AMES NATIONAL CORPORATION Overview
The following financial data of the Company for the three years endedDecember 31, 2020 through 2022 is derived from the Company's historical audited financial statements and related footnotes. The information set forth below should be read in conjunction with the consolidated financial statements and related notes contained elsewhere in this Annual Report. Years Ended
(dollars in thousands, except per share
amounts) 2022 2021 2020
STATEMENT OF INCOME DATA
Interest income $ 61,553 $ 60,482 $ 62,941
Interest expense 8,309 4,485 8,098
Net interest income 53,244 55,997 54,843
Provision (credit) for loan losses (874 ) (757 ) 5,681
Net interest income after provision (credit) for loan losses 54,118 56,754 49,162 Noninterest income 9,687 10,537 10,620 Noninterest expense 38,644 36,618 36,551 Income before provision for income tax 25,161 30,673 23,231 Provision for income taxes 5,868 6,760 4,381 Net income$ 19,293 $ 23,913 $ 18,850 DIVIDENDS AND EARNINGS PER SHARE DATA Cash dividends declared*$ 9,739 $ 11,753 $ 6,859 Cash dividends declared per share*$ 1.08 $ 1.29 $ 0.75 Basic and diluted earnings per share$ 2.14 $ 2.62 $ 2.06 Weighted average shares outstanding 9,033,410 9,114,379 9,148,244 BALANCE SHEET DATA Total assets$ 2,134,926 $ 2,137,041 $ 1,975,648 Net loans 1,226,011 1,144,108 1,129,505 Deposits 1,897,957 1,878,019 1,716,446 Stockholders' equity 149,098 207,778 209,486 Equity to assets ratio 6.98 % 9.72 % 10.60 % FINANCIAL PERFORMANCE Net income$ 19,293 $ 23,913 $ 18,850 Average assets 2,134,947 2,082,705 1,866,188 Average stockholders' equity 168,752 209,135 198,880 Return on assets (net income divided by average assets) 0.90 % 1.15 % 1.01 % Return on equity (net income divided by average equity) 11.43 % 11.43 % 9.48 % Net interest margin (net interest income divided by average earning assets)** 2.55 % 2.83 % 3.13 % Efficiency ratio (noninterest expense divided by noninterest income plus net interest income) 61.41 % 55.04 % 55.83 % Dividend payout ratio (dividends per share divided by net income per share)* 50.47 % 49.24 % 36.41 % Dividend yield (dividends per share divided by closing year-end market price)* 4.57 % 5.27 % 3.12 % Equity to assets ratio (average equity divided by average assets) 7.90 % 10.04 % 10.66 % * Dividends are typically declared in one quarter and then paid in the subsequent quarter. Beginning inJuly 2020 the dividends were declared and paid in the same quarter before returning to the previous practice inAugust 2021 . ** See page 31 for further discussion of this Non-GAAP financial measure.
The following discussion is provided for the consolidated operations of the Company and its Banks. The purpose of this discussion is to focus on significant factors affecting the Company's financial condition and results of operations.
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Table of Contents
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. Some Banks also offer investment services through a third-party broker-dealer. The Company employs 19 individuals to assist with financial reporting, human resources, marketing, audit, compliance, technology systems, property appraisals, training and the coordination of management activities, in addition to 247 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 prompt response times and flexibility in the products and services offered. This strategy is viewed as providing an opportunity to increase revenues through the creation of a competitive advantage over other financial institutions. The Company also strives to remain operationally efficient to improve profitability while enabling the Banks to offer more competitive loan and deposit rates. The principal sources of Company revenues and cash flows are: (i) interest and fees earned on loans made or held by the Company and Banks; (ii) interest on investments, primarily on bonds, held by the Banks; (iii) fees on wealth management services; (iv) service charges on deposit accounts maintained at the Banks; (v) merchant and card fees; (vi) gain on the sale of loans held for sale; and (vii) securities gains. The Company's principal expenses are: (i) interest expense on deposit accounts and other borrowings; (ii) salaries and employee benefits; (iii) data processing costs primarily associated with maintaining the Banks' loan and deposit functions; (iv) occupancy expenses for maintaining the Banks' facilities; (v) professional fees; and (vi) business development. 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 deposit accounts 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 reported net income of$19.3 million for the year endedDecember 31, 2022 compared to$23.9 million for the year endedDecember 31, 2021 . This represents a decrease in net income of 19.3% when comparing 2022 with 2021. The decrease in earnings in 2022 from 2021 is primarily the result of higher interest expense on deposits and fewer Paycheck Protection Program ("PPP") fees recognized into income, offset in part by an increase in interest income on loans and taxable securities. Earnings per share for 2022 were$2.14 compared to$2.62 in 2021. All six Banks demonstrated profitable operations during 2022 and 2021. The Company's return on average equity was 11.43% in both 2022 and 2021. The return on average equity stayed the same due to a reduction in both earnings and equity. The return on average assets for 2022 was 0.90% compared to 1.15% in 2021. The decrease in return on average assets when comparing 2022 to 2021 was primarily a result of a reduction in earnings.
The following discussion will provide a summary review of important items relating to:
? Challenges, Risks and Uncertainties
? Key Performance Indicators
? Industry Results
? Critical Accounting Policies
? Non-GAAP Financial Measures
? Income Statement Review
? Balance Sheet Review
? Asset Quality Review and Credit Risk Management
? Liquidity and Capital Resources
? Interest Rate Risk
? Inflation
? Forward-Looking Statements and Business Risks
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Table of Contents
Challenges, Risks and Uncertainties
Management has identified certain events or circumstances that have the potential to 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.
? If interest rates continue to increase over a relatively short period of time
due to higher inflationary numbers or other factors, the interest rate
environment may present a challenge to the Company. Increases in interest
rates may negatively impact the Company's net interest margin if interest
expense increases more quickly than interest income, thus placing downward
pressure on net interest income. The Company's earning assets (primarily its
loan and investment portfolio) have longer maturities than its
interest-bearing liabilities (primarily deposits and other borrowings);
therefore, in a rising interest rate environment, interest expense will tend
to increase more quickly than interest income as the interest-bearing
liabilities reprice more quickly than earning assets, resulting in a reduction
in net interest income. In response to this challenge, the Banks model
quarterly the changes in income that would result from various changes in
interest rates. Based on this modeling, management believes Bank earning
assets currently have the appropriate maturity and repricing characteristics
to optimize earnings and the Banks' interest rate risk positions.
? If market interest rates in the three to five year term remain at low levels
as compared to the short term interest rates, the interest rate environment
may present a challenge to the Company. The Company's earning assets
(typically priced at market interest rates in the three to five year range)
will reprice at lower interest rates, but the deposits generally reprice at
short term interest rates, therefore the net interest income may decrease.
Management believes Bank earning assets currently have the appropriate
maturity and repricing characteristics to optimize earnings and the
Banks' interest rate risk positions.
? The agricultural community is subject to commodity price fluctuations.Extended periods of low commodity prices, higher input costs or poor weather
conditions could result in reduced profit margins, reducing demand for goods
and services provided by agriculture-related businesses, which, in turn, could
affect other businesses in the Company's market area. Moreover, changes in
the volume of exports of agricultural products to these foreign markets could
be adversely impacted. Lastly, uncertainty regarding governmental mandates
affecting ethanol production could reduce the demand for corn in the Company's
trade area, thus introducing further price volatility for this commodity. Any
combination of these factors could produce losses within the Company's
agricultural loan portfolio and in the commercial loan portfolio with respect
to borrowers whose businesses are directly or indirectly impacted by the
health of the agricultural economy. Such losses could result in an accelerated
level of charge-offs and the need to increase provision expenses, thus
resulting in reduced earnings.
The current economic environment, characterized by increasing interest rates in
response to significant inflationary pressures in the economy and the potential
for a period of slower or negative economic growth resulting from efforts to
dampen economic activity, has heightened the level of challenges, risks and
uncertainties facing our business, including the following:
? Market interest rates are expected to continue increasing during the course of
2023 in response to inflationary pressues on the economy which could adversely
affect our net interest income, net interest margin and earnings;
? We may experience a potential slowdown in demand for our products andservices, including the demand for traditional loans, although we believe the
decline may be offset, in whole or in part, due to inflation and higher
interest rates;
? We may experience an increase in risk of delinquencies, defaults andforeclosures, as well as declining collateral values and further impairment of
the ability of our borrowers to repay their loans, all of which may result in
additional credit charges and other losses in our loan portfolio;
?
determined to not be impaired as of
may be impaired if the effects of the economic slowdown negatively impacts our
net income and fair value. An impairment of goodwill would decrease the
Company's earnings during the period in which the impairment is recorded;
? We have experienced a decline in the fair value of our investment portfolio as
a result of the increasing interest rate environment. This trend may continue
in the near term, which could result in impairment charges and increase the
unrealized losses reported as part of our consolidated comprehensive income;
and
? In meeting our objective to maintain our capital levels and liquidityposition, our Board of Directors could reduce, or determine to altogether
forego, payment of future dividends in order to maintain and/or strengthen our
capital and liquidity position.
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Table of Contents Key Performance Indicators Certain key performance indicators for the Company and the industry are presented in the following chart. The industry figures are compiled by theFederal Deposit Insurance Corporation (FDIC) and are derived from 4,258 community banks and savings institutions insured by theFDIC . 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
Years Ended December 31,
2022 2021 2020
Company Industry Company Industry Company Industry
Return on
assets 0.90 % 1.15 % 1.15 % 1.25 % 1.01 % 1.09 %
Return on
equity 11.43 % 12.01 % 11.43 % 11.61 % 9.48 % 9.72 %
Net interest
margin* 2.55 % 3.45 % 2.83 % 3.27 % 3.13 % 3.39 %
Efficiency
ratio 61.41 % 61.36 % 55.04 % 61.42 % 55.83 % 62.34 %
Capital
ratio 7.90 % 10.51 % 10.04 % 10.16 % 10.66 % 10.32 %
* See page 31 for further discussion of this Non-GAAP financial measure.
Key performance 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 return on assets ratio lower than the industry average for 2022. ? 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 equity ratio was lower than the industry average for 2022. ? Net Interest Margin
This ratio is calculated by dividing tax-equivalent net interest income by average earning assets. Earning assets consist primarily of loans and investments that earn interest. This ratio is used to measure how well the Company maintains interest rates on earning assets above those of interest-bearing liabilities, which is the interest expense paid on deposit accounts and other borrowings. The Company's net interest margin was lower than the industry average for 2022.
? Efficiency Ratio
This ratio is calculated by dividing noninterest expense by the sum of 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 similar to the industry average for 2022.
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Table of Contents ? Capital Ratio The 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 was lower than the industry average for 2022. The Company's capital ratio for 2022 was lower than 2021 due to unrealized losses on the investment portfolio. Unrealized losses on the investment portfolio are excluded from regulatory capital. The Company's tier 1 to average assets capital ratio was 9.1% and 9.0% as ofDecember 31, 2022 and 2021, respectively. Critical Accounting Policies The discussion contained in this Item 7 and other disclosures included within this Annual Report are based on the Company's audited consolidated financial statements which appear in Item 8 of this Annual Report. These statements have been prepared in accordance with accounting principles generally accepted inthe United States of America ("GAAP"). 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 fair value determination of 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 change in estimates will occur in the near term and that such changes could be material to the amounts reported in the Company's financial statements. For further discussion concerning the allowance for loan losses and the process of establishing specific reserves, see the section of this Annual Report entitled "Asset Quality Review and Credit Risk Management" and "Analysis of the Allowance for Loan Losses".
The Company is currently finalizing the CECL model and upon adoption of ASU
2016-13 (CECL) in the first quarter of 2023 anticipates an increase to the
allowance for credit losses for loans and unfunded commitments liability of
approximately
Fair Value of
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.
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Table of ContentsGoodwill Goodwill arose in connection with four 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. The Company completed a quantitative assessment of goodwill as ofOctober 1, 2022 which indicated that goodwill was not impaired. Subsequently, the Company determined there were no adverse changes in criteria and key considerations to the previous assessment. Accordingly, the Company concluded that there is no impairment of goodwill as ofDecember 31, 2022 .Goodwill may be impaired in the future if actual future test results differ from the present evaluation of impairment due to changes in the conditions used in the current evaluation. An impairment of goodwill would decrease the Company's earnings during the period in which the impairment is recorded. Non-GAAP Financial Measures This Annual 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). Reconciliation of net interest income and annualized net interest margin on an FTE basis to GAAP: 2022 2021 Net interest income (GAAP) $ 53,244$ 55,997 Tax-equivalent adjustment (1) 690 823 Net interest income on an FTE basis (non-GAAP) 53,934 56,820 Average interest-earning assets$ 2,114,234 $ 2,008,217 Net interest margin on an FTE basis (non-GAAP) 2.55 % 2.83 % Reconciliation of net interest income and annualized net interest spread on an FTE basis to GAAP: 2022 2021 Net interest income (GAAP)$ 53,244 $ 55,997 Tax-equivalent adjustment (1) 690
823
Net interest income on an FTE basis (non-GAAP) 53,934 56,820 Average assets
$ 2,134,947 $
2,082,705
Net interest spread on an FTE basis (non-GAAP) 2.53 % 2.73 %
(1) Computed on a tax-equivalent basis using an incremental federal income tax rate of 21 percent for the years endedDecember 31, 2022 and 2021, adjusted to reflect the effect of the nondeductible interest expense associated with owning tax-exempt securities and loans. 31
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Table of Contents Income Statement Review
The following highlights a comparative discussion of the major components of net income and their impact for the last two years.
Average Balances and Interest Rates
The following two tables are used to calculate the Company's non-GAAP net
interest margin on an FTE basis. 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. (dollars in thousands)
ASSETS
2022 2021
Average Revenue/ Yield/ Average Revenue/ Yield/
balance expense rate balance expense rate
Interest-earning
assets
Loans (1)
Commercial $ 72,844 $ 3,381 4.64 % $ 105,265 $ 7,467 7.09 %
Agricultural 95,029 4,576 4.82 % 96,774 3,993 4.13 %
Real estate 985,084 37,342 3.79 % 924,905 35,697 3.86 %
Consumer and other 16,200 657 4.06 % 14,806 672 4.54 %
Total loans
(including fees) 1,169,157 45,956 3.93 % 1,141,750 47,829 4.19 %
Investment securities
Taxable 742,675 12,101 1.63 % 562,568 8,861 1.58 %
Tax-exempt (2) 134,710 3,285 2.44 % 153,421 3,918 2.55 %
Total investment
securities 877,385 15,386 1.75 % 715,989 12,779 1.78 %
Other
interest-earning
assets 67,692 901 1.33 % 150,478 697 0.46 %
Total
interest-earning
assets 2,114,234 $ 62,243 2.94 % 2,008,217 $ 61,305 3.05 %
Noninterest-earning
assets
Cash and due from
banks 23,390 26,515
Premises and
equipment, net 18,213 16,971
Other, less allowance
for loan losses (20,890 ) 31,002
Total
noninterest-earning
assets 20,713 74,488
TOTAL ASSETS $ 2,134,947 $ 2,082,705 (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% for the years ended
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Table of Contents
Average Balances and Interest Rates (continued)
LIABILITIES AND STOCKHOLDERS'
EQUITY
2022 2021
Average Revenue/ Yield/ Average Revenue/ Yield/
balance expense rate balance expense rateInterest-bearing liabilities Deposits Savings, interest-bearing checking and money markets accounts$ 1,297,503 $ 5,498 0.42 %$ 1,212,935 $ 1,908 0.16 % Time deposits 206,401 1,818 0.88 % 234,626 2,434 1.04 % Total deposits 1,503,904 7,316 0.49 % 1,447,561 4,342 0.30 % Other borrowed funds 55,874 993 1.78 % 40,705 143 0.35 % Total interest-bearing liabilities 1,559,778 8,309 0.53 % 1,488,266 4,485 0.30 % Noninterest-bearing liabilities Noninterest-bearing checking 397,436 375,167 Other liabilities 8,981 10,137 Stockholders' equity 168,752 209,135 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY$ 2,134,947 $ 2,082,705 Net interest income (FTE)(3)$ 53,934 2.55 %$ 56,820 2.83 % Spread Analysis (FTE)(3) Interest income/average assets$ 62,243 2.92 %$ 61,305 2.94 % Interest expense/average assets 8,309 0.39 % 4,485 0.22 % Net interest income/average assets 53,934 2.53 % 56,820 2.73 % (3) Net interest income (FTE) and Spread Analysis (FTE) are non-GAAP financial measures. For further information, refer to the Non-GAAP Financial Measures section of this report. 33
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Table of Contents Rate and Volume Analysis
The rate and volume analysis is used to determine how much of the change in
interest income or expense is the result of a change in volume or a change in
interest rate. For example, real estate loan interest income increased
The following table sets forth, on a tax-equivalent basis, a summary of the
changes in net interest income resulting from changes in volume and rates (in
thousands).
2022 Compared to 2021
Volume Rate Total (1)
Interest income
Loans
Commercial $ (1,926 ) $ (2,160 ) $ (4,086 )
Agricultural (73 ) 656 583
Real estate 2,299 (654 ) 1,645
Consumer and other 60 (75 ) (15 )
Total loans (including fees) 360 (2,233 ) (1,873 )
Investment securities
Taxable 2,949 291 3,240
Tax-exempt (467 ) (166 ) (633 )
Total investment securities 2,482 125 2,607
Other interest and dividend income (544 ) 748 204
Total interest-earning assets 2,298 (1,360 ) 938
Interest-bearing liabilities
Deposits
Savings, interest-bearing checking and
money market 147 3,443 3,590
Time deposits (271 ) (345 ) (616 )
Total deposits (124 ) 3,098 2,974
Other borrowed funds 71 779 850
Total interest-bearing liabilities (53 ) 3,877 3,824
Net interest income-earning assets
$ (2,886 )
(1) The change in interest due to both volume and yield/rate has been allocated
to change due to volume and change due to yield/rate in proportion to the
absolute value of the change in each.
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Table of Contents Net Interest Income The Company's largest contributing component to net income is net interest income, which is the difference between interest earned on earning assets and interest paid on interest-bearing liabilities. The volume of and yields earned on earning assets and the volume of and the rates paid on interest-bearing liabilities determine net interest income. Refer to the tables preceding this paragraph for additional detail. Interest earned and interest paid is also affected by general economic conditions, particularly changes in market interest rates, by government policies and the action of regulatory authorities. Net interest income divided by average earning assets is referred to as net interest margin. For the yearsDecember 31, 2022 and 2021, the Company's non-GAAP net interest margin was 2.55% and 2.83%, respectively, computed on an FTE basis. For further information, refer to the Non-GAAP Financial Measures section of this report. Net interest income during 2022 and 2021 totaled$53.2 million and$56.0 million , respectively, representing a 4.9% decrease in 2022 compared to 2021. Net interest income decreased in 2022 as compared to 2021 due primarily to fewer PPP fees recognized into income and an increase in market interest rates on core deposits. In addition to interest income on PPP loans, fee income of$218 thousand and$4.3 million was recognized into interest income for the years endedDecember 31, 2022 and 2021, respectively. The high level of competition in the local markets will continue to put downward pressure on the net interest margin of the Company. Currently, the Company's primary market inAmes, Iowa , has fourteen banks, five credit unions and several other financial investment companies. Multiple banks are also located in the Company's other market areas in central, north-central and south-centralIowa creating similarly competitive environments.
Provision (Credit) for Loan Losses
The provision (credit) for loan losses reflects management's judgment of the expense to be recognized in order to maintain an adequate allowance for loan losses. The Company's credit for loan losses for the year endedDecember 31, 2022 was($874) thousand compared to a credit for loan losses of($757) thousand for the previous year. Net loan charge-offs totaled$50 thousand for the year endedDecember 31, 2022 compared to net loan recoveries of$163 thousand for the previous year. The credit for loan losses in 2022 was primarily due to a reduction in specific reserves and offset in part by growth in the loan portfolio. The credit for loan losses in 2021 was primarily due to loan recoveries, a reduction in specific reserves, and improving economic conditions. Classified loans, excluding 1-4 family and consumer loans, decreased$24.7 million to$36.6 million in 2022 primarily due to improving credit quality. Refer to the "Asset Quality Review and Credit Risk Management" discussion for additional details with regard to loan loss provision expense. Management believes the allowance for loan losses is adequate to absorb probable losses in the current portfolio. This statement is based upon management's continuing evaluation of inherent risks in the current loan portfolio, current levels of classified assets and general economic factors. The Company will continue to monitor the allowance and make future adjustments to the allowance as conditions dictate. Due to potential changes in conditions and upon CECL adoption as described in Note 1, it is at least reasonably possible that change in estimates will occur in the near term and that such changes could be material to the amounts reported in the Company's financial statements.
Noninterest Income and Expense
Total noninterest income is comprised primarily of fee-based revenues from wealth management and trust services, bank-related service charges on deposit activities, net securities gains, merchant and card fees related to electronic processing of merchant and cash transactions and gain on the sale of loans held for sale. Noninterest income during the years ended 2022 and 2021 totaled$9.7 million and$10.5 million , respectively. The decrease in noninterest income in 2022 compared to 2021 is primarily due to fewer gains on sale of residential loans held for sale as refinancing volume has slowed and offset in part by an increase in wealth management income due to growth in assets under management and new account relationships. Noninterest expense for the Company consists of all operating expenses other than interest expense on deposits and other borrowed funds. Salaries and employee benefits are the largest component of the Company's operating expenses and comprise 59% and 61% of noninterest expense in 2022 and 2021, respectively. Noninterest expense during the years ended 2022 and 2021 totaled$38.6 million and$36.6 million , respectively. The increase in noninterest expense is primarily due to data processing costs as a result of additional investments in technology and normal increases in salaries and benefits. The percentage of noninterest expense to average assets was 1.81% in 2022, compared to 1.76% during 2021. 35
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Table of Contents Provision for Income Taxes The provision for income taxes for 2022 and 2021 was$5.9 million and$6.8 million , respectively. This amount represents an effective tax rate of 23.3% and 22.0%, respectively. The Company's federal income tax rate was 21% for the years endedDecember 31, 2022 and 2021. The increase in the effective tax rate in 2022 was due to a non-recurring$780 thousand adjustment to deferred taxes for the reduction in futureIowa bank franchise tax rates enacted in the second quarter of 2022. In 2021, the Company established a deferred tax valuation allowance of$396 thousand on a state tax net operating loss at the holding company. The effective tax rate in both years were also impacted by tax exempt interest income and New Markets Tax Credits. Balance Sheet Review The Company's assets are comprised primarily of loans and investment securities. The majority of average earning asset maturity or repricing dates are generally five years or less for the combined portfolios as the assets are funded for the most part by short term deposits with either immediate availability or less than one-year average maturities. This exposes the Company to risk regarding changes in interest rates. Total assets were$2.13 billion in 2022 and approximately the same in 2021. The largest fluctuations in assets during 2022 was primarily due to higher unrealized losses on the investment portfolio as market interest rates have risen. In the same time period, increases in loan volume and purchases of investments were funded by federal funds sold and an increase in deposits and advances. Loan Portfolio Net loans as ofDecember 31, 2022 totaled$1.23 billion , an increase of 7.2% from the$1.14 billion as ofDecember 31, 2021 . Loans increased primarily due to increases in the 1-4 family and commercial real estate loan portfolios. Loans are the primary contributor to the Company's revenues and cash flows. The average yield on loans was 218 and 241 basis points higher in 2022 and 2021, respectively, in comparison to the average tax-equivalent investment portfolio yields. Types of Loans The Company's loan portfolio consists of real estate, commercial, agricultural and consumer loans. As ofDecember 31, 2022 , gross loans totaled approximately$1.24 billion , which equals approximately 65.4% of total deposits and 58.1% of total assets. The Iowa State Average Report (consisting of 246 banks in theState of Iowa ) loan to deposit ratio as ofDecember 31, 2022 was 72%. As ofDecember 31, 2022 , the majority of the loans were originated directly by the Banks to borrowers within the Banks' principal market areas. There are no foreign loans outstanding during the years presented. Real estate loans include various types of loans for which the Banks hold real property as collateral and consist of loans primarily on commercial, agricultural, and multifamily properties and single-family residences. Real estate loans typically have fixed rates for up to five years, with the Company's loan policy permitting a maximum fixed rate maturity of up to 15 years. The majority of construction loan volume is provided to contractors to construct 1-4 family residence and commercial buildings. The Banks also originate residential real estate loans for sale to the secondary market for a fee. Commercial loans consist primarily of loans to businesses for various purposes, including revolving lines to finance current operations, floor-plans, inventory and accounts receivable; capital expenditure loans to finance equipment and other fixed assets; and letters of credit. These loans generally have short maturities of less than five years, have either adjustable or fixed rates and are unsecured or secured by inventory, accounts receivable, equipment and/or real estate. Agricultural loans play an important part in the Banks' loan portfolios.Iowa is a major agricultural state and is a national leader in both grain and livestock production. The Banks play a significant role in their communities in financing operating, livestock and real estate activities for area producers.
Consumer loans include loans extended to individuals for household, family and other personal expenditures not secured by real estate. Most of the Banks' consumer lending is for vehicles, consolidation of personal debts and home improvements.
The interest rates charged on loans vary with the degree of risk and the amount
and maturity terms of the loan. Competitive pressures, market interest rates,
the availability of funds and government regulation further influence the rate
charged on a loan. The Banks follow a loan policy, which has been approved by
both the board of directors of the Company and the Banks and is overseen by both
Company and Bank management. These policies establish lending limits, review and
grading criteria and other guidelines such as loan administration and allowance
for loan losses. Loans are approved by the Banks' board of directors and/or
designated officers in accordance with respective guidelines and underwriting
policies of the Company. Credit limits generally vary according to the type of
loan and the individual loan officer's experience. Loans to any one borrower are
limited by applicable state and federal banking laws.
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Maturities and Sensitivities of Loans to Changes in Interest Rates as of
The contractual maturities of the Company's loan portfolio are as shown below. Actual maturities may differ from contractual maturities because individual borrowers may have the right to prepay loans with or without prepayment penalties (in thousands).
After one After five
year but years but
Within within within After
one year five years 15 years 15 years Total
Real Estate
Construction $ 28,237 $ 13,304 $ 5,634 $ 4,054 $ 51,229
1-4 family residential 9,075 118,036 116,875 41,059 285,045
Commercial 16,759 336,389 99,197 86,708 539,053
Agricultural 4,562 25,131 55,614 74,112 159,419
Commercial 28,659 32,898 14,568 1,015 77,140
Agricultural 79,830 29,768 3,261 405 113,264
Consumer and other 1,629 8,526 5,905 110 16,170
Total loans $ 168,751 $ 564,052 $ 301,054 $ 207,463 $ 1,241,320
The following table shows the contractual maturities after one year of the
Company's loan portfolio by fixed- and variable-rate loans as of December 31,
2022 (in thousands):
After one After five
year but years but
within within After
five years 15 years 15 years
Fixed-rate loans
Real Estate
Construction $ 8,455 $ 3,612 $ 2,044
1-4 family residential 113,518 97,366 2,378
Commercial 331,784 70,322 81
Agricultural 23,143 21,738 937
Commercial 30,403 9,940 -
Agricultural 27,225 2,650 405
Consumer and other 8,170 5,903 10
Total fixed-rate loans 542,698 211,531 5,855
Variable-rate loans
Real Estate
Construction 4,849 2,022 2,010
1-4 family residential 4,518 19,509 38,681
Commercial 4,605 28,875 86,627
Agricultural 1,988 33,876 73,175
Commercial 2,495 4,628 1,015
Agricultural 2,543 611 -
Consumer and other 356 2 100
Total variable-rate loans 21,354 89,523 201,608
Total loans $ 564,052 $ 301,054 $ 207,463
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Table of Contents Loans Held For Sale There was$154 thousand of mortgage origination funding awaiting delivery to the secondary market as ofDecember 31, 2022 and none as ofDecember 31, 2021 . Residential mortgage loans are originated by the Banks and sold to several secondary mortgage market outlets based upon customer product preferences and pricing considerations. The mortgages are sold in the secondary market to eliminate interest rate risk and to generate secondary market fee income. It is not anticipated at the present time that loans held for sale will become a significant portion of total assets. Investment Portfolio Total investments as ofDecember 31, 2022 were$786.4 million , a decrease of$44.6 million or 5.4% from the prior year end. As ofDecember 31, 2022 and 2021, the investment portfolio comprised 37% and 39% of total assets, respectively. The decrease in investments is primarily due to a decline in fair value of the portfolio due to interest rate increases during 2022. The decrease is offset in part by purchases ofU.S. treasuries and municipal securities.
Management's process for obtaining and validating the fair value of investment securities is discussed in Note 16 of the "Notes to Consolidated Financial Statements," which is included in Part II, Item 8 "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K.
Investment Maturities as of
The investments in the following table are reported by contractual maturity.
Expected maturities may differ from contractual maturities because issuers of
the securities may have the right to call or prepay obligations with or without
prepayment penalties (in thousands).
After one After five
year but years but
Within within within After
one year five years ten years ten years Total
U.S. government treasuries $ 16,614 $ 171,012 $ 19,971 $ - $ 207,597
U.S. government agencies 8,939 62,477 29,517 - 100,933
U.S. government
mortgage-backed securities 447 38,929 77,365 - 116,741
States and political
subdivisions (1) 13,133 104,432 157,768 10,670 286,003
Corporate bonds 5,557 30,290 39,317 - 75,164
Total $ 44,690 $ 407,140 $ 323,938 $ 10,670 $ 786,438
Weighted average yield
U.S. government treasuries 1.45 % 1.09 % 1.32 % n/a 1.14 %
U.S. government agencies 2.19 % 1.83 % 2.06 % n/a 1.93 %
U.S government
mortgage-backed securities 2.34 % 1.88 % 0.95 % n/a 1.25 %
States and political
subdivisions (1) 2.15 % 2.10 % 2.38 % 2.44 % 2.27 %
Corporate bonds 2.91 % 2.82 % 2.70 % n/a 2.76 %
Total 1.99 % 1.66 % 1.97 % 2.44 % 1.82 %
(1) Yields on tax-exempt obligations of states and political subdivisions have
been computed on a tax-equivalent basis using a federal income tax rate of 21
percent.
The Company's investment portfolio had an expected duration of 4.06 years and
4.07 years as of
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AtDecember 31, 2022 and 2021, the Company's investment securities portfolio included securities issued by 289 and 298 government municipalities and agencies located within 30 and 28 states with a fair value of$286.0 million and$292.9 million , respectively. No one municipality or agency represents a concentration within this segment of the investment portfolio.Storm Lake, Iowa , general obligation bonds with a fair value of$5.5 million (approximately 1.9% of the fair value of the government municipalities and subdivisions) represent the largest exposure to any one municipality or subdivision for the Company as ofDecember 31, 2022 ; the bonds are repayable from the levy of continuing annual tax on all the taxable property within the territory of the city ofStorm Lake . The Company's procedures for evaluating investments in states, municipalities and political subdivisions include but are not limited to reviewing the offering statement and the most current available financial information, comparing yields to yields of bonds of similar credit quality, confirming capacity to repay, assessing operating and financial performance, evaluating the stability of tax revenues, considering debt profiles and local demographics, and for revenue bonds, assessing the source and strength of revenue structures for municipal authorities. These procedures, as applicable, are utilized for all municipal purchases and are utilized in whole or in part for monitoring the portfolio of municipal holdings. The Company does not utilize third party credit rating agencies as a primary component of determining if the municipal issuer has an adequate capacity to meet the financial commitments under the security for the projected life of the investment, and, therefore, does not compare internal assessments to those of the credit rating agencies. Credit rating downgrades are utilized as an additional indicator of credit weakness and as a reference point for historical default rates. The following table summarizes the total general obligation and revenue bonds in the Company's investment securities portfolios as ofDecember 31, 2022 and 2021 identifying the state in which the issuing government municipality or agency operates (in thousands): 2022 2021 Estimated Estimated Amortized Fair Amortized Fair Cost Value Cost Value Obligations of states and political subdivisions: General Obligation bonds: Iowa$ 66,168 $ 60,884 $ 72,128 $ 72,830 Texas 29,750 26,241 24,742 24,953 Nebraska 20,165 16,845 19,546 19,486 Oregon 11,049 10,079 4,757 4,864 Washington 10,911 9,898 11,013 11,241 Other (2022: 16 states; 2021: 16 states) 42,028 37,804
36,614 36,753
Total general obligation bonds$ 180,071 $ 161,751 $ 168,800 $ 170,127 Revenue bonds: Iowa$ 57,330 $ 53,649 $ 61,718 $ 62,181 Texas 14,824 12,680 11,898 12,090 Nebraska 9,777 8,265 9,727 9,636 Other (2022: 23 states; 2021: 21 states) 55,177 49,658 38,405 38,825 Total revenue bonds$ 137,108 $ 124,252 $ 121,748 $ 122,732 Total obligations of states and political subdivisions$ 317,179 $ 286,003 $ 290,548 $ 292,859 39
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As ofDecember 31, 2022 and 2021, 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 and water utilities. The revenue bonds are to be paid from 16 revenue sources in 2022 and 2021. 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): 2022 2021 Estimated Estimated Amortized Fair Amortized Fair Cost Value Cost Value Revenue bonds by revenue source Sales tax$ 31,768 $ 28,917 $ 31,632 $ 31,896 Water 21,754 19,792 22,611 22,924 College and universities, primarily dormitory revenues 19,550 17,368 17,169 17,353 Sewer 13,333 11,592 14,248 14,327 Leases 10,863 9,929 8,788 8,894 Other 39,840 36,654 27,300 27,338
Total revenue bonds by revenue source
Deposits Total deposits were$1.90 billion and$1.88 billion as ofDecember 31, 2022 and 2021, respectively. The increase of$19.9 million between the periods can be primarily attributed to increases in interest-bearing core deposits, including commercial and public funds, and offset in part by a decrease in time deposits. Balances fluctuate as customer liquidity needs vary and could be impacted by distressed economic conditions or additional government stimulus. The Company's primary source of funds is customer deposits. The Banks attempt to attract noninterest-bearing deposits, which are a low-cost funding source. In addition, the Banks offer a variety of interest-bearing accounts designed to attract both short-term and longer-term deposits from customers. Interest-bearing accounts earn interest at rates established by Bank management based on competitive market factors and the Company's need for funds. While 68.4% of the Banks' certificates of deposit mature in the next year, it is anticipated that many of these certificates will be renewed. Rate sensitive certificates of deposits in excess of$250,000 are subject to somewhat higher volatility with regard to renewal volume as the Banks adjust rates based upon funding needs. In the event a substantial volume of certificates is not renewed, the Company has sufficient liquid assets and borrowing lines to fund significant runoff. A sustained reduction in deposit volume would have a significant negative impact on the Company's operations and liquidity. The Company had$11.4 million and$7.0 million of brokered deposits as ofDecember 31, 2022 and 2021, respectively. The Company has approximately$389.0 million of uninsured deposits as ofDecember 31, 2022 . Average Deposits by Type
The following table sets forth the average balances for each major category of
deposit and the weighted average interest rate paid for deposits during the
years ended
2022 2021
Average Average
Amount Rate Amount Rate
Non-interest bearing checking deposits
612,419 0.47 % 564,780 0.13 %
Money market deposits 457,053 0.48 % 436,320 0.21 %
Savings deposits 228,031 0.18 % 211,835 0.11 %
Time certificates 206,401 0.88 % 234,626 1.04 %
$ 1,901,340 $ 1,822,728
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Table of Contents Deposit Maturity
The following table shows the amounts and remaining maturities of time
certificates of deposit that had balances in excess of the
2022 2021
3 months or less $ 14,444 $ 4,624
Over 3 through 6 months 13,261 8,578
Over 6 through 12 months 7,166 21,327
Over 12 months 8,015 6,264
Total $ 42,886 $ 40,793
The following table shows the amounts and remaining maturities of estimated
uninsured time certificates of deposit as of December 31, 2022 and 2021 (in
thousands).
2022 2021
3 months or less $ 8,862 $ 3,124
Over 3 through 6 months 8,010 7,608
Over 6 through 12 months 5,109 20,307
Over 12 months 8,616 13,838
Total $ 30,597 $ 44,877
Borrowed Funds
Borrowed funds that may be utilized by the Company are comprised of FHLB
advances, federal funds purchased and securities sold under agreements to
repurchase (repurchase agreements). Borrowed funds are an alternative funding
source to deposits and can be used to fund the Company's assets and unforeseen
liquidity needs. FHLB advances are loans from the FHLB that can mature daily or
have longer maturities for fixed or floating rates of interest. Federal funds
purchased are borrowings from other banks that mature daily. Repurchase
agreements are similar to deposits as they are funds lent by various Bank
customers; however, investment securities are pledged to secure such borrowings.
The Company's repurchase agreements reprice daily.
The following table summarizes the outstanding amount of, and the average rate
on, borrowed funds as of
2022 2021
Average Average
Balance Rate Balance Rate
Federal funds purchased and
repurchase agreements $ 40,676 2.50 % $ 39,851 0.25 %
FHLB advances and other borrowings 39,120 4.39 % 3,000 1.57 %
Total $ 79,796 3.43 % $ 42,851 0.35 %
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Average Annual Borrowed Funds
The following table sets forth the average amount of and the average rate paid on borrowed funds for the years endedDecember 31, 2022 and 2021 (dollars in thousands). 2022 2021 Average Average Average Average Balance Rate Balance Rate Federal funds purchased and repurchase agreements$ 41,143 1.17 %$ 37,705 0.25 % FHLB advances and other borrowings 14,731 3.49 % 3,000 1.57 % Total$ 55,874 1.78 %$ 40,705 0.35 %
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 that assist customers with their credit needs to conduct business. The instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. As ofDecember 31, 2022 , the most likely impact of these financial instruments on revenues, expenses, or cash flows of the Company would come from unidentified credit risk causing higher provision expense for loan losses in future periods. These financial instruments are not expected to have a significant impact on the liquidity or capital resources of the Company. For additional information, including quantification of the amounts involved, see Note 14 of the "Notes to Consolidated Statements" and the "Liquidity and Capital Resources" section of this discussion. 42
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Asset Quality Review and Credit Risk Management
The Company's credit risk is centered in the loan portfolio, which onDecember 31, 2022 , totaled$1.23 billion as compared to$1.14 billion as ofDecember 31, 2021 , an increase of 7.2%. Net loans comprise approximately 57% of total assets as of the end of 2022. 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 a transaction and to quantify and manage credit risk on a portfolio basis. As the following chart indicates, the Company's non-performing assets have increased by 13% fromDecember 31, 2021 and total$14.7 million as ofDecember 31, 2022 . The Company's level of non-performing loans as a percentage of loans of 1.19% as ofDecember 31, 2022 , is higher than theIowa State Average peer group ofFDIC insured institutions as ofDecember 31, 2022 , of 0.33%. Management believes that the allowance for loan losses as ofDecember 31, 2022 remains adequate based on its analysis of the non-performing assets and the portfolio as a whole. Non-performing Assets The following table sets forth information concerning the Company's non-performing assets for the past three years endedDecember 31, 2022 (dollars in thousands): 2022 2021 2020 Nonperforming assets: Nonaccrual loans$ 14,722 $ 12,670 $ 15,273 Loans 90 days or more past due - 169 39 Total nonperforming loans 14,722 12,839
15,312
Securities available-for-sale - - - Other real estate owned - 218 218 Total nonperforming assets$ 14,722 $ 13,057 $ 15,530 Ratio of nonaccrual loans to total loans outstanding 1.19 % 1.09 % 1.33 % Ratio of allowance for loan losses to nonaccrual loans 106.62 % 131.18 % 112.72 % The accrual of interest on nonaccrual and other impaired loans is generally discontinued at 90 days or when, in the opinion of management, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received and when principal obligations are expected to be recoverable. Interest income on restructured loans is recognized pursuant to the terms of the new loan agreement. Interest income on other impaired loans remaining on accrual is monitored and income is recognized based upon the terms of the underlying loan agreement. However, the recorded net investment in impaired loans, including accrued interest, is limited to the present value of the expected cash flows of the impaired loan or the observable fair value of the loan's collateral. Non-performing loans totaled$14.7 million as ofDecember 31, 2022 and were$1.9 million higher than the non-performing loans as ofDecember 31, 2021 . The increase in non-performing loans was due primarily to one loan relationship in the commercial real estate portfolio. The Company considers non-performing loans to generally include nonaccrual loans, loans past due 90 days or more and still accruing and other loans that may or may not meet the former nonperforming criteria but are considered to meet the definition of impaired. The allowance for loan losses related to these impaired loans was approximately$95 thousand and$1.4 million atDecember 31, 2022 and 2021, respectively. The average balances of impaired loans for the years endedDecember 31, 2022 and 2021 were$13.0 million and$13.2 million , respectively. For the years endedDecember 31, 2022 and 2021, interest income, which would have been recorded under the original terms of nonaccrual loans, was approximately$733 thousand and$650 thousand , respectively. There were no loans and$169 thousand of loans greater than 90 days past due and still accruing interest as ofDecember 31, 2022 and 2021, respectively.
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Summary of the Allowance for Loan Losses
The provision for loan losses represents an expense charged against earnings to
maintain an adequate allowance for loan losses. 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;
historical charge-offs; the condition of the local economy; 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 adequacy of the allowance for loan losses is evaluated quarterly by
management, the Company and respective Bank boards. This evaluation focuses on
specific loan reviews, changes in the type and volume of the loan portfolio
given the current economic conditions and historical loss experience. Any one of
the following conditions may result in the review of a specific loan: concern
about whether the customer's cash flow or collateral are sufficient to repay the
loan; delinquent status; criticism of the loan in a regulatory examination; the
accrual of interest has been suspended; or other reasons, including when the
loan has other special or unusual characteristics which warrant special
monitoring.
While management uses available information to recognize losses on loans,
further reductions in the carrying amounts of loans may be necessary based on
changes in economic conditions. In addition, regulatory agencies, as an integral
part of their examination process, periodically review the estimated losses on
loans. Such agencies may require the Company to recognize additional losses
based on their judgment about information available to them at the time of their
examination. Due to potential changes in conditions, it is at least reasonably
possible that change in estimates will occur in the near term and that such
changes could be material to the amounts reported in the Company's financial
statements.
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Analysis of the Allowance for Loan Losses
The Company's policy is to charge-off loans when, in management's opinion, the
loan is deemed uncollectible, although concerted efforts are made to maximize
future recoveries. The following table sets forth information regarding changes
in the Company's allowance for loan losses for the most recent three years
(dollars in thousands):
2022 2021 2020
Balance at beginning of period $ 16,621 $ 17,215 $ 12,619
Charge-offs:
Real estate
Construction - - -
1-4 Family residential 23 34 18
Commercial - - 444
Agricultural - - -
Commercial 41 113 628
Agricultural 7 - 48
Consumer and other 21 29 272
Total charge-offs 92 176 1,410
Recoveries:
Real estate
Construction - - 1
1-4 Family residential 8 268 6
Commercial 3 4 26
Agricultural - - -
Commercial 4 5 14
Agricultural - 48 -
Consumer and other 27 14 278
Total recoveries 42 339 325
Net charge-offs (recoveries) 50 (163 ) 1,085
Provisions charged (credited) to operations (874 ) (757 ) 5,681 Balance at end of period$ 15,697 $ 16,621 $ 17,215 Average loans outstanding$ 1,169,157 $ 1,141,750 $ 1,138,265 Ratio of net charge-offs (recoveries) during the period to average loans outstanding 0.00 % -0.01 % 0.10 % Ratio of allowance for loan losses to total loans net of deferred fees 1.26 % 1.43 % 1.50 % 45
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The following table sets forth information regarding net charge-offs to average loans outstanding by loan type during the years endedDecember 31, 2022 and 2021 (in thousands). 2022 2021 Net Net charge-offs charge-offs Net (recoveries) Net (recoveries) charge-offs Average to average charge-offs Average to average (recoveries) Loans loans (recoveries) Loans loans
Net charge-offs (recoveries): Real estate Construction $ -$ 43,905 0.00 % $ -$ 44,745 0.00 % 1-4 Family residential 15 266,029 0.01 % (234 ) 224,639 -0.10 % Commercial (3 ) 519,161 0.00 % (4 ) 504,343 0.00 % Agricultural - 155,989 0.00 % - 151,178 0.00 % Commercial 37 72,844 0.05 % 108 105,265 0.10 % Agricultural 7 95,029 0.01 % (48 ) 96,774 -0.05 % Consumer and other (6 ) 16,200 -0.04 % 15 14,806 0.10 % Totals $ 50$ 1,169,157 0.00 %$ (163 ) $ 1,141,750 -0.01 % General reserves for loan categories range from 1.10% to 1.97% of the outstanding loan balances as ofDecember 31, 2022 . In general, as loan volume increases, the general reserve levels increase with that growth and as loan volume decreases, the general reserve levels decrease with that decline. The allowance relating to commercial real estate is the largest reserve component. Construction, commercial operating and agricultural operating loans have higher general reserve levels as a percentage than the other loan categories as management perceives more risk in this type of lending. Elements contributing to the higher risk level include a higher percentage of watch, special mention, substandard and impaired loans, and less favorable economic conditions for those portfolios. As ofDecember 31, 2022 , commercial real estate loans have general reserves ranging from 1.34% to 1.61%. Other factors considered when determining the adequacy of the general reserve include historical losses; watch, substandard and impaired loan volume; the ability to collect past due loans; loan growth; loan-to-value ratios; loan administration; collateral values; and economic factors. The Company's concentration risks include geographic concentration inIowa ; the local economy's dependence upon several large governmental entity employers, includingIowa State University ; and the health ofIowa's agricultural sector that, in turn, is dependent on crop and livestock prices, weather conditions, trade policies and government programs. No assurances can be made that losses will remain at the relatively favorable levels experienced over the past five years. Loans that the Banks have identified as having higher risk levels are reviewed individually in an effort to establish adequate loss reserves. These reserves are considered specific reserves and are directly impacted by the credit quality of the underlying loans. The specific reserves are dependent upon assumptions regarding the liquidation value of collateral and the cost of recovering collateral including legal fees. Changing the amount of specific reserves on individual loans has historically had a significant impact on the reallocation of the allowance among different parts of the portfolio. The following table sets forth information regarding changes in the Company's specific reserve on loans individually evaluated for impairment and loans individually evaluated for impairment for the most recent three years (dollars in thousands): 2022 2021 2020 Specific reserve on loans individually evaluated for impairment$ 95 $ 1,392
Loans individually evaluated for impairment
Percentage increase (decrease) in specific
reserve on loans individually evaluated for
impairment
-93 % -23 % 770 %
Percentage increase (decrease) in loans
individually evaluated for impairment
17 % -19 % 219 %
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Allocation of the Allowance for Loan Losses
The following table sets forth information concerning the Company's allocation
of the allowance for loan losses for the most recent three years (dollars in
thousands):
2022 2021 2020
Amount % * Amount % * Amount % *
Balance at end of
period applicable to:
Real Estate
Construction $ 730 4 % $ 675 4 % $ 725 4 %
1-4 family
residential 3,028 23 % 2,752 21 % 2,581 19 %
Commercial 7,235 44 % 8,406 44 % 8,930 43 %
Agricultural 1,625 13 % 1,584 13 % 1,595 13 %
Commercial 1,153 6 % 1,170 7 % 1,453 11 %
Agricultural 1,705 9 % 1,836 10 % 1,696 9 %
Consumer and other 221 1 % 198 1 % 235 1 %
$ 15,697 100 % $ 16,621 100 % $ 17,215 100 %
* Percent of loans in each category to total loans.
Liquidity and Capital Resources
Liquidity management is the process by which the Company, through its Banks' Asset and Liability Committees (ALCO), ensures 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 investment securities; 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 ofDecember 31, 2022 , the level of liquidity and capital resources of the Company remain at a satisfactory level and compare favorably to that of otherFDIC insured institutions. 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 the Consolidated Statements of Cash Flows ? Review of Company Only Cash Flows
? Review of Commitments for Capital Expenditures, Cash Flow Uncertainties and
Known Trends in Liquidity and Cash Flow Needs
? Capital Resources
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Review of the Company's Current Liquidity Sources
Liquid assets of cash on hand, balances due from other banks and interest-bearing deposits in financial institutions forDecember 31, 2022 and 2021 totaled$27.9 million and$89.1 million , respectively. The lower balance of liquid assets as ofDecember 31, 2022 primarily relates to decreased deposits at theFederal Reserve Bank as the funds were invested. Other sources of liquidity available to the Banks as ofDecember 31, 2022 include available borrowing capacity with the FHLB of$285.3 million and federal funds borrowing capacity at correspondent banks of$100.6 million . As ofDecember 31, 2022 , the Company had outstanding FHLB advances and other borrowings of$39.1 million , no federal funds purchased, and securities sold under agreements to repurchase of$40.7 million .
Total investments as of
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 represent a significant source of liquidity.
Review of the Consolidated Statements of Cash Flows
Net cash provided by operating activities for the years endedDecember 31, 2022 and 2021 totaled$21.2 million and$30.5 million , respectively. The change in net cash provided by operating activities in 2022 was primarily due to a decrease in net income and proceeds from the sales of loans held for sale. Net cash (used in) investing activities for the years endedDecember 31, 2022 and 2021 was($127.4) million and($268.6) million , respectively. The change in net cash (used in) investing activities in 2022 was primarily due to fewer purchases of securities and partially offset by a larger increase in loans. Net cash provided by financing activities for the years endedDecember 31, 2022 and 2021 totaled$44.9 million and$154.1 million , respectively. The change in net cash provided by financing activities in 2022 was due primarily to a lower increase in deposits.
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 Company requires adequate liquidity to pay its expenses and pay stockholder dividends. In 2022, dividends from the Banks amounted to$10.2 million compared to$9.7 million in 2021. Various federal and state statutory provisions limit the amount 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, theFederal Reserve and theFDIC 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. First National, as a national bank, generally may pay dividends, without obtaining the express approval of the OCC, in an amount up to its retained net profits for the preceding two calendar years plus retained net profits up to the date of any dividend declaration in the current calendar year. Retained net profits, as defined by the OCC, consists of net income less dividends declared during the period.Boone Bank ,Reliance Bank ,State Bank ,United Bank andIowa State Bank are also restricted underIowa law to paying dividends only out of their undivided profits. Additionally, the payment of dividends by the Banks is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations, and the Banks generally are prohibited from paying any dividends if, following payment thereof, the Bank would be undercapitalized.
The Company has unconsolidated cash and interest-bearing deposits totaling
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Review of Commitments for Capital Expenditures, Cash Flow Uncertainties and Known Trends in Liquidity and Cash Flow Needs
Commitments to extend credit totaled$262.9 million as ofDecember 31, 2022 compared to a total of$223.4 million at the end of 2021. The timing of these credit commitments varies with the underlying borrowers; however, the Company believes it has satisfactory liquidity to fund these obligations as ofDecember 31, 2022 . 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 other known trends in liquidity and cash flow needs as ofDecember 31, 2022 , that are of concern to management.
On
Capital Resources The Company's total stockholders' equity decreased to$149.1 million atDecember 31, 2022 , from$207.8 million atDecember 31, 2021 . As ofDecember 31, 2022 and 2021, stockholders' equity as a percentage of total assets was 7.0% and 9.7%, respectively. The decrease in stockholders' equity was primarily the result of an increase in unrealized losses on the investment portfolio precipitated by the significant increase in market interest rates during 2022, offset in part by the retention of net income in excess of dividends. The capital levels of the Company currently exceed applicable regulatory guidelines to be considered "well capitalized" as ofDecember 31, 2022 . Unrealized losses on the investment portfolio are excluded from regulatory capital. From time to time, the Company's board of directors has authorized stock repurchase plans. Stock repurchase plans allow the Company to proactively manage its capital position and return excess capital to shareholders. 100,000 shares of common stock were repurchased under stock repurchase plans in 2022 and 30,580 shares of common stock were repurchased in 2021. Also see Part II, Item 5 - Market For Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases ofEquity Securities , included elsewhere in this Annual Report. Interest Rate Risk Interest rate risk refers to the impact that a change in interest rates may have on the Company's earnings and capital. Management's objectives are to control interest rate risk and to ensure predictable and consistent growth of earnings and capital. Interest rate risk management focuses on fluctuations in net interest income identified through computer simulations to evaluate volatility, varying interest rate, spread and volume assumptions. The risk is quantified and compared against tolerance levels. The Company uses a third-party computer software simulation modeling program to measure its exposure to potential interest rate changes. For various assumed hypothetical changes in market interest rates, numerous other assumptions are made such as prepayment speeds on loans, the slope of theTreasury yield curve, the rates and volumes of the Company's deposits and the rates and volumes of the Company's loans. This analysis measures the estimated change in net interest income in the event of hypothetical changes in interest rates. Another measure of interest rate sensitivity is the gap ratio. This ratio indicates the amount of interest-earning assets repricing within a given period in comparison to the amount of interest-bearing liabilities repricing within the same period of time. A gap ratio of 1.0 indicates a matched position, in which case the effect on net interest income due to interest rate movements will be minimal. A gap ratio of less than 1.0 indicates that more liabilities than assets reprice within the time period, while a ratio greater than 1.0 indicates that more assets reprice than liabilities. The simulation model process provides a dynamic assessment of interest rate sensitivity, whereas a static interest rate gap table is compiled as of a point in time. The model simulations differ from a traditional gap analysis, as a traditional gap analysis does not reflect the multiple effects of interest rate movement on the entire range of assets and liabilities and ignores the future impact of new business strategies. Inflation The primary impact of inflation on the Company's operations is to increase asset yields, deposit costs and operating overhead. Unlike most industries, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution's performance than they would on non-financial companies. Although interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services, increases in inflation generally have resulted in increased interest rates. The effects of inflation can magnify the growth of assets and, if significant, require that equity capital increase at a faster rate than would be otherwise necessary.
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Forward-Looking Statements and Business Risks
Certain statements contained in the foregoing Management's Discussion and Analysis and elsewhere in this Annual Report that are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the "Act"), notwithstanding that such statements are not specifically identified. In addition, certain statements may be contained in the Company's future filings with theSEC , in press releases and in oral and written statements made by or with the Company's approval that are not statements of historical fact and constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements include but are not limited to: (i) projections of revenues, expenses, income or loss, earnings or loss per share, the payment or nonpayment of dividends, capital structure and other financial items; (ii) statements of plans, objectives and expectations of the Company or its management, including those relating to products or services; (iii) statements of future economic performance; and (iv) statements of assumptions underlying such statements. Words such as "believes", "anticipates", "expects", "intends", "targeted", "projected", "continue", "remain", "will", "should", "may" and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements. Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statement. Factors that could cause actual results to differ from those discussed in the forward-looking statement include, but are not limited to:
? Local, regional and national economic conditions and the impact they may have
on the Company and its customers, and management's assessment of that impact
on its estimates including, but not limited to, the allowance for loan losses
and fair value of other real estate owned. Of particular relevance are the
economic conditions in the concentrated geographic area in central,
north-central and south-central Iowa in which the Banks conduct their
operations.
? Adequacy of the allowance for loan losses and changes in the level of
nonperforming assets and charge-offs.
? Inflation and interest rate, securities market and monetary fluctuations,
including increases in interest rates initiated during 2022 and expected to
continue during 2023 in response to significant inflationary pressures
affecting the national economy.
? Changes in the fair value of securities available-for-sale, which negatively
impacted our capital position during 2022, and management's assessments of
other-than-temporary impairment of such securities.
? The effects of and changes in trade and monetary and fiscal policies and laws,
including the changes in assessment rates established by the Federal Deposit
policies of the
? Changes in sources and uses of funds, including loans, deposits and
borrowings, including the ability of the Banks to maintain unsecured federal
funds lines with correspondent banks.
? Changes imposed by regulatory agencies to increase capital to a level greater
than the level currently required for well capitalized financial institutions.
? Political instability, acts of war or terrorism and natural disasters.
? The timely development and acceptance of new products and services and
perceived overall value of these products and services by customers.
? Revenues being lower than expected.
? Changes in consumer spending, borrowings and savings habits.
? Changes in the financial performance and/or condition of the Company's
borrowers.
? Credit quality deterioration, which could cause an increase in the provision
for loan losses.
? Technological changes and operational and reputational risks related to
breaches of data security and cyber-attacks.
? The ability to increase market share and control expenses.
? Changes in the competitive environment among financial or bank holding
companies and other financial service providers.
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? The effect of changes in laws and regulations with which the Company and the
Banks must comply, including developments and changes related to the
implementation of the Dodd-Frank Act and the effect of any Federal tax reform
on the operations of the Company and its customers.
? Changes in the securities markets.
? The effect of changes in accounting policies and practices, as may be adopted
by the regulatory agencies, as well as the Public Company Accounting Oversight
Board, the FASB, International Financial Reporting Standards and other
accounting standard setters, including the adoption of the CECL model for
estimating credit losses within the loan and investment portfolios.
? The costs and effects of legal and regulatory developments, including the
resolution of regulatory or other governmental inquiries and the results of
regulatory examinations or reviews.
? Recent changes in the
the
the potential negative effect of these actions on the Company's borrowers.
? The ability of the Company to successfully integrate the operations of
financial institutions it has acquired or may acquire in the future.
? The Company's success at managing the risks involved in the foregoing items.
Certain of the foregoing risks and uncertainties are discussed in greater detail under the heading "Risk Factors" in Item 1A herein.
These factors may not constitute all factors that could cause actual results to differ materially from those discussed in any forward-looking statement. The Company operates in a continually changing business environment and new facts emerge from time to time. The Company cannot predict such factors, nor can it assess the impact, if any, of such factors on its financial condition or its results of operations. Accordingly, forward-looking statements should not be relied upon as a predictor of actual results. The Company disclaims any responsibility to update any forward-looking statement provided in this document.
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