Item 1. Business
Hills Bancorporation (the "Company") is a multibank holding company principally engaged in the business of banking. Its three wholly-owned subsidiary banks are Hills Bank and Trust Company, Hills, Iowa ("Hills Bank and Trust"); Hills Bank, Lisbon, Iowa ("Hills Bank Lisbon"); and Hills Bank Kalona, Kalona, Iowa ("Hills Bank Kalona") (hereinafter collectively referred to as the "Banks").
The Company was incorporated December 12, 1982 and all operations are conducted within the state of Iowa. The Company became owner of 100% of the outstanding stock of Hills Bank and Trust 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 acquired for cash all the outstanding shares of Hills Bank Lisbon and on September 20, 1996, Hills Bank Kalona acquired cash, certain assets and assumed the deposits of the Kalona, Iowa office of Boatmen's Bank Iowa, N.A.
The Banks are all full-service commercial banks extending their services to individuals, business, governmental units and institutional customers primarily in the communities of Hills, Iowa City, Coralville, North Liberty, Lisbon, Mount Vernon and Kalona and the surrounding area and most recently in Cedar Rapids. This area includes parts of Johnson, Linn and Washington counties. All of the Banks are actively engaged in all areas of commercial banking, including acceptance of demand; savings and time deposits; making commercial, real estate, agricultural and consumer loans; maintaining night and safe deposit facilities; and performing collection, exchange and other banking services tailored for individual customers. Hills Bank and Trust administers estates, personal trusts, and pension and profit-sharing funds and, in connection therewith, provides for farm management and investment advisory and custodial services for individuals, corporations and nonprofit organizations. At this time, trust services are available only at the Hills Bank and Trust locations. The loan activity of the Banks is diversified, with commercial and agricultural loans, real estate loans, automobile, installment and other consumer loans composing the majority of its loan portfolio. In addition, the Banks earn substantial fees from originating mortgages that are sold in the secondary residential real estate market without mortgage servicing rights being maintained.
Each Bank has established formal loan origination policies. In general, the loan origination policies require individual lenders to reduce the risk of credit loss to the Bank by requiring that, among other things, minimum loan to value ratios be maintained, evidence of appropriate levels of insurance be carried by borrowers and documenting appropriate types and amounts of collateral and sources of expected payment.
The Banks' business is not seasonal, except that loan origination fees are higher during the spring and summer months. The Banks have not undertaken significant new services during the current year that might exceed the limits of their human resources and data processing capabilities.
Hills Bank and Trust serves the communities of Iowa City, Coralville, Hills and North Liberty, located near Interstate 80 and Interstate 380 in Eastern Iowa. The communities have a population of approximately 80,000 and Johnson County, Iowa has a population of approximately 106,000. The University of Iowa 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 one of the strongest economies in Iowa and has had substantial economic growth in the past ten years. Johnson County is known for its educational institutions, health care facilities, cultural and sports events, and retail centers.
Hills Bank Lisbon has offices located in Lisbon, Iowa (Linn County) and Mount Vernon, Iowa (Linn County), approximately 25 miles northeast of Iowa City and does not conduct business in the same trade territories as Hills Bank and Trust. Lisbon has a population of approximately 1,500 and Mount Vernon, located two miles away, has a population of 3,700. Both communities are strong economically and are easy commuting distances to Cedar Rapids and Iowa City, Iowa. In addition, Mount Vernon is the home of Cornell College, which has approximately 1,200 students. In February 2000, Hills Bank Lisbon opened an office in downtown Cedar Rapids, Iowa. Cedar Rapids has a metropolitan population of approximately 180,000 and is located approximately 10 miles west of Lisbon, Iowa.
Hills Bank Kalona is located in Kalona, Iowa (Washington County), approximately 20 miles south of Iowa City with a population of approximately 2,000 people. Kalona is primarily an agricultural community, but is located within easy driving distance for employment in Iowa City and Washington, Iowa.
The commercial banking business is highly competitive and the Banks compete with other commercial banks, credit unions, brokerage firms, finance companies, insurance companies and other financial institutions.
Iowa's banking laws regarding interstate banking and interstate branching are currently more restrictive than many other states. As a result of the enactment of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 many of the state-imposed geographic limitations on bank ownership have been liberalized. The 1994 Act expanded opportunities for interstate banking, interstate mergers and interstate branching in the United States. First, subject to certain limitations, bank holding companies from anywhere in the United States are able to acquire Iowa banks with the permission of the Federal Reserve Board. Second, the 1994 Act authorizes a national or state bank which has its main office in another state to merge with an Iowa bank and operate the Iowa location as a branch office. However, out-of-state bank holding companies cannot acquire Iowa commercial banks unless such banks have been in existence for at least five years. Hills Bank Kalona has been in existence since September 20, 1996. Iowa also currently has a deposit concentration limit of 10% on the amount of deposits that any one banking organization can control and continue to acquire banks, which applies to both in-state and out-of-state banks. Iowa also has a 35% limit on the aggregate amount of deposits all out-of-state banking organizations can control within Iowa.
In recent years, Norwest Bank Iowa, N.A., Mercantile Bancorporation, Firstar Corporation, Commercial Federal Bank and NationsBank have acquired a number of independent banks and smaller multibank holding companies in various metropolitan areas of Iowa. Each operates under a single charter in Iowa. In September 1998, the Company's largest competing bank in Iowa City, with assets of approximately $550 million, was acquired by Mercantile Bancorporation and effective January 2000 the Mercantile banks in Iowa were merged into Firstar Bank Iowa.
Iowa's intrastate branching statutes are also rather restrictive when compared with those of other states. Generally, bank branch offices may only be operated or acquired in counties contiguous to or cornering upon the county in which the Bank has its principal place of business. Also, a bank in Iowa may not establish a new branch office in a city in which there exists an office of another bank, other than by acquisition of an existing office or bank. Effective July 1, 1998, the number of bank branch offices allowed within a municipal corporation or an urban complex is unlimited. However, some of Iowa's intrastate branching limitations regarding geographic location of branch offices and the number of branch offices which may be established in an urban complex or any other location in Iowa may be overcome by merging two or more affiliated banking organizations that have been in continuous operation in Iowa for at least five years into a "united community bank."
In 1999 and 1998, three smaller banks from outlying communities in Johnson County opened branches or De Novo banks in Iowa City or Coralville, and Brenton Bank opened an office in Coralville. Similarly, several smaller banks have recently began competing in the Cedar Rapids trade area.
The Financial Services Modernization Act ("FSMA") was enacted into law on November 12, 1999. The most significant provision in this legislation is the repeal of the restriction on banks affiliating with securities firms. The FSMA would allow the creation of a "financial holding company" which 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 FSMA amends the federal securities laws to incorporate functional regulation of bank securities activities and provides for the functional regulation of insurance activities by establishing which insurance products banks and bank subsidiaries may provide as principal. Furthermore, the FSMA 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 net earnings.
In the area of privacy, the FSMA 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 FSMA 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 FSMA also provides reform in the areas of ATM's, Community Reinvestment, Community Banks and Deposit Production Offices. Specifically, the FSMA 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 ATM's not operated by the car issuer. The FSMA also clarifies that nothing in the act repeals any provision of the Community Reinvestment Act ("CRA"); however, the FSMA 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 FSMA 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 FSMA expands the prohibition of deposit production offices contained in the Reigle-Neal Interstate bill to include all branches of an out-of-state bank holding company.
Hills Bank and Trust Company is in direct competition for deposits, loans and other financial related business with other financial institutions in Johnson County, Iowa. One of the largest competitors serving Johnson County is a branch of Mercantile Bank, which does not disclose local assets. Other independent financial institutions are:
Assets As Of December 31, ------------- (In Millions)
Largest competing bank $ 382 Next largest competing bank 155 Largest competing credit union 185
Hills Bank Kalona and Hills Bank Lisbon compete with other banks in their trade territories. Management estimates that these banks hold less than 40% of the deposits in their respective communities.
No material portion of the Banks' deposits have been obtained from a single person or a few persons. Accordingly, management of the Banks have no reason to believe that the loss of the deposits of any person or few persons would have a materially adverse effect on the Banks' operations or erode its deposit base. Approximately 4.7% of the Banks' loans have been made for agricultural purposes. The agricultural sector of the economy has been cyclical with a general trend toward fewer and larger farms. The Banks have not experienced a material adverse effect on their business as a result of defaults on agricultural loans and expect none in the future.
The Company does not engage in any business activities apart from its ownership of the Banks and, therefore, does not encounter any competition for its services other than as described above for the Banks.
The Company and the Banks have undertaken no material research activities during the last three years relating to research and development activities.
The Company is regulated by the Federal Reserve Bank.
All the Banks are regulated by the Federal Deposit Insurance Corporation and the State of Iowa Division of Banking.
The Company had no employees as of December 31, 1999 and the Banks had 232 regular and 80 part-time employees.
The following consolidated statistical information reflects selected balances and operations of the Company and the Banks for the periods indicated.
The following tables show (1) average balances of assets and liabilities, (2) interest income and expense on a tax equivalent basis, (3) interest rates and differential and (4) changes in interest income and expense.
AVERAGE BALANCES (Average Daily Basis)
December 31, ---------------------------------- 1999 1998 1997 ---------------------------------- (In Thousands) ASSETS
Cash and due from banks ................... $ 16,863 $ 13,441 $ 12,689 Taxable securities ........................ 119,856 111,099 110,542 Nontaxable securities ..................... 34,699 30,122 25,184 Federal funds sold ........................ 9,796 23,279 3,032 Loans, net ................................ 508,293 438,072 397,787 Property and equipment, net ............... 11,633 10,410 8,603 Other assets .............................. 17,249 16,098 14,829 -------------------------------- $ 718,389 $ 642,521 $ 572,666 ================================ LIABILITIES AND STOCKHOLDERS' EQUITY Noninterest-bearing demand deposits ....... $ 62,317 $ 52,538 $ 48,330 Interest-bearing demand deposits .......... 57,017 46,874 43,262 Savings deposits .......................... 152,507 131,988 119,282 Time deposits ............................. 274,507 262,111 250,241 Securities sold under agreements to repurchase and federal funds purchased .............................. 12,139 7,974 8,740 FHLB borrowings ........................... 86,880 75,262 43,026 Other liabilities ......................... 4,659 4,250 4,255 Redeemable common stock held by Employee Stock Ownership Plan .......... 10,127 8,491 7,049 Stockholders' equity ...................... 58,236 53,033 48,481 -------------------------------- $ 718,389 $ 642,521 $ 572,666 ================================
INTEREST INCOME AND EXPENSE
Year Ended December 31, ------------------------------------ 1999 1998 1997 ---------------------------------- (In Thousands)
Income: Loans (1) ................................. $ 42,107 $ 38,039 $ 34,814 Taxable securities ........................ 7,167 6,832 6,769 Nontaxable securities (1) ................. 2,373 2,112 1,845 Federal funds sold ........................ 455 1,209 158 --------------------------------- Total interest income .......... 52,102 48,192 43,586 --------------------------------- Expense: Interest-bearing demand deposits .......... 1,175 997 949 Savings deposits .......................... 4,769 4,648 4,183 Time deposits ............................. 14,882 14,813 14,162 Securities sold under agreements to repurchase ............................. 517 417 426 FHLB borrowings ........................... 4,970 4,379 2,782 --------------------------------- Total interest expense ......... 26,313 25,254 22,502 ---------------------------------
Net interest income ............ $ 25,789 $ 22,938 $ 21,084 =================================
(1) Presented on a tax equivalent basis using a federal tax rate of 34%.
INTEREST RATES AND INTEREST DIFFERENTIAL
Year Ended December 31, ----------------------------- 1999 1998 1997 ----------------------------- Average yields: Taxable securities ............................. 5.98% 6.15% 6.12% Nontaxable securities .......................... 4.51 4.63 4.84 Nontaxable securities (tax equivalent basis) ... 6.84 7.01 7.33 Loans (1) ...................................... 8.25 8.64 8.70 Loans (tax equivalent basis) ................... 8.28 8.68 8.75 Federal funds sold ............................. 4.64 5.19 5.21 Interest-bearing demand deposits ............... 2.06 2.13 2.19 Savings deposits ............................... 3.13 3.52 3.51 Time deposits .................................. 5.42 5.65 5.66 Securities sold under agreements to repurchase . 4.26 5.23 4.87 Interest on FHLB borrowings .................... 5.72 5.82 6.47 Yield on average interest-earning assets ....... 7.75 8.00 8.12 Rate on average interest-bearing liabilities ... 4.51 4.82 4.84 Net interest spread (2) ........................ 3.24 3.18 3.28 Net interest margin (3) ........................ 3.83 3.81 3.93
(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
(3) Net interest margin is net interest income, on a tax equivalent basis, divided by average interest-earning assets.
CHANGE IN INTEREST INCOME AND EXPENSE
Change Due Change Due Total ------------------------------- To Volume To Rates Change ------------------------------- (In Thousands)
Year ended December 31, 1999: Change in interest income: Loans ..................................... $ 5,882 $ (1,814) $ 4,068 Taxable securities ........................ 528 (193) 335 Nontaxable securities ..................... 337 (76) 261 Federal funds sold ........................ (637) (117) (754) ------------------------------- 6,110 (2,200) 3,910 ------------------------------- Change in interest expense: Interest-bearing demand deposits .......... 212 (34) 178 Savings deposits .......................... 672 (551) 121 Time deposits ............................. 685 (616) 69 Securities sold under agreements to repurchase ............................. 188 (88) 100 Interest on FHLB borrowings ............... 667 (76) 591 ------------------------------- 2,424 (1,365) 1,059 ------------------------------- Change in net interest income ................ $ 3,686 $ (835) $ 2,851 ===============================
Year ended December 31, 1998: Change in interest income: Loans ..................................... $ 3,505 $ (280) $ 3,225 Taxable securities ........................ 32 31 63 Nontaxable securities ..................... 330 (63) 267 Federal funds sold ........................ 1,052 (1) 1,051 ------------------------------- 4,919 (313) 4,606 ------------------------------- Change in interest expense: Interest-bearing demand deposits .......... 75 (27) 48 Savings deposits .......................... 453 12 465 Time deposits ............................. 676 (25) 651 Securities sold under agreements to repurchase ............................. (39) 30 (9) Interest on FHLB borrowings ............... 1,901 (304) 1,597 ------------------------------- 3,066 (314) 2,752 ------------------------------- Change in net interest income ................ $ 1,853 $ 1 $ 1,854 ===============================
Rate/volume variances are allocated on a consistent basis using the absolute values of changes in volume compared to the absolute values of the changes in rates. Loan fees included in interest income are not material. Interest on nontaxable securities and loans is shown at tax equivalent amounts.
LOANS
The following table shows the composition of loans (before deducting the reserve for loan losses) as of December 31 for each of the last five years.
December 31, --------------------------------------------------- 1999 1998 1997 1996 1995 --------------------------------------------------- (In Thousands)
Agricultural ................ $ 27,302 $ 32,318 $ 27,636 $ 23,133 $ 19,000 Commercial and financial .... 36,848 39,438 33,616 30,650 26,810 Real estate, construction ... 40,879 28,476 8,157 8,846 7,937 Real estate, mortgage ....... 439,072 338,871 332,655 279,134 239,899 Loans to individuals ........ 31,030 30,664 28,707 33,812 31,640 --------------------------------------------------- Total ......... $ 575,131 $ 469,767 $ 430,771 $ 375,575 $ 325,286 ===================================================
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, 1999:
(1) A significant portion of the commercial loans are six-month notes. However, a significant amount of these notes are renewed when due.
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:
1999 1998 1997 1996 1995 --------------------------------------------- (In Thousands)
Nonaccrual loans .................. $ - - $ 12 $ - - $ 339 $ 489 Accruing loans past due 90 days or more ................ 1,320 945 954 1,092 417 Restructured loans Impaired loans .................... 9,265 8,956 9,556 7,811 5,465
The Company does not have a significant amount of loans which are past due less than 90 days on which there are serious doubts as to the ability of the borrowers to comply with the loan repayment terms.
Loans are placed on nonaccrual status when management believes the collection of future interest is not reasonably assured. Interest income was not materially affected by this classification.
The Company has no individual borrower or borrowers engaged in the same or similar industry exceeding 10% of total loans. The Company has no other interest-bearing assets, other than loans, that meet the nonaccrual, past due, restructured or potential problem loan criteria.
No allowance for losses has been recognized for impaired loans because partial charge-offs have been taken to reduce the loan balances to the net present value of the future cash flows or the fair value of the collateral if the loan is collateral dependent.
SUMMARY OF LOAN LOSS EXPERIENCE
The following table summarizes the Company's loan loss experience for each of the last five years:
Year Ended December 31, ---------------------------------------------- 1999 1998 1997 1996 1995 ---------------------------------------------- (In Thousands)
Amount of loan loss allowance at beginning of year .......... $ 8,856 $ 8,010 $ 7,311 $ 6,740 $ 6,210 ---------------------------------------------- Charge-offs: Agriculture ................... 60 4 197 300 101 Commercial and financial ...... 181 431 326 236 387 Real estate, mortgage ......... 104 132 215 127 180 Loans to individuals .......... 418 401 390 308 254 ---------------------------------------------- 763 968 1,128 971 922 ---------------------------------------------- Recoveries: Agriculture ................... 157 125 65 48 218 Commercial and financial ...... 260 256 195 95 226 Real estate, mortgage ......... 30 100 377 215 149 Loans to individuals .......... 310 417 142 80 137 ---------------------------------------------- 757 898 779 438 730 ---------------------------------------------- Net charge-offs .................. 6 70 349 533 192 ---------------------------------------------- Allowances of acquired banks ..... - - - - - - 350 - - ---------------------------------------------- Provision for loan losses (1) .... 900 916 1,048 754 722 ---------------------------------------------- Balance of loan loss allowance at end of year ................ $ 9,750 $ 8,856 $ 8,010 $ 7,311 $ 6,740 ============================================== Ratio of net charge-offs during year to average loans outstanding ................... 0.00% 0.02% 0.09% 0.16% 0.06% ==============================================
The balance of the loan loss allowance has not been allocated by type of loan. Management regularly reviews the loan portfolio and does not expect any unusual material amount to be charged off during 2000 that would be significantly different than the years ended December 31, 1999, 1998, 1997, 1996 and 1995.
(1) For financial reporting purposes, management regularly reviews the loan portfolio and determines a provision for loan losses based upon the impact of economic conditions on the borrower's ability to repay, past collection experience, the risk characteristics of the loan portfolio and such other factors which deserve current recognition. For income tax purposes, the allowance is maintained at the maximum allowable amount.
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
The Banks review and place in risk categories specific borrowings. Based upon the risk category assigned, the Banks allocate a percentage, as determined by management, for a required allowance needed. The risk categories are similar to those used by federal and state regulatory agencies and consist of the following:
(1) Potential watch and watch (2) Problem (3) Substandard (4) Doubtful
In addition, each bank's management also reviews and, where determined necessary, allows for specific allowances based upon reviews of specific borrowers and provides general allowances for areas which management believes are of higher credit risk (agricultural loans and constructed model real estate homes as of December 31, 1999).
A summary of the components of the allowance for loan loss, by risk category, as of December 31, 1999 and 1998 is as follows:
1999 1998 ------------------------------ (In Thousands)
Potential watch and watch loans .................. $ 3,164 $ 2,905 Substandard ...................................... 2,416 2,169 Specific borrowers (agricultural loans) .......... 1,025 1,048 Constructed model real estate homes .............. 925 969
Anticipated charge-offs of the above categories are not determinable at December 31, 1999; however, it is possible that agricultural loan charge-offs could be higher in 2000 than the historical average due to lower farm commodity prices in recent months.
INVESTMENT SECURITIES
The following tables show the carrying value of the investment securities as of December 31, 1999, 1998 and 1997 and the maturities and weighted average yield of the investment securities as of December 31, 1999:
December 31, --------------------------------- 1999 1998 1997 --------------------------------- (In Thousands) Carrying value: U. S. Treasury securities .................. $ 19,470 $ 33,340 $ 40,189 Obligations of other U. S. Government agencies and corporations ............... 94,302 78,083 65,445 Obligations of states and political subdivisions ............................ 36,496 33,580 27,692 --------------------------------- $ 150,268 $ 145,003 $ 133,326 =================================
December 31, 1999 ------------------------ Weighted Carrying Average Value Yield ------------------------ (In Thousands) Type and maturity grouping: U. S. Treasury maturities: Within 1 year .................................... $ 9,029 6.23% From 1 to 5 years ................................ 10,441 5.96 ------------ 19,470 ------------ Obligations of other U. S. Government agencies and corporations, maturities: Within 1 year .................................... 17,477 6.15% From 1 to 5 years ................................ 76,353 6.02 From 5 to 10 years ............................... 472 6.05 ------------ 94,302 ------------ Obligations of states and political subdivisions, maturities: Within 1 year .................................... 3,302 6.97% From 1 to 5 years ................................ 19,080 From 5 to 10 years ............................... 13,851 6.71 Over 10 years .................................... 263 8.11 ------------ 36,496 ------------ Total .................................... $ 150,268 ============
INVESTMENT SECURITIES
As of December 31, 1999, there were no investment securities of any issuer, other than securities of the U. S. Government and U. S. Government agencies and corporations, exceeding 10% of stockholders' equity.
The weighted average yield is based on the amortized cost of the investment securities. 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 average deposits and rates paid on such deposits for the years ended December 31, 1999, 1998 and 1997 and the composition of the certificates issued in denominations in excess of $100,000 as of December 31, 1999:
Time certificates issued in amounts of $100,000 or more as of December 31, 1999 with Amount Rate maturity in: ------------------------------- 3 months or less ........................ $ 4,861 5.15 3 through 6 months ...................... 9,228 5.05 6 through 12 months ..................... 6,285 5.07 Over 12 months .......................... 10,068 5.60 ----------- $ 30,442 ===========
There were no deposits in foreign banking offices.
RETURN ON STOCKHOLDERS' EQUITY AND ASSETS
The following table presents the return on average stockholders' equity and average assets for the years ended December 31, 1999, 1998 and 1997:
December 31, ------------------------------ 1999 1998 1997 ------------------------------ Return on assets .............................. 1.18% 1.17% 1.24% Return on stockholders' equity ................ 14.54 14.12 14.62 Dividend payout ratio ......................... 22.56 23.52 21.69 Stockholders' equity to assets ratio .......... 8.11 8.25 8.47
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 1999, 1998 and 1997:
1999 1998 1997 ------------------------------- (Amounts In Thousands)
Outstanding as of December 31 ................... $ 26,714 $ 10,554 $ 9,008 Weighted average interest rate at year end ...... 4.28% 4.40% 4.30% Maximum month-end balance ....................... 27,815 10,547 16,104 Average month-end balance ....................... 12,139 7,974 8,740 Weighted average interest rate for the year ..... 4.26% 5.23% 4.87%
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 1999, 1998 and 1997:
1999 1998 1997 -------------------------------- Outstanding as of December 31 .................. $ 108,700 $ 75,732 $ 50,764 Weighted average interest rate at year end ..... 5.66% 5.68% 6.42% Maximum month-end balance ...................... 108,700 85,764 50,764 Average month-end balance ...................... 86,880 75,262 43,026 Weighted average interest rate for the year .... 5.72% 5.82% 6.47%
PART I
Item 2.
Item 2. Properties
The Company's office and the main bank of Hills Bank and Trust are located at 131 Main Street, Hills, Iowa. This is a brick building containing approximately 14,200 square feet, a portion of which was built in 1977 and remodeled in 1986. A two-story addition was completed in 1984.
The 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 is 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 that contains approximately 16,700 square feet of space. This ofice is equipped with four drive-up teller lanes and one 24-hour automatic teller machine.
3. A 2,800 square foot branch bank in North Liberty, Iowa was opened for business in 1986. That office is a full-service location including three drive-up teller lanes and a drive-up automatic teller machine.
4. The Bank leases an office at 132 East Washington Street in downtown Iowa City with approximately 2,500 square feet. The office has two 24-hour automatic teller machines and two private offices in addition to a tellers and customer service area. The lease expires in 2001, but the Bank has an option for an additional five years.
5. In June 1999, the Bank opened an office at 2400 Towncrest Drive on the eastside of Iowa City. The office is approximately 1,100 square fet and the lease expires in June 2002.
The Lisbon office of Hills Bank is a two-story brick building in Lisbon, Iowa with approximately 3,000 square feet of banking retail space located on the first floor. The building was extensively remodeled in 1996 and has one drive-up lane and a walk-up 24-hour automatic teller machine. Hills Bank Lisbon constructed and opened its Mount Vernon office location in February 1998 with the completion of a full service, 4,200 square foot office, with four drive-up lanes and a drive-up automatic teller machine. In February 2000, the Bank opened a 2,900 square foot branch office in Cedar Rapids which is leased.
Hills Bank Kalona owns a 6,400 square foot building in Kalona that contains a walk-up 24-hour automatic teller machine and one drive-up lane. This is an older building that has been remodeled a number of times including a major renovation in late 1998.
All of the properties owned by the Bank are free and clear of any mortgages or other encumbrances of any type.
PART I
Item 3.
Item 3. Legal Proceedings
There are no material pending legal proceedings.
Neither the Company nor the Banks hold any properties which are the subject of hazardous waste clean up investigations.
Item 4.
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, 1999.
PART II
Item 5.
Item 5. Market for the Registrant's Common Stock and Related Security Holder Matters
There is no established trading market for the Company's common stock. Its stock is not listed with any exchange or quoted in an automated quotation system of a registered securities association, nor is there any broker/dealer acting as a market maker for its stock. A bid and ask price is quoted in an Iowa City local paper and the quotes are provided by a local broker. The Company's stock is not actively traded. As of December 31, 1999, the Company had 1,166 shareholders.
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 - -------------------------------------------------------------------------------- 1999 6,415 22 $ 70 $ 58 1998 2,320 12 58 48 1997 7,314 12 48 40
The Company paid aggregate annual cash dividends in 1999 and 1998 of $1,910,000 and $1,761,000, respectively, or $1.30 per share in 1999 and $1.20 per share in 1998. In January 2000, the Company declared and paid a dividend of $1.45 per share totaling $2,169,000. The decision to declare any such cash dividends in the future and the amount thereof rests within the discretion of the Board of Directors and will remain subject to, among other things, certain regulatory restrictions imposed on the payment of dividends by the Banks, and the future earnings, capital requirements and financial condition of the Company.
PART II
Item 6.
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 banks.
Forward-looking statements are typically identified by the words "believe," "expect," "anticipate," "target," "goal," "objective," "intend," "estimate" and similar expressions.
The risks involved in the operations and strategies of the Company 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 which has been attributed to it. The loan loss reserve, while believed to be adequate, may prove inadequate if one or more large-balance borrowers, or numerous mid-balance borrowers, or a combination of both, experience financial difficulty for a variety of reasons. These reasons may relate to the financial circumstances of an individual borrower, or may be caused by negative economic circumstances of an individual borrower, or may be caused by negative economic circumstances at the local, regional, national or international level which are beyond the control of the borrowers or the lender.
Because the business of banking is of a highly regulated nature, the decisions of governmental entities can have a major effect on operating results.
All of these uncertainties, as well as others, are present in the 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.
Financial Position - ------------------
In 1999, net loans increased $104.5 million, primarily in real estate mortgage loans, as demand remained high and rates continued to be attractive. The large increase in loans was primarily driven by a strong local economy, the sale of a local competing bank and favorable interest rates. The 1998 loan growth of $38.2 million was also concentrated in real estate mortgage loans.
Total assets increased 12.20% in 1999, compared to an increase of 14.37% in 1998. The growth in assets in 1999 and 1998 was primarily attributable to strong loan demand real estate mortgage loans.
Deposits increased 5.23% in 1999 compared to an increase of 11.33% in 1998. The banks continued to compete for deposits in a market area where the total deposit growth was weak. Federal Home Loan Bank note borrowings increased by a net $33 million in 1999 and $25 million in 1998 with the advances used to fund the loan growth.
Components of Diluted Earnings Per Share - ----------------------------------------
1999 1998 1997 - --------------------------------------------------------------------------------
Net interest income ............................. $ 16.59 $ 14.78 $ 13.64 Provision for loan losses ....................... (0.60) (0.61) (0.71) Noninterest income .............................. 4.30 3.90 4.00 Noninterest expense ............................. (12.24) (11.03) (10.44) ------------------------------- Income before income taxes ........ 8.05 7.04 6.49 Income tax expense .............................. (2.39) (2.02) (1.71) ------------------------------- Net income ........................ $ 5.66 $ 5.02 $ 4.78 ===============================
In 1999, the increase in net income was due primarily to increased net interest income, primarily resulting from a large increase in earning assets. The 1999 increase in noninterest income totaling $941,000 included increases in trust fees ($286,000), deposit charges and fees ($375,000) and other charges and fees ($487,000).
The 1998 increase in net income resulted from increases in net interest income and noninterest income, but was partially offset by higher noninterest expense. Both noninterest income and noninterest expense for 1997 included the recognition of a $1,054,000 gain on the contribution of a marketable equity security to Hills Bancorporation Foundation, a private charitable foundation. As a result of the stock contribution, Hills Bancorporation received an income tax benefit of approximately $340,000, which reduced income tax expense.
The Company consistently benefited from low provisions for loan losses, a result of a strong local economy and a loan portfolio that is concentrated in well-secured real estate loans.
Net Interest Income - -------------------
Net interest income is the excess of the interest and fees received on interest-earning assets over the interest expense of the interest-bearing liabilities. The measure is shown on a tax-equivalent basis to make the interest earned on taxable and nontaxable assets more comparable.
Net interest income on a tax-equivalent basis changed in 1999 as follows:
Net interest income changes for 1998 were as follows:
Change In Effect Of Effect Of Average Volume Rate Net Balance Changes Changes Change -------------------------------------------- Interest-earning assets ............ $ 66,027 $ 4,919 $ (313) $ 4,606 Interest-bearing liabilities ....... 59,658 3,066 (314) 2,752 -------------------------------- Change in net interest income ...... $ 1,853 $ 1 $ 1,854 ================================
A summary of the net interest spread and margin is as follows:
(Tax Equivalent Basis) 1999 1998 1997 - --------------------------------------------------------------------------------
Yield on average interest-earning assets ............... 7.75% 8.00% 8.12% Rate on average interest-bearing liabilities ........... 4.51 4.82 4.84 ------------------------ Net interest spread .................................... 3.24 3.18 3.28 Effect of noninterest-bearing funds .................... 0.59 0.63 0.65 ------------------------ Net interest margin (tax equivalent interest income divided by average interest-earning assets) ......... 3.83% 3.81% 3.93% ========================
Loan Losses - -----------
The provision for loan losses totaled $900,000, $916,000 and $1,048,000 for 1999, 1998 and 1997, respectively. Charge-offs, net of recoveries were $6,000 for 1999, $70,000 for 1998 and $349,000 for 1997.
The allowance for loan losses totaled $9,750,000 at December 31, 1999 compared to $8,856,000 at December 31, 1998. The percentage of the allowance to outstanding loans was 1.70% and 1.89% at December 31, 1999 and 1998, respectively. The economy remains strong in the Banks' trade areas of Johnson, Washington and Linn Counties, Iowa. Unemployment remains quite low in the Bank's trade territory and, for the most part, area businesses have maintained stable employment levels.
Agricultural loans totaled $27,302,000 at December 31, 1999. Management has assessed the risks for agricultural loans higher than the other loans due to unpredictable commodity prices, the effects of weather on crops and uncertainties regarding government support programs. Therefore, the allowance for loan losses includes general and specific reserves for these loans.
Loan concentrations, quality and loan terms had no other significant change in 1999 except that agricultural loans experienced a $5,000,000 decrease from 1999 and $100,000,000 of the 1999 loan growth was in real estate mortgages. Therefore, the estimation methods and assumptions used in determining the 1999 allowance were consistent with 1998 and nearly all the additional allowance for loan losses was allocated to new loans. Net loss experience for the past three years has been consistently low, but the overall growth of the loan portfolio results in a higher allowance for loan losses.
There are no known trends or uncertainties that are reasonably likely to have a material effect on the allowance for loan losses in the near-term.
Other Income - ------------
Dollars Per Share, Based on Weighted Average Diluted Shares Outstanding 1999 1998 1997 - --------------------------------------------------------------------------------
Real estate origination fees ...................... $ 0.39 $ 0.54 $ 0.26 Trust fees ........................................ 1.36 1.17 0.92 Deposit account charges and fees .................. 1.47 1.23 1.28 Other fees and charges ............................ 1.29 0.96 0.81 Other ............................................. - - - - 0.10 Investment securities gains (losses) .............. (0.21) - - 0.63 ----------------------------- $ 4.30 $ 3.90 $ 4.00 =============================
Other income for 1999 increased by $626,000 to $6,437,000. Loan origination fees were $592,000 compared to $799,000 for 1998. The decrease is due primarily to the fewer loan refinancing after interest rates increased in the second half of 1999. Trust fees increased $286,000 for the year to $2,029,000 due to more trust assets under management. Deposit account charges and fees increased $375,000 for 1999 and other fees and charges increased $487,000. Other income was reduced for 1999 by $315,000, which represented investment securities losses taken to replace lower yielding securities with higher yielding securities of similar risk and maturity.
In 1998, total other income increased $967,000 on a comparable basis to 1997 after adjusting for investment securities gain in 1997 of $940,000 and $154,000 gain on the sale of the student loan portfolio. Due to the lower interest rate environment in 1998, loan origination fees increased $412,000 over the 1997 amount of $387,000. In addition, trust fees increased $380,000 due to new accounts and higher balances under management.
Other Expenses - --------------
Dollars Per Share, Based on Weighted Average Diluted Shares Outstanding 1999 1998 1997 - --------------------------------------------------------------------------------
Salaries and employees benefits ................... $ 6.56 $ 5.75 $ 4.79 Occupancy ......................................... 0.84 0.76 0.68 Furniture and equipment ........................... 1.26 1.13 0.96 Office supplies and postage ....................... 0.74 0.79 0.60 Contributions ..................................... 0.03 0.03 0.75 Other ............................................. 2.81 2.57 2.66 ----------------------------- $ 12.24 $ 11.03 $ 10.44 =============================
Other expenses for 1999 increased to $18,309,000 from $16,438,000 in 1998. Salaries and benefits accounted for $1,200,000 of the increase for the year. This is a result of new staff additions during 1999 including staff for the new branch, salary adjustments in January 1999 and significant increases in medical insurance claims in 1999 compared to 1998. All other expenses increased from $7,863,000 in 1998 to $8,502,000 for the year ended December 31, 1999. The major category that increased was furniture and equipment, which was $1,687,000 in 1998 and $1,893,000 in 1999 and was the result of depreciation and amortization of major computer hardware and software additions in 1999 and late 1998.
Salaries and benefits increased $1,457,000 in 1998 compared to 1997. The Banks have added positions in the retail sector of the Banks, including the Trust Department, as a result of increased business. At the end of 1998, full time equivalent employees totaled 253, an increase of 30 since December 31, 1997. Included in the 1998 increase are new personnel located at the Mount Vernon office of Hills Bank Lisbon, which opened in February 1998. Occupancy and furniture and equipment expenses increased $378,000 in 1998, or 15.45% over 1997 due to depreciation on the new office in Mount Vernon, a new computer hardware and software system installed in the first quarter of 1998, and expenses related to the Year 2000 computer changes which totaled approximately $88,000.
Income Taxes - ------------
Income tax expense was $3,570,000, $3,006,000 and $2,545,000 for the years ended December 31, 1999, 1998 and 1997, respectively. The corresponding percentage of income taxes compared to income before income taxes is 29.66% in 1999, 28.65% in 1998 and 26.40% in 1997. Income tax expense for 1997 was 26.4% of pretax income, compared to an average of 29.16% for other years, due to contributions.
Impact of Recently Issued Accounting Standards - ----------------------------------------------
Recently issued accounting standards are summarized below.
Statement No. 133 on derivatives will, in 2000, require all derivatives to be recorded at fair value in the balance sheet, with changes in fair value run through income. If derivatives are documented and effective as hedges, the change in the derivative fair value will be offset by an equal change in the fair value of the hedged item.
This standard is not expected to have a material effect on future financial statements.
Interest Rate Sensitivity and Liquidity Analysis - ------------------------------------------------
At December 31, 1999, 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 Banks' historical data indicates that these have been very stable deposits without much interest rate fluctuation. Historically, these accounts would not need to be adjusted upward as quickly in a period of rate increases so the interest risk exposure would be less than the repricing schedule indicates.
Inflation - ---------
Inflation has an impact on the growth of total assets and has resulted in the need to increase equity capital to maintain an appropriate equity to asset ratio. The results of operations have been affected by inflation, but the effect has been minimal.
Liquidity and Capital Resources - -------------------------------
On an unconsolidated basis, Hills Bancorporation (the holding company) had cash balances of $1,419,000 as of December 31, 1999. In 1999, the holding company received dividends of $1,911,000 from its subsidiary banks and used those funds to pay dividends to its stockholders of $1,910,000.
As of December 31, 1999 and 1998, stockholders' equity before deducting for the maximum cash obligation related to ESOP was $71,217,000 and $65,753,000, respectively. This measure of equity as a percent of total assets was 9.20% at December 31, 1999 and 9.53% at December 31, 1998. These ratios are comparable with the Company's peers. As of December 31, 1999, total equity was 7.79% of assets compared to 8.18% of assets at the prior year end. The ability of the Company to pay dividends to its shareholders is dependent upon the earnings and capital adequacy of the subsidiaries banks, which affects the Banks' dividends to the Company. The Banks are subject to certain statutory and regulatory restrictions on the amount they may pay in dividends. In order to maintain acceptable capital ratios in the subsidiary banks, certain of their retained earnings are not available for the payment of dividends. Retained earnings available for the payment of dividends to the Company total approximately $4,032,000 as of December 31, 1999.
The Company and the Banks are subject to the Federal Deposit Insurance Corporation Improvement Act of 1991 and the Banks are subject to Prompt Corrective Action Rules as determined and enforced by the Federal Reserve. These regulations establish minimum capital requirements which member banks must maintain.
As of December 31, 1999, risk-based capital standards require 8% of risk-weighted assets. At least half of that 8% must consist of Tier I core capital (common stockholders' equity, noncumulative perpetual preferred stock and minority interest in the equity accounts of consolidated subsidiaries), and the remainder may be Tier II supplementary capital (perpetual debt, intermediate-term preferred stock, cumulative perpetual, long-term and convertible preferred stock, and loan loss reserve up to a maximum of 1.25% of risk-weighted assets). Total risk-weighted assets are determined by weighing the assets according to their risk characteristics. Certain off-balance sheet items (such as standby letters of credit and firm loan commitments) are multiplied by "credit conversion factors" to translate them into balance sheet equivalents before assigning them risk weightings. Any bank having a capital ratio less than the 8% minimum required level must, within 60 days, submit to the Federal Reserve a plan describing the means and schedule by which the Bank shall achieve the applicable minimum capital ratios.
Each of the Banks is an insured state bank, incorporated under the laws of the state of Iowa. As such, the Banks are 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 must also be 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. This ratio was reduced in 1999 from the eight percent (8%) ratio formerly required. 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, 1999, the primary capital to total assets ratio of each of the Banks exceeded the ratio required by the Superintendent.
A comparison of the Company's capital as of December 31, 1999 with minimum requirements is presented below:
Minimum Actual Requirements --------------------------------
Tier I Risk-Based Capital ....................... 13.2% 4% Total Risk-Based Capital ........................ 14.47 8 Leverage Ratio .................................. 9.56 3
Each of the Banks is classified as "well capitalized" by FDIC capital guidelines.
On a consolidated basis, 1999 cash flows from operations provided $10,844,000, net increases in deposits provided $27,935,000 and Federal Home Loan Bank borrowings provided $32,968,000. These cash flows were invested in net loans of $105,370,000, net securities of $10,937,000 and net federal funds sold decrease of $36,605,000. In addition, $1,937,000 was used to purchase property and equipment.
At December 31, 1999, the Company had total outstanding loan commitments of $83,894,000. Management believes that its liquidity levels are sufficient, but the Company may slow down the growth of its assets by selling more loans in the secondary market or by selling portions of loans to other banks through participation agreements.
Commitments and Trends - ----------------------
The Company has no material commitments or plans which will materially affect its liquidity or capital resources. Property and equipment may be acquired in cash purchases, or they may be financed if favorable terms are available.
Year 2000 - ---------
Like other financial service providers and business organizations, the Company took appropriate measures in advance of the calendar change on January 1, 2000 to ensure its application software programs and operating systems would accommodate this date value. Beginning in 1997, the Company began carrying out a plan to address the "Y2K" issue. All systems were examined to determine the extent and complexity of their vulnerability. Evaluations included hardware, software, mechanical and other critical systems.
In each case where a potential problem was identified, action was taken to address it by replacing or upgrading the system affected. All critical systems were tested by simulating Year 2000 operating conditions and verifying the results of those tests. Contingency plans were developed to ensure operations would continue in the unlikely event a system failed. The Company employed verification procedures during the century rollover period and encountered no problems to any of its systems.
The Company's plans included communications to and evaluation of significant borrowers to assess their readiness and determine if loan payments could be delayed due to Year 2000 problems. To date, the Company has not experienced any loan losses, nor does it anticipate future losses, related to this issue.
Total capitalized hardware and software costs of the Year 2000 project in 1999 and 1998 were approximately $136,000 and $1,180,000, respectively. Expenses charged to earnings for the Year 2000 project in 1999 and 1998 were $88,000 and $105,000, respectively. In addition, the Company estimates the opportunity cost of maintaining additional cash reserves have been $66,000 in 1999.
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 Banks maintain an asset/liability committee which meets at least quarterly to review the interest rate sensitivity position and to review various strategies as to interest rate risk management. In addition, the Banks use a simulation model to review various assumptions relating to interest rate movement. The model attempts to limit rate risk even if it appears the Banks' asset and liability maturities are perfectly matched and a favorable interest margin is present.
In order to minimize the potential effects of adverse material and prolonged increases or decreases in market interest rates on the Company's operations, management has implemented an asset/liability program designed to mitigate the Company's interest rate sensitivity. The program emphasizes the origination of adjustable rate loans, which are held in the portfolio, the investment of excess cash in short or intermediate term interest-earning assets, and the solicitation of passbook or transaction deposit accounts which are less sensitive to changes in interest rates and can be repriced rapidly.
Based on the data following, net interest income should decline with instantaneous increases in interest rates while net interest income should increase with instantaneous declines in interest rates. Generally, during periods of increasing interest rates, the Company's interest rate sensitive liabilities would reprice faster than its interest rate sensitive assets causing a decline in the Company's interest rate spread and margin. This would result from an increase in the Company's cost of funds that would not be immediately offset by an increase in its yield on earning assets which would tend to reduce net interest income. In times of decreasing interest rates, fixed rate assets could increase in value and the lag in repricing of interest rate sensitive assets could be expected to have a positive effect on the Company's net interest income.
The following table provides quantitative information with respect to interest sensitive assets and liabilities.
PART II
Item 7A. Quantitative and Qualitative Disclosures About Market Risk (Continued)
The following table provides information about the Company's loans, investment securities and deposits that are sensitive to changes in interest rates. The table presents principal cash flows and related weighted average interest rates by expected maturity dates.
(1) Includes all available-for-sale investments, held-to-maturity investments and federal funds.
(2) Includes passbook accounts, NOW accounts, Super NOW accounts and money market funds.
Item 8.
Item 8. Financial Statements and Supplementary Data
The financial statements are included on Pages 33 through 61. The Company does not meet the requirements of Item 302 of Regulation S-K to include the supplementary financial information required by that item.
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Stockholders Hills Bancorporation Hills, Iowa
We have audited the accompanying consolidated balance sheets of Hills Bancorporation and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for the years ended December 31, 1999, 1998 and 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Hills Bancorporation and subsidiaries as of December 31, 1999 and 1998, and the results of their operations and their cash flows for the years ended December 31, 1999, 1998 and 1997 in conformity with generally accepted accounting principles.
/s/McGLADREY & PULLEN, LLP
Iowa City, Iowa February 14, 2000
HILLS BANCORPORATION
CONSOLIDATED BALANCE SHEETS December 31, 1999 and 1998 (In Thousands, Except Shares)
See Notes to Financial Statements.
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 1999, 1998 and 1997 (In Thousands, Except Per Share Amounts)
See Notes to Financial Statements.
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Years Ended December 31, 1999, 1998 and 1997 (In Thousands)
See Notes to Financial Statements.
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Notes 7 and 9) Years Ended December 31, 1999, 1998 and 1997 (In Thousands, Except Share Amounts)
See Notes to Financial Statements.
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 1999, 1998 and 1997 (In Thousands)
(Continued)
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) Years Ended December 31, 1999, 1998 and 1997 (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 multibank holding company engaged in the business of banking. The Company's three wholly-owned subsidiary commercial banks are Hills Bank and Trust Company, Hills, Iowa, Hills Bank, Lisbon, Iowa, and Hills Bank Kalona, Kalona, Iowa. The Banks are all full-service commercial banks extending their services to individuals, businesses, governmental units and institutional customers primarily in the communities of Hills, Iowa City, Coralville, North Liberty, Lisbon, Mount Vernon, Kalona and Cedar Rapids, Iowa.
The Banks compete with other financial institutions and nonfinancial institutions providing similar financial products. Although the loan activity of the Banks is diversified with commercial and agricultural loans, real estate loans, automobile, installment and other consumer loans, each Bank's credit is concentrated in real estate loans.
Accounting estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Certain significant estimates: The allowance for loan losses, fair values of securities and other financial instruments, and stock-based compensation expense involve 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, 1999 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 subsidiaries, which are wholly-owned. 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, 1999 and 1998.
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.
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 Banks make continuous reviews of the loan portfolio and considers current economic conditions, historical loss experience, review of specific problem loans and other factors in determining the adequacy of the allowance.
Loans are considered impaired when, based on current information and events, it is probable the Banks 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.
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 3-20 years for furniture and equipment.
Deferred income taxes: Deferred income taxes are provided under the liability method whereby deferred tax assets are recognized for deductible temporary differences and net operating loss, and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
Intangible assets: Intangible assets consist principally of goodwill which represents the excess of cost over fair value of net assets acquired in business combinations of two banks in 1996 accounted for under the purchase method. Goodwill is amortized on a straight-line basis over the estimated period to be benefited, 15 years. The carrying value of goodwill is reviewed periodically for impairment. Goodwill totaled $3,021,000 and $3,282,000, net of accumulated amortization of $876,000 and $615,000 as of December 31, 1999 and 1998 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 Banks in fiduciary or agency capacities for its customers are not included in these statements since they are not assets of the Company.
Earnings per share: Basic per-share amounts are computed by dividing net income (the numerator) by the weighted-average number of common shares outstanding (the denominator). Diluted per share amounts assume the conversion, exercise or issuance of all potential common stock unless the effect is to reduce the loss or increase the income per common share from continuing operations.
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 Banks, deposits and federal funds purchased and sold 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 cash equivalents and federal funds sold: The carrying amounts reported in the balance sheet for cash and short-term instruments approximate their fair values.
Investment securities: Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.
Loans receivable: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for other loans are determined using estimated future cash flows, discounted at the interest rates currently being offered for loans with similar terms to borrowers with similar credit quality. The carrying amount of accrued interest receivable approximates its fair value.
Deposit liabilities: The fair values of demand deposits equal their carrying amounts which represent the amount payable on demand. The carrying amounts for variable-rate, fixed-term money market accounts and certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
Short-term borrowings: The carrying amounts of borrowings under repurchase agreements approximate their fair values.
Long-term borrowings: The fair values of the Banks' long-term borrowings (other than deposits) are estimated using discounted cash flow analyses, based on the Banks' current incremental borrowing rates for similar types of borrowing arrangements.
Note 2. Investment Securities
The amortized cost and fair value of investment securities available for sale are as follows:
The amortized cost and fair value of debt securities held to maturity are as follows:
The contractual maturity distribution of investment securities as of December 31, 1999 is summarized as follows:
As of December 31, 1999, investment securities with a carrying value of $58,981,000 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, ----------------------------------- 1999 1998 1997 ----------------------------------- (Amounts In Thousands)
Gross gains ........................ $ 4 $ - - $ 1,059 Gross (losses) ..................... (319) - - (119) ----------------------------------- Net gains (losses) ... $ (315) $ - - $ 940 ===================================
Included in 1997 gains was the contribution of a marketable equity security to a private charitable foundation organized by the Company, upon which a gain of $1,054,000 was recognized. The marketable equity security was an investment in a development stage company that later became a public entity.
Note 3. Loans
The composition of loans is as follows:
December 31, -------------------------- 1999 1998 -------------------------- (Amounts In Thousands)
Agricultural ......................................... $ 27,302 $ 32,318 Commercial and financial ............................. 36,848 39,438 Real estate: Construction ...................................... 40,879 28,476 Mortgage .......................................... 439,072 338,871 Loans to individuals ................................. 31,030 30,664 -------------------------- 575,131 469,767 Less allowance for loan losses ....................... 9,750 8,856 -------------------------- $ 565,381 $ 460,911 ==========================
Changes in the allowance for loan losses are as follows:
Year Ended December 31, -------------------------------------- 1999 1998 1997 -------------------------------------- (Amounts In Thousands)
Balance, beginning ....................... $ 8,856 $ 8,010 $ 7,311 Provision charged to expenses ......... 900 916 1,048 Recoveries ............................ 757 898 779 Loans charged off ..................... (763) (968) (1,128) -------------------------------------- Balance, ending .......................... $ 9,750 $ 8,856 $ 8,010 ======================================
Information about impaired loans as of and for the years ended December 31, 1999 and 1998 is as follows:
1999 1998 -------------------------- (Amounts In Thousands)
Loans receivable for which there is a related allowance for credit losses ........... $ - - $ - - Loans receivable for which there is no related allowance for credit losses ........... 9,750 8,956 -------------------------- Total impaired loans ............... $ 9,750 $ 8,956 ========================== Related allowance for credit losses .............. $ - - $ - - Average balance .................................. 9,110 9,216 Interest income recognized ....................... 814 869
No allowance for credit losses has been recognized for impaired loans because partial charge-offs have been taken to reduce the loan balances to the net present value of the future cash flows or to the fair value of the collateral if the loan is collateral dependent.
Note 4. Property and Equipment
The major classes of property and equipment and the total accumulated depreciation are as follows:
December 31, ---------------------- 1999 1998 ---------------------- (Amounts In Thousands)
Land ............................................. $ 2,195 $ 1,950 Buildings and improvements ....................... 8,858 8,363 Furniture and equipment .......................... 12,129 10,932 ---------------------- 23,182 21,245 Less accumulated depreciation .................... 11,536 10,052 ---------------------- Net ................................ $ 11,646 $ 11,193 ======================
Note 5. Interest-Bearing Deposits
A summary of these deposits is as follows:
December 31, ----------------------- 1999 1998 ----------------------- (Amounts In Thousands)
NOW and other demand ............................. $ 62,081 $ 53,296 Savings .......................................... 155,001 144,177 Time, $100,000 and over .......................... 30,442 33,657 Other time ....................................... 247,768 234,921 ----------------------- $ 495,292 $ 466,051 =======================
Note 6. Federal Home Loan Bank Borrowings
As of December 31, 1999, the borrowings were as follows: (In Thousands) --------------
Due January 24, 2000, 6.21% ................................. $ 10,000 Due April 9, 2000, 6.71% .................................... 3,000 Due November 18, 2002, 5.33% ................................ 5,000 Due August 17, 2005, 7.12% .................................. 100 Due January 14, 2008, 5.22% ................................. 10,000 Due February 4, 2008, 5.38% ................................. 10,000 Due February 4, 2008, 5.25% ................................. 10,000 Due April 30, 2008, 5.40% ................................... 10,000 Due August 11, 2008, 6.00% .................................. 600 Due June 15, 2009, 5.66% .................................... 10,000 Due June 15, 2009, 6.04% .................................... 10,000 Due June 17, 2009, 5.11% .................................... 5,000 Due October 6, 2009, 5.37% .................................. 5,000 Due October 6, 2009, 5.85% .................................. 10,000 Due October 6, 2009, 6.22% .................................. 10,000 ----------- $ 108,700 ===========
The borrowings are collateralized by 1-4 family mortgage loans with a face amount of $135,875,000. As of December 31, 1999, the Company held Federal Home Loan Bank stock with a cost of $5,930,000.
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 $64,000, $58,000 and $49,000 for the years ended December 31, 1999, 1998 and 1997, 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, 1999, 156,474 shares held by the ESOP, at a fair value of $70 per share, have been reclassified from stockholders' equity to liabilities.
The Company has a profit-sharing plan with a 401(k) feature which provides for discretionary annual contributions in amounts to be determined by the Board of Directors. The profit-sharing contribution totaled $509,000, $461,000 and $394,000 for the years ended December 31, 1999, 1998 and 1997, respectively.
The Company has a Stock Incentive Plan for certain key employees and directors whereby shares of common stock have been reserved for awards in the form of stock options or stock awards. A Stock Option Committee may grant options at prices equal to the fair value of the stock at the date of the grant. Options expire 10 years from the date of the grant. Directors may exercise options immediately and officers' rights under the plan vest over a five-year period from the date of the grant. Additional compensation is accrued equivalent to the amount of dividends that would have been paid on the stock had the options been exercised. Such compensation is payable upon exercise of the options. No compensation expense has been charged to expense using the intrinsic value based method as prescribed by APB No. 25. Had compensation expense been determined based on the grant date fair values of the awards, as prescribed by SFAS No. 123, reported net income and earnings per share would have been as follows:
Years Ended December 31, -------------------------- 1999 1998 1997 --------------------------
Pro forma net income (in thousands) ........... $ 8,461 $ 7,481 $ 7,084 Pro forma earnings per share: Basic ...................................... 5.70 5.10 4.83 Diluted .................................... 5.66 5.02 4.77
The pro forma effects of applying SFAS are not indicative of future amounts since, among other reasons, the pro forma requirements of SFAS No. 123 have been applied only to options granted after December 31, 1994.
The fair value of each grant is established at the grant date using the Black-Scholes option-pricing model with the following weighted average assumptions for grants in 1997: Dividend rate 2.19%; price volatility of 4.64%; risk-free interest rate of 6.63% and an expected life of 5 years.
A summary of the stock options is as follows:
Weighted Average Number Exercise Of Shares Price --------------------------
Balance, December 31, 1997 ...................... 46,569 $ 26.45 Exercised .................................... (1,029) 25.33 -------------------------- Balance, December 31, 1998 ...................... 45,540 26.48 Exercised .................................... (25,078) 25.93 -------------------------- Balance, December 31, 1999 ...................... 20,462 $ 27.15 ==========================
1999 1998 1997 -------------------------------- Number of options exercisable, end of year ... 20,462 45,540 22,605 Weighted-average fair value of options granted during the year ........................... $ - - $ - - $ 13.22
Other pertinent information related to the options outstanding at December 31, 1999 is as follows:
Remaining Exercise Number Contractual Number Price Outstanding Life Exercisable - -------------------------------------------------------------------------------- $ 25.33 12,330 27 Months 12,330 26.17 6,077 30 Months 6,077 41.00 2,055 75 Months 2,055 ---------- ---------- 20,462 20,462 ========== ==========
As of December 31, 1999, no options were available for future grants.
The committee is also authorized to grant awards of common stock and authorized the issuance of 1,587, 902 and 938 shares of common stock to a group of employees in 1999, 1998 and 1997, respectively.
Note 8. Income Taxes
Income taxes for the years ended December 31, 1999, 1998 and 1997 are summarized as follows: 1999 1998 1997 ------------------------------- (Amounts In Thousands) Current: Federal ................................... $ 3,707 $ 2,435 $ 2,399 State ..................................... 710 586 563 Deferred ..................................... (847) (15) (417) ------------------------------- $ 3,570 $ 3,006 $ 2,545 ===============================
Deferred income tax liabilities and assets arose from the following temporary differences:
December 31, ------------------------------ 1999 1998 1997 ------------------------------ (Amounts In Thousands) Deferred income tax assets: Allowance for loan losses .............. $ 3,597 $ 3,079 $ 2,622 Unrealized losses on debt securities ... 574 - - - - Deferred compensation .................. 311 156 77 Certain accrued expenses ............... 190 211 302 Other .................................. 112 - - - - ------------------------------ Gross tax assets .................... 4,784 3,446 3,001 ------------------------------ Deferred income tax liabilities: Property and equipment ................. 700 677 644 FHLB dividends ......................... 130 130 130 Unrealized gains on debt securities .... - - 696 283 Other .................................. - - 105 85 ------------------------------ Gross tax liabilities ............... 830 1,608 1,142 ------------------------------ Net deferred income tax asset ....... $ 3,954 $ 1,838 $ 1,859 ==============================
The net change in the deferred income taxes for the years ended December 31, 1999, 1998 and 1997 is reflected in the financial statements as follows:
Year Ended December 31, ---------------------------------- 1999 1998 1997 ---------------------------------- (Amounts In Thousands)
Statement of income ....................... $ (847) $ (15) $ (417) Statement of stockholders' equity ......... (1,269) 413 (83) ---------------------------------- $ (2,116) $ 398 $ (500) ==================================
The income tax provisions for the years ended December 31, 1999, 1998 and 1997 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:
1999 1998 1997 -------------------------------------------------------- % Of % Of % Of Pretax Pretax Pretax Amount Income Amount Income Amount Income -------------------------------------------------------- (Amounts In Thousands)
Expected provision ..... $ 4,213 35.0% $ 3,672 35.0% $ 3,371 35.0% Tax-exempt interest .... (647) (5.3) (596) (5.7) (557) (5.8) Interest expense limitation .......... 120 1.0 102 1.0 97 1.0 Investment securi- ties contributed .... - - - - - - - - (358) (3.7) State income taxes, net of federal income tax benefit ............. 468 3.9 398 3.8 372 3.9 Income tax credits ..... (345) (2.9) (345) (3.3) (345) (3.6) Other .................. (239) (2.0) (225) (2.2) (35) (0.4) -------------------------------------------------------- $ 3,570 29.7% $ 3,006 28.6% $ 2,545 26.4% ========================================================
Note 9. Regulatory Capital Requirements, Restrictions on Subsidiary Dividends and Cash Restrictions
Federal regulatory agencies have adopted various capital standards for financial institutions, including risk-based capital standards. The primary objectives of the risk-based capital framework are to provide a more consistent system for comparing capital positions of financial institutions and to take into account the different risks among financial institutions' assets and off-balance sheet items.
Risk-based capital standards include requirements for a minimum Tier 1 capital to assets ratio (leverage ratio). In addition, regulatory agencies consider the published capital levels as minimum levels and may require a financial institution to maintain capital at higher levels.
A comparison of the Company's capital as of December 31, 1999 with the minimum requirements is presented below.
Minimum Actual Requirements -------------------------------- Tier 1 Risk-Based Capital ....................... 13.21% 4.00% Total Risk-Based Capital ........................ 14.47% 8.00% Leverage Ratio .................................. 9.56% 3.00%
According to FDIC capital guidelines, each of the Banks is classified as "Well Capitalized." The ability of the Company to pay dividends to its stockholders is dependent upon dividends paid by the Banks. The Banks are subject to certain statutory and regulatory restrictions on the amount they may pay in dividends. To maintain acceptable capital ratios in the Banks, certain of their retained earnings are not available for the payment of dividends. To maintain a ratio of capital to assets of 8%, retained earnings of $4,032,000 as of December 31, 1999 are available for the payment of dividends to the Company.
Each of the Banks is required to maintain reserve balances in cash or with the Federal Reserve Bank. Reserve balances totaled $7,938,000 and $5,783,000 as of December 31, 1999 and 1998, respectively.
Note 10. Related Party Transactions
Certain directors of the Company and the Banks and companies with which the directors are affiliated and certain principal officers are customers of, and have banking transactions with, the Banks in the ordinary course of business. Such indebtedness has been incurred on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons.
The following is an analysis of the changes in the loans to related parties during the years ended December 31, 1999 and 1998:
Year Ended December 31, ---------------------------- 1999 1998 ---------------------------- (Amounts In Thousands)
Balance, beginning ..................... $ 10,981 $ 10,511 Advances ............................ 5,732 7,077 Collections ......................... (5,980) (6,607) ---------------------------- Balance, ending ........................ $ 10,733 $ 10,981 ============================
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, 1999 and 1998 are as follows:
Note 12. Parent Company Only Financial Information
Following is condensed financial information of the Company (parent company only): BALANCE SHEETS December 31, 1999 and 1998 (Amounts In Thousands)
ASSETS 1999 1998 - -------------------------------------------------------------------------------- Cash ..................................................... $ 1,419 $ 698 Investment securities available for sale ................. 499 303 Investment in subsidiary banks ........................... 68,790 64,332 Other assets ............................................. 833 653 ---------------------- Total assets ............................... $ 71,541 $ 65,986 ======================
LIABILITIES AND STOCKHOLDERS' EQUITY - -------------------------------------------------------------------------------- Liabilities .............................................. $ 324 $ 233 ---------------------- Redeemable common stock held by ESOP ..................... 10,953 9,301 ---------------------- Stockholders' equity: Capital stock ......................................... 10,214 9,140 Retained earnings ..................................... 61,984 55,428 Unrealized gains (losses) on investment securities, net .................................... (981) 1,185 ---------------------- 71,217 65,753 Less maximum cash obligation related to ESOP shares ... 10,953 9,301 ---------------------- Total stockholders' equity ................. 60,264 56,452 ---------------------- Total liabilities and stockholders' equity . $ 71,541 $ 65,986 ======================
STATEMENTS OF INCOME Years Ended December 31, 1999, 1998 and 1997 (Amounts In Thousands)
1999 1998 1997 - -------------------------------------------------------------------------------- Interest on investment securities ................. $ 16 $ 17 $ 17 Gain on sale of investment security ............... - - - - 1,054 Dividends received from subsidiaries .............. 1,911 2,762 2,515 Contributions ..................................... - - - - (1,054) Other expenses .................................... (121) (113) (102) Income before income taxes and equity ----------------------------- in subsidiaries' undistributed income .... 1,806 2,666 2,430 Income tax benefit ................................ 37 39 370 ----------------------------- 1,843 2,705 2,800 Equity in subsidiaries' undistributed income ...... 6,623 4,781 4,286 ----------------------------- Net income .......................... $ 8,466 $ 7,486 $ 7,086 =============================
STATEMENTS OF CASH FLOWS Years Ended December 31, 1999, 1998 and 1997 (Amounts In Thousands)
Concentrations of credit risk: All of the Banks' loans, commitments to extend credit, unused lines of credit and outstanding letters of credit have been granted to customers within each Bank's market area. Investments in securities issued by state and political subdivisions within the state of Iowa totaled approximately $15,898,000. The concentrations of credit by type of loan are set forth in Note 3. Outstanding letters of credit were granted primarily to commercial borrowers. Although the Banks have a diversified loan portfolio, a substantial portion of its debtors' ability to honor their contracts is dependent upon the economic conditions in Johnson County, Iowa.
Contingencies: In the normal course of business, the Banks are involved in various legal proceedings. In the opinion of management, any liability resulting from such proceedings would not have a material adverse effect on the accompanying financial statements.
Financial instruments with off-balance sheet risk: The Banks are parties to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of their customers. These financial instruments include commitments to extend credit, credit card participations and standby letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheets.
Note 13. Commitments and Contingencies (Continued)
The Banks' exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, credit card participations and standby letters of credit is represented by the contractual amount of those instruments. The Banks use the same credit policies in making commitments and conditional obligations as they do for on-balance sheet instruments. A summary of the Banks' commitments at December 31, 1999 and 1998 is as follows:
1999 1998 ------------------------ (Amounts In Thousands) Firm loan commitments and unused portion of lines of credit: Home equity loans .................................... $ 3,628 $ 3,509 Credit card participations ........................... 10,695 8,689 Commercial, real estate and home construction ........ 35,882 27,549 Commercial lines ..................................... 33,689 54,173 Outstanding letters of credit ........................... 10,711 10,571
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Banks evaluate each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management's credit evaluation of the party. Collateral held varies, but may include accounts receivable, crops, livestock, inventory, property and equipment, residential real estate and income-producing commercial properties. Credit card participations are the unused portion of the holders' credit limits. Such amounts represent the maximum amount of additional unsecured borrowings.
Outstanding letters of credit are the conditional commitments issued by the Banks to guarantee the performance of a customer to a third party and collateralize the customer's borrowing arrangement with other creditors. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral held varies as specified above and is required in instances which the Banks deem necessary.
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, 1999 and 1998 Consolidated statements of income for the years ended December 31, 1999, 1998 and 1997 Consolidated statements of comprehensive income for the years ended December 31, 1999, 1998 and 1997 Consolidated statements of stockholders' equity for the years ended December 31, 1999, 1998 and 1997 Consolidated statements of cash flows for the years ended December 31, 1999, 1998 and 1997 Notes to financial statements
(a) 2. Financial Statements Schedules
All schedules are omitted because they are not applicable or not required, or because the required information is included in the consolidated financial statements or notes thereto.
(a) 3. Exhibits
Exhibit 3 - Articles of Incorporation and Bylaws filed as Exhibit 3 of Form 10-K for the year ended December 31, 1993 are incorporated by reference.
Exhibit 10(a) - Material Contract (Employee Stock Ownership Plan) filed as Exhibit 10(a) in Form 10-K for the year ended December 31, 1993 is incorporated by reference.
Exhibit 10(b) - Material Contract (1993 Stock Incentive Plan) filed as Exhibit 10(b) in Form 10-K for the year ended December 31, 1993 is incorporated by reference.
Exhibit 10(c) - Material contract (1995 Deferred Compensation Plans) filed as Exhibit 10(c) in Form 10-K for the year ended December 31, 1995 is incorporated by reference.
Exhibit 11 - Statement Re Computation of Basic and Diluted Earnings Per Share is attached on Page 68.
Exhibit 21 - Subsidiaries of the Registrant is attached on Page 69.
Exhibit 23 - Consent of Accountants is attached on Page 70.
Exhibit 27 - Financial Data Schedule is attached on Pages 71 and 72.
(b) Reports on Form 8-K:
There were no reports on Form 8-K for the three months ended December 31, 1999.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
HILLS BANCORPORATION
Date March 30, 1999 By /s/ Dwight O. Seegmiller -------------------------- -------------------------------------------- Dwight O. Seegmiller, Director and President
Date March 30, 1999 By /s/ James G. Pratt -------------------------- -------------------------------------------- James G. Pratt, Treasurer and Chief Accounting Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Date March 30, 1999 By /s/ Willis M. Bywater -------------------------- -------------------------------------------- Willis M. Bywater, Director
Date March 30, 1999 By /s/ Thomas J. Gill -------------------------- -------------------------------------------- Thomas J. Gill, Director
Date March 30, 1999 By /s/ Donald H. Gringer -------------------------- -------------------------------------------- Donald H. Gringer, Director
Date March 30, 1999 By /s/ Richard W. Oberman -------------------------- -------------------------------------------- Richard W. Oberman, Director
Date March 30, 1999 By /s/ Theodore H. Pacha -------------------------- -------------------------------------------- Theodore H. Pacha, Director
Date March 30, 1999 By /s/ Ann M. Rhodes -------------------------- -------------------------------------------- Ann M. Rhodes, Director
Date March 30, 1999 By /s/ Ronald E. Stutsman -------------------------- -------------------------------------------- Ronald E. Stutsman, Director
Date March 30, 1999 By /s/ Earl M. Yoder -------------------------- -------------------------------------------- Earl M. Yoder, Director
Date March 30, 1999 By /s/ Sheldon E. Yoder -------------------------- -------------------------------------------- Sheldon E. Yoder, Director
HILLS BANCORPORATION ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
EXHIBIT INDEX
Exhibit Number Description - -------------------------------------------------------------------------------- 11 Statement Re Computation of Basic and Diluted Earnings Per Share
21 Subsidiaries of the Registrant
23 Consent of Independent Certified Public Accountants
27 Financial Data Schedule