ITEM 1. BUSINESS
General. Iowa First Bancshares Corp. (the "Company"), is a bank holding company headquartered in Muscatine, Iowa. The Company owns all the outstanding stock of two national banks in Iowa, First National Bank of Muscatine and First National Bank in Fairfield. Both banks are members of the Federal Reserve System with depository accounts insured to the maximum amount permitted by law by the Federal Deposit Insurance Corporation.
On a full-time equivalent basis, year-end employment for the Company and its subsidiary banks totaled 131 employees. No one customer accounts for more than 3% of revenues, loans, or deposits.
First National Bank of Muscatine has a total of five locations in Muscatine, Iowa (see Item 2
ITEM 2. PROPERTIES
Since the Company commenced business, its principal executive office has been located at 300 East Second Street, Muscatine, Iowa, which is the principal office of First National Bank of Muscatine, a national banking association and a wholly-owned subsidiary of the Company.
First National Bank of Muscatine conducts its operations from five facilities located in Muscatine. The main bank is located at 300 East Second Street and is a modern brick and steel building completed in 1979 containing 36,000 square feet of floor space on three floors. The bank owns both the building and the underlying real estate. All administrative and many sales functions of the bank are conducted at its main office. Portions of the building are leased to commercial tenants. A substantial remodeling of the main floor of the downtown Muscatine primary bank building is nearly complete.
During 1997, a branch was opened inside the then new Wal-Mart Supercenter located on Highway 61 at Muscatine. This branch and the Wal-Mart Supercenter were the first of their kind in Iowa. The bank operates this branch under a five-year lease agreement with Wal-Mart, with two five-year renewal options. Additionally, another new branch facility, which includes drive-through banking services and is located across the alley from the main Muscatine banking headquarters, was completed in the fall of 1997. This branch replaced a previous downtown branch. The bank owns this facility and the underlying real estate.
The bank's Southside office at 608 Grandview Avenue is located two miles southwest of the main bank. The office contains 3,600 square feet of floor space and is located in a one-story steel frame, concrete block building. The facility offers a walk-in lobby and three drive-up lanes. The building and underlying real estate are owned by the bank. Portions of the building are leased to commercial tenants.
The Company plans to enhance its market presence in Muscatine, Iowa with a new branch. This branch will be located on a major thoroughfare and retail area, Highway 61, on the northeast side of Muscatine. The branch will offer a wide variety of banking services in its 3,000 square feet of space. In addition to consumer and real estate lending services, a traditional inside four-person teller line and four drive-up teller lanes, the branch will also offer freestanding twenty-four hour ATM services. Construction of this branch is anticipated to be completed in the third quarter of 2003. The building and underlying real estate are owned by the bank.
The new branch discussed above will serve as a replacement for the current rented branch facilities at the Muscatine Mall, approximately two miles northeast of the main downtown bank building. In recent years, the Muscatine Mall has lost numerous tenants resulting in lower customer traffic counts. The current space allocated to our bank has been deemed inadequate by the Company to properly serve the long-term needs of our customers. Thus, the Company decided to build its own branch in the strong and growing retail section of town described above.
The current office at the Muscatine Mall, a one-story concrete and steel building, is approximately two miles northeast of the main bank. The facility offers a walk-in lobby and night depository. The two-lane, mobile drive-up facility of this branch is located approximately 100 feet west of the branch at the parking lot of the mall. The building, drive-up facility and real estate are leased. The terms of the leases provide for monthly payments of $3,465. These facilities will be vacated by the bank upon completion of the new Highway 61 branch.
First National Bank in Fairfield conducts its operations from a modern brick and steel building completed in 1968 containing 8,200 square feet of floor space on two floors. The bank owns both the building and the underlying real estate. Portions of the building are leased to commercial tenants. A three-lane drive-up facility is located at the main bank. In the spring of 1997, a new 2,500 square foot branch facility was opened at Fairfield, Iowa. The building, which is located in a high traffic area in front of the local Wal-Mart store on Highway 34, contains several private offices for lending staff and management as well as teller and deposit services, including several drive-through lanes.
After completion and occupancy of the Highway 61 branch, management believes all facilities will be of sound construction, in good operating condition, and are adequately equipped for carrying on the business of the Company.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company has no pending legal proceedings which are material.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to the stockholders of the Company for a vote during the fourth quarter of 2002.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The brokerage firms of Howe Barnes Investments, Inc. and Sandler O'Neill & Partners, L.P. make a market for the Company's common stock. Iowa First Bancshares Corp. common stock is traded on the over-the-counter bulletin board market under the symbol "IFST". As of February 28, 2003, there were 1,424,445 shares of the common stock outstanding.
High and low common stock prices and dividends paid for the last two years were:
2002 by Dividend Quarters High Low Per Share - --------------------------------------------------------------------------------
First .................................. $22.50 $20.40 $0.2275 Second ................................. 25.00 21.70 0.2275 Third .................................. 25.25 23.30 0.2275 Fourth ................................. 25.00 24.16 0.2275
Total dividends paid ................... $ 0.91
2001 by Dividend Quarters High Low Per Share - --------------------------------------------------------------------------------
First .................................. $23.75 $19.13 $ 0.22 Second ................................. 22.60 18.88 0.22 Third .................................. 21.75 19.75 0.22 Fourth ................................. 22.50 20.10 0.22
Total dividends paid ................... $ 0.88
The above quotations were furnished by the brokerage firms that serve as market makers for the Company's stock. The quotations represent prices between dealers and do not include retail markup, markdown, or commissions.
Future dividends are dependent on future earnings, regulatory restrictions (see Management's Discussion and Analysis of Financial Condition and Results of Operations section of this Form 10-K; and Note 10 to the Company's Consolidated Financial Statements in the Company's 2002 Annual Report to Shareholders), capital requirements, and the Company's financial condition.
As of February 28, 2003, the Company had approximately 350 shareholders of its outstanding class of common stock. The Iowa First Bancshares Corp. Employee Stock Ownership Plan with 401(k) Provisions is considered one shareholder as all shares owned by this plan are voted by the trustees of said plan unless the vote in question encompasses approval or disapproval of any corporate merger, consolidation, dissolution, or similar transaction.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The "Selected Consolidated Financial Data" of Iowa First Bancshares Corp. set forth on the following page is derived in part from, and should be read in conjunction with, our consolidated financial statements and the accompanying notes thereto. See Item 8 "Financial Statements and Supplementary Data." Results for past periods are not necessarily indicative of results to be expected for any future period.
IOWA FIRST BANCSHARES CORP. AND SUBSIDIARIES
SELECTED CONSOLIDATED FINANCIAL DATA
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion provides additional information regarding our operations for the years ended December 31, 2002, 2001 and 2000, and financial condition for the years ended December 31, 2002 and 2001. This discussion should be read in conjunction with "Selected Consolidated Financial Data" and our consolidated financial statements and the accompanying notes thereto included elsewhere in this document.
Iowa First Bancshares Corp. (Company) is a bank holding company providing bank and bank related services through its wholly-owned subsidiaries, First National Bank of Muscatine (Muscatine), First National Bank in Fairfield (Fairfield), and Iowa First Capital Trust I.
Total average assets of the Company increased 1.2% in 2002, 2.6% in 2001, and 3.1% in 2000. The distribution of average assets, liabilities and stockholders' equity and interest rates, and interest differential was as follows (dollar amounts in thousands and income and rates on a fully taxable equivalent basis using statutory tax rates in effect for the year presented):
Nonaccruing loans are included in the average balance. Loan fees are not material.
The net interest margin increased in 2002 (from 3.24% in 2001 to 3.39% in 2002). The return on average interest-earning assets decreased 110 basis points (from 7.50% in 2001 to 6.40% in 2002) and interest paid on average interest-bearing liabilities decreased 137 basis points (from 4.81% in 2001 to 3.44% in 2002). Average interest-earning assets to total assets rose in 2002 to 93.3% from 93.1% in 2001. The Federal Reserve Bank Board and Chairman Greenspan continued, albeit at a much slower pace than 2001, to decrease short-term interest rates during 2002. The prime lending rate, which began the year at 4.75%, ended 2002 at 4.25%.
During this period of low interest rates, increased emphasis has been given to incorporating interest rate floors on selected commercial and agricultural loans. During 2002 most, if not all, of such loans subject to interest rate floors were actually paying the floor rate. This resulted in the rates received on loans falling less than the rates paid on interest-bearing liabilities. Eventually, when market interest rates again rise, rates paid on interest-bearing liabilities may, for a time, increase more than rates received on loans. This outcome is possible due to the loans which are subject to floor rate pricing lagging market interest rate increases until such time as the floor rate has been exceeded. The extent of this impact will depend on the amount and timing of eventual market interest rate hikes.
The net interest margin decreased in 2001 (from 3.49% in 2000 to 3.24% in 2001). The return on average interest-earning assets decreased 57 basis points (from 8.07% in 2000 to 7.50% in 2001) and interest paid on average interest-bearing liabilities decreased 40 basis points (from 5.21% in 2000 to 4.81% in 2001). Average interest-earning assets to total assets declined in 2001 to 93.1% from 93.7% in 2000. The Federal Reserve Bank Board and Chairman Greenspan decreased short-term interest rates an amazing 11 times during 2001. The prime lending rate, which began the year at 9.5%, ended 2001 at only 4.75%. This dramatic reduction in interest rates was a major contributing factor to the decline in the net interest margin.
CRITICAL ACCOUNTING POLICY:
The Company's financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The financial information contained within these statements is, to a significant extent, financial information that is based on approximate measures of the financial effects of transactions and events that have already occurred. Based on its consideration of accounting policies that involve the most complex and subjective decisions and assessments, management has identified its most critical accounting policy to be that related to the allowance for loan losses. The Company's allowance for loan loss methodology incorporates a variety of risk considerations, both quantitative and qualitative in establishing an allowance for loan loss that management believes is appropriate at each reporting date. Quantitative factors include the Company's historical loss experience, delinquency and charge-off trends, collateral values, changes in nonperforming loans, and other factors. Quantitative factors also incorporate known information about individual loans, including borrowers' sensitivity to interest rate movements. Qualitative factors include the general economic environment in the Company's markets, including economic conditions throughout the Midwest and in particular, the state of certain industries. Size and complexity of individual credits in relation to loan structure, existing loan policies and pace of portfolio growth are other qualitative factors that are considered in the methodology. As the Company adds new products and increases the complexity of its loan portfolio, it will enhance its methodology accordingly. Management may report a materially different amount for the provision for loan losses in the statement of operations to change the allowance for loan losses if its assessment of the above factors were different. This discussion and analysis should be read in conjunction with the Company's financial statements and the accompanying notes presented elsewhere herein, as well as the portion of this Management's Discussion and Analysis section entitled "Financial Condition - Allowance for Loan Losses". Although management believes the levels of the allowance as of both December 31, 2002 and 2001 were adequate to absorb losses inherent in the loan portfolio, a decline in local economic conditions, or other factors, could result in increasing losses that cannot be reasonably predicted at this time.
FINANCIAL CONDITION:
Total assets of Iowa First Bancshares Corp. decreased by $1,892,000 or one-half of one percent when comparing December 31, 2002 and December 31, 2001 balances. On average for the year 2002 assets increased $4,573,000 or 1.2%.
Cash, Interest-Bearing Deposits, and Federal Funds Sold
Cash and due from banks increased by $2,622,000 or 17.9% to $17,283,000 at December 31, 2002, from $14,661,000 at December 31, 2001. Cash and due from banks represented both cash maintained at the Banks, as well as funds that the Banks had deposited in other banks in the form of demand deposits.
Interest-bearing deposits at financial institutions increased $171,000 or 10.6% to $1,791,000 at December 31, 2002, from $1,620,000 at December 31, 2001. These deposits are primarily certificates of deposit at financial institutions with the balance held at any individual bank maintained to not exceed the insurance limits provided by the Federal Deposit Insurance Corporation (FDIC). Some of these funds may also be held in interest-bearing demand accounts at various banking institutions.
Federal funds sold are inter-bank funds with daily liquidity. Federal funds sold decreased $400,000 or 1.3% to $30,600,000 at December 31, 2002, from $31,000,000 at December 31, 2001. As of December 31, 2002, federal funds sold represented 8.1% of total assets. These federal funds can be used to fund future loan demand, deposit or other liability outflows, investment securities purchases, or various other purposes as identified by management.
Investment Securities
All the Banks' securities are maintained in the available for sale category as the securities may be liquidated to provide cash for operating, investing, or financing purposes. These securities are reported at fair value. Investment securities decreased $6,371,000 or 14.3% to $38,095,000 at December 31, 2002, from $44,466,000 at December 31, 2001. The amortized cost of such securities at December 31, 2002 and December 31, 2001 was $36,339,000 and $43,099,000, respectively. The net decrease was the result of a number of transactions in the securities portfolio. The Banks purchased additional available for sale securities totaling $9,520,000 and recognized a net increase in unrealized gains on securities available for sale before applicable income tax of $389,000. This was more than offset by $4,013,000 of securities sales and $12,307,000 of paydowns, maturities, and calls. Additionally, the investment securities portfolio realized net gains of $84,000 during 2002 and net premium amortization of $44,000.
Rates received on investment securities available for sale have decreased less than the rates paid on interest-bearing liabilities. This was due largely to a longer average duration for investment securities available for sale than the average duration for interest-bearing liabilities. Most of the investment securities available for sale were purchased when market interest rates were higher than rates currently available. In the current interest rate environment, when such investment securities mature or are sold, called, or otherwise paid down, the reinvestment rate available is nearly always lower than the yield of the liquidating security.
Investment securities as of December 31, 2002 were approximately 0% U.S. Treasury securities, 48% U.S. government agency securities, 1% mortgage-backed securities, 44% state and political subdivisions, and 7% corporate obligations. During 2002, management again focused the investment securities portfolio in the U.S. government agency as well as state and political subdivisions categories. These investment types earn a "spread" over U.S. Treasury securities thus offering an opportunity to increase after-tax income. The year 2002 experienced continuing market interest rate reductions with rates as low as any time in several decades. In an effort to prudently maintain a competitive yield in the investment portfolio, over 92% of the total portfolio was invested in relatively highly rated U.S. government agency securities and state and political subdivisions. Additionally, to increase total return of the investment portfolio, 7% was invested in corporate obligations, which was less than the prior year in recognition of the greater credit and event risk of such securities, especially during the current challenging economic times.
Investment securities as of December 31, 2001 were approximately 3% U.S. Treasury securities, 41% U.S. government agency securities, 1% mortgage-backed securities, 42% state and political subdivisions, and 13% corporate obligations. During 2001, management again focused the investment securities portfolio in the U.S. government agency as well as state and political subdivisions categories. These investment types earn a "spread" over U.S. Treasury securities thus offering an opportunity to increase after-tax income. The year 2001 was marked by tremendous market interest rate reductions. In an effort to prudently maintain a competitive yield in the investment portfolio, over 80% of the total portfolio was invested in relatively highly rated U.S. government agency securities and state and political subdivisions. Additionally, to increase total return of the investment portfolio, 13% was invested in corporate obligations, with the concomitant credit and event risk.
Investment securities as of December 31, 2000 were approximately 10% U.S. Treasury securities, 46% U.S. government agency securities, 2% mortgage-backed securities, 34% state and political subdivisions, and 8% corporate obligations. During 2000, management focused the investment securities portfolio in the U.S. government agency as well as state and political subdivisions categories. These investment types are relatively safe investments which earn a reasonable after-tax return.
The fair value of investment securities available for sale at the date indicated are summarized as follows (dollar amounts in thousands):
December 31, -------------------------------- 2002 2001 2000 ---------------------------------
U.S. Treasury ........................... $ -- $ 1,533 $ 6,036 U.S. government agencies ................ 18,242 18,119 29,315 Mortgage-backed securities .............. 281 640 1,299 State and political subdivisions ........ 16,769 18,478 21,245 Corporate obligations ................... 2,803 5,696 5,164 --------------------------------- $38,095 $44,466 $63,059 =================================
The following table shows the maturities of investment securities available for sale at December 31, 2002 and the weighted average yields of such securities (dollar amounts in thousands):
The weighted average yields in the previous table are calculated on the basis of the carrying value and effective yields weighted for the scheduled maturity of each security. Weighted average yields on tax-exempt securities have been computed on a fully taxable equivalent basis using the federal statutory tax rate of 34%, the rate in effect for the year ended December 31, 2002, and excluding the interest expense allocated to carry certain tax-exempt securities.
The Company does not use any financial instruments referred to as derivatives to manage interest rate risk and as of December 31, 2002, no investment in a single security, other than U.S. government agency securities, exceeded 10% of stockholders' equity.
Loans
Loans outstanding at December 31, 2002 increased $1,349,000 or 0.5% from December 31, 2001. This increase was the result of loan origination and purchases exceeding loan repayments, sales, and net loan charge-offs.
The amounts of loans outstanding at the indicated dates is shown in the following table according to the type of loans (dollar amounts in thousands):
The following loan categories outstanding at December 31, 2002 mature as follows (dollar amounts in thousands):
After One Year, But Amount One Year Within After of Loans or Less Five Years Five Years --------------------------------------------
Commercial ..................... $109,045 $ 38,906 $ 60,659 $ 9,480 Agricultural ................... 28,185 13,727 9,700 4,758 Real estate, construction ...... 6,051 3,840 2,211 -- -------------------------------------------- $143,281 $ 56,473 $ 72,570 $ 14,238 ============================================
The interest rates on the amount due after one year that are fixed or adjustable are as follows (dollar amounts in thousands):
Fixed Adjustable ------------------------
Commercial ................................... $55,281 $14,858 Agricultural ................................. 13,924 534 Real estate, construction .................... 2,165 46 ------------------------ $71,370 $15,438 ========================
During 2002 commercial loans increased by $2,759,000 or 2.6%, agricultural loans increased $259,000 or .9%, construction real estate loans decreased by $1,701,000 or 21.9%, mortgage real estate loans increased by $2,364,000 or 2.1%, tax exempt real estate mortgage loans increased by $2,007,000 or 156%, and installment and other loans decreased by $4,339,000 or 20.0%. Overall loan growth totaled $1,349,000 or 0.5%. The reduction in installment loans is largely attributable to very low, including 0%, financing of new automobiles by the financing arms of the major auto companies. Additionally, national financial companies offer rates and other terms which our management believes would be imprudent to match. Management continues to search for quality growth in all loan categories while remaining vigilant in maintaining high credit standards. The Company sells some real estate loans to the secondary market resulting in increased fee income and reduced interest rate risk. These sales of real estate loans, net of any gains recognized upon sale, totaled $20,415,000, $8,209,000, and $2,095,000 for the years ended December 31, 2002, 2001, and 2000, respectively. As of December 31, 2002, the Company's general legal lending limit was approximately $5,458,000. For loans collateralized by marketable securities, the total legal limit was approximately $9,098,000 as of December 31, 2002.
Loan Risk Elements Nonaccrual, Past Due and Restructured Loans
The following table presents information concerning the aggregate amount of nonperforming loans. Nonperforming loans comprise (a) loans accounted for on a nonaccrual basis; (b) accruing loans contractually past due 90 days or more as to interest or principal payments (but not included in the nonaccrual loans in (a) above); and (c) other loans whose terms have been renegotiated to provide a reduction or deferral of interest or principal because of a deterioration in the financial position of the borrower (exclusive of loans in (a) or (b) above) (dollar amounts in thousands):
Total nonaccrual loans were $1,730,000 at December 31, 2002, an increase of $1,090,000 or 170% from December 31, 2001. Total nonaccrual and accrual loans contractually past due 90 days or more were $2,783,000 at December 31, 2002, an increase of $2,015,000 or 262.4% from a year earlier. Compared to the average over the past five years, nonaccrual loans at December 31, 2002 were $867,000 or 100.5% more than average. Total nonaccrual and accrual loans contractually past due 90 days or more were $1,586,000 or 132.5% higher at December 31, 2002 than the average for these categories over the past five years.
When the full collectibility of principal or interest on any loan is considered doubtful, previously accrued but uncollected interest remains as accrued if the principal and interest is protected by sound collateral value based upon a current independent, qualified appraisal. In practice, in the vast majority of cases, the interest accrued but uncollected on loans transferred to nonaccrual status is charged-off at the time of transfer. Interest in the amounts of $100,000, $63,000, and $47,000, would have been earned on the nonaccrual loans had they been performing loans in accordance with their original terms during 2002, 2001, and 2000, respectively. The interest collected on loans designated as nonaccrual loans and included in income for the years ended December 31, 2002, 2001, and 2000 was $30,000, $57,000, and $14,000, respectively.
As of December 31, 2002, the Company had loans totaling $7,783,000 in addition to those listed as nonaccrual, past due or renegotiated that were identified by the Banks' internal asset rating systems as classified assets. This represents a $2,291,000 or 22.8% decrease from 2001. The Company is not aware of any single loan or group of loans, other than these and those reflected above, of which full collectibility cannot reasonably be expected. Management has committed resources and is focusing its attention on efforts designed to control the amount of classified assets. The Company has $28,185,000 in total agricultural loans outstanding. The Company does not have any other substantial portion of its loans concentrated in one or a few industries nor does it have any foreign loans outstanding as of December 31, 2002. The Company's loans are heavily concentrated geographically in the Iowa counties of Muscatine and Jefferson.
In general, the agricultural loan portfolio risk is dependent on factors such as governmental policies, weather conditions, agricultural commodities prices, marketing strategies and timing, as well as the mix of grain and livestock raised. Commercial loan risk can also vary widely from period to period and is particularly sensitive to changing business and economic conditions as well as governmental policies. Consumer (installment and real estate mortgage) loan risk is substantially influenced by employment opportunities in the markets served by the Company. The national, regional, State of Iowa, and Counties of Muscatine and Jefferson economic activity and success levels dramatically influence the risk in each of the loan portfolios.
Other real estate owned was $503,000, $251,000, and $101,000 as of December 31, 2002, 2001, and 2000, respectively.
Allowance for Loan Losses
The allowance for loan losses is established through charges to earnings in the form of provisions for loan losses. Loan losses or recoveries are charged or credited directly to the allowance for loan losses. The provision for loan losses is determined based upon an evaluation of a number of factors by management of the Banks including (i) loss experience in relation to outstanding loans, loan delinquencies, and the existing level of the allowance for loan losses, (ii) a continuing review of problem loans and overall portfolio composition and quality, (iii) regular examinations and appraisals of loan portfolios conducted by federal supervisory authorities, (iv) current and expected economic conditions, and (v) other factors that, in management's judgment, deserved evaluation in estimating loan losses. Management of the Banks continues to review the loan portfolios and believes the allowance for loan losses provides for losses that are probable as of December 31, 2002. However, there can be no assurance that such losses will not exceed the estimated amounts or that the Company will not be required to make additional provisions for loan losses in the future. Asset quality is a constant priority for the Company and its subsidiary banks. Should the already weak economic climate continue to deteriorate, borrowers may experience difficulty, and the level of non-performing loans, charge-offs, and delinquencies could rise thus requiring further increases in the provision.
The Banks allocate the allowance for loan losses according to the amount deemed to be necessary to provide for probable losses being incurred within the categories of loans set forth in the table below. The amount of such components of the allowance for loan losses and the ratio of loans in such categories to total loans outstanding are as follows (dollar amounts in thousands):
Deposits
Total average deposits increased 1.0% in 2002, 2.2% in 2001, and decreased 0.2% in 2000. The average deposits are summarized below (dollar amounts in thousands):
Included in interest-bearing time deposits are certificates of deposit with a minimum denomination of $100,000, with scheduled maturities as follows (dollar amounts in thousands):
Year Ended December 31, ------------
One to three months ...................................... $ 5,525 Three to six months ...................................... 2,920 Six to twelve months ..................................... 5,676 Over twelve months ....................................... 13,201 ------- $27,322 =======
RESULTS OF OPERATIONS:
Changes in Diluted Earnings Per Share
The increase in diluted earnings per share between 2002 and 2001 amounted to $.18. The major sources of change are presented in the following table:
2002 2001 ------------------
Net income per share, prior year ....................... $ 2.30 $ 2.34 ------------------ Increase (decrease) attributable to: Net interest income .................................. 0.50 (0.42) Provision for loan losses ............................ (0.05) 0.04 Investment securities gains, net ..................... (0.17) 0.22 Other income ......................................... 0.08 0.17 Salaries and employee benefits ....................... (0.01) (0.10) Other operating expenses ............................. (0.15) (0.13) Income taxes ......................................... (0.08) 0.11 Change in average common shares outstanding .......... 0.06 0.07 ------------------ Net change ..................................... 0.18 (0.04) ------------------ Net income per share, current year ............. $ 2.48 $ 2.30 ==================
Net Interest Income
The following table sets forth a summary of the changes in interest earned and paid resulting from changes in volume and rates. Changes attributable to both rate and volume which cannot be segregated have been allocated to the change due to volume (dollar amounts in thousands and income on a fully taxable equivalent basis using statutory rates in effect for year presented):
Nonaccruing loans are included in the average balance. Loan fees are not material.
Provision for Loan Losses
The following table summarizes average loan balances at the end of each year; changes in the allowance for loan losses arising from loans charged off and recoveries on loans previously charged off by loan category; and the provisions for loan losses which have been charged to operating expense (dollar amounts in thousands):
Operating Expenses
Operating expenses include all the costs incurred to operate the Company, except for interest expense, the loan loss provision, and income taxes. A continuing objective of the Company is to manage overhead costs while maintaining optimal productivity, efficiency, capacity, and quality service. Significant time and money was spent in 2002 and 2001 to maintain and enhance our state-of-the-art Internet banking solution for our customers. While enthusiastically embraced by our target segment of customers, these necessary expenditures will likely not be recovered for some time in the future as most competitors charge little, if anything, for Internet banking services. It is important for the Company to offer this service, however, to maintain a satisfied customer base and market share with cross-selling opportunities for other more profitable products and services. Salaries and benefits, the largest component of operating expenses, were actively monitored and controlled during 2002. Total salaries and benefits of $4,913,000 in 2002 increased only $13,000 or .3% from 2001. Occupancy expenses decreased to $674,000 during 2002, a $54,000 or 7.4% decline from 2001. Office supplies, printing, and postage of $342,000 in 2002 was $34,000 or 9.0% less than 2001. Computer costs rose in 2002 to total $506,000, a $60,000 or 13.5% increase from 2001. This computer cost increase was primarily attributed to additional costs associated with the Company's relatively new digital document imaging as well as business continuity contracts. Advertising and business promotion decreased $24,000 or 12.4% to total $170,000 in 2002 compared to 2001. This decline was the result of a more focused and shared approach to advertising by our subsidiary banks during 2002. Finally, other operating expenses increased $300,000 or 26.6% to $1,426,000 for 2002 compared to 2001. This increase was largely due to the impact of costs incurred for consulting, employee recruiting, Federal Reserve Bank processing, losses incurred on other real estate, and insurance and bonds. Overall, operating expenses increased $234,000 or 2.8% to total $8,711,000 versus $8,477,000 in 2001. The efficiency ratio, defined as noninterest expense, excluding the provision for loan losses, as a percent of net interest income plus noninterest income, was 61.1% in 2002. This was an improvement from the efficiency ratio of 62.0% for the year ended December 31, 2001.
Net Income
The Company's consolidated net income for the three years is as follows (dollar amounts in thousands):
Year Ended December 31, -------------------------------------- 2002 2001 2000 --------------------------------------
Net income ..................... $3,570 $3,400 $3,560 ======================================
Net income increased $170,000 or 5.0% in 2002. The net interest income increased a strong $725,000 or 6.7%. The provisions for loan losses increased $74,000 to total $440,000 in 2002. Other income, without securities gains, grew $111,000 or 4.5%. Securities gains decreased to $84,000 in 2002 from $331,000 a year earlier. Operating expenses rose $234,000 or 2.8% and income taxes increased $111,000 or 7.7%. Income tax expense increase was attributed to higher net income in 2002 than 2001 and a slight increase in the effective tax for the year ended December 31, 2002 of 30.2% compared to 29.7% the prior year.
Net income decreased $160,000 or 4.5% in 2001. The net interest income decreased $619,000 or 5.4%. The provisions for loan losses decreased $63,000 to total $366,000 in 2001. Other income, without securities gains, grew $245,000 or a strong 11.0%. Securities gains increased to $331,000 in 2001 from $13,000 a year earlier. Operating expenses rose $333,000 or 4.1% and income taxes decreased $166,000 or 10.4%.
SELECTED CONSOLIDATED RATIOS:
Year Ended December 31, -------------------------- 2002 2001 2000 --------------------------
Percentage of net income to: Average stockholders' equity ................... 14.87% 14.96% 17.76% Average total assets ........................... 0.93 0.90 0.97 Percentage of average stockholders' equity to average total assets ........................... 6.28 6.01 5.44 Dividend payout ratio, based on dividends declared during the year ....................... 37.10 38.70 36.32
INTEREST RATE SENSITIVITY AND RISK MANAGEMENT:
The Company manages its balance sheet to minimize the impact of interest rate movements on its earnings. The term "rate sensitivity" refers to those assets and liabilities which are "sensitive" to fluctuations in rates and yields. When interest rates move, earnings may be affected in many ways. Interest rates on assets and liabilities may change at different times or by different amounts. Maintaining a proper balance between rate sensitive earning assets and rate sensitive liabilities is the principal function of asset and liability management of a banking organization.
The following table shows the interest rate sensitivity position at several repricing intervals (dollar amounts in thousands):
The data in this table incorporates the contractual repricing characteristics as well as an estimate of the actual repricing characteristics of the Company's assets and liabilities. Based on the estimate, 20% of the savings and NOW accounts are reflected in the less than 3 months category, 30% in the 3-12 months category, with the remainder in the 1-5 years category. Also, 25% of the money market accounts are reflected in the less than 3 months repricing category with the remainder in the 3-12 months category.
FHLB advances in the 1-5 year repricing category include $17,443,000 of advances with actual maturities in the greater than 5 year category. These advances have options associated with them which allow the Company to "put" the advances back to the FHLB at a date substantially earlier than the stated maturity. The Company may utilize this put option if deemed appropriate, or hold such advances until maturity. As part of the Company's overall interest rate risk management, these puts are analyzed and used when advantageous. During 2002, no advances were put back to the FHLB.
A positive repricing gap for a given period exists when total interest-earning assets exceed total interest-bearing liabilities and a negative repricing gap exists when total interest-bearing liabilities are in excess of interest-earning assets. Generally a positive repricing gap will result in increased net interest income in a rising rate environment and decreased net interest income in a falling rate environment. A negative repricing gap tends to produce increased net interest income in a falling rate environment and decreased net interest income in a rising rate environment. At December 31, 2002, using the estimates discussed above, rate sensitive liabilities exceeded rate sensitive assets within a one-year period by $56,073,000 and, thus, the Company is positioned to benefit from a fall in interest rates within the next year.
The Company's repricing gap position is useful for measuring general relative risk levels. However, even with perfectly matched repricing of assets and liabilities, interest rate risk cannot be avoided entirely. Interest rate risk remains in the form of prepayment risk of assets and liabilities, timing lags in adjusting certain assets and liabilities that have varying sensitivities to market interest rates, and basis risk. Basis risk refers to the possibility that the repricing behavior of variable-rate assets could differ from the repricing characteristics of liabilities which reprice in the same time period. Even though these assets are match-funded, the spread between asset yields and funding costs could change.
Because the repricing gap position does not capture these risks, management utilizes simulation modeling to measure and manage the rate sensitivity exposure of earnings. The Company's simulation model provides a projection of the effect on net interest income of various interest rate scenarios and balance sheet strategies.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's net income is dependent on its net interest income. Net interest income is susceptible to interest rate risk to the degree that interest-bearing liabilities mature or reprice on a different basis than interest-earning assets. When interest-bearing liabilities mature or reprice more quickly than interest-earning assets in a given period, a significant increase in market rates of interest could adversely affect net interest income. Similarly, when interest-earning assets mature or reprice more quickly than interest-bearing liabilities, falling interest rates could result in a decrease in net income.
In an attempt to manage its exposure to changes in interest rates, management monitors the Company's interest rate risk. Management's asset/liability committee meets periodically to review the Company's interest rate risk position and profitability, and to make or recommend adjustments for consideration by the Board of Directors. Management also reviews the Banks' securities portfolio, formulates investment strategies, and oversees the timing and implementation of transactions to assure attainment of the Board's objectives in the most effective manner. Notwithstanding the Company's interest rate risk management activities, the potential for changing interest rates is an uncertainty that can have an adverse effect on net income.
In adjusting the Company's asset/liability position, the Board and management attempt to manage the Company's interest rate risk while maintaining or enhancing net interest margins. At times, depending on the level of general interest rates, the relationship between long- and short-term interest rates, market conditions and competitive factors, the Board and management may determine to increase the Company's interest rate risk position somewhat in order to increase its net interest margin. The Company's results of operations and net portfolio values remain vulnerable to increases in interest rates and to fluctuations in the difference between long- and short-term interest rates.
One approach used to quantify interest rate risk is the net portfolio value ("NPV") analysis. In essence, this analysis calculates the difference between the present value of liabilities and the present value of expected cash flows from assets and off-balance-sheet contracts. The following table sets forth, at December 31, 2002, an analysis of the Bank's interest rate risk as measured by the estimated changes in NPV resulting from instantaneous and sustained parallel shifts in the yield curve (+ or - 200 basis points, measured in 100 basis point increments).
Estimated Increase Change in (Decrease) in NPV Interest Estimated -------------------------- Rates NPV Amount Amount Percent - ------------------------------------------------------------------------- (Basis Points) (Dollars in Thousands)
+200 $ 21,864 $ (3,714) (15%) +100 23,614 (1,964) (8) - 25,578 - - - -100 27,786 2,208 9 - -200 30,335 4,757 19
The Company does not currently engage in trading activities or use derivative instruments to control interest rate risk. Even though such activities may be permitted with the approval of the Board of Directors, the Company does not intend to engage in such activities in the immediate future.
Interest rate risk is the most significant market risk affecting the Company. Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company's business activities, except commodity price risk to the extent such risk may affect the agricultural loan portfolio.
LIQUIDITY:
For banks, liquidity represents ability to meet both loan commitments and deposit withdrawals. Factors which influence the need for liquidity are varied, but include general economic conditions, asset/liability mix, bank reputation, future FDIC funding needs, changes in regulatory environment, and credit standing. Assets which provide liquidity consist principally of loans, cash and due from banks, interest-bearing deposits at financial institutions, investment securities, and short-term investments such as federal funds. Maturities of securities and loan payments provide a constant flow of funds available for cash needs. Liquidity also can be gained by the sale of loans or securities, which were previously designated as available for sale, FHLB advances, and lines of credit. Interest rates, relative to the rate paid by the security or loan sold, along with the maturity of the security or loan, are the major determinants of the price which can be realized upon sale. Net cash provided by operating activities totaled $4,477,000 in 2002 which compares to cash provided by operating activities for the year ended December 31, 2001 of $4,132,000. The Company continues to generate operating cash from sales of its new production and refinancing mortgage loans. Net cash provided by investing activities totaled $3,739,000 for the year ended December 31, 2002 and net cash used in investing activities totaled $1,676,000 for the year ended December 31, 2001. Securities available for sale were sold, matured, called, and paid down much faster than they were replaced. During the years ended December 31, 2002 and 2001 cash used in financing activities totaled $5,594,000 and $3,789,000, respectively. The cash used during the year resulted primarily from scheduled payments and prepayments of notes payable and payments which exceeded new advances from the Federal Home Loan Bank.
The stability of the Company's funding, and thus its ability to manage liquidity, is greatly enhanced by its consumer deposit base. Consumer deposits tend to be small in size, diversified across a large base of individuals, and are government insured to the extent permitted by law. Total deposits under $100,000 at December 31, 2002 were $243,100,000 or 89.9% of total deposits and 64.2% of total liabilities, mezzanine capital, and equity.
At December 31, 2002, securities sold under agreements to repurchase and treasury tax and loan open note funding sources totaled $7,376,000. Federal Home Loan Bank advances totaled $64,609,000. At year-end total federal funds sold and securities maturing within one year were $39,026,000 or 10.3% of total assets. Both short-term and long-term liquidity are actively monitored and managed. The Company had an unused secured line of credit totaling $2,000,000 at December 31, 2002.
Equity increased $1,273,000 during 2002 to total $24,313,000 at December 31, 2002.
At December 31, 2002, securities available for sale totaling $38,095,000 included $1,756,000 of gross unrealized gains and no gross unrealized losses. These securities may be sold in whole or part to increase liquid assets, reposition the investment portfolio, or for other purposes as defined by management.
CAPITAL:
As previously noted, stockholders' equity increased $1,273,000 or 5.5% in 2002. The Company had net income of $3,570,000, an increase in accumulated other comprehensive income of $243,000, cash dividends declared totaling $1,319,000, increase in obligation related to KSOP shares totaling $475,000, and net treasury shares purchased of $746,000. Dividends to stockholders were declared at a rate of $.92, $.89, and $.85 per share during the years ended December 31, 2002, 2001, and 2000, respectively.
IMPACT OF INFLATION AND CHANGING PRICES:
The financial statements and related data presented herein have been prepared in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation.
Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution's performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the price of goods and services. In the current interest rate environment, liquidity and the maturity structure of the Company's assets and liabilities are critical to the maintenance of acceptable performance levels.
EFFECT OF FASB STATEMENTS:
Current accounting developments: The Financial Accounting Standards Board has issued Statement No. 143, Accounting for Asset Retirement Obligations. This Statement requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. For the Company, the Statement is effective January 1, 2003. Implementation of the Statement is not expected to have a material impact on the Company's financial statements.
The Financial Accounting Standards Board has issued Statement No. 145, Rescission of FASB Statement Nos. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. This Statement rescinds FASB Statement Nos. 4 and 64, relative to debt extinguishments and provides that gains and losses from extinguishment of debt should be classified as extraordinary items only if they meet the criteria in Opinion 30. Applying the provisions of Opinion 30 will distinguish transactions that are part of an entity's recurring operations from those that are unusual or infrequent or that meet the criteria for classification as an extraordinary item. The Statement amends FASB Statement No. 13, Accounting for Leases, to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. Finally, the Statement rescinds FASB Statement No. 44, Accounting for Intangible Assets of Motor Carriers, and amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. The provisions of the Statement relative to accounting for leases were effective for transactions occurring after May 15, 2002. Implementation of these provisions of the Statement had no impact on the Company's consolidated financial statements. For the Company, the provisions of the Statement relative to accounting for debt extinguishment are effective January 1, 2003. Implementation of these provisions of the Statement is not expected to have a material impact on the Company's consolidated financial statements.
The Financial Accounting Standards Board has issued Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities. This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, Liability and Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). The Statement provides that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. For the Company, the provisions of the Statement are effective for exit or disposal activities that are initiated after December 31, 2002. Implementation of the Statement is not expected to have a material impact on the Company's consolidated financial statements.
The Financial Accounting Standards Board has issued Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others - an interpretation of FASB Statement Nos. 5, 57 and 107 and rescission of FASB Interpretation No. 34. This Interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and measurement provisions of this Interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. Implementation of these provisions of the Interpretation is not expected to have a material impact on the Company's consolidated financial statements. The disclosure requirements of the Interpretation are effective for financial statements of interim or annual periods ending after December 15, 2002, and have been adopted in the consolidated financial statements for December 31, 2002.
FORWARD LOOKING STATEMENTS:
Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995. This document (including information incorporated by reference) contains, and future oral and written statements of the Company and its management may contain, forward-looking statements, within the meaning of such term in the Private Securities Litigation Reform Act of 1995, with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company's management and on information currently available to management, are generally identifiable by the use of words such as "believe," "expect," "anticipate," "bode," "predict," "suggest," "appear," "plan," "intend," "estimate," "may," "will," "would," "could," "should" or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events.
The Company's ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries include, but are not limited to, the following:
o The strength of the United States economy in general and the strength of the local economies in which the Company conducts its operations which may be less favorable than expected and may result in, among other things, a deterioration in the credit quality and value of the Company's assets.
o The economic impact of the terrorist attacks that occurred on September 11, as well as any future threats and attacks, and the response of the United States to any such threats and attacks.
o The effects of, and changes in, federal, state and local laws, regulations and policies affecting banking, securities, insurance and monetary and financial matters.
o The effects of changes in interest rates (including the effects of changes in the rate of prepayments of the Company's assets) and the policies of the Board of Governors of the Federal Reserve System.
o The ability of the Company to compete with other financial institutions as effectively as the Company currently intends due to increases in competitive pressures in the financial services sector.
o The inability of the Company to obtain new customers and to retain existing customers.
o The timely development and acceptance of products and services, including products and services offered through alternative delivery channels such as the Internet.
o Technological changes implemented by the Company and by other parties, including third-party vendors, which may be more difficult or more expensive than anticipated or which may have unforeseen consequences to the Company and its customers.
o The ability of the Company to develop and maintain secure and reliable electronic systems.
o The ability of the Company to retain key executives and employees and the difficulty that the Company may experience in replacing key executives and employees in an effective manner.
o Consumer spending and saving habits which may change in a manner that affects the Company's business adversely.
o Business combinations and the integration of acquired businesses which may be more difficult or expensive than expected.
o The costs, effects, and outcomes of existing or future litigation.
o Changes in accounting policies and practices, as may be adopted by state and federal regulatory agencies and the Financial Accounting Standards Board.
o The ability of the Company to manage the risks associated with the foregoing as well as anticipated.
These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Additional information concerning the Company and its business, including other factors that could materially affect the Company's financial results, is included in the Company's filings with the Securities and Exchange Commission.
QUARTERLY RESULTS OF OPERATIONS (UNAUDITED):
In the fourth quarter of 2002, net income was $861,000, compared with $821,000 in the same period of 2001, an increase of 4.9%. The net interest income during the fourth quarter of 2002 was $2,919,000 compared with $2,731,000 for the fourth quarter of 2001. The provision for loan losses in the fourth quarter of 2002 was $110,000 compared with $58,000 in 2001. Other income totaled $705,000 and $756,000 during the fourth quarter of 2002 and 2001, respectively. Other operating expenses of $2,321,000 in the last quarter of 2002 compared with $2,320,000 for the last quarter of 2001. Income tax expense was $332,000 and $288,000 for the final quarter of 2002 and 2001, respectively.
Quarterly results of operations are as follows (dollar amounts in thousands):
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
IOWA FIRST BANCSHARES CORP.
Index to Consolidated Financial Statements
- -------------------------------------------------------------------------------- INDEPENDENT AUDITOR'S REPORT 25 - --------------------------------------------------------------------------------
FINANCIAL STATEMENTS
Consolidated balance sheets 26 Consolidated statements of income 27 Consolidated statements of changes in stockholders' equity 28 Consolidated statements of cash flows 29 - 30 Notes to consolidated financial statements 31 - 46
- --------------------------------------------------------------------------------
McGladrey & Pullen Certified Public Accountants
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors Iowa First Bancshares Corp. Muscatine, Iowa
We have audited the accompanying consolidated balance sheets of Iowa First Bancshares Corp. and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for the years ended December 31, 2002, 2001, and 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statements 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 Iowa First Bancshares Corp. and subsidiaries as of December 31, 2002 and 2001, and the results of their operations and their cash flows for the years ended December 31, 2002, 2001, and 2000, in conformity with accounting principles generally accepted in the United States of America.
/s/ McGladrey & Pullen, LLP
Davenport, Iowa January 17, 2003
McGladrey & Pullen, LLP is an independent member firm of RSM International, an affiliation of independent accounting and consulting firms.
IOWA FIRST BANCSHARES CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS December 31, 2002 and 2001
See Notes to Consolidated Financial Statements.
IOWA FIRST BANCSHARES CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 2002, 2001, and 2000
See Notes to Consolidated Financial Statements.
IOWA FIRST BANCSHARES CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Years Ended December 31, 2002, 2001, and 2000
See Notes to Consolidated Financial Statements.
IOWA FIRST BANCSHARES CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 2002, 2001, and 2000
(Continued)
IOWA FIRST BANCSHARES CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) Years Ended December 31, 2002, 2001, and 2000
See Notes to Consolidated Financial Statements.
IOWA FIRST BANCSHARES CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
Note 1. Nature of Business and Significant Accounting Policies
Nature of business:
Iowa First Bancshares Corp. (the "Company") is a bank holding company headquartered in Muscatine, Iowa. The Company owns the outstanding stock of two national banks, First National Bank of Muscatine and First National Bank in Fairfield. First National Bank of Muscatine has a total of five locations in Muscatine, Iowa. First National Bank in Fairfield has two locations in Fairfield, Iowa. Each bank is engaged in the general commercial banking business and provides full service banking to individuals and businesses, including checking, savings, money market, and time deposit accounts, commercial loans, consumer loans, real estate loans, safe deposit facilities, transmitting of funds, trust services, and such other banking services as are usual and customary for commercial banks. The Company also owns the outstanding stock of Iowa First Capital Trust I, which was capitalized in March 2001 for the purpose of issuing Company obligated mandatorily redeemable preferred securities.
Significant accounting policies:
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. The allowance for loan losses is inherently subjective, as it requires material estimates that are susceptible to significant change. The fair value disclosure of financial instruments is an estimate that can be computed within a range.
Principles of consolidation: The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All material intercompany accounts and transactions have been eliminated in consolidation.
Presentation of cash flows: For purposes of reporting cash flows, cash and due from banks includes cash on-hand, amounts due from banks, and the cash items in process of clearing. Cash flows from interest-bearing deposits at financial institutions, federal funds sold, loans, deposits, securities sold under agreements to repurchase, revolving line of credit, and the treasury tax and loan open note are reported net.
Cash and due from banks: The Banks are required by federal banking regulations to maintain certain cash and due from bank reserves. The reserve requirement was approximately $3,232,000 and $1,668,000 at December 31, 2002 and 2001, respectively.
Investment securities available for sale: Securities available for sale are accounted for at fair value and the unrealized holding gains or losses are presented as a separate component of accumulated other comprehensive income, net of their deferred income tax effect. Realized gains and losses, determined using the specific-identification method, are included in earnings.
Declines in the fair value of individual available-for-sale securities below their cost that are other than temporary would result in write-downs of the individual securities to their fair value. The related write-downs would be included in earnings as realized losses.
Premiums and discounts are recognized in interest income using the interest method over the expected life of the security. There were no investments held to maturity or for trading purposes as of December 31, 2002 or 2001.
Loans: Loans are stated at the amount of unpaid principal, reduced by unearned discount and an allowance for loan losses. The Banks record impaired loans at the present value of expected future cash flows discounted at the loan's effective interest rate, or as an expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. A loan is impaired when it is probable the creditor will be unable to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. The Banks recognize interest income on impaired loans on a cash basis.
The allowance for loan losses is maintained at the level considered adequate by management of the Banks to provide for losses that are probable. The allowance is increased by provisions charged to operating expense and reduced by net charge-offs. In determining the adequacy of the allowance balance the Banks make continuous evaluations of the loan portfolio and related off-balance sheet commitments, consider current economic conditions, historical loan loss experience, review of specific problem loans, and other factors.
Direct loan origination fees and costs are generally being deferred and the net amounts amortized as an adjustment of the related loan or lease's yield. The Banks generally amortize these amounts over the contractual life. Direct loan origination fees and costs related to loans sold to unrelated third parties are recognized as income or expense in the current consolidated statements of income. Commitment fees based upon a percentage of customers' unused lines of credit and fees related to standby letters of credit are not significant.
Sales of loans: As part of its management of assets and liabilities, the Company periodically sells residential real estate loans. Loans which are expected to be sold in the forseeable future are classified as held for sale and are recorded at the lower of cost or estimated market value in the aggregate.
Credit related financial instruments: In the ordinary course of business, the Company has entered into commitments to extend credit, including standby letters of credit. Such financial instruments are recorded when they are funded.
Transfers of financial assets: Transfers of financial assets are accounted for as sales, only when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right to pledge or exchange the assets it received, and no condition both constrains the transferee from taking advantage of its right to pledge or exchange and provides more than a modest benefit to the transferor, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.
Bank premises and equipment: Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed primarily by the straight-line method based on the estimated useful lives.
Life insurance contracts: Life insurance contracts are stated at their cash surrender value.
Restricted investment securities: Restricted investment securities represent Federal Home Loan Bank and Federal Reserve Bank common stock. The stock is carried at cost.
Other assets: Other real estate (ORE), which is included in other assets, represents properties acquired through foreclosure, in-substance foreclosure, or other proceedings. ORE is recorded at the lower of the amount of the loan or fair value of the properties. Any write-down to fair value at the time of transfer to ORE is charged to the allowance for loan losses. Property is evaluated regularly to ensure that the recorded amount is supported by the current fair value. Subsequent write-downs to fair value are charged to earnings.
Other revenue recognition: Revenue from trust services and other service charges and fees is recognized as the services are provided.
Income taxes: The Company files its tax return on a consolidated basis with its subsidiary banks. The entities follow the direct reimbursement method of accounting for income taxes under which income taxes or credits which result from the subsidiary banks' inclusion in the consolidated tax return are paid to or received from the parent company.
Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and 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 portion 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.
Common stock held by KSOP: 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 the accompanying consolidated balance sheets since such items are not assets of the Banks.
Earnings per share: Basic earnings per share are arrived at by dividing net income by the weighted average number of shares of common stock outstanding for the respective period. Diluted earnings per share are arrived at by dividing net income by the weighted average number of common stock and common stock equivalents outstanding for the respective period.
Current accounting developments: The Financial Accounting Standards Board has issued Statement No. 143, Accounting for Asset Retirement Obligations. This Statement requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. For the Company, the Statement is effective January 1, 2003. Implementation of the Statement is not expected to have a material impact on the Company's consolidated financial statements.
The Financial Accounting Standards Board has issued Statement No. 145, Rescission of FASB Statements Nos. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. This Statement rescinds FASB Statement Nos. 4 and 64, relative to debt extinguishments and provides that gains and losses from extinguishment of debt should be classified as extraordinary items only if they meet the criteria in Opinion 30. Applying the provisions of Opinion 30 will distinguish transactions that are part of an entity's recurring operations from those that are unusual or infrequent or that meet the criteria for classification as an extraordinary item. The Statement amends FASB Statement No. 13, Accounting for Leases, to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. Finally, the Statement rescinds FASB Statement No. 44, Accounting for Intangible Assets of Motor Carriers, and amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. The provisions of the Statement relative to accounting for leases were effective for transactions occurring after May 15, 2002. Implementation of these provisions of the Statement had no impact on the Company's consolidated financial statements. For the Company, the provisions of the Statement relative to accounting for debt extinguishment are effective January 1, 2003. Implementation of these provisions of the Statement is not expected to have a material impact on the Company's consolidated financial statements.
The Financial Accounting Standards Board has issued Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities. This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, Liability and Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). The Statement provides that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. For the Company, the provisions of the Statement are effective for exit or disposal activities that are initiated after December 31, 2002. Implementation of the Statement is not expected to have a material impact on the Company's consolidated financial statements.
The Financial Accounting Standards Board has issued Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others - an interpretation of FASB Statements No. 5, 57 and 107 and rescission of FASB Interpretation No. 34. This Interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and measurement provisions of this Interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. Implementation of these provisions of the Interpretation is not expected to have a material impact on the Company's consolidated financial statements. The disclosure requirements of the Interpretation are effective for financial statements of interim or annual periods ending after December 15, 2002, and have been adopted in the consolidated financial statements for December 31, 2002.
Reclassifications: Certain amounts in the prior year financial statements have been reclassified, with no effect on net income or stockholders' equity, to conform with current year presentations.
Note 2. Comprehensive Income
Comprehensive income is defined as the change in equity during a period from transactions and other events from non-owner sources. Comprehensive income is the total of net income and other comprehensive income, which for the Company is comprised entirely of unrealized gains and losses on securities available for sale.
Other comprehensive income is comprised as follows:
Tax Before Expense Net Tax (Benefit) of Tax ---------------------------------- Year Ended December 31, 2002 ---------------------------------- Unrealized gains on securities available for sale: Unrealized holding gains arising during the year .............................. $ 473,000 $ 178,000 $ 295,000 Less, reclassification adjustment for gains included in net income .......... 84,000 32,000 52,000 ---------------------------------- Other comprehensive income ........ $ 389,000 $ 146,000 $ 243,000 ==================================
Year Ended December 31, 2001 ---------------------------------- Unrealized gains on securities available for sale: Unrealized holding gains arising during the year .............................. $1,235,000 $ 459,000 $ 776,000 Less, reclassification adjustment for gains included in net income .......... 331,000 123,000 208,000 ---------------------------------- Other comprehensive income ........ $ 904,000 $ 336,000 $ 568,000 ==================================
Year Ended December 31, 2000 ---------------------------------- Unrealized gains on securities available for sale: Unrealized holding gains arising during the year .............................. $1,511,000 $ 564,000 $ 947,000 Less, reclassification adjustment for gains included in net income .......... 13,000 5,000 8,000 ---------------------------------- Other comprehensive income ........ $1,498,000 $ 559,000 $ 939,000 ==================================
Note 3. Investment Securities Available for Sale
The amortized cost and fair value of investment securities available for sale as of December 31, 2002 and 2001 are summarized as follows:
The amortized cost and fair value of investment securities available for sale as of December 31, 2002, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities for mortgage-backed securities because the mortgages underlying the securities may be prepaid without any penalties. Therefore, these securities are not included in the maturity categories in the following summary.
Amortized Fair Cost Value --------------------------- Securities available for sale: Due in one year or less ........................ $ 8,285,000 $ 8,426,000 Due after one year through five years .......... 17,595,000 18,601,000 Due after five years through ten years ......... 7,897,000 8,381,000 Due after ten years ............................ 2,294,000 2,406,000 --------------------------- 36,071,000 37,814,000 Mortgage-backed securities ..................... 268,000 281,000 --------------------------- $36,339,000 $38,095,000 ===========================
Investment securities with a carrying value of $17,633,000 and $16,359,000 as of December 31, 2002 and 2001, respectively, are pledged on securities sold under agreements to repurchase, trust deposits, and for other purposes as required or permitted by law.
All sales of securities during the years ended December 31, 2002, 2001, and 2000 were from securities identified as available for sale. Information on proceeds received, as well as the gross gains and losses from the sale of those securities is as follows for the years ended December 31, 2002, 2001, and 2000:
2002 2001 2000 ----------------------------------
Proceeds from sales of securities .......... $4,013,000 $11,077,000 $ 23,000 Gross gains from sales of securities ....... 86,000 332,000 13,000 Gross losses from sales of securities ...... 2,000 1,000 --
Note 4. Loans
The composition of loans is summarized as follows:
December 31, ------------------------------- 2002 2001 -------------------------------
Commercial ............................... $109,045,000 $106,286,000 Agricultural ............................. 28,185,000 27,926,000 Real estate: Construction ........................... 6,051,000 7,752,000 Mortgage ............................... 113,295,000 110,931,000 Tax exempt, mortgage ................... 3,297,000 1,290,000 Installment .............................. 17,118,000 21,401,000 Other .................................... 235,000 291,000 ------------------------------- Total loans ...................... 277,226,000 275,877,000 Less allowance for loan losses ........... 3,304,000 3,182,000 ------------------------------- $273,922,000 $272,695,000 ===============================
Included in commercial loans above are general warehousing and storage industry loans totaling $7,709,000 as of December 31, 2002.
Included in real estate mortgage loans above are loans held for sale of $390,000 and none as of December 31, 2002 and 2001, respectively.
Loans considered to be impaired are as follows:
December 31, ----------------------- 2002 2001 ----------------------- Impaired loans for which an allowance has been provided ........................................... $2,095,000 $2,866,000 =======================
Allowance provided for impaired loans, included in the allowance for loan losses .......................... $ 410,000 $ 251,000 =======================
There are no loans impaired for which an allowance has not been provided.
The average recorded investment in impaired loans during 2002 and 2001 was $2,319,000 and $3,462,000, respectively. Interest income on impaired loans of $269,000, $339,000, and $9,000 was recognized for cash payments received in 2002, 2001, and 2000, respectively.
Nonaccruing loans totaled $1,730,000 and $640,000 at December 31, 2002 and 2001, respectively. Interest income in the amount of $100,000, $63,000, and $47,000 would have been earned on the nonaccrual loans had they been performing loans in accordance with their original terms during the years ended December 31, 2002, 2001, and 2000, respectively. The interest collected on loans designated as nonaccrual loans and included in income for the years ended December 31, 2002, 2001, and 2000 totaled $30,000, $57,000, and $14,000, respectively.
Loans past due 90 days or more and still accruing interest totaled $1,053,000 and $128,000 as of December 31, 2002 and 2001, respectively.
Changes in the allowance for loan losses are summarized as follows:
Year Ended December 31, ------------------------------------- 2002 2001 2000 -------------------------------------
Beginning balance .................... $3,182,000 $3,268,000 $3,091,000 Provisions charged to expense ...... 440,000 366,000 429,000 Recoveries ......................... 53,000 52,000 78,000 ------------------------------------- 3,675,000 3,686,000 3,598,000 Loans charged off .................. 371,000 504,000 330,000 ------------------------------------- Ending balance ....................... $3,304,000 $3,182,000 $3,268,000 =====================================
The Company retains mortgage loan servicing on loans sold into the secondary market which are not included in the accompanying consolidated balance sheets. The unpaid principal balance on these loans was $28,170,000 and $14,021,000 as of December 31, 2002 and 2001, respectively. Custodial escrow balances maintained in connection with these loans were approximately $133,000 and $88,000 as of December 31, 2002 and 2001, respectively. All loans sold are without recourse.
Note 5. Bank Premises and Equipment
Bank premises and equipment are summarized as follows:
Years of Useful Lives December 31, ------------------------ 2002 2001 ------------------------
Land ................................ $ 1,136,000 $ 756,000 Bank premises ....................... 10-40 6,452,000 6,265,000 Leasehold improvements .............. 5-15 122,000 201,000 Furniture and equipment ............. 5-15 2,864,000 3,079,000 ------------------------ 10,574,000 10,301,000 Accumulated depreciation ............ 5,271,000 5,246,000 ------------------------ $ 5,303,000 $ 5,055,000 ========================
Included in land at December 31, 2002 is $380,000 representing the cost of property acquired for the purpose of construction of a new branch bank building. Additionally, as of December 31, 2002, bank premises include $185,000 of construction in process related to the construction of this new branch bank building as well as the remodeling of one of the Company's main banking facilities. Also see Note 14.
Note 6. Deposits
The composition of deposits is summarized as follows:
December 31, ---------------------------------- 2002 2001 ----------------------------------
Demand ............................. $ 96,350,000 $ 95,819,000 NOW accounts ....................... 35,246,000 32,948,000 Savings ............................ 22,584,000 20,478,000 Time certificates .................. 116,242,000 118,279,000 ---------------------------------- $270,422,000 $267,524,000 ==================================
Included in interest-bearing deposits are certificates of deposit with a minimum denomination of $100,000 totaling $27,322,000 and $27,947,000 as of December 31, 2002 and 2001, respectively.
At December 31, 2002, the scheduled maturities of all certificates of deposit are as follows:
Year ending December 31: 2003 $ 61,754,000 2004 30,134,000 2005 7,413,000 2006 5,911,000 2007 6,172,000 Thereafter 4,858,000 ------------- $ 116,242,000 =============
Note 7. Notes Payable
Notes payable are summarized as follows:
The Company also has a $2,000,000 line of credit with interest floating and paid quarterly at prime rate (4.25% as of December 31, 2002), which is due May 4, 2003. There were no borrowings under this agreement as of December 31, 2002 and 2001.
The notes payable include certain restrictive covenants regarding the Company's net worth and regulatory capital.
Note 8. Other Borrowed Funds
Other borrowed funds consist of the following:
December 31, -------------------------- 2002 2001 --------------------------
Securities sold under agreements to repurchase ... $ 6,591,000 $ 5,068,000 Federal Home Loan Bank advances .................. 64,609,000 70,706,000 Treasury tax and loan open note .................. 785,000 622,000
The securities sold under agreements to repurchase represent agreements with customers of the Banks which are collateralized with securities of the Banks held by the Federal Home Loan Bank of Des Moines. The Federal Home Loan Bank may sell, loan, or otherwise dispose of such securities to other parties in the normal course of their operations with prior written approval of the Banks, and have agreed to resell to the Banks substantially identical securities at the maturities of the agreements. At December 31, 2002, all but $1,036,000 of the securities sold under agreements to repurchase mature within twelve months. Of this $1,036,000, $502,000 matures within two years and the remaining $534,000 matures within four years. At December 31, 2001, all but $1,318,000 of the securities sold under agreements to repurchase mature within twelve months. Of this $1,318,000, $1,011,000 matures within 2 years and the remaining $307,000 matures within three years.
Additional information concerning securities sold under agreements to repurchase follows:
December 31, ------------------------ 2002 2001 ------------------------
Daily average amount outstanding during the year .... $ 5,845,000 $ 4,464,000 Maximum outstanding as of any month-end ............. 7,349,000 5,068,000
Weighted average interest rate during the year ...... 2.68% 4.11% Weighted average interest rate at the end of the year 2.18% 2.78%
Securities underlying the agreements at the end of the year, carrying and fair value .............. $10,734,000 $10,935,000
Advances from the Federal Home Loan Bank as of December 31, 2002 bear interest and are due as follows:
Weighted Average Interest Rate at Year-End Balance Due ------------------------- Year ending December 31: 2003 ................................ 5.81% $ 9,050,000 2004 ................................ 6.25 7,950,000 2005 ................................ 5.19 6,500,000 2006 ................................ 5.32 10,950,000 2007 ................................ 4.75 4,950,000 Thereafter .......................... 5.79 25,209,000 ------------ $ 64,609,000 ============
Of the advances maturing after 2007, $17,443,000 have options which allow the Company the right, but not the obligation, to "put" the advances back to the Federal Home Loan Bank. The majority of these put options begin to be exercisable in 2003 and 2004.
As of December 31, 2001 advances from the Federal Home Loan Bank in the amount of $70,706,000 had interest rates between 3.83% and 7.39% and various maturity dates between 2000 and 2014.
First mortgage loans of approximately $90,526,000 and $92,380,000 as of December 31, 2002 and 2001, respectively, are pledged as collateral on Federal Home Loan Bank advances.
The treasury tax and loan open note represents overnight borrowings from the Federal Reserve Bank system.
Note 9. Company Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust Holding Solely Subordinated Debentures
On March 28, 2001, the Company issued 4,000 shares totaling $4,000,000 of Company obligated mandatorily redeemable preferred securities of Iowa First Capital Trust I. The securities provide for cumulative cash distributions calculated at a 10.18% annual rate. The Company may, at one or more times, defer interest payments on the capital securities for up to 10 consecutive semi-annual periods, but not beyond June 8, 2031. At the end of the deferral period, all accumulated and unpaid distributions will be paid. The capital securities will be redeemed on June 8, 2031; however, the Company has the option to shorten the maturity date to a date not earlier than June 8, 2011. The redemption price begins at 105.09% to par and is reduced 51 basis points each year until June 8, 2021 when the capital securities can be redeemed at par. Holders of the capital securities have no voting rights, are unsecured, and rank junior in priority of payment to all of the Company's indebtedness and senior to the Company's capital stock. For regulatory purposes, the entire amount of the capital securities is allowed in the calculation of Tier 1 capital. The capital securities are included in the consolidated balance sheet as a liability with the cash distributions included in interest expense.
Note 10. Regulatory Matters
The Company and Banks ("Entities") are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Entities' financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Entities must meet specific capital guidelines that involve quantitative measures of the Entities' assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Entities' capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy require the Entities to maintain minimum amounts and ratios (set forth in the following table) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2002, that the Entities meet all capital adequacy requirements to which they are subject.
As of December 31, 2002, the most recent notification from the Federal Deposit Insurance Corporation categorized the Banks as well capitalized under the regulatory framework for prompt corrective action. To be categorized as adequately or well capitalized an institution must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since the notification that management believes have changed the Banks' categories.
The Company and Banks' actual capital amounts and ratios are presented in the following table.
Current banking law limits the amount of dividends banks can pay. As of December 31, 2002, amounts available for payment of dividends were $4,279,000 and $464,000 for First National Bank of Muscatine and First National Bank in Fairfield, respectively. Regardless of formal regulatory restrictions the Banks may not pay dividends which would result in their capital levels being reduced below the minimum requirements shown above.
Note 11. Employee Benefits
The Company and bank subsidiaries sponsor an Employee Stock Ownership Plan with 401(k) provisions (KSOP). This plan owns 102,545 shares of the Company as of December 31, 2002 and covers substantially all employees who have reached the age of 21 and worked at least 1,000 hours any year. The Company and subsidiary banks match 50% of the amount an employee contributes to the plan up to a maximum of 6% of the employee's pay. Additionally, the Company and subsidiary banks may make profit sharing contributions to the plan which are allocated to the accounts of participants in the plan on the basis of total relative compensation. The amounts expensed for the years ended December 31, 2002, 2001, and 2000 were $319,000, $320,000, and $321,000, respectively.
An employee, upon termination of employment, has the option of retaining ownership of shares vested pursuant to the plan or selling such shares to the Company. Since the shares of common stock held by the KSOP are not readily traded, the Company has reflected the maximum cash obligation related to those securities outside of stockholders' equity. As of December 31, 2002, 102,545 shares held by the KSOP, at a fair value of $26.50 per share, have been reclassified from stockholders' equity to mezzanine capital.
The Company has entered into deferred compensation agreements with certain directors and executive officers of the Company and Banks. Under the provisions of the agreements the directors and officers may defer a portion of their compensation each year. Based upon individual performance, if Board established performance targets are met, a match of up to 50% of the officers deferrals (with an annual cap of $6,250 per participant) may be paid by the Company. Related to the agreements, the Company has purchased various life insurance contracts. Interest on deferrals is computed at an annual rate equal to the taxable equivalent (determined using the Company's highest marginal tax bracket) of the highest yielding insurance contract purchased by the Company related to the agreements. At December 31, 2002 the rate is 10%. Upon retirement, the director or officer will receive the deferral balance in 180 equal monthly installments. During the years ended December 31, 2002, 2001, and 2000, the Company expensed $134,000, $124,000, and $119,000, respectively, related to the agreements. As of December 31, 2002 and 2001 the liability related to the agreements was $342,000 and $243,000, respectively. During the years ended December 31, 2002, 2001, and 2000, total cash payouts pursuant to the agreements totaled $35,000, none, and none, respectively.
Note 12. Income Taxes
The components of income tax expense are as follows:
Year Ended December 31, -------------------------------------- 2002 2001 2000 --------------------------------------
Currently paid or payable .............. $1,581,000 $1,478,000 $1,776,000 Deferred income taxes .................. (37,000) (45,000) (177,000) -------------------------------------- $1,544,000 $1,433,000 $1,599,000 ======================================
Income tax expense differs from the amount computed by applying the federal income tax rate to income before income taxes. The reasons for this difference are as follows:
Net deferred taxes, included in other liabilities on the consolidated balance sheets, consist of the following components as of December 31:
2002 2001 --------------------------- Deferred tax assets: Allowance for loan losses .................. $ 546,000 $ 500,000 Deferred compensation ...................... 128,000 91,000 Other real estate owned .................... 33,000 -- --------------------------- 707,000 591,000 --------------------------- Deferred tax liabilities: Securities available for sale .............. (655,000) (509,000) Bank premises and equipment ................ (116,000) (66,000) Unrealized bond accretion .................. (47,000) (45,000) Net deferred loan origination fees ......... (64,000) (37,000) --------------------------- (882,000) (657,000) --------------------------- Net deferred tax (liabilities) ............... $(175,000) $ (66,000) ===========================
The change in deferred income taxes was reflected in the financial statements as follows for the years ended December 31, 2002, 2001, and 2000.
2002 2001 2000 ----------------------------------
Provision for income taxes .............. $(37,000) $(45,000) $(177,000) Statement of stockholders' equity, accumulated other comprehensive income ................................ 146,000 336,000 559,000 ---------------------------------- $109,000 $291,000 $ 382,000 ==================================
Note 13. Earnings Per Share
The following information was used in the computation of basic and diluted earnings per share:
Year Ended December 31, ----------------------------------- 2002 2001 2000 -----------------------------------
Basic and diluted earnings, net income ... $3,570,000 $3,400,000 $3,560,000 ===================================
Weighted average common shares outstanding ............................ 1,440,466 1,478,220 1,524,473 Weighted average common shares issuable upon conversion of stock options ....... -- -- -- ---------------------------------- Weighted average common and common equivalent shares ........................... 1,440,466 1,478,220 1,524,473 ===================================
Note 14. Commitments and Contingencies
Financial instruments with off-balance-sheet risk: The Banks are parties to financial instruments with off-balance-sheet risk made in the normal course of business to meet the financing needs of their customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate 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 and standby letters of credit is represented by the contractual amounts of those instruments. The Banks use the same credit policies in making commitments and conditional obligations as they do for on-balance-sheet instruments.
December 31, ---------------------------- 2002 2001 ---------------------------- Financial instruments whose contract amounts represent credit risk: Commitments to extend credit ............... $44,521,000 $40,989,000 Standby letters of credit .................. 2,539,000 1,913,000
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. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon and some of the commitments will be sold to other financial intermediaries if drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Banks evaluate each customer's creditworthiness on a case-by-case basis.
Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements and, generally, have terms of one year, or less. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Banks hold collateral, which may include accounts receivable, inventory, property, equipment, and income-producing properties, supporting those commitments if deemed necessary. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Banks would be required to fund the commitment. The maximum potential amount of future payments the Banks could be required to make is represented by the contractual amount shown in the summary above. If the commitment is funded, the Banks would be entitled to seek recovery from the customer. At December 31, 2002 and 2001 no amounts have been recorded as liabilities for the Banks' potential obligations under these guarantees.
The Company has also executed contracts for the sale of mortgage loans in the secondary market in the amount of $390,000 and none as of December 31, 2002 and 2001, respectively. These amounts are included in loans held for sale at the respective balance sheet dates.
Concentration of credit risk: The Banks grant commercial, real estate, and installment loans to customers in the Banks' primary market area which includes Muscatine and Jefferson Counties in Iowa. The Banks have diversified loan portfolios, as set forth in Note 4. The distribution of commitments to extend credit and standby letters of credit approximates the distribution of loans outstanding. The Banks' policies for requiring collateral are consistent with prudent lending practices and anticipate the potential for economic fluctuations. Collateral varies but may include accounts receivable, inventory, property and equipment, residential real estate properties, and income producing commercial properties. It is the policy of the Banks to file financing statements and mortgages covering collateral pledged.
Aside from cash on-hand and in-vault, the Company's cash is maintained at correspondent banks. The total amount of cash on deposit, certificates of deposit, and federal funds sold with correspondent banks exceeded federal insured limits by $30,552,000 and $30,385,000 as of December 31, 2002 and 2001, respectively. In the opinion of management, no material risk of loss exists due to the correspondent banks' financial condition and the fact they are all well capitalized.
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 Company's financial statements.
Commitments: As of December 31, 2002 the Company has entered into contracts for construction of a new branch in Muscatine and a remodeling of the main floor of the existing downtown Muscatine location. The total costs, including the cost of land and site work at the new branch and equipment for both projects are anticipated to be approximately $1,500,000 and $500,000 with $499,000 and $66,000, respectively, incurred as of December 31, 2002. The new branch discussed above will serve as a replacement for a current rented branch facility in Muscatine.
Note 15. Related Party Matters
Senior officers and directors of the Company and the Banks, principal holders of equity securities of the Company, and their associates were indebted to the Banks for loans made in the ordinary course of business. Such loans are on the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with others. As of December 31, 2002, none of these loans are classified as nonaccrual, past due, or restructured.
The activity in such loans during the years ended December 31, 2002 and 2001 is as follows:
2002 2001 ----------------------------------
Balance, beginning ................... $ 10,355,000 $ 10,049,000 Additions .......................... 8,633,000 5,451,000 Deductions (payments) .............. (5,513,000) (5,145,000) ---------------------------------- Balance, ending ...................... $ 13,475,000 $ 10,355,000 ==================================
Note 16. 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 No. 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 in estimating fair value disclosures for financial instruments in the table below:
Cash and due from banks and interest-bearing deposits at financial institutions: The carrying value for cash and due from banks and interest-bearing deposits at financial institutions, with maturities of one month or less, equal their fair values. Fair values of interest-bearing deposits at financial institutions with remaining maturities of over one month are estimated using discounted cash flow analysis, using interest rates currently available for similar instruments.
Federal funds sold: The carrying value for federal funds sold equal their fair value.
Investment securities available for sale: Fair values for investment securities available for sale 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: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for all other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.
Accrued interest receivable and payable: The carrying value of accrued interest receivable and payable represents its fair value.
Restricted investment securities: The carrying value of restricted investment securities equals their fair value.
Deposits: Fair values for demand deposits (i.e., interest and noninterest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed-rate 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 of time deposits.
Notes payable and Company obligated mandatorily redeemable preferred securities: For variable rate notes payable, the carrying amount is a reasonable estimate of fair value. For fixed rate notes payable and Company obligated mandatorily redeemable preferred securities, fair values are estimated using a discounted cash flow calculation that applies interest rates currently being offered on similar borrowings.
Securities sold under agreements to repurchase and treasury tax and loan open note: For such short-term instruments, the carrying amount is a reasonable estimate of fair value. The fair value of securities sold under agreements to repurchase with maturities of over one month is estimated using discounted cash flow analysis, using interest rates available on similar borrowings.
Federal Home Loan Bank advances: The fair value of Federal Home Loan Bank advances is estimated using a discounted cash flow analysis, employing interest rates currently being quoted by the Federal Home Loan Bank on similar borrowings.
Commitments to extend credit and standby letters of credit: The fair value of these commitments is not material.
The carrying values and estimated fair values of financial instruments at December 31, 2002 and 2001 are summarized as follows:
Note 17. Parent Company Only Condensed Financial Information
The following is condensed financial information of Iowa First Bancshares Corp. (parent company only):
BALANCE SHEETS (Parent Company Only)
STATEMENTS OF INCOME (Parent Company Only)
Note 17. Parent Company Only Condensed Financial Information (Continued)
STATEMENTS OF CASH FLOWS (Parent Company Only)
IOWA FIRST BANCSHARES CORP.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information called for by this Item is set forth under the caption "Information Concerning Nominees for Election as Directors" in the Company's 2002 Proxy Statement, and is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information called for by this Item is set forth under the captions "Executive Compensation", "Performance Incentive Plans", "Executive Employment Agreements" and "Deferred Compensation Agreements" in the Company's 2002 Proxy Statement, and is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERHSIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for by this Item is set forth under the caption "Security Ownership of Certain Beneficial Owners" and "Information Concerning Nominees for Election as Directors" in the Company's 2002 Proxy Statement, and is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Officers and Directors of the Company and its subsidiaries have had, and may have in the future, banking transactions in the ordinary course of business of the Company's subsidiaries. All such transactions are on substantially the same terms, including interest rates on loans and collateral, as those prevailing at the time for comparable transactions with others, and involve no more than the normal risk of collectibility.
ITEM 14.
ITEM 14. CONTROLS AND PROCEDURES
During the 90-day period prior to the filing date of this report, management, including the Company's Executive Vice President, Chief Operating Officer & Treasurer and Vice Chairman of the Board, President and CEO, evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based upon, and as of the date of that evaluation, management concluded that the disclosure controls and procedures were effective, in all material respects, to ensure that information required to be disclosed in the reports the Company files and submits under the Exchange Act is recorded, processed, summarized and reported as and when required.
There have been no significant changes in the Company's internal controls or in other factors which could significantly affect internal controls subsequent to the date the Company carried out its evaluation. There were no significant deficiencies or material weaknesses identified in the evaluation and therefore, no corrective actions were taken.
IOWA FIRST BANCSHARES CORP.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents Filed with This Report:
(1) Financial Statements. The following consolidated financial statements of the Company and its subsidiaries are incorporated by reference from the 2002 Annual Report to Shareholders of the Company:
Independent Auditor's Report
Consolidated balance sheets -- dated December 31, 2002 and 2001.
Consolidated statements of income -- years ended December 31, 2002, 2001, and 2000.
Consolidated statements of changes in stockholders' equity -- years ended December 31, 2002, 2001, and 2000.
Consolidated statements of cash flows - years ended December 31, 2002, 2001, and 2000.
Notes to consolidated financial statements.
(2) Financial Statement Schedules. All schedules are omitted because they are not applicable, are not required, or because the required information is included in the financial statements or the accompanying notes thereto.
(3) Exhibits.
(b) Reports on Form 8-K.
No reports on Form 8-K have been filed during the last quarter of the period covered by this report.
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.
IOWA FIRST BANCSHARES CORP.
Date: March 20, 2003 /s/ George A. Shepley -------------- ------------------------------------------------ George A. Shepley Chairman of the Board
Date: March 20, 2003 /s/ Kim K. Bartling -------------- ------------------------------------------------ Kim K. Bartling, Executive Vice President, Chief Operating Officer, Treasurer and Director (Principal Financial and Accounting Officer)
We, the undersigned directors of Iowa First Bancshares Corp. hereby severally constitute George A. Shepley and Kim K. Bartling, and each of them, our true and lawful attorneys with full power to them, and each of them, to sign for us and in our name, the capacities indicated below, the Annual Report on Form 10-K of Iowa First Bancshares Corp. for the fiscal year ended December 31, 2002, to be filed herewith and any amendments to said Annual Report, and generally do all such things in our name and behalf in our capacities as directors to enable Iowa First Bancshares Corp. to comply with the provisions of the Securities Exchange Act of 1934 as amended, and all requirements of the Securities and Exchange Commission, hereby ratifying and confirming our signatures as they may be signed by our said attorneys, or either of them, to said Annual Report on Form 10-K and any and all amendments thereto.
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.
Signature Title Date
/s/ Roy J. Carver, Jr. Director February 20, 2003 - ----------------------- ------------------ Roy J. Carver, Jr.
/s/ Stephen R. Cracker Director February 20, 2003 - ----------------------- ------------------ Stephen R. Cracker
/s/ Larry L. Emmert Director February 20, 2003 - ----------------------- ------------------ Larry L. Emmert
/s/ Craig R. Foss Director February 20, 2003 - ----------------------- ------------------ Craig R. Foss
/s/ Donald R. Heckman Director February 20, 2003 - ----------------------- ------------------ Donald R. Heckman
/s/ David R. Housley Director February 20, 2003 - ----------------------- ------------------ David R. Housley
/s/ D. Scott Ingstad Director February 20, 2003 - ----------------------- ------------------ D. Scott Ingstad
/s/ Victor G. McAvoy Director February 20, 2003 - ----------------------- ------------------ Victor G. McAvoy
/s/ John "Jay" S. McKee Director February 20, 2003 - ----------------------- ------------------ John "Jay" S. McKee
/s/ Beverly J. White Director February 20, 2003 - ----------------------- ------------------ Beverly J. White
Section 302 Certification
I, Kim K. Bartling, certify that:
1. I have reviewed this annual report on Form 10-K of Iowa First Bancshares Corp.
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a. designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's Board of Directors (or persons performing the equivalent function):
a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 20, 2003 Signature: /s/ Kim K. Bartling --------------- -------------------------------- Kim K. Bartling, Executive Vice President, Chief Operating Officer & Treasurer
Section 302 Certification
I, D. Scott Ingstad, certify that:
1. I have reviewed this annual report on Form 10-K of Iowa First Bancshares Corp.
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a. designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's Board of Directors (or persons performing the equivalent function):
a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 20, 2003 Signature: /s/ D. Scott Ingstad -------------- ---------------------------------- D. Scott Ingstad, Vice Chairman of the Board, President, and Chief Executive Officer