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. The Banks also offer investment services through a third-party broker-dealer. The Company employs fourteen individuals to assist with financial reporting, human resources, audit, compliance, marketing, technology systems, training and the coordination of management activities, in addition to 213 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 $4,317,000, or $0.46 per share, for the three months ended June 30, 2018, compared to net income of $3,472,000, or $0.37 per share, for the three months ended June 30, 2017.
The increase in quarterly earnings can be primarily attributed to an increase in loan interest income, a reduction in the provision for loan losses and lower federal income tax expense, offset in part by higher deposit interest expense and an increase in salaries and benefits.
Net loan charge-offs totaled $4,000 and $481,000 for the three months ended June 30, 2018 and 2017, respectively. The provision for loan losses totaled $64,000 and $767,000 for the three months ended June 30, 2018 and 2017, respectively.
The Company had net income of $8,354,000, or $0.90 per share, for the six months ended June 30, 2018, compared to net income of $7,082,000, or $0.76 per share, for the six months ended June 30, 2017.
The increase in six month earnings can be primarily attributed to an increase in loan interest income, a reduction in the provision for loan losses and lower federal income tax expense, offset in part by higher deposit interest expense, an increase in salaries and benefits and a decrease in securities gains
Net loan charge-offs totaled $31,000 and $483,000 for the six months ended June 30, 2018 and 2017, respectively. The provision for loan losses totaled $93,000 and $1,164,000 for the six months ended June 30, 2018 and 2017, 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, 2018.
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 5,606 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
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3 Months
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6 Months
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Ended
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Ended
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3 Months Ended
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Years Ended December 31,
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June 30, 2018
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March 31, 2018
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2017
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2016
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Company
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Company
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Industry*
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Company
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Industry*
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Company
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Industry
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Return on assets
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1.26
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%
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1.22
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%
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1.19
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%
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1.28
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%
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1.00
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%
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0.97
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%
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1.18
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%
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1.04
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%
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Return on equity
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10.35
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%
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9.95
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%
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9.55
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%
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11.44
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%
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8.02
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%
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8.64
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%
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9.38
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%
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9.32
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%
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Net interest margin
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3.16
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%
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3.17
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%
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3.19
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%
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3.32
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%
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3.25
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%
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3.25
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%
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3.36
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%
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3.13
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%
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Efficiency ratio
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55.02
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%
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56.22
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%
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57.45
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%
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57.53
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%
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52.70
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%
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57.94
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%
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51.95
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%
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58.28
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%
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Capital ratio
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12.18
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%
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12.30
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%
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12.43
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%
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9.66
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%
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12.48
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%
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9.62
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%
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12.60
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%
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9.48
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%
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*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 1.26% and 1.01% for the three months ended June 30, 2018 and 2017, respectively. The increase in this ratio in 2018 from the previous period is primarily due to a decrease in income tax expense and the provision for loan losses.
● 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 10.35% and 8.17% for the three months ended June 30, 2018 and 2017, respectively. The increase in this ratio in 2018 from the previous period is primarily due to a decrease in income tax expense and the provision for loan losses.
● Net Interest Margin
The net interest margin for the three months ended June 30, 2018 and 2017 was 3.16% and 3.25%, 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 55.02% and 52.93% for the three months ended June 30, 2018 and 2017, respectively. The efficiency ratio increase for the three months ended June 30, 2018 primarily an increase in salaries and benefits.
● 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 12.18% as of June 30, 2018 is significantly higher than the industry average of 9.62% as of December 31, 2017.
Industry Results
The FDIC Quarterly Banking Profile reported the following results for the first quarter of 2018:
Net Income Increases 27.5% From a Year Earlier Due to Higher Net Operating Revenue and a Lower Effective Tax Rate
Aggregate net income for the 5,606 FDIC-insured commercial banks and savings institutions reporting first quarter performance totaled $56 billion in first quarter 2018, an increase of $12.1 billion (27.5%) from a year earlier. Improvement in net income was attributable to higher net operating revenue (the sum of net interest income and noninterest income) and a lower effective tax rate, but was offset in part by higher loan-loss provisions and noninterest expense. Using the effective tax rate before the new tax law, estimated net income would have been $49.4 billion, an increase of $5.5 billion (12.6%) from first quarter 2017. The average return on assets rose by 24 basis points from first quarter 2017 to 1.28%. Less than 4% of institutions were unprofitable during the quarter, the lowest level since first quarter 1996.
Net Interest Income Rises 8.5% From the Year Before
Net interest income rose by $10.3 billion (8.5%), as more than four out of five banks (85.9%) reported an increase from 12 months ago. For the past seven consecutive quarters, the annual growth rate for net interest income has exceeded 7.4%. The net interest margin (NIM) increased from 3.19% in first quarter 2017 to 3.32%, due to growth in interest income as interest-bearing assets rose by 3.6%. The improvement in NIM was widespread, as more than two out of three banks (69.4%) reported increases from a year earlier.
Noninterest Income Increases 7.9% From a Year Earlier
Over the past 12 months, noninterest income grew by $4.9 billion (7.9%) to $67.4 billion. This increase is the highest 12-month growth rate since third quarter 2014. The annual increase in noninterest income was led by higher trading revenue (up $1.1 billion, or 14.9%) and other noninterest income (up $2.4 billion, or 8.8%). More than half (55.1%) of all banks reported increases in noninterest income compared with first quarter 2017.
Noninterest Expense Increases 5.8% From a Year Earlier
Noninterest expenses were $6.3 billion (5.8%) higher than first quarter 2017, as almost three out of four banks (74%) reported increases. Other noninterest expense rose by $3.7 billion (8.6%), and salary and employee benefits grew by $2.3 billion (4.3%). Average assets per employee increased from $8.2 million in first quarter 2017 to $8.4 million.
Provisions Increase Modestly From First Quarter 2017
In the first quarter, banks allocated $12.4 billion in loan-loss provisions, an increase of $356.6 million (3%) from a year earlier. Almost 37% of institutions reported higher loan-loss provisions than in first quarter 2017. The increase is due to higher net charge-offs, and a growing loan portfolio. Loan-loss provisions as a percent of net operating revenue totaled 6.2% for the first quarter, down from 6.6% a year ago.
Net Charge-Off Rate Remains Stable
Banks charged off $12.1 billion in uncollectable loans during the quarter, an increase of $540.6 million (4.7%) from a year earlier. The annual increase in net charge-offs was led by credit card balances (up $1.1 billion, or 16.3%). However, less than half (42.9%) of all banks reported a year-over-year increase, and net charge-offs were lower for most major loan categories. The average net-charge off rate remained stable (0.50%) from a year earlier.
Noncurrent Loan Rate Declines Modestly
Noncurrent loan balances (90 days or more past due or in nonaccrual status) were $3.9 billion (3.4%) lower compared with the previous quarter. Slightly more than half (50.8%) of all banks reported declines in their noncurrent loan balances during the quarter. The decline in noncurrent loan balances was led by residential mortgages (down $2.8 billion, or 4.9%), commercial and industrial loans (down $617.2 million, or 3.4%), and credit cards (down $436.4 million, or 3.7%). The average noncurrent rate declined by 5 basis points from the previous quarter to 1.15%.
Coverage Ratio Rises to 110%
Banks reduced their loan-loss reserves by $15 million from the previous quarter, with less than one-third (23.8%) of all banks reporting a quarterly decline. Banks with assets greater than $1 billion, which itemize their reserves, reported the largest quarterly increase in reserves for credit card losses (up $850.2 million, or 2.3%). Reserves declined for residential real estate losses (down $654.3 million, or 4.5%) and commercial loan losses (down $368.5 million, or 1.1%). With noncurrent loan balances declining at a faster quarterly rate than loan-loss reserves, the coverage ratio (loan-loss reserves to noncurrent loan balances) increased from 106.3% in fourth quarter 2017 to 110%. This marks the fourth consecutive quarter that the coverage ratio was above 100%.
Equity Capital Rises Modestly
Bank equity capital rose by $11.2 billion (0.6%) from the previous quarter. Retained earnings contributed $25.3 billion to equity growth, but were offset in part by the decline in the market value of available-for-sale securities, which reduced accumulated other comprehensive income by $25.8 billion. Declared dividends in the first quarter totaled $30.7 billion, an increase of $3.3 billion (12.2%) from the year-earlier quarter. At the end of the quarter, 99.5% of all insured institutions, which account for 99.98% of total industry assets, met or exceeded the requirements for the highest regulatory capital category as defined for Prompt Corrective Action purposes.
Loan Balances Rise 4.9% Over 12 Months
Total loan and lease balances rose by $31.3 billion (0.3%) from fourth quarter 2017. Commercial and industrial loans increased by $38.6 billion (1.9%), nonfarm nonresidential loans grew by $11.5 billion (0.8%), and residential mortgage loans rose by $8.8 billion (0.4%). Credit card balances posted a seasonal decline of $44.6 billion (5.2%). Over the past 12 months, total loan and lease balances rose by $455.2 billion (4.9%), exceeding last quarter’s annual growth rate of 4.5%. Commercial and industrial loans increased by $91.8 billion (4.7%), residential mortgage loans grew by $87.8 billion (4.4%), credit card balances rose by $64.3 billion (8.5%), and nonfarm nonresidential loans increased by $56.1 billion (4.2%). Home equity lines of credit declined by $31.6 billion (7.3%) over the past 12 months. Unused loan commitments increased by 5.5% from a year earlier, the highest annual growth rate since first quarter 2016.
Deposits Increase From the Previous Quarter
Total deposits grew by $129.7 billion (1%) in the first quarter. Domestic interest-bearing deposits increased by $176.1 billion (2%), while noninterest-bearing deposits fell by $655.9 million (0.02%). Nondeposit liabilities declined by $24.1 billion (1.2%), led by other liabilities (down $30.7 billion, or 1.9%) and borrowings from Federal Home Loan Banks (down $28.6 billion, or 4.9%). Domestic deposits in accounts less than $250,000 rose by $169.7 billion (2.9%) from fourth quarter 2017.
Three New Charters Added in First Quarter 2018
There were 5,607 FDIC-insured commercial banks and savings institutions at the end of first quarter 2018, a decline from 5,670 the year before. The number of institutions on the FDIC’s “Problem Bank List” fell from 95 to 92. During the quarter, 65 institutions were absorbed by merger transactions, three new charters were added, and there were no failures.
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, 2017 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 two 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 June 30, 2018, 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)
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Three Months Ended June 30,
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Six Months Ended June 30,
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2018
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2017
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2018
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2017
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Reconciliation of net interest income and annualized net interest margin on an FTE basis to GAAP:
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Net interest income (GAAP)
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$
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10,211
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$
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10,066
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$
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20,397
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$
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19,949
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Tax-equivalent adjustment
(1)
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313
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695
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629
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1,405
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Net interest income on an FTE basis (non-GAAP)
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10,524
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10,761
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21,026
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21,354
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Average interest-earning assets
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$
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1,330,909
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$
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1,325,985
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$
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1,324,875
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$
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1,324,522
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Net interest margin on an FTE basis (non-GAAP)
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3.16
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%
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3.25
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%
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3.17
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%
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3.22
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%
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(1) Computed on a tax-equivalent basis using an incremental federal income tax rate of 21 percent for the three and six months ended June 30, 2018 and 35 percent for the three and six months ended June 30, 2017, adjusted to reflect the effect of the tax-exempt interest income associated with owning tax-exempt securities and loans.
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Income Statement Review for the Three Months ended June 30, 2018 and 2017
The following highlights a comparative discussion of the major components of net income and their impact for the three months ended June 30, 2018 and 2017:
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
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Three Months Ended June 30,
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2018
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2017
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Average
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Revenue/
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Yield/
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Average
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Revenue/
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Yield/
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balance
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expense
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rate
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balance
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expense
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rate
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ASSETS
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(dollars in thousands)
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Interest-earning assets
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Loans 1
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Commercial
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|
$
|
72,939
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|
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$
|
927
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|
|
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5.08
|
%
|
|
$
|
79,493
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|
|
$
|
879
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|
|
|
4.42
|
%
|
Agricultural
|
|
|
68,992
|
|
|
|
945
|
|
|
|
5.48
|
%
|
|
|
71,939
|
|
|
|
946
|
|
|
|
5.26
|
%
|
Real estate
|
|
|
637,835
|
|
|
|
7,008
|
|
|
|
4.40
|
%
|
|
|
613,289
|
|
|
|
6,537
|
|
|
|
4.26
|
%
|
Consumer and other
|
|
|
8,240
|
|
|
|
116
|
|
|
|
5.62
|
%
|
|
|
11,241
|
|
|
|
138
|
|
|
|
4.91
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total loans (including fees)
|
|
|
788,006
|
|
|
|
8,996
|
|
|
|
4.57
|
%
|
|
|
775,962
|
|
|
|
8,500
|
|
|
|
4.38
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxable
|
|
|
271,835
|
|
|
|
1,590
|
|
|
|
2.34
|
%
|
|
|
272,735
|
|
|
|
1,567
|
|
|
|
2.30
|
%
|
Tax-exempt 2
|
|
|
223,979
|
|
|
|
1,493
|
|
|
|
2.67
|
%
|
|
|
244,088
|
|
|
|
1,986
|
|
|
|
3.25
|
%
|
Total investment securities
|
|
|
495,814
|
|
|
|
3,083
|
|
|
|
2.49
|
%
|
|
|
516,823
|
|
|
|
3,553
|
|
|
|
2.75
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest bearing deposits with banks and federal funds sold
|
|
|
47,089
|
|
|
|
230
|
|
|
|
1.95
|
%
|
|
|
33,200
|
|
|
|
113
|
|
|
|
1.37
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest-earning assets
|
|
|
1,330,909
|
|
|
$
|
12,309
|
|
|
|
3.70
|
%
|
|
|
1,325,985
|
|
|
$
|
12,166
|
|
|
|
3.67
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noninterest-earning assets
|
|
|
38,895
|
|
|
|
|
|
|
|
|
|
|
|
48,727
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TOTAL ASSETS
|
|
$
|
1,369,804
|
|
|
|
|
|
|
|
|
|
|
$
|
1,374,712
|
|
|
|
|
|
|
|
|
|
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 for the three months ended June 30, 2018 and 2017 of 21% and 35%, respectively.
|
AVERAGE BALANCE SHEETS AND INTEREST RATES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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
|
|
$
|
744,936
|
|
|
$
|
1,070
|
|
|
|
0.57
|
%
|
|
$
|
728,850
|
|
|
$
|
656
|
|
|
|
0.36
|
%
|
Time deposits
|
|
|
193,897
|
|
|
|
564
|
|
|
|
1.16
|
%
|
|
|
197,492
|
|
|
|
458
|
|
|
|
0.93
|
%
|
Total deposits
|
|
|
938,833
|
|
|
|
1,634
|
|
|
|
0.70
|
%
|
|
|
926,342
|
|
|
|
1,114
|
|
|
|
0.48
|
%
|
Other borrowed funds
|
|
|
44,124
|
|
|
|
151
|
|
|
|
1.37
|
%
|
|
|
76,769
|
|
|
|
291
|
|
|
|
1.52
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Interest-bearing liabilities
|
|
|
982,957
|
|
|
|
1,785
|
|
|
|
0.73
|
%
|
|
|
1,003,111
|
|
|
|
1,405
|
|
|
|
0.56
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noninterest-bearing liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Demand deposits
|
|
|
211,586
|
|
|
|
|
|
|
|
|
|
|
|
194,505
|
|
|
|
|
|
|
|
|
|
Other liabilities
|
|
|
8,487
|
|
|
|
|
|
|
|
|
|
|
|
7,064
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders' equity
|
|
|
166,774
|
|
|
|
|
|
|
|
|
|
|
|
170,032
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
|
|
$
|
1,369,804
|
|
|
|
|
|
|
|
|
|
|
$
|
1,374,712
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest income
|
|
|
|
|
|
$
|
10,524
|
|
|
|
3.16
|
%
|
|
|
|
|
|
$
|
10,761
|
|
|
|
3.25
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Spread Analysis
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income/average assets
|
|
$
|
12,309
|
|
|
|
3.59
|
%
|
|
|
|
|
|
$
|
12,166
|
|
|
|
3.54
|
%
|
|
|
|
|
Interest expense/average assets
|
|
$
|
1,785
|
|
|
|
0.52
|
%
|
|
|
|
|
|
$
|
1,405
|
|
|
|
0.41
|
%
|
|
|
|
|
Net interest income/average assets
|
|
$
|
10,524
|
|
|
|
3.07
|
%
|
|
|
|
|
|
$
|
10,761
|
|
|
|
3.13
|
%
|
|
|
|
|
Net Interest Income
For the three months ended June 30, 2018 and 2017, the Company's net interest margin adjusted for tax exempt income was 3.16% and 3.25%, respectively. Net interest income, prior to the adjustment for tax-exempt income, for the three months ended June 30, 2018 totaled $10,211,000 compared to $10,066,000 for the three months ended June 30, 2017.
For the three months ended June 30, 2018, interest income increased $525,000, or 5%, when compared to the same period in 2017. The increase from 2017 was primarily attributable to higher rates on loans. The higher rates on loans were primarily due to an increase in general market interest rates, as the Federal Reserve Bank increased short term interest rate targets by 0.75% since June 30, 2017.
Interest expense increased $380,000, or 27%, for the three months ended June 30, 2018 when compared to the same period in 2017. 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
The Company’s provision for loan losses was $64,000 and $767,000 for the three months ended June 30, 2018 and 2017, respectively. An increase in the specific reserve on one commercial credit was the primary factor for the provision for loan losses for the quarter ended June 30, 2017, with no significant growth in the loan portfolio for the quarter ended June 30, 2018. Net loan charge-offs were $4,000 and $481,000 for the three months ended June 30, 2018 and 2017, respectively. While the current provision for loan losses are not related to agricultural loans, the Iowa agricultural economy remains challenged as the result of the current low grain prices, potential tariff concerns on Iowa exports and excessive rainfall in a portion of our markets.
Noninterest Income and Expense
Noninterest income decreased $34,000 for the three months ended June 30, 2018 compared to the same period in 2017. The decrease in noninterest income is primarily due to lower security gains and other noninterest income, offset in part by higher wealth management income. The higher wealth management income was primarily due to an increase in one time estate fees. Exclusive of realized securities gains, noninterest income was 3% higher in the second quarter of 2018 compared to the same period in 2017.
Noninterest expense increased $314,000 or 5% for the three months ended June 30, 2018 compared to the same period in 2017 primarily as a result of increases in salaries and employee benefits. This increase in salaries and benefits was primarily due to increases in employee benefit costs, additional personnel, changes in the Company’s paid time off benefits and normal salary increases. The efficiency ratio was 55.0% for the second quarter of 2018 as compared to 52.9% in 2017.
Income Taxes
The provision for income taxes expense for the three months ended June 30, 2018 and 2017 was $1,107,000 and $1,453,000, respectively, representing an effective tax rate of 20% and 29%, respectively. The expected combined federal and state tax rate was 25% and 37% for the three months ended June 30, 2018 and 2017, respectively. The lower expected tax rate in 2018 is due to the enactment of the Tax Cut and Jobs Act Bill on December 22, 2017. The lower than expected effective tax rate for both periods is primarily due to tax-exempt interest income.
Income Statement Review for the Six Months ended June 30, 2018 and 2017
The following highlights a comparative discussion of the major components of net income and their impact for the six months ended June 30, 2018 and 2017:
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
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Revenue/
|
|
|
Yield/
|
|
|
Average
|
|
|
Revenue/
|
|
|
Yield/
|
|
|
|
balance
|
|
|
expense
|
|
|
rate
|
|
|
balance
|
|
|
expense
|
|
|
rate
|
|
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-earning assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans 1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial
|
|
$
|
73,180
|
|
|
$
|
1,795
|
|
|
|
4.90
|
%
|
|
$
|
77,310
|
|
|
$
|
1,693
|
|
|
|
4.38
|
%
|
Agricultural
|
|
|
68,776
|
|
|
|
1,913
|
|
|
|
5.56
|
%
|
|
|
69,674
|
|
|
|
1,781
|
|
|
|
5.11
|
%
|
Real estate
|
|
|
634,953
|
|
|
|
13,949
|
|
|
|
4.39
|
%
|
|
|
607,575
|
|
|
|
12,863
|
|
|
|
4.23
|
%
|
Consumer and other
|
|
|
8,532
|
|
|
|
228
|
|
|
|
5.34
|
%
|
|
|
11,429
|
|
|
|
278
|
|
|
|
4.87
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total loans (including fees)
|
|
|
785,441
|
|
|
|
17,885
|
|
|
|
4.55
|
%
|
|
|
765,988
|
|
|
|
16,615
|
|
|
|
4.34
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxable
|
|
|
271,924
|
|
|
|
3,147
|
|
|
|
2.31
|
%
|
|
|
270,092
|
|
|
|
3,080
|
|
|
|
2.28
|
%
|
Tax-exempt 2
|
|
|
225,197
|
|
|
|
2,995
|
|
|
|
2.66
|
%
|
|
|
246,706
|
|
|
|
4,013
|
|
|
|
3.25
|
%
|
Total investment securities
|
|
|
497,121
|
|
|
|
6,142
|
|
|
|
2.47
|
%
|
|
|
516,798
|
|
|
|
7,093
|
|
|
|
2.74
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest bearing deposits with banks and federal funds sold
|
|
|
42,313
|
|
|
|
395
|
|
|
|
1.87
|
%
|
|
|
41,736
|
|
|
|
251
|
|
|
|
1.20
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest-earning assets
|
|
|
1,324,875
|
|
|
$
|
24,422
|
|
|
|
3.69
|
%
|
|
|
1,324,522
|
|
|
$
|
23,959
|
|
|
|
3.62
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noninterest-earning assets
|
|
|
40,125
|
|
|
|
|
|
|
|
|
|
|
|
49,217
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TOTAL ASSETS
|
|
$
|
1,365,000
|
|
|
|
|
|
|
|
|
|
|
$
|
1,373,739
|
|
|
|
|
|
|
|
|
|
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 for the six months ended June 30, 2018 and 2017 of 21% and 35%, respectively.
|
AVERAGE BALANCE SHEETS AND INTEREST RATES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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
|
|
$
|
733,157
|
|
|
$
|
1,901
|
|
|
|
0.52
|
%
|
|
$
|
720,989
|
|
|
$
|
1,135
|
|
|
|
0.31
|
%
|
Time deposits
|
|
|
194,481
|
|
|
|
1,095
|
|
|
|
1.13
|
%
|
|
|
199,465
|
|
|
|
900
|
|
|
|
0.90
|
%
|
Total deposits
|
|
|
927,638
|
|
|
|
2,996
|
|
|
|
0.65
|
%
|
|
|
920,454
|
|
|
|
2,035
|
|
|
|
0.44
|
%
|
Other borrowed funds
|
|
|
51,832
|
|
|
|
400
|
|
|
|
1.54
|
%
|
|
|
77,896
|
|
|
|
571
|
|
|
|
1.47
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Interest-bearing liabilities
|
|
|
979,470
|
|
|
|
3,396
|
|
|
|
0.69
|
%
|
|
|
998,350
|
|
|
|
2,606
|
|
|
|
0.52
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noninterest-bearing liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Demand deposits
|
|
|
209,169
|
|
|
|
|
|
|
|
|
|
|
|
199,555
|
|
|
|
|
|
|
|
|
|
Other liabilities
|
|
|
8,456
|
|
|
|
|
|
|
|
|
|
|
|
7,414
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders' equity
|
|
|
167,905
|
|
|
|
|
|
|
|
|
|
|
|
168,420
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
|
|
$
|
1,365,000
|
|
|
|
|
|
|
|
|
|
|
$
|
1,373,739
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest income
|
|
|
|
|
|
$
|
21,026
|
|
|
|
3.17
|
%
|
|
|
|
|
|
$
|
21,353
|
|
|
|
3.22
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Spread Analysis
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income/average assets
|
|
$
|
24,422
|
|
|
|
3.58
|
%
|
|
|
|
|
|
$
|
23,959
|
|
|
|
3.49
|
%
|
|
|
|
|
Interest expense/average assets
|
|
$
|
3,396
|
|
|
|
0.50
|
%
|
|
|
|
|
|
$
|
2,606
|
|
|
|
0.38
|
%
|
|
|
|
|
Net interest income/average assets
|
|
$
|
21,026
|
|
|
|
3.08
|
%
|
|
|
|
|
|
$
|
21,353
|
|
|
|
3.11
|
%
|
|
|
|
|
Net Interest Income
For the six months ended June 30, 2018 and 2017, the Company's net interest margin adjusted for tax exempt income was 3.17% and 3.22%, respectively. Net interest income, prior to the adjustment for tax-exempt income, for the six months ended June 30, 2018 totaled $20,397,000 compared to $19,949,000 for the six months ended June 30, 2017.
For the six months ended June 30, 2018, interest income increased $1,239,000, or 5%, when compared to the same period in 2017. The increase from 2017 was primarily attributable to increased loan rates and recognition of nonaccrual loan interest income on loans, offset by a decrease in interest income on tax-exempt investments.
Interest expense increased $790,000, or 30%, for the six months ended June 30, 2018 when compared to the same period in 2017. 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
The Company’s provision for loan losses was $93,000 and $1,164,000 for the six months ended June 30, 2018 and 2017, respectively. An increase in the specific reserve on one loan credit and the growth in the loan portfolio was the primary factor for the provision for loan losses for the six months ended June 30, 2017, with no significant growth in the loan portfolio for the six months ended June 30, 2018. Net loan charge-offs were $31,000 and $483,000 for the six months ended June 30, 2018 and 2017, respectively. While the current provision for loan losses are not related to agricultural loans, the Iowa agricultural economy remains challenged as the result of the current low grain prices, potential tariff concerns on Iowa exports and excessive rainfall in a portion of our markets.
Noninterest Income and Expense
Noninterest income decreased $351,000 for the six months ended June 30, 2018 compared to the same period in 2017. The decrease in noninterest income is primarily due to lower security gains, offset in part by higher wealth management income. The higher wealth management income was primarily due to an increase in one time estate fees. Exclusive of realized securities gains, noninterest income was 3% higher for the six months ended June 30, 2018 as compared to the same period in 2017.
Noninterest expense increased $702,000 or 5% for the six months ended June 30, 2018 compared to the same period in 2017 primarily as a result of increases in salaries and employee benefits. This increase in salaries and benefits was primarily due to a one-time $1,000 bonus paid to full-time employees, increases in employee benefit costs, additional personnel, changes in the Company’s paid time off benefits and normal salary increases. The efficiency ratio was 56.2% for the six months ended June 30, 2018 as compared to 53.5% in 2017.
Income Taxes
The provision for income taxes expense for the six months ended June 30, 2018 and 2017 was $2,127,000 and $2,932,000, respectively, representing an effective tax rate of 20% and 29%, respectively. The expected combined federal and state tax rate was 25% and 37% for the six months ended June 30, 2018 and 2017, respectively. The lower expected tax rate in 2018 is due to the enactment of the Tax Cut and Jobs Act Bill on December 22, 2017. The lower than expected effective tax rate for both periods is primarily due to tax-exempt interest income.
Balance Sheet Review
As of June 30, 2018, total assets were $1,362,055,000, a $13,005,000 decrease compared to December 31, 2017. The decrease in assets was due primarily to a decrease in cash and due from banks and securities available-for-sale, offset in part by an increase in loans. This decrease in asset funding was primarily due to a decrease in FHLB advances and other borrowings, offset in part by an increase in deposits.
Investment Portfolio
The investment portfolio totaled $478,733,000 as of June 30, 2018, a decrease of $16,589,000 from the December 31, 2017 balance of $495,322,000. The decrease in the investment portfolio was primarily due to maturities and call on municipal bonds.
On a quarterly basis, the investment portfolio is reviewed for other-than-temporary impairment. As of June 30, 2018, gross unrealized losses of $7,513,000, are considered to be temporary in nature due to the interest rate environment of 2018 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 June 30, 2018, the Company’s investment securities portfolio included securities issued by 256 government municipalities and agencies located within 20 states with a fair value of $223.2 million. At December 31, 2017, the Company’s investment securities portfolio included securities issued by 272 government municipalities and agencies located within 25 states with a fair value of $261.6 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 June 30, 2018 was $4.3 million (approximately 2.0% of the fair value of the governmental municipalities and agencies) represented by the Dubuque, 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 June 30, 2018 and December 31, 2017 identifying the state in which the issuing government municipality or agency operates.
(Dollars in thousands)
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
Estimated
|
|
|
|
|
|
|
Estimated
|
|
|
|
Amortized
|
|
|
Fair
|
|
|
Amortized
|
|
|
Fair
|
|
|
|
Cost
|
|
|
Value
|
|
|
Cost
|
|
|
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Obligations of states and political subdivisions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General Obligation bonds:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Iowa
|
|
$
|
53,078
|
|
|
$
|
52,451
|
|
|
$
|
56,029
|
|
|
$
|
55,829
|
|
Texas
|
|
|
11,521
|
|
|
|
11,457
|
|
|
|
12,141
|
|
|
|
12,174
|
|
Pennsylvania
|
|
|
9,725
|
|
|
|
9,689
|
|
|
|
8,719
|
|
|
|
8,745
|
|
Washington
|
|
|
6,961
|
|
|
|
6,766
|
|
|
|
7,017
|
|
|
|
6,900
|
|
Other (2018: 13 states; 2017: 17 states)
|
|
|
19,544
|
|
|
|
19,630
|
|
|
|
22,023
|
|
|
|
22,228
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total general obligation bonds
|
|
$
|
100,829
|
|
|
$
|
99,993
|
|
|
$
|
105,929
|
|
|
$
|
105,876
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue bonds:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Iowa
|
|
$
|
114,333
|
|
|
$
|
113,693
|
|
|
$
|
122,044
|
|
|
$
|
122,140
|
|
Other (2018: 9 states; 2017: 9 states)
|
|
|
9,598
|
|
|
|
9,541
|
|
|
|
9,376
|
|
|
|
9,397
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue bonds
|
|
$
|
123,931
|
|
|
$
|
123,234
|
|
|
$
|
131,420
|
|
|
$
|
131,537
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total obligations of states and political subdivisions
|
|
$
|
224,760
|
|
|
$
|
223,227
|
|
|
$
|
237,349
|
|
|
$
|
237,413
|
|
As of June 30, 2018 and December 31, 2017, 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)
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
Estimated
|
|
|
|
|
|
|
Estimated
|
|
|
|
Amortized
|
|
|
Fair
|
|
|
Amortized
|
|
|
Fair
|
|
|
|
Cost
|
|
|
Value
|
|
|
Cost
|
|
|
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue bonds by revenue source
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales tax
|
|
$
|
72,868
|
|
|
$
|
72,788
|
|
|
$
|
74,631
|
|
|
$
|
74,973
|
|
Water
|
|
|
11,776
|
|
|
|
11,528
|
|
|
|
12,763
|
|
|
|
12,611
|
|
College and universities, primarily dormitory revenues
|
|
|
9,240
|
|
|
|
9,193
|
|
|
|
10,452
|
|
|
|
10,443
|
|
Leases
|
|
|
9,556
|
|
|
|
9,454
|
|
|
|
9,383
|
|
|
|
9,331
|
|
Electric
|
|
|
7,371
|
|
|
|
7,345
|
|
|
|
7,382
|
|
|
|
7,416
|
|
Other
|
|
|
13,120
|
|
|
|
12,926
|
|
|
|
16,809
|
|
|
|
16,763
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue bonds by revenue source
|
|
$
|
123,931
|
|
|
$
|
123,234
|
|
|
$
|
131,420
|
|
|
$
|
131,537
|
|
Loan Portfolio
The loan portfolio, net of the allowance for loan losses, totaled $780,260,000, $771,550,000 and $768,208,000 as of June 30, 2018, December 31, 2017 and June 30, 2017, respectively. Loan demand has moderated since year end.
Deposits
Deposits totaled $1,151,815,000, $1,134,391,000 and $1,126,771,000 as of June 30, 2018, December 31, 2017 and June 30, 2017, respectively. The increase in deposits since December 31, 2017 was primarily due to increases in commercial and public funds NOW account balances, retail savings account balances and money market account balances, offset in part by a decrease in retail NOW account balances. The increase in deposits since June 30, 2017 was primarily due to increases in retail and commercial demand deposit and retail savings account balances.
Securities Sold Under Agreements to Repurchase
Securities sold under agreements to repurchase totaled $34,108,000 as of June 30, 2018, a decrease of $3,317,000, or 9%, from the December 31, 2017 balance of $37,425,000.
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, 2017.
Asset Quality Review and Credit Risk Management
The Company’s credit risk is historically centered in the loan portfolio, which on June 30, 2018 totaled $780,260,000 compared to $771,550,000 as of December 31, 2017. Net loans comprise 57% of total assets as of June 30, 2018. 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 a transaction 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 0.49% at June 30, 2018, as compared to 0.62% at December 31, 2017 and 0.66% at June 30, 2017. The Company’s level of problem loans as a percentage of total loans at June 30, 2018 of 0.49% is slightly lower than the Company’s peer group (334 bank holding companies with assets of $1 billion to $3 billion) of 0.66% as of March 31, 2018.
Impaired loans, net of specific reserves, totaled $3,014,000 as of June 30, 2018 and have decreased $985,000 as compared to the impaired loans of $3,999,000 as of December 31, 2017.
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 $2,828,000 as of June 30, 2018, all of which were included in impaired and nonaccrual loans. The Company had TDRs of $2,984,000 as of December 31, 2017, 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 $80,000 specific reserve was established in the three and six months ended June 30, 2018 on a TDR loan, respectively. The Company had $12,000 of charge-offs related to TDRs for the six months ended June 30, 2018. A $500,000 specific reserve was established in the six months ended June 30, 2017 on a TDR loan. The Company had $12,000 and $257,000 of net charge-offs related to TDRs for the six months ended June 30, 2018 and 2017, respectively.
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 June 30, 2018, non-accrual loans totaled $3,803,000 and there was a loan in the amount of $96,000 that was past due 90 days and still accruing. This compares to non-accrual loans of $4,810,000 and loans past due 90 days and still accruing totaled $18,000 as of December 31, 2017. Other real estate owned totaled $386,000 as of June 30, 2018 and December 31, 2017.
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 $37,104,000 as of June 30, 2018 as compared to $42,754,000 as of December 31, 2017. The substandard loans in these categories totaled $9,326,000 as of June 30, 2018 as compared to $2,725,000 as of December 31, 2017. The Iowa agricultural economy remains challenged as the result of the current low grain prices, potential tariff concerns on Iowa exports and excessive rainfall in a portion of our markets.
The allowance for loan losses as a percentage of outstanding loans as of June 30, 2018 was 1.44%, as compared to 1.45% at December 31, 2017. The allowance for loan losses totaled $11,383,000 and $11,321,000 as of June 30, 2018 and December 31, 2017, respectively. Net charge-offs of loans totaled $31,000 and $483,000 for the six months ended June 30, 2018 and 2017, 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 June 30, 2018, 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 June 30, 2018 and December 31, 2017 totaled $62,386,000 and $69,420,000, respectively, and provide an adequate level of liquidity given current economic conditions.
Other sources of liquidity available to the Banks as of June 30, 2018 include outstanding lines of credit with the FHLB of Des Moines, Iowa of $185,490,000, with $2,000,000 of outstanding FHLB advances. Federal funds borrowing capacity at correspondent banks was $109,035,000, with no outstanding federal fund purchase balances as of June 30, 2018. The Company had securities sold under agreements to repurchase totaling $34,108,000 as of June 30, 2018.
Total investments as of June 30, 2018 were $478,733,000 compared to $495,322,000 as of December 31, 2017. These investments provide the Company with a significant amount of liquidity since all of the investments are classified as available-for-sale as of June 30, 2018.
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 six months ended June 30, 2018 totaled $9,157,000 compared to $9,434,000 for the six months ended June 30, 2017.
Net cash provided by (used in) investing activities for the six months ended June 30, 2018 was $1,910,000 compared to $(12,042,000) for the six months ended June 30, 2017. The increase of $13,952,000 in cash provided by investing activities was primarily due to lower purchases of securities of $21,497,000 and a net increase in the change in the loan portfolio of $8,576,000, offset in part by decreases in the proceeds from the sale of securities available-for-sale of $10,824,000.
Net cash used in financing activities for the six months ended June 30, 2018 totaled $16,910,000 compared to $7,296,000 for the six months ended June 30, 2017. The change of $9,614,000 in net cash used in financing activities was primarily due to repayments on FHLB and other borrowings, offset in part by a net decrease in the change in the securities sold under agreements to repurchase. As of June 30, 2018, 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 $5,690,000 and $5,345,000 for the six months ended June 30, 2018 and 2017, 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 $0.23 per share in 2018 from $0.22 per share in 2017.
The Company, on an unconsolidated basis, has interest bearing deposits totaling $13,101,000 as of June 30, 2018 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 June 30, 2018 that are of concern to management.
Capital Resources
The Company’s total stockholders’ equity as of June 30, 2018 totaled $167,941,000 and was $2,812,000 lower than the $170,753,000 recorded as of December 31, 2017. The decrease in stockholders’ equity was primarily due to an increase in other comprehensive loss and dividends declared, offset in part by net income. The increase in other comprehensive loss is created by higher market interest rates compared to December 31, 2017, which resulted in lower fair values in the securities available-for-sale portfolio. At June 30, 2018 and December 31, 2017, stockholders’ equity as a percentage of total assets was 12.33% and 12.42%, respectively. The capital levels of the Company exceed applicable regulatory guidelines as of June 30, 2018.
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.