Table of Contents
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 June 30, 2018
[ ] 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) 736‑3580
(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,” “smaller reporting company” and “emerging growth company” in Rule 12b‑2 of the Exchange Act. (Check one):
Large accelerated filer [ ]
Accelerated filer [ X ]
Non-accelerated filer [ ]
Smaller reporting company [ ]
Emerging growth company [ ]
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
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 August 1, 2018, the Registrant had outstanding 15,664,417 shares of common stock, $1.00 par value per share.
QCR HOLDINGS, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
PageNumber(s)
Part I FINANCIAL INFORMATION
Item 1 Consolidated Financial Statements (Unaudited)
Consolidated Balance SheetsAs of June 30, 2018 and December 31, 2017
Consolidated Statements of IncomeFor the Three Months Ended June 30, 2018 and 2017
Consolidated Statements of IncomeFor the Six Months Ended June 30, 2018 and 2017
Consolidated Statements of Comprehensive IncomeFor the Three and Six Months Ended June 30, 2018 and 2017
Consolidated Statements of Changes in Stockholders' EquityFor the Three and Six Months Ended June 30, 2018 and 2017
Consolidated Statements of Cash FlowsFor the Six Months Ended June 30, 2018 and 2017
Notes to Consolidated Financial Statements
Note 1. Summary of Significant Accounting Policies
Note 2. Investment Securities
Note 3. Loans/Leases Receivable
Note 4. Derivatives
Note 5. Earnings Per Share
Note 6. Fair Value
Note 7. Business Segment Information
Note 8. Regulatory Capital Requirements
Note 9. Revenue Recognition
Note 10. Mergers and Acquisitions
Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations
Introduction
General
Executive Overview
Long-Term Financial Goals
Strategic Developments
GAAP to Non-GAAP Reconciliations
Net Interest Income (Tax Equivalent Basis)
Critical Accounting Policies
Results of Operations
Interest Income
2
Interest Expense
Provision for Loan/Lease Losses
Noninterest Income
Noninterest Expense
Income Taxes
Financial Condition
Investment Securities
Loans/Leases
Allowance for Estimated Losses on Loans/Leases
Nonperforming Assets
Deposits
Borrowings
Stockholders' Equity
Liquidity and Capital Resources
Special Note Concerning Forward-Looking Statements
Item 3 Quantitative and Qualitative Disclosures About Market Risk
Item 4 Controls and Procedures
Part II OTHER INFORMATION
Item 1 Legal Proceedings
Item 1A Risk Factors
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds
Item 3 Defaults upon Senior Securities
Item 4 Mine Safety Disclosures
Item 5 Other Information
Item 6 Exhibits
Signatures
Throughout this Quarterly Report on Form 10-Q, we use certain acronyms and abbreviations, as defined in Note 1.
3
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
As of June 30, 2018 and December 31, 2017
June 30,
December 31,
2018
2017
Assets
Cash and due from banks
$
69,069,403
75,721,663
Federal funds sold
10,866,000
30,197,000
Interest-bearing deposits at financial institutions
40,801,388
55,765,012
Securities held to maturity, at amortized cost
400,052,344
379,474,205
Securities available for sale, at fair value
257,944,671
272,907,907
Total securities
657,997,015
652,382,112
Loans receivable held for sale
1,033,700
645,001
Loans/leases receivable held for investment
3,113,758,723
2,963,840,399
Gross loans/leases receivable
3,114,792,423
2,964,485,400
Less allowance for estimated losses on loans/leases
(37,545,076)
(34,355,728)
Net loans/leases receivable
3,077,247,347
2,930,129,672
Bank-owned life insurance
59,876,754
59,059,494
Premises and equipment, net
64,472,319
62,838,255
Restricted investment securities
23,888,600
19,782,525
Other real estate owned, net
12,750,023
13,558,308
Goodwill
28,090,897
28,334,092
Core deposit intangible
8,469,851
9,078,953
Other assets
53,353,108
45,817,687
Total assets
4,106,882,705
3,982,664,773
Liabilities and Stockholders' Equity
Liabilities:
Deposits:
Noninterest-bearing
746,821,779
789,547,696
Interest-bearing
2,551,454,248
2,477,107,360
Total deposits
3,298,276,027
3,266,655,056
Short-term borrowings
17,585,605
13,993,122
Federal Home Loan Bank advances
254,100,000
192,000,000
Other borrowings
71,125,000
66,000,000
Junior subordinated debentures
37,580,881
37,486,487
Other liabilities
58,627,027
53,242,979
Total liabilities
3,737,294,540
3,629,377,644
Stockholders' Equity:
Preferred stock, $1 par value; shares authorized 250,000 June 2018 and December 2017- No shares issued or outstanding
—
Common stock, $1 par value; shares authorized 20,000,000 June 2018 - 13,973,940 shares issued and outstanding December 2017 - 13,918,168 shares issued and outstanding
13,973,940
13,918,168
Additional paid-in capital
190,533,240
189,077,550
Retained earnings
171,955,296
151,962,661
Accumulated other comprehensive loss:
Securities available for sale
(6,058,893)
(866,223)
Derivatives
(815,418)
(805,027)
Total stockholders' equity
369,588,165
353,287,129
Total liabilities and stockholders' equity
See Notes to Consolidated Financial Statements (Unaudited)
4
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three Months Ended June 30,
Interest and dividend income:
Loans/leases, including fees
35,407,851
28,114,729
Securities:
Taxable
1,593,660
1,260,575
Nontaxable
3,295,046
2,688,243
228,314
219,714
211,902
131,890
61,441
38,117
Total interest and dividend income
40,798,214
32,453,268
Interest expense:
6,528,340
2,990,603
62,503
19,157
882,118
354,213
732,881
695,669
507,876
346,929
Total interest expense
8,713,718
4,406,571
Net interest income
32,084,496
28,046,697
Provision for loan/lease losses
2,300,735
2,022,993
Net interest income after provision for loan/lease losses
29,783,761
26,023,704
Noninterest income:
Trust department fees
2,057,987
1,692,001
Investment advisory and management fees
1,057,666
868,835
Deposit service fees
1,610,403
1,458,359
Gains on sales of residential real estate loans, net
101,772
112,628
Gains on sales of government guaranteed portions of loans, net
87,053
Swap fee income
1,648,885
327,577
Securities gains, net
38,464
Earnings on bank-owned life insurance
399,273
459,359
Debit card fees
844,286
743,521
Correspondent banking fees
212,530
200,057
Other
979,464
794,664
Total noninterest income
8,912,266
6,782,518
Noninterest expense:
Salaries and employee benefits
15,804,016
12,930,944
Occupancy and equipment expense
3,132,658
2,698,336
Professional and data processing fees
2,771,223
2,340,699
Acquisition costs
413,602
Post-acquisition compensation, transition and integration costs
165,314
FDIC insurance, other insurance and regulatory fees
840,458
645,277
Loan/lease expense
260,089
260,284
Net cost of (income from) operations of other real estate
(70,190)
27,957
Advertising and marketing
753,084
567,588
Bank service charges
466,091
447,445
Correspondent banking expense
204,337
201,693
CDI amortization
304,551
230,867
1,324,590
1,053,539
Total noninterest expense
26,369,823
21,404,629
Net income before income taxes
12,326,204
11,401,593
Federal and state income tax expense
1,880,819
2,635,576
Net income
10,445,385
8,766,017
Basic earnings per common share
0.75
0.67
Diluted earnings per common share
0.73
0.65
Weighted average common shares outstanding
13,919,565
13,170,283
Weighted average common and common equivalent shares outstanding
14,232,423
13,516,592
Cash dividends declared per common share
0.06
0.05
5
Six Months Ended June 30,
69,621,583
55,326,146
3,149,544
2,402,810
6,584,048
5,335,965
425,317
418,366
446,246
262,320
117,772
52,760
80,344,510
63,798,367
11,409,489
5,223,359
95,416
43,117
1,946,231
757,682
1,451,057
1,378,877
954,903
679,752
15,857,096
8,082,787
64,487,414
55,715,580
4,840,574
4,128,102
59,646,840
51,587,478
4,295,068
3,432,208
2,010,010
1,830,434
3,141,856
2,774,749
202,587
208,951
358,434
1,037,694
2,607,579
441,097
817,260
929,046
1,610,394
1,446,322
477,357
445,246
1,933,170
1,482,061
17,453,715
14,066,272
Noninterest expenses:
31,781,991
26,238,275
6,198,469
5,200,555
5,478,939
4,424,091
506,141
1,596,669
1,266,519
550,836
553,822
61,552
42,187
1,446,323
1,177,019
906,662
871,346
409,091
400,044
609,102
461,733
2,522,231
2,042,155
Total noninterest expenses
52,233,320
42,677,746
Income before income taxes
24,867,235
22,976,004
3,871,889
5,025,022
20,995,346
17,950,982
1.51
1.36
1.48
1.33
13,904,113
13,151,833
14,219,003
13,502,505
0.12
0.10
6
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
Three and Six Months Ended June 30, 2018 and 2017
Other comprehensive income (loss):
Unrealized gains (losses) on securities available for sale:
Unrealized holding gains (losses) arising during the period before tax
(1,512,488)
1,170,310
Less reclassification adjustment for gains included in net income before tax
1,131,846
Unrealized gains (losses) on derivatives:
(322,937)
(132,352)
Less reclassification adjustment for ineffectiveness and caplet amortization before tax
177,688
(136,639)
(500,625)
4,287
Other comprehensive income (loss), before tax
(2,013,113)
1,136,133
Tax expense (benefit)
(678,492)
434,394
Other comprehensive income (loss), net of tax
(1,334,621)
701,739
Comprehensive income
9,110,764
9,467,756
(6,878,601)
1,768,500
Less reclassification adjustment for gains (losses) included in net income before tax
Less reclassification adjustment for adoption of ASU 2016-01
855,039
(6,023,562)
1,730,036
(172,459)
(177,554)
97,173
(259,452)
(269,632)
81,898
(6,293,194)
1,811,934
(1,757,033)
699,456
(4,536,161)
1,112,478
16,459,185
19,063,460
7
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED)
Accumulated
Additional
Common
Paid-In
Retained
Comprehensive
Stock
Capital
Earnings
(Loss)
Total
Balance December 31, 2017
(1,671,250)
10,549,961
Other comprehensive loss, net of tax
(3,201,540)
Impact of adoption of ASU 2016-01
666,900
(666,900)
Common cash dividends declared, $0.06 per share
(833,730)
Issuance of 2,669 shares of common stock as a result of stock purchased under the Employee Stock Purchase Plan
2,669
100,262
102,931
Issuance of 13,074 shares of common stock as a result of stock options exercised
13,074
192,522
205,596
Stock-based compensation expense
495,493
Restricted stock awards - 6,860 shares of common stock
6,860
(6,860)
Exchange of 3,814 shares of common stock in connection with stock options exercised and restricted stock vested
(3,814)
(174,109)
(177,923)
Balance, March 31, 2018
13,936,957
189,684,858
162,345,792
(5,539,690)
360,427,917
(835,881)
Issuance of 5,728 shares of common stock as a result of stock purchased under the Employee Stock Purchase Plan
5,728
215,173
220,901
Issuance of 26,641 shares of common stock as a result of stock options exercised
26,641
362,292
388,933
291,912
Restricted stock awards - 3,972 shares of common stock
3,972
(3,972)
Exchange of 642 shares of common stock in connection with stock options exercised and restricted stock vested
642
(17,023)
(16,381)
Balance, June 30, 2018
(6,874,311)
Balance December 31, 2016
13,106,845
156,776,642
118,616,901
(2,459,589)
286,040,799
9,184,965
410,739
Common cash dividends declared, $0.05 per share
(656,574)
Issuance of 3,573 shares of common stock as a result of stock purchased under the Employee Stock Purchase Plan
3,573
83,091
86,664
Issuance of 44,284 shares of common stock as a result of stock options exercised
44,284
630,290
674,574
388,753
Restricted stock awards - 13,289 shares of common stock
13,289
(13,289)
Exchange of 6,772 shares of common stock in connection with stock options exercised and restricted stock vested
(6,772)
(283,518)
(290,290)
Balance, March 31, 2017
13,161,219
157,581,969
127,145,292
(2,048,850)
295,839,630
(657,003)
Issuance of 4,582 shares of common stock as a result of stock purchased under the Employee Stock Purchase Plan
4,582
170,061
174,643
Issuance of 8,027 shares of common stock as a result of stock options exercised
8,027
109,392
117,419
168,314
Restricted stock awards - 2,000 shares of common stock
2,000
(2,000)
Exchange of 594 shares of common stock in connection with stock options exercised and restricted stock vested
(594)
(26,730)
(27,324)
Balance, June 30, 2017
13,175,234
158,001,006
135,254,306
(1,347,111)
305,083,435
8
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six Months Ended June 30, 2018 and 2017
CASH FLOWS FROM OPERATING ACTIVITIES
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation
2,074,618
1,847,963
787,405
557,067
Deferred compensation expense accrued
1,004,010
724,422
Losses on other real estate owned, net
118,159
3,596
Amortization of premiums on securities, net
828,972
1,005,121
(38,464)
Loans originated for sale
(21,899,515)
(32,130,683)
Proceeds on sales of loans
22,071,837
33,807,027
Gains on sales of residential real estate loans
(202,587)
(208,951)
Gains on sales of government guaranteed portions of loans
(358,434)
(1,037,694)
Amortization of core deposit intangible
Accretion of acquisition fair value adjustments, net
(496,561)
(3,578,379)
Increase in cash value of bank-owned life insurance
(817,260)
(929,046)
Increase (decrease) in other assets
(5,878,796)
3,412,207
Decrease (increase) in other liabilities
5,688,375
(7,059,305)
Net cash provided by operating activities
29,365,245
18,915,698
CASH FLOWS FROM INVESTING ACTIVITIES
Net decrease in federal funds sold
19,331,000
3,074,000
Net decrease in interest-bearing deposits at financial institutions
14,963,624
10,777,600
Proceeds from sales of other real estate owned
736,370
487,815
Activity in securities portfolio:
Purchases
(54,950,828)
(85,169,891)
Calls, maturities and redemptions
12,618,640
33,079,683
Paydowns
27,187,398
21,606,220
Sales
13,554,075
Activity in restricted investment securities:
(4,215,275)
(2,407,600)
Redemptions
109,200
1,300,700
Net increase in loans/leases originated and held for investment
(150,992,827)
(146,365,255)
Purchase of premises and equipment
(2,666,098)
(2,422,880)
Net cash used in investing activities
(137,878,796)
(152,485,533)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposit accounts
31,652,051
201,041,035
Net increase (decrease) in short-term borrowings
3,592,483
(21,753,994)
Activity in Federal Home Loan Bank advances:
Calls and maturities
(10,000,000)
(6,000,000)
Net change in short-term and overnight advances
72,100,000
(25,000,000)
Activity in other borrowings:
Proceeds from other borrowings
9,000,000
Calls, maturities and scheduled principal payments
(3,875,000)
(8,000,000)
Payment of cash dividends on common stock
(1,526,604)
(1,179,146)
Proceeds from issuance of common stock, net
918,361
1,053,300
Net cash provided by financing activities
101,861,291
140,161,195
Net decrease in cash and due from banks
(6,652,260)
6,591,360
Cash and due from banks, beginning
70,569,993
Cash and due from banks, ending
77,161,353
(Continued)
9
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) - continued
Supplemental disclosure of cash flow information, cash payments for:
Interest
12,303,768
7,876,668
Income/franchise taxes
1,010,097
7,450,738
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
(194,304)
(317,614)
Transfers of loans to other real estate owned
46,244
141,828
Due to broker for purchases of securities
(4,662,631)
Dividends payable
835,881
657,003
Decrease (increase) in the fair value of interest rate swap assets and liabilities
1,774,502
(209,185)
Transfer of equity securities from securities available for sale to other assets at fair value
2,614,261
10
Part I
Item 1
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
June 30, 2018
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, 2017, included in the Company's Annual Report on Form 10‑K filed with the SEC on March 12, 2018. 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 GAAP 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 June 30, 2018 are not necessarily indicative of the results expected for the year ending December 31, 2018, or for any other period.
The acronyms and abbreviations identified below are used throughout this Quarterly Report on Form 10‑Q. It may be helpful to refer back to this page as you read this report.
Allowance: Allowance for estimated losses on loans/leases
Guaranty: Guaranty Bankshares, Ltd.
AOCI: Accumulated other comprehensive income (loss)
Guaranty Bank: Guaranty Bank and Trust Company
AFS: Available for sale
HTM: Held to maturity
ASC: Accounting Standards Codification
m2: m2 Lease Funds, LLC
ASU: Accounting Standards Update
NIM: Net interest margin
Bates Companies: Bates Financial Advisors, Inc., Bates
NPA: Nonperforming asset
Financial Services, Inc., Bates Securities, Inc. and
NPL: Nonperforming loan
Bates Financial Group, Inc.
OREO: Other real estate owned
BOLI: Bank-owned life insurance
OTTI: Other-than-temporary impairment
Caps: Interest rate cap derivatives
PCI: Purchased credit impaired
CDI: Core deposit intangible
Provision: Provision for loan/lease losses
Community National: Community National Bancorporation
QCBT: Quad City Bank & Trust Company
CRBT: Cedar Rapids Bank & Trust Company
RB&T: Rockford Bank & Trust Company
CRE: Commercial real estate
ROAA: Return on Average Assets
CSB: Community State Bank
SBA: U.S. Small Business Administration
C&I: Commercial and industrial
SEC: Securities and Exchange Commission
Dodd-Frank Act: Dodd-Frank Wall Street Reform and
SFC Bank: Springfield First Community Bank
Consumer Protection Act
Springfield Bancshares: Springfield Bancshares, Inc.
EPS: Earnings per share
TA: Tangible assets
Exchange Act:Securities Exchange Act of 1934, as amended
Tax Act: Tax Cuts and Jobs Act of 2017
FASB: Financial Accounting Standards Board
TCE: Tangible common equity
FDIC: Federal Deposit Insurance Corporation
TDRs: Troubled debt restructurings
FHLB: Federal Home Loan Bank
TEY: Tax equivalent yield
FRB: Federal Reserve Bank of Chicago
The Company: QCR Holdings, Inc.
GAAP: Generally Accepted Accounting Principles
USDA: U.S. Department of Agriculture
11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - continued
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, with the exception of SFC Bank which was acquired by merger on July 1, 2018, and include the accounts of four commercial banks: QCBT, CRBT, CSB and RB&T. All are state-chartered commercial banks and all are members of the Federal Reserve system. The Company also engages in direct financing lease contracts through m2, a wholly-owned subsidiary of QCBT. All material intercompany transactions and balances have been eliminated in consolidation.
The acquisition of Guaranty Bank, headquartered in Cedar Rapids, Iowa occurred on October 2, 2017 and Guaranty Bank was merged into CRBT on December 2, 2017. The financial results for the periods since acquisition are included in this report. See Note 2 of the Company's Annual Report on Form 10‑K for the year ended December 31, 2017 for additional information about the acquisition.
On July 1, 2018, the Company completed its previously announced merger with Springfield Bancshares, the holding company of SFC Bank, headquartered in Springfield, Missouri. The financial results of Springfield Bancshares and SFC Bank are not included in this report because the closing was effective July 1, 2018. See Note 10 to the Consolidated Financial Statements for additional information about the merger.
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 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 was adopted by the Company on January 1, 2018 and did not have a significant impact on the Company's consolidated financial statements.
In January 2016, FASB issued ASU 2016‑01, Financial Instruments–Overall. ASU 2016‑01 makes targeted adjustments to GAAP by eliminating the AFS classification for equity securities and requiring equity investments to be measured at fair value with changes in fair value recognized in net income. The standard also requires public business entities to use the exit price notion when measuring fair value of financial instruments for disclosure purposes. The standard clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to AFS securities in combination with the entity's other deferred tax assets. It also requires an entity to present separately (within other comprehensive income) the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. Additionally, the standard eliminates the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet. Upon adoption of ASU 2016‑01 by the Company on January 1, 2018, the fair value of the Company's loan portfolio is now presented using an exit price method. Also, the Company is no longer required to disclose the methodologies used for estimating fair value of financial assets and liabilities that are not measured at fair value on a recurring or nonrecurring basis. The remaining requirements of this update had no significant impact on the consolidated financial statements.
In February 2016, the FASB issued ASU 2016‑02, Leases. Under ASU 2016‑02, lessees will be required to recognize a lease liability measured on a discounted basis and a right-of-use asset for all leases (with the exception of short-term leases). Lessor accounting is largely unchanged under ASU 2016‑02. However, the definition of initial direct costs was updated to include only initial direct costs that are considered incremental. This change in definition will change the manner in which the Company recognizes the costs associated with originating leases. ASU 2016‑02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is
12
permitted for all entities. The Company has analyzed the impact of adoption and has concluded that it will not have a significant impact on the consolidated financial statements.
In June 2016, the FASB issued ASU 2016‑13, Financial Instruments – Credit Losses. Under the standard, assets measured at amortized costs (including loans, leases and AFS securities) will be presented at the net amount expected to be collected. Rather than the “incurred” model that is currently being utilized, the standard will require the use of a forward-looking approach to recognizing all expected credit losses at the beginning of an asset's life. For public companies, ASU 2016‑13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Companies may choose to early adopt for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is in the process of analyzing the impact of adoption on the Company's consolidated financial statements.
In February 2018, the FASB issued ASU 2018‑02, Income Statement – Reporting Comprehensive Income: Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. Under the standard, entities are allowed to make a one-time reclassification from AOCI to retained earnings for the effect of remeasuring deferred tax liabilities and assets originally recorded in other comprehensive income as a result of the change in the federal tax rate as defined by the Tax Act. ASU 2018‑02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those years. Companies may choose to early adopt for fiscal years or interim periods that have not been issued or made available for issuance as of February 14, 2018. The Company chose to early adopt ASU 2018‑02 and apply the guidance to the consolidated financial statements for the year ended December 31, 2017.
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 June 30, 2018 and December 31, 2017 are summarized as follows:
Gross
Amortized
Unrealized
Fair
Cost
Gains
(Losses)
Value
June 30, 2018:
Securities HTM:
Municipal securities
399,002,344
4,916,288
(7,700,914)
396,217,718
Other securities
1,050,000
(15,350)
1,034,650
(7,716,264)
397,252,368
Securities AFS:
U.S. govt. sponsored agency securities
36,767,888
7,872
(1,109,224)
35,666,536
Residential mortgage-backed and related securities
164,791,715
49,915
(6,307,182)
158,534,448
60,160,248
221,112
(874,093)
59,507,267
4,254,509
(18,089)
4,236,420
265,974,360
278,899
(8,308,588)
13
December 31, 2017:
378,424,205
2,763,718
(2,488,119)
378,699,804
379,749,804
38,409,157
37,344
(349,967)
38,096,534
165,459,470
155,363
(2,313,529)
163,301,304
66,176,364
660,232
(211,100)
66,625,496
4,014,004
896,384
(25,815)
4,884,573
274,058,995
1,749,323
(2,900,411)
The Company's HTM 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 private 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 June 30, 2018 and December 31, 2017, are summarized as follows:
Less than 12 Months
12 Months or More
Losses
140,257,617
(3,873,043)
61,121,755
(3,827,871)
201,379,372
1,034,649
141,292,266
(3,888,393)
202,414,021
31,724,483
(928,027)
3,532,286
(181,197)
35,256,769
93,074,220
(3,402,034)
59,724,819
(2,905,148)
152,799,039
36,033,296
(648,203)
7,706,943
(225,890)
43,740,239
165,068,419
(4,996,353)
70,964,048
(3,312,235)
236,032,467
23,750,826
(354,460)
72,611,780
(2,133,659)
96,362,606
28,576,258
(200,022)
3,640,477
(149,945)
32,216,735
88,927,779
(871,855)
57,931,731
(1,441,674)
146,859,510
10,229,337
(41,151)
9,997,433
(169,949)
20,226,770
923,535
128,656,909
(1,138,843)
71,569,641
(1,761,568)
200,226,550
At June 30, 2018, the investment portfolio included 602 securities. Of this number, 303 securities were in an unrealized loss position. The aggregate losses of these securities totaled approximately 2.4% of the total amortized cost of the portfolio. Of these 303 securities, 42 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,
14
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 lacks the intent 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.
The Company did not recognize OTTI on any investment securities for the three or six months ended June 30, 2018 and 2017.
There were no sales of securities for the three and six months ended June 30, 2018. All sales of securities for the three and six months ended June 30, 2017 were from securities identified as AFS. Information on proceeds received, as well as pre-tax gross gains and losses from sales on those securities are as follows:
Three and Six Months Ended
June 30, 2017
Proceeds from sales of securities
Gross gains from sales of securities
59,568
Gross losses from sales of securities
(21,104)
The amortized cost and fair value of securities as of June 30, 2018 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.
Amortized Cost
Fair Value
Due in one year or less
1,732,495
1,737,807
Due after one year through five years
25,021,326
25,051,928
Due after five years
373,298,523
370,462,633
2,882,932
2,891,934
25,265,433
24,969,540
73,034,280
71,548,749
101,182,645
99,410,223
15
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. These callable securities are summarized as folows:
232,556,893
230,900,385
4,998,914
4,873,050
52,730,591
51,992,220
57,729,505
56,865,270
As of June 30, 2018, the Company's municipal securities portfolios were comprised of general obligation bonds issued by 122 issuers with fair values totaling $94.8 million and revenue bonds issued by 150 issuers, primarily consisting of states, counties, towns, villages and school districts with fair values totaling $360.9 million. The Company held investments in general obligation bonds in 26 states, including six states in which the aggregate fair value exceeded $5.0 million. The Company held investments in revenue bonds in 16 states, including seven states in which the aggregate fair value exceeded $5.0 million.
As of December 31, 2017, the Company's municipal securities portfolios were comprised of general obligation bonds issued by 131 issuers with fair values totaling $108.0 million and revenue bonds issued by 145 issuers, primarily consisting of states, counties, towns, villages and school districts with fair values totaling $337.3 million. The Company held investments in general obligation bonds in 26 states, including six states in which the aggregate fair value exceeded $5.0 million. The Company held investments in revenue bonds in 16 states, including seven states in which the aggregate fair value exceeded $5.0 million.
Both general obligation and revenue bonds are diversified across many issuers. As of June 30, 2018 and December 31, 2017, the Company did not hold general obligation or revenue bonds of any single issuer, the aggregate book or market value of which exceeded 5% 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 four charters, whose investment policies set forth limits for various subcategories within the municipal securities portfolio. Each charter is monitored individually, and as of June 30, 2018, all were well within policy limitations approved by the board of directors. Policy limits are calculated as a percentage of each charter's total risk-based capital.
As of June 30, 2018, 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.
16
NOTE 3 – LOANS/LEASES RECEIVABLE
The composition of the loan/lease portfolio as of June 30, 2018 and December 31, 2017 is presented as follows:
As of
C&I loans*
1,273,000,094
1,134,516,315
CRE loans
Owner-occupied CRE
349,007,830
332,742,477
Commercial construction, land development, and other land
162,644,566
186,402,404
Other non owner-occupied CRE
837,666,518
784,347,000
1,349,318,914
1,303,491,882
Direct financing leases **
133,196,613
141,448,232
Residential real estate loans ***
257,433,713
258,646,265
Installment and other consumer loans
92,952,124
118,610,799
3,105,901,458
2,956,713,493
Plus deferred loan/lease origination costs, net of fees
8,890,965
7,771,907
Less allowance
** Direct financing leases:
Net minimum lease payments to be received
147,388,211
156,583,887
Estimated unguaranteed residual values of leased assets
929,932
Unearned lease/residual income
(15,121,530)
(16,065,587)
Plus deferred lease origination costs, net of fees
4,159,711
4,624,027
137,356,324
146,072,259
(2,724,355)
(2,382,098)
134,631,969
143,690,161
* Includes equipment financing agreements outstanding at m2, totaling $92,815,742 and $66,758,397 as of June 30, 2018 and December 31, 2017, respectively.
** 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 and six months ended June 30, 2018 and 2017.
*** Includes residential real estate loans held for sale totaling $1,033,700 and $645,001 as of June 30, 2018, and December 31, 2017, respectively.
17
Changes in accretable yield for acquired loans were as follows:
Three months ended June 30, 2018
Six months ended June 30, 2018
PCI
Performing
Loans
Balance at the beginning of the period
(156,896)
(5,659,543)
(5,816,439)
(191,132)
(6,280,075)
(6,471,207)
Accretion recognized
14,848
608,119
622,967
49,084
1,228,651
1,277,735
Balance at the end of the period
(142,048)
(5,051,424)
(5,193,472)
Three months ended June 30, 2017
Six months ended June 30, 2017
(127,616)
(6,944,074)
(7,071,690)
(194,306)
(9,115,614)
(9,309,920)
43,756
1,618,603
1,662,359
110,446
3,790,143
3,900,589
(83,860)
(5,325,471)
(5,409,331)
The aging of the loan/lease portfolio by classes of loans/leases as of June 30, 2018 and December 31, 2017 is presented as follows:
As of June 30, 2018
Accruing Past
30-59 Days
60-89 Days
Due 90 Days or
Nonaccrual
Classes of Loans/Leases
Current
Past Due
More
C&I
1,270,508,073
602,885
403,841
1,485,295
CRE
Owner-Occupied CRE
348,357,289
228,703
421,838
Commercial Construction, Land Development, and Other Land
158,999,305
1,758,740
1,886,521
Other Non Owner-Occupied CRE
832,861,572
91,345
4,713,601
Direct Financing Leases
129,115,766
1,019,243
532,600
2,529,004
Residential Real Estate
254,927,412
374,480
816,670
1,315,151
Installment and Other Consumer
92,086,640
588,332
55,189
19,573
202,390
3,086,856,057
4,663,728
1,808,300
12,553,800
As a percentage of total loan/lease portfolio
99.39
%
0.15
0.00
0.40
100.00
18
As of December 31, 2017
1,124,734,486
8,306,829
243,647
1,231,353
331,868,142
540,435
333,900
181,558,092
4,844,312
782,526,249
572,877
4,146
1,243,728
137,708,397
1,305,191
259,600
2,175,044
253,261,821
3,552,709
393,410
74,519
1,363,806
117,773,259
517,537
56,760
14,152
249,091
2,929,430,446
14,795,578
957,563
88,671
11,441,234
99.08
0.50
0.03
0.39
NPLs by classes of loans/leases as of June 30, 2018 and December 31, 2017 are presented as follows:
Percentage of
Loans/Leases*
Accruing TDRs
Total NPLs
800,176
2,285,471
16.44
106,874
528,712
3.80
13.57
33.92
137,432
2,666,436
19.18
270,903
1,586,054
11.41
11,623
233,586
1.68
1,327,008
13,900,381
* Nonaccrual loans/leases included $1,841,006 of TDRs, including $66,021 in C&I loans, $1,066,701 in CRE loans, $619,727 in direct financing leases, $83,287 in residential real estate loans, and $5,270 in installment loans.
Loans/Leases **
5,224,182
6,455,535
34.63
107,322
441,222
2.37
25.99
6.67
1,494,448
3,669,492
19.68
272,493
1,710,818
9.18
14,027
277,270
1.49
7,112,472
18,642,377
** Nonaccrual loans/leases included $2,282,495 of TDRs, including $122,598 in C&I loans, $1,336,871 in CRE loans, $700,255 in direct financing leases, $115,190 in residential real estate loans, and $7,581 in installment loans.
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Changes in the allowance by portfolio segment for the three and six months ended June 30, 2018 and 2017, respectively, are presented as follows:
Three Months Ended June 30, 2018
Direct Financing
Residential Real
Installment and
Leases
Estate
Other Consumer
Balance, beginning
15,065,245
14,938,020
2,730,301
2,375,219
1,423,817
36,532,602
Provisions (credits) charged to expense
777,013
871,475
687,908
57,283
(92,944)
Loans/leases charged off
(728,890)
(794,299)
(1,086)
(1,524,275)
Recoveries on loans/leases previously charged off
120,503
9,545
100,445
600
4,921
236,014
Balance, ending
15,233,871
15,819,040
2,724,355
2,433,102
1,334,708
37,545,076
Three Months Ended June 30, 2017
12,954,090
12,643,266
2,978,260
2,375,864
1,107,670
32,059,150
1,281,786
339,857
297,672
116,151
(12,473)
(74,071)
(10,375)
(684,079)
(61,561)
(21,518)
(851,604)
45,928
26,485
46,448
7,232
126,093
14,207,733
12,999,233
2,638,301
2,430,454
1,080,911
33,356,632
Six Months Ended June 30, 2018
14,323,036
13,962,688
2,382,098
2,466,431
1,221,475
34,355,728
Provisions charged to expense
1,585,174
1,836,858
1,292,691
17,946
107,905
(824,389)
(1,078,186)
(52,325)
(5,833)
(1,960,733)
150,050
19,494
127,752
1,050
11,161
309,507
Six Months Ended June 30, 2017
12,545,110
11,670,609
3,111,898
2,342,344
1,087,487
30,757,448
1,875,144
1,306,128
802,687
159,671
(15,528)
(292,344)
(1,342,763)
(75,184)
(23,564)
(1,744,230)
79,823
32,871
66,479
3,623
32,516
215,312
The allowance by impairment evaluation and by portfolio segment as of June 30, 2018 and December 31, 2017 is presented as follows:
Allowance for impaired loans/leases
308,091
2,109,374
375,803
239,419
106,878
3,139,565
Allowance for nonimpaired loans/leases
14,925,780
13,709,666
2,348,552
2,193,683
1,227,830
34,405,511
Impaired loans/leases
1,551,445
6,967,425
1,449,866
214,655
12,712,395
Nonimpaired loans/leases
1,271,448,649
1,342,351,489
130,667,609
255,983,847
92,737,469
3,093,189,063
Allowance as a percentage of impaired loans/leases
19.86
30.27
14.86
16.51
49.79
24.70
Allowance as a percentage of nonimpaired loans/leases
1.17
1.02
1.80
0.86
1.32
1.11
Total allowance as a percentage of total loans/leases
1.20
2.05
0.95
1.44
1.21
20
715,627
1,429,460
504,469
355,167
38,596
3,043,319
13,607,409
12,533,228
1,877,629
2,111,264
1,182,879
31,312,409
6,248,209
6,529,262
1,704,846
202,354
18,354,163
1,128,268,106
1,296,962,620
137,778,740
256,941,419
118,408,445
2,938,359,330
11.45
21.89
13.75
20.83
19.07
16.58
0.97
0.82
1.00
1.07
1.26
1.03
1.16
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.
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Loans/leases, by classes of financing receivable, considered to be impaired as of and for the six months ended June 30, 2018 are presented as follows:
Average
Recognized for
Recorded
Unpaid Principal
Related
Cash Payments
Investment
Balance
Allowance
Recognized
Received
Impaired Loans/Leases with No Specific Allowance Recorded:
1,159,577
1,173,853
1,465,402
138,543
288,813
289,112
11,690
982,428
1,151,245
1,903,173
2,551,149
9,292
941,520
1,016,299
904,898
99,814
95,448
5,375,325
5,464,380
6,457,254
159,525
Impaired Loans/Leases with Specific Allowance Recorded:
391,868
327,859
142,788
39,288
147,375
5,553,396
2,070,086
5,275,992
625,831
521,142
508,346
531,422
522,134
5,893
114,841
109,254
159
7,337,070
7,360,146
6,903,756
6,052
Total Impaired Loans/Leases:
1,565,721
1,793,261
431,601
436,487
3,072,291
1,547,721
1,427,032
204,702
12,824,526
13,361,010
165,577
Impaired loans/leases for which no allowance has been provided have adequate collateral, based on management's current estimates.
22
Loans/leases, by classes of financing receivable, considered to be impaired as of and for the three months ended June 30, 2018 and 2017, respectively, are presented as follows:
1,400,498
59,176
805,309
9,399
289,036
5,868
1,105,004
1,160,161
2,198,852
2,544
2,560,019
38,949
928,809
712,793
101,582
173,585
218
6,023,781
67,588
5,411,867
48,566
353,153
1,978
8,066,702
35,055
145,082
238,584
5,491,832
4,348,142
38,260
566,063
757,602
512,222
2,959
624,641
2,989
116,887
76
34,333
7,185,239
5,014
14,108,264
38,044
1,753,651
61,154
8,872,011
44,454
434,118
1,198,421
2,764,915
3,317,621
1,441,031
1,337,434
218,469
207,918
13,209,020
72,602
19,520,131
86,610
23
Loans/leases, by classes of financing receivable, considered to be impaired as of December 31, 2017 are presented as follows:
Unpaid
Principal
1,634,269
1,644,706
289,261
1,171,565
2,944,540
943,388
1,018,167
134,245
7,117,268
7,202,484
4,613,940
4,617,879
151,962
48,462
1,379,235
72,163
1,763
724,953
761,458
68,109
11,236,897
11,240,836
6,262,585
1,779,625
18,443,318
For C&I and CRE 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 certain C&I loans (equipment financing agreements), 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.
24
For each class of financing receivable, the following presents the recorded investment by credit quality indicator as of June 30, 2018 and December 31, 2017:
Non Owner-Occupied
Commercial
Construction,
Land
Owner-Occupied
Development,
As a % of
Internally Assigned Risk Rating
and Other Land
Other CRE
Pass (Ratings 1 through 5)
1,135,035,263
342,518,625
160,224,065
805,031,050
2,442,809,003
96.57
Special Mention (Rating 6)
29,414,324
3,984,113
10,804,187
44,202,624
1.75
Substandard (Rating 7)
15,734,765
2,505,092
2,420,501
21,831,281
42,491,639
Doubtful (Rating 8)
1,180,184,352
2,529,503,266
Delinquency Status *
92,361,366
130,530,177
255,847,659
92,718,538
571,457,740
99.14
Nonperforming
454,376
4,940,452
92,815,742
576,398,192
1,031,963,703
318,293,608
179,142,839
767,119,909
2,296,520,059
96.85
10,944,924
8,230,060
1,780,000
10,068,870
31,023,854
1.31
24,578,731
6,218,809
5,479,565
7,158,221
43,435,326
1.83
270,559
0.01
1,067,757,917
2,371,249,799
65,847,177
256,935,447
118,333,529
578,894,893
98.88
911,220
6,568,800
1.12
66,758,397
585,463,693
* 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 June 30, 2018 and December 31, 2017, TDRs totaled $3,168,014 and $9,394,967, 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 six months ended June 30, 2018 and 2017. The difference between
25
the pre-modification recorded investment and the post-modification recorded investment would be any partial charge-offs at the time of the restructuring. No loans were restructured during the three months ended June 30, 2018.
For the three months ended June 30, 2018
For the three months ended June 30, 2017
Pre-
Post-
Modification
Number of
Specific
Loans / Leases
CONCESSION - Significant Payment Delay
1
47,509
802,542
850,051
CONCESSION - Extension of Maturity
98,119
TOTAL
948,170
For the six months ended June 30, 2018
For the six months ended June 30, 2017
104,382
181,198
Real Estate
46,320
47,524
1,472,403
93,844
26
1,653,601
28
1,757,983
Of the TDRs reported above, one with a post-modification recorded balance of $46,320 was on nonaccrual as of June 30, 2018. Of the TDRs reported above, none were on nonaccrual as of June 30, 2017.
For the three and six months ended June 30, 2018, seven of the Company's TDRs redefaulted within 12 months subsequent to restructure where default is defined as delinquency of 90 days or more and/or placement on nonaccrual status. Three of these TDRs were related to one customer whose loans were restructured in the second quarter of 2017 with pre-modification balances totaling $78 thousand and the other TDRs related to other customers whose loans were restructured in the second and third quarters of 2017 with pre-modification balances totaling $378 thousand.
For the three and six months ended June 30, 2017, two of the Company's TDRs redefaulted within 12 months subsequent to restructure where default is defined as delinquency of 90 days or more and/or placement on nonaccrual status. These two TDRs were related to the same customer and were restructured in the fourth quarter of 2016 with pre-modification balances totaling $195 thousand.
Not included in the table above, the Company had 8 TDRs that were restructured and charged off in 2018, totaling $577,377. The Company had 2 TDRs that were restructured and charged off in 2017, totaling $65,623.
NOTE 4 – DERIVATIVES
The Company uses interest rate swap and cap instruments to manage interest rate risk related to the variability of interest payments due to changes in interest rates. The Company entered into interest rate caps on June 5, 2014 to hedge against the risk of rising interest rates on short-term liabilities. The short-term liabilities consist of $30.0 million of 1-month FHLB advances, and the benchmark rate hedged is 1-month LIBOR. The interest rate caps are designated as a cash flow
hedge in accordance with ASC 815. An initial premium of $2.1 million was paid upfront for the two caps. The details of the interest rate caps are as follows:
Balance Sheet
1-Month LIBOR
Fair Value as of
Hedged Instrument
Effective Date
Maturity Date
Location
Notional Amount
Strike Rate
December 31, 2017
1-month FHLB Advance
6/3/2014
6/5/2019
Other Assets
199,821
190,085
6/5/2014
6/5/2021
506,470
316,615
706,291
506,700
On June 21, 2018, the Company entered into interest rate swaps to hedge against the risk of rising rates on its variable rate trust preferred securities. The floating rate trust preferred securities are tied to 3-month LIBOR, and the interest rate swaps utilize 3-month LIBOR, so the hedge is effective. The interest rate swaps are designated as a cash flow hedge in accordance with ASC 815. The details of the interest rate swaps are as follows:
Receive Rate
Pay Rate
QCR Holdings Statutory Trust II
9/30/2018
9/30/2028
Other Liabilities
QCR Holdings Statutory Trust III
QCR Holdings Statutory Trust V
7/7/2018
7/7/2028
Community National Statutory Trust II
9/20/2018
9/20/2028
Community National Statutory Trust III
9/15//2018
9/15/2028
Guaranty Bankshares Statutory Trust I
9/15/2018
Changes in fair values of derivatives designated as cash flow hedges are recorded in OCI to the extent the hedge is effective, and reclassified to earnings as the hedged transaction (interest payments on debt) impact earnings.
The caps and swaps are valued by the transaction counterparty on a monthly basis and corroborated by a third party annually.
NOTE 5 - EARNINGS PER SHARE
The following information was used in the computation of EPS on a basic and diluted basis:
Three months ended
Six months ended
Basic EPS
Diluted EPS
Weighted average common shares issuable upon exercise of stock options and under the employee stock purchase plan
312,858
346,309
314,890
350,672
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The increase in weighted average common shares outstanding when comparing the three and six months ended June 30, 2018 to June 30, 2017 was primarily due to the common stock issuance discussed in Note 2 to the Consolidated Financial Statements included in the Company's Annual Report on Form 10‑K for the year ended December 31, 2017.
NOTE 6 – 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 and liabilities measured at fair value on a recurring basis comprise the following at June 30, 2018 and December 31, 2017:
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)
Interest rate caps
Interest rate swaps - assets
6,171,740
Total assets measured at fair value
264,822,702
Interest rate swaps - liabilities
6,543,790
Total liabilities measured at fair value
1,028
4,883,545
4,397,238
277,811,845
277,810,817
There were no transfers of assets or liabilities between Levels 1, 2, and 3 of the fair value hierarchy for the three and six months ended June 30, 2018 or 2017.
The securities AFS 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).
Interest rate caps are used for the purpose of hedging interest rate risk. The fair values are determined by pricing models that consider observable market data for derivative instruments with similar structures (Level 2 inputs).
Interest rate swaps are executed for select commercial customers. The interest rate swaps are further described in Note 1 to the Consolidated Financial Statements included in the Company's Annual Report on Form 10‑K for the year ended December 31, 2017. The fair values are determined by comparing the contract rate on the swap with the then-current market rate for the remaining term of the transaction (Level 2 inputs).
Interest rate swaps are also used for the purpose of hedging interest rate risk on junior subordinated debt. The fair values are determined by comparing the contract rate on the swap with the then-current market rate for the remaining term of the transaction (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 June 30, 2018 and December 31, 2017:
Level 1
Level 2
Level 3
4,674,218
OREO
13,770,025
18,444,243
8,972,337
14,642,973
23,615,310
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.
29
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:
Quantitative Information about Level Fair Value Measurements
Valuation Technique
Unobservable Input
Range
Appraisal of collateral
Appraisal adjustments
to
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 three and six months ended June 30, 2018 and 2017.
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:
HTM
AFS
See Previous Table
Loans/leases receivable, net
4,327,980
8,307,719
3,072,919,367
3,020,805,000
2,921,821,953
2,892,963,000
Nonmaturity deposits
2,622,243,626
2,670,583,178
Time deposits
676,032,401
677,799,000
596,071,878
591,772,000
FHLB advances
254,008,000
192,115,000
71,645,000
66,520,000
29,851,237
29,253,624
NOTE 7 – 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.
30
The Company's primary segment, Commercial Banking, is geographically divided by markets into the secondary segments comprised of the five subsidiary banks wholly owned by the Company: QCBT, CRBT, CSB, RB&T and SFC Bank. 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 five 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 six months ended June 30, 2018 and 2017.
Commercial Banking
Wealth
Intercompany
Consolidated
QCBT
CRBT
CSB
RB&T
Management
All other
Eliminations
Total revenue
16,682,874
16,503,977
8,406,295
5,119,916
3,115,653
13,024,443
(13,142,678)
49,710,480
12,290,034
10,481,055
6,734,510
3,401,849
(822,952)
Provision
1,254,493
627,742
221,000
197,500
4,510,902
4,705,042
2,158,347
813,623
796,911
10,405,693
(12,945,133)
3,222,688
14,979,984
9,888,225
3,439,864
5,029,987
1,563,643,434
1,345,431,093
712,138,515
484,123,277
463,206,792
(461,660,406)
14,210,040
10,149,769
8,171,307
4,241,431
2,560,836
10,181,814
(10,279,411)
39,235,786
11,414,818
7,230,425
6,920,820
3,095,512
(614,878)
552,993
300,000
861,000
309,000
4,073,777
2,870,582
1,920,040
834,842
454,465
8,766,014
(10,153,703)
13,110,913
1,172,141
5,747,339
6,919,480
1,400,307,827
993,768,912
642,761,140
426,159,677
382,407,292
(388,218,153)
3,457,186,695
32,490,444
32,501,309
16,569,618
10,117,861
6,305,078
25,556,486
(25,742,571)
97,798,225
24,410,336
21,316,903
13,478,457
6,867,003
(1,585,285)
2,374,902
1,229,570
796,602
439,500
8,968,770
9,321,570
4,026,935
1,554,918
1,567,776
20,920,203
(25,364,826)
27,745,981
20,536,314
16,303,013
8,189,230
5,262,642
20,057,957
(20,230,498)
77,864,639
22,716,300
14,204,472
13,947,328
6,063,586
(1,216,106)
1,484,102
550,000
1,635,000
459,000
7,728,783
5,763,142
3,815,174
1,679,411
1,015,527
(20,002,037)
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NOTE 8 – REGULATORY CAPITAL REQUIREMENTS
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 June 30, 2018 and December 31, 2017, 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 June 30, 2018 and December 31, 2017 are presented in the following table (dollars in thousands). As of June 30, 2018 and December 31, 2017, each of the subsidiary banks met the requirements to be “well capitalized”.
For Capital
To Be Well
Adequacy Purposes
Capitalized Under
With Capital
Prompt Corrective
Actual
Conservation Buffer*
Action Provisions
Amount
Ratio
As of June 30, 2018:
Company:
Total risk-based capital
407,222
11.23
290,121
>
8.00
358,118
9.875
362,652
10.00
Tier 1 risk-based capital
369,677
10.19
217,591
6.00
285,588
7.875
Tier 1 leverage
9.22
160,373
4.00
4.000
200,466
5.00
Common equity Tier 1
332,096
9.16
163,193
4.50
231,190
6.375
235,723
6.50
Quad City Bank & Trust:
158,480
11.67
108,599
134,052
135,748
145,157
10.69
81,449
106,902
9.19
63,193
78,992
61,087
86,540
88,236
Cedar Rapids Bank & Trust:
143,414
11.76
97,602
120,477
122,003
130,203
10.67
73,202
96,077
9.83
52,961
66,201
54,901
77,777
79,302
Community State Bank:
70,656
11.70
48,330
59,658
60,413
65,443
10.83
36,248
47,575
9.56
27,384
34,229
27,186
38,513
39,268
Rockford Bank & Trust:
47,697
10.81
35,283
43,553
44,104
42,181
26,463
34,732
8.90
18,947
23,684
19,847
28,116
28,668
32
As of December 31, 2017:
383,282
11.15
275,090
318,073
9.25
343,862
348,530
10.14
206,317
249,300
7.25
8.98
155,256
194,070
313,012
9.10
154,738
197,721
5.75
223,510
160,112
12.35
103,711
119,916
129,639
147,472
11.38
77,783
93,988
9.52
61,985
77,481
58,337
74,542
84,265
138,492
11.88
93,272
107,846
116,590
126,601
10.86
69,954
84,528
11.68
43,348
54,185
52,465
67,039
75,783
66,271
11.71
45,293
52,370
56,616
61,941
10.94
33,970
41,047
9.77
25,354
31,693
25,477
32,554
36,801
45,684
11.28
32,413
37,477
40,516
40,615
10.02
24,310
29,374
8.94
18,177
22,721
18,232
23,297
26,335
* The minimums under Basel III increase by .625% (the capital conservation buffer) annually until 2019. The fully phased-in minimums are 10.5% (Total risk-based capital), 8.5% (Tier 1 risk-based capital), and 7.0% (Common equity Tier 1).
NOTE 9 – REVENUE RECOGNITION
As of January 1, 2018, the Company adopted ASU 2014‑09 using the modified retrospective approach. The adoption of the guidance had no material impact on the measurement or recognition of revenue as approximately 89% of the Company's revenue (based on 2017 audited financial results) is outside the scope of this guidance; however, additional disclosures have been added in accordance with the ASU. See Note 1 for additional information on this new accounting standard.
Descriptions of our revenue-generating contracts with customers that are within the scope of ASU 2014‑09, which are presented in our income statements as components of non-interest income are as follows:
Trust department and Investment advisory and management fees: This is a contract between the Company and its customers for fiduciary and/or investment administration services on trust and brokerage accounts. Trust services and brokerage fee income is determined as a percentage of assets under management and is recognized over the period the underlying trust account is serviced. Such contracts are generally cancellable at any time, with the customer subject to a pro-rated fee in the month of termination.
Deposit service fees: The deposit contract obligates the Company to serve as a custodian of the customer's deposited funds and is generally terminable at will by either party. The contract permits the customer to access the funds on deposit and request additional services related to the deposit account. Deposit account related fees, including analysis charges, overdraft/nonsufficient fund charges, service charges, debit card usage fees, overdraft fees and wire transfer fees are within the scope of the guidance; however, revenue recognition practices did not change under the guidance, as deposit agreements are considered day-to-day contracts. Income for deposit accounts is recognized over the statement cycle period (typically on a monthly basis) or at the time the service is provided, if additional services are requested.
33
Correspondent banking fees: A contract between the Company and its correspondent banks for corresponding banking services. This line of business provides a strong source of noninterest bearing and interest bearing deposits, fee income, high-quality loan participations and bank stock loans. Correspondent banking fee income is tied to transaction activity and revenue is recognized monthly as earned for services provided.
NOTE 10 –MERGERS AND ACQUISITIONS
BATES COMPANIES
On March 20, 2018 the Company announced the signing of definitive agreements to acquire the Bates Companies, headquartered in Rockford, Illinois. The acquisition and subsequent merger of the Bates Companies into RB&T will enhance the wealth management services of RB&T by adding approximately $700.0 million of assets under management.
In the acquisition, the Company will acquire 100% of the Bates Companies' outstanding common stock for an aggregate consideration of $3.0 million cash and up to $3.0 million of the Company's common stock. In a private placement exempt from registration with the SEC, the Company expects to issue upon closing of the transaction approximately 21,528 common shares or $1.0 million of Company stock. Assuming all future performance based contingent consideration is realized total stock consideration can reach $3.0 million, which would result in the Company expecting to issue approximately 64,583 common shares based on closing stock price at the date of announcement.
This transaction is subject to regulatory approval and certain closing conditions. The transaction is expected to close early in fourth quarter of 2018.
SPRINGFIELD BANCSHARES, INC.
On July 1, 2018, the Company completed its previously announced merger with Springfield Bancshares, the holding company of SFC Bank, headquartered in Springfield, Missouri. SFC Bank is a Missouri-chartered bank that operates one location in the Springfield, Missouri market. As a result of the transaction, SFC Bank became the Company’s fifth independent charter.
Stockholders of Springfield Bancshares received 0.3060 shares of the Company’s common stock and $1.50 in cash in exchange for each common share of Springfield Bancshares held. On June 29, 2018, the last trading date before the closing, the Company’s common stock closed at $47.45, resulting in stock consideration valued at $79.2 million and total consideration paid by the Company of $87.4 million. To help fund the cash portion of the purchase price, on June 29, 2018, the Company borrowed $4.1 million on its existing $10.0 million revolving line of credit. The Company also borrowed $4.9 million on this same revolving line of credit to fund the repayment of certain debt assumed in the merger, shortly after closing. This note is included within other borrowings on the June 30, 2018 Consolidated Balance Sheet. The remaining cash consideration paid to the shareholders of Springfield Bancshares came from operating cash.
As of the merger date, SFC Bank had assets with a historical book value of $573 million, loans with a book value of $487 million, and deposits with a book value of $439 million. The Company is in the process of determining the fair value of the individual assets and liabilities purchased/assumed, including goodwill and core deposit intangible.
34
Item 2
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 as of and for the three months ending June 30, 2018. 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 a financial holding company and the parent company of QCBT, CRBT, CSB, RB&T and SFC Bank.
QCBT, CRBT and CSB are Iowa-chartered commercial banks, RB&T is an Illinois-chartered commercial bank and SFC Bank is a Missouri-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, 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 five offices located in Cedar Rapids and Marion, Iowa. Cedar Falls and Waterloo, Iowa and adjacent communities are served through three additional CRBT offices (two in Waterloo and one in Cedar Falls).
CSB was acquired by QCR in 2016, as further described in Note 2 to the Consolidated Financial Statements included in the Annual Report on Form 10‑K for the year ended December 31, 2017. CSB provides full-service commercial and consumer banking to the Des Moines, Iowa area and adjacent communities through its 10 offices, including its main office located on North Ankeny Boulevard in Ankeny, Iowa.
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.
The financial results of SFC Bank are not included in this report because the Company’s acquisition of SFC Bank through merger of Springfield Bancshares, previously the holding company of SFC Bank, into the Company occurred on July 1, 2018.
35
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued
EXECUTIVE OVERVIEW
The Company reported net income of $10.4 million and diluted EPS of $0.73 for the quarter ended June 30, 2018. By comparison, for the quarter ended March 31, 2018, the Company reported net income of $10.6 million and diluted EPS of $0.74. For the quarter ended June 30, 2017, the Company reported net income of $8.8 million and diluted EPS of $0.65. For the six months ended June 30, 2018, the Company reported net income of $21.0 million, and diluted EPS of $1.48. By comparison, for the six months ended June 30, 2017, the Company reported net income of $18.0 million, and diluted EPS of $1.33.
The second quarter of 2018 was highlighted by several significant items:
Net income of $10.4 million, or $0.73 per diluted share;
Core net income (non-GAAP) of $10.9 million, or $0.77 per diluted share;
Annualized loan and lease growth of 7.8% for the quarter ended and 10.1% year-to-date; and
Annualized noninterest income growth of 17.4%.
Following is a table that represents various net income measurements for the Company.
For the three months ended
For the six months ended
9,901,590
0.70
14,193,191
The increase in weighted average common shares outstanding from June 30, 2017 to June 30, 2018 was primarily due to the common stock issued to Guaranty as consideration for the acquisition of Guaranty Bank.
Following is a table that represents the major income and expense categories for the Company.
March 31, 2018
32,402,918
Provision expense
2,539,839
Noninterest income
8,541,449
Noninterest expense
25,863,497
1,991,070
Following are some noteworthy changes in the Company's financial results:
Net interest income in the second quarter of 2018 was down 1% compared to the first quarter of 2018. Net interest income increased 14% compared to the second quarter of 2017 and 16% when comparing the first six months of 2018 to the same period in the prior year. This increase was primarily due to strong loan and lease growth and the acquisition of Guaranty Bank.
36
Provision expense in the second quarter of 2018 decreased 9% compared to the first quarter of 2018 and increased 14% from the same period of 2017. Provision expense increased 17% in the first six months of 2018 from the same period of 2017 and was attributable to both strong loan growth and accounting for acquired loans. As acquired loans renew, the discount associated with those loans is eliminated and the Company must establish an allowance.
Noninterest income in the second quarter of 2018 increased 4% compared to the first quarter of 2018, primarily due to higher swap fee income. Noninterest income in the second quarter of 2018 increased 31% from the second quarter of 2017 and 24% when comparing the first six months of 2018 to the same period in the prior year. This increase was primarily attributable to higher swap fee income, as well as solid growth in wealth management fee income and the acquisition of Guaranty Bank.
Noninterest expense increased 2% from the first quarter of 2018. Noninterest expense increased 23% from the second quarter of 2017 and 22% when comparing the first six months of 2018 to the same period in the prior year which was primarily due to the acquisition of Guaranty Bank.
Federal and state income tax expense in the second quarter of 2018 decreased 6% compared to the first quarter of 2018. Federal and state income tax expense in the second quarter of 2018 decreased 29% compared to the second quarter of 2017 and decreased 23% when comparing the first six months of 2018 to the same period in the prior year primarily due to a lower federal tax rate. See the “Income Taxes” section of this Report for additional details.
LONG-TERM FINANCIAL GOALS
As previously stated, the Company has established certain financial goals by which it manages its business and measures its performance. The goals are periodically updated to reflect changes in business developments. While the Company is determined to work prudently to achieve these goals, there is no assurance that they will be met. Moreover, the Company's ability to achieve these goals will be affected by the factors discussed under “Forward Looking Statements” as well as the factors detailed in the “Risk Factors” section included under Item 1A. of Part I of the Company's Annual Report on Form 10‑K for the year ended December 31, 2017. The Company's long-term financial goals are as follows:
Improve balance sheet efficiency by maintaining a gross loans and leases to total assets ratio in the range of 73 – 78%;
Improve profitability (measured by NIM and ROAA);
Improve asset quality by reducing NPAs to total assets to below 0.75% and maintain charge-offs as a percentage of average loans/leases of under 0.25% annually;
Maintain reliance on wholesale funding at less than 15% of total assets;
Grow noninterest bearing deposits to more than 30% of total assets;
Continue to focus on generating gains on sales of government guaranteed portions of loans and swap fee income to more than $4 million annually; and
Grow wealth management segment net income by 10% annually.
37
The following table shows the evaluation of the Company's long-term financial goals.
For the Quarter Ending
Goal
Key Metric
Target**
Balance sheet efficiency
Gross loans and leases to total assets
73% - 78%
74
NIM TEY (non-GAAP)*
> 3.65%
3.52
3.64
3.81
Profitability
ROAA
> 1.10%
1.06
1.04
Core ROAA (non-GAAP)*
1.08
Asset quality
NPAs to total assets
< 0.75%
0.77
Net charge-offs to average loans and leases***
< 0.25% annually
0.11
0.13
Reliance on wholesale funding
Wholesale funding to total assets****
< 15%
Funding mix
Noninterest bearing deposits as a percentage of total assets
> 30%
Consistent, high quality noninterest income revenue streams
Gains on sales of government guaranteed portions of loans and swap fee income***
> $4 million annually
5.9
million
5.3
3.0
Grow wealth management segment net income***
> 10% annually
54
* See “GAAP to Non-GAAP” reconciliations section.
** Targets will be re-evaluated and adjusted as appropriate.
*** Ratios and amounts provided for these measurements represent year-to-date actual amounts for the respective period, that are then annualized for comparison.
**** Wholesale funding to total assets is calculated by dividing total borrowings and brokered deposits by total assets.
STRATEGIC DEVELOPMENTS
The Company took the following actions during the second quarter of 2018 to support its corporate strategy and the long-term financial goals shown above.
The Company grew loans and leases in the second quarter of 2018 by 7.8% on an annualized basis. Strong loan and lease growth for the remainder of the year will help keep the Company's loan and leases to asset ratio within the targeted range of 73‑78%.
The Company has participated, and intends to continue to participate, in a prudent manner as an acquirer in the consolidation taking place in our markets to continue to grow EPS, further boost ROAA and improve the Company's efficiency ratio. The Company announced in March 2018 the signing of definitive agreements to acquire and merge the Bates Companies into RB&T. The Company announced in July 2018 the completion of the merger of Springfield Bancshares. See Note 10 to the Consolidated Financial Statements for additional details about these strategic transactions.
The Company has continued to focus on lowering the NPAs to total assets ratio. This ratio decreased by 12 basis points to 0.65%, compared to the first quarter 2018. This decrease was primarily due to the upgrade of one large credit that was taken out of TDR status. The Company remains committed to improving asset quality ratios in 2018 and beyond.
Management has continued to focus on reducing the Company's reliance on wholesale funding. Core deposit growth in the second quarter of 2018 allowed wholesale funding to decrease 1%. Management continues to prioritize core deposit growth through a variety of strategies including growth in correspondent banking.
38
Correspondent banking has continued to be a core line of business for the Company. The Company is competitively positioned with experienced staff, software systems and processes to continue growing in the three states currently served – Iowa, Illinois and Wisconsin - and to expand into the Missouri market. The Company acts as the correspondent bank for 192 downstream banks with average total noninterest bearing deposits of $215.3 million that hadaverage total interest bearing deposits of $208.3 million during the first six months of 2018. This line of business provides a strong source of noninterest bearing and interest bearing deposits, fee income, high-quality loan participations and bank stock loans.
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.
As a result of the relatively low interest rate environment including a flat yield curve, the Company has focused on executing interest rate swaps on select commercial loans. 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 on the pricing. Management believes that these swaps help position the Company more favorably for rising rate environments. The Company 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.
Wealth management is another core line of business for the Company and includes a full range of products, including trust services, brokerage and investment advisory services, asset management, estate planning and financial planning. As of June 30, 2018, the Company had $2.72 billion of total financial assets in trust (and related) accounts and $1.05 billion of total financial assets in brokerage (and related) accounts. Continued growth in assets under management will help drive trust and investment advisory fees. The Company offers trust and investment advisory services to the correspondent banks that it serves. As management continues to focus on growing wealth management fee income, expanding market share will continue to be a primary strategy, both through organic growth as well as the acquisition of managed assets. The Company announced in March 2018 the signing of definitive agreements to acquire and merge the Bates Companies into RB&T. The acquisition and subsequent merger of the Bates Companies into RB&T will add approximately $700 million of assets under management.
GAAP TO NON-GAAP RECONCILIATIONS
The following table presents certain non-GAAP financial measures related to the “TCE/TA ratio”, “core net income”, “core net income attributable to QCR Holdings, Inc. common stockholders”, “core EPS”, “core ROAA”, “NIM (TEY)”, and “efficiency ratio”. In compliance with applicable rules of the SEC, all non-GAAP measures are reconciled to the most directly comparable GAAP measure, as follows:
TCE/TA ratio (non-GAAP) is reconciled to stockholders' equity and total assets;
Core net income, core net income attributable to QCR Holdings, Inc. common stockholders, core EPS and core ROAA (all non-GAAP measures) are reconciled to net income;
NIM (TEY) (non-GAAP) is reconciled to NIM; and
Efficiency ratio (non-GAAP) is reconciled to noninterest expense, net interest income and noninterest income.
The TCE/TA non-GAAP 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.
39
The table following also includes several “core” non-GAAP 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.
NIM (TEY) is a financial measure that the Company's management utilizes to take into account the tax benefit associated with certain tax-exempt loans and securities. It is standard industry practice to measure net interest margin using tax-equivalent measures.
The efficiency ratio is a ratio that management utilizes to compare the Company to peers. It is a standard ratio in the banking industry and widely utilized by investors.
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.
GAAP TO NON-GAAP
March 31,
September 30,
RECONCILIATIONS
(dollars in thousands, except per share data)
TCE/TA RATIO
Stockholders' equity (GAAP)
369,588
360,428
353,287
313,039
305,083
Less: Intangible assets
36,561
37,108
37,413
19,800
20,030
TCE (non-GAAP)
333,027
323,320
315,874
293,239
285,053
Total assets (GAAP)
4,106,883
4,026,314
3,982,665
3,550,463
3,457,187
TA (non-GAAP)
4,070,322
3,989,206
3,945,252
3,530,663
3,437,157
TCE/TA ratio (non-GAAP)
8.18
8.10
8.01
8.31
8.29
40
For the Quarter Ended
For the Six Months Ended
(dollars in thousands,except per share data)
CORE NET INCOME
Net income (GAAP)
10,445
10,550
9,902
20,995
17,951
Less nonrecurring items (post-tax) (*):
Income:
(41)
Total nonrecurring income (non-GAAP)
Expense:
327
73
430
400
130
2,462
Total nonrecurring expense (non-GAAP)
457
2,892
530
Adjustment of tax expense related to the Tax Act
2,919
Core net income (non-GAAP)
10,902
10,623
9,916
21,525
17,926
CORE EPS
Core net income (non-GAAP) (from above)
13,888,661
13,845,497
14,205,584
Core EPS (non-GAAP):
Basic
0.78
0.76
0.72
1.55
Diluted
CORE ROAA
Average Assets
4,053,684
3,994,691
3,923,337
4,024,188
3,326,454
Core ROAA (annualized) (non-GAAP)
1.01
NIM (TEY)*
Net interest income (GAAP)
32,085
32,403
31,793
64,488
55,716
Plus: Taxequivalent adjustment
1,462
1,353
2,585
2,815
4,218
Net interest income - taxequivalent (non-GAAP)
33,547
33,756
34,378
67,303
59,934
Average earning assets
3,820,333
3,759,475
3,699,193
3,789,905
3,128,569
NIM (GAAP)
3.37
3.50
3.41
3.43
3.59
NIM (TEY) (non-GAAP)
3.69
3.58
3.86
EFFICIENCY RATIO
Noninterest expense (GAAP)
26,370
25,863
31,351
52,234
42,678
Noninterest income (GAAP)
8,912
8,541
9,714
17,454
14,066
Total income
40,997
40,944
41,507
81,942
69,782
Efficiency ratio (noninterest expense/total income) (non-GAAP)
64.32
63.17
75.53
63.75
61.16
* Nonrecurring items (after-tax) are calculated using an estimated effective tax rate of 35% for periods prior to March 31, 2018 and 21% for periods including and after March 31, 2018.
NET INTEREST INCOME - (TAX EQUIVALENT BASIS)
As part of the Tax Act, the Company's federal income tax rate was reduced from 35% down to 21% effective January 1, 2018. In order to compare periods before and after the effective date of the Tax Act, it's important to note the difference in the federal income tax rate and the impact on the Company's tax exempt earning assets (loans and securities) and the related tax equivalent yield reporting.
41
Net interest income, on a tax equivalent basis, increased 11% to $33.5 million for the quarter ended June 30, 2018, compared to the same quarter of the prior year, and increased 12% to $67.3 million for the six months ended June 30, 2018 compared to the same period of the prior year. Excluding the tax equivalent adjustments, net interest income increased 14% for the quarter ended June 30, 2018 compared to the same quarter of the prior year, and increased 16% for the six months ended June 30, 2018 compared to the same period of the prior year. Net interest income improved due to several factors:
Organic loan and lease growth has been strong over the past 12 months pushing loans/leases up to 76% of total assets;
The acquisition of Guaranty Bank in the fourth quarter of 2017, whose strong NIM has contributed to the Company's results; and
The Company's continued strategy to redeploy funds from the lower yielding taxable securities portfolio into higher yielding loans and municipal bonds, especially with the Company's most recent acquisitions of CSB and Guaranty Bank.
A comparison of yields, spread and margin on a tax equivalent and GAAP basis is as follows:
Tax Equivalent Basis
GAAP
Average Yield on Interest-Earning Assets
4.44
4.41
4.37
4.28
4.27
4.09
Average Cost of Interest-Bearing Liabilities
Net Interest Spread
3.23
3.38
3.60
3.07
3.24
3.32
NIM
3.54
NIM Excluding Acquisition Accounting Net Accretion
3.46
3.56
3.61
3.31
3.42
3.34
4.42
4.38
4.11
1.13
3.29
3.65
3.15
3.51
3.63
3.36
Acquisition accounting net accretion can fluctuate depending on the payoff activity of the acquired loans. In evaluating net interest income and NIM, it's important to understand the impact of acquisition accounting net accretion when comparing periods. The above table reports NIM with and without the acquisition accounting net accretion to allow for more appropriate comparisons. A comparison of acquisition accounting net accretion included in NIM is as follows:
dollars in thousands
Acquisition Accounting Net Accretion in NIM
NIM on a tax equivalent basis was down 12 basis points on a linked quarter basis. . Excluding acquisition accounting net accretion, NIM was down 10 basis points on a linked quarter basis. This margin compression was primarily due to the following:
42
Increases in the cost of funds due to both mix and rate as the Company continues to grow larger commercial and public deposits which tend to have higher interest rate sensitivity;
In the first quarter of 2018, the Company recognized elevated loan origination fee income through NIM for select commercial loans which contributed to approximately five basis points of the core NIM decline;
With the flat yield curve and continued competition in our markets, loan pricing continues to be pressured. The Company had success in widening spreads as core loan yields increased 13 basis points on linked quarter basis; however, the pace and magnitude of the widening has been offset by the increasing cost of funds;
The majority of the Company’s earning asset growth in the second quarter of 2018 occurred at the end of the quarter.
The Company's management closely monitors and manages NIM. From a profitability standpoint, an important challenge for the Company's subsidiary banks and leasing company is focusing on quality growth in conjunction with the improvement of their NIMs. Management continually addresses this issue with pricing and other balance sheet management strategies which included better loan pricing, reducing reliance on very rate-sensitive funding, closely managing deposit rate increases and finding additional ways to manage cost of funds through derivatives.
43
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 June 30,
Earned
Yield or
or Paid
(dollars in thousands)
ASSETS
Interest earning assets:
18,561
61
18,742
0.81
54,879
228
1.67
86,236
220
Investment securities (1)
648,276
5,752
573,747
5,384
3.76
21,100
212
4.03
13,226
132
Gross loans/leases receivable (1) (2) (3)
3,077,517
36,008
4.69
2,488,828
28,881
4.65
Total interest earning assets
42,261
3,180,779
34,655
Noninterest-earning assets:
68,266
63,526
Premises and equipment
63,665
61,327
(36,960)
(32,361)
138,380
104,924
3,378,195
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Interest-bearing deposits
1,919,406
4,089
0.85
1,566,106
1,835
0.47
665,643
2,439
1.47
527,719
1,156
0.88
19,024
63
17,936
0.42
174,826
882
2.02
76,739
354
1.85
67,044
733
4.39
72,000
696
3.88
37,558
508
5.43
33,530
347
4.15
Total interest-bearing liabilities
2,883,501
8,714
2,294,030
4,407
Noninterest-bearing demand deposits
757,954
741,886
Other noninterest-bearing liabilities
47,198
41,411
3,688,653
3,077,327
Stockholders' equity
365,031
300,868
30,248
Net interest spread
Net interest margin
Ratio of average interest-earning assets to average interest-bearing liabilities
132.49
138.65
(1)
Interest earned and yields on nontaxable investment securities and nontaxable loans are determined on a tax equivalent basis using a 35% tax rate for periods prior to March 31, 2018 and 21% for periods including and after March 31, 2018.
(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.
44
Analysis of Changes of Interest Income/Interest Expense
Inc./(Dec.)
Components
from
of Change (1)
Prior Period
Rate
Volume
2018 vs. 2017
INTEREST INCOME
412
(404)
Investment securities (2)
368
(1,549)
1,917
80
79
Gross loans/leases receivable (2) (3) (4)
7,127
241
6,886
Total change in interest income
7,606
(870)
8,476
INTEREST EXPENSE
2,254
1,767
487
1,283
924
359
528
492
276
(239)
161
116
45
Total change in interest expense
4,307
3,162
1,145
Total change in net interest income
3,299
(4,032)
7,331
The column "Inc./(Dec.) from Prior Period" is segmented into the changes attributable to variations in volume and the changes attributable to changes in interest rates. The variations attributable to simultaneous volume and rate changes have been proportionately allocated to rate and volume.
(4)
For the six months ended June 30,
19,132
118
1.24
14,917
53
52,205
425
1.64
89,394
418
0.94
648,656
11,418
3.55
567,101
10,543
3.75
21,465
446
4.19
13,549
262
3.90
3,048,447
70,753
4.68
2,443,608
56,741
83,160
68,017
67,745
64,409
63,530
61,152
(36,048)
(31,930)
139,057
104,256
4,024,189
3,326,456
Interest-bearing demand deposits
1,873,817
7,109
1,486,876
2,974
641,152
4,301
1.35
519,419
2,249
0.87
18,148
95
21,562
205,758
1,946
1.91
95,548
758
1.60
65,862
1,451
73,381
1,379
3.79
37,534
955
5.13
33,514
680
2,842,271
15,857
2,230,300
8,083
776,314
757,566
44,826
42,704
3,663,411
3,030,569
360,778
295,887
Ratio of average interest earning assets to average interest-bearing liabilities
133.34
140.28
46
65
47
Interest-bearing deposits at other financial institutions
454
(447)
875
(1,414)
2,289
184
163
14,012
(80)
14,092
15,143
(972)
16,115
4,135
3,205
930
2,052
1,438
614
52
(21)
1,188
170
1,018
72
403
(331)
275
(40)
315
7,774
5,249
2,525
7,369
(6,221)
13,590
CRITICAL ACCOUNTING POLICIES
The Company's financial statements are prepared in accordance with GAAP. 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. Certain critical accounting policies are described below.
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 for loan and lease losses.
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 management's view regarding 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 structures, 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 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 June 30, 2018 was adequate to absorb losses 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.
RESULTS OF OPERATIONS
Interest income increased 26%, comparing the second quarter of 2018 to the same period of 2017 and comparing the first half of 2018 to the same period of 2017. This increase was primarily the result of strong organic loan growth, the acquisition of Guaranty Bank, and improved pricing with the rising rate environment. Although the latter has been less than the Company would like due to competitive pressures and the flat yield cureve, the Company is focused on growing loans at higher rates with widening spreads to more than effect the rising cost of funds
Overall, the Company's average earning assets increased 20%, comparing the second quarter of 2018 to the second quarter of 2017. During the same time period, average gross loans and leases increased 24%, while average investment securities increased 13% with a portion being private placement tax-exempt municipal securities. Average earning assets increased 21%, comparing the first half of 2018 to the same period of 2017. Average gross loans and leases increased 25% and average investment securities increased 14%, comparing the first half of 2018 to the same period to 2017. These increases were also the result of strong loan growth and the acquisition of Guaranty Bank.
The Company intends to continue to grow quality loans and leases as well as its private placement tax-exempt securities portfolio to maximize yield while minimizing credit and interest rate risk.
Interest expense for the second quarter of 2018 increased 98% from the second quarter of 2017 and increased 96%, comparing the first half of 2018 to the same period of 2017. The acquisition of Guaranty Bank contributed to this increase as we added over $200MM in deposits. Additionally, as the Company has grown organically at a significant pace over the past several years, the loan growth has been funded in larger part by bigger depositor relationships with higher rate sensitivity and many of those relationships which have pricing tied to a certain index. As a result, the cost of these funds is higher than the rest of the Company’s core deposit portfolio, and the cost rises at a higher rate (beta) as market interest rates rise which has been the case over the past several quarters. The beta on the balance of the Company’s core deposit portfolio has performed well and is much lower than the beta on these relationships with pricing tied to a certain index. Additionally, the loan growth has outpaced deposit growth, short-term borrowings have increased to fill in the funding gap and the cost of these funds has increased with the rising rate environment.
The Company's management intends to continue to shift the mix of funding from wholesale funds to well-priced core deposits, including noninterest-bearing deposits. Continuing this trend is expected to strengthen the Company's franchise value, reduce funding costs, and increase fee income opportunities through deposit service charges.
48
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 $2.3 million for the second quarter of 2018, which was an increase of $278 thousand or 14% from the same quarter of the prior year. Provision for the first six months of the year totaled $4.8 million, which was up $712 thousand or 17%, compared to the first six months of 2017. The increase from the second quarter of 2017 to the second quarter of 2018 was primarily attributable to loan growth and the accounting for the loans acquired through the acquisitions of CSB and Guaranty Bank. As acquired loans renew, the discount associated with those loans is eliminated and the Company must establish an allowance through provision. This provision, when coupled with net charge-offs of $1.7 million for the first six months of 2018, increased the Company's allowance to $37.5 million at June 30, 2018. As of June 30, 2018, the Company's allowance to total loans/leases was 1.21%, which was relatively flat from 1.20% at March 31, 2018 and down from 1.31% at June 30, 2017.
In accordance with GAAP for business combination accounting, acquired loans are recorded at fair value; therefore, no allowance is associated with such loans at acquisition. Management continues to evaluate the allowance needed on acquired loans factoring in the net remaining discount ($6.6 million and $6.3 million at June 30, 2018 and June 30, 2017, respectively). When factoring this remaining discount into the Company's allowance to total loans and leases calculation, the Company's allowance as a percentage of total loans and leases increases from 1.21% to 1.42% as of June 30, 2018 and increases from 1.31% to 1.55% as of June 30, 2017.
A more detailed discussion of the Company's allowance can be found in the “Financial Condition” section of this Report.
NONINTEREST INCOME
Three Months Ended
$ Change
% Change
365,986
21.6
188,831
21.7
152,044
10.4
(10,856)
(9.6)
(87,053)
(100.0)
1,321,308
403.4
(60,086)
(13.1)
100,765
13.6
12,473
6.2
184,800
23.3
2,129,748
31.4
49
Six Months Ended
862,860
25.1
179,576
9.8
367,107
13.2
(6,364)
(3.0)
(679,260)
(65.5)
2,166,482
491.2
(111,786)
(12.0)
164,072
11.3
32,111
7.2
451,109
30.4
3,387,443
24.1
In recent years, the Company has been successful in expanding its wealth management customer base. Trust department fees continue to be a significant contributor to noninterest income and, due to favorable market conditions in early 2018 coupled with strong growth in assets under management, trust department fees increased 22%, comparing the second quarter of 2018 to the same period of the prior year. Trust department fees increased 25% when comparing the first half of 2018 to the same period of the prior year. 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. Additionally, the Company started offering trust operations services to correspondent banks.
Investment advisory and management fees increased 22%, comparing the second quarter of 2018 to the same period of the prior year, and they increased 10% when comparing the first half of 2018 to the first half of 2017. Management has placed a stronger 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 the 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. The Company announced in March 2018 the signing of definitive agreements to acquire and merge the Bates Companies into RB&T. The acquisition and subsequent merger of the Bates Companies into RB&T will add approximately $700 million of assets under management. This acquisition is expected to close early in the fourth quarter of 2018.
Deposit service fees expanded 10% comparing the second quarter of 2018 to the same period of the prior year and expanded 13% when comparing the first half of 2018 to the same period of the prior year. This increase was primarily the result of the growth in deposits due to the acquisition of Guaranty Bank. Additionally, 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 continuing 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 10% when comparing the second quarter of 2018 to the same period of the prior year and decreased 3% when comparing the first half of 2018 to the same period of the prior year. Overall, with the continued 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 generally become a smaller contributor to overall noninterest income.
The Company's gains on the sale of government-guaranteed portions of loans for the second quarter of 2018 decreased 100% compared to the second quarter of 2017 and decreased 66% when comparing the first half of 2018 to the same period
50
of the prior year. Given the nature of these gains, large fluctuations can occur from quarter-to-quarter and year-to-year. As one of its core strategies, the Company continues to leverage its expertise by taking advantage of programs offered by the SBA and the USDA. In the past several years, 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 loans that fit the criteria for the government guarantee. Further, the size of the transactions can vary and, as the gain is determined as a percentage of the guaranteed amount, the resulting gain on sale can vary. 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. Recently, competitors have been offering SBA loan candidates traditional financing without the guarantee and the Company is not willing to relax structure for those lending opportunities.
As a result of the continued relatively low interest rate environment including a flat yield curve, the Company was able to execute numerous interest rate swaps on select commercial loans. 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. An optimal interest rate swap candidate must be of a certain size and sophistication which can lead to volatility in activity from quarter to quarter. Swap fee income totaled $1.6 million for the second quarter of 2018, compared to $328 thousand for the second quarter of 2017. Swap fee income totaled $2.6 million for the first half of 2018 compared to $441 thousand in the first half of 2017. Future levels of swap fee income are also dependent upon prevailing interest rates.
Earnings on BOLI decreased 13% comparing the second quarter of 2018 to the first quarter of 2018 and decreased 12% comparing the first half of 2018 to the first half of 2017. There were no purchases of BOLI within the last 12 months. Notably, a small portion of the Company's BOLI is variable rate whereby the returns are determined by the performance of the equity market. Equity market performance accounted for the majority of the decrease in earnings on BOLI. 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.
Debit card fees are the interchange fees paid on certain debit card customer transactions. Debit card fees increased 14% comparing the second quarter of 2018 to the second quarter of the prior year and increased 11% comparing the first half of 2018 to the first half of 2017. This increase was primarily related to the acquisition of Guaranty Bank in the fourth quarter of 2017. 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 retail deposit product with a higher interest rate that incentivizes debit card activity, which has been taken advantage of by the Company's customers.
Correspondent banking fees increased 6% comparing the second quarter of 2018 to the second quarter of the prior year and increased 7% comparing the first half of 2018 to the first half of 2017. Management will continue to evaluate earnings credit rates and the resulting impact on deposit balances and fees while balancing the ability to grow market share. Correspondent banking continues to be a core strategy for the Company, as this line of business provides a high level of deposits that can be used to fund loan growth as well as a steady source of fee income. The Company now serves approximately 192 banks in Iowa, Illinois and Wisconsin.
Other noninterest income increased 23% comparing the second quarter of 2018 to the second quarter of the prior year and increased 30% comparing the first half of 2018 to the first half of 2017. These increases were primarily driven by fluctuations in net gains recognized on the disposal of leased assets.
51
NONINTEREST EXPENSE
The following tables set forth the various categories of noninterest expense for the three and six months ended June 30, 2018 and 2017.
2,873,072
22.2
434,322
16.1
430,524
18.4
100.0
195,181
30.2
(195)
(0.1)
(98,147)
(351.1)
185,496
32.7
18,646
4.2
2,644
1.3
CDI amortization expense
73,684
31.9
271,051
25.7
4,965,194
23.2
5,543,716
21.1
997,914
19.2
1,054,848
23.8
330,150
26.1
(2,986)
(0.5)
Net cost of operations of other real estate
19,365
45.9
269,304
22.9
35,316
4.1
9,047
2.3
147,369
480,076
23.5
9,555,574
22.4
Management places a strong emphasis on overall cost containment and is committed to improving the Company's general efficiency. One-time charges relating to acquisitions are expected to impact expense throughout 2018.
Salaries and employee benefits, which is the largest component of noninterest expense, increased from the second quarter of 2017 to the second quarter of 2018 by 22%. This line item also increased 21% when comparing the first half of 2018 to the first half of 2017. This increase was primarily related to new hires, merit increases and the addition of the Guaranty Bank employees. To help support recent and expected growth, the Company is adding to operational infrastructure and investing in additional staffing both at the corporate level and at some of the bank charters. Some of these hires are opportunistic, as the Company takes advantage of strong talent in the marketplace as a result of ongoing industry consolidation.
Occupancy and equipment expense increased 16%, comparing the second quarter of 2018 to the same period of the prior year and increased 19% comparing the first half of 2018 to the same period of the prior year. The increased expense was primarily due to the addition of Guaranty Bank.
Professional and data processing fees increased 18%, comparing the second quarter of 2018 to the same period in 2017 and increased 24% comparing the first half of 2018 to the same period of the prior year. This increased expense was partially due to the addition of Guaranty Bank. Additionally, legal expense was also elevated due to a legal matter at RB&T where two employees have been charged with wrongdoing in connection with an SBA loan application. The Company anticipates these legal expenses will continue to increase until the court proceedings are completed, which the Company expects to be in late 2018. Neither RB&T nor the Company have been charged in the case. Generally, professional and data processing fees can fluctuate depending on certain one-time project costs. Management will continue to focus on minimizing one-time costs and driving recurring costs down through contract renegotiation or managed reduction in activity where costs are determined on a usage basis.
Acquisition costs totaled $413 thousand for the second quarter of 2018 and $506 thousand for the first half of 2018. There were no acquisition costs in the first half of 2017. These costs were comprised primarily of legal, accounting and investment banking costs related to the acquisitions described in Note 10 to the Consolidated Financial Statements.
Post-acquisition costs totaled $165 thousand for the second quarter of 2018 and for the first half of 2018. These costs were comprised primarily of personnel costs, IT integration, and data conversion costs related to acquisitions.
FDIC insurance, other insurance and regulatory fee expense increased 30%, comparing the second quarter of 2018 to the second quarter of 2017 and increased 26% comparing the first half of 2018 to the same period of the prior year. The increase in expense was due to the acquisition of Guaranty Bank.
Loan/lease expense remained flat when comparing the second quarter of 2018 to the same quarter of 2017 as well as when comparing the first half of 2018 to the same period of the prior year. Generally, loan/lease expense has a direct relationship with the level of NPLs; however, it may deviate depending upon the individual NPLs.
Net cost of/income from operations of other real estate includes gains/losses on the sale of OREO, write-downs of OREO and all income/expenses associated with OREO. Net income from operations of other real estate totaled $70 thousand for the second quarter of 2018, compared to net costs of operations of $28 thousand for the second quarter of 2017. Net cost of operations of other real estate totaled $62 thousand for the first half of 2018 compared to $42 thousand for the same period of the prior year.
Advertising and marketing expense increased 33%, comparing the second quarter of 2018 to the second quarter of 2017 and increased 23% comparing the first half of 2018 to the same period of the prior year. The increase in expense was primarily due to the addition of Guaranty Bank.
Bank service charges, a large portion of which includes indirect costs incurred to provide services to QCBT's correspondent banking customer portfolio, increased 4% from the second quarter of 2017 to the second quarter of 2018 and increased 4%, comparing the first half of 2018 to the same period of the prior year. The increase was due, in large part, to the success QCBT has had in growing its correspondent banking customer portfolio. As transactions volumes continue to increase and the number of correspondent banking clients increases, the associated expenses will also increase.
Correspondent banking expense increased 1% when comparing the second quarter of 2018 to the second quarter of 2017 and increased 2% when comparing the first half of 2018 to the same period of the prior year. The increase was due to both increases in volume and in the number of correspondent banking clients. These are direct costs incurred to provide services to QCBT's correspondent banking customer portfolio, including safekeeping and cash management services.
CDI amortization expense increased 32% when comparing the second quarter of 2018 to the second quarter of 2017 and when comparing the first half of 2018 to the same period of the prior year. The increase was due to the acquisition of Guaranty Bank.
Other noninterest expense was up 26% when comparing the second quarter of 2018 to the second quarter of 2017 and increased 24% when comparing the first half of 2018 to the same period of the prior year. Included in other noninterest expense are items such as subscriptions, sales and use tax and expenses related to wealth management. A portion of this increase is related to the addition of Guaranty Bank.
INCOME TAXES
In the second quarter of 2018, the Company incurred income tax expense of $1.9 million. During the first half of the year, the Company incurred income tax expense of $3.9 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 six months ended June 30, 2018 and 2017.
For the Three Months Ended June 30,
For the Six Months Ended June 30,
% of
Pretax
Income
Computed "expected" tax expense
2,588,503
21.0
3,990,557
35.0
5,222,119
8,041,601
Tax exempt income, net
(956,089)
(7.8)
(1,433,903)
(12.6)
(1,899,190)
(7.6)
(2,739,330)
(11.9)
(83,848)
(0.7)
(160,775)
(1.4)
(171,625)
(325,166)
State income taxes, net of federal benefit, current year
557,656
4.5
394,410
3.5
1,109,124
802,735
Excess tax benefit on stock options exercised and restricted stock awards vested
(200,644)
(1.6)
(89,545)
(0.8)
(333,005)
(1.3)
(622,867)
(2.7)
(24,759)
(65,168)
(0.6)
(55,534)
(0.3)
(131,951)
15.3
23.1
15.6
21.9
The effective tax rate for the quarter ended June 30, 2018 was 15.3% which was a 7.8% decrease from the effective tax rate of 23.1% for the quarter ended June 30, 2017. The effective tax rate for the six months ended June 30, 2018 was 15.6%, which was a decrease over the effective tax rate of 21.9% for the six months ended June 30, 2017. The Tax Act was enacted on December 22, 2017 and was effective January 1, 2018 reducing the federal corporate tax rate from 35% to 21%.
FINANCIAL CONDITION
Following is a table that represents the major categories of the Company's balance sheet.
69,069
61,846
75,722
77,161
Federal funds sold and interest-bearing deposits
51,667
59,557
85,962
72,354
Securities
657,997
638,229
652,382
593,485
Net loans/leases
3,077,247
75
3,018,370
2,930,130
2,520,209
250,903
248,312
238,469
193,978
100
3,298,276
81
3,280,001
82
3,266,655
2,870,234
83
Total borrowings
380,392
334,802
309,480
230,264
58,627
51,083
53,243
51,606
During the second quarter of 2018, the Company's total assets increased $80.6 million, or 2%, to a total of $4.1 billion. Net loans/leases grew $58.9 million. This loan and lease growth was funded by deposits, which increased $18.3 million in the second quarter of 2018, and borrowings, which increased $45.6 million in the second quarter of 2018. Stockholders' equity increased $9.2 million, or 3%, in the current quarter due to net retained income.
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. Over the past five years, the Company has further diversified the portfolio by decreasing U.S government sponsored agency securities, while increasing residential mortgage-backed and related securities and tax-exempt municipal securities. Of the latter, the large majority are privately placed tax-exempt 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.
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:
35,667
36,868
38,097
41,944
458,510
70
438,736
69
445,049
68
381,254
64
158,534
157,289
163,301
164,415
5,286
5,336
5,935
5,872
Securities as a % of Total Assets
16.02
15.85
16.38
17.17
Net Unrealized Losses as a % of Amortized Cost
(1.58)
(1.01)
(0.13)
(0.33)
Duration (in years)
7.0
6.9
6.3
Quarterly Yield on Investment Securities (TEY)
3.82
Quarterly Yield on Investment Securities (GAAP)
3.02
3.03
2.77
2.75
Management monitors the level of unrealized gains/losses including performing quarterly reviews of individual securities for evidence of OTTI. Management identified no OTTI in any of the periods presented.
The duration of the securities portfolio shortened modestly with the TEY on the portfolio decreasing 26 bps in the first half of 2018; however, excluding the tax benefit and the related variance due to the lower tax rate, the portfolio yield expanded 25 basis points.
The Company has not invested in private 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.
55
LOANS/LEASES
Total loans/leases grew 7.8% on an annualized basis during the second quarter of 2018. The mix of the loan/lease types within the Company's loan/lease portfolio is presented in the following table.
C&I loans
1,273,000
1,201,087
1,134,516
942,538
1,349,319
1,357,703
1,303,492
1,131,906
Direct financing leases
133,196
137,614
141,448
153,337
Residential real estate loans
257,434
254,484
258,646
233,871
92,952
95,912
118,611
84,047
Total loans/leases
3,105,901
3,046,800
2,956,713
2,545,699
8,891
8,103
7,773
7,867
(37,545)
(36,533)
(34,356)
(33,357)
As CRE loans have historically been the Company's largest portfolio segment, management places a strong emphasis on monitoring the composition of the Company's CRE loan portfolio. For example, management tracks the level of owner-occupied CRE loans relative to non owner-occupied loans. Owner-occupied loans are generally considered to have less risk. As of June 30, 2018 and December 31, 2017, approximately 26% of the CRE 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 C&I loans. C&I loans grew $71.9 million in the current quarter.
A syndicated loan is a commercial loan provided by a group of lenders and is structured, arranged and administered by one or several commercial or investment banks known as arrangers. The nationally syndicated loans invested in by the Company consist of fully funded, highly liquid term loans for which there is a liquid secondary market. As of June 30, 2018 and December 31, 2017, the amount of nationally syndicated loans totaled $38.6 million and $51.2 million, respectively.
Following is a listing of significant industries within the Company's CRE loan portfolio:
As of June 30,
As of March 31,
As of December 31,
Lessors of Nonresidential Buildings
439,067
435,919
388,648
344,747
Lessors of Residential Buildings
230,187
221,978
199,047
159,370
Hotels
73,335
70,887
70,447
39,881
Nonresidential Property Managers
55,979
56,572
51,621
52,947
Land Subdivision
39,883
45,356
44,192
46,117
New Housing For-Sale Builders
38,392
52,951
61,480
52,277
Nursing Care Facilities
37,417
38,830
47,008
33,607
Lessors of Other Real Estate Property
28,149
31,121
29,078
20,932
Other *
406,910
404,089
411,971
382,028
Total CRE Loans
* “Other” consists of all other industries. None of these had concentrations greater than $27.0 million, or approximately 2% of total CRE loans in the most recent period presented.
56
The Company's residential real estate loan portfolio includes 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 and 20‑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. The Company has not originated any subprime, Alt-A, no documentation, or stated income residential real estate loans throughout its history.
Following is a listing of significant equipment types within the m2 loan and lease portfolio:
Trucks, Vans and Vocational Vehicles
35,814
28,219
19,927
16,679
Construction - General
18,494
18,067
18,705
15,207
Manufacturing - General
16,794
16,624
16,571
19,092
Food Processing Equipment
14,377
13,270
12,965
13,754
Marine - Travelifts
12,875
12,843
10,802
12,497
Computer Hardware
10,141
10,694
11,340
9,821
Trailers
10,137
9,161
8,983
9,611
Miscellaneous Equipment
7,032
6,459
6,644
5,126
Restaurant
6,509
6,844
7,107
7,238
101,124
101,473
102,192
105,228
Total m2 loans and leases
233,297
223,654
215,236
214,253
* “Other” consists of all other equipment types. None of these had concentrations greater than 3% of total m2 loan and lease portfolio in the most recent period presented.
See Note 3 to the Consolidated Financial Statements for additional information regarding the Company's loan and lease portfolio.
ALLOWANCE FOR ESTIMATED LOSSES ON LOANS/LEASES
Changes in the allowance for the three and six months ended June 30, 2018 and 2017 are presented as follows:
36,533
32,059
34,356
30,757
2,301
2,023
4,841
4,128
(1,524)
(851)
(1,961)
(1,743)
235
126
309
215
37,545
33,357
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,
57
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”, as described in Note 1 to the Consolidated Financial Statements contained in the Company's Annual Report on Form 10‑K for the year ended December 31, 2017, and carrying aggregate exposure in excess of $250 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 *
44,202
42,926
31,024
27,737
42,492
39,815
43,435
45,290
271
86,694
82,741
74,730
73,027
Criticized Loans **
Classified Loans ***
43,706
Criticized Loans as a % of Total Loans/Leases
2.79
2.52
2.86
Classified Loans as a % of Total Loans/Leases
1.37
1.34
1.77
* 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 7% increase in classified loans during the second quarter of 2018. Criticized loans increased 5% during the same period. The Company experienced a decrease of 3% in classified loans during the first six months of 2018. Criticized loans increased 16% during the same period. The Company continues its strong focus on improving credit quality in an effort to limit NPLs.
Allowance / Gross Loans/Leases
Allowance / NPLs
270.09
202.11
184.28
162.27
Although management believes that the allowance at June 30, 2018 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.
58
NONPERFORMING ASSETS
The table below presents the amount of NPAs and related ratios.
Nonaccrual loans/leases (1) (2)
12,554
12,759
11,441
13,217
Accruing loans/leases past due 90 days or more
89
424
TDRs - accruing
1,327
5,276
7,113
6,915
13,901
18,076
18,643
20,556
12,750
13,558
5,174
Other repossessed assets
150
200
123
Total NPAs
26,801
31,026
32,281
25,853
NPLs to total loans/leases
0.45
0.59
0.63
0.80
NPAs to total loans/leases plus repossessed property
Includes government guaranteed portion of loans, as applicable.
Includes TDRs of $1.8 million at June 30, 2018, $2.6 million at March 31, 2018, $2.3 million at December 31, 2017, and $2.2 million at June 30, 2017.
NPAs at June 30, 2018 were $26.8 million, down $4.2 million from March 31, 2018 and up $948 thousand from June 30, 2017. The decrease in the second quarter of 2018 was due to one large loan that was upgraded and taken out of TDR status.
The ratio of NPAs to total assets was 0.65% at June 30, 2018, down from 0.77% at March 31, 2018 and down from 0.75% at June 30, 2017.
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.
The Company's lending/leasing practices remain unchanged and asset quality remains a priority for management.
DEPOSITS
Deposits increased $18.3 million during the second quarter of 2018. The table below presents the composition of the Company's deposit portfolio.
Noninterest bearing demand deposits
746,822
784,815
789,548
760,625
Interest bearing demand deposits
1,865,382
1,789,019
1,855,893
1,526,103
519,999
496,644
516,058
478,580
Brokered deposits
166,073
209,523
105,156
104,926
Quarter-end balances can greatly fluctuate due to large customer and correspondent bank activity.
59
In an effort to strengthen the relationship and maximize the liquidity potential of its correspondent banking clients, the Company introduced an interest-bearing money market deposit account to its correspondent banking clients and this generated strong deposit growth in 2017.
Management will continue to focus on growing its core 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 a few of their significant customers. Also, the subsidiary banks purchase federal funds for short-term funding needs from the FRB or from their correspondent banks. The table below presents the composition of the Company's short-term borrowings.
Overnight repurchase agreements with customers
2,186
3,820
7,003
4,897
Federal funds purchased
15,400
13,040
6,990
13,320
17,586
16,860
13,993
18,217
The Company's federal funds purchased fluctuates based on the short-term funding needs of the Company's subsidiary banks.
As a result of their memberships in either the FHLB of Des Moines or Chicago, the subsidiary banks have the ability to borrow funds for short or long-term purposes under a variety of programs. Generally, FHLB advances are utilized for loan matching as a hedge against the possibility of rising interest rates and when these advances provide a less costly or more readily available source of funds than customer deposits.
The table below presents the Company's term and overnight FHLB advances.
Term FHLB advances
46,600
56,600
57,000
Overnight FHLB advances
207,500
159,745
135,400
49,500
254,100
216,345
192,000
106,500
Term FHLB advances decreased $10.0 million in the current quarter, as compared to the prior quarter. Overnight FHLB advances increased by $47.8 million in the second quarter of 2018 due to the strong loan and lease growth, which outpaced the Company's deposit growth.
The table below presents the composition of the Company's other borrowings.
Wholesale structured repurchase agreements
35,000
45,000
Term notes
27,125
29,063
31,000
27,000
Revolving line of credit
9,000
71,125
64,063
66,000
60
Other borrowings include structured repos which are utilized as an alternative funding source to FHLB advances and customer deposits. Structured repos are collateralized by certain U.S. government agency securities and residential mortgage backed and related securities.
As described in Note 11 to the Consolidated Financial Statements included in the Company's Annual Report on Form 10‑K for the year ended December 31, 2017, the Company has outstanding term notes and an available revolving line of credit. As of June 30, 2018, the term debt had been paid down to $27.1 million, as scheduled. The term notes and revolving line of credit were used to help fund acquisitions as described in Note 10 to the Consolidated Financial Statements. As of June 30, 2018, $1.0 million of the $10.0 million line of credit was available. Interest is calculated at the effective LIBOR rate plus 2.50% per annum (4.84% at June 30, 2018).
It is management's intention to reduce its reliance on wholesale funding, including FHLB advances, structured repos, and brokered deposits. Replacement of this funding with core deposits helps to reduce interest expense as wholesale funding tends to be higher cost. However, the Company may choose to utilize advances and/or brokered deposits to supplement funding needs, as this is a way for the Company to effectively and efficiently manage interest rate risk.
The table below presents the maturity schedule including weighted average interest cost for the Company's combined wholesale funding portfolio.
Weighted
Maturity:
Amount Due
Interest Rate
(dollar amounts in thousands)
Year ending December 31:
373,653
2.04
273,677
2019
50,921
2.20
31,950
2.32
2020
30,694
2.42
26,600
2.44
Total Wholesale Funding
455,268
2.09
332,227
During the first six months of 2018, wholesale funding increased $123.0 million. Year-to-date, the Company has repaid $79.0 million of term borrowings at maturity. However, this was more than offset by growth in short-term borrowings used to temporarily fund strong earning asset growth.
STOCKHOLDERS' EQUITY
The table below presents the composition of the Company's stockholders' equity.
Common stock
13,974
13,937
13,918
13,175
Additional paid in capital
190,533
189,685
189,078
158,001
171,955
162,346
135,254
AOCI (loss)
(6,874)
(5,540)
(1,671)
(1,347)
TCE* / TA
* TCE is defined as total common stockholders' equity excluding goodwill and other intangibles. This ratio is a non-GAAP financial measure. See GAAP to Non-GAAP Reconciliations.
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 $141.7 million during the second quarter of 2018 and $164.0 million during the full year of 2017. 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 deposits, lines of credit, borrowing at the Federal Reserve Discount Window, sales of securities AFS, 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).
At June 30, 2018, the subsidiary banks had 33 lines of credit totaling $371.7 million, of which $2.7 million was secured and $369.0 million was unsecured. At June 30, 2018, the full $371.7 million was available.
At December 31, 2017, the subsidiary banks had 34 lines of credit totaling $375.0 million, of which $3.0 million was secured and $372.0 million was unsecured. At December 31, 2017, the full $375.0 million was available.
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 $10.0 million secured revolving credit note with a variable interest rate and a maturity of June 30, 2019. At June 30, 2018, $1.0 million of the $10.0 million was available.
As of June 30, 2018, the Company had $415.0 million in average correspondent banking deposits spread over 192 relationships. While the Company believes that these funds are relatively 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 $137.9 million during the first six months of 2018, compared to $152.5 million for the same period of 2017. The net decrease in federal funds sold was $19.3 million for the first six months of 2018, compared to a net decrease of $3.1 million for the same period of 2017. The net decrease in interest-bearing deposits at financial institutions was $15.0 million for the first six months of 2018, compared to a net increase of $10.8 million for the same period of 2017. Proceeds from calls, maturities, and paydowns of securities were $39.8 million for the first six months of 2018, compared to $68.2 million for the same period of 2017. Purchases of securities used cash of $55.0 million for the first six months of 2018, compared to $85.2 million for the same period of 2017. The net increase in loans/leases used cash of $151.0 million for the first six months of 2018 compared to $146.4 million for the same period of 2017.
Financing activities provided cash of $101.9 million for the first six months of 2018, compared to $140.2 million for same period of 2017. Net increases in deposits totaled $31.7 million for the first six months of 2018, compared to $201.0 million for the same period of 2017. During the first six months of 2018, the Company's short-term borrowings increased $3.6 million, while they decreased $21.8 million for the same period of 2017. In the first six months of 2018, the Company increased short-tem and overnight FHLB advances by $72.1 million and increased other borrowings by $9.0 million. Maturities and principal payments on borrowings totaled $13.9 millionin the first six months of 2018. In the first
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six months of 2017, the Company reduced FHLB advances and borrowings by $39.0 million through a mixture of maturities, scheduled payments, and changes in short-term and overnight FHLB advances.
Total cash provided by operating activities was $29.4 million for the first six months of 2018, compared to $18.9 million for the same period of 2017.
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.
The following table presents the details of the trust preferred securities outstanding as of June 30, 2018 and December 31, 2017.
Outstanding
Interest Rate as of
Name
Date Issued
February 2004
10,310,000
2.85% over 3-month LIBOR
5.19
4.54
8,248,000
February 2006
1.55% over 3-month LIBOR
2.91
September 2004
3,093,000
2.17% over 3-month LIBOR
4.49
March 2007
3,609,000
1.75% over 3-month LIBOR
May 2005
4,640,000
40,210,000
Weighted Average Rate
4.58
As described in Note 4 to the Consolidated Financial Statements, on June 21, 2018, the Company entered into interest rate swaps to hedge against the risk of rising rates on its variable rate trust preferred securities. The floating rate trust preferred securities are tied to 3-month LIBOR, and the interest rate swaps utilize 3-month LIBOR, so the hedge is effective. The interest rate swaps are designated as a cash flow hedge in accordance with ASC 815. See Note 4 for the notional amount swapped and the related effective fixed rates. The Company assumed the trust preferred securities originally issued by Community National in connection with its acquisition in May 2013. The Company assumed the trust preferred securities originally issued by Guaranty in connection with its acquisition in October 2017. 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. As of June 30, 2018, the remaining discount was $2.6 million.
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. Refer to Note 8 of the Consolidated Financial Statements for additional information regarding regulatory capital.
SPECIAL NOTE CONCERNING FORWARD-LOOKING STATEMENTS
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. Factors that could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries include, but are not limited to, the following:
The strength of the local and national economy.
Changes in the interest rate environment.
The economic impact of past and any future terrorist attacks, acts of war or threats thereof and the response of the United States to any such threats and attacks.
The impact of cybersecurity risks.
The costs, effects and outcomes of existing or future litigation.
Changes in accounting policies and practices, as may be adopted by state and federal regulatory agencies, the FASB, the SEC or the PCAOB.
Unexpected results of acquisitions which may include failure to realize the anticipated benefits of the acquisition.
The economic impact of exceptional weather occurrences such as tornadoes, floods and blizzards.
The ability of the Company to manage the risks associated with the foregoing as well as anticipated.
These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. For a discussion of the factors that could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries, see the “Risk Factors” section included under Item 1A of Part I of the Company's Annual Report on Form 10‑K for the year ended December 31, 2017.
Item 3
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
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK - continued
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
2016
100 basis point downward shift
(10.0)
0.9
0.3
(1.7)
200 basis point upward shift
(4.4)
(3.7)
(1.2)
300 basis point upward shock
(25.0)
(11.5)
(8.4)
The simulation is well 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, 2018 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.
On June 21, 2018, the Company entered into interest rate swaps to hedge against the risk of rising rates on its variable rate trust preferred securities, for a total of $39.0 million.
The Company will continue to analyze and evaluate similar transactions as an alternative and cost effective way to mitigage 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.
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Item 4
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 June 30, 2018. 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.
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Part II
PART II - OTHER INFORMATION
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.
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 Annual Report on Form 10‑K for the year ended December 31, 2017. 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.
None
Item 3 Defaults Upon Senior Securities
Not applicable
3.1*
Agreement and Plan of Merger between QCR Holdings, Inc. and Springfield Bancshares, Inc., dated April 17, 2018 (incorporated by reference to Exhibit 2.1 to the Company’s Form 8-K filed with the SEC on April 18, 2018).
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 June 30, 2018 and December 31, 2017; (ii) Consolidated Statements of Income for the three and six months ended June 30, 2018 and June 30, 2017; (iii) Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2018 and June 30, 2017; (iv) Consolidated Statements of Changes in Stockholders' Equity for the three and six months ended June 30, 2018 and June 30, 2017; (v) Consolidated Statements of Cash Flows for the six months ended June 30, 2018 and June 30, 2017; and (vi) Notes to the Consolidated Financial Statements.
*
The Company has omitted schedules and similar attachments to the subject agreement pursuant to Item 601(b) of Regulation S-K. The Company will furnish a copy of any omitted schedule or similar attachment to the SEC upon request.
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
August 8, 2018
/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, First Vice President
Director of Financial Reporting
Principal Accounting Officer