AMES NATIONAL CORPORATION Overview
Ames National Corporation (the "Company") is a bank holding company established in 1975 that owns and operates six bank subsidiaries in centralIowa (the "Banks"). The following discussion is provided for the consolidated operations of the Company and its Banks,First National Bank ,Ames, Iowa (First National),State Bank & Trust Co. (State Bank ),Boone Bank & Trust Co. (Boone Bank ),Reliance State Bank (Reliance Bank ),United Bank & Trust NA (United Bank ) andIowa State Savings Bank (Iowa State Bank ). The purpose of this discussion is to focus on significant factors affecting the Company's financial condition and results of operations. The Company does not engage in any material business activities apart from its ownership of the Banks. Products and services offered by the Banks are for commercial and consumer purposes including loans, deposits and wealth management services. Wealth management services includes financial planning and managing trust, agencies, estates and investment brokerage accounts. The Company employs sixteen individuals to assist with financial reporting, human resources, audit, compliance, marketing, technology systems, training, real estate valuation services and the coordination of management activities, in addition to 254 full-time equivalent individuals employed by the Banks. The Company's primary competitive strategy is to utilize seasoned and competent Bank management and local decision making authority to provide customers with faster response times and more flexibility in the products and services offered. This strategy is viewed as providing an opportunity to increase revenues through creating a competitive advantage over other financial institutions. The Company also strives to remain operationally efficient to provide better profitability while enabling the Company to offer more competitive loan and deposit rates. The principal sources of Company revenues and cash flow are: (i) interest and fees earned on loans made by the Company and Banks; (ii) interest on fixed income investments held by the Banks; (iii) fees on wealth management services provided by those Banks exercising trust powers; (iv) service fees on deposit accounts maintained at the Banks; (v) gain on sale of loans; and (vi) merchant and card fees. The Company's principal expenses are: (i) interest expense on deposit accounts and other borrowings; (ii) provision for loan losses; (iii) salaries and employee benefits; (iv) data processing costs associated with maintaining the Banks' loan and deposit functions; (v) occupancy expenses for maintaining the Bank's facilities; and (vi) professional fees. The largest component contributing to the Company's 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 deposits 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. The Company had net income of$5.9 million , or$0.64 per share, for the three months endedJune 30, 2021 , compared to net income of$4.4 million , or$0.49 per share, for the three months endedJune 30, 2020 . The increase in earnings is primarily the result of a decrease in provision for loan losses due to a higher level of provision in 2020 as a result of the onset of the COVID-19 pandemic and a reduction in interest expense due to declines in market interest rates. Net loan recoveries totaled$6 thousand for the three months endedJune 30, 2021 compared to net loan charge offs of$471 thousand for the three months endedJune 30, 2020 . A (credit) for loan losses of($20) thousand was recognized for the three months endedJune 30, 2021 as compared to a$1.6 million provision for loan loss for the three months endedJune 30, 2020 . The credit for loan losses was primarily due to improving economic conditions. The provision for loan losses in 2020 was primarily due to the onset of the COVID-19 pandemic. 29
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The following management discussion and analysis will provide a review of important items relating to:
? Challenges and COVID-19 Status, Risks and Uncertainties
? Key Performance Indicators and Industry Results
? Critical Accounting Policies
? Non-GAAP Financial Measures
? Income Statement Review ? Balance Sheet Review
? Asset Quality Review and Credit Risk Management
? Liquidity and Capital Resources
? Forward-Looking Statements and Business Risks
Challenges and COVID-19 Status, Risks and Uncertainties
Management has identified certain events or circumstances that may negatively impact the Company's financial condition and results of operations in the future and is attempting to position the Company to best respond to those challenges. These challenges are addressed in the Company's most recent Annual Report on Form 10-K filed onMarch 12, 2021 . The continuation of the COVID-19 pandemic has significantly heightened the level of challenges, risks and uncertainties facing our business and continuation of operations, including the following:
? Although the economy continues to rebound from the depths of the economic
slowdown associated with the pandemic, some of the Company's customers may
continue to experience decreased revenues, which may correlate to an inability
to make timely loan payments or maintain payrolls. This, in turn, could
adversely impact the revenues and earnings of the Company by, among other
things, requiring further increases in the allowance for loan losses and
increases in the level of charge-offs in the loan portfolio. Management may
increase the allowance if the effects of the COVID-19 pandemic negatively
impact the loan portfolio;
? Market interest rates remain at historic lows and if prolonged, couldadversely affect our net interest income, net interest margin and earnings;
? We may experience a slowdown in demand for our products and services as the
effects of the pandemic continue to linger, including the demand for
traditional loans, although we believe any decline experienced to date has
largely been offset by the new volume of PPP loans under the CARES Act and
other governmental programs established in response to the pandemic. We had
897 PPP loans with an aggregate outstanding balance of
June 30, 2021 ;
? As evidenced by the level of loans classified as substandard and watch as of
defaults and foreclosures, as well as declining collateral values and further
impairment of the ability of our borrowers to repay their loans, all of which
may result in additional credit charges and other losses in our loan
portfolio;
? Throughout the COVID-19 pandemic we actively worked with loan customers to
evaluate prudent loan modification terms. As of
$15.3 million , or 1.34%, of loans were in payment deferral status under COVID-19 related modifications; and 30
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? In meeting our objective to maintain our capital levels and liquidity position
through the COVID-19 pandemic, our Board of Directors may reduce or determine
to altogether forego payment of future dividends in order to maintain and/or
strengthen our capital and liquidity position.
Key Performance Indicators and Industry Results
Certain key performance indicators for the Company and the industry are
presented in the following chart. The industry figures are compiled by the
Selected Indicators for the Company and the Industry
3 Months 6 Months Years Ended December 31,
Ended Ended 3 Months Ended
June 30, 2021 March 31, 2021 2020 2019
Company Company Industry* Company Industry* Company Industry*
Return on assets 1.12 % 1.16 % 1.19 % 1.38 % 1.01 % 0.72 % 1.14 % 1.29 %
Return on equity 11.39 % 11.46 % 11.52 % 13.73 % 9.48 % 6.88 % 9.48 % 11.38 %
Net interest margin 2.84 % 2.85 % 2.86 % 2.56 % 3.13 % 2.82 % 3.21 % 3.36 %
Efficiency ratio 56.01 % 55.86 % 55.70 % 59.96 % 55.83 % 59.78 % 58.51 % 56.63 %
Capital ratio 9.84 % 10.08 % 10.33 % 9.97 % 10.66 % 8.81 % 12.05 % 9.66 %
*Latest available data
Key performances indicators include:
? Return on Assets This ratio is calculated by dividing net income by average assets. It is used to measure how effectively the assets of the Company are being utilized in generating income. The Company's annualized return on average assets was 1.12% and 0.94% for the three months endedJune 30, 2021 and 2020, respectively. This ratio increase was primarily the result of a decrease in the provision for loan loss and a reduction in interest expense due to market rate decreases. ? Return on Equity This ratio is calculated by dividing net income by average equity. It is used to measure the net income or return the Company generated for the shareholders' equity investment in the Company. The Company's return on average equity was at 11.39% and 9.09% for the three months endedJune 30, 2021 and 2020, respectively. This ratio increase was primarily the result of a decrease in the provision for loan loss and a reduction in interest expense due to market rate decreases. 31
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Table of Contents ? Net Interest Margin The net interest margin for the three months endedJune 30, 2021 and 2020 was 2.84% and 3.10%, respectively. The ratio is calculated by dividing tax equivalent net interest income by average earning assets. Earning assets are primarily made up of loans and investments that earn interest. This ratio is used to measure how well the Company is able to maintain interest rates on earning assets above those of interest-bearing liabilities, which is the interest expense paid on deposits and other borrowings. ? Efficiency Ratio This ratio is calculated by dividing noninterest expense by the sum of net interest income and noninterest income. The ratio is a measure of the Company's ability to manage noninterest expenses. The Company's efficiency ratio was 56.01% and 56.49% for the three months endedJune 30, 2021 and 2020, respectively. The efficiency ratio has slightly improved compared to the same quarter last year. ? Capital Ratio The average capital ratio is calculated by dividing average total equity capital by average total assets. It measures the level of average assets that are funded by shareholders' equity. Given an equal level of risk in the financial condition of two companies, the higher the capital ratio, generally the more financially sound the company. The Company's capital ratio of 9.84% as ofJune 30, 2021 is similar to the industry average of 9.97% as ofMarch 31, 2021 . Industry Results:
The FDIC Quarterly Banking Profile reported the following results for the first quarter of 2021:
Quarterly Net Income More Than Tripled From the
Net income totaled$76.8 billion in first quarter 2021, an increase of$17.3 billion (29.1%) from fourth quarter 2020 and$58.3 billion (315.3%) from a year ago. Aggregate negative provision expense of$14.5 billion , which declined$17.7 billion from fourth quarter 2020, drove the improvement in net income from the previous quarter. Three-fourths of all banks (74.8%) reported higher quarterly net income compared with the year-ago quarter. The share of unprofitable institutions dropped from 7.4% a year ago to 3.9%. The banking industry reported an aggregate return on average assets ratio of 1.38%, up 1 percentage point from a year ago and 28 basis points from fourth quarter 2020.
Net Interest Margin Contracted Further to a New Record Low
The average net interest margin contracted 57 basis points from a year ago to 2.56%, the lowest level on record in the Quarterly Banking Profile (QBP). Net interest income declined$7.6 billion (5.6%) from first quarter 2020 as the year-over-year reduction in interest income (down$29.8 billion , or 17.6%) outpaced the decline in interest expense (down$22.2 billion , or 68.7%). Despite the aggregate decline in net interest income, more than three-fifths of all banks (64.4%) reported higher net interest income compared with a year ago. The average yield on earning assets declined 1.1% points from the year-ago quarter to 2.76%, while the average cost of funding earning assets declined 54 basis points to 0.20%, both of which are record lows. 32
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More Than Two-Thirds of Banks Reported Higher Noninterest Income Year Over Year
More than two thirds of all banks (67.9%) reported an annual increase in noninterest income. Increased revenue from servicing fees, loan sales, and trading activities lifted noninterest income by$9.9 billion (14.8%) to$76.8 billion from a year ago. Servicing fee revenue increased$5.2 billion , net gains on loan sales increased$4.5 billion , and trading revenue increased$3.8 billion . A decline in "other noninterest income" of$4.3 billion (12.1%) partially offset the improvement in noninterest income from the year-ago quarter.
Noninterest Expense Declined From the
A decline in amortization expense of intangible assets drove a$4.1 billion (3.2%) reduction in total noninterest expense year over year. Amortization expense declined$8.4 billion (88.8%). An increase in salary and employee benefits (up$6.2 billion or 10.6%) offset the annual reduction in noninterest expense. Average assets per employee rose$1.1 million from a year ago to$10.9 million . Nearly two-thirds of all banks (65.3%) reported higher noninterest expense year over year. However, the average efficiency ratio (noninterest expense as a percentage of net interest income plus noninterest income, which indicates the cost of generating bank income) during this period declined 2.7 percentage points to 60.5%. Banks in all QBP asset size groups reported improvements in this ratio.
Provisions for Credit Losses Were Negative for the First Time on Record
Provisions for credit losses (provisions) declined$17.7 billion (552.6%) from the previous quarter and$67.2 billion from the year-ago quarter to negative$14.5 billion , the lowest level on record. Less than one-fourth of all institutions (24.5%) reported higher provisions compared with the year-ago quarter. The number of banks that have adopted current expected credit loss (CECL) accounting rose by 41 to 320 from fourth quarter 2020. CECL adopters reported aggregate negative provisions of$14.9 billion in the first quarter, a reduction of$16.1 billion from the previous quarter and a reduction of$63.0 billion from one year ago. Provisions for banks that have not adopted CECL accounting totaled$391.4 million (a reduction of$1.7 billion from a quarter ago and$4.0 billion from one year ago).
The Coverage Ratio Remained Above the Financial Crisis Average
The allowance for loan and lease losses as a percentage of loans that are 90
days or more past due or in nonaccrual status (coverage ratio) declined 9.4%
points to 174.2% from fourth quarter 2020. This ratio remains above the
financial crisis average of 79.1%. Coverage ratios for banks in the largest two
QBP asset size groups ("$10 billion to $250 billion " and "greater than $250
billion ") declined the most from fourth quarter 2020.
The Noncurrent Rate Declined Modestly From Fourth Quarter 2020
Loans and leases that were 90 days or more past due or in nonaccrual status (noncurrent loans and leases) declined$5.9 billion (4.6%) to$122.9 billion from fourth quarter 2020. The noncurrent rate for total loans and leases improved 5 basis points to 1.14% from the previous quarter. However, the noncurrent rate for construction and development loans increased 7 basis points from the previous quarter to 0.72%, and the noncurrent rate for home equity credit lines increased 5 basis points from the previous quarter to 2.17%.
Net Charge-Off Volume Declined From the
During the year ending first quarter 2021, net charge-offs declined$5.4 billion (36.8%), and the net charge-off rate fell 20 basis points to 0.34%, slightly above the record low of 0.32%. Reductions in charged-off credit card balances (down$3.3 billion , or 36.4%) and charged-off commercial and industrial (C&I) loans (down$1.2 billion , or 43.5%) contributed most to the decline. 33
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Total Assets Increased From the
Total assets increased$680.9 billion (3.1%) from fourth quarter 2020 to$22.6 trillion . Cash and balances due from depository institutions expanded$440.1 billion (13.8%), and securities rose a record$366.9 billion (7.2%). Mortgage-backed securities led the quarterly growth, rising$220.4 billion (7.2%), followed by growth inU.S. Treasury securities, which rose$110.7 billion (11.5%). Total loan and lease volume declined by a modest 0.4% from the previous quarter. Together, the asset growth and loan volume contraction led to a decline in the net loans and leases to total assets ratio to 47.0%, a record low.
Loan Volume Continued to Decline, Driven by a Reduction in Credit Card Balances
Total loan and lease balances contracted$38.7 billion (0.4%) from the previous quarter. A reduction in credit card balances (down$60.9 billion , or 7.4%) drove the quarterly decline in loan volume. Unused credit card commitments declined for a fourth consecutive quarter (down$364.6 billion , or 9.2%). This was the largest percentage reduction in credit card commitments since first quarter 2009. Growth in Paycheck Protection Program loans, guaranteed by theSmall Business Administration , grew$61.2 billion from the previous quarter to$469.4 billion . Compared with the year-ago quarter, total loan and lease balances declined$136.3 billion (1.2%). This was the first annual contraction in loan and lease volume reported by the banking industry since third quarter 2011. Reductions in credit card balances (down$111.9 billion , or 12.8%) and C&I loans (down$93.2 billion , or 3.7%) drove the annual decline in loan volume. Despite the aggregate decline in loan volume, more than two-thirds of all banks (71.9%) reported year-over-year growth in loan and lease volume.
Deposit Growth Remained Strong
Deposits grew$635.2 billion (3.6%) from fourth quarter 2020 to$18.5 trillion , continuing several quarters of unprecedented deposit growth. Among deposit categories, deposits above$250,000 (up$424.8 billion , or 4.7%) and noninterest-bearing deposits (up$371.1 billion , or 8.1%) grew most from the previous quarter. Deposits as a percentage of total assets reached a record high for the QBP of 81.8% in first quarter 2021.
Equity Capital Continued to Grow
Equity capital rose$26.1 billion (1.2%) from fourth quarter 2020, supported by an increase in retained earnings of$15.3 billion (40.5%). Cash dividends totaled$23.9 billion , up 9.4% from the previous quarter. Fewer institutions-six banks with total assets of$536.5 million - reported capital ratios that did not meet Prompt Corrective Action (PCA) requirements for the well capitalized category, compared with eight banks that did not meet this requirement in fourth quarter 2020. The number of banks that are not "well capitalized" for PCA purposes is the lowest on record.
Three New Banks Opened in First Quarter 2021
Three new banks opened and 25 institutions merged in first quarter 2021. No banks failed during the quarter. With these changes, the number ofFDIC -insured commercial banks and savings institutions declined from 5,002 to 4,978 in first quarter 2021. The number of institutions on theFDIC's "ProblemBank List " declined by one to 55 from fourth quarter 2020. Total assets of problem banks declined$1.7 billion from the fourth quarter to$54.2 billion . 34
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Table of Contents Critical Accounting Policies The discussion contained in this Item 2 and other disclosures included within this report are based, in part, on the Company's auditedDecember 31, 2020 consolidated financial statements. These statements have been prepared in accordance with accounting principles generally accepted inthe United States of America . The financial information contained in these statements is, for the most part, 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" accompanying the Company's audited financial statements. Based on its consideration of accounting policies that involve the most complex and subjective estimates and judgments, management has identified the allowance for loan losses, the assessment of other-than-temporary impairment for investment securities and the assessment of goodwill impairment to be the Company's most critical accounting policies. Allowance for Loan Losses The allowance for loan losses is established through a provision for loan losses that is treated as an expense and charged against earnings. 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 various considerations regarding the general economic environment in the Company's market area. To the extent actual results differ from forecasts and management's judgment, the allowance for loan losses may be greater or lesser than future charge-offs. Due to potential changes in conditions, including the economic disruption and uncertainties resulting from the COVID-19 pandemic, it is at least reasonably possible that changes in estimates will occur in the near term and that such changes could be material to the amounts reported in the Company's financial statements. For further discussion concerning the allowance for loan losses and the process of establishing specific reserves, see the section of the Annual Report on Form 10-K entitled "Asset Quality Review and Credit Risk Management" and "Analysis of the Allowance for Loan Losses". 35
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Fair Value and Other-Than-Temporary Impairment of
The Company's securities available-for-sale portfolio is carried at fair value with "fair value" being defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability is not adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact, and (iv) willing to transact. Declines in the fair value of available-for-sale securities below their cost that are deemed to be other-than-temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers (1) the intent to sell the investment securities and the more likely than not requirement that the Company will be required to sell the investment securities prior to recovery (2) the length of time and the extent to which the fair value has been less than cost and (3) the financial condition and near-term prospects of the issuer. Due to potential changes in conditions, including the economic disruption and uncertainties resulting from the COVID-19 pandemic, it is at least reasonably possible that changes in management's assessment of other-than-temporary impairment will occur in the near term and that such changes could be material to the amounts reported in the Company's financial statements.Goodwill Goodwill arose in connection with four acquisitions consummated in previous periods.Goodwill is tested annually for impairment or more often if conditions indicate a possible impairment. For the purposes of goodwill impairment testing, determination of the fair value of a reporting unit involves the use of significant estimates and assumptions. Impairment would arise if the fair value of a reporting unit is less than its carrying value. AtJune 30, 2021 , Company's management has completed the goodwill impairment assessment and determined goodwill was not impaired. Actual future test results may differ from the present evaluation of impairment due to changes in the conditions used in the current evaluation.Goodwill may be impaired in the future if the effects of the COVID-19 pandemic negatively impacts our net income and fair value. An impairment of goodwill would decrease the Company's earnings during the period in which the impairment is recorded. 36
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Non-GAAP Financial Measures
This report contains references to financial measures that are not defined in
GAAP. Such non-GAAP financial measures include the Company's presentation of net
interest income and net interest margin on a fully taxable equivalent (FTE)
basis. Management believes these non-GAAP financial measures are widely used in
the financial institutions industry and provide useful information to both
management and investors to analyze and evaluate the Company's financial
performance. Limitations associated with non-GAAP financial measures include the
risks that persons might disagree as to the appropriateness of items included in
these measures and that different companies might calculate these measures
differently. These non-GAAP disclosures should not be considered an alternative
to the Company's GAAP results. The following table reconciles the non-GAAP
financial measures of net interest income and net interest margin on an FTE
basis to GAAP (dollars in thousands).
Three Months Ended June 30, Six Months Ended June 30, Three Months Ended March 31,
2021 2020 2021 2020 2021 2020
Reconciliation of net interest income and annualized net
interest margin on an FTE basis to GAAP:
Net interest income
(GAAP) $ 14,172 $ 13,680 $ 27,836 $ 26,726 $ 13,664 $ 13,046
Tax-equivalent
adjustment (1) 218 255 443 496 225 241
Net interest income on
an FTE basis (non-GAAP) 14,390 13,935 28,279 27,222 13,889 13,287
Average interest-earning
assets $ 2,026,045 $ 1,797,290 $ 1,984,184 $ 1,733,323 $ 1,941,859 $ 1,669,356
Net interest margin on
an FTE basis (non-GAAP) 2.84 % 3.10 % 2.85 % 3.14 % 2.86 % 3.18 %
(1) Computed on a tax-equivalent basis using an incremental federal income tax
rate of 21 percent, adjusted to reflect the effect of the tax-exempt interest
income associated with owning tax-exempt securities and loans.
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Income Statement Review for the Three Months ended
The following highlights a comparative discussion of the major components of net
income and their impact for the three months ended
AVERAGE BALANCES AND INTEREST RATES
The following two tables are used to calculate the Company's non-GAAP net
interest margin on an FTE basis. The first table includes the Company's average
assets and the related income to determine the average yield on earning assets.
The second table includes the average liabilities and related expense to
determine the average rate paid on interest-bearing liabilities. The net
interest margin is equal to interest income less interest expense divided by
average earning assets. Refer to the net interest income discussion following
the tables for additional detail.
AVERAGE BALANCE SHEETS AND INTEREST RATES
Three Months Ended June 30,
2021 2020
Average Revenue/ Yield/ Average Revenue/ Yield/
balance expense rate balance expense rate
ASSETS
(dollars in
thousands)
Interest-earning
assets
Loans (1)
Commercial $ 122,183 $ 2,159 7.07 % $ 145,337 $ 1,642 4.52 %
Agricultural 97,144 996 4.10 % 111,289 1,322 4.75 %
Real estate 912,226 8,798 3.86 % 881,437 9,371 4.25 %
Consumer and other 14,954 174 4.65 % 18,195 235 5.16 %
Total loans
(including fees) 1,146,507 12,127 4.23 % 1,156,258 12,570 4.35 %
Investment securities
Taxable 545,319 2,212 1.62 % 317,447 1,948 2.45 %
Tax-exempt (2) 161,780 1,041 2.57 % 176,812 1,208 2.73 %
Total investment
securities 707,099 3,253 1.84 % 494,259 3,156 2.55 %
Interest-bearing
deposits with banks
and federal funds
sold 172,439 169 0.39 % 146,773 166 0.45 %
Total
interest-earning
assets 2,026,045 $ 15,549 3.07 % 1,797,290 $ 15,892 3.54 %
Noninterest-earning
assets 71,709 83,938
TOTAL ASSETS $ 2,097,754 $ 1,881,228 (1) Average loan balances include nonaccrual loans, if any. Interest income collected on nonaccrual loans has been included.
(2) Tax-exempt income has been adjusted to a tax-equivalent basis using an incremental tax rate of 21%.
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