HILLS BANCORPORATION The following is management's discussion and analysis of the financial condition ofHills Bancorporation ("Hills Bancorporation" or "the Company") and its banking subsidiaryHills Bank and Trust Company ("the Bank") for the dates and periods indicated. The discussion and analysis should be read in conjunction with the consolidated financial statements and the accompanying footnotes.
Special Note Regarding Forward Looking Statements
This report contains, and future oral and written statements of the Company and its management may contain, forward-looking statements within the meaning of such term in the Private Securities Litigation Reform Act of 1995 with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company. Actual results may differ materially from those included in the forward-looking statements. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company's management and on information currently available to management, are generally identifiable by the use of words such as "believe," "expect," "anticipate," "plan," "intend," "estimate," "may," "will," "would," "could," "should" or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events. The Company's ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations and future prospects of the Company include, but are not limited to, the following: •The strength ofthe United States economy in general and the strength of the local economies in which the Company conducts its operations which may be less favorable than expected and may result in, among other things, a deterioration in the credit quality and value of the Company's assets. This includes current concerns related to higher inflation, rising energy prices, theRussia -Ukraine war and supply chain imbalances.
•The effects of recent financial market disruptions and/or an economic recession, and monetary and other governmental actions designed to address such disruptions, including in response to the COVID-19 pandemic.
•The financial strength of the counterparties with which the Company or the Company's customers do business and as to which the Company has investment or financial exposure. •The credit quality and credit agency ratings of the securities in the Company's investment securities portfolio, a deterioration or downgrade of which could lead to recognition of an allowance for credit losses on the affected securities and the recognition of a credit loss. •The effects of, and changes in, laws, regulations and policies affecting banking, securities, insurance and monetary and financial matters as well as any laws otherwise affecting the Company, including, but not limited to, potential changes inU.S. tax laws and regulations. •The effects of changes in interest rates (including the effects of changes in the rate of prepayments of the Company's assets) and the policies of theBoard of Governors of theFederal Reserve System . •The ability of the Company to compete with other financial institutions as effectively as the Company currently intends due to increases in competitive pressures in the financial services sector.
•The ability of the Company to obtain new customers and to retain existing customers.
•The timely development and acceptance of products and services, including products and services offered through alternative electronic delivery channels.
•Technological changes implemented by the Company and by other parties,
including third party vendors, which may be more difficult or more expensive
than anticipated or which may have unforeseen consequences to the Company and
its customers.
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•The ability of the Company to develop and maintain secure and reliable technology systems.
•The ability of the Company to retain key executives and employees and the difficulty that the Company may experience in replacing key executives and employees in an effective manner.
•Consumer spending and saving habits which may change in a manner that affects the Company's business adversely.
•The economic impact of natural disasters, diseases and/or pandemics, and terrorist attacks and military actions.
•Business combinations and the integration of acquired businesses and assets which may be more difficult or expensive than expected.
•The costs, effects and outcomes of existing or future litigation.
•Changes in accounting policies and practices that may be adopted by state and
federal regulatory agencies and the
•The ability of the Company to manage the risks associated with the foregoing as well as anticipated.
These risks and uncertainties should be considered in evaluating forward-looking statements, and undue reliance should not be placed on such statements. Additional information concerning the Company and its business, including other factors that could materially affect the Company's financial results, is included in the Company's filings with theSecurities and Exchange Commission .
Economic Environment
Economic conditions have created significant uncertainty about the future economic environment which will continue to evolve and potentially impact our business in future periods. Concerns over interest rate levels, energy prices, domestic and global policy issues, trade policy in theU.S. and geopolitical events, as well as the implications of those events on the markets in general, further add to the global uncertainty. Currently, however, theU.S. economy remains surprisingly strong, given the collective impact of the recent global pandemic, significant inflationary pressures, severe supply chain issues, and a war inEastern Europe affecting a key global energy supplier. In addition, current labor market conditions suggest there is some potential support for the idea that the economy can achieve the desired "soft landing." Inflation, however, continues to remain a concern, but much less of one than it was a year ago. While the risk that interest rate increases to fight inflation could lead to a recession remains a pressing concern assuming thatU.S. policymakers can avoid any materially damaging policy moves, such as not lifting the debt ceiling, signs are hopeful that theU.S. economy can begin to stabilize in the near-term. Nonetheless, interest rate levels and energy prices, in combination with global economic conditions, fiscal and monetary policy and the level of regulatory and government scrutiny of financial institutions will likely continue to impact our results throughout the remainder of 2023 and possibly into 2024. Our credit administration continues to closely monitor and analyze the higher risk segments within the loan portfolio, tracking loan payment deferrals, customer liquidity and providing timely reports to senior management and the board of directors. Based on the Company's capital levels, prudent underwriting policies, loan concentration diversification and our geographic footprint, senior management is cautiously optimistic that the Company is positioned to continue managing the impact of the varied set of risks and uncertainties currently impacting the economy and remain adequately capitalized. However, the Company may be required to make additional credit loss provisions as warranted by the extremely fluid economic condition. Page 53
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Critical Accounting Policies
The Company's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America . The
financial information contained within these financial statements is, to a
significant extent, financial information that is based on approximate measures
of the financial effects of transactions and events that have already occurred.
Based on its consideration of accounting policies that involve the most complex
and subjective decisions and assessments, management has identified its most
critical accounting policies to be those which are related to the allowance for
credit losses.
Allowance for Credit Losses
On
The preparation of financial statements in accordance with the accounting principles generally accepted inthe United States ("U.S. GAAP") requires management to make a number of judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, income and expense in the financial statements. Various elements of our accounting policies, by their nature, involve the application of highly sensitive and judgmental estimates and assumptions. Some of these policies and estimates relate to matters that are highly complex and contain substantial inherent uncertainties. Management has made significant estimates in several areas, including the allowance for credit losses (see Note 5 - Loans and Note 4 - Securities) and the fair value of debt securities (see Note 4 - Securities). We have identified the following accounting policies and estimates that, due to the inherent judgments and assumptions and the potential sensitivity of the financial statements to those judgments and assumptions, are critical to an understanding of our financial statements. We believe that the judgments, estimates and assumptions used in the preparation of the Company's financial statements are appropriate. For a further description of our accounting policies, see Note 1 - Summary of Significant Accounting Policies in the financial statements included in this Form 10-Q. The allowance for credit losses for loans represents management's estimate of all expected credit losses over the expected contractual life of our existing loan portfolio. Determining the appropriateness of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. Subsequent evaluations of the then-existing loan portfolio, in light of the factors then prevailing, may result in significant changes in the allowance for credit losses in those future periods. We employ a disciplined process and methodology to establish our allowance for credit losses that has two basic components: first, an asset-specific component involving individual loans that do not share risk characteristics with other loans and the measurement of expected credit losses for such individual loans; and second, a pooled component for estimated expected credit losses for pools of loans that share similar risk characteristics. Based upon this methodology, management establishes an asset-specific allowance for loans that do not share risk characteristics with other loans based on the amount of expected credit losses calculated on those loans and charges off amounts determined to be uncollectible. Factors we consider in measuring the extent of expected credit loss include payment status, collateral value, borrower financial condition, guarantor support and the probability of collecting scheduled principal and interest payments when due. When a loan does not share risk characteristics with other loans, we measure expected credit loss as the difference between the amortized cost basis in the loan and the present value of expected future cash flows discounted at the loan's effective interest rate except that, for collateral- dependent loans, credit loss is measured as the difference between the amortized cost basis in the loan and the fair value of the underlying collateral. The fair value of the collateral is adjusted for the estimated cost to sell if repayment or satisfaction of a loan is dependent on the sale (rather than only on the operation) of the collateral. In accordance with our appraisal policy, the fair value of collateral-dependent loans is based upon independent third-party appraisals or on collateral valuations prepared by in-house evaluations. Once a third-party appraisal is greater than one year old, or if its determined that market conditions, changes to the property, changes in intended use of the property or other factors indicate that an appraisal is no longer reliable, we perform an internal collateral valuation to assess whether a change in collateral value requires an additional adjustment to carrying value. When we receive an updated appraisal or collateral valuation, management reassesses the need for adjustments to the loan's expected credit loss measurements and, where appropriate, records an Page 54
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HILLS BANCORPORATION adjustment. If the calculated expected credit loss is determined to be permanent, fixed or nonrecoverable, the credit loss portion of the loan will be charged off against the allowance for credit losses. Loans designated having significantly increased credit risk are generally placed on nonaccrual and remain in that status until all principal and interest payments are current and the prospects for future payments in accordance with the loan agreement are reasonably assured, at which point the loan is returned to accrual status. In estimating the component of the allowance for credit losses for loans that share common risk characteristics, loans are segregated into loan classes. Loans are designated into loan classes based on loans pooled by product types and similar risk characteristics or areas of risk concentration. Credit loss assumptions are estimated using a model that categorizes loan pools based on loan type and purpose. This model calculates an expected life-of-loan loss percentage for each loan category by considering the probability of default using historical life-of-loan analysis periods for agricultural, 1 to 4 family first and junior liens, commercial and consumer segments, and the severity of loss, based on the aggregate net lifetime losses incurred per loan class. The component of the allowance for credit losses for loans that share common risk characteristics also considers factors for each loan class to adjust for differences between the historical period used to calculate historical default and loss severity rates and expected conditions over the remaining lives of the loans in the portfolio related to: •Lending policies and procedures; •International, national, regional and local economic business conditions and developments that affect the collectability of the portfolio, including the condition of various markets; •The nature of the loan portfolio, including the terms of the loans; •The experience, ability and depth of the lending management and other relevant staff; •The volume and severity of past due and adversely classified or graded loans and the volume of nonaccrual loans; •The quality of our loan review and process; •The value of underlying collateral for collateral-dependent loans; •The existence and effect of any concentrations of credit and changes in the level of such concentrations; and •The effect of external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the existing portfolio. Such factors are used to adjust the historical probabilities of default and severity of loss so that they reflect management expectation of future conditions based on a reasonable and supportable forecast. To the extent the lives of the loans in the portfolio extend beyond the period for which a reasonable and supportable forecast can be made, the Company reduces, on a straight-line basis over the remaining life of the loans, the adjustments so that model reverts back to the historical rates of default and severity of loss. The credit loss expense recorded through earnings is the amount necessary to maintain the allowance for credit losses at the amount of expected credit losses inherent within the loans held for investment portfolio. The amount of expense and the corresponding level of allowance for credit losses for loans are based on our evaluation of the collectability of the loan portfolio based on historical loss experience, reasonable and supportable forecasts, and other significant qualitative and quantitative factors. The allowance for credit losses for loans, as reported in our consolidated balance sheet, is adjusted by an expense for credit losses, which is recognized in earnings, and reduced by the charge-off of loan amounts, net of recoveries. For further information on the allowance for credit losses for loans, see Note 1 - Summary of Significant Accounting Policies and Note 5 - Loans in the notes to the financial statements of this Form 10-Q. Page 55
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Overview
This overview highlights selected information and may not contain all of the
information that is important to you in understanding our performance during the
period. For a more complete understanding of trends, events, commitments,
uncertainties, liquidity, capital resources, and critical accounting estimates,
you should carefully read this entire report.
The Company is a holding company engaged in the business of commercial banking.
The Company's subsidiary is Hills Bank and Trust Company , Hills, Iowa (the
"Bank"), which is wholly-owned. The Bank was formed in Hills, Iowa in 1904.
The Bank is a full-service commercial bank extending its services to
individuals, businesses, governmental units and institutional customers
primarily in the communities of Hills, Iowa City, Coralville , North Liberty ,
Lisbon , Mount Vernon , Kalona , Wellman , Cedar Rapids , Marion , and Washington ,
Iowa . At March 31, 2023 , the Bank has nineteen full-service locations.
Net income for the three month period ended March 31, 2023 was $12.46 million
compared to $10.65 million for the same three months of 2022, an increase of
$1.81 million or 16.99%. The principal factors in the increase in net income
for the first three months of 2023 were an increase in net interest income of
$4.02 million , a decrease in credit loss expense of $0.74 million , offset by a
decrease in noninterest income of $1.10 million and an increase in noninterest
expense of $1.34 million .
The Company achieved a return on average assets of 1.24% and a return on average
equity of 11.69% for the twelve months ended March 31, 2023 , compared to the
twelve months ended March 31, 2022 , which were 1.09% and 10.23%, respectively.
The return on average assets and return on average equity for the three months
ended March 31, 2023 were 1.25% and 11.79%, respectively, compared to the three
months ended March 31, 2022 , which were 1.07% and 10.08%, respectively.
Dividends of $1.05 per share were paid in January 2023 to 2,718 shareholders.
The dividend paid in January 2022 was $1.00 per share.
The Company's net interest income is the largest component of revenue and it is
primarily a function of the average earning assets and the net interest margin
percentage. The Company achieved a net interest margin on a tax-equivalent
basis of 3.05% for the three months ended March 31, 2023 compared to 2.64% for
the same three months of 2022. Average earning assets were $3.961 billion year
to date in 2023 and $3.942 billion in 2022.
Highlights noted on the balance sheet as of
•Total assets were$4.177 billion , an increase of$196.25 million sinceDecember 31, 2022 . •Cash and cash equivalents were$146.61 million , an increase of$109.96 million sinceDecember 31, 2022 . The majority of the increase can be attributed to approximately$100 million of temporary public funds. •Net loans were$3.161 billion , an increase of$92.14 million sinceDecember 31, 2022 . The increase is primarily attributable to approximately$40.03 million growth in land development and commercial construction loans,$12.24 million growth in farmland mortgages,$37.24 million growth in 1-4 family mortgages and$4.04 million growth in multi-family mortgages sinceDecember 31, 2022 . Loans held for sale increased$1.33 million sinceDecember 31, 2022 . •Deposits increased$86.71 million sinceDecember 31, 2022 , primarily due to approximately$100 million in temporary public funds.
Refer to Note 7 for a discussion of fair value measurements which relate to methods used by the Company in recording assets and liabilities on its financial statements.
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Financial Condition
There has been continued loan demand in 2023, primarily in land development and commercial construction, farmland mortgages, 1 to 4 family mortgages and multi-family mortgages. The lingering inflationary pressures have created significant uncertainty regarding projecting loan demand throughout the remainder of 2023. However, outstanding loan commitments continue to be significantly elevated compared to historical levels.
The following table sets forth the composition of the loan portfolio as of
March 31, 2023 December 31, 2022
Amount Percent Amount Percent
(Amounts In Thousands) (Amounts In Thousands)
Agricultural $ 105,316 3.29 % $ 112,705 3.63 %
Commercial and financial 271,784 8.50 269,568 8.67
Real estate:
Construction, 1 to 4 family residential 91,526 2.86 92,408 2.97
Construction, land development and commercial 236,265 7.39 196,240 6.31
Mortgage, farmland 268,805 8.40 256,570 8.25
Mortgage, 1 to 4 family first liens 1,162,996 36.36 1,130,989 36.40
Mortgage, 1 to 4 family junior liens 130,179 4.07 124,951 4.02
Mortgage, multi-family 440,990 13.79 436,952 14.06
Mortgage, commercial 405,156 12.66 402,842 12.96
Loans to individuals 37,937 1.19 36,675 1.18
Obligations of state and political subdivisions 47,588 1.49 48,213 1.55
$ 3,198,542 100.00 % $ 3,108,113 100.00 %
Net unamortized fees and costs 316 308
$ 3,198,858 $ 3,108,421
Less allowance for credit losses 41,070 41,440
$ 3,157,788 $ 3,066,981
The Bank has an established formal loan origination policy. In general, the
loan origination policy attempts to reduce the risk of credit loss to the
Company by requiring, among other things, maintenance of minimum loan to value
ratios, evidence of appropriate levels of insurance carried by borrowers and
documentation of appropriate types and amounts of collateral and sources of
expected payment. The collateral relied upon in the loan origination policy is
generally the property being financed by the Company. The source of expected
payment is generally the income produced from the property being financed.
Personal guarantees are required of individuals owning or controlling at least
20% of the ownership of an entity. Limited or proportional guarantees may be
accepted in circumstances if approved by the Company's Board of Directors.
Financial information provided by the borrower is verified as considered
necessary by reference to tax returns, or audited, reviewed or compiled
financial statements. The Company does not originate subprime loans. In order
to modify, restructure or otherwise change the terms of a loan, the Company's
policy is to evaluate each borrower situation individually. Modifications,
restructures, extensions and other changes are done to improve the Company's
position and to protect the Company's capital. If a borrower is not current
with its payments, any additional loans to such borrowers are evaluated on an
individual borrower basis.
The Company has not experienced any significant time lapses in recognizing the
required provisions for collateral dependent loans, nor has the Company delayed
appropriate charge offs. When an updated appraisal value has been obtained, the
Company has used the appraisal amount in determining the appropriate charge off
or required reserve. The Company also evaluates any changes in the financial
condition of the borrower and guarantors (if applicable), economic conditions,
and the Company's loss experience with the type of property in question. Any
information utilized in addition to the appraisal is intended to identify
additional charge offs or provisions, not to override the appraised value.
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In accordance with Staff Accounting Bulletin No. 102, Selected Loan Loss
Allowance Methodology and Documentation Issues, and Staff Accounting Bulletin
No. 119, which aligns the staff's guidance with FASB ASC Topic 326, or CECL, the
Company determines and assigns ratings to loans using factors that include the
following: an assessment of the financial condition of the borrower; a realistic
determination of the 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.
Through the credit risk rating process, loans are reviewed to determine if they
are performing in accordance with the original contractual terms. If the
borrower has failed to comply with the original contractual terms, further
action may be required by the Company, including a downgrade in the credit risk
rating, movement to non-accrual status, a charge-off or the establishment of a
specific reserve. In the event a collateral shortfall is identified during the
credit review process, the Company will work with the borrower for a principal
reduction and/or a pledge of additional collateral and/or additional guarantees.
In the event that these options are not available, the loan may be subject to a
downgrade of the credit risk rating. If the Company determines a loan amount or
portion thereof, is uncollectible, the loan's credit risk rating may be
downgraded and the uncollectible amount charged-off or recorded as a specific
allowance for losses. The Company's credit and legal departments undertake a
thorough and ongoing analysis to determine if additional specific reserves
and/or charge-offs are appropriate and to begin a workout plan for the loan to
minimize actual losses.
The following table presents the allowance for credit losses as of March 31,
2023 and December 31, 2022 by loan category, the percentage of the allowance for
each category to the total allowance, and the percentage of all loans in each
category to total loans:
March 31, 2023 December 31, 2022
% of Total % of Loans to % of Total % of Loans to
Amount Allowance Total Loans Amount Allowance Total Loans
(In Thousands) (In Thousands)
Agricultural $ 2,156 5.25 % 3.29 % $ 2,542 6.13 % 3.63 %
Commercial and financial 5,563 13.55 8.50 6,259 15.10 8.67
Real estate:
Construction, 1 to 4 family
residential 1,114 2.71 2.86 1,111 2.68 2.97
Construction, land development
and commercial 3,616 8.80 7.39 3,078 7.43 6.31
Mortgage, farmland 2,851 6.94 8.40 2,989 7.21 8.25
Mortgage, 1 to 4 family first
liens 11,600 28.25 36.36 11,147 26.91 36.40
Mortgage, 1 to 4 family junior
liens 3,135 7.63 4.07 3,061 7.39 4.02
Mortgage, multi-family 4,931 12.01 13.79 4,435 10.70 14.06
Mortgage, commercial 4,766 11.60 12.66 4,981 12.02 12.96
Loans to individuals 930 2.26 1.19 1,397 3.37 1.18
Obligations of state and
political subdivisions 408 1.00 1.49 440 1.06 1.55
$ 41,070 100.00 % 100.00 % $ 41,440 100.00 % 100.00 %
The allowance for credit losses (ACL) totaled $41.07 million at March 31, 2023
compared to the allowance of $41.44 million at December 31, 2022 . The percentage
of the allowance to outstanding loans was 1.28% and 1.33% at March 31, 2023 and
December 31, 2022 , respectively. The allowance was based on management's
consideration of a number of factors, including composition of the loan
portfolio, loans with higher credit risks and the overall amount of loans
outstanding. The changes in the ACL in 2023 compared to December 31, 2022 is the
result of the following factors: slight increase in the forecasted Iowa
unemployment used in the ACL calculation which resulted in an increase of
$0.39 million ; increase in loan volume which resulted in an increase of
$0.54 million ; changes in prepayment and curtailment rates resulting in a
decrease of $0.40 million ;
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increase in the individually analyzed loans reserve of
The adequacy of the allowance is reviewed quarterly and adjusted as appropriate after consideration has been given to the impact of economic conditions on the borrowers' ability to repay, loan collateral values, past collection experience, the risk characteristics of the loan portfolio and such other factors that deserve current recognition. The growth of the loan portfolio and the trends in problem and watch loans are significant elements in the determination of the provision for credit losses. Quantitative factors include the Company's historical loss experience, which is then adjusted for levels and trends in past due, levels and trends in charged-off and recovered loans, trends in volume growth, trends in problem and watch loans, trends in restructured loans, local economic trends and conditions, industry and other conditions, and effects of changing interest rates. Management has determined that the allowance for credit losses was adequate atMarch 31, 2023 , and that the loan portfolio is diversified and secured, without undue concentration in any specific risk area. This process involves a high degree of management judgment; however, the allowance for credit losses is based on a comprehensive, well documented, and consistently applied analysis of the Company's loan portfolio. This analysis takes into consideration all available information existing as of the financial statement date, including environmental factors such as economic, industry, geographical and political factors. The relative level of allowance for credit losses is reviewed and compared to industry data. This review encompasses levels of total collateral-dependent loans, portfolio mix, portfolio concentrations, current geographic risks and overall levels of net charge-offs. Investment securities available for sale held by the Company decreased by$11.66 million fromDecember 31, 2022 toMarch 31, 2023 . The fair value of securities available for sale was$45.71 million less than the amortized cost of such securities as ofMarch 31, 2023 . AtDecember 31, 2022 , the fair value of the securities available for sale was$54.20 million less than the amortized cost of such securities. Deposits increased$86.71 million in the first three months of 2023 primarily due to approximately$100 million in temporary public funds. In the opinion of the Company's management, the Company continues to have sufficient liquidity resources available to fund expected additional loan growth. Brokered deposits are included in total deposits and totaled$23.87 million as ofMarch 31, 2023 with an average rate of 4.70%. Brokered deposits were$31.74 million as ofDecember 31, 2022 with an average interest rate of 2.60%. As ofMarch 31, 2023 andDecember 31, 2022 , brokered deposits were 0.69% and 0.95% of total deposits, respectively. There were$220 million and$40 million ofFederal Home Loan Bank (FHLB) borrowings as ofMarch 31, 2023 andDecember 31, 2022 , respectively. There were no Federal Funds purchased as ofMarch 31, 2023 and$81.06 million as ofDecember 31, 2022 . It is expected that the FHLB and Federal Funds funding sources will be considered in the future if loan growth continues to exceed core deposit increases and the interest rates on funds borrowed from the FHLB and Federal Funds are favorable compared to other funding alternatives.
Dividends and Equity
InJanuary 2023 ,Hills Bancorporation paid a dividend of$9.69 million or$1.05 per share. The dividend paid inJanuary 2022 was$1.00 per share. After payment of the dividend and the adjustment for accumulated other comprehensive income, stockholders' equity as ofMarch 31, 2023 totaled$436.66 million . The Company elected to use the Community Bank Leverage Ratio (CBLR) framework as provided for in the Economic Growth, Regulatory Relief and Consumer Protection Act. Under the CBLR framework, the Company is required to maintain a CBLR of greater than 9%, as measured by dividing the Bank's Tier 1 capital by its average total consolidated assets. As ofMarch 31, 2023 andDecember 31, 2022 , the Company had regulatory capital in excess of theFederal Reserve's minimum and well-capitalized definition requirements. The actual amounts and capital ratios as ofMarch 31, 2023 andDecember 31, 2022 are presented below (amounts in thousands): Page 59
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Actual
Amount of Tier 1 Capital Ratio
As of March 31, 2023 :
Company:
Community Bank Leverage ratio $ 518,617 12.87 %
Bank:
Community Bank Leverage ratio 519,497 12.90
Actual
Amount of Tier 1 Capital Ratio
As of December 31, 2022 :
Company:
Community Bank Leverage ratio $ 517,831 13.27 %
Bank:
Community Bank Leverage ratio 520,149 13.33
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Discussion of operations for the three months ended
Net Income Overview Total net income was$12.46 million in 2023 and$10.65 million in the comparable period in 2022, an increase of$1.81 million or 16.99%. The change in net income in 2023 from the first three months of 2022 was primarily the result of the following: •Net interest income increased by$4.02 million , before credit loss expense. •For the three months endedMarch 31, 2023 , credit loss expense was$0.37 million . This represents a decrease in expense of$0.73 million from the credit loss expense of$1.10 million for the three months endedMarch 31, 2022 . •Noninterest income decreased by$1.10 million . •Noninterest expenses increased by$1.34 million . •Income tax expense increased by$0.52 million . For the three month period endedMarch 31, 2023 andMarch 31, 2022 basic earnings per share was$1.35 and$1.15 , respectively. Diluted earnings per share was$1.35 for the three months endedMarch 31, 2023 compared to$1.15 for the same period in 2022. The Company's net income for the period was driven primarily by four factors. The first factor is credit loss expense. The majority of the Company's interest-earning assets are in loans outstanding, which amounted to more than$3.161 billion atMarch 31, 2023 . Credit loss expense was$0.37 million in 2023 compared to$1.10 million in 2022. The decrease in expense when compared to the same period in 2022 is primarily attributable to qualitative factor decreases determined necessary by management given historical charge-offs for agriculture and commercial loan classes compared to allowances recorded for these loan classes. The Company believes that credit loss expense is expected to be dependent on the Company's loan growth, local economic conditions and asset quality. The second factor affecting the Company's net income is the interaction between changes in net interest margin and changes in average volumes of the Company's earnings assets. Net interest income of$29.20 million for the first three months of 2023 was derived from the Company's$3.961 billion of average earning assets during that period and its tax-equivalent net interest margin of 3.05%. Average earning assets in the three months endedMarch 31, 2022 were$3.942 billion and the tax-equivalent net interest margin was 2.64%. Net interest income for the Company increased primarily as a result of interest income on increased loan volume and rates partially offset by increased interest expense from increased interest rates, including on FHLB borrowings. The Company expects net interest compression to impact earnings for the foreseeable future due to competition for loans and deposits. The Company believes growth in net interest income will be contingent on the growth of the Company's earning assets, increasing yield on loans and the ongoing interest rate stance of theFederal Reserve Board . The third factor affecting the Company's net income is noninterest income, primarily the decrease in net gain on the sale of loans. The net gain on the sale of loans was$0.15 million and$0.81 million for the three months endedMarch 31, 2023 and 2022, respectively, a decrease of 82.12% for the three months endedMarch 31, 2023 compared to the same period in 2022. The amount of the net gain on sale of secondary market mortgage loans in each year can vary significantly. The volume of activity in these types of loans is directly related to the level of interest rates as well as the current origination and refinancing activity. The volume was significantly impacted by theFederal Reserve Board's increases to the federal funds rate in 2022 and 2023, resulting in a significant decline in the amount of mortgage loan origination and refinance activity.
The fourth factor affecting the Company's net income is noninterest expenses, primarily the increase in salaries and related employee benefits due to increased employee levels and annual compensation increases.
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Discussion of operations for the three months ended
Net Interest Income
Net interest income is the excess of the interest and fees earned on interest-earning bearing assets over the interest expense of the interest-bearing liabilities. Net interest income on a tax equivalent basis increased$4.12 million for the three months endedMarch 31, 2023 compared to the comparable period in 2022. The increase was primarily attributable to higher interest income on increased loan volume and rates partially offset by increased interest expense from increased interest rates, including on FHLB borrowings. The net interest margin for the first three months of 2023 was 3.05% compared to 2.64% in 2022 for the same period. The measure is shown on a tax-equivalent basis using a tax rate of 21% to make the interest earned on taxable and non-taxable assets more comparable. The change in average balances and average rates between periods and the effect on the net interest income on a tax equivalent basis for the three months ended in 2023 compared to the comparable period in 2022 are shown in the following table: Increase (Decrease) in Net Interest Income Change in Change in Average Balance Average Rate Volume Changes Rate Changes Net Change (Amounts in Thousands)
Interest income: Loans, net$ 477,829 0.55 %$ 4,440 $ 4,505 $ 8,945 Taxable securities 220,642 0.52 808 757 1,565 Nontaxable securities 6,651 0.53 35 244 279 Interest-bearing bank balances (686,360) 4.60 (327) 188 (139) $ 18,762$ 4,956 $ 5,694 $ 10,650 Interest expense: Interest-bearing demand deposits$ (118,414) 0.70 % $ 52$ (1,809) $ (1,757) Savings deposits (115,209) 0.50 40 (1,328) (1,288) Time deposits 25,261 0.72 (93) (1,080) (1,173) FHLB borrowings 193,462 4.85 (206) (2,106) (2,312) Interest-bearing other liabilities (11) - - - -$ (14,911) $ (207) $ (6,323) $ (6,530) Change in net interest income$ 4,749 $ (629) $ 4,120 Rate/volume variances are allocated on a consistent basis using the absolute values of changes in volume compared to the absolute values of the changes in rates. Interest on nontaxable securities and loans is shown on a tax-equivalent basis.
A summary of the net interest spread and margin is as follows:
(Tax Equivalent Basis) 2023 2022
Yield on average interest-earning assets 4.03 % 2.94 %
Rate on average interest-bearing liabilities 1.34 0.42
Net interest spread 2.69 % 2.52 %
Effect of noninterest-bearing funds 0.36 0.12
Net interest margin (tax equivalent net interest income divided by average interest-earning assets)
3.05 % 2.64 %
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Discussion of operations for the three months ended
In pricing loans and deposits, the Company considers theU.S. Treasury indexes as benchmarks in determining interest rates. TheFederal Open Market Committee met two times during the first three months of 2023. The federal funds target rate increased to 5.00% as ofMarch 31, 2023 from 0.50% as of the same period in 2022. Interest rates on loans are generally affected by the federal funds target rate since interest rates for theU.S. Treasury market normally increase or decrease when theFederal Reserve Board raises or lowers the federal funds rate. As ofMarch 31, 2023 , the rate indexes for the one, three and five year indexes were 4.64%, 3.81% and 3.60%, respectively. The one year index increased 184.66% from 1.63% atMarch 31, 2022 , the three year index increased 55.51% and the five year index increased 48.76%. The three year index was 2.45% and the five year index was 2.42% atMarch 31, 2022 .
Credit Loss Expense
Credit loss expense was$0.37 million for the three months endedMarch 31, 2023 compared to$1.10 million in 2022, a decrease of expense of$0.73 million . Credit loss expense is the amount necessary to adjust the allowance for credit losses to the level considered by management to appropriately account for the estimated current expected credit losses within the Company's loan portfolio. A significant component of the Company's approach to estimating expected credit losses are economic forecasts such asIowa unemployment, all-transactions house price index forIowa andIowa real gross domestic product. The decrease in expense when compared to the same period in 2022 is attributable to qualitative factor decreases determined necessary by management given historical charge-offs for agriculture and commercial loan classes compared to allowances recorded for these loan classes. The allowance for credit losses balance is impacted by charge-offs, net of recoveries, for the periods presented. For the three months endedMarch 31, 2023 and 2022, recoveries were$0.29 million and$0.46 million , respectively; and charge-offs were$0.89 million in 2023 and$0.34 million in 2022. The allowance for credit losses totaled$41.07 million atMarch 31, 2023 compared to$41.44 million as ofDecember 31, 2022 . The allowance represented 1.28% and 1.33% of loans held for investment atMarch 31, 2023 andDecember 31, 2022 .
Noninterest Income
The following table sets forth the various categories of noninterest income for
the three months ended
Three Months Ended March 31,
2023 2022 $ Change % Change
(Amounts in thousands)
Net gain on sale of loans $ 145 $ 811 $ (666) (82.12) %
Trust fees 3,270 3,268 2 0.06
Service charges and fees 3,033 2,880 153 5.31
Other noninterest income (expense) (67) 518 (585) (112.93)
$ 6,381 $ 7,477 $ (1,096) (14.66)
In the three months ended March 31, 2023 and 2022, the net gain on sale of loans
was $0.15 million and $0.81 million , respectively. The amount of the net gain
on sale of secondary market mortgage loans in each period can vary
significantly. The volume of activity, margin and demand in these types of
loans is directly related to the changes in interest rates and new originations
and refinancing activity. The primary reason for the decrease in 2023 compared
to 2022 is the increased mortgage interest rates in 2022 and 2023 leading to the
significant decrease in loans originated for sale. The servicing of the loans
sold into the secondary market is not retained by the Company so these loans do
not provide an ongoing stream of income.
Other noninterest income (expense) decreased $0.59 million for the three months
ended March 31, 2023 compared to the same period in 2022, primarily due to the
decrease in tax credit real estate investments based on the investments year-end
audited financial statements.
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Other noninterest income categories experienced marginal period-to-period
fluctuations for the three months ended
Noninterest Expenses
The following table sets forth the various categories of noninterest expenses
for the three months ended
Three Months Ended March 31,
2023 2022 $ Change % Change
(Amounts in thousands)
Salaries and employee benefits $ 11,503 $ 10,396 $ 1,107 10.65 %
Occupancy 1,177 1,132 45 3.98
Furniture and equipment 1,692 1,697 (5) (0.29)
Office supplies and postage 448 484 (36) (7.44)
Advertising and business development 874 730 144 19.73
Outside services 2,910 2,950 (40) (1.36)
FDIC insurance assessment 270 281 (11) (3.91)
Other noninterest expense 536 405 131 32.35
$ 19,410 $ 18,075 $ 1,335 7.39
In the three months ended
Other noninterest expense categories experienced marginal period-to-period
fluctuations for the three months ended
Income Taxes
Federal and state income tax expenses were$3.34 million and$2.83 million for the three months endedMarch 31, 2023 and 2022, respectively. Income taxes as a percentage of income before taxes were 21.15% in 2023 and 20.97% in 2022.
Liquidity
The Company actively monitors and manages its liquidity position with the objective of maintaining sufficient cash flows to fund operations, meet commitments, take advantage of market opportunities and provide a margin against unforeseeable liquidity needs. Federal funds sold and investment securities available for sale are readily marketable assets. Maturities of all investment securities are managed to meet the Company's normal liquidity needs, to respond to market changes or to adjust the Company's interest rate risk position. Investment securities available for sale comprised 18.30% of the Company's total assets atMarch 31, 2023 compared to 19.50% atDecember 31, 2022 . As ofMarch 31, 2023 , investment securities with a carrying value of$9.58 million were pledged to collateralize public and trust deposits and other borrowings. As ofDecember 31, 2022 , investment securities with a carrying value of$9.13 million were pledged. The Company has historically maintained a stable deposit base and a relatively low level of large deposits, which has mitigated the volatility in the Company's liquidity position. Deposit inflows and outflows can vary widely based on prevailing market interest rates, competition, economic conditions, our business customers' liquidity needs and by recent developments in the financial services industry. Uninsured deposits as ofMarch 31, 2023 andDecember 31, 2022 were approximately$879.89 million and$800.81 million , respectively, which comprised 25.55% and 23.85% of total deposits. As ofMarch 31, 2023 , the Company had$220.00 million of outstanding borrowings from theFederal Home Loan Bank ("FHLB") ofDes Moines compared to$40.00 million as ofDecember 31, 2022 . The Company had no other short-term borrowings as ofMarch 31, 2023 compared to$82.06 million of other Fed Funds purchased as ofDecember 31, 2022 . Advances are used as a means of providing both long and short-term, fixed-rate funding for certain assets and for managing Page 64
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interest rate risk. The Company had additional borrowing capacity available
from the FHLB of approximately
As additional sources of liquidity, the Company has the ability to borrow up to$10.00 million from theFederal Reserve Bank of Chicago , and has lines of credit with three banks totaling$160.00 million . The borrowings under these credit lines would be secured by the Company's investment securities. In addition, the Company has the option of issuing short-, medium-, and long-term debt, should the Company decide to do so. The Bank Term Funding Program was established by theFederal Reserve inMarch 2023 to provide an additional source of liquidity against high-quality securities. As ofMarch 31, 2023 , the Company had no borrowings from the Bank Term Funding Program. The combination of high levels of potentially liquid assets, low dependence on volatile liabilities, positive cash flows from operations, and both additional borrowing and brokered deposits capacity provided sources of liquidity for the Company which management considered sufficient atMarch 31, 2023 .
Contractual Obligations
There have been no material changes with regard to contractual obligations
disclosed in the Company's Form 10-K for the year ended
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