Item 1. Business
GENERAL
Hills Bancorporation (the "Company") is a holding company principally engaged, through its subsidiary bank, in the business of banking. The Company was incorporated December 12, 1982 and all operations are conducted within the state of Iowa. The Company became owner of 100% of the outstanding stock of Hills Bank and Trust Company, Hills, Iowa ("Hills Bank and Trust" or the "Bank") as of January 23, 1984 when stockholders of Hills Bank and Trust exchanged their shares for shares of the Company. Effective July 1, 1996, the Company formed a new subsidiary, Hills Bank, which acquired for cash all the outstanding shares of a bank in Lisbon, Iowa. Subsequently an office of Hills Bank was opened in Mount Vernon, Iowa, a community that is contiguous in Lisbon. Effective November 17, 2000, Hills Bank was merged into Hills Bank and Trust.
On September 20, 1996, another subsidiary, Hills Bank Kalona, acquired cash and other assets and assumed the deposits of the Kalona, Iowa office of Boatmen's Bank Iowa, N.A., Kalona, Iowa (Washington County) is approximately 20 miles south of Iowa City. Kalona has a population of approximately 2,000 people. Kalona is primarily an agricultural community, but is located within easy driving distance for employment in Iowa City and Coralville (combined population 87,000) and Washington, Iowa (population 7,300). Effective October 26, 2001, Hills Bank Kalona was merged into Hills Bank and Trust.
The Bank primarily serves the communities of Iowa City, Coralville, Hills and North Liberty, located near Interstate 80 and Interstate 380 in Eastern Iowa. These communities have a combined population of approximately 80,000 and Johnson County, Iowa has a population of approximately 106,000. The University of Iowa in Iowa City has over 27,000 students and 23,000 full and part-time employees, including employees of The University of Iowa Hospitals and Clinics. Johnson County, Iowa has had one of the strongest economies in Iowa and has had substantial economic growth in the past ten years.
The Bank also operates offices in the Linn County, Iowa communities of Lisbon, Mount Vernon and Cedar Rapids, Iowa. Lisbon has a population of approximately 1,500 and Mount Vernon, located two miles from Lisbon, has a population of 3,700. Both communities are strong economically and are within easy commuting distances to Cedar Rapids and Iowa City, Iowa. Mount Vernon is the home of Cornell College, which has approximately 1,200 students. Cedar Rapids has a metropolitan population of approximately 180,000 and is located approximately 10 miles west of Lisbon, Iowa and approximately 25 miles north of Iowa City on Interstate 380. The larger employers in the Cedar Rapids area are Rockwell Collins with approximately 6,300 employees and Amana Appliances with approximately 2,950 employees. Other major employers include Cedar Rapids Community Schools (about 2,475 employees), St. Luke's Hospital (about 2,250 employees) and McLeod USA (approximately 2,000 employees). There are several additional employers in Cedar Rapids having from 1,000 to 2,000 employees each.
The Bank is an all full-service commercial bank extending its services to individuals, business, governmental units and institutional customers primarily in the communities of Hills, Iowa City, Cedar Rapids, Coralville, North Liberty, Lisbon, Mount Vernon and Kalona. This area includes all of Johnson County and parts of Linn and Washington counties. The Bank is actively engaged in all areas of commercial banking, including acceptance of demand, savings and time deposits; making commercial, real estate, agricultural and consumer loans; maintaining night and safe deposit facilities; and performing collection, exchange and other banking services tailored for individual customers. The Bank administers estates, personal trusts, and pension plans and provides farm management and investment advisory and custodial services for individuals, corporations and nonprofit organizations. The Bank makes commercial and agricultural loans, real estate loans, automobile, installment and other consumer loans. In addition, the Bank earns substantial fees from originating mortgages that are sold in the secondary residential real estate market without mortgage servicing rights being retained.
The Bank has an established formal loan origination policy. In general, the loan origination policy requires individual lenders to reduce the risk of credit loss to the Bank by requiring that, among other things, minimum loan to value ratios be maintained, evidence of appropriate levels of insurance be carried by borrowers and documenting appropriate types and amounts of collateral and sources of expected payment.
The Bank's business is not seasonal, except that loan origination fees are normally higher during the spring and summer months. Management believes that the Bank has not undertaken any significant new services during the current year that might exceed the limits of its human resources and data processing capabilities.
The Company does not engage in any business activities apart from its ownership of the Bank and, therefore, does not encounter any competition for its services other than as described above for the Bank.
The Company and the Bank have undertaken no material research activities during the last three years relating to research and development activities.
The Company had no employees as of December 31, 2001 and the Bank had 265 regular and 101 part-time employees.
COMPETITION
The financial services industry is highly competitive. The Bank must compete with financial services providers, such as banks, savings and loan associations, credit unions, finance companies, mortgage banking companies, insurance companies and money market and mutual fund companies. It also faces increased competition from nonbanking institutions such as brokerage houses and insurance companies, as well as from financial services subsidiaries of commercial and manufacturing companies. Many of these competitors enjoy the benefits of fewer regulatory constraints and lower cost structures.
Effective March 13, 2000, securities firms and insurance companies that elect to become financial holding companies may acquire banks and other financial institutions. This may significantly change the competitive environment in which the Company conducts business. The financial services industry is also likely to become more competitive as further technological advances enable more companies to provide financial services. These technological advances may diminish the importance of depository institutions and other financial intermediaries in the transfer of funds between parties.
The Company does not engage in any business activities apart from its ownership of the Bank and, therefore, does not encounter any competition for its services other than as described above for the Bank.
The Company and the Bank have undertaken no material research activities during the last three years relating to research and development activities.
The Company had no employees as of December 31, 2001 and the Bank had 265 regular and 101 part-time employees.
The Bank is in direct competition for loans and deposits and financial services with a number of other banks in Johnson County, Iowa. A comparison of deposits in Johnson County is as follows: Deposits June 30, ------------- (In Millions) Hills Bank and Trust Company ................................ $557 Branches of largest competing regional bank ................. 245 Largest competing independent bank .......................... 321 Largest competing credit union .............................. 202
In Linn County, Iowa, the June 30, 2001 deposits of the Bank totaled $70 million out of total deposits of $2,512 million.
THE ECONOMY
The Bank's primary trade territory is Johnson County, Iowa. Recent employment data indicates that the total employment in the county is approximately 45,000, of which 23,000 employees work for the University of Iowa or the University of Iowa Hospitals and Clinics. Other larger sectors of the economy are health care (two other hospitals employ 2,500), educational testing and data processing (two employers employ 2,300), governmental (city, county and schools employ 2,600) and retail and service sectors. The University of Iowa's impact on the local economy has been to maintain employment levels because of record enrollments at the University of Iowa and to stabilize unemployment at approximately 2.1% for the past four years.
The State of Iowa has recently seen decreasing tax revenues while spending has increased, and the Iowa legislature has required the University to reduce spending in the year ending June 30, 2002 with further reductions expected for the year ending June 2003. So far, the University has reacted to its budget constraints without significant lay-offs and has announced that it intends to reduce employment, when necessary, through attrition. However, salary increases at the University are expected to be minimal in the next year.
The Bank also serves a number of smaller communities in Johnson, Linn and Washington counties that are more dependent upon the agricultural economy, which has historically been affected by commodity prices and weather. However, the Bank's total agricultural loans comprise only about 5% of the Bank's total loans.
The Bank also competes in Linn County, Iowa where it holds approximately 3% of the county's total deposits. Linn County, with a population of approximately 180,000, has a much higher dependence on manufacturing and its largest employer is Rockwell Collins, with about 6,300 employees. Other employment sectors include telecommunications with McLeod USA and MCI employing approximately 5,000 total employees. Several of Linn County's larger employers have recently reduced employment, including McLeod USA, which is operating in bankruptcy, Rockwell Collins, and Amana Appliances, which has been acquired by Maytag.
SUPERVISION AND REGULATION
Financial institutions and their holding companies are extensively regulated under federal and state law. As a result, the growth and earnings performance of the Company can be affected not only by management decisions and general economic conditions but also by the requirements of applicable state and federal statutes and regulations and the policies of various governmental regulatory authorities, including the Iowa Superintendent of Banking (the "Superintendent"), the Board of Governors of the Federal Reserve System (the "Federal Reserve"), the Federal Deposit Insurance Corporation (the "FDIC"), the Internal Revenue Service and state taxing authorities and the Securities and Exchange Commission (the "SEC"). The effect of applicable statues, regulations and regulatory policies can be significant and cannot be predicted with a high degree of certainty.
Federal and state laws and regulations generally applicable to financial institutions, such as the Company and its subsidiary Bank, regulate, among other things, the scope of business, investments, reserves against deposits, capital levels relative to operations, the nature and amount of collateral for loans, the establishment of branches, mergers, consolidations and dividends. The system of supervision and regulation applicable to the Company and its subsidiary Bank establishes a comprehensive framework for their respective operations and is intended primarily for the protection of the FDIC's deposit insurance funds and the depositors, rather than the stockholders, of financial institutions.
The following is a summary of the material elements of the regulatory framework that applies to the Company and its subsidiary Bank. It does not describe all of the statutes, regulations and regulatory policies that apply, nor does it restate all of the requirements of the statutes, regulations and regulatory policies that are described. As such, the following is qualified in its entirety by reference to the applicable statutes, regulations and regulatory policies. Any change in applicable law, regulations or regulatory policies may have a material effect on the business of the Company and its subsidiary Bank.
Recent Regulatory Developments
The Gramm-Leach-Bliley Act, also known as the Financial Services Modernization Act (the "Act"), was enacted on November 12, 1999. The Act allows eligible bank holding companies to engage in a wider range of nonbanking activities and grants them greater authority to engage in securities and insurance activities. Under the Act, an eligible bank holding company that elects to become a financial holding company may engage in any activity that the Federal Reserve, in consultation with the Secretary of the Treasury, determines by regulation or order is financial in nature, incidental to any such financial activity, or complementary to any such financial activity and does not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally. A financial service corporation can engage in a number of financial activities including insurance and securities underwriting and other agency activities, merchant banking and insurance company portfolio investment activities. Activities that are ancillary to financial activities are also allowed. Additionally, the Act amends the federal securities laws to incorporate functional regulation of bank securities and activities and provides for the functional regulation of insurance activities by establishing which insurance products banks and bank subsidiaries may provide as principal. National banks are also authorized by the Act to engage, through "financial subsidiaries," in certain activity that is permissible for financial holding companies (as described above) and certain activity that the Secretary of the Treasury, in consultation with the Federal Reserve, determines is financial in nature or incidental to any such financial activity.
Various bank regulatory agencies have issued regulations as mandated by the Act. During June 2000, all of the federal bank regulatory agencies jointly issued regulations implementing the privacy provisions of the Act. In addition, the Federal Reserve issued interim regulations establishing procedures for bank holding companies to elect to become financial holding companies and listing the financial activities permissible for financial holding companies, as well as describing the extent to which financial holding companies may engage in securities and merchant banking activities. The Federal Reserve has issued an interim regulation regarding the parameters under which state member banks may establish and maintain financial subsidiaries. At this time, it is not possible to predict the impact the Act and its implementing regulations may have on the Company. As of the date of this filing, the Company has not applied for or received approval to operate as a financial holding company. In addition, the Bank has not applied for or received approval to establish financial subsidiaries.
Furthermore, the Act provides reform in the Federal Home Loan Bank area by providing that banks with less than $500 million in assets may use long-term advances for loans to small businesses, small farms and small agri-businesses and replaces the current $300 million funding formula for the REFCORP obligations of the Federal Home Loan Banks to twenty percent (20%) of the Bank's annual earnings.
In the area of privacy, the Act requires clear disclosure by all financial institutions of their privacy policy regarding the sharing of nonpublic information with both affiliates and third parties. Further, the Act requires a notice to consumers and an opportunity to "opt out" of sharing of nonpublic personal information with nonaffiliated third parties subject to certain limited exceptions. The Act also provides reform in the area of ATMs, Community Reinvestment Community Banks and Deposit Production Offices. Specifically, the Act requires ATM operators who impose a fee for use of an ATM by a noncustomer to post a notice on the machine that a fee will be charged and on the screen that a fee will be charged and the amount of the fee, and further requires a notice when ATM cards are issued that surcharges may be imposed by other parties when transactions are initiated from ATMs not operated by the card issuer. The Act also clarifies that nothing in the act repeals any provision of the Continuity Reinvestment Act ("CRA"); however, the Act requires full disclosure of all CRA agreements and grants regulatory relief regarding the frequency of CRA exams to small banks and savings and loans (those with no more than $250 million in assets). In the community bank area, the Act allows community banks all the powers as a matter of right that large institutions have accumulated on an ad hoc basis, including the ability to underwrite municipal bonds in several years. Finally, the Act expands the prohibition of deposit production offices contained in the Riegle-Neal Interstate bill to include all branches of an out-of-state bank holding company.
Regulation of the Company
General. The Company, as the sole shareholder of the Bank, is a bank holding company. As a bank holding company, the Company is registered with, and is subject to regulation by, the Federal Reserve under the Bank Holding Company Act, as amended (the "BHCA"). In accordance with the Federal Reserve policy, the Company is expected to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances where the Company might not otherwise do so. Under the BHCA, the Company is subject to periodic examination by the Federal Reserve. The Company is also required to file with the Federal Reserve periodic reports of the Company's operations and such additional information regarding the Company and its subsidiaries as the Federal Reserve may require.
Investments and Activities. Under the BHCA, a bank holding company must obtain Federal Reserve approval before: (i) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after the acquisition, it would own or control more than 5% of the shares of the other bank or bank holding company (unless it already owns or controls the majority of such shares), (ii) acquiring all or substantially all of the assets of another bank or (iii) merging or consolidating with another bank holding company. Subject to certain conditions (including certain deposit concentration limits established by the BHCA), the Federal Reserve may allow a bank holding company to acquire banks located in any state of the United States without regard to whether the acquisition is prohibited by the law of the state in which the target bank is located. On approving interstate acquisitions, however, the Federal Reserve is required to give effect to applicable state law limitations on the aggregate amount of deposits that may be held by the acquiring bank holding company and its insured depository institution affiliates in the state in which the target bank is located (provided that those limits do not discriminate against out-of-state depository institutions or their holding companies) and state laws which require that the target bank have been in existence for a minimum period of time (not to exceed five years) before being acquired by an out-of-state bank holding company.
The BHCA also generally prohibits the Company from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to banks and their subsidiaries. This general prohibition is subject to a number of exceptions. The principal exception allows bank holding companies to engage in, and to own shares of companies engaged in, certain businesses found by the Federal Reserve to be "so closely related to banking . . . as to be a proper incident thereto." Under current regulations of the Federal Reserve, the Company either directly or through nonbank subsidiaries would be permitted to engage in a variety of banking-related businesses, including the operation of a thrift, sales and consumer finance, equipment leasing, the operation of a computer service bureau (including software development) and mortgage banking and brokerage. The BHCA generally does not place territorial restrictions on the domestic activities of nonbank subsidiaries of bank holding companies.
Federal law also prohibits any person from acquiring "control" of a bank holding company without prior notice to the appropriate federal bank regulator. "Control" is defined in certain cases as the acquisition of 10% or more of the outstanding shares of a bank or a bank holding company depending on the circumstances surrounding the acquisition.
Regulatory Capital Requirements
Regulatory guidelines define capital and spell out the minimum acceptable capital levels for banks. The purpose of these guidelines is to increase depositor protection and to reduce deposit insurance fund losses. Currently, the three federal banking agencies use as "risk-based" approach to gauge bank capital. Under this approach, the agencies define what is to be included in bank capital and establish the minimum capital a bank must have to protect it, primarily from the inherent risk in its asset holdings.
Risk-based capital guidelines divide capital into core and supplemental capital. Core or Tier I capital is similar to what is normally thought of as capital in other businesses. It consists primarily of common and certain preferred stock, surplus and undivided profits. Bank holding companies are required to maintain these minimum levels of capital in accordance with Federal Reserve capital adequacy guidelines. If capital falls below minimum guideline levels, a bank holding company, among other things, may be denied approval to acquire or establish additional banks or nonbank businesses. Total capital consists primarily of Tier 1 capital plus certain other debt and equity instruments which do not qualify as Tier 1 capital and a portion of the company's allowance for loan and lease losses. Supplemental or Tier 2 capital consists, within certain specified limits, of such things as the allowance for loan losses, hybrid capital instruments and subordinated debt. These supplemental items are often forms of debt that are subordinate to claims of depositors and the FDIC. As such, they provide depositor protection and are included in bank capital. The sum of Tier 1 and Tier 2 capital, less certain deductions, represents a bank's total capital. In the capital guidelines, Tier 1 capital must constitute at least 50% of a bank's total capital. Thus, the use of Tier 2 capital is limited by the "hard" equity in a bank's capital structure.
As part of their capital adequacy assessment, the regulatory agencies convert a bank's assets, including off-balance sheet items, to risk-equivalent assets. The purpose of this conversion is to quantify the relative risk, primarily credit risk, in these assets and to determine the minimum capital necessary to compensate for this risk. For example, assets that pose little risk, such as cash held at the bank's offices and U. S. government securities, are weighted zero, meaning that no capital support is required for these assets. Assets that pose greater risk are weighted at 20%, 50% or 100% of their dollar value, indicating the level of capital support they require. Except for banks with large "off-balance sheet" asset positions, risk weighting will nearly always lower total assets requiring capital support. However, even if a bank held nothing but cash and U.S. securities, it would still be required to maintain capital support for these assets. The reason is that banks face more than credit risk (e.g., market risk), and these other risks require that capital be kept at some minimum level to protect the bank and its depositors.
The Federal Reserve's capital guidelines establish the following minimum regulatory capital requirements for bank holding companies: a risk-based requirement expressed as a percentage of total risk-weighted assets, and a leverage requirement expressed as a percentage of total assets. The risk-based requirement consists of a minimum ratio of total capital to total risk-weighted assets of 8%, at least one-half of which must be Tier 1 capital. The leverage requirement consisted of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly rated companies, with a minimum requirement of 4% for all others.
The risk-based and leverage standards described above are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual banking organizations. For example, the Federal Reserve's capital guidelines contemplate that additional capital may be required to take adequate account of, among other things, interest rate risk, or the risks posed by concentration of credit, nontraditional activities or securities trading activities. Further, any banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios (i.e., Tier 1 capital less all intangible assets), well above the minimum levels. Current Federal Reserve requirements for a well capitalized organization experiencing significant growth are a minimum of leverage capital of 5%, a Tier 1 capital of 6% and total risk-based capital of 10%. As of December 31, 2001, the Company had regulatory capital in excess of the Federal Reserve's minimum and well-capitalized definition requirements, with a leverage ratio of 8.86%, with total Tier 1 risk-based capital ratio of 13.47% and a total risk-based capital of 14.72%.
Dividends. The Iowa Business Corporation Act ("IBCA") allows the Company to pay dividends only out of its surplus (as defined and computed in accordance with the provision of the IBCA) or if the Company has no such surplus, out of its net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year. Additionally, the Federal Reserve has issued a policy statement with regard to the payment of cash dividends by bank holding companies. The policy statement provides that a bank holding company should not pay cash dividends which exceed its net income or which can only be funded in ways that weaken the bank holding company's financial health, such as by borrowing. The Federal Reserve also possesses enforcement powers over bank holding companies and their nonbank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends by banks and bank holding companies.
Federal Securities Regulation. The Company's common stock is registered with the SEC under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Consequently, the Company is subject to the information, proxy solicitation, insider trading and other restrictions and requirements of the SEC under the Exchange Act.
Regulation of the Bank
General. The Bank is an Iowa-chartered bank, the deposit accounts of which are insured by the FDIC's Bank Insurance Fund ("BIF"). As an Iowa-chartered, FDIC insured bank, the Bank is subject to the examination, supervision, reporting and enforcement requirements of the Superintendent, as the chartering authority for Iowa banks, and the FDIC, as administrator of the BIF.
Deposit Insurance. As an FDIC-insured institution, the Bank is required to pay deposit insurance premium assessments to the FDIC. The FDIC has adopted a risk-based assessment system under which all insured depository institutions are placed into one of nine categories and assessed insurance premiums based upon their respective levels of capital and results of supervisory evaluations. Institutions classified as well-capitalized (as defined by the FDIC) and considered healthy, pay the lowest premium while institutions that are less than adequately capitalized (as defined by the FDIC) and considered of substantial supervisory concern, pay the highest premium. Risk classification of all insured institutions is made by the FDIC for each semi-annual assessment period. The Bank is currently paying the minimum assessment under the FDIC's risk assessment system.
The FDIC may terminate the deposit insurance of any insured depository institution if the FDIC determines, after a hearing, that the institution (i) has engaged in or is engaging in unsafe or unsound practices, (ii) is in an unsafe or unsound condition to continue operations or (iii) has violated any applicable law, regulation, order, or any condition imposed in writing by, or written agreement with, the FDIC. The FDIC may also suspend deposit insurance temporarily during the hearing process for a permanent termination of insurance if the institution has no tangible capital. Management of the Company is not aware of any activity or condition that could result in termination of the deposit insurance of the Bank.
Capital Requirements. Among the requirements and restrictions imposed upon state banks by the Superintendent are the requirements to maintain reserves against deposits, restrictions on the nature and amount of loans, which may be made by state banks, and restrictions relating to investments, opening of bank offices and other activities of state banks. Changes in the capital structure of state banks are also approved by the Superintendent. One of the most significant standards of operation of state banks is the six and one-half percent (6-1/2%) primary capital to total assets ratio generally required by the Superintendent. In certain instances, the Superintendent may mandate higher capital, but the Superintendent has not imposed such a requirement on the Bank. The Superintendent defines the term "primary capital" to mean the sum of stockholders' equity and the allowance for loan losses less any intangible assets. In determining the primary capital ratio, the Superintendent uses the total assets as of the date of computation. At December 31, 2001, the primary capital to total assets ratio of the Bank exceeded the ratio required by the Superintendent.
Capital adequacy for banks took on an added dimension with the establishment of a formal system of prompt corrective action under the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA). This system uses bank capital levels to trigger supervisory actions designed to quickly correct banking problems. Capital adequacy zones are used by the federal banking agencies to trigger these actions. The ratios and the definition of "adequate capital" (refer to line two in the table) are the same as those used by the agencies in their capital adequacy guidelines.
Federal law provides the federal banking regulators of the Bank with broad power to take prompt corrective action to resolve the problems of undercapitalized banking institutions. The extent of the regulators' powers depends on whether the institution in question is "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" or "critically undercapitalized," in each case as defined by regulation. Under prompt corrective action, banks that are inadequately capitalized face a variety of mandatory and discretionary supervisory actions. For example, "undercapitalized banks" must restrict asset growth, obtain prior approval for business expansion, and have an approved plan to restore capital. "Critically undercapitalized banks" must be placed in receivership or conservatorship within 90 days unless some other action would result in lower long-term costs to the deposit insurance fund.
Depending upon the capital category to which an institution is assigned, the regulators' corrective powers include: requiring the institution to submit a capital restoration plan; limiting the institution's asset growth and restricting its activities; requiring the institution to issue additional capital stock (including additional voting stock) or to be acquired; restricting transactions between the institution and its affiliates; restricting the interest rate the institution may pay on deposits; ordering a new election of directors of the institution; requiring that senior executive officers or directors be dismissed; prohibiting the institution from accepting deposits from correspondent banks; requiring the institution to divest certain subsidiaries; prohibiting the payment of principal or interest on subordinated debt; and ultimately, appointing a receiver for the institution. As of December 31, 2001, the Bank was well capitalized, as defined by FDIC regulations.
Supervisory Assessments. All Iowa banks are required to pay supervisory assessments to the Iowa Superintendent of Banking to fund the operations of the Superintendent for their examination and supervision. During the fiscal year ended December 31, 2001, the Bank paid supervisory assessments to the Superintendent totaling $9,679.
Dividends. The Iowa Banking Act provides that an Iowa bank may not pay dividends in an amount greater than its undivided profits.
The payment of dividends by any financial institution or its holding company is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations, and a financial institution generally is prohibited from paying any dividends if, following payment thereof, the institution would be undercapitalized. As described above, the Bank exceeded its minimum capital requirements under applicable guidelines as of December 31, 2001. Notwithstanding the availability of funds for dividends; however, the Superintendent may prohibit the payment of any dividends by the Bank if the Superintendent determines such payment would constitute an unsafe or unsound practice.
Insider Transactions. The Bank is subject to certain restrictions imposed by federal law on extensions of credit to the Company and its subsidiaries, on investments in the stock or other securities of the Company and its subsidiaries and the acceptance of the stock or other securities of the Company or its subsidiaries as collateral for loans. Certain limitations and reporting requirements are also placed on extensions of credit by the Bank to its directors and officers, to directors and officers of the Company and its subsidiaries, to principal stockholders of the Company, and to "related interests" of such directors, officers and principal stockholders. In addition, federal law and regulations may affect the terms upon which any person becoming a director or officer of the Company or one of its subsidiaries or a principal stockholder of the Company may obtain credit from banks with which the Bank maintains a correspondent relationship.
Safety and Soundness Standards. The federal banking agencies have adopted guidelines that establish operational and managerial standards to promote the safety and soundness of federally insured depository institutions. The guidelines set forth standards for internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset quality and earnings.
In general, the safety and soundness guidelines prescribe the goals to be achieved in each area, and each institution is responsible for establishing its own procedures to achieve those goals. If an institution fails to comply with any of the standards set forth in the guidelines, the institution's primary federal regulator may require the institution to submit a plan for achieving and maintaining compliance. If an institution fails to submit an acceptable compliance plan, or fails in any material respect to implement a compliance plan that has been accepted by its primary federal regulator, the regulator is required to issue an order directing the institution to cure the deficiency. Until the deficiency cited in the regulator's order is cured, the regulator may restrict the institution's rate of growth, require the institution to increase its capital, restrict the rates the institution pays on deposits or require the institution to take any action the regulator deems appropriate under the circumstances. Noncompliance with the standards established by the safety and soundness guidelines may also constitute grounds for other enforcement action by the federal banking regulators, including cease and desist order and civil money penalty assessments.
Branching Authority. Historically, Iowa's intrastate branching statutes have been rather restrictive when compared with those of other states. Iowa's intrastate branching statutes were relaxed in recent legislation that became effective on February 21, 2001 (the "2001 Amendment"). The 2001 Amendment allows Iowa banks to move towards statewide branching by allowing every Iowa bank with the approval of its primary regulator, to establish three new bank offices anywhere in Iowa during the next three years. The three offices are in addition to those offices allowed within certain restricted geographic areas under prior Iowa law. Effective July 1, 2004, the 2001 Amendment repeals all limitations on bank office location and effectively allows statewide branching. After that date, banks will be allowed to establish an unlimited number of offices in any location in Iowa subject only to regulator's approval.
Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Riegle-Neal Act"), both state and national banks are allowed to establish interstate branch networks through acquisitions of other banks, subject to certain conditions, including certain limitations on the aggregate amount of deposits that may be held by the surviving bank and all of its insured depository institution affiliates. The establishment of new interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) is allowed by the Riegle-Neal Act only if specifically authorized by state law. The legislation allowed individual states to "opt-out" of certain provisions of the Riegle-Neal Act by enacting appropriate legislation prior to June 1, 1997. Iowa permits interstate bank mergers, subject to certain restrictions, including a prohibition against interstate mergers involving an Iowa bank that has been in existence and continuous operation for fewer than five years.
State Bank Activities. Under federal law and FDIC regulations, FDIC insured state banks are prohibited, subject to certain exceptions, from making or retaining equity investments of a type, or in an amount, that are not permissible for a national bank. Federal law and FDIC regulations also prohibit FDIC insured state banks and their subsidiaries, subject to certain exceptions, from engaging as principal in any activity that is not permitted for a national bank or its subsidiary, respectively, unless the Bank meets, and continues to meet, its minimum regulatory capital requirements and the FDIC determines the activity would not pose a significant risk to the deposit insurance fund of which the Bank is a member. These restrictions have not had, and are not currently expected to have, a material impact on the operations of the Bank.
CONSOLIDATED STATISTICAL INFORMATION
The following consolidated statistical information reflects selected balances and operations of the Company and the Bank for the periods indicated.
The following tables show (1) average balances of assets, liabilities and stockholders' equity, (2) interest income and expense on a tax equivalent basis, (3) interest rates and interest differential and (4) changes in interest income and expense.
AVERAGE BALANCES (Average Daily Basis)
December 31, ------------------------------ 2001 2000 1999 ------------------------------ (In Thousands) ------------------------------ ASSETS Cash and due from banks ..................... $ 24,493 $ 20,347 $ 16,863 Taxable securities .......................... 132,227 121,499 119,856 Nontaxable securities ....................... 42,783 38,026 34,699 Federal funds sold .......................... 29,551 11,358 9,796 Loans, net .................................. 646,196 600,215 508,293 Property and equipment, net ................. 18,889 13,675 11,633 Other assets ................................ 19,575 16,129 17,249 ------------------------------ $913,714 $821,249 $718,389 ==============================
LIABILITIES AND STOCKHOLDERS' EQUITY Noninterest-bearing demand deposits ........... $ 78,687 $ 69,246 $ 62,317 Interest-bearing demand deposits .............. 76,366 66,090 57,017 Savings deposits .............................. 169,561 154,121 152,507 Time deposits ................................. 357,882 309,565 274,507 Securities sold under agreements to repurchase 17,444 14,665 12,139 FHLB borrowings ............................... 123,211 128,043 86,880 Other liabilities ............................. 5,924 5,569 4,659 Redeemable common stock held by Employee Stock Ownership Plan ............... 11,872 11,251 10,127 Stockholders' equity .......................... 72,767 62,699 58,236 ------------------------------ $913,714 $821,249 $718,389 ==============================
INTEREST INCOME AND EXPENSE
Year Ended December 31, --------------------------- 2001 2000 1999 --------------------------- (In Thousands)
Income: Loans (1) ...................................... $53,121 $50,267 $42,107 Taxable securities ............................. 7,670 7,481 7,167 Nontaxable securities (1) ...................... 2,924 2,624 2,373 Federal funds sold ............................. 1,132 698 455 --------------------------- Total interest income .................... 64,847 61,070 52,102 ---------------------------
Expense: Interest-bearing demand deposits ............... 1,412 1,566 1,175 Savings deposits ............................... 4,611 5,615 4,769 Time deposits .................................. 20,611 17,690 14,882 Securities sold under agreements to repurchase . 617 699 517 FHLB borrowings ................................ 7,184 7,494 4,970 --------------------------- Total interest expense ................... 34,435 33,064 26,313 ---------------------------
Net interest income ...................... $30,412 $28,006 $25,789 ===========================
(1) Presented on a tax equivalent basis using a federal tax rate of 34% and state tax rates of 5%.
INTEREST RATES AND INTEREST DIFFERENTIAL
Year Ended December 31, - -------------------------------------------------------------------------------- 2001 2000 1999 - -------------------------------------------------------------------------------- Average yields: Loans (1) ......................................... 8.20% 8.34% 8.25% Loans (tax equivalent basis) ...................... 8.22 8.37 8.28 Taxable securities ................................ 5.80 6.15 5.98 Nontaxable securities ............................. 4.51 4.55 4.51 Nontaxable securities (tax equivalent basis) ...... 6.83 6.90 6.84 Federal funds sold ................................ 3.85 6.15 4.64 Interest-bearing demand deposits .................. 1.85 2.37 2.06 Savings deposits .................................. 2.72 3.64 3.13 Time deposits ..................................... 5.76 5.71 5.42 Securities sold under agreements to repurchase .... 3.53 4.77 4.26 FHLB borrowings ................................... 5.83 5.85 5.72 Yield on average interest-earning assets .......... 7.62 7.92 7.75 Rate on average interest-bearing liabilities ...... 4.63 4.92 4.51 Net interest spread (2) ........................... 2.99 3.00 3.24 Net interest margin (3) ........................... 3.58 3.62 3.83
(1) Nonaccruing loans are not significant and have been included in the average loan balances for purposes of this computation.
(2) Net interest spread is the difference between the yield on average interest-earning assets and the yield on average interest-paying liabilities stated on a tax equivalent basis using a federal and state tax rate of 34% and 5%, respectively, for the three years presented.
(3) Net interest margin is net interest income, on a tax equivalent basis, divided by average interest-earning assets.
CHANGES IN INTEREST INCOME AND EXPENSE
Rate volume variances are allocated on a consistent basis using the absolute values of changes in volume compared to the absolute values of the changes in rates. Loan fees included in interest income are not material. Interest on nontaxable securities and loans is shown at tax equivalent amounts.
LOANS
The following table shows the composition of loans (before deducting the allowance for loan losses) as of December 31 for each of the last five years.
December 31, ---------------------------------------------------- 2001 2000 1999 1998 1997 ---------------------------------------------------- (In Thousands)
Agricultural ............ $ 34,304 $ 28,560 $ 27,302 $ 32,318 $ 27,636 Commercial and financial 44,363 37,832 36,848 39,438 33,616 Real estate, construction 40,430 38,184 40,879 28,476 8,157 Real estate, mortgage ... 538,832 499,010 439,072 338,871 332,655 Loans to individuals .... 34,713 33,715 31,030 30,664 28,707 Total ........... $692,642 $637,301 $575,131 $469,767 $430,771
There were no foreign loans outstanding for any of the years presented
MATURITY DISTRIBUTION OF LOANS
The following table shows the principal payments due on loans as of December 31, 2001:
NONACCRUAL, PAST DUE AND RESTRUCTURED LOANS
The following table summarizes the Company's nonaccrual, past due, restructured and impaired loans as of December 31 for each of the years presented:
2001 2000 1999 1998 1997 ----------------------------------------------- (In Thousands)
Nonaccrual loans ............. $ 1,001 $ 618 $ -- $ 12 $ -- Accruing loans past due 90 days or more ............ 2,921 2,143 1,320 945 954 Restructured loans ........... -- -- -- -- -- Impaired loans ............... 11,288 11,068 9,265 8,956 9,556
The Company does not have a significant amount of loans that are past due less than 90 days on which there are serious doubts as to the ability of the borrowers to comply with the loan repayment terms.
Loans are placed on non-accrual status when management believes the collection of future interest is not reasonably assured. Interest income was not materially affected by this classification.
The Company has no individual borrower or borrowers engaged in the same or similar industry exceeding 10% of total loans. The Company has no other interest-bearing assets, other than loans, that meet the nonaccrual, past due, restructured or potential problem loan criteria.
Specific allowance for losses on impaired loans are established if the loan balances exceed the net present value of the future cash flows or the fair value of the collateral if the loan is collateral dependent.
SUMMARY OF LOAN LOSS EXPERIENCE
The following table summarizes the Bank's loan loss experience for each of the last five years:
The allowance for loan losses has not been allocated by type of loan. Management regularly reviews the loan portfolio and does not expect any unusual material amount to be charged off during 2002 that would be significantly different than the years ended December 31, 2001, 2000, 1999, 1998 and 1997.
(1) For financial reporting purposes, management regularly reviews the loan portfolio and determines a provision for loan losses based upon the impact of economic conditions on the borrowers' ability to repay, past collection experience, the risk characteristics of loan portfolio and such other factors that deserve current recognition. The growth of the loan portfolio is a significant element in the determination of the provision for loan losses.
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
The Bank regularly reviews a substantial portion of the loans in the portfolio and assesses whether the loans are impaired. If the loans are impaired, the Bank determines if a specific allowance is appropriate. Loans for which there are no specific allowances are classified into one or more risk categories. Based upon the risk category assigned, the Banks allocate a percentage, as determined by management, for a required allowance needed. The percentage begins with historical loss experience factors, which are then adjusted for current economic factors. The risk categories are compared to the risk categories used by federal and state regulatory agencies as follows:
(1) Pass (2) Watch (3) Substandard
In addition, the Bank's management also reviews and, where determined necessary, provides allowances based upon reviews of specific borrowers and provides general allowances for areas that management believes are of higher credit risk (agricultural loans and constructed model real estate homes as of December 31, 2001).
The following table presents the allowance for estimated loan losses on loans by type of loans and the percentage in each category to total loans as of December 31, 2001:
% Of Loans Amount To Total Loans ------------------------- (In Thousands)
Agriculture .................................. $1,032 4.95% Commercial ................................... 1,714 6.40 Real estate, construction .................... 770 5.84 Real estate .................................. 5,722 77.79 Consumer ..................................... 712 5.01 -------------------- $9,950 100.00% ====================
Prior to December 31, 2001, the allowance for loan losses was allocated by risk category and not by type of loan. The components of the allowance for loan loss, by risk category, as of December 31, 2000 is as follows:
(In Thousands)
Pass ..................................................... $ 1,316 Watch .................................................... 3,471 Substandard .............................................. 2,521 Specific allowances ...................................... 3,120 ------- $10,428 ======= Anticipated charge-offs of the above categories are not determinable at December 31, 2001; however, management does not believe there are any categories of loans where future charge-offs are likely to be higher than the allowances provided.
INVESTMENT SECURITIES
The following tables show the carrying value of the investment securities which are principally held by the Bank as of December 31, 2001, 2000 and 1999 and the maturities and weighted average yield of the investment securities as of December 31, 2001:
December 31, ---------------------------- 2001 2000 1999 (In Thousands) Carrying value: U. S. Treasury securities ................... $ 12,073 $ 18,318 $ 19,470 Obligations of other U. S. Government agencies and corporations ................. 123,165 95,036 94,302 Obligations of state and political subdivisions .............................. 46,913 39,923 36,496 ------------------------------ $182,151 $153,277 $150,268 ==============================
December 31, 2001 ------------------------------ Weighted Carrying Average Value Yield ------------------------------ (In Thousands) Type and maturity grouping: U. S. Treasury maturities: Within 1 year ............................ $ 5,644 6.09% From 1 to 5 years ........................ 6,429 6.35% -------- 12,073 -------- Obligations of other U. S. Government agencies and corporations, maturities: Within 1 year .............................. 19,859 5.82% From 1 to 5 years .......................... 103,306 5.62 ------- 123,165 ------- Obligations of state and political subdivisions, maturities: Within 1 year .............................. 4,744 7.17% From 1 to 5 years .......................... 25,506 6.44 From 5 to 10 years ......................... 16,437 6.84 Over 10 years .............................. 226 8.22 -------- 46,913 -------- Total ................................ $182,151 ========
INVESTMENT SECURITIES
As of December 31, 2001, there were no investment securities, exceeding 10% of stockholders' equity, other than securities of the U. S. Government and U. S. Government agencies and corporations.
The weighted average yield is based on the amortized cost of the investment securities. The yields are computed on a tax-equivalent basis using a federal tax rate of 34% and a state tax rate of 5%.
DEPOSITS
The following tables show the amount of average deposits and rates paid on such deposits for the years ended December 31, 2001, 2000 and 1999 and the composition of the certificates of deposit issued in denominations in excess of $100,000 as of December 31, 2001:
There were no deposits in foreign banking offices.
RETURN ON STOCKHOLDERS' EQUITY AND ASSETS
The following table presents the return on average assets, return on average stockholders' equity, the dividend payout ratio and average stockholders' equity to average assets ratio for the years ended December 31, 2001, 2000 and 1999:
December 31, ---------------------- 2001 2000 1999 ----------------------
Return on average assets ............................ 1.11% 1.14% 1.18% Return on average stockholders' equity .............. 13.94 14.94 14.54 Dividend payout ratio ............................... 23.58 23.18 22.56 Average stockholders' equity to average assets ratio 7.96 7.63 8.11
SHORT-TERM BORROWINGS
The following table shows outstanding balances, weighted average interest rates at year end, maximum month-end balances, average month-end balances and weighted average interest rates of federal funds purchased and securities sold under agreements to repurchase during 2001, 2000 and 1999:
2001 2000 1999 ----------------------------- (Amounts In Thousands) -----------------------------
Outstanding balance as of December 31 ......... $22,409 $16,561 $26,714 Weighted average interest rate at year end .... 2.36% 4.80% 4.28% Maximum month-end balance ..................... 22,711 16,678 27,815 Average month-end balance ..................... 17,444 14,665 12,139 Weighted average interest rate for the year ... 3.53% 4.77% 4.26%
FEDERAL HOME LOAN BANK BORROWINGS
The following table shows outstanding balances, weighted average interest rates at year end, maximum month-end balances, average month-end balances and weighted average interest rates during 2001, 2000 and 1999:
2001 2000 1999 ---------------------------------
Outstanding balance as of December 31 ...... $137,637 $120,668 $108,700 Weighted average interest rate at year end . 5.57% 5.79% 5.66% Maximum month-end balance .................. 137,637 148,700 108,700 Average month-end balance .................. 123,211 128,043 86,880 Weighted average interest rate for the year 5.83% 5.85% 5.72%
PART I
Item 2.
Item 2. Properties
The Company's office and the main bank of the Bank are located at 131 Main Street, Hills, Iowa. This is a brick building containing approximately 45,000 square feet. A portion of the building was built in 1977, a two-story addition was completed in 1984, and in February 2001, the Bank completed a two-story brick addition. With the completion of the 2001 addition, all bank processing and administrative systems, including trust, were consolidated in Hills, Iowa. A majority of these operations were located previously in the Coralville office and sixty-five full-time and part-time employees relocated.
The other offices of Hills Bank and Trust are as follows:
1. Iowa City office located at 1401 South Gilbert Street is a one-story brick building containing approximately 15,400 square feet. The branch has five drive-up teller lanes and a drive-up, 24-hour automatic teller machine. The Bank's trust department customer service representatives are located here. This building was constructed in 1982 and has been expanded several times, most recently in 1998.
2. Coralville office is a two-story building built in 1972 and expanded in 2001 that contains approximately 23,000 square
3. A 2,800 square foot branch bank in North Liberty, Iowa was opened for business in 1986. This office is a full-service
4. The Bank leases an office at 132 East Washington Street in downtown Iowa City with approximately 2,500 square feet. The
5. In December 2001, the Bank opened a new East Side office location at 2621 Muscatine Avenue, Iowa City. The office is a
6. The Lisbon office is a two-story brick building in Lisbon, Iowa with approximately 3,000 square feet of banking retail
7. The Mount Vernon office opened in February 1998 with the completion of a full-service, 4,200 square foot office, with
8. In February 2000, the Bank opened a 2,900 square foot branch office in downtown Cedar Rapids that is leased. In April
9. The Kalona office is a 6,400 square foot building that contains a walk-up 24-hour automatic teller machine and one drive-up lane. This is an older building that was remodeled in late 1998.
10. In October 2001, the Bank began construction in Cedar Rapids on a second branch office. The new 7,200 square foot, one-story building will have three drive-up lanes and a drive-up automatic teller machine. The location is on Williams Boulevard in Southwest Cedar Rapids.
All of the properties owned by the Bank are free and clear of any mortgages or other encumbrances of any type.
Item 3.
Item 3. Legal Proceedings
There are no material pending legal proceedings.
Neither the Company nor the Bank hold any properties that are the subject of hazardous waste clean-up investigations.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders for the three months ended December 31, 2001.
PART II
Item 5.
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters
There is no established trading market for the Company's common stock. Its stock is not listed with any exchange or quoted in an automated quotation system of a registered securities association, nor is there any broker/dealer acting as a market maker for its stock. A bid and ask price is quoted in an Iowa City local paper and the quotes are provided by a local broker. The Company's stock is not actively traded. As of March 15, 2002, the Company had 1,309 stockholders.
Based on the Company's stock transfer records and information informally provided to the Company, its stock trading transactions have been as follows:
- ------------------------------------------------------------------------------- Number High Low Of Shares Number Of Selling Selling Year Traded Transactions Price Price - ------------------------------------------------------------------------------- 2001 9,273 28 $ 82.00 $ 77.00 2000 14,187 16 77.00 70.00 1999 6,415 22 70.00 58.00
The Company paid aggregate annual cash dividends in 2001, 2000 and 1999 of $2,392,000, $2,171,000 and $1,910,000, respectively, or $1.60 per share in 2001, $1.45 per share in 2000 and $1.30 per share in 1999. In January 2002, the Company declared and paid a dividend of $1.75 per share totaling $2,622,000. The decision to declare any such cash dividends in the future and the amount thereof rests within the discretion of the Board of Directors and will remain subject to, among other things, certain regulatory restrictions imposed on the payment of dividends by the Bank, and the future earnings, capital requirements and financial condition of the Company.
As of December 31, 2001, stock option information is as follows:
Number of shares that would be issued if all options were exercised 29,179 Weighted average price of options outstanding $ 44.98 Number of additional shares that could be granted 55,600
There are no stock option plans that have not been approved by the stockholders.
PART II
Item 6.
Item 6. Selected Financial Data
CONSOLIDATED FIVE-YEAR STATISTICAL SUMMARY
PART II
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition And Results of Operations
Special Note Regarding Forward-Looking Statements
The discussion following contains certain forward-looking statements with respect to the financial condition, the results of operations and business of the Company. These statements involve certain risks and uncertainties, which are often inherent in the ongoing operation of financial institutions such as the Company's subsidiary bank.
Forward-looking statements discuss matters that are not facts and are typically identified by the words "believe," "expect," "anticipate," "target," "goal," "objective," "intend," "estimate," "will," "can," "would," "should," "could," "may" and similar expressions. They discuss expectations about the future and are not guarantees. Forward-looking statements speak only as of the date they are made, and the Company undertakes no obligation to update them to reflect changes that occur after the date they are made.
There are several factors - many of which are beyond the control of the Company or its subsidiary Bank - that could cause results to differ significantly from expectations. Some of these factors are described below. There are factors other than those described below that could cause results to differ from expectations. Any factor described below could by itself, or together with one or more other factors, adversely affect the business, earnings and/or financial condition of the Company and its subsidiary Bank.
The risks involved in the operations and strategies of the Company and its subsidiary Bank include competition from other financial institutions, changes in interest rates, changes in economic or market conditions as well as events and trends affecting specific assets, the effect of credit quality and market perceptions of value on the fair values of financial instruments and regulatory factors. These risks, which are not inclusive, cannot be accurately estimated.
For example, a financial institution may accept deposits at fixed interest rates, at different times and for different terms, and lend funds at fixed interest rates, at different times and for different terms. In doing so, it accepts the risk that its cost of funds may rise while the use of those funds may be at a fixed rate. Similarly, although market rates of interest may decline, the financial institution may have committed by virtue of the term of a deposit, to pay what essentially becomes an above-market rate.
Loans, and the allowance for loan losses, carry the risk that borrowers will not repay all funds in a timely manner, as well as the risk of total loss. The collateral pledged as security for loans may or may not have the value that has been attributed to it. The loan loss reserve, while believed to be adequate, may prove inadequate if one or more large-balance borrowers, or numerous mid-balance borrowers, or a combination of both, experience financial difficulty for a variety of reasons. These reasons may relate to the financial circumstances of an individual borrower, or may be caused by negative economic circumstances at the local, regional, national or international level that are beyond the control of the borrowers or the lender.
Because the business of banking is of a highly regulated nature, the decisions of governmental entities can have a major effect on operating results. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could have substantial and unpredictable effects including increasing the ability of nonbanks to offer competing financial services and products.
PART II
Item 7. Management's Discussion and Analysis of Financial Condition And Results of Operations
The Bank's success depends, in part, on its ability to attract and retain key people. Competition for the best people - in particular individuals with technology experience - is intense. The Bank may not be able to hire well-qualified people or pay them enough to keep them.
All of these uncertainties, as well as others, are present in the operations and business of the Company, and stockholders are cautioned that the Company's actual results may differ materially from those included in the forward-looking statements.
Critical Accounting Policies
The Company's most critical accounting policies that affect net income are the accrual of interest income and expense and providing an appropriate allowance for loan losses. Interest is accrued at the stated rate on the outstanding balances of all interest earning assets and interest-bearing liabilities. The Company discontinues accruing interest income on certain loans at the point there is reasonable doubt about the borrower's ability to make all the principal and interest payments. The allowance for loan losses and the provision for loan losses charged to expense is affected by the Bank's quarterly review of the loan portfolio, the Bank's identification of impaired loans for which specific allowances may be provided and the allowances on all other loans. The allowance is affected, among other things, by loan delinquency rates, local economic conditions and the estimated fair value of collateral on loans.
Other critical policies that affect the Company's balance sheet are the fair value of investment securities available-for-sale and the Company's maximum cash obligation related to its obligation to redeem common stock held by the ESOP.
Financial Position
In 2001, total assets grew $100.4 million, slightly below the record growth of $101.8 million for 2000. The percentage increase in total assets was 11.46% in 2001, compared to 13.15% in 2000. Asset growth for both years was primarily reflected in higher loan balances and investment securities.
In 2001, net loans increased by $55.8 million, including $42.1 million in real estate loans. For the year 2000, net loans increased $61.5 million, and $60 million of the increase was attributable to real estate mortgage loans. Declining interest rates in 2001 and stable interest rates in 2000 have helped housing starts and new real estate development projects in the Bank's trade territory.
Deposits increased $67.3 million, or 10.31 % in 2001 compared to an increase of 16.12% in 2000. After several years of slower deposit growth, the past two years have seen substantial deposit growth. In 2001, the increase in net deposits resulted from uncertainties in the stock market that led a number of investors to move their funds to bank deposits. In addition, the addition and renovation of branch banks helped bring new customers to the Bank. In 2001 and 2000, the Company has also borrowed from the Federal Home Loan Bank, and such borrowings increased by a net $17 million in 2001 and $12 million in 2000. The advances were used to fund loan growth and lock in low interest rates.
Components of Diluted Earnings Per Share
2001 2000 1999 ------------------------------------
Net interest income ..................... $ 19.40 $ 17.85 $ 16.59 Provision for loan losses ............... (0.61) (0.63) (0.60) Noninterest income ...................... 6.13 4.98 4.30 Noninterest expense ..................... (15.14) (13.30) (12.24) ------------------------------------ Income before income taxes ...... 9.78 8.90 8.05 Income tax expense ...................... (3.06) (2.69) (2.39) ------------------------------------ Net income ...................... $ 6.72 $ 6.21 $ 5.66 ====================================
Net income for 2001 reached a record high of $10,144,000, or diluted earnings per share of $6.72. The rate of increase in earnings in 2001 slowed slightly from 2000 results. For 2001, diluted earnings per share increased $.51 per share, while 2000 results had increased $.55 per share. For the year ended December 31, 2000, net income increased by $900,000 from the 1999 results. Net interest income for 2000 was $2.1 million higher than 1999. For both 2001 and 2000, the Company's net interest income has benefited from substantial growth in average earning assets and a stable net interest margin.
The Company consistently benefited from a high quality loan portfolio and a strong local economy. Because the loan portfolio is concentrated in well-secured real estate loans, the Bank has not needed higher provisions for loan losses.
Net Interest Income
Net interest income is the excess of the interest and fees received on interest-earning assets over the interest expense of the interest-bearing liabilities. The measure is shown on a tax-equivalent basis to make the interest earned on taxable and nontaxable assets more comparable.
Net interest income on a tax-equivalent basis changed in 2001 as follows:
Net interest income changes for 2000 were as follows:
Change In Effect Of Effect Of Average Volume Rate Net Balance Changes Changes Change -------------------------------------------
Interest-earning assets ........... $98,454 $ 8,109 $ 859 $ 8,968 Interest-bearing liabilities ...... 89,434 4,756 1,995 6,751 ------------------------------------------ Change in net interest income ..... $ 3,353 $(1,136) $ 2,217 ==========================================
A summary of the net interest spread and margin is as follows:
(Tax Equivalent Basis) 2001 2000 1999 - --------------------------------------------------------------------------------
Yield on average interest-earning assets ............... 7.62% 7.92% 7.75% Rate on average interest-bearing liabilities ........... 4.63 4.92 4.51 --------------------- Net interest spread .................................... 2.99 3.00 3.24 Effect of noninterest-bearing funds .................... 0.59 0.62 0.59 --------------------- Net interest margin (tax equivalent interest income divided by average interest-earning assets) .......... 3.58% 3.62% 3.83% =====================
Provision For Loan Losses
The provision for loan losses totaled $924,000, $948,000 and $900,000 for 2001, 2000 and 1999, respectively. Charge-offs, net of recoveries, were $1,402,000, $270,000 for 2000 and $6,000 for 2001, 2000 and 1999, respectively. Although net charge-offs for 2001 increased from the prior two years, the charge-offs related to loans that had previously been classified and the losses had been accrued in prior years.
The allowance for loan losses totaled $9,950,000 at December 31, 2001 compared to $10,428,000 at December 31, 2000. The percentage of the allowance to outstanding loans was 1.44% and 1.64% at December 31, 2001 and 2000, respectively.
Agricultural loans totaled $34,304,000 and $28,560,000 at December 31, 2001 and 2000, respectively. Management has assessed the risks for agricultural loans higher than other loans due to unpredictable commodity prices, the effects of weather on crops and uncertainties regarding government support programs. Therefore, the allowance for loan losses includes general and specific reserves for these loans.
Loan concentrations, quality and credit terms had no significant changes from 2000 to 2001. Therefore, the 2001 allowance for loan losses was not materially different than the 2000 allowance. In 2001, the Bank refined the methodology used to compute the allowance for loan losses, primarily by applying loss rates to several risk categories of loans instead of more general populations. The estimated loss rates used in 2001 increased slightly because there were several early indicators of an economic slowdown in the area. The primary indicator in Johnson County is the tightening of the budget for the University of Iowa and the possibility of staffing cutbacks and wage constraints.
The allowance for loan losses is sensitive to the underlying collateral value of real estate, especially in Johnson County, Iowa. Real estate values are affected by the inventory of unsold properties, vacancy rates for residential rental units, the supply and demand for commercial and retail space and overall employment and retail sales. Overbuilding in the area could lower the fair value of properties and affect the allowance for loan losses. Likewise, sharply higher interest rates could affect the ability of some borrowers to make scheduled interest and principal payments.
The University of Iowa has a dominant economic effect on the economy of the Bank's primary trade area, Johnson County, Iowa, and in 2001 and 2000, the University has helped the local economy remain strong even when the national economy has experienced weaknesses. However, in recent months the economy of the state of Iowa has weakened to the point that the University has recently suffered modest budget cuts and for its fiscal year beginning July 1, 2002 the University is anticipating more significant budget constraints. The possible effects on the local economy cannot be predicted, but are likely to weaken the economy in future years.
The above factors could, but are not reasonably expected, to have a material effect on the allowance for loan losses.
Other Income
Dollars Per Share, Based on Weighted Average Diluted Shares Outstanding 2001 2000 1999 - --------------------------------------------------------------------------------
Real estate origination fees ................. $ 0.77 $ 0.21 $ 0.39 Trust fees ................................... 1.59 1.58 1.36 Deposit account charges and fees ............. 2.06 1.70 1.47 Other fees and charges ....................... 1.71 1.49 1.29 Investment securities gains (losses) ......... -- -- (0.21) ------------------------------- $ 6.13 $ 4.98 $ 4.30 ===============================
In 2001, the Company's total other income increased $1,743,000 compared to the prior year. Real estate origination fee revenue for 2001 made up $849,000 of the increase from the prior year because of reduced interest rates that enabled many borrowers to re-finance at lower interest rates. In addition, the increase in customer deposit accounts, along with changes in the fee structure, accounted for a $542,000 increase in deposit account charges and fees. Trust fees in 2001 were virtually unchanged from 2000 because new trust accounts provided fees that offset the decline in asset related trust fees affected by the stock market. Total other income reached a record high of $6.13 per share in 2001.
Total other income increased $1,077,000 for the year ended December 31, 2000 compared to the same period in 1999. Loan origination fees for the year 2000 were $276,000 less than 1999 as a result of higher interest rates in 2000 that slowed re-financings. Trust fees, deposit account charges and other fees increased $1,038,000 for 2000 and resulted from volume increases in trust assets and deposit accounts. During 1999, the Company had a reduction of other income of $315,000, which represented investment securities losses taken to replace lower yielding securities with higher yielding securities of similar risk and maturity. For the year 2000, no gains and losses on sale of investment securities occurred.
Other Expenses
Dollars Per Share, Based on Weighted Average Diluted Shares Outstanding 2001 2000 1999 - --------------------------------------------------------------------------------
Salaries and employees benefits ............ $ 7.86 $ 7.06 $ 6.56 Occupancy .................................. 1.21 0.94 0.84 Furniture and equipment .................... 1.86 1.43 1.26 Office supplies and postage ................ 0.79 0.75 0.74 Other ...................................... 3.42 3.12 2.84 --------------------------------- $ 15.14 $ 13.30 $ 12.24 =================================
Total other expenses increased $2,790,000 in 2001. Occupancy expenses increased $409,000 in 2001, up sharply from $1,417,000 in 2000. The increase was primarily related to the opening and use of the Bank's 31,000 square foot operations area in early 2001 and the Coralville expansion. Salary and employee benefits increased $1,212,000 in 2001 and were primarily related to an increase in new employees at various locations and higher employee benefit costs. The new operations center in Hills and the Coralville expansion accounted for most of the increase in occupancy and furniture and equipment related expenses and depreciation.
Other expenses increased $1,760,000 in 2000. Of the increase, salaries and benefits accounted for $844,000, occupancy and furniture and equipment expense $431,000 and all other expenses $485,000. The salaries and employee benefits increased as a direct result of salary adjustments in the first quarter of 2000 and furniture and equipment related expenses. The Iowa City eastside location of Hills Bank and Trust Company opened in June 1999 and the Cedar Rapids office opened in February 2000. The two new locations also accounted for a portion of the increase in occupancy expense and other expense increases were in marketing and business promotion. Also during 2000, the Bank introduced an on-line banking product and incurred increased product promotion expense.
Income Taxes
Income tax expense was $4,613,000, $4,059,000 and $3,570,000 for the years ended December 31, 2001, 2000 and 1999, respectively. The corresponding percentage of income taxes compared to income before income taxes is 31.26% in 2001, 30.23% in 2000 and 29.66% in 1999.
Impact of Recently Issued Accounting Standards
In July 2001, the Financial Accounting Standards Board issued Statement 141, "Business Combinations" and Statement 142, "Goodwill and Other Intangible Assets." Statement 141 eliminates the pooling method for accounting for business combinations, requires that intangible assets that meet certain criteria be reported separately from goodwill and requires negative goodwill arising from a business combination to be recorded as an extraordinary gain. Statement 142 eliminates the amortization of goodwill and other intangibles that are determined to have an indefinite life, and requires, at a minimum, annual impairment tests for goodwill and other intangible assets that are determined to have an indefinite life. For the Company, the provisions of the Statements are effective January 1, 2002.
Implementation of Statement 141 will have no immediate impact on the Company's financial statements. Implementation of Statement 142 is not expected to have a material effect on the Company's financial statements in 2002.
The Financial Accounting Standards Board has issued Statement 143, "Accounting for Asset Retirement Obligations" and Statement 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." Statement 143 requires that the fair value of 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. Statement 144 supersedes FASB Statement 121 and the accounting and reporting provisions of APB Opinion No. 30. Statement 144 establishes a single accounting model for long-lived assets to be disposed of by sale which includes measuring a long-lived asset classified as held for sale at the lower of its carrying amount or its fair value less costs to sell and to cease depreciation/amortization. For the Company, the provisions of Statement 143 and 144 are effective January 1, 2003, and January 1, 2002, respectively. Implementation of the Statements is not expected to have a material impact on the Company's financial statements.
Interest Rate Sensitivity and Liquidity Analysis
At December 31, 2001, the Company's interest rate sensitivity report is as follows (in thousands):
A portion of the interest-bearing checking, savings and money market accounts has been included in the above table as maturing immediately based upon management's estimate using a financial model and the rest of these deposits are shown as more than one year. The classifications are used because the Bank's historical data indicates that these have been very stable deposits without much interest rate fluctuation. Historically, these accounts would not need to be adjusted upward as quickly in a period of rate increases so the interest risk exposure would be less than the re-pricing schedule indicates. The FHLB borrowings are classified based on their callable dates because they may be called if interest rates rise over current rates.
Inflation
Inflation has an impact on the growth of total assets and has resulted in the need to increase equity capital to maintain an appropriate equity to asset ratio. The results of operations have been affected by inflation, but the effect has been minimal.
Liquidity and Capital Resources
On an unconsolidated basis, the Company had cash balances of $1,655,000 as of December 31, 2001. In 2001, the holding company received dividends of $2,392,000 from its subsidiary bank and used those funds to pay dividends to its stockholders of $2,392,000.
As of December 31, 2001 and 2000, stockholders' equity, before deducting for the maximum cash obligation related to ESOP, was $90,349,000 and $80,074,000, respectively. This measure of equity as a percent of total assets was 9.26% at December 31, 2001 and 9.14% at December 31, 2000. As of December 31, 2001, total equity was 8.01% of assets compared to 7.82% of assets at the prior year end. The ability of the Company to pay dividends to its shareholders is dependent upon the earnings and capital adequacy of its subsidiary bank, which affects the Bank's dividends to the Company. The Bank is subject to certain statutory and regulatory restrictions on the amount it may pay in dividends. In order to maintain acceptable capital ratios in the subsidiary bank, certain of its retained earnings are not available for the payment of dividends. Retained earnings available for the payment of dividends to the Company total approximately $7,015,000 as of December 31, 2001.
The Company and the Bank are subject to the Federal Deposit Insurance Corporation Improvement Act of 1991 and the Bank is subject to Prompt Corrective Action Rules as determined and enforced by the Federal Reserve. These regulations establish minimum capital requirements that member banks must maintain.
As of December 31, 2001, risk-based capital standards require 8% of risk-weighted assets. At least half of that 8% must consist of Tier I core capital (common stockholders' equity, non-cumulative perpetual preferred stock and minority interest in the equity accounts of consolidated subsidiaries), and the remainder may be Tier II supplementary capital (perpetual debt, intermediate-term preferred stock, cumulative perpetual, long-term and convertible preferred stock, and loan loss reserve up to a maximum of 1.25% of risk-weighted assets). Total risk-weighted assets are determined by weighing the assets according to their risk characteristics. Certain off-balance sheet items (such as standby letters of credit and firm loan commitments) are multiplied by "credit conversion factors" to translate them into balance sheet equivalents before assigning them risk weightings. Any bank having a capital ratio less than the 8% minimum required level must, within 60 days, submit to the Federal Reserve a plan describing the means and schedule by which the Bank shall achieve the applicable minimum capital ratios.
The Bank is an insured state bank, incorporated under the laws of the state of Iowa. As such, the Bank is subject to regulation, supervision and periodic examination by the Superintendent of Banking of the State of Iowa (the "Superintendent"). Among the requirements and restrictions imposed upon state banks by the Superintendent are the requirements to maintain reserves against deposits, restrictions on the nature and amount of loans, which may be made by state banks, and restrictions relating to investments, opening of bank offices and other activities of state banks. Changes in the capital structure of state banks are also approved by the Superintendent. One of the most significant standards of operation of state banks is the six and one-half percent (6 1/2%) primary capital to total assets ratio generally required by the Superintendent. In certain instances, the Superintendent may mandate higher capital, but the Superintendent has not imposed such a requirement on the Bank. The Superintendent defines the term "primary capital" to mean the sum of stockholders' equity and the allowance for loan losses less any intangible assets. In determining the primary capital ratio, the Superintendent uses the total assets as of the date of computation. At December 31, 2001, the primary capital to total assets ratio of the Bank exceeded the ratio required by the Superintendent.
The actual amounts and capital ratios as of December 31, 2001 and the minimum regulatory requirements for the Company and the Bank are presented below (in thousands):
The Bank is classified as "well capitalized" by FDIC capital guidelines.
On a consolidated basis, 2001 cash flows from operations provided $13,778,000, net increases in deposits provided $67,312,000 and Federal Home Loan Bank borrowings provided $17,000,000. These cash flows were invested in net loans of $56,743,000, net securities of $25,377,000 and net federal funds sold of $1,363,000. In addition, $6,710,000 was used to purchase property and equipment.
At December 31, 2001, the Bank had total outstanding loan commitments and unused portions of lines of credit totaling $117,609,000. Management believes that its liquidity levels are sufficient, but the Bank may increase its liquidity by limiting the growth of its assets by selling more loans in the secondary market or selling portions of loans to other banks through participation agreements. It may also obtain additional funds from the Federal Home Loan Bank.
While the Bank has off-balance sheet commitments to fund additional borrowings of customers, it does not use other off-balance-sheet financial instruments, including interest rate swaps, as part of its asset and liability management. Contractual commitments to fund loans are met from the proceeds of Federal funds sold or investment securities and additional borrowings. Many of the contractual commitments to extend credit will not be funded because they represent the credit limits on credit cards and home equity lines of credits.
As of December 31, 2001, the Bank estimates that 2002 additional construction expenditures for the new office on Williams Boulevard in Cedar Rapids, Iowa, to be completed in 2002 will total $893,000 and will not require outside financing.
Related Party Transactions
The Bank's primary transactions with related parties are the loans and deposit relationships it maintains with officers, directors and entities related to these individuals. The Bank makes loans to related parties under substantially the same interest rates, terms and collateral as those prevailing for comparable transactions with unrelated persons. In addition, these parties may maintain deposit account relationships with the Bank that also are on the same terms as with unrelated persons. As of December 31, 2001 and 2000, loan balances to related individuals and businesses totaled $24,440,000 and $13,297,000, respectively. Deposits from related parties totaled $5,884,000 and $4,825,000 as of December 31, 2001 and 2000, respectively.
Commitments and Trends
The Company and the Bank have no material commitments or plans that will materially affect liquidity or capital resources. Property and equipment may be acquired in cash purchases, or they may be financed if favorable terms are available.
PART II
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market Risk Exposures
The Company's primary market risk exposure is to changes in interest rates. The Company's asset/liability management, or its management of interest rate risk, is focused primarily on evaluating and managing net interest income given various risk criteria. Factors beyond the Company's control, such as market interest rates and competition, may also have an impact on the Company's interest income and interest expense. In the absence of other factors, the Company's overall yield on interest-earning assets will increase as will its cost of funds on its interest-bearing liabilities when market rates increase over an extended period of time. Inversely, the Company's yields and cost of funds will decrease when market rates decline. The Company is able to manage these swings to some extent by attempting to control the maturity or rate adjustments of its interest-earning assets and interest-bearing liabilities over given periods of time.
The Bank maintains an asset/liability committee, which meets at least quarterly to review the interest rate sensitivity position and to review various strategies as to interest rate risk management. In addition, the Bank uses a simulation model to review various assumptions relating to interest rate movement. The model attempts to limit rate risk even if it appears the Bank's asset and liability maturities are perfectly matched and a favorable interest margin is present.
In order to minimize the potential effects of adverse material and prolonged increases or decreases in market interest rates on the Company's operations, management has implemented an asset/liability program designed to mitigate the Company's interest rate sensitivity. The program emphasizes the origination of adjustable rate loans, which are held in the portfolio, the investment of excess cash in short or intermediate term interest-earning assets, and the solicitation of passbook or transaction deposit accounts, which are less sensitive to changes in interest rates and can be re-priced rapidly.
Based on the data following, net interest income should decline with instantaneous increases in interest rates while net interest income should increase with instantaneous declines in interest rates. Generally, during periods of increasing interest rates, the Company's interest rate sensitive liabilities would re-price faster than its interest rate sensitive assets causing a decline in the Company's interest rate spread and margin. This would result from an increase in the Company's cost of funds that would not be immediately offset by an increase in its yield on earning assets that would tend to reduce net interest income. In times of decreasing interest rates, fixed rate assets could increase in value and the lag in re-pricing of interest rate sensitive assets could be expected to have a positive effect on the Company's net interest income.
The following table, which presents principal cash flows and related weighted average interest rates by expected maturity dates, provides information about the Company's loans, investment securities and deposits that are sensitive to changes in interest rates.
Item 8.
Item 8. Financial Statements and Supplementary Data
The financial statements and supplementary data are included on Pages 39 through 67.
Independent Auditor's Report
To the Board of Directors and Stockholders Hills Bancorporation Hills, Iowa
We have audited the accompanying consolidated balance sheets of Hills Bancorporation and subsidiary as of December 31, 2001 and 2000, and the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for the years ended December 31, 2001, 2000 and 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Hills Bancorporation and subsidiary as of December 31, 2001 and 2000, and the results of their operations and their cash flows for the years ended December 31, 2001, 2000 and 1999 in conformity with accounting principles generally accepted in the United States of America.
/s/ McGladrey & Pullen, LLP
Iowa City, Iowa February 7, 2002
HILLS BANCORPORATION
CONSOLIDATED BALANCE SHEETS December 31, 2001 and 2000 (In Thousands, Except Shares)
See Notes to Financial Statements.
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 2001, 2000 and 1999 (In Thousands, Except Per Share Amounts)
See Notes to Financial Statements.
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Years Ended December 31, 2001, 2000 and 1999 (In Thousands)
See Notes to Financial Statements.
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Notes 7 and 9) Years Ended December 31, 2001, 2000 and 1999 (In Thousands, Except Share Amounts)
See Notes to Financial Statements.
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 2001, 2000 and 1999 (In Thousands)
(Continued)
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) Years Ended December 31, 2001, 2000 and 1999 (In Thousands)
See Notes to Financial Statements.
HILLS BANCORPORATION
NOTES TO FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
Note 1. Nature of Activities and Significant Accounting Policies
Nature of activities: Hills Bancorporation (the "Company") is a holding company engaged in the business of commercial banking. The Company's subsidiary is Hills Bank and Trust Company, Hills, Iowa (the "Bank"), which is wholly-owned. The Bank is a full-service commercial bank extending its services to individuals, businesses, governmental units and institutional customers primarily in the communities of Hills, Iowa City, Coralville, North Liberty, Lisbon, Mount Vernon, Kalona and Cedar Rapids, Iowa.
The Bank competes with other financial institutions and nonfinancial institutions providing similar financial products. Although the loan activity of the Bank is diversified with commercial and agricultural loans, real estate loans, automobile, installment and other consumer loans, the Bank's credit is concentrated in real estate loans.
Accounting estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Certain significant estimates: The allowance for loan losses, fair values of securities and other financial instruments, and stock-based compensation expense involves certain significant estimates made by management. These estimates are reviewed by management routinely and it is reasonably possible that circumstances that exist at December 31, 2001 may change in the near-term future and that the effect could be material to the consolidated financial statements.
Principles of consolidation: The consolidated financial statements include the accounts of the Company and its subsidiary. All significant intercompany balances and transactions have been eliminated in consolidation.
Investment securities: Held-to-maturity securities consist solely of debt securities, which the Company has the positive intent and ability to hold to maturity and are stated at amortized cost.
Available-for-sale securities consist of debt securities not classified as trading or held to maturity. Available-for-sale securities are stated at fair value, and unrealized holding gains and losses, net of the related deferred tax effect, are reported as a separate component of stockholders' equity. There were no trading securities as of December 31, 2001 and 2000.
Stock of the Federal Home Loan Bank is carried at cost.
Premiums and discounts on debt securities are amortized over the contractual lives of those securities. The method of amortization results in a constant effective yield on those securities (the interest method). Realized gains and losses on investment securities are included in income, determined on the basis of the cost of the specific securities sold.
Loans: Loans are stated at the amount of unpaid principal, reduced by the allowance for loan losses. Interest income is accrued on the unpaid balances as earned.
The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance when management believes the collectability of principal is unlikely. The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. The allowance is increased by provisions charged to expense and is reduced by net charge-offs. The Bank makes continuous reviews of the loan portfolio and considers current economic conditions, historical loss experience, review of specific problem loans and other factors in determining the adequacy of the allowance.
Loans are considered impaired when, based on current information and events, it is probable the Bank will not be able to collect all amounts due. The portion of the allowance for loan losses applicable to impaired loans has been computed based on the present value of the estimated future cash flows of interest and principal discounted at the loans effective interest rate or on the fair value of the collateral for collateral dependent loans. The entire change in present value of expected cash flows of impaired loans or of collateral value is reported as bad debt expense in the same manner in which impairment initially was recognized or as a reduction in the amount of bad debt expense that otherwise would be reported. Interest income on impaired loans is recognized on the cash basis.
The accrual of interest income on loans is discontinued when, in the opinion of management, there is reasonable doubt as to the borrower's ability to meet payments of interest or principal when they become due.
Loan fees and origination costs are reflected in the statement of income as collected or incurred. Compared to the net deferral method, this practice had no significant effect on income.
Transfers of financial assets: Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.
Credit related financial instruments: In the ordinary course of business, the Company has entered into commitments to extend credit, including commitments under credit card arrangements, commercial letters of credit and standby letters of credit. Such financial instruments are recorded when they are funded.
Property and equipment: Property and equipment is stated at cost less accumulated depreciation. Depreciation is computed using primarily declining-balance methods over the estimated useful lives of 7-40 years for buildings and improvements and 3-10 years for furniture and equipment.
Deferred income taxes: Deferred income taxes are provided under the liability method whereby deferred tax assets are recognized for deductible temporary differences and net operating loss, and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
Intangible assets: Intangible assets consist principally of goodwill, which represents the excess of cost over fair value of net assets acquired in business combinations of two banks in 1996 accounted for under the purchase method. Goodwill is amortized on a straight-line basis over the estimated period to be benefited, 15 years. The carrying value of goodwill is reviewed periodically for impairment. Goodwill totaled $2,500,000 and $2,760,000, net of accumulated amortization of $1,398,000 and $1,137,000, respectively, as of December 31, 2001 and 2000, respectively, and is included in other assets.
Stock options: Compensation expense for stock issued through stock option and award plans is accounted for using the intrinsic value based method of accounting prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees." Under this method, compensation is measured as the difference between the estimated fair value of the stock at the date of award less the amount required to be paid for the stock. The difference, if any, is charged to expense over the periods of service.
Common stock held by ESOP: The Company's maximum cash obligation related to these shares is classified outside stockholders' equity because the shares are not readily traded and could be put to the Company for cash.
Trust assets: Trust assets, other than cash deposits, held by the Bank in fiduciary or agency capacities for its customers are not included in these statements since they are not assets of the Company.
Earnings per share: Basic per-share amounts are computed by dividing net income (the numerator) by the weighted-average number of common shares outstanding (the denominator). Diluted per share amounts assume the conversion, exercise or issuance of all potential common stock equivalents unless the effect is to reduce the loss or increase the income per common share from continuing operations.
Following is a reconciliation of the denominator:
There are no potentially dilutive securities that have not been included in the determination of diluted shares.
Statement of cash flows: For purposes of reporting cash flows, cash and due from banks includes cash on hand and amounts due from banks (including cash items in process of clearing). Cash flows from loans originated by the Bank, deposits and federal funds purchased and securities sold under agreements to repurchase are reported net.
Recently issued accounting standards: Recently issued accounting standards are not expected to materially affect the Company's financial statements.
Fair value of financial instruments: In cases where quoted market prices are not available, fair values of financial instruments are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Certain financial instruments and all nonfinancial instruments are excluded from fair value disclosure. Accordingly, the aggregate fair value amounts presented in Note 11 do not represent the underlying value of the Company.
The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:
Off-balance sheet instruments: Fair values for outstanding letters of credit are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing. The fair value of the outstanding letters of credit is not believed to be significant. Unfunded loan commitments are not valued since the loans are generally priced at market at the time of funding.
Cash and due from banks and federal funds sold: The carrying amounts reported in the balance sheet for cash and short-term instruments approximate their fair values.
Investment securities: Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.
Loans receivable: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for other loans are determined using estimated future cash flows, discounted at the interest rates currently being offered for loans with similar terms to borrowers with similar credit quality. The carrying amount of accrued interest receivable approximates its fair value.
Deposit liabilities: The fair values of demand deposits equal their carrying amounts, which represent the amount payable on demand. The carrying amounts for variable-rate, fixed-term money market accounts and certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
Short-term borrowings: The carrying amounts of federal funds sold and securities sold under agreements to repurchase approximate their fair values.
Long-term borrowings: The fair values of the Bank's long-term borrowings (other than deposits) are estimated using discounted cash flow analyses, based on the Bank's current incremental borrowing rates for similar types of borrowing arrangements.
Accrued interest payable: The carrying amount of accrued interest payable approximates its fair value. Note 2.
Investment Securities
The amortized cost and fair value of investment securities available for sale are as follows:
Gross Gross Amortized Unrealized Unrealized Fair Cost Gains (Losses) Value -------------------------------------------- (Amounts In Thousands)
December 31, 2001: U. S. Treasury .................. $ 11,549 $ 524 $ -- $ 12,073 U. S. Government agencies and corporations .................. 119,308 3,887 (30) 123,165 State and political subdivisions 34,658 544 (129) 35,073 -------------------------------------------- Total ..................... $165,515 $ 4,955 $ (159) $170,311 ============================================
December 31, 2000: U. S. Treasury .................. $ 18,070 $ 249 $ (1) $ 18,318 U. S. Government agencies and corporations .................. 94,439 720 (123) 95,036 State and political subdivisions 24,152 331 (69) 24,414 -------------------------------------------- Total ..................... $136,661 $ 1,300 $ (193) $137,768 ============================================
The amortized cost and fair value of debt securities held to maturity are as follows:
Gross Gross Amortized Unrealized Unrealized Fair Cost Gains (Losses) Value ------------------------------------------ (Amounts In Thousands)
December 31, 2001: State and political subdivisions ... $11,840 $ 306 $ -- $12,146 =========================================
December 31, 2000: State and political subdivisions ... $15,509 $ 168 $ (1) $15,676 =========================================
The contractual maturity distribution of investment securities as of December 31, 2001 is summarized as follows:
Available For Sale Held To Maturity ------------------------------------------ Amortized Fair Amortized Fair Cost Value Cost Value ------------------------------------------ (Amounts In Thousands)
Due in one year or less .............. $ 26,680 $ 27,193 $ 3,053 $ 3,090 Due after one year through five years 122,597 126,643 8,599 8,855 Due after five years through ten years 16,038 16,273 163 174 Due over ten years ................... 200 202 25 27 ----------------------------------------- Total ........................ $165,515 $170,311 $ 11,840 $ 12,146 =========================================
As of December 31, 2001, investment securities with a carrying value of $44,782,000 were pledged to collateralize public and trust deposits, short-term borrowings and for other purposes, as required or permitted by law.
Net gains or losses from the sale of investment securities were as follows:
Year Ended December 31, ------------------------------ 2001 2000 1999 ------------------------------ (Amounts In Thousands)
Gross gains ............................... $ -- $ -- $ 4 Gross (losses) ............................ -- -- (319) ----------------------------- Net (losses) ...................... $ -- $ -- $ (315) =============================
Note 3. Loans
The composition of loans is as follows:
December 31, ------------------------- 2001 2000 ------------------------- (Amounts In Thousands)
Agricultural ................................. $ 34,304 $ 28,560 Commercial and financial ..................... 44,363 37,832 Real estate: Construction ............................... 40,430 38,184 Mortgage ................................... 538,832 499,010 Loans to individuals ......................... 34,713 33,715 ------------------------- 692,642 637,301 Less allowance for loan losses ............... 9,950 10,428 ------------------------- $682,692 $626,873 =========================
Changes in the allowance for loan losses are as follows:
Year Ended December 31, ------------------------------------- 2001 2000 1999 ------------------------------------- (Amounts In Thousands)
Balance, beginning ................... $ 10,428 $ 9,750 $ 8,856 Provision charged to expenses ...... 924 948 900 Recoveries ......................... 1,139 904 757 Loans charged off .................. (2,541) (1,174) (763) ------------------------------------- Balance, ending ...................... $ 9,950 $ 10,428 $ 9,750 =====================================
Information about impaired loans as of and for the years ended December 31, 2001 and 2000 is as follows:
Note 4. Property and Equipment
The major classes of property and equipment and the total accumulated depreciation are as follows:
December 31, ----------------------- 2001 2000 ----------------------- (Amounts In Thousands)
Land ........................................... $ 3,715 $ 3,080 Buildings and improvements ..................... 15,844 12,664 Furniture and equipment ........................ 16,834 13,939 ----------------------- 36,393 29,683 Less accumulated depreciation .................. 15,396 13,184 ----------------------- Net .................................... $20,997 $16,499 =======================
Note 5. Interest-Bearing Deposits
A summary of these deposits is as follows:
December 31, -------------------------- 2001 2000 -------------------------- (Amounts In Thousands)
NOW and other demand ....................... $ 84,480 $ 70,980 Savings .................................... 175,900 161,603 Time, $100,000 and over .................... 55,517 46,653 Other time ................................. 311,942 297,383 -------------------------- $627,839 $576,619 ==========================
Note 6. Federal Home Loan Bank Borrowings
As of December 31, 2001 and 2000, the borrowings were as follows:
2001 2000 -------------------------- (Effective interest rates as of December 31, 2001) (In Thousands)
Due 2005, 3.72% ............................ $ 4,350 $ 10,000 Due 2006, 4.08% ............................ 12,750 -- Due 2008, 5.22% to 6.00% ................... 50,000 40,100 Due 2009, 5.66% to 6.04% ................... 30,537 30,568 Due 2010, 5.77% to 6.61% ................... 40,000 40,000 -------------------------- $137,637 $120,668 ==========================
Approximately $120,000,000 of the borrowings are callable at various dates through 2005.
The borrowings are collateralized by 1-4 family mortgage loans with an aggregate face amount of $165,165,000. As of December 31, 2001, the Company held Federal Home Loan Bank stock with a cost of $7,809,000.
Note 7. Employee Benefit Plans
The Company has an Employee Stock Ownership Plan (the "ESOP") to which it makes discretionary cash contributions. The Company's contribution to the ESOP totaled $79,000, $70,000 and $64,000 for the years ended December 31, 2001, 2000 and 1999, respectively.
In the event a terminated plan participant desires to sell his or her shares of the Company stock, or for certain employees who elect to diversify their account balances, the Company may be required to purchase the shares from the participant at their fair value. To the extent that shares of common stock held by the ESOP are not readily traded, a sponsor must reflect the maximum cash obligation related to those securities outside of stockholders' equity. As of December 31, 2001, 148,713 shares held by the ESOP, at a fair value of $82 per share, had been reclassified from stockholders' equity to liabilities.
The Company has a profit-sharing plan with a 401(k) feature, which provides for discretionary annual contributions in amounts to be determined by the Board of Directors. The profit-sharing contribution totaled $636,000, $562,000 and $509,000 for the years ended December 31, 2001, 2000 and 1999, respectively.
The Company has a Stock Option and Incentive Plan for certain key employees and directors whereby shares of common stock have been reserved for awards in the form of stock options or stock awards. Under the plan, the aggregate number of options and shares granted cannot exceed 66,000 shares. A Stock Option Committee may grant options at prices equal to the fair value of the stock at the date of the grant. Options expire 10 years from the date of the grant. Directors may exercise options immediately and officers' rights under the plan vest over a five-year period from the date of the grant. No compensation expense has been charged to expense using the intrinsic value based method as prescribed by APB No. 25. Had compensation expense been determined based on the grant date fair values of the awards, as prescribed by SFAS No. 123, reported net income and earnings per share would have been as follows:
Years Ended December 31, ------------------------------------ 2001 2000 1999 ------------------------------------
Pro forma net income (in thousands) .... $ 10,131 $ 9,361 $ 8,461 Pro forma earnings per share: Basic ................................ 6.77 6.26 5.70 Diluted .............................. 6.71 6.21 5.66
The fair value of each grant is established at the grant date using the Black-Scholes option-pricing model with the following weighted average assumptions for 2001 grants: Dividend rate 2.19%; risk-free interest rate of 4.40% and an expected life of 10 years. There were no grants in 2000 or 1999.
Weighted Average Number Exercise Of Shares Price ----------------------------
Balance, December 31, 1999 ................... 20,462 $ 27.15 Exercised .................................. -- -- --------------------------- Balance, December 31, 2000 ................... 20,462 27.15 Granted* ................................... 10,400 77.00 Exercised .................................. (1,683) 26.17 --------------------------- Balance, December 31, 2001 ................... 29,179 $ 44.98 ===========================
* The weighted average fair value of these options was $15 per share.
Other pertinent information related to the options outstanding at December 31, 2001 is as follows:
Remaining Exercise Number Contractual Number Price Outstanding Life Exercisable - --------------------------------------------------------------
$ 25.33 12,330 15 Months 12,330 26.17 4,394 18 Months 4,394 41.00 2,055 63 Months 2,055 77.00 10,400 113 months - ------ ------ 29,179 18,779 ====== ======
As of December 31, 2001, 55,600 options were available for future grants.
The committee is also authorized to grant awards of common stock, and if authorized the issuance of 1,550, none and 1,587 shares of common stock to a group of employees in 2001, 2000 and 1999, respectively.
Note 8. Income Taxes
Income taxes for the years ended December 31, 2001, 2000 and 1999 are summarized as follows:
2001 2000 1999 ----------------------------------------- (Amounts In Thousands) Current: Federal .................... $ 3,819 $ 3,648 $ 3,707 State ...................... 747 726 710 Deferred ..................... 47 (315) (847) ----------------------------------------- $ 4,613 $ 4,059 $ 3,570 =========================================
Deferred income tax liabilities and assets arose from the following temporary differences: December 31, -------------------------- 2001 2000 1999 -------------------------- (Amounts In Thousands) Deferred income tax assets: Allowance for loan losses ...................... $3,693 $3,860 $3,597 Unrealized losses on investment securities ..... -- -- 574 Deferred compensation .......................... 530 433 311 Certain accrued expenses ....................... 276 198 190 Other .......................................... 91 90 112 -------------------------- Gross deferred tax assets ................ 4,590 4,581 4,784 -------------------------- Deferred income tax liabilities: Property and equipment ......................... 773 750 700 FHLB dividends ................................. 130 130 130 Unrealized gains on investment securities ...... 1,775 409 -- Other .......................................... 39 6 -- -------------------------- Gross deferred tax liabilities ........... 2,717 1,295 830 -------------------------- Net deferred income tax asset ............ $1,873 $3,286 $3,954 ==========================
The net change in the deferred income taxes for the years ended December 31, 2001, 2000 and 1999 is reflected in the financial statements as follows:
Year Ended December 31, --------------------------------- 2001 2000 1999 --------------------------------- (Amounts In Thousands)
Statement of income ...................... $ 47 $ (315) $ (847) Statement of stockholders' equity ........ 1,366 983 (1,269) --------------------------------- $ 1,413 $ 668 $(2,116) =================================
The income tax provisions for the years ended December 31, 2001, 2000 and 1999 are less than the amounts computed by applying the maximum effective federal income tax rate to the income before income taxes because of the following items:
2001 2000 1999 % Of % Of % Of Pretax Pretax Pretax Amount Income Amount Income Amount Income -------------------------------------------------------- (Amounts In Thousands)
Expected provision $ 5,165 35.0% $ 4,699 35.0% $ 4,213 35.0% Tax-exempt interest (745) (5.0) (712) (5.3) (647) (5.3) Interest expense limitation ...... 143 1.0 111 1.0 120 1.0 State income taxes, net of federal income tax benefit ......... 493 3.3 479 3.6 468 3.9 Income tax credits (345) (2.3) (345) (2.6) (345) (2.9) Other ............. (98) (0.7) (173) (1.3) (239) (2.0) ------------------------------------------------------- $ 4,613 31.3% $ 4,059 30.4% $ 3,570 29.7% =======================================================
Note 9. Regulatory Capital Requirements, Restrictions on Subsidiary Dividends and Cash Restrictions
Federal regulatory agencies have adopted various capital standards for financial institutions, including risk-based capital standards. The primary objectives of the risk-based capital framework are to provide a more consistent system for comparing capital positions of financial institutions and to take into account the different risks among financial institutions' assets and off-balance sheet items.
Risk-based capital standards include requirements for a minimum Tier 1 capital to assets ratio (leverage ratio). In addition, regulatory agencies consider the published capital levels as minimum levels and may require a financial institution to maintain capital at higher levels.
The actual amounts and capital ratios as of December 31, 2001, with the minimum regulatory requirements for the Company and Bank are presented below (amounts in thousands):
The ability of the Company to pay dividends to its stockholders is dependent upon dividends paid by the Bank. The Bank is subject to certain statutory and regulatory restrictions on the amount it may pay in dividends. To maintain acceptable capital ratios in the Bank, certain of its retained earnings are not available for the payment of dividends. To maintain a ratio of capital to assets of 8%, retained earnings of $7,015,000 as of December 31, 2001 are available for the payment of dividends to the Company.
The Bank is required to maintain reserve balances in cash or with the Federal Reserve Bank. Reserve balances totaled $11,998,000 and $9,662,000 as of December 31, 2001 and 2000, respectively.
Note 10. Related Party Transactions
Certain directors of the Company and the Bank and companies with which the directors are affiliated and certain principal officers are customers of, and have banking transactions with, the Bank in the ordinary course of business. Such indebtedness has been incurred on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons.
The following is an analysis of the changes in the loans to related parties during the years ended December 31, 2001 and 2000:
Year Ended December 31, ----------------------------- 2001 2000 ----------------------------- (Amounts In Thousands)
Balance, beginning ..................... $ 13,297 $ 10,733 Advances ............................. 15,445 8,725 Collections .......................... (4,302) (6,161) ----------------------------- Balance, ending ........................ $ 24,440 $ 13,297 =============================
Deposits from related parties are accepted subject to the same interest rates and terms as those from nonrelated parties.
Note 11. Fair Value of Financial Instruments
The carrying value and estimated fair values of the Company's financial instruments as of December 31, 2001 and 2000 are as follows:
Note 12. Parent Company Only Financial Information
Following is condensed financial information of the Company (parent company only):
CONDENSED BALANCE SHEETS December 31, 2001 and 2000 (Amounts In Thousands)
ASSETS 2001 2000 - --------------------------------------------------------------------------------
Cash ................................................... $ 1,655 $ 1,583 Investment securities available for sale ............... 520 499 Investment in subsidiary bank .......................... 87,837 77,711 Other assets ........................................... 572 529 ------------------- Total assets ................................... $90,584 $80,322 ===================
LIABILITIES AND STOCKHOLDERS' EQUITY - -------------------------------------------------------------------------------- Liabilities ............................................ $ 235 $ 248 ------------------- Redeemable common stock held by ESOP ................... 12,194 11,550 ------------------- Stockholders' equity: Capital stock ........................................ 10,397 10,197 Retained earnings .................................... 76,931 69,179 Accumulated other comprehensive income ............... 3,021 698 ------------------- 90,349 80,074 Less maximum cash obligation related to ESOP shares .... 12,194 11,550 ------------------- Total stockholders' equity ..................... 78,155 68,524 ------------------- Total liabilities and stockholders' equity ..... $90,584 $80,322 ===================
CONDENSED STATEMENTS OF INCOME Years Ended December 31, 2001, 2000 and 1999 (Amounts In Thousands)
2001 2000 1999 ---------------------------------
Interest on investment securities ........... $ 32 $ 30 $ 16 Dividends received from subsidiary .......... 2,392 2,170 1,911 Other expenses .............................. (112) (119) (121) --------------------------------- Income before income taxes and equity in subsidiary's undistributed income 2,312 2,081 1,806 Income tax benefit .......................... 29 43 37 --------------------------------- 2,341 2,124 1,843 Equity in subsidiary's undistributed income . 7,803 7,242 6,623 --------------------------------- Net income .......................... $ 10,144 $ 9,366 $ 8,466 =================================
CONDENSED STATEMENTS OF CASH FLOWS Years Ended December 31, 2001, 2000 and 1999 (Amounts In Thousands)
Note 13. Commitments and Contingencies
Concentrations of credit risk: The Bank's loans, commitments to extend credit, unused lines of credit and outstanding letters of credit have been granted to customers within the Bank's market area. Investments in securities issued by state and political subdivisions within the state of Iowa totaled approximately $17,417,000. The concentrations of credit by type of loan are set forth in Note 3. Outstanding letters of credit were granted primarily to commercial borrowers. Although the Bank has a diversified loan portfolio, a substantial portion of its debtors' ability to honor their contracts is dependent upon the economic conditions in Johnson County, Iowa.
Contingencies: In the normal course of business, the Company and Bank are involved in various legal proceedings. In the opinion of management, any liability resulting from such proceedings would not have a material adverse effect on the accompanying financial statements.
Financial instruments with off-balance sheet risk: The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, credit card participations and standby letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheets.
The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, credit card participations and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. A summary of the Bank's commitments at December 31, 2001 and 2000 is as follows:
2001 2000 ---------------------- (Amounts In Thousands) Firm loan commitments and unused portion of lines of credit: Home equity loans ................................... $ 5,819 $ 4,693 Credit card participations .......................... 14,050 12,639 Commercial, real estate and home construction ....... 44,880 33,562 Commercial lines .................................... 52,860 40,166 Outstanding letters of credit ......................... 12,569 10,993
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management's credit evaluation of the party. Collateral held varies, but may include accounts receivable, crops, livestock, inventory, property and equipment, residential real estate and income-producing commercial properties. Credit card participations are the unused portion of the holders' credit limits. Such amounts represent the maximum amount of additional unsecured borrowings.
Outstanding letters of credit are the conditional commitments issued by the Bank to guarantee the performance of a customer to a third party and collateralize the customer's borrowing arrangement with other creditors. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral held varies as specified above and is required in instances which the Bank deems it necessary.
Note 14. Quarterly Results of Operations (unaudited, in thousands, except per share amounts)
Quarter Ended ----------------------------------------------- March June September December Year ----------------------------------------------- 2001: Total interest income ...... $15,752 $15,931 $16,032 $16,003 $63,718 Net interest income after provisions for loan losses 6,527 6,923 7,298 7,611 28,359 Net income ................. 2,307 2,534 2,680 2,623 10,144 Basic earnings per share ... 1.54 1.69 1.79 1.76 6.78 Diluted earnings per share . 1.53 1.68 1.77 1.74 6.72
2000: Total interest income ...... $14,059 $14,651 $15,300 $15,982 $59,992 Net interest income after provisions for loan losses 6,294 6,496 6,511 6,679 25,980 Net income ................. 2,204 2,399 2,336 2,427 9,366 Basic earnings per share ... 1.47 1.60 1.56 1.63 6.26 Diluted earnings per share . 1.46 1.59 1.55 1.61 6.21
Part II
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 concerning directors is contained in the Registrant's Proxy Statement under the heading "Information Concerning Nominees for Election as Directors" and "Information Concerning Directors Other Than Nominees," which sections are incorporated herein by this reference.
The following table sets forth the name, age and principal occupation of the Executive Officers of the Registrant and Executive Officers of the Bank. All officers of the Registrant and the Bank are elected annually for one-year terms of office.
Item 11.
Item 11. Executive Compensation
Information required by this item is contained in the Registrant's Proxy Statement under the heading "Executive Compensation and Benefits," which section is incorporated herein by this reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information required by this item is contained in the Registrant's Proxy Statement under the heading "Security Ownership of Certain Beneficial Owners and Management" and "Report on Executive Compensation," which sections are incorporated herein by this reference.
Item 13.
Item 13. Certain Relationships and Related Transactions
Information required by this item is contained in the Registrant's Proxy Statement under the heading "Loans To and Certain Other Transactions With Executive Officers and Directors," which section is incorporated herein by this reference.
Part IV
Item 14.
Item 14. Exhibits, Financial Statements, Schedules and Reports on Form 8-K
Form 10-K Reference --------- (a) 1. Financial Statements
Independent auditor's report on the financial statements Consolidated balance sheets as of December 31, 2001 and 2000 Consolidated statements of income for the years ended December 31, 2001, 2000 and 1999 Consolidated statements of comprehensive income for the years ended December 31, 2001, 2000 and 1999 Consolidated statements of stockholders' equity for the years ended December 31, 2001, 2000 and 1999 Consolidated statements of cash flows for the years ended December 31, 2001, 2000 and 1999 Notes to financial statements
(a) 2. Financial Statements Schedules
All schedules are omitted because they are not applicable or not required, or because the required information is included in the consolidated financial statements or notes thereto.
(a) 3. Exhibits
Exhibit 3 - Articles of Incorporation and Bylaws filed as Exhibit 3 of Form 10-K for the year ended December 31, 1993 are incorporated by reference.
Exhibit 10(a) - Material Contract (Employee Stock Ownership Plan) filed as Exhibit 10(a) in Form 10-K for the year ended December 31, 1993 is incorporated by reference.
Exhibit 10(b) - Material Contract (1993 Stock Incentive Plan) filed as Exhibit 10(b) in Form 10-K for the year ended December 31, 1993 is incorporated by reference.
Exhibit 10(c) - Material contract (1995 Deferred Compensation Plans) filed as Exhibit 10(c) in Form 10-K for the year ended December 31, 1995 is incorporated by reference.
Exhibit 10(d) - Material contract (2000 Stock Option and Incentive Plan) filed as Exhibit 10(d) in Form 10-K for the year ended December 31, 2000 is incorporated by reference.
Exhibit 11 - Statement Re Computation of Basic and Diluted Earnings Per Share is attached on Page 73.
Exhibit 21 - Subsidiaries of the Registrant is attached on Page 74.
Exhibit 23 - Consent of Accountants is attached on Page 75.
(b) Reports on Form 8-K:
The Registrant filed no reports on Form 8-K for the three months ended December 31, 2001.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
HILLS BANCORPORATION
Date March 25, 2002 By /s/ Dwight O. Seegmiller --------------------------- ----------------------------------- Dwight O. Seegmiller, Director and President
Date March 25, 2002 By /s/ James G. Pratt --------------------------- ----------------------------------- James G. Pratt, Treasurer and Chief Accounting Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Date March 25, 2002 By /s/ Willis M. Bywater ---------------------------- ----------------------------------- Willis M. Bywater, Director
Date March 25, 2002 By /s/ Thomas J. Gill ---------------------------- ----------------------------------- Thomas J. Gill, Director
Date March 25, 2002 By /s/ Donald H. Gringer ---------------------------- ----------------------------------- Donald H. Gringer, Director
Date March 25, 2002 By /s/ Michael E. Hodge --------------------------- ----------------------------------- Michael E. Hodge, Director
Date March 25, 2002 By /s/ Richard W. Oberman --------------------------- ----------------------------------- Richard W. Oberman, Director
Date March 25, 2002 By /s/ Theodore H. Pacha --------------------------- ----------------------------------- Theodore H. Pacha, Director
Date March 25, 2002 By /s/ Ann M. Rhodes ---------------------------- ----------------------------------- Ann M. Rhodes, Director
Date March 25, 2002 By /s/ Ronald E. Stutsman ----------------------------- ----------------------------------- Ronald E. Stutsman, Director
Date March 25, 2002 By /s/ Sheldon E. Yoder ---------------------------- ----------------------------------- Sheldon E. Yoder, Director
HILLS BANCORPORATION
ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
EXHIBIT INDEX