GREAT WESTERN BANCORP, INC. The historical consolidated financial data discussed below reflects our historical results of operations and financial condition and should be read in conjunction with our financial statements and related notes thereto presented in Item 8 of this Annual Report on Form 10-K. In addition to historical financial data, this discussion includes certain forward-looking statements regarding events and trends that may affect our future results. Such statements are subject to risks and uncertainties that could cause our actual results to differ materially. See "Cautionary Note Regarding Forward-Looking Statements." For a more complete discussion of the factors that could affect our future results, see "Item 1A. Risk Factors." Any discrepancies included in this filing between totals and the sums of percentages and dollar amounts presented, or between rounded dollar amounts, are due to rounding. Tax Equivalent Presentation All references to net interest income, net interest margin, interest income on non-ASC 310-30 loans, yield on ASC 310-30 loans and the related non-GAAP adjusted financial measure of each item are presented on a FTE basis unless otherwise noted. In fiscal year 2018, the Tax Reform Act reduced the federal tax rate for corporations from 35% to 21%. Because of ourSeptember 30 fiscal year end, a blended statutory rate of 24.5% was applied to all FTE non-GAAP adjusted financial measures for fiscal year 2018 and a fully phased in statutory federal tax rate of 21% was applied to all FTE non-GAAP adjusted financial measures beginning in fiscal year 2019. Overview We are a full-service regional bank holding company focused on relationship-based business and agri-business banking. We serve our customers through 175 branches in attractive markets in nine states:Arizona ,Colorado ,Iowa ,Kansas ,Minnesota ,Missouri ,Nebraska ,North Dakota andSouth Dakota . Our Bank was established more than 80 years ago and we have achieved strong market positions by developing and maintaining extensive local relationships in the communities we serve. By leveraging our business and agri-business focus, presence in attractive markets, highly efficient operating model and robust approach to risk management, we have achieved significant and profitable growth-both organically and through disciplined acquisitions. We provide financial results based on a fiscal year endingSeptember 30 as a single reportable segment. 59- -------------------------------------------------------------------------------- The principal sources of our revenues and cash flows are: (i) interest and fees earned on loans made or held by our Bank; (ii) interest on fixed income investments held by our Bank; (iii) fees on wealth management services; (iv) service charges on deposit accounts maintained at our Bank; (v) gain on the sale of loans held for sale (vi) gains on sales of securities; and (vii) merchant and card fees. Our principal expenses are: (i) interest expense on deposit accounts and other borrowings; (ii) salaries and employee benefits; (iii) data processing costs primarily associated with maintaining our Bank's loan and deposit functions; (iv) occupancy expenses for maintaining our Bank's facilities; (v) professional fees; (vi) business development; (vii)FDIC insurance assessments; and (viii) other real estate owned expenses. The largest component contributing to our net income is net interest income, which is the difference between interest earned on earning assets (primarily loans and investments) and interest paid on interest-bearing liabilities (primarily deposit accounts and other borrowings). One of management's principal functions is to manage the spread between interest earned on earning assets and interest paid on interest-bearing liabilities in an effort to maximize net interest income while maintaining an appropriate level of interest rate risk. Highlights for the Fiscal Year EndedSeptember 30, 2019 Net income was$167.4 million , or$2.92 per diluted share, for fiscal year 2019, compared to net income of$157.9 million , or$2.67 per diluted share, for fiscal year 2018, an increase of$9.4 million , or 6.0%. Total revenue (non-FTE) for fiscal year 2019 remained flat, while there was a slight reduction in noninterest expenses, a higher provision for loan and lease losses and a lower provision for income taxes. Total revenue (non-FTE) is the sum of net interest income (non-FTE) and noninterest income. Our efficiency ratio, which measures our ability to manage noninterest expenses, remained strong during fiscal year 2019 at 45.8%, compared to 47.1% for fiscal year 2018. For more information on our efficiency ratio, see "-Non-GAAP Financial Measures" and for a reconciliation to the most directly comparable GAAP financial measure, see "Item 6. Selected Financial Data-Non-GAAP Financial Measures Reconciliations." Net interest margin, which measures our ability to maintain interest rates on interest earning assets above those of interest-bearing liabilities, was 3.74%, 3.89% and 3.90% for fiscal years 2019, 2018 and 2017, respectively. Adjusted net interest margin, which reflects the realized gain (loss) on interest rate swaps, was 3.74%, 3.84% and 3.76% for the same periods, respectively. We believe our adjusted net interest margin is more representative of our underlying performance and is the measure we use internally to evaluate our results. Net interest margin and adjusted net interest margin were 15 and 10 basis points lower, respectively, compared to fiscal year 2018. Net interest margin decreased between the two periods primarily a result of a 40 basis point increase in the cost of deposits, partially offset by a 24 basis point increase in the yield on loans. A$6.0 million reduction in the cost of interest rate swaps between the periods is the primary driver of the less pronounced decrease in adjusted net interest margin compared to net interest margin. For more information on our adjusted net interest margin, see "-Non-GAAP Financial Measures" and for a reconciliation to the most directly comparable GAAP financial measure, see "Item 6. Selected Financial Data-Non-GAAP Financial Measures Reconciliations." Total loans were$9.71 billion as ofSeptember 30, 2019 , compared to$9.42 billion as ofSeptember 30, 2018 . The majority of growth was focused in the CRE segment of the portfolio, which grew by$463.1 million , or 10.0%, partially offset by a reduction in the agriculture segment of$174.0 million , or 8.0%. Deposits as ofSeptember 30, 2019 were$10.30 billion , an increase of$566.8 million , or 5.8%, from$9.73 billion as ofSeptember 30, 2018 , as a result of brokered deposits being a more cost effective source of funding. Nonaccrual loans, including ASC 310-30 loans, were$107.2 million atSeptember 30, 2019 a decrease of$36.0 million , or 25.2%, compared to$143.2 million atSeptember 30, 2018 . Loans graded "Watch" were$405.5 million as ofSeptember 30, 2019 , an increase of$62.2 million , or 18.1%, compared to$343.3 million atSeptember 30, 2018 , while loans graded "Substandard" were$472.5 million , an increase of$219.8 million , or 87.0%, compared to$252.7 million over the same periods. The increase in loans graded "Watch" was primarily due to a deterioration during the year of a small number of commercial non-real estate relationships while the increase in "Substandard" was primarily due to a deterioration during the year of a small number of dairy relationships. Other repossessed property balances increased by$13.7 million , or 59.3%, primarily due to the addition of one large property during the period. Provision for loan and lease losses was$40.9 million for fiscal year 2019, compared to$18.0 million for fiscal year 2018. Net charge-offs for fiscal year 2019 were$34.7 million , or 0.36% of average total loans on an annualized basis, compared to$16.9 million , or 0.18%, for fiscal year 2018. Net charge-offs in fiscal year 2019 were concentrated in the agriculture segment of the loan portfolio, which included$18.7 million of net charge-offs related to the cattle industry, and the commercial non-real estate segment of the loan portfolio, which included$7.5 million of net charge-offs. The ratio of ALLL to total loans was 0.73% atSeptember 30, 2019 , an increase from 0.69% atSeptember 30, 2018 . The balance of the ALLL increased to$70.8 million atSeptember 30, 2019 from$64.5 million atSeptember 30, 2018 . 60- -------------------------------------------------------------------------------- Tier 1 capital, total capital and Tier 1 leverage ratios were 11.7%, 12.7% and 10.1%, respectively, atSeptember 30, 2019 , compared to 12.0%, 13.0% and 10.7%, respectively, atSeptember 30, 2018 . In addition, our Common Equity Tier 1 ratio was 11.0% atSeptember 30, 2019 , compared to 11.3% atSeptember 30, 2018 . Our tangible common equity to tangible assets ratio was 9.6% atSeptember 30, 2019 and 2018. All regulatory capital ratios remain above regulatory minimums to be considered "well capitalized". During fiscal year 2019,$94.3 million was deployed to repurchase and retire approximately 2.7 million shares of Company's common stock under the repurchase program authorized by the Board of Directors. For more information on our tangible common equity to tangible assets ratio, see "-Non-GAAP Financial Measures" and for a reconciliation to the most directly comparable GAAP financial measure, see "Item 6. Selected Financial Data-Non-GAAP Financial Measures Reconciliations." Key Factors Affecting Our Business and Financial Performance We believe that stable long-term growth and profitability are the result of building strong customer relationships while maintaining disciplined underwriting standards and continuing to focus on our operational efficiency. We plan to focus on originating high-quality loans and growing our deposit base through our relationship-based business and agri-business banking approach. We believe that continuing to focus on our core strengths will enable us to gain market share and increase profitability. For more information on the key components of our strategy for continued success and future growth, see "Part I, Item 1. Business-Our Business Strategy." We face a variety of risks that may impact various aspects of our risk profile from time to time. The extent of such impacts may vary depending on factors such as the current economic, political and regulatory environment, merger and acquisition activity and operational challenges. For more information on these risks and our risk management strategies, see "Cautionary Note Regarding Forward-Looking Statements, "Part I, Item 1. Business" and "Part I, Item 1A. Risk Factors." Results of Operations-Fiscal Years EndedSeptember 30, 2019 , 2018 and 2017 Overview The following table highlights certain key financial and performance information for fiscal years 2019, 2018 and 2017. At and for
Fiscal Years Ended
2019 2018 2017
(dollars in thousands, except share and per share amounts)
Operating Data:
Interest income (FTE) $ 548,760 $ 488,434 $ 443,114
Interest expense 122,209 74,000 45,320
Noninterest income 60,732 73,609 63,214
Noninterest expense 224,898 231,425 216,643
Provision for loan and lease losses 40,947 17,986 21,539
Net income 167,365 157,916 144,786
Adjusted net income ¹ $ 167,365 $ 171,502 $ 145,226
Common shares outstanding 56,283,659 58,917,147 58,834,066
Weighted average diluted common shares outstanding 57,257,061 59,131,650 59,029,382
Earnings per common share - diluted $ 2.92 $ 2.67 $ 2.45
Adjusted earnings per common share - diluted ¹ 2.92 2.90 2.46
Performance Ratios:
Net interest margin (FTE) ¹ 3.74 % 3.89 % 3.90 %
Adjusted net interest margin (FTE) ¹ 3.74 % 3.84 % 3.76 %
Return on average total assets 1.33 % 1.34 % 1.27 %
Return on average common equity 9.1 % 8.8 % 8.5 %
Return on average tangible common equity ¹ 15.3 % 15.3 % 15.4 %
Efficiency ratio ¹ 45.8 % 47.1 % 46.5 %
1 This is a non-GAAP financial measure we believe is helpful to interpreting our financial results. For more
information on this non-GAAP financial measure, see "-Non-GAAP Financial Measures" and for a reconciliation to
the most directly comparable GAAP financial measure, see "Item 6. Selected Financial Data - Non-GAAP Financial
Measures Reconciliations".
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Net Interest Income The following tables present net interest income, net interest margin and adjusted net interest margin for fiscal years 2019, 2018 and 2017.
At and for
Fiscal Years Ended
2019 2018 2017
(dollars in thousands)
Net interest income:
Total interest income (FTE) $ 548,760 $ 488,434 $ 443,114
Less: Total interest expense 122,209 74,000 45,320
Net interest income (FTE) $ 426,551 $ 414,434 $ 397,794
Net interest margin (FTE) and adjusted net interest
margin (FTE) ¹
Average interest-earning assets $ 11,414,926 $ 10,647,357 $ 10,209,741
Average interest-bearing liabilities $ 10,698,555 $ 9,952,961 $ 9,573,937
Net interest margin (FTE) 3.74 % 3.89 % 3.90 %
Adjusted net interest margin (FTE) ¹ 3.74 % 3.84 % 3.76 %
1 This is a non-GAAP financial measure we believe is helpful to interpreting our financial results. For more
information on this non-GAAP financial measure, see "-Non-GAAP Financial Measures" and for a reconciliation to the
most directly comparable GAAP financial measure, see "Item 6. Selected Financial Data-Non-GAAP Financial Measures
Reconciliations".
Net interest income increased $12.2 million , or 2.9%, to $426.6 million in
fiscal year 2019 from $414.4 million in fiscal year 2018, which increased $16.6
million , or 4.2%, from $397.8 million in fiscal year 2017. The increase in net
interest income for both periods was primarily attributable to higher loan
interest income driven by 5.3% and 5.7% of growth in average loans outstanding
between the periods, respectively, combined with higher yields on total loans,
partially offset by higher interest expense associated with the cost of deposits
for the same periods.
Net interest margin was 3.74% and 3.89% in fiscal years 2019 and 2018,
respectively, while adjusted net interest margin was 3.74% and 3.84% over the
same periods, respectively. The 15 basis points decrease in net interest margin
was primarily due to a 40 basis point increase in the cost of deposits,
partially offset by a 24 basis point increase in the yield on loans. A $6.0
million reduction in the cost of interest rate swaps between the periods is the
primary driver of the less pronounced decrease in adjusted net interest margin
compared to net interest margin.
Net interest margin was 3.89% in fiscal year 2018, compared with 3.90% in fiscal
year 2017. Adjusted net interest margin was 3.84% and 3.76% over the same
periods, respectively. The decrease in net interest margin was primarily due to
a 27 basis point increase in the cost of interest-bearing liabilities, partially
offset by a 25 basis point increase in the cost of interest-earning assets
driven by higher average loan balances as a proportion of earning assets and
improving loan yields. A $9.0 million reduction in the cost of interest rate
swaps between the periods is the primary driver of the more pronounced increase
in adjusted net interest margin compared to net interest margin. For more
information on our adjusted net interest margin, see "-Non-GAAP Financial
Measures" and for a reconciliation to the most directly comparable GAAP
financial measure, see "Item 6. Selected Financial Data-Non-GAAP Financial
Measures Reconciliations."
The following table presents the distribution of average assets, liabilities and
equity, interest income and resulting yields on average interest-earning assets,
and interest expense and rates on average interest-bearing liabilities for
fiscal years 2019, 2018 and 2017, respectively. Loans on nonaccrual status that
had interest accrued as of the date of nonaccrual are immediately reversed as a
reduction to interest income, while any interest subsequently recovered is
recorded in the period of recovery. Tax-exempt loans and securities, totaling
$768.8 million at September 30, 2019 and $789.0 million at September 30, 2018 ,
are typically entered at lower interest rate arrangements than comparable
non-exempt loans and securities. The amount of interest income reflected below
has been adjusted to include the amount of tax benefit realized in the period
and as such is presented on a fully-tax equivalent basis, the calculation of
which is outlined in the discussion of non-GAAP items, see "-Non-GAAP Financial
Measures" and for a reconciliation to the most directly comparable GAAP
financial measure, see "Item 6. Selected Financial Data-Non-GAAP Financial
Measures Reconciliations." ASC 310-30 loans represent loans accounted for in
accordance with ASC 310-30 Accounting for Purchased Loans that were credit
impaired at the time we acquired them. Non-ASC 310-30 loans represent loans we
have originated and loans we have acquired that were not credit impaired at the
time we acquired them.
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Fiscal Years Ended September 30,
2019 2018 2017
Average Balance Interest (FTE) Yield / Cost Average Balance Interest (FTE) Yield / Cost Average Balance Interest (FTE) Yield / Cost
(dollars in thousands)
Assets
Interest-bearing bank deposits ¹ $ 61,646 $ 2,472 4.01 % $ 75,101 $ 1,376 1.83 % $ 123,616 $ 922 0.75 %
Investment securities 1,681,185 41,510 2.47 % 1,384,632 29,171 2.11 % 1,390,453 26,311 1.89 %
Non-ASC 310-30 loans, net ² 9,610,956 496,753 5.17 % 9,106,519 446,386 4.90 % 8,581,615 405,080 4.72 %
ASC 310-30 loans, net 61,139 8,025 13.13 % 81,105 11,501 14.18 % 114,057 10,801 9.47 %
Loans, net 9,672,095 504,778 5.22 % 9,187,624 457,887 4.98 % 8,695,672 415,881 4.78 %
Total interest-earning assets 11,414,926 548,760 4.81 % 10,647,357 488,434 4.59 % 10,209,741 443,114 4.34 %
Noninterest-earning assets 1,206,151 1,160,802 1,154,861
Total assets $ 12,621,077 $ 548,760 4.35 % $ 11,808,159 $ 488,434 4.14 % $ 11,364,602 $ 443,114 3.90 %
Liabilities and Stockholders' Equity
Noninterest-bearing deposits $ 1,860,645 $ 1,809,470 $ 1,806,491
Interest-bearing deposits 6,286,878 $ 69,305 1.10 % 5,990,182 $ 43,092 0.72 % 5,709,863 $ 25,969 0.45 %
Time deposits 2,030,619 37,413 1.84 % 1,483,760 17,020 1.15 % 1,300,987 9,066 0.70 %
Total deposits 10,178,142 106,718 1.05 % 9,283,412 60,112 0.65 % 8,817,341 35,035 0.40 %
Securities sold under agreements to repurchase 66,485 180 0.27 % 108,599 340 0.31 % 122,188 384 0.31 %
FHLB advances and other borrowings 345,375 9,771 2.83 % 452,572 8,508 1.88 % 525,491 5,437 1.03 %
Subordinated debentures and subordinated notes
payable 108,553 5,540 5.10 % 108,378 5,040 4.65 % 108,917 4,464 4.10 %
Total borrowings 520,413 15,491 2.98 % 669,549 13,888 2.07 % 756,596 10,285 1.36 %
Total interest-bearing liabilities 10,698,555 $ 122,209 1.14 % 9,952,961 $ 74,000 0.74 % 9,573,937 $ 45,320 0.47 %
Noninterest-bearing liabilities 75,045 67,045 88,440
Stockholders' equity 1,847,477 1,788,153 1,702,225
Total liabilities and stockholders' equity
$ 11,808,159 $ 11,364,602 Net interest spread 3.21 % 3.40 % 3.43 % Net interest income and net interest margin (FTE)$ 426,551 3.74 %$ 414,434 3.89 %$ 397,794 3.90 % Less: Tax equivalent adjustment 5,843 6,597 8,599 Net interest income and net interest margin - ties to Statements of Comprehensive Income$ 420,708 3.69 %$ 407,837 3.83 %$ 389,195
3.81 %
1 Interest income includes$0.7 million ,$0.0 million and$0.0 million for fiscal years 2019, 2018 and 2017, respectively, resulting from interest earned on derivative collateral included in other assets on the consolidated balance sheets. 2 Interest income includes$1.3 million ,$2.7 million and$4.1 million for fiscal years 2019, 2018 and 2017, respectively, resulting from accretion of purchase accounting discount associated with acquired loans. Interest Income The following table presents interest income for fiscal years 2019, 2018 and 2017. Fiscal Years Ended September 30, 2019 2018 2017 (dollars in thousands) Interest income: Loans (FTE)$ 504,778 $ 457,887 $ 415,881 Investment securities 41,510 29,171 26,311 Federal funds sold and other 2,472 1,376 922 Total interest income (FTE) 548,760 488,434 443,114 Less: Tax equivalent adjustment 5,843 6,597 8,599 Total interest income (GAAP)$ 542,917 $ 481,837 $ 434,515 Total interest income consists primarily of interest income on loans and interest income on our investment portfolio. Total interest income (FTE) increased$60.4 million , or 12.4%, to$548.8 million for fiscal year 2019, from$488.4 million for fiscal year 2018, which increased$45.3 million , or 10.2%, from$443.1 million for fiscal year 2017. Significant components of interest income are described in further detail below. 63- -------------------------------------------------------------------------------- Loans. Interest income on all loans increased to$504.8 million in fiscal year 2019 from$457.9 million in fiscal year 2018, an increase of$46.9 million , or 10.2%. Average net loan balances for fiscal year 2019 were$9.67 billion , representing a 5.3% increase compared to the same period in fiscal year 2018. The majority of growth was focused in the CRE segment of the portfolio, which grew by$463.1 million , or 10.0%, partially offset by a reduction in the agriculture segment of$174.0 million , or 8.0%. The largest contributors to the overall growth in the CRE segment during fiscal year 2019 were the non-owner-occupied CRE segment, which grew$505.9 million , or 21.6%, and the owner-occupied CRE segment, which increased$76.7 million , or 5.7%, offset in part by a decrease of$173.9 million , or 27.3%, in the construction and development segment. Interest income on ASC 310-30 loans, which are purchased credit impaired loans with a different income recognition model, decreased$3.5 million between the two periods, primarily driven by the runoff of the acquired loan portfolios. Interest income on all loans increased to$457.9 million in fiscal year 2018 from$415.9 million in fiscal year 2017, an increase of$42.0 million , or 10.1% during the fiscal year. Average net loan balances for fiscal year 2018 were$9.19 billion , representing a 5.7% increase compared to the same period in fiscal year 2017. The majority of growth was focused in the CRE segment of the portfolio, which grew by$504.5 million , or 12.2%, partially offset by a reduction in the residential real estate segment of$95.3 million , or 10.2%. The largest contributors to growth in the CRE segment during fiscal year 2018 were the non-owner-occupied CRE subsegment, which grew$321.9 million , or 15.9%, the owner-occupied CRE subsegment, which showed an increase of$115.0 million , or 9.4%, and the construction and development subsegment, which grew$99.0 million , or 18.4%. Interest income on ASC 310-30 loans increased$0.7 million between the two periods, primarily driven by accelerated accretion of interest income on one pool of purchased credit impaired loans in fiscal year 2018. Our yield on loans is affected by market interest rates, the level of adjustable-rate loan indices, interest rate floors and caps, customer repayment activity, the level of loans held for sale, portfolio mix, and the level of nonaccrual loans. The average tax equivalent yield on non-ASC 310-30 loans was 5.17% for fiscal year 2019, a 27 basis point increase compared to 4.90% for fiscal year 2018, which was an 18 basis point increase from 4.72% for fiscal year 2017. Adjusted for the current realized gain (loss) on derivatives we use to manage interest rate risk on certain of our loans at fair value, which we believe represents the underlying economics of the transactions, the adjusted yield on non-ASC 310-30 loans was 5.18% for fiscal year 2019, an increase of 34 basis points compared to 4.84% for fiscal year 2018, which was a 29 basis points increase compared to 4.55% for fiscal year 2017. For more information on our adjusted yield on non-ASC 310-30 loans, see "-Non-GAAP Financial Measures" and for a reconciliation to the most directly comparable GAAP financial measure, see "Item 6. Selected Financial Data-Non-GAAP Financial Measures Reconciliations." The average duration of the loan portfolio, including the impact of the interest rate swaps on the duration of fair value loans, was a relatively short 1.4 years as ofSeptember 30, 2019 . Approximately 47%, or$4.57 billion , of the portfolio is comprised of fixed rate loans, of which$813.0 million of loans are fixed-rate loans with an original term of 5 years or greater which we have entered into equal and offsetting fixed-to-floating interest rate swaps. These loans effectively behave as floating rate loans. For floating rate loans in the portfolio, approximately 40% are indexed to Wall Street Journal Prime, 30% to 5-year Treasuries and the balance to various other indices. Less than 7% of our total loans' rates are floored, with an average interest rate floor 54 basis points above market rates. Loan-related fee income of$7.0 million is included in interest income for fiscal year 2019, compared to$4.9 million and$4.3 million for fiscal years 2018 and 2017, respectively. In addition, certain fees collected at loan origination are considered to be a component of yield on the underlying loans and are deferred and recognized into income over the life of the loans. Amortization related to theFDIC indemnification assets of$1.4 million ,$2.8 million and$4.7 million for fiscal years 2019, 2018 and 2017, respectively, is included as a reduction to interest income. Investment Portfolio. The carrying value of investment securities and FHLB stock was$1.81 billion and$1.41 billion as ofSeptember 30, 2019 and 2018, respectively. Interest income on investments includes income earned on investment securities and FHLB stock. Interest income on investments was$41.5 million for fiscal year 2019, an increase of$12.3 million , or 42.3%, from$29.2 million in fiscal year 2018. The increase in interest income was driven by an increase in average investment balance of$296.6 million , or 21.4%, combined with the yield on investments which increased 36 basis points to 2.47% for fiscal year 2019, compared to 2.11% for fiscal year 2018. In fiscal year 2018, interest income on investments increased to$29.2 million from$26.3 million in fiscal year 2017, an increase of$2.9 million , or 10.9%. The increase was driven by a 22 basis point increase in the yield on investments in fiscal year 2018 to 2.11%, compared to 1.89% for fiscal year 2017, partially offset by a decrease in average balances. The weighted average life of the portfolio was 3.7 years atSeptember 30, 2019 , 3.9 years atSeptember 30, 2018 and 3.6 years atSeptember 30, 2017 . Average investments in fiscal years 2019, 2018 and 2017 were 14.7%, 13.0% and 13.6% of total average interest-earning assets, respectively. 64- -------------------------------------------------------------------------------- Interest Expense The following table presents interest expense for fiscal years 2019, 2018 and 2017. Fiscal Years Ended September 30, 2019 2018 2017 (dollars in thousands) Interest expense Deposits$ 106,718 $ 60,112 $ 35,035 FHLB advances and other borrowings 9,951 8,848 5,821 Subordinated debentures and subordinated notes payable 5,540 5,040 4,464 Total interest expense$ 122,209 $ 74,000 $ 45,320 Total interest expense consists primarily of interest expense on three components: deposits, FHLB advances and other borrowings and our outstanding subordinated debentures and subordinated notes payable. Total interest expense increased$48.2 million , or 65.1%, to$122.2 million in fiscal year 2019, from$74.0 million in fiscal year 2018, which increased$28.7 million , or 63.3%, from$45.3 million in fiscal year 2017. Average interest-bearing liabilities increased$745.6 million , or 7.5%, to$10.70 billion in fiscal year 2019, from$9.95 billion in fiscal year 2018, which increased$379.0 million , or 4.0%, from$9.57 billion in fiscal year 2017. The average cost of total interest-bearing liabilities increased to 1.14% in fiscal year 2019, compared to 0.74% in fiscal year 2018 and 0.47% in fiscal year 2017. Significant components of interest expense are described in further detail below. Deposits. Interest expense on deposits, consisting of interest-bearing accounts and time deposits, was$106.7 million in fiscal year 2019 compared with$60.1 million in fiscal year 2018, an increase of$46.6 million , or 77.5%, which was an increase of$25.1 million , or 71.6%, from$35.0 million in fiscal year 2017. The increases for both periods were driven by growth in average deposits outstanding and increasing benchmark interest rates in the cost of deposits. Average deposit balances increased to$10.18 billion in fiscal year 2019 from$9.28 billion in fiscal year 2018, an increase of$894.7 million , or 9.6%, which was an increase of$466.1 million , or 5.3%, from$8.82 billion in fiscal year 2017. The cost of deposits increased 40 basis points to 1.05% for fiscal year 2019 from 0.65% for fiscal year 2018, which increased 25 basis points from 0.40% for fiscal year 2017 reflecting a rise in market interest rates and increased competition for deposit balances. Average noninterest-bearing demand account balances decreased to 18.3% of average total deposits for fiscal year 2019, compared with 19.5% for fiscal year 2018 and 20.5% for fiscal year 2017. Total average other liquid accounts, consisting of interest-bearing demand accounts, comprised 61.8% of total average deposits in fiscal year 2019, compared to 64.5% of total average deposits for fiscal year 2018 and 64.8% in fiscal year 2017, while time deposit accounts increased in fiscal year 2019 to 20.0% of total average deposits compared to 16.0% in fiscal year 2018 and 14.8% in fiscal year 2017. FHLB Advances and Other Borrowings. Interest expense on FHLB advances and other borrowings was$10.0 million for fiscal year 2019, compared to$8.8 million for fiscal year 2018 and$5.8 million for fiscal year 2017, reflecting weighted average cost of 2.83%, 1.88% and 1.03%, respectively. Our average balance for FHLB advances and other borrowings decreased to$345.4 million in fiscal year 2019 from$452.6 million in fiscal year 2018, which decreased from$525.5 million in fiscal year 2017. Average FHLB advances and other borrowings as a proportion of total average interest-bearing liabilities were 3.2% for fiscal year 2019, 4.5% for fiscal year 2018 and 5.5% for fiscal year 2017. The average rate paid on FHLB advances is impacted by market rates and the various terms and repricing frequency of the specific outstanding borrowings in each year. The weighted average contractual rate paid on our FHLB advances was 2.74% atSeptember 30, 2019 , 2.58% atSeptember 30, 2018 and 1.36% atSeptember 30, 2017 . The average tenor of our FHLB advances was 34 months atSeptember 30, 2019 , 15 months atSeptember 30, 2018 and 4 months atSeptember 30, 2017 . The amount of other borrowings and related interest expense are immaterial in each of fiscal years 2019, 2018 and 2017. We must collateralize FHLB advances by pledging real estate loans or investments. We pledge more assets than required by our current level of borrowings in order to maintain additional borrowing capacity. Although we may substitute other loans for such pledged loans, we are restricted in our ability to sell or otherwise pledge these loans without substituting collateral or prepaying a portion of the FHLB advances. AtSeptember 30, 2019 , we had pledged$4.20 billion of loans to the FHLB, against which we had borrowed$340.0 million . Subordinated Debentures and Subordinated Notes Payable. Interest expense on our outstanding junior subordinated debentures and subordinated notes payable was$5.5 million for fiscal year 2019,$5.0 million for fiscal year 2018, and$4.5 million for fiscal year 2017. The weighted average contractual rate on outstanding junior subordinated debentures was 4.38%, 4.55% and 3.53% atSeptember 30, 2019 , 2018 and 2017, respectively. The weighted average contractual rate on outstanding subordinated notes payable was 4.88% at each of the periods endedSeptember 30, 2019 , 2018 and 2017. 65- -------------------------------------------------------------------------------- Rate and Volume Variances Net interest income is affected by changes in both volume and interest rates. Volume changes are caused by increases or decreases during the year in the level of average interest-earning assets and average interest-bearing liabilities. Rate changes result from increases or decreases in the yields earned on assets or the rates paid on liabilities. The following table presents each of the last two fiscal years and a summary of the changes in interest income and interest expense on a tax equivalent basis resulting from changes in the volume of average asset and liability balances and changes in the average yields or rates compared with the preceding fiscal year. If significant, the change in interest income or interest expense due to both volume and rate has been prorated between the volume and the rate variances based on the dollar amount of each variance. 2019 vs 2018 2018 vs 2017 Volume Rate Total Volume Rate Total (dollars in thousands) Increase (decrease) in interest income: Cash and cash equivalents$ (283) $ 1,379 $ 1,096 $ (474) $ 928 $ 454 Investment securities 6,844 5,495 12,339 (111) 2,971 2,860 Non-ASC 310-30 loans 25,406 24,961 50,367 25,362 15,944 41,306 ASC 310-30 loans (2,670) (806) (3,476) (3,691) 4,391 700 Loans 22,736 24,155 46,891 21,671 20,335 42,006 Total increase 29,297 31,029 60,326 21,086 24,234 45,320 Increase (decrease) in interest expense: Interest-bearing deposits 2,209 24,004 26,213 1,333 15,790 17,123 Time deposits 7,710 12,683 20,393 1,421 6,533 7,954 Securities sold under agreements to repurchase (119) (41) (160) (44) - (44) FHLB advances and other borrowings (2,332) 3,595 1,263 (844) 3,915 3,071 Subordinated debentures and subordinated notes payable 8 492 500 (22) 598 576 Total increase 7,476 40,733 48,209 1,844 26,836 28,680 Increase (decrease) in net interest income (FTE)$ 21,821 $ (9,704) $ 12,117
Provision for Loan and Lease Losses We recognized a provision for loan and lease losses of$40.9 million for fiscal year 2019 compared to a provision for loan and lease losses of$18.0 million for fiscal year 2018, an increase of$22.9 million or 127.7%. The increase in provision was mainly driven by a higher level of net charge-offs recognized between the periods. Net charge-offs in fiscal year 2019 were concentrated in the agriculture segment of the loan portfolio, which included$18.7 million of net charge-offs related to the cattle industry, and the commercial non-real estate segment of the loan portfolio, which included$7.5 million of net charge-offs. Included within the provision for loan and lease losses was a net reversal of$0.6 million during fiscal year 2019 associated with ASC 310-30 loans. This compares to a net impairment of$0.2 million related to this portion of the portfolio recorded in fiscal year 2018. We recognized a provision for loan and lease losses of$18.0 million for fiscal year 2018 compared to a provision for loan and lease losses of$21.5 million for fiscal year 2017, a decrease of$3.5 million , or 16.5%. The decrease provision for loan and lease losses compared to fiscal year 2017 was driven by a lower level of charge-offs recognized between the periods combined with a stable level of specific provisions. Included within the provision for loan and lease losses was a net impairment of$0.2 million during fiscal year 2018 associated with ASC 310-30 loans. This compares to net reversal of$0.7 million related to this portion of the portfolio recorded in fiscal year 2017. Fiscal
Years Ended
2019 2018 2017
(dollars in thousands) Provision for loan and lease losses, non-ASC 310-30 loans *
$ 41,506
(559) 232 (671)
Provision for loan and lease losses, total
* As presented above, the non-ASC 310-30 loan portfolio includes originated loans, other than loans for which
we have elected the fair value option, and loans we acquired that we did not determine were acquired with
deteriorated credit quality.
66-
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Total Credit-Related Charges
We recognized other credit-related charges during fiscal year 2019 that were
higher compared to fiscal year 2018, which was lower compared to fiscal year
2017. We believe the following table, which summarizes each component of the
total credit-related charges incurred during the current and prior fiscal years,
is helpful to understanding the overall impact on our yearly results of
operations. Net other repossessed property charges include other repossessed
property operating costs, valuation adjustments and gain (loss) on sale of other
repossessed properties, each of which entered other repossessed property as a
result of the former borrower failing to perform on a loan obligation. Reversal
of interest income on nonaccrual loans occurs when we become aware that a loan,
for which we had been recognizing interest income, will no longer be able to
perform according to the terms and conditions of the loan agreement, including
repayment of interest owed to us. We record a recovery of interest income on
nonaccrual loans occurs when we receive payment of interest owed to us. Loan
fair value adjustments related to credit relate to the portion of our loan
portfolio for which we have elected the fair value option; these amounts reflect
expected credit losses in the portfolio.
Fiscal Years Ended
Included within F/S Line
Item Item(s): 2019 2018 2017
(dollars in thousands) Provision for loan and lease Provision for loan and lease losses
losses $ 40,947 $ 17,986 $ 21,539 Net other repossessed property Net loss on repossessed charges
property and other related
expenses 4,367 4,369 1,749
Reversal of interest income on Interest income on loans nonaccrual loans
312 1,901 930
Loan fair value adjustment Net increase in fair value of
related to credit loans at fair value 7,664 194 936
Total $ 53,290 $ 24,450 $ 25,154
Total credit-related charges for fiscal year 2019 increased $28.8 million , or
118.0%, compared to fiscal year 2018. The increase in total credit-related
charges was primarily driven by an increase in net charge-offs in fiscal year
2019, mainly concentrated in the agriculture and commercial non-real estate
segments of the loan portfolio. Total credit-related charges for fiscal year
2018 decreased $0.7 million , or 2.8%, compared to fiscal year 2017 primarily
driven by a decrease in net charge-offs, partially offset by higher expenses
associated with other repossessed property.
Noninterest Income
The following table presents noninterest income for the fiscal years ended
September 30, 2019 , 2018 and 2017.
Fiscal
Years Ended
2019 2018 2017
(dollars in thousands)
Noninterest income
Service charges and other fees $ 43,893 $ 51,077 $ 55,725
Wealth management fees 8,914 9,219 9,118
Mortgage banking income, net 4,848 5,842 7,928
Net (loss) gain on sale of securities (178) 6 75
Other 5,287 8,276 5,699
Subtotal, product and service fees 62,764 74,420 78,545
Net increase (decrease) in fair value of loans at fair value
61,412 (45,407) (65,231)
Net realized and unrealized (loss) gain on derivatives (63,444) 44,596 49,900
Subtotal, loans at fair value and related derivatives (2,032)
(811) (15,331)
Total noninterest income $ 60,732 Our noninterest income is comprised of the various fees we charge our customers for products and services we provide and the impact of changes in fair value of loans for which we have elected the fair value treatment and realized and unrealized gains (losses) on the related interest rate swaps we utilize to manage interest rate risk on these loans. While we are required underU.S. GAAP to present both components within total noninterest income, we believe it is helpful to analyze the two broader components of noninterest income separately to better understand the underlying performance of the business. Noninterest income was$60.7 million for fiscal year 2019, compared with$73.6 million for fiscal year 2018, a decrease of$12.9 million or 17.5%, which increased$10.4 million , or 16.4%, from$63.2 million for fiscal year 2017. Significant components of noninterest income are described in further detail below. 67- -------------------------------------------------------------------------------- Product and Service Fees. We recognized$62.8 million of noninterest income related to product and service fees in fiscal year 2019, a decrease of$11.6 million , or 15.7%, from$74.4 million for fiscal year 2018. The decrease was due to a$7.2 million decrease in services charges and other fees combined with a$3.0 million decrease in other income. The decrease in service charges and other fees was primarily due to the impact of adopting the revenue recognition accounting standard in fiscal year 2019, which resulted in netting$5.7 million of credit and debit card network expenses against related interchange income, combined with a decrease in net overdraft and non-sufficient funds income. The decrease in other income compared to the prior period was due to a one-time gain on the sale of Visa, Inc. Class B common stock shares and a sign on bonus received from a service provider in fiscal year 2018. Noninterest income related to product and service fees for the fiscal year 2018 decreased$4.1 million , or 5.3%, from$78.5 million for fiscal year 2017. The decrease was primarily attributable to decreases of$4.6 million , or 8.3%, in service charges and other fees and$2.1 million , or 26.3%, in mortgage banking income, partially offset by a$2.6 million increase, or 45.2%, in other income. The decrease in service charges and other fees reflects the impact of the "Durbin Amendment" limit on debit card interchange income that became effective inJuly 2017 . The decrease in mortgage banking income was due to fewer loans sold during the fiscal year, while the increase in other income was primarily driven by a gain on the sale of Visa, Inc. Class B common stock shares and the sign on bonus noted previously. Loans at fair value and related derivatives. As discussed in "-Analysis of Financial Condition-Derivatives," changes in the fair value of loans for which we have elected the fair value treatment and realized and unrealized gains and losses on the related derivatives are recognized within noninterest income. For fiscal years 2019, 2018 and 2017 these items accounted for$(2.0) million ,$(0.8) million and$(15.3) million , respectively. The change during fiscal year 2019 was driven by a$6.0 million reduction in the current cost of interest rate swaps and a$1.7 million increase in swap fees combined with a net unfavorable change in the credit risk adjustment of$8.9 million . The change during fiscal year 2018 was driven by a$9.0 million reduction in the current cost of interest rate swaps and a$4.7 million increase in swap fees combined with a net favorable change in the credit risk adjustment of$(0.8) million . We believe that the current realized loss on the derivatives economically offsets the interest income earned on the related loans. We present elsewhere the adjusted net interest income and adjusted net interest margin reflecting the metrics we use to manage the business. Noninterest Expense The following table presents noninterest expense for fiscal yearsSeptember 30, 2019 , 2018 and 2017. Fiscal Years Ended September 30, 2019 2018 2017 (dollars in thousands) Noninterest expense Salaries and employee benefits$ 136,305 $ 135,352 $ 128,135 Data processing and communication 24,077 29,805 28,288 Occupancy and equipment 20,784 20,330 19,817 Professional fees 14,579 17,891 15,038 Advertising 4,493 4,507 3,983 Net loss on repossessed property and other related expenses 4,367 4,369 1,749 Acquisition expenses - - 710 Other 20,293 19,171 18,923 Total noninterest expense$ 224,898
Noninterest expense was$224.9 million for fiscal year 2019 compared with$231.4 million for fiscal year 2018, a decrease of$6.5 million , or 2.8%, which was an increase of$14.8 million , or 6.8%, compared to$216.6 million in fiscal year 2017. Our efficiency ratio was 45.8% for fiscal year 2019, 47.1% for fiscal year 2018 and 46.5% for fiscal year 2017. For more information on our efficiency ratio, see "-Non-GAAP Financial Measures" and for a reconciliation to the most directly comparable GAAP financial measure, see "Item 6. Selected Financial Data-Non-GAAP Financial Measures Reconciliations." Significant changes in components of noninterest expense are described in further detail below. Salaries and Employee Benefits. Salaries and employee benefits are the largest component of noninterest expense and include the cost of incentive compensation, stock compensation, benefit plans, health insurance and payroll taxes. These expenses were$136.3 million for fiscal year 2019, an increase of$0.9 million , or 0.7%, from$135.4 million for fiscal year 2018. The majority of the increase was driven by annual merit increases partially offset by a reduction in health insurance costs during the period. Salaries and employee benefits for fiscal year 2018 increased$7.3 million , or 5.6%, from$128.1 million for fiscal year 2017. The majority of the increase was driven by living wage increases in response to federal tax reform and annual merit increases. 68- -------------------------------------------------------------------------------- Data Processing and Communication. Data processing and communication expenses include payments to vendors who provide software, data processing, and services on an outsourced basis, costs related to supporting and developing internet-based activities, credit card rewards provided to our customers, depreciation of bank-owned hardware and software, postage and telephone expenses. Expenses for data processing and communication were$24.1 million for fiscal year 2019 and$29.8 million for fiscal year 2018, a decrease of$5.7 million , or 19.2%. This decrease was due to the impact of adopting the revenue recognition standard as discussed in noninterest income above. Expenses for data processing and communication for fiscal year 2018 increased$1.5 million , or 5.4%, from$28.3 million for fiscal year 2017. The increase was driven primarily by an estimated breakage cost of an existing contract. Occupancy and Equipment. Occupancy and equipment expenses include our branch network and administrative office locations throughout our footprint, including both owned and leased locations, property taxes, maintenance expense and depreciation of bank-owned furniture and equipment. These costs were$20.8 million for fiscal year 2019 and$20.3 million for fiscal year 2018, an increase of$0.5 million , or 2.2%. Expenses for occupancy and equipment for fiscal year 2018 increased$0.5 million , or 2.6%, from$19.8 million for fiscal year 2017. The increases in fiscal years 2019 and 2018 were primarily due to annual increases in rent, utilities and property tax expenses. Professional Fees. Professional fees include ourFDIC and FICO assessments, the cost of accountants and other consultants, and legal services in connection with delinquent loans, business transactions, regulatory compliance matters and to resolve other legal matters. These expenses were$14.6 million for fiscal year 2019 and$17.9 million for fiscal year 2018, a decrease of$3.3 million , or 18.5%. Expenses for professional fees for fiscal year 2018 increased$2.9 million , or 19.0%, from$15.0 million for fiscal year 2017. Professional fees decreased in fiscal year 2019 due to the discontinuation of the surcharge for banks with assets exceeding$10.0 million in ourFDIC assessment and increased in fiscal year 2018 due to an increase in ourFDIC assessment as a result of exceeding$10.0 billion in total assets. Net Loss on Repossessed Property and Other Assets. Our net loss on the sale of repossessed property and other assets was$4.4 million for both fiscal years 2019 and 2018. Net loss on the sale of repossessed property and other assets for fiscal year 2018 increased$2.7 million , or 149.8%, from$1.7 million for fiscal year 2017. The increase in fiscal year 2018 was primarily due to the expenses related to the foreclosure of a single other repossessed property. Other. Other noninterest expenses include costs related to other repossessed property costs prior to foreclosure, business development and professional membership fees, travel and entertainment costs, amortization of core deposits and other intangibles, and other costs incurred. Other noninterest expenses were$20.3 million in fiscal year 2019 and$19.2 million in fiscal year 2018, an increase of$1.1 million , or 5.9%. The increase was primarily due to increases in loan expenses. Other noninterest expenses for fiscal year 2018 increased$0.3 million , or 1.3%, from$18.9 million in fiscal year 2017. The increase was primarily due to an increase in other repossessed property costs prior to foreclosure. Our efficiency ratio was 45.8%, 47.1% and 46.5% for the fiscal years 2019, 2018 and 2017, respectively. For more information on our efficiency ratio, see "-Non-GAAP Financial Measures" and for a reconciliation to the most directly comparable GAAP financial measure, see "Item 6. Selected Financial Data-Non-GAAP Financial Measures Reconciliations." Provision for Income Taxes The provision for income taxes varies due to the amount of taxable income, the investments in tax-advantaged securities and tax credit funds and the rates charged by federal and state authorities. As a result of the Tax Reform Act of 2017, we moved to a fully phased in statutory federal tax rate of 21.0% in fiscal year 2019 versus a blended statutory federal rate of 24.5% in fiscal year 2018 and a statutory federal rate of 35.0% in fiscal year 2017. The provision for income taxes of$48.2 million in fiscal year 2019 represents an effective tax rate of 22.4%, compared to$74.1 million or 31.9%, for fiscal year 2018 and$69.4 million or 32.4%, for fiscal year 2017. Excluding the deferred taxes revaluation as a result of the Tax Reform Act, the effective tax rate was 26.1% for fiscal year 2018. Return on Assets and Equity The table below presents our return on average total assets, return on average common equity and return on average tangible common equity to average assets ratio at and for the dates presented. Fiscal
Years Ended
2019 2018 2017
Return on average total assets 1.33 % 1.34 % 1.27 %
Return on average common equity 9.1 % 8.8 % 8.5 %
Return on average tangible common equity ¹ 15.3 % 15.3 % 15.4 %
1 This is a non-GAAP financial measure we believe is helpful to interpreting our financial results. For more
information on this non-GAAP financial measure, see "-Non-GAAP Financial Measures" and for a reconciliation to the
most directly comparable GAAP financial measure, see "Item 6. Selected Financial Data-Non-GAAP Financial Measures
Reconciliations".
69-
-------------------------------------------------------------------------------- Analysis of Financial Condition The following table highlights certain key financial and performance information for fiscal years endedSeptember 30, 2019 , 2018 and 2017. As of September 30, 2019 2018 2017 (dollars in thousands) Balance Sheet and Other Information Total assets$ 12,788,301 $ 12,116,808 $ 11,690,011 Loans ¹ 9,706,763 9,415,924 8,968,553 Allowance for loan and lease losses 70,774 64,540 63,503 Deposits 10,300,339 9,733,499 8,977,613 Stockholders' equity 1,900,249 1,840,551 1,755,000 Tangible common equity ²$ 1,155,052 $ 1,093,816 $ 1,006,603 Tier 1 capital ratio 11.7 % 12.0 % 11.4 % Total capital ratio 12.7 % 13.0 % 12.5 % Tier 1 leverage ratio 10.1 % 10.7 % 10.3 % Common equity tier 1 ratio 11.0 % 11.3 % 10.7 % Tangible common equity / tangible assets ² 9.6 % 9.6 % 9.2 % Book value per share - GAAP $ 33.76$ 31.24 $ 29.83 Tangible book value per share ² $ 20.52$ 18.57 $ 17.11 Nonaccrual loans / total loans 1.10 % 1.52 % 1.54 % Net charge-offs (recoveries) / average total loans 0.36 % 0.18 % 0.26 % Allowance for loan and lease losses / total loans 0.73 % 0.69 % 0.71 % 1 Loans include unpaid principal balance net of unamortized discount on acquired loans and unearned net deferred fees and costs and loans in process. 2 This is a non-GAAP financial measure we believe is helpful to interpreting our financial results. For more information on this non-GAAP financial measure, see "-Non-GAAP Financial Measures" and for a reconciliation to the most directly comparable GAAP financial measure, see "Item 6. Selected Financial Data-Non-GAAP Financial Measures Reconciliations". Our total assets were$12.79 billion atSeptember 30, 2019 , compared with$12.12 billion atSeptember 30, 2018 and$11.69 billion atSeptember 30, 2017 . The increase in total assets for each of the fiscal years 2019 and 2018 was primarily attributable to growth in loans and securities available for sale, partially offset by a reduction in cash and cash equivalents compared to the prior period. AtSeptember 30, 2019 , loans were$9.71 billion , an increase of$290.8 million , or 3.1%, from$9.42 billion atSeptember 30, 2018 , which increased$447.4 million , or 5.0%, compared to$8.97 billion atSeptember 30, 2017 . The majority of the growth for fiscal year 2019 occurred in the CRE segment of the portfolio, which grew by$463.1 million , mainly across the non-owner segment, partially offset by a reduction of$174.0 million in the agriculture segment of the portfolio. Total deposits were$10.30 billion atSeptember 30, 2019 , an increase of$566.8 million , or 5.8%, from$9.73 billion atSeptember 30, 2018 , which increased$755.9 million , or 8.4%, from$8.98 billion atSeptember 30, 2017 . Noninterest-bearing deposits were$1.96 billion , a 6.1% increase for the fiscal year and interest-bearing deposits were$8.34 billion , a 5.7% increase for the fiscal year. FHLB and other borrowings increased slightly by$65.0 million , or 23.6%, for the fiscal year. 70- -------------------------------------------------------------------------------- Loan Portfolio The following table presents our loan portfolio by category at each of the dates indicated: As of September 30, 2019 2018 2017 2016 2015 (dollars in thousands) Unpaid principal balance: Commercial real estate ¹ Originated$ 4,824,827 $ 4,255,272 $ 3,628,235 $ 3,171,516 $ 2,708,512 Acquired 267,583 374,058 496,570 582,591 137,236 Total 5,092,410 4,629,330 4,124,805 3,754,107 2,845,748 Agriculture ¹ Originated 1,932,722 2,082,778 1,990,648 1,974,226 1,841,437 Acquired 75,922 99,910 131,490 194,711 20,028 Total 2,008,644 2,182,688 2,122,138 2,168,937 1,861,465 Commercial non-real estate ¹ Originated 1,691,026 1,656,563 1,670,349 1,601,328 1,591,974 Acquired 28,930 43,424 48,565 71,838 17,536 Total 1,719,956 1,699,987 1,718,914 1,673,166 1,609,510 Residential real estate Originated 696,403 682,615 724,906 746,384 714,855 Acquired 115,805 154,954 207,986 274,574 208,290 Total 812,208 837,569 932,892 1,020,958 923,145 Consumer Originated 47,324 43,325 56,467 59,850 68,840 Acquired 4,601 6,364 10,092 16,423 4,209 Total 51,925 49,689 66,559 76,273 73,049 Other lending Originated 47,541 46,487 43,132 42,398 38,371 Acquired - - 75 79 - Total 47,541 46,487 43,207 42,477 38,371 Total originated 9,239,843 8,767,040 8,113,737 7,595,702 6,963,989 Total acquired 492,841 678,710 894,778 1,140,216 387,299 Total unpaid principal balance 9,732,684 9,445,750 9,008,515 8,735,918 7,351,288 Less: Unamortized discount on acquired loans (13,655) (18,283) (29,121) (39,947) (19,264) Less: Unearned net deferred fees and costs and loans in process (12,266) (11,543) (10,841) (13,327) (6,826) Total loans 9,706,763 9,415,924 8,968,553 8,682,644 7,325,198 Allowance for loan and lease losses (70,774) (64,540) (63,503) (64,642) (57,200) Loans, net$ 9,635,989 $
9,351,384
1 Unpaid principal balance for commercial real estate, agriculture and commercial non-real estate loans includes fair value adjustments associated with long-term fixed-rate loans where we have entered into interest rate swaps to manage our interest rate risk.
During the fiscal year endedSeptember 30, 2019 , total loans grew by$290.8 million , or 3.1%. The growth was primarily focused in CRE loans, which grew$463.1 million , or 10.0%, partially offset by agriculture loans, which decreased$174.0 million , or 8.0%. Over the same time period, commercial non-real estate, residential real estate, consumer and other loan balances remained generally stable. During the fiscal year endedSeptember 30, 2018 , total loans grew by$447.4 million , or 5.0%. The growth was primarily focused in CRE loans, which grew$504.5 million , or 12.2%, partially offset by residential real estate loans, which declined$95.3 million , or 10.2%. Over the same time period, agriculture, commercial non-real estate, consumer and other loan balances remained stable. 71- -------------------------------------------------------------------------------- The following table presents an analysis of the unpaid principal balance of our loan portfolio atSeptember 30, 2019 , by loan and collateral type and by each of the six major geographic areas we use to manage our markets. September 30, 2019 Iowa / South Kansas / North Dakota / Dakota Missouri Nebraska Arizona Colorado Minnesota Other ² Total % (dollars in thousands) Commercial real estate ¹$ 1,112,863 $ 1,430,247 $ 920,062 $ 516,445 $ 853,975 $ 231,500 $ 27,318 $ 5,092,410 52.3 % Agriculture ¹ 599,664 358,610 140,570 738,580 166,635 2,183 2,402 2,008,644 20.6 % Commercial non-real estate ¹ 307,080 736,273 389,917 83,256 108,400 6,614 88,416 1,719,956 17.7 % Residential real estate 203,497 235,330 170,580 36,524 129,189 20,197 16,891 812,208 8.4 % Consumer 17,244 19,315 12,386 487 1,441 502 550 51,925 0.5 % Other lending - - - - - - 47,541 47,541 0.5 % Total$ 2,240,348 $ 2,779,775 $ 1,633,515 $ 1,375,292 $ 1,259,640 $ 260,996 $ 183,118 $ 9,732,684 100.0 % % by location 23.0 % 28.6 % 16.8 % 14.1 % 12.9 % 2.7 % 1.9 % 100.0 %
1 Unpaid principal balance for commercial real estate, agriculture and commercial non-real estate loans includes fair value adjustments associated with long-term fixed-rate loans where we have entered into interest rate swaps to manage our interest rate risk.
2 Balances in this column represent acquired workout loans and certain other loans managed by our workout staff, commercial and consumer credit card loans, fair value adjustments related to acquisitions and loans for which we have elected the fair value option, which could result in a negative carrying amount in the event of a net negative fair value adjustment.
The following table presents additional detail regarding our CRE, agriculture, commercial non-real estate and residential real estate loans atSeptember 30, 2019 . September 30, 2019 (dollars in thousands) Construction and development $ 463,757 Owner-occupied CRE 1,411,199 Non-owner-occupied CRE 2,853,131 Multifamily residential real estate 364,323 Commercial real estate 5,092,410 Agriculture real estate 957,568 Agriculture operating loans 1,051,076 Agriculture 2,008,644 Commercial non-real estate 1,719,956 Home equity lines of credit 185,444 Closed-end first lien 498,108 Closed-end junior lien 36,865 Residential construction 91,791 Residential real estate 812,208 Consumer 51,925 Other 47,541 Total unpaid principal balance $ 9,732,684Commercial Real Estate . CRE includes owner-occupied CRE, non-owner-occupied CRE, construction and development lending, and multi-family residential real estate. While CRE lending is a significant component of our overall loan portfolio, we are committed to managing our exposure to riskier construction and development deals specifically, and to CRE lending in general, by targeting relationships with sound management and financials which are priced to reflect the amount of risk we accept as the lender. Agriculture. Agriculture loans include farm operating loans and loans collateralized by farm land. According to theAmerican Banker's Association , atJune 30, 2019 , we were ranked the sixth-largest farm lender bank inthe United States measured by total dollar volume of farm loans. We consider agriculture lending one of our core lending areas. We target a portfolio composition for agriculture loans not to exceed 225% of total capital according to our Risk Appetite Statement approved by our Board of Directors. Within our agriculture portfolio, loans are diversified across a wide range of subsectors with the majority of the portfolio concentrated within various types of grain, livestock and dairy products, and across different geographical segments within our footprint. Over recent years, our borrowers have experienced volatile commodity prices, due in part to the effects of recently imposed and proposed tariffs on the export of agricultural products, waivers of the amount of ethanol to be blended into the country's gasoline production and isolated areas of flooding within parts of the Midwest in which certain of our agricultural borrowers conduct their operations. While these events, or a further downturn in the agriculture economy, could directly and adversely affect our agricultural loan portfolio and indirectly and adversely impact other lending 72- -------------------------------------------------------------------------------- categories including commercial non-real estate, CRE, residential real estate and consumer, we believe there continues to typically be strong secondary sources of repayment and low borrower leverage for the agriculture loan portfolio.Commercial Non-Real Estate . Commercial non-real estate, or business lending, represents one of our core competencies. We believe that providing a tailored range of integrated products and services, including lending, to small- and medium-enterprise customers is the business at which we excel and through which we can generate favorable returns for our stockholders. We offer a number of different products including working capital and other shorter-term lines of credit, fixed-rate loans and variable rate loans with interest rate swaps over a wide range of terms, and variable-rate loans with varying terms.Residential Real Estate . Residential real estate lending reflects 1-to-4-family real estate construction loans, closed-end first-lien mortgages (primarily single-family long-term first mortgages resulting from acquisitions of other banks), closed-end junior-lien mortgages and HELOCs. Our closed-end first-lien mortgages include a small percentage of single-family first mortgages that we originate and do not subsequently sell into the secondary market, including some jumbo products, adjustable-rate mortgages and rural home mortgages. Conversely, a large percentage of our total single-family first mortgage originations are sold into the secondary market in order to meet our interest rate risk management objectives. Consumer. Our consumer lending offering comprises a relatively small portion of our total loan portfolio, and predominantly reflects small-balance secured and unsecured products marketed by our branches. Other Lending. Other lending includes all other loan relationships that do not fit within the categories above, primarily consumer and commercial credit cards, customer deposit account overdrafts, and lease receivables. The following table presents the maturity distribution of our loan portfolio as ofSeptember 30, 2019 . The maturity dates were determined based on the contractual maturity date of the loan. September 30, 2019 1 Year or Less >1 Through 5 Years >5 Years Total (dollars in thousands)
Maturity distribution: Commercial real estate$ 516,537 $ 2,201,971 $ 2,373,902 $ 5,092,410 Agriculture 961,934 668,418 378,292 2,008,644 Commercial non-real estate 824,653 554,238 341,065 1,719,956 Residential real estate 150,326 256,811 405,071 812,208 Consumer 8,308 37,157 6,460 51,925 Other lending 47,541 - - 47,541 Total$ 2,509,299 $ 3,718,595 $ 3,504,790 $ 9,732,684 The following table presents the distribution, as ofSeptember 30, 2019 , of our loans that were due after one year between fixed and variable interest rates. September 30, 2019 Fixed Variable Total (dollars in thousands) Maturity distribution: Commercial real estate$ 2,170,598 $ 2,405,275 $ 4,575,873 Agriculture 803,985 242,725 1,046,710 Commercial non-real estate 581,326 313,977 895,303 Residential real estate 287,066 374,816 661,882 Consumer 40,659 2,958 43,617 Total$ 3,883,634 $ 3,339,751 $ 7,223,385 Other Repossessed Property In the normal course of business, we obtain title to real estate and other assets when borrowers are unable to meet their contractual obligations and we initiate foreclosure proceedings, or via deed in lieu of foreclosure actions. Other repossessed property assets are considered nonperforming assets. When we obtain title to an asset, we evaluate how best to maintain and protect our interest in the property and seek to liquidate the assets at an acceptable price in a timely manner. Our total other repossessed property carrying value was$36.8 million as ofSeptember 30, 2019 , an increase of$13.7 million , or 59.3%, compared to$23.1 million atSeptember 30, 2018 , which increased$14.1 million , or 156.8%, compared to$9.0 million atSeptember 30, 2017 . The increase in fiscal year 2019 was due to one large relationship moving into other repossessed property during the year. The increase in fiscal year 2018 was primarily due to the addition of one large property during the period. 73- -------------------------------------------------------------------------------- The following table presents our other repossessed property balances for the period indicated. Fiscal Years Ended September 30, 2019 2018 2017 (dollars in thousands) Balance, beginning of period$ 23,074 $ 8,985 $ 10,282 Additions to other repossessed property 25,668 25,926
7,786
Valuation adjustments and other (2,328) (1,447) (1,630) Sales (9,650) (10,390) (7,453) Balance, end of period$ 36,764 $ 23,074 $ 8,985 Asset Quality We place an asset on nonaccrual status when management believes, after considering collection efforts and other factors, the borrowers' condition is such that collection of interest is doubtful, which is generally 90 days past due. If a borrower has failed to comply with the original contractual terms, further action may be required, including a downgrade in the risk rating, movement to nonaccrual status, a charge-off or the establishment of a specific reserve. If there is a collateral shortfall, we generally work with the borrower for a principal reduction, pledge of additional collateral or guarantee. If these alternatives are not available, we engage in formal collection activities. Restructured loans for which we grant payment or significant interest rate concessions are placed on nonaccrual status until collectability improves and a satisfactory payment history is established, generally by the receipt of at least six consecutive payments. The following table presents the dollar amount of nonaccrual loans, other repossessed property, restructured performing loans and accruing loans over 90 days past due, at the end of the dates indicated. We entered into a loss-sharing agreement with theFDIC related to certain assets (loans and other repossessed property) acquired fromTierOne Bank onJune 4, 2010 . Loans covered by aFDIC loss-sharing agreement are generally pooled with other similar loans and are accreting purchase discount into income each period. Subject to compliance with the applicable loss-sharing agreement, we are indemnified by theFDIC at a rate of 80% for any future credit losses for single-family real estate loans and other repossessed property covered by theFDIC loss-sharing agreement throughJune 4, 2020 . As of September 30, 2019 2018 2017 2016 2015 (dollars in thousands) Nonaccrual loans ¹ Commercial real estate ²$ 14,973 $ 22,908
77,880 107,226 100,504 68,526 24,569
Commercial non-real estate ² 9,502 6,887 13,674 27,307 14,287
Residential real estate
Loans covered by a FDIC loss-sharing
agreement 2,190 2,699 4,893 4,095 5,317
Loans not covered by a FDIC loss-sharing
agreement 2,572 3,425 4,206 5,599 7,124
Total 4,762 6,124 9,099 9,694 12,441
Consumer ² 74 61 123 244 122
Total nonaccrual loans covered by a FDIC
loss-sharing agreement 2,190 2,699 4,893 4,095 5,317
Total nonaccrual loans not covered by a FDIC
loss-sharing agreement 105,001 140,507 133,419 122,300 62,972
Total nonaccrual loans 107,191 143,206 138,312 126,395 68,289
Other repossessed property 36,764 23,074 8,985 10,282 15,892
Total nonperforming assets 143,955 166,280 147,297 136,677 84,181
Restructured performing loans 44,842 19,783 32,490 46,568 60,371
Total nonperforming and restructured assets
$ 30,073 $ 77,156 $ 71,334 $ 36,778 $ 13,966 Percent of total assets Nonaccrual loans not covered by aFDIC loss-sharing agreement 0.82 % 1.16 % 1.14 % 1.06 % 0.64 % Total nonaccrual loans 0.84 % 1.18 % 1.18 % 1.10 % 0.70 % Other repossessed property 0.29 % 0.19 % 0.08 % 0.09 % 0.16 % Nonperforming assets ³ 1.13 % 1.37 % 1.26 % 1.19 % 0.86 % Nonperforming and restructured assets ³ 1.48 % 1.54 % 1.54 % 1.59 % 1.48 %
1 Includes nonperforming restructured loans.
2 Loans not covered by
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At September 30, 2019 , our nonperforming assets were 1.13% of total assets,
compared to 1.37% at September 30, 2018 . Total nonaccrual loans decreased by
$36.0 million , or 25.2% compared to September 30, 2018 , which increased $4.9
million , or 3.5%, compared to September 30, 2017 . The decrease in nonaccrual
loans in fiscal year 2019 was primarily driven by our focus on exiting loans in
all categories with a higher risk profile. The increase in nonaccrual loans for
fiscal year 2018 was primarily driven by the deterioration of a relationship in
the CRE portfolio that has been closely monitored for a number of quarters,
partially offset by improvements in the commercial non-real estate portfolio.
We recognized approximately $2.6 million of interest income on loans that were
on nonaccrual for the fiscal year ended 2019. Excluding loans covered by a FDIC
loss-sharing agreement, we had average nonaccrual loans (calculated as a
two-point average) of $122.8 million outstanding during fiscal year 2019. Based
on the average loan portfolio yield for these loans for the current fiscal year,
we estimate that interest income would have been $6.3 million higher during the
period had these loans been accruing.
We consistently monitor all loans internally rated "watch" or worse because that
rating indicates we have identified some potential weakness emerging; but loans
rated "watch" will not necessarily become problem loans or become impaired.
Aside from the loans on the watch list, we do not believe we have any potential
problem loans that are not already identified as nonaccrual, past due or
restructured as it is our policy to promptly reclassify loans as soon as we
become aware of doubts as to the borrowers' ability to meet repayment terms.
When we grant concessions to borrowers that we would not otherwise grant if not
for the borrowers' financial difficulties, such as reduced interest rates or
extensions of loan periods, we consider these modifications TDRs.
The table below outlines total TDRs, split between accruing and nonaccruing
loans, at each of the dates indicated.
Fiscal Years Ended September 30,
2019 2018 2017
(dollars in thousands)
Commercial real estate
Performing TDRs $ 17,145 $ 2,649 $ 1,121
Nonperforming TDRs 904 2,616 5,351
Total 18,049 5,265 6,472
Agriculture
Performing TDRs 22,929 13,248 22,678
Nonperforming TDRs 24,762 73,741 59,633
Total 47,691 86,989 82,311
Commercial non-real estate
Performing TDRs 4,398 3,420 8,369
Nonperforming TDRs 4,257 656 5,641
Total 8,655 4,076 14,010
Residential real estate
Performing TDRs 263 389 311
Nonperforming TDRs 102 143 688
Total 365 532 999
Consumer
Performing TDRs 107 77 11
Nonperforming TDRs 48 - 21
Total 155 77 32
Total performing TDRs 44,842 19,783 32,490
Total nonperforming TDRs 30,073 77,156 71,334
Total TDRs $ 74,915 $ 96,939 $ 103,824
As of September 30, 2019 , total performing TDRs increased $25.1 million , or
126.7%, compared to September 30, 2018 , which decreased $12.7 million , or 39.1%,
compared to September 30, 2017 . Performing TDRs increased from September 30,
2018 primarily due to one large relationship in the commercial real estate
segment of the loan portfolio. Performing TDRs decreased from September 30, 2017
primarily due to a large relationship in the agriculture portfolio that
transferred from performing to nonperforming TDR status. As of September 30,
2019 , total nonperforming TDRs decreased $47.1 million , or 61.0%, compared to
September 30, 2018 , which increased $5.8 million , or 8.2%, compared to
September 30, 2017 . Nonperforming TDRs decreased from September 30, 2018 mainly
due to two large relationships in the agriculture portfolio, one that moved into
other repossessed property and one that paid off. Nonperforming TDRs increased
from September 30, 2017 mainly due to the large relationship in the agriculture
portfolio that moved to nonperforming status.
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The following table presents nonaccrual loans, TDRs, and other repossessed
property covered by the remaining FDIC loss-sharing agreement; a rollforward of
the allowance for loan and lease losses for loans covered by the remaining FDIC
loss-sharing agreement; a rollforward of allowance for loan and lease losses for
only ASC 310-30 loans covered by the remaining FDIC loss-sharing agreement; and
a rollforward of other repossessed property covered by the remaining FDIC
loss-sharing agreement at and for the periods presented.
At and
for Fiscal Years Ended
2019 2018 2017 2016 2015
(dollars in thousands)
Assets covered by a FDIC loss-sharing agreement
Nonaccrual loans ¹ $ 2,190 $ 2,699 $ 4,893 $ 4,095 $ 5,317
TDRs 43 154 191 255 425
Other repossessed property - 131 - 106 61
Allowance for loan and lease losses, loans
covered by a FDIC loss-sharing agreement
Balance, beginning of period $ 262 $
196
309 386 196 - 782
Recoupment of previously-recorded impairment (379) (302) (892) (677) (1,701)
Charge-offs (79) (18) (15) (41) -
Expiration of loss-sharing arrangement - - - - (2,564)
Balance, end of period $ 113 $
262
Other repossessed property covered by a loss-sharing agreement Balance, beginning of period$ 131 $
-
- 131 14 182 1,666
Valuation adjustments and other - - - (15) (2,034)
Sales (131) - (120) (122) (7,031)
Expiration of loss-sharing agreement - - - - (3,168)
Balance, end of period $ - $
131 $ -
1 Includes nonperforming restructured loans.
Allowance for Loan and Lease Losses
We establish an allowance for the inherent risk of probable losses within our
loan portfolio. The allowance for loan and lease losses is management's best
estimate of probable credit losses that are incurred in the loan portfolio. We
determine the allowance for loan and lease losses based on an ongoing
evaluation, driven primarily by monitoring changes in loan risk grades,
delinquencies and other credit risk indicators, which is an inherently
subjective process. We consider the uncertainty related to certain industry
sectors and the extent of credit exposure to specific borrowers within the
portfolio. In addition, we consider concentration risks associated with the
various loan portfolios and current economic conditions that might impact the
portfolio. All of these estimates are susceptible to significant change. Changes
to the allowance for loan and lease losses are made by charges to the provision
for loan and lease losses. Loans deemed to be uncollectible are charged off
against the allowance for loan and lease losses. Recoveries of amounts
previously charged-off are credited to the allowance for loan and lease losses.
Our allowance for loan and lease losses consists of two components. For
non-impaired loans, we calculate a weighted average loss ratio of 12-, 36- and
60-month historical realized losses by collateral type; adjust as necessary for
our interpretation of current economic conditions, environmental factors and
current portfolio trends including credit quality, concentrations, aging of the
portfolio and/or significant policy and underwriting changes not entirely
covered by the calculated historical loss rates; and apply the loss rates to
outstanding loan balances in each collateral category. We calculate the weighted
average ratio of 12-, 36- and 60-month historical realized losses for each
collateral type by dividing the average net annual charge-offs by the average
outstanding loans of such type subject to the calculation for each of the 12-,
36- and 60-month periods, then averaging those three results. For impaired
loans, we estimate our exposure for each individual relationship, given the
current payment status of the loan and the value of the underlying collateral as
supported by third party appraisals, broker's price opinions, and/or the
borrower's financial statements and internal valuation assessments, each
adjusted for liquidation costs. Any shortfall between the liquidation value of
the underlying collateral and the recorded investment value of the loan is
considered the required specific reserve amount. Actual losses in any period may
exceed allowance amounts. We evaluate and adjust our allowance for loan and
lease losses, and the allocation of the allowance between loan categories, each
month.
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--------------------------------------------------------------------------------The following table presents an analysis of our allowance for loan and lease losses, including provisions for loan and lease losses, charge-offs and recoveries, for the periods indicated.
At and for Fiscal Years Ended
2019 2018 2017 2016 2015
(dollars in thousands)
Allowance for loan and lease losses:
Balance, beginning of period $ 64,540 $
63,503
41,506 17,754 22,210 18,011 19,718
(Improvement) impairment of ASC 310-30
loans (559) 232 (671) (1,056) (677)
Charge-offs:
Commercial real estate (1,511) (3,925) (2,043) (3,625) (1,971)
Agriculture (24,847) (9,473) (7,853) (4,294) (606)
Commercial non-real estate (7,895) (3,813) (12,576) (2,629) (11,153)
Residential real estate (998) (569) (809) (1,157) (238)
Consumer (452) (192) (196) (206) (129)
Other lending (1,358) (1,932) (2,403) (2,255) (1,617)
Total charge-offs (37,061) (19,904) (25,880) (14,166) (15,714)
Recoveries:
Commercial real estate 567 533 485 719 1,339
Agriculture 385 332 415 556 131
Commercial non-real estate 392 994 652 1,429 3,407
Residential real estate 468 337 507 495 231
Consumer 174 141 102 149 104
Other lending 362 618 1,041 1,305 1,143
Total recoveries 2,348 2,955 3,202 4,653 6,355
Net loan charge-offs (34,713) (16,949) (22,678) (9,513) (9,359)
Balance, end of period $ 70,774 $ 64,540 $ 63,503 $ 64,642 $ 57,200
Average total loans for the period ¹ $ 9,741,293 $
9,252,436
$ 9,706,763 $ 9,415,924 $ 8,968,553 $ 8,682,644 $ 7,325,198 Ratios Net charge-offs (recoveries) / average total loans 0.36 % 0.18 % 0.26 % 0.12 % 0.13 % Allowance for loan and lease losses to: Total loans 0.73 % 0.69 % 0.71 % 0.74 % 0.78 % Nonaccruing loans ² 67.40 % 45.93 % 47.60 % 52.86 % 90.83 %
1 Loans include unpaid principal balance net of unamortized discount on acquired loans and unearned net deferred fees and costs and loans in
process.
2 Nonaccruing loans excludes loans covered by
In the fiscal year 2019, we recorded net charge-offs of$34.7 million , representing 0.36% of average total loans, an 18 basis point increase compared to 0.18% of average total loans for fiscal year 2018. The increase in net charge-offs in fiscal year 2019 was primarily driven by net charge-offs in the agriculture segment of the loan portfolio, which included$18.7 million of net charge-offs related to the cattle industry, and$7.5 million of net charge-offs related to the commercial non-real estate segment of the loan portfolio. AtSeptember 30, 2019 , the allowance for loan and lease losses was 0.73% of our total loan portfolio, a 4 basis point increase compared with 0.69% atSeptember 30, 2018 . The balance of the ALLL increased from$64.5 million to$70.8 million over the same period. Additionally, a portion of our loans which are carried at fair value, totaling$813.0 million and$865.4 million atSeptember 30, 2019 and 2018, respectively, have no associated allowance for loan and lease losses, but rather have a fair value adjustment related to credit risk included within their carrying value, thus driving the overall ratio of allowance for loan and lease losses to total loans lower. The amount of fair value adjustment related to credit risk on these loans was$6.8 million and$7.4 million atSeptember 30, 2019 and 2018, respectively, translating to an additional 0.07% and 0.08% of total loans atSeptember 30, 2019 and 2018, respectively. Finally, the total purchase discount remaining on all acquired loans equates to 0.14% and 0.19% of total loans atSeptember 30, 2019 and 2018, respectively. 77- -------------------------------------------------------------------------------- The following tables present management's allocation of the allowance for loan and lease losses by loan category, in both dollars and percentage of our total allowance for loan and lease losses, to specific loans in those categories at the dates indicated. September 30, 2019 2018 2017 2016 2015 (dollars in thousands) Allocation of allowance for loan and lease losses: Commercial real estate$ 16,827 $ 16,777 $ 16,941 $ 17,946 $ 18,014 Agriculture 30,819 28,121 25,757 25,115 13,952 Commercial non-real estate 17,567 13,610 14,114 12,990 15,996 Residential real estate 4,095 4,749 5,347 7,106 8,025 Consumer 427 257 329 438 348 Other lending 1,039 1,026 1,015 1,047 865 Total$ 70,774 $ 64,540 $ 63,503 $ 64,642 $ 57,200 September 30, 2019 2018 2017 2016 2015 Allocation of allowance for loan and lease losses: Commercial real estate 23.8 % 26.0 % 26.7 % 27.8 % 31.5 % Agriculture 43.5 % 43.6 % 40.6 % 38.9 % 24.4 % Commercial non-real estate 24.8 % 21.1 % 22.2 % 20.1 % 28.0 % Residential real estate 5.8 % 7.3 % 8.4 % 11.0 % 14.0 % Consumer 0.6 % 0.4 % 0.5 % 0.6 % 0.6 % Other lending 1.5 % 1.6 % 1.6 % 1.6 % 1.5 % Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % Management will continue to evaluate the loan portfolio and assess economic conditions in order to determine future allowance levels and the amount of loan and lease loss provisions. We review the appropriateness of our allowance for loan and lease losses on a monthly basis. Management monitors closely all past due and restructured loans in assessing the appropriateness of its allowance for loan and lease losses. In addition, we follow procedures for reviewing and grading all substantial commercial and agriculture relationships at least annually. Based predominantly upon the review and grading process, we determine the appropriate level of the allowance in response to our assessment of the probable risk of loss inherent in our loan portfolio. Management makes additional loan and lease loss provisions when the results of our problem loan assessment methodology or overall allowance testing of appropriateness indicates additional provisions are required. The review of problem loans is an ongoing process during which management may determine that additional charge-offs are required or additional loans should be placed on nonaccrual status. We have also recorded an allowance for unfunded lending-related commitments that represents our estimate of incurred losses on the portion of lending commitments that borrowers have not advanced. The balance of the allowance for unfunded lending-related commitments was$0.5 million at bothSeptember 30, 2019 andSeptember 30, 2018 and is recorded in accrued expenses and other liabilities in the consolidated balance sheet.Investment Securities The following table presents the amortized cost of each category of our investment portfolio at the dates indicated. September 30, 2019 2018 2017 (dollars in thousands) U.S. Treasury securities$ 94,178 $ 168,394 $ 228,039 Mortgage-backed securities: Government National Mortgage Association 501,139 442,458
511,457
Federal Home Loan Mortgage Corporation 463,974 297,380
169,147
Federal National Mortgage Association 322,340 188,192
170,247
Small Business Assistance Program 316,502 260,458
224,005
States and political subdivision securities 66,145 69,566 73,041 Other 1,006 1,006 1,006 Total$ 1,765,284 $ 1,427,454 $ 1,376,942
We generally invest excess deposits in high-quality, liquid investment
securities including residential agency mortgage-backed securities and, to a
lesser extent,
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political subdivisions. Our investment portfolio serves as a means to
collateralize FHLB borrowings and public funds deposits, to earn net spread
income on excess deposits and to maintain liquidity and balance interest rate
risk. Since September 30, 2018 , the fair value of the portfolio has increased by
$397.6 million , or 28.7%.
The following tables present the aggregate amortized cost of each investment
category of the investment portfolio and the weighted average yield ("WA yield")
for each investment category for each maturity period at September 30, 2019 .
Maturities of mortgage-backed securities may differ from contractual maturities
because the mortgages underlying the securities may be called or prepaid without
any penalties. The WA yield on these assets is presented below based on the
contractual rate, as opposed to a tax equivalent yield concept.
September 30, 2019
Due after five
Due in one year Due after one year years Due after Mortgage-backed Securities without
or less through five years through ten years ten years securities contractual maturities Total
Amount WA Yield Amount WA Yield Amount WA Yield Amount WA Yield Amount WA Yield Amount WA Yield Amount WA Yield
(dollars in thousands)
U.S. Treasury securities $ 44,761 1.68 % $ 49,417 2.85 % $ - - % $ - - % $ - - % $ - - % $ 94,178 2.29 %
Mortgage-backed securities - - % - - % - - % - - % 1,603,955 2.51 % - - % 1,603,955 2.51 %
States and political subdivision
securities ¹ ² 13,616 1.46 % 40,419 1.71 % 12,110 2.53 % - - % - - % - - % 66,145 1.81 %
Other - - % - - % - - % - - % - - % 1,006 - % 1,006 - %
Total $ 58,377 1.63 % $ 89,836 2.34 % $ 12,110 2.53 % $ - - % $ 1,603,955 2.51 % $ 1,006 - % $ 1,765,284 2.47 %
1 Information related to obligations of state and political subdivisions is presented based upon yield to first optional call date if the security is purchased at a premium, yield to maturity if purchased at par or a discount. 2 Maturity calculations for obligations of state and political subdivisions are based on the first optional call date for securities with a fair value above par and contractual maturity for securities with a fair value equal to or below par.
Declines in the fair value of investment securities available for sale that are deemed to be other-than-temporary are recognized in earnings as a realized loss, and a new cost basis for the securities is established. In evaluating other-than-temporary impairment, we consider the length of time and extent to which the fair value has been less than amortized cost, the financial condition and near-term prospects of the issuer, and our intent and ability to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value in the near term. Declines in the fair value of debt securities below amortized cost are deemed to be other-than-temporary in circumstances where: (1) we have the intent to sell a security; (2) it is more-likely-than-not that we will be required to sell the security before recovery of its amortized cost basis; or (3) we do not expect to recover the entire amortized cost basis of the security. If we intend to sell a security or if it is more-likely-than-not that we will be required to sell the security before recovery, an other-than-temporary impairment loss is recognized in earnings equal to the difference between the security's amortized cost basis and its fair value. If we do not intend to sell the security or it is not more-likely-than-not that it will be required to sell the security before recovery, the other-than-temporary impairment write-down is separated into an amount representing credit loss, which is recognized in earnings, and an amount related to all other factors, which is recognized in other comprehensive income (loss). Deposits We obtain funds from depositors by offering consumer and business interest-bearing accounts and term time deposits. AtSeptember 30, 2019 andSeptember 30, 2018 , our total deposits were$10.30 billion and$9.73 billion , respectively, representing an increase of 5.8%, which was primarily spread across brokered deposits, consumer and commercial deposit accounts. Our accounts are federally insured by theFDIC up to the legal maximum. The following table presents the balances and weighted average cost of our deposit portfolio at the following dates. September 30, 2019 2018 2017 Weighted Avg. Weighted Avg. Weighted Avg. Amount Cost Amount Cost Amount Cost (dollars in thousands)
Noninterest-bearing demand$ 1,956,025 - %$ 1,842,704 - %$ 1,856,126 - % Interest-bearing demand 6,248,638 1.00 % 6,043,717 0.95 % 5,847,432 0.55 % Time deposits, greater than$250,000 493,530 2.30 % 383,868 1.89 % 273,365 1.16 % Time deposits, less than or equal to$250,000 1,602,146 1.68 % 1,463,210 1.29 % 1,000,690 0.78 % Total$ 10,300,339 0.98 %$ 9,733,499 0.86 %$ 8,977,613 0.48 %
At
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Municipal public deposits constituted $1.04 billion and $959.4 million of our
deposit portfolio at September 30, 2019 , and September 30, 2018 , respectively,
of which $691.9 million and $622.1 million , respectively, were required to be
collateralized. Our top 10 depositors were responsible for 7.0% and 6.6% of our
total deposits at September 30, 2019 and September 30, 2018 , respectively.
The following table presents deposits by region.
September 30,
2019 2018 2017
(dollars in thousands)
South Dakota $ 2,575,833 $ 2,422,208 $ 2,231,857
Iowa / Kansas / Missouri 2,936,256 2,757,408 2,561,315
Nebraska 2,474,673 2,472,297 2,521,631
Arizona 508,308 399,212 377,610
Colorado 1,237,052 1,228,762 1,153,058
North Dakota / Minnesota 55,258 50,359 51,527
Corporate and other 512,959 403,253 80,615
Total deposits $ 10,300,339 $ 9,733,499 $ 8,977,613
We fund a portion of our assets with time deposits that have balances greater
than $250,000 and that have maturities generally in excess of six months. At
September 30, 2019 and September 30, 2018 , our time deposits greater than
$250,000 totaled $493.5 million and $383.9 million , respectively. The following
table presents the maturities of our time deposits greater than $250,000 and
less than or equal to $250,000 in size at September 30, 2019 .
Greater than Less than or equal
$250,000 to $250,000
(dollars in thousands)
Remaining maturity:
Three months or less $ 105,363 $ 613,444
Over three through six months 106,654 408,358
Over six through twelve months 170,889 342,188
Over twelve months 110,624 238,156
Total $ 493,530 $ 1,602,146
Percent of total deposits 4.8 % 15.6 %
At September 30, 2019 and September 30, 2018 , the average remaining maturity of
all time deposits was approximately 8 and 11 months, respectively. The average
time deposit amount per account was approximately $45,936 and $39,896 at
September 30, 2019 and September 30, 2018 , respectively.
Derivatives
Beginning in the second quarter of fiscal year 2018, we entered into RPAs with
some of our derivative counterparties to assume the credit exposure related to
interest rate derivative contracts. Our loan customer enters into an interest
rate swap directly with a derivative counterparty and we agree through an RPA to
take on the counterparty's risk of loss on the interest rate swap due to a
default by the customer. The notional amounts of RPAs sold were $56.8 million
and $37.4 million as of September 30, 2019 and September 30, 2018 , respectively.
Assuming all underlying loan customers defaulted on their obligation to perform
under the interest rate swap with a derivative counterparty, the exposure from
these RPAs would be $0.1 million and $0.4 million at September 30, 2019 and
September 30, 2018 , respectively, based on the fair value of the underlying
swaps.
In 2017 we began a new program of selling interest swaps directly to customers.
These interest rate swaps sales are used to enable customers to achieve a
long-term fixed rate by selling the customer a long-term variable rate loan
indexed to LIBOR plus a credit spread whereby the Bank enters into an interest
rate swap with our customer where the customer pays a fixed rate of interest set
at the time of origination on the interest rate swap and then the customer
receives a floating rate equal to the rate paid on the loan, thus resulting in a
fixed rate of interest over the life of the interest rate swap. We then enter
into a mirrored interest rate swap with a swap dealer where we pay and receive
the same fixed and floating rate as we pay and receive from the interest rate
swap we have with our customer. As the interest paid and received by us on the
two swaps net to zero, we are left with the variable rate of the long-term loan.
Prior to 2017 we entered into fixed-rate loans having original maturities of 5
years or greater (typically between 5 and 15 years) with certain of our
commercial and agri-business banking customers to assist them in facilitating
their risk management strategies. We mitigated our interest rate risk associated
with certain of these loans by entering into equal and offsetting
fixed-to-floating interest rate swap agreements for these loans with swap
counterparties. We elected to account for the loans at fair value
80-
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under ASC 825, Fair Value Option. Changes in the fair value of these loans are
recorded in earnings as a component of noninterest income in the relevant
period. The related interest rate swaps are recognized as either assets or
liabilities in our financial statements and any gains or losses on these swaps,
both realized and unrealized, are recorded in earnings as a component of
noninterest income. The interest rate swaps are fully effective from an interest
rate risk perspective, as gains and losses on our swaps are directly offset by
changes in fair value of the fair value option loans (i.e., swap interest rate
risk adjustments are directly offset by associated loan interest rate risk
adjustments). Consequently, any changes in noninterest income associated with
changes in fair value resulting from interest rate movement, as opposed to
changes in credit quality, on the loans are directly offset by equal and
opposite unrealized charges to or reductions in noninterest income for the
related interest rate swap. Any changes in the fair value of the loans related
to credit quality and the current realized gain (loss) on derivatives are not
offsetting amounts within noninterest income. To ensure the correlation of
movements in fair value between the interest rate swap and the related loan, we
pass on all economic costs associated with our interest rate swap activity
resulting from loan customer prepayments (partial or full) to the customer.
Short-Term Borrowings
Our primary sources of short-term borrowings include securities sold under
repurchase agreements and certain FHLB advances maturing within 12 months. The
following table presents certain information with respect to only our borrowings
with original maturities less than 12 months at and for the periods noted.
At and for
Fiscal Years Ended
2019 2018 2017
(dollars in thousands)
Short-term borrowings:
Securities sold under agreements to repurchase $ 68,992 $ 90,907 $ 132,636
FHLB advances 15,000 100,000 587,200
Total short-term borrowings $ 83,992 Maximum amount outstanding at any month-end during the period
$ 371,649 $ 808,325 $ 719,836 Average amount outstanding during the period$ 175,133 $ 442,398 $ 352,395 Weighted average rate for the period 1.72 % 1.32 % 0.70 % Weighted average rate as of date indicated 0.91 % 0.80 % 1.24 % Other Borrowings In addition to FHLB short-term advances, we also have FHLB long-term borrowings of$325.0 million and$175.0 million outstanding as ofSeptember 30, 2019 andSeptember 30, 2018 , respectively. We have outstanding$73.7 million and$73.6 million of junior subordinated debentures to affiliated trusts in connection with the issuance of trust preferred securities by such trusts as ofSeptember 30, 2019 andSeptember 30, 2018 , respectively. We are permitted under applicable laws and regulations to count these trust preferred securities as part of our Tier 1 capital. We issued$35.0 million of fixed-to-floating rate subordinated notes that mature onAugust 15, 2025 through a private placement. The notes, which qualify as Tier 2 capital under Capital Rules in effect atSeptember 30, 2019 , have an interest rate of 4.875 per annum, payable semi-annually on eachFebruary 15 andAugust 15 , commencing onFebruary 15, 2016 untilAugust 15, 2020 . During the fiscal year 2019, we incurred$5.5 million in interest expense on all outstanding subordinated debentures and notes compared to$5.0 million in fiscal year 2018. 81- -------------------------------------------------------------------------------- Off-Balance Sheet Commitments, Commitments, Guarantees and Contractual Obligations The following table summarizes the maturity of our contractual obligations and other commitments to make future payments atSeptember 30, 2019 . Customer deposit obligations categorized as "not determined" include noninterest-bearing demand accounts and interest-bearing demand accounts with no stated maturity date. September 30, 2019 Less Than 1 Year 1 to 2 Years 2 to 5 Years >5 Years Not Determined Total (dollars in thousands) Contractual Obligations: Customer deposits$ 1,724,682 $
250,248
$ 10,300,339 Securities sold under agreement to repurchase 68,992 - - - -
68,992
FHLB advances and other borrowings 15,000 120,000 205,000 - - 340,000 Subordinated debentures - - - 75,920 - 75,920 Subordinated notes payable - - - 35,000 - 35,000 Operating leases, net of sublease income 5,327 4,193 9,117 7,355 - 25,992 Accrued interest payable 16,091 - - - - 16,091 Interest on FHLB advances 9,012 7,969 10,432 - - 27,413 Interest on subordinated notes payable 3,324 3,324 9,973 33,897 -
50,518
Interest on subordinated debentures 1,706 1,706 5,119 1,493 -
10,024
Other Commitments: Commitments to extend credit-non-credit card$ 316,520 $ 959,117 $ 485,245 $ 342,491 $ -$ 2,103,373 Commitments to extend credit-credit card 126,305 - - - - 126,305 Letters of credit 68,983 - - - - 68,983 Instruments with Off-Balance Sheet Risk In the normal course of business, we enter into various transactions that are not included in our consolidated financial statements in accordance withU.S. GAAP. These transactions include commitments to extend credit to our customers and letters of credit. Commitments to extend credit are agreements to lend to a customer provided there is no violation of any condition established in the commitment. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Letters of credit are conditional commitments issued primarily to support or guarantee the performance of a customer's obligations to a third party. The credit risk involved in issuing letters of credit is essentially the same as originating a loan to the customer. We manage the risks associated with these arrangements by evaluating each customer's creditworthiness prior to issuance through a process similar to that used by us in deciding whether to extend credit to the customer. The following table presents the total notional amounts of all commitments by us to extend credit and letters of credit as of the dates indicated. September 30, 2019 2018 2017 (dollars in thousands) Commitments to extend credit$ 2,229,678 $ 2,344,550 $ 2,515,653 Letters of credit 68,983 69,613 70,186 Total$ 2,298,661 $ 2,414,163 $ 2,585,839 Liquidity Liquidity refers to our ability to maintain resources that are adequate to fund operations and meet present and future financial obligations through either the sale or maturity of existing assets or by obtaining additional funding through liability management. We consider the effective and prudent management of liquidity to be fundamental to our health and strength. Our objective is to manage our cash flow and liquidity reserves so that they are adequate to fund our obligations and other commitments on a timely basis and at a reasonable cost. Our liquidity risk is managed through a comprehensive framework of policies and limits overseen by our Bank's asset and liability committee. We continuously monitor and make adjustments to our liquidity position by adjusting the balance between sources and uses of funds as we deem appropriate. Our primary measures of liquidity include monthly cash flow analyses under ordinary business activities and conditions and under situations simulating a severe run on our Bank. We also monitor our Bank's deposit to loan ratio to ensure high quality funding is available to support our strategic lending growth objectives, and have internal management targets for theFDIC's liquidity ratio, net short-term non-core funding dependence ratio and non-core liabilities to total assets ratio. The results of these measures and analyses are incorporated into our contingency funding plan, which provides the basis for the identification of our liquidity needs. We also acquire brokered deposits when the cost of funds is advantageous to other funding sources. 82- --------------------------------------------------------------------------------Great Western Bancorp, Inc. Our primary source of liquidity is cash obtained from dividends by our Bank. We primarily use our cash for the payment of dividends, when and if declared by our Board of Directors, and the payment of interest on our outstanding junior subordinated debentures and subordinated notes. We also use cash, as necessary, to satisfy the needs of our Bank through equity contributions and for acquisitions. AtSeptember 30, 2019 , our holding company had$57.5 million of cash. During the first quarter of fiscal year 2020, we declared and paid a dividend of$0.30 per common share. The outstanding amount under our private placement subordinated capital notes was$35.0 million atSeptember 30, 2019 . Our management believes that the sources of available liquidity are adequate to meet all reasonably foreseeable short-term and intermediate-term demands. We may consider raising additional capital in public or private offerings of debt or equity securities. To this end, inAugust 2018 we filed a shelf registration statement with theSEC registering an indeterminate amount of our common stock, debt securities and other securities which we may decide to issue in the future. The specific terms of any shares or other securities we choose to issue will be based on current market conditions and will be described in a supplement to the prospectus contained in the shelf registration statement.Great Western Bank . Our Bank maintains sufficient liquidity by maintaining minimum levels of excess cash reserves (measured on a daily basis), a sufficient amount of unencumbered, highly liquid assets and access to contingent funding with the FHLB. AtSeptember 30, 2019 , our Bank had cash of$243.5 million and$1.78 billion of highly-liquid securities held in our investment portfolio, of which$863.9 million were pledged as collateral on public deposits, securities sold under agreements to repurchase, and for other purposes as required or permitted by law. The balance could be sold to meet liquidity requirements. Our Bank has a letter of credit from the FHLB, which is pledged as collateral on public deposits, for$170.0 million . Our Bank had$340.0 million in FHLB borrowings atSeptember 30, 2019 , with additional available lines of$1.80 billion . Our Bank also had an additional borrowing capacity of$1.44 billion with the FRB Discount Window. Our Bank primarily uses liquidity to meet loan requests and commitments (including commitments under letters of credit), to accommodate outflows in deposits and to take advantage of interest rate market opportunities. AtSeptember 30, 2019 , we had a total of$2.30 billion of outstanding exposure under commitments to extend credit and issued letters of credit. Our management believes that the sources of available liquidity are adequate to meet all our Bank's reasonably foreseeable short-term and intermediate-term demands. Capital As a bank holding company, we must comply with the capital requirements established by theFederal Reserve , and our Bank must comply with the capital requirements established by theFDIC . The current risk-based guidelines applicable to us and our Bank are based on the Basel III framework, as implemented by the federal bank regulators. The following table presents our regulatory capital ratios atSeptember 30, 2019 and the standards for both well-capitalized depository institutions and minimum capital requirements. Our capital ratios exceeded applicable regulatory requirements as of that date. September 30, 2019 Actual Minimum Capital Well Capitalized Capital Amount Ratio Requirement Ratio ¹ Ratio (dollars in thousands)
Great Western Bancorp, Inc. Tier 1 capital$ 1,225,355 11.7 % 6.0 % N/A Total capital 1,331,611 12.7 % 8.0 % N/A Tier 1 leverage 1,225,355 10.1 % 4.0 % N/A Common equity Tier 1 1,151,658 11.0 % 4.5 % N/A Risk-weighted assets$ 10,458,225 Great Western Bank Tier 1 capital$ 1,201,476 11.5 % 6.0 % 8.0 % Total capital 1,272,733 12.2 % 8.0 % 10.0 % Tier 1 leverage 1,201,476 9.9 % 4.0 % 5.0 % Common equity Tier 1 1,201,476 11.5 % 4.5 % 6.5 % Risk-weighted assets$ 10,455,186
1 Does not include capital conservation buffer, which was 2.5% at
AtSeptember 30, 2019 andSeptember 30, 2018 , our Tier 1 capital included an aggregate of$73.7 million and$73.6 million , respectively, of trust preferred securities issued by our subsidiaries, net of fair value adjustment. AtSeptember 30, 2019 , our Tier 2 capital included$70.8 million of the allowance for loan and lease losses and$35.0 million of subordinated capital notes. AtSeptember 30, 2018 , our Tier 2 capital included$64.5 million of the allowance for loan and lease losses and$35.0 million of subordinated capital notes. Our total risk-weighted assets were$10.46 billion atSeptember 30, 2019 . 83- -------------------------------------------------------------------------------- Non-GAAP Financial Measures We rely on certain non-GAAP financial measures in making financial and operational decisions about our business. We believe that each of the non-GAAP financial measures presented is helpful in highlighting trends in our business, financial condition and results of operations which might not otherwise be apparent when relying solely on our financial results calculated in accordance withU.S. GAAP. We disclose net interest income and related ratios and analysis on a taxable-equivalent basis, which may also be considered non-GAAP financial measures. We believe this presentation to be the preferred industry measurement of net interest income as it provides a relevant comparison of net interest income arising from taxable and tax-exempt sources. In addition, certain performance measures, including the efficiency ratio and net interest margin utilize net interest income on a taxable-equivalent basis. In particular, we evaluate our profitability and performance based on our adjusted net income, adjusted earnings per common share, tangible net income and return on average tangible common equity. Our adjusted net income and adjusted earnings per common share exclude the after-tax effect of items with a significant impact to net income that we do not believe to be recurring in nature, (e.g., one-time acquisition expenses as well as the effect of revaluation of deferred taxes). Our tangible net income and return on average tangible common equity exclude the effects of amortization expense relating to intangible assets and related tax effects from the acquisition of us by NAB and our acquisitions of other institutions. We believe these measures help highlight trends associated with our financial condition and results of operations by providing net income and return information excluding significant nonrecurring items (for adjusted net income and adjusted earnings per common share) and based on our cash payments and receipts during the applicable period (for tangible net income and return on average tangible common equity). We also evaluate our profitability and performance based on our adjusted net interest income, adjusted net interest margin, adjusted interest income on non-ASC 310-30 loans and adjusted yield on non-ASC 310-30 loans. We adjust each of these four measures to include the current realized gain (loss) of derivatives we use to manage interest rate risk on certain of our loans, which we believe economically offsets the interest income earned on the loans. Similarly, we evaluate our operational efficiency based on our efficiency ratio, which excludes the effect of amortization of core deposit and other intangibles (a non-cash expense item) and includes the tax benefit associated with our tax-advantaged loans. We evaluate our financial condition based on the ratio of our tangible common equity to our tangible assets and the ratio of our tangible common equity to common shares outstanding. Our calculation of this ratio excludes the effect of our goodwill and other intangible assets. We believe this measure is helpful in highlighting the common equity component of our capital and because of its focus by federal bank regulators when reviewing the health and strength of financial institutions in recent years and when considering regulatory approvals for certain actions, including capital actions. We also believe the ratio of our tangible common equity to common shares outstanding is helpful in understanding our stockholders' relative ownership position as we undertake various actions to issue and retire common shares outstanding. For reconciliations for each of these non-GAAP financial measures to the closest GAAP financial measures, see "Item 6. Selected Financial Data-Non-GAAP Financial Measures Reconciliations" and "Item 6. Selected Financial Data-Non-GAAP Quarterly Financial Measures Reconciliations." Each of the non-GAAP financial measures presented should be considered in context with our GAAP financial results included in this Annual Report on Form 10-K. Impact of Inflation and Changing Prices Our financial statements included in this Annual Report on Form 10-K have been prepared in accordance withU.S. GAAP, which requires us to measure financial position and operating results primarily in terms of historic dollars. Changes in the relative value of money due to inflation or recession generally are not considered. The primary effect of inflation on our operations is reflected in increased operating costs. In our management's opinion, changes in interest rates affect the financial condition of a financial institution to a far greater degree than changes in the inflation rate. While interest rates are greatly influenced by changes in the inflation rate, they do not necessarily change at the same rate or in the same magnitude as the inflation rate. Interest rates are highly sensitive to many factors that are beyond our control, including changes in the expected rate of inflation, the influence of general and local economic conditions and the monetary and fiscal policies ofthe United States government, its agencies and various other governmental regulatory authorities. Recent Accounting Pronouncements See "Note 2. New Accounting Standards" in the accompanying "Notes to Consolidated Financial Statements" included in this Annual Report on Form 10-K for a discussion of new accounting pronouncements and their expected impact on our financial statements. 84- -------------------------------------------------------------------------------- Critical Accounting Policies and the Impact of Accounting Estimates Our consolidated financial statements and accompanying notes are prepared in accordance withU.S. GAAP. Our accounting policies are more fully described in Note 1 of the consolidated financial statements. Certain accounting policies require our management to use significant judgment and assumptions, which can have a material impact on the carrying amount of certain assets and liabilities. We consider these policies to be critical accounting policies. The judgment and assumptions made are based upon historical experience or other factors that management believes to be reasonable under the circumstances. Because of the nature of the judgment and assumptions, actual results could differ from estimates, which could have a material effect on our financial condition and results of operations. We have identified the following accounting policies as critical: the allowance for loan and lease losses, goodwill impairment, core deposits and other intangibles, derivatives, and income taxes. We have reviewed these critical accounting estimates and related disclosures with our Audit Committee. Allowance for Loan and Lease Losses Description. We maintain an allowance for loan and lease losses at a level management believes is appropriate based on ongoing evaluation of the probable estimated losses inherent in the loan portfolio driven primarily by monitoring changes in loan risk grades, delinquencies, and other credit risk indicators, which are inherently subjective. A well-documented methodology has been developed and is applied to ensure consistency across our markets. We also have a formalized independent loan review program to evaluate loan administration, credit quality, and compliance with corporate loan standards. This program includes periodic, regular reviews of problem loan reports, delinquencies and charge-offs. The allowance for loan and lease losses consists of reserves for probable losses that have been identified related to specific borrowing relationships that are individually evaluated for impairment ("specific reserve"), as well as probable losses inherent in our loan portfolio that are not specifically identified ("collective reserve"). Changes to the allowance for loan and lease losses are made by charges to the provision for loan and lease losses, which is reflected in the consolidated statements of income. Loans deemed to be uncollectible are charged off against the allowance for loan and lease losses. Recoveries of amounts previously charged-off are credited to the allowance for loan and lease losses. The specific reserve relates to impaired loans. A loan is impaired when, based on current information and events, it is probable we will be unable to collect all amounts due (interest as well as principal) according to the contractual terms of the loan agreement. Specific reserves are determined on a loan-by-loan basis based on management's best estimate of our exposure, given the current payment status of the loan, the present value of expected payments, and the value of any underlying collateral. If the impaired loan is identified as collateral dependent, then the fair value of the collateral method of measuring the amount of the impairment is utilized. This method requires obtaining an independent appraisal of the collateral and reducing the appraised value by applying a discount factor to the appraised value, if necessary, and including costs to sell. Management's estimate for collective reserves reflects losses incurred in the loan portfolio as of the consolidated balance sheet reporting date. Incurred loss estimates primarily are based on historical loss experience and portfolio mix. Incurred loss estimates may be adjusted for qualitative factors such as current economic conditions and current portfolio trends including credit quality, concentrations, aging of the portfolio, and/or significant policy and underwriting changes, which may not be reflected in historical loss experience. Further discussion of the methodology used in establishing the allowance for loan and lease losses is provided in the Allowance for Loan and Lease Losses section of "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Note 1. Nature of Operations and Summary of Significant Accounting Policies." Judgments and Uncertainties. Management makes a range of assumptions to determine what is believed to be the appropriate level of allowance for loan and lease losses. Specific reserves for impaired loans rely on a present value of expected payments or the value of underlying collateral generally based on independent appraisals. Collective reserves rely on historical loss experience based on the portfolio mix, qualitative factors such as current economic conditions and current portfolio trends including credit quality, concentrations, aging of the portfolio, and/or significant policy and underwriting changes. All of these estimates are susceptible to significant change. Effect if Actual Results Differ From Assumptions. The allowance represents our best estimate of estimated losses in the loan portfolio, but significant downturns in circumstances relating to loan quality and economic conditions could result in a requirement for additional allowance. Likewise, an upturn in loan quality and improved economic conditions may allow a reduction in the required allowance. In either instance, unanticipated changes could have a significant impact on our financial position and results of operations. 85- -------------------------------------------------------------------------------- Goodwill Impairment Description.Goodwill represents the excess purchase price over the fair value of identifiable net assets of acquired companies.Goodwill often involves estimates based on third party valuations, such as appraisals, or internal valuations based on discounted cash flow analyses or other valuation techniques. Under ASC Topic 350,Goodwill and Other Intangible Assets, we conduct a goodwill impairment test on the basis of one reporting unit at least annually, and more frequently if events occur or circumstances change that would more-likely-than-not reduce the fair value below its carrying amount. We assess qualitative factors to determine whether it is more-likely-than-not the fair value is less than its carrying amount. If we conclude based on the qualitative assessment that goodwill may be impaired, we would perform a quantitative one-step impairment test. An impairment loss would be recognized for any excess of carrying value over fair value of the goodwill, and any subsequent increases in goodwill would not be recognized on the consolidated financial statements. Judgments and Uncertainties. When performing the qualitative assessment to determine whether the fair value of the reporting unit is less than the carrying value, we assess relevant events and circumstances, including macroeconomic conditions, industry and market considerations, overall financial performance, changes in the composition or carrying amount of assets and liabilities, the market price of the Company's common stock, and other relevant factors. If a quantitative assessment is considered necessary, the fair value of the reporting unit is calculated with the assistance of a third party using management's assumptions of future growth rates, future attrition of the customer base, discount rates, multiples of earnings and other relevant factors. Effect if Actual Results Differ From Assumptions. Changes in these qualitative and quantitative factors, as well as downturns in economic or business conditions, could have a significant adverse impact on the fair value of the reporting unit in relation to the carrying value of goodwill and could result in an impairment loss affecting our consolidated financial statements as a whole. Core Deposits and Other Intangibles Description. Intangible assets are non-physical assets generally recognized as part of an acquisition, where the acquirer is allowed to assign some portion of the purchase price to acquired intangible assets having a useful life of greater than one year. These assets often involve estimates based on third party valuations or internal valuations based on discounted cash flow analyses or other valuation techniques. Our intangible assets include core deposits, brand intangibles, customer relationships, and other intangibles. In addition, the determination of the useful lives over which an intangible asset will be amortized is subjective. Under ASC Topic 350,Goodwill and Other Intangible Assets, intangible assets are evaluated for impairment if indicators of impairment are identified. Judgments and Uncertainties. The determination of fair values is based on a quantitative analysis using management's assumptions of future growth rates, future attrition of the customer base, discount rates and other relevant factors. Effect if Actual Results Differ From Assumptions. Changes in these factors, as well as downturns in economic or business conditions, could have a significant adverse impact on the carrying value of core deposits and other intangibles and could result in an impairment loss affecting our consolidated financial statements as a whole. Derivatives Description. We maintain an overall interest rate risk management strategy that permits the use of derivative instruments to modify exposure to interest rate risk. We enter into interest rate swap contracts to offset the interest rate risk associated with borrowers who lock in long-term fixed rates (greater than or equal to 5 years to maturity) through a fixed rate loan. Generally, under these swaps, we agree with various swap counterparties to exchange the difference between fixed-rate and floating-rate interest amounts based upon notional principal amounts. These contracts do not qualify for hedge accounting. These interest rate derivative instruments are recognized as assets and liabilities on the consolidated balance sheets and measured at fair value, with changes in fair value reported in net realized and unrealized gain (loss) on derivatives. Since each fixed rate loan is paired with an offsetting derivative contract, the impact to net income is minimized. We also have back to back swaps with customers where we enter into an interest rate swap with loan customers to provide a facility to mitigate the interest rate risk associated with offering a fixed rate and simultaneously enters into a swap with an outside third party that is matched in exact offsetting terms. The back to back swaps are recorded at fair value and recognized as assets and liabilities, depending on the rights or obligations under the contract, in fair value of derivatives on the consolidated balance sheet, with changes in fair value reported in net realized and unrealized gain (loss) on derivatives. In 2017 we began a new program of selling interest swaps directly to customers. These interest rate swaps sales are used to enable customers to achieve a long-term fixed rate by selling the customer a long-term variable rate loan indexed to LIBOR plus a credit spread whereby the Bank enters into an interest rate swap with our customer where the customer pays a fixed rate of interest set at the time of origination on the interest rate swap and then the customer receives a floating rate equal to the rate paid on the loan, thus resulting in a fixed rate of interest over the life of the interest rate swap. We minimize the market and liquidity risks of the swaps entered into with the customer by entering into an offsetting position with a swap dealer. 86-
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In 2018 we entered into RPAs with some of our derivative counterparties to assume the credit exposure related to interest rate derivative contracts. Our loan customer enters into an interest rate swap directly with a derivative counterparty and we agree through an RPA to take on the counterparty's risk of loss on the interest rate swap due to a default by the customer. We enter into forward interest rate lock commitments on mortgage loans to be held for sale, which are commitments to originate loans whereby the interest rate on the loan is determined prior to funding. We also have corresponding forward sales contracts related to these interest rate lock commitments. Both the mortgage loan commitments and the related sales contracts are considered derivatives and are recorded at fair value with changes in fair value recorded in noninterest income. Judgments and Uncertainties. Our exposure to derivative credit risk is defined as the possibility of sustaining a loss due to the failure of the counterparty to perform in accordance with the terms of the contract. Credit risks associated with interest rate swaps are similar to those relating to traditional on-balance sheet financial instruments. We manage interest rate swap credit risk with the same standards and procedures applied to our commercial lending activities. Effect if Actual Results Differ From Assumptions. As with any financial instrument, derivative financial instruments have inherent risk including adverse changes in interest rates. We have agreements with our derivative counterparties that contain a provision where if we fail to maintain our status as a well/adequately capitalized institution, then the counterparty has the right to terminate the derivative positions and we would be required to settle our obligations under the agreements. Income Taxes Description. We are subject to the income tax laws of theU.S. , its states, and the municipalities in which we operate. These tax laws are complex and subject to different interpretations by the taxpayer and the relevant government taxing authorities. We review income tax expense and the carrying value of deferred tax assets quarterly, and as new information becomes available, the balances are adjusted as appropriate. We follow ASC Topic 740, Income Taxes, which prescribes a recognition threshold of more-likely-than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for those tax positions to be recognized on the consolidated financial statements. OnDecember 22, 2017 , the Tax Reform Act was enacted into law. Beginning in 2018, the Tax Reform Act reduced the federal tax rate for corporations from 35.0% to 21.0% and changed or limited certain tax deductions. The Tax Reform Act required us to revalue our net deferred tax assets in the period of enactment, which stranded certain effects of the tax rate change in accumulated other comprehensive income. We adopted new accounting guidance in the second quarter of fiscal year 2018 that allowed reclassification of$2.4 million in stranded tax effects that related to a change in the federal tax rate from accumulated other comprehensive income to retained earnings. Further discussion is provided in "Note 18. Income Taxes:" on the consolidated financial statements. Judgments and Uncertainties. In establishing a provision for income tax expense, we must make judgments and interpretations about the application of these inherently complex tax laws. We must also make estimates about when in the future certain items will affect taxable income in the various tax jurisdictions. Disputes over interpretations of the tax laws may be subject to review/adjudication by the court systems of the various tax jurisdictions or may be settled with the taxing authority upon examination or audit. Effect if Actual Results Differ From Assumptions. Although we believe the judgments and estimates used are reasonable, actual results could differ and we may be exposed to losses or gains that could be material. To the extent we prevail in matters for which reserves have been established, or are required to pay amounts in excess of our reserves, our effective income tax rate in a given financial statement period could be materially affected. An unfavorable tax settlement would result in an increase in our effective income tax rate in the period of resolution. A favorable tax settlement would result in a reduction in our effective income tax rate in the period of resolution.
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