HILLS BANCORPORATION - Quarter Report: 2005 March (Form 10-Q)
UNITED STATES FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) For the quarterly period ended March 31, 2005 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 o 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 o 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. |
| CLASS | SHARES OUTSTANDING At April 30, 2005 |
|
| Common Stock, no par value | 4,553,173 |
Page 1 of 27 |
Page 2 of 27 |
HILLS BANCORPORATION |
| ASSETS | March 31, 2005 (Unaudited) |
December 31, 2004* | ||||||
| Cash and due from banks | $ | 28,848 | $ | 23,008 | ||||
| Investment securities: | ||||||||
| Available for sale (amortized cost March 31, 2005 $204,759; December 31, 2004 $203,208) |
203,143 | 204,123 | ||||||
| Held to maturity (fair value March 31, 2005 $4,999; December 31, 2004 $4,986) |
5,000 | 5,000 | ||||||
| Stock of Federal Home Loan Bank | 9,095 | 8,893 | ||||||
| Federal funds sold | 15,765 | — | ||||||
| Loans held for sale | 4,596 | 3,908 | ||||||
| Loans, net | 1,015,037 | 998,231 | ||||||
| Property and equipment, net | 22,057 | 21,814 | ||||||
| Tax credit real estate | 7,879 | 8,010 | ||||||
| Accrued interest receivable | 7,975 | 7,349 | ||||||
| Deferred income taxes | 5,510 | 4,506 | ||||||
| Goodwill | 2,500 | 2,500 | ||||||
| Other assets | 2,390 | 3,107 | ||||||
| $ | 1,329,795 | $ | 1,290,449 | |||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
| Liabilities | ||||||||
| Noninterest-bearing deposits | $ | 132,956 | $ | 131,256 | ||||
| Interest-bearing deposits | 880,651 | 825,980 | ||||||
| Total deposits | $ | 1,013,607 | $ | 957,236 | ||||
| Short-term borrowings | 20,061 | 37,985 | ||||||
| Federal Home Loan Bank borrowings | 167,542 | 167,542 | ||||||
| Accrued interest payable | 1,643 | 1,632 | ||||||
| Other liabilities | 7,667 | 5,915 | ||||||
| $ | 1,210,520 | $ | 1,170,310 | |||||
| REDEEMABLE COMMON STOCK HELD BY EMPLOYEE STOCK OWNERSHIP PLAN (ESOP) |
$ | 16,785 | $ | 16,336 | ||||
| STOCKHOLDERS’ EQUITY | ||||||||
| Capital stock, no par value; authorized 10,000,000 shares; issued March 31, 2005 and December 31, 2004 4,549,656 shares |
$ | — | $ | — | ||||
| Paid in capital | 11,364 | 11,364 | ||||||
| Retained earnings | 108,929 | 108,199 | ||||||
| Accumulated other comprehensive income (loss) | (1,018 | ) | 576 | |||||
| $ | 119,275 | $ | 120,139 | |||||
| Less maximum cash obligation related to ESOP shares | 16,785 | 16,336 | ||||||
| $ | 102,490 | $ | 103,803 | |||||
| $ | 1,329,795 | $ | 1,290,449 | |||||
* Derived from audited financial statements. See Notes to Consolidated Financial Statements. |
Page 3 of 27 |
HILLS BANCORPORATION |
| Three Months Ended March 31, |
||||||
| 2005 | 2004 | |||||
| Interest income: | ||||||
| Loans, including fees | $ | 15,184 | $ | 13,475 | ||
| Investment securities: | ||||||
| Taxable | 1,229 | 1,423 | ||||
| Nontaxable | 644 | 602 | ||||
| Federal funds sold | 36 | 15 | ||||
| Total interest income | $ | 17,093 | $ | 15,515 | ||
| Interest expense: | ||||||
| Deposits | $ | 4,052 | $ | 3,530 | ||
| Short-term borrowings | 79 | 74 | ||||
| FHLB borrowings | 2,240 | 2,266 | ||||
| Total interest expense | $ | 6,371 | $ | 5,870 | ||
| Net interest income | $ | 10,722 | $ | 9,645 | ||
| Provision for loan losses | 11 | 354 | ||||
| Net interest income after provision for loan losses | $ | 10,711 | $ | 9,291 | ||
| Other income: | ||||||
| Net gain on sale of loans | $ | 238 | $ | 351 | ||
| Trust fees | 733 | 710 | ||||
| Service charges and fees | 1,279 | 1,207 | ||||
| Rental revenue on tax credit real estate | 197 | 150 | ||||
| Other noninterest income | 608 | 631 | ||||
| $ | 3,055 | $ | 3,049 | |||
| Other expenses: | ||||||
| Salaries and employee benefits | $ | 4,150 | $ | 4,064 | ||
| Occupancy | 535 | 502 | ||||
| Furniture and equipment | 835 | 806 | ||||
| Office supplies and postage | 306 | 271 | ||||
| Advertising and business development | 345 | 414 | ||||
| Outside services | 1,066 | 986 | ||||
| Rental expenses on tax credit real estate | 218 | 163 | ||||
| Other noninterest expense | 262 | 272 | ||||
| $ | 7,717 | $ | 7,478 | |||
| Income before income taxes | $ | 6,049 | $ | 4,862 | ||
| Federal and state income taxes | 1,906 | 1,500 | ||||
| Net income | $ | 4,143 | $ | 3,362 | ||
| Earnings per share: | ||||||
| Basic | $ | 0.91 | $ | 0.74 | ||
| Diluted | 0.91 | 0.74 | ||||
See Notes to Consolidated Financial Statements. |
Page 4 of 27 |
HILLS BANCORPORATION |
| Three Months Ended March 31, |
||||||
| 2005 | 2004 | |||||
| Net income | $ | 4,143 | $ | 3,362 | ||
| Other comprehensive income (loss): | ||||||
| Unrealized holding gains (losses) arising during the period, net of income taxes, 2005 ($937); 2004 $283 |
(1,594 | ) | 483 | |||
| Comprehensive income | $ | 2,549 | $ | 3,845 | ||
See Notes to Consolidated Financial Statements. |
Page 5 of 27 |
HILLS BANCORPORATION |
| Paid In Capital |
Retained Earnings |
Accumulated Other Comprehensive Income (Loss) |
Maximum Cash Obligation Related To ESOP Shares |
Total | |||||||||||
| Balance, December 31, 2004 | $ | 11,364 | $ | 108,199 | $ | 576 | $ | (16,336 | ) | $ | 103,803 | ||||
| Change related to ESOP shares | — | — | — | (449 | ) | (449 | ) | ||||||||
| Net income | — | 4,143 | — | — | 4,143 | ||||||||||
| Cash dividends ($.75 per share) | — | (3,413 | ) | — | — | (3,413 | ) | ||||||||
| Other comprehensive income (loss) | — | — | (1,594 | ) | — | (1,594 | ) | ||||||||
| Balance, March 31, 2005 | $ | 11,364 | $ | 108,929 | $ | (1,018 | ) | $ | (16,785 | ) | $ | 102,490 | |||
| Balance, December 31, 2003 | $ | 11,353 | $ | 97,189 | $ | 3,087 | $ | (14,864 | ) | $ | 96,765 | ||||
| Issuance of 74 shares of common stock |
7 | — | — | — | 7 | ||||||||||
| Change related to ESOP shares | — | — | — | (442 | ) | (442 | ) | ||||||||
| Net income | — | 3,362 | — | — | 3,362 | ||||||||||
| Cash dividends ($.70 per share) | — | (3,185 | ) | — | — | (3,185 | ) | ||||||||
| Other comprehensive income | — | — | 483 | — | 483 | ||||||||||
| Balance, March 31, 2004 | $ | 11,360 | $ | 97,366 | $ | 3,570 | $ | (15,306 | ) | $ | 96,990 | ||||
See Notes to Consolidated Financial Statements. |
Page 6 of 27 |
HILLS BANCORPORATION |
| Three Months Ended March 31, |
||||||
| 2005 | 2004 | |||||
| Cash Flows from Operating Activities | ||||||
| Net income | $ | 4,143 | $ | 3,362 | ||
| Adjustments to reconcile net income to net cash provided by (used in) operating activities: |
||||||
| Depreciation | 510 | 619 | ||||
| Provision for loan losses | 11 | 354 | ||||
| Compensation expensed through issuance of common stock | — | 7 | ||||
| Deferred income taxes | (67 | ) | — | |||
| (Increase) decrease in accrued interest receivable | (626 | ) | 57 | |||
| Amortization of bond discount, net | 270 | 334 | ||||
| Decrease in other assets | 717 | 330 | ||||
| Increase in accrued interest and other liabilities | 1,763 | 1,342 | ||||
| Loans originated for sale | (24,561 | ) | (39,613 | ) | ||
| Proceeds on sales of loans | 24,111 | 33,448 | ||||
| Net gain on sales of loans | (238 | ) | (351 | ) | ||
| Net cash provided by (used in) operating activities | $ | 6,033 | $ | (111 | ) | |
| Cash Flows from Investing Activities | ||||||
| Proceeds from maturities of investment securities: | ||||||
| Available for sale | $ | 13,850 | $ | 23,394 | ||
| Held to maturity | — | 299 | ||||
| Purchases of investment securities available for sale | (15,873 | ) | (20,305 | ) | ||
| Federal funds sold, net | (15,765 | ) | 13,133 | |||
| Loans made to customers, net of collections | (16,817 | ) | (30,191 | ) | ||
| Purchases of property and equipment | (753 | ) | (638 | ) | ||
| Investment in tax credit real estate, net | 131 | (5,896 | ) | |||
| Net cash used in investing activities | $ | (35,227 | ) | $ | (20,204 | ) |
| Cash Flows from Financing Activities | ||||||
| Net increase in deposits | $ | 56,371 | $ | 23,483 | ||
| Net decrease in short-term borrowings | (17,924 | ) | (2,669 | ) | ||
| Dividends paid | (3,413 | ) | (3,185 | ) | ||
| Net cash provided by (used in) financing activities | $ | 35,034 | $ | 17,629 | ||
(Continued) |
Page 7 of 27 |
HILLS BANCORPORATION |
| Three Months Ended March 31, |
||||||
| 2005 | 2004 | |||||
| Increase (decrease) in cash and due from banks | $ | 5,840 | $ | (2,686 | ) | |
| Cash and due from banks: | ||||||
| Beginning of year | 23,008 | 24,194 | ||||
| End of period | $ | 28,848 | $ | 21,508 | ||
| Supplemental Disclosures Cash payments for: | ||||||
| Interest paid to depositors | $ | 4,041 | $ | 3,704 | ||
| Interest paid on other obligations | 2,319 | 2,340 | ||||
| Income taxes (received) paid | (34 | ) | 14 | |||
| Noncash financing activities: | ||||||
| Increase in maximum cash obligation related to ESOP shares | $ | 449 | $ | 442 | ||
See Notes to Consolidated Financial Statements. |
Page 8 of 27 |
| HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) |
| Note 1. | Basis of Presentation |
| The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial reporting and with instructions for Form 10-Q and Regulation S-X. These financial statements include all adjustments (consisting of normal recurring accruals) which in the opinion of management are considered necessary for the fair presentation of the financial position and results of operations for the periods shown. Certain prior year amounts may be reclassified to conform to the current year presentation. | |
| Operating results for the three month period ended March 31, 2005 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2005. For further information, refer to the consolidated financial statements and footnotes thereto included in the Form 10-K Annual Report of Hills Bancorporation and subsidiary (the “Company”) for the year ended December 31, 2004 filed with the Securities Exchange Commission on March 10, 2005. |
| Note 2. | Earnings Per Share |
| Basic earnings per share amounts are computed by dividing net income (the numerator) by the weighted average number of common shares outstanding (the denominator) during the period. Diluted per share amounts assume the conversion, exercise or issuance of all potential common stock equivalents unless the effect is to reduce the loss or increase the income per common share from continuing operations. | |
| The computation of basic and diluted earnings per share for the periods presented is as follows: | |
| Three months ended March 31, |
|||||||
| 2005 | 2004 | ||||||
| Common shares outstanding at the beginning of the period | 4,549,656 | 4,550,034 | |||||
| Weighted average number of net shares issued (redemption) | 0 | 111 | |||||
| Weighted average shares outstanding (basic) | 4,549,656 | 4,550,145 | |||||
| Weighted average of potential dilutive shares attributable to stock options granted, computed under the treasury stock method |
18,153 | 13,923 | |||||
| Weighted average number of shares (diluted) | 4,567,809 | 4,564,068 | |||||
| Net income (In Thousands) | $ | 4,143 | $ | 3,362 | |||
| Earnings per share: | |||||||
| Basic | $ | 0.91 | $ | 0.74 | |||
| Diluted | $ | 0.91 | $ | 0.74 | |||
Page 9 of 27 |
| HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Unaudited) |
| Note 3. | Recent Accounting Pronouncements |
At its March 2004 meeting, the Emerging Issues Task Force (“EITF”) revisited EITF Issue No. 03-1, “The Meaning of Other- Than-Temporary Impairment and its Application to Certain Investments” (“EITF No. 03-1”). Effective with reporting periods beginning after June 15, 2004, companies carrying certain types of debt and equity securities at amounts higher than the securities’ fair values will have to use more detailed criteria to evaluate whether to record a loss and will have to disclose additional information about unrealized losses. The Company has reviewed the revised EITF No. 03-1 and had planned to implement these additional procedures effective with the quarter beginning on July 1, 2004, however the FASB has since issued a statement of financial position deferring the effective date of the revised EITF No- 03-1 until further implementation issues may be resolved. Adoption of the new issuance could have an impact on the Company’s financial position and results of operations but the extent of any impact will vary due to the fact that the model, as issued, calls for many judgments and additional evidence gathering as such evidence exists at each securities valuation date. In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 123 (Revised 2004), “Share-Based Payment.” SFAS No 123R is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation” and supersedes Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees” and its related implementation guidance. SFAS No. 123R focuses primarily on accounting for transactions in which an entity obtains employee services through share-based payment transactions. SFAS No 123R requires a public entity to measure the cost of employee services received in exchange for the award of equity instruments based on the fair value of the award at the date of grant. The cost will be recognized over the period during which an employee is required to provide services in exchange for the award. The date at which SFAS No. 123R is expected to apply to the Company was recently extended from the beginning of the first interim or annual reporting period which begins after June 15, 2005 to January 1, 2006. While the Company cannot precisely determine the impact on net earnings as a result of the adoption of SFAS No 123R, estimated compensation expense can be found in the table below. The ultimate amount of increased compensation expense will be dependent on whether the Company adopts SFAS 123R using the modified prospective or retrospective method, the number of option shares granted during the year, their timing and vesting period, and the method used to calculate the fair value of the awards, among other factors. | |
| Three months ended March 31, |
||||||||
| 2005 | 2004 | |||||||
| Net income: | ||||||||
| As reported | $ | 4,143 | $ | 3,362 | ||||
| Deduct total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects |
(7 | ) | (6 | ) | ||||
| Pro forma | $ | 4,136 | $ | 3,356 | ||||
| Basic earnings per share: | ||||||||
| As reported | $ | 0.91 | $ | 0.74 | ||||
| Pro forma | $ | 0.91 | $ | 0.74 | ||||
| Diluted earnings per share: | ||||||||
| As reported | $ | 0.91 | $ | 0.74 | ||||
| Pro forma | $ | 0.91 | $ | 0.74 | ||||
Page 10 of 27 |
| HILLS BANCORPORATION | |
| Item 2. | Management’s Discussion and Analysis of Financial Condition And Results of Operations |
The following is management’s discussion and analysis of the financial condition of Hills Bancorporation (“Hills Bancorporation” or “the Company”) and its banking subsidiary Hills Bank and Trust Company (“the Bank”) for the dates and periods indicated. The discussion should be read in conjunction with the consolidated financial statements and the accompanying footnotes. Special Note Regarding Forward Looking Statements This report contains, and future oral and written statements of the Company and its management may contain, forward-looking statements within the meaning of such term in the Private Securities Litigation Reform Act of 1995 with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company. Actual results may differ materially from those included in the forward-looking statements. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company’s management and on information currently available to management, are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events. The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations and future prospects of the Company include, but are not limited to, the following: |
| • | The strength of the United States economy in general and the strength of the local economies in which the Company conducts its operations which may be less favorable than expected and may result in, among other things, a deterioration in the credit quality and value of the Company’s assets. | |
| • | The effects of, and changes in, laws, regulations and policies affecting banking, securities, insurance and monetary and financial matters as well as any laws otherwise affecting the Company. | |
| • | The effects of changes in interest rates (including the effects of changes in the rate of prepayments of the Company’s assets) and the policies of the Board of Governors of the Federal Reserve System. | |
| • | The ability of the Company to compete with other financial institutions as effectively as the Company currently intends due to increases in competitive pressures in the financial services sector. | |
| • | The ability of the Company to obtain new customers and to retain existing customers. | |
| • | The timely development and acceptance of products and services, including products and services offered through alternative delivery channels such as the Internet. | |
| • | Technological changes implemented by the Company and by other parties, including third party vendors, which may be more difficult or more expensive than anticipated or which may have unforeseen consequences to the Company and its customers. | |
| • | The ability of the Company to develop and maintain secure and reliable electronic systems. |
Page 11 of 27 |
| HILLS BANCORPORATION | |
| Item 2. | Management’s Discussion and Analysis of Financial Condition And Results of Operations |
| • | The ability of the Company to retain key executives and employees and the difficulty that the Company may experience in replacing key executives and employees in an effective manner. | |
| • | Consumer spending and saving habits which may change in a manner that affects the Company’s business adversely. | |
| • | The economic impact of terrorist attacks and military actions. | |
| • | Business combinations and the integration of acquired businesses and assets which may be more difficult or expensive than expected. | |
| • | The costs, effects and outcomes of existing or future litigation. | |
| • | Changes in accounting policies and practices, as may be adopted by state and federal regulatory agencies and the Financial Accounting Standards Board. | |
| • | The ability of the Company to manage the risks associated with the foregoing as well as anticipated. |
|
These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Additional information concerning the Company and its business, including other factors that could materially affect the Company’s financial results, is included in the Company’s filings with the Securities and Exchange Commission. Critical Accounting Policy The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The financial information contained within these statements is, to a significant extent, financial information that is based on approximate measures of the financial effects of transactions and events that have already occurred. Based on its consideration of accounting policies that involve the most complex and subjective decisions and assessments, management has identified its most critical accounting policies to be those which are related to the allowance for loan losses. The Company’s allowance for loan loss methodology incorporates a variety of risk considerations, both quantitative and qualitative in establishing an allowance for loan loss that management believes is appropriate at each reporting date. Quantitative factors include the Company’s historical loss experience, delinquency and charge-off trends, collateral values, changes in non-performing loans, and other factors. Quantitative factors also incorporate known information about individual loans, including borrowers’ sensitivity to interest rate movements. Qualitative factors include the general economic environment in the Company’s markets, including economic conditions throughout the Midwest and in particular, the state of certain industries. Size and complexity of individual loans in relation to loan structure, existing loan policies and pace of portfolio growth are other qualitative factors that are considered in the methodology. As the Company adds new products and increases the complexity of its loan portfolio, it will enhance its methodology accordingly. This discussion and analysis should be read in conjunction with the Company’s financial statements and the accompanying notes presented elsewhere herein, as well as the Management’s Discussion and Analysis of Financial Condition and Results of Operation that is included. Although management believes the levels of the allowance as of March 31, 2005 and December 31, 2004 were adequate to absorb probable losses inherent in the loan portfolio, a decline in local economic conditions, or other factors, could result in increasing losses that cannot be reasonably predicted at this time. |
Page 12 of 27 |
| HILLS BANCORPORATION | |
| Item 2. | Management’s Discussion and Analysis of Financial Condition And Results of Operations (continued) |
Overview The Company is a holding company engaged in the business of commercial banking. The Company’s subsidiary is Hills Bank and Trust Company, Hills, Iowa (the “Bank”), which is wholly-owned. The Bank was formed in Hills, Iowa in 1904. The Bank is a full-service commercial bank extending its services to individuals, businesses, governmental units and institutional customers primarily in the communities of Hills, Iowa City, Coralville, North Liberty, Mount Vernon, Kalona, Cedar Rapids and Marion, Iowa. At March 31, 2005 the Bank has twelve full service locations. Net income for the period ended March 31, 2005 was $4.14 million compared to $3.36 million for the first quarter of 2004. The increase in 2005 of $781,000 is a 23.23% increase over the 2004 amount. As discussed in the net income overview section below, the results are primarily due to a larger amount of net interest income, a smaller provision for loan losses and other expenses that increased significantly less than the total revenue of the Company. The Bank’s net interest income is the largest component of revenue and it is a function of the average earnings assets and the net interest margin percentage. For the period ended March 31, 2005, the Bank achieved a net interest margin of 3.63% compared to 3.59% in 2004. This favorable increase coupled with the average earning assets growth of $111.05 million resulted in a $1.08 million increase in net interest margin. Highlights noted on the balance sheet as of March 31, 2005 for the Company included the following: |
| • | Net loans are $1.015 billion. |
| • | Loan growth of $17.49 million and deposit growth of $56.4 million since December 31, 2004. |
| • | Dividends of $.75 per share were paid in January of 2005 to 1,485 shareholders. The 2005 dividend was a 7.14% increase over the prior year’s dividend of $.70. |
|
A detailed discussion of the financial position and results of operations follows this overview. Financial Position The asset growth of $39.3 million included a net loan increase of $17.5 million and an increase in federal funds sold of $15.8 million. Since December 31, 2004, the federal funds target rate has been raised by the Federal Reserve Open Market Committee twice by .25%, from 2.25% to 2.75%. The upward movement of the federal funds target rate started on June 30, 2004 when the rate was 1.00% and focused consumers on concerns with higher interest rates. Interest rates on loans are generally affected by these increases since the U.S. Treasury market rates normally increases when the Federal Reserve Board raises the federal funds target rate. The Bank prices its real estate loans based on the U.S. Treasury indexes. Loans secured by real estate accounted for $10.0 million of the increase in loans. The increase in the interest rates will at some point affect the loan demand and the economy, but at the current interest rate levels, demand for loans remains good. The overall economy in the Company’s principal place of business, Johnson and Linn Counties, remains good with unemployment levels that remain low. |
Page 13 of 27 |
| HILLS BANCORPORATION | |
| Item 2. | Management’s Discussion and Analysis of Financial Condition And Results of Operations (continued) |
|
The tables below set forth the composition of the loan portfolio as of March 31, 2005 and December 31, 2004 (dollars in thousands), along with changes in the allowance for loan losses and non-performing loan information: |
| March 31, 2005 | December 31, 2004 | |||||||||
| Amount | Percent | Amount | Percent | |||||||
| (Amounts In Thousands) | (Amounts In Thousands) | |||||||||
| Agricultural | $ | 37,588 | 3.65 | % | $ | 39,116 | 3.87 | % | ||
| Commercial and financial | 73,233 | 7.12 | 68,214 | 6.74 | ||||||
| Real estate: | ||||||||||
| Construction | 75,385 | 7.33 | 72,388 | 7.15 | ||||||
| Mortgage | 810,949 | 78.83 | 800,197 | 79.07 | ||||||
| Loans to individuals | 31,632 | 3.07 | 32,106 | 3.17 | ||||||
| $ | 1,028,787 | 100.00 | % | $ | 1,012,021 | 100.00 | % | |||
| Less allowance for loan losses | 13,750 | 13,790 | ||||||||
| $ | 1,015,037 | $ | 998,231 | |||||||
| Changes in the allowance for loan losses for the period shown in the following table were as follows: |
| Three Months Ended | ||||||
| March 31, | ||||||
| 2005 | 2004 | |||||
| (Amounts In Thousands) | ||||||
| Balance, beginning | $ | 13,790 | $ | 12,585 | ||
| Provision charged to expenses | 11 | 354 | ||||
| Recoveries | 252 | 269 | ||||
| Loans charged off | (303 | ) | (228 | ) | ||
| Balance, ending | $ | 13,750 | $ | 12,980 | ||
Page 14 of 27 |
| HILLS BANCORPORATION | |
| Item 2. | Management’s Discussion and Analysis of Financial Condition And Results of Operations (continued) |
Non-performing loan information at March 31, 2005 and December 31, 2004, was as follows: |
| March 31, 2005 | December 31, 2004 | |||||||
| (Amounts in thousands) | ||||||||
| Impaired loans, non-accrual | $ | 614 | $ | 808 | ||||
| Loans past due ninety days or more and still accruing | 4,056 | 2,313 | ||||||
| Restructured loans | — | — | ||||||
Federal funds sold increased from zero at December 31, 2004 to $15.8 million at March 31, 2005. As discussed in the deposit section below, deposit growth of $56.4 million exceeded the funds required for loan growth and some were invested on a temporary basis in federal funds sold. It is expected that the funds will be used to fund loan growth in the second quarter of 2005. Investment securities decreased $980,000, primarily as a result of a $2.5 million decline in the market value of securities available for sale from December 31, 2004 to March 31, 2005. The carrying values of investment securities for March 31, 2005 and December 31, 2004 are summarized in the following table (dollars in thousands): |
| March 31, 2005 | December 31, 2004 | |||||||||||
| Amount | Percent | Amount | Percent | |||||||||
| Securities available for sale | ||||||||||||
| U.S. Government agencies and corporations |
$ | 131,426 | 64.70 | % | $ | 133,929 | 65.61 | % | ||||
| State and political subdivisions |
71,717 | 35.30 | 70,194 | 34.39 | ||||||||
| Total securities available for sale |
$ | 203,143 | 100.00 | % | $ | 204,123 | 100.00 | % | ||||
| Securities held to maturity, | ||||||||||||
| State and political subdivisions |
$ | 5,000 | 100.00 | % | $ | 5,000 | 100.00 | % | ||||
Deposit growth was $56.4 million in the first quarter of 2005 and included a $36.7 million increase in public funds that are temporary deposits. As a result of the deposit growth federal funds purchased included in short-term borrowings at December 31, 2004 were reduced $19.2 million to zero and federal funds sold increased $15.8 million. In the opinion of the Company’s management, the Company continues to have sufficient liquidity resources available to fund expected additional loan growth. In March of 2005, the Bank relocated its downtown Iowa City office to the Old Capitol Town Center. The relocation doubled the size of the Bank’s downtown presence to 5,800 square feet. It is expected that the expanded space will assist in the growth of both retail and commercial deposits and will permit the Bank to offer real estate and commercial loan products at the downtown location. |
Page 15 of 27 |
| HILLS BANCORPORATION | |
| Item 2. | Management’s Discussion and Analysis of Financial Condition And Results of Operations (continued) |
Dividends and Equity In January 2005, Hills Bancorporation paid a dividend of $3,413,000 or $.75 per share, a 7.14% increase from the $.70 per share paid in January 2004. After payment of the dividend and the adjustment for accumulated other comprehensive income, stockholders’ equity as of March 31, 2005 totaled $102,490,000. Under risk-based capital rules, the total amount of risk based capital is 13.84% of risk-adjusted assets, and is substantially in excess of required minimums. Net Income Overview Net income increased $781,000 or 23.23% for the three months ended March 31, 2005 compared to the first quarter of 2004. Total net income was $4,143,000 in the 2005 quarter and $3,362,000 in the comparable 2004 quarter. The changes from the first quarter in 2004 were primarily the result of the following: |
| • | Net interest income increased $1,076,000. |
| • | The provision for loan losses decreased by $344,000. |
| • | Other expenses increased $239,000. |
| • | Income taxes increased $406,000. |
|
Earnings per share, both basic and diluted increased for the quarter ending March 31, 2005 compared to 2004. For the quarter ending March 31, 2005, basic and diluted earnings per share were $.91 and for March 31, 2004, basic and diluted earnings were $.74. Quarterly fluctuations in the Company’s net income continue to be driven primarily by three important factors. The first important factor is net interest margin. Net interest income of $10.7 million for the first quarter of 2005 was derived from the Company’s $1.223 billion of average earning assets and its net interest margin of 3.63%. Average earning assets in 2004 were $1.112 billion and the net interest margin was 3.59%. The importance of net interest margin is illustrated by the fact that a decrease in the net interest margin of 10 basis points to 3.53% would have resulted approximately in a $302,000 decrease in income before income taxes. The second significant factor affecting the Company’s net income is the provision for loan losses. The majority of the Company’s interest-earning assets are in loans outstanding, which amounted to more than $1.033 billion at March 31, 2005. An increase in problem loans results in a higher allocation to the provision for loan losses, which in turn reduces the Company’s net income. The provision for loan losses was $10,711 in 2005 compared to $354,000 in 2004. The amount of mortgage loans sold on the secondary market is the third factor that can cause fluctuations in net income. In the quarters ended March 31, 2005 and 2004, the net gain on sale of loans was $238,000 and $351,000, respectively. The sale of loans is influenced by the real estate market and interest rates. As a result in 2003, when rates were lowest, the volume of loans sold was high. For example, the net gain on sale of loans for the three months ended March 31, 2003 was $865,000. Due primarily to higher rates in 2004 and 2005, mortgage activity volume is reduced from the levels in 2003 and the first three months of 2004. |
Page 16 of 27 |
| HILLS BANCORPORATION | |
| Item 2. | Management’s Discussion and Analysis of Financial Condition And Results of Operations (continued) |
Net Interest Income Net interest income is the excess of the interest and fees received on interest-earning bearing assets over the interest expense of the interest-bearing liabilities. The factors that have the greatest impact on net interest income are the volume of average earning assets and the net interest margin. The net interest margin for the first three months of 2005 was 3.63% compared to 3.59% in 2004 for the same period. The measure is shown on a tax-equivalent basis using a tax rate of 35% to make the interest earned on taxable and non-taxable assets more comparable. Included in the volume changes column in the table that follows is the time variances between 2005 and 2004 since the three months ended March 31, 2004 had one additional day. The change in average balances and average rates between years and the effect on the net interest income on a tax equivalent basis for the three months ended in 2005 compared to 2004 are shown in the following table: |
Change in Average Balance |
Change in Average Rate |
|||||||||||||
| Increase (Decrease) | ||||||||||||||
| Volume Changes | Rate Changes | Net Change | ||||||||||||
| (Amounts in Thousands) | ||||||||||||||
| Interest income: | ||||||||||||||
| Loans, net | $ | 118,482 | — | % | $ | 1,655 | $ | — | $ | 1,655 | ||||
| Taxable securitities | (12,830 | ) | (0.18 | ) | (138 | ) | (56 | ) | (194 | ) | ||||
| Nontaxable securities | 7,851 | (0.18 | ) | 106 | (41 | ) | 65 | |||||||
| Federal funds sold | (2,454 | ) | 1.98 | (5 | ) | 26 | 21 | |||||||
| $ | 111,049 | $ | 1,618 | $ | (71 | ) | $ | 1,547 | ||||||
| Interest expense: | ||||||||||||||
| Interest-bearing demand deposits |
$ | 10,510 | 0.09 | $ | 9 | $ | 32 | $ | 41 | |||||
| Savings deposits | 38,350 | 0.36 | 56 | 236 | 292 | |||||||||
| Time deposits | 43,843 | (0.11 | ) | 308 | (119 | ) | 189 | |||||||
| Short-term borrowings | (4,455 | ) | 0.29 | (11 | ) | 16 | 5 | |||||||
| FHLB borrowings | (32 | ) | — | (26 | ) | — | (26 | ) | ||||||
| $ | 88,216 | $ | 336 | $ | 165 | $ | 501 | |||||||
| Change in net interest income | $ | 1,282 | $ | (236 | ) | $ | 1,046 | |||||||
| A summary of the net interest spread and margin is as follows: |
| (Tax Equivalent Basis) | 2005 | 2004 | ||||
| Yield on average interest-earning assets | 5.74 | % | 5.71 | % | ||
| Rate on average interest-bearing liabilities | 2.48 | 2.48 | ||||
| Net interest spread | 3.26 | % | 3.23 | % | ||
| Effect of noninterest-bearing funds | 0.37 | 0.36 | ||||
| Net interest margin (tax equivalent interest income divided by average interest-earning assets) |
3.63 | % | 3.59 | % | ||
Page 17 of 27 |
| HILLS BANCORPORATION | |
| Item 2. | Management’s Discussion and Analysis of Financial Condition And Results of Operations (continued) |
Provision for Loan Losses
The provision for loan losses was $11,000 in 2005 compared to $354,000 in 2004. The provision adjustment is computed on a quarterly basis and 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 non-accrual) and loans past due ninety days or more. The amount of problem or watch loans considered in the reserve computation decreased approximately $45,000 from the end of 2004 to March 31, 2005. The allowance for loan losses balance is also affected by the charge-offs, net of recoveries, for the periods presented. For the quarters ended March 31, 2005 and 2004, recoveries were $252,000 and $269,000, respectively; and charge-offs were $303,000 in 2005 and $228,000 in 2004. The allowance for loan losses totaled $13,750,000 at March 31, 2005 compared to $13,790,000 at December 31, 2004. The allowance represented 1.34% and 1.36% of outstanding loans at March 31, 2005 and December 31, 2004, respectively. The allowance was based on management’s consideration of a number of factors, including loan concentrations, loans with higher credit risks (primarily agriculture loans and spec real estate construction) and overall increases in net loans outstanding. The methodology used in 2005 is consistent with the prior year. Net Gain on Sale of Loans Net gain on sale of loans for the three months ended March 31, 2005 was $238,000 compared to $351,000 for the comparable period ended March 31, 2004. The number of loans sold in 2005 was approximately 55% of the volume in 2004. The decrease in the volume of loans was expected because many consumers had taken advantage of lower interest rates in 2003 and 2004 to refinance loans. Other Income The only significant change in other income was a $72,000 increase in service charges and fees for the quarter ended March 31, 2005 compared to the first quarter of 2004. This line item includes fees on deposit accounts, including debit card interchange fees and credit card fees on merchant accounts. Due to the increased volume of activity on debit cards, revenue increased $98,000 for the quarter over the first quarter of 2004 for this item included in service charges and fees. Other Expenses Other expenses increased $239,000 in 2005 to $7,717,000 from the same period in 2004. This increase of 3.20% included $86,000 in salaries and benefits. Direct salary expense was up $19,000 due to additional employees in 2005 compared to 2004. Medical expense for employees’ health insurance increased $30,000 due to premium increases. The $80,000 increase in outside services is attributable to higher debit card processing charges due to the increased volume of activity. Included in the other income section for service charges and fees is a $98,000 increase in debit card revenues. Income Taxes Federal and state income tax expenses were $1,906,000 and $1,500,000 for the three months ended March 31, 2005 and 2004, respectively. Income taxes as a percentage of income before taxes were 31.51% in 2005 and 30.85% in 2004. The dollar amount increase of $406,000 is primarily due to an increase of $1,187,000 in income before income taxes at March 31, 2005. Only $42,000 of this increase is offset with nontaxable interest and the Company’s marginal effective tax rate is 38.25%. The amount of tax credits in 2005 was $169,000, compared to $132,000 in 2004. |
Page 18 of 27 |
| HILLS BANCORPORATION | |
| Item 2. | Management’s Discussion and Analysis of 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 16.46% of the Company’s total assets at March 31, 2005, compared to 15.82% at December 31, 2004. The Company has historically maintained a stable deposit base and a relatively low level of large deposits, which has mitigated the volatility in the Company’s liquidity position. As of March 31, 2005, the Company had borrowed $167.5 million from the Federal Home Loan Bank (“FHLB”) of Des Moines. The amount of advances from the FHLB of Des Moines is unchanged from December 31, 2004. These advances were used as a means of providing both long and short-term, fixed-rate funding for certain assets and for managing interest rate risk. The Company had additional borrowing capacity available from the FHLB of approximately $195 million at March 31, 2005. As additional sources of liquidity, the Company has the ability to borrow up to $10 million from the Federal Reserve Bank of Chicago, and has lines of credit with two banks totaling $108 million. Those two lines of credit require the pledging of investment securities when drawn upon. The combination of high levels of potentially liquid assets, low dependence on volatile liabilities and additional borrowing capacity provided sources of liquidity for the Company which management considered sufficient at March 31, 2005. |
Page 19 of 27 |
| HILLS BANCORPORATION | |
| Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
Market Risk Management The Company’s primary market risk exposure is to changes in interest rates. The Company’s asset/liability management, or its management of interest rate risk, is focused primarily on evaluating and managing net interest income given various risk criteria. Factors beyond the Company’s control, such as market interest rates and competition, may also have an impact on the Company’s interest income and interest expense. In the absence of other factors, the Company’s overall yield on interest-earning assets will increase, as will its cost of funds on its interest-bearing liabilities when market interest rates increase over an extended period of time. Conversely, 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. Asset/Liability Management The Bank maintains an asset/liability committee, which meets at least quarterly to review the Bank’s interest rate sensitivity position and to review various strategies as to interest rate risk management. In addition, the Bank uses a simulation model to review various assumptions relating to interest rate movement. The model attempts to limit rate risk even if it appears the Bank’s asset and liability maturities are perfectly matched and a favorable interest margin is present. In order to minimize the potential effects of adverse material and prolonged increases or decreases in market interest rates on the Company’s operations, management has implemented an asset/liability program designed to mitigate the Company’s interest rate sensitivity. The program emphasizes the origination of adjustable rate loans, which are held in the portfolio, the investment of excess cash in short or intermediate term interest-earning assets, and the solicitation of passbook or transaction deposit accounts, which are less sensitive to changes in interest rates and can be re-priced rapidly. Net interest income should decline as interest rates increase, while net interest income should increase as interest rates decline. Generally, during periods of increasing interest rates, the Company’s interest rate sensitive liabilities would re-price faster than its interest rate sensitive assets causing a decline in the Company’s interest rate spread and margin. This would tend to reduce net interest income because the resulting increase in the Company’s cost of funds would not be immediately offset by an increase in its yield on earning assets. In times of decreasing interest rates, fixed rate assets could increase in value and the lag in re-pricing of interest rate sensitive assets could be expected to have a positive effect on the Company’s net interest income. |
Page 20 of 27 |
Page 21 of 27 |
Page 22 of 27 |
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Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. |
| HILLS BANCORPORATION | |||
| Date: May 9, 2005 | By: Dwight O. Seegmiller | ||
| Dwight O. Seegmiller, Director and President |
| Date: May 9, 2005 | By: James G. Pratt | ||
| James G. Pratt, Treasurer and Chief Accounting Officer |
Page 23 of 27 |
| HILLS BANCORPORATION QUARTERLY REPORT OF FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2005 |
| Exhibit Number |
Description | Page Number In The Sequential Numbering System March 31, 2005 Form 10-Q |
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| 31 | Certifications under Section 302 of the Sarbanes-Oxley Act of 2002 | 25 - 26 of 27 | |||
| 32 | Certifications under Section 906 of the Sarbanes-Oxley Act of 2002 | 27 of 27 | |||
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