Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2019
[ ] 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 ]
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, $1.00 Par Value
QCRH
The Nasdaq Global Market
Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date: As of August 1, 2019, the Registrant had outstanding 15,779,717 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 Sheets As of June 30, 2019 and December 31, 2018
4
Consolidated Statements of Income For the Three Months Ended June 30, 2019 and 2018
Consolidated Statements of Income For the Six Months Ended June 30, 2019 and 2018
Consolidated Statements of Comprehensive Income For the Three and Six Months Ended June 30, 2019 and 2018
Consolidated Statements of Changes in Stockholders' Equity For the Three and Six Months Ended June 30, 2019 and 2018
Consolidated Statements of Cash Flows For the Six months Ended June 30, 2019 and 2018
Notes to Consolidated Financial Statements
Note 1. Summary of Significant Accounting Policies
Note 2. Investment Securities
Note 3. Loans/Leases Receivable
Note 4. Derivatives
Note 5. Borrowings
Note 6. Earnings Per Share
Note 7. Fair Value
Note 8. Business Segment Information
Note 9. Regulatory Capital Requirements
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
Goodwill
Allowance for Loan and Lease Losses
2
Results of Operations
Interest Income
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
Legal Proceedings
Item 1A
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults upon Senior Securities
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 to the Consolidated Financial Statements.
3
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
As of June 30, 2019 and December 31, 2018
June 30,
December 31,
2019
2018
(dollars in thousands)
Assets
Cash and due from banks
$
87,919
85,523
Federal funds sold
10,215
26,398
Interest-bearing deposits at financial institutions
195,282
133,198
Securities held to maturity, at amortized cost
388,713
401,913
Securities available for sale, at fair value
255,090
261,056
Total securities
643,803
662,969
Loans receivable held for sale
4,180
1,295
Loans/leases receivable held for investment
3,906,339
3,731,459
Gross loans/leases receivable
3,910,519
3,732,754
Less allowance for estimated losses on loans/leases
(41,104)
(39,847)
Net loans/leases receivable
3,869,415
3,692,907
Bank-owned life insurance
68,735
67,783
Premises and equipment, net
78,887
75,582
Restricted investment securities
22,195
25,689
Other real estate owned, net
8,637
9,378
77,748
77,832
Intangibles
16,089
17,450
Other assets
115,927
75,001
Total assets
5,194,852
4,949,710
Liabilities and Stockholders' Equity
Liabilities:
Deposits:
Noninterest-bearing
795,951
791,102
Interest-bearing
3,526,559
3,185,929
Total deposits
4,322,510
3,977,031
Short-term borrowings
19,191
28,774
Federal Home Loan Bank advances
105,733
266,492
Other borrowings
—
67,250
Subordinated notes
68,274
4,782
Junior subordinated debentures
37,755
37,670
Other liabilities
137,089
94,573
Total liabilities
4,690,552
4,476,572
Stockholders' Equity:
Preferred stock, $1 par value; shares authorized 250,000 June 2019 and December 2018- No shares issued or outstanding
Common stock, $1 par value; shares authorized 20,000,000 June 2019 - 15,772,939 shares issued and outstanding December 2018 - 15,718,208 shares issued and outstanding
15,773
15,718
Additional paid-in capital
272,744
270,761
Retained earnings
216,741
192,203
Accumulated other comprehensive income (loss):
Securities available for sale
2,412
(4,268)
Derivatives
(3,370)
(1,276)
Total stockholders' equity
504,300
473,138
Total liabilities and stockholders' equity
See Notes to Consolidated Financial Statements (Unaudited)
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three Months Ended June 30, 2019 and 2018
(dollars in thousands, except share data)
Interest and dividend income:
Loans/leases, including fees
47,515
35,408
Securities:
Taxable
1,678
1,594
Nontaxable
3,474
3,295
1,168
228
290
212
56
62
Total interest and dividend income
54,181
40,799
Interest expense:
13,825
6,528
81
63
601
1,019
92
596
993
576
508
Total interest expense
16,168
8,714
Net interest income
38,013
32,085
Provision for loan/lease losses
1,941
2,301
Net interest income after provision for loan/lease losses
36,072
29,784
Noninterest income:
Trust department fees
2,361
2,058
Investment advisory and management fees
1,888
1,058
Deposit service fees
1,658
1,610
Gains on sales of residential real estate loans, net
489
102
Gains on sales of government guaranteed portions of loans, net
39
Swap fee income
7,891
1,649
Securities losses, net
(52)
Earnings on bank-owned life insurance
412
399
Debit card fees
914
844
Correspondent banking fees
172
213
Other
1,293
979
Total noninterest income
17,065
8,912
Noninterest expense:
Salaries and employee benefits
22,749
15,804
Occupancy and equipment expense
3,533
3,133
Professional and data processing fees
3,031
2,771
Acquisition costs
414
Post-acquisition compensation, transition and integration costs
708
165
FDIC insurance, other insurance and regulatory fees
926
840
Loan/lease expense
312
260
Net cost of (income from) and gains/losses on operations of other real estate
1,182
(70)
Advertising and marketing
1,037
753
Bank service charges
466
Correspondent banking expense
206
204
Intangibles amortization
615
305
1,753
1,325
Total noninterest expense
36,560
26,370
Net income before income taxes
16,577
12,326
Federal and state income tax expense
3,073
1,881
Net income
13,504
10,445
Basic earnings per common share
0.86
0.75
Diluted earnings per common share
0.85
0.73
Weighted average common shares outstanding
15,714,588
13,919,565
Weighted average common and common equivalent shares outstanding
15,938,377
14,232,423
Cash dividends declared per common share
0.06
5
Six Months Ended June 30, 2019 and 2018
93,082
69,622
3,344
3,150
7,018
6,584
2,091
425
598
446
150
118
106,283
80,345
26,304
11,410
152
95
1,662
2,215
539
1,557
1,148
955
31,362
15,857
74,921
64,488
4,075
4,841
70,846
59,647
4,854
4,295
3,624
2,010
3,212
3,142
858
203
70
358
11,089
2,608
952
817
1,706
388
477
2,357
1,934
29,058
17,454
Noninterest expenses:
43,628
31,782
7,227
6,198
5,781
5,479
506
842
1,890
1,597
526
551
1,480
1,822
1,446
991
907
410
409
CDI amortization
1,147
609
3,251
2,523
Total noninterest expenses
68,995
52,234
Income before income taxes
30,909
24,867
4,487
3,872
26,422
20,995
1.68
1.51
1.66
1.48
15,703,967
13,904,113
15,930,659
14,219,003
0.12
6
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
Three and Six Months Ended June 30, 2019 and 2018
Three Months Ended June 30,
Other comprehensive income (loss):
Unrealized gains (losses) on securities available for sale:
Unrealized holding gains (losses) arising during the period before tax
4,669
(1,512)
Less reclassification adjustment for losses included in net income before tax
4,721
Unrealized losses on derivatives:
Unrealized holding losses arising during the period before tax
(1,780)
(323)
Less reclassification adjustment for ineffectiveness and caplet amortization before tax
(134)
178
(1,646)
(501)
Other comprehensive income (loss), before tax
3,075
(2,013)
Tax expense (benefit)
833
(679)
Other comprehensive income (loss), net of tax
2,242
(1,334)
Comprehensive income
15,746
9,111
Six Months Ended June 30,
8,813
(6,879)
Less reclassification adjustment for adoption of ASU 2016-01
855
8,865
(6,024)
(2,942)
(172)
(291)
97
(2,651)
(269)
6,214
(6,293)
1,628
(1,757)
4,586
(4,536)
31,008
16,459
7
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED)
Accumulated
Additional
Common
Paid-In
Retained
Comprehensive
Stock
Capital
Earnings
(Loss)
Total
Balance December 31, 2018
(5,544)
12,918
Other comprehensive income, net of tax
2,344
Common cash dividends declared, $0.06 per share
(942)
Issuance of 4,446 shares of common stock as a result of
stock purchased under the Employee Stock Purchase Plan
124
128
Issuance of 25,238 shares of common stock as a result of
stock options exercised
25
263
288
Stock-based compensation expense
722
Restricted stock awards and restricted stock units - 12,719
shares of common stock, net of restricted stock units
withheld for payment of taxes
13
(50)
(37)
Exchange of 5,169 shares of common stock in connection
with payroll taxes for restricted stock vested and in
connection with stock options exercised
(5)
(147)
(152)
Balance, March 31, 2019
15,755
271,673
204,179
(3,200)
488,407
Other comprehensive loss, net of tax
Issuance of 11,346 shares of common stock as a result of
11
323
334
Issuance of 2,414 shares of common stock as a result of
41
44
719
Restricted stock awards and restricted stock units- 4,769
Exchange of 1,032 shares of common stock in connection
(1)
(7)
(8)
Balance, June 30, 2019
(958)
Balance December 31, 2017
13,918
189,077
151,963
(1,671)
353,287
10,550
(3,202)
Impact of adoption of ASU 2016-01
667
(667)
(834)
Issuance of 2,669 shares of common stock as a result of
100
103
Issuance of 13,074 shares of common stock as a result of stock
options exercised
193
496
Restricted stock awards - 6,860 shares of common stock
Exchange of 3,814 shares of common stock in connection
(4)
(174)
(178)
Balance, March 31, 2018
13,937
189,685
162,346
(5,540)
360,428
(836)
Issuance of 5,728 shares of common stock as a result of
215
221
Issuance of 26,641 shares of common stock as a result of stock
26
362
292
Restricted stock awards - 3,972 shares of common stock
Exchange of 642 shares of common stock in connection
1
(17)
(16)
Balance, June 30, 2018
13,974
190,533
171,955
(6,874)
369,588
8
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
CASH FLOWS FROM OPERATING ACTIVITIES
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation
2,518
2,075
1,441
787
Deferred compensation expense accrued
1,323
1,004
Losses on other real estate owned, net
1,214
Amortization of premiums on securities, net
854
829
52
Loans originated for sale
(45,926)
(21,899)
Proceeds on sales of loans
43,969
22,072
Gains on sales of residential real estate loans
(858)
(203)
Gains on sales of government guaranteed portions of loans
(358)
Gains on sales of premises and equipment
(67)
Amortization of intangibles
Accretion of acquisition fair value adjustments, net
(2,145)
(1,244)
Increase in cash value of bank-owned life insurance
(952)
(817)
Decrease (increase) in other assets
942
(5,132)
Increase (decrease) in other liabilities
(4,615)
5,688
Net cash provided by operating activities
29,324
29,365
CASH FLOWS FROM INVESTING ACTIVITIES
Net decrease in federal funds sold
16,183
19,331
Net decrease (increase) in interest-bearing deposits at financial institutions
(62,084)
14,964
Proceeds from sales of other real estate owned
736
Activity in securities portfolio:
Purchases
(10,709)
(54,951)
Calls, maturities and redemptions
5,958
12,619
Paydowns
27,088
27,187
Sales
4,661
Activity in restricted investment securities:
(3,868)
(4,215)
Redemptions
7,362
109
Net increase in loans/leases originated and held for investment
(176,394)
(150,993)
Purchase of premises and equipment
(6,032)
(2,666)
Proceeds from sales of premises and equipment
146
Net cash used in investing activities
(197,150)
(137,879)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposit accounts
345,614
31,652
Net increase (decrease) in short-term borrowings
(9,583)
3,592
Activity in Federal Home Loan Bank advances:
Term advances
5,000
Calls and maturities
(35,000)
(10,000)
Net change in short-term and overnight advances
(130,865)
72,100
Activity in other borrowings:
Proceeds from other borrowings
9,000
Calls, maturities and scheduled principal payments
(11,937)
(3,875)
Prepayments
(46,313)
Paydown of revolving line of credit
(9,000)
Proceeds from subordinated notes
63,393
Payment of cash dividends on common stock
(1,881)
(1,526)
Proceeds from issuance of common stock, net
794
918
Net cash provided by financing activities
170,222
101,861
Net increase (decrease) in cash and due from banks
2,396
(6,653)
Cash and due from banks, beginning
75,722
Cash and due from banks, ending
69,069
(Continued)
9
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) - continued
Supplemental disclosure of cash flow information, cash payments (receipts) for:
Interest
29,346
12,304
Income/franchise taxes
(1,032)
1,010
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
(160)
(194)
Transfers of loans to other real estate owned
1,012
46
Increase in the fair value of back-to-back interest rate swap assets and liabilities
1,775
Dividends payable
836
Transfer of equity securities from securities available for sale to other assets at fair value
2,614
10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
June 30, 2019
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, 2018, included in the Company's Annual Report on Form 10‑K filed with the SEC on March 15, 2019. Accordingly, footnote disclosures, which would substantially duplicate the disclosures contained in the audited consolidated financial statements, have been omitted.
The financial information of the Company included herein has been prepared in accordance with GAAP for interim financial reporting and has been prepared pursuant to the rules and regulations for reporting on Form 10‑Q and Rule 10‑01 of Regulation S-X. Such information reflects all adjustments (consisting of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the periods presented. Any differences appearing between the numbers presented in financial statements and management's discussion and analysis are due to rounding. The results of the interim period ended June 30, 2019 are not necessarily indicative of the results expected for the year ending December 31, 2019, 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
EPS: Earnings per share
SFC Bank: Springfield First Community Bank
Exchange Act: Securities Exchange Act of 1934, as
Springfield Bancshares: Springfield Bancshares, Inc.
amended
TA: Tangible assets
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
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, SFC Bank and RB&T. All are state-chartered commercial banks and all are members of the Federal Reserve system. The Company also engages in direct financing lease contracts through m2, a wholly-owned subsidiary of QCBT. The Company also engages in wealth management services through its banking subsidiaries and its subsidiaries, the Bates Companies. All material intercompany transactions and balances have been eliminated in consolidation.
The acquisition of the Bates Companies, headquartered in Rockford, Illinois, occurred on October 1, 2018. The merger with Springfield Bancshares, the holding company of SFC Bank, headquartered in Springfield, Missouri, occurred on July 1, 2018. The financial results for the periods since acquisition/merger are included in this report. See Note 2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2018 for additional information about the acquisition and merger.
Recent accounting developments: 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 standard was adopted on January 1, 2019 and did not have a significant impact on the Company’s Consolidated Financial Statements.
In June 2016, the FASB issued ASU 2016‑13, Financial Instruments – Credit Losses. Under the standard, assets measured at amortized costs (including loans, leases and AFS securities) will be presented at the net amount expected to be collected. Rather than the “incurred” model that is currently being utilized, the standard will require the use of a forward-looking approach to recognizing all expected credit losses at the beginning of an asset's life. For public companies, ASU 2016‑13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Companies may choose to early adopt for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is in the process of analyzing the impact of adoption on the Company's Consolidated Financial Statements.
In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350). ASU 2017-04 is intended to simplify goodwill impairment testing by eliminating the second step of the analysis. ASU 2017-04 requires entities to compare the fair value of a reporting unit with its carrying amount and recognize an impairment charge for any amount by which the carrying amount exceeds the reporting unit’s fair value, to the extent that the loss recognized does not exceed the amount of goodwill allocated to that reporting unit. This guidance is effective for annual and interim periods beginning after December 15, 2019, with early adoption permitted. The Company does not expect this guidance to have a significant impact on its Consolidated Financial Statements.
Reclassifications: Certain amounts in the prior year's consolidated financial statements have been reclassified, with no effect on net income or stockholders' equity, to conform with the current period presentation.
12
NOTE 2 – INVESTMENT SECURITIES
The amortized cost and fair value of investment securities as of June 30, 2019 and December 31, 2018 are summarized as follows:
Gross
Amortized
Unrealized
Fair
Cost
Gains
(Losses)
Value
June 30, 2019:
Securities HTM:
Municipal securities
387,663
17,967
(468)
405,162
Other securities
1,050
406,212
Securities AFS:
U.S. govt. sponsored agency securities
35,430
431
(99)
35,762
Residential mortgage-backed and related securities
157,760
2,053
(585)
159,228
51,948
1,259
(18)
53,189
6,754
157
6,911
251,892
3,900
(702)
December 31, 2018:
400,863
5,661
(6,803)
399,721
1,049
(6,804)
400,770
37,150
(778)
36,411
163,698
182
(4,631)
159,249
59,069
180
(703)
58,546
6,850
266,671
501
(6,116)
The Company's HTM municipal securities consist largely of private issues of municipal debt. The large majority of the municipalities are located within the Midwest. The municipal debt investments are underwritten using specific guidelines with ongoing monitoring.
The Company's residential mortgage-backed and related securities portfolio consists entirely of government sponsored or government guaranteed securities. The Company has not invested in private mortgage-backed securities or pooled trust preferred securities.
Gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of June 30, 2019 and December 31, 2018, are summarized as follows:
Less than 12 Months
12 Months or More
Losses
513
(3)
21,731
(465)
22,244
6,652
47,176
2,914
248
56,742
56,990
114,201
(2,187)
69,412
(4,616)
183,613
549
114,750
(2,188)
184,162
1,565
(34)
29,605
(744)
31,170
12,810
(148)
133,535
(4,483)
146,345
28,356
(394)
15,932
(309)
44,288
4,249
46,980
(580)
179,072
(5,536)
226,052
At June 30, 2019, the investment portfolio included 587 securities. Of this number, 69 securities were in an unrealized loss position. The aggregate losses of these securities totaled approximately 0.2% of the total amortized cost of the portfolio. Of these 69 securities, 67 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 six months ended June 30, 2019 and 2018.
14
All sales of securities for the three and six months ended June 30, 2019 were securities identified as AFS. There were no sales for the three and six months ended June 30, 2018. Information on proceeds received, as well as pre-tax gross gains and losses from sales on those securities are as follows:
Three and Six Months Ended
Proceeds from sales of securities
Gross gains from sales of securities
Gross losses from sales of securities
The amortized cost and fair value of securities as of June 30, 2019 by contractual maturity are shown below. Expected maturities of residential mortgage-backed and related securities may differ from contractual maturities because the residential mortgages underlying the residential mortgage-backed and related securities may be prepaid without any penalties. Therefore, these securities are not included in the maturity categories in the following table.
Amortized Cost
Fair Value
Due in one year or less
2,781
2,794
Due after one year through five years
32,323
32,929
Due after five years
353,609
370,489
1,624
1,633
27,466
27,638
65,042
66,591
94,132
95,862
Portions of the U.S. government sponsored agency securities, municipal securities and other 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:
188,313
193,173
4,999
5,003
44,184
45,185
6,505
6,662
55,688
56,850
15
As of June 30, 2019, the Company's municipal securities portfolios were comprised of general obligation bonds issued by 101 issuers with fair values totaling $81.0 million and revenue bonds issued by 159 issuers, primarily consisting of states, counties, towns, villages and school districts with fair values totaling $377.3 million. The Company held investments in general obligation bonds in 24 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, 2018, the Company's municipal securities portfolios were comprised of general obligation bonds issued by 110 issuers with fair values totaling $86.4 million and revenue bonds issued by 160 issuers, primarily consisting of states, counties, towns, villages and school districts with fair values totaling $371.9 million. The Company held investments in general obligation bonds in 26 states, including six states in which the aggregate fair value exceeded $5.0 million. The Company held investments in revenue bonds in 19 states, including seven states in which the aggregate fair value exceeded $5.0 million.
Both general obligation and revenue bonds are diversified across many issuers. As of June 30, 2019 and December 31, 2018 the Company held revenue bonds of one single issuer, located in Ohio, of which the aggregate book or market value exceeded 5% of the Company’s stockholders’ equity. The issuer’s financial condition is strong and the source of repayment is diversified. The Company monitors the investment and concentration closely. Of the general obligation and revenue bonds in the Company's portfolio, the majority are unrated bonds that represent small, private issuances. All unrated bonds were underwritten according to loan underwriting standards and have an average loan risk rating of 2, indicating very high quality. Additionally, many of these bonds are funding essential municipal services such as water, sewer, education, and medical facilities.
The Company's municipal securities are owned by each of the five charters, whose investment policies set forth limits for various subcategories within the municipal securities portfolio. Each charter is monitored individually, and as of June 30, 2019, all were well within policy limitations approved by the board of directors. Policy limits are calculated as a percentage of each charter's total risk-based capital.
As of June 30, 2019, the Company's standard monitoring of its municipal securities portfolio had not uncovered any facts or circumstances resulting in significantly different credit ratings than those assigned by a nationally recognized statistical rating organization, or in the case of unrated bonds, the rating assigned using the credit underwriting standards.
16
NOTE 3 – LOANS/LEASES RECEIVABLE
The composition of the loan/lease portfolio as of June 30, 2019 and December 31, 2018 is presented as follows:
As of June 30,
As of December 31,
C&I loans *
1,548,657
1,429,410
CRE loans
Owner-occupied CRE
494,638
500,654
Commercial construction, land development, and other land
312,578
236,787
Other non owner-occupied CRE
1,030,257
1,028,670
1,837,473
1,766,111
Direct financing leases **
101,180
117,969
Residential real estate loans ***
293,479
290,759
Installment and other consumer loans
120,947
119,381
3,901,736
3,723,630
Plus deferred loan/lease origination costs, net of fees
8,783
9,124
Less allowance
** Direct financing leases:
Net minimum lease payments to be received
111,764
130,371
Estimated unguaranteed residual values of leased assets
690
828
Unearned lease/residual income
(11,274)
(13,230)
Plus deferred lease origination costs, net of fees
2,760
3,642
103,940
121,611
(1,459)
(1,792)
102,481
119,819
* Includes equipment financing agreements outstanding at m2, totaling $122.6 million and $103.4 million as of June 30, 2019 and December 31, 2018, respectively.
** Management performs an evaluation of the estimated unguaranteed residual values of leased assets on an annual basis, at a minimum. The evaluation consists of discussions with reputable and current vendors, which is combined with management's expertise and understanding of the current states of particular industries to determine informal valuations of the equipment. As necessary and where available, management will utilize valuations by independent appraisers. The large majority of leases with residual values contain a lease options rider, which requires the lessee to pay the residual value directly, finance the payment of the residual value, or extend the lease term to pay the residual value. In these cases, the residual value is protected and the risk of loss is minimal. There were no losses related to residual values for the three and six months ended June 30, 2019 and 2018.
*** Includes residential real estate loans held for sale totaling $4.2 million and $1.3 million as of June 30, 2019 and December 31, 2018, respectively.
17
Changes in accretable yield for acquired loans were as follows:
Three months ended June 30, 2019
Six months ended June 30, 2019
PCI
Performing
Loans
Balance at the beginning of the period
(319)
(8,830)
(9,149)
(9,656)
(10,323)
Reclassification of nonaccretable discount to accretable
(159)
Accretion recognized
327
812
1,139
675
1,638
2,313
Balance at the end of the period
(151)
(8,018)
(8,169)
Three months ended June 30, 2018
Six months ended June 30, 2018
(157)
(5,659)
(5,816)
(191)
(6,280)
(6,471)
608
623
49
1,229
1,278
(142)
(5,051)
(5,193)
The aging of the loan/lease portfolio by classes of loans/leases as of June 30, 2019 and December 31, 2018 is presented as follows:
As of June 30, 2019
Accruing Past
30-59 Days
60-89 Days
Due 90 Days or
Nonaccrual
Classes of Loans/Leases
Current
Past Due
More
C&I
1,540,661
4,136
307
3,553
CRE
Owner-Occupied CRE
493,877
571
190
Commercial Construction, Land Development, and Other Land
312,288
96
194
Other Non Owner-Occupied CRE
1,024,769
67
5,410
Direct Financing Leases
98,581
971
80
1,548
Residential Real Estate
291,605
160
54
1,470
Installment and Other Consumer
120,082
78
783
3,881,863
6,109
558
58
13,148
As a percentage of total loan/lease portfolio
99.49
%
0.16
0.01
0.00
0.34
100.00
As of December 31, 2018
1,423,406
930
597
389
4,088
500,138
107
216
234,704
1,764
319
1,022,664
484
5,522
114,078
1,642
488
1,761
284,844
3,877
89
1,743
118,343
356
24
47
611
3,698,177
9,053
1,508
632
14,260
99.32
0.24
0.04
0.02
0.38
18
NPLs by classes of loans/leases as of June 30, 2019 and December 31, 2018 are presented as follows:
Percentage of
More*
Loans/Leases*
Accruing TDRs
Total NPLs
1,112
4,665
32.13
104
294
2.02
1.34
37.26
1,645
11.33
1,524
10.50
5.42
1,313
14,519
* Nonaccrual loans/leases included $2.8 million of TDRs, including $28 thousand in C&I loans, $2.2 million in CRE loans, $314 thousand in direct financing leases, $286 thousand in residential real estate loans, and $2 thousand in installment loans.
Loans/Leases **
454
4,931
26.58
1.74
1.72
2,984
8,506
45.86
111
1,872
10.09
1,932
10.41
3.60
3,658
18,550
* As of December 31, 2018 accruing past due 90 days or more included $496 thousand of TDRs, including $389 thousand in C&I loans and $107 thousand in CRE loans.
** Nonaccrual loans/leases included $2.3 million of TDRs, including $265 thousand in C&I loans, $1.4 million in CRE loans, $321 thousand in direct financing leases, $344 thousand in residential real estate loans, and $3 thousand in installment loans.
19
Changes in the allowance by portfolio segment for the three and six months ended June 30, 2019 and 2018, respectively, are presented as follows:
Three Months Ended June 30, 2019
Direct Financing
Residential Real
Installment and
Leases
Estate
Other Consumer
Balance, beginning
17,260
18,303
1,606
2,538
1,457
41,164
Provisions (credits) charged to expense
1,116
331
86
(6)
Loans/leases charged off
(193)
(1,369)
(497)
(73)
(20)
(2,152)
Recoveries on loans/leases previously charged off
65
31
21
151
Balance, ending
18,248
17,363
1,459
2,582
1,452
41,104
Three Months Ended June 30, 2018
15,065
14,938
2,730
2,375
1,424
36,532
777
872
688
57
(93)
(729)
(794)
(1,524)
121
236
15,234
15,819
2,724
2,433
1,335
37,545
Six Months Ended June 30, 2019
16,420
17,719
1,792
2,557
1,359
39,847
Provisions charged to expense
2,123
948
776
68
(527)
(1,149)
(94)
(3,212)
232
40
30
27
394
Six Months Ended June 30, 2018
14,323
13,963
2,382
2,466
1,222
34,356
1,585
1,837
108
(824)
(1,079)
(1,961)
309
20
The allowance by impairment evaluation and by portfolio segment as of June 30, 2019 and December 31, 2018 is presented as follows:
Allowance for impaired loans/leases
1,085
445
93
192
1,967
Allowance for nonimpaired loans/leases
17,163
16,918
1,366
2,390
1,300
39,137
Impaired loans/leases
4,520
7,736
1,860
1,052
16,796
Nonimpaired loans/leases
1,544,137
1,829,737
99,320
291,851
119,895
3,884,940
Allowance as a percentage of impaired loans/leases
24.00
5.75
5.00
11.79
14.45
11.71
Allowance as a percentage of nonimpaired loans/leases
1.11
0.92
1.38
0.82
1.08
1.01
Total allowance as a percentage of total loans/leases
1.18
0.94
1.44
0.88
1.20
1.05
973
2,124
257
3,659
15,447
15,595
1,598
2,300
1,248
36,188
4,499
10,447
2,249
2,110
898
20,203
1,424,911
1,755,664
115,720
288,649
118,483
3,703,427
21.62
20.33
8.63
12.18
12.38
18.11
0.89
0.80
0.98
1.15
1.00
1.52
1.14
1.07
Information for impaired loans/leases is presented in the tables below. The recorded investment represents customer balances net of any partial charge-offs recognized on the loan/lease. The unpaid principal balance represents the recorded balance outstanding on the loan/lease prior to any partial charge-offs.
Loans/leases, by classes of financing receivable, considered to be impaired as of and for the six months ended June 30, 2019 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:
2,048
2,088
1,680
187
546
902
628
3,417
4,296
4,183
1,600
1,901
810
1,001
765
875
797
9,512
10,994
10,141
Impaired Loans/Leases with Specific Allowance Recorded:
2,472
2,478
1,917
129
142
145
3,291
393
1,588
196
818
177
136
7,284
7,290
4,940
22
Total Impaired Loans/Leases:
4,566
3,597
340
316
1,044
773
6,708
7,587
5,771
2,097
1,819
933
18,284
15,081
214
Loans/leases, by classes of financing receivable, considered to be impaired as of and for the three months ended June 30, 2019 and 2018, respectively are presented as follows:
1,683
29
1,401
59
289
603
3,985
1,105
1,795
2,199
801
929
816
101
9,877
74
6,024
2,046
353
127
143
5,492
1,980
227
566
822
512
117
5,495
7,185
3,729
38
1,754
61
321
434
746
5,965
2,022
2,765
1,623
966
218
15,372
84
13,209
73
23
Loans/leases, by classes of financing receivable, considered to be impaired as of December 31, 2018 are presented as follows:
Unpaid
Principal
1,846
4,540
106
507
1,804
1,929
984
762
7,938
10,706
2,653
304
660
149
33
7,577
2,052
320
1,126
12,265
12,621
7,193
766
656
9,381
2,184
23,327
Impaired loans/leases for which no allowance has been provided have adequate collateral, based on management's current estimates.
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.
For each class of financing receivable, the following presents the recorded investment by credit quality indicator as of June 30, 2019 and December 31, 2018:
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)
1,398,762
487,200
308,269
1,008,427
3,202,658
98.14
Special Mention (Rating 6)
9,811
4,236
64
5,802
19,913
0.61
Substandard (Rating 7)
17,460
3,202
4,245
16,028
40,935
1.25
Doubtful (Rating 8)
1,426,033
3,263,506
Delinquency Status *
121,836
99,536
291,955
120,160
633,487
99.26
Nonperforming
788
1,644
4,743
0.74
122,624
638,230
1,294,418
487,949
230,473
1,008,626
3,021,466
97.72
23,302
9,599
3,848
5,309
42,058
1.36
8,286
3,106
14,735
28,593
1,326,006
3,092,117
102,713
116,097
288,827
118,714
626,351
99.18
691
5,162
103,404
631,513
* Performing = loans/leases accruing and less than 90 days past due. Nonperforming = loans/leases on nonaccrual, accruing loans/leases that are greater than or equal to 90 days past due, and accruing TDRs.
As of June 30, 2019 and December 31, 2018, TDRs totaled $4.1 million and $6.5 million, respectively.
For each class of financing receivable, the following presents the number and recorded investment of TDRs, by type of concession, that were restructured during the three and six months ended June 30, 2019 and 2018. The difference between the pre-modification recorded investment and the post-modification recorded investment would be any partial charge-offs at the time of the restructuring.
For the three months ended June 30, 2019
For the three months ended June 30, 2018
Pre-
Post-
Modification
Number of
Specific
Loans / Leases
CONCESSION - Significant Payment Delay
CONCESSION - Foregiveness of Principal
587
537
TOTAL
639
589
For the six months ended June 30, 2019
For the six months ended June 30, 2018
71
48
174
94
CONCESSION - Forgiveness of Principal
761
711
Of the loans restructured during the six months ended June 30, 2019, two with post-modification recorded balances of $65 thousand were on nonaccrual. Of the loans restructured during the six months ended June 30, 2018, one with a post-modification recorded balance of $46 thousand was on nonaccrual.
For the three and six months ended June 30, 2019, three 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 one customer whose leases were restructured in the first quarter of 2019 with pre-modification balances totaling $66 thousand. The other TDR related to a customer whose loan was restructured in the third quarter of 2018 with an original pre-modification balance of $2.9 million and a current pre-modification balance of $1.5 million and a partial charge off of $879 thousand in the second quarter of 2019.
For the three and six months ended June 30, 2018, seven of the Company's TDRs redefaulted within 12 months subsequent to restructure where default is defined as delinquency of 90 days or more and/or placement on nonaccrual status. Three of these TDRs were related to one customer whose loans were restructured in the second quarter of 2017 with pre-modification balances totaling $78 thousand and the other TDRs related to other customers whose loans were restructured in the second and third quarters of 2017 with pre-modification balances totaling $378 thousand.
Not included in the table above, the Company had three TDRs that were restructured and charged off for the six months ended June 30, 2019, totaling $161 thousand. The Company had eight TDRs that were restructured and charged off for the six months ended June 30, 2018, totaling $577 thousand.
NOTE 4 – DERIVATIVES
The Company uses interest rate swap and cap instruments to manage interest rate risk related to the variability of interest payments due to changes in interest rates. The Company entered into two 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 caps. As noted below, one of the caps matured during the quarter ended June 30, 2019. The details of the interest rate caps are as follows:
Balance Sheet
1-Month LIBOR
Fair Value as of
Hedged Instrument
Effective Date
Maturity Date
Location
Notional Amount
Strike Rate
December 31, 2018
1-month FHLB Advance
6/3/2014
6/5/2019
Other Assets
N/A
-
6/5/2014
6/5/2021
98
342
459
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
5.17
(965)
(298)
QCR Holdings Statutory Trust III
(772)
(239)
QCR Holdings Statutory Trust V
7/7/2018
7/7/2028
4.15
(940)
(288)
Community National Statutory Trust II
9/20/2018
9/20/2028
4.56
(89)
Community National Statutory Trust III
9/15//2018
9/15/2028
4.16
(336)
(104)
Guaranty Bankshares Statutory Trust I
9/15/2018
(431)
(133)
4.65
(3,732)
(1,151)
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.
The Company has also entered into interest rate swap contracts that are not designated as hedging instruments. These derivative contracts relate to transactions in which the Company enters into an interest rate swap with a customer while at the same time entering into an equal and offsetting interest rate swap with a third party financial institution. Because the Company acts as an intermediary for the customer, changes in the fair value of the underlying derivative contracts, for the most part, offset each other and do not significantly impact the Company’s results of operations.
Estimated Fair Value
Non-Hedging Interest Rate Derivatives Assets:
Interest rate swap contracts
596,451
65,824
Non-Hedging Interest Rate Derivatives Liabilities:
Swap fee income totaled $11.1 million and $2.6 million for the six months ended June 30, 2019 and 2018, respectively. Swap fee income totaled $10.8 million for the year ended December 31, 2018.
NOTE 5 –BORROWINGS
On February 12, 2019, the Company completed an underwritten public offering of $65.0 million in aggregate principal amount of fixed-to-floating subordinated notes that mature on February 15, 2029. Net proceeds, after deducting the underwriting discount and estimated expenses, were $63.4 million. The subordinated notes, which qualify as Tier 2 capital for the Company, are at a fixed rate of 5.375% per year until but excluding February 15, 2024. On this date, the interest rate will change to an annual floating rate equal to three-month LIBOR plus 282 basis points until the maturity date. The interest on the subordinated notes are payable semi-annually, commencing on August 15, 2019 during the five year fixed term and thereafter quarterly, commencing on February 15, 2024. The subordinated notes have an optional redemption at par in whole or in part on any interest payment date on or after February 15, 2024. The subordinated notes are subordinate in the right of payment to the Company’s senior indebtedness and the indebtedness and other liabilities of the subsidiary banks. Unamortized debt issuance costs related to the subordinated notes totaled $1.5 million at June 30, 2019.
Immediately following the issuance, the Company repaid term notes totaling $21.3 million and the outstanding balance of $9.0 million on its revolving line of credit. The Company intends to use the remaining net proceeds from this offering for general corporate purposes, including the pursuit of opportunistic acquisitions of similar or complementary financial service organizations, repaying indebtedness, financing investments and capital expenditures, repurchasing shares of the Company’s common stock, investing in the subsidiary banks as regulatory capital or other strategic opportunities that may arise in the future.
In the second quarter of 2019, the Company renewed its revolving line of credit. At renewal, the line amount was increased from $10.0 million to $20.0 million. The interest on the revolving line of credit is calculated at the effective LIBOR rate plus 2.25% per annum (4.57% at June 30, 2019). Prior to the renewal, the interest on the revolving line of credit was calculated at the effective LIBOR rate plus 2.50% per annum. The collateral on the revolving line of credit is the original stock certificates and stock powers of all bank subsidiaries. The outstanding balance on the revolving line of credit was $0 and $9.0 million at June 30, 2019 and December 31, 2018, respectively.
The Company prepaid two wholesale structured repurchase agreements in the second quarter of 2019 using excess funds generated by strong deposit growth. The first wholesale structured repurchase agreement totaled $5.0 million and had original maturity date of March 13, 2020 with a rate of 2.58%. The second wholesale structured repurchase agreement totaled $20.0 million and had an original maturity of June 13, 2020 with a rate of 2.46%. The loss on the prepayment of the two wholesale structured repurchase agreements totaled $50 thousand. In addition, wholesale structured repurchase agreements totaling $10.0 million matured in the second quarter of 2019. The wholesale structured repurchase agreements were utilized as an alternative funding source to FHLB advances and customer deposits. Wholesale structured repurchase agreements were collateralized by certain U.S. government agency securities and residential mortgage backed and related securities.
28
NOTE 6 - EARNINGS PER SHARE
The following information was used in the computation of EPS on a basic and diluted basis:
Three months ended
Six months ended
Basic EPS
Diluted EPS
Weighted average common shares issuable upon exercise of stock options
and under the employee stock purchase plan
223,789
312,858
226,692
314,890
The increase in weighted average common shares outstanding when comparing the three and six months ended June 30, 2019 to June 30, 2018 was primarily due to the common stock issuance as a result of the merger with Springfield Banshares as discussed in Note 2 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.
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.
Assets and liabilities measured at fair value on a recurring basis comprise the following at June 30, 2019 and December 31, 2018:
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
Total assets measured at fair value
321,012
Interest rate swaps - liabilities
69,556
Total liabilities measured at fair value
22,196
283,711
23,347
There were no transfers of assets or liabilities between Levels 1, 2, and 3 of the fair value hierarchy for the three and six months ended June 30, 2019 or 2018.
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 interest rate caps are further described in Note 4 to the Consolidated Financial Statements. 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 4 to the Consolidated Financial Statements. 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 interest rate swaps are further described in Note 4 to the Consolidated Financial Statements. The fair values are determined by comparing the contract rate on the swap with the then-current market rate for the remaining term of the transaction (Level 2 inputs).
Certain financial assets are measured at fair value on a non-recurring basis; that is, the assets are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).
Assets measured at fair value on a non-recurring basis comprise the following at June 30, 2019 and December 31, 2018:
Level 1
Level 2
Level 3
7,539
OREO
9,328
16,867
9,657
10,128
19,785
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 six months ended June 30, 2019 and 2018.
The following table presents the carrying values and estimated fair values of financial assets and liabilities carried on the Company's consolidated balance sheets, including those financial assets and liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis:
Hierarchy
Carrying
Estimated
Level
Investment securities:
HTM
AFS
See Previous Table
Loans/leases receivable, net
6,981
8,942
3,862,434
3,842,781
3,683,965
3,639,329
Nonmaturity deposits
3,275,004
3,002,327
Time deposits
1,047,506
1,033,017
974,704
968,906
FHLB advances
105,768
265,926
67,770
68,478
4,933
30,465
29,992
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, SFC Bank and RB&T. Each of these secondary segments offers similar products and services, but is managed separately due to different pricing, product demand, and consumer markets. Each offers commercial, consumer, and mortgage loans and deposit services.
The Company's Wealth Management segment represents the trust and asset management and investment management and advisory services offered at the Company's five subsidiary banks and the Bates Companies 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.
32
Selected financial information on the Company's business segments is presented as follows as of and for the three and six months ended June 30, 2019 and 2018.
Commercial Banking
Wealth
Intercompany
Consolidated
QCBT
CRBT
CSB
SFC Bank
RB&T
Management
All other
Eliminations
Total revenue
20,374
23,575
9,730
7,757
5,659
17,772
(17,870)
71,246
12,632
10,785
7,294
5,425
3,373
(1,496)
Provision
300
485
Net income (loss)
4,505
6,928
2,207
2,079
786
583
13,583
(17,167)
3,223
14,980
9,888
45,975
3,682
2,935
4,328
7,268
1,558
1,637,115
1,527,521
806,704
671,644
523,262
641,639
(613,033)
16,683
16,504
8,406
5,120
3,116
13,024
(13,142)
49,711
12,290
10,481
6,735
3,402
(823)
1,254
198
4,511
4,705
2,158
814
10,405
(12,945)
28,091
3,440
5,030
8,470
1,563,643
1,345,431
712,139
484,123
463,207
(461,660)
4,106,883
38,918
42,819
19,000
15,045
11,255
8,478
32,354
(32,528)
135,341
24,771
21,193
10,651
6,801
(2,755)
1,993
725
301
985
8,690
12,028
4,363
3,732
1,304
1,741
26,181
(31,617)
32,491
32,501
16,570
10,118
6,305
25,556
(25,742)
97,799
24,410
21,317
13,479
6,867
(1,585)
1,230
439
8,969
9,321
4,027
1,555
1,568
20,920
(25,365)
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 June 30, 2019 and December 31, 2018, that the Company and the subsidiary banks met all capital adequacy requirements to which they are subject.
Under the regulatory framework for prompt corrective action, to be categorized as “well capitalized,” an institution must maintain minimum total risk-based, Tier 1 risk-based, Tier 1 leverage and common equity Tier 1 ratios as set forth in the following tables. The Company and the subsidiary banks' actual capital amounts and ratios as of June 30, 2019 and
December 31, 2018 are presented in the following table (dollars in thousands). As of June 30, 2019 and December 31, 2018, each of the subsidiary banks met the requirements to be “well capitalized”.
For Capital
To Be Well
Adequacy Purposes
Capitalized Under
With Capital
Prompt Corrective
Actual
Conservation Buffer*
Action Provisions
Amount
Ratio
As of June 30, 2019:
Company:
Total risk-based capital
551,046
12.04
366,017
>
8.00
480,397
457,521
10.00
Tier 1 risk-based capital
446,490
9.76
274,513
6.00
388,893
8.50
Tier 1 leverage
8.96
199,304
4.00
249,130
Common equity Tier 1
408,735
8.93
205,884
4.50
320,265
7.00
297,389
6.50
Quad City Bank & Trust:
171,919
11.53
119,322
156,610
149,152
158,453
10.62
89,491
126,779
9.39
67,519
84,398
67,119
104,407
96,949
Cedar Rapids Bank & Trust:
159,747
11.56
110,543
145,088
138,179
146,594
10.61
82,908
117,452
10.16
57,716
72,145
62,181
96,725
89,816
Community State Bank:
85,269
12.33
55,307
72,591
69,134
78,770
11.39
41,481
58,764
10.03
31,420
39,275
31,110
48,394
44,937
Springfield First Community Bank:
65,725
12.91
40,724
53,451
50,906
58,978
11.59
30,543
43,270
10.58
22,306
27,883
22,907
35,634
33,089
Rockford Bank & Trust:
52,293
10.68
39,163
51,401
48,954
46,232
9.44
29,372
41,611
9.04
20,466
25,582
22,029
34,268
31,820
Conservation Buffer
As of December 31, 2018:
460,416
10.69
344,551
425,305
9.875
430,689
420,569
9.77
258,413
339,168
7.875
8.87
189,858
4.000
237,322
382,899
8.89
193,810
274,564
6.375
279,948
162,009
11.38
113,900
140,596
142,376
148,529
10.43
85,425
112,121
65,744
82,180
64,069
90,764
92,544
146,292
11.55
101,310
125,054
126,637
133,982
75,982
99,727
9.98
53,682
67,103
56,987
80,731
82,314
75,233
11.24
53,567
66,122
66,959
69,101
10.32
40,175
52,730
9.19
30,070
37,588
30,131
42,686
43,523
57,051
12.24
37,278
46,016
46,598
51,279
11.00
27,959
36,696
21,849
27,312
20,969
29,706
30,289
50,648
10.89
37,208
45,929
46,511
44,821
9.64
27,906
36,627
20,081
25,101
20,930
29,650
30,232
* June 30, 2019 minimums reflect the fully phased-in ratios (including the capital conservation buffer).
34
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 six months ending June 30, 2019. 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 in this discussion 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, SFC Bank and RB&T. QCBT, CRBT and CSB are Iowa-chartered commercial banks, SFC Bank is a Missouri-chartered commercial bank, and RB&T is an Illinois-chartered commercial bank. All are members of the Federal Reserve system with depository accounts insured to the maximum amount permitted by law by the FDIC.
QCBT commenced operations in 1994 and provides full-service commercial and consumer banking, and trust and asset management services to the Quad City area and adjacent communities through its five offices that are located in Bettendorf and Davenport, Iowa and Moline, Illinois. QCBT also provides leasing services through its wholly-owned subsidiary, m2, 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 (one in Cedar Falls and two in Waterloo).
CSB was acquired by the Company in 2016 and provides full-service commercial and consumer banking services 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.
SFC Bank became a subsidiary of the Company in 2018, as further described in Note 2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2018. SFC Bank provides full-service commercial and consumer banking services to the Springfield, Missouri area through its main office located on Glenstone Avenue in Springfield, Missouri.
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 in Rockford and its branch facility in downtown Rockford.
EXECUTIVE OVERVIEW
The Company reported net income of $13.5 million and diluted EPS of $0.85 for the quarter ended June 30, 2019. By comparison, for the quarter ended March 31, 2019, the Company reported net income of $12.9 million and diluted EPS of $0.81. For the quarter ended June 30, 2018, the Company reported net income of $10.4 million, and diluted EPS of $0.73. For the six months ended June 30, 2019, the Company reported net income of $26.4 million, and diluted EPS of $1.66.
35
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued
By comparison, for the six months ended June 30, 2018, the Company reported net income of $21.0 million, and diluted EPS of $1.48.
The second quarter of 2019 was highlighted by several significant items:
Record net income of $13.5 million, or $0.85 per diluted share;
Record adjusted net income (non-GAAP) of $14.1 million, or $0.88 per diluted share;
Annualized loan and lease growth of 11.7% for the quarter and 9.5% year-to-date;
Annualized deposit growth of 12.2% for the quarter and 17.4% year-to-date;
Record noninterest income of $17.1 million for the quarter and $29.1 million year-to-date;
NIM and NIM (TEY) (non-GAAP) stabilized at 3.25% and 3.40%, respectively; and
Nonperforming assets down $3.2 million, or 12.2%, from the prior quarter.
Following is a table that represents various net income measurements for the Company.
For the three months ended
For the six months ended
March 31, 2019
June 30, 2018
0.81
15,922,940
The increase in weighted average common shares outstanding since June 30, 2018 was primarily due to the common stock issued as a result of the merger with Springfield Bancshares as further described in Note 2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.
Following is a table that represents the major income and expense categories for the Company.
36,908
Provision expense
2,134
Noninterest income
11,993
Noninterest expense
32,435
1,414
36
Following are some noteworthy changes in the Company's financial results:
Net interest income in the second quarter of 2019 was up 3% compared to the first quarter of 2019. The increase was primarily due to an $85.5 million increase in average interest earning assets, as reported net interest margin remained stable between quarters. Net interest income increased 18% compared to the second quarter of 2018 and 16% when comparing the first six months of 2019 to the same period in the prior year. These increases were primarily due to strong loan growth and the addition of SFC Bank.
Provision expense in the second quarter of 2019 decreased 9% compared to the first quarter of 2019. Provision expense decreased 16% compared to the second quarter of 2018 and 16% when comparing the first six months of 2019 to the same period in the prior year. The decreases were primarily due to continued asset quality improvements. See the Provision for Loan Lease Losses section of this report for additional details.
Noninterest income in the second quarter of 2019 increased 42% compared to the first quarter of 2019 primarily due to higher swap fee income. Noninterest income increased 91% compared to the second quarter of 2018 and 66% when comparing the first six months of 2019 to the same period in the prior year. These increases were primarily attributable to higher swap fee income as well as solid growth in wealth management fee income and the addition of SFC Bank and the Bates Companies.
Noninterest expense increased 13% in the second quarter of 2019 compared to the first quarter of 2019. In the second quarter of 2019, there was $708 thousand of post-acquisition compensation, transition and integration cost as compared to $134 thousand in the first quarter of 2019. Net cost and gains/losses on operations of other real estate was $1.2 million in the second quarter of 2019 primarily due to a write down of an OREO property of $1 million, as compared to $298 thousand in the first quarter of 2019. Additionally, the Company incurred approximately $2.5 million in additional bonus and commission expense during the second quarter due to strong year-to-date results and higher than expected fee income. Noninterest expense increased 39% compared to the second quarter of 2018 and 32% when comparing the first six months of 2019 to the same period in the prior year primarily due to the addition of SFC Bank.
Federal and state income tax expense in the second quarter of 2019 increased 117% compared to the first quarter of 2019. Federal and state income tax expense increased 63% compared to the second quarter of 2018 and 16% when comparing the first six months of 2019 to the same period in the prior year. See the “Income Taxes” section of this report for additional details on these decreases.
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, 2018. The Company's long-term financial goals are as follows:
Generate 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);
Support strong asset quality by maintaining NPAs to total assets to below 0.75% and maintaining charge-offs as a percentage of average loans/leases of under 0.25% annually;
37
Grow core deposits to maintain reliance on wholesale funding at less than 15% of total assets;
Continue to focus on generating gains on sales of government guaranteed portions of loans and swap fee income between $8 million and $12 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%
75
76
NIM TEY (non-GAAP)*
> 3.35%
3.40
3.52
Profitability
ROAA
> 1.10%
1.06
1.04
1.03
Adjusted ROAA (non-GAAP)*
Asset quality
NPAs to total assets
< 0.75%
0.45
0.52
0.65
Net charge-offs to average loans and leases***
< 0.25% annually
0.15
0.09
0.11
Reliance on wholesale funding
Wholesale funding to total assets****
< 15%
Consistent, high quality noninterest income revenue streams
Gains on sales of government guaranteed portions of loans and swap fee income***
$8-12 million annually
22.3
million
12.9
5.9
Grow wealth management net income***
> 10% annually
50
* See “GAAP to Non-GAAP” reconciliations section.
** Targets will be re-evaluated and adjusted as appropriate.
*** Ratios and amounts provided for these measurements represent year-to-date actual amounts for the respective period that are then annualized for comparison.
**** Wholesale funding to total assets is calculated by dividing total borrowings and brokered deposits by total assets.
STRATEGIC DEVELOPMENTS
The Company took the following actions during the second quarter of 2019 to support its corporate strategy and the long-term financial goals shown above:
The Company grew loans and leases in the second quarter of 2019 by 11.7% on an annualized basis and 9.5% year-to-date. Strong loan and lease growth for the remainder of the year will help keep the Company's loans and leases to assets 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 has continued to focus on lowering the NPAs to total assets ratio. This ratio decreased by seven basis points to 0.45% compared to the first quarter 2019. The Company remains committed to improving asset quality ratios in 2019 and beyond.
Management has continued to focus on reducing the Company's reliance on wholesale funding. Wholesale funding as a percentage of total assets decreased to 10% in the second quarter of 2019 due to the strong core deposit growth which outpaced the Company’s loan growth. 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 four states currently served – Iowa, Illinois,Wisconsin and Missouri. The Company acts as the correspondent bank for 192 downstream banks with average total noninterest bearing deposits of $168.9 million and average total interest bearing deposits of $310.1 million during the first six months of 2019. By comparison, the Company acted as the correspondent bank for 192 downstream banks with average total noninterest bearing deposits of $215.3 million and average total interest bearing deposits of $208.3 million during the first six months of 2018. This line of business provides a strong source of noninterest bearing and interest bearing deposits, fee income, high-quality loan participations and bank stock loans.
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 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. The Company will continue to review opportunities to execute these swaps at all of its subsidiary banks as appropriate for the borrowers and the Company. Swap fee income totaled $11.1 million for the six months ended June 30, 2019 as compared to $2.6 million for the six months ended June 30, 2018.
Wealth management is another core line of business for the Company and includes a full range of products, including trust services, brokerage and investment advisory services, asset management, estate planning and financial planning. As of June 30, 2019, the Company had $2.95 billion of total financial assets in trust (and related) accounts and $1.75 billion of total financial assets in brokerage (and related) accounts. Continued growth in assets under management are expected to 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 through the acquisition of managed assets.
GAAP TO NON-GAAP RECONCILIATIONS
The following table presents certain non-GAAP financial measures related to the “TCE/TA ratio”, “adjusted net income”, “adjusted EPS”, “adjusted ROAA”, “NIM (TEY)”, “adjusted NIM”, 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;
Adjusted net income, adjusted EPS and adjusted ROAA (all non-GAAP measures) are reconciled to net income;
NIM (TEY) (non-GAAP) and adjusted NIM (non-GAAP) are 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 following tables also include several “adjusted” 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 performance.
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. In addition, the Company calculates NIM without the impact of acquisition accounting net accretion (adjusted NIM), as accretion amounts can fluctuate a great deal, making comparions difficult.
The efficiency ratio is a ratio that management utilizes to compare the Company to its peers. It is a standard ratio in the banking industry and widely utilized by investors.
As of
GAAP TO NON-GAAP
March 31,
RECONCILIATIONS
(dollars in thousands, except per share data)
TCE/TA RATIO
Stockholders' equity (GAAP)
Less: Intangible assets
93,837
94,790
36,561
TCE (non-GAAP)
410,463
393,617
333,027
Total assets (GAAP)
5,066,662
TA (non-GAAP)
5,101,015
4,971,872
4,070,322
TCE/TA ratio (non-GAAP)
8.05
7.92
8.18
For the Quarter Ended
For the Six Months Ended
ADJUSTED NET INCOME
Net income (GAAP)
Less nonrecurring items (post-tax) (*):
Income:
(41)
Total nonrecurring income (non-GAAP)
Expense:
400
559
130
665
Total nonrecurring expense (non-GAAP)
457
530
Adjusted net income (non-GAAP)
14,104
10,902
27,128
21,525
ADJUSTED EPS
Adjusted net income (non-GAAP) (from above)
15,693,345
Adjusted EPS (non-GAAP):
Basic
0.90
0.83
0.78
1.55
Diluted
0.77
ADJUSTED ROAA
Average Assets
5,077,900
4,968,502
4,053,684
5,023,201
4,024,188
Adjusted ROAA (annualized) (non-GAAP)
ADJUSTED NIM (TEY)*
Net interest income (GAAP)
Plus: Taxequivalent adjustment
1,808
1,794
1,462
3,509
2,815
Net interest income - taxequivalent (non-GAAP)
39,821
38,702
33,547
78,430
67,303
Less: Accquisition accounting net accretion
1,076
1,069
545
2,145
1,244
Adjusted net interest income
38,745
37,633
33,002
76,285
66,059
Average earning assets
4,698,021
4,612,553
3,820,333
4,655,287
3,789,905
NIM (GAAP)
3.25
3.37
3.43
NIM (TEY) (non-GAAP)
3.58
Adjusted NIM (TEY) (non-GAAP)
3.31
3.46
3.30
3.51
EFFICIENCY RATIO
Noninterest expense (GAAP)
Noninterest income (GAAP)
Total income
55,078
48,901
40,997
103,979
81,942
Efficiency ratio (noninterest expense/total income) (non-GAAP)
66.38
66.33
64.32
66.35
63.75
* Nonrecurring items (after-tax) are calculated using an estimated effective tax rate of 21%.
NET INTEREST INCOME - (TAX EQUIVALENT BASIS)
Net interest income, on a tax equivalent basis, increased 19% to $39.8 million for the quarter ended June 30, 2019, compared to the same quarter of the prior year, and increased 17% to $78.4 million for the six months ended June 30, 2019 compared to the same period of the prior year. Excluding the tax equivalent adjustments, net interest income increased 18% for the quarter ended June 30, 2019 compared to the same quarter of the prior year, and increased 16% for the six months ended June 30, 2019 compared to the same period of the prior year. Net interest income improved due to two main factors:
The merger of Springfield Bancshares in the third quarter of 2018; and
Strong organic loan and deposit growth over the past 12 months.
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
4.78
4.74
4.44
4.63
4.58
4.28
Average Cost of Interest-Bearing Liabilities
1.76
1.21
Net Interest Spread
3.02
3.23
2.87
2.86
3.07
NIM
NIM Excluding Acquisition Accounting Net Accretion
3.15
4.76
4.42
4.60
1.13
3.29
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:
Acquisition Accounting Net Accretion in NIM
NIM on a tax equivalent basis remained stable on a linked quarter basis at 3.40%. Excluding acquisition accounting net accretion, NIM also remained stable on a linked quarter basis at 3.31%. The stability in net interest margin during the quarter was due to a 4 basis point increase in the yield on interest earning assets, offset by a 4 basis point increase in the total cost of funds (due to both mix and rate).
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 include better loan pricing, reducing reliance on very rate-sensitive funding, closely managing deposit rate changes and finding additional ways to manage NIM through derivatives.
The Company's average balances, interest income/expense, and rates earned/paid on major balance sheet categories, as well as the components of change in net interest income, are presented in the following tables:
For the three months ended June 30,
Earned
Yield or
or Paid
ASSETS
Interest earning assets:
9,690
2.32
18,561
1.32
182,651
2.56
54,879
1.67
Investment securities (1)
644,999
6,062
3.77
648,276
5,752
3.56
21,007
5.54
21,100
4.03
Gross loans/leases receivable (1) (2) (3)
3,839,674
48,413
5.06
3,077,517
36,008
4.69
Total interest earning assets
55,989
42,261
Noninterest-earning assets:
82,394
68,266
Premises and equipment
78,008
63,665
(41,224)
(36,960)
260,701
138,380
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Interest-bearing deposits
2,461,768
8,271
1.35
1,919,406
4,089
1,013,391
5,554
2.20
665,643
2,439
1.47
16,145
2.01
19,024
1.33
76,154
3.17
174,826
2.34
3.50
67,044
3.57
68,239
5.84
37,731
6.12
37,558
5.43
Total interest-bearing liabilities
3,683,978
2,883,501
Noninterest-bearing demand deposits
796,232
757,954
Other noninterest-bearing liabilities
99,427
47,198
4,579,637
3,688,653
Stockholders' equity
498,263
365,031
Net interest spread
Net interest margin
Net interest margin (TEY)(Non-GAAP)
Adjusted net interest margin (TEY)(Non-GAAP)
Ratio of average interest-earning assets to average interest-bearing liabilities
127.53
132.49
Interest earned and yields on nontaxable investment securities and nontaxable loans are determined on a tax equivalent basis using a 21% tax rate.
(2)
Loan/lease fees are not material and are included in interest income from loans/leases receivable in accordance with accounting and regulatory guidance.
Non-accrual loans/leases are included in the average balance for gross loans/leases receivable in accordance with accounting and regulatory guidance.
42
Analysis of Changes of Interest Income/Interest Expense
For the Three Months Ended June 30, 2019
Inc./(Dec.)
Components
from
of Change (1)
Prior Period (1)
Rate
Volume
2019 vs. 2018
INTEREST INCOME
141
(146)
940
763
Investment securities (2)
310
85
Gross loans/leases receivable (2) (3)
12,405
2,961
9,444
Total change in interest income
13,728
3,865
9,863
INTEREST EXPENSE
4,182
2,807
1,375
3,115
1,517
(55)
(418)
1,617
(2,035)
(504)
(11)
(493)
66
Total change in interest expense
7,454
6,069
1,385
Total change in net interest income
6,274
(2,204)
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.
43
For the six months ended June 30,
12,713
2.38
19,132
1.24
169,057
2.49
52,205
1.64
652,727
12,158
3.76
648,656
11,418
3.55
21,146
5.70
21,465
4.19
3,799,645
94,795
5.03
3,048,447
70,753
4.68
109,792
83,160
80,513
67,745
77,266
63,530
(40,843)
(36,048)
250,979
139,057
4,024,189
Interest-bearing demand deposits
2,374,939
15,445
1.31
1,873,817
7,109
1,012,925
10,859
2.16
641,152
4,301
15,261
18,148
111,755
3.00
205,758
2.17
27,126
4.01
65,862
3.62
53,438
5.88
37,709
6.14
37,534
5.13
3,633,151
2,842,271
803,266
776,314
96,441
44,826
4,532,858
3,663,411
490,343
360,778
Ratio of average interest earning assets to average interest-bearing liabilities
128.13
133.34
140
(108)
Interest-bearing deposits at other financial institutions
1,666
314
1,352
740
668
72
171
(19)
Gross loans/leases receivable (2) (3) (4)
24,042
5,606
18,436
26,632
6,899
19,733
8,336
6,065
2,271
6,558
3,330
3,228
(43)
(553)
(2,159)
(643)
(977)
15,505
11,435
4,070
11,127
15,663
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.
Based on its consideration of accounting policies that involve the most complex and subjective decisions and assessments, management has identified the following as critical accounting policies:
GOODWILL
The Company records all assets and liabilities purchased in an acquisition, including intangibles, at fair value. Goodwill is not amortized but is subject, at a minimum, to annual tests for impairment. A more detailed discussion of this critical accounting policy can be found in the Company's Annual Report on Form 10‑K for the year ended December 31, 2018.
45
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. A more detailed discussion of this critical accounting policy can be found in the Company's Annual Report on Form 10‑K for the year ended December 31, 2018.
RESULTS OF OPERATIONS
Interest income increased 33%, comparing the second quarter of 2019 to the same period of 2018, and increased 32% comparing the first half of 2019 to the same period of 2018. This increase was primarily the result of the addition of SFC Bank, strong organic loan growth and loans repricing with the rising rate environment.
Overall, the Company's average earning assets increased 23%, comparing the second quarter of 2019 to the second quarter of 2018. During the same time period, average gross loans and leases increased 25%, while average investment securities decreased 1%. Average earning assets increased 23%, comparing the first half of 2019 to the same period of 2018. Average gross loans and leases increased 25% and average investment securities increased 1%, comparing the first half of 2019 to the same period of 2018. These increases were the result of the addition of SFC Bank and strong organic 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 second quarter of 2019 increased 86% from the second quarter of 2018 and increased 98%, comparing the first half of 2019 to the same period of 2018. The addition of SFC Bank primarily contributed to this increase as the Company added over $439 million in deposits. The Company has grown organically at a significant pace over the past several years and the loan growth has been funded in large 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. 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 cost of funds on the Company’s short-term wholesale 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 $1.9 million for the second quarter of 2019, which was a decrease of 16% from the same quarter of the prior year. Provision for the first six months of 2019 totaled $4.1 million, which was down 16% compared to the first six months of 2018. These decreases were primarily attributable to improved asset quality.
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 $2.8 million for the first six months of 2019, increased the Company's allowance to $41.1 million at June 30, 2019. As of June 30, 2019, the Company's allowance to total loans/leases was 1.05%, which was down from 1.07% at December 31, 2018 and down from 1.21% at June 30, 2018. Management continues to evaluate the allowance needed on acquired loans factoring in the net remaining discount ($9.3 million and $6.6 million at June 30, 2019 and June 30, 2018, respectively).
A more detailed discussion of the Company's allowance can be found in the “Financial Condition” section of this Report.
NONINTEREST INCOME
The following tables set forth the various categories of noninterest income for the three and six months ended June 30, 2019 and 2018.
Three Months Ended
$ Change
% Change
303
14.7
830
78.4
3.0
387
379.4
100.0
6,242
378.5
(100.0)
3.3
8.3
(19.2)
32.1
8,153
91.5
Six Months Ended
13.0
1,614
80.3
2.2
655
322.7
(80.4)
8,481
325.2
135
16.5
6.0
(18.7)
423
21.9
11,604
66.5
In recent years, the Company has been successful in expanding its wealth management client base. Trust department fees continue to be a significant contributor to noninterest income. Assets under management increased $198.3 million in the first six months of 2019 with 186 new client relationships. With strong growth in assets under management, trust department fees increased 15%, comparing the second quarter of 2019 to the same period of the prior year. Trust
department fees increased 13%, when comparing the first half of 2019 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 78%, comparing the second quarter of 2019 to the same period of the prior year, and they increased 80% when comparing the first half of 2019 to the first half of 2018. In October 2018, the Company acquired the Bates Companies which increased assets under management by approximately $704 million as of closing. 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, investment advisory and management fees are largely determined based on the value of the investments managed.
Deposit service fees expanded 3% comparing the second quarter of 2019 to the same period of the prior year, and expanded 2% when comparing the first half of 2019 to the same period of the prior year. 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, net, increased 379% when comparing the second quarter of 2019 to the same period of the prior year and increased 323% when comparing the first half of 2019 to the same period of the prior year. The increase was due to the addition of SFC Bank which recognized gains on sales of residential real estate of $351 thousand in the second quarter of 2019 and $635 thousand in the first half of 2019. Overall, refinancing activity has slowed, as many of the Company's existing and prospective customers have already executed a refinancing. Therefore, this area has generally become a smaller contributor to overall noninterest income.
The Company's gains on the sale of government-guaranteed portions of loans for the second quarter of 2019 increased 100% compared to the second quarter of 2018 and decreased 80% when comparing the first half of 2019 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. The Company continues to leverage its expertise by taking advantage of programs offered by the SBA and the USDA. 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. 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 interest rate environment, the Company was able to execute numerous interest rate swaps on select commercial loans, including tax credit project loans. The interest rate swaps allow 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 will continue to review opportunities to execute these swaps at all of its subsidiary banks, as the circumstances are appropriate for the borrowers 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 $7.9 million for the second quarter of 2019, compared to $1.6 million for the second quarter of 2018. Swap fee income totaled $11.1 million for the first half of 2019, compared to $2.6 million in the first half of 2018. The increase in swap fee income for the first three and six months of 2019, as compared to all prior periods, was due to both the volume and the size of the transactions executed. Future levels of swap fee income are somewhat dependent upon prevailing interest rates.
Securities losses totaled $52 thousand for the three and six months ended June 30, 2019. By comparison, there were no securities losses for the three and six months ended June 30, 2018.
Earnings on BOLI increased 3% comparing the second quarter of 2019 to the second quarter of 2018, and increased 17% comparing the first half of 2019 to the first half of 2018. There were no purchases of BOLI within the last 12 months. Notably, a portion of the Company's BOLI is variable rate whereby returns are determined by the performance of the equity market and can lead to volatility in earnings. 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 8% comparing the second quarter of 2019 to the second quarter of the prior year, and increased 6% comparing the first half of 2019 to the first half of 2018. This increase was primarily related to recent acquisitions. 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.
Correspondent banking fees decreased 19% comparing the second quarter of 2019 to the second quarter of the prior year, as well as the first half of 2019 to the first half of 2018. Management will continue to evaluate earnings credit rates and the resulting impact on deposit balances and fees while balancing the ability to grow market share. Correspondent banking continues to be a core strategy for the Company, as this line of business provides a high level of deposits that can be used to fund loan growth as well as a steady source of fee income. The Company now serves approximately 192 banks in Iowa, Illinois and Wisconsin.
Other noninterest income increased 32% comparing the second quarter of 2019 to the second quarter of the prior year, and increased 22% comparing the first half of 2019 to the first half of 2018. This increase was primarily due to loan related fee income, equity investment income and gain on disposal of leased assets.
NONINTEREST EXPENSE
The following tables set forth the various categories of noninterest expense for the three and six months ended June 30, 2019 and 2018.
6,945
43.9
12.8
9.4
(414)
543
329.1
10.2
20.0
1,252
(1,788.6)
284
37.7
9.0
1.0
101.6
428
32.3
10,190
38.6
11,846
37.3
1,029
16.6
302
5.5
(506)
677
410.3
293
18.3
(25)
(4.5)
1,418
2,287.1
376
26.0
9.3
0.2
538
88.3
728
28.9
16,761
Management places a strong emphasis on overall cost containment and is committed to improving the Company's general efficiency. One-time charges to post-acquisition transition and integration costs related to the core system conversion of SFC Bank are expected to impact expense throughout 2019.
Salaries and employee benefits, which is the largest component of noninterest expense, increased from the second quarter of 2019 to the second quarter of 2018 by 44%. This line item also increased 37% when comparing the first half of 2019 to the first half of 2018. This increase was primarily related to bonuses and commissions on elevated swap fee income, the addition of SFC Bank employees, new hires and merit increases. Over the past year, the Company has added several producers to bolster growth prospects. Further, to help support recent and expected growth, the Company has added 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 13% comparing the second quarter of 2019 to the same period of the prior year, and increased 17% comparing the first half of 2019 to the same period of the prior year. The increased expense was due to higher information technology service contract costs, increases in repairs and maintenance costs and the additions of SFC Bank and the Bates Companies.
Professional and data processing fees increased 9% comparing the first quarter of 2019 to the same period in 2018, and increased 6% comparing the first half of 2019 to the same period of the prior year. This increased expense was mostly due to recent mergers/acquisitions. Legal expense continues to be 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 until the court proceedings are completed, which the Company expects to occur in early 2020. 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.
There were no acquisition costs in the first six months of 2019. Acquisition costs totaled $414 thousand and $506 thousand for the second quarter of 2018 and first half of 2018, respectively. These costs were comprised primarily of legal, accounting and investment banking costs related to mergers/acquisitions.
Post-acquisition costs totaled $708 thousand for the second quarter of 2019 as compared to $165 thousand for the same period of the prior year. Post-acquisition costs totaled $842 thousand for the first half of 2019 as compared to $165 thousand for the same period of the prior year. These costs were comprised primarily of personnel costs, IT integration and data conversion costs related to mergers/acquisitions.
FDIC insurance, other insurance and regulatory fee expense increased 10%, comparing the second quarter of 2019 to the second quarter of 2018, and increased 18% comparing the first half of 2019 to the same period of the prior year. The increase in expense was due to the addition of SFC Bank and organic asset growth.
Loan/lease expense increased 20% when comparing the second quarter of 2019 to the same quarter of 2018, and decreased 5% comparing the first half of 2019 to the same period of 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) and gains/losses on 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 cost of (income from) and gains/losses on operations of other real estate totaled $1.2 million for the second quarter of 2019, compared to $70 thousand for the second quarter of 2018. Net cost of (income from) and gains/losses on operations of other real estate totaled $1.5 million for the first half of 2019 compared to $62 thousand for the same period of the prior year. In the second quarter of 2019, the Company wrote down an OREO property by $1 million.
Advertising and marketing expense increased 38% comparing the second quarter of 2019 to the second quarter of 2018, and increased 26% comparing the first half of 2019 to the same period of the prior year. The increase in expense was primarily due to the addition of SFC Bank.
Bank service charges, a large portion of which includes indirect costs incurred to provide services to QCBT's correspondent banking customer portfolio, increased 9% from the second quarter of 2018 to the second quarter of 2019, as well as comparing the first half of 2019 to the same period of the prior year. As transaction volumes continue to increase and the number of correspondent banking clients increases, the associated expenses will also increase.
Correspondent banking expense increased 1% when comparing the second quarter of 2019 to the second quarter of 2018 and remained flat when comparing the first half of 2019 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.
51
Intangibles amortization expense increased 102% when comparing the second quarter of 2019 to the second quarter of 2018, and increased 88% when comparing the first half of 2019 to the same period of the prior year. The increase was due to the addition of SFC Bank and the Bates Companies.
Other noninterest expense was up 32% when comparing the second quarter of 2019 to the second quarter of 2018, and increased 29% when comparing the first half of 2019 to the same period of the prior year. Included in other noninterest expense are items such as subscriptions, sales and use tax and expenses related to wealth management. A portion of this increase is related to the addition of SFC Bank.
INCOME TAXES
In the second quarter of 2019, the Company incurred income tax expense of $3.1 million. During the first half of the year, the Company incurred income tax expense of $4.5 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 six months ended June 30, 2019 and 2018.
For the Three Months Ended June 30,
For the Six Months Ended June 30,
% of
Pretax
Income
Computed "expected" tax expense
3,481
21.0
2,589
6,491
5,222
Tax exempt income, net
(1,068)
(6.5)
(956)
(7.8)
(2,175)
(7.1)
(1,899)
(7.6)
(87)
(0.5)
(84)
(0.7)
(200)
(0.6)
State income taxes, net of federal benefit, current year
772
4.7
4.5
1,421
4.6
1,109
Tax credits
(38)
(0.2)
(77)
(0.3)
True-up adjustment to year-end provision
(715)
(2.3)
Excess tax benefit on stock options exercised and restricted stock awards vested
(54)
(201)
(1.6)
(154)
(333)
(1.3)
0.3
(0.1)
18.5
15.3
14.5
15.6
The effective tax rate for the quarter ended June 30, 2019 was 18.5%, which was a 3.2% increase from the effective tax rate of 15.3% for the quarter ended June 30, 2018. The effective tax rate for the six months ended June 30, 2019 was 14.5%, which was a decrease over the effective tax rate of 15.6% for the six months ended June 30, 2018. During the first quarter of 2019 and in conjunction with the Company’s year-end tax preparation process, the Company identified a one-time true-up adjustment of $715 thousand. Excluding this, the Company’s effective tax rate was approximately 16.8% for the six months ended June 30, 2019.
FINANCIAL CONDITION
Following is a table that represents the major categories of the Company’s balance sheet.
Cash, federal funds sold, and interest-bearing deposits
293,416
292,559
245,119
120,736
Securities
655,749
657,997
Net loans/leases
3,758,268
3,077,247
388,218
360,086
348,715
250,903
4,194,220
83
3,298,276
Total borrowings
230,953
282,994
404,968
380,392
101,041
58,627
During the second quarter of 2019, the Company's total assets increased $128 million, or 3%, to a total of $5.2 billion. The Company grew its net loan/lease portfolio $111 million, which was primarily funded by an increase in core deposits. Deposits grew $128 million in the second quarter of 2019, while borrowings decreased $52 million in the second quarter of 2019.
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 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.
53
Following is a breakdown of the Company's securities portfolio by type, the percentage of unrealized gains (losses) to carrying value on the total portfolio, and the portfolio duration:
35,843
35,667
440,852
450,376
459,409
458,510
161,692
158,534
7,961
7,838
7,900
5,286
Securities as a % of Total Assets
12.39
12.94
13.39
16.02
Net Unrealized Gains (Losses) as a % of Amortized Cost
1.46
(1.58)
Duration (in years)
6.4
6.6
6.8
7.0
Yield on investment securities (tax equivalent)
3.74
Quarterly Yield on Investment Securities (GAAP)
3.20
3.18
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 increasing 19 basis points in the first half of 2019; however, excluding the tax benefit and the related variance due to the lower tax rate, the portfolio yield expanded 35 basis points.
The Company has not invested in non-agency commercial or residential 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.
LOANS/LEASES
Total loans/leases grew 11.7% on an annualized basis during the second quarter of 2019 and 9.5% year-to-date. The mix of the loan/lease types within the Company's loan/lease portfolio is presented in the following table.
C&I loans
1,479,247
1,273,000
1,790,845
1,349,319
Direct financing leases
108,543
133,196
Residential real estate loans
288,502
257,434
123,087
92,952
Total loans/leases
3,790,224
3,105,901
9,208
8,891
(41,164)
(37,545)
As CRE loans have historically been the Company's largest portfolio segment, management places a strong emphasis on monitoring the composition of the Company's CRE loan portfolio. For example, management tracks the level of owner-occupied CRE loans relative to non owner-occupied loans. Owner-occupied loans are generally considered to have less risk. As of June 30, 2019 and December 31, 2018, respectively, approximately 27% and 28% 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 $69 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 June 30, 2019 and December 31, 2018, the amount of nationally syndicated loans totaled $45.7 million and $40.8 million, respectively.
Following is a listing of significant industries within the Company's CRE loan portfolio:
As of March 31,
Lessors of Nonresidential Buildings
612,526
613,024
612,327
439,067
Lessors of Residential Buildings
394,235
355,850
346,270
230,187
Hotels
81,107
81,345
73,335
Nonresidential Property Managers
58,207
65,736
69,885
55,979
Land Subdivision
45,847
46,042
48,378
39,883
New Housing For-Sale Builders
43,520
47,276
47,598
38,392
Other *
600,958
581,810
560,308
472,476
Total CRE Loans
* “Other” consists of all other industries. None of these had concentrations greater than $36.8 million, or approximately 2.0% of total CRE loans in the most recent period presented.
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 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
46,650
43,489
40,588
35,814
Manufacturing - General
17,879
16,952
16,760
16,794
Construction - General
16,026
16,295
17,236
18,494
Food Processing Equipment
15,863
15,622
15,334
14,377
Marine - Travelifts
11,659
11,819
12,370
12,875
Trailers
9,303
9,603
9,842
10,137
Manufacturing - CNC
6,832
6,702
6,616
6,344
Computer Hardware
6,282
8,350
9,166
Crane
5,756
5,749
5,726
5,089
94,426
93,775
95,008
103,232
Total m2 loans and leases
230,676
228,356
228,646
233,297
* “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.
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See Note 3 to the Consolidated Financial Statements for additional information regarding the Company's loan and lease portfolio.
ALLOWANCE FOR ESTIMATED LOSSES ON LOANS/LEASES
Changes in the allowance for the three and six months ended June 30, 2019 and 2018 are presented as follows:
The adequacy of the allowance was determined by management based on factors that included the overall composition of the loan/lease portfolio, types of loans/leases, historical loss experience, loan/lease delinquencies, potential substandard and doubtful credits, economic conditions, collateral positions, government guarantees and other factors that, in management's judgment, deserved evaluation. To ensure that an adequate allowance was maintained, provisions were made based on a number of factors, including the increase in loans/leases and a detailed analysis of the loan/lease portfolio. The loan/lease portfolio is reviewed and analyzed quarterly with specific detailed reviews completed on all credits risk-rated less 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, 2018, and carrying aggregate exposure in excess of $250 thousand. The adequacy of the allowance is monitored by the credit administration 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 *
24,769
44,202
43,696
42,492
60,848
68,465
70,651
86,694
Criticized Loans **
Classified Loans ***
Criticized Loans as a % of Total Loans/Leases
1.56
1.80
1.89
2.79
Classified Loans as a % of Total Loans/Leases
1.16
1.37
* Amounts above include the government guaranteed portion, if any. For the calculation of allowance, the Company assigns internal risk ratings of Pass (Rating 2) for the government guaranteed portion.
** Criticized loans are defined as commercial and industrial and commercial real estate loans with internally assigned risk ratings of 6, 7, or 8, regardless of performance.
*** Classified loans are defined as commercial and industrial and commercial real estate loans with internally assigned risk ratings of 7 or 8, regardless of performance.
The Company experienced a 6% decrease in classified loans during the second quarter of 2019. Classified loans increased 43% during the first six months of 2019. The increase was due to one C&I loan relationship and one CRE loan relationship that were downgraded from a rating of special mention to substandard in the first quarter of 2019. Criticized loans
decreased 11% during the second quarter of 2019 and 14% during the first six months of 2019. The Company continues its strong focus on improving credit quality in an effort to limit NPLs.
Allowance / Gross Loans/Leases
Allowance / NPLs
283.10
238.48
214.80
270.09
Although management believes that the allowance at June 30, 2019 was at a level adequate to absorb losses on existing loans/leases, there can be no assurance that such losses will not exceed the estimated amounts or that the Company will not be required to make additional provisions in the future. Unpredictable future events could adversely affect cash flows for both commercial and individual borrowers, which could cause the Company to experience increases in problem assets, delinquencies and losses on loans/leases, and require further increases in the provision. Asset quality is a priority for the Company and its subsidiaries. The ability to grow profitably is in part dependent upon the ability to maintain that quality. The Company continually focuses efforts at its subsidiary banks and leasing company with the intention to improve the overall quality of the Company's loan/lease portfolio.
See Note 3 to the Consolidated Financial Statements for additional information regarding the Company's allowance.
NONPERFORMING ASSETS
The table below presents the amount of NPAs and related ratios.
Nonaccrual loans/leases (1) (2)
13,406
12,554
Accruing loans/leases past due 90 days or more (3)
TDRs - accruing
3,794
1,327
17,261
18,551
13,901
9,110
12,750
Other repossessed assets
Total NPAs
23,156
26,371
27,937
26,801
.
NPLs to total loans/leases
0.37
0.50
NPAs to total loans/leases plus repossessed property
0.59
0.69
0.56
Includes government guaranteed portion of loans, as applicable.
Includes TDRs of $2.8 million at June 30, 2019, $1.5 million at March 31, 2019, $2.3 million at December 31, 2018, and $1.8 million at June 30, 2018.
Includes TDRs of $0 at June 30, 2019, $0 at March 31, 2019, $496 thousand at December 31, 2018, and $0 at June 30, 2018.
NPAs at June 30, 2019 were $23.2 million, down $3.2 million from March 31, 2019 and down $3.6 million from June 30, 2018.
The ratio of NPAs to total assets was 0.45% at June 30, 2019, down from 0.52% at March 31, 2019 and down from 0.65% at June 30, 2018.
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 $128.3 million during the second quarter of 2019, primarily due to growth in correspondent bank deposits and growth in large customers’ balances. The table below presents the composition of the Company's deposit portfolio.
Noninterest bearing demand deposits
821,599
746,822
Interest bearing demand deposits
2,505,956
2,334,474
2,204,205
1,865,382
733,135
719,286
704,903
519,999
Brokered deposits
287,468
318,861
276,821
166,073
Quarter-end balances can greatly fluctuate due to large customer and correspondent bank activity.
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. With the significant success achieved by QCBT in growing its correspondent banking business, QCBT has developed procedures to proactively monitor this industry concentration of deposits and loans. Other deposit-related industy concentrations and large accounts are monitored by the internal asset liability management committees.
BORROWINGS
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
2,181
3,056
2,084
2,186
Federal funds purchased
17,010
12,830
26,690
15,400
15,886
17,586
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. The subsidiary banks can utilize FHLB advances for loan matching as a hedge against the possibility of changing interest rates and when these advances provide a less costly or more readily available source of funds than customer deposits.
The table below presents the Company's term and overnight FHLB advances.
Term FHLB advances
46,433
66,380
76,327
46,600
Overnight FHLB advances
59,300
59,800
190,165
207,500
126,180
254,100
Term FHLB advances decreased $19.9 million in the current quarter, as compared to the prior quarter due to maturities. Due to strong deposit growth, the Company did not replace these maturities. Overnight FHLB advances decreased slightly in the second quarter of 2019.
Other borrowings decreased $35.0 million in the current quarter. The Company prepaid two wholesale structured repurchase agreements in the second quarter of 2019 using excess funds generated by strong deposit growth. The first wholesale structured repurchase agreement totaled $5.0 million and had original maturity date of March 13, 2020 with an interest rate of 2.58%. The second wholesale structured repurchase agreement totaled $20.0 million and had an original maturity of June 13, 2020 with an interest rate of 2.46%. In addition, wholesale structured repurchase agreements totaling $10.0 million matured in the second quarter of 2019 with an interest rate of 3.59%. The wholesale structured repurchase agreements were utilized as an alternative funding source to FHLB advances and customer deposits. Wholesale structured repurchase agreements were collateralized by certain U.S. government agency securities and residential mortgage backed and related securities.
The Company had subordinated notes totaling $68.3 million as of June 30, 2019, $68.2 million as of March 31, 2019 and $4.8 million as of December 31, 2018. There were no outstanding subordinated notes as of June 30, 2018. See Note 5 to the Company’s Consolidated Financial Statements for additional information regarding our subordinated notes, including the repayment of our term notes (totaling $21.3 million) and our revolving line of credit (totaling $9.0 million) during the first quarter of 2019.
The Company renewed its revolving credit note in the second quarter of 2019. See Note 5 to the Consolidated Financial Statements for additional details regarding this renewal.
It is management's intention to reduce its reliance on wholesale funding, including FHLB advances, wholesale structured repurchase agreements, 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 (defined as FHLB advances, brokered deposits and wholesale structured repurchase agreements).
Weighted
Maturity:
Amount Due
Interest Rate
Year ending December 31:
315,799
510,736
2.35
2020
58,382
2.23
48,557
2.31
2021
15,050
2022
3,970
2.00
Total Wholesale Funding
393,201
578,313
During the first six months of 2019, wholesale funding decreased $185.1 million. FHLB overnight advances and term advances decreased $130.9 million and $29.9 million in the first half of 2019, respectively. Brokered deposits increased $10.6 million in the first half of 2019 as some of the banks rotated from overnight advances to short-term brokered deposits, as the latter was cheaper. Wholesale structured repurchase agreements decreased $35.0 million in the first half of 2019 with $25.0 million of prepayments (with original maturities in 2020) and a $10.0 million maturity.
STOCKHOLDERS' EQUITY
The table below presents the composition of the Company's stockholders' equity.
Common stock
Additional paid in capital
AOCI (loss)
TCE / TA ratio (non-GAAP)
7.78
* 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 $274.7 million during the second quarter of 2019 and $159.7 million during the full year of 2018. 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
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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.
At June 30, 2019, the subsidiary banks had 34 lines of credit totaling $373.0 million, of which $1.7 million was secured and $371.3 million was unsecured. At June 30, 2019, the full $373.0 million was available.
At December 31, 2018, the subsidiary banks had 33 lines of credit totaling $363.7 million, of which $1.7 million was secured and $362.0 million was unsecured. At December 31, 2018, $343.7 million of the $363.7 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 $20.0 million secured revolving credit note with a variable interest rate and a maturity of June 30, 2020. At June 30, 2019, the full $20.0 million was available.
As of June 30, 2019, the Company had $479.0 million in average correspondent banking deposits spread over 192 relationships. While the Company believes that these funds are relatively stable, there is the potential for large fluctuations that can impact liquidity. Seasonality and the liquidity needs of these correspondent banks can impact balances. Management closely monitors these fluctuations and runs stress scenarios to measure the impact on liquidity and interest rate risk with various levels of correspondent deposit run-off.
Investing activities used cash of $197.1 million during the first six months of 2019, compared to $137.9 million for the same period of 2018. The net decrease in federal funds sold was $16.2 million for the first six months of 2019, compared to a net decrease of $19.3 million for the same period of 2018. The net increase in interest-bearing deposits at financial institutions was $62.1 million for the first six months of 2019, compared to a net decrease of $15.0 million for the same period of 2018. Proceeds from calls, maturities, and paydowns of securities were $33.0 million for the first six months of 2019, compared to $39.8 million for the same period of 2018. Purchases of securities used cash of $10.7 million for the first six months of 2019, compared to $55.0 million for the same period of 2018. Proceeds from sales of securities were $4.7 million for the first six months of 2019, compared to no proceeds from sales of securities for the first six months of 2018. The net increase in loans/leases used cash of $176.4 million for the first six months of 2019 compared to $151.0 million for the same period of 2018.
Financing activities provided cash of $170.2 million for the first six months of 2019, compared to $101.9 million for same period of 2018. Net increases in deposits totaled $345.6 million for the first six months of 2019, compared to $31.7 million for the same period of 2018. During the first six months of 2019, the Company's short-term borrowings decreased $9.6 million, compared to an increase of $3.6 million for the same period of 2018. In the first six months of 2019, the Company decreased short-term and overnight FHLB advances by $130.9 million. Maturities and principal payments on FHLB term advances totaled $35.0 million and on other borrowings totaled $11.9 million in the first six months of 2019. Prepayments on other borrowings totaled $46.3 million in the first six months of 2019. During the first six months of 2019, proceeds from subordinated notes were $63.4 million. In the first six months of 2018, the Company increased short-term and overnight FHLB advances by $72.1 million and increased other borrowings by $9.0 million. Maturities and principal payments on borrowings totaled $13.9 million in the first six months of 2018.
Total cash provided by operating activities was $29.3 million for the first six months of 2019, compared to $29.4 million for the same period of 2018.
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 and, most recently, subordinated notes.
The following table presents the details of the trust preferred securities outstanding as of June 30, 2019 and December 31, 2018.
Outstanding
Interest Rate as of
Name
Date Issued
February 2004
10,310
2.85% over 3-month LIBOR
5.65
8,248
February 2006
1.55% over 3-month LIBOR
3.99
September 2004
3,093
2.17% over 3-month LIBOR
4.96
March 2007
3,609
1.75% over 3-month LIBOR
4.54
May 2005
4,640
40,210
Weighted Average Rate
4.94
As described in Note 4 to the Consolidated Financial Statements, on June 21, 2018 the Company entered into interest rate swaps to hedge against the risk of rising rates on its variable rate trust preferred securities. The floating rate trust preferred securities are tied to 3-month LIBOR, and the interest rate swaps utilize 3-month LIBOR, so the hedge is effective. The interest rate swaps are designated as a cash flow hedge in accordance with ASC 815. See Note 4 for the notional amount swapped and the related effective fixed rates.
The Company (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.
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, 2018.
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, no balance sheet mix change, and various interest rate scenarios including no change in rates; 100, 200, 300, and 400 basis point upward shifts; and a 100 and 200 basis point downward shifts 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 and 200 basis point downward shifts. 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.
Further, in recent years, the Company added additional interest rate scenarios where interest rates experience a parallel and instantaneous shift (“shock”) upward of 100, 200, 300, and 400 basis points and a parallel and instantaneous shock 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 is a 25% decline in net interest income. The increased policy limit is appropriate as the shock scenario is extreme and unlikely and warrants a higher limit than the more realistic and traditional parallel/pro-rata shift scenarios.
Application of the simulation model analysis for select interest rate scenarios at the most recent quarter-end available is presented in the following table:
NET INTEREST INCOME EXPOSURE in YEAR 1
INTEREST RATE SCENARIO
POLICY LIMIT
2017
100 basis point downward shift
(10.0)
0.7
200 basis point upward shift
(2.7)
(3.7)
300 basis point upward shock
(25.0)
(6.4)
(9.0)
(8.4)
The simulation is well within the board-established policy limits for all three scenarios. Additionally, for all of the various interest rate scenarios modeled and measured by management (as described above), the results at June 30, 2019 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).
Interest rate risk is considered to be one of the most significant market risks affecting the Company. For that reason, the Company engages the assistance of a national consulting firm and its risk management system to monitor and control the Company's interest rate risk exposure. Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company's business activities.
CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures. An evaluation was performed under the supervision and with the participation of the Company's management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rule 13a‑15(e) and 15d‑15(e) promulgated under the Exchange Act of 1934) as of June 30, 2019. Based on that evaluation, the Company's management, including the Chief Executive Officer and Chief Financial Officer, concluded that the Company's disclosure controls and procedures were effective, as of the end of the period covered by this report, to ensure that information required to be disclosed in the reports filed and submitted under the Exchange Act was recorded, processed, summarized and reported as and when required.
Changes in Internal Control over Financial Reporting. There have been no significant changes to the Company's internal control over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1 Legal Proceedings
There are no material pending legal proceedings to which the Company or any of its subsidiaries is a party other than ordinary routine litigation incidental to their respective businesses.
Item 1A Risk Factors
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, 2018. 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.
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds
None
Item 3 Defaults Upon Senior Securities
Item 4 Mine Safety Disclosures
Not applicable
Item 5 Other Information
Item 6 Exhibits
31.1
Certification of Chief Executive Officer Pursuant to Rule 13a‑14(a)/15d‑14(a).
31.2
Certification of Chief Financial Officer Pursuant to Rule 13a‑14(a)/15d‑14(a).
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 June 30, 2019 and December 31, 2018; (ii) Consolidated Statements of Income for the three and six months ended June 30, 2019 and June 30, 2018; (iii) Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2019 and June 30, 2018; (iv) Consolidated Statements of Changes in Stockholders' Equity for the three and six months ended June 30, 2019 and June 30, 2018; (v) Consolidated Statements of Cash Flows for the six months ended June 30, 2019 and June 30, 2018; and (vi) Notes to the Consolidated Financial Statements.
SIGNATURES
Pursuant to the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
(Registrant)
Date
August 6, 2019
/s/ Larry J. Helling
Larry J. Helling
Chief Executive Officer
/s/ Todd A. Gipple
Todd A. Gipple, President
Chief Operating Officer
Chief Financial Officer
/s/ Elizabeth A. Grabin
Elizabeth A. Grabin, Senior Vice President
Chief Accounting Officer
(Principal Accounting Officer)
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