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 consolidated financial statements and the accompanying notes thereto included or incorporated by reference elsewhere in this document. For a discussion on the comparison of results of operations for the years ended December 31, 2021 and 2020, refer to Item 7. “Management's Discussion and Analysis of Financial Condition and Results of Operation” in the Company’s Annual Form 10-K filed with the SEC on March 4, 2022. An overview of the year 2022 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. 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. • The financial strength of the counterparties with which the Company or the Company’s customers do business and as to which the Company has investment or financial exposure. • The credit quality and credit agency ratings of the securities in the Company’s investment securities portfolio, a deterioration or downgrade of which could lead to recognition of an allowance for credit losses on the affected securities and the recognition of a credit loss. • The effects of, and changes in, laws, regulations and policies affecting banking, securities, insurance and monetary and financial matters as well as any laws otherwise affecting the Company, including, but not limited to, 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. • 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. Page 27 Table of Contents • Consumer spending and saving habits which may change in a manner that affects the Company’s business adversely. • The economic impact of natural disasters, diseases and/or pandemics, including any extended impact from the COVID-19 pandemic, and terrorist attacks and military actions. • Business combinations and the integration of acquired businesses and assets which may be more difficult or expensive than expected. • The costs, effects and outcomes of existing or future litigation. • Changes in accounting policies and practices that may be adopted by state and federal regulatory agencies and the 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. Economic Environment U.S. 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, 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. 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 2022 was $47.75 million compared to $48.09 million in 2021 and $38.65 million in 2020. Diluted earnings per share were $5.15, $5.16, and $4.12 for the years ended December 31, 2022, 2021 and 2020, 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, 2022 and 2021, the Bank achieved a net interest margin of 3.00% and 2.75%, respectively. For the Page 28 Table of Contents 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 $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, 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. Page 29 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 credit losses. Allowance for Credit Losses On January 1, 2021, the Company adopted ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments , which requires the allowance for credit losses use the current expected credit loss (CECL) methodology. The following is a discussion of the methodologies used by the Company with the adoption of ASC 326. The preparation of financial statements in accordance with the accounting principles generally accepted in the United States ("U.S. GAAP") requires management to make a number of judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, income and expense in the financial statements. Various elements of our accounting policies, by their nature, involve the application of highly sensitive and judgmental estimates and assumptions. Some of these policies and estimates relate to matters that are highly complex and contain substantial inherent uncertainties. Management has made significant estimates in several areas, including the allowance for credit losses (see Note 3 - Loans and Note 2 - Securities) and the fair value of debt securities (see Note 2 - Securities). We have identified the following accounting policies and estimates that, due to the inherent judgments and assumptions and the potential sensitivity of the financial statements to those judgments and assumptions, are critical to an understanding of our financial statements. We believe that the judgments, estimates and assumptions used in the preparation of the Company's financial statements are appropriate. For a further description of our accounting policies, see Note 1 - Summary of Significant Accounting Policies in the financial statements included in this Form 10-K. The allowance for credit losses for loans represents management's estimate of all expected credit losses over the expected contractual life of our existing loan portfolio. Determining the appropriateness of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. Subsequent evaluations of the then-existing loan portfolio, in light of the factors then prevailing, may result in significant changes in the allowance for credit losses in those future periods. We employ a disciplined process and methodology to establish our allowance for credit losses that has two basic components: first, an asset-specific component involving individual loans that do not share risk characteristics with other loans and the measurement of expected credit losses for such individual loans; and second, a pooled component for estimated expected credit losses for pools of loans that share similar risk characteristics. Based upon this methodology, management establishes an asset-specific allowance for loans that do not share risk characteristics with other loans based on the amount of expected credit losses calculated on those loans and charges off amounts determined to be uncollectible. Factors we consider in measuring the extent of expected credit loss include payment status, collateral value, borrower financial condition, guarantor support and the probability of collecting scheduled principal and interest payments when due. When a loan does not share risk characteristics with other loans, we measure expected credit loss as the difference between the amortized cost basis in the loan and the present value of expected future cash flows discounted at the loan's effective interest rate except that, for collateral-dependent loans, credit loss is measured as the difference between the amortized cost basis in the loan and the fair value of the underlying collateral. The fair value of the collateral is adjusted for the estimated cost to sell if repayment or satisfaction of a loan is dependent on the sale (rather than only on the operation) of the collateral. In accordance with our appraisal policy, the fair value of collateral-dependent loans is based upon independent third-party appraisals or on collateral valuations prepared by in-house evaluations. Once a third-party appraisal is greater than one year old, or if its determined that market conditions, changes to the property, changes in intended use of the property or other factors indicate that an appraisal is no longer reliable, we perform an internal collateral valuation to assess whether a change in collateral value requires an additional adjustment to carrying value. When we receive an updated appraisal or collateral valuation, management reassesses the need for adjustments to the loan's expected credit loss measurements and, where appropriate, records an adjustment. If the calculated expected credit loss is determined to be permanent, fixed or nonrecoverable, the credit loss portion of the loan will be charged off against the allowance for credit losses. Loans designated having significantly increased credit Page 30 Table of Contents risk are generally placed on nonaccrual and remain in that status until all principal and interest payments are current and the prospects for future payments in accordance with the loan agreement are reasonably assured, at which point the loan is returned to accrual status. In estimating the component of the allowance for credit losses for loans that share common risk characteristics, loans are segregated into loan classes. Loans are designated into loan classes based on loans pooled by product types and similar risk characteristics or areas of risk concentration. Credit loss assumptions are estimated using a model that categorizes loan pools based on loan type and purpose. This model calculates an expected life-of-loan loss percentage for each loan category by considering the probability of default using historical life-of-loan analysis periods for agricultural, 1 to 4 family first and junior liens, commercial and consumer segments, and the severity of loss, based on the aggregate net lifetime losses incurred per loan class. The component of the allowance for credit losses for loans that share common risk characteristics also considers factors for each loan class to adjust for differences between the historical period used to calculate historical default and loss severity rates and expected conditions over the remaining lives of the loans in the portfolio related to: • Lending policies and procedures; • International, national, regional and local economic business conditions and developments that affect the collectability of the portfolio, including the condition of various markets; • The nature of the loan portfolio, including the terms of the loans; • The experience, ability and depth of the lending management and other relevant staff; • The volume and severity of past due and adversely classified or graded loans and the volume of nonaccrual loans; • The quality of our loan review and process; • The value of underlying collateral for collateral-dependent loans; • The existence and effect of any concentrations of credit and changes in the level of such concentrations; and • The effect of external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the existing portfolio. Such factors are used to adjust the historical probabilities of default and severity of loss so that they reflect management expectation of future conditions based on a reasonable and supportable forecast. To the extent the lives of the loans in the portfolio extend beyond the period for which a reasonable and supportable forecast can be made, the bank reduces, on a straight-line basis over the remaining life of the loans, the adjustments so that model reverts back to the historical rates of default and severity of loss. The credit loss expense recorded through earnings is the amount necessary to maintain the allowance for credit losses at the amount of expected credit losses inherent within the loans held for investment portfolio. The amount of expense and the corresponding level of allowance for credit losses for loans are based on our evaluation of the collectability of the loan portfolio based on historical loss experience, reasonable and supportable forecasts, and other significant qualitative and quantitative factors. The allowance for credit losses for loans, as reported in our consolidated balance sheet, is adjusted by a credit loss expense, which is recognized in earnings, and reduced by the charge-off of loan amounts, net of recoveries. For further information on the allowance for credit losses for loans, see Note 1 - Summary of Significant Accounting Policies and Note 3 - Loans in the notes to the financial statements of this Form 10-K. 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. Page 31 Table of Contents Financial Position Year End Amounts 2022 2021 2020 2019 2018 (Amounts In Thousands) Total assets $ 3,980,481 $ 4,044,562 $ 3,782,362 $ 3,302,550 $ 3,044,037 Investment securities 782,565 555,900 416,544 366,368 331,098 Loans held for sale 1,663 5,716 43,947 8,400 1,984 Loans, net 3,066,981 2,625,062 2,674,012 2,606,277 2,591,085 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 Redeemable common stock 51,011 50,013 47,329 51,826 48,870 Stockholders' equity 428,260 438,450 416,076 375,211 334,882 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. Loans held for investment represent the largest component of the Bank’s earning assets. 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 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. The Company held participations purchased of $16.20, $17.18 and $19.83 million as of December 31, 2022, 2021 and 2020, respectively. The participations purchased were less than one percent of loans held for investment for each of the three years. 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 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. 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 Page 32 Table of Contents 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. The following table shows the composition of loans (before deducting the allowance for credit 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. 2022 2021 2020 2019 2018 Agricultural $ 112,705 $ 106,933 $ 94,842 $ 91,317 $ 92,673 Commercial and financial 269,568 222,002 286,242 221,323 229,501 Real estate: Construction, 1 to 4 family residential 92,408 80,486 71,117 80,209 72,279 Construction, land development and commercial 196,240 127,021 111,913 108,410 113,807 Mortgage, farmland 256,570 232,744 247,142 242,730 236,454 Mortgage, 1 to 4 family first liens 1,130,989 909,564 892,089 910,742 912,059 Mortgage, 1 to 4 family junior liens 124,951 114,342 127,833 149,227 152,625 Mortgage, multi-family 436,952 382,792 374,014 350,761 352,434 Mortgage, commercial 402,842 401,377 417,139 402,181 383,314 Loans to individuals 36,675 32,687 31,325 32,308 30,072 Obligations of state and political subdivisions 48,213 50,285 56,488 49,896 52,725 $ 3,108,113 $ 2,660,233 $ 2,710,144 $ 2,639,104 $ 2,627,943 Net unamortized fees and costs 308 299 938 933 952 $ 3,108,421 $ 2,660,532 $ 2,711,082 $ 2,640,037 $ 2,628,895 Less allowance for credit losses 41,440 35,470 37,070 33,760 37,810 $ 3,066,981 $ 2,625,062 $ 2,674,012 $ 2,606,277 $ 2,591,085 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, 2022: Amount Of Loans Amounts Due in One Year Or Less (1) Amounts Due in One To Five Years Amounts Due in Five To Fifteen Years Amounts Due in Over Fifteen Years (Amounts In Thousands) Commercial and Agricultural $ 1,763,657 $ 375,853 $ 1,102,823 $ 248,822 $ 36,159 Real Estate (2) 1,257,281 144,245 668,747 408,638 35,651 Other 87,175 8,925 30,925 21,420 25,905 Totals $ 3,108,113 $ 529,023 $ 1,802,495 $ 678,880 $ 97,715 The types of interest rates applicable to these principal payments are shown below: Fixed rate $ 1,969,450 $ 383,369 $ 1,177,275 $ 312,262 $ 96,544 Variable rate 1,138,663 145,654 625,220 366,618 1,171 $ 3,108,113 $ 529,023 $ 1,802,495 $ 678,880 $ 97,715 (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 33 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 and estimated median income information as of December 31, 2022, 2021 and 2020. Unemployment Rate % Median Income 2022 2021 2020 2022 2021 2020 United States 3.5 % 3.9 % 6.7 % $ 69,021 $ 67,521 $ 68,703 State of Iowa 3.1 % 3.5 % 3.1 % 68,326 64,386 62,995 Johnson County 2.3 % 2.5 % 2.8 % 73,102 68,510 66,353 Linn County 3.5 % 3.3 % 3.8 % 68,757 69,363 66,163 Washington County 2.7 % 2.5 % 2.7 % 71,756 68,975 63,938 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 decreased by $176.63 million in 2022. Deposits increased by $341.43 million in 2021. As of June 30, 2022 (latest data available from the FDIC), Johnson County total deposits were $13.018 billion and the Company’s deposits were $2.317 billion, which represent a 17.80% market share. The Company had nine office locations in Johnson County as of June 30, 2022. 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. As of June 30, 2022, Linn County total deposits were $8.487 billion and there were 101 total banking locations in the county. The seven Linn County offices of the Company had deposits of $813 million or a 9.6% share of the market. The Company’s Linn County deposits at June 30, 2021 were $764 million and represented a 8.9% market share. As of June 30, 2022, the Company’s three Washington County offices had deposits of $317 million which was 33.5% of the County’s total deposits of $945 million. Washington County had a total of 14 banking locations as of June 30, 2022. In 2021, the Company’s Washington County deposits were $287 million or a 34.5% 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, 2022, 2021 and 2020 and the composition of the certificates of deposit issued in denominations in excess of $250,000 as of December 31, 2022, 2021 and 2020: December 31, 2022 Rate 2021 Rate 2020 Rate (Amounts In Thousands) Average noninterest-bearing deposits $ 647,286 — $ 578,931 — $ 459,664 — Average interest-bearing demand deposits 1,105,811 0.22 % 1,062,059 0.22 % 876,595 0.48 % Average savings deposits 1,163,316 0.17 1,093,560 0.17 875,091 0.32 Average time deposits 566,888 1.63 643,934 1.63 695,468 2.07 $ 3,483,301 $ 3,378,484 $ 2,906,818 Uninsured deposits $ 800,806 $ 884,402 $ 687,612 Time certificates issued in amounts of $250,000 or more with maturity in: 2022 Rate (Amounts In Thousands) 3 months or less $ 10,921 1.89 % 3 through 6 months 11,122 2.17 6 through 12 months 17,697 2.70 Over 12 months 49,068 2.01 $ 88,808 Portion uninsured $ 31,808 Page 34 Table of Contents Investment securities increased $226.67 million in 2022. In 2021, investment securities increased by $139.36 million. 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. 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, 2022, 2021 and 2020 and the maturities and weighted average yields of the investment securities, computed using amortized cost on a tax-equivalent basis using a federal tax rate of 21%, as of December 31, 2022: December 31, 2022 2021 2020 (Amounts In Thousands) Carrying value: U.S. Treasury $ 445,392 $ 243,925 $ 148,646 Other securities (FHLB, FHLMC and FNMA) 31,934 34,467 35,160 Stock of the Federal Home Loan Bank 6,461 4,546 8,172 Mortgage-backed securities and collateralized mortgage obligations 50,196 9,446 — State and political subdivisions 248,582 263,516 224,566 $ 782,565 $ 555,900 $ 416,544 December 31, 2022 Carrying Value Weighted Average Yield (Amounts In Thousands) U.S. Treasury Within 1 year $ 73,566 2.06 % From 1 to 5 years 371,826 1.72 From 5 to 10 years $ — — $ 445,392 Other securities (FHLB, FHLMC and FNMA), maturities: Within 1 year $ — — % From 1 to 5 years 31,934 0.42 From 5 to 10 years — — $ 31,934 Stock of the Federal Home Loan Bank $ 6,461 3.09 % State and political subdivisions, maturities: Within 1 year $ 34,643 2.94 % From 1 to 5 years 77,228 2.79 From 5 to 10 years 98,786 2.41 Over 10 years 37,925 2.35 $ 248,582 Mortgage Backed Securities From 1 to 5 years $ — — % From 5 to 10 years 50,196 2.38 $ 50,196 Total $ 782,565 Page 35 Table of Contents As of December 31, 2022, 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. 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 $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. 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 $216.57 million and paid shareholders dividends of $41.06 million, or 18.96% 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, 2022, 2021 and 2020: 2022 2021 2020 Return on average assets 1.20 % 1.21 % 1.09 % Return on average stockholders' equity 11.32 11.29 9.82 Dividend payout ratio 19.48 18.24 21.54 Average stockholders' equity to average assets ratio 10.58 10.70 11.07 Net Income Overview Net income and diluted earnings per share for the last three years are as presented below: Year Net Income % (Decrease) Increase Earnings Per Share - Diluted (In Thousands) 2022 $ 47,753 (0.69) % $ 5.15 2021 48,085 24.42 % 5.16 2020 38,647 (14.72) 4.12 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) 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. Page 36 Table of Contents Annual fluctuations in the Company's net income are driven primarily by three factors. The first important factor is net interest margin. Net interest income of $115.00 million in 2022 was derived from the Company's $3.904 billion of average earning assets and its net interest margin of 3.00%, compared to $3.866 billion of average earning assets and a 2.75% net interest margin in 2021. 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 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 (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. The Company’s allowance for credit losses was $41.44 million at December 31, 2022. Expected credit loss expense is computed on a quarterly basis and 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 expense reflects a number of factors, including the size of the loan portfolio, the overall composition of the loan portfolio and loan concentrations, the borrowers’ ability to repay, past loss experience, loan collateral values, current economic conditions, reasonable and supportable economic forecasts, adjustments for prepayments and curtailments, 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 problem and watch loans, including loans with historically higher credit risk. 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 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. Page 37 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 interest-bearing liabilities and the net interest margin. 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. The measure is shown on a tax-equivalent basis using a rate of 21% for 2022, 2021 and 2020 to make the interest earned on taxable and nontaxable assets more comparable. Interest income and expense for 2022, 2021 and 2020 are indicated on the following table: Years Ended December 31, 2022 2021 2020 (Amounts In Thousands) Income: Loans (1) $ 115,919 $ 114,202 $ 120,814 Taxable securities 8,662 3,604 3,512 Nontaxable securities (1) 5,558 5,177 5,201 Interest-bearing cash and cash equivalents 2,889 983 945 Total interest income $ 133,028 $ 123,966 $ 130,472 Expense: Interest-bearing demand deposits 4,084 2,385 4,258 Savings deposits 3,173 1,827 2,841 Time deposits 8,561 10,500 14,454 Federal funds purchased 267 — — FHLB borrowings — 2,915 5,399 Total interest expense $ 16,085 $ 17,627 $ 26,952 Net interest income $ 116,943 $ 106,339 $ 103,520 (1) Presented on a tax equivalent basis using a rate of 21% for 2022, 2021 and 2020. Interest income includes certain loan origination and document preparation fees, which comprise approximately 1.5% of the amounts indicated. Net interest income on a tax-equivalent basis changed in 2022 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 $ 142,714 (0.16) % $ 5,338 $ (3,621) $ 1,717 Taxable securities 270,895 0.22 3,952 1,106 5,058 Nontaxable securities 22,807 (0.06) 528 (147) 381 Interest-bearing cash and cash equivalents (398,446) 0.69 (522) 2,428 1,906 Federal funds sold 75 0.29 — — — $ 38,045 $ 9,296 $ (234) $ 9,062 Interest expense: Interest-bearing demand deposits $ 43,752 0.15 % $ (98) $ (1,602) $ (1,700) Savings deposits 69,756 0.11 (67) (1,278) (1,345) Time deposits (77,046) (0.12) 1,256 683 1,939 Federal funds purchased 5,685 4.22 (27) (240) (267) FHLB borrowings (101,895) (2.82) 2,915 — 2,915 Interest-bearing other liabilities — — — — — $ (59,748) $ 3,979 $ (2,437) $ 1,542 Change in net interest income $ 13,275 $ (2,671) $ 10,604 Page 38 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 2021 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 $ (60,288) (0.14) % $ (2,959) $ (3,653) $ (6,612) Taxable securities 68,311 (0.51) 1,005 (913) 92 Nontaxable securities 27,333 (0.34) 724 (748) (24) Interest-bearing cash and cash equivalents 388,817 (0.13) 1,009 (971) 38 Federal funds sold (19) (0.09) — — — $ 424,154 $ (221) $ (6,285) $ (6,506) Interest expense: Interest-bearing demand deposits $ 185,464 (0.26) % $ (887) $ 2,760 $ 1,873 Savings deposits 218,469 (0.16) (609) 1,623 1,014 Time deposits (51,535) (0.44) 1,108 2,846 3,954 Other borrowings (3) (0.46) — — — FHLB borrowings (79,198) (0.11) 2,369 115 2,484 Interest-bearing other liabilities — — — — — $ 273,197 $ 1,981 $ 7,344 $ 9,325 Change in net interest income $ 1,760 $ 1,059 $ 2,819 Page 39 Table of Contents A summary of the average yields, average rates paid, net interest spread and margin is as follows: Years Ended December 31, 2022 2021 2020 Average yields: Loans (1) 4.14 % 4.30 % 4.44 % Loans (tax equivalent basis) (1) 4.16 4.32 4.46 Taxable securities 1.67 1.45 1.96 Nontaxable securities 1.71 1.74 1.99 Nontaxable securities (tax equivalent basis) 2.25 2.31 2.65 Interest-bearing cash and cash equivalents 0.82 0.13 0.26 Federal funds sold 0.31 0.03 0.11 Average rates paid: Interest-bearing demand deposits 0.37 0.22 0.48 Savings deposits 0.27 0.17 0.32 Time deposits 1.51 1.63 2.07 Short-term borrowings 4.69 0.47 0.93 FHLB borrowings — 2.82 2.93 Yield on average interest-earning assets 3.41 3.20 3.78 Rate on average interest-bearing liabilities 0.57 0.61 1.02 Net interest spread (2) 2.84 2.59 2.76 Net interest margin (3) 3.00 2.75 3.00 (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 2022, 2021 and 2020. 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 increased 25 basis points in 2022. The net interest margin decreased 25 basis points in 2021 compared to 2020. 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. 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, 2022, the average rate indexes for the one, three and five year indexes were 4.73%, 4.22% and 3.99%, respectively. 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%. 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 $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. 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. The Page 40 Table of Contents 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. This process involves a high degree of management judgment; however, the allowance for credit 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 credit losses is reviewed and compared to industry peers. This review encompasses levels of total nonperforming loans, portfolio mix, portfolio concentrations, current geographic risks and overall levels of net charge-offs. However, there is no assurance losses will not exceed the allowance, and any growth in the loan portfolio or uncertainty in the general economy will require that management continue to evaluate the adequacy of the ACL and make additional provisions in future periods as deemed necessary. 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 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 an additional specific reserve 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. 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. The Bank regularly reviews loans in the portfolio and assesses whether the loans are nonperforming. If the loans are nonperforming, the Bank determines if a specific reserve 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. The extent to which collateral secures collateral-dependent loans and changes in the extent to which collateral secures its collateral-dependent loans are described below. Collateral-dependent loans decreased $3.05 million from December 31, 2021 to December 31, 2022. Collateral-dependent loans include any loan that has been placed on nonaccrual status, accruing loans past due 90 days or more and TDR loans. Collateral-dependent loans also include loans that, based on management’s evaluation of current information and events, the Company expects to be unable to collect in full according to the contractual terms of the original loan agreement. 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 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. See Note 1 Adoption of New Financial Accounting Standard for further discussion of the allowance for credit losses for loans held for investment. A description of the Bank's credit quality indicators are discussed in Note 3 to the Company's Consolidated Financial Statements. Page 41 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: 2022 2021 2020 2019 2018 (Amounts In Thousands) Nonaccrual loans (1) $ 6,815 $ 8,491 $ 8,849 $ 10,768 $ 10,829 Accruing loans past due 90 days or more (2) 553 201 1,056 606 370 Specific reserve loans 307 20 573 243 8,247 Troubled debt restructurings ("TDR loans")(1) (3) 5,905 7,921 10,251 9,308 8,539 Total non-performing loans $ 13,580 $ 16,633 $ 20,729 $ 20,925 $ 27,985 Other real estate — — — — — Non-performing assets (includes impaired loans and other real estate) $ 13,580 $ 16,633 $ 20,729 $ 20,925 $ 27,985 Loans held for investment $3,108,113 $2,660,233 $2,710.144 $2,639.104 $2,627,943 Ratio of allowance for credit losses to loans held for investment 1.33 % 1.33 % 1.37 % 1.28 % 1.44 % Ratio of allowance for credit losses to non-performing loans 305.15 213.25 178.83 161.34 135.11 Ratio of non-performing loans to total loans held for investment 0.44 0.63 0.76 0.79 1.06 Ratio of non-performing assets to total assets 0.34 0.41 0.55 0.63 0.92 (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 $0.37 million in 2022 and $0.46 million in 2021. The amount of interest income on the loans that was included in income was $0.33 million in 2022 and $0.44 million in 2021. (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 $7.66, $10.20, $13.22, $13.71 and $13.38 million as of December 31, 2022, 2021, 2020, 2019 and 2018, respectively. Included in the total nonaccrual loans were $1.75, $2.28, $2.97, $4.34 and $4.84 million of TDR loans as of December 31, 2022, 2021, 2020, 2019 and 2018, respectively. 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 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 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. 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, 2022, the unemployment levels in Johnson County and Linn County were 2.3% and 3.5%, respectively, compared to 2.5% and 3.3% in December of 2021. These levels compare favorably to the State of Iowa at 3.1% and the national unemployment level at 3.5% in December 2022 compared to 3.5% and 3.9%, respectively in December 2021. The residential rental vacancy rates in 2021 and 2022 in Johnson and Linn County were estimated between 6.0% and 8.0%. The State of Iowa vacancy rate is 6.7% and the national rate is 5.8% with the Midwest rate at 6.9%. These vacancy rates one year ago were 7.5%, 5.6% and 6.5%, 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 2023, 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 42 Table of Contents SUMMARY OF LOAN LOSS EXPERIENCE 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; charge-offs were $2.21 million, $1.32 million and $2.92 million in 2022, 2021 and 2020, respectively. Overall credit quality may deteriorate in 2023. Such deterioration could cause increases in non-performing loans, allowance for credit losses, credit loss expense and net charge-offs. Management will monitor changing market conditions as a part of its allowance for credit 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) 2022 Allowance for credit losses: Beginning balance $ 2,261 $ 4,269 $ 2,300 $ 3,433 $ 11,498 $ 10,498 $ 1,211 $ 35,470 Charge-offs (357) (447) — (40) (729) (51) (589) (2,213) Recoveries 83 584 48 296 898 361 153 2,423 Credit loss (benefit) expense 555 1,853 1,841 (700) 2,541 (1,392) 1,062 5,760 Ending balance $ 2,542 $ 6,259 $ 4,189 $ 2,989 $ 14,208 $ 9,416 $ 1,837 $ 41,440 Net charge-offs/(net recoveries) to average net loans outstanding 0.25 % (0.06) % (0.02) % (0.10) % (0.01) % (0.04) % 0.52 % (0.01) % 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) 2021 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 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 Net charge-offs/(net recoveries) to average net loans outstanding (0.04) % (0.38) % (0.05) % (0.01) % (0.05) % — % 0.20 % (0.05) % Page 43 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) 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 Net charge-offs/(net recoveries) to average net loans outstanding (0.02) % 0.30 % (0.04) % — % — % 0.03 % 0.24 % 0.04 % 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 Net charge-offs/(net recoveries) to average net loans outstanding 0.19 % 0.15 % 0.02 % — % 0.02 % 0.02 % 0.33 % 0.04 % 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 Net charge-offs/(net recoveries) to average net loans outstanding (0.03) % (0.21) % (0.08) % (0.01) % 0.02 % 0.02 % 0.48 % — % Page 44 Table of Contents ALLOCATION OF THE ALLOWANCE FOR CREDIT LOSSES The following table presents the allowance for credit 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, 2022, 2021, 2020, 2019 and 2018: 2022 2021 Amount % of Total Allowance % of Loans to Total Loans Amount % of Total Allowance % of Loans to Total Loans (In Thousands) (In Thousands) Agricultural $ 2,542 6.13 % 3.63 % $ 2,261 6.37 % 4.02 % Commercial and financial 6,259 15.10 8.67 4,269 12.04 % 8.35 Real estate: Construction, 1 to 4 family residential 1,111 2.68 2.97 818 2.31 % 3.03 Construction, land development and commercial 3,078 7.43 6.31 1,482 4.18 % 4.77 Mortgage, farmland 2,989 7.21 8.25 3,433 9.68 % 8.75 Mortgage, 1 to 4 family first liens 11,147 26.91 36.40 8,340 23.52 % 34.19 Mortgage, 1 to 4 family junior liens 3,061 7.39 4.02 3,158 8.90 % 4.30 Mortgage, multi-family 4,435 10.70 14.06 3,715 10.47 % 14.39 Mortgage, commercial 4,981 12.02 12.96 6,783 19.12 % 15.09 Loans to individuals 1,397 3.37 1.18 771 2.17 % 1.23 Obligations of state and political subdivisions 440 1.06 1.55 440 1.24 % 1.88 $ 41,440 100.00 % 100.00 % $ 35,470 100.00 % 100.00 % 2020 2019 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 % Page 45 Table of Contents 2018 Amount % of Total Allowance % of Loans to Total Loans (In Thousands) Agricultural $ 2,789 7.38 % 3.53 % Commercial and financial 5,826 15.41 % 8.73 Real estate: Construction, 1 to 4 family residential 1,297 3.43 % 2.75 Construction, land development and commercial 1,995 5.28 % 4.33 Mortgage, farmland 3,972 10.51 % 9.00 Mortgage, 1 to 4 family first liens 10,750 28.43 % 34.71 Mortgage, 1 to 4 family junior liens 1,766 4.67 % 5.81 Mortgage, multi-family 4,083 10.80 % 13.41 Mortgage, commercial 4,082 10.80 % 14.58 Loans to individuals 723 1.91 % 1.14 Obligations of state and political subdivisions 527 1.38 2.01 $ 37,810 100.00 % 100.00 % The Company believes that the allowance for credit 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 non-performing loans, charge-offs and delinquencies could rise and require increases in the allowance for credit 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, 2022, 2021 and 2020. Year Ended December 31, $ Change % Change 2022 2021 2020 2022/2021 2021/2020 2022/2021 2021/2020 (Amounts in thousands) Net gain on sale of loans $ 1,517 $ 7,588 $ 6,678 $ (6,071) $ 910 (80.01) % 13.63 % Trust fees 12,284 13,521 10,275 (1,237) 3,246 (9.15) 31.59 Service charges and fees 12,646 11,774 10,186 872 1,588 7.41 15.59 Other noninterest income 1,333 581 1,187 752 (606) 129.43 (51.05) 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 decrease of $5.68 million in 2022 was the result of a combination of factors discussed below. 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 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 Page 46 Table of Contents 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 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 $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 The following table sets forth the various categories of noninterest expenses for the year ended December 31, 2022, 2021 and 2020. Year Ended December 31, $ Change % Change 2022 2021 2020 2022/2021 2021/2020 2022/2021 2021/2020 (Amounts in thousands) Salaries and employee benefits $ 43,468 $ 42,458 $ 40,621 $ 1,010 $ 1,837 2.38 % 4.52 % Occupancy 4,549 4,152 4,343 397 (191) 9.56 (4.40) Furniture and equipment 6,937 7,276 7,357 (339) (81) (4.66) (1.10) Office supplies and postage 1,837 1,739 1,799 98 (60) 5.64 (3.34) Advertising and business development 2,576 2,132 2,082 444 50 20.83 2.40 Outside services 12,766 12,592 11,069 174 1,523 1.38 13.76 FDIC insurance assessment 1,079 1,043 856 36 187 3.45 21.85 Other noninterest expense 2,363 9,949 7,504 (7,586) 2,445 (76.25) 32.58 $ 75,575 $ 81,341 $ 75,631 $ (5,766) $ 5,710 (7.09) % 7.55 % Total noninterest expenses were $75.58 and $81.34 million for the years ended December 31, 2022 and 2021, respectively. 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. 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. Page 47 Table of Contents Income Taxes 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. The amount of tax credits were $0.48, $0.48 and $0.05 million for 2022, 2021, and 2020, 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, 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. The Company had $82.06 million outstanding under those federal funds lines as of December 31, 2022. On an unconsolidated basis, the Company had cash balances of $0.60 million as of December 31, 2022. In 2022, the Company received dividends of $12.81 million from its subsidiary Bank and used those funds to pay dividends to its stockholders of $9.30 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 $7.91 and $3.57 million for the years ended December 31, 2022 and 2021, respectively. As of December 31, 2022 and 2021, stockholders' equity, before deducting for the maximum cash obligation related to the ESOP, was $479.27 million and $488.46 million, respectively. This measure of stockholders’ equity as a percent of total assets was 12.04% at December 31, 2022 and 12.08% at December 31, 2021. As of December 31, 2022, total equity, after deducting the maximum cash value related to the ESOP, was 10.76% of assets compared to 10.84% 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 48 Table of Contents 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. 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, 2022, the Bank had total outstanding loan commitments and unused portions of lines of credit totaling $708.35 million (see Note 16 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, 2022, the Bank can obtain an additional $955.12 million from the FHLB based on the current real estate mortgage loans held. In addition, the Bank has arranged $77.94 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 Home Loan Bank borrowings during 2022, 2021 and 2020: 2022 2021 2020 (Amounts In Thousands) Outstanding balance as of December 31 $ 40,000 $ — $ 105,000 Weighted average interest rate at year end 4.62 % 2.82 % 2.93 % Maximum month-end balance 40,000 105,000 185,000 Average month-end balance 2,043 101,895 181,093 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. 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 49 Table of Contents As disclosed in Note 16 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, 2022: 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 $ 122,061 $ 122,061 $ — $ — $ — Operating lease obligations 489 402 82 3 2 Total contractual obligations: $ 122,550 $ 122,463 $ 82 $ 3 $ 2 Other commitments: Lines of credit $ 701,729 $ 461,622 $ 201,441 $ 34,305 $ 4,361 Standby letters of credit 6,618 6,618 — — — Total other commitments $ 708,347 $ 468,240 $ 201,441 $ 34,305 $ 4,361 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.