MIDWESTONE FINANCIAL GROUP, INC. CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Form 10-Q contains certain "forward-looking statements" within the meaning of such term in the Private Securities Litigation Reform Act of 1995. We and our representatives may, from time to time, make written or oral statements that are "forward-looking" and provide information other than historical information. These statements involve known and unknown risks, uncertainties and other factors that may cause actual results to be materially different from any results, levels of activity, performance or achievements expressed or implied by any forward-looking statement. These factors include, among other things, the factors listed below. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of our management and on information currently available to management, are generally identifiable by the use of words such as "believe," "expect," "anticipate," "should," "could," "would," "plans," "intend," "project," "estimate," "forecast," "may" or similar expressions. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those expressed in, or implied by, these statements. Readers are cautioned not to place undue reliance on any such forward-looking statements, which speak only as of the date made. Additionally, we undertake no obligation to update any statement in light of new information or future events, except as required under federal securities law. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors that could have an impact on our ability to achieve operating results, growth plan goals and future prospects include, but are not limited to, the following: •the risks of mergers (including with IOFB), including, without limitation, the related time and costs of implementing such transactions, integrating operations as part of these transactions and possible failures to achieve expected gains, revenue growth and/or expense savings from such transactions; •credit quality deterioration or pronounced and sustained reduction in real estate market values, or uncertainties, including the impact of inflationary pressures on economic conditions and our business, resulting in an increase in the allowance for credit losses, an increase in the credit loss expense, and a reduction in net earnings; •the effects of actual and expected increases in inflation and interest rates, including on our net income and the value of our securities portfolio; •changes in the economic environment, competition, or other factors that may affect our ability to acquire loans or influence the anticipated growth rate of loans and deposits and the quality of the loan portfolio and loan and deposit pricing; •fluctuations in the value of our investment securities; •governmental monetary and fiscal policies; •changes in and uncertainty related to benchmark interest rates used to price loans and deposits, including the expected elimination of LIBOR, and the adoption of a substitute; •legislative and regulatory changes, including changes in banking, securities, trade, and tax laws and regulations and their application by our regulators, including the new 1.0% excise tax on stock buybacks by publicly traded companies and any changes in response to the recent failures of other banks; •the ability to attract and retain key executives and employees experienced in banking and financial services; •the sufficiency of the allowance for credit losses to absorb the amount of actual losses inherent in our existing loan portfolio; •our ability to adapt successfully to technological changes to compete effectively in the marketplace; •credit risks and risks from concentrations (by geographic area and by industry) within our loan portfolio; •the effects of competition from other commercial banks, thrifts, mortgage banking firms, consumer finance companies, credit unions, securities brokerage firms, insurance companies, money market and other mutual funds, financial technology companies, and other financial institutions operating in our markets or elsewhere or providing similar services; •the failure of assumptions underlying the establishment of allowances for credit losses and estimation of values of collateral and various financial assets and liabilities; •volatility of rate-sensitive deposits; •operational risks, including data processing system failures or fraud; •asset/liability matching risks and liquidity risks; •the costs, effects and outcomes of existing or future litigation; •changes in general economic, political, or industry conditions, nationally, internationally or in the communities in which we conduct business; •changes in accounting policies and practices, as may be adopted by state and federal regulatory agencies and the FASB; •war or terrorist activities, including the war inUkraine , widespread disease or pandemic, or other adverse external events, which may cause deterioration in the economy or cause instability in credit markets; •the effects of cyber-attacks; •the imposition of tariffs or other domestic or international governmental policies impacting the value of the agricultural or other products of our borrowers; •effects of the ongoing COVID-19 pandemic, including its effects on the economic environment, our customers, employees and supply chain; •the concentration of large deposits from certain clients who have balances above currentFDIC insurance limits and may withdraw deposits to diversify their exposure; •the effects of recent developments and events in the financial services industry, including the large-scale deposit withdrawals over a short period of time at other banks that resulted in failure of those institutions; and •factors and risks described under "Risk Factors" in this Form 10-Q and in other reports we file with theSEC . We qualify all of our forward-looking statements by the foregoing cautionary statements. Because of these risks and other uncertainties, our actual future results, performance or achievement, or industry results, may be materially different from the results indicated by these forward-looking statements. In addition, our past results of operations are not necessarily indicative of our future results. 32 -------------------------------------------------------------------------------- Table of Contents OVERVIEW The Company provides financial services to individuals, businesses, governmental units and institutional customers located primarily in the upper Midwest through its bank subsidiary,MidWestOne Bank . The Bank has locations throughout central and easternIowa , theMinneapolis/St. Paul metropolitan area ofMinnesota , southwesternWisconsin ,Naples andFort Myers, Florida , andDenver, Colorado . OnJune 9, 2022 , the Company completed the acquisition of IOFB, a bank holding company headquartered inMuscatine, Iowa , and the parent company of FNBM and FNBF. Immediately following the completion of the acquisition, FNBM and FNBF were merged with and into the Bank. As consideration for the merger, we paid cash of$46.7 million . The acquisition added to the Company's existing presence inFairfield, Iowa and expanded the Company's footprint intoMuscatine, Iowa . The Bank is focused on delivering relationship-based business and personal banking products and services. The Bank provides commercial loans, real estate loans, agricultural loans, credit card loans, and consumer loans. The Bank also provides deposit products including demand and interest checking accounts, savings accounts, money market accounts, and time deposits. Complementary to our loan and deposit products, the Bank also provides products and services including treasury management, Zelle, online and mobile banking, credit and debit cards, ATMs, and safe deposit boxes. The Bank also has a trust department through which it offers services including the administration of estates, personal trusts, and conservatorships and the management of real property. Finally, the Bank's investment services department offers financial planning, investment advisory, and retail securities brokerage services (the latter of which is provided through an agreement with a third-party registered broker-dealer). Our results of operations are significantly affected by our net interest income. Results of operations are also affected by noninterest income and expense, credit loss expense and income tax expense. Significant external factors that impact our results of operations include general economic and competitive conditions, as well as changes in market interest rates, government policies, and actions of regulatory authorities. The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes and the statistical information and financial data appearing in this report as well as our Annual Report on Form 10-K for the year endedDecember 31, 2022 , filed with theSEC onMarch 13, 2023 . Results of operations for the three months endedMarch 31, 2023 are not necessarily indicative of results to be attained for any other period.
FINANCIAL SUMMARY
The Company reported net income for the three months ended
The period as of and for the three months ended
Balance Sheet: •Total assets decreased to$6.41 billion atMarch 31, 2023 from$6.58 billion atDecember 31, 2022 , primarily as a result of the sale of$231 million in book value of available for sale debt securities in the first quarter of 2023. •AtMarch 31, 2023 the total amount of the held to maturity debt securities was$1.12 billion and the total amount of the debt securities available for sale was$954.1 million . There were$1.13 billion held to maturity debt securities atDecember 31, 2022 , while the total amount of the debt securities available for sale was$1.15 billion . •Gross loans held for investment increased$78.1 million , from$3.85 billion atDecember 31, 2022 , to$3.93 billion atMarch 31, 2023 . This increase was primarily driven by new loan production, draws on construction loans, and higher line of credit usage during the first quarter of 2023. •The allowance for credit losses was$49.8 million , or 1.27% of total loans as ofMarch 31, 2023 , compared with$49.2 million , or 1.28% of total loans, atDecember 31, 2022 . •Nonperforming assets declined$1.5 million , from$15.9 million atDecember 31, 2022 , to$14.4 million atMarch 31, 2023 . •Total deposits increased$86.2 million from$5.47 billion atDecember 31, 2022 , to$5.56 billion atMarch 31, 2023 , which is primarily reflective of the increase in brokered deposits. •Short-term borrowings declined to$144.0 million atMarch 31, 2023 , from$391.9 million atDecember 31, 2022 , and long-term debt decreased to$138.0 million atMarch 31, 2023 from$139.2 million atDecember 31, 2022 . •The Company is well-capitalized with a total risk-based capital ratio of 12.31% atMarch 31, 2023 . 33
-------------------------------------------------------------------------------- Table of Contents Income Statement: •Tax equivalent net interest income (a non-GAAP financial measure - see the "Non-GAAP Presentations" section for a reconciliation to the most comparable GAAP equivalent) was$41.3 million for the first quarter of 2023, an increase of$2.8 million , from$38.5 million in the first quarter of 2022. The increase in tax equivalent net interest income was due primarily to an increase of$15.3 million in loan interest income and an increase of$2.0 million in interest income earned from investment securities. The increase in loan interest income was reflective of higher loan volume from the IOFB acquisition and organic loan growth, coupled with an increase in loan yield, while the increase in interest income earned from investment securities stemmed from the higher yield on such securities. Partially offsetting these identified increases in tax equivalent interest income were increases in interest expense on interest-bearing deposits and borrowed funds of$12.4 million and$2.3 million , respectively. •Credit loss expense of$0.9 million was recorded during the first quarter of 2023, with no credit loss expense recorded in the first quarter of 2022. Credit loss expense in the current quarter was primarily attributable to loan growth. •Noninterest income decreased$15.7 million , from$11.6 million in the first quarter of 2022 to a loss of$4.0 million in the first quarter of 2023, primarily due to investment security losses of$13.2 million related to the Company's balance sheet repositioning. •Noninterest expense increased$1.7 million , from$31.6 million in the first quarter of 2022, to$33.3 million in the first quarter of 2023, due primarily to increases of$0.9 million and$0.5 million in compensation and employee benefits and amortization of intangibles, respectively. These increases primarily reflected costs associated with the acquired operations of IOFB, which closed in the second quarter of 2022.
Critical Accounting Estimates
Management has identified the accounting policies related to the ACL, fair value of assets acquired and liabilities assumed in a business combination, and the annual impairment testing of goodwill and other intangible assets to be critical accounting policies. Information about our critical accounting estimates is included under Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year endedDecember 31, 2022 , filed with theSEC onMarch 13, 2023 , and there have been no material changes in these critical accounting policies sinceDecember 31, 2022 . RESULTS OF OPERATIONS Comparison of Operating Results for the Three Months EndedMarch 31, 2023 andMarch 31, 2022 Summary As of or for
the Three Months Ended March
31,
(dollars in thousands, except per share amounts) 2023 2022 Net Interest Income$ 40,076 $ 37,336 Noninterest Income (Loss) (4,046) 11,644 Total Revenue, Net of Interest Expense 36,030 48,980 Credit Loss Expense 933 - Noninterest Expense 33,319 31,643 Income Before Income Tax Expense 1,778 17,337 Income Tax Expense 381 3,442 Net Income 1,397 13,895 Diluted Earnings Per Share $ 0.09$ 0.88 Return on Average Assets 0.09 % 0.95 % Return on Average Equity 1.14 10.74 Return on Average Tangible Equity(1) 2.70 13.56 Efficiency Ratio(1) 62.32 60.46 Dividend Payout Ratio 269.44 26.69 Common Equity Ratio 7.81 8.46 Tangible Common Equity Ratio(1) 6.48 7.20 Book Value per Share$ 31.94 $ 32.15 Tangible Book Value per Share(1) 26.13 26.98
(1) A non-GAAP financial measure. See "Non-GAAP Financial Measures" for a reconciliation to the most comparable GAAP equivalents.
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Net Interest Income
The following table shows consolidated average balance sheets, detailing the major categories of assets and liabilities, the interest income earned on interest-earning assets, the interest expense paid for interest-bearing liabilities, and the related yields and costs for the periods indicated.
Three Months Ended March 31,
2023 2022
Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Cost Balance Expense Cost
(dollars in thousands)
ASSETS
Loans, including fees (1)(2)(3) $ 3,867,110 $ 47,206 4.95 % $ 3,245,449 $ 31,858 3.98 %
Taxable investment securities 1,811,388 10,444 2.34 1,835,911 8,123 1.79
Tax-exempt investment securities (2)(4) 397,110 2,649 2.71 450,547 2,998 2.70
Total securities held for investment (2) 2,208,498 13,093 2.40 2,286,458 11,121 1.97
Other 24,848 244 3.98 56,094 28 0.20
Total interest earning assets (2)
4.02 %$ 5,588,001 $ 43,007 3.12 % Other assets 423,609 326,603 Total assets$ 6,524,065 $ 5,914,604 LIABILITIES AND SHAREHOLDERS' EQUITY Interest checking deposits$ 1,515,845 $ 1,849 0.49 %$ 1,560,402 $ 1,061 0.28 % Money market deposits 930,543 3,269 1.42 953,943 499 0.21 Savings deposits 653,043 272 0.17 641,703 279 0.18 Time deposits 1,417,688 9,929 2.84 883,997 1,071 0.49 Total interest bearing deposits 4,517,119 15,319 1.38 4,040,045 2,910 0.29 Securities sold under agreements to repurchase 145,809 450 1.25 159,417 96 0.24 Other short-term borrowings 111,306 1,336 4.87 3,029 23 3.08 Total short-term borrowings 257,115 1,786 2.82 162,446 119 0.30 Long-term debt 139,208 2,124 6.19 140,389 1,487 4.30 Total borrowed funds 396,323 3,910 4.00 302,835 1,606 2.15
Total interest bearing liabilities
1.59 %$ 4,342,880 $ 4,516 0.42 % Noninterest bearing deposits 1,029,575 1,004,001 Other liabilities 82,501 42,872 Shareholders' equity 498,547 524,851 Total liabilities and shareholders' equity$ 6,524,065 $ 5,914,604 Net interest income (2)$ 41,314 $ 38,491 Net interest spread(2) 2.43 % 2.70 % Net interest margin(2) 2.75 % 2.79 % Total deposits(5)$ 5,546,694 $ 15,319 1.12 %$ 5,044,046 $ 2,910 0.23 % Cost of funds(6) 1.31 % 0.34 %
(1) Average balance includes nonaccrual loans. (2) Tax equivalent. The federal statutory tax rate utilized was 21%. (3) Interest income includes net loan fees, loan purchase discount accretion and tax
equivalent adjustments. Net loan fees were
months ended
accretion was
and
thousand for the three months ended
federal statutory tax rate utilized was 21%.
(4) Interest income includes tax equivalent adjustments of
for the three months ended
statutory tax rate utilized was 21%. (5) Total deposits is the sum of total interest-bearing deposits and noninterest bearing
deposits. The cost of total deposits is calculated as annualized interest expense on
deposits divided by average total deposits. (6) Cost of funds is calculated as annualized total interest expense divided by the sum of
average total deposits and borrowed funds.
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The following table shows changes to tax equivalent net interest income attributable to (i) changes in volume and (ii) changes in rate. Changes attributable to both rate and volume have been allocated proportionately to the change due to volume and the change due to rate.
Three Months Ended March 31,
2023 Compared to 2022 Change due to
(in thousands) Volume Yield/Cost Net
Increase (decrease) in interest income:
Loans, including fees (1) $ 6,755 $ 8,593 $ 15,348
Taxable investment securities (111) 2,432 2,321
Tax-exempt investment securities (1) (360) 11 (349)
Total securities held for investment (1) (471) 2,443 1,972
Other (23) 239 216
Change in interest income (1) 6,261 11,275 17,536
Increase (decrease) in interest expense:
Interest checking deposits (31) 819 788
Money market deposits (12) 2,782 2,770
Savings deposits 6 (13) (7)
Time deposits 991 7,867 8,858
Total interest-bearing deposits 954 11,455 12,409
Securities sold under agreements to repurchase (9) 363 354
Other short-term borrowings 1,293 20 1,313
Total short-term borrowings 1,284 383 1,667
Long-term debt (13) 650 637
Total borrowed funds 1,271 1,033 2,304
Change in interest expense 2,225 12,488 14,713
Change in net interest income $ 4,036 $ (1,213) $ 2,823
Percentage increase in net interest income over prior period 7.3 %
(1) Tax equivalent, using a federal statutory tax rate of 21%.
Our tax equivalent net interest income for the first quarter of 2023 was$41.3 million , an increase of$2.8 million , or 7.3%, as compared to$38.5 million for the first quarter of 2022. The increase in tax equivalent net interest income in the first quarter of 2023 as compared to the first quarter of 2022 was due primarily to an increase of$17.5 million , or 40.8%, in interest income, which more than offset the increase of$14.7 million , or 325.8%, in interest expense. The change in interest income reflected an increase of$15.3 million , or 48.2%, in loan interest income, which reflected higher loan volume from the IOFB acquisition and organic loan growth, and an increase in loan yield. The change in interest income also reflected an increase of$2.0 million , or 17.7%, in interest income earned from investment securities, which stemmed from the higher yield on such securities. The change in interest expense reflected increases in interest paid on interest bearing deposits and borrowed funds of$12.4 million and$2.3 million , respectively, due to higher costs and volumes. The tax equivalent net interest margin for the first quarter of 2023 declined to 2.75%, from 2.79% for the first quarter of 2022, driven by higher funding costs, partially offset by higher interest earning asset yields. The cost of interest bearing liabilities increased 117 bps to 1.59%, due to interest bearing deposit costs of 1.38%, short-term borrowing costs of 2.82%, and long-term debt costs of 6.19%, which increased 109 bps, 252 bps and 189 bps, respectively from the first quarter of 2022. Total interest earning assets yield increased 90 bps primarily as a result of an increase in loan and securities yields of 97 bps and 43 bps, respectively. Credit Loss Expense Credit loss expense of$0.9 million was recorded during the first quarter of 2023, with no credit loss expense recorded in the first quarter of 2022. The increase in credit loss expense was primarily attributable to loan growth. Net loan charge-offs were$0.3 million in the first quarter of 2023 as compared to net loan charge-offs of$2.2 million in the first quarter of 2022. The economic forecast factors utilized by the Company for its loan credit loss estimation process are: (1) Midwest unemployment - increases over the next four forecasted quarters; (2) Year-to-year change in national retail sales - increases over the next four forecasted quarters; (3) Year-to-year change in CRE Index - increase in the first forecasted quarter and declines in the second through fourth forecasted quarters; (4) Year-to-year change inU.S. GDP - increases over the next four forecasted quarters; (5) Year-to-year change in National Home Price Index - declines over the next four forecasted quarters; and (6) Rental Vacancy - increases over the next four forecasted quarters. In addition, management utilized qualitative factors to adjust the calculated ACL as appropriate. Qualitative factors are based on management's judgment of company, market, industry or business specific data, changes in underlying loan composition of specific portfolios, trends relating to credit quality, delinquency, non-performing and adversely rated loans, and reasonable and supportable forecasts of economic conditions. 36 -------------------------------------------------------------------------------- Table of Contents Noninterest Income (Loss)
The following table presents significant components of noninterest income and the related dollar and percentage change from period to period:
Three Months Ended March 31,
(dollars in thousands) 2023 2022 $ Change % Change
Investment services and trust activities $ 2,933 $ 3,011 $ (78) (2.6) %
Service charges and fees 2,008 1,657 351 21.2
Card revenue 1,748 1,650 98 5.9
Loan revenue 1,420 4,293 (2,873) (66.9)
Bank-owned life insurance 602 531 71 13.4
Investment securities (losses) gains, net (13,170) 40 (13,210) (33,025.0)
Other 413 462 (49) (10.6)
Total noninterest (loss) income $ (4,046) $ 11,644 $ (15,690) (134.7) %
Total noninterest income for the first quarter of 2023 decreased $15.7 million ,
or 134.7%, to a loss of $4.0 million from $11.6 million in the first quarter of
2022, primarily due to investment security losses of $13.2 million related to
the Company's balance sheet repositioning. In addition, noninterest income
declined from the comparative period due to the first quarter of 2022 benefiting
from a larger increase in the fair value of our mortgage servicing rights, as
well as a larger gain on sale from residential mortgage loans as a result of
higher mortgage origination volumes.
Noninterest Expense
The following table presents significant components of noninterest expense and the related dollar and percentage change from period to period:
Three Months Ended March 31,
(dollars in thousands) 2023 2022 $ Change % Change
Compensation and employee benefits $ 19,607 $ 18,664 $ 943 5.1 %
Occupancy expense of premises, net 2,746 2,779 (33) (1.2)
Equipment 2,171 1,901 270 14.2
Legal and professional 1,736 2,353 (617) (26.2)
Data processing 1,363 1,231 132 10.7
Marketing 986 1,029 (43) (4.2)
Amortization of intangibles 1,752 1,227 525 42.8
FDIC insurance 749 420 329 78.3
Communications 261 272 (11) (4.0)
Foreclosed assets, net (28) (112) 84 (75.0)
Other 1,976 1,879 97 5.2
Total noninterest expense $ 33,319 $ 31,643 $ 1,676 5.3 %
Three Months Ended March 31,
Merger-related expenses: 2023 2022
(dollars in thousands)
Compensation and employee benefits $ 70 $ -
Equipment - 5
Legal and professional - 63
Data processing 65 38
Marketing - 7
Communications - 1
Other 1 14
Total merger-related expenses $ 136 $ 128
Noninterest expense for the first quarter of 2023 increased $1.7 million , or
5.3%, to $33.3 million from $31.6 million for the first quarter of 2022,
primarily due to increases of $0.9 million and $0.5 million in compensation and
employee benefits and amortization of intangibles, respectively. These increases
primarily reflected costs associated with the acquired operations of IOFB, which
closed in the second quarter of 2022. Partially offsetting the increases above
was a decline of $0.6 million in legal and professional expenses stemming
primarily from reductions in legal expenses related to litigation and executive
recruitment.
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Income Tax Expense
Our effective income tax rate, or income taxes divided by income before taxes, was 21.4% for the three months endedMarch 31, 2023 , as compared to an effective tax rate of 19.9% for the three months endedMarch 31, 2022 . The effective tax rate for the full year 2023 is expected to be in the range of 19.5% to 21.5%.
FINANCIAL CONDITION
The table below presents the major categories of the Company's balance sheet as
of the dates indicated:
December 31,
(dollars in thousands) March 31, 2023 2022 $ Change % Change
ASSETS
Cash and cash equivalents$ 69,218 $ 86,435 $ (17,217) (19.9) % Loans held for sale 2,553 612 1,941 317.2 Debt securities available for sale at fair value 954,074 1,153,547 (199,473) (17.3) Held to maturity securities at amortized cost 1,117,709 1,129,421 (11,712) (1.0) Loans held for investment, net of unearned income 3,919,365 3,840,524 78,841 2.1 Allowance for credit losses (49,800) (49,200) (600) 1.2 Total loans held for investment, net 3,869,565 3,791,324 78,241 2.1 Other assets 396,833 416,537 (19,704) (4.7) Total assets$ 6,409,952 $ 6,577,876 $ (167,924) (2.6) % LIABILITIES AND SHAREHOLDERS' EQUITY Total deposits$ 5,555,153 $ 5,468,942 $ 86,211 1.6 % Total borrowings 281,962 531,083 (249,121) (46.9) Other liabilities 72,187 85,058 (12,871) (15.1) Total shareholders' equity 500,650 492,793 7,857 1.6
Total liabilities and shareholders' equity
(2.6) %
The composition of debt securities available for sale and held to maturity as of the dates indicated was as follows:
March 31, 2023 December 31, 2022
(dollars in thousands) Balance % of Total Balance % of Total
Available for Sale
U.S. Government agencies and corporations $ - - % $ 7,345 0.6 %
States and political subdivisions 184,581 19.3 285,356 24.7
Mortgage-backed securities 5,679 0.6 5,944 0.5
Collateralized loan obligations 54,074 5.7 - -
Collateralized mortgage obligations 144,666 15.2 147,193 12.8
Corporate debt securities 565,074 59.2 707,709 61.4
Fair value of debt securities available for sale $ 954,074 100.0 % $ 1,153,547 100.0 %
Held to Maturity
States and political subdivisions $ 538,182 48.2 $ 538,746 47.7 %
Mortgage-backed securities 79,597 7.1 81,032 7.2 %
Collateralized mortgage obligations 499,930 44.7 509,643 45.1 %
Amortized cost of debt securities held to maturity
100.0 %$ 1,129,421 100.0 % OnJanuary 1, 2022 , the Company re-classified, at fair value, from available for sale to held to maturity,$1.25 billion of mortgage-backed securities, collateralized mortgage obligations, and securities issued by state and political subdivisions. The net unrealized after tax loss of$11.5 million associated with those re-classified securities remained in accumulated other comprehensive loss and will be amortized over the remaining life of the securities. No gains or losses were recognized in earnings at the time of the transfer. As ofMarch 31, 2023 , there were$0.1 million of gross unrealized gains and$95.4 million of gross unrealized losses in our debt securities available for sale portfolio for a net unrealized loss of$95.3 million . As ofMarch 31, 2023 there were no gross unrealized gains and$179.2 million of gross unrealized losses in our held to maturity debt securities. During the first quarter of 2023, the Company undertook a balance sheet repositioning related to its debt securities portfolio. Specifically, the Company executed the sale of$231 million in book value of its AFS debt securities, with a pre-tax loss of$13.2 million and$220 million of proceeds that were used to pay off short-term borrowings and reinvest in higher yielding, floating rate securities. 38
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See Note 3.
Loans
The composition of our loan portfolio by type of loan was as follows:
March 31, 2023 December 31, 2022
(dollars in thousands) Balance % of Total Balance % of Total
Agricultural $ 106,641 2.7 % $ 115,320 3.0 %
Commercial and industrial 1,080,514 27.6 1,055,162 27.5
Commercial real estate 2,048,971 52.4 1,980,018 51.6
Residential real estate 610,862 15.5 614,428 15.9
Consumer 72,377 1.8 75,596 2.0
Loans held for investment, net of unearned income $ 3,919,365 100.0 % $ 3,840,524 100.0 %
Loans held for sale $ 2,553 $ 612
Loans held for investment, net of unearned income at March 31, 2023 , increased
$78.8 million , or 2.1%, from December 31, 2022 to $3.92 billion , driven
primarily by new loan production, draws on construction loans, and higher line
of credit usage during the first quarter of 2023. See Note 4. Loans Receivable
and the Allowance for Credit Losses to our consolidated financial statements
for additional information related to our loan portfolio.
Commitments under standby letters of credit, unused lines of credit and other
conditionally approved credit lines totaled approximately
Our loan to deposit ratio increased to 70.55% as ofMarch 31, 2023 as compared to 70.22% as ofDecember 31, 2022 . The loan to deposit ratio increased when compared to the prior year-end due to new loan production, draws on construction loans and higher line of credit usage, which offset the increase in total deposits.
Nonperforming Assets
The following table sets forth information concerning nonperforming loans by
class of receivable and our nonperforming assets at
(in thousands) March 31, 2023 December 31, 2022 Nonaccrual loans held for investment$ 14,440 $ 15,256 Accruing loans contractually past due 90 days or more 2 565 Total nonperforming loans 14,442 15,821 Foreclosed assets, net - 103 Total nonperforming assets 14,442 15,924 Nonaccrual loans ratio (1) 0.37 % 0.40 % Nonperforming loans ratio (2) 0.37 % 0.41 % Nonperforming assets ratio (3) 0.23 % 0.24 % (1) Nonaccrual loans ratio is calculated as nonaccrual loans divided by loans held for investment, net of unearned income, at the end of the period. (2) Nonperforming loans ratio is calculated as total nonperforming loans divided by loans held for investment, net of unearned income, at the end of the period. (3) Nonperforming assets ratio is calculated as total nonperforming assets divided by total assets at the end of the period. When compared toDecember 31, 2022 , overall asset quality improved. The nonperforming loans ratio declined 4 basis points from the prior year-end to 0.37%, while the nonperforming assets ratio declined 1 basis points from the prior year-end to 0.23%.
Loan Review and Classification Process for Agricultural, Commercial and Industrial, and Commercial Real Estate Loans:
The Bank maintains a loan review and classification process which involves multiple officers of the Bank and is designed to assess the general quality of credit underwriting and to promote early identification of potential problem loans. All commercial and agricultural loan officers are charged with the responsibility of risk rating all loans in their portfolios and updating the ratings, positively or negatively, on an ongoing basis as conditions warrant. Risk ratings are selected from an 8-point scale with ratings as follows: ratings 1- 4 Satisfactory (pass), rating 5 Watch (potential weakness), rating 6 Substandard (well-defined weakness), rating 7 Doubtful, and rating 8 Loss.
When a loan officer originates a new loan, based upon proper loan authorization, they document the credit file with an offering sheet summary, supplemental underwriting analysis, relevant financial information and collateral evaluations. Segregation of
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owner-occupied and non-owner occupied residential real estate loans is made at
the time of origination. This information is used in the determination of the
initial loan risk rating. The Bank's loan review department undertakes
independent credit reviews of relationships based on either criteria established
by loan policy, risk-focused sampling, or random sampling. Credit relationships
with larger exposure may pose incrementally higher risks. As a result, the
Bank's loan review department is required to review all credit relationships
with total exposure of $5.0 million or more at least annually. In addition, the
individual loan reviews consider such items as: loan type; nature, type and
estimated value of collateral; borrower and/or guarantor estimated financial
strength; most recently available financial information; related loans and total
borrower exposure; and current and anticipated performance of the loan. The
results of such reviews are presented to both executive management and the audit
committee of the Company's board of directors.
Through the review of delinquency reports, updated financial statements or other
relevant information, the lending officer and/or loan review personnel may
determine that a loan relationship has weakened to the point that a Watch (risk
rating 5) or Classified (risk ratings 6 through 8) status is warranted. At least
quarterly, the loan strategy committee will meet to discuss loan relationships
with total exposure of $1.0 million or above that are Watch rated credits, loan
relationships with total exposure of $500 thousand and above that are
Substandard or Worse rated credits, as well as loan relationships with total
exposure of $250 thousand and above that are on non-accrual. Loan relationships
outside these designated thresholds are reviewed upon request. The lending
officer is charged with preparing a loan strategy summary worksheet that
outlines the background of the credit problem, current repayment status of the
loans, current collateral evaluation and a workout plan of action. This plan may
include goals to improve the credit rating, assist the borrower in moving the
loans to another institution and/or collateral liquidation. All such reports are
presented to the loan strategy committee. The minutes of the loan strategy
committee meetings are provided to the board of directors of the Bank.
Depending upon the individual facts and circumstances and the result of the
classified/watch review process, loan officers and/or loan review personnel may
categorize a loan relationship as requiring an individual analysis. Once that
determination has occurred, the credit analyst will complete an individually
analyzed worksheet that contains an evaluation of the collateral (for
collateral-dependent loans) based upon the estimated collateral value, adjusting
for current market conditions and other local factors that may affect collateral
value. Loan review personnel may also complete an independent individual
analysis when deemed necessary. These judgmental evaluations may produce an
initial specific allowance for recognition in the Company's allowance for credit
losses calculation. An analysis for the underlying collateral value of each
individually analyzed loan relationship is completed in the last month of the
quarter. The individually analyzed worksheets are reviewed by the Credit
Administration department prior to quarter-end. The board of directors of the
Bank on a quarterly basis reviews the classified/watch reports including changes
in credit grades of 5 or higher as well as all individually analyzed loans, the
related allowances and foreclosed assets, net.
The review process also provides for the upgrade of loans that show improvement
since the last review. All requests for an upgrade of a credit are approved by
the proper authority based upon the aggregate credit exposure before the rating
can be changed.
Loan Modifications for Borrowers Experiencing Financial Difficulty
Infrequently, the Company makes modification to certain loans in order to alleviate temporary difficulties in the borrower's financial condition and/or constraints on the borrower's ability to repay a loan, and to minimize potential losses to the Company. GAAP requires that certain types of modifications be reported, including: •Principal forgiveness. •Interest rate reduction. •An other than-insignificant payment delay. •Term extension. During the three months endedMarch 31, 2023 , the amortized cost of the loans that were modified to borrowers in financial distress was$2.0 million , which represented 0.05% of total loans held for investment, net of unearned income. 40 -------------------------------------------------------------------------------- Table of Contents Allowance for Credit Losses The following table sets forth the allowance for credit losses by loan portfolio segments compared to the percentage of loans to total loans by loan portfolio segment for the periods indicated:March 31, 2023 December 31, 2022 % of Loans in % of Loans in Allowance for Each
Segment to Allowance for Each Segment to (dollars in thousands)
Credit Losses Total Loans Credit Losses Total Loans
Agricultural $ 513 2.7 % $ 923 3.0 %
Commercial and industrial 22,345 27.6 % 22,855 27.5 %
Commercial real estate 21,833 52.4 % 20,123 51.6 %
Residential real estate 4,545 15.5 % 4,678 15.9 %
Consumer 564 1.8 % 621 2.0 %
Total $ 49,800 100.0 % $ 49,200 100.0 %
Allowance for credit losses ratio(1) 1.27 % 1.28 %
Allowance for credit losses to nonaccrual loans
ratio(2) 344.88 % 322.50 %
(1) Allowance for credit losses ratio is calculated as allowance for credit losses divided by loans held for investment, net of unearned income at the end of the period.
(2) Allowance for credit losses to nonaccrual loans ratio is calculated as allowance for credit losses divided by nonaccrual loans at the end of the period.
The following table sets forth the net (charge-offs) recoveries by loan portfolio segments for the periods indicated:
For the Three Months Ended
Commercial and Commercial Residential Real
(in thousands) Agricultural Industrial Real Estate Estate Consumer Total
For the Three Months EndedMarch 31, 2023 Charge-offs $ (1)$ (320) $ (18) $ -$ (148) $ (487) Recoveries 26 75 5 4 44 154 Net (charge-offs) recoveries $ 25$ (245) $ (13) $ 4$ (104)
Net (charge-off) recovery ratio(1) - % (0.03) % - % - % (0.01) %
(0.03) %
For the Three Months EndedMarch 31, 2022 Charge-offs $ -$ (233) $ (2,184) $ (30) $ (184) $ (2,631) Recoveries 7 225 117 16 44 409 Net (charge-offs) recoveries $ 7 $ (8)$ (2,067) $ (14) $ (140)
Net (charge-off) recovery ratio(1) - % - % (0.26) % - % (0.02) %
(0.28) %
(1) Net (charge-off) recovery ratio is calculated as the annualized net (charge-offs) recoveries divided by average loans held for investment, net of unearned income and average loans held for sale, during the period.
Actual Results: Our ACL as ofMarch 31, 2023 was$49.8 million , which was 1.27% of loans held for investment, net of unearned income as of that date. This compares with an ACL of$49.2 million as ofDecember 31, 2022 , which was 1.28% of loans held for investment, net of unearned income. The increase in the ACL primarily reflected an additional reserve taken to support loan growth. The liability for off-balance sheet credit exposures totaled$4.8 million as ofMarch 31, 2023 andDecember 31, 2022 , and is included in 'Other liabilities' on the balance sheet. The Company recorded a credit loss expense related to loans of$0.9 million for the three months endedMarch 31, 2023 as compared to a credit loss benefit related to loans of$0.3 million for the three months endedMarch 31, 2022 . Gross charge-offs for the first three months of 2023 totaled$0.5 million , while there were$0.2 million in gross recoveries of previously charged-off loans. The ratio of annualized net charge-offs to average loans for the first three months of 2023 was 0.03% compared to 0.28% for the three months endedMarch 31, 2022 . Economic Forecast: AtMarch 31, 2023 , the economic forecast used by the Company showed the following: (1) Midwest unemployment - increases over the next four forecasted quarters; (2) Year-to-year change in national retail sales - increases over the next four forecasted quarters; (3) Year-to-year change in CRE Index - increase in the first forecasted quarter and declines in the second through fourth forecasted quarters; (4) Year-to-year change inU.S. GDP - increases over the next four 41
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forecasted quarters; (5) Year-to-year change in National Home Price Index - declines over the next four forecasted quarters; and (6) Rental Vacancy - increases over the next four forecasted quarters. In addition, management utilized qualitative factors to adjust the calculated ACL as appropriate. Qualitative factors are based on management's judgment of company, market, industry or business specific data, changes in underlying loan composition of specific portfolios, trends relating to credit quality, delinquency, non-performing and adversely rated loans, and reasonable and supportable forecasts of economic conditions.
Loan Policy: We review all nonaccrual loans greater than$250,000 individually on a quarterly basis to measure any amount to be recognized in the Company's allowance for credit losses by analyzing the borrower's ability to repay amounts owed, collateral deficiencies, and other relevant factors. In addition, PCD loans greater than$250,000 are evaluated individually to determine the required ACL. Loans modified to borrowers experiencing financial difficulty performing in accordance with their modified contractual terms for a reasonable period of time may be included in the Company's existing pools based on the underlying risk characteristics of the loan to measure the ACL. Upon the Company's determination that a modified loan (or a portion of a loan) has subsequently been deemed uncollectible, the loan (or a portion of the loan) is written off. Therefore, the amortized cost basis of the loan is reduced by the uncollectible amount and the allowance for credit losses is adjusted by the same amount. We review loans 90 days or more past due that are still accruing interest no less than quarterly to determine if the asset is both well secured and in the process of collection. If not, such loans are placed on non-accrual status. Based on the inherent risk in the loan portfolio, management believed that as ofMarch 31, 2023 , the ACL was adequate; however, there is no assurance losses will not exceed the ACL. In addition, growth in the loan portfolio or general economic deterioration may require the recognition of additional credit loss expense in future periods. See Note 4. Loans Receivable and the Allowance for Credit Losses to our unaudited consolidated financial statements for additional information related to the allowance for credit losses.
Deposits
The composition of deposits was as follows:
As of March 31, 2023 As of December 31, 2022
(in thousands) Balance % of Total Balance % of Total
Noninterest bearing deposits $ 989,469 17.8 % $ 1,053,450 19.3 %
Interest checking deposits 1,476,948 26.6 1,624,278 29.8
Money market deposits 969,238 17.4 937,340 17.1
Savings deposits 631,811 11.4 664,169 12.1
Time deposits of $250 and under 599,302 10.8 559,466 10.2
Total core deposits 4,666,768 84.0 4,838,703 88.5
Brokered deposits 366,539 6.6 126,767 2.3
Time deposits of over $250 521,846 9.4 503,472 9.2
Total non-core deposits 888,385 16.0 630,239 11.5
Total deposits $ 5,555,153 100.0 % $ 5,468,942 100.0 %
Deposits increased $86.2 million from December 31, 2022 , or 1.6%. Brokered
deposits as of March 31, 2023 totaled $366.5 million , compared with $126.8
million as of December 31, 2022 . Approximately 84.0% of our total deposits were
considered "core" deposits as of March 31, 2023 , compared to 88.5% at
December 31, 2022 . We consider core deposits to be the total of all deposits
other than time deposits greater than $250k and non-reciprocal brokered
deposits. Deposit inflows and outflows are influenced by prevailing market
interest rates, competition, local and national economic conditions, and
fluctuations in our business customers own liquidity needs and may also be
influenced by recent developments in the financial services industry. See Note
8. Deposits to our consolidated financial statements for additional
information related to our deposits.
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Short-Term Borrowings and Long-Term Debt
The following table sets forth the composition of short-term borrowings and long-term debt for the periods presented.
(dollars in thousands) March 31, 2023 December 31, 2022 Securities sold under agreements to repurchase$ 137,481 $ 156,373 Federal home loan bank advances 6,500 235,500 Total short-term borrowings$ 143,981 $ 391,873 Junior subordinated notes issued to capital trusts 42,160 42,116 Subordinated debentures 64,039 64,006 Finance lease payable 744 787 Federal home loan bank borrowings 17,288 17,301 Other long-term debt 13,750 15,000 Total long-term debt$ 137,981 $ 139,210 See Note 9. Short-Term Borrowings and Note 10. Long-Term Debt to our unaudited consolidated financial statements for additional information related to short-term borrowings and long-term debt.
Capital Resources
Shareholder's Equity and Capital Adequacy
The following table summarizes certain equity capital ratios and book value per share amounts of the Company as of or for the periods presented:
March 31, 2023 December 31, 2022
Total shareholders' equity to total assets ratio 7.81 % 7.49 %
Tangible common equity ratio(1) 6.48 % 6.17 %
Total risk-based capital ratio 12.31 % 12.07 %
Tier 1 risk-based capital ratio 10.18 % 10.05 %
Common equity tier 1 risk-based capital ratio 9.39 % 9.28 %
Tier 1 leverage ratio 8.30 % 8.35 %
Book value per share $ 31.94 $ 31.54
Tangible book value per share(1) $ 26.13 $ 25.60
(1)A non-GAAP financial measure - see the "Non-GAAP Presentations" section for a reconciliation to the most comparable GAAP equivalent.
Shareholders' Equity: Total shareholders' equity was$500.7 million as ofMarch 31, 2023 , compared to$492.8 million as ofDecember 31, 2022 , an increase of$7.9 million , or 1.6%, primarily due to a decrease in AOCI due to a decrease in the unrealized loss on available for sale debt securities, which was partially offset by a decrease in retained earnings. Capital Adequacy: Risk-based capital guidelines require the classification of assets and some off-balance-sheet items in terms of credit-risk exposure and the measuring of capital as a percentage of the risk-adjusted asset totals. Management believed that, as ofMarch 31, 2023 , the Company and the Bank met all capital adequacy requirements to which we were subject. As of that date, the Bank was "well capitalized" under regulatory prompt corrective action provisions. See Note 12. Regulatory Capital Requirements and Restrictions on Subsidiary Cash to our unaudited consolidated financial statements for additional information related to our capital.
Stock Compensation
Restricted stock units were granted to certain officers and directors of the Company onFebruary 15, 2023 , in the aggregate amount of 80,745. Additionally, during the first three months of 2023, 68,962 shares of common stock were issued in connection with the vesting of previously awarded grants of restricted stock units, of which 17,614 shares were surrendered by grantees to satisfy tax requirements, and 446 unvested restricted stock units were forfeited.
Liquidity
Liquidity management involves meeting the cash flow requirements of depositors and borrowers. We conduct liquidity management on both a daily and long-term basis, and adjust our investments in liquid assets based on expected loan demand, projected loan maturities and payments, expected deposit flows, yields available on interest-bearing deposits, and the objectives of our asset/liability management program. Excess liquidity is invested generally in short-termU.S. government and agency 43
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securities, short- and medium-term state and political subdivision securities, and other investment securities. Our most liquid assets are cash and due from banks, interest-bearing bank deposits, and federal funds sold. The balances of these assets are dependent on our operating, investing, and financing activities during any given period.
Cash and cash equivalents are summarized in the table below. Since
(dollars in thousands) As of March 31, 2023 As of December 31, 2022 Cash and due from banks $ 63,945 $ 83,990 Interest-bearing deposits 5,273 2,445 Total $ 69,218 $ 86,435 Generally, our principal sources of funds are deposits, advances from the FHLB, principal repayments on loans, proceeds from the sale of loans, proceeds from the maturity and sale of investment securities, our federal funds lines, and funds provided by operations. While scheduled loan amortization and maturing interest-bearing deposits are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by economic conditions, the general level of interest rates, and competition. We utilized particular sources of funds based on comparative costs and availability. The Bank maintains unsecured lines of credit with several correspondent banks and secured lines with theFederal Reserve Bank of Chicago and the FHLB that would allow us to borrow funds on a short-term basis, if necessary. We also hold debt securities classified as available for sale that could be sold to meet liquidity needs if necessary. Net cash provided by operations was another major source of liquidity. The net cash provided by operating activities was$17.6 million for the three-months endedMarch 31, 2023 and$26.2 million for the three-months endedMarch 31, 2022 .
Inflation
The effects of price changes and inflation can vary substantially for most financial institutions. While management believes that inflation affects the growth of total assets, it is difficult to assess its overall impact on the Company. The price of one or more of the components of the Consumer Price Index may fluctuate considerably and thereby influence the overall Consumer Price Index without having a corresponding effect on interest rates or upon the cost of those goods and services normally purchased by us. Inflation and related increases in market rates by theFederal Reserve generally decrease the market value of investments and loans held and may adversely affect liquidity, earnings and shareholders' equity. Ongoing higher inflation levels and higher interest rates could have a negative impact on both our consumer and commercial borrowers. We anticipate our noninterest income may be adversely affected in future periods as a result of increasing interest rates and inflationary pressure, which has begun to and will continue to adversely affect mortgage originations and mortgage banking revenue. Additionally, the economic impact of the recent rise in inflation and rising interest rates could place increased demand on our liquidity if we experience significant credit deterioration and as we meet borrowers' needs. There is also a risk that interest rate increases to fight inflation could lead to a recession.
Off-Balance-Sheet Arrangements
During the normal course of business, we are a party to financial instruments with off-balance-sheet risk in order to meet the financing needs of our customers. These financial instruments include commitments to extend credit, commitments to sell loans, and standby letters of credit. We follow the same credit policy (including requiring collateral, if deemed appropriate) to make such commitments as is followed for those loans that are recorded in our financial statements. Our exposure to credit losses in the event of nonperformance is represented by the contractual amount of the commitments. Management does not expect any significant losses as a result of these commitments, and also expects to have sufficient liquidity available to cover these off-balance-sheet instruments. Off-balance-sheet transactions are more fully discussed in Note 13. Commitments and Contingencies to our unaudited consolidated financial statements.
Contractual Obligations
There have been no material changes to the Company's contractual obligations existing atDecember 31, 2022 , as disclosed in the Annual Report on Form 10-K, filed with theSEC onMarch 13, 2023 .
Non-GAAP Financial Measures
Certain ratios and amounts not in conformity with GAAP are provided to evaluate
and measure the Company's operating performance and financial condition,
including return on average tangible equity, tangible common equity, tangible
book value per share, tangible common equity ratio, efficiency ratio, net
interest margin (tax equivalent), and core net interest margin. Management
believes these ratios and amounts provide investors with useful information
regarding the Company's
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profitability, financial condition and capital adequacy, consistent with how
management evaluates the Company's financial performance. The following tables
provide a reconciliation of each non-GAAP measure to the most comparable GAAP
equivalent.
Three Months Ended
Return on Average Tangible Equity March 31, 2023 March 31, 2022
(Dollars in thousands)
Net income $ 1,397 $ 13,895
Intangible amortization, net of tax (1) 1,314 920
Tangible net income $ 2,711 $ 14,815
Average shareholders' equity $ 498,547 $ 524,851
Average intangible assets, net (92,002) (81,763)
Average tangible equity $
406,545
Return on average equity 1.14 % 10.74 % Return on average tangible equity (2) 2.70 % 13.56 %
(1) Computed assuming a combined marginal income tax rate of 25%. (2) Annualized tangible net income divided by average tangible equity.
Tangible Common Equity/Tangible Book Value per Share / Tangible Common Equity Ratio
March 31, 2023 December 31, 2022
(Dollars in thousands, except per share data)
Total shareholders' equity $ 500,650 $ 492,793
Intangible assets, net (91,040) (92,792)
Tangible common equity $ 409,610 $ 400,001
Total assets $ 6,409,952 $ 6,577,876
Intangible assets, net (91,040) (92,792)
Tangible assets $ 6,318,912 $ 6,485,084
Book value per share $ 31.94 $ 31.54
Tangible book value per share (1) $ 26.13 $ 25.60
Shares outstanding 15,675,325 15,623,977
Equity to assets ratio 7.81 % 7.49 %
Tangible common equity ratio (2) 6.48 % 6.17 %
(1) Tangible common equity divided by shares outstanding. (2) Tangible common equity divided by tangible assets.
Three Months Ended
Efficiency Ratio March 31, 2023 March 31, 2022
(dollars in thousands)
Total noninterest expense $ 33,319 $ 31,643
Amortization of intangibles (1,752) (1,227)
Merger-related expenses (136) (128)
Noninterest expense used for efficiency ratio $
31,431
Net interest income, tax equivalent(1)$ 41,314 $ 38,491 Noninterest income (4,046) 11,644 Investment security losses (gains), net 13,170 (40) Net revenues used for efficiency ratio $
50,438
Efficiency ratio(2) 62.32 % 60.46 %
(1) The federal statutory tax rate utilized was 21%. (2) Noninterest expense adjusted for amortization of intangibles and merger-related expenses divided by the sum of tax equivalent net interest income, noninterest income and net investment securities gains.
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Three Months Ended
Net Interest Margin, Tax Equivalent/Core Net Interest Margin March 31, 2023 March 31, 2022
(dollars in thousands)
Net interest income $ 40,076 $ 37,336
Tax equivalent adjustments:
Loans (1) 716 540
Securities (1) 522 615
Net interest income, tax equivalent $ 41,314 $ 38,491
Loan purchase discount accretion (1,189) (732)
Core net interest income $ 40,125 $ 37,759
Net interest margin 2.66 % 2.71 %
Net interest margin, tax equivalent (2) 2.75 % 2.79 %
Core net interest margin (3) 2.67 % 2.74 %
Average interest earning assets $
6,100,456
(1) The federal statutory tax rate utilized was 21%. (2) Annualized tax equivalent net interest income divided by average interest earning assets. (3) Annualized core net interest income divided by average interest earning assets.
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