HILLS BANCORPORATION - Quarter Report: 2007 September (Form 10-Q)
UNITED STATES FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) For the quarterly period ended September 30, 2007 Commission file number: 0-12668 Hills Bancorporation |
| Incorporated in Iowa | I.R.S. Employer Identification No. 42-1208067 |
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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. [ü] Yes o No Indicate by checkmark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer o Accelerated Filer ü Non-accelerated filer o Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ü 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 October 31, 2007 |
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| Common Stock, no par value | 4,494,844 | |
Page 1 of 33 |
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HILLS BANCORPORATION Part I |
Page 2 of 33 |
| HILLS BANCORPORATION |
| CONSOLIDATED BALANCE SHEETS |
| (Amounts In Thousands, Except Shares) |
| ASSETS | September 30, 2007 (Unaudited) |
December 31, 2006 | ||||
| Cash and due from banks | $ | 21,014 | $ | 23,397 | ||
| Federal funds sold | 21 | — | ||||
| Total cash and cash equivalents | $ | 21,035 | $ | 23,397 | ||
| Investment securities: | ||||||
| Available for sale at fair value (amortized cost September 30, 2007 $193,787; December 31, 2006 $180,106) |
193,097 | 178,057 | ||||
| Held to maturity at amortized cost (fair value September 30, 2007 $130; December 31, 2006 $177) |
125 | 170 | ||||
| Stock of Federal Home Loan Bank | 14,169 | 12,757 | ||||
| Loans held for sale | 3,544 | 3,808 | ||||
| Loans, net | 1,325,249 | 1,279,227 | ||||
| Property and equipment, net | 21,314 | 22,061 | ||||
| Tax credit real estate | 6,840 | 7,111 | ||||
| Accrued interest receivable | 12,343 | 10,292 | ||||
| Deferred income taxes | 7,971 | 7,613 | ||||
| Goodwill | 2,500 | 2,500 | ||||
| Other assets | 4,125 | 4,240 | ||||
| $ | 1,612,312 | $ | 1,551,233 | |||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||
| Liabilities | ||||||
| Noninterest-bearing deposits | $ | 137,604 | $ | 143,274 | ||
| Interest-bearing deposits | 1,003,924 | 964,135 | ||||
| Total deposits | $ | 1,141,528 | $ | 1,107,409 | ||
| Short-term borrowings | 45,955 | 59,063 | ||||
| Federal Home Loan Bank borrowings | 265,347 | 235,379 | ||||
| Accrued interest payable | 3,528 | 3,500 | ||||
| Other liabilities | 7,827 | 6,303 | ||||
| $ | 1,464,185 | $ | 1,411,654 | |||
| Redeemable Common Stock Held by Employee Stock Ownership Plan (ESOP) |
$ | 21,985 | $ | 20,940 | ||
| STOCKHOLDERS’ EQUITY | ||||||
| Capital stock, no par value; authorized 10,000,000 shares; issued September 30, 2007 4,579,789 shares; December 31, 2006 4,571,659 shares |
$ | — | $ | — | ||
| Paid in capital | 12,662 | 12,364 | ||||
| Retained earnings | 140,140 | 131,852 | ||||
| Accumulated other comprehensive loss | (426 | ) | (1,265 | ) | ||
| Treasury stock at cost (September 30, 2007 84,945 shares; December 31, 2006 67,921 shares) |
(4,249 | ) | (3,372 | ) | ||
| $ | 148,127 | $ | 139,579 | |||
| Less maximum cash obligation related to ESOP shares | 21,985 | 20,940 | ||||
| $ | 126,142 | $ | 118,639 | |||
| $ | 1,612,312 | $ | 1,551,233 | |||
| See Notes to Consolidated Financial Statements. |
Page 3 of 33 |
| HILLS BANCORPORATION |
| CONSOLIDATED STATEMENTS OF INCOME (Unaudited) |
| (Amounts In Thousands, Except Per Share Amounts) |
| Three Months Ended September 30, |
Nine Months Ended September 30, |
|||||||||||
| 2007 | 2006 | 2007 | 2006 | |||||||||
| Interest income: | ||||||||||||
| Loans, including fees | $ | 22,690 | $ | 20,780 | $ | 65,952 | $ | 58,860 | ||||
| Investment securities: | ||||||||||||
| Taxable | 1,212 | 1,113 | 3,453 | 3,403 | ||||||||
| Nontaxable | 794 | 727 | 2,333 | 2,149 | ||||||||
| Federal funds sold | 28 | — | 278 | 31 | ||||||||
| Total interest income | $ | 24,724 | $ | 22,620 | $ | 72,016 | $ | 64,443 | ||||
| Interest expense: | ||||||||||||
| Deposits | $ | 8,890 | $ | 7,182 | $ | 26,333 | $ | 19,720 | ||||
| Short-term borrowings | 552 | 907 | 1,541 | 2,107 | ||||||||
| FHLB borrowings | 3,256 | 3,054 | 9,186 | 8,657 | ||||||||
| Total interest expense | $ | 12,698 | $ | 11,143 | $ | 37,060 | $ | 30,484 | ||||
| Net interest income | $ | 12,026 | $ | 11,477 | $ | 34,956 | $ | 33,959 | ||||
| Provision for loan losses | 1,270 | 433 | 2,756 | 2,142 | ||||||||
| Net interest income after provision for loan losses | $ | 10,756 | $ | 11,044 | $ | 32,200 | $ | 31,817 | ||||
| Other income: | ||||||||||||
| Net gain on sale of loans | $ | 216 | $ | 280 | $ | 743 | $ | 661 | ||||
| Trust fees | 1,022 | 837 | 2,910 | 2,550 | ||||||||
| Service charges and fees | 2,106 | 1,801 | 5,837 | 5,134 | ||||||||
| Rental revenue on tax credit real estate | 190 | 190 | 496 | 592 | ||||||||
| Other noninterest income | 683 | 648 | 1,996 | 2,046 | ||||||||
| $ | 4,217 | $ | 3,756 | $ | 11,982 | $ | 10,983 | |||||
| Other expenses: | ||||||||||||
| Salaries and employee benefits | $ | 4,868 | $ | 4,623 | $ | 14,516 | $ | 13,725 | ||||
| Occupancy | 563 | 555 | 1,726 | 1,651 | ||||||||
| Furniture and equipment | 873 | 892 | 2,596 | 2,505 | ||||||||
| Office supplies and postage | 336 | 311 | 975 | 959 | ||||||||
| Advertising and business development | 466 | 359 | 1,281 | 1,218 | ||||||||
| Outside services | 1,365 | 1,185 | 3,793 | 3,597 | ||||||||
| Rental expenses on tax credit real estate | 240 | 224 | 731 | 689 | ||||||||
| Other noninterest expense | 359 | 367 | 985 | 968 | ||||||||
| $ | 9,070 | $ | 8,516 | $ | 26,603 | $ | 25,312 | |||||
| Income before income taxes | $ | 5,903 | $ | 6,284 | $ | 17,579 | $ | 17,488 | ||||
| Income taxes | 1,814 | 1,991 | 5,418 | 5,456 | ||||||||
| Net income | $ | 4,089 | $ | 4,293 | $ | 12,161 | $ | 12,032 | ||||
| Earnings per share: | ||||||||||||
| Basic | $ | 0.91 | $ | 0.94 | $ | 2.70 | $ | 2.64 | ||||
| Diluted | 0.90 | 0.93 | 2.68 | 2.62 | ||||||||
| See Notes to Consolidated Financial Statements. |
Page 4 of 33 |
| HILLS BANCORPORATION |
| CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited) |
| (Amounts In Thousands) |
| Three Months Ended September 30, |
Nine Months Ended September 30, |
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| 2007 | 2006 | 2007 | 2006 | |||||||||
| Net income | $ | 4,089 | $ | 4,293 | $ | 12,161 | $ | 12,032 | ||||
| Other comprehensive income: | ||||||||||||
| Unrealized holding gains arising during the period, | $ | 2,518 | $ | 2,859 | $ | 1,359 | $ | 822 | ||||
| Income tax effect of unrealized gains | (963 | ) | (1,094 | ) | (520 | ) | (315 | ) | ||||
| Other comprehensive income | $ | 1,555 | $ | 1,765 | $ | 839 | $ | 507 | ||||
| Comprehensive income | $ | 5,644 | $ | 6,058 | $ | 13,000 | $ | 12,539 | ||||
| See Notes to Consolidated Financial Statements. |
Page 5 of 33 |
| HILLS BANCORPORATION |
| CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (Unaudited) |
| (Amounts In Thousands, Except Share Amounts) |
| Paid In Capital |
Retained Earnings |
Accumulated Other Comprehensive Loss |
Maximum Cash Obligation Related To ESOP Shares |
Treasury Stock |
Total | |||||||||||||
| Balance, December 31, 2006 | $ | 12,364 | $ | 131,852 | $ | (1,265 | ) | $ | (20,940 | ) | $ | (3,372 | ) | $ | 118,639 | |||
| Issuance of 8,875 shares of common stock |
208 | — | — | — | — | 208 | ||||||||||||
| Forfeiture of 745 shares of common stock |
(33 | ) | — | — | — | — | (33 | ) | ||||||||||
| Share-based compensation | 30 | — | — | — | — | 30 | ||||||||||||
| Income tax benefit related to share-based compensation |
93 | — | — | — | — | 93 | ||||||||||||
| Change related to ESOP shares | — | — | — | (1,045 | ) | — | (1,045 | ) | ||||||||||
| Net income | — | 12,161 | — | — | — | 12,161 | ||||||||||||
| Cash dividends ($.86 per share) | — | (3,873 | ) | — | — | — | (3,873 | ) | ||||||||||
| Purchase of 17,024 shares of common stock |
— | — | — | — | (877 | ) | (877 | ) | ||||||||||
| Other comprehensive income | — | — | 839 | — | — | 839 | ||||||||||||
| Balance, September 30, 2007 | $ | 12,662 | $ | 140,140 | $ | (426 | ) | $ | (21,985 | ) | $ | (4,249 | ) | $ | 126,142 | |||
| Balance, December 31, 2005 | $ | 11,970 | $ | 119,989 | $ | (1,783 | ) | $ | (20,634 | ) | $ | (63 | ) | $ | 109,479 | |||
| Issuance of 4,144 shares of common stock |
200 | — | — | — | — | 200 | ||||||||||||
| Forfeiture of 1,509 shares of common stock |
(56 | ) | — | — | — | — | (56 | ) | ||||||||||
| Share-based compensation | 36 | — | — | — | — | 36 | ||||||||||||
| Change related to ESOP shares | — | — | — | 148 | — | 148 | ||||||||||||
| Net income | — | 12,032 | — | — | — | 12,032 | ||||||||||||
| Cash dividends ($.81 per share) | — | (3,695 | ) | — | — | — | (3,695 | ) | ||||||||||
| Purchase of 9,692 shares of common stock |
— | — | — | — | (468 | ) | (468 | ) | ||||||||||
| Other comprehensive income | — | — | 507 | — | — | 507 | ||||||||||||
| Balance, September 30, 2006 | $ | 12,150 | $ | 128,326 | $ | (1,276 | ) | $ | (20,486 | ) | $ | (531 | ) | $ | 118,183 | |||
| See Notes to Consolidated Financial Statements. |
Page 6 of 33 |
| HILLS BANCORPORATION |
| CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) |
| (Amounts In Thousands) |
| Nine Months Ended September 30, |
||||||
| 2007 | 2006 | |||||
| Cash Flows from Operating Activities | ||||||
| Net income | $ | 12,161 | $ | 12,032 | ||
| Adjustments to reconcile net income to net cash and cash equivalents provided by operating activities: |
||||||
| Depreciation | 1,719 | 1,755 | ||||
| Provision for loan losses | 2,756 | 2,142 | ||||
| Share-based compensation | 30 | 36 | ||||
| Forfeiture of common stock | (33 | ) | (56 | ) | ||
| Compensation expensed through issuance of common stock | 112 | 200 | ||||
| Excess tax benefits from share-based compensation | (93 | ) | — | |||
| Provision for deferred income taxes | (878 | ) | (1,098 | ) | ||
| Increase in accrued interest receivable | (2,051 | ) | (1,844 | ) | ||
| Amortization of discount on investment securities, net | 239 | 405 | ||||
| Decrease in other assets | 207 | 398 | ||||
| Increase in accrued interest and other liabilities | 1,553 | 725 | ||||
| Loans originated for sale | (88,751 | ) | (75,802 | ) | ||
| Proceeds on sales of loans | 89,758 | 76,365 | ||||
| Net gain on sales of loans | (743 | ) | (661 | ) | ||
| Net cash and cash equivalents provided by operating activities | $ | 15,986 | $ | 14,597 | ||
| Cash Flows from Investing Activities | ||||||
| Proceeds from maturities of investment securities: | ||||||
| Available for sale | $ | 27,612 | $ | 25,531 | ||
| Held to maturity | 45 | 45 | ||||
| Purchases of investment securities available for sale | (42,944 | ) | (15,061 | ) | ||
| Loans made to customers, net of collections | (48,778 | ) | (113,303 | ) | ||
| Purchases of property and equipment | (972 | ) | (1,906 | ) | ||
| Investment in tax credit real estate, net | 271 | 382 | ||||
| Net cash used in investing activities | $ | (64,766 | ) | $ | (104,312 | ) |
| Cash Flows from Financing Activities | ||||||
| Net increase in deposits | $ | 34,119 | $ | 39,246 | ||
| Net (decrease) increase in short-term borrowings | (13,108 | ) | 28,251 | |||
| Stock options exercised | 96 | — | ||||
| Income tax benefits related to share-based compensation | 93 | — | ||||
| Borrowings from FHLB | 60,700 | 45,000 | ||||
| Payments on FHLB borrowings | (30,732 | ) | (20,032 | ) | ||
| Borrowings from FRB | 8 | — | ||||
| Payments on FRB borrowings | (8 | ) | — | |||
| Purchase of treasury stock | (877 | ) | (468 | ) | ||
| Dividends paid | (3,873 | ) | (3,695 | ) | ||
| Net cash provided by financing activities | $ | 46,418 | $ | 88,302 | ||
Page 7 of 33 |
| HILLS BANCORPORATION |
| CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Continued) |
| (Amounts In Thousands) |
| Nine Months Ended September 30, |
||||||
| 2007 | 2006 | |||||
| Decrease in cash and cash equivalents | $ | (2,362 | ) | $ | (1,413 | ) |
| Cash and cash equivalents: | ||||||
| Beginning of year | 23,397 | 29,956 | ||||
| End of period | $ | 21,035 | $ | 28,543 | ||
| Supplemental Disclosures | ||||||
| Cash payments for: | ||||||
| Interest paid to depositors | $ | 26,305 | $ | 19,343 | ||
| Interest paid on other obligations | 10,727 | 10,764 | ||||
| Income taxes paid | 6,016 | 6,137 | ||||
| Noncash financing activities: | ||||||
| Increase (decrease) in maximum cash obligation related to ESOP shares |
$ | 1,045 | $ | (148 | ) | |
| See Notes to Consolidated Financial Statements. |
Page 8 of 33 |
| Three months ended September 30, |
Nine months ended September 30, |
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| 2007 | 2006 | 2007 | 2006 | |||||||||
| Common shares outstanding at the beginning of the period |
4,497,121 | 4,559,883 | 4,503,738 | 4,562,237 | ||||||||
| Weighted average number of net shares issued (redeemed) |
(499 | ) | (2,119 | ) | (2,083 | ) | (2,929 | ) | ||||
| Weighted average shares outstanding (basic) | 4,496,622 | 4,557,764 | 4,501,655 | 4,559,308 | ||||||||
| Weighted average of potential dilutive shares attributable to stock options granted, computed under the treasury stock method |
24,923 | 27,650 | 22,717 | 27,806 | ||||||||
| Weighted average number of shares (diluted) | 4,521,545 | 4,585,414 | 4,524,372 | 4,587,114 | ||||||||
| Net income (In Thousands) | $ | 4,089 | $ | 4,293 | $ | 12,161 | $ | 12,032 | ||||
| Earnings per share: | ||||||||||||
| Basic | $ | 0.91 | $ | 0.94 | $ | 2.70 | $ | 2.64 | ||||
| Diluted | $ | 0.90 | $ | 0.93 | $ | 2.68 | $ | 2.62 | ||||
Page 9 of 33 |
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HILLS BANCORPORATION Note 3. Recent Accounting Pronouncements In March 2006, the FASB issued FASB Statement No. 156 (“FAS 156”), Accounting for Servicing of Financial Assets and amendment of FASB Statement No. 140 (“FAS 140”), Accounting for Transfers and Extinguishment of Liabilities. FAS 156 requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. The Company elected the fair value measurement method with changes in fair value reflected in earnings for subsequent measurements. FAS 156 was effective for the Company as of January 1, 2007. The adoption of this statement did not have a significant effect on the Company’s financial statements. In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes. FIN 48 requires that the Company recognize in its financial statements, the impact of a tax position if that position is more likely than not of being sustained on audit based on the technical merits of the position. The provisions of FIN 48 were effective as of January 1, 2007. The adoption of the Interpretation did not have a significant effect on the Company’s financial statements. See Footnote 7. In September 2006, the FASB issued FASB Statement No. 157, Fair Value Measurements. The Statement provides a single definition of fair value, a framework for measuring fair value and expanded disclosures concerning fair value. Previously, different definitions of fair value were contained in various accounting pronouncements that prescribe fair value as the relevant measure of value, except FAS 123R and related interpretation and pronouncements that require or permit measurement similar to fair value but are not intended to measure fair value. The Statement is effective for financial statements issued for year beginning after November 15, 2007. The Company is currently evaluating the impact that the Statement will have on its consolidated financial statements. In February 2007, the FASB issued FASB Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilties – Including an Amendment of FASB Statement No. 115 (“FAS 159). FAS 159 permits companies to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The objective of FAS 159 is to provide opportunities to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply hedge accounting provisions. FAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. The Statement is effective for financial statements issued for the year beginning after November 15, 2007. The Company is currently evaluating the impact that the Statement will have on its consolidated financial statements. Note 4. Employee Benefit Plans The Company has a Stock Option and Incentive Plan for certain key employees and directors whereby shares of common stock have been reserved for awards in the form of stock options or restricted stock awards. Under the plan, the aggregate number of options and shares granted cannot exceed 198,000 shares. A Stock Option Committee may grant options at prices equal to the fair value of the stock at the date of the grant. Options expire 10 years from the date of the grant. Director options granted on or before December 31, 2006 may be exercised immediately. Director options granted on or after January 1, 2007 and officers’ rights under the plan vest over a five-year period from the date of the grant. |
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HILLS BANCORPORATION Note 4. Employee Benefit Plans (continued) Information concerning the issuance of stock options is presented in the following table: |
| Options | Weighted-Average Exercise Price |
Weighted-Average Remaining Contractual Term (years) |
Aggregate Intrinsic Value (In Thousands) |
||||||||
| Outstanding at January 1, 2007 | 57,195 | $ | 26.79 | 4.88 | $ | 1,532 | |||||
| Options outstanding at September 30, 2007 | 55,110 | 30.36 | 5.10 | 1,673 | |||||||
| Options exercisable at September 30, 2007 | 31,930 | 27.45 | 4.27 | 876 | |||||||
Options for 4,580 shares of stock were granted during the second quarter of 2007. The weighted-average value of the options granted was $16.98 per share. The fair value of each option is estimated as of the date of grant using a Black-Scholes option pricing model. The expected lives of options granted incorporate historical employee exercise behavior. The risk-free rate for periods that coincide with the expected life of the options is based on the annual 10 year interest rate swap rate as published by the Federal Reserve Bank. Expected volatility is based on volatility levels of the Company’s peer’s common stock as the Company’s stock has limited trading activity. Expected dividend yield was based a set dividend rate. Significant assumptions related to the options granted in 2007 include: |
| Risk-free interest rate | 5.21% | |||
| Expected option life | 7.5 years | |||
| Expected volatility | 25.33% | |||
| Expected dividends | 1.69% |
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At September 30, 2007, 115,516 shares were available for issuance under the plan. Stock options for 6,665 shares with a weighted-average exercise price of $14.57 were exercised during the nine months ended September 30, 2007. The intrinsic value of the options exercised was $97,088. As of September 30, 2007, there was $33,318 in unrecognized compensation cost for stock options granted under the plan compared to $44,800 as of September 30, 2006. This unrecognized cost is expected to be recognized over a weighted-average period of 1.44 years. Note 5. Stock Repurchase Program In July of 2005, the Company’s Board of Directors authorized a program to repurchase up to a total of 750,000 shares of the Company’s common stock (the “2005 Stock Repurchase Program”). This authorization will expire on December 31, 2009. The Company expects the purchases pursuant to the 2005 Stock Repurchase Program to be made from time to time in private transactions at a price equal to the most recent quarterly independent appraisal of the shares of the Company’s common stock and with the Board reviewing the overall results of the 2005 Stock Repurchase Program on a quarterly basis. The amount and timing of stock repurchases will be based on various factors, such as the Board’s assessment of the Company’s capital structure and liquidity, the amount of interest shown by shareholders in selling shares of stock to the Company at their appraised value, and applicable regulatory and legal factors. The Company has purchased 84,945 shares of its common stock in privately negotiated transactions from August 1, 2005 through September 30, 2007. Of these 84,945 shares, 2,396 shares were purchased during the quarter ended September 30, 2007, at an average price per share of $52.50. |
Page 11 of 33 |
HILLS BANCORPORATION Note 6. Commitments and Contingencies The Company’s subsidiary, Hills Bank and Trust (the “Bank”) is a party to financial instruments with off-balance–sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, credit card participations and standby letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets. The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, credit card participations and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. A summary of the Bank’s commitments at September 30, 2007 and December 31, 2006 is as follows: |
| September 30, 2007 | December 31, 2006 | |||||
| (Amounts In Thousands) | ||||||
| Firm loan commitments and unused portion of lines of credit: | ||||||
| Home equity loans | $ | 20,620 | $ | 18,796 | ||
| Credit card participations | 30,357 | 28,091 | ||||
| Commercial, real estate and home construction | 91,519 | 83,699 | ||||
| Commercial lines and real estate purchase loans | 101,162 | 70,200 | ||||
| Outstanding letters of credit | 10,574 | 10,107 | ||||
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Commitments for commercial and real estate loans increased $31.0 million since December 31, 2006. The majority of this increase is due to the volume of residential real estate loan commitments as of September 30, 2007. Real estate loan commitments were $29.2 million at September 30, 2007 and $3.6 million at December 31, 2006, an increase of $25.6 million. Note 7. Income Taxes Federal income tax expense for the nine months ended September 30, 2007 and 2006 was computed using the consolidated effective federal tax rate. The Company also recognized income tax expense pertaining to state franchise taxes payable individually by the subsidiary bank. On January 1, 2007, the Company adopted FIN 48, Accounting for Uncertainty in Income Taxes. The evaluation was performed for those tax years which remain open to audit. The Company files a consolidated tax return for federal purposes and separate tax returns for the State of Iowa purposes. The tax years ended December 31, 2006, 2005 and 2004, remain subject to examination by the Internal Revenue Service. For state tax purposes, the tax years ended December 31, 2006, 2005 and 2004, remain open for examination. As a result of the implementation of FIN 48, the Company did not recognize any increase or decrease for unrecognized tax benefits. There were no material unrecognized tax benefits on January 1, 2007 and September 30, 2007. No interest or penalties on these unrecognized tax benefits has been recorded. As of September 30, 2007, the Company does not anticipate any significant increase or decrease in unrecognized tax benefits during the twelve-month period ending September 30, 2008. |
Page 12 of 33 |
| • | 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 13 of 33 |
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HILLS BANCORPORATION Item 2. Management’s Discussion and Analysis of Financial Condition |
| • | 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. |
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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 Policies 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 September 30, 2007 and December 31, 2006 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 14 of 33 |
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HILLS BANCORPORATION Item 2. Management’s Discussion and Analysis of Financial Condition 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, Wellman, Cedar Rapids and Marion, Iowa. At September 30, 2007, the Bank has thirteen full-service locations. Net income for the nine-month period ended September 30, 2007 was $12.16 million compared to $12.03 million for the same nine months of 2006, an increase of 1.07%. The $91,000 increase in net income before income taxes is due to the combined result of an increase in net interest income of $997,000, other income of $999,000, the increase in the provision for loan losses of $614,000 and expenses increasing $1,291,000. Return on average equity was 13.36% for the nine months ended September 30, 2007 compared to 14.40% for the same period in 2006. Return on average assets was 1.03% in 2007 compared to 1.08% in 2006. Dividends of $.86 per share were paid in January 2007 to 1,535 shareholders. The 2007 dividend was a 6.17% increase over the prior year’s dividend of $.81 per share. The Bank’s net interest income is the largest component of revenue and it is primarily a function of the average earnings assets and the net interest margin percentage. The Bank achieved a net interest margin on a tax-equivalent basis of 3.25% compared to 3.35% in 2006. Average earning assets were $1.501 billion in 2007 and $1.409 billion in 2006. Highlights noted on the balance sheet as of September 30, 2007 for the Company included the following: |
| • | Total assets are over $1.6 billion, at $1.612 billion. |
| • | Net loans are $1.329 billion. |
| • | Loan growth of $45.8 million since December 31, 2006. |
| • | Deposit growth of $34.1 million since December 31, 2006. |
| • | Short-term borrowings decreased $13.1 million and Federal Home Loan Bank borrowings increased $30.0 million since December 31, 2006. |
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A detailed discussion of the financial condition and results of operations follows this overview. Financial Condition The asset growth for the nine months ended September 30, 2007 of $61.1 million included a net loan increase of $45.8 million and an increase in investment securities of $16.4 million that includes an increase of $1.4 million in stock of the Federal Home Loan Bank. The Federal Reserve Open Market Committee decreased the federal funds target rate on September 18, 2007 from 5.25% to 4.75%. This was the first change in the target rate since June 29, 2006 and the first decrease since June 25, 2003. Prior to this decrease, the federal funds target rate increased on June 30, 2004 when the rate was increased from 1.00% to 1.25% and increased 17 times to 5.25%. Interest rates on loans are generally affected by these increases since interest rates for the U.S. Treasury market normally increase when the Federal Reserve Board raises the federal funds target rate. In pricing of loans and deposits, the Bank considers the U.S. Treasury indexes as benchmarks in determining interest rates. Increases in interest rates may at some point materially reduce the loan demand and slow 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 15 of 33 |
HILLS BANCORPORATION Item 2. Management’s Discussion and Analysis of Financial Condition The tables below set forth the composition of the loan portfolio as of September 30, 2007 and December 31, 2006 (dollars in thousands), along with changes in the allowance for loan losses and non-performing loan information: |
| September 30, 2007 | December 31, 2006 | ||||||||||||
| Amount | Percent | Amount | Percent | ||||||||||
| (Amounts In Thousands) | (Amounts In Thousands) | ||||||||||||
| Agricultural | $ | 53,791 | 4.00 | % | $ | 49,223 | 3.80 | % | |||||
| Commercial and financial | 136,554 | 10.15 | 118,339 | 9.12 | |||||||||
| Real estate: | |||||||||||||
| Construction | 118,510 | 8.81 | 114,199 | 8.80 | |||||||||
| Mortgage | 1,007,046 | 74.89 | 983,489 | 75.83 | |||||||||
| Loans to individuals | 28,838 | 2.14 | 31,827 | 2.45 | |||||||||
| $ | 1,344,739 | 100.00 | % | $ | 1,297,077 | 100.00 | % | ||||||
| Less allowance for loan losses | 19,490 | 17,850 | |||||||||||
| $ | 1,325,249 | $ | 1,279,227 | ||||||||||
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The Bank has an established formal loan origination policy. In general, the loan origination policy attempts to reduce the risk of credit loss to the Bank by requiring that, among other things, maintenance of minimum loan to value ratios, evidence of appropriate levels of insurance carried by borrowers and documentation of appropriate types and amounts of collateral and sources of expected payment. Changes in the allowance for loan losses for the periods shown in the following table were as follows: |
| Three Months Ended September 30, |
Nine Months Ended September 30, |
|||||||||||||
| 2007 | 2006 | 2007 | 2006 | |||||||||||
| (Amounts In Thousands) | (Amounts In Thousands) | |||||||||||||
| Balance, beginning | $ | 18,850 | $ | 17,100 | $ | 17,850 | $ | 15,360 | ||||||
| Provision charged to expense | 1,270 | 433 | 2,756 | 2,142 | ||||||||||
| Recoveries | 328 | 336 | 1,050 | 1,117 | ||||||||||
| Loans charged off | (958 | ) | (389 | ) | (2,166 | ) | (1,139 | ) | ||||||
| Balance, ending | $ | 19,490 | $ | 17,480 | $ | 19,490 | $ | 17,480 | ||||||
| The provision for loan losses was larger in the three-month period ended September 30, 2007 due to an increase in loans classified as potential watch, watch or problem loans of $11.1 million. In 2006, these categories of loans increased $6.1 million. In addition, the provision was larger in the third quarter of 2007 due to the level of charge offs experienced in the quarter. In order to maintain the reserve at an adequate level, the additional provision was required. |
Page 16 of 33 |
HILLS BANCORPORATION Item 2. Management’s Discussion and Analysis of Financial Condition Non-performing loan information at September 30, 2007 and December 31, 2006, was as follows: |
| September 30, 2007 | December 31, 2006 | |||||
| (Amounts in thousands) | ||||||
| Non-accrual loans | $ | 782 | $ | 879 | ||
| Accruing loans past due ninety days or more | 12,425 | 4,983 | ||||
| Restructured loans | — | — | ||||
| Non-performing loans (includes non-accrual loans) | 36,630 | 14,681 | ||||
| Loans held for investment | 1,344,739 | 1,297,077 | ||||
| Ratio of allowance for loan losses to loans held for investment | 1.45 | % | 1.37 | % | ||
| Ratio of allowance for loan losses to non-performing loans | 53.21 | 121.59 | ||||
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Non-performing loans increased by $21.9 million from December 31, 2006 to September 30, 2007. Non-performing loans were 2.76% of net loans as of September 30, 2007 and 1.15% as of December 31, 2006. Non-performing loans include any loan that has been placed on nonaccrual status. Non-performing loans also include loans that based on management’s evaluation of current information and events, the Bank expects to be unable to collect in full according to the contractual terms of the original loan agreement. These loans are also considered impaired loans. This increase in non-performing loans is due primarily to deterioration in the credit quality of eight borrower relationships having an aggregate balance of approximately $29.0 million as of September 30, 2007. The Bank believes that the allowance for loan losses is at a level commensurate with the overall risk exposure of the loan portfolio. However, if economic conditions become unfavorable, certain borrowers may experience difficulty and the level of nonperforming loans, chargeoffs and delinquencies could continue to rise and require further increases in the provision for loan losses. The estimated fair value of the investment securities held by the Company increased by $16.4 million from December 31, 2006 to September 30, 2007, including a $1.4 million increase in stock of the Federal Home Loan Bank. This increase resulted from purchases of securities of approximately $15.3 million in excess of maturities during the nine-month period ended September 30, 2007. In addition, there was an increase in the fair value of securities available for sale of $1.4 million since December 31, 2006. The carrying values of investment securities for September 30, 2007 and December 31, 2006 are summarized in the following table (dollars in thousands): |
| September 30, 2007 | December 31, 2006 | |||||||||||||
| Amount | Percent | Amount | Percent | |||||||||||
| Securities available for sale | ||||||||||||||
| U.S. Government agencies and corporations |
$ | 103,473 | 53.59 | % | $ | 94,068 | 52.83 | % | ||||||
| State and political subdivisions |
89,624 | 46.41 | 83,989 | 47.17 | ||||||||||
| Total securities available for sale |
$ | 193,097 | 100.00 | % | $ | 178,057 | 100.00 | % | ||||||
| Securities held to maturity | ||||||||||||||
| State and political subdivisions |
$ | 125 | 100.00 | % | $ | 170 | 100.00 | % | ||||||
Page 17 of 33 |
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HILLS BANCORPORATION Item 2. Management’s Discussion and Analysis of Financial Condition Deposit growth was $34.1 million in the first nine months of 2007. Repurchase agreements decreased $7.1 million in the same period. Short-term borrowings at December 31, 2006 included federal funds purchased that decreased $6.0 million to $4.7 million as of September 30, 2007. The borrowings from the Federal Home Loan Bank (FHLB) decreased by $30 million with maturities in June and August 2007. The Company borrowed an additional $60 million in June and August 2007. The June borrowings included a $15 million advance at a rate of 4.62% for ten years that is callable in one year and a $15 million advance at a rate of 4.89% for ten years that is callable in three years. The August borrowings included a $15 million advance at a rate of 4.09% for ten years that is callable in one year and a $15 million advance at a rate of 4.48% for ten years that is callable in three years. In the opinion of the Company’s management, the Company continues to have sufficient liquidity resources available to fund expected additional loan growth. Dividends and Equity In January 2007, Hills Bancorporation paid a dividend of $3,873,000 or $.86 per share, a 6.17% increase from the $.81 per share paid in January 2006. After payment of the dividend and the adjustment for accumulated other comprehensive income, stockholders’ equity as of September 30, 2007 totaled $126.1 million. Under risk-based capital rules, the total amount of risk based capital of the Company as of September 30, 2007, was 13.39% of risk-adjusted assets, and is substantially in excess of the required minimum of 8.00%. Risk-based capital was 13.53% and 13.31% as of September 30 and December 31, 2006, respectively. As of September 30, 2007, the most recent notifications from the Federal Reserve System categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Company’s category. Discussion of operations for the nine months ended September 30, 2007 and 2006 Net Income Overview Net income increased $129,000 for the nine months ended September 30, 2007 compared to the first nine months of 2006. Total net income was $12,161,000 in 2007 and $12,032,000 in the comparable period in 2006 which represented an increase of approximately 1%. The changes in net income in 2007 from the first nine months of 2006 were the result of the following: |
| • | Net interest income increased by $997,000 ($1,129,000 on a tax-equivalent basis). |
| • | The provision for loan losses increased by $614,000. |
| • | Other income increased by $999,000. |
| • | Other expenses increased by $1,291,000. |
| • | Income taxes decreased by $38,000. |
| For the nine-month periods ended September 30, 2007 and 2006, basic earnings per share were $2.70 and $2.64, respectively. Diluted earnings per share were $2.68 for the nine months ended September 30, 2007 compared to $2.62 for the same period in 2006. |
Page 18 of 33 |
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HILLS BANCORPORATION Item 2. Management’s Discussion and Analysis of Financial Condition Discussion of operations for the nine months ended September 30, 2007 and 2006 (continued) Quarterly fluctuations in the Company’s net income continue to be driven primarily by two important factors. The first important factor is the interaction between changes in net interest margin and changes in average earnings assets. Net interest income of $35.0 million for the first nine months of 2007 was derived from the Company’s $1.501 billion of average earning assets during that period and its net interest margin of 3.25%. Average earning assets in the nine months ended September 30, 2006 were $1.409 billion and the net interest margin was 3.35%. The margin compression was the result of the continued flattening of the yield curve and pricing pressure on loans and short-term deposits. The importance of net interest margin is illustrated by the fact that a decrease in the net interest margin of 10 basis points to 3.15% would have resulted in an approximate $1,123,000 decrease in income before income taxes in the nine month period ended September 30, 2007. Similarly, an increase in the net interest margin of 10 basis points to 3.35% would have resulted in an approximate $1,123,000 increase in net interest income before taxes. Despite the decline in the net interest margin, the net interest income for the Company increased due to the increase in average earning assets over the similar nine-month period in 2006. 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 $1.325 billion at September 30, 2007. 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 non-performing loans (which includes non-accrual loans) and loans past due 90 days or more. The provision for loan losses was $2,756,000 in the first nine months of 2007 compared to $2,142,000 the same period in 2006. Net Interest Income Net interest income is the excess of the interest and fees earned 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 nine months of 2007 was 3.25% compared to 3.35% in 2006 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. The change in average balances and average rates between periods and the effect on the net interest income on a tax equivalent basis for the nine months ended in 2007 compared to the comparable period in 2006 are shown in the following table: |
| Change in Average Balance |
Change in Average Rate |
Increase (Decrease) in Net Interest Income | ||||||||||||
| Volume Changes | Rate Changes | Net Change | ||||||||||||
| (Amounts in Thousands) | ||||||||||||||
| Interest income: | ||||||||||||||
| Loans, net | $ | 93,850 | 0.26 | % | $ | 4,613 | $ | 2,512 | $ | 7,125 | ||||
| Taxable securities | (14,474 | ) | 0.52 | (383 | ) | 433 | 50 | |||||||
| Nontaxable securities | 6,324 | 0.04 | 258 | 25 | 283 | |||||||||
| Federal funds sold | 6,419 | 0.90 | 197 | 50 | 247 | |||||||||
| $ | 92,119 | $ | 4,685 | $ | 3,020 | $ | 7,705 | |||||||
| Interest expense: | ||||||||||||||
| Interest-bearing demand deposits | $ | 13,896 | 0.45 | $ | (98 | ) | $ | (519 | ) | $ | (617 | ) | ||
| Savings deposits | (5,397 | ) | 0.37 | 313 | (974 | ) | (661 | ) | ||||||
| Time deposits | 72,460 | 0.74 | (2,133 | ) | (3,202 | ) | (5,335 | ) | ||||||
| Short-term borrowings | (15,571 | ) | (0.15 | ) | 680 | (114 | ) | 566 | ||||||
| FHLB borrowings | 14,528 | (0.01 | ) | (550 | ) | 21 | (529 | ) | ||||||
| $ | 79,916 | $ | (1,788 | ) | $ | (4,788 | ) | $ | (6,576 | ) | ||||
| Change in net interest income | $ | 2,897 | $ | (1,768 | ) | $ | 1,129 | |||||||
Page 19 of 33 |
HILLS BANCORPORATION Item 2. Management’s Discussion and Analysis of Financial Condition Discussion of operations for the nine months ended September 30, 2007 and 2006 (continued) A summary of the net interest spread and margin is as follows: |
| (Tax Equivalent Basis) | 2007 |
2006 | |||||
| Yield on average interest-earning assets | 6.54 | % | 6.23 | % | |||
| Rate on average interest-bearing liabilities | 3.86 | 3.37 | |||||
| Net interest spread | 2.68 | % | 2.86 | % | |||
| Effect of noninterest-bearing funds | 0.57 | 0.49 | |||||
| Net interest margin (tax equivalent interest income divided by average interest-earning assets) |
3.25 | % | 3.35 | % | |||
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Provision for Loan Losses The provision for loan losses was $2,756,000 in 2007 compared to $2,142,000 in 2006, an increase of $614,000. The loan loss provision is the amount necessary to adjust the allowance to the level considered appropriate by management. 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 impact of borrowers’ ability to repay, loan collateral values, the level of impaired loans and loans past due ninety days or more. In addition, management considers the credit quality of the loans based on management’s review of problem and watch loans, including loans with historically higher credit risks (primarily agricultural and spec real estate construction loans). The provision for loan losses increased in the first nine months of 2007 as a result of overall growth in the loan portfolio and an increase in problem and watch loans of $30.3 million since December 31, 2006. In contrast, in the nine months ended September 30, 2006, the problem and watch loans increased by $5.8 million. While loan growth was substantial in both periods, $45.8 in 2007 and $111.3 million in 2006, the provision expense increased in 2007 due to a decline in loan quality. The increase in non-performing loans is due primarily to the deterioration in the credit quality of eight borrower relationships having an aggregate balance of approximately $29.0 million as of September 30, 2007. The Bank believes that the allowance for loan losses is at a level commensurate with the overall risk exposure of the loan portfolio. However, if economic conditions become unfavorable, certain borrowers may experience difficulty and the level of nonperforming loans, chargeoffs and delinquencies could continue to rise and require further increases in the provision for loan losses. The allowance for loan losses balance is also affected by the charge-offs, net of recoveries, for the periods presented. For the nine months ended September 30, 2007 and 2006, recoveries were $1,050,000 and $1,117,000, respectively; and charge-offs were $2,166,000 in 2007 and $1,139,000 in 2006. The increase in charge offs during the nine months ended September 30, 2007 is due to individual customer situations. There were five charge offs totaling approximately $862,000 in 2007 and were not concentrated in one industry or loan type. The allowance for loan losses totaled $19,490,000 at September 30, 2007 compared to $17,850,000 at December 31, 2006. The allowance represented 1.45% and 1.37% of outstanding loans at September 30, 2007 and December 31, 2006, respectively. The methodology used in 2007 is consistent with 2006. Net Gain on Sale of Loans Net gain on sale of loans for the nine months ended September 30, 2007 was $743,000 compared to $661,000 for the comparable period ended September 30, 2006. Loans sold in the first nine months of 2007 totaled $88.8 million compared to $75.8 million in the same period in 2006, an increase of 17%. |
Page 20 of 33 |
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HILLS BANCORPORATION Item 2. Management’s Discussion and Analysis of Financial Condition Discussion of operations for the nine months ended September 30, 2007 and 2006 (continued) Other Income Other income, other than the net gain on sale of loans discussed above, increased by $917,000 for the nine months ended September 30, 2007. Trust fees increased $360,000 in 2007 as a result of assets under management increasing from $823.7 million as of September 30, 2006 to $952.3 million as of September 30, 2007. Service charges and fees were up $703,000 in 2007. $314,000 was the result of fee income strategies. Debit card and point of sale (POS) pin interchange fees increased during the same period by $308,000 due to volume of activity. Credit card merchant fees increased $70,000 also due to volume of activity. Rental revenue on tax credit real estate decreased $96,000 for the nine-month period ended September 30, 2007. This decrease was due to adjustments recorded upon receipt of the 2006 audited financial statements for the tax credit properties. Other noninterest income decreased $50,000 as of September 30, 2007 compared to 2006. Included in 2006 other income was a one-time $79,000 sales tax refund. Other Expenses Other expenses increased $1,291,000 in 2007 to $26,603,000 from the same period in 2006. This increase of 5.10% included $904,000 in salaries and benefits. Direct salary expense was up $508,000, or 4.97%, due to annual pay adjustments and the addition of employees in 2007. Medical expense for employees’ health insurance increased $90,000 due to a premium increase of 6.90%. Furniture and equipment expense increased $91,000 in the nine months ended September 30, 2007 compared to the same period in 2006. This variance is due to a $145,000 increase in software maintenance contract expense. The increase in software maintenance expense resulted from amortization related to various systems added in 2006; the 2007 expense includes nine months of amortization for these systems while 2006 did not. Also, costs related to existing systems were more due to vendor price increases. Advertising and business development expenses increased $63,000 as of September 30, 2007. The increase is primarily the result of promotions held in 2007 for the retail areas of the Bank. Outside services increased $196,000 from 2006. Outside services include professional fees, courier services and ATM fees and processing charges for the merchant credit card program, retail credit cards and other data processing services. The credit card, merchants’ card and debit card processing charges increased $112,000 due to the increase in the volume of activity. Professional fees increased $55,000 in part due to the timing of fees for outsourced internal audit services. Income Taxes Federal and state income tax expenses were $5,418,000 and $5,456,000 for the nine months ended September 30, 2007 and 2006, respectively. Income taxes as a percentage of income before taxes were 30.82% in 2007 and 31.20% in 2006. The amount of tax credits was $420,000 for the nine month period for both 2007 and 2006. |
Page 21 of 33 |
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HILLS BANCORPORATION Item 2. Management’s Discussion and Analysis of Financial Condition Discussion of operations for the three months ended September 30, 2007 and 2006 Net Income Net income decreased to $4,089,000 for the three months ended September 30, 2007 from $4,293,000 for the same period in 2006, a decrease of 4.75%. Earnings per share, both basic and diluted, decreased for the three months ended September 30, 2007 compared to the same period in 2006. For the three-month period ended September 30, 2007, basic earnings per share was $0.91 and diluted earnings per share was $0.90. For the three months ended September 30, 2006, basic earnings per share was $0.94 and diluted earnings per share was $0.93. Return on average equity was 13.27% for the three months ended September 30, 2007 compared to 14.88%, for the same period in 2006. Return on average assets was 1.04% in 2007 compared to 1.13% in 2006. Net Interest Income Net interest income increased for the three month period ended September 30, 2007 by $549,000 ($600,000 on a tax-equivalent basis) from the similar period in 2006. The net interest margin in 2007 was 3.27% compared to 3.28% in 2006. The decrease is primarily due to an increase in rates on core deposit accounts, including insured money market accounts and short-term certificates of deposits. Offsetting this increase, rates paid on repurchase agreements decreased. Rates on federal funds borrowed remained stable. The increase in the volume of interest earning assets accounted for a significant portion of the net interest income improvement. Net interest income changes on a tax-equivalent basis for the three months ended September 30, 2007 and 2006 are as follows: |
| Change in Average Balance |
Change in Average Rate |
Increase (Decrease) in Net Interest Income | ||||||||||||
| Volume Changes | Rate Changes | Net Change | ||||||||||||
| (Amounts in Thousands) | ||||||||||||||
| Interest income: | ||||||||||||||
| Loans, net | $ | 70,852 | 0.23 | % | $ | 1,198 | $ | 727 | $ | 1,925 | ||||
| Taxable securities | (5,068 | ) | 0.50 | (43 | ) | 142 | 99 | |||||||
| Nontaxable securities | 7,099 | 0.03 | 97 | 6 | 103 | |||||||||
| Federal funds sold | 2,233 | (0.27 | ) | 29 | (1 | ) | 28 | |||||||
| $ | 75,116 | $ | 1,281 | $ | 874 | $ | 2,155 | |||||||
| Interest expense: | ||||||||||||||
| Interest-bearing demand deposits | $ | 16,278 | 0.36 | $ | (42 | ) | $ | (142 | ) | $ | (184 | ) | ||
| Savings deposits | 1,391 | 0.19 | 101 | (236 | ) | (135 | ) | |||||||
| Time deposits | 51,732 | 0.60 | (537 | ) | (852 | ) | (1,389 | ) | ||||||
| Short-term borrowings | (24,983 | ) | (0.44 | ) | 350 | 5 | 355 | |||||||
| FHLB borrowings | 17,591 | (0.03 | ) | (223 | ) | 21 | (202 | ) | ||||||
| $ | 62,009 | $ | (351 | ) | $ | (1,204 | ) | $ | (1,555 | ) | ||||
| Change in net interest income | $ | 930 | $ | (330 | ) | $ | 600 | |||||||
Page 22 of 33 |
HILLS BANCORPORATION Item 2. Management’s Discussion and Analysis of Financial Condition Discussion of operations for the three months ended September 30, 2007 and 2006 A summary of the net interest spread and margin is as follows: |
| (Tax Equivalent Basis) | 2007 |
2006 | |||||
| Yield on average interest-earning assets | 6.58 | % | 6.33 | % | |||
| Rate on average interest-bearing liabilities | 3.86 | 3.56 | |||||
| Net interest spread | 2.72 | % | 2.77 | % | |||
| Effect of noninterest-bearing funds | 0.55 | 0.51 | |||||
| Net interest margin (tax equivalent interest income divided by average interest-earning assets) |
3.27 | % | 3.28 | % | |||
|
Provision for Loan Losses The provision for loan losses was $1,270,000 for the quarter ended September 30, 2007 compared to $433,000 for the comparable quarter in 2006, an increase of $837,000. As discussed in connection with the results of operations for the nine months, the allowance for loan losses was increased due to management’s analysis of the outstanding loans at September 30, 2007. The provision for loan losses was larger in the three-month period ended September 30, 2007 due to an increase in loans classified as potential watch, watch or problem loans of $11.1 million. In 2006, these categories of loans increased $6.1 million. In addition, the provision in both quarters increased due to growth in the overall loan portfolio. The allowance for loan losses balance is also affected by the charge-offs, net of recoveries, for the periods presented. For the three months ended September 30, 2007 and 2006, recoveries were $328,000 and $336,000, respectively; and charge-offs were $958,000 in 2007 and $389,000 in 2006. The increase in charge offs during the three months ended September 30, 2007 is due to individual customer situations. There were two charge offs totaling approximately $421,000 in 2007 and were not concentrated in one industry or loan type. The allowance for loan losses totaled $19,490,000 at September 30, 2007 compared to $17,480,000 at September 30, 2006. The allowance represented 1.45% and 1.38% of outstanding loans at September 30, 2007 and September 30, 2006, respectively. Other Income Total other income was $4,217,000 and $3,756,000 for the three months ended September 30, 2007 and 2006. Net gain on sale of loans decreased by $64,000 in the quarter ended September 30, 2007 as compared to the same quarter in 2006 due to a decrease in the volume of loans sold in 2007. The Trust Department fees for 2007 were $185,000 higher than 2006 due to the growth of assets under management. Service charges and fees were up $305,000 in the three months ended September 30, 2007. $141,000 was the result of fee income strategies. Debit card and point of sale (POS) pin interchange fees increased $110,000 during the same period due to the volume of activity. Credit card merchant fees increased $38,000 in 2007. |
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HILLS BANCORPORATION Item 2. Management’s Discussion and Analysis of Financial Condition Discussion of operations for the three months ended September 30, 2007 and 2006 (continued) Other Expenses Total expenses for the 2007 quarter compared to the 2006 quarter increased $554,000 to $9,070,000. Salaries and employee benefits increased $245,000 for the quarter ended September 30, 2007 compared to 2006. Direct salary expense was up $132,000, or 3.80%, due to annual pay adjustments and additional employees in 2007. Advertising and business development expenses increased $107,000 in comparing the quarters. The increase is due to office promotions held in 2007 for the retail area of the Bank. Outside services increased $180,000 from the third quarter of 2006. Credit card, merchants’ card and debit card processing charges increased $57,000 for the three-month period ended September 30, 2007 due to volume of card activity. Professional fees increased $128,000 in 2007 in part due to the timing of fees related to outsourced internal audit services, as noted in the nine month discussion above. Income Taxes Income tax expense as a percentage of income before taxes decreased to 30.73% in 2007 from 31.68% in 2006. Income tax expense was $177,000 less in 2007 compared to 2006 primarily due to the $381,000 decrease in income before income taxes. The amount of tax credits was $140,000 in the third quarters of both 2007 and 2006. |
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HILLS BANCORPORATION Item 2. Management’s Discussion and Analysis of Financial Condition 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 12.86% of the Company’s total assets at September 30, 2007, compared to 11.48% at December 31, 2006. 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 September 30, 2007, the Company had borrowed $265.3 million from the Federal Home Loan Bank (“FHLB”) of Des Moines. This includes four new advances in June and August 2007, each for $15 million. Also, a $20 million advance matured in June 2007. 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 $171 million at September 30, 2007. As additional sources of liquidity, the Company has the ability to borrow up to $136 million from the Federal Reserve Bank of Chicago. The Company also has lines of credit with two banks totaling $10 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, 2007. As of September 30, 2007, investment securities with a carrying value of $45,955,000 were pledged to collateralize public and trust deposits, short-term borrowings and for other purposes, as permitted by law. As of December 31, 2006, investment securities with a carrying value of $59,063,000 were pledged. Contractual Obligations As of September 30, 2007, there had been no material changes in the Company’s contractual obligations from those disclosed in its Annual Report in Form 10-K for the year ended December 31, 2006. |
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| Period | Total number of shares purchased |
Average price paid per share |
Total number of shares purchased as part of publicly announced plans or programs |
Maximum number of shares that may yet be purchased under the plans or programs (1) |
||||||
| July 1 to July 31 | 100 | $ | 52.50 | 82,649 | 667,351 | |||||
| August 1 to August 31 | 1,596 | 52.50 | 84,245 | 665,755 | ||||||
| September 1 to September 30 | 700 | 52.50 | 84,945 | 665,055 | ||||||
| Total | 2,396 | $ | 52.50 | 84,945 | 665,055 | |||||
| 31 | Certifications under Section 302 of the Sarbanes-Oxley Act of 2002 |
| 32 | Certifications under Section 906 of the Sarbanes-Oxley Act of 2002 |
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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: 11/6/07 | By: /s/ Dwight O. Seegmiller |
| Dwight O. Seegmiller, Director, President and Chief Executive Officer | |
| Date: 11/6/07 | By: /s/ James G. Pratt |
| James G. Pratt, Secretary, Treasurer and Chief Accounting Officer |
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HILLS BANCORPORATION
QUARTERLY REPORT OF FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2007 |
| Exhibit Number |
Description | Page Number In The Sequential Numbering System September 30, 2007 Form 10-Q |
|
| 31 | Certifications under Section 302 of the Sarbanes-Oxley Act of 2002 | 31 - 32 of 33 | |
| 32 | Certifications under Section 906 of the Sarbanes-Oxley Act of 2002 | 33 of 33 | |
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