MidWestOne Financial Group, Inc. - Annual Report: 2017 (Form 10-K)
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K | ||
☒ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2017
☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number 001-35968 | ||
MIDWESTONE FINANCIAL GROUP, INC.
(Exact name of Registrant as specified in its charter)
Iowa | 42-1206172 |
(State or Other Jurisdiction of | (I.R.S. Employer |
Incorporation or Organization) | Identification Number) |
102 South Clinton Street, Iowa City, IA 52240
(Address of principal executive offices, including zip code)
(319) 356-5800
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each Class | Name of each exchange on which registered |
Common Stock, $1.00 par value | The Nasdaq Stock Market LLC |
Securities registered pursuant to Section 12(g) of the Act:
None
(Title of class)
Indicate by check mark if registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. ☐ Yes ☒ No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. ☐ Yes ☒ No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒ Yes ☐ No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ☒ Yes ☐ No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☒
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer | ¨ | Accelerated filer | ☒ | |
Non-accelerated filer | ¨ (Do not check if a smaller reporting company) | Smaller reporting company | ☐ | |
Emerging growth company | ☐ | |||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). ☐ Yes ☒ No
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, based on the last sales price quoted on the Nasdaq Global Select Market on the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $243.7 million.
The number of shares outstanding of the registrant’s common stock, par value $1.00 per share, as of February 26, 2018, was 12,235,240.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s Proxy Statement for the 2018 Annual Meeting of Shareholders of MidWestOne Financial Group, Inc. to be held on April 19, 2018, are incorporated by reference into Part III of this Annual Report on Form 10-K.
MIDWESTONE FINANCIAL GROUP, INC.
Annual Report on Form 10-K
Table of Contents
Page No. | ||||
PART I | ||||
Item 1. | ||||
Item 1A. | ||||
Item 1B. | ||||
Item 2. | ||||
Item 3. | ||||
Item 4. | ||||
PART II | ||||
Item 5. | ||||
Item 6. | ||||
Item 7. | ||||
Item 7A. | ||||
Item 8. | ||||
Item 9. | ||||
Item 9A. | ||||
Item 9B. | ||||
PART III | ||||
Item 10. | ||||
Item 11. | ||||
Item 12. | ||||
Item 13. | ||||
Item 14. | ||||
PART IV | ||||
Item 15. | ||||
Item 16. | ||||
PART I
ITEM 1. | BUSINESS. |
General
MidWestOne Financial Group, Inc. (“MidWestOne” or the “Company,” which is also referred to herein as “we,” “our” or “us”) is an Iowa corporation incorporated in 1983, a bank holding company under the Bank Holding Company Act of 1956 and a financial holding company under the Gramm-Leach-Bliley Act of 1999. Our principal executive offices are located at 102 South Clinton Street, Iowa City, Iowa 52240.
We currently operate primarily through our bank subsidiary, MidWestOne Bank, an Iowa state non-member bank chartered in 1934 with its main office in Iowa City, Iowa (the “Bank”), as well as MidWestOne Insurance Services, Inc., our wholly-owned subsidiary that operates through three agencies located in central and east-central Iowa.
On May 1, 2015, we consummated a merger with Central Bancshares, Inc. (“Central”), a Minnesota corporation. In connection with the merger, Central Bank, a Minnesota-chartered commercial bank and wholly-owned subsidiary of Central, became a wholly-owned subsidiary of MidWestOne. On April 2, 2016, Central Bank merged into the Bank. See Note 2. “Business Combination” to our consolidated financial statements.
As of December 31, 2017, we had total consolidated assets of $3.21 billion, total deposits of $2.61 billion and total shareholders’ equity of $340.3 million, all of which is common shareholders’ equity. For the year ended December 31, 2017, we generated net income available to common shareholders of $18.7 million, which was a decrease from the net income available to common shareholders of $20.4 million for the year ended December 31, 2016, and a decrease from the net income available to common shareholders of $25.1 million for the year ended December 31, 2015. For our complete financial information as of December 31, 2017 and 2016 and for each of the years in the three-year period ended December 31, 2017, see Item 8. Financial Statements and Supplementary Data.
The Bank operates a total of 44 branch locations, including its specialized Home Mortgage Center. It operates 23 branches in 13 counties throughout central and east-central Iowa, and 18 offices, which includes 17 branches and a loan production office, in the Twin Cities metro area and western Wisconsin. Additionally, the Bank operates two Florida offices in Naples and Fort Myers, and one office in Denver, Colorado. The Bank provides full-service retail banking in and around the communities in which their respective branch offices are located. Deposit products offered include checking and other demand deposit accounts, NOW accounts, savings accounts, money market accounts, certificates of deposit, individual retirement accounts and other time deposits. The Bank offers commercial and industrial, agricultural, commercial and residential real estate and consumer loans. Other products and services include debit cards, automated teller machines, online banking, mobile banking, and safe deposit boxes. The principal services of the Bank consist of making loans to and accepting deposits from individuals, businesses, governmental units and institutional customers. The Bank also has a trust and investment department through which it offers a variety of trust and investment services, including administering estates, personal trusts, and conservatorships and providing property management, farm management, custodial, financial planning, investment management and retail brokerage services (the latter of which is provided through an agreement with a third-party registered broker-dealer).
Operating Strategy
Our operating strategy is based upon a sophisticated community banking model delivering a complete line of financial products and services while following five guiding principles: (1) hire and retain excellent employees; (2) take care of our customers; (3) conduct business with the utmost integrity; (4) work as one team; and (5) learn constantly so we can continually improve.
Management believes the personal and professional service offered to customers provides an appealing alternative to the “megabanks” that have resulted from large out-of-state national banks acquiring Iowa and Minnesota-based community banks. While we employ a community banking philosophy, we believe that our size, combined with our complete line of financial products and services, is sufficient to effectively compete in our relevant market areas. To remain price competitive, management also believes that we must grow organically as well as through strategic transactions, manage expenses and our efficiency ratio, and remain disciplined in our asset/liability management practices.
Market Areas
Our holding company’s principal offices are located in Iowa City, Iowa. The city of Iowa City is located in east-central Iowa, approximately 220 miles west of Chicago, Illinois, and approximately 115 miles east of Des Moines, Iowa. It is situated approximately 60 miles west of the Mississippi River on Interstate 80 and is the home of the University of Iowa, a public university
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with approximately 24,500 undergraduate students and 8,900 graduate and professional students. Iowa City is the home of the University of Iowa Hospitals and Clinics, a 811-bed comprehensive academic medical center and regional referral center with approximately 1,650 staff physicians, residents, and fellows and approximately 2,300 professional nurses. The city of Iowa City has a total population of approximately 74,000 and the Iowa City metropolitan statistical area (“MSA”) has a total population of approximately 161,000. Iowa City is the fifth largest city in the state of Iowa, and Johnson County is the second fastest growing county in Iowa. Based on deposit information collected by the Federal Deposit Insurance Corporation (the ”FDIC”) as of June 30, 2017, the most recent date for which data is available, the Bank had the second highest deposit market share in the Iowa City MSA at approximately 16.8% compared to 20 other institutions in the market.
The Bank operates 23 branch offices in 13 counties in central and east-central Iowa, 13 branches along with a loan production office in Minnesota, 4 branches in Wisconsin, 2 branches in Florida, and 1 branch in Denver, Colorado. Based on deposit information collected by the FDIC as of June 30, 2017, in 7 of the 13 counties in Iowa, the Bank held between 8% and 43% of the deposit market share, which includes Mahaska County, Iowa, where the Bank held approximately 42% of the deposit market share. In the remaining 6 counties of Iowa, the Bank’s market share is less than 8%. In Chisago County, Minnesota, the Bank held approximately 17% of the deposit market share, but less than 6% of the deposit market share in the other 7 counties in Minnesota. In Polk County, Wisconsin, the Bank held approximately 25% of the deposit market share. In the remaining 4 counties in Wisconsin, Florida and Colorado, the Bank’s market share is less than 5%.
Lending Activities
General
We provide a range of commercial and retail lending services to businesses, individuals and government agencies. These credit activities include commercial and industrial loans; agricultural loans; commercial and residential real estate loans; and consumer loans.
We market our services to qualified lending customers. Lending officers actively solicit the business of new companies entering their market areas as well as long-standing members of the business communities in which we operate. Through professional service, competitive pricing and innovative structure, we have been successful in attracting new lending customers. We also actively pursue consumer lending opportunities. With convenient locations, advertising and customer communications, we believe that we have been successful in capitalizing on the credit needs of our market areas.
Our management emphasizes credit quality and seeks to avoid undue concentrations of loans to a single industry or based on a single class of collateral. We have established lending policies that include a number of underwriting factors to be considered in making a loan, including location, loan-to-value ratio, cash flow, interest rate and credit history of the borrower.
Real Estate Loans
Construction and Development Loans. We offer loans both to individuals who are constructing personal residences and to real estate developers and building contractors for the acquisition of land for development and the construction of homes and commercial properties. These loans are generally in-market to known and established borrowers. Construction and development loans generally have a short term, such as one to two years. As of December 31, 2017, construction and development loans constituted approximately 7.3% of our total loan portfolio.
Mortgage Loans. We offer residential, commercial and agricultural mortgage loans. As of December 31, 2017, we had $1.64 billion in combined residential, commercial, including construction and development loans, and farmland mortgage loans outstanding, which represented approximately 71.8% of our total loan portfolio.
Residential mortgage lending is a focal point for us, as residential real estate loans constituted approximately 20.5% of our total loan portfolio at December 31, 2017. Included in this category are home equity loans made to individuals. As long-term interest rates have remained at relatively low levels since 2008, many customers opted for mortgage loans that have a fixed rate with 15- or 30-year maturities. We generally retain short-term residential mortgage loans that we originate for our own portfolio, but sell most long-term loans to other parties while retaining servicing rights on the majority of such loans. We also perform loan servicing activity for third parties on participations sold. At December 31, 2017, we serviced approximately $287.9 million in mortgage loans for others. We do not offer subprime mortgage loans and do not operate a wholesale mortgage business.
We also offer mortgage loans to our commercial and agricultural customers for the acquisition of real estate used in their businesses, such as offices, farmland, warehouses and production facilities, and to real estate investors for the acquisition of
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apartment buildings, retail centers, office buildings and other commercial buildings. In deciding whether to make a commercial real estate loan, we consider, among other things, the experience and qualifications of the borrower as well as the value and cash flow of the underlying property. Some factors considered are net operating income of the property before debt service and depreciation, the debt service coverage ratio (the ratio of the property’s net cash flow to debt service requirements), the cash flows of the borrower, the ratio of the loan amount to the property value and the overall creditworthiness of the prospective borrower. As of December 31, 2017, commercial and farmland real estate mortgage loans, including construction and development loans, constituted approximately 51.3% of our total loan portfolio.
Commercial and Industrial Loans
We have a strong commercial loan base. We focus on, and tailor our commercial loan programs to, small- to mid-sized businesses in our market areas. Our loan portfolio includes loans to wholesalers, manufacturers, contractors, business services companies and retailers. We provide a wide range of business loans, including lines of credit for working capital and operational purposes and term loans for the acquisition of equipment. Although most loans are made on a secured basis, loans may be made on an unsecured basis where warranted by the overall financial condition of the borrower. Terms of commercial business loans generally range from one to five years.
Our commercial and industrial loans are primarily made based on the reported cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. The collateral support provided by the borrower for most of these loans and the probability of repayment is based on the liquidation of the pledged collateral and enforcement of a personal guarantee, if any exists. The primary repayment risks of commercial loans are that the cash flows of the borrower may be unpredictable, and the collateral securing these loans may fluctuate in value. As of December 31, 2017, commercial and industrial loans comprised approximately 22.0% of our total loan portfolio.
Agricultural Loans
Due to the rural market areas in and around which we operate, agricultural loans are an important part of our business. Agricultural loans include loans made to finance agricultural production and other loans to farmers and farming operations. Agricultural loans comprised approximately 4.6% of our total loan portfolio at December 31, 2017.
Agricultural loans, most of which are secured by crops, livestock and machinery, are generally provided to finance capital improvements and farm operations as well as acquisitions of livestock and machinery. The ability of the borrower to repay may be affected by many factors outside of the borrower’s control, including adverse weather conditions, loss of livestock due to disease or other factors, declines in market prices for agricultural products and the impact of government regulations. The ultimate repayment of agricultural loans is dependent upon the profitable operation or management of the agricultural entity.
Our agricultural lenders work closely with our customers, including companies and individual farmers, and review the preparation of budgets and cash flow projections for the ensuing crop year. These budgets and cash flow projections are monitored closely during the year and reviewed with the customers at least once annually. We also work closely with governmental agencies to help agricultural customers obtain credit enhancement products such as loan guarantees or interest rate assistance.
Consumer Lending
Our consumer lending department provides all types of consumer loans, including personal loans (secured or unsecured) and automobile loans. Consumer loans typically have shorter terms, lower balances, higher yields and higher risks of default than one- to four-family residential real estate mortgage loans. Consumer loan collections are dependent on the borrower’s continuing financial stability and are therefore more likely to be affected by adverse personal circumstances. As of December 31, 2017, consumer loans comprised only 1.6% of our total loan portfolio.
Loan Pool Participations
The Company acquired its loan pool participations in the merger with former MidWestOne in 2008, and continued in this business following that merger. However, in 2010, the Company made the decision to exit this line of business and did not purchase new loan pool participations as existing pools paid down. The Company sold its remaining loan pool participations in June 2015, and has now completely exited this line of business.
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Other Products and Services
Deposit Products
We believe that we offer competitive deposit products and programs that address the needs of customers in each of the local markets that we serve. The deposit products are offered to individuals, nonprofit organizations, partnerships, small businesses, corporations and public entities. These products include non-interest-bearing and interest-bearing demand deposits, savings accounts, money market accounts and certificates of deposit.
Trust and Investment Services
We offer trust and investment services, primarily in our Iowa market at this time, to help our business and individual clients in meeting their financial goals and preserving wealth. Our services include administering estates, personal trusts, conservatorships and providing property management, farm management, investment advisory, retail securities brokerage, and financial planning and custodial services. Licensed brokers (who are registered representatives of a third-party registered broker-dealer) serve selected branches and provide investment-related services including securities trading, financial planning, mutual funds sales, fixed and variable annuities and tax-exempt and conventional unit trusts.
Insurance Services
Through our insurance subsidiary, MidWestOne Insurance Services, Inc., we offer property and casualty insurance products to individuals and small businesses in the Iowa markets that we service.
Liquidity and Funding
A discussion of our liquidity and funding programs has been included in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations under “Liquidity,” and Item 7A. Quantitative and Qualitative Disclosures About Market Risk under “Liquidity Risk.”
Competition
We encounter competition in all areas of our business pursuits. To compete effectively, grow our market share, maintain flexibility and keep pace with changing economic and social conditions, we continuously refine and develop our products and services. The principal methods of competing in the financial services industry are through service, convenience and price.
The banking industry is highly competitive, and we face strong direct competition for deposits, loans, and other finance-related services. Our offices in Iowa, Minnesota, Wisconsin, Florida, and Colorado compete with other commercial banks, thrifts, credit unions, stockbrokers, finance divisions of auto and farm equipment companies, agricultural suppliers, and other agriculture-related lenders. Some of these competitors are local, while others are statewide, regional or nationwide. We compete for deposits principally by offering depositors a wide variety of deposit programs, convenient office locations, hours and other services, and for loan originations primarily through the interest rates and loan fees we charge, the variety of our loan products and the efficiency and quality of services we provide to borrowers, with an emphasis on building long-lasting relationships. Some of the financial institutions and financial service organizations with which we compete are not subject to the same degree of regulation as that imposed on federally insured state-chartered banks. The financial services industry is also likely to become more competitive as technological advances enable more companies to provide financial services. These technological advances may diminish the importance of depository institutions and other financial intermediaries in the transfer of funds between parties.
We compete for loans principally through the range and quality of the services we provide, with an emphasis on building long-lasting relationships. Our strategy is to serve our customers above and beyond their expectations through excellence in customer service and needs-based selling. We believe that our long-standing presence in the communities we serve and the personal service we emphasize enhance our ability to compete favorably in attracting and retaining individual and business customers. We actively solicit deposit-oriented clients and compete for deposits by offering personal attention, combined with electronic banking convenience, professional service and competitive interest rates.
Employees
As of December 31, 2017, we had 610 full-time equivalent employees. We provide our employees with a comprehensive program of benefits, some of which are on a contributory basis, including comprehensive medical and dental plans, life insurance,
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long-term and short-term disability coverage, a 401(k) plan, and an employee stock ownership plan. None of our employees are represented by unions. Our management considers its relationship with our employees to be good.
Company Website
We maintain a website for the Bank at www.midwestone.com. We make available, free of charge, on this website our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (the “SEC”). Information on, or accessible through, our website is not part of, or incorporated by reference in, this Annual Report on Form 10-K.
Supervision and Regulation
General
FDIC-insured institutions, like the Bank, their holding companies and their affiliates are extensively regulated under federal and state law. As a result, our growth and earnings performance may be affected not only by management decisions and general economic conditions, but also by the requirements of federal and state statutes and by the regulations and policies of various bank regulatory agencies, including the Iowa Division of Banking (the “Iowa Division”), the Board of Governors of the Federal Reserve System (the “Federal Reserve”), the FDIC and the Consumer Financial Protection Bureau (the “CFPB”). Furthermore, taxation laws administered by the Internal Revenue Service and state taxing authorities, accounting rules developed by the Financial Accounting Standards Board (the “FASB”), securities laws administered by the SEC and state securities authorities, and anti-money laundering laws enforced by the U.S. Department of the Treasury (“Treasury”) have an impact on our business. The effect of these statutes, regulations, regulatory policies and accounting rules are significant to our operations and results.
Federal and state banking laws impose a comprehensive system of supervision, regulation and enforcement on the operations of FDIC-insured institutions, their holding companies and affiliates that is intended primarily for the protection of the FDIC-insured deposits and depositors of banks, rather than shareholders. These laws, and the regulations of the bank regulatory agencies issued under them, affect, among other things, the scope of our business, the kinds and amounts of investments we may make, reserve requirements, required capital levels relative to our assets, the nature and amount of collateral for loans, the establishment of branches, our ability to merge, consolidate and acquire, dealings with our insiders and affiliates and our payment of dividends. In reaction to the global financial crisis and particularly following passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), we experienced heightened regulatory requirements and scrutiny. Although the reforms primarily targeted systemically important financial service providers, their influence filtered down in varying degrees to community banks over time and caused our compliance and risk management processes, and the costs thereof, to increase. After the 2016 federal elections, momentum to decrease the regulatory burden on community banks gathered strength. Although these deregulatory trends continue to receive much discussion among the banking industry, lawmakers and the bank regulatory agencies, little substantive progress has yet been made. The true impact of proposed reforms remains difficult to predict with any certainty.
The supervisory framework for U.S. banking organizations subjects banks and bank holding companies to regular examination by their respective regulatory agencies, which results in examination reports and ratings that are not publicly available and that can impact the conduct and growth of their business. These examinations consider not only compliance with applicable laws and regulations, but also capital levels, asset quality and risk, management ability and performance, earnings, liquidity, and various other factors. The regulatory agencies generally have broad discretion to impose restrictions and limitations on the operations of a regulated entity where the agencies determine, among other things, that such operations are unsafe or unsound, fail to comply with applicable law or are otherwise inconsistent with laws and regulations or with the supervisory policies of these agencies.
The following is a summary of the material elements of the supervisory and regulatory framework applicable to the Company and the Bank, beginning with a discussion of the continuing regulatory emphasis on our capital levels. It does not describe all of the statutes, regulations and regulatory policies that apply, nor does it restate all of the requirements of those that are described. The descriptions are qualified in their entirety by reference to the particular statutory and regulatory provision.
Regulatory Emphasis on Capital
Regulatory capital represents the net assets of a banking organization available to absorb losses. Because of the risks attendant to their business, FDIC-insured institutions are generally required to hold more capital than other businesses, which
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directly affects our earnings capabilities. While capital has historically been one of the key measures of the financial health of both bank holding companies and banks, its role became fundamentally more important in the wake of the global financial crisis, as the banking regulators recognized that the amount and quality of capital held by banks prior to the crisis was insufficient to absorb losses during periods of severe stress. Certain provisions of the Dodd-Frank Act and Basel III, discussed below, establish strengthened capital standards for banks and bank holding companies, require more capital to be held in the form of common stock and disallow certain funds from being included in capital determinations. These standards represent regulatory capital requirements that are meaningfully more stringent than those in place previously.
Minimum Required Capital Levels. Banks have been required to hold minimum levels of capital based on guidelines established by the bank regulatory agencies since 1983. The minimums have been expressed in terms of ratios of capital divided by total assets. As discussed below, bank capital measures have become more sophisticated over the years and have focused more on the quality of capital and the risk of assets. Bank holding companies have historically had to comply with less stringent capital standards than their bank subsidiaries and have been able to raise capital with hybrid instruments such as trust preferred securities. The Dodd-Frank Act mandated the Federal Reserve to establish minimum capital levels for holding companies on a consolidated basis as stringent as those required for FDIC-insured institutions. A result of this change is that the proceeds of hybrid instruments, such as trust preferred securities, are being excluded from capital over a phase-out period. However, if such securities were issued prior to May 19, 2010 by bank holding companies with less than $15 billion of assets, they may be retained, subject to certain restrictions. Because we have assets of less than $15 billion, we are able to maintain our trust preferred proceeds as capital but we have to comply with new capital mandates in other respects and will not be able to raise capital in the future through the issuance of trust preferred securities.
The Basel International Capital Accords. The risk-based capital guidelines for U.S. banks since 1989 were based upon the 1988 capital accord known as “Basel I” adopted by the international Basel Committee on Banking Supervision, a committee of central banks and bank supervisors that acts as the primary global standard-setter for prudential regulation, as implemented by the U.S. bank regulatory agencies on an interagency basis. The accord recognized that bank assets for the purpose of the capital ratio calculations needed to be risk-weighted (the theory being that riskier assets should require more capital) and that off-balance sheet exposures needed to be factored in the calculations. Basel I had a very simple formula for assigning risk weights to bank assets from 0% to 100% based on four categories. In 2008, the banking agencies collaboratively began to phase-in capital standards based on a second capital accord, referred to as “Basel II,” for large or “core” international banks (generally defined for U.S. purposes as having total assets of $250 billion or more, or consolidated foreign exposures of $10 billion or more) known as “advanced approaches” banks. The primary focus of Basel II was on the calculation of risk weights based on complex models developed by each advanced approaches bank. As most banks were not subject to Basel II, the U.S. bank regulators worked to improve the risk sensitivity of Basel I standards without imposing the complexities of Basel II. This “standardized approach” increased the number of risk weight categories and recognized risks well above the original 100% risk-weighting. It is institutionalized by the Dodd-Frank Act for all banking organizations, even for the advanced approaches banks, as a floor.
On September 12, 2010, the Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, announced agreement on a strengthened set of capital requirements for banking organizations around the world, known as Basel III, to address deficiencies recognized in connection with the global financial crisis.
The Basel III Rule. In July 2013, the U.S. federal banking agencies approved the implementation of the Basel III regulatory capital reforms in pertinent part, and, at the same time, promulgated rules effecting certain changes required by the Dodd-Frank Act (the “Basel III Rule”). In contrast to capital requirements historically, which were in the form of guidelines, Basel III was released in the form of regulations by each of the regulatory agencies. The Basel III Rule is applicable to all banking organizations that are subject to minimum capital requirements, including federal and state banks and savings and loan associations, as well as to bank and savings and loan holding companies, other than “small bank holding companies” (generally bank holding companies with consolidated assets of less than $1 billion).
The Basel III Rule required higher capital levels, increased the required quality of capital, and required more detailed categories of risk-weighting of riskier, more opaque assets. For nearly every class of assets, the Basel III Rule requires a more complex, detailed and calibrated assessment of credit risk and calculation of risk weightings.
Not only did the Basel III Rule increase most of the required minimum capital ratios in effect prior to January 1, 2015, but it introduced the concept of Common Equity Tier 1 Capital, which consists primarily of common stock, related surplus (net of Treasury stock), retained earnings, and Common Equity Tier 1 minority interests subject to certain regulatory adjustments. The Basel III Rule also changed the definition of capital by establishing more stringent criteria that instruments must meet to be considered Additional Tier 1 Capital (primarily non-cumulative perpetual preferred stock that meets certain requirements) and Tier 2 Capital (primarily other types of preferred stock and subordinated debt, subject to limitations). A number of instruments
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that qualified as Tier 1 Capital under Basel I do not qualify, or their qualifications will change. For example, noncumulative perpetual preferred stock, which qualified as simple Tier 1 Capital under Basel I, does not qualify as Common Equity Tier 1 Capital, but qualifies as Additional Tier 1 Capital. The Basel III Rule also constrained the inclusion of minority interests, mortgage-servicing assets, and deferred tax assets in capital and requires deductions from Common Equity Tier 1 Capital in the event that such assets exceed a certain percentage of a banking institution’s Common Equity Tier 1 Capital.
The Basel III Rule required minimum capital ratios as of January 1, 2015, as follows:
• | A ratio of minimum Common Equity Tier 1 Capital equal to 4.5% of risk-weighted assets; |
• | An increase in the minimum required amount of Tier 1 Capital from 4% to 6% of risk-weighted assets; |
• | A continuation of the minimum required amount of Total Capital (Tier 1 plus Tier 2) at 8% of risk-weighted assets; and |
• | A minimum leverage ratio of Tier 1 Capital to total quarterly average assets equal to 4% in all circumstances. |
In addition, institutions that seek the freedom to make capital distributions (including for dividends and repurchases of stock) and pay discretionary bonuses to executive officers without restriction must also maintain 2.5% in Common Equity Tier 1 Capital attributable to a capital conservation buffer being phased in over four years beginning in 2016 (as of January 1, 2018, it had phased in to 1.875%). The purpose of the conservation buffer is to ensure that banking institutions maintain a buffer of capital that can be used to absorb losses during periods of financial and economic stress. Factoring in the fully phased-in conservation buffer increases the minimum ratios depicted above to 7% for Common Equity Tier 1 Capital, 8.5% for Tier 1 Capital and 10.5% for Total Capital.
Banking organizations (except for large, internationally active banking organizations) became subject to the new rules on January 1, 2015. However, there are separate phase-in/phase-out periods for: (i) the capital conservation buffer; (ii) regulatory capital adjustments and deductions; (iii) nonqualifying capital instruments; and (iv) changes to the prompt corrective action rules discussed below. The phase-in periods commenced on January 1, 2016 and extend until January 1, 2019.
Well-Capitalized Requirements. The ratios described above are minimum standards in order for banking organizations to be considered “adequately capitalized.” Bank regulatory agencies uniformly encourage banks to hold more capital and be “well-capitalized” and, to that end, federal law and regulations provide various incentives for banking organizations to maintain regulatory capital at levels in excess of minimum regulatory requirements. For example, a banking organization that is well-capitalized may: (i) qualify for exemptions from prior notice or application requirements otherwise applicable to certain types of activities; (ii) qualify for expedited processing of other required notices or applications; and (iii) accept, roll-over or renew brokered deposits. Higher capital levels could also be required if warranted by the particular circumstances or risk profiles of individual banking organizations. For example, the Federal Reserve’s capital guidelines contemplate that additional capital may be required to take adequate account of, among other things, interest rate risk, or the risks posed by concentrations of credit, nontraditional activities or securities trading activities. Further, any banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios, including tangible capital positions (i.e., Tier 1 Capital less all intangible assets), well above the minimum levels.
Under the capital regulations of the FDIC and Federal Reserve, in order to be well‑capitalized, a banking organization must maintain:
• | A Common Equity Tier 1 Capital ratio to risk-weighted assets of 6.5% or more; |
• | A ratio of Tier 1 Capital to total risk-weighted assets of 8% or more (6% under Basel I); |
• | A ratio of Total Capital to total risk-weighted assets of 10% or more (the same as Basel I); and |
• | A leverage ratio of Tier 1 Capital to total adjusted average quarterly assets of 5% or greater. |
It is possible under the Basel III Rule to be well-capitalized while remaining out of compliance with the capital conservation buffer discussed above.
As of December 31, 2017: (i) the Bank was not subject to a directive from the FDIC to increase its capital and (ii) the Bank was well-capitalized, as defined by FDIC regulations. As of December 31, 2017, the Company had regulatory capital in excess of the Federal Reserve’s requirements and met the Basel III Rule requirements to be well-capitalized.
Prompt Corrective Action. An FDIC-insured institution’s capital plays an important role in connection with regulatory enforcement as well. Federal law provides the federal banking regulators with broad power to take prompt corrective action to resolve the problems of undercapitalized institutions. The extent of the regulators’ powers depends on whether the institution in
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question is “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized,” in each case as defined by regulation. Depending upon the capital category to which an institution is assigned, the regulators’ corrective powers include: (i) requiring the institution to submit a capital restoration plan; (ii) limiting the institution’s asset growth and restricting its activities; (iii) requiring the institution to issue additional capital stock (including additional voting stock) or to sell itself; (iv) restricting transactions between the institution and its affiliates; (v) restricting the interest rate that the institution may pay on deposits; (vi) ordering a new election of directors of the institution; (vii) requiring that senior executive officers or directors be dismissed; (viii) prohibiting the institution from accepting deposits from correspondent banks; (ix) requiring the institution to divest certain subsidiaries; (x) prohibiting the payment of principal or interest on subordinated debt; and (xi) ultimately, appointing a receiver for the institution.
Regulation and Supervision of the Company
General. The Company, as the sole shareholder of the Bank, is a bank holding company that has elected financial holding company status. As a financial holding company, we are registered with, and subject to regulation by, the Federal Reserve under the BHCA. We are legally obligated to act as a source of financial and managerial strength to the Bank and to commit resources to support the Bank in circumstances where we might not otherwise do so. Under the BHCA, we are subject to periodic examination by the Federal Reserve and are required to file with the Federal Reserve periodic reports of our operations and such additional information regarding us and the Bank as the Federal Reserve may require.
Acquisitions, Activities and Change in Control. The primary purpose of a bank holding company is to control and manage banks. The BHCA generally requires the prior approval of the Federal Reserve for any merger involving a bank holding company or any acquisition by a bank holding company of another bank or bank holding company. Subject to certain conditions (including deposit concentration limits established by the BHCA), the Federal Reserve may allow a bank holding company to acquire banks located in any state of the United States. In approving interstate acquisitions, the Federal Reserve is required to give effect to applicable state law limitations on the aggregate amount of deposits that may be held by the acquiring bank holding company and its FDIC-insured institution affiliates in the state in which the target bank is located (provided that those limits do not discriminate against out-of-state institutions or their holding companies) and state laws that require that the target bank have been in existence for a minimum period of time (not to exceed five years) before being acquired by an out-of-state bank holding company. Furthermore, in accordance with the Dodd-Frank Act, bank holding companies must be well-capitalized and well-managed in order to effect interstate mergers or acquisitions. For a discussion of the capital requirements, see “Regulatory Emphasis on Capital” above.
The BHCA generally prohibits the Company from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company that is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to banks and their subsidiaries. This general prohibition is subject to a number of exceptions. The principal exception allows bank holding companies to engage in, and to own shares of companies engaged in, certain businesses found by the Federal Reserve prior to November 11, 1999 to be “so closely related to banking ... as to be a proper incident thereto.” This authority would permit us to engage in a variety of banking-related businesses, including the ownership and operation of a savings association, or any entity engaged in consumer finance, equipment leasing, the operation of a computer service bureau (including software development) and mortgage banking and brokerage services. The BHCA does not place territorial restrictions on the domestic activities of nonbank subsidiaries of bank holding companies.
Additionally, bank holding companies that meet certain eligibility requirements prescribed by the BHCA and elect to operate as financial holding companies may engage in, or own shares in companies engaged in, a wider range of nonbanking activities, including securities and insurance underwriting and sales, merchant banking and any other activity that the Federal Reserve, in consultation with the Secretary of the Treasury, determines by regulation or order is financial in nature or incidental to any such financial activity or that the Federal Reserve determines by order to be complementary to any such financial activity and does not pose a substantial risk to the safety or soundness of FDIC-insured institutions or the financial system generally. We have elected to operate as a financial holding company.
In order to maintain our status as a financial holding company, both the Company and the Bank must be well-capitalized, well-managed, and have a least a satisfactory Community Reinvestment Act (“CRA”) rating. If the Federal Reserve determines that we are not well-capitalized or well-managed, we will have a period of time in which to achieve compliance, but during the period of noncompliance, the Federal Reserve may place any limitations on us it believes to be appropriate. Furthermore, if the Federal Reserve determines that the Bank has not received a satisfactory CRA rating, we will not be able to commence any new financial activities or acquire a company that engages in such activities.
Federal law also prohibits any person or company from acquiring “control” of an FDIC-insured depository institution or its holding company without prior notice to the appropriate federal bank regulator. “Control” is conclusively presumed to exist
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upon the acquisition of 25% or more of the outstanding voting securities of a bank or bank holding company, but may arise under certain circumstances between 10% and 24.99% ownership.
Capital Requirements. Bank holding companies are required to maintain capital in accordance with Federal Reserve capital adequacy requirements. For a discussion of capital requirements, see “-Regulatory Emphasis on Capital” above.
Dividend Payments. Our ability to pay dividends to our shareholders may be affected by both general corporate law considerations and policies of the Federal Reserve applicable to bank holding companies. As an Iowa corporation, we are subject to the limitations of Iowa law, which allows us to pay dividends unless, after such dividend, (i) we would not be able to pay our debts as they become due in the usual course of business or (ii) our total assets would be less than the sum of our total liabilities plus any amount that would be needed if we were to be dissolved at the time of the dividend payment, to satisfy the preferential rights upon dissolution of shareholders whose rights are superior to the rights of the shareholders receiving the distribution.
As a general matter, the Federal Reserve has indicated that the board of directors of a bank holding company should eliminate, defer or significantly reduce dividends to shareholders if: (i) the company’s net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; (ii) the prospective rate of earnings retention is inconsistent with the company’s capital needs and overall current and prospective financial condition; or (iii) the company will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. The Federal Reserve also possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends by banks and bank holding companies. In addition, under the Basel III Rule, institutions that seek the freedom to pay dividends will have to maintain 2.5% in Common Equity Tier 1 Capital attributable to the capital conservation buffer to be phased in over three years beginning in 2016. See “-Regulatory Emphasis on Capital” above.
Incentive Compensation. There have been a number of developments in recent years focused on incentive compensation plans sponsored by bank holding companies and banks, reflecting recognition by the bank regulatory agencies and Congress that flawed incentive compensation practices in the financial industry were one of many factors contributing to the global financial crisis. Layered on top of that are the abuses in the headlines dealing with product cross-selling incentive plans. The result is interagency guidance on sound incentive compensation practices and proposed rulemaking by the agencies required under Section 956 of the Dodd-Frank Act.
The interagency guidance recognized three core principles: Effective incentive plans should: (i) provide employees incentives that appropriately balance risk and reward; (ii) be compatible with effective controls and risk-management; and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors. Much of the guidance addresses large banking organizations and, because of the size and complexity of their operations, the regulators expect those organizations to maintain systematic and formalized policies, procedures, and systems for ensuring that the incentive compensation arrangements for all executive and non-executive employees covered by this guidance are identified and reviewed, and appropriately balance risks and rewards. Smaller banking organizations like the Company that use incentive compensation arrangements are expected to be less extensive, formalized, and detailed than those of the larger banks.
Section 956 of the Dodd-Frank Act required the banking agencies, the National Credit Union Administration, the SEC and the Federal Housing Finance Agency to jointly prescribe regulations that prohibit types of incentive-based compensation that encourage inappropriate risk taking and to disclose certain information regarding such plans. On June 10, 2016, the agencies released an updated proposed rule for comment. Section 956 will only apply to banking organizations with assets of greater than $1 billion. We have consolidated assets greater than $1 billion and less than $50 billion and we are considered a Level 3 banking organization under the proposed rules. The proposed rules contain mostly general principles and reporting requirements for Level 3 institutions so there are no specific prescriptions or limits, deferral requirements or claw-back mandates. Risk management and controls are required, as is board or committee level approval and oversight. Management expects to review its incentive plans in light of the proposed rulemaking and guidance and implement policies and procedures that mitigate unreasonable risk. As of December 31, 2017, these rules remain in proposed form.
Monetary Policy. The monetary policy of the Federal Reserve has a significant effect on the operating results of financial or bank holding companies and their subsidiaries. Among the tools available to the Federal Reserve to affect the money supply are open market transactions in U.S. government securities, changes in the discount rate on bank borrowings and changes in reserve requirements against bank deposits. These means are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits, and their use may affect interest rates charged on loans or paid on deposits.
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Federal Securities Regulation. Our common stock is registered with the SEC under the Securities Exchange Act of 1934, as amended (Exchange Act). Consequently, we are subject to the information, proxy solicitation, insider trading and other restrictions and requirements of the SEC under the Exchange Act.
Corporate Governance. The Dodd-Frank Act addressed many investor protection, corporate governance and executive compensation matters that will affect most U.S. publicly traded companies. The Dodd-Frank Act increased shareholder influence over boards of directors by requiring companies to give stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments, and authorizing the SEC to promulgate rules that would allow shareholders to nominate and solicit voters for their own candidates using a company’s proxy materials. The legislation also directed the Federal Reserve to promulgate rules prohibiting excessive compensation paid to executives of bank holding companies, regardless of whether such companies are publicly traded.
Regulation and Supervision of the Bank
General. The Bank is an Iowa-chartered bank. The deposit accounts of the Bank are insured by the FDIC’s Deposit Insurance Fund (DIF) to the maximum extent provided under federal law and FDIC regulations, currently $250,000 per insured depositor category. As an Iowa-chartered FDIC-insured bank, the Bank is subject to the examination, supervision, reporting and enforcement requirements of the Iowa Division, the chartering authority for Iowa banks, and the FDIC, designated by federal law as the primary federal regulator of insured state banks that, like the Bank, are not members of the Federal Reserve System (nonmember banks).
Deposit Insurance. As an FDIC-insured institution, the Bank is required to pay deposit insurance premium assessments to the FDIC. The FDIC has adopted a risk-based assessment system whereby FDIC-insured institutions pay insurance premiums at rates based on their risk classification. For institutions like the Bank that are not considered large and highly complex banking organizations, assessments are now based on examination ratings and financial ratios. The total base assessment rates currently range from 1.5 basis points to 30 basis points. At least semi-annually, the FDIC updates its loss and income projections for the DIF and, if needed, increases or decreases the assessment rates, following notice and comment on proposed rulemaking. The assessment base against which an FDIC-insured institution’s deposit insurance premiums paid to the DIF are calculated is based on its average consolidated total assets less its average tangible equity. This method shifts the burden of deposit insurance premiums toward those large depository institutions that rely on funding sources other than U.S. deposits.
The reserve ratio is the FDIC insurance fund balance divided by estimated insured deposits. The Dodd-Frank Act altered the minimum reserve ratio of the DIF, increasing the minimum from 1.15% to 1.35% of the estimated amount of total insured deposits, and eliminating the requirement that the FDIC pay dividends to FDIC-insured institutions when the reserve ratio exceeds certain thresholds. The reserve ratio reached 1.28% on September 30, 2017. If the reserve ratio does not reach 1.35% by December 31, 2018 (provided it is at least 1.15%), the FDIC will impose a shortfall assessment on March 31, 2019 on insured depository institutions with total consolidated assets of $10 billion or more. The FDIC will provide assessment credits to insured depository institutions, like the Bank, with total consolidated assets of less than $10 billion for the portion of their regular assessments that contribute to growth in the reserve ratio between 1.15% and 1.35%. The FDIC will apply the credits each quarter that the reserve ratio is at least 1.38% to offset the regular deposit insurance assessments of institutions with credits.
FICO Assessments. In addition to paying basic deposit insurance assessments, FDIC-insured institutions must pay Financing Corporation (FICO) assessments. FICO is a mixed-ownership governmental corporation chartered by the former Federal Home Loan Bank (“FHLB”) Board pursuant to the Competitive Equality Banking Act of 1987 to function as a financing vehicle for the recapitalization of the former Federal Savings and Loan Insurance Corporation. FICO issued 30-year noncallable bonds of approximately $8.1 billion that mature in 2017 through 2019. FICO’s authority to issue bonds ended on December 12, 1991. Since 1996, federal legislation has required that all FDIC-insured institutions pay assessments to cover interest payments on FICO’s outstanding obligations. The FICO assessment rate is adjusted quarterly and for the fourth quarter of 2017 was 54 cents per $100 dollars of assessable deposits.
Supervisory Assessments. All Iowa banks are required to pay supervisory assessments to the Iowa Division to fund the operations of that agency. The amount of the assessment is calculated on the basis of the Bank’s total assets. During the year ended December 31, 2017, the Bank paid supervisory assessments to the Iowa Division totaling approximately $147,000.
Capital Requirements. Banks are generally required to maintain capital levels in excess of other businesses. For a discussion of capital requirements, see “-Regulatory Emphasis on Capital” above.
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Liquidity Requirements. Liquidity is a measure of the ability and ease with which bank assets may be converted to cash. Liquid assets are those that can be converted to cash quickly if needed to meet financial obligations. To remain viable, FDIC-insured institutions must have enough liquid assets to meet their near-term obligations, such as withdrawals by depositors. Because the global financial crisis was in part a liquidity crisis, Basel III also includes a liquidity framework that requires FDIC-insured institutions to measure their liquidity against specific liquidity tests. One test, referred to as the Liquidity Coverage Ratio (LCR), is designed to ensure that the banking entity has an adequate stock of unencumbered high-quality liquid assets that can be converted easily and immediately in private markets into cash to meet liquidity needs for a 30-calendar day liquidity stress scenario. The other test, known as the Net Stable Funding Ratio (NSFR), is designed to promote more medium- and long-term funding of the assets and activities of FDIC-insured institutions over a one-year horizon. These tests provide an incentive for banks and holding companies to increase their holdings in Treasury securities and other sovereign debt as a component of assets, increase the use of long-term debt as a funding source and rely on stable funding like core deposits (in lieu of brokered deposits).
In addition to liquidity guidelines already in place, the federal bank regulatory agencies implemented the Basel III LCR in September 2014, which requires large financial firms to hold levels of liquid assets sufficient to protect against constraints on their funding during times of financial turmoil, and in 2016 proposed implementation of the NSFR. While these tests only apply to the largest banking organizations in the country, certain elements are expected to filter down to all FDIC-insured institutions. We are reviewing our liquidity risk management policies in light of the LCR and NSFR.
Stress Testing. A stress test is an analysis or simulation designed to determine the ability of a given FDIC-insured institution to deal with an economic crisis. In October 2012, U.S. bank regulators unveiled new rules mandated by the Dodd-Frank Act that require the largest U.S. banks to undergo stress tests twice per year, once internally and once conducted by the regulators. Stress tests are not required for banks with less than $10 billion in assets; however, the FDIC now recommends stress testing as means to identify and quantify loan portfolio risk.
Dividend Payments. The primary source of funds for the Company is dividends from the Bank. Under the Iowa Banking Act, Iowa-chartered banks generally may pay dividends only out of undivided profits. The Iowa Division may restrict the declaration or payment of a dividend by an Iowa-chartered bank, such as the Bank. The payment of dividends by any FDIC-insured institution is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations, and a FDIC-insured institution generally is prohibited from paying any dividends if, following payment thereof, the institution would be undercapitalized. As described above, the Bank exceeded its capital requirements under applicable guidelines as of December 31, 2017. Notwithstanding the availability of funds for dividends, however, the FDIC and the Iowa Division may prohibit the payment of dividends by the Bank if either or both determine such payment would constitute an unsafe or unsound practice. In addition, under the Basel III Rule, institutions that seek the freedom to pay dividends will have to maintain 2.5% in Common Equity Tier 1 Capital attributable to the capital conservation buffer to be phased in over three years beginning in 2016. See “Regulatory Emphasis on Capital” above.
State Bank Investments and Activities. The Bank is permitted to make investments and engage in activities directly or through subsidiaries as authorized by Iowa law. However, under federal law and FDIC regulations, FDIC-insured state banks are prohibited, subject to certain exceptions, from making or retaining equity investments of a type, or in an amount, that are not permissible for a national bank. Federal law and FDIC regulations also prohibit FDIC-insured state banks and their subsidiaries, subject to certain exceptions, from engaging as principal in any activity that is not permitted for a national bank unless the Bank meets, and continues to meet, its minimum regulatory capital requirements and the FDIC determines that the activity would not pose a significant risk to the DIF. These restrictions have not had, and are not currently expected to have, a material impact on the operations of the Bank.
Insider Transactions. The Bank is subject to certain restrictions imposed by federal law on “covered transactions” between the Bank and its “affiliates.” The Company is an affiliate of the Bank for purposes of these restrictions, and covered transactions subject to the restrictions include extensions of credit to the Company, investments in the stock or other securities of the Company and the acceptance of the stock or other securities of the Company as collateral for loans made by the Bank. The Dodd-Frank Act enhanced the requirements for certain transactions with affiliates, including an expansion of the definition of “covered transactions” and an increase in the amount of time for which collateral requirements regarding covered transactions must be maintained.
Certain limitations and reporting requirements are also placed on extensions of credit by the Bank to its directors and officers, to directors and officers of the Company and its subsidiaries, to principal shareholders of the Company and to “related interests” of such directors, officers and principal shareholders. In addition, federal law and regulations may affect the terms upon which any person who is a director or officer of the Company or the Bank, or a principal shareholder of the Company, may obtain credit from banks with which the Bank maintains a correspondent relationship.
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Safety and Soundness Standards/Risk Management. The federal banking agencies have adopted guidelines that establish operational and managerial standards to promote the safety and soundness of FDIC-insured institutions. The guidelines set forth standards for internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset quality and earnings.
In general, the safety and soundness guidelines prescribe the goals to be achieved in each area, and each institution is responsible for establishing its own procedures to achieve those goals. If an institution fails to comply with any of the standards set forth in the guidelines, the FDIC-insured institution’s primary federal regulator may require the institution to submit a plan for achieving and maintaining compliance. If a FDIC-insured institution fails to submit an acceptable compliance plan, or fails in any material respect to implement a compliance plan that has been accepted by its primary federal regulator, the regulator is required to issue an order directing the institution to cure the deficiency. Until the deficiency cited in the regulator’s order is cured, the regulator may restrict the FDIC-insured institution’s rate of growth, require the FDIC-insured institution to increase its capital, restrict the rates the institution pays on deposits or require the institution to take any action the regulator deems appropriate under the circumstances. Noncompliance with the standards established by the safety and soundness guidelines may also constitute grounds for other enforcement action by the federal bank regulatory agencies, including cease and desist orders and civil money penalty assessments.
During the past decade, the bank regulatory agencies have increasingly emphasized the importance of sound risk management processes and strong internal controls when evaluating the activities of the FDIC-insured institutions they supervise. Properly managing risks has been identified as critical to the conduct of safe and sound banking activities and has become even more important as new technologies, product innovation, and the size and speed of financial transactions have changed the nature of banking markets. The agencies have identified a spectrum of risks facing a banking institution including, but not limited to, credit, market, liquidity, operational, legal, and reputational risk. In particular, recent regulatory pronouncements have focused on operational risk, which arises from the potential that inadequate information systems, operational problems, breaches in internal controls, fraud, or unforeseen catastrophes will result in unexpected losses. New products and services, third-party risk and cybersecurity are critical sources of operational risk that FDIC-insured institutions must address in the current environment. The Bank is expected to have active board and senior management oversight; adequate policies, procedures, and limits; adequate risk measurement, monitoring, and management information systems; and comprehensive internal controls.
Branching Authority. Iowa banks, such as the Bank, have the authority under Iowa law to establish branches anywhere in the State of Iowa, subject to receipt of all required regulatory approvals. Federal law permits state and national banks to merge with banks in other states subject to: (i) regulatory approval; (ii) federal and state deposit concentration limits; and (iii) state law limitations requiring the merging bank to have been in existence for a minimum period of time (not to exceed five years) prior to the merger. The establishment of new interstate branches has historically been permitted only in those states the laws of which expressly authorize such expansion. The Dodd-Frank Act permits well-capitalized and well-managed banks to establish new interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) without impediments.
Transaction Account Reserves. Federal Reserve regulations require FDIC-insured institutions to maintain reserves against their transaction accounts (primarily NOW and regular checking accounts). For 2018, the first $16 million of otherwise reservable balances are exempt from reserves and have a zero percent reserve requirement; for transaction accounts aggregating more than $16 million to $122.3 million, the reserve requirement is 3% of total transaction accounts; and for net transaction accounts in excess of $122.3 million, the reserve requirement is 3% up to $122.3 million plus 10% of the aggregate amount of total transaction accounts in excess of $122.3 million. These reserve requirements are subject to annual adjustment by the Federal Reserve.
Community Reinvestment Act Requirements. The Community Reinvestment Act requires the Bank to have a continuing and affirmative obligation in a safe and sound manner to help meet the credit needs of its entire community, including low- and moderate-income neighborhoods. Federal regulators regularly assess the Bank’s record of meeting the credit needs of its communities. Applications for additional acquisitions would be affected by the evaluation of the Bank’s effectiveness in meeting its Community Reinvestment Act requirements.
Anti-Money Laundering. The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA PATRIOT Act) is designed to deny terrorists and criminals the ability to obtain access to the U.S. financial system and has significant implications for FDIC-insured institutions, brokers, dealers and other businesses involved in the transfer of money. The USA PATRIOT Act mandates financial services companies to have policies and procedures with respect to measures designed to address any or all of the following matters: (i) customer identification programs; (ii) money laundering; (iii) terrorist financing; (iv) identifying and reporting suspicious activities and currency transactions; (v) currency crimes; and (vi) cooperation between FDIC-insured institutions and law enforcement authorities.
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Concentrations in Commercial Real Estate. Concentration risk exists when FDIC-insured institutions deploy too many assets to any one industry or segment. A concentration in commercial real estate is one example of regulatory concern. The interagency Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices guidance (CRE Guidance) provides supervisory criteria, including the following numerical indicators, to assist bank examiners in identifying banks with potentially significant commercial real estate loan concentrations that may warrant greater supervisory scrutiny: (i) commercial real estate loans exceeding 300% of capital and increasing 50% or more in the preceding three years; or (ii) construction and land development loans exceeding 100% of capital. The CRE Guidance does not limit banks’ levels of commercial real estate lending activities, but rather guides institutions in developing risk management practices and levels of capital that are commensurate with the level and nature of their commercial real estate concentrations. On December 18, 2015, the federal banking agencies issued a statement to reinforce prudent risk-management practices related to CRE lending, having observed substantial growth in many CRE asset and lending markets, increased competitive pressures, rising CRE concentrations in banks, and an easing of CRE underwriting standards. The federal bank agencies reminded FDIC-insured institutions to maintain underwriting discipline and exercise prudent risk-management practices to identify, measure, monitor, and manage the risks arising from CRE lending. In addition, FDIC-insured institutions must maintain capital commensurate with the level and nature of their CRE concentration risk.
Based on the Bank’s loan portfolio as of December 31, 2017, it did not exceed the 300% guideline for commercial real estate loans.
Consumer Financial Services. The historical structure of federal consumer protection regulation applicable to all providers of consumer financial products and services changed significantly on July 21, 2011, when the CFPB commenced operations to supervise and enforce consumer protection laws. The CFPB has broad rulemaking authority for a wide range of consumer protection laws that apply to all providers of consumer products and services, including the Bank, as well as the authority to prohibit “unfair, deceptive or abusive” acts and practices. The CFPB has examination and enforcement authority over providers with more than $10 billion in assets. FDIC-insured institutions with $10 billion or less in assets, like the Bank, continue to be examined by their applicable bank regulators. We do not currently expect the CFPB’s rules to have a significant impact on our operations, except for higher compliance costs.
Special Cautionary Note Regarding Forward-Looking Statements
This report contains certain “forward-looking statements” within the meaning of such term in the Private Securities Litigation Reform Act of 1995. We and our representatives may, from time to time, make written or oral statements that are “forward-looking” and provide information other than historical information. These statements involve known and unknown risks, uncertainties and other factors that may cause actual results to be materially different from any results, levels of activity, performance or achievements expressed or implied by any forward-looking statement. These factors include, among other things, the factors listed below.
Forward-looking statements, which may be based upon beliefs, expectations and assumptions of our management and on information currently available to management, are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “should,” “could,” “would,” “plans,” “intend,” “project,” “estimate,” “forecast,” “may” or similar expressions. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those expressed in, or implied by, these statements. Readers are cautioned not to place undue reliance on any such forward-looking statements, which speak only as of the date made. Additionally, we undertake no obligation to update any statement in light of new information or future events, except as required under federal securities law.
Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors that could have an impact on our ability to achieve operating results, growth plan goals and future prospects include, but are not limited to, the following:
• | credit quality deterioration or pronounced and sustained reduction in real estate market values could cause an increase in our allowance for loan losses and a reduction in net earnings; |
• | our management’s ability to reduce and effectively manage interest rate risk and the impact of interest rates in general on the volatility of our net interest income; |
• | changes in the economic environment, competition, or other factors that may affect our ability to acquire loans or influence the anticipated growth rate of loans and deposits and the quality of the loan portfolio and loan and deposit pricing; |
• | fluctuations in the value of our investment securities; |
• | governmental monetary and fiscal policies; |
• | legislative and regulatory changes, including changes in banking, securities and tax laws and regulations and their application by our regulators, and changes in the scope and cost of FDIC insurance and other coverages; |
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• | the ability to attract and retain key executives and employees experienced in banking and financial services; |
• | the sufficiency of the allowance for loan losses to absorb the amount of actual losses inherent in our existing loan portfolio; |
• | our ability to adapt successfully to technological changes to compete effectively in the marketplace; |
• | credit risks and risks from concentrations (by geographic area and by industry) within our loan portfolio; |
• | the effects of competition from other commercial banks, thrifts, mortgage banking firms, consumer finance companies, credit unions, securities brokerage firms, insurance companies, money market and other mutual funds, and other financial institutions operating in our markets or elsewhere or providing similar services; |
• | the failure of assumptions underlying the establishment of allowances for loan losses and estimation of values of collateral and various financial assets and liabilities; |
• | the risks of mergers, including, without limitation, the related time and costs of implementing such transactions, integrating operations as part of these transactions and possible failures to achieve expected gains, revenue growth and/or expense savings from such transactions; |
• | volatility of rate-sensitive deposits; |
• | operational risks, including data processing system failures or fraud; |
• | asset/liability matching risks and liquidity risks; |
• | the costs, effects and outcomes of existing or future litigation; |
• | changes in general economic or industry conditions, nationally, internationally, or in the communities in which we conduct business; |
• | changes in accounting policies and practices, as may be adopted by state and federal regulatory agencies and the FASB; |
• | war or terrorist activities which may cause deterioration in the economy or cause instability in credit markets; |
• | cyber-attacks; and |
• | other factors and risks described under “Risk Factors” herein. |
We qualify all of our forward-looking statements by the foregoing cautionary statements. Because of these risks and other uncertainties, our actual future results, performance or achievement, or industry results, may be materially different from the results indicated by these forward-looking statements. In addition, our past results of operations are not necessarily indicative of our future results.
ITEM 1A. | RISK FACTORS. |
An investment in our securities is subject to risks inherent in our business. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included in this report. In addition to the risks and uncertainties described below, other risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially and adversely affect our business, financial condition and results of operations. The value or market price of our securities could decline due to any of these identified or other risks, and you could lose all or part of your investment.
Risks Related to Our Business
Our business is concentrated in and largely dependent upon the continued growth and welfare of the Iowa City and Minneapolis/St. Paul markets.
We operate primarily in the Iowa City, Iowa and Minneapolis/St. Paul, Minnesota markets and their surrounding communities in the upper-Midwest. As a result, our financial condition, results of operations and cash flows are significantly impacted by changes in the economic conditions in those areas. Our success depends to a significant extent upon the business activity, population, income levels, deposits and real estate activity in these markets. Although our customers’ business and financial interests may extend well beyond these market areas, adverse economic conditions that affect these market areas could reduce our growth rate, affect the ability of our customers to repay their loans to us, affect the value of collateral underlying loans and generally affect our financial condition and results of operations. Because of our geographic concentration, we are less able than other regional or national financial institutions to diversify our credit risks across multiple markets.
We must manage our credit risk effectively.
There are risks inherent in making any loan, including risks inherent in dealing with individual borrowers, risks of nonpayment, risks resulting from uncertainties as to the future value of collateral and cash flows available to service debt and risks resulting from changes in economic and industry conditions. We attempt to minimize our credit risk through prudent loan application approval procedures, careful monitoring of the concentration of our loans within specific industries and periodic independent
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reviews of outstanding loans by our credit review department. We periodically examine our credit process and implement changes to improve our procedures and standards. However, we cannot assure you that such approval and monitoring procedures will reduce these credit risks. If the overall economic climate in the United States, generally, or our market areas, specifically, declines, or even if it does not, our borrowers may experience difficulties in repaying their loans, and the level of nonperforming loans, charge-offs and delinquencies could rise and require increases in the provision for loan losses, which would cause our net income and return on equity to decrease.
The small to mid-sized businesses that we lend to may have fewer resources to weather adverse business developments, which may impair a borrower’s ability to repay a loan.
We primarily serve the banking and financial services needs of small to mid-sized businesses. These businesses generally have fewer financial resources in terms of capital or borrowing capacity than larger entities, may be more vulnerable to economic downturns, and may experience volatility in operating results, any of which may impair a borrower’s ability to repay a loan. In addition, the success of a small and medium-sized business often depends on the management talents and efforts of one or two people or a small group of people, and the death, disability or resignation of one or more of these people could have a material adverse impact on the business and its ability to repay its loan. Should the economic conditions negatively impact the markets in which we operate, our borrowers may experience financial difficulties, and the level of nonperforming loans, charge-offs and delinquencies could rise, which could negatively impact our business.
Commercial, industrial and agricultural loans make up a significant portion of our loan portfolio.
Commercial, industrial and agricultural loans (including credit cards and commercially related overdrafts) were $609.1 million, or approximately 26.6% of our total loan portfolio, as of December 31, 2017. Our commercial loans are primarily made based on the identified cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. Most often, this collateral is accounts receivable, inventory and equipment. Credit support provided by the borrower for most of these loans and the probability of repayment is based on the liquidation value of the pledged collateral and enforcement of a personal guarantee, if any exists. As a result, in the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. The collateral securing these loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. In addition, if the U.S. economy declines, this could harm the businesses of our commercial and industrial customers and reduce the value of the collateral securing these loans.
Payments on agricultural loans are dependent on the successful operation or management of the farm property. The success of the farm may be affected by many factors outside the control of the borrower, including adverse weather conditions that prevent the planting of a crop or limit crop yields (such as hail, drought and floods), loss of livestock due to disease or other factors, declines in market prices for agricultural products (both domestically and internationally) and the impact of government regulations (including changes in price supports, subsidies and environmental regulations). In addition, many farms are dependent on a limited number of key individuals whose injury or death may significantly affect the successful operation of the farm. If the cash flow from a farming operation is diminished, the borrower’s ability to repay the loan may be impaired. The primary crops in our market areas are corn and soybeans. Accordingly, adverse circumstances affecting these crops could have an adverse effect on our agricultural portfolio. Likewise, agricultural operating loans involve a greater degree of risk than lending on residential properties, particularly in the case of loans that are unsecured or secured by rapidly depreciating assets such as farm equipment or assets such as livestock or crops. In these cases, any repossessed collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation.
Our loan portfolio has a significant concentration of commercial real estate loans, which involve risks specific to real estate value.
Commercial real estate lending comprises a significant portion of our lending business. Specifically, commercial real estate loans were $1.17 billion, or approximately 51.3% of our total loan portfolio, as of December 31, 2017. Of this amount, $353.6 million, or approximately 15.5% of our total loan portfolio, are loans secured by owner-occupied property. The market value of real estate securing our commercial real estate loans can fluctuate significantly in a short period of time as a result of market conditions in the geographic area in which the real estate is located. Although a significant portion of such loans is secured by real estate as a secondary form of repayment, adverse developments affecting real estate values in one or more of our markets could increase the credit risk associated with our loan portfolio. Additionally, real estate lending typically involves higher loan principal amounts, and the repayment of the loans generally is dependent, in large part, on sufficient income from the properties securing the loans to cover operating expenses and debt service. Economic events or governmental regulations outside of the control of the borrower or lender could negatively impact the future cash flow and market values of the affected properties.
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If problems develop in the commercial real estate sector, particularly within one or more of our markets, the value of collateral securing our commercial real estate loans could decline. In such case, we may not be able to realize the amount of security that we anticipated at the time of originating the loan, which could cause us to increase our provision for loan losses and adversely affect our operating results, financial condition and/or capital. In light of the continued general uncertainty that exists in the economy and credit markets nationally, we may experience deterioration in the performance of our commercial real estate loan customers.
Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio.
We establish our reserve or “allowance” for loan losses at a level considered appropriate by management to absorb probable loan losses based on an analysis of the portfolio, market environment and other factors we deem relevant. The allowance for loan losses represents our estimate of probable losses in the portfolio at each balance sheet date and is based upon relevant information available to us. The allowance contains an allocation for probable losses that have been identified relating to specific borrowing relationships, as well as probable losses inherent in the loan portfolio and credit undertakings that are not specifically identified. Additions to the allowance for loan losses, which are charged to earnings through the provision for loan losses, are determined based on a variety of factors, including an analysis of the loan portfolio, historical loss experience and an evaluation of current economic conditions in our market areas. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Although management has established an allowance for loan losses it believes is adequate to absorb probable and reasonably estimable losses in our loan portfolio, the allowance may not be adequate. We could sustain credit losses that are significantly higher than the amount of our allowance for loan losses. Higher loan losses could arise for a variety of reasons, including changes in economic, operating and other conditions within our markets, as well as changes in the financial condition, cash flows, and operations of our borrowers.
At December 31, 2017, our allowance for loan losses as a percentage of total gross loans was 1.23% and as a percentage of total nonperforming loans was approximately 117.59%. Although management believes that the allowance for loan losses is appropriate to absorb probable loan losses on any existing loans that may become uncollectible, we cannot predict loan losses with certainty, and we cannot assure you that our allowance for loan losses will prove sufficient to cover actual loan losses in the future. We may be required to make additional provisions for loan losses in the future to supplement the allowance for loan losses, either due to management’s decision to do so or because our banking regulators require us to do so. If we experience significant charge-offs in future periods or charge-offs in future periods exceed the allowance for loan losses, we may need additional provisions to replenish the allowance for loan losses. An increase in the allowance for loan losses will result in a decrease in net income and, most likely, capital, and may have a material negative impact on our financial condition and results of operations. Loan losses in excess of our reserves may adversely affect our business, financial condition and results of operations.
Nonperforming assets take significant time to resolve and adversely affect our results of operations and financial condition, and could result in further losses in the future.
As of December 31, 2017, our nonperforming loans (which consist of nonaccrual loans, loans past due 90 days or more and still accruing interest and loans modified under troubled debt restructurings, and excluded purchased credit impaired loans) totaled $23.9 million, or 1.04% of our loan portfolio, and our nonperforming assets (which include nonperforming loans plus other real estate owned) totaled $25.9 million, or 1.13% of loans. In addition, we had $8.4 million in accruing loans (not included in the nonperforming loan totals) that were 31-89 days delinquent as of December 31, 2017.
Our nonperforming assets adversely affect our net income in various ways. We do not record interest income on nonaccrual loans or other real estate owned, thereby adversely affecting our net income and returns on assets and equity, increasing our loan administration costs and adversely affecting our efficiency ratio. When we take collateral in foreclosure and similar proceedings, we are required to mark the collateral to its then-fair market value, which may result in a loss. These nonperforming loans and other real estate owned also increase our risk profile and the capital our regulators believe is appropriate in light of such risks. The resolution of nonperforming assets requires significant time commitments from management and can be detrimental to the performance of their other responsibilities. If we experience increases in nonperforming loans and nonperforming assets, our net interest income may be negatively impacted and our loan administration costs could increase, each of which could have an adverse effect on our net income and related ratios, such as return on assets and equity.
We depend on the accuracy and completeness of information provided by customers and counterparties.
In deciding whether to extend credit or enter into other transactions with customers and counterparties, we may rely on information furnished to us by or on behalf of customers and counterparties, including financial statements and other financial information. We also may rely on representations of customers and counterparties as to the accuracy and completeness of that
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information. In deciding whether to extend credit, we may rely upon our customers' representations that their financial statements conform to U.S. Generally Accepted Accounting Principles (“GAAP”) and present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer. We also may rely on customer representations and certifications, or other audit or accountants' reports, with respect to the business and financial condition of our clients. Our financial condition, results of operations, financial reporting and reputation could be negatively affected if we rely on materially misleading, false, inaccurate or fraudulent information.
We may encounter issues with environmental law compliance if we take possession, through foreclosure or otherwise, of the real property that secures a loan.
A significant portion of our loan portfolio is secured by real property. In the ordinary course of business, we may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require us to incur substantial expenses and may materially reduce the affected property's value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on our financial condition and results of operations.
Adverse weather affecting the markets we serve could hurt our business and prospects for growth.
Substantially all of our business is conducted in the states of Iowa and Minnesota, and a significant portion is conducted in rural communities. The upper-Midwest economy, in general, is heavily dependent on agriculture and therefore the economy, and particularly the economies of the rural communities that we serve, can be greatly affected by severe weather conditions, including hail, droughts, storms, tornadoes and flooding. Unfavorable weather conditions may decrease agricultural productivity or could result in damage to our branch locations or the property of our customers, all of which could adversely affect the local economy, which would negatively affect our profitability.
We are subject to interest rate risk, which could adversely affect our financial condition and profitability.
Shifts in short-term interest rates may reduce net interest income, which is the principal component of our earnings. Net interest income is the difference between the amounts received by us on our interest-earning assets and the interest paid by us on our interest-bearing liabilities. When interest rates rise, the rate of interest we pay on our liabilities such as deposits, may rise more quickly than the rate of interest that we receive on our interest bearing assets, such as loans, which could cause our profits to decrease. The impact on earnings can be more adverse when the slope of the yield curve flattens, that is, when short-term interest rates increase more than long-term interest rates or when long-term interest rates decrease more than short-term interest rates.
Changes in interest rates also can affect the value of loans, securities and other assets. An increase in interest rates that adversely affects the ability of borrowers to pay the principal or interest on loans may lead to an increase in nonperforming assets and a reduction of income recognized, which could have a material adverse effect on our results of operations and cash flows. Further, when we place a loan on nonaccrual status, we reverse any accrued but unpaid interest receivable, which decreases interest income. Subsequently, we continue to have a cost to fund the loan, which is reflected as interest expense, without any interest income to offset the associated funding expense. Thus, an increase in the amount of nonperforming assets would have an adverse impact on net interest income.
Rising interest rates will likely result in a decline in value of our fixed-rate debt securities. Any unrealized losses resulting from holding these securities are recognized in other comprehensive income (or net income, if the decline is other-than- temporary), and reduce total shareholders’ equity. Unrealized losses do not negatively impact our regulatory capital ratios; however, tangible common equity and the associated ratios used by many investors would be reduced. If debt securities in an unrealized loss position are sold, such losses become realized and will reduce our regulatory capital ratios.
In late 2015, the Federal Reserve’s Open Market Committee began the process of raising short-term interest rates from near-zero levels, however, the overall level of interest rates remains low. If short-term interest rates remain at these low levels for a prolonged period, and assuming longer term interest rates do not increase, we could experience net interest margin compression as our rates on our interest earning assets would decline while rates on our interest-bearing liabilities could fail to decline in tandem. Furthermore, if short-term interest rates continue to increase and long-term interest rates do not rise, or increase but at a slower rate, we could experience net interest margin compression as our rates on interest-earning assets decline measured relative to rates
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on our interest-bearing liabilities. Any such occurrence could have a material adverse effect on our net interest income and on our business, financial condition and results of operations.
We measure interest rate risk under various rate scenarios and using specific criteria and assumptions. A summary of this process, along with the results of our net interest income simulations, is included at Item 7A. Quantitative and Qualitative Disclosures About Market Risk under “Interest Rate Risk.” Although we believe our current level of interest rate sensitivity is reasonable and effectively managed, significant fluctuations in interest rates may have an adverse effect on our business, financial condition and results of operations.
Liquidity risks could affect operations and jeopardize our business, financial condition and results of operations.
Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a substantial negative effect on our liquidity. Our most important source of funds consists of customer deposits. Deposit balances can decrease when customers perceive alternative investments, such as the stock market, provide a better risk/return trade-off. If customers move money out of bank deposits and into other investments, we could lose a relatively low cost source of funds, which would require us to seek other, potentially higher cost funding alternatives. Other primary sources of funds consist of cash from operations, investment securities maturities and sales, and funds from sales of our stock. Additional liquidity is provided by brokered deposits, bank lines of credit, repurchase agreements and the ability to borrow from the Federal Reserve Bank and the FHLB. Our access to funding sources in amounts adequate to finance or capitalize our activities or on terms that are acceptable to us could be impaired by factors that affect us directly or the financial services industry or economy in general, such as disruptions in the financial markets or negative views and expectations about the prospects for the financial services industry.
Any decline in available funding could adversely impact our ability to originate loans, invest in securities, pay our expenses, pay dividends to our shareholders, or fulfill obligations such as repaying our borrowings or meeting deposit withdrawal demands, any of which could have a material adverse impact on our liquidity, business, financial condition and results of operations.
We may desire or be required to raise additional capital in the future, but that capital may not be available.
We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. We intend to grow our business organically and to explore opportunities to grow our business by taking advantage of attractive acquisition opportunities, and such growth plans may require us to raise additional capital to ensure that we have adequate levels of capital to support such growth on top of our current operations. In order to accommodate future capital needs we maintain a universal shelf registration statement, which allowed for future sale up to $75 million of securities. During the first and second quarters of 2017, we utilized the shelf registration and issued an additional 750,000 shares of common stock resulting in $24.4 million of new capital for the Company, net of expenses, leaving approximately $49.3 million of securities available to be issued under our shelf registration statement. Our ability to raise additional capital will depend on conditions in the capital markets, economic conditions and a number of other factors, including investor perceptions regarding the banking industry, market conditions and governmental activities, and on our financial condition and performance. Accordingly, we cannot assure you of our ability to raise additional capital, if needed or desired, on terms acceptable to us. If we cannot raise additional capital when needed or desired, our ability to further expand our operations through internal growth or acquisitions could be materially impaired.
We face the risk of possible future goodwill impairment.
We performed a valuation analysis of our goodwill, $64.7 million related to our acquisition of Central, as of October 1, 2017, and the analysis indicated no impairment existed. We will be required to perform additional goodwill impairment assessments on at least an annual basis, and perhaps more frequently, which could result in goodwill impairment charges. Any future goodwill impairment charge on the current goodwill balance, or future goodwill arising out of acquisitions that we are required to take, could have a material adverse effect on our results of operations by reducing our net income or increasing our net losses.
We could recognize losses on securities held in our securities portfolio, particularly if interest rates increase or economic and market conditions deteriorate.
As of December 31, 2017, the fair value of our securities portfolio was approximately $642.0 million. Factors beyond our control can significantly influence the fair value of securities in our portfolio and can cause potential adverse changes to the fair value of these securities. For example, fixed-rate securities acquired by us are generally subject to decreases in market value when interest rates rise. Additional factors include, but are not limited to, rating agency downgrades of the securities, defaults by the issuer or individual mortgagors with respect to the underlying securities, and instability in the credit markets. Any of the foregoing factors could cause an other-than-temporary impairment in future periods and result in realized losses. The process for determining whether impairment is other-than-temporary usually requires subjective judgments about the future financial
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performance of the issuer and any collateral underlying the security in order to assess the probability of receiving all contractual principal and interest payments on the security. Because of changing economic and market conditions affecting interest rates, the financial condition of issuers of the securities and the performance of the underlying collateral, we may recognize realized and/ or unrealized losses in future periods, which could have an adverse effect on our financial condition and results of operations.
Downgrades in the credit rating of one or more insurers that provide credit enhancement for our state and municipal securities portfolio may have an adverse impact on the market for, and valuation of, these types of securities.
We invest in tax-exempt and taxable state and local municipal securities, some of which are insured by monoline insurers. As of December 31, 2017, we had $268.3 million of municipal securities (recorded values), which represented 41.7% of our total securities portfolio. Following the onset of the financial crisis, several of these insurers came under scrutiny by rating agencies. Even though management generally purchases municipal securities on the overall credit strength of the issuer, the reduction in the credit rating of an insurer may negatively impact the market for and valuation of our investment securities. Such a downgrade could adversely affect our liquidity, financial condition and results of operations.
Our ability to pay dividends is subject to certain limitations and restrictions, and there is no guarantee that we will be able to continue paying the same level of dividends in the future that we have paid in the past or that we will be able to pay future dividends at all.
Our ability to pay dividends is limited by regulatory restrictions and the need to maintain sufficient consolidated capital. The ability of the Bank to pay dividends to us is limited by its obligations to maintain sufficient capital and liquidity and by other general restrictions on dividends that are applicable to the Bank, including the requirement under the Iowa Banking Act that the Bank may not pay dividends in excess of its undivided profits. If these regulatory requirements are not met, the Bank will not be able to pay dividends to us, and we may be unable to pay dividends on our common stock.
In addition, as a bank holding company, our ability to declare and pay dividends is subject to the guidelines of the Federal Reserve regarding capital adequacy and dividends. The Federal Reserve guidelines generally require us to review the effects of the cash payment of dividends on common stock and other Tier 1 capital instruments (i.e., perpetual preferred stock and trust preferred debt) in light of our earnings, capital adequacy and financial condition. As a general matter, the Federal Reserve indicates that the board of directors of a bank holding company (including a financial holding company) should eliminate, defer or significantly reduce the Company’s dividends if:
• | the company’s net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; |
• | the prospective rate of earnings retention is inconsistent with the company’s capital needs and overall current and prospective financial condition; or |
• | the company will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. |
As of December 31, 2017, we had $23.8 million of junior subordinated debentures held by three statutory business trusts that we control. Interest payments on the debentures, which totaled $0.9 million for the year ended December 31, 2017, must be paid before we pay dividends on our capital stock, including our common stock. We have the right to defer interest payments on the debentures for up to 20 consecutive quarters. However, if we elect to defer interest payments, all deferred interest must be paid before we may pay dividends on our capital stock.
Our ability to attract and retain management and key personnel may affect future growth and earnings.
Much of our success and growth has been influenced by our ability to attract and retain management experienced in banking and financial services and familiar with the communities in our market areas. Our ability to retain our executive officers, current management teams, branch managers and loan officers will continue to be important to the successful implementation of our strategy. It is also critical, as we grow, to be able to attract and retain qualified additional management and loan officers with the appropriate level of experience and knowledge about our market areas to implement our operating strategy. The Dodd-Frank Act also directs the Federal Reserve to promulgate rules prohibiting excessive compensation paid to bank holding company executives. These rules, when adopted, may make it more difficult to attract and retain the people we need to operate our businesses and limit our ability to promote our objectives through our compensation and incentive programs. The unexpected loss of services of any key management personnel, or the inability to recruit and retain qualified personnel in the future, could have an adverse effect on our business, results of operations and financial condition.
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We face intense competition in all phases of our business from banks and other financial institutions.
The banking and financial services businesses in our markets are highly competitive. Our competitors include large regional banks, local community banks, savings and loan associations, securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market mutual funds, small local credit unions as well as large aggressive and expansion-minded credit unions, and other non-bank financial services providers. Many of these competitors are not subject to the same regulatory restrictions as we are. Many of our unregulated competitors compete across geographic boundaries and are able to provide customers with a competitive alternative to traditional banking services.
Increased competition in our markets may result in a decrease in the amounts of our loans and deposits, reduced spreads between loan rates and deposit rates or loan terms that are more favorable to the borrower. Any of these results could have a material adverse effect on our ability to grow and remain profitable. If increased competition causes us to significantly discount the interest rates we offer on loans or increase the amount we pay on deposits, our net interest income could be adversely impacted. If increased competition causes us to modify our underwriting standards, we could be exposed to higher losses from lending activities. Additionally, many of our competitors are much larger in total assets and capitalization, have greater access to capital markets, have larger lending limits and offer a broader range of financial services than we can offer.
Consumers and businesses are increasingly using non-banks to complete their financial transactions, which could adversely affect our business and results of operations.
Technology and other changes are allowing consumers and businesses to complete financial transactions that historically have involved banks through alternative methods. For example, the wide acceptance of Internet-based commerce has resulted in a number of alternative payment processing systems and lending platforms in which banks play only minor roles. Customers can now maintain funds in prepaid debit cards or digital currencies, and pay bills and transfer funds directly without the direct assistance of banks. The diminishing role of banks as financial intermediaries has resulted and could continue to result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the potential loss of lower cost deposits as a source of funds could have a material adverse effect on our business, financial condition and results of operations.
We have a continuing need for technological change, and we may not have the resources to effectively implement new technology.
The financial services industry continues to undergo rapid technological changes with frequent introductions of new technology-driven products and services. In addition to enabling us to better serve our customers, the effective use of technology increases efficiency and the potential for cost reduction. Our future success will depend in part upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in our operations as we continue to grow our market share. Many of our larger competitors have substantially greater resources to invest in technological improvements. As a result, they may be able to offer additional or superior products to those that we will be able to offer, which could put us at a competitive disadvantage. Accordingly, we cannot provide you with assurance that we will be able to effectively implement new technology-driven products and services or be successful in marketing such products and services to our customers.
The occurrence of fraudulent activity, breaches or failures of our information security controls or cybersecurity-related incidents could have a material adverse effect on our business, financial condition, results of operations and growth prospects.
As a bank, we are susceptible to fraudulent activity, information security breaches and cybersecurity-related incidents that may be committed against us or our clients, which may result in financial losses or increased costs to us or our clients, disclosure or misuse of our information or our client information, misappropriation of assets, privacy breaches against our clients, litigation or damage to our reputation. Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud, phishing, social engineering and other dishonest acts. Information security breaches and cybersecurity-related incidents may include fraudulent or unauthorized access to systems used by us or our clients, denial or degradation of service attacks and malware or other cyber-attacks.
In recent periods, there continues to be a rise in electronic fraudulent activity, security breaches and cyber-attacks within the financial services industry, especially in the commercial banking sector due to cyber criminals targeting commercial bank accounts. Moreover, in recent periods, several large corporations, including financial institutions and retail companies, have suffered major data breaches, in some cases exposing not only confidential and proprietary corporate information, but also sensitive financial and other personal information of their customers and employees and subjecting them to potential fraudulent activity.
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Some of our clients may have been affected by these breaches, which could increase their risks of identity theft and other fraudulent activity that could involve their accounts with us.
Information pertaining to us and our clients is maintained, and transactions are executed, on networks and systems maintained by us and certain third party partners, such as our online banking, mobile banking or accounting systems. The secure maintenance and transmission of confidential information, as well as execution of transactions over these systems, are essential to protect us and our clients against fraud and security breaches and to maintain the confidence of our clients. Breaches of information security also may occur through intentional or unintentional acts by those having access to our systems or the confidential information of our clients, including employees. In addition, increases in criminal activity levels and sophistication, advances in computer capabilities, new discoveries, vulnerabilities in third party technologies (including browsers and operating systems) or other developments could result in a compromise or breach of the technology, processes and controls that we use to prevent fraudulent transactions and to protect data about us, our clients and underlying transactions, as well as the technology used by our clients to access our systems. Our third party partners’ inability to anticipate, or failure to adequately mitigate, breaches of security could result in a number of negative events, including losses to us or our clients, loss of business or clients, damage to our reputation, the incurrence of additional expenses, disruption to our business, additional regulatory scrutiny or penalties or our exposure to civil litigation and possible financial liability, any of which could have a material adverse effect on our business, financial condition, results of operations and growth prospects.
We depend on information technology and telecommunications systems of third parties, and any systems failures, interruptions or data breaches involving these systems could adversely affect our operations and financial condition.
Our business is highly dependent on the successful and uninterrupted functioning of our information technology and telecommunications systems, third party servicers, accounting systems, mobile and online banking platforms and financial intermediaries. We outsource to third parties many of our major systems, such as data processing and mobile and online banking. The failure of these systems, or the termination of a third party software license or service agreement on which any of these systems is based, could interrupt our operations. Because our information technology and telecommunications systems interface with and depend on third party systems, we could experience service denials if demand for such services exceeds capacity or such third party systems fail or experience interruptions. A system failure or service denial could result in a deterioration of our ability to process loans or gather deposits and provide customer service, compromise our ability to operate effectively, result in potential noncompliance with applicable laws or regulations, damage our reputation, result in a loss of customer business or subject us to additional regulatory scrutiny and possible financial liability, any of which could have a material adverse effect on business, financial condition, results of operations and growth prospects. In addition, failures of third parties to comply with applicable laws and regulations, or fraud or misconduct on the part of employees of any of these third parties, could disrupt our operations or adversely affect our reputation.
It may be difficult for us to replace some of our third party vendors, particularly vendors providing our core banking and information services, in a timely manner if they are unwilling or unable to provide us with these services in the future for any reason and even if we are able to replace them, it may be at higher cost or result in the loss of customers. Any such events could have a material adverse effect on our business, financial condition, results of operations and growth prospects.
Our operations rely heavily on the secure processing, storage and transmission of information and the monitoring of a large number of transactions on a minute-by-minute basis, and even a short interruption in service could have significant consequences. We also interact with and rely on retailers, for whom we process transactions, as well as financial counterparties and regulators. Each of these third parties may be targets of the same types of fraudulent activity, computer break-ins and other cyber security breaches described above, and the cyber security measures that they maintain to mitigate the risk of such activity may be different than our own and may be inadequate.
As a result of financial entities and technology systems becoming more interdependent and complex, a cyber incident, information breach or loss, or technology failure that compromises the systems or data of one or more financial entities could have a material impact on counterparties or other market participants, including ourselves. As a result of the foregoing, our ability to conduct business may be adversely affected by any significant disruptions to us or to third parties with whom we interact.
We are subject to certain operational risks, including, but not limited to, customer or employee fraud and data processing system failures and errors.
Employee errors and employee and customer misconduct could subject us to financial losses or regulatory sanctions and seriously harm our reputation. Misconduct by our employees could include hiding unauthorized activities from us, improper or unauthorized activities on behalf of our customers or improper use of confidential information. It is not always possible to prevent
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employee errors and misconduct, and the precautions we take to prevent and detect this activity may not be effective in all cases. Employee errors could also subject us to financial claims for negligence.
We maintain a system of internal controls and insurance coverage to mitigate against operational risks, including data processing system failures and errors and customer or employee fraud. Should our internal controls fail to prevent or detect an occurrence, and if any resulting loss is not insured or exceeds applicable insurance limits, such failure could have a material adverse effect on our business, financial condition and results of operations.
We are subject to changes in accounting principles, policies or guidelines.
Our financial performance is impacted by accounting principles, policies and guidelines. Some of these policies require the use of estimates and assumptions that may affect the value of our assets or liabilities and financial results. Some of our accounting policies are critical because they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions. If such estimates or assumptions underlying our financial statements are incorrect, we may experience material losses.
From time to time, the FASB and the SEC change the financial accounting and reporting standards or the interpretation of those standards that govern the preparation of our financial statements. These changes are beyond our control, can be difficult to predict and could materially impact how we report our financial condition and results of operations. Changes in these standards are continuously occurring, and given recent economic conditions, more drastic changes may occur. The implementation of such changes could have a material adverse effect on our financial condition and results of operations.
A new accounting standard may require us to increase our allowance for loan losses and may have a material adverse effect on our financial condition and results of operations.
The FASB has adopted a new accounting standard that will be effective for the Company and the Bank for our first fiscal year after December 15, 2019. This standard, referred to as Current Expected Credit Loss, or CECL, will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans, and recognize the expected credit losses as allowances for loan losses. This will change the current method of providing allowances for loan losses that are probable, which may require us to increase our allowance for loan losses, and to greatly increase the types of data we will need to collect and review to determine the appropriate level of the allowance for loan losses. Any increase in our allowance for loan losses or expenses incurred to determine the appropriate level of the allowance for loan losses may have a material adverse effect on our financial condition and results of operations.
Our framework for managing risks may not be effective in mitigating risk and loss to us.
Our risk management framework seeks to mitigate risk and loss to us. We have established processes and procedures intended to identify, measure, monitor, report and analyze the types of risk to which we are subject, including liquidity risk, credit risk, market risk, interest rate risk, operational risk, compensation risk, legal and compliance risk, and reputational risk, among others. However, as with any risk management framework, there are inherent limitations to our risk management strategies as there may exist, or develop in the future, risks that we have not appropriately anticipated or identified. Our ability to successfully identify and manage risks facing us is an important factor that can significantly impact our results. If our risk management framework proves ineffective, we could suffer unexpected losses and could be materially adversely affected.
Our internal controls may be ineffective
Management regularly reviews and updates our internal controls, disclosure controls and procedures and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our financial condition and results of operations.
Our reputation could be damaged by negative publicity.
Reputational risk, or the risk to our business, financial condition or results of operations from negative publicity, is inherent in our business. Negative publicity can result from actual or alleged conduct in a number of areas, including legal and regulatory compliance, lending practices, corporate governance, litigation, inadequate protection of customer data, ethical behavior of our
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employees, and from actions taken by regulators, ratings agencies and others as a result of that conduct. Damage to our reputation could impact our ability to attract new or maintain existing loan and deposit customers, employees and business relationships.
We have counterparty risk and therefore we may be adversely affected by the soundness of other financial institutions.
Our ability to engage in routine funding and other transactions could be negatively affected by the actions and the soundness of other financial institutions. Financial services institutions are generally interrelated as a result of trading, clearing, counterparty, credit or other relationships. We have exposure to many different industries and counterparties and regularly engage in transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks and other institutional customers. Many of these transactions may expose us to credit or other risks if another financial institution experiences adverse circumstances. In certain circumstances, the collateral that we hold may be insufficient to fully cover the risk that a counterparty defaults on its obligations, which may cause us to experience losses that could have a material adverse effect on our business, financial condition and results of operations.
We may be adversely affected by risks associated with completed and potential acquisitions, including execution risks, failure to realize anticipated transaction benefits, and failure to overcome integration risks, which could adversely affect our growth and profitability.
We plan to continue to grow our businesses organically but remain open to considering potential bank or other acquisition opportunities that make financial and strategic sense. In the event that we do pursue acquisitions, we may have difficulty executing on acquisitions and may not realize the anticipated benefits of any transaction we complete. Any of the foregoing matters could materially and adversely affect us.
In any acquisition that we complete, we may fail to realize some or all of the anticipated transaction benefits if the integration process takes longer or is more costly than expected or otherwise fails to meet our expectations. Acquisition activities could be material to our business and involve a number of risks, including the following:
• | We may incur time and expense associated with identifying and evaluating potential acquisitions and negotiating potential transactions, resulting in our attention being diverted from the operation of our existing business; |
• | We are exposed to potential asset and credit quality risks and unknown or contingent liabilities of the banks or businesses we acquire. If these issues or liabilities exceed our estimates, our earnings, capital and financial condition may be materially and adversely affected. |
• | The acquisition of other entities generally requires integration of systems, procedures and personnel of the acquired entity. This integration process is complicated and time consuming and can also be disruptive to the customers and employees of the acquired business and our business. If the integration process is not conducted successfully, we may not realize the anticipated economic benefits of acquisitions within the expected time frame, or ever, and we may lose customers or employees of the acquired business. We may also experience greater than anticipated customer losses even if the integration process is successful. |
• | To finance an acquisition, we may borrow funds or pursue other forms of financing, such as issuing voting and/or non-voting common stock or convertible preferred stock, which may have high dividend rights or may be highly dilutive to holders of our common stock, thereby increasing our leverage and diminishing our liquidity, or issuing capital stock, which could dilute the interests of our existing shareholders. |
• | We may be unsuccessful in realizing the anticipated benefits from acquisitions. For example, we may not be successful in realizing anticipated cost savings. We also may not be successful in preventing disruptions in service to existing customer relationships of the acquired institution, which could lead to a loss in revenues. |
In addition to the foregoing, we may face additional risks in acquisitions to the extent we acquire new lines of business or new products, or enter new geographic areas, in which we have little or no current experience, especially if we lose key employees of the acquired operations. We cannot assure you that we will be successful in overcoming these risks or any other problems encountered in connection with acquisitions. Our inability to overcome risks associated with acquisitions could have an adverse effect on our ability to successfully implement our acquisition growth strategy and grow our business and profitability.
Risks Relating to the Regulation of our Industry
We operate in a highly regulated industry and the laws and regulations to which we are subject, or changes in them, or our failure to comply with them, may adversely affect us.
The Company and the Bank are subject to extensive regulation by multiple regulatory agencies. These regulations may affect the manner and terms of delivery of our services. If we do not comply with governmental regulations, we may be subject
23
to fines, penalties, lawsuits or material restrictions on our businesses in the jurisdiction where the violation occurred, which may adversely affect our business operations. Changes in these regulations can significantly affect the services that we provide, as well as our costs of compliance with such regulations. In addition, adverse publicity and damage to our reputation arising from the failure or perceived failure to comply with legal, regulatory or contractual requirements could affect our ability to attract and retain customers.
There is uncertainty surrounding the potential legal, regulatory and policy changes by the current presidential administration in the U.S. that may directly affect financial institutions and the global economy.
The current presidential administration has indicated it would like to reduce the burdens associated with certain financial reform regulations including the Dodd-Frank Act, which has increased regulatory uncertainty. Changes in federal policy and at regulatory agencies are expected over time through policy and personnel changes, which could lead to changes in the level of oversight of the financial services industry. The nature, timing and economic and political effects of potential changes to the current legal and regulatory framework affecting financial institutions is uncertain, and at this time, it is unclear whether future changes will adversely affect our operating environment and therefore our business, financial condition and results of operations.
Legislative and regulatory reforms applicable to the financial services industry may have a significant impact on our business, financial condition and results of operations.
The Dodd-Frank Act, among other things, imposed new capital requirements on bank holding companies; changed the base for FDIC insurance assessments to a bank’s average consolidated total assets minus average tangible equity, rather than its deposit base; permanently raised the current standard deposit insurance limit to $250,000; and expanded the FDIC’s authority to raise the premiums we pay for deposit insurance. The Dodd-Frank Act established the CFPB as an independent entity within the Federal Reserve. This entity has broad rulemaking, supervisory and enforcement authority over consumer financial products and services, including deposit products, residential mortgages, home-equity loans and credit cards and contains provisions on mortgage-related matters such as steering incentives, determinations as to a borrower’s ability to repay and prepayment penalties. However, the CFPB experienced a leadership change in late 2017, which is subject to ongoing litigation and may impact the CFPB’s policies and supervision and enforcement efforts. Moreover, the Dodd-Frank Act included provisions that affect corporate governance and executive compensation at all publicly traded companies.
In addition, the Company and the Bank are subject to the Basel III Rule. The Basel III Rule became effective on January 1, 2015 with a phase-in period through 2019 for many of the new rules. The Basel III Rule also expanded the definition of capital by establishing additional criteria that capital instruments must meet to be considered Additional Tier 1 Capital (i.e., Tier 1 Capital in addition to Common Equity) and Tier 2 Capital. A number of instruments that previously generally qualified as Tier 1 Capital do not qualify or their qualifications changed upon the effectiveness of the Basel III Rule. The Basel III Rule maintained the general structure of the prompt corrective action thresholds while incorporating the increased requirements, including the Common Equity Tier 1 Capital ratio. In order to be a “well-capitalized” depository institution under the Basel III Rule, an institution must maintain a Common Equity Tier 1 Capital ratio of 6.5% or more, a Tier 1 Capital ratio of 8% or more, a Total Capital ratio of 10% or more, and a leverage ratio of 5% or more. Institutions must also maintain a capital conservation buffer consisting of Common Equity Tier 1 Capital.
These provisions, as well as any other aspects of current or proposed regulatory or legislative changes to laws applicable to the financial industry, impact the profitability of our business activities and may change certain of our business practices, including the ability to offer new products, obtain financing, attract deposits, make loans, and achieve satisfactory interest spreads, and could expose us to additional costs, including increased compliance costs. These changes also may require us to invest significant management attention and resources to make any necessary changes to operations in order to comply, and could therefore also materially and adversely affect our business, financial condition and results of operations.
Monetary policies and regulations of the Federal Reserve could adversely affect our business, financial condition and results of operations.
In addition to being affected by general economic conditions, our earnings and growth are affected by the policies of the Federal Reserve. An important function of the Federal Reserve is to regulate the money supply and credit conditions. Among the instruments used by the Federal Reserve to implement these objectives are open market operations in U.S. government securities, adjustments of the discount rate and changes in reserve requirements against bank deposits. These instruments are used in varying combinations to influence overall economic growth and the distribution of credit, bank loans, investments and deposits. Their use also affects interest rates charged on loans or paid on deposits.
24
The monetary policies and regulations of the Federal Reserve have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. The effects of such policies upon our business, financial condition and results of operations cannot be predicted.
Federal and state regulators periodically examine our business, and we may be required to remediate adverse examination findings.
The Federal Reserve, the FDIC, and the Iowa Division of Banking periodically examine our business, including our compliance with laws and regulations. If, as a result of an examination, a banking agency were to determine that our financial condition, capital resources, asset quality, earnings prospects, management, liquidity or other aspects of any of our operations had become unsatisfactory, or that we were in violation of any law or regulation, they may take a number of different remedial actions as they deem appropriate. These actions include the power to enjoin “unsafe or unsound” practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in our capital, to restrict our growth, to assess civil money penalties, to fine or remove officers and directors and, if it is concluded that such conditions cannot be corrected or there is an imminent risk of loss to depositors, to terminate our deposit insurance and place our bank into receivership or conservatorship. Any regulatory action against us could have an adverse effect on our business, financial condition and results of operations.
We are subject to numerous laws designed to protect consumers, including the CRA and fair lending laws, and failure to comply with these laws could lead to a wide variety of sanctions.
The CRA requires our bank, consistent with safe and sound operations, to ascertain and meet the credit needs of its entire community, including low and moderate income areas. Our bank’s failure to comply with the CRA could, among other things, result in the denial or delay of certain corporate applications filed by us or our bank, including applications for branch openings or relocations and applications to acquire, merge or consolidate with another banking institution or holding company. In addition, the Equal Credit Opportunity Act, the Fair Housing Act and other fair lending laws and regulations prohibit discriminatory lending practices by financial institutions. The U.S. Department of Justice, federal banking agencies, and other federal agencies are responsible for enforcing these laws and regulations. A challenge to an institution’s compliance with fair lending laws and regulations could result in a wide variety of sanctions, including damages and civil money penalties, injunctive relief, restrictions on mergers and acquisitions activity, restrictions on expansion, and restrictions on entering new business lines. Private parties may also challenge an institution’s performance under fair lending laws in private class action litigation. Such actions could have a material adverse effect on our business, financial condition, results of operations and growth prospects.
Non-compliance with the USA PATRIOT Act, the Bank Secrecy Act or other laws and regulations could result in fines or sanctions against us.
The USA PATRIOT Act and the Bank Secrecy Act require financial institutions to design and implement programs to prevent financial institutions from being used for money laundering and terrorist activities. If such activities are detected, financial institutions are obligated to file suspicious activity reports with the Financial Crimes Enforcement Network of the Treasury. These rules require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Federal and state bank regulators also have focused on compliance with Bank Secrecy Act and anti-money laundering regulations. Failure to comply with these regulations could result in fines or sanctions, including restrictions on conducting acquisitions or establishing new branches. In recent years, several banking institutions have received large fines for non-compliance with these laws and regulations. While we have developed policies and procedures designed to assist in compliance with these laws and regulations, these policies and procedures may not be effective in preventing violations of these laws and regulations. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us, which could have a material adverse effect on our business, financial condition or results of operations.
Risks Related to Our Common Stock
There is a limited trading market for our common shares, and you may not be able to resell your shares at or above the price you paid for them.
Although our common shares are listed for quotation on the Nasdaq Global Select Market, the trading in our common shares has substantially less liquidity than many other companies listed on Nasdaq. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the market of willing buyers and sellers of our common shares at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. We cannot assure you that the volume of trading in our common shares will increase in the future.
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The stock market can be volatile, and fluctuations in our operating results and other factors could cause our stock price to decline.
The stock market has experienced, and may continue to experience, fluctuations that significantly impact the market prices of securities issued by many companies. Market fluctuations could adversely affect our stock price. These fluctuations have often been unrelated or disproportionate to the operating performance of particular companies. These broad market fluctuations, as well as general economic, systemic, political and market conditions, such as recessions, loss of investor confidence, interest rate changes, or international currency fluctuations, may negatively affect the market price of our common stock. Moreover, our operating results may fluctuate and vary from period to period due to the risk factors set forth herein. As a result, period-to-period comparisons should not be relied upon as an indication of future performance. Our stock price could fluctuate significantly in response to our quarterly or annual results, annual projections and the impact of these risk factors on our operating results or financial position.
Certain shareholders own a significant interest in the company and may exercise their control in a manner detrimental to your interests.
Certain MidWestOne shareholders who are descendants of our founder collectively control approximately 23.0% of our outstanding common stock. These shareholders may have the opportunity to exert influence on the outcome of matters required to be submitted to shareholders for approval. In addition, the significant level of ownership by these shareholders may contribute to the rather limited liquidity of our common stock on the Nasdaq Global Select Market.
ITEM 1B. | UNRESOLVED STAFF COMMENTS. |
None.
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ITEM 2. | PROPERTIES. |
The following table is a listing of the Company’s operating facilities:
Facility Address | Facility Square Footage | Owned or Leased |
Iowa Offices | ||
802 13th Street in Belle Plaine | 5,013 | Owned |
3225 Division Street in Burlington | 10,550 | Owned |
4510 Prairie Parkway in Cedar Falls | 14,500 | Owned |
120 West Center Street in Conrad | 8,382 | Owned |
110 First Avenue in Coralville | 5,000 | Owned |
58 East Burlington Avenue in Fairfield | 5,896 | Owned |
2408 West Burlington Avenue in Fairfield | 3,520 | Owned |
926 Avenue G in Fort Madison | 3,548 | Owned |
102 South Clinton Street in Iowa City (1) | 58,440 | Owned |
500 South Clinton Street in Iowa City (2) | 44,427 | Owned |
1906 Keokuk Street in Iowa City | 6,333 | Owned |
2233 Rochester Avenue in Iowa City | 3,916 | Owned |
202 Main Street in Melbourne | 2,800 | Owned |
10030 Highway 149 in North English | 2,080 | Owned |
465 Highway 965 NE, Suite A in North Liberty | 3,245 | Leased |
124 South First Street in Oskaloosa | 7,160 | Owned |
222 First Avenue East in Oskaloosa | 6,692 | Owned |
1001 Highway 57 in Parkersburg | 7,420 | Owned |
700 Main Street in Pella | 9,374 | Leased |
500 Oskaloosa Street in Pella | 1,960 | Owned |
112 North Main Street in Sigourney | 4,440 | Owned |
3110 Kimball Avenue in Waterloo | 3,364 | Leased |
305 West Rainbow Drive in West Liberty | 4,791 | Owned |
Minnesota Offices | ||
7111 21st Avenue N. in Centerville | 3,167 | Owned |
7031 20th Avenue S. in Centerville (3) | 2,400 | Leased |
11151 Lake Boulevard in Chisago City | 2,500 | Owned |
3585 124th Avenue in Coon Rapids | 4,125 | Owned |
6640 Shady Oak Road in Eden Prairie | 4,464 | Leased |
18233 Carson Court NW in Elk River | 6,393 | Owned |
1650 South Lake Street in Forest Lake | 8,150 | Owned |
945 Winnetka Avenue N. in Golden Valley | 18,078 | Owned |
2120 Hennepin Avenue S. in Minneapolis | 4,360 | Owned |
2104 Hastings Avenue in Newport | 16,600 | Owned |
750 Central Avenue E., Suite 100 in Saint Michael | 7,378 | Leased |
835 Southview Boulevard in South Saint Paul | 11,088 | Owned |
2270 Frontage Road W. in Stillwater | 12,730 | Owned |
3670 East County Line N. in White Bear Lake | 5,440 | Owned |
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Facility Address | Facility Square Footage | Owned or Leased |
Wisconsin Offices | ||
404 County Road UU in Hudson | 5,300 | Owned |
880 Sixth Street N. in Hudson | 4,763 | Owned |
304 Cascade Street in Osceola | 21,500 | Owned |
2183 US Highway 8 E. in Saint Croix Falls | 3,400 | Owned |
Florida Offices | ||
1520 Royal Palm Square Boulevard, Suite 100 in Fort Myers | 5,863 | Leased |
4099 Tamiami Trail N., Suite 100 in Naples | 9,365 | Leased |
Colorado Office | ||
1899 Wynkoop Street, Suite 100 in Denver | 4,052 | Leased |
(1) - This facility is utilized as a branch in addition to housing the Company’s headquarters. | ||
(2) - This facility contains a total of 63,206 square feet, of which the Bank occupies 44,427 square feet. | ||
(3) - This facility is not a full service branch, but is used exclusively for the origination of Small Business Administration (SBA) loans. | ||
The Bank intends to limit its investment in premises to no more than 50% of capital. Management believes that the facilities are of sound construction, in good operating condition, appropriately insured and adequately equipped for carrying on the business of the Company.
No individual real estate property amounts to 10% or more of consolidated assets.
ITEM 3. | LEGAL PROCEEDINGS. |
We and our subsidiaries are from time to time parties to various legal actions arising in the normal course of business. We believe that there is no threatened or pending proceeding, other than ordinary routine litigation incidental to the Company’s business, against us or our subsidiaries or of which our property is the subject, which, if determined adversely, would have a material adverse effect on our consolidated business or financial condition.
ITEM 4. | MINE SAFETY DISCLOSURES. |
Not applicable.
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PART II
ITEM 5. | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES. |
Our common stock is listed on the Nasdaq Global Select Market under the symbol “MOFG.” The following table presents for the periods indicated the high and low sale price for our common stock as reported on the Nasdaq Global Select Market:
Cash | |||||||||||||
Dividend | |||||||||||||
High | Low | Declared | |||||||||||
2016 | |||||||||||||
First Quarter | $ | 30.04 | $ | 24.71 | $ | 0.160 | |||||||
Second Quarter | 30.50 | 25.49 | 0.160 | ||||||||||
Third Quarter | 30.74 | 26.50 | 0.160 | ||||||||||
Fourth Quarter | 39.20 | 27.93 | 0.160 | ||||||||||
2017 | |||||||||||||
First Quarter | $ | 38.56 | $ | 33.25 | $ | 0.165 | |||||||
Second Quarter | 36.72 | 32.92 | 0.165 | ||||||||||
Third Quarter | 35.63 | 31.93 | 0.170 | ||||||||||
Fourth Quarter | 37.94 | 30.56 | 0.170 | ||||||||||
As of February 26, 2018, there were 12,235,240 shares of common stock outstanding held by approximately 436 holders of record. Additionally, there are an estimated 2,339 beneficial holders whose stock was held in street name by brokerage houses and other nominees as of that date.
Dividends
We may pay dividends on our common stock as and when declared by our Board of Directors out of any funds legally available for the payment of such dividends, subject to any and all preferences and rights of any preferred stock or a series thereof and subject to the payment of interest on our junior subordinated debentures. We expect to continue to pay comparable dividends in the future. The amount of dividend payable will depend upon our earnings and financial condition and other factors, including applicable governmental regulations and policies. See “Item 1. Business- Supervision and Regulation - Regulation and Supervision of the Company - Dividend Payments.”
Repurchases of Company Equity Securities
On July 21, 2016, the board of directors of the Company approved a share repurchase program, allowing for the repurchase of up to $5.0 million of stock through December 31, 2018. During the fourth quarter of 2017 the Company repurchased no common stock. Of the $5.0 million of stock authorized under the repurchase plan, $5.0 million remained available for possible future repurchases as of December 31, 2017.
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Performance Graph
The following table compares MidWestOne’s performance, as measured by the change in price of its common stock plus reinvested dividends, with the Nasdaq Composite Index and the SNL-Midwestern Banks Index for the five years ended December 31, 2017.
MidWestOne Financial Group, Inc.
At | |||||||||||||||||||||||
Index | 12/31/2012 | 12/31/2013 | 12/31/2014 | 12/31/2015 | 12/31/2016 | 12/31/2017 | |||||||||||||||||
MidWestOne Financial Group, Inc. | $ | 100.00 | $ | 135.38 | $ | 146.72 | $ | 158.01 | $ | 199.65 | $ | 181.47 | |||||||||||
Nasdaq Composite Index | 100.00 | 140.12 | 160.78 | 171.97 | 187.22 | 242.71 | |||||||||||||||||
SNL-Midwestern Banks Index | 100.00 | 136.91 | 148.84 | 151.10 | 201.89 | 216.95 | |||||||||||||||||
The banks in the custom peer group - SNL-Midwestern Banks Index - represent all publicly traded banks, thrifts or financial service companies located in Iowa, Illinois, Indiana, Kansas, Kentucky, Michigan, Minnesota, Missouri, Nebraska, North Dakota, Ohio, South Dakota and Wisconsin.
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ITEM 6. | SELECTED FINANCIAL DATA. |
The following selected financial data for each of the five years in the period ended December 31, 2017, have been derived from our audited consolidated financial statements and the results of operations for each of the five years in the period ended December 31, 2017. This financial data should be read in conjunction with the financial statements and the related notes thereto.
Year Ended December 31, | ||||||||||||||||||||
(Dollars in thousands, except per share data) | 2017 | 2016 | 2015 | 2014 | 2013 | |||||||||||||||
Summary of Income Data: | ||||||||||||||||||||
Total interest income excluding loan pool participations | $ | 119,320 | $ | 112,328 | $ | 99,902 | $ | 62,888 | $ | 64,048 | ||||||||||
Total interest and discount on loan pool participations | — | — | 798 | 1,516 | 2,046 | |||||||||||||||
Total interest income including loan pool participations | 119,320 | 112,328 | 100,700 | 64,404 | 66,094 | |||||||||||||||
Total interest expense | 15,145 | 12,722 | 10,648 | 9,551 | 12,132 | |||||||||||||||
Net interest income | 104,175 | 99,606 | 90,052 | 54,853 | 53,962 | |||||||||||||||
Provision for loan losses | 17,334 | 7,983 | 5,132 | 1,200 | 1,350 | |||||||||||||||
Noninterest income | 22,370 | 23,434 | 21,193 | 15,313 | 14,728 | |||||||||||||||
Noninterest expense | 80,136 | 87,806 | 73,176 | 43,413 | 42,087 | |||||||||||||||
Income before income tax | 29,075 | 27,251 | 32,937 | 25,553 | 25,253 | |||||||||||||||
Income tax expense | 10,376 | 6,860 | 7,819 | 7,031 | 6,646 | |||||||||||||||
Net income | $ | 18,699 | $ | 20,391 | $ | 25,118 | $ | 18,522 | $ | 18,607 | ||||||||||
Per share data: | ||||||||||||||||||||
Earnings per common share - basic | $ | 1.55 | $ | 1.78 | $ | 2.42 | $ | 2.20 | $ | 2.19 | ||||||||||
Earnings per common share - diluted | 1.55 | 1.78 | 2.42 | 2.19 | 2.18 | |||||||||||||||
Earnings per common share, exclusive of merger-related expenses - diluted* | N/A | 2.03 | 2.70 | 2.31 | N/A | |||||||||||||||
Earnings per common share, exclusive of deferred tax adjustment - diluted* | 1.82 | N/A | N/A | N/A | N/A | |||||||||||||||
Cash dividends declared | 0.67 | 0.64 | 0.60 | 0.58 | 0.50 | |||||||||||||||
Book value | 27.85 | 26.71 | 25.96 | 23.07 | 20.99 | |||||||||||||||
Net tangible book value* | 21.67 | 20.00 | 19.10 | 22.08 | 19.95 | |||||||||||||||
Selected financial ratios: | ||||||||||||||||||||
Return on average assets | 0.60 | % | 0.68 | % | 0.91 | % | 1.05 | % | 1.06 | % | ||||||||||
Return on average assets, exclusive of merger-related expenses* | N/A | 0.78 | 1.01 | 1.11 | N/A | |||||||||||||||
Return on average assets, exclusive of deferred tax adjustment* | 0.71 | N/A | N/A | N/A | N/A | |||||||||||||||
Return on average equity | 5.58 | 6.69 | 9.84 | 9.94 | 10.59 | |||||||||||||||
Return on average equity, exclusive of merger-related expenses* | N/A | 7.64 | 11.00 | 10.45 | N/A | |||||||||||||||
Return on average equity, exclusive of deferred tax adjustment* | 6.54 | N/A | N/A | N/A | N/A | |||||||||||||||
Return on average tangible equity* | 8.00 | 10.13 | 14.29 | 10.61 | 11.43 | |||||||||||||||
Dividend payout ratio | 43.23 | 35.96 | 24.79 | 26.36 | 22.83 | |||||||||||||||
Total equity to total assets | 10.59 | 9.92 | 9.94 | 10.71 | 10.14 | |||||||||||||||
Tangible equity to tangible assets net of deferred tax on intangibles* | 8.44 | 7.62 | 7.51 | 10.29 | 9.69 | |||||||||||||||
Tier 1 capital to average assets* | 9.48 | 8.75 | 8.34 | 10.85 | 10.55 | |||||||||||||||
Tier 1 capital to risk-weighted assets* | 10.96 | 10.73 | 10.63 | 13.47 | 13.36 | |||||||||||||||
Net interest margin* | 3.83 | 3.80 | 3.71 | 3.53 | 3.46 | |||||||||||||||
Efficiency ratio* | 58.64 | 66.43 | 61.36 | 58.71 | 57.11 | |||||||||||||||
Gross revenue of loan pools to total gross revenue | — | — | 0.72 | 2.16 | 2.98 | |||||||||||||||
Allowance for bank loan losses to total bank loans | 1.23 | 1.01 | 0.90 | 1.44 | 1.49 | |||||||||||||||
Allowance for loan pool losses to total loan pools | — | — | — | 9.94 | 7.71 | |||||||||||||||
Non-performing loans to total loans | 1.04 | 1.31 | 0.54 | 1.15 | 1.27 | |||||||||||||||
Net loans charged off to average loans | 0.51 | 0.26 | 0.11 | 0.09 | 0.11 | |||||||||||||||
* - Non-GAAP measure. See pages 32 - 34 for a detailed explanation. | ||||||||||||||||||||
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Year Ended December 31, | ||||||||||||||||||||
(In thousands) | 2017 | 2016 | 2015 | 2014 | 2013 | |||||||||||||||
Selected balance sheet data: | ||||||||||||||||||||
Total assets | $ | 3,212,271 | $ | 3,079,575 | $ | 2,979,975 | $ | 1,800,302 | $ | 1,755,218 | ||||||||||
Total loans net of purchase accounting and unearned discounts | 2,286,695 | 2,165,143 | 2,151,942 | 1,132,519 | 1,088,412 | |||||||||||||||
Allowance for loan losses | 28,059 | 21,850 | 19,427 | 16,363 | 16,179 | |||||||||||||||
Loan pool participations, net | — | — | — | 19,332 | 25,533 | |||||||||||||||
Total deposits | 2,605,319 | 2,480,448 | 2,463,521 | 1,408,542 | 1,374,942 | |||||||||||||||
Federal funds purchased and repurchase agreements | 97,229 | 117,871 | 68,963 | 78,229 | 66,665 | |||||||||||||||
Federal Home Loan Bank advances | 115,000 | 115,000 | 87,000 | 93,000 | 106,900 | |||||||||||||||
Junior subordinated notes issued to capital trusts | 23,793 | 23,692 | 23,587 | 15,464 | 15,464 | |||||||||||||||
Long-term debt | 12,500 | 17,500 | 22,500 | — | — | |||||||||||||||
Total equity | 340,304 | 305,456 | 296,178 | 192,731 | 178,016 | |||||||||||||||
Non-GAAP Presentations:
Certain ratios and amounts not in conformity with GAAP are provided to evaluate and measure the Company’s operating performance and financial condition, including return on average tangible equity, tangible equity to tangible assets net of deferred tax on intangibles, Tier 1 capital to average assets, Tier 1 capital to risk-weighted assets, efficiency ratio, net income per diluted share - excluding merger-related expenses, net tangible book value, net income per diluted share - exclusive of deferred tax adjustment, net tangible book value, return on average assets - exclusive of merger-related expenses, return on average assets - exclusive of deferred tax adjustment, return on average equity - exclusive of merger-related expenses, return on average equity - exclusive of deferred tax adjustment, and net interest margin, as further discussed under Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. Management believes these ratios and amounts provide investors with information regarding the Company’s balance sheet, profitability, financial condition and capital adequacy and how management evaluates such metrics internally, and that providing certain metrics exclusive on merger-related expenses and the deferred tax adjustment, which were either one-time or non-recurring items, enhances comparability between periods. The following tables provide a reconciliation of each non-GAAP measure to the most comparable GAAP equivalent.
For the Year Ended December 31, | |||||||||||||||||||||
(dollars in thousands) | 2017 | 2016 | 2015 | 2014 | 2013 | ||||||||||||||||
Average Tangible Equity | |||||||||||||||||||||
Average total equity | $ | 334,966 | $ | 304,670 | $ | 255,307 | $ | 186,375 | $ | 175,666 | |||||||||||
Plus: | Average deferred tax liability associated with intangibles | 2,436 | 3,909 | 5,354 | — | — | |||||||||||||||
Less: | Average goodwill and intangibles, net | (78,159 | ) | (81,727 | ) | (69,975 | ) | (8,477 | ) | (9,073 | ) | ||||||||||
Average tangible equity | $ | 259,243 | $ | 226,852 | $ | 190,686 | $ | 177,898 | $ | 166,593 | |||||||||||
Net Income | |||||||||||||||||||||
Net income | $ | 18,699 | $ | 20,391 | $ | 25,118 | $ | 18,522 | $ | 18,607 | |||||||||||
Plus: | Intangible amortization, net of tax(1) | 2,031 | 2,581 | 2,126 | 356 | 431 | |||||||||||||||
Adjusted net income | $ | 20,730 | $ | 22,972 | $ | 27,244 | $ | 18,878 | $ | 19,038 | |||||||||||
Return on Average Tangible Equity | 8.00 | % | 10.13 | % | 14.29 | % | 10.61 | % | 11.43 | % | |||||||||||
(1) Computed on a tax-equivalent basis, assuming a federal income tax rate of 35%. | |||||||||||||||||||||
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For the Year Ended December 31, | |||||||||||||||||||||
(dollars in thousands, except per share amounts) | 2017 | 2016 | 2015 | 2014 | 2013 | ||||||||||||||||
Tangible Equity | |||||||||||||||||||||
Total equity | $ | 340,304 | $ | 305,456 | $ | 296,179 | $ | 192,731 | $ | 178,016 | |||||||||||
Plus: | Deferred tax liability associated with intangibles | 1,241 | 3,068 | 5,366 | — | — | |||||||||||||||
Less: | Goodwill and intangibles, net | (76,700 | ) | (79,825 | ) | (83,689 | ) | (8,259 | ) | (8,806 | ) | ||||||||||
Tangible common equity | $ | 264,845 | $ | 228,699 | $ | 217,856 | $ | 184,472 | $ | 169,210 | |||||||||||
Tangible Assets | |||||||||||||||||||||
Total assets | $ | 3,212,271 | $ | 3,079,575 | $ | 2,979,975 | $ | 1,800,302 | $ | 1,755,218 | |||||||||||
Plus: | Deferred tax liability associated with intangibles | 1,241 | 3,068 | 5,366 | — | — | |||||||||||||||
Less: | Goodwill and intangibles, net | (76,700 | ) | (79,825 | ) | (83,689 | ) | (8,259 | ) | (8,806 | ) | ||||||||||
Tangible Assets | $ | 3,136,812 | $ | 3,002,818 | $ | 2,901,652 | $ | 1,792,043 | $ | 1,746,412 | |||||||||||
Common shares outstanding | 12,219,611 | 11,436,360 | 11,408,773 | 8,355,666 | 8,481,799 | ||||||||||||||||
Net Tangible Book Value Per Share | $ | 21.67 | $ | 20.00 | $ | 19.10 | $ | 22.08 | $ | 19.95 | |||||||||||
Tangible Equity to Tangible Assets, Net of Deferred Tax on Intangibles | 8.44 | % | 7.62 | % | 7.51 | % | 10.29 | % | 9.69 | % | |||||||||||
Tier 1 Capital | |||||||||||||||||||||
Total equity | $ | 340,304 | $ | 305,456 | $ | 296,179 | $ | 192,731 | $ | 178,016 | |||||||||||
Plus: | Long term debt (qualifying restricted core capital) | 23,793 | 23,666 | 23,587 | 15,464 | 15,464 | |||||||||||||||
Less: | Net unrealized gains on securities available for sale, net of tax | 2,602 | 1,133 | (3,408 | ) | (5,322 | ) | (1,049 | ) | ||||||||||||
Disallowed goodwill and intangibles | (73,340 | ) | (71,951 | ) | (72,203 | ) | (8,511 | ) | (9,036 | ) | |||||||||||
Tier 1 capital | $ | 293,359 | $ | 258,304 | $ | 244,155 | $ | 194,362 | $ | 183,395 | |||||||||||
Average Assets | |||||||||||||||||||||
Quarterly average assets | $ | 3,169,081 | $ | 3,022,919 | $ | 3,000,284 | $ | 1,799,666 | $ | 1,746,313 | |||||||||||
Less: | Disallowed goodwill and intangibles | (73,340 | ) | (71,951 | ) | (72,203 | ) | (8,511 | ) | (9,036 | ) | ||||||||||
Average assets | $ | 3,095,741 | $ | 2,950,968 | $ | 2,928,081 | $ | 1,791,155 | $ | 1,737,277 | |||||||||||
Tier 1 Capital to Average Assets | 9.48 | % | 8.75 | % | 8.34 | % | 10.85 | % | 10.56 | % | |||||||||||
Risk-weighted assets | $ | 2,677,721 | $ | 2,407,661 | $ | 2,296,478 | $ | 1,442,585 | $ | 1,372,648 | |||||||||||
Tier 1 Capital to Risk-Weighted Assets | 10.96 | % | 10.73 | % | 10.63 | % | 13.47 | % | 13.36 | % | |||||||||||
Operating Expense | |||||||||||||||||||||
Total noninterest expense | $ | 80,136 | $ | 87,806 | $ | 73,176 | $ | 43,413 | $ | 42,087 | |||||||||||
Less: | Amortization of intangibles and goodwill impairment | (3,125 | ) | (3,970 | ) | (3,271 | ) | (547 | ) | (663 | ) | ||||||||||
Operating expense | $ | 77,011 | $ | 83,836 | $ | 69,905 | $ | 42,866 | $ | 41,424 | |||||||||||
Operating Revenue | |||||||||||||||||||||
Tax-equivalent net interest income(1) | $ | 109,202 | $ | 104,321 | $ | 94,243 | $ | 58,890 | $ | 57,720 | |||||||||||
Plus: | Noninterest income | 22,370 | 23,434 | 21,193 | 15,313 | 14,728 | |||||||||||||||
Impairment losses on investment securities | — | — | — | — | — | ||||||||||||||||
Less: | Gain on sale or call of available for sale securities | 188 | 464 | 1,011 | 1,227 | 65 | |||||||||||||||
Gain on sale or call of held to maturity securities | 53 | — | — | — | — | ||||||||||||||||
Gain (loss) on sale of premises and equipment | 2 | (44 | ) | (29 | ) | (1 | ) | (3 | ) | ||||||||||||
Other gain (loss) | 11 | 1,133 | 527 | (37 | ) | (146 | ) | ||||||||||||||
Operating Revenue | $ | 131,318 | $ | 126,202 | $ | 113,927 | $ | 73,014 | $ | 72,532 | |||||||||||
Efficiency Ratio | 58.64 | % | 66.43 | % | 61.36 | % | 58.71 | % | 57.11 | % | |||||||||||
(1) Computed on a tax-equivalent basis, assuming a federal income tax rate of 35%. | |||||||||||||||||||||
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For the Year Ended December 31, | |||||||||||||||||||||
(dollars in thousands, except per share amounts) | 2017 | 2016 | 2015 | 2014 | 2013 | ||||||||||||||||
Net Interest Margin Tax Equivalent Adjustment | |||||||||||||||||||||
Net interest income | $ | 104,175 | $ | 99,606 | $ | 90,052 | $ | 54,853 | $ | 53,962 | |||||||||||
Plus tax equivalent adjustment:(1) | |||||||||||||||||||||
Loans | 1,730 | 1,692 | 1,293 | 1,157 | 963 | ||||||||||||||||
Securities | 3,297 | 3,023 | 2,898 | 2,880 | 2,795 | ||||||||||||||||
Tax equivalent net interest income(1) | $ | 109,202 | $ | 104,321 | $ | 94,243 | $ | 58,890 | $ | 57,720 | |||||||||||
Average interest-earning assets | $ | 2,853,830 | $ | 2,747,493 | $ | 2,541,681 | $ | 1,669,130 | $ | 1,667,251 | |||||||||||
Net Interest Margin | 3.83 | % | 3.80 | % | 3.71 | % | 3.53 | % | 3.46 | % | |||||||||||
Net Income | $ | 18,699 | $ | 20,391 | $ | 25,118 | $ | 18,522 | $ | 18,607 | |||||||||||
Plus: | Merger-related expenses | — | 4,568 | 3,512 | 1,061 | — | |||||||||||||||
Deferred tax adjustment(2) | 3,212 | — | — | — | — | ||||||||||||||||
Less: | Net tax effect of merger-related expenses(3) | — | (1,682 | ) | (539 | ) | (111 | ) | — | ||||||||||||
Net income, exclusive of merger-related expenses | $ | 21,911 | $ | 23,277 | $ | 28,091 | $ | 19,472 | $ | 18,607 | |||||||||||
Average Assets | $ | 3,097,496 | $ | 2,993,875 | $ | 2,773,095 | $ | 1,760,776 | $ | 1,756,344 | |||||||||||
Average Equity | $ | 334,966 | $ | 304,670 | $ | 255,307 | $ | 186,375 | $ | 175,666 | |||||||||||
Diluted average number of shares | 12,062,577 | 11,456,324 | 10,391,323 | 8,433,296 | 8,525,119 | ||||||||||||||||
Return on Average Assets | 0.60 | % | 0.68 | % | 0.91 | % | 1.05 | % | 1.06 | % | |||||||||||
Return on Average Assets, Exclusive of Merger-related Expenses | N/A | 0.78 | % | 1.01 | % | 1.11 | % | N/A | |||||||||||||
Return on Average Assets, Exclusive of Deferred Tax Adjustment | 0.71 | % | N/A | N/A | N/A | N/A | |||||||||||||||
Return on Average Equity | 5.58 | % | 6.69 | % | 9.84 | % | 9.94 | % | 10.59 | % | |||||||||||
Return on Average Equity, Exclusive of Merger-related Expenses | N/A | 7.64 | % | 11.00 | % | 10.45 | % | N/A | |||||||||||||
Return on Average Equity, Exclusive of Deferred Tax Adjustment | 6.54 | % | N/A | N/A | N/A | N/A | |||||||||||||||
Earnings Per Common Share-Diluted | $ | 1.55 | $ | 1.78 | $ | 2.42 | $ | 2.19 | $ | 2.18 | |||||||||||
Earnings Per Common Share-Diluted, Exclusive of Merger-related Expenses | N/A | $ | 2.03 | $ | 2.70 | $ | 2.31 | N/A | |||||||||||||
Earnings Per Common Share-Diluted, Deferred Tax Adjustment | $ | 1.82 | N/A | N/A | N/A | N/A | |||||||||||||||
(1) Computed on a tax-equivalent basis, assuming a federal income tax rate of 35%. | |||||||||||||||||||||
(2) Reflective of the adjustment of deferred taxes related to the change of corporate tax rate from 35% to 21%, effective December 22, 2017. | |||||||||||||||||||||
(3) Computed assuming a combined state and federal tax rate of 38% on eligible tax-deductible expenses. | |||||||||||||||||||||
ITEM 7. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. |
This section should be read in conjunction with the following parts of this Form 10-K: Part II, Item 8 “Financial Statements and Supplementary Data,” Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” and Part I, Item 1 “Business.”
Overview
We are the holding company for MidWestOne Bank, an Iowa state non-member bank with its main office in Iowa City, Iowa. We are headquartered in Iowa City, Iowa, and are a bank holding company under the Bank Holding Company Act of 1956, as amended, that has elected to be a financial holding company. We also are the holding company for MidWestOne Insurance Services, Inc., which operates an insurance business through three agencies located in central and east-central Iowa.
The Bank operates a total of 44 banking offices in Iowa, Minnesota, Wisconsin, Florida, and Colorado. It provides full service retail banking in the communities in which its branch offices are located and also offers trust and investment management services.
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On May 1, 2015, we completed our merger with Central, pursuant to which Central was merged with and into the Company. In connection with the merger, Central Bank, a Minnesota-chartered commercial bank and wholly-owned subsidiary of Central, became a wholly-owned subsidiary of the Company. On April 2, 2016, Central Bank merged with and into the Bank. See Note 2. “Business Combination” to our consolidated financial statements.
MidWestOne Financial Group showed many improvements in operating performance in 2017 compared to 2016. However, during the fourth quarter of 2017 a credit impairment related to a loan made to one commercial borrower caused the Company’s performance to fall short of our expectations.
Net income for the year ended December 31, 2017 was $18.7 million, a decrease of $1.7 million, or 8.3%, compared to $20.4 million of net income for 2016, with diluted earnings per share of $1.55 and $1.78 for the comparative twelve month periods, respectively. The decrease in net income was due primarily to the provision for loans losses increasing by $9.4 million in 2017 compared to 2016, due primarily to a previously disclosed $7.3 million credit impairment related to a loan made to a commercial borrower. This was partially offset by a $7.7 million, or 8.7%, decrease in noninterest expense driven by a $4.6 million decrease in merger-related expenses, mainly in data processing ($1.9 million) and salaries and employee benefits expense ($1.9 million), attributable to the merger of Central Bank into MidWestOne Bank in 2016. Net interest income increased $4.6 million, or 4.6%, and noninterest income decreased $1.1 million, or 4.5% between 2016 and 2017. Also, the Company realized a $3.5 million increase in income tax expense, $3.2 million of which was related to the revaluation of the Company’s deferred tax assets in accordance with the Tax Cuts and Jobs Act (the “Tax Act”).
Total assets increased to $3.21 billion at December 31, 2017 from $3.08 billion at December 31, 2016. Total deposits at December 31, 2017, were $2.61 billion, an increase of $124.9 million, or 5.0%, from December 31, 2016. The mix of deposits experienced increases between December 31, 2016 and December 31, 2017 of $91.8 million, or 8.1%, in interest-bearing checking deposits, $15.7 million, or 8.0%, in savings deposits, and $49.9 million, or 7.66%, in certificates of deposit. These increases were partially offset by a decrease in non-interest bearing demand deposits of $32.6 million, or 6.6% between December 31, 2016 and December 31, 2017. Total loans (excluding loans held for sale) increased $121.6 million, or 5.6%, from $2.17 billion at December 31, 2016, to $2.29 billion at December 31, 2017. The increase was primarily concentrated in commercial real estate-other, construction and development, and commercial and industrial loans. On a geographic basis, loans increased in Minnesota, Wisconsin, Florida, and Colorado and decreased in Iowa, while the Iowa market contributed the largest increase in deposits in the Company.
Net interest income for the year ended December 31, 2017, was $104.2 million, up $4.6 million, or 4.6%, from $99.6 million for the year ended December 31, 2016, primarily due to an increase of $7.0 million, or 6.2%, in interest income. Loan interest income increased $4.2 million, or 4.3%, to $102.4 million for the year 2017 compared to the year 2016, primarily due to an increase in portfolio loan yield, which included the effect of an increase in the merger-related discount accretion to $4.8 million for the year ended December 31, 2017, compared to $3.2 million for the year ended December 31, 2016, as well as an increase in average loan balances of $40.0 million, or 1.9%, between the two periods. Interest expense was $15.1 million for the year ended December 31, 2017, an increase of $2.4 million, or 19.0%, compared to the year of 2016. Interest expense on deposits increased $2.1 million, or 22.5%, to $11.5 million for the year ended December 31, 2017 (with no merger-related amortization of the purchase accounting premium on certificates of deposit), compared to $9.4 million (including $0.9 million in merger-related amortization) for the year ended December 31, 2016. We posted a net interest margin of 3.83% for the year 2017, up 3 basis points from the net interest margin of 3.80% for the same period in 2016. An increase in both the volume of and yield received on loans was the primary driver of the increased margin.
For the year ended December 31, 2017, noninterest income decreased to $22.4 million, a decrease of $1.1 million, or 4.5%, from $23.4 million during 2016. This decline was primarily due to the $1.1 million decrease in other gains for the year ended December 31, 2017, compared to the same period in 2016. The year of 2016 included a net gain on other real estate owned of $0.6 million, a net gain on the sale of the Rice Lake and Barron, Wisconsin, and Davenport, Iowa, branch offices of $1.2 million, and the writedown of other real estate owned of $0.6 million. Loan origination and servicing fees decreased $0.4 million, or 9.3%, between the comparative periods, and gains on the sale of available for sale securities decreased $0.3 million between the comparative 2016 and 2017 periods. These decreases were partially offset by an increase of $0.6 million, or 11.0%, in trust, investment, and insurance fees to $6.2 million for the year of 2017 compared with $5.6 million for the same period in 2016 due to the hiring of additional business development officers, growth in equity markets, and an increase in overall sales volume.
Noninterest expense decreased to $80.1 million for the year ended December 31, 2017 compared with $87.8 million for the year ended December 31, 2016, a decrease of $7.7 million, or 8.7%. All categories of noninterest expense decreased for the year ended December 31, 2017, primarily due to the absence of merger-related expenses for the year ended December 31, 2017, compared to $4.6 million for the year ended December 31, 2016 relating to the merger of Central Bank into MidWestOne Bank. Data processing expense declined $2.3 million, or 45.9%, for the year ended December 31, 2017, compared to the year ended
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December 31, 2016, primarily due to the inclusion of $1.9 million in contract termination expense in connection with the bank merger in 2016. Salaries and employee benefits decreased $1.8 million, or 3.5%, from $49.6 million for the year ended December 31, 2016, to $47.9 million for the year ended December 31, 2017. This decrease was primarily due to $1.9 million of merger-related expenses for the year ended December 31, 2016. Other operating expenses decreased $1.5 million, or 14.3%, from $10.4 million for the year ended December 31, 2016, to $8.9 million for the year ended December 31, 2017, primarily due to lower customer fraud losses and deposit account charge-offs.
Nonperforming loans decreased from $28.5 million, or 1.31% of total bank loans, at December 31, 2016, to $23.9 million, or 1.04% of total bank loans, at December 31, 2017. The decrease was due primarily to a lower level of nonaccrual loans. As of December 31, 2017, the allowance for loan losses was $28.1 million, or 1.23% of total loans, compared with $21.9 million, or 1.01% of total loans at December 31, 2016. The allowance for loan losses represented 117.59% of nonperforming loans at December 31, 2017, compared with 76.76% of nonperforming loans at December 31, 2016. The Company had net loan charge-offs of $11.1 million in the year ended December 31, 2017, or an annualized 0.51% of average loans outstanding, and our level of non-performing loans to total loans decreased to 1.04%, compared to net charge-offs of $5.6 million, or an annualized 0.26% of average loans outstanding, and a non-performing loans to total loan ratio of 1.31% for the same period of 2016. During the fourth quarter of 2017, the Company identified an additional $7.3 million of credit impairment related to a loan made to one of its commercial borrowers based on new information received about the financial status of the borrower. Prior to the fourth quarter of 2017, this loan had been classified as substandard and had a specific allowance for loan losses related to it of $1.9 million.
The Company’s capital position increased in 2017 compared to 2016, with our tangible equity to tangible assets (both net of associated deferred tax liability on intangibles) ratio of 8.44%, which is inside of our target range of 8.00% to 8.50%, and higher than the December 31, 2016 ratio of 7.62%. Our regulatory capital levels remain well above the minimums established to be considered well-capitalized.
Critical Accounting Policies
We have identified the following critical accounting policies and practices relative to the reporting of our results of operations and financial condition. These accounting policies relate to the allowance for loan losses, application of purchase accounting, goodwill and intangible assets, and fair value of available for sale investment securities.
Allowance for Loan Losses
The allowance for loan losses is based on our estimate of probable incurred credit losses in our loan portfolio. In evaluating our loan portfolio, we take into consideration numerous factors, including current economic conditions, prior loan loss experience, the composition of the loan portfolio, and management’s estimate of probable credit losses. The allowance for loan losses is established through a provision for loss based on our evaluation of the risk inherent in the loan portfolio, the composition of the portfolio, specific impaired loans, and current economic conditions. Such evaluation, which includes a review of all loans on which full collectability may not be reasonably assured, considers, among other matters, the estimated net realizable value or the fair value of the underlying collateral, economic conditions, historical loss experience, and other factors that warrant recognition in providing for an appropriate allowance for loan losses. In the event that our evaluation of the level of the allowance for loan losses indicates that it is inadequate, we would need to increase our provision for loan losses. We believed the allowance for loan losses as of December 31, 2017, was adequate to absorb probable losses in the existing portfolio.
Application of Purchase Accounting
In May 2015, we completed the acquisition of Central, which generated significant amounts of fair value adjustments to assets and liabilities. The fair value adjustments assigned to assets and liabilities, as well as their related useful lives, are subject to judgment and estimation by our management. Valuation of intangible assets is generally based on the estimated cash flows related to those assets, while the initial value assigned to goodwill is the residual of the purchase price over the fair value of all identifiable assets acquired and liabilities assumed. Useful lives are determined based on the expected future period of the benefit of the asset or liability, the assessment of which considers various characteristics of the asset or liability, including the historical cash flows. Due to the number of estimates involved related to the allocation of purchase price and determining the appropriate useful lives, we have identified purchase accounting as a critical accounting policy.
Goodwill and Intangible Assets
Goodwill and intangible assets arise from business combinations accounted for as a purchase. In May 2015, we completed our merger with Central. We were deemed to be the purchaser for accounting purposes and thus recognized goodwill and other intangible assets in connection with the merger. The goodwill was assigned to the Bank. As a general matter, goodwill and other
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intangible assets generated from purchase business combinations and deemed to have indefinite lives are not subject to amortization and are instead tested for impairment at least annually. The other intangible assets reflected on our financial statements are core deposit premium, insurance agency, trade name, and customer list intangibles. The establishment and subsequent amortization, when required by the accounting standards, of these intangible assets involve the use of significant estimates and assumptions. These estimates and assumptions include, among other things, the estimated cost to service deposits acquired, discount rates, estimated attrition rates and useful lives, future economic and market conditions, comparison of our market value to book value and determination of appropriate market comparables. Actual future results may differ from those estimates. We assess these intangible assets for impairment annually or more often if conditions indicate a possible impairment. Periodically we evaluate the estimated useful lives of intangible assets and whether events or changes in circumstances warrant a revision to the remaining periods of amortization. Recoverability of these assets is measured by comparison of the carrying amount of the asset to the future undiscounted cash flows the asset is expected to generate. If the asset is considered to be impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset. See Note 6. “Goodwill and Intangible Assets” to our consolidated financial statements for additional information related to our intangible assets.
Fair Value of Available for Sale Securities
Securities available for sale are reported at fair value, with unrealized gains and losses reported as a separate component of accumulated other comprehensive income, net of deferred income taxes. Declines in fair value of individual securities, below their amortized cost, are evaluated by management to determine whether the decline is temporary or “other-than-temporary.’’ Declines in the fair value of available for sale securities below their cost that are deemed “other-than-temporary” are reflected in earnings as impairment losses. In determining whether other-than-temporary impairment (“OTTI”) exists, management considers whether: (1) we have the intent to sell the security, (2) it is more likely than not that we will be required to sell the security before recovery of the amortized cost basis, and (3) we do not expect to recover the entire amortized cost basis of the security. When we determine that OTTI has occurred, the amount of the OTTI recognized in earnings depends on whether we intend to sell the security or whether it is more likely than not we will be required to sell the security before recovery of its amortized cost basis. If we intend to sell, or it is more likely than not we will be required to sell, the security before recovery of its amortized cost basis, the OTTI recognized in earnings is equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If we do not intend to sell the security, and it is not more likely than not that we will be required to sell before recovery of its amortized cost basis, the OTTI is separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected, using the original yield as the discount rate, and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in accumulated other comprehensive income (loss), net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment. The assessment of whether an OTTI exists involves a high degree of subjectivity and judgment and is based on the information available to management at the time.
Results of Operations - Three-Year Period Ended December 31, 2017
Summary
Our consolidated net income for the year ended December 31, 2017 was $18.7 million, a decrease of $1.7 million, or 8.3%, compared to $20.4 million for 2016, with diluted earnings per share of $1.55 and $1.78 for the comparative twelve month periods, respectively. The decrease in net income was due primarily to the provision for loans losses increasing $9.4 million in 2017 compared to 2016, due primarily to the previously disclosed credit impairment related to a loan made to one commercial borrower. This was partially offset by a $7.7 million, or 8.7%, decrease in noninterest expense driven by a $4.6 million decrease in merger-related expenses, mainly in data processing ($1.9 million) and salaries and employee benefits expense ($1.9 million), attributable to the merger of Central Bank into MidWestOne Bank in 2016. Net interest income increased $4.6 million, or 4.6%, primarily due to an increase of $7.0 million, or 6.2%, in interest income partially offset by an increase of $2.4 million, or 19.0%, in interest expense, to $15.1 million for the year ended December 31, 2017, compared to $12.7 million for the year of 2016. Noninterest income decreased $1.1 million, or 4.5% between 2016 and 2017, primarily due to the $1.1 million decrease in other gains for the year ended December 31, 2017, compared to the same period in 2016. The year of 2016 included a net gain on other real estate owned of $0.6 million, a net gain on the sale of the Rice Lake and Barron, Wisconsin, and Davenport, Iowa, branch offices of $1.2 million, and the writedown of other real estate owned of $0.6 million. Also, the Company realized a $3.5 million increase in income tax expense in 2017 compared to 2016, $3.2 million of which was related to the revaluation of the Company’s deferred tax assets in accordance with the Tax Act.
Our consolidated net income for the year ended December 31, 2016 was $20.4 million, or $1.78 per fully-diluted share, compared to net income of $25.1 million, or $2.42 per fully-diluted share, for the year ended December 31, 2015. The decrease in consolidated net income was due primarily to a $14.6 million, or 20.0%, increase in noninterest expense from 2015 to 2016,
37
which was mainly due to the inclusion of a full year of expenses related to the Central merger in 2016, versus eight months of post-merger operations in 2015. Salaries and employee benefits increased $7.7 million, or 18.5%, from the year ended December 31, 2015 to the year ended December 31, 2016. In addition, the provision for loan losses for the year 2016 increased $2.9 million to $8.0 million from $5.1 million for the same period in 2015, primarily due to the increased level of impaired loans and the greater level of loans moving from the purchased accounting portfolio to our standard methodology for the allowance for loan and lease losses (“ALLL”) in 2016. Partially offsetting these expense increases was a $9.5 million, or 10.6%, increase in net interest income, again mainly related to the merger with Central. We also experienced a mainly merger-related increase in noninterest income to $23.4 million for the year ended December 31, 2016 from $21.2 million for 2015, which was primarily due to a $1.0 million increase in loan origination and servicing fees to $3.8 million, compared with $2.8 million in 2015. Merger-related expenses paid were $4.6 million ($2.9 million after tax), for the year ended December 31, 2016, compared to $3.5 million ($3.0 million after tax) for the year ended December 31, 2015. After excluding the effects of the merger-related expenses, adjusted diluted earnings per share for the year ended December 31, 2016 were $2.03, compared to $2.70 for the year ended December 31, 2015.
We ended 2017 with an allowance for loan losses of $28.1 million, which represented 117.59% coverage of our nonperforming loans at December 31, 2017 as compared to 76.76% at December 31, 2016 and 168.52% coverage of our nonperforming loans at December 31, 2015. Nonperforming loans totaled $23.9 million as of December 31, 2017 compared with $28.5 million and $11.5 million at December 31, 2016 and December 31, 2015, respectively. For the year ended December 31, 2017, the provision for loan losses increased to $17.3 million from $8.0 million for 2016, which had increased from $5.1 million for 2015. The increased provision for 2017 compared to 2016 primarily reflects the identification of $7.3 million of credit impairment related to a loan made to one of the Company’s commercial borrowers based on new information received about the financial status of the borrower in the fourth quarter of 2017, and the increase in outstanding loan balances due to organic loan growth. The increased provision for 2016 compared to 2015 primarily reflects the increase in nonperforming loans and the increase in outstanding loan balances due to the merger and organic growth.
Various operating and equity ratios for the Company are presented in the table below for the years indicated. The dividend payout ratio represents the percentage of our prior year’s net income that is paid to shareholders in the form of cash dividends. Average equity to average assets is a measure of capital adequacy that presents the percentage of average total shareholders’ equity compared to our average assets. The equity to assets ratio is expressed using the period-end amounts instead of an average amount. As of December 31, 2017, under regulatory standards, the Bank had capital levels in excess of the minimums necessary to be considered “well capitalized,” which is the highest regulatory designation.
As of and For the Years Ended December 31, | |||||||||
2017 | 2016 | 2015 | |||||||
Return on average assets | 0.60 | % | 0.68 | % | 0.91 | % | |||
Return on average shareholders' total equity | 5.58 | 6.69 | 9.84 | ||||||
Return on average tangible equity* | 8.00 | 10.13 | 14.29 | ||||||
Dividend payout ratio | 43.23 | 35.96 | 24.79 | ||||||
Average equity to average assets | 10.81 | 10.18 | 9.21 | ||||||
Equity to assets ratio (at period end) | 10.59 | 9.92 | 9.94 | ||||||
* For information on the calculation of non-GAAP measures, please see pages 32 to 34.
Net Interest Income
Net interest income is the difference between interest income and fees earned on interest-earning assets, less interest expense incurred on interest-bearing liabilities. Interest rate levels and volume fluctuations within interest-earning assets and interest-bearing liabilities impact net interest income. Net interest margin is tax-equivalent net interest income as a percent of average interest-earning assets.
Certain assets with tax favorable treatment are evaluated on a tax-equivalent basis. Tax-equivalent basis assumes a federal income tax rate of 35%. Tax favorable assets generally have lower contractual pre-tax yields than fully taxable assets. A tax-equivalent analysis is performed by adding the tax savings to the earnings on tax favorable assets. After factoring in the tax favorable effects of these assets, the yields may be more appropriately evaluated against alternative interest-earning assets. In addition to yield, various other risks are factored into the evaluation process.
38
The following table shows the consolidated average balance sheets, detailing the major categories of assets and liabilities, the interest income earned on interest-earning assets, the interest expense paid for interest-bearing liabilities, and the related interest rates/yields for the periods shown. Average information is provided on a daily average basis.
Year ended December 31, | ||||||||||||||||||||||||||||||||
2017 | 2016 | 2015 | ||||||||||||||||||||||||||||||
Average Balance | Interest Income/ Expense | Average Rate/Yield | Average Balance | Interest Income/ Expense | Average Rate/Yield | Average Balance | Interest Income/ Expense | Average Rate/Yield | ||||||||||||||||||||||||
(dollars in thousands) | ||||||||||||||||||||||||||||||||
Average interest-earning assets: | ||||||||||||||||||||||||||||||||
Loans (1)(2)(3) | $ | 2,201,364 | $ | 104,096 | 4.73 | % | $ | 2,161,376 | $ | 99,854 | 4.62 | % | $ | 1,962,846 | $ | 87,837 | 4.47 | % | ||||||||||||||
Loan pool participations (4) | — | — | — | — | — | — | 10,032 | 798 | 7.95 | |||||||||||||||||||||||
Investment securities: | ||||||||||||||||||||||||||||||||
Taxable investments | 423,678 | 10,573 | 2.50 | 358,727 | 8,297 | 2.31 | 362,217 | 7,734 | 2.14 | |||||||||||||||||||||||
Tax exempt investments (2) | 217,650 | 9,536 | 4.38 | 192,656 | 8,726 | 4.53 | 180,298 | 8,451 | 4.69 | |||||||||||||||||||||||
Total investment securities | 641,328 | 20,109 | 3.14 | 551,383 | 17,023 | 3.09 | 542,515 | 16,185 | 2.98 | |||||||||||||||||||||||
Federal funds sold and interest-bearing balances | 11,138 | 142 | 1.27 | 34,734 | 166 | 0.48 | 26,288 | 71 | 0.27 | |||||||||||||||||||||||
Total earning assets | $ | 2,853,830 | $ | 124,347 | 4.36 | % | $ | 2,747,493 | $ | 117,043 | 4.26 | % | $ | 2,541,681 | $ | 104,891 | 4.13 | % | ||||||||||||||
Noninterest-earning assets: | ||||||||||||||||||||||||||||||||
Cash and due from banks | 35,745 | 37,335 | 39,474 | |||||||||||||||||||||||||||||
Premises and equipment | 75,082 | 75,948 | 66,842 | |||||||||||||||||||||||||||||
Allowance for loan losses | (23,557 | ) | (20,909 | ) | (18,866 | ) | ||||||||||||||||||||||||||
Other assets | 156,396 | 154,008 | 143,964 | |||||||||||||||||||||||||||||
Total assets | $ | 3,097,496 | $ | 2,993,875 | $ | 2,773,095 | ||||||||||||||||||||||||||
Average interest-bearing liabilities: | ||||||||||||||||||||||||||||||||
Savings and interest-bearing demand deposits | $ | 1,357,554 | $ | 3,863 | 0.28 | % | $ | 1,282,994 | $ | 3,418 | 0.27 | % | $ | 1,139,175 | $ | 2,987 | 0.26 | % | ||||||||||||||
Certificates of deposit | 674,757 | 7,626 | 1.13 | 649,986 | 5,961 | 0.92 | 648,516 | 4,851 | 0.75 | |||||||||||||||||||||||
Total deposits | 2,032,311 | 11,489 | 0.57 | 1,932,980 | 9,379 | 0.49 | 1,787,691 | 7,838 | 0.44 | |||||||||||||||||||||||
Federal funds purchased and repurchase agreements | 87,763 | 412 | 0.47 | 74,566 | 205 | 0.27 | 69,498 | 210 | 0.30 | |||||||||||||||||||||||
Federal Home Loan Bank borrowings | 110,000 | 1,838 | 1.67 | 104,954 | 1,827 | 1.74 | 86,614 | 1,451 | 1.68 | |||||||||||||||||||||||
Long-term debt and other | 40,679 | 1,406 | 3.46 | 45,788 | 1,311 | 2.86 | 40,603 | 1,149 | 2.83 | |||||||||||||||||||||||
Total borrowed funds | 238,442 | 3,656 | 1.53 | 225,308 | 3,343 | 1.48 | 196,715 | 2,810 | 1.43 | |||||||||||||||||||||||
Total interest-bearing liabilities | $ | 2,270,753 | $ | 15,145 | 0.67 | % | $ | 2,158,288 | $ | 12,722 | 0.59 | % | $ | 1,984,406 | $ | 10,648 | 0.54 | % | ||||||||||||||
Net interest spread (2) | 3.69 | % | 3.67 | % | 3.59 | % | ||||||||||||||||||||||||||
Noninterest-bearing liabilities | ||||||||||||||||||||||||||||||||
Demand deposits | $ | 471,170 | $ | 512,383 | $ | 488,312 | ||||||||||||||||||||||||||
Other liabilities | 20,607 | 18,534 | 45,070 | |||||||||||||||||||||||||||||
Shareholders’ equity | 334,966 | 304,670 | 255,307 | |||||||||||||||||||||||||||||
Total liabilities and shareholders’ equity | $ | 3,097,496 | $ | 2,993,875 | $ | 2,773,095 | ||||||||||||||||||||||||||
Interest income/earning assets (2) | $ | 2,853,830 | $ | 124,347 | 4.36 | % | $ | 2,747,493 | $ | 117,043 | 4.26 | % | $ | 2,541,681 | $ | 104,891 | 4.13 | % | ||||||||||||||
Interest expense/earning assets | $ | 2,853,830 | $ | 15,145 | 0.53 | % | $ | 2,747,493 | $ | 12,722 | 0.46 | % | $ | 2,541,681 | $ | 10,648 | 0.42 | % | ||||||||||||||
Net interest income/margin (2)(5) | $ | 109,202 | 3.83 | % | $ | 104,321 | 3.80 | % | $ | 94,243 | 3.71 | % | ||||||||||||||||||||
Non-GAAP to GAAP Reconciliation: | ||||||||||||||||||||||||||||||||
Tax Equivalent Adjustment: | ||||||||||||||||||||||||||||||||
Loans | $ | 1,730 | $ | 1,692 | $ | 1,293 | ||||||||||||||||||||||||||
Securities | 3,297 | 3,023 | 2,898 | |||||||||||||||||||||||||||||
Total tax equivalent adjustment | 5,027 | 4,715 | 4,191 | |||||||||||||||||||||||||||||
Net Interest Income | $ | 104,175 | $ | 99,606 | $ | 90,052 | ||||||||||||||||||||||||||
(1) | Loan fees included in interest income are not material. | |
(2) | Computed on a tax-equivalent basis, assuming a federal income tax rate of 35%. | |
(3) | Non-accrual loans have been included in average loans, net of unearned discount. | |
(4) | Includes interest income and discount realized on loan pool participations. | |
(5) | Net interest margin is tax-equivalent net interest income as a percentage of average interest-earning assets. | |
39
The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It distinguishes between the difference related to changes in average outstanding balances and the increase or decrease due to the levels and volatility of interest rates. For each category of interest-earning assets and interest-bearing liabilities information is provided on changes attributable to (i) changes in volume (i.e. changes in volume multiplied by old rate) and (ii) changes in rate (i.e. changes in rate multiplied by old volume). For purposes of this table, changes attributable to both rate and volume that cannot be segregated have been allocated proportionately to the change due to volume and the change due to rate.
Years Ended December 31, 2017, 2016, and 2015 | |||||||||||||||||||||||
Year 2017 to 2016 Change due to | Year 2016 to 2015 Change due to | ||||||||||||||||||||||
Volume | Rate/Yield | Net | Volume | Rate/Yield | Net | ||||||||||||||||||
(dollars in thousands) | |||||||||||||||||||||||
Increase (decrease) in interest income | |||||||||||||||||||||||
Loans (tax equivalent) | $ | 1,867 | $ | 2,375 | $ | 4,242 | $ | 9,102 | $ | 2,915 | $ | 12,017 | |||||||||||
Loan pool participations | — | — | — | (399 | ) | (399 | ) | 798 | |||||||||||||||
Investment securities: | |||||||||||||||||||||||
Taxable investments | 1,585 | 691 | 2,276 | (75 | ) | 638 | 563 | ||||||||||||||||
Tax exempt investments (tax equivalent) | 1,103 | (293 | ) | 810 | 566 | (291 | ) | 275 | |||||||||||||||
Total investment securities | 2,688 | 398 | 3,086 | 491 | 347 | 838 | |||||||||||||||||
Federal funds sold and interest-bearing balances | (167 | ) | 143 | (24 | ) | 28 | 67 | 95 | |||||||||||||||
Change in interest income | 4,388 | 2,916 | 7,304 | 9,222 | 2,930 | 12,152 | |||||||||||||||||
Increase (decrease) in interest expense | |||||||||||||||||||||||
Savings and interest-bearing demand deposits | 205 | 240 | 445 | 382 | 49 | 431 | |||||||||||||||||
Certificates of deposit | 235 | 1,430 | 1,665 | 11 | 1,099 | 1,110 | |||||||||||||||||
Total deposits | 440 | 1,670 | 2,110 | 393 | 1,148 | 1,541 | |||||||||||||||||
Federal funds purchased and repurchase agreements | 41 | 166 | 207 | 15 | (20 | ) | (5 | ) | |||||||||||||||
Federal Home Loan Bank borrowings | 86 | (75 | ) | 11 | 317 | 59 | 376 | ||||||||||||||||
Other long-term debt | (157 | ) | 252 | 95 | 148 | 14 | 162 | ||||||||||||||||
Total borrowed funds | (30 | ) | 343 | 313 | 480 | 53 | 533 | ||||||||||||||||
Change in interest expense | 410 | 2,013 | 2,423 | 873 | 1,201 | 2,074 | |||||||||||||||||
Increase in net interest income | $ | 3,978 | $ | 903 | $ | 4,881 | $ | 8,349 | $ | 1,729 | $ | 10,078 | |||||||||||
Percentage increase in net interest income over prior period | 4.7 | % | 10.7 | % | |||||||||||||||||||
Earning Assets, Sources of Funds, and Net Interest Margin
Average earning assets were $2.85 billion in 2017, an increase of $106.3 million, or 3.9%, from $2.75 billion in 2016. The growth in the average balance of earning assets in 2017 compared to 2016 was due primarily to an increase in average investment securities outstanding of $89.9 million, or 16.3%, primarily due to the rate of growth in average deposits exceeding the increase in average loans, which rose $40.0 million, or 1.9%, in 2017 compared to 2016. Average earning assets in 2016 increased by $205.8 million, or 8.1%, from 2015. The growth in the average balance of earning assets in 2016 compared to 2015 was due primarily to an increase in average loans outstanding of $198.5 million, or 10.1%, primarily due to a full year of post-merger balances in 2016 as opposed to only eight months of post-merger balances in 2015, partially offset by a decrease in average loan pool participations of $10.0 million, or 100.0%, due to the sale of the complete portfolio of loan pool participations during 2015. Interest-bearing liabilities averaged $2.27 billion for the year ended December 31, 2017, an increase of $112.5 million, or 5.2%, from the average balance for the year ended December 31, 2016. An increase in average deposits of $99.3 million during 2017 compared to 2016, mainly due to an increased focus on deposit gathering, accounted for the majority of the increase in average interest-bearing liabilities. Average borrowed funds increased $13.1 million during 2017 compared to 2016, primarily due to a $13.2 million, or 17.7%, increase in the average balance of federal funds purchased and repurchase agreements, and a $5.0 million, or 4.8%, increase in the average balance of FHLB borrowings for 2017 compared to 2016. These increases in average borrowed funds were partially offset by a $5.1 million, or 11.2%, decrease in the average balance of long-term debt and junior subordinated notes, primarily due to normal amortization of long-term debt. Interest-bearing liabilities averaged $2.16 billion for the year ended December 31, 2016, an increase of $173.9 million, or 8.8%, from the average balance for the year ended December 31, 2015. An increase in average deposits of $145.3 million during 2016 compared to 2015, mainly due to the merger, accounted for the majority of the increase in average interest-bearing liabilities. Average borrowed funds increased $28.6 million during 2016 compared to 2015, primarily due to new FHLB borrowings.
40
Interest income, on a tax-equivalent basis, increased $7.3 million, or 6.2%, to $124.3 million in 2017 from $117.0 million in 2016. Tax equivalent interest income in 2016 increased $12.2 million, or 11.6%, to $117.0 million in 2016 from $104.9 million in 2015. The higher interest income in 2017 compared to 2016, was due primarily to the increase in the volume of loans due to new originations, the increased interest rate on loans and the inclusion in loan interest income of $4.8 million of merger-related loan discount accretion in 2017, compared to loan discount accretion of $3.2 million in 2016, which increased interest income, and by an increase in the volume of investment securities. In 2016, interest income increased compared to 2015 due primarily to the merger-related increase in the volume of loans, the increased interest rate on loans and despite lower merger-related loan discount accretion in 2016 of $3.2 million, compared to $4.4 million in 2015, and by an increase in the volume of investment securities. Our yield on average earning assets was 4.36% in 2017 compared to 4.26% in 2016 and 4.13% in 2015. The increase in interest income in 2017 compared to 2016, as well as 2016 compared to 2015, was due primarily to an increased volume of interest earning assets.
Interest expense increased during 2017 by $2.4 million, or 19.0%, to $15.1 million from $12.7 million in 2016. Interest expense in 2016 increased by $2.1 million, or 19.5%, from 2015. The increase in interest expense during 2017 compared to 2016 was primarily due to no merger-related premium amortization on certificate of deposits in 2017 compared to $0.9 million in 2016, which served to decrease deposit interest expense in 2016, combined with a higher average balance of interest-bearing deposits. The increase in interest expense during 2016 compared to 2015 was primarily due to the full year of additional cost of merger-related assumptions of deposits and debt in 2016, partially offset by the lower expense on federal funds and repurchase agreements, and the decrease in merger-related premium amortization on certificate of deposits to $0.9 million in 2016 compared to $1.1 million in 2015. The average rate paid on interest-bearing liabilities was 0.67% in 2017 compared to 0.59% in 2016 and 0.54% in 2015.
Net interest income, on a tax-equivalent basis, increased 4.7% in 2017 to $109.2 million from $104.3 million in 2016. Tax-equivalent net interest income in 2016 increased by $10.1 million, or 10.7%, from 2015. The net interest margin, which is our net interest income expressed as a percentage of average interest-earning assets stated on a tax-equivalent basis, was higher at 3.83% during 2017 compared to 3.80% in 2016 and 3.71% in 2015. The net interest spread, also on a tax-equivalent basis, was 3.69% in 2017 compared to 3.67% in 2016 and 3.59% in 2015.
Net interest income increased in 2017 as compared to 2016 due primarily to the increase in interest earned on interest-earning assets, due to increased average balances and rates on interest-earning assets, partially offset by the increase in interest paid on interest-bearing liabilities. The increased interest income in 2017 included $4.8 million of merger-related discount accretion income for loans, and did not include any merger-related amortization of the purchase accounting premium on certificates of deposit. The increased net interest income for 2016 as compared to 2015 was due primarily to the increase in interest earned on interest-earning assets, due to increased average balances and rates on interest-earning assets, partially offset by the increase in interest paid on interest-bearing liabilities. The increased interest income in 2016 included $3.2 million of merger-related discount accretion income for loans, combined with the inclusion of $0.9 million of merger-related amortization of the purchase accounting premium on certificates of deposit. The average balance sheets reflect a competitive marketplace on both interest-earning assets and interest-bearing deposits. The competition for loans in the marketplace and the overall rising interest rate environment has allowed new loan rates to increase somewhat, while interest rates paid on deposit products have increased at a somewhat faster pace, a condition which we expect to continue in the future.
Provision for Loan Losses
The provision for loan losses is a current charge against income and represents an amount which management believes is sufficient to maintain an adequate allowance for known and probable loan losses. In assessing the adequacy of the allowance for loan losses, management considers the size, composition, and quality of the loan portfolio measured against prevailing economic conditions, regulatory guidelines, historical loan loss experience and credit quality of the portfolio. When a determination is made by management to write-off a loan balance, such write-off is charged against the allowance for loan losses.
Our provision for loan losses was $17.3 million during 2017 compared to $8.0 million in 2016 and $5.1 million in 2015. The increased provision reflects the increase in outstanding loan balances and the previously disclosed $7.3 million credit impairment related to a loan made to a commercial borrower. We expect the provision for loan losses to return to a lower amount in future periods. Purchased loans acquired in the 2015 merger were recorded at estimated fair value on their purchase date without a carryover of the related allowance for loan losses. The level of provision expense during 2015, 2016, and 2017 was reflective of management’s assessment of the then-current risk in the loan portfolio as compared to the allowance for loan losses. See further discussion of the nonperforming loans, under the section Nonperforming Assets.
41
Noninterest Income
The following table sets forth the various categories of noninterest income for the years ended December 31, 2017, 2016, and 2015.
For the Year Ended December 31, | |||||||||||||||||||||||||||||
2017 | 2016 | $ Change | % Change | 2016 | 2015 | $ Change | % Change | ||||||||||||||||||||||
(dollars in thousands) | |||||||||||||||||||||||||||||
Trust, investment, and insurance fees | $ | 6,189 | $ | 5,574 | $ | 615 | 11.0 | % | $ | 5,574 | $ | 6,005 | $ | (431 | ) | (7.2 | )% | ||||||||||||
Service charges and fees on deposit accounts | 5,126 | 5,219 | (93 | ) | (1.8 | ) | 5,219 | 4,401 | 818 | 18.6 | |||||||||||||||||||
Loan origination and servicing fees | 3,421 | 3,771 | (350 | ) | (9.3 | ) | 3,771 | 2,756 | 1,015 | 36.8 | |||||||||||||||||||
Other service charges and fees | 5,992 | 5,951 | 41 | 0.7 | 5,951 | 5,215 | 736 | 14.1 | |||||||||||||||||||||
Bank-owned life insurance income | 1,388 | 1,366 | 22 | 1.6 | 1,366 | 1,307 | 59 | 4.5 | |||||||||||||||||||||
Gain on sale or call of available for sale securities | 188 | 464 | (276 | ) | (59.5 | ) | 464 | 1,011 | (547 | ) | (54.1 | ) | |||||||||||||||||
Gain on sale or call of held to maturity securities | 53 | — | 53 | NM | — | — | — | NM | |||||||||||||||||||||
Gain (loss) on sale of premises and equipment | 2 | (44 | ) | 46 | (104.5 | ) | (44 | ) | (29 | ) | (15 | ) | 51.7 | ||||||||||||||||
Other gain | 11 | 1,133 | (1,122 | ) | (99.0 | ) | 1,133 | 527 | 606 | 115.0 | |||||||||||||||||||
Total noninterest income | $ | 22,370 | $ | 23,434 | $ | (1,064 | ) | (4.5 | )% | $ | 23,434 | $ | 21,193 | $ | 2,241 | 10.6 | % | ||||||||||||
Noninterest income as a % of total revenue* | 17.5 | % | 18.0 | % | 18.0 | % | 17.9 | % | |||||||||||||||||||||
NM - Percentage change not considered meaningful. | |||||||||||||||||||||||||||||
* Total revenue is net interest income plus noninterest income excluding gain/loss on sales of securities, premises and equipment, and other gains or losses, and impairment of investment securities. | |||||||||||||||||||||||||||||
Total noninterest income for the year ended December 31, 2017 was $22.4 million, a decrease of $1.1 million, or 4.5%, from $23.4 million during the same period of 2016. This decline was primarily due to the $1.1 million decrease in other gains for the year ended December 31, 2017, compared to the same period in 2016. The year of 2016 included a net gain on other real estate owned of $0.6 million, a net gain on the sale of the Rice Lake and Barron, Wisconsin, and Davenport, Iowa, branch offices of $1.4 million, and the writedown of other real estate owned of $0.6 million. Loan origination and servicing fees decreased $0.4 million, or 9.3%, between the comparative periods, and gains on the sale of available for sale securities decreased $0.3 million between the comparative 2016 and 2017 periods. These decreases were partially offset by an increase of $0.6 million, or 11.0%, in trust, investment, and insurance fees to $6.2 million for the year of 2017 compared with $5.6 million for the same period in 2016 due to the hiring of additional business development officers, growth in equity markets, and an increase in overall sales volume.
Management has set a strategic goal for the percentage of total revenue that noninterest income represents (total revenue is net interest income plus noninterest income before gains or losses on sales of securities available for sale, held to maturity, premises and equipment, other gains or losses, and impairment of investment securities) to be 25%. In 2017, noninterest income comprised 17.5% of total revenue, compared with 18.0% for 2016 and 17.9% for 2015. The decline between 2017 and 2016 was due to a decrease in fee income related to the origination of loans held for sale due to a general decrease in originations in our market area, and the reorganization of the mortgage lending department. We expect that continued management focus on increasing the rate of growth in both our trust and investment services revenues and mortgage origination and loan servicing fees will gradually improve this ratio going forward.
Total noninterest income for the year ended December 31, 2016 was $23.4 million, an increase of $2.2 million, or 10.6%, from $21.2 million during the same period of 2015, primarily due to the merger. The greatest increase for the year ended December 31, 2016 compared to 2015, was in loan origination and servicing fees which increased $1.0 million, or 36.8%, in the year 2016, from $2.8 million for the same period in 2015, due to increased gains on the sale of SBA loans. Another significant contributor to the overall increase in noninterest income was service charges and fees on deposit accounts, which increased $0.8 million to $5.2 million for the year 2016, compared with $4.4 million for the same period of 2015. Other service charges and fees rose from $5.2 million for the year ended December 31, 2015, to $6.0 million for the year ended December 31, 2016, an increase of $0.7 million, or 14.1%. Other gain increased $0.6 million to a gain of $1.1 million for the year ended December 31, 2016, compared to a gain of $0.5 million for the year ended December 31, 2015. The year 2016 reflected a net gain on other real estate owned of $0.6 million, a net gain on the sale of the Rice Lake and Barron, Wisconsin, and Davenport, Iowa, branch offices of $1.4 million, and the writedown of other real estate owned of $0.6 million. The year 2015 included a net loss on other real estate owned of $0.2 million, and a net gain of $0.7 million on the sale of the Ottumwa, Iowa branch office. These increases were partially offset by decreased gains on the sale of available for sale securities of $0.5 million between the years 2015 and 2016. In addition, trust,
42
investment, and insurance fees also decreased to $5.6 million for the year 2016, a decline of $0.4 million, or 7.2%, from $6.0 million for the same period in 2015.
Noninterest Expense
The following table sets forth the various categories of noninterest expense for the years ended December 31, 2017, 2016, and 2015.
For the Year Ended December 31, | |||||||||||||||||||||||||||||
2017 | 2016 | $ Change | % Change | 2016 | 2015 | $ Change | % Change | ||||||||||||||||||||||
(dollars in thousands) | |||||||||||||||||||||||||||||
Salaries and employee benefits | $ | 47,864 | $ | 49,621 | $ | (1,757 | ) | (3.5 | )% | $ | 49,621 | $ | 41,865 | $ | 7,756 | 18.5 | % | ||||||||||||
Net occupancy and equipment expense | 12,305 | 13,066 | (761 | ) | (5.8 | ) | 13,066 | 9,975 | 3,091 | 31.0 | |||||||||||||||||||
Professional fees | 3,962 | 4,216 | (254 | ) | (6.0 | ) | 4,216 | 4,929 | (713 | ) | (14.5 | ) | |||||||||||||||||
Data processing expense | 2,674 | 4,940 | (2,266 | ) | (45.9 | ) | 4,940 | 2,659 | 2,281 | 85.8 | |||||||||||||||||||
FDIC insurance expense | 1,265 | 1,563 | (298 | ) | (19.1 | ) | 1,563 | 1,397 | 166 | 11.9 | |||||||||||||||||||
Amortization of intangible assets | 3,125 | 3,970 | (845 | ) | (21.3 | ) | 3,970 | 3,271 | 699 | 21.4 | |||||||||||||||||||
Other operating expense | 8,941 | 10,430 | (1,489 | ) | (14.3 | ) | 10,430 | 9,080 | 1,350 | 14.9 | |||||||||||||||||||
Total noninterest expense | $ | 80,136 | $ | 87,806 | $ | (7,670 | ) | (8.7 | )% | $ | 87,806 | $ | 73,176 | $ | 14,630 | 20.0 | % | ||||||||||||
Noninterest expense decreased to $80.1 million for the year ended December 31, 2017, compared with $87.8 million for the year ended December 31, 2016, a decrease of $7.7 million, or 8.7%, with all expense line items showing a decrease between 2016 and 2017. The decrease was primarily due to the absence of merger-related expenses for the year ended December 31, 2017, compared to $4.6 million for the year ended December 31, 2016 relating to the merger of Central Bank into MidWestOne Bank. Data processing expense declined $2.3 million, or 45.9%, for the year ended December 31, 2017, compared to the year ended December 31, 2016, primarily due to the inclusion in 2016 of $1.9 million in contract termination expense in connection with the bank merger. Salaries and employee benefits decreased $1.8 million, or 3.5%, from $49.6 million for the year ended December 31, 2016, to $47.9 million for the year ended December 31, 2017. This decrease was primarily due to $1.9 million of merger-related salaries and employee benefits expenses for the year ended December 31, 2016. Other operating expenses decreased $1.5 million, or 14.3%, from $10.4 million for the year ended December 31, 2016, to $8.9 million for the year ended December 31, 2017, primarily due to lower customer fraud losses and deposit account charge-offs. We expect to see a slight increase in noninterest expense, primarily salary and employee benefits expense, in future periods, as we believe most merger-related cost savings have now been achieved.
In 2015 noninterest expense increased to $87.8 million for the year ended December 31, 2016 compared with $73.2 million for the year ended December 31, 2015, an increase of $14.6 million, or 20.0%. All categories of noninterest expense increased for the year ended December 31, 2016 compared to 2015, with the exception of professional fees, which decreased $0.7 million, or 14.5%, due to lower merger-related expenses for professional fees of $0.3 million for the year of 2016 compared with $1.9 million for the same period in 2015. Salaries and employee benefits increased $7.7 million, or 18.5%, from $41.9 million for the year ended December 31, 2015, to $49.6 million for the year ended December 31, 2016. This increase includes $2.1 million of merger-related expenses for the year ended December 31, 2016, compared to $0.6 million for the same period in 2015. The increase in salaries and employee benefits is primarily due to the increased number of employees after the merger with Central and merger-related stay bonuses and severance costs. Net occupancy and equipment expense rose from $10.0 million for the year of 2015 to $13.1 million for the same period of 2016, an increase of $3.1 million, or 31.0%. The increase in data processing expense for the year ended December 31, 2016 compared to 2015, of $2.3 million, or 85.8%, was attributable primarily to one-time contract termination expenses of $1.9 million in connection with the merger of the Bank and Central Bank.
Full-time equivalent employee levels were 610, 587 and 648 at December 31, 2017, 2016 and 2015, respectively.
Income Tax Expense
Our effective tax rate, or income taxes divided by income before taxes, was 35.7% for 2017 compared with 25.2% for 2016. Income tax expense increased by $3.5 million to $10.4 million in 2017 compared to tax expense of $6.9 million for 2016 The higher effective tax rate in 2017 as well as the increase in tax expense in 2017 was due primarily to the $3.2 million impact of the the Tax Act enacted by the U.S. government on December 22, 2017. The Tax Act introduced tax reform that reduces the corporate federal income tax rate from 35% to 21%, among other changes. While the corporate tax rate reduction is effective January 1, 2018, the Company determined that GAAP requires a revaluation of its net deferred tax asset. Deferred income taxes result from temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements,
43
which will result in taxable or deductible amounts in future years. Deferred tax assets and liabilities are measured using enacted rates expected to apply to taxable income in years in which those temporary differences are expected to be recovered or settled. Deferred tax assets and liabilities are adjusted through income tax expense as changes in tax laws are enacted. The Company’s revaluation of its deferred tax asset is subject to further clarifications of the Tax Act that cannot be estimated at this time, and the Company will continue to analyze the Tax Act to determine the full effects of the new law, including the new lower corporate tax rate, on its financial condition and results of operations.
Income taxes decreased by $1.0 million for 2016 compared with 2015 due primarily to decreased taxable income, net of the decreased tax credits. The effective income tax rate as a percentage of income before tax was 25.2% for 2016, compared with 23.7% for 2015. The higher effective rate in 2016 was primarily due to a reduction of $1.9 million in the recognition of rehabilitation and historic tax credits from $2.3 million in 2015 to $0.4 million in 2016.
Financial Condition - December 31, 2017 and 2016
Summary
Our total assets increased $132.7 million, or 4.3%, to $3.21 billion as of December 31, 2017 from $3.08 billion as of December 31, 2016. This growth resulted primarily from increases in total loans, excluding loans held for sale, of $121.6 million, or 5.6%, due to increased origination activity, bank-owned life insurance of $12.6 million, or 26.7%, due to new policy purchases, and cash and cash equivalents of $7.7 million, or 17.9%. These increases were partially offset by decreases in intangible assets of $3.1 million, or 20.6%, due to scheduled amortization, and investment securities of $2.6 million, or 0.4%, between December 31, 2017 and December 31, 2016. Our loan-to-deposit ratio rose slightly to 87.8% at year-end 2017 compared to 87.3% at year-end 2016, with our target range being between 80% and 90%
Total liabilities increased by $97.8 million from December 31, 2016 to December 31, 2017. Our deposits increased $124.9 million, or 5.0%, to $2.61 billion as of December 31, 2017 from $2.48 billion at December 31, 2016. The mix of deposits saw increases between December 31, 2016 and December 31, 2017 of $91.8 million, or 8.1%, in interest-bearing checking deposits, $15.7 million, or 8.0%, in savings deposits, and $49.9 million, or 7.7%, in certificates of deposit. These increases were partially offset by a decrease in non-interest bearing demand deposits of $32.6 million, or 6.6%, between December 31, 2016 and December 31, 2017. Brokered CDs obtained through participation in the Certificate of Deposit Account Registry Service (“CDARS”) program increased by $2.7 million in 2017 to $5.3 million, while brokered business money market accounts obtained through participation in the Insured Cash Sweeps (“ICS”) program increased by $56.8 million to $95.8 million. We have an internal policy limit on brokered deposits of not more than 10% of our total assets. At December 31, 2017 brokered deposits were 3.1% of our total assets. FHLB borrowings were $115.0 million at December 31, 2017, the same as at December 31, 2016. Junior subordinated notes issued to capital trusts increased from $23.7 million at December 31, 2016 to $23.8 million at December 31, 2017 as a result of merger-related discount accretion. The Company initiated new long-term borrowings from an unaffiliated bank of $25.0 million during the second quarter of 2015 in connection with the closing of the merger with Central. At December 31, 2017, this note had an outstanding balance of $12.5 million, a decrease of $5.0 million, or 28.6%, from December 31, 2016, due to normal scheduled repayments. Securities sold under agreement to repurchase rose $14.0 million between December 31, 2016 and December 31, 2017, and federal funds purchased declined by $34.7 million between the two dates, both as a result of normal business cash need fluctuations.
44
Shareholders’ equity increased by $34.8 million primarily due to the issuance of 750,000 shares of Company common stock for $24.4 million, net of expenses, net income of $18.7 million for the year of 2017, and a $0.6 million decrease in treasury stock due to the issuance of 33,251 shares of Company common stock in connection with stock compensation plans. These increases were partially offset by the payment of $8.1 million in common stock dividends, and a $1.5 million decrease in accumulated other comprehensive income, with $1.0 million due to market value adjustments on investment securities available for sale, and $0.5 million due to a reclassification adjustment to retained earnings due to the effect of the Tax Act.
December 31, | December 31, | |||||||||||||
2017 | 2016 | $ Change | % Change | |||||||||||
(dollars in thousands) | ||||||||||||||
Assets | ||||||||||||||
Investment securities available for sale | $ | 447,660 | $ | 477,518 | $ | (29,858 | ) | (6.3 | )% | |||||
Investment securities held to maturity | 195,619 | 168,392 | 27,227 | 16.2 | ||||||||||
Net loans | 2,258,636 | 2,143,293 | 115,343 | 5.4 | ||||||||||
Premises and equipment | 75,969 | 75,043 | 926 | 1.2 | ||||||||||
Goodwill | 64,654 | 64,654 | — | NM | ||||||||||
Other intangible assets, net | 12,046 | 15,171 | (3,125 | ) | (20.6 | ) | ||||||||
Total Assets | $ | 3,212,271 | $ | 3,079,575 | $ | 132,696 | 4.3 | % | ||||||
Liabilities | ||||||||||||||
Deposits: | ||||||||||||||
Noninterest bearing | $ | 461,969 | $ | 494,586 | $ | (32,617 | ) | (6.6 | )% | |||||
Interest bearing | 2,143,350 | 1,985,862 | 157,488 | 7.9 | ||||||||||
Total deposits | 2,605,319 | 2,480,448 | 124,871 | 5.0 | ||||||||||
Federal Home Loan Bank borrowings | 115,000 | 115,000 | — | — | ||||||||||
Junior subordinated notes issued to capital trusts | 23,793 | 23,692 | 101 | 0.4 | ||||||||||
Long-term debt | 12,500 | 17,500 | (5,000 | ) | (28.6 | ) | ||||||||
Total liabilities | $ | 2,871,967 | $ | 2,774,119 | $ | 97,848 | 3.5 | % | ||||||
Shareholders’ equity | $ | 340,304 | $ | 305,456 | $ | 34,848 | 11.4 | % | ||||||
Investment Securities
Our investment securities portfolio is managed to provide both a source of liquidity and earnings. The size of the portfolio varies along with fluctuations in levels of deposits and loans. Our investment securities portfolio totaled $643.3 million at December 31, 2017 compared to $645.9 million at December 31, 2016.
Securities available for sale are carried at fair value. As of December 31, 2017, the fair value of our securities available for sale was $447.7 million and the amortized cost was $451.2 million. There were $2.8 million of gross unrealized gains and $6.4 million of gross unrealized losses in our investment securities available for sale portfolio for a net unrealized loss of $3.6 million. The after-tax effect of this unrealized loss has been included in the accumulated other comprehensive income component of shareholders’ equity. The ratio of the fair value as a percentage of amortized cost decreased compared to December 31, 2016, due to an increase in interest rates, particularly in the market for tax-exempt municipal securities, during 2017.
U.S. treasury and U.S. government agency securities as a percentage of total securities increased to 4.0% at December 31, 2017, from 0.9% at December 31, 2016, and corporate debt securities increased to 16.5% at December 31, 2017, as compared to 16.2% at December 31, 2016. Investments in mortgage-backed securities and collateralized mortgage obligations decreased to 37.4% of total securities at December 31, 2017, as compared to 40.4% of total securities at December 31, 2016, and obligations of state and political subdivisions (primarily tax-exempt obligations) as a percentage of total securities also decreased to 41.7% at December 31, 2017, from 42.3% at December 31, 2016. As of December 31, 2017 and 2016, the Company’s mortgage-backed and collateralized mortgage obligations portfolios consisted of securities predominantly backed by one- to four- family mortgage loans and underwritten to the standards of and guaranteed by the following government-sponsored agencies: Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association, and the Government National Mortgage Association. The receipt of principal, at par, and interest on these securities is guaranteed by the respective government-sponsored agency guarantor, such that the Company believes that its mortgage-backed securities and collateralized mortgage obligations do not expose the Company to significant credit-related losses.
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We consider many factors in determining the composition of our investment portfolio including tax-equivalent yield, credit quality, duration, expected cash flows and prepayment risk, as well as the liquidity position and the interest rate risk profile of the Company.
The composition of securities available for sale was as follows:
December 31, | |||||||||||
2017 | 2016 | 2015 | |||||||||
(dollars in thousands) | |||||||||||
Securities available for sale | |||||||||||
U.S. Treasury | $ | — | $ | — | $ | 6,910 | |||||
U.S. Government agency securities and corporations | 15,626 | 5,905 | 26,653 | ||||||||
States and political subdivisions | 141,839 | 165,272 | 183,384 | ||||||||
Mortgage-backed securities | 48,497 | 61,354 | 57,062 | ||||||||
Collateralized mortgage obligations | 168,196 | 171,267 | 106,404 | ||||||||
Corporate debt securities | 71,166 | 72,453 | 45,566 | ||||||||
Other equity securities | 2,336 | 1,267 | 1,262 | ||||||||
Fair value of securities available for sale | $ | 447,660 | $ | 477,518 | $ | 427,241 | |||||
Amortized cost | $ | 451,190 | $ | 479,390 | $ | 421,740 | |||||
Fair value as a percentage of amortized cost | 99.22 | % | 99.61 | % | 101.30 | % | |||||
Securities held to maturity are carried at amortized cost. As of December 31, 2017, the amortized cost of these securities was $195.6 million and the fair value was $194.3 million.
The composition of securities held to maturity was as follows:
December 31, | |||||||||||
2017 | 2016 | 2015 | |||||||||
(dollars in thousands) | |||||||||||
Securities held to maturity | |||||||||||
U.S. Government agency securities and corporations | $ | 10,049 | $ | — | $ | — | |||||
States and political subdivisions | 126,413 | 107,941 | 66,454 | ||||||||
Mortgage-backed securities | 1,906 | 2,398 | 3,920 | ||||||||
Collateralized mortgage obligations | 22,115 | 26,036 | 30,505 | ||||||||
Corporate debt securities | 35,136 | 32,017 | 17,544 | ||||||||
Amortized cost | $ | 195,619 | $ | 168,392 | $ | 118,423 | |||||
Fair value of securities held to maturity | $ | 194,343 | $ | 164,792 | $ | 118,234 | |||||
Fair value as a percentage of amortized cost | 99.35 | % | 97.86 | % | 99.84 | % | |||||
See Note 3. “Investment Securities,’’ and Note 20. “Estimated Fair Value of Financial Instruments and Fair Value Measurements” to our consolidated financial statements for additional information related to the investment portfolio.
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The maturities, carrying values and weighted average yields of debt securities as of December 31, 2017 were as follows:
Maturity | |||||||||||||||||||||||||||
After One but | After Five but | ||||||||||||||||||||||||||
Within One Year | Within Five Years | Within Ten Years | After Ten Years | ||||||||||||||||||||||||
Amount | Yield | Amount | Yield | Amount | Yield | Amount | Yield | ||||||||||||||||||||
(dollars in thousands) | |||||||||||||||||||||||||||
Securities available for sale: (1) | |||||||||||||||||||||||||||
U.S. Government agency securities and corporations | $ | — | — | % | $ | 5,649 | 1.65 | % | $ | — | — | % | $ | 9,977 | 2.70 | % | |||||||||||
States and political subdivisions (2) | 16,284 | 4.30 | 53,156 | 4.38 | 68,716 | 4.59 | 3,683 | 4.92 | |||||||||||||||||||
Mortgage-backed securities (3) | 49 | 4.73 | 5,422 | 2.30 | 23,728 | 2.27 | 19,298 | 2.35 | |||||||||||||||||||
Collateralized mortgage obligations (3) | 5,023 | 1.53 | 6,349 | 2.64 | 5,399 | 1.61 | 151,425 | 2.19 | |||||||||||||||||||
Corporate debt securities | 9,999 | 1.75 | 61,167 | 2.20 | — | — | — | — | |||||||||||||||||||
Total debt securities available for sale | $ | 31,355 | 3.04 | % | $ | 131,743 | 3.08 | % | $ | 97,843 | 3.86 | % | $ | 184,383 | 2.29 | % | |||||||||||
Securities held to maturity: (1) | |||||||||||||||||||||||||||
U.S. Government agency securities and corporations | $ | — | — | % | $ | — | — | % | $ | — | — | % | $ | 10,049 | 2.69 | % | |||||||||||
States and political subdivisions (2) | — | — | 11,616 | 3.49 | 64,745 | 3.92 | 50,052 | 3.72 | |||||||||||||||||||
Mortgage-backed securities (3) | — | — | — | — | 4 | 6.00 | 1,902 | 3.04 | |||||||||||||||||||
Collateralized mortgage obligations (3) | — | — | — | — | 2,236 | 1.60 | 19,879 | 1.97 | |||||||||||||||||||
Corporate debt securities | — | — | 7,422 | 2.76 | 25,045 | 4.94 | 2,669 | 4.48 | |||||||||||||||||||
Total debt securities held to maturity | $ | — | — | % | $ | 19,038 | 3.21 | % | $ | 92,030 | 4.14 | % | $ | 84,551 | 3.19 | % | |||||||||||
Total debt investment securities | $ | 31,355 | 3.04 | % | $ | 150,781 | 3.10 | % | $ | 189,873 | 4.00 | % | $ | 268,934 | 2.57 | % | |||||||||||
(1) Excludes equity securities. | |||||||||||||||||||||||||||
(2) Yield is on a tax-equivalent basis, assuming a federal income tax rate of 35% (the applicable federal income tax rate as of December 31, 2017). | |||||||||||||||||||||||||||
(3) These securities are presented based upon contractual maturities. | |||||||||||||||||||||||||||
As of December 31, 2017, no non-agency issuer’s securities exceeded 10% of the Company’s total shareholders’ equity.
47
Loans
The composition of loans (before deducting the allowance for loan losses) was as follows:
As of December 31, | ||||||||||||||||||||||||||||||||||
2017 | 2016 | 2015 | 2014 | 2013 | ||||||||||||||||||||||||||||||
% of | % of | % of | % of | % of | ||||||||||||||||||||||||||||||
Amount | Total | Amount | Total | Amount | Total | Amount | Total | Amount | Total | |||||||||||||||||||||||||
(dollars in thousands) | ||||||||||||||||||||||||||||||||||
Agricultural | $ | 105,512 | 4.6 | % | $ | 113,343 | 5.2 | % | $ | 121,714 | 5.7 | % | $ | 104,809 | 9.3 | % | $ | 97,167 | 8.9 | % | ||||||||||||||
Commercial and industrial | 503,624 | 22.0 | 459,481 | 21.2 | 467,412 | 21.7 | 303,108 | 26.7 | 262,368 | 24.1 | ||||||||||||||||||||||||
Credit cards(2) | — | — | 1,489 | 0.1 | 1,377 | 0.1 | 1,246 | 0.1 | 1,028 | 0.1 | ||||||||||||||||||||||||
Overdrafts(1) | — | — | — | — | 1,483 | 0.1 | 744 | 0.1 | 537 | 0.1 | ||||||||||||||||||||||||
Commercial real estate: | ||||||||||||||||||||||||||||||||||
Construction & development | 165,276 | 7.3 | 126,685 | 5.9 | 120,753 | 5.6 | 59,383 | 5.2 | 72,589 | 6.6 | ||||||||||||||||||||||||
Farmland | 87,868 | 3.8 | 94,979 | 4.4 | 89,084 | 4.1 | 83,700 | 7.4 | 85,475 | 7.9 | ||||||||||||||||||||||||
Multifamily | 134,506 | 5.9 | 136,003 | 6.3 | 121,763 | 5.7 | 54,886 | 4.8 | 55,443 | 5.1 | ||||||||||||||||||||||||
Commercial real estate-other | 784,321 | 34.3 | 706,576 | 32.6 | 660,341 | 30.7 | 228,552 | 20.2 | 220,917 | 20.3 | ||||||||||||||||||||||||
Total commercial real estate | 1,171,971 | 51.3 | 1,064,243 | 49.2 | 991,941 | 46.1 | 426,521 | 37.6 | 434,424 | 39.9 | ||||||||||||||||||||||||
Residential real estate: | ||||||||||||||||||||||||||||||||||
One- to four- family first liens | 352,226 | 15.4 | 372,233 | 17.2 | 428,233 | 19.9 | 219,314 | 19.4 | 220,668 | 20.3 | ||||||||||||||||||||||||
One- to four- family junior liens | 117,204 | 5.1 | 117,763 | 5.4 | 102,273 | 4.7 | 53,297 | 4.7 | 53,458 | 4.9 | ||||||||||||||||||||||||
Total residential real estate | 469,430 | 20.5 | 489,996 | 22.6 | 530,506 | 24.6 | 272,611 | 24.1 | 274,126 | 25.2 | ||||||||||||||||||||||||
Consumer | 36,158 | 1.6 | 36,591 | 1.7 | 37,509 | 1.7 | 23,480 | 2.1 | 18,762 | 1.7 | ||||||||||||||||||||||||
Total loans | $ | 2,286,695 | 100.0 | % | $ | 2,165,143 | 100.0 | % | $ | 2,151,942 | 100.0 | % | $ | 1,132,519 | 100.0 | % | $ | 1,088,412 | 100.0 | % | ||||||||||||||
Total assets | $ | 3,212,271 | $ | 3,079,575 | $ | 2,979,975 | $ | 1,800,302 | $ | 1,755,218 | ||||||||||||||||||||||||
Loans to total assets | 71.2 | % | 70.3 | % | 72.2 | % | 62.9 | % | 62.0 | % | ||||||||||||||||||||||||
(1) - Beginning in 2016, the Company no longer considered overdrafts a separate class of loans, and these balances are now included in commercial and consumer loans, as appropriate. | ||||||||||||||||||||||||||||||||||
(2) - Beginning in 2017, the Company no longer considered credit cards a separate class of loans, and these balances are now included in commercial and industrial loans. | ||||||||||||||||||||||||||||||||||
Our loan portfolio, before allowance for loan losses, increased 5.6% to $2.29 billion as of December 31, 2017 from $2.17 billion at December 31, 2016. Increased balances were primarily concentrated in commercial real estate loans, which increased $107.7 million, or 10.1%, to $1.17 billion as of December 31, 2017, from $1.06 billion as of December 31, 2016. Within commercial real estate, other commercial real estate increased $77.7 million, or 11.0%, construction and development increased $38.6 million, or 30.5%, farmland loans decreased $7.1 million, or 7.5%, and multifamily decreased $1.5 million, or 1.1%, between December 31, 2017 and December 31, 2016. Commercial and industrial loans also increased $44.1 million, or 9.6%, to $503.6 million between December 31, 2017 and December 31, 2016. The increases were partially offset by decreases in residential real estate loans, which decreased $20.6 million, or 4.2%, between December 31, 2017 and December 31, 2016, and agricultural loans which decreased $7.8 million, or 6.9%, between December 31, 2017 and December 31, 2016, to $105.5 million at December 31, 2017. Commitments under standby letters of credit, unused lines of credit and other conditionally approved credit lines totaled approximately $574.4 million and $487.3 million as of December 31, 2017 and 2016, respectively.
Our loan to deposit ratio increased slightly to 87.8% at year end 2017 from 87.3% at the end of 2016, with our target range for this ratio being between 80% and 90%. The increase in this ratio is reflective of new loans originations growing at a slightly greater rate than deposits.
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The following table sets forth remaining maturities and rate types of selected loans at December 31, 2017:
Total for Loans | Total for Loans | ||||||||||||||||||||||||||||||
Due Within | Due After | ||||||||||||||||||||||||||||||
Due In | One Year Having | One Year Having | |||||||||||||||||||||||||||||
Due Within | One to | Due After | Fixed | Variable | Fixed | Variable | |||||||||||||||||||||||||
One Year | Five Years | Five Years | Total | Rates | Rates | Rates | Rates | ||||||||||||||||||||||||
(in thousands) | |||||||||||||||||||||||||||||||
Agricultural | $ | 72,128 | $ | 25,388 | $ | 7,996 | $ | 105,512 | $ | 3,599 | $ | 68,529 | $ | 21,391 | $ | 11,993 | |||||||||||||||
Commercial and industrial | 149,232 | 200,370 | 154,022 | 503,624 | 28,089 | 121,143 | 185,149 | 169,243 | |||||||||||||||||||||||
Commercial real estate: | |||||||||||||||||||||||||||||||
Construction & development | 61,003 | 80,916 | 23,357 | 165,276 | 27,507 | 33,496 | 52,185 | 52,088 | |||||||||||||||||||||||
Farmland | 6,105 | 43,716 | 38,047 | 87,868 | 4,652 | 1,453 | 48,507 | 33,256 | |||||||||||||||||||||||
Multifamily | 8,504 | 58,749 | 67,253 | 134,506 | 3,312 | 5,192 | 79,561 | 46,441 | |||||||||||||||||||||||
Commercial real estate-other | 61,018 | 416,051 | 307,252 | 784,321 | 48,132 | 12,886 | 359,776 | 363,527 | |||||||||||||||||||||||
Total commercial real estate | 136,630 | 599,432 | 435,909 | 1,171,971 | 83,603 | 53,027 | 540,029 | 495,312 | |||||||||||||||||||||||
Residential real estate: | |||||||||||||||||||||||||||||||
One- to four- family first liens | 26,181 | 98,294 | 227,751 | 352,226 | 17,470 | 8,711 | 160,134 | 165,911 | |||||||||||||||||||||||
One- to four- family junior liens | 9,670 | 35,938 | 71,596 | 117,204 | 3,070 | 6,600 | 40,972 | 66,562 | |||||||||||||||||||||||
Total residential real estate | 35,851 | 134,232 | 299,347 | 469,430 | 20,540 | 15,311 | 201,106 | 232,473 | |||||||||||||||||||||||
Consumer | 6,418 | 28,272 | 1,468 | 36,158 | 5,362 | 1,056 | 29,410 | 330 | |||||||||||||||||||||||
Total loans | $ | 400,259 | $ | 987,694 | $ | 898,742 | $ | 2,286,695 | $ | 141,193 | $ | 259,066 | $ | 977,085 | $ | 909,351 | |||||||||||||||
Of the $1.17 billion of variable rate loans, approximately $717.7 million, or 61.4%, are subject to interest rate floors, with a weighted average floor rate of 4.36%.
Nonperforming Assets
It is management’s policy to place loans on nonaccrual status when interest or principal is 90 days or more past due. Such loans may continue on accrual status only if they are both well-secured with marketable collateral and in the process of collection.
The following table sets forth information concerning nonperforming assets at December 31 for each of the years indicated:
December 31, | |||||||||||||||||||
2017 | 2016 | 2015 | 2014 | 2013 | |||||||||||||||
(dollars in thousands) | |||||||||||||||||||
90 days or more past due and still accruing interest | $ | 207 | $ | 485 | $ | 284 | $ | 848 | $ | 1,385 | |||||||||
Troubled debt restructure | 8,870 | 7,312 | 7,232 | 8,918 | 9,151 | ||||||||||||||
Nonaccrual | 14,784 | 20,668 | 4,012 | 3,255 | 3,240 | ||||||||||||||
Total nonperforming loans | 23,861 | 28,465 | 11,528 | 13,021 | 13,776 | ||||||||||||||
Other real estate owned | 2,010 | 2,097 | 8,834 | 1,916 | 1,770 | ||||||||||||||
Total nonperforming loans and nonperforming other assets | $ | 25,871 | $ | 30,562 | $ | 20,362 | $ | 14,937 | $ | 15,546 | |||||||||
Nonperforming loans to loans, before allowance for loan losses | 1.04 | % | 1.31 | % | 0.54 | % | 1.15 | % | 1.27 | % | |||||||||
Nonperforming loans and nonperforming other assets to loans, before allowance for loan losses | 1.13 | % | 1.41 | % | 0.95 | % | 1.32 | % | 1.43 | % | |||||||||
Total nonperforming assets were $25.9 million at December 31, 2017, compared to $30.6 million at December 31, 2016, a $4.7 million, or 15.3%, decrease. Nonperforming loans decreased $4.6 million during 2017, and nonperforming other assets (other real estate owned) decreased $0.1 million during 2017. The decrease in other real estate owned (“OREO”) from $2.1 million at December 31, 2016 to $2.0 million at December 31, 2017, was primarily attributable to the net decrease of 13 properties in other real estate owned during the year ended December 31, 2017. All of the OREO property was acquired through foreclosures, and we are actively working to sell all properties held as of December 31, 2017. OREO is carried at the lower of cost or fair value less estimated costs of disposal. Additional discounts could be required to market and sell the properties, resulting in a write down through expense.
Nonperforming loans decreased from $28.5 million, or 1.31% of total loans, at December 31, 2016, to $23.9 million, or 1.04% of total loans, at December 31, 2017. At December 31, 2017, nonperforming loans consisted of $14.8 million in nonaccrual
49
loans, $8.9 million in troubled debt restructures (“TDRs”) and $0.2 million in loans past due 90 days or more and still accruing interest. This compares to nonaccrual loans of $20.7 million, TDRs of $7.3 million, and loans past due 90 days or more and still accruing interest of $0.5 million at December 31, 2016. Nonaccrual loans decreased $5.9 million between December 31, 2016, and December 31, 2017. This was primarily driven by net charge-offs of $11.1 million in 2017 coupled with one loan being added in the fourth quarter of 2017 for $5.0 million, which was the same borrower that resulted in the large credit impairment also in the fourth quarter of 2017. The balance of TDRs increased $1.6 million between these two dates, as a result of the addition of seven loans (representing four lending relationships) totaling $5.3 million, which was partially offset by payments collected from TDR-status borrowers totaling $2.8 million, and three loans totaling $0.9 million moving to non-disclosed status. Loans 90 days past due and still accruing interest decreased $0.3 million between December 31, 2016, and December 31, 2017. Loans past due 30 to 89 days and still accruing interest (not included in the nonperforming loan totals) increased to $8.4 million at December 31, 2017, compared with $7.8 million at December 31, 2016. As of December 31, 2017, the allowance for loan losses was $28.1 million, or 1.23% of total loans, compared with $21.9 million, or 1.01% of total loans at December 31, 2016. The allowance for loan losses represented 117.59% of nonperforming loans at December 31, 2017, compared with 76.76% of nonperforming loans at December 31, 2016.
The following table sets forth information concerning nonperforming loans by portfolio class at December 31, 2017 and December 31, 2016:
90 Days or More Past Due and Still Accruing Interest | Troubled Debt Restructure | Nonaccrual | Total | ||||||||||||
(in thousands) | |||||||||||||||
December 31, 2017 | |||||||||||||||
Agricultural | $ | — | $ | 2,637 | $ | 168 | $ | 2,805 | |||||||
Commercial and industrial | — | 1,450 | 7,124 | 8,574 | |||||||||||
Commercial real estate: | |||||||||||||||
Construction & development | — | — | 188 | 188 | |||||||||||
Farmland | — | — | 386 | 386 | |||||||||||
Multifamily | — | — | — | — | |||||||||||
Commercial real estate-other | — | 4,028 | 5,279 | 9,307 | |||||||||||
Total commercial real estate | — | 4,028 | 5,853 | 9,881 | |||||||||||
Residential real estate: | |||||||||||||||
One- to four- family first liens | 205 | 755 | 1,228 | 2,188 | |||||||||||
One- to four- family junior liens | 2 | — | 346 | 348 | |||||||||||
Total residential real estate | 207 | 755 | 1,574 | 2,536 | |||||||||||
Consumer | — | — | 65 | 65 | |||||||||||
Total | $ | 207 | $ | 8,870 | $ | 14,784 | $ | 23,861 | |||||||
December 31, 2016 | |||||||||||||||
Agricultural | $ | — | $ | 2,770 | $ | 2,690 | $ | 5,460 | |||||||
Commercial and industrial | — | 595 | 8,358 | 8,953 | |||||||||||
Commercial real estate: | |||||||||||||||
Construction & development | 95 | — | 780 | 875 | |||||||||||
Farmland | — | 2,174 | 227 | 2,401 | |||||||||||
Multifamily | — | — | — | — | |||||||||||
Commercial real estate-other | — | 247 | 7,360 | 7,607 | |||||||||||
Total commercial real estate | 95 | 2,421 | 8,367 | 10,883 | |||||||||||
Residential real estate: | |||||||||||||||
One- to four- family first liens | 375 | 1,501 | 1,127 | 3,003 | |||||||||||
One- to four- family junior liens | 15 | 13 | 116 | 144 | |||||||||||
Total residential real estate | 390 | 1,514 | 1,243 | 3,147 | |||||||||||
Consumer | — | 12 | 10 | 22 | |||||||||||
Total | $ | 485 | $ | 7,312 | $ | 20,668 | $ | 28,465 | |||||||
Not included in the loans above were purchased credit impaired loans with an outstanding balance of $0.7 million, net of a discount of $0.1 million as of December 31, 2017, and an outstanding balance of $2.6 million, net of a discount of $0.5 million as of December 31, 2016.
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The largest category of nonperforming loans was commercial real estate loans, with a balance of $9.9 million at December 31, 2017. The remaining nonperforming loans consisted of $8.6 million in commercial and industrial, $2.8 million in agricultural, and $2.5 million in residential real estate.
A loan is considered to be impaired when, based on current information and events, it is probable that we will not be able to collect all amounts due. The accrual of interest income on impaired loans is discontinued when there is reasonable doubt as to the borrower’s ability to meet contractual payments of interest or principal. Interest income on these loans is recognized to the extent interest payments are received and the principal is considered fully collectible.
The gross interest income that would have been recorded in the years ended December 31, 2017, 2016 and 2015 if the nonaccrual and TDRs had been current in accordance with their original terms was $2.5 million, $1.9 million, and $0.8 million, respectively. The amount of interest collected on those loans that was included in interest income was $1.4 million, $0.6 million, and $0.3 million for the years ended December 31, 2017, 2016 and 2015, respectively.
In addition to the non-performing and past due loans mentioned above, the Company also has identified loans for which management has concerns about the ability of the borrowers to meet existing repayment terms. The loans are generally secured by either real estate or other borrower assets, reducing the potential for loss should they become non-performing. Although these loans are generally identified as potential problem loans, it is possible that they never become non-performing.
Loan Review and Classification Process for Agricultural Loans, Commercial and Industrial Loans, and Commercial Real Estate Loans:
The Bank maintains a loan review and classification process which involves multiple officers of the Bank and is designed to assess the general quality of credit underwriting and to promote early identification of potential problem loans. All commercial and agricultural loan officers are charged with the responsibility of risk rating all loans in their portfolios and updating the ratings, positively or negatively, on an ongoing basis as conditions warrant. Risk ratings are selected from an 8-point scale with ratings as follows: ratings 1- 4 Satisfactory (pass), rating 5 Watch (potential weakness), rating 6 Substandard (well-defined weakness), rating 7 Doubtful, and rating 8 Loss.
When a loan officer originates a new loan, based upon proper loan authorization, he or she documents the credit file with an offering sheet summary, supplemental underwriting analysis, relevant financial information and collateral evaluations. All of this information is used in the determination of the initial loan risk rating. The Bank’s loan review department undertakes independent credit reviews of relationships based on either criteria established by loan policy, risk-focused sampling, or random sampling. Loan policy requires all lending relationships with total exposure of $5.0 million or more as well as all classified (loan grades 6 through 8) and watch (loan grade 5) rated credits over $1.0 million be reviewed no less than annually. The individual loan reviews consider such items as: loan type; nature, type and estimated value of collateral; borrower and/or guarantor estimated financial strength; most recently available financial information; related loans and total borrower exposure; and current and anticipated performance of the loan. The results of such reviews are presented to executive management.
Through the review of delinquency reports, updated financial statements or other relevant information, the lending officer and/or loan review personnel may determine that a loan relationship has weakened to the point that a watch (loan grade 5) or classified (loan grades 6 through 8) status is warranted. When a loan relationship with total related exposure of $1.0 million or greater is adversely graded (loan grade 5 or above), or is classified as a TDR (regardless of size), the lending officer is then charged with preparing a loan strategy summary worksheet that outlines the background of the credit problem, current repayment status of the loans, current collateral evaluation and a workout plan of action. This plan may include goals to improve the credit rating, assist the borrower in moving the loans to another institution and/or collateral liquidation. All such reports are first presented to regional management and then to the loan strategy committee. Copies of the minutes of these committee meetings are presented to the board of directors of the Bank.
Depending upon the individual facts and circumstances and the result of the classified/watch review process, loan officers and/or loan review personnel may categorize the loan relationship as impaired. Once that determination has occurred, the credit analyst will complete an evaluation of the collateral (for collateral-dependent loans) based upon the estimated collateral value, adjusting for current market conditions and other local factors that may affect collateral value. Loan review personnel may also complete an independent impairment analysis when deemed necessary. These judgmental evaluations may produce an initial specific allowance for placement in the Company’s allowance for loan and lease losses calculation. Impairment analysis for the underlying collateral value is completed in the last month of the quarter. The impairment analysis worksheets are reviewed by the Credit Administration department prior to quarter-end. The board of directors of the Bank on a quarterly basis reviews the classified/watch reports including changes in credit grades of 5 or higher as well as all impaired loans, the related allowances and OREO.
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In general, once the specific allowance has been finalized, regional and executive management will consider a charge-off prior to the calendar quarter-end in which that reserve calculation is finalized.
The review process also provides for the upgrade of loans that show improvement since the last review. All requests for an upgrade of a credit are approved by the loan strategy committee before the rating can be changed.
Restructured Loans
We restructure loans for our customers who appear to be able to meet the terms of their loan over the long term, but who may be unable to meet the terms of the loan in the near term due to individual circumstances. We consider the customer’s past performance, previous and current credit history, the individual circumstances surrounding the current difficulties and their plan to meet the terms of the loan in the future prior to restructuring the terms of the loan. The following factors are indicators that a concession has been granted (one or multiple items may be present):
• | The borrower receives a reduction of the stated interest rate for the remaining original life of the debt. |
• | The borrower receives an extension of the maturity date or dates at a stated interest rate lower than the current market interest rate for new debt with similar risk characteristics. |
• | The borrower receives a reduction of the face amount or maturity amount of the debt as stated in the instrument or other agreement. |
• | The borrower receives a deferral of required payments (principal and/or interest). |
• | The borrower receives a reduction of the accrued interest. |
Generally, loans are restructured through short-term interest rate relief, short-term principal payment relief or short-term principal and interest payment relief. Once a restructured loan has gone 90 days or more past due or is placed on nonaccrual status, it is included in the 90 days or more past due or nonaccrual totals.
During the year ended December 31, 2017, the Company restructured 11 loans by granting concessions to borrowers experiencing financial difficulties.
A loan classified as a troubled debt restructuring will no longer be included in the troubled debt restructuring disclosures in the periods after the restructuring if the loan performs in accordance with the terms specified by the restructuring agreement and the interest rate specified in the restructuring agreement represents a market rate at the time of modification. The specified interest rate is considered a market rate when the interest rate is equal to or greater than the rate the Company is willing to accept at the time of restructuring for a new loan with comparable risk. If there are concerns that the borrower will not be able to meet the modified terms of the loan, the loan will continue to be included in the troubled debt restructuring disclosures.
We consider all TDRs, regardless of whether they are performing in accordance with their modified terms, to be impaired loans when determining our allowance for loan losses. A summary of restructured loans as of December 31, 2017 and December 31, 2016 is as follows:
December 31, | |||||||
2017 | 2016 | ||||||
(in thousands) | |||||||
Restructured Loans (TDRs): | |||||||
In compliance with modified terms | $ | 8,870 | $ | 7,312 | |||
Not in compliance with modified terms - on nonaccrual status or over 90 days past due and still accruing interest | 4,778 | 1,003 | |||||
Total restructured loans | $ | 13,648 | $ | 8,315 | |||
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Allowance for Loan Losses
The following table shows activity affecting the allowance for loan losses:
Year ended December 31, | |||||||||||||||||||
2017 | 2016 | 2015 | 2014 | 2013 | |||||||||||||||
(dollars in thousands) | |||||||||||||||||||
Amount of loans outstanding at end of period (net of unearned interest) (1) | $ | 2,286,695 | $ | 2,165,143 | $ | 2,151,942 | $ | 1,132,519 | $ | 1,088,412 | |||||||||
Average amount of loans outstanding for the period (net of unearned interest) | $ | 2,201,364 | $ | 2,161,376 | $ | 1,962,846 | $ | 1,092,280 | $ | 1,059,356 | |||||||||
Allowance for loan losses at beginning of period (1) | $ | 21,850 | $ | 19,427 | $ | 16,363 | $ | 16,179 | $ | 15,957 | |||||||||
Charge-offs: | |||||||||||||||||||
Agricultural | $ | 1,202 | $ | 1,204 | $ | 245 | $ | 26 | $ | 39 | |||||||||
Commercial and industrial | 2,338 | 3,024 | 639 | 673 | 695 | ||||||||||||||
Credit cards | — | 42 | 53 | 12 | 95 | ||||||||||||||
Overdrafts | — | — | 44 | 37 | 64 | ||||||||||||||
Commercial real estate: | |||||||||||||||||||
Construction & development | 257 | 734 | 193 | 86 | 342 | ||||||||||||||
Farmland | — | — | — | — | — | ||||||||||||||
Multifamily | — | — | — | — | — | ||||||||||||||
Commercial real estate-other | 7,674 | 197 | 660 | 79 | 203 | ||||||||||||||
Total commercial real estate | 7,931 | 931 | 853 | 165 | 545 | ||||||||||||||
Residential real estate: | |||||||||||||||||||
One- to four- family first liens | 250 | 462 | 653 | 349 | 170 | ||||||||||||||
One- to four- family junior liens | 55 | 320 | 87 | 60 | 116 | ||||||||||||||
Total residential real estate | 305 | 782 | 740 | 409 | 286 | ||||||||||||||
Consumer | 257 | 98 | 48 | 39 | 83 | ||||||||||||||
Total charge-offs | $ | 12,033 | $ | 6,081 | $ | 2,622 | $ | 1,361 | $ | 1,807 | |||||||||
Recoveries: | |||||||||||||||||||
Agricultural | $ | 187 | $ | 33 | $ | 1 | $ | 10 | $ | 36 | |||||||||
Commercial and industrial | 232 | 124 | 372 | 215 | 68 | ||||||||||||||
Credit cards(2) | — | — | — | 2 | 2 | ||||||||||||||
Overdrafts(3) | — | — | 11 | 13 | 6 | ||||||||||||||
Commercial real estate: | |||||||||||||||||||
Construction & development | 167 | 54 | — | 38 | — | ||||||||||||||
Farmland | 24 | 1 | 4 | — | 1 | ||||||||||||||
Multifamily | — | — | — | — | 4 | ||||||||||||||
Commercial real estate-other | 100 | 137 | 3 | 23 | 474 | ||||||||||||||
Total commercial real estate | 291 | 192 | 7 | 61 | 479 | ||||||||||||||
Residential real estate: | |||||||||||||||||||
One- to four- family first liens | 24 | 82 | 131 | 18 | 24 | ||||||||||||||
One- to four- family junior liens | 156 | 75 | 12 | 4 | 43 | ||||||||||||||
Total residential real estate | 180 | 157 | 143 | 22 | 67 | ||||||||||||||
Consumer | 18 | 15 | 20 | 22 | 21 | ||||||||||||||
Total recoveries | $ | 908 | $ | 521 | $ | 554 | $ | 345 | $ | 679 | |||||||||
Net loans charged off | $ | 11,125 | $ | 5,560 | $ | 2,068 | $ | 1,016 | $ | 1,128 | |||||||||
Provision for loan losses | 17,334 | 7,983 | 5,132 | 1,200 | 1,350 | ||||||||||||||
Allowance for loan losses at end of period | $ | 28,059 | $ | 21,850 | $ | 19,427 | $ | 16,363 | $ | 16,179 | |||||||||
Net loans charged off to average loans | 0.51 | % | 0.26 | % | 0.11 | % | 0.09 | % | 0.11 | % | |||||||||
Allowance for loan losses to total loans at end of period | 1.23 | % | 1.01 | % | 0.90 | % | 1.44 | % | 1.49 | % | |||||||||
(1) - Loans do not include, and the allowance for loan losses does not include, loan pool participations for the years 2015, 2014 and 2013. | |||||||||||||||||||
(2) - Beginning in 2017, the Company no longer considered credit cards a separate class of loans, and these balances are now included in commercial and industrial loans. | |||||||||||||||||||
(3) - Beginning in 2016, the Company no longer considered overdrafts a separate class of loans, and these balances are now included in commercial and consumer loans, as appropriate. | |||||||||||||||||||
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The following table sets forth the allowance for loan losses by loan portfolio segments compared to the percentage of loans to total loans by loan portfolio segment as of December 31 for each of the years indicated:
December 31, | ||||||||||||||||||||||||||||||||||
2017 | 2016 | 2015 | 2014 | 2013 | ||||||||||||||||||||||||||||||
Allowance Amount | Percent of Loans to Total Loans | Allowance Amount | Percent of Loans to Total Loans | Allowance Amount | Percent of Loans to Total Loans | Allowance Amount | Percent of Loans to Total Loans | Allowance Amount | Percent of Loans to Total Loans | |||||||||||||||||||||||||
(dollars in thousands) | ||||||||||||||||||||||||||||||||||
Agricultural | $ | 2,790 | 4.6 | % | $ | 2,003 | 5.2 | % | $ | 1,417 | 5.7 | % | $ | 1,506 | 9.3 | % | $ | 1,358 | 8.9 | % | ||||||||||||||
Commercial and industrial | 8,518 | 22.0 | 6,274 | 21.3 | 5,451 | 21.9 | 5,780 | 26.9 | 4,980 | 24.3 | ||||||||||||||||||||||||
Commercial real estate | 13,637 | 51.3 | 9,860 | 49.2 | 8,556 | 46.1 | 4,399 | 37.6 | 5,294 | 39.9 | ||||||||||||||||||||||||
Residential real estate | 2,870 | 20.5 | 3,458 | 22.6 | 3,968 | 24.6 | 3,167 | 24.1 | 3,185 | 25.2 | ||||||||||||||||||||||||
Consumer | 244 | 1.6 | 255 | 1.7 | 409 | 1.7 | 323 | 2.1 | 275 | 1.7 | ||||||||||||||||||||||||
Unallocated | — | — | — | — | (374 | ) | — | 1,188 | — | 1,087 | — | |||||||||||||||||||||||
Total | $ | 28,059 | 100.0 | % | $ | 21,850 | 100.0 | % | $ | 19,427 | 100.0 | % | $ | 16,363 | 100.0 | % | $ | 16,179 | 100.0 | % | ||||||||||||||
Our ALLL as of December 31, 2017 was $28.1 million, which was 1.23% of total loans and 1.39% of non-acquired loans as of that date. This compares with an ALLL of $21.9 million as of December 31, 2016, which was 1.01% of total loans and 1.27% of non-acquired loans as of that date. Gross charge-offs for the year of 2017 totaled $12.0 million, which includes the charge-off of $7.3 million related to one commercial borrower, while recoveries of previously charged-off loans totaled $0.9 million. The ratio of annualized net loan charge offs to average loans for the year of 2017 was 0.51% compared to 0.26% for the year ended December 31, 2016. As of December 31, 2017, the ALLL was 117.59% of nonperforming loans compared with 76.76% as of December 31, 2016. Based on the inherent risk in the loan portfolio, we believed that as of December 31, 2017, the ALLL was adequate; however, there is no assurance losses will not exceed the allowance, and any growth in the loan portfolio or uncertainty in the general economy may require that management continue to evaluate the adequacy of the ALLL and make additional provisions in future periods as deemed necessary.
Non-acquired loans with a balance of $1.96 billion at December 31, 2017, had $27.2 million of the allowance for loan losses allocated to them, providing an allocated allowance for loan loss to non-acquired loan ratio of 1.39%, compared to balances of $1.68 billion and an allocated allowance for loan loss to non-acquired loan ratio of 1.27% at December 31, 2016. Non-acquired loans are total loans minus those loans acquired in the Central merger. New loans and loans renewed after the merger are considered non-acquired loans.
At December 31, 2017 | |||||||||||||||||||||
Gross Loans (A) | Discount (B) | Loans, Net of Discount (A-B) | Allowance (C) | Allowance/Gross Loans (C/A) | Allowance + Discount/Gross Loans ((B+C)/A) | ||||||||||||||||
Total Non-Acquired Loans | $ | 1,964,047 | $ | — | $ | 1,964,047 | $ | 27,209 | 1.39 | % | 1.39 | % | |||||||||
Total Acquired Loans | 331,122 | 8,474 | 322,648 | 850 | 0.26 | 2.82 | |||||||||||||||
Total Loans | $ | 2,295,169 | $ | 8,474 | $ | 2,286,695 | $ | 28,059 | 1.23 | % | 1.59 | % | |||||||||
At December 31, 2016 | |||||||||||||||||||||
Gross Loans (A) | Discount (B) | Loans, Net of Discount (A-B) | Allowance (C) | Allowance/Gross Loans (C/A) | Allowance + Discount/Gross Loans ((B+C)/A) | ||||||||||||||||
Total Non-Acquired Loans | $ | 1,677,935 | $ | — | $ | 1,677,935 | $ | 21,229 | 1.27 | % | 1.27 | % | |||||||||
Total Acquired Loans | 500,423 | 13,215 | 487,208 | 621 | 0.12 | 2.76 | |||||||||||||||
Total Loans | $ | 2,178,358 | $ | 13,215 | $ | 2,165,143 | $ | 21,850 | 1.01 | % | 1.61 | % | |||||||||
The Bank uses a rolling 20-quarter annual average historical net charge-off component for its ALLL calculation. One qualitative factor table is used for the entire bank. Differences in regional (Iowa, Minnesota/Wisconsin, Florida and Colorado) economic and business conditions are included in the qualitative factor narrative and the risk is spread over the entire loan portfolios. All pass rated loans, regardless of size, are allocated based on delinquency status. The Bank has streamlined the ALLL process for a number of low-balance loan types that do not have a material impact on the overall calculation, which are applied a reserve amount equal to the overall reserve calculated pursuant to applicable accounting standards to total loan calculated pursuant to applicable accounting standards. The guaranteed portion of any government guaranteed loan is included in the calculation and is reserved for according to the type of loan. Special mention/watch and substandard rated credits not individually reviewed for impairment are allocated at a higher amount due to the inherent risks associated with these types of loans. Special mention/watch
54
risk rated loans (i.e. early stages of financial deterioration, technical exceptions, etc.) are reserved at a level that will cover losses above a pass allocation for loans that had a loss in the trailing 20-quarters in which the loan was risk-rated special mention/watch at the time of the loss. Substandard loans carry a greater risk than special mention/watch loans, and as such, this subset is reserved at a level that covers losses above a pass allocation for loans that had a loss in the trailing 20-quarters in which the loans was risk-rated substandard at the time of the loss. Classified and impaired loans are reviewed per the requirements of applicable accounting standards.
We currently track the loan to value (“LTV”) ratio of loans in our portfolio, and those loans in excess of internal and supervisory guidelines are presented to the Bank’s board of directors on a quarterly basis. At December 31, 2017, there were 25 owner-occupied 1-4 family loans with a LTV ratio of 100% or greater. In addition, there were 158 home equity loans without credit enhancement that had a LTV ratio of 100% or greater. We have the first lien on 3 of these equity loans and other financial institutions have the first lien on the remaining 155. There were also 164 commercial real estate loans without credit enhancement that exceed the supervisory LTV guidelines.
We review all impaired and nonperforming loans individually on a quarterly basis to determine their level of impairment due to collateral deficiency or insufficient cash-flow based on a discounted cash-flow analysis. At December 31, 2017, TDRs were not a material portion of the loan portfolio. We review loans 90 days or more past due that are still accruing interest no less than quarterly to determine if there is a strong reason that the credit should not be placed on non-accrual. The Bank’s board of directors has reviewed these credit relationships and determined that these loans and the risks associated with them were acceptable and did not represent any undue risk.
Premises and Equipment
As of December 31, 2017, premises and equipment totaled $76.0 million, an increase of $1.0 million, or 1.2%, from $75.0 million at December 31, 2016. This increase was primarily due to normal building improvements, somewhat offset by depreciation. We expect the balance of premises and equipment to remain stable in future periods.
Goodwill and Other Intangible Assets
Goodwill was unchanged at $64.7 million as of December 31, 2016 and 2017. Other intangible assets decreased $3.1 million, or 20.6%, to $12.0 million at December 31, 2017 compared to December 31, 2016, due to normal amortization. See Note 6. “Goodwill and Intangible Assets” to our consolidated financial statements for additional information.
Deposits
Deposits increased $124.9 million, or 5.0%, during the year ended December 31, 2017, due in part to an increased focus on deposit gathering in Minnesota and Wisconsin, and growth in the Colorado market. The mix of deposits saw increases between December 31, 2016 and December 31, 2017 of $91.8 million, or 8.1%, in interest-bearing checking deposits, $15.7 million, or 8.0%, in savings deposits, and $49.9 million, or 7.7%, in certificates of deposit. These increases were partially offset by a decrease in non-interest bearing demand deposits of $32.6 million, or 6.6%, between December 31, 2016 and December 31, 2017.
The average balance of non-interest-bearing accounts decreased $41.2 million, or 8.0%, from 2016 to 2017. The average balance of interest-bearing demand deposits increased $64.6 million, or 5.9%, and the average balance of savings accounts increased by $10.0 million, or 5.1%, between 2016 and 2017. The aggregate average balance of time deposits increased by $24.8 million, or 3.8%, from 2016 to 2017, primarily in deposits of $100,000 and over.
Year Ended December 31, | |||||||||||||||||||||||||||||||||||||||||||||||||
2017 | 2016 | 2015 | 2014 | 2013 | |||||||||||||||||||||||||||||||||||||||||||||
Average | % | Average | Average | % | Average | Average | % | Average | Average | % | Average | Average | % | Average | |||||||||||||||||||||||||||||||||||
Balance | Total | Rate | Balance | Total | Rate | Balance | Total | Rate | Balance | Total | Rate | Balance | Total | Rate | |||||||||||||||||||||||||||||||||||
(dollars in thousands) | |||||||||||||||||||||||||||||||||||||||||||||||||
Non-interest-bearing demand deposits | $ | 471,170 | 18.8 | % | NA | $ | 512,383 | 21.0 | % | NA | $ | 488,312 | 21.4 | % | NA | $ | 208,071 | 15.0 | % | NA | $ | 204,185 | 15.0 | % | NA | ||||||||||||||||||||||||
Interest-bearing demand (NOW and money market) | 1,152,350 | 46.0 | 0.32 | % | 1,087,757 | 44.5 | 0.29 | % | 859,945 | 37.8 | 0.31 | % | 603,812 | 43.7 | 0.36 | % | 581,723 | 42.8 | 0.41 | % | |||||||||||||||||||||||||||||
Savings | 205,204 | 8.2 | 0.10 | 195,237 | 8.0 | 0.14 | 279,230 | 12.3 | 0.13 | 102,850 | 7.4 | 0.14 | 96,034 | 7.1 | 0.15 | ||||||||||||||||||||||||||||||||||
Time deposits | 674,757 | 27.0 | 1.13 | 649,986 | 26.5 | 0.92 | 648,516 | 28.5 | 0.75 | 469,351 | 33.9 | 1.00 | 477,537 | 35.1 | 1.35 | ||||||||||||||||||||||||||||||||||
Total deposits | $ | 2,503,481 | 100.0 | % | 0.46 | % | $ | 2,445,363 | 100.0 | % | 0.38 | % | $ | 2,276,003 | 100.0 | % | 0.35 | % | $ | 1,384,084 | 100.0 | % | 0.51 | % | $ | 1,359,479 | 100.0 | % | 0.66 | % | |||||||||||||||||||
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Certificates of deposit of $100,000 and over at December 31, 2017 had the following maturities:
(in thousands) | |||
Three months or less | $ | 108,796 | |
Over three through six months | 42,121 | ||
Over six months through one year | 80,513 | ||
Over one year | 145,697 | ||
Total | $ | 377,127 | |
Federal Funds Purchased and Securities Sold Under Agreement to Repurchase
Federal funds purchased were $1.0 million as of December 31, 2017, a decrease of $34.7 million, or 97.2%, from $35.7 million at December 31, 2016. The Bank uses federal funds to meet its routine liquidity requirements and to maintain short-term liquidity, which accounts for fluctuations in this balance. Securities sold under agreement to repurchase were $96.2 million as of December 31, 2017, an increase of $14.0 million, or 17.1%, from $82.2 million at December 31, 2016. The Company enters into repurchase agreements and also offers a demand deposit account product to customers that sweeps their balances in excess of an agreed upon target amount into overnight repurchase agreements. Changes in the balance of securities sold under agreement to repurchase are due to variances in the cash needs of these customers. See Note 10. “Short-Term Borrowings” to our consolidated financial statements for additional information related to our federal funds purchased and securities sold under agreement to repurchase.
Junior Subordinated Notes Issued to Capital Trusts
Junior subordinated notes that have been issued to capital trusts that issued trust preferred securities were $23.8 million as of December 31, 2017, an increase of $0.1 million, or 0.4%, from $23.7 million at December 31, 2016. This increase was due to purchase accounting amortization on junior subordinated notes that were assumed by us from Central in the merger. See Note 11. “Subordinated Notes Payable” to our consolidated financial statements for additional information related to our junior subordinated notes.
Federal Home Loan Bank Borrowings
FHLB borrowings totaled $115.0 million as of December 31, 2017, the same as of December 31, 2016. We utilize FHLB borrowings as a supplement to customer deposits to fund earning assets and to assist in managing interest rate risk. Thus, if deposits decline, FHLB borrowing may increase to provide necessary liquidity. See Note 12. “Long-Term Borrowings” to our consolidated financial statements for additional information related to our FHLB borrowings.
Long-term Debt
Long-term debt in the form of a $35.0 million unsecured note payable to a correspondent bank was entered into on April 30, 2015 in connection with the payment of the merger consideration at the closing of the Central merger, of which $12.5 million was outstanding as of December 31, 2017. See Note 12. “Long-Term Borrowings” to our consolidated financial statements for additional information related to our long-term debt.
The following table sets forth the distribution of borrowed funds and weighted average interest rates thereon at the end of each of the last three years.
December 31, | ||||||||||||||||||||
2017 | 2016 | 2015 | ||||||||||||||||||
Average | Average | Average | ||||||||||||||||||
Balance | Rate | Balance | Rate | Balance | Rate | |||||||||||||||
(dollars in thousands) | ||||||||||||||||||||
Federal funds purchased and repurchase agreements | $ | 97,229 | 0.47 | % | $ | 117,871 | 0.40 | % | $ | 68,963 | 0.30 | % | ||||||||
FHLB borrowings | 115,000 | 1.67 | 115,000 | 1.56 | 87,000 | 1.64 | ||||||||||||||
Junior subordinated notes issued to capital trusts | 23,793 | 4.00 | 23,692 | 3.16 | 23,587 | 2.71 | ||||||||||||||
Long-term debt | 12,500 | 2.85 | 17,500 | 2.52 | 22,500 | 2.17 | ||||||||||||||
Total | $ | 248,522 | 1.48 | % | $ | 274,063 | 1.26 | % | $ | 202,050 | 1.38 | % | ||||||||
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The following table sets forth the maximum amount of borrowed funds outstanding at any month-end for the years ended December 31, 2017, 2016 and 2015.
Year Ended December 31, | |||||||||||
2017 | 2016 | 2015 | |||||||||
(in thousands) | |||||||||||
Federal funds purchased and repurchase agreements | $ | 124,952 | $ | 117,871 | $ | 102,009 | |||||
FHLB borrowings | 145,000 | 115,000 | 93,000 | ||||||||
Junior subordinated notes issued to capital trusts | 23,793 | 23,692 | 23,523 | ||||||||
Subordinated note | — | — | 12,099 | ||||||||
Long-term debt | 17,500 | 22,500 | 25,000 | ||||||||
Total | $ | 311,245 | $ | 279,063 | $ | 255,631 | |||||
The following table sets forth the average amount of and the average rate paid on borrowed funds for the years ended December 31, 2017, 2016 and 2015:
Year Ended December 31, | ||||||||||||||||||||
2017 | 2016 | 2015 | ||||||||||||||||||
Average | Average | Average | Average | Average | Average | |||||||||||||||
Balance | Rate | Balance | Rate | Balance | Rate | |||||||||||||||
(dollars in thousands) | ||||||||||||||||||||
Federal funds purchased and repurchase agreements | $ | 87,763 | 0.47 | % | $ | 74,566 | 0.27 | % | $ | 69,498 | 0.30 | % | ||||||||
FHLB borrowings | 110,000 | 1.67 | 104,954 | 1.74 | 86,614 | 1.68 | ||||||||||||||
Junior subordinated notes issued to capital trusts | 23,743 | 4.00 | 23,641 | 3.49 | 20,868 | 2.84 | ||||||||||||||
Subordinated note | — | — | — | — | 1,805 | 8.98 | ||||||||||||||
Long-term debt | 15,596 | 2.75 | 20,604 | 2.27 | 16,527 | 2.26 | ||||||||||||||
Total | $ | 237,102 | 1.53 | % | $ | 223,765 | 1.48 | % | $ | 195,312 | 1.43 | % | ||||||||
Contractual Obligations
The following table summarizes contractual obligations payments due by period, as of December 31, 2017:
Less than | 1 to 3 | 3 to 5 | More than | ||||||||||||||||
Total | 1 year | years | years | 5 years | |||||||||||||||
Contractual obligations | |||||||||||||||||||
(in thousands) | |||||||||||||||||||
Time certificates of deposit | $ | 701,808 | $ | 391,444 | $ | 238,267 | $ | 72,094 | $ | 3 | |||||||||
Federal funds purchased and repurchase agreements | 97,229 | 97,229 | — | — | — | ||||||||||||||
FHLB borrowings | 115,000 | 19,000 | 74,000 | 22,000 | — | ||||||||||||||
Junior subordinated notes issued to capital trusts | 23,793 | — | — | — | 23,793 | ||||||||||||||
Long-term debt | 12,500 | 5,000 | 5,000 | 2,500 | — | ||||||||||||||
Noncancelable operating leases and capital lease obligations | 1,294 | 103 | 249 | 502 | 440 | ||||||||||||||
Total | $ | 951,624 | $ | 512,776 | $ | 317,516 | $ | 97,096 | $ | 24,236 | |||||||||
Off-Balance-Sheet Transactions
During the normal course of business, we become a party to financial instruments with off-balance-sheet risk in order to meet the financing needs of our customers. These financial instruments include commitments to extend credit, commitments to sell loans, and standby letters of credit. We follow the same credit policy (including requiring collateral, if deemed appropriate) to make such commitments as is followed for those loans that are recorded in our financial statements.
Our exposure to credit losses in the event of nonperformance is represented by the contractual amount of the commitments. Management does not expect any significant losses as a result of these commitments, and also expects to have
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sufficient liquidity available to cover these off-balance-sheet instruments. Off-balance-sheet transactions are more fully discussed in Note 18. “Commitments and Contingencies” to our consolidated financial statements.
The following table summarizes our off-balance-sheet commitments by expiration period, as of December 31, 2017:
Less than | 1 to 3 | 3 to 5 | More than | ||||||||||||||||
Total | 1 year | years | years | 5 years | |||||||||||||||
Contractual obligations | |||||||||||||||||||
(in thousands) | |||||||||||||||||||
Commitments to extend credit | $ | 563,305 | $ | 219,257 | $ | 344,048 | $ | — | $ | — | |||||||||
Commitments to sell loans | 856 | 856 | — | — | — | ||||||||||||||
Standby letters of credit | 10,260 | 7,644 | 2,616 | — | — | ||||||||||||||
Total | $ | 574,421 | $ | 227,757 | $ | 346,664 | $ | — | $ | — | |||||||||
Capital Resources
The Federal Reserve uses capital adequacy guidelines in its examination and regulation of bank holding companies and their subsidiary banks. Risk-based capital ratios are established by allocating assets and certain off-balance-sheet commitments into four risk-weighted categories. These balances are then multiplied by the factor appropriate for that risk-weighted category. Pursuant to the Basel III Rule, the Company and the Bank, respectively, are subject to regulatory capital adequacy requirements promulgated by the Federal Reserve and the FDIC. Failure by the Company or the Bank to meet minimum capital requirements could result in certain mandatory and discretionary actions by our regulators that could have a material adverse effect on our consolidated financial statements. Under the capital requirements and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company’s and the Bank’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’s and the Bank’s capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of total risk-based capital, Tier 1 capital (as defined in the regulations) and Common Equity Tier 1 Capital (as defined in the regulations) to risk-weighted assets (as defined in the regulations), and a leverage ratio consisting of Tier 1 capital (as defined in the regulations) to average assets (as defined in the regulations). As of December 31, 2017, both the Bank and the Company exceeded federal regulatory minimum capital requirements to be classified as well-capitalized under the prompt corrective action requirements. See Note 17. “Regulatory Capital Requirements and Restrictions on Subsidiary Cash” to our consolidated financial statements for additional information related to our regulatory capital ratios.
In order to be a “well-capitalized” depository institution, a bank must maintain a Common Equity Tier 1 capital ratio of 6.5% or more; a Tier 1 capital ratio of 8% or more; a Total capital ratio of 10% or more; and a leverage ratio of 5% or more. A capital conservation buffer, comprised of Common Equity Tier 1 Capital, is also established above the regulatory minimum capital requirements. This capital conservation buffer is being phased in, which began January 1, 2016, at 0.625% of risk-weighted assets and increases each subsequent year by an additional 0.625% until reaching the final level of 2.5% on January 1, 2019. The capital conservation buffer during 2017 was 1.25%.
On May 1, 2015, as consideration for the Central merger, the Company issued 2,723,083 shares of its common stock. On June 22, 2015, the Company entered into a Securities Purchase Agreement with certain institutional accredited investors, pursuant to which, on June 23, 2015, the Company sold an aggregate of 300,000 newly issued shares of the Company’s common stock at a purchase price of $28.00 per share. Each of the purchasers was an existing shareholder of the Company. On March 17, 2017, the Company entered into an underwriting agreement to offer and sell, through an underwriter, up to 750,000 newly issued shares of the Company’s common stock at a public purchase price of $34.25 per share. This included 250,000 shares of the Company’s common stock granted as a 30-day option to purchase to cover over-allotments, if any. On April 6, 2017, the underwriter purchased the full amount of its over-allotment option of 250,000 shares.
At the 2017 Annual Meeting of Shareholders of the Company held on April 20, 2017, the Company’s shareholders approved the MidWestOne Financial Group, Inc. 2017 Equity Incentive Plan (the “Plan”). The Plan is the successor to the MidWestOne Financial Group, Inc. 2008 Equity Incentive Plan (the “2008 Plan”), which expired on November 20, 2017.
On February 15, 2017, 25,400 restricted stock units were granted to certain officers of the Company under the 2008 Plan. Additionally, during the year of 2017, 27,625 shares of common stock were issued in connection with the vesting of previously awarded grants of restricted stock units, of which 3,124 shares were surrendered by grantees to satisfy tax requirements, and 3,225 nonvested restricted stock units were forfeited. During 2017, 8,750 shares of common stock were issued in connection with the exercise of previously issued stock options, and no options expired.
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On May 15, 2017, 7,600 restricted stock units were granted to the directors of the Company under the Plan. See Note 15. “Stock Compensation Plans” to our consolidated financial statements for additional information related to our stock compensation program.
On July 21, 2016, the board of directors of the Company approved a share repurchase program, allowing for the repurchase of up to $5.0 million of stock through December 31, 2018. During 2017, the Company repurchased no common stock. Of the $5.0 million of stock authorized under the repurchase plan, $5.0 million remained available for possible future repurchases as of December 31, 2017.
Liquidity
Liquidity management involves the ability to meet the cash flow requirements of depositors and borrowers. We conduct liquidity management on both a daily and long-term basis. We adjust our investments in liquid assets based upon management’s assessment of expected loan demand, projected loan sales, expected deposit flows, yields available on interest-bearing deposits, and the objectives of our asset/liability management program. Excess liquidity is invested generally in short-term U.S. government and agency securities, short- and medium-term state and political subdivision securities, and other investment securities.
Our most liquid assets are cash and due from banks, interest-bearing bank deposits, and federal funds sold. The balances of these assets are dependent on our operating, investing, lending, and financing activities during any given period.
Liquid assets on hand are summarized in the table below:
Year Ended December 31, | |||||||||||
2017 | 2016 | 2015 | |||||||||
(dollars in thousands) | |||||||||||
Cash and due from banks | $ | 44,818 | $ | 41,464 | $ | 44,199 | |||||
Interest-bearing deposits | 5,474 | 1,764 | 2,731 | ||||||||
Federal funds sold | 680 | — | 167 | ||||||||
Total | $ | 50,972 | $ | 43,228 | $ | 47,097 | |||||
Percentage of average total assets | 1.6 | % | 1.4 | % | 1.7 | % | |||||
Generally, our principal sources of funds are deposits, advances from the FHLB, principal repayments on loans, proceeds from the sale of loans, proceeds from the maturity and sale of investment securities, our federal funds lines of credit, and funds provided by operations. While scheduled loan amortization and maturing interest-bearing deposits are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by economic conditions, the general level of interest rates, and competition. We utilized particular sources of funds based on comparative costs and availability. This included fixed-rate advances from the FHLB that were obtained at a more favorable cost than deposits of comparable maturity. We generally managed the pricing of our deposits to maintain a steady deposit base but from time to time decided not to pay rates on deposits as high as our competition. Our banking subsidiary also maintains unsecured lines of credit with several correspondent banks and secured lines with the Federal Reserve Bank Discount Window and the FHLB that would allow us to borrow funds on a short-term basis, if necessary.
As of December 31, 2017, we had $12.5 million of long-term debt outstanding to an unaffiliated banking organization. See Note 12. “Long-Term Borrowings” to our consolidated financial statements for additional information related to our long-term debt. As of December 31, 2017, we also had $23.8 million of indebtedness payable under junior subordinated debentures issued to subsidiary trusts that issued trust preferred securities in pooled offerings. See Note 11. “Subordinated Notes Payable” to our consolidated financial statements for additional information related to our junior subordinated notes.
Net cash provided by operations was another major source of liquidity. The net cash provided by operating activities was $41.0 million for the year ended December 31, 2017 and $38.2 million for the year ended December 31, 2016.
As of December 31, 2017, we had outstanding commitments to extend credit to borrowers of $563.3 million, standby letters of credit of $10.3 million, and commitments to sell loans of $0.9 million. Certificates of deposit maturing in one year or less totaled $391.4 million as of December 31, 2017. We believe that a significant portion of these deposits will remain with us upon maturity.
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Inflation
The effects of price changes and inflation can vary substantially for most financial institutions. While management believes that inflation affects the growth of total assets, it is difficult to assess the overall impact. The price of one or more of the components of the Consumer Price Index may fluctuate considerably and thereby influence the overall Consumer Price Index without having a corresponding effect on interest rates or upon the cost of those goods and services normally purchased by us. In years of high inflation and high interest rates, intermediate and long-term interest rates tend to increase, thereby adversely impacting the market values of investment securities, mortgage loans and other long-term fixed rate loans held by financial institutions. In addition, higher short-term interest rates caused by inflation tend to increase financial institutions’ cost of funds. In other years, the reverse situation may occur.
ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. |
In general, market risk is the risk of change in asset values due to movements in underlying market rates and prices. Interest rate risk is the risk to earnings and capital arising from movements in interest rates. Interest rate risk is the most significant market risk affecting us as other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of our business activities.
In addition to interest rate risk, economic conditions in recent years have made liquidity risk (namely, funding liquidity risk) a more prevalent concern among financial institutions. In general, liquidity risk is the risk of being unable to fund an entity’s obligations to creditors (including, in the case of banks, obligations to depositors) as such obligations become due and/or fund its acquisition of assets.
Liquidity Risk
Liquidity refers to our ability to fund operations, to meet depositor withdrawals, to provide for our customers’ credit needs, and to meet maturing obligations and existing commitments. Our liquidity principally depends on cash flows from operating activities, investment in and maturity of assets, changes in balances of deposits and borrowings, and our ability to borrow funds.
Net cash provided by operating activities was $41.0 million during 2017, compared with $38.2 million in 2016 and $32.7 million in 2015. Proceeds from loans held for sale, net of funds used to originate loans held for sale, represented a $3.4 million inflow for 2017, compared to an outflow of $1.1 million for 2016 and a $2.4 million net outflow for 2015.
Net cash used in investing activities was $148.8 million during 2017, compared with net cash used in investing activities of $123.6 million in 2016 and net cash provided by investing activities of $5.0 million in 2015. During 2017, securities transactions were cash neutral, while they resulted in a net cash outflow for 2016 of $108.8 million, and a net cash inflow of $137.7 million for 2015. Net origination of loans and principal received from loan pools resulted in $133.8 million in cash outflows for 2017, compared to a $20.6 million outflows for 2016 and $86.9 million outflows in 2015. Net cash used to acquire Central in 2015 was $35.6 million.
Net cash provided by financing activities was $115.5 million during 2017, compared with net cash provided by financing activities of $81.5 million in 2016, and net cash used in financing activities of $14.0 million in 2015. Sources of cash from financing activities for 2017 included a $124.9 million increase in net deposits, and $24.4 million (net of expenses) proceeds from the issuance of common stock. These increases in cash were partially offset by a net decrease of $34.7 million in federal funds purchased, $8.1 million cash dividends paid, and $5.0 million in payments on long-term debt. In 2016, our main sources of cash from financing activities were a net increase of $34.2 million in federal funds purchased, $28.0 million net proceeds from FHLB borrowings, and a $16.9 million increase in net deposits, partially offset by $7.3 million cash dividends paid, and $5.0 million in payments on long-term debt. In 2015, our main sources of cash from financing activities were $25.0 million of new long-term borrowings, $7.9 million proceeds from the issuance of common stock, and a $5.8 million increase in net deposits, partially offset by a net decrease of $15.9 million in federal funds purchased, $12.7 million to redeem a subordinated note, and a net decrease in FHLB borrowings of $6.0 million.
To further mitigate liquidity risk, the Bank has several sources of liquidity in place to maximize funding availability and increase the diversification of funding sources. The criteria for evaluating the use of these sources include volume concentration (percentage of liabilities), cost, volatility, and the fit with the current asset/liability management plan. These acceptable sources of liquidity include:
• | Federal funds lines; |
• | FHLB borrowings; |
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• | Brokered deposits; |
• | Brokered repurchase agreements; and |
• | Federal Reserve Bank Discount Window. |
Federal Funds Lines: Routine liquidity requirements are met by fluctuations in the federal funds position of the Bank. The principal function of these funds is to maintain short-term liquidity. Unsecured federal funds purchased lines are viewed as a volatile liability and are not used as a long-term funding solution, especially when used to fund long-term assets. Multiple correspondent relationships are preferable and federal funds sold exposure to any one customer is continuously monitored. The current federal funds purchased limit is 10% of total assets, or the amount of established federal funds lines, whichever is smaller. Currently, the Bank has unsecured federal funds lines totaling $150.0 million, which lines are tested annually to ensure availability.
FHLB Borrowings: FHLB borrowings provide both a source of liquidity and long-term funding for the Bank. Use of this type of funding is coordinated with both the strategic balance sheet growth projections and interest rate risk profile of the Bank. Factors that are taken into account when contemplating use of FHLB borrowings are the effective interest rate, the collateral requirements, community investment program credits, and the implications and cost of having to purchase incremental FHLB stock. The current FHLB borrowing limit is 35% of total assets. As of December 31, 2017, the Bank had $115.0 million in outstanding FHLB borrowings, leaving $198.0 million available for liquidity needs, based on collateral capacity. These borrowings are secured by various real estate loans (residential, commercial and agricultural).
Brokered Deposits: The Bank has brokered certificate of deposit lines/deposit relationships available to help diversify its various funding sources. Brokered deposits offer several benefits relative to other funding sources, such as: maturity structures which cannot be duplicated in the current deposit market, deposit gathering which does not cannibalize the existing deposit base, the unsecured nature of these liabilities, and the ability to quickly generate funds. However, brokered deposits are often viewed as a volatile liability by banking regulators and market participants. This viewpoint, and the desire to not develop a large funding concentration in any one area outside of the Bank’s core market area, is reflected in an internal policy stating that the Bank limit the use of brokered deposits as a funding source to no more than 10% of total assets. Board approval is required to exceed this limit. The Bank will also have to maintain a “well capitalized” standing to access brokered deposits, as an “adequately capitalized” rating would require an FDIC waiver to do so, and an “undercapitalized” rating would prohibit it from using brokered deposits altogether.
Brokered Repurchase Agreements: Brokered repurchase agreements may be established with approved brokerage firms and banks. Repurchase agreements create rollover risk (the risk that a broker will discontinue the relationship due to market factors) and are not used as a long-term funding solution, especially when used to fund long-term assets. Collateral requirements and availability are evaluated and monitored. The current policy limit for brokered repurchase agreements is 10% of total assets. There were no outstanding brokered repurchase agreements at December 31, 2017.
Federal Reserve Bank Discount Window: The Federal Reserve Bank Discount Window is another source of liquidity, particularly during difficult economic times. The Bank has a borrowing capacity with the Federal Reserve Bank of Chicago limited by the amount of municipal securities pledged against the line. As of December 31, 2017, the Bank had municipal securities with an approximate market value of $12.8 million pledged for liquidity purposes.
Interest Rate Risk
Interest rate risk is defined as the exposure of net interest income and fair value of financial instruments (interest-earning assets, deposits and borrowings) to movements in interest rates. The Company’s results of operations depend to a large degree on its net interest income and its ability to manage interest rate risk. The Company considers interest rate risk to be one of its more significant market risks. The major sources of the Company's interest rate risk are timing differences in the maturity and re-pricing characteristics of assets and liabilities, changes in the shape of the yield curve, changes in customer behavior and changes in relationships between rate indices (basis risk). Management measures these risks and their impact in various ways, including through the use of income simulation and valuation analyses. Multiple interest rate scenarios are evaluated which include gradual or rapid changes in interest rates, spread narrowing and widening, yield curve twists and changes in assumptions about customer behavior in various interest rate scenarios. A mismatch between maturities, interest rate sensitivities and prepayment characteristics of assets and liabilities results in interest-rate risk. Like most financial institutions, we have material interest-rate risk exposure to changes in both short-term and long-term interest rates, as well as variable interest rate indices (e.g., the prime rate or LIBOR). The change in the Company’s interest rate profile between December 31, 2016 and December 31, 2017 is largely attributable to the growth in the investment securities portfolio.
The Bank’s asset and liability committee meets regularly and is responsible for reviewing its interest rate sensitivity position and establishing policies to monitor and limit exposure to interest rate risk. Our asset and liability committee seeks to
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manage interest rate risk under a variety of rate environments by structuring our balance sheet and off-balance-sheet positions in such a way that changes in interest rates do not have a large negative impact. The risk is monitored and managed within approved policy limits.
We use a third-party service to model and measure our 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 and securities backed by mortgages, the slope of the Treasury yield-curve, the rates and volumes of our deposits, and the rates and volumes of our loans. There are two primary tools used to evaluate interest rate risk: net interest income simulation and economic value of equity ("EVE"). In addition, interest rate gap is reviewed to monitor asset and liability repricing over various time periods.
Net Interest Income Simulation: Management utilizes net interest income simulation models to estimate the near-term effects of changing interest rates on its net interest income. Net interest income simulation involves forecasting net interest income under a variety of scenarios, including the level of interest rates and the shape of the yield curve. Management exercises its best judgment in making assumptions regarding events that management can influence, such as non-contractual deposit re-pricings, and events outside management's control, such as customer behavior on loan and deposit activity and the effect that competition has on both loan and deposit pricing. These assumptions are subjective, and, as a result, net interest income simulation results will differ from actual results due to the timing, magnitude and frequency of interest rate changes, changes in market conditions, customer behavior and management strategies, among other factors. We perform various sensitivity analyses on assumptions of deposit attrition and deposit re-pricing.
The following table presents the anticipated effect on net interest income over a twelve month period if short- and long-term interest rates were to sustain an immediate decrease of 100 basis points or increase of 100 basis points and 200 basis points.
Immediate Change in Rates | |||||||||||
-100 | +100 | +200 | |||||||||
(dollars in thousands) | |||||||||||
December 31, 2017 | |||||||||||
Dollar change | $ | (729 | ) | $ | 55 | $ | (361 | ) | |||
Percent change | (0.7 | )% | 0.1 | % | (0.4 | )% | |||||
December 31, 2016 | |||||||||||
Dollar change | $ | (886 | ) | $ | 157 | $ | 453 | ||||
Percent change | (0.9 | )% | 0.2 | % | 0.5 | % | |||||
As of December 31, 2017, 37.7% of the Company’s interest-earning asset balances will reprice or are expected to pay down in the next 12 months and 64.9% of the Company’s deposit balances are low cost or no cost deposits.
Economic Value of Equity: Management also uses EVE to measure risk in the balance sheet that might not be taken into account in the net interest income simulation analysis. Net interest income simulation highlights exposure over a relatively short time period, while EVE analysis incorporates all cash flows over the estimated remaining life of all balance sheet positions. The valuation of the balance sheet, at a point in time, is defined as the discounted present value of asset cash flows minus the discounted present value of liability cash flows. EVE analysis addresses only the current balance sheet and does not incorporate the run-off replacement assumptions that are used in the net interest income simulation model. As with the net interest income simulation model, EVE analysis is based on key assumptions about the timing and variability of balance sheet cash flows and does not take into account any potential responses by management to anticipated changes in interest rates.
Interest Rate Gap: The interest rate gap is the difference between interest-earning assets and interest-bearing liabilities re-pricing within a given period and represents the net asset or liability sensitivity at a point in time. An interest rate gap measure could be significantly affected by external factors such as loan prepayments, early withdrawals of deposits, changes in the correlation of various interest-bearing instruments, competition, or a rise or decline in interest rates.
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ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. |
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors of MidWestOne Financial Group, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of MidWestOne Financial Group, Inc. and its subsidiaries’ (the Company) as of December 31, 2017 and 2016, and the related consolidated statements of operations, comprehensive income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2017, and the related notes to the consolidated financial statements (collectively, financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013, and our report dated March 1, 2018 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits includes performing procedures to assess the risk of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also include evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ RSM US LLP
We have served as the Company’s auditor since 2013.
Cedar Rapids, Iowa
March 1, 2018
63
MIDWESTONE FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2017 and 2016
(dollars in thousands)
2017 | 2016 | ||||||
ASSETS | |||||||
Cash and due from banks | $ | 44,818 | $ | 41,464 | |||
Interest-bearing deposits in banks | 5,474 | 1,764 | |||||
Federal funds sold | 680 | — | |||||
Cash and cash equivalents | 50,972 | 43,228 | |||||
Investment securities: | |||||||
Available for sale | 447,660 | 477,518 | |||||
Held to maturity (fair value of $194,343 as of December 31, 2017 and $164,792 as of December 31, 2016) | 195,619 | 168,392 | |||||
Loans held for sale | 856 | 4,241 | |||||
Loans | 2,286,695 | 2,165,143 | |||||
Allowance for loan losses | (28,059 | ) | (21,850 | ) | |||
Net loans | 2,258,636 | 2,143,293 | |||||
Premises and equipment, net | 75,969 | 75,043 | |||||
Accrued interest receivable | 14,732 | 13,871 | |||||
Goodwill | 64,654 | 64,654 | |||||
Other intangible assets, net | 12,046 | 15,171 | |||||
Bank-owned life insurance | 59,831 | 47,231 | |||||
Other real estate owned | 2,010 | 2,097 | |||||
Deferred income taxes, net | 6,525 | 6,523 | |||||
Other assets | 22,761 | 18,313 | |||||
Total assets | $ | 3,212,271 | $ | 3,079,575 | |||
LIABILITIES AND SHAREHOLDERS' EQUITY | |||||||
Deposits: | |||||||
Non-interest-bearing demand | $ | 461,969 | $ | 494,586 | |||
Interest-bearing checking | 1,228,112 | 1,136,282 | |||||
Savings | 213,430 | 197,698 | |||||
Certificates of deposit under $100,000 | 324,681 | 326,832 | |||||
Certificates of deposit $100,000 and over | 377,127 | 325,050 | |||||
Total deposits | 2,605,319 | 2,480,448 | |||||
Federal funds purchased | 1,000 | 35,684 | |||||
Securities sold under agreements to repurchase | 96,229 | 82,187 | |||||
Federal Home Loan Bank borrowings | 115,000 | 115,000 | |||||
Junior subordinated notes issued to capital trusts | 23,793 | 23,692 | |||||
Long-term debt | 12,500 | 17,500 | |||||
Deferred compensation liability | 5,199 | 5,180 | |||||
Accrued interest payable | 1,428 | 1,472 | |||||
Other liabilities | 11,499 | 12,956 | |||||
Total liabilities | 2,871,967 | 2,774,119 | |||||
Commitments and contingencies (Note 18) | |||||||
Shareholders' equity: | |||||||
Preferred stock, no par value; authorized 500,000 shares; no shares issued and outstanding at December 31, 2017 and December 31, 2016 | — | — | |||||
Common stock, $1.00 par value; authorized 30,000,000 shares at December 31, 2017 and 15,000,000 shares at December 31, 2016; issued 12,463,481 shares at December 31, 2017 and 11,713,481 shares at December 31, 2016; outstanding 12,219,611 shares at December 31, 2017 and 11,436,360 shares at December 31, 2016 | 12,463 | 11,713 | |||||
Additional paid-in capital | 187,486 | 163,667 | |||||
Treasury stock at cost, 243,870 shares as of December 31, 2017 and 277,121 shares as of December 31, 2016 | (5,121 | ) | (5,766 | ) | |||
Retained earnings | 148,078 | 136,975 | |||||
Accumulated other comprehensive loss | (2,602 | ) | (1,133 | ) | |||
Total shareholders' equity | 340,304 | 305,456 | |||||
Total liabilities and shareholders' equity | $ | 3,212,271 | $ | 3,079,575 | |||
See accompanying notes to consolidated financial statements.
64
MIDWESTONE FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2017, 2016, and 2015
(in thousands, except per share amounts)
2017 | 2016 | 2015 | ||||||||||
Interest income: | ||||||||||||
Interest and fees on loans | $ | 102,366 | $ | 98,162 | $ | 86,544 | ||||||
Interest and discount on loan pool participations | — | — | 798 | |||||||||
Interest on bank deposits | 138 | 161 | 70 | |||||||||
Interest on federal funds sold | 4 | 5 | 1 | |||||||||
Interest on investment securities: | ||||||||||||
Taxable securities | 10,573 | 8,297 | 7,734 | |||||||||
Tax-exempt securities | 6,239 | 5,703 | 5,553 | |||||||||
Total interest income | 119,320 | 112,328 | 100,700 | |||||||||
Interest expense: | ||||||||||||
Interest on deposits: | ||||||||||||
Interest-bearing checking | 3,648 | 3,151 | 2,627 | |||||||||
Savings | 215 | 267 | 360 | |||||||||
Certificates of deposit under $100,000 | 3,579 | 2,929 | 2,445 | |||||||||
Certificates of deposit $100,000 and over | 4,047 | 3,032 | 2,406 | |||||||||
Total interest expense on deposits | 11,489 | 9,379 | 7,838 | |||||||||
Interest on federal funds purchased | 171 | 47 | 34 | |||||||||
Interest on securities sold under agreements to repurchase | 241 | 158 | 176 | |||||||||
Interest on Federal Home Loan Bank borrowings | 1,838 | 1,827 | 1,451 | |||||||||
Interest on other borrowings | 12 | 19 | 22 | |||||||||
Interest on junior subordinated notes issued to capital trusts | 949 | 825 | 592 | |||||||||
Interest on subordinated notes | — | — | 162 | |||||||||
Interest on long-term debt | 445 | 467 | 373 | |||||||||
Total interest expense | 15,145 | 12,722 | 10,648 | |||||||||
Net interest income | 104,175 | 99,606 | 90,052 | |||||||||
Provision for loan losses | 17,334 | 7,983 | 5,132 | |||||||||
Net interest income after provision for loan losses | 86,841 | 91,623 | 84,920 | |||||||||
Noninterest income: | ||||||||||||
Trust, investment, and insurance fees | 6,189 | 5,574 | 6,005 | |||||||||
Service charges and fees on deposit accounts | 5,126 | 5,219 | 4,401 | |||||||||
Loan origination and servicing fees | 3,421 | 3,771 | 2,756 | |||||||||
Other service charges and fees | 5,992 | 5,951 | 5,215 | |||||||||
Bank-owned life insurance income | 1,388 | 1,366 | 1,307 | |||||||||
Gain on sale or call of available for sale securities | 188 | 464 | 1,011 | |||||||||
Gain on sale or call of held to maturity securities | 53 | — | — | |||||||||
Gain (loss) on sale of premises and equipment | 2 | (44 | ) | (29 | ) | |||||||
Other gain | 11 | 1,133 | 527 | |||||||||
Total noninterest income | 22,370 | 23,434 | 21,193 | |||||||||
Noninterest expense: | ||||||||||||
Salaries and employee benefits | 47,864 | 49,621 | 41,865 | |||||||||
Net occupancy and equipment expense | 12,305 | 13,066 | 9,975 | |||||||||
Professional fees | 3,962 | 4,216 | 4,929 | |||||||||
Data processing expense | 2,674 | 4,940 | 2,659 | |||||||||
FDIC insurance expense | 1,265 | 1,563 | 1,397 | |||||||||
Amortization of intangible assets | 3,125 | 3,970 | 3,271 | |||||||||
Other operating expense | 8,941 | 10,430 | 9,080 | |||||||||
Total noninterest expense | 80,136 | 87,806 | 73,176 | |||||||||
Income before income tax expense | 29,075 | 27,251 | 32,937 | |||||||||
Income tax expense | 10,376 | 6,860 | 7,819 | |||||||||
Net income | $ | 18,699 | $ | 20,391 | $ | 25,118 | ||||||
Earnings per share: | ||||||||||||
Basic | $ | 1.55 | $ | 1.78 | $ | 2.42 | ||||||
Diluted | $ | 1.55 | $ | 1.78 | $ | 2.42 | ||||||
See accompanying notes to consolidated financial statements.
65
MIDWESTONE FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years Ended December 31, 2017, 2016, and 2015
(in thousands)
2017 | 2016 | 2015 | ||||||||||
Net income | $ | 18,699 | $ | 20,391 | $ | 25,118 | ||||||
Other comprehensive loss, available for sale securities: | ||||||||||||
Unrealized holding losses arising during period | (1,470 | ) | (6,906 | ) | (2,046 | ) | ||||||
Reclassification adjustment for gains included in net income | (188 | ) | (464 | ) | (1,011 | ) | ||||||
Income tax benefit | 654 | 2,829 | 1,143 | |||||||||
Other comprehensive loss on available for sale securities | (1,004 | ) | (4,541 | ) | (1,914 | ) | ||||||
Total other comprehensive loss | $ | (1,004 | ) | $ | (4,541 | ) | $ | (1,914 | ) | |||
Comprehensive income | $ | 17,695 | $ | 15,850 | $ | 23,204 | ||||||
See accompanying notes to consolidated financial statements.
66
MIDWESTONE FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
Years Ended December 31, 2017, 2016, and 2015
(in thousands, except share and per share amounts)
Preferred Stock | Common Stock | Additional Paid-in Capital | Treasury Stock | Retained Earnings | Accumulated Other Comprehensive Income (Loss) | Total | ||||||||||||||||||||||
Balance at December 31, 2014 | $ | — | $ | 8,690 | $ | 80,537 | $ | (6,945 | ) | $ | 105,127 | $ | 5,322 | $ | 192,731 | |||||||||||||
Net income | — | — | — | — | 25,118 | — | 25,118 | |||||||||||||||||||||
Issuance of common stock due to business combination (2,723,083 shares) | — | 2,723 | 75,172 | — | — | — | 77,895 | |||||||||||||||||||||
Issuance of common stock - private placement (300,000 shares), net of expenses | — | 300 | 7,600 | — | — | — | 7,900 | |||||||||||||||||||||
Dividends paid on common stock ($0.60 per share) | — | — | — | — | (6,344 | ) | — | (6,344 | ) | |||||||||||||||||||
Stock options exercised (8,414 shares) | — | — | (40 | ) | 169 | — | — | 129 | ||||||||||||||||||||
Release/lapse of restriction on RSUs (23,123 shares) | — | — | (416 | ) | 445 | — | — | 29 | ||||||||||||||||||||
Share-based compensation | — | — | 634 | — | — | 634 | ||||||||||||||||||||||
Other comprehensive loss, net of tax | — | — | — | — | — | (1,914 | ) | (1,914 | ) | |||||||||||||||||||
Balance at December 31, 2015 | $ | — | $ | 11,713 | $ | 163,487 | $ | (6,331 | ) | $ | 123,901 | $ | 3,408 | $ | 296,178 | |||||||||||||
Net income | — | — | — | — | 20,391 | — | 20,391 | |||||||||||||||||||||
Dividends paid on common stock ($0.64 per share) | — | — | — | — | (7,317 | ) | — | (7,317 | ) | |||||||||||||||||||
Stock options exercised (2,900 shares) | — | — | (22 | ) | 60 | — | — | 38 | ||||||||||||||||||||
Release/lapse of restriction on RSUs (26,133 shares) | — | — | (529 | ) | 505 | — | — | (24 | ) | |||||||||||||||||||
Share-based compensation | — | — | 731 | — | — | 731 | ||||||||||||||||||||||
Other comprehensive loss, net of tax | — | — | — | — | — | (4,541 | ) | (4,541 | ) | |||||||||||||||||||
Balance at December 31, 2016 | $ | — | $ | 11,713 | $ | 163,667 | $ | (5,766 | ) | $ | 136,975 | $ | (1,133 | ) | $ | 305,456 | ||||||||||||
Net income | — | — | — | — | 18,699 | — | 18,699 | |||||||||||||||||||||
Issuance of common stock (750,000 shares), net of expenses of $1,328 | — | 750 | 23,610 | — | — | — | 24,360 | |||||||||||||||||||||
Dividends paid on common stock ($0.67 per share) | — | — | — | — | (8,061 | ) | — | (8,061 | ) | |||||||||||||||||||
Stock options exercised (8,750 shares) | — | — | (83 | ) | 183 | — | — | 100 | ||||||||||||||||||||
Release/lapse of restriction on RSUs (27,625 shares) | — | — | (576 | ) | 462 | — | — | (114 | ) | |||||||||||||||||||
Share-based compensation | — | — | 868 | — | — | — | 868 | |||||||||||||||||||||
Tax Cuts and Jobs Act of 2017, reclassified from AOCI to Retained Earnings, tax effect | — | — | — | — | 465 | (465 | ) | — | ||||||||||||||||||||
Other comprehensive loss, net of tax | — | — | — | — | — | (1,004 | ) | (1,004 | ) | |||||||||||||||||||
Balance at December 31, 2017 | $ | — | $ | 12,463 | $ | 187,486 | $ | (5,121 | ) | $ | 148,078 | $ | (2,602 | ) | $ | 340,304 | ||||||||||||
See accompanying notes to consolidated financial statements.
67
MIDWESTONE FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2017, 2016, and 2015
(in thousands)
2017 | 2016 | 2015 | |||||||||
Cash flows from operating activities: | |||||||||||
Net income | $ | 18,699 | $ | 20,391 | $ | 25,118 | |||||
Adjustments to reconcile net income to net cash provided by operating activities: | |||||||||||
Provision for loan losses | 17,334 | 7,983 | 5,132 | ||||||||
Depreciation of premises and equipment | 4,133 | 4,555 | 3,284 | ||||||||
Amortization of other intangibles | 3,125 | 3,970 | 3,271 | ||||||||
Amortization of premiums and discounts on investment securities, net | 1,176 | 1,624 | 1,833 | ||||||||
(Gain) loss on sale of premises and equipment | (2 | ) | 44 | 29 | |||||||
Deferred income tax expense (benefit) | 744 | (2,853 | ) | 1,300 | |||||||
Excess tax benefits from share-based award activity | (92 | ) | — | — | |||||||
Stock-based compensation | 868 | 731 | 634 | ||||||||
Net gain on sale or call of available for sale securities | (188 | ) | (464 | ) | (1,011 | ) | |||||
Net gain on sale or call of held to maturity securities | (53 | ) | — | — | |||||||
Net gain on sale of other real estate owned | (28 | ) | (795 | ) | (332 | ) | |||||
Net gain on sale of loans held for sale | (1,794 | ) | (2,475 | ) | (1,794 | ) | |||||
Writedown of other real estate owned | 58 | 675 | — | ||||||||
Origination of loans held for sale | (87,579 | ) | (132,003 | ) | (129,129 | ) | |||||
Proceeds from sales of loans held for sale | 92,758 | 133,424 | 128,537 | ||||||||
Increase in accrued interest receivable | (861 | ) | (135 | ) | (167 | ) | |||||
Increase in cash value of bank-owned life insurance | (1,388 | ) | (1,366 | ) | (1,307 | ) | |||||
(Increase) decrease in other assets | (4,448 | ) | 3,496 | 3,037 | |||||||
Increase in deferred compensation liability | 19 | 48 | 83 | ||||||||
Increase (decrease) in accounts payable, accrued expenses, and other liabilities | (1,501 | ) | 1,334 | (5,810 | ) | ||||||
Net cash provided by operating activities | $ | 40,980 | $ | 38,184 | $ | 32,708 | |||||
Cash flows from investing activities: | |||||||||||
Proceeds from sales of available for sale securities | $ | 22,538 | $ | 23,381 | $ | 116,829 | |||||
Proceeds from maturities and calls of available for sale securities | 67,743 | 84,612 | 70,806 | ||||||||
Purchases of available for sale securities | (62,849 | ) | (166,618 | ) | (25,424 | ) | |||||
Proceeds from sales of held to maturity securities | 1,153 | — | — | ||||||||
Proceeds from maturities and calls of held to maturity securities | 15,477 | 12,080 | 4,669 | ||||||||
Purchases of held to maturity securities | (44,024 | ) | (62,231 | ) | (29,182 | ) | |||||
Increase in loans | (133,836 | ) | (20,648 | ) | (106,278 | ) | |||||
Decrease in loan pool participations, net | — | — | 19,332 | ||||||||
Purchases of premises and equipment | (4,988 | ) | (5,634 | ) | (14,869 | ) | |||||
Proceeds from sale of other real estate owned | 1,216 | 8,744 | 3,594 | ||||||||
Proceeds from sale of premises and equipment | 32 | 2,299 | 1,132 | ||||||||
Proceeds from bank-owned life insurance death benefit | — | 430 | — | ||||||||
Purchases of bank-owned life insurance | (11,212 | ) | — | — | |||||||
Net cash paid in business acquisition (Note 2) | — | — | (35,596 | ) | |||||||
Net cash provided by (used in) investing activities | $ | (148,750 | ) | $ | (123,585 | ) | $ | 5,013 | |||
Cash flows from financing activities: | |||||||||||
Net increase in deposits | $ | 124,871 | $ | 16,927 | $ | 5,812 | |||||
Net increase (decrease) in federal funds purchased | (34,684 | ) | 34,184 | (15,908 | ) | ||||||
Net increase (decrease) in securities sold under agreements to repurchase | 14,042 | 14,724 | (9,482 | ) | |||||||
Proceeds from Federal Home Loan Bank borrowings | 215,000 | 50,000 | 24,000 | ||||||||
Repayment of Federal Home Loan Bank borrowings | (215,000 | ) | (22,000 | ) | (30,000 | ) | |||||
Proceeds from share-based award activity | 100 | 14 | 158 | ||||||||
Taxes paid relating to net share settlement of equity awards | (114 | ) | — | — | |||||||
Redemption of subordinated note | — | — | (12,669 | ) | |||||||
Proceeds from long-term debt | — | — | 25,000 | ||||||||
Payments on long-term debt | (5,000 | ) | (5,000 | ) | (2,500 | ) | |||||
Dividends paid | (8,061 | ) | (7,317 | ) | (6,344 | ) | |||||
Issuance of common stock | 25,688 | — | 7,900 | ||||||||
Expenses incurred in stock issuance | (1,328 | ) | — | — | |||||||
Net cash provided by (used in) financing activities | $ | 115,514 | $ | 81,532 | $ | (14,033 | ) | ||||
Net increase (decrease) in cash and cash equivalents | $ | 7,744 | $ | (3,869 | ) | $ | 23,688 | ||||
Cash and cash equivalents: | |||||||||||
Beginning of period | 43,228 | $ | 47,097 | $ | 23,409 | ||||||
Ending balance | $ | 50,972 | $ | 43,228 | $ | 47,097 | |||||
68
2017 | 2016 | 2015 | |||||||||
Supplemental disclosures of cash flow information: | |||||||||||
Cash paid during the period for interest | $ | 15,189 | $ | 12,757 | $ | 10,004 | |||||
Cash paid during the period for income taxes | 13,199 | 7,957 | 7,677 | ||||||||
Supplemental schedule of non-cash investing activities: | |||||||||||
Transfer of loans to other real estate owned | $ | 1,159 | $ | 1,887 | $ | 1,760 | |||||
Supplemental schedule of non-cash operating activities: | |||||||||||
Transfer due to Tax Cuts and Jobs Act of 2017, reclassified from AOCI to Retained Earnings, tax effect | $ | 465 | $ | — | $ | — | |||||
Supplemental Schedule of non-cash Investing Activities from Acquisition: | |||||||||||
Noncash assets acquired: | |||||||||||
Investment securities | $ | — | $ | — | $ | 160,775 | |||||
Loans | — | — | 916,973 | ||||||||
Premises and equipment | — | — | 27,908 | ||||||||
Goodwill | — | — | 64,654 | ||||||||
Core deposit intangible | — | — | 12,773 | ||||||||
Trade name intangible | — | — | 1,380 | ||||||||
FDIC indemnification asset | — | — | 3,753 | ||||||||
Other real estate owned | — | — | 8,420 | ||||||||
Other assets | — | — | 14,482 | ||||||||
Total noncash assets acquired | — | — | 1,211,118 | ||||||||
Liabilities assumed: | |||||||||||
Deposits | — | — | 1,049,167 | ||||||||
Short-term borrowings | — | — | 16,124 | ||||||||
Junior subordinated notes issued to capital trusts | — | — | 8,050 | ||||||||
Subordinated note payable | — | — | 12,669 | ||||||||
Other liabilities | — | — | 11,617 | ||||||||
Total liabilities assumed | $ | — | $ | — | $ | 1,097,627 | |||||
See accompanying notes to consolidated financial statements.
69
Note 1. | Nature of Business and Significant Accounting Policies |
Nature of business: The Company is a bank holding company registered under the Bank Holding Company Act of 1956, as amended, that has elected to be a financial holding company. It is headquartered in Iowa City, Iowa and owns all of the outstanding common stock of MidWestOne Bank, Iowa City, Iowa, and all of the common stock of MidWestOne Insurance Services, Inc., Oskaloosa, Iowa. The Bank is also headquartered in Iowa City, Iowa, and provides services to individuals, businesses, governmental units and institutional customers through a total of 44 branch locations in central and east-central Iowa, the Twin Cities metro area in Minnesota and western Wisconsin, Naples and Fort Myers, Florida, and Denver, Colorado. MidWestOne Insurance Services, Inc. provides personal and business insurance services in Cedar Falls, Conrad, Melbourne, Oskaloosa, Parkersburg, and Pella, Iowa. The Bank is actively engaged in many areas of commercial banking, including: acceptance of demand, savings and time deposits; making commercial, real estate, agricultural and consumer loans, and other banking services tailored for its individual customers. The wealth management area of the Bank administers estates, personal trusts, and conservatorships accounts along with providing other management services to customers.
On May 1, 2015, the Company consummated a merger with Central Bancshares, Inc., a Minnesota corporation. In connection with the merger, Central Bank, a Minnesota-chartered commercial bank and wholly-owned subsidiary of Central, became a wholly-owned subsidiary of MidWestOne. Per the merger agreement, each of the outstanding shares of Central common stock was converted into the pro rata portion of 2,723,083 shares of Company common stock and $64.0 million in cash (See Note 2. “Business Combination” for additional information). On April 2, 2016, Central Bank merged with and into the Bank.
Accounting estimates: The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Certain significant estimates: The allowance for loan losses, fair value of assets acquired and liabilities assumed in a business combination, annual impairment testing of goodwill, and the fair values of investment securities and other financial instruments involve certain significant estimates made by management. These estimates are reviewed by management routinely, and it is reasonably possible that circumstances that exist may change in the near-term future and that the effect could be material to the consolidated financial statements.
Principles of consolidation: The consolidated financial statements include the accounts of MidWestOne Financial Group, Inc., a bank holding company, and its wholly-owned subsidiary MidWestOne Bank, which is a state chartered bank whose primary federal regulator is the FDIC, and MidWestOne Insurance Services, Inc. All significant inter-company accounts and transactions have been eliminated in consolidation.
Certain reclassifications have been made to prior periods’ consolidated financial statements to present them on a basis comparable with the current period’s consolidated financial statements.
Trust assets, other than cash deposits held by the Bank in a fiduciary or agency capacity for its customers, are not included in the accompanying consolidated financial statements because such accounts are not assets of the the Bank.
In the normal course of business, the Company may enter into a transaction with a variable interest entity (“VIE”). VIEs are legal entities whose investors lack the ability to make decisions about the entity’s activities, or whose equity investors do not have the right to receive the residual returns of the entity. The applicable accounting guidance requires the Company to perform ongoing quantitative and qualitative analysis to determine whether it must consolidate any VIE. The Company does not have any ownership interest in or exert any control over any VIE, and thus no VIEs are included in the consolidated financial statements. Investments in non-marketable loan participation certificates for which the Company does not have the ability to exert significant influence are accounted for using the cost method.
Presentation of cash flows: For purposes of reporting cash flows, cash and due from banks includes cash on hand, amounts due from banks, and federal funds sold. Cash flows from portfolio loans originated by the Bank, deposits, federal funds purchased, and securities sold under agreements to repurchase are reported net.
70
Cash receipts and cash payments resulting from acquisitions and sales of loans originated for sale are classified as operating cash flows on a gross basis in the consolidated statements of cash flows.
The nature of the Company’s business requires that it maintain amounts due from banks that, at times, may exceed federally insured limits. In the opinion of management, no material risk of loss exists due to the various correspondent banks’ financial condition and the fact that they are well capitalized.
Investment securities: Certain debt securities that the Company has the positive intent and ability to hold to maturity are classified as held to maturity and recorded at amortized cost. Securities not classified as held to maturity, including equity securities with readily determinable fair values, are classified as available for sale and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income.
The Company employs valuation techniques which utilize observable inputs when those inputs are available. These observable inputs reflect assumptions market participants would use in pricing the security, developed based on market data obtained from sources independent of the Company. When such information is not available, the Company employs valuation techniques which utilize unobservable inputs, or those which reflect the Company’s own assumptions about assumptions that market participants would use, based on the best information available in the circumstances. These valuation methods typically involve cash flow and other financial modeling techniques. Changes in underlying factors, assumptions, estimates, or other inputs to the valuation techniques could have a material impact on the Company’s future financial condition and results of operations. Fair value measurements are required to be classified as Level 1 (quoted prices), Level 2 (based on observable inputs) or Level 3 (based on unobservable inputs) discussed in more detail in Note 20 to the consolidated financial statements. Available for sale securities are recorded at fair value with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders’ equity until realized.
Purchase premiums and discounts are recognized in interest income using the interest method between the date of purchase and the first call date, or the maturity date of the security when there is no call date. Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In determining whether other than temporary impairment exists, management considers whether: (1) we have the intent to sell the security; (2) it is more likely than not that we will be required to sell the security before recovery of the amortized cost basis; and (3) we do not expect to recover the entire amortized cost basis of the security. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
Loans: Loans are stated at the principal amount outstanding, net of deferred loan fees and costs and allowance for loan losses. Interest on loans is credited to income as earned based on the principal amount outstanding. Deferred loan fees and costs are amortized using the level yield method over the remaining maturities on the loans.
The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 120 days past due, unless the credit is well secured and in process of collection. Credit card loans and other personal loans are typically charged off no later than 180 days past due. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged off at an earlier date, if collection of principal or interest is considered doubtful.
All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Purchased loans: All purchased loans (nonimpaired and impaired) are initially measured at fair value as of the acquisition date in accordance with applicable authoritative accounting guidance. Credit discounts are included in the determination of fair value. An allowance for loan losses is not recorded at the acquisition date for loans purchased.
Individual loans acquired through the completion of a transfer, including loans that have evidence of deterioration of credit quality since origination and for which it is probable, at acquisition, that the Company will be unable to collect all contractually required payments receivable, are referred to herein as “purchased credit impaired loans.” In determining the acquisition date fair value and estimated credit losses of purchased credit impaired loans, and in subsequent accounting, the Company accounts for loans individually. Contractually required payments for interest and principal that exceed the undiscounted cash flows expected at acquisition, or the “nonaccretable difference,” are not recognized as a yield adjustment or as a loss accrual or valuation allowance.
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Expected cash flows at the purchase date in excess of the fair value of loans, if any, are recorded as interest income over the expected life of the loans if the timing and amount of future cash flows are reasonably estimable. Subsequent to the purchase date, increases in cash flows over those expected at the purchase date are recognized as interest income prospectively. The present value of any decreases in expected cash flows after the purchase date is recognized by recording an allowance for loan losses and a provision for loan losses. If the Company does not have the information necessary to reasonably estimate cash flows to be expected, it may use the cost-recovery method or cash-basis method of income recognition.
Subsequent to the purchase date, increases in cash flows over those expected at the purchase date are recognized as interest income prospectively. Subsequent to the purchase date, the methods utilized to estimate the required allowance for loan losses for these loans are similar to originated loans. The remaining differences between the purchase price and the unpaid balance at the date of acquisition are recorded in interest income over the life of the loan.
Covered assets and indemnification asset: As part of the Central transaction, the Company assumed loss-share or similar credit protection agreements with the FDIC. The FDIC loss sharing agreements were terminated on July 14, 2017, at which time the loans were reclassified to non-covered assets.
Loan Pool Participations: In 2010, the Company made the decision to exit the loan pool participation line of business, and all remaining loan pool participations were sold in June 2015.
Loans held for sale: Loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or estimated fair value, as determined by aggregate outstanding commitments from investors or current investor yield requirements. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income.
Mortgage loans held for sale are generally sold with the mortgage servicing rights retained. Gains or losses on sales of mortgage loans are recognized based on the difference between the selling price plus the value of servicing rights, less the carrying value of the related mortgage loans sold.
Allowance for loan losses: The allowance for loan losses is established through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a quarterly basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.
The allowance consists of specific and general components. The specific component relates to loans that are classified as doubtful, substandard or special mention. For such loans that are also classified as impaired as well as any loan (regardless of classification) meeting the definition of a troubled debt restructuring, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan are lower than the carrying value of that loan. The general component covers loans not classified as impaired and is based on historical loss experience adjusted for qualitative factors.
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include: payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price or the fair value of the collateral, if the loan is collateral dependent.
Large groups of smaller-balance loans (with individual balances less than $100,000) are not evaluated for impairment, but are collectively applied a standard allocation under ASC 450.
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Transfers of financial assets: Revenue from the origination and sale of loans in the secondary market is recognized upon the transfer of financial assets and accounted for as sales when control over the assets has been surrendered. The Company also sells participation interests in some large loans originated, to non-affiliated entities. Control over transferred assets is deemed to be surrendered when: (1) the assets have been isolated from the Company; (2) the transferee has the right to pledge or exchange the assets it received and no condition both constrains the transferee from taking advantage of its right to pledge or exchange and provides more than a trivial benefit to the transferor; and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.
Revenue recognition: Trust fees, deposit account service charges and other fees are recognized when payment is received for the services (cash basis), which generally occurs at the time the services are provided.
Credit-related financial instruments: In the ordinary course of business, the Company has entered into commitments to extend credit, including commitments under credit card arrangements, commercial letters of credit and standby letters of credit. Such financial instruments are recorded when they are funded. The Company records a liability to the extent losses on its commitments to lend are probable.
Premises and equipment: Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. The estimated useful lives and primary method of depreciation for the principal items are as follows:
Years | |||||
Type of Assets | Minimum | Maximum | Depreciation Method | ||
Buildings and leasehold improvements | 10 | - | 30 | Straight-line | |
Furniture and equipment | 3 | - | 10 | Straight-line | |
Charges for maintenance and repairs are expensed as incurred. When assets are retired or disposed of the related cost and accumulated depreciation are removed from the respective accounts and the resulting gain or loss is recorded.
Other real estate owned: Real estate properties acquired through or in lieu of foreclosure are initially recorded at fair value less estimated selling cost at the date of foreclosure, establishing a new cost basis. Fair value is determined by management by obtaining appraisals or other market value information at least annually. Any write-downs in value at the date of acquisition are charged to the allowance for loan losses. After foreclosure, valuations are periodically performed by management by obtaining updated appraisals or other market value information. Any subsequent write-downs are recorded as a charge to operations, if necessary, to reduce the carrying value of a property to the updated fair value less estimated selling cost. Net costs related to the holding of properties are included in noninterest expense.
Goodwill and other intangibles: Goodwill is the excess of the purchase price over the fair value of identifiable net assets acquired in business combinations accounted for as purchases. Under ASC Topic 350, goodwill of a reporting unit is tested for impairment on an annual basis, or between annual tests if an event occurs or circumstances change that would reduce the fair value of a reporting unit below its carrying amount. The Company's annual assessment is done at the unit level. The Company did not recognize impairment losses during the year ended December 31, 2017. Any future impairment will be recorded as noninterest expense in the period of assessment. Certain other intangible assets that have finite lives are amortized over the remaining useful lives.
Mortgage servicing rights: Mortgage servicing rights are recorded at fair value based on assumptions through a third-party valuation service. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the servicing cost per loan, the discount rate, the escrow float rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses.
Bank-owned life insurance: Bank-owned life insurance is carried at cash surrender value, net of surrender and other charges, with increases/decreases reflected as income/expense in the consolidated statements of operations.
Employee benefit plans: Deferred benefits under a salary continuation plan are charged to expense during the period in which the participating employees attain full eligibility.
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Stock-based compensation: Compensation expense for share based awards is recorded over the vesting period at the fair value of the award at the time of grant. The exercise price of options or fair value of nonvested shares granted under the Company’s incentive plans is equal to the fair market value of the underlying stock at the grant date. The Company assumes no projected forfeitures on its stock based compensation, since actual historical forfeiture rates on its stock-based incentive awards has been negligible.
Income taxes: The Company and/or its subsidiaries currently file tax returns in all states and local taxing jurisdictions which impose corporate income, franchise or other taxes where it operates. The methods of filing and the methods for calculating taxable and apportionable income vary depending upon the laws of the taxing jurisdiction. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.
In accordance with ASC 740, Income Taxes, the Company recognizes a tax position as a benefit only if it is more likely than not that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized upon examination. For tax positions not meeting the more likely than not test, no tax benefit is recorded. The Company recognizes interest and/or penalties related to income tax matters in income tax expense.
On December 22, 2017, the U.S. Government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act introduced tax reform that reduced the corporate federal income tax rate from 35% to 21%, among other changes. While the corporate tax rate reduction is effective January 1, 2018, GAAP required a revaluation of the Company’s net deferred tax asset. Deferred tax assets and liabilities are measured using enacted rates expected to apply to taxable income in years in which those temporary differences are expected to be recovered or settled. Deferred tax assets and liabilities are adjusted through income tax expense as changes in tax laws are enacted. On February 14, 2018 the FASB issued Accounting Standards Update No. 2018-02, Income Statement-Reporting Comprehensive Income (Topic 220) - Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The amendments of this ASU allow a reclassification from other accumulated comprehensive income to retained earnings for stranded tax effects resulting from the Tax Act.
The Company’s revaluation of its deferred tax asset is subject to further clarifications of the Tax Act that cannot be estimated at this time, and the Company will continue to analyze the Tax Act to determine the full effects of the new law, including the new lower corporate tax rate, on its financial condition and results of operations. See Note 13. “Income Taxes” for more information,
There were no material unrecognized tax benefits or any interest or penalties on any unrecognized tax benefits as of December 31, 2017 and 2016.
Common stock: On July 17, 2014, the board of directors of the Company approved a share repurchase program, allowing for the repurchase of up to $5.0 million of stock through December 31, 2016. Pursuant to the program, the Company could continue to repurchase shares from time to time in the open market, and the method, timing and amounts of repurchase were solely in the discretion of the Company's management. The repurchase program did not require the Company to acquire a specific number of shares. Therefore, the amount of shares repurchased pursuant to the program depended on several factors, including market conditions, capital and liquidity requirements, and alternative uses for cash available. In 2015 and 2016 the Company repurchased no shares of common stock.
On July 21, 2016, the board of directors of the Company approved a new share repurchase program, allowing for the repurchase of up to $5.0 million of stock through December 31, 2018. During 2016 and 2017, the Company repurchased no common stock under this plan, and thus, of the $5.0 million of stock authorized under the repurchase plan, $5.0 million remained available for possible future repurchases as of December 31, 2017.
On May 1, 2015, in connection with the Central merger, the Company issued 2,723,083 shares of its common stock. On June 22, 2015, the Company entered into a Securities Purchase Agreement with certain institutional accredited investors, pursuant to which, on June 23, 2015, the Company sold an aggregate of 300,000 newly issued shares of the Company’s common stock, at a purchase price of $28.00 per share. Each of the purchasers was an existing shareholder of the Company.
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On March 17, 2017, the Company entered into an underwriting agreement to offer and sell, through an underwriter, up to 750,000 newly issued shares of the Company’s common stock at a public purchase price of $34.25 per share. This included 250,000 shares of the Company’s common stock granted as a 30-day option to purchase to cover over-allotments, if any. On April 6, 2017, the underwriter purchased the full amount of its over-allotment option of 250,000 shares.
Comprehensive income: Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of shareholders’ equity on the consolidated balance sheets, and are disclosed in the consolidated statements of comprehensive income.
The components of accumulated other comprehensive income (loss) included in shareholders’ equity, net of tax, are as follows:
Year Ended December 31, | ||||||||||||
2017 | 2016 | 2015 | ||||||||||
(in thousands) | ||||||||||||
Unrealized gains (losses) on securities available for sale, net of tax | $ | (2,602 | ) | $ | (1,133 | ) | $ | 3,408 | ||||
Accumulated other comprehensive income (loss), net of tax | $ | (2,602 | ) | $ | (1,133 | ) | $ | 3,408 | ||||
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update No. 2014-09, Revenue from Contract with Customers (Topic 606). The guidance in this update affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (for example, insurance contracts or lease contracts). The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply the following five steps: 1) identify the contracts(s) with the customer; 2) identify the performance obligations in the contract; 3) determine the transaction price; 4) allocate the transaction price to the performance obligations in the contract; and 5) recognize revenue when (or as) the entity satisfies a performance obligation. The guidance also specifies the accounting for some costs to obtain or fulfill a contract with a customer. For a public entity, the amendments in this update were effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early application was not permitted. In July 2015, the FASB announced a delay to the effective date of Accounting Standards Update No. 2015-09, Revenue from Contract with Customers (Topic 606). Reporting entities may choose to adopt the standard as of the original date, or take advantage of a one-year delay. For a public entity, the revised effective date is for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Early application is not permitted prior to the original effective date. The Company’s revenue is comprised of interest income on financial assets, which is excluded from the scope of this new guidance, and noninterest income. This new guidance will required the Company to examine how certain recurring revenue streams are recognized within trust and asset management fees, sales of other real estate, and debit card interchange fees. Topic 606 provides for two transition methods available for an entity to elect from at adoption of the standard. The full-retrospective method requires Topic 606 to be applied to all prior reporting periods presented. The modified-retrospective method requires the application of Topic 606 at the adoption date to be accounted for through a cumulative effect adjustment from the initial application of Topic 606 to the beginning balance of stockholders’ equity in the year of adoption. The Company has finalized its analysis of the expected areas of impact using the modified retrospective transition method, and has determined that the effect on the Company’s consolidated financial statements is immaterial, thus no adjustment to beginning stockholders’ equity for 2018 was required. The Company will adopt this standard as of January 1, 2018.
In August 2014, the FASB issued Accounting Standards Update No. 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. The amendments in this update provide guidance in GAAP about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. In doing so, the amendment should reduce diversity in the timing and content of footnote disclosures. Disclosures are required if it is probable an entity will be unable to meet its obligations within the look-forward period of twelve months after the financial statements are made available. Incremental substantial doubt disclosure is required if the probability is not mitigated by management’s plans. The new standard applies to all entities for the first annual period ending after December 15, 2016, and interim periods thereafter. The adoption of this standard did not have a material effect on the Company’s consolidated financial statements.
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In January 2016, the FASB issued Accounting Standards Update No. 2016-01, Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities. The guidance in this update makes changes to the current GAAP model primarily affect the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. In addition, the FASB clarified guidance related to the valuation allowance assessment when recognizing deferred tax assets resulting from unrealized losses on available-for-sale debt securities. The accounting for other financial instruments, such as loans, investments in debt securities, and financial liabilities is largely unchanged. The treatment of gains and losses for all equity securities, including those without a readily determinable market value, is expected to result in additional volatility in the income statement, with the loss of mark to market via equity for these investments. Additionally, changes in the allowable method for determining the fair value of financial instruments in the financial statement footnotes (“exit price” only) will likely require changes to current methodologies of determining these values, and how they are disclosed in the financial statement footnotes. The new standard applies to public business entities in fiscal years beginning after December 15, 2017, including interim periods within those fiscal years on a prospective basis, with a cumulative-effect adjustment to the balance sheet at the beginning of the fiscal year adopted. Early adoption is not permitted. The Company has formed a working group to evaluate the changes required as a result of the adoption of this ASU and is engaged in discussions with a third party to assist with the calculation of fair value information, particularly for fair value disclosures of the Company's loan portfolio. The application of the ASU is not expected to have a material effect on the Company’s consolidated financial statements.
In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842). The guidance in this update is meant to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The core principle of Topic 842 is that a lessee should recognize the assets and liabilities that arise from leases. All leases create an asset and a liability for the lessee in accordance with FASB Concepts Statement No. 6, Elements of Financial Statements, and, therefore, recognition of those lease assets and lease liabilities represents an improvement over previous GAAP, which did not require lease assets and lease liabilities to be recognized for most leases. Disclosures are required by lessees and lessors to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. To meet that objective, qualitative disclosures along with specific quantitative disclosures are required. The new standard applies to public business entities in fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted. The Company has several lease agreements, such as branch locations, which are currently considered operating leases, and therefore not recognized on the Company’s consolidated balance sheets. The Company expects the new guidance will require these lease agreements to now be recognized on the consolidated balance sheets as right-of-use assets and a corresponding lease liability. However, the Company continues to evaluate the extent of the potential impact the new guidance will have on the Company’s consolidated financial statements and the availability of outside vendor products to assist in the implementation, and does not expect to early adopt the standard.
In March 2016, the FASB issued Accounting Standards Update No. 2016-09, Compensation - Stock Compensation (Topic 718). The guidance involves several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The new standard applies to public business entities for annual periods beginning after December 15, 2016, including interim periods within those annual periods, with early adoption permitted. An entity that elects early adoption must adopt all of the amendments in the same period. The amendments were effective January 1, 2017. The Company elected to account for forfeitures as they occur. The effect of this election and other amendments did not have a material effect on the Company’s consolidated financial statements.
In June 2016, the FASB issued Accounting Standards Update No. 2016-13, Financial Instruments-Credit Losses (Topic 326) - Measurement of Credit Losses on Financial Instruments. The new guidance introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments. It also modifies the impairment model for available-for-sale debt securities and provides for a simplified accounting model for purchased financial assets with credit deterioration since their origination. The amendment requires the use of a new model covering current expected credit losses (CECL), which will apply to: (1) financial assets subject to credit losses and measured at amortized cost, and (2) certain off-balance sheet credit exposures. Upon initial recognition of the exposure, the CECL model requires an entity to estimate the credit losses expected over the life of an exposure (or pool of exposures). The estimate of expected credit losses (ECL) should consider historical information, current information, and reasonable and supportable forecasts, including estimates of prepayments. The new guidance also amends the current available for sale (AFS) security OTTI model for debt securities. The new model will require an estimate of ECL only when the fair value is below the amortized cost of the asset. The length of time the fair value of an AFS debt security has been below the amortized cost will no longer impact the determination of whether a credit loss exists. As such, it is no longer an other-than-temporary model. Finally, the purchased financial assets with credit deterioration (PCD) model applies to purchased financial assets (measured at amortized cost or AFS) that have experienced more than insignificant credit deterioration since origination.
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This represents a change from the scope of what are considered purchased credit-impaired assets under today’s model. Different than the accounting for originated or purchased assets that do not qualify as PCD, the initial estimate of expected credit losses for a PCD would be recognized through an allowance for loan and lease losses with an offset to the cost basis of the related financial asset at acquisition. The new standard applies to public business entities that are SEC filers in fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, with early adoption permitted for fiscal years beginning after December 31, 2018, including interim periods within those fiscal years, and is expected to increase the allowance for loan losses upon adoption. The Company has formed a working group to evaluate the impact of the standard’s adoption on the Company’s consolidated financial statements, and has selected an outside vendor software system with the ability to meet the processing necessary to support the data collection, retention, and disclosure requirements of the Company in implementation of the new standard. The Company does not anticipate the early adoption of this standard.
In January 2017, the FASB issued Accounting Standards Update No. 2017-04, Intangibles-Goodwill and Other (Topic 350) - Simplifying the Test for Goodwill Impairment. The new guidance removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. All other goodwill impairment guidance will remain largely unchanged. The update applies to public business entities that are SEC filers in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company early adopted this amendment during the second quarter of 2017, and adoption did not have a significant effect on the Company’s consolidated financial statements.
In March 2017, the FASB issued Accounting Standards Update No. 2017-08, Receivables-Nonrefundable Fees and Other Costs (Subtopic 310-20) - Premium Amortization on Purchased Callable Debt Securities. The new guidance requires that the premium amortization period on non-contingently callable securities, end at the earliest call date, rather than the contractual maturity date. The shorter amortization period means that interest income would generally be lower in the periods before the earliest call date and higher thereafter (if the security is not called) compared to current GAAP. The update applies to public business entities in fiscal years beginning after December 15, 2018. Early adoption is permitted. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. The Company adopted this update during the second quarter of 2017. Since the Company was already amortizing premiums on callable investment securities between the date of purchase and the first call date, there was no effect on the Company’s consolidated financial statements.
In August 2017, the FASB issued Accounting Standards Update No. 2017-12, Derivatives and Hedging (Topic 815) - Targeted Improvements to Accounting for Hedging Activities. The amendments in this update more closely align the results of cash flow and fair value hedge accounting with risk management activities through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results in the financial statements. The amendments address specific limitations in current GAAP by expanding hedge accounting for both nonfinancial and financial risk components and by refining the measurement of hedge results to better reflect the hedging strategies. Thus, the amendments will enable more faithful reporting of the economic results of hedging activities for certain fair value and cash flow hedges and will avoid mismatches in earnings by allowing for greater precision when measuring changes in fair value of the hedged item for certain fair value hedges. Additionally, by aligning the timing of recognition of hedge results with the earnings effect of the hedged item for cash flow and net investment hedges, and by including the earnings effect of the hedging instrument in the same income statement line item in which the earnings effect of the hedged item is presented, the results of a hedging program and the cost of executing that program will be more visible to users of financial statements. The new standard applies to public business entities that are SEC filers for annual or any interim periods beginning after December 15, 2018. Early adoption is permitted with cumulative effect adjustment being reflected as of the beginning of the fiscal year, generally through an adjustment to accumulated other comprehensive income and retained earnings. The Company adopted this update during the third quarter of 2017. Since the Company currently has no hedging arrangements, there was no cumulative effect adjustment necessary to the Company’s consolidated financial statements.
In February 2018, the FASB issued Accounting Standards Update No. 2018-02, Income Statement-Reporting Comprehensive Income (Topic 220) - Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. On December 22, 2017, the U.S. Government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act introduced tax reform that reduced the corporate federal income tax rate from 35% to 21%, among other changes. Stakeholders in the banking and insurance industries submitted unsolicited comment letters to the FASB about a narrow-scope financial reporting issue that arose as a consequence of the Tax Act. Specifically, stakeholders expressed concern about the guidance in current GAAP that requires deferred tax liabilities and assets to be adjusted for the effect of a change in tax laws or rates with the effect included in income from continuing operations in the reporting period that includes the enactment date. That
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guidance is applicable even in situations in which the related income tax effects of items in accumulated other comprehensive income were originally recognized in other comprehensive income (rather than in income from continuing operations). The amendments in this update affect any entity that is required to apply the provisions of Topic 220, Income Statement—Reporting Comprehensive Income, and has items of other comprehensive income for which the related tax effects are presented in other comprehensive income as required by GAAP. The amendments in this update allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Act. Consequently, the amendments eliminate the stranded tax effects resulting from the Tax Act and will improve the usefulness of information reported to financial statement users. However, because the amendments only relate to the reclassification of the income tax effects of the Tax Act, the underlying guidance that requires that the effect of a change in tax laws or rates be included in income from continuing operations is not affected. The amendments in this update also require certain disclosures about stranded tax effects. The amendments in this update are effective for all entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption of the amendments in this update is permitted, including adoption in any interim period, (1) for public business entities for reporting periods for which financial statements have not yet been issued and (2) for all other entities for reporting periods for which financial statements have not yet been made available for issuance. The amendments in this update should be applied either in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Act is recognized. The Company adopted this update effective for the year ended December 31, 2017. The amount of the reclassification for the Company was $465 thousand, as shown in the Consolidated Statements of Shareholders’ Equity.
Note 2. | Business Combination |
On May 1, 2015, the Company acquired all of the equity interests of Central, a bank holding company and the parent company of Central Bank, a commercial bank headquartered in Golden Valley, Minnesota, through the merger of Central with and into the Company. Among other things, this transaction provided the Company with the opportunity to expand the business into new markets and grow the size of the business. At the effective time of the merger, each share of common stock of Central converted into a pro rata portion of (1) 2,723,083 shares of common stock of the Company, and (2) $64.0 million in cash.
This business combination was accounted for under the acquisition method of accounting. Accordingly, the results of operations of the acquired company have been included in the Company’s results of operations since the date of acquisition. Under this method of accounting, assets and liabilities acquired are recorded at their estimated fair values. The excess cost over fair value of net assets acquired is recorded as goodwill. As the consideration paid for Central exceeded the net assets acquired, goodwill of $64.7 million has been recorded on the acquisition. Goodwill recorded in this transaction, which reflects the entry into the geographically new markets served by Central. Goodwill recorded in the transaction is not tax deductible. The amounts recognized for the business combination in the financial statements have been determined to be final as of March 31, 2016.
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Estimated fair values of assets acquired and liabilities assumed in the Central transaction, as of the closing date of the transaction, were as follows:
(in thousands) | May 1, 2015 | |||
ASSETS | ||||
Cash and due from banks | $ | 28,404 | ||
Investment securities | 160,775 | |||
Loans | 916,973 | |||
Premises and equipment | 27,908 | |||
Goodwill | 64,654 | |||
Core deposit intangible | 12,773 | |||
Trade name intangible | 1,380 | |||
FDIC indemnification asset | 3,753 | |||
Other real estate owned | 8,420 | |||
Other assets | 14,482 | |||
Total assets | 1,239,522 | |||
LIABILITIES | ||||
Deposits | 1,049,167 | |||
Short-term borrowings | 16,124 | |||
Junior subordinated notes issued to capital trusts | 8,050 | |||
Subordinated notes payable | 12,669 | |||
Accrued expenses and other liabilities | 11,617 | |||
Total liabilities | 1,097,627 | |||
Net assets | 141,895 | |||
Consideration: | ||||
Market value of common stock at $29.31 per share at May 1, 2015 (2,723,083 shares of common stock issued), net of stock illiquidity discount due to restrictions | 77,895 | |||
Cash paid | 64,000 | |||
Total fair value of consideration | $ | 141,895 | ||
Purchased loans acquired in a business combination are recorded and initially measured at their estimated fair value as of the acquisition date. Credit discounts are included in the determination of fair value. An allowance for loan losses is not carried over. These purchased loans are segregated into two types: purchased credit impaired loans and purchased non-credit impaired loans without evidence of significant credit deterioration.
• | Purchased credit impaired loans are accounted for in accordance with ASC 310-30 “Loans and Debt Securities Acquired with Deteriorated Credit Quality” as they display significant credit deterioration since origination and it is probable, as of the acquisition date, that the Company will be unable to collect all contractually required payments from the borrower. |
• | Purchased non-credit impaired loans are accounted for in accordance with ASC 310-20 “Nonrefundable Fees and Other Costs” as these loans do not have evidence of significant credit deterioration since origination and it is probable all contractually required payments will be received from the borrower. |
For purchased non-credit impaired loans, the difference between the estimated fair value of the loans (computed on a loan-by-loan basis) and the principal outstanding is accreted over the remaining life of the loans.
For purchased credit impaired loans the difference between contractually required payments at acquisition and the cash flows expected to be collected is referred to as the non-accretable difference. Further, any excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized into interest income over the expected remaining life of the loan if the timing and amount of the future cash flows are reasonably estimable. Subsequent to the purchase date, increases in cash flows over those expected at the purchase date are recognized as interest income prospectively. The present value of any decreases in expected cash flows after the purchase date is recognized by recording an allowance for credit losses and a provision for loan losses.
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The following table presents the purchased loans as of the acquisition date:
(in thousands) | Purchased Credit Impaired Loans | Purchased Non-Credit Impaired Loans | ||||||
Contractually required principal payments | $ | 36,886 | $ | 905,314 | ||||
Nonaccretable difference | (6,675 | ) | — | |||||
Principal cash flows expected to be collected | 30,211 | 905,314 | ||||||
Accretable discount(1) | (1,882 | ) | (16,670 | ) | ||||
Fair value of acquired loans | $ | 28,329 | $ | 888,644 | ||||
(1) Included in the accretable discount for Purchased Non-Credit Impaired Loans is approximately $10.4 million of estimated undiscounted principal losses.
Disclosures required by ASC 805-20-50-1(a) concerning the FDIC indemnification assets have not been included due to the immateriality of the amount involved. See Note 4. “Loans Receivable and the Allowance for Loan Losses” to our consolidated financial statements for additional information related to the FDIC indemnification asset.
ASC 805-30-30-7 requires that the consideration transfered in a business combination should be measured at fair value. Since the common shares issued as part of the consideration of the merger included a restriction on their sale, pledge or other disposition, an illiquidity discount has been assigned to the shares based upon the volatility of the underlying shares’ daily returns and the period of restriction.
The Company recorded $4.6 million in pre-tax merger-related expenses for the year ended December 31, 2016, including retention and severance compensation costs in the amount of $2.1 million, which are included in salaries and employee benefits in the consolidated statements of operations. The remainder of merger-related expenses consisted of data processing contract termination expenses in the amount of $1.9 million, which are included in data processing expense in the consolidated statement of operations, professional and legal fees of $0.3 million to directly consummate the merger, included in professional fees in the Company’s consolidated statements of operations, and $0.3 million of miscellaneous costs, which are included in other operating expenses. The above expenses include those associated with the merger of Central Bank with and into MidWestOne Bank, which was effective on April 2, 2016.
During the year ended December 31, 2015, the Company recorded $3.5 million in pre-tax merger-related expenses. These expenses primarily consisted of $1.9 million of professional and legal fees to directly consummate the merger, included in professional fees in the Company’s consolidated statements of operations, $0.6 million of retention and severance compensation costs which are included in salaries and employee benefits in the consolidated statements of operations, and $1.0 million of service contract termination and miscellaneous costs, which are included in other operating expenses.
During the measurement period, specifically the three months ended March 31, 2016, the Company recognized adjustments to the provisional amounts reported at December 31, 2015, which reflect new information that existed as of May 1, 2015 that, if known, would have affected the measurement of the amounts recognized as of that date. In its interim financial statements for the quarter ended March 31, 2016, the Company adjusted the provisional amounts for deferred taxes. The results of this adjustment is reflected in the $0.1 million increase to goodwill during the quarter ended March 31, 2016. The provisional adjustments had no impact on earnings, and in accordance with ASU 2015-16 were recorded during the three months ending March 31, 2016.
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Note 3. | Investment Securities |
The amortized cost and fair value of investment securities available for sale, with gross unrealized gains and losses, are as follows:
Gross | Gross | ||||||||||||||
Amortized | Unrealized | Unrealized | Estimated | ||||||||||||
Cost | Gains | Losses | Fair Value | ||||||||||||
(in thousands) | |||||||||||||||
December 31, 2017 | |||||||||||||||
U.S. Government agencies and corporations | $ | 15,716 | $ | — | $ | 90 | $ | 15,626 | |||||||
State and political subdivisions | 139,561 | 2,475 | 197 | 141,839 | |||||||||||
Mortgage-backed securities | 48,744 | 181 | 428 | 48,497 | |||||||||||
Collateralized mortgage obligations | 173,339 | 29 | 5,172 | 168,196 | |||||||||||
Corporate debt securities | 71,562 | 31 | 427 | 71,166 | |||||||||||
Total debt securities | 448,922 | 2,716 | 6,314 | 445,324 | |||||||||||
Other equity securities | 2,268 | 124 | 56 | 2,336 | |||||||||||
Total investment securities | $ | 451,190 | $ | 2,840 | $ | 6,370 | $ | 447,660 | |||||||
December 31, 2016 | |||||||||||||||
U.S. Government agencies and corporations | $ | 5,895 | $ | 10 | $ | — | $ | 5,905 | |||||||
State and political subdivisions | 162,145 | 3,545 | 418 | 165,272 | |||||||||||
Mortgage-backed securities | 61,606 | 315 | 567 | 61,354 | |||||||||||
Collateralized mortgage obligations | 175,506 | 148 | 4,387 | 171,267 | |||||||||||
Corporate debt securities | 72,979 | 76 | 602 | 72,453 | |||||||||||
Total debt securities | 478,131 | 4,094 | 5,974 | 476,251 | |||||||||||
Other equity securities | 1,259 | 66 | 58 | 1,267 | |||||||||||
Total investment securities | $ | 479,390 | $ | 4,160 | $ | 6,032 | $ | 477,518 | |||||||
The amortized cost and fair value of investment securities held to maturity, with gross unrealized gains and losses, are as follows:
Gross | Gross | ||||||||||||||
Amortized | Unrealized | Unrealized | Estimated | ||||||||||||
Cost | Gains | Losses | Fair Value | ||||||||||||
(in thousands) | |||||||||||||||
December 31, 2017 | |||||||||||||||
U.S. Government agencies and corporations | $ | 10,049 | $ | — | $ | — | $ | 10,049 | |||||||
State and political subdivisions | 126,413 | 804 | 1,631 | 125,586 | |||||||||||
Mortgage-backed securities | 1,906 | 4 | 13 | 1,897 | |||||||||||
Collateralized mortgage obligations | 22,115 | — | 707 | 21,408 | |||||||||||
Corporate debt securities | 35,136 | 548 | 281 | 35,403 | |||||||||||
Total | $ | 195,619 | $ | 1,356 | $ | 2,632 | $ | 194,343 | |||||||
December 31, 2016 | |||||||||||||||
State and political subdivisions | $ | 107,941 | $ | 156 | $ | 2,713 | $ | 105,384 | |||||||
Mortgage-backed securities | 2,398 | 5 | 34 | 2,369 | |||||||||||
Collateralized mortgage obligations | 26,036 | — | 598 | 25,438 | |||||||||||
Corporate debt securities | 32,017 | 149 | 565 | 31,601 | |||||||||||
Total | $ | 168,392 | $ | 310 | $ | 3,910 | $ | 164,792 | |||||||
Investment securities with a carrying value of $237.4 million and $212.1 million at December 31, 2017 and 2016, respectively, were pledged on public deposits, securities sold under agreements to repurchase and for other purposes, as required or permitted by law.
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The summary of investment securities shows that some of the securities in the available for sale and held to maturity investment portfolios had unrealized losses, or were temporarily impaired, as of December 31, 2017 and December 31, 2016. This temporary impairment represents the estimated amount of loss that would be realized if the securities were sold on the valuation date.
The following tables present information pertaining to securities with gross unrealized losses as of December 31, 2017 and 2016, aggregated by investment category and length of time that individual securities have been in a continuous loss position:
As of December 31, 2017 | ||||||||||||||||||||||||||
Number of Securities | Less than 12 Months | 12 Months or More | Total | |||||||||||||||||||||||
Available for Sale | Estimated Fair Value | Unrealized Losses | Estimated Fair Value | Unrealized Losses | Estimated Fair Value | Unrealized Losses | ||||||||||||||||||||
(in thousands, except number of securities) | ||||||||||||||||||||||||||
U.S. Government agencies and corporations | 3 | $ | 15,626 | $ | 90 | $ | — | $ | — | $ | 15,626 | $ | 90 | |||||||||||||
State and political subdivisions | 34 | 11,705 | 167 | 1,800 | 30 | 13,505 | 197 | |||||||||||||||||||
Mortgage-backed securities | 20 | 37,964 | 359 | 3,961 | 69 | 41,925 | 428 | |||||||||||||||||||
Collateralized mortgage obligations | 35 | 37,881 | 489 | 122,757 | 4,683 | 160,638 | 5,172 | |||||||||||||||||||
Corporate debt securities | 12 | 55,340 | 298 | 8,778 | 129 | 64,118 | 427 | |||||||||||||||||||
Other equity securities | 1 | — | — | 1,944 | 56 | 1,944 | 56 | |||||||||||||||||||
Total | 105 | $ | 158,516 | $ | 1,403 | $ | 139,240 | $ | 4,967 | $ | 297,756 | $ | 6,370 | |||||||||||||
As of December 31, 2016 | ||||||||||||||||||||||||||
Number of Securities | Less than 12 Months | 12 Months or More | Total | |||||||||||||||||||||||
Estimated Fair Value | Unrealized Losses | Estimated Fair Value | Unrealized Losses | Estimated Fair Value | Unrealized Losses | |||||||||||||||||||||
(in thousands, except number of securities) | ||||||||||||||||||||||||||
State and political subdivisions | 63 | $ | 24,574 | $ | 389 | $ | 427 | $ | 29 | $ | 25,001 | $ | 418 | |||||||||||||
Mortgage-backed securities | 20 | 40,752 | 566 | 23 | 1 | 40,775 | 567 | |||||||||||||||||||
Collateralized mortgage obligations | 29 | 140,698 | 3,544 | 16,776 | 843 | 157,474 | 4,387 | |||||||||||||||||||
Corporate debt securities | 11 | 54,891 | 602 | — | — | 54,891 | 602 | |||||||||||||||||||
Other equity securities | 1 | — | — | 942 | 58 | 942 | 58 | |||||||||||||||||||
Total | 124 | $ | 260,915 | $ | 5,101 | $ | 18,168 | $ | 931 | $ | 279,083 | $ | 6,032 | |||||||||||||
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As of December 31, 2017 | ||||||||||||||||||||||||||
Number of Securities | Less than 12 Months | 12 Months or More | Total | |||||||||||||||||||||||
Held to Maturity | Estimated Fair Value | Unrealized Losses | Estimated Fair Value | Unrealized Losses | Estimated Fair Value | Unrealized Losses | ||||||||||||||||||||
(in thousands, except number of securities) | ||||||||||||||||||||||||||
State and political subdivisions | 167 | $ | 33,237 | $ | 393 | $ | 25,843 | $ | 1,238 | $ | 59,080 | $ | 1,631 | |||||||||||||
Mortgage-backed securities | 4 | 349 | 2 | 887 | 11 | 1,236 | 13 | |||||||||||||||||||
Collateralized mortgage obligations | 7 | 5,221 | 90 | 16,168 | 617 | 21,389 | 707 | |||||||||||||||||||
Corporate debt securities | 3 | 3,093 | 4 | 2,617 | 277 | 5,710 | 281 | |||||||||||||||||||
Total | 181 | $ | 41,900 | $ | 489 | $ | 45,515 | $ | 2,143 | $ | 87,415 | $ | 2,632 | |||||||||||||
As of December 31, 2016 | ||||||||||||||||||||||||||
Number of Securities | Less than 12 Months | 12 Months or More | Total | |||||||||||||||||||||||
Estimated Fair Value | Unrealized Losses | Estimated Fair Value | Unrealized Losses | Estimated Fair Value | Unrealized Losses | |||||||||||||||||||||
(in thousands, except number of securities) | ||||||||||||||||||||||||||
State and political subdivisions | 180 | $ | 65,174 | $ | 2,713 | $ | — | $ | — | $ | 65,174 | $ | 2,713 | |||||||||||||
Mortgage-backed securities | 5 | 2,246 | 34 | — | — | 2,246 | 34 | |||||||||||||||||||
Collateralized mortgage obligations | 7 | 18,964 | 369 | 6,435 | 229 | 25,399 | 598 | |||||||||||||||||||
Corporate debt securities | 11 | 19,198 | 187 | 2,512 | 378 | 21,710 | 565 | |||||||||||||||||||
Total | 203 | $ | 105,582 | $ | 3,303 | $ | 8,947 | $ | 607 | $ | 114,529 | $ | 3,910 | |||||||||||||
The Company's assessment of OTTI is based on its reasonable judgment of the specific facts and circumstances impacting each individual security at the time such assessments are made. The Company reviews and considers factual information, including expected cash flows, the structure of the security, the creditworthiness of the issuer, the type of underlying assets and the current and anticipated market conditions.
At December 31, 2017, approximately 57% of the municipal obligations held by the Company were Iowa-based, and approximately 22% were Minnesota-based. The Company does not intend to sell these municipal obligations, and it is more likely than not that the Company will not be required to sell them until the recovery of their cost. Due to the issuers’ continued satisfaction of their obligations under the securities in accordance with their contractual terms and the expectation that they will continue to do so, management’s intent and ability to hold these securities for a period of time sufficient to allow for any anticipated recovery in fair value, as well as the evaluation of the fundamentals of the issuers’ financial conditions and other objective evidence, the Company believes that the municipal obligations identified in the tables above were temporarily impaired as of December 31, 2017 and 2016.
At December 31, 2017 and 2016, the Company’s mortgage-backed securities and collateralized mortgage obligations portfolios consisted of securities predominantly backed by one- to four-family mortgage loans and underwritten to the standards of and guaranteed by the following government-sponsored agencies: the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association, and the Government National Mortgage Association. The receipt of principal, at par, and interest on mortgage-backed securities is guaranteed by the respective government-sponsored agency guarantor, such that the Company believes that its mortgage-backed securities and collateralized mortgage obligations do not expose the Company to credit-related losses and that these securities had no OTTI.
At December 31, 2017 and 2016, all but one of the Company’s corporate bonds held an investment grade rating from Moody’s, S&P or Kroll, or carried a guarantee from an agency of the US government. We have evaluated financial statements of the company issuing the non-investment grade bond and found the company’s earnings and equity position to be satisfactory and in line with industry norms. Therefore, we believe the low market value of this investment is temporary and expect to receive all contractual payments. The internal evaluation of the non-investment grade bond along with the investment grade ratings on the remainder of the corporate portfolio lead us to conclude that all of the corporate bonds in our portfolio will continue to pay according to their contractual terms. Since the Company has the ability and intent to hold securities until price recovery, we believe that there is no other-than-temporary-impairment of in the corporate bond portfolio.
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As of December 31, 2017, the Company owned $0.4 million of equity securities in banks and financial service-related companies, and $1.9 million of mutual funds invested in debt securities and other debt instruments that will cause units of the fund to be deemed to be qualified under the Community Reinvestment Act. Equity securities are considered to have OTTI whenever they have been in a loss position, compared to current book value, for twelve consecutive months, and the Company does not expect them to recover to their original cost basis. For the years ended December 31, 2017 and 2016, no impairment charges were recorded, as the affected equity securities were not deemed impaired due to stabilized market prices in relation to the Company’s original purchase price.
During the first quarter of 2017 as part of the Company’s annual review and analysis of municipal investments, $1.2 million of municipal bonds from a single issuer in the held to maturity portfolio, which did not carry a credit rating from one of the major statistical rating agencies, were identified as having an elevated level of credit risk. While the instruments were currently making payments as agreed, certain financial trends were identified that provided material doubt as to the ability of the entity to continue to service the debt in the future. The investment securities were classified as “watch,” and the Company’s asset and liability management committee were notified of the situation. In early March 2017 the Company learned of a potential buyer for the investments and a bid to purchase was received and accepted. Investment securities designated as held to maturity may generally not be sold without calling into question the Company’s stated intention to hold other debt securities to maturity in the future (“tainting”), unless certain conditions are met that provide for an exception to accounting policy. One of these exceptions, as outlined under Accounting Standards Codification (“ASC”) 320-10-25-6(a), allows for the sale of an investment that is classified as held to maturity due to significant deterioration of the issuer’s creditworthiness. Since the bonds had been internally classified as “watch” due to credit deterioration, the Company believes that the sale was in accordance with the allowable provisions of ASC 320-10-25-6(a), and as such, does not “taint” the remainder of the held to maturity portfolio. A small gain was realized on the sale. During the fourth quarter of 2017, a single issuer of $0.6 million of municipal bonds in the held to maturity portfolio exercised a call option, resulting in the realization of a small gain.
It is reasonably possible that the fair values of the Company’s investment securities could decline in the future if interest rates increase or the overall economy or the financial conditions of the issuers deteriorate. As a result, there is a risk that OTTI may be recognized in the future, and any such amounts could be material to the Company’s consolidated statements of operations.
The contractual maturity distribution of investment debt securities at December 31, 2017, is summarized as follows:
Available For Sale | Held to Maturity | ||||||||||||||
Amortized Cost | Fair Value | Amortized Cost | Fair Value | ||||||||||||
(in thousands) | |||||||||||||||
Due in one year or less | $ | 26,155 | $ | 26,283 | $ | — | $ | — | |||||||
Due after one year through five years | 119,633 | 119,972 | 19,038 | 19,062 | |||||||||||
Due after five years through ten years | 67,369 | 68,716 | 89,790 | 90,298 | |||||||||||
Due after ten years | 13,682 | 13,660 | 62,770 | 61,678 | |||||||||||
Debt securities without a single maturity date | 222,083 | 216,693 | 24,021 | 23,305 | |||||||||||
Total | $ | 448,922 | $ | 445,324 | $ | 195,619 | $ | 194,343 | |||||||
Mortgage-backed securities and collateralized mortgage obligations are collateralized by mortgage loans and guaranteed by U.S. government agencies. Our experience has indicated that principal payments will be collected sooner than scheduled because of prepayments. Therefore, these securities are not scheduled in the maturity categories indicated above. Equity securities available for sale with an amortized cost of $2.3 million and a fair value of $2.3 million are also excluded from this table.
Proceeds from the sales of investment securities available for sale during 2017 were $22.5 million. During 2016 there was $23.4 million of sales of investment securities available for sale, while in 2015 there was $116.8 million of sales of investment securities available for sale.
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Realized gains and losses on sales are determined on the basis of specific identification of investments based on the trade date. Realized gains (losses) on investments, including impairment losses for the years ended December 31, 2017, 2016 and 2015, were as follows:
Year Ended December 31, | |||||||||||
2017 | 2016 | 2015 | |||||||||
(in thousands) | |||||||||||
Available for sale fixed maturity securities: | |||||||||||
Gross realized gains | $ | 199 | $ | 469 | $ | 1,265 | |||||
Gross realized losses | (11 | ) | (5 | ) | (442 | ) | |||||
188 | 464 | 823 | |||||||||
Equity securities: | |||||||||||
Gross realized gains | — | — | 188 | ||||||||
— | — | 188 | |||||||||
Held to maturity fixed maturity securities: | |||||||||||
Gross realized gains | 53 | — | — | ||||||||
Total net realized gains and losses | $ | 241 | $ | 464 | $ | 1,011 | |||||
Note 4. | Loans Receivable and the Allowance for Loan Losses |
The composition of allowance for loan losses and loans by portfolio segment and based on impairment method are as follows:
Allowance for Loan Losses and Recorded Investment in Loan Receivables | |||||||||||||||||||||||
As of December 31, 2017 | |||||||||||||||||||||||
(in thousands) | Agricultural | Commercial and Industrial | Commercial Real Estate | Residential Real Estate | Consumer | Total | |||||||||||||||||
Allowance for loan losses: | |||||||||||||||||||||||
Individually evaluated for impairment | $ | 140 | $ | 1,126 | $ | 2,157 | $ | 226 | $ | — | $ | 3,649 | |||||||||||
Collectively evaluated for impairment | 2,650 | 7,392 | 11,144 | 2,182 | 244 | 23,612 | |||||||||||||||||
Purchased credit impaired loans | — | — | 336 | 462 | — | 798 | |||||||||||||||||
Total | $ | 2,790 | $ | 8,518 | $ | 13,637 | $ | 2,870 | $ | 244 | $ | 28,059 | |||||||||||
Loans receivable | |||||||||||||||||||||||
Individually evaluated for impairment | $ | 2,969 | $ | 9,734 | $ | 10,386 | $ | 3,722 | $ | — | $ | 26,811 | |||||||||||
Collectively evaluated for impairment | 102,543 | 493,844 | 1,147,133 | 460,475 | 36,158 | 2,240,153 | |||||||||||||||||
Purchased credit impaired loans | — | 46 | 14,452 | 5,233 | — | 19,731 | |||||||||||||||||
Total | $ | 105,512 | $ | 503,624 | $ | 1,171,971 | $ | 469,430 | $ | 36,158 | $ | 2,286,695 | |||||||||||
As of December 31, 2016 | |||||||||||||||||||||||
(in thousands) | Agricultural | Commercial and Industrial | Commercial Real Estate | Residential Real Estate | Consumer | Total | |||||||||||||||||
Allowance for loan losses: | |||||||||||||||||||||||
Individually evaluated for impairment | $ | 62 | $ | 2,066 | $ | 1,924 | $ | 299 | $ | — | $ | 4,351 | |||||||||||
Collectively evaluated for impairment | 1,941 | 4,199 | 7,692 | 2,791 | 255 | 16,878 | |||||||||||||||||
Purchased credit impaired loans | — | 9 | 244 | 368 | — | 621 | |||||||||||||||||
Total | $ | 2,003 | $ | 6,274 | $ | 9,860 | $ | 3,458 | $ | 255 | $ | 21,850 | |||||||||||
Loans receivable | |||||||||||||||||||||||
Individually evaluated for impairment | $ | 5,339 | $ | 11,434 | $ | 11,450 | $ | 3,955 | $ | — | $ | 32,178 | |||||||||||
Collectively evaluated for impairment | 108,004 | 449,380 | 1,036,049 | 480,143 | 36,591 | 2,110,167 | |||||||||||||||||
Purchased credit impaired loans | — | 156 | 16,744 | 5,898 | — | 22,798 | |||||||||||||||||
Total | $ | 113,343 | $ | 460,970 | $ | 1,064,243 | $ | 489,996 | $ | 36,591 | $ | 2,165,143 | |||||||||||
Included in the December 31, 2016 table above are loans with a contractual balance of $74.9 million and a recorded balance of $72.4 million at December 31, 2016, which were covered under loss sharing agreements with the FDIC. The agreements covered certain losses and expenses and expired at various dates through October 7, 2021. The related FDIC indemnification asset was reported separately in Note 7. “Other Assets.” The FDIC loss sharing agreements were terminated on July 14, 2017, at which time the loans were reclassified to non-covered assets.
85
As of December 31, 2017, the purchased credit impaired loans included above were $21.5 million, net of a discount of $1.7 million. As of December 31, 2016 the purchased credit impaired loans included above were $26.2 million net of a discount of $3.4 million.
Loans with unpaid principal in the amount of $477.6 million and $498.3 million at December 31, 2017 and December 31, 2016, respectively, were pledged to the FHLB as collateral for borrowings.
The changes in the allowance for loan losses by portfolio segment are as follows:
Allowance for Loan Loss Activity | |||||||||||||||||||||||||||
For the Years Ended December 31, 2017, 2016, and 2015 | |||||||||||||||||||||||||||
(in thousands) | Agricultural | Commercial and Industrial | Commercial Real Estate | Residential Real Estate | Consumer | Unallocated | Total | ||||||||||||||||||||
2017 | |||||||||||||||||||||||||||
Beginning balance | $ | 2,003 | $ | 6,274 | $ | 9,860 | $ | 3,458 | $ | 255 | $ | — | $ | 21,850 | |||||||||||||
Charge-offs | (1,202 | ) | (2,338 | ) | (7,931 | ) | (305 | ) | (257 | ) | — | (12,033 | ) | ||||||||||||||
Recoveries | 187 | 232 | 291 | 180 | 18 | — | 908 | ||||||||||||||||||||
Provision | 1,802 | 4,350 | 11,417 | (463 | ) | 228 | — | 17,334 | |||||||||||||||||||
Ending balance | $ | 2,790 | $ | 8,518 | $ | 13,637 | $ | 2,870 | $ | 244 | $ | — | $ | 28,059 | |||||||||||||
2016 | |||||||||||||||||||||||||||
Beginning balance | $ | 1,417 | $ | 5,451 | $ | 8,556 | $ | 3,968 | $ | 409 | $ | (374 | ) | $ | 19,427 | ||||||||||||
Charge-offs | (1,204 | ) | (3,066 | ) | (931 | ) | (782 | ) | (98 | ) | — | (6,081 | ) | ||||||||||||||
Recoveries | 33 | 124 | 192 | 157 | 15 | — | 521 | ||||||||||||||||||||
Provision | 1,757 | 3,765 | 2,043 | 115 | (71 | ) | 374 | 7,983 | |||||||||||||||||||
Ending balance | $ | 2,003 | $ | 6,274 | $ | 9,860 | $ | 3,458 | $ | 255 | $ | — | $ | 21,850 | |||||||||||||
2015 | |||||||||||||||||||||||||||
Beginning balance | $ | 1,506 | $ | 5,780 | $ | 4,399 | $ | 3,167 | $ | 323 | $ | 1,188 | $ | 16,363 | |||||||||||||
Charge-offs | (245 | ) | (692 | ) | (853 | ) | (740 | ) | (92 | ) | — | (2,622 | ) | ||||||||||||||
Recoveries | 1 | 372 | 7 | 143 | 31 | — | 554 | ||||||||||||||||||||
Provision | 155 | (9 | ) | 5,003 | 1,398 | 147 | (1,562 | ) | 5,132 | ||||||||||||||||||
Ending balance | $ | 1,417 | $ | 5,451 | $ | 8,556 | $ | 3,968 | $ | 409 | $ | (374 | ) | $ | 19,427 | ||||||||||||
Loan Portfolio Segment Risk Characteristics
Agricultural - Agricultural loans, most of which are secured by crops, livestock, and machinery, are provided to finance capital improvements and farm operations as well as acquisitions of livestock and machinery. The ability of the borrower to repay may be affected by many factors outside of the borrower’s control including adverse weather conditions, loss of livestock due to disease or other factors, declines in market prices for agricultural products and the impact of government regulations. The ultimate repayment of agricultural loans is dependent upon the profitable operation or management of the agricultural entity. Collateral for these loans generally includes accounts receivable, inventory, equipment and real estate. However, depending on the overall financial condition of the borrower, some loans are made on an unsecured basis. The collateral securing these loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.
Commercial and Industrial - Commercial and industrial loans are primarily made based on the reported cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. The collateral support provided by the borrower for most of these loans and the probability of repayment are based on the liquidation of the pledged collateral and enforcement of a personal guarantee, if any exists. The primary repayment risks of commercial and industrial loans are that the cash flows of the borrower may be unpredictable, and the collateral securing these loans may fluctuate in value. The size of the loans the Company can offer to commercial customers is less than the size of the loans that competitors with larger lending limits can offer. This may limit the Company’s ability to establish relationships with the largest businesses in the areas in which the Company operates. As a result, the Company may assume greater lending risks than financial institutions that have a lesser concentration of such loans and tend to make loans to larger businesses. Collateral for these loans generally includes accounts receivable, inventory, equipment and real estate. However, depending on the overall financial condition of the borrower, some loans are made on an unsecured basis. The collateral securing these loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. In addition, a decline in the U.S. economy could harm or continue to harm the businesses of the Company’s commercial and industrial customers and reduce the value of the collateral securing these loans.
Commercial Real Estate - The Company offers mortgage loans to commercial and agricultural customers for the acquisition of real estate used in their businesses, such as offices, warehouses and production facilities, and to real estate investors for the acquisition of apartment buildings, retail centers, office buildings and other commercial buildings. The market value of real estate
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securing commercial real estate loans can fluctuate significantly in a short period of time as a result of market conditions in the geographic area in which the real estate is located. Adverse developments affecting real estate values in one or more of the Company’s markets could increase the credit risk associated with its loan portfolio. Additionally, real estate lending typically involves higher loan principal amounts than other loans, and the repayment of the loans generally is dependent, in large part, on sufficient income from the properties securing the loans to cover operating expenses and debt service. Economic events or governmental regulations outside of the Company’s control or that of the borrower could negatively impact the future cash flow and market values of the affected properties.
Residential Real Estate - The Company generally retains short-term residential mortgage loans that are originated for its own portfolio but sells most long-term loans to other parties while retaining servicing rights on the majority of those loans. The market value of real estate securing residential real estate loans can fluctuate as a result of market conditions in the geographic area in which the real estate is located. Adverse developments affecting real estate values in one or more of the Company’s markets could increase the credit risk associated with its loan portfolio. Additionally, real estate lending typically involves higher loan principal amounts than other loans, and the repayment of the loans generally is dependent, in large part, on the borrower’s continuing financial stability, and is therefore more likely to be affected by adverse personal circumstances.
Consumer - Consumer loans typically have shorter terms, lower balances, higher yields and higher risks of default than real estate-related loans. Consumer loan collections are dependent on the borrower’s continuing financial stability, and are therefore more likely to be affected by adverse personal circumstances. Collateral for these loans generally includes automobiles, boats, recreational vehicles, mobile homes, and real estate. However, depending on the overall financial condition of the borrower, some loans are made on an unsecured basis. The collateral securing these loans may depreciate over time, may be difficult to recover and may fluctuate in value based on condition. In addition, a decline in the United States economy could result in reduced employment, impacting the ability of customers to repay their obligations.
Purchased Loans Policy
All purchased loans (nonimpaired and impaired) are initially measured at fair value as of the acquisition date in accordance with applicable authoritative accounting guidance. Credit discounts are included in the determination of fair value. An allowance for loan losses is not recorded at the acquisition date for loans purchased.
Individual loans acquired through the completion of a transfer, including loans that have evidence of deterioration of credit quality since origination and for which it is probable, at acquisition, that the Company will be unable to collect all contractually required payments receivable, are referred to herein as “purchased credit impaired loans.” In determining the acquisition date fair value and estimated credit losses of purchased credit impaired loans, and in subsequent accounting, the Company accounts for loans individually. Contractually required payments for interest and principal that exceed the undiscounted cash flows expected at acquisition, or the “nonaccretable difference,” are not recognized as a yield adjustment or as a loss accrual or valuation allowance. Expected cash flows at the purchase date in excess of the fair value of loans, if any, are recorded as interest income over the expected life of the loans if the timing and amount of future cash flows are reasonably estimable. Subsequent to the purchase date, increases in cash flows over those expected at the purchase date are recognized as interest income prospectively. The present value of any decreases in expected cash flows after the purchase date is recognized by recording an allowance for loan losses and a provision for loan losses. If the Company does not have the information necessary to reasonably estimate cash flows to be expected, it may use the cost-recovery method or cash-basis method of income recognition.
Charge-off Policy
The Company requires a loan to be charged-off, in whole or in part, as soon as it becomes apparent that some loss will be incurred, or when its collectability is sufficiently questionable that it no longer is considered a bankable asset. The primary considerations when determining if and how much of a loan should be charged-off are as follows: (1) the potential for future cash flows; (2) the value of any collateral; and (3) the strength of any co-makers or guarantors.
When it is determined that a loan requires a partial or full charge-off, a request for approval of a charge-off is submitted to the Company's President, Executive Vice President and Chief Credit Officer, and the Senior Regional Loan officer. The Bank's board of directors formally approves all loan charge-offs. Once a loan is charged-off, it cannot be restructured and returned to the Company's books.
The Allowance for Loan and Lease Losses
The Company requires the maintenance of an adequate allowance for loan and lease losses (“ALLL”) in order to cover estimated probable losses without eroding the Company’s capital base. Calculations are done at each quarter end, or more frequently if
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warranted, to analyze the collectability of loans and to ensure the adequacy of the allowance. In line with FDIC directives, the ALLL calculation does not include consideration of loans held for sale or off-balance-sheet credit exposures (such as unfunded letters of credit). Determining the appropriate level for the ALLL relies on the informed judgment of management, and as such, is subject to inexactness. Given the inherently imprecise nature of calculating the necessary ALLL, the Company’s policy permits the actual ALLL to be between 20% above and 5% below the “indicated reserve.”
As part of the merger between MidWestOne Bank and Central Bank, management developed a single methodology for determining the amount of the ALLL that would be needed at the combined bank. The new methodology is a hybrid of the methods used at MidWestOne Bank and Central Bank prior to the bank merger, and the results from the new ALLL model are consistent with the results that the two banks calculated individually. The refined allowance calculation allocates the portion of allowance that was previously deemed to be unallocated to instead be included in management’s determination of appropriate qualitative factors.
Loans Reviewed Individually for Impairment
The Company identifies loans to be reviewed and evaluated individually for impairment based on current information and events and the probability that the borrower will be unable to repay all amounts due according to the contractual terms of the loan agreement. Specific areas of consideration include: size of credit exposure, risk rating, delinquency, nonaccrual status, and loan classification.
The level of individual impairment is measured using one of the following methods: (1) the fair value of the collateral less costs to sell; (2) the present value of expected future cash flows, discounted at the loan's effective interest rate; or (3) the loan's observable market price. Loans that are deemed fully collateralized or have been charged down to a level corresponding with any of the three measurements require no assignment of reserves from the ALLL.
A loan modification is a change in an existing loan contract that has been agreed to by the borrower and the Bank, which may or may not be a troubled debt restructure or “TDR.” All loans deemed TDR are considered impaired. A loan is considered a TDR when, for economic or legal reasons related to a borrower’s financial difficulties, a concession is granted to the borrower that would not otherwise be considered. Both financial distress on the part of the borrower and the Bank’s granting of a concession, which are detailed further below, must be present in order for the loan to be considered a TDR.
All of the following factors are indicators that the debtor is experiencing financial difficulties (one or more items may be present):
• | The debtor is currently in default on any of its debt. |
• | The debtor has declared or is in the process of declaring bankruptcy. |
• | There is significant doubt as to whether the debtor will continue to be a going concern. |
• | Currently, the debtor has securities being held as collateral that have been delisted, are in the process of being delisted, or are under threat of being delisted from an exchange. |
• | Based on estimates and projections that only encompass the current business capabilities, the debtor forecasts that its entity-specific cash flows will be insufficient to service the debt (both interest and principal) in accordance with the contractual terms of the existing agreement through maturity. |
• | Absent the current modification, the debtor cannot obtain funds from sources other than the existing creditors at an effective interest rate equal to the current market interest rate for similar debt for a non-troubled debtor. |
The following factors are potential indicators that a concession has been granted (one or multiple items may be present):
• | The borrower receives a reduction of the stated interest rate for the remaining original life of the debt. |
• | The borrower receives an extension of the maturity date or dates at a stated interest rate lower that the current market interest rate for new debt with similar risk characteristics. |
• | The borrower receives a reduction of the face amount or maturity amount of the debt as stated in the instrument or other agreement. |
• | The borrower receives a deferral of required payments (principal and/or interest). |
• | The borrower receives a reduction of the accrued interest. |
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The following table sets forth information on the Company's TDRs by class of financing receivable occurring during the stated periods. TDRs may include multiple concessions, and the disclosure classifications in the table are based on the primary concession provided to the borrower.
2017 | 2016 | 2015 | |||||||||||||||||||||||||||
Number of Contracts | Pre-Modification Outstanding Recorded Investment | Post-Modification Outstanding Recorded Investment | Number of Contracts | Pre-Modification Outstanding Recorded Investment | Post-Modification Outstanding Recorded Investment | Number of Contracts | Pre-Modification Outstanding Recorded Investment | Post-Modification Outstanding Recorded Investment | |||||||||||||||||||||
(dollars in thousands) | |||||||||||||||||||||||||||||
Troubled Debt Restructurings(1): | |||||||||||||||||||||||||||||
Agricultural | |||||||||||||||||||||||||||||
Extended maturity date | 0 | $ | — | $ | — | 1 | $ | 25 | $ | 25 | 0 | $ | — | $ | — | ||||||||||||||
Commercial and industrial | |||||||||||||||||||||||||||||
Extended maturity date | 6 | 2,037 | 2,083 | 0 | — | — | 0 | — | — | ||||||||||||||||||||
Commercial real estate: | |||||||||||||||||||||||||||||
Farmland | |||||||||||||||||||||||||||||
Extended maturity date | 2 | 176 | 176 | 0 | — | — | 0 | — | — | ||||||||||||||||||||
Commercial real estate-other | |||||||||||||||||||||||||||||
Extended maturity date | 2 | 4,276 | 4,276 | 0 | — | — | 0 | — | — | ||||||||||||||||||||
Other | 1 | 10,546 | 10,923 | 1 | 1,000 | 700 | 0 | — | — | ||||||||||||||||||||
Residential real estate: | |||||||||||||||||||||||||||||
One- to four- family first liens | |||||||||||||||||||||||||||||
Interest rate reduction | 0 | — | — | 2 | 394 | 394 | 1 | 151 | 151 | ||||||||||||||||||||
One- to four- family junior liens | |||||||||||||||||||||||||||||
Interest rate reduction | 0 | — | — | 1 | 71 | 71 | 0 | — | — | ||||||||||||||||||||
Total | 11 | $ | 17,035 | $ | 17,458 | 5 | $ | 1,490 | $ | 1,190 | 1 | $ | 151 | $ | 151 | ||||||||||||||
(1) TDRs may include multiple concessions, and the disclosure classifications are based on the primary concession provided to the borrower.
Loans by class of financing receivable modified as TDRs within the previous 12 months and for which there was a payment default during the stated periods were:
2017 | 2016 | 2015 | |||||||||||||||
Number of Contracts | Recorded Investment | Number of Contracts | Recorded Investment | Number of Contracts | Recorded Investment | ||||||||||||
(dollars in thousands) | |||||||||||||||||
Troubled Debt Restructurings(1) That Subsequently Defaulted: | |||||||||||||||||
Commercial and industrial | |||||||||||||||||
Extended maturity date | 4 | $ | 1,504 | 0 | $ | — | 0 | $ | — | ||||||||
Commercial real estate: | |||||||||||||||||
Commercial real estate-other | |||||||||||||||||
Extended maturity date | 1 | 968 | 0 | — | 0 | — | |||||||||||
Total | 5 | $ | 2,472 | 0 | $ | — | 0 | $ | — | ||||||||
(1) TDRs may include multiple concessions, and the disclosure classifications are based on the primary concession provided to the borrower.
Loans Reviewed Collectively for Impairment
All loans not evaluated individually for impairment will be separated into homogeneous pools to be collectively evaluated. Loans will be first grouped into the various loan types (i.e. commercial, agricultural, consumer, etc.) and further segmented within each subset by risk classification (i.e. pass, special mention/watch, and substandard). Homogeneous loans past due 60-89 days and 90 days and over are classified special mention/watch and substandard, respectively, for allocation purposes.
The Company's historical loss experience for each loan type is calculated using the fiscal quarter-end data for the most recent 20 quarters as a starting point for estimating losses. In addition, other prevailing qualitative or environmental factors likely to cause probable losses to vary from historical data are incorporated in the form of adjustments to increase or decrease the loss rate applied to each group. These adjustments are documented and fully explain how the current information, events, circumstances, and conditions impact the historical loss measurement assumptions.
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Although not a comprehensive list, the following are considered key factors and are evaluated with each calculation of the ALLL to determine if adjustments to historical loss rates are warranted:
• | Changes in national and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments. |
• | Changes in the quality and experience of lending staff and management. |
• | Changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses. |
• | Changes in the volume and severity of past due loans, classified loans and non-performing loans. |
• | The existence and potential impact of any concentrations of credit. |
• | Changes in the nature and terms of loans such as growth rates and utilization rates. |
• | Changes in the value of underlying collateral for collateral-dependent loans, considering the Company’s disposition bias. |
• | The effect of other external factors such as the legal and regulatory environment. |
The Company may also consider other qualitative factors for additional allowance allocations, including changes in the Company’s loan review process. Changes in the criteria used in this evaluation or the availability of new information could cause the allowance to be increased or decreased in future periods. In addition, bank regulatory agencies, as part of their examination process, may require adjustments to the allowance for loan losses based on their judgments and estimates.
The items listed above are used to determine the pass percentage for loans evaluated under ASC 450, and as such, are applied to the loans risk rated pass. Due to the inherent risks associated with special mention/watch risk-rated loans (i.e. early stages of financial deterioration, technical exceptions, etc.), this subset is reserved at a level that will cover losses above a pass allocation for loans that had a loss in the last 20 quarters in which the loan was risk-rated special mention/watch at the time of the loss. Substandard loans carry greater risk than special mention/watch loans, and as such, this subset is reserved at a level that will cover losses above a pass allocation for loans that had a loss in the last 20 quarters in which the loan was risk-rated substandard at the time of the loss. Ongoing analysis is performed to support these factor multiples.
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The following table sets forth the risk category of loans by class of loans and credit quality indicator based on the most recent analysis performed, as of December 31, 2017 and 2016:
Pass | Special Mention/Watch | Substandard | Doubtful | Loss | Total | ||||||||||||||||||
(in thousands) | |||||||||||||||||||||||
2017 | |||||||||||||||||||||||
Agricultural | $ | 80,377 | $ | 21,989 | $ | 3,146 | $ | — | $ | — | $ | 105,512 | |||||||||||
Commercial and industrial(1) | 453,363 | 23,153 | 27,102 | 6 | — | 503,624 | |||||||||||||||||
Commercial real estate: | |||||||||||||||||||||||
Construction & development | 162,968 | 1,061 | 1,247 | — | — | 165,276 | |||||||||||||||||
Farmland | 76,740 | 10,357 | 771 | — | — | 87,868 | |||||||||||||||||
Multifamily | 131,507 | 2,498 | 501 | — | — | 134,506 | |||||||||||||||||
Commercial real estate-other | 731,231 | 34,056 | 19,034 | — | — | 784,321 | |||||||||||||||||
Total commercial real estate | 1,102,446 | 47,972 | 21,553 | — | — | 1,171,971 | |||||||||||||||||
Residential real estate: | |||||||||||||||||||||||
One- to four- family first liens | 340,446 | 2,776 | 9,004 | — | — | 352,226 | |||||||||||||||||
One- to four- family junior liens | 114,763 | 952 | 1,489 | — | — | 117,204 | |||||||||||||||||
Total residential real estate | 455,209 | 3,728 | 10,493 | — | — | 469,430 | |||||||||||||||||
Consumer | 36,059 | — | 68 | 31 | — | 36,158 | |||||||||||||||||
Total | $ | 2,127,454 | $ | 96,842 | $ | 62,362 | $ | 37 | $ | — | $ | 2,286,695 | |||||||||||
2016 | |||||||||||||||||||||||
Agricultural | $ | 95,103 | $ | 14,089 | $ | 4,151 | $ | — | $ | — | $ | 113,343 | |||||||||||
Commercial and industrial | 429,392 | 11,065 | 19,016 | 8 | — | 459,481 | |||||||||||||||||
Credit cards | 1,489 | — | — | — | — | 1,489 | |||||||||||||||||
Commercial real estate: | |||||||||||||||||||||||
Construction & development | 121,982 | 2,732 | 1,971 | — | — | 126,685 | |||||||||||||||||
Farmland | 83,563 | 8,986 | 2,430 | — | — | 94,979 | |||||||||||||||||
Multifamily | 134,975 | 548 | 480 | — | — | 136,003 | |||||||||||||||||
Commercial real estate-other | 666,767 | 20,955 | 18,854 | — | — | 706,576 | |||||||||||||||||
Total commercial real estate | 1,007,287 | 33,221 | 23,735 | — | — | 1,064,243 | |||||||||||||||||
Residential real estate: | |||||||||||||||||||||||
One- to four- family first liens | 359,029 | 2,202 | 11,002 | — | — | 372,233 | |||||||||||||||||
One- to four- family junior liens | 114,233 | 1,628 | 1,902 | — | — | 117,763 | |||||||||||||||||
Total residential real estate | 473,262 | 3,830 | 12,904 | — | — | 489,996 | |||||||||||||||||
Consumer | 36,419 | 1 | 134 | 37 | — | 36,591 | |||||||||||||||||
Total | $ | 2,042,952 | $ | 62,206 | $ | 59,940 | $ | 45 | $ | — | $ | 2,165,143 | |||||||||||
(1) As of the first quarter of 2017, the Company no longer considered credit cards a separate class of loans, and these balances were included in commercial and industrial loans as of December 31, 2017.
Included within the special mention, substandard, and doubtful categories at December 31, 2017 and 2016 were purchased credit impaired loans totaling $12.6 million and $15.3 million, respectively.
Special Mention/Watch - A special mention/watch asset has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the Company’s credit position at some future date. Special mention/watch assets are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification.
Substandard - Substandard loans are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.
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Doubtful - Loans classified as doubtful have all the weaknesses inherent in those classified as substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions and values, highly questionable and improbable.
Loss - Loans classified as loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be effected in the future.
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The following table presents loans individually evaluated for impairment, excluding purchased credit impaired loans, by class of loan, as of December 31, 2017 and 2016:
As of December 31, | |||||||||||||||||||||||
2017 | 2016 | ||||||||||||||||||||||
Recorded Investment | Unpaid Principal Balance | Related Allowance | Recorded Investment | Unpaid Principal Balance | Related Allowance | ||||||||||||||||||
(in thousands) | |||||||||||||||||||||||
With no related allowance recorded: | |||||||||||||||||||||||
Agricultural | $ | 1,523 | $ | 2,023 | $ | — | $ | 3,673 | $ | 4,952 | $ | — | |||||||||||
Commercial and industrial | 7,588 | 7,963 | — | 6,211 | 6,259 | — | |||||||||||||||||
Commercial real estate: | |||||||||||||||||||||||
Construction & development | 84 | 84 | — | 445 | 1,170 | — | |||||||||||||||||
Farmland | 287 | 287 | — | 2,230 | 2,380 | — | |||||||||||||||||
Multifamily | — | — | — | — | — | — | |||||||||||||||||
Commercial real estate-other | 5,746 | 6,251 | — | 2,224 | 2,384 | — | |||||||||||||||||
Total commercial real estate | 6,117 | 6,622 | — | 4,899 | 5,934 | — | |||||||||||||||||
Residential real estate: | |||||||||||||||||||||||
One- to four- family first liens | 2,449 | 2,482 | — | 2,429 | 2,442 | — | |||||||||||||||||
One- to four- family junior liens | 26 | 26 | — | — | — | — | |||||||||||||||||
Total residential real estate | 2,475 | 2,508 | — | 2,429 | 2,442 | — | |||||||||||||||||
Consumer | — | — | — | — | — | — | |||||||||||||||||
Total | $ | 17,703 | $ | 19,116 | $ | — | $ | 17,212 | $ | 19,587 | $ | — | |||||||||||
With an allowance recorded: | |||||||||||||||||||||||
Agricultural | $ | 1,446 | $ | 1,446 | $ | 140 | $ | 1,666 | $ | 1,669 | $ | 62 | |||||||||||
Commercial and industrial | 2,146 | 2,177 | 1,126 | 5,223 | 5,223 | 2,066 | |||||||||||||||||
Commercial real estate: | |||||||||||||||||||||||
Construction & development | — | — | — | 263 | 270 | 21 | |||||||||||||||||
Farmland | — | — | — | — | — | — | |||||||||||||||||
Multifamily | — | — | — | — | — | — | |||||||||||||||||
Commercial real estate-other | 4,269 | 11,536 | 2,157 | 6,288 | 6,344 | 1,903 | |||||||||||||||||
Total commercial real estate | 4,269 | 11,536 | 2,157 | 6,551 | 6,614 | 1,924 | |||||||||||||||||
Residential real estate: | |||||||||||||||||||||||
One- to four- family first liens | 979 | 979 | 185 | 1,526 | 1,526 | 299 | |||||||||||||||||
One- to four- family junior liens | 268 | 268 | 41 | — | — | — | |||||||||||||||||
Total residential real estate | 1,247 | 1,247 | 226 | 1,526 | 1,526 | 299 | |||||||||||||||||
Consumer | — | — | — | — | — | — | |||||||||||||||||
Total | $ | 9,108 | $ | 16,406 | $ | 3,649 | $ | 14,966 | $ | 15,032 | $ | 4,351 | |||||||||||
Total: | |||||||||||||||||||||||
Agricultural | $ | 2,969 | $ | 3,469 | $ | 140 | $ | 5,339 | $ | 6,621 | $ | 62 | |||||||||||
Commercial and industrial | 9,734 | 10,140 | 1,126 | 11,434 | 11,482 | 2,066 | |||||||||||||||||
Commercial real estate: | |||||||||||||||||||||||
Construction & development | 84 | 84 | — | 708 | 1,440 | 21 | |||||||||||||||||
Farmland | 287 | 287 | — | 2,230 | 2,380 | — | |||||||||||||||||
Multifamily | — | — | — | — | — | — | |||||||||||||||||
Commercial real estate-other | 10,015 | 17,787 | 2,157 | 8,512 | 8,728 | 1,903 | |||||||||||||||||
Total commercial real estate | 10,386 | 18,158 | 2,157 | 11,450 | 12,548 | 1,924 | |||||||||||||||||
Residential real estate: | |||||||||||||||||||||||
One- to four- family first liens | 3,428 | 3,461 | 185 | 3,955 | 3,968 | 299 | |||||||||||||||||
One- to four- family junior liens | 294 | 294 | 41 | — | — | — | |||||||||||||||||
Total residential real estate | 3,722 | 3,755 | 226 | 3,955 | 3,968 | 299 | |||||||||||||||||
Consumer | — | — | — | — | — | — | |||||||||||||||||
Total | $ | 26,811 | $ | 35,522 | $ | 3,649 | $ | 32,178 | $ | 34,619 | $ | 4,351 | |||||||||||
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The following table presents the average recorded investment and interest income recognized for loans individually evaluated for impairment, excluding purchased credit impaired loans, by class of loan, during the stated periods:
For the Year Ended December 31, | |||||||||||||||||||||||
2017 | 2016 | 2015 | |||||||||||||||||||||
Average Recorded Investment | Interest Income Recognized | Average Recorded Investment | Interest Income Recognized | Average Recorded Investment | Interest Income Recognized | ||||||||||||||||||
(in thousands) | |||||||||||||||||||||||
With no related allowance recorded: | |||||||||||||||||||||||
Agricultural | $ | 1,585 | $ | 66 | $ | 3,815 | $ | 88 | $ | 1,533 | $ | 58 | |||||||||||
Commercial and industrial | 7,588 | 230 | 6,540 | 79 | 6,769 | 424 | |||||||||||||||||
Commercial real estate: | |||||||||||||||||||||||
Construction & development | 364 | 2 | 390 | 54 | 325 | 7 | |||||||||||||||||
Farmland | 1,012 | 58 | 2,389 | 97 | 2,743 | 128 | |||||||||||||||||
Multifamily | — | — | — | — | 1,833 | 68 | |||||||||||||||||
Commercial real estate-other | 5,682 | 233 | 2,243 | 60 | 12,772 | 446 | |||||||||||||||||
Total commercial real estate | 7,058 | 293 | 5,022 | 211 | 17,673 | 649 | |||||||||||||||||
Residential real estate: | |||||||||||||||||||||||
One- to four- family first liens | 2,406 | 84 | 2,430 | 101 | 2,469 | 81 | |||||||||||||||||
One- to four- family junior liens | 27 | 2 | — | — | 1,313 | 42 | |||||||||||||||||
Total residential real estate | 2,433 | 86 | 2,430 | 101 | 3,782 | 123 | |||||||||||||||||
Consumer | — | — | — | — | 21 | 2 | |||||||||||||||||
Total | $ | 18,664 | $ | 675 | $ | 17,807 | $ | 479 | $ | 29,778 | $ | 1,256 | |||||||||||
With an allowance recorded: | |||||||||||||||||||||||
Agricultural | $ | 1,457 | $ | 44 | $ | 1,678 | $ | 46 | $ | 1,572 | $ | 48 | |||||||||||
Commercial and industrial | 2,189 | 103 | 5,277 | 74 | 1,313 | 67 | |||||||||||||||||
Commercial real estate: | |||||||||||||||||||||||
Construction & development | — | — | 263 | 3 | 34 | — | |||||||||||||||||
Farmland | — | — | — | — | 70 | 2 | |||||||||||||||||
Multifamily | — | — | — | — | 226 | 6 | |||||||||||||||||
Commercial real estate-other | 4,275 | 34 | 6,515 | — | 6,528 | 344 | |||||||||||||||||
Total commercial real estate | 4,275 | 34 | 6,778 | 3 | 6,858 | 352 | |||||||||||||||||
Residential real estate: | |||||||||||||||||||||||
One- to four- family first liens | 1,030 | 35 | 1,559 | 41 | 1,928 | 44 | |||||||||||||||||
One- to four- family junior liens | 267 | 5 | — | — | 15 | — | |||||||||||||||||
Total residential real estate | 1,297 | 40 | 1,559 | 41 | 1,943 | 44 | |||||||||||||||||
Consumer | — | — | — | — | 9 | — | |||||||||||||||||
Total | $ | 9,218 | $ | 221 | $ | 15,292 | $ | 164 | $ | 11,695 | $ | 511 | |||||||||||
Total: | |||||||||||||||||||||||
Agricultural | $ | 3,042 | $ | 110 | $ | 5,493 | $ | 134 | $ | 3,105 | $ | 106 | |||||||||||
Commercial and industrial | 9,777 | 333 | 11,817 | 153 | 8,082 | 491 | |||||||||||||||||
Commercial real estate: | |||||||||||||||||||||||
Construction & development | 364 | 2 | 653 | 57 | 359 | 7 | |||||||||||||||||
Farmland | 1,012 | 58 | 2,389 | 97 | 2,813 | 130 | |||||||||||||||||
Multifamily | — | — | — | — | 2,059 | 74 | |||||||||||||||||
Commercial real estate-other | 9,957 | 267 | 8,758 | 60 | 19,300 | 790 | |||||||||||||||||
Total commercial real estate | 11,333 | 327 | 11,800 | 214 | 24,531 | 1,001 | |||||||||||||||||
Residential real estate: | |||||||||||||||||||||||
One- to four- family first liens | 3,436 | 119 | 3,989 | 142 | 4,397 | 125 | |||||||||||||||||
One- to four- family junior liens | 294 | 7 | — | — | 1,328 | 42 | |||||||||||||||||
Total residential real estate | 3,730 | 126 | 3,989 | 142 | 5,725 | 167 | |||||||||||||||||
Consumer | — | — | — | — | 30 | 2 | |||||||||||||||||
Total | $ | 27,882 | $ | 896 | $ | 33,099 | $ | 643 | $ | 41,473 | $ | 1,767 | |||||||||||
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The following table presents the contractual aging of the recorded investment in past due loans by class of loans at December 31, 2017 and 2016:
30 - 59 Days Past Due | 60 - 89 Days Past Due | 90 Days or More Past Due | Total Past Due | Current | Total Loans Receivable | ||||||||||||||||||
(in thousands) | |||||||||||||||||||||||
December 31, 2017 | |||||||||||||||||||||||
Agricultural | $ | 95 | $ | 118 | $ | 168 | $ | 381 | $ | 105,131 | $ | 105,512 | |||||||||||
Commercial and industrial(1) | 1,434 | 1,336 | 1,576 | 4,346 | 499,278 | 503,624 | |||||||||||||||||
Commercial real estate: | |||||||||||||||||||||||
Construction & development | 57 | 97 | 82 | 236 | 165,040 | 165,276 | |||||||||||||||||
Farmland | 217 | — | 373 | 590 | 87,278 | 87,868 | |||||||||||||||||
Multifamily | — | 25 | — | 25 | 134,481 | 134,506 | |||||||||||||||||
Commercial real estate-other | 74 | — | 1,852 | 1,926 | 782,395 | 784,321 | |||||||||||||||||
Total commercial real estate | 348 | 122 | 2,307 | 2,777 | 1,169,194 | 1,171,971 | |||||||||||||||||
Residential real estate: | |||||||||||||||||||||||
One- to four- family first liens | 3,854 | 756 | 1,019 | 5,629 | 346,597 | 352,226 | |||||||||||||||||
One- to four- family junior liens | 325 | 770 | 271 | 1,366 | 115,838 | 117,204 | |||||||||||||||||
Total residential real estate | 4,179 | 1,526 | 1,290 | 6,995 | 462,435 | 469,430 | |||||||||||||||||
Consumer | 79 | 15 | 29 | 123 | 36,035 | 36,158 | |||||||||||||||||
Total | $ | 6,135 | $ | 3,117 | $ | 5,370 | $ | 14,622 | $ | 2,272,073 | $ | 2,286,695 | |||||||||||
Included in the totals above are the following purchased credit impaired loans | $ | 164 | $ | 756 | $ | 553 | $ | 1,473 | $ | 18,258 | $ | 19,731 | |||||||||||
December 31, 2016 | |||||||||||||||||||||||
Agricultural | $ | 44 | $ | — | $ | 399 | $ | 443 | $ | 112,900 | $ | 113,343 | |||||||||||
Commercial and industrial | 2,615 | 293 | 9,654 | 12,562 | 446,919 | 459,481 | |||||||||||||||||
Credit cards | — | — | — | — | 1,489 | 1,489 | |||||||||||||||||
Commercial real estate: | |||||||||||||||||||||||
Construction & development | 630 | — | 297 | 927 | 125,758 | 126,685 | |||||||||||||||||
Farmland | 373 | — | 91 | 464 | 94,515 | 94,979 | |||||||||||||||||
Multifamily | — | 129 | — | 129 | 135,874 | 136,003 | |||||||||||||||||
Commercial real estate-other | 1,238 | 763 | 6,655 | 8,656 | 697,920 | 706,576 | |||||||||||||||||
Total commercial real estate | 2,241 | 892 | 7,043 | 10,176 | 1,054,067 | 1,064,243 | |||||||||||||||||
Residential real estate: | |||||||||||||||||||||||
One- to four- family first liens | 2,851 | 1,143 | 1,328 | 5,322 | 366,911 | 372,233 | |||||||||||||||||
One- to four- family junior liens | 437 | 151 | 150 | 738 | 117,025 | 117,763 | |||||||||||||||||
Total residential real estate | 3,288 | 1,294 | 1,478 | 6,060 | 483,936 | 489,996 | |||||||||||||||||
Consumer | 50 | 23 | 33 | 106 | 36,485 | 36,591 | |||||||||||||||||
Total | $ | 8,238 | $ | 2,502 | $ | 18,607 | $ | 29,347 | $ | 2,135,796 | $ | 2,165,143 | |||||||||||
Included in the totals above are the following purchased credit impaired loans | 965 | 489 | 549 | 2,003 | 20,795 | 22,798 | |||||||||||||||||
(1) As of the first quarter of 2017, the Company no longer considered credit cards a separate class of loans, and these balances were included in commercial and industrial loans at December 31, 2017.
Non-accrual and Delinquent Loans
Loans are placed on non-accrual when (1) payment in full of principal and interest is no longer expected or (2) principal or interest has been in default for 90 days or more (unless the loan is both well secured with marketable collateral and in the process of collection). All loans rated doubtful or loss, and certain loans rated substandard, are placed on non-accrual.
A non-accrual asset may be restored to an accrual status when (1) all past due principal and interest has been paid (excluding renewals and modifications that involve the capitalizing of interest) or (2) the loan becomes well secured with marketable collateral and is in the process of collection. An established track record of performance is also considered when determining accrual status.
Delinquency status of a loan is determined by the number of days that have elapsed past the loan’s payment due date, using the following classification groupings: 30-59 days, 60-89 days and 90 days or more. Once a TDR has gone 90 days or more past due
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or is placed on nonaccrual status, it is included in the 90 days or more past due or nonaccrual totals.
The following table sets forth the composition of the Company’s recorded investment in loans on nonaccrual status and past due 90 days or more and still accruing by class of loans, excluding purchased credit impaired loans, as of December 31, 2017 and 2016:
As of December 31, | |||||||||||||||
2017 | 2016 | ||||||||||||||
Non-Accrual | Loans Past Due 90 Days or More and Still Accruing | Non-Accrual | Loans Past Due 90 Days or More and Still Accruing | ||||||||||||
(in thousands) | |||||||||||||||
Agricultural | $ | 168 | $ | — | $ | 2,690 | $ | — | |||||||
Commercial and industrial | 7,124 | — | 8,358 | — | |||||||||||
Commercial real estate: | |||||||||||||||
Construction & development | 188 | — | 780 | 95 | |||||||||||
Farmland | 386 | — | 227 | — | |||||||||||
Multifamily | — | — | — | — | |||||||||||
Commercial real estate-other | 5,279 | — | 7,360 | — | |||||||||||
Total commercial real estate | 5,853 | — | 8,367 | 95 | |||||||||||
Residential real estate: | |||||||||||||||
One- to four- family first liens | 1,228 | 205 | 1,127 | 375 | |||||||||||
One- to four- family junior liens | 346 | 2 | 116 | 15 | |||||||||||
Total residential real estate | 1,574 | 207 | 1,243 | 390 | |||||||||||
Consumer | 65 | — | 10 | — | |||||||||||
Total | $ | 14,784 | $ | 207 | $ | 20,668 | $ | 485 | |||||||
Not included in the loans above as of December 31, 2017 and 2016 were purchased credit impaired loans with an outstanding balance of $0.7 million and $2.6 million, net of a discount of $0.1 million and $0.5 million, respectively.
As of December 31, 2017, the Company had no commitments to lend additional funds to any borrowers who have had a TDR.
Purchased Loans
Purchased loans acquired in a business combination are recorded and initially measured at their estimated fair value as of the acquisition date. Credit discounts are included in the determination of fair value. An allowance for loan losses is not carried over. These purchased loans are segregated into two types: purchased credit impaired loans and purchased non-credit impaired loans.
• | Purchased non-credit impaired loans are accounted for in accordance with ASC 310-20 “Nonrefundable Fees and Other Costs” as these loans do not have evidence of significant credit deterioration since origination and it is probable all contractually required payments will be received from the borrower. |
• | Purchased credit impaired loans are accounted for in accordance with ASC 310-30 “Loans and Debt Securities Acquired with Deteriorated Credit Quality” as they display significant credit deterioration since origination and it is probable, as of the acquisition date, that the Company will be unable to collect all contractually required payments from the borrower. |
For purchased non-credit impaired loans the accretable discount is the discount applied to the expected cash flows of the portfolio to account for the differences between the interest rates at acquisition and rates currently expected on similar portfolios in the marketplace. As the accretable discount is accreted to interest income over the expected average life of the portfolio, the result will be interest income on loans at the estimated current market rate. We record a provision for the acquired portfolio as the former Central loans renew and the discount is accreted.
For purchased credit impaired loans the difference between contractually required payments at acquisition and the cash flows expected to be collected is referred to as the non-accretable difference. Further, any excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized into interest income over the expected remaining life of the loan if the timing and amount of the future cash flows are reasonably estimable. This discount includes an adjustment
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on loans that are not accruing or paying contractual interest so that interest income will be recognized at the estimated current market rate.
Subsequent to the purchase date, increases in cash flows over those expected at the purchase date are recognized as interest income prospectively. The present value of any decreases in expected cash flows after the purchase date is recognized by recording an allowance for credit losses and a provision for loan losses.
Changes in the accretable yield for loans acquired and accounted for under ASC 310-30 were as follows for the year ended December 31, 2017 and 2016:
For the Year Ended December 31, | |||||||
2017 | 2016 | ||||||
(in thousands) | |||||||
Balance at beginning of period | $ | 1,961 | $ | 1,446 | |||
Purchases | — | — | |||||
Accretion | (1,711 | ) | (3,287 | ) | |||
Reclassification from nonaccretable difference (1) | 590 | 3,802 | |||||
Balance at end of period | $ | 840 | $ | 1,961 | |||
(1) The reclassifications from non-accretable difference are due to increases in estimated cash flows from the related loans.
Note 5. | Premises and Equipment |
Premises and equipment as of December 31, 2017 and 2016 were as follows:
As of December 31, | |||||||
2017 | 2016 | ||||||
(in thousands) | |||||||
Land | $ | 13,175 | $ | 12,970 | |||
Buildings and leasehold improvements | 71,057 | 68,405 | |||||
Furniture and equipment | 16,535 | 15,851 | |||||
Construction in process | 2,658 | 1,439 | |||||
Premises and equipment | 103,425 | 98,665 | |||||
Accumulated depreciation and amortization | 27,456 | 23,622 | |||||
Premises and equipment, net | $ | 75,969 | $ | 75,043 | |||
Premises and equipment depreciation and amortization expense for the years ended December 31, 2017, 2016 and 2015 was $4.1 million, $4.6 million and $3.3 million, respectively.
Note 6. | Goodwill and Intangible Assets |
The excess of the cost of an acquisition over the fair value of the net assets acquired, including core deposit, trade name, and client relationship intangibles, consists of goodwill. Under ASC Topic 350, goodwill and the non-amortizing portion of the trade name intangible are subject to at least annual assessments for impairment by applying a fair value based test. The Company reviews goodwill and the non-amortizing portion of the trade name intangible at the reporting unit level to determine potential impairment annually on October 1, or more frequently if events or changes in circumstances indicate that the carrying value may not be recoverable, by comparing the carrying value of the reporting unit with the fair value of the reporting unit. No impairment was recorded on either the goodwill or the trade name intangible assets in 2017, 2016, or 2015. The carrying amount of goodwill was $64.7 million at December 31, 2017 and December 31, 2016.
Amortization of intangible assets is recorded using an accelerated method based on the estimated useful life of insurance agency intangible, the core deposit intangible, the amortizing portion of the trade name intangible, and the customer list intangible. Projections of amortization expense are based on existing asset balances and the remaining useful lives.
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The following tables present the changes in the carrying amount of intangibles (excluding goodwill), gross carrying amount, accumulated amortization, net book value, and weighted average life as of December 31, 2017 and 2016:
Insurance Agency Intangible | Core Deposit Intangible | Indefinite-Lived Trade Name Intangible | Finite-Lived Trade Name Intangible | Customer List Intangible | Total | ||||||||||||||||||
(dollars in thousands) | |||||||||||||||||||||||
December 31, 2017 | |||||||||||||||||||||||
Balance, beginning of period | $ | 203 | $ | 6,846 | $ | 7,040 | $ | 960 | $ | 122 | $ | 15,171 | |||||||||||
Amortization expense | (55 | ) | (2,835 | ) | — | (216 | ) | (19 | ) | (3,125 | ) | ||||||||||||
Balance at end of period | $ | 148 | $ | 4,011 | $ | 7,040 | $ | 744 | $ | 103 | $ | 12,046 | |||||||||||
Gross carrying amount | $ | 1,320 | $ | 18,206 | $ | 7,040 | $ | 1,380 | $ | 330 | $ | 28,276 | |||||||||||
Accumulated amortization | (1,172 | ) | (14,195 | ) | — | (636 | ) | (227 | ) | (16,230 | ) | ||||||||||||
Net book value | $ | 148 | $ | 4,011 | $ | 7,040 | $ | 744 | $ | 103 | $ | 12,046 | |||||||||||
Remaining weighted average useful life (years) | 6 | 4 | 7 | 6 | |||||||||||||||||||
Insurance Agency Intangible | Core Deposit Intangible | Indefinite-Lived Trade Name Intangible | Finite-Lived Trade Name Intangible | Customer List Intangible | Total | ||||||||||||||||||
(dollars in thousands) | |||||||||||||||||||||||
December 31, 2016 | |||||||||||||||||||||||
Balance, beginning of period | $ | 275 | $ | 10,480 | $ | 7,040 | $ | 1,203 | $ | 143 | $ | 19,141 | |||||||||||
Amortization expense | (72 | ) | (3,634 | ) | — | (243 | ) | (21 | ) | (3,970 | ) | ||||||||||||
Balance at end of period | $ | 203 | $ | 6,846 | $ | 7,040 | $ | 960 | $ | 122 | $ | 15,171 | |||||||||||
Gross carrying amount | $ | 1,320 | $ | 18,206 | $ | 7,040 | $ | 1,380 | $ | 330 | $ | 28,276 | |||||||||||
Accumulated amortizations | (1,117 | ) | (11,360 | ) | — | (420 | ) | (208 | ) | (13,105 | ) | ||||||||||||
Net book value | $ | 203 | $ | 6,846 | $ | 7,040 | $ | 960 | $ | 122 | $ | 15,171 | |||||||||||
Remaining weighted average useful life (years) | 7 | 5 | 8 | 7 | |||||||||||||||||||
The following table summarizes future amortization expense of intangible assets:
Insurance | Core | Trade | Customer | ||||||||||||||||
Agency | Deposit | Name | List | ||||||||||||||||
Intangible | Premium | Intangible | Intangible | Totals | |||||||||||||||
(in thousands) | |||||||||||||||||||
Year ending December 31, | |||||||||||||||||||
2018 | $ | 38 | $ | 2,037 | $ | 188 | $ | 18 | $ | 2,281 | |||||||||
2019 | 21 | 1,312 | 161 | 17 | 1,511 | ||||||||||||||
2020 | 20 | 613 | 133 | 16 | 782 | ||||||||||||||
2021 | 19 | 49 | 106 | 15 | 189 | ||||||||||||||
2022 | 18 | — | 79 | 14 | 111 | ||||||||||||||
Thereafter | 32 | — | 77 | 23 | 132 | ||||||||||||||
Total | $ | 148 | $ | 4,011 | $ | 744 | $ | 103 | $ | 5,006 | |||||||||
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Note 7. | Other Assets |
The components of the Company’s other assets as of December 31, 2017 and 2016 were as follows:
As of December 31, | |||||||
2017 | 2016 | ||||||
(in thousands) | |||||||
Federal Home Loan Bank Stock | $ | 11,324 | $ | 12,800 | |||
FDIC indemnification asset, net | — | 479 | |||||
Prepaid expenses | 2,992 | 1,760 | |||||
Mortgage servicing rights | 2,316 | 1,951 | |||||
Federal and state taxes, current | 3,120 | — | |||||
Accounts receivable & other miscellaneous assets | 3,009 | 1,323 | |||||
$ | 22,761 | $ | 18,313 | ||||
The Bank is a member of the FHLB of Des Moines, and ownership of FHLB stock is a requirement for such membership. The amount of FHLB stock the Bank is required to hold is directly related to the amount of FHLB advances borrowed. Because this security is not readily marketable and there are no available market values, this security is carried at cost and evaluated for potential impairment each quarter. Redemption of this investment is at the option of the FHLB. No impairment was recorded on FHLB stock in 2017 or 2016.
As part of the Central merger, the Company became a party to certain loss-share agreements with the FDIC from previous Central-related acquisitions. These agreements cover realized losses on loans and foreclosed real estate for specified periods. These loss-share assets are measured separately from the loan portfolios because they are not contractually embedded in the loans and are not transferable with the loans should the Company choose to dispose of them. Fair values at the acquisition dates were estimated based on projected cash flows available for loss-share based on the credit adjustments estimated for each loan. The loss-share assets are recorded within other assets on the balance sheet. On July 14, 2017, the Bank entered into an agreement with the FDIC that terminated all of the Bank's loss sharing agreements related to the former Central Bank.
Mortgage servicing rights are recorded at fair value based on assumptions provided by a third-party valuation service. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the servicing cost per loan, the discount rate, the escrow float rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses.
Note 8. | Loans Serviced for Others |
Loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of mortgage and other loans serviced for others were $432.0 million and $391.8 million at December 31, 2017 and 2016, respectively. Servicing loans for others generally consists of collecting mortgage payments, maintaining escrow accounts, disbursing payments to investors and collection and foreclosure processing. Loan servicing income is recorded on the accrual basis and includes servicing fees from investors and certain charges collected from borrowers, such as late payment fees, and is net of fair value adjustments to capitalized mortgage servicing rights.
Note 9. | Time Deposits |
Time deposits that meet or exceed the FDIC insurance limit of $250,000 at December 31, 2017 and December 31, 2016 were $221.6 million and $177.9 million, respectively.
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At December 31, 2017, the scheduled maturities of certificates of deposits were as follows:
(in thousands) | |||
2018 | $ | 391,444 | |
2019 | 166,518 | ||
2020 | 71,749 | ||
2021 | 44,331 | ||
2022 | 27,763 | ||
Thereafter | 3 | ||
Total | $ | 701,808 | |
The Company had $5.3 million and $2.6 million in brokered time deposits through the CDARS program as of December 31, 2017 and December 31, 2016, respectively. The CDARS program coordinates, on a reciprocal basis, a network of banks to spread deposits exceeding the FDIC insurance coverage limits out to numerous institutions in order to provide insurance coverage for all participating deposits.
Note 10. | Short-Term Borrowings |
Short-term borrowings were as follows as of December 31, 2017 and December 31, 2016:
December 31, 2017 | December 31, 2016 | |||||||||||||
(dollars in thousands) | Weighted Average Cost | Balance | Weighted Average Cost | Balance | ||||||||||
Federal funds purchased | 1.77 | % | $ | 1,000 | 0.83 | % | $ | 35,684 | ||||||
Securities sold under agreements to repurchase | 0.71 | 96,229 | 0.22 | 82,187 | ||||||||||
Total | 0.73 | % | $ | 97,229 | 0.40 | % | $ | 117,871 | ||||||
At December 31, 2017 and 2016, the Company had no borrowings through the Federal Reserve Discount Window, while the borrowing capacity at December 31, 2017 and 2016 was $11.5 million. As of December 31, 2017 and December 31, 2016, the Bank had municipal securities with a market value of $12.8 million and $12.8 million, respectively, pledged to the Federal Reserve to secure potential borrowings. The Company also has various other unsecured federal funds agreements with correspondent banks. As of December 31, 2017 and 2016, there were $1.0 million and $35.7 million of borrowings through these correspondent bank federal funds agreements, respectively.
Securities sold under agreements to repurchase are agreements in which the Company acquires funds by selling assets to another party under a simultaneous agreement to repurchase the same assets at a specified price and date. The Company enters into repurchase agreements and also offers a demand deposit account product to customers that sweeps their balances in excess of an agreed upon target amount into overnight repurchase agreements. All securities sold under agreements to repurchase are recorded on the face of the balance sheet.
On April 30, 2015, the Company entered into a $5.0 million unsecured line of credit with a correspondent bank. Interest is payable at a rate of one-month LIBOR + 2.00%. The line is scheduled to mature on April 28, 2018. The Company had no balance outstanding under this agreement as of December 31, 2017.
Note 11. | Subordinated Notes Payable |
The Company has established three statutory business trusts under the laws of the state of Delaware: Central Bancshares Capital Trust II, Barron Investment Capital Trust I, and MidWestOne Statutory Trust II. The trusts exist for the exclusive purposes of (i) issuing trust securities representing undivided beneficial interests in the assets of the respective trust; (ii) investing the gross proceeds of the trust securities in junior subordinated deferrable interest debentures (junior subordinated notes); and (iii) engaging in only those activities necessary or incidental thereto. For regulatory capital purposes, these trust securities qualify as a component of Tier 1 capital.
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The table below summarizes the outstanding junior subordinated notes and the related trust preferred securities issued by each trust as of December 31, 2017 and December 31, 2016:
Face Value | Book Value | Interest Rate | Year-end Interest Rate | Maturity Date | Callable Date | ||||||||||||
(in thousands) | |||||||||||||||||
2017 | |||||||||||||||||
Central Bancshares Capital Trust II(1) (2) | $ | 7,217 | $ | 6,674 | Three-month LIBOR + 3.50% | 5.09 | % | 03/15/2038 | 03/15/2013 | ||||||||
Barron Investment Capital Trust I(1) (2) | 2,062 | 1,655 | Three-month LIBOR + 2.15% | 3.82 | % | 09/23/2036 | 09/23/2011 | ||||||||||
MidWestOne Statutory Trust II(1) | 15,464 | 15,464 | Three-month LIBOR + 1.59% | 3.18 | % | 12/15/2037 | 12/15/2012 | ||||||||||
Total | $ | 24,743 | $ | 23,793 | |||||||||||||
2016 | |||||||||||||||||
Central Bancshares Capital Trust II(1) (2) | $ | 7,217 | $ | 6,614 | Three-month LIBOR + 3.50% | 4.46 | % | 3/15/2038 | 3/15/2013 | ||||||||
Barron Investment Capital Trust I(1) (2) | 2,062 | 1,614 | Three-month LIBOR + 2.15% | 3.15 | % | 9/23/2036 | 9/23/2011 | ||||||||||
MidWestOne Statutory Trust II(1) | 15,464 | 15,464 | Three-month LIBOR + 1.59% | 2.55 | % | 12/15/2037 | 12/15/2012 | ||||||||||
Total | $ | 24,743 | $ | 23,692 | |||||||||||||
(1) All distributions are cumulative and paid in cash quarterly.
(2) Central Bancshares Capital Trust II was established by Central and Barron Investment Capital Trust I was acquired by Central prior to the Company’s merger with Central, and the obligations under the junior subordinated notes issued by Central to these trusts were assumed by the Company.
The trust preferred securities are subject to mandatory redemption, in whole or in part, upon repayment of the junior subordinated notes at the stated maturity date or upon redemption of the junior subordinated notes. Each trust’s ability to pay amounts due on the trust preferred securities is solely dependent upon the Company making payment on the related junior subordinated notes. The Company’s obligation under the junior subordinated notes and other relevant trust agreements, in aggregate, constitutes a full and unconditional guarantee by the Company of each trust’s obligations under the trust preferred securities issued by each trust. The Company has the right to defer payment of interest on the junior subordinated notes and, therefore, distributions on the trust preferred securities, for up to five years, but not beyond the stated maturity date in the table above. During any such deferral period the Company may not pay cash dividends on its stock and generally may not repurchase its stock.
Note 12. | Long-Term Borrowings |
Long-term borrowings were as follows as of December 31, 2017 and December 31, 2016:
December 31, 2017 | December 31, 2016 | |||||||||||||
(dollars in thousands) | Weighted Average Cost | Balance | Weighted Average Cost | Balance | ||||||||||
FHLB Borrowings | 1.72 | % | $ | 115,000 | 1.56 | % | $ | 115,000 | ||||||
Note payable to unaffiliated bank | 3.32 | 12,500 | 2.52 | 17,500 | ||||||||||
Total | 1.88 | % | $ | 127,500 | 1.69 | % | $ | 132,500 | ||||||
The Company utilizes FHLB borrowings as a supplement to customer deposits to fund earning assets and to assist in managing interest rate risk. As a member of the Federal Home Loan Bank of Des Moines, the Bank may borrow funds from the FHLB in amounts up to 35% of the Bank’s total assets, provided the Bank is able to pledge an adequate amount of qualified assets to secure the borrowings. Advances from the FHLB are collateralized primarily by one- to four-family residential, commercial and agricultural real estate first mortgages equal to various percentages of the total outstanding notes. See Note 4 “Loans Receivable and the Allowance for Loan Losses” of the notes to the consolidated financial statements.
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As of December 31, 2017 and 2016, FHLB borrowings were as follows:
Rates | Amount | ||||||||||||
Minimum | Maximum | 2017 | 2016 | ||||||||||
(dollars in thousands) | |||||||||||||
Due in 2017 | 0.79 | % | to | 2.78 | % | $ | — | $ | 30,000 | ||||
Due in 2018 | 1.30 | % | to | 1.60 | % | 19,000 | 19,000 | ||||||
Due in 2019 | 1.42 | % | to | 1.85 | % | 27,000 | 27,000 | ||||||
Due in 2020 | 1.52 | % | to | 2.25 | % | 47,000 | 32,000 | ||||||
Due in 2021 | 1.78 | % | to | 1.93 | % | 22,000 | 7,000 | ||||||
Total | $ | 115,000 | $ | 115,000 | |||||||||
On April 30, 2015, the Company entered into a $35.0 million unsecured note payable with a correspondent bank with a maturity date of June 30, 2020. The Company drew $25.0 million on the note prior to June 30, 2015, at which time the ability to obtain additional advances ceased. Payments of principal and interest are payable quarterly beginning September 30, 2015. As of December 31, 2017, $12.5 million of that note was outstanding. The note contains certain requirements, covenants and restrictions that we view to be customary for such a transaction, including those that place restrictions on additional debt and stipulate minimum capital and various operating ratios.
Note 13. | Income Taxes |
Income taxes for the years ended December 31, 2017, 2016 and 2015 are summarized as follows:
December 31, | |||||||||||
2017 | 2016 | 2015 | |||||||||
(in thousands) | |||||||||||
Current: | |||||||||||
Federal tax expense | $ | 7,289 | $ | 7,410 | $ | 6,147 | |||||
State tax expense | 2,435 | 2,303 | 372 | ||||||||
Deferred: | |||||||||||
Deferred income tax expense | 744 | (2,853 | ) | 1,300 | |||||||
Excess tax benefit from share-based award activity | (92 | ) | — | — | |||||||
Total income tax provision | $ | 10,376 | $ | 6,860 | $ | 7,819 | |||||
The income tax provision for the year ended December 31, 2017 was more than, and the income tax provision for the years ended December 31, 2016 and 2015 were less than, the amounts computed by applying the maximum effective federal income tax rate of 35% to the income before income taxes for such years because of the following items:
2017 | 2016 | 2015 | ||||||||||||||||||
(dollars in thousands) | Amount | % of Pretax Income | Amount | % of Pretax Income | Amount | % of Pretax Income | ||||||||||||||
Expected provision | $ | 10,176 | 35.0 | % | $ | 9,538 | 35.0 | % | $ | 11,528 | 35.0 | % | ||||||||
Tax-exempt interest | (3,182 | ) | (10.9 | ) | (3,011 | ) | (11.0 | ) | (2,817 | ) | (8.6 | ) | ||||||||
Bank-owned life insurance | (485 | ) | (1.7 | ) | (477 | ) | (1.8 | ) | (438 | ) | (1.3 | ) | ||||||||
State income taxes, net of federal income tax benefit | 1,307 | 4.5 | 1,257 | 4.6 | 333 | 1.0 | ||||||||||||||
Non-deductible acquisition expenses | — | — | 83 | 0.3 | 691 | 2.1 | ||||||||||||||
General business credits | (466 | ) | (1.6 | ) | (537 | ) | (2.0 | ) | (1,225 | ) | (3.7 | ) | ||||||||
Federal income tax rate change | 3,212 | 11.1 | — | — | — | — | ||||||||||||||
Other | (186 | ) | (0.7 | ) | 7 | 0.1 | (253 | ) | (0.8 | ) | ||||||||||
Total income tax provision | $ | 10,376 | 35.7 | % | $ | 6,860 | 25.2 | % | $ | 7,819 | 23.7 | % | ||||||||
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Net deferred tax assets as of December 31, 2017 and 2016 consisted of the following components:
December 31, | |||||||
2017 | 2016 | ||||||
(in thousands) | |||||||
Deferred income tax assets: | |||||||
Allowance for loan losses | $ | 7,311 | $ | 8,585 | |||
Deferred compensation | 1,344 | 1,982 | |||||
Net operating losses (state net operating loss carryforwards) | 4,131 | 3,838 | |||||
Unrealized losses on investment securities | 928 | 738 | |||||
Other real estate owned | 175 | 283 | |||||
Deferred loan fees | 143 | — | |||||
Other | 1,777 | 3,012 | |||||
Gross deferred tax assets | 15,809 | 18,438 | |||||
Deferred income tax liabilities: | |||||||
Premises and equipment depreciation and amortization | 2,604 | 4,092 | |||||
Federal Home Loan Bank stock | 91 | 137 | |||||
Purchase accounting adjustments | 1,179 | 2,352 | |||||
Mortgage servicing rights | 603 | 766 | |||||
Prepaid expenses | 523 | 289 | |||||
Deferred loan fees | — | 225 | |||||
Other | 153 | 216 | |||||
Gross deferred tax liabilities | 5,153 | 8,077 | |||||
Net deferred income tax asset | 10,656 | 10,361 | |||||
Valuation allowance | 4,131 | 3,838 | |||||
Net deferred tax asset | $ | 6,525 | $ | 6,523 | |||
The Tax Act was signed into law on December 22, 2017. The Tax Act has a significant impact on the U.S. corporate income tax regime by lowering the U.S. corporate tax rate from 35 percent to 21 percent effective for taxable years beginning on or after January 1, 2018 in addition to implementing numerous other changes. GAAP requires that the impact of tax legislation be recognized in the period in which the law was enacted.
As a result of the Tax Act, the Company remeasured its deferred tax assets and deferred tax liabilities during the fourth quarter of 2017, resulting in additional income tax expense of $3.2 million.
In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118 (SAB 118), which provides guidance regarding how a company is to reflect provisional amounts when necessary information is not yet available, prepared or analyzed sufficiently to complete its accounting for the effect of the changes in the Tax Act. The income tax expense of $3.2 million recorded during the fourth quarter of 2017 represents all known and estimable impacts of the Tax Act and is a provisional amount based on the Company’s current best estimate. This provisional amount incorporates assumptions made based upon the Company’s current interpretations of the Tax Act and may change as the Company receives additional clarification and implementation guidance, and as data becomes available allowing for a more accurate scheduling of the deferred tax assets and liabilities, including those related to items potentially impacted by the Tax Act such as fixed assets and employee compensation. Adjustments to this provisional amount through December 22, 2018 will be included in income from operations as an adjustment to tax expense in future periods.
The Company has recorded a deferred tax asset for the future tax benefits of Iowa net operating loss carryforwards. The Iowa net operating loss carryforwards amounting to approximately $51.2 million will expire in various amounts from 2018 to 2038. As of December 31, 2017 and 2016, the Company believed it was more likely than not that all temporary differences associated with the Iowa corporate tax return would not be fully realized. Accordingly, the Company has recorded a valuation allowance to reduce the net operating loss carryforward. A valuation allowance related to the remaining deferred tax assets has not been provided because management believes it is more likely than not that the results of future operations will generate sufficient taxable income to realize the deferred tax assets.
The Company had no material unrecognized tax benefits as of December 31, 2017 and 2016.
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Note 14. | Employee Benefit Plans |
The Company has a salary reduction profit-sharing 401(k) plan covering all employees fulfilling minimum age and service requirements. Employee contributions to the plan are optional. Employer contributions are discretionary and may be made to the plan in an amount equal to a percentage of each participating employee’s salary. The 401(k) contribution expense for this plan totaled $1.3 million, $1.3 million and $1.2 million for the years ended December 31, 2017, 2016 and 2015, respectively.
The Company has an employee stock ownership plan (ESOP) covering all employees fulfilling minimum age and service requirements. Employer contributions are discretionary and may be made to the plan in an amount equal to a percentage of each participating employee’s salary. The ESOP contribution expense for this plan totaled $1.1 million, $0.8 million and $1.0 million for the years ended December 31, 2017, 2016 and 2015, respectively.
The Company has a salary continuation plan for several officers and directors. These plans provide annual payments of various amounts upon retirement or death. The Company accrues the expense for these benefits by charges to operating expense during the period the respective officer or director attains full eligibility. The amount charged to operating expense during the years ended December 31, 2017, 2016 and 2015 totaled $0.4 million, $0.4 million and $0.4 million, respectively. To provide the retirement benefits, the Company carries life insurance policies which had cash values totaling $16.8 million, $16.4 million and $14.7 million at December 31, 2017, 2016 and 2015, respectively.
Note 15. | Stock Compensation Plans |
At the 2017 Annual Meeting of Shareholders of the Company held on April 20, 2017, the Company’s shareholders approved the MidWestOne Financial Group, Inc. 2017 Equity Incentive Plan. The Plan is the successor to the 2008 Plan, which expired on November 20, 2017. Awards granted under the 2008 Plan will remain subject to its terms as long as such awards are outstanding. The Company maintains the Plan as a means to attract, retain and reward certain designated employees and directors of, and service providers to, the Company and its subsidiaries. Under the terms of the Plan, the Company may grant a total of 500,000 total shares of the Company’s common stock as stock options, stock appreciation rights or stock awards (including restricted stock units) and may also grant cash incentive awards to eligible individuals. As of December 31, 2017, 492,400 shares of the Company’s common stock remained available for future awards under the Plan. As of December 31, 2016, 431,828 shares of the Company’s common stock remained available under the 2008 Plan.
During 2017, the Company recognized $868,000 of stock based compensation expense, which consisted of $868,000 of expense related to restricted stock unit grants and no expense related to stock option grants. In comparison, during 2016, the Company recognized $731,000 of stock-based compensation expense, which consisted of $731,000 for restricted stock unit grants and no expense related to stock option grants, while total stock-based compensation expense in 2015 was $634,000 which consisted of $634,000 for restricted stock unit grants and no expense related to stock option grants.
Incentive Stock Options:
The Company is required to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as compensation expense in the Company’s consolidated statements of operations over the requisite service periods using a straight-line method. The Company assumes no projected forfeitures on its stock-based compensation, since actual historical forfeiture rates on its stock-based incentive awards have been negligible.
The stock options have a maximum term of ten years, an exercise price equal to the fair market value of a share of stock on the date of grant and vest 25% per year over four years, with the first vesting date being the one-year anniversary of the grant date.
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The following is a summary of stock option activity for the year ended December 31, 2017:
Weighted- | ||||||||||||
Average | ||||||||||||
Weighted- | Remaining | Aggregate | ||||||||||
Average | Contractual | Intrinsic | ||||||||||
Exercise | Term in | Value | ||||||||||
Shares | Price | Years | ($000) | |||||||||
Outstanding at December 31, 2016 | 18,450 | $ | 12.42 | |||||||||
Granted | — | — | ||||||||||
Exercised | (8,750 | ) | 10.69 | |||||||||
Forfeited | — | — | ||||||||||
Expired | — | — | ||||||||||
Outstanding at December 31, 2017 | 9,700 | $ | 13.98 | 0.58 | $ | 190 | ||||||
Exercisable at December 31, 2017 | 9,700 | $ | 13.98 | 0.58 | $ | 190 | ||||||
During 2017, the Company received $100,000 from the exercise of stock option awards. Plan participants realized an intrinsic value of $219,000 from the exercise of these stock options during 2017. In comparison, Plan participants realized an intrinsic value of $26,000 and $119,000 from the exercise of stock options during 2016 and 2015, respectively. As of December 31, 2017, there were no remaining compensation costs related to nonvested stock options that have not yet been recognized.
There were no stock option awards granted in 2017, 2016, or 2015.
Value Information:
The risk-free interest rate assumption is based upon observed interest rates for the expected term of the Company’s stock options. The expected volatility input into the model takes into account the historical volatility of the Company’s stock over the period that it has been publicly traded or the expected term of the option. The expected dividend yield assumption is based upon the Company’s historical dividend payout determined at the date of grant, if any.
Restricted Stock Units:
Under the Plan, the Company may grant restricted stock unit awards that vest upon the completion of future service requirements or specified performance criteria. The fair value of these awards is equal to the market price of the common stock at the date of the grant. The Company recognizes stock-based compensation expense for these awards over the vesting period, using the straight-line method, based upon the number of awards ultimately expected to vest. Each restricted stock unit entitles the recipient to receive one share of stock on the vesting date. Generally, for employee awards, the restricted stock units vest 25% per year over four years, with the first vesting date being the one-year anniversary of the grant date, or 100% upon the death or disability of the recipient, or upon change of control (as defined in the Plan) of the Company. Awards granted to directors vest 100% one year from the date of the award. If a participant terminates employment or service prior to the end of the continuous service period, the unearned portion of the stock unit award may be forfeited, at the discretion of the Company’s Compensation Committee. The Company may also issue awards that vest upon satisfaction of specified performance criteria. For these types of awards, the final measure of compensation cost is based upon the number of shares that ultimately vest considering the performance criteria.
The following is a summary of nonvested restricted stock unit activity for the year ended December 31, 2017:
Weighted- | ||||||
Average | ||||||
Grant-Date | ||||||
Shares | Fair Value | |||||
Nonvested at December 31, 2016 | 66,050 | $ | 27.04 | |||
Granted | 33,000 | 36.26 | ||||
Vested | (27,625 | ) | 26.68 | |||
Forfeited | (3,225 | ) | 32.36 | |||
Nonvested at December 31, 2017 | 68,200 | $ | 31.39 | |||
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The fair value of restricted stock unit awards that vested during 2017 was $926,000, compared to $983,000 and $703,000 during the years ended December 31, 2016 and 2015, respectively. As of December 31, 2017, the total compensation costs related to nonvested restricted stock units that have not yet been recognized totaled $1,429,000, and the weighted average period over which these costs are expected to be recognized is approximately 2.5 years.
Note 16. | Earnings per Share |
Basic per-share amounts are computed by dividing net income (the numerator) by the weighted-average number of common shares outstanding (the denominator). Diluted per-share amounts assume issuance of all common stock issuable upon conversion or exercise of other securities, unless the effect is to reduce the loss or increase the income per common share from continuing operations.
Following are the calculations for basic and diluted earnings per common share:
Year Ended December 31, | |||||||||||
2017 | 2016 | 2015 | |||||||||
(dollars in thousands, except per share amounts) | |||||||||||
Basic earnings per common share computation | |||||||||||
Numerator: | |||||||||||
Net income | $ | 18,699 | $ | 20,391 | $ | 25,118 | |||||
Denominator: | |||||||||||
Weighted average shares outstanding | 12,038,499 | 11,430,087 | 10,362,929 | ||||||||
Basic earnings per common share | $ | 1.55 | $ | 1.78 | $ | 2.42 | |||||
Diluted earnings per common share computation | |||||||||||
Numerator: | |||||||||||
Net income | $ | 18,699 | $ | 20,391 | $ | 25,118 | |||||
Denominator: | |||||||||||
Weighted average shares outstanding, included all dilutive potential shares | 12,062,577 | 11,456,324 | 10,391,323 | ||||||||
Diluted earnings per common share | $ | 1.55 | $ | 1.78 | $ | 2.42 | |||||
Note 17. | Regulatory Capital Requirements and Restrictions on Subsidiary Cash |
The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s and the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Prompt corrective action provisions are not applicable to bank holding companies.
Quantitative measures established by the regulations in effect on December 31, 2015, to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total, Tier 1 capital (as defined in the regulations) and Common Equity Tier 1 Capital (as defined in the regulations) to risk-weighted assets (as defined in the regulations) and of Tier 1 capital (as defined in the regulations) to average assets (as defined in the regulations). Management believed, as of December 31, 2017 and 2016, that the Company and the Bank met all capital adequacy requirements to which they were subject.
As of December 31, 2017, the most recent notification from the FDIC categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action then in effect. To be categorized as well capitalized under those requirements, an institution had to maintain minimum total risk-based, Tier 1 risk-based, Common Equity Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table below. There are no conditions or events since the notification that management believes have changed the Bank’s category. Notwithstanding its compliance with the specified regulatory thresholds, however, the Bank’s board of
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directors, subsequent to December 31, 2008, adopted a capital policy pursuant to which it will maintain a ratio of Tier 1 capital to total assets of 8% or greater, which ratio is greater than the ratio required to be well capitalized under the regulatory framework for prompt corrective action. This capital policy also provides that the Bank will maintain a ratio of total capital to total risk-weighted assets of at least 10%, which is equal to the threshold for being well capitalized under the regulatory framework for prompt corrective action.
A comparison of the Company’s and the Bank’s capital with the corresponding minimum regulatory requirements in effect as of December 31, 2017 and December 31, 2016, is presented below:
Actual | For Capital Adequacy Purposes | To Be Well Capitalized Under Prompt Corrective Action Provisions | ||||||||||||||||||
Amount | Ratio | Amount | Ratio(1) | Amount | Ratio | |||||||||||||||
(dollars in thousands) | ||||||||||||||||||||
At December 31, 2017: | ||||||||||||||||||||
Consolidated: | ||||||||||||||||||||
Total capital/risk weighted assets | $ | 321,459 | 12.00 | % | $ | 247,689 | 9.250 | % | N/A | N/A | ||||||||||
Tier 1 capital/risk weighted assets | 293,359 | 10.96 | 194,135 | 7.250 | N/A | N/A | ||||||||||||||
Common equity tier 1 capital/risk weighted assets | 269,566 | 10.07 | 153,969 | 5.750 | N/A | N/A | ||||||||||||||
Tier 1 leverage capital/average assets | 293,359 | 9.48 | 123,831 | 4.000 | N/A | N/A | ||||||||||||||
MidWestOne Bank: | ||||||||||||||||||||
Total capital/risk weighted assets | $ | 322,679 | 12.08 | % | $ | 247,010 | 9.250 | % | $ | 267,038 | 10.00 | % | ||||||||
Tier 1 capital/risk weighted assets | 294,620 | 11.03 | 193,603 | 7.250 | 213,631 | 8.00 | ||||||||||||||
Common equity tier 1 capital/risk weighted assets | 294,620 | 11.03 | 153,547 | 5.750 | 173,575 | 6.50 | ||||||||||||||
Tier 1 leverage capital/average assets | 294,620 | 9.53 | 123,678 | 4.000 | 154,598 | 5.00 | ||||||||||||||
At December 31, 2016: | ||||||||||||||||||||
Consolidated: | ||||||||||||||||||||
Total capital/risk weighted assets | $ | 280,396 | 11.65 | % | $ | 207,661 | 8.625 | % | N/A | N/A | ||||||||||
Tier 1 capital/risk weighted assets | 258,304 | 10.73 | 159,508 | 6.625 | N/A | N/A | ||||||||||||||
Common equity tier 1 capital/risk weighted assets | 234,638 | 9.75 | 123,393 | 5.125 | N/A | N/A | ||||||||||||||
Tier 1 leverage capital/average assets | 258,304 | 8.75 | 118,040 | 4.000 | N/A | N/A | ||||||||||||||
MidWestOne Bank: | ||||||||||||||||||||
Total capital/risk weighted assets | $ | 286,959 | 11.96 | % | $ | 206,892 | 8.625 | % | $ | 239,875 | 10.00 | % | ||||||||
Tier 1 capital/risk weighted assets | 264,871 | 11.04 | 158,917 | 6.625 | 191,900 | 8.00 | ||||||||||||||
Common equity tier 1 capital/risk weighted assets | 264,871 | 11.04 | 122,936 | 5.125 | 155,919 | 6.50 | ||||||||||||||
Tier 1 leverage capital/average assets | 264,871 | 8.98 | 118,000 | 4.000 | 147,500 | 5.00 | ||||||||||||||
(1) Includes the capital conservation buffer of 0.625% at December 31, 2016 and 1.25% at December 31, 2017.
The ability of the Company to pay dividends to its shareholders is dependent upon dividends paid by the Bank to the Company. The Bank is subject to certain statutory and regulatory restrictions on the amount of dividends it may pay. In addition, as previously noted, subsequent to December 31, 2008, the Bank’s board of directors adopted a capital policy requiring it to maintain a ratio of Tier 1 capital to total assets of at least 8% and a ratio of total capital to risk-based capital of at least 10%. Failure to maintain these ratios also could limit the ability of the Bank to pay dividends to the Company.
The Bank is required to maintain reserve balances in cash on hand or on deposit with Federal Reserve Banks. Reserve balances totaled $9.4 million and $6.8 million as of December 31, 2017 and 2016, respectively.
Note 18. | Commitments and Contingencies |
Financial instruments with off-balance-sheet risk: The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, commitments to sell loans, and standby letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheets.
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The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. A summary of the Bank’s commitments at December 31, 2017 and 2016, is as follows:
December 31, | |||||||
2017 | 2016 | ||||||
(in thousands) | |||||||
Commitments to extend credit | $ | 563,305 | $ | 473,725 | |||
Commitments to sell loans | 856 | 4,241 | |||||
Standby letters of credit | 10,260 | 9,320 | |||||
Total | $ | 574,421 | $ | 487,286 | |||
The Bank’s exposure to credit loss in the event of nonperformance by the counterparty to the financial instrument for commitments to extend credit is represented by the contractual amount of those instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the party. Collateral held varies, but may include accounts receivable, crops, livestock, inventory, property and equipment, residential real estate and income-producing commercial properties.
Commitments to sell loans are agreements to sell loans held for sale to third parties at an agreed upon price.
Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements and, generally, have terms of one year or less. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank holds collateral, which may include accounts receivable, inventory, property, equipment and income-producing properties, that support those commitments, if deemed necessary. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Bank would be required to fund the commitment. The maximum potential amount of future payments the Bank could be required to make is represented by the contractual amount shown in the summary above. If the commitment is funded, the Bank would be entitled to seek recovery from the customer. At December 31, 2017 and 2016, the amount recorded as liabilities for the Bank’s potential obligations under these guarantees was zero and $0.2 million.
Contingencies: In the normal course of business, the Bank is involved in various legal proceedings. In the opinion of management, any liability resulting from such proceedings would not have a material adverse effect on the accompanying consolidated financial statements.
Concentrations of credit risk: Substantially all of the Bank’s loans, commitments to extend credit and standby letters of credit have been granted to customers in the Bank’s market areas. Although the loan portfolio of the Bank is diversified, approximately 72% of the loans are real estate loans and approximately 8% are agriculturally related. The concentrations of credit by type of loan are set forth in Note 4 “Loans Receivable and the Allowance for Loan Losses”. Commitments to extend credit are primarily related to commercial loans and home equity loans. Standby letters of credit were granted primarily to commercial borrowers. Investments in securities issued by state and political subdivisions involve certain governmental entities within Iowa and Minnesota. The carrying value of investment securities of Iowa and Minnesota political subdivisions totaled $151.3 million and $59.6 million, respectively, as of December 31, 2017. The amount of investment securities issued by one individual municipality did not exceed $5.0 million.
Note 19. | Related Party Transactions |
Certain directors of the Company and certain principal officers are customers of, and have banking transactions with, the Bank in the ordinary course of business. Such indebtedness has been incurred on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons.
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The following is an analysis of the changes in the loans to related parties during the years ended December 31, 2017 and 2016:
Year Ended December 31, | |||||||
2017 | 2016 | ||||||
(in thousands) | |||||||
Balance, beginning | $ | 10,856 | $ | 10,247 | |||
Net decrease due to change in related parties | — | (906 | ) | ||||
Advances | 6,487 | 2,834 | |||||
Collections | (3,212 | ) | (1,319 | ) | |||
Balance, ending | $ | 14,131 | $ | 10,856 | |||
None of these loans are past due, nonaccrual or restructured to provide a reduction or deferral of interest or principal because of deterioration in the financial position of the borrower. Deposits from these related parties totaled $29.1 million and $8.3 million as of December 31, 2017 and 2016, respectively. Deposits from related parties are accepted subject to the same interest rates and terms as those from nonrelated parties.
The Company has from time to time engaged Neumann Monson, P.C. (“Neumann Monson”), an architectural services firm headquartered in Iowa City for which Kevin Monson, Chairman of the Company, is President, Managing Partner and majority owner, to perform architectural and design services with respect to the Company's offices. During 2017 and 2016, the Company paid Neumann Monson zero and $77,000, respectively, for such services. The engagement of Neumann Monson to provide the services described was reviewed by our Audit Committee, which also monitors the level of services by Neumann Monson on a periodic basis. Apart from the approval and monitoring process involving the Audit Committee, Neumann Monson was retained in the ordinary course of business, and the Company believes that such services are provided to the Company on terms no less favorable than those that would have been realized in transactions with unaffiliated parties.
Note 20. | Estimated Fair Value of Financial Instruments and Fair Value Measurements |
Fair value is the price that would be received in selling an asset or paid in transferring 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 (1) independent, (2) knowledgeable, (3) able to transact and (4) willing to transact.
GAAP requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, GAAP establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:
• | Level 1 Inputs – Unadjusted quoted prices for identical assets or liabilities in active markets that the reporting entity has the ability to access at the measurement date. |
• | Level 2 Inputs – Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means. |
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• | Level 3 Inputs – Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities. |
It is the Company’s policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements. The Company is required to use observable inputs, to the extent available, in the fair value estimation process unless that data results from forced liquidations or distressed sales. A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.
Valuation methods for instruments measured at fair value on a recurring basis
Securities Available for Sale - The Company’s investment securities classified as available for sale include: debt securities issued by the U.S. Treasury and other U.S. Government agencies and corporations, debt securities issued by state and political subdivisions, mortgage-backed securities, collateralized mortgage obligations, corporate debt securities, and equity securities. Quoted exchange prices are available for equity securities, which are classified as Level 1. The Company utilizes an independent pricing service to obtain the fair value of debt securities. On a quarterly basis, the Company selects a sample of 30 securities from its primary pricing service and compares them to a secondary independent pricing service to validate value. In addition, the Company periodically reviews the pricing methodology utilized by the primary independent service for reasonableness. Debt securities issued by the U.S. Treasury and other U.S. Government agencies and corporations and mortgage-backed obligations are priced utilizing industry-standard models that consider various assumptions, including time value, yield curves, volatility factors, prepayment speeds, default rates, loss severity, current market and contractual prices for the underlying financial instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace and are classified as Level 2. Municipal securities are valued using a type of matrix, or grid, pricing in which securities are benchmarked against the treasury rate based on credit rating. These model and matrix measurements are classified as Level 2 in the fair value hierarchy. On an annual basis, a group of selected municipal securities are priced by a securities dealer and that price is used to verify the primary independent service’s valuation.
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The following table summarizes assets measured at fair value on a recurring basis as of December 31, 2017 and 2016. There were no liabilities subject to fair value measurement on a recurring basis as of these dates. The assets are segregated by the level of valuation inputs within the fair value hierarchy utilized to measure fair value:
Fair Value Measurement at December 31, 2017 Using | |||||||||||||||
(in thousands) | Total | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||
Assets: | |||||||||||||||
Available for sale debt securities: | |||||||||||||||
U.S. Government agencies and corporations | $ | 15,626 | $ | — | $ | 15,626 | $ | — | |||||||
State and political subdivisions | 141,839 | — | 141,839 | — | |||||||||||
Mortgage-backed securities | 48,497 | — | 48,497 | — | |||||||||||
Collateralized mortgage obligations | 168,196 | — | 168,196 | — | |||||||||||
Corporate debt securities | 71,166 | — | 71,166 | — | |||||||||||
Total available for sale debt securities | 445,324 | — | 445,324 | — | |||||||||||
Other equity securities | 2,336 | 2,336 | — | — | |||||||||||
Total securities available for sale | $ | 447,660 | $ | 2,336 | $ | 445,324 | $ | — | |||||||
Fair Value Measurement at December 31, 2016 Using | |||||||||||||||
(in thousands) | Total | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||
Assets: | |||||||||||||||
Available for sale debt securities: | |||||||||||||||
U.S. Government agencies and corporations | $ | 5,905 | $ | — | $ | 5,905 | $ | — | |||||||
State and political subdivisions | 165,272 | — | 165,272 | — | |||||||||||
Mortgage-backed securities | 61,354 | — | 61,354 | — | |||||||||||
Collateralized mortgage obligations | 171,267 | — | 171,267 | — | |||||||||||
Corporate debt securities | 72,453 | — | 72,453 | — | |||||||||||
Total available for sale debt securities | 476,251 | — | 476,251 | — | |||||||||||
Other equity securities | 1,267 | 1,267 | — | — | |||||||||||
Total securities available for sale | $ | 477,518 | $ | 1,267 | $ | 476,251 | $ | — | |||||||
There were no transfers of assets between levels of the fair value hierarchy during the years ended December 31, 2017 and 2016.
There have been no changes in valuation techniques used for any assets measured at fair value during the year ended December 31, 2017.
Changes in the fair value of available for sale securities are included in other comprehensive income to the extent the changes are not considered OTTI. OTTI tests are performed on a quarterly basis and any decline in the fair value of an individual security below its cost that is deemed to be other-than-temporary results in a write-down that is reflected directly in the Company’s consolidated statements of operations.
Valuation methods for instruments measured at fair value on a nonrecurring basis
Collateral Dependent Impaired Loans - From time to time, a loan is considered impaired and an allowance for credit losses is established. The specific reserves for collateral dependent impaired loans are based on the fair value of the collateral less estimated costs to sell. The fair value of collateral is determined based on appraisals. In some cases, adjustments are made to the appraised values due to various factors, including age of the appraisal, age of comparables included in the appraisal, and known changes in the market and in the collateral. Because many of these inputs are unobservable, the valuations are classified as Level 3.
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Other Real Estate Owned (“OREO”) - OREO represents property acquired through foreclosures and settlements of loans. Property acquired through or in lieu of foreclosure are initially recorded at fair value less estimated selling cost at the date of foreclosure, establishing a new cost basis. The Company considers third party appraisals as well as independent fair value assessments from real estate brokers or persons involved in selling OREO in determining the fair value of particular properties. Accordingly, the valuation of OREO is subject to significant external and internal judgment. The Company also periodically reviews OREO to determine whether the property continues to be carried at the lower of its recorded book value or fair value of the property, less disposal costs. Because many of these inputs are unobservable, the valuations are classified as Level 3.
The following table discloses the Company’s estimated fair value amounts of its assets recorded at fair value on a nonrecurring basis. It is management’s belief that the fair values presented below are reasonable based on the valuation techniques and data available to the Company as of December 31, 2017 and 2016, as more fully described above.
Fair Value Measurement at December 31, 2017 Using | |||||||||||||||
(in thousands) | Total | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||
Assets: | |||||||||||||||
Collateral dependent impaired loans | $ | 3,927 | $ | — | $ | — | $ | 3,927 | |||||||
Other real estate owned | $ | 2,010 | $ | — | $ | — | $ | 2,010 | |||||||
Fair Value Measurement at December 31, 2016 Using | |||||||||||||||
(in thousands) | Total | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||
Assets: | |||||||||||||||
Collateral dependent impaired loans | $ | 8,774 | $ | — | $ | — | $ | 8,774 | |||||||
Other real estate owned | $ | 2,097 | $ | — | $ | — | $ | 2,097 | |||||||
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The following presents the carrying amount and estimated fair value of the financial instruments held by the Company at December 31, 2017 and 2016. The information presented is subject to change over time based on a variety of factors. The operations of the Company are managed on a going concern basis and not a liquidation basis. As a result, the ultimate value realized from the financial instruments presented could be substantially different when actually recognized over time through the normal course of operations. Additionally, a substantial portion of the Company’s inherent value is the capitalization and franchise value of the Bank. Neither of these components has been given consideration in the presentation of fair values below.
December 31, 2017 | |||||||||||||||||||
Carrying Amount | Estimated Fair Value | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||||||
(in thousands) | |||||||||||||||||||
Financial assets: | |||||||||||||||||||
Cash and cash equivalents | $ | 50,972 | $ | 50,972 | $ | 50,972 | $ | — | $ | — | |||||||||
Investment securities: | |||||||||||||||||||
Available for sale | 447,660 | 447,660 | 2,336 | 445,324 | — | ||||||||||||||
Held to maturity | 195,619 | 194,343 | — | 194,343 | — | ||||||||||||||
Total investment securities | 643,279 | 642,003 | 2,336 | 639,667 | — | ||||||||||||||
Loans held for sale | 856 | 871 | — | — | 871 | ||||||||||||||
Loans, net | 2,258,636 | 2,256,726 | — | 2,256,726 | — | ||||||||||||||
Accrued interest receivable | 14,732 | 14,732 | 14,732 | — | — | ||||||||||||||
Federal Home Loan Bank stock | 11,324 | 11,324 | — | 11,324 | — | ||||||||||||||
Financial liabilities: | |||||||||||||||||||
Deposits: | |||||||||||||||||||
Non-interest-bearing demand | 461,969 | 461,969 | 461,969 | — | — | ||||||||||||||
Interest-bearing checking | 1,228,112 | 1,228,112 | 1,228,112 | — | — | ||||||||||||||
Savings | 213,430 | 213,430 | 213,430 | — | — | ||||||||||||||
Certificates of deposit under $100,000 | 324,681 | 321,197 | — | 321,197 | — | ||||||||||||||
Certificates of deposit $100,000 and over | 377,127 | 374,685 | — | 374,685 | — | ||||||||||||||
Total deposits | 2,605,319 | 2,599,393 | 1,903,511 | 695,882 | — | ||||||||||||||
Federal funds purchased and securities sold under agreements to repurchase | 97,229 | 97,229 | 97,229 | — | — | ||||||||||||||
Federal Home Loan Bank borrowings | 115,000 | 114,945 | — | 114,945 | — | ||||||||||||||
Junior subordinated notes issued to capital trusts | 23,793 | 19,702 | — | 19,702 | — | ||||||||||||||
Long-term debt | 12,500 | 12,500 | — | 12,500 | — | ||||||||||||||
Accrued interest payable | 1,428 | 1,428 | 1,428 | — | — | ||||||||||||||
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December 31, 2016 | |||||||||||||||||||
Carrying Amount | Estimated Fair Value | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||||||
(in thousands) | |||||||||||||||||||
Financial assets: | |||||||||||||||||||
Cash and cash equivalents | $ | 43,228 | $ | 43,228 | $ | 43,228 | $ | — | $ | — | |||||||||
Investment securities: | |||||||||||||||||||
Available for sale | 477,518 | 477,518 | 1,267 | 476,251 | — | ||||||||||||||
Held to maturity | 168,392 | 164,792 | — | 164,792 | — | ||||||||||||||
Total investment securities | 645,910 | 642,310 | 1,267 | 641,043 | — | ||||||||||||||
Loans held for sale | 4,241 | 4,286 | — | — | 4,286 | ||||||||||||||
Loans, net | 2,143,293 | 2,138,252 | — | 2,138,252 | — | ||||||||||||||
Accrued interest receivable | 13,871 | 13,871 | 13,871 | — | — | ||||||||||||||
Federal Home Loan Bank stock | 12,800 | 12,800 | — | 12,800 | — | ||||||||||||||
Financial liabilities: | |||||||||||||||||||
Deposits: | |||||||||||||||||||
Non-interest bearing demand | 494,586 | 494,586 | 494,586 | — | — | ||||||||||||||
Interest-bearing checking | 1,136,282 | 1,136,282 | 1,136,282 | — | — | ||||||||||||||
Savings | 197,698 | 197,698 | 197,698 | — | — | ||||||||||||||
Certificates of deposit under $100,000 | 326,832 | 324,978 | — | 324,978 | — | ||||||||||||||
Certificates of deposit $100,000 and over | 325,050 | 324,060 | — | 324,060 | — | ||||||||||||||
Total deposits | 2,480,448 | 2,477,604 | 1,828,566 | 649,038 | — | ||||||||||||||
Federal funds purchased and securities sold under agreements to repurchase | 117,871 | 117,871 | 117,871 | — | — | ||||||||||||||
Federal Home Loan Bank borrowings | 115,000 | 114,590 | — | 114,590 | — | ||||||||||||||
Junior subordinated notes issued to capital trusts | 23,692 | 19,248 | — | 19,248 | — | ||||||||||||||
Long-term debt | 17,500 | 17,500 | — | 17,500 | — | ||||||||||||||
Accrued interest payable | 1,472 | 1,472 | 1,472 | — | — | ||||||||||||||
• | Cash and cash equivalents, federal funds purchased, securities sold under repurchase agreements, and accrued interest are instruments with carrying values that approximate fair value. |
• | Investment securities available for sale are measured at fair value on a recurring basis. Held to maturity securities are carried at amortized cost. Fair value is based upon quoted prices, if available. If a quoted price is not available, the fair value is obtained from benchmarking the security against similar securities by using a third-party pricing service. |
• | Loans held for sale are carried at the lower of cost or fair value, with fair value being based on recent observable loan sales. The portfolio has historically consisted primarily of residential real estate loans. |
• | For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for other loans are determined using estimated future cash flows, discounted at the interest rates currently being offered for loans with similar terms to borrowers with similar credit quality. The Company does record nonrecurring fair value adjustments to loans to reflect (1) partial write-downs and allowances that are based on the observable market price or appraised value of the collateral or (2) the full charge-off of the loan carrying value. |
• | The fair value of FHLB stock is estimated at its carrying value and redemption price of $100 per share. |
• | Deposit liabilities are carried at historical cost. The fair value of non-interest bearing demand deposits, savings accounts and certain interest-bearing checking deposits is the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. If the fair value of the fixed maturity certificates of deposit is calculated at less than the carrying amount, the carrying value of these deposits is reported as the fair value. |
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• | FHLB borrowings, junior subordinated notes issued to capital trusts, and long-term debt are recorded at historical cost. The fair value of these items is estimated using discounted cash flow analysis, based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements. |
The following presents the valuation technique(s), observable inputs, and quantitative information about the unobservable inputs used for fair value measurements of the financial instruments held by the Company at December 31, 2017, categorized within Level 3 of the fair value hierarchy:
Quantitative Information About Level 3 Fair Value Measurements | |||||||||||||
(dollars in thousands) | Fair Value at December 31, 2017 | Valuation Techniques(s) | Unobservable Input | Range of Inputs | Weighted Average | ||||||||
Collateral dependent impaired loans | $ | 3,927 | Modified appraised value | Third party appraisal | NM * | NM * | NM * | ||||||
Appraisal discount | NM * | NM * | NM * | ||||||||||
Other real estate owned | $ | 2,010 | Modified appraised value | Third party appraisal | NM * | NM * | NM * | ||||||
Appraisal discount | NM * | NM * | NM * | ||||||||||
* Not Meaningful. Third party appraisals are obtained as to the value of the underlying asset, but disclosure of this information would not provide meaningful information, as the range will vary widely from loan to loan. Types of discounts considered include age of the appraisal, local market conditions, current condition of the property, and estimated sales costs. These discounts will also vary from loan to loan, thus providing a range would not be meaningful.
Changes in assumptions or estimation methodologies may have a material effect on these estimated fair values.
Note 21. | Variable Interest Entities |
The Company had invested in certain participation certificates of loan pools which were purchased, held and serviced by a third-party independent servicing corporation. The Company's portfolio held approximately 95% of the participation interests in the pools of loans owned and serviced by States Resources Corporation (“SRC”), a third-party loan servicing organization located in Omaha, Nebraska, in which the Company participated. SRC's owner held the remaining interest. The Company did not have any ownership interest in or exert any control over SRC, and thus it was not included in the consolidated financial statements. The Company exited this line of business in June 2015.
These pools of loans were purchased from large nonaffiliated banking organizations and from the FDIC acting as receiver of failed banks and savings associations. As loan pools were put out for bid (generally in a sealed bid auction), SRC’s due diligence teams evaluated the loans and determined their interest in bidding on the pool. After the due diligence, the Company’s management reviewed the status and decided if it wished to continue in the process. If the decision to consider a bid was made, SRC conducted additional analysis to determine the appropriate bid price. This analysis involved discounting loan cash flows with adjustments made for expected losses, changes in collateral values as well as targeted rates of return. A cost or investment basis was assigned to each individual loan on a cents-per-dollar (discounted price) basis based on SRC’s assessment of the recovery potential of each loan.
Once a bid was awarded to SRC, the Company assumed the risk of profit or loss, but did so on a non-recourse basis so the risk was limited to its initial investment. The extent of the risk was also dependent upon: the debtor or guarantor’s financial condition, the possibility that a debtor or guarantor may file for bankruptcy protection, SRC’s ability to locate any collateral and obtain possession, the value of such collateral, and the length of time it took to realize the recovery either through collection procedures, legal process, or resale of the loans after a restructure.
Loan pool participations were shown on the Company’s consolidated balance sheets as a separate asset category. The original carrying value or investment basis of loan pool participations was the discounted price paid by the Company to acquire its interests, which, as noted, was less than the face amount of the underlying loans. The Company’s investment basis was reduced as SRC recovered principal on the loans and remitted its share to the Company or as loan balances were written off as uncollectible.
Note 22. | Operating Segments |
The Company’s activities are considered to be a single industry segment for financial reporting purposes. The Company is engaged in the business of commercial and retail banking, investment management and insurance services with operations throughout central and eastern Iowa, the Twin Cities area of Minnesota, Wisconsin, Florida, and Colorado. Substantially all income is derived from a diverse base of commercial, mortgage and retail lending activities, and investments.
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Note 23. | Branch Sales |
On September 10, 2015, the Bank entered into an agreement to sell its Ottumwa, Iowa branch to Peoples State Bank headquartered in Albia, Iowa, a unit of Peoples Tri-County BanCorp. Peoples State Bank assumed approximately $33.0 million in deposits and $17.1 million in loans on the sale completion date of December 4, 2015, and the Company realized a net gain of $0.7 million, which is included on the Consolidated Statements of Operation in Other gain.
On September 24, 2015, Central Bank, which at the time was a wholly owned subsidiary of the Company, entered into an agreement to sell its Barron and Rice Lake, Wisconsin branches to Citizens Community Federal Bank headquartered in Altoona, Wisconsin, a unit of Citizens Community Bancorp, Inc. of Eau Claire, Wisconsin. Citizens Community Federal Bank assumed approximately $27.6 million in deposits and $14.2 million in loans. The transaction was completed on February 5, 2016, and the Company realized a net gain of $0.7 million, which is included on the Consolidated Statements of Operations in Other gain.
On May 9, 2016, the Bank entered into an agreement to sell its Davenport, Iowa branch to CBI Bank and Trust (“CBI Bank”) headquartered in Muscatine, Iowa, a unit of Central Bancshares, Inc. of Muscatine, Iowa. CBI Bank assumed approximately $12.0 million in deposits and $33.0 million in loans on the sale completion date of August 5, 2016, and the Company realized a net gain of $0.7 million, which is included on the Consolidated Statements of Operations in Other gain.
Note 24. | Parent Company Only Financial Information |
The following are condensed balance sheets of MidWestOne Financial Group, Inc. as of December 31, 2017 and 2016 (parent company only):
As of December 31, | |||||||
2017 | 2016 | ||||||
(in thousands) | |||||||
Balance Sheets | |||||||
Assets | |||||||
Cash | $ | 4,200 | $ | 2,621 | |||
Investment in subsidiaries | 366,672 | 336,937 | |||||
Investment securities available for sale | 392 | 326 | |||||
Investment securities held to maturity | 743 | 743 | |||||
Income tax receivable | — | 1,479 | |||||
Bank-owned life insurance | 4,872 | 4,746 | |||||
Other assets | 176 | 201 | |||||
Total assets | $ | 377,055 | $ | 347,053 | |||
Liabilities and Shareholders’ Equity | |||||||
Liabilities: | |||||||
Junior subordinated notes issued to capital trusts | $ | 23,793 | $ | 23,692 | |||
Long-term debt | 12,500 | 17,500 | |||||
Deferred income taxes | 11 | 84 | |||||
Other liabilities | 447 | 321 | |||||
Total liabilities | 36,751 | 41,597 | |||||
Shareholders’ equity: | |||||||
Capital stock, preferred | — | — | |||||
Capital stock, common | 12,463 | 11,713 | |||||
Additional paid-in capital | 187,486 | 163,667 | |||||
Treasury stock | (5,121 | ) | (5,766 | ) | |||
Retained earnings | 148,078 | 136,975 | |||||
Accumulated other comprehensive income | (2,602 | ) | (1,133 | ) | |||
Total shareholders’ equity | 340,304 | 305,456 | |||||
Total liabilities and shareholders’ equity | $ | 377,055 | $ | 347,053 | |||
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The following are condensed statements of income of MidWestOne Financial Group, Inc.for the years ended December 31, 2017, 2016, and 2015 (parent company only):
Year Ended December 31, | |||||||||||
2017 | 2016 | 2015 | |||||||||
(in thousands) | |||||||||||
Statements of Income | |||||||||||
Dividends received from subsidiaries | $ | 6,500 | $ | 12,508 | $ | 53,511 | |||||
Interest income and dividends on investment securities | 47 | 31 | 30 | ||||||||
Interest and discount on loan pool participations | — | — | (69 | ) | |||||||
Investment securities gains | — | — | 188 | ||||||||
Loss on sale of loan pool participations | — | — | (455 | ) | |||||||
Interest on debt | (1,406 | ) | (1,305 | ) | (1,135 | ) | |||||
Bank-owned life insurance income | 126 | 128 | 128 | ||||||||
Operating expenses | (2,281 | ) | (2,094 | ) | (5,361 | ) | |||||
Income before income taxes and equity in subsidiaries’ undistributed income | 2,986 | 9,268 | 46,837 | ||||||||
Income tax benefit | (1,137 | ) | (1,245 | ) | (1,951 | ) | |||||
Income before equity in subsidiaries’ undistributed income (loss) | 4,123 | 10,513 | 48,788 | ||||||||
Equity in subsidiaries’ undistributed income (loss) | 14,576 | 9,878 | (23,670 | ) | |||||||
Net income | $ | 18,699 | $ | 20,391 | $ | 25,118 | |||||
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The following are condensed statements of cash flows of MidWestOne Financial Group, Inc. for the years ended December 31, 2017, 2016, and 2015 (parent company only):
Year Ended December 31, | |||||||||||
2017 | 2016 | 2015 | |||||||||
(in thousands) | |||||||||||
Statements of Cash Flows | |||||||||||
Cash flows from operating activities: | |||||||||||
Net income | $ | 18,699 | $ | 20,391 | $ | 25,118 | |||||
Adjustments to reconcile net income to net cash provided by operating activities: | |||||||||||
Undistributed (income) loss of subsidiaries, net of dividends and distributions | (14,576 | ) | (9,878 | ) | 23,670 | ||||||
Amortization of premium on junior subordinated notes issued to capital trusts | 101 | 105 | 73 | ||||||||
Deferred income taxes, net, expense (benefit) | (1 | ) | (35 | ) | 617 | ||||||
Investment securities gain | — | — | (188 | ) | |||||||
Excess tax benefit from share-based award activity | (92 | ) | — | — | |||||||
Stock-based compensation | 868 | 731 | 634 | ||||||||
Increase in cash value of bank-owned life insurance | (126 | ) | (128 | ) | (128 | ) | |||||
(Increase) decrease in other assets | 1,617 | (751 | ) | 646 | |||||||
Increase (decrease) in other liabilities | 13 | 8 | (907 | ) | |||||||
Net cash provided by operating activities | 6,503 | 10,443 | 49,535 | ||||||||
Cash flows from investing activities | |||||||||||
Proceeds from sales of available for sale securities | 1 | 1 | 1,173 | ||||||||
Purchase of available for sale securities | (10 | ) | (9 | ) | (14 | ) | |||||
Proceeds from maturities and calls of held to maturity securities | — | — | 246 | ||||||||
Loan participation pools, net | — | — | 1,964 | ||||||||
Net cash paid in business combination | — | — | (62,902 | ) | |||||||
Investment in subsidiary | (16,200 | ) | — | (3,000 | ) | ||||||
Net cash used in investing activities | (16,209 | ) | (8 | ) | (62,533 | ) | |||||
Cash flows from financing activities: | |||||||||||
Proceeds from share-based award activity | 100 | 14 | 158 | ||||||||
Taxes paid relating to net share settlement of equity awards | (114 | ) | — | — | |||||||
Redemption of subordinated note payable | — | — | (12,669 | ) | |||||||
Proceeds from long-term debt | — | — | 25,000 | ||||||||
Payments on long-term debt | (5,000 | ) | (5,000 | ) | (2,500 | ) | |||||
Issuance of common stock | 25,688 | — | 7,900 | ||||||||
Expenses incurred in stock issuance | (1,328 | ) | — | — | |||||||
Dividends paid | (8,061 | ) | (7,317 | ) | (6,344 | ) | |||||
Net cash provided by (used in) financing activities | 11,285 | (12,303 | ) | 11,545 | |||||||
Net increase (decrease) in cash | 1,579 | (1,868 | ) | (1,453 | ) | ||||||
Cash Balance: | |||||||||||
Beginning | 2,621 | 4,489 | 5,942 | ||||||||
Ending | $ | 4,200 | $ | 2,621 | $ | 4,489 | |||||
Note 25. | Subsequent Events |
Management evaluated subsequent events through the date the consolidated financial statements were issued. Events or transactions occurring after December 31, 2017, but prior to the date the consolidated financial statements were issued, that provided additional evidence about conditions that existed at December 31, 2017 have been recognized in the consolidated financial statements for the period ended December 31, 2017. Events or transactions that provided evidence about conditions that did not exist at December 31, 2017, but arose before the consolidated financial statements were issued, have not been recognized in the consolidated financial statements for the period ended December 31, 2017.
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On January 17, 2018, the board of directors of the Company declared a cash dividend of $0.195 per share payable on March 15, 2018 to shareholders of record as of the close of business on March 1, 2018.
Note 26. | Quarterly Results of Operations (unaudited) |
Three Months Ended | |||||||||||||||
December 31 | September 30 | June 30 | March 31 | ||||||||||||
(in thousands, except per share amounts) | |||||||||||||||
2017 | |||||||||||||||
Interest income | $ | 30,538 | $ | 30,361 | $ | 29,854 | $ | 28,567 | |||||||
Interest expense | 4,127 | 3,869 | 3,663 | 3,486 | |||||||||||
Net interest income | 26,411 | 26,492 | 26,191 | 25,081 | |||||||||||
Provision for loan losses | 10,669 | 4,384 | 1,240 | 1,041 | |||||||||||
Noninterest income | 5,534 | 5,916 | 5,383 | 5,537 | |||||||||||
Noninterest expense | 20,093 | 19,744 | 19,964 | 20,335 | |||||||||||
Income before income taxes | 1,183 | 8,280 | 10,370 | 9,242 | |||||||||||
Income tax expense | 2,773 | 1,938 | 3,136 | 2,529 | |||||||||||
Net income | $ | (1,590 | ) | $ | 6,342 | $ | 7,234 | $ | 6,713 | ||||||
Net income per common share - basic | $ | (0.13 | ) | $ | 0.52 | $ | 0.59 | $ | 0.58 | ||||||
Net income per common share - diluted | $ | (0.13 | ) | $ | 0.52 | $ | 0.59 | $ | 0.58 | ||||||
2016 | |||||||||||||||
Interest income | $ | 27,914 | $ | 27,891 | $ | 28,038 | $ | 28,485 | |||||||
Interest expense | 3,384 | 3,310 | 3,098 | 2,930 | |||||||||||
Net interest income | 24,530 | 24,581 | 24,940 | 25,555 | |||||||||||
Provision for loan losses | 4,742 | 1,005 | 1,171 | 1,065 | |||||||||||
Noninterest income | 5,720 | 5,714 | 5,595 | 6,405 | |||||||||||
Noninterest expense | 21,106 | 20,439 | 22,815 | 23,446 | |||||||||||
Income before income taxes | 4,402 | 8,851 | 6,549 | 7,449 | |||||||||||
Income tax expense | 532 | 2,629 | 1,794 | 1,905 | |||||||||||
Net income | $ | 3,870 | $ | 6,222 | $ | 4,755 | $ | 5,544 | |||||||
Net income per common share - basic | $ | 0.34 | $ | 0.54 | $ | 0.42 | $ | 0.49 | |||||||
Net income per common share - diluted | $ | 0.34 | $ | 0.54 | $ | 0.42 | $ | 0.48 | |||||||
ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. |
None.
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ITEM 9A. | CONTROLS AND PROCEDURES. |
Disclosure Controls and Procedures
The Company’s management, including the Chief Executive Officer and Interim Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule 15d-15(e) under the Exchange Act) that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including the Company’s Chief Executive Officer and Interim Chief Financial Officer, to allow timely decisions regarding required disclosure. Based on this evaluation, the Chief Executive Officer and Interim Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2017.
Changes in Internal Control over Financial Reporting
There were no changes in the Company’s internal controls over financial reporting (as defined in Rule 13a-15(f) and Rule 15d-15(f) under the Exchange Act) that occurred during the quarter ended December 31, 2017 that have materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.
Management’s Annual Report on Internal Control over Financial Reporting
Management of the Company is responsible for establishing and maintaining effective internal control over financial reporting. Internal control is designed to provide reasonable assurance to the Company’s management and board of directors regarding the preparation of reliable published financial statements. Internal control over financial reporting includes self-monitoring mechanisms, and actions are taken to correct deficiencies as they are identified.
Because of inherent limitations in any system of internal control, no matter how well designed, misstatements due to error or fraud may occur and not be detected, including the possibility of the circumvention or overriding of controls. Accordingly, even effective internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, internal control effectiveness may vary over time.
Management assessed the Company’s internal control over financial reporting as of December 31, 2017. This assessment was based on criteria for effective internal control over financial reporting described in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, the Chief Executive Officer and Interim Chief Financial Officer assert that the Company maintained effective internal control over financial reporting as of December 31, 2017 based on the specified criteria.
The effectiveness of the Company’s internal control over financial reporting as of December 31, 2017, has been audited by RSM US LLP, the independent registered public accounting firm who also has audited the Company’s consolidated financial statements included in this Annual Report on Form 10-K. RSM US LLP’s report on the Company’s internal control over financial reporting appears on the following page.
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Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors of MidWestOne Financial Group, Inc.
Opinion on the Internal Control Over Financial Reporting
We have audited MidWestOne Financial Group, Inc. and its subsidiaries, (the Company) internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets as of December 31, 2017 and 2016 and the consolidated statements of operations, comprehensive income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2017, and the related notes to the consolidated financial statements of the Company and our report dated March 1, 2018 expressed an unqualified opinion.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting in the accompanying Management’s Annual Report on Internal Controls over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ RSM US LLP
Cedar Rapids, Iowa
March 1, 2018
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ITEM 9B. | OTHER INFORMATION. |
None.
PART III
ITEM 10. | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE. |
The information required by this Item 10 will be included in the Company’s Definitive Proxy Statement for the 2018 Annual Meeting of Shareholders under the headings “Proposal 1: Election of Directors,” “Information About Nominees, Continuing Directors and Named Executive Officers,” “Corporate Governance and Board Matters,” “Section 16(a) Beneficial Ownership Reporting Compliance,” and “Shareholder Communications with the Board and Nomination and Proposal Procedures” and is incorporated herein by reference. The Definitive Proxy Statement will be filed with the SEC pursuant to Regulation 14A within 120 days of the end of the Company’s 2017 fiscal year.
ITEM 11. | EXECUTIVE COMPENSATION. |
The information required by this Item 11 will be included in the Company’s Definitive Proxy Statement for the 2018 Annual Meeting of Shareholders under the headings “Compensation Discussion and Analysis,” “Compensation Committee Report,” “Compensation Committee Interlocks and Insider Participation,” “Executive Compensation” and “Director Compensation” and is incorporated herein by reference. The Definitive Proxy Statement will be filed with the SEC pursuant to Regulation 14A within 120 days of the end of the Company’s 2017 fiscal year.
ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS. |
The information required by this Item 12 will be included in the Company’s Definitive Proxy Statement for the 2018 Annual Meeting of Shareholders under the headings “Security Ownership of Certain Beneficial Owners and Management” and “Equity Compensation Plan Information” and is incorporated herein by reference. The Definitive Proxy Statement will be filed with the SEC pursuant to Regulation 14A within 120 days of the end of the Company’s 2017 fiscal year.
ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE. |
The information required by this Item 13 will be included in the Company’s Definitive Proxy Statement for the 2018 Annual Meeting of Shareholders under the headings “Corporate Governance and Board Matters” and “Certain Relationships and Related-Person Transactions” and is incorporated herein by reference. The Definitive Proxy Statement will be filed with the SEC pursuant to Regulation 14A within 120 days of the end of the Company’s 2017 fiscal year.
ITEM 14. | PRINCIPAL ACCOUNTANT FEES AND SERVICES. |
The information required by this Item 14 will be included in the Company’s Definitive Proxy Statement for the 2018 Annual Meeting of Shareholders under the caption “Proposal 4: Ratification of Appointment of Independent Registered Public Accounting Firm” and is incorporated herein by reference. The Definitive Proxy Statement will be filed with the SEC pursuant to Regulation 14A within 120 days of the end of the Company’s 2017 fiscal year.
PART IV
ITEM 15. | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. |
Financial Statements and Schedules
The Consolidated Financial Statements of MidWestOne Financial Group, Inc. and Subsidiaries are included in Item 8 of this report.
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Exhibits
Exhibit | ||||
Number | Description | Incorporated by Reference to: | ||
Agreement and Plan of Merger, dated | Exhibit 2.1 to the Company’s Current Report on Form 8-K | |||
November 20, 2014, between MidWestOne Financial | filed with the SEC on November 21, 2014 | |||
Group, Inc. and Central Bancshares, Inc.+ | ||||
Amended and Restated Articles of Incorporation of | Exhibit 3.3 to the Company’s Amendment No. 1 to | |||
MidWestOne Financial Group, Inc. filed with the | Registration Statement on Form S-4 (File No. 333-147628) | |||
Secretary of State of the State of Iowa on March 14, 2008 | filed with the SEC on January 14, 2008 | |||
Articles of Amendment (First Amendment) to the | Exhibit 3.1 to the Company’s Current Report on Form 8-K | |||
Amended and Restated Articles of Incorporation of | filed with the SEC on January 23, 2009 | |||
MidWestOne Financial Group, Inc. filed with the | ||||
Secretary of State of the State of Iowa on | ||||
January 23, 2009 | ||||
Articles of Amendment (Second Amendment) to the | Exhibit 3.1 to the Company’s Current Report on Form 8-K | |||
Amended and Restated Articles of Incorporation of | filed with the SEC on February 6, 2009 | |||
MidWestOne Financial Group, Inc. filed with the | ||||
Secretary of State of the State of Iowa on | ||||
February 4, 2009 (containing the Certificate of | ||||
Designations for the Company’s Fixed Rate | ||||
Cumulative Perpetual Preferred Stock, Series A) | ||||
Articles of Amendment (Third Amendment) to the | Exhibit 3.1 to the Company’s Form 10-Q for the quarter | |||
Amended and Restated Articles of Incorporation of | ended March 31, 2017, filed with the SEC on May 4, 2017 | |||
MidWestOne Financial Group, Inc., filed with the Secretary | ||||
of State of the State of Iowa on April 21, 2017 | ||||
Second Amended and Restated Bylaws of MidWestOne | Exhibit 3.1 to the Company’s Current Report on Form 8-K | |||
Financial Group, Inc. | filed with the SEC on February 1, 2017 | |||
4.1 | Reference is made to Exhibits 3.1 through 3.5 hereof | N/A | ||
Shareholder Agreement, by and among MidWestOne | Exhibit 99.1 to the Company’s Current Report on Form 8-K | |||
Financial Group, Inc., Riverbank Insurance Center, Inc., | filed with the SEC on November 21, 2014 | |||
CBS LLC, John M. Morrison Revocable Trust #4 and | ||||
John M. Morrison, dated November 20, 2014 | ||||
MidWestOne Financial Group, Inc. Employee Stock | Exhibit 10.1 of former MidWestOne Financial Group, Inc.’s | |||
Ownership Plan and Trust (Restated as of January 1, | Form 10-K (File No. 000-24630) for the year ended | |||
2006)* | December 31, 2006, filed with the SEC on March 23, 2007 | |||
ISB Financial Corp. (now known as MidWestOne | Appendix F of the Joint Proxy Statement-Prospectus | |||
Financial Group, Inc.) 2008 Equity Incentive Plan* | constituting part of the Company’s Amendment No. 2 to | |||
Registration Statement on Form S-4 (File No. 333-147628) | ||||
filed with the SEC on January 22, 2008 | ||||
MidWestOne Financial Group, Inc. 2017 Equity | Appendix A of the Company’s Definitive Proxy Statement on | |||
Incentive Plan* | Schedule 14A filed with the SEC on March 10, 2017 | |||
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Exhibit | ||||
Number | Description | Incorporated by Reference to: | ||
Form of MidWestOne Financial Group, Inc. 2017 Equity | Exhibit 4.7 to the Company’s Registration Statement on Form | |||
Incentive Plan Incentive Stock Option Award Agreement* | S-8 (File No. 333-217718) filed with the SEC on May 5, 2017 | |||
Form of MidWestOne Financial Group, Inc. 2017 Equity | Exhibit 4.8 to the Company’s Registration Statement on Form | |||
Incentive Plan Restricted Stock Unit Award Agreement* | S-8 (File No. 333-217718) filed with the SEC on May 5, 2017 | |||
Employment Agreement between MidWestOne Financial | Exhibit 10.1 to the Company’s Current Report on | |||
Group, Inc. and Charles N. Funk, dated October 18, 2017* | Form 8-K filed with the SEC on October 18, 2017 | |||
Employment Agreement between MidWestOne Financial | Exhibit 10.3 to the Company’s Current Report on | |||
Group, Inc. and Kent L. Jehle, dated October 18, 2017* | Form 8-K filed with the SEC on October 18, 2017 | |||
Supplemental Retirement Agreement between Iowa State | Exhibit 10.13 of the Company’s Registration Statement on | |||
Bank & Trust Company (now known as MidWestOne | Form S-4 (File No. 333-147628) filed with the SEC on | |||
Bank) and Charles N. Funk, dated November 1, 2001* | November 27, 2007 | |||
Supplemental Retirement Agreement between Iowa State | Exhibit 10.16 of the Company’s Amendment No. 1 to | |||
Bank & Trust Company (now known as MidWestOne | Registration Statement on Form S-4 (File No. 333-147628) | |||
Bank) and Kent L. Jehle, dated January 1, 1998, as | filed with the SEC on January 14, 2008 | |||
amended by the First Amendment to the Supplemental | ||||
Retirement Agreement, dated January 1, 2003* | ||||
Second Supplemental Retirement Agreement between | Exhibit 10.17 of the Company’s Amendment No. 1 to | |||
Iowa State Bank & Trust Company (now known as | Registration Statement on Form S-4 (File No. 333-147628) | |||
MidWestOne Bank) and Kent L. Jehle, dated January 1, | filed with the SEC on January 14, 2008 | |||
2002* | ||||
Employment Agreement between MidWestOne Financial | Exhibit 10.4 to the Company’s Current Report on Form 8-K | |||
Group, Inc. and Katie Lorenson, dated October 18, 2017* | filed with the SEC on October 18, 2017. | |||
Employment Agreement between MidWestOne Financial | Exhibit 10.5 to the Company’s Current Report on | |||
Group, Inc. and James M. Cantrell, dated October 18, | Form 8-K filed with the SEC on October 18, 2017 | |||
2017* | ||||
Employment Agreement between MidWestOne Financial | Exhibit 10.1 to the Company’s Current Report on | |||
Group, Inc. and Kurt Weise, dated December 12, 2014* | Form 8-K filed with the SEC on October 3, 2016 | |||
Letter Amendment to Employment Agreement between | Exhibit 10.2 to the Company’s Current Report on | |||
MidWestOne Financial Group, Inc. and Kurt Weise | Form 8-K filed with the SEC on October 3, 2016 | |||
effective as of September 30, 2016* | ||||
Employment Agreement between MidWestOne Financial | Exhibit 10.2 to the Company’s Current Report on | |||
Group, Inc. and Kevin Kramer, dated October 18, 2017* | Form 8-K filed with the SEC on October 18, 2017 | |||
Employment Agreement between MidWestOne Financial | Exhibit 10.1 to the Company’s Current Report on Form 8-K | |||
Group, Inc. and Mitch Cook, dated May 11, 2017* | filed with the SEC on May 15, 2017 | |||
Central Bank Supplemental Retirement Agreement 2008 | Exhibit 10.19 to the Company’s Form 10-K for the year | |||
Restatement between Central Bank (now known as | ended December 31, 2016 filed with the SEC on March 2, | |||
MidWestOne Bank) and Kurt Weise, dated December 30, | 2017 | |||
2008* | ||||
124
Exhibit | ||||
Number | Description | Incorporated by Reference to: | ||
First Amendment to the Central Bank Supplemental | Exhibit 10.20 to the Company’s Form 10-K for the year | |||
Retirement Agreement (2008 Restatement) for Kurt | ended December 31, 2016 filed with the SEC on March 2, | |||
Weise between Central Bank (now known as MidWestOne | 2017 | |||
Bank) and Kurt Weise, dated April 23, 2014* | ||||
Central Bank 2014 Supplemental Retirement Agreement | Exhibit 10.21 to the Company’s Form 10-K for the year | |||
between Central Bank (now known as MidWestOne Bank) | ended December 31, 2016 filed with the SEC on March 2, | |||
and Mitch Cook, dated September 30, 2014* | 2017 | |||
Credit Agreement by and between MidWestOne | Exhibit 10.1 to the Company’s Form 10-Q for the quarter | |||
Financial Group, Inc. and U.S. Bank National Association | ended June 30, 2015 filed with the SEC on August 10, 2015 | |||
dated April 30, 2015 | ||||
Subsidiaries of MidWestOne Financial Group, Inc. | Filed herewith | |||
Consent of RSM US LLP | Filed herewith | |||
Certification of Chief Executive Officer pursuant to | Filed herewith | |||
Rule 13a-14(a) and Rule 15d-14(a) | ||||
Certification of Chief Financial Officer pursuant to | Filed herewith | |||
Rule 13a-14(a) and Rule 15d-14(a) | ||||
Certification of Chief Executive Officer pursuant to | Filed herewith | |||
18 U.S.C. Section 1350, as adopted pursuant to | ||||
Section 906 of the Sarbanes-Oxley Act of 2002 | ||||
Certification of Chief Financial Officer pursuant to | Filed herewith | |||
18 U.S.C. Section 1350, as adopted pursuant to | ||||
Section 906 of the Sarbanes-Oxley Act of 2002 | ||||
101.INS | XBRL Instance Document | Filed herewith | ||
101.SCH | XBRL Taxonomy Extension Schema Document | Filed herewith | ||
101.CAL | XBRL Taxonomy Extension Calculation Linkbase | Filed herewith | ||
Document | ||||
101.DEF | XBRL Taxonomy Extension Definition Linkbase | Filed herewith | ||
Document | ||||
101.LAB | XBRL Taxonomy Extension Label Linkbase Document | Filed herewith | ||
101.PRE | XBRL Taxonomy Extension Presentation Linkbase | Filed herewith | ||
Document | ||||
+ Schedules and/or exhibits to the Exhibit have been omitted pursuant to Item 601(b)(2) of Regulation S-K. The Company agrees to furnish | ||||
a copy of any omitted schedule or exhibit to the SEC upon request. | ||||
* Indicates management contract or compensatory plan or arrangement. | ||||
125
ITEM 16. | FORM 10-K SUMMARY. |
None.
126
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
MIDWESTONE FINANCIAL GROUP, INC. | |||||
Dated: | March 1, 2018 | By: | /s/ CHARLES N. FUNK | ||
Charles N. Funk | |||||
President and Chief Executive Officer | |||||
By: | /s/ JAMES M. CANTRELL | ||||
James M. Cantrell | |||||
Vice President and Interim Chief Financial Officer | |||||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature | Title | Date | ||
/s/ CHARLES N. FUNK | President and Chief Executive Officer; | March 1, 2018 | ||
Charles N. Funk | Director (principal executive officer) | |||
Vice President | ||||
/s/ JAMES M. CANTRELL | and Interim Chief Financial Officer | March 1, 2018 | ||
James M. Cantrell | (principal financial officer and | |||
principal accounting officer) | ||||
/s/ KEVIN W. MONSON | Chairman of the Board | March 1, 2018 | ||
Kevin W. Monson | ||||
/s/ RICHARD R. DONOHUE | Director | March 1, 2018 | ||
Richard R. Donohue | ||||
/s/ MICHAEL A. HATCH | Director | March 1, 2018 | ||
Michael A. Hatch | ||||
/s/ TRACY S. MCCORMICK | Director | March 1, 2018 | ||
Tracy S. McCormick | ||||
/s/ JOHN M. MORRISON | Director | March 1, 2018 | ||
John M. Morrison | ||||
/s/ RICHARD J. SCHWAB | Director | March 1, 2018 | ||
Richard J. Schwab | ||||
/s/ RUTH E. STANOCH | Director | March 1, 2018 | ||
Ruth E. Stanoch | ||||
127
/s/ DOUGLAS K. TRUE | Director | March 1, 2018 | ||
Douglas K. True | ||||
/s/ KURT R. WEISE | Director | March 1, 2018 | ||
Kurt R. Weise | ||||
/s/ STEPHEN L. WEST | Director | March 1, 2018 | ||
Stephen L. West | ||||
/s/ R. SCOTT ZAISER | Director | March 1, 2018 | ||
R. Scott Zaiser | ||||
128