UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2015
[ ] 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 0-22208
QCR HOLDINGS, INC.
(Exact name of Registrant as specified in its charter)
Delaware
42-1397595
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
3551 7th Street, Moline, Illinois 61265
(Address of principal executive offices, including zip code)
(309) 743-7724
(Registrant’s telephone number, including area code)
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 [ ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, 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).
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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ]
Accelerated filer [ X ]
Non-accelerated filer [ ]
Smaller reporting company [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [ X ]
Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date: As of November 3, 2015, the Registrant had outstanding 11,741,029 shares of common stock, $1.00 par value per share.
QCR HOLDINGS, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
Page
Number(s)
Part I
FINANCIAL INFORMATION
Item 1
Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheets
3
As of September 30, 2015 and December 31, 2014
Consolidated Statements of Income
For the Three Months Ended September 30, 2015 and 2014
4
For the Nine Months Ended September 30, 2015 and 2014
5
Consolidated Statements of Comprehensive Income
For the Three and Nine Months Ended September 30, 2015 and 2014
6
Consolidated Statements of Changes in Stockholders' Equity
7
Consolidated Statements of Cash Flows
9
Notes to Consolidated Financial Statements
Note 1. Summary of Significant Accounting Policies
11
Note 2. Investment Securities
13
Note 3. Loans/Leases Receivable
18
Note 4. Derivatives and Hedging Activities
28
Note 5. Federal Home Loan Bank Advances
29
Note 6. Other Borrowings and Unused Lines of Credit
30
Note 7. Common Stock Offering and Balance Sheet Restructuring
32
Note 8. Regulatory Capital Requirements and Restrictions on Dividends
33
Note 9. Earnings Per Share
35
Note 10. Fair Value
Note 11. Business Segment Information
39
Item 2
Management's Discussion and Analysis of Financial Condition and Results of Operations
Introduction
41
General
Executive Overview
Long-Term Financial Goals
44
Strategic Developments
45
GAAP to Non-GAAP Reconciliations
46
Net Interest Income (Tax Equivalent Basis)
48
Critical Accounting Policies
53
Results of Operations
Interest Income
54
Interest Expense
Provision for Loan/Lease Losses
55
Noninterest Income
56
Noninterest Expense
60
Income Taxes
63
Financial Condition
Investment Securities
64
Loans/Leases
65
Allowance for Estimated Losses on Loans/Leases
67
Nonperforming Assets
69
Deposits
70
Borrowings
Stockholders' Equity
71
Liquidity and Capital Resources
Special Note Concerning Forward-Looking Statements
74
Item 3
Quantitative and Qualitative Disclosures About Market Risk
75
Item 4
Controls and Procedures
78
Part II
OTHER INFORMATION
Legal Proceedings
79
Item 1A
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults upon Senior Securities
80
Mine Safety Disclosures
Item 5
Other Information
Item 6
Exhibits
81
Signatures
82
Throughout the Notes to the Consolidated Financial Statements and Management's Discussion and Analysis of Financial Condition and Results of Operations, we use certain acronyms and abbreviations, as defined in Note 1.
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
September 30,
December 31,
2015
2014
ASSETS
Cash and due from banks
Federal funds sold
Interest-bearing deposits at financial institutions
Securities held to maturity, at amortized cost
Securities available for sale, at fair value
Total securities
Loans receivable held for sale
Loans/leases receivable held for investment
Gross loans/leases receivable
Less allowance for estimated losses on loans/leases
Net loans/leases receivable
Premises and equipment, net
Bank-owned life insurance
Restricted investment securities
Other real estate owned, net
Goodwill
Core deposit intangible
Other assets
Total assets
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest-bearing
Interest-bearing
Total deposits
Short-term borrowings
Federal Home Loan Bank advances
Other borrowings
Junior subordinated debentures
Other liabilities
Total liabilities
STOCKHOLDERS' EQUITY
Common stock, $1 par value; shares authorized 20,000,000
September 2015 - 11,728,911 shares issued and outstanding
December 2014 - 8,074,443 shares issued and 7,953,197 outstanding
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income (loss):
Securities available for sale
Interest rate cap derivatives
Less treasury stock, at cost
September 2015 - 0 common shares
December 2014 - 121,246 common shares
Total stockholders' equity
Total liabilities and stockholders' equity
See Notes to Consolidated Financial Statements (Unaudited)
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three Months Ended September 30,
Interest and dividend income:
Loans/leases, including fees
Securities:
Taxable
Nontaxable
Total interest and dividend income
Interest expense:
Total interest expense
Net interest income
Provision for loan/lease losses
Net interest income after provision for loan/lease losses
Noninterest income:
Trust department fees
Investment advisory and management fees
Deposit service fees
Gains on sales of residential real estate loans
Gains on sales of government guaranteed portions of loans
Securities gains, net
Earnings on bank-owned life insurance
Swap fee income
Debit card fees
Correspondent banking fees
Participation service fees on commercial loan participations
Gains on other real estate owned, net
Other
Total noninterest income
Noninterest expense:
Salaries and employee benefits
Occupancy and equipment expense
Professional and data processing fees
FDIC and other insurance
Loan/lease expense
Advertising and marketing
Postage and telephone
Stationery and supplies
Bank service charges
Total noninterest expense
Net income before income taxes
Federal and state income tax expense
Net income
Earnings per common share attributable to QCR Holdings, Inc. common shareholders
Basic
Diluted
Weighted average common shares outstanding
Weighted average common and common equivalent shares outstanding
Cash dividends declared per common share
Nine Months Ended September 30,
Gains (losses) on other real estate owned, net
Losses on debt extinguishment
Less: Preferred stock dividends
Net income attributable to QCR Holdings, Inc. common stockholders
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
Three and Nine Months Ended September 30, 2015 and 2014
Other comprehensive income (loss):
Unrealized gains (losses) on securities available for sale:
Unrealized holding gains (losses) arising during the period before tax
Less reclassification adjustment for gains included in net income before tax
Unrealized gains (losses) on interest rate cap derivatives:
Less reclassification adjustment for ineffectiveness and caplet amortization before tax
Other comprehensive income (loss), before tax
Tax expense (benefit)
Other comprehensive income (loss), net of tax
Comprehensive income attributable to QCR Holdings, Inc.
Other comprehensive income:
Unrealized gains on securities available for sale:
Unrealized holding gains arising during the period before tax
Unrealized losses on interest rate cap derivatives:
Unrealized holding losses arising during the period before tax
Other comprehensive income, before tax
Tax expense
Other comprehensive income, net of tax
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED)
Accumulated
Additional
Common
Paid-In
Retained
Comprehensive
Treasury
Stock
Capital
Earnings
Income (Loss)
Total
Balance December 31, 2014
Proceeds from issuance of 5,679 shares of common stock as a result of stock purchased under the Employee Stock Purchase Plan
Proceeds from issuance of 9,688 shares of common stock as a result of stock options exercised
Stock compensation expense
Tax benefit of nonqualified stock options exercised
Restricted stock awards
Exchange of 3,272 shares of common stock in connection with restricted stock vested, net
Balance March 31, 2015
Net loss
Other comprehensive loss, net of tax
Common cash dividends declared, $0.04 per share
Proceeds from issuance of 3,680,000 shares of common stock, net of issuance costs
Proceeds from issuance of 8,558 shares of common stock as a result of stock purchased under the Employee Stock Purchase Plan
Proceeds from issuance of 17,240 shares of common stock as a result of stock options exercised
Exchange of 630 shares of common stock in connection with stock options exercised
Balance June 30, 2015
Adjustment to common cash dividends declared
Proceeds from issuance of 5,394 shares of common stock as a result of stock purchased under the Employee Stock Purchase Plan
Proceeds from issuance of 24,711 shares of common stock as a result of stock options exercised
Retirement of treasury stock, 121,246 shares of common stock
Balance September 30, 2015
(Continued)
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED) - continued
Preferred
Balance December 31, 2013
Preferred cash dividends declared
Redemption of 15,000 shares of Series F Noncumulative Perpetual Preferred Stock
Proceeds from issuance of 6,189 shares of common stock as a result of stock purchased under the Employee Stock Purchase Plan
Proceeds from issuance of 9,814 shares of common stock as a result of stock options exercised
Exchange of 10,300 shares of common stock in connection with restricted stock vested, net
Balance March 31, 2014
Redemption of 14,867 shares of Series F Noncumulative Perpetual Preferred Stock
Proceeds from issuance of 8,361 shares of common stock as a result of stock purchased under the Employee Stock Purchase Plan
Proceeds from issuance of 630 shares of common stock as a result of stock options exercised
Balance June 30, 2014
Proceeds from issuance of 5,481 shares of common stock as a result of stock purchased under the Employee Stock Purchase Plan
Proceeds from issuance of 2,400 shares of common stock as a result of stock options exercised
Balance September 30, 2014
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Nine Months Ended September 30, 2015 and 2014
CASH FLOWS FROM OPERATING ACTIVITIES
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation
Stock-based compensation expense
Deferred compensation expense accrued
Losses (gains) on other real estate owned, net
Amortization of premiums on securities, net
Loans originated for sale
Proceeds on sales of loans
Amortization of core deposit intangible
Accretion of acquisition fair value adjustments, net
Increase in cash value of bank-owned life insurance
Increase in other assets
Increase in other liabilities
Net cash provided by operating activities
CASH FLOWS FROM INVESTING ACTIVITIES
Net decrease in federal funds sold
Net decrease (increase) in interest-bearing deposits at financial institutions
Proceeds from sales of other real estate owned
Purchase of derivative instruments
Activity in securities portfolio:
Purchases
Calls, maturities and redemptions
Paydowns
Sales
Activity in restricted investment securities:
Redemptions
Net increase in loans/leases originated and held for investment
Purchase of premises and equipment
Net cash used in investing activities
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposit accounts
Net increase (decrease) in short-term borrowings
Activity in Federal Home Loan Bank advances:
Term advances
Calls and maturities
Net change in short-term and overnight advances
Prepayments
Activity in other borrowings:
Proceeds from other borrowings
Calls, maturities and scheduled principal payments
Payment of cash dividends on common and preferred stock
Net proceeds from common stock offering, 3,680,000 shares issued
Redemption of 15,000 shares of Series F Noncumulative Perpetual Preferred Stock, net
Redemption of 14,867 shares of Series F Noncumulative Perpetual Preferred Stock, net
Proceeds from issuance of common stock, net
Net cash provided by financing activities
Net increase in cash and due from banks
Cash and due from banks, beginning
Cash and due from banks, ending
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) - continued
Supplemental disclosure of cash flow information, cash payments for:
Interest
Income/franchise taxes
Supplemental schedule of noncash investing activities:
Change in accumulated other comprehensive income, unrealized gains on securities available for sale and derivative instruments, net
Exchange of shares of common stock in connection with payroll taxes for restricted stock and in connection with stock options exercised
Transfers of loans to other real estate owned
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
September 30, 2015
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation: The interim unaudited consolidated financial statements contained herein should be read in conjunction with the audited consolidated financial statements and accompanying notes to the consolidated financial statements for the fiscal year ended December 31, 2014, included in QCR Holdings, Inc.’s (the “Company”) Form 10-K filed with the Securities and Exchange Commission on March 12, 2015. Accordingly, footnote disclosures, which would substantially duplicate the disclosures contained in the audited consolidated financial statements, have been omitted.
The financial information of the Company included herein has been prepared in accordance with U.S. generally accepted accounting principles for interim financial reporting and has been prepared pursuant to the rules and regulations for reporting on Form 10-Q and Rule 10-01 of Regulation S-X. Such information reflects all adjustments (consisting of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the periods presented. Any differences appearing between the numbers presented in financial statements and management’s discussion and analysis are due to rounding. The results of the interim period ended September 30, 2015, are not necessarily indicative of the results expected for the year ending December 31, 2015.
The acronyms and abbreviations identified below are used in the Notes to the Consolidated Financial Statements as well as in Management’s Discussion & Analysis of Financial Condition & Results of Operations. It may be helpful to refer back to this page as you read this report.
Allowance: Allowance for estimated losses on loans/leases
NIM: Net interest margin
AOCI: Accumulated other comprehensive income (loss)
NPA: Nonperforming asset
ASU: Accounting Standards Update
NPL: Nonperforming loan
BOLI: Bank-owned life insurance
OREO: Other real estate owned
Community National: Community National Bancorporation
OTTI: Other-than-temporary impairment
CRBT: Cedar Rapids Bank & Trust Company
Provision: Provision for loan/lease losses
Dodd-Frank Act: Dodd-Frank Wall Street Reform and
QCBT: Quad City Bank & Trust Company
Consumer Protection Act
RB&T: Rockford Bank & Trust Company
EPS: Earnings per share
SBA: U.S. Small Business Administration
Exchange Act: Securities Exchange Act of 1934, as amended
SEC: Securities and Exchange Commission
FASB: Financial Accounting Standards Board
TA: Tangible assets
FDIC: Federal Deposit Insurance Corporation
TCE: Tangible common equity
FHLB: Federal Home Loan Bank
TDRs: Troubled debt restructurings
m2: m2 Lease Funds, LLC
USDA: U.S. Department of Agriculture
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries which include three commercial banks: QCBT, CRBT, and RB&T. All are state-chartered commercial banks. The Company also engages in direct financing lease contracts through m2 Lease Funds, a wholly-owned subsidiary of QCBT. All material intercompany transactions and balances have been eliminated in consolidation.
Recent accounting developments: In May 2014, FASB issued ASU 2014-09, Revenue from Contracts with Customers. ASU 2014-09 implements a common revenue standard that clarifies the principles for recognizing revenue. The core principle of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply the following steps: (i) identify the contract(s) with a customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract and (v) recognize revenue when (or as) the entity satisfies a performance obligation. ASU 2014-09 was originally effective for the Company on January 1, 2017, however, FASB recently issued ASU 2015-14 which defers the effective date in order to provide additional time for both public and private entities to evaluate the impact. ASU 2014-09 will now be effective for the Company on January 1, 2018 and it is not expected to have a significant impact on the Company’s consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued
In February 2015, FASB issued ASU 2015-02, Consolidation: Amendments to the Consolidation Analysis. ASU 2015-02 is intended to improve targeted areas of consolidation guidance for legal entities such as limited partnerships, limited liability corporations, and securitization structures (collateralized debt obligations, collateralized loan obligations, and mortgage-backed security transactions). The ASU focuses on the consolidation evaluation for reporting organizations that are required to evaluate whether they should consolidate certain legal entities. The ASU also reduces the number of consolidation models from four to two. ASU 2015-02 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2015 and adoption is not expected to have a significant impact on the Company’s consolidated financial statements.
Reclassifications: Certain amounts in the prior year’s consolidated financial statements have been reclassified, with no effect on net income or stockholders’ equity, to conform with the current period presentation.
NOTE 2 – INVESTMENT SECURITIES
The amortized cost and fair value of investment securities as of September 30, 2015 and December 31, 2014 are summarized as follows:
Gross
Amortized
Unrealized
Fair
Cost
Gains
(Losses)
Value
Securities held to maturity:
Municipal securities
Other securities
Securities available for sale:
U.S. govt. sponsored agency securities
Residential mortgage-backed and related securities
December 31, 2014:
The Company’s held to maturity municipal securities consist largely of private issues of municipal debt. The large majority of the municipalities are located within the Midwest. The municipal debt investments are underwritten using specific guidelines with ongoing monitoring.
The Company’s residential mortgage-backed and related securities portfolio consists entirely of government sponsored or government guaranteed securities. The Company has not invested in commercial mortgage-backed securities or pooled trust preferred securities.
Gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of September 30, 2015 and December 31, 2014, are summarized as follows:
Less than 12 Months
12 Months or More
Losses
September 30, 2015:
At September 30, 2015, the investment portfolio included 483 securities. Of this number, 128 securities were in an unrealized loss position. The aggregate losses of these securities totaled less than 1% of the total amortized cost of the portfolio. Of these 128 securities, 48 securities had an unrealized loss for twelve months or more. All of the debt securities in unrealized loss positions are considered acceptable credit risks. Based upon an evaluation of the available evidence, including the recent changes in market rates, credit rating information and information obtained from regulatory filings, management believes the declines in fair value for these debt securities are temporary. In addition, the Company does not intend to sell these securities and it is not more-likely-than-not that the Company will be required to sell these debt securities before their anticipated recovery. At September 30, 2015 and December 31, 2014, equity securities represented less than 1% of the total portfolio.
The Company did not recognize OTTI on any debt or equity securities for the three or nine months ended September 30, 2015 and 2014.
All sales of securities for the three and nine months ended September 30, 2015 and 2014, respectively, were from securities identified as available for sale. Information on proceeds received, as well as pre-tax gross gains and losses from sales on those securities are as follows:
Three Months Ended
Nine Months Ended
September 30, 2014
Proceeds from sales of securities
Pre-tax gross gains from sales of securities
Pre-tax gross losses from sales of securities
The amortized cost and fair value of securities as of September 30, 2015 by contractual maturity are shown below. Expected maturities of residential mortgage-backed and related securities may differ from contractual maturities because the residential mortgages underlying the residential mortgage-backed and related securities may be prepaid without any penalties. Therefore, these securities are not included in the maturity categories in the following table. “Other securities” available for sale are excluded from the maturity categories as there is no fixed maturity date for those securities.
Amortized Cost
Fair Value
Due in one year or less
Due after one year through five years
Due after five years
Portions of the U.S. government sponsored agency securities and municipal securities contain call options, at the discretion of the issuer, to terminate the security at par and at predetermined dates prior to the stated maturity, summarized as follows:
As of September 30, 2015, the Company’s municipal securities portfolios were comprised of general obligation bonds issued by 81 issuers with fair values totaling $64.7 million and revenue bonds issued by 87 issuers, primarily consisting of states, counties, towns, villages and school districts with fair values totaling $201.4 million. The Company held investments in general obligation bonds in 19 states, including four states in which the aggregate fair value exceeded $5.0 million. The Company held investments in revenue bonds in eight states, including four states in which the aggregate fair value exceeded $5.0 million.
As of December 31, 2014, the Company’s municipal securities portfolios were comprised of general obligation bonds issued by 77 issuers with fair values totaling $68.8 million and revenue bonds issued by 64 issuers, primarily consisting of states, counties, towns, villages and school districts with fair values totaling $161.7 million. The Company held investments in general obligation bonds in 19 states, including three states in which the aggregate fair value exceeded $5.0 million. The Company held investments in revenue bonds in eight states, including four states in which the aggregate fair value exceeded $5.0 million.
The amortized cost and fair values of the Company’s portfolio of general obligation bonds are summarized in the following tables by the issuer’s state:
U.S. State:
Number of
Issuers
Average
Exposure Per
Issuer
(Fair Value)
Iowa
Illinois
Missouri
North Dakota
Total general obligation bonds
The amortized cost and fair values of the Company’s portfolio of revenue bonds are summarized in the following tables by the issuer’s state:
Indiana
Kansas
Total revenue bonds
Both general obligation and revenue bonds are diversified across many issuers. As of September 30, 2015 and December 31, 2014, the Company did not hold general obligation or revenue bonds of any single issuer, the aggregate book or market value of which exceeded 5% and 10%, respectively, of the Company’s stockholders’ equity. Of the general obligation and revenue bonds in the Company’s portfolio, the majority are unrated bonds that represent small, private issuances. All unrated bonds were underwritten according to loan underwriting standards and have an average loan risk rating of 2, indicating very high quality. Additionally, many of these bonds are funding essential municipal services such as water, sewer, education, and medical facilities.
The Company’s municipal securities are owned by each of the three charters, whose investment policies set forth limits for various subcategories within the municipal securities portfolio. Each charter is monitored individually, and as of September 30, 2015, all were well within policy limitations approved by the board of directors. Policy limits are calculated as a percentage of total risk-based capital.
As of September 30, 2015, the Company’s standard monitoring of its municipal securities portfolio had not uncovered any facts or circumstances resulting in significantly different credit ratings than those assigned by a nationally recognized statistical rating organization, or in the case of unrated bonds, the rating assigned using the credit underwriting standards.
NOTE 3 – LOANS/LEASES RECEIVABLE
The composition of the loan/lease portfolio as of September 30, 2015 and December 31, 2014 is presented as follows:
As of September 30,
As of December 31,
Commercial and industrial loans
Commercial real estate loans
Owner-occupied commercial real estate
Commercial construction, land development, and other land
Other non owner-occupied commercial real estate
Direct financing leases *
Residential real estate loans **
Installment and other consumer loans
Plus deferred loan/lease origination costs, net of fees
* Direct financing leases:
Net minimum lease payments to be received
Estimated unguaranteed residual values of leased assets
Unearned lease/residual income
Plus deferred lease origination costs, net of fees
Less allowance for estimated losses on leases
*Management performs an evaluation of the estimated unguaranteed residual values of leased assets on an annual basis, at a minimum. The evaluation consists of discussions with reputable and current vendors, which is combined with management’s expertise and understanding of the current states of particular industries to determine informal valuations of the equipment. As necessary and where available, management will utilize valuations by independent appraisers. The large majority of leases with residual values contain a lease options rider, which requires the lessee to pay the residual value directly, finance the payment of the residual value, or extend the lease term to pay the residual value. In these cases, the residual value is protected and the risk of loss is minimal. There were no losses related to residual values for the three or nine months ended September 30, 2015 and 2014.
**Includes residential real estate loans held for sale totaling $533,225 and $553,000 as of September 30, 2015, and December 31, 2014, respectively.
The aging of the loan/lease portfolio by classes of loans/leases as of September 30, 2015 and December 31, 2014 is presented as follows:
As of September 30, 2015
Classes of Loans/Leases
Current
30-59 Days Past
Due
60-89 Days Past
Accruing Past Due 90 Days or More
Nonaccrual Loans/Leases
Commercial and Industrial
Commercial Real Estate
Owner-Occupied Commercial Real Estate
Commercial Construction, Land Development, and Other Land
Other Non Owner-Occupied Commercial Real Estate
Direct Financing Leases
Residential Real Estate
Installment and Other Consumer
As a percentage of total loan/lease portfolio
As of December 31, 2014
NPLs by classes of loans/leases as of September 30, 2015 and December 31, 2014 are presented as follows:
Nonaccrual Loans/Leases *
Accruing
TDRs
Total NPLs
Percentage of Total NPLs
*Nonaccrual loans/leases includes $1,865,749 of TDRs, including $1,260,992 in commercial and industrial loans, $335,409 in commercial real estate loans, $47,846 in direct financing leases, $207,299 in residential real estate loans, and $14,203 in installment loans.
Nonaccrual Loans/Leases **
**Nonaccrual loans/leases includes $5,013,041 of TDRs, including $1,227,537 in commercial and industrial loans, $3,214,468 in commercial real estate loans, $61,144 in direct financing leases, $506,283 in residential real estate loans, and $3,609 in installment loans.
Changes in the allowance by portfolio segment for the three and nine months ended September 30, 2015 and 2014, respectively, are presented as follows:
Three Months Ended September 30, 2015
Balance, beginning
Provisions charged to expense
Loans/leases charged off
Recoveries on loans/leases previously charged off
Balance, ending
Three Months Ended September 30, 2014
Provisions (credits) charged to expense
Nine Months Ended September 30, 2015
Nine Months Ended September 30, 2014
The allowance by impairment evaluation and by portfolio segment as of September 30, 2015 and December 31, 2014 is presented as follows:
Allowance for impaired loans/leases
Allowance for nonimpaired loans/leases
Impaired loans/leases
Nonimpaired loans/leases
Allowance as a percentage of impaired loans/leases
Allowance as a percentage of nonimpaired loans/leases
Information for impaired loans/leases is presented in the tables below. The recorded investment represents customer balances net of any partial charge-offs recognized on the loan/lease. The unpaid principal balance represents the recorded balance outstanding on the loan/lease prior to any partial charge-offs.
Loans/leases, by classes of financing receivable, considered to be impaired as of and for the nine months ended September 30, 2015 are presented as follows:
Recorded
Investment
Unpaid Principal Balance
Related
Allowance
Average Recorded Investment
Interest Income Recognized
Interest Income Recognized for
Cash Payments Received
Impaired Loans/Leases with No Specific Allowance Recorded:
Impaired Loans/Leases with Specific Allowance Recorded:
Total Impaired Loans/Leases:
Impaired loans/leases for which no allowance has been provided have adequate collateral, based on management’s current estimates.
Loans/leases, by classes of financing receivable, considered to be impaired as of and for the three months ended September 30, 2015 and 2014, respectively, are presented as follows:
Loans/leases, by classes of financing receivable, considered to be impaired as of December 31, 2014 are presented as follows:
Unpaid Principal
Balance
For commercial and industrial and commercial real estate loans, the Company’s credit quality indicator consists of internally assigned risk ratings. Each commercial loan is assigned a risk rating upon origination. The risk rating is reviewed every 15 months, at a minimum, and on an as-needed basis depending on the specific circumstances of the loan.
For direct financing leases, residential real estate loans, and installment and other consumer loans, the Company’s credit quality indicator is performance determined by delinquency status. Delinquency status is updated daily by the Company’s loan system.
For each class of financing receivable, the following presents the recorded investment by credit quality indicator as of September 30, 2015 and December 31, 2014:
Non Owner-Occupied
Internally Assigned Risk Rating
Other Commercial Real Estate
As a % of Total
Pass (Ratings 1 through 5)
Special Mention (Rating 6)
Substandard (Rating 7)
Doubtful (Rating 8)
Delinquency Status *
Performing
Nonperforming
*Performing = loans/leases accruing and less than 90 days past due. Nonperforming = loans/leases on nonaccrual, accruing loans/leases that are greater than or equal to 90 days past due, and accruing TDRs.
As of September 30, 2015 and December 31, 2014, TDRs totaled $2,905,661 and $6,434,259, respectively.
For each class of financing receivable, the following presents the number and recorded investment of TDRs, by type of concession, that were restructured during the three and nine months ended September 30, 2014. There was one TDR that was restructured during the three and nine months ended September 30, 2015. The difference between the pre-modification recorded investment and the post-modification recorded investment would be any partial charge-offs at the time of the restructuring.
For the three months ended September 30, 2015
For the three months ended September 30, 2014
Number of Loans / Leases
Pre-Modification Recorded Investment
Post-Modification Recorded Investment
Specific Allowance
CONCESSION - Interest rate adjusted below market
CONCESSION - Other
TOTAL
For the nine months ended September 30, 2015
For the nine months ended September 30, 2014
CONCESSION - Significant payment delay
CONCESSION - Extension of Maturity
Of the TDRs reported above, one with a post-modification recorded investment of $14,203 was on nonaccrual as of September 30, 2015, and three with post-modification recorded investments totaling $75,767 were on nonaccrual as of September 30, 2014.
For the three and nine months ended September 30, 2015 and 2014, none of the Company’s TDRs had redefaulted within 12 months subsequent to restructure where default is defined as delinquency of 90 days or more and/or placement on nonaccrual status.
NOTE 4 – DERIVATIVES AND HEDGING ACTIVITIES
Following is a summary of interest rate cap derivatives held by the Company as of September 30, 2015 and December 31, 2014. An initial premium of $2.1 million was paid for the two caps. The fair value of these instruments will fluctuate with market value changes, as well as amortization of the initial premium to interest expense.
Effective Date
Maturity Date
Balance Sheet
Location
Notional Amount
Accounting Treatment
December 31, 2014
June 5, 2014
June 5, 2019
Other Assets
Cash Flow Hedging
June 5, 2021
Changes in the fair values of derivative financial instruments accounted for as cash flow hedges to the extent they are effective hedges, are recorded as a component of AOCI. The following is a summary of how AOCI was impacted during the reporting periods:
Unrealized loss at beginning of period, net of tax
Amount reclassified from AOCI to noninterest income related to hedge ineffectiveness
Amount reclassified from AOCI to interest expense related to caplet amortization
Amount of income (loss) recognized in other comprehensive income, net of tax
Unrealized loss at end of period
Changes in the fair value related to the ineffective portion of cash flow hedges are reported in noninterest income during the period of the change. As shown in the tables above, $15,561 and $23,658 of expense from the change in fair value for the three and nine months ended September 30, 2015, respectively, was due to ineffectiveness. There was income recognized of $10,968 related to the ineffectiveness of cash flow hedges during the three and nine months ended September 30, 2014.
NOTE 5 – FEDERAL HOME LOAN BANK ADVANCES
The subsidiary banks are members of the FHLB of Des Moines or Chicago. As of September 30, 2015 and December 31, 2014, the subsidiary banks held $9,227,800 and $11,279,000, respectively, of FHLB stock, which is included in restricted investment securities on the consolidated balance sheet.
During the second quarter of 2015, QCBT and CRBT prepaid a total of $75,500,000 of fixed rate FHLB advances with a weighted average interest rate of 4.36% and maturity dates ranging from May 2016 to June 2019. The prepayment fees associated with these advances totaled $5,692,185 and are included in losses on debt extinguishment in the statements of income. The prepayments were a part of the Company’s balance sheet restructuring, which is described in Note 7 to the Consolidated Financial Statements.
Maturity and interest rate information on advances from the FHLB as of September 30, 2015 and December 31, 2014 is as follows:
Amount Due
Weighted
Average Interest Rate at
Quarter-End
Amount Due with Putable Option *
Maturity:
Year ending December 31:
2016
2017
2018
Total FHLB advances
Weighted Average Interest Rate at Year-End
Putable Option *
2019
*Of the advances outstanding, a portion have putable options which allow the FHLB, at its discretion, to terminate the advances and require the subsidiary banks to repay at predetermined dates prior to the stated maturity date of the advances. The amount of advances with putable options decreased $45.5 million from December 31, 2014 to September 30, 2015 due to the prepayment of advances having putable options.
Advances are collateralized by loans totaling $450.9 million and $499.1 million, in the aggregate, as of September 30, 2015 and December 31, 2014, respectively. On pledged loans, the FHLB applies varying collateral maintenance levels from 125% to 333% based on the loan type. No securities were pledged as collateral on advances as of September 30, 2015 or December 31, 2014.
As of September 30, 2015, and included with the 2015 maturity grouping above, are $61.0 million of short-term and overnight advances from the FHLB. These advances have maturities ranging from one day to one month. As of December 31, 2014, and included with the 2015 maturity grouping above, are $37.0 million of short-term advances from the FHLB. These advances have maturities ranging from two weeks to one month.
NOTE 6 – OTHER BORROWINGS AND UNUSED LINES OF CREDIT
Other borrowings as of September 30, 2015 and December 31, 2014 are summarized as follows:
Wholesale structured repurchase agreements
Term note
Series A subordinated notes
During the second quarter of 2015, CRBT prepaid a $10,000,000 wholesale structured repurchase agreement with an interest rate of 4.40% and a maturity in May 2019. The prepayment fee associated with the transaction totaled $1,202,000. This amount is included in losses on debt extinguishment in the statements of income. The wholesale structured repurchase agreement prepayments were a part of the Company’s balance sheet restructuring, which is described in Note 7 to the Consolidated Financial Statements.
Maturity and interest rate information concerning wholesale structured repurchase agreements is summarized as follows:
Interest Rate
at Quarter-End
at Year-End
Thereafter
Total Wholesale Structured Repurchase Agreements
Some of the wholesale structured repurchase agreements have a one-time put option, at the discretion of the counterparty, to terminate the agreement and require the subsidiary bank to repay at predetermined dates prior to the stated maturity date of the agreement. Of the $115.0 million in wholesale structured repurchase agreements outstanding at September 30, 2015, $50.0 million are putable in 2016 and $20.0 million are putable in 2017.
The wholesale structured repurchase agreements are collateralized by securities with a carrying value of $138.3 million and $153.8 million as of September 30, 2015 and December 31, 2014, respectively.
At December 31, 2014, the Company had a 4-year term note with principal and interest due quarterly. Interest was calculated at the effective LIBOR rate plus 3.00% per annum (3.23% at December 31, 2014) and the balance totaled $17,625,000 at December 31, 2014. After two quarterly principal payments totaling $2,350,000 were made in January and April 2015, the resulting balance of the term debt was $15,275,000. In May 2015, the Company repaid this term note in its entirety without prepayment penalty and using proceeds from a common stock offering. Additional information regarding the capital raise and balance sheet restructuring is described in Note 7 to the Consolidated Financial Statements.
Additionally, as of December 31, 2014, the Company maintained a $10.0 million revolving line of credit note where the interest is calculated at the effective LIBOR rate plus 2.50% per annum. At December 31, 2014, the Company had not borrowed on this revolving credit note and had the full amount available. At the renewal date in June 2015, the note was amended to increase the maximum amount available. The Company now maintains a $40.0 million revolving line of credit note, with interest calculated at the effective LIBOR rate plus 2.50% per annum. At September 30, 2015, the Company had not borrowed on this revolving credit note and had the full amount available.
The current revolving note agreement contains certain covenants that place restrictions on additional debt and stipulate minimum capital and various operating ratios.
As of December 31, 2014, the Company had Series A subordinated notes outstanding totaling $2.7 million with a maturity date of September 1, 2018 and interest payable semi-annually, in arrears, on June 30 and December 30 of each year. This debt was at a fixed rate of 6.00% per year. In June 2015, the Company redeemed all of these subordinated notes using proceeds from a common stock offering, leaving no remaining balance as of September 30, 2015. There was no penalty related to this redemption.
At September 30, 2015, the subsidiary banks had 32 lines of credit totaling $347.2 million, of which $15.2 million was secured and $332.0 million was unsecured. At September 30, 2015, $266.2 million was available as $81.0 million was utilized for short-term borrowing needs at QCBT.
At December 31, 2014, the subsidiary banks had 35 lines of credit totaling $351.6 million, of which $17.1 million was secured and $334.5 million was unsecured. At December 31, 2014, $237.6 million was available as $114.0 million was utilized for short-term borrowing needs at QCBT and RB&T.
As of September 30, 2015 and December 31, 2014, the Company had Public Unit Deposit Letters of Credit with the FHLB of Des Moines totaling $55.0 million and $15.0 million, respectively. There were no amounts outstanding under these letters of credit as of either date.
NOTE 7 – COMMON STOCK OFFERING AND BALANCE SHEET RESTRUCTURING
On May 13, 2015, the Company announced the closing of an underwritten public offering of 3,680,000 shares of its common stock at a price of $18.25 per share. The net proceeds to the Company, after deducting the underwriting discount and offering expenses, totaled $63.5 million. As a result of the capital raise, the Company’s regulatory capital ratios increased significantly. Additional information regarding regulatory capital is described in Note 8 to the Consolidated Financial Statements.
The Company utilized the proceeds from the common stock offering to restructure certain debt obligations and to bolster overall capital levels. Specifically, the Company repaid $15.3 million of holding company senior debt at an interest rate of 3.27%, and $2.7 million of subordinated debt at an interest rate of 6.00%. Additionally, $85.5 million of FHLB advances and wholesale structured repurchase agreements at a weighted average interest rate of 4.36% were prepaid at QCBT and CRBT. As a result of this planned restructuring, the Company incurred $6.9 million (pre-tax) in losses for debt extinguishment that were recognized in the second quarter of 2015.
Of the $103.5 million in debt extinguishments, $63.5 million was funded with the proceeds from the common stock issuance. Approximately $27.7 million was funded through the maturity of low-yielding securities. Brokered CDs and overnight FHLB advances were utilized to fund the remaining $12.3 million. The weighted average interest rate on these new borrowings was approximately 0.90%.
This restructuring and deleveraging significantly reduced the wholesale borrowings portfolio of the Company, which includes FHLB advances, wholesale structured repurchase agreements, and brokered time deposits. The table below presents the maturity schedule including weighted average cost for the Company’s combined wholesale borrowings portfolio.
(dollar amounts in thousands)
Total Wholesale Borrowings
Total wholesale borrowings decreased $71.9 million from December 31, 2014 to September 30, 2015. Specifically, FHLB advances decreased $70.5 million, wholesale structured repurchase agreements decreased $15.0 million, and brokered time deposits increased $13.6 million, as liquidity needs were supplemented with this source. The average cost of wholesale borrowings decreased from 2.66% to 2.00% and the average duration shortened, as many of the borrowings that were extinguished were long-term in nature. Of the $85.5 million in FHLB advances and wholesale structured repurchase agreements that were prepaid, $30.5 million were set to mature in 2016, $15.0 million in 2017, $10.0 million in 2018 and $30.0 million in 2019. The weighted average duration of these borrowings was 2.56 years.
NOTE 8 – REGULATORY CAPITAL REQUIREMENTS AND RESTRICTIONS ON DIVIDENDS
The Company (on a consolidated basis) and the subsidiary banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company and subsidiary banks’ financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the subsidiary banks must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the subsidiary banks to maintain minimum amounts and ratios (set forth in the following table) of total common equity Tier 1 and Tier 1 capital to risk-weighted assets and of Tier 1 capital to average assets, each as defined by regulation. Management believes, as of September 30, 2015 and December 31, 2014, that the Company and the subsidiary banks met all capital adequacy requirements to which they are subject.
Under the regulatory framework for prompt corrective action, to be categorized as “well capitalized,” an institution must maintain minimum total risk-based, Tier 1 risk-based, Tier 1 leverage and common equity Tier 1 ratios as set forth in the following tables. The Company and the subsidiary banks’ actual capital amounts and ratios as of September 30, 2015 and December 31, 2014 are also presented in the following table (dollars in thousands). As of September 30, 2015 and December 31, 2014, each of the subsidiary banks met the requirements to be “well capitalized”.
To Be Well
Capitalized Under
New
For Capital
Prompt Corrective
Basel III
Actual
Adequacy Purposes
Action Provisions
Minimums*
Amount
Ratio
As of September 30, 2015:
Company:
Total risk-based capital
Tier 1 risk-based capital
Tier 1 leverage
Common equity Tier 1
Quad City Bank & Trust:
Cedar Rapids Bank & Trust:
Rockford Bank & Trust:
*The minimums under Basel III phase in higher by .625% (the capital conservation buffer) annually until 2019. The fully phased-in mimimums are 10.5% (Total risk-based capital), 8.5% (Tier 1 risk-based capital), and 7.0% (Common equity Tier 1).
As of December 31, 2014:
>
In July 2013, the U.S. federal banking authorities approved the implementation of the Basel III regulatory capital reforms and issued rules effecting certain changes required by the Dodd-Frank Act. The Basel III Rules are applicable to all U.S. banks that are subject to minimum capital requirements, 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 Rules not only increased most of the required minimum regulatory capital ratios, but they introduced a new common equity Tier 1 capital ratio and the concept of a capital conservation buffer. Failure to maintain capital levels above Basel III minimums may lead to restrictions on dividends, share buybacks, discretionary payments on Tier 1 instruments and discretionary bonus payments.
The Basel III Rules also permit smaller banking organizations to retain, through a one-time election, the existing treatment for AOCI, which excluded the affect of AOCI from regulatory capital. The Company made this election in the first quarter of 2015.
On August 27, 2015, the Company filed a universal shelf registration statement on Form S-3 with the SEC. This registration statement, declared effective by the SEC on October 5, 2015, will allow the Company to issue various types of securities, including common stock, preferred stock, debt securities or warrants, from time to time, up to an aggregate amount of $100.0 million. The specific terms and prices of the securities will be determined at the time of any future offering and described in a separate prospectus supplement, which would be filed with the SEC at the time of the particular offering, if any.
NOTE 9 - EARNINGS PER SHARE
The following information was used in the computation of EPS on a basic and diluted basis:
Three months ended
Nine months ended
Earnings per common share attributable to QCR Holdings, Inc. common stockholders
Weighted average common shares outstanding*
Weighted average common shares issuable upon exercise of stock options and under the employee stock purchase plan
*The increase in weighted average common shares outstanding was primarily due to the common stock issuance discussed in Note 7 to the Consolidated Financial Statements.
NOTE 10 – FAIR VALUE
Accounting guidance on fair value measurement uses a hierarchy intended to maximize the use of observable inputs and minimize the use of unobservable inputs. This hierarchy includes three levels and is based upon the valuation techniques used to measure assets and liabilities. The three levels are as follows:
●
Level 1 – Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in markets;
Level 2 – Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument; and
Level 3 – Inputs to the valuation methodology are unobservable and significant to the fair value measurement.
Assets measured at fair value on a recurring basis comprise the following at September 30, 2015 and December 31, 2014:
Fair Value Measurements at Reporting Date Using
Quoted Prices
Significant
in Active
Markets for
Observable
Unobservable
Identical Assets
Inputs
(Level 1)
(Level 2)
(Level 3)
Derivative instruments
There were no transfers of assets or liabilities between Levels 1, 2, and 3 of the fair value hierarchy for the nine months ended September 30, 2015 or 2014.
A small portion of the securities available for sale portfolio consists of common stock issued by various unrelated bank holding companies. The fair values used by the Company are obtained from an independent pricing service and represent quoted market prices for the identical securities (Level 1 inputs).
The remainder of the securities available for sale portfolio consists of securities whereby the Company obtains fair values from an independent pricing service. The fair values are determined by pricing models that consider observable market data, such as interest rate volatilities, LIBOR yield curve, credit spreads and prices from market makers and live trading systems (Level 2 inputs).
Derivative instruments consist of interest rate caps that are used for the purpose of hedging interest rate risk. See Note 4 to the Consolidated Financial Statements for the details of these instruments. The fair values are determined by pricing models that consider observable market data for derivative instruments with similar structures (Level 2 inputs).
Certain financial assets are measured at fair value on a non-recurring basis; that is, the assets are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).
Assets measured at fair value on a non-recurring basis comprise the following at September 30, 2015 and December 31, 2014:
Level 1
Level 2
Level 3
OREO
Impaired loans/leases are evaluated and valued at the time the loan/lease is identified as impaired, at the lower of cost or fair value, and are classified as Level 3 in the fair value hierarchy. Fair value is measured based on the value of the collateral securing these loans/leases. Collateral may be real estate and/or business assets, including equipment, inventory and/or accounts receivable, and is determined based on appraisals by qualified licensed appraisers hired by the Company. Appraised and reported values are discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and client’s business.
OREO in the table above consists of property acquired through foreclosures and settlements of loans. Property acquired is carried at the estimated fair value of the property, less disposal costs, and is classified as Level 3 in the fair value hierarchy. The estimated fair value of the property is determined based on appraisals by qualified licensed appraisers hired by the Company. Appraised and reported values are discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the property.
The following table presents additional quantitative information about assets measured at fair value on a non-recurring basis for which the Company has utilized Level 3 inputs to determine fair value:
Quantitave Information about Level Fair Value Measurments
Valuation Technique
Unobservable Input
Range
Appraisal of collateral
Appraisal adjustments
For the impaired loans/leases and OREO, the Company records carrying value at fair value less disposal or selling costs. The amounts reported in the tables above are fair values before the adjustment for disposal or selling costs.
There have been no changes in valuation techniques used for any assets measured at fair value during the nine months ended September 30, 2015 and 2014.
The following table presents the carrying values and estimated fair values of financial assets and liabilities carried on the Company’s consolidated balance sheets, including those financial assets and liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis:
Hierarchy
Carrying
Estimated
Level
Investment securities:
Held to maturity
Available for sale
See Previous Table
Loans/leases receivable, net
Nonmaturity deposits
Time deposits
FHLB advances
NOTE 11 – BUSINESS SEGMENT INFORMATION
Selected financial and descriptive information is required to be disclosed for reportable operating segments, applying a “management perspective” as the basis for identifying reportable segments. The management perspective is determined by the view that management takes of the segments within the Company when making operating decisions, allocating resources, and measuring performance. The segments of the Company have been defined by the structure of the Company’s internal organization, focusing on the financial information that the Company’s operating decision-makers routinely use to make decisions about operating matters.
The Company’s primary segment, Commercial Banking, is geographically divided by markets into the secondary segments which are the three subsidiary banks wholly owned by the Company: QCBT, CRBT, and RB&T. Each of these secondary segments offers similar products and services, but is managed separately due to different pricing, product demand, and consumer markets. Each offers commercial, consumer, and mortgage loans and deposit services.
The Company’s Wealth Management segment represents the trust and asset management and investment management and advisory services offered at the Company’s three subsidiary banks in aggregate. This segment generates income primarily from fees charged based on assets under administration for corporate and personal trusts, custodial services, and investments managed. No assets of the subsidiary banks have been allocated to the Wealth Management segment.
The Company’s All Other segment includes the operations of all other consolidated subsidiaries and/or defined operating segments that fall below the segment reporting thresholds. This segment includes the corporate operations of the parent company.
Selected financial information on the Company’s business segments is presented as follows as of and for the three and nine months ended September 30, 2015 and 2014.
Commercial Banking
Quad City Bank & Trust
Cedar Rapids Bank & Trust
Rockford Bank & Trust
Wealth Management
All Other
Intercompany Eliminations
Consolidated Total
Total revenue
Provision
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
This section reviews the financial condition and results of operations of the Company and its subsidiaries for the three months and nine months ending September 30, 2015 and 2014. Some tables may include additional periods to comply with disclosure requirements or to illustrate trends. When reading this discussion, also refer to the consolidated financial statements and related notes in this report. The page locations and specific sections and notes that are referred to are presented in the table of contents.
Additionally, a comprehensive list of the acronyms and abbreviations used throughout this discussion is included in Note 1 to the Consolidated Financial Statements.
GENERAL
QCR Holdings, Inc. is the parent company of QCBT, CRBT, and RB&T.
QCBT and CRBT are Iowa-chartered commercial banks, and RB&T is an Illinois-chartered commercial bank. All are members of the Federal Reserve system with depository accounts insured to the maximum amount permitted by law by the FDIC.
QCBT commenced operations in 1994 and provides full-service commercial and consumer banking, and trust and asset management services to the Quad City area and adjacent communities through its five offices that are located in Bettendorf and Davenport, Iowa and Moline, Illinois. QCBT also provides leasing services through its wholly-owned subsidiary, m2 Lease Funds, located in Brookfield, Wisconsin. In addition, QCBT owns 100% of Quad City Investment Advisors, LLC, which is an investment management and advisory company.
CRBT commenced operations in 2001 and provides full-service commercial and consumer banking, and trust and asset management services to Cedar Rapids, Iowa and adjacent communities through its main office located on First Avenue in downtown Cedar Rapids, Iowa and its branch facility located on Council Street in northern Cedar Rapids. Cedar Falls and Waterloo, Iowa and adjacent communities are served through three additional CRBT offices (two in Waterloo and one in Cedar Falls).
RB&T commenced operations in January 2005 and provides full-service commercial and consumer banking, and trust and asset management services to Rockford, Illinois and adjacent communities through its main office located on Guilford Road at Alpine Road in Rockford and its branch facility in downtown Rockford.
EXECUTIVE OVERVIEW
The Company reported net income of $6.5 million for the quarter ended September 30, 2015, and diluted EPS of $0.55. By comparison, for the quarter ended June 30, 2015, the Company reported a net loss of $524 thousand, and diluted EPS of ($0.05). During the second quarter, the Company successfully executed several planned initiatives aimed at improving the long-term profitability of the Company and strengthening its capital base. As a result, financial performance was greatly impacted by several previously announced nonrecurring income and expense items; most prominently the one-time expense related to the prepayment of certain FHLB advances and other wholesale borrowings, which totaled approximately $4.5 million (after-tax). For the third quarter of 2014, the Company reported net income of $4.1 million, and diluted EPS of $0.50. As a result of the redemption of all of the Company’s remaining outstanding shares of preferred stock in the second quarter of 2014, none of these periods included preferred stock dividends.
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued
For the nine months ended September 30, 2015, the Company reported net income of $10.1 million and diluted EPS of $1.01. By comparison, for the nine months ended September 30, 2014, the Company reported net income of $12.0 million, and diluted EPS of $1.35, after preferred stock dividends of $1.1 million.
The third quarter of 2015 was highlighted by several significant items:
Net interest margin improvement of 18 basis points, quarter-over-quarter, primarily attributable to the balance sheet restructuring described in Note 7 to the Consolidated Financial Statements;
Loan and lease growth at an annualized rate of 10.3% through the first nine months of the year;
Strong gains on the sale of government guaranteed portions of loans;
A gain on the sale of an OREO property totaling $1.2 million (pre-tax); and
Improved asset quality metrics, with a reduction in NPAs as a percentage of total assets from 1.61% at September 30, 2014 to 0.80% at the current quarter-end.
Following is a table that represents the various net income measurements for the Company.
For the three months ended
For the nine months ended
Diluted earnings per common share
Weighted average common and common equivalent outstanding*
*The increase in weighted average common and common equivalent outstanding shares was primarily due to the common stock issuance discussed in Note 7 to the consolidated financial statements.
The Company reported core net income (non-GAAP) for the quarter ending September 30, 2015 of $6.2 million, with diluted core EPS of $0.52. Core net income for the quarter included a $788 thousand (after-tax) gain on the sale of other real estate. While this gain is considered core income, it is non-recurring in nature. Core net income for the quarter excluded after-tax gains on the sale of securities of $37 thousand and after-tax income from the conclusion of a favorable lawsuit of $252 thousand.
For the nine months ended September 30, 2015, the Company reported core net income (non-GAAP) of $14.6 million, with diluted core EPS of $1.45. Core net income year-to-date excludes $5.0 million of after-tax non-recurring expenses, $4.5 million of which related to the previously announced prepayment of FHLB advances and other wholesale borrowings during the second quarter of 2015.
Following is a table that represents the major income and expense categories for the Company.
June 30,
Provision expense
Noninterest income
Noninterest expense
Federal and state income tax (benefit)
Net income (loss)
In comparing quarter-over-quarter, following are some noteworthy changes in the Company’s financial results:
Net interest income increased 9% compared to the second quarter of 2015 and increased 15% from the same period in 2014.
Provision decreased 30% compared to the second quarter of 2015. The increased provision in the second quarter of 2015 was the result of a $971 thousand increase in a specific allowance allocated to one relationship at QCBT. This relationship was not a new NPA, but new circumstances developed in the second quarter requiring an increase in specific allowance allocation. This relationship was subsequently charged off in the third quarter of 2015. Provision increased 54% from the same period in 2014, primarily due to loan growth and changes in qualititative factors utilized in the calculation.
Noninterest income increased 35% compared to the second quarter of 2015. Noninterest income increased 48% from the third quarter of 2014. Noninterest income in the third quarter of 2015 included a $1.2 million gain on the sale of an OREO property, a $387 thousand lawsuit award and a strong quarter of gains on the sale of government guaranteed portions of loans ($760 thousand compared to $69 thousand and $159 thousand for the quarters ending June 30, 2015 and September 30, 2014, respectively).
Noninterest expense decreased 29% compared to the second quarter of 2015. The second quarter of 2015 included several nonrecurring expense items totaling approximately $7.7 million, $6.9 million of which related to the extinguishment of debt discussed in Note 7 to the Consolidated Financial Statements. Noninterest expense increased 4% from the third quarter of 2014.
Federal and state income tax increased significantly compared to the second quarter of 2015 and the same period in the prior year. The company recognized a large tax benefit in the second quarter of 2015 due to a reduction in taxable income. See the Income Taxes section of this report for additional details.
LONG-TERM FINANCIAL GOALS
The Company’s long-term (defined as the next 12-24 months) financial goals are as follows:
Improve balance sheet efficiency by targeting a gross loans and leases to total assets ratio in the range of 70 – 75%;
Improve profitability (measured by net interest margin and return on average assets);
Continue to improve asset quality by reducing NPAs to total assets to below 1.00% and maintain charge-offs as a percentage of average loans of under 0.25% annually;
Reduce reliance on wholesale funding to less than 15% of total assets;
Grow noninterest bearing deposits to more than 30% of total assets;
Increase the commercial lease portfolio so that it represents 10% of total assets;
Grow gains on sales of government guaranteed portions of loans to more than $3 million annually; and
Continue to grow trust and investment advisory fees by 15% annually.
The following table shows the evaluation of the Company’s long-term financial goals.
September 30, 2015 (non-GAAP*)
June 30, 2015 (non-GAAP*)
(dollars in thousands)
Balance sheet efficiency
Gross loans and leases to total assets
70 - 75%
68%
67%
64%
Profitability
Net interest margin
>3.45%
3.51%
3.33%
3.15%
Return on average assets
>1.00%
1.01%
0.97%
-0.08%
0.71%
0.66%
Asset quality
Nonperforming assets to total assets
<1.00%
0.80%
1.07%
1.61%
Net charge-offs to average loans**
< 0.25% annually
0.26%
0.12%
0.16%
Lower reliance on wholesale funding
Wholesale funding to total assets
< 15%
21%
22%
26%
Funding mix
Noninterest bearing deposits as a percentage of total assets
> 30%
23%
25%
Commercial leasing
Leases as a percentage of total assets
10%
7%
Consistent, high quality noninterest
Gains on sales of government guaranteed portions of loans**
> $3 million annually
$1.0 million
$0.3 million
$1.1 million
Grow trust and investment advisory fees**
> 15% annually
8%
13%
*
Non-GAAP calculations are provided, when applicable. Refer to GAAP to non-GAAP reconciliation table on page 47 of this report.
**
Ratios and amounts provided for these measurements represent year-to-date actual amounts for the respective period, that are then annualized for comparison.
Annual growth percentages are calculated with a base of December 31, 2014 and 2013 year-to-date totals.
***
Targets will be re-evaluated and adjusted annually in the first quarter of each year.
****
These goals are aspirational in nature and, depending on the actual performance of the Company, may or may not be achieved. See the Special Note Concerning Forward-Looking Statement located within the Notes to the Consolidated Financial Statements.
MANAGEMENT'S DESCUSSION AND ANALYSIS OF
STRATEGIC DEVELOPMENTS
The Company took the following actions to support our corporate strategy and the long-term financial goals shown above.
Loan growth for the first nine months of 2015 was 10.3% on an annualized basis. This was within the Company’s target organic growth rate of 10-12%. A majority of this growth was in the commercial and industrial loan category. As of September 30, 2015,this segment of the portfolio accounted for 37% of total loans and leases. At the same time, the Company has reduced its reliance on commercial real estate loans, with that segment representing 39% of the portfolio as of September 30, 2015. This loan and lease growth has continued to help move the loan and lease to total asset ratio upward to 68%, from 67% in the second quarter of 2015 and 64% one year ago. Additionally, the Company continues to evaluate market opportunities to rotate out of securities and into loans and leases, as this will also make the balance sheet more profitable. Generally, securities have a lower yield, therefore, by replacing with loans and leases, the Company will continue to improve NIM.
In the second quarter of 2015, the Company executed a balance sheet restructuring that greatly reduced borrowings and the weighted average cost of borrowings in order to improve the long-term profitability of the Company. Refer to Note 7 to the Consolidated Financial Statements for additional information. The majority of the debt restructuring activity was executed mid-quarter, so management expected to see net interest margin improvement in the third quarter. Management anticipated that the quarterly net interest margin percentage would be in the range of 3.40% to 3.45%; however, due to improvement in the Company’s yield on securities and yield on loans and leases, NIM improved to 3.51% for the third quarter.
The Company has been heavily focused on reducing NPAs to total assets ratio to below 1.00% and was successful in achieving this benchmark during the third quarter, with an actual ratio of 0.80%. The reduction of NPAs was primarily due to the sale of a large OREO property during the quarter, as well as the charge-off of a nonaccrual loan that was fully reserved in prior periods. The Company plans to continue to dispose of OREO properties to further improve asset quality ratios. As of September 30, 2015, the Company had four OREO properties totaling $7.1 million. Additionally, the Company had two nonaccrual relationships totaling $6.9 million. In total, these six relationships made up $14.0 million, or 68%, of our Company’s NPAs as of September 30, 2015. The Company will concentrate workout efforts on these six relationships.
Management continues to focus on reducing the Company’s reliance on wholesale funding. The balance sheet restructuring that was executed in the second quarter lowered the Company’s reliance by 4%, from 26% at September 30, 2014 to 22% at June 30, 2015. In the third quarter of 2015, the Company lowered its reliance by another 1%, primarily due to brokered CD maturities that were replaced with core deposits. Management continues to closely evaluate opportunities for further reduction in wholesale funding.
Correspondent banking continues to be a core line of business for the Company. The Company is competitively positioned with veteran staff, software systems and processes to continue growing in the three states currently served – Iowa, Illinois and Wisconsin. The Company acts as the correspondent bank for 172 downstream banks with total noninterest bearing deposits of approximately $272.0 million as of September 30, 2015. This line of business provides a strong source of noninterest bearing deposits, fee income and high-quality loan participations.
The Company provides commercial leasing services through its wholly-owned subsidiary, m2 Lease Funds, which has lease specialists in Iowa, Illinois, Wisconsin, Minnesota, South Carolina, North Carolina, Georgia, Florida and Pennsylvania. Historically, this portfolio has been high yielding, with an average gross yield through the first nine months of 2015 approximating 8.4%. This portfolio has also shown strong asset quality throughout its history and the Company intends to grow this portfolio to 10% of consolidated assets.
SBA and USDA lending is a specialty lending area on which the Company has focused. Once these loans are originated, the government-guaranteed portion of the loan can be sold to the secondary market for premiums. The Company intends to make this a more significant and consistent source of noninterest income. In 2014, the Company hired a government-guaranteed lending specialist in the QCBT market. Also in 2014, in the CRBT market, the Company added a USDA relationship manager to CRBT’s specialty lending team.
Wealth management is another core line of business for the Company and offers a full range of products, including trust services, brokerage and investment advisory services, asset management, estate planning and financial planning. As of September 30, 2015 the Company had $1.69 billion of total financial assets in trust (and related) accounts and $660 million of total financial assets in brokerage (and related) accounts. Continued growth in assets under management will help to drive trust and investment advisory fees, with a goal of growing this line item 15% annually. The Company hired four business development officers in 2014 to help with this strategy. Additionally, the Company has started offering trust and investment advisory services to the correspondent banks that it serves. As management focuses on growing fee income, expanding market share will continue to be a primary strategy.
GAAP TO NON-GAAP RECONCILIATIONS
The following table presents certain non-GAAP financial measures related to the “tangible common equity to tangible assets ratio”, “core net income”, “core net income attributable to QCR Holdings, Inc. common stockholders”, “core earnings per common share” and “core return on average assets”. The table also reconciles the GAAP performance measures to the corresponding non-GAAP measures.
The tangible common equity to tangible assets ratio has been a focus for investors and management believes that this ratio may assist investors in analyzing the Company’s capital position without regard to the effects of intangible assets.
The table below also includes several “core” measurements of financial performance. The Company's management believes that these measures are important to investors as they exclude non-recurring income and expense items; therefore, they provide a better comparison for analysis and may provide a better indicator of future run-rates.
Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied, and are not audited. Although these non-GAAP financial measures are frequently used by investors to evaluate a company, they have limitations as analytical tools and should not be considered in isolation, or as a substitute for analyses of results as reported under GAAP.
As of
(dollars in thousands, except per share data)
TANGIBLE COMMON EQUITY TO TANGIBLE ASSETS RATIO
Stockholders' equity (GAAP)
Less: Intangible assets
Tangible common equity (non-GAAP)
Total assets (GAAP)
Tangible assets (non-GAAP)
Tangible common equity to tangible assets ratio (non-GAAP)
For the Quarter ended
For the Nine Months Ended
Net income (loss) (GAAP)
Less nonrecurring items (after-tax*) :
Income:
Securities gains
Lawsuit settlement
Total nonrecurring income (non-GAAP)
Expense:
Other non-recurring expenses
Total nonrecurring expense (non-GAAP)
Core net income (non-GAAP)
Core net income attributable to QCR Holdings, Inc. common stockholders (non-GAAP)
CORE EARNINGS PER COMMON SHARE
Core net income attributable to QCR Holdings, Inc. common stockholders (non-GAAP) (from above)
Core earnings per common share (non-GAAP):
CORE RETURN ON AVERAGE ASSETS
Core net income (non-GAAP) (from above)
Average Assets
Core return on average assets (annualized) (non-GAAP)
NET INTEREST INCOME - (TAX EQUIVALENT BASIS)
Net interest income, on a tax equivalent basis, increased 16% to $21.4 million for the quarter ended September 30, 2015. For the nine months ending September 30, 2015, net interest income, on a tax equivalent basis, increased 11% to $60.1 million. Net interest income improved due to several factors:
The Company’s strategy to redeploy funds from the taxable securities portfolio into higher yielding loans and leases;
Organic loan and lease growth has been strong over the past twelve months, as evidenced by average gross loan/lease growth of 11% in that period; and
The Company’s balance sheet restructuring and deleveraging strategy that was executed in the second quarter of 2015. This strategy reduced high-cost borrowings and resulted in a decrease in the cost of total interest bearing liabilities from 0.99% to 0.71%, or 28 basis points, comparing the third quarter of 2015 to the third quarter of 2014. Refer to Note 7 to the Consolidated Financial Statements for additional details.
A comparison of yields, spread and margin from the third quarter of 2014 to the third quarter of 2015 is as follows (on a tax equivalent basis):
The average yield on interest-earning assets increased 11 basis points.
The average cost of interest-bearing liabilities decreased 28 basis points.
The net interest spread increased 39 basis points from 2.90% to 3.29%.
The net interest margin improved 36 basis points from 3.15% to 3.51%.
A comparison of yields, spread and margin from the first nine months of 2014 to the first nine months of 2015 is as follows (on a tax equivalent basis):
The average cost of interest-bearing liabilities decreased 16 basis points.
The net interest spread increased 27 basis points from 2.86% to 3.13%.
The net interest margin improved 24 basis points from 3.13% to 3.37%.
The Company’s management closely monitors and manages net interest margin. From a profitability standpoint, an important challenge for the Company’s subsidiary banks and leasing company is the improvement of their net interest margins. Management continually addresses this issue with pricing and other balance sheet management strategies.
During 2014 and 2015, the Company placed an emphasis on shifting its balance sheet mix. With a stated goal of increasing loans/leases as a percentage of assets to at least 70%, the Company has funded this loan/lease growth with a mixture of core deposits and cash from the maturities, sales and pay downs in the taxable investment securities portfolio.
Strategies are continuously being evaluated in which securities are sold and the cash is redeployed into the loan/lease portfolio, with little to no extension of duration and a significant increase in yield. Additionally, the Company is recognizing net gains on these sales due to the current low rate environment. As rates rise, the Company will also have less market volatility in the investment securities portfolio, as this continues to become a smaller portion of the balance sheet.
The Company continues to monitor and evaluate both prepayment and debt restructuring opportunities within the wholesale funding portion of the balance sheet, as such a strategy may increase net interest margin at a quicker pace than holding the debt until maturity.
The Company’s average balances, interest income/expense, and rates earned/paid on major balance sheet categories, as well as the components of change in net interest income, are presented in the following tables:
For the three months ended September 30,
Earned
Yield or
or Paid
Interest earning assets:
Investment securities (1)
Gross loans/leases receivable (1) (2) (3)
Total interest earning assets
Noninterest-earning assets:
Premises and equipment
Less allowance
Interest-bearing liabilities:
Interest-bearing deposits
Total interest-bearing liabilities
Noninterest-bearing demand deposits
Other noninterest-bearing liabilities
Stockholders' equity
Net interest spread
Ratio of average interest-earning assets to average interest-bearing liabilities
(1) Interest earned and yields on nontaxable investment securities and nontaxable loans are determined on a tax equivalent basis using a 35% tax rate.
(2) Loan/lease fees are not material and are included in interest income from loans/leases receivable in accordance with accounting and regulatory guidance.
(3) Non-accrual loans/leases are included in the average balance for gross loans/leases receivable in accordance with accounting and regulatory guidance.
Analysis of Changes of Interest Income/Interest Expense
Inc./(Dec.)
Components
from
of Change (1)
Prior Period
Rate
Volume
2015 vs. 2014
INTEREST INCOME
Investment securities (2)
Gross loans/leases receivable (3) (4)
Total change in interest income
INTEREST EXPENSE
Total change in interest expense
Total change in net interest income
(1)
(2)
(3)
(4)
For the nine months ended September 30,
Gross loans/leases receivable (2) (3) (4)
CRITICAL ACCOUNTING POLICIES
The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The financial information contained within these statements is, to a significant extent, financial information that is based on approximate measures of the financial effects of transactions and events that have already occurred.
ALLOWANCE FOR LOAN AND LEASE LOSSES
Based on its consideration of accounting policies that involve the most complex and subjective decisions and assessments, management has identified its most critical accounting policy to be that related to the allowance.
The Company’s allowance methodology incorporates a variety of risk considerations, both quantitative and qualitative, in establishing an allowance that management believes is appropriate at each reporting date. Quantitative factors include the Company’s historical loss experience, delinquency and charge-off trends, collateral values, changes in NPLs, and other factors. Quantitative factors also incorporate known information about individual loans/leases, including borrowers’ sensitivity to interest rate movements.
Qualitative factors include the general economic environment in the Company’s markets, including economic conditions throughout the Midwest, and in particular, the state of certain industries. Size and complexity of individual credits in relation to loan/lease structure, existing loan/lease policies and pace of portfolio growth are other qualitative factors that are considered in the methodology.
Management may report a materially different amount for the provision in the statement of income to change the allowance if its assessment of the above factors were different. This discussion and analysis should be read in conjunction with the Company’s financial statements and the accompanying notes presented elsewhere herein, as well as the portion in the section entitled “Financial Condition” of this Management’s Discussion and Analysis that discusses the allowance.
Although management believes the level of the allowance as of September 30, 2015 was adequate to absorb losses inherent in the loan/lease portfolio, a decline in local economic conditions, or other factors, could result in increasing losses that cannot be reasonably predicted at this time.
OTHER–THAN-TEMPORARY IMPAIRMENT
The Company’s assessment of OTTI of its investment securities portfolio is another critical accounting policy due to the level of judgment required by management. Investment securities are evaluated to determine whether declines in fair value below their cost are other-than-temporary.
In estimating OTTI losses, management considers a number of factors including, but not limited to, (1) the length of time and extent to which the fair value has been less than amortized cost, (2) the financial condition and near-term prospects of the issuer, (3) the current market conditions, and (4) the intent of the Company to not sell the security prior to recovery and whether it is not more-likely-than-not that the Company will be required to sell the security prior to recovery. The discussion regarding the Company’s assessment of OTTI should be read in conjunction with the Company’s financial statements and the accompanying notes presented elsewhere herein.
RESULTS OF OPERATIONS
Interest income increased 6%, comparing the third quarter of 2015 to the same period of 2014 and 5%, comparing the first nine months of 2015 to the same period of 2014.
A portion of this growth was the result of the Company’s strategy to redeploy funds from the securities portfolio into higher yielding loans and leases. In addition, organic loan and lease growth has been strong over the past twelve months.
Overall, the Company’s average earning assets increased 4%, comparing the third quarter of 2015 to the third quarter of 2014. During the same time period, average gross loans and leases increased 11%, while average securities decreased 12%.
The securities portfolio yield continued to increase (from 2.74% for the third quarter of 2014 to 3.14% for the third quarter of 2015) as the Company continued to sell low-yielding investments taking advantage of favorable market opportunities. Additionally, the Company continued to take actions to diversify its securities portfolio, including increasing its portfolio of tax-exempt municipal securities, in an effort to increase tax equivalent interest income without additional income tax expense.
The Company intends to continue to grow quality loans and leases as well as diversify its securities portfolio to maximize yield while minimizing credit and interest rate risk.
Interest expense for the third quarter of 2015 decreased 30% from the third quarter of 2014. For the first nine months of 2015, interest expense decreased 16% compared to the first nine months of 2014. The Company has been successful in maintaining pricing discipline on deposits and decreasing the cost of borrowings, which has more than offset the growth impact and contributed to the net decline in interest expense.
Management has placed a strong focus on reducing the reliance on long-term wholesale funding as it tends to be higher cost than deposits. In the second quarter of 2015, the Company executed a balance sheet restructuring that is estimated to save $4.2 million of interest expense annually. Refer to Note 7 to the Consolidated Financial Statements for additional information regarding this restructuring.
Management continues to consider strategies to accelerate the reduction of the reliance on wholesale funding and continue the shift in mix to a funding base consisting of a higher percentage of core deposits, including noninterest-bearing deposits. An important consideration to these strategies, however, will be the impact on the Company’s interest rate risk position, as some of its wholesale funding was originally borrowed to help strengthen the Company’s net interest income in rising interest rate scenarios.
PROVISION FOR LOAN/LEASE LOSSES
The provision is established based on a number of factors, including the Company’s historical loss experience, delinquencies and charge-off trends, the local and national economy and risk associated with the loans/leases in the portfolio as described in more detail in the “Critical Accounting Policies” section.
The Company’s provision totaled $1.6 million for the third quarter of 2015, which was down $713 thousand from the prior quarter. The increased provision in the second quarter of 2015 was primarily the result of a $971 thousand increase in a specific allowance allocated to one relationship at QCBT, as well as general allowances allocated to new loan growth. This relationship was not a new NPA, but new circumstances developed in the second quarter requiring an increase in specific allowance allocation. This NPA was subsequently charged-off in the third quarter at no additional loss. Provision increased $572 thousand compared to the third quarter of 2014, primarily due to loan growth and changes in qualitative factors utilized in the calculation.
The Company had net charge-offs of $2.2 million for the third quarter of 2015 which, when coupled with the provision of $1.6 million, decreased the Company’s allowance to $25.5 million at September 30, 2015. As of September 30, 2015, the Company’s allowance to total loans/leases was 1.45%, which was down slightly from 1.52% at June 30, 2015, and flat compared to September 30, 2014.
A more detailed discussion of the Company’s allowance can be found in the “Financial Condition” section of this report.
NONINTEREST INCOME
The following tables set forth the various categories of noninterest income for the three and nine months ended September 30, 2015 and 2014.
$ Change
% Change
%
Gains on the disposal of leased assets
Income on other real estate owned
Lawsuit award
Trust department fees continue to be a significant contributor to noninterest income, increasing 13% from the third quarter of 2014 to the third quarter of 2015 and increasing 9% when comparing the first nine months of 2014 to the first nine months of 2015. Income is generated primarily from fees charged based on assets under administration for corporate and personal trusts and for custodial services. The majority of the trust department fees are determined based on the value of the investments within the fully managed trusts. As the markets have strengthened with the national economy’s recovery from recession, the Company’s fee income has experienced similar growth. In recent years, the Company has been successful in expanding its customer base, which has helped to drive the increases in fee income. Additionally, the Company recently started offering trust operations services to correspondent banks. Fees are expected to continue to grow as this new offering is rolled out.
Management has placed a strong emphasis on growing its investment advisory and management services. Part of this initiative has been to restructure the Company’s Wealth Management Division to allow for more efficient delivery of products and services through selective additions of talent as well as leverage of and collaboration among existing resources (including the aforementioned trust department). Similar to trust department fees, these fees are largely determined based on the value of the investments managed. And, similar to the trust department, the Company has had some success in expanding its customer base, which has helped drive the recent increases in fee income. Investment advisory fees increased 8% from the third quarter of 2014 to the third quarter of 2015 and when comparing the first nine months of 2014 to the first nine months of 2015.
Deposit service fees expanded 2%, comparing the third quarter of 2015 to the same period in 2014 and 3%, comparing the first nine months of 2015 to the same period in 2014. The Company continues its emphasis on shifting the mix of deposits from brokered and retail time deposits to non-maturity demand deposits across all its markets. With this shift in mix, the Company has increased the number of demand deposit accounts, which tend to be lower in interest cost and higher in service fees. The Company plans to continue this shift in mix and to further focus on growing deposit service fees.
Gains on sales of residential real estate loans decreased 30%, comparing the third quarter of 2015 to the third quarter of 2014 and decreased 16%, comparing the first nine months of 2015 to the same period of 2014. With the sustained historically low interest rate environment, refinancing activity has slowed, as many of the Company’s existing and prospective customers have already executed a refinancing. Therefore, this area has become a much smaller contributor to overall noninterest income.
The Company’s gains on the sale of government-guaranteed portions of loans for the third quarter of 2015 were up 379%, compared to the third quarter of 2014 and were up 5%, comparing the first nine months of 2015 to the same period in 2014. As one of its core strategies, the Company continues to leverage its small business lending expertise by taking advantage of programs offered by the SBA and the USDA. The Company’s portfolio of government-guaranteed loans has grown as a direct result of the Company’s strong expertise in SBA and USDA lending. In some cases, it is more beneficial for the Company to sell the government-guaranteed portion on the secondary market for a premium rather than retain the loans in the Company’s portfolio. Sales activity for government-guaranteed portions of loans tends to fluctuate depending on the demand for small business loans that fit the criteria for the government guarantee. Further, some of the transactions can be large and, as the gain is determined as a percentage of the guaranteed amount, the resulting gain on sale can be large. Lastly, a strategy for improved pricing is packaging loans together for sale. From time to time, the Company may execute on this strategy, which may delay the gains on sales of some loans to achieve better pricing. The Company has added additional talent and is executing on strategies in an effort to make this a more consistent and larger source of revenue. The pipelines for SBA and USDA lending are strong, and management believes that the Company will continue to post strong numbers in this category.
Securities gains, net, were $57 thousand for the third quarter of 2015, which were up from $19 thousand in the third quarter of the prior year. For the first nine months of 2015, securities gains, net, totaled $474 thousand, as the Company took advantage of market opportunities by selling approximately $65.9 million of government agency investments that were low-yielding. Proceeds were then used to purchase higher-yielding, tax-exempt municipal bonds and to fund loan and lease growth. This strategy is being used to shift the balance sheet mix in an effort to improve profitability. The Company intends to redeploy funds from the investment portfolio into higher yielding loans and leases, with a goal of growing loans and leases to 70-75% of total assets.
Earnings on BOLI decreased 6% from the third quarter of 2014 to the third quarter of 2015 and increased 3% comparing the first nine months of 2014 to the first nine months of 2015. There were no purchases of BOLI that contributed to this increase. Notably, a small portion of the Company’s BOLI is variable in nature whereby the returns are determined by the performance of the equity market. Management intends to continue to review its BOLI investments to be consistent with policy and regulatory limits in conjunction with the rest of its earning assets in an effort to maximize returns while minimizing risk.
As a result of the sustained historically low interest rate environment, the Company was able to execute several interest rate swaps on select commercial loans, resulting in fee income of $63 thousand for the third quarter of 2015 and $1.2 million for the first three quarters of 2015. The interest rate swaps allow the commercial borrowers to pay a fixed interest rate while the Company receives a variable interest rate as well as an upfront fee dependent upon the pricing. Management believes that these swaps help position the Company more favorably for rising rate environments. Management will continue to review opportunities to execute these swaps at all of its subsidiary banks, as the circumstances are appropriate for the borrower and the Company.
Debit card fees are the interchange fees paid on certain debit card customer transactions. Debit card fees increased 15% comparing the third quarter of 2015 to the third quarter of 2014 and increased 3% comparing the first nine months of 2015 to the first nine months of 2014. These fees can vary based on customer debit card usage, so fluctuations from period to period may occur. As an opportunity to maximize fees, the Company offers a deposit product with a modestly increased interest rate that incentivizes debit card activity.
Correspondent banking fees increased 5%, comparing the third quarter of 2015 to the third quarter of 2014 and increased 23%, comparing the first nine months of 2015 to the first nine months of 2014. Correspondent banking continues to be a core strategy for the Company, as this line of business provides a high level of noninterest bearing deposits that can be used to fund loan growth as well as a steady source of fee income. In 2014, the Company expanded its territory to Wisconsin in order to continue to build this business unit. The Company now serves approximately 172 banks in Iowa, Illinois and Wisconsin.
Participation service fees on commercial loan participations represent fees paid to the Company by the participant(s) to cover servicing expenses incurred by the Company. The fee is generally 25 basis points of the participated loan amount. Additionally, the Company receives a mandated 1% servicing fee on the sold portion of government-guaranteed loans. Participation service fees decreased 8%, comparing the third quarter of 2015 to the third quarter of 2014 and grew 2%, comparing the first nine months of 2015 to the first nine months of 2014.
During the third quarter of 2015, the Company had net gains from the sales of OREO properties totaling $1.1 million. Most notably, this included a $1.2 million gain on the sale of a large OREO property that also reduced NPAs by $3.2 million. Year-to-date, the Company has recognized net gains totaling $1.2 million. Management continues to proactively manage its OREO portfolio in an effort to sell the properties as promptly as is prudent.
Gains on the disposal of leased assets totaled $89 thousand for the third quarter of 2015 and $251 thousand for the first nine months of the year. These gains are generated through the sale of leased assets at QCBT’s wholly-owned subsidiary, m2.
Income on OREO totaled $146 thousand for the third quarter of 2015 and $371 thousand for the first nine months of the year. This is primarily rental income that the Company is earning on foreclosed properties that are held in OREO.
The Company recognized $387 thousand of one-time income during the third quarter of 2015 from the favorable conclusion of a lawsuit.
NONINTEREST EXPENSE
The following tables set forth the various categories of noninterest expense for the three and nine months ended September 30, 2015 and 2014.
Correspondent banking expense
Management places a strong emphasis on overall cost containment and is committed to improving the Company’s general efficiency.
Salaries and employee benefits, which is the largest component of noninterest expense, increased from the third quarter of 2014 to the third quarter of 2015 by 2%. This category increased 8% comparing the first nine months of 2015 to the first nine months of 2014. This increase was largely the result of:
Customary annual salary and benefits increases for the majority of the Company’s employee base.
Higher accrued incentive compensation based on core net income.
Increased cost of providing health insurance to employees, including higher than expected claim experience.
Targeted talent additions. Throughout 2014, the Company added twelve business development/sales officers (four in the Wealth Management area, four in the Commercial Banking area, three in the Correspondent Banking area, and one at m2) in an effort to continue to grow market share. Four additional business development/sales officers (two in the Wealth Management area, one in the Commercial Banking area and one at m2) were added in the first nine months of 2015.
Occupancy and equipment expense increased 4%, comparing the third quarter of 2015 to the same period of the prior year and was flat, comparing the first nine months of 2015 to the same period of the prior year. The increased expense in the third quarter was mostly due to higher depreciation costs related to recently purchased software.
Professional and data processing fees increased 14%, comparing the third quarter of 2015 to the same period in 2014, and increased 4% comparing the first nine months of 2015 to the same period of the prior year. Generally, professional and data processing fees can fluctuate depending on certain one-time project costs. Management will continue to focus on minimizing such one-time costs and driving recurring costs down through contract renegotiation or managed reduction in activity where costs are determined on a usage basis. In the third quarter of 2015, the Company experienced higher consulting fees for one-time projects.
FDIC and other insurance expense decreased 1%, comparing the third quarter of 2015 to the third quarter of 2014 and increased 1%, comparing the first nine months of 2015 to the first nine months of 2014. The slight increase in expense year-to-date was due to an increase in the asset base, upon which the FDIC and other regulatory agencies calculate their fees. On June 16, 2015, the FDIC issued a Notice of Proposed Rulemaking on proposed refinements to the deposit insurance assessment system for small insured depository institutions (generally, those institutions with less than $10 billion in total assets). The refinements become effective the quarter after the reserve ratio of the Deposit Insurance Fund reaches 1.15%. The Company’s initial analysis projects an immaterial change to the annual cost of FDIC insurance based on the Company’s current operations.
Loan/lease expense increased 37%, comparing the third quarter of 2015 to the same quarter of 2014 and increased 20%, comparing the first nine months of 2015 to the same period of 2014. The Company incurred elevated levels of expense for certain existing NPAs in connection with the work-out of these loans and OREO properties. Generally, loan/lease expense has a direct relationship with the level of NPAs; however, it may deviate depending upon the individual NPAs. Management expects these historically elevated levels of expense to decline in line with the declining trend in NPAs. Additionally, a portion of these expenses are offset by the increase in income earned on OREO, as the income and expense related to repossessed properties must be recognized on a gross basis.
Bank service charges, which include costs incurred to provide services to QCBT’s correspondent banking customer portfolio, increased 16% from the third quarter of 2014 to the third quarter of 2015 and increased 14%, comparing the first nine months of 2015 to the first nine months of 2014. The increase was due, in large part, to the success QCBT has had in growing its correspondent banking customer portfolio.
In the second quarter of 2015, the Company incurred $6.9 million of losses on debt extinguishment. These losses relate to the prepayment of certain FHLB advances and whole structured repurchase agreements. Refer to Note 7 to the Consolidated Financial Statements for additional information.
INCOME TAXES
In the third quarter of 2015, the Company recognized tax expense of $2.5 million. For the first nine months of the year, the Company recognized tax expense of $1.4 million. Following is a reconciliation of the expected income tax expense to the income tax expense included in the consolidated statements of income for the three and nine months ended September 30, 2015 and 2014.
For the Three Months Ended September 30,
For the Nine Months Ended September 30,
% of
Pretax
Income
Computed "expected" tax expense
Tax exempt income, net
State income taxes, net of federal benefit, current year
Other*
FINANCIAL CONDITION
Following is a table that represents the major categories of the Company’s balance sheet.
June 30, 2015
Cash, federal funds sold, and interest-bearing deposits
Securities
Net loans/leases
Total borrowings
During the third quarter of 2015, the Company’s total assets increased $32.9 million, or 1%, to a total of $2.6 billion, while total gross loans and leases grew $40.9 million, or 2.4%. The loan and lease growth was funded primarily by deposit growth. Deposits grew $18.6 million, or 1%, during the quarter. Borrowings were flat in the third quarter at $456 million. Stockholders’ equity increased $9.4 million, or 4%, in the current quarter due to the increase to retained earnings from net income, as well as an increase in AOCI.
INVESTMENT SECURITIES
The composition of the Company’s securities portfolio is managed to meet liquidity needs while prioritizing the impact on interest rate risk and maximizing return, while minimizing credit risk. The Company has further diversified the portfolio by decreasing U.S government sponsored agency securities and residential mortgage-backed securities, while increasing municipal securities. Of the latter, the large majority are privately placed debt issuances by municipalities located in the Midwest (with some in or near the Company’s existing markets) and require a thorough underwriting process before investment. Additionally, management will continue to diversify the portfolio with further growth strictly dictated by the pace of growth in deposits and loans. Management expects to fund future loan growth partially with cashflow from the securities portfolio (calls and maturities of government sponsored agencies, paydowns on residential mortgage-backed securities, and/or targeted sales of securities that meet certain criteria as defined by management).
Following is a breakdown of the Company’s securities portfolio by type, the percentage of unrealized gains (losses) to carrying value on the total portfolio, and the portfolio duration:
Securities as a % of Total Assets
Net Unrealized Gains (Losses) as a % of Amortized Cost
Duration (in years)
As a result of fluctuations in longer-term interest rates, the fair value of the Company’s securities portfolio went from a net unrealized loss position of (0.69%) of amortized cost at June 30, 2015 to a net unrealized gain position of 0.41% of amortized cost at September 30, 2015. Management performs an evaluation of the portfolio quarterly to understand the current market value as well as projections of market value in a variety of rising and falling interest rate scenarios. In addition, management has evaluated those securities with an unrealized loss position to determine whether the loss is derived from credit deterioration or the movement in interest rates. The evaluation determined that there were no securities in the portfolio with OTTI. See the “Critical Accounting Policies” section of this report for further discussion on this evaluation.
The duration of the securities portfolio has stayed relatively flat over the past twelve months for two main reasons:
A portion of the government-sponsored agency securities contain call options at the discretion of the issuer whereby the issuer can call the security at par at certain times which vary by individual security. With a decline in longer-term market interest rates, the duration of these callable agency securities shortened, as the likelihood of a call increased.
Offsetting the shortened duration of the callable agencies, management continued the shift in mix with increases in longer-term, higher-yielding, tax-exempt municipals and reductions in lower-yielding government agencies and agency-sponsored mortgage-backed securities. Overall, this shift has led to modest extension of duration with significant increases in interest income (securities yield expanded from 2.74% in the third quarter of 2014 to 3.14% in the third quarter of 2015).
The Company has not invested in commercial mortgage-backed securities or pooled trust preferred securities. Additionally, the Company has not invested in the types of securities subject to the Volcker Rule (a provision of the Dodd-Frank Act).
See Note 2 to the Consolidated Financial Statements for additional information regarding the Company’s investment securities.
LOANS/LEASES
Total loans/leases grew 10.3% on an annualized basis during the first nine months of 2015. The mix of the loan/lease types within the Company’s loan/lease portfolio is presented in the following table.
Direct financing leases
Residential real estate loans
Total loans/leases
As commercial real estate loans have historically been the Company’s largest portfolio segment, management places a strong emphasis on monitoring the composition of the Company’s commercial real estate loan portfolio. For example, management tracks the level of owner-occupied commercial real estate loans relative to non owner-occupied loans. Owner-occupied loans are generally considered to have less risk. As of September 30, 2015 and December 31, 2014, respectively, approximately 36% and 37% of the commercial real estate loan portfolio was owner-occupied.
Over the past several quarters, the Company has been successful in shifting the mix of its commercial loan portfolio by adding more commercial and industrial loans and direct financing leases, and fewer commercial real estate and construction loans. Commercial and industrial loans as a percentage of total loans and leases have grown from 31% at September 30, 2014 to 37% at the end of the current quarter. During the same period, the Company has reduced its investment in commercial real estate loans from 45% to 40%.
Following is a listing of significant industries within the Company’s commercial real estate loan portfolio:
As of June 30,
Lessors of Nonresidential Buildings
Lessors of Residential Buildings
Nursing Care Facilities
Lessors of Other Real Estate Property
Land Subdivision
Hotels
New Car Dealers
Other *
Total Commercial Real Estate Loans
* “Other” consists of all other industries. None of these had concentrations greater than $15.0 million, or approximately 2% of total commercial real estate loans in the most recent period presented.
The Company’s residential real estate loan portfolio consists of the following:
Certain loans that do not meet the criteria for sale into the secondary market. These are often structured as adjustable rate mortgages with maturities ranging from three to seven years to avoid the long-term interest rate risk.
A limited amount of 15-year fixed rate residential real estate loans that meet certain credit guidelines.
The remaining residential real estate loans originated by the Company were sold on the secondary market to avoid the interest rate risk associated with longer term fixed rate loans. Loans originated for this purpose were classified as held for sale and are included in the residential real estate loans above. In addition, the Company has not originated any subprime, Alt-A, no documentation, or stated income residential real estate loans throughout its history.
See Note 3 to the Consolidated Financial Statements for additional information regarding the Company’s loan/lease portfolio.
ALLOWANCE FOR ESTIMATED LOSSES ON LOANS/LEASES
Changes in the allowance for the three and nine months ended September 30, 2015 and 2014 are presented as follows:
The allowance was $25.5 million at September 30, 2015 compared to $23.1 million at December 31, 2014 and $22.8 million at September 30, 2014. Net charge-offs of loans/leases for the third quarter of 2015 were 13 basis points of average loans/leases. Year-to-date net charge-offs were 19 basis points of average loans/leases.
The allowance was determined based on factors that included the overall composition of the loan/lease portfolio, types of loans/leases, past loss experience, loan/lease delinquencies, potential substandard and doubtful credits, economic conditions, collateral positions, governmental guarantees and other factors that, in management’s judgment, deserved evaluation. To ensure that an adequate allowance was maintained, provisions were made based on a number of factors, including the increase in loans/leases and a detailed analysis of the loan/lease portfolio. The loan/lease portfolio is reviewed and analyzed monthly with specific detailed reviews completed on all loans risk-rated worse than “fair quality” and carrying aggregate exposure in excess of $100 thousand. The adequacy of the allowance is monitored by the loan review staff and reported to management and the board of directors.
The Company’s levels of criticized and classified loans are reported in the following table.
Internally Assigned Risk Rating *
Criticized Loans **
Classified Loans ***
* Amounts above include the government guaranteed portion, if any. For the calculation of allowance, the Company assigns internal risk ratings of Pass (Rating 2) for the government guaranteed portion.
** Criticized loans are defined as commercial and industrial and commercial real estate loans with internally assigned risk ratings of 6, 7, or 8, regardless of performance.
*** Classified loans are defined as commercial and industrial and commercial real estate loans with internally assigned risk ratings of 7 or 8, regardless of performance.
The Company experienced a 10% decrease in criticized loans during the third quarter of 2015, while classified loans decreased 6% during this same period. NPLs also decreased 17% during the same period. The Company continues its strong focus on improving credit quality in an effort to limit NPLs.
The following table summarizes the trend in the allowance as a percentage of gross loans/leases and as a percentage of NPLs.
Allowance / Gross Loans/Leases
Allowance / Nonperforming Loans/Leases *
*NPLs consist of nonaccrual loans/leases, accruing loans/leases past due 90 days or more, and accruing TDRs.
In accordance with generally accepted accounting principles for acquisition accounting, the acquired Community National loans were recorded at market value; therefore, there was no allowance associated with Community National’s loans at acquisition.
Although management believes that the allowance at September 30, 2015 was at a level adequate to absorb losses on existing loans/leases, there can be no assurance that such losses will not exceed the estimated amounts or that the Company will not be required to make additional provisions in the future. Unpredictable future events could adversely affect cash flows for both commercial and individual borrowers, which could cause the Company to experience increases in problem assets, delinquencies and losses on loans/leases, and require further increases in the provision. Asset quality is a priority for the Company and its subsidiaries. The ability to grow profitably is in part dependent upon the ability to maintain that quality. The Company continually focuses efforts at its subsidiary banks and leasing company with the intention to improve the overall quality of the Company’s loan/lease portfolio.
See Note 3 to the Consolidated Financial Statements for additional information regarding the Company’s allowance.
NONPERFORMING ASSETS
The table below presents the amounts of NPAs.
2013
Nonaccrual loans/leases (1) (2)
Accruing loans/leases past due 90 days or more
TDRs - accruing
Total nonperforming loans/leases
Other repossessed assets
Total nonperforming assets
Nonperforming loans/leases to total loans/leases
Nonperforming assets to total loans/leases plus repossessed property
Texas ratio (3)
Includes government guaranteed portion of loans, as applicable.
Includes TDRs of $1.9 million at September 30, 2015, $4.1 million at March 31, 2015, $5.0 million at December 31, 2014, $9.8 million at September 30, 2014, and $10.9 million at December 31, 2013.
Texas Ratio = Nonperforming Assets (excluding Other Repossessed Assets) / Tangible Equity plus Allowance. Texas Ratio is a non-GAAP financial measure. Management included this ratio as it is considered by many investors and analysts to be a metric with which to analyze and evaluate asset quality. Other companies may calculate this ratio differently.
NPAs at September 30, 2015 were $20.6 million, which were down $6.5 million from June 30, 2015, and down $18.8 million from September 30, 2014. In addition, the ratio of NPAs to total assets was 0.80% at September 30, 2015, which was down from 1.07% at June 30, 2015, and down from 1.61% at September 30, 2014. During the first nine months of 2015, the Company saw improvement in NPAs due to the payoff or improved performance of nonaccrual loans, charge-offs, as well as the sale of OREO.
The large majority of the NPAs consist of nonaccrual loans/leases, accruing TDRs, and OREO. For nonaccrual loans/leases and accruing TDRs, management has thoroughly reviewed these loans/leases and has provided specific allowances as appropriate.
OREO is carried at the lower of carrying amount or fair value less costs to sell.
Additionally, a portion of several of the nonaccrual loans are guaranteed by the government. At September 30, 2015, government guaranteed amounts of nonaccrual loans totaled approximately $736 thousand, or 7% of the $11.3 million of total nonaccrual loans/leases.
The Company’s lending/leasing practices remain unchanged and asset quality remains a top priority for management.
DEPOSITS
Deposits grew $18.6 million during the third quarter of 2015. The table below presents the composition of the Company’s deposit portfolio.
Noninterest bearing demand deposits
Interest bearing demand deposits
Brokered time deposits
The Company has been successful in growing its noninterest bearing deposit portfolio over the past several years. During the third quarter, noninterest bearing demand deposits decreased 8%, however, they have increased 14% from the most recent year-end.
Quarter-end balances can fluctuate a great deal due to large customer and correspondent bank activity. Management will continue to focus on growing its noninterest bearing deposit portfolio, including its correspondent banking business at QCBT, as well as shifting the mix from brokered and other higher cost deposits to lower cost core deposits.
BORROWINGS
The subsidiary banks offer short-term repurchase agreements to some of their significant customers. Also, the subsidiary banks purchase federal funds for short-term funding needs from the Federal Reserve Bank of Chicago or from their correspondent banks. The table below presents the composition of the Company’s short-term borrowings.
Overnight repurchase agreements with customers
Federal funds purchased
It is management’s intention to continue to reduce its reliance on wholesale funding, including FHLB advances, wholesale structured repurchase agreements, and brokered time deposits. Replacement of this funding with core deposits helps to reduce interest expense as the wholesale funding tends to be higher cost. However, the Company may choose to utilize wholesale funding sources to supplement funding needs, as this is a way for the Company to effectively and efficiently manage interest rate risk.
See Notes 5, 6 and 7 to the Consolidated Financial Statements for additional information regarding FHLB advances, other borrowings and the balance sheet restructuring that occurred in the second quarter of 2015.
STOCKHOLDERS’ EQUITY
The table below presents the composition of the Company’s stockholders’ equity.
Common stock
Additional paid in capital
AOCI
Less: Treasury stock
TCE* / TA
TCE/TA excluding AOCI
*TCE is defined as total common stockholders’ equity excluding goodwill and other intangibles. This ratio is a non-GAAP financial measure.
The following table presents the rollforward of stockholders’ equity for the three and nine months ended September 30, 2015 and 2014, respectively.
For the quarter ended
Beginning balance
Preferred and common cash dividends declared
Proceeds from issuance of 3,680,000 shares of common stock, net of costs
Redemption of 15,000 shares of Series F Preferred Stock
Redemption of 14,867 shares of Series F Preferred Stock
Ending balance
*Includes mostly common stock issued for options exercised and the employee stock purchase plans, as well as stock-based compensation.
Refer to Note 7 of the Consolidated Financial Statements for additional information regarding the common stock issuance in the second quarter of 2015.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity measures the ability of the Company to meet maturing obligations and its existing commitments, to withstand fluctuations in deposit levels, to fund its operations, and to provide for customers’ credit needs. The Company monitors liquidity risk through contingency planning stress testing on a regular basis. The Company seeks to avoid over-concentration of funding sources and to establish and maintain contingent funding facilities that can be drawn upon if normal funding sources become unavailable. One source of liquidity is cash and short-term assets, such as interest-bearing deposits in other banks and federal funds sold, which averaged $118.5 million during the third quarter of 2015, $118.8 million during 2014 and $102.8 million during 2013. The Company’s on balance sheet liquidity position can fluctuate based on short-term activity in deposits and loans.
The subsidiary banks have a variety of sources of short-term liquidity available to them, including federal funds purchased from correspondent banks, FHLB advances, wholesale structured repurchase agreements, brokered time deposits, lines of credit, borrowing at the Federal Reserve Discount Window, sales of securities available for sale, and loan/lease participations or sales. The Company also generates liquidity from the regular principal payments and prepayments made on its loan/lease portfolio, and on the regular monthly payments on its securities portfolio (both residential mortgage-backed securities and municipal securities).
The Company has emphasized growing the number and amount of lines of credit in an effort to strengthen this contingent source of liquidity. Additionally, the Company maintains a $40.0 million secured revolving credit note with a variable interest rate and a maturity of June 30, 2016. At September 30, 2015, the Company had not borrowed on this revolving credit note and had the full amount available.
The Company currently has $272.0 million in correspondent banking deposits spread over 172 relationships. While the Company feels that these funds are very stable, there is the potential for large fluctuations that can impact liquidity. Seasonality and the liquidity needs of these correspondent banks can impact balances. Management closely monitors these fluctuations and runs stress scenarios to measure the impact on liquidity and interest rate risk with various levels of correspondent deposit run-off.
Investing activities used cash of $46.2 million during the first nine months of 2015 and used $41.0 million for the same period of 2014. Proceeds from calls, maturities, paydowns, and sales of securities were $264.8 million for the first nine months of 2015, compared to $115.7 million for the same period of 2014. Purchases of securities used cash of $200.2 million for the first nine months of 2015, compared to $48.5 million for the same period of 2014. Of the $200.2 million in securities purchases, $122.5 million was short-term in nature and purchased for collateral needs. As of September 30, 2015, all of these short-term securities have matured. The net increase in loans/leases used cash of $129.4 million for the first nine months of 2015 compared to $115.6 million for the same period of 2014.
Financing activities provided cash of $25.9 million for the first nine months of 2015, compared to $22.5 million for same period of 2014. Net increases in deposits totaled $175.7 million for the first nine months of 2015, compared to $66.9 million for the same period of 2014. During the first nine months of 2015, the Company’s short-term borrowings decreased $100.8 million, while they increased $12.9 million for the same period of 2014. During the first nine months of 2015, the Company used $110.4 million to prepay select FHLB advances and other borrowings. In the same period, the Company received $63.5 million of proceeds from the public common stock offering of 3.7 million shares of common stock.
Total cash provided by operating activities was $23.1 million for the first nine months of 2015, compared to $18.9 million for the same period of 2014.
Throughout its history, the Company has secured additional capital through various sources, including the issuance of common and preferred stock, as well as trust preferred securities. Trust preferred securities are reported on the Company’s balance sheet as liabilities, but currently qualify for treatment as regulatory capital.
The following table presents the details of the trust preferred securities issued and outstanding as of September 30, 2015.
Name
Date Issued
Amount Issued
as of
9/30/15
12/31/2014
QCR Holdings Statutory Trust II
February 2004
$12,372,000
2.85% over 3-month LIBOR
3.13%
3.08%
QCR Holdings Statutory Trust III
8,248,000
QCR Holdings Statutory Trust IV
May 2005
5,155,000
1.80% over 3-month LIBOR
2.09%
2.03%
QCR Holdings Statutory Trust V
February 2006
10,310,000
1.55% over 3-month LIBOR
1.84%
1.78%
Community National Statutory Trust II
September 2004
3,093,000
2.17% over 3-month LIBOR
2.52%
2.42%
Community National Statutory Trust III
March 2007
3,609,000
1.75% over 3-month LIBOR
1.99%
$42,787,000
Weighted Average Rate
2.56%
2.50%
The Company assumed the trust preferred securities originally issued by Community National in connection with its acquisition in May 2013. As a result of acquisition accounting, the liabilities were recorded at fair value upon acquisition with the resulting discount being accreted as interest expense on a level yield basis over the expected term. The original discount totaled $2.6 million. As of September 30, 2015, the remaining discount was $2.3 million.
Refer to Note 8 to the Consolidated Financial Statements for information regarding regulatory capital requirements and restrictions on dividends.
SPECIAL NOTE CONCERNING FORWARD-LOOKING STATEMENTS
Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995. This document (including information incorporated by reference) contains, and future oral and written statements of the Company and its management may contain, forward-looking statements, within the meaning of such term in the Private Securities Litigation Reform Act of 1995, with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company’s management and on information currently available to management, are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “bode,” “predict,” “suggest,” “project,” “appear,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should,” “likely,” or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events.
The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. The factors which could have a material adverse effect on the Company’s operations and future prospects are detailed in the “Risk Factors” sections included under Item 1A of Part I of the Company’s Form 10-K and Item 1A of Part II of this report. In addition to the risk factors described in that section, there are other factors that may impact any public company, including the Company, which could have a material adverse effect on the Company’s operations and future prospects of the Company and its subsidiaries.
These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company, like other financial institutions, is subject to direct and indirect market risk. Direct market risk exists from changes in interest rates. The Company’s net income is dependent on its net interest income. Net interest income is susceptible to interest rate risk to the degree that interest-bearing liabilities mature or reprice on a different basis than interest-earning assets. When interest-bearing liabilities mature or reprice more quickly than interest-earning assets in a given period, a significant increase in market rates of interest could adversely affect net interest income. Similarly, when interest-earning assets mature or reprice more quickly than interest-bearing liabilities, falling interest rates could result in a decrease in net interest income.
In an attempt to manage the Company’s exposure to changes in interest rates, management monitors the Company’s interest rate risk. Each subsidiary bank has an asset/liability management committee of the board of directors that meets quarterly to review the bank’s interest rate risk position and profitability, and to make or recommend adjustments for consideration by the full board of each bank.
Internal asset/liability management teams consisting of members of the subsidiary banks’ management meet weekly to manage the mix of assets and liabilities to maximize earnings and liquidity and minimize interest rate and other risks. Management also reviews the subsidiary banks’ securities portfolios, formulates investment strategies, and oversees the timing and implementation of transactions to assure attainment of the board's objectives in an effective manner. Notwithstanding the Company’s interest rate risk management activities, the potential for changing interest rates is an uncertainty that can have an adverse effect on net income.
In adjusting the Company’s asset/liability position, the board of directors and management attempt to manage the Company’s interest rate risk while maintaining or enhancing net interest margins. At times, depending on the level of general interest rates, the relationship between long-term and short-term interest rates, market conditions and competitive factors, the board of directors and management may decide to increase the Company’s interest rate risk position somewhat in order to increase its net interest margin. The Company’s results of operations and net portfolio values remain vulnerable to increases in interest rates and to fluctuations in the difference between long-term and short-term interest rates.
One method used to quantify interest rate risk is a short-term earnings at risk summary, which is a detailed and dynamic simulation model used to quantify the estimated exposure of net interest income to sustained interest rate changes. This simulation model captures the impact of changing interest rates on the interest income received and interest expense paid on all interest sensitive assets and liabilities reflected on the Company’s consolidated balance sheet. This sensitivity analysis demonstrates net interest income exposure annually over a five-year horizon, assuming no balance sheet growth and various interest rate scenarios including no change in rates; 200, 300, 400, and 500 basis point upward shifts; and a 100 basis point downward shift in interest rates, where interest-bearing assets and liabilities reprice at their earliest possible repricing date.
The model assumes parallel and pro rata shifts in interest rates over a twelve-month period for the 200 basis point upward shift and 100 basis point downward shift. For the 400 basis point upward shift, the model assumes a parallel and pro rata shift in interest rates over a twenty-four month period. For the 500 basis point upward shift, the model assumes a flattening and pro rata shift in interest rates over a twelve-month period where the short-end of the yield curve shifts upward greater than the long-end of the yield curve.
Further, in recent years, the Company added additional interest rate scenarios where interest rates experience a parallel and instantaneous shift upward 100, 200, 300, and 400 basis points and a parallel and instantaneous shift downward 100 basis points. The Company will run additional interest rate scenarios on an as-needed basis.
The asset/liability management committees of the subsidiary bank boards of directors have established policy limits of a 10% decline in net interest income for the 200 basis point upward parallel shift and the 100 basis point downward parallel shift. For the 300 basis point upward shock, the established policy limit has been increased to 25% decline in net interest income. The increased policy limit is appropriate as the shock scenario is extreme and unlikely and warrants a higher limit than the more realistic and traditional parallel/pro-rata shift scenarios.
Application of the simulation model analysis for select interest rate scenarios at the most recent quarter-end available is presented in the following table:
NET INTEREST INCOME EXPOSURE in YEAR 1
INTEREST RATE SCENARIO
POLICY LIMIT
As of June 30, 2015
As of December 31, 2013
100 basis point downward shift
200 basis point upward shift
300 basis point upward shock
The simulation is within the board-established policy limits for all three scenarios. Additionally, for all of the various interest rate scenarios modeled and measured by management (as described above), the results at June 30, 2015 (the most recent quarter available) were within established risk tolerances as established by policy or by best practice (if the interest rate scenario didn’t have a specific policy limit).
In 2014, the Company executed two interest rate cap transactions, each with a notional value of $15.0 million, for a total of $30.0 million. The interest rate caps purchased essentially set a ceiling to the interest rate paid on the $30.0 million of short-term FHLB advances that are being hedged, minimizing the interest rate risk associated with rising interest rates. The Company will continue to analyze and evaluate similar transactions as an alternative and cost effective way to mitigate interest rate risk.
Interest rate risk is considered to be one of the most significant market risks affecting the Company. For that reason, the Company engages the assistance of a national consulting firm and its risk management system to monitor and control the Company’s interest rate risk exposure. Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company’s business activities.
CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures. An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) promulgated under the Exchange Act of 1934) as of September 30, 2015. Based on that evaluation, the Company’s management, including the Chief Executive Officer and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective, as of the end of the period covered by this report, to ensure that information required to be disclosed in the reports filed and submitted under the Exchange Act was recorded, processed, summarized and reported as and when required.
Changes in Internal Control over Financial Reporting. There have been no significant changes to the Company’s internal control over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1 Legal Proceedings
There are no material pending legal proceedings to which the Company or any of its subsidiaries is a party other than ordinary routine litigation incidental to their respective businesses.
Item 1A Risk Factors
Other than the risk factor listed below, there have been no material changes in the risk factors applicable to the Company from those disclosed in Part I, Item 1.A. “Risk Factors,” in the Company’s 2014 Annual Report on Form 10-K. Please refer to that section of the Company’s Form 10-K for disclosures regarding the risks and uncertainties related to the Company’s business.
Our correspondent banking business subjects us to concentration and lending risks.
We have significantly grown our portfolio of correspondent bank customers in recent years. As of September 30, 2015, noninterest-bearing correspondent bank deposits totaled approximately $272.0 million, which was 15% of our total deposits and 11% of our total assets. We closely monitor this concentration using measures such as detailed trend reporting on an individual bank basis. Should the liquidity needs change for our downstream correspondent banks and the level of the noninterest-bearing deposits they have with us decline, our liquidity would be negatively impacted. We may have to replace the funding with higher cost deposits or other borrowings, which could have a material adverse impact on our liquidity, results of operations and financial condition.
As part of our relationship with some of our correspondent banking customers, in addition to credit arrangements at the depository institution, we also make secured loans to the parent bank holding company. As of September 30, 2015, we had approximately $67.0 million in loans outstanding to correspondent banking customers. Currently, consistent with market practices in this business line, we seek to structure these loans as senior secured loans and, with respect to our loans to bank holding companies, we take the capital stock of the subsidiary depository institution as collateral. Notwithstanding our efforts to manage the credit risks associated with our correspondent banking business, the failure or financial distress of a depository institution owned by a bank holding company to whom we have made a loan may result in an impairment of our loan and lease losses. To the extent that our correspondent banking customers experience deterioration in their financial condition, our results of operations and financial condition may be adversely impacted.
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds
None
PART II - OTHER INFORMATION – continued
Item 3 Defaults Upon Senior Securities
Item 4 Mine Safety Disclosures
Not applicable
Item 5 Other Information
PART II - OTHER INFORMATION - continued
Item 6 Exhibits
31.1
Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a).
31.2
Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a).
32.1
Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2
Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101
Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets as of September 30, 2015 and December 31, 2014; (ii) Consolidated Statements of Income for the three and nine months ended September 30, 2015 and September 30, 2014; (iii) Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2015 and September 30, 2014; (iv) Consolidated Statements of Changes in Stockholders’ Equity for the three and nine months ended September 30, 2015 and September 30, 2014; (v) Consolidated Statements of Cash Flows for the nine months ended September 30, 2015 and September 30, 2014; and (vi) Notes to the Consolidated Financial Statements.
SIGNATURES
Pursuant to the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
(Registrant)
Date
November 6, 2015
/s/ Douglas M. Hultquist
Douglas M. Hultquist, President
Chief Executive Officer
/s/ Todd A. Gipple
Todd A. Gipple, Executive Vice President
Chief Operating Officer
Chief Financial Officer
/s/ Elizabeth A. Grabin
Elizabeth A. Grabin, Vice President
Controller & Director of Financial Reporting
Principal Accounting Officer