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FORM 10-Q - QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
(As last amended in Rel. No. 34-26589, eff. 4/12/93.)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003
Commission file number: 0-12668
Hills Bancorporation
Incorporated in Iowa I.R.S. Employer Identification
No. 42-1208067
131 MAIN STREET, HILLS, IOWA 52235
Telephone number: (319) 679-2291
Indicate by checkmark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
|X| Yes |_| No
Indicate by checkmark whether the Registrant is an accelerated filer (as defined
by Rule 12b-2 of the Securities Exchange Act of 1934).
|X| Yes |_| No
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date.
SHARES OUTSTANDING
CLASS At October 31, 2003
----- -------------------
Common Stock, no par value 1,515,778
1
HILLS BANCORPORATION
Index to Form 10-Q
Part I
FINANCIAL INFORMATION
Page
Number
------
Item 1. Financial Statements
Consolidated balance sheets, September 30, 2003 (unaudited)
and December 31, 2002. 3
Consolidated statements of income, (unaudited) for three
and nine months ended September 30, 2003 and 2002. 4
Consolidated statements of comprehensive income, (unaudited)
for three and nine months ended September 30, 2003 and 2002. 5
Consolidated statements of stockholders' equity, (unaudited)
for nine months ended September 30, 2003 and 2002. 6
Consolidated statements of cash flows (unaudited) for nine
months ended September 30, 2003 and 2002. 7
Notes to consolidated financial statements 8-10
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 11-17
Item 3. Quantitative and Qualitative Disclosures About Market Risk 18
Item 4. Evaluation of Disclosures Controls 19
Part II
OTHER INFORMATION
Item 1. Legal proceedings 20
Item 2. Changes in securities and use of proceeds 20
Item 3. Defaults upon senior securities 20
Item 4. Submission of matters to vote of security holders 20
Item 5. Other information 20
Item 6. Exhibits and reports on Form 8-K 20
Signatures and Certifications 21-24
2
HILLS BANCORPORATION
CONSOLIDATED BALANCE SHEETS
(Amounts In Thousands, Except Shares)
September 30, 2003
Unaudited December 31, 2002*
---------- ------------------
ASSETS
Cash and due from banks $ 32,274 $ 32,647
Investment securities:
Available for sale (amortized cost
September 30, 2003 $201,293
December 31, 2002 $190,313) 207,120 197,807
Held to maturity (fair value
September 30, 2003 $8,374;
December 31, 2002 $8,303) 8,224 8,022
Stock of Federal Home Loan Bank 8,774 8,382
Federal funds sold 40,492 32,514
Loans held for sale 4,890 6,884
Loans, net 846,310 773,973
Property and equipment, net 22,248 21,500
Accrued interest receivable 7,415 7,278
Deferred income taxes, net 2,067 1,971
Other assets 8,339 7,569
---------- ----------
$1,188,153 $1,098,547
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Noninterest-bearing deposits $ 112,697 $ 107,833
Interest-bearing deposits 761,484 694,488
---------- ----------
Total deposits $ 874,181 $ 802,321
Securities sold under agreements to repurchase 29,690 20,798
Federal Home Loan Bank ("FHLB") borrowings 167,574 167,606
Accrued interest payable 1,846 2,134
Other liabilities 5,193 4,653
Redeemable common stock held by employee
stock ownership plan (ESOP) 14,570 12,951
---------- ----------
$1,093,054 $1,010,463
---------- ----------
STOCKHOLDERS' EQUITY
Capital stock, common, no par value;
authorized 10,000,000 shares;
issued September 30, 2003 - 1,515,778 shares;
December 31, 2002 - 1,501,054 shares $ 11,252 $ 10,541
Retained earnings 94,747 85,773
Accumulated other comprehensive income 3,670 4,721
---------- ----------
$ 109,669 $ 101,035
Less unallocated shares of ESOP 14,570 12,951
---------- ----------
$ 95,099 $ 88,084
---------- ----------
$1,188,153 $1,098,547
========== ==========
* Derived from audited financial statements.
See Notes to Consolidated Financial Statements.
3
HILLS BANCORPORATION
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
Three and Nine Months Ended September 30, 2003 and 2002
(Amounts In Thousands, Except Per Share Amounts)
Three Months Ended Nine Months Ended
------------------ -----------------
September 30 September 30
------------ ------------
2003 2002 2003 2002
---- ---- ---- ----
Interest income:
Loans, including fees $ 13,680 $13,940 $40,773 $40,206
Investment securities:
Taxable 1,532 1,852 4,757 5,665
Nontaxable 575 584 1,780 1,681
Federal funds sold 68 134 285 407
-------- ------- ------- -------
Total interest income $ 15,855 $16,510 $47,595 $47,959
-------- ------- ------- -------
Interest expense:
Deposits $ 4,123 $ 5,528 $13,015 $17,296
Securities sold under
agreements to repurchase 87 77 297 289
FHLB borrowings 2,291 2,343 6,799 6,232
-------- ------- ------- -------
Total interest expense $ 6,501 $ 7,948 $20,111 $23,817
-------- ------- ------- -------
Net interest income $ 9,354 $ 8,562 $27,484 $24,142
Provision for loan losses (326) 244 123 731
-------- ------- ------- -------
Net interest income after provision
for loan losses $ 9,680 $ 8,318 $27,361 $23,411
-------- ------- ------- -------
Other income:
Gain on sale of loans $ 1,520 $ 407 $ 3,972 $ 1,026
Trust fees 605 605 1,783 1,764
Deposit account charges and fees 900 845 2,695 2,366
Other fees and charges 853 647 2,442 1,950
-------- ------- ------- -------
$ 3,878 $ 2,504 $10,892 $ 7,106
-------- ------- ------- -------
Other expenses:
Salaries and employee benefits $ 3,933 $ 3,351 $11,445 $10,068
Occupancy 496 453 1,416 1,299
Furniture and equipment 762 684 2,246 2,146
Office supplies and postage 330 304 914 844
Other 1,525 1,287 4,517 3,782
-------- ------- ------- -------
$ 7,046 $ 6,079 $20,538 $18,139
-------- ------- ------- -------
Income before income taxes $ 6,512 $ 4,743 $17,715 $12,378
Federal and state income taxes 2,193 1,507 5,888 3,846
-------- ------- ------- -------
Net income $ 4,319 $ 3,236 $11,827 $ 8,532
======== ======= ======= =======
Earning per share:
Basic $ 2.85 $ 2.15 $ 7.83 $ 5.69
Diluted 2.84 2.14 7.81 5.64
See Notes to Consolidated Financial Statements.
4
HILLS BANCORPORATION
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Three and Nine Months Ended September 30, 2003 and 2002
(In Thousands)
Three Months Ended Nine Months Ended
------------------ -----------------
September 30 September 30
------------ ------------
2003 2002 2003 2002
---- ---- ---- ----
Net Income $ 4,319 $3,236 $ 11,827 $ 8,532
------- ------ -------- -------
Other comprehensive income:
unrealized holding gains arising
during the year, net of income taxes (1,472) 1,247 (1,051) 1,911
------- ------ -------- -------
Comprehensive Income $ 2,847 $4,483 $ 10,776 $10,443
======= ====== ======== =======
See Notes to Consolidated Financial Statements.
5
HILLS BANCORPORATION
UNAUDITED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Nine Months Ended September 30, 2003 and 2002
(In Thousands)
Accumulated
Other Unallocated
Capital Retained Comprehensive Shares of
Stock Earnings Income (Loss) ESOP Total
----- -------- ------------- ------ -------
Balance, December 31, 2002 $10,541 $ 85,773 $ 4,721 $(12,951) $ 88,084
Net income -- 11,827 -- -- 11,827
Stock options exercised for
14,724 shares of common stock 375 -- -- -- 375
Income tax benefit related to
stock based compensation 336 -- -- -- 336
Change related to ESOP shares -- -- -- (1,619) (1,619)
Cash dividends ($1.90 per share) -- (2,853) -- -- (2,853)
Other comprehensive income -- -- (1,051) -- (1,051)
------- -------- ------- -------- --------
Balance, September 30, 2003 $11,252 $ 94,747 $ 3,670 $(14,570) $ 95,099
======= ======== ======= ======== ========
Accumulated
Other Unallocated
Capital Retained Comprehensive Shares of
Stock Earnings Income (Loss) ESOP Total
----- -------- ------------- ------ -------
Balance, December 31, 2001 $10,397 $ 76,931 $ 3,021 $(12,194) $ 78,155
Net income -- 8,532 -- -- 8,532
Issuance of 550 shares
of common stock 45 -- -- -- 45
Change related to ESOP shares -- -- -- (462) (462)
Cash dividends ($1.75 per share) -- (2,622) -- -- (2,622)
Other comprehensive income -- -- 1,911 -- 1,911
------- -------- ------- -------- --------
Balance, September 30, 2002 $10,442 $ 82,841 $ 4,932 $(12,656) $ 85,559
======= ======== ======= ======== ========
See Notes to Consolidated Financial Statements.
6
HILLS BANCORPORATION
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30, 2003 and 2002
(In Thousands)
2003 2002
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 11,827 $ 8,532
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation 1,694 1,711
Amortization -- 127
Provision for loan losses 123 731
Compensation paid by issuance of common stock -- 45
Deferred income taxes 521 88
(Increase) in accrued interest receivable (137) (470)
Amortization of bond premium 637 230
(Increase) in other assets (770) (850)
Increase in accrued interest and other liabilities 252 1,009
Loans originated for sale (299,339) (104,146)
Proceeds on sales of loans 305,305 99,228
Net gain on sales of loans (3,972) (1,026)
Income tax benefits related to stock based compensation 336 --
--------- ---------
Net cash provided by operating activities $ 16,477 $ 5,209
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturities of investment securities:
Available for sale $ 53,365 $ 44,657
Held to maturity 3,368 3,106
Purchase of investment securities:
Available for sale (65,375) (64,657)
Held to maturity (3,570) --
Federal funds sold, net (7,978) 6,879
Loans made to customers, net of collections (72,460) (84,921)
Purchases of property and equipment (2,442) (2,187)
--------- ---------
Net cash (used in) investing activities $ (95,092) $ (97,123)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits $ 71,860 $ 68,406
Net increase (decrease) in federal funds purchased
and securities sold under agreements to repurchase 8,892 (5,159)
Borrowings from FHLB -- 30,000
Payments on FHLB borrowings (32) (31)
Stock options exercised 375 --
Dividends paid (2,853) (2,622)
--------- ---------
Net cash provided by financing activities $ 78,242 $ 90,594
--------- ---------
Decrease in cash and due from banks $ (373) $ (1,320)
--------- ---------
CASH AND DUE FROM BANKS
Beginning 32,647 37,070
--------- ---------
Ending $ 32,274 $ 35,750
========= =========
SUPPLEMENTAL DISCLOSURES
Cash payments for:
Interest paid to depositors $ 13,303 $ 17,572
Interest paid on other obligations 7,096 6,518
Income taxes 6,226 3,926
Non-cash financing activity,
increase in unallocated ESOP shares 1,619 462
See Notes to Consolidated Financial Statements.
7
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 1. Interim Financial Statements
Interim consolidated financial statements have not been examined by
independent public accountants, but include all adjustments (consisting
only of normal recurring accruals), which, in the opinion of management,
are necessary for a fair presentation of the results for these periods.
The results of operations for the interim periods are not necessarily
indicative of the results for a full year.
In reviewing these financial statements, reference should be made to the
Notes to Financial Statements contained in the audited Financial
Statements for the year ended December 31, 2002, included in Hills
Bancorporation (the "Company") Form 10-K filed with the Securities
Exchange Commission on March 24, 2003.
There were no changes in accounting policies, which had a significant
effect on the interim consolidated financial statements for the periods
presented except as disclosed in Note 3 to the financial statements.
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 demand deposits, NOW accounts, savings
accounts, and federal funds purchased and sold are reported net since
their original maturities are less than three months. Cash flows from
loans and time deposits are presented as net increases or decreases.
Note 2. Earnings Per Share
Basic earnings per share amounts are computed by dividing net income (the
numerator) by the weighted average number of common shares outstanding
(the denominator) during the period. Diluted per share amounts assume the
conversion, exercise or issuance of all potential common stock equivalents
unless the effect is to reduce the loss or increase the income per common
share from continuing operations.
The computation of earnings per common share for the periods presented are
as follows:
Three months ended Six months ended
------------------ ----------------
September 30 September 30
------------ ------------
2003 2002 2003 2002
---- ---- ---- ----
Weighted average number of shares
outstanding (basic) 1,515,778 1,499,108 1,509,888 1,498,723
Weighted average of potential dilutive shares
attributable to stock options granted computed
under the treasury stock method 3,989 13,145 3,450 13,259
---------- ---------- ---------- ----------
Weighted average number of shares (diluted) 1,519,767 1,512,253 1,513,338 1,511,982
========== ========== ========== ==========
Earnings Per Share:
Net income (in thousands) $ 4.319 $ 3,236 $ 11,827 $ 8,532
========== ========== ========== ==========
Earnings per common share:
Basic $ 2.85 $ 2.15 $ 7.83 $ 5.69
========== ========== ========== ==========
Diluted 2.84 2.14 7.81 5.64
========== ========== ========== ==========
8
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Note 3. Recent Accounting Pronouncements
The FASB has issued Statement No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." The provisions of the Statement are
effective for exit or disposal activities that are initiated after
December 31, 2002. Implementation of the Statement is not expected to have
a material impact on the Company's financial statements.
The FASB has issued Interpretation No. 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others"- an interpretation of FASB Statements No. 5, 57,
and 107 and rescission of FASB Interpretation No. 34." This Interpretation
elaborates on the disclosures to be made by a guarantor in its interim and
annual financial statements about its obligations under certain guarantees
that it has issued. It also clarifies that a guarantor is required to
recognize, at the inception of a guarantee, a liability for the fair value
of the obligation undertaken in issuing the guarantee. The initial
recognition and measurement provisions of the Interpretation are
applicable on a prospective basis to guarantees issued or modified after
December 31, 2002. Implementation of these provisions of the
Interpretation is not expected to have a material impact on the Company's
consolidated financial statements. The disclosure requirements of the
Interpretation are effective for financial statements of interim or annual
periods ending after December 15, 2002. The adoption of Interpretation No.
45's measurement and recognition provisions did not have a material impact
to the Company's financial position or results of operations.
In October 2002, the FASB issued Statement of Financial Accounting
Standards No.147, "Acquisition of Certain Financial Institutions, an
Amendment to FASB Statements No.72 and 144 and FASB Interpretation No.9.
The statement removes acquisitions of financial institutions from the
scope of the previous issued statements and interpretation and requires
that those transactions be accounted for in accordance with Statement of
Financial Accounting Standards No.141, "Business Combinations" and
Statement of Financial Accounting Standards No.142, "Goodwill and
Intangible Assets." Thus, the requirement to recognize (and subsequently
amortize) any excess of the fair value of liabilities assumed over the
fair value of tangible and identifiable intangible assets acquired as an
unidentifiable intangible asset no longer applies to acquisitions within
the scope of this statement. The Company adopted FASB No. 147 on October
1, 2002 and the adoption resulted in no reclassification or revisions to
prior period financial statements.
In January 2003, the FASB issued Interpretation No.46,"Consolidation of
Variable Interest Entities," which addresses consolidation by business
enterprises of variable interest entities which have certain
characteristics by requiring that if a business enterprise has a
controlling interest in a variable interest entity, the assets,
liabilities and results of activities of the variable interest entity be
included in the consolidated financial statements with those of the
business enterprise. This statement applies to variable interest entities
created after January 31, 2003 and to variable interest entities in which
an enterprise obtains an interest after that date. For variable interest
acquired before February 1, 2003, it applies in the first fiscal year or
interim period beginning after June 15, 2003. The Company has, and will
continue to, adopt the various provisions of this statement but presently
does not have any variable interest entities that would be required to be
included in its consolidated financial statements.
9
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Note 3. Recent Accounting Pronouncements (continued)
In May 2003, the FASB issued Statement of Financial Accounting Standards
No. 150, " Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity." This statement
established standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity.
It requires that an issuer classify a financial instrument that is within
its scope as a liability (or asset in some circumstances). Many of those
instruments were previously classified as equity. The statement is
effective for financial instruments entered into or modified after May 31,
2003, and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003. The Company adopted the statement on
July 1, 2003 and such adoption did not have a material effect on its
financial position or results of operations.
10
HILLS BANCORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is management's discussion and analysis of the financial condition
of Hills Bancorporation and subsidiary ("Company") at September 30, 2003,
(unaudited) when compared with December 31, 2002 and the results of operations
for the three and nine months ended September 30, 2003 and 2002 (unaudited).
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
The discussion following contains certain forward-looking statements with
respect to the financial condition, the results of operations and business of
the Company. These statements involve certain risks and uncertainties, which are
often inherent in the ongoing operation of financial institutions such as the
Company's subsidiary bank.
Forward-looking statements discuss matters that are not facts and are typically
identified by the words "believe," "expect," "anticipate," " target," " goal,"
"objective," " intend," "estimate," " will," "can," "would," "should," "could,"
"may" and similar expressions. They discuss expectations about the future and
are not guarantees. Forward-looking statements speak only as of the date they
are made, and the Company undertakes no obligation to update them to reflect
changes that occur after the date they are made.
There are several factors - many of which are beyond the control of the Company
or its subsidiary Bank - that could cause results to differ significantly from
expectations. Some of these factors are described below. There are factors other
than those described below that could cause results to differ from expectations.
Any factor described below could by itself, or together with one or more other
factors, adversely affect the business, earnings and/ or financial condition of
the Company and its subsidiary Bank.
The risks involved in the operations and strategies of the Company include
competition from other financial institutions, changes in interest rates,
changes in economic or market conditions and changes in regulatory factors.
These risks, which are not all inclusive, cannot be estimated.
CRITICAL ACCOUNTING POLICIES
The Company's financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America. The financial
information within these statements is, to a significant extent, financial
information that is based on approximate measures of the financial effects of
transactions and events that have already occurred. Based on its consideration
of accounting policies that involve the most complex and subjective decisions
and assessments, management has identified its most critical accounting policy
to be related to the allowance for loan losses. The Company's allowance for loan
loss methodology incorporates a variety of risk considerations, both
quantitative and qualitative in establishing an allowance for loan loss that
management believes is appropriate at each reporting date. Quantitative factors
include the Company's historical loss experience, delinquency and charge-off
trends, collateral values, changes in nonperforming loans, and other factors.
Quantitative factors also incorporate known information about individual loans,
including borrowers' sensitivity to interest rate movements. Qualitative factors
include the general economic environment in the Company's markets, including
economic conditions throughout the Midwest and in particular, the state of
certain industries.
11
HILLS BANCORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(continued)
CRITICAL ACCOUNTING POLICIES (continued)
Size and complexity of individual credits in relation to loan structure,
existing loan policies and pace of portfolio growth are other qualitative
factors that are considered in the methodology. As the Company adds new products
and increases the complexity of its loan portfolio, it will enhance its
methodology accordingly. This discussion and analysis should be read in
conjunction with the Company's financial statements and the accompanying notes
presents elsewhere herein, as well as the portion of this Management's
Discussion and Analysis section entitled "Financial Condition - Allowance for
Loan Losses". Although management believes the levels of the allowance as of
both September 30, 2003 and December 31, 2002 were adequate to absorb losses
inherent in the loan portfolio, a decline in local economic conditions, or other
factors, could result in increasing losses that cannot be reasonably predicted
at this time.
12
HILLS BANCORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(continued)
FINANCIAL CONDITION AT SEPTEMBER 30, 2003 COMPARED TO DECEMBER 31, 2002.
Assets and Liabilities Review
Total assets grew to $1.188 billion at September 30, 2003, compared to total
assets of $1.099 billion at December 31, 2002. The asset growth of $89.6 million
included a net increase in the investment securities of $9.9 million and net
loan growth of $70.3 million. The net loan growth includes loans held for sale
of $4.9 million as of September 30, 2003, which were secondary market loans that
are waiting funding. The loans held for sale at December 31,2002 were $6.9
million.
The following tables set forth the composition of loans and the allowance for
loan losses and information on non-performing loans:
September 30
------------
2003 2002
---- ----
(Amounts in thousands)
Agricultural $ 41,887 $ 37,323
Commercial and financial 46,326 39,436
Real estate:
Construction 60,018 46,352
Mortgage 676,966 612,611
Loans to individuals 33,538 36,235
-------- --------
$858,735 $771,957
Less allowance for loan losses 12,425 10,650
-------- --------
$846,310 $761,307
======== ========
Changes in the allowance for loan losses are as follows:
Three Months Ended Nine Months Ended
September 30 September 30
------------ ------------
2003 2002 2003 2002
---- ---- ---- ----
(Amounts in thousands) (Amounts in thousands)
Balance, beginning $ 12,740 $ 10,350 $ 12,125 $ 9,950
Provision charged to expense (326) 244 123 731
Recoveries 488 271 1,298 1,066
Loans charged off (477) (215) (1,121) (1,097)
-------- -------- -------- --------
Balance, ending $ 12,425 $ 10,650 $ 12,425 $ 10,650
======== ======== ======== ========
Non-performing loan information at September 30, was as follows:
2003 2002
---- ----
(Amounts in thousands)
Impaired loans, non-accrual $3,897 $1,998
Loans past due ninety days or more and still accruing 2,078 2,613
Restructured loans -- --
13
HILLS BANCORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(continued)
Assets and Liabilities Review (continued)
Interest rates at historically low levels have helped drive both new loan growth
and secondary market loans, including refinances. Effective June 25, 2003, the
Federal Reserve Open Market Committee lowered the federal funds target rate to
1.00%. This 1.00% federal funds target rate is the lowest since July of 1958.
The June 25, 2003 action was the only such interest rate reduction since the
prior 25 basis point decrease on November 6, 2002. The June 25, 2003 decrease in
the federal funds rate marked the thirteenth decrease since May 16, 2000, when
the rate was 6.50%. The University of Iowa continues to have a dominant effect
on the economy of the Bank's primary trade area, Johnson County, Iowa, and has
helped the local economy remain strong even when the national economy has
experienced weaknesses. However, in the last two years the economy of the state
of Iowa has weakened and the University continues to deal with budget cuts. The
possible effects on the local economy cannot be predicted.
Overall, the local economy remains in good condition but weaknesses have been
seen in some industries with some layoffs in employment. Budget restraints
continue to adversely affect the University of Iowa and state government
spending. Although weaknesses in the national economy has not directly affected
the Company, continuing uncertainty about the situation in Iraq and other
national economic news will continue to affect the financial markets. The new
tax relief act signed into law in May, 2003, contains major tax cuts for
individuals and business taxpayers. One of the most talked about provisions is
lower tax on corporate dividends and this has aided recent stock market gains.
As of September 30, 2003, the major stock indices all show a positive growth for
the first nine months of 2003.
The growth of deposits in the first nine months of the year has been $71.9
million and a total of $80.8 million when repurchase agreements are included.
Borrowings from the FHLB remained static at $167.6 million for the two periods
presented.
Dividends and Equity
In January 2003, Hills Bancorporation paid a dividend of $2,853,000 or $1.90 per
share, an 8.57% increase from the $1.75 paid in January 2002. After payment of
the dividend and the adjustment for accumulated other comprehensive income,
stockholders' equity as of September 30, 2003 totaled $95,099,000. Under
risk-based capital rules, the total risk based capital is 14.34% of
risk-adjusted assets, and is substantially in excess of required minimums.
14
HILLS BANCORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(continued)
RESULTS OF OPERATIONS FOR THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 AND
2002.
Net income, net interest income and other income
Net income for the nine months ended September 30, 2003 is $11,827,000, which
represents a $3,295,000 increase over the reported income for the same period in
2002. The increase in net income is related to three significant factors. The
factors are the continued growth in average earning assets, the decrease in the
provision for loan losses and the increase in the gain on sale of loans. Net
interest income, including fees increased $3.3 million for the nine months ended
September 30, 2003 compared to 2002. The improvement is due to an increase in
average earning assets of $120.3 million. The provision for loan losses and its
effect on net income is discussed in a later section of this report. Mortgage
refinancing growth continued in the third quarter of the year as the number of
loans sold on the secondary market increased and the resulting gain on sale was
$3,972,000 which is $1,991,000 more than for all of 2002 and $2,946,000 higher
than the gain on sale of loans for the period ended September 30, 2002. The
interest rates on secondary market loans that are sold increased in late summer
as long-term investment rates rose. As a result of this increase in interest
rates, coupled with the fact that many consumers had taken advantage of the
opportunity to borrow or refinance at lower rates, the volume of loans sold and
the related level of income from this mortgage activity is not expected to
continue in the fourth quarter of 2003.
The net income for the quarter ended September 30, 2003 was $1,083,000 ahead of
the same quarter in 2002. This change is due in large part to the gain on sale
of loans, to the secondary market, which was $1,113,000 higher in 2003 than 2002
for the three months. Another factor in such increased net income is that net
interest income is $792,000 higher due to average earning assets increasing by
$112.7 million. In addition to these two items, the provision for loan losses
was $570,000 less in 2003 than 2002. The provision for loan losses is discussed
in a separate section.
Deposit account charges and fees increased $329,000 for the nine months ended
September 30, 2003 compared to the same period in 2002. The increase is
primarily due to increased service charges on selected deposit accounts and the
volume of accounts. Other fees and charges increased $492,000 from the first
nine months of 2003 compared to the same period in 2002. The increase included
$391,000 in credit card processing fees, but this income was offset by
additional processing expense fees of $431,000, included in the other expense
category.
In comparing the three months ended September 30, 2003 and 2002, other income
increased by $1,374,000 to $3,878,000. The increase was the result of the gain
on sale of loans increasing by $1,113,000 and this was primarily due to the
continued low rate environment. Deposit account charges increased $55,000 from
$845,000 to $900,000. As was true for the nine months results previously
discussed, the change was due to increased service charges and the increased
volume of accounts. The $206,000 increase for the nine months ended September
30, 2003 in other fees is primarily attributable to an increase in credit card
processing fees, offset by similar increases in processing fees included in the
expenses.
15
HILLS BANCORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(continued)
Provision for loan losses and allowance for loan losses
The provision for loan losses resulted in a reduction in expense of $326,000 in
the third quarter of 2003 compared to an increase in expense of $244,000 for the
same period in 2002. The provision for loan losses for the nine months ended
September 30, 2003 is $123,000 compared to $731,000 for the nine months ended
September 30, 2002. The net adjustment required on a quarterly basis for loan
losses is a result of management's determination of the quality of the loan
portfolio. The provision reflects a number of factors, including the size of the
loan portfolio, loan concentrations, the level of impaired loans which are all
non-accrual and loans past due ninety days or more. In addition, management
considers the credit quality based on their review of problem and watch loans,
including loans with historical higher credit risks (primarily agricultural
loans). During the quarter ended September 30, 2003, agricultural loans which
have a higher credit risk, were reduced by payments of $2.2 million. The result
of this was that the allowance for loan losses required at September 30, 2003
was lowered by approximately $450,000. The allowance for loan losses balance is
also affected by the net charge-offs for the periods presented. For the nine
months ended September 30, 2003 and 2002, net recoveries were $177,000 in 2003,
compared to net charge-offs of $31,000 in 2002. In the three months ended
September 2003 and 2002, net recoveries were $56,000 and $11,000 respectively.
Primarily as a result of the factors discussed in the preceding paragraph, the
allowance for loan losses totaled $12,425,000 at September 30, 2003 compared to
$10,650,000 at September 30, 2002. The percentage of the allowance to
outstanding loans was 1.44% and 1.36% at September 30, 2003 and 2002,
respectively. The methodology used in 2003 is consistent with the prior years.
Other expenses and income taxes expense
Total other expenses were $20,538,000 and $18,139,000 for the nine months ended
September 30, 2003 and 2002, respectively. The increase since September 30, 2002
includes $1,376,000 in salaries and benefits, which is the direct result of an
increase of fifteen full-time equivalent employees to 361 employees at September
30, 2003. The new employees added included nine in the secondary market
department and eleven in the Marion office, which opened in February 2003. All
other expenses other than salaries and benefits increased a total of $1,023,000
or 12.68%. Credit card processing fees, which composed part of the other
expenses, increased $431,000 and was offset by $391,000 of increased fee income
of credit card processing included in the other income section.
The three months ended September 30, 2003 compared to the same period ending
September 30, 2002, saw an increase in other expenses of $967,000. Salaries and
employee benefits accounted for $582,000 of the increase and reflect salary
increases over the prior year and the increase discussed above in the full-time
equivalents added in 2003. The only other large increase in expenses was the
credit card processing expense of approximately $146,000 discussed in the other
income review.
Income tax expense was $5,888,000 and $3,846,000 for the nine months ended
September 30, 2003 and 2002, respectively. The corresponding percentage of
income taxes compared to income before income taxes is 33.24% in 2003 and 31.07%
in 2002. For the three months ended September 30, 2003 and 2002, the percentage
of income taxes to income before income taxes, increased to 33.68% in 2003 from
31.77% in 2002. The percentage is up slightly due to substantially more income
from the gain on sale of loans and not a corresponding increase in the
percentage of non-taxable interest income.
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HILLS BANCORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(continued)
Liquidity
The Company actively monitors and manages its liquidity position with the
objective of maintaining sufficient cash flows to fund operations, meet client
commitments, take advantage of market opportunities and provide a margin against
unforeseeable liquidity needs. Federal funds sold and investment securities
available for sale are readily marketable assets. Maturities of all investment
securities are managed to meet the Company's normal liquidity needs, to respond
to market changes or to adjust the Company's interest rate risk position.
Federal funds sold and investment securities available for sale comprised 20.8%
of the Company's total assets at September 30, 2003, compared to 19.9% at
September 30, 2002.
Net cash provided from operations is another primary source of liquidity. For
the nine months ended September 30, 2003 and 2002, net cash provided by
operating activities was $16,477,000 and $5,209,000 respectively.
The Company has historically maintained a stable deposit base and a relatively
low level of large deposits, which has mitigated the volatility in liquidity. As
of September 30, 2003, the Company had borrowed $167,574,000 from the FHLB of
Des Moines compared to $167,606,000 at September 30, 2002. These advances were
used as a means of providing both long and short-term, fixed-rated funding for
certain assets and managing interest rate risk. The Company had additional
borrowing capacity available from the FHLB of approximately $136 million at
September 30, 2003.
As additional sources of liquidity, the Company has the ability to borrow up to
$10 million from the Federal Reserve Bank of Chicago, and two lines of credit
with two banks totaling $98 million. Those two lines of credit require the
pledging of investment securities when drawn upon.
The combination of high levels of potentially liquid assets, low dependence on
volatile liabilities and additional borrowing capacity provided sources of
liquidity for the Company which management considered sufficient at September
30, 2003.
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HILLS BANCORPORATION
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
Market Risk Management
Market risk is the risk of loss arising from adverse changes in market prices
and rates. The Company's market risk is comprised primarily of interest rate
risk resulting from its core banking activities of lending and deposit
gathering. Interest rate risk measures the impact on earnings from changes in
interest rates and the effect on current fair market values of the Company's
assets, liabilities and off-balance sheet contracts. The Company's objective is
to measure this risk and manage the balance sheet to avoid unacceptable
potential for economic loss. Management continually develops and applies
strategies to mitigate market risk, some of which are described below. Exposure
to market risk is reviewed on a regular basis by the asset/liability committee
at the bank. Management does not believe that the Company's primary market risk
exposures and how those exposures have been managed to date in 2003, changed
significantly when compared to 2002.
Asset/Liability Management
The Company has a fully integrated asset/liability management system to assist
in managing the balance sheet. The process, which is used to project the results
of alternative investment decisions, includes the development of simulations
that reflect the effects of various interest rate scenarios on net interest
income. Management analyzes the simulations to manage interest risk, the net
interest margin and levels of net interest income.
The goal is to structure the balance sheet so that net interest margin
fluctuates in a narrow range during periods of changing interest rates. The
Company currently believes that net interest income would fall by less than 5
percent if interest rates increased by 300 basis points over a one-year time
horizon. This is within the Company's policy limits.
To improve net interest income and lessen interest rate risk, management
continues its strategy of de-emphasizing fixed-rate portfolio residential real
estate loans with long re-pricing periods. The Company continues to focus on
reducing interest rate risk by emphasizing growth in variable-rate consumer and
commercial loans. Other actions include the use of fixed-rate Federal Home Loan
Bank (FHLB) advances as alternatives to certificates of deposit, and active
management of the available for sale investment securities portfolio to provide
for cash flows that will facilitate rate risk management.
The highly competitive banking environment in Iowa also greatly impacts the
Company's net interest margin. The future effect of competition on net interest
income is difficult to predict.
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HILLS BANCORPORATION
ITEM 4.
EVALUATION OF DISCLOSURE CONTROLS
Based on their evaluation of the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date of
this quarterly report, the undersigned officers of the registrant have concluded
that such disclosure controls and procedures are adequate. There were no
significant changes in internal controls or in other factors that could
significantly affect internal controls, including any corrective actions with
regard to significant deficiencies and material weaknesses, subsequent to the
date of the most recent evaluation by the undersigned officers of the registrant
of the design and operation of internal controls which could adversely affect
the registrant's ability to record, process, summarize and report financial
data.
19
HILLS BANCORPORATION
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
There are no materials pending legal proceedings.
Item 2. Changes in Securities
There were no changes in securities.
Item 3. Defaults upon Senior Securities
Hills Bancorporation has no senior securities.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the quarter
ended September 30, 2003.
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit II - Statement Re Computation of Earnings Per Common Share
(b) Reports on Form 8-K
No reports on Form 8-K have been filed during the quarter ended
September 30, 2003.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HILLS BANCORPORATION
Date 11/10/03 By /s/ Dwight O. Seegmiller
Dwight O. Seegmiller, President
Date 11/10/03 By /s/ James G. Pratt
James G. Pratt, Treasurer and Chief Accounting Officer
21