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 six 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), United Bank & Trust NA (United Bank) and Iowa State Savings Bank (Iowa State 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 sixteen 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 269 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.
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.
The Company had net income of $3,555,000, or $0.39 per share, for the three months ended March 31, 2020, compared to net income of $4,237,000, or $0.46 per share, for the three months ended March 31, 2019.
The decrease in earnings is primarily due to the additional provision for loan losses in 2020. The increase in the provision for loan losses was primarily due to the economic slowdown associated with COVID-19 and to a lesser extent loan growth. The economic slowdown associated with COVID-19 will adversely affect our loan portfolios, but will more quickly affect the loans associated with hospitality and entertainment industries. 8.5% of our loan portfolio as of March 31, 2020 is associated with these industries. The federal government is providing numerous programs to lessen the effects of COVID-19 on the economy and on our loan portfolio. The severity of the effect of COVID-19 on our operations is difficult to determine at this time. The State of Iowa has significant restrictions on non-essential businesses as well as enforcing social distancing. The longer these restrictions are in place the more severe the effects of the economic slowdown will be and the greater the negative consequences for our loan customers which, in turn, could adversely affect the Company’s financial condition, liquidity and results of operations.
Net loan charge-offs (recoveries) totaled $26,000 and $(30,000) for the three months ended March 31, 2020 and 2019, respectively. The provision for loan losses totaled $2,316,000 and $98,000 for the three months ended March 31, 2020 and 2019, respectively.
The following management discussion and analysis will provide a review of important items relating to:
● Challenges and COVID-19 Status, Risks and Uncertainties
● 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 and COVID-19 Status, Risks and Uncertainties
Prior to the onset of the COVID-19 pandemic during the first quarter of 2020, management had identified certain events or circumstances that may negatively impact the Company’s financial condition and results of operations in the future and detailed its efforts 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 10, 2020.
The Company conducts business in the State of Iowa and Iowa began to place significant restrictions on companies and individuals on March 9, 2020 as a result of the COVID-19 pandemic. The State of Iowa continues to evaluate the need for additional restrictions it may consider necessary to stem the spread of infection. The Company, as a financial institution, is considered an essential business and therefore continues to operate on a modified basis to comply with governmental restrictions and public health authority guidelines. The Company’s bank lobbies are generally closed to the public, although business is still being transacted through drive-up facilities, online, telephone or by appointment. Although the Company anticipates these arrangements will remain in effect until the restrictions are lifted by governmental authorities, the Company continues to operate and maintain its customer relationships. The health and safety of the Company’s employees is a major concern to the Company and a significant effort is being made to have employees work from home or, if working from the Company’s locations are required, to maintain appropriate social distancing and observe other health precautions.
The onset of the COVID-19 pandemic has significantly heightened the level of challenges, risks and uncertainties facing the Company and its operations, including the following:
●
|
As the economic slowdown continues to evolve due to the pandemic, some of the Company’s customers will experience decreased revenues, which may correlate to an inability to make timely loan payments or maintain payrolls. This, in turn, could adversely impact the revenues and earnings of the Company by, among other things, requiring further increases in the allowance for loan losses and increases in the level of charge-offs in the loan portfolio. Although the economic slowdown will adversely affect the loan portfolio in general, it will more quickly affect loans associated with the hospitality and entertainment industries which comprise approximately 8.5% of the loan portfolio as of March 31, 2020. As detailed herein, the Company recognized a significant increase in provision expense during the first quarter of 2020 to increase its allowance for loan losses due to the economic slowdown, and management anticipates additional increases in the allowance if the effects of the COVID-19 restrictions continue to negatively impact the loan portfolio.
|
●
|
Local and the State of Iowa’s increased unemployment may continue to cause economic challenges to our consumer and commercial customers due to the economic effects of the COVID-19 restrictions. This increase in unemployment may adversely impact the revenues and earnings of the Company.
|
●
|
The Company anticipates a slowdown in demand for its products and services, including in the demand for traditional loans, although the decline will likely be temporarily offset due to the new volume of governmental guaranteed loans under the CARES Act and other governmental programs established in response to the pandemic.
|
●
|
Goodwill is currently evaluated for impairment on a quarterly basis and may in the future become impaired if the effects of the COVID-19 restrictions negatively impact net income and fair value, particularly the fair value at which the most recent bank acquisition is carried on the financial statements. An impairment of goodwill would decrease the Company’s earnings during the period in which the impairment is recorded.
|
●
|
The COVID-19 restrictions have created significant volatility and disruption in the financial markets, and these conditions may require the Company to recognize an elevated level of other than temporary impairments on securities held in the Company’s investment portfolio as issuers of these securities are negatively impacted by the economic slowdown. Declines in fair value of securities held in the portfolio could also reduce the unrealized gains reported as part of the Company’s other comprehensive income.
|
●
|
Market interest rates have declined significantly and these reductions, especially if prolonged, could adversely affect the Company’s net interest income, net interest margin and earnings.
|
●
|
Dividends in the future may be reduced or eliminated if the COVID-19 restrictions have an adverse effect on net income, an unanticipated increase in deposits or other unidentified risks that may negatively affect the Company’s capital ratios.
|
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 5,177 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
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ended
|
|
|
Years Ended December 31,
|
|
|
|
March, 31,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2020
|
|
|
2019
|
|
|
2018
|
|
|
|
Company
|
|
|
Company
|
|
|
Industry*
|
|
|
Company
|
|
|
Industry*
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Return on assets
|
|
|
0.81
|
%
|
|
|
1.14
|
%
|
|
|
1.29
|
%
|
|
|
1.23
|
%
|
|
|
1.35
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Return on equity
|
|
|
7.44
|
%
|
|
|
9.48
|
%
|
|
|
11.40
|
%
|
|
|
10.09
|
%
|
|
|
11.98
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest margin
|
|
|
3.18
|
%
|
|
|
3.21
|
%
|
|
|
3.36
|
%
|
|
|
3.23
|
%
|
|
|
3.40
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Efficiency ratio
|
|
|
57.73
|
%
|
|
|
58.51
|
%
|
|
|
56.63
|
%
|
|
|
55.90
|
%
|
|
|
56.27
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital ratio
|
|
|
10.92
|
%
|
|
|
12.05
|
%
|
|
|
9.66
|
%
|
|
|
12.18
|
%
|
|
|
9.70
|
%
|
*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 0.81% and 1.17% for the three months ended March 31, 2020 and 2019, respectively. This ratio declined primarily due to an increase in the provision for loan losses for the three months ended March 31, 2020 as compared to 2019.
● 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 7.44% and 9.73% for the three months ended March 31, 2020 and 2019, respectively. This ratio declined primarily due to an increase in the provision for loan losses for the three months ended March 31, 2020 as compared to 2019.
● Net Interest Margin
The net interest margin for the three months ended March 31, 2020 and 2019 was 3.18% and 3.23%, respectively. The ratio is calculated by dividing tax equivalent 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 57.73% and 57.82% for the three months ended March 31, 2020 and 2019, respectively. The efficiency ratio remains comparable to the prior quarter last year.
● 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 10.92% as of March 31, 2020 is higher than the industry average of 9.81% as of December 31, 2019.
Industry Results:
The FDIC Quarterly Banking Profile reported the following results for the fourth quarter of 2020
Full-Year 2019 Net Income Declines to $233.1 Billion
For the 5,177 FDIC-insured commercial banks and savings institutions, full-year 2019 net income totaled $233.1 billion, down $3.6 billion (1.5%) from 2018. The decline was primarily attributable to slower growth in net interest income (up $5.5 billion, or 1%) and higher loan-loss provisions (up $5 billion, or 9.9%). Average net interest margin (NIM) declined from 3.40% in 2018 to 3.36% in 2019, as average earning assets grew at a faster rate than net interest income. The average return on assets (ROA) fell from 1.35% in 2018 to 1.29% in 2019.
Quarterly Net Income Declines Almost 7% From a Year Ago to $55.2 Billion
Quarterly net income totaled $55.2 billion during fourth quarter 2019, down $4.1 billion (6.9%) from a year ago. The annual decline in quarterly net income was a result of lower net interest income and higher noninterest expenses. About half (45.6%) of all banks reported year-over-year declines in net income, and the percentage of unprofitable banks in the fourth quarter remained stable from a year ago at 7.2%. The average ROA was 1.20% in fourth quarter 2019, down 13 basis points from a year ago.
Net Interest Income Declines 2.4% From Fourth Quarter 2018
Net interest income declined by $3.4 billion (2.4%) from 12 months ago, marking the first annual decline since third quarter 2013. NIM for the banking industry fell by 20 basis points from a year ago to 3.28%, as average asset yields declined more rapidly than average funding costs. The annual decline in NIM occurred for all five asset size groups featured in the Quarterly Banking Profile but was especially pronounced among banks with total assets between $10 billion and $250 billion. Banks responded to the low interest-rate environment by growing longer-term assets, but these assets generated lower yields and contributed to the NIM decline.
Noninterest Expense Increases 3.2% From Fourth Quarter 2018
Noninterest expense was $121.5 billion in fourth quarter 2019, up $3.7 billion (3.2%) from fourth quarter 2018. About two out of every three banks (67.5%) reported annual increases in noninterest expense. Close to 80% of the aggregate increase was attributable to higher salary and employee benefits, which grew by $2.9 billion (5.4%). The average assets per employee increased from $8.7 million in fourth quarter 2018 to $9 million in fourth quarter 2019.
Noninterest Income Expands 2.5% From 12 Months Ago
Noninterest income totaled $66 billion during the fourth quarter, up $1.6 billion (2.5%) from 12 months ago. The increase was broad-based, as more than half (61.8%) of all banks reported higher annual noninterest income. The annual increase was driven by higher trading revenues (up $3.2 billion, or 76.4%) and net gains on loan sales (up $1.1 billion, or 41.6%).
Loan-Loss Provisions Increase Modestly From a Year Ago
In the fourth quarter, banks set aside $14.8 billion in loan-loss provisions, an increase of $779 million (5.5%) from a year ago. More than one-third (38.4%) of all banks reported year-over-year increases in loan-loss provisions. The increase was mostly concentrated at larger institutions. Loan-loss provisions as a share of net operating revenue increased to 7.3% during the fourth quarter, the highest level since year-end 2012.
Net Charge-Offs Rise by $1.3 Billion From a Year Ago
Net charge-offs totaled $13.9 billion during the fourth quarter, an increase of $1.3 billion (10.4%) from fourth quarter 2018. The largest contributor to the year-over-year increase in net charge-offs was the commercial and industrial (C&I) loan portfolio, which registered a charge-off increase of $591.2 million (34.3%), and the credit card portfolio, which registered a charge-off increase of $409.9 million (5%). The average net charge-off rate increased by 4 basis points from fourth quarter 2018 to 0.54%. The C&I net charge-off rate was 0.42% during fourth quarter 2019, up from 0.32% a year ago but below the recent high of 0.50% reported in fourth quarter 2016. The credit card net charge-off rate increased by 4 basis points from fourth quarter 2018 to 3.75%.
Noncurrent Loan Rate Remains Stable at 0.91%
Noncurrent loan balances (90 days or more past due or in nonaccrual status) remained relatively stable (down $46.4 million, or 0.05%) from the previous quarter. About half of all banks (51.2%) reported declines in noncurrent loan balances. All major loan categories experienced declining levels of noncurrent loans from the previous quarter, except for credit card balances, which increased by $1.3 billion (10.3%). The credit card loan portfolio also registered the largest quarterly increase in the noncurrent rate, up 7 basis points to 1.47%.
Loan-Loss Reserves Decline Modestly From Third Quarter 2019
Loan-loss reserves totaled $123.9 billion at the end of fourth quarter 2019, down $1.3 billion (1%) from the previous quarter. At banks that itemize their loan-loss reserves, those with total assets of $1 billion or more, residential real estate reserves declined by $831.4 million (8%) and commercial real estate reserves fell by $669.6 million (2%). Loan-loss reserves for credit card portfolios rose by $775.6 million (1.9%) from third quarter 2019.
Total Assets Increase From the Previous Quarter
Total assets increased by $163.4 billion (0.9%) from the previous quarter, primarily because of growth in loan and leases balances (up $117.9 billion). Banks increased their securities holdings by $45.5 billion (1.2%), as mortgage-backed securities rose by $24.4 billion (1%) and holdings of U.S. Treasury securities grew by $8.5 billion (1.4%). Cash and balances due from depository institutions rose by $40.6 billion (2.5%).
Loan Balances Expand From the Previous Quarter and a Year Ago
Total loan and lease balances rose by $117.9 billion (1.1%) from third quarter 2019. More than half (59.2%) of all banks grew their loan and lease balances from the third quarter. Almost all of the major loan categories registered quarterly increases, except for the C&I loan portfolio which registered the first quarterly decline since fourth quarter 2016 (down $11 billion, or 0.5%). Quarterly growth among major loan categories was led by consumer loans (up $58.2 billion, or 3.3%), nonfarm nonresidential loans (up $21.6 billion, or 1.4%), and residential mortgage loans (up $19.1 billion, or 0.9%). Over the past year, total loan and lease balances rose by $366.3 billion (3.6%), slightly below the annual growth rate reported in third quarter 2019. The slowdown in annual growth of total loan and lease balances was led by the C&I loan portfolio, which expanded at its slowest rate since 2010 (1.9%).
Deposits Rise 1.8% From the Previous Quarter
Total deposit balances increased by $258.4 billion (1.8%) from the previous quarter, as interest-bearing accounts rose by $216.3 billion (2.2%) and noninterest-bearing accounts grew by $22.6 billion (0.7%). Deposits held in foreign offices increased by $19.5 billion (1.5%). Nondeposit liabilities, which include fed funds purchased, repurchase agreements, Federal Home Loan Bank (FHLB) advances, and secured and unsecured borrowings, fell by $69 billion (5%) from the previous quarter. The change in nondeposit liabilities was led by a decline in securities sold under agreements to repurchase (down $30 billion, or 13.3%), the largest quarterly dollar decline since fourth quarter 2013. FHLB advances were lower by $16.3 billion (3.3%).
Equity Capital Increases From Third Quarter 2019
Equity capital rose by $12.8 billion (0.6%) from third quarter 2019. Fourth quarter 2019 declared dividends of $49.1 billion were below quarterly net income of $55.2 billion. Common equity tier 1 ratio increased by 5 basis points from a year ago to 13.21%. Fourteen insured institutions with $1.8 billion in total assets were below the requirements for the well-capitalized category as defined for Prompt Corrective Action purposes.
Three New Banks Are Added in Fourth Quarter 2019
The number of FDIC-insured commercial banks and savings institutions declined from 5,258 to 5,177 during fourth quarter 2019. Three new banks were added, 77 institutions were absorbed by mergers, and three banks failed. For full-year 2019, 13 new banks were added, 226 institutions were absorbed by mergers, and four banks failed. The number of institutions on the FDIC’s “Problem Bank List” fell from 55 at the end of third quarter to 51 at the end of fourth quarter, the lowest level since fourth quarter 2006. Aggregate total assets of problem banks declined from $48.8 billion in third quarter 2019 to $46.2 billion in fourth quarter 2019.
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, 2019 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, including the recent onset of the COVID-19 pandemic, 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, including the recent onset of the COVID-19 pandemic, 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 March 31, 2020, 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. Goodwill may be impaired in the future if the effects of the COVID-19 restrictions negatively impacts our net income and fair value, particularly of our most recent acquisition. An impairment of goodwill would decrease the Company’s earnings during the period in which the impairment is recorded.
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 are widely used in the financial institutions industry and 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 March 31,
|
|
|
|
2020
|
|
|
2019
|
|
Reconciliation of net interest income and annualized net interest margin on an FTE basis to GAAP:
|
|
Net interest income (GAAP)
|
|
$
|
13,046
|
|
|
$
|
10,970
|
|
Tax-equivalent adjustment (1)
|
|
|
241
|
|
|
|
293
|
|
Net interest income on an FTE basis (non-GAAP)
|
|
|
13,287
|
|
|
|
11,263
|
|
Average interest-earning assets
|
|
$
|
1,669,356
|
|
|
$
|
1,393,813
|
|
Net interest margin on an FTE basis (non-GAAP)
|
|
|
3.18
|
%
|
|
|
3.23
|
%
|
(1) Computed on a tax-equivalent basis using an incremental federal income tax rate of 21 percent for the three months ended March 31, 2020 and 2019, 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 March 31, 2020 and 2019
The following highlights a comparative discussion of the major components of net income and their impact for the three months ended March 31, 2020 and 2019:
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. Refer to the net interest income discussion following the tables for additional detail.
AVERAGE BALANCE SHEETS AND INTEREST RATES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2020
|
|
|
2019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Revenue/
|
|
|
Yield/
|
|
|
Average
|
|
|
Revenue/
|
|
|
Yield/
|
|
|
|
balance
|
|
|
expense
|
|
|
rate
|
|
|
balance
|
|
|
expense
|
|
|
rate
|
|
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-earning assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans (1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial
|
|
$
|
85,400
|
|
|
$
|
1,081
|
|
|
|
5.06
|
%
|
|
$
|
84,182
|
|
|
$
|
1,120
|
|
|
|
5.32
|
%
|
Agricultural
|
|
|
110,296
|
|
|
|
1,699
|
|
|
|
6.16
|
%
|
|
|
81,216
|
|
|
|
1,284
|
|
|
|
6.32
|
%
|
Real estate
|
|
|
862,650
|
|
|
|
9,557
|
|
|
|
4.43
|
%
|
|
|
714,021
|
|
|
|
8,092
|
|
|
|
4.53
|
%
|
Consumer and other
|
|
|
18,483
|
|
|
|
250
|
|
|
|
5.41
|
%
|
|
|
16,686
|
|
|
|
205
|
|
|
|
4.90
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total loans (including fees)
|
|
|
1,076,829
|
|
|
|
12,587
|
|
|
|
4.68
|
%
|
|
|
896,105
|
|
|
|
10,701
|
|
|
|
4.78
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxable
|
|
|
303,865
|
|
|
|
1,854
|
|
|
|
2.44
|
%
|
|
|
251,145
|
|
|
|
1,489
|
|
|
|
2.37
|
%
|
Tax-exempt (2)
|
|
|
170,487
|
|
|
|
1,152
|
|
|
|
2.70
|
%
|
|
|
209,071
|
|
|
|
1,393
|
|
|
|
2.67
|
%
|
Total investment securities
|
|
|
474,352
|
|
|
|
3,006
|
|
|
|
2.54
|
%
|
|
|
460,216
|
|
|
|
2,882
|
|
|
|
2.50
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest bearing deposits with banks and federal funds sold
|
|
|
118,175
|
|
|
|
484
|
|
|
|
1.64
|
%
|
|
|
37,492
|
|
|
|
238
|
|
|
|
2.53
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest-earning assets
|
|
|
1,669,356
|
|
|
$
|
16,077
|
|
|
|
3.85
|
%
|
|
|
1,393,813
|
|
|
$
|
13,821
|
|
|
|
3.97
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noninterest-earning assets
|
|
|
81,546
|
|
|
|
|
|
|
|
|
|
|
|
52,602
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TOTAL ASSETS
|
|
$
|
1,750,902
|
|
|
|
|
|
|
|
|
|
|
$
|
1,446,415
|
|
|
|
|
|
|
|
|
|
(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 March 31,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2020
|
|
|
2019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Revenue/
|
|
|
Yield/
|
|
|
Average
|
|
|
Revenue/
|
|
|
Yield/
|
|
|
|
balance
|
|
|
expense
|
|
|
rate
|
|
|
balance
|
|
|
expense
|
|
|
rate
|
|
LIABILITIES AND STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest bearing checking, savings accounts and money markets
|
|
$
|
955,890
|
|
|
$
|
1,284
|
|
|
|
0.54
|
%
|
|
$
|
786,677
|
|
|
$
|
1,517
|
|
|
|
0.77
|
%
|
Time deposits
|
|
|
282,833
|
|
|
|
1,367
|
|
|
|
1.93
|
%
|
|
|
213,970
|
|
|
|
842
|
|
|
|
1.57
|
%
|
Total deposits
|
|
|
1,238,723
|
|
|
|
2,651
|
|
|
|
0.86
|
%
|
|
|
1,000,647
|
|
|
|
2,359
|
|
|
|
0.94
|
%
|
Other borrowed funds
|
|
|
50,190
|
|
|
|
139
|
|
|
|
1.11
|
%
|
|
|
43,460
|
|
|
|
199
|
|
|
|
1.83
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Interest-bearing liabilities
|
|
|
1,288,913
|
|
|
|
2,790
|
|
|
|
0.87
|
%
|
|
|
1,044,107
|
|
|
|
2,558
|
|
|
|
0.98
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noninterest-bearing liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noninterest bearing checking
|
|
|
260,092
|
|
|
|
|
|
|
|
|
|
|
|
220,155
|
|
|
|
|
|
|
|
|
|
Other liabilities
|
|
|
10,711
|
|
|
|
|
|
|
|
|
|
|
|
7,863
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders' equity
|
|
|
191,186
|
|
|
|
|
|
|
|
|
|
|
|
174,290
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
|
|
$
|
1,750,902
|
|
|
|
|
|
|
|
|
|
|
$
|
1,446,415
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest income
|
|
|
|
|
|
$
|
13,287
|
|
|
|
3.18
|
%
|
|
|
|
|
|
$
|
11,263
|
|
|
|
3.23
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Spread Analysis
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income/average assets
|
|
$
|
16,077
|
|
|
|
3.67
|
%
|
|
|
|
|
|
$
|
13,821
|
|
|
|
3.82
|
%
|
|
|
|
|
Interest expense/average assets
|
|
$
|
2,790
|
|
|
|
0.64
|
%
|
|
|
|
|
|
$
|
2,558
|
|
|
|
0.71
|
%
|
|
|
|
|
Net interest income/average assets
|
|
$
|
13,287
|
|
|
|
3.03
|
%
|
|
|
|
|
|
$
|
11,263
|
|
|
|
3.11
|
%
|
|
|
|
|
Net Interest Income
For the three months ended March 31, 2020 and 2019, the Company's net interest margin adjusted for tax exempt income was 3.18% and 3.23%, respectively. Net interest income, prior to the adjustment for tax-exempt income, for the three months ended March 31, 2020 totaled $13,046,000 compared to $10,970,000 for the three months ended March 31, 2019.
For the three months ended March 31, 2020, interest income increased $2,307,000, or 17%, when compared to the same period in 2019. The increase from 2020 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 an increase in foregone interest on nonaccrual loans of $131,000.
Interest expense increased $231,000, or 9%, for the three months ended March 31, 2020 when compared to the same period in 2019. The higher interest expense for the period is primarily attributable to an increase in deposits related to the Acquisition, offset in part by lower rates on deposits due to market interest rates.
Provision for Loan Losses
A provision for loan losses of $2,316,000 was recognized in the first quarter of 2020 as compared to $98,000 in the first quarter of 2019. Net loan charge offs (recoveries) totaled $26,000 for the quarter ended March 31, 2020 compared to $(30,000) for the quarter ended March 31, 2019. The increase in the provision for loan losses was primarily due to the economic slowdown associated with COVID-19 and to a lesser extent loan growth. The economic slowdown associated with COVID-19 will adversely affect our loan portfolios, but will more quickly affect the loans associated with hospitality and entertainment industries. Approximately 8.5% of our loan portfolio as of March 31, 2020 is associated with these industries. We are anticipating requests for loan payment deferrals and have had a significant number of requests for the Paycheck Protection Program loans in April, 2020. The federal government is providing numerous programs to lessen the effects of COVID-19 on the economy and on our loan portfolio. The severity of the effect of COVID-19 on our operations is difficult to determine at this time. The State of Iowa has significant restrictions on non-essential businesses as well as enforcing social distancing. The longer these restrictions are in place the more severe the effects of the economic slowdown will be and the greater the negative consequences for our loan customers which, in turn, could adversely affect the Company’s financial condition, liquidity and results of operations.
Noninterest Income and Expense
Noninterest income for the first quarter of 2020 totaled $2,631,000 as compared to $1,926,000 in the first quarter of 2019, an increase of 37%. The increase in noninterest income was primarily due to a security gain of $386,000 in 2020 and to a lesser extent the Acquisition.
Noninterest expense for the first quarter of 2020 totaled $9,050,000 compared to $7,457,000 recorded in the first quarter of 2019, an increase of 21%. Most of the increase was related to the Acquisition, salary and employee benefits and the amortization of Federal new market tax credit projects, offset in part by a decrease in the FDIC insurance assessments. Salaries and employee benefits, excluding the Acquisition, increased 7% primarily due to normal salary increases, increases in health insurance costs and additional personnel. The decrease in FDIC insurance assessments was due to the receipt of a small bank credit as the deposit insurance reserve ratio exceeded 1.35%. The efficiency ratio was 57.7% for the first quarter of 2020 as compared to 57.8% in the first quarter of 2019.
Income Taxes
Income tax expense for the first quarter of 2020 totaled $756,000 compared to $1,104,000 recorded in the first quarter of 2019. The effective tax rate was 17.5% and 20.7% for the quarters ended March 31, 2020 and 2019, respectively. The lower than expected tax rate in 2020 and 2019 was due primarily to tax-exempt interest income and new market tax credits recognized in 2020.
Balance Sheet Review
As of March 31, 2020, total assets were $1,797,746,000, a $60,564,000 increase compared to December 31, 2019. The increase in assets, primarily interest bearing deposits and loans, was funded primarily by deposits.
Investment Portfolio
The investment portfolio totaled $489,304,000 as of March 31, 2020, an increase of $9,461,000 from the December 31, 2019 balance of $479,843,000. The increase in securities available-for-sale is primarily due to purchases of municipal and corporate bonds, offset in part by maturities in the U.S. Government Agency portfolio.
On a quarterly basis, the investment portfolio is reviewed for other-than-temporary impairment. As of March 31, 2020, gross unrealized losses of $3,321,000, are considered to be temporary in nature due to the interest rate environment of 2020 and other general economic factors. As a result of the economic slowdown resulting from the COVID-19 pandemic, certain bonds in the investment portfolio may become other-than-temporarily impaired and could negatively affect the Company’s net income. 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 March 31, 2020, the Company’s investment securities portfolio included securities issued by 268 government municipalities and agencies located within 20 states with a fair value of $205.8 million. At December 31, 2019, the Company’s investment securities portfolio included securities issued by 251 government municipalities and agencies located within 18 states with a fair value of $195.3 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 March 31, 2020 was $3.6 million (approximately 1.7% 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 March 31, 2020 and December 31, 2019 identifying the state in which the issuing government municipality or agency operates. (in thousands)
|
|
2020
|
|
|
2019
|
|
|
|
|
|
|
|
Estimated
|
|
|
|
|
|
|
Estimated
|
|
|
|
Amortized
|
|
|
Fair
|
|
|
Amortized
|
|
|
Fair
|
|
|
|
Cost
|
|
|
Value
|
|
|
Cost
|
|
|
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Obligations of states and political subdivisions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General Obligation bonds:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Iowa
|
|
$
|
61,844
|
|
|
$
|
61,519
|
|
|
$
|
58,457
|
|
|
$
|
59,072
|
|
Texas
|
|
|
9,437
|
|
|
|
9,414
|
|
|
|
11,243
|
|
|
|
11,382
|
|
Pennsylvania
|
|
|
7,900
|
|
|
|
7,875
|
|
|
|
7,895
|
|
|
|
7,989
|
|
Washington
|
|
|
6,506
|
|
|
|
6,466
|
|
|
|
6,530
|
|
|
|
6,629
|
|
Other (2020: 14 states; 2019: 12 states)
|
|
|
22,303
|
|
|
|
22,113
|
|
|
|
18,168
|
|
|
|
18,375
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total general obligation bonds
|
|
$
|
107,990
|
|
|
$
|
107,387
|
|
|
$
|
102,293
|
|
|
$
|
103,447
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue bonds:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Iowa
|
|
$
|
77,019
|
|
|
$
|
76,894
|
|
|
$
|
78,281
|
|
|
$
|
78,624
|
|
Texas
|
|
|
6,595
|
|
|
|
6,176
|
|
|
|
480
|
|
|
|
476
|
|
Other (2020: 12 states; 2019: 12 states)
|
|
|
15,672
|
|
|
|
15,301
|
|
|
|
12,691
|
|
|
|
12,755
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue bonds
|
|
$
|
99,286
|
|
|
$
|
98,371
|
|
|
$
|
91,452
|
|
|
$
|
91,855
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total obligations of states and political subdivisions
|
|
$
|
207,276
|
|
|
$
|
205,758
|
|
|
$
|
193,745
|
|
|
$
|
195,302
|
|
As of March 31, 2020 and December 31, 2019, 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 6 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)
|
|
2020
|
|
|
2019
|
|
|
|
|
|
|
|
Estimated
|
|
|
|
|
|
|
Estimated
|
|
|
|
Amortized
|
|
|
Fair
|
|
|
Amortized
|
|
|
Fair
|
|
|
|
Cost
|
|
|
Value
|
|
|
Cost
|
|
|
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue bonds by revenue source
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales tax
|
|
$
|
36,270
|
|
|
$
|
36,162
|
|
|
$
|
37,928
|
|
|
$
|
38,173
|
|
Water
|
|
|
15,675
|
|
|
|
15,455
|
|
|
|
7,271
|
|
|
|
7,272
|
|
College and universities, primarily dormitory revenues
|
|
|
12,899
|
|
|
|
12,401
|
|
|
|
14,016
|
|
|
|
14,103
|
|
Leases
|
|
|
6,952
|
|
|
|
6,927
|
|
|
|
7,291
|
|
|
|
7,351
|
|
Electric power & light revenues
|
|
|
6,454
|
|
|
|
6,366
|
|
|
|
4,370
|
|
|
|
4,405
|
|
Sewer
|
|
|
5,120
|
|
|
|
5,115
|
|
|
|
4,612
|
|
|
|
4,645
|
|
Other
|
|
|
15,916
|
|
|
|
15,945
|
|
|
|
15,964
|
|
|
|
15,906
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue bonds by revenue source
|
|
$
|
99,286
|
|
|
$
|
98,371
|
|
|
$
|
91,452
|
|
|
$
|
91,855
|
|
Loan Portfolio
The loan portfolio, net of the allowance for loan losses, totaled $1,079,657,000 and $1,048,147,000 as of March 31, 2020 and December 31, 2019, respectively. Loan demand has softened since March 31, 2020, with the exception of the Payroll Protection Program (“PPP”) loans. The PPP loans bear an interest rate of 1.0% with a two year maturity. The Small Business Administration is providing fees to financial institutions to originate the PPP loans. Under certain conditions these loans may be forgiven and the fees associated with these loans will be accelerated into interest income. Through April 25, 2020, prior to the second allocation, the Company has originated approximately $70 million of the PPP loans.
Deposits
Deposits totaled $1,552,425,000 and $1,493,175,000 as of March 31, 2020 and December 31, 2019, respectively. The increase in deposits since December 31, 2019 was primarily due to account balances in interest bearing checking accounts, money market and certificate of deposit public funds and retail interest bearing checking accounts, offset in part by a decline in account balances of retail money market and certificate of deposits.
Securities Sold Under Agreements to Repurchase
Securities sold under agreements to repurchase totaled $41,618,000 as of March 31, 2020, a decrease of $416,000, or 1%, from the December 31, 2019 balance of $42,034,000.
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, 2019.
Asset Quality Review and Credit Risk Management
The Company’s credit risk is historically centered in the loan portfolio, which on March 31, 2020 totaled $1,079,657,000 compared to $1,048,147,000 as of December 31, 2019. Net loans comprise 60% of total assets as of March 31, 2020. The objective 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 1.69% at March 31, 2020, as compared to 0.48% at December 31, 2019. The increase in the level of problem loans is due primarily to the deterioration of one loan relationship in the hospitality portfolio. The Company’s level of problem loans as a percentage of total loans at March 31, 2020 of 1.69% is higher as compared to the Iowa State Average peer group of FDIC insured institutions as of December 31, 2019, of 0.63%.
Impaired loans, net of specific reserves, totaled $16,991,000 as of March 31, 2020 and have increased $12,203,000 as compared to the impaired loans of $4,788,000 as of December 31, 2019. The increase is primarily due to one hospitality loan relationship.
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 $1,372,000 as of March 31, 2020, all of which were included in impaired and nonaccrual loans. The Company had TDRs of $1,171,000 as of December 31, 2019, 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.
On March 22, 2020, federal banking regulators issued an interagency statement that included guidance on their approach for the accounting of loan modifications in light of the economic impact of the Coronavirus Disease 2019 (COVID-19) pandemic. The guidance interprets current accounting standards and indicates that a lender can conclude that a borrower is not experiencing financial difficulty if short-term modifications are made in response to COVID-19, such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant related to the loans in which the borrower is less than 30 days past due on its contractual payments at the time a modification program is implemented. The agencies confirmed in working with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not TDRs.
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. No additional specific reserves were provided for the three months ended March 31, 2020 and 2019. The Company had $16,000 of charge-offs for TDR’s for the three months ended March 31, 2020. There were no charge-offs related to TDRs for the three months ended March 31, 2019. The Company does not have material commitments to lend additional funds to borrowers with loans whose terms have been modified in troubled debt restructurings or whose loans are on nonaccrual.
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 March 31, 2020, non-accrual loans totaled $17,712,000 and there were $838,000 of loans past due 90 days and still accruing. This compares to non-accrual loans of $4,788,000 and loans past due 90 days and still accruing totaled $255,000 as of December 31, 2019. The increase in non-accrual loans are due primarily to a hospitality loan and an agricultural loan relationship. The increase in loans 90 days past due and still accruing is primarily due to an agricultural relationship well secured and in the process of collection. Real estate owned totaled $1,713,000 and $4,004,000 as of March 31, 2020 and December 31, 2019, 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 $51,520,000 as of March 31, 2020 as compared to $48,028,000 as of December 31, 2019. The substandard loans in these categories totaled $16,030,000 as of March 31, 2020 as compared to $15,913,000 as of December 31, 2019. The Iowa agricultural economy remains challenged as the result of the price of commodities, including corn, soybeans, cattle, hogs and ethanol, along with export concerns. The effects of the COVID-19 pandemic could exacerbate these challenges.
The watch and special mention loans classified as commercial real estate totaled $80,929,000 as of March 31, 2020 as compared to $33,790,000 as of December 31, 2019. This increase in commercial real estate loans was due primarily to the hospitality loan portfolio. The substandard commercial real estate loans totaled $16,163,000 as of March 31, 2020 as compared to $14,786,000 as of December 31, 2019.
The allowance for loan losses as a percentage of outstanding loans as of March 31, 2020 was 1.36%, as compared to 1.19% at December 31, 2019. The allowance for loan losses totaled $14,909,000 and $12,619,000 as of March 31, 2020 and December 31, 2019, respectively. Net charge-offs (recoveries) of loans totaled $26,000 and $(30,000) for the three months ended March 31, 2020 and 2019, 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. The qualitative factors considered as a part of our allowance for loan loss calculation may deteriorate if the economic effects of COVID-19 are not eased by the State of Iowa in a timely manner and a resumption to typical social and economic activity.
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 March 31, 2020, 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
|
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 March 31, 2020 and December 31, 2019 totaled $168,523,000 and $143,565,000, respectively, and management believes these sources provide an adequate level of liquidity given current economic conditions.
Other sources of liquidity available to the Banks as of March 31, 2020 include outstanding lines of credit with the FHLB of Des Moines, Iowa of $216,888,000, with $3,000,000 of outstanding FHLB advances. Federal funds borrowing capacity at correspondent banks was $109,481,000, with no outstanding federal fund purchase balances as of March 31, 2020. The Company had securities sold under agreements to repurchase totaling $41,618,000 as of March 31, 2020.
Total investments as of March 31, 2020 were $489,304,000 compared to $479,843,000 as of December 31, 2019. These investments provide the Company with a significant amount of liquidity since all of the investments are classified as available-for-sale as of March 31, 2020.
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 the Consolidated Statements of Cash Flows
Net cash provided by operating activities for the three months ended March 31, 2020 totaled $11,686,000 compared to $6,284,000 for the three months ended March 31, 2019. The increase in cash provided by operating activities was $5,402,000. This increase was primarily due to the proceeds from loans held for sale, a decrease in the balance of accrued interest receivable and an increase in accrued expenses and other liabilities, offset in part by the increase in originations from loans held for sale.
Net cash used in investing activities for the three months ended March 31, 2020 was $68,297,000 compared to $19,679,000 for the three months ended March 31, 2019. The increase of $48,618,000 in cash used in investing activities was primarily due to a higher level of loans and purchases of investments, offset in part by proceeds from the maturities of investments.
Net cash provided by financing activities for the three months ended March 31, 2020 totaled $54,051,000 compared to $7,144,000 for the three months ended March 31, 2019. The increase in cash provided by financing activities was $46,907,000. The increase was primarily due to an increase in deposits and a lower amount of repayments of FHLB advances in 2020 as compared to 2019. As of March 31, 2020, the Company did not have any external debt financing, off-balance sheet financing arrangements, or derivative instruments linked to its stock.
Review of 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 $2,330,000 and $3,198,000 for the three months ended March 31, 2020 and 2019, 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 $0.25 per share in 2020 from $0.24 per share in 2019.
The Company, on an unconsolidated basis, has interest bearing deposits totaling $4,043,000 as of March 31, 2020 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. 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 March 31, 2020 that are of concern to management.
Capital Resources
The Company’s total stockholders’ equity as of March 31, 2020 totaled $188,493,000 and was $914,000 higher than the $187,579,000 recorded as of December 31, 2019. The increase in stockholders’ equity was primarily due to net income and an increase in other comprehensive income, offset in part by dividends declared and stock repurchases. The increase in other comprehensive income is created by lower market interest rates compared to December 31, 2019, which resulted in higher fair values in the securities available-for-sale portfolio. At March 31, 2020 and December 31, 2019, stockholders’ equity as a percentage of total assets was 10.5% and 10.8% respectively. The capital levels of the Company exceed applicable regulatory guidelines as of March 31, 2020.
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: the substantial negative impact of the COVID-19 restrictions on national, regional and local economies in general and on our customers in particular; 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 resulting from the COVID-19 restrictions or as 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 heading “Risk Factors” in the Company’s annual report on Form 10-K. Management intends to identify forward-looking statements when using words such as “believe”, “expect”, “intend”, “anticipate”, “estimate”, “should”, “forecasting” 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.