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, 2022 and 2021, 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 3, 2023. An overview of the year 2023 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, Israeli-Palestinian conflict, 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, recession, or pandemics. • 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 29 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, 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 The global economy continues to shrug off elevated inflation and rising interest rates, though economic growth is likely to moderate into 2024. Global inflation may also continue to moderate slowly, with some supply constraints a key risk. After a strong first half, higher interest rates are likely to begin dampening U.S. consumer spending going in 2024 and temper inflation somewhat in the process. Many economists continue to expect U.S. economic conditions consistent with a soft-landing as the economy decelerates into early next year. However, persistent inflation may force additional Fed rate hikes, raising the odds of a mild recession in 2024. The tight labor market is likely to ease in coming months, and the restart of student loan payments and tougher lending standards should further decelerate economic activity. Higher borrowing costs continue to present a risk to the economy, with consumer and business budgets accounting for higher interest costs. In addition, federal debt service costs totaled 17% of federal spending as of January 2024. Nonetheless, interest rate levels and energy prices, in combination with global economic conditions, fiscal and monetary policy and the level of regulatory and government scrutiny of financial institutions will likely continue to impact our results into 2024. Our credit administration continues to closely monitor and analyze the higher risk segments within the loan portfolio, tracking loan payment deferrals, customer liquidity and providing timely reports to senior management and the board of directors. Based on the Company’s capital levels, prudent underwriting policies, loan concentration diversification and our geographic footprint, senior management is cautiously optimistic that the Company is positioned to continue managing the impact of the varied set of risks and uncertainties currently impacting the economy and remain adequately capitalized. However, the Company may be required to make additional credit loss provisions as warranted by the extremely fluid economic condition. 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 2023 was $38.18 million compared to $47.75 million in 2022 and $48.09 million in 2021. Diluted earnings per share were $4.16, $5.15, and $5.16 for the years ended December 31, 2023, 2022 and 2021, 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, 2023 and 2022, the Bank achieved a net interest margin of 2.86% and 3.00%, respectively. For the year ended December 31, 2023, net interest income on a tax equivalent basis decreased by $0.86 million. In 2023, interest income increased $16.00 million due to growth of $151.91 million in the Bank's average earning assets and increased $24.09 Page 30 Table of Contents million due to increased interest rates. This was offset by increased interest expense of $24.22 million due to interest rate increases and $16.73 million due to increased volume of certificates of deposit and borrowings. Highlights with respect to items on the Company’s balance sheet as of December 31, 2023 included the following: • Total assets were $4.342 billion, an increase of $361.19 million since December 31, 2022, primarily due to loan growth as described further below. • Cash and cash equivalents were $59.48 million, an increase of $22.84 million since December 31, 2022. • Loans, net of allowance for credit losses and unamortized fees and costs, totaling $3.389 billion, an increase of $322.39 million since December 31, 2022. The increase is primarily attributable to growth of approximately $105.49 million in construction loans, $90.31 million in 1 to 4 family first mortgages, $19.57 million in junior mortgages, $34.06 million in multi-family mortgages, $37.62 million in commercial and financial loans and $24.59 million in farmland mortgages. Loans held for sale increased $.36 million since December 31, 2022. • Deferred income tax assets were $21.27 million, a decrease of $2.79 million since December 31, 2022. The decrease is primarily attributable to lower unrealized losses on available for sale investments of $35.42 million as of December 31, 2023. • Deposits decreased $74.59 million in 2023 to $3.283 billion primarily due to decreases in investment checking and savings accounts of approximately $324.82 million, decreases in brokered deposits and insured cash sweep (ICS) deposits of approximately $15.73 million, decrease of $47.05 million in non-interest bearing deposits, offset by an increase of $313.01 million in time deposits. • Short-term borrowings increased $136.94 million as of December 31, 2023, consisting of $219.00 million of borrowings from the Bank Term Funding Program, compared to short-term borrowings of $82.06 million as of December 31, 2022, consisting of Federal Funds Purchased. FHLB borrowings increased $256.65 million as of December 31, 2023, compared to $40.00 million as of December 31, 2022. Borrowings were primarily used to fund strong loan growth and increased customer deposit usage. • Stockholders’ equity increased $42.03 million to $470.29 million in 2023, with dividends having been paid in 2023 of $9.69 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 8.63% in 2023 compared to 11.32% in 2022. The Company remains well-capitalized as of December 31, 2023 with a CBLR of 12.77%. The minimum regulatory guideline is 9%. The Company paid a dividend per share of $1.05 in 2023, $1.00 per share in 2022 and $0.94 in 2021. A detailed discussion of the financial position and results of operations follows this overview. Page 31 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 32 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 33 Table of Contents Financial Position Year End Amounts 2023 2022 2021 2020 2019 (Amounts In Thousands) Total assets $ 4,341,667 $ 3,980,481 $ 4,044,562 $ 3,782,362 $ 3,302,550 Investment securities 795,167 782,565 555,900 416,544 366,368 Loans held for sale 2,023 1,663 5,716 43,947 8,400 Loans, net 3,389,372 3,066,981 2,625,062 2,674,012 2,606,277 Deposits 3,282,780 3,357,367 3,533,994 3,192,568 2,661,364 Other short-term borrowings 219,000 82,061 249 — — Federal Home Loan Bank borrowings 296,648 40,000 — 105,000 185,000 Redeemable common stock 44,853 51,011 50,013 47,329 51,826 Stockholders' equity 470,286 428,260 438,450 416,076 375,211 Total assets at December 31, 2023 increased $361.19 million, or 9.07%, from the prior year-end. The largest growth in assets in 2023 occurred in net loans which increased $322.39 million for the year ended December 31, 2023. Loans held for sale to the secondary market increased $0.36 million for the year ended December 31, 2023. Loans held for investment represent the largest component of the Bank’s earning assets. Loans held for investment were $3.439 billion and $3.108 billion at December 31, 2023 and 2022, 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 $105.49 million in construction loans, $90.31 million in 1 to 4 family first mortgages, $34.06 million in multi-family mortgages, $37.62 million in commercial financial loans, $24.59 million in farmland mortgages, and $19.57 million in junior mortgages. Given the current economic environment and the potential for a recession in 2024, the increase in net loans in 2023 may not continue into 2024, and as a result, may not be indicative of future performance. On a net basis, the Company originated $337.69 million in loans to customers for the year ended December 31, 2023 compared to loans originated of $447.84 million for the year ended December 31, 2022. 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 $17.04, $16.20 and $17.18 million as of December 31, 2023, 2022 and 2021, 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 2023 compared to 2022 though the loan composition in 2023 remained comparable to 2022. Residential real estate loans, including first and junior liens, were $1,365.82 million and $1,255.94 million as of December 31, 2023 and 2022, respectively. The dollar total of residential real estate loans increased 8.75% in 2023 and increased 22.66% in 2022. Residential real estate loans were 39.72% of the loan portfolio at December 31, 2023 and 40.41% at December 31, 2022. Agricultural loans, including production and mortgages, were $396.95 million and $369.28 million as of December 31, 2023 and 2022, respectively, an increase of 7.49% in 2023 compared to 2022. Agricultural loans represented 11.54% and 11.88% of the Company's loan portfolio as of December 31, 2023 and 2022, respectively. Construction loans were $394.13 million and $288.65 million as of December 31, 2023 and 2022, respectively, an increase of 36.54% in 2023 compared to 2022. Construction loans represented 11.46% and 9.29% of the Company's loan portfolio as of December 31, 2023 and 2022, respectively. Commercial and financial loans were $307.19 million and $269.57 million as of December 31, 2023 and 2022, respectively, an increase of 13.96% in 2023 compared to 2022. Commercial and financial loans represented 8.93% and 8.67% of the Company's loan portfolio as of December 31, 2023 and 2022, respectively. Multi-family real estate loans were $471.01 million and $436.95 million as of December 31, 2023 and 2022, respectively, an increase of 7.79% in 2023 compared to 2022. Multi-family real estate loans represented 13.70% and 14.06% of the Company's loan portfolio as of December 31, 2023 and 2022, respectively. Commercial real estate loans totaled $416.67 million at December 31, 2023, a 3.43% increase over the December 31, 2022 total of $402.84 million. Commercial real estate loans increased 0.36% in 2022. Commercial real estate loans represented 12.12% and 12.96% of the Company’s loan portfolio as of December 31, 2023 and 2022, respectively. The Company monitors its commercial real estate level so that it does not have a concentration in that category that exceeds 300% of its capital. Commercial real estate loan concentration was 186.24% of capital as of December 31, 2023. Page 34 Table of Contents 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. 2023 2022 2021 2020 2019 Agricultural $ 115,786 $ 112,705 $ 106,933 $ 94,842 $ 91,317 Commercial and financial 307,190 269,568 222,002 286,242 221,323 Real estate: Construction, 1 to 4 family residential 80,255 92,408 80,486 71,117 80,209 Construction, land development and commercial 313,878 196,240 127,021 111,913 108,410 Mortgage, farmland 281,164 256,570 232,744 247,142 242,730 Mortgage, 1 to 4 family first liens 1,221,296 1,130,989 909,564 892,089 910,742 Mortgage, 1 to 4 family junior liens 144,524 124,951 114,342 127,833 149,227 Mortgage, multi-family 471,009 436,952 382,792 374,014 350,761 Mortgage, commercial 416,670 402,842 401,377 417,139 402,181 Loans to individuals 40,205 36,675 32,687 31,325 32,308 Obligations of state and political subdivisions 46,446 48,213 50,285 56,488 49,896 $ 3,438,423 $ 3,108,113 $ 2,660,233 $ 2,710,144 $ 2,639,104 Net unamortized fees and costs 359 308 299 938 933 $ 3,438,782 $ 3,108,421 $ 2,660,532 $ 2,711,082 $ 2,640,037 Less allowance for credit losses 49,410 41,440 35,470 37,070 33,760 $ 3,389,372 $ 3,066,981 $ 2,625,062 $ 2,674,012 $ 2,606,277 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, 2023: 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 $ 1,985,951 $ 498,426 $ 1,211,265 $ 239,139 $ 37,121 Real Estate (2) 1,365,821 151,370 814,283 363,228 36,940 Other 86,651 6,706 34,721 22,029 23,195 Totals $ 3,438,423 $ 656,502 $ 2,060,269 $ 624,396 $ 97,256 The types of interest rates applicable to these principal payments are shown below: Fixed rate $ 2,251,532 $ 504,457 $ 1,352,092 $ 298,841 $ 96,142 Variable rate 1,186,891 152,045 708,177 325,555 1,114 $ 3,438,423 $ 656,502 $ 2,060,269 $ 624,396 $ 97,256 (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 35 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, 2023, 2022 and 2021. Unemployment Rate % Median Income 2023 2022 2021 2023 2022 2021 United States 3.7 % 3.5 % 3.9 % $ 74,580 $ 70,780 $ 67,521 State of Iowa 3.2 % 3.1 % 3.5 % 70,616 68,326 64,386 Johnson County 2.0 % 2.3 % 2.5 % 71,385 73,102 68,510 Linn County 3.0 % 3.5 % 3.3 % 68,705 68,757 69,363 Washington County 2.1 % 2.7 % 2.5 % 68,296 71,756 68,975 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 $74.59 million in 2023. Deposits decreased by $176.63 million in 2022. As of June 30, 2023 (latest data available from the FDIC), Johnson County total deposits were $13.862 billion and the Company’s deposits were $2.213 billion, which represent a 15.96% market share. The Company had eight office locations in Johnson County as of June 30, 2023. The total banking locations in Johnson County were 48 as of June 30, 2023. At June 30, 2022, the Company’s deposits were $2.317 billion or a 17.80% market share. As of June 30, 2023, Linn County total deposits were $8.522 billion and there were 102 total banking locations in the county. The seven Linn County offices of the Company had deposits of $747 million or a 8.8% share of the market. The Company’s Linn County deposits at June 30, 2022 were $813 million and represented a 9.6% market share. As of June 30, 2023, the Company’s three Washington County offices had deposits of $324 million which was 33.9% of the County’s total deposits of $955 million. Washington County had a total of 13 banking locations as of June 30, 2023. In 2022, the Company’s Washington County deposits were $317 million or a 33.5% 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, 2023, 2022 and 2021 and the composition of the certificates of deposit issued in denominations in excess of $250,000 as of December 31, 2023, 2022 and 2021: December 31, 2023 Rate 2022 Rate 2021 Rate (Amounts In Thousands) Average noninterest-bearing deposits $ 607,510 — $ 647,286 — $ 578,931 — Average interest-bearing demand deposits 962,148 0.37 % 1,105,811 0.22 % 1,062,059 0.22 % Average savings deposits 990,168 0.78 1,163,316 0.17 1,093,560 0.17 Average time deposits 742,855 1.51 566,888 1.63 643,934 1.63 $ 3,302,681 $ 3,483,301 $ 3,378,484 Uninsured deposits $ 693,827 $ 800,806 $ 884,402 Time certificates issued in amounts of $250,000 or more with maturity in: 2023 Rate (Amounts In Thousands) 3 months or less $ 86,229 4.08 % 3 through 6 months 47,472 4.13 6 through 12 months 62,065 4.89 Over 12 months 4,611 3.84 $ 200,377 Portion uninsured $ 82,377 Investment securities increased $12.60 million in 2023. In 2022, investment securities increased by $226.67 million. The investment portfolio consists of $779.42 million of securities that are stated at fair value, with any unrealized gain or loss, net of Page 36 Table of Contents income taxes, reported as a separate component of stockholders’ equity. The securities portfolio is used for liquidity and pledging purposes and to provide a rate of return that is acceptable to management. The following tables show the carrying value of the investment securities held by the Bank, including stock of the Federal Home Loan Bank, as of December 31, 2023, 2022 and 2021 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, 2023: December 31, 2023 2022 2021 (Amounts In Thousands) Carrying value: U.S. Treasury $ 422,490 $ 445,392 $ 243,925 Other securities (FHLB, FHLMC and FNMA) 33,049 31,934 34,467 Stock of the Federal Home Loan Bank 15,746 6,461 4,546 Mortgage-backed securities and collateralized mortgage obligations 60,929 50,196 9,446 State and political subdivisions 262,953 248,582 263,516 $ 795,167 $ 782,565 $ 555,900 December 31, 2023 Carrying Value Weighted Average Yield (Amounts In Thousands) U.S. Treasury Within 1 year $ 201,063 2.00 % From 1 to 5 years 221,427 2.30 From 5 to 10 years $ — — $ 422,490 Other securities (FHLB, FHLMC and FNMA), maturities: Within 1 year $ — — % From 1 to 5 years 33,049 0.42 From 5 to 10 years — — $ 33,049 Stock of the Federal Home Loan Bank $ 15,746 6.75 % State and political subdivisions, maturities: Within 1 year $ 37,034 4.05 % From 1 to 5 years 71,062 3.12 From 5 to 10 years 110,264 2.42 Over 10 years 44,593 4.04 $ 262,953 Mortgage Backed Securities From 1 to 5 years $ — — % From 5 to 10 years 9,035 5.35 Over 10 years 51,894 2.69 $ 60,929 Total $ 795,167 Page 37 Table of Contents As of December 31, 2023, 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 2023, the major funding source for the growth in loans and other assets was from short-term borrowings in addition to FHLB borrowings. In 2022, the major source of funding for the growth in loans was cash and cash equivalents in addition to federal funds purchased and FHLB borrowings. Brokered deposits totaled $24.22 million and $31.74 million as of December 31, 2023 and 2022, respectively. Total advances from the FHLB were $296.65 million at December 31, 2023 and $40 million in 2022. Total federal funds purchased were none as of December 31, 2023 and $82.06 million as of December 31, 2022. Total funds purchased from the Bank Term Funding program was $219.00 million as December 31, 2023, and none in 2022. The federal funds purchased, Bank Term Funding Program, and FHLB funding sources are considered when loan growth exceeds core deposit increases and the interest rates on funds borrowed from the FHLB or other sources are favorable compared to other funding alternatives. Stockholders’ equity was $470.29 million at December 31, 2023 compared to $428.26 million at December 31, 2022. 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 $217.98 million and paid shareholders dividends of $43.75 million, or 20.07% 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, 2023, 2022 and 2021: 2023 2022 2021 Return on average assets 0.92 % 1.20 % 1.21 % Return on average stockholders' equity 8.63 11.32 11.29 Dividend payout ratio 25.38 19.48 18.24 Average stockholders' equity to average assets ratio 10.72 10.58 10.70 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) 2023 $ 38,176 (20.06) % $ 4.16 2022 47,753 (0.69) % 5.15 2021 48,085 24.42 % 5.16 Net income for 2023 decreased by $9.58 million or 20.06% and diluted earnings per share decreased by 19.22%. In 2023, net interest income, before credit loss expense, decreased by $1.12 million due to the following reasons: 1) increase in interest income of $39.83 million primarily due to higher loan growth and higher interest rates; and 2) increase in interest expense of $40.95 million primarily due to increased interest rates on deposits, an increase in short term borrowings of $136.94 million, and an increase in Federal Home Loan Bank borrowings of $256.65 million. Noninterest income increased by $0.83 million primarily due to an increase in trust fees, the credit loss expense increased by $9.28 million and total noninterest expenses increased by $2.82 million primarily due to an increase in salaries and employee benefits and an increase in FDIC assessments. Page 38 Table of Contents Annual fluctuations in the Company's net income are driven primarily by four factors. The first factor is credit loss expense. The majority of the Company's interest earning assets are in loans outstanding, which amounted to more than $3.438 billion at December 31, 2023. Credit loss expense was $15.62 million in 2023 compared to $6.34 million in 2022. The increase in expense when compared to 2022 is primarily attributable to the decreased credit quality in specific relationships leading to an increased allowance for credit losses for individually analyzed loans, increases in loan volume during 2023, and an increase in loss rates resulting from increased charge-off activity. The Company believes that credit loss expense is expected to be dependent on the Company's loan growth, local economic conditions, and asset quality. The second factor affecting the Company’s net income is the interaction between changes in net interest margin and changes in average volumes of the Company's earnings assets. Net interest income of $113.89 million for 2023 was derived from the Company’s $4.056 billion of average earning assets and its tax-equivalent net interest margin of 2.86%. Average earning assets in 2022 were $3.904 billion and the tax-equivalent net interest margin was 3.00%. Net interest income for the Company decreased primarily as a result of interest income on increased loan volume and rates offset by increased interest expense from increased interest rates, including on borrowings, certificates of deposit, and interest-bearing deposits. The Company expects net interest compression to impact earnings for the foreseeable future due to competition for loans and deposits. The Company believes growth in net interest income will be contingent on the growth of the Company’s earning assets, increasing yield on loans and the ongoing interest rate stance of the Federal Reserve Board. The third factor affecting the Company’s net income is noninterest income, primarily the increase in trust fees and service charges and fees income. Trust fees were $13.58 million and $12.28 million for the twelve months ended December 31, 2023 and 2022, respectively, an increase of 10.53%. This is primarily driven by the increase in assets under management of $0.383 billion from $2.262 billion as of December 31, 2022 to $2.645 billion as of December 31, 2023. The fourth factor affecting the Company’s net income is noninterest expenses, primarily the increase in salaries and related employee benefits due to annual compensation increases and increased FDIC insurance assessment expense from rate increases. Page 39 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 loan growth in 2023. The volume of interest-bearing liabilities increased in 2023 primarily due to increased volume in certificates of deposit and borrowings. Increased interest rates led to increases in interest income as well as interest expense on interest-bearing deposits, certificates of deposit and borrowings. The net interest margin was 2.86% in 2023, 3.00% in 2022 and 2.75% in 2021. The measure is shown on a tax-equivalent basis using a rate of 21% for 2023, 2022 and 2021 to make the interest earned on taxable and nontaxable assets more comparable. Interest income and expense for 2023, 2022 and 2021 are indicated on the following table: Years Ended December 31, 2023 2022 2021 (Amounts In Thousands) Income: Loans (1) $ 155,076 $ 115,919 $ 114,202 Taxable securities 10,674 8,662 3,604 Nontaxable securities (1) 6,534 5,558 5,177 Interest-bearing cash and cash equivalents 829 2,889 983 Total interest income $ 173,113 $ 133,028 $ 123,966 Expense: Interest-bearing demand deposits 10,134 4,084 2,385 Savings deposits 7,721 3,173 1,827 Time deposits 22,539 8,561 10,500 Other short-term borrowings, including Bank Term Funding Program and federal funds purchased 11,330 267 — FHLB borrowings 5,309 — 2,915 Total interest expense $ 57,033 $ 16,085 $ 17,627 Net interest income $ 116,080 $ 116,943 $ 106,339 (1) Presented on a tax equivalent basis using a rate of 21% for 2023, 2022 and 2021. Interest income includes certain loan origination and document preparation fees, which comprise approximately 1.5% of the amounts indicated. Page 40 Table of Contents Net interest income on a tax-equivalent basis changed in 2023 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 $ 449,881 0.64 % $ 17,884 $ 21,404 $ 39,288 Taxable securities 38,655 0.22 860 1,152 2,012 Nontaxable securities 657 0.39 15 832 847 Interest-bearing cash and cash equivalents (337,285) 4.47 (2,761) 701 (2,060) $ 151,908 $ 15,998 $ 24,089 $ 40,087 Interest expense: Interest-bearing demand deposits $ (143,663) 0.68 % $ 530 $ (6,580) $ (6,050) Savings deposits (173,148) 0.51 481 (5,028) (4,547) Time deposits 175,967 1.52 (2,657) (11,322) (13,979) Other short-term borrowings, including Bank Term Funding Program and federal funds purchased 210,608 0.60 (9,870) (1,287) (11,157) FHLB borrowings 92,330 5.50 (5,215) — (5,215) $ 162,094 $ (16,731) $ (24,217) $ (40,948) Change in net interest income $ (733) $ (128) $ (861) 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 2022 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 $ 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 Other borrowings 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 41 Table of Contents A summary of the average yields, average rates paid, net interest spread and margin is as follows: Years Ended December 31, 2023 2022 2021 Average yields: Loans (1) 4.78 % 4.14 % 4.30 % Loans (tax equivalent basis) (1) 4.80 4.16 4.32 Taxable securities 1.89 1.67 1.45 Nontaxable securities 2.01 1.71 1.74 Nontaxable securities (tax equivalent basis) 2.64 2.25 2.31 Interest-bearing cash and cash equivalents 5.32 0.82 0.13 Federal funds sold 1.51 0.31 0.03 Average rates paid: Interest-bearing demand deposits 1.05 0.37 0.22 Savings deposits 0.78 0.27 0.17 Time deposits 3.03 1.51 1.63 Short-term borrowings 5.29 4.69 0.47 FHLB borrowings 5.55 — 2.82 Yield on average interest-earning assets 4.27 3.41 3.20 Rate on average interest-bearing liabilities 1.90 0.57 0.61 Net interest spread (2) 2.37 2.84 2.59 Net interest margin (3) 2.86 3.00 2.75 (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 2023, 2022 and 2021. The net interest spread decreased 47 basis points in 2023 compared to 2022 and the net interest spread increased 25 basis points compared to 2021. (3) Net interest margin is net interest income, on a tax equivalent basis, divided by average interest-earning assets. The net interest margin decreased 14 basis points in 2023. The net interest margin increased 25 basis points in 2022 compared to 2021. The Federal Open Market Committee met eight times during 2023. The federal funds target rate increased to 5.50% as of December 31, 2023 from 4.50% as of December 31, 2022. 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, 2023, the average rate indexes for the one, three and five year indexes were 4.79%, 4.01% and 3.84%, respectively. The one year index increased 1.27% from December 31, 2022, the three year index decreased 4.98% and the five year index decreased 3.76%. 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 $15.62 million for the year ended December 31, 2023 compared to expense of $6.34 million in 2022, an increase of expense of $9.28 million. The credit loss expense includes expense of $0.68 million related to the ACL on off-balance sheet credit exposures for the year ended December 31, 2023 compared to $0.58 million expense for 2022. 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 percentage of the allowance to Page 42 Table of Contents outstanding loans was 1.44% and 1.33% at December 31, 2023 and 2022, respectively. The credit loss expense was $15.62 million in 2023, $6.34 million in 2022 and a reduction to expense of $5.51 million in 2021. Loan charge-offs net of recoveries were $6.97 million in 2023, loan recoveries net of charge-offs were $0.21 million in 2022 and loan charge-offs net of recoveries were $1.43 million in 2021. Management has determined that the allowance for credit losses was appropriate at December 31, 2023, and that the loan portfolio is diversified and secured, without undue concentration in any specific risk area. This process involves a high degree of management judgment; however, the allowance for credit losses is based on a comprehensive 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, so concessionary modification is granted to the borrower that otherwise would not be considered. Prior to January 1, 2023, these loans were accounted for as troubled debt restructure ("TDR") loans. 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 increased $26.77 million from December 31, 2022 to December 31, 2023. Collateral-dependent loans include any loan that has been placed on nonaccrual status, accruing loans past due 90 days or more and loans to borrowers with financial difficulties. 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 1.17% of loans held for investment as of December 31, 2023 and 0.44% as of December 31, 2022. The increase in collateral-dependent loans is due to an increase in loans modified due to financial difficulties of $4.09 million, an increase in nonaccrual loans of $24.07 million, an increase of $1.36 million in loans with a specific reserve and is offset by a decrease in 90 days or more accruing loans of $0.01 million and former individually analyzed loans totaling $2.44 million being classified as pooled loans as of December 31, 2023 for purposes of the ACL calculation due to having similar risk characteristics as pooled loans. 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 43 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: 2023 2022 2021 2020 2019 (Amounts In Thousands) Nonaccrual loans $ 30,888 $ 6,815 $ 8,491 $ 8,849 $ 10,768 Accruing loans past due 90 days or more (1) 545 553 201 1,056 606 Individually evaluated loans 1,665 307 20 573 243 Loan modifications to borrowers experiencing financial difficulties 4,087 — — — — 2023 Other non-performing loans; 2022 and prior Former troubled debt restructurings ("TDR loans")(2) 3,159 5,905 7,921 10,251 9,308 Total non-performing loans $ 40,344 $ 13,580 $ 16,633 $ 20,729 $ 20,925 Other real estate — — — — — Non-performing assets (includes impaired loans and other real estate) $ 40,344 $ 13,580 $ 16,633 $ 20,729 $ 20,925 Loans held for investment $3,438,423 $3,108,113 $2,660,233 $2,710.144 $2,639.104 Ratio of allowance for credit losses to loans held for investment 1.44 % 1.33 % 1.33 % 1.37 % 1.28 % Ratio of allowance for credit losses to non-performing loans 122.47 305.15 213.25 178.83 161.34 Ratio of non-performing loans to total loans held for investment 1.17 0.44 0.63 0.76 0.79 Ratio of non-performing assets to total assets 0.93 0.34 0.41 0.55 0.63 (1) 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. (2) Total TDR loans were $7.66, $10.20, $13.22 and $13.71 million as of December 31, 2022, 2021, 2020, and 2019, respectively. Included in the total nonaccrual loans were $1.75, $2.28, $2.97, and $4.34 million of TDR loans as of December 31, 2022, 2021, 2020, and 2019, respectively. The ratio of allowance for credit losses to non-performing loans decreased to 122.47% as of December 31, 2023 compared to 305.15% as of December 31, 2022. The decrease in 2023 is primarily due to the large increase in nonaccrual loans and loan modifications to borrowers experiencing financial difficulties compared to 2022. The ratio of non-performing loans to total gross loans was 1.17% and 0.44% at December 31, 2023 and 2022, respectively. The increase in the 2023 ratio is primarily due to the increase in nonaccrual loans and loan modifications to borrowers experiencing financial difficulties. 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, 2023, the unemployment levels in Johnson County and Linn County were 2.0% and 3.0%, respectively, compared to 2.3% and 3.5% in December of 2022. These levels compare favorably to the State of Iowa at 3.2% and the national unemployment level at 3.7% in December 2023 compared to 3.1% and 3.5%, respectively in December 2022. The residential rental vacancy rates in 2022 and 2023 in Johnson and Linn County were estimated between 6.0% and 8.0%. The State of Iowa vacancy rate is 7.9% and the national rate is 6.6% with the Midwest rate at 6.8%. These vacancy rates one year ago were 6.7%, 5.8% and 6.9%, 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 2024, 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 44 Table of Contents SUMMARY OF CREDIT LOSS EXPERIENCE ON LOANS The allowance for credit losses is also affected by the charge-offs and recoveries for the periods presented. For the years ended December 31, 2023, 2022 and 2021, recoveries were $1.67 million, $2.42 million, and $2.74 million, respectively; charge-offs were $8.64 million, $2.21 million, and $1.32 million in 2023, 2022 and 2021, respectively. Overall credit quality may deteriorate in 2024. 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 credit loss experience on loans 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) 2023 Allowance for credit losses: Beginning balance $ 2,542 $ 6,259 $ 4,189 $ 2,989 $ 14,208 $ 9,416 $ 1,837 $ 41,440 Charge-offs (781) (3,214) (2,066) (21) (467) (869) (1,219) (8,637) Recoveries 72 556 13 56 446 256 267 1,666 Credit loss (benefit) expense 683 5,149 4,346 405 4,365 (647) 640 14,941 Ending balance $ 2,516 $ 8,750 $ 6,482 $ 3,429 $ 18,552 $ 8,156 $ 1,525 $ 49,410 Net charge-offs/(net recoveries) to average net loans outstanding 0.62 % 0.92 % 0.60 % (0.01) % — % 0.07 % 1.11 % 0.21 % 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) % Page 45 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) 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) % 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 % Page 46 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, 2023, 2022, 2021, 2020 and 2019: 2023 2022 Amount % of Total Allowance % of Loans to Total Loans Amount % of Total Allowance % of Loans to Total Loans (In Thousands) (In Thousands) Agricultural $ 2,516 5.09 % 3.37 % $ 2,542 6.13 % 3.63 % Commercial and financial 8,750 17.71 8.93 6,259 15.10 8.67 Real estate: Construction, 1 to 4 family residential 1,113 2.25 2.33 1,111 2.68 2.97 Construction, land development and commercial 5,369 10.87 9.13 3,078 7.43 6.31 Mortgage, farmland 3,429 6.94 8.18 2,989 7.21 8.25 Mortgage, 1 to 4 family first liens 14,664 29.68 35.52 11,147 26.91 36.40 Mortgage, 1 to 4 family junior liens 3,888 7.87 4.20 3,061 7.39 4.02 Mortgage, multi-family 4,255 8.61 13.70 4,435 10.70 14.06 Mortgage, commercial 3,901 7.90 12.12 4,981 12.02 12.96 Loans to individuals 1,247 2.52 1.17 1,397 3.37 1.18 Obligations of state and political subdivisions 278 0.56 1.35 440 1.06 1.55 $ 49,410 100.00 % 100.00 % $ 41,440 100.00 % 100.00 % 2021 2020 Agricultural $ 2,261 6.37 % 4.02 % $ 2,508 6.77 % 3.50 % Commercial and financial 4,269 12.04 8.35 4,885 13.18 10.56 Real estate: Construction, 1 to 4 family residential 818 2.31 3.03 907 2.45 2.62 Construction, land development and commercial 1,482 4.18 4.77 1,412 3.81 4.13 Mortgage, farmland 3,433 9.68 8.75 4,173 11.26 9.12 Mortgage, 1 to 4 family first liens 8,340 23.52 34.19 10,871 29.32 32.92 Mortgage, 1 to 4 family junior liens 3,158 8.90 4.30 1,497 4.04 4.72 Mortgage, multi-family 3,715 10.47 14.39 4,462 12.04 13.80 Mortgage, commercial 6,783 19.12 15.09 4,953 13.36 15.39 Loans to individuals 771 2.17 1.23 752 2.03 1.16 Obligations of state and political subdivisions 440 1.24 1.88 650 1.74 2.08 $ 35,470 100.00 % 100.00 % $ 37,070 100.00 % 100.00 % Page 47 Table of Contents 2019 Amount % of Total Allowance % of Loans to Total Loans (In Thousands) Agricultural $ 2,400 7.11 % 3.46 % Commercial and financial 4,988 14.77 8.39 Real estate: Construction, 1 to 4 family residential 1,113 3.30 3.04 Construction, land development and commercial 1,486 4.40 4.11 Mortgage, farmland 3,950 11.70 9.20 Mortgage, 1 to 4 family first liens 9,045 26.79 34.51 Mortgage, 1 to 4 family junior liens 1,593 4.72 5.65 Mortgage, multi-family 3,823 11.32 13.29 Mortgage, commercial 4,036 11.95 15.24 Loans to individuals 853 2.53 1.22 Obligations of state and political subdivisions 473 1.41 1.89 $ 33,760 100.00 % 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, 2023, 2022 and 2021. Year Ended December 31, $ Change % Change 2023 2022 2021 2023/2022 2022/2021 2023/2022 2022/2021 (Amounts in thousands) Net gain on sale of loans $ 1,541 $ 1,517 $ 7,588 $ 24 $ (6,071) 1.58 % (80.01) % Trust fees 13,578 12,284 13,521 1,294 (1,237) 10.53 (9.15) Service charges and fees 12,946 12,646 11,774 300 872 2.37 7.41 Other noninterest income 541 1,333 581 (792) 752 (59.41) 129.43 $ 28,606 $ 27,780 $ 33,464 $ 826 $ (5,684) 2.97 % (16.99) % The noninterest income of the Company was $28.61 million in 2023 compared to $27.78 million in 2022. The increase of $0.83 million in 2023 was the result of a combination of factors discussed below. Trust fees were $13.58 million and $12.28 million for the years ended December 31, 2023 and 2022, respectively, an increase of 10.53% for the year ended December 31, 2023 compared to the same period in 2022. This is primarily driven by the increase in assets under management of $0.383 billion from $2.262 billion as of December 31, 2022 to $2.645 billion as of December 31, 2023 and increased 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 2023, the Dow Jones Industrial Average increased 13.70%. Page 48 Table of Contents Other noninterest income decreased $0.79 million in 2023 primarily due to the decrease in tax credit real estate investments based on the investments year-end audited financial statements. Noninterest Expenses The following table sets forth the various categories of noninterest expenses for the year ended December 31, 2023, 2022 and 2021. Year Ended December 31, $ Change % Change 2023 2022 2021 2023/2022 2022/2021 2023/2022 2022/2021 (Amounts in thousands) Salaries and employee benefits $ 44,897 $ 43,468 $ 42,458 $ 1,429 $ 1,010 3.29 % 2.38 % Occupancy 4,408 4,549 4,152 (141) 397 (3.10) 9.56 Furniture and equipment 6,835 6,937 7,276 (102) (339) (1.47) (4.66) Office supplies and postage 1,879 1,837 1,739 42 98 2.29 5.64 Advertising and business development 2,851 2,576 2,132 275 444 10.68 20.83 Outside services 13,791 12,766 12,592 1,025 174 8.03 1.38 FDIC insurance assessment 1,807 1,079 1,043 728 36 67.47 3.45 Other noninterest expense 1,929 2,363 9,949 (434) (7,586) (18.37) (76.25) $ 78,397 $ 75,575 $ 81,341 $ 2,822 $ (5,766) 3.73 % (7.09) % Total noninterest expenses were $78.40 and $75.58 million for the years ended December 31, 2023 and 2022, respectively. The increase is $2.82 million or 3.73% in 2023 and a decrease of $5.77 million or 7.09% in 2022. Salaries and employee benefits increased $1.43 million in 2023 primarily due to annual salary adjustments. The FDIC insurance assessment expense increased $0.72 million compared to 2022 due to rate increases enacted for 2023. Other noninterest expense categories experienced marginal period-to-period fluctuations for the year ended December 31, 2023. Income Taxes Income tax expense was $10.30, $13.11, and $14.01 million for the years ended December 31, 2023, 2022 and 2021, respectively. The Company's income tax expense in 2022 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 21.24% in 2023, 21.55% in 2022 and 22.56% in 2021. The amount of tax credits were $0.48 million for 2023, 2022, and 2021. 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 Page 49 Table of Contents 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, Bank Term Funding Program borrowings, 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. The Company has historically maintained a stable deposit base and a relatively low level of large deposits, which has mitigated the volatility in the Company’s liquidity position. Deposit inflows and outflows can vary widely based on prevailing market interest rates, competition, economic conditions, our business customers' liquidity needs and by recent developments in the financial services industry. Uninsured deposits as of December 31, 2023 and 2022 were approximately $693.83 million and $800.81 million, respectively, which comprised 21.14% and 23.85% of total deposits. As of December 31, 2023, the Company had additional borrowing capacity available from the FHLB of $782.27 million. The Company had $296.65 million outstanding in FHLB borrowings as of December 31, 2023 with maturities all within one year. In addition, the Company had $175.00 million in borrowing capacity available through secured and unsecured lines of credit with correspondent banks with no borrowings under those federal funds lines as of December 31, 2023. The Company also has additional borrowing capacity available from the Federal Reserve's Bank Term Funding Program of $77.46 million. The Company had $219.00 million outstanding in Bank Term Funding Program borrowings as of December 31, 2023. Finally, the Company had $103.87 million in borrowing capacity available through the Federal Reserve Discount Window with no borrowings as of December 31, 2023. On an unconsolidated basis, the Company had cash balances of $0.65 million as of December 31, 2023. In 2023, the Company received dividends of $16.69 million from its subsidiary Bank and used those funds to pay dividends to its stockholders of $9.69 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 $7.71 and $7.91 million for the years ended December 31, 2023 and 2022, respectively. As of December 31, 2023 and 2022, stockholders' equity, before deducting for the maximum cash obligation related to the ESOP, was $515.14 million and $479.27 million, respectively. This measure of stockholders’ equity as a percent of total assets was 11.87% at December 31, 2023 and 12.04% at December 31, 2022. As of December 31, 2023, total equity, after deducting the maximum cash value related to the ESOP, was 10.83% of assets compared to 10.76% 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 50 Table of Contents On a consolidated basis, 2023 cash flows from operations provided $52.84 million, proceeds from maturities of investments available for sale provided $116.08 million and proceeds from FHLB borrowings, federal funds purchased and Bank Term Funding Program borrowings provided $393.59 million. These cash flows were invested $100.65 million in purchases of investment securities and $337.69 million of loans made to customers. In addition, $3.03 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, 2023, the Bank had total outstanding loan commitments and unused portions of lines of credit totaling $693.52 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, 2023, the Bank can obtain an additional $782.27 million from the FHLB based on the current real estate mortgage loans held. In addition, the Bank has arranged $175.00 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 $103.87 million line of credit with the Federal Reserve Bank of Chicago, an additional $77.46 million from the Federal Reserve's Bank Term Funding Program, 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 2023, 2022 and 2021: 2023 2022 2021 (Amounts In Thousands) Outstanding balance as of December 31 $ 296,648 $ 40,000 $ — Weighted average interest rate at year end 5.55 % 4.62 % 2.82 % Maximum month-end balance 296,648 40,000 105,000 Average month-end balance 94,413 2,043 101,895 Weighted average interest rate for the year 5.55 % 4.62 % 2.82 % 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 bank term funding program borrowings during 2023, 2022 and 2021: 2023 2022 2021 (Amounts In Thousands) Outstanding balance as of December 31 $ 219,000 $ 82,061 $ 249 Weighted average interest rate at year end 5.29 % 4.73 % 0.47 % Maximum month-end balance 219,000 82,061 249 Average month-end balance 8,900 3,648 6 Weighted average interest rate for the year 5.29 % 4.73 % 0.47 % 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 51 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, 2023: 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 $ 515,648 $ 515,648 $ — $ — $ — Operating lease obligations 832 239 314 278 1 Total contractual obligations: $ 516,480 $ 515,887 $ 314 $ 278 $ 1 Other commitments: Lines of credit $ 685,861 $ 474,304 $ 159,254 $ 49,087 $ 3,216 Standby letters of credit 7,654 3,239 1,407 360 2,648 Total other commitments $ 693,515 $ 477,543 $ 160,661 $ 49,447 $ 5,864 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.