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 (Reliance Bank), 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 wealth management services. Wealth management services includes financial planning and managing trust, agencies, estates and investment brokerage accounts. The Company employs thirteen individuals to assist with financial reporting, human resources, audit, compliance, marketing, technology systems, training, real estate valuation services and the coordination of management activities, in addition to 230 full-time equivalent individuals employed by the Banks, including employees from the Acquisition.
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.
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 Banks; (iii) fees on wealth management services provided by those Banks exercising trust powers; (iv) service fees on deposit accounts maintained at the Banks and (v) merchant and card fees. 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 Bank’s facilities; and (vi) professional fees. 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.
On September 14, 2018, FNB purchased the stock of CCSB for approximately $14.8 million. First National operates all three bank offices previously owned by Clarke County as branches of First National.
The Company had net income of $4,041,000, or $0.44 per share, for the three months ended September 30, 2019, compared to net income of $4,459,000, or $0.48 per share, for the three months ended September 30, 2018.
The decrease in earnings is primarily the result of higher deposit interest expense, salaries and employee benefits and provision for loan losses, offset in part by improved loan interest income.
Net loan charge-offs totaled $314,000 and $195,000 for the three months ended September 30, 2019 and 2018, respectively. The provision for loan losses totaled $379,000 and $100,000 for the three months ended September 30, 2019 and 2018, respectively.
The Company had net income of $12,896,000, or $1.40 per share, for the nine months ended September 30, 2019, compared to net income of $12,813,000, or $1.38 per share, for the nine months ended September 30, 2018.
The increase in earnings is primarily the result of improved loan interest income, offset in part by elevated deposit interest expense and higher salary and employee benefits.
Net loan charge-offs totaled $295,000 and $226,000 for the nine months ended September 30, 2019 and 2018, respectively. The provision for loan losses totaled $545,000 and $193,000 for the nine months ended September 30, 2019 and 2018, 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 Review and Credit Risk Management
● Liquidity and Capital Resources
● Forward-Looking Statements and Business Risks
● Non-GAAP Financial Measures
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. These challenges are addressed in the Company’s most recent Annual Report on Form 10-K filed on March 12, 2019.
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 Federal Deposit Insurance Corporation (the “FDIC”) and are derived from 5,303 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.
Selected Indicators for the Company and the Industry
|
|
3 Months
|
|
|
9 Months
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ended
|
|
|
Ended
|
|
|
3 Months Ended
|
|
|
Years Ended December 31,
|
|
|
|
September 30, 2019
|
|
|
June 30, 2019
|
|
|
2018
|
|
|
2017
|
|
|
|
Company
|
|
|
Company
|
|
|
Industry*
|
|
|
Company
|
|
|
Industry*
|
|
|
Company
|
|
|
Industry*
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Return on assets
|
|
|
1.10
|
%
|
|
|
1.18
|
%
|
|
|
1.27
|
%
|
|
|
1.36
|
%
|
|
|
1.23
|
%
|
|
|
1.35
|
%
|
|
|
1.00
|
%
|
|
|
0.97
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Return on equity
|
|
|
8.74
|
%
|
|
|
9.58
|
%
|
|
|
10.32
|
%
|
|
|
12.01
|
%
|
|
|
10.09
|
%
|
|
|
11.98
|
%
|
|
|
8.02
|
%
|
|
|
8.64
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest margin
|
|
|
3.15
|
%
|
|
|
3.20
|
%
|
|
|
3.20
|
%
|
|
|
3.40
|
%
|
|
|
3.23
|
%
|
|
|
3.40
|
%
|
|
|
3.25
|
%
|
|
|
3.25
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Efficiency ratio
|
|
|
57.80
|
%
|
|
|
56.84
|
%
|
|
|
54.92
|
%
|
|
|
55.58
|
%
|
|
|
55.90
|
%
|
|
|
56.27
|
%
|
|
|
52.70
|
%
|
|
|
57.94
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital ratio
|
|
|
12.64
|
%
|
|
|
12.33
|
%
|
|
|
12.30
|
%
|
|
|
9.81
|
%
|
|
|
12.18
|
%
|
|
|
9.70
|
%
|
|
|
12.48
|
%
|
|
|
9.62
|
%
|
*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 1.10% and 1.31% for the three months ended September 30, 2019 and 2018, respectively. This ratio declined primarily due to lower net income for the three months ended September 30, 2019 as compared to 2018.
● 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 at 8.74% and 10.54% for the three months ended September 30, 2019 and 2018, respectively. This ratio declined primarily due to lower net income and higher average stockholders’ equity for the three months ended September 30, 2019 as compared to 2018.
● Net Interest Margin
The net interest margin for the three months ended September 30, 2019 and 2018 was 3.15% and 3.28%, 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.
● 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 57.80% and 54.82% for the three months ended September 30, 2019 and 2018, respectively. The efficiency ratio increased primarily due to higher noninterest expenses, which was mainly due to the Acquisition.
● 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 of 12.64% as of September 30, 2019 is significantly higher than the industry average of 9.81% as of June 30, 2019.
Industry Results:
The FDIC Quarterly Banking Profile reported the following results for the second quarter of 2019:
Net Income Rises 4.1% to $62.6 Billion on Higher Net Interest Income
During the three months ended June 30, quarterly net income for the 5,303 FDIC-insured commercial banks and savings institutions totaled $62.6 billion, an increase of $2.5 billion (4.1%) from a year ago. Improvement in quarterly net income was attributable to higher net interest income and an increase in realized securities gains. Almost 60% of all banks reported annual increases in net income from the year-ago quarter, while less than 4% of banks were unprofitable during the second quarter. The average return on assets increased to 1.38% from 1.37% in second quarter 2018.
Net Interest Income Expands 3.7% From a Year Earlier
Net interest income of $139 billion increased by $4.9 billion (3.7%) from a year earlier, the slowest year over-year growth rate since fourth quarter 2015. Slightly more than three-quarters of all banks (75.1%) reported an increase in net interest income from second quarter 2018. Net interest margin for the banking industry was 3.39% during the quarter, up slightly from 3.38% a year ago but below a recent high of 3.48% in fourth quarter 2018. Since year-end 2018, the average yield on earning assets rose by 1 basis point, while the average cost of funding increased by 11 basis points. During this period, the largest increase in the average cost of funding was among banks with assets from $1 billion to $10 billion.
Loan-Loss Provisions Increase More Than 9% From Second Quarter 2018
Banks set aside $12.8 billion in loan-loss provisions during the second quarter, an increase of $1.1 billion (9.3%) from a year earlier. More than one-third of all banks (36.1%) reported year-over-year increases in loan-loss provisions. Loan-loss provisions as a percentage of net operating revenue increased from 5.80% in second quarter 2018 to 6.25%.
Noninterest Income Falls 2.7% From a Year Earlier
Noninterest income fell by $1.8 billion (2.7%) from 12 months ago, although less than half of all banks (41%) reported declines. The overall decline in noninterest income was driven primarily by servicing fees, which fell by $3.1 billion from a year ago to $332.7 million, and investment banking fees, which declined by $533.5 million (16.1%). Increases in all other noninterest income (up $1.2 billion, or 3.8%) and trading revenue (up $742.5 million, or 9.8%) helped offset the decline in noninterest income during the year.
Noninterest Expense Increases From Second Quarter 2018
Noninterest expense rose by $1.6 billion (1.4%) from a year ago. The increase was widespread with 75.3% of all banks contributing to the growth. Salary and employee benefits rose by $1.8 billion (3.2%) from a year ago, as average assets per employee increased from $8.4 million to $8.8 million.
Net Charge-Offs Rise 9.3% From a Year Ago
Banks charged off $12.8 billion in uncollectable loans during the second quarter, up $1.1 billion (9.3%) from a year ago. The overall increase in net charge-offs was led by credit card balances (up $669.4 million, or 8.3%) and commercial and industrial loans (up $368.9 million, or 25.2%). The average net charge-off rate increased modestly from 0.48% in second quarter 2018 to 0.50%. The net charge-off rate for commercial and industrial loans rose 5 basis points from a year ago to 0.33%, while the net charge-off rate for credit cards rose by 12 basis points from a year ago to 4.03%, surpassing the 4% level for the first time since second quarter 2012.
Noncurrent Loan Rate Improves to 0.93%
Noncurrent loan balances (90 days or more past due or in nonaccrual status) declined by $4.9 billion (4.8%) from first quarter 2019. Slightly more than half of all banks (50.6%) reported declines in noncurrent loan balances. The quarter-over-quarter improvement was reflected in residential mortgages, which fell by $2.1 billion (5%), and credit card balances, which declined by $1.1 billion (8.7%). The average noncurrent rate declined by 6 basis points from the previous quarter to 0.93%.
Loan-Loss Reserves Decline Modestly From the Previous Quarter
Loan-loss reserves totaled $124.9 billion at the end of second quarter, down $292.5 million (0.2%) from the first quarter. Just over one-quarter of all banks (26.3%) reported quarterly declines in loan-loss reserves. At banks that itemize their loan-loss reserves, which are banks with total assets of $1 billion or more and represent 91% of total industry loan-loss reserves, the quarterly decline was attributable to residential real estate (down $762.7 million, or 6.5%) and credit cards (down $59.3 million, or 0.1%). Loan-loss reserves for commercial loans increased by $445.2 million (1.4%) from the previous quarter.
Total Assets Increase From First Quarter 2019
Total assets rose by $177.3 billion (1%) from the previous quarter. Cash and balances due from depository institutions declined by $81.5 billion (4.8%). Banks increased their investment securities by $54.8 billion (1.5%), as mortgage-backed securities rose by $65 billion (2.9%) and state and municipal securities declined by $14.5 billion (4.5%). After reaching an all-time high of 35.8% in second quarter 2018, the percentage of industry assets maturing or repricing in more than three years continued to decline, falling to 35.1% in the second quarter.
Loan Balances Increase From the Previous Quarter and a Year Ago
Total loan and lease balances rose by $152.3 billion (1.5%) from first quarter 2019. Almost three-quarters of all banks (72.7%) reported quarterly increases in their loan and lease balances. All major loan categories reported quarter-over-quarter increases, led by consumer loans, which rose by $42.2 billion (2.5%), and residential mortgage loans, which increased by $38.3 billion (1.8%). Over the past year, total loan and lease balances rose by $443 billion (4.5%), a modest increase from the 4.1% annual growth rate reported last quarter. Commercial and industrial loans had the largest dollar increase from a year ago, increasing by $142.8 billion (6.9%).
Deposits Increase From First Quarter 2019
Total deposit balances increased by $114 billion (0.8%) from the previous quarter, as deposits in foreign offices increased by $51.3 billion (4.1%) and domestic office deposits rose by $62.7 billion (0.5%). Domestic deposits in noninterest-bearing accounts rose by $37.2 billion (1.2%), while interest-bearing deposits increased by $25.5 billion (0.3%). Nondeposit liabilities increased by $25.1 billion (1.2%) from the previous quarter, as other liabilities rose by $25.2 billion (6.2%).
Equity Capital Rises From the Previous Quarter
Equity capital rose to $2.1 trillion in the second quarter, up $38.6 billion (1.9%) from the previous quarter, led by accumulated other comprehensive income. Declared dividends totaled $48.6 billion, an increase of $10.8 billion (28.6%) from second quarter 2018. At end of second quarter, 16 insured institutions with $2.2 billion in total assets were below the requirements for the well-capitalized category as defined for Prompt Corrective Action purposes.
Five New Banks Are Added in Second Quarter 2019
The number of FDIC-insured commercial banks and savings institutions declined from 5,362 to 5,303 during the three months ended June 30. Five new banks were added during the second quarter, 60 institutions were absorbed by mergers, and one bank failed. The number of institutions on the FDIC’s “Problem Bank List” declined from 59 to 56 at the end of second quarter, the lowest number since first quarter 2007. Total assets of problem banks increased from $46.7 billion to $48.5 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 December 31, 2018 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” accompanying the Company’s audited financial statements. Based on its consideration of accounting policies that involve the most complex and subjective estimates and judgments, management has identified the allowance for loan losses, the assessment of other-than-temporary impairment for investment securities and the assessment of goodwill to be the Company’s most critical accounting policies.
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 various considerations regarding 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 changes 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.
For further discussion concerning the allowance for loan losses and the process of establishing specific reserves, see the section of the Annual Report on Form 10-K entitled “Asset Quality Review and Credit Risk Management” and “Analysis of the Allowance for Loan Losses”.
Fair Value and Other-Than-Temporary Impairment of Investment Securities
The Company’s securities available-for-sale portfolio is carried at fair value with “fair value” being defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability is not adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact, and (iv) willing to transact.
Declines in the fair value of available-for-sale securities below their cost that are deemed to be other-than-temporary are 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 changes 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
Goodwill arose in connection with three acquisitions consummated in previous periods. Goodwill is 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. Impairment would arise if the fair value of a reporting unit is less than its carrying value. At September 30, 2019, Company’s management has completed the goodwill impairment assessment and determined goodwill was not impaired. Actual future test results may differ from the present evaluation of impairment due to changes in the conditions used in the current evaluation.
Non-GAAP Financial Measures
This report contains references to financial measures that are not defined in GAAP. Such non-GAAP financial measures include the Company’s presentation of net interest income and net interest margin on a fully taxable equivalent (FTE) basis. Management believes these non-GAAP financial measures provide useful information to both management and investors to analyze and evaluate the Company’s financial performance. Limitations associated with non-GAAP financial measures include the risks that persons might disagree as to the appropriateness of items included in these measures and that different companies might calculate these measures differently. These non-GAAP disclosures should not be considered an alternative to the Company’s GAAP results. The following table reconciles the non-GAAP financial measures of net interest income and net interest margin on an FTE basis to GAAP. (dollars in thousands)
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
2019
|
|
|
2018
|
|
|
2019
|
|
|
2018
|
|
Reconciliation of net interest income and annualized net interest margin on an FTE basis to GAAP:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest income (GAAP)
|
|
$
|
10,814
|
|
|
$
|
10,586
|
|
|
$
|
32,715
|
|
|
$
|
30,983
|
|
Tax-equivalent adjustment (1)
|
|
|
251
|
|
|
|
288
|
|
|
|
827
|
|
|
|
917
|
|
Net interest income on an FTE basis (non-GAAP)
|
|
|
11,065
|
|
|
|
10,874
|
|
|
|
33,542
|
|
|
|
31,900
|
|
Average interest-earning assets
|
|
$
|
1,403,303
|
|
|
$
|
1,324,697
|
|
|
$
|
1,399,302
|
|
|
$
|
1,324,817
|
|
Net interest margin on an FTE basis (non-GAAP)
|
|
|
3.15
|
%
|
|
|
3.28
|
%
|
|
|
3.20
|
%
|
|
|
3.21
|
%
|
(1) Computed on a tax-equivalent basis using an incremental federal income tax rate of 21 percent for the three and nine months ended September 30, 2019 and 2018, adjusted to reflect the effect of the tax-exempt interest income associated with owning tax-exempt securities and loans.
|
Income Statement Review for the Three Months ended September 30, 2019 and 2018
The following highlights a comparative discussion of the major components of net income and their impact for the three months ended September 30, 2019 and 2018:
AVERAGE BALANCES AND INTEREST RATES
The following two tables are used to calculate the Company’s net interest margin. The first table includes the Company’s average assets and the related income to determine the average yield on earning assets. The second table includes the average liabilities and related expense to determine the average rate paid on interest bearing liabilities. The net interest margin is equal to the interest income less the interest expense divided by average earning assets.
AVERAGE BALANCE SHEETS AND INTEREST RATES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
|
2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Revenue/
|
|
|
Yield/
|
|
|
Average
|
|
|
Revenue/
|
|
|
Yield/
|
|
|
|
balance
|
|
|
expense
|
|
|
rate
|
|
|
balance
|
|
|
expense
|
|
|
rate
|
|
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-earning assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans 1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial
|
|
$
|
76,808
|
|
|
$
|
1,062
|
|
|
|
5.53
|
%
|
|
$
|
75,533
|
|
|
$
|
972
|
|
|
|
5.15
|
%
|
Agricultural
|
|
|
78,286
|
|
|
|
989
|
|
|
|
5.05
|
%
|
|
|
70,925
|
|
|
|
1,075
|
|
|
|
6.06
|
%
|
Real estate
|
|
|
713,796
|
|
|
|
8,255
|
|
|
|
4.63
|
%
|
|
|
648,628
|
|
|
|
7,375
|
|
|
|
4.55
|
%
|
Consumer and other
|
|
|
15,861
|
|
|
|
207
|
|
|
|
5.22
|
%
|
|
|
10,206
|
|
|
|
136
|
|
|
|
5.34
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total loans (including fees)
|
|
|
884,751
|
|
|
|
10,513
|
|
|
|
4.75
|
%
|
|
|
805,292
|
|
|
|
9,558
|
|
|
|
4.75
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxable
|
|
|
277,264
|
|
|
|
1,672
|
|
|
|
2.41
|
%
|
|
|
266,510
|
|
|
|
1,545
|
|
|
|
2.32
|
%
|
Tax-exempt 2
|
|
|
177,431
|
|
|
|
1,197
|
|
|
|
2.70
|
%
|
|
|
205,003
|
|
|
|
1,374
|
|
|
|
2.68
|
%
|
Total investment securities
|
|
|
454,695
|
|
|
|
2,869
|
|
|
|
2.52
|
%
|
|
|
471,513
|
|
|
|
2,919
|
|
|
|
2.48
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest bearing deposits with banks and federal funds sold
|
|
|
63,857
|
|
|
|
401
|
|
|
|
2.51
|
%
|
|
|
47,892
|
|
|
|
272
|
|
|
|
2.27
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest-earning assets
|
|
|
1,403,303
|
|
|
$
|
13,783
|
|
|
|
3.93
|
%
|
|
|
1,324,697
|
|
|
$
|
12,749
|
|
|
|
3.85
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noninterest-earning assets
|
|
|
59,894
|
|
|
|
|
|
|
|
|
|
|
|
41,596
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TOTAL ASSETS
|
|
$
|
1,463,197
|
|
|
|
|
|
|
|
|
|
|
$
|
1,366,293
|
|
|
|
|
|
|
|
|
|
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 tax rate of 21%.
|
AVERAGE BALANCE SHEETS AND INTEREST RATES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
|
2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Revenue/
|
|
|
Yield/
|
|
|
Average
|
|
|
Revenue/
|
|
|
Yield/
|
|
|
|
balance
|
|
|
expense
|
|
|
rate
|
|
|
balance
|
|
|
expense
|
|
|
rate
|
|
LIABILITIES AND STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NOW, savings accounts and money markets
|
|
$
|
777,506
|
|
|
$
|
1,451
|
|
|
|
0.75
|
%
|
|
$
|
732,905
|
|
|
$
|
1,109
|
|
|
|
0.61
|
%
|
Time deposits
|
|
|
226,972
|
|
|
|
1,097
|
|
|
|
1.93
|
%
|
|
|
196,664
|
|
|
|
632
|
|
|
|
1.29
|
%
|
Total deposits
|
|
|
1,004,478
|
|
|
|
2,548
|
|
|
|
1.01
|
%
|
|
|
929,569
|
|
|
|
1,741
|
|
|
|
0.75
|
%
|
Other borrowed funds
|
|
|
43,204
|
|
|
|
170
|
|
|
|
1.57
|
%
|
|
|
45,100
|
|
|
|
134
|
|
|
|
1.19
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Interest-bearing liabilities
|
|
|
1,047,682
|
|
|
|
2,718
|
|
|
|
1.04
|
%
|
|
|
974,669
|
|
|
|
1,875
|
|
|
|
0.77
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noninterest-bearing liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Demand deposits
|
|
|
221,586
|
|
|
|
|
|
|
|
|
|
|
|
214,956
|
|
|
|
|
|
|
|
|
|
Other liabilities
|
|
|
8,975
|
|
|
|
|
|
|
|
|
|
|
|
7,523
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders' equity
|
|
|
184,954
|
|
|
|
|
|
|
|
|
|
|
|
169,145
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
|
|
$
|
1,463,197
|
|
|
|
|
|
|
|
|
|
|
$
|
1,366,293
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest income
|
|
|
|
|
|
$
|
11,065
|
|
|
|
3.15
|
%
|
|
|
|
|
|
$
|
10,874
|
|
|
|
3.28
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Spread Analysis
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income/average assets
|
|
$
|
13,783
|
|
|
|
3.77
|
%
|
|
|
|
|
|
$
|
12,749
|
|
|
|
3.73
|
%
|
|
|
|
|
Interest expense/average assets
|
|
$
|
2,718
|
|
|
|
0.74
|
%
|
|
|
|
|
|
$
|
1,875
|
|
|
|
0.55
|
%
|
|
|
|
|
Net interest income/average assets
|
|
$
|
11,065
|
|
|
|
3.02
|
%
|
|
|
|
|
|
$
|
10,874
|
|
|
|
3.18
|
%
|
|
|
|
|
Net Interest Income
For the three months ended September 30, 2019 and 2018, the Company's net interest margin adjusted for tax exempt income was 3.15% and 3.28%, respectively. Net interest income, prior to the adjustment for tax-exempt income, for the three months ended September 30, 2019 totaled $10,814,000 compared to $10,586,000 for the three months ended September 30, 2018.
For the three months ended September 30, 2019, interest income increased $1,071,000, or 9%, when compared to the same period in 2018. The increase from 2019 was primarily attributable to increased loan volume, related to the Acquisition. The increase in loan interest income due to loan volume was offset in part by foregone interest on nonaccrual loans which was $272,000 for the three months ended September 30, 2019, as compared to $80,000 for the three months ended September 30, 2018. The increase in loan interest income was also offset in part by a decrease in tax-exempt income due to maturity of municipal bonds.
Interest expense increased $843,000, or 45%, for the three months ended September 30, 2019 when compared to the same period in 2018. The higher interest expense for the period is primarily attributable to higher rates on deposits due to market interest rates and competitive pressures.
Provision for Loan Losses
A provision for loan losses of $379,000 was recognized in the third quarter of 2019 as compared to $100,000 in the third quarter of 2018. Net loan charge offs totaled $314,000 for the quarter ended September 30, 2019 compared to net loan charge offs of $195,000 for the quarter ended September 30, 2018. The loan charge offs this quarter were primarily related to one commercial relationship that was restructured. While the current provision for loan losses are not related to agricultural loans, the Iowa agricultural economy remains challenged as the result of the low grain prices throughout much of 2018 and 2019 and tariff concerns on Iowa exports. Grain prices rebounded since the second quarter of 2019; however, initial crop reports in our markets indicate significant variability in crop yields. Presently, it is too early to gauge the financial impact of the 2019 growing season on most of our agricultural borrowers.
Noninterest Income and Expense
Noninterest income for the third quarter of 2019 totaled $2,119,000 as compared to $2,162,000 in the third quarter of 2018, a decrease of 2%. The decrease in noninterest income was primarily due to the $162,000 gain on foreclosure of real estate in 2018, offset in part by increases due to the Acquisition and gain on the sale of loans. The increase in the gain on sale of loans was due to higher loan volume driven by a healthy residential mortgage market in central Iowa.
Noninterest expense for the third quarter of 2019 totaled $7,475,000 compared to $6,988,000 recorded in the third quarter of 2018, an increase of 7%. Most of the increase was related to higher salaries and employee benefits and data processing costs, offset in part by one time data conversion costs incurred in 2018 related to the Acquisition and a decrease in FDIC insurance assessments. The increase in salaries and employee benefits were primarily due to the Acquisition and normal salary increases. The increase in data processing costs were due to the cost associated with expanded services and the Acquisition. The decrease in FDIC insurance assessments was due to the receipt of a small bank credit as the deposit insurance reserve ratio exceeded 1.38%. The efficiency ratio was 57.8% for the third quarter of 2019 as compared to 54.8% in the third quarter of 2018.
Income Taxes
The provision for income taxes expense for the three months ended September 30, 2019 and 2018 was $1,038,000 and $1,201,000, respectively, representing an effective tax rate of 20% and 21%, respectively. The lower than expected effective tax rate for both periods is primarily due to tax-exempt interest income.
Income Statement Review for the Nine Months ended September 30, 2019 and 2018
The following highlights a comparative discussion of the major components of net income and their impact for the nine months ended September 30, 2019 and 2018:
AVERAGE BALANCES AND INTEREST RATES
The following two tables are used to calculate the Company’s net interest margin. The first table includes the Company’s average assets and the related income to determine the average yield on earning assets. The second table includes the average liabilities and related expense to determine the average rate paid on interest bearing liabilities. The net interest margin is equal to the interest income less the interest expense divided by average earning assets.
AVERAGE BALANCE SHEETS AND INTEREST RATES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
|
2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Revenue/
|
|
|
Yield/
|
|
|
Average
|
|
|
Revenue/
|
|
|
Yield/
|
|
|
|
balance
|
|
|
expense
|
|
|
rate
|
|
|
balance
|
|
|
expense
|
|
|
rate
|
|
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-earning assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans 1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial
|
|
$
|
81,022
|
|
|
$
|
3,301
|
|
|
|
5.43
|
%
|
|
$
|
73,973
|
|
|
$
|
2,766
|
|
|
|
4.99
|
%
|
Agricultural
|
|
|
80,424
|
|
|
|
3,576
|
|
|
|
5.93
|
%
|
|
|
69,500
|
|
|
|
3,023
|
|
|
|
5.80
|
%
|
Real estate
|
|
|
713,449
|
|
|
|
24,523
|
|
|
|
4.58
|
%
|
|
|
639,563
|
|
|
|
21,290
|
|
|
|
4.44
|
%
|
Consumer and other
|
|
|
16,403
|
|
|
|
623
|
|
|
|
5.06
|
%
|
|
|
9,096
|
|
|
|
364
|
|
|
|
5.33
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total loans (including fees)
|
|
|
891,298
|
|
|
|
32,023
|
|
|
|
4.79
|
%
|
|
|
792,132
|
|
|
|
27,443
|
|
|
|
4.62
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxable
|
|
|
261,456
|
|
|
|
4,715
|
|
|
|
2.40
|
%
|
|
|
268,284
|
|
|
|
4,639
|
|
|
|
2.31
|
%
|
Tax-exempt 2
|
|
|
196,129
|
|
|
|
3,942
|
|
|
|
2.68
|
%
|
|
|
218,392
|
|
|
|
4,368
|
|
|
|
2.67
|
%
|
Total investment securities
|
|
|
457,585
|
|
|
|
8,657
|
|
|
|
2.52
|
%
|
|
|
486,676
|
|
|
|
9,007
|
|
|
|
2.47
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest bearing deposits with banks and federal funds sold
|
|
|
50,419
|
|
|
|
929
|
|
|
|
2.46
|
%
|
|
|
46,009
|
|
|
|
721
|
|
|
|
2.09
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest-earning assets
|
|
|
1,399,302
|
|
|
$
|
41,609
|
|
|
|
3.96
|
%
|
|
|
1,324,817
|
|
|
$
|
37,171
|
|
|
|
3.74
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noninterest-earning assets
|
|
|
55,522
|
|
|
|
|
|
|
|
|
|
|
|
40,619
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TOTAL ASSETS
|
|
$
|
1,454,824
|
|
|
|
|
|
|
|
|
|
|
$
|
1,365,436
|
|
|
|
|
|
|
|
|
|
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 tax rate of 21%.
|
AVERAGE BALANCE SHEETS AND INTEREST RATES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
|
2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Revenue/
|
|
|
Yield/
|
|
|
Average
|
|
|
Revenue/
|
|
|
Yield/
|
|
|
|
balance
|
|
|
expense
|
|
|
rate
|
|
|
balance
|
|
|
expense
|
|
|
rate
|
|
LIABILITIES AND STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NOW, savings accounts and money markets
|
|
$
|
784,985
|
|
|
$
|
4,584
|
|
|
|
0.78
|
%
|
|
$
|
733,072
|
|
|
$
|
3,009
|
|
|
|
0.55
|
%
|
Time deposits
|
|
|
221,275
|
|
|
|
2,929
|
|
|
|
1.76
|
%
|
|
|
195,217
|
|
|
|
1,727
|
|
|
|
1.18
|
%
|
Total deposits
|
|
|
1,006,260
|
|
|
|
7,513
|
|
|
|
1.00
|
%
|
|
|
928,289
|
|
|
|
4,736
|
|
|
|
0.68
|
%
|
Other borrowed funds
|
|
|
42,530
|
|
|
|
554
|
|
|
|
1.74
|
%
|
|
|
49,563
|
|
|
|
534
|
|
|
|
1.44
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Interest-bearing liabilities
|
|
|
1,048,790
|
|
|
|
8,067
|
|
|
|
1.03
|
%
|
|
|
977,852
|
|
|
|
5,270
|
|
|
|
0.72
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noninterest-bearing liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Demand deposits
|
|
|
218,229
|
|
|
|
|
|
|
|
|
|
|
|
211,120
|
|
|
|
|
|
|
|
|
|
Other liabilities
|
|
|
8,388
|
|
|
|
|
|
|
|
|
|
|
|
8,141
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders' equity
|
|
|
179,417
|
|
|
|
|
|
|
|
|
|
|
|
168,323
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
|
|
$
|
1,454,824
|
|
|
|
|
|
|
|
|
|
|
$
|
1,365,436
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest income
|
|
|
|
|
|
$
|
33,542
|
|
|
|
3.20
|
%
|
|
|
|
|
|
$
|
31,900
|
|
|
|
3.21
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Spread Analysis
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income/average assets
|
|
$
|
41,609
|
|
|
|
3.81
|
%
|
|
|
|
|
|
$
|
37,171
|
|
|
|
3.63
|
%
|
|
|
|
|
Interest expense/average assets
|
|
$
|
8,067
|
|
|
|
0.74
|
%
|
|
|
|
|
|
$
|
5,270
|
|
|
|
0.51
|
%
|
|
|
|
|
Net interest income/average assets
|
|
$
|
33,542
|
|
|
|
3.07
|
%
|
|
|
|
|
|
$
|
31,900
|
|
|
|
3.12
|
%
|
|
|
|
|
Net Interest Income
For the nine months ended September 30, 2019 and 2018, the Company's net interest margin adjusted for tax exempt income was 3.20% and 3.21%, respectively. Net interest income, prior to the adjustment for tax-exempt income, for the nine months ended September 30, 2019 totaled $32,715,000 compared to $30,983,000 for the nine months ended September 30, 2018.
For the nine months ended September 30, 2019, interest income increased $4,528,000, or 12%, when compared to the same period in 2018. The increase from 2019 was primarily attributable to increased loan volume and to a lesser extent rates. The increase in loan volume was due to the Acquisition and a favorable lending environment in the Company’s market areas.
Interest expense increased $2,797,000, or 53%, for the nine months ended September 30, 2019 when compared to the same period in 2018. The higher interest expense for the period is primarily attributable to higher rates on deposits due to market interest rates and competitive pressures.
Provision for Loan Losses
A provision for loan losses of $545,000 was recognized in the nine months ended September 30, 2019 as compared to $193,000 for the nine months ended September 30, 2018. Net loan charge offs totaled $295,000 for the nine months ended September 30, 2019 compared to $226,000 for the nine months ended September 30, 2018. While the current provision for loan losses are not related to agricultural loans, the Iowa agricultural economy remains challenged as the result of the low grain prices throughout much of 2018 and 2019 and tariff concerns on Iowa exports. Grain prices rebounded since the second quarter of 2019; however, initial crop reports in our markets indicate significant variability in crop yields. Presently, it is too early to gauge the financial impact of the 2019 growing season on most of our agricultural borrowers.
Noninterest Income and Expense
Noninterest income for the nine months ended September 30, 2019 totaled $6,258,000 as compared to $5,917,000 for the nine months ended September 30, 2018, an increase of 6%. The increase in noninterest income is primarily due to the Acquisition and higher wealth management income, offset in part by a gain on foreclosure of other real estate owned in 2018. The increase in wealth management income was primarily related to growth in the assets under management, fueled by a favorable equity market and new account relationships.
Noninterest expense for the nine months ended September 30, 2019 totaled $22,150,000 compared to $20,566,000 for the nine months ended September 30, 2018, an increase of 8%, which was primarily due to the Acquisition. Salaries and benefits was the largest component of the increase in noninterest expense which also includes normal salary and employee benefit increases, offset in part by a one-time $1,000 bonus paid to full-time employees in 2018. Another component of the increase in noninterest expense was the increase in data processing costs which was due primarily to the cost associated with expanded services and the Acquisition. The efficiency ratio was 56.8% and 55.7% for the nine months ended September 30, 2019 and 2018, respectively.
Income Taxes
The provision for income taxes expense for the nine months ended September 30, 2019 and 2018 was $3,381,000 and $3,328,000, respectively, representing an effective tax rate of 21%. The lower than expected effective tax rate for both periods is primarily due to tax-exempt interest income.
Balance Sheet Review
As of September 30, 2019, total assets were $1,499,976,000, a $44,288,000 increase compared to December 31, 2018. The increase in assets, primarily interest bearing deposits, was funded primarily by deposits and repurchase agreements.
Investment Portfolio
The investment portfolio totaled $457,995,000 as of September 30, 2019, a decrease of $976,000 from the December 31, 2018 balance of $458,971,000. The decrease in securities available-for-sale is primarily due to maturities in the municipal investment portfolio and to a lesser extent payments on mortgage backed securities. This decrease in investments was offset in part by increases in the unrealized gain on the investment portfolio as market interest rates caused an increase in the fair value of the investment portfolio and purchases of U.S. Agencies and corporate bonds.
On a quarterly basis, the investment portfolio is reviewed for other-than-temporary impairment. As of September 30, 2019, gross unrealized losses of $320,000, are considered to be temporary in nature due to the interest rate environment of 2019 and other general economic factors. As a result of the Company’s favorable liquidity position, the Company does not have the intent to sell securities with an unrealized loss at the present time. In addition, management believes it is more likely than not that the Company will hold these securities until recovery of their fair value to cost basis and avoid considering present unrealized loss positions to be other-than-temporary.
At September 30, 2019, the Company’s investment securities portfolio included securities issued by 222 government municipalities and agencies located within 17 states with a fair value of $187.9 million. At December 31, 2018, the Company’s investment securities portfolio included securities issued by 263 government municipalities and agencies located within 16 states with a fair value of $216.0 million. No one municipality or agency represents a concentration within this segment of the investment portfolio. The largest exposure to any one municipality or agency as of September 30, 2019 was $3.6 million (approximately 1.9% of the fair value of the governmental municipalities and agencies) represented by the West Des Moines, Iowa Community School District to be repaid by sales tax revenues and property taxes.
The Company’s procedures for evaluating investments in states, municipalities and political subdivisions include but are not limited to reviewing the offering statement and the most current available financial information, comparing yields to yields of bonds of similar credit quality, confirming capacity to repay, assessing operating and financial performance, evaluating the stability of tax revenues, considering debt profiles and local demographics, and for revenue bonds, assessing the source and strength of revenue structures for municipal authorities. These procedures, as applicable, are utilized for all municipal purchases and are utilized in whole or in part for monitoring the portfolio of municipal holdings. The Company does not utilize third party credit rating agencies as a primary component of determining if the municipal issuer has an adequate capacity to meet the financial commitments under the security for the projected life of the investment, and, therefore, does not compare internal assessments to those of the credit rating agencies. Credit rating downgrades are utilized as an additional indicator of credit weakness and as a reference point for historical default rates.
The following table summarizes the total general obligation and revenue bonds in the Company’s investment securities portfolios as of September 30, 2019 and December 31, 2018 identifying the state in which the issuing government municipality or agency operates. (Dollars in thousands)
|
|
2019
|
|
|
2018
|
|
|
|
|
|
|
|
Estimated
|
|
|
|
|
|
|
Estimated
|
|
|
|
Amortized
|
|
|
Fair
|
|
|
Amortized
|
|
|
Fair
|
|
|
|
Cost
|
|
|
Value
|
|
|
Cost
|
|
|
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Obligations of states and political subdivisions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General Obligation bonds:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Iowa
|
|
$
|
56,464
|
|
|
$
|
57,108
|
|
|
$
|
59,935
|
|
|
$
|
59,481
|
|
Texas
|
|
|
9,524
|
|
|
|
9,717
|
|
|
|
11,822
|
|
|
|
11,803
|
|
Pennsylvania
|
|
|
8,580
|
|
|
|
8,675
|
|
|
|
9,167
|
|
|
|
9,144
|
|
Washington
|
|
|
6,822
|
|
|
|
6,903
|
|
|
|
6,905
|
|
|
|
6,762
|
|
Other (2019: 12 states; 2018: 12 states)
|
|
|
17,924
|
|
|
|
18,176
|
|
|
|
17,138
|
|
|
|
17,198
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total general obligation bonds
|
|
$
|
99,314
|
|
|
$
|
100,579
|
|
|
$
|
104,967
|
|
|
$
|
104,388
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue bonds:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Iowa
|
|
$
|
78,971
|
|
|
$
|
79,230
|
|
|
$
|
104,589
|
|
|
$
|
103,925
|
|
Other (2019: 5 states; 2018: 7 states)
|
|
|
8,010
|
|
|
|
8,131
|
|
|
|
7,691
|
|
|
|
7,642
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue bonds
|
|
$
|
86,981
|
|
|
$
|
87,361
|
|
|
$
|
112,280
|
|
|
$
|
111,567
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total obligations of states and political subdivisions
|
|
$
|
186,295
|
|
|
$
|
187,940
|
|
|
$
|
217,247
|
|
|
$
|
215,955
|
|
As of September 30, 2019 and December 31, 2018, the revenue bonds in the Company’s investment securities portfolios were issued by government municipalities and agencies to fund public services such as community school facilities, college and university dormitory facilities, water utilities and electrical utilities. The revenue bonds are to be paid from primarily 5 revenue sources. The revenue sources that represent 5% or more, individually, as a percent of the total revenue bonds are summarized in the following table. (in thousands)
|
|
2019
|
|
|
2018
|
|
|
|
|
|
|
|
Estimated
|
|
|
|
|
|
|
Estimated
|
|
|
|
Amortized
|
|
|
Fair
|
|
|
Amortized
|
|
|
Fair
|
|
|
|
Cost
|
|
|
Value
|
|
|
Cost
|
|
|
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue bonds by revenue source
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales tax
|
|
$
|
44,153
|
|
|
$
|
44,412
|
|
|
$
|
60,422
|
|
|
$
|
60,322
|
|
Water
|
|
|
12,929
|
|
|
|
12,977
|
|
|
|
13,863
|
|
|
|
13,644
|
|
College and universities, primarily dormitory revenues
|
|
|
5,463
|
|
|
|
5,481
|
|
|
|
8,183
|
|
|
|
8,139
|
|
Leases
|
|
|
7,477
|
|
|
|
7,534
|
|
|
|
8,958
|
|
|
|
8,861
|
|
Electric power & light revenues
|
|
|
4,659
|
|
|
|
4,693
|
|
|
|
5,223
|
|
|
|
5,185
|
|
Other
|
|
|
12,300
|
|
|
|
12,264
|
|
|
|
15,631
|
|
|
|
15,416
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue bonds by revenue source
|
|
$
|
86,981
|
|
|
$
|
87,361
|
|
|
$
|
112,280
|
|
|
$
|
111,567
|
|
Loan Portfolio
The loan portfolio, net of the allowance for loan losses, totaled $882,130,000 and $890,461,000 as of September 30, 2019 and December 31, 2018, respectively. Loan demand has moderated since year end.
Deposits
Deposits totaled $1,249,133,000 and $1,221,084,000 as of September 30, 2019 and December 31, 2018, respectively. The increase in deposits since December 31, 2018 was primarily due to account balances in NOW account public funds and certificates of deposits, offset in part by a decline in retail demand deposit account balances.
Securities Sold Under Agreements to Repurchase
Securities sold under agreements to repurchase totaled $52,196,000 as of September 30, 2019, an increase of $11,522,000, or 28%, from the December 31, 2018 balance of $40,674,000. The increase was due primarily to an increase in the balances of one existing customer.
Off-Balance Sheet Arrangements
The Company is party to financial instruments with off-balance-sheet risk in the normal course of business. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. No material changes in the Company’s off-balance sheet arrangements have occurred since December 31, 2018.
Asset Quality Review and Credit Risk Management
The Company’s credit risk is historically centered in the loan portfolio, which on September 30, 2019 totaled $882,130,000 compared to $890,461,000 as of December 31, 2018. Net loans comprise 59% of total assets as of September 30, 2019. The object in managing loan portfolio risk is to reduce the risk of loss resulting from a customer’s failure to perform according to the terms of an agreement and to quantify and manage credit risk on a portfolio basis. The Company’s level of problem loans (consisting of nonaccrual loans and loans past due 90 days or more) as a percentage of total loans was 0.58% at September 30, 2019, as compared to 0.38% at December 31, 2018 and 0.42% at September 30, 2018. The increase in the level of problem loans is due primarily to two agricultural loan relationships. The Company’s level of problem loans as a percentage of total loans at September 30, 2019 of 0.58% is lower as compared to the Iowa State Average peer group of FDIC insured institutions as of June 30, 2019, of 0.72%.
Impaired loans, net of specific reserves, totaled $4,923,000 as of September 30, 2019 and have increased $2,190,000 as compared to the impaired loans of $2,733,000 as of December 31, 2018.
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payment of principal and interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. The Company applies its normal loan review procedures to identify loans that should be evaluated for impairment.
The Company had TDRs of $1,171,000 as of September 30, 2019, all of which were included in impaired and nonaccrual loans. The Company had TDRs of $2,350,000 as of December 31, 2018, all of which were included in impaired and nonaccrual loans.
TDRs are monitored and reported on a quarterly basis. Certain TDRs are on nonaccrual status at the time of restructuring. These borrowings are typically returned to accrual status after the following: sustained repayment performance in accordance with the restructuring agreement for a reasonable period of at least six months; and, management is reasonably assured of future performance. If the TDR meets these performance criteria and the interest rate granted at the modification is equal to or greater than the rate that the Company was willing to accept at the time of the restructuring for a new loan with comparable risk, then the loan will return to performing status.
For TDRs that were on nonaccrual status before the modification, a specific reserve may already be recorded. In periods subsequent to modification, the Company will continue to evaluate all TDRs for possible impairment and, as necessary, recognize impairment through the allowance. A specific reserve was established in the amount of $200,000 in the nine months ended September 30, 2019. An $80,000 specific reserve was established in the nine months ended September 30, 2018 on a TDR loan, respectively. The Company had $275,000 of charge-offs for TDR’s for the nine months ended September 30, 2019. The Company had $12,000 of charge-offs related to TDRs for the nine months ended September 30, 2018.
Loans past due 90 days or more that are still accruing interest are reviewed no less frequently than quarterly to determine if there continues to be a strong reason that the credit should not be placed on non-accrual. As of September 30, 2019, non-accrual loans totaled $5,167,000 and there were $9,000 of loans past due 90 days and still accruing. This compares to non-accrual loans of $3,234,000 and loans past due 90 days and still accruing totaled $150,000 as of December 31, 2018. The increases are due primarily to two agricultural loan relationships. Real estate owned totaled $218,000 and $830,000 as of September 30, 2019 and December 31, 2018, respectively.
The agricultural real estate and agricultural operating loan portfolio classifications remain elevated as a result of lower grain prices. The watch and special mention loans in these categories totaled $43,236,000 as of September 30, 2019 as compared to $47,808,000 as of December 31, 2018. The substandard loans in these categories totaled $9,465,000 as of September 30, 2019 as compared to $9,666,000 as of December 31, 2018. The Iowa agricultural economy remains challenged as the result of the delayed planting, late maturing crops, current grain prices and tariff concerns on Iowa exports.
The watch and special mention loans classified as commercial real estate totaled $35,949,000 as of September 30, 2019 as compared to $30,952,000 as of December 31, 2018. The substandard loans in this category totaled $16,053,000 as of September 30, 2019 as compared to $13,318,000 as of December 31, 2018.
The allowance for loan losses as a percentage of outstanding loans as of September 30, 2019 was 1.33%, as compared to 1.30% at December 31, 2018. The allowance for loan losses totaled $11,934,000 and $11,684,000 as of September 30, 2019 and December 31, 2018, respectively. Net charge-offs of loans totaled $295,000 and $226,000 for the nine months ended September 30, 2019 and 2018, respectively.
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.
Liquidity and Capital Resources
Liquidity management is the process by which the Company, through its Banks’ Asset and Liability Committees (ALCO), ensures that adequate liquid funds are available to meet its financial commitments on a timely basis, at a reasonable cost and within acceptable risk tolerances. These commitments include funding credit obligations to borrowers, funding of mortgage originations pending delivery to the secondary market, withdrawals by depositors, maintaining adequate collateral for pledging for public funds, trust deposits and borrowings, paying dividends to shareholders, payment of operating expenses, funding capital expenditures and maintaining deposit reserve requirements.
Liquidity is derived primarily from core deposit growth and retention; principal and interest payments on loans; principal and interest payments, sale, maturity and prepayment of securities available-for-sale; net cash provided from operations; and access to other funding sources. Other funding sources include federal funds purchased lines, FHLB advances and other capital market sources.
As of September 30, 2019, the level of liquidity and capital resources of the Company remain at a satisfactory level. Management believes that the Company's liquidity sources will be sufficient to support its existing operations for the foreseeable future.
The liquidity and capital resources discussion will cover the following topics:
● Review of the Company’s Current Liquidity Sources
● Review of Statements of Cash Flows
● Company Only Cash Flows
● Review of Commitments for Capital Expenditures, Cash Flow Uncertainties and Known Trends in Liquidity and Cash Flows Needs
● Capital Resources
Review of the Company’s Current Liquidity Sources
Liquid assets of cash and due from banks and interest-bearing deposits in financial institutions as of September 30, 2019 and December 31, 2018 totaled $112,416,000 and $56,442,000, respectively, and provide an adequate level of liquidity given current economic conditions.
Other sources of liquidity available to the Banks as of September 30, 2019 include outstanding lines of credit with the FHLB of Des Moines, Iowa of $182,063,000, with $5,000,000 of outstanding FHLB advances. Federal funds borrowing capacity at correspondent banks was $93,531,000, with no outstanding federal fund purchase balances as of September 30, 2019. The Company had securities sold under agreements to repurchase totaling $52,196,000 as of September 30, 2019.
Total investments as of September 30, 2019 were $457,995,000 compared to $458,971,000 as of December 31, 2018. These investments provide the Company with a significant amount of liquidity since all of the investments are classified as available-for-sale as of September 30, 2019.
The investment portfolio serves an important role in the overall context of balance sheet management in terms of balancing capital utilization and liquidity. The decision to purchase or sell securities is based upon the current assessment of economic and financial conditions, including the interest rate environment, liquidity and credit considerations. The portfolio’s scheduled maturities and payments represent a significant source of liquidity.
Review of Statements of Cash Flows
Net cash provided by operating activities for the nine months ended September 30, 2019 totaled $14,339,000 compared to $15,471,000 for the nine months ended September 30, 2018. The cash flow from operations in 2019 is comparable to the same period in 2018.
Net cash provided by (used in) investing activities for the nine months ended September 30, 2019 was $(32,866,000) compared to $9,570,000 for the nine months ended September 30, 2018. The increase of $42,436,000 in cash used in investing activities was primarily due to a higher level of interest bearing deposits in financial institutions and purchases of investments, offset in part by a lower level of loans, interest bearing deposits and purchases of investments contributed to the increase.
Net cash provided by (used in) financing activities for the nine months ended September 30, 2019 totaled $21,628,000 compared to $(26,120,000) for the nine months ended September 30, 2018. The increase in cash provided by financing activities was $47,748,000. The increase was primarily due to an increase in deposits and a lower amount of repayments of FHLB advances and other borrowings in 2019 as compared to 2018. As of September 30, 2019, the Company did not have any external debt financing, off-balance sheet financing arrangements, or derivative instruments linked to its stock.
Company Only Cash Flows
The Company’s liquidity on an unconsolidated basis is heavily dependent upon dividends paid to the Company by the Banks. The Banks provide adequate liquidity to pay the Company’s expenses and stockholder dividends. Dividends paid by the Banks to the Company amounted to $9,568,000 and $8,790,000 for the nine months ended September 30, 2019 and 2018, respectively. Various federal and state statutory provisions limit the amounts 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. The quarterly dividend declared by the Company increased to $0.24 per share in 2019 from $0.23 per share in 2018.
The Company, on an unconsolidated basis, has interest bearing deposits totaling $16,143,000 as of September 30, 2019 that are presently available to provide additional liquidity to the Banks.
Review of Commitments for Capital Expenditures, Cash Flow Uncertainties and Known Trends in Liquidity and Cash Flows Needs
No other material capital expenditures or material changes in the capital resource mix are anticipated at this time, with the exception of the need to finance approximately $22.3 million of the purchase price for the Company’s recently-announced stock acquisition of Iowa State Savings Bank. The purchase was funded on October 25, 2019 by current cash at the Company as well as dividends from affiliate banks to the Company. The banks remain well-capitalized after these dividends are accrued. The primary cash flow uncertainty would be a sudden decline in deposits causing the Banks to liquidate securities. Historically, the Banks have maintained an adequate level of short-term marketable investments to fund the temporary declines in deposit balances. There are no known trends in liquidity and cash flow needs as of September 30, 2019 that are of concern to management.
Capital Resources
The Company’s total stockholders’ equity as of September 30, 2019 totaled $186,163,000 and was $13,298,000 higher than the $172,865,000 recorded as of December 31, 2018. The increase in stockholders’ equity was primarily due to net income and an increase in other comprehensive income, offset in part by dividends declared. The increase in other comprehensive income is created by lower market interest rates compared to December 31, 2018, which resulted in higher fair values in the securities available-for-sale portfolio. At September 30, 2019 and December 31, 2018, stockholders’ equity as a percentage of total assets was 12.4% and 11.9%, respectively. The capital levels of the Company exceed applicable regulatory guidelines as of September 30, 2019.
Forward-Looking Statements and Business Risks
The Private Securities Litigation Reform Act of 1995 provides the Company with the opportunity to make cautionary statements regarding forward-looking statements contained in this Quarterly Report, including forward-looking statements concerning the Company’s future financial performance and asset quality. Any forward-looking statement contained in this Quarterly Report is based on management’s current beliefs, assumptions and expectations of the Company’s future performance, taking into account all information currently available to management. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to management. If a change occurs, the Company’s business, financial condition, liquidity, results of operations, asset quality, plans and objectives may vary materially from those expressed in the forward-looking statements. The risks and uncertainties that may affect the actual results of the Company include, but are not limited to, the following: economic conditions, particularly in the concentrated geographic area in which the Company and its affiliate banks operate; competitive products and pricing available in the marketplace; changes in credit and other risks posed by the Company’s loan and investment portfolios, including declines in commercial or residential real estate values or changes in the allowance for loan losses dictated by new market conditions or regulatory requirements; 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; the availability of and cost associated with sources of liquidity; and other risks and uncertainties inherent in the Company’s business, including those discussed under the headings “Risk Factors” and “Forward-Looking Statements and Business Risks” in the Company’s Annual Report. Management intends to identify forward-looking statements when using words such as “believe”, “expect”, “intend”, “anticipate”, “estimate”, “should” or similar expressions. Undue reliance should not be placed on these forward-looking statements. The Company undertakes no obligation to revise or update such forward-looking statements to reflect current events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.