UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the quarterly period ended June 30, 2003
-------------
OR
_____ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the transition period from _________________ to __________________
Commission file number 2-89283
-------
IOWA FIRST BANCSHARES CORP.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
STATE OF IOWA 42-1211285
- --------------------------------------------------------------------------------
(State or other jurisdiction (IRS Employer of
incorporation or organization) Identification No.)
300 East Second Street
Muscatine, Iowa 52761
----------------------------------------
(Address of principal executive offices)
563-263-4221
-------------------------------
(Registrant's telephone number)
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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
At June 30, 2003 there were 1,420,445 shares of the registrant's common stock
outstanding.
1
IOWA FIRST BANCSHARES CORP. AND SUBSIDIARIES
INDEX TO FORM 10-Q
PAGE NO.
PART 1 Financial Information
Item 1. Financial Statements
Consolidated Condensed Balance Sheets,
June 30, 2003 and December 31, 2002 1
Consolidated Condensed Statements of
Income, Three and Six Months Ended
June 30, 2003 and 2002 2
Consolidated Condensed Statements of
Cash Flows, Six Months Ended
June 30, 2003 and 2002 3
Notes to Consolidated Condensed
Financial Statements 4-5
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of
Operations 6-16
Item 4. Controls and Procedures 17
PART II Other Information
Item 6. Exhibits and Reports on Form 8-K 17
Signatures 18
2
IOWA FIRST BANCSHARES CORP. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(In Thousands)
(Unaudited)
June 30, December 31,
2003 2002
--------------------------
ASSETS
Cash and due from banks ................................ $ 13,653 $ 17,283
Interest-bearing deposits at financial institutions .... 6,641 1,791
Federal funds sold ..................................... 47,035 30,600
Investment securities available for sale ............... 37,415 38,095
Loans, net of allowance for loan losses June 30,
2003, $3,355; December 31, 2002, $3,304 .............. 271,383 273,922
Bank premises and equipment, net ....................... 6,659 5,303
Accrued interest receivable ............................ 2,180 2,672
Life insurance contracts ............................... 4,053 3,953
Restricted investment securities ....................... 3,957 3,957
Other assets ........................................... 1,102 1,129
---------------------
TOTAL ASSETS ........................................ $394,078 $378,705
=====================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Noninterest bearing deposits ........................... $ 46,146 $ 45,293
Interest bearing deposits .............................. 245,231 225,129
---------------------
TOTAL DEPOSITS ...................................... 291,377 270,422
Note payable ........................................... 3,300 3,300
Securities sold under agreements to repurchase ......... 5,003 6,591
Federal Home Loan Bank advances ........................ 59,752 64,609
Treasury tax and loan open note ........................ 697 785
Company obligated mandatorily redeemable preferred
securities of subsidiary trust ....................... 4,000 4,000
Dividends payable ...................................... 334 335
Other liabilities ...................................... 1,724 1,633
---------------------
TOTAL LIABILITIES ................................... 366,187 351,675
---------------------
Redeemable common stock held by employee stock
ownership plan with 401(k) provisions (KSOP) ........... 2,717 2,717
---------------------
STOCKHOLDERS' EQUITY
Common stock ........................................... 200 200
Additional paid-in capital ............................. 4,254 4,254
Retained earnings ...................................... 35,087 34,195
Accumulated other comprehensive income ................. 1,177 1,101
Less net cost of common shares acquired for the treasury (12,827) (12,720)
Less maximum cash obligation related to KSOP shares .... (2,717) (2,717)
---------------------
TOTAL STOCKHOLDERS' EQUITY .......................... 25,174 24,313
---------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ............. $394,078 $378,705
=====================
See notes to Consolidated Condensed Financial Statements.
3
IOWA FIRST BANCSHARES CORP. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(In Thousands, Except Per Share Data)
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------------------
2003 2002 2003 2002
--------------------------------------
INTEREST AND DIVIDEND INCOME:
Loans, including fees:
Taxable ................................. $ 4,435 $ 4,950 $ 8,917 $ 9,827
Nontaxable .............................. 25 24 59 43
Investment securities available for sale:
Taxable ................................. 247 294 503 615
Nontaxable .............................. 183 207 376 418
Federal funds sold ........................ 141 128 258 277
Restricted investment securities .......... 30 31 61 57
Other ..................................... 29 20 51 44
-------------------------------------
Total interest income .................. 5,090 5,654 10,225 11,281
-------------------------------------
INTEREST EXPENSE:
Deposits .................................. 1,229 1,495 2,486 3,039
Note payable .............................. 39 75 100 183
Other borrowed funds ...................... 880 1,043 1,813 2,121
Company obligated mandatorily redeemable
preferred securities ................... 103 103 206 206
-------------------------------------
Total interest expense .................. 2,251 2,716 4,605 5,549
-------------------------------------
Net interest income ....................... 2,839 2,938 5,620 5,732
Provision for loan losses .................... 90 167 460 235
-------------------------------------
Net interest income after provision for
loan losses ............................. 2,749 2,771 5,160 5,497
-------------------------------------
Other income:
Trust department .......................... 95 103 190 207
Service fees .............................. 415 375 763 706
Investment securities gains, net .......... 12 8 22 80
Other ..................................... 243 133 437 282
-------------------------------------
Total other income ...................... 765 619 1,412 1,275
-------------------------------------
Operating expenses:
Salaries and employee benefits ............ 1,218 1,193 2,484 2,418
Occupancy expenses, net ................... 164 167 342 331
Equipment expenses ........................ 179 177 332 363
Office supplies, printing, and postage .... 85 90 192 181
Computer processing ....................... 135 116 265 237
Advertising and business promotion ........ 49 41 79 81
Other operating expenses .................. 350 348 686 674
-------------------------------------
Total operating expenses ................. 2,180 2,132 4,380 4,285
-------------------------------------
Income before income taxes ................ $ 1,334 $ 1,258 $ 2,192 $ 2,487
Applicable income taxes ...................... 390 389 631 763
-------------------------------------
Net income ................................... $ 944 $ 869 $ 1,561 $ 1,724
=====================================
Net income per common share, basic and diluted $ 0.67 $ 0.60 $ 1.10 $ 1.19
=====================================
Dividends declared per common share .......... $ 0.24 $ 0.23 $ 0.47 $ 0.46
=====================================
Comprehensive income ......................... $ 1,015 $ 1,146 $ 1,637 $ 1,865
====================================
See notes to Consolidated Condensed Financial Statements.
4
IOWA FIRST BANCSHARES CORP. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
For The Six Months Ended June 30, 2003 and 2002
(In Thousands)
(Unaudited)
2003 2002
--------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income ........................................................... $ 1,561 $ 1,724
Adjustments to reconcile net income to net cash
provided by operating activities:
Proceeds from loans sold .......................................... 9,800 3,970
Loans underwritten ................................................ (10,268) (3,927)
Gains on loans sold .............................................. (145) (43)
Provision for loan losses ......................................... 460 235
Investment securities gains, net .................................. (22) (80)
Depreciation ...................................................... 259 311
Amortization of premiums and accretion of discounts
on investment securities available for sale, net ................ 95 14
Net decrease in accrued interest receivable ....................... 492 403
Net (increase) decrease in other assets ........................... 27 (347)
Net increase in other liabilities ................................ 44 77
--------------------
Net cash provided by operating activities ............................ $ 2,303 $ 2,337
--------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Net increase in interest-bearing deposits at financial institut$ons (4,850) $ (528)
Net (increase) decrease in federal funds sold ..................... (16,435) 5,415
Proceeds from sales, maturities, calls and paydowns of available
for sale securities ............................................... 4,767 14,534
Purchases of available for sale securities ........................ (4,037) (7,990)
Net (increase) decrease in loans .................................. 2,692 (5,633)
Purchases of bank premises and equipment .......................... (1,615) (159)
Purchases of life insurance contracts ............................. -- (405)
Increase in cash value of life insurance contracts ................ (100) (88)
Purchases of restricted investment securities ..................... -- (43)
--------------------
Net cash provided by (used in) investing activities ............... $(19,578) $ 5,103
--------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in noninterest bearing deposits ...................... $ 853 $ 20
Net increase in interest bearing deposits ......................... 20,102 31
Net (decrease) in securities sold under
agreements to repurchase ........................................ (1,588) (155)
Repayment of note payable ......................................... (3,324) (2,119)
Proceeds from note payable ........................................ 3,324 --
Net increase (decrease) in treasury tax and loan open note ........ (88) 295
Advances from Federal Home Loan Bank .............................. 9,550 1,000
Payments of advances from Federal Home Loan Bank .................. (14,407) (5,649)
Cash dividends paid ............................................... (670) (663)
Purchases of common stock for the treasury ........................ (107) (430)
Proceeds from issuance of common stock ............................ -- 105
--------------------
Net cash provided by (used in)financing activities ................ $ 13,645 $ (7,565)
--------------------
Net (decrease) in cash and due from banks ......................... (3,630) (125)
Cash and due from banks:
Beginning ......................................................... $ 17,283 $ 14,661
--------------------
Ending ............................................................ $ 13,653 $ 14,536
====================
Supplemental Disclosures of Cash Flow Information, cash payments for:
Interest ....................................................... $ 4,676 $ 5,669
Income taxes ................................................... 697 721
Supplemental Schedule of Noncash Investing and Financing Activities:
Change in accumulated other comprehensive income, unrealized
gains on investment securities available for sale, net ............. 76 141
See notes to Consolidated Condensed Financial Statements.
5
IOWA FIRST BANCSHARES CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
Note 1. Nature of Business and Significant Accounting Policies
Nature of business:
Iowa First Bancshares Corp. (the "Company") is a bank holding company
headquartered in Muscatine, Iowa. The Company owns the outstanding stock of two
national banks, First National Bank of Muscatine (Muscatine) and First National
Bank in Fairfield (Fairfield). First National Bank of Muscatine has a total of
five locations in Muscatine, Iowa. First National Bank in Fairfield has two
locations in Fairfield, Iowa. Each bank is engaged in the general commercial
banking business and provides full service banking to individuals and
businesses, including checking, savings, money market and time deposit accounts,
commercial loans, consumer loans, real estate loans, safe deposit facilities,
transmitting of funds, trust services, and such other banking services as are
usual and customary for commercial banks. Some of these other services include
sweep accounts, lock-box deposits, debit cards, credit-related insurance,
internet banking, automated teller machines, telephone banking and investment
services through a third-party arrangement. The Company also owns the
outstanding stock of Iowa First Capital Trust I, which was capitalized in March
2001 for the purpose of issuing Company Obligated Mandatorily Redeemable
Preferred Securities.
Basis of Presentation:
The consolidated financial statements of the Company and its subsidiaries are
unaudited and should be read in conjunction with the consolidated financial
statements contained in the 2002 Annual Report on Form 10-K. The consolidated
financial statements have been prepared in accordance with accounting principles
generally accepted in the United States of America and conform to predominant
practices within the banking industry. Management of the Company has made a
number of estimates and assumptions relating to the reporting of assets and
liabilities and the disclosure of contingent assets and liabilities to prepare
the consolidated financial statements. In the opinion of management, all
adjustments and normal recurring accruals considered necessary for a fair
presentation of the results of operations for the interim periods presented
herein have been included. Operating results for the three and six months ended
June 30, 2003 are not necessarily indicative of the results that may be expected
for the year ending December 31, 2003.
Reclassifications:
Certain amounts in the prior year financial statements have been reclassified,
with no effect on net income or stockholders' equity, to conform to current year
presentations.
Note 2. Capital Stock and Earnings Per Share
Common shares and preferred stock authorized total 6,000,000 shares and 500,000
shares, respectively. Basic earnings per share is arrived at by dividing net
income by the weighted average number of shares of common stock outstanding for
the respective period. Diluted earnings per share is arrived at by dividing net
income by the weighted average number of common stock and common stock
equivalents outstanding for the respective period. The average number of shares
of common stock outstanding for the three and six months ended June 30, 2003
were 1,418,983 and 1,423,214, respectively. The average number of shares of
common stock outstanding for the three and six months ended June 30, 2002 were
1,440,800 and 1,448,637, respectively. There were no common stock equivalents in
2003 or 2002.
Note 3. Commitments and Contingencies
The Banks are parties to financial instruments with off-balance-sheet risk made
in the normal course of business to meet the financing needs of their customers.
These financial instruments include commitments to extend credit and standby
letters of credit. These instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the balance
sheets.
6
The Banks' exposure to credit loss in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit and standby
letters of credit is represented by the contractual amounts of those
instruments. The Banks use the same credit policies in making commitments and
conditional obligations as they do for on-balance-sheet instruments.
June 30, December 31,
2003 2002
--------------------------
Financial instruments whose contract
amounts represent credit risk:
Commitments to extend credit ................... $35,667,000 $44,521,000
Standby letters of credit ...................... 1,677,000 2,539,000
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon and some of the commitments will be sold to other
financial intermediaries if drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. The Banks evaluate each
customer's creditworthiness on a case-by-case basis.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. Those guarantees are
primarily issued to support public and private borrowing arrangements and,
generally, have terms of one year, or less. The credit risk involved in issuing
letters of credit is essentially the same as that involved in extending loan
facilities to customers. The Banks hold collateral, which may include accounts
receivable, inventory, property, equipment, and income-producing properties,
supporting those commitments if deemed necessary. In the event the customer does
not perform in accordance with the terms of the agreement with the third party,
the Banks would be required to fund the commitment. The maximum potential amount
of future payments the Banks could be required to make is represented by the
contractual amount shown in the summary above. If the commitment is funded, the
Banks would be entitled to seek recovery from the customer. At June 30, 2003 and
December 31, 2002 no amounts have been recorded as liabilities for the Banks'
potential obligations under these guarantees.
The Company has also executed contracts for the sale of mortgage loans in the
secondary market in the amount of $1,003,000 and $390,000 as of June 30, 2003
and December 31, 2002, respectively. These amounts are included in loans at the
respective balance sheet dates.
Results of Operations:
Quarter ended June 30, 2003 compared with quarter ended June 30, 2002:
The Company recorded net income of $944,000 for the quarter ended June 30, 2003,
compared with net income of $869,000 for the quarter ended June 30, 2002, an
increase of $75,000 or 8.6%. This increase in net income, despite a decline in
net interest income, resulted from lower provision for loan losses during the
second quarter of 2003 than experienced the second quarter of 2002.
Additionally, noninterest income was substantially higher in the quarter ended
June 30, 2003 than the quarter ended June 30, 2002.
Basic and diluted earnings per share were $.67 for the three months ended June
30, 2003, $.07 or 11.7% greater than the same period in 2002. The Company's
annualized return on average assets for the second quarter of 2003 was .95%
compared to .92% during the second quarter of the prior year. The Company's
annualized return on average equity for the three months ended June 30, 2003 and
June 30, 2002 was 15.2% and 14.7%, respectively.
7
The distribution of average assets, liabilities and stockholders' equity and
intrest rates, as well as interest differential was as follows (dollar amounts
in thousands and income and rates on a fully taxable equivalent basis using
staturory tax rates in effect for the year presented):
Three Months Ended Three Months Ended
June 30, 2003 June 30, 2002
------------------------ ------------------------
Average Average
Balance Interest Rate Balance Interest Rate
--------------------------------------------------
Assets
Taxable loans, net .... $270,395 $4,435 6.56% $276,891 $4,950 7.15%
Taxable investment
securities available
for sale ............ 21,903 247 4.51% 21,182 294 5.55%
Nontaxable investment
securities and loans 18,131 315 6.95% 19,319 350 7.25%
Federal funds sold .... 51,271 141 1.10% 30,658 128 1.67%
Restricted investment
securities .......... 3,957 30 3.03% 3,890 31 3.19%
Interest-bearing
deposits at financial
institutions ........ 5,166 29 2.25% 2,188 20 3.66%
---------------- ----------------
Total interest-
earning assets .. 370,823 5,197 5.61% 354,128 5,773 6.52%
------ ------
Cash and due from banks 13,845 13,449
Bank premises and
equipment, net ...... 6,498 4,913
Life insurance
contracts ........... 4,031 3,518
Other assets .......... 3,498 3,391
-------- --------
Total ........... $398,695 $379,399
======== ========
Liabilities
Deposits:
Interest-bearing
demand.. .......... $134,976 $ 274 0.81% $117,229 $ 402 1.37%
Time ................ 114,833 955 3.34% 112,671 1,093 3.89%
Note payable .......... 3,300 39 4.73% 4,050 75 7.41%
Other borrowings ...... 69,102 880 5.11% 73,237 1,043 5.71%
Company obligated
mandatorily redeemable
preferred securities 4,000 103 10.30% 4,000 103 10.30%
---------------- ----------------
Total interest-
bearing
liabilities.... 326,211 2,251 2.77% 311,187 2,716 3.49%
Noninterest-bearing
deposits .......... 42,811 40,235
Other liabilities ..... 2,020 1,958
-------- -------
Total
liabilities .... 371,042 353,380
Redeemable common
stock held by
KSOP ............... 2,717 2,242
Stockholders' Equity ... 24,936 23,777
-------- --------
Total .......... $398,695 $379,399
======== ========
Net interest earnings .. $2,946 $3,057
====== ======
Net Annualized Yield (net
interest earnings
divided by total
interest-earning
assets) ............. 3.18% 3.45%
===== =====
Nonaccruing loans are included in the average balance. Loan fees are not
material.
8
The net interest margin continues to be pressured as evidenced by a decrease to
3.18% during the second quarter of 2003 compared to 3.45% during the second
quarter of 2002. The return on average interest-earning assets decreased 91
basis points (from 6.52% in 2002 to 5.61% in 2003) and interest paid on average
interest-bearing liabilities decreased 72 basis points (from 3.49% in 2002 to
2.77% in 2003).
The prime lending rate began the year 2002 at 4.75% and ended 2002 lower at
4.25%; it subsequently dropped to 4.00% as of late June 2003. This is the lowest
prime lending rate in several decades. During this period of historically low
interest rates, increased emphasis has been given to incorporating interest rate
floors on selected commercial and agricultural loans. During the first two
quarters of 2003 most, if not all, of such loans subject to interest rate floors
were actually paying the floor rate. This resulted in the rates received on
taxable loans during the second quarter of 2003, compared to the second quarter
of 2002, falling somewhat less than the rates paid on interest-bearing
liabilities (59 basis points versus 72 basis points). Eventually, when market
interest rates again rise, rates paid on interest-bearing liabilities may, for a
time, increase more than rates received on taxable loans. This outcome is
possible due to the loans which are subject to floor rate pricing lagging market
interest rate increases until such time as the floor rate has been exceeded. The
extent of this impact will depend on the amount and timing of eventual market
interest rate hikes.
Rates received on taxable investment securities available for sale have
decreased during the second quarter of 2003 versus the second quarter of 2002 at
a faster pace than the rates paid on interest-bearing liabilities (decreases of
104 basis points and 72 basis points, respectively). This is largely due to
maturities and early calls of taxable investment securities coupled with
reinvestment at appreciably lower interest rates. This portfolio, however, with
an average maturity of less than four years, had an interest rate return during
the quarter similar to that of thirty year treasury securities.
Rates received during the quarter ended June 30, 2003 compared to the quarter
ended June 30, 2002 on nontaxable investment securities available for sale and
loans decreased at a much slower pace than the rates paid on interest-bearing
liabilities (decreases of 30 basis points and 72 basis points, respectively).
This was due largely to a longer average duration for nontaxable investment
securities available for sale and loans than the average duration for
interest-bearing liabilities. Most of the nontaxable investment securities
available for sale were purchased when market interest rates were higher than
rates currently available. In the current interest rate environment, when
taxable and nontaxable investment securities mature or are sold, called, or
otherwise paid down, the reinvestment rate available is nearly always lower than
the yield of the liquidating security.
The usage of wholesale funding sources (primarily Federal Home Loan Bank
advances), while mitigating intermediate and long-term interest rate risk, tends
to increase overall interest expense. The Company's average rate paid for such
Federal Home Loan Bank advances was reduced by 60 basis points when comparing
the second quarter of 2003 with the second quarter of 2002.
Intense competition for all types of loans and deposits tends to limit the
Company's ability to control pricing and other terms when dealing with
customers.
Provisions for loan losses were $90,000 for the three months ended June 30,
2003. This was $77,000 less than the second quarter of 2002. Net loan
charge-offs for the quarter ended June 30, 2003 totaled $54,000 compared to net
charge-offs of $74,000 for the same quarter in 2002.
Loan quality has been negatively impacted by a variety of factors including, but
not necessarily limited to, a generally sluggish economy. Specifically, the
quality of the agricultural loan portfolio at the Company's Fairfield subsidiary
bank has declined, resulting in larger than normal first quarter 2003 provision
for loan losses.
Various strategies are being implemented by management in an effort to improve
the loan quality of the portfolio in question. These strategies include
obtaining government guarantees for portions of certain identified loans,
increasing monitoring efforts over the loan portfolio in general and past due
loans in particular, as well as a renewed focus on taking appropriate corrective
actions with borrowers who are not fulfilling their contractual obligations.
While cautiously optimistic as to the likelihood of positive results emanating
from the strategies being employed, management realizes that significantly
improving loan quality is not normally a quick process.
9
The allowance for possible loan losses is maintained at the level considered
adequate by management of the Banks to provide for probable losses in the
existing loan portfolio. The allowance is increased by provisions charged to
operating expense and reduced by net charge-offs. In determining the adequacy of
the allowance balance the Banks make continuous evaluations of the loan
portfolio and related off-balance sheet commitments, consider current economic
conditions, the composition of the loan portfolio, historical loan loss
experience, review of specific problem loans, the estimated net realizable value
or the fair value of the underlying collateral, and other factors.
Nonaccrual loans totaled $2,182,000 at June 30, 2003, an increase of $768,000 or
54.3% from June 30, 2002. Other real estate owned totaled $391,000, a decrease
of $144,000 or 26.9% from a year ago. Loans past due 90 days or more and still
accruing totaled $592,000, which was $447,000 or 308% more than a year earlier.
The allowance for possible loan losses of $3,355,000 represented 1.2% of gross
loans and 106% of total nonaccrual loans, other real estate owned, and loans
past due 90 days or more and still accruing.
Other income results from the charges and fees collected by the Company from its
customers for various services performed, gross trust department revenue,
miscellaneous other income and gains (or losses) from the sale of investment
securities in the available for sale category. Total other income for the second
quarter of 2003, without gains on investment securities, was $753,000; $142,000
or 23.2% more than the second quarter of 2002.
Operating expenses include all the costs incurred to operate the Company except
for interest expense, the loan loss provision and income taxes. For the quarter
ended June 30, 2003, salaries and employee benefits expense increased $25,000 or
2.1% due principally to normal cost of living and merit raises, training time
for new employees and rising health care cost. Occupancy and equipment expenses
decreased $1,000 or 0.3%. Office supplies and related expenses decreased $5,000
or 5.6%. Computer processing increased $19,000 or 16.4% as additional costs
associated with enhanced communications, marketing applications and disaster
recovery contracts were recognized. Finally, other operating expenses increased
only $2,000 or 0.6% due largely to management's focus on controlling noninterest
operating expenses. Total operating expenses increased a modest $48,000 or 2.3%
during the second quarter of 2003 versus the same quarter last year.
Income tax expense for the quarter ended June 30, 2003 of $390,000 represented
29.2% of income before taxes. The comparable quarter last year was 30.9% of
income before tax.
The efficiency ratio, defined as noninterest expense, excluding the provision
for loan losses, as a percent of net interest income plus noninterest income,
was 60.5% and 59.9% for the three months ended June 30, 2003 and 2002,
respectively. The primary reasons for this change in the efficiency ratio are
discussed above.
Results of Operations:
Six months ended June 30, 2003 compared with six months ended June 30, 2002:
The Company recorded net income of $1,561,000 for the six months ended June 30,
2003, compared with net income of $1,724,000 for the same period in 2002, a
decrease of $163,000 or 9.5%. This decrease in net income was primarily
attributable to higher provision for loan losses during the first six months of
2003 than experienced in 2002. Additionally, net interest income for the first
two quarters of 2003 was lower than the comparable period in 2002.
Basic and diluted earnings per share were $1.10 for the six months ended June
30, 2003, $.09 or 7.6% less than the same period in 2002. The Company's
annualized return on average assets for the first two quarters of 2003 was .80%
compared to .91% during the same quarters of the prior year. The Company's
annualized return on average equity for the six months ended June 30, 2003 and
June 30, 2002 was 12.7% and 14.8%, respectively.
10
The distribution of average assets, liabilities and stockholders' equity and
intrest rates, as well as interest differential was as follows (dollar amounts
in thousands and income and rates on a fully taxable equivalent basis using
staturory tax rates in effect for the year presented):
Six Months Ended Six Months Ended
June 30, 2003 June 30, 2002
------------------------ ------------------------
Average Average
Balance Interest Rate Balance Interest Rate
--------------------------------------------------
Assets
Taxable loans, net .... $269,522 $8,917 6.62% $273,617 $9,827 7.18%
Taxable investment
securities available
for sale ............ 21,616 503 4.65% 21,777 615 5.65%
Nontaxable investment
securities and loans 18,750 659 7.03% 19,379 698 7.20%
Federal funds sold .... 47,207 258 1.09% 34,445 277 1.61%
Restricted investment
securities .......... 3,957 61 3.08% 3,879 57 2.94%
Interest-bearing
deposits at financial
institutions ........ 4,490 51 2.27% 2,662 44 3.31%
---------------- ----------------
Total interest-
earning assets .. 365,542 10,449 5.72% 355,759 11,518 6.48%
------ ------
Cash and due from banks 14,027 13,143
Bank premises and
equipment, net ...... 6,129 4,958
Life insurance
contracts ........... 4,005 3,453
Other assets .......... 3,744 3,459
-------- --------
Total ........... $393,447 $380,772
======== ========
Liabilities
Deposits:
Interest-bearing
demand............. $126,382 $ 542 0.86% $115,239 $ 805 1.40%
Time ................ 115,666 1,944 3.39% 113,893 2,235 3.96%
Note payable .......... 3,300 100 6.06% 4,950 183 7.39%
Other borrowings ...... 70,825 1,813 5.16% 74,930 2,120 5.71%
Company obligated
mandatorily redeemable
preferred securities 4,000 206 10.30% 4,000 206 10.30%
---------------- ----------------
Total interest-
bearing
liabilities... 320,173 4,605 2.90% 313,012 5,549 3.58%
Noninterest-bearing
deposits ........... 43,720 39,988
Other liabilities .... 2,021 2,034
-------- --------
Total
liabilities .... 365,914 355,034
Redeemable common
stock held by
KSOP ............... 2,717 2,242
Stockholders' Equity ... 24,816 23,496
-------- --------
Total .......... $393,447 $380,772
======== ========
Net interest earnings .. $5,844 $5,969
====== ======
Net Annualized Yield (net
interest earnings
divided by total
interest-earning
assets) .............. 3.20% 3.36%
===== =====
11
The net interest margin declined to 3.20% from 3.36% for the six month periods
ended June 30, 2003 and June 30, 2002, respectively. The return on average
interest-earning assets decreased 76 basis points (from 6.48% in 2002 to 5.72%
in 2003) and interest paid on average interest-bearing liabilities decreased 65
basis points (from 3.55% in 2002 to 2.90% in 2003).
The rates received on taxable loans during the first six months of 2003,
compared to the first six months of 2002, declined somewhat less than the rates
paid on interest-bearing liabilities (56 basis points versus 65 basis points).
Eventually, when market interest rates again rise, rates paid on
interest-bearing liabilities may, for a time, increase more than rates received
on taxable loans. This outcome is possible due to the loans which are subject to
floor rate pricing lagging market interest rate increases until such time as the
floor rate has been exceeded. The extent of this impact will depend on the
amount and timing of eventual market interest rate hikes.
Rates received on taxable investment securities available for sale have
decreased during the first two quarters of 2003 versus the same quarters in 2002
at a faster pace than the rates paid on interest-bearing liabilities (decreases
of 100 basis points and 65 basis points, respectively). This is largely due to
maturities and early calls of taxable investment securities coupled with
reinvestment at appreciably lower interest rates.
Rates received during the quarter ended June 30, 2003 compared to the quarter
ended June 30, 2002 on nontaxable investment securities available for sale and
loans decreased at a much slower pace than the rates paid on interest-bearing
liabilities (decreases of 17 basis points and 65 basis points, respectively).
This was due largely to a longer average duration for nontaxable investment
securities available for sale and loans than the average duration for
interest-bearing liabilities. Most of the nontaxable investment securities
available for sale were purchased when market interest rates were higher than
rates currently available. In the current interest rate environment, when
taxable and nontaxable investment securities mature or are sold, called, or
otherwise paid down, the reinvestment rate available is nearly always lower than
the yield of the liquidating security.
The usage of wholesale funding sources (primarily Federal Home Loan Bank
advances), while mitigating intermediate and long-term interest rate risk, tends
to increase overall interest expense. The Company's average rate paid for such
Federal Home Loan Bank advances was reduced by 50 basis points when comparing
the first two quarters of 2003 with 2002.
Intense competition for all types of loans and deposits tends to limit the
Company's ability to control pricing and other terms when dealing with
customers.
Provisions for loan losses were $460,000 for the six months ended June 30, 2003.
This was $225,000 more than the provision for loan losses during the first six
months of 2002. Net loan charge-offs for the six month period ended June 30,
2003 totaled $409,000 compared to net charge-offs of $103,000 for the same time
frame in 2002.
As previously discussed, various strategies are being implemented by management
in an effort to improve loan quality. These strategies include obtaining
government guarantees for portions of certain identified loans, increasing
monitoring efforts over the loan portfolio in general and past due loans in
particular, as well as a renewed focus on taking appropriate corrective actions
with borrowers who are not fulfilling their contractual obligations. While
cautiously optimistic as to the likelihood of positive results emanating from
the strategies being employed, management realizes that significantly improving
loan quality is not normally a quick process.
Other income results from the charges and fees collected by the Company from its
customers for various services performed, gross trust department revenue,
miscellaneous other income and gains (or losses) from the sale of investment
securities in the available for sale category. Total other income for the first
six months of 2003, without gains on investment securities, was $1,390,000;
$195,000 or 16.3% more than the same period in 2002.
12
Operating expenses include all the costs incurred to operate the Company except
for interest expense, the loan loss provision and income taxes. For the two
quarters ended June 30, 2003 compared to the two quarters ended June 30, 2002,
salaries and employee benefits expense increased $66,000 or 2.7% due principally
to normal cost of living and merit raises, training time for new employees and
rising health care cost. Occupancy and equipment expenses decreased $20,000 or
2.9%. Office supplies and related expenses increased $11,000 or 6.1% and
computer processing increased $28,000 or 11.8%. Finally, other operating
expenses increased only $12,000 or 1.8% due largely to management's focus on
controlling noninterest operating expenses. Total operating expenses increased
$95,000 or 2.2% during the first two quarters of 2003 versus the same time frame
last year.
Income tax expense for the six months ended June 30, 2003 of $631,000 was
$132,000 or 17.3% less than the prior year. This decrease was primarily
attributable to decreased net income generated in 2003 than 2002, and a
reduction in the effective tax rate for 2003 of 28.8% versus 30.7% in 2002.
The efficiency ratio, defined as noninterest expense, excluding the provision
for loan losses, as a percent of net interest income plus noninterest income,
was 62.3% and 61.2% for the six months ended June 30, 2003 and 2002,
respectively. The primary reasons for this change in the efficiency ratio are
discussed above.
Discussion and Analysis of Financial Condition
The Company's assets at June 30, 2003 totaled $394,078,000, an increase of
$15,373,000 or 4.1% from December 31, 2002. As of June 30, 2003, the Company had
$47,035,000 of federal funds sold compared to $30,600,000 at December 31, 2002.
Additionally, interest-bearing deposits at financial institutions (primarily
fully FDIC insured certificates of deposit with original maturities of three
years or less and interest-bearing demand accounts at various banking
institutions) totaled $6,641,000 versus $1,791,000 at December 31, 2002. This
increase was primarily the result of higher yields available on such
certificates of deposit than could be obtained in the federal funds and treasury
securities markets. Federal funds sold and other liquid assets have been higher
the past several quarters than the Company would historically consider normal.
These liquid assets may be used to fund future loan growth, deposit or other
liability outflows, purchases of investment securities available for sale when
interest rates again rise, or various other purposes as identified by
management.
Total available for sale securities decreased $680,000 or 1.8% during the first
six months of 2003 to total $37,415,000 at June 30, 2003. The Banks emphasize
purchase of securities with maturities of five years and less as such purchases
typically offer reasonable yields with limited credit risk as well as limited
interest rate risk. Additionally, selected securities with longer maturities are
owned in order to enhance overall portfolio yield without significantly
increasing risk. In the low interest rate environment which continued during the
first six months of 2003, the banks limited their purchases of securities to
approximately the total of securities that were sold, matured, called, or paid
down. Furthermore, most of the securities that were purchased had relatively
short maturities or likely early call dates. Securities sold thus far in 2003
totaled $516,000 and resulted in net gains recognized of $22,000.
Net loans totaled $271,383,000 at June 30, 2003, a decrease of $2,539,000 or
0.9% from December 31, 2002. Competition for high-quality loans remains intense,
particularly in the small consumer and residential real estate loan categories.
Refinancing of home loans, fueled by historically low interest rates, continues
at a rapid pace. The Company sells many of these loans in the secondary market.
However, the loans which are sold, as well as the loans remaining in the
Company's portfolio but refinance at lower rates, combine to put pressure on
loan yields and the volume of home loans on the balance sheet.
Total deposits at June 30, 2003, were $291,377,000, an increase of $20,955,000
or 7.8% from the balance at December 31, 2002. Certificates of deposit
represented on average for the six months ended June 30, 2003, approximately 41%
of total deposits. Interest-bearing demand deposits, comprised of savings, money
market and NOW accounts, represented another 44% of average deposits. The final
15% of average deposits were in noninterest-bearing accounts. Securities sold
under agreements to repurchase decreased $1,588,000 to $5,003,000, and advances
borrowed from the Federal Home Loan Bank declined by $4,857,000 from year-end
2002, totaling $59,752,000 at quarter end.
The note payable balance of $3,300,000 at June 30, 2003, was identical to the
December 31, 2002 balance. This note was refinanced during the second quarter of
2003. The new variable rate revolving five-year term note is priced at Prime
less one percent, with a floor of 3.25% and a ceiling of 5.25%, considerably
lower than the prior fixed rate of over 7.35%.
13
Interest Rate Sensitivity
The Company manages its balance sheet to minimize the impact of interest rate
movements on its earnings. The term "rate sensitive" refers to those assets and
liabilities which are "sensitive" to fluctuations in rates and yields. When
interest rates move, earnings may be affected in many ways. Interest rates on
assets and liabilities may change at different times or by different amounts.
Maintaining a proper balance between rate sensitive earning assets and rate
sensitive liabilities is the principal function of asset and liability
management of a banking organization.
A positive repricing gap for a given period exists when total interest-earning
assets exceed total interest-bearing liabilities and a negative gap exists when
total interest-bearing liabilities are in excess of interest-earning assets.
Generally a positive repricing gap will result in increased net interest income
in a rising rate environment and decreased net interest income in a falling rate
environment. A negative repricing gap tends to produce increased net interest
income in a falling rate environment and decreased net interest income in a
rising rate environment. At June 30, 2003, rate sensitive liabilities exceeded
rate sensitive assets within a one year maturity range and, thus, the Company is
theoretically positioned to benefit from a decline in interest rates within the
next year.
The Company's repricing gap position is useful for measuring general relative
risk levels. However, even with perfectly matched repricing of assets and
liabilities, interest rate risk cannot be avoided entirely. Interest rate risk
remains in the form of prepayment risk of assets and liabilities, timing lags in
adjusting certain assets and liabilities that have varying sensitivities to
market interest rates, and basis risk. Basis risk refers to the possibility that
the repricing behavior of variable-rate assets could differ from the repricing
characteristics of liabilities which reprice in the same time period. Even
though these assets are match-funded, the spread between asset yields and
funding costs could change.
Because the repricing gap position does not capture these risks, Management
utilizes simulation modeling to measure and manage the rate sensitivity exposure
of earnings. The Company's simulation model provides a projection of the effect
on net interest income of various interest rate scenarios and balance sheet
strategies.
Liquidity
For banks, liquidity represents ability to meet both loan commitments and
deposit withdrawals. Factors which influence the need for liquidity are varied,
but include general economic conditions, asset/liability mix, bank reputation,
future FDIC funding needs, changes in regulatory environment, and credit
standing. Assets which provide liquidity consist principally of loans, cash and
due from banks, interest-bearing deposits at financial institutions, investment
securities, and short-term investments such as federal funds. Maturities of
securities held for investment purposes and loan payments provide a constant
flow of funds available for cash needs. Additionally, liquidity can be gained by
the sale of loans or securities prior to maturity if such assets had previously
been designated as available for sale. Interest rates, relative to the rate paid
by the security or loan sold, along with the maturity of the security or loan,
are the major determinates of the price which can be realized upon sale.
14
The stability of the Company's funding, and thus its ability to manage
liquidity, is greatly enhanced by its consumer deposit base. Consumer deposits
tend to be small in size, diversified across a large base of individuals, and
are government insured to the extent permitted by law. Total deposits at June
30, 2003, were $291,377,000 or 73.9% of total liabilities and equity.
Federal funds sold overnight totaled $47,035,000 or 11.9% of June 30, 2003 total
assets. These federal funds sold may be used to fund loans as well as deposit
withdrawals, or for other purposes as defined by management.
Securities available for sale with a fair value totaling $37,415,000 at
quarter-end included net unrealized gains of $1,879,000. These securities may be
sold in whole or in part to increase liquid assets, reposition the investment
portfolio, or for other purposes as defined by management.
Capital
Stockholders' equity increased $574,000 (2.3%) and $861,000 (3.6%) during the
three and six months ended June 30, 2003, respectively. The year-to-date
increase included net income of $1,561,000, growth of $76,000 in accumulated
other comprehensive income, $669,000 of dividends declared to shareholders, and
$107,000 of treasury share purchases.
Federal regulatory agencies have adopted various capital standards for financial
institutions, including risk-based capital standards. The primary objectives of
the risk-based capital framework are to provide a consistent system for
comparing capital positions of financial institutions and to take into account
the different inherent risks among financial institutions' assets and
off-balance-sheet items.
Risk-based capital standards have been supplemented with requirements for a
minimum Tier 1 capital to assets ratio (leverage ratio). In addition, regulatory
agencies consider the published capital levels as minimum levels and may require
a financial institution to maintain capital at higher levels.
A comparison of the Company's capital as of June 30, 2003 with the requirements
to be considered adequately capitalized is presented below.
For Capital
Actual Adequacy Purposes
-----------------------------
Total capital to risk-weighted assets ..... 12.5% 8.00%
Tier 1 capital to risk-weighted assets .... 11.3% 4.00%
Tier 1 capital to average assets .......... 7.6% 4.00%
Impact of Inflation and Changing Prices
The financial statements and related data presented herein have been prepared in
accordance with accounting principles generally accepted in the United States of
America, which require the measurement of financial position and operating
results in terms of historical dollars without considering changes in the
relative purchasing power of money over time due to inflation. Unlike most
industrial companies, virtually all of the assets and liabilities of a financial
institution are monetary in nature.
As a result, interest rates have a more significant impact on a financial
institution's performance than the effects of general levels of inflation.
Interest rates do not necessarily move in the same direction or in the same
magnitude as the price of goods and services. In the current interest rate
environment, liquidity and the maturity structure of the Company's assets and
liabilities are critical to the maintenance of acceptable performance levels.
Trends, Events or Uncertainties
Officers and Directors of the Company and its subsidiaries have had, and may
have in the future, banking transactions in the ordinary course of business of
the Company's subsidiaries. All such transactions are on substantially the same
terms, including interest rates on loans and collateral, as those prevailing at
the time for comparable transactions with others, involve no more than normal
risk of collectibility, and present no other unfavorable features.
15
In the normal course of business, the Banks are involved in various legal
proceedings. In the current opinion of management, any liability resulting from
such proceedings would not have a material effect on the Company's financial
statements.
The Company, during the second quarter of 2003, completed construction of a new
branch in Muscatine, Iowa. This branch is located on a major thoroughfare and
retail area, Highway 61, on the northeast side of Muscatine. The branch offers a
wide variety of banking services in its 3,000 square feet of space. In addition
to deposit products, the new branch also offers consumer and real estate lending
services. A traditional inside four person teller line and four drive-up teller
lanes are complemented by freestanding twenty-four hour ATM services.
The Company has in the past purchased, and is authorized under an existing stock
repurchase plan to buy in the future, shares of its outstanding common stock for
the treasury as they become available. Pursuant to the stock repurchase plan
approved by the Board of Directors, 4,000 shares were purchased by the Company
during the first two quarters of 2003.
Current Accounting Developments
The Financial Accounting Standards Board has issued Statement 149, "Amendment of
Statement 133 on Derivative Instruments and Hedging". This Statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities under Statement 133. The Statement is effective for contracts
entered into or modified after June 30, 2003 and for hedging relationships
designated after June 30, 2003. Implementation of the Statement is not expected
to have a material impact on the consolidated financial statements.
The Financial Accounting Standards Board has issued Statement 150, "Accounting
for Certain Financial Instruments with Characteristics of both Liabilities and
Equity". This Statement establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both liabilities
and equity and requires that certain freestanding financial instruments be
reported as liabilities in the balance sheet. Depending on the type of financial
instrument, it is required to be accounted for at either fair value or the
present value of future cash flows determined at each balance sheet date with
the change in that value reported as interest expense in the income statement.
Prior to the application of Statement No. 150, either those financial
instruments were not required to be recognized, or if recognized were reported
in the balance sheet as equity and changes in the value of those instruments
were normally not recognized in net income. For the Company, the Statement is
effective July 1, 2003, and management is currently in the process of evaluating
the impact that implementation will have on the consolidated financial
statements.
"SAFE HARBOR" STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT
With the exception of the historical information contained in this report, the
matters described herein contain certain forward-looking statements with respect
to the Company's financial condition, results of operations and business. These
forward-looking statements are subject to certain risks and uncertainties, not
all of which can be predicted or anticipated. Factors that may cause actual
results to differ materially from those contemplated by the forward-looking
statements herein include market conditions as well as conditions affecting the
banking industry generally and factors having a specific impact on the Company,
including but limited to fluctuations in interest rates and in the economy; the
impact of laws and regulations applicable to the Company and changes therein;
the impact of accounting pronouncements applicable to the Company and changes
therein; competitive conditions in the markets in which the Company operates,
including competition from banking and non-banking companies with substantially
greater resources; the Company's ability to control the composition of its loan
portfolio without adversely affecting interest income; the Company's dependence
on third party suppliers; and the Company's ability to respond to changes in
technology. Readers of this Form 10-Q should therefore not place undue reliance
on forward-looking statements.
Item 4 - Disclosure Controls and Procedures
As of the end of the period covered by this report, the Company conducted an
evaluation, under the supervision and with the participation of the principal
executive officer (Chairman of the Board, President and CEO) and principal
financial officer (Executive Vice President, Chief Operating Officer &
Treasurer), of the Company's disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the
"Exchange Act")). Based on this evaluation, the principal executive officer and
principal financial officer concluded that the Company's disclosure controls and
procedures are effective to ensure that information required to be disclosed by
the Company in reports that it files or submits under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in Securities and Exchange Commission rules and forms. There was no change in
the Company's internal control over financial reporting during the Company's
most recently completed fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the Company's internal control over
financial reporting.
16
Part II OTHER INFORMATION
ITEM 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit 31.1 - Certification pursuant to Rule 13a-15(e) and
15d-15(e)
Exhibit 31.2 - Certification pursuant to Rule 13a-15(e) and
15d-15(e)
Exhibit 32.1 - Certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
Exhibit 32.2 - Certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K.
A Form 8-K was filed on April 18, 2003 and consisted of a press
release discussing financial results of the Company for the
quarter ended March 31, 2003 as well as the shareholder dividend
payable in April 2003 and the retirement of the Company's Chairman
of the Board and announcement of his successor.
17
IOWA FIRST BANCSHARES CORP. AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
IOWA FIRST BANCSHARES CORP.
(Registrant)
August 14, 2003 /s/ D. Scott Ingstad
- --------------- -------------------------------
Date D. Scott Ingstad, Chairman of
the Board, President and CEO
August 14, 2003 /s/ Kim K. Bartling
- --------------- -------------------------------
Date Kim K. Bartling, Executive Vice
President, Chief Operating
Officer & Treasurer
18