West Bancorporation, Inc. — Q3 2018 Form 10-Q Summary
Business context and reporting period
West Bancorporation, Inc. is the holding company for West Bank, serving central and eastern Iowa and the Rochester, Minnesota area. This unaudited Form 10-Q covers the three and nine months ended September 30, 2018, compared with the corresponding 2017 periods, and the balance sheet is compared with December 31, 2017. Unless noted otherwise, amounts are in thousands.
Financial performance and condition
| Metric | Q3 2018 | Q3 2017 | Change |
|---|---|---|---|
| Net interest income | $15,687 | $15,031 | +$656 |
| Net income | $7,133 | $6,405 | +11.4% |
| Diluted EPS | $0.43 | $0.39 | +$0.04 |
| Tax-equivalent net interest margin | 2.95% | 3.31% | -36 basis points |
| Adjusted efficiency ratio | 47.71% | 45.10% | +2.61 percentage points |
| Return on average assets | 1.28% | 1.29% | -1 basis point |
| Return on average equity | 15.40% | 14.41% | +99 basis points |
For the first nine months, net income was $21,281, or $1.30 diluted EPS, versus $18,876, or $1.16 diluted EPS, in 2017. Net interest income was $46,402, compared with $44,513. Tax-equivalent net interest margin declined to 3.05% from 3.41%, while the adjusted efficiency ratio increased to 47.93% from 45.95%.
- Total assets were $2.172 billion at September 30, 2018, up 2.7% from December 31, 2017.
- Loans were $1.601 billion, up $90.3 million, or 6.0%; commercial real estate loans increased $125.7 million, partly offset by a $31.0 million decline in commercial loans.
- Total deposits were $1.839 billion, up $28.5 million, or 1.6%. Savings deposits increased $93.5 million, while interest-bearing demand deposits declined $81.1 million.
- Cash and cash equivalents were $27.3 million, down from $47.9 million at year-end 2017.
- Stockholders’ equity was $184.6 million, compared with $178.1 million at December 31, 2017. The tangible common equity ratio was 8.50%.
- The allowance for loan losses was $16.7 million, or 1.04% of total loans. The company recorded negative provisions of $400 in Q3 and $250 for the nine-month period, reflecting recoveries and improved or favorable credit-quality factors.
- Net cash provided by operating activities was $26.9 million for the nine months. Investing activities used $85.9 million, primarily for loan growth and securities purchases, while financing activities provided $38.3 million. Ending cash and cash equivalents were $27.3 million.
- Debt and other borrowings included $77.5 million of Federal Home Loan Bank advances, $26.2 million of federal funds purchased, $20.4 million of subordinated notes and $17.6 million of long-term debt.
Material changes versus comparable periods
- Net income increased primarily because of higher net interest income, negative loan-loss provisions and lower income taxes.
- Interest income benefited from higher average loan and investment balances, but deposit interest expense increased substantially as balances and market rates rose. Deposit interest expense increased $2.7 million in Q3 and $6.5 million for the nine months.
- Net interest margin compressed because deposit and borrowing costs rose faster than loan yields. Management also noted that the lower 21% federal tax rate reduced the tax-equivalent adjustment used in the margin calculation.
- Noninterest income declined $150 in Q3 and $690 for the nine months. The change reflected net investment-security losses in 2018 versus gains in 2017, the absence of a $307 bank-owned life insurance gain recorded in 2017, and lower service and debit-card fees. Trust-service income and guarantee fees partly offset the declines.
- Noninterest expense increased $541 in Q3 and $1.6 million for the nine months, driven mainly by salaries and benefits, occupancy costs and a $333 write-down of the Iowa City branch facility.
- The company recognized $492 of additional income tax expense in Q3 related to correcting the treatment of interest income on one loan for periods from January 1, 2014 through June 30, 2018, plus $97 of related tax penalties and interest.
- All securities previously classified as held to maturity, with an amortized cost of $45.5 million, were transferred to available-for-sale status on January 1, 2018 to enhance liquidity and asset-liability flexibility. Accumulated other comprehensive loss increased to $8.5 million, largely because of unrealized investment-security losses.
Guidance, outlook, risks and unusual items
- Management stated that the loan pipeline was strong and expected loan growth in all three markets during the remainder of 2018.
- Management expected further pressure on net interest margin from rising deposit costs and a potentially flattening U.S. Treasury yield curve. The company expected one additional 25-basis-point Federal Reserve rate increase in 2018.
- The Iowa City and Coralville branches were expected to be consolidated before year-end 2018; Eastern Iowa customers would continue to be served through the Coralville branch and digital channels.
- Credit quality remained strong by management’s assessment, but nonaccrual loans increased to $1.846 million from $622 thousand at year-end. The Texas ratio increased to 0.92% from 0.32%, primarily because of nonaccrual loans related to two customers.
- Commercial real estate, commercial lending and construction lending expose the company to borrower performance, refinancing, collateral-value and regional economic risks. Concentration risks exist in central and eastern Iowa and southeastern Minnesota.
- The company had approximately $343 million of additional FHLB borrowing capacity and $67 million of unsecured federal funds lines. Management believed liquidity was strong.
- At September 30, 2018, West Bank exceeded applicable regulatory capital requirements and the fully phased-in capital conservation buffer. Consolidated total capital and common equity tier 1 ratios were 11.95% and 10.04%, respectively.
- Off-balance-sheet commitments included $591.3 million of commitments to extend credit and $6.0 million of standby letters of credit. The filing reported no material pending legal proceedings.
- The company did not plan to early adopt the current expected credit losses standard, ASC 326, which was expected to become effective in 2020; management stated that the eventual impact could not yet be assessed.
- The board declared a quarterly dividend of $0.20 per share, payable November 21, 2018 to shareholders of record November 7, 2018.
Important facts for investors to verify
- Whether loan growth remains strong without a corresponding deterioration in nonaccrual loans, criticized loans or charge-offs.
- The sensitivity of net interest margin and earnings to additional rate increases, deposit repricing and yield-curve changes.
- The sustainability of the negative loan-loss provision and the adequacy of the $16.7 million allowance under changing economic conditions.
- The magnitude and duration of accumulated other comprehensive losses from the investment portfolio and their effect on tangible capital.
- The impact of the Iowa City and Coralville branch consolidation, including any additional restructuring or impairment costs.
- The final effect of the tax correction and whether additional tax liabilities, penalties or interest could arise.
- The eventual adoption impact of ASC 326 and the company’s exposure under its $597.3 million of credit-related off-balance-sheet commitments.