Business Context and Reporting Period
West Bancorporation, Inc., through West Bank, operates a community banking business in central and eastern Iowa and southern Minnesota. This unaudited Form 10-Q covers the three months ended March 31, 2021, with comparisons to the three months ended March 31, 2020 and December 31, 2020. Unless otherwise noted, amounts are in thousands, except per-share data and percentages.
Key Financial Metrics
| Metric | Q1 2021 | Comparable period or date |
|---|---|---|
| Net income | $11,752 | $8,089 in Q1 2020 |
| Diluted earnings per share | $0.70 | $0.49 in Q1 2020 |
| Net interest income | $23,121 | $18,464 in Q1 2020 |
| Net interest margin, FTE | 3.17% | 3.10% in Q1 2020 |
| Provision for loan losses | $500 | $1,000 in Q1 2020 |
| Noninterest income | $2,465 | $2,520 in Q1 2020 |
| Noninterest expense | $10,271 | $9,663 in Q1 2020 |
| Return on average assets | 1.53% | 1.29% in Q1 2020 |
| Return on average equity | 20.77% | 15.54% in Q1 2020 |
| Efficiency ratio, adjusted and FTE | 39.75% | 45.64% in Q1 2020 |
| Total assets | $3,172,906 | $3,185,744 at December 31, 2020 |
| Total loans | $2,303,999 | $2,280,575 at December 31, 2020 |
| Total deposits | $2,682,093 | $2,700,994 at December 31, 2020 |
| Cash and cash equivalents | $325,489 | $396,435 at December 31, 2020 |
| Stockholders’ equity | $234,529 | $223,695 at December 31, 2020 |
Material Changes Versus Prior Comparable Period
- Net income increased 45.3%, primarily because net interest income rose $4,657 and the provision for loan losses declined $500, partly offset by higher noninterest expense.
- Net interest income increased 25.2% on an FTE basis. Interest expense declined substantially, including a $3,169 reduction in deposit interest expense, following lower market and deposit rates.
- Average loans increased 15.8%, but the overall loan yield declined to 4.30% from 4.59%. PPP loans contributed $2,842 of interest income, including approximately $2,046 of accelerated origination-fee recognition.
- Noninterest income decreased modestly because Q1 2021 had no loan swap-fee revenue compared with $586 in Q1 2020. Trust services revenue increased $189.
- Noninterest expense increased 6.3%, driven mainly by salaries and benefits, FDIC insurance, and other expenses, including the settlement of a check-fraud loss.
- Comprehensive income was $15,037 versus a comprehensive loss of $7,450 in Q1 2020, reflecting improved derivative values that more than offset unrealized securities losses.
- Loans increased 1.0% from year-end, while deposits declined 0.7%. Securities available for sale increased $26,581 to $447,152 as the Company invested excess liquidity.
- The allowance for loan losses increased to $30,008 from $29,436. The allowance ratio was 1.30% of total loans and 1.39% excluding PPP loans.
Cash Flow, Debt, Liquidity and Capital
- Operating activities provided $15,049 of cash. Investing activities used $60,304, primarily for $72,650 of securities purchases and a $23,352 net increase in loans. Financing activities used $25,691, principally because deposits declined and dividends of $3,623 were paid.
- Cash and cash equivalents declined $70,946 during the quarter to $325,489.
- Borrowings included $175,000 of Federal Home Loan Bank advances, $20,455 of subordinated notes, $20,919 of long-term debt and $4,060 of federal funds purchased.
- Management reported approximately $462,000 of additional FHLB borrowing capacity, $31,000 of Federal Reserve discount-window capacity and $67,000 of unsecured federal funds lines. It considered liquidity strong.
- The Company planned to repay $25,000 of FHLB advances in April 2021 and an additional $25,000 in May 2021 because of excess liquidity.
- At March 31, 2021, consolidated total capital, Tier 1 capital, CET1 capital and Tier 1 leverage ratios were 11.47%, 10.30%, 9.51% and 8.48%, respectively. Management stated that the Company and West Bank met applicable capital requirements and the capital-conservation buffer.
Guidance, Outlook, Risks and Unusual Items
- Management expects loan interest income and loan yields to decline during 2021 as PPP forgiveness reduces balances and approximately 88.1% of first-round PPP origination fees had been recognized by March 31, 2021.
- Management warned that net interest income and net interest margin could decrease because of historically low interest rates, lower reinvestment yields, loan prepayments, PPP runoff and economic uncertainty.
- COVID-19-related loan modifications totaled $109,078 at quarter-end, including $64,449 of hotel loans and $17,863 of movie-theater loans. Deferrals were scheduled to expire from April through June 2021.
- Hotel, restaurant and movie-theater exposures totaled approximately $212,176, $22,120 and $18,363, respectively, or approximately 11.0% of the total loan portfolio. Management continues to monitor these sectors for deteriorating cash flows, delinquencies and defaults.
- Loans classified as Watch increased to $100,057 from $26,715, primarily because a borrowing group with $69,386 of hotel, restaurant and other commercial real estate loans was downgraded. The group had a weighted-average loan-to-value ratio of 63%; $45,051 was subject to COVID-19 modifications.
- Nonperforming assets increased to $24,804, or 0.78% of assets, from $16,194 at year-end. The increase resulted from one loan becoming more than 90 days past due; the renewal was completed after quarter-end and the loan was no longer nonperforming.
- Commercial real estate, commercial lending and construction lending create concentration and collateral-value risks. The Company’s real estate exposure exceeds certain regulatory concentration guidelines, although management stated that enhanced monitoring is in place.
- In March 2021, the Company terminated interest-rate swaps with aggregate notional amounts of $150,000. The transactions produced net swap termination gains of $181 in noninterest income, while $3,600 of hedge termination losses were reclassified from accumulated other comprehensive income.
- The Company expects to adopt the CECL credit-loss standard after December 15, 2022 and cannot yet reasonably estimate the impact. It is also evaluating reference-rate reform guidance.
- The Board declared a quarterly dividend of $0.24 per share on April 28, 2021, up $0.02 from the prior quarter and payable May 26, 2021.
- Management reported no material changes to previously disclosed risk factors, no material pending legal proceedings and effective disclosure controls as of March 31, 2021.
Facts Investors Should Verify
- Whether COVID-19 loan deferrals, particularly in hotels, movie theaters and commercial real estate, convert into delinquencies, defaults or additional provisions.
- The pace of PPP loan forgiveness and the resulting effect on loan balances, interest income, fee recognition and net interest margin.
- Trends in deposits, excess liquidity and planned FHLB debt repayments, including the effect on asset yields and balance-sheet growth.
- Changes in Watch-list loans, nonperforming assets and the adequacy of the $30,008 allowance for loan losses.
- The potential future effect of CECL adoption, reference-rate reform and changes in interest rates on earnings, capital and accumulated other comprehensive income.
- The sustainability of Q1 profitability, including the effects of unusually favorable deposit funding costs and derivative-related gains or losses.