What changed in this filing

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Item 7. Management’s Discussion and Analysis

2023-03-03 compared with 2022-03-04 · 142 added, 133 removed, 650 unchanged (30% of the section changed)

13 unchanged sentences

• 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.

This includes current concerns related to higher inflation, rising energy prices, the Russia-Ukraine war and supply chain imbalances.

• The effects of financial market disruptions and/or an economic recession, and monetary and other governmental actions designed to address such disruptions and recession, including in response to the COVID-19 pandemic.

1 unchanged sentence

• The credit quality and credit agency ratings of the securities in the Company’s investment securities portfolio, a deterioration or downgrade of which could lead to recognition of an allowance for credit losses on the affected securities and the recognition of a credit loss.

• The effects of, and changes in, laws, regulations and policies affecting banking, securities, insurance and monetary and financial matters as well as any laws otherwise affecting the Company.

• The effects of, and changes in, laws, regulations and policies affecting banking, securities, insurance and monetary and financial matters as well as any laws otherwise affecting the Company, including, but not limited to, changes in U.S.

tax laws and regulations.

• The effects of changes in interest rates (including the effects of changes in the rate of prepayments of the Company’s assets) and the policies of the Board of Governors of the Federal Reserve System.

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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.

Update on Company Action and Ongoing Risks

Our response to COVID-19 continues to be focused on how we can best serve our employees, customers, and communities.

We implemented additional safety measures to achieve appropriate social distancing for both customers and employees throughout our locations.

We have continued to adjust procedures and restrictions based on local conditions and generally in alignment with guidance from the Centers for Disease Control.

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.

Lending Assistance

The Bank continues to work with customers to determine how best to serve them, including providing 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, 2021 and December 31, 2020, COVID-19 related payment deferrals were approximately 0.12% and 1.20% of total loans, respectively.

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.

With the passage of the Coronavirus Response and Relief Supplemental Appropriations Act 2021 in late December 2020, the Bank provided additional PPP loans in 2021 totaling $58.34 million through December 31, 2021 to further assist our customers.

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, 2021, the Bank has outstanding PPP loan balances of $5.34 million and for the year ended December 31, 2021 has received total forgiveness payments of $140.1 million from the SBA.

Financial Exposures

The COVID-19 pandemic continues to represent an unprecedented challenge to the global economy in general and the financial services sector in particular.

However, given the emergence of multiple new and more infectious variants of COVID-19 along with the hesitancy of a significant portion of the U.S.

population to become vaccinated, 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.

Economic Environment

economic activity slowed in the first half of 2022 reflecting the impacts of significantly higher inflation and rising interest rates as well as repercussions from the Russia-Ukraine war alongside continued economic impacts from the COVID-19 pandemic which have resulted in supply chain disruptions and increased energy prices.

After contracting during the first two quarters of the year, U.S.

Gross Domestic Product ("GDP") grew 2.9% for 2022, while the personal consumption expenditures price index declined to an annual rate of 5.0 percent in December 2022, though still well above the FRB's target inflation rate.

The FRB increased short-term interest rates by a total of 425 basis points during 2022 and has indicated that it will increase short-term interest rates further during the first quarter of 2023 in order to fight inflation.

These conditions have created significant uncertainty about the future economic environment which will continue to evolve and potentially impact our business in future periods.

Concerns over interest rate levels, energy prices, domestic and global policy issues, trade policy in the U.S.

and geopolitical events, as well as the implications of those events on the markets in general, further add to the global uncertainty.

There is also a risk that interest rate increases to fight inflation could lead to a recession.

Interest rate levels and energy prices, in combination with global economic conditions, fiscal and monetary policy and the level of regulatory and government scrutiny of financial institutions will likely continue to impact our results into 2023.

Our credit administration continues to closely monitor and analyze the higher risk segments within the loan portfolio, tracking loan payment deferrals, customer liquidity and providing timely reports to senior management and the board of directors.

Based on the Company’s capital levels, prudent underwriting policies, loan concentration diversification and our geographic footprint, we currently expect to be able to continue to manage the economic risks and uncertainties associated with the pandemic and remain adequately capitalized.

However, the Company may be required to make additional loan loss provisions as warranted by the fluid COVID-19 situation.

Based on the Company’s capital levels, prudent underwriting policies, loan concentration diversification and our geographic footprint, senior management is cautiously optimistic that the Company is positioned to continue managing the impact of the varied set of risks and uncertainties currently impacting the economy and remain adequately capitalized.

However, the Company may be required to make additional credit loss provisions as warranted by the extremely fluid economic condition.

The Company is a bank holding company engaged, through its wholly-owned subsidiary bank, in the business of commercial banking.

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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 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 2022 was $47.75 million compared to $48.09 million in 2021 and $38.65 million in 2020.

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For the years ended December 31, 2022 and 2021, the Bank achieved a net interest margin of 3.00% and 2.75%, respectively.

For the year ended December 31, 2021, net interest income on a tax equivalent basis increased by $2.82 million.

In 2021, net interest income increased $1.77 million due to growth of $424.15 million in the Bank's average earning assets and decreases in certficates of deposit and FHLB borrowings as well as increased $1.05 million due to interest rate changes.

year ended December 31, 2022, net interest income on a tax equivalent basis increased by $10.60 million.

In 2022, net interest income increased $9.30 million due to growth of $38.05 million in the Bank's average earning assets, increased $3.98 million due to decreases in certificates of deposit and FHLB borrowings and was offset by decreases of $2.67 million due to interest rate changes.

Highlights with respect to items on the Company’s balance sheet as of December 31, 2022 included the following:

• Total assets were $4.045 billion, an increase of $262.20 million since December 31, 2020.

• Cash and cash equivalents were $781.92 million, an increase of $207.61 million since December 31, 2020.

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 credit losses and unamortized fees and costs, totaling $2.631 billion, a decrease of $87.18 million since December 31, 2020.

The decrease is primarily attributable to the forgiveness of PPP loans totaling a net of $81.16 million for the year ended December 31, 2021.

Loans held for sale decreased $38.23 million since December 31, 2020 due to the slowdown in mortgage loan refinance activity later in 2021.

• Tax credit real estate increased by $2.54 million for the year ended December 31, 2021, primarily attributable to a $4.18 million investment in a multi-family affordable housing rental property.

• Deposit growth of $341.43 million in 2021.

Deposits increased to $3.534 billion and included $51.59 million of brokered deposits.

A substantial portion of the increase can be attributed to increased savings with the current negative economic environment due to the pandemic.

• FHLB borrowings decreased $105.00 million due to prepaying all outstanding FHLB borrowings compared to December 31, 2020.

• Liabilities as of December 31, 2021 include $3.85 million of allowance for credit losses on off-balance sheet credit exposures under CECL compared to zero under the incurred loss model as of December 31, 2020.

• Stockholders’ equity increased $22.37 million to $438.45 million in 2021, with dividends having been paid in 2021 of $8.77 million.

• Total assets were $3.980 billion, a decrease of $64.08 million since December 31, 2021.

• Cash and cash equivalents were $36.64 million, a decrease of $745.28 million since December 31, 2021.

A substantial portion of the decrease can be attributed to increased investments of approximately $280.92 million since December 31, 2021, primarily in U.S.

Treasury and mortgage-backed securities as well as loan growth of approximately $447.88 million since December 31, 2021.

• Loans, net of allowance for credit losses and unamortized fees and costs, totaling $3.067 billion, an increase of $437.87 million since December 31, 2021.

The increase is primarily attributable to growth of approximately $81.14 million in construction loans, $221.43 million in 1 to 4 family first mortgages, $54.16 million in multi-family mortgages, $47.57 million in commercial and financial loans and $23.83 million in farmland mortgages.

Loans held for sale decreased $4.05 million since December 31, 2021.

• Deferred income tax assets were $24.06 million, an increase of $14.94 million since December 31, 2021.

The increase is primarily attributable to unrealized losses on available for sale investments of $54.20 million as of December 31, 2022.

• Deposits decreased $176.63 million in 2022 to $3.357 billion primarily due to decreases in brokered deposits and insured cash sweep (ICS) deposits of approximately $97 million, decrease of $32.34 million of time deposits and increased customer usage of deposits throughout 2022.

• Fed Funds purchased and FHLB borrowings increased $82.06 million and $40.00 million, respectively, as of December 31, 2022 compared to no borrowings as of December 31, 2021, primarily to fund strong loan growth and increased customer deposit usage.

• Stockholders’ equity decreased $10.19 million to $428.26 million in 2022, with dividends having been paid in 2022 of $9.30 million.

Reference is made to Note 14 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 11.32% in 2022 compared to 11.29% in 2021.

The Company remains well-capitalized as of December 31, 2021 with total risk-based capital at 20.24% 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 $0.940 in 2021, $0.890 in 2020 and $0.820 in the year ended December 31, 2019.

The Company remains well-capitalized as of December 31, 2022 with a CBLR of 13.27%.

The minimum regulatory guideline is 9%.

The Company paid a dividend per share of $1.00 in 2022, $0.94 in 2021 and $0.89 in 2020.

A detailed discussion of the financial position and results of operations follows this overview.

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The following is a discussion of the methodologies used by the Company with the adoption of ASC 326.

ASC 326 CECL Adoption:

The preparation of financial statements in accordance with the accounting principles generally accepted in the United States ("U.S.

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Deposits 3,357,367 3,533,994 3,192,568 2,661,364 2,421,124

Other short-term borrowings 82,061 249 — — —

Federal Home Loan Bank borrowings 40,000 — 105,000 185,000 215,000

1 unchanged sentence

Stockholders' equity 428,260 438,450 416,076 375,211 334,882

Total assets at December 31, 2021 increased $262.20 million, or 6.93%, from the prior year-end.

The largest growth in assets in 2021 occurred in Cash and Cash Equivalents, which increased $207.61 million as of December 31, 2021 compared to December 31, 2020.

Net Loans decreased $(48.95) million for the year ended December 31, 2021.

Total assets at December 31, 2022 decreased $64.08 million, or 1.58%, from the prior year-end.

The largest decrease in assets in 2022 occurred in cash and cash equivalents, which decreased $745.28 million as of December 31, 2022 compared to December 31, 2021.

A substantial portion of the decrease can be attributed to increased investments of approximately $280.92 million since December 31, 2021, primarily in U.S.

Treasury and mortgage-backed securities as well as loan growth of approximately $447.84 million since December 31, 2021.

The largest growth in assets in 2022 occurred in net loans which increased $441.92 million for the year ended December 31, 2022.

Loans held for sale to the secondary market decreased $4.05 million for the year ended December 31, 2022.

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Loans held for investment were $3.108 billion and $2.661 billion at December 31, 2022 and 2021, 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 2021 and 2020 and may not continue, and as a result, may not be indicative of future performance.

The primary reason for the decrease in 2021 was the forgiveness of PPP loans totaling a net of $81.16 million that were provided to customers in response to the COVID-19 pandemic as discussed previously.

Without the decrease due to PPP loan forgiveness, loans held for investment increased $30.61 million.

Commercial and financial loans represent a significant portion of the loan growth.

These loans increased $16.92 million in 2021 excluding the impact of PPP loans.

Construction loans, both 1 to 4 family residential and land development and commercial, had significant growth totaling $24.48 million in 2021.

Agricultural loans increased $12.09 million in 2021 though farmland mortgages decreased $14.40 million due to significant competition in the Bank's trade area.

On a net basis, the Company collected $52.02 million in loan payments from customers and the SBA for the year ended December 31, 2021 compared to loan originations of $72.14 million for the year ended December 31, 2020, primarily due to the collections from the forgiveness of PPP loans.

The Company does not engage in significant participation activity and does not purchase participations from outside its established trade area.

The local economy that generated consistent demand for loans was a significant factor in the increase in net loans.

Significant loan growth was noted in the following areas:

approximately $81.14 million in construction loans, $221.43 million in 1 to 4 family first mortgages, $54.16 million in multi-family mortgages, $47.57 million in commercial and financial loans and $23.83 million in farmland mortgages.

Given the current economic environment and the potential for a recession in 2023, the increase in net loans in 2022 may not continue into 2023, and as a result, may not be indicative of future performance.

On a net basis, the Company originated $447.84 million in loans to customers for the year ended December 31, 2022 compared to loan collections of $52.02 million for the year ended December 31, 2021, primarily due to the collections from the forgiveness of PPP loans.

The Company has not historically engaged 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.

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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 2021 or 2020.

The Company did experience significant overall increases in its loans held for investment in 2022 compared to 2021 though the loan composition in 2022 remained comparable to 2021.

Residential real estate loans, including first and junior liens, were $1,255.94 million and $1,023.91 million as of December 31, 2022 and 2021, respectively.

The dollar total of residential real estate loans increased 0.39% in 2021 and decreased 3.78% in 2020.

The dollar total of residential real estate loans increased 22.66% in 2022 and increased 0.39% in 2021.

Residential real estate loans were 40.41% of the loan portfolio at December 31, 2022 and 38.49% at December 31, 2021.

Commercial real estate loans totaled $401.38 million at December 31, 2021, a 3.78% decrease over the December 31, 2020 total of $417.14 million.

Commercial real estate loans increased 3.72% in 2020.

Agricultural loans, including production and mortgages, were $369.28 million and $339.68 million as of December 31, 2022 and 2021, respectively, an increase of 8.71% in 2022 compared to 2021.

Agricultural loans represented 11.88% and 12.77% of the Company's loan portfolio as of December 31, 2022 and 2021, respectively.

Construction loans were $288.65 million and $207.51 million as of December 31, 2022 and 2021, respectively, an increase of 39.10% in 2022 compared to 2021.

Construction loans represented 9.29% and 7.80% of the Company's loan portfolio as of December 31, 2022 and 2021, respectively.

Commercial and financial loans were $269.57 million and $222.00 million as of December 31, 2022 and 2021, respectively, an increase of 21.43% in 2022 compared to 2021.

Commercial and financial loans represented 8.67% and 8.35% of the Company's loan portfolio as of December 31, 2022 and 2021, respectively.

Multi-family real estate loans were $436.95 million and $382.79 million as of December 31, 2022 and 2021, respectively, an increase of 14.15% in 2022 compared to 2021.

Multi-family real estate loans represented 14.06% and 14.39% of the Company's loan portfolio as of December 31, 2022 and 2021, respectively.

Commercial real estate loans totaled $402.84 million at December 31, 2022, a 0.36% increase over the December 31, 2021 total of $401.38 million.

Commercial real estate loans decreased 3.78% in 2021.

Commercial real estate loans represented 12.96%, 15.09% and 15.39% of the Company’s loan portfolio as of December 31, 2022, 2021 and 2020, 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.

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 169.01% of capital as of December 31, 2022.

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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 $341.43 million in 2021.

Total deposits decreased by $176.63 million in 2022.

Deposits increased by $341.43 million in 2021.

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The Company had nine office locations in Johnson County as of June 30, 2022.

The total banking locations in Johnson County was 48 as of June 30, 2021.

The total banking locations in Johnson County were 47 as of June 30, 2022.

At June 30, 2021, the Company’s deposits were $2.272 billion or a 20.51% market share.

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In 2021, investment securities increased by $139.36 million.

The investment portfolio consists of $551.35 million of securities that are stated at fair value, with any unrealized gain or loss, net of

income taxes, reported as a separate component of stockholders’ equity.

The investment portfolio consists of $776.10 million of securities that are stated at fair value, with any unrealized gain or loss, net of 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.

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Mortgage-backed securities and collateralized mortgage obligations 50,196 9,446 —

Obligations of state and political subdivisions 263,516 224,566 211,489

State and political subdivisions 248,582 263,516 224,566

$ 782,565 $ 555,900 $ 416,544

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Stock of the Federal Home Loan Bank $ 6,461 3.09 %

Obligations of state and political subdivisions, maturities:

State and political subdivisions, maturities:

Within 1 year $ 34,643 2.94 %

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See Note 2 to the Company’s Consolidated Financial Statements.

During 2021, the major funding source for the growth in loans and other assets was the $341.43 million increase in deposits.

During 2022, the major funding source for the growth in loans and other assets was cash and cash equivalents in addition to federal funds purchased and FHLB borrowings.

In 2021, the major source of funding for the growth in loans was deposit growth of $341.43 million.

Brokered deposits totaled $31.74 million and $51.59 million as of December 31, 2022 and 2021, respectively.

Total advances from the FHLB were $0.00 million at December 31, 2021 and $105.00 million in 2020.

The FHLB funding source is considered when loan growth exceeds core deposit increases and the interest rates on funds borrowed from the FHLB are favorable compared to other funding alternatives.

Total advances from the FHLB were $40.00 million at December 31, 2022 and none in 2021.

Total federal funds purchased were $82.06 million and $0.25 million as of December 31, 2022 and 2021, respectively.

The federal funds purchased and FHLB funding sources are considered when loan growth exceeds core deposit increases and the interest rates on funds borrowed from the FHLB are favorable compared to other funding alternatives.

Stockholders’ equity was $428.26 million at December 31, 2022 compared to $438.45 million at December 31, 2021.

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2020 38,647 (14.72) 4.12

Net income for 2021 increased by $9.44 million or 24.42% and diluted earnings per share increased by 25.24%.

Net income for 2022 decreased by $0.33 million or 0.69% and diluted earnings per share decreased by 0.19%.

In 2022, net interest income, before credit loss expense, increased by $10.54 million due to the following reasons:

1) decrease in interest income of $6.44 million primarily due to decreases in interest rates and 2) decrease in interest expense of $9.33 million due to interest rate decreases and decreases in the volume of certificates of deposit and FHLB borrowings.

Noninterest income increased by $5.13 million, the credit loss expense decreased by $9.87 million and total noninterest expenses increased by $5.71 million.

Annual fluctuations in the Company's net income are driven primarily by three important factors.

1) increase in interest income of $9.00 million primarily due to higher loan growth, increased volume in U.S.

Treasuries, mortgage-backed and municipal securities and higher interest rates offset by no PPP fee income in 2022 compared to $6.27 million in 2021;

and 2) decrease in interest expense of $1.54 million primarily due to decreases in the volume of certificates of deposit and FHLB borrowings.

Noninterest income decreased by $5.68 million primarily due to the decrease in net gain on the sale of loans, the credit loss expense increased by $11.85 million and total noninterest expenses decreased by $5.77 million primarily due to $7.69 million in fees incurred from the prepayment of FHLB borrowings in 2021.

Annual fluctuations in the Company's net income are driven primarily by three factors.

The first important factor is net interest margin.

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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 $3.90 million decrease or increase in income before taxes.

Net interest income for the Company increased primarily due to the continued low interest rates on interest bearing deposits resulting in decreased interest expense of $9.33 million compared to 2020.

$7.34 million of the decrease in interest expense was due to interest rate decreases and $1.99 million was primarily due to volume decreases in certificates of deposit and FHLB borrowings.

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.

Net interest income for the Company increased primarily due to higher loan growth resulting in an increase of $5.34 million, increased volume in U.S.

Treasuries, mortgage-backed and municipal securities resulting in an increase of $4.66 million and higher interest rates resulting in an increase of $6.04 million offset by no PPP fee income in 2022 compared to $6.27 million in 2021.

In addition, the decrease in interest expense was due to volume decreases in certificates of deposit and FHLB borrowings resulting in a decrease of $4.17 million offset by increased cost of funds resulting in higher interest expense of approximately $3.12 million.

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 increases by the Federal Reserve Board.

The Company believes growth in net interest income will be contingent on the growth of the Company’s earning assets and maintaining yield on loans.

The second significant factor affecting the Company's net income is the credit loss expense recorded under CECL.

The second significant factor affecting the Company's net income is the credit loss expense (benefit).

The majority of the Company's interest-earning assets are in loans outstanding, which amounted to $3.110 billion at the end of 2022.

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In addition, management considers the credit quality of the loans based on management’s review of problem and watch loans, including loans with historically higher credit risk.

Credit loss expense was a reduction of expense of $5.51 million in 2021 under CECL compared to an expense of $4.36 million in 2020 and a reduction of expense of $2.88 million in 2019 under the incurred loss model.

The decrease is attributable to improvements in the economic factor forecasts, primarily Iowa unemployment in the first quarter 2021, and continued improvement in asset quality, relative to the sizable expense taken for the first half of 2020 from management increases to qualitative factors as a result of the significant economic uncertainties surrounding the pandemic.

The Company believes that credit loss 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 will continue to have potential volatility for the foreseeable future resulting from the uncertainties due to the COVID-19 pandemic.

The third significant factor affecting the Company’s net income is noninterest income, primarily net gain on the sale of loans, services charges and trust fees.

The net gain on the sale of loans was $7.59 million and $6.68 million for the years ended December 31, 2021 and 2020, respectively, an increase of 13.63% for the year ended December 31, 2021 compared to the same period in 2020.

Credit loss expense was $6.34 million in 2022 compared to credit loss (benefit) of $5.51 million in 2021 and a loan loss expense of $4.36 million in 2020 under the incurred loss model.

The increase in credit loss expense is attributable to increases in loan volume which resulted in an increase of $4.72 million;

changes in prepayment and curtailment rates resulting in an increase of $1.00 million;

decreases in the individually analyzed loans reserve of $0.18 million;

and increases in qualitative factors determined necessary by management which resulted in an increase of $1.52 million offset by slight improvements in the economic factor forecasts, primarily Iowa unemployment, used in the ACL calculation which resulted in a decrease of $1.09 million.

The reduction in expense in 2021 was primarily due to the increases to the allowance taken in 2020 in response to the COVID-19 pandemic that were released in 2021.

The Company believes that credit loss expense is expected to be dependent on the Company’s loan growth, local economic conditions and asset quality.

The third significant factor affecting the Company’s net income is noninterest income, primarily net gain on the sale of loans.

The net gain on the sale of loans was $1.52 million and $7.59 million for the years ended December 31, 2022 and 2021, respectively, a decrease of 80.01% for the year ended December 31, 2022 compared to the same period in 2021.

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.

Services charges and fees were $11.77 million and $10.19 million for the years ended December 31, 2021 and 2020, respectively, an increase of 15.59% for the year ended December 31, 2021 compared to the same period in 2020.

This is primarily due to an increase in debit and credit card interchange fees of $1.52 million compared to 2020 with increased usage activity.

Trust fees were $13.52 million and $10.28 million for the years ended December 31, 2021 and 2020, respectively, an increase of 31.59% for the year ended December 31, 2021 compared to the same period in 2020.

This is primarily driven by the increase in assets under management of $0.37 billion from $2.18 billion as of December 31, 2020 to $2.55 billion as of December 31, 2021 and increased investment transaction activity.

The volume of activity in these types of loans is directly related to the level of interest rates as well as the current origination and refinancing activity.

The volume was significantly impacted by the Federal Reserve Board's increases to the federal funds rate in 2022, resulting in a significant decline in the amount of mortgage loan origination and refinance activity.

Net Interest Income

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The factors that have the greatest impact on net interest income are the volume of average earning assets and interest-bearing liabilities and the net interest margin.

The volume of average earning assets has continued to grow each year, primarily due to excess cash for 2021.

The volume of interest-bearing liabilities also grew in 2021 due to growth of interest-bearing demand and savings deposits.

The volume of average earning assets has continued to grow each year, primarily due to increased investments and loan growth in 2022.

The volume of interest-bearing liabilities decreased in 2022 due to decreased volume in certificates of deposit and FHLB borrowings being prepaid in December 2021.

The net interest margin was 3.00% in 2022, 2.75% in 2021 and 3.00% in 2020.

12 unchanged sentences

Time deposits 8,561 10,500 14,454

Federal funds purchased 267 — —

FHLB borrowings — 2,915 5,399

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Time deposits (77,046) (0.12) 1,256 683 1,939

Other borrowings (3) (0.46) — — —

Federal funds purchased 5,685 4.22 (27) (240) (267)

FHLB borrowings (101,895) (2.82) 2,915 — 2,915

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(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 2022, 2021 and 2020.

The net interest spread decreased 17 basis points in 2021 compared to 2020 and the net interest spread decreased 10 basis points compared to 2019.

The net interest spread increased 25 basis points in 2022 compared to 2021 and the net interest spread decreased 17 basis points compared to 2020.

(3) Net interest margin is net interest income, on a tax equivalent basis, divided by average interest-earning assets.

The net interest margin decreased 25 basis points in 2021.

The net interest margin increased 25 basis points in 2022.

The net interest margin decreased 25 basis points in 2021 compared to 2020.

In March 2020, the Federal Open Market Committee decreased the target rate to 0.25%.

The Federal Open Market Committee met eight times during 2022.

The federal funds target rate increased to 4.50% as of December 31, 2022 from 0.25% as of December 31, 2021.

Interest rates on loans are generally affected by the target rate since interest rates for the U.S.

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The one year index increased 1,112.82% from December 31, 2021, the three year index increased 335.05% and the five year index increased 216.67%.

CECL Adoption and Allowance for Credit Losses (ACL)

Current Expected Credit Losses and Allowance for Credit Losses (ACL)

The framework requires that management's estimate reflects credit losses over the full remaining expected life of each credit and considers expected future changes in macroeconomic conditions.

The adoption resulted in the recognition on January 1, 2021 of cumulative effect adjustments of $2.75 million related to the ACL for loans and $3.58 million related to the ACL on off-balance sheet credit exposures.

Credit loss expense was a reduction of expense of $5.51 million for the year ended December 31, 2021 compared to an expense of $4.36 million in 2020 under the incurred loss model, a decrease of expense of $9.87 million.

The credit loss expense includes expense of $0.27 million related to the ACL on off-balance sheet credit exposures.

Credit loss expense was $6.34 million for the year ended December 31, 2022 compared to a reduction of expense of $5.51 million in 2021, an increase of expense of $11.85 million.

The credit loss expense includes expense of $0.58 million related to the ACL on off-balance sheet credit exposures for the year ended December 31, 2022 compared to $0.27 million expense for 2021.

Credit loss expense is the amount necessary to adjust the allowance for credit losses to the level considered by management to appropriately account for the estimated current expected credit losses within the Bank's loan portfolio.

The credit loss expense taken to fund the allowance for credit losses is computed on a quarterly basis and is a result of management’s determination of the quality of the loan portfolio.

The expense reflects a number of factors, including the size of the loan portfolio, the overall composition of the loan portfolio and loan concentrations, the impact on the borrowers’ ability to repay, past loss experience, loan collateral values, the level of collateral-dependent loans and loans past due ninety days or more.

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.

Also, under CECL, a significant component in estimating expected credit losses are economic forecasts such as Iowa unemployment, all-transactions house price index for Iowa and Iowa real GDP.

The percentage of the allowance to outstanding loans was 1.33% and 1.37% at December 31, 2021 and 2020, respectively.

The credit loss expense totaled a reduction of expense of $5.51 million in 2021, an expense of $4.36 million in 2020 and a reduction of expense of $2.88 million in 2019.

Loan recoveries net of charge-offs were $1.43 million in 2021, loan charge-offs net of recoveries were $1.05 million in 2020 and loan charge-offs net of recoveries were $1.17 million in 2019.

Also, under CECL, a significant component in estimating expected credit losses are economic forecasts such as Iowa unemployment, all-transactions house price index for Iowa and Iowa real gross domestic product.

The Company believes that credit loss expense is expected to be dependent on the Company’s loan growth, local economic conditions and asset quality.

percentage of the allowance to outstanding loans was 1.33% and 1.33% at December 31, 2022 and 2021, respectively.

The credit loss expense was $6.34 million in 2022, a reduction of expense of $5.51 million in 2021 and an expense of $4.36 million in 2020.

Loan recoveries net of charge-offs were $0.21 million in 2022, loan recoveries net of charge-offs were $1.43 million in 2021 and loan charge-offs net of recoveries were $1.05 million in 2020.

Management has determined that the allowance for credit losses was appropriate at December 31, 2022, and that the loan portfolio is diversified and secured, without undue concentration in any specific risk area.

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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.

Troubled debt restructure ("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.

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Collateral-dependent loans were 0.44% of loans held for investment as of December 31, 2022 and 0.63% as of December 31, 2021.

The decrease in collateral-dependent loans is due to a decrease of $0.55 million in loans with a specific reserve, a decrease in nonaccrual loans of $0.36 million, a decrease in 90 days or more accruing loans of $0.86 million and a decrease in TDR loans of $2.33 million from December 31, 2020 to December 30, 2021.

The decrease in collateral-dependent loans is due to a decrease in nonaccrual loans of $1.68 million, a decrease in TDR loans of $2.02 million and is offset by an increase of $0.29 million in loans with a specific reserve and an increase in 90 days or more accruing loans of $0.35 million from December 31, 2021 to December 30, 2022.

There were no significant changes noted in the extent to which collateral secures collateral-dependent loans.

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The ratio of allowance for credit losses to non-performing loans increased to 305.15% as of December 31, 2022 compared to 213.25% as of December 31, 2021.

The increase in 2021 is primarily due to the reduction in non-performing loans compared to 2020.

The increase in 2022 is primarily due to the reduction in nonaccrual and TDR loans compared to 2021.

The ratio of non-performing loans to total gross loans was 0.44% and 0.63% at December 31, 2022 and 2021, respectively.

The decrease in the 2021 ratio is primarily due to the decrease in TDR loans and accruing loans past due 90 days or more.

The decrease in the 2022 ratio is primarily due to the decrease in TDR and 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.

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SUMMARY OF LOAN LOSS EXPERIENCE

The allowance for credit losses balance is also affected by the charge-offs and recoveries for the periods presented.

The allowance for credit losses is also affected by the charge-offs and recoveries for the periods presented.

For the years ended December 31, 2022, 2021 and 2020, recoveries were $2.42 million, $2.74 million and $1.87 million, respectively;

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Beginning balance $ 2,261 $ 4,269 $ 2,300 $ 3,433 $ 11,498 $ 10,498 $ 1,211 $ 35,470

Impact of adopting ASC 326 (328) 298 327 763 522 1,396 (232) 2,746

Charge-offs (357) (447) — (40) (729) (51) (589) (2,213)

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(Amounts In Thousands)

Allowance for loan losses:

Allowance for credit losses:

Beginning balance $ 2,508 $ 4,885 $ 2,319 $ 4,173 $ 12,368 $ 9,415 $ 1,402 $ 37,070

Impact of adopting ASC 326 (328) 298 327 763 522 1,396 (232) 2,746

Charge-offs (106) (136) (3) (1) (482) (265) (323) (1,316)

Recoveries 142 1,103 94 25 964 263 152 2,743

Provision 88 652 (355) 214 1,684 1,798 277 4,358

Credit loss (benefit) expense 45 (1,881) (437) (1,527) (1,874) (311) 212 (5,773)

Ending balance $ 2,261 $ 4,269 $ 2,300 $ 3,433 $ 11,498 $ 10,498 $ 1,211 $ 35,470

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Other noninterest income 1,333 581 1,187 752 (606) 129.43 (51.05)

Gain (loss) on sale of investment securities $ — $ 10 $ (28) (10) 38 (100.00) (135.71)

Gain on sale of investment securities $ — $ — $ 10 — (10) — (100.00)

$ 27,780 $ 33,464 $ 28,336 $ (5,684) $ 5,128 (16.99) % 18.10 %

The noninterest income of the Company was $27.78 million in 2022 compared to $33.46 million in 2021.

The increase of $5.13 million in 2021 was the result of a combination of factors discussed below.

The decrease of $5.68 million in 2022 was the result of a combination of factors discussed below.

The amount of the net gain on sale of secondary market mortgage loans in each year can vary significantly.

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.

The volume of activity in these types of loans is directly related to the level of interest rates as well as the current origination and refinancing activity.

The volume was significantly impacted by the Federal Reserve Board's increases to the federal funds rate in 2022, resulting in a

significant decline in the amount of mortgage loan origination and 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 were $12.28 million and $13.52 million for the years ended December 31, 2022 and 2021, respectively, a decrease of 9.15% for the year ended December 31, 2022 compared to the same period in 2021.

This is primarily driven by the decrease in assets under management of $0.291 billion from $2.553 billion as of December 31, 2021 to $2.262 billion as of December 31, 2022 and decreased investment transaction activity.

The trust assets that are the most volatile are those that are held in common stocks, which amount to approximately 68% of assets under management.

In 2021, the Dow Jones Industrial Average increased 18.73%.

In 2022, the Dow Jones Industrial Average decreased 8.78%.

Services charges and fees were $12.64 million and $11.77 million for the years ended December 31, 2022 and 2021, respectively, an increase of 7.41% for the year ended December 31, 2022 compared to the same period in 2021.

This is primarily due to an increase in debit and credit card interchange fees of $1.52 million compared to 2020 with increased usage activity.

Other noninterest income decreased $0.61 million in 2021 primarily due to the net loss recognized on the tax credit real estate.

This is primarily due to an increase in debit and credit card interchange fees of $0.39 million compared to 2021 with increased usage activity and an increase in overdraft and non-sufficient funds fees of $0.47 million compared to 2021.

Other noninterest income increased $0.75 million in 2022 primarily due to a lower net loss recognized on the tax credit real estate compared to 2021.

Noninterest Expenses

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Total noninterest expenses were $75.58 and $81.34 million for the years ended December 31, 2022 and 2021, respectively.

The increase is $5.71 million or 7.55% in 2021 and an increase of $8.37 million or 12.44% in 2020.

The decrease is $5.77 million or 7.09% in 2022 and an increase of $5.71 million or 7.55% in 2021.

Salaries and employee benefits increased $1.01 million in 2022.

The increase is primarily the result of annual salary adjustments.

Outside services increased $1.52 million in 2021 compared to 2020 primarily due to increased debit and credit card processing charges with increase usage activity.

Other noninterest expenses increased $2.44 million in 2021 primarily due to $7.69 million in fees incurred from the prepayment of FHLB borrowings compared to $2.53 million of FHLB prepayment fees and $2.68 million of interest rate swap termination fees paid in 2020.

Other noninterest expenses decreased $7.59 million in 2022 primarily due to $7.69 million in fees incurred from the prepayment of FHLB borrowings in 2021.

Income tax expense was $13.11, $14.01 and $11.28 million for the years ended December 31, 2022, 2021 and 2020, respectively.

The Company's income tax expense included a one-time increase in state income tax expense related to the 2022 enactment of changes in the Iowa bank franchise tax rates.

This legislation reduces the Iowa bank franchise tax rate applied to apportioned income for 2023 and future years and required the Company to reduce net deferred tax assets and increase income tax expense.

Income taxes as a percentage of income before income taxes were 21.55% in 2022, 22.56% in 2021 and 22.59% in 2020.

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As of December 31, 2022, the Company had additional borrowing capacity available from the FHLB of $955.12 million.

The Company had $40.00 million outstanding in FHLB overnight borrowings as of December 31, 2022.

In addition, the Company had $87.94 million in borrowing capacity available through secured and unsecured lines of credit with correspondent banks.

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For more information regarding regulatory capital requirements, see the section under Part I, Item 1 to this 10-K captioned “Supervision and Regulation.”

On a consolidated basis, 2021 cash flows from operations provided $85.07 million, net increases in deposits provided $341.43 million and net collections on loans to customers provided $52.02 million.

These cash flows were invested $245.38 million in purchases of investment securities.

In addition, $1.46 million was used to purchase property and equipment and leasehold improvements and $4.18 million was used to invest in a tax credit real estate property.

On a consolidated basis, 2022 cash flows from operations provided $56.46 million, proceeds from maturities of investments available for sale provided $78.04 million and proceeds from FHLB borrowings and federal funds purchased provided $121.81 million.

These cash flows and cash and cash equivalents of $781.92 million as of December 31, 2021 were invested $358.98 million in purchases of investment securities and $447.84 million of loans made to customers.

In addition, $1.91 million was used to purchase property and equipment.

The Bank has a contingency funding plan to address liquidity issues in times of crisis.

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Weighted average interest rate for the year 4.62 % 2.82 % 2.93 %

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 2022, 2021 and 2020:

2022 2021 2020

(Amounts In Thousands)

Outstanding balance as of December 31 $ 82,061 $ 249 $ —

Weighted average interest rate at year end 4.73 % 0.47 % — %

Maximum month-end balance 82,061 249 —

Average month-end balance 3,648 6 —

Weighted average interest rate for the year 4.73 % 0.47 % 0.93 %

The Bank has off-balance sheet commitments to fund additional borrowings of customers.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis