UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2004
Commission file number: 0-12668
Hills Bancorporation
Incorporated in Iowa I.R.S. Employer Identification
dNo. 42-1208067
131 MAIN STREET, HILLS, IOWA 52235
Telephone number: (319) 679-2291
Indicate by checkmark 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.
|X| Yes |_| No
Indicate by checkmark whether the Registrant is an accelerated filer (as defined
by Rule 12b-2 of the Securities Exchange Act of 1934).
|X| Yes |_| No
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date.
SHARES OUTSTANDING
CLASS At April 30, 2004
----- -----------------
Common Stock, no par value 4,550,256
Page 1 of 27
HILLS BANCORPORATION
Index to Form 10-Q
Part I
FINANCIAL INFORMATION
Page
Number
------
Item 1. Financial Statements
Consolidated balance sheets, March 31, 2004 (unaudited)
and December 31, 2003. 3
Consolidated statements of income, (unaudited) for three
months ended March 31, 2004 and 2003. 4
Consolidated statements of comprehensive income, (unaudited) for
three ended March 31, 2004 and 2003. 5
Consolidated statements of stockholders' equity, (unaudited)
for three months ended March 31, 2004 and 2003. 6
Consolidated statements of cash flows (unaudited) for three
months ended March 31, 2004 and 2003. 7-8
Notes to consolidated financial statements 9-10
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 11-17
Item 3. Quantitative and Qualitative Disclosures About Market Risk 18
Item 4. Controls and Procedures 19
Part II
OTHER INFORMATION
Item 1. Legal proceedings 20
Item 2. Changes in securities and use of proceeds 20
Item 3. Defaults upon senior securities 20
Item 4. Submission of matters to vote of security holders 20
Item 5. Other information 20-21
Item 6. Exhibits and reports on Form 8-K 22
Signatures 23
Exhibits Index 24
Page 2 of 27
HILLS BANCORPORATION
CONSOLIDATED BALANCE SHEETS
(Amounts In Thousands, Except Shares)
March 31, 2004
ASSETS (Unaudited) December 31, 2003*
- ------------------------------------------------------------------------------------------------------------------------
Cash and due from banks $ 21,508 $ 24,194
Investment securities:
Available for sale (amortized cost March 31, 2004 $211,107 ;
December 31, 2003 $214,530) 216,773 219,430
Held to maturity (fair value March 31, 2004 $7,744 ; December 31, 2003 $8,064) 7,654 7,953
Stock of Federal Home Loan Bank 8,774 8,774
Federal funds sold 100 13,233
Loans held for sale 8,476 1,960
Loans, net 898,031 868,194
Property and equipment, net 22,229 22,210
Tax credit real estate 8,178 2,282
Accrued interest receivable 7,246 7,303
Deferred income taxes 2,127 2,411
Goodwill 2,500 2,500
Other assets 2,747 3,077
----------------------------------
$1,206,343 $1,183,521
==================================
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------------------------------------------------------------------------------------------
Liabilities
Noninterest-bearing deposits $ 116,372 $ 116,206
Interest-bearing deposits 775,762 752,446
----------------------------------
Total deposits $ 892,134 $ 868,652
Federal funds purchased and securities sold under agreements to repurchase 27,257 29,926
Federal Home Loan Bank borrowings ("FHLB") 167,574 167,574
Accrued interest payable 1,561 1,735
Other liabilities 5,521 4,005
----------------------------------
$1,094,047 $1,071,892
----------------------------------
REDEEMABLE COMMON STOCK HELD BY EMPLOYEE STOCK
OWNERSHIP PLAN (ESOP) $ 15,306 $ 14,864
----------------------------------
STOCKHOLDERS' EQUITY**
Capital stock, no par value; authorized 10,000,000 shares;
issued March 31, 2004 1,516,752 shares; December 31, 2003 1,516,678 shares $ 11,360 $ 11,353
Retained earnings 97,366 97,189
Accumulated other comprehensive income 3,570 3,087
----------------------------------
$ 112,296 $ 111,629
Less maximum cash obligation related to ESOP shares 15,306 14,864
----------------------------------
$ 96,990 $ 96,765
----------------------------------
$1,206,343 $1,183,521
==================================
* Derived from audited financial statements.
** See Part II - Item 5 (a) for details of a stock split effective April 19,
2004.
See Notes to Consolidated Financial Statements.
Page 3 of 27
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(Amounts In Thousands, Except Per Share Amounts)
Three Months Ended
March 31,
2004 2003
- ---------------------------------------------------------------------------------------------------------------
Interest income:
Loans, including fees $ 13,475 $ 13,431
Investment securities:
Taxable 1,423 1,680
Nontaxable 602 602
Federal funds sold 15 101
----------------------------
Total interest income $ 15,515 $ 15,814
----------------------------
Interest expense:
Deposits $ 3,530 $ 4,560
Federal funds purchased and securities sold under agreements to repurchase 74 93
FHLB borrowings 2,266 2,242
----------------------------
Total interest expense $ 5,870 $ 6,895
----------------------------
Net interest income $ 9,645 $ 8,919
Provision for loan losses 354 484
----------------------------
Net interest income after provision for loan losses $ 9,291 $ 8,435
----------------------------
Other income:
Net gain on sale of loans $ 351 $ 865
Trust fees 710 619
Deposit account charges and fees 886 873
Other fees and charges 1,102 898
----------------------------
$ 3,049 $ 3,255
----------------------------
Other expenses:
Salaries and employee benefits $ 4,064 $ 3,680
Occupancy 502 456
Furniture and equipment 806 734
Office supplies and postage 271 326
Advertising and business development 414 276
Other 1,421 1,179
----------------------------
$ 7,478 $ 6,651
----------------------------
Income before income taxes $ 4,862 $ 5,039
Federal and state income taxes 1,500 1,658
----------------------------
Net income $ 3,362 $ 3,381
============================
Earnings per share:
Basic $ 2.22 $ 2.25
Diluted 2.21 2.23
See Notes to Consolidated Financial Statements.
Page 4 of 27
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(Amounts In Thousands)
Three Months Ended
March 31,
2004 2003
- -----------------------------------------------------------------------------------------------
Net income $ 3,362 $ 3,381
Other comprehensive income,
Unrealized holding gains (losses) arising during the period,
net of income taxes, 2004 $283; 2003 $(204) 483 (347)
--------------------------
Comprehensive income $ 3,845 $ 3,034
==========================
See Notes to Consolidated Financial Statements.
Page 5 of 27
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited)
(Amounts In Thousands, Except Share Amounts)
Maximum
Cash
Accumulated Obligation
Other Related
Capital Retained Comprehensive To ESOP
Stock Earnings Income (Loss) Shares Total
- --------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2002 $ 10,541 $ 85,773 $ 4,721 $ (12,951) $ 88,084
Change related to ESOP shares -- -- -- (658) (658)
Net income -- 3,381 -- -- 3,381
Cash dividends ($1.90 per share) -- (2,853) -- -- (2,853)
Other comprehensive income -- -- (347) -- (347)
----------------------------------------------------------------------------
Balance, March 31, 2003 $ 10,541 $ 86,301 $ 4,374 $ (13,609) $ 87,607
============================================================================
Balance, December 31, 2003 $ 11,353 $ 97,189 $ 3,087 $ (14,864) $ 96,765
Issuance of 74 shares of
common stock 7 -- -- -- 7
Change related to ESOP shares -- -- -- (442) (442)
Net income -- 3,362 -- -- 3,362
Cash dividends ($2.10 per share) -- (3,185) -- -- (3,185)
Other comprehensive income -- -- 483 -- 483
----------------------------------------------------------------------------
Balance, March 31, 2004 $ 11,360 $ 97,366 $ 3,570 $ (15,306) $ 96,990
============================================================================
See Notes to Consolidated Financial Statements.
Page 6 of 27
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Amounts In Thousands)
Three Months Ended
March 31,
2004 2003
- -------------------------------------------------------------------------------------------
Cash Flows from Operating Activities
Net income $ 3,362 $ 3,381
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 619 565
Provision for loan losses 354 484
Compensation paid by issuance of common stock 7 --
Deferred income taxes -- 124
Decrease in accrued interest receivable 57 202
Amortization of bond discount 334 166
Decrease in other assets 330 377
Increase in accrued interest and other liabilities 1,342 1,427
Loans originated for sale (39,613) (73,028)
Proceeds on sales of loans 33,448 63,383
Net gain on sales of loans (351) (865)
--------------------------
Net cash using in operating activities $ (111) $ (3,784)
--------------------------
Cash Flows from Investing Activities
Proceeds from maturities of investment securities:
Available for sale $ 23,394 $ 16,500
Held to maturity 299 675
Purchases of investment securities available for sale (20,305) (12,569)
Federal funds sold, net 13,133 (21,730)
Loans made to customers, net of collections (30,191) (25,250)
Purchases of property and equipment (638) (1,128)
Investment in tax credit real estate (5,896) --
--------------------------
Net cash used in investing activities $(20,204) $(43,502)
--------------------------
Cash Flows from Financing Activities
Net increase in deposits $ 23,483 $ 41,566
Net increase (decrease) in federal funds purchased and
securities sold under agreements to repurchase (2,669) 7,029
Dividends paid (3,185) (2,853)
--------------------------
Net cash provided by financing activities $ 17,629 $ 45,742
--------------------------
(Continued)
Page 7 of 27
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Continued
(Amounts In Thousands)
Three Months Ended
March 31,
2004 2003
- -------------------------------------------------------------------------------------
Increase (decrease) in cash and due from banks $ (2,686) $ (1,544)
Cash and due from banks:
Beginning 24,194 32,647
--------------------------
Ending $ 21,508 $ 31,103
==========================
Supplemental Disclosures
Cash payments for:
Interest paid to depositors $ 3,704 $ 4,712
Interest paid on other obligations 2,340 2,335
Income taxes 14 725
Noncash financing activities:
Increase in maximum cash obligation related to
ESOP shares $ 442 $ 658
See Notes to Consolidated Financial Statements.
Page 8 of 27
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Basis of Presentation
The accompanying unaudited consolidated financial statements have
been prepared in accordance with accounting principles generally
accepted in the United States of America for interim financial
reporting and with instructions for Form 10-Q and Regulation S-X.
These financial statements include all adjustments (consisting of
normal recurring accruals) which in the opinion of management are
considered necessary for the fair presentation of the financial
position and results of operations for the periods shown. Certain
prior year amounts may be reclassified to conform to the current
year presentation.
Operating results for the three month period ended March 31, 2004
are not necessarily indicative of the results that may be expected
for the fiscal year ending December 31, 2004. For further
information, refer to the consolidated financial statements and
footnotes thereto included in the Form 10-K Annual Report of Hills
Bancorporation and subsidiary (the "Company") for the year ended
December 31, 2003 filed with the Securities Exchange Commission on
March 11, 2004.
Note 2. Earnings Per Share
Basic earnings per share amounts are computed by dividing net income
(the numerator) by the weighted average number of common shares
outstanding (the denominator) during the period. Diluted per share
amounts assume the conversion, exercise or issuance of all potential
common stock equivalents unless the effect is to reduce the loss or
increase the income per common share from continuing operations.
The computation of basic and diluted earnings per share for the
periods presented is as follows:
Three months ended
2004 2003
------------ ------------
Common shares outstanding at the beginning of the year 1,516,678 1,501,054
Weighted average number of net shares issued (redemption) 37 0
------------ ------------
Weighted average shares outstanding (basic) 1,516,715 1,501,054
Weighted average of potential dilutive shares
attributable to stock options granted, computed under
the treasury stock method 4,641 13,408
------------ ------------
Weighted average number of shares (diluted) 1,521,356 1,514,462
============ ============
Net income (In Thousands) $ 3,362 $ 3,381
============ ============
Earnings per share:
Basic $ 2.22 $ 2.25
============ ============
Diluted $ 2.21 $ 2.23
============ ============
Page 9 of 27
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 3. Recent Accounting Pronouncement
In December, 2003, the FASB issued a revised Interpretation No. 46,
Consolidation of Variable Interest Entities (FIN 46). FIN 46 addresses
consolidation by business enterprises of variable interest entities that have
certain characteristics. It requires a business enterprise that has a
controlling interest in a variable interest entity (as defined by FIN 46) to
include the assets, liabilities, and results of the activities of the variable
interest entity in the consolidated financial statements of the business
enterprise. FIN 46 applies to a public entity that is not a small business
issuer no later than the end of the first reporting period that ends after March
15, 2004. The impact of adopting FIN 46 on the Company's financial condition and
results of operations was not material.
Page 10 of 27
HILLS BANCORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition And Results
of Operations
The following is management's discussion and analysis of the financial condition
of Hills Bancorporation and subsidiary ("Hills Bancorporation" or the "Company")
at March 31, 2004, (unaudited) when compared with December 31, 2003 and the
results of operations for the three months ended March 31, 2004 compared to the
same period in 2003.
Special Note Regarding Forward Looking Statements
The discussion following contains certain forward-looking statements with
respect to the financial condition, the results of operations and business of
the Company. These statements involve certain risks and uncertainties, which are
often inherent in the ongoing operation of financial institutions such as the
Company's subsidiary bank.
Forward-looking statements discuss matters that are not facts and are typically
identified by the words "believe," "expect," "anticipate," "target," "goal,"
"objective," "intend," "estimate," "will," "can," "would," "should," "could,"
"may" and similar expressions. They discuss expectations about the future and
are not guarantees. Forward-looking statements speak only as of the date they
are made, and the Company undertakes no obligation to update them to reflect
changes that occur after the date they are made.
There are several factors - many of which are beyond the control of the Company
or its subsidiary Bank that could cause results to differ significantly from
expectations. Some of these factors are described below. There are factors other
than those described below that could cause results to differ from expectations.
Any factor described below could by itself, or together with one or more other
factors, adversely affect the business, earnings and/or financial condition of
the Company and its subsidiary Bank.
The risks involved in the operations and strategies of the Company and its
subsidiary Bank include competition from other financial institutions, changes
in interest rates, changes in economic or market conditions as well as events
and trends affecting specific assets, the effect of credit quality and market
perceptions of value on the fair values of financial instruments and regulatory
factors. These risks, which are not inclusive, cannot be accurately estimated.
For example, a financial institution may accept deposits at fixed interest
rates, at different times and for different terms, and lend funds at fixed
interest rates, at different times and for different terms. In doing so, it
accepts the risk that its cost of funds may raise while the use of those funds
may be at a fixed rate. Similarly, although market rates of interest may
decline, the financial institution may have committed by virtue of the term of a
deposit, to pay what essentially becomes an above-market rate.
Loans, and the allowance for loan losses, carry the risk that borrowers will not
repay all funds in a timely manner, as well as the risk of total loss. The
collateral pledged as security for loans may or may not have the value that has
been attributed to it. The loan loss reserve, while believed to be adequate, may
prove inadequate if one or more large-balance borrowers, or numerous mid-balance
borrowers, or a combination of both, experience financial difficulty for a
variety of reasons. These reasons may relate to the financial circumstances of
an individual borrower, or may be caused by negative economic circumstances at
the local, regional, national or international level that are beyond the control
of the borrowers or the lender.
Page 11 of 27
HILLS BANCORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition And Results
of Operations (continued)
Because the business of banking is of a highly regulated nature, the decisions
of governmental entities can have a major effect on operating results. Changes
to statutes, regulations or regulatory policies, including changes in
interpretation or implementation of statutes, regulations or policies, could
have substantial and unpredictable effects including increasing the ability of
non-banks to offer competing financial services and products.
The Bank's success depends, in part, on its ability to attract and retain key
people. Competition for the best people - in particular individuals with
technology experience - is intense. The Bank may not be able to hire
well-qualified people or pay them enough to keep them.
All of these uncertainties, as well as others, are present in the operations and
business of the Company, and stockholders are cautioned that the Company's
actual results may differ materially from those included in the forward-looking
statements.
Critical Accounting Policies
The Company's financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America. The financial
information contained within these statements is, to a significant extent,
financial information that is based on approximate measures of the financial
effects of transactions and events that have already occurred. Based on its
consideration of accounting policies that involve the most complex and
subjective decisions and assessments, management has identified its most
critical accounting policies to be related to the allowance for loan losses. The
Company's allowance for loan loss methodology incorporates a variety of risk
considerations, both quantitative and qualitative in establishing an allowance
for loan loss that management believes is appropriate at each reporting date.
Quantitative factors include the Company's historical loss experience,
delinquency and charge-off trends, collateral values, changes in non-performing
loans, and other factors. Quantitative factors also incorporate known
information about individual loans, including borrowers' sensitivity to interest
rate movements. Qualitative factors include the general economic environment in
the Company's markets, including economic conditions throughout the Midwest and
in particular, the state of certain industries. Size and complexity of
individual credits in relation to loan structure, existing loan policies and
pace of portfolio growth are other qualitative factors that are considered in
the methodology. As the Company adds new products and increases the complexity
of its loan portfolio, it will enhance its methodology accordingly. This
discussion and analysis should be read in conjunction with the Company's
financial statements and the accompanying notes presented elsewhere herein, as
well as the portion of this Management's Discussion and Analysis section
entitled "Financial Condition - Allowance for Loan Losses". Although management
believes the levels of the allowance as of March 31, 2004 and December 31, 2003
were adequate to absorb probable losses inherent in the loan portfolio, a
decline in local economic conditions, or other factors, could result in
increasing losses that cannot be reasonably predicted at this time.
Page 12 of 27
HILLS BANCORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition And Results
of Operations (continued)
Financial condition at March 31, 2004 compared to December 31, 2003.
Assets and Liabilities Review
Total assets grew to $1.206 billion at March 31, 2004, compared to total assets
of $1.184 billion at December 31, 2003. The asset growth of $22.8 million
includes an increase in net loans of $29.8 million. Loans held for sale to the
secondary market increased $6.5 million to $8.5 million at March 31, 2004. The
change is due to the volume of secondary market loans increasing in the last six
weeks of the quarter compared to the quarter ended December 31, 2003. The volume
change is due to a drop in rates in the first quarter of 2004 compared to the
quarter ended December 31, 2003. Other significant changes in assets on the
balance sheet for the two periods presented include a reduction in federal funds
sold of $13.1 million, an increase in the investment in tax credit real estate
of $5.9 million and a reduction of cash and investment securities of $5.6
million. The liabilities of the Company increased a net $22.2 million as of
March 31, 2004. This increase in net liabilities was primarily the result of a
net increase in deposits and short-term borrowings of $20.8 million.
The table below sets forth the composition of the loan portfolio as of March 31,
2004 and December 31, 2003
(in thousands):
March 31, 2004 December 31, 2003
Amount Percent Amount Percent
--------------------- ------------------------
Agricultural $ 38,881 4.27% $ 38,153 4.33%
Commercial and financial 50,820 5.58 47,938 5.44
Real estate:
Construction 63,240 6.94 66,644 7.57
Mortgage 724,705 79.55 696,453 79.07
Loans to indivuals 33,365 3.66 31,591 3.59
--------- ------ ---------- ------
$ 911,011 100.00% $ 880,779 100.00%
========= ====== ========== ======
Less allowance for loan losses (12,980) (12,585)
--------- ----------
Loans, net $ 898,031 $ 868,194
========= ==========
Changes in the allowance for loan losses were as follows:
Three months ended
March 31,
2004 2003
-------- --------
(Amounts in thousands)
Balance, beginning $ 12,585 $ 12,125
Provision charged to expense 354 484
Recoveries 269 342
Loans charged off (228) (421)
-------- --------
Balance, ending $ 12,980 $ 12,530
======== ========
Page 13 of 27
HILLS BANCORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition And Results
of Operations (continued)
Non-performing loan information at March 31, 2004 and December 31, 2003, was as
follows:
March 31, 2004 December 31, 2003
2004 2003
-------------- -----------------
(Amounts in thousands)
Impaired loans, non-accrual $ 3,670 $ 3,944
Loans past due ninety days or more and still accruing 2,087 2,296
Restructured loans -- --
Interest rates remained relatively stable during the first quarter of 2004. As a
result of stable interest rates, the growth of the loan portfolio continued as
the overall economy in the Company's primary trade area in Johnson and Linn
County remained positive. The increase in deposits for the first three months of
2004 reflects the continued marketing of deposits in this local economy and
steady deposit increase at the twelve banking locations.
Dividends and Equity
In January 2004, Hills Bancorporation paid a dividend of $3,185,000 or $2.10 per
share, a 10.53% increase from the $1.90 paid in January 2003. After payment of
the dividend and the adjustment for accumulated other comprehensive income,
stockholders' equity as of March 31, 2004 totaled $96,990,000. Under risk-based
capital rules, the total risk based capital is 14.13% of risk-adjusted assets,
and is substantially in excess of required minimums.
Page 14 of 27
HILLS BANCORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition And Results
of Operations (continued)
Results of operations for the three months ended March 31, 2004 and 2003.
Net income decreased for the quarter ended March 31, 2004 compared to March 31,
2003 by $19,000. Net interest income increased $726,000 in 2004 compared to
2003. 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 factors that have the greatest impact on net interest income
are the volume of average earning assets and the net interest margin. The volume
of average earning assets continues to have significant increases. In comparing
the earning assets as of March 31, 2004 to March 31, 2003, the increase is $76
million. Net loan growth accounts for a $90 million increase while federal funds
and investments have decreased $14 million. The net interest margin continues to
remain steady at 3.53% for the first quarter of 2004 compared to 3.51% for the
same quarter in 2003. The measure is shown on a tax-equivalent basis using a
rate of 34% to make the interest earned on taxable and non-taxable assets more
comparable. The provision for loan losses was $354,000 and $484,000 for the
three months ended March 31, 2004 and 2003, respectively. The Company
experienced net recoveries in the first quarter of 2004 of $41,000 compared to
net charge-offs of $79,000 in the first quarter of 2003. The provision
adjustment computed on a quarterly basis is a result of management's
determination of the quality of the loan portfolio and the adequacy of the
allowance for loan losses. The provision reflects a number of factors, including
the size of the loan portfolio, loan concentrations, the level of impaired loans
which are all non-accrual and loans past due ninety days or more. In addition,
management considers the credit quality of the loan portfolio based on review of
problem and watch loans, including loans with historically higher credit risks
(primarily agricultural loans).
The allowance for loan losses totaled $12,980,000 at March 31, 2004 compared to
$12,530,000 at March 31, 2003. The percentage of the allowance to outstanding
loans was 1.42% and 1.54% at March 31, 2004 and 2003, respectively. The
allowance was based on management's consideration of a number of factors,
including loan concentrations, loans with higher credit risks (primarily
agriculture loans and spec real estate construction) and overall increases in
net loans outstanding. The methodology used in 2004 is consistent with the prior
year.
Net gain on sale of loans for the quarter ended March 31, 2004 were $351,000
compared to $865,000 for the same period ended March 31, 2003. The decrease was
expected as net gain on sale of secondary market loans dropped significantly
from the levels experienced in the first three quarters of 2003. The decrease in
the volume of loans is due to the fact that many consumers had taken advantage
of lower rates in 2003 to refinance loans and rates remain similar to rates that
existed during the summer of 2003, resulting in additional refinancing activity.
Trust fees increased $91,000 or 14.71% in the first quarter of 2004 compared to
2003 and is due to the increase in total assets under management. Since
approximately 51% of the trust assets are held in common stocks the asset growth
has been fueled by the increase in the stock market the last twelve months. For
example, the Dow Jones Industrial Average is up just over 25% in the twelve
months ended March 31, 2004. Other fees and charges increased for the two
quarters shown from $898,000 in 2003 to $1,102,000 in 2004 or $204,000.
Approximately $60,000 of the increased revenue is in ATM service fees and credit
card merchant fees. In addition, rental revenue from a new tax credit real
estate property added in January, 2004 was $81,000 higher in 2004 than in 2003.
Page 15 of 27
HILLS BANCORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition And Results
of Operations (continued)
Total other expenses were $7,478,000 and $6,651,000 for the three months ended
March 31, 2004 and 2003, respectively. The increase of $827,000 included
salaries and employee benefits which were $384,000 higher. The increase in
direct salaries was $291,000 or 10.47%. The increase is due to salary
adjustments for 2004 and full-time equivalents increasing. Increased employment
resulted in part from the need to staff the Marion office that opened in
February of 2003. Medical expenses on the Company's self-funding plan increased
by $69,000 for the quarter from one year ago and are a result of higher medical
costs and more employees in the plan.
Other expenses were $1,421,000 for the quarter ended March 31, 2004 compared to
$1,179,000 for the three months ended March 31, 2003. The increase of $242,000
included a $138,000 increase in the advertising and business development
expenses primarily costs associated with the 2004, 100th Anniversary celebration
of the registrant's.
Merchant card processing charges were $37,000 higher in 2004 than 2003 and were
related to the increased volume of activity. Also, expenses for the rental of
the tax credit real estate increased from $66,000 in the three months ended
March 31, 2003 to $163,000 for the same period in 2004. The increase is due to a
new property added in January of 2004.
Income tax expense was $1,500,000 and $1,658,000 for the three months ended
March 31, 2004 and 2003, respectively. The corresponding percentage of income
taxes compared to income before income taxes is 30.85% in 2004 and 32.90% in
2003. The percentage in 2004 is lower due to higher income tax credits available
from the tax credit real estate investments. The credits were $132,000 and
$59,000 for the quarters ended March 31, 2004 and 2003, respectively.
Liquidity
The Company actively monitors and manages its liquidity position with the
objective of maintaining sufficient cash flows to fund operations, meet client
commitments, take advantage of market opportunities and provide a margin against
unforeseeable liquidity needs. Federal funds sold and investment securities
available for sale are readily marketable assets. Maturities of all investment
securities are managed to meet the Company's normal liquidity needs, to respond
to market changes or to adjust the Company's interest rate risk position.
Federal funds sold and investment securities available for sale comprised 17.98%
of the Company's total assets at March 31, 2004, compared to 19.66% at December
31, 2003.
The Company has historically maintained a stable deposit base and a relatively
low level of large deposits, which has mitigated the volatility in liquidity. As
of March 31, 2004, the Company had borrowed $167.6 million from the FHLB of Des
Moines. The amount of advances from the FHLB of Des Moines is unchanged from
March 31, 2003. These advances were used as a means of providing both long and
short-term, fixed-rated funding for certain assets and managing interest rate
risk. The Company had additional borrowing capacity available from the FHLB of
approximately $141 million at March 31, 2004.
Page 16 of 27
HILLS BANCORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition And Results
of Operations (continued)
As additional sources of liquidity, the Company has the ability to borrow up to
$10 million from the Federal Reserve Bank of Chicago, and two lines of credit
with two banks totaling $102 million. Those two lines of credit require the
pledging of investment securities when drawn upon.
The combination of high levels of potentially liquid assets, low dependence on
volatile liabilities and additional borrowing capacity provided sources of
liquidity for the Company which management considered sufficient at March 31,
2004.
Page 17 of 27
HILLS BANCORPORATION
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market Risk Management
Market risk is the risk of loss arising from adverse changes in market prices
and rates. The Company's market risk is comprised primarily of interest rate
risk resulting from its core banking activities of lending and deposit
gathering. Interest rate risk measures the impact on earnings from changes in
interest rates and the effect on current fair market values of the Company's
assets, liabilities and off-balance sheet contracts. The Company's objective is
to measure this risk and manage the balance sheet to avoid unacceptable
potential for economic loss. Management continually develops and applies
strategies to mitigate market risk, some of which are described below. Exposure
to market risk is reviewed on a regular basis by the asset/liability committee
at the bank. Management does not believe that the Company's primary market risk
exposures and how those exposures have been managed to date in 2004, changed
significantly when compared to 2003.
Asset/Liability Management
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. The Company's yields and cost of funds will
decrease when market rates decline. The Company is able to manage these swings
to some extent by attempting to control the maturity or rate adjustments of its
interest-earning assets and interest-bearing liabilities over given periods of
time.
The Bank maintains an asset/liability committee, which meets at least quarterly
to review the interest rate sensitivity position and to review various
strategies as to interest rate risk management. In addition, the Bank uses a
simulation model to review various assumptions relating to interest rate
movement. The model attempts to limit rate risk even if it appears the Bank's
asset and liability maturities are perfectly matched and a favorable interest
margin is present.
In order to minimize the potential effects of adverse material and prolonged
increases or decreases in market interest rates on the Company's operations,
management has implemented an asset/liability program designed to mitigate the
Company's interest rate sensitivity. The program emphasizes the origination of
adjustable rate loans, which are held in the portfolio, the investment of excess
cash in short or intermediate term interest-earning assets, and the solicitation
of passbook or transaction deposit accounts, which are less sensitive to changes
in interest rates and can be re-priced rapidly.
Net interest income should decline with instantaneous increases in interest
rates while net interest income should increase with instantaneous declines in
interest rates. Generally, during periods of increasing interest rates, the
Company's interest rate sensitive liabilities would re-price faster than its
interest rate sensitive assets causing a decline in the Company's interest rate
spread and margin. This would tend to reduce net interest income because the
resulting increase in the Company's cost of funds would not be immediately
offset by an increase in its yield on earning assets. In times of decreasing
interest rates, fixed rate assets could increase in value and the lag in
re-pricing of interest rate sensitive assets could be expected to have a
positive effect on the Company's net interest income.
Page 18 of 27
HILLS BANCORPORATION
Item 4. Controls and Procedures
As of the end of the period covered by this report, the Company carried out an
evaluation, under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operations of the Company's
disclosure controls and procedures, and as defined in Exchange Act Rule
15d-15(e). Based upon that evaluation, the Company's Chief Executive Officer and
Chief Financial Officer concluded that the Company's disclosure controls and
procedures are effective in enabling the Company's periodic SEC filings within
the required time period. There have been no changes in the Company's internal
controls over financial reporting that occurred during the Company's most recent
fiscal quarter that has materially affected, or is reasonably likely to
materially affect, the Company's internal control over financial reporting.
Page 19 of 27
HILLS BANCORPORATION
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
There is no material pending legal proceedings.
Item 2. Changes in Securities
There were no changes in securities.
Item 3. Defaults upon Senior Securities
Hills Bancorporation has no senior securities.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the
quarter ended March 31, 2004.
Item 5. Other Information
(a) Effective with a record date of April 19, 2004, Hills
Bancorporation approved a three for one stock split on April
13, 2004. On April 26, 2004, each shareholder of Hills
Bancorporation was mailed two additional shares of stock for
each share owned on the record date. This transaction
increased the shares outstanding from 1,516,752 at March 31,
2004 to 4,550,256 shares.
(b) The Company does not have a standing nominating committee of
the Board of Directors or a committee performing similar
functions. Historically, changes in the membership of the
Company's Board of Directors have been relatively infrequent.
In the view of the Board of Directors the amount of nominating
activity does not justify the establishment of such a
committee. The Board of Directors has directly performed and
expects that it will continue to be capable of directly
performing all nominating functions. Therefore, the Board of
Directors has concluded that such a committee is not needed.
In connection with its performance of such nominating
functions, the Board of Directors does not have a charter.
All directors would participate in the consideration of
director nominees. Each of the directors, with the exception
of Mr. Seegmiller, is independent as defined under the rules
of the NASDAQ Stock Market. If one or more positions on the
Board of Directors were to become vacant for any reason, the
vacancy would be filled by the Board of Directors and all
directors would participate in the selection of a person to
fill each such vacancy.
The Board will utilize a variety of methods for identifying
and evaluating candidates for director. The size of the Board
is established by the Company's bylaws. The Board will
regularly assess whether any vacancies on the Board are
expected due to retirement or otherwise. In the event that
vacancies are anticipated, or otherwise arise, the Board will
consider various potential candidates for director. Candidates
may come to the attention of the committee through current
Board members, shareholders, or other persons. The Board has
never paid fees to any third party to identify, evaluate, or
to assist in identifying or evaluating, potential nominees,
and it does not now anticipate that it will be necessary to do
so in the future.
Page 20 of 27
HILLS BANCORPORATION
PART II - OTHER INFORMATION (continued)
(b) (continued)
The Board is not obligated to nominate any candidate for
election. Candidates will be evaluated at meetings of the
Board. In evaluating possible candidates for membership on the
Board of Directors, the Board will seek to achieve a balance
of knowledge, experience, and capability on the Board and to
address the following qualifications. Members of the Board
should have the highest professional and personal ethics and
values and excellent personal and professional reputations and
must satisfy all regulatory requirements to serve as
directors. They should have broad experience at the
policy-making level in business, government, education,
technology, or public interest. They should be committed to
furthering the long-term as well as short-term interest of the
Company and its shareholders, and in doing so they should be
willing to consider the effect of any action on the Company's
shareholders, employees, suppliers, creditors, and customers
and on the communities in which the Company and its subsidiary
operate. They should have sufficient time to carry out their
duties and to provide insight and practical wisdom based on
experience. Their service on other boards of public companies
should be limited to a number that permits them, given their
individual circumstances, to perform responsibly all
directors' duties. The Board of Directors reserves the right
to modify these qualifications from time to time.
In general, advance notice of the shareholder's intention to
nominate such candidate for election to the Board must be
given to the Company's Treasurer. In order to be considered
for nomination by the Board of Directors in connection with
the Annual Meeting of Shareholders to be held in 2005, such
advance notice of nominations must be received by the Company
no later than November 20, 2004. A shareholder's advance
notice of nomination should set forth (i) as to each person
whom the shareholder proposes to nominate for election or
re-election as a director all information relating to such
person that is required to be disclosed in solicitations of
proxies for election of directors, or is otherwise required,
in each case pursuant to Regulation 14A under the Securities
Exchange Act of 1934, as amended (including such person's
written consent to being named in the proxy statement as a
nominee and to serving as a director, if elected); and (ii) as
to the shareholder giving the notice and the beneficial owner,
if any, on whose behalf the nomination is made, (A) the name
and address of such shareholder, as they appear on the
Company's books, and of such beneficial owner, (B) the number
of shares of Common Stock that are owned (beneficially or of
record) by such shareholder and such beneficial owner, (C) a
description of all arrangements or understandings between such
shareholder and such beneficial owner and any other person or
persons (including their names) in connection with the
nomination, and (D) a representation that such shareholder or
its agent or designee intends to appear in person or by proxy
at the annual meeting to place such candidate in nomination
for election as a director.
Page 21 of 27
HILLS BANCORPORATION
PART II - OTHER INFORMATION (continued)
Item 6. Exhibits and Reports on Form 8-K
Exhibits
31 Certifications under Section 302 of the Sarbanes-Oxley Act of 2002
32 Certifications under Section 906 of the Sarbanes-Oxley Act of 2002
Reports on Form 8-K
No reports on Form 8-K have been filed during the quarter ended
March 30, 2004.
Page 22 of 27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HILLS BANCORPORATION
Date May 7, 2004 By /s/ Dwight O. Seegmiller
------------ -----------------------------------
Dwight O. Seegmiller, President and
Chief Executive Officer
Date May 7, 2004 By /s/ James G. Pratt
------------ -----------------------------------
James G. Pratt, Treasurer and
Chief Financial Officer
Page 23 of 27
HILLS BANCORPORATION
QUARTERLY REPORT OF FORM 10-Q FOR THE
QUARTER ENDED MARCH 31, 2004
Page Number
In The Sequential
Exhibit Numbering System
Number Description March 31, 2004 Form 10-Q
- ------------------------------------------------------------------------------------------------------------
31 Certifications under Section 302 of the Sarbanes-Oxley Act of 2002 25-26 of 27
32 Certifications under Section 906 of the Sarbanes-Oxley Act of 2002 27 of 27
Page 24 of 27