West Bancorporation, Inc. 2017 Form 10-K Summary
Business context and reporting period
West Bancorporation, Inc. is an Iowa financial holding company whose primary subsidiary, West Bank, operates as a business-focused community bank. The bank serves central and eastern Iowa and Rochester, Minnesota, through 11 offices and provides commercial, real estate and consumer lending, deposit, trust, treasury-management and electronic-banking services. The filing covers the fiscal year ended December 31, 2017, with comparisons primarily to 2016.
The consolidated financial statements received an unqualified audit opinion, and management and the independent auditor concluded that internal control over financial reporting was effective as of December 31, 2017.
Financial performance and key metrics
| Metric | 2017 | 2016 | Change or comment |
|---|---|---|---|
| Net income | $23.1 million | $23.0 million | Record income; essentially flat year over year |
| Basic diluted EPS | $1.42 / $1.41 | $1.43 / $1.42 | Declined modestly |
| Net interest income | $60.1 million | $57.1 million | Increased 5.1% |
| Net interest margin | 3.37% | 3.49% | Declined 12 basis points |
| Noninterest income | $8.6 million | $8.0 million | Increased 8.3% |
| Noninterest expense | $32.3 million | $31.1 million | Increased 3.6% |
| Income before taxes | $36.4 million | $33.0 million | Increased 10.6% |
| Return on average assets | 1.18% | 1.27% | Declined |
| Return on average equity | 13.29% | 14.35% | Declined |
| Efficiency ratio | 45.39% | 46.03% | Improved; non-GAAP measure |
| Texas ratio | 0.32% | 0.56% | Improved; lower is better |
Net interest income benefited from growth in average interest-earning assets, particularly loans and investment securities. This benefit exceeded higher funding costs, although the average rate paid on interest-bearing liabilities increased faster than asset yields. The efficiency ratio improved despite higher salaries, occupancy, data-processing and professional costs.
Balance sheet, credit quality and liquidity
- Total assets increased to $2.11 billion from $1.85 billion.
- Loans increased 7.9% to $1.51 billion, primarily from commercial and commercial real estate lending.
- Deposits increased 17.1% to $1.81 billion, supporting loan and investment growth.
- Investment securities increased to approximately $489.7 million, including $444.2 million of available-for-sale securities and $45.5 million held to maturity.
- Nonperforming assets declined to $0.6 million, or 0.03% of assets, from $1.0 million, or 0.06%, in 2016. Nonperforming loans were $0.6 million, or 0.04% of loans.
- No provision for loan losses was recorded in 2017 because recoveries exceeded charge-offs. The allowance for loan losses was $16.4 million, or 1.09% of loans.
- Commercial real estate exposure was significant. The company reported commercial real estate concentrations of 377% of capital under the applicable regulatory risk-management criteria and implemented additional monitoring and stress-testing processes.
- Cash and cash equivalents ended at $47.9 million, compared with $76.8 million at year-end 2016. Operating activities provided $29.4 million of cash, while investing activities used $294.0 million, principally for securities purchases and loan growth.
- West Bank had approximately $384 million of additional FHLB borrowing capacity and $67 million of unused unsecured federal funds lines at year-end. Management considered liquidity sufficient.
Debt, capital and shareholder returns
- Total borrowings were approximately $120.3 million at year-end, consisting primarily of $76.4 million of FHLB advances, $20.4 million of subordinated notes and $22.9 million of long-term debt.
- The company borrowed $25 million under a new commercial-bank credit agreement in May 2017, using the proceeds for a $40 million capital contribution to West Bank; it also repaid a $25 million FHLB advance in December.
- Stockholders’ equity increased to $178.1 million from $165.4 million. The tangible common equity ratio was 8.42%, compared with 8.92% in 2016.
- West Bank was well-capitalized, and the company and bank exceeded applicable minimum regulatory capital requirements, including the fully phased-in capital conservation buffer.
- Cash dividends were $0.71 per share in 2017 versus $0.67 in 2016. A quarterly dividend of $0.18 per share was declared for payment in February 2018. No shares were repurchased during 2017.
Material changes versus the prior comparable period
- Pre-tax income increased because of higher net interest income, higher noninterest income and the absence of a loan-loss provision, partly offset by higher operating expenses.
- Net income increased only slightly because the Tax Cuts and Jobs Act required a $2.34 million one-time reduction in deferred tax assets and corresponding increase in 2017 tax expense. This accounting adjustment did not increase taxes actually paid.
- The effective tax rate increased to 36.7% from 30.2%. Excluding the one-time tax-reform adjustment, management expected a materially lower tax burden beginning in 2018.
- The net interest margin fell from 3.49% to 3.37% as deposit and borrowing costs rose faster than asset yields. Management expected continued margin pressure in 2018.
- Credit quality improved, with nonperforming loans and the Texas ratio declining. However, the allowance ratio declined from 1.15% to 1.09% of loans as the portfolio expanded.
- Investment securities purchases and sales increased substantially as management repositioned the portfolio toward higher-yielding securities with similar risk profiles and somewhat longer durations.
Guidance, outlook, risks and unusual items
- Management expressed a positive 2018 outlook, expecting profitability at a level favorable relative to peers and an effective income tax rate of approximately 20%.
- Future results depend substantially on loan growth, credit losses, interest-rate movements and local and national economic conditions.
- Management expected additional loan growth in 2018 but also anticipated continued pressure on the net interest margin and higher money-market deposit costs.
- The loan portfolio exceeded the regulatory concentration guideline for commercial real estate. A downturn in commercial real estate values, borrower cash flows or refinancing conditions could increase provisions, charge-offs and capital requirements.
- The company identified approximately $10.1 million of potential problem loans to three commercial and commercial real estate customers; none was in default at year-end.
- Approximately $623.9 million of off-balance-sheet commitments consisted of $617.9 million of commitments to extend credit and $6.0 million of standby letters of credit. Management did not expect significant losses, but future funding obligations depend on customer performance.
- The company had no material pending legal proceedings beyond routine litigation. It did, however, identify ongoing risks from cybersecurity, third-party technology providers, regulatory change, competition, interest rates, liquidity, deposit pricing and economic conditions.
- The current expected credit loss standard is scheduled to become effective for the company in 2020. Management had not yet determined its financial impact and indicated that it could increase allowance volatility and capital needs.
- Gross unrealized securities losses were approximately $5.1 million and were considered temporary; management stated it did not intend, and did not expect to be required, to sell the affected securities before recovery.
Most important facts for an investor to verify
- Whether loan growth and the high commercial real estate concentration remain supported by underwriting quality, collateral values and borrower cash flow.
- Whether the absence of a 2017 loan-loss provision is sustainable as the portfolio grows and CECL implementation approaches.
- Whether deposit repricing and higher market rates further reduce the net interest margin.
- Whether the projected approximately 20% effective tax rate for 2018 is achieved and offsets the 2017 one-time tax-reform charge.
- The maturity, repricing and refinancing risks associated with FHLB advances, subordinated notes and variable-rate long-term debt.
- The liquidity impact if time deposits, municipal deposits or other funding sources decline or are renewed only at higher rates.
- The company’s ability to maintain capital and dividend payments while funding growth and meeting regulatory requirements.
- Potential credit exposure from the identified problem loans, off-balance-sheet commitments and geographic concentration in Iowa and Minnesota.