WEST BANCORPORATION INC 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. "SAFE HARBOR" CONCERNING FORWARD-LOOKING STATEMENTS Certain statements in this report, other than purely historical information, including estimates, projections, statements relating to the Company’s business plans, objectives and expected operating results, and the assumptions upon which those statements are based, are “forward-looking statements” within the meanings of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). Forward-looking statements may appear throughout this report. These forward-looking statements are generally identified by the words “believes,” “expects,” “intends,” “anticipates,” “projects,” “future,” “may,” “should,” “will,” “strategy,” “plan,” “opportunity,” “will be,” “will likely result,” “will continue” or similar references, or references to estimates, predictions or future events. Such forward-looking statements are based upon certain underlying assumptions, risks and uncertainties. Because of the possibility that the underlying assumptions are incorrect or do not materialize as expected in the future, actual results could differ materially from these forward-looking statements. Risks and uncertainties that may affect future results include: the effects of the COVID-19 pandemic, including its potential effects on the economic environment, our customers and our operations, including due to supply chain disruptions, as well as any changes to federal, state or local government laws, regulations or orders in connection with the pandemic; interest rate risk; competitive pressures, including from non-bank competitors such as "fintech" companies; pricing pressures on loans and deposits; changes in credit and other risks posed by the Company’s loan and investment portfolios, including declines in commercial or residential real estate values or changes in the allowance for loan losses dictated by new market conditions, accounting standards (including as a result of the future implementation of the current expected credit loss (CECL) accounting standard) or regulatory requirements; changes in local, national and international economic conditions, including rising rates of inflation; changes in legal and regulatory requirements, limitations and costs; changes in customers’ acceptance of the Company’s products and services; cyber-attacks; unexpected outcomes of existing or new litigation involving the Company; the monetary, trade and other regulatory policies of the U.S. government, including anticipated rate increases; acts of war or terrorism, including the Russian invasion of Ukraine, widespread disease or pandemics, such as the COVID-19 pandemic, or other adverse external events; developments and uncertainty related to the future use and availability of some reference rates, such as the London Interbank Offered Rate, as well as other alternative reference rates; changes to U.S. tax laws, regulations and guidance; liquidity risk due to excess liquidity at the Company's bank subsidiary; talent and labor shortages; and any other risks described in the “Risk Factors” sections of this and other reports filed by the Company with the SEC. The Company undertakes no obligation to revise or update such forward-looking statements to reflect current or future events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. CRITICAL ACCOUNTING POLICIES The discussion and analysis of the Company's financial condition and results of operations are based upon the Company's consolidated financial statements that have been prepared in accordance with GAAP. The preparation of the Company's financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, income and expenses. These estimates are based upon historical experience and on various other assumptions that management believes are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The estimates and judgments that management believes involve the most complex and subjective estimates and judgments and have the most effect on the Company's reported financial position and results of operations are described as critical accounting policies in the Company's Annual Report on Form 10-K for the year ended December 31, 2021, as filed with the SEC on February 24, 2022. There have been no significant changes in the critical accounting policies or the assumptions and judgments utilized in applying these policies since December 31, 2021. 29 Table of Contents West Bancorporation, Inc. Management's Discussion and Analysis (in thousands, except share and per share data) NON-GAAP FINANCIAL MEASURES This report contains references to financial measures that are not defined in GAAP. Such non-GAAP financial measures include the Company’s presentation of net interest income and net interest margin on a fully taxable equivalent (FTE) basis, the presentation of the efficiency ratio on an adjusted and FTE basis, excluding certain income and expenses, loans, net of PPP loans, and the presentation of the allowance for loan losses ratio, excluding PPP loans. Management believes these non-GAAP financial measures provide useful information to both management and investors to analyze and evaluate the Company’s financial performance. These measures are considered standard measures of comparison within the banking industry. Additionally, management believes providing measures on a FTE basis enhances the comparability of income arising from taxable and nontaxable sources. Limitations associated with non-GAAP financial measures include the risks that persons might disagree as to the appropriateness of items included in these measures and that different companies might calculate these measures differently. These non-GAAP disclosures should not be considered an alternative to the Company’s GAAP results. The following table reconciles the non-GAAP financial measures of net interest income and net interest margin on a fully taxable equivalent basis, efficiency ratio on an adjusted and FTE basis, loans, net of PPP loans and allowance for loan losses ratio, excluding PPP loans to their most directly comparable measures under GAAP. Three Months Ended March 31, 2022 2021 Reconciliation of net interest income and net interest margin on a FTE basis to GAAP: Net interest income (GAAP) $ 23,828 $ 23,121 Tax-equivalent adjustment (1) 329 229 Net interest income on a FTE basis (non-GAAP) 24,157 23,350 Average interest-earning assets 3,432,114 2,979,710 Net interest margin on a FTE basis (non-GAAP) 2.85 % 3.17 % Reconciliation of efficiency ratio on an adjusted and FTE basis to GAAP: Net interest income on a FTE basis (non-GAAP) $ 24,157 $ 23,350 Noninterest income 2,389 2,465 Adjustment for realized securities gains, net — (4) Adjustment for losses on disposal of premises and equipment, net 18 24 Adjusted income 26,564 25,835 Noninterest expense 10,662 10,271 Efficiency ratio on an adjusted and FTE basis (non-GAAP) (2) 40.14 % 39.75 % March 31, 2022 December 31, 2021 March 31, 2021 Reconciliation of allowance for loan losses ratio, excluding PPP loans: Loans outstanding (GAAP) $ 2,485,366 $ 2,456,196 $ 2,303,999 Less: PPP loans (9,398) (22,206) (151,122) Loans, net of PPP loans (non-GAAP) 2,475,968 2,433,990 2,152,877 Allowance for loan losses 27,623 28,364 30,008 Allowance for loan losses ratio, excluding PPP loans (non-GAAP) (3) 1.12 % 1.17 % 1.39 % (1) Computed on a tax-equivalent basis using a federal income tax rate of 21 percent, adjusted to reflect the effect of the nondeductible interest expense associated with owning tax-exempt securities and loans. Management believes the presentation of this non-GAAP measure provides supplemental useful information for proper understanding of the financial results, as it enhances the comparability of income arising from taxable and nontaxable sources. (2) The efficiency ratio expresses noninterest expense as a percent of fully taxable equivalent net interest income and noninterest income, excluding specific noninterest income and expenses. Management believes the presentation of this non-GAAP measure provides supplemental useful information for proper understanding of the Company's financial performance. It is a standard measure of comparison within the banking industry. A lower ratio is more desirable. (3) Management believes that presenting the allowance for loan losses as a percentage of total loans excluding PPP loans is useful in assessing the credit quality of the Company's core portfolio. 30 Table of Contents West Bancorporation, Inc. Management's Discussion and Analysis (in thousands, except share and per share data) OVERVIEW The following discussion describes the consolidated operations and financial condition of the Company, West Bank and West Bank's special purpose subsidiaries (which are invested in new markets tax credit activities). Results of operations for the three months ended March 31, 2022 are compared to the results for the same period in 2021, and the consolidated financial condition of the Company as of March 31, 2022 is compared to that as of December 31, 2021. This discussion and analysis should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations included in the Company's Annual Report on Form 10-K for the year ended December 31, 2021, filed with the SEC on February 24, 2022. The Company conducts business from its main office in West Des Moines, Iowa and through its branch offices in central Iowa, which is generally the greater Des Moines metropolitan area; eastern Iowa, which is the area including and surrounding Iowa City and Coralville; and southern Minnesota, which includes the cities of Rochester, Owatonna, Mankato and St. Cloud. Net income for the three months ended March 31, 2022 was $13,184, or $0.78 per diluted common share, compared to $11,752, or $0.70 per diluted common share, for the three months ended March 31, 2021. The Company's annualized return on average assets and return on average equity for the three months ended March 31, 2022 were 1.51 percent and 20.96 percent, respectively, compared to 1.53 percent and 20.77 percent, respectively, for the three months ended March 31, 2021. The increase in net income for the three months ended March 31, 2022 compared to the same period in 2021 was primarily due to a decrease in the provision for loan losses and an increase in net interest income, partially offset by an increase in noninterest expense. Net interest income for the three months ended March 31, 2022 grew $707, or 3.1 percent, compared to the three months ended March 31, 2021. The increase in net interest income was primarily due to the increase in interest income on securities and the decrease in interest expense on FHLB advances, partially offset by a decrease in interest income on loans and increase in interest expense on deposits and long-term debt. The Company recorded a negative provision for loan losses of $750 during the three months ended March 31, 2022, compared to a provision of $500 for the three months ended March 31, 2021. The provision in 2021 was due to uncertainty surrounding economic conditions as a result of the COVID-19 pandemic and an increase in loan balances. The negative provision in 2022 was due to the sustained performance of loans after the expiration of COVID modifications and sustained improvement in classified loans. Noninterest expense increased $391 during the three months ended March 31, 2022 compared to the three months ended March 31, 2021, primarily due to an increase in salaries and employee benefits expense. Total loans outstanding increased $29,170, or 1.2 percent, during the first three months of 2022. Excluding the impact of PPP loan activity, total loans outstanding increased $41,978, or 1.7 percent, during the first three months of 2022. As of March 31, 2022, the allowance for loan losses was 1.11 percent of outstanding loans, compared to 1.15 percent as of December 31, 2021. At March 31, 2022, the allowance for loan losses was 1.12 percent of outstanding loans, excluding $9,398 of PPP loans (a non-GAAP financial measure), which are 100 percent guaranteed by the SBA, compared to 1.17 percent of outstanding loans, excluding $22,206 of PPP loans, as of December 31, 2021. Management believed the allowance for loan losses at March 31, 2022 was adequate to absorb any losses inherent in the loan portfolio as of that date. 31 Table of Contents West Bancorporation, Inc. Management's Discussion and Analysis (in thousands, except share and per share data) On a quarterly basis, the Company compares three key performance metrics to those of our identified peer group. The peer group for 2022 consists of 20 Midwestern, publicly traded financial institutions including Bank First Corporation, Civista Bancshares, Inc., CrossFirst Bankshares, Inc., Equity Bancshares, Inc., Farmers National Banc Corp., Farmers & Merchants Bancorp., First Business Financial Services, Inc., First Financial Corp., First Mid Bancshares, Inc., German American Bancorp, Inc., Hills Bancorporation, Isabella Bank Corporation, LCNB Corp., Level One Bancorp, Inc., Macatawa Bank Corporation, Mercantile Bank Corporation, MidWestOne Financial Group, Inc., Nicolet Bankshares, Inc., Peoples Bancorp, Inc., and Southern Missouri Bancorp, Inc. The Company is in the middle of the group in terms of asset size. The Company's goal is to perform at or near the top of this peer group relative to what we consider to be three key metrics: return on average equity, efficiency ratio and nonperforming assets to total assets. We believe these measures encompass the factors that define the performance of a community bank. Company and peer results for the key financial performance measures are summarized below. West Bancorporation, Inc. Peer Group Range (2) As of and for the three months ended March 31, 2022 As of and for the year ended December 31, 2021 As of and for the year ended December 31, 2021 Return on average equity 20.96% 20.33% 7.24% - 17.69% Efficiency ratio (1) 40.14% 40.91% 43.01% - 64.81% Nonperforming assets to total assets 0.25% 0.26% 0.17% - 1.32% (1) The efficiency ratio is a non-GAAP financial measure. For further information, refer to the Non-GAAP Financial Measures section of this report. (2) Latest data available. At its meeting on April 27, 2022, the Company's Board of Directors declared a quarterly cash dividend of $0.25 per common share. The dividend is payable on May 25, 2022, to stockholders of record on May 11, 2022. 32 Table of Contents West Bancorporation, Inc. Management's Discussion and Analysis (in thousands, except share and per share data) RESULTS OF OPERATIONS The following table shows selected financial results and measures for the three months ended March 31, 2022 compared with the same period in 2021. Three Months Ended March 31, 2022 2021 Change Change % Net income $ 13,184 $ 11,752 $ 1,432 12.19 % Average assets 3,544,564 3,109,852 434,712 13.98 % Average stockholders' equity 255,130 229,473 25,657 11.18 % Return on average assets 1.51 % 1.53 % (0.02) % Return on average equity 20.96 % 20.77 % 0.19 % Net interest margin (1) 2.85 % 3.17 % (0.32) % Efficiency ratio (1) (2) 40.14 % 39.75 % 0.39 % Dividend payout ratio 31.39 % 30.83 % 0.56 % Average equity to average assets ratio 7.20 % 7.38 % (0.18) % As of March 31, 2022 2021 Change Nonperforming assets to total assets (2) 0.25 % 0.78 % (0.53) % Equity to assets ratio 6.67 % 7.39 % (0.72) % Tangible common equity ratio 6.67 % 7.39 % (0.72) % (1) Amounts are presented on a FTE basis. These are non-GAAP financial measures. For further information, refer to the Non-GAAP Financial Measures section of this report. (2) A lower ratio is more desirable. Definitions of ratios: • Return on average assets - annualized net income divided by average assets. • Return on average equity - annualized net income divided by average stockholders' equity. • Net interest margin - annualized tax-equivalent net interest income divided by average interest-earning assets. • Efficiency ratio - noninterest expense (excluding other real estate owned expense and write-down of premises) divided by noninterest income (excluding net securities gains/losses and gains/losses on disposition of premises and equipment) plus tax-equivalent net interest income. • Dividend payout ratio - dividends paid to common stockholders divided by net income. • Average equity to average assets ratio - average equity divided by average assets. • Nonperforming assets to total assets - total nonperforming assets divided by total assets. • Equity to assets ratio - equity divided by assets. • Tangible common equity ratio - common equity less intangible assets (none held) divided by tangible assets. 33 Table of Contents West Bancorporation, Inc. Management's Discussion and Analysis (in thousands, except share and per share data) Net Interest Income The following table presents average balances and related interest income or interest expense, with the resulting annualized average yield or rate by category of interest-earning assets or interest-bearing liabilities. Interest income and the resulting net interest income are shown on a FTE basis. Three Months Ended June 30 Three Months Ended March 31, Average Balance Interest Income/Expense Yield/Rate 2022 2021 Change Change- % 2022 2021 Change Change- % 2022 2021 Change Interest-earning assets: Loans: (1) (2) Commercial $ 470,105 $ 566,621 $ (96,516) (17.03) % $ 4,658 $ 6,810 $ (2,152) (31.60) % 4.02 % 4.87 % (0.85) % Real estate (3) 1,975,858 1,703,943 271,915 15.96 % 18,725 17,273 1,452 8.41 % 3.84 % 4.11 % (0.27) % Consumer and other 3,558 5,383 (1,825) (33.90) % 34 54 (20) (37.04) % 3.90 % 4.09 % (0.19) % Total loans 2,449,521 2,275,947 173,574 7.63 % 23,417 24,137 (720) (2.98) % 3.88 % 4.30 % (0.42) % Securities: Taxable 633,654 326,731 306,923 93.94 % 2,889 1,645 1,244 75.62 % 1.82 % 2.01 % (0.19) % Tax-exempt (3) 170,898 100,994 69,904 69.22 % 1,056 688 368 53.49 % 2.47 % 2.73 % (0.26) % Total securities 804,552 427,725 376,827 88.10 % 3,945 2,333 1,612 69.10 % 1.96 % 2.18 % (0.22) % Federal funds sold 178,041 276,038 (97,997) (35.50) % 82 69 13 18.84 % 0.19 % 0.10 % 0.09 % Total interest-earning assets (3) $ 3,432,114 $ 2,979,710 $ 452,404 15.18 % 27,444 26,539 905 3.41 % 3.24 % 3.61 % (0.37) % Interest-bearing liabilities: Deposits: Interest-bearing demand $ 546,237 $ 452,426 $ 93,811 20.74 % 250 169 81 47.93 % 0.19 % 0.15 % 0.04 % Savings and money market 1,610,639 1,306,886 303,753 23.24 % 1,620 1,315 305 23.19 % 0.41 % 0.41 % — % Time deposits 195,638 187,192 8,446 4.51 % 281 393 (112) (28.50) % 0.58 % 0.85 % (0.27) % Total deposits 2,352,514 1,946,504 406,010 20.86 % 2,151 1,877 274 14.60 % 0.37 % 0.39 % (0.02) % Borrowed funds: Federal funds purchased 1,506 5,387 (3,881) (72.04) % — 1 (1) (100.00) % 0.05 % 0.10 % (0.05) % Subordinated notes, net 20,467 20,453 14 0.07 % 248 249 (1) (0.40) % 4.91 % 4.93 % (0.02) % Federal Home Loan Bank advances 125,000 175,000 (50,000) (28.57) % 630 983 (353) (35.91) % 2.04 % 2.28 % (0.24) % Long-term debt 51,497 21,164 30,333 143.32 % 258 79 179 226.58 % 2.03 % 1.51 % 0.52 % Total borrowed funds 198,470 222,004 (23,534) (10.60) % 1,136 1,312 (176) (13.41) % 2.32 % 2.40 % (0.08) % Total interest-bearing liabilities $ 2,550,984 $ 2,168,508 $ 382,476 17.64 % 3,287 3,189 98 3.07 % 0.52 % 0.60 % (0.08) % Net interest income (FTE) (4) $ 24,157 $ 23,350 $ 807 3.46 % Net interest spread (FTE) 2.72 % 3.01 % (0.29) % Net interest margin (FTE) (4) 2.85 % 3.17 % (0.32) % (1) Average loan balances include nonaccrual loans. Interest income recognized on nonaccrual loans has been included. (2) Interest income on loans includes amortization of loan fees and costs and prepayment penalties collected, which are not material. (3) Tax-exempt income has been adjusted to a tax-equivalent basis using a federal income tax rate of 21 percent and is adjusted to reflect the effect of the nondeductible interest expense associated with owning tax-exempt securities and loans. (4) Net interest income (FTE) and net interest margin (FTE) are non-GAAP financial measures. For further information, refer to the Non-GAAP Financial Measures section of this report. 34 Table of Contents West Bancorporation, Inc. Management's Discussion and Analysis (in thousands, except share and per share data) The Company's largest component of net income is net interest income, which is the difference between interest earned on interest-earning assets, consisting primarily of loans and securities, and interest paid on interest-bearing liabilities, consisting of deposits and borrowings. Fluctuations in net interest income can result from the combination of changes in the average balances of asset and liability categories and changes in interest rates. Interest rates earned and paid are affected by general economic conditions, particularly changes in market interest rates, and by competitive factors, government policies and actions of regulatory authorities. Net interest margin on a FTE basis, a non-GAAP financial measure, is a measure of the net return on interest-earning assets and is computed by dividing annualized tax-equivalent net interest income by total average interest-earning assets for the period. The net interest margin for the three months ended March 31, 2022 decreased by 32 basis points compared to the three months ended March 31, 2021. The primary driver of the decrease in the net interest margin was a decrease in yield on loans and securities, partially offset by a decrease in the interest rates paid on deposits and borrowed funds. The higher average balances of securities also contributed to a lower net interest margin. Tax-equivalent net interest income for the three months ended March 31, 2022 increased $807 compared to the same time period in 2021. Tax-equivalent interest income on loans decreased $720 for the three months ended March 31, 2022 compared to the three months ended March 31, 2021. Included in commercial loans were PPP loans with interest income of $439 and $2,842 and yields of 12.60 percent and 7.41 percent for the three months ended March 31, 2022 and March 31, 2021, respectively. This decrease in interest income from PPP loans was the largest driver of the overall decrease of interest income from loans. The PPP loan interest income in 2022 and 2021 included accelerated origination fees recognized at the time of loan forgiveness. Exclusive of the PPP loans, the yield on loans was 3.83 percent and 4.07 percent for the three months ended March 31, 2022 and March 31, 2021, respectively. The decrease in loan yield was due to lower rates on new and renewed loans resulting from low market rates and competitive pressures on loan pricing. The Company continues to focus on expanding existing and entering into new customer relationships while maintaining strong credit quality. The yield on the Company's loan portfolio is affected by the portfolio's loan mix, the interest rate environment, the effects of competition, the level of nonaccrual loans and reversals of previously accrued interest on charged-off loans. The political and economic environments can also influence the volume of new loan originations and the mix of variable-rate versus fixed-rate loans. The average balance of securities available for sale was $376,827 higher for the three months ended March 31, 2022 compared to the three months ended March 31, 2021. This was the result of securities purchased during 2021 and 2022 to improve the yield on excess liquidity. Due to the interest rate environment during 2021 and the first three months of 2022, securities added to the portfolio have been at significantly lower yields than the existing portfolio holdings, resulting in an overall decline in the securities portfolio yield. The average balance of deposits increased $406,010 for the three months ended March 31, 2022, compared to the three months ended March 31, 2021. The increase was primarily due to an increase in the average balance of money market accounts. The growth in these deposit balances was primarily due to customers' desire to retain liquidity, as well as a result of additional funds provided to individuals and businesses by government relief programs in 2021. The average balance of borrowed funds decreased $23,534 for the three months ended March 31, 2022 compared to the three months ended March 31, 2021. The rate paid on borrowed funds declined to 2.32 percent for the three months ended March 31, 2022 from 2.40 percent for the three months ended March 31, 2021. These declines were primarily due to the repayment of $50,000 of FHLB advances in the second quarter of 2021, partially offset by the $34,500 increase in variable-rate long-term debt in December 2021. In March 2022, the Federal Reserve increased the target federal funds rate by 25 basis points, and is expected to make additional rate increases throughout 2022. These rate increases could improve reinvestment rates on loans and securities, but could also increase the Company's cost of deposits and borrowed funds and increase the unrealized losses in the Company's securities portfolio. 35 Table of Contents West Bancorporation, Inc. Management's Discussion and Analysis (in thousands, except share and per share data) Provision for Loan Losses and the Related Allowance for Loan Losses The provision for loan losses represents a charge made to earnings to maintain an adequate allowance for loan losses. The adequacy of the allowance for loan losses is evaluated quarterly by management and reviewed by the Board of Directors. The allowance for loan losses is management's best estimate of probable losses inherent in the loan portfolio as of the balance sheet date. The provision for loan losses was negative $750 for the three months ended March 31, 2022, compared to a provision of $500 for the three months ended March 31, 2021. The provision in 2021 was due primarily to uncertainty surrounding economic conditions as a result of the COVID-19 pandemic and an increase in loan balances, while the negative provision recorded in 2022 was due to the sustained performance of loans after the expiration of COVID modifications and sustained improvement in classified loans. Factors management considers in establishing an appropriate allowance include: the borrower's financial condition; the value and adequacy of loan collateral; the condition of the local economy and the borrower's specific industry; the levels and trends of loans by segment; and a review of delinquent and classified loans. The quarterly evaluation of the allowance focuses on factors such as specific loan reviews, changes in the components of the loan portfolio given the current and forecasted economic conditions, and historical loss experience. Any one of the following conditions may result in the review of a specific loan: concern about whether the customer's cash flow or net worth is sufficient to repay the loan; delinquency status; criticism of the loan in a regulatory examination; the suspension of interest accrual; or other factors, including whether the loan has other special or unusual characteristics that suggest special monitoring is warranted. The Company's concentration risks include geographic concentrations in central and eastern Iowa and southern Minnesota. The local economies in those markets are composed primarily of major financial service companies, healthcare providers, educational institutions, technology and agribusiness companies, and state and local governments. West Bank has a significant portion of its loan portfolio in commercial real estate loans, commercial lines of credit, commercial term loans, and construction and land development loans. West Bank's typical commercial borrower is a small- or medium-sized, privately owned business entity. Compared to residential mortgages or consumer loans, commercial loans typically have larger balances and repayment usually depends on the borrowers' successful business operations. Commercial loans generally are not fully repaid over the loan period and may require refinancing or a large payoff at maturity. When the economy turns downward, commercial borrowers may not be able to repay their loans, and the value of their assets, which are usually pledged as collateral, may decrease rapidly and significantly. While management uses available information to recognize losses on loans, further reduction in the carrying amounts of loans may be necessary based on changes in circumstances, changes in the overall economy in the markets we currently serve, or later acquired information. Identifiable sectors within the general economy are subject to additional volatility, which at any time may have a substantial impact on the loan portfolio. In addition, regulatory agencies, as integral parts of their examination processes, periodically review the credit quality of the loan portfolio and the level of the allowance for loan losses. Such agencies may require West Bank to recognize additional charge-offs or provision for loan losses based on such agencies' review of information available to them at the time of their examinations. 36 Table of Contents West Bancorporation, Inc. Management's Discussion and Analysis (in thousands, except share and per share data) West Bank's policy is to charge off loans when, in management's opinion, a loan or a portion of a loan is deemed uncollectible. Commercially reasonable efforts are made to maximize subsequent recoveries. The following table summarizes the activity in the Company's allowance for loan losses for the three months ended March 31, 2022 and 2021 and related ratios. Three Months Ended March 31, 2022 2021 Change Balance at beginning of period $ 28,364 $ 29,436 $ (1,072) Charge-offs — — — Recoveries 9 72 (63) Net recoveries 9 72 (63) Provision for loan losses charged to operations (750) 500 (1,250) Balance at end of period $ 27,623 $ 30,008 $ (2,385) Average loans outstanding $ 2,449,521 $ 2,275,947 Ratio of annualized net (charge-offs) recoveries during the period to average loans outstanding — % 0.01 % Ratio of allowance for loan losses to average loans outstanding 1.13 % 1.32 % Ratio of allowance for loan losses to total loans at end of period 1.11 % 1.30 % Ratio of allowance for loan losses to total loans at end of period, excluding PPP loans (1) 1.12 % 1.39 % (1) A non-GAAP financial measure. For further information, refer to the Non-GAAP Financial Measures section of this report. The U.S. economy continues to be affected by the Federal Reserve's accommodative monetary policies initiated during the COVID-19 pandemic. Current economic concerns include inflationary trends, continuing supply chain issues and labor shortages, and anticipated increases in the Federal Reserve targeted federal funds rate. Monthly job growth for the first three months of 2022 averaged approximately 562,000 based on preliminary estimates and the national unemployment rate decreased to 3.6 percent, which is only 0.1 percent higher than the rate in February 2020, prior to the COVID-19 pandemic. Gross domestic product increased at an annual rate of 6.9 percent in the fourth quarter of 2021. In response to increasing inflation rates, the Federal Reserve increased the targeted federal funds rate by 25 basis points in March 2022. It is expected that additional rate increases will occur throughout 2022. The Company decreased certain qualitative factors used in the allowance for loan losses evaluation in the first quarter of 2022 based upon the sustained performance of loans after the expiration of COVID modifications and sustained improvement in classified loans, resulting in a negative provision for the quarter. Management believes the resulting allowance for loan losses as of March 31, 2022 was adequate to absorb any losses inherent in the loan portfolio at the end of the quarter. 37 Table of Contents West Bancorporation, Inc. Management's Discussion and Analysis (in thousands, except share and per share data) Noninterest Income The following table shows the variance from the prior year in the noninterest income categories shown in the Consolidated Statements of Income. Three Months Ended March 31, Noninterest income: 2022 2021 Change Change % Service charges on deposit accounts $ 580 $ 582 $ (2) (0.34) % Debit card usage fees 472 442 30 6.79 % Trust services 629 652 (23) (3.53) % Increase in cash value of bank-owned life insurance 227 220 7 3.18 % Realized securities gains, net — 4 (4) (100.00) % Other income: All other income 481 565 (84) (14.87) % Total other income 481 565 (84) (14.87) % Total noninterest income $ 2,389 $ 2,465 $ (76) (3.08) % The decrease in other income for the three months ended March 31, 2022 compared to the three months ended March 31, 2021 was primarily due to the recognition of net swap termination gains totaling $181 in March 2021. Interest rate swaps with a total notional amount of $150,000 were terminated and the pre-tax gains and losses were recorded in other noninterest income. Refer to Note 5 to the financial statements for additional information. In the first quarter of 2022, the Company also recognized other income of $97 related to the purchase of discounted transferable state income tax credits. 38 Table of Contents West Bancorporation, Inc. Management's Discussion and Analysis (in thousands, except share and per share data) Noninterest Expense The following table shows the variance from the prior year in the noninterest expense categories shown in the Consolidated Statements of Income. In addition, accounts within the “other expenses” category that represent a significant portion of the total or a significant variance are shown below. Three Months Ended March 31, Noninterest expense: 2022 2021 Change Change % Salaries and employee benefits $ 6,298 $ 5,608 $ 690 12.30 % Occupancy 1,086 1,228 (142) (11.56) % Data processing 624 602 22 3.65 % FDIC insurance 337 404 (67) (16.58) % Professional fees 217 283 (66) (23.32) % Director fees 168 191 (23) (12.04) % Other expenses: Subscriptions and service contracts 476 378 98 25.93 % Business development 236 186 50 26.88 % Insurance expense 151 121 30 24.79 % Trust 137 141 (4) (2.84) % Marketing 54 45 9 20.00 % Consulting fees 50 75 (25) (33.33) % Charitable contributions — 60 (60) (100.00) % Low income housing projects amortization 142 134 8 5.97 % New markets tax credit project amortization and management fees 230 230 — — % All other 456 585 (129) (22.05) % Total other expenses 1,932 1,955 (23) (1.18) % Total noninterest expense $ 10,662 $ 10,271 $ 391 3.81 % Salaries and employee benefits increased for the three months ended March 31, 2022 when compared to the three months ended March 31, 2021, primarily due to an increase in expense related to restricted stock units, the addition of four commercial bankers in the third quarter of 2021 and first quarter of 2022, and normal operating increases. FDIC insurance expense decreased during the three months ended March 31, 2022 when compared to the same time period in 2021 primarily due to reductions in the assessment rate. Occupancy expense decreased primarily due to the closure of leased branches. Subscriptions and service contracts increased primarily due to increases in information technology and information security solutions. All other expenses were lower for the three months ended March 31, 2022 when compared to the three months ended March 31, 2021, due primarily to the settlement of a loss on a check fraud scheme in 2021. Income Tax Expense The Company recorded income tax expense of $3,121 (19.1 percent of pre-tax income) for the three months ended March 31, 2022, compared with $3,063 (20.7 percent of pre-tax income) for the three months ended March 31, 2021. The Company's consolidated income tax rate differs from the federal statutory income tax rate in each period, primarily due to tax-exempt interest income, the tax-exempt increase in cash value of bank-owned life insurance, disallowed interest expense, and state income taxes. In addition, for the three months ended March 31, 2022 and 2021, a tax benefit of $377 and $199, respectively, was recorded as a result of the increase in fair value of restricted stock over the vesting period. The tax rates for the first three months of 2022 and 2021 were also impacted by year-to-date federal low income housing tax credits and a new markets tax credit of approximately $367 and $310, respectively. 39 Table of Contents West Bancorporation, Inc. Management's Discussion and Analysis (in thousands, except share and per share data) FINANCIAL CONDITION The Company had total assets of $3,547,069 as of March 31, 2022, compared to total assets of $3,500,201 as of December 31, 2021. Fluctuations in the balance sheet included increases in securities, loans, deposits, deferred tax assets, and other assets and decreases in federal funds sold. Securities Securities available for sale increased by $39,090 during the three months ended March 31, 2022. In the first three months of 2022, the Company continued to grow the securities portfolio, purchasing securities to improve the yield on excess liquidity while monitoring duration and interest rate risk. Additionally, in the first quarter of 2022, the fair value of the securities portfolio declined $54,594. The decline in fair value was the result of increases in market interest rates and is not an indication of declining credit quality. These are unrealized losses that are recorded in accumulated other comprehensive loss, net of tax. Future increases in market interest rates could result in an increase of the unrealized losses in the securities portfolio. As of March 31, 2022, approximately 66 percent of the available for sale securities portfolio consisted of government agency guaranteed collateralized mortgage obligations and mortgage-backed securities. Management currently believes these securities provide acceptable yields, have little to no credit risk and provide fairly consistent cash flows. Loans and Nonperforming Assets Loans outstanding increased $29,170 from $2,456,196 as of December 31, 2021 to $2,485,366 as of March 31, 2022. Changes in the loan portfolio during the first three months of 2022 included increases of $24,783 in commercial real estate loans and $29,166 in construction, land and land development loans. Commercial loans declined $25,941, which included a $12,808 decline in PPP loans. As of March 31, 2022, PPP loans outstanding totaled $9,398. The Company continues to focus on business development efforts in all of its markets. Exclusive of PPP loans, loan growth in the first three months of 2022 was $41,978, or 1.7 percent. In accordance with regulatory guidelines, the Company exercises heightened risk management practices when non-owner occupied commercial real estate lending exceeds 300 percent of total risk-based capital or construction, land development, and other land loans exceed 100 percent of total risk-based capital. Although the Company's loan portfolio is heavily concentrated in real estate and its real estate portfolio levels exceed these regulatory guidelines, it has established risk management policies and procedures to regularly monitor the commercial real estate portfolio. An analysis of the Company's non-owner occupied commercial real estate portfolio as of December 31, 2021 was presented in the Company's Form 10-K filed with the SEC on February 24, 2022, and the Company has not experienced any material changes to that portfolio since December 31, 2021. The following table sets forth the amount of nonperforming assets held by the Company and common ratio measurements of those assets as of the dates shown. March 31, 2022 December 31, 2021 Change Nonaccrual loans $ 8,800 $ 8,948 $ (148) Loans past due 90 days and still accruing interest — — — Troubled debt restructured loans (1) — — — Total nonperforming loans 8,800 8,948 (148) Other real estate owned — — — Total nonperforming assets $ 8,800 $ 8,948 $ (148) Nonperforming loans to total loans 0.35 % 0.36 % (0.01) % Nonperforming assets to total assets 0.25 % 0.26 % (0.01) % (1) While TDR loans are commonly reported by the industry as nonperforming, those not classified in the nonaccrual category are accruing interest due to payment performance. TDR loans on nonaccrual status are categorized as nonaccrual. There were six TDR loans related to one borrower as of March 31, 2022 and December 31, 2021, categorized as nonaccrual. 40 Table of Contents West Bancorporation, Inc. Management's Discussion and Analysis (in thousands, except share and per share data) Premises and Equipment In 2020, the Company began construction of a new office for its St. Cloud, Minnesota branch. Construction was completed in the first quarter of 2022 and the new building opened in March. At that time, the previously leased location was vacated. Additionally, the Company purchased land in the first quarter of 2022 for its new corporate headquarters to be located in West Des Moines, Iowa and development planning is underway. Construction of a new office in Mankato, Minnesota began in the first quarter of 2022. Deposits Deposits increased $75,247 during the first three months of 2022. Savings accounts, which include money market accounts, increased by a total of $82,054 from December 31, 2021 to March 31, 2022. Interest-bearing demand accounts increased $5,993 from December 31, 2021 to March 31, 2022, while noninterest-bearing demand accounts decreased $9,439 during the same period. Balance fluctuations were primarily due to normal customer activity, as corporate customers' liquidity needs vary at any given time. We believe that deposit balances could decrease in 2022 as a result of the end of broad government stimulus programs related to the COVID-19 pandemic and increasing inflation. Derivatives At March 31, 2022 and December 31, 2021, the Company had interest rate swap contracts associated with loans, borrowed funds and deposits with a total notional amount of $425,992 and $427,008, respectively. The fair value of these derivative contracts are reported in other assets or other liabilities on the balance sheet. Changes in the fair values of the interest rate swap contracts resulted in a $8,574 increase in other assets and $3,008 decrease in other liabilities from December 31, 2021 to March 31, 2022 due to projected increases in long-term interest rates. Liquidity and Capital Resources The objectives of liquidity management are to ensure the availability of sufficient cash flows to meet all financial commitments and to capitalize on opportunities for profitable business expansion. The Company's principal source of funds is deposits. Other sources include loan principal repayments, proceeds from the maturity and sale of securities, principal payments on collateralized mortgage obligations and mortgage-backed securities, federal funds purchased, advances from the FHLB, 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 securities maturities and payments, expected deposit flows and the objectives set by the Company's asset-liability management policy. The Company had liquid assets (cash and cash equivalents) of $144,255 as of March 31, 2022 compared with $192,825 as of December 31, 2021. As of March 31, 2022, West Bank had additional borrowing capacity available from the FHLB of approximately $548,000, as well as approximately $15,000 through the Federal Reserve discount window and $67,000 through unsecured federal funds lines of credit with correspondent banks. Net cash from operating activities contributed $15,519 to liquidity for the three months ended March 31, 2022. Management believed that the combination of high levels of potentially liquid assets, cash flows from operations, and additional borrowing capacity provided the Company with strong liquidity as of March 31, 2022. The Company's total stockholders' equity decreased to $236,480 at March 31, 2022 from $260,328 at December 31, 2021. The decrease was primarily the result of the increase in accumulated other comprehensive loss, partially offset by net income less dividends paid. At March 31, 2022, the Company's tangible common equity as a percent of tangible assets was 6.67 percent compared to 7.44 percent as of December 31, 2021. The increase in accumulated other comprehensive loss of $32,131, resulting primarily from the decline in fair value of securities during the first quarter of 2022, reduced tangible common equity, however it has no impact on regulatory capital. The Company had remaining commitments to invest in qualified affordable housing projects totaling $3,947 and $3,986 as of March 31, 2022 and December 31, 2021, respectively. 41 Table of Contents West Bancorporation, Inc. Management's Discussion and Analysis (in thousands, except share and per share data) The Company and West Bank are subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements (as shown in the following table) can result in certain mandatory and possibly additional discretionary actions by regulators, which, if undertaken, could have a direct material effect on the Company's consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and West Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Company's and West Bank's capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Management believed the Company and West Bank met all capital adequacy requirements to which they were subject as of March 31, 2022. 42 Table of Contents West Bancorporation, Inc. Management's Discussion and Analysis (in thousands, except share and per share data) The Company's and West Bank's capital amounts and ratios are presented in the following table. Actual For Capital Adequacy Purposes For Capital Adequacy Purposes With Capital Conservation Buffer To Be Well-Capitalized Amount Ratio Amount Ratio Amount Ratio Amount Ratio As of March 31, 2022: Total Capital (to Risk-Weighted Assets) Consolidated $ 326,871 10.72 % $ 244,000 8.00 % $ 320,249 10.50 % $ 304,999 10.00 % West Bank 362,312 11.88 % 243,926 8.00 % 320,153 10.50 % 304,908 10.00 % Tier 1 Capital (to Risk-Weighted Assets) Consolidated 299,248 9.81 % 183,000 6.00 % 259,249 8.50 % 244,000 8.00 % West Bank 334,689 10.98 % 182,945 6.00 % 259,172 8.50 % 243,926 8.00 % Common Equity Tier 1 Capital (to Risk-Weighted Assets) Consolidated 279,248 9.16 % 137,250 4.50 % 213,500 7.00 % 198,250 6.50 % West Bank 334,689 10.98 % 137,209 4.50 % 213,435 7.00 % 198,190 6.50 % Tier 1 Capital (to Average Assets) Consolidated 299,248 8.39 % 142,645 4.00 % 142,645 4.00 % 178,306 5.00 % West Bank 334,689 9.39 % 142,604 4.00 % 142,604 4.00 % 178,255 5.00 % As of December 31, 2021: Total Capital (to Risk-Weighted Assets) Consolidated $ 319,329 10.89 % $ 234,670 8.00 % $ 308,004 10.50 % $ 293,337 10.00 % West Bank 354,846 12.10 % 234,621 8.00 % 307,941 10.50 % 293,277 10.00 % Tier 1 Capital (to Risk-Weighted Assets) Consolidated 290,965 9.92 % 176,002 6.00 % 249,337 8.50 % 234,670 8.00 % West Bank 326,482 11.13 % 175,966 6.00 % 249,284 8.50 % 234,621 8.00 % Common Equity Tier 1 Capital (to Risk-Weighted Assets) Consolidated 270,965 9.24 % 132,002 4.50 % 205,336 7.00 % 190,669 6.50 % West Bank 326,482 11.13 % 131,975 4.50 % 205,294 7.00 % 190,630 6.50 % Tier 1 Capital (to Average Assets) Consolidated 290,965 8.49 % 137,065 4.00 % 137,065 4.00 % 171,331 5.00 % West Bank 326,482 9.53 % 137,011 4.00 % 137,011 4.00 % 171,264 5.00 % The Company and West Bank are subject to the rules of the Basel III regulatory capital framework and related Dodd-Frank Wall Street Reform and Consumer Protection Act. The rules include the implementation of a 2.5 percent capital conservation buffer that is added to the minimum requirements for capital adequacy purposes. A banking organization with a capital conservation buffer of less than the required amount will be subject to limitations on capital distributions, including dividend payments, and certain discretionary bonus payments to executive officers. At March 31, 2022, the capital ratios for the Company and West Bank were sufficient to meet the conservation buffer. 43 Table of Contents