SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
Annual Report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the fiscal year ended December 31, 2001. Commission File Number 0-32637
AMES NATIONAL CORPORATION
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(Exact name of registrant as specified in its charter)
IOWA 42-1039071
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(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
405 FIFTH STREET, AMES, IOWA 50010
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(Address of principal executive offices) (Zip Code)
(515) 232-6251
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $5.00 PAR VALUE
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(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 Regulation S-K 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. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of February 28, 2002 was $74,610,560.
The number of shares outstanding of the registrant's common stock, $5.00 par
value, on February 28, 2002, were 3,125,229.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement, as filed with the
Securities and Exchange Commission on March 25, 2002, are incorporated by
reference under Part III of this Form 10-K.
1
TABLE OF CONTENTS
PAGE
Part I
Item 1. Business.......................................................... 3
Item 2. Properties........................................................ 13
Item 3. Legal Proceedings................................................. 13
Item 4. Submission of Matters to a Vote of Shareholders................... 14
Part II
Item 5. Market for Registrant's Common Stock and Related
Shareholder Matters............................................. 14
Item 6. Selected Financial Data........................................... 15
Item 7. Management's Discussion and Analysis of Financial
Condition and Results Of Operations............................. 16
Item 7A. Quantitative and Qualitative Disclosures about Market Risk........ 28
Item 8. Financial Statements and Supplementary Data....................... 30
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure............................ 49
Part III
Item 10. Directors and Executive Officers of the Registrant................ 50
Item 11. Executive Compensation............................................ 50
Item 12. Security Ownership of Certain Beneficial Owners and Management.... 50
Item 13. Certain Relationships and Related Transactions.................... 50
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K... 51
2
PART I
ITEM 1. BUSINESS
General
Ames National Corporation (the "Company") is an Iowa corporation and bank
holding company registered under the Bank Holding Company Act of 1956, as
amended. The Company owns 100 percent of the stock of four banking subsidiaries
consisting of one national bank and three state-chartered banks, as described
below. All of the Company's operations are conducted in the State of Iowa and
primarily within the central Iowa counties of Boone and Story where the
Company's banking subsidiaries are located. The Company does not engage in any
material business activities apart from its ownership of its banking
subsidiaries. The principal executive offices of the Company are located at 405
Fifth Street, Ames, Iowa 50010 and its telephone number is (515) 232-6251.
The Company was organized and incorporated on January 21, 1975 under the laws of
the State of Iowa to serve as a holding company for its principal banking
subsidiary, First National Bank, Ames, Iowa ("First National") located in Ames,
Iowa. In 1983, the Company acquired the stock of the State Bank & Trust Co.
("State Bank") located in Nevada, Iowa; in 1991, the Company, through a
newly-chartered state bank known as Boone Bank and Trust Co. ("Boone Bank"),
acquired certain assets and assumed certain liabilities of the former Boone
State Bank & Trust Company located in Boone, Iowa; and in 1995, the Company
acquired the stock of the Randall-Story State Bank ("Randall-Story Bank")
located in Story City, Iowa. First National, State Bank, Boone Bank and
Randall-Story Bank are each operated as a wholly owned subsidiary of the
Company. These four financial institutions are referred to in this Form 10-K
collectively as the "Banks" and individually as a "Bank".
The principal sources of Company revenue are: (i) interest and fees earned on
loans made by the Banks; (ii) service charges on deposit accounts maintained at
the Banks; (iii) interest on fixed income investments held by the Banks; (iv)
fees on trust services provided by those Banks exercising trust powers; and (v)
securities gains and dividends on equity investments held by the Company and the
Banks.
The Banks' lending activities consist primarily of short-term and medium-term
commercial and real estate loans, agricultural and business operating loans and
lines of credit, equipment loans, vehicle loans, personal loans and lines of
credit, home improvement loans and secondary mortgage loan origination. The
Banks also offer a variety of demand, savings and time deposits, cash management
services, merchant credit card processing, safe deposit boxes, wire transfers,
direct deposit of payroll and social security checks and automated teller
machine access. Three of the four Banks also offer trust services.
The Company provides various services to the Banks which include, but are not
limited to, management assistance, auditing services, human resources services
and administration, compliance management, marketing assistance and
coordination, loan review and assistance with respect to computer systems and
procedures.
On February 14, 2002, the Company submitted an application to the Office of the
Comptroller of the Currency ("OCC") to establish a de novo national bank in
Marshalltown, Iowa under the name "United Bank & Trust National Association"
(the "Proposed Bank"). The Company received preliminary conditional approval to
establish the Proposed Bank from the OCC on March 20, 2002. Final approval from
the OCC is contingent, among other things, upon approval by the Board of
Governors of the Federal Reserve System of the Company's application to
establish the Proposed Bank and approval by the Federal Deposit Insurance
Corporation ("FDIC") of deposit insurance for the Proposed Bank. Provided that
all regulatory approvals are received within the expected timeframe, the Company
contemplates that the Proposed Bank will commence operations during the second
or third quarter of 2002. Additional information concerning the Proposed Bank is
set forth below.
3
Banking Subsidiaries
First National Bank, Ames, Iowa. First National is a nationally chartered,
commercial bank insured by the FDIC. It was organized in 1903 and became a
wholly owned subsidiary of the Company in 1975 through a bank holding company
reorganization whereby the then shareholders of First National exchanged all of
their First National stock for stock in the Company. First National provides
full-service banking to businesses and residents within the Ames community and
surrounding area. It provides a variety of products and services designed to
meet the needs of the market it serves. It has an experienced staff of bank
officers who have spent the majority of their banking careers with First
National and who emphasize long-term customer relationships. First National
conducts business out of three full-service offices and one super market
location, all located in the city of Ames.
As of December 31, 2001, First National had capital of $34,192,364 and 90
full-time equivalent employees. Full-time equivalents represent the number of
people a business would employ if all its employees were employed on a full-time
basis. It is calculated by dividing the total number of hours worked by all full
and part-time employees by the number of hours a full-time individual would work
for a given period of time. First National had net income of $5,834,000 in 2001,
$4,800,000 in 2000 and $5,659,000 in 1999. Total assets as of December 31, 2001,
2000 and 1999 were $349,702,000, $341,864,000 and $343,461,000, respectively.
State Bank & Trust Co., Nevada, Iowa. State Bank is an Iowa, state-chartered,
FDIC insured commercial bank. State Bank was acquired by the Company in 1983
through a stock transaction whereby the then shareholders of State Bank
exchanged all their State Bank stock for stock in the Company. State Bank was
organized in 1939 and provides full-serve banking to businesses and residents
within the Nevada area from its main Nevada location and two offices; one in
McCallsburg, Iowa and the other in Colo, Iowa. It is strong in agricultural,
commercial, and residential real estate lending. State Bank also provides a
broad line of property, casualty, personal and business insurance products to
its customers.
As of December 31, 2001, State Bank had capital of $10,128,000 and 23 full-time
equivalent employees. It had net income of $1,294,000 in 2001, $1,134,000 in
2000 and $1,284,000 in 1999. Total assets as of December 31, 2001, 2000 and 1999
were $94,004,000, $97,285,000 and $92,436,000, respectively.
Boone Bank and Trust Co., Boone, Iowa. Boone Bank is an Iowa, state-chartered,
FDIC insured commercial bank. Boone Bank was organized in 1992 by the Company
under a new state charter in connection with a purchase and assumption
transaction whereby Boone Bank purchased certain assets and assumed certain
liabilities of the former Boone State Bank & Trust Company in exchange for a
cash payment. It provides full service banking to businesses and residents
within the Boone community and surrounding area. It is actively engaged in
agricultural, consumer and commercial lending, including real estate, operating
and equipment loans. It conducts business from its main office and a full
service office, both located in Boone.
As of December 31, 2001, Boone Bank had capital of $10,032,000 and 26 full-time
equivalent employees. It had net income of $1,302,000 in 2001, $1,178,000 in
2000 and $1,306,000 in 1999. Total assets as of December 31, 2001, 2000 and 1999
were $94,356,000, $99,867,000 and $99,294,000, respectively.
Randall-Story State Bank, Story City, Iowa. Randall-Story Bank is an Iowa,
state-chartered, FDIC insured commercial bank. Randall-Story Bank was acquired
by the Company in 1995 through a stock transaction whereby the then shareholders
of Randall-Story Bank exchanged all their Randall-Story Bank stock for stock in
the Company. Randall-Story Bank was organized in 1928 and provides full-service
banking to Story City and the surrounding area from its main location in Story
City and a full service office in Randall, Iowa. While its primary emphasis is
in agricultural lending, Randall-Story Bank also provides the traditional
lending services typically offered by community banks. It also owns a small
insurance agency which operates out of the Randall office.
As of December 31, 2001, Randall-Story Bank had capital of $6,933,000 and 16
full-time equivalent employees. It had net income of $692,000 in 2001, $744,000
in 2000 and $611,000 in 1999. Total assets as of December 31, 2001, 2000 and
1999 were $63,680,000, $60,312,000 and $55,024,000, respectively.
The business plan for the Proposed Bank submitted as part of the OCC application
provides that the Proposed Bank will be established as a de novo national bank
in Marshalltown, Iowa. The Proposed Bank will operate as a community bank
offering a broad range of deposit and loan products, as well as internet banking
and trust services, to customers located in the Marshalltown and surrounding
Marshall County, Iowa area. The Proposed Bank will be wholly-owned by the
Company and will be capitalized through a $5 million contribution to capital
(consisting of $1.5 million of capital and $3.5 million of surplus) to be made
by the Company. The capital contribution to be made by the Company will be
financed through the sale of a portion of the Company's investment portfolio.
4
Business Strategy and Operations
As a locally owned, multi-bank holding company, the Company emphasizes strong
personal relationships to provide products and services that meet the needs of
the Banks' customers. The Company seeks to achieve growth and maintain a strong
return on equity. To accomplish these goals, the Banks focus on small to medium
size businesses that traditionally wish to develop an exclusive relationship
with a single bank. The Banks, individually and collectively, have the size to
give the personal attention required by business owners, in addition to the
credit expertise to help businesses meet their goals.
The Banks offer a full range of deposit services that are typically available in
most financial institutions, including checking accounts, savings accounts and
other time deposits of various types, ranging from money market accounts to
longer term certificates of deposit. One major goal in developing the Banks'
product mix is to keep the product offerings as simple as possible, both in
terms of the number of products and the features and benefits of the individual
services. The transaction accounts and time certificates are tailored to each
Bank's principal market area at rates competitive in that Bank's market. In
addition, retirement accounts such as IRAs (Individual Retirement Accounts) are
available. The FDIC insures all deposit accounts up to the maximum amount. The
Banks solicit these accounts from small-to-medium sized businesses in their
respective primary trade areas, and from individuals who live and/or work within
these areas. No material portion of the Banks' deposits has been obtained from a
single person or from a few persons. Therefore, the Company does not believe
that the loss of the deposits of any person or of a few persons would have an
adverse effect on the Banks' operations or erode their deposit base.
Loans are provided to creditworthy borrowers regardless of their race, color,
national origin, religion, sex, age, marital status, disability, receipt of
public assistance or any other basis prohibited by law. The Banks intend to
fulfill this commitment while maintaining prudent credit standards. In the
course of fulfilling this obligation to meet the credit needs of the communities
which they serve, the Banks give consideration to each credit application
regardless of the fact that the applicant may reside in a low to moderate income
neighborhood, and without regard to the geographic location of the residence,
property or business within their market areas.
The Banks provide innovative, quality financial products, such as Internet
banking and trust services that meet the banking needs of their customers and
communities. The loan programs and acceptance of certain loans may vary from
time-to-time depending on the funds available and regulations governing the
banking industry. The Banks offer all basic types of credit to their local
communities and surrounding rural areas, including commercial, agricultural and
consumer loans. The types of loans within these categories are as follows:
Commercial Loans. Commercial loans are typically made to sole proprietors,
partnerships, corporations and other business entities such as municipalities
and individuals where the loan is to be used primarily for business purposes.
These loans are typically secured by assets owned by the borrower and often
times involve personal guarantees given by the owners of the business. The types
of loans the Banks offer include:
- - financing guaranteed under Small Business Administration programs
- - operating and working capital loans
- - loans to finance equipment and other capital purchases
- - commercial real estate loans
- - business lines of credit
- - term loans
- - loans to professionals
- - letters of credit
Agricultural Loans. The Banks by nature of their location in central Iowa are
directly and indirectly involved in agriculture and agri-business lending. This
includes short-term seasonal lending associated with cyclical crop and livestock
production, intermediate term lending for machinery, equipment and breeding
stock acquisition and long-term real estate lending. These loans are typically
secured by the crops, livestock, equipment or real estate being financed. The
basic tenet of the Banks' agricultural lending philosophy is a blending of
strong, positive cash flow supported by an adequate collateral position, along
with a demonstrated capacity to withstand short-term negative impact if
necessary. Applicable governmental subsidies and affiliated programs are
utilized if warranted to accomplish these parameters. Approximately 15 percent
of the Banks' loans have been made for agricultural purposes. The Banks have not
experienced a material adverse effect on their business as a result of defaults
on agricultural loans and do not anticipate at the present time experiencing any
such effect in the future.
5
Consumer Loans. Consumer loans are typically available to finance home
improvements and consumer purchases, such as automobiles, household furnishings,
boats and education. These loans are made on both a secured and an unsecured
basis. The following types of consumer loans are available:
- - automobiles and trucks
- - boats and recreational vehicles
- - personal loans and lines of credit
- - home equity lines of credit
- - home improvement and rehabilitation loans
- - consumer real estate loans
Other types of credit programs, such as loans to nonprofit organizations, to
public entities, for community development and to other governmental offered
programs also are available.
First National, Boone Bank and State Bank offer trust services typically found
in a commercial bank with trust powers, including the administration of estates,
conservatorships, personal and corporate trusts and agency accounts. The Banks
also provide farm management, investment and custodial services for individuals,
businesses and non-profit organizations.
The Banks earn fees from the origination of residential mortgages that are sold
in the secondary real estate market without retaining the mortgage servicing
rights.
The Banks offer traditional banking services, such as safe deposit boxes, wire
transfers, direct deposit of payroll and social security checks, automated
teller machine access and automatic drafts (ACH) for various accounts. State
Bank offers individual, professional and business insurance services through a
subsidiary established for that purpose.
Credit Management
The Company strives to achieve sound credit risk management. In order to achieve
this goal, the Company has established uniform credit policies and underwriting
criteria for the Banks' loan portfolios. The Banks diversify in the types of
loans offered and are subject to regular credit examinations, annual internal
and external loan audits and annual review of large loans, as well as quarterly
reviews of loans experiencing deterioration in credit quality. The Company
attempts to identify potential problem loans early, charge off loans promptly
and maintain an adequate allowance for loan losses. The Company has established
credit guidelines for the Banks' lending portfolios which include guidelines
relating to the more commonly requested loan types, as follows:
Commercial Real Estate Loans - Commercial real estate loans, including
agricultural real estate loans, are normally based on loan to appraisal value
ratios of 75 percent and secured by a first priority lien position. Loans are
typically subject to interest rate adjustments no less frequently than 5 years
from origination. Fully amortized monthly repayment terms normally do not exceed
twenty years. Projections and cash flows that show ability to service debt
within the amortization period are required. Property and casualty insurance is
required to protect the Banks' collateral interests. Commercial and agricultural
real estate loans represent approximately 42 percent of the loan portfolio.
Major risk factors for commercial real estate loans, as well as the other loan
types described below, include a geographic concentration in central Iowa; the
dependence of the local economy upon several large governmental entities,
including Iowa State University and the Iowa Department of Transportation; and
the health of Iowa's agricultural sector that is dependent on weather conditions
and government programs.
Commercial and Agricultural Operating Lines - These loans are made to businesses
and farm operations with terms up to twelve months. The credit needs are
generally seasonal with the source of repayment coming from the entity's normal
business cycle. Cash flow reviews are completed to establish the ability to
service the debt within the terms of the loan. A first priority lien on the
general assets of the business normally secure these types of loans. Loan to
value limits vary and are dependent upon the nature and type of the underlying
collateral and the financial strength of the borrower. Crop and hail insurance
is required for most agricultural borrowers. Loans are generally guaranteed by
the principal(s).
6
Commercial and Agricultural Term Loans - These loans are made to businesses and
farm operations to finance equipment, breeding stock and other capital
expenditures. Terms are generally the lesser of five years or the useful life of
the asset. Term loans are normally secured by the asset being financed and are
often additionally secured with the general assets of the business. Loan to
value is generally 75 percent of the cost or value of the assets. Loans are
normally guaranteed by the principal(s). Commercial and agricultural operating
and term loans represent approximately 22 percent of the loan portfolio.
Residential First Mortgage Loans - Proceeds of these loans are used to buy or
refinance the purchase of residential real estate with the loan secured by a
first lien on the real estate. Most of the residential mortgage loans originated
by the Banks (including servicing rights) are sold in the secondary mortgage
market due to the higher interest rate risk inherent in the 15 and 30 year fixed
rate terms consumers prefer. Loans that are originated and not sold in the
secondary market generally have higher interest rates and have rate adjustment
periods of no longer than seven years. The maximum amortization of first
residential real estate is 30 years. The loan-to-value ratios normally do not
exceed 80 percent without credit enhancements such as mortgage insurance.
Property insurance is required on all loans to protect the Banks' collateral
position. Loans secured by one to four family residential properties represent
approximately 26 percent of the loan portfolio.
Home Equity Term Loans - These loans are normally for the purpose of home
improvement or other consumer purposes and are secured by a junior mortgage on
residential real estate. Loan-to-value ratios normally do not exceed 90 percent
of market value.
Home Equity Lines of Credit - The Banks offer a home equity line of credit with
a maximum term of 60 months. These loans are secured by a junior mortgage on the
residential real estate and normally do not exceed a loan-to-market value ratio
of 90 percent with the interest adjusted quarterly.
Consumer Loans - Consumer loans are normally made to consumers under the
following guidelines. Automobiles - loans on new and used automobiles will not
exceed 80 and 75 percent of the value, respectively. Recreational vehicles and
boats - 66 percent of the value. Mobile home - maximum term on these loans is
180 months with the loan-to-value ratio generally not exceeding 66 percent. Each
of these loans is secured by a first priority lien on the assets and requires
insurance to protect the Banks' collateral position. Unsecured - The term for
unsecured loans generally does not exceed 12 months. Consumer and other loans
represent approximately 6 percent of the loan portfolio.
Employees
At December 31, 2001, the Banks had a total of 163 full-time equivalent
employees including eight full-time Company employees. The Company and Banks
provide their employees with a comprehensive program of benefits, including
comprehensive medical and dental plans, long-term and short-term disability
coverage, a 401(k) profit sharing plan, a money purchase plan and an employee
stock purchase plan. Management considers its relations with employees to be
satisfactory. Unions represent none of the employees.
Market Area
The Company operates four commercial banks with locations in Story and Boone
Counties in central Iowa.
First National is located in Ames, Iowa with a population of 50,731. The major
employers are Iowa State University, Ames Laboratories, Iowa Department of
Transportation, Mary Greeley Medical Center, National Veterinary Services
Laboratory, Ames Community Schools, City of Ames, Barilla, Sauer-Danfoss and
McFarland Clinic. First National's primary business includes providing retail
banking services and business and consumer lending. First National has a minimum
exposure to agricultural lending.
Boone Bank is located in Boone, Iowa with a population of 12,800. Boone is the
county seat of Boone County. The major employers are Fareway Stores, Inc.,
Patterson Dental Supply Co., Union Pacific Railroad, and Communication Data
Services. Boone Bank provides lending services to the agriculture, commercial
and real estate markets.
7
State Bank is located in Nevada, Iowa with a population of 6,658. Nevada is the
county seat of Story County. The major employers are Print Graphics, General
Financial Supply, Central Iowa Printing, Burke Corporation and Almaco. State
Bank provides various types of loans with a major agricultural presence. It
provides a wide variety of banking services and products including insurance
services to its customers.
Randall-Story Bank is located in Story City, Iowa with a population of 3,228.
The major employers are Pella Corporation, Bethany Manor, American Packaging,
Precision Machine and Record Printing. Located in a major agricultural area, it
has a strong presence in this type of lending. As a full service commercial bank
it provides a full line of products and services including insurance services.
The Proposed Bank will be located in Marshalltown, Iowa with a population of
26,000. The major employers are Swift & Co., Fisher Controls International,
Lenox Industries and Marshalltown Medical & Surgical Center.
Competition
The geographic market area served by the Banks is highly competitive with
respect to both loans and deposits. The Banks compete principally with other
commercial banks, savings and loan associations, credit unions, mortgage
companies, finance divisions of auto and farm equipment companies, agricultural
suppliers and other financial service providers. Some of these competitors are
local, while others are statewide or nationwide. The major commercial bank
competitors include several regional banks, F & M Bank and Firstar Bank, and
nationwide banks, U.S. Bank National Association and Wells Fargo Bank, that have
a branch office or offices within the Banks' primary trade areas. Among the
advantages such larger banks have are their ability to finance extensive
advertising campaigns and to allocate their investment assets to geographic
regions of higher yield and demand. Such banks offer certain services, which are
not offered directly by the Banks, but that may be offered through correspondent
banking institutions. These larger banking organizations have much higher legal
lending limits than the Banks and thus are better able to finance large
regional, national and global commercial customers.
In order to compete with the other financial institutions in their primary trade
areas, the Banks use, to the fullest extent possible, the flexibility, which is
accorded by independent status. This includes an emphasis on specialized
services, local promotional activity and personal contacts by the Banks'
officers, directors and employees. In particular, the Banks compete for deposits
principally by offering depositors a wide variety of deposit programs,
convenient office locations, hours and other services. The Banks compete for
loans primarily by offering competitive interest rates, experienced lending
personnel and quality products and services.
As of December 31, 2001, there were approximately 21 other banks or savings and
loan associations having approximately 37 offices or branch offices within Boone
and Story County, Iowa where the Banks' offices are located. First National,
State Bank and Randall-Story Bank together have the largest percentage of
deposits in Story County and Boone Bank has the highest percentage of deposits
in Boone County.
In Marshall County, Iowa, the location of the Proposed Bank in Marshalltown,
Iowa, there were 11 banks and savings institutions with approximately $700
million in deposits as of June 30, 2001. The two largest banks accounted for
nearly 60% of the total deposits.
The Banks also compete with the financial markets for funds. Yields on corporate
and government debt securities and commercial paper affect the ability of
commercial banks to attract and hold deposits. Commercial banks also compete for
funds with money market instruments and similar investment vehicles offered by
competitors including brokerage firms, insurance companies, credit card issuers
and retailers such as Sears. Money market funds offered by these types of
organizations have provided substantial competition for deposits. This trend
will likely continue in the future.
The Company anticipates bank competition will continue to change materially over
the next several years as more banks, including the major regionals and
nationals, continue to consolidate. The larger financial institutions will
continue to consolidate their branch systems by providing incentives to their
customers to use electronic banking instead of brick and mortar branches. Credit
unions, because of their income tax benefits, will continue to show substantial
growth.
8
Supervision and Regulation
The following discussion generally refers to certain statutes and regulations
affecting the banking industry. These references provide brief summaries and
therefore do not purport to be complete and are qualified in their entirety by
reference to those statutes and regulations. In addition, due to the numerous
statutes and regulations that apply to and regulate the operation of the banking
industry, many are not referenced below.
The Company and the Banks are subject to extensive federal and state regulation
and supervision. Regulation and supervision of financial institutions is
primarily intended to protect depositors and the FDIC rather than shareholders
of the Company. The laws and regulations affecting banks and bank holding
companies have changed significantly over recent years, particularly with the
passage of the Financial Services Modernization Act. There is reason to expect
that similar changes will continue in the future. Any change in applicable laws,
regulations or regulatory policies may have a material effect on the business,
operations and prospects of the Company. The Company is unable to predict the
nature or the extent of the effects on its business and earnings that any fiscal
or monetary policies or new federal or state legislation may have in the future.
The Company
The Company is a bank holding company by virtue of its ownership of the Banks,
and is registered as such with the Board of Governors of the Federal Reserve
System (the "Federal Reserve"). The Company is subject to regulation under the
Bank Holding Company Act of 1956, as amended (the "BHCA"), which subjects the
Company and the Banks to supervision and examination by the Federal Reserve.
Under the BHCA, the Company files with the Federal Reserve annual reports of its
operations and such additional information as the Federal Reserve may require.
Source of Strength to the Banks. The Federal Reserve takes the position that a
bank holding company is required to serve as a source of financial and
managerial strength to its subsidiary banks and may not conduct its operations
in an unsafe or unsound manner. In addition, it is the Federal Reserve's
position that in serving as a source of strength to its subsidiary banks, bank
holding companies should use available resources to provide adequate capital
funds to its subsidiary banks during periods of financial stress or adversity.
It should also maintain the financial flexibility and capital raising capacity
to obtain additional resources for providing assistance to its subsidiary banks.
A bank holding company's failure to meet its obligations to serve as a source of
strength to its subsidiary banks will generally be considered by the Federal
Reserve to be an unsafe and unsound banking practice or a violation of the
Federal Reserve's regulations or both.
Federal Reserve Approval. Bank holding companies must obtain the approval of the
Federal Reserve before they: (i) acquire direct or indirect ownership or control
of any voting stock of any bank if, after such acquisition, they would own or
control, directly or indirectly, more than 5 percent of the voting stock of such
bank; (ii) merge or consolidate with another bank holding company; or (iii)
acquire substantially all of the assets of any additional banks.
Non-Banking Activities. With certain exceptions, the BHCA also prohibits bank
holding companies from acquiring direct or indirect ownership or control of
voting stock in any company other than a bank or a bank holding company unless
the Federal Reserve finds the company's business to be incidental to the
business of banking. When making this determination, the Federal Reserve in part
considers whether allowing a bank holding company to engage in those activities
would offer advantages to the public that would outweigh possible adverse
effects. A bank holding company may engage in permissible non-banking activities
on a de novo basis, if the holding company meets certain criteria and notifies
the Federal Reserve within ten (10) business days after the activity has
commenced.
Under the Financial Services Modernization Act, eligible bank holding companies
may elect (with the approval of the Federal Reserve) to become a "financial
holding company." Financial holding companies are permitted to engage in certain
financial activities through affiliates which had previously been prohibited
activities for bank holding companies. Such financial activities include
securities and insurance underwriting and merchant banking. At this time, the
Company has not elected to become a financial holding company, but may choose to
do so at some time in the future.
9
Control Transactions. The Change in Bank Control Act of 1978, as amended,
requires a person or group of persons acquiring "control" of a bank holding
company to provide the Federal Reserve with at least 60 days prior written
notice of the proposed acquisition. Following receipt of this notice, the
Federal Reserve has 60 days to issue a notice disapproving the proposed
acquisition, but the Federal Reserve may extend this time period for up to
another 30 days. An acquisition may be completed before the disapproval period
expires if the Federal Reserve issues written notice of its intent not to
disapprove the action. Under a rebuttable presumption established by the Federal
Reserve, the acquisition of 10 percent or more of a class of voting stock of a
bank holding company with a class of securities registered under Section 12 of
the Securities Exchange Act of 1934, as amended, would constitute the
acquisition of control. In addition, any "company" would be required to obtain
the approval of the Federal Reserve under the BHCA before acquiring 25 percent
(or 5 percent if the "company" is a bank holding company) or more of the
outstanding shares of the Company, or otherwise obtain control over the Company.
Affiliate Transactions. The Company and the Banks are deemed affiliates within
the meaning of the Federal Reserve Act, and transactions between affiliates are
subject to certain restrictions. Generally, the Federal Reserve Act: (i) limits
the extent to which the financial institution or its subsidiaries may engage in
"covered transactions" with an affiliate; and (ii) requires all transactions
with an affiliate, whether or not "covered transactions," to be on terms
substantially the same, or at least as favorable to the institution or
subsidiary, as those provided to a non-affiliate. The term "covered transaction"
includes the making of loans, purchase of assets, issuance of a guarantee and
similar transactions.
State Law on Acquisitions. Iowa law permits bank holding companies to make
acquisitions throughout the state. However, Iowa currently has a deposit
concentration limit of 15 percent on the amount of deposits in the state that
any one banking organization can control and continue to acquire banks or bank
deposits (by acquisitions), which applies to all depository institutions doing
business in Iowa.
Banking Subsidiaries
Applicable federal and state statutes and regulations governing a bank's
operations relate, among other matters, to capital adequacy requirements,
required reserves against deposits, investments, loans, legal lending limits,
certain interest rates payable, mergers and consolidations, borrowings, issuance
of securities, payment of dividends, establishment of branches and dealings with
affiliated persons.
First National is a national bank subject to primary federal regulation and
supervision by the Office of the Comptroller of the Currency (the "OCC"). The
FDIC, as an insurer of the deposits of First National, also has some limited
regulatory authority over First National. State Bank, Boone Bank and
Randall-Story Bank are state banks subject to regulation and supervision by the
Iowa Division of Banking. The three state Banks are also subject to regulation
and examination by the FDIC, which insures their respective deposits to the
maximum extent permitted by law. The federal laws that apply to the Banks
regulate, among other things, the scope of their business, their investments,
their reserves against deposits, the timing of the availability of deposited
funds and the nature and amount of and collateral for loans. The laws and
regulations governing the Banks generally have been promulgated to protect
depositors and the deposit insurance fund of the FDIC and not to protect
stockholders of such institutions or their holding companies.
The OCC and FDIC each has authority to prohibit banks under their supervision
from engaging in what it considers to be an unsafe and unsound practice in
conducting their business. The Federal Deposit Insurance Corporation Improvement
Act of 1991 ("FDICIA") requires federal banking regulators to adopt regulations
or guidelines in a number of areas to ensure bank safety and soundness,
including internal controls, credit underwriting, asset growth, management
compensation, ratios of classified assets to capital and earnings. FDICIA also
contains provisions which are intended to change independent auditing
requirements, restrict the activities of state-chartered insured banks, amend
various consumer banking laws, limit the ability of "undercapitalized banks" to
borrow from the Federal Reserve's discount window, require regulators to perform
periodic on-site bank examinations and set standards for real estate lending.
10
Borrowing Limitations. Each of the Banks is subject to limitations on the
aggregate amount of loans that it can make to any one borrower, including
related entities. Subject to numerous exceptions based on the type of loans and
collateral, applicable statutes and regulations generally limit loans to one
borrower of 15 percent of total equity and reserves. Each of the Banks is in
compliance with applicable loans to one borrower requirements.
FDIC Insurance. Generally, customer deposit accounts in banks are insured by the
FDIC for up to a maximum amount of $100,000. The FDIC has adopted a risk-based
insurance assessment system under which depository institutions contribute funds
to the FDIC insurance fund based on their risk classification. The FDIC may
terminate the deposit insurance of any insured depository institution if it
determines after an administrative hearing that the institution has engaged or
is engaging in unsafe or unsound practices, is in an unsafe or unsound condition
to continue operations or has violated any applicable law.
Capital Adequacy Requirements. The Federal Reserve, the FDIC and the OCC
(collectively, the "Agencies") have adopted risk-based capital guidelines for
banks and bank holding companies that are designed to make regulatory capital
requirements more sensitive to differences in risk profiles among banks and bank
holding companies and account for off-balance sheet items. Failure to achieve
and maintain adequate capital levels may give rise to supervisory action through
the issuance of a capital directive to ensure the maintenance of required
capital levels. Each of the Banks is in compliance with applicable capital level
requirements.
The current guidelines require all federally regulated banks to maintain a
minimum risk-based total capital ratio equal to 8 percent, of which at least 4
percent must be Tier 1 capital. Tier 1 capital includes common shareholders'
equity, qualifying perpetual preferred stock and minority interests in equity
accounts of consolidated subsidiaries, but excludes goodwill and most other
intangibles and the allowance for loan and lease losses. Tier 2 capital includes
the excess of any preferred stock not included in Tier 1 capital, mandatory
convertible securities, hybrid capital instruments, subordinated debt and
intermediate term preferred stock, 45 percent of unrealized gain of equity
securities and general reserve for loan and lease losses up to 1.25 percent of
risk weighted assets. None of the Banks has received any notice indicating that
it will be subject to higher capital requirements.
Under these guidelines, banks' assets are given risk weights of 0 percent, 20
percent, 50 percent or 100 percent. Most loans are assigned to the 100 percent
risk category, except for first mortgage loans fully secured by residential
property and, under certain circumstances, residential construction loans (both
carry a 50 percent rating). Most investment securities are assigned to the 20
percent category, except for municipal or state revenue bonds (which have a 50
percent rating) and direct obligations of or obligations guaranteed by the
United States Treasury or United States Government Agencies (which have a 0
percent rating).
The Agencies have also implemented a leverage ratio, which is equal to Tier 1
capital as a percentage of average total assets less intangibles, to be used as
a supplement to the risk based guidelines. The principal objective of the
leverage ratio is to limit the maximum degree to which a bank may leverage its
equity capital base. The minimum required leverage ratio for top rated
institutions is 3 percent, but most institutions are required to maintain an
additional cushion of at least 100 to 200 basis points. Any institution
operating at or near the 3 percent level is expected to be a strong banking
organization without any supervisory, financial or operational weaknesses or
deficiencies. Any institutions experiencing or anticipating significant growth
would be expected to maintain capital ratios, including tangible capital
positions, well above the minimum levels.
Prompt Corrective Action. Regulations adopted by the Agencies impose even more
stringent capital requirements. The FDIC and other Agencies must take certain
"prompt corrective action" when a bank fails to meet capital requirements. The
regulations establish and define five capital levels: (i) "well-capitalized,"
(ii) "adequately capitalized," (iii) "undercapitalized," (iv) "significantly
undercapitalized" and (v) "critically undercapitalized." Increasingly severe
restrictions are imposed on the payment of dividends and management fees, asset
growth and other aspects of the operations of institutions that fall below the
category of being "adequately capitalized". Undercapitalized institutions are
required to develop and implement capital plans acceptable to the appropriate
federal regulatory agency. Such plans must require that any company that
controls the undercapitalized institution must provide certain guarantees that
the institution will comply with the plan until it is adequately capitalized. As
of February 28, 2002, neither the Company nor any of the Banks were subject to
any regulatory order, agreement or directive to meet and maintain a specific
capital level for any capital measure. Furthermore, as of that same date, each
of the Banks was categorized as "well capitalized" under regulatory prompt
corrective action provisions.
11
Restrictions on Dividends. Dividends paid to the Company by the Banks is the
major source of Company cash flow. Various federal and state statutory
provisions limit the amount of dividends banking subsidiaries are permitted to
pay to their holding companies without regulatory approval. Federal Reserve
policy further limits the circumstances under which bank holding companies may
declare dividends. For example, a bank holding company should not continue its
existing rate of cash dividends on its common stock unless its net income is
sufficient to fully fund each dividend and its prospective rate of earnings
retention appears consistent with its capital needs, asset quality and overall
financial condition. In addition, the Federal Reserve and the FDIC have issued
policy statements which provide that insured banks and bank holding companies
should generally pay dividends only out of current operating earnings. Federal
and state banking regulators may also restrict the payment of dividends by
order.
First National, as a national bank, generally may pay dividends from undivided
profits without restriction, provided that its surplus fund is at least equal to
its common stock capital fund. Boone Bank, Randall-Story Bank and State Bank are
also restricted under Iowa law to paying dividends only out of their undivided
profits. Additionally, the payment of dividends by the Banks is affected by the
requirement to maintain adequate capital pursuant to applicable capital adequacy
guidelines and regulations, and the Banks generally are prohibited from paying
any dividends if, following payment thereof, the Bank would be undercapitalized.
Reserves Against Deposits. The Federal Reserve requires all depository
institutions to maintain reserves against their transaction accounts (primarily
checking accounts) and non-personal time deposits. Generally, reserves of 3
percent must be maintained against total transaction accounts of $35,600,000 or
less (subject to an exemption not in excess of the first $5,700,000 of
transaction accounts). A reserve of $1,068,000 plus 10 percent of amounts in
excess of $35,600,000 must be maintained in the event total transaction accounts
exceed $35,600,000. The balances maintained to meet the reserve requirements
imposed by the Federal Reserve may be used to satisfy applicable liquidity
requirements. Because required reserves must be maintained in the form of vault
cash or a non-interest bearing account at a Federal Reserve Bank, the effect of
this reserve requirement is to reduce the earning assets of the Banks.
Bank Offices. Iowa law regulates the establishment of bank offices and thus may
affect the Company's future plans to establish additional offices of its Banks.
Pursuant to amendments to Iowa law effective February 21, 2001, current Iowa law
permits a state bank to establish up to three (3) offices anywhere in the state.
Until July 1, 2004, and in addition to the three offices which may be
established anywhere in the state, a bank may only establish a bank office
inside the boundaries of the county in which the principal place of business of
the state bank is located and those counties contiguous to or cornering upon
such county. The number of offices a state bank may establish in a particular
municipality or urban complex may also be limited depending upon the population.
Effective July 1, 2004, the geographical restrictions on bank office locations
will be repealed. Finally, until July 1, 2004, Iowa law restricts the ability of
a bank to establish a de novo office within the limits of a municipal
corporation where there is an already established state or national bank or bank
office.
Regulatory Developments
In 1999, the Financial Services Modernization Act was enacted which: (i)
repealed historical restrictions on preventing banks from affiliating with
securities firms; (ii) broadens the activities that may be conducted by national
banks and banking subsidiaries of holding companies; and (iii) provides an
enhanced framework for protecting the privacy of consumers' information. In
addition, bank holding companies may be owned, controlled or acquired by any
company engaged in financially related activities, as long as such company meets
regulatory requirements. To the extent that this legislation permits banks to
affiliate with financial services companies, the banking industry may experience
further consolidation, although the impact of this legislation on the Company
and the Banks is unclear at this time.
Regulatory Enforcement Authority
The enforcement powers available to federal and state banking regulators are
substantial and include, among other things, the ability to assess civil
monetary penalties, to issue cease-and-desist or removal orders and to initiate
injunctive actions against banking organizations and institution-affiliated
parties, as defined. In general, enforcement actions must be initiated for
violations of laws and regulations and unsafe or unsound practices. Other
actions, or inactions, may provide the basis for enforcement action, including
misleading or untimely reports filed with regulatory authorities. Applicable law
also requires public disclosure of final enforcement actions by the federal
banking agencies.
12
National Monetary Policies
In addition to being affected by general economic conditions, the earnings and
growth of the Banks are affected by the regulatory authorities' policies,
including the Federal Reserve. An important function of the Federal Reserve is
to regulate the money supply, credit conditions and interest rates. Among the
instruments used to implement these objectives are open market operations in
U.S. Government securities, changes in reserve requirements against bank
deposits and the Federal Reserve Discount Rate, which is the rate charged member
banks to borrow from the Federal Reserve Bank. These instruments are used in
varying combinations to influence overall growth and distribution of credit,
bank loans, investments and deposits, and their use may also affect interest
rates charged on loans or paid on deposits.
The monetary policies of the Federal Reserve have had a material impact on the
operating results of commercial banks in the past and are expected to have a
similar impact in the future. Also important in terms of effect on banks are
controls on interest rates paid by banks on deposits and types of deposits that
may be offered by banks. The Depository Institutions Deregulation Committee,
created by Congress in 1980, phased out ceilings on the rate of interest that
may be paid on deposits by commercial banks and savings and loan associations,
with the result that the differentials between the maximum rates banks and
savings and loans can pay on deposit accounts have been eliminated. The effect
of deregulation of deposit interest rates has been to increase banks' cost of
funds and to make banks more sensitive to fluctuation in market rates.
ITEM 2. PROPERTIES
The Company's office is housed in the main office of First National located at
405 Fifth Street, Ames, Iowa. That building is owned by First National free of
any mortgage and consists of approximately 36,000 square feet and includes a
drive through banking facility. First National has nearly completed construction
of a 16,000 square foot addition to the building. The Company's office is now
located in the new addition. In addition to its main office, First National
conducts its business through two full-service offices, the University office
and the North Grand office, and one super-market location, the Cub Food office.
All offices are located within the city of Ames. The North Grand office is owned
by First National free of any mortgage. The University office is located in a
16,000 square foot multi-tenant property owned by the Company. First National
occupies 5,422 square feet in that building under a 24 year lease with rent
adjusted every six years based upon a consumer price index. The current annual
rental is $120,804. The Cub Foods office is leased by First National from Super
Valu Stores under a 20 year lease with a five year initial term and three, five
year renewal options. The current annual rental payment is $19,000.
State Bank conducts its business from its main office located at 1025 Sixth
Street, Nevada, Iowa and from two additional full-service offices located in
McCallsburg and Colo, Iowa. All of these properties are owned by State Bank free
of any mortgage.
Boone Bank conducts its business from its main office located at 716 Eighth
Street, Boone, Iowa and from one additional full-service office also located in
Boone, Iowa. All properties are owned by Boone Bank free of any mortgage.
Randall-Story Bank conducts its business from its main office located at 606
Broad Street, Story City, Iowa and from one additional full-service office
located in Randall, Iowa. All of these properties are owned by Randall-Story
Bank free of any mortgage.
It is anticipated that the Proposed Bank, upon receiving all regulatory
approvals and commencing operations, will conduct its business from an office
located at 2101 S. Center Street, Marshalltown, Iowa. This property will be
purchased by the Proposed Bank from the individual who is expected to become the
president of the Proposed Bank upon commencement of operations at a price that
the Company believes to be the fair market value of the property.
The only property the Company owns is located at 2330 Lincoln Way, Ames, Iowa
consisting of a multi tenant building of approximately 16,000 square feet. First
National leases 5,422 square feet of this building to serve as its University
office. The remaining space is currently leased to four other tenants who occupy
the space for business purposes.
ITEM 3. LEGAL PROCEEDINGS
The Banks are from time to time parties to various legal actions arising in the
normal course of business. The Company believes that there is no threatened or
pending proceeding against the Company or the Banks, which, if determined
adversely, would have a material adverse effect on the business or financial
position of the Company or the Banks.
13
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS
There were no matters submitted to a vote of the shareholders of the Company
during the fourth quarter of 2001.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
On February 28, 2002, the Company had approximately 562 shareholders of record.
The Company's common stock is traded in the over-the-counter market under the
symbol "ATLO". Trading in the Company's common stock is, however, relatively
limited. Market makers in the stock include US Bancorp Piper Jaffray, 402 Main
Street, Ames, Iowa 50010 (515-233-4064); Howe Barnes Investments, Inc., 135 So.
LaSalle, Chicago, IL 60603 (312-655-3000); and Monroe Securities, Inc., 47 State
St., Rochester, NY 14614 (800-766-5560). Based on information provided to and
gathered by the Company on an informal basis, the Company believes that the high
and low sales price for the common stock on a per share basis during the last
two years is as follows:
2001 2000
- ---------------------------- --------------------------
Quarter High Low Quarter High Low
- ---------------------------------------------------------
1st $55.00 $40.00 1st $55.00 $55.00
2nd 44.50 36.25 2nd 57.00 55.00
3rd 41.50 36.55 3rd 57.00 57.00
4th 40.00 35.75 4th 55.00 55.00
The Company declared aggregate annual cash dividends in 2001 and 2000 of
$5,187,000 and $4,932,000, respectively, or $1.66 per share in 2001 and $1.58
per share in 2000. In February 2002, the Company declared an aggregate cash
dividend of $1,313,000 or $.42 per share. Quarterly dividends declared during
the last two years were as follows:
2001 2000
--------------------------------------------
Cash Dividends Cash Dividends
Quarter Declared Per Share Declared Per Share
- -----------------------------------------------------------------
1st $0.40 $0.38
2nd 0.42 0.40
3rd 0.42 0.40
4th 0.42 0.40
The decision to declare any such cash dividends in the future and the amount
thereof rests within the discretion of the Board of Directors of the Company and
will be subject to, among other things, the future earnings, capital
requirements and financial condition of the Company and certain regulatory
restrictions imposed on the payment of dividends by the Banks. Such restrictions
are discussed in greater detail in "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Liquidity and Capital
Resources."
The Company engaged in certain sales of its common stock during 2001 without
registration of such sales under the Securities Act of 1933, as amended (the
"Securities Act"). On June 15, 2001, the Company sold a total of 2,936 shares of
its common stock, previously reacquired and held as treasury shares, at a price
of $37.75 per share, for an aggregate purchase price of $110,834, to eligible
employees and directors under the Ames National Corporation Stock Purchase Plan.
The Company relied on Rule 504 promulgated under the Securities Act to exempt
the issuance of such shares from the registration provisions of the Securities
Act.
14
ITEM 6. SELECTED FINANCIAL DATA
The following financial data of the Company for the five years ended December
31, 2001 through 1997 is derived from the Company's historical audited financial
statements and related footnotes. The information set forth below should be read
in conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operation" and the consolidated financial statements and related
notes contained elsewhere in this Annual Report.
Selected Financial Data
Year Ended December 31
------------------------------------------------------------------
(dollars in thousands, except per share amounts)
------------------------------------------------------------------
2001 2000 1999 1998 1997
------------------------------------------------------------------
STATEMENT OF INCOME DATA
Interest Income ....................... $ 41,474 $ 44,018 $ 40,361 $ 39,439 $ 37,073
Interest expense ...................... 18,883 24,261 19,981 19,668 18,830
------------------------------------------------------------------
Net interest income ............. 22,591 19,757 20,380 19,771 18,243
Provision for loan losses ............. 898 460 166 437 279
Net interest income after provision for
loan losses ......................... 21,693 19,297 20,214 19,334 17,964
Noninterest income .................... 5,080 4,130 5,750 4,835 4,192
Noninterest expense ................... 11,587 10,712 11,208 10,264 9,447
------------------------------------------------------------------
Income before provision for income tax 15,186 12,715 14,756 13,905 12,709
Provision for income tax .............. 4,639 3,596 4,429 4,279 3,966
------------------------------------------------------------------
Net Income ...................... $ 10,547 $ 9,119 $ 10,327 $ 9,626 $ 8,743
==================================================================
DIVIDENDS AND EARNINGS PER SHARE DATA
Cash Dividends ........................ $ 5,187 $ 4,932 $ 4,664 $ 4,355 $ 3,971
Cash Dividends declared per weighted
average share outstanding ........... $ 1.66 $ 1.58 $ 1.50 $ 1.39 $ 1.26
Basic and diluted earnings per share .. $ 3.38 $ 2.92 $ 3.31 $ 3.07 $ 2.78
Weighted average shares outstanding ... 3,123,885 3,120,375 3,118,427 3,138,939 3,143,656
BALANCE SHEET DATA
Total Assets .......................... $ 622,280 $ 619,385 $ 605,881 $ 579,956 $ 542,460
Net loans ............................. 323,043 344,015 309,652 287,713 266,305
Deposits .............................. 511,509 493,429 484,620 482,513 442,353
Stockholders' equity .................. 93,622 86,177 76,073 79,109 74,045
Equity to assets ratio ................ 15.04% 13.91% 12.56% 13.64% 13.65%
FIVE YEAR FINANCIAL PERFORMANCE
Net Income ............................ $ 10,547 $ 9,119 $ 10,327 $ 9,626 $ 8,743
Average Assets ........................ 616,971 626,560 594,441 560,524 518,631
Average Stockholders' Equity .......... 91,373 80,081 80,074 77,445 70,451
Return on Assets (net income divided by
average assets) ..................... 1.71% 1.46% 1.74% 1.72% 1.69%
Return on Equity (net income divided
by average equity) .................. 11.54% 11.39% 12.90% 12.43% 12.41%
Efficiency Ratio (noninterest expense
divided by noninterest income plus
net interest income) ................ 41.87% 44.84% 42.89% 41.71% 42.11%
Dividend payout ratio (dividends per
share divided by net income per
share) .............................. 49.11% 54.11% 45.32% 45.28% 45.32%
Equity to assets ratio (Average equity
divided by average assets) .......... 14.81% 12.78% 12.78% 13.03% 13.58%
15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion is provided for the consolidated operations of the
Company, which includes its wholly owned banking subsidiaries, First National,
State Bank, Boone Bank and Randall-Story Bank. The purpose of this discussion is
to focus on significant factors affecting the Company's financial condition and
results of operations.
Forward-Looking Statements
The discussion herein may contain forward-looking statements about the Company,
its business and its prospects. Forward-looking statements can be identified by
the fact that they do not relate strictly to historical or current facts. They
often include use of the words "believe", "expect", "anticipate", "intend",
"plan", "estimate" or words of similar meaning, or future or conditional verbs
such as "will", "would", "should", "could" or "may". Forward-looking statements,
by their nature, are subject to risks and uncertainties. A number of factors,
many of which are beyond the Company's control, could cause actual conditions,
events or results to differ significantly from those described in the
forward-looking statements. Such risks and uncertainties with respect to the
Company include those related to the economic environment, particularly in the
areas in which the Company and the Banks operate, competitive products and
pricing, fiscal and monetary policies of the U.S. government, changes in
governmental regulations affecting financial institutions, including regulatory
fees and capital requirements, changes in prevailing interest rates, credit risk
management and asset/liability management, the financial and securities markets
and the availability of and costs associated with sources of liquidity.
General
The Company earned net income of $10,547,000 in 2001, compared to net income of
$9,119,000 in 2000 and net income of $10,327,000 in 1999. The higher level of
income in 2001 as compared to 2000 is attributable to lower interest expense on
deposits and other borrowings partially offset by lower interest income on loans
and investment securities. Income declined in 2000 in comparison to 1999
primarily as a result of reduced realized gains on securities ($716,000 in 2000
versus $1,266,000 in 1999) and a charged-off bond recovery of $846,000 in 1999
which did not recur in 2000. The Company's net income is derived principally
from the operating results of the Banks. All four Banks are well-established
financial institutions that have a record of profitable operations.
Financial Condition
Net loans for the year ended December 31, 2001, declined to $328,489,000 from
$349,388,000 for the same period in 2000. The decline in loan volume can be
attributed to a slowdown in local, state, and national economic activity and
aggressive competition for loans. For the year 2000, net loans increased
$34,363,000, and $26,323,000 of the increase was in real estate mortgage loans.
A strong local economy, moderate interest rates and several new business
opportunities in 2000 contributed to the loan growth. The reasons for the
declining trend in the net interest margin prior to 2001 were the competitive
pressures in the local markets and the higher deposit interest rates experienced
in 2000. Currently, the Company's largest market, Ames, Iowa, has six banks,
three thrifts, five credit unions and several other financial investment
companies. In addition, several of the financial institutions have multiple
branch locations. Multiple banks are also located in the Company's other
communities creating similarly competitive environments. This high level of
competition in the local markets will likely cause downward pressure on the net
interest margin of the Company into the foreseeable future. The decrease in
investment securities to $213,778,000 on December 31, 2001 compare to
$232,706,000 on December 31, 2000 resulted from the proceeds of maturing and
called investment securities being held as federal funds sold. These short-term
funds are expected to be re-invested in longer-term assets as investment yields
become more favorable. Total assets increased 0.47 percent in 2001, compared to
an increase of 2.29 percent in 2000. The limited increase in assets in 2001 and
2000 was primarily attributable to market competition limiting deposit growth.
In 2001, the rates paid on deposits were lower than in 2000 as a result of
decreases in market interest rates. Deposits increased 3.66 percent in 2001
compared to an increase of 1.82 percent in 2000. The Banks continue to compete
for deposits in market areas where the total deposit growth continues to be weak
as a result of significant bank and non-bank competition. Other borrowings,
including Federal Home Loan Bank Advances, federal funds purchased, and
securities sold under agreement to repurchase, totaled $11,596,000 in 2001
compared to $35,007,000 in 2000. Other borrowings declined in 2001 as the result
of the maturity and sale of securities.
16
Average Balance Sheet and Interest Rates
The following tables show average balances and interest income or interest
expense, with the resulting average yield or rate by category of average earning
asset or interest bearing liability.
ASSETS
(dollars in thousands)
2001 2000 1999
-----------------------------------------------------------------------------------------
Average Revenue/ Yield/ Average Revenue/ Yield/ Average Revenue/ Yield/
Balance Expense Rate Balance Expense Rate Balance Expense Rate
-----------------------------------------------------------------------------------------
Interest-earning assets
Loans ................................ $ 49,081 $ 4,107 8.37% $ 52,764 $ 4,378 8.30% $ 44,536 $ 4,072 9.14%
Commercial ........................... 28,302 2,492 8.81% 26,328 2,465 9.36% 24,242 2,365 9.76%
Agricultural ......................... 240,382 19,458 8.09% 232,823 18,963 8.14% 206,830 16,091 7.78%
Consumer and other ................... 23,675 1,834 7.75% 27,200 2,500 9.19% 23,456 1,858 7.92%
-----------------------------------------------------------------------------------------
Total loans (including fees) ... $341,440 $ 27,891 8.17% $339,115 $ 28,306 8.35% $299,064 $ 24,386 8.15%
Investment securities
Taxable .............................. $146,213 $ 9,303 6.36% $179,858 $ 11,644 6.47% $186,504 $ 12,187 6.53%
Tax-exempt ........................... 68,001 5,210 7.66% 72,521 5,442 7.50% 67,998 5,088 7.48%
-----------------------------------------------------------------------------------------
Total investment securities .... $214,214 $ 14,513 6.78% $252,379 $ 17,086 6.77% $254,502 $ 17,275 6.79%
Interest bearing deposits with banks ... $ 251 $ 13 5.18% $ 1,718 $ 99 5.76%$ 2,416 $ 137 5.67%
Federal funds sold ..................... 25,953 829 3.19% 5,602 377 6.73% 5,927 294 4.96%
-----------------------------------------------------------------------------------------
Total interest-earning assets .. $581,858 $ 43,246 7.43% $598,814 $ 45,868 7.66% $561,909 $ 42,092 7.49%
Noninterest-earning assets
Cash and due from banks .............. $ 21,040 $ 19,324 $ 18,255
Premises and equipment, net .......... 5,892 5,285 5,368
Other, less allowance for loan losses 8,181 3,137 8,909
-------- -------- --------
Total noninterest-earning assets $ 35,113 $ 27,746 $ 32,532
-------- -------- --------
Total assets ................... $616,971 $626,560 $594,441
======== ======== ========
1 Average loan balance includes nonaccrual loans, if any. Interest income
collected on nonaccrual loans has been included.
2 Tax-exempt income has been adjusted to a tax-equivalent basis using an
incremental rate of 34%.
17
Average Balance Sheet and Interest Rates
LIABILITIES AND STOCKHOLDERS' EQUITY
(dollars in thousands) 2001 2000 1999
---------------------------------------------------------------------------------------
Average Revenue/ Yield/ Average Revenue/ Yield/ Average Revenue/ Yield/
Balance Expense Rate Balance Expense Rate Balance Expense Rate
---------------------------------------------------------------------------------------
Interest-bearing liabilities
Deposits
Savings, NOW accounts, and money markets $228,908 $ 5,727 2.50% $218,795 $ 8,144 3.72% $212,612 $ 6,880 3.24%
Time deposits < $100,000 ............... 158,625 8,736 5.51% 159,035 8,972 5.64% 157,268 8,327 5.29%
Time deposits > $100,000 ............... 58,253 3,329 5.71% 62,052 3,823 6.16% 67,310 3,687 5.48%
---------------------------------------------------------------------------------------
Total deposits ......................... $445,786 $ 17,792 3.99% $439,882 $ 20,939 4.76% $437,208 $18,894 4.32%
Other borrowed funds ................... 23,008 1,091 4.74% 52,749 3,322 6.30% 22,854 1,087 4.76%
---------------------------------------------------------------------------------------
Total Interest-bearing liabilities $468,794 $ 18,883 4.03% $492,631 $ 24,261 4.92% $460,062 $19,981 4.34%
---------------------------------------------------------------------------------------
Noninterest-bearing liabilities
Demand deposits ........................ $ 51,113 $ 47,590 $ 45,719
Other liabilities ...................... 5,691 6,258 8,586
-------- -------- --------
Stockholders' equity ..................... $ 91,373 $ 80,081 $ 80,074
-------- -------- --------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY ............. $616,971 $626,560 $594,441
======== ======== ========
Net interest income ...................... $ 24,363 4.19% $ 21,607 3.61% $ 22,111 3.93%
======== ======== ========
Margin Analysis
Interest income/earning assets ......... $ 43,246 7.43% $ 45,868 7.66% $ 42,092 7.49%
Interest expense/earning assets ........ 18,883 3.25% 24,261 4.05% 19,981 3.56%
Net interest income/earning assets ..... 24,363 4.19% 21,607 3.61% 22,111 3.93%
Rate and Volume Analysis
The following table sets forth, on a tax-equivalent basis, a summary of the
changes in net interest income resulting from changes in volume and rates
(dollars in thousands and in tax equivalent basis).
2001 Compared to 2000 2000 Compared to 1999
--------------------------------------------------------------
Volume Rate Total Volume Rate Total
--------------------------------------------------------------
Interest income
Loans
Commercial ............................. ($ 308) $ 37 ($ 271) $ 706 ($ 400) $ 306
Agricultural ........................... 179 (152) $ 27 198 (98) 100
Real estate ............................ 613 (118) 495 2,091 781 2,872
Consumer and other ..................... (301) (365) (666) 321 321 642
--------------------------------------------------------------
Total loans (including fees) ....... $ 183 ($ 598) ($ 415) $ 3,316 $ 604 $ 3,920
Investment securities
Taxable .................................. ($2,144) ($ 197) ($2,341) ($ 431) ($ 112) ($ 543)
Tax-exempt ............................... (344) 112 (232) 339 15 354
--------------------------------------------------------------
Total investment securities ........ ($2,488) ($ 85) ($2,573) ($ 92) ($ 97) ($ 189)
Interest bearing deposits with banks ....... ($ 77) ($ 9) ($ 86) ($ 40) $ 2 ($ 38)
Federal funds sold ......................... 741 (289) 452 (17) 100 83
--------------------------------------------------------------
Total Interest-earning assets ...... ($1,641) ($ 981) ($2,622) $ 3,167 $ 609 $ 3,776
Interest-bearing liabilities
Deposits
Savings, NOW accounts, and money markets $ 361 ($2,778) ($2,417) $ 205 $ 1,059 $ 1,264
Time deposits < $100,000 ............... (23) (213) (236) 94 551 645
Time deposits > $100,000 ............... (226) (268) (494) (301) 437 136
--------------------------------------------------------------
Total deposits ..................... $ 112 ($3,259) ($3,147) ($ 2) $ 2,047 $ 2,045
Other borrowed funds ....................... (1,551) (680) (2,231) 1,792 443 2,235
--------------------------------------------------------------
Total Interest-bearing liabilities . ($1,439) ($3,939) ($5,378) $ 1,790 $ 2,490 $ 4,280
--------------------------------------------------------------
Net interest income/earning assets . ($ 202) $ 2,958 $ 2,756 $ 1,377 ($1,881) ($ 504)
==============================================================
1 The change in interest due to both volume and yield/rate has been allocated
to change due to volume and change due to yield/rate in proportion to the
absolute value of the change in each.
18
Net Interest Income
The Company's largest component contributing to net income is net interest
income, which is the difference between interest earned on earning assets which
are primarily loans and investments and interest paid on interest bearing
liabilities which are primarily deposits and borrowings. The volume of and
yields earned on earning assets and the volume of and the rates paid on interest
bearing liabilities determine net interest income. Interest earned and interest
paid is also affected by general economic conditions, particularly changes in
market interest rates, and by government policies and the action of regulatory
authorities. Net interest income divided by average earning assets is referred
to as net interest margin. For the years December 31, 2001, 2000 and 1999, the
Company's net interest margin was 4.19 percent, 3.61 percent and 3.93 percent,
respectively. The improved net interest margin in 2001 is attributable to lower
interest expense as the Company was able to lower deposit and other borrowings
rates more quickly than loans and investment rates declined. Conversely, rising
rates and market competition caused the net interest margin to decline in 2000.
The reasons for the declining trend in the net interest margin prior to 2001
were the competitive pressures in the local markets and the higher deposit
interest rates experienced in 2000. Currently, the Company's largest market,
Ames, Iowa, has six banks, three thrifts, five credit unions and several other
financial investment companies. In addition, several of the financial
institutions have multiple branch locations. Multiple banks are also located in
the Company's other communities creating similarly competitive environments.
This high level of competition in the local markets will likely cause downward
pressure on the net interest margin of the Company into the foreseeable future.
Net interest income during 2001, 2000 and 1999 totaled $22,591,000, $19,757,000
and $20,380,000, respectively, representing a 14.34 percent increase in 2001
from 2000 and a 3.06 percent decrease in 2000 compared to 1999. The higher net
interest income in 2001 as compared to 2000 resulted from lower interest expense
as the Company was able to lower deposit and other borrowings rates more quickly
than loans and investment rates declined. Other borrowing costs were also down
significantly as the result of a lower level of borrowing in 2001 versus 2000,
as proceeds from maturing and sold investments were utilized to lower borrowing
levels. The decrease in net interest income in 2000 as compared to 1999 is
attributable to higher interest expense on interest bearing liabilities
attributable to both volume and interest rate, partially offset by higher
interest income on earning assets. The rising 2000 interest rate environment
increased interest expense compared to 1999 as the funding liabilities repriced
more quickly than the assets.
Provision For Loan Losses
The provision for loan losses reflects management's judgment of the expense to
be recognized in order to maintain an adequate allowance for loan losses. The
Company provided $898,000 for loan losses during 2001 compared to $460,000 in
2000 and $166,000 in 1999. The primary reason for the increased allowance for
loan losses in 2001 versus 2000 was the charge-off of $612,000 in commercial
leases. The increased provision for loan losses in 2000 versus 1999 was due to
the growth in the Banks' loan portfolios.
Management believes the allowance for loan losses to be adequate to absorb
probable losses in the current portfolio. This statement is based upon
management's continuing evaluation of inherent risks in the current loan
portfolio, current levels of classified assets and general economic factors. The
Company will continue to monitor the allowance and make future adjustments to
the allowance as conditions dictate.
Noninterest Income and Expense
Non-interest income during 2001, 2000 and 1999 totaled $5,080,000, $4,130,000
and $5,750,000, respectively, representing a 23.00 percent increase in 2001 from
2000 and a 28.17 percent decrease in 2000 compared 1999. The increase in 2001
can be attributed to higher security gains and increased revenues from deposit,
trust and secondary market lending services. The decrease in 2000 was primarily
related to a lower level of security gains, decreased income from secondary
market loan fees and the non-recurrence of a recovery of a charged-off
investment in 1999. The recovered investment was a corporate bond issued by the
Bank of New England purchased for $1,004,000 in 1989 that was subsequently
written down to $150,000 in 1991 and 1992 due to the commencement of bankruptcy
proceedings by the issuer. The delay in the recovery was due to extended
litigation involving the issuer's bankruptcy trustee, bank regulatory agencies
and the issuer's external auditors.
19
Non-interest expense during 2001, 2000 and 1999 totaled $11,587,000, $10,712,000
and $11,208,000, respectively, representing a 8.17 percent increase in 2001
versus 2000 and a 4.43 percent decrease in 2000 compared to 1999. The higher
noninterest expense in 2001 is primarily attributable to higher salary and
benefits expenses, data processing costs, and professional fees associated with
filings with the Securities and Exchange Commission. The decrease in 2000 was
primarily related to lower costs associated with data processing, equipment and
advertising. The percentage of non-interest expense to average assets was 1.88
percent in 2001, compared to 1.71 percent and 1.89 percent during 2000 and 1999,
respectively.
Provision for Income Taxes
The provision for income taxes for 2001, 2000 and 1999 was $4,639,000,
$3,596,000 and $4,429,000, respectively. This amount represents an effective tax
rate of 30.54 percent during 2001, compared to 28.28 percent and 30.01 percent
for 2000 and 1999, respectively. The Company's marginal federal tax rate is
currently 35 percent. The difference between the Company's effective and
marginal tax rate is primarily related to investments made in tax exempt
securities.
Investment Portfolio
The following table presents the market values, which represent the carrying
values due to the available-for-sale classification, of the Company's investment
portfolio as of December 31, 2001, 2000 and 1999, respectively (dollars in
thousands).
----------------------------------
2001 2000 1999
----------------------------------
U.S. treasury securities ................ $ 12,548 $ 23,150 $ 29,599
U.S. government agencies ................ 60,858 85,864 97,209
State and political subdivisions ........ 63,109 61,411 64,582
Corporate bonds ......................... 51,106 43,167 46,011
Equity securities ....................... 26,157 19,114 16,763
----------------------------------
Total ........................... $213,778 $232,706 $254,164
==================================
Investments in States and political subdivisions represent purchases of
municipal bonds located primarily in the state of Iowa and contiguous states.
Investment in other securities includes corporate debt obligations of companies
located and doing business throughout the United States. The debt obligations
were all within the credit ratings acceptable under the Banks' investment
policies with the exception of one corporate bond with an amortized cost of
$496,000 and a market value of $448,000. The bond was rated by Moody's and
Standard & Poor's rating service publications as BA1 and BB, respectively, as of
December 31, 2001 falling outside the bank's acceptable rating standards
subsequent to its purchase date of November 16, 1998. As of December 31, 2001,
the Company did not have securities from a single issuer, except for the United
States Government or its agencies, which exceeded 10 percent of consolidated
stockholders' equity.
20
Investment Maturities as of December 31, 2001
The investments in the following table are reported by contractual maturity.
Expected maturities may differ from contractual maturities because borrowers may
have the right to call or prepay obligations with or without prepayment
penalties (dollars in thousands).
After one After five
year but years but
Within within within After
One Year five years ten years ten years Total
-------------------------------------------------------------------
U.S. treasury ...................... $ 8,888 $ 3,162 $ 498 $ -- $ 12,548
U.S. government agencies ........... 5,425 34,892 18,541 2,000 60,858
States and political subdivisions .. 6,953 20,283 24,026 11,847 63,109
Corporate bonds .................... 7,357 22,987 19,489 1,273 51,106
-------------------------------------------------------------------
Total ...................... $ 28,623 $ 81,324 $ 62,554 $ 15,120 $ 187,621
===================================================================
Weighted average yield
U.S. treasury .................... 6.41% 5.45% 5.20% -- 6.15%
U.S. government agencies ......... 6.07% 5.73% 6.54% 7.00% 6.06%
States and political subdivisions* 7.24% 7.38% 7.65% 7.57% 7.51%
Corporate bonds .................. 7.36% 6.51% 6.44% 6.42% 6.60%
-------------------------------------------------------------------
Total ...................... 6.76% 6.36% 6.93% 7.40% 6.70%
* Yields on tax-exempt obligations of states and political subdivisions have
been computed on a tax-equivalent basis.
Loan Portfolio
Types of Loans
The following table sets forth the composition of the Company's loan portfolio
for the past five years ending at December 31, 2001 (dollars in thousands).
----------------------------------------------------
2001 2000 1999 1998 1997
----------------------------------------------------
Real Estate
Construction ......... $ 12,677 $ 12,221 $ 9,062 $ 7,641 $ 8,562
1-4 family residential 84,379 97,663 89,171 84,767 80,632
Commercial ........... 117,211 112,415 98,840 83,115 69,193
Agricultural ......... 21,029 21,095 19,999 18,336 17,202
Commercial .............. 45,631 53,955 48,920 52,458 50,387
Agricultural ............ 27,367 28,199 25,575 23,882 23,682
Consumer and other ...... 20,920 24,576 23,897 23,263 22,023
----------------------------------------------------
Total loans ..... 329,214 350,124 315,464 293,462 271,681
Deferred loan fees, net . 725 736 826 903 917
----------------------------------------------------
Net loans ....... $328,489 $349,388 $314,638 $292,559 $270,764
====================================================
The Company's loan portfolio consists of commercial loans, agricultural loans,
commercial real estate and residential real estate loans and consumer loans. As
of December 31, 2001, gross loans totaled approximately $329 million, which
equals approximately 64 percent of total deposits and 53 percent of total
assets. As of December 31, 2001, the majority of the loans were originated
directly by the Banks to borrowers within the Banks' principal market areas.
There are no foreign loans outstanding during the years presented.
Commercial loans consist primarily of loans to businesses for various purposes
including revolving lines to finance current operations, floor-plans, inventory
and accounts receivable; capital expenditure loans to finance equipment and
other fixed assets; and letters of credit. These loans generally have short
maturities, have either adjustable or fixed rates and are unsecured or secured
by inventory, accounts receivable, equipment and/or real estate.
21
Agricultural loans play an important part in the Banks' loan portfolios. Iowa is
a major agricultural state and is a national leader in both grain and livestock
production. The Banks play a significant role in their communities in financing
operating, livestock and real estate activities.
All lending is done on a personal basis using cash flow as the most important
criterion after assessing the borrower's character. Government programs are
utilized where the benefit to both borrower and lender is evident.
Real estate loans include various types of loans for which the Banks hold real
property as collateral and consist of loans primarily on commercial properties
and single family residences. Real estate loans typically have fixed rates for
up to five years with the Company's loan policy having a maximum fixed rate
maturity of up to 15 years. The majority of construction loan volume is to
contractors to construct commercial buildings and generally have maturities of
up to 12 months. The Banks originate residential real estate loans for sale to
the secondary market for a fee.
Consumer loans include loans extended to individuals for household, family and
other personal expenditures not secured by real estate. The majority of the
Banks' consumer lending is for vehicles, consolidation of personal debts,
household appliances and improvements.
The interest rates charged on loans vary with the degree of risk, the amount of
the loan and the maturity of the loan. Competitive pressures, market interest
rates, the availability of funds and government regulation further influence the
rate charged on a loan.
The Banks follow a loan policy, which has been approved by both the Company and
Banks' Boards of Directors and are overseen by both Company and Bank management.
These policies establish lending limits, review and grading criteria and other
guidelines such as loan administration and allowance for loan losses. Loans are
approved by the Banks' Board of Directors and/or designated officers in
accordance with respective guidelines and underwriting policies of the Company.
Loans to one borrower are limited by applicable state and federal banking laws.
Credit limits generally vary according to the type of loan and the individual
loan officer's experience.
Maturities and Sensitivities of Loans to Changes in Interest Rates as of
December 31, 2001
The contractual maturities of the Company's loan portfolio are as shown below.
Actual maturities may differ from contractual maturities because individual
borrowers may have the right to prepay loans with or without prepayment
penalties (dollars in thousands).
After one
year but
Within within After
One Year five years five years Total
--------------------------------------------
Real Estate
Construction ................ $ 9,778 $ 2,583 $ 316 $ 12,677
1-4 family residential ...... 5,036 36,151 43,192 84,379
Commercial .................. 7,671 76,098 33,442 117,211
Agricultural ................ 1,999 3,939 15,091 21,029
Commercial ..................... 19,844 19,843 5,944 45,631
Agricultural ................... 18,377 6,128 2,862 27,367
Consumer and other ............. 4,175 8,854 7,891 20,920
--------------------------------------------
Total loans .................... $ 66,880 $153,596 $108,738 $329,214
============================================
After one
year but
within After
five years five years
-----------------------
Loan maturities after one year with:
Fixed rates .................................... $129,409 $108,551
Variable rates ................................. 24,187 187
-----------------------
$153,596 $108,738
=======================
22
Non-performing Assets
The following table sets forth information concerning the Company's
non-performing assets for the past five years ending December 31, 2001 (dollars
in thousands).
------------------------------------------
2001 2000 1999 1998 1997
------------------------------------------
Non-performing assets:
Nonaccrual loans ................ $2,692 $2,663 $ 405 $ 80 $ 69
Loans 90 days or more past due .. 797 242 723 581 872
Restructured loans .............. -- -- -- -- 253
------------------------------------------
3,489 2,905 1,128 661 1,194
Other real estate owned ........... 159 75 41 43 89
------------------------------------------
Total non-performing
assets .................... $3,648 $2,980 $1,169 $ 704 $1,283
==========================================
The accrual of interest on non-accrual and other impaired loans is discontinued
at 90 days or when, in the opinion of management, the borrower may be unable to
meet payments as they become due. When interest accrual is discontinued, all
unpaid accrued interest is reversed. Interest income is subsequently recognized
only to the extent cash payments are received. Interest income on restructured
loans is recognized pursuant to the terms of the new loan agreement. Interest
income on other impaired loans is monitored and based upon the terms of the
underlying loan agreement. However, the recorded net investment in impaired
loans, including accrued interest, is limited to the present value of the
expected cash flows of the impaired loan or the observable fair market value of
the loan's collateral.
Outstanding loans of $886,000 were placed on non-accrual status in 2001 with
total non-accrual loans equaling $2,692,000 as of December 31, 2001. Outstanding
loans of $2,578,000 were placed on non-accrual status in 2000 with total
non-accrual loans equaling $2,663,000 as of December 31, 2000. Outstanding loans
of $392,000 were placed on non-accrual status in 1999 with total non-accrual
loans equaling $405,000 as of December 31, 1999. A real estate loan at First
National with a December 31, 2001 balance of $1,305,000 compared to $1,790,000
as December 31, 2000 is the largest non-performing asset that was placed on
non-accrual status in 2000. For the years ended December 31, 2001, 2000 and
1999, interest income, which would have been recorded under the original terms
of such loans was approximately $243,000, $254,000 and $46,000, respectively,
with $114,000, $101,000 and $17,000, respectively, recorded. Additional
potential problem loans and leases as of December 31, 2001, consisted of a pool
of purchased leases with a balance of $2,330,000.
Summary of the Allowance for Loan Losses
The provision for loan losses represents charges made to earnings to maintain an
adequate allowance for loan losses. The allowance for loan losses is
management's best estimate of probable losses inherent in the loan portfolio as
of the balance sheet date. Factors considered in establishing an appropriate
allowance include: an assessment of the financial condition of the borrower; a
realistic determination of value and adequacy of underlying collateral; the
condition of the local economy and the condition of the specific industry of the
borrower; an analysis of the levels and trends of loan categories; and a review
of delinquent and classified loans.
The adequacy of allowance for loan losses is evaluated quarterly by management
and the respective Bank boards. This evaluation focuses on specific loan
reviews, changes in the type and volume of the loan portfolio given the current
and forecasted economic conditions and historical loss experience. Any one of
the following conditions may result in the review of a specific loan: concern
about whether the customer's cash flow or net worth are sufficient to repay the
loan; delinquent status; the loan has been criticized in a regulatory
examination; the accrual of interest has been suspended; or other reasons
including when the loan has other special or unusual characteristics which
suggest special monitoring is warranted.
While management uses available information to recognize losses on loans,
further reductions in the carrying amounts of loans may be necessary based on
changes in local economic conditions. In addition, regulatory agencies, as an
integral part of their examination process, periodically review the estimated
losses on loans. Such agencies may require the Company to recognize additional
losses based on their judgment about information available to them at the time
of their examination.
23
Analysis of the Allowance for Loan Losses
The Company's policy is to charge-off loans when, in management's opinion, the
loan is deemed uncollectable, although concerted efforts are made to maximize
future recoveries. The following table sets forth information regarding changes
in the Company's Allowance For Loan Losses For The Most Recent Five Years
(dollars in thousands).
--------------------------------------------------------------
2001 2000 1999 1998 1997
--------------------------------------------------------------
Balance at beginning of period .... $ 5,373 $ 4,986 $ 4,846 $ 4,459 $ 4,159
Charge-offs:
Real Estate
Construction ................... -- -- -- -- --
1-4 Family Residential ......... 1 -- -- -- --
Commercial ..................... -- -- 18 -- --
Agricultural ................... -- -- -- -- --
Commercial ........................ 768 55 -- 118 --
Agricultural ...................... -- -- -- -- --
Consumer and other ................ 83 96 41 26 34
-------------------------------------------------------------
852 151 59 144 34
Recoveries:
Real Estate
Construction ................... -- -- -- -- --
1-4 Family Residential ......... -- -- -- -- --
Commercial ..................... -- -- 16 -- 1
Agricultural ................... -- -- -- -- --
Commercial ........................ 8 66 -- 79 36
Agricultural ...................... -- -- -- -- --
Consumer and other ................ 19 12 17 15 18
-------------------------------------------------------------
27 78 33 94 55
Net charge-offs (recoveries) ...... $ 825 $ 73 $ 26 $ 50 ($ 21)
Additions charged to
operations ...................... 898 460 166 437 279
-------------------------------------------------------------
Balance at end of period .......... $ 5,446 $ 5,373 $ 4,986 $ 4,846 $ 4,459
=============================================================
Average Loans Outstanding ......... $ 341,440 $ 339,115 $ 299,064 $ 279,054 $ 237,601
Ratio of net charge-offs during the
period to average loans
outstanding ..................... 0.24% 0.02% 0.01% 0.02% -0.01%
Ratio of allowance for loan losses
to average loans outstanding .... 1.60% 1.58% 1.67% 1.74% 1.88%
Reserve levels increased to 1.60 percent of outstanding loans as of December 31,
2001 compared to 1.58 percent for the prior year-end. Problem commercial leases
identified in 2001 led to higher provision expense, net charge-offs and specific
reserves as credit weaknesses were identified. General reserve allocations
remained consistent in 2001 with prior years.
General reserves for loan categories normally range from 1.0 to 2.0 percent of
the outstanding loan balances. As loan volume increases, the general reserve
levels increase with that growth. As the previous table indicates, the
additional loan provision for years 1997 through 2000 is the most significant
change in the reserve level as a result of growth in the loan portfolio. The
general reserve loss factors have remained consistent over the five-year period
presented. The allowance relating to commercial and 1-4 family residential real
estate loans are the largest reserve components. Commercial real estate loans
have higher general reserve levels than 1-4 family residential real estate loans
as management perceives more risk in this type of lending. Elements contributing
to the higher risk level include susceptibility of businesses to changing
environmental factors such as the economic business cycle, the larger individual
loan amounts, a limited number of buyers and the specialized uses for some
properties. As of December 31, 2001, commercial real estate loans have general
reserves of 1.30 percent and 1-4 family residential loans, which management
generally considers lower risk, have general reserves of 1.00 percent. The
estimation methods and assumptions used in determining the allowance for the
five years presented have remained consistent.
24
Loans that the Banks have identified as having higher risk levels are reviewed
individually in an effort to establish adequate loss reserves. These reserves
are considered specific reserves and are directly impacted by the credit quality
of the underlying loans. Normally, as the actual or expected level of
non-performing loans increase, the specific reserves also increase. The rise in
specific reserves from 1997 through 1999 was minimal, with the largest increase
in total specific reserves being limited to $35,000 from 1998 to 1999. For
December 31, 2001 and 2000, specific reserves increased $142,000 or 12 percent
and $177,000 or 18 percent, respectively. Specific allocations for commercial
leases was the primary reason for the increase in total reserve levels in 2001.
The specific reserves are dependent upon assumptions regarding the liquidation
value of collateral and the cost of recovering collateral including legal fees.
Changing the amount of specific reserves on individual loans has had the largest
impact on the reallocation of the reserve among different parts of the
portfolio.
Other factors that are considered when determining the adequacy of the reserve
include loan concentrations, loan growth, the economic outlook and historical
losses. The Company's concentration risks include geographic concentration in
central Iowa; the local economy's dependence upon several large governmental
entities, including Iowa State University and the Iowa Department of
Transportation; and the health of Iowa's agricultural sector that is dependent
on weather conditions and government programs. Additional reserves have not been
established for local and national economic conditions over the last five-year
period, as the economy has been healthy and credit quality has remained
favorable. Historical losses reflect good credit quality over the past five
years, as net losses have not exceeded .24 percent which compares favorably to
the Company's reserve of 1.60 percent as of December 31, 2001. However, no
assurances can be made that losses will remain at the favorable levels
experienced over the past five years.
Allocation of the Allowance for Loan Losses
The following table sets forth information concerning the Company's allocation
of the allowance for loan losses (dollars in thousands).
--------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
--------------------------------------------------------------------------------------------
Amount % * Amount % * Amount % * Amount % * Amount % *
--------------------------------------------------------------------------------------------
Balance at end of period
applicable to:
Real Estate
Construction ......... $ 178 3.85% $ 163 3.49% $ 91 2.87% $ 80 2.60% $ 99 3.15%
1-4 family residential 980 25.63% 1,088 27.89% 899 28.27% 809 28.89% 916 29.68%
Commercial ........... 1,704 35.60% 1,619 32.11% 1,536 31.33% 1,330 28.32% 1,143 25.47%
Agricultural ......... 279 6.39% 315 6.03% 237 6.34% 194 6.25% 175 6.33%
Commercial .............. 938 13.86% 754 15.41% 573 15.51% 828 17.88% 728 18.55%
Agricultural ............ 457 8.31% 421 8.05% 541 8.11% 517 8.14% 367 8.72%
Consumer and other ...... 258 6.35% 538 7.02% 560 7.58% 604 7.93% 535 8.11%
Unallocated ............. 652 475 549 484 479
--------------------------------------------------------------------------------------------
$5,446 100% $5,373 100% $4,986 100% $4,846 100% $4,442 100%
============================================================================================
* Percent of total loans in each category to total loans.
Deposits
Types of Deposits
The Company's primary source of funds is customer deposits. The Company attempts
to attract non-interest-bearing deposits, which are a low cost funding source.
In addition, the Banks offer a variety of interest-bearing accounts designed to
attract both short-term and longer-term deposits from customers.
Interest-bearing accounts earn interest at rates established by Bank management
based on competitive market factors and the Company's need for funds. While
nearly 75 percent of the Banks' certificates of deposit mature in the next year,
it is anticipated that a majority of these certificates will be renewed. Rate
sensitive certificates of deposits in excess of $100,000 are subject to somewhat
higher volatility with regard to renewal volume as the Banks adjust rates based
upon funding needs. In the event a substantial volume of certificates are not
renewed, the Company has sufficient liquid assets and borrowing lines to fund
significant runoff. A sustained reduction in deposit volume would have a
significant negative impact on the Company's operation and liquidity. The
Company traditionally has not relied upon brokered deposits and does not
anticipate utilizing such funds at the present time.
25
Average Deposits by Type
The following table sets forth the average balances for each major category of
deposit and the weighted average interest rate paid for deposits during the
years ended December 31, 2001, 2000 and 1999 (dollars in thousands).