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WTBA > SEC Filings for WTBA > Form 10-K on 6-Mar-2014All Recent SEC Filings

Show all filings for WEST BANCORPORATION INC

Form 10-K for WEST BANCORPORATION INC


6-Mar-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(dollars in thousands, except per share amounts)

INTRODUCTION

The Company's 2013 net income improved by 5.5 percent in comparison to 2012. The Company's 2013 net income was $16,891 compared to $16,011 in 2012. On a diluted per common share basis, earnings improved to $1.02 from $0.92, or 10.9 percent. This was higher than the increase in earnings due to the June 2013 repurchase and cancellation of 1,440,592 shares from our then largest shareholder. We earned 1.17 percent on average assets in 2013 compared to 1.21 percent in 2012. The return on average equity (ROE) increased during 2013 to 13.22 percent from 12.34 percent in 2012. During 2013, we paid our common stockholders $6,995 ($0.42 per common share) in dividends compared to $6,265 ($0.36 per common share) in 2012. The dividend declared in the first quarter of 2014 was $0.11 per common share.

In 2012, we began a program of quantitative peer analysis for evaluating Company results. At the beginning of 2013, we identified a set of 16 publicly traded peer financial institutions against which we compared our performance each quarter, but two companies were acquired in the fourth quarter of 2013. Our remaining peer group consists of BankFinancial Corporation, Baylake Corp., Firstbank Corporation, First Mid-Illinois Bancshares, Inc., Hills Bancorporation, Horizon Bancorp, Isabella Bank Corporation, Macatawa Bank Corporation, Mercantile Bank Corporation, MidWestOne Financial Group, Inc., MutualFirst Financial, Inc., NASB Financial, Inc., Pulaski Financial Corp. and QCR Holdings, Inc. Our goal is to perform at or near the top of those peers relative to what we consider to be four key metrics: return on average equity, return on average assets, efficiency ratio and Texas ratio. We believe these measures encompass the factors that define the performance of a community bank. Through September 30, 2013, we ranked in the top 25 percent of our defined peer group for each of these measures. We expect that trend to have continued through the end of 2013. Our Company was named a "Sm-All Star" for the second year in a row by the investment banking firm Sandler O'Neill + Partners (SOP). According to financial criteria defined by SOP, we are one of the top 31 small cap publicly traded bank holding companies in the United States. For purposes of this analysis, small cap companies are those with a market value between $25 million and $2.5 billion.

The Texas ratio, which is the ratio of nonperforming assets to tangible capital plus the allowance for loan losses, improved to 7.69 percent as of December 31, 2013, compared to 11.25 percent as of December 31, 2012. These are both significant improvements from the 44.91 percent reported as of the end of 2009. The continued decline was the result of additional reductions in the level of nonperforming assets, as resources were devoted to collection and disposal of these assets. With a lower level of nonperforming assets, management has been able to concentrate on business development.

Net interest income increased to $45,683 in 2013 compared to $41,198 in 2012, primarily due to higher volumes of earning assets. An improvement in credit quality within the loan portfolio resulted in a negative provision for loan losses in 2013 of $850 compared to expense of $625 in 2012. Noninterest income declined by $2,491, primarily due to a decline in gains and fees on sales of residential mortgages. Noninterest expense increased by $2,033 in 2013 compared to 2012 because of higher salary and benefit costs. Our efficiency ratio increased slightly to 52.55 percent for 2013 from 50.83 percent in 2012.

Our loan portfolio grew 6.9 percent to $991,720 as of December 31, 2013 from $927,401 at the end of 2012, with approximately half of the growth occurring in the fourth quarter. Deposits increased 2.6 percent by the end of 2013 compared to the end of 2012. Both of these happened as a result of developing new relationships and strengthening existing relationships.

We have strong capital resources, and the U.S. economy appears to be slowly improving. Our stock price increased approximately 46.8 percent from the end of 2012 to the end of 2013, and our earnings outlook is positive.

We expect the unusually low interest rate environment to continue in the current year, and we will continue to carefully review strategies aimed at maintaining or improving our net interest margin. We anticipate the Company will be profitable in 2014 at a level that compares favorably with our peers. The amount of our future profit will depend, in large part, on the amount of loan losses we incur and our ability to grow the loan portfolio.

The following discussion describes the consolidated operations of the Company, including West Bank, West Bank's wholly-owned subsidiary WB Funding Corporation (which owns an interest in SmartyPig, LLC), and West Bank's 99.99 percent owned subsidiary ICD IV, LLC (a community development entity), and the Company's financial condition as of December 31, 2013.


Table of Contents
(dollars in thousands, except per share amounts)

CRITICAL ACCOUNTING POLICIES

This report is based on the Company's audited consolidated financial statements, which have been prepared in accordance with generally accepted accounting policies (GAAP). The financial information contained in these statements is based on the financial effects of transactions and events that have already occurred. However, the preparation of these statements requires management to make certain estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses.

The Company's significant accounting policies are described in the Notes to Consolidated Financial Statements. Based on its consideration of accounting policies that involve the most complex and subjective estimates and judgments, management has identified its most critical accounting policies to be those related to asset impairment judgments, including fair value and other than temporary impairment (OTTI) of available for sale investment securities, the allowance for loan losses and the valuation of other real estate owned.

Investment securities available for sale are reported at fair value, with unrealized gains and losses reported as a separate component of accumulated other comprehensive income (loss), net of deferred income taxes. The Company evaluates each of its investment securities whose value has declined below amortized cost to determine whether the decline in fair value is OTTI. The investment portfolio is evaluated for OTTI by segregating the portfolio into two segments and applying the appropriate OTTI model. Investment securities classified as available for sale are generally evaluated for OTTI under Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 320, Investments - Debt and Equity Securities. However, certain purchased beneficial interests in securitized financial assets, including asset-backed securities and collateralized debt obligations, that had credit ratings of below AA at the time of purchase are evaluated using the model outlined in FASB ASC 325, Beneficial Interests in Securitized Financial Assets.

In determining OTTI under the FASB ASC 320 model, the review takes into consideration the severity and duration of the decline in fair value, the length of time expected for recovery, the financial condition of the issuer, and other qualitative factors, as well as whether the Company intends to sell the debt security or whether it is more likely than not the Company will be required to sell the debt security before its anticipated recovery.

Under the FASB ASC 325 model for the second segment of the portfolio, the Company compares the present value of the remaining cash flows as estimated at the preceding evaluation date to the current expected remaining cash flows. An OTTI is deemed to have occurred if there has been an adverse change in the remaining expected future cash flows.

When OTTI occurs under either model, the amount of the OTTI recognized in earnings depends on whether the Company intends to sell the security or whether it is more likely than not that it will be required to sell the security before recovery of its amortized cost basis. If the Company intends to sell, or it is more likely than not that it will be required to sell the security before recovery of its amortized cost basis, the OTTI is recognized in earnings equal to the entire difference between the investment's amortized cost basis and its fair value at the balance sheet date. If the Company does not intend to sell the security and it is not more likely than not that it will be required to sell before recovery of its amortized cost basis, the OTTI is separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected, using the original yield as the discount rate, and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income
(loss), net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment. The assessment of whether an OTTI exists involves a high degree of subjectivity and judgment and is based on the information available to management at the time.

The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that collectability of the principal is unlikely. The Company has policies and procedures for evaluating the overall credit quality of its loan portfolio, including timely identification of potential problem loans. On a quarterly basis, management reviews the appropriate level for the allowance for loan losses, incorporating a variety of risk considerations, both quantitative and qualitative. Quantitative factors include the Company's historical loss experience, delinquency and charge-off trends, collateral values, known information about individual loans and other factors. Qualitative factors include the general economic environment in the Company's market areas and the expected trend of those economic conditions. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions or the other factors relied upon. To the extent that actual results differ from forecasts and management's judgment, the allowance for loan losses may be greater or less than future charge-offs.


Table of Contents
(dollars in thousands, except per share amounts)

Other real estate owned (OREO) includes real estate properties acquired through or in lieu of foreclosure. Properties are initially recorded at fair value less estimated selling costs at the date of foreclosure thus establishing a new cost basis. Fair value is determined by management by obtaining appraisals or other market value information at least annually. Any write-downs in value at the acquisition date are charged to the allowance for loan losses. After foreclosure, valuations are periodically performed by management by obtaining updated appraisals or other market information. Any subsequent write-downs are recorded as a charge to operations, if necessary, to reduce the carrying value of a property to the updated fair value less estimated selling cost. Net costs related to the holding of properties are included in noninterest expense.

RESULTS OF OPERATIONS - 2013 COMPARED TO 2012

OVERVIEW

Net income for the year ended December 31, 2013 was $16,891, compared to $16,011 for the year ended December 31, 2012. Basic and diluted earnings per common share were $1.02 and $0.92 for 2013 and 2012, respectively. The Company's 2013 return on equity (ROE) was 13.22 percent, compared to 12.34 percent in 2012. The return on average assets (ROA) was 1.17 percent, compared to 1.21 percent for the year ended December 31, 2012.

The improvement in net income in 2013 compared to 2012 was primarily because of an increase in net interest income which resulted from a higher volume of earning assets. Improvement in credit quality of the loan portfolio resulted in a negative provision for loan losses in 2013 of $850 compared to an expense of $625 for 2012. Noninterest income declined $2,491 for 2013 due to lower gains from the sale of home mortgages in the secondary market, and a gain from bank-owned life insurance in 2012 that was due to the death of a West Bank officer.

The Company has consistently used the efficiency ratio as one of its key financial metrics to measure expense control. For the year ended December 31, 2013, the Company's efficiency ratio increased to 52.55 percent from the prior year's ratio of 50.83 percent. This ratio is computed by dividing noninterest expense (excluding other real estate owned expense) by the sum of tax-equivalent net interest income plus noninterest income (excluding securities gains and net impairment losses). The ratio for both years is significantly better than peer group averages, which were generally around 70 percent according to data in the September 2013 Bank Holding Company Performance Report, which is prepared by the Federal Reserve Board's Division of Banking Supervision and Regulation.

Net Interest Income

Net interest income increased $4,485 to $45,683 for 2013 as the impact of a higher volume of loans and investment securities and lower rates paid on deposits and borrowings exceeded the 44 basis point decline in average yield on loans. The net interest margin increased to 3.48 percent from 3.42 percent in 2012. The average yield on earning assets declined 18 basis points, while the rate on interest-bearing liabilities declined 34 basis points. As a result, the net interest spread, which is the difference between the yields earned on assets and the rates paid on liabilities, increased to 3.29 percent from 3.13 percent a year earlier.

Loan Volume/Loan Quality

Total loans increased $64,319 to $991,720 as of December 31, 2013, from $927,401 a year earlier. Management believes the loan portfolio will continue to grow during 2014 as the pipeline for new loans remains strong. As the economy shows some signs of improvement, the Company is focused on business development efforts. The March 2013 addition of the Rochester, Minnesota office produced loan balances of approximately $11,600 as of December 31, 2013. Nonperforming loans at December 31, 2013, totaled $2,915 or 0.29 percent of total loans. At December 31, 2012, nonperforming loans totaled $7,256 or 0.78 percent of total loans. Nonperforming loans include loans on nonaccrual status, loans past due 90 days or more, and loans that have been considered to be troubled debt restructured (TDR) due to the borrowers experiencing financial difficulties. In addition, the Company held $5,800 of other real estate owned as of December 31, 2013. The Company's Texas ratio improved to 7.69 percent as of December 31, 2013, compared to 11.25 percent as of December 31, 2012. The ratio for both years is significantly better than peer group averages, which were approximately 20 percent and 25 percent, respectively, according to data in the September 2013 and 2012 Bank Holding Company Performance Reports. For more discussion on loan quality, see the Loan Portfolio and Summary of the Allowance for Loan Losses sections of this report.


Table of Contents
(dollars in thousands, except per share amounts)

The allowance for loan losses, which totaled $13,791 as of December 31, 2013, represented 1.39 percent of total loans and 473.1 percent of nonperforming loans at year end, compared to 1.67 percent and 214.0 percent, respectively, as of December 31, 2012. The provision for loan losses was a negative $850 in 2013 due to improvement in credit quality of the portfolio, compared to an expense of $625 for 2012. The Company's net charge-offs as a percent of average loans were 0.09 percent for 2013 compared to 0.22 percent for 2012.

Noninterest Income

The following table shows the variance from the prior year in the noninterest
income categories shown in the Consolidated Statements of Income. In addition,
accounts within the "Other income" category that represent a significant portion
of the total or a significant variance are shown.
                                                        Years ended December 31
Noninterest income:                         2013           2012          Change       Change %
Service charges on deposit accounts     $    2,923     $    3,009     $      (86 )      (2.86 )%
Debit card usage fees                        1,787          1,586            201        12.67  %
Trust services                                 997            817            180        22.03  %
Gains and fees on sales of residential
mortgages                                    1,275          3,104         (1,829 )     (58.92 )%
Increase in cash value of bank-owned
life insurance                                 646            737            (91 )     (12.35 )%
Gain from bank-owned life insurance              -            841           (841 )    (100.00 )%
Investment securities impairment losses          -           (203 )          203       100.00  %
Realized investment securities gains,
net                                              -            246           (246 )    (100.00 )%
Other income:
Wire transfer fees                             126            138            (12 )      (8.70 )%
Credit card fees                               208            193             15         7.77  %
Loan fees                                       76             16             60       375.00  %
All other income                               465            510            (45 )      (8.82 )%
Total other income                             875            857             18         2.10  %
Total noninterest income                $    8,503     $   10,994     $   (2,491 )     (22.66 )%

Debit card usage fees continued to show positive growth in 2013 as customers continued the trend of writing fewer checks and increasing the volume of electronic transactions. West Bank also changed debit card processors during 2013, which resulted in debit card fees being provided to West Bank sooner than the previous processor. Due to the switch in processors, there was approximately $100 in debit card income that will not be recurring in future years because of the timing of receiving fees. The Company believes debit card usage fees may decline in the future due to the Dodd-Frank Act and the Federal Reserve final rule which sets a cap on interchange fees at a rate below the market-driven levels. While financial institutions such as West Bank, with less than $10 billion in assets, are exempt from the cap, industry groups believe the price controls will have a negative impact on community banks over time.

Revenues from trust services increased during 2013 as a result of a combination of new business and strong asset values resulting from favorable market conditions.

The volume of originations of residential mortgages sold into the secondary market during 2013 declined to $93,593 from $129,322 in 2012, resulting in a 59 percent reduction in revenue. The decline in volume was a result of a sudden rise in long-term interest rates at the end of June 2013 and the rates continued to edge up through the end of the year. Along with the rise in interest rates, total revenue from gains and fees on sales of residential mortgages declined due to a lower proportion of refinancings as compared to purchase transactions, which typically have lower margins. Approximately 55 percent of the originations during 2013 involved homeowners refinancing current mortgages as compared to approximately 65 percent during 2012. The volume of originations for 2014 is expected to be lower than it was in 2013; however, long-term interest rates have moved slightly lower in the early portion of 2014, which could spur activity.

The lower increase in cash value of bank-owned life insurance was due to lower crediting rates within the policies, which are attributable to the low interest rate environment. The gain from bank-owned life insurance in 2012 was due to the death of a bank officer.


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(dollars in thousands, except per share amounts)

As of December 31, 2013, the Company held one pooled trust preferred security (TPS) it considered to have OTTI. No impairment losses were recognized during the year ended December 31, 2013, while impairment losses of $203 were recognized during the year ended December 31, 2012. Quarterly evaluations showed the value of this security improved throughout 2013. Based on the current regulatory guidelines regarding implementation of the Volcker Rule, the Company does not currently anticipate selling this security.

There were no sales of investment securities during 2013. During 2012, the Company took advantage of an opportunity to sell two collateralized mortgage obligations at a gain and was able to replace them with similar bonds with comparable yields, thus resulting in net gains of $246 for 2012.

The increase in loan fees was due to an increase in loan covenant waiver fees compared to 2012, as well as amortization of commitment fees related to one customer that began in March 2013.

Noninterest Expense

The following table shows the variance from the prior year in the noninterest
expense categories shown in the Consolidated Statements of Income. In addition,
accounts within the "Other expenses" category that represent a significant
portion of the total or a significant variance are shown.
                                                        Years ended December 31
Noninterest expense:                        2013           2012          Change      Change %
Salaries and employee benefits          $   15,757     $   14,532     $    1,225         8.43  %
Occupancy                                    3,906          3,519            387        11.00  %
Data processing                              2,030          2,070            (40 )      (1.93 )%
FDIC insurance expense                         733            672             61         9.08  %
Other real estate owned expense              1,359          1,491           (132 )      (8.85 )%
Professional fees                            1,200          1,064            136        12.78  %
Miscellaneous losses                           736            195            541       277.44  %
Other expenses:
Marketing                                      359            268             91        33.96  %
Business development                           505            410             95        23.17  %
Director fees                                  584            448            136        30.36  %
Insurance expense                              370            341             29         8.50  %
Bank service charges and investment
advisory fees                                  496            505             (9 )      (1.78 )%
Consulting fees                                276            582           (306 )     (52.58 )%
Contributions                                  180            380           (200 )     (52.63 )%
Supplies                                       334            302             32        10.60  %
Loss on disposal of fixed assets                 9            125           (116 )     (92.80 )%
All other                                    1,991          1,888            103         5.46  %
Total other                                  5,104          5,249           (145 )      (2.76 )%
Total noninterest expense               $   30,825     $   28,792     $    2,033         7.06  %

The increase in salaries and employee benefits consisted of normal salary increases plus salaries for employees added in the past year ($970), recognition of a larger amount of stock-based compensation costs ($166), higher bonus accruals ($88) and higher benefit costs ($303). The benefit cost increases were primarily for payroll taxes ($68), health insurance ($151) and 401(k) plan contributions ($72).

Occupancy expense increased due to higher depreciation and equipment service contract expenses related to technology upgrades. Rent expense also increased due to the addition of the Rochester, Minnesota office, a replacement office in West Des Moines, Iowa, and the lease of additional space at the main bank location.

Data processing expense was lower in 2013 as a result of renegotiating the contract with the Company's core processor. FDIC insurance expense increased because of the growth in total average assets. The assessment rate declined slightly compared to 2012 and is expected to remain at the lowest established rate for the foreseeable future.


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(dollars in thousands, except per share amounts)

Other real estate owned expense for the years ended December 31, 2013 and 2012, included $1,341 and $1,442, respectively, of property valuation write-downs due to updated appraisals and estimated disposal costs for several properties. The Company's practice is to obtain updated appraisals on other real estate owned at least annually. The remaining reduction in other real estate owned expense was attributed to the Company having a smaller inventory of properties in other real estate owned in 2013 as compared to 2012. We expect this category of expense to trend lower in 2014.

Professional fees increased primarily due to higher legal fees incurred to defend the previously disclosed potential class-action lawsuit. Miscellaneous losses include uncollected overdrafts, debit card fraud, other losses due to operational errors and charges to establish loss reserves related to mortgage loans sold in the secondary market. Collectively, these activities generated higher losses in 2013 than 2012.

Marketing expense grew primarily as a result of costs related to opening a replacement office in West Des Moines, Iowa and the opening of the previously mentioned office in Rochester, Minnesota. The increase in business development costs was the result of focusing on developing new relationships and expanding sponsorships of local events in the communities the Company serves. Director fees increased compared to 2012 primarily due to the $94 increase in recognition of stock-based compensation expense related to the grant of restricted stock units to board members.

Consulting fees declined in 2013 as a number of projects were completed in 2012 and were not repeated in 2013. Charitable contributions declined for 2013 as compared to 2012 due to a larger donation to the West Bancorporation Foundation in the second quarter of 2012. The cost of supplies for 2013 included one-time costs to reissue debit cards related to changing processors and the Target breach, which affected a number of our debit card customers. Whenever we are notified of a breach affecting our debit card customers, as a safeguard, we reissue new debit cards to the affected customers. The 2012 loss on disposal of fixed assets included the write-off of design costs not used in the final plans related to the construction of the leased replacement office in West Des Moines.

Income Taxes

The Company records a provision for income tax expense currently payable, along with a provision for those taxes payable or refundable in the future. Such deferred taxes arise from differences in the timing of certain items for financial statement reporting compared to income tax reporting. The effective income tax rate differs from the federal statutory income tax rate primarily due to tax-exempt interest income, the tax-exempt increase in cash value of . . .

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