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 September 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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth 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.
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 November 1, 2018, the Registrant had outstanding 15,673,883 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 September 30, 2018 and December 31, 2017
Consolidated Statements of IncomeFor the Three Months Ended September 30, 2018 and 2017
Consolidated Statements of IncomeFor the Nine Months Ended September 30, 2018 and 2017
Consolidated Statements of Comprehensive IncomeFor the Three and Nine Months Ended September 30, 2018 and 2017
Consolidated Statements of Changes in Stockholders' EquityFor the Three and Nine Months Ended September 30, 2018 and 2017
Consolidated Statements of Cash FlowsFor the Nine Months Ended September 30, 2018 and 2017
Notes to Consolidated Financial Statements
Note 1. Summary of Significant Accounting Policies
Note 2. Mergers and Acquisitions
Note 3. Investment Securities
Note 4. Loans/Leases Receivable
Note 5. Derivatives
Note 6. Earnings Per Share
Note 7. Fair Value
Note 8. Business Segment Information
Note 9. Regulatory Capital Requirements
Note10. Revenue Recognition
Note 11. Subsequent Events - Acquisition
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 September 30, 2018 and December 31, 2017
September 30,
December 31,
2018
2017
Assets
Cash and due from banks
$
73,406,657
75,721,663
Federal funds sold
33,070,000
30,197,000
Interest-bearing deposits at financial institutions
96,590,367
55,765,012
Securities held to maturity, at amortized cost
395,421,195
379,474,205
Securities available for sale, at fair value
255,323,442
272,907,907
Total securities
650,744,637
652,382,112
Loans receivable held for sale
2,557,907
645,001
Loans/leases receivable held for investment
3,650,828,460
2,963,840,399
Gross loans/leases receivable
3,653,386,367
2,964,485,400
Less allowance for estimated losses on loans/leases
(43,077,457)
(34,355,728)
Net loans/leases receivable
3,610,308,910
2,930,129,672
Bank-owned life insurance
67,443,063
59,059,494
Premises and equipment, net
73,828,512
62,838,255
Restricted investment securities
28,679,400
19,782,525
Other real estate owned, net
12,203,780
13,558,308
Goodwill
73,618,426
28,334,092
Core deposit intangible
16,136,914
9,078,953
Other assets
56,701,829
45,817,687
Total assets
4,792,732,495
3,982,664,773
Liabilities and Stockholders' Equity
Liabilities:
Deposits:
Noninterest-bearing
802,090,334
789,547,696
Interest-bearing
2,986,186,588
2,477,107,360
Total deposits
3,788,276,922
3,266,655,056
Short-term borrowings
12,929,499
13,993,122
Federal Home Loan Bank advances
359,128,925
192,000,000
Other borrowings
73,950,426
66,000,000
Junior subordinated debentures
37,626,070
37,486,487
Other liabilities
63,433,264
53,242,979
Total liabilities
4,335,345,106
3,629,377,644
Stockholders' Equity:
Preferred stock, $1 par value; shares authorized 250,000 September 2018 and December 2017- No shares issued or outstanding
—
Common stock, $1 par value; shares authorized 20,000,000 September 2018 - 15,673,760 shares issued and outstanding December 2017 - 13,918,168 shares issued and outstanding
15,673,760
13,918,168
Additional paid-in capital
269,373,303
189,077,550
Retained earnings
179,826,524
151,962,661
Accumulated other comprehensive loss:
Securities available for sale
(7,347,979)
(866,223)
Derivatives
(138,219)
(805,027)
Total stockholders' equity
457,387,389
353,287,129
Total liabilities and stockholders' equity
See Notes to Consolidated Financial Statements (Unaudited)
4
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three Months Ended September 30,
Interest and dividend income:
Loans/leases, including fees
44,033,687
29,245,320
Securities:
Taxable
1,521,789
1,367,212
Nontaxable
3,516,550
2,862,208
323,636
141,331
329,767
172,776
105,042
52,018
Total interest and dividend income
49,830,471
33,840,865
Interest expense:
8,722,555
3,556,189
78,053
33,248
1,272,538
607,751
924,780
724,854
519,062
362,475
Total interest expense
11,516,988
5,284,517
Net interest income
38,313,483
28,556,348
Provision for loan/lease losses
6,205,828
2,086,436
Net interest income after provision for loan/lease losses
32,107,655
26,469,912
Noninterest income:
Trust department fees
2,195,828
1,721,401
Investment advisory and management fees
1,059,413
968,452
Deposit service fees
1,655,529
1,522,461
Gains on sales of residential real estate loans, net
336,679
98,409
Gains on sales of government guaranteed portions of loans, net
46,417
91,974
Swap fee income
1,110,182
194,256
Securities losses, net
(63,588)
Earnings on bank-owned life insurance
474,426
428,002
Debit card fees
845,740
754,803
Correspondent banking fees
195,450
239,060
Other
889,161
746,073
Total noninterest income
8,808,825
6,701,303
Noninterest expense:
Salaries and employee benefits
17,432,632
13,423,943
Occupancy and equipment expense
3,318,470
2,516,274
Professional and data processing fees
2,537,027
2,950,839
Acquisition costs
1,292,043
407,997
Post-acquisition compensation, transition and integration costs
493,063
522,740
FDIC insurance, other insurance and regulatory fees
932,746
690,894
Loan/lease expense
369,379
257,540
Net income from operations of other real estate
(50,362)
(160,640)
Advertising and marketing
983,762
669,923
Bank service charges
461,656
460,153
Correspondent banking expense
205,121
204,189
CDI amortization
541,665
230,867
1,982,408
1,221,028
Total noninterest expense
30,499,610
23,395,747
Net income before income taxes
10,416,870
9,775,468
Federal and state income tax expense
1,608,035
1,921,533
Net income
8,808,835
7,853,935
Basic earnings per common share
0.56
0.60
Diluted earnings per common share
0.55
0.58
Weighted average common shares outstanding
15,625,123
13,151,350
Weighted average common and common equivalent shares outstanding
15,922,324
13,507,955
Cash dividends declared per common share
0.06
0.05
5
Nine Months Ended September 30,
113,655,270
84,571,466
4,671,333
3,770,022
10,100,598
8,198,173
748,953
559,697
776,013
435,096
222,814
104,778
130,174,981
97,639,232
20,132,044
8,779,548
173,469
76,365
3,218,769
1,365,433
2,375,837
2,103,731
1,473,965
1,042,227
27,374,084
13,367,304
102,800,897
84,271,928
11,046,402
6,214,538
91,754,495
78,057,390
6,490,896
5,153,609
3,069,423
2,798,886
4,797,385
4,297,210
539,266
307,360
404,851
1,129,668
3,717,761
635,353
(25,124)
1,291,686
1,357,049
2,456,134
2,201,125
672,807
684,306
2,822,331
2,228,133
26,262,540
20,767,575
Noninterest expenses:
49,214,623
39,662,218
9,516,939
7,716,829
8,015,966
7,374,930
1,798,184
658,377
2,529,415
1,957,413
920,215
811,362
Net cost of (income from) operations of other real estate
11,190
(118,453)
2,430,085
1,846,942
1,368,318
1,331,499
614,212
604,233
1,150,767
692,600
4,504,639
3,263,183
Total noninterest expenses
82,732,930
66,073,493
Income before income taxes
35,284,105
32,751,472
5,479,924
6,946,555
29,804,181
25,804,917
2.06
1.96
2.02
1.91
14,477,783
13,151,672
14,786,777
13,509,566
0.18
0.15
6
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
Three and Nine Months Ended September 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
(1,652,382)
289,086
Less reclassification adjustment for gains (losses) included in net income before tax
352,674
Unrealized gains (losses) on derivatives:
Unrealized holding losses arising during the period before tax
576,559
(8,446)
Less reclassification adjustment for ineffectiveness and caplet amortization before tax
(187,087)
(95,361)
763,646
86,915
Other comprehensive income (loss), before tax
(888,736)
439,589
Tax expense (benefit)
(276,849)
165,012
Other comprehensive income (loss), net of tax
(611,887)
274,577
Comprehensive income
8,196,948
8,128,512
(8,530,983)
2,057,586
Less reclassification adjustment for adoption of ASU 2016-01
855,039
(7,675,944)
2,082,710
404,100
(186,000)
(89,914)
(354,813)
494,014
168,813
(7,181,930)
2,251,523
(2,033,882)
864,468
(5,148,048)
1,387,055
24,656,133
27,191,972
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 payroll taxes for restriced stock and in connection with stock options exercised
(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
10,445,385
(1,334,621)
(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 payroll taxes for restricted stock and in connection with stock options exercised
642
(17,023)
(16,381)
Balance, June 30, 2018
13,973,940
190,533,240
171,955,296
(6,874,311)
369,588,165
(937,607)
Issuance of 1,699,414 shares of common stock, net of issuance costs as a result of merger with Springfield Bancshares
1,699,414
78,831,543
80,530,957
Issuance of 3,205 shares of common stock as a result of stock purchased under the Employee Stock Purchase Plan
3,205
120,396
123,601
Issuance of 1,754 shares of common stock as a result of stock options exercised
1,754
32,300
34,054
318,906
Restricted stock awards - 5,300 shares of common stock
5,300
(5,300)
Exchange of 9,853 shares of common stock in connection with payroll taxes for restricted stock and in connection with stock options exercised
(9,853)
(457,782)
(467,635)
Balance September 30, 2018
(7,486,198)
(Continued)
8
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED) - continued
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 payroll taxes for restricted stock and in connection with stock options exercised
(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
8,766,017
701,739
(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 payroll taxes for restricted stock and in connection with stock options exercised
(594)
(26,730)
(27,324)
Balance, June 30, 2017
13,175,234
158,001,006
135,254,306
(1,347,111)
305,083,435
Other comprehensive income, net of tax
(658,110)
Issuance of 2,319 shares of common stock as a result of stock purchased under the Employee Stock Purchase Plan
2,319
88,052
90,371
Issuance of 19,906 shares of common stock as a result of stock options exercised
19,906
73,915
93,821
300,599
Restricted stock awards - 4,500 shares of common stock
4,500
(4,500)
Balance September 30, 2017
13,201,959
158,459,072
142,450,131
(1,072,534)
313,038,628
9
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Nine Months Ended September 30, 2018 and 2017
CASH FLOWS FROM OPERATING ACTIVITIES
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation
3,256,799
2,810,971
1,106,311
857,666
Deferred compensation expense accrued
1,453,042
1,098,741
Losses (gains) on other real estate owned, net
48,598
(154,743)
Amortization of premiums on securities, net
1,201,320
1,330,946
25,124
Loans originated for sale
(39,923,078)
(40,423,117)
Proceeds on sales of loans
38,954,289
42,705,325
Gains on sales of residential real estate loans
(539,266)
(307,360)
Gains on sales of government guaranteed portions of loans
(404,851)
(1,129,668)
Amortization of core deposit intangible
Accretion of acquisition fair value adjustments, net
(2,951,021)
(4,063,435)
Increase in cash value of bank-owned life insurance
(1,291,686)
(1,357,049)
Increase (decrease) in other assets
(8,292,864)
1,666,921
Decrease (increase) in other liabilities
2,252,939
(8,610,333)
Net cash provided by operating activities
36,871,882
27,162,044
CASH FLOWS FROM INVESTING ACTIVITIES
Net decrease (increase) in federal funds sold
(2,873,000)
1,689,000
Net decrease in interest-bearing deposits at financial institutions
22,099,041
22,727,542
Proceeds from sales of other real estate owned
1,288,208
829,213
Activity in securities portfolio:
Purchases
(66,419,802)
(103,509,208)
Calls, maturities and redemptions
22,915,126
40,435,714
Paydowns
36,279,229
30,123,674
Sales
1,938,043
21,969,870
Activity in restricted investment securities:
(5,351,875)
(3,788,275)
Redemptions
109,200
199,900
Net increase in loans/leases originated and held for investment
(208,737,932)
(269,891,345)
Purchase of premises and equipment
(7,112,494)
(4,045,217)
Net cash paid for SFC Bank acquisition
(3,747,209)
Cash prepaid for Guaranty Bank acquisition
(7,803,420)
Net cash used in investing activities
(209,613,465)
(271,062,552)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposit accounts
82,308,885
225,109,315
Net decrease in short-term borrowings
(2,207,101)
(23,960,582)
Activity in Federal Home Loan Bank advances:
Term advances
1,600,000
Calls and maturities
(27,000,000)
(6,000,000)
Net change in short-term and overnight advances
120,330,000
35,955,000
Activity in other borrowings:
Proceeds from other borrowings
9,000,000
7,000,000
Calls, maturities and scheduled principal payments
(10,612,500)
(9,500,000)
Payment of cash dividends on common stock
(2,362,486)
(1,836,150)
Proceeds from issuance of common stock, net
969,779
1,237,492
Net cash provided by financing activities
170,426,577
229,605,075
Net decrease in cash and due from banks
(2,315,006)
(14,295,433)
Cash and due from banks, beginning
70,569,993
Cash and due from banks, ending
56,274,560
10
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) - continued
Supplemental disclosure of cash flow information, cash payments (receipts) for:
Interest
23,102,221
13,140,273
Income/franchise taxes
(1,099,902)
10,881,610
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
(661,939)
(314,614)
Transfers of loans to other real estate owned
46,243
286,212
Due to broker for purchases of securities
1,300,000
Dividends payable
937,606
658,110
Decrease in the fair value of interest rate swap assets and liabilities
2,440,649
264,721
Transfer of equity securities from securities available for sale to other assets at fair value
2,614,261
Supplemental disclosure of cash flow information for acquisitions:
Fair value of assets acquired:
4,586,326
62,924,396
Securities
4,845,441
Loans receivable, net
477,336,699
7,091,883
6,091,978
3,654,200
8,208,728
989,056
Total assets acquired
575,728,707
Fair value of liabilities assumed:
439,579,328
1,143,478
FHLB advances
73,610,427
9,543,810
8,408,464
Total liabilities assumed
532,285,507
Net assets acquired
43,443,200
Consideration paid:
Cash paid *
8,333,535
Common stock
80,637,194
Total consideration paid
88,970,729
45,527,529
* Net cash paid at closing totalted $3,747,209
11
Part I
Item 1
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
September 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 September 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
12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – continued
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries which include the accounts of five commercial banks: QCBT, CRBT, CSB, RB&T and SFC Bank. 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.
The merger with Springfield Bancshares occurred on July 1, 2018; therefore, the financial results for the period since acquisition is included in this report. See Note 2 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 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.
13
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 – MERGERS/ACQUISITIONS
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. The Company acquired 100% of Springfield Bancshares common stock in the merger. 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.
The merger with Springfield Bancshares allowed the Company to enter the Springfield, Missouri market which is consistent with the Company’s strategic plan to selectively acquire other high-performing financial institutions in vibrant mid-sized metropolitan markets with a concentration of commercial clients. Financial metrics related to the transaction were favorable, as measured by EPS and ROAA accretion.
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 $80.6 million and total consideration paid by the Company of $89.0 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 September 30, 2018 Consolidated Balance Sheet. The remaining cash consideration paid to the shareholders of Springfield Bancshares came from operating cash.
The Company accounted for the business combination under the acquisition method of accounting in accordance with ASC 805. The Company recognized the full fair value of the assets acquired and liabilities assumed at the acquisition date, net of applicable income tax effects. The Company considers all purchase accounting adjustments as provisional and fair values are subject to refinement for up to one year after the closing date.
The excess of the consideration paid over the fair value of the net assets acquired is recorded as goodwill. This goodwill is not deductible for tax purposes.
14
The fair values of the assets acquired and liabilities assumed including the consideration paid and resulting goodwill is as follows:
As of
July 1, 2018
ASSETS
Loans/leases receivable, net
Premises and equipment
LIABILITIES
CONSIDERATION PAID:
Cash
Loans acquired in a business combination are recorded and initially measured at their estimated fair value as of the acquisition date. Credit discounts are included in the determination of fair value. A third party valuation consultant assisted with the determination of fair value.
Purchased loans are segregated into two categories: PCI loans and non-PCI (performing) loans. PCI loans are accounted for in accordance with ASC 310-30, as they display significant credit deterioration since origination and it is probable, as of the acquisition date, that the Company will be unable to collect all contractually required payments from the borrower. Performing loans are accounted for in accordance with ASC 310-20, as these loans do not have evidence of significant credit deterioration since origination and it is probable that the contractually required payments will be received from the borrower.
For PCI loans, the difference between the contractually required payments at acquisition and the cash flows expected to be collected is referred to as the non-accretable discount. Further, any excess cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized in interest income over the expected remaining life of the loan. Subsequent to the purchase date, increases in cash flows over those expected at the purchase date are recognized as interest income prospectively. The present value of any decreases in expected cash flows after the purchase date is recognized by recording and allowance for loan and lease losses and provision for loan losses.
For performing loans, the difference between the estimated fair value of the loans and the principal balance outstanding is accreted over the remaining life of the loans.
15
The following table presents the purchased loans as of the acquisition date:
PCI
Performing
Loans
Contractually required principal payments
7,552,912
479,439,547
486,992,459
Nonaccretable discount
(1,562,455)
Principal cash flows expected to be collected
5,990,457
485,430,004
Accretable discount
(293,445)
(7,799,860)
(8,093,305)
Fair Value of acquired loans
5,697,012
471,639,687
Changes in accretable yield for the loans acquired were as follows for the three months ended September 30, 2018:
Discount added at acquisition
Reclassification of nonaccretable discount to accretable
(891,569)
Accretion recognized
262,852
951,592
1,214,444
Balance at the end of the period
(922,162)
(6,848,268)
(7,770,430)
During the current quarter, there was no nonaccretable discount that was accelerated due to the early repayment of PCI loans. However, $891,569 of nonaccretable discount was reclassified to accretable during the third quarter of 2018 due to significant improvement on one specific credit subsequent to the acquisition date. Of this amount, $262,852 was accreted to income in the third quarter of 2018, while the remainder will be accreted over the next 11 months, which is the remaining contractual life of the loan.
Premises and equipment acquired with a fair value of $6,091,978 includes one branch location including a write-up of $617,286. The fair value was determined with the assistance of a third party appraiser. The assets and related fair value adjustments will be recognized as an increase in depreciation expense over 39 years.
The Company recorded a core deposit intangible totaling $8,208,728 which is the portion of the acquisition purchase price which represents the value assigned to the existing deposit base. The core deposit intangible has a finite life and is amortized using an accelerated method over the estimated useful life of the deposits (estimated to be ten years).
The following table presents the changes in the carrying amount of core deposit intangibles, gross carrying amount, accumulated amortization, and net book value:
Balance at acquisition
Amortization expense
(237,114)
7,971,614
Gross carrying amount
Accumulated amortization
Net book value
The following presents the remaining estimated amortization of the core deposit intangible:
Years ending December 31,
Amount
237,114
2019
932,810
2020
915,051
2021
893,192
2022
867,227
Thereafter
4,126,220
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FHLB advances and other borrowings assumed with a fair value of $83,154,237 included $40,000,000 in overnight FHLB advances, $33,610,427 of FHLB term advances, $4,743,810 in subordinated debentures and a $4,800,000 bank stock loan. The $4.8 million bank stock loan was paid off immediately after the acquisition date on July 2, 2018, at its book value.
The following table presents the assumed FHLB advances and other borrowings as of the acquisition date:
Rate
Terms
Maturity Date
Collateral
FHLB advance
$ 40,000,000
2.10%
daily interest payments; principal due at maturity
7/2/2018
commercial and residential real estate loans
4,991,962
2.01%
monthly interest payments; principal due at maturity
7/30/2018
4,966,060
2.09%
10/1/2018
4,848,879
9/30/2019
4,787,502
1.50%
2/10/2020
4,756,169
1.93%
5/27/2020
4,664,663
1.96%
1/27/2021
4,595,192
2.00%
7/29/2021
Subordinated debenture
952,566
4.00%
4/30/2021
unsecured
946,226
9/15/2021
Bank stock loan
4,800,000
5.25%
3/13/2020
4,000,000 issued and outstanding shares of common stock of SFC Bank
Fair value of FHLB and other borrowings assumed
$ 83,154,237
During the first nine months of 2018, the Company incurred $1.4 million of expenses related to the acquisition, comprised primarily of legal, accounting, investment banking costs and personnel costs. SFC Bank results are included in the consolidated statements of income effective on the merger date. For the period July 1, 2018 to September 30, 2018, SFC Bank reported revenues of $7.4 million and net income of $2.2 million, which included $279 thousand of after tax post-acquisition, compensation, transition and integration costs.
NOTE 3 – INVESTMENT SECURITIES
The amortized cost and fair value of investment securities as of September 30, 2018 and December 31, 2017 are summarized as follows:
Gross
Amortized
Unrealized
Fair
Cost
Gains
(Losses)
Value
September 30, 2018:
Securities HTM:
Municipal securities
394,371,195
3,887,422
(10,753,857)
387,504,760
Other securities
1,050,000
(13,480)
1,036,520
(10,767,337)
388,541,280
Securities AFS:
U.S. govt. sponsored agency securities
37,715,802
9,963
(1,234,016)
36,491,749
Residential mortgage-backed and related securities
162,933,727
35,691
(7,236,822)
155,732,596
60,101,620
150,615
(1,348,028)
58,904,207
4,254,364
(59,474)
4,194,890
265,005,513
196,269
(9,878,340)
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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 September 30, 2018 and December 31, 2017, are summarized as follows:
Less than 12 Months
12 Months or More
Losses
170,633,644
(5,439,521)
64,984,249
(5,314,336)
235,617,893
536,520
171,170,164
(5,453,001)
236,154,413
18,437,573
(521,633)
15,829,173
(712,383)
34,266,746
44,903,593
(1,712,003)
105,007,537
(5,524,819)
149,911,130
79,442,346
(976,811)
10,952,533
(371,217)
90,394,879
146,978,402
(3,269,921)
131,789,243
(6,608,419)
278,767,645
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 September 30, 2018, the investment portfolio included 613 securities. Of this number, 434 securities were in an unrealized loss position. The aggregate losses of these securities totaled approximately 3.2% of the total amortized cost of
18
the portfolio. Of these 434 securities, 171 securities had an unrealized loss for twelve months or more. All of the debt securities in unrealized loss positions are considered acceptable credit risks. Based upon an evaluation of the available evidence, including the recent changes in market rates, credit rating information and information obtained from regulatory filings, management believes the declines in fair value for these debt securities are temporary. In addition, the Company 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 nine months ended September 30, 2018 and 2017.
All sales of securities for the three and nine months ended September 30, 2018 and 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 Months Ended
Nine Months Ended
September 30, 2017
Proceeds from sales of securities
8,415,795
Gross gains from sales of securities
6,312
65,880
Gross losses from sales of securities
(69,900)
(91,004)
The amortized cost and fair value of securities as of September 30, 2018 by contractual maturity are shown below. Expected maturities of residential mortgage-backed and related securities may differ from contractual maturities because
19
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
1,710,335
1,711,153
Due after one year through five years
27,876,391
27,826,476
Due after five years
365,834,469
359,003,651
3,153,996
3,156,871
25,663,131
25,220,152
73,254,659
71,213,823
102,071,786
99,590,846
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 follows:
229,992,901
226,439,711
4,998,969
4,847,750
50,248,182
49,027,162
Corporate securities
4,006,462
3,948,640
59,253,613
57,823,552
As of September 30, 2018, the Company's municipal securities portfolios were comprised of general obligation bonds issued by 113 issuers with fair values totaling $86.2 million and revenue bonds issued by 163 issuers, primarily consisting of states, counties, towns, villages and school districts with fair values totaling $360.2 million. The Company held investments in general obligation bonds in 27 states, including six states in which the aggregate fair value exceeded $5.0 million. The Company held investments in revenue bonds in 19 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 nine 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 September 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
20
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 five charters, whose investment policies set forth limits for various subcategories within the municipal securities portfolio. Each charter is monitored individually, and as of September 30, 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 September 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.
NOTE 4 – LOANS/LEASES RECEIVABLE
The composition of the loan/lease portfolio as of September 30, 2018 and December 31, 2017 is presented as follows:
C&I loans*
1,380,542,524
1,134,516,315
CRE loans
Owner-occupied CRE
449,056,125
332,742,477
Commercial construction, land development, and other land
224,295,259
186,402,404
Other non owner-occupied CRE
1,053,974,806
784,347,000
1,727,326,190
1,303,491,882
Direct financing leases **
126,751,783
141,448,232
Residential real estate loans ***
309,287,535
258,646,265
Installment and other consumer loans
100,191,471
118,610,799
3,644,099,503
2,956,713,493
Plus deferred loan/lease origination costs, net of fees
9,286,864
7,771,907
Less allowance
** Direct financing leases:
Net minimum lease payments to be received
140,055,010
156,583,887
Estimated unguaranteed residual values of leased assets
929,932
Unearned lease/residual income
(14,233,159)
(16,065,587)
Plus deferred lease origination costs, net of fees
4,039,635
4,624,027
130,791,418
146,072,259
(2,632,247)
(2,382,098)
128,159,171
143,690,161
* Includes equipment financing agreements outstanding at m2, totaling $98,823,351 and $66,758,397 as of September 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
21
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 nine months ended September 30, 2018 and 2017.
*** Includes residential real estate loans held for sale totaling $2,557,907 and $645,001 as of September 30, 2018, and December 31, 2017, respectively.
Changes in accretable yield for acquired loans were as follows:
Three months ended September 30, 2018
Nine months ended September 30, 2018
Balance at the beginning of the period
(142,048)
(5,051,424)
(5,193,472)
(191,132)
(6,280,075)
(6,471,207)
268,694
1,579,568
1,848,262
317,778
2,808,219
3,125,997
(1,058,368)
(11,271,716)
(12,330,084)
Three months ended September 30, 2017
Nine months ended September 30, 2017
(83,860)
(5,325,471)
(5,409,331)
(194,306)
(9,115,614)
(9,309,920)
25,158
658,547
683,705
135,604
4,448,690
4,584,294
(58,702)
(4,666,924)
(4,725,626)
The aging of the loan/lease portfolio by classes of loans/leases as of September 30, 2018 and December 31, 2017 is presented as follows:
As of September 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
1,371,826,021
143,866
526,049
8,046,588
CRE
Owner-Occupied CRE
447,031,462
1,506,334
109,681
408,648
Commercial Construction, Land Development, and Other Land
217,512,489
3,994,986
1,131,975
1,655,809
Other Non Owner-Occupied CRE
1,043,267,553
413,292
10,293,961
Direct Financing Leases
123,407,592
1,153,460
224,015
1,966,716
Residential Real Estate
306,900,388
1,142,787
270,413
973,947
Installment and Other Consumer
99,501,411
38,912
413,565
6,967
230,616
3,609,446,916
7,250,850
2,416,097
1,409,355
23,576,285
As a percentage of total loan/lease portfolio
99.05
%
0.20
0.07
0.04
0.65
100.00
22
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
0.00
0.39
NPLs by classes of loans/leases as of September 30, 2018 and December 31, 2017 are presented as follows:
Percentage of
Loans/Leases*
Accruing TDRs
Total NPLs
677,859
8,724,447
29.85
106,470
515,118
1.76
2,787,784
9.54
2,975,703
13,269,664
45.41
163,681
2,130,397
7.29
305,792
1,550,152
5.30
10,410
247,993
0.85
4,239,915
29,225,555
* Nonaccrual loans/leases included $3,036,422 of TDRs, including $336,168 in C&I loans, $2,026,376 in CRE loans, $587,613 in direct financing leases, $82,151 in residential real estate loans, and $4,114 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 nine months ended September 30, 2018 and 2017, respectively, are presented as follows:
Three Months Ended September 30, 2018
Direct Financing
Residential Real
Installment and
Leases
Estate
Other Consumer
Balance, beginning
15,233,871
15,819,040
2,724,355
2,433,102
1,334,708
37,545,076
Provisions (credits) charged to expense
3,698,588
2,254,313
124,803
131,977
(3,853)
Loans/leases charged off
(87,040)
(387,499)
(427,638)
(58,241)
(30,230)
(990,648)
Recoveries on loans/leases previously charged off
71,440
30,344
210,727
4,690
317,201
Balance, ending
18,916,859
17,716,198
2,632,247
2,506,838
1,305,315
43,077,457
Three Months Ended September 30, 2017
14,207,733
12,999,233
2,638,301
2,430,454
1,080,911
33,356,632
469,977
1,349,393
179,190
(11,654)
99,530
(338,361)
(268,669)
(25,822)
(16,872)
(649,724)
63,366
10,748
103,936
6,000
4,947
188,997
14,402,715
14,359,374
2,652,758
2,398,978
1,168,516
34,982,341
Nine Months Ended September 30, 2018
14,323,036
13,962,688
2,382,098
2,466,431
1,221,475
34,355,728
Provisions charged to expense
5,283,763
4,091,170
1,417,494
149,923
104,052
(911,429)
(1,505,824)
(110,566)
(36,063)
(2,951,381)
221,489
49,839
338,479
1,050
15,851
626,708
Nine Months Ended September 30, 2017
12,545,110
11,670,609
3,111,898
2,342,344
1,087,487
30,757,448
2,345,121
2,655,521
981,877
148,017
84,002
(630,704)
(10,375)
(1,611,432)
(101,006)
(40,436)
(2,393,953)
143,188
43,619
170,415
9,623
37,463
404,308
The allowance by impairment evaluation and by portfolio segment as of September 30, 2018 and December 31, 2017 is presented as follows:
Allowance for impaired loans/leases
4,787,321
3,555,829
363,439
226,263
102,649
9,035,501
Allowance for nonimpaired loans/leases
14,129,538
14,160,369
2,268,808
2,280,575
1,202,666
34,041,956
Impaired loans/leases
11,064,848
15,944,006
2,147,125
1,148,009
241,614
30,545,602
Nonimpaired loans/leases
1,369,477,676
1,711,382,184
124,604,658
308,139,526
99,949,857
3,613,553,901
Allowance as a percentage of impaired loans/leases
43.27
22.30
16.93
19.71
42.48
29.58
Allowance as a percentage of nonimpaired loans/leases
1.03
0.83
1.82
0.74
1.20
0.94
Total allowance as a percentage of total loans/leases
1.37
2.08
0.81
1.30
1.18
24
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
1.21
0.97
1.36
0.82
1.00
1.07
1.26
1.68
0.95
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.
25
Loans/leases, by classes of financing receivable, considered to be impaired as of and for the nine months ended September 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:
4,549,509
4,563,785
2,139,521
145,605
288,409
288,936
2,018,910
504,880
26,649
1,569,905
2,295,387
10,852
663,167
737,946
649,064
207
130,814
104,290
9,220,714
9,309,769
5,982,078
183,313
Impaired Loans/Leases with Specific Allowance Recorded:
6,515,339
1,845,156
5,878
138,201
34,701
145,082
5,801,618
2,145,425
5,116,524
7,696,868
1,375,703
1,924,217
8,506
577,220
532,999
484,842
507,918
447,006
8,877
110,800
127,434
229
21,324,888
21,347,964
10,138,418
23,490
Total Impaired Loans/Leases:
11,079,124
3,984,677
151,483
426,610
434,018
9,715,778
2,429,097
35,155
2,828,386
1,245,864
1,096,070
9,084
231,724
30,657,733
16,120,496
206,803
Impaired loans/leases for which no allowance has been provided have adequate collateral, based on management's current estimates.
26
Loans/leases, by classes of financing receivable, considered to be impaired as of and for the three months ended September 30, 2018 and 2017, respectively, are presented as follows:
2,794,748
16,792
1,301,977
25,816
288,611
53,661
6,783
1,009,590
9,189
1,173,629
1,780,494
2,483
2,820,518
39,759
665,567
690,791
115,314
139,533
6,654,324
28,671
6,180,109
72,358
3,401,073
1,916
5,157,671
53,127
140,495
155,020
5,483,757
4,345,880
3,848,434
4,929,960
557,572
893,042
461,398
2,984
550,476
5,601
113,122
69
48,164
99
14,005,851
13,475
16,080,213
58,827
6,195,821
18,708
6,459,648
78,943
429,106
208,681
4,858,024
17,695
6,103,589
2,338,066
3,713,560
1,126,965
3,191
1,241,267
228,436
187,697
20,660,175
42,146
22,260,322
131,185
27
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.
28
For each class of financing receivable, the following presents the recorded investment by credit quality indicator as of September 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)
1,236,971,045
438,799,404
216,655,705
1,021,710,298
2,914,136,452
96.85
Special Mention (Rating 6)
28,051,461
6,972,157
3,850,042
10,356,053
49,229,713
1.64
Substandard (Rating 7)
16,693,746
3,284,564
3,789,512
21,908,455
45,676,277
1.51
Doubtful (Rating 8)
2,921
1,281,719,173
3,009,045,363
Delinquency Status *
98,150,050
124,621,386
307,737,383
99,943,478
630,452,297
99.28
Nonperforming
673,301
4,601,843
0.72
98,823,351
635,054,140
1,031,963,703
318,293,608
179,142,839
767,119,909
2,296,520,059
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 September 30, 2018 and December 31, 2017, TDRs totaled $7,276,337 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 nine months ended September 30, 2018 and 2017. The difference between the pre-modification recorded investment and the post-modification recorded investment would be any partial
29
charge-offs at the time of the restructuring. No loans were restructured during the three months ended September 30, 2018.
For the three months ended September 30, 2018
For the three months ended September 30, 2017
Pre-
Post-
Modification
Number of
Specific
Loans / Leases
CONCESSION - Significant Payment Delay
1
273,717
620,452
980,899
60,000
44,374
416,597
1,298,990
333,717
1,037,049
CONCESSION - Extension of Maturity
815,703
35,287
3,010,990
TOTAL
4,309,980
1,149,420
For the nine months ended September 30, 2018
For the nine months ended September 30, 2017
801,650
Real Estate
46,320
91,898
1,889,000
1,392,834
34
2,690,650
104,382
4,403,824
36
2,795,032
Of the loans restructured during the nine months ended September 30, 2018, four with a post-modification recorded balance of $1,300,424 were on nonaccrual. Of the loans restructured during the nine moths ended September 30, 2017, three with a post-modification recorded balance of $1,384,680 were on nonaccrual. For the three and nine months ended September 30, 2018, 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 TDRs related to customers whose loans were restructured in the third quarter of 2018 with pre-modification balances totaling $774 thousand.
For the three and nine months ended September 30, 2017, four 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. Two of these TDRs were related to the one customer whose loans were restructured in the second quarter of 2017 with pre-modification balances totaling $112 thousand and the other two TDRs related to another customer whose loans 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.
30
NOTE 5 – 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
Location
Notional Amount
Strike Rate
December 31, 2017
1-month FHLB Advance
6/3/2014
6/5/2019
Other Assets
164,214
190,085
6/5/2014
6/5/2021
539,253
316,615
703,467
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.
31
NOTE 6 - EARNINGS PER SHARE
The following information was used in the computation of EPS on a basic and diluted basis:
Three months ended
Nine months ended
Basic EPS
Diluted EPS
Weighted average common shares issuable upon exercise of stock options and under the employee stock purchase plan
297,201
356,605
308,994
357,894
The increase in weighted average common shares outstanding when comparing the three and nine months ended September 30, 2018 to September 30, 2017 was primarily due to the common stock issuance as a result of the merger with Springfield Banshares as discussed in Note 2 of the Consolidated Financial Statements, and in connection with the acquisition of Guaranty Bank.
NOTE 7 – 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.
32
Assets and liabilities measured at fair value on a recurring basis comprise the following at September 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
7,045,220
Total assets measured at fair value
263,072,129
Interest rate swaps - liabilities
6,837,887
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 nine months ended September 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).
33
Certain financial assets are measured at fair value on a non-recurring basis; that is, the assets are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).
Assets measured at fair value on a non-recurring basis comprise the following at September 30, 2018 and December 31, 2017:
Level 1
Level 2
Level 3
13,400,072
OREO
13,180,082
26,580,154
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. 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 or liabilities measured at fair value during the three and nine months ended September 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
392,621,219
AFS
See Previous Table
12,407,474
8,307,719
3,597,901,436
3,527,043,000
2,921,821,953
2,892,963,000
Nonmaturity deposits
2,917,002,466
2,670,583,178
Time deposits
871,274,455
863,227,000
596,071,878
591,772,000
358,357,000
192,115,000
74,600,000
66,520,000
29,946,263
29,253,624
NOTE 8 – BUSINESS SEGMENT INFORMATION
Selected financial and descriptive information is required to be disclosed for reportable operating segments, applying a “management perspective” as the basis for identifying reportable segments. The management perspective is determined by the view that management takes of the segments within the Company when making operating decisions, allocating resources, and measuring performance. The segments of the Company have been defined by the structure of the Company's internal organization, focusing on the financial information that the Company's operating decision-makers routinely use to make decisions about operating matters.
The Company's primary segment, Commercial Banking, is geographically divided by markets into the secondary segments 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.
35
Selected financial information on the Company's business segments is presented as follows as of and for the three and nine months ended September 30, 2018 and 2017.
Commercial Banking
Wealth
Intercompany
Consolidated
QCBT
CRBT
CSB
RB&T
SFC Bank
Management
All other
Eliminations
Total revenue
17,321,929
16,799,795
8,888,955
5,244,856
7,360,191
3,255,241
12,475,438
(12,707,109)
58,639,296
12,218,192
10,832,532
7,101,066
3,414,760
5,700,566
(958,624)
4,991
Provision
409,086
452,742
20,000
4,849,000
475,000
Net income (loss)
4,827,397
4,868,765
2,533,392
(2,519,016)
2,197,448
768,095
8,600,144
(12,467,390)
3,222,688
14,979,984
9,888,225
3,313,000
4,852,300
1,579,327,112
1,354,294,043
734,535,978
484,059,163
623,519,770
554,345,558
(537,349,129)
11,771,842
10,892,025
7,678,006
4,534,768
2,689,853
10,028,660
(7,052,986)
40,542,168
11,664,970
7,903,483
6,379,111
3,245,346
(636,562)
1,140,436
200,000
574,000
172,000
3,929,158
3,130,319
1,669,209
726,926
539,091
(9,994,703)
13,110,913
1,122,263
5,566,350
6,688,613
1,456,251,244
1,007,062,151
631,963,143
445,098,530
395,697,820
(385,609,794)
3,550,463,094
49,812,373
49,301,104
25,458,573
15,362,717
9,560,319
38,031,924
(38,449,680)
156,437,521
36,628,528
32,149,435
20,579,523
10,281,763
(2,543,909)
2,783,988
1,682,312
816,602
5,288,500
13,796,167
14,190,335
6,560,327
(964,098)
2,335,871
29,520,347
(37,832,216)
39,517,823
31,428,339
23,981,019
12,723,998
7,952,495
30,086,617
(27,283,484)
118,406,807
34,381,270
22,107,955
20,326,439
9,308,932
(1,852,668)
2,624,538
750,000
2,209,000
631,000
11,657,941
8,893,461
5,484,383
2,406,337
1,554,618
(29,996,740)
NOTE 9 – 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 September 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 September 30, 2018 and December 31, 2017 are presented in the following table (dollars in thousands). As of September 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
Ratio
As of September 30, 2018:
Company:
Total risk-based capital
449,655
10.87
330,798
>
8.00
408,329
9.875
413,497
10.00
Tier 1 risk-based capital
406,578
9.83
248,098
6.00
325,629
7.875
Tier 1 leverage
8.87
183,278
4.00
4.000
229,098
5.00
Common equity Tier 1
368,952
8.92
186,074
4.50
263,605
6.375
268,773
6.50
Quad City Bank & Trust:
160,806
11.72
109,744
135,466
137,180
147,532
10.75
82,308
108,029
9.32
63,297
79,121
61,731
87,452
89,167
Cedar Rapids Bank & Trust:
145,066
11.79
98,462
121,540
123,078
131,839
10.71
73,847
96,924
53,659
67,074
55,385
78,462
80,001
Community State Bank:
72,601
11.43
50,801
62,708
63,501
67,149
10.57
38,101
50,007
9.62
27,918
34,898
28,576
40,482
41,276
Rockford Bank & Trust:
45,314
10.19
35,583
43,923
44,479
39,692
26,688
35,027
8.20
19,365
24,207
20,016
28,356
28,912
Springfield First Community Bank:
54,108
11.64
37,196
45,914
46,495
48,870
10.51
27,897
36,615
9.31
20,988
26,235
20,923
29,640
30,222
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 10 – 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
37
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.
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 11 –SUBSEQUENT EVENTS - ACQUISITIONS
BATES COMPANIES
On October 1, 2018 the Company announced the successful completion of the previously announced acquisition of 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 million of assets under management.
In the acquisition, the Company acquired 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. Of the total cash consideration, $1.5 million in cash was paid at closing. This was funded through operating cash. The additional $1.5 million was recorded as a promissory note and will be repaid in five equal, annual installments of $300,000 each on the first through fifth anniversaries of the closing date. Interest will be paid at a rate of 2.18% per annum, based on the applicable federal rate as of the closing date. Additionally, in a private placement exempt from registration with the SEC, the Company will issue $1.0 million of Company stock in November 2018. Assuming all future performance based contingent consideration is realized, total stock consideration can reach $3.0 million, which would result in the Company issuing approximately 70,504 common shares based on the 10-day volume weighted average of the closing stock price of the Company ending five days prior to closing.
During the first nine months of 2018, the Company incurred $401 thousand of expenses related to the acquisition, comprised primarily of legal and accounting costs.
38
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 and nine months ending September 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. With the exception of SFC Bank, all are members of the Federal Reserve system with depository accounts insured to the maximum amount permitted by law by the FDIC. SFC Bank’s application to become a member of the Federal Reserve system is in process with the Federal Reserve.
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 the Company in 2016 and 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.
SFC Bank was merged into the Company in 2018, as further described in Note 2 to the Consolidated Financial Statements. SFC Bank provides full-service commercial and consumer banking to the Springfield, Missouri area through its branch office located on Glenstone Avenue in Springfield, Missouri.
39
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued
EXECUTIVE OVERVIEW
The Company reported net income of $8.8 million and diluted EPS of $0.55 for the quarter ended September 30, 2018. By comparison, for the quarter ended June 30, 2018, the Company reported net income of $10.4 million and diluted EPS of $0.73. For the quarter ended September 30, 2017, the Company reported net income of $7.9 million and diluted EPS of $0.58. For the nine months ended September 30, 2018, the Company reported net income of $29.8 million, and diluted EPS of $2.02. By comparison, for the nine months ended September 30, 2017, the Company reported net income of $25.8 million, and diluted EPS of $1.91.
The third quarter of 2018 was highlighted by several significant items:
Net income of $8.8 million, or $0.55 per diluted share;
Core net income (non-GAAP) of $10.4 million, or $0.65 per diluted share;
Annualized loan and lease growth of 7.9% for the quarter and 10.5% year-to-date;
Provision for loan and lease losses of $6.2 million for the quarter;
Nonperforming loans increased $15.3 million; and
Completion of merger with Springfield Bancshares, Inc. on July 1, 2018.
Following is a table that represents various net income measurements for the Company.
For the three months ended
For the nine months ended
9,901,590
0.70
14,193,191
The increase in weighted average common shares outstanding from September 30, 2017 to September 30, 2018 was primarily due to the common stock issued as a result of the merger with Springfield Bancshares and the acquisition of Guaranty Bank.
Following is a table that represents the major income and expense categories for the Company.
June 30, 2018
32,084,496
Provision expense
2,300,735
Noninterest income
8,912,266
Noninterest expense
26,369,823
1,880,819
40
Following are some noteworthy changes in the Company's financial results:
Net interest income in the third quarter of 2018 was up 19% compared to the second quarter of 2018. Net interest income increased 34% compared to the third quarter of 2017 and 22% when comparing the first nine months of 2018 to the same period in the prior year. This increase was primarily due to strong loan and lease growth and the acquisitions of SFC Bank and Guaranty Bank.
Provision expense in the third quarter of 2018 increased 170% compared to the second quarter of 2018 and increased 197% from the same period of 2017. Provision expense increased 78% in the first nine months of 2018 from the same period of 2017. The increase was primarily attributable to two unrelated borrowers as well as to 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). See the Provision for Loan Lease Losses section of this report for additional details.
Noninterest income in the third quarter of 2018 decreased 1% compared to the second quarter of 2018 primarily due to lower swap fee income. Noninterest income in the third quarter of 2018 increased 31% from the third quarter of 2017 and 26% when comparing the first nine 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 acquisitions of Guaranty Bank and SFC Bank.
Noninterest expense increased 16% from the second quarter of 2018. Noninterest expense increased 30% from the third quarter of 2017 and 25% when comparing the first nine months of 2018 to the same period in the prior year primarily due to the acquisitions of Guaranty Bank and SFC Bank.
Federal and state income tax expense in the third quarter of 2018 decreased 15% compared to the second quarter of 2018. Federal and state income tax expense in the third quarter of 2018 decreased 16% compared to the third quarter of 2017 and decreased 21% when comparing the first nine 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:
Strong organic loan and lease growth in order to maintain 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;
Grow core deposits to maintain reliance on wholesale funding at less than 15% of total assets;
Grow noninterest bearing deposits to more than 30% of total assets;
41
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 net income by 10% annually.
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%
76
75
NIM TEY (non-GAAP)*
> 3.65%
3.60
3.52
3.71
Profitability
ROAA
> 1.10%
0.75
0.90
Core ROAA (non-GAAP)*
0.89
1.08
Asset quality
NPAs to total assets
< 0.75%
0.87
Net charge-offs to average loans and leases***
< 0.25% annually
0.09
0.11
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
5.5
million
5.9
2.4
Grow wealth management net income***
> 10% annually
50
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 third quarter of 2018 to support its corporate strategy and the long-term financial goals shown above.
The Company grew loans and leases in the third quarter of 2018 by 7.9% on an annualized basis, excluding acquired loans of SFC Bank. 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 July 2018 the completion of the merger of Springfield Bancshares. On October 1, 2018 the Company announced the successful completion of the previously announced acquisition of 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 million of assets under management. See Notes 2 and 11 to the Consolidated Financial Statements for additional details about these strategic transactions.
42
The Company has continued to focus on lowering the NPAs to total assets ratio. This ratio increased by 22 basis points to 0.87%, compared to the second quarter 2018. This increase was primarily due to two large credits in the Rockford, Illinois market. 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, however, wholesale funding increased 3% in the third quarter of 2018. Management continues to prioritize core deposit growth through a variety of strategies including growth in correspondent banking.
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 191 downstream banks with average total noninterest bearing deposits of $197.5 million and average total interest bearing deposits of $221.1 million during the first nine 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 September 30, 2018, the Company had $2.71 billion of total financial assets in trust (and related) accounts and $1.08 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. On October 1, 2018 the Company announced the successful completion of the previously announced acquisition of 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 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;
43
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.
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
June 30,
March 31,
RECONCILIATIONS
(dollars in thousands, except per share data)
TCE/TA RATIO
Stockholders' equity (GAAP)
457,387
369,588
360,428
353,287
313,039
Less: Intangible assets
89,755
36,561
37,108
37,413
19,800
TCE (non-GAAP)
367,632
333,027
323,320
315,874
293,239
Total assets (GAAP)
4,792,732
4,106,883
4,026,314
3,982,665
3,550,463
198,000
TA (non-GAAP)
4,702,977
4,070,322
3,989,206
3,945,252
3,352,463
TCE/TA ratio (non-GAAP)
7.82
8.18
8.10
8.01
8.31
44
For the Quarter Ended
For the Nine Months Ended
(dollars in thousands,except per share data)
CORE NET INCOME
Net income (GAAP)
8,809
10,445
9,902
29,804
25,805
Less nonrecurring items (post-tax) (*):
Income:
Securities gains, net
(41)
(16)
Total nonrecurring income (non-GAAP)
Expense:
1,495
327
430
1,616
265
111
130
2,462
520
340
Total nonrecurring expense (non-GAAP)
1,606
457
2,892
2,136
605
Adjustment of tax expense related to the Tax Act
2,919
Core net income (non-GAAP)
10,415
10,902
9,916
31,940
26,426
CORE EPS
Core net income (non-GAAP) (from above)
13,919,565
13,845,497
13,151,752
14,232,423
13,509,673
Core EPS (non-GAAP):
Basic
0.67
0.78
2.21
2.01
Diluted
0.77
2.16
CORE ROAA
Average Assets
4,677,875
4,053,684
3,923,337
4,342,083
3,385,352
Core ROAA (annualized) (non-GAAP)
1.01
1.04
NIM (TEY)*
Net interest income (GAAP)
38,314
32,085
31,793
102,801
84,272
Plus: Taxequivalent adjustment
1,548
1,462
2,585
4,329
6,632
Net interest income - taxequivalent (non-GAAP)
39,862
33,547
34,378
107,130
90,904
Average earning assets
4,387,487
3,820,333
3,699,193
3,989,099
3,186,716
NIM (GAAP)
3.46
3.37
3.41
3.45
3.54
NIM (TEY) (non-GAAP)
3.69
3.59
3.81
EFFICIENCY RATIO
Noninterest expense (GAAP)
30,500
26,370
31,351
82,733
66,073
Noninterest income (GAAP)
8,912
9,714
26,262
20,768
Total income
47,123
40,997
41,507
129,063
105,040
Efficiency ratio (noninterest expense/total income) (non-GAAP)
64.72
64.32
75.53
64.10
62.90
* 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.
45
Net interest income, on a tax equivalent basis, increased 29% to $39.9 million for the quarter ended September 30, 2018, compared to the same quarter of the prior year, and increased 18% to $107.1 million for the nine months ended September 30, 2018 compared to the same period of the prior year. Excluding the tax equivalent adjustments, net interest income increased 34% for the quarter ended September 30, 2018 compared to the same quarter of the prior year, and increased 22% for the nine months ended September 30, 2018 compared to the same period of the prior year. Net interest income improved due to several factors:
The merger of SFC Bank in the third quarter of 2018 and the acquisition of Guaranty Bank in the fourth quarter of 2017;
Organic loan and lease growth has been strong over the past 12 months pushing loans/leases up to 76% of total assets; 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
4.65
4.44
4.34
4.51
4.28
4.06
Average Cost of Interest-Bearing Liabilities
1.35
Net Interest Spread
3.30
3.23
3.47
3.16
3.07
3.19
NIM
3.43
NIM Excluding Acquisition Accounting Net Accretion
3.44
3.65
3.31
4.37
4.36
4.10
3.15
3.32
3.56
3.29
3.28
Acquisition accounting net accretion can fluctuate mostly 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
46
NIM on a tax equivalent basis was up 8 basis points on a linked quarter basis. Excluding acquisition accounting net accretion, NIM was down 2 basis points on a linked quarter basis. This modest margin compression was primarily due to the following:
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;
With the flat yield curve and continued competition in our markets, loan pricing continues to be pressured but the pressure has eased moderately as evidenced by the third quarter results. The Company had success in widening spreads as core loan yields increased 10 basis points on a linked quarter basis; however, the pace and magnitude of the widening has been offset by the increasing cost of funds; and
The majority of the Company’s earning asset growth in the third 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.
47
The Company's average balances, interest income/expense, and rates earned/paid on major balance sheet categories, as well as the components of change in net interest income, are presented in the following tables:
For the three months ended September 30,
Earned
Yield or
or Paid
(dollars in thousands)
Interest earning assets:
23,199
105
1.80
19,966
52
61,815
323
2.07
42,178
141
1.33
Investment securities (1)
667,142
5,973
3.55
593,451
5,808
3.88
22,683
330
5.77
17,793
173
3.86
Gross loans/leases receivable (1) (2) (3)
3,612,648
44,648
4.90
2,629,626
29,978
4.52
Total interest earning assets
51,379
3,303,014
36,152
Noninterest-earning assets:
78,103
64,272
72,489
61,585
(38,083)
(34,086)
177,879
108,363
3,503,148
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Interest-bearing deposits
2,214,480
5,432
1,613,162
2,230
825,020
3,290
1.58
530,120
1,326
0.99
21,407
78
1.45
16,138
209,111
1,273
2.42
146,556
608
1.65
74,503
925
4.93
72,617
726
3.97
37,600
519
5.48
33,563
362
Total interest-bearing liabilities
3,382,121
11,517
2,412,156
5,285
Noninterest-bearing demand deposits
800,577
738,824
Other noninterest-bearing liabilities
59,112
42,572
4,241,810
3,193,552
Stockholders' equity
436,065
309,596
30,867
Net interest spread
Net interest margin
Ratio of average interest-earning assets to average interest-bearing liabilities
129.73
136.93
(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.
48
Analysis of Changes of Interest Income/Interest Expense
Inc./(Dec.)
Components
from
of Change (1)
Prior Period
Volume
2018 vs. 2017
INTEREST INCOME
53
182
100
82
Investment securities (2)
165
(2,261)
2,426
157
101
56
Gross loans/leases receivable (2) (3) (4)
14,670
2,694
11,976
Total change in interest income
15,227
678
14,549
INTEREST EXPENSE
3,202
2,162
1,040
1,964
1,014
950
665
347
318
199
180
110
Total change in interest expense
6,232
3,845
2,387
Total change in net interest income
8,995
(3,167)
12,162
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)
49
For the nine months ended September 30,
20,488
223
1.46
16,600
55,408
749
1.81
73,655
560
1.02
654,818
17,391
575,884
16,350
3.80
21,871
776
4.74
14,963
435
3.89
3,236,514
115,365
4.77
2,505,614
86,821
4.63
134,504
104,271
71,198
64,363
66,516
61,296
(36,726)
(32,648)
151,996
105,625
4,242,083
Interest-bearing demand deposits
1,987,371
12,541
0.84
1,528,971
5,205
0.46
702,441
7,591
1.44
522,986
3,575
0.91
19,234
19,754
0.51
206,875
3,219
112,550
1,365
1.62
68,742
2,376
4.62
73,126
2,104
3.85
37,557
1,474
5.25
33,530
1,042
4.15
3,022,220
27,374
2,290,917
13,367
784,401
751,318
49,588
42,660
3,856,209
3,084,895
385,874
300,457
Ratio of average interest earning assets to average interest-bearing liabilities
131.99
139.10
118
89
Interest-bearing deposits at other financial institutions
189
424
(235)
1,041
(1,585)
2,626
341
231
28,544
2,556
25,988
30,233
1,594
28,639
7,336
5,430
1,906
4,016
2,525
1,491
97
1,854
468
1,386
272
470
(198)
432
297
135
14,007
9,291
4,716
16,226
(7,697)
23,923
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
51
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 September 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 on a tax equivalent basis increased 42%, comparing the third quarter of 2018 to the same period of 2017, and increased 29% comparing the first nine months of 2018 to the same period of 2017. This increase was primarily the result of the acquisitions of SFC Bank and Guaranty Bank, strong organic loan growth, 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 curve, the Company is focused on growing loans at higher rates with widening spreads to more than offset the effect of the rising cost of funds.
Overall, the Company's average earning assets increased 33%, comparing the third quarter of 2018 to the third quarter of 2017. During the same time period, average gross loans and leases increased 37%, while average investment securities increased 12% with a portion allocable to private placement tax-exempt municipal securities. Average earning assets increased 25%, comparing the first nine months of 2018 to the same period of 2017. Average gross loans and leases increased 29% and average investment securities increased 14%, comparing the first nine months of 2018 to the same period to 2017. These increases were also the result of the acquisition of SFC Bank and Guaranty Bank and strong loan growth.
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 third quarter of 2018 increased 118% from the third quarter of 2017 and increased 105%comparing the first nine months of 2018 to the same period of 2017. The acquisitions of Guaranty Bank and SFC Bank primarily contributed to this increase as the Company added over $650 million in deposits and $78 million in FHLB advances. 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, many of 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 relationships with pricing tied to a certain index. Additionally, the loan growth has outpaced deposit growth, short-term borrowings have increased to temporarily 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.
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, state and national economies 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 $6.2 million for the third quarter of 2018, which was an increase of $4.1 million or 197% from the same quarter of the prior year. Provision for the first nine months of the year totaled $11.0 million, which was up $4.8 million or 78%, compared to the first nine months of 2017. The increaseswere primarily attributable to additional provision of $4.7 million related to two unrelated borrowers as well as to loan growth and accounting for loans acquired through acquisitions.
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. 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 $2.3 million for the first nine months of 2018, increased the Company's allowance to $43.1 million at September 30, 2018. As of September 30, 2018, the Company's allowance to total loans/leases was 1.18%, which was down from 1.21% at June 30, 2018 and down from 1.31% at September 30, 2017. Management continues to evaluate the allowance needed on acquired loans factoring in the net remaining discount ($14.4 million and $5.6 million at September 30, 2018 and September 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 increased from 1.18% to 1.57% as of September 30, 2018 and increased from 1.31% to 1.52% as of September 30, 2017.
A more detailed discussion of the Company's allowance can be found in the “Financial Condition” section of this Report.
NONINTEREST INCOME
$ Change
% Change
474,427
27.6
90,961
9.4
133,068
8.7
238,270
242.1
(45,557)
(49.5)
915,926
471.5
Securities gains (losses), net
63,588
(100.0)
46,424
10.8
90,937
12.0
(43,610)
(18.2)
143,088
19.2
2,107,522
31.4
1,337,287
25.9
270,537
9.7
500,175
11.6
231,906
75.5
(724,817)
(64.2)
3,082,408
485.1
(65,363)
(4.8)
255,009
(11,499)
(1.7)
594,198
26.7
5,494,965
26.5
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 2018 coupled with strong growth in assets under management, trust department fees increased 28%, comparing the third quarter of 2018 to the same period of the prior year. Trust department fees increased 26% when comparing the first nine months 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.
Investment advisory and management fees increased 9%, comparing the third quarter of 2018 to the same period of the prior year, and they increased 10% when comparing the first nine months of 2018 to the first nine months 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. On October 1, 2018 the Company announced the successful completion of the previously announced acquisition of 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 million of assets under management.
Deposit service fees expanded 9% comparing the third quarter of 2018 to the same period of the prior year and expanded 12% when comparing the first nine months of 2018 to the same period of the prior year. This increase was primarily the result of the growth in deposits due to the acquisitions of Guaranty Bank and SFC 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 increased 242% when comparing the third quarter of 2018 to the same period of the prior year and increased 76% when comparing the first nine months 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 third quarter of 2018 decreased 50% compared to the third quarter of 2017 and decreased 64% when comparing the first nine months of 2018 to the same period 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 its 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 $1.1 million for the third quarter of 2018, compared to $194 thousand for the third quarter of 2017. Swap fee income totaled $3.7 million for the first nine months of 2018 compared to $635 thousand in the first nine months of 2017. Future levels of swap fee income are also dependent upon prevailing interest rates.
Earnings on BOLI increased 11% comparing the third quarter of 2018 to the second quarter of 2018 and decreased 5% comparing the first nine months of 2018 to the first nine months 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 12% comparing the third quarter of 2018 to the third quarter of the prior year and 12% comparing the first nine months of 2018 to the first nine months 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 decreased 18% comparing the third quarter of 2018 to the third quarter of the prior year and decreased 2% comparing the first nine months of 2018 to the first nine months 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 191 banks in Iowa, Illinois and Wisconsin.
Other noninterest income increased 19% comparing the third quarter of 2018 to the third quarter of the prior year and increased 27% comparing the first nine months of 2018 to the first nine months of 2017. These increases were primarily driven by fluctuations in net gains recognized on the disposal of leased assets.
55
NONINTEREST EXPENSE
The following tables set forth the various categories of noninterest expense for the three and nine months ended September 30, 2018 and 2017.
4,008,689
29.9
802,196
31.9
(413,812)
(14.0)
884,046
216.7
(29,677)
(5.7)
241,852
35.0
111,839
43.4
110,278
(68.6)
313,839
46.8
1,503
0.3
932
0.5
CDI amortization expense
310,798
134.6
761,380
62.4
7,103,863
30.4
9,552,405
24.1
1,800,110
23.3
641,036
1,390,187
340.7
135,637
572,002
29.2
108,853
13.4
129,643
(109.4)
583,143
31.6
36,819
2.8
9,979
1.7
458,167
66.2
1,241,456
38.0
16,659,437
25.2
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 third quarter of 2017 to the third quarter of 2018 by 30%. This line item also increased 24% when comparing the first nine months of 2018 to the first nine months of 2017. This increase was primarily related to the addition of SFC Bank and Guaranty Bank employees, new hires and merit increases. 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 talent availability in the marketplace as a result of ongoing industry consolidation.
Occupancy and equipment expense increased 32%, comparing the third quarter of 2018 to the same period of the prior year and increased 23% comparing the first nine months of 2018 to the same period of the prior year. The increased expense was primarily due to the addition of Guaranty Bank and SFC Bank.
Professional and data processing fees decreased 14%, comparing the third quarter of 2018 to the same period in 2017, and increased 9% comparing the first nine months of 2018 to the same period of the prior year. This increased expense was partially due to the addition of SFC 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 occur in mid 2019. 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 $1.3 million for the third quarter of 2018 and $1.8 million for the first nine months of 2018. Acquisition costs for the third quarter and the first nine months of 2017 totaled $408 thousand. These costs were comprised primarily of legal, accounting and investment banking costs related to the acquisitions described in Notes 2 and 11 to the Consolidated Financial Statements.
Post-acquisition costs totaled $493 thousand for the third quarter of 2018 and $658 thousand for the first nine months 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 35%, comparing the third quarter of 2018 to the third quarter of 2017 and increased 29% comparing the first nine months of 2018 to the same period of the prior year. The increase in expense was due to the acquisitions of Guaranty Bank and SFC Bank.
Loan/lease expense increased 43% when comparing the third quarter of 2018 to the same quarter of 2017 and increased 13% comparing the first nine months 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 $50 thousand for the third quarter of 2018, compared to $161 thousand for the third quarter of 2017. Net cost of operations of other real estate totaled $11 thousand for the first nine months of 2018 compared to net income from operations of $118 thousand for the same period of the prior year.
Advertising and marketing expense increased 47%, comparing the third quarter of 2018 to the third quarter of 2017 and increased 32% comparing the first nine months of 2018 to the same period of the prior year. The increase in expense was primarily due to the additions of Guaranty Bank and SFC Bank.
Bank service charges, a large portion of which includes indirect costs incurred to provide services to QCBT's correspondent banking customer portfolio, remained flat from the third quarter of 2017 to the third quarter of 2018 and increased 3%, comparing the first nine months of 2018 to the same period of the prior year. As transactions volumes continue to increase and the number of correspondent banking clients increases, the associated expenses will also increase.
Correspondent banking expense was flat when comparing the third quarter of 2018 to the third quarter of 2017 and increased 2% when comparing the first nine months of 2018 to the same period of the prior year. 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 135% when comparing the third quarter of 2018 to the third quarter of 2017 and increased 66% when comparing the first nine months of 2018 to the same period of the prior year. The increase was due to the acquisitions of Guaranty Bank and SFC Bank.
57
Other noninterest expense was up 62% when comparing the third quarter of 2018 to the third quarter of 2017 and increased 38% when comparing the first nine months 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 lease termination fees at Guaranty Realty as well as the additions of Guaranty Bank and SFC Bank.
INCOME TAXES
In the third quarter of 2018, the Company incurred income tax expense of $1.6 million. During the first nine months of the year, the Company incurred income tax expense of $5.5 million. Following is a reconciliation of the expected income tax expense to the income tax expense included in the consolidated statements of income for the three and nine months ended September 30, 2018 and 2017.
For the Three Months Ended September 30,
For the Nine Months Ended September 30,
% of
Pretax
Income
Computed "expected" tax expense
2,187,543
21.0
3,421,414
7,409,662
11,463,015
Tax exempt income, net
(1,046,728)
(10.0)
(1,479,786)
(15.1)
(2,945,918)
(8.3)
(4,219,116)
(12.9)
(89,489)
(0.9)
(149,802)
(1.5)
(261,114)
(0.7)
(474,968)
(1.4)
State income taxes, net of federal benefit, current year
392,789
3.8
389,200
4.0
1,501,913
4.3
1,191,935
3.6
Excess tax benefit on stock options exercised and restricted stock awards vested
(8,802)
(0.1)
(190,554)
(1.9)
(341,807)
(1.0)
(813,421)
(2.5)
172,722
1.6
(68,939)
(0.8)
117,188
0.2
(200,890)
(0.6)
15.4
19.7
15.5
21.2
The effective tax rate for the quarter ended September 30, 2018 was 15.4% which was a 4.3% decrease from the effective tax rate of 19.7% for the quarter ended September 30, 2017. The effective tax rate for the nine months ended September 30, 2018 was 15.5%, which was a decrease over the effective tax rate of 21.2% for the nine months ended September 30, 2017. The Tax Act, enacted on December 22, 2017 and effective January 1, 2018, reduced 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.
73,407
69,069
75,722
56,275
Federal funds sold and interest-bearing deposits
129,660
51,667
85,962
61,789
650,745
657,997
652,382
583,936
Net loans/leases
3,610,309
3,077,247
2,930,130
74
2,641,772
328,611
250,903
238,469
206,691
3,788,277
79
3,298,276
81
3,266,655
2,894,268
Total borrowings
483,635
380,392
309,480
296,145
63,433
58,627
53,243
47,011
During the third quarter of 2018, the Company's total assets increased $685.8 million, or 17%, to a total of $4.8 billion. This included $575.7 million in assets acquired and new goodwill of $45.5 million as part of the SFC Bank acquisition (further described in Note 2 to the Consolidated Financial Statements). The Company organically grew its net loan/lease portfolio $61.3 million, which was primarily funded by an increase in short-term wholesale funding. Deposits grew $50.3
58
million in the third quarter of 2018, excluding the $439.6 million of deposits acquired. Borrowings increased $18.9 million in the third quarter of 2018, excluding the $84.3 million of borrowings acquired.
INVESTMENT SECURITIES
The composition of the Company's securities portfolio is managed to meet liquidity needs while prioritizing the impact on interest rate risk, maximizing return and minimizing credit risk. Over the past five years, the Company has further diversified the portfolio by decreasing U.S government sponsored agency securities and 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:
36,492
35,667
38,097
39,340
453,275
70
458,510
445,049
68
379,694
65
155,733
158,534
163,301
158,969
5,245
5,286
5,935
5,933
Securities as a % of Total Assets
13.58
16.02
16.38
16.45
Net Unrealized Losses as a % of Amortized Cost
(1.47)
(1.58)
(0.13)
(0.16)
Duration (in years)
7.0
6.4
Quarterly Yield on Investment Securities (TEY)
3.82
Quarterly Yield on Investment Securities (GAAP)
3.02
2.77
2.85
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 28 bps in the first nine months 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.
See Note 2 to the Consolidated Financial Statements for additional information regarding the Company's investment securities.
59
LOANS/LEASES
Total loans/leases grew 7.9% on an annualized basis during the third 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
1,380,543
1,273,000
1,134,516
1,034,531
1,727,326
1,349,319
1,303,492
1,157,856
Direct financing leases
126,752
133,196
141,448
147,063
Residential real estate loans
309,287
257,434
258,646
239,958
100,191
92,952
118,611
89,605
Total loans/leases
3,644,099
3,105,901
2,956,713
2,669,013
9,287
8,891
7,773
7,741
(43,077)
(37,545)
(34,356)
(34,982)
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 September 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 $107.5 million during 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 September 30, 2018 and December 31, 2017, the amount of nationally syndicated loans totaled $48.4 million and $51.2 million, respectively.
Following is a listing of significant industries within the Company's CRE loan portfolio:
As of September 30,
As of June 30,
As of December 31,
Lessors of Nonresidential Buildings
605,517
439,067
388,648
345,387
Lessors of Residential Buildings
321,357
230,187
199,047
159,542
Hotels
87,850
73,335
70,447
42,121
Nonresidential Property Managers
56,600
55,979
51,621
53,231
Land Subdivision
50,252
39,883
44,192
41,795
Nursing Care Facilities
39,306
37,417
47,008
41,264
New Housing For-Sale Builders
37,911
38,392
61,480
56,390
Lessors of Other Real Estate Property
34,376
28,149
29,078
21,160
Other *
494,157
406,910
411,971
396,966
Total CRE Loans
* “Other” consists of all other industries. None of these had concentrations greater than $34.0 million, or approximately 2% of total CRE loans in the most recent period presented.
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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
37,942
35,814
19,927
18,146
Construction - General
17,201
18,494
18,705
18,807
Manufacturing - General
16,666
16,794
16,571
16,997
Food Processing Equipment
15,490
14,377
12,965
13,317
Marine - Travelifts
12,729
12,875
10,802
10,417
Trailers
10,016
10,137
8,983
9,272
Computer Hardware
9,656
10,141
11,340
11,483
Manufacturing - CNC
6,990
6,344
6,742
6,722
106,156
108,321
109,201
109,798
Total m2 loans and leases
232,846
233,297
215,236
214,959
* “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 nine months ended September 30, 2018 and 2017 are presented as follows:
37,545
33,357
34,356
30,757
6,206
2,086
11,046
6,215
(991)
(650)
(2,951)
(2,394)
317
626
404
43,077
34,982
The allowance was determined based on factors that included the overall composition of the loan/lease portfolio, types of loans/leases, past loss experience, loan/lease delinquencies, potential substandard and doubtful credits, economic conditions, collateral positions, governmental guarantees and other factors that, in management's judgment, deserved evaluation. To ensure that an adequate allowance was maintained, provisions were made based on a number of factors, including the increase in loans/leases and a detailed analysis of the loan/lease portfolio. The loan/lease portfolio is reviewed
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and analyzed quarterly 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 *
49,230
44,202
31,024
27,315
45,676
42,492
43,435
50,323
271
94,909
86,694
74,730
77,638
Criticized Loans **
Classified Loans ***
45,679
43,706
Criticized Loans as a % of Total Loans/Leases
2.60
2.79
2.52
2.90
Classified Loans as a % of Total Loans/Leases
1.25
1.47
1.88
* 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 an 8% increase in classified loans during the third quarter of 2018. Criticized loans increased 9% during the same period. The Company experienced an increase of 5% in classified loans during the first nine months of 2018. Criticized loans increased 27% 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
147.39
270.09
184.28
123.05
Although management believes that the allowance at September 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 4 to the Consolidated Financial Statements for additional information regarding the Company's allowance.
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NONPERFORMING ASSETS
The table below presents the amount of NPAs and related ratios.
Nonaccrual loans/leases (1) (2)
23,576
12,554
11,441
20,443
Accruing loans/leases past due 90 days or more
1,410
423
TDRs - accruing
4,240
1,327
7,113
7,563
29,226
13,901
18,643
28,429
12,204
12,750
13,558
5,135
Other repossessed assets
150
80
120
Total NPAs
41,580
26,801
32,281
33,684
NPLs to total loans/leases
0.80
0.45
0.63
1.06
NPAs to total loans/leases plus repossessed property
1.13
0.86
Includes government guaranteed portion of loans, as applicable.
Includes TDRs of $1.8 million at September 30, 2018, $2.6 million at March 31, 2018, $2.3 million at December 31, 2017, and $2.2 million at September 30, 2017.
NPAs at September 30, 2018 were $41.6 million, up $14.8 million from June 30, 2018 and up $7.9 million from September 30, 2017. The increase in the third quarter of 2018 was primarily due to three loans that were downgraded and moved to nonaccrual status.
The ratio of NPAs to total assets was 0.87% at September 30, 2018, up from 0.65% at June 30, 2018 and down from 0.95% at September 30, 2017. SFC Bank had no NPAs at the end of the third quarter.
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 $490.0 million during the third quarter of 2018, primarily due to the acquisition of SFC Bank. The table below presents the composition of the Company's deposit portfolio.
Noninterest bearing demand deposits
802,090
746,822
789,548
715,537
Interest bearing demand deposits
2,094,814
1,865,382
1,855,893
1,614,894
615,323
519,999
516,058
430,270
Brokered deposits
276,050
166,073
105,156
133,567
Quarter-end balances can greatly fluctuate due to large customer and correspondent bank activity.
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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
4,259
2,186
7,003
3,671
Federal funds purchased
8,670
15,400
12,340
12,929
17,586
13,993
16,011
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
63,399
46,600
58,600
Overnight FHLB advances
295,730
207,500
135,400
110,455
359,129
254,100
192,000
169,055
Term FHLB advances increased $16.8 million in the current quarter, as compared to the prior quarter. Overnight FHLB advances increased by $88.2 million in the third quarter of 2018 due to the acquisition of SFC Bank and 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
25,187
27,125
31,000
32,500
Subordinated debentures
4,763
Revolving line of credit
9,000
73,950
71,125
66,000
77,500
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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 September 30, 2018, the term debt had been paid down to $25.2 million, as scheduled. The term notes and revolving line of credit have been used to fund acquisitions as described in Note 2 to the Consolidated Financial Statements. As of September 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 (4.90% at September 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:
422,889
2.28
273,677
185,976
2.14
31,950
2.32
48,694
2.31
26,600
2.44
10,000
1.98
3,970
2.00
Total Wholesale Funding
671,529
2.24
332,227
During the first nine months of 2018, wholesale funding increased $339.3 million. Year-to-date, the Company has repaid $147.2 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.
15,674
13,974
13,918
13,202
Additional paid in capital
269,373
190,533
189,078
158,459
179,826
171,955
142,450
AOCI (loss)
(7,486)
(6,874)
(1,671)
(1,072)
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 $163.1 million during the third 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 September 30, 2018, the subsidiary banks had 33 lines of credit totaling $371.9 million, of which $2.9 million was secured and $369.0 million was unsecured. At September 30, 2018, the full $371.9 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 September 30, 2019. At September 30, 2018, $1.0 million of the $10.0 million was available.
As of September 30, 2018, the Company had $418.6 million in average correspondent banking deposits spread over 191 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 $209.6 million during the first nine months of 2018, compared to $271.1 million for the same period of 2017. The net increase in federal funds sold was $2.9 million for the first nine months of 2018, compared to a net decrease of $1.7 million for the same period of 2017. The net decrease in interest-bearing deposits at financial institutions was $22.1 million for the first nine months of 2018, compared to $22.7 million for the same period of 2017. Proceeds from calls, maturities, and paydowns of securities were $61.1 million for the first nine months of 2018, compared to $92.5 million for the same period of 2017. Purchases of securities used cash of $66.4 million for the first nine months of 2018, compared to $103.5 million for the same period of 2017. The net increase in loans/leases used cash of $208.7 million for the first nine months of 2018 compared to $269.9 million for the same period of 2017.
Financing activities provided cash of $170.4 million for the first nine months of 2018, compared to $229.6 million for same period of 2017. Net increases in deposits totaled $82.3 million for the first nine months of 2018, compared to $225.1 million for the same period of 2017. During the first nine months of 2018, the Company's short-term borrowings decreased $2.2 million, compared to $24.0 million for the same period of 2017. In the first nine months of 2018, the Company increased short-term and overnight FHLB advances by $120.3 million and increased other borrowings by $9.0 million. Maturities and principal payments on FHLB term advances totaled $27.0 million and on other borrowings totaled $10.6 million in the first nine months of 2018. In the first nine months of 2017, the Company increased FHLB advances and
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borrowings by $44.6 million through a mixture of term advances, proceeds from other borrowings and net change in short-term and overnight advances, while borrowing maturities and principal payments on borrowings totaled $15.5 million.
Total cash provided by operating activities was $36.9 million for the first nine months of 2018, compared to $27.2 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 September 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
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
March 2007
3,609,000
1.75% over 3-month LIBOR
4.08
May 2005
4,640,000
3.34
40,210,000
Weighted Average Rate
4.60
As described in Note 5 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 5 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 September 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 9 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.
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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, state, and national economy (including the impact of tariffs, a U.S. withdrawal from or significant renegotiation of trade agreements, trade wars and other changes in trade regulation).
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.
The imposition of tariffs or other governmental policies impacting the value of the agricultural or other products of our borrowers.
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 of 100, 200, 300, and 400 basis points and a parallel and instantaneous shift downward of 100 and 200 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
0.7
200 basis point upward shift
(3.5)
(3.7)
(1.2)
300 basis point upward shock
(25.0)
(8.8)
(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 September 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 mitigate interest rate risk.
Interest rate risk is considered to be one of the most significant market risks affecting the Company. For that reason, the Company engages the assistance of a national consulting firm and its risk management system to monitor and control the Company's interest rate risk exposure. Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company's business activities.
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 September 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
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10.1
First Amendment to Employment Agreement between QCR Holdings, Inc. and Ronald Nagel, dated September 10, 2018 (incorporated by reference to Exhibit 10.1 to the Company’s 8-K filed with the SEC on September 10, 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.
Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets as of September 30, 2018 and December 31, 2017; (ii) Consolidated Statements of Income for the three and nine months ended September 30, 2018 and September 30, 2017; (iii) Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2018 and September 30, 2017; (iv) Consolidated Statements of Changes in Stockholders' Equity for the three and nine months ended September 30, 2018 and September 30, 2017; (v) Consolidated Statements of Cash Flows for the nine months ended September 30, 2018 and September 30, 2017; and (vi) Notes to the Consolidated Financial Statements.
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SIGNATURES
Pursuant to the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
(Registrant)
Date
November 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