Business Context and Reporting Period
West Bancorporation, Inc. is a community banking holding company operating primarily through West Bank in Iowa and southern Minnesota. This unaudited Form 10-Q covers the three and nine months ended September 30, 2020, compared with the corresponding 2019 periods, and the balance sheet is compared with December 31, 2019. Amounts are in thousands except per-share data.
Key Financial Metrics
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Net income | $8,100 | $7,526 | $24,158 | $21,083 |
| Diluted EPS | $0.49 | $0.46 | $1.46 | $1.28 |
| Net interest income | $21,132 | $17,116 | $60,343 | $49,043 |
| Provision for loan losses | $4,000 | $300 | $8,000 | $300 |
| Noninterest income | $3,203 | $2,158 | $7,498 | $6,276 |
| Noninterest expense | $10,059 | $9,536 | $29,139 | $28,830 |
| Net interest margin, FTE | 3.21% | 2.94% | 3.19% | 2.95% |
| Adjusted FTE efficiency ratio | 41.35% | 49.03% | 42.68% | 51.74% |
| Return on average assets | 1.16% | 1.22% | 1.21% | 1.20% |
| Return on average equity | 15.20% | 14.76% | 15.47% | 14.25% |
At September 30, 2020, total assets were $2.776 billion, up from $2.474 billion at December 31, 2019. Loans were $2.247 billion, up 15.7%, including $224.5 million of Paycheck Protection Program loans. Deposits were $2.297 billion, up $282.0 million. Investment securities declined to $374.4 million from $398.6 million.
Cash and cash equivalents were $65.8 million, compared with $53.3 million at year-end 2019. Nine-month operating cash flow was $31.1 million; investing activities used $283.4 million, primarily because of net loan growth, while financing activities provided $264.9 million, primarily from deposit growth.
Debt at September 30, 2020 included $175.0 million of Federal Home Loan Bank advances, $22.2 million of long-term debt, $20.4 million of subordinated notes and $2.4 million of federal funds purchased. Available additional borrowing capacity was approximately $367 million from the FHLB, $51 million through the Federal Reserve discount window and $67 million through unsecured correspondent-bank lines.
Stockholders’ equity was $215.3 million, while the tangible common equity ratio was 7.76%. Consolidated total capital, Tier 1 capital and common equity Tier 1 ratios were 11.47%, 10.42% and 9.58%, respectively; management stated that the Company and West Bank exceeded applicable capital requirements.
Material Changes Versus Prior Comparable Period
- Third-quarter net income increased 7.6% and nine-month net income increased 14.6%, driven mainly by higher net interest income and noninterest income.
- Net interest income increased 23.5% in the third quarter and 23.0% for the first nine months. Lower deposit and borrowing costs more than offset lower asset yields and increased interest-bearing liabilities.
- The allowance provision rose substantially to $4.0 million in the third quarter and $8.0 million year to date, versus $0.3 million in each 2019 comparable period.
- Noninterest income benefited from $983 thousand of third-quarter and $1.572 million of year-to-date loan swap fees, which were not recorded in the 2019 periods, and from net investment securities gains.
- Noninterest expense increased modestly, including higher FDIC insurance expense. The Company also reported operational losses related to check-fraud schemes and was seeking to recover approximately $380 thousand, with collectibility described as undeterminable.
- Nonaccrual loans increased to $17.8 million from $0.5 million at December 31, 2019. The allowance for loan losses increased to $25.4 million from $17.2 million, or 1.26% of loans excluding PPP loans versus 0.93% at year-end.
- Accumulated other comprehensive loss increased to $14.5 million from $3.3 million, principally because of unrealized losses on interest-rate swaps. Nine-month comprehensive income was $12.9 million versus $21.9 million in 2019.
Guidance, Outlook, Commentary, Risks and Unusual Items
No formal earnings guidance was provided. Management expects the COVID-19 pandemic and related economic uncertainty to slow loan growth and potentially reduce net interest income and net interest margin in future periods as lower market rates reduce loan yields. Management also expects credit quality and loan-loss provisions could deteriorate further during the remainder of 2020 and into 2021.
COVID-19-related payment modifications covered approximately $434.4 million, or 19.3% of loans, at September 30, 2020. Approximately $361.0 million of these loans were scheduled to return to regular payments in October and November. Additional deferrals had been granted to hotel and movie-theater borrowers, and approximately $67 million of additional hotel modifications were expected in November.
Exposure to the hotel, retail, restaurant and movie-theater industries totaled approximately $331.7 million, or 14.8% of the loan portfolio. Management identified these sectors, along with commercial real estate and commercial operating loans, as elevated credit risks. Nonperforming assets were $17.8 million, or 0.64% of total assets, and the Texas ratio increased to 7.38% from 0.23% at year-end.
The Bank originated 925 PPP loans totaling $224.5 million. SBA forgiveness payments began in October 2020 and the forgiveness process was expected to extend into 2021. PPP loans are 100% SBA-guaranteed, although the filing identifies risks that the SBA could deny or reduce guarantees if eligibility, origination or servicing deficiencies are found. PPP-related litigation and reputational risks were also disclosed.
The Board maintained the quarterly dividend at $0.21 per share for the second, third and fourth quarters of 2020, citing economic uncertainty. The October 28, 2020 dividend was payable November 25, 2020. The Board stated that the dividend would be evaluated quarterly.
Other risks include prolonged recession or unemployment, deposit outflows and increased reliance on wholesale funding, lower collateral values, interest-rate risk, concentration in commercial real estate, cyber and operational risks, reference-rate reform, regulatory changes and the future adoption of the current expected credit loss standard. The Company plans to adopt CECL after the delayed effective date for smaller reporting companies and cannot yet estimate the impact.
Management stated that disclosure controls were effective and that no material changes to internal control over financial reporting occurred during the quarter. No material pending legal proceedings were reported.
Investor Verification Priorities
- Track the performance, payment status and eventual SBA forgiveness of the $224.5 million PPP portfolio.
- Monitor the $434.4 million of COVID-19-modified loans, especially hotel, restaurant, retail and movie-theater borrowers returning from deferral.
- Reconcile changes in nonaccrual loans, criticized loans, charge-offs and the $25.4 million allowance as economic conditions evolve.
- Assess the sustainability of net interest margin gains given near-zero policy rates, lower loan yields and potential deposit or funding changes.
- Review interest-rate swap valuations, the $20.2 million accumulated derivative loss and related future reclassifications to interest expense.
- Evaluate liquidity capacity, deposit trends, wholesale borrowings and the effect of any increase in line-of-credit utilization.
- Confirm capital ratios and dividend capacity if credit losses, asset growth or accumulated other comprehensive losses increase.