10-K 1 wtba-20161231x10k.htm 10-K Document

 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549

FORM 10-K

(Mark One)
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT of 1934
 
For the fiscal year ended December 31, 2016
 
 
 
or
 
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from __________ to __________

Commission file number:  0-49677

WEST BANCORPORATION, INC.
(Exact name of registrant as specified in its charter)
 
IOWA
42-1230603
(State of incorporation or organization)
(I.R.S. Employer Identification No.)
 
 
1601 22nd STREET, WEST DES MOINES, IOWA
50266
(Address of principal executive offices)
(Zip code)

Registrant's telephone number, including area code:  (515) 222-2300

Securities registered pursuant to Section 12(b) of the Act: 
Title of Class
 
Name of Each Exchange on Which Registered
Common Stock, No Par Value
 
The Nasdaq Global Select Market

Securities registered pursuant to Section 12(g) of the Act:  NONE

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes  o     No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes  o     No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x No  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  x No  o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x


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Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
o
Accelerated filer
x
Non-accelerated filer
o
Smaller reporting company
o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes  o No  x

The aggregate market value of the voting common stock held by non-affiliates of the registrant as of June 30, 2016, was approximately $291,567,735.

Indicate the number of shares outstanding of each of the registrant's classes of common stock as of the most recent practicable date, February 27, 2017.

16,137,999 shares of common stock, no par value

DOCUMENTS INCORPORATED BY REFERENCE

The definitive proxy statement of West Bancorporation, Inc., which was filed on March 1, 2017, is incorporated by reference into Part III hereof to the extent indicated in such Part.

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FORM 10-K
TABLE OF CONTENTS
 
 
 
 
 
 
 
 
 
PART I
 
 
 
ITEM 1.
 
 
 
ITEM 1A.
 
 
 
ITEM 1B.
 
 
 
ITEM 2.
 
 
 
ITEM 3.
 
 
 
ITEM 4.
MINE SAFETY DISCLOSURES
 
 
 
PART II
 
 
 
ITEM 5.
 
 
 
ITEM 6.
 
 
 
ITEM 7.
 
 
 
ITEM 7A.
 
 
 
ITEM 8.
 
 
 
ITEM 9.
 
 
 
ITEM 9A.
 
 
 
ITEM 9B.
 
 
 
PART III
 
 
 
ITEM 10.
 
 
 
ITEM 11.
 
 
 
ITEM 12.
 
 
 
ITEM 13.
 
 
 
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
 
 
 
PART IV
 
 
 
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
 
 
 
ITEM 16.

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"SAFE HARBOR" CONCERNING FORWARD-LOOKING STATEMENTS

Certain statements in this report, other than purely historical information, including estimates, projections, statements relating to the Company's business plans, objectives and expected operating results, and the assumptions upon which those statements are based, are “forward-looking statements” within the meanings of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). Forward-looking statements may appear throughout this report. These forward-looking statements are generally identified by the words “believes,” “expects,” “intends,” “anticipates,” “projects,” “future,” “may,” “should,” “will,” “strategy,” “plan,” “opportunity,” “will be,” “will likely result,” “will continue” or similar references, or references to estimates, predictions or future events.  Such forward-looking statements are based upon certain underlying assumptions, risks and uncertainties.  Because of the possibility that the underlying assumptions are incorrect or do not materialize as expected in the future, actual results could differ materially from these forward-looking statements.  Risks and uncertainties that may affect future results include: interest rate risk; competitive pressures; pricing pressures on loans and deposits; changes in credit and other risks posed by the Company's loan and investment portfolios, including declines in commercial or residential real estate values or changes in the allowance for loan losses dictated by new market conditions or regulatory requirements; actions of bank and nonbank competitors; changes in local, national and international economic conditions; changes in regulatory requirements, limitations and costs; changes in customers' acceptance of the Company's products and services; cyber-attacks; unexpected outcomes of existing or new litigation involving the Company; and any other risks described in the “Risk Factors” sections of this and other reports filed by the Company with the Securities and Exchange Commission. The Company undertakes no obligation to revise or update such forward-looking statements to reflect current or future events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

PART I

ITEM 1.  BUSINESS

General Development of Business

West Bancorporation, Inc. (the Company or West Bancorporation) is an Iowa corporation and a financial holding company registered under the Bank Holding Company Act of 1956, as amended (BHCA).  The Company was formed in 1984 to own West Bank, an Iowa-chartered bank headquartered in West Des Moines, Iowa.  West Bank is a business-focused community bank that was organized in 1893. The Company's primary activity during 2016 was the ownership of West Bank. The Company's and West Bank's only business is banking, and therefore, no segment information is presented in this report.

During the third quarter of 2016, the Company elected to become a financial holding company. The election provides the Company with additional flexibility to engage in a broader range of financial activities through affiliates than are permissible for bank holding companies that are not financial holding companies. While the Company does not currently have a plan to engage in any new activities, the election affords the ability to respond more quickly to market developments and opportunities.

The Company operates in three markets: central Iowa, which is generally the greater Des Moines metropolitan area; eastern Iowa, which is the area including and surrounding Iowa City and Coralville, Iowa; and the Rochester, Minnesota, area.

The Company's financial performance goal is to be in the top quartile of our benchmarking peer group, which in 2016 consisted of 16 Midwestern, publicly traded financial institutions. The fiscal year ended December 31, 2016 produced strong results for the Company and West Bank as measured by the following four key metrics:
l
Return on average assets:
1.27
%
l
Return on average equity:
14.35
%
l
Efficiency ratio:
46.03
%
l
Texas ratio:
0.56
%
Based on peer group analysis using the nine months ended September 30, 2016 data, which is the latest available data, the Company's results and ratios for the fiscal year 2016 were better than those of each member of our defined peer group for each of the measures shown above, except for two peers that had a higher return on average assets. We currently believe our fiscal year 2016 results will remain in the top quartile once comparable peer results are available.


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During 2016, the Company received a number of financial performance recognitions, including the following:

West Bancorporation, Inc. received national recognition from investment bank and research firm Raymond James in the fourth annual Raymond James Community Bankers Cup. They identified America’s top 30 performing community banks with assets between $500 million and $10 billion. Raymond James ranked West Bancorporation, Inc. among the top 5 in the nation for 2015. The Raymond James Community Bankers Cup recognizes the top 10 percent of the 300 exchanged-traded community banks based on various profitability, operational efficiency, and balance sheet metrics. This is the third consecutive year we have made this list.

S&P Global Market Intelligence ranked West Bancorporation as the 33rd best-performing community bank in 2015 with assets between $1 billion and $10 billion. The rankings were based on various measures related to profitability, growth and asset quality.

West Bancorporation was ranked number 9 among the 166 publicly traded banks with assets between $1 billion and $5 billion in Bank Director Magazine's 2016 Bank Performance Scorecard. The rankings were based on five measures related to profitability, capitalization and asset quality. This is the fourth consecutive year we have made this list.

The Independent Community Bankers Association named West Bank to its annual listing of the most outstanding community bank performers across the nation. The Independent Community Bankers Association identified the top-performing community banks in its 2016 listing using year-end FDIC call report earnings data for 2015. In those rankings, the top 25 community banks with the best return on average assets (ROA) and return on average equity (ROE) ratios were identified. West Bank was ranked 22nd among Subchapter C corporation community banks with assets of more than $1 billion.

American Banker Magazine, the publication of the American Bankers Association, rated community banks by ROE in an article entitled "Which Small Bank has the Biggest ROE." West Bank came in at number 13 in America out of the 684 institutions that qualified for consideration. All public financial institutions across America with assets of less than $2 billion were eligible for the distinction. The most heavily weighted financial performance criterion was the 3-year ROE.

The Company continued to grow in 2016, as loans outstanding at the end of 2016 totaled $1.40 billion compared to $1.25 billion at the end of 2015, an increase of 12.3 percent. Total deposits grew 7.3 percent during 2016 from the balances as of December 31, 2015. We believe the pipeline for new business is good as we continue to focus efforts on sales through strengthening existing relationships and developing new relationships.

The Company's Rochester, Minnesota, office, which opened in March 2013, again experienced strong growth in 2016. After almost four years of operations, this location had approximately $112 million of loans outstanding as of December 31, 2016. It is expected that this office will continue to have a strong growth rate in 2017, as the office moved into its new permanent building in Rochester in November 2016. The prior leased office space was vacated. The Company believes that southeastern Minnesota is a desirable market and an economic bedrock due to the strength and projected growth of the Mayo Clinic, which is headquartered in Rochester.

One of the keys to our 2016 operating success was an improvement in net interest income as a result of an increase in the average volume of interest-earning assets. Also contributing to our higher 2016 earnings was the continued low level of nonperforming assets. As of December 31, 2016, total nonperforming assets declined to $1.0 million, or 0.06 percent of total assets, compared to $1.5 million, or 0.08 percent of total assets, as of December 31, 2015.

The Company declared and paid common stock dividends totaling $0.67 per share in 2016 and declared a $0.17 quarterly dividend on January 25, 2017, payable on February 22, 2017 to stockholders of record on February 8, 2017. The Company expects to continue paying regular quarterly dividends in the future. In the opinion of management, the capital position of the Company was strong at December 31, 2016. The Company's tangible common equity ratio at December 31, 2016 was 8.92 percent.

Description of the Company's Business

West Bank provides full-service community banking and trust services to customers located primarily in the Des Moines and Iowa City, Iowa, and the Rochester, Minnesota, metropolitan areas.  West Bank has eight offices in the Des Moines area, one office in Iowa City, one office in Coralville and one office in Rochester. West Bank offers many basic types of credit to its customers, including commercial, real estate and consumer loans.  West Bank offers trust services, including the administration of estates, conservatorships, personal trusts and agency accounts.  


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West Bank offers a full range of deposit services, including checking, savings, money market accounts and time certificates of deposit. West Bank also offers internet, mobile banking and treasury management services, which help to meet the banking needs of its customers and communities. Treasury management services offered to business customers include cash management, client-generated automated clearing house transactions, remote deposit and fraud protection services. Also offered are merchant credit card processing and corporate credit cards.

West Bank's business strategy emphasizes strong business and personal relationships between West Bank and its customers and the delivery of products and services that meet the individualized needs of those customers.  West Bank also emphasizes strong cost controls, while striving to achieve an above average return on equity and return on assets.  To accomplish these goals, West Bank focuses on small- to medium-sized businesses in its local markets that traditionally wish to develop an exclusive relationship with a single bank.  West Bank has the size to provide the personal attention required by local business owners and the financial expertise and entrepreneurial attitude to help businesses meet their financial service needs.

The economies in our market areas are fairly diversified. The Des Moines, Iowa, metropolitan area has a population of approximately 620,000 and an unemployment rate of 2.9 percent. The major sources of employment in this area include financial services companies, healthcare providers and agribusiness industries along with local school districts and federal, state and local governments. Major employers include Wells Fargo & Co., Mercy Medical Center, Unity Point Health, Hy-Vee Inc., The Principal Financial Group and the State of Iowa. The Iowa City, Iowa, metropolitan area has a population of approximately 95,000 and an unemployment rate of 2.1 percent. The major sources of employment in this area include educational institutions, healthcare providers, and local schools and government. Major employers include the University of Iowa and University of Iowa Hospitals and Clinics. The Rochester, Minnesota, metropolitan area has a population of approximately 110,000 and an unemployment rate of 2.6 percent. The major sources of employment in this area include healthcare, technology and agribusiness industries, and local schools and government. Major employers include the Mayo Clinic and IBM.

The market areas served by West Bank are highly competitive with respect to both loans and deposits.  West Bank competes with other commercial banks, many of which are subsidiaries of other bank holding companies, credit unions, mortgage companies and other financial service providers. According to the Federal Deposit Insurance Corporation's (FDIC) Summary of Deposits, as of June 30, 2016, there were 35 banks operating within Polk County, Iowa, where seven of West Bank's offices are located.  As of the same date, West Bank ranked fourth based on total deposits of all banking offices in Polk County.  As of June 30, 2016, there were 18 banks within Johnson County, Iowa, which includes Iowa City and Coralville.  Two West Bank offices were located in Johnson County as of June 30, 2016.  As of the same date, West Bank ranked fourth based on total deposits of all banking offices in Johnson County.  West Bank also has one office located in Dallas County, Iowa.  For the entire state of Iowa, West Bank ranked seventh in terms of deposit size as of June 30, 2016. As previously mentioned, West Bank also has one office located in Rochester, Minnesota.

Some of West Bank's competitors are locally controlled, while others are regional, national or international companies. The larger national or regional banks have certain competitive advantages due to their ability to undertake substantial advertising campaigns and allocate their investment assets to out-of-market geographic regions with potentially higher returns.  Such banks also offer certain services, for example, international and conduit financing transactions, which are not offered directly by West Bank.  These larger banking organizations also have much higher legal lending limits than West Bank, and therefore, may be better able to service large regional, national and global commercial customers.

In order to compete to the fullest extent possible with the other financial institutions in its primary market areas, West Bank uses the flexibility and knowledge of its local management, Board of Directors and community advisors.  West Bank has a group of community advisors in each of its markets who provide insight to management on current business activity levels and trends. West Bank seeks to capitalize on customers who desire to do business with a local institution. This includes emphasizing specialized services, local promotional activities, and personal contacts by West Bank's officers, directors and employees.  In particular, West Bank competes for loans primarily by offering competitive interest rates, experienced lending personnel with local decision-making authority, flexible loan arrangements, quality products and services, and proactive relationship management. West Bank competes for deposits principally by offering depositors a variety of deposit programs, convenient office locations and hours, and other personalized services.  

West Bank also competes with the general financial markets for funds.  Yields on corporate and government debt securities and commercial paper affect West Bank's ability to attract and hold deposits.  West Bank also competes for funds with money market accounts and similar investment vehicles offered by brokerage firms, mutual fund companies, internet banks and others. The competition for these funds is based almost exclusively on yields to customers.

The Company and West Bank had approximately 165 full-time equivalent employees as of December 31, 2016.


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Supervision and Regulation

General

FDIC-insured institutions, their holding companies and their affiliates are extensively regulated under federal and state law. As a result, our growth and earnings performance may be affected not only by management decisions and general economic conditions, but also by the requirements of federal and state statutes and by the regulations and policies of various bank regulatory agencies, including the Iowa Division of Banking, the Board of Governors of the Federal Reserve System (Federal Reserve), the FDIC and the Consumer Financial Protection Bureau (CFPB). Furthermore, taxation laws administered by the Internal Revenue Service and state taxing authorities, accounting rules developed by the Financial Accounting Standards Board, securities laws administered by the Securities and Exchange Commission (SEC) and state securities authorities, and anti-money laundering laws enforced by the U.S. Department of the Treasury (Treasury) have an impact on our business. The effect of these statutes, regulations, regulatory policies and accounting rules are significant to our operations and results.

Federal and state banking laws impose a comprehensive system of supervision, regulation and enforcement on the operations of FDIC-insured institutions, their holding companies and affiliates that is intended primarily for the protection of the FDIC-insured deposits and depositors of banks, rather than stockholders. These federal and state laws, and the regulations of the bank regulatory agencies issued under them, affect, among other things, the scope of our business; the kinds and amounts of investments we may make; reserve requirements; required capital levels relative to our assets; the nature and amount of collateral for loans; the establishment of branches; our ability to merge, consolidate and acquire; dealings with our insiders and affiliates; and our payment of dividends. In the last several years, we have experienced heightened regulatory requirements and scrutiny following the global financial crisis and as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). Although the reforms primarily targeted systemically important financial service providers, their influence filtered down in varying degrees to community banks over time, and the reforms have caused our compliance and risk management processes, and the costs thereof, to increase. While it is anticipated that the new administration will not increase the regulatory burden on community banks and may reduce some of the burdens associated with implementation of the Dodd-Frank Act, the true impact of the new administration is impossible to predict with any certainty at this time.

This supervisory and regulatory framework subjects banks and bank holding companies to regular examination by their respective regulatory agencies, which results in examination reports and ratings that are not publicly available and that can impact the conduct and growth of their business. These examinations consider not only compliance with applicable laws and regulations, but also capital levels, asset quality and risk, management ability and performance, earnings, liquidity and various other factors. The regulatory agencies generally have broad discretion to impose restrictions and limitations on the operations of a regulated entity where the agencies determine, among other things, that such operations are unsafe or unsound, fail to comply with applicable laws or are otherwise inconsistent with laws and regulations or with the supervisory policies of these agencies.  

The following is a summary of the material elements of the supervisory and regulatory framework applicable to the Company and West Bank, beginning with a discussion of the continuing regulatory emphasis on our capital levels. It does not describe all of the statutes, regulations and regulatory policies that apply, nor does it restate all of the requirements of those that are described. The descriptions are qualified in their entirety by reference to the particular statutory and regulatory provision.

Regulatory Emphasis on Capital

Regulatory capital represents the net assets of a banking organization available to absorb losses. Because of the risks attendant to their business, FDIC-insured institutions are generally required to hold more capital than other businesses, which directly affects our earnings capabilities. While capital has historically been one of the key measures of the financial health of both bank holding companies and banks, its role became fundamentally more important in the wake of the global financial crisis, as the banking regulators recognized that the amount and quality of capital held by some banks prior to the crisis was insufficient to absorb losses during periods of severe stress. Certain provisions of the Dodd-Frank Act and Basel III, discussed below, establish strengthened capital standards for banks and bank holding companies, require more capital to be held in the form of common stock and disallow certain funds from being included in capital determinations.  These standards represent regulatory capital requirements that are meaningfully more stringent than those in place previously.


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Minimum Required Capital Levels. Banks have been required to hold minimum levels of capital based on guidelines established by the bank regulatory agencies since 1983. The minimums have been expressed in terms of ratios of capital divided by total assets. As discussed below, bank capital measures have become more sophisticated over the years and have focused more on the quality of capital and the risk of assets. Bank holding companies have historically had to comply with less stringent capital standards than their bank subsidiaries and have been able to raise capital with hybrid instruments such as trust preferred securities. The Dodd-Frank Act mandated the Federal Reserve to establish minimum capital levels for holding companies on a consolidated basis as stringent as those required for FDIC-insured institutions. A result of this change is that the proceeds of hybrid instruments, such as trust preferred securities, are being excluded from Tier 1 Capital over a phase-out period. However, if such securities were issued prior to May 19, 2010 by bank holding companies with less than $15 billion of assets, they may be retained, subject to certain restrictions. Because we have assets of less than $15 billion, we are able to maintain our trust preferred proceeds as Tier 1 Capital, but we have to comply with new capital mandates in other respects and will not be able to raise Tier 1 Capital in the future through the issuance of trust preferred securities.

The Basel International Capital Accords. The risk-based capital guidelines for U.S. banks since 1989 are based upon the 1988 capital accord known as “Basel I” adopted by the international Basel Committee on Banking Supervision, a committee of central banks and bank supervisors that acts as the primary global standard setter for prudential regulation, as implemented by the U.S. bank regulatory agencies on an interagency basis. The accord recognized that bank assets for the purpose of the capital ratio calculations needed to be risk weighted (the theory being that riskier assets should require more capital) and that off-balance sheet exposures needed to be factored in the calculations. Basel I had a very simple formula for assigning risk weights to bank assets from 0 percent to 100 percent based on four categories.  In 2008, the banking agencies collaboratively began to phase in capital standards based on a second capital accord, referred to as “Basel II,” for large or “core” international banks (generally defined for U.S. purposes as having total assets of $250 billion or more, or consolidated foreign exposures of $10 billion or more) known as “advanced approaches” banks. The primary focus of Basel II was on the calculation of risk weights based on complex models developed by each advanced approaches bank. As most banks were not subject to Basel II, the U.S. bank regulators worked to improve the risk sensitivity of Basel I standards without imposing the complexities of Basel II. This “standardized approach” increased the number of risk weight categories and recognized risks well above the original 100 percent risk weighting. It is institutionalized by the Dodd-Frank Act for all banking organizations, even for the advanced approaches banks, as a floor.
  
On September 12, 2010, the Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, announced agreement on a strengthened set of capital requirements for banking organizations around the world, known as Basel III, to address deficiencies recognized in connection with the global financial crisis.

The Basel III Rule. In July of 2013, the U.S. federal banking agencies approved the implementation of the Basel III regulatory capital reforms in pertinent part, and, at the same time, promulgated rules effecting certain changes required by the Dodd-Frank Act (the Basel III Rule). In contrast to capital requirements historically, which were in the form of guidelines, Basel III was released in the form of regulations by each of the regulatory agencies. The Basel III Rule is applicable to all banking organizations that are subject to minimum capital requirements, including federal and state banks and savings and loan associations, as well as to bank and savings and loan holding companies other than “small bank holding companies” (generally bank holding companies with consolidated assets of less than $1 billion).

The Basel III Rule required higher capital levels, increased the required quality of capital, and required more detailed categories of risk weighting of riskier, more opaque assets. For nearly every asset class, the Basel III Rule requires a more complex, detailed and calibrated assessment of credit risk and calculation of risk weightings.

Not only did the Basel III Rule increase most of the required minimum capital ratios effective January 1, 2015, but it also introduced the concept of Common Equity Tier 1 Capital, which consists primarily of common stock, related surplus (net of Treasury stock), retained earnings, and Common Equity Tier 1 minority interests subject to certain regulatory adjustments. The Basel III Rule also changed the definition of capital by establishing more stringent criteria that instruments must meet to be considered Additional Tier 1 Capital (primarily other types of preferred stock and subordinated debt, subject to limitations) and Tier 2 Capital (primarily other types of preferred stock and subordinated debt, subject to limitations). A number of instruments that qualified as Tier 1 Capital under Basel I do not qualify, or their qualifications changed. For example, noncumulative perpetual preferred stock, which qualified as simple Tier 1 Capital, does not qualify as Common Equity Tier 1 Capital, but qualifies as Additional Tier 1 Capital. The Basel III Rule also constrained the inclusion of minority interests, mortgage-servicing assets, and deferred tax assets in capital and requires deductions from Common Equity Tier 1 Capital in the event that such assets exceed a certain percentage of a banking institution’s Common Equity Tier 1 Capital.


9


The Basel III Rule requires minimum capital ratios beginning January 1, 2015, as follows:

A new ratio of minimum Common Equity Tier 1 Capital equal to 4.5 percent of risk-weighted assets;

An increase in the minimum required amount of Tier 1 Capital from 4 percent to 6 percent of risk-weighted assets;

A continuation of the current minimum required amount of Total Capital (Tier 1 plus Tier 2) at 8 percent of risk-weighted assets; and

A minimum leverage ratio of Tier 1 Capital to total quarterly average assets equal to 4 percent in all circumstances.

In addition, institutions that seek the freedom to make capital distributions (including for dividends and repurchases of stock) and pay discretionary bonuses to executive officers without restriction must also maintain 2.5 percent in Common Equity Tier 1 Capital attributable to a capital conservation buffer being phased in over three years beginning in 2016 (as of January 1, 2017, it had phased in halfway to 1.25 percent). The purpose of the conservation buffer is to ensure that banking institutions maintain a buffer of capital that can be used to absorb losses during periods of financial and economic stress. Factoring in the fully phased-in conservation buffer increases the minimum ratios depicted above to 7 percent for Common Equity Tier 1, 8.5 percent for Tier 1 Capital and 10.5 percent for Total Capital.

Banking organizations (except for large, internationally active banking organizations) became subject to the new rules on January 1, 2015. However, there are separate phase-in/phase-out periods for: (i) the capital conservation buffer; (ii) regulatory capital adjustments and deductions; (iii) nonqualifying capital instruments; and (iv) changes to the prompt corrective action rules discussed below. The phase-in periods commenced on January 1, 2016 and extend until January 1, 2019.

Well-Capitalized Requirements. The ratios described above are minimum standards in order for banking organizations to be considered “adequately capitalized.” Bank regulatory agencies uniformly encourage banks to hold more capital and be “well-capitalized” and, to that end, federal law and regulations provide various incentives for banking organizations to maintain regulatory capital at levels in excess of minimum regulatory requirements. For example, a banking organization that is well-capitalized may: (i) qualify for exemptions from prior notice or application requirements otherwise applicable to certain types of activities; (ii) qualify for expedited processing of other required notices or applications; and (iii) accept, roll-over or renew brokered deposits. Higher capital levels could also be required if warranted by the particular circumstances or risk profiles of individual banking organizations. For example, the Federal Reserve’s capital guidelines contemplate that additional capital may be required to take adequate account of, among other things, interest rate risk, or the risks posed by concentrations of credit, nontraditional activities or securities trading activities. Further, any banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios, including tangible capital positions (i.e., Tier 1 Capital less all intangible assets), well above the minimum levels.

Under the capital regulations of the FDIC and Federal Reserve, in order to be well-capitalized, a banking organization must maintain:

A Common Equity Tier 1 Capital ratio to risk-weighted assets of 6.5 percent or more;

A ratio of Tier 1 Capital to total risk-weighted assets of 8 percent or more;

A ratio of Total Capital to total risk-weighted assets of 10 percent or more; and

A leverage ratio of Tier 1 Capital to total adjusted average quarterly assets of 5 percent or greater.

It is possible under the Basel III Rule to be well-capitalized while remaining out of compliance with the capital conservation buffer discussed above.

As of December 31, 2016: (i) West Bank was not subject to a directive from the FDIC to increase its capital, and (ii) West Bank was well-capitalized, as defined by FDIC regulations. As of December 31, 2016, the Company had regulatory capital in excess of the Federal Reserve’s requirements and met the fully phased-in Basel III Rule requirements.


10


Prompt Corrective Action. An FDIC-insured institution’s capital plays an important role in connection with regulatory enforcement as well. Federal law provides the federal banking regulators with broad power to take prompt corrective action to resolve the problems of undercapitalized institutions. The extent of the regulators’ powers depends on whether the institution in question is “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized,” in each case as defined by regulation. Depending upon the capital category to which an institution is assigned, the regulators’ corrective powers include: (i) requiring the institution to submit a capital restoration plan; (ii) limiting the institution’s asset growth and restricting its activities; (iii) requiring the institution to issue additional capital stock (including additional voting stock) or to sell itself; (iv) restricting transactions between the institution and its affiliates; (v) restricting the interest rates that the institution may pay on deposits; (vi) ordering a new election of directors of the institution; (vii) requiring that senior executive officers or directors be dismissed; (viii) prohibiting the institution from accepting deposits from correspondent banks; (ix) requiring the institution to divest certain subsidiaries; (x) prohibiting the payment of principal or interest on subordinated debt; and (xi) ultimately, appointing a receiver for the institution.

Regulation and Supervision of the Company

General. The Company, as the sole stockholder of West Bank, is a bank holding company with a financial holding company election in place. As a financial holding company, we are registered with, and subject to regulation by, the Federal Reserve under the BHCA. We are legally obligated to act as a source of financial and managerial strength to West Bank and to commit resources to support West Bank in circumstances where we might not otherwise do so. Under the BHCA, we are subject to periodic examination by the Federal Reserve and are required to file with the Federal Reserve periodic reports of our operations and such additional information regarding us and West Bank as the Federal Reserve may require.

Acquisitions, Activities and Change in Control. The primary purpose of a bank holding company is to control and manage banks. The BHCA generally requires the prior approval of the Federal Reserve for any merger involving a bank holding company or any acquisition by a bank holding company of another bank or bank holding company. Subject to certain conditions (including deposit concentration limits established by the BHCA), the Federal Reserve may allow a bank holding company to acquire banks located in any state of the United States. In approving interstate acquisitions, the Federal Reserve is required to give effect to applicable state law limitations on the aggregate amount of deposits that may be held by the acquiring bank holding company and its FDIC-insured institution affiliates in the state in which the target bank is located (provided that those limits do not discriminate against out-of-state institutions or their holding companies) and state laws that require that the target bank has been in existence for a minimum period of time (not to exceed five years) before being acquired by an out-of-state bank holding company. Furthermore, in accordance with the Dodd-Frank Act, bank holding companies must be well-capitalized and well-managed in order to effect interstate mergers or acquisitions. For a discussion of the capital requirements, see “—Regulatory Emphasis on Capital” above.

The BHCA generally prohibits the Company from acquiring direct or indirect ownership or control of more than five percent of the voting shares of any company that is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to banks and their subsidiaries. This general prohibition is subject to a number of exceptions. The principal exception allows bank holding companies to engage in, and to own shares of companies engaged in, certain businesses found by the Federal Reserve prior to November 11, 1999 to be “so closely related to banking ... as to be a proper incident thereto.” This authority would permit us to engage in a variety of banking-related businesses, including the ownership and operation of a savings association, or any entity engaged in consumer finance, equipment leasing, the operation of a computer service bureau (including software development) and mortgage banking and brokerage services. The BHCA does not place territorial restrictions on the domestic activities of nonbank subsidiaries of bank holding companies.

Additionally, bank holding companies that meet certain eligibility requirements prescribed by the BHCA and elect to be treated as a financial holding companies may engage, or own shares in companies engaged, in a wider range of nonbanking activities, including securities and insurance underwriting and sales, merchant banking and any other activity that the Federal Reserve, in consultation with the Secretary of the Treasury, determines by regulation or order is financial in nature or incidental to any such financial activity or that the Federal Reserve determines by order to be complementary to any such financial activity and does not pose a substantial risk to the safety or soundness of FDIC-insured institutions or the financial system generally. In the third quarter of 2016, we elected to operate as a financial holding company. In order to maintain our status as a financial holding company, both the Company and West Bank must be well-capitalized, well-managed, and have at least a satisfactory Community Reinvestment Act (CRA) rating. If the Federal Reserve determines that we are not well-capitalized or well-managed, we will have a period of time in which to achieve compliance, but during the period of noncompliance, the Federal Reserve may place any limitations on us it believes to be appropriate. Furthermore, if the Federal Reserve determines that West Bank has not received a satisfactory CRA rating, we will not be able to commence any new financial activities or acquire a company that engages in such activities. As of December 31, 2016, we were a financial holding company, but we have not engaged in any activity and did not own any assets for which a financial holding company designation was required. The election affords the ability to respond more quickly to market developments and opportunities.

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Federal law also prohibits any person or company from acquiring “control” of an FDIC-insured depository institution or its holding company without prior notice to the appropriate federal bank regulator. Control is conclusively presumed to exist upon the acquisition of 25 percent or more of the outstanding voting securities of a bank or bank holding company, but may arise under certain circumstances between 10 percent and 24.99 percent ownership.

Capital Requirements. Bank holding companies are required to maintain capital in accordance with Federal Reserve capital adequacy requirements. For a discussion of capital requirements, see “—Regulatory Emphasis on Capital” above.

Dividend Payments. Our ability to pay dividends to our stockholders may be affected by both general corporate law considerations and policies of the Federal Reserve applicable to bank holding companies. As an Iowa corporation, we are subject to the limitations of Iowa law, which allows us to pay dividends unless, after such dividend, (i) we would not be able to pay our debts as they become due in the usual course of business, or (ii) our total assets would be less than the sum of our total liabilities plus any amount that would be needed if we were to be dissolved at the time of the dividend payment, to satisfy the preferential rights upon dissolution of stockholders whose rights are superior to the rights of the stockholders receiving the distribution.

As a general matter, the Federal Reserve has indicated that the board of directors of a bank holding company should eliminate, defer or significantly reduce dividends to stockholders if: (i) the company’s net income available to stockholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; (ii) the prospective rate of earnings retention is inconsistent with the company’s capital needs and overall current and prospective financial condition; or (iii) the company will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. The Federal Reserve also possesses enforcement powers over bank holding companies and their nonbank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends by banks and bank holding companies. In addition, under the Basel III Rule, institutions that seek the freedom to pay dividends will have to maintain 2.5 percent in Common Equity Tier 1 attributable to the capital conservation buffer to be phased in over three years beginning in 2016. See “—Regulatory Emphasis on Capital” above.

Incentive Compensation. There have been a number of developments in recent years focused on incentive compensation plans sponsored by bank holding companies and banks, reflecting recognition by the bank regulatory agencies and Congress that flawed incentive compensation practices in the financial industry were one of many factors contributing to the global financial crisis. Layered on top of that are the abuses in the news headlines dealing with product cross-selling incentive plans. The result is interagency guidance on sound incentive compensation practices and proposed rulemaking by the agencies required under Section 956 of the Dodd-Frank Act.

The interagency guidance recognized three core principles: Effective incentive plans should: (i) provide employees incentives that appropriately balance risk and reward; (ii) be compatible with effective controls and risk-management; and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors. Much of the guidance addresses large banking organizations and, because of the size and complexity of their operations, the regulators expect those organizations to maintain systematic and formalized policies, procedures, and systems for ensuring that the incentive compensation arrangements for all executive and non-executive employees covered by this guidance are identified and reviewed, and appropriately balance risks and rewards.  The incentive compensation arrangements of smaller banking organizations like the Company are expected to be less extensive, formalized, and detailed than those of the larger banks. 

Section 956 of the Dodd-Frank Act required the banking agencies, the National Credit Union Administration, the SEC and the Federal Housing Finance Agency to jointly prescribe regulations that prohibit types of incentive-based compensation that encourage inappropriate risk-taking and to disclose certain information regarding such plans. On June 10, 2016, the agencies released an updated proposed rule for comment. Section 956 will only apply to banking organizations with assets of greater than $1 billion. We have consolidated assets greater than $1 billion and less than $50 billion, and we are considered a Level 3 banking organization under the proposed rules. The proposed rules contain mostly general principles and reporting requirements for Level 3 institutions, so there are no specific prescriptions or limits, deferral requirements or clawback mandates. Risk management and controls are required, as is board or committee level approval and oversight. Management expects to review its incentive plans in light of the proposed rulemaking and guidance to ensure its policies and procedures are in compliance.

Monetary Policy. The monetary policy of the Federal Reserve has a significant effect on the operating results of financial or bank holding companies and their subsidiaries. Among the tools available to the Federal Reserve to affect the money supply are open market transactions in U.S. government securities, changes in the discount rate on bank borrowings and changes in reserve requirements against bank deposits. These means are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits, and their use may affect interest rates charged on loans or paid on deposits.

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Federal Securities Regulation. Our common stock is registered with the SEC under the Exchange Act. Consequently, we are subject to the information, proxy solicitation, insider trading and other restrictions and requirements of the SEC under the Exchange Act.

Corporate Governance. The Dodd-Frank Act addressed many investor protection, corporate governance and executive compensation matters that will affect most U.S. publicly traded companies. The Dodd-Frank Act increased stockholder influence over boards of directors by requiring companies to give stockholders a nonbinding vote on executive compensation and so-called “golden parachute” payments, and authorizing the SEC to promulgate rules that would allow stockholders to nominate and solicit voters for their own candidates using a company’s proxy materials. The legislation also directed the Federal Reserve to promulgate rules prohibiting excessive compensation paid to executives of bank holding companies, regardless of whether such companies are publicly traded.

Regulation and Supervision of West Bank

General. West Bank is an Iowa-chartered bank. The deposit accounts of West Bank are insured by the FDIC’s Deposit Insurance Fund (DIF) to the maximum extent provided under federal law and FDIC regulations, which is $250,000 per insured depositor category. As an Iowa-chartered FDIC-insured bank, West Bank is subject to the examination, supervision, reporting and enforcement requirements of the Iowa Division of Banking, the chartering authority for Iowa banks, and the FDIC, designated by federal law as the primary federal regulator of insured state banks that, like West Bank, are not members of the Federal Reserve System (nonmember banks).

Deposit Insurance. As an FDIC-insured institution, West Bank is required to pay deposit insurance premium assessments to the FDIC.  The FDIC has adopted a risk-based assessment system whereby FDIC-insured institutions pay insurance premiums at rates based on their risk classification. The total base assessment rates currently range from 3 to 30 basis points. At least semi-annually, the FDIC updates its loss and income projections for the DIF and, if needed, increases or decreases the assessment rates, following notice and comment on proposed rulemaking. The assessment base against which an FDIC-insured institution’s deposit insurance premiums paid to the DIF are calculated is based on its average consolidated total assets less its average tangible equity.  This method shifts the burden of deposit insurance premiums toward those large depository institutions that rely on funding sources other than U.S. deposits.

The reserve ratio is the FDIC insurance fund balance divided by estimated insured deposits. The Dodd-Frank Act altered the minimum reserve ratio of the DIF, increasing the minimum from 1.15 percent to 1.35 percent of the estimated amount of total insured deposits, and eliminating the requirement that the FDIC pay dividends to FDIC-insured institutions when the reserve ratio exceeds certain thresholds.  The reserve ratio reached 1.15 percent on June 30, 2016 when revised factors were put in place for calculating the assessment.  If the reserve ratio does not reach 1.35 percent by December 31, 2018 (provided it is at least 1.15 percent), the FDIC will impose a shortfall assessment on March 31, 2019 on insured depository institutions with total consolidated assets of $10 billion or more. The FDIC will provide assessment credits to insured depository institutions, like West Bank, with total consolidated assets of less than $10 billion for the portion of their regular assessments that contribute to growth in the reserve ratio between 1.15 percent and 1.35 percent. The FDIC will apply the credits each quarter that the reserve ratio is at least 1.38 percent to offset the regular deposit insurance assessments of institutions with credits.

FICO Assessments.   In addition to paying basic deposit insurance assessments, FDIC-insured institutions must pay Financing Corporation (FICO) assessments. FICO is a mixed-ownership governmental corporation chartered by the former Federal Home Loan Bank Board pursuant to the Competitive Equality Banking Act of 1987 to function as a financing vehicle for the recapitalization of the former Federal Savings and Loan Insurance Corporation. FICO issued 30-year noncallable bonds of approximately $8.1 billion that mature in 2017 through 2019. FICO’s authority to issue bonds ended on December 12, 1991. Since 1996, federal legislation has required that all FDIC-insured institutions pay assessments to cover interest payments on FICO’s outstanding obligations. The FICO assessment rate is adjusted quarterly and for the fourth quarter of 2016 was 0.56 basis points (56 cents per $100 of assessable deposits).

Supervisory Assessments. All Iowa banks are required to pay supervisory assessments to the Iowa Division of Banking to fund the operations of that agency. The amount of the assessment is calculated on the basis of West Bank’s total assets. During the year ended December 31, 2016, West Bank paid supervisory assessments to the Iowa Division of Banking totaling approximately $110,000.

Capital Requirements. Banks are generally required to maintain capital levels in excess of other businesses. For a discussion of capital requirements, see “—Regulatory Emphasis on Capital” above.


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Liquidity Requirements. Liquidity is a measure of the ability and ease with which bank assets may be converted to cash. Liquid assets are those that can be converted to cash quickly if needed to meet financial obligations. To remain viable, FDIC-insured institutions must have enough liquid assets to meet their near-term obligations, such as withdrawals by depositors. In addition to liquidity guidelines already in place, the U.S. bank regulatory agencies implemented the Basel III Liquidity Coverage Ratios (LCR) in September 2014, which require large financial firms to hold levels of liquid assets sufficient to protect against constraints on their funding during times of financial turmoil. While the LCR only applies to the largest banking organizations in the country, certain elements are expected to filter down to all FDIC-insured institutions.

Stress Testing. A stress test is an analysis or simulation designed to determine the ability of a given FDIC-insured institution to deal with an economic crisis. In October 2012, U.S. bank regulators unveiled new rules mandated by the Dodd-Frank Act that require the largest U.S. banks to undergo stress tests twice per year, once internally and once conducted by the regulators. Stress tests are not required for banks with less than $10 billion in assets; however, the FDIC now recommends stress testing as a means to identify and quantify loan portfolio risk, and West Bank is conducting quarterly commercial real estate portfolio stress testing.

Dividend Payments. The primary source of funds for the Company is dividends from West Bank. Under the Iowa Banking Act, Iowa-chartered banks generally may pay dividends only out of undivided profits. The Iowa Division of Banking may restrict the declaration or payment of a dividend by an Iowa-chartered bank, such as West Bank. The payment of dividends by any FDIC-insured institution is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations, and an FDIC-insured institution generally is prohibited from paying any dividends if, following payment thereof, the institution would be undercapitalized. As described above, West Bank exceeded its capital requirements under applicable guidelines as of December 31, 2016. Notwithstanding the availability of funds for dividends, however, the FDIC and the Iowa Division of Banking may prohibit the payment of dividends by West Bank if either or both determine such payment would constitute an unsafe or unsound practice. In addition, under the Basel III Rule, institutions that seek the freedom to pay dividends will have to maintain 2.5 percent in Common Equity Tier 1 Capital attributable to the capital conservation buffer to be phased in over three years that began in 2016. See “—Regulatory Emphasis on Capital” above.

State Bank Investments and Activities. West Bank is permitted to make investments and engage in activities directly or through subsidiaries as authorized by Iowa law. However, under federal law and FDIC regulations, FDIC-insured state banks are prohibited, subject to certain exceptions, from making or retaining equity investments of a type, or in an amount, that are not permissible for a national bank. Federal law and FDIC regulations also prohibit FDIC-insured state banks and their subsidiaries, subject to certain exceptions, from engaging as principal in any activity that is not permitted for a national bank unless West Bank meets, and continues to meet, its minimum regulatory capital requirements and the FDIC determines that the activity would not pose a significant risk to the DIF. These restrictions have not had, and are not currently expected to have, a material impact on the operations of West Bank.

Insider Transactions. West Bank is subject to certain restrictions imposed by federal law on “covered transactions” between West Bank and its “affiliates.” The Company is an affiliate of West Bank for purposes of these restrictions, and covered transactions subject to the restrictions include extensions of credit to the Company, investments in the stock or other securities of the Company and the acceptance of the stock or other securities of the Company as collateral for loans made by West Bank. The Dodd-Frank Act enhanced the requirements for certain transactions with affiliates, including an expansion of the definition of covered transactions and an increase in the amount of time for which collateral requirements regarding covered transactions must be maintained.

Certain limitations and reporting requirements are also placed on extensions of credit by West Bank to its directors and officers, to directors and officers of the Company and its subsidiaries, to principal stockholders of the Company and to “related interests” of such directors, officers and principal stockholders. In addition, federal law and regulations may affect the terms upon which any person who is a director or officer of the Company or West Bank, or a principal stockholder of the Company, may obtain credit from banks with which West Bank maintains a correspondent relationship.

Safety and Soundness Standards/Risk Management. The federal banking agencies have adopted guidelines that establish operational and managerial standards to promote the safety and soundness of FDIC-insured institutions. The guidelines set forth standards for internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset quality and earnings.


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In general, the safety and soundness guidelines prescribe the goals to be achieved in each area, and each institution is responsible for establishing its own procedures to achieve those goals. If an institution fails to comply with any of the standards set forth in the guidelines, the FDIC-insured institution’s primary federal regulator may require the institution to submit a plan for achieving and maintaining compliance. If an FDIC-insured institution fails to submit an acceptable compliance plan, or fails in any material respect to implement a compliance plan that has been accepted by its primary federal regulator, the regulator is required to issue an order directing the institution to cure the deficiency. Until the deficiency cited in the regulator’s order is cured, the regulator may restrict the FDIC-insured institution’s rate of growth, require the FDIC-insured institution to increase its capital, restrict the rates the institution pays on deposits, or require the institution to take any action the regulator deems appropriate under the circumstances. Noncompliance with the standards established by the safety and soundness guidelines may also constitute grounds for other enforcement action by the federal bank regulatory agencies, including cease and desist orders and civil money penalty assessments.

During the past decade, the bank regulatory agencies have increasingly emphasized the importance of sound risk management processes and strong internal controls when evaluating the activities of the FDIC-insured institutions they supervise. Properly managing risks has been identified as critical to the conduct of safe and sound banking activities and has become even more important as new technologies, product innovation, and the size and speed of financial transactions have changed the nature of banking markets. The agencies have identified a spectrum of risks facing a banking institution including, but not limited to, credit, market, liquidity, operational, legal and reputational risk. In particular, recent regulatory pronouncements have focused on operational risk, which arises from the potential that inadequate information systems, operational problems, breaches in internal controls, fraud or unforeseen catastrophes will result in unexpected losses. New products and services, third-party risk management and cybersecurity are critical sources of operational risk that FDIC-insured institutions are expected to address in the current environment. West Bank is expected to have active Board and senior management oversight; adequate policies, procedures and limits; adequate risk measurement, monitoring and management information systems; and comprehensive internal controls.

Branching Authority. Iowa banks, such as West Bank, have the authority under Iowa law to establish branches anywhere in the State of Iowa, subject to receipt of all required regulatory approvals. Federal law permits state and national banks to merge with banks in other states subject to: (i) regulatory approval; (ii) federal and state deposit concentration limits; and (iii) state law limitations requiring the merging bank to have been in existence for a minimum period of time (not to exceed five years) prior to the merger. The establishment of new interstate branches has historically been permitted only in those states the laws of which expressly authorize such expansion. The Dodd-Frank Act permits well-capitalized and well-managed banks to establish new interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) without impediments.

Transaction Account Reserves. Federal Reserve regulations require FDIC-insured institutions to maintain reserves against their transaction accounts (primarily NOW and regular checking accounts). For 2017, the first $15.5 million of otherwise reservable balances are exempt from reserves and have no reserve requirement; for transaction accounts aggregating more than $15.5 million to $115.1 million, the reserve requirement is 3 percent of total transaction accounts; and for net transaction accounts in excess of $115.1 million, the reserve requirement is 3 percent up to $115.1 million plus 10 percent of the aggregate amount of total transaction accounts in excess of $115.1 million. These reserve requirements are subject to annual adjustment by the Federal Reserve.

Community Reinvestment Act Requirements. The Community Reinvestment Act requires West Bank to have a continuing and affirmative obligation in a safe and sound manner to help meet the credit needs of its entire community, including low- and moderate-income neighborhoods. Federal regulators regularly assess West Bank’s record of meeting the credit needs of its communities. Applications for acquisitions would be affected by the evaluation of West Bank’s effectiveness in meeting its Community Reinvestment Act requirements.

Anti-Money Laundering. The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the Patriot Act) is designed to deny terrorists and criminals the ability to obtain access to the U.S. financial system and has significant implications for FDIC-insured institutions, brokers, dealers and other businesses involved in the transfer of money. The Patriot Act mandates financial services companies to have policies and procedures with respect to measures designed to address any or all of the following matters: (i) customer identification programs; (ii) money laundering; (iii) terrorist financing; (iv) identifying and reporting suspicious activities and currency transactions; (v) currency crimes; and (vi) cooperation between FDIC-insured institutions and law enforcement authorities.


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Concentrations in Commercial Real Estate. Concentration risk exists when FDIC-insured institutions deploy too many assets to any one industry or segment. A concentration in commercial real estate is one example of regulatory concern. The interagency Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices guidance (CRE Guidance) provides supervisory criteria, including the following numerical indicators, to assist bank examiners in identifying banks with potentially significant commercial real estate loan concentrations that may warrant greater supervisory scrutiny: (i) commercial real estate loans exceeding 300 percent of capital and increasing 50 percent or more in the preceding three years or (ii) construction and land development loans exceeding 100 percent of capital. The CRE Guidance does not limit banks’ levels of commercial real estate lending activities, but rather guides institutions in developing risk management practices and levels of capital that are commensurate with the level and nature of their commercial real estate concentrations. On December 18, 2015, the federal banking agencies issued a statement to reinforce prudent risk-management practices related to CRE lending, having observed substantial growth in many CRE asset and lending markets, increased competitive pressures, rising CRE concentrations in banks, and an easing of CRE underwriting standards. The federal bank agencies reminded FDIC-insured institutions to maintain underwriting discipline and exercise prudent risk-management practices to identify, measure, monitor and manage the risks arising from CRE lending. In addition, FDIC-insured institutions must maintain capital commensurate with the level and nature of their CRE concentration risk.

Based on West Bank’s loan portfolio as of December 31, 2016, it exceeded the 300 percent and 100 percent guidelines for commercial real estate loans. Additional monitoring processes have been implemented to manage this increased risk.

Consumer Financial Services. The historical structure of federal consumer protection regulation applicable to all providers of consumer financial products and services changed significantly on July 21, 2011, when the CFPB commenced operations to supervise and enforce consumer protection laws. The CFPB has broad rulemaking authority for a wide range of consumer protection laws that apply to all providers of consumer products and services, including West Bank, as well as the authority to prohibit “unfair, deceptive or abusive” acts and practices. The CFPB has examination and enforcement authority over providers with more than $10 billion in assets. FDIC-insured institutions with $10 billion or less in assets, like West Bank, continue to be examined by their applicable bank regulators.

Because abuses in connection with residential mortgages were a significant factor contributing to the global financial crisis, many new rules issued by the CFPB and required by the Dodd-Frank Act address mortgage and mortgage-related products, their underwriting, origination, servicing and sales. The Dodd-Frank Act significantly expanded underwriting requirements applicable to loans secured by 1-4 family residential real property and augmented federal law combating predatory lending practices. In addition to numerous disclosure requirements, the Dodd-Frank Act imposed new standards for mortgage loan originations on all lenders, including all FDIC-insured institutions, in an effort to strongly encourage lenders to verify a borrower’s "ability to repay," while also establishing a presumption of compliance for certain “qualified mortgages.” In addition, the Dodd-Frank Act generally required lenders or securitizers to retain an economic interest in the credit risk relating to loans that the lender sells, and other asset-backed securities that the securitizer issues, if the loans have not complied with the ability-to-repay standards.

ADDITIONAL INFORMATION

The principal executive offices of the Company are located at 1601 22nd Street, West Des Moines, Iowa 50266. The Company's telephone number is (515) 222-2300, and the internet address is www.westbankstrong.com. Copies of the Company's annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments thereto are available for viewing or downloading free of charge from the Investor Relations section of the Company's website as soon as reasonably practicable after the documents are filed or furnished to the SEC. Copies of the Company's filings with the SEC are also available from the SEC's website (www.sec.gov) free of charge.


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ITEM 1A.  RISK FACTORS

West Bancorporation's business is conducted almost exclusively through West Bank.  West Bancorporation and West Bank are subject to many of the common risks that challenge publicly traded, regulated financial institutions.   An investment in West Bancorporation's common stock is also subject to the following specific risks.

Risks Related to West Bancorporation's Business

We must effectively manage the credit risks of our loan portfolio.

The largest component of West Bank's income is interest received on loans. Our business depends on the creditworthiness of our customers. There are obvious risks inherent in making loans. We attempt to reduce our credit risk through prudent loan application, underwriting and approval procedures, including internal loan reviews before and after proceeds have been disbursed, careful monitoring of the concentration of our loans within specific industries, and collateral and guarantee requirements. These procedures cannot, however, be expected to completely eliminate our credit risks, and we can make no guarantees concerning the strength of our loan portfolio.

Our loan portfolio primarily includes commercial loans, which involve risks specific to commercial borrowers.

West Bank’s loan portfolio includes a significant amount of commercial real estate loans, construction and land development loans, commercial lines of credit and commercial term loans. West Bank's typical commercial borrower is a small- or medium-sized, privately owned Iowa or Minnesota business entity. Our commercial loans typically have greater credit risks than standard residential mortgage or consumer loans because commercial loans often have larger balances, and repayment usually depends on the borrowers' successful business operations. Commercial loans also involve some additional risk because they generally are not fully repaid over the loan period and thus may require refinancing or a large payoff at maturity. If the general economy turns downward, commercial borrowers may not be able to repay their loans, and the value of their assets, which are usually pledged as collateral, may decrease rapidly and significantly. Also, when credit markets tighten due to adverse developments in specific markets or the general economy, opportunities for refinancing may become more expensive or unavailable, resulting in loan defaults.

Our loan portfolio includes commercial real estate loans, which involve risks specific to real estate value.

Commercial real estate loans were a significant portion of our total loan portfolio as of December 31, 2016. The market value of real estate can fluctuate significantly in a short period of time as a result of market conditions in the geographic area in which the real estate is located. Adverse developments affecting real estate values in one or more of our markets could increase the credit risk associated with our loan portfolio. Additionally, real estate lending typically involves higher loan principal amounts, and repayment of the loans is generally dependent, in large part, on sufficient income from the properties securing the loans to cover operating expenses and debt service. Economic events or governmental regulations outside of the control of the borrower or lender could negatively impact the future cash flow and market values of the affected properties.

If the loans that are collateralized by real estate become troubled and the value of the real estate has been significantly impaired, then we may not be able to recover the full contractual amount of principal and interest that we anticipated at the time of originating the loans, which could cause us to charge off all or a portion of the loans. This could lead to an increased provision for loan losses and adversely affect our operating results and financial condition.


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The level of our commercial real estate loan portfolio may subject us to additional regulatory scrutiny.

The federal banking regulators have promulgated joint guidance on sound risk management practices for financial institutions with concentrations in commercial real estate lending. Under this guidance, a financial institution that, like West Bank, is actively involved in commercial real estate lending should perform a risk assessment to identify concentrations. A financial institution may have a concentration in commercial real estate lending if, among other factors (i) total reported loans for construction, land development, and other land represent 100 percent or more of total capital, or (ii) total reported loans secured by multifamily and non-farm residential properties, loans for construction, land development and other land, and loans otherwise sensitive to the general commercial real estate market, including loans to commercial real estate related entities, represent 300 percent or more of total capital. Based on these criteria, West Bank had concentrations of 109 percent and 417 percent, respectively, as of December 31, 2016. The purpose of the guidance is to assist banks in developing risk management practices and capital levels commensurate with the level and nature of commercial real estate concentrations. The guidance states that management should employ heightened risk management practices, including board and management oversight, strategic planning, development of underwriting standards, and risk assessment and monitoring through market analysis and stress testing. West Bank believes that its current risk management processes adequately address the regulatory guidance; however, there can be no guarantee of the effectiveness of the risk management processes on an ongoing basis.

We are subject to environmental liability risk associated with real estate collateral securing our loans.

A significant portion of our loan portfolio is secured by real property. Under certain circumstances, we may take title to the real property collateral through foreclosure or other means. As the titleholder of the property, we may be responsible for environmental risks, such as hazardous materials, which attach to the property. For these reasons, prior to extending credit, we have an environmental risk assessment program to identify any known environmental risks associated with the real property that will secure our loans. In addition, we routinely inspect properties following the taking of title. When environmental risks are found, environmental laws and regulations may prescribe our approach to remediation. As a result, while we have ownership of a property, we may incur substantial expense and bear potential liability for any damages caused. The environmental risks may also materially reduce the property's value or limit our ability to use or sell the property. We also cannot guarantee that our environmental risk assessment will detect all environmental issues relating to a property, which could subject us to additional liability.

Our allowance for loan losses may be insufficient to absorb potential losses in our loan portfolio.

We maintain an allowance for loan losses at a level we believe adequate to absorb probable losses inherent in our existing loan portfolio. The level of the allowance reflects management’s continuing evaluation of industry concentrations; specific credit risks; credit loss experience; current loan portfolio quality; present economic, political and regulatory conditions; and unidentified losses inherent in the current loan portfolio.

Determination of the allowance is inherently subjective as it requires significant estimates and management’s judgment of credit risks and future trends, all of which may undergo material changes.  Deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically review our allowance and may require an increase in the provision for loan losses or the recognition of additional loan charge-offs, based on judgments different from those of management. Also, if charge-offs in future periods exceed the allowance for loan losses, we will need additional provisions to increase the allowance. Any increases in provisions will result in a decrease in net income and capital and may have a material adverse effect on our financial condition and results of operations.

Our accounting policies and methods are the basis for how we report our financial condition and results of operations, and they may require management to make estimates about matters that are inherently uncertain.

Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. Our management must exercise judgment in selecting and applying many of these accounting policies and methods in order to ensure they comply with U.S. Generally Accepted Accounting Principles (GAAP) and reflect management's judgment as to the most appropriate manner in which to record and report our financial condition and results of operations. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which might be reasonable under the circumstances. The application of that chosen accounting policy or method might result in us reporting different amounts than would have been reported under a different alternative. If management's estimates or assumptions are incorrect, the Company may experience a material loss.


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From time to time, the Financial Accounting Standards Board (FASB) and the SEC change the financial accounting and reporting standards or the interpretation of those standards that govern the preparation of our financial statements.  These changes are beyond our control, can be difficult to predict and could have a materially adverse impact on our financial condition and results of operations.

A new accounting standard could require us to increase our allowance for loan losses and may have a material adverse effect on our financial condition and results of operations.

The FASB has issued a new accounting standard that will be effective for the Company for the fiscal year beginning January 1, 2020. This standard, referred to as Current Expected Credit Loss, or CECL, will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans, and recognize the expected credit losses as allowances for loan losses. This will change the current method of providing for loan losses that are probable, and will likely require us to increase our allowance for loan losses and to greatly increase the types of data we will need to collect and analyze to determine the appropriate level of the allowance for loan losses. Any increase in our allowance for loan losses or expenses incurred to determine the appropriate level of the allowance for loan losses will result in a decrease in net income and capital and may have a material adverse impact on our financial condition and results of operations. Moreover, the CECL model may create more volatility in our level of allowance for loan losses and could result in the need for additional capital.

If a significant portion of any future unrealized losses in our portfolio of investment securities were to become other than temporarily impaired with credit losses, we would recognize a material charge to our earnings, and our capital ratios would be adversely impacted.

Factors beyond our control can significantly influence the fair value of securities in our portfolio and can cause potential adverse changes to the fair value of those securities. These factors include, but are not limited to, changes in interest rates, rating agency downgrades of the securities, defaults by the issuer or individual mortgagors with respect to the underlying securities, and instability in the credit markets. Any of the foregoing factors could cause an other than temporary impairment (OTTI) in future periods and result in realized losses.

We analyze our investment securities quarterly to determine whether, in the opinion of management, any of the securities have OTTI. To the extent that any portion of the unrealized losses in our portfolio of investment securities is determined to have OTTI and is credit-loss related, we will recognize a charge to our earnings in the quarter during which such determination is made, and our capital ratios will be adversely impacted. Generally, a fixed income security is determined to have OTTI when it appears unlikely that we will receive all the principal and interest due in accordance with the original terms of the investment. In addition to credit losses, losses are recognized for a security with an unrealized loss if the Company has the intent to sell the security or if it is more likely than not that the Company will be required to sell the security before collection of the principal amount.

We are subject to liquidity risks.

West Bank maintains liquidity primarily through customer deposits and other short-term funding sources, including advances from the Federal Home Loan Bank (FHLB) and purchased federal funds. If economic influences change so that we do not have access to short-term credit, or our depositors withdraw a substantial amount of their funds for other uses, West Bank might experience liquidity issues. Our efforts to monitor and manage liquidity risk may not be successful or sufficient to deal with dramatic or unanticipated reductions in our liquidity. If this were to occur and additional debt is needed for liquidity purposes in the future, there can be no assurance that such debt would be available or, if available, would be on favorable terms. In such events, our cost of funds may increase, thereby reducing our net interest income, or we may need to sell a portion of our investment portfolio, which, depending upon market conditions, could result in the Company or West Bank realizing losses. Although we believe West Bank's current sources of funds are adequate for its liquidity needs, there can be no assurance in this regard for the future.

The competition for banking and financial services in our market areas is high, which could adversely affect our financial condition and results of operations.

We operate in highly competitive markets and face strong competition in originating loans, seeking deposits and offering our other services. We compete in making loans, attracting deposits, and recruiting and retaining talented employees. The Des Moines metropolitan market area, in particular, has attracted many new financial institutions within the last two decades. We also compete with nonbank financial service providers, many of which are not subject to the same regulatory restrictions that we are and may be able to compete more effectively as a result.


19


Customer loyalty can be influenced by a competitor's new products, especially if those offerings are priced lower than our products. Some of our competitors may also be better able to attract customers because they provide products and services over a larger geographic area than we serve. This competitive climate can make it more difficult to establish and maintain relationships with new and existing customers, can lower the rate that we are able to charge on loans, and can affect our charges for other services. Our growth and profitability depend on our continued ability to compete effectively within our market, and our inability to do so could have a material adverse effect on our financial condition and results of operations.

Technology and other changes are allowing customers to complete financial transactions using nonbanks that historically have involved banks at one or both ends of the transaction. For example, customers can now pay bills and transfer funds directly without going through a bank. The process of eliminating banks as intermediaries, known as disintermediation, could result in the loss of fee income as well as the loss of customer deposits.

Loss of customer deposits due to increased competition could increase our funding costs.

We rely on bank deposits to be a low cost and stable source of funding. We compete with banks and other financial services companies for deposits. If our competitors raise the rates they pay on deposits, our funding costs may increase, either because we raise our rates to avoid losing deposits or because we lose deposits and must rely on more expensive sources of funding.  Higher funding costs could reduce our net interest margin and net interest income and could have a material adverse effect on our financial condition and results of operations.
Systems failures, interruptions or breaches of security could have an adverse effect on our financial condition and results of operations.
We are subject to certain operational risks, including, but not limited to, data processing system failures and errors, inadequate or failed internal processes, customer or employee fraud, and catastrophic failures resulting from terrorist acts or natural disasters. We depend upon data processing, software, communication and information exchange on a variety of computing platforms and networks and over the internet, and we rely on the services of a variety of vendors to meet our data processing and communication needs. Despite instituted safeguards, we cannot be certain that all of our systems are entirely free from vulnerability to attack or other technological difficulties or failures. Information security risks have increased significantly due to the use of online, telephone and mobile banking channels by clients and the increased sophistication and activities of organized crime, hackers, terrorists and other external parties. Our technologies, systems, networks and our clients’ devices have been subject to, and are likely to continue to be the target of, cyber-attacks, computer viruses, malicious code, phishing attacks or information security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of our or our clients’ confidential, proprietary and other information, the theft of client assets through fraudulent transactions or disruption of our or our clients’ or other third parties’ business operations. If information security is breached or other technology difficulties or failures occur, information may be lost or misappropriated, services and operations may be interrupted, and we could be exposed to claims from customers. While we maintain a system of internal controls and information security procedures, any of these results could have a material adverse effect on our business, financial condition, results of operations or liquidity.

Failure to maintain effective internal controls over financial reporting could impair our ability to accurately and timely report our financial results and could increase the risk of fraud.

Effective internal controls over financial reporting are necessary to provide reliable financial reports and prevent fraud. Management believes that our internal controls over financial reporting are currently effective. While management will continue to assess our controls and procedures and take immediate action to remediate any future perceived issues, there can be no guarantee of the effectiveness of these controls and procedures on an ongoing basis. Any failure to maintain an effective internal control environment could impact our ability to report our financial results on an accurate and timely basis, which could result in regulatory actions, loss of investor confidence, and an adverse impact on our business operations and stock price.

West Bank and West Bancorporation’s operations rely on third-party service providers and vendors.

The Company utilizes a number of third-party service providers and vendors to provide products and services necessary to maintain our day-to-day operations. The Company is exposed to the risk that such vendors fail to perform under these arrangements. This could result in disruption of the Company’s business and have a material adverse impact on our results of operations and financial condition. There can be no assurance that the Company’s policies and procedures designed to monitor and mitigate vendor risks will be effective in preventing or limiting the effect of vendor nonperformance.


20


Damage to our reputation could adversely affect our business.

Our business depends upon earning and maintaining the trust and confidence of our customers, stockholders and employees. Damage to our reputation could cause significant harm to our business. Harm to our reputation can arise from numerous sources, including employee misconduct, vendor nonperformance, cybersecurity breaches, compliance failures, litigation or governmental investigations, among other things. In addition, a failure to deliver appropriate standards of service, or a failure or perceived failure to treat customers and clients fairly, can result in customer dissatisfaction, litigation, and heightened regulatory scrutiny, all of which can lead to lost revenue, higher operating costs and harm to our reputation. Adverse publicity about West Bank, whether or not true, may also result in harm to our business. Should any events or circumstances that could undermine our reputation occur, there can be no assurance that any lost revenue from customers opting to move their business to another institution and the additional costs and expenses that we may incur in addressing such issues would not adversely affect our financial condition and results of operations.

We are subject to various legal claims and litigation.

We are periodically involved in routine litigation incidental to our business. Regardless of whether these claims and legal actions are founded or unfounded, if such legal actions are not resolved in a manner favorable to us, they may result in significant financial liability and/or adversely affect the Company’s reputation. In addition, litigation can be costly. Any financial liability, litigation costs or reputational damage caused by these legal claims could have a material adverse impact on our business, financial condition and results of operations.

The soundness of other financial institutions could adversely affect us.

Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks and other institutional clients. Many of these transactions expose us to credit risk in the event of default by our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure due us. There is no assurance that any such losses would not materially and adversely affect our results of operations or earnings.

We may experience difficulties in managing our growth.

In the future, we may decide to expand into additional communities or attempt to strengthen our position in our current markets through opportunistic acquisitions of all or part of other financial institutions or related businesses that we believe provide a strategic fit with our business, or by opening new branches or loan production offices. To the extent that we undertake acquisitions or new office openings, we are likely to experience the effects of higher operating expense relative to operating income from the new operations, which may have an adverse effect on our overall levels of reported net income, return on average equity and return on average assets. Other effects of engaging in such growth strategies may include potential diversion of our management's time and attention and general disruption to our business.

To the extent that we grow through acquisitions or office openings, we cannot provide assurance that we will be able to adequately or profitably manage such growth. Acquiring other banks and businesses will involve risks similar to those commonly associated with new office openings, but may also involve additional risks. These additional risks include potential exposure to unknown or contingent liabilities of banks and businesses we acquire, exposure to potential asset quality issues of the acquired bank or related business, difficulty and expense of integrating the operations and personnel of banks and businesses we acquire, and the possible loss of key employees and customers of the banks and businesses we acquire.

Maintaining or increasing our market share may depend on lowering prices and the adoption of new products and services.

Our success depends, in part, on our ability to adapt our products and services to evolving industry standards. There is increased pressure to provide products and services at lower prices. Lower prices can reduce our net interest margin and revenues from our fee-based products and services. In addition, the widespread adoption of new technologies could require us to make substantial expenditures to modify or adapt our existing products and services. Also, these and other capital investments in our business may not produce expected growth in earnings anticipated at the time of the expenditure. We may not be successful in introducing new products and services, achieving market acceptance of our products and services, or developing and maintaining loyal customers.


21


The loss of the services of any of our senior executive officers or key personnel could cause our business to suffer.

Much of our success is due to our ability to attract and retain senior management and key personnel experienced in bank and financial services who are very involved in the communities we currently serve. Our continued success depends to a significant extent upon the continued services of relatively few individuals. In addition, our success depends in significant part upon our senior management's ability to develop and implement our business strategies. The loss of services of a few of our senior executive officers or key personnel, or the inability to recruit and retain qualified personnel in the future, could have an adverse effect on our business, financial condition or results of operations, at least in the short term.

Risks Related to the Banking Industry in General and Community Banking in Particular

We may be materially and adversely affected by the highly regulated environment in which we operate.

We are subject to extensive federal and state regulation, supervision and examination. A more detailed description of the primary federal and state banking laws and regulations that affect us is contained in Item 1 of this Form 10-K in the section captioned “Supervision and Regulation.” Banking regulations are primarily intended to protect depositors’ funds, FDIC funds, customers and the banking system as a whole, rather than our stockholders.  These regulations affect our lending practices, capital structure, investment practices, dividend policy and growth, among other things.

As a financial holding company, we are subject to extensive regulation and supervision and undergo periodic examinations by our regulators, who have extensive discretion and authority to prevent or remedy unsafe or unsound practices or violations of law by banks and financial holding companies.  Failure to comply with applicable laws, regulations or policies could result in sanctions by regulatory agencies, civil monetary penalties and/or damage to our reputation, which could have a material adverse effect on us.  Although we have policies and procedures designed to mitigate the risk of any such violations, there can be no assurance that such violations will not occur.

Current or proposed regulatory or legislative changes to laws applicable to the financial industry may impact the profitability of our business activities and may change certain of our business practices, including our ability to offer new products, obtain financing, attract deposits, make loans and achieve satisfactory interest spreads, and could expose us to additional costs, including increased compliance costs. These changes also may require us to invest significant management attention and resources to make any necessary changes to operations in order to comply and could therefore also materially and adversely affect our business, financial condition and results of operations.

While it is anticipated that the new presidential administration will not increase the regulatory burdens on community banks and may reduce some of the burdens associated with the implementation of the Dodd-Frank Act, the actual impact of the new administration is impossible to predict with any certainty at this time.

Our business is subject to domestic and, to a lesser extent, international economic conditions and other factors, many of which are beyond our control and could materially and adversely affect us.

Our financial performance generally, and in particular the ability of customers to pay interest on and repay principal on outstanding loans and the value of collateral securing those loans, as well as demand for loans and other products and services we offer, is highly dependent upon the business environment, not only in the markets where we operate, but also in the states of Iowa and Minnesota, generally, in the United States as a whole, and internationally. A favorable business environment is generally characterized by, among other factors, economic growth, efficient capital markets, low inflation, low unemployment, high business and investor confidence, and strong business earnings. Unfavorable or uncertain economic and market conditions can be caused by declines in economic growth, business activity, or investor or business confidence; limitations on the availability or increases in the cost of credit and capital; increases in inflation or interest rates; high unemployment; natural disasters; or a combination of these or other factors.

While economic conditions in our markets, the states of Iowa and Minnesota and the United States have generally improved since the recession, there can be no assurance that this improvement will continue or occur at a meaningful rate. A return of recessionary conditions and/or continued negative developments in the domestic and international credit markets may significantly affect the markets in which we do business, the value of our loans and investments, and our ongoing operations, costs and profitability. Such conditions could materially and adversely affect us.


22


Monetary policies and regulations of the Federal Reserve could adversely affect our business, financial condition and results of operations.

In addition to being affected by general economic conditions, our earnings and growth are affected by the policies of the Federal Reserve. An important function of the Federal Reserve is to regulate the money supply and credit conditions. Among the instruments used by the Federal Reserve to implement these objectives are open market operations in U.S. government securities, adjustments of the discount rate, and changes in reserve requirements against bank deposits. These instruments are used in varying combinations to influence overall economic growth and the distribution of credit, bank loans, investments and deposits. Their use also affects interest rates charged on loans or paid on deposits.

The monetary policies and regulations of the Federal Reserve have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. The specific effects of such policies upon our business, financial condition and results of operations cannot be predicted.

Changes in interest rates could negatively impact our financial condition and results of operations.

Earnings in the banking industry, particularly the community bank segment, are substantially dependent on net interest income, which is the difference between interest earned on interest-earning assets (investments and loans) and interest paid on interest-bearing liabilities (deposits and borrowings). Interest rates are sensitive to many factors, including government monetary and fiscal policies and domestic and international economic and political conditions. During the last several years, interest rates have been at historically low levels. Near the end of 2015, the Federal Reserve raised the target federal funds rate range from 0 percent to 0.25 percent to a range of 0.25 percent to 0.50 percent. Near the end of 2016, the Federal Reserve again raised the target federal funds rate range from 0.25 percent to 0.50 percent to a range of 0.50 percent to 0.75 percent and has indicated that it will consider additional increases in 2017. If interest rates continue to increase, banks will experience competitive pressures to increase rates paid on deposits. Depending on competitive pressures, such deposit rate increases may increase faster than rates received on loans, which may reduce net interest income during the transition periods. Changes in interest rates could also influence our ability to originate loans and obtain deposits, the fair value of our financial assets and liabilities, and the average duration of our securities portfolio. Community banks, such as West Bank, rely more heavily than larger institutions on net interest income as a revenue source. Larger institutions generally have more diversified sources of noninterest income. See Item 7A of this Form 10-K for a discussion of the Company's interest rate risk management.

Technology is changing rapidly and may put us at a competitive disadvantage.

The banking industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. Effective use of technology increases efficiency and enables banks to better serve customers. Our future success depends, in part, on our ability to effectively implement new technology. Many of our larger competitors have substantially greater resources than we do to invest in technological improvements. As a result, they may be able to offer, or more quickly offer, additional or superior products that could put West Bank at a competitive disadvantage.

Risks Related to West Bancorporation's Common Stock

Our stock is relatively thinly traded.

Although our common stock is traded on the Nasdaq Global Select Market, the average daily trading volume of our common stock is relatively small compared to many public companies. The desired market characteristics of depth, liquidity, and orderliness require the substantial presence of willing buyers and sellers in the marketplace at any given time. In our case, this presence depends on the individual decisions of a relatively small number of investors and general economic and market conditions over which we have no control. Due to the relatively small trading volume of our common stock, significant sales of our common stock, or the expectation of these sales, could cause the stock price to fall more than would be justified by the inherent worth of the Company. Conversely, attempts to purchase a significant amount of our stock could cause the market price to rise above the reasonable inherent worth of the Company.


23


The stock market can be volatile, and fluctuations in our operating results and other factors could cause our stock price to decline.

The stock market has experienced, and may continue to experience, fluctuations that significantly impact the market prices of securities issued by many companies. Market fluctuations could adversely affect our stock price. These fluctuations have often been unrelated or disproportionate to the operating performance of particular companies. These broad market fluctuations, as well as general economic, systemic, political and market conditions, such as recessions, loss of investor confidence, interest rate changes, or international currency fluctuations, may negatively affect the market price of our common stock. Moreover, our operating results may fluctuate and vary from period to period due to the risk factors set forth herein. As a result, period-to-period comparisons should not be relied upon as an indication of future performance. Our stock price could fluctuate significantly in response to the impact these risk factors have on our operating results or financial position.

Issuing additional common or preferred stock may adversely affect the market price of our common stock, and capital may not be available when needed.

The Company may issue additional shares of common or preferred stock in order to raise capital at some date in the future to support continued growth, either internally generated or through an acquisition. Common shares have been and will be issued through the Company's 2012 Equity Incentive Plan as grants of restricted stock units vest, and may be issued through the Company's 2017 Equity Incentive Plan, subject to the future approval of such plan by the Company's stockholders. As additional shares of common or preferred stock are issued, the ownership interests of our existing stockholders may be diluted. The market price of our common stock might decline or fail to increase in response to issuing additional common or preferred stock. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside of our control. Accordingly, we cannot provide any assurance that we will be able to raise additional capital, if needed, at acceptable terms.

The holders of our junior subordinated debentures have rights that are senior to those of our common stockholders.

As of December 31, 2016, the Company had $20.6 million in junior subordinated debentures outstanding that were issued to the Company's subsidiary trust, West Bancorporation Capital Trust I. The junior subordinated debentures are senior to the Company's shares of common stock. As a result, the Company must make payments on the junior subordinated debentures (and the related trust preferred securities (TPS)) before any dividends can be paid on its common stock, and, in the event of the Company's bankruptcy, dissolution or liquidation, the holders of the debentures must be satisfied before any distributions can be made to the holders of the common stock. The Company has the right to defer distributions on the junior subordinated debentures (and the related TPS) for up to five years during which time no dividends may be paid to holders of the Company's common stock. The Company's ability to pay future distributions depends upon the earnings of West Bank and the issuance of dividends from West Bank to the Company, which may be inadequate to service the obligations. Interest payments on the junior subordinated debentures underlying the TPS are classified as a “dividend” by the Federal Reserve supervisory policies and therefore are subject to applicable restrictions and approvals imposed by the Federal Reserve Board.

There can be no assurances concerning continuing dividend payments.

Our common stockholders are only entitled to receive the dividends declared by our Board of Directors. Although we have historically paid quarterly dividends on our common stock, there can be no assurances that we will be able to continue to pay regular quarterly dividends or that any dividends we do declare will be in any particular amount. The primary source of money to pay our dividends comes from dividends paid to the Company by West Bank. West Bank's ability to pay dividends to the Company is subject to, among other things, its earnings, financial condition and applicable regulations, which in some instances limit the amount that may be paid as dividends.


24


We are required to maintain capital to meet regulatory requirements, and if we fail to maintain sufficient capital, whether due to an inability to raise capital, operational losses, or otherwise, our financial condition, liquidity and results of operations, as well as our ability to maintain regulatory compliance, could be adversely affected.

The Company and West Bank are required by federal and state regulatory authorities to maintain adequate levels of capital to support their operations, which increased on January 1, 2015, with the implementation of the Basel III Rule. The ability to raise additional capital, when and if needed, will depend on conditions in the capital markets, economic conditions, and a number of other factors, including investor perceptions regarding the banking industry and market conditions, and governmental activities, many of which are outside of our control, as well as on our financial condition and performance. Accordingly, we cannot provide assurance that we will be able to raise additional capital, if needed, or on terms acceptable to us. Failure to meet these capital and other regulatory requirements could affect customer confidence, our ability to grow, the costs of funds, FDIC insurance costs, the ability to pay dividends on common stock and to make distributions on the junior subordinated debentures, the ability to make acquisitions, the ability to make certain discretionary bonus payments to executive officers, and the results of operations and financial condition.

ITEM 1B.  UNRESOLVED STAFF COMMENTS

There are no unresolved comments from the SEC staff.


ITEM 2.  PROPERTIES

The Company is located in the main office building of West Bank, at 1601 22nd Street in West Des Moines, Iowa.  The headquarters location is leased.  West Bank pays annual rent of approximately $469,000 for its headquarters, including a full-service bank location that includes drive-up facilities, one automated teller machine and one integrated teller machine.  In addition to its main office and headquarters, as of December 31, 2016, West Bank also leased bank buildings and space for six other branch offices in the Des Moines, Iowa, metropolitan area and for operational departments.  Three offices are full-service locations with drive-up facilities and an automated teller machine.  The other three offices were converted to drive-up only, express locations during 2016 and offer drive-up services and an automated teller machine. Annual lease payments for these six offices and the space for operational departments total approximately $923,000.  The Company owns four full-service banking locations in Iowa City, Coralville and Waukee, Iowa, and Rochester, Minnesota. We believe each of our facilities is adequate to meet our needs.
ITEM 3.  LEGAL PROCEEDINGS

Neither the Company nor West Bank is party to any material pending legal proceedings, other than ordinary litigation incidental to West Bank's business, and no property of these entities is the subject of any such proceeding.  The Company does not know of any proceedings contemplated by a governmental authority against the Company or West Bank.

ITEM 4.  MINE SAFETY DISCLOSURES

Not applicable.


25


PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES

West Bancorporation common stock is traded on the Nasdaq Global Select Market under the symbol “WTBA.”   The table below shows the high and low sale prices and cash dividends on common stock declared for each quarter, and the closing price at the end of each quarter, in 2016 and 2015.  The market quotations, reported by Nasdaq, do not include retail markup, markdown or commissions.
Market and Dividend Information
 
 
 
 
 
 
 
 
High
 
Low
 
Close
 
Dividends
2016
 
 
 
 
 
 
 
4th Quarter
$
25.05

 
$
18.75

 
$
24.70

 
$
0.17

3rd Quarter
20.52

 
17.65

 
19.60

 
0.17

2nd Quarter
19.65

 
17.33

 
18.59

 
0.17

1st Quarter
19.58

 
16.04

 
18.23

 
0.16

 
 
 
 
 
 
 
 
2015
 
 
 
 
 
 
 
4th Quarter
$
21.09

 
$
17.74

 
$
19.75

 
$
0.16

3rd Quarter
20.99

 
17.67

 
18.75

 
0.16

2nd Quarter
20.46

 
17.98

 
19.84

 
0.16

1st Quarter
19.94

 
16.00

 
19.89

 
0.14

There were 194 holders of record of the Company's common stock as of February 17, 2017, and an estimated 2,400 additional beneficial holders whose stock was held in street name by brokerages or fiduciaries.  The closing price of the Company's common stock was $23.10 on February 17, 2017.

In the aggregate, cash dividends paid to common stockholders in 2016 and 2015 were $0.67 and $0.62 per common share, respectively.  Dividend declarations are evaluated and determined by the Board of Directors on a quarterly basis, and the dividends are paid quarterly.  The ability of the Company to pay dividends in the future will depend primarily upon the earnings of West Bank and its ability to pay dividends to the Company.

The ability of West Bank to pay dividends is governed by various statutes.  These statutes provide that no bank shall declare or pay any dividends in an amount greater than its retained earnings without approval from governing regulatory bodies.  In addition, applicable bank regulatory authorities have the power to require any bank to suspend the payment of dividends until the bank complies with all requirements that may be imposed by such authorities.

In April 2016, the Company's stock repurchase plan expired and was not renewed by the Board of Directors. No shares had been repurchased during 2016 under this plan, prior to its expiration.


26


The following performance graph provides information regarding the cumulative, five-year return on an indexed basis of the common stock of the Company as compared with the Nasdaq Composite Index and the SNL Midwest Bank Index prepared by S&P Global Market Intelligence. The latter index reflects the performance of bank holding companies operating principally in the Midwest as selected by S&P Global Market Intelligence. The indices assume the investment of $100 on December 31, 2011, in the common stock of the Company, the Nasdaq Composite Index and the SNL Midwest Bank Index, with all dividends reinvested. The Company's common stock price performance shown in the following graph is not indicative of future stock price performance.
WEST BANCORPORATION, INC.
wtba2015123110kcharta01a03.jpg
 
Period Ending
Index
12/31/2011
12/31/2012
12/31/2013
12/31/2014
12/31/2015
12/31/2016
West Bancorporation, Inc.
100.00

116.61

177.09

196.92

236.01

306.14

Nasdaq Composite
100.00

117.45

164.57

188.84

201.98

219.89

SNL Midwest Bank
100.00

120.36

164.78

179.14

181.86

242.99

*Source: S&P Global Market Intelligence.  Used with permission.  All rights reserved.

27


ITEM 6.  SELECTED FINANCIAL DATA
West Bancorporation, Inc. and Subsidiary
 
 
 
 
 
 
 
 
 
 
Selected Financial Data
 
 
 
 
 
 
 
 
 
 
 
 
As of and for the Years Ended December 31
(in thousands, except per share amounts)
 
2016
 
2015
 
2014
 
2013
 
2012
Operating Results
 
 
 
 
 
 
 
 
 
 
Interest income
 
$
64,994

 
$
60,147

 
$
55,301

 
$
52,741

 
$
50,662

Interest expense
 
7,876

 
5,993

 
6,156

 
7,058

 
9,464

Net interest income
 
57,118

 
54,154

 
49,145

 
45,683

 
41,198

Provision for loan losses
 
1,000

 
850

 
750

 
(850
)
 
625

Net interest income after provision for loan losses
 
56,118

 
53,304

 
48,395

 
46,533

 
40,573

Noninterest income
 
7,982

 
8,203

 
10,296

 
8,494

 
10,869

Noninterest expense
 
31,148

 
30,068

 
32,002

 
30,816

 
28,667

Income before income taxes
 
32,952

 
31,439

 
26,689

 
24,211

 
22,775

Income taxes
 
9,936

 
9,697

 
6,649

 
7,320

 
6,764

Net income
 
$
23,016

 
$
21,742

 
$
20,040

 
$
16,891

 
$
16,011

 
 
 
 
 
 
 
 
 
 
 
Dividends and Per Share Data
 
 
 
 
 
 
 
 
 
 
Cash dividends
 
$
10,800

 
$
9,952

 
$
7,842

 
$
6,995

 
$
6,265

Cash dividends per common share
 
0.67

 
0.62

 
0.49

 
0.42

 
0.36

Basic earnings per common share
 
1.43

 
1.35

 
1.25

 
1.02

 
0.92

Diluted earnings per common share
 
1.42

 
1.35

 
1.25

 
1.02

 
0.92

Closing stock price per common share
 
24.70

 
19.75

 
17.02

 
15.82

 
10.78

Book value per common share
 
10.25

 
9.49

 
8.75

 
7.74

 
7.73

Average common shares outstanding
 
16,117

 
16,050

 
16,004

 
16,582

 
17,404

 
 
 
 
 
 
 
 
 
 
 
Year End and Average Balances
 
 
 
 
 
 
 
 
 
 
Total assets
 
$
1,854,204

 
$
1,748,396

 
$
1,615,566

 
$
1,442,111

 
$
1,447,901

Average assets
 
1,806,250

 
1,675,652

 
1,512,506

 
1,445,773

 
1,326,408

Investment securities
 
319,794

 
384,420

 
339,208

 
357,067

 
304,103

Loans
 
1,399,870

 
1,246,688

 
1,184,045

 
991,720

 
927,401

Allowance for loan losses
 
(16,112
)
 
(14,967
)
 
(13,607
)
 
(13,791
)
 
(15,529
)
Deposits
 
1,546,605

 
1,440,729

 
1,270,462

 
1,163,842

 
1,134,576

Long-term borrowings
 
125,410

 
127,175

 
129,916

 
131,653

 
114,235

Stockholders' equity
 
165,376

 
152,377

 
140,175

 
123,625

 
134,587

Average stockholders' equity
 
160,420

 
146,089

 
131,924

 
127,789

 
129,795

 
 
 
 
 
 
 
 
 
 
 
Performance Ratios
 
 
 
 
 
 
 
 
 
 
Average equity to average assets ratio
 
8.88
%
 
8.72
%
 
8.72
%
 
8.84
%
 
9.79
%
Return on average assets
 
1.27
%
 
1.30
%
 
1.32
%
 
1.17
%
 
1.21
%
Return on average equity
 
14.35
%
 
14.88
%
 
15.19
%
 
13.22
%
 
12.34
%
Efficiency ratio*
 
46.03
%
 
46.30
%
 
49.93
%
 
52.55
%
 
50.83
%
Texas ratio*
 
0.56
%
 
0.87
%
 
2.71
%
 
7.69
%
 
11.25
%
Net interest margin
 
3.49
%
 
3.59
%
 
3.59
%
 
3.48
%
 
3.42
%
Dividend payout ratio
 
46.92
%
 
45.77
%
 
39.13
%
 
41.41
%
 
39.13
%
Dividend yield
 
2.71
%
 
3.14
%
 
2.88
%
 
2.65
%
 
3.34
%
Definition of ratios:
Average equity to average assets ratio - average equity divided by average assets.
Return on average assets - net income divided by average assets.
Return on average equity - net income divided by average equity.
Efficiency ratio - noninterest expense (excluding other real estate owned expense) divided by noninterest income (excluding net securities gains, net impairment losses and gains/losses on disposition of premises and equipment) plus tax-equivalent net interest income.
Texas ratio - total nonperforming assets divided by tangible common equity plus the allowance for loan losses.
Net interest margin - tax-equivalent net interest income divided by average interest-earning assets.
Dividend payout ratio - dividends paid to common stockholders divided by net income.
Dividend yield - dividends per share paid to common stockholders divided by closing year-end stock price.

* A lower ratio is better.

28


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 2016 net income was $23,016 compared to $21,742 in 2015, an increase of 5.9 percent. Annual earnings for 2016 represented the highest annual earnings in the 123-year history of the Company. Basic and diluted earnings per common share for 2016 improved to $1.43 and $1.42, respectively, from $1.35 and $1.35, respectively, in 2015. During 2016, we paid our common stockholders $10,800 ($0.67 per common share) in dividends compared to $9,952 ($0.62 per common share) in 2015. The dividend declared and paid in the first quarter of 2017 was $0.17 per common share, the same amount as paid in the fourth quarter of 2016.

The increase in 2016 net income compared to 2015 was primarily due to a $2,964, or 5.5 percent, increase in net interest income. The growth in net interest income was primarily the result of strong loan growth. The Company also recognized tax-exempt gain from bank-owned life insurance of $443 in 2016 due to the losses of a colleague and a former employee. Our 2016 results were also impacted by a $150 increase in the provision for loan losses compared to 2015. Additionally, noninterest expense grew by 3.6 percent between 2016 and 2015.

Our loan portfolio grew to $1,399,870 as of December 31, 2016, from $1,246,688 at the end of 2015. Deposits increased to $1,546,605 as of December 31, 2016, from $1,440,729 as of December 31, 2015. The growth in both was the result of our bankers working with existing customers to provide them with additional products and services, as well as business development efforts targeted at new clients. Our loan portfolio continues to have a high level of credit quality. As indicated by the year-end Texas ratio, nonperforming assets declined further in 2016 compared to 2015. As shown in the table below, our ratio was significantly better than that of any financial instituion in our defined peer group.

The Company has a quantitative peer analysis program in place for evaluating our results. The group of 16 Midwestern, publicly traded, peer financial institutions against which we compared our performance consisted of BankFinancial Corporation, Farmers Capital Bank Corporation, First Business Financial Services, Inc., First Defiance Financial Corp., First Mid-Illinois Bancshares, Inc., Hills Bancorporation, Horizon Bancorp, Isabella Bank Corporation, Mercantile Bank Corporation, MidWestOne Financial Group, Inc., MutualFirst Financial, Inc., Nicolet Bankshares, Inc., Peoples Bancorp, QCR Holdings, Inc., Southwest Bancorp and Waterstone Financial, Inc. The members of the peer group are selected based on their business focus, scope and location of operations, size and other considerations. The Company is in the middle of the group in terms of asset size. The group is periodically reviewed, with changes made primarily to reflect merger and acquisition activity. Our goal is to perform at or near the top of these peers relative to what we consider to be four key metrics: return on average assets (ROA), return on average equity (ROE), efficiency ratio and Texas ratio. We believe these measures encompass the factors that define the performance of a community bank. When contrasted with the peer group's metrics for the nine months ended September 30, 2016 (latest data available), the Company's metrics for the year ended December 31, 2016 were better than those of each company in the peer group as shown in the table below, except for two peers that had a higher ROA. We expect that trend to have continued through the end of 2016.
 
West Bancorporation, Inc.
 
Peer Group Range
 
Year ended December 31, 2016
 
Nine months ended September 30, 2016
Return on average assets
1.27%
 
0.46% - 1.45%
Return on average equity
14.35%
 
3.34% - 10.49%
Efficiency ratio*
46.03%
 
54.50% - 75.30%
Texas ratio*
0.56%
 
4.02% - 22.98%
   * A lower ratio is better.
 
 
 

Based on Nasdaq market quotations of our closing stock prices, our stock price increased approximately 25.0 percent from the end of 2015 to the end of 2016. Our earnings outlook is positive, and we have strong capital resources. We anticipate the Company will be profitable in 2017 at a level that compares favorably with our peers. The amount of our future profit will depend, in large part, on our ability to continue to grow the loan portfolio, the amount of loan losses we incur, fluctuations in market interest rates and the strength of the local and national economy.


29

(dollars in thousands, except per share amounts)



The following discussion describes the consolidated operations and financial condition of the Company, including West Bank and West Bank's wholly-owned subsidiary WB Funding Corporation (which owned an interest in a limited liability company that was sold in the fourth quarter of 2015). Results of operations for the year ended December 31, 2016 are compared to the results for the year ended December 31, 2015, results of operations for the year ended December 31, 2015 are compared to the results for the year ended December 31, 2014, and the consolidated financial condition of the Company as of December 31, 2016 is compared to December 31, 2015.
  
CRITICAL ACCOUNTING POLICIES

This report is based on the Company's audited consolidated financial statements, which have been prepared in accordance with U.S. GAAP established by the FASB.  The preparation of the Company's financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, income and expenses. These estimates are based upon historical experience and on various other assumptions that management believes are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

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 investment securities and the allowance for loan losses.

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. When determining whether an investment security is OTTI, management assesses 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: (a) it has the intent to sell the security, and (b) it is more likely than not that it will be required to sell the security prior to its anticipated recovery.  In instances when a determination is made that an OTTI exists but management does not intend to sell the security and it is not more likely than not that it will be required to sell the security prior to its anticipated repayment or maturity, the OTTI is separated into: (a) the amount of the total OTTI related to a decrease in cash flows expected to be collected from the security (the credit loss); and (b) the amount of the total OTTI related to all other factors.  The amount of the total OTTI related to the credit loss is recognized as a charge to earnings.  The amount of the total OTTI related to all other factors is recognized in other comprehensive income. 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 as of the balance sheet date.

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 considered.  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.



30

(dollars in thousands, except per share amounts)



RESULTS OF OPERATIONS - 2016 COMPARED TO 2015

OVERVIEW

Key performance measures of our 2016 operations compared to 2015 included:

ROA was 1.27 percent compared to 1.30 percent in 2015.
ROE was 14.35 percent compared to 14.88 percent in 2015.
Efficiency ratio was 46.03 percent compared to 46.30 percent in 2015.
Texas ratio was 0.56 percent compared to 0.87 percent in 2015.
The loan portfolio grew 12.3 percent during 2016.
Deposits increased by 7.3 percent during 2016.


Net income for the year ended December 31, 2016, was $23,016, compared to $21,742 for the year ended December 31, 2015. Basic and diluted earnings per common share for 2016 were $1.43 and $1.42, respectively, and were $1.35 and $1.35, respectively, for 2015.

The improvement in 2016 net income compared to 2015 was primarily because of an increase in interest income due to growth in average loan volume. Growth in loans outstanding required a provision for loan losses of $1,000 in 2016, compared to a provision of $850 in 2015. Noninterest income declined $221 in 2016 compared to 2015. Noninterest income in 2015 included a gain of $590 on the sale of WB Funding's investment in SmartyPig, LLC, while 2016 included a $443 tax-exempt gain from bank-owned life insurance. Meanwhile, noninterest expense increased $1,080 between 2015 and 2016. The increase in noninterest expense included increases in salaries and benefit costs and higher amortization of low income housing projects, which is included in other expense.

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, 2016, the Company's efficiency ratio improved slightly to 46.03 percent from the prior year's ratio of 46.30 percent (a lower ratio is better.) 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, net impairment losses and gains/losses on disposition of premises and equipment). The ratio for both years was significantly better than our peer group's averages, which were approximately 68 percent and 65 percent, respectively, according to data in the September 2016 and September 2015 Bank Holding Company Performance Report, which is prepared by the Federal Reserve Board's Division of Banking Supervision and Regulation.

The Texas ratio, which is the ratio of nonperforming assets to tangible capital plus the allowance for loan losses, improved to 0.56 percent as of December 31, 2016, compared to 0.87 percent as of December 31, 2015. A lower Texas ratio indicates a stronger credit quality condition. The ratio for both years was significantly better than peer group averages, which were approximately 10 percent and 9 percent, respectively, according to data in the September 2016 and September 2015 Bank Holding Company Performance Reports. For more discussion on loan quality, see the "Loan Portfolio" and "Summary of the Allowance for Loan Losses" sections in this Item of this Form 10-K.

Net Interest Income

Net interest income increased to $57,118 for 2016 from $54,154 for 2015 as the impact of loan growth exceeded the effect of the increase in the average rate paid on interest-bearing liabilities. The net interest margin for 2016 declined 10 basis points to 3.49 percent compared to 3.59 percent for 2015. The average yield on earning assets declined by one basis point, while the rate on interest-bearing liabilities increased 14 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, declined to 3.27 percent for 2016 from 3.42 percent a year earlier. For additional analysis of net interest income, see the section captioned "Distribution of Assets, Liabilities and Stockholders' Equity; Interest Rates; and Interest Differential" in this Item of this Form 10-K.


31

(dollars in thousands, except per share amounts)



Provision for Loan Losses and Loan Quality

The allowance for loan losses, which totaled $16,112 as of December 31, 2016, represented 1.15 percent of total loans and 1,576.5 percent of nonperforming loans at year end, compared to 1.20 percent and 1,024.4 percent, respectively, as of December 31, 2015. The provision for loan losses increased to $1,000 in 2016 compared to $850 for 2015 due to growth in the loan portfolio. The Company experienced net recoveries of 0.01 percent of average loans for 2016 compared to net recoveries of 0.04 percent for 2015.

Nonperforming loans at December 31, 2016 totaled $1,022, or 0.07 percent of total loans, down from $1,461, or 0.12 percent, at December 31, 2015. 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' financial difficulties. The Company held no other real estate properties as of December 31, 2016 or 2015.

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:
2016
 
2015
 
Change
 
Change %
Service charges on deposit accounts
$
2,461

 
$
2,609

 
$
(148
)
 
(5.67
)%
Debit card usage fees
1,825

 
1,830

 
(5
)
 
(0.27
)%
Trust services
1,310

 
1,286

 
24

 
1.87
 %
Revenue from residential mortgage banking
151

 
163

 
(12
)
 
(7.36
)%
Increase in cash value of bank-owned life insurance
647

 
727

 
(80
)
 
(11.00
)%
Gain from bank-owned life insurance
443

 

 
443

 
N/A

Gain (loss) on disposition of premises and equipment
(4
)
 
(6
)
 
2

 
(33.33
)%
Realized investment securities gains, net
66

 
47

 
19

 
40.43
 %
Other income:
 

 
 

 
 

 
 

Loan fees
110

 
120

 
(10
)
 
(8.33
)%
Letter of credit fees
96

 
82

 
14

 
17.07
 %
Credit card fees
261

 
213

 
48

 
22.54
 %
Gain on sale of other assets

 
590

 
(590
)
 
(100.00
)%
Discount on purchased income tax credits
94

 
58

 
36

 
62.07
 %
All other
522

 
484

 
38

 
7.85
 %
Total other income
1,083

 
1,547

 
(464
)
 
(29.99
)%
Total noninterest income
$
7,982

 
$
8,203

 
$
(221
)
 
(2.69
)%
Service charges on deposit accounts declined primarily due to lower fees resulting from fewer instances of nonsufficient funds as customers continue to improve monitoring of their account balances.

Revenue from trust services was higher in 2016 than in 2015 due to the combination of successful business development efforts, pricing updates for certain account types and higher asset values.

The increase in cash value of bank-owned life insurance was lower in 2016 than in 2015 as crediting rates within the policies declined slightly due to the low interest rate environment. As previously mentioned, gain from bank-owned life insurance was recognized in 2016 due to the losses of a colleague and a former employee.

The Company sold three preferred stocks and three corporate bonds during 2016, recognizing investment securities gains of $66, while gains of $47 were recognized on sales during 2015.

Loan fees declined in 2016 compared to 2015 due to the recognition of a previously deferred rate lock fee on one loan in 2015. Letter of credit fees grew due to the increase in the amount of standby letters of credit activity in 2016 compared to 2015. Volumes of letters of credit fluctuate based upon the needs of our commercial customers.

Credit card fees increased in 2016 compared to 2015 due to both higher volumes of transactions and an increase in the number of credit cards issued through a third party.
As previously mentioned, the gain on sale of other assets in 2015 was associated with the sale of WB Funding's investment in SmartyPig, LLC.

Total discounts recognized on purchased State of Iowa income tax credits were higher in 2016 than in 2015 because the Company purchased one Enterprise Zone tax credit at a discount of $33. The Company also has an agreement in place to purchase wind energy credits at a discounted rate. This source of revenue is expected to decline in 2017 as the agreement to purchase discounted wind energy credits ends in May 2017.

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:
2016
 
2015
 
Change
 
Change %

Salaries and employee benefits
$
16,731

 
$
16,065

 
$
666

 
4.15
 %
Occupancy
4,033

 
4,105

 
(72
)
 
(1.75
)%
Data processing
2,510

 
2,329

 
181

 
7.77
 %
FDIC insurance
937

 
839

 
98

 
11.68
 %
Other real estate owned

 
10

 
(10
)
 
(100.00
)%
Professional fees
774

 
748

 
26

 
3.48
 %
Director fees
888

 
881

 
7

 
0.79
 %
Other expenses:
 
 
 

 
 

 
 

Marketing
231

 
253

 
(22
)
 
(8.70
)%
Business development
701

 
654

 
47

 
7.19
 %
Insurance expense
348

 
361

 
(13
)
 
(3.60
)%
Investment advisory fees
442

 
517

 
(75
)
 
(14.51
)%
Charitable contributions
180

 
360

 
(180
)
 
(50.00
)%
Trust
415

 
396

 
19

 
4.80
 %
Consulting fees
302

 
260

 
42

 
16.15
 %
Postage and courier
321

 
326

 
(5
)
 
(1.53
)%
Supplies
310

 
305

 
5

 
1.64
 %
Amortization of low income housing projects
418

 
228

 
190

 
83.33
 %
All other
1,607

 
1,431

 
176

 
12.30
 %
Total other
5,275

 
5,091

 
184

 
3.61
 %
Total noninterest expense
$
31,148

 
$
30,068

 
$
1,080

 
3.59
 %

Salaries and employee benefits increased in 2016 compared to 2015 primarily as the result of increases in stock-based compensation costs, health insurance, defined contribution plan expenses and payroll taxes. The increases in defined contribution plan expenses and payroll taxes were primarily associated with a one-time payout of accrued vacation that occurred in 2016 in conjunction with a change in the Company's vacation carryover policy.

Occupancy costs declined for 2016 compared to 2015 primarily as the result of the February 2016 purchase of the Waukee, Iowa, branch facility. The reduction reflects the one-time reversal of previously accrued rent related to the terms of the previous lease. Ongoing costs for that location are expected to remain lower than previous rental costs. Occupancy costs are expected to increase in 2017 as the Rochester, Minnesota, office moved into its new permanent building in November 2016.

The increase in data processing expense in 2016 was primarily because of the implementation of additional security measures, technology upgrades, and an annual contractual increase in fees paid to our core processor that is based upon an inflation factor.


32

(dollars in thousands, except per share amounts)



FDIC insurance expense increased for 2016 compared to 2015 due to the combination of growth in total assets and a July 1, 2016 revision in the assessment rate system for institutions with less than $10 billion in total assets. Based on the change in the rate calculation methodology within the revised assessment system, the rate can be significantly affected by the types of loans within the portfolio and by the credit quality of the portfolio.

Investment advisory fees consisted of fees paid to an independent investment advisory firm for assistance with managing the investment portfolio through September 30, 2016, and an administrative fee charged by an investment management firm for assisting with the purchase and administration of public company floating rate commercial loans. Effective October 1, 2016, the investment portfolio is managed internally, with an expected annual cost savings of approximately $280.

Charitable contributions were higher in 2015 than in 2016 as management made a decision to make an extra contribution to the West Bancorporation Foundation in 2015.

Consulting fees increased in 2016 compared to 2015 primarily due to expenses relating to data analysis conducted in association with class action litigation that was disclosed in prior filings. A proposed settlement of $250 related to the litigation was reached in the third quarter of 2016, and preliminary approval was received from the court in the fourth quarter of 2016. An insurance reimbursement of litigation costs in the amount of $300 was received in the fourth quarter of 2016. Ongoing costs related to the litigation should be minimal, as future administrative costs are included in the $250 settlement.

The increase in amortization of our investment in low income housing projects in 2016 compared to 2015 was related to the Company committing in both years to invest in additional projects. Offsetting the amortization expense in both 2016 and 2015 were approximately $375 and $275, respectively, of federal low income housing tax credits, which reduced federal income tax expense.

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 rate of income tax expense as a percent of income before income taxes was 30.2 percent and 30.8 percent, respectively, for 2016 and 2015. 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 bank-owned life insurance, disallowed interest expense, state income taxes, and federal income tax credits. Income tax expense for 2016 was also lower than the statutory income tax rate due to the previously mentioned tax-exempt gain from bank-owned life insurance. Income tax expense for 2015 was slightly lower than would be expected due to utilization of approximately $372 of capital loss carryforwards. The capital gains were generated from the sale of the Company's investment in SmartyPig, LLC in 2015. The reduction in 2015 income tax expense related to the carryforwards utilized was approximately $130. The effective tax rate for both years was also impacted by federal tax credits, including low income housing tax credits, as mentioned above, and an energy tax credit of $30 in 2016 related to the new Rochester, Minnesota, building.  

Federal income tax expense was approximately $8,335 and $8,169 for 2016 and 2015, respectively, while state income tax expense was approximately $1,601 and $1,528, respectively. The Company continues to maintain a valuation allowance against the tax effect of state net operating losses carryforwards associated with West Bancorporation, Inc., as management believes it is likely that such carryforwards will expire without being utilized.


33

(dollars in thousands, except per share amounts)



RESULTS OF OPERATIONS - 2015 COMPARED TO 2014

OVERVIEW

Key performance measures of our 2015 operations compared to 2014 included:

ROA was 1.30 percent compared to 1.32 percent in 2014.
ROE was 14.88 percent compared to 15.19 percent in 2014.
Efficiency ratio improved to 46.30 percent compared to 49.93 percent in 2014.
Texas ratio improved to 0.87 percent compared to 2.71 percent in 2014.
The loan portfolio grew 5.3 percent during 2015.
Deposits increased by 13.4 percent during 2015.


Net income for the year ended December 31, 2015, was $21,742, compared to $20,040 for the year ended December 31, 2014. Basic and diluted earnings per common share were $1.35 and $1.25 for 2015 and 2014, respectively.

The improvement in 2015 net income compared to 2014 was primarily because of an increase in interest income due to growth in average loan volume. Growth in loans outstanding required a provision for loan losses of $850 in 2015, compared to a provision of $750 in 2014. Noninterest income declined $2,093 for 2015 primarily due to a $1,231 reduction in revenue from residential mortgage banking, a $1,075 reduction in net gains on disposition of premises and equipment, a $181 reduction in service charges on deposit accounts and a $176 reduction in net gains from sale of investment securities. Partially offsetting these reductions was a one-time gain of $590 on the sale of WB Funding's investment in SmartyPig, LLC in 2015, which was included in other income. Noninterest expense declined $1,934 between 2014 and 2015 primarily because 2014 included $1,786 in other real estate owned write-downs based on updated appraisals of several properties. Income taxes increased in 2015 as the prior year included a higher level of utilization of capital loss carryforwards in connection with the sale of one branch office and one investment security.

Net Interest Income

Net interest income increased to $54,154 for 2015 from $49,145 for 2014 as the impact of loan growth and lower deposit rates exceeded the effect of an 11 basis point decline in average yield on loans. The net interest margin held steady at 3.59 percent for both years. The average yield on earning assets declined by six basis points, while the rate on interest-bearing liabilities declined five 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, declined to 3.42 percent for 2015 from 3.43 percent for 2014.

Provision for Loan Losses and Loan Quality

The allowance for loan losses, which totaled $14,967 as of December 31, 2015, represented 1.20 percent of total loans and 1,024.4 percent of nonperforming loans at year end, compared to 1.15 percent and 702.5 percent, respectively, as of December 31, 2014. The provision for loan losses increased to $850 in 2015 compared to $750 for 2014 due to growth in the loan portfolio. The Company experienced net recoveries of 0.04 percent of average loans for 2015 compared to net charge-offs of 0.09 percent for 2014.

Nonperforming loans at December 31, 2015, totaled $1,461, or 0.12 percent of total loans, down from $1,937, or 0.16 percent, at December 31, 2014. The Company held no other real estate properties as of December 31, 2015, compared to $2,235 as of December 31, 2014.


34

(dollars in thousands, except per share amounts)



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:
2015
 
2014
 
Change
 
Change %
Service charges on deposit accounts
$
2,609

 
$
2,790

 
$
(181
)
 
(6.49
)%
Debit card usage fees
1,830

 
1,764

 
66

 
3.74
 %
Trust services
1,286

 
1,327

 
(41
)
 
(3.09
)%
Revenue from residential mortgage banking
163

 
1,394

 
(1,231
)
 
(88.31
)%
Increase in cash value of bank-owned life insurance
727

 
731

 
(4
)
 
(0.55
)%
Gain (loss) on disposition of premises and equipment
(6
)
 
1,069

 
(1,075
)
 
(100.56
)%
Realized investment securities gains, net
47

 
223

 
(176
)
 
(78.92
)%
Other income:
 
 
 
 
 
 
 
Loan fees
120

 
98

 
22

 
22.45
 %
Letter of credit fees
82

 
127

 
(45
)
 
(35.43
)%
Gain on sale of other assets
590

 

 
590

 
N/A

All other
755

 
773

 
(18
)
 
(2.33
)%
Total other income
1,547

 
998

 
549

 
55.01
 %
Total noninterest income
$
8,203

 
$
10,296

 
$
(2,093
)
 
(20.33
)%
The decline in service charges on deposit accounts between 2014 and 2015 was caused by fewer instances of nonsufficient funds fees as customers strove to maintain positive balances in their accounts.

Revenue from trust services was lower in 2015 compared to 2014 due to a reduction in the number of accounts and amount of assets held within custody accounts, and fewer one-time estate fees. The reduction was partially offset through business development efforts that increased the number of accounts and amount of assets held within trust accounts. Trust assets earn fees at a higher rate than those of custody assets.

Revenue from residential mortgage banking declined in 2015 compared to 2014 due to the Company changing its process for providing first mortgage loans to its customers at the end of 2014. Starting in January 2015, residential mortgage underwriting and processing were outsourced, and funding for residential mortgages is provided by a third party. The Company currently receives a fee from that third party for each residential mortgage loan initiated and closed by our retail staff. The reduction in this source of revenue had a correlating reduction in associated operating expenses.

The sale of the downtown Iowa City office and the disposition of other unused assets resulted in a net gain of $1,069 in 2014. In January 2015, West Bank opened a newly constructed eastern Iowa main office in Coralville, which replaced the operations of the office that was sold.

The Company recognized net gains on sales of securities in 2015 and 2014 as sales were undertaken in order to capitalize on net gains while being able to reinvest the proceeds in investment securities with higher yields. In the fourth quarter of 2014, the Company also sold a pooled trust preferred security that had previously been reported as a security available for sale with OTTI at a loss of $493.

Loan fees were higher in 2015 compared to 2014 primarily due to recognition of a previously deferred rate lock fee on one loan in 2015. A lower level of outstanding letters of credit caused the reduction in revenue from letter of credit fees in 2015 compared to 2014.

The gain on sale of other assets recognized in 2015 was a nonrecurring item. On November 30, 2015, SmartyPig, LLC was sold, and the Company recognized a gain of $590 on its ownership interest.


35

(dollars in thousands, except per share amounts)



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:
2015
 
2014
 
Change
 
Change %
Salaries and employee benefits
$
16,065

 
$
16,086

 
$
(21
)
 
(0.13
)%
Occupancy
4,105

 
4,165

 
(60
)
 
(1.44
)%
Data processing
2,329

 
2,241

 
88

 
3.93
 %
FDIC insurance
839

 
757

 
82

 
10.83
 %
Other real estate owned
10

 
1,865

 
(1,855
)
 
(99.46
)%
Professional fees
748

 
944

 
(196
)
 
(20.76
)%
Director fees
881

 
714

 
167

 
23.39
 %
Other expenses:
 
 
 
 
 
 
 
Marketing
253

 
220

 
33

 
15.00
 %
Business development
654

 
702

 
(48
)
 
(6.84
)%
Insurance
361

 
384

 
(23
)
 
(5.99
)%
Investment advisory fees
517

 
366

 
151

 
41.26
 %
Charitable contributions
360

 
180

 
180

 
100.00
 %
Trust
396

 
344

 
52

 
15.12
 %
Consulting fees
260

 
337

 
(77
)
 
(22.85
)%
Supplies
305

 
292

 
13

 
4.45
 %
Amortization of low income housing projects
228

 
188

 
40

 
21.28
 %
Miscellaneous losses
30

 
329

 
(299
)
 
(90.88
)%
All other
1,727

 
1,888

 
(161
)
 
(8.53
)%
Total other
5,091

 
5,230

 
(139
)
 
(2.66
)%
Total noninterest expense
$
30,068

 
$
32,002

 
$
(1,934
)
 
(6.04
)%

Salaries and employee benefits for 2015 had a minimal net change compared to 2014. Staff reductions in December 2014, related to the residential mortgage loan operational changes previously mentioned, lowered salaries and employee benefits by approximately $1,051 in 2015 compared to 2014. Partially offsetting these reductions were increases in stock-based compensation costs of $342 in 2015 compared to 2014, along with normal annual salary increases.

Data processing expense increased in 2015 primarily because of the addition of mobile banking technology, the continued strengthening of security measures and an annual contractual increase in fees paid to our core processor that is based upon an inflation factor.

FDIC insurance expense increased for 2015 compared to 2014 due to growth in total assets.

Other real estate owned expense declined in 2015 compared to 2014, as the prior year included other real estate owned property valuation write-downs of $1,786 due to obtaining updated appraisals of several properties held. The Company held only one parcel of land in other real estate owned throughout 2015 and incurred a negligible amount of real estate taxes up to the date of its sale in December 2015.

Professional fees declined in 2015 compared to 2014 due to lower legal fees. Director fees increased between the same time periods as a result of higher stock-based compensation costs.

The increase in investment advisory fees for 2015 compared to 2014 resulted from the administrative fee charged by an investment management firm for assisting with the purchase and administration of public company floating rate commercial loans. This arrangement began in the second quarter of 2014.

Charitable contributions doubled in 2015 compared to 2014 as management chose to increase contributions to the West Bancorporation Foundation.

36

(dollars in thousands, except per share amounts)



Consulting fees declined in 2015 compared to 2014 as the prior year included fees paid for three one-time projects.

The increase in amortization of our investment in low income housing projects in 2015 compared to 2014 was related to the Company committing in 2014 to invest in additional projects. Offsetting the amortization expense in both 2015 and 2014 were approximately $275 and $160, respectively, of federal low income housing tax credits, which reduced federal income tax expense.

Income Taxes

The effective rate of income tax expense as a percent of income before income taxes was 30.8 percent and 24.9 percent, respectively, for 2015 and 2014. Income tax expense for 2015 was slightly lower than would be expected due to the utilization of $372 of capital loss carryforwards. The capital gains were generated from the sale of the Company's investment in SmartyPig, LLC. The 2014 effective rate was impacted by utilization of $3,774 of capital loss carryforwards related to the sale of an office in Iowa City and the sale of an impaired investment security. The reductions in 2015 and 2014 income tax expense related to the carryforwards utilized was approximately $130 and $1,318, respectively. The effective tax rate for both years was also impacted by federal low income housing tax credits as discussed in the previous section. Federal income tax expense was approximately $8,169 and $5,446 for 2015 and 2014, respectively, while state income tax expense was approximately $1,528 and $1,203, respectively.


37

(dollars in thousands, except per share amounts)



DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY; INTEREST RATES; AND INTEREST DIFFERENTIAL

Average Balances and an Analysis of Average Rates Earned and Paid

The following table shows average balances and interest income or interest expense, with the resulting average yield or rate by category of average interest-earning assets or interest-bearing liabilities for the years indicated.  Interest income and the resulting net interest income are shown on a fully taxable basis.
 
2016
 
2015
 
2014
 
Average
Balance
 
Revenue/
Expense
 
Yield/
Rate
 
Average
Balance
 
Revenue/
Expense
 
Yield/
Rate
 
Average
Balance
 
Revenue/
Expense
 
Yield/
Rate
Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans: (1) (2)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
$
354,790

 
$
14,854

 
4.19
%
 
$
331,306

 
$
13,813

 
4.17
%
 
$
276,201

 
$
11,662

 
4.22
%
Real estate (3)
972,571

 
43,193

 
4.44
%
 
873,844

 
39,404

 
4.51
%
 
779,223

 
36,121

 
4.64
%
Consumer and other
8,795

 
348

 
3.95
%
 
8,304

 
325

 
3.91
%
 
9,811

 
393

 
4.01
%
Total loans
1,336,156

 
58,395

 
4.37
%
 
1,213,454

 
53,542

 
4.41
%
 
1,065,235

 
48,176

 
4.52
%
Investment securities:
 

 
 

 
 
 
 

 
 

 
 
 
 

 
 

 
 
Taxable
236,770

 
4,201

 
1.77
%
 
232,078

 
4,363

 
1.88
%
 
252,500

 
4,938

 
1.96
%
Tax-exempt (3)
118,622

 
4,913

 
4.14
%
 
107,414

 
4,765

 
4.44
%
 
94,851

 
4,347

 
4.58
%
Total investment securities
355,392

 
9,114

 
2.56
%
 
339,492

 
9,128

 
2.69
%
 
347,351

 
9,285

 
2.67
%
Federal funds sold
20,064

 
108

 
0.54
%
 
30,113

 
81

 
0.27
%
 
17,007

 
45

 
0.26
%
Total interest-earning assets (3)
1,711,612

 
67,617

 
3.95
%
 
1,583,059

 
62,751

 
3.96
%
 
1,429,593

 
57,506

 
4.02
%
Noninterest-earning assets:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Cash and due from banks
44,875

 
 

 
 

 
46,122

 
 

 
 

 
34,152

 
 

 
 

Premises and equipment, net
18,843

 
 

 
 

 
10,904

 
 

 
 

 
9,513

 
 

 
 

Other, less allowance for
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
loan losses
30,920

 
 

 
 

 
35,567

 
 

 
 

 
39,248

 
 

 
 

Total noninterest-earning assets
94,638

 
 

 
 

 
92,593

 
 

 
 

 
82,913

 
 

 
 

Total assets
$
1,806,250

 
 

 
 

 
$
1,675,652

 
 

 
 

 
$
1,512,506

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and Stockholders' Equity
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Interest-bearing liabilities:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Deposits:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Savings, interest-bearing
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
demand and money markets
$
917,774

 
2,610

 
0.28
%
 
$
825,771

 
1,341

 
0.16
%
 
$
736,002

 
1,222

 
0.17
%
Time
110,407

 
781

 
0.71
%
 
128,899

 
844

 
0.65
%
 
150,378

 
1,204

 
0.80
%
Total deposits
1,028,181

 
3,391

 
0.33
%
 
954,670

 
2,185

 
0.23
%
 
886,380

 
2,426

 
0.27
%
Other borrowed funds
136,535

 
4,485

 
3.28
%
 
146,693

 
3,808

 
2.60
%
 
150,654

 
3,730

 
2.48
%
Total interest-bearing liabilities
1,164,716

 
7,876

 
0.68
%
 
1,101,363

 
5,993

 
0.54
%
 
1,037,034

 
6,156

 
0.59
%
Noninterest-bearing liabilities:
 

 
 

 
 
 
 

 
 

 
 

 
 

 
 

 
 

Demand deposits
473,380

 
 

 
 
 
420,842

 
 

 
 

 
336,456

 
 

 
 

Other liabilities
7,734

 
 

 
 
 
7,358

 
 

 
 

 
7,092

 
 

 
 

Stockholders' equity
160,420

 
 

 
 

 
146,089

 
 

 
 

 
131,924

 
 

 
 

Total liabilities and
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
stockholders' equity
$
1,806,250

 
 

 
 

 
$
1,675,652

 
 

 
 

 
$
1,512,506

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income/net interest spread (3)
 
$
59,741

 
3.27
%
 
 
 
$
56,758

 
3.42
%
 
 

 
$
51,350

 
3.43
%
Net interest margin (3)
 

 
 

 
3.49
%
 
 

 
 

 
3.59
%
 
 

 
 

 
3.59
%
(1)
Average loan balances include nonaccrual loans.  Interest income recognized on nonaccrual loans has been included.
(2)
Interest income on loans includes amortization of loan fees and costs and prepayment penalties collected, which are not material.
(3)
Tax-exempt income has been adjusted to a tax-equivalent basis using an incremental federal income tax rate of 35 percent and is adjusted to reflect the effect of the nondeductible interest expense associated with owning tax-exempt investment securities and loans.

38

(dollars in thousands, except per share amounts)



Net Interest Income

The Company's largest component of net income is net interest income, which is the difference between interest earned on interest-earning assets, consisting primarily of loans and investment securities, and interest paid on interest-bearing liabilities, consisting of deposits and borrowings.  Fluctuations in net interest income can result from the combination of changes in the balances of asset and liability categories and changes in interest rates.  Interest rates earned and paid are also affected by general economic conditions, particularly changes in market interest rates, and by competitive factors, government policies and the actions of regulatory authorities.  Net interest margin is a measure of the net return on interest-earning assets and is computed by dividing tax-equivalent net interest income by total average interest-earning assets for the year.

For the years ended December 31, 2016, 2015 and 2014, the Company's net interest margin on a tax-equivalent basis was 3.49, 3.59 and 3.59 percent, respectively.  There was an increase of $2,983 in tax-equivalent net interest income in 2016 compared to 2015 primarily due to growth in the average outstanding loan balances. This was partially offset by the increase in the rates on deposits and borrowed funds.

Rate and Volume Analysis

The rate and volume analysis shown below, on a tax-equivalent basis, is used to determine how much of the change in interest income or expense is the result of a change in volume or a change in interest yield or rate.  The change in interest that is due to both volume and rate has been allocated to the change due to volume and the change due to rate in proportion to the absolute value of the change in each.
 
2016 Compared to 2015
 
2015 Compared to 2014
 
Volume
 
Rate
 
Total
 
Volume
 
Rate
 
Total
Interest Income
 
 
 
 
 
 
 
 
 
 
 
Loans: (1)
 
 
 
 
 
 
 
 
 
 
 
Commercial
$
983

 
$
58

 
$
1,041

 
$
2,299

 
$
(148
)
 
$
2,151

Real estate (2)
4,393

 
(604
)
 
3,789

 
4,289

 
(1,006
)
 
3,283

Consumer and other
19

 
4