HILLS BANCORPORATION
FORM 10-K
DECEMBER 31, 1997
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, 1997. Commission File Number 0-12668.
HILLS BANCORPORATION
------------------------------------------------------
(Exact name of Registrant as specified in its charter)
Iowa 42-1208067
- ------------------------------- ---------------------------------
(State or Other Jurisdiction of (IRS Employer Identification No.)
Incorporation or Organization)
131 Main Street, Hills, Iowa 52235
----------------------------------------
(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
-------------------------
Title of Class
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Registrant S-K (229.405 of this chapter) is not contained herein, and will
not be contained to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [X]
While it is difficult to determine the market value of shares owned by
nonaffiliates (within the meaning of such term under the applicable regulations
of the Securities and Exchange Commission), the Registrant estimates that the
aggregate market value of the Registrant's common stock held by nonaffiliates on
March 13, 1998 (based upon reports of beneficial ownership that approximately
81% 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 $48 per share) was $57,066,000.
The number of shares outstanding of the Registrant's common stock as of March
13, 1998 is 1,467,754 shares of no par value common stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement dated March 23, 1998, for the Annual Meeting of
the Shareholders of the Registrant to be held April 20, 1998 (the Proxy
Statement) are incorporated by reference in Part III of this Form 10-K.
EXHIBIT INDEX
The exhibits index is on Page .
PART I
Item 1. Business
Hills Bancorporation (the "Company") is a multi-bank holding company principally
engaged in the business of banking. Its three wholly-owned subsidiary banks are
Hills Bank and Trust Company, Hills, Iowa ("Hills Bank and Trust"); Hills Bank
(formerly Lisbon Bank and Trust Company), Lisbon, Iowa ("Hills Bank Lisbon");
and Hills Bank Kalona, Kalona, Iowa ("Hills Bank Kalona") (hereinafter referred
to as the "Banks").
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 as of January 23, 1984 when stockholders
of the Bank exchanged their shares for shares of the Company. Effective July 1,
1996, the Company acquired for cash all of the outstanding shares of LBC, Inc.,
which owned 100% of the outstanding shares of Alliance Bancorporation, which
held 100% of the outstanding shares of Hills Bank Lisbon, Lisbon, Iowa. The
Company chartered a new subsidiary bank, Hills Bank Kalona, and on September 20,
1996, the subsidiary bank acquired cash, certain assets and assumed the deposits
of the Kalona, Iowa office of Boatmen's Bank Iowa, N.A.
The Banks are all full-service commercial banks extending their services to
individuals, business, governmental units, and institutional customers primarily
in the communities of Hills, Iowa City, Coralville, North Liberty, Lisbon, Mount
Vernon and Kalona and the surrounding area. This area includes parts of Johnson,
Linn, and Washington counties. All of the Banks are 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
Hills Bank and Trust Company's trust department administers estates, personal
trusts, and pension and profit-sharing funds and, in connection therewith,
provides for farm management and investment advisory and custodial services for
individuals, corporations and nonprofit organizations. At this time, trust
services are available only at the Hills Bank and Trust Company's locations. The
loan activity of the Banks is diversified, with commercial and agricultural
loans, real estate loans, automobile, installment, and other consumer loans
composing the majority of its loan portfolio. In addition, the Banks earn
substantial fees from originating mortgages that are sold in the secondary
residential real estate market without mortgage servicing rights being
maintained.
Each Bank has established formal loan origination policies. In general, the loan
origination policies require individual lenders to reduce the risk of credit
loss to the Bank by requiring that, among other things, minimum loan to value
ratios be maintained, evidence of appropriate levels of insurance be carried by
borrowers and documenting appropriate types and amounts of collateral and
sources of expected payment.
The Banks' business is not seasonal, except that loan origination fees are
higher during the spring and summer months. The Banks have not undertaken
significant new services during the current year that might exceed the limits of
their human resources and data processing capabilities.
Iowa City, Coralville, Hills and North Liberty are located near Interstate 80
and Interstate 380 in Eastern Iowa. The communities have a population of
approximately 80,000 and Johnson County, Iowa has a population of approximately
96,000. The University of Iowa has over 27,000 students and 15,000 employees,
including employees of The University of Iowa Hospitals and Clinics. Johnson
County, Iowa has one of the strongest economies in Iowa and has had substantial
economic growth in the past ten years. The area is known for its educational
institutions, health care facilities, cultural and sports events, and retail
centers.
Hills Bank Lisbon is located in Lisbon, Iowa (Linn County), approximately 25
miles north of Iowa City and does not conduct business in the same trade
territories as Hills Bank and Trust Company. Lisbon has a population of
approximately 1,500 and Mount Vernon, located two miles away, has 3,700 people.
In February 1998 Hills Bank opened a new office location in Mount Vernon, Iowa.
The 4,200 square foot one-story full-service location in Mount Vernon has four
drive-up lanes and a drive-up automatic teller machine. Both communities are
strong economically and are easy commuting distances to Cedar Rapids and Iowa
City, Iowa. In addition, Mount Vernon is the home of Cornell College, which has
approximately 1,200 students.
Hills Bank Kalona is located in Kalona, Iowa (Washington County), approximately
20 miles south of Iowa City with a population of approximately 2,000 people.
Kalona is primarily an agriculture community, but is located within easy driving
distance for employment in Iowa City and Washington, Iowa.
The commercial banking business is highly competitive and the Company's banks
compete with other commercial banks, credit unions, brokerage firms, finance
companies, insurance companies, and other financial institutions.
Iowa's banking laws regarding interstate banking and interstate branching are
currently more restrictive than many other states. As a result of the enactment
of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 many
of the state-imposed geographic limitations on bank ownership have been
liberalized. The 1994 Act expanded opportunities for interstate banking,
interstate mergers, and interstate branching in the United States. First,
subject to certain limitations, bank holding companies from anywhere in the
United States are able to acquire Iowa banks with the permission of the Federal
Reserve Board. Second, the 1994 Act authorizes a national or state bank which
has its main office in another state to merger with an Iowa bank and operate the
Iowa location as a branch office. However, out-of-state bank holding companies
cannot acquire Iowa commercial banks unless such banks have been in existence
for at least five years. Hills Bank Kalona has been in existence only since
September 20, 1996. Iowa also currently has a deposit concentration limit of 10%
on the amount of deposits that any one banking organization can control and
continue to acquire banks, which applies to both in-state and out-of-state
banks. Iowa also has a 35% limit on the aggregate amount of deposits all
out-of-state banking organizations can control within Iowa.
In recent years, Norwest Corporation, Mercantile Bancorporation, Firstar
Corporation and Nations Bank have acquired a number of independent banks and
smaller multi-bank holding companies in various metropolitan areas of Iowa. Each
operates under a single charter in Iowa. To date none of the Bank's local
competitors have been purchased by the larger regional or national bank holding
companies.
As with its law regarding interstate banking and branching, Iowa's intrastate
branching statutes are also rather restrictive when compared with those of other
states. Generally, bank branch offices may only be operated or acquired in
counties contiguous to or cornering upon the county in which the Bank has its
principal place of business. Also, a bank in Iowa may not establish a new branch
office in a city in which there exists an office of another bank, other than by
acquisition of an existing office or bank. Furthermore, the number of bank
branch offices allowed within a municipal corporation or an urban complex is
limited to four offices in populations of 100,000 or less, five offices in
populations of over 100,000 to 200,000, and six offices in areas with
populations over 200,000. However, some of Iowa's intrastate branching
limitations regarding geographic location of branch offices and the number of
branch offices which may be established in an urban complex may be overcome by
merging two or more affiliated banking organizations that have been in
continuous operation in Iowa for at least five years into a "united community
bank."
Iowa law permits the acquisition of an Iowa bank holding company or state bank
by an out-of-state bank holding company located anywhere in the United States.
Certain restrictions relating to deposit concentrations and requirements of
operations have also been established for out-of-state bank holding companies by
the Iowa Legislature. The state law prohibits de novo entry and the acquisition
of individual branch offices by out-of-state bank holding companies. No state
bank may be directly or indirectly acquired by an out-of-state bank holding
company that has not been in continuous existence and operation for at least
five years.
Hills Bank and Trust Company is in direct competition for deposits, loans and
other financial related business with other financial institutions in Johnson
County, Iowa as follows:
Approximate
Assets As Of
December 31,
1997
-------------
(In Millions)
Largest competing bank (includes assets in out-of-territory
branches) $550
Next largest competing bank 331
Largest competing credit union 152
Hills Bank Kalona and Hills Bank Lisbon compete with other banks in their trade
territories. Based upon deposits, their market share compared to the other local
banks was approximately 35% and 28%, respectively.
No material portion of the Banks' deposits have been obtained from a single
person or a few persons. Accordingly, management of the Banks have no reason to
believe that the loss of the deposits of any person or few persons would have a
materially adverse effect on the Banks' operations or erode its deposit base.
Approximately 6.4% of the Banks' loans have been made to farmers for
agricultural purposes. The agricultural sector of the economy has been cyclical
with a general trend toward fewer and larger farms. The Banks have not
experienced a material adverse effect on their business as a result of defaults
on agricultural loans and expects none in the future.
The Company does not engage in any business activities apart from its ownership
of the Banks and, therefore, does not encounter any competition for its services
other than as described above for the Banks.
As the Year 2000 approaches, an important business issue has emerged regarding
how existing application software and operating systems can accommodate this
date value. Many existing application software products were developed to
accommodate a two-digit year. Due to the nature of the banking industry, the
subsidiary banks are heavily reliant on data processing, causing the "Year 2000"
issue to be a critical issue for the Company. Technology experts believe that
many data processing application systems could fail or improperly perform as a
result of erroneous calculation or data integrity problems if they are unable to
process date information beyond December 31, 1999. The subsidiary banks have
responded to this issue by forming a Year 2000 steering committee. The committee
is responsible for identifying date sensitive financial applications, obtaining
certification and validation related to outside systems, and developing a
testing plan for in-house and outside systems in order to insure Year 2000
compliance. Because substantially all the Company's critical data processing
equipment and applications are licensed or purchased from outside vendors, it is
critical for the Company to assess whether its equipment and applications are
Year 2000 compliant, and to replace any items that are not compliant. In this
regard, the Company has planned to convert to a new financial accounting system
that the Company and the vendor believe to be Year 2000 compliant and to test
other critical applications. Subject to the identification of material
noncompliance by its outside vendors, the Company currently believes that it
will be Year 2000 compliant on a timely basis and thereby meet regulatory
requirements concerning the Year 2000 issue and avoid material operational
disruptions. In the immediate future, the Company will be completing a number of
steps in its Year 2000 compliance program. These steps include completion of a
Year 2000 project budget, implementation of customer contacts using notices and
questionnaires, preparing a draft assessment report, obtaining an analysis of
legal and insurance issues, planning for implementation of improved systems, and
developing preliminary testing strategies and audit plans. Although the Company
currently does not expect that its expenditures to become Year 2000 compliant
will have a material effect on its operations, there can be no assurance that
operational difficulties relating to the Year 2000 issue will not be experienced
in the future or that more material expenditures will not be required in the
future to fully resolve the Year 2000 issue.
The Company and the Banks have undertaken no material research activities during
the last three years relating to research and development activities.
The Company is regulated by the Federal Reserve Bank.
All the Banks are regulated by the Federal Deposit Insurance Corporation and the
State of Iowa Division of Banking.
The Company had no employees as of December 31, 1997, and the Banks had 191
regular and 63 part-time employees.
The following consolidated statistical information reflects selected balances
and operations of the Company and the Banks for the periods indicated. Average
refers to an average daily basis for the periods stated.
The following tables show (1) average balances of assets and liabilities, (2)
interest income and expense on a tax equivalent basis, (3) interest rates and
differential and (4) changes in interest income and expense.
AVERAGE BALANCES
(Average Daily Basis)
Year Ended December 31,
----------------------------
1997 1996 1995
----------------------------
(In Thousands)
ASSETS
Cash and due from banks ..................................................... $ 12,689 $ 9,987 $ 9,795
Taxable securities .......................................................... 110,542 107,106 95,747
Nontaxable securities ....................................................... 25,184 22,291 19,528
Federal funds sold .......................................................... 3,032 9,159 8,980
Loans, net .................................................................. 397,787 337,630 311,592
Property and equipment, net ................................................. 8,603 7,516 6,685
Other assets ................................................................ 14,829 11,091 7,484
----------------------------
$572,666 $504,780 $459,811
============================
LIABILITIES AND STOCKHOLDERS' EQUITY
Noninterest-bearing demand deposits ......................................... $ 48,330 $ 39,929 $ 36,085
Interest-bearing demand deposits ............................................ 43,262 37,310 37,249
Savings deposits ............................................................ 119,282 102,849 74,146
Time deposits ............................................................... 250,241 234,825 226,251
Securities sold under agreements to repurchase
and federal funds purchased .............................................. 8,740 7,607 9,424
FHLB borrowings ............................................................. 43,026 28,914 28,965
Other liabilities ........................................................... 4,255 3,509 2,978
Redeemable common stock held by
Employee Stock Ownership Plan ............................................ 7,049 5,844 5,241
Stockholders' equity ........................................................ 48,481 43,993 39,472
----------------------------
$572,666 $504,780 $459,811
============================
INTEREST INCOME AND EXPENSE
Year Ended December 31,
-------------------------
1997 1996 1995
-------------------------
(In Thousands)
Income:
Loans (1) .................................... $34,814 $29,966 $27,506
Taxable securities ........................... 6,769 6,190 5,189
Nontaxable securities (1) .................... 1,845 1,692 1,567
Federal funds sold ........................... 158 485 519
-------------------------
Total interest income ............. 43,586 38,333 34,781
-------------------------
Expense:
Interest-bearing demand deposits ............. 949 819 894
Savings deposits ............................. 4,183 3,668 2,618
Time deposits ................................ 14,162 13,275 12,673
Securities sold under agreements to repurchase 426 326 409
FHLB borrowings .............................. 2,782 1,863 1,874
-------------------------
Total interest expense ............ 22,502 19,951 18,468
-------------------------
Net interest income ............... $21,084 $18,382 $16,313
=========================
(1) Presented on a tax equivalent basis using a federal tax rate of 34%.
INTEREST RATES AND INTEREST DIFFERENTIAL
Year Ended
December 31,
---------------------
1997 1996 1995
---------------------
Average yields:
Taxable securities .................................. 6.12% 5.78% 5.42%
Nontaxable securities ............................... 4.84 5.01 5.29
Nontaxable securities (tax equivalent basis) ........ 7.33 7.59 8.02
Loans (1) ........................................... 8.70 8.80 8.74
Loans (tax equivalent basis) ........................ 8.75 8.87 8.83
Federal funds sold .................................. 5.21 5.30 5.78
Interest-bearing demand deposits .................... 2.19 2.20 2.40
Savings deposits .................................... 3.51 3.57 3.53
Time deposits ....................................... 5.66 5.65 5.60
Securities sold under agreements to repurchase ...... 4.87 4.29 4.34
Interest on FHLB borrowings ......................... 6.47 6.44 6.47
Yield on average interest earning assets ............ 8.12 8.05 7.98
Rate on average interest-bearing liabilities ........ 4.84 4.85 4.91
Net interest spread (2) ............................. 3.28 3.20 3.07
Net interest margin (3) ............................. 3.93 3.86 3.74
(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.
CHANGE IN INTEREST INCOME AND EXPENSE
Change Due Change Due Total
-----------------------------
To Volume To Rates Change
-----------------------------
(In Thousands)
Year ended December 31, 1997: Change in interest income:
Loans ............................................ $ 5,259 $ (411) $ 4,848
Taxable securities ............................... 204 375 579
Nontaxable securities ............................ 213 (60) 153
Federal funds sold ............................... (319) (8) (327)
---------------------------
5,357 (104) 5,253
---------------------------
Change in interest expense:
Interest-bearing demand deposits ................. 134 (4) 130
Savings deposits ................................. 578 (63) 515
Time deposits .................................... 864 23 887
Securities sold under agreements to repurchase ... 52 48 100
Interest on FHLB borrowings ...................... 910 9 919
---------------------------
2,538 13 2,551
---------------------------
Change in net interest income ....................... $ 2,819 $ (117) $ 2,702
===========================
Year ended December 31, 1996: Change in interest income:
Loans ............................................ $ 2,334 $ 126 $ 2,460
Taxable securities ............................... 642 359 1,001
Nontaxable securities ............................ 212 (87) 125
Federal funds sold ............................... 10 (44) (34)
---------------------------
3,198 354 3,552
---------------------------
Change in interest expense:
Interest-bearing demand deposits ................. 1 (76) (75)
Savings deposits ................................. 1,020 30 1,050
Time deposits .................................... 487 115 602
Securities sold under agreements to repurchase ... (78) (5) (83)
Interest on FHLB borrowings ...................... (3) (8) (11)
---------------------------
1,427 56 1,483
--------------------------
Change in net interest income ....................... $ 1,771 $ 298 $ 2,069
==========================
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 reserve
for loan losses) as of December 31 for each of the last five years.
December 31,
------------------------------------------------
1997 1996 1995 1994 1993
------------------------------------------------
(In Thousands)
Agricultural ............ $ 27,636 $ 23,133 $ 19,000 $ 17,826 $ 17,117
Commercial and financial 33,616 30,650 26,810 26,024 24,721
Real estate, construction 8,157 8,846 7,937 6,933 7,006
Real estate, mortgage ... 332,655 279,134 239,899 225,342 195,527
Loans to individuals .... 28,707 33,812 31,640 30,906 24,380
------------------------------------------------
Total ..... $430,771 $375,575 $325,286 $307,031 $268,751
================================================
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,
1997:
Amount One Year One To Over
Of Loans or Less(1) Five Years Five Years
-------------------------------------------
(In Thousands)
Commercial, financial and agricultural ........................ $ 61,252 $ 32,834 $ 18,927 $ 9,491
Real estate, construction and mortgage ........................ 340,812 65,010 147,710 128,092
Other ......................................................... 28,707 6,572 20,884 1,251
----------------------------------------
$430,771 $104,416 $187,521 $138,834
========================================
Interest rates on loans are as follows:
Fixed rate ................................................. $280,951 $ 80,361 $175,570 $ 25,020
Variable rate .............................................. 149,820 24,055 11,951 113,814
----------------------------------------
$430,771 $104,416 $187,521 $138,834
========================================
<FN>
(1) A significant portion of the commercial loans are six-month notes. However,
a significant amount of these notes are renewed when due.
</FN>
NONACCRUAL, PAST DUE AND RESTRUCTURED LOANS
The following table summarizes the Company's nonaccrual, past due, restructured
and impaired loans as to interest or principal payment as of December 31 for
each of the years presented:
1997 1996 1995 1994 1993
------------------------------------------
(In Thousands)
Nonaccrual loans ................... $ - - $ 339 $ 489 $ -- $ --
Accruing loans past due 90 days
or more ......................... 954 1,092 417 822 1,064
Restructured loans ................. - - - - - - - - - -
Impaired loans ..................... 9,556 7,811 5,465 N/A N/A
The Company does not have a significant amount of loans which 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 nonaccrual 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.
No allowance for losses has been recognized for impaired loans because the loans
have been charged off to the net present value of the future cash flows or the
fair value of the collateral if the loan is collateral dependent.
SUMMARY OF LOAN LOSS EXPERIENCE
The following table summarizes the Company's loan loss experience for each of
the last five years:
Year Ended
December 31,
------------------------------------------
1997 1996 1995 1994 1993
------------------------------------------
(In Thousands)
Amount of loan loss allowance at
beginning of year ............... $7,311 $6,740 $6,210 $5,775 $5,190
------------------------------------------
Charge-offs:
Agriculture ..................... 197 300 101 423 270
Commercial and financial ........ 326 236 387 334 326
Real estate, mortgage ........... 215 127 180 172 165
Loans to individuals ............ 390 308 254 131 300
------------------------------------------
1,128 971 922 1,060 1,061
------------------------------------------
Recoveries:
Agriculture ..................... 65 48 218 368 247
Commercial and financial ........ 195 95 226 206 213
Real estate, mortgage ........... 377 215 149 154 87
Loans to individuals ............ 142 80 137 126 178
------------------------------------------
779 438 730 854 725
------------------------------------------
Net charge-offs .................... 349 533 192 206 336
------------------------------------------
Allowances of acquired banks ....... - - 350 - - - - - -
------------------------------------------
Provision for loan losses (1) ...... 1,048 754 722 641 921
------------------------------------------
Balance of loan loss allowance
at end of year .................. $8,010 $7,311 $6,740 $6,210 $5,775
==========================================
Ratio of net charge-offs during year
to average loans outstanding .... 0.09% 0.16% 0.06% 0.07% 0.13%
==========================================
The balance of the loan loss allowance has not been allocated by type of loan.
Management regularly reviews the loan portfolio and does not expect any unusual
material amount to be charged off during 1998 that would be significantly
different than the years ended December 31, 1997, 1996, 1995, 1994 and 1993.
(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 borrower's ability to repay, past collection
experience, the risk characteristics of the loan portfolio and such other
factors which deserve current recognition. For income tax purposes, the
allowance is maintained at the maximum allowable amount.
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
The Banks review and place in risk categories specific borrowings. Based upon
the risk category assigned, the Banks allocate a percentage, as determined by
management, for a required allowance needed. The risk categories are similar to
those used by federal and state regulatory agencies and consist of the
following:
(1) Potential Watch and Watch
(2) Problem
(3) Substandard
(4) Doubtful
In addition, each bank's management also reviews and, where determined
necessary, allows for specific allowances based upon reviews of specific
borrowers and provides general allowances for areas which management believes
are of higher credit risk (agricultural loans and constructed model real estate
homes as of December 31, 1997).
A summary of the components of the allowance for loan loss, by risk element, as
of December 31, 1997 and 1996 is as follows:
1997 1996
-----------------
(In Thousands)
Potential Watch and Watch Loans ............... $2,600 $1,769
Substandard ................................... 1,507 1,337
Specific borrowers ............................ 1,550 2,009
Constructed model real estate homes ........... 682 858
Agricultural loans ............................ 250 250
Anticipated charge-offs of the above categories are not determinable at December
31, 1997; however, the Banks have no reason to expect actual charge-offs to be
significantly different from historical charge-offs.
INVESTMENT SECURITIES
The following tables show the carrying value of the investment securities as of
December 31, 1997, 1996 and 1995 and the maturities and yield of the investment
securities as of December 31, 1997:
December 31,
----------------------------
1997 1996 1995
----------------------------
(In Thousands)
Carrying value:
U. S. Treasury securities .................................................. $ 40,189 $ 45,213 $ 41,275
Obligations of other U. S. Government agencies and corporations ............ 65,445 57,397 55,537
Obligations of states and political subdivisions ........................... 27,692 23,447 21,443
Other ...................................................................... - - 3,180 - -
----------------------------
$133,326 $129,237 $118,255
============================
December 31, 1997
--------------------------
Weighted
Carrying Average
Value Yield
--------------------------
(In Thousands)
Type and maturity grouping:
U. S. Treasury maturities:
Within 1 year ........................................................... $ 6,996 6.21%
From 1 to 5 years ....................................................... 33,193 6.18
--------
40,189
--------
Obligations of other U. S. Government agencies and corporations, maturities:
Within 1 year ........................................................... 17,313 6.02%
From 1 to 5 years ....................................................... 47,728 6.21
From 5 to 10 years ...................................................... 404 7.19
--------
65,445
--------
Obligations of states and political subdivisions, maturities:
Within 1 year ........................................................... 3,095 7.92%
From 1 to 5 years ....................................................... 15,144 7.10
From 5 to 10 years ...................................................... 9,318 7.10
Over 10 years ........................................................... 135 8.08
--------
27,692
--------
Total ........................................................... $133,326
========
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%.
As of December 31, 1997, there were no investment securities of any issuer,
other than securities of the U. S. Government and U. S. Government agencies and
corporations, exceeding 10% of stockholders' equity.
The weighted average yield is based on the amortized cost of the investment
securities.
DEPOSITS
The following tables show the average deposits and rates paid on such deposits
for the years ended December 31, 1997, 1996 and 1995 and the composition of the
certificates issued in excess of $100,000 as of December 31, 1997:
December 31,
-------------------------------------------------------------
1997 Rate 1996 Rate 1995 Rate
-------------------------------------------------------------
Average noninterest-bearing deposit $ 48,330 0.00% $ 39,929 0.00%$ $ 36,085 0.00%
Average interest-bearing demand
deposits ....................... 43,262 2.19 37,310 2.20 37,249 2.40
Average savings deposits .......... 119,282 3.51 102,849 3.57 74,146 3.53
Average time deposits ............. 250,241 5.66 234,825 5.65 226,251 5.60
-------- -------- --------
$461,115 $414,913 $373,731
======== ======== ========
Time certificates issued in amounts
of $100,000 or more as of
December 31, 1997 with Amount Rate
------------------------
maturity in:
3 months or less $ 9,200 6.03%
3 through 6 months 7,950 5.14
6 through 12 months 13,727 5.64
Over 12 months 7,497 6.22
--------------
$ 38,374
==============
RETURN ON STOCKHOLDERS' EQUITY AND ASSETS
The following table presents the return on average stockholders' equity and
average assets for the years ended December 31, 1997, 1996 and 1995:
December 31,
------------------------------
1997 1996 1995
------------------------------
Return on assets ........................... 1.24% 1.22% 1.14%
Return on stockholders' equity ............. 14.62 13.97 13.32
Dividend payout ratio ...................... 21.69 22.62 24.12
Stockholders' equity to assets ratio ....... 8.47 8.72 8.58
SHORT-TERM BORROWINGS
The following table shows outstanding balances, weighted average interest rates
at year end, maximum month-end balances, average month-end balances and weighted
average interest rates of federal funds purchased and securities sold under
agreements to repurchase during 1997, 1996 and 1995:
1997 1996 1995
---------------------------
(Amounts In Thousands)
Outstanding as of December 31 ............. $ 9,008 $6,071 $10,019
Weighted average interest rate at year end 4.30% 4.31% 4.25%
Maximum month-end balance ................. 16,104 9,112 12,028
Average month-end balance ................. 8,740 7,607 9,424
Weighted average interest rate for the year 4.87% 4.29% 4.34%
FEDERAL HOME LOAN BANK BORROWINGS
The following table shows outstanding month-end balances, weighted average
interest rates at year end, maximum month-end balances, average balances and
weighted average interest rates during 1997, 1996 and 1995:
1997 1996 1995
---------------------------------
Outstanding as of December 31 ............. $50,764 $25,795 $30,727
Weighted average interest rate at year end 6.42% 6.42% 6.29%
Maximum month-end balance ................. 50,764 30,826 35,758
Average month-end balance ................. 43,026 28,914 28,965
Weighted average interest rate for the year 6.47% 6.44% 6.47%
PART I
Item 2. Properties
The Company's office and the main bank of Hills Bank and Trust Company is
located at 131 Main Street, Hills, Iowa. The Hills office is a brick building
containing approximately 14,200 square feet, a portion of which was built in
1977 and remodeled in 1986. A two-story addition was completed in 1984.
The branch offices of Hills Bank and Trust Company are as follows:
1. Iowa City office located at 1401 South Gilbert Street is a one-story brick
building containing approximately 11,400 square feet. The branch has five
drive-up teller lanes and a drive-up 24-hour automatic teller machine. The
Bank's trust department is located here.
2. Coralville office is a two-story building built in 1972 that contains
approximately 16,700 square feet of space. This office is equipped with
four drive-up teller lanes and one 24-hour automatic teller machine.
3. A 2,800 square foot renovated and expanded building in North Liberty, Iowa
was opened for business in 1986. That office is a full-service location
including three drive-up teller lanes and a drive-up automatic teller
machine.
4. The Bank leases an office at 132 East Washington Street in downtown Iowa
City with approximately 2,500 square feet. The office has two 24-hour
automatic teller machines and two private offices in addition to a tellers'
and customer service area. The Bank has options to renew the lease in 2001.
The main office of Hills Bank Lisbon is a two-story brick building in Lisbon,
Iowa with approximately 3,000 square feet of banking retail space located on the
first floor. The building was extensively remodeled in 1996 and has one drive-up
lane and a walk-up 24-hour automatic teller machine. Hills Bank Lisbon added its
first office location in Mount Vernon, Iowa in February 1998 with the completion
of a full service, 4,200 square foot office, with four drive-up lanes and a
drive-up automatic teller machine.
Hills Bank Kalona in Kalona 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 has been remodeled a number of times.
All of the above properties, with the exception of the East Washington Street
branch which is being leased, are owned by the Bank, 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 Banks hold any properties which 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, 1997.
PART II
Item 5. Market for the Registrant's Common Stock and Related Security Holder
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.
During 1997, the Company's stock transfer records reflect that 7,314 shares were
traded in a total of 12 transactions. While the Company has no direct knowledge
of the selling price for these shares, based upon information informally related
by shareholders, it believes that in 1997 the range of selling price of shares
was $40.00 to $48.00 per share. During 1996, 5,716 shares were traded in a total
of 29 transactions. The 1996 price of these shares was believed to be in the
$33.34 to $40.00 range. In 1995, 5,322 shares were traded in 15 transactions. As
of December 31, 1997, the Company has 1,035 shareholders.
The Company paid aggregate annual cash dividends in 1997 and 1996 of $1,537,000
and $1,391,000, respectively, or $1.05 per share in 1997 and $.95 per share in
1996. In January 1998, the Company declared and paid a dividend of $1.20 per
share totaling $1,761,000. 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 Banks, and the future
earnings, capital requirements and financial condition of the Company.
PART II
Item 6. Selected Financial Data
CONSOLIDATED FIVE-YEAR STATISTICAL SUMMARY
1997 1996 1995 1994 1993
------------------------------------------------------------
YEAR-END TOTALS
Total assets .................... $603,102 $539,452 $484,607 $444,912 $417,043
Investment securities ........... 138,064 132,635 121,536 110,050 126,894
Federal funds sold .............. 2,447 1,107 16,080 7,500 3,768
Loans, net ...................... 422,761 368,264 318,546 300,821 262,976
Deposits ........................ 479,770 450,061 392,257 372,838 353,486
Federal Home Loan Bank notes .... 50,764 25,795 30,727 20,758 15,790
Redeemable common stock ......... 7,682 6,416 5,271 5,210 4,616
Stockholders' equity ............ 51,500 47,335 43,277 36,447 35,943
EARNINGS
Interest income ................. $ 42,743 $ 37,516 $ 33,978 $ 29,583 $ 29,031
Interest expense ................ 22,502 19,951 18,468 14,834 15,520
Provision for loan losses ....... 1,048 754 722 641 921
Other income .................... 5,938 3,868 3,438 3,311 4,181
Other expenses .................. 15,500 12,057 10,975 10,640 10,299
Applicable income taxes ......... 2,545 2,478 1,994 1,845 1,799
Net income ...................... 7,086 6,144 5,257 4,934 4,673
PER SHARE Net income:
Basic ........................ $ 4.83 $ 4.19 $ 3.59 $ 3.37 $ 3.20
Diluted ...................... 4.78 4.15 3.57 3.36 3.20
Cash dividends .................. 1.05 0.95 0.87 0.80 0.73
Book value as of December 31 .... 35.08 32.30 29.57 24.91 24.57
Increase (decrease) in book value
due to:
ESOP obligation and debt ..... (5.23) (4.38) (3.60) (3.56) (3.29)
Unrealized gains (losses) on
debt securities ............ 0.33 0.46 0.20 (1.77) 0.19
SELECTED RATIOS
Return on average assets ........ 1.24% 1.22% 1.14% 1.15% 1.16%
Return on average equity ........ 14.62 13.97 13.32 13.62 13.91
Net interest margin ............. 3.93 3.86 3.74 3.85 3.73
Average stockholders' equity to
average total assets ......... 8.47 8.72 8.58 8.47 8.32
Dividend payout ratio ........... 21.69 22.62 24.12 23.83 22.92
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 banks.
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 reserve 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 which 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 of
an individual borrower, or may be caused by negative economic circumstances at
the local, regional, national or international level which 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.
All of these uncertainties, as well as others, are present in the operation of a
financial institution, and stockholders are cautioned that management's view of
the future, which serves as the basis for both the ongoing operation of the
Company and the forward looking statements included in this report, may prove to
be other than anticipated.
Financial Position
Year End Amounts (In Thousands) 1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------
Loans, net of allowance for losses $422,761 $368,264 $318,546 $300,821 $262,976
Investment securities ............ 138,064 132,635 121,536 110,050 126,894
Deposits ......................... 479,770 450,061 392,257 372,838 353,486
Federal Home Loan Bank notes ..... 50,764 25,795 30,727 20,758 15,790
Stockholders' equity ............. 51,500 47,335 43,277 36,447 35,943
Total assets ..................... 603,102 539,452 484,607 444,912 417,043
In 1997, net loans increased $54.5 million, primarily in real estate mortgage
loans, as demand remains high and rates continue to be attractive.
Total assets increased 11.80% in 1997, compared to an increase of 11.32% in
1996. In 1997 net loans increased $54.5 million, primarily in real estate
mortgage loans, as demand remained high and rates continued to be attractive.
The growth in assets in 1996 was attributable to strong loan demand and the
acquisition of approximately $39 million of investment securities, federal funds
sold and loans acquired in two purchase business transactions that occurred in
the third quarter. Approximately 42% of the total loan growth in 1996 was
attributable to the purchase business transactions.
Deposits increased 6.60% in 1997 compared to an increase of 14.74% in 1996.
Federal Home Loan Bank note borrowings in 1997 increased by a net $25.0 million
and the advances were used to fund the loan growth. Of the $57.8 million
increase in deposits in 1996, approximately $39 million was deposits acquired in
the purchases.
Components of Diluted Earnings Per Share
1997 1996 1995
- --------------------------------------------------------------------------
Net interest income ........................... $13.64 $11.87 $10.53
Provision for loan losses ..................... (0.71) (0.51) (0.49)
Noninterest income ............................ 4.00 2.61 2.34
Noninterest expense ........................... (10.44) (8.14) (7.46)
------------------------
Income before income taxes ...... 6.49 5.83 4.92
Income tax expense ............................ (1.71) (1.68) (1.35)
------------------------
Net income ...................... $ 4.78 $ 4.15 $ 3.57
========================
Higher net income per share in 1997 resulted from increases in net interest
income and noninterest income, but were partially offset by higher noninterest
expense. Both noninterest income and noninterest expense for 1997 included the
recognition of $1,054,000 gain on the transfer of a marketable equity security
to Hills Bancorporation Foundation, a private charitable foundation. As a result
of the stock contribution, Hills Bancorporation received an income tax benefit
of approximately $340,000, which is reflected as a reduction in the income tax
expense for 1997. Each of the years benefited from low provisions for loan
losses, a result of a strong local economy and a loan portfolio that is
concentrated in well secured real estate loans.
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 1997 as follows:
INTEREST INCOME
------------------------------------------------------
Increase (Decrease)
Change In Change In -------------------------------
Average Average Volume Rate Net
Balance Rate Change Changes Changes
-----------------------------------------------------
(Amounts In Thousands)
Loans, net ................................................. $ 60,157 (0.12) $ 5,259 $ (411) $ 4,848
Taxable securities ......................................... 3,436 0.34 204 375 579
Nontaxable securities ...................................... 2,893 (0.26) 213 (60) 153
Federal funds sold ......................................... (6,127) (0.09) (319) (8) (327)
-------- --------------------------------
$ 60,359 $ 5,357 $ (104) $ 5,253
======== =================================
INTEREST EXPENSE
------------------------------------------------------
Interest-bearing demand deposits ........................... $ 5,952 (0.01) $ 134 $ (4) $ 130
Savings deposits ........................................... 16,433 (0.06) 578 (63) 515
Time deposits .............................................. 15,416 0.01 864 23 887
Securities sold under agreements to repurchase ............. 1,133 0.58 52 48 100
FHLB borrowings ............................................ 14,112 0.03 910 9 919
-------- ---------------------------------
$ 53,046 $ 2,538 $ 13 $ 2,551
=================================
Change in net interest income .............................. $ 2,819 $ (117) $ 2,702
=================================
A summary of the net interest spread and margin is as follows:
(Tax Equivalent Basis) 1997 1996 1995
- -----------------------------------------------------------------------------------------
Yield on average interest-earning assets ..................... 8.12% 8.05% 7.98%
Rate on average interest-bearing liabilities ................. 4.84 4.85 4.91
---------------------
Net interest spread .......................................... 3.28 3.20 3.07
Effect of noninterest-bearing funds .......................... 0.65 0.66 0.67
--------------------
Net interest margin (tax equivalent interest income divided by
average interest-earning assets) .......................... 3.93% 3.86% 3.74%
=====================
Loan Losses
The provision for loan losses was $1,048,000, $754,000 and $722,000 for 1997,
1996 and 1995. Charge-offs, net of recoveries were $349,000 for 1997, $533,000
for 1996 and $192,000 for 1995.
The allowance for loan losses totaled $8,010,000 at December 31, 1997 compared
to $7,311,000 at December 31, 1996. The percentage of the allowance to
outstanding loans was 1.86% and 1.95% at December 31, 1997 and 1996,
respectively. Agricultural loans totaled $27,636,000 at December 31, 1997.
Management has assessed the risks for agricultural loans higher than the other
loans due to unpredictable commodity prices, the effects of weather on crops,
and uncertainties regarding government support programs. Therefore, the
allowance for loan losses includes general and specific reserves for these
loans.
The economy remains strong in the Banks' trade areas of Johnson, Washington and
Linn counties, Iowa. Unemployment remains low, the University of Iowa enrollment
is stable, the University of Iowa Hospitals and Clinics and, for the most part,
area businesses have maintained stable employment levels. The allowance for loan
losses is an estimate by the Banks to reserve for loan losses based upon
management's evaluation of the total loan portfolio and current economic
conditions. There are no known trends or uncertainties that are reasonably
likely to have a material effect on the allowance for loan losses in the
near-term.
Other Income
Dollars Per Share, Based on Weighted
Average Diluted Shares Outstanding 1997 1996 1995
- --------------------------------------------------------------------------
Real estate origination fees ................ $0.26 $0.22 $0.20
Trust fees .................................. 0.92 0.61 0.51
Deposit account charges and fees ............ 1.28 1.11 1.09
Other fees and charges ...................... 0.81 0.71 0.62
Other (sale of portfolio) ................... 0.10
Investment securities gains (losses) ........ 0.63 (0.04) (0.08)
------------------------
$4.00 $2.61 $2.34
========================
Total other income increased $2,070,000 or 53.5% in 1997, including net gains on
sale of investment securities of $940,000, which included a $1,054,000 gain on
the sale of a marketable equity security. Additional increases were $455,000 in
trust fees, $248,000 in deposit account charges and fees, $153,000 in other fees
and charges and $154,000 gain on the sale of the student loan portfolio of
approximately $8 million. Total other income increased $430,000 in 1996 compared
to 1995, which was primarily due to higher trust fees and deposit account
charges. Trust fees have increased in 1997, 1996 and 1995 because of new
accounts and the effect of higher balances under management. There were $940,000
in investment securities gains in 1997 following losses of $57,000 and $111,000
in 1996 and 1995, respectively.
Other Expenses
Dollars Per Share, Based on Weighted
Average Diluted Shares Outstanding 1997 1996 1995
- ----------------------------------------------------------------------------
Salaries and employees benefits .................... $4.79 $4.15 $3.73
Occupancy .......................................... 0.68 0.60 0.54
Furniture and fixtures ............................. 0.96 0.75 0.75
F.D.I.C. insurance ................................. 0.04 0.01 0.29
Supplies and postage ............................... 0.60 0.55 0.49
Contributions ...................................... 0.75 0.06 0.06
Other .............................................. 2.62 2.02 1.60
--------------------
$10.44 $8.14 $7.46
====================
Total other expenses increased $3,443,000 or 28.6% in 1997 following increases
of 9.86% for 1996 and 3.31% for 1995, respectively. Contributions for 1997
includes the $1,054,000 gift to the Hills Bancorporation Foundation. Salaries
and employee benefits increased $981,000, due to a full year of salaries for
personnel at the two banks acquired during 1996 and the number of full-time
equivalent employees increasing by 23 from December 31, 1996. In 1996 an
increase of $645,000 in salaries and employee benefits was partially offset by a
decrease of $416,000 in FDIC insurance after the first full year in which the
lower FDIC insurance rates became effective. Salaries increased $487,000 in
1996, due partly to an increase of 28 full-time equivalent employees, primarily
attributable to additional positions added at the acquired banks. The increase
in employees occurred in early July and late September 1996. For 1995 there were
eleven full-time equivalents added. Medical insurance has had only modest
increases in the past three years. Occupancy and furniture and fixtures had
total increase of $438,000 in 1997 due to this being the first full year of
operations for the banks acquired in 1996 and the acquisition of new data
processing equipment.
Income Taxes
Income tax expense was $2,545,000, $2,478,000 and $1,994,000 for the years ended
December 31, 1997, 1996 and 1995, respectively. The corresponding percentage of
tax expense compared to income before income taxes is 26.4% in 1997, 28.7% in
1996 and 27.5% in 1995.
Impact of Recently Issued Accounting Standards
The adoption of new accounting standards had no effect on financial position or
results of operations in 1997, and the adoption of several recently issued
standards is not expected to have a significant effect.
Interest Rate Sensitivity and Liquidity Analysis
At December 31, 1997, the Company's interest rate sensitivity report is as
follows (in thousands):
Repricing Days
Maturities ---------------------------------------------- More Than
Immediately 2-30 31-90 91-180 181-365 One Year Total
-----------------------------------------------------------------------------------
Earning assets:
Federal funds sold ............ $ 2,447 $ - - $ - - $ - - $ - - $ - - $ 2,447
Investment
securities ................. - - 3,550 4,200 7,053 12,021 111,240 138,064
Loans ......................... - - 41,255 21,146 28,563 53,737 286,070 430,771
---------------------------------------------------------------------------------
Total earning
assets ................ 2,447 44,805 25,346 35,616 65,758 397,310 571,282
---------------------------------------------------------------------------------
Sources of funds:
Interest-bearing
checking and
savings accounts ........... 55,712 - - - - - - - - 112,600 168,312
Certificates of
deposit .................... - - 6,755 39,300 55,449 66,874 90,909 259,287
Other borrowings -
FHLB ....................... - - - - 5,000 10,000 5,000 30,764 50,764
Repurchase
agreements ................. 9,008 - - - - - - - - - - 9,008
---------------------------------------------------------------------------------
64,720 6,755 44,300 65,449 71,874 234,273 487,371
Other sources ................. - - - - - - - - - - 83,911 83,911
---------------------------------------------------------------------------------
Total sources ............ 64,720 6,755 44,300 65,449 71,874 318,184 571,282
---------------------------------------------------------------------------------
Repricing
differences ................ $(62,273) $38,050 $(18,954) $(29,833) $ (6,116) $79,126 $ - -
=================================================================================
A portion of the interest-bearing checking, savings, and money market accounts
have been included in the above table as maturing immediately and the rest of
these deposits are shown as more than one year. The classifications are used
because the Banks' 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 repricing schedule indicates.
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, Hills Bancorporation (the holding company) had cash
balances of $408,000 as of December 31, 1997. In 1997, the holding company
received dividends of $2,515,000 from its subsidiary banks and used those funds
to make a $750,000 capital contribution to a subsidiary bank, pay dividends to
its stockholders of $1,537,000 and increase its cash position by $114,000.
As of December 31, 1997 and 1996, stockholders' equity before deducting for the
maximum cash obligation related to ESOP was $59,182,000 and $53,751,000,
respectively. This measure of equity as a percent of total assets was 9.81% at
December 31, 1997 and 9.96% at December 31, 1996. These ratios are competitive
with the Company's peers. As of December 31, 1997, total equity was 8.54% of
assets compared to 8.77% 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 the subsidiaries banks, which affects the Banks' dividends
to the Company. The Banks are subject to certain statutory and regulatory
restrictions on the amount they may pay in dividends. In order to maintain
acceptable capital ratios in the subsidiary banks, certain of their retained
earnings are not available for the payment of dividends. Retained earnings
available for the payment of dividends to the Company total approximately
$4,902,000 as of December 31, 1997.
The Company and the Banks are subject to the Federal Deposit Insurance
Corporation Improvement Act of 1991 and the Banks are subject to Prompt
Corrective Action Rules as determined and enforced by the Federal Reserve. These
regulations establish minimum capital requirements which member banks must
maintain.
As of December 31, 1997, 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, noncumulative perpetual preferred stock,
and minority interest in the equity accounts of consolidated subsidiaries), and
the remainder may be Tier II supplementary capital (perpetual debt,
intermediate-term preferred stock, cumulative perpetual, long-term and
convertible preferred stock, and loan loss reserve up to a maximum of 1.25% of
risk-weighted assets). Total risk-weighted assets are determined by weighing the
assets according to their risk characteristics. Certain off-balance sheet items
(such as standby letters of credit and firm loan commitments) are multiplied by
"credit conversion factors" to translate them into balance sheet equivalents
before assigning them risk weightings. Any bank having a capital ratio less than
the 8% minimum required level must, within 60 days, submit to the Federal
Reserve a plan describing the means and schedule by which the Bank shall achieve
the applicable minimum capital ratios.
A comparison of the Company's capital as of December 31, 1997 with minimum
requirements is presented below:
Minimum
Actual Requirements
----------------------------
Tier I Risk-Based Capital 13.97% 4%
Total Risk-Based Capital 15.23 8
Leverage Ratio 9.09 3
Each of the Banks is classified as "well capitalized" by FDIC capital
guidelines.
On a consolidated basis, 1997 cash flows from operations provided $9,644,000 and
another $57,615,000 was provided by net increases in deposits of $32,646,000 and
Federal Home Loan Bank borrowings of $24,969,000. These cash flows were invested
in net loans of $55,545,000 and net securities of $6,194,000. In addition,
$2,171,000 was used to purchase property and equipment.
At December 31, 1997, the Company had total outstanding loan commitments of
$97,530,000. Management believes that its liquidity levels are appropriate and
that it has borrowing capacity from the Federal Home Loan Bank and other
sources.
Commitments and Trends
The Company has no material commitments or plans which will materially affect
its liquidity or capital resources. The acquisition of property and equipment
may be in cash purchases, or they may be financed if favorable terms are
available.
The Company is currently involved in the assessment phase of its Year 2000 plan.
Critical applications have been identified and an outside consultant has been
engaged to assist with obtaining certification from outside vendors. Upon
completion of the assessment phase, applications will be tested. To date, the
Company has incurred expenses related to this issue in the form of outside
consulting fees as well as time spent by internal staff, but the expense has not
been significant. In 1998, the subsidiary banks are converting to a new
financial accounting system, which will be Year 2000 compliant. As a result,
costs for hardware upgrades have been incurred in 1997. Additional hardware and
software costs are expected in 1998 related to the conversion. These costs are
not expected to have a significant impact on the earnings or future liquidity of
the Company.
As of December 31, 1997, the Company is not aware of any known trends or
uncertainties which are expected that will have a material effect on the
financial condition of the Company.
PART II
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market Risk Exposures
The Company's primary market risk exposure is to changes in interest rates. The
Company's asset/liability management, or its management of interest rate risk,
is focused primarily on evaluating and managing net interest income given
various risk criteria. Factors beyond the Company's control, such as market
interest rates and competition, may also have an impact on the Company's
interest income and interest expense. In the absence of other factors, the
Company's overall yield on interest-earning assets will increase as will its
cost of funds on its interest-bearing liabilities when market rates increase
over an extended period of time. Inversely, the Company's yields and cost of
funds will decrease when market rates decline. The Company is able to manage
these swings to some extent by attempting to control the maturity or rate
adjustments of its interest-earning assets and interest-bearing liabilities over
given periods of time.
The Banks maintain 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 Banks use a
simulation model to review various assumptions relating to interest rate
movement. The model attempts to limit rate risk even if it appears the Banks'
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 repriced 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 reprice faster than its interest rate sensitive assets causing
a decline in the Company's interest rate spread and margin. This would result
from an increase in the Company's cost of funds that would not be immediately
offset by an increase in its yield on earning assets which would tend to reduce
net interest income. In times of decreasing interest rates, fixed rate assets
could increase in value and the lag in repricing of interest rate sensitive
assets could be expected to have a positive effect on the Company's net interest
income.
The following table provides quantitative information with respect to interest
sensitive assets and liabilities.
The following table provides information about the Company's loans, investment
securities and deposits that are sensitive to changes in interest rates. The
table presents principal cash flows and related weighted average interest rates
by expected maturity dates.
1998 1999 2000 2001 2002 Thereafter Total Fair Value
------------------------------------------------------------------------------------------
Assets:
Loans, fixed:
Balance $ 80,361 $ 53,205 $ 50,889 $ 29,068 $ 42,408 $ 25,020 $ 280,951 $ 281,986
Average
interest rate 8.37% 8.38% 8.48% 8.53% 8.37% 7.94% 8.37%
Loans, variable:
Balance $ 24,055 $ 2,478 $ 4,527 $ 1,628 $ 3,318 $ 113,814 $ 149,820 $ 149,820
Average
interest rate 9.33% 9.07% 8.39% 8.77% 8.65% 8.35% 8.53%
Investments (1):
Balance $ 29,296 $ 30,916 $ 30,084 $ 26,670 $ 6,614 $ 16,931 $ 140,511 $ 140,901
Average
interest rate 6.20% 6.36% 6.28% 6.26% 6.79% 6.89% 6.37%
Liabilities:
Liquid
deposits (2):
Balance $ 168,312 $ - - $ - - $ - - $ - - $ - - $ 168,312 $ 168,312
Average
interest rate 3.22% 0.00% 0.00% 0.00% 0.00% 0.00% 3.22%
Deposits,
certificates:
Balance $ 168,376 $ 56,302 $ 27,806 $ 4,874 $ 1,827 $ 102 $ 259,287 $ 260,296
Average
interest rate 5.63% 5.80% 6.29% 5.63% 5.52% 5.75% 5.73%
<FN>
(1) Includes all available-for-sale investments, held-to-maturity investments,
and federal funds.
(2) Includes passbook accounts, NOW accounts, Super NOW accounts, and money
market funds.
</FN>
Item 8. Financial Statements and Supplementary Data
The financial statements are included on Pages 31 through 58. The Company does
not meet the requirements of Item 302 of Regulation S-K to include the
supplementary financial information required by that item.
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 subsidiaries as of December 31, 1997 and 1996, and the
related consolidated statements of income, stockholders' equity, and cash flows
for the years ended December 31, 1997, 1996 and 1995. 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 generally accepted auditing
standards. 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 subsidiaries as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for the years ended December 31, 1997, 1996 and
1995 in conformity with generally accepted accounting principles.
/s/McGLADREY & PULLEN, LLP
Iowa City, Iowa
February 6, 1998
HILLS BANCORPORATION
CONSOLIDATED BALANCE SHEETS
December 31, 1997 and 1996
(In Thousands, Except Shares)
ASSETS 1997 1996
- ---------------------------------------------------------------------------------------------------------------
Cash and due from banks (Note 9) .......................................................... $ 15,508 $ 15,036
Investment securities (Note 2):
Available for sale (amortized cost 1997 $108,718; 1996 $106,097) ....................... 109,486 107,139
Held to maturity (fair value 1997 $24,230; 1996 $22,232) ............................... 23,840 22,098
Stock of Federal Home Loan Bank ........................................................ 4,738 3,398
Federal funds sold ........................................................................ 2,447 1,107
Loans, net (Notes 3, 7 and 10) ............................................................ 422,761 368,264
Property and equipment, net (Note 4) ...................................................... 9,437 8,409
Accrued interest receivable ............................................................... 5,441 4,884
Deferred income taxes, net (Note 8) ....................................................... 1,859 1,359
Other assets .............................................................................. 7,585 7,758
------------------
$603,102 $539,452
==================
LIABILITIES AND STOCKHOLDERS' EQUITY
- ---------------------------------------------------------------------------------------------------------------
Liabilities
Noninterest-bearing deposits ........................................................... $ 52,174 $ 46,154
Interest-bearing deposits (Note 5) ..................................................... 427,596 403,907
------------------
Total deposits .............................................................. 479,770 450,061
Securities sold under agreements to repurchase ......................................... 9,008 6,071
Federal Home Loan Bank notes (Note 6) .................................................. 50,764 25,795
Accrued interest payable ............................................................... 2,060 1,952
Other liabilities ...................................................................... 2,318 1,822
------------------
543,920 485,701
------------------
Commitments and Contingencies (Notes 7 and 13)
Redeemable Common Stock Held By Employee Stock
Ownership Plan (ESOP) (Note 7) ......................................................... 7,682 6,416
------------------
Stockholders' Equity (Note 9)
Capital stock, no par value; authorized 10,000,000 shares;
issued 1997 1,467,754 shares; 1996 1,465,384 shares ................................. 9,070 8,997
Retained earnings ...................................................................... 49,627 44,078
Unrealized gains on investment securities, net ......................................... 485 676
------------------
59,182 53,751
Less maximum cash obligation related to ESOP shares (Note 7) ........................... 7,682 6,416
------------------
51,500 47,335
------------------
$603,102 $539,452
==================
See Notes to Financial Statements.
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 1997, 1996 and 1995
(In Thousands, Except Per Share Amounts)
1997 1996 1995
- ------------------------------------------------------------------------------------------------
Interest income:
Interest and fees on loans ................................... $34,598 $29,724 $27,236
Interest on investment securities:
Taxable ................................................... 6,769 6,190 5,189
Nontaxable ................................................ 1,218 1,117 1,034
Interest on federal funds sold ............................... 158 485 519
----------------------------
Total interest income ............................. 42,743 37,516 33,978
----------------------------
Interest expense:
Interest on deposits ......................................... 19,294 17,762 16,185
Interest on securities sold under agreements to repurchase ... 426 326 409
Interest on FHLB borrowings .................................. 2,782 1,863 1,874
----------------------------
Total interest expense ............................ 22,502 19,951 18,468
----------------------------
Net interest income ............................... 20,241 17,565 15,510
Provision for loan losses (Note 3) .............................. 1,048 754 722
----------------------------
Net interest income after provision for loan losses 19,193 16,811 14,788
----------------------------
Other income:
Loan origination fees ........................................ 387 324 294
Trust fees ................................................... 1,363 908 755
Deposit account charges and fees ............................. 1,893 1,645 1,606
Other fees and charges ....................................... 1,201 1,048 894
Net gains (losses) on sale of investment securities (Note 2) 940 (57) (111)
Other ........................................................ 154 - - - -
----------------------------
5,938 3,868 3,438
----------------------------
Other expenses:
Salaries and employee benefits ............................... 7,118 6,137 5,492
Occupancy .................................................... 1,017 891 792
Furniture and equipment ...................................... 1,429 1,117 1,099
F.D.I.C. insurance ........................................... 58 8 424
Office supplies and postage .................................. 889 819 725
Contributions ................................................ 1,118 88 94
Other ........................................................ 3,871 2,997 2,349
----------------------------
15,500 12,057 10,975
----------------------------
Income before income taxes ........................ 9,631 8,622 7,251
Federal and state income taxes (Note 8) ......................... 2,545 2,478 1,994
----------------------------
Net income ........................................ $ 7,086 $ 6,144 $ 5,257
============================
Earnings per share:
Basic ........................................................ $ 4.83 $ 4.19 $ 3.59
Diluted ...................................................... 4.78 4.15 3.57
See Notes to Financial Statements.
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (NOTES
7 AND 9)
Years Ended December 31, 1997, 1996 and 1995
(In Thousands, Except Share Amounts)
Less
Maximum
Unrealized Cash
Gains On Obligation
Investment Related
Capital Retained Securities, To ESOP
Stock Earnings Net Shares Total
- ------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1994 ........................ $ 8,915 $35,336 $(2,594) $(5,210) $36,447
Issuance of 609 shares of
common stock ................................ 20 - - - - - - 20
Redemption of 324 shares of
common stock ................................ (10) - - - - - - (10)
Change related to ESOP shares .................. - - - - - - (61) (61)
Net income ..................................... - - 5,257 - - - - 5,257
Cash dividends ($.87 per share) ................ - - (1,268) - - - - (1,268)
Unrealized gains on investment
securities, net ............................. - - - - 2,892 - - 2,892
---------------------------------------------------------
Balance, December 31, 1995 ........................ 8,925 39,325 298 (5,271) 43,277
Issuance of 1,936 shares of
common stock ................................ 77 - - - - - - 77
Redemption of 156 shares
of common stock ............................. (5) - - - - - - (5)
Change related to ESOP shares .................. - - - - - - (1,145) (1,145)
Net income ..................................... - - 6,144 - - - - 6,144
Cash dividends ($.95 per share) ................ - - (1,391) - - - - (1,391)
Unrealized gains on investment
securities, net ............................. - - - - 378 - - 378
---------------------------------------------------------
Balance, December 31, 1996 ........................ 8,997 44,078 676 (6,416) 47,335
Issuance of 2,993 shares of
common stock ................................ 97 - - - - - - 97
Redemption of 623 shares
of common stock ............................. (24) - - - - - - (24)
Change related to ESOP shares .................. - - - - - - (1,266) (1,266)
Net income ..................................... - - 7,086 - - - - 7,086
Cash dividends ($1.05 per share) ............... - - (1,537) - - - - (1,537)
Unrealized (losses) on investment
securities, net ............................. - - - - (191) - - (191)
---------------------------------------------------------
Balance, December 31, 1997 ........................ $ 9,070 $49,627 $ 485 $(7,682) $51,500
=========================================================
See Notes to Financial Statements.
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 1997, 1996 and 1995
(In Thousands)
1997 1996 1995
- -------------------------------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities
Net income ........................................................................... $ 7,086 $ 6,144 $ 5,257
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation ...................................................................... 1,143 884 837
Amortization ...................................................................... 261 133
Provision for loan losses ......................................................... 1,048 754 722
Net (gains) losses on disposition of investment securities ........................ (940) 57 111
Compensation paid by issuance of common stock ..................................... 73 72 10
Contribution of investment securities ............................................. 1,054 - - - -
Deferred income taxes ............................................................. (417) (77) (238)
(Increase) in accrued interest receivable ......................................... (557) (121) (670)
Amortization of bond discount ..................................................... 378 454 383
(Increase) in other assets ........................................................ (88) 1,589 (971)
Increase in accrued interest and other liabilities ................................ 603 505 440
-----------------------------
Net cash provided by operating activities ................................. 9,644 10,394 5,881
-----------------------------
Cash Flows from Investing Activities Proceeds from maturities of investment
securities:
Available for sale ................................................................ 21,292 22,353 19,404
Held to maturity .................................................................. 2,590 4,069 2,653
Proceeds from sales of available-for-sale securities ................................. 16,411 10,988 11,013
Purchases of investment securities:
Available for sale ................................................................ (42,083) (37,026) (35,563)
Held to maturity .................................................................. (4,404) (4,784) (4,896)
Federal funds sold, net .............................................................. (1,340) 26,421 (8,580)
Loans made to customers, net of collections .......................................... (55,545) (29,807) (18,447)
Purchases of property and equipment .................................................. (2,171) (859) (1,483)
Purchase of subsidiary banks, net of cash acquired (Note 14) ......................... - - (7,163) - -
------------------------------
Net cash (used in) investing activities ................................... (65,250) (15,808) (35,899)
------------------------------
Cash Flows from Financing Activities
Net increase in deposits ............................................................. 29,709 18,938 19,419
Net increase (decrease) in securities sold under agreements
to repurchase ..................................................................... 2,937 (3,948) 2,976
Borrowings from FHLB ................................................................. 30,000 - - 15,000
Payments on FHLB notes ............................................................... (5,031) (5,032) (5,031)
Dividends paid ....................................................................... (1,537) (1,391) (1,268)
------------------------------
Net cash provided by financing activities ................................. 56,078 8,567 31,096
------------------------------
Increase in cash and due from banks ....................................... $ 472 $ 3,153 $ 1,078
Cash and due from banks:
Beginning ............................................................................ 15,036 11,883 10,805
------------------------------
Ending ............................................................................... $ 15,508 $15,036 $11,883
==============================
Supplemental Disclosures
Cash payments for:
Interest paid to depositors and others ............................................ $ 19,186 $17,848 $15,868
Interest paid on other obligations ................................................ 3,208 2,189 2,263
Income taxes ...................................................................... 2,942 2,565 2,099
Noncash financing transactions:
Increase in maximum cash obligation related to
ESOP shares ..................................................................... 1,266 1,145 61
Available-for-sale investment securities transferred
as a charitable contribution .................................................... 1,054 - - - -
Purchase business acquisitions (Note 14)
See Notes to Financial Statements.
HILLS BANCORPORATION
NOTES TO FINANCIAL STATEMENTS
Note 1. Nature of Activities and Significant Accounting Policies
Nature of activities: Hills Bancorporation (the "Company") is a multi-bank
holding company engaged in the business of banking. The Company's three
wholly-owned subsidiary commercial banks are Hills Bank and Trust Company,
Hills, Iowa; Hills Bank, Lisbon, Iowa; and Hills Bank Kalona, Kalona, Iowa. The
Banks are all full-service commercial banks extending their services to
individuals, businesses, governmental units, and institutional customers
primarily in the communities of Hills, Iowa City, Coralville, North Liberty,
Lisbon, Mount Vernon, and Kalona, Iowa.
The Banks compete with other financial institutions and nonfinancial
institutions providing similar financial products. Although the loan activity of
the Banks is diversified with commercial and agricultural loans, real estate
loans, automobile, installment and other consumer loans, each Bank's credit is
concentrated in real estate loans.
Accounting estimates: The preparation of financial statements in conformity with
generally accepted accounting principles 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.
Principles of consolidation: The consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiaries. All significant
intercompany balances and transactions have been eliminated in consolidation.
Investment securities: Held-to-maturity securities consist solely of debt
securities which the Company has the positive intent and ability to hold to
maturity and are stated at amortized cost.
Available-for-sale securities consist of debt securities and marketable equity
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, 1997
and 1996.
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). Interest on debt
securities is recognized in income as accrued. Realized gains and losses 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.
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 collectibility 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 Banks make continuous reviews
of the loan portfolio and considers current economic conditions, historical loss
experience, review of specific problem loans and other factors in determining
the adequacy of the allowance.
Loans are considered impaired when, based on current information and events, it
is probable the Company 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.
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 3-20 years for furniture and equipment.
Deferred income taxes: Deferred income taxes are provided under the liability
method whereby deferred tax assets are recognized for deductible temporary
differences and net operating loss, and tax credit carryforwards and deferred
tax liabilities are recognized for taxable temporary differences. Temporary
differences are the differences between the reported amounts of assets and
liabilities and their tax bases. Deferred tax assets are reduced by a valuation
allowance when, in the opinion of management, it is more likely than not that
some or all of the deferred tax assets will not be realized. Deferred tax assets
and liabilities are adjusted for the effects of changes in tax laws and rates on
the date of enactment.
Intangible assets: Intangible assets consist principally of goodwill which
represents the excess of cost over fair value of net assets acquired in business
combinations of two banks in 1996 accounted for under the purchase method.
Goodwill is amortized on a straight-line basis over the estimated period to be
benefited, 15 years. The carrying value of goodwill is reviewed periodically for
impairment. Goodwill totaled $3,543,000 and $3,804,000, net of accumulated
amortization of $354,000 and $93,000 as of December 31, 1997 and 1996 and is
included in other assets.
Stock options: Compensation expense for stock issued through stock options 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 Banks in
fiduciary or agency capacities for its customers are not included in these
statements since they are not assets of the Company.
Earnings per share: The FASB has issued Statement No. 128, "Earnings Per Share,"
which supersedes APB Opinion No. 15. Statement No. 128 requires the presentation
of basic and diluted earnings per share by all entities that have common stock
or potential common stock, such as options, warrants and convertible securities
outstanding. 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 unless the effect is to reduce the loss
or increase the income per common share from continuing operations. Statement
No. 128 has been applied for annual and interim periods ending after December
15, 1997, and earnings per share for prior periods have been retroactively
restated, which had no effect on reported earnings per share.
Following is a reconciliation of the denominator:
Year Ended
December 31,
---------------------------------
1997 1996 1995
---------------------------------
Weighted average number of shares ................ 1,465,914 1,465,384 1,463,319
Potential number of dilutive shares .............. 18,040 13,968 9,465
---------------------------------
Total shares to compute diluted earnings per share 1,483,954 1,479,352 1,472,784
=================================
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 Banks, deposits
and federal funds purchased and sold are reported net.
Recently issued accounting standards: SFAS No. 130, "Reporting Comprehensive
Income," establishes standards for reporting and display of comprehensive income
and its components (revenues, expenses, gains and losses) in a full set of
general-purpose financial statements. The Statement requires that all items that
are required to be recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is displayed with
the same prominence as other financial statements. The Statement does not
require a specific format for that financial statement but requires that an
enterprise display an amount representing total comprehensive income for the
period in that financial statement. The Statement requires that an enterprise:
(a) classify items of other comprehensive income by their nature in a financial
statement and (b) display the accumulated balance of other comprehensive income
separately from retained earnings and additional paid-in capital in the equity
section of a statement of financial position. It is not expected that this
Statement will materially affect the presentation of the Company's comprehensive
income.
Fair value of financial instruments: FASB Statement No. 107, "Disclosures About
Fair Value of Financial Instruments," requires disclosure of fair value
information about financial instruments, whether or not recognized in the
balance sheet, for which it is practicable to estimate that value. In cases
where quoted market prices are not available, fair values 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. Statement 107
excludes certain financial instruments and all nonfinancial instruments from its
disclosure requirements. Accordingly, the aggregate fair value amounts presented
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 at December 31, 1997. Unfunded loan commitments are not valued
since the loans are generally priced at market at the time of funding.
Cash and cash equivalents and federal funds sold: The carrying amounts reported
in the balance sheet for cash and short-term instruments approximate their fair
values.
Investment securities: Fair values for investment securities are based on quoted
market prices, where available. If quoted market prices are not available, fair
values are based on quoted market prices of comparable instruments.
Loans receivable: For variable-rate loans that reprice frequently and with no
significant change in credit risk, fair values are based on carrying values. The
fair values for other loans are determined using estimated future cash flows,
discounted at the interest rates currently being offered for loans with similar
terms to borrowers with similar credit quality. The carrying amount of accrued
interest receivable approximates its fair value.
Deposit liabilities: The fair values of demand deposits equal their carrying
amounts which represent the amount payable on demand. The carrying amounts for
variable-rate, fixed-term money market accounts and certificates of deposit are
estimated using a discounted cash flow calculation that applies interest rates
currently being offered on certificates to a schedule of aggregated expected
monthly maturities on time deposits.
Short-term borrowings: The carrying amounts of borrowings under repurchase
agreements approximate their fair values.
Long-term borrowings: The fair values of the Banks' long-term borrowings (other
than deposits) are estimated using discounted cash flow analyses, based on the
Banks' current incremental borrowing rates for similar types of borrowing
arrangements.
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, 1997:
U. S. Treasury ................. $ 39,858 $ 331 $ - - $ 40,189
U. S. Government agencies and
corporations ................ 65,054 404 (13) 65,445
State and political subdivisions 3,806 46 - - 3,852
------------------------------------------
Total ............... $108,718 $ 781 $ (13) $109,486
==========================================
December 31, 1996:
U. S. Treasury ................. $ 45,100 $ 220 $ (107) $ 45,213
U. S. Government agencies and
corporations ................ 57,405 295 (303) 57,397
State and political subdivisions 1,329 20 - - 1,349
Other debt securities .......... 2,263 39 (3) 2,299
Marketable equity securities ... - - 881 - - 881
------------------------------------------
Total ............... $106,097 $ 1,455 $ (413) $107,139
==========================================
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, 1997:
States and political subdivisions . $23,840 $ 405 $ (15) $24,230
========================================
December 31, 1996:
States and political subdivisions . $22,098 $ 239 $ (105) $22,232
========================================
The contractual maturity distribution of investment securities as of December
31, 1997 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 .............. $ 24,915 $ 24,973 $ 2,431 $ 2,435
Due after one year through five years 83,304 84,005 12,058 12,256
Due after five years through ten years 499 508 9,214 9,396
Due over ten years ................... - - - - 137 143
-----------------------------------
Total .................. $108,718 $109,486 $ 23,840 $ 24,230
===================================
As of December 31, 1997, investment securities with a carrying value of $38,043
were pledged to collateralize public and trust deposits, short-term borrowings,
and for other purposes, as required or permitted by law.
For the years ended December 31, 1997, 1996 and 1995, net gains or losses from
the sale of investment securities were as follows:
Year Ended December 31,
-------------------------------
1997 1996 1995
-------------------------------
(Amounts In Thousands)
Gross gains ............................ $1,059 $ - - $ - -
Gross (losses) ......................... (119) (57) (111)
-------------------------------
Net gains (losses) ....... $ 940 $ (57) $ (111)
===============================
Included in 1997 gains was the contribution of a marketable equity security to a
private charitable foundation organized by the Company, upon which a gain of
$1,054,000 was recognized. The marketable equity security was an investment in a
development stage company that later went public in 1996.
Note 3. Loans
The composition of loans is as follows:
December 31,
------------------
1997 1996
------------------
(Amounts In
Thousands)
Agricultural ................................................................ $ 27,636 $ 23,133
Commercial and financial .................................................... 33,616 30,650
Real estate:
Construction ............................................................. 8,157 8,846
Mortgage ................................................................. 332,655 279,134
Loans to individuals ........................................................ 28,707 33,812
------------------
430,771 375,575
Less allowance for loan losses .............................................. 8,010 7,311
------------------
$422,761 $ 368,264
==================
Changes in the allowance for loan losses are as follows:
Year Ended December 31,
---------------------------
1997 1996 1995
---------------------------
(Amounts In Thousands)
Balance, beginning ...................... $7,311 $6,740 $6,210
Provision charged to expenses ........ 1,048 754 722
Recoveries ........................... 779 438 730
Allowances of acquired banks ......... - - 350 - -
Loans charged off .................... (1,128) (971) (922)
--------------------------
Balance, ending ......................... $8,010 $7,311 $6,740
==========================
Information about impaired loans as of and for the years ended December 31, 1997
and 1996 is as follows:
1997 1996
--------------
(Amounts In
Thousands)
Loans receivable for which there is a related allowance for credit losses $ - - $ - -
Loans receivable for which there is no related allowance for credit losses 9,556 7,811
--------------
Total impaired loans ....................................... $9,556 $7,811
==============
Related allowance for credit losses ...................................... $ - - $ - -
Average balance .......................................................... 8,401 6,438
Interest income recognized ............................................... 808 547
No allowance for credit losses has been recognized for impaired loans because
the loans have been charged off to the net present value of the future cash
flows or to the fair value of the collateral if the loan is collateral
dependent.
Note 4. Property and Equipment
The major classes of property and equipment and the total accumulated
depreciation are as follows:
December 31,
-------------------
1997 1996
-------------------
(Amounts In
Thousands)
Land .................................... $1,950 $1,700
Buildings and improvements .............. 7,149 6,475
Furniture and equipment ................. 9,065 8,007
-------------------
18,164 16,182
Less accumulated depreciation ........... 8,727 7,773
-------------------
Net ....................... $9,437 $8,409
===================
Note 5. Interest-Bearing Deposits
A summary of these deposits is as follows:
December 31,
------------------
1997 1996
------------------
(Amounts In
Thousands)
NOW and other demand .................................... $ 46,526 $ 43,017
Savings ................................................. 121,785 115,037
Time, $100,000 and over ................................. 38,374 32,635
Other time .............................................. 220,911 213,218
------------------
$427,596 $403,907
==================
Note 6. Federal Home Loan Bank Borrowings
As of December 31, 1997, the borrowings were as follows:
(In
Thousands)
----------
Due June 5, 1998, 5.74% .................................... $10,000
Due July 2, 1998, 5.83% .................................... 5,000
Due April 9, 1999, 6.55% ................................... 7,000
Due August 5, 1999, 6.57% .................................. 5,000
Due January 24, 2000, 6.21% ................................ 10,000
Due February 22, 2000, 7.73% ............................... 5,000
Due April 9, 2000, 6.71% ................................... 3,000
Due November 18, 2002, 5.33% ............................... 5,000
Due August 17, 2005, 7.12% ................................. 100
Due August 11, 2008, 6.00% ................................. 664
-------
$50,764
=======
The borrowings are collateralized by 1-4 family mortgage loans with a face
amount of $65,993,000. As of December 31, 1997, the Company held Federal Home
Loan Bank stock with a cost of $4,738,000 which is included in investment
securities.
Note 7. Employee Benefit Plans
The Company has an unleveraged Employee Stock Ownership Plan (the "Plan") to
which it makes discretionary cash contributions. The Company's contribution to
the Plan totaled $49,000, $42,000 and $76,000 for the years ended December 31,
1997, 1996 and 1995, 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, 1997, 160,049 shares held by the ESOP, at a fair value of $48 per
share, have 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 $394,000, $340,000 and
$419,000 for the years ended December 31, 1997, 1996 and 1995, respectively.
The Company has a Stock 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. 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. Additional compensation is accrued equivalent to the
amount of dividends that would have been paid on the stock had the options been
exercised. Such compensation is payable upon exercise of the options. No
compensation expense has been charged to expense using the intrinsic value based
method as prescribed by APB No. 25. Had compensation expense been determined
based on the grant date fair values of the awards, as prescribed by SFAS No.
123, reported net income and earnings per common and common equivalent share
would have been as follows:
Years Ended December 31,
---------------------------
1997 1996 1995
---------------------------
Pro forma net income (in thousands) ...... $ 7,084 $ 6,144 $ 5,257
Pro forma earnings per share:
Basic ................................. 4.83 4.19 3.59
Diluted ............................... 4.77 4.15 3.57
The pro forma effects of applying SFAS are not indicative of future amounts
since, among other reasons, the pro forma requirements of SFAS No. 123 have been
applied only to options granted after December 31, 1994. No options were granted
during 1996 or 1995.
The fair value of each grant is established at the grant date using the
Black-Scholes option-pricing model with the following weighted average
assumptions for grants in 1997: Dividend rate 2.19%; price volatility of 4.64%;
risk-free interest rate of 6.63%; and an expected life of 5 years.
A summary of the stock options are as follows:
Weighted
Average
Number Exercise
Of Shares Price
-----------------
Balance, December 31, 1995 .................... 46,569 $25.76
Exercised .................................. - - - -
Forfeited .................................. - - - -
----------------
Balance, December 31, 1996 .................... 46,569 25.76
Granted .................................... 2,055 41.00
Exercised .................................. (2,055) 25.33
Forfeited .................................. - - - -
-----------------
Balance, December 31, 1997 .................... 46,569 $26.45
=================
1997 1996 1995
------------------------
Number of options exercisable, end of year .......... 22,605 22,605 22,605
Weighted-average fair value of options granted
during the year .................................. $13.22 $ - - $ - -
Other pertinent information related to the options outstanding at December 31,
1997 is as follows:
Remaining
Exercise Number Contractual Number
Price Outstanding Life Exercisable
- -------- --------------------------------------------------------------
$25.33 20,550 63 Months 20,550
41.00 2,055 111 Months 2,055
26.17 23,964 66 Months - -
------ ------
46,569 22,605
====== ======
The committee is also authorized to grant awards of common stock and authorized
the issuance of 938, 1,936 and 609 shares of common stock to a group of
employees in 1997, 1996 and 1995, respectively.
As of December 31, 1997, option to purchase 83,176 shares of common stock were
available for future grants.
Note 8. Income Taxes
Income taxes for the years ended December 31, 1997, 1996 and 1995 are summarized
as follows:
1997 1996 1995
------------------------
(Amounts In Thousands)
Current:
Federal .......................................... $2,399 $2,098 $1,828
State ............................................ 563 457 404
Deferred ............................................ (417) (77) (238)
-----------------------
$2,545 $2,478 $1,994
=======================
Deferred income tax liabilities and assets arose from the following temporary
differences:
December 31,
----------------------
1997 1996 1995
----------------------
(Amounts In Thousands)
Deferred income tax assets:
Allowance for loan losses ................... $2,622 $2,264 $2,135
Certain accrued expenses .................... 302 205 166
Other ....................................... 8 7 43
----------------------
Gross tax assets ................. 2,932 2,476 2,344
----------------------
Deferred income tax liabilities:
Property and equipment ...................... 644 621 591
FHLB dividends .............................. 130 130 105
Unrealized gains on debt securities ......... 283 366 174
Other ....................................... 16 - - - -
----------------------
Gross tax liabilities ............ 1,073 1,117 870
----------------------
Net deferred income tax asset .... $1,859 $1,359 $1,474
======================
The net change in the deferred income taxes for the years ended December 31,
1997, 1996 and 1995 is reflected in the financial statements as follows:
Year Ended
December 31,
--------------------------
1997 1996 1995
--------------------------
(Amounts In Thousands)
Statement of income ............................. $ (417) $ (77) $ (238)
Statement of stockholders' equity ............... (83) 192 1,699
--------------------------
$ (500) $ 115 $1,461
==========================
The income tax provisions for the years ended December 31, 1997, 1996 and 1995
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:
1997 1996 1995
-------------------------------------------------------------
% Of % Of % Of
Pretax Pretax Pretax
Amount Income Amount Income Amount Income
-------------------------------------------------------------
(Amounts In Thousands)
Expected provision $ 3,275 34.0% $ 2,931 34.0% $ 2,465 34.0%
Tax-exempt interest (557) (5.8) (539) (6.3) (530) (7.3)
Interest expense
limitation ..... 97 1.0 95 1.1 87 1.2
Investment securi-
ties contributed (358) (3.7) - - - - - - - -
State income taxes,
net of federal
income tax
benefit ........ 372 3.9 315 3.7 245 3.4
Income tax credits (345) (3.6) (344) (4.0) (250) (3.5)
Other ............. 61 0.6 20 0.2 (23) (0.3)
------------------------------------------------------------
$ 2,545 26.4% $ 2,478 28.7% $ 1,994 27.5%
============================================================
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.
A comparison of the Company's capital as of December 31, 1997 with the minimum
requirements is presented below.
Minimum
Actual Requirements
--------------------------
Tier 1 Risk-Based Capital ..................... 13.97% 4.00%
Total Risk-Based Capital ...................... 15.23 8.00
Leverage Ratio ................................ 9.09 3.00
According to FDIC capital guidelines, all of the Banks are considered to be
"Well Capitalized."
The ability of the Company to pay dividends to its stockholders is dependent
upon dividends paid by the Banks. The Banks are subject to certain statutory and
regulatory restrictions on the amount they may pay in dividends. To maintain
acceptable capital ratios in the Banks, certain of their retained earnings are
not available for the payment of dividends. To maintain a ratio of capital to
assets of 8%, retained earnings which otherwise could be available for the
payment of dividends to the Company total approximately $4,902,000 as of
December 31, 1997.
The Bank is required to maintain reserve balances in cash or with the Federal
Reserve Bank. Reserve balances totaled $4,503,000 and $3,974,000 as of December
31, 1997 and 1996, respectively.
Note 10. Related Party Transactions
Certain directors of the Company and companies with which they are affiliated
and certain principal officers are customers of, and have banking transactions
with, the Banks 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, 1997 and 1996:
Year Ended
December 31,
------------------
1997 1996
------------------
(Amounts In
Thousands)
Balance, beginning .............. $ 9,232 $ 9,548
Advances ..................... 2,243 1,502
Collections .................. (964) (1,818)
------------------
Balance, ending ................. $10,511 $ 9,232
==================
Deposits from related parties are accepted subject to the same interest rates
and terms as those from nonrelated parties.
Note 11. Fair Value of Financial Instruments
The carrying value and estimated fair values of the Company's financial
instruments as of December 31, 1997 and 1996 are as follows:
1997 1996
---------------------------------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
---------------------------------------------------
(Amounts In Thousands)
Cash and due from banks ...................................... $ 15,508 $ 15,508 $ 15,036 $ 15,036
Federal funds sold ........................................... 2,447 2,447 1,107 1,107
Investment securities ........................................ 138,064 138,454 132,635 132,769
Loans ........................................................ 422,761 431,806 368,264 374,804
Accrued interest receivable .................................. 5,441 5,441 4,884 4,884
Deposits ..................................................... 479,770 480,780 450,061 451,114
Securities sold under agreements
to repurchase ............................................. 9,008 9,008 6,071 6,071
Borrowings from Federal Home Loan
Bank ...................................................... 50,764 50,678 25,795 26,629
Accrued interest payable ..................................... 2,060 2,060 1,952 1,952
Face Amount Face Amount
----------- -----------
Off-balance sheet instruments:
Loan commitments .......................................... $ 97,530 $ - - $ 72,322 $ - -
Letters of credit ......................................... 9,779 - - 9,583 - -
Note 12. Parent Company Only Financial Information
Following is condensed financial information of the Company (parent company
only):
BALANCE SHEETS
December 31, 1997 and 1996
(Amounts In Thousands)
ASSETS 1997 1996
- ---------------------------------------------------------------------------
Cash ................................................... $ 408 $ 294
Investment securities available for sale ............... 300 1,181
Investment in subsidiary banks ......................... 57,774 52,355
Other assets ........................................... 940 693
-----------------
Total assets ............................. $59,422 $54,523
=================
LIABILITIES AND STOCKHOLDERS' EQUITY
- ---------------------------------------------------------------------------
Liabilities ............................................ $ 240 $ 772
----------------
Redeemable common stock held by ESOP ................... 7,682 6,416
----------------
Stockholders' equity:
Capital stock ....................................... 9,070 8,997
Retained earnings ................................... 49,627 44,078
Unrealized gains on investment securities, net ...... 485 676
----------------
59,182 53,751
Less maximum cash obligation related to ESOP shares . 7,682 6,416
----------------
Total stockholders' equity ............... 51,500 47,335
----------------
Total liabilities and stockholders' equity $59,422 $54,523
================
STATEMENTS OF INCOME
Years Ended December 31, 1997, 1996 and 1995
(Amounts In Thousands)
1997 1996 1995
- ----------------------------------------------------------------------------------
Interest on investment securities ................... $ 17 $ 15 $ 20
Gain on sale of investment security ................. 1,054 - - - -
Dividends received from subsidiaries ................ 2,515 9,422 1,272
Contributions ....................................... (1,054) - - - -
Other expenses ...................................... (102) (67) (20)
---------------------------
Income before income taxes and equity
in subsidiaries' undistributed income 2,430 9,370 1,272
Income tax benefit .................................. 370 22 2
---------------------------
2,800 9,392 1,274
Equity in subsidiaries' undistributed income ........ 4,286 (3,248) 3,983
---------------------------
Net income ............................ $ 7,086 $ 6,144 $ 5,257
===========================
STATEMENTS OF CASH FLOWS
Years Ended December 31, 1997, 1996 and 1995
(Amounts In Thousands)
1997 1996 1995
- ---------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income ......................................... $ 7,086 6,144 $ 5,257
Noncash items included in net income:
Undistributed earnings of subsidiaries .......... (4,286) 3,248 (3,983)
(Increase) decrease in other assets ............. (174) (414) 39
Increase in liabilities ......................... (225) 464 - -
-----------------------------
Net cash provided by operating activities 2,401 9,442 1,313
-----------------------------
Cash flows from investing activities:
Investment in subsidiary banks ..................... (750) (8,073) - -
Proceeds from maturities of investment securities .. - - 300 300
Purchase of investment securities .................. - - (300) (300)
-----------------------------
Net cash (used in) investing activities . (750) (8,073) - -
-----------------------------
Cash flows (used in) financing activities,
cash dividends paid ................................ (1,537) (1,391) (1,268)
-----------------------------
Increase (decrease) in cash ............. 114 (22) 45
Cash balance:
Beginning .......................................... 294 316 271
-----------------------------
Ending ............................................. $ 408 294 $ 316
=============================
Note 13. Commitments and Contingencies
Concentrations of credit risk: All of the Banks' loans, commitments to extend
credit, unused lines of credit and outstanding letters of credit have been
granted to customers within each Bank's market area. Investments in securities
issued by state and political subdivisions within the state of Iowa totaled
approximately $11,006,000. 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 Banks have 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 Banks 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.
Year 2000 plans: Information technology experts believe that many data
processing application systems could fail or improperly perform as a result of
erroneous calculation or data integrity problems if they are unable to process
data information beyond December 31, 1999, an issue known as Year 2000. The
Company is heavily dependent upon computer processing and has addressed this
issue by forming a Year 2000 committee responsible for identifying and testing
critical applications and vendors. The Company expects the plan to be completed
by December 31, 1998. Management believes the costs associated with Year 2000
will not be material to the financial statements.
Financial instruments with off-balance sheet risk: The Banks are parties to
financial instruments with off-balance sheet risk in the normal course of
business to meet the financing needs of their customers. These financial
instruments include commitments to extend credit, credit card participations and
standby letters of credit. These instruments involve, to varying degrees,
elements of credit risk in excess of the amount recognized in the balance
sheets.
The Banks' 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 Banks use the same credit policies in making
commitments and conditional obligations as they do for on-balance sheet
instruments. A summary of the Banks' commitments at December 31, 1997 and 1996
is as follows:
1997 1996
----------------
(Amounts In
Thousands)
Firm loan commitments and unused portion of lines of credit:
Home equity loans ....................................... $ 4,861 $ 3,979
Credit card participants ................................ 6,896 6,336
Commercial, real estate and home construction ........... 38,784 23,862
Commercial lines ........................................ 46,989 38,145
Outstanding letters of credit .............................. 9,779 9,583
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
Banks evaluate each customer's credit worthiness on a case-by-case basis. The
amount of collateral obtained, if deemed necessary by the Bank upon extension of
credit, is based on management's credit evaluation of the party. Collateral held
varies, but may include accounts receivable, crops, livestock, inventory,
property and equipment, residential real estate and income-producing commercial
properties. Credit card participations are the unused portion of the holders'
credit limits. Such amounts represent the maximum amount of additional unsecured
borrowings.
Outstanding letters of credit are the conditional commitments issued by the
Banks to guarantee the performance of a customer to a third party and
collateralize the customer's borrowing arrangement with other creditors. The
credit risk involved in issuing letters of credit is essentially the same as
that involved in extending loan facilities to customers. Collateral held varies
as specified above and is required in instances which the Banks deem necessary.
Note 14. Business Acquisitions
Effective July 1, 1996, the Company acquired for cash all of the outstanding
shares of LBC, Inc., which owned 100% of the outstanding shares of Alliance
Bancorporation, which held 100% of the outstanding shares of the Lisbon Bank and
Trust Company, Lisbon, Iowa. The total acquisition cost was $3,042,000. The
excess of the total acquisition cost over the fair value of the net assets
acquired of $1,373,000 is being amortized over 15 years by the straight-line
method.
The Company chartered a new subsidiary bank, Hills Bank Kalona, and on September
20, 1996, the subsidiary bank acquired cash, certain assets and assumed the
deposits of the Kalona, Iowa office of Boatmen's Bank Iowa, N.A. The total
acquisition cost was $5,031,000. The excess of the cost over the fair value of
the net assets acquired was $2,523,000 and is being amortized over 15 years by
the straight-line method.
The acquisitions were accounted for as purchases and the results of operations
since the acquisition dates are included in the consolidated financial
statements.
Unaudited pro forma net income for 1996 and 1995, as though the Banks had been
acquired as of January 1, 1994, is not significantly different than reported net
income of the Company after consideration of goodwill amortization and imputed
interest on borrowed funds.
A summary of the net assets acquired of these two institutions is as follows:
(Amounts
In
Thousands)
----------
Cash purchase price .......................................... $ 8,073
========
Assets acquired:
Cash and due from banks ................................... $ 910
Investment securities available for sale .................. 6,640
Federal funds sold ........................................ 11,448
Loans ..................................................... 20,665
Property and equipment .................................... 1,438
Accrued interest receivable ............................... 317
Intangible assets ......................................... 3,896
Other assets .............................................. 1,938
Liabilities assumed:
Deposits and accrued interest ............................. (39,019)
Borrowings from FHLB ...................................... (100)
Other liabilities ......................................... (60)
--------
$ 8,073
========
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 45 Director of Registrant and Bank; President, Registrant and Bank 1986 (1975)
Willis M. Bywater 59 Director of Registrant and Bank; Chairman of the Board, Bank; 1997
Vice President of the Registrant; Executive Officer and Shareholder
of Economy Advertising Company
Earl M. Yoder 70 Director of Registrant and Bank; Vice President of the Registrant; 1997
Executive Officer and Shareholder of Iowa City Ready Mix, Inc.
James G. Pratt 49 Treasurer of Registrant; Senior Vice President from January 1986 1985 (1982)
to present
Thomas J. Cilek 51 Secretary of Registrant; Senior Vice President of Bank from 1988 (1986)
August 1986 to present
PART III
Item 11. Executive Compensation
Information required by this item is contained in the Registrant's Proxy
Statement under the heading "Executive Compensation and Benefits," which section
is incorporated herein by this reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information required by this item is contained in the Registrant's Proxy
Statement under the heading "Security Ownership of Certain Beneficial Owners and
Management" and "Report on Executive Compensation," which sections are
incorporated herein by this reference.
Item 13. Certain Relationships and Related Transactions
Information required by this item is contained in the Registrant's Proxy
Statement under the heading "Loans To and Certain Other Transactions With
Executive Officers and Directors," which section is incorporated herein by this
reference.
PART IV
Item 14. Exhibits, Financial Statements, Schedules, and Reports on Form 8-K
Form 10-K
Reference
-------------
(a) 1. Financial Statements
Independent auditor's report on the financial statements
Consolidated balance sheets as of December 31, 1997 and 1996
Consolidated statements of income for the years ended December 31, 1997, 1996 and 1995
Consolidated statements of stockholders' equity for the years ended
December 31, 1997, 1996 and 1995
Consolidated statements of cash flows for the years ended December 31, 1997, 1996 and 1995
Notes to financial statements
(a) 2. Financial Statements Schedules
All schedules are omitted because they are not applicable or not
required, or because the required information is included in the
consolidated financial statements or notes thereto.
(a) 3. Exhibits
Exhibit 3 - Articles of Incorporation and Bylaws filed as Exhibit 3 of
Form 10-K for the year ended December 31, 1993 are incorporated by
reference.
Exhibit 10(a) - Material Contract (Employee Stock Ownership Plan) filed
as Exhibit 10(a) in Form 10-K for the year ended December 31, 1993 is
incorporated by reference.
Exhibit 10(b) - Material Contract (1993 Stock Incentive Plan) filed as
Exhibit 10(b) in Form 10-K for the year ended December 31, 1993 is
incorporated by reference.
Exhibit 10(c) - Material contract (1995 Deferred Compensation Plans)
filed as Exhibit 10(c) in Form 10-K for the year ended December 31,
1995 is incorporated by reference.
Exhibit 11 - Statement Re Computation of Basic and Diluted Earnings Per
Share is attached on Page 65.
Exhibit 21 - Subsidiaries of the Registrant is attached on Page 66.
Exhibit 23 - Consent of Accountants is attached on Page 67.
Exhibit 27 - Financial Data Schedule is attached on Pages 68 and 69.
(b) Reports on Form 8-K:
There were no reports on Form 8-K for the three months ended December
31, 1997.
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 30, 1998 By /s/ Dwight O. Seegmiller
------------------------- -------------------------------------------
Dwight O. Seegmiller, Director and
President
Date MARCH 30, 1998 By /s/ James G. Pratt
------------------------- -------------------------------------------
James G. Pratt, Treasurer and Chief
Accounting Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
Date MARCH 30, 1998 By /s/ Willis M. Bywater
------------------------- -------------------------------------------
Willis M. Bywater, Director
Date MARCH 30, 1998 By /s/ Thomas J. Gill
------------------------- -------------------------------------------
Thomas J. Gill, Director
Date MARCH 30, 1998 By /s/ Donald H. Gringer
------------------------- -------------------------------------------
Donald H. Gringer, Director
Date MARCH 30, 1998 By /s/ Richard W. Oberman
------------------------- -------------------------------------------
Richard W. Oberman, Director
Date MARCH 30, 1998 By /s/ Theodore H. Pacha
------------------------- -------------------------------------------
Theodore H. Pacha, Director
Date MARCH 30, 1998 By /s/ Ann M. Rhodes
------------------------- -------------------------------------------
Ann M. Rhodes, Director
Date MARCH 30, 1998 By /s/ Ronald E. Stutsman
------------------------- -------------------------------------------
Ronald E. Stutsman, Director
Date MARCH 30, 1998 By /s/ Earl M. Yoder
------------------------- -------------------------------------------
Earl M. Yoder, Director
Date MARCH 30, 1998 By /s/ Sheldon E. Yoder
------------------------- -------------------------------------------
Sheldon E. Yoder
HILLS BANCORPORATION
ANNUAL REPORT ON FORM 10-K FOR THE
FISCAL YEAR ENDED DECEMBER 31, 1996
EXHIBIT INDEX
Page Number
In The Sequential
Exhibit Numbering System
Number Description For 1997 Form 10-K
- ------------------------------------------------------------------------------------------------------------------------------
11 Statement Re Computation of Basic and Diluted Earnings Per Share
21 Subsidiaries of the Registrant
23 Consent of Independent Certified Public Accountants
27 Financial Data Schedule