HILLS BANCORPORATION 10-K

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation The following discussion by management is presented regarding the financial results for the Company for the dates and periods indicated. The discussion should be read in conjunction with the “Selected Consolidated Five-Year Statistical Summary” and the consolidated financial statements and the accompanying notes thereto included or incorporated by reference elsewhere in this document. An overview of the year 2020 is presented following the section discussing a special note regarding forward looking statements. Special Note Regarding Forward Looking Statements This report contains, and future oral and written statements of the Company and its management may contain, forward-looking statements within the meaning of such term in the Private Securities Litigation Reform Act of 1995 with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company. Actual results may differ materially from those included in the forward-looking statements. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company’s management and on information currently available to management, are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events. The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations and future prospects of the Company include, but are not limited to, the following: • The strength of the United States economy in general and the strength of the local economies in which the Company conducts its operations which may be less favorable than expected and may result in, among other things, a deterioration in the credit quality and value of the Company’s assets. • The effects of financial market disruptions and/or an economic recession, and monetary and other governmental actions designed to address such disruptions and recession. • The financial strength of the counterparties with which the Company or the Company’s customers do business and as to which the Company has investment or financial exposure. • The credit quality and credit agency ratings of the securities in the Company’s investment securities portfolio, a deterioration or downgrade of which could lead to other-than-temporary impairment of the affected securities and the recognition of an impairment loss. • The effects of, and changes in, laws, regulations and policies affecting banking, securities, insurance and monetary and financial matters as well as any laws otherwise affecting the Company. • The effects of changes in interest rates (including the effects of changes in the rate of prepayments of the Company’s assets) and the policies of the Board of Governors of the Federal Reserve System. • The ability of the Company to compete with other financial institutions as effectively as the Company currently intends due to increases in competitive pressures in the financial services sector. • The ability of the Company to obtain new customers and to retain existing customers. • The timely development and acceptance of products and services, including products and services offered through alternative electronic delivery channels. • Technological changes implemented by the Company and by other parties, including third-party vendors, which may be more difficult or more expensive than anticipated or which may have unforeseen consequences to the Company and its customers. • The ability of the Company to develop and maintain secure and reliable technology systems. • The ability of the Company to retain key executives and employees and the difficulty that the Company may experience in replacing key executives and employees in an effective manner. • Consumer spending and saving habits which may change in a manner that affects the Company’s business adversely. Page 29 Table of Contents • The economic impact of natural disasters, diseases and/or pandemics, such as the COVID-19 pandemic, terrorist attacks and military actions. • Business combinations and the integration of acquired businesses and assets which may be more difficult or expensive than expected. • The costs, effects and outcomes of existing or future litigation. • Changes in accounting policies and practices that may be adopted by state and federal regulatory agencies and the Financial Accounting Standards Board. • The ability of the Company to manage the risks associated with the foregoing as well as anticipated. These risks and uncertainties should be considered in evaluating forward-looking statements, and undue reliance should not be placed on such statements. Additional information concerning the Company and its business, including other factors that could materially affect the Company’s financial results, is included in the Company’s filings with the Securities and Exchange Commission. COVID-19: What the Company knows and what steps we have taken. The outbreak of Coronavirus Disease 2019 (“COVID-19”) has and will continue to adversely impact a broad range of industries in which the Company’s customers operate and impair their ability to fulfill their financial obligations to the Company. The World Health Organization has declared COVID-19 to be a global pandemic indicating that almost all public commerce and related business activities must be, to varying degrees, curtailed with the goal of decreasing the rate of new infections. The spread of the outbreak has caused significant disruptions in the U.S. economy and is highly likely to disrupt banking and other financial activity in the areas in which the Company operates and could also potentially create widespread business continuity issues for the Company. The Company’s business is dependent upon the willingness and ability of its employees and customers to conduct banking and other financial transactions. If the global response to contain COVID-19 escalates or is unsuccessful, the Company could experience a material adverse effect on its business, financial condition, results of operations and cash flows. Communities Offices With the health of our employees and customers being our top concern, as of March 17, 2020, the Bank temporarily suspended branch lobby hours to the public for walk-in transactions while allowing limited scheduled appointments. The Bank reopened branch lobbies in the third quarter of 2020, but in November 2020 again temporarily suspended branch lobby hours to the public for walk-in transactions. In late January 2021, the Bank has since started the process of reopening branch lobbies. The Bank implemented the following changes in response to the pandemic: • Plexiglass windows on our teller stations and reception areas • A limit on the number of people who can be in the lobbies at one time • Transaction areas and reusable items will be frequently cleaned • Hand sanitizing stations located at each entrance • Floor stickers to guide social distancing while waiting in line • Require both customers and employees to wear protective face coverings, among other social distancing requirements for both customers and employees. Drive-thru services remain available as well as all ATM’s to complete needed transactions. Customers are also able to directly contact our bankers through calling the customer contact center, engaging with a digital banker via the HERE by Hills Bank app, or through Hills Bank Online which is available 24/7. The Bank continues to promote social distancing by encouraging employees who can work remotely to do so and in other cases, departments have been dispersed to keep the team separated. We do not anticipate significant challenges to our ability to maintain our systems and controls in light of the measures we have taken to prevent the spread of COVID-19. No material operational or internal control challenges or risks have been identified to date. Page 30 Table of Contents Customers Loans With the Federal Reserve rate drops of 150 basis points in March (100 basis points of which was directly related to the effects of the virus on the economy), a surge in home loan activity has occurred, a significant portion of which is refinance related. The Bank sells most of its home loans into the secondary market and has seen a significant increase in the net gain on the sale of these loans. The Bank is working with customers who request forbearance agreements and has also provided short-term modifications for customers primarily through deferrals of principal only payments for three to six months. Throughout 2020, COVID-19 related payment deferrals provided for customers totaled approximately 14.82% of total loans. As of December 31, 2020, COVID-19 related payment deferrals were approximately 1.20% of total loans. The Bank continues to assist customers through this difficult time in the best manner possible by providing $127.10 million of Paycheck Protection Program (PPP) loans through December 31, 2020. The PPP loans have a two or five year term and earn interest at 1%. Loans funded through the PPP program are fully guaranteed by the U.S. government if certain criteria are met. The Bank believes that the majority of these loans will ultimately be forgiven by the SBA in accordance with the terms of the program. As of December 31, 2020, the Bank has outstanding PPP loan balances of $86.5 million and has received forgiveness payments totaling $40.4 million from the SBA. With the passage of the Coronavirus Response and Relief Supplemental Appropriations Act 2021 in late December 2020 , the Bank is planning to provide additional PPP loans beginning in late January 2021 to further assist our customers. Financial - Exposures As discussed above, throughout 2020 the Company provided a significant number of PPP loans to customers as well as short-term loan modifications deferring principal and interest or principal only for three to six months. During late summer and fall, a significant number of the COVID-19 related short-term loan modifications expired with the majority of customers able to return to scheduled payments. A small percentage of customers have requested additional pandemic-related modifications described above. Section 4013 of the CARES Act, “Temporary Relief From Troubled Debt Restructurings,” allows financial institutions the option to temporarily suspend certain requirements under GAAP related to TDRs for a limited period of time during the COVID-19 pandemic. In March 2020, various regulatory agencies, including the FRB and the FDIC, issued an interagency statement, effective immediately, on loan modifications and reporting for financial institutions working with customers affected by COVID-19. The agencies confirmed with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not to be considered TDRs. This includes short-term (e.g., six months) modifications, such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. As of December 31, 2020, the total amount of the eligible loans in deferral (deferral of principal and/or interest) that met the requirements set forth under the interagency statement and therefore were not considered TDRs was 13 loans, totaling $9.4 million. The Bank anticipates that the current and future economic conditions will continue to have an impact on the initial modifications that were made that qualified under such criteria. The COVID-19 pandemic represents an unprecedented challenge to the global economy in general and the financial services sector in particular. However, there is still significant uncertainty regarding the overall length of the pandemic and the aggregate impact that it will have on global and regional economies, including uncertainties regarding the potential positive effects of governmental actions taken in response to the pandemic during 2020. With so much uncertainty, it is impossible for the Bank to accurately predict the impact that the pandemic will have on the Bank’s primary markets and the overall extent to which it will affect the Bank’s financial condition and results of operations into 2021. Nonetheless, management believes that the Bank’s current regulatory capital position is adequate to face the coming challenges. To account for potential exposures resulting from the pandemic, the Bank has increased its allowance for loan losses for the year ended December 31, 2020 by approximately $3.3 million since December 31, 2019. The Bank is fully prepared to make additional provisions as warranted by the COVID-19 situation. The Bank anticipates that a significant portion of the Bank’s borrowers in the hospitality industry, which represents approximately 0.2% of our loan portfolio, will endure significant economic distress which will adversely affect their ability to repay existing indebtedness. These developments, together with economic conditions generally, are also expected to impact the value of certain collateral securing our loans. Page 31 Table of Contents Our credit administration is closely monitoring and analyzing the higher risk segments within the loan portfolio, tracking loan payment deferrals, customer liquidity and providing timely reports to senior management and the board of directors. Based on the Company’s capital levels, prudent underwriting policies, loan concentration diversification and our geographic footprint, we currently expect to be able to manage the economic risks and uncertainties associated with the pandemic and remain adequately capitalized. The Company continued to maintain the payment of its annual dividend consistent with its past practices. Government Response Congress, the FRB and the other U.S. state and federal financial regulatory agencies have taken actions to mitigate disruptions to economic activity and financial stability resulting from the COVID-19 pandemic. The federal banking agencies have encouraged financial institutions to prudently work with affected borrowers and passed measures to provide relief from reporting loan classifications due to modifications related to the COVID-19 outbreak. The descriptions below summarize additional significant government actions taken in response to the COVID-19 pandemic. The descriptions are qualified in their entirety by reference to the particular statutory or regulatory provisions or government programs summarized. The CARES Act The Coronavirus Aid, Relief and Economic Security (CARES) Act was signed into law on March 27, 2020. Among other provisions, the CARES Act includes funding for the SBA to expand lending, relief from certain U.S. GAAP requirements to allow COVID-19-related loan modifications to not be categorized as troubled debt restructurings and a range of incentives to encourage deferment, forbearance or modification of consumer credit and mortgage contracts. One of the key CARES Act programs is the Paycheck Protection Program, which temporarily expanded the SBA’s business loan guarantee program to include forgivable loans used for permissible purposes, which were issued under the program through August 8, 2020. Paycheck Protection Program loans are available to a broader range of entities than ordinary SBA loans, and the loan may be forgiven in an amount equal to payroll costs and certain other expenses during either an eight-week or twenty-four week “covered period.” The Bank is participating in this program as described above. The CARES Act contains additional protections for homeowners and renters of properties with federally-backed mortgages, including a 60-day moratorium on the initiation of foreclosure proceedings beginning on March 18, 2020 and a 120-day moratorium on initiating eviction proceedings effective March 27, 2020. These foreclosure and eviction moratoriums have been extended through year-end by the Federal Housing Administration. Borrowers of federally-backed mortgages have the right under the CARES Act to request up to 360 days of forbearance on their mortgage payments if they experience financial hardship directly or indirectly due to the coronavirus-related public health emergency. Also pursuant to the CARES Act, the U.S. Treasury has the authority to provide loans, guarantees and other investments in support of eligible businesses, states and municipalities affected by the economic effects of COVID-19. Some of these funds have been used to support several FRB programs and facilities described below or additional programs or facilities that are established by its authority under Section 13(3) of the Federal Reserve Act and meeting certain criteria. Coronavirus Response and Relief Supplemental Appropriations Act 2021 On December 21, 2020, the House and Senate passed legislation to supply the latest round of COVID-19 relief, authorizing more than $900 billion in economic aid to small businesses and consumers—the second largest stimulus in history, behind only the CARES (Coronavirus Aid Relief and Economic Security) Act that Congress enacted in March. The bill also includes appropriations provisions to keep the government funded through September 30, 2021, as well as a host of miscellaneous items. The summary below focuses on key banking provisions while omitting significant provisions on many other important topics, including an extension of enhanced unemployment insurance and funding for vaccine distribution, school reopening, and the airline industry. In particular, the banking aspects of the package include the following: a. An additional $284.6 billion in Paycheck Protection Program (PPP) funding for loans to small businesses, including for borrowers who have previously received a PPP loan. b. A one-page simplified forgiveness process for PPP loans under $150,000. c. Clarification to various CARES Act provisions, the tax treatment of PPP expenses, lender responsibilities for agent fees, and lender “hold harmless” protections under the PPP and other laws. Page 32 Table of Contents d. A further delay in Troubled Debt Restructuring (TDR) accounting until 60 days after the termination of the national emergency, or January 1, 2022. e. A further optional delay in Current Expected Credit Loss (CECL) accounting until January 1, 2022. f. A new round of Economic Impact Payments (EIPs) for consumers, with aggressive distribution timelines and new exemptions from garnishments. g. Significant added support for Community Development Financial Institutions (CDFIs) and Minority Depository Institutions (MDIs). h. Funding for agricultural support programs and for renter assistance programs. i. Termination of existing Federal Reserve emergency lending authority under the CARES Act, while preserving the Fed’s general 13(3) emergency authority existing prior to that Act. FRB Actions The FRB has taken a range of actions to support the flow of credit to households and businesses. For example, on March 15, 2020, the FRB reduced the target range for the federal funds rate to 0 to 0.25% and announced that it would increase its holdings of U.S. Treasury securities and agency mortgage-backed securities and begin purchasing agency commercial mortgage-backed securities. The FRB has also encouraged depository institutions to borrow from the discount window and has lowered the primary credit rate for such borrowing by 150 basis points while extending the term of such loans up to 90 days. Reserve requirements have been reduced to zero as of March 26, 2020. In addition, the FRB has established, or has taken steps to establish, a range of facilities and programs to support the U.S. economy and U.S. marketplace participants in response to economic disruptions associated with COVID-19. Through these facilities and programs, the FRB, relying on its authority under Section 13(3) of the Federal Reserve Act, has taken steps to directly or indirectly purchase assets from, or make loans to, U.S. companies, financial institutions, municipalities and other market participants. Non-GAAP Financial Measures This report contains references to financial measures that are not defined in GAAP. Such non-GAAP financial measures include the Company's presentation of net income without the effect of the Tax Cut and Jobs Act enacted on December 22, 2017 (the "Tax Act"), and the presentation of earnings per share, return on assets and return on equity with the adjusted net income figure. Management believes these Non-GAAP financial measures provide useful information to both management and investors to analyze and evaluate the Company's financial performance. Limitations associated with non-GAAP financial measures include the risks that persons might disagree as to the appropriateness of items included in these measures. These non-GAAP disclosures should not be considered an alternative to the Company's GAAP results. The following table reconciles the non-GAAP financial measures to GAAP. Page 33 Table of Contents Year Ended December 31, 2017 Reconciliation of net income before effect of Tax Act to net income (GAAP): Net Income (GAAP) $ 28,061 Tax Act related tax expense 4,709 Net Income before Tax Act related expense $ 32,770 Reconciliation of earnings per share before effect of Tax Act to earnings per share (GAAP): Non-GAAP net income reconciled above $ 32,770 Weighted average shares outstanding (basic) 9,330,003 Earnings Per Share (basic) before effect of Tax Act $ 3.51 Weighted average shares outstanding (diluted) 9,334,635 Earnings Per Share (diluted) before effect of Tax Act $ 3.51 Reconciliation of return on average assets before effect of Tax Act to return on average assets (GAAP): Non-GAAP net income reconciled above $ 32,770 Average assets 2,756,360 Return on average assets before effect of Tax Act 1.19 % Reconciliation of return on average equity after effect of Tax Act to return on average equity (GAAP): Non-GAAP net income reconciled above $ 32,770 Average equity 303,768 Return on average equity before effect of Tax Act 10.79 % Overview The Company is a bank holding company engaged, through its wholly-owned subsidiary bank, in the business of commercial banking. The Company’s subsidiary is Hills Bank and Trust Company, Hills, Iowa. The Bank was formed in Hills, Iowa in 1904. The Bank is a full-service commercial bank extending its services to individuals, businesses, governmental units and institutional customers primarily in the communities of Hills, Iowa City, Coralville, North Liberty, Lisbon, Mount Vernon, Kalona, Wellman, Cedar Rapids, Marion and Washington, Iowa. The Company’s net income for 2020 was $38.65 million compared to $45.32 million in 2019 and $36.77 million in 2018. Diluted earnings per share were $4.12, $4.85, and $3.92 for the years ended December 31, 2020, 2019 and 2018, respectively. The Bank’s net interest income is the largest component of the Bank’s revenue, and is a function of the average earning assets and the net interest margin percentage. Net interest margin is the ratio of net interest income to average earning assets. For the years ended December 31, 2020 and 2019, the Bank achieved a net interest margin of 3.00% and 3.18%, respectively. For the year ended December 31, 2020, net interest income on a tax equivalent basis increased by $4.14 million. In 2020, net interest income increased $10.57 million due to growth of $309.59 million in the Bank's average earning assets and decreased $6.43 million due to interest rate changes. Highlights with respect to items on the Company’s balance sheet as of December 31, 2020 included the following: • Total assets were $3.781 billion, an increase of $479.72 million since December 31, 2019. Page 34 Table of Contents • Cash and cash equivalents were $574.31 million, an increase of $332.35 million since December 31, 2019. A substantial portion of the increase can be attributed to increased savings with the current negative economic environment due to the pandemic and equity investors fleeing volatile capital markets in an effort to preserve principal. • Loans, net of allowance for loan losses and unamortized fees and costs, totaling $2.718 billion. • Net loan growth in 2020 of $67.74 million. The increase was primarily due to PPP loans provided to customers totaling $127.10 million. Loans held for sale increased $35.55 million since December 31, 2019 due to the significant reduction in interest rates during 2020, resulting in a significant amount of mortgage loan refinance activity. • Deposit growth of $531.20 million in 2020. Deposits increased to $3.193 billion and included $74.08 million of brokered deposits. A substantial portion of the increase can be attributed to the current negative economic environment. • FHLB borrowings decreased $80.00 million. The decrease was largely due to prepaying $55 million of FHLB borrowings. • Stockholders’ equity increased $40.87 million to $416.08 million in 2020, with dividends having been paid in 2020 of $8.33 million. Reference is made to Note 13 of the Company’s consolidated financial statements for a discussion of fair value measurements which relate to methods used by the Company in recording certain assets and liabilities on its consolidated financial statements. The return on average equity was 8.72% in 2020 compared to 11.23% in 2019. The returns for the three previous years, 2018, 2017 and 2016, were 9.92%, 9.24% and 11.26%, respectively. Before the effect of the Tax Act, the Company's 2017 return on average equity would have been 10.79%. (1) The Company remains well-capitalized as of December 31, 2020 with total risk-based capital at 18.50% and Tier 1 risk-based capital at 17.25%. The minimum regulatory guidelines are 8% and 6% respectively. The Company paid a dividend per share of $0.890 in 2020, $0.820 in 2019 and $0.750 in the year ended December 31, 2018. A detailed discussion of the financial position and results of operations follows this overview. (1) Non-GAAP financial measurement. For further information, refer to the Non-GAAP Financial Measurement section of this report. Page 35 Table of Contents Critical Accounting Policies The Company's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The financial information contained within these financial statements is, to a significant extent, financial information that is based on approximate measures of the financial effects of transactions and events that have already occurred. Based on its consideration of accounting policies that involve the most complex and subjective decisions and assessments, management has identified its most critical accounting policies to be those which are related to the allowance for loan losses. Allowance for Loan Losses The Company separates its portfolio loans and leases into segments for determining the allowance for loan losses. The Company's portfolio segments includes agricultural, commercial and financial, real estate, loans to individuals and obligations of state and political subdivisions. The Company further separates its portfolio into classes for purposes of monitoring and assessing credit quality based on certain risk characteristics. Classes within the real estate portfolio segment includes 1 to 4 family residential construction, land development and commercial construction, farmland, 1 to 4 family first liens, 1 to 4 family junior liens, multi-family and commercial. For an analysis of the Company's allowance for loan losses by portfolio segment and credit risk rating information by class, see Note 3 to the Company's Consolidated Financial Statements. Loans that exhibit probable or observed credit weaknesses, as well as loans that have been modified in a troubled debt restructuring ("TDR loans"), are subject to individual review for impairment. When individual loans are reviewed for impairment, the Company determines allowances based on management's estimate of the borrower's ability to repay the loan given the availability of the collateral, other sources of cash flow, as well as evaluation of legal options available. Allowances for impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or the fair value of the underlying collateral. Historical loss rates are applied to loans that are not individually reviewed for impairment. A 20 quarter migration analysis performed by management uses loan level attributes to track the movement of loans through the various credit risk rating categories in order to estimate the percentage of historical loss to apply to each specific credit risk rating in each loan category. The credit risk rating system currently utilized for allowance analysis purposes encompasses six categories. The Company's allowance for loan loss methodology incorporates a variety of risk considerations, both quantitative and qualitative, in establishing an allowance for loan losses that management believes is appropriate at each reporting date. Quantitative factors include the Company's historical loss experience, delinquency and charge-off trends, collateral values, changes in impaired loans, and other factors. Quantitative factors also incorporate known information about individual loans, including borrowers' sensitivity to interest rate movements. Qualitative factors include changes in lending policies and procedures; changes in national and local economic and business conditions; changes in the nature and volume of the loan portfolio; changes in the experience, ability and depth of lending management and staff; changes in the quality of the Bank's loan review system; the existence and effect of concentrations of credit; and the effect of any other identified external factors. Determinations relating to the possible level of future loan losses are based in part on subjective judgments by management. Future loan losses in excess of current estimates, could materially adversely affect our results of operations or financial position. As the Company adds new products and increases the complexity of its loan portfolio, it will enhance its methodology accordingly. This discussion of the Company’s critical accounting policies should be read in conjunction with the Company’s consolidated financial statements and the accompanying notes presented elsewhere herein, as well as other relevant portions of Management’s Discussion and Analysis of Financial Condition and Results of Operations. Although management believes the levels of the allowance for loan losses as of December 31, 2020 and 2019 were adequate to absorb probable losses inherent in the loan portfolio, a decline in local economic conditions, or other factors, could result in increasing losses that cannot be reasonably predicted at this time. The Company is currently finalizing the CECL model and upon adoption of ASU 2016-13 (CECL) in the first quarter of 2021 anticipates an increase to the allowance for credit losses for loans of approximately $2 to $4 million and an unfunded commitment liability of approximately $2 to $4 million. See Note 1 to the Company's Consolidated Financial Statements for further discussion. Page 36 Table of Contents Financial Position Year End Amounts 2020 2019 2018 2017 2016 (Amounts In Thousands) Total assets $ 3,780,611 $ 3,300,887 $ 3,042,464 $ 2,963,360 $ 2,655,770 Investment securities 416,544 366,368 331,098 300,160 279,950 Loans held for sale 43,947 8,400 1,984 5,162 9,806 Loans, net 2,674,012 2,606,277 2,591,085 2,431,165 2,251,445 Deposits 3,192,568 2,661,364 2,421,124 2,288,565 2,036,312 Federal Home Loan Bank borrowings 105,000 185,000 215,000 295,000 235,000 Redeemable common stock 47,329 51,826 48,870 43,308 40,781 Stockholders' equity 416,076 375,211 334,882 311,716 289,270 Total assets at December 31, 2020 increased $479.72 million, or 14.53%, from the prior year-end. Asset growth from 2018 to 2019 was $258.42 million and represented a 8.49% increase. The largest growth in assets in 2020 occurred in Cash and Cash Equivalents, which increased $332.35 million as of December 31, 2020 compared to December 31, 2019 and increased $198.66 million as of December 31, 2019 compared to December 31, 2018. Net Loans increased $67.74 million and $15.19 million for the years ended December 31, 2020 and 2019, respectively. Loans held for sale to the secondary market increased $35.55 million and increased $6.42 for the years ended December 31, 2020 and 2019, respectively. Loans held for investment represent the largest component of the Bank’s earning assets. Loans held for investment were $2.711 billion and $2.640 billion at December 31, 2020 and 2019, respectively. The local economy that generated consistent demand for loans was a significant factor in the trend of increasing net loans in past years. The trend of increasing Net Loans did slow in 2020 and may not continue, and as a result, may not be indicative of future performance. The primary reason for the increase in 2020 was PPP loans provided to customers in response to the COVID-19 pandemic as discussed previously. Commercial and financial loans represent the largest increase in loan growth. These loans increased $64.92 million in 2020 and decreased $8.18 million in 2019. Commercial and financial loans increased due to PPP loans provided to customers, which had an outstanding balance of $86.5 million as of December 31, 2020. On a net basis, the Company originated $72.14 million and $13.02 million in loans to customers for the years ended December 31, 2020 and 2019, respectively. Net loan originations increased 453.89% in 2020 compared to 2019. The increase in net loan originations in 2020 as compared to 2019 is reflective of loan demand primarily for PPP loans provided in response to the COVID-19 pandemic. The Company does not engage in significant participation activity and does not purchase participations from outside its established trade area. The Company’s policy allows for the purchase or sale of participations related to existing customers or to participate in community development activity. The Company held participations purchased of $19.83, $15.17 and $14.03 million as of December 31, 2020, 2019 and 2018, respectively. The participations purchased were less than one percent of loans held for investment for each of the three years. The Company did not experience a material change in the composition of its loans held for investment in 2020 or 2019. Residential real estate loans, including first and junior liens, were $1,019.92 million, $1,059.97 million and $1,064.68 million as of December 31, 2020, 2019 and 2018, respectively. The dollar total of residential real estate loans decreased 3.78% in 2020 and decreased 0.44% in 2019. Residential real estate loans were 37.63% of the loan portfolio at December 31, 2020, 40.16% at December 31, 2019 and 40.51% at December 31, 2018. Commercial real estate loans totaled $417.14 million at December 31, 2020, a 3.72% increase over the December 31, 2019 total of $402.18 million. Commercial real estate loans increased 4.92% in 2019. Commercial real estate loans totaled $383.31 million at December 31, 2018. Commercial real estate loans represented 15.39%, 15.24% and 14.59% of the Company’s loan portfolio as of December 31, 2020, 2019 and 2018, respectively. The Company monitors its commercial real estate level so that it does not have a concentration in that category that exceeds 300% of its capital. Commercial real estate loan concentration was 165.93% of capital as of December 31, 2020. Page 37 Table of Contents The following table shows the composition of loans (before deducting the allowance for loan losses) as of December 31 for each of the last five years. The table does not include loans held for sale to the secondary market. 2020 2019 2018 2017 2016 Agricultural $ 94,842 $ 91,317 $ 92,673 $ 88,580 $ 92,871 Commercial and financial 286,242 221,323 229,501 218,632 192,995 Real estate: Construction, 1 to 4 family residential 71,117 80,209 72,279 69,738 57,864 Construction, land development and commercial 111,913 108,410 113,807 109,595 121,561 Mortgage, farmland 247,142 242,730 236,454 215,286 202,340 Mortgage, 1 to 4 family first liens 892,089 910,742 912,059 831,591 767,469 Mortgage, 1 to 4 family junior liens 127,833 149,227 152,625 144,200 125,400 Mortgage, multi-family 374,014 350,761 352,434 336,810 302,831 Mortgage, commercial 417,139 402,181 383,314 361,196 334,198 Loans to individuals 31,325 32,308 30,072 26,417 25,157 Obligations of state and political subdivisions 56,488 49,896 52,725 57,626 54,462 $ 2,710,144 $ 2,639,104 $ 2,627,943 $ 2,459,671 $ 2,277,148 Net unamortized fees and costs 938 933 952 894 827 $ 2,711,082 $ 2,640,037 $ 2,628,895 $ 2,460,565 $ 2,277,975 Less allowance for loan losses 37,070 33,760 37,810 29,400 26,530 $ 2,674,012 $ 2,606,277 $ 2,591,085 $ 2,431,165 $ 2,251,445 There were no foreign loans outstanding for any of the years presented. The following table shows the principal payments due on loans as of December 31, 2020: Amount Of Loans Amounts Due in One Year Or Less (1) Amounts Due in One To Five Years Amounts Due in Over Five Years (Amounts In Thousands) Commercial and Agricultural $ 1,602,362 $ 385,805 $ 1,153,469 $ 63,088 Real Estate (2) 1,019,269 139,031 696,294 183,944 Other 88,513 5,700 27,968 54,845 Totals $ 2,710,144 $ 530,536 $ 1,877,731 $ 301,877 The types of interest rates applicable to these principal payments are shown below: Fixed rate $ 1,699,403 $ 357,894 $ 1,175,466 $ 166,043 Variable rate 1,010,741 172,642 702,265 135,834 $ 2,710,144 $ 530,536 $ 1,877,731 $ 301,877 (1) A significant portion of the commercial loans are due in one year or less. A significant percentage of the loans will be re-evaluated prior to their maturity and are likely to be extended. (2) Commercial, multi-family, construction 1 to 4 family residential, construction land development and commercial, and agricultural real estate loans are reflected in the Commercial and Agricultural total. Page 38 Table of Contents The overall economy in the Company’s trade area, Johnson, Linn and Washington Counties, remains in stable condition with levels of unemployment below national and state levels. The following table shows unemployment as of December 31, 2020, 2019 and 2018 and median income information as of December 31, 2019, 2018 and 2017, as December 31, 2020 information is not available as of the date of this report: Unemployment Rate % Median Income 2020 2019 2018 2019 2018 2017 United States 6.7 % 3.5 % 3.9 % $ 62,843 $ 60,293 $ 60,336 State of Iowa 3.1 % 2.7 % 2.5 % 60,523 58,580 58,570 Johnson County 2.8 % 2.2 % 1.7 % 62,542 61,640 59,965 Linn County 3.8 % 3.1 % 2.7 % 64,903 64,862 62,702 Washington County 2.7 % 2.5 % 2.2 % 62,556 61,769 59,157 Competition for quality loans and deposits may continue to be a challenge. The increased competition for both loans and deposits could result in a lower interest rate margin that could result in lower net interest income if the volume of loans and deposits does not increase to offset any such reduction in the interest margin. Total deposits increased by $531.20 million in 2020. Deposits increased by $240.24 million in 2019. As of June 30, 2020 (latest data available from the FDIC), Johnson County total deposits were $9.490 billion and the Company’s deposits were $2.060 billion, which represent a 21.71% market share. The Company had nine office locations in Johnson County as of June 30, 2020. The total banking locations in Johnson County was 49 as of June 30, 2020. At June 30, 2019, the Company’s deposits were $1.925 billion or a 23.6% market share. As of June 30, 2020, Linn County total deposits were $7.791 billion and there were 102 total banking locations in the county. The seven Linn County offices of the Company had deposits of $612 million or a 7.9% share of the market. The Company’s Linn County deposits at June 30, 2019 were $488.05 million and represented a 7.1% market share. As of June 30, 2020, the Company’s three Washington County offices had deposits of $254 million which was 33.0% of the County’s total deposits of $769 million. Washington County had a total of 15 banking locations as of June 30, 2020. In 2019, the Company’s Washington County deposits were $207.78 million or a 32.3% market share. The following tables show the amounts of the Company's average deposits and average rates paid on such deposits for the years ended December 31, 2020, 2019 and 2018 and the composition of the certificates of deposit issued in denominations in excess of $100,000 as of December 31, 2020, 2019 and 2018: December 31, 2020 Rate 2019 Rate 2018 Rate (Amounts In Thousands) Average noninterest-bearing deposits $ 459,664 — $ 366,682 — $ 364,916 — Average interest-bearing demand deposits 876,595 0.48 % 716,848 0.87 % 644,712 0.63 % Average savings deposits 875,091 0.32 851,503 0.92 832,772 0.75 Average time deposits 695,468 2.07 661,548 2.19 537,575 1.72 $ 2,906,818 $ 2,596,581 $ 2,379,975 Time certificates issued in amounts of $100,000 or more with maturity in: 2020 Rate 2019 Rate 2018 Rate (Amounts In Thousands) 3 months or less $ 29,429 2.31 % $ 30,832 2.24 % $ 6,988 0.86 % 3 through 6 months 62,628 1.57 51,404 2.21 20,346 1.68 6 through 12 months 64,413 1.30 59,986 1.92 69,782 2.01 Over 12 months 171,391 2.20 150,760 3.67 131,435 2.29 $ 327,861 $ 292,982 $ 228,551 Investment securities increased $50.18 million in 2020. In 2019, investment securities increased by $35.27 million. The investment portfolio consists of $408.37 million of securities that are stated at fair value, with any unrealized gain or loss, net of Page 39 Table of Contents income taxes, reported as a separate component of stockholders’ equity. The securities portfolio is used for liquidity and pledging purposes and to provide a rate of return that is acceptable to management. The following tables show the carrying value of the investment securities held by the Bank, including stock of the Federal Home Loan Bank, as of December 31, 2020, 2019 and 2018 and the maturities and weighted average yields of the investment securities, computed on a tax-equivalent basis using a federal tax rate of 21%, as of December 31, 2020: December 31, 2020 2019 2018 (Amounts In Thousands) Carrying value: U.S. Treasury $ 148,646 $ 128,585 $ 83,155 Other securities (FHLB, FHLMC and FNMA) 35,160 15,229 34,871 Stock of the Federal Home Loan Bank 8,172 11,065 12,172 Obligations of state and political subdivisions 224,566 211,489 200,900 $ 416,544 $ 366,368 $ 331,098 December 31, 2020 Carrying Value Weighted Average Yield (Amounts In Thousands) U.S. Treasury Within 1 year $ 22,698 1.78 % From 1 to 5 years 125,948 1.86 % $ 148,646 Other securities (FHLB, FHLMC and FNMA), maturities: Within 1 year $ 2,509 1.33 % From 1 to 5 years 32,651 0.41 From 5 to 10 years — — $ 35,160 Stock of the Federal Home Loan Bank $ 8,172 2.82 % Obligations of state and political subdivisions, maturities: Within 1 year $ 34,309 1.66 % From 1 to 5 years 80,711 2.36 From 5 to 10 years 82,626 2.82 Over 10 years 26,920 1.90 $ 224,566 Total $ 416,544 As of December 31, 2020, the Company held no investment securities exceeding 10% of stockholders’ equity, other than securities of the U.S. Government agencies and corporations. The Company does not hold any investments in FNMA preferred stock, any pooled trust preferred stocks or other preferred stock type investments. See Note 2 to the Company’s Consolidated Financial Statements. Page 40 Table of Contents During 2020, the major funding source for the growth in loans and other assets was the $531.20 million increase in deposits. In 2019, the major source of funding for the growth in loans was deposit growth of $240.24 million. Brokered deposits totaled $74.08 million and $109.29 million as of December 31, 2020 and 2019, respectively. Total advances from the FHLB were $105.00 million at December 31, 2020 and $185.00 million in 2019. It is expected that the FHLB funding source and brokered deposits funding will be considered in the future if loan growth continues to exceed core deposit increases and the interest rates on funds borrowed from the FHLB and interest rates on brokered deposits are favorable compared to other funding alternatives. Stockholders’ equity was $416.08 million at December 31, 2020 compared to $375.21 million at December 31, 2019. The Company’s capital resources are discussed in detail in the Liquidity and Capital Resources section. Over the last five years, the Company has realized cumulative earnings of $180.35 million and paid shareholders dividends of $35.53 million, or 19.70% of earnings, while maintaining capital ratios in excess of regulatory requirements. The following table presents the return on average assets, return on average stockholders' equity, the dividend payout ratio and average stockholders’ equity to average assets ratio for the years ended December 31, 2020, 2019 and 2018: 2020 2019 2018 Return on average assets 1.09 % 1.40 % 1.23 % Return on average stockholders' equity 8.72 11.23 9.92 Dividend payout ratio 21.54 16.90 19.05 Average stockholders' equity to average assets ratio 12.47 12.45 12.35 Net Income Overview Net income and diluted earnings per share for the last five years are as presented below: Year Net Income % (Decrease) Increase Earnings Per Share - Diluted (In Thousands) 2020 $ 38,647 (14.72) % $ 4.12 2019 45,318 23.26 4.85 2018 36,767 31.03 3.92 2017 28,061 (11.07) 3.01 2017 (1) 32,770 3.85 3.51 2016 31,555 11.04 3.40 (1) Non-GAAP financial measurement. For further information, refer to the Non-GAAP Financial Measurement section of this report. Net income for 2020 decreased by $(6.67) million or (14.72)% and diluted earnings per share decreased by (15.05)%. In 2020, net interest income increased $10.57 million due to growth of $309.59 million in the Bank's average earning assets and decreased $6.43 million due to interest rate changes. Noninterest income increased by $3.54 million, the provision for loan losses increased by $7.24 million and total noninterest expenses increased by $8.37 million. Page 41 Table of Contents Annual fluctuations in the Company's net income are driven primarily by four important factors. The first important factor is net interest margin. Net interest income of $101.58 million in 2020 was derived from the Company's $3.442 billion of average earning assets and its net interest margin of 3.00%, compared to $3.133 billion of average earning assets and a 3.18% net interest margin in 2019. The importance of net interest margin is illustrated by the fact that a decrease or an increase in the net interest margin of 10 basis points would result in a $3.44 million decrease or increase in income before taxes. Net interest margin in 2018 was 3.25%. Net interest income for the Company increased primarily as a result of growth in the volume of earning assets (offsetting reductions in interest income caused by declines in interest rates) and the continued low interest rates on interest bearing deposits resulting in decreased interest expense. The Company expects net interest compression to impact earnings for the foreseeable future due to competition for loans and deposits combined with the interest rate decreases by the Federal Reserve Board. The Company believes growth in net interest income will be contingent on the growth of the Company’s earnings assets and maintaining yield on loans. Net interest income was also impacted by the decrease in interest expense of $7.92 million compared to 2019, primarily driven by interest rate decreases which accounted for $8.54 million of the change. A significant portion of the increase in the loan portfolio is attributable to PPP loans. The Company anticipates most PPP loans will be forgiven in accordance with the SBA's requirements. The second significant factor affecting the Company's net income is the provision for loan losses. The majority of the Company's interest-earning assets are in loans outstanding, which amounted to $2.755 billion at the end of 2020. The Company’s allowance for loan losses was $37.07 million at December 31, 2020. The allowance in 2020 increased in comparison to 2019 due to a increased provision for loan losses of $7.24 million resulting from a combination of the composition of loan growth, historical loss rates, changes in the composition of loans among the credit risk ratings in 2020 and management's evaluation of qualitative factors given the current and expected national and local economic conditions primarily given the impact of the COVID-19 pandemic. The loan loss provision, which is the amount necessary to adjust the allowance to the level considered appropriate by management, totaled an expense of $4.36 million for 2020, a reduction of expense of $2.88 million for 2019 and an expense of $8.50 million for 2018. Provision expense is expected to be dependent on the Company’s loan growth, local economic conditions, including, but not limited to, conditions associated with the COVID-19 pandemic and the attendant risks and uncertainties related thereto, asset quality and the adoption of ASU 2016-13, or CECL, through the end of 2021. See Note 3 to the Company's Consolidated Financial Statements. A detailed discussion is included in the Provision for Loan Losses section below. The third significant factor affecting the Company’s net income is net gain on the sale of loans. The net gain on the sale of loans was $6.68 million and $3.54 million for the years ended December 31, 2020 and 2019, respectively, an increase of 88.70% for the year ended December 31, 2020 compared to the same period in 2019. Loans originated for sale in 2020 totaled $475.19 million compared to $299.22 million in the same period in 2019, an increase of 58.81%. The amount of the net gain on sale of secondary market mortgage loans in each year can vary significantly. The volume of activity in these types of loans is directly related to the level of interest rates and has been significantly impacted by the Federal Reserve Board's reduction of the federal funds rate to 0.25%, resulting in a significant amount of mortgage loan refinance activity. The fourth significant factor affecting the Company's net income is noninterest expenses. Noninterest expenses were $75.63 million and 67.26 million for the years ended December 31, 2020 and 2019, respectively. Salaries and employee benefits increased $3.91 million in 2020. The increase is primarily the result of annual salary adjustments, hiring of additional employees to staff growth, increased variable compensation due to the increase in loans originated for sale described above and increased overtime due to the increase in loans originated for sale and processing of PPP loans. Other noninterest expenses increased $3.07 million in 2020 primarily due to $2.53 million in fees incurred from the prepayment of FHLB borrowings and $2.68 million paid for the early termination of the interest rate swap. Net income for 2019 was $45.32 million, or diluted earnings per share of $4.85. For 2019, diluted earnings per share increased by $0.93 per share compared to 2018. Net interest income increased $5.55 million for the year ended December 31, 2019 compared to 2018. This increase in net interest income was due to an increase in average earning assets of $229.77 million in 2019. Noninterest income increased 4.09% in 2019 to $24.79 million. Noninterest expense increased from $62.12 million in 2018 to $67.26 million in 2019, or 8.28%. Page 42 Table of Contents Net Interest Income Net interest income is the excess of the interest and fees received on interest-earning assets over the interest paid on the interest-bearing liabilities. The factors that have the greatest impact on net interest income are the volume of average earning assets and the net interest margin. The volume of average earning assets has continued to grow each year, primarily due to net loan growth. The net interest margin was 3.00% in 2020, 3.18% in 2019, 3.25% in 2018, 3.43% in 2017, and 3.43% in 2016. The measure is shown on a tax-equivalent basis using a rate of 21% for 2020, 2019 and 2018 to make the interest earned on taxable and nontaxable assets more comparable. Interest income and expense for 2020, 2019 and 2018 are indicated on the following table: Years Ended December 31, 2020 2019 2018 (Amounts In Thousands) Income: Loans (1) $ 120,814 $ 121,862 $ 111,172 Taxable securities 3,512 3,239 2,759 Nontaxable securities (1) 5,201 5,168 4,717 Interest-bearing cash and cash equivalents 945 3,980 1,939 Total interest income $ 130,472 $ 134,249 $ 120,587 Expense: Interest-bearing demand deposits 4,258 6,232 4,056 Savings deposits 2,841 7,825 6,208 Time deposits 14,454 14,483 9,267 FHLB borrowings 5,399 6,333 6,792 Total interest expense $ 26,952 $ 34,873 $ 26,323 Net interest income $ 103,520 $ 99,376 $ 94,264 (1) Presented on a tax equivalent basis using a rate of 21% for 2020, 2019 and 2018. Net interest income on a tax-equivalent basis changed in 2020 as follows: Change In Change In Increase (Decrease) Average Balance Average Rate Volume Changes Rate Changes Net Change (Amounts In Thousands) Interest income: Loans, net $ 93,443 (0.21) % $ 6,531 $ (7,579) $ (1,048) Taxable securities 37,196 (0.32) 847 (574) 273 Nontaxable securities 6,698 (0.07) 183 (150) 33 Interest-bearing cash and cash equivalents 172,147 (1.83) 3,621 (6,654) (3,033) Federal funds sold 112 (2.78) 3 (5) (2) $ 309,596 $ 11,185 $ (14,962) $ (3,777) Interest expense: Interest-bearing demand deposits $ 159,747 (0.39) % $ (1,410) $ 3,384 $ 1,974 Savings deposits 23,588 (0.59) 634 4,350 4,984 Time deposits 33,920 (0.12) (784) 813 29 Other borrowings 1 (1.71) — — — FHLB borrowings (32,375) — 946 (12) 934 Interest-bearing other liabilities — — — — — $ 184,881 $ (614) $ 8,535 $ 7,921 Change in net interest income $ 10,571 $ (6,427) $ 4,144 Page 43 Table of Contents Rate/volume variances are allocated on a consistent basis using the absolute values of changes in volume compared to the absolute values of the changes in rates. Loan fees included in interest income are not material. Interest on nontaxable securities and loans is shown at tax equivalent amounts. Net interest income on a tax equivalent basis changed in 2019 as follows: Change In Average Balance Change In Average Rate Increase (Decrease) Volume Changes Rate Changes Net Change (Amounts In Thousands) Interest income: Loans, net $ 123,810 0.20 % $ 5,716 $ 4,974 $ 10,690 Taxable securities 11,060 0.15 325 155 480 Nontaxable securities 8,827 0.11 230 221 451 Interest-bearing cash and cash equivalents 84,596 0.26 1,553 488 2,041 Federal funds sold 33 1.13 — — — $ 228,326 $ 7,824 $ 5,838 $ 13,662 Interest expense: Interest-bearing demand deposits $ 72,136 0.24 % $ (454) $ (1,723) $ (2,177) Savings deposits 18,731 0.17 (119) (1,497) (1,616) Time deposits 123,973 0.47 (2,137) (3,079) (5,216) Other borrowings (1) (0.07) — — — FHLB borrowings (14,598) (0.01) 435 24 459 Interest-bearing other liabilities — — — — — $ 200,241 $ (2,275) $ (6,275) $ (8,550) Change in net interest income $ 5,549 $ (437) $ 5,112 Page 44 Table of Contents A summary of the average yields, average rates paid, net interest spread and margin is as follows: Years Ended December 31, 2020 2019 2018 Average yields: Loans (1) 4.44 % 4.64 % 4.45 % Loans (tax equivalent basis) (1) 4.46 4.67 4.47 Taxable securities 1.96 2.27 2.13 Nontaxable securities 1.99 2.04 1.96 Nontaxable securities (tax equivalent basis) 2.65 2.72 2.61 Interest-bearing cash and cash equivalents 0.26 2.09 1.84 Federal funds sold 0.11 2.89 1.75 Average rates paid: Interest-bearing demand deposits 0.48 0.87 0.63 Savings deposits 0.32 0.92 0.75 Time deposits 2.07 2.19 1.72 Short-term borrowings 0.93 2.64 2.71 FHLB borrowings 2.93 2.93 2.94 Yield on average interest-earning assets 3.78 4.29 4.15 Rate on average interest-bearing liabilities 1.02 1.42 1.17 Net interest spread (2) 2.76 2.86 2.99 Net interest margin (3) 3.00 3.18 3.25 (1) Non-accruing loans have been included in the average loan balances for purposes of this computation. (2) Net interest spread is the difference between the yield on average interest-earning assets and the yield on average interest-paying liabilities stated on a tax equivalent basis using a federal rate of 21% for 2020, 2019 and 2018. The net interest spread decreased 10 basis points in 2020 compared to 2019 and the net interest spread decreased 13 basis points compared to 2018. (3) Net interest margin is net interest income, on a tax equivalent basis, divided by average interest-earning assets. The net interest margin decreased 18 basis points in 2020. The net interest margin decreased 7 basis points in 2019 compared to 2018. In March 2020, the Federal Open Market Committee decreased the target rate to 0.25%. Interest rates on loans are generally affected by the target rate since interest rates for the U.S. Treasury market normally correlate to the Federal Reserve Board federal funds rate. In pricing of loans and deposits, the Bank considers the U.S. Treasury indexes as benchmarks in determining interest rates. As of December 31, 2020, the average rate indexes for the one, three and five year indexes were 0.10%, 0.17% and 0.36%, respectively. The one year index decreased 93.71% from December 31, 2019, the three year index decreased 89.51% and the five year index decreased 78.70%. Provision for Loan Losses Management has determined that the allowance for loan losses was appropriate at December 31, 2020, and that the loan portfolio is diversified and secured, without undue concentration in any specific risk area. This process involves a high degree of management judgment; however, the allowance for loan losses is based on a comprehensive and well-documented applied analysis of the Company’s loan portfolio. This analysis takes into consideration all available information existing as of the financial statement date, including environmental factors such as economic, industry, geographical and political factors. The relative level of allowance for loan losses is reviewed and compared to industry peers. This review encompasses levels of total impaired loans, portfolio mix, portfolio concentrations, current geographic risks and overall levels of net charge-offs. Page 45 Table of Contents The allowance for loan losses totaled $37.07 million at December 31, 2020 compared to $33.76 million at December 31, 2019. The increase in 2020 is the result of an increase of $3.39 million due to changes in average balances, composition of loans outstanding and significant uncertainties with respect to qualitative factors considered by management due to the COVID-19 pandemic's economic impact. There was a decrease of $0.08 million in the amount allocated to the allowance due to improvements in credit quality. The percentage of the allowance to outstanding loans was 1.37% and 1.28% at December 31, 2020 and 2019, respectively. The provision for loan losses totaled an expense of $4.36 million in 2020, a reduction of expense of $2.88 million in 2019 and an expense of $8.50 million for 2018. Loan charge-offs net of recoveries were $1.05 million in 2019. Loan charge-offs net of recoveries were $1.17 million in 2019 and loan recoveries net of charge-offs were $0.09 million in 2018. The provision for loan losses is the amount necessary to adjust the allowance for loan losses to the level considered appropriate by management. The adequacy of the allowance for loans and any related provision is computed on a quarterly basis and is a result of management’s determination of the quality of the loan portfolio. The provision reflects a number of significant factors, including the size and growth of the loan portfolio, the overall composition of the loan portfolio and loan concentrations, the impact of the borrowers’ ability to repay, past loss experience, loan collateral values, the level of impaired loans and loans past due ninety days or more and the trends in problem and watch loans. In addition, management considers the credit quality of the loans based on management’s review of special mention and substandard loans, including loans with historical higher credit risks. Quantitative factors include the Company’s historical loss experience, which is then adjusted for levels and trends in past due loans, levels and trends in charged-off and recovered loans, trends in volume growth, trends in problem and watch loans, trends in TDR loans, local economic trends and conditions, industry and other conditions, and effects of changing interest rates. In accordance with Staff Accounting Bulletin No. 102, Selected Loan Loss Allowance Methodology and Documentation Issues, the Company determines and assigns ratings to loans using factors that include the following: an assessment of the financial condition of the borrower; a realistic determination of the value and adequacy of underlying collateral; the condition of the local economy and the condition of the specific industry of the borrower; an analysis of the levels and trends of loan categories; and a review of delinquent and classified loans. Through the credit risk rating process, loans are reviewed to determine if they are performing in accordance with the original contractual terms. If the borrower has failed to comply with the original contractual terms, further action may be required by the Company, including a downgrade in the credit risk rating, movement to nonaccrual status, a charge-off or the establishment of a specific impairment reserve. In the event a collateral shortfall is identified during the credit review process, the Company will work with the borrower for a principal reduction payment and/or a pledge of additional collateral and/or additional guarantees. In the event that these options are not available, the loan may be subject to a downgrade of the credit risk rating. If we determine that a loan amount, or portion thereof, is uncollectible, the loan’s credit risk rating is immediately downgraded and the uncollectible amount is charged-off. The Bank’s credit and legal departments undertake a thorough and ongoing analysis to determine if additional impairment and/or charge-offs are appropriate and to begin a workout plan for the loan to minimize realized loss. In certain circumstances, the Bank may modify the terms of a loan to maximize the collection of amounts due. In most cases, the modification is either a reduction in interest rate, conversion to interest only payments, deferral of payments or extension of the maturity date. Generally, the borrower is experiencing financial difficulties or is expected to experience difficulties in the near-term, so concessionary modification is granted to the borrower that otherwise would not be considered. TDR loans accrue interest as long as the borrower complies with the revised terms and conditions and has demonstrated repayment performance at a level commensurate with the modified terms over several payment cycles. The Bank’s TDR loans occur on a case-by-case basis in connection with ongoing loan collection processes. For loans that are collateral dependent, losses are evaluated based on the portion of a loan that exceeds the fair market value of the collateral that can be identified as uncollectible. In general, this is the amount that the carrying value of the loan exceeds the related appraised value less estimated selling costs. Generally, it is the Company’s policy not to rely on appraisals that are older than one year prior to the date the impairment is being measured. The most recent appraisal values may be adjusted if, in the Company’s judgment, experience and other market data indicate that the property’s value, use, condition, exit market or other variable affecting its value may have changed since the appraisal was performed, consistent with the December 2006 joint interagency guidance on the allowance for loan losses. The charge-off or loss adjustment supported by an appraisal is considered the minimum charge-off. Any adjustments made to the appraised value are to provide additional charge-off or loss allocations based on the applicable facts and circumstances. In instances where there is an estimated decline in value, a loss allocation may be provided or a charge-off taken pending confirmation of the amount of the loss from an updated appraisal. Upon receipt of the new appraisals, an additional loss allocation may be provided or charge-off taken based on the appraised value of the collateral. On average, appraisals are obtained within one month of order. Page 46 Table of Contents The Company has not experienced any significant time lapses in recognizing the required provisions for collateral dependent loans, nor has the Company delayed appropriate charge-offs. When an updated appraisal value has been obtained, the Company has used the appraisal amount in determining the appropriate charge-off or required reserve. The Company also evaluates any changes in the financial condition of the borrower and guarantors (if applicable), economic conditions, and the Company’s loss experience with the type of property in question. Any information utilized in addition to the appraisal is intended to identify additional charge-offs or provisions, not to override the appraised value. The Bank regularly reviews loans in the portfolio and assesses whether the loans are impaired in accordance with ASC 310-10-35 , Accounting by Creditors for Impairment of a Loan . If the loans are impaired, the Bank determines if a specific allowance is appropriate. In addition, the Bank's management also reviews and, where determined necessary, provides allowances for particular loans based upon (1) reviews of specific borrowers and (2) management’s assessment of areas that management considers are of higher credit risk, including loans that have been restructured. Loans that are determined not to be impaired and for which there are no specific allowances are classified into one or more risk categories. Based upon the risk category assigned, the Bank allocates a percentage, as determined by management, for a required allowance needed. The determination concerning the appropriate percentage begins with historical loss experience factors, which are then adjusted for levels and trends in past due loans, levels and trends in charged-off and recovered loans, trends in volume growth, trends in problem and watch loans, trends in TDR loans, local economic trends and conditions, industry and other conditions, and effects of changing interest rates. Specific allowances for losses on impaired loans are established if the loan balances exceed the net present value of the relevant future cash flows or the fair value of the collateral based on updated appraisals and/or updated collateral analysis for the properties if the loan is collateral dependent. The Company may recognize a charge-off related to an impaired loan when loan balances exceed net present value of cash flows or collateral. Impaired loans decreased by $0.20 million from December 31, 2019 to December 31, 2020. Impaired loans include any loan that has been placed on nonaccrual status, accruing loans past due 90 days or more and TDR loans. Impaired loans also include loans that, based on management’s evaluation of current information and events, the Bank expects to be unable to collect in full according to the contractual terms of the original loan agreement. The decrease in impaired loans is primarily due to a decrease in nonaccrual loans of $1.92 million and offset by an increase of accruing loans past due 90 days or more of $0.45 million, an increase of $0.43 million in specific reserve loans and an increase in TDR loans of $0.94 million from December 31, 2019 to December 31, 2020. Special mention loan balances were $78.05 million at December 31, 2020 and $66.81 million at December 31, 2019. These asset quality changes increased the provision by $0.13 million based upon the relative mix of special mention loans by category. The $11.24 million increase in special mention loans is related to management’s evaluation of its loan portfolio. The total increase of $11.24 million is comprised of approximately $2.03 million in agricultural operating loans, $3.10 million in commercial loans, $3.04 million in real estate farmland, $1.72 million in 1 to 4 family residential mortgages and $14.94 million for commercial real estate mortgages. The increase is offset by a decrease in the special mention classification of $0.63 million in construction 1 to 4 family residential, $0.29 million in construction land development and commercial, $0.16 million in 1 to 4 family junior mortgages, $12.18 million for multi-family real estate mortgages, $0.09 million in individual loans and $0.24 million for obligations of state and political subdivisions. Substandard loan balances were $51.03 million at December 31, 2020 and $43.34 million at December 31, 2019. These asset quality changes increased the provision by $0.21 million at December 31, 2020 due to the mix of the reserve required for certain substandard loans. The increase of $7.69 million in substandard loans at December 31, 2020 includes an increase of $2.01 million in commercial loans, $0.32 million in construction 1 to 4 family residential, $1.11 million in construction land development, $0.02 million in 1 to 4 family junior mortgages, $12.31 million in multi-family real estate mortgages, $1.02 million in commercial real estate mortgages and $0.03 million in loans to individuals. The increase is offset by a decrease in the substandard classification of $1.90 million in agricultural operating loans, $5.09 million in real estate farmland and $2.14 million of 1 to 4 family residential mortgages. A description of the Bank's credit quality indicators are discussed in Note 3 to the Company's Consolidated Financial Statements. The Company evaluates the following loans to determine impairment: 1) all nonaccrual and TDR loans, 2) all non-consumer and non 1 to 4 family residential loans with prior charge-offs, 3) all non-consumer and non 1 to 4 family loan relationships classified as substandard and 4) loans with indications of or suspected deteriorating credit quality. Page 47 Table of Contents The following table summarizes the Company's impaired loans and non-performing assets as of December 31 for each of the years presented: 2020 2019 2018 2017 2016 (Amounts In Thousands) Nonaccrual loans (1) $ 8,849 $ 10,768 $ 10,829 $ 9,096 $ 9,938 Accruing loans past due 90 days or more (2) 1,056 606 370 971 635 Specific reserve loans 573 243 8,247 12,950 17,683 Troubled debt restructurings ("TDR loans")(1) (3) 10,251 9,308 8,539 8,470 5,408 Total impaired loans $ 20,729 $ 20,925 $ 27,985 $ 31,487 $ 33,664 Other real estate — — — — 237 Non-performing assets (includes impaired loans and other real estate) $ 20,729 $ 20,925 $ 27,985 $ 31,487 $ 33,901 Loans held for investment $2,710,144 $2,639.104 $2,627,943 $2,459,671 $2,277,148 Ratio of allowance for loan losses to loans held for investment 1.37 % 1.28 % 1.44 % 1.20 % 1.17 % Ratio of allowance for loan losses to impaired loans 178.83 161.34 135.11 93.37 78.81 Ratio of impaired loans to total loans held for investment 0.76 0.79 1.06 1.28 1.48 Ratio of non-performing assets to total assets 0.55 0.63 0.92 1.06 1.28 (1) The gross interest income that would have been recorded if the loans had been current in accordance with their original terms and had been outstanding throughout the period or since origination if held for part of the period was $0.66 million in 2020 and $0.58 million in 2019. The amount of interest income on the loans that was included in income was $0.57 million in 2020 and $0.53 million in 2019. (2) The accruing loans past due 90 days or more are still believed to be adequately collateralized. Loans are placed on nonaccrual status when management believes the collection of future principal and interest is not reasonably assured. (3) Total TDR loans were $13.22, $13.71, $13.38, $12.09 and $9.64 million as of December 31, 2020, 2019, 2018, 2017 and 2016, respectively. Included in the total nonaccrual loans were $2.97, $4.34, $4.84, $3.62 and $4.23 million of TDR loans as of December 31, 2020, 2019, 2018, 2017 and 2016, respectively. The ratio of allowance for loan losses to impaired loans increased to 178.83% as of December 31, 2020 compared to 161.34% as of December 31, 2019. The increase in 2020 is the result of an increase in the allowance for loan losses primarily due to management's evaluation of qualitative factors in response to the COVID-19 pandemic and related uncertainties. The ratio of impaired loans to total gross loans was 0.76% and 0.79% at December 31, 2020 and 2019, respectively. The decrease in the 2020 ratio is primarily due to the decrease in nonaccrual loans. Other factors that are considered in determining the credit quality of the Company’s loan portfolio are the vacancy rates for both residential and commercial space, current equity the borrower has in the property and overall financial strength of the customer including cash flow to continue to fund loan payments. The Company also considers the state of the total economy including unemployment levels. In most instances, the borrowers have used in their rental projections of income at least a 10% vacancy rate. As of December 31, 2020, the unemployment levels in Johnson County and Linn County were 2.8% and 3.8%, respectively, compared to 2.2% and 3.1% in December of 2019. These levels compare favorably to the State of Iowa at 3.1% and the national unemployment level at 6.7% in December 2020 compared to 2.7% and 3.5%, respectively in December 2019. The residential rental vacancy rates in 2019 and 2020 in Johnson and Linn County were estimated between 6.0% and 8.0%. The State of Iowa vacancy rate is 8.5% and the national rate is 6.5% with the Midwest rate at 7.8%. These vacancy rates one year ago were 6.7%, 6.4% and 6.8%, respectively. The Company continues to consider those vacancy rates among other factors in its current evaluation of the real estate portion of its loan portfolio. Favorable vacancy rates may not continue in 2021, and vacancy rates may rise and affect the overall quality of the loan portfolio. See Note 3 to the Company's Consolidated Financial Statements for additional disclosures on loans. Page 48 Table of Contents SUMMARY OF LOAN LOSS EXPERIENCE The allowance for loan losses balance is also affected by the charge-offs and recoveries for the periods presented. For the years ended December 31, 2020, 2019 and 2018, recoveries were $1.87 million, $1.80 million and $2.24 million, respectively; charge-offs were $2.92 million, $2.97 million and $2.32 million in 2020, 2019 and 2018, respectively. Overall credit quality may deteriorate in 2021. Such deterioration could cause increases in impaired loans, allowance for loan losses provision expense and net charge-offs. Management will monitor changing market conditions as a part of its allowance for loan loss methodology. The following table summarizes the Bank's loan loss experience for the years ended December 31 for each of the years presented: Agricultural Commercial and Financial Real Estate: Construction and land development Real Estate: Mortgage, farmland Real Estate: Mortgage, 1 to 4 family Real Estate: Mortgage, multi-family and commercial Other Total (Amounts In Thousands) 2020 Allowance for loan losses: Beginning balance $ 2,400 $ 4,988 $ 2,599 $ 3,950 $ 10,638 $ 7,859 $ 1,326 $ 33,760 Charge-offs (43) (1,425) (43) (1) (738) (291) (381) (2,922) Recoveries 63 670 118 10 784 49 180 1,874 Provision 88 652 (355) 214 1,684 1,798 277 4,358 Ending balance $ 2,508 $ 4,885 $ 2,319 $ 4,173 $ 12,368 $ 9,415 $ 1,402 $ 37,070 Agricultural Commercial and Financial Real Estate: Construction and land development Real Estate: Mortgage, farmland Real Estate: Mortgage, 1 to 4 family Real Estate: Mortgage, multi-family and commercial Other Total (Amounts In Thousands) 2019 Allowance for loan losses: Beginning balance $ 2,789 $ 5,826 $ 3,292 $ 3,972 $ 12,516 $ 8,165 $ 1,250 $ 37,810 Charge-offs (266) (981) (45) (6) (896) (341) (434) (2,969) Recoveries 95 646 8 5 700 180 165 1,799 Provision (218) (503) (656) (21) (1,682) (145) 345 (2,880) Ending balance $ 2,400 $ 4,988 $ 2,599 $ 3,950 $ 10,638 $ 7,859 $ 1,326 $ 33,760 Agricultural Commercial and Financial Real Estate: Construction and land development Real Estate: Mortgage, farmland Real Estate: Mortgage, 1 to 4 family Real Estate: Mortgage, multi-family and commercial Other Total (Amounts In Thousands) 2018 Allowance for loan losses: Beginning balance $ 2,294 $ 4,837 $ 2,989 $ 3,669 $ 8,668 $ 5,700 $ 1,243 $ 29,400 Charge-offs (95) (585) — — (830) (251) (561) (2,322) Recoveries 119 1,057 148 30 612 107 162 2,235 Provision 471 517 155 273 4,066 2,609 406 8,497 Ending balance $ 2,789 $ 5,826 $ 3,292 $ 3,972 $ 12,516 $ 8,165 $ 1,250 $ 37,810 Page 49 Table of Contents Agricultural Commercial and Financial Real Estate: Construction and land development Real Estate: Mortgage, farmland Real Estate: Mortgage, 1 to 4 family Real Estate: Mortgage, multi-family and commercial Other Total (Amounts In Thousands) 2017 Allowance for loan losses: Beginning balance $ 2,947 $ 4,531 $ 2,890 $ 3,417 $ 7,677 $ 4,045 $ 1,023 $ 26,530 Charge-offs (167) (583) (114) (3) (553) (130) (554) (2,104) Recoveries 146 1,183 662 — 661 376 258 3,286 Provision (632) (294) (449) 255 883 1,409 516 1,688 Ending balance $ 2,294 $ 4,837 $ 2,989 $ 3,669 $ 8,668 $ 5,700 $ 1,243 $ 29,400 Agricultural Commercial and Financial Real Estate: Construction and land development Real Estate: Mortgage, farmland Real Estate: Mortgage, 1 to 4 family Real Estate: Mortgage, multi-family and commercial Other Total (Amounts In Thousands) 2016 Allowance for loan losses: Beginning balance $ 3,082 $ 4,517 $ 2,280 $ 3,342 $ 8,172 $ 4,223 $ 894 $ 26,510 Charge-offs (226) (315) (34) (116) (1,181) (66) (693) (2,631) Recoveries 181 1,169 849 — 1,043 385 187 3,814 Provision (90) (840) (205) 191 (357) (497) 635 (1,163) Ending balance $ 2,947 $ 4,531 $ 2,890 $ 3,417 $ 7,677 $ 4,045 $ 1,023 $ 26,530 The ratio of net charge-offs to average net loans outstanding during the years ended December 31, 2020, 2019, 2018, 2017 and 2016 was 0.04%, 0.04%, 0.00%, (0.05)% and (0.05)%, respectively. Page 50 Table of Contents ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES The following table presents the allowance for loan losses by type of loans, the percentage of the allocation for each category to the total allowance and the percentage of all loans in each category to total loans as of December 31, 2020, 2019, 2018, 2017 and 2016: 2020 2019 Amount % of Total Allowance % of Loans to Total Loans Amount % of Total Allowance % of Loans to Total Loans (In Thousands) (In Thousands) Agricultural $ 2,508 6.77 % 3.50 % $ 2,400 7.11 % 3.46 % Commercial and financial 4,885 13.18 % 10.56 4,988 14.77 % 8.39 Real estate: Construction, 1 to 4 family residential 907 2.45 % 2.62 1,113 3.30 % 3.04 Construction, land development and commercial 1,412 3.81 % 4.13 1,486 4.40 % 4.11 Mortgage, farmland 4,173 11.26 % 9.12 3,950 11.70 % 9.20 Mortgage, 1 to 4 family first liens 10,871 29.32 % 32.92 9,045 26.79 % 34.51 Mortgage, 1 to 4 family junior liens 1,497 4.04 % 4.72 1,593 4.72 % 5.65 Mortgage, multi-family 4,462 12.04 % 13.80 3,823 11.32 % 13.29 Mortgage, commercial 4,953 13.36 % 15.39 4,036 11.95 % 15.24 Loans to individuals 752 2.03 % 1.16 853 2.53 % 1.22 Obligations of state and political subdivisions 650 1.74 % 2.08 473 1.41 1.89 $ 37,070 100.00 % 100.00 % $ 33,760 100.00 % 100.00 % 2018 2017 Agricultural $ 2,789 7.38 % 3.53 % $ 2,294 7.80 % 3.60 % Commercial and financial 5,826 15.41 % 8.73 4,837 16.45 % 8.89 Real estate: Construction, 1 to 4 family residential 1,297 3.43 % 2.75 1,193 4.06 % 2.84 Construction, land development and commercial 1,995 5.28 % 4.33 1,796 6.11 % 4.46 Mortgage, farmland 3,972 10.51 % 9.00 3,669 12.48 % 8.75 Mortgage, 1 to 4 family first liens 10,750 28.43 % 34.71 7,369 25.07 % 33.81 Mortgage, 1 to 4 family junior liens 1,766 4.67 % 5.81 1,299 4.42 % 5.86 Mortgage, multi-family 4,083 10.80 % 13.41 2,791 9.49 % 13.69 Mortgage, commercial 4,082 10.80 % 14.58 2,909 9.89 % 14.69 Loans to individuals 723 1.91 % 1.14 782 2.66 % 1.07 Obligations of state and political subdivisions 527 1.38 2.01 461 1.57 2.34 $ 37,810 100.00 % 100.00 % $ 29,400 100.00 % 100.00 % Page 51 Table of Contents 2016 Amount % of Total Allowance % of Loans to Total Loans (In Thousands) Agricultural $ 2,947 11.11 % 4.08 % Commercial and financial 4,531 17.08 8.48 Real estate: Construction, 1 to 4 family residential 1,023 3.86 2.54 Construction, land development and commercial 1,867 7.04 5.34 Mortgage, farmland 3,417 12.88 8.89 Mortgage, 1 to 4 family first liens 6,560 24.72 33.70 Mortgage, 1 to 4 family junior liens 1,117 4.21 5.51 Mortgage, multi-family 1,669 6.29 13.30 Mortgage, commercial 2,376 8.95 14.67 Loans to individuals 642 2.42 1.10 Obligations of state and political subdivisions 381 1.44 2.39 $ 26,530 100.00 % 100.00 % The Company believes that the allowance for loan losses is at a level commensurate with the overall risk exposure of the loan portfolio. However, if economic conditions deteriorate, certain borrowers may experience difficulty and the level of impaired loans, charge-offs and delinquencies could rise and require increases in the provision for loan losses. The Company will continue to monitor the adequacy of the allowance on a quarterly basis and will consider the impact of economic conditions on the borrowers’ ability to repay, loan collateral values, past collection experience, the risk characteristics of the loan portfolio and such other factors that deserve current recognition. Noninterest Income The following table sets forth the various categories of noninterest income for the years ended December 31, 2020, 2019 and 2018. Year Ended December 31, $ Change % Change 2020 2019 2018 2020/2019 2019/2018 2020/2019 2019/2018 (Amounts in thousands) Net gain on sale of loans $ 6,678 $ 3,539 $ 1,517 $ 3,139 $ 2,022 88.70 % 133.29 % Trust fees 10,275 9,579 10,007 696 (428) 7.27 (4.28) Service charges and fees 10,186 10,276 9,614 (90) 662 (0.88) 6.89 Other noninterest income 1,187 1,426 2,680 (239) (1,254) (16.76) (46.79) Gain (loss) on sale of investment securities $ 10 $ (28) $ — 38 (28) (135.71) — $ 28,336 $ 24,792 $ 23,818 $ 3,544 $ 974 14.29 % 4.09 % The noninterest income of the Company was $28.34 million in 2020 compared to $24.79 million in 2019. The increase of $3.54 million in 2020 was the result of a combination of factors discussed below. In 2019, the total noninterest income increased $0.97 million from 2018. Loans originated for sale in 2020, which consist primarily of fixed rate residential mortgage loans, totaled $475.19 million compared to $299.22 million in 2019, an increase of 58.81%. In the year ended December 31, 2020 and 2019, the net gain on sale of loans was $6.68 million and $3.54 million, respectively. The amount of the net gain on sale of secondary market mortgage loans in each year can vary significantly. The volume of activity in these types of loans is directly related to the level Page 52 Table of Contents of interest rates and has been significantly impacted by the Federal Reserve Board's reduction of the federal funds rate to 0.25% in 2020, resulting in a significant amount of mortgage loan refinance activity. The servicing of the loans sold into the secondary market is not retained by the Company so these loans do not provide an ongoing stream of income. Trust fees increased $0.70 million to $10.28 million in 2020. Trust fees decreased $(0.43) million in 2019. As of December 31, 2020, the Bank’s Trust Department had $2.176 billion in assets under management compared to $1.919 billion and $1.618 billion at December 31, 2019 and 2018, respectively. In 2020, the Dow Jones Industrial Average increased 7.25%. The market value of the Dow Jones Industrial Average increased 22.34% in 2019 and decreased 5.63% in 2018. Other noninterest income decreased $1.25 million in 2019 primarily due to the sale of the insurance department in August 2018 for a gain of $885,000. Noninterest Expenses The following table sets forth the various categories of noninterest expenses for the year ended December 31, 2020, 2019 and 2018. Year Ended December 31, $ Change % Change 2020 2019 2018 2020/2019 2019/2018 2020/2019 2019/2018 (Amounts in thousands) Salaries and employee benefits $ 40,621 $ 36,709 $ 34,981 $ 3,912 $ 1,728 10.66 % 4.94 % Occupancy 4,343 4,336 4,374 7 (38) 0.16 (0.87) Furniture and equipment 7,357 6,795 5,741 562 1,054 8.27 18.36 Office supplies and postage 1,799 1,841 1,778 (42) 63 (2.28) 3.54 Advertising and business development 2,082 2,595 2,513 (513) 82 (19.77) 3.26 Outside services 11,069 10,360 10,076 709 284 6.84 2.82 FDIC insurance assessment 856 194 856 662 (662) 341.24 (77.34) Other noninterest expense 7,504 4,434 1,804 3,070 2,630 69.24 145.79 $ 75,631 $ 67,264 $ 62,123 $ 8,367 $ 5,141 12.44 % 8.28 % Total noninterest expenses were $75.63 and $67.26 million for the years ended December 31, 2020 and 2019, respectively. The increase is $8.37 million or 12.44% in 2020 and an increase of $5.14 million or 8.28% in 2019. Salaries and employee benefits increased $3.91 million in 2020. The increase is primarily the result of annual salary adjustments, hiring of additional employees to staff growth, increased variable compensation due to the increase in loans originated for sale described above and increased overtime due to the increase in loans originated for sale and processing of PPP loans. Furniture and equipment increased $0.56 million in 2020 primarily due to planned increases in software maintenance contract costs. Advertising and business development decreased $0.51 million in 2020 due to lower spending in response to the pandemic. FDIC insurance assessment increased $0.66 million in 2020 primarily due to the use of the credit carryover in 2019. Other noninterest expenses increased $3.07 million in 2020 primarily due to $2.53 million in fees incurred from the prepayment of FHLB borrowings and $2.68 million paid for the early termination of the interest rate swap. Total noninterest expenses were $62.12 million for the year ended December 31, 2018. The increase in expenses in 2019 was $5.14 million. This included an increase of $1.73 million in salaries and benefits, which was the direct result of salary adjustments and hiring additional employees. Furniture and equipment increased $1.05 million in 2019 primarily due to Page 53 Table of Contents increases in software maintenance contract costs. Other noninterest expenses increased $2.63 million in 2019 primarily due to $2.09 million in fees incurred from the prepayment of FHLB borrowings. Income Taxes Income tax expense was $11.28, $12.55 and $8.91 million for the years ended December 31, 2020, 2019 and 2018, respectively. Income taxes as a percentage of income before income taxes were 22.59% in 2020, 21.69% in 2019 and 19.50% in 2018. The amount of tax credits were $0.05, $0.53 and $1.29 million for 2020, 2019, and 2018, respectively. Effects of Inflation The consolidated financial statements and the accompanying notes have been prepared in accordance with accounting principles generally accepted in the United States of America. These principles require the measurement of financial position and operating results in terms of historical dollar amounts without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Company’s operations. Nearly all of the assets and liabilities of the Company are monetary in nature. As a result, interest rates have a more significant impact in the Company’s performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services. Liquidity and interest rate adjustments are features of the Company’s asset/liability management, which are important to the maintenance of acceptable performance levels. Item 7A of this Form 10-K contains a more thorough discussion of interest rate risk. The Company attempts to maintain a balance between monetary assets and monetary liabilities to offset the potential effects of changing interest rates. Liquidity and Capital Resources The objective of liquidity management is to ensure the availability of sufficient cash flows to fund operations, to meet depositor withdrawals, to provide for our customers' credit needs and to meet maturing obligations and existing commitments. The Company's principal source of funds is deposits. Other sources include loan principal repayments, proceeds from the maturity and sale of investment securities, federal funds purchased, advances from the FHLB, advances on bank lines of credit, brokered deposit relationships and funds provided by operations. Liquidity management is conducted on both a daily and a long-term basis. Investments in liquid assets are adjusted based on expected loan demand, projected loan and investment securities maturities and payments, expected deposit flows and the objectives set by the Company's asset-liability management, liquidity and contingency funding policies. As of December 31, 2020, the Company had additional borrowing capacity available from the FHLB of $776.67 million. In addition, the Company had $523.07 million in borrowing capacity available through secured and unsecured lines of credit with correspondent banks. The Company had no amounts outstanding under those federal funds lines as of December 31, 2020. On an unconsolidated basis, the Company had cash balances of $1.10 million as of December 31, 2020. In 2020, the Company received dividends of $14.82 million from its subsidiary Bank and used those funds to pay dividends to its stockholders of $8.33 million and to fund purchases of treasury stock under the 2005 Stock Repurchase Program. The total purchase of treasury stock under the 2005 Stock Repurchase Program totaled $8.55 and $5.53 million for the years ended December 31, 2020 and 2019, respectively. As of December 31, 2020 and 2019, stockholders' equity, before deducting for the maximum cash obligation related to the ESOP, was $463.41 million and $427.04 million, respectively. This measure of stockholders’ equity as a percent of total assets was 12.26% at December 31, 2020 and 12.94% at December 31, 2019. As of December 31, 2020, total equity, after deducting the maximum cash value related to the ESOP, was 11.01% of assets compared to 11.37% of assets at the prior year end. The Company and the Bank are subject to the Federal Deposit Insurance Corporation Improvement Act of 1991, and the Bank is subject to Prompt Corrective Action Rules as determined and enforced by the Federal Reserve. These regulations establish minimum capital requirements that member banks must maintain. The Bank is classified as "well-capitalized" by FDIC capital guidelines. For more information regarding regulatory capital requirements, see the section under Part I, Item 1 to this 10-K captioned “Supervision and Regulation.” Page 54 Table of Contents On a consolidated basis, 2020 cash flows from operations provided $8.15 million and net increases in deposits provided $531.20 million. These cash flows were invested in Net Loans of $72.14 million and $129.36 million in purchases of investment securities. In addition, $1.86 million was used to purchase property and equipment and leasehold improvements. The Bank has a contingency funding plan to address liquidity issues in times of crisis. The primary source of funding will be the Bank’s customer deposit base. The Bank has established alternative sources of funding available to increase liquidity. The availability of the funding sources is tested on an annual basis. The Bank performs quarterly stress testing to determine if the Bank has an appropriate amount of funding sources to address potential liquidity needs. At December 31, 2020, the Bank had total outstanding loan commitments and unused portions of lines of credit totaling $491.66 million (see Note 15 to the Company's Consolidated Financial Statements). Management believes that its liquidity levels are sufficient at this time, but the Bank may increase its liquidity by limiting the growth of its assets, by selling more loans in the secondary market or selling portions of loans to other banks through participation agreements. Another liquidity source includes obtaining additional funds from the Federal Home Loan Bank (FHLB). As of December 31, 2020, the Bank can obtain an additional $776.67 million from the FHLB based on the current real estate mortgage loans held. In addition, the Bank has arranged $513.07 million of credit lines at three banks. The borrowings under these credit lines would be secured by the Bank’s investment securities. Other liquidity sources include a $10.00 million line of credit with the Federal Reserve Bank of Chicago and various sources of brokered deposits. The following table shows outstanding balances, weighted average interest rates at year end, maximum month-end balances, average month-end balances and weighted average interest rates of federal funds purchased and securities sold under agreements to repurchase during 2020, 2019 and 2018: 2020 2019 2018 (Amounts In Thousands) Outstanding balance as of December 31 $ — $ — $ — Weighted average interest rate at year end — % — % — % Maximum month-end balance — — — Average month-end balance — — — Weighted average interest rate for the year 0.93 % 2.64 % 2.71 % The following table shows outstanding balances, weighted average interest rates at year end, maximum month-end balances, average month-end balances and weighted average interest rates of Federal Home Loan Bank borrowings during 2020, 2019 and 2018: 2020 2019 2018 (Amounts In Thousands) Outstanding balance as of December 31 $ 105,000 $ 185,000 $ 215,000 Weighted average interest rate at year end 2.93 % 2.93 % 2.94 % Maximum month-end balance 185,000 215,000 280,000 Average month-end balance 181,093 212,500 228,066 Weighted average interest rate for the year 2.93 % 2.93 % 2.94 % The Bank has off-balance sheet commitments to fund additional borrowings of customers as well as derivative financial instruments, consisting of interest rate swaps as disclosed in Note 17 to the Company's Consolidated Financial Statements. Contractual commitments to fund loans are met from the proceeds of federal funds sold or investment securities and additional borrowings. Many of the contractual commitments to extend credit will not be funded because they represent the credit limits on credit cards and home equity lines of credits. Page 55 Table of Contents As disclosed in Note 15 to the Company's Consolidated Financial Statements, the Company has certain obligations and commitments to make future payments under contracts. The following table summarizes significant contractual obligations and other commitments as of December 31, 2020: Payments Due By Period (Amounts In Thousands) Total Less Than One Year One - Three Years Three - Five Years More Than Five Years Contractual obligations: Long-term debt obligations $ 105,000 $ — $ — $ 45,000 $ 60,000 Operating lease obligations 1,093 375 635 83 — Total contractual obligations: $ 106,093 $ 375 $ 635 $ 45,083 $ 60,000 Other commitments: Lines of credit $ 483,602 $ 353,060 $ 101,713 $ 24,623 $ 4,206 Standby letters of credit 8,056 8,056 — — — Total other commitments $ 491,658 $ 361,116 $ 101,713 $ 24,623 $ 4,206 The Company and the Bank have no additional material commitments or plans that will materially affect liquidity or capital resources. Property and equipment may be acquired in cash purchases, or they may be financed if favorable terms are available.