SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [Mark One] [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2005 [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________ to ____________ Commission File Number 0-32637 AMES NATIONAL CORPORATION ------------------------------------------------------ (Exact Name of Registrant as Specified in Its Charter) IOWA 42-1039071 - ------------------------------------------------------------------------------- (State or Other Jurisdiction of (I. R. S. Employer Incorporation or Organization) Identification Number) 405 FIFTH STREET AMES, IOWA 50010 ---------------------------------------- (Address of Principal Executive Offices) Registrant's Telephone Number, Including Area Code: (515) 232-6251 NOT APPLICABLE ---------------------------------------------------- (Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report) 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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes __X__ No _____ Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. COMMON STOCK, $5.00 PAR VALUE 3,137,066 - ----------------------------- ----------------------------------- (Class) (Shares Outstanding at May 2, 2005) 1 AMES NATIONAL CORPORATION INDEX Page PART I. FINANCIAL INFORMATION Item 1. Consolidated Financial Statements (Unaudited) Consolidated Balance Sheets at March 31, 2005 and December 31, 2004 3 Consolidated Statements of Income for the three months ended March 31, 2005 and 2004 4 Consolidated Statements of Cash Flows for the three months ended March 31, 2005 and 2004 5 Notes to Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 6 Item 3. Quantitative and Qualitative Disclosures About Market Risk 19 Item 4. Controls and Procedures 19 PART II. OTHER INFORMATION Items 1 through 6 20 Signatures 21 2 AMES NATIONAL CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets (unaudited) March 31, December 31, ASSETS 2005 2004 - --------------------------------------------------------------------------------------- Cash and due from banks $ 24,733,223 $ 18,759,086 Federal funds sold 31,070,000 19,865,000 Interest bearing deposits in financial institutions 7,340,508 9,575,174 Securities available-for-sale 356,561,743 363,459,462 Loans receivable, net 424,922,071 411,638,565 Loans held for sale 202,000 234,469 Bank premises and equipment, net 8,706,945 8,790,636 Accrued income receivable 6,471,383 6,262,424 Other assets 3,451,592 1,167,971 ---------------------------- Total assets $863,459,465 $839,752,787 ============================ LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Deposits Demand, noninterest bearing $ 65,577,644 $ 71,666,385 NOW accounts 186,747,294 172,313,429 Savings and money market 188,598,917 174,358,165 Time, $100,000 and over 79,171,833 69,063,977 Other time 170,999,798 170,773,883 ---------------------------- Total deposits 691,095,486 658,175,839 Federal funds purchased and securities sold under agreements to repurchase 58,652,611 64,072,475 Dividend payable 2,352,800 1,537,162 Deferred income taxes - 2,334,670 Accrued expenses and other liabilities 3,773,689 2,708,701 ---------------------------- Total liabilities 755,874,586 728,828,847 COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY Common stock, $5 par value, authorized 6,000,000 shares; issued March 31, 2005 and December 31, 2004 3,153,230 shares; outstanding 3,137,066 shares 15,766,150 15,766,150 Additional paid-in capital 5,378,746 25,378,746 Retained earnings 63,861,476 63,200,352 Treasury stock, at cost, 16,164 shares (889,020) (889,020) Accumulated other comprehensive income, net unrealized gain on securities available-for-sale 3,467,527 7,467,712 ---------------------------- Total stockholders' equity 107,584,879 110,923,940 ---------------------------- Total liabilities and stockholders' equity $863,459,465 $839,752,787 ============================ 3 AMES NATIONAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Income (unaudited) Three Months Ended March 31, 2005 2004 - ----------------------------------------------------------------------- Interest and dividend income: Loans, including fees $ 6,252,751 $ 5,352,668 Securities: Taxable 2,230,118 2,076,081 Tax-exempt 1,060,849 1,051,986 Federal funds sold 52,567 56,873 Dividends 347,451 377,196 ------------------------ Total interest income 9,943,736 8,914,804 ------------------------ Interest expense: Deposits 2,982,306 2,316,646 Other borrowed funds 366,593 74,528 ------------------------ Total interest expense 3,348,899 2,391,174 ------------------------ Net interest income 6,594,837 6,523,630 Provision for loan losses 53,725 58,355 ------------------------ Net interest income after provision for loan losses 6,541,112 6,465,275 ------------------------ Noninterest income: Trust department income 332,509 283,871 Service fees 420,156 356,931 Securities gains, net 134,938 31,542 Gain on sales of loans held for sale 113,825 164,188 Merchant and ATM fees 145,930 149,080 Other 128,236 155,321 ------------------------ Total noninterest income 1,275,594 1,140,933 ------------------------ Noninterest expense: Salaries and employee benefits 2,375,948 2,258,919 Data processing 476,713 541,053 Occupancy expenses 310,175 267,977 Other operating expenses 644,820 584,805 ------------------------ Total noninterest expense 3,807,656 3,652,754 ------------------------ Income before income taxes 4,009,050 3,953,454 Provision for income taxes 995,126 988,912 ------------------------ Net income $ 3,013,924 $ 2,964,542 ======================== Basic and diluted earnings per share $ 0.96 $ 0.95 ======================== Dividends declared per share $ 0.75 $ 0.46 ======================== Comprehensive income (loss) $ (986,261) $ 4,871,687 ======================== 4 AMES NATIONAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Cashflows (unaudited) 2005 2004 - ---------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 3,013,924 $ 2,964,542 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 53,725 58,355 Amortization and accretion 157,722 128,672 Depreciation 219,430 215,597 Provision for deferred taxes 13,808 (18,693) Securities gains, net (134,938) (31,542) Change in assets and liabilities: Decrease in loans held for sale 32,469 199,139 (Increase) in accrued income receivable (208,959) (139,553) (Increase) in other assets (2,282,784) (181,626) Increase in accrued expenses and other liabilities 1,064,988 536,406 ------------------------------ Net cash provided by operating activities 1,929,385 3,731,297 ------------------------------ CASH FLOWS FROM INVESTING ACTIVITIES Purchase of securities available-for-sale (25,935,564) (45,577,674) Proceeds from sale of securities available-for-sale 11,971,370 1,465,948 Proceeds from maturities and calls of securities available-for-sale 14,489,629 19,992,064 Net (increase) decrease in interest bearing deposits in financial institutions 2,234,666 (2,225,038) Net (increase) in federal funds sold (11,205,000) (18,310,000) Net (increase) in loans (13,337,231) (3,931,007) Purchase of bank premises and equipment (135,739) (285,684) ------------------------------ Net cash (used in) investing activities (21,917,869) (48,871,391) ------------------------------ CASH FLOWS FROM FINANCING ACTIVITIES Increase in deposits 32,919,647 40,211,580 Increase (decrease) in federal funds purchased and securities sold under agreements to repurchase (5,419,864) 655,834 Dividends paid (1,537,162) (1,441,204) ------------------------------ Net cash provided by financing activities $ 25,962,621 39,426,210 ------------------------------ Net increase (decrease) in cash and cash equivalents $ 5,974,137 (5,713,884) CASH AND DUE FROM BANKS Beginning 18,759,086 31,982,144 ------------------------------ Ending 24,733,223 $ 26,268,260 ============================== Cash payments for: Interest 3,358,146 2,482,191 Income taxes 122,947 $ 130,780 5 AMES NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Unaudited) 1. Significant Accounting Policies The consolidated financial statements for the three month periods ended March 31, 2005 and 2004 are unaudited. In the opinion of the management of Ames National Corporation (the "Company"), these financial statements reflect all adjustments, consisting only of normal recurring accruals, necessary to present fairly these consolidated financial statements. The results of operations for the interim periods are not necessarily indicative of results which may be expected for an entire year. Certain information and footnote disclosures normally included in complete financial statements prepared in accordance with generally accepted accounting principles have been omitted in accordance with the requirements for interim financial statements. The interim financial statements and notes thereto should be read in conjunction with the year-end audited financial statements contained in the Company's 10-K. The consolidated condensed financial statements include the accounts of the Company and its wholly-owned banking subsidiaries (the "Banks"). All significant intercompany balances and transactions have been eliminated in consolidation. 2. Dividends On February 9, 2005, the Company declared a cash dividend on its common stock, payable on May 16, 2005 to stockholders of record as of May 2, 2005, equal to $0.75 per share. 3. Earnings Per Share Earnings per share amounts were calculated using the weighted average shares outstanding during the periods presented. The weighted average outstanding shares for the three months ended March 31, 2005 and 2004 were 3,137,066 and 3,133,053, respectively. 4. Off-Balance Sheet Arrangements The Company is party to financial instruments with off-balance-sheet risk in the normal course of business. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. No material changes in the Company's off-balance sheet arrangements have occurred since December 31, 2004. 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Overview Ames National Corporation is a bank holding company established in 1975 that owns and operates five bank subsidiaries in central Iowa. The following discussion is provided for the consolidated operations of the Company and its Banks, First National Bank, Ames, Iowa (First National), State Bank & Trust Co. (State Bank), Boone Bank & Trust Co. (Boone Bank), Randall-Story State Bank (Randall-Story Bank) and United Bank & Trust NA (United Bank). The purpose of this discussion is to focus on significant factors affecting the Company's financial condition and results of operations. The Company does not engage in any material business activities apart from its ownership of the Banks. Products and services offered by the Banks are for commercial and consumer purposes including loans, deposits and trust services. The Banks also offer investment services through a third-party broker dealer. The Company employs ten individuals to assist with financial reporting, human resources, audit, compliance, marketing, technology systems and the coordination of management activities, in addition to 174 full-time equivalent individuals employed by the Banks. The Company's primary competitive strategy is to utilize seasoned and competent Bank management and local decision making authority to provide customers with faster response times and more flexibility in the products and services offered. This strategy is viewed as providing an opportunity to increase revenues through creating a competitive advantage over other financial institutions. The Company also strives to remain operationally efficient to provide better profitability while enabling the Company to offer more competitive loan and deposit rates. The principal sources of Company revenues and cashflow are: (i) interest and fees earned on loans made by the Banks; (ii) securities gains and dividends on equity investments held by the Company and the Banks; (iii) service charges on deposit accounts maintained at the Banks; (iv) interest on fixed income investments held by the Banks; and (v) fees on trust services provided by those Banks exercising trust powers. The Company's principal expenses are: (i) interest expense on deposit accounts and other borrowings; (ii) salaries and employee benefits; (iii) data processing costs associated with maintaining the Bank's loan and deposit functions; and (iv) occupancy expenses for maintaining the Banks' facilities. The largest component contributing to the Company's net income is net interest income, which is the difference between interest earned on earning assets (primarily loans and investments) and interest paid on interest bearing liabilities (primarily deposits and other borrowings). One of management's principal functions is to manage the spread between interest earned on earning assets and interest paid on interest bearing liabilities in an effort to maximize net interest income while maintaining an appropriate level of interest rate risk. The Company earned net income of $3,014,000, or $0.96 per share for the three months ended March 31, 2005, compared to net income of $2,965,000, or $0.95 per share, for the three months ended March 31, 2004, an increase of 2%. Security gains of $135,000 were the largest contributor to the higher level of quarterly earnings as net interest income had only a marginal increase. 7 The following management discussion and analysis will provide a summary review of important items relating to: o Challenges o Key Performance Indicators and Industry Results o Income Statement Review o Balance Sheet Review o Asset Quality and Credit Risk Management o Liquidity and Capital Resources o Forward-Looking Statements and Business Risks Challenges Management has identified certain challenges that may negatively impact the Company's revenues in the future and is attempting to position the Company to best respond to those challenges. o Interest rates have moved above their historic lows; however, additional rapid increases in interest rates may present a challenge to the Company. Such an increase may negatively impact the Company's net interest margin if interest expense increases more quickly than interest income. As a the result of a significant increase in short term interest rates and the competitive nature of the Company's markets this past year, the net interest margin has fallen to 3.69% for the three months ended March 31, 2005 compared to 4.09% for the three months ended March 31, 2004. The Company's earning assets (primarily its loan and investment portfolio) have longer maturities than its interest bearing liabilities (primarily deposits and other borrowings); therefore, in a rising interest rate environment, interest expense will increase more quickly than interest income as the interest bearing liabilities reprice more quickly than earning assets. In response to this challenge, the Banks model quarterly the changes in income that would result from various changes in interest rates. Management believes Bank assets have the appropriate maturity and repricing characteristics to optimize earnings and the Banks' interest rate risk positions. o The Company's market in central Iowa has numerous banks, credit unions, and investment and insurance companies competing for similar business opportunities. This competitive environment will continue to put downward pressure on the Banks' net interest margins and thus affect profitability. Strategic planning efforts at the Company and Banks continue to focus on capitalizing on the Banks' strengths in local markets while working to identify opportunities for improvement to gain competitive advantages. o A potential challenge to the Company's earnings would be poor performance in the Company's equity portfolio, thereby reducing the historical level of realized security gains. The Company, on an unconsolidated basis, invests capital that may be utilized for future expansion in a portfolio of primarily financial and utility stocks totaling $23 million as of March 31, 2005. The Company focuses on stocks that have historically paid dividends that may lessen the negative effects of a bear market. 8 Key Performance Indicators and Industry Results Certain key performance indicators for the Company and the industry are presented in the following chart. The industry figures are compiled by the Federal Deposit Insurance Corporation (FDIC) and are derived from 8,975 commercial banks and savings institutions insured by the FDIC. Management reviews these indicators on a quarterly basis for purposes of comparing the Company's performance from quarter to quarter against the industry as a whole. Selected Indicators for the Company and the Industry Quarter Ended Year Ended December 31, March 31, 2005 2004 2003 2002 --------------------------------------------------------------------- Company Company Industry Company Industry Company Industry Return on assets 1.45% 1.56% 1.29% 1.60% 1.38% 1.78% 1.30% Return on equity 10.90% 11.47% 13.28% 11.16% 15.04% 11.54% 14.14% Net interest margin 3.69% 3.97% 3.53% 4.02% 3.73% 4.51% 3.96% Efficiency ratio 48.38% 46.59% 58.03% 47.18% 56.59% 44.64% 56.00% Capital ratio 12.91% 13.62% 8.12% 14.33% 7.88% 15.46% 7.87% Key performances indicators include: o Return on Assets This ratio is calculated by dividing net income by average assets. It is used to measure how effectively the assets of the Company are being utilized in generating income. The Company's annualized return on average assets was 1.45% and 1.56%, respectively, for the three month periods ending March 31, 2005 and 2004. Although the Company's return on assets ratio compares favorably to that of the industry, this ratio declined in 2005 as assets grew more quickly than income. o Return on Equity This ratio is calculated by dividing net income by average equity. It is used to measure the net income or return the Company generated for the shareholders' equity investment in the Company. The Company's annualized return on equity ratio is below that of the industry primarily as a result of the higher level of capital the Company maintains for future growth and acquisitions. The Company's return on average equity was 10.90% and 10.91%, respectively for the three month periods ending March 31, 2005 and 2004. 9 o Net Interest Margin The net interest margin for the three months ended March 31, 2005 was 3.69% compared to 4.09% for the three months ended March 31, 2004. The ratio is calculated by dividing net interest income by average earning assets. Earning assets are primarily made up of loans and investments that earn interest. This ratio is used to measure how well the Company is able to maintain interest rates on earning assets above those of interest-bearing liabilities, which is the interest expense paid on deposits and other borrowings. The Company's net interest margin declined 40 basis points when compared to March 31, 2004 but still compares favorably to the industry. Management expects the rising interest rate environment and the competitive nature of the Company's market environment to put downward pressure on the Company's margin for the remainder of 2005. o Efficiency Ratio This ratio is calculated by dividing noninterest expense by net interest income and noninterest income. The ratio is a measure of the Company's ability to manage noninterest expenses. The Company's efficiency ratio compares favorably to the industry's average and was 48.38% and 48.02% for the three months ended March 31, 2005 and 2004, respectively. o Capital Ratio The average capital ratio is calculated by dividing total equity capital by average total assets. It measures the level of average assets that are funded by shareholders' equity. Given an equal level of risk in the financial condition of two companies, the higher the capital ratio, generally the more financially sound the company. The Company's capital ratio is significantly higher than the industry average. The capital ratio declined from December 31, 2004 as the result of higher interest rates causing the capital related to net unrealized gains in the Company and Banks' investment portfolios to decline. Industry Results The FDIC Quarterly Banking Profile reported the following results for the fourth quarter of 2004: Strong loan growth and wider net interest margins did not offset the negative effects of merger expenses at large banks and lower gains on sales of securities and other assets in the fourth quarter. Insured commercial banks and savings institutions reported $31.8 billion in net income for the quarter, a decline of $668 million (2.1%) from the record earnings registered in the third quarter. Nevertheless, the industry's earnings were the third-highest ever reported, and represented a $787-million (2.5%) improvement over the fourth quarter of 2003. Also, the industry's net operating (core) income, which does not include gains on securities sales, set a new quarterly record of $30.9 billion. The average return on assets (ROA) was 1.28% in the fourth quarter, marking the first time in two years that the industry's quarterly ROA has been below 1.30%. Fewer than half of all insured banks and thrifts (48.4%) had an ROA of 1% or higher in the fourth quarter, but this was an improvement over the fourth quarter of 2003, when only 44.8% achieved this benchmark level of profitability. Almost two out of every three institutions (62.1%) had higher net income than in the fourth quarter of 2003. 10 Income Statement Review The following highlights a comparative discussion of the major components of net income and their impact for the three month periods ended March 31, 2005 and 2004: Critical Accounting Policies The discussion contained in this Item 2 and other disclosures included within this report are based on the Company's audited consolidated financial statements. These statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The financial information contained in these statements is, for the most part, based on the financial effects of transactions and events that have already occurred. However, the preparation of these statements requires management to make certain estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. The Company's significant accounting policies are described in the "Notes to Consolidated Financial Statements" contained in the Company's 10-K. Based on its consideration of accounting policies that involve the most complex and subjective estimates and judgments, management has identified its most critical accounting policy to be that related to the allowance for loan losses. The allowance for loan losses is established through a provision for loan losses that is treated as an expense and charged against earnings. Loans are charged against the allowance for loan losses when management believes that collectibility of the principal is unlikely. The Company has policies and procedures for evaluating the overall credit quality of its loan portfolio, including timely identification of potential problem loans. On a quarterly basis, management reviews the appropriate level for the allowance for loan losses incorporating a variety of risk considerations, both quantitative and qualitative. Quantitative factors include the Company's historical loss experience, delinquency and charge-off trends, collateral values, known information about individual loans and other factors. Qualitative factors include the general economic environment in the Company's market area and the expected trend of the economic conditions. To the extent actual results differ from forecasts and management's judgment, the allowance for loan losses may be greater or lesser than future charge-offs. AVERAGE BALANCES AND INTEREST RATES The following two tables are used to calculate the Company's net interest margin. The first table includes the Company's average assets and the related income to determine the average yield on earning assets. The second table includes the average liabilities and related expense to determine the average rate paid on interest bearing liabilities. The net interest margin is equal to the interest income less the interest expense divided by average earning assets. 11 AVERAGE BALANCE SHEETS AND INTEREST RATES Three Months Ended March 31, 2005 2004 --------------------------------- -------------------------------- ASSETS Average Revenue/ Yield/ Average Revenue/ Yield/ (dollars in thousands) balance expense rate balance expense rate --------------------------------- --------------------------------- Interest-earning assets Loans Commercial $ 63,604 $ 918 5.77% $ 40,780 $ 531 5.21% Agricultural 28,672 485 6.77% 26,705 431 6.46% Real estate 307,232 4,507 5.87% 271,841 4,048 5.96% Installment and other 25,398 343 5.40% 22,851 343 6.00% ------------------------------ ------------------------------- Total loans (including fees) $424,906 $ 6,253 5.89% $362,177 $5,353 5.91% Investment securities Taxable $225,750 $ 2,289 4.06% $195,356 $2,164 4.43% Tax-exempt 127,949 2,007 6.27% 120,834 2,024 6.70% ------------------------------ ------------------------------- Total investment securities $353,699 $ 4,296 4.86% $316,190 $4,189 5.30% Interest bearing deposits with banks $ 4,749 $44 3.71% $ 7,252 $24 1.32% Federal funds sold 8,719 53 2.43% 21,388 57 1.07% ------------------------------ ------------------------------- Total interest-earning assets $792,073 $10,646 5.38% $707,007 $9,623 5.44% Non-interest-earning assets 41,042 51,465 -------- -------- TOTAL ASSETS $833,115 $758,472 ======== ======== <FN> 1 Average loan balances include nonaccrual loans, if any. Interest income on nonaccrual loans has been included. 2 Tax-exempt income has been adjusted to a tax-equivalent basis using an incremental tax rate of 35%. </FN> 12 AVERAGE BALANCE SHEETS AND INTEREST RATES Three Months Ended March 31, 2005 2004 ------------------------------ ---------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Average Revenue/ Yield/ Average Revenue/ Yield/ (dollars in thousands) balance expense rate balance expense rate ------------------------------ ---------------------------------------- Interest-bearing liabilities Deposits Savings, NOW accounts, and money markets $335,822 $1,202 1.43% $311,503 $ 615 0.79% Time deposits < $100,000 170,985 1,239 2.90% 175,513 1,277 2.91% Time deposits > $100,000 74,115 541 2.92% 69,366 424 2.45% ----------------------------- ---------------------------------------- Total deposits $580,922 $2,982 2.05% $556,382 $2,316 1.67% Other borrowed funds 69,149 367 2.12% 20,857 75 1.44% ----------------------------- ---------------------------------------- Total Interest-bearing $650,071 $3,349 2.06% $577,239 $2,391 1.66% liabilities ------ ------ Non-interest-bearing liabilities Demand deposits $ 64,929 $ 64,154 Other liabilities 7,550 8,380 -------- -------- Stockholders' equity $110,565 $108,699 -------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $833,115 $758,472 ======== ======== Net interest: income / margin $7,297 3.69% $7,232 4.09% ======= Spread Analysis Interest income/average assets $ 10,646 5.11% $9,623 5.07% Interest expense/average assets 3,349 1.61% 2,391 1.26% Net interest income/average assets 7,297 3.50% 7,232 3.81% <FN> 1 Tax-exempt income has been adjusted to a tax-equivalent basis using an incremental tax rate of 35%. </FN> 13 Net Interest Income For the three months ended March 31, 2005 and 2004, the Company's net interest margin adjusted for tax exempt income was 3.69% and 4.09%, respectively. Net interest income, prior to the adjustment for tax-exempt income, for the three months ended March 31, 2005 and March 31, 2004 totaled $6,595,000 and $6,524,000, respectively. For the quarter ended March 31, 2005, net interest income increased $71,000 or 1.2% when compared to the same period in 2004. Interest income increased $1,029,000 or 11.5% over that same time frame. The increase in interest income was attributable to higher volume of loans and investments and a lower volume of federal funds sold. Interest expense increased $958,000 or 40.1% for the quarter ended March 31, 2005 when compared to the same period in 2004. The higher interest expense for the quarter is attributable to a higher volume and rate on total deposits and other borrowed funds as market interest rates increased during the quarter. Average deposit interest rates were up significantly for all deposit categories with the exception of certificates of deposits under $100,000. Provision for Loan Losses The Company's provision for loan losses for the three months ended March 31, 2005 was $54,000 compared to $58,000 during the same period last year. Non-interest Income and Expense Non-interest income increased $135,000, or 11.8% during the quarter ended March 31, 2005 compared to the same period in 2004. The increase can be attributed in part to a $135,000 of realized gains on the sale of securities in the Company's equity portfolio in the first quarter of 2005 compared to $32,000 in the first quarter of 2004. Higher trust and service fees offset lower gains on the sale of secondary market residential mortgage loans. Overdraft protection programs introduced in 2004 have increased the Company's service fee income and a slow down in refinancing activities has resulted in lower revenue on the sale of secondary market residential mortgage loans. Non-interest expense increased $155,000 or 4.2% for the first quarter of 2005 compared to the same period in 2004. The increase in other expenses related to higher auditing costs and employee salary and benefits. The higher auditing costs were associated with complying with Sarbanes-Oxley Act of 2002. Income Taxes The provision for income taxes for March 31, 2005 and March 31, 2004 was $995,000 and $989,000, respectively. This amount represents an effective tax rate of 24.8% for the three months ended March 31, 2005 versus 25.0% for the same quarter in 2004. The Company's marginal federal tax rate is currently 35%. The difference between the Company's effective and marginal tax rate is primarily related to investments made in tax exempt securities. 14 Balance Sheet Review As of March 31, 2005, total assets were $863,459,000, a $23,707,000 increase compared to December 31, 2004. Asset growth was funded by an increase in deposits primarily at State Bank that created a higher volume of federal funds sold resulting from temporary public fund deposit balances associated with the collection of property taxes. The loan portfolio grew $13,284,000 for the quarter ended March 31, 2005 and also contributed to the higher level of assets. Investment Portfolio The investment portfolio totaled $356,562,000 as of March 31, 2005, lower than the December 31, 2004 balance of $363,459,000. The decline was primarily due to a decline in market values on the Company and Banks investment portfolios as the result of increasing market interest rates. Loan Portfolio Net loans totaled $424,922,000 as of March 31, 2005 compared to $411,639,000 as of December 31, 2004. The increased level of loans relates to new loan originations at First National, Boone Bank, and United Bank. Commercial and agricultural operating loans were the loan categories with the most significant growth. Deposits Deposits totaled $691,095,000 as of March 31, 2005, an increase of $32,920,000 from December 31, 2004. Much of the increase is related to public fund deposits included in the interest bearing checking (NOW) and savings and money market accounts and a higher level of certificates of deposit greater than $100,000. Other Borrowed Funds Other borrowed funds as of March 31, 2005 totaled $58,653,000 consisting of federal funds purchased and securities sold under agreements to repurchase (repurchase agreements). Other borrowings as of December 31, 2004 totaled $64,072,000. The expected run-off of repurchase agreements funding at First National was the primary reason for the lower level of borrowed funds. Off-Balance Sheet Arrangements The Company is party to financial instruments with off-balance-sheet risk in the normal course of business. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. No material changes in the Company's off-balance sheet arrangements have occurred since December 31, 2004. Asset Quality Review and Credit Risk Management The Company's credit risk is centered in the loan portfolio, which on March 31, 2005 totaled $424,922,000 compared to $411,639,000 as of December 31, 2004. Net loans comprise 49% of total assets as of March 31, 2005. The object in managing loan portfolio risk is to reduce the risk of loss resulting from a customer's failure to perform according to the terms of a transaction and to quantify and manage credit risk on a portfolio basis. The Company's level of problem loans consisting of non-accrual loans and loans past due 90 days or more as a percentage of total loans of 0.41% is below that of the Company's peer group of 358 bank holding companies with assets of $500 million to $1 billion as of December 31, 2004 of 0.56%. 15 Impaired loans totaled $1,747,000 as of March 31, 2005 compared to $1,976,000 as of December 31, 2004. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Impaired loans include loans accounted for on a non-accrual basis, accruing loans which are contractually past due 90 days or more as to principal or interest payments, and any restructured loans. As of March 31, 2005, non-accrual loans totaled $1,647,000, loans past due 90 days still accruing totaled $100,000 and there were no restructured loans outstanding. Other real estate owned as of March 31, 2005 and December 31, 2004 totaled $728,000 and $772,000, respectively. The allowance for loan losses as a percentage of outstanding loans as of March 31, 2005 and December 31, 2004 was 1.51% and 1.55%, respectively. The allowance for loan and lease losses totaled $6,516,000 and $6,475,000 as of March 31, 2005 and December 31, 2004, respectively. Net charge-offs totaled $13,000 for the most recent quarter end compared to $20,000 for the three month period ended March 31, 2004. The allowance for loan losses is management's best estimate of probable losses inherent in the loan portfolio as of the balance sheet date. Factors considered in establishing an appropriate allowance include: an assessment of the financial condition of the borrower, a realistic determination of value and adequacy of underlying collateral, the condition of the local economy and the condition of the specific industry of the borrower, an analysis of the levels and trends of loan categories and a review of delinquent and classified loans. Liquidity and Capital Resources Liquidity management is the process by which the Company, through its Banks' Asset and Liability Committees (ALCO), ensures that adequate liquid funds are available to meet its financial commitments on a timely basis, at a reasonable cost and within acceptable risk tolerances. These commitments include funding credit obligations to borrowers, funding of mortgage originations pending delivery to the secondary market, withdrawals by depositors, maintaining adequate collateral for pledging for public funds, trust deposits and borrowings, paying dividends to shareholders, payment of operating expenses, funding capital expenditures and maintaining deposit reserve requirements. Liquidity is derived primarily from core deposit growth and retention; principal and interest payments on loans; principal and interest payments, sale, maturity and prepayment of investment securities; net cash provided from operations; and access to other funding sources. Other funding sources include federal funds purchased lines, Federal Home Loan Bank (FHLB) advances and other capital market sources. As of March 31, 2005, the level of liquidity and capital resources of the Company remain at a satisfactory level and compare favorably to that of other FDIC insured institutions. Management believes that the Company's liquidity sources will be sufficient to support its existing operations for the foreseeable future. The liquidity and capital resources discussion will cover the follows topics: o Review the Company's Current Liquidity Sources o Review of the Statements of Cash Flows o Company Only Cash Flows o Review of Commitments for Capital Expenditures, Cash Flow Uncertainties and Known Trends in Liquidity and Cash Flows Needs o Capital Resources 16 Review of the Company's Current Liquidity Sources Liquid assets of cash on hand, balances due from other banks, federal funds sold and interest-bearing deposits in financial institutions for March 31, 2005 and December 31, 2004 totaled $63,144,000 and $48,199,000, respectively. Higher levels of liquidity are primarily the result of large temporary public fund deposits being held as federal fund sold. Other sources of liquidity available to the Banks as of March 31, 2005 include outstanding lines of credit with the Federal Home Loan Bank of Des Moines, Iowa of $31,000,000 and federal funds borrowing capacity at correspondent banks of $57,500,000 with no current outstanding federal fund balances. The Company had securities sold under agreements to repurchase totaling $58,653,000 and did not have any outstanding FHLB advances as of March 31, 2005. Total investments as of March 31, 2005 were $356,562,000 compared to $363,459,000 as of year end 2004. These investments provide the Company with a significant amount of liquidity since all of the investments are classified as available for sale as of March 31, 2005. The investment portfolio serves an important role in the overall context of balance sheet management in terms of balancing capital utilization and liquidity. The decision to purchase or sell securities is based upon the current assessment of economic and financial conditions, including the interest rate environment, liquidity and credit considerations. The portfolio's scheduled maturities represent a significant source of liquidity. Review of Statements of Cash Flows Operating cash flows for March 31, 2005 and 2004 totaled $1,929,000 and $3,731,000, respectively. The variance in operating cash flows for the first three months of 2005 is an increase in other assets of $2,283,000 primarily related to accounts receivable associated with corporate bonds that had been sold but have not settled as of March 31, 2005. Net cash used in investing activities through March 31, 2005 and 2004 was $21,918,000 and $48,871,000, respectively. Investment purchases nearly offset the bond sales and maturities in the portfolio for the first quarter of 2005. The decrease in net cash used in investing activity was primarily due to lower bond purchases as a significant level of bond purchases occurred in the first quarter of 2004 as federal fund sold balances were reduced. Net cash provided by financing activities for March 31, 2005 and 2004 totaled $25,963,000 and $39,426,000, respectively. A higher level of deposits is the largest source of financing cash flows for the three months ended March 31, 2005 but was lower than the deposit increase recorded in 2004. As of March 31, 2005, the Company did not have any external debt financing, off balance sheet financing arrangements, or derivative instruments linked to its stock. 17 Company Only Cash Flows The Company's liquidity on an unconsolidated basis is heavily dependent upon dividends paid to the Company by the Banks. The Company requires adequate liquidity to pay its expenses and pay stockholder dividends. For the quarter ended March 31, 2005, dividends paid by the Banks to the Company amounted to $2,146,000 compared to $2,096,000 for the same period in 2004. In 2004, dividends paid by the Banks to the Company amounted to $8,384,000 through December 31, 2004 compared to $7,868,000 for the year ended December 31, 2003. Various federal and state statutory provisions limit the amount of dividends banking subsidiaries are permitted to pay to their holding companies without regulatory approval. Federal Reserve policy further limits the circumstances under which bank holding companies may declare dividends. For example, a bank holding company should not continue its existing rate of cash dividends on its common stock unless its net income is sufficient to fully fund each dividend and its prospective rate of earnings retention appears consistent with its capital needs, asset quality and overall financial condition. In addition, the Federal Reserve and the FDIC have issued policy statements which provide that insured banks and bank holding companies should generally pay dividends only out of current operating earnings. Federal and state banking regulators may also restrict the payment of dividends by order. The Company has unconsolidated interest bearing deposits and marketable investment securities totaling $33,706,000 that are presently available to provide additional liquidity to the Banks. Review of Commitments for Capital Expenditures, Cash Flow Uncertainties and Known Trends in Liquidity and Cash Flows Needs No material capital expenditures or material changes in the capital resource mix are anticipated at this time. The primary cash flow uncertainty would be a sudden decline in deposits causing the Banks to liquidate securities. Historically, the Banks have maintained an adequate level of short term marketable investments to fund the temporary declines in deposit balances. There are no known trends in liquidity and cash flows needs as of March 31, 2005 that is a concern to management. Capital Resources The Company's total stockholders' equity decreased to $107,585,000 as of March 31, 2005, from $110,924,000 at December 31, 2004. The decrease in equity is primarily attributable to a decline in capital accounts relating to lower net unrealized gains on the market value of the Company and Banks' investment portfolios. At March 31, 2005 and December 31, 2004, stockholders' equity as a percentage of total assets was 12.46% and 13.21%, respectively. The capital levels of the Company currently exceed applicable regulatory guidelines as of March 31, 2005. 18 Forward-Looking Statements and Business Risks The discussion in the foregoing Management Discussion and Analysis and elsewhere in this Report contains forward-looking statements about the Company, its business and its prospects. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include use of the words "believe", "expect", "anticipate", "intend", "plan", "estimate" or words of similar meaning, or future or conditional verbs such as "will", "would", "should", "could" or "may". Forward-looking statements, by their nature, are subject to risks and uncertainties. A number of factors, many of which are beyond the Company's control, could cause actual conditions, events or results to differ significantly from those described in the forward-looking statements. Such risks and uncertainties with respect to the Company include, but are not limited to, those related to the economic conditions, particularly in the areas in which the Company and the Banks operate, competitive products and pricing, fiscal and monetary policies of the U.S. government, changes in governmental regulations affecting financial institutions (including regulatory fees and capital requirements), changes in prevailing interest rates, credit risk management and asset/liability management, the financial and securities markets and the availability of and costs associated with sources of liquidity. These factors may not constitute all factors that could cause actual results to differ materially from those discussed in any forward-looking statement. The Company operates in a continually changing business environment and new facts emerge from time to time. It cannot predict such factors nor can it assess the impact, if any, of such factors on its financial position or its results of operations. Accordingly, forward-looking statements should not be relied upon as a predictor of actual results. The Company disclaims any responsibility to update any forward-looking statement provided in this document. Item 3. Quantitative and Qualitative Disclosures About Market Risk The Company's market risk is comprised primarily of interest rate risk arising from its core banking activities of lending and deposit taking. Interest rate risk results from the changes in market interest rates which may adversely affect the Company's net interest income. Management continually develops and applies strategies to mitigate this risk. Management does not believe that the Company's primary market risk exposure and how it has been managed to-date in 2005 changed significantly when compared to 2004. Item 4. Controls and Procedures The principal executive officer and principal financial officer of the Company have evaluated the effectiveness of the Company's disclosure controls and procedures (as such terms are defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period covered by this annual report (the "Evaluation Date"). Based on such evaluation, such officers have concluded that, as of the Evaluation Date, the Company's disclosure controls and procedures are effective in bringing to their attention on a timely basis material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's periodic filings under the Exchange Act. Changes in Internal Controls There was no change in the Company's internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) of the Exchange Act that occurred during the Company's last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. 19 PART II. OTHER INFORMATION Item 1. Legal Proceedings Not applicable Item 2. Unregistered Sales of Equity Securities and Use of Proceeds Not applicable Item 3. Defaults Upon Senior Securities Not applicable Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information None Item 6. Exhibits (a) Exhibits 31.1 Certification of Principal Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002. 31.2 Certification of Principal Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002. 32.1 Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350. 32.2 Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350. 20 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. AMES NATIONAL CORPORATION DATE: May 3, 2005 By: /s/ Daniel L. Krieger --------------------------- Daniel L. Krieger, President Principal Executive Officer By: /s/ John P. Nelson --------------------------- John P. Nelson, Vice President Principal Financial Officer 21