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ATLO > SEC Filings for ATLO > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for AMES NATIONAL CORP

Form 10-Q for AMES NATIONAL CORP


9-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

Ames National Corporation (the "Company") is a bank holding company established in 1975 that owns and operates five bank subsidiaries in central Iowa (the "Banks"). The following discussion is provided for the consolidated operations of the Company and its Banks, First National Bank, Ames, Iowa (First National), State Bank & Trust Co. (State Bank), Boone Bank & Trust Co. (Boone Bank), Reliance State Bank (RSB), and United Bank & Trust NA (United Bank). The purpose of this discussion is to focus on significant factors affecting the Company's financial condition and results of operations.

The Company does not engage in any material business activities apart from its ownership of the Banks. Products and services offered by the Banks are for commercial and consumer purposes including loans, deposits and trust services. The Banks also offer investment services through a third-party broker-dealer. The Company employs eleven individuals to assist with financial reporting, human resources, audit, compliance, marketing, technology systems and the coordination of management activities, in addition to 194 full-time equivalent individuals employed by the Banks.

The Company's primary competitive strategy is to utilize seasoned and competent Bank management and local decision making authority to provide customers with faster response times and more flexibility in the products and services offered. This strategy is viewed as providing an opportunity to increase revenues through creating a competitive advantage over other financial institutions. The Company also strives to remain operationally efficient to provide better profitability while enabling the Company to offer more competitive loan and deposit rates.


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The principal sources of Company revenues and cash flow are: (i) interest and fees earned on loans made by the Company and Banks; (ii) interest on fixed income investments held by the Company and Banks; (iii) fees on trust services provided by those Banks exercising trust powers; (iv) service charges on deposit accounts maintained at the Banks and (v) gain on sale of loans held for sale. The Company's principal expenses are: (i) interest expense on deposit accounts and other borrowings; (ii) provision for loan losses; (iii) salaries and employee benefits; (iv) data processing costs associated with maintaining the Banks' loan and deposit functions; (v) occupancy expenses for maintaining the Banks' facilities; (vi) other real estate owned costs and (vii) Federal Deposit Insurance Corporation ("FDIC") insurance assessments. The largest component contributing to the Company's net income is net interest income, which is the difference between interest earned on earning assets (primarily loans and investments) and interest paid on interest bearing liabilities (primarily deposits and other borrowings). One of management's principal functions is to manage the spread between interest earned on earning assets and interest paid on interest bearing liabilities in an effort to maximize net interest income while maintaining an appropriate level of interest rate risk.

The Company had net income of $3,861,000, or $0.41 per share, for the three months ended September 30, 2012, compared to net income of $3,590,000, or $0.38 per share, for the three months ended September 30, 2011. Total equity capital as of September 30, 2012 totaled $144.1 million or 12.3% of total assets. Total tangible equity capital as of September 30, 2012 totaled $137.1 million or 11.8% of total tangible assets.

The improvement in quarterly earnings can be primarily attributed to the net income attributable to the acquisition of the Garner and Klemme, Iowa offices by RSB, lower interest expense on deposits and a higher gain on loans held for sale sold on the secondary market.

Net loan charge-offs totaled $47,000 and $16,000 for the three months ended September 30, 2012 and 2011, respectively. The provision for loan losses totaled $36,000 and $5,000 for the three months ended September 30, 2012 and 2011, respectively.

The Company had net income of $10,714,000, or $1.15 per share, for the nine months ended September 30, 2012, compared to net income of $10,306,000, or $1.09 per share, for the nine months ended September 30, 2011.

The change in nine months earnings can be primarily attributed to the net income attributable to the RSB acquisition, lower interest expense on deposits and a higher gain on loans held for sale sold on the secondary market.

Net loan charge-offs totaled $47,000 and $66,000 for the nine months ended September 30, 2012 and 2011, respectively. The provision for loan losses totaled $151,000 and $410,000 for the nine months ended September 30, 2012 and 2011, respectively.

The following management discussion and analysis will provide a review of important items relating to:

Challenges

Key Performance Indicators and Industry Results

Critical Accounting Policies

Income Statement Review

Balance Sheet Review

Asset Quality and Credit Risk Management

Liquidity and Capital Resources

Forward-Looking Statements and Business Risks


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Challenges

Management has identified certain events or circumstances that may negatively impact the Company's financial condition and results of operations in the future and is attempting to position the Company to best respond to those challenges.

Interest rates are likely to increase as the economy continues its gradual recovery and the increasing interest rate environment may present a challenge to the Company. Increases in interest rates may negatively impact the Company's net interest margin if interest expense increases more quickly than interest income. The Company's earning assets (primarily its loan and investment portfolio) have longer maturities than its interest bearing liabilities (primarily deposits and other borrowings); therefore, in a rising interest rate environment, interest expense may increase more quickly than interest income as the interest bearing liabilities reprice more quickly than earning assets. In response to this challenge, the Banks model quarterly the changes in income that would result from various changes in interest rates. Management believes Banks' earning assets have the appropriate maturity and repricing characteristics to optimize earnings and the Banks' interest rate risk positions.

The Company's market in central Iowa has numerous banks, credit unions, and investment and insurance companies competing for similar business opportunities. This competitive environment will continue to compress the Banks' net interest margins and, thus, affect profitability. Strategic planning efforts at the Company and Banks continue to focus on capitalizing on the Banks' strengths in local markets while working to identify opportunities for improvement to gain competitive advantages.

Other real estate owned amounted to $9.9 million and $9.5 million as of September 30, 2012 and December 31, 2011, respectively. Other real estate owned costs, net amounted to $472,000 and $418,000 for the nine months ended September 30, 2012 and 2011, respectively. Management obtains independent appraisals or performs evaluations to determine that these properties are carried at the lower of the new cost basis or fair value less cost to sell. It is at least reasonably possible that change in fair values will occur in the near term and that such changes could have a negative impact on the Company's earnings.

The Company operates in a highly regulated environment and is subject to extensive regulation, supervision and examination. The compliance burden and impact on the Company's operations and profitability is significant. On July 21, 2010, the Dodd-Frank Act was signed into law. The Dodd-Frank Act represents a comprehensive overhaul of the financial services industry within the United States and, among many other things, establishes the new federal Consumer Finance Protection Bureau ("CFPB"). The CFPB and other federal agencies are continuing to implement many new and significant rules and regulations. At this time, it is difficult to predict the extent to which the Dodd-Frank Act or the resulting rules and regulations will impact the Company's and the Banks' business. Compliance with the new law and regulations are likely to result in additional costs, which could be significant, and could adversely impact the Company's results of operations, financial condition or liquidity. The Company cannot predict what changes, if any, will be made to existing federal and state legislation and regulations or the effect that any changes may have on future business and earnings prospects.

Key Performance Indicators and Industry Results

Certain key performance indicators for the Company and the industry are presented in the following chart. The industry figures are compiled by the FDIC and are derived from 7,246 commercial banks and savings institutions insured by the FDIC. Management reviews these indicators on a quarterly basis for purposes of comparing the Company's performance from quarter to quarter against the industry as a whole.


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Selected Indicators for the Company and the Industry

                          September 30, 2012               June 30, 2012
                       3 Months        9 Months              6 Months                             Year Ended December 31,
                        Ended           Ended                  Ended                         2011                         2010
                       Company         Company        Company       Industry*       Company       Industry       Company       Industry

Return on assets            1.32 %          1.27 %        1.24 %          0.99 %        1.38 %         0.88 %        1.40 %         0.66 %

Return on equity           10.86 %         10.26 %        9.94 %          8.84 %       10.82 %         7.86 %       10.91 %         5.99 %

Net interest margin         3.34 %          3.37 %        3.39 %          3.49 %        3.60 %         3.60 %        3.74 %         3.76 %

Efficiency ratio           48.93 %         51.52 %       52.88 %         61.60 %       49.80 %        61.37 %       50.12 %        57.22 %

Capital ratio              12.18 %         12.34 %       12.43 %          9.25 %       12.75 %         9.09 %       12.80 %         8.90 %

* Latest available data

Key performances indicators include:

Return on Assets

This ratio is calculated by dividing net income by average assets. It is used to measure how effectively the assets of the Company are being utilized in generating income. The Company's annualized return on average assets was 1.32% and 1.43%, respectively, for the three months ended September 30, 2012 and 2011. The decrease in this ratio in 2012 from the previous period is primarily the result of an increase in average assets, offset in part by an increase in net income.

Return on Equity

This ratio is calculated by dividing net income by average equity. It is used to measure the net income or return the Company generated for the shareholders' equity investment in the Company. The Company's return on average equity was 10.86% and 10.91%, respectively for the three months ended September 30, 2012 and 2011. The decrease in this ratio in 2012 from the previous period is primarily the result of higher average equity, offset in part by an increase in net income.

Net Interest Margin

The net interest margin for the three months ended September 30, 2012 and 2011 was 3.34% and 3.67%, respectively. The ratio is calculated by dividing net interest income by average earning assets. Earning assets are primarily made up of loans and investments that earn interest. This ratio is used to measure how well the Company is able to maintain interest rates on earning assets above those of interest-bearing liabilities, which is the interest expense paid on deposits and other borrowings. The decrease in this ratio in 2012 is primarily the result of lower market yields on interest earning assets, offset in part by lower market cost of funds on interest bearing liabilities.


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Efficiency Ratio

This ratio is calculated by dividing noninterest expense by net interest income and noninterest income. The ratio is a measure of the Company's ability to manage noninterest expenses. The Company's efficiency ratio was 48.93% and 50.61% for the three months ended September 30, 2012 and 2011, respectively. The change in the efficiency ratio in 2012 from the previous period is primarily the result of increased net interest income.

Capital Ratio

The average capital ratio is calculated by dividing average total equity capital by average total assets. It measures the level of average assets that are funded by shareholders' equity. Given an equal level of risk in the financial condition of two companies, the higher the capital ratio, generally the more financially sound the company. The Company's capital ratio is significantly higher than the industry average.

Industry Results

The FDIC Quarterly Banking Profile reported the following results for the second quarter of 2012:

Earnings Improvement Trend Reaches Three-Year Mark

The benefits of reduced expenses for loan losses outweighed the drag from declining net interest margins, as insured institutions posted a 12th consecutive year-over-year increase in quarterly net income. Banks earned $34.5 billion in the quarter, a $5.9 billion (20.7%) increase compared with second quarter 2011. Almost two out of every three banks (62.7%) reported higher earnings than a year ago. Only 10.9% were unprofitable, down from 15.7% in second quarter 2011. The average return on assets (ROA) rose to 0.99% from 0.85% a year earlier. This is the third-highest quarterly ROA for the industry since second quarter 2007.

Banks Reduce Loan-Loss Provisions to Five-Year Low

Banks set aside $14.2 billion in provisions for loan losses in the second quarter. This amount represents a $5 billion (26.2%) decline from second quarter 2011, and is the smallest quarterly total in five years. The reduction in provision expenses helped offset a $287 million (0.3%) decline in net interest income, as the industry's average net interest margin fell to a three-year low. The average net interest margin was 3.46%, compared with 3.61% a year earlier, because average asset yields declined faster than average funding costs. Noninterest income made a positive contribution to the increase in earnings, rising by $1.6 billion (2.8%) from second quarter 2011. Gains on loan sales and on fair values of financial instruments contributed to the rise in noninterest income, while a $4.7 billion decline in trading income limited the year-over-year improvement. Net operating revenue (the sum of net interest income and total noninterest income) was only $1.3 billion (0.8%) higher than in second quarter 2011. Realized gains on securities and other assets were $1.7 billion (208.2%) higher than a year ago. A few large banks accounted for most of the dollar amounts of the decline in trading results, increased gains on loan sales and higher realized gains on securities.

Net Charge-Offs Decline Across All Loan Categories

Net charge-offs totaled $20.5 billion in the second quarter, an $8.4 billion (29.1%) reduction from second quarter 2011. This is the eighth consecutive quarter that charge-offs have declined from year-earlier levels and represents the lowest quarterly charge-off total since first quarter 2008. The year-over-year improvement was led by a $2.2 billion (24.6%) decline in credit card charge-offs, a $1.5 billion (25.2%) decline in charge-offs of residential mortgage loans, and a $1.2 billion (51.5%) drop in real estate construction loan charge-offs. All major loan categories posted lower charge-offs compared with a year ago. Half of all insured institutions (50.6%) reported year-over-year declines in charge-offs.


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Noncurrent Loan Balances Continue to Fall

Noncurrent loan balances (loans 90 days or more past due or in nonaccrual status) declined for a ninth consecutive quarter, falling by $12.9 billion (4.2%). Noncurrent levels fell in all major loan categories. The largest declines occurred in real estate construction and development loans, where noncurrent balances fell by $5.1 billion (17.8%), and in real estate loans secured by nonfarm nonresidential properties, where noncurrents declined by $3.6 billion (9.2%). Well over half of all institutions (58%) reported reductions in noncurrent balances during the quarter.

Reserve Drawdowns at Large Banks Surpass Reserve Buildups at Smaller Institutions

Reserves for loan losses fell by $6.7 billion (3.6%) during the quarter, as the $14.2 billion in loss provisions that banks added to reserves were less than the $20.5 billion in net charge-offs that were taken out. More banks (54.4%) reported reserve increases than reported reductions (38.2%), but the reductions were concentrated among larger institutions, and added up to more than the additions. Eight of the 10 largest banks (and 34 of the 50 largest) reduced their reserves in the second quarter. Reserve balances have fallen for nine consecutive quarters, and are $86.7 billion (32.9%) below the peak level reached at the end of first quarter 2010. Even with the reduction in reserves, the larger drop in noncurrent loan balances during the quarter meant that the industry's "coverage ratio" of reserves to noncurrent loans inched up from 60% to 60.4% between March 31 and June 30.

Retained Earnings Provide a Boost to Capital

Insured institutions continued to build their capital in the second quarter. Total equity capital increased by $20.3 billion (1.3%), with retained earnings contributing $14.9 billion to capital growth. This is the second-highest quarterly total for retained earnings since third quarter 2006. Dividends were $763 million (3.8%) lower than in second quarter 2011. Tier 1 regulatory capital rose by $14 billion (1.1%), but total risk-based capital was basically unchanged (up $524 million, or 0.04%), due to the decline in reserves, declines in deferred tax assets, and declines in intangible assets. At midyear, almost 97% of all insured institutions, representing more than 99% of insured institution assets, met or exceeded the requirements for "well-capitalized" institutions as defined for Prompt Corrective Action purposes.

Loans Increase for Fourth Time in Last Five Quarters

Total assets increased by $105.3 billion (0.8%), as loan balances rose for the fourth time in the last five quarters. Total loans and leases grew by $102 billion (1.4%), with loans to commercial and industrial (C&I) borrowers increasing by $48.9 billion (3.6%), residential mortgage loans rising by $16.6 billion (0.9%), and credit card balances growing by $14.7 billion (2.3%). Balances of real estate construction and development loans fell for a 17th consecutive quarter, declining by $10.9 billion (4.8%), while home equity lines of credit declined for the 13th quarter in a row, falling by $10.2 billion
(1.7%). Loans to small businesses and farms posted a $1.5 billion (0.2%)
increase, driven primarily by seasonal demand for agricultural credit. More than 60% of institutions reported growth in total loan balances during the quarter. Banks reduced their mortgage-backed securities holdings by $33.1 billion (1.9%), and increased their holdings of U.S. Treasury securities by $20.1 billion (12%).


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Nondeposit Liabilities Increase

Deposits increased by $61.6 billion (0.6%) during the quarter. Deposits in domestic offices rose by $88.1 billion (1.0%), while foreign office deposits fell by $26.5 billion (1.8%). Much of the growth in domestic deposits ($71.7 billion) consisted of noninterest-bearing transaction accounts with balances greater than $250,000 that are temporarily fully covered by the FDIC. The portion of these deposits that is above the $250,000 basic coverage limit increased by $65.7 billion (5.0%). In addition to the increase in large-denomination domestic deposits, insured institutions increased their nondeposit liabilities for the first time in seven quarters. Securities sold under repurchase agreements increased by $28 billion (6.7%), and Federal Home Loan Bank advances rose by $19.8 billion (6.5%).

More Than a Year Since Last New Charter

During the second quarter, the number of insured institutions reporting financial results declined from 7,308 to 7,246. Forty-five institutions were merged into other institutions, and 15 institutions failed. No new charters were added during the quarter. This is the fourth quarter in a row in which no new charters have been added. It has been more than six quarters since the last time a new charter was created other than to absorb a failing bank. The number of full-time equivalent employees at FDIC-insured institutions increased from 2,102,280 to 2,108,200. The number of institutions on the FDIC's "Problem List" fell for a fifth consecutive quarter, from 772 to 732. Total assets of "problem" institutions declined from $291 billion to $282 billion.

Critical Accounting Policies

The discussion contained in this Item 2 and other disclosures included within this report are based, in part, on the Company's audited consolidated financial statements. These statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The financial information contained in these statements is, for the most part, based on the financial effects of transactions and events that have already occurred. However, the preparation of these statements requires management to make certain estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses.

The Company's significant accounting policies are described in the "Notes to Consolidated Financial Statements" contained in the Company's Annual Report. Based on its consideration of accounting policies that involve the most complex and subjective estimates and judgments, management has identified its most critical accounting policies to be those related to the allowance for loan losses, valuation of other real estate owned, the assessment of other-than-temporary impairment of certain securities available-for-sale and the valuation of goodwill and other intangible assets.

Allowance for Loan Losses

The allowance for loan losses is established through a provision for loan losses that is treated as an expense and charged against earnings. Loans are charged against the allowance for loan losses when management believes that collectability of the principal is unlikely. The Company has policies and procedures for evaluating the overall credit quality of its loan portfolio, including timely identification of potential problem loans. On a quarterly basis, management reviews the appropriate level for the allowance for loan losses, incorporating a variety of risk considerations, both quantitative and qualitative. Quantitative factors include the Company's historical loss experience, delinquency and charge-off trends, collateral values, known information about individual loans and other factors. Qualitative factors include the general economic environment in the Company's market area. To the extent actual results differ from forecasts and management's judgment, the allowance for loan losses may be greater or lesser than future charge-offs. Due to potential changes in conditions, it is at least reasonably possible that change in estimates will occur in the near term and that such changes could be material to the amounts reported in the Company's financial statements.


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Other Real Estate Owned

Real estate properties acquired through or in lieu of foreclosure are initially recorded at the fair value less estimated selling cost at the date of foreclosure. Any write-downs based on the asset's fair value at the date of acquisition are charged to the allowance for loan losses. After foreclosure, valuations are periodically performed by management and property held for sale is carried at the lower of the new cost basis or fair value less cost to sell. Impairment losses are measured as the amount by which the carrying amount of a property exceeds its fair value. Costs of significant property improvements are capitalized, whereas costs relating to holding property are expensed. The portion of interest costs relating to development of real estate is capitalized. Independent appraisals or evaluations are periodically performed by management, and any subsequent write-downs are recorded as a charge to operations, if necessary, to reduce the carrying value of a property to the lower of its cost basis or fair value less cost to sell. These appraisals or evaluations are inherently subjective and require estimates that are susceptible to significant revisions as more information becomes available. Due to potential changes in conditions, it is at least reasonably possible that changes in fair values will occur in the near term and that such changes could materially affect the amounts reported in the Company's financial statements.

Other-Than-Temporary Impairment of Available-for-Sale Securities

Declines in the fair value of securities available-for-sale below their cost that are deemed to be other-than-temporary are generally reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers: (1) the intent to sell the investment securities and the more likely than not requirement that the Company will be required to sell the investment securities prior to recovery; (2) the length of time and the extent to which the fair value has been less than cost; and (3) the financial condition and near-term prospects of the issuer. Due to potential changes in conditions, it is at least reasonably possible that change in management's assessment of other-than-temporary impairment will occur in the near term and that such changes could be material to the amounts reported in the Company's financial statements.

Goodwill and Intangible Assets

Goodwill and the core deposit intangible asset arose in connection with the acquisition of the Garner and Klemme, Iowa offices by RSB on April 27, 2012. These assets are tested annually for impairment or more often if conditions indicate a possible impairment. For the purposes of goodwill impairment testing, determination of the fair value of a reporting unit involves the use of significant estimates and assumptions. Through September 30, 2012, no conditions indicated impairment has incurred. The first annual test will be performed in the fourth quarter of 2012. Actual future test results may differ from the present evaluation of impairment due to changes in the conditions used in the current evaluation.


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Income Statement Review for the Three Months ended September 30, 2012

The following highlights a comparative discussion of the major components of net . . .

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