchased and securities
sold under agreements to repurchase 3,796 (1.74) 114 (350) (236)
FHLB borrowings ...................... 30,332 (0.31) 1,687 (399) 1,288
-------- -----------------------------
$102,576 $ 4,028 $(7,322) $(3,294)
-------- -----------------------------
Change in net interest income .......... $ 4,395 $ (92) $ 4,303
=============================
Net interest income changes for 2001 were as follows:
Change In Effect Of Effect Of
Average Volume Rate Net
Balance Changes Changes Change
-------------------------------------------
(Amounts In Thousands)
Interest-earning assets .......... $79,659 $ 5,504 $(1,727) $ 3,777
Interest-bearing liabilities ..... 71,980 3,344 (1,973) $ 1,371
-------------------------------
Change in net interest income .... $ 2,160 $ 246 $ 2,406
===============================
A summary of the net interest spread and margin is as follows:
(Tax Equivalent Basis) 2002 2001 2000
- --------------------------------------------------------------------------------
Yield on average interest-earning assets ............. 6.80% 7.62% 7.92%
Rate on average interest-bearing liabilities ......... 3.68 4.63 4.92
---------------------
Net interest spread .................................. 3.12 2.99 3.00
Effect of noninterest-bearing funds .................. 0.46 0.59 0.62
---------------------
Net interest margin (tax equivalent interest income
divided by average interest-earning assets) ........ 3.58% 3.58% 3.62%
=====================
Provision For Loan Losses
The provision for loan losses totaled $2,449,000, $924,000 and $948,000 for
2002, 2001 and 2000, respectively. Charge-offs, net of recoveries, were $274,000
for 2002, $1,402,000 for 2001 and $270,000 for 2000, respectively. Although net
charge-offs for 2002 decreased from the prior year, the provision for loan
losses increased to reflect the estimated loan losses in the loan portfolio at
December 31, 2002.
24
The allowance for loan losses totaled $12,125,000 at December 31, 2002 compared
to $9,950,000 at December 31, 2001. The percentage of the allowance to
outstanding loans was 1.53% and 1.44% at December 31, 2002 and 2001,
respectively. The increase in the allowance was based on management's
consideration of a number of factors, including loan concentrations, loans with
higher credit risks (primarily agriculture loan and spec real estate
construction) and overall increases in net loans outstanding. The methodology
used in 2002 is consistent with the prior year. Beginning in 2001, the Bank
refined the methodology used to compute the allowance for loan losses, primarily
by applying estimated loss rates to several risk categories of loans instead of
more general categories of loans. The estimated loss rates used in 2001
increased because management believes 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.
Agricultural loans totaled $37,937,000 and $34,304,000 at December 31, 2002 and
2001, 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. In
particular, loans that are in the swine production segment continue to be of
major concern as prices for hogs are subject to severe fluctuations. Therefore,
the allowance for loan losses includes general and specific reserves for these
loans.
The University of Iowa has a dominant economic effect on the economy of the
Bank's primary trade area, Johnson County, Iowa, and in 2002 and 2001, the
University has helped the local economy remain strong even when the national
economy has experienced weaknesses. However, in the last fifteen months the
economy of the state of Iowa has weakened and the University continues to suffer
from budget cuts. For its fiscal year beginning July 1, 2003 the University
expects continued budget constraints. The possible effects on the local economy
cannot be predicted, but are likely to weaken the economy in future years.
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, the
possibility of sharply higher interest rates could affect the ability of some
borrowers to make scheduled interest and principal payments. 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 2002 2001 2000
- --------------------------------------------------------------------------------
Real estate origination fees ............... $ 1.32 $ 0.77 $ 0.21
Trust fees ................................. 1.56 1.59 1.58
Deposit account charges and fees ........... 2.18 2.06 1.70
Other fees and charges ..................... 1.71 1.71 1.49
--------------------------------
$ 6.77 $ 6.13 $ 4.98
================================
In 2002, the Company's total other income increased $973,000 compared to the
prior year. Real estate origination fee revenue for 2002 increased over the
prior year by $826,000 due to continued low interest rates that enabled
borrowers to re-finance. Interest rates on secondary market loans averaged under
6.50% the last half of 2002 compared to 7.10% in 2001 and 8.20% in 2000. In
addition, the increase in customer deposit accounts, along with changes in the
fee structure, accounted for a $189,000 increase in deposit account charges and
fees. Trust fees in 2002 were virtually unchanged from 2001, a $47,000 increase.
The number of trust accounts under management increased in 2002 but the
continued decline in stock values had the effect of reducing trust fees which
are based on asset value. Approximately 47% of the trust assets are held in
common stock and the major stock market averages declined in 2002 (including the
Dow Jones Industrial Average which was down approximately 16% in 2002). Total
other income reached a record high of $6.77 per share in 2002.
25
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.
Other Expenses
Dollars Per Share, Based on Weighted
Average Diluted Shares Outstanding 2002 2001 2000
- --------------------------------------------------------------------------------
Salaries and employees benefits ............ $ 9.05 $ 7.86 $ 7.06
Occupancy .................................. 1.20 1.21 0.94
Furniture and equipment .................... 1.91 1.86 1.43
Office supplies and postage ................ 0.77 0.79 0.75
Other ...................................... 3.36 3.42 3.12
---------------------------------
$ 16.29 $ 15.14 $ 13.30
=================================
Other expenses increased $1,756,000 in 2002. Of the increase, salaries and
benefits accounted for $1,804,000, occupancy and furniture and equipment expense
accounted for $76,000 of the increase and all other expenses decreased $124,000.
The salaries and employee benefits increased as a direct result of salary
adjustments for 2002 and staff additions primarily at the new office locations.
Total full-time equivalent employees increased between years by twenty-four. The
benefits include a $150,000 increase in medical insurance costs due to
increasing medical costs. The increased occupancy and furniture and equipment
expense was the result of new locations added and new equipment purchases both
in 2001 and 2002. Other expenses decreased $124,000 between 2001 and 2002. The
other expenses in 2001 included $261,000 for amortization of intangible assets,
which consisted principally of goodwill, equal to 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. As discussed in the section of Impact
of Recently Issued Accounting Standards amortization of goodwill with an
indefinite life was suspended on January 1, 2002.
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.
Income Taxes
Income tax expense was $5,122,000, $4,613,000 and $4,059,000 for the years ended
December 31, 2002, 2001 and 2000, respectively. The corresponding percentage of
income taxes compared to income before income taxes is 30.88% in 2002, 31.26% in
2001 and 30.23% in 2000.
Impact of Recently Issued Accounting Standards
The FASB has issued Statement No. 143, "Accounting for Asset Retirement
Obligations" which requires that the fair value of a 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.
For the Company, the Statement is effective January 1, 2003, but its
implementation will not have any impact on the financial statements.
The FASB has issued Statement No. 145, "Rescission of FASB Statements No. 4, 44,
and 64, Amendment of FASB Statement No. 13, and Technical Corrections." This
statement is applicable to debt extinguishments and their classification;
certain sale-leaseback transactions and intangible assets of motor carriers.
Implementation of these provisions of the Statement had no effect and is not
expected to have a material impact on the Company's financial statements.
The FASB has issued Statement No.146, "Accounting for Costs Associated with Exit
or Disposal Activities." The provisions of the Statement are effective for exit
or disposal activities that are initiated after December 31, 2002.
Implementation of the Statement is not expected to have a material impact on the
Company's financial statements.
26
The FASB has issued Interpretation No. 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" - an interpretation of FASB Statements No. 5, 57 and 107
and rescission of FASB Interpretation No. 34." This Interpretation elaborates on
the disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued. It
also clarifies that a guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The initial recognition and measurement provisions of
this Interpretation are applicable on a prospective basis to guarantees issued
or modified after December 31, 2002. Implementation of these provisions of the
Interpretation is not expected to have a material impact on the Company's
consolidated financial statements. The disclosure requirements of the
Interpretation are effective for financial statements of interim or annual
periods ending after December 15, 2002, and have been adopted in the
consolidated financial statements for December 31, 2002.
Interest Rate Sensitivity and Liquidity Analysis
At December 31, 2002, the Company's interest rate sensitivity report is as
follows (amounts in thousands):
Repricing Days
Maturities -------------------------------------------------- More Than
Immediately 2-30 31-90 91-180 181-365 One Year Total
-------------------------------------------------------------------------------------------
Earning assets:
Federal funds sold $ 32,514 $ -- $ -- $ -- $ -- $ -- $ 32,514
Investment
securities ...... -- 4,665 4,600 20,323 16,647 167,976 214,211
Loans ............. -- 63,518 25,582 28,816 68,869 606,197 792,982
-------------------------------------------------------------------------------------------
Total ....... 32,514 68,183 30,182 49,139 85,516 774,173 1,039,707
-------------------------------------------------------------------------------------------
Sources of funds:
Interest-bearing
checking and
savings accounts 118,463 -- -- -- -- 181,842 300,305
Certificates of
deposit ......... -- 24,883 48,302 39,759 61,651 219,589 394,184
Other borrowings -
FHLB ............ -- 60,000 30,000 -- -- 77,606 167,606
Repurchase
agreements and
federal funds ... 20,798 -- -- -- -- -- 20,798
-------------------------------------------------------------------------------------------
139,261 84,883 78,302 39,759 61,651 479,037 882,893
Other sources,
primarily
noninterest-
bearing ........... -- -- -- -- -- 107,833 107,833
-------------------------------------------------------------------------------------------
Total sources 139,261 84,883 78,302 39,759 61,651 586,870 990,726
-------------------------------------------------------------------------------------------
Repricing
differences ....... $ (106,747) $ (16,700) $ (48,120) $ 9,380 $ 23,865 $ 187,303 $ 48,981
===========================================================================================
27
The table set forth above includes the portion of the balances in
interest-bearing checking, savings and money market accounts that management has
estimated to mature within on 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 $1,856,000 as of
December 31, 2002. In 2002, the holding company received dividends of $2,623,000
from its subsidiary bank and used those funds to pay dividends to its
stockholders of $2,622,000.
As of December 31, 2002 and 2001, stockholders' equity, before deducting for the
maximum cash obligation related to ESOP, was $101,035,000 and $90,349,000,
respectively. This measure of equity as a percent of total assets was 9.20% at
December 31, 2002 and 9.26% at December 31, 2001. As of December 31, 2002, total
equity was 8.02% of assets compared to 8.01% 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 $6,092,000 as of December 31, 2002.
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, 2002, risk-based capital standards require 8% of
risk-weighted assets. At least half of that 8% must consist of Tier I core
capital (common stockholders' equity, non-cumulative perpetual preferred stock
and minority interest in the equity accounts of consolidated subsidiaries), and
the remainder may be Tier II supplementary capital (perpetual debt,
intermediate-term preferred stock, cumulative perpetual, long-term and
convertible preferred stock, and loan loss reserve up to a maximum of 1.25% of
risk-weighted assets). Total risk-weighted assets are determined by weighting
the assets according to their risk characteristics. Certain off-balance sheet
items (such as standby letters of credit and firm loan commitments) are
multiplied by "credit conversion factors" to translate them into balance sheet
equivalents before assigning them risk weightings. Any bank having a capital
ratio less than the 8% minimum required level must, within 60 days, submit to
the Federal Reserve a plan describing the means and schedule by which the Bank
shall achieve the applicable minimum capital ratios.
28
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, 2002, 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, 2002 and the minimum
regulatory requirements for the Company and the 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, 2002:
Company:
Total risk based capital .......... $102,921 14.19% 8.00% 10.00%
Tier 1 risk based capital ......... 93,814 12.93 4.00 6.00
Leverage ratio .................... 8.64 3.00 5.00
Bank:
Total risk based capital .......... 100,288 13.84 8.00 10.00
Tier 1 risk based capital ......... 91,189 12.58 4.00 6.00
Leverage ratio .................... 8.41 3.00 5.00
The Bank is classified as "well capitalized" by FDIC capital guidelines.
On a consolidated basis, 2002 cash flows from operations provided $15,972,000,
net increases in deposits provided $82,303,000 and Federal Home Loan Bank
borrowings provided $30,000,000. These cash flows were invested in net loans of
$100,614,000, net securities of $21,984,000 and net federal funds sold of
$3,086,000. In addition, $2,819,000 was used to purchase property and equipment.
At December 31, 2002, the Bank had total outstanding loan commitments and unused
portions of lines of credit totaling $112,260,000. 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, 2002, the Bank estimates that 2003 additional construction
expenditures for the new office on 11th Street in Marion, Iowa, to be completed
in 2003 will total $456,000 and will not require outside financing.
29
PART II
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
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, 2002 and 2001, loan balances to
related individuals and businesses totaled $27,813,000 and $24,440,000,
respectively. Deposits from related parties totaled $ 6,599,000 and $5,884,000
as of December 31, 2002 and 2001, respectively.
Commitments and Trends
The Company and the Bank have no material commitments or plans that will
materially affect liquidity or capital resources. Property and equipment may be
acquired in cash purchases, or they may be financed if favorable terms are
available.
Market Risk Exposures
The Company's primary market risk exposure is to changes in interest rates. The
Company's asset/liability management, or its management of interest rate risk,
is focused primarily on evaluating and managing net interest income given
various risk criteria. Factors beyond the Company's control, such as market
interest rates and competition, may also have an impact on the Company's
interest income and interest expense. In the absence of other factors, the
Company's overall yield on interest-earning assets will increase as will its
cost of funds on its interest-bearing liabilities when market 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
tend to reduce net interest income because the resulting increase in the
Company's cost of funds would not be immediately offset by an increase in its
yield on earning assets. In times of decreasing interest rates, fixed rate
assets could increase in value and the lag in re-pricing of interest rate
sensitive assets could be expected to have a positive effect on the Company's
net interest income.
30
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.
2003 2004 2005 2006 2007 Thereafter Total Fair Value
-----------------------------------------------------------------------------------------------------------
(Amounts In Thousands)
Assets:
Loans, fixed:
Balance ....... $ 92,665 $ 53,298 $ 42,625 $ 77,505 $ 80,557 $ 38,435 $385,085 $431,501
Average
interest rate 6.86% 7.45% 7.36% 6.86% 7.05% 6.84% 7.04%
Loans, variable:
Balance ......... $ 51,675 $ 4,812 $ 2,054 $ 2,333 $ 4,412 $ 342,611 $407,897 $407,897
Average
interest rate . 6.72% 6.32% 6.57% 6.77% 6.55% 6.61% 6.62%
Investments (1):
Balance ......... $ 78,749 $ 37,967 $ 61,647 $ 21,392 $ 16,757 $ 30,213 $246,725 $247,006
Average
interest rate . 3.44% 5.83% 4.99% 4.51% 4.51% 5.30% 4.59%
Liabilities:
Liquid
deposits (2):
Balance ......... $ 300,304 $ -- $ -- $ -- $ -- $ -- $300,304 $300,304
Average
interest rate . 1.22% 1.22%
Deposits,
certificates:
Balance ......... $ 174,595 $ 132,283 $ 17,726 $ 36,336 $ 33,244 $ -- $394,184 $373,793
Average
interest rate . 3.90% 3.74% 4.09% 4.41% 4.67% 0.00% 3.97%
<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 42 through
70.
31
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, 2002 and 2001, and the related
consolidated statements of income, comprehensive income, stockholders' equity
and cash flows for the years ended December 31, 2002, 2001 and 2000. 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, 2002 and 2001, and the results of their
operations and their cash flows for the years ended December 31, 2002, 2001 and
2000 in conformity with accounting principles generally accepted in the United
States of America.
/s/ McGladrey & Pullen, LLP
- ---------------------------
Iowa City, Iowa
February 25, 2003
32
HILLS BANCORPORATION
CONSOLIDATED BALANCE SHEETS
December 31, 2002 and 2001
(Amounts In Thousands, Except Shares)
ASSETS 2002 2001
- ---------------------------------------------------------------------------------------------
Cash and due from banks (Note 9) .................................. $ 32,647 $ 37,070
Investment securities (Note 2):
Available for sale (amortized cost 2002 $190,313 ; 2001 $165,515) 197,807 170,311
Held to maturity (fair value 2002 $8,303 ; 2001 $12,146) ........ 8,022 11,840
Stock of Federal Home Loan Bank ................................... 8,382 7,809
Federal funds sold ................................................ 32,514 29,428
Loans, net of allowance for loan losses 2002 $12,125 ; 2001 $9,950
(Notes 3, 6 and 10) ............................................. 780,857 682,692
Property and equipment, net (Note 4) .............................. 21,500 20,997
Accrued interest receivable ....................................... 7,278 7,257
Deferred income taxes (Note 8) .................................... 1,971 1,873
Other assets ...................................................... 7,569 6,828
-----------------------
$1,098,547 $ 976,105
=======================
LIABILITIES AND STOCKHOLDERS' EQUITY
- ---------------------------------------------------------------------------------------------
Liabilities
Noninterest-bearing deposits .................................... $ 107,833 $ 92,179
Interest-bearing deposits (Note 5) .............................. 694,488 627,839
-----------------------
Total deposits ............................................ 802,321 720,018
Securities sold under agreements to repurchase .................... 20,798 22,409
Federal Home Loan Bank borrowings ("FHLB") (Note 6) ............... 167,606 137,637
Accrued interest payable .......................................... 2,134 2,683
Other liabilities ................................................. 4,653 3,009
-----------------------
997,512 885,756
-----------------------
Commitments and Contingencies (Notes 7 and 13)
Redeemable Common Stock Held By Employee Stock
Ownership Plan (ESOP) (Note 7) .................................. 12,951 12,194
-----------------------
Stockholders' Equity (Note 9)
Capital stock, no par value; authorized 10,000,000 shares;
issued 2002 1,501,054 shares; 2001 1,498,558 shares ........... 10,541 10,397
Retained earnings ............................................... 85,773 76,931
Accumulated other comprehensive income .......................... 4,721 3,021
-----------------------
101,035 90,349
Less maximum cash obligation related to ESOP shares (Note 7) .... 12,951 12,194
-----------------------
88,084 78,155
-----------------------
$1,098,547 $ 976,105
=======================
See Notes to Financial Statements.
33
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2002, 2001 and 2000
(Amounts In Thousands, Except Per Share Amounts)
2002 2001 2000
- -----------------------------------------------------------------------------------------
Interest income:
Loans, including fees ................................... $54,363 $52,986 $50,081
Investment securities:
Taxable ............................................... 7,412 7,670 7,481
Nontaxable ............................................ 2,266 1,930 1,732
Federal funds sold ...................................... 520 1,132 698
---------------------------
Total interest income ............................. 64,561 63,718 59,992
---------------------------
Interest expense:
Deposits ................................................ 22,294 26,634 24,871
Securities sold under agreements to repurchase .......... 375 617 699
FHLB borrowings ......................................... 8,472 7,184 7,494
---------------------------
Total interest expense ............................ 31,141 34,435 33,064
---------------------------
Net interest income ............................... 33,420 29,283 26,928
Provision for loan losses (Note 3) ........................ 2,449 924 948
---------------------------
Net interest income after provision for loan losses 30,971 28,359 25,980
---------------------------
Other income:
Loan origination fees ................................... 1,991 1,165 316
Trust fees .............................................. 2,352 2,399 2,388
Deposit account charges and fees ........................ 3,297 3,108 2,566
Other fees and charges .................................. 2,590 2,585 2,244
---------------------------
10,230 9,257 7,514
---------------------------
Other expenses:
Salaries and employee benefits .......................... 13,667 11,863 10,651
Occupancy ............................................... 1,817 1,826 1,417
Furniture and equipment ................................. 2,892 2,807 2,156
Office supplies and postage ............................. 1,167 1,198 1,128
Other ................................................... 5,072 5,165 4,717
---------------------------
24,615 22,859 20,069
---------------------------
Income before income taxes ........................ 16,586 14,757 13,425
Federal and state income taxes (Note 8) ................... 5,122 4,613 4,059
---------------------------
Net income ........................................ $11,464 $10,144 $ 9,366
===========================
Earnings per share:
Basic ................................................... $ 7.65 $ 6.78 $ 6.26
Diluted ................................................. 7.58 6.72 6.21
See Notes to Financial Statements.
34
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years Ended December 31, 2002, 2001 and 2000
(Amounts In Thousands)
2002 2001 2000
- -------------------------------------------------------------------------------------
Net income ............................................ $11,464 $10,144 $ 9,366
Other comprehensive income,
unrealized holding gains arising during the year,
net of income taxes 2002 $998; 2001 $1,366; 2000 $983 1,700 2,323 1,679
---------------------------
Comprehensive income .......................... $13,164 $12,467 $11,045
===========================
See Notes to Financial Statements.
35
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Notes 7 and 9)
Years Ended December 31, 2002, 2001 and 2000
(Amounts 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, 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
Issuance of 2,891 shares of
common stock ................. 127 -- -- -- 127
Redemption of 395 shares
of common stock .............. (30) -- -- -- (30)
Change related to ESOP shares .. -- -- -- (757) (757)
Net income ..................... -- 11,464 -- -- 11,464
Income tax benefit related to
stock based compensation ..... 47 -- -- -- 47
Cash dividends ($1.75 per share) -- (2,622) -- -- (2,622)
Other comprehensive income ..... -- -- 1,700 -- 1,700
---------------------------------------------------------
Balance, December 31, 2002 ....... 10,541 85,773 4,721 (12,951) 88,084
=========================================================
See Notes to Financial Statements.
36
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2002, 2001 and 2000
(Amounts In Thousands)
2002 2001 2000
-----------------------------------
Cash Flows from Operating Activities
Net income .................................................... $ 11,464 $ 10,144 $ 9,366
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation ................................................ 2,316 2,212 1,648
Amortization ................................................ -- 301 261
Provision for loan losses ................................... 2,449 924 948
Compensation paid by issuance of common stock ............... 75 121 --
Deferred income taxes ....................................... (1,096) 47 (315)
(Increase) decrease in accrued interest receivable .......... (21) 266 (1,146)
Amortization of bond discount ............................... 431 171 39
(Increase) decrease in other assets ......................... (741) (359) 1,409
Increase (decrease) in accrued interest and other liabilities 1,095 (49) 492
-----------------------------------
Net cash provided by operating activities ............... 15,972 13,778 12,702
-----------------------------------
Cash Flows from Investing Activities
Proceeds from maturities of investment securities:
Available for sale ............................................ 59,140 47,282 27,115
Held to maturity .............................................. 3,819 3,668 2,798
Purchases of investment securities available for sale ......... (84,943) (76,327) (32,158)
Federal funds sold, net ....................................... (3,086) (1,363) (27,859)
Loans made to customers, net of collections ................... (100,614) (56,743) (62,440)
Purchases of property and equipment ........................... (2,819) (6,710) (6,501)
-----------------------------------
Net cash (used in) investing activities ................. (128,503) (90,193) (99,045)
-----------------------------------
Cash Flows from Financing Activities
Net increase in deposits ...................................... 82,303 67,312 90,620
Net increase (decrease) in federal funds purchased and
securities sold under agreements to repurchase .............. (1,611) 5,848 (10,153)
Borrowings from FHLB .......................................... 30,000 17,000 40,000
Payments on FHLB borrowings ................................... (31) (31) (28,032)
Stock options exercised ....................................... 52 44 --
Income tax benefits related to stock based compensation ....... 47 43 6
Redemption of common stock .................................... (30) (8) (23)
Dividends paid ................................................ (2,622) (2,392) (2,171)
-----------------------------------
Net cash provided by financing activities ............... 108,108 87,816 90,247
-----------------------------------
Increase (decrease) in cash and due from banks .................. $ (4,423) $ 11,401 $ 3,904
Cash and due from banks:
Beginning ..................................................... 37,070 25,669 21,765
-----------------------------------
Ending ........................................................ $ 32,647 $ 37,070 $ 25,669
===================================
Supplemental Disclosures
Cash payments for:
Interest paid to depositors and others ...................... $ 22,843 $ 26,884 $ 24,046
Interest paid on other obligations .......................... 8,847 8,504 8,193
Income taxes ................................................ 5,245 4,974 4,424
Noncash financing activities:
Increase in maximum cash obligation related to
ESOP shares ............................................... $ 757 $ 644 $ 597
See Notes to Financial Statements.
37
HILLS BANCORPORATION
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 1. 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, Cedar Rapids and Marion Iowa.
The Bank competes with other financial institutions and nonfinancial
institutions providing similar financial products. Although the loan activity of
the Bank is diversified with commercial and agricultural loans, real estate
loans, automobile, installment and other consumer loans, the Bank's credit is
concentrated in real estate loans.
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, 2002 may change in the near-term future
and that the effect could be material to the consolidated financial statements.
Principles of consolidation: The consolidated financial statements include the
accounts of the Company and its subsidiary. All significant intercompany
balances and transactions have been eliminated in consolidation.
Revenue recognition: Interest income on loans and investment securities is
recognized on the accrual method. Loan origination fees are recognized when the
loans are sold. Trust fees, deposit account service charges and other fees are
recognized when the services are provided or when customers use the services.
Investment securities: Held-to-maturity securities 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, 2002 and 2001.
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.
38
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.
Goodwill: Goodwill represents the excess of cost over the fair value of the net
assets acquired, and FASB Statement No. 142 provides for the elimination of the
amortization of goodwill and other intangibles that are determined to have an
indefinite life, and requires, at a minimum, annual impairment tests for
intangibles that are determined to have an indefinite life. Effective January 1,
2002, the Company discontinued the amortization of goodwill, but makes an annual
assessment for possible impairment. The change in this accounting policy reduced
goodwill amortization by $261,000 for the year ended December 31, 2002 compared
to the year ended December 31, 2001. The carrying amount of goodwill as of
December 31, 2002 and 2001 totaled $2,500,000 net of accumulated amortization of
$1,398,000 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.
39
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,
---------------------------------
2002 2001 2000
---------------------------------
Weighted average number of shares ................ 1,499,269 1,497,064 1,495,906
Potential number of dilutive shares .............. 12,106 12,432 12,875
---------------------------------
Total shares to compute diluted earnings per share 1,511,375 1,509,496 1,508,781
=================================
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 sold 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.
40
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, 2002:
U. S. Treasury .................... $ 6,035 $ 330 $ -- $ 6,365
U. S. Government agencies and
corporations ...................... 129,916 5,020 -- 134,936
State and political subdivisions .. 54,362 2,159 (15) 56,506
------------------------------------------
Total ............................. $190,313 $ 7,509 $ (15) $197,807
==========================================
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
==========================================
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, 2002:
State and political subdivisions ....... $ 8,022 $ 281 $ -- $ 8,303
===========================================
December 31, 2001:
State and political subdivisions ....... $11,840 $ 306 $ -- $12,146
===========================================
The contractual maturity distribution of investment securities as of December
31, 2002 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 .............. $ 43,479 $ 44,202 $ 3,068 $ 3,100
Due after one year through five years 127,618 133,545 4,817 5,051
Due after five years through ten years 18,723 19,561 137 152
Due over ten years ................... 493 499 -- --
-----------------------------------------
Total ................................ $190,313 $197,807 $ 8,022 $ 8,303
=========================================
As of December 31, 2002, investment securities with a carrying value of
$51,746,000 were pledged to collateralize public and trust deposits, short-term
borrowings and for other purposes, as required or permitted by law.
There were no net gains or losses from the sale of investment securities for the
years ended December 31, 2002, 2001 and 2000.
41
Note 3. Loans
The composition of loans is as follows:
December 31,
-------------------------
2002 2001
-------------------------
(Amounts In Thousands)
Agricultural ................................. $ 37,937 $ 34,304
Commercial and financial ..................... 46,828 44,363
Real estate:
Construction ................................. 47,201 40,430
Mortgage # ................................... 628,110 538,832
Loans to individuals ......................... 32,906 34,713
-------------------------
792,982 692,642
Less allowance for loan losses ............... 12,125 9,950
-------------------------
$780,857 $682,692
=========================
# Includes loans held for sale with a cost and fair value of $5,105 and $5,575
as of December 31, 2002 and 2001, respectively.
Changes in the allowance for loan losses are as follows:
Year Ended December 31,
-------------------------------------
2002 2001 2000
-------------------------------------
(Amounts In Thousands)
Balance, beginning ................... $ 9,950 $ 10,428 $ 9,750
Provision charged to expenses ........ 2,449 924 948
Recoveries ........................... 1,514 1,139 904
Loans charged off .................... (1,788) (2,541) (1,174)
------------------------------------
Balance, ending ...................... $ 12,125 $ 9,950 $ 10,428
====================================
Information about impaired and nonaccrual loans as of and for the years ended
December 31, 2002 and 2001 is as follows:
2002 2001
----------------------
(Amounts In Thousands)
Loans receivable for which there is a related allowance for loan losses $ 4,588 $ 4,417
Loans receivable for which there is no related allowance for loan losses 11,673 6,871
-----------------
Total impaired loans ................................................... $16,261 $11,288
=================
Related allowance for credit losses on impaired loans .................. $ 547 $ 897
Average balance of impaired loans ...................................... 12,739 11,200
Nonaccrual loans ....................................................... 1,538 1,001
Loans past due ninety days or more and still accruing .................. 2,516 2,921
Interest income recognized on impaired loans ........................... 962 962
Note 4. Property and Equipment
The major classes of property and equipment and the total accumulated
depreciation are as follows:
December 31,
-----------------------
2002 2001
-----------------------
(Amounts In Thousands)
Land ........................................... $ 3,715 $ 3,715
Buildings and improvements ..................... 17,041 15,844
Furniture and equipment ........................ 18,456 16,834
-----------------------
39,212 36,393
Less accumulated depreciation .................. 17,712 15,396
-----------------------
Net ............................................ $21,500 $20,997
=======================
42
Note 5. Interest-Bearing Deposits
A summary of these deposits is as follows:
December 31,
--------------------------
2002 2001
--------------------------
(Amounts In Thousands)
NOW and other demand ....................... $ 98,415 $ 84,480
Savings .................................... 201,890 175,900
Time, $100,000 and over .................... 60,536 55,517
Other time ................................. 333,647 311,942
--------------------------
$694,488 $627,839
==========================
Note 6. Federal Home Loan Bank Borrowings
As of December 31, 2002 and 2001, the borrowings were as follows:
2002 2001
--------------------------
(Effective interest rates as of December 31, 2002) (Amounts In Thousands)
Due 2005, 3.80% ............................ $ 4,350 $ 4,350
Due 2006, 4.27% ............................ 42,750 12,750
Due 2008, 5.22% to 6.00% ................... 40,506 50,000
Due 2009, 5.66% to 6.22% ................... 40,000 30,537
Due 2010, 5.77% to 6.61% ................... 40,000 40,000
--------------------------
$167,606 $137,637
==========================
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 $201,127,000. As of December 31, 2002, the Company held Federal
Home Loan Bank stock with a cost of $8,382,000. .
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
$93,000, $79,000 and $70,000 for the years ended December 31, 2002, 2001 and
2000, 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, 2002, 147,122 shares held by the ESOP, at a fair value of $88 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 $741,000, $636,000 and
$562,000 for the years ended December 31, 2002, 2001 and 2000, 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.
43
The following table illustrates the effect on net income and earnings per share
had compensation cost for all of the stock-based compensation plans been
determined based on the grant date values of awards (the method described in
FASB Statement No. 123, Accounting for Stock-based Compensation):
Years Ended December 31,
-------------------------------------
2002 2001 2000
-------------------------------------
Net income:
As reported ...................................... $ 11,464 $ 10,144 $ 9,366
Deduct total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax effects (18) (13) (5)
-------------------------------------
Pro forma ........................................ $ 11,446 $ 10,131 $ 9,361
=====================================
Basic earnings per share:
As reported ......................................... $ 7.65 $ 6.79 $ 6.26
Pro forma ........................................... $ 7.64 $ 6.77 $ 6.26
Diluted earnings per share:
As reported ......................................... $ 7.58 $ 6.72 $ 6.21
Pro forma ........................................... $ 7.57 $ 6.71 $ 6.21
A summary of the stock options is as follows:
Weighted
Average
Number Exercise
Of Shares Price
------------------------
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
Granted ...................................... 636 73.81
Exercised .................................... (2,000) 26.17
------------------------
Balance, December 31, 2002 ................... 27,815 $ 46.99
========================
The weighted average fair value of options granted in 2002 and 2001 was $20.13
per share and $15.00 per share, respectively.
Other pertinent information related to the options outstanding at December 31,
2002 is as follows:
Remaining
Exercise Number Contractual Number
Price Outstanding Life Exercisable
- -------------------------------------------------------------------------
$ 25.33 12,330 3 Months 12,330
26.17 2,394 6 Months 2,394
41.00 2,055 51 Months 2,055
77.00 10,400 101 Months -
73.00 378 104 Months -
75.00 258 108 months -
------ ------
27,815 16,779
====== ======
As of December 31, 2002, 53,156 options were available for future grants.
The committee is also authorized to grant awards of common stock, and it
authorized the issuance of 891, 1,550 and none shares of common stock to a group
of employees in 2002, 2001 and 2000, respectively.
44
Note 8. Income Taxes
Income taxes for the years ended December 31, 2002, 2001 and 2000 are summarized
as follows:
2002 2001 2000
-----------------------------------------
(Amounts In Thousands)
Current:
Federal .................... $ 5,258 $ 3,819 $ 3,648
State ...................... 960 747 726
Deferred ..................... (1,096) 47 (315)
----------------------------------------
$ 5,122 $ 4,613 $ 4,059
=======================================
Deferred income tax liabilities and assets arose from the following temporary
differences:
December 31,
----------------------------
2002 2001 2000
----------------------------
(Amounts In Thousands)
Deferred income tax assets:
Allowance for loan losses ..................... $4,515 $3,693 $3,860
Deferred compensation ......................... 624 530 433
Certain accrued expenses ...................... 301 276 198
Other ......................................... 150 91 90
----------------------------
Gross deferred tax assets ..................... 5,590 4,590 4,581
----------------------------
Deferred income tax liabilities:
Property and equipment ........................ 716 773 750
FHLB dividends ................................ 130 130 130
Unrealized gains on investment securities ..... 2,773 1,775 409
Other ......................................... -- 39 6
----------------------------
Gross deferred tax liabilities ................ 3,619 2,717 1,295
----------------------------
Net deferred income tax asset ................. $1,971 $1,873 $3,286
============================
The net change in the deferred income taxes for the years ended December 31,
2002, 2001 and 2000 is reflected in the financial statements as follows:
Year Ended December 31,
---------------------------------
2002 2001 2000
---------------------------------
(Amounts In Thousands)
Statement of income ...................... $(1,096) $ 47 $ (315)
Statement of stockholders' equity ........ 998 1,366 983
--------------------------------
$ (98) $ 1,413 $ 668
================================
The income tax provisions for the years ended December 31, 2002, 2001 and 2000
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:
2002 2001 2000
-------------------------------------------------------------
% Of % Of % Of
Pretax Pretax Pretax
Amount Income Amount Income Amount Income
-------------------------------------------------------------
(Amounts In Thousands)
Expected provision $ 5,805 35.0% $ 5,165 35.0% $ 4,699 35.0%
Tax-exempt interest (875) (5.3) (745) (5.0) (712) (5.3)
Interest expense
limitation ...... 128 0.8 143 1.0 111 1.0
State income taxes,
net of federal
income tax
benefit ......... 547 3.3 493 3.3 479 3.6
Income tax credits (345) (2.1) (345) (2.3) (345) (2.6)
Other ............. (138) (0.8) (98) (0.7) (173) (1.3)
-------------------------------------------------------------
$ 5,122 30.9% $ 4,613 31.3% $ 4,059 30.4%
=============================================================
45
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, 2002, 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, 2002:
Company:
Total risk based capital .......... $102,921 14.19% 8.00% 10.00%
Tier 1 risk based capital ......... 93,814 12.93 4.00 6.00
Leverage ratio .................... 8.64 3.00 5.00
Bank:
Total risk based capital .......... 100,288 13.84 8.00 10.00
Tier 1 risk based capital ......... 91,189 12.58 4.00 6.00
Leverage ratio .................... 8.41 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 $6,092,000 as of December 31, 2002 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 $1,405,000 and $11,998,000 as of December
31, 2002 and 2001, 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, 2002 and 2001: Deposits from related parties
are accepted subject to the same interest rates and terms as those from
nonrelated parties.
Year Ended December 31,
-----------------------------
2002 2001
-----------------------------
(Amounts In Thousands)
Balance, beginning ..................... $ 24,440 $ 13,297
Advances ............................... 15,607 15,445
Collections ............................ (12,234) (4,302)
----------------------------
Balance, ending ........................ $ 27,813 $ 24,440
============================
46
Note 11. Fair Value of Financial Instruments
The carrying value and estimated fair values of the Company's financial
instruments as of December 31, 2002 and 2001 are as follows:
2002 2001
-------------------------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
-------------------------------------------
(Amounts In Thousands)
Cash and due from banks ...................................... $ 32,647 $ 32,647 $ 37,070 $ 37,070
Federal funds sold ........................................... 32,514 32,514 29,428 29,428
Investment securities ........................................ 214,211 214,492 189,960 190,266
Loans ........................................................ 780,857 839,398 682,692 679,337
Accrued interest receivable .................................. 7,278 7,278 7,257 7,257
Deposits ..................................................... 802,321 783,784 720,018 728,943
Federal funds purchased and securities
sold under agreements to repurchase .......................... 20,798 20,798 22,409 22,409
Borrowings from Federal Home Loan
Bank ......................................................... 167,606 169,085 137,637 137,371
Accrued interest payable ..................................... 2,134 2,134 2,683 2,683
Face Amount Face Amount
------------------------------------------
Off-balance sheet instruments:
Loan commitments ............................................. $112,260 $ -- $117,609 $ --
Letters of credit ............................................ 12,650 -- 12,569 --
Note 12. Parent Company Only Financial Information
Following is condensed financial information of the Company (parent company
only):
CONDENSED BALANCE SHEETS
December 31, 2002 and 2001
(Amounts In Thousands)
ASSETS 2002 2001
- --------------------------------------------------------------------------------
Cash ................................................... $ 1,856 $ 1,655
Investment securities available for sale ............... 514 520
Investment in subsidiary bank .......................... 98,410 87,837
Other assets ........................................... 564 572
--------------------
Total assets ........................................... $101,344 $ 90,584
====================
LIABILITIES AND STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------------
Liabilities ............................................ $ 309 $ 235
--------------------
Redeemable common stock held by ESOP ................... 12,951 12,194
--------------------
Stockholders' equity:
Capital stock ........................................ 10,541 10,397
Retained earnings .................................... 85,773 76,931
Accumulated other comprehensive income ............... 4,721 3,021
--------------------
101,035 90,349
Less maximum cash obligation related to ESOP shares .... 12,951 12,194
--------------------
Total stockholders' equity ............................. 88,084 78,155
--------------------
Total liabilities and stockholders' equity ............. $101,344 $ 90,584
====================
47
CONDENSED STATEMENTS OF INCOME
Years Ended December 31, 2002, 2001 and 2000
(Amounts In Thousands)
2002 2001 2000
- --------------------------------------------------------------------------------------
Interest on investment securities ................. $ 25 $ 32 $ 30
Dividends received from subsidiary ................ 2,623 2,392 2,170
Other expenses .................................... (80) (112) (119)
--------------------------------
Income before income tax benefit and
equity in subsidiary's undistributed income 2,568 2,312 2,081
Income tax benefit ................................ 23 29 43
--------------------------------
2,591 2,341 2,124
Equity in subsidiary's undistributed income ....... 8,873 7,803 7,242
--------------------------------
Net income ................................ $ 11,464 $ 10,144 $ 9,366
================================
48
CONDENSED STATEMENTS OF CASH FLOWS Years Ended December 31,
2002, 2001 and 2000
(Amounts In Thousands)
2002 2001 2000
- ----------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income .............................................. $ 11,464 $ 10,144 $ 9,366
Noncash items included in net income:
Undistributed income of subsidiary .................... (8,873) (7,803) (7,242)
(Increase) decrease in other assets ................... 8 (43) 304
Increase (decrease) in liabilities .................... 73 (13) (76)
--------------------------------
Net cash provided by operating activities ......... 2,672 2,285 2,352
--------------------------------
Cash flows from investing activities:
Proceeds from maturities of investment securities ....... 250 250 --
Purchase of investment securities ....................... (243) (271) --
--------------------------------
Net cash provided by (used in) investing activities 7 (21) --
--------------------------------
Cash flows from financing activities:
Stock issued (redeemed) ................................. 97 157 (23)
Income tax benefits related to stock based
compensation .......................................... 47 43 6
Dividends paid .......................................... (2,622) (2,392) (2,171)
--------------------------------
Net cash (used in) financing activities ........... (2,478) (2,192) (2,188)
--------------------------------
Increase in cash .................................. 201 72 164
Cash balance:
Beginning ............................................... 1,655 1,583 1,419
--------------------------------
Ending .................................................. $ 1,856 $ 1,655 $ 1,583
================================
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
$25,960,000. 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.
49
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, 2002 and 2001
is as follows:
2002 2001
----------------------
(Amounts In Thousands)
Firm loan commitments and unused portion
of lines of credit:
Home equity loans ...................................... $ 6,923 $ 5,819
Credit card participations ............................. 15,057 14,050
Commercial, real estate and home construction .......... 51,272 44,880
Commercial lines ....................................... 39,008 52,860
Outstanding letters of credit .......................... 12,650 12,569
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Since many
of the commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements. The
Bank evaluates each customer's credit worthiness on a case-by-case basis. The
amount of collateral obtained, if deemed necessary by the Bank upon extension of
credit, is based on management's credit evaluation of the party. Collateral held
varies, but may include accounts receivable, crops, livestock, inventory,
property and equipment, residential real estate and income-producing commercial
properties. Credit card participations are the unused portion of the holders'
credit limits. Such amounts represent the maximum amount of additional unsecured
borrowings.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. Those guarantees are
primarily issued to support public and private borrowing arrangements and,
generally, have terms of one year, or less. The credit risk involved in issuing
letters of credit is essentially the same as that involved in extending loans to
customers. The Bank holds collateral, which may include accounts receivable,
inventory, property, equipment, and income-producing properties, supporting
those commitments if deemed necessary. In the event the customer does not
perform in accordance with the terms of the agreement with the third party, the
Bank would be required to fund the commitment. The maximum potential amount of
future payments the Bank could be required to make is represented by the
contractual amount shown in the summary above. If the commitment is funded the
Bank would be entitled to seek recovery from the customer. At December 31, 2002
and 2001 no amounts have been recorded as liabilities for the Bank's potential
obligations under these guarantees.
Note 14. Quarterly Results of Operations (unaudited, amounts in thousands,
except per share amounts)
Quarter Ended
-----------------------------------------------
March June September December Year
-----------------------------------------------
2002:
- ------------------------------
Total interest income ........ $15,521 $15,928 $16,510 $16,602 $64,561
Net interest income after
provisions for loan losses ... 7,295 7,798 8,318 7,560 30,971
Net income ................... 2,623 2,673 3,236 2,932 11,464
Basic earnings per share ..... 1.75 1.78 2.15 1.97 7.65
Diluted earnings per share ... 1.74 1.76 2.14 1.94 7.58
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
50
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 50 Director of Registrant and Bank; President, Registrant and Bank 1986 (1975)
Willis M. Bywater 64 Director of Registrant and Bank; Chairman of the Board, Bank; 1997 (1997)
Vice President of the Registrant; Executive Officer and Shareholder
of Economy Advertising Company
James G. Pratt 54 Treasurer of Registrant; Senior Vice President and Chief Financial 1985 (1982)
Officer from January 1986 to present
Thomas J. Cilek 56 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 and
Related Shareholders Matters
Information required by this item is contained in the Registrant's Proxy
Statement under the headings "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 III
Item 14. Controls and Procedures
Within the ninety days prior to the filing of this report, the Company's
management, under the supervision and with the participation of the Chief
Executive Officer and Chief Financial Officer, evaluated the effectiveness of
the design and operation of the Company's disclosure controls and procedures, as
defined in Rule 13a-14 under the Securities Exchange Act of 1934. Based on that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the Company's disclosure controls and procedures were adequate. There were
no significant changes (including corrective actions with regard to significant
deficiencies or material weaknesses) in the Company's internal controls or in
other factors subsequent to the date of the evaluation that would significantly
affect those controls.
51
Part IV
Item 15. 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 42
Consolidated balance sheets as of December 31, 2002 and 2001 43
Consolidated statements of income for the years ended December 31, 2002, 2001 and 2000 44
Consolidated statements of comprehensive income for the years ended
December 31, 2002, 2001 and 2000 45
Consolidated statements of stockholders' equity for the years ended
December 31, 2002, 2001 and 2000 46
Consolidated statements of cash flows for the years ended December 31, 2002,
2001 and 2000 47 - 48
Notes to financial statements 49 - 70
(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, 2001 is incorporated by reference.
Exhibit 11 - Statement Re Computation of Basic and Diluted Earnings Per
Share is attached on Page 80.
Exhibit 21 - Subsidiaries of the Registrant is attached on Page 81.
Exhibit 23 - Consent of Accountants is attached on Page 82.
(b) Reports on Form 8-K:
The Registrant filed no reports on Form 8-K for the three months ended
December 31, 2002.
52
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 21, 2003 By /s/ Dwight O. Seegmiller
-------------- ------------------------------------------------------
Dwight O. Seegmiller, Director and President
Date March 21, 2003 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.
DIRECTORS OF THE REGISTRANT
Date March 21, 2003 By /s/ Willis M. Bywater
--------------------------- ------------------------------
Willis M. Bywater, Director
Date March 21, 2003 By /s/ Thomas J. Gill
--------------------------- ------------------------------
Thomas J. Gill, Director
Date March 21, 2003 By /s/ David H. Gringer
--------------------------- ------------------------------
Donald H. Gringer, Director
Date March 21, 2003 By /s/ Michael E. Hodge
--------------------------- ------------------------------
Michael E. Hodge, Director
Date March 21, 2003 By /s/ Richard W. Oberman
--------------------------- ------------------------------
Richard W. Oberman, Director
Date March 21, 2003 By /s/ Theodore H. Pacha
--------------------------- ------------------------------
Theodore H. Pacha, Director
Date March 21, 2003 By /s/ Ann M. Rhodes
-------------------------- ------------------------------
Ann M. Rhodes, Director
Date March 21, 2003 By /s/ Ronald E. Stutsman
-------------------------- ------------------------------
Ronald E. Stutsman, Director
Date March 21, 2003 By /s/ Sheldon E. Yoder
-------------------------- ------------------------------
Sheldon E. Yoder, Director
53
CERTIFICATIONS
I, Dwight O. Seegmiller, certify that:
1. I have reviewed this annual report on Form 10-K of Hills Bancorporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 21, 2003 By /s/ Dwight O. Seegmiller
-------------- -------------------------------
Dwight O. Seegmiller, President
54
CERTIFICATIONS
I, James G. Pratt, certify that:
1. I have reviewed this annual report on Form 10-K of Hills Bancorporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 21, 2003 By /s/ James G. Pratt
-------------- ------------------------------------------------------
James G. Pratt, Treasurer and Chief Accounting Officer
55
HILLS BANCORPORATION
ANNUAL REPORT ON FORM 10-K FOR THE
FISCAL YEAR ENDED DECEMBER 31, 2002
EXHIBIT INDEX
Page Number
In The Sequential
Exhibit Numbering System
Number Description For 2002 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
99.1 Section 906 Certification by Dwight O. Seegmiller
99.2 Section 906 Certification by James G. Pratt
56