-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, NjP844nRBTAUBN9SLXwS33+Fdf2hgwKBQxPbgiu7bzxRYV9IJ0H2i2HWuBZURUA/ //XN7XHKvt51R5rJRcjW9A== 0000743530-99-000015.txt : 19990325 0000743530-99-000015.hdr.sgml : 19990325 ACCESSION NUMBER: 0000743530-99-000015 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990323 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HILLS BANCORPORATION CENTRAL INDEX KEY: 0000732417 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 421208067 STATE OF INCORPORATION: IA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-12668 FILM NUMBER: 99570434 BUSINESS ADDRESS: STREET 1: 131 MAIN ST CITY: HILLS STATE: IA ZIP: 52235 BUSINESS PHONE: 3196792291 MAIL ADDRESS: STREET 1: 131 MAIN ST CITY: HILLS STATE: IA ZIP: 52235 10-K 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-k [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998. Commission File Number 0-12668. HILLS BANCORPORATION ------------------------------------------------------ (Exact name of Registrant as specified in its charter) Iowa 42-1208067 - ------------------------------- --------------------------------- (State or Other Jurisdiction of (IRS Employer Identification No.) Incorporation or Organization) 131 Main Street, Hills, Iowa 52235 ---------------------------------------- (Address of principal executive offices) Registrant's telephone number, including area code: (319) 679-2291 Securities Registered pursuant to Section 12 (b) of the Act: None Securities Registered pursuant to Section 12 (g) of the Act: No par value common stock Title of Class Indicate by check mark 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. Yes X No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Registrant S-K (229.405 of this chapter) is not contained herein, and will not be contained to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] While it is difficult to determine the market value of shares owned by nonaffiliates (within the meaning of such term under the applicable regulations of the Securities and Exchange Commission), the Registrant estimates that the aggregate market value of the Registrant's common stock held by nonaffiliates on March 12, 1999 (based upon reports of beneficial ownership that approximately 81% of the shares are so owned by nonaffiliates and upon information communicated informally to the Registrant by various purchasers and sellers that the sale price for the common stock is generally $58 per share) was $69,034,000. The number of shares outstanding of the Registrant's common stock as of March 12, 1999 is 1,469,443 shares of no par value common stock. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement dated March 22, 1999, for the Annual Meeting of the Shareholders of the Registrant to be held April 19, 1999 (the Proxy Statement) are incorporated by reference in Part III of this Form 10-K. EXHIBIT INDEX The exhibits index is on Page __. Part I Item 1. Business Hills Bancorporation (the "Company") is a multibank holding company principally engaged in the business of banking. Its three wholly-owned subsidiary banks are Hills Bank and Trust Company, Hills, Iowa ("Hills Bank and Trust"); Hills Bank, Lisbon, Iowa ("Hills Bank Lisbon"); and Hills Bank Kalona, Kalona, Iowa ("Hills Bank Kalona") (hereinafter collectively referred to as the "Banks"). The Company was incorporated December 12, 1982 and all operations are conducted within the state of Iowa. The Company became owner of 100% of the outstanding stock of Hills Bank and Trust as of January 23, 1984 when stockholders of Hills Bank and Trust exchanged their shares for shares of the Company. Effective July 1, 1996, the Company acquired for cash all the outstanding shares of Hills Bank Lisbon and on September 20, 1996, Hills Bank Kalona acquired cash, certain assets and assumed the deposits of the Kalona, Iowa office of Boatmen's Bank Iowa, N.A. The Banks are all full-service commercial banks extending their services to individuals, business, governmental units, and institutional customers primarily in the communities of Hills, Iowa City, Coralville, North Liberty, Lisbon, Mount Vernon and Kalona and the surrounding area. This area includes parts of Johnson, Linn, and Washington counties. All of the Banks are actively engaged in all areas of commercial banking, including acceptance of demand; savings and time deposits; making commercial, real estate, agricultural and consumer loans; maintaining night and safe deposit facilities; and performing collection, exchange, and other banking services tailored for individual customers. Hills Bank and Trust administers estates, personal trusts, and pension and profit-sharing funds and, in connection therewith, provides for farm management and investment advisory and custodial services for individuals, corporations and nonprofit organizations. At this time, trust services are available only at the Hills Bank and Trust locations. The loan activity of the Banks is diversified, with commercial and agricultural loans, real estate loans, automobile, installment, and other consumer loans composing the majority of its loan portfolio. In addition, the Banks earn substantial fees from originating mortgages that are sold in the secondary residential real estate market without mortgage servicing rights being maintained. Each Bank has established formal loan origination policies. In general, the loan origination policies require individual lenders to reduce the risk of credit loss to the Bank by requiring that, among other things, minimum loan to value ratios be maintained, evidence of appropriate levels of insurance be carried by borrowers and documenting appropriate types and amounts of collateral and sources of expected payment. The Banks' business is not seasonal, except that loan origination fees are higher during the spring and summer months. The Banks have not undertaken significant new services during the current year that might exceed the limits of their human resources and data processing capabilities. Iowa City, Coralville, Hills and North Liberty are located near Interstate 80 and Interstate 380 in Eastern Iowa. The communities have a population of approximately 80,000 and Johnson County, Iowa has a population of approximately 106,000. The University of Iowa has over 27,000 students and 23,000 full and part-time employees, including employees of The University of Iowa Hospitals and Clinics. Johnson County, Iowa has one of the strongest economies in Iowa and has had substantial economic growth in the past ten years. The area is known for its educational institutions, health care facilities, cultural and sports events, and retail centers. Hills Bank Lisbon is located in Lisbon, Iowa (Linn County), approximately 25 miles north of Iowa City and does not conduct business in the same trade territories as Hills Bank and Trust. Lisbon has a population of approximately 1,500 and Mount Vernon, located two miles away, has a population of 3,700. In February 1998, Hills Bank Lisbon opened a new office location in Mount Vernon. This 4,200 square foot one-story full-service location has four drive-up lanes and a drive-up automatic teller machine. Both communities are strong economically and are easy commuting distances to Cedar Rapids and Iowa City, Iowa. In addition, Mount Vernon is the home of Cornell College, which has approximately 1,200 students. Hills Bank Kalona is located in Kalona, Iowa (Washington County), approximately 20 miles south of Iowa City with a population of approximately 2,000 people. Kalona is primarily an agricultural community, but is located within easy driving distance for employment in Iowa City and Washington, Iowa. The commercial banking business is highly competitive and the Banks compete with other commercial banks, credit unions, brokerage firms, finance companies, insurance companies, and other financial institutions. Iowa's banking laws regarding interstate banking and interstate branching are currently more restrictive than many other states. As a result of the enactment of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 many of the state-imposed geographic limitations on bank ownership have been liberalized. The 1994 Act expanded opportunities for interstate banking, interstate mergers, and interstate branching in the United States. First, subject to certain limitations, bank holding companies from anywhere in the United States are able to acquire Iowa banks with the permission of the Federal Reserve Board. Second, the 1994 Act authorizes a national or state bank which has its main office in another state to merge with an Iowa bank and operate the Iowa location as a branch office. However, out-of-state bank holding companies cannot acquire Iowa commercial banks unless such banks have been in existence for at least five years. Hills Bank Kalona has been in existence since September 20, 1996. Iowa also currently has a deposit concentration limit of 10% on the amount of deposits that any one banking organization can control and continue to acquire banks, which applies to both in-state and out-of-state banks. Iowa also has a 35% limit on the aggregate amount of deposits all out-of-state banking organizations can control within Iowa. In recent years, Norwest Bank Iowa, N.A., Mercantile Bancorporation, Firstar Corporation, Commercial Federal Bank, and NationsBank have acquired a number of independent banks and smaller multibank holding companies in various metropolitan areas of Iowa. Each operates under a single charter in Iowa. In September 1998, the Company's largest competing bank in Iowa City, with assets of approximately $550 million, was acquired by Mercantile Bancorporation. Iowa's intrastate branching statutes are also rather restrictive when compared with those of other states. Generally, bank branch offices may only be operated or acquired in counties contiguous to or cornering upon the county in which the Bank has its principal place of business. Also, a bank in Iowa may not establish a new branch office in a city in which there exists an office of another bank, other than by acquisition of an existing office or bank. Effective July 1, 1998, the number of bank branch offices allowed within a municipal corporation or an urban complex is unlimited. However, some of Iowa's intrastate branching limitations regarding geographic location of branch offices and the number of branch offices which may be established in an urban complex or any other location in Iowa may be overcome by merging two or more affiliated banking organizations that have been in continuous operation in Iowa for at least five years into a "united community bank." Hills Bank and Trust Company is in direct competition for deposits, loans and other financial related business with other financial institutions in Johnson County, Iowa. The largest competitor is believed to be a branch of Mercantile Bancorporation, which does not disclose local assets. Other independent financial institutions are: Approximate Assets As Of December 31, 1998 ------------- (In Millions) Largest competing bank ........................................ $359 Next largest competing bank ................................... 125 Largest competing credit union ................................ 185 Hills Bank Kalona and Hills Bank Lisbon compete with other banks in their trade territories. Management estimates that these banks hold less than 40% of the deposits in their respective communities. No material portion of the Banks' deposits have been obtained from a single person or a few persons. Accordingly, management of the Banks have no reason to believe that the loss of the deposits of any person or few persons would have a materially adverse effect on the Banks' operations or erode its deposit base. Approximately 6.9% of the Banks' loans have been made for agricultural purposes. The agricultural sector of the economy has been cyclical with a general trend toward fewer and larger farms. The Banks have not experienced a material adverse effect on their business as a result of defaults on agricultural loans and expects none in the future. The Company does not engage in any business activities apart from its ownership of the Banks and, therefore, does not encounter any competition for its services other than as described above for the Banks. As the Year 2000 approaches, an important business issue has emerged regarding how existing application software and operating systems can accommodate this date value. Many existing application software products were developed to accommodate a two-digit year. Due to the nature of the banking industry, the subsidiary banks are heavily reliant on data processing, causing the "Year 2000" issue to be a critical issue for the Company. This issue is discussed in more detail in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations." The Company and the Banks have undertaken no material research activities during the last three years relating to research and development activities. The Company is regulated by the Federal Reserve Bank. All the Banks are regulated by the Federal Deposit Insurance Corporation and the State of Iowa Division of Banking. The Company had no employees as of December 31, 1998, and the Banks had 216 regular and 74 part-time employees. The following consolidated statistical information reflects selected balances and operations of the Company and the Banks for the periods indicated. Average refers to an average daily basis for the periods stated. The following tables show (1) average balances of assets and liabilities, (2) interest income and expense on a tax equivalent basis, (3) interest rates and differential and (4) changes in interest income and expense. AVERAGE BALANCES (Average Daily Basis) Year Ended December 31, ---------------------------- 1998 1997 1996 ---------------------------- (In Thousands) ASSETS Cash and due from banks ..................................................... $ 13,441 $ 12,689 $ 9,987 Taxable securities .......................................................... 111,099 110,542 107,106 Nontaxable securities ....................................................... 30,122 25,184 22,291 Federal funds sold .......................................................... 23,279 3,032 9,159 Loans, net .................................................................. 438,072 397,787 337,630 Property and equipment, net ................................................. 10,410 8,603 7,516 Other assets ................................................................ 16,098 14,829 11,091 ---------------------------- $642,521 $572,666 $504,780 ============================ LIABILITIES AND STOCKHOLDERS' EQUITY Noninterest-bearing demand deposits ......................................... $ 52,538 $ 48,330 $ 39,929 Interest-bearing demand deposits ............................................ 46,874 43,262 37,310 Savings deposits ............................................................ 131,988 119,282 102,849 Time deposits ............................................................... 262,111 250,241 234,825 Securities sold under agreements to repurchase and federal funds purchased .............................................. 7,974 8,740 7,607 FHLB borrowings ............................................................. 75,262 43,026 28,914 Other liabilities ........................................................... 4,250 4,255 3,509 Redeemable common stock held by Employee Stock Ownership Plan ............................................ 8,491 7,049 5,844 Stockholders' equity ........................................................ 53,033 48,481 43,993 ---------------------------- $642,521 $572,666 $504,780 ============================
PART I Item 1. Business (Continued) INTEREST INCOME AND EXPENSE Year Ended December 31, -------------------------- 1998 1997 1996 -------------------------- (In Thousands) Income: Loans (1) .................................... $ 38,039 $ 34,814 $ 29,966 Taxable securities ........................... 6,832 6,769 6,190 Nontaxable securities (1) .................... 2,112 1,845 1,692 Federal funds sold ........................... 1,209 158 485 -------------------------- Total interest income ............. 48,192 43,586 38,333 -------------------------- Expense: Interest-bearing demand deposits ............. 997 949 819 Savings deposits ............................. 4,648 4,183 3,668 Time deposits ................................ 14,813 14,162 13,275 Securities sold under agreements to repurchase 417 426 326 FHLB borrowings .............................. 4,379 2,782 1,863 -------------------------- Total interest expense ............ 25,254 22,502 19,951 -------------------------- Net interest income ............... $ 22,938 $ 21,084 $ 18,382 ========================== (1) Presented on a tax equivalent basis using a federal tax rate of 34%. PART I Item 1. Business (Continued) INTEREST RATES AND INTEREST DIFFERENTIAL Year Ended December 31, ----------------------- 1998 1997 1996 ----------------------- Average yields: Taxable securities .................................. 6.15% 6.12% 5.78% Nontaxable securities ............................... 4.63 4.84 5.01 Nontaxable securities (tax equivalent basis) ........ 7.01 7.33 7.59 Loans (1) ........................................... 8.64 8.70 8.80 Loans (tax equivalent basis) ........................ 8.68 8.75 8.87 Federal funds sold .................................. 5.19 5.21 5.30 Interest-bearing demand deposits .................... 2.13 2.19 2.20 Savings deposits .................................... 3.52 3.51 3.57 Time deposits ....................................... 5.65 5.66 5.65 Securities sold under agreements to repurchase ...... 5.23 4.87 4.29 Interest on FHLB borrowings ......................... 5.82 6.47 6.44 Yield on average interest earning assets ............ 8.00 8.12 8.05 Rate on average interest-bearing liabilities ........ 4.82 4.84 4.85 Net interest spread (2) ............................. 3.18 3.28 3.20 Net interest margin (3) ............................. 3.81 3.93 3.86 (1) Nonaccruing loans are not significant and have been included in the average loan balances for purposes of this computation. (2) Net interest spread is the difference between the yield on average interest-earning assets and the yield on average interest-paying liabilities stated on a tax equivalent basis using a federal and state tax rate of 34% and 5%, respectively, for the three years presented. (3) Net interest margin is net interest income, on a tax equivalent basis, divided by average interest-earning assets. PART I Item 1. Business (Continued) CHANGE IN INTEREST INCOME AND EXPENSE Change Due Total ------------------ ------- To Volume To Rates Change ---------------------------- (In Thousands) Year ended December 31, 1998: Change in interest income: Loans ............................................ $ 3,505 $ (280) $ 3,225 Taxable securities ............................... 32 31 63 Nontaxable securities ............................ 330 (63) 267 Federal funds sold ............................... 1,052 (1) 1,051 --------------------------- 4,919 (313) 4,606 --------------------------- Change in interest expense: Interest-bearing demand deposits ................. 75 (27) 48 Savings deposits ................................. 453 12 465 Time deposits .................................... 676 (25) 651 Securities sold under agreements to repurchase ... (39) 30 (9) Interest on FHLB borrowings ...................... 1,901 (304) 1,597 --------------------------- 3,066 (314) 2,752 --------------------------- Change in net interest income ....................... $ 1,853 $ 1 $ 1,854 =========================== Year ended December 31, 1997: Change in interest income: Loans ............................................ $ 5,259 $ (411) $ 4,848 Taxable securities ............................... 204 375 579 Nontaxable securities ............................ 213 (60) 153 Federal funds sold ............................... (319) (8) (327) --------------------------- 5,357 (104) 5,253 --------------------------- Change in interest expense: Interest-bearing demand deposits ................. 134 (4) 130 Savings deposits ................................. 578 (63) 515 Time deposits .................................... 864 23 887 Securities sold under agreements to repurchase ... 52 48 100 Interest on FHLB borrowings ...................... 910 9 919 --------------------------- 2,538 13 2,551 --------------------------- Change in net interest income ....................... $ 2,819 $ (117) $ 2,702 ===========================
Rate/volume variances are allocated on a consistent basis using the absolute values of changes in volume compared to the absolute values of the changes in rates. Loan fees included in interest income are not material. Interest on nontaxable securities and loans is shown at tax equivalent amounts. PART I Item 1. Business (Continued) LOANS The following table shows the composition of loans (before deducting the reserve for loan losses) as of December 31 for each of the last five years. December 31, ------------------------------------------------ 1998 1997 1996 1995 1994 ------------------------------------------------ (In Thousands) Agricultural ............ $ 32,318 $ 27,636 $ 23,133 $ 19,000 $ 17,826 Commercial and financial 39,438 33,616 30,650 26,810 26,024 Real estate, construction 28,476 8,157 8,846 7,937 6,933 Real estate, mortgage ... 338,871 332,655 279,134 239,899 225,342 Loans to individuals .... 30,664 28,707 33,812 31,640 30,906 ------------------------------------------------ Total ..... $469,767 $430,771 $375,575 $325,286 $307,031 ================================================ There were no foreign loans outstanding for any of the years presented MATURITY DISTRIBUTION OF LOANS The following table shows the principal payments due on loans as of December 31, 1998: Amount One Year One To Over Five Of Loans Or Less(1) Five Years Years ---------------------------------------- (In Thousands) Commercial, financial and agricultural ........................ $ 71,756 $ 32,796 $ 29,608 $ 9,352 Real estate, construction and mortgage ........................ 367,347 69,312 153,064 144,971 Other ......................................................... 30,664 10,421 19,700 543 --------------------------------------- $469,767 $112,529 $202,372 $154,866 ======================================= Interest rates on loans are as follows: Fixed rate ................................................. $308,578 $ 90,317 $194,682 $ 23,579 Variable rate .............................................. 161,189 22,212 7,690 131,287 --------------------------------------- $469,767 $112,529 $202,372 $154,866 ======================================= (1) A significant portion of the commercial loans are six-month notes. However, a significant amount of these notes are renewed when due.
PART I Item 1. Business (Continued) NONACCRUAL, PAST DUE AND RESTRUCTURED LOANS The following table summarizes the Company's nonaccrual, past due, restructured and impaired loans as of December 31 for each of the years presented: 1998 1997 1996 1995 1994 -------------------------------------- (In Thousands) Nonaccrual loans ....................... $ 12 $ - - $ 339 $ 489 $ - - Accruing loans past due 90 days or more ............................. 945 954 1,092 417 822 Restructured loans - - - - - - - - - - Impaired loans ......................... 8,956 9,556 7,811 5,465 N/A The Company does not have a significant amount of loans which are past due less than 90 days on which there are serious doubts as to the ability of the borrowers to comply with the loan repayment terms. Loans are placed on nonaccrual status when management believes the collection of future interest is not reasonably assured. Interest income was not materially affected by this classification. The Company has no individual borrower or borrowers engaged in the same or similar industry exceeding 10% of total loans. The Company has no other interest-bearing assets, other than loans, that meet the nonaccrual, past due, restructured or potential problem loan criteria. No allowance for losses has been recognized for impaired loans because partial charge-offs have been taken to reduce the loan balances to the net present value of the future cash flows or the fair value of the collateral if the loan is collateral dependent. PART I Item 1. Business (Continued) SUMMARY OF LOAN LOSS EXPERIENCE The following table summarizes the Company's loan loss experience for each of the last five years: Year Ended December 31, ------------------------------------------ 1998 1997 1996 1995 1994 ------------------------------------------ (In Thousands) Amount of loan loss allowance at beginning of year ............... $8,010 $7,311 $6,740 $6,210 $5,775 ------------------------------------------ Charge-offs: Agriculture ..................... 4 197 300 101 423 Commercial and financial ........ 431 326 236 387 334 Real estate, mortgage ........... 132 215 127 180 172 Loans to individuals ............ 401 390 308 254 131 ------------------------------------------ 968 1,128 971 922 1,060 ------------------------------------------ Recoveries: Agriculture ..................... 125 65 48 218 368 Commercial and financial ........ 256 195 95 226 206 Real estate, mortgage ........... 100 377 215 149 154 Loans to individuals ............ 417 142 80 137 126 ------------------------------------------ 898 779 438 730 854 ------------------------------------------ Net charge-offs .................... 70 349 533 192 206 ------------------------------------------ Allowances of acquired banks ....... - - - - 350 - - - - ------------------------------------------ Provision for loan losses (1) ...... 916 1,048 754 722 641 ------------------------------------------ Balance of loan loss allowance at end of year .................. $8,856 $8,010 $7,311 $6,740 $6,210 ========================================== Ratio of net charge-offs during year to average loans outstanding .... 0.02% 0.09% 0.16% 0.06% 0.07% ========================================== The balance of the loan loss allowance has not been allocated by type of loan. Management regularly reviews the loan portfolio and does not expect any unusual material amount to be charged off during 1999 that would be significantly different than the years ended December 31, 1998, 1997, 1996, 1995 and 1994. (1) For financial reporting purposes, management regularly reviews the loan portfolio and determines a provision for loan losses based upon the impact of economic conditions on the borrower's ability to repay, past collection experience, the risk characteristics of the loan portfolio and such other factors which deserve current recognition. For income tax purposes, the allowance is maintained at the maximum allowable amount. ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES The Banks review and place in risk categories specific borrowings. Based upon the risk category assigned, the Banks allocate a percentage, as determined by management, for a required allowance needed. The risk categories are similar to those used by federal and state regulatory agencies and consist of the following: (1) Potential watch and watch (2) Problem (3) Substandard (4) Doubtful In addition, each bank's management also reviews and, where determined necessary, allows for specific allowances based upon reviews of specific borrowers and provides general allowances for areas which management believes are of higher credit risk (agricultural loans and constructed model real estate homes as of December 31, 1998). A summary of the components of the allowance for loan loss, by risk category, as of December 31, 1998 and 1997 is as follows: 1998 1997 ----------------- (In Thousands) Potential watch and watch loans ............... $2,905 $2,850 Substandard ................................... 2,169 1,507 Specific borrowers (agricultural loans) ....... 1,048 1,550 Constructed model real estate homes ........... 969 682 Anticipated charge-offs of the above categories are not determinable at December 31, 1998; however, it is possible that agricultural loan charge-offs could be higher in 1999 that the historical average due to lower farm commodity prices in recent months. INVESTMENT SECURITIES The following tables show the carrying value of the investment securities as of December 31, 1998, 1997 and 1996 and the maturities and weighted average yield of the investment securities as of December 31, 1998: December 31, ---------------------------- 1998 1997 1996 ---------------------------- (In Thousands) Carrying value: U. S. Treasury securities .................................................................... $ 33,340 $ 40,189 $ 45,213 Obligations of other U. S. Government agencies and corporations .............................. 78,083 65,445 57,397 Obligations of states and political subdivisions ............................................. 33,580 27,692 23,447 Other ........................................................................................ - - - - 3,180 ---------------------------- $145,003 $133,326 $129,237 ============================
December 31, 1998 ------------------ Weighted Carrying Average Value Yield ------------------ (In Thousands) Type and maturity grouping: U. S. Treasury maturities: Within 1 year ........................................................... $ 16,847 6.15% From 1 to 5 years ....................................................... 16,493 6.19 -------- 33,340 -------- Obligations of other U. S. Government agencies and corporations, maturities: Within 1 year ........................................................... 11,369 6.36% From 1 to 5 years ....................................................... 66,513 5.89 From 5 to 10 years ...................................................... 201 7.60 -------- 78,083 -------- Obligations of states and political subdivisions, maturities: Within 1 year ........................................................... 2,841 7.16% From 1 to 5 years ....................................................... 17,263 6.78 From 5 to 10 years ...................................................... 13,170 6.71 Over 10 years ........................................................... 306 8.02 -------- 33,580 -------- Total ........................................................... $145,003 ========
INVESTMENT SECURITIES As of December 31, 1998, there were no investment securities of any issuer, other than securities of the U. S. Government and U. S. Government agencies and corporations, exceeding 10% of stockholders' equity. The weighted average yield is based on the amortized cost of the investment securities. The yields are computed on a tax-equivalent basis using a federal tax rate of 34% and a state tax rate of 5%. DEPOSITS The following tables show the average deposits and rates paid on such deposits for the years ended December 31, 1998, 1997 and 1996 and the composition of the certificates issued in denominations in excess of $100,000 as of December 31, 1998: December 31, ------------------------------------------------- 1998 Rate 1997 Rate 1996 Rate ------------------------------------------------- Average noninterest-bearing deposit $ 52,538 0.00% $ 48,330 0.00% $ 39,929 0.00% Average interest-bearing demand ... 46,874 2.13 deposits ....................... 43,262 2.19 37,310 2.20 Average savings deposits .......... 131,988 3.52 119,282 3.51 102,849 3.57 Average time deposits ............. 262,111 5.65 250,241 5.66 234,825 5.65 -------- -------- -------- $493,511 $461,115 $414,913 ======== ======== ========
Time certificates issued in amounts of $100,000 or more as of December 31, 1998 with ......... Amount Rate ---------------- maturity in: 3 months or less ............... $ 4,776 4.91% 3 through 6 months ............. 5,609 4.59 6 through 12 months ............ 11,828 5.55 Over 12 months ................. 11,444 5.93 -------- $ 33,657 ======== There were no deposits in foreign banking offices. RETURN ON STOCKHOLDERS' EQUITY AND ASSETS The following table presents the return on average stockholders' equity and average assets for the years ended December 31, 1998, 1997 and 1996: December 31, ------------------------------ 1998 1997 1996 ------------------------------ Return on assets ........................... 1.17% 1.24% 1.22% Return on stockholders' equity ............. 14.12 14.62 13.97 Dividend payout ratio ...................... 23.52 21.69 22.62 Stockholders' equity to assets ratio ....... 8.25 8.47 8.72 SHORT-TERM BORROWINGS The following table shows outstanding balances, weighted average interest rates at year end, maximum month-end balances, average month-end balances and weighted average interest rates of federal funds purchased and securities sold under agreements to repurchase during 1998, 1997 and 1996: 1998 1997 1996 --------------------------- (Amounts In Thousands) Outstanding as of December 31 ............. $10,554 $ 9,008 $ 6,071 Weighted average interest rate at year end 4.40% 4.30% 4.31% Maximum month-end balance ................. 10,547 16,104 9,112 Average month-end balance ................. 7,974 8,740 7,607 Weighted average interest rate for the year 5.23% 4.87% 4.29% FEDERAL HOME LOAN BANK BORROWINGS The following table shows outstanding month-end balances, weighted average interest rates at year end, maximum month-end balances, average month-end balances and weighted average interest rates during 1998, 1997 and 1996: 1998 1997 1996 ----------------------------- Outstanding as of December 31 ............. $75,732 $ 50,764 $ 25,795 Weighted average interest rate at year end 5.68% 6.42% 6.42% Maximum month-end balance ................. 85,764 50,764 30,826 Average month-end balance ................. 75,262 43,026 28,914 Weighted average interest rate for the year 5.82% 6.47% 6.44% PART I Item 2. Properties The Company's office and the main bank of Hills Bank and Trust is located at 131 Main Street, Hills, Iowa. This is a brick building containing approximately 14,200 square feet, a portion of which was built in 1977 and remodeled in 1986. A two-story addition was completed in 1984. The branch offices of Hills Bank and Trust are as follows: 1. Iowa City office located at 1401 South Gilbert Street is a one-story brick building containing approximately 15,400 square feet. The branch has five drive-up teller lanes and a drive-up 24-hour automatic teller machine. The Bank's trust department is located here. This building was constructed in 1982 and has been expanded several times, most recently in 1998. 2. Coralville office is a two-story building built in 1972 that contains approximately 16,700 square feet of space. This office is equipped with four drive-up teller lanes and one 24-hour automatic teller machine. 3. A 2,800 square foot branch bank in North Liberty, Iowa was opened for business in 1986 after substantial remodeling. That office is a full-service location including three drive-up teller lanes and a drive-up automatic teller machine. 4. The Bank leases an office at 132 East Washington Street in downtown Iowa City with approximately 2,500 square feet. The office has two 24-hour automatic teller machines and two private offices in addition to a tellers and customer service area. The lease expires in 2001, but the Bank has an option for an additional five years. The main office of Hills Bank Lisbon is a two-story brick building in Lisbon, Iowa with approximately 3,000 square feet of banking retail space located on the first floor. The building was extensively remodeled in 1996 and has one drive-up lane and a walk-up 24-hour automatic teller machine. Hills Bank Lisbon constructed and opened its Mount Vernon office location in February 1998 with the completion of a full service, 4,200 square foot office, with four drive-up lanes and a drive-up automatic teller machine. Hills Bank Kalona in Kalona is a 6,400 square foot building that contains a walk-up 24-hour automatic teller machine and one drive-up lane. This is an older building that has been remodeled a number of times including a major renovation in late 1998. All of the above properties, with the exception of the East Washington Street branch, which is being leased, are owned by the Bank, free and clear of any mortgages or other encumbrances of any type. Item 3. Legal Proceedings There are no material pending legal proceedings. Neither the Company nor the Banks hold any properties which are the subject of hazardous waste clean up investigations. Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of security holders for the three months ended December 31, 1998. Item 5. Market for the Registrant's Common Stock and Related Security Holder Matters There is no established trading market for the Company's common stock. Its stock is not listed with any exchange or quoted in an automated quotation system of a registered securities association, nor is there any broker/dealer acting as a market maker for its stock. A bid and ask price is quoted in an Iowa City local paper and the quotes are provided by a local broker. The Company's stock is not actively traded. As of December 31, 1998, the Company has 1,083 shareholders. Based on the Company's stock transfer records and information informally provided to the Company, its stock trading transactions have been as follows: Number High Low Of Shares Number Of Selling Selling Year Traded Transactions Price Price - ----------------- ----------- ------------- -------- -------- 1998 2,320 12 $ 58.00 $ 48.00 1997 7,314 12 48.00 40.00 1996 5,716 15 40.00 33.34 The Company paid aggregate annual cash dividends in 1998 and 1997 of $1,761,000 and $1,537,000, respectively, or $1.20 per share in 1998 and $1.05 per share in 1997. In January 1999, the Company declared and paid a dividend of $1.30 per share totaling $1,910,000. The decision to declare any such cash dividends in the future and the amount thereof rests within the discretion of the Board of Directors and will remain subject to, among other things, certain regulatory restrictions imposed on the payment of dividends by the Banks, and the future earnings, capital requirements and financial condition of the Company. Item 6. Selected Financial Data CONSOLIDATED FIVE-YEAR STATISTICAL SUMMARY 1998 1997 1996 1995 1994 ------------------------------------------------------------ YEAR-END TOTALS Total assets .................... $689,787 $603,102 $539,452 $484,607 $444,912 Investment securities ........... 149,350 138,064 132,635 121,536 110,050 Federal funds sold .............. 36,811 2,447 1,107 16,080 7,500 Loans, net ...................... 460,911 422,761 368,264 318,546 300,821 Deposits ........................ 534,151 479,770 450,061 392,257 372,838 Federal Home Loan Bank notes .... 75,732 50,764 25,795 30,727 20,758 Redeemable common stock ......... 9,301 7,682 6,416 5,271 5,210 Stockholders' equity ............ 56,452 51,500 47,335 43,277 36,447 EARNINGS Interest income ................. $ 47,289 $ 42,743 $ 37,516 $ 33,978 $ 29,583 Interest expense ................ 25,254 22,502 19,951 18,468 14,834 Provision for loan losses ....... 916 1,048 754 722 641 Other income .................... 5,811 5,938 3,868 3,438 3,311 Other expenses .................. 16,438 15,500 12,057 10,975 10,640 Applicable income taxes ......... 3,006 2,545 2,478 1,994 1,845 Net income ...................... 7,486 7,086 6,144 5,257 4,934 PER SHARE Net income: Basic ........................ $ 5.10 $ 4.83 $ 4.19 $ 3.59 $ 3.37 Diluted ...................... 5.02 4.78 4.15 3.57 3.36 Cash dividends .................. 1.20 1.05 0.95 0.87 0.80 Book value as of December 31 .... 38.42 35.08 32.30 29.57 24.91 Increase (decrease) in book value due to: ESOP obligation and debt ..... (6.33) (5.23) (4.38) (3.60) (3.56) Unrealized gains (losses) on debt securities ............ 0.81 0.33 0.46 0.20 (1.77) SELECTED RATIOS Return on average assets ........ 1.17% 1.24% 1.22% 1.14% 1.15% Return on average equity ........ 14.12 14.62 13.97 13.32 13.62 Net interest margin ............. 3.81 3.93 3.86 3.74 3.85 Average stockholders' equity to average total assets ......... 8.25 8.47 8.72 8.58 8.47 Dividend payout ratio ........... 23.52 21.69 22.62 24.12 23.83
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Special Note Regarding Forward Looking Statements The discussion following contains certain forward-looking statements with respect to the financial condition, the results of operations and business of the Company. These statements involve certain risks and uncertainties which are often inherent in the ongoing operation of financial institutions such as the Company's subsidiary banks. Forward-looking statements are typically identified by the words "believe," "expect," "anticipate," "target," "goal," "objective," "intend," "estimate," and similar expressions. The risks involved in the operations and strategies of the Company include competition from other financial institutions, changes in interest rates, changes in economic or market conditions as well as events and trends affecting specific assets, the effect of credit quality and market perceptions of value on the fair values of financial instruments, regulatory factors, and unanticipated costs associated with Year 2000 compliance. These risks, which are not inclusive, cannot be accurately estimated. For example, a financial institution may accept deposits at fixed interest rates, at different times and for different terms, and lend funds at fixed interest rates, at different times and for different terms. In doing so, it accepts the risk that its cost of funds may rise while the use of those funds may be at a fixed rate. Similarly, although market rates of interest may decline, the financial institution may have committed, by virtue of the term of a deposit, to pay what essentially becomes an above-market rate. Loans, and the reserve for loan losses, carry the risk that borrowers will not repay all funds in a timely manner, as well as the risk of total loss. The collateral pledged as security for loans may or may not have the value which has been attributed to it. The loan loss reserve, while believed to be adequate, may prove inadequate if one or more large-balance borrowers, or numerous mid-balance borrowers, or a combination of both, experience financial difficulty for a variety of reasons. These reasons may relate to the financial circumstances of an individual borrower, or may be caused by negative economic circumstances of an individual borrower, or may be caused by negative economic circumstances at the local, regional, national or international level which are beyond the control of the borrowers or the lender. Because the business of banking is of a highly regulated nature, the decisions of governmental entities can have a major effect on operating results. All of these uncertainties, as well as others, are present in the operations and business of the Company, and stockholders are cautioned that the Company's actual results may differ materially from those included in the forward-looking statements. Financial Position Year End Amounts (In Thousands) 1998 1997 1996 1995 1994 ------------------------------------------------ Loans, net of allowance for losses $460,911 $422,761 $368,264 $318,546 $300,821 Investment securities ............ 149,350 138,064 132,635 121,536 110,050 Deposits ......................... 534,151 479,770 450,061 392,257 372,838 Federal Home Loan Bank notes ..... 75,732 50,764 25,795 30,727 20,758 Stockholders' equity ............. 56,452 51,500 47,335 43,277 36,447 Total assets ..................... 689,787 603,102 539,452 484,607 444,912
In 1998, net loans increased $38.2 million, primarily in real estate mortgage loans, as demand remained high and rates continue to be attractive. The 1997 loan growth of $54.5 million was the highest in the Company's history. Total assets increased 14.37% in 1998, compared to an increase of 11.80% in 1997. The growth in assets in 1998 and 1997 was primarily attributable to strong loan demand real estate mortgage loans. Deposits increased 11.33% in 1998 compared to an increase of 6.60% in 1997, reflecting good economic conditions. Federal Home Loan Bank note borrowings in 1998 and in 1997 increased by a net $25.0 million each year and the advances were used to fund the loan growth. Components of Diluted Earnings Per Share 1998 1997 1996 ------------------------ Net interest income .......................... $14.78 $ 13.64 $ 11.87 Provision for loan losses .................... (0.61) (0.71) (0.51) Noninterest income ........................... 3.90 4.00 2.61 Noninterest expense .......................... (11.03) (10.44) (8.14) ------------------------ Income before income taxes ..... 7.04 6.49 5.83 Income tax expense ........................... (2.02) (1.71) (1.68) ------------------------ Net income ..................... $ 5.02 $ 4.78 $ 4.15 ======================== In 1998, the increase in net income was due primarily to increased net interest income, primarily resulting from a large increase in earning assets. The 1998 increase in noninterest income, when excluding gains on sale of investment securities and student loans, totaled $967,000. Higher net income per share in 1997 resulted from increases in net interest income and noninterest income, but was partially offset by higher noninterest expense. Both noninterest income and noninterest expense for 1997 included the recognition of a $1,054,000 gain on the contribution of a marketable equity security to Hills Bancorporation Foundation, a private charitable foundation. As a result of the stock contribution, Hills Bancorporation received an income tax benefit of approximately $340,000, which reduced income tax expense. In recent years, the Company has benefited from low provisions for loan losses, a result of a strong local economy and a loan portfolio that is concentrated in well secured real estate loans. Net Interest Income Net interest income is the excess of the interest and fees received on interest-earning assets over the interest expense of the interest-bearing liabilities. The measure is shown on a tax-equivalent basis to make the interest earned on taxable and nontaxable assets more comparable. Net interest income on a tax-equivalent basis changed in 1998 as follows: INTEREST INCOME ----------------------------------------------- Increase (Decrease) Change In Change In -------------------------- Average Average Volume Rate Net Balance Rate Change Changes Changes ----------------------------------------------- (Amounts In Thousands) Loans, net .................... $ 40,285 (0.07) $ 3,505 $ (280) $ 3,225 Taxable securities ............ 557 0.03 32 31 63 Nontaxable securities ......... 4,938 (0.23) 330 (63) 267 Federal funds sold ............ 20,247 (0.02) 1,052 (1) 1,051 ---------------------------------------------- $ 66,027 $ 4,919 $ (313) $ 4,606 ======== =========================== INTEREST EXPENSE ---------------------------------------------- Interest-bearing demand deposits $ 3,612 (0.06) $ 75 $ (27) $ 48 Savings deposits ............... 12,706 0.01 453 12 465 Time deposits .................. 11,870 (0.01) 676 (25) 651 Securities sold under agreements to repurchase ................ (766) 0.36 (39) 30 (9) FHLB borrowings ................ 32,236 (0.65) 1,901 (304) 1,597 -------- --------------------------- $ 59,658 $ 3,066 $ (314) $ 2,752 ======== =========================== Change in net interest income .. $ 1,853 $ 1 $ 1,854 =========================== A summary of the net interest spread and margin is as follows: (Tax Equivalent Basis) 1998 1997 1996 - -------------------------------------------------------------------------------- Yield on average interest-earning assets ........... 8.00% 8.12% 8.05% Rate on average interest-bearing liabilities ....... 4.82 4.84 4.85 --------------------- Net interest spread ................................ 3.18 3.28 3.20 Effect of noninterest-bearing funds ................ 0.63 0.65 0.66 --------------------- Net interest margin (tax equivalent interest income divided by average interest-earning assets) ..... 3.81% 3.93% 3.86% ===================== Loan Losses The provision for loan losses was $916,000, $1,048,000 and $754,000 for 1998, 1997 and 1996, respectively. Charge-offs, net of recoveries were $70,000 for 1998, $349,000 for 1997 and $533,000 for 1996. The allowance for loan losses totaled $8,856,000 at December 31, 1998 compared to $8,010,000 at December 31, 1997. The percentage of the allowance to outstanding loans was 1.89% and 1.86% at December 31, 1998 and 1997, respectively. Agricultural loans totaled $32,318,000 at December 31, 1998. Management has assessed the risks for agricultural loans higher than the other loans due to unpredictable commodity prices, the effects of weather on crops, and uncertainties regarding government support programs. Therefore, the allowance for loan losses includes general and specific reserves for these loans. The economy remains strong in the Banks' trade areas of Johnson, Washington and Linn Counties, Iowa. Unemployment remains quite low in the Bank's trade territory and, for the most part, area businesses have maintained stable employment levels. The allowance for loan losses is an estimate by the Banks to reserve for loan losses based upon management's evaluation of the total loan portfolio and current economic conditions. There are no known trends or uncertainties that are reasonably likely to have a material effect on the allowance for loan losses in the near-term. Other Income Dollars Per Share, Based on Weighted Average Diluted Shares Outstanding 1998 1997 1996 - -------------------------------------------------------------------------- Real estate origination fees .................. $ 0.54 $ 0.26 $ 0.22 Trust fees .................................... 1.17 0.92 0.61 Deposit account charges and fees .............. 1.23 1.28 1.11 Other fees and charges ........................ 0.96 0.81 0.71 Other (sale of portfolio) ..................... - - 0.10 - - Investment securities gains (losses) .......... - - 0.63 (0.04) ------------------------ $ 3.90 $ 4.00 $ 2.61 ======================== Total other income increased $2,070,000 or 53.5% in 1997, including net gains on sale of investment securities of $940,000, which included a $1,054,000 gain on the sale of a marketable equity security. Additional increases were $455,000 in trust fees, $248,000 in deposit account charges and fees, $153,000 in other fees and charges and $154,000 gain on the sale of the student loan portfolio of approximately $8 million. Trust fees increased in 1997 and 1996 because of new accounts and balances under management. There were $940,000 in investment securities gains in 1997 following losses of $57,000 in 1996. In 1998, total other income increased $967,000 on a comparable basis to 1997 after adjusting for investment securities gain in 1997 of $940,000 and $154,000 gain on the sale of student loan portfolio. Due to the lower interest rate environment in 1998, loan origination fees increased $412,000 over the 1997 amount of $387,000. In addition, trust fees increased $380,000 due to new accounts and higher balances under management. Other Expenses Dollars Per Share, Based on Weighted Average Diluted Shares Outstanding 1998 1997 1996 - -------------------------------------------------------------------------------- Salaries and employees benefits ..................... $ 5.75 $ 4.79 $ 4.15 Occupancy ........................................... 0.76 0.68 0.60 Furniture and equipment ............................. 1.13 0.96 0.75 Office supplies and postage ......................... 0.79 0.60 0.55 Contributions ....................................... 0.03 0.75 0.06 Other ............................................... 2.57 2.66 2.03 ------------------------ $11.03 $10.44 $ 8.14 ======================== Salaries and benefits increased $1,457,000 in 1998 compared to 1997. The Banks have continued to add positions in the retail sector of the Banks, including the Trust Department, as a result of increased business. At the end of 1998, full time equivalent employees totaled 253, an increase of 30 since December 31, 1997. Included in the 1998 increase are new personnel located at the Mount Vernon office of Hills Bank Lisbon, which opened in February 1998. Occupancy and furniture and equipment expenses increased $378,000 in 1998, or 15.45% over 1997 due to depreciation on the new office in Mount Vernon, a new computer hardware and software system installed in the first quarter of 1998, and expenses related to the Year 2000 computer changes which totaled approximately $88,000. Total other expenses increased $938,000 or 6.05% in 1998 following increases of 28.60% for 1997 and 9.86% for 1996. Contributions for 1997 includes the $1,054,000 contribution to the Hills Bancorporation Foundation. Salaries and employee benefits increased $981,000 in 1997 due to a full year of salaries for personnel at the two banks acquired during 1996 and the number of full-time equivalent employees increasing by 23 from December 31, 1996. In 1996 an increase of $645,000 in salaries and employee benefits was partially offset by a decrease of $416,000 in FDIC insurance after the first full year in which the lower FDIC insurance rates became effective. Salaries increased $487,000 in 1996, due partly to an increase of 28 full-time equivalent employees, primarily attributable to additional positions added at the acquired banks. The increase in employees occurred in early July and late September 1996. Medical insurance has had only modest increases in the past three years. Occupancy expense and furniture and equipment expense increased by $438,000 in 1997 due to this being the first full year of operations for the banks acquired in 1996 and the acquisition of new data processing equipment. Income Taxes Income tax expense was $3,006,000, $2,545,000 and $2,478,000 for the years ended December 31, 1998, 1997 and 1996, respectively. The corresponding percentage of tax expense compared to income before income taxes is 28.65% in 1998, 26.40% in 1997 and 28.70% in 1996. Income tax expense for 1997 was 26.4% of pretax income, compared to an average of 28.6% for other years, due to contributions. Impact of Recently Issued Accounting Standards During 1998 and for the next few years, new accounting pronouncements that have been issued will take effect and others are expected. These are summarized below. Statement No. 130, which was adopted in 1998, requires "other comprehensive income" and "comprehensive income" to be displayed along with net income. Other comprehensive income includes changes in unrealized gains and losses on available for sale securities, the offset of some pension liabilities currently recorded as reductions in equity, foreign currency translation, and in the future will also include deferred hedging gains and losses. Comprehensive income is net income plus other comprehensive income. Statement No. 131 for public companies redefines segment reporting to follow how each company's chief operating decision maker gets information about business segments to make operating decisions. Since the Company does business in one segment, this standard had no effect on the Company's financial statements. Statement No. 132 increases and revises pension plan disclosures for public companies, and simplifies such disclosures for nonpublic companies. This statement had no effect on the Company's financial statements in 1998. Statement No. 133 on derivatives will, in 2000, require all derivatives to be recorded at fair value in the balance sheet, with changes in fair value run through income. If derivatives are documented and effective as hedges, the change in the derivative fair value will be offset by an equal change in the fair value of the hedged item. Statement No. 134 on mortgage banking will, in 1999, allow mortgage loans that are securitized to be classified as trading, available for sale, or in certain circumstances held to maturity. Currently these must be classified as trading. Interest Rate Sensitivity and Liquidity Analysis At December 31, 1998, the Company's interest rate sensitivity report is as follows (in thousands): Repricing Days Maturities ----------------------------------------- More Than Immediately 2-30 31-90 91-180 181-365 One Year Total ---------------------------------------------------------------------------- Earning assets: Federal funds sold $ 36,811 $ - - $ - - $ - - $ - - $ - - $ 36,811 Investment securities ..... - - 2,295 5,600 9,590 13,249 118,616 149,350 Loans ............. - - 43,409 24,218 31,101 53,463 317,576 469,767 -------------------------------------------------------------------------- Total earning assets .... 36,811 45,704 29,818 40,691 66,712 436,192 655,928 -------------------------------------------------------------------------- Sources of funds: Interest-bearing checking and savings accounts 66,708 - - - - - - - - 130,765 197,473 Certificates of deposit ........ - - 15,106 16,033 24,034 94,555 118,850 268,578 Other borrowings - FHLB ........... - - - - - - 7,000 15,000 53,732 75,732 Repurchase agreements ..... 10,554 - - - - - - - - - - 10,554 -------------------------------------------------------------------------- 77,262 15,106 16,033 31,034 109,555 303,347 552,337 Other sources, primarily noninterest- bearing ........ - - - - - - - - - - 103,591 103,591 -------------------------------------------------------------------------- Total sources 77,262 15,106 16,033 31,034 109,555 406,938 655,928 -------------------------------------------------------------------------- Repricing differences .... $(40,451) $ 30,598 $ 13,785 $ 9,657 $(42,843) $ 29,254 $ - - ==========================================================================
A portion of the interest-bearing checking, savings, and money market accounts has been included in the above table as maturing immediately based upon management's estimate using a financial model and the rest of these deposits are shown as more than one year. The classifications are used because the Banks' historical data indicates that these have been very stable deposits without much interest rate fluctuation. Historically, these accounts would not need to be adjusted upward as quickly in a period of rate increases so the interest risk exposure would be less than the repricing schedule indicates. Inflation Inflation has an impact on the growth of total assets and has resulted in the need to increase equity capital to maintain an appropriate equity to asset ratio. The results of operations have been affected by inflation, but the effect has been minimal. Liquidity and Capital Resources On an unconsolidated basis, Hills Bancorporation (the holding company) had cash balances of $698,000 as of December 31, 1998. In 1998, the holding company received dividends of $2,762,000 from its subsidiary banks and used those funds to make a $1,000,000 capital contribution to a subsidiary bank and to pay dividends to its stockholders of $1,761,000. As of December 31, 1998 and 1997, stockholders' equity before deducting for the maximum cash obligation related to ESOP was $65,753,000 and $59,182,000, respectively. This measure of equity as a percent of total assets was 9.53% at December 31, 1998 and 9.81% at December 31, 1997. These ratios are comparable with the Company's peers. As of December 31, 1998, total equity was 8.18% of assets compared to 8.54% of assets at the prior year end. The ability of the Company to pay dividends to its shareholders is dependent upon the earnings and capital adequacy of the subsidiaries banks, which affects the Banks' dividends to the Company. The Banks are subject to certain statutory and regulatory restrictions on the amount they may pay in dividends. In order to maintain acceptable capital ratios in the subsidiary banks, certain of their retained earnings are not available for the payment of dividends. Retained earnings available for the payment of dividends to the Company total approximately $3,632,000 as of December 31, 1998. The Company and the Banks are subject to the Federal Deposit Insurance Corporation Improvement Act of 1991 and the Banks are subject to Prompt Corrective Action Rules as determined and enforced by the Federal Reserve. These regulations establish minimum capital requirements which member banks must maintain. As of December 31, 1998, risk-based capital standards require 8% of risk-weighted assets. At least half of that 8% must consist of Tier I core capital (common stockholders' equity, noncumulative perpetual preferred stock, and minority interest in the equity accounts of consolidated subsidiaries), and the remainder may be Tier II supplementary capital (perpetual debt, intermediate-term preferred stock, cumulative perpetual, long-term and convertible preferred stock, and loan loss reserve up to a maximum of 1.25% of risk-weighted assets). Total risk-weighted assets are determined by weighing the assets according to their risk characteristics. Certain off-balance sheet items (such as standby letters of credit and firm loan commitments) are multiplied by "credit conversion factors" to translate them into balance sheet equivalents before assigning them risk weightings. Any bank having a capital ratio less than the 8% minimum required level must, within 60 days, submit to the Federal Reserve a plan describing the means and schedule by which the Bank shall achieve the applicable minimum capital ratios. A comparison of the Company's capital as of December 31, 1998 with minimum requirements is presented below: Minimum Actual Requirements ----------------------- Tier I Risk-Based Capital ........................ 13.87% 4% Total Risk-Based Capital ......................... 15.13 8 Leverage Ratio ................................... 9.15 3 Each of the Banks is classified as "well capitalized" by FDIC capital guidelines. On a consolidated basis, 1998 cash flows from operations provided $8,693,000, net increases in deposits provided $54,381,000 and Federal Home Loan Bank borrowings provided $24,968,000. These cash flows were invested in net loans of $39,066,000, net securities of $10,473,000 and net federal funds sold of $34,364,000. In addition, $3,081,000 was used to purchase property and equipment. At December 31, 1998, the Company had total outstanding loan commitments of $93,920,000. Management believes that its liquidity levels are appropriate and that it has borrowing capacity from the Federal Home Loan Bank and other sources. Commitments and Trends The Company has no material commitments or plans which will materially affect its liquidity or capital resources. Property and equipment may be acquired in cash purchases, or they may be financed if favorable terms are available. Year 2000 The Year 2000 poses an important business issue regarding how existing application software programs and operating systems can accommodate this date value. Many computer programs that can only distinguish the final two digits of the year entered are expected to read entries for the Year 2000 as the Year 1900. Like most financial service providers, the Company may be significantly affected by the Year 2000 issue due to the nature of financial information. Software, hardware and equipment both within and outside the Company's direct control and with whom the Company electronically or operationally interfaces are likely to be affected. If computer systems are not adequately changed to identify the Year 2000, many computer applications could fail or create erroneous results. As a result, many calculations that rely on the data field information, such as interest, payment or due dates and other operating functions, may generate results that could be significantly misstated, and the Company could experience a temporary inability to process transactions and engage in normal business activities. All of the significant computer programs of the Company that could be affected by this issue are provided by major third-party vendors. In 1998, the Company completed the replacement/upgrading of most of its computer systems and programs, as well as most equipment, in order to provide cost-effective and efficient delivery of services to its customers, information to management, and to provide additional capacity for processing information and transactions due to acquisitions. The third-party vendors have advised the Company that all such computer systems and programs either are or shortly will be Year 2000 compliant. The Company completed off-site testing of its major applications in 1998. The total cost of the Year 2000 project in 1998 was approximately $1,180,000 for capitalized hardware and software and an additional $88,000 in expenses charged to earnings in 1998. Management estimates the cost of the remediation effort to make the Company's systems Year 2000 ready will be approximately $40,000 to be charged to expense in 1999 and $105,000 to be capitalized in 1999. In addition, it is estimated that 2,000 man hours will be incurred by Company personnel related to Year 2000 issues at an approximate cost of $40,000. Such costs will be charged to expense as they are incurred. The Company is developing a Year 2000 contingency plan that addresses, among other issues, critical operations and potential failures thereof, and strategies for business continuation. The contingency plan includes back up power sources, off-site processing of data and a detailed listing of responsibilities among various employees of their contingency plan duties. The plan is expected to be finalized during the third quarter of 1999. The Company could incur losses if loan payments are delayed due to Year 2000 problems affecting significant borrowers. The Company is communicating with such parties to assess their progress is evaluating and implementing any corrective measures required by them to be Year 2000 ready. To date, the Company has been advised by such parties that they have plans in place to address and correct the issues associated with the Year 2000 problem; however, no assurance can be given as to the adequacy of such plans or to the timeliness of their implementation. As part of the current credit approval process, new and renewed loans are evaluated as to the borrower's Year 2000 readiness. Management does not anticipate significant loan losses related to this issue. Although management believes the Company's computer systems and service providers will be Year 2000 ready, there can be no assurance that these systems, or those systems of other companies on which the Company's systems rely, will be fully functional in the Year 2000. Such failure could have a significant adverse impact on the financial condition and results of operations of the Company. In addition, there could be a material effect to the financial statements if there are significant interruptions in basic services, such as the electric power grid, telephone services or the banking system. These risks cannot be estimated. Item 7A. Quantitative and Qualitative Disclosures About Market Risk Market Risk Exposures The Company's primary market risk exposure is to changes in interest rates. The Company's asset/liability management, or its management of interest rate risk, is focused primarily on evaluating and managing net interest income given various risk criteria. Factors beyond the Company's control, such as market interest rates and competition, may also have an impact on the Company's interest income and interest expense. In the absence of other factors, the Company's overall yield on interest-earning assets will increase as will its cost of funds on its interest-bearing liabilities when market rates increase over an extended period of time. Inversely, the Company's yields and cost of funds will decrease when market rates decline. The Company is able to manage these swings to some extent by attempting to control the maturity or rate adjustments of its interest-earning assets and interest-bearing liabilities over given periods of time. The Banks maintain an asset/liability committee which meets at least quarterly to review the interest rate sensitivity position and to review various strategies as to interest rate risk management. In addition, the Banks use a simulation model to review various assumptions relating to interest rate movement. The model attempts to limit rate risk even if it appears the Banks' asset and liability maturities are perfectly matched and a favorable interest margin is present. In order to minimize the potential effects of adverse material and prolonged increases or decreases in market interest rates on the Company's operations, management has implemented an asset/liability program designed to mitigate the Company's interest rate sensitivity. The program emphasizes the origination of adjustable rate loans, which are held in the portfolio, the investment of excess cash in short or intermediate term interest-earning assets, and the solicitation of passbook or transaction deposit accounts which are less sensitive to changes in interest rates and can be repriced rapidly. Based on the data following, net interest income should decline with instantaneous increases in interest rates while net interest income should increase with instantaneous declines in interest rates. Generally, during periods of increasing interest rates, the Company's interest rate sensitive liabilities would reprice faster than its interest rate sensitive assets causing a decline in the Company's interest rate spread and margin. This would result from an increase in the Company's cost of funds that would not be immediately offset by an increase in its yield on earning assets which would tend to reduce net interest income. In times of decreasing interest rates, fixed rate assets could increase in value and the lag in repricing of interest rate sensitive assets could be expected to have a positive effect on the Company's net interest income. The following table provides quantitative information with respect to interest sensitive assets and liabilities. The following table provides information about the Company's loans, investment securities and deposits that are sensitive to changes in interest rates. The table presents principal cash flows and related weighted average interest rates by expected maturity dates. 1999 2000 2001 2002 2003 Thereafter Total Fair Value ------------------------------------------------------------------------------ Assets: Loans, fixed: Balance $ 90,317 $ 42,903 $ 53,879 $ 33,238 $ 64,662 $ 23,579 $308,578 $316,248 Average interest rate 8.18 8.32 8.27 8.39 7.85 7.09 8.08 Loans, variable: Balance $ 22,212 $ 1,819 $ 1,587 $ 2,763 $ 1,521 $131,287 $161,189 $161,189 Average interest rate 9.39 9.06 9.11 8.72 8.84 8.02 8.25 Investments (1): Balance $ 67,277 $ 32,893 $ 45,521 $ 11,282 $ 9,870 $ 19,318 $186,161 $186,733 Average interest rate 5.86 6.20 5.97 6.24 6.39 6.75 6.09 Liabilities: Liquid deposits (2): Balance $197,473 $ - - $ - - $ - - $ - - $ - - $197,473 $197,473 Average interest rate 2.94 - - - - - - - - - - 2.94 Deposits, certificates: Balance $149,728 $ 86,470 $ 15,537 $ 6,976 $ 9,867 $ - - $268,578 $271,231 Average interest rate 5.44 5.71 5.62 5.70 5.75 - - 5.56 (1) Includes all available-for-sale investments, held-to-maturity investments, and federal funds. (2) Includes passbook accounts, NOW accounts, Super NOW accounts, and money market funds.
Item 8. Financial Statements and Supplementary Data The financial statements are included on Pages 34 through 62. The Company does not meet the requirements of Item 302 of Regulation S-K to include the supplementary financial information required by that item. Independent Auditor's Report To the Board of Directors and Stockholders Hills Bancorporation Hills, Iowa We have audited the accompanying consolidated balance sheets of Hills Bancorporation and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income, comprehensive income, stockholders' equity, and cash flows for the years ended December 31, 1998, 1997 and 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Hills Bancorporation and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for the years ended December 31, 1998, 1997 and 1996 in conformity with generally accepted accounting principles. /s/ McGladrey & Pullen, LLP Iowa City, Iowa February 3, 1999 Hills Bancorporation Consolidated Balance Sheets December 31, 1998 and 1997 (In Thousands, Except Shares) ASSETS 1998 1997 - --------------------------------------------------------------------------------------------------------------- Cash and due from banks (Note 9) .......................................................... $ 16,427 $ 15,508 Investment securities (Note 2): Available for sale (amortized cost 1998 $121,954; 1997 $108,718) ....................... 123,835 109,486 Held to maturity (fair value 1998 $21,740; 1997 $24,230) ............................... 21,168 23,840 Stock of Federal Home Loan Bank ........................................................ 4,347 4,738 Federal funds sold ........................................................................ 36,811 2,447 Loans, net (Notes 3 and 10) ............................................................... 460,911 422,761 Property and equipment, net (Note 4) ...................................................... 11,193 9,437 Accrued interest receivable ............................................................... 5,885 5,441 Deferred income taxes, net (Note 8) ....................................................... 1,838 1,859 Other assets .............................................................................. 7,372 7,585 ------------------ $689,787 $603,102 ================== LIABILITIES AND STOCKHOLDERS' EQUITY - --------------------------------------------------------------------------------------------------------------- Liabilities Noninterest-bearing deposits ........................................................... $ 68,100 $ 52,174 Interest-bearing deposits (Note 5) ..................................................... 466,051 427,596 ------------------ Total deposits .............................................................. 534,151 479,770 Securities sold under agreements to repurchase ......................................... 10,554 9,008 Federal Home Loan Bank notes (Note 6) .................................................. 75,732 50,764 Accrued interest payable ............................................................... 2,048 2,060 Other liabilities ...................................................................... 1,549 2,318 ------------------ 624,034 543,920 ------------------ Commitments and Contingencies (Notes 7 and 13) Redeemable Common Stock Held By Employee Stock Ownership Plan (ESOP) (Note 7) ......................................................... 9,301 7,682 ------------------ Stockholders' Equity (Note 9) Capital stock, no par value; authorized 10,000,000 shares; issued 1998 1,469,443 shares; 1997 1,467,754 shares ................................. 9,140 9,070 Retained earnings ...................................................................... 55,428 49,627 Accumulated other comprehensive income, unrealized gains on debt securities, net ............................................................ 1,185 485 ------------------ 65,753 59,182 Less maximum cash obligation related to ESOP shares (Note 7) 9,301 7,682 ------------------ 56,452 51,500 ------------------ $689,787 $603,102 ==================
See Notes to Financial Statements. Hills Bancorporation Consolidated Statements of Income Years Ended December 31, 1998, 1997 and 1996 (In Thousands, Except Per Share Amounts) 1998 1997 1996 - ------------------------------------------------------------------------------------------------ Interest and fees on loans ................................... $ 37,854 $ 34,598 $ 29,724 Interest on investment securities: Taxable ................................................... 6,832 6,769 6,190 Nontaxable ................................................ 1,394 1,218 1,117 Interest on federal funds sold ............................... 1,209 158 485 ----------------------------- Total interest income ............................. 47,289 42,743 37,516 ------------------------------ Interest expense: Interest on deposits ......................................... 20,458 19,294 17,762 Interest on securities sold under agreements to repurchase ... 417 426 326 Interest on FHLB borrowings .................................. 4,379 2,782 1,863 ----------------------------- Total interest expense ............................ 25,254 22,502 19,951 ----------------------------- Net interest income ............................... 22,035 20,241 17,565 Provision for loan losses (Note 3) .............................. 916 1,048 754 ----------------------------- Net interest income after provision for loan losses 21,119 19,193 16,811 ----------------------------- Other income: Loan origination fees ........................................ 799 387 324 Trust fees ................................................... 1,743 1,363 908 Deposit account charges and fees ............................. 1,828 1,893 1,645 Other fees and charges ....................................... 1,441 1,201 1,048 Net gains (losses) on sale of investment securities (Note 2) - - 940 (57) Other ........................................................ - - 154 - - ---------------------------- 5,811 5,938 3,868 ---------------------------- Other expenses: Salaries and employee benefits ............................... 8,575 7,118 6,137 Occupancy .................................................... 1,137 1,017 891 Furniture and equipment ...................................... 1,687 1,429 1,117 Office supplies and postage .................................. 1,178 889 819 Contributions ................................................ 39 1,118 88 Other ........................................................ 3,822 3,929 3,005 ---------------------------- 16,438 15,500 12,057 ---------------------------- Income before income taxes ........................ 10,492 9,631 8,622 Federal and state income taxes (Note 8) ......................... 3,006 2,545 2,478 ---------------------------- Net income ........................................ $ 7,486 $ 7,086 $ 6,144 ============================ Earnings per share: Basic ........................................................ $ 5.10 $ 4.83 $ 4.19 Diluted ...................................................... 5.02 4.78 4.15
See Notes to Financial Statements. Hills Bancorporation Consolidated Statements of comprehensive income Years Ended December 31, 1998, 1997 and 1996 (In Thousands) 1998 1997 1996 - ------------------------------------------------------------------------------------------------ Net income ........................................................... $ 7,486 $ 7,086 $ 6,144 ------------------------- Other comprehensive income, net of income taxes: Unrealized holding gains arising during the year, net of income taxes 1998 $413; 1997 $202; 1996 $173 ............ 700 464 340 Reclassification adjustments for net (gains) losses realized in net income, net of income taxes 1998 none; 1997 $(285); 1996 $19 ... - - (655) 38 ------------------------- Other comprehensive income (loss) ...................... 700 (191) 378 ------------------------- Comprehensive income ................................... $ 8,186 $ 6,895 $ 6,522 =========================
See Notes to Financial Statements. Hills Bancorporation Consolidated Statements of stockholders' equity (Notes 7 and 9) Years Ended December 31, 1998, 1997 and 1996 (In Thousands, Except Share Amounts) Less Maximum Accumulated Cash Other Obligation Capital Retained Comprehensive To ESOP Stock Earnings Income Shares Total - --------------------------------------------------------------------------------------------- Balance, December 31, 1995 ........ $ 8,925 $39,325 $ 298 $(5,271) $43,277 Issuance of 1,936 shares of common stock ................ 77 - - - - - - 77 Redemption of 156 shares of common stock ............. (5) - - - - - - (5) Change related to ESOP shares .. - - - - - - (1,145) (1,145) Net income ..................... - - 6,144 - - - - 6,144 Cash dividends ($.95 per share) - - (1,391) - - - - (1,391) Other comprehensive income ..... - - - - 378 - - 378 ------------------------------------------------------- Balance, December 31, 1996 ........ 8,997 44,078 676 (6,416) 47,335 Issuance of 2,993 shares of common stock ................ 97 - - - - - - 97 Redemption of 623 shares of common stock ............. (24) - - - - - - (24) Change related to ESOP shares .. - - - - - - (1,266) (1,266) Net income ..................... - - 7,086 - - - - 7,086 Cash dividends ($1.05 per share) - - (1,537) - - - - (1,537) Other comprehensive income ..... - - - - (191) - - (191) ------------------------------------------------------- Balance, December 31, 1997 ........ 9,070 49,627 485 (7,682) 51,500 Issuance of 1,931 shares of common stock ................ 78 - - - - - - 78 Redemption of 242 shares of common stock ............. (8) - - - - - - (8) Change related to ESOP shares .. - - - - - - (1,619) (1,619) Net income ..................... - - 7,486 - - - - 7,486 Income tax benefit related to stock based compensation .... - - 76 - - - - 76 Cash dividends ($1.20 per share) - - (1,761) - - - - (1,761) Other comprehensive income ..... - - - - 700 - - 700 ------------------------------------------------------- Balance, December 31, 1998 ........ $ 9,140 $55,428 $ 1,185 $(9,301) $56,452 =======================================================
See Notes to Financial Statements. Hills Bancorporation Consolidated Statements of Cash Flows Years Ended December 31, 1998, 1997 and 1996 (In Thousands) 1998 1997 1996 - ---------------------------------------------------------------------------------------------------------------- Cash Flows from Operating Activities Net income .................................................................. $ 7,486 $ 7,086 $ 6,144 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation ............................................................. 1,325 1,143 884 Amortization ............................................................. 261 261 133 Provision for loan losses ................................................ 916 1,048 754 Net (gains) losses on disposition of investment securities ............... (940) 57 Compensation paid by issuance of common stock ............................ 70 73 72 Contribution of investment securities .................................... 1,054 Deferred income taxes .................................................... (15) (417) (77) (Increase) in accrued interest receivable ................................ (444) (557) (121) Amortization of bond discount ............................................ 300 378 454 (Increase) decrease in other assets ...................................... (425) (88) 1,589 Increase (decrease) in accrued interest and other liabilities ............ (781) 603 505 ------------------------------ Net cash provided by operating activities ........................ 8,693 9,644 10,394 ------------------------------ Cash Flows from Investing Activities Proceeds from maturities of investment securities: Available for sale ....................................................... 27,300 21,292 22,353 Held to maturity ......................................................... 2,607 2,590 4,069 Proceeds from sales of available-for-sale securities ........................ - - 16,411 10,988 Purchases of investment securities: Available for sale ....................................................... (40,380) (42,083) (37,026) Held to maturity ......................................................... - - (4,404) (4,784) Federal funds sold, net ..................................................... (34,364) (1,340) 26,421 Loans made to customers, net of collections ................................. (39,066) (55,545) (29,807) Purchases of property and equipment ......................................... (3,081) (2,171) (859) Purchase of subsidiary banks, net of cash acquired (Note 14) ................ - - - - (7,163) ------------------------------ Net cash (used in) investing activities .......................... (86,984) (65,250) (15,808) ------------------------------ Cash Flows from Financing Activities Net increase in deposits .................................................... 54,381 29,709 18,938 Net increase (decrease) in securities sold under agreements to repurchase ............................................................ 1,546 2,937 (3,948) Borrowings from FHLB ........................................................ 40,000 30,000 - - Payments on FHLB notes ...................................................... (15,032) (5,031) (5,032) Income tax benefits related to stock based compensation ..................... 76 Dividends paid .............................................................. (1,761) (1,537) (1,391) ------------------------------ Net cash provided by financing activities ........................ 79,210 56,078 8,567 ------------------------------ Increase in cash and due from banks .............................. $ 919 $ 472 $ 3,153 Cash and due from banks: Beginning ................................................................... 15,508 15,036 11,883 ------------------------------ Ending ...................................................................... $ 16,427 $ 15,508 $ 15,036 ============================== Supplemental Disclosures Cash payments for: Interest paid to depositors and others ................................... $ 20,470 $ 19,186 $ 17,848 Interest paid on other obligations ....................................... 4,796 3,208 2,189 Income taxes ............................................................. 3,544 2,942 2,565 Noncash financing transactions: Increase in maximum cash obligation related to ESOP shares ............................................................ 1,619 1,266 1,145 Available-for-sale investment securities transferred as a charitable contribution ........................................... - - 1,054 - - Purchase business acquisitions (Note 14)
See Notes to Financial Statements. Hills Bancorporation Notes to Financial Statements - -------------------------------------------------------------------------------- Note 1. Nature of Activities and Significant Accounting Policies Nature of activities: Hills Bancorporation (the "Company") is a multibank holding company engaged in the business of banking. The Company's three wholly-owned subsidiary commercial banks are Hills Bank and Trust Company, Hills, Iowa, Hills Bank, Lisbon, Iowa, and Hills Bank Kalona, Kalona, Iowa. The Banks are all full-service commercial banks extending their services to individuals, businesses, governmental units, and institutional customers primarily in the communities of Hills, Iowa City, Coralville, North Liberty, Lisbon, Mount Vernon, and Kalona, Iowa. The Banks compete with other financial institutions and nonfinancial institutions providing similar financial products. Although the loan activity of the Banks is diversified with commercial and agricultural loans, real estate loans, automobile, installment and other consumer loans, each Bank's credit is concentrated in real estate loans. Accounting estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain significant estimates: The allowance for loan losses, fair values of securities and other financial instruments, and stock-based compensation expense involve certain significant estimates made by management. These estimates are reviewed by management routinely and it is reasonably possible that circumstances that exist at December 31, 1998 may change in the near-term future and that the effect could be material to the consolidated financial statements. Principles of consolidation: The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Investment securities: Held-to-maturity securities consist solely of debt securities which the Company has the positive intent and ability to hold to maturity and are stated at amortized cost. Available-for-sale securities consist of debt securities and marketable equity securities not classified as trading or held to maturity. Available-for-sale securities are stated at fair value, and unrealized holding gains and losses, net of the related deferred tax effect, are reported as a separate component of stockholders' equity. There were no trading securities as of December 31, 1998 and 1997. Stock of the Federal Home Loan Bank is carried at cost. Premiums and discounts on debt securities are amortized over the contractual lives of those securities. The method of amortization results in a constant effective yield on those securities (the interest method). Realized gains and losses on investment securities are included in income, determined on the basis of the cost of the specific securities sold. Loans: Loans are stated at the amount of unpaid principal, reduced by the allowance for loan losses. The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance when management believes the collectability of principal is unlikely. The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. The allowance is increased by provisions charged to expense and is reduced by net charge-offs. The Banks make continuous reviews of the loan portfolio and considers current economic conditions, historical loss experience, review of specific problem loans and other factors in determining the adequacy of the allowance. Loans are considered impaired when, based on current information and events, it is probable the Banks will not be able to collect all amounts due. The portion of the allowance for loan losses applicable to impaired loans has been computed based on the present value of the estimated future cash flows of interest and principal discounted at the loans effective interest rate or on the fair value of the collateral for collateral dependent loans. The entire change in present value of expected cash flows of impaired loans or of collateral value is reported as bad debt expense in the same manner in which impairment initially was recognized or as a reduction in the amount of bad debt expense that otherwise would be reported. Interest income on impaired loans is recognized on the cash basis. The accrual of interest income on loans is discontinued when, in the opinion of management, there is reasonable doubt as to the borrower's ability to meet payments of interest or principal when they become due. Loan fees and origination costs are reflected in the statement of income as collected or incurred. Compared to the net deferral method, this practice had no significant effect on income. Property and equipment: Property and equipment is stated at cost less accumulated depreciation. Depreciation is computed using primarily declining-balance methods over the estimated useful lives of 7-40 years for buildings and improvements and 3-20 years for furniture and equipment. Deferred income taxes: Deferred income taxes are provided under the liability method whereby deferred tax assets are recognized for deductible temporary differences and net operating loss, and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. Intangible assets: Intangible assets consist principally of goodwill which represents the excess of cost over fair value of net assets acquired in business combinations of two banks in 1996 accounted for under the purchase method. Goodwill is amortized on a straight-line basis over the estimated period to be benefited, 15 years. The carrying value of goodwill is reviewed periodically for impairment. Goodwill totaled $3,282,000 and $3,543,000, net of accumulated amortization of $615,000 and $354,000 as of December 31, 1998 and 1997 and is included in other assets. Stock options: Compensation expense for stock issued through stock option and award plans is accounted for using the intrinsic value based method of accounting prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees." Under this method, compensation is measured as the difference between the estimated fair value of the stock at the date of award less the amount required to be paid for the stock. The difference, if any, is charged to expense over the periods of service. Common stock held by ESOP: The Company's maximum cash obligation related to these shares is classified outside stockholders' equity because the shares are not readily traded and could be put to the Company for cash. Trust assets: Trust assets, other than cash deposits, held by the Banks in fiduciary or agency capacities for its customers are not included in these statements since they are not assets of the Company. Earnings per share: Basic per-share amounts are computed by dividing net income (the numerator) by the weighted-average number of common shares outstanding (the denominator). Diluted per share amounts assume the conversion, exercise or issuance of all potential common stock unless the effect is to reduce the loss or increase the income per common share from continuing operations. Following is a reconciliation of the denominator: Year Ended December 31, --------------------------------- 1998 1997 1996 --------------------------------- Weighted average number of shares .......... 1,467,772 1,465,914 1,465,384 Potential number of dilutive shares ........ 22,702 18,040 13,968 --------------------------------- Total shares to compute diluted earnings per share ................................ 1,490,474 1,483,954 1,479,352 ================================= There are no potentially dilutive securities that have not been included in the determination of diluted shares. Statement of cash flows: For purposes of reporting cash flows, cash and due from banks includes cash on hand and amounts due from banks (including cash items in process of clearing). Cash flows from loans originated by the Banks, deposits and federal funds purchased and sold are reported net. Recently issued accounting standards: SFAS No. 130, "Reporting Comprehensive Income," establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. The Statement requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. The Statement does not require a specific format for that financial statement but requires that an enterprise display an amount representing total comprehensive income for the period in that financial statement. The Statement requires that an enterprise: (a) classify items of other comprehensive income by their nature in a financial statement and (b) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. The Company has adopted this accounting standard for the year ended December 31, 1998 and retroactively presented prior year statements of comprehensive income. Other recently issued accounting standards are not expected to materially affect the Company's financial statements. Fair value of financial instruments: FASB Statement No. 107, "Disclosures About Fair Value of Financial Instruments," requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Statement 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments: Off-balance sheet instruments: Fair values for outstanding letters of credit are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing. The fair value of the outstanding letters of credit is not believed to be significant at December 31, 1998. Unfunded loan commitments are not valued since the loans are generally priced at market at the time of funding. Cash and cash equivalents and federal funds sold: The carrying amounts reported in the balance sheet for cash and short-term instruments approximate their fair values. Investment securities: Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. Loans receivable: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for other loans are determined using estimated future cash flows, discounted at the interest rates currently being offered for loans with similar terms to borrowers with similar credit quality. The carrying amount of accrued interest receivable approximates its fair value. Deposit liabilities: The fair values of demand deposits equal their carrying amounts which represent the amount payable on demand. The carrying amounts for variable-rate, fixed-term money market accounts and certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits. Short-term borrowings: The carrying amounts of borrowings under repurchase agreements approximate their fair values. Long-term borrowings: The fair values of the Banks' long-term borrowings (other than deposits) are estimated using discounted cash flow analyses, based on the Banks' current incremental borrowing rates for similar types of borrowing arrangements. Note 2. Investment Securities The amortized cost and fair value of investment securities available for sale are as follows: Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value ------------------------------------------ (Amounts In Thousands) December 31, 1998: U. S. Treasury ................. $ 32,804 $ 536 $ - - $ 33,340 U. S. Government agencies and corporations ................ 76,882 1,206 (5) 78,083 State and political subdivisions 12,268 168 (24) 12,412 ----------------------------------------- Total ............... $121,954 $ 1,910 $ (29) $123,835 ========================================= December 31, 1997: U. S. Treasury ................. $ 39,858 $ 331 $ - - $ 40,189 U. S. Government agencies and corporations ................ 65,054 404 (13) 65,445 State and political subdivisions 3,806 46 - - 3,852 ----------------------------------------- Total ............... $108,718 $ 781 $ (13) $109,486 ========================================= The amortized cost and fair value of debt securities held to maturity are as follows: Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------------------------------------- (Amounts In Thousands) December 31, 1998: States and political subdivisions .. $ 21,168 $ 574 $ (2) $ 21,740 ======================================= December 31, 1997: States and political subdivisions .. $ 23,840 $ 405 $ (15) $ 24,230 ======================================= The contractual maturity distribution of investment securities as of December 31, 1998 is summarized as follows: Available For Sale Held to Maturity -------------------------------------- Amortized Fair Fair Amortized Cost Value Value Cost -------------------------------------- (Amounts In Thousands) Due in one year or less .............. $ 28,117 $ 28,337 $ 2,720 $ 2,732 Due after one year through five years 85,759 87,318 12,951 13,288 Due after five years through ten years 7,878 7,977 5,393 5,607 Due over ten years ................... 200 203 104 113 ----------------------------------- Total .................. $121,954 $123,835 $ 21,168 $ 21,740 =================================== As of December 31, 1998, investment securities with a carrying value of $34,928 were pledged to collateralize public and trust deposits, short-term borrowings, and for other purposes, as required or permitted by law. For the years ended December 31, 1998, 1997 and 1996, net gains or losses from the sale of investment securities were as follows: Year Ended December 31, ---------------------------- 1998 1997 1996 ---------------------------- (Amounts In Thousands) Gross gains ............................... $ - - $1,059 $ - - Gross (losses) ............................ - - (119) (57) ---------------------------- Net gains (losses) .......... $ - - $ 940 $ (57) ============================ Included in 1997 gains was the contribution of a marketable equity security to a private charitable foundation organized by the Company, upon which a gain of $1,054,000 was recognized. The marketable equity security was an investment in a development stage company that later went public in 1996. Note 3. Loans The composition of loans is as follows: December 31, ---------------------- 1998 1997 ---------------------- (Amounts In Thousands) Agricultural .................................... $ 32,318 $ 27,636 Commercial and financial ........................ 39,438 33,616 Real estate: Construction ................................. 28,476 8,157 Mortgage ..................................... 338,871 332,655 Loans to individuals ............................ 30,664 28,707 ------------------- 469,767 430,771 Less allowance for loan losses .................. 8,856 8,010 ------------------- $460,911 $422,761 =================== Changes in the allowance for loan losses are as follows: Year Ended December 31, --------------------------- 1998 1997 1996 --------------------------- (Amounts In Thousands) Balance, beginning ...................... $ 8,010 $ 7,311 $ 6,740 Provision charged to expenses ........ 916 1,048 754 Recoveries ........................... 898 779 438 Allowances of acquired banks ......... - - - - 350 Loans charged off .................... (968) (1,128) (971) --------------------------- Balance, ending ......................... $ 8,856 $ 8,010 $ 7,311 =========================== Information about impaired loans as of and for the years ended December 31, 1998 and 1997 is as follows: 1998 1997 -------------- (Amounts In Thousands) Loans receivable for which there is a related allowance for credit losses.................. $ - - $ - - Loans receivable for which there is no related allowance for credit losses .................. 8,956 9,556 -------------- Total impaired loans ..................... $8,956 $9,556 ============== Related allowance for credit losses .................... $ - - $ - - Average balance ........................................ 9,216 8,401 Interest income recognized ............................. 869 808 No allowance for credit losses has been recognized for impaired loans because partial charge-offs have been taken to reduce the loan balances to the net present value of the future cash flows or to the fair value of the collateral if the loan is collateral dependent. Note 4. Property and Equipment The major classes of property and equipment and the total accumulated depreciation are as follows: December 31, ---------------------- 1998 1997 ---------------------- (Amounts In Thousands) Land .................................... $ 1,950 $ 1,950 Buildings and improvements .............. 8,363 7,149 Furniture and equipment ................. 10,932 9,065 -------------------- 21,245 18,164 Less accumulated depreciation ........... 10,052 8,727 -------------------- Net ....................... $11,193 $ 9,437 ==================== Note 5. Interest-Bearing Deposits A summary of these deposits is as follows: December 31, ---------------------- 1998 1997 ---------------------- (Amounts In Thousands) NOW and other demand ............................ $ 53,296 $ 46,526 Savings ......................................... 144,177 121,785 Time, $100,000 and over ......................... 33,657 38,374 Other time ...................................... 234,921 220,911 -------------------- $466,051 $427,596 ==================== Note 6. Federal Home Loan Bank Borrowings As of December 31, 1998, the borrowings were as follows: (In Thousands) -------------- Due April 9, 1999, 6.55% $ 7,000 Due August 5, 1999, 6.57% 5,000 Due January 24, 2000, 6.21% 10,000 Due April 9, 2000, 6.71% 3,000 Due July 8, 2003, 5.21% 5,000 Due November 18, 2002, 5.33% 5,000 Due August 17, 2005, 7.12% 100 Due January 14, 2008, 5.22% 10,000 Due February 4, 2008, 5.38% 10,000 Due February 4, 2008, 5.24% 10,000 Due April 30, 2008, 5.40% 10,000 Due August 11, 2008, 6.00% 632 -------- $ 75,732 ======== The borrowings are collateralized by 1-4 family mortgage loans with a face amount of $94,540,000. As of December 31, 1998, the Company held Federal Home Loan Bank stock with a cost of $4,347,000 which is included in investment securities. Note 7. Employee Benefit Plans The Company has an Employee Stock Ownership Plan (the "ESOP") to which it makes discretionary cash contributions. The Company's contribution to the ESOP totaled $58,000, $49,000 and $42,000 for the years ended December 31, 1998, 1997 and 1996, respectively. In the event a terminated plan participant desires to sell his or her shares of the Company stock, or for certain employees who elect to diversify their account balances, the Company may be required to purchase the shares from the participant at their fair value. To the extent that shares of common stock held by the ESOP are not readily traded, a sponsor must reflect the maximum cash obligation related to those securities outside of stockholders' equity. As of December 31, 1998, 160,458 shares held by the ESOP, at a fair value of $58 per share, have been reclassified from stockholders' equity to liabilities. The Company has a profit-sharing plan with a 401(k) feature which provides for discretionary annual contributions in amounts to be determined by the Board of Directors. The profit-sharing contribution totaled $461,000, $394,000 and $340,000 for the years ended December 31, 1998, 1997 and 1996, respectively. The Company has a Stock Incentive Plan for certain key employees and directors whereby shares of common stock have been reserved for awards in the form of stock options or stock awards. A Stock Option Committee may grant options at prices equal to the fair value of the stock at the date of the grant. Options expire 10 years from the date of the grant. Directors may exercise options immediately and officers' rights under the plan vest over a five-year period from the date of the grant. Additional compensation is accrued equivalent to the amount of dividends that would have been paid on the stock had the options been exercised. Such compensation is payable upon exercise of the options. No compensation expense has been charged to expense using the intrinsic value based method as prescribed by APB No. 25. Had compensation expense been determined based on the grant date fair values of the awards, as prescribed by SFAS No. 123, reported net income and earnings per share would have been as follows: Years Ended December 31, ---------------------------- 1998 1997 1996 ---------------------------- Pro forma net income (in thousands) ...... $ 7,481 $ 7,084 $ 6,144 Pro forma earnings per share: Basic ................................. 5.10 4.83 4.19 Diluted ............................... 5.02 4.77 4.15 The pro forma effects of applying SFAS are not indicative of future amounts since, among other reasons, the pro forma requirements of SFAS No. 123 have been applied only to options granted after December 31, 1994. No options were granted during 1998 or 1996. The fair value of each grant is established at the grant date using the Black-Scholes option-pricing model with the following weighted average assumptions for grants in 1997: Dividend rate 2.19%; price volatility of 4.64%; risk-free interest rate of 6.63%; and an expected life of 5 years. A summary of the stock options is as follows: Weighted Average Number Exercise Of Shares Price ------------------- Balance, December 31, 1996 and 1995 ............... 46,569 $ 25.76 Granted ........................................ 2,055 41.00 Exercised ...................................... (2,055) 25.33 ----------------- Balance, December 31, 1997 ........................ 46,569 26.45 Exercised ...................................... (1,029) 25.33 ----------------- Balance, December 31, 1998 ........................ 45,540 $ 26.48 ================= 1998 1997 1996 ------------------------- Number of options exercisable, end of year .......... 45,540 22,605 22,605 Weighted-average fair value of options granted during the year .................................. $ - - $ - - $ 13.22 Other pertinent information related to the options outstanding at December 31, 1998 is as follows: Remaining Exercise Number Contractual Number Price Outstanding Life Exercisable - -------------------------------------------------------------------- $ 25.33 19,521 39 Months 19,521 41.00 2,055 87 Months 2,055 26.17 23,964 42 Months 23,964 ------ ------ 45,540 45,540 ====== ====== The committee is also authorized to grant awards of common stock and authorized the issuance of 902, 938 and 1,936 shares of common stock to a group of employees in 1998, 1997 and 1996, respectively. As of December 31, 1998, options for 70,208 shares of common stock were available for future grants. Note 8. Income Taxes Income taxes for the years ended December 31, 1998, 1997 and 1996 are summarized as follows: 1998 1997 1996 ----------------------- (Amounts In Thousands) Current: Federal .......................................... $2,435 $2,399 $2,098 State ............................................ 586 563 457 Deferred ............................................ (15) (417) (77) ---------------------- $3,006 $2,545 $2,478 ====================== Deferred income tax liabilities and assets arose from the following temporary differences: December 31, ---------------------- 1998 1997 1996 ---------------------- (Amounts In Thousands) Deferred income tax assets: Allowance for loan losses ................... $3,079 $2,622 $2,264 Deferred compensation ....................... 156 77 - - Certain accrued expenses .................... 211 302 205 Other ....................................... - - - - 7 ---------------------- Gross tax assets ................. 3,446 3,001 2,476 ---------------------- Deferred income tax liabilities: Property and equipment ...................... 677 644 621 FHLB dividends .............................. 130 130 130 Unrealized gains on debt securities ......... 696 283 366 Other ....................................... 105 85 - - ---------------------- Gross tax liabilities ............ 1,608 1,142 1,117 ---------------------- Net deferred income tax asset .... $1,838 $1,859 $1,359 ====================== The net change in the deferred income taxes for the years ended December 31, 1998, 1997 and 1996 is reflected in the financial statements as follows: Year Ended December 31, ----------------------------- 1998 1997 1996 ----------------------------- (Amounts In Thousands) Statement of income ........................ $ (15) (417) $ (77) Statement of stockholders' equity .......... 413 (83) 192 ----------------------------- $ 398 (500) $ 115 ============================= The income tax provisions for the years ended December 31, 1998, 1997 and 1996 are less than the amounts computed by applying the maximum effective federal income tax rate to the income before income taxes because of the following items: 1998 1997 1996 ------------------------------------------------------ % Of % Of % Of Pretax Pretax Pretax Amount Income Amount Income Amount Income ------------------------------------------------------ (Amounts In Thousands) Expected provision $ 3,567 34.0% $ 3,275 34.0% $ 2,931 34.0% Tax-exempt interest (596) (5.7) (557) (5.8) (539) (6.3) Interest expense limitation ..... 102 1.0 97 1.0 95 1.1 Investment securi- ties contributed - - - - (358) (3.7) - - - - State income taxes, net of federal income tax benefit ........ 398 3.8 372 3.9 315 3.7 Income tax credits (345) (3.3) (345) (3.6) (344) (4.0) Other ............. (120) (1.2) 61 0.6 20 0.2 ------------------------------------------------------ $ 3,006 28.6% $ 2,545 26.4% $ 2,478 28.7% ====================================================== Note 9. Regulatory Capital Requirements, Restrictions on Subsidiary Dividends and Cash Restrictions Federal regulatory agencies have adopted various capital standards for financial institutions, including risk-based capital standards. The primary objectives of the risk-based capital framework are to provide a more consistent system for comparing capital positions of financial institutions and to take into account the different risks among financial institutions' assets and off-balance sheet items. Risk-based capital standards include requirements for a minimum Tier 1 capital to assets ratio (leverage ratio). In addition, regulatory agencies consider the published capital levels as minimum levels and may require a financial institution to maintain capital at higher levels. A comparison of the Company's capital as of December 31, 1998 with the minimum requirements is presented below. Minimum Actual Requirements ---------------------- Tier 1 Risk-Based Capital ..................... 13.87% 4.00% Total Risk-Based Capital ...................... 15.13 8.00 Leverage Ratio ................................ 9.15 3.00 According to FDIC capital guidelines, each of the Banks is classified as "Well Capitalized." The ability of the Company to pay dividends to its stockholders is dependent upon dividends paid by the Banks. The Banks are subject to certain statutory and regulatory restrictions on the amount they may pay in dividends. To maintain acceptable capital ratios in the Banks, certain of their retained earnings are not available for the payment of dividends. To maintain a ratio of capital to assets of 8%, retained earnings, which otherwise could be available for the payment of dividends to the Company, total approximately $3,632,000 as of December 31, 1998. Each of the Banks is required to maintain reserve balances in cash or with the Federal Reserve Bank. Reserve balances totaled $5,783,000 and $4,503,000 as of December 31, 1998 and 1997, respectively. Note 10. Related Party Transactions Certain directors of the Company and the Banks and companies with which the directors are affiliated and certain principal officers are customers of, and have banking transactions with, the Banks in the ordinary course of business. Such indebtedness has been incurred on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons. The following is an analysis of the changes in the loans to related parties during the years ended December 31, 1998 and 1997: Year Ended December 31, ----------------------- 1998 1997 ---------------------- (Amounts In Thousands) Balance, beginning .............. $10,511 $ 9,232 Advances ..................... 7,077 2,243 Collections .................. (6,607) (964) -------------------- Balance, ending ................. $10,981 $10,511 ==================== Deposits from related parties are accepted subject to the same interest rates and terms as those from nonrelated parties. Note 11. Fair Value of Financial Instruments The carrying value and estimated fair values of the Company's financial instruments as of December 31, 1998 and 1997 are as follows: 1998 1997 ------------------- ------------------- Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value --------------------------------------- (Amounts In Thousands) Cash and due from banks ......... $ 16,427 $ 16,427 $ 15,508 $ 15,508 Federal funds sold .............. 36,811 36,811 2,447 2,447 Investment securities ........... 149,350 149,922 138,064 138,454 Loans ........................... 460,911 468,581 422,761 431,806 Accrued interest receivable ..... 5,885 5,885 5,441 5,441 Deposits ........................ 534,151 536,824 479,770 480,780 Securities sold under agreements to repurchase ................ 10,554 10,554 9,008 9,008 Borrowings from Federal Home Loan Bank ......................... 75,732 78,609 50,764 50,678 Accrued interest payable ........ 2,048 2,048 2,060 2,060 Face Face Amount Amount ------- ------- Off-balance sheet instruments: Loan commitments............. $93,920 $97,530 Letters of credit ........... 10,571 9,779 Parent Company Only Financial Information Following is condensed financial information of the Company (parent company only): BALANCE SHEETS December 31, 1998 and 1997 (Amounts In Thousands) ASSETS 1998 1997 - -------------------------------------------------------------------------- Cash ................................................... $ 698 $ 408 Investment securities available for sale ............... 303 300 Investment in subsidiary banks ......................... 64,332 57,774 Other assets ........................................... 653 940 ---------------- Total assets ............................. $65,986 $59,422 ================ LIABILITIES AND STOCKHOLDERS' EQUITY - -------------------------------------------------------------------------- Liabilities ............................................ $ 233 $ 240 ---------------- Redeemable common stock held by ESOP ................... 9,301 7,682 ---------------- Stockholders' equity: Capital stock ....................................... 9,140 9,070 Retained earnings ................................... 55,428 49,627 Unrealized gains on investment securities, net ...... 1,185 485 ---------------- 65,753 59,182 Less maximum cash obligation related to ESOP shares . 9,301 7,682 ---------------- Total stockholders' equity ............... 56,452 51,500 ---------------- Total liabilities and stockholders' equity $65,986 $59,422 ================ Note 12. Parent Company Only Financial Information (Continued) STATEMENTS OF INCOME Years Ended December 31, 1998, 1997 and 1996 (Amounts In Thousands) 1998 1997 1996 - ---------------------------------------------------------------------------------- Interest on investment securities ................... $ 17 $ 17 $ 15 Gain on sale of investment security ................. - - 1,054 - - Dividends received from subsidiaries ................ 2,762 2,515 9,422 Contributions ....................................... - - (1,054) - - Other expenses ...................................... (113) (102) (67) --------------------------- Income before income taxes and equity in subsidiaries' undistributed income 2,666 2,430 9,370 Income tax benefit .................................. 39 370 22 --------------------------- 2,705 2,800 9,392 Equity in subsidiaries' undistributed income ........ 4,781 4,286 (3,248) --------------------------- Net income ............................ $ 7,486 $ 7,086 $ 6,144 ===========================
STATEMENTS OF CASH FLOWS Years Ended December 31, 1998, 1997 and 1996 (Amounts In Thousands) 1998 1997 1996 - -------------------------------------------------------------------------------------- Cash flows from operating activities: Net income ........................................... $ 7,486 $ 7,086 $ 6,144 Noncash items included in net income: Undistributed earnings of subsidiaries ............ (4,781) (4,286) 3,248 (Increase) decrease in other assets ............... 357 (174) (414) Increase (decrease) in liabilities ................ (84) (225) 464 --------------------------- Net cash provided by operating activities . 2,978 2,401 9,442 --------------------------- Cash flows from investing activities: Investment in subsidiary banks ....................... (1,000) (750) (8,073) Proceeds from maturities of investment securities .... 300 - - 300 Purchase of investment securities .................... (303) - - (300) --------------------------- Net cash (used in) investing activities ... (1,003) (750) (8,073) --------------------------- Cash flows (used in) financing activities: Income tax benefit related to stock based compensation 76 - - - - Dividends paid ....................................... (1,761) (1,537) (1,391) --------------------------- Net cash (used in) financing activities ... (1,685) (1,537) (1,391) --------------------------- Increase (decrease) in cash ............... 290 114 (22) Cash balance: Beginning ............................................ 408 294 316 --------------------------- Ending ............................................... $ 698 $ 408 $ 294 ===========================
Note 13. Commitments and Contingencies Concentrations of credit risk: All of the Banks' loans, commitments to extend credit, unused lines of credit and outstanding letters of credit have been granted to customers within each Bank's market area. Investments in securities issued by state and political subdivisions within the state of Iowa totaled approximately $15,229,000. The concentrations of credit by type of loan are set forth in Note 3. Outstanding letters of credit were granted primarily to commercial borrowers. Although the Banks have a diversified loan portfolio, a substantial portion of its debtors' ability to honor their contracts is dependent upon the economic conditions in Johnson County, Iowa. Contingencies: In the normal course of business, the Banks are involved in various legal proceedings. In the opinion of management, any liability resulting from such proceedings would not have a material adverse effect on the accompanying financial statements. Risks and uncertainties: Certain data processing application systems could fail or perform improperly as a result of erroneous calculation or data integrity problems if they are unable to process date information beyond December 31, 1999, an issue known as Year 2000. The Banks have identified, assessed and tested critical information systems and are developing contingency plans for their own applications. There is risk that in the early weeks of the Year 2000, the Banks could experience disruptions that may affect its operations. Management believes that the Year 2000 problem will not pose significant operations problems for the Banks' computer systems, but disruptions could be material to the financial statements if there are significant interruptions in basic services, such as the electric power grid, telephone services or the banking system. These risks cannot be estimated. Financial instruments with off-balance sheet risk: The Banks are parties to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of their customers. These financial instruments include commitments to extend credit, credit card participations and standby letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheets. The Banks' exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, credit card participations and standby letters of credit is represented by the contractual amount of those instruments. The Banks use the same credit policies in making commitments and conditional obligations as they do for on-balance sheet instruments. A summary of the Banks' commitments at December 31, 1998 and 1997 is as follows: 1998 1997 --------------- (Amount In Thousands) Firm loan commitments and unused portion of lines of credit: Home equity loans ....................................... $ 3,509 $ 4,861 Credit card participations .............................. 8,689 6,896 Commercial, real estate and home construction ........... 27,549 38,784 Commercial lines ........................................ 54,173 46,989 Outstanding letters of credit .............................. 10,571 9,779 Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Banks evaluate each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management's credit evaluation of the party. Collateral held varies, but may include accounts receivable, crops, livestock, inventory, property and equipment, residential real estate and income-producing commercial properties. Credit card participations are the unused portion of the holders' credit limits. Such amounts represent the maximum amount of additional unsecured borrowings. Outstanding letters of credit are the conditional commitments issued by the Banks to guarantee the performance of a customer to a third party and collateralize the customer's borrowing arrangement with other creditors. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral held varies as specified above and is required in instances which the Banks deem necessary. Note 14. Business Acquisitions Effective July 1, 1996, the Company acquired for cash all of the outstanding shares of LBC, Inc., which owned 100% of the outstanding shares of Alliance Bancorporation, which held 100% of the outstanding shares of the Lisbon Bank and Trust Company, Lisbon, Iowa. The total acquisition cost was $3,042,000. The excess of the total acquisition cost over the fair value of the net assets acquired of $1,373,000 is being amortized over 15 years by the straight-line method. On September 20, 1996, the Company acquired cash, certain assets and assumed the deposits of the Kalona, Iowa office of Boatmen's Bank Iowa, N.A. The total acquisition cost was $5,031,000. The excess of the cost over the fair value of the net assets acquired was $2,523,000 and is being amortized over 15 years by the straight-line method. The acquisitions were accounted for as purchases and the results of operations since the acquisition dates are included in the consolidated financial statements. Unaudited pro forma net income for 1996, as though these banks were acquired at January 1, 1995, is not significantly different than reported net income. A summary of the net assets acquired of these two institutions is as follows: (Amounts In Thousands) ---------- Cash purchase price .......................................... $ 8,073 ======== Assets acquired: Cash and due from banks ................................... $ 910 Investment securities available for sale .................. 6,640 Federal funds sold ........................................ 11,448 Loans ..................................................... 20,665 Property and equipment .................................... 1,438 Accrued interest receivable ............................... 317 Intangible assets ......................................... 3,896 Other assets .............................................. 1,938 Liabilities assumed: Deposits and accrued interest ............................. (39,019) Borrowings from FHLB ...................................... (100) Other liabilities ......................................... (60) -------- $ 8,073 ======== Part II Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure None Part III Item 10. Directors and Executive Officers of the Registrant Information concerning directors is contained in the Registrant's Proxy Statement under the heading "Information Concerning Nominees for Election as Directors" and "Information Concerning Directors Other Than Nominees," which sections are incorporated herein by this reference. The following table sets forth the name, age and principal occupation of the Executive Officers of the Registrant and Executive Officers of the Bank. All officers of the Registrant and the Bank are elected annually for one-year terms of office. Year First Elected Position With Registrant Or Bank And Officer Of Principal Occupation And Employment Registrant Name Age During The Past Five Years (Bank) - ----------------------------------------------------------------------------------------------------------------------- Dwight O. Seegmiller 46 Director of Registrant and Bank; President, Registrant and Bank 1986 (1975) Willis M. Bywater 60 Director of Registrant and Bank; Chairman of the Board, Bank; 1997 Vice President of the Registrant; Executive Officer and Shareholder of Economy Advertising Company Earl M. Yoder 71 Director of Registrant and Bank; Vice President of the Registrant; 1997 Executive Officer and Shareholder of Iowa City Ready Mix, Inc. James G. Pratt 50 Treasurer of Registrant; Senior Vice President from January 1986 1985 (1982) to present Thomas J. Cilek 52 Secretary of Registrant; Senior Vice President of Bank from 1988 (1986) August 1986 to present
PART III Item 11. Executive Compensation Information required by this item is contained in the Registrant's Proxy Statement under the heading "Executive Compensation and Benefits," which section is incorporated herein by this reference. Item 12. Security Ownership of Certain Beneficial Owners and Management Information required by this item is contained in the Registrant's Proxy Statement under the heading "Security Ownership of Certain Beneficial Owners and Management" and "Report on Executive Compensation," which sections are incorporated herein by this reference. Item 13. Certain Relationships and Related Transactions Information required by this item is contained in the Registrant's Proxy Statement under the heading "Loans To and Certain Other Transactions With Executive Officers and Directors," which section is incorporated herein by this reference. Part IV Item 14. Exhibits, Financial Statements, Schedules, and Reports on Form 8-K Form 10-K Reference --------- (a) 1. Financial Statements Independent auditor's report on the financial statements Consolidated balance sheets as of December 31, 1998 and 1997 Consolidated statements of income for the years ended December 31, 1998, 1997 and 1996 Consolidated statements of comprehensive income for the years ended December 31, 1998, 1997 and 1996 Consolidated statements of stockholders' equity for the years ended December 31, 1998, 1997 and 1996 Consolidated statements of cash flows for the years ended December 31, 1998, 1997 and 1996 Notes to financial statements (a) 2. Financial Statements Schedules All schedules are omitted because they are not applicable or not required, or because the required information is included in the consolidated financial statements or notes thereto. (a) 3. Exhibits Exhibit 3 - Articles of Incorporation and Bylaws filed as Exhibit 3 of Form 10-K for the year ended December 31, 1993 are incorporated by reference. Exhibit 10(a) - Material Contract (Employee Stock Ownership Plan) filed as Exhibit 10(a) in Form 10-K for the year ended December 31, 1993 is incorporated by reference. Exhibit 10(b) - Material Contract (1993 Stock Incentive Plan) filed as Exhibit 10(b) in Form 10-K for the year ended December 31, 1993 is incorporated by reference. Exhibit 10(c) - Material contract (1995 Deferred Compensation Plans) filed as Exhibit 10(c) in Form 10-K for the year ended December 31, 1995 is incorporated by reference. Exhibit 11 - Statement Re Computation of Basic and Diluted Earnings Per Share is attached on Page 69. Exhibit 21 - Subsidiaries of the Registrant is attached on Page 70. Exhibit 23 - Consent of Accountants is attached on Page 71. Exhibit 27 - Financial Data Schedule is attached on Pages 72 and 73. (b) Reports on Form 8-K: There were no reports on Form 8-K for the three months ended December 31, 1998. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. HILLS BANCORPORATION Date: March 22, 1999 By /s/ Dwight O. Seegmiller ------------------------------------------------ Dwight O. Seegmiller, Director and President Date: March 22, 1999 By /s/ James G. Pratt ------------------------------------------------ James G. Pratt, Treasurer and Chief Accounting Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Date: March 22, 1999 By /s/ Willis M. Bywater ------------------------------------------------ Willis M. Bywater, Director Date: March 22, 1999 By /s/ Thomas J. Gill ------------------------------------------------ Thomas J. Gill, Director Date: March 22, 1999 By /s/ Donald H. Gringer ------------------------------------------------ Donald H. Gringer, Director Date: March 22, 1999 By /s/ Richard W. Oberman ------------------------------------------------ Richard W. Oberman, Director Date: March 22, 1999 By /s/ Theodore H. Pacha ------------------------------------------------ Theodore H. Pacha, Director Date: March 22, 1999 By /s/ Ann M. Rhodes ------------------------------------------------ Ann M. Rhodes, Director Date: March 22, 1999 By /s/ Ronald E. Stutsman ------------------------------------------------ Ronald E. Stutsman, Director Date: March 22, 1999 By /s/ Earl M. Yoder ------------------------------------------------ Earl M. Yoder, Director Date: March 22, 1999 By /s/ Sheldon E. Yoder ------------------------------------------------ Sheldon E. Yoder HILLS BANCORPORATION ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996 EXHIBIT INDEX Page Number In The Sequential Exhibit Numbering System Number Description For 1998 Form 10-K - -------------------------------------------------------------------------------- 11 Statement Re Computation of Basic and Diluted Earnings Per Share 21 Subsidiaries of the Registrant 23 Consent of Independent Certified Public Accountants 27 Financial Data Schedule EX-11 2 Hills Bancorporation EXHIBIT 11 Statement Re Computation Of basic and diluted earnings per share Year Ended December 31, ----------------------------------- 1998 1997 1996 - ---------------------------------------------------------------------------------------------------------- Shares of common stock, beginning ................................. 1,467,754 1,465,385 1,463,604 =================================== Shares of common stock, ending .................................... 1,469,443 1,467,754 1,465,385 =================================== Computation of weighted average number of basic and diluted shares: Common shares outstanding at the beginning of the year ......... 1,467,754 1,465,385 1,463,604 Weighted average number of net shares issued ................... 18 529 1,780 ----------------------------------- Weighted average shares outstanding (basic) ......... 1,467,772 1,465,914 1,465,384 Weighted average of potential dilutive shares attributable to stock options granted, computed under the treasury stock method ................................... 22,702 18,040 13,968 ----------------------------------- Weighted average number of shares (diluted) ......... 1,490,474 1,483,954 1,479,352 =================================== Net income (In Thousands) ......................................... $ 7,486 7,086 $ 6,144 =================================== Earnings per share: Basic .......................................................... $ 5.10 4.83 $ 4.19 =================================== Diluted ........................................................ $ 5.02 4.78 $ 4.15 =================================== Dividends per common share ........................................ $ 1.20 1.05 $ 0.95 ===================================
The above information is retroactively restated for a three-for-one stock split in 1996. EX-21 3 EXHIBIT 21 HILLS BANCORPORATION SUBSIDIARIES OF THE REGISTRANT Name Of Subsidiary State Of Incorporation - -------------------------------------------------------------------------------- Hills Bank and Trust Company Iowa LBC, Inc. Iowa Hills Bank Kalona Iowa EX-23 4 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To the Board of Directors Hills Bancorporation We hereby consent to the incorporation by reference of our report dated February 3, 1999 with respect to the financial statements of Hills Bancorporation and subsidiaries included in the Annual Report on Form 10-K of Hills Bancorporation for the year ended December 31, 1998 in Registrant Statement No. 33-73606 on Form S-8 filed December 30, 1993 and Registrant Statement No. 33-2657 on Form S-8 filed January 10, 1986. /s/ McGladrey & Pullen, LLP Iowa City, Iowa March 22, 1999 EX-27 5
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FORM THE DECEMBER 31, 1998 FORM 10-K OF HILLS BANCORPORATION AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS 1,000 YEAR DEC-31-1998 DEC-31-1998 16,427 0 36,811 0 123,835 21,168 21,740 469,767 8,856 689,787 534,151 22,554 3,597 63,732 9,301 0 9,140 47,312 689,787 37,854 8,226 1,209 47,289 20,458 25,254 22,035 916 0 16,438 10,492 7,486 0 0 7,486 5.10 5.02 3.81 12 945 0 8,956 8,010 968 898 8,856 8,856 0 1,765
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