Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2020
☐ 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)
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 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 ☒ 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 ☒
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 ☒
Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date: As of November 1, 2020, the Registrant had outstanding 15,793,357 shares of common stock, $1.00 par value per share.
1
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 September 30, 2020 and December 31, 2019
4
Consolidated Statements of Income For the Three Months Ended September 30, 2020 and 2019
5
Consolidated Statements of Income
For the Nine Months Ended September 30, 2020 and 2019
6
Consolidated Statements of Comprehensive Income For the Three and Nine Months Ended September 30, 2020 and 2019
7
Consolidated Statements of Changes in Stockholders' Equity For the Three and Nine Months Ended September 30, 2020 and 2019
8
Consolidated Statements of Cash Flows For the Nine Months Ended September 30, 2020 and 2019
10
Notes to Consolidated Financial Statements
12
Note 1. Summary of Significant Accounting Policies
Note 2. Investment Securities
14
Note 3. Loans/Leases Receivable
18
Note 4. Derivatives and Hedging Activities
29
Note 5. Subordinated Notes
31
Note 6. Earnings Per Share
32
Note 7. Fair Value
34
Note 8. Business Segment Information
35
Note 9. Regulatory Capital Requirements
Note 10. Sale of Subsidiary
37
Item 2
Management's Discussion and Analysis of Financial Condition and Results of Operations
Introduction
38
General
Impact of COVID-19
Executive Overview
42
Strategic Financial Metrics
44
Strategic Developments
GAAP to Non-GAAP Reconciliations
45
Net Interest Income - (Tax Equivalent Basis)
48
Critical Accounting Policies
52
Goodwill
Allowance for Loan and Lease Losses
53
2
Results of Operations
Interest Income
Interest Expense
Provision for Loan/Lease Losses
54
Noninterest Income
55
Noninterest Expense
58
Income Taxes
60
Financial Condition
61
Investment Securities
Loans/Leases
62
Allowance for Estimated Losses on Loans/Leases
64
Nonperforming Assets
65
Deposits
66
Borrowings
67
Stockholders' Equity
68
Liquidity and Capital Resources
69
Special Note Concerning Forward-Looking Statements
70
Item 3
Quantitative and Qualitative Disclosures About Market Risk
72
Item 4
Controls and Procedures
74
Part II
OTHER INFORMATION
75
Legal Proceedings
Item 1A
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
79
Defaults Upon Senior Securities
Mine Safety Disclosures
Item 5
Other Information
Item 6
Exhibits
80
Signatures
81
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 September 30, 2020 and December 31, 2019
September 30,
December 31,
2020
2019
(dollars in thousands)
Assets
Cash and due from banks
$
68,932
76,254
Federal funds sold
530
9,800
Interest-bearing deposits at financial institutions
302,138
147,891
Securities held to maturity, at amortized cost
434,892
400,646
Securities available for sale, at fair value
347,196
210,695
Total securities
782,088
611,341
Loans receivable held for sale
8,811
3,673
Loans/leases receivable held for investment
4,239,166
3,686,532
Gross loans/leases receivable
4,247,977
3,690,205
Less allowance for estimated losses on loans/leases
(79,582)
(36,001)
Net loans/leases receivable
4,168,395
3,654,204
Bank-owned life insurance
60,126
58,834
Premises and equipment, net
72,001
73,859
Restricted investment securities
19,009
23,252
Other real estate owned, net
125
4,129
74,066
74,748
Intangibles
11,902
14,970
Derivatives
236,381
87,827
Assets held for sale
—
11,966
Other assets
68,867
59,975
Total assets
5,864,560
4,909,050
Liabilities and Stockholders' Equity
Liabilities:
Deposits:
Noninterest-bearing
1,175,085
777,224
Interest-bearing
3,497,183
3,133,827
Total deposits
4,672,268
3,911,051
Short-term borrowings
30,430
13,423
Federal Home Loan Bank advances
40,000
159,300
Subordinated notes
118,577
68,394
Junior subordinated debentures
37,955
37,838
244,510
88,437
Liabilities held for sale
5,003
Other liabilities
148,207
90,253
Total liabilities
5,291,947
4,373,699
Stockholders' Equity:
Preferred stock, $1 par value; shares authorized 250,000 September 2020 and December 2019 - no shares issued or outstanding
Common stock, $1 par value; shares authorized 20,000,000 September 2020 - 15,792,357 shares issued and outstanding December 2019 - 15,828,098 shares issued and outstanding
15,792
15,828
Additional paid-in capital
275,122
274,785
Retained earnings
283,480
245,836
Accumulated other comprehensive income (loss):
Securities available for sale
7,817
2,817
(9,598)
(3,915)
Total stockholders' equity
572,613
535,351
Total liabilities and stockholders' equity
See Notes to Consolidated Financial Statements (Unaudited)
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three Months Ended September 30, 2020 and 2019
(dollars in thousands, except share data)
Interest and dividend income:
Loans/leases, including fees
44,768
50,406
Securities:
Taxable
1,938
1,682
Nontaxable
3,842
3,443
92
951
249
293
Total interest and dividend income
50,890
56,817
Interest expense:
4,484
13,394
11
97
211
1,023
1,031
1,003
572
581
Total interest expense
6,309
16,098
Net interest income
44,581
40,719
Provision for loan/lease losses
20,342
2,012
Net interest income after provision for loan/lease losses
24,239
38,707
Noninterest income:
Trust department fees
2,280
2,340
Investment advisory and management fees
1,266
1,782
Deposit service fees
1,403
1,813
Gains on sales of residential real estate loans, net
1,370
890
Gains on sales of government guaranteed portions of loans, net
519
Swap fee income
26,688
9,797
Securities gains (losses), net
1,802
(3)
Earnings on bank-owned life insurance
502
489
Debit card fees
946
886
Correspondent banking fees
220
189
Other
1,482
1,204
Total noninterest income
37,959
19,906
Noninterest expense:
Salaries and employee benefits
25,999
24,215
Occupancy and equipment expense
3,807
3,860
Professional and data processing fees
3,758
4,030
Post-acquisition compensation, transition and integration costs
884
Disposition costs
192
FDIC insurance, other insurance and regulatory fees
1,301
542
Loan/lease expense
403
221
Net cost of (income from) and gains/losses on operations of other real estate
16
2,078
Advertising and marketing
750
1,056
Bank service charges
488
Losses on liability extinguishment
1,874
148
Correspondent banking expense
205
209
Intangibles amortization
531
560
Loss on sale of subsidiary
305
1,209
1,640
Total noninterest expense
40,838
39,945
Net income before income taxes
21,360
18,668
Federal and state income tax expense
4,016
3,573
Net income
17,344
15,095
Basic earnings per common share
1.10
0.96
Diluted earnings per common share
1.09
0.94
Weighted average common shares outstanding
15,767,152
15,739,430
Weighted average common and common equivalent shares outstanding
15,923,578
15,976,742
Cash dividends declared per common share
0.06
Nine Months Ended September 30, 2020 and 2019
130,542
143,488
5,714
5,026
10,865
10,461
587
3,042
795
891
19
191
148,522
163,099
19,457
39,697
275
1,007
2,685
Other borrowings
512
3,019
2,561
1,715
1,729
25,279
47,459
123,243
115,640
48,624
6,087
74,619
109,553
6,819
7,194
4,392
5,406
4,166
5,025
3,218
1,748
589
53,419
20,886
1,867
(56)
1,443
1,441
2,479
2,591
633
578
3,345
3,562
81,781
48,964
Noninterest expenses:
65,822
67,843
11,587
11,087
10,773
9,811
1,727
626
2,892
2,432
970
748
(303)
3,557
1,984
2,878
1,493
1,494
2,450
619
1,628
1,706
Goodwill impairment
500
4,891
Total noninterest expenses
105,391
108,941
51,009
49,576
8,698
8,059
42,311
41,517
2.68
2.64
2.65
2.60
15,770,335
15,715,788
15,945,832
15,946,020
0.18
See Notes to Consolidated Financial Statements (Unaudited
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
Three and Nine Months Ended September 30, 2020 and 2019
Three Months Ended September 30,
Other comprehensive income (loss):
Unrealized gains (losses) on securities available for sale:
Unrealized holding gains arising during the period before tax
585
1,827
Less reclassification adjustment for gains (losses) included in net income before tax
(1,217)
1,830
Unrealized gains (losses) on derivatives:
Unrealized holding losses arising during the period before tax
445
(1,159)
Less reclassification adjustment for caplet amortization before tax
(149)
296
Unrealized gains (losses) on assets held for sale:
Unrealized holding gains (losses) arising during the period before tax on securities held for sale
Unrealized holding losses arising during the period before tax on derivatives held for sale
(31)
(80)
Other comprehensive income (loss), before tax
(921)
768
Tax expense
(307)
224
Other comprehensive income (loss), net of tax
(614)
544
Comprehensive income
16,730
15,639
Nine Months Ended September 30,
Unrealized gains on securities available for sale:
8,467
10,639
6,600
10,695
Unrealized losses on derivatives:
(7,903)
(4,101)
Less reclassification adjustment for ineffectiveness and caplet amortization before tax
(384)
(291)
(7,519)
(3,810)
(919)
6,982
(236)
1,852
(683)
5,130
41,628
46,647
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED)
Accumulated
Additional
Common
Paid-In
Retained
Comprehensive
Stock
Capital
Earnings
(Loss)
Total
Balance December 31, 2019
(1,098)
11,228
Other comprehensive loss, net of tax
(3,691)
Common cash dividends declared, $0.06 per share
(942)
Repurchase and cancellation of 100,932 shares of common stock
as a result of a share repurchase program
(101)
(1,844)
(1,835)
(3,780)
Issuance of 5,553 shares of common stock as a result of
stock purchased under the Employee Stock Purchase Plan
208
214
Issuance of 31,729 shares of common stock as a result of
stock options exercised
274
306
Stock-based compensation expense
641
Restricted stock awards and restricted stock units- 10,300 shares
of common stock , net of restricted stock units
withheld for payment for taxes
(8)
Exchange of 1,012 shares of common stock in connection
with payroll taxes for restricted stock and in connection
with stock options exercised
(1)
(189)
(190)
Balance, March 31, 2020
15,774
273,867
254,287
(4,789)
539,139
13,739
Other comprehensive income, net of tax
3,622
(945)
Issuance of 16,413 shares of common stock as a result of
462
478
Issuance of 975 shares of common stock as a result of
9
423
Exchange of 513 shares of common stock in connection
with payroll taxes for restricted stock vested and in
connection with stock options exercised
(446)
Balance, June 30, 2020
15,791
274,315
267,081
(1,167)
556,020
Issuance of 6,310 shares of common stock as a result of
161
167
Issuance of 1,123 shares of common stock as a result of
23
24
472
Exchange of 5,687 shares of common stock in connection
(6)
151
145
Balance, September 30, 2020
(1,781)
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED) - continued
Balance December 31, 2018
15,718
270,761
192,203
(5,544)
473,138
12,918
2,344
Issuance of 4,446 shares of common stock as a result of
124
128
Issuance of 25,238 shares of common stock as a result of
25
263
288
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
(5)
(147)
(152)
Balance, March 31, 2019
15,755
271,673
204,179
(3,200)
488,407
13,504
2,242
Issuance of 11,346 shares of common stock as a result of
323
334
Issuance of 2,414 shares of common stock as a result of
41
719
Restricted stock awards and restricted stock units- 4,769
Exchange of 1,032 shares of common stock in connection
(7)
Balance, June 30, 2019
15,773
272,744
216,741
(958)
504,300
(944)
Issuance of 5,674 shares of common stock as a result of
187
193
Issuance of 12,438 shares of common stock as a result of
144
156
428
Exchange of 589 shares of common stock in connection
(28)
(29)
Balance, September 30, 2019
15,790
273,475
230,892
(414)
519,743
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
CASH FLOWS FROM OPERATING ACTIVITIES
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation
4,006
3,889
1,536
1,869
Deferred compensation expense accrued
2,660
2,087
Losses (gains) on other real estate owned, net
(298)
3,205
Amortization of premiums on securities, net
728
1,339
Caplet amortization
383
Securities (gains) losses, net
(1,867)
56
Loans originated for sale
(172,282)
(104,824)
Proceeds on sales of loans
170,362
97,916
Gains on sales of residential real estate loans
(3,218)
(1,748)
Gains on sales of government guaranteed portions of loans
(589)
Loss on liability extinguishment, net
Gains on sales of premises and equipment
(13)
(67)
Amortization of intangibles
Accretion of acquisition fair value adjustments, net
(2,194)
(3,413)
Increase in cash value of bank-owned life insurance
(1,443)
(1,441)
Increase in other assets
(8,351)
(1,953)
Decrease in other liabilities
43,489
336
Net cash provided by operating activities
129,316
46,120
CASH FLOWS FROM INVESTING ACTIVITIES
Net decrease in federal funds sold
9,270
17,098
Net increase in interest-bearing deposits at financial institutions
(154,247)
(57,180)
Proceeds from sales of other real estate owned
4,353
840
Activity in securities portfolio:
Purchases
(255,500)
(28,119)
Calls, maturities and redemptions
38,461
9,074
Paydowns
33,870
36,649
Sales
28,579
33,128
Activity in restricted investment securities:
(4,600)
(5,682)
Redemptions
8,843
5,006
Proceeds from the liquidation of bank-owned life insurance
10,999
Net increase in loans/leases originated and held for investment
(555,315)
(237,286)
Purchase of premises and equipment
(2,250)
(8,755)
Proceeds from sales of premises and equipment
94
146
Net cash transfered in sale of subsidiary
(349)
Net cash (used in) investing activities
(837,792)
(235,081)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposit accounts
731,374
276,960
Net increase (decrease) in short-term borrowings
17,007
(9,091)
Activity in Federal Home Loan Bank advances:
Term advances
125,000
25,000
Calls and maturities
(81,600)
(35,000)
Net change in short-term and overnight advances
(109,300)
(15,965)
Prepayments
(55,274)
(30,228)
Activity in other borrowings:
Calls, maturities and scheduled principal payments
(11,937)
(46,313)
Paydown of revolving line of credit
(9,000)
Prepayments on brokered and public time deposits
29,359
Proceeds from subordinated notes
50,000
63,393
Payment of cash dividends on common stock
(2,831)
(2,822)
Proceeds from issuance of common stock, net
1,199
1,143
Repurchase and cancellation of shares
Net cash provided by financing activities
701,154
206,140
Net increase (decrease) in cash and due from banks
(7,322)
17,179
Cash and due from banks, beginning
85,523
Cash and due from banks, ending
102,702
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) - continued
Supplemental disclosure of cash flow information, cash payments (receipts) for:
Interest
26,920
45,826
Income/franchise taxes
16,713
(769)
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
(491)
Transfers of loans to other real estate owned
51
1,049
Due to broker for purchases of securities
8,550
Increase in the fair value of back-to-back interest rate swap assets and liabilities
151,398
80,760
Dividends payable
945
944
Consideration received on sale of the Bates Companies
1,328
Supplemental disclosure of cash flow information for sale of the Bates Companies
Assets Sold:
349
2,211
Total assets sold
2,579
Liabilities Sold:
Total liabilities sold
Net assets sold
1,633
Forgiveness of earn-out consideration
880
Note receivable consideration
448
Loss on sale of the Bates Companies
(305)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
September 30, 2020
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, 2019, included in the Company's Annual Report on Form 10-K filed with the SEC on March 13, 2020. Accordingly, footnote disclosures, which would substantially duplicate the disclosures contained in the audited Consolidated Financial Statements, have been omitted.
The financial information of the Company included herein has been prepared in accordance with GAAP for interim financial reporting and has been prepared pursuant to the rules and regulations for reporting on Form 10-Q and Rule 10-01 of Regulation S-X. Such information reflects all adjustments (consisting of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the periods presented. Any differences appearing between the numbers presented in financial statements and management's discussion and analysis are due to rounding. The results of the interim period ended September 30, 2020 are not necessarily indicative of the results expected for the year ending December 31, 2020, 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
AOCI: Accumulated other comprehensive income (loss)
AFS: Available for sale
HTM: Held to maturity
ASC: Accounting Standards Codification
LRP: Loan Relief Program
ASU: Accounting Standards Update
m2: m2 Lease Funds, LLC
Bates Companies: Bates Financial Advisors, Inc., Bates
MSELF: Main Street Expanded Loan Facility
Financial Services, Inc., Bates Securities, Inc. and
MSNLF: Main Street New Loan Facility
Bates Financial Group, Inc.
NIM: Net interest margin
BOLI: Bank-owned life insurance
NPA: Nonperforming asset
Caps: Interest rate cap derivatives
NPL: Nonperforming loan
CARES Act: Coronavirus Aid, Relief and Economy
OREO: Other real estate owned
Security Act
OTTI: Other-than-temporary impairment
CDI: Core deposit intangible
PCI: Purchased credit impaired
CECL: Current Expected Credit Losses
PPP: Paycheck Protection Program
Community National: Community National Bancorporation
Provision: Provision for loan/lease losses
COVID-19: Coronavirus Disease 2019
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
SFCB: 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
The Consolidated Financial Statements include the accounts of the Company and its wholly-owned subsidiaries which include the accounts of four commercial banks: QCBT, CRBT, CSB and SFCB. All are state-chartered commercial banks and all are members of the Federal Reserve system. The Company engages in direct financing lease contracts through m2, a wholly-owned subsidiary of QCBT. All material intercompany transactions and balances have been eliminated in consolidation.
On November 30, 2019, the Company sold substantially all of the assets and transferred substantially all of the deposits and certain other liabilities of the Company’s wholly-owned subsidiary, RB&T. The financial results of RB&T prior to its sale are included in this report. See Note 2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 for additional information about the sale.
On August 12, 2020, the Company sold of all the issued and outstanding capital stock of the Bates Companies, wholly-owned subsidiaries of the Company. See Note 10 to the Consolidated Financial Statements for additional information about the sale.
Recent accounting developments: In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses. Under the standard, assets measured at amortized cost (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 became effective for fiscal years beginning after December 15, 2019, including items periods within those fiscal years. On March 27, 2020, the CARES Act, a stimulus package designed in response to the economic disruption created by COVID-19, was signed into law. The CARES Act includes provisions that, if elected, temporarily delay the required implementation date of ASU 2016-13. Section 4014 of the CARES Act stipulates that no insured depository institution, bank holding company, or affiliate will be required to comply with ASU 2016-13, beginning on the date of CARES Act’s enactment and continuing until the earlier of: (1) the date on which the national emergency related to the COVID-19 outbreak is terminated or (2) December 31, 2020. The Company has elected to defer its implementation of ASU 2016-13 as allowed by the CARES Act. The Company has developed a CECL allowance model which calculates allowances over the life of a loan and is largely driven by portfolio characteristics, risk-grading, economic outlook, and other key methodology assumptions. Those assumptions are based upon the existing probability of default and loss given default framework. The Company will utilize economic and other forecasts over a four quarter reasonable and supportable forecast period and then fully revert back to average historical losses. The Company’s credit administration team will periodically refine the model as needed and is running parallel calculations. The Company anticipates increases in the allowance for credit losses on longer dated portfolios and decreases in the shorter dated portfolios. The Company estimates an increase in the allowance for estimated losses on loans/leases in the range of $3 million to $8 million upon adoption of CECL at both January 1, 2020 and September 30, 2020. The Company continues to work on the process of finalizing the review of the most recent model run and of finalizing certain assumptions, including qualitative adjustments and economic forecasts, which have resulted in adjustments to previous estimates.
Risks and Uncertainties: On January 30, 2020, the World Health Organization declared the COVID-19 outbreak a “Public Health Emergency of International Concern” and on March 11, 2020, declared it to be a pandemic. Actions taken around the world to help mitigate the spread of COVID-19 include restrictions on travel, quarantines in certain areas, and forced closures for certain types of public places and businesses. COVID-19 and actions taken to mitigate the spread of it have had and are expected to continue to have an adverse impact on the economies and financial markets of many countries, including the geographical area in which the Company operates. On March 27, 2020, the CARES Act was enacted to, among other things, provide emergency assistance for individuals, families and businesses affected by the COVID-19 pandemic. The Company currently expects that the COVID-19 pandemic will have a significant impact on its business. In particular, the Company anticipates that a significant portion of the subsidiary banks’ borrowers in the hotel, restaurant, arts/entertainment/recreation and retail industries will continue to endure significant economic distress, and some borrowers’ ability and willingness to repay existing indebtedness have been adversely impacted. Therefore, the value of certain collateral pledged to the banks have been adversely impacted. These developments, together with economic conditions generally, have impacted and are expected to continue to impact the Company’s commercial real estate portfolio, particularly with respect to real estate with exposure to these industries, the Company’s equipment leasing business and loan portfolio, the Company’s consumer loan business and loan portfolio, and the value of certain collateral
securing the Company’s loans. As a result, the Company anticipates that its asset quality and results of operations have been adversely affected, as described in further detail in this report.
In light of the economic impact that COVID-19 has had on the Company, management concluded that factors such as the decline in macroeconomic conditions led to the occurrence of a triggering event during the first quarter of 2020. Therefore an interim impairment test over goodwill was performed as of March 31, 2020. When such an assessment is performed, if the Company conclude that all or a portion of goodwill is impaired, a non-cash charge for the amount of such impairment would be recorded to earnings. Such a charge would have no impact on tangible capital or regulatory capital. Based upon the results of the interim goodwill assessment during the first quarter of 2020, the Company concluded that an impairment did not exist on the bank reporting units as of the time of the assessment. There was no occurrence of a triggering event during the second or third quarter of 2020; therefore no impairment test over goodwill was required.
NOTE 2– INVESTMENT SECURITIES
The amortized cost and fair value of investment securities as of September 30, 2020 and December 31, 2019 are summarized as follows:
Gross
Amortized
Unrealized
Fair
Cost
Gains
(Losses)
Value
September 30, 2020:
Securities HTM:
Municipal securities
433,842
26,292
(984)
459,150
Other securities
1,050
(985)
460,199
Securities AFS:
U.S. govt. sponsored agency securities
17,791
667
(21)
18,437
Residential mortgage-backed and related securities
128,281
6,158
(292)
134,147
132,545
3,497
(809)
135,233
Asset-backed securities
39,696
1,108
(139)
40,665
18,550
164
18,714
336,863
11,594
(1,261)
December 31, 2019:
399,596
26,042
(143)
425,495
426,545
19,872
283
(77)
20,078
118,724
2,045
(182)
120,587
46,659
1,602
(4)
48,257
16,958
(71)
16,887
4,749
138
4,886
206,962
4,068
(335)
The Company's HTM municipal securities consist largely of private issues of municipal debt. The large majority of the municipalities are located within the Midwest. The municipal debt investments are underwritten using specific guidelines with ongoing monitoring.
The Company's residential mortgage-backed and related securities portfolio consists entirely of government sponsored or government guaranteed securities. The Company has not invested in private mortgage-backed securities or pooled trust preferred securities.
Gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of September 30, 2020 and December 31, 2019, are summarized as follows:
Less than 12 Months
12 Months or More
Losses
33,252
34,301
3,243
31,124
27,277
16,796
78,440
509
10,047
(142)
10,556
550
1,059
11,106
1,431
2,117
3,548
2,263
(17)
17,862
(165)
20,125
724
16,886
20,829
(110)
20,703
(225)
41,532
At September 30, 2020, the investment portfolio included 647 securities. Of this number, 73 securities were in an unrealized loss position. The aggregate losses of these securities totaled approximately 0.3% of the total amortized cost of the portfolio. Of these 73 securities, there were no securities that had an unrealized loss for twelve months or more. Asset-backed securities are comprised of collateralized loan obligations, which are debt securities backed by pools of senior secured commercial loans to a diverse group of companies across a broad spectrum of industries. At September 30, 2020, the Company only owned collateralized loan obligations that were AAA rated. All of the debt securities in unrealized loss positions are considered acceptable credit risks. Based upon an evaluation of the available evidence, including the recent changes in market rates, credit rating information and information obtained from regulatory filings, management believes the declines in fair value for these debt securities are temporary. In addition, the Company lacks the intent to sell these securities and it is not more-likely-than-not that the Company will be required to sell these debt securities before their anticipated recovery.
The Company did not recognize OTTI on any investment securities for the three or nine months ended September 30, 2020 and 2019.
15
All sales of securities for the three and nine months ended September 30, 2020 and 2019 were securities identified as AFS.
Three Months Ended
Nine Months Ended
September 30, 2019
Proceeds from sales of securities
22,252
23,364
28,025
Gross gains from sales of securities
143
1,936
150
Gross losses from sales of securities
(146)
(69)
(206)
The amortized cost and fair value of securities as of September 30, 2020 by contractual maturity are shown below. Expected maturities of residential mortgage-backed and related securities and asset-backed securities may differ from contractual maturities because the residential mortgages underlying the 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
3,509
3,525
Due after one year through five years
32,354
32,909
Due after five years
399,029
423,765
7,795
7,810
14,010
14,423
147,081
150,151
168,886
172,384
Portions of the U.S. government sponsored agency securities, municipal securities and other securities contain call options, which, at the discretion of the issuer, terminate the security at par and at predetermined dates prior to the stated maturity. These callable securities are summarized as follows:
204
203
118,030
120,371
4,500
4,664
122,530
125,035
As of September 30, 2020, the Company's municipal securities portfolios were comprised of general obligation bonds issued by 114 issuers with fair values totaling $110.3 million and revenue bonds issued by 182 issuers, primarily consisting of states, counties, towns, villages and school districts with fair values totaling $484.1 million. The Company also held investments in general obligation bonds in 21 states, including nine states in which the aggregate fair value exceeded $5.0 million, and in revenue bonds in 24 states, including 13 states in which the aggregate fair value exceeded $5.0 million.
As of December 31, 2019, the Company's municipal securities portfolios were comprised of general obligation bonds issued by 93 issuers with fair values totaling $77.2 million and revenue bonds issued by 154 issuers, primarily consisting of states, counties, towns, villages and school districts with fair values totaling $396.6 million. The Company also held investments in general obligation bonds in 22 states, including six states in which the aggregate fair value exceeded $5.0 million, and in revenue bonds in 17 states, including nine states in which the aggregate fair value exceeded $5.0 million.
Both general obligation and revenue bonds are diversified across many issuers. As of September 30, 2020 the Company did not hold any revenue bonds of one single issuer of which the aggregate book or market value exceeded 5% of the Company’s stockholders’ equity. As of December 31, 2019, 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 the four charters, whose investment policies set forth limits for various subcategories within the municipal securities portfolio. The investments of each charter are monitored individually, and as of September 30, 2020, all were within policy limitations approved by the board of directors. Policy limits are calculated as a percentage of each charter's total risk-based capital.
As of September 30, 2020, 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.
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NOTE 3 – LOANS/LEASES RECEIVABLE
The composition of the loan/lease portfolio as of September 30, 2020 and December 31, 2019 is presented as follows:
C&I loans*
1,823,049
1,507,825
CRE loans
Owner-occupied CRE
486,254
443,989
Commercial construction, land development, and other land
503,086
378,797
Other non owner-occupied CRE
1,010,375
913,610
1,999,715
1,736,396
Direct financing leases **
73,011
87,869
Residential real estate loans ***
245,032
239,904
Installment and other consumer loans
102,471
109,352
4,243,278
3,681,346
Plus deferred loan/lease origination costs, net of fees
4,699
8,859
Less allowance
** Direct financing leases:
Net minimum lease payments to be received
80,560
97,025
Estimated unguaranteed residual values of leased assets
616
547
Unearned lease/residual income
(8,165)
(9,703)
Plus deferred lease origination costs, net of fees
1,270
1,892
74,281
89,761
(1,902)
(1,464)
72,379
88,297
* Includes equipment financing agreements outstanding at m2, totaling $162.1 million and $142.0 million as of September 30, 2020 and December 31, 2019, 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 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.
*** Includes residential real estate loans held for sale totaling $8.8 million and $3.7 million as of September 30, 2020 and December 31, 2019, respectively.
Changes in accretable yield for acquired loans were as follows:
Three months ended September 30, 2020
Nine months ended September 30, 2020
PCI
Performing
Loans
Balance at the beginning of the period
(58)
(4,935)
(4,993)
(57)
(6,378)
(6,435)
Reclassification of nonaccretable discount to accretable
(30)
Accretion recognized
941
942
30
2,384
2,414
Balance at the end of the period
(3,994)
(4,051)
Three months ended September 30, 2019
Nine months ended September 30, 2019
(151)
(8,489)
(8,640)
(667)
(10,127)
(10,794)
(159)
1,344
1,438
769
2,982
3,751
(7,145)
(7,202)
The aging of the loan/lease portfolio by classes of loans/leases as of September 30, 2020 and December 31, 2019 is presented as follows:
As of September 30, 2020
Accruing Past
30-59 Days
60-89 Days
Due 90 Days or
Nonaccrual
Classes of Loans/Leases
Current
Past Due
More
C&I
1,816,454
1,275
339
4,981
CRE
Owner-Occupied CRE
485,950
304
Commercial Construction, Land Development, and Other Land
Other Non Owner-Occupied CRE
999,369
378
10,628
Direct Financing Leases
71,692
649
Residential Real Estate
243,646
814
Installment and Other Consumer
102,107
83
26
4,222,304
2,306
985
86
17,597
As a percentage of total loan/lease portfolio
99.52
%
0.05
0.02
0.00
0.41
100.00
As of December 31, 2019
1,499,891
6,126
1,236
443,707
177
71
375,940
2,857
909,684
73
3,853
85,636
463
253
1,517
235,845
2,939
414
706
108,750
33
556
3,659,453
12,638
1,320
7,902
99.41
0.34
0.04
0.21
NPLs by classes of loans/leases as of September 30, 2020 and December 31, 2019 are presented as follows:
Percentage of
Loans/Leases **
Accruing TDRs
Total NPLs
828
5,809
30.99
1.62
-
56.70
233
882
4.71
874
4.66
247
1.32
1,061
18,744
** Nonaccrual loans/leases included $204 thousand of TDRs, including $48 thousand in commercial and industrial loans, $50 in commercial real estate loans, and $106 thousand in installment loans.
646
1,882
21.12
0.38
43.22
333
1,850
20.75
7.92
6.61
979
8,914
** Nonaccrual loans/leases included $747 thousand of TDRs, including $98 thousand in C&I loans, $269 thousand in CRE loans, $294 thousand in direct financing leases, $31 thousand in residential real estate loans, and $55 thousand in installment loans.
20
Changes in the allowance by portfolio segment for the three and nine months ended September 30, 2020 and 2019, respectively, are presented as follows:
Three Months Ended September 30, 2020
Direct Financing
Residential Real
Installment and
Leases
Estate
Other Consumer
Balance, beginning
25,748
29,123
1,639
3,010
1,307
60,827
Provisions charged to expense
9,008
10,428
608
Loans/leases charged off
(1,079)
(362)
(358)
(20)
(1,819)
Recoveries on loans/leases previously charged off
232
Balance, ending
33,827
39,253
1,902
3,263
1,337
79,582
Three Months Ended September 30, 2019
18,248
17,363
1,459
2,582
1,452
41,104
Reclassification of allowance related to held for sale assets
(2,814)
(2,392)
(628)
(288)
(6,122)
Provisions (credits) charged to expense*
998
241
1,584
(351)
(741)
100
114
291
16,151
15,291
1,302
2,158
1,214
36,116
Nine Months Ended September 30, 2020
16,072
15,379
1,464
1,948
1,138
36,001
20,564
24,609
1,890
1,286
(3,058)
(873)
(1,554)
(119)
(5,604)
102
43
561
Nine Months Ended September 30, 2019
16,420
17,719
1,792
2,557
1,359
39,847
3,120
1,168
856
309
206
5,659
(876)
(1,369)
(1,501)
(109)
(99)
(3,953)
300
155
36
685
*Excludes provision related to loans included in assets held for sale of $428 thousand for the three and nine months ended September 30, 2019.
21
The allowance by impairment evaluation and by portfolio segment as of September 30, 2020 and December 31, 2019 is presented as follows:
Allowance for impaired loans/leases
3,210
3,306
Allowance for nonimpaired loans/leases
36,043
3,242
1,262
76,276
Impaired loans/leases
2,004
14,669
766
18,604
Nonimpaired loans/leases
1,821,045
1,985,046
72,067
244,266
102,250
4,224,674
Allowance as a percentage of impaired loans/leases
21.88
2.74
33.94
17.77
Allowance as a percentage of nonimpaired loans/leases
1.86
1.82
1.33
1.23
1.81
Total allowance as a percentage of total loans/leases
1.96
2.61
1.30
1.88
170
270
660
15,902
15,254
1,194
1,933
1,058
35,341
1,846
3,585
2,025
8,661
1,505,979
1,732,811
85,844
239,255
108,796
3,672,685
9.21
3.49
13.33
2.31
14.41
7.62
1.06
0.88
1.39
0.81
0.97
1.07
0.89
1.67
1.04
0.98
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.
22
Loans/leases, by classes of financing receivable, considered to be impaired as of and for the nine months ended September 30, 2020 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:
2,114
1,418
287
528
1,336
792
507
416
119
5,224
5,575
3,225
Impaired Loans/Leases with Specific Allowance Recorded:
13,046
7,228
259
13,380
7,517
Total Impaired Loans/Leases:
14,382
7,562
636
188
18,955
10,742
Loans/leases, by classes of financing receivable, considered to be impaired as of and for the three months ended September 30, 2020 and 2019 are presented as follows:
1,825
1,433
292
668
739
953
540
543
4,396
4,656
141
123
9,757
3,254
120
260
390
77
84
10,094
4,112
1,574
165
10,425
3,993
1,479
772
930
223
627
14,490
8,768
Loans/leases, by classes of financing receivable, considered to be impaired as of December 31, 2019 are presented as
follows:
Unpaid
Principal
1,607
1,647
50
684
686
1,642
469
614
476
4,912
5,115
239
2,867
180
3,749
1,886
3,551
3,553
794
8,864
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 September 30, 2020 and December 31, 2019:
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)
1,610,503
478,852
491,928
929,398
3,510,681
95.91
Special Mention (Rating 6)
25,547
680
51,149
79,587
2.17
Substandard (Rating 7)
24,912
5,191
10,478
29,828
70,409
1.92
Doubtful (Rating 8)
1,660,962
3,660,677
Delinquency Status *
162,043
72,129
244,157
102,224
580,553
99.65
Nonperforming
875
2,048
0.35
162,087
582,601
1,334,446
439,418
378,572
896,206
3,048,642
98.27
12,962
3,044
3,905
19,952
0.65
18,439
1,527
184
13,499
33,649
1.08
1,365,847
3,102,243
140,992
86,019
239,198
108,763
574,972
99.29
986
4,131
0.71
141,978
579,103
* Performing = loans/leases accruing and less than 90 days past due. Nonperforming = loans/leases on nonaccrual, accruing loans/leases that are greater than or equal to 90 days past due, and accruing TDRs.
As of September 30, 2020 and December 31, 2019, TDRs totaled $1.3 million and $1.7 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 nine months ended September 30, 2020 and 2019. The difference between the pre-modification recorded investment and the post-modification recorded investment would be any partial charge-offs at the time of the restructuring.
For the three months ended September 30, 2020
For the three months ended September 30, 2019
Pre-
Post-
Modification
Number of
Specific
Loans / Leases
CONCESSION - Significant Payment Delay
197
116
CONCESSION - Extension of Maturity
TOTAL
172
For the nine months ended September 30, 2020
For the nine months ended September 30, 2019
C & I
308
219
453
238
CONCESSION - Forgiveness of Principal
537
881
831
76
Of the loans restructured during the nine months ended September 30, 2020, none were on nonaccrual. Of the loans restructured during the nine months ended September 30, 2019, three with post-modification recorded balances of $121 thousand were on nonaccrual.
For the three months ended September 30, 2020, one 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. This TDR was a lease restructured in the fourth quarter of 2019 with pre-modification balances totaling $32 thousand. For the nine months ended September 30, 2020, 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. These TDRs included the TDR that defaulted in the third quarter of 2020 as well as a lease that was restructured in the fourth quarter of 2019 with pre-modification balance of $55 thousand and a commercial loan that that was restructured in the fourth quarter of 2019 with a pre-modification balance of $48 thousand.
For the nine months ended September 30, 2019, two of the Company's TDRs redefaulted within 12 months subsequent to restructure, where default is defined as delinquency of 90 days or more and/or placement on nonaccrual status. These TDRs were related to one customer whose leases were restructured in the first quarter of 2019 with pre-modification balances totaling $66 thousand.
Not included in the table above are 10 TDRs that were restructured and charged off for the nine months ended September 30, 2020, totaling $482 thousand. The Company had three TDRs that were restructured and charged off for the three
27
months ended September 30, 2020, totaling $128 thousand The Company had three TDRs that were restructured and charged off for the nine months ended September 30, 2019, totaling $108 thousand.
On March 22, 2020, federal banking regulators issued an interagency statement that included guidance on their approach for the accounting of loan modifications in light of the economic impact of the COVID-19 pandemic. The guidance interprets current accounting standards and indicates that a lender can conclude that a borrower is not experiencing financial difficulty if short-term modifications are made in response to COVID-19, such as payment deferrals, fee waivers, extensions of repayment terms or other delays in payment that are insignificant related to the loans in which the borrower is less than 30 days past due on its contractual payments at the time a modification program is implemented. The agencies confirmed in working with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not TDRs.
In addition, the CARES Act provides financial institutions the option to temporarily suspend certain requirements under GAAP related to TDRs for a limited period of time to account for the effects of COVID-19. To be eligible, the modification must be related to COVID-19, the existing loan could not be more than 30 days past due as of December 31, 2019 and the modification must be executed between March 1, 2020 and the earlier of 60 days after the termination of the National Emergency or December 31, 2020. If a modification does not meet the criteria of the CARES Act, a deferral can still be excluded from TDR treatment as long as the modifications meet the banking regulatory criteria discussed in the preceding paragraph.
The Company implemented its LRP offering to extend qualifying customers’ payments for 90 days. Since implementing the program, the Company has provided 1,498 bank modifications of loans to commercial and consumer clients totaling $522 million and 953 m2 modifications of loans and leases totaling $53 million for a combined 2,451 modifications totaling $575 million, representing 13.53% of the total loan and lease portfolio. As of September 30, 2020, the majority of customers have resumed regularly scheduled payments with only 238 total loans/leases representing $83 million, or 1.95% of total loans/leases, receiving a second deferral under the LRP.
28
NOTE 4 – DERIVATIVES AND HEDGING ACTIVITIES
The Company uses interest rate swap and cap instruments to manage interest rate risk related to the variability of interest payments due to changes in interest rates.
The Company entered into interest rate caps in December 2019 to hedge against the risk of rising interest rates on liabilities. The liabilities consist of $375.0 million of deposits and the benchmark rates hedged vary at 1-month LIBOR, 3-month LIBOR and Prime. The interest rate caps are designated as cash flow hedges in accordance with ASC 815. An initial premium of $4.3 million was paid upfront for the caps executed in 2019. The details of the interest rate caps are as follows:
Balance Sheet
Fair Value as of
Hedged Item
Effective Date
Maturity Date
Location
Notional Amount
Strike Rate
December 31, 2019
1/1/2020
1/1/2023
Other Assets
1.75
112
1.57
218
1.90
96
1.80
109
1/1/2024
401
2/1/2020
2/1/2024
202
201
1/1/2025
337
617
3/1/2020
3/1/2025
40
332
375,000
3,148
The Company has entered into interest rate swaps to hedge against the risk of rising rates on its rolling fixed rate short-term FHLB advances or brokered CDs and its variable rate trust preferred securities. All of the interest rate swaps are designated as cash flow hedges in accordance with ASC 815. The details of the interest rate swaps are as follows:
Receive Rate
Pay Rate
CRBT - FHLB Advances or Brokered CDs
3/16/2020
3/16/2023
Derivatives - Liabilities
30,000
0.23
1.12
(660)
SFCB - FHLB Advances or Brokered CDs
10,000
0.24
0.95
(181)
QCR Holdings Statutory Trust II
9/30/2018
9/30/2028
3.07
5.85
(1,963)
(971)
QCR Holdings Statutory Trust III
8,000
(1,570)
(777)
QCR Holdings Statutory Trust V
7/7/2018
7/7/2028
1.83
4.54
(1,909)
Community National Statutory Trust II
9/20/2018
9/20/2028
3,000
2.40
5.17
(587)
Community National Statutory Trust III
9/15//2018
9/15/2028
3,500
2.00
4.75
(684)
(339)
Guaranty Bankshares Statutory Trust I
9/15/2018
(879)
(436)
79,000
1.34
5.24
(8,433)
(3,758)
Changes in fair values of derivative financial instruments accounted for as cash flow hedges, to the extent that they are included in the assessment of effectiveness, are recorded as a component of AOCI.
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 counterparty. Additionally, the Company receives an upfront fee from the financial institution counterparty, dependent upon the pricing that is recognized upon receipt from the financial institution counterparty. 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.
Interest rate swaps that are not designated as hedging instruments are summarized as follows:
Estimated Fair Value
Non-Hedging Interest Rate Derivatives Assets:
Interest rate swap contracts
1,435,379
236,077
787,221
84,679
Non-Hedging Interest Rate Derivatives Liabilities:
Swap fee income totaled $26.7 million and $9.8 million for the three months ended September 30, 2020 and 2019, respectively. Swap fee income totaled $53.4 million and $20.9 million for the nine months ended September 30, 2020 and 2019, respectively.
The Company’s hedged interest rate swaps and non-hedged interest rate swaps are collateralized with cash and investment securities with carrying values as follows:
Cash
81,373
10,990
U.S govt. sponsored agency securities
3,650
3,541
50,730
68,089
105,631
27,027
241,384
109,647
The Company may be exposed to credit risk in the event of non-performance by the counterparties to its interest rate derivative agreements. The Company assesses the credit risk of its financial institution counterparties by monitoring publicly available credit rating and financial information. Additionally, the Company enters into interest rate derivatives only with primary and highly rated counterparties, and uses ISDA master agreements, central clearing mechanisms and counterparty limits. The ISDA master agreements contain bilateral collateral agreements with the amount of collateral to be posted generally governed by the settlement value of outstanding swaps. The Company manages the risk of default by its borrower/customer counterparties through its normal loan underwriting and credit monitoring policies and procedures. Specifically, the underwriting considers collateral value, including the excess collateral over the loan value and swap exposure, and debt service capacity for the underlying loan as well as the exposure from the interest rate swap. Ongoing credit monitoring policies and procedures are current. As of September 30, 2020, the Company does not currently anticipate any losses from failure of interest rate derivative counterparties to honor their obligations.
NOTE 5 – SUBORDINATED NOTES
On September 14, 2020, the Company completed a private offering of $50.0 million in aggregate principal amount of fixed-to-floating subordinated notes that mature on September 15, 2030. The subordinated notes, which qualify as Tier 2 capital for the Company, will bear interest at a fixed rate of 5.125% per year, from and including September 14, 2020 to, but excluding September 15, 2025 or earlier redemption. From and including September 15, 2025 to, but excluding the maturity date or earlier redemption date, the interest rate will reset quarterly at a variable rate, which is expected to be the then three-month Term SOFR, plus 500 basis points. Interest on the subordinated notes is payable quarterly, commencing on December 15, 2020. The notes are redeemable, in whole or in part, at any time upon the occurrence of certain events. The subordinated notes may be redeemed at the Company’s option, in whole or in part, on any interest payment date on or after September 15, 2025, at a redemption price equal to 100% of the principal amount of the notes to be redeemed plus accrued and unpaid interest to, but excluding, the date of redemption. 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.
The details of the Company’s subordinated notes are as follows:
Amount Outstanding
Interest Rate
as of September 30, 2020
as of December 31, 2019
Subordinated debenture dated 9/14/20
5.125
9/15/2030
Subordinated debenture dated 2/1/19
65,000
5.375
Subordinated debenture dated 4/30/16*
2,000
4.00
4/30/2026
Subordinated debenture dated 9/15/16*
9/15/2026
Debt issuance costs
(1,423)
(1,606)
Total Subordinated Debentures
*Assumed in acquisition of SFCB
NOTE 6 - EARNINGS PER SHARE
The following information was used in the computation of EPS on a basic and diluted basis:
Three months ended
Nine months ended
Basic EPS
Diluted EPS
Weighted average common shares issuable upon exercise of stock options
and under the employee stock purchase plan
156,426
237,312
175,497
230,232
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:
Assets and liabilities measured at fair value on a recurring basis comprise the following at September 30, 2020 and December 31, 2019:
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)
Total assets measured at fair value
583,577
Total liabilities measured at fair value
298,522
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 used for the purpose of hedging interest rate risk on FHLB advances, brokered deposits and 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).
Interest rate swaps are also 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).
Certain financial assets are measured at fair value on a non-recurring basis; that is, the assets are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).
Assets measured at fair value on a non-recurring basis comprise the following at September 30, 2020 and December 31, 2019:
Level 1
Level 2
Level 3
11,226
OREO
135
11,361
3,394
4,459
7,853
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
(10.00)
to
(30.00)
(35.00)
For the impaired loans/leases and OREO, the Company records carrying value at fair value less disposal or selling costs. The amounts reported in the tables above are fair values before the adjustment for disposal or selling costs.
There have been no changes in valuation techniques used for any assets or liabilities measured at fair value during the three and nine months ended September 30, 2020 and 2019.
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
*
Loans/leases receivable, net
10,394
3,143
4,158,001
4,142,232
3,651,061
3,606,520
Nonmaturity deposits
4,116,250
3,184,726
Time deposits
556,018
562,068
726,325
742,444
FHLB advances
40,182
159,193
68,563
30,487
30,477
*See previous table in Note 2.
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 four subsidiary banks wholly owned by the Company: QCBT, CRBT, CSB, and SFCB. 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, asset management, investment management and advisory services offered at the Company's subsidiary banks and the Bates Companies in aggregate. The Bates Companies were sold on August 12, 2020 and the business segment information below reflects the activity of the Bates Companies through this date. 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 corporate operations of the parent and operations of all other consolidated subsidiaries and/or defined operating segments that fall below the segment reporting thresholds. The financial results for RB&T prior to the sale of the majority of its assets and liabilities at November 30, 2019 are also included in the Company’s All Other Segment.
Selected financial information on the Company's business segments is presented as follows as of and for the three and nine months ended September 30, 2020 and 2019.
Commercial Banking
Wealth
Intercompany
Consolidated
QCBT
CRBT
CSB
SFCB
Management
All other
Eliminations
Total revenue
20,856
43,331
11,033
10,266
3,545
21,657
(21,839)
88,849
16,648
14,432
8,593
6,159
(1,531)
280
7,861
8,878
2,493
1,110
Net income (loss) from continuing operations
2,455
13,221
2,869
1,053
17,362
(21,483)
3,223
14,980
9,888
45,975
2,313
3,474
6,115
2,205,934
2,012,182
937,016
803,478
756,716
(850,766)
21,230
25,707
11,596
8,351
4,122
27,753
(22,036)
76,723
13,357
11,478
8,894
5,056
1,934
948
276
4,870
7,900
3,482
2,116
926
15,081
(19,280)
3,682
77,748
2,810
4,154
7,034
1,531
15,529
1,642,950
1,592,896
801,596
693,898
1,180,872
(619,830)
5,292,382
60,083
99,938
30,836
28,490
11,211
55,087
(55,342)
230,303
46,728
38,638
23,631
18,002
(4,514)
758
18,583
18,288
7,268
4,485
Net income (loss)
10,664
30,178
3,496
6,974
2,860
42,296
(54,157)
60,148
68,526
30,596
23,396
12,599
71,361
(54,563)
212,063
38,129
32,671
23,154
15,707
5,979
2,941
451
1,261
559
13,560
19,928
7,845
5,848
2,667
42,566
(50,897)
NOTE 9 – REGULATORY CAPITAL REQUIREMENTS
The Company (on a consolidated basis) and the subsidiary banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company and subsidiary banks' financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the subsidiary banks must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the subsidiary banks to maintain minimum amounts and ratios (set forth in the following table) of total common equity Tier 1 and Tier 1 capital to risk-weighted assets and of Tier 1 capital to average assets, each as defined by regulation. Management believes, as of September 30, 2020 and December 31, 2019, that the Company and the subsidiary banks met all capital adequacy requirements to which they are subject.
Under the regulatory framework for prompt corrective action, to be categorized as “well capitalized,” an institution must maintain minimum total risk-based, Tier 1 risk-based, Tier 1 leverage and common equity Tier 1 ratios as set forth in the following tables. The Company and the subsidiary banks’ actual capital amounts and ratios as of September 30, 2020 and
December 31, 2019 are presented in the following table (dollars in thousands). As of September 30, 2020 and December 31, 2019, 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 September 30, 2020:
Company:
Total risk-based capital
700,831
14.93
375,643
>
8.00
493,031
10.50
469,553
10.00
Tier 1 risk-based capital
528,228
11.25
281,732
6.00
399,120
8.50
Tier 1 leverage
229,457
286,822
5.00
Common equity Tier 1
490,273
10.44
211,299
4.50
328,687
7.00
305,210
6.50
Quad City Bank & Trust:
204,284
12.13
134,760
176,872
168,450
183,131
10.87
101,070
143,182
7.85
93,313
116,642
75,802
117,915
109,492
Cedar Rapids Bank & Trust:
214,219
12.92
132,656
174,112
165,821
193,384
11.66
99,492
140,948
9.72
79,559
99,449
116,074
107,783
Community State Bank:
99,123
12.74
62,222
81,666
77,777
89,359
11.49
46,666
66,110
9.85
36,273
45,341
35,000
54,444
50,555
Springfield First Community Bank:
83,283
13.68
48,718
63,943
60,898
71,617
11.76
36,539
51,763
10.27
27,903
34,879
27,404
42,629
39,584
As of December 31, 2019:
581,234
348,937
457,980
10.500
436,171
481,702
11.04
261,703
370,746
8.500
9.53
202,207
4.000
252,758
443,864
10.18
196,277
305,320
7.000
283,511
183,855
11.83
124,362
163,225
155,452
170,137
10.94
93,271
132,134
9.94
68,479
85,598
69,953
108,817
101,044
175,498
11.90
117,953
154,813
147,441
162,127
11.00
88,465
125,325
10.41
62,286
77,857
66,349
103,209
95,837
92,095
12.32
59,813
78,504
74,766
85,437
11.43
44,860
63,551
10.39
32,902
41,128
33,645
52,336
48,598
71,074
12.72
44,704
58,674
55,880
63,956
11.45
33,528
47,498
9.70
26,379
32,974
25,146
39,116
36,322
NOTE 10 –SALE OF SUBSIDIARY
On August 12, 2020, the Company sold all the issued and outstanding capital stock of the Bates Companies. The aggregate consideration paid to the Company was a $500 thousand note receivable, less imputed interest of $52 thousand, plus cancellation of all future amounts otherwise to become payable to the purchaser by the Company under an earn-out agreement entered into between the same parties in 2018 with a non-discounted value of approximately $880 thousand at September 30, 2020.
Assets and liabilities of the Bates Companies sold are summarized as follows as of the date of closing:
As of
August 12, 2020
ASSETS
LIABILITIES
Disposition costs related to the sale totaled $192 thousand and were comprised primarily of legal, accounting and personnel costs.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
This section reviews the financial condition and results of operations of the Company and its subsidiaries as of and for the three and nine months ending September 30, 2020. 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 and SFCB. QCBT, CRBT and CSB are Iowa-chartered commercial banks and SFCB is a Missouri-chartered commercial bank. All four charters are members of the Federal Reserve system with depository accounts insured to the maximum amount permitted by the FDIC.
IMPACT OF COVID-19
The progression of the COVID-19 pandemic in the United States has had an adverse impact on the Company’s financial condition and results of operations as of and for the three and nine months ended September 30, 2020, and could have a complex and significant adverse impact on the economy, the banking industry and the Company in future fiscal periods, all subject to a high degree of uncertainty.
Effects on the Company’s Market Areas
The Company offers commercial and consumer banking products and services primarily in Iowa, Missouri and Illinois. Each of these three states has taken different steps to reopen since COVID-19 thrust the country into lockdown starting in March 2020. In June 2020, the governors of Iowa, Missouri and Illinois each lifted or modified COVID-19 restrictions.
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued
Although the reopening of each jurisdiction is subject to change and setback, currently all of the subsidiary banks’ branches are open during normal business hours.
Each state experienced rapidly increasing unemployment levels as a result of the curtailment of business activities, rising from an average of 4.6% in Illinois in March 2020 to an average of 11.0% in August 2020, according to the Illinois Department of Employment Security. The unemployment rate in Illinois has improved from its highest point this year in May 2020 of an average of 15.2%. Unemployment rose from an average of 4.5% in Missouri in March 2020 to 4.9% in September 2020, according to the Missouri Department of Labor and Industrial Relations. The unemployment rate in Missouri has improved from its highest point this year in May 2020 of an average of 10.1%. In Iowa, unemployment rose from an average of 3.7% in March 2020 to 4.7% in September 2020, according to the Iowa Workforce Development. The unemployment rate in Iowa has improved from its highest point this year in May 2020 of an average of 10.0%.
Policy and Regulatory Developments
Federal, state and local governments and regulatory authorities have enacted and issued a range of policy responses to the COVID-19 pandemic, including the following:
39
Effects on the Company’s Business
The Company currently expects that the COVID-19 pandemic and the specific developments referred to above could continue to have a significant impact on its business. In particular, the Company anticipates that a significant portion of the subsidiary banks’ borrowers in the hotel, restaurant, arts/entertainment/recreation and retail industries could continue to endure significant economic distress, and some borrowers’ability to repay existing indebtedness have been adversely effected. Therefore, the value of certain collateral pledged to the banks have been adversely impacted. These developments, together with economic conditions generally, have impacted and are expected to continue to impact the Company’s commercial real estate portfolio, particularly with respect to real estate with exposure to these industries, the Company’s equipment leasing business and loan portfolio, the Company’s consumer loan business and loan portfolio, and the value of certain collateral securing the Company’s loans. In addition, the Company’s loan and lease growth, exclusive of PPP loans, could slow while deposit growth could accelerate as businesses and consumers navigate the continuing impact. As a result, the Company anticipates that its asset quality and results of operations could be adversely affected, as described in further detail below.
The Company’s Response
The Company has taken numerous steps in response to the COVID-19 pandemic, including the following:
EXECUTIVE OVERVIEW
The Company reported net income of $17.3 million and diluted EPS of $1.09 for the quarter ended September 30, 2020. By comparison, for the quarter ended June 30, 2020, the Company reported net income of $13.7 million and diluted EPS of $0.86. For the quarter ended September 30, 2019, the Company reported net income of $15.1 million, and diluted EPS of $0.94. For the nine months ended September 30, 2020, the Company reported net income of $42.3 million, and diluted EPS of $2.65. By comparison, for the nine months ended September 30, 2019, the Company reported net income of $41.5 million, and diluted EPS of $2.60.
The third quarter of 2020 was also highlighted by the following results and events:
Following is a table that represents various income measurements for the Company.
For the three months ended
For the nine months ended
June 30, 2020
0.86
15,895,336
Following is a table that represents the major income and expense categories for the Company:
40,948
Provision expense
19,915
Noninterest income
28,626
Noninterest expense
33,122
2,798
Following are some noteworthy changes in the Company's financial results:
STRATEGIC FINANCIAL METRICS
The Company has established certain strategic financial metrics 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 metrics, there is no assurance that they will be met. Moreover, the Company's ability to achieve these metrics 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, 2019. The Company's long-term strategic financial metrics are as follows:
The following table shows the evaluation of the Company’s strategic financial metrics:
Year to Date
Strategic Financial Metric*
Key Metric
Target
September 30, 2020*
Loans and leases growth organically **
Loans and leases growth
> 9% annually
11.5
Fee income growth
> 6% annually
61.1
Improve operational efficiencies and hold noninterest expense growth
Noninterest expense growth
< 5% annually
(5.3)
* Ratios and amounts provided for these measurements represent year-to-date actual amounts for the respective period that are then annualized for comparison. The calculations provided exclude non-core noninterest income and noninterest expense.
** Loans and leases growth excludes PPP loans.
It should be noted that these initiatives are long-term targets. Due to the impact of the COVID-19 pandemic, among other factors, the Company may not be able to achieve these goals for the full year 2020.
STRATEGIC DEVELOPMENTS
The Company has taken the following actions during the third quarter of 2020 to support its corporate strategy:
GAAP TO NON-GAAP RECONCILIATIONS
The following table presents certain non-GAAP financial measures related to the “TCE/TA ratio”, “TCE/TA ratio excluding PPP loans”, “adjusted net income”, “adjusted EPS”, “adjusted ROAA”, “pre-provision/pre-tax adjusted income”, “pre-provision/pre-tax adjusted ROAA”, “NIM (TEY)”, “adjusted NIM”, “efficiency ratio”, “ALLL to total loans and leases excluding PPP loans” and “loan growth annualized excluding PPP loans”. In compliance with applicable rules of the SEC, all non-GAAP measures are reconciled to the most directly comparable GAAP measure, as follows:
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 TCE/TA ratio excluding PPP loans non-GAAP ratio is provided as the Company’s management believes this financial measure is important to investors as total assets for the quarter ended September 30, 2020 and June 30, 2020 were materially higher due to the addition of PPP loans. By excluding the PPP loans, management believes the investor is provided a better comparison to prior periods for analysis.
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.
The pre-provision/pre-tax adjusted income and pre-provision/pre-tax adjusted ROAA are measurements of the Company’s financial performance excluding provision and income taxes as well as non-recurring income and expense items. The
Company’s management believes this financial measure is important to investors as the provision for the quarters ended September 30, 2020 and June 30, 2020 was materially higher due to the impact of COVID-19. By excluding the provision and income taxes as well as non-recurring income and expense items, the investor is provided a better comparison to prior periods for analysis.
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 widely, making comparisons difficult.
The efficiency ratio is a ratio that management utilizes to compare the Company to its peers. It is a standard ratio used to calculate overhead as a percentage of revenue in the banking industry and is widely utilized by investors.
ALLL to total loans and leases, excluding PPP loans, and loan growth annualized, excluding PPP loans, are ratios that management utilizes to compare the Company to its peers. The Company’s management believes these financial measures are important to investors as total loans and leases for the quarters ended September 30, 2020 and June 30, 2020 were materially higher due to the addition of PPP loans which are guaranteed by the government and therefore do not necessitate an increase in ALLL. By excluding the PPP loans, the investor is provided a better comparison to prior periods for analysis.
GAAP TO NON-GAAP
June 30,
RECONCILIATIONS
(dollars in thousands, except per share data)
TCE/TA RATIO
Stockholders' equity (GAAP)
Less: Intangible assets
85,968
88,120
93,277
TCE (non-GAAP)
486,645
467,900
426,466
Total assets (GAAP)
5,604,761
TA (non-GAAP)
5,778,592
5,516,641
5,199,105
TCE/TA ratio (non-GAAP)
8.42
8.48
8.20
TCE/TA RATIO EXCLUDING PPP LOANS
Less: PPP loan interest income (post-tax)
4,934
2,085
481,711
465,815
Less: PPP loans
357,506
358,052
5,421,086
5,158,589
TCE/TA ratio excluding PPP loans (non-GAAP)
8.89
9.03
46
For the Quarter Ended
For the Nine Months Ended
ADJUSTED NET INCOME
Net income (GAAP)
Less non-coore items (post-tax) (*):
Income:
1,424
(2)
1,475
(43)
Total non-core income (non-GAAP)
Expense:
Losses on debt extinguishment
1,480
117
152
(66)
495
(25)
698
149
1,363
212
Total non-core expense (non-GAAP)
1,819
328
815
3,291
Adjusted net income (non-GAAP)
17,739
14,016
15,912
44,127
43,040
PRE-PROVISION/PRE-TAX ADJUSTED INCOME
Less: Non-core income not tax-effected
(54)
Plus: Non-core expense not tax-effected
2,339
1,032
4,070
1,873
Pre-provision/pre-tax adjusted income (non-GAAP)
42,239
36,803
21,714
101,836
57,591
PRE-PROVISION/PRE-TAX ADJUSTED RETURN ON AVERAGE ASSETS (NON-GAAP)
Average assets
5,820,555
5,800,164
5,217,763
5,524,087
5,088,055
Pre-provision/pre-tax adjusted return on average assets (non-GAAP)
2.90
2.54
1.66
2.46
1.51
ADJUSTED EPS
Adjusted net income (non-GAAP) (from above)
15,747,056
Adjusted EPS (non-GAAP):
Basic
1.13
1.01
2.80
Diluted
1.11
1.00
2.77
2.70
ADJUSTED ROAA
Average Assets
Adjusted ROAA (annualized) (non-GAAP)
1.22
ADJUSTED NIM (TEY)*
Net interest income (GAAP)
Plus: Tax equivalent adjustment
1,942
1,728
1,763
5,587
4,944
Net interest income - tax equivalent (non-GAAP)
46,523
42,676
42,482
128,830
120,584
Less: Accquisition accounting net accretion
833
736
1,268
2,194
3,413
Adjusted net interest income
45,690
41,940
41,214
126,636
117,171
Average earning assets
5,278,298
5,252,663
4,791,274
4,998,352
4,700,617
NIM (GAAP)
3.36
3.14
3.37
3.29
NIM (TEY) (non-GAAP)
3.51
3.27
3.52
3.44
3.43
Adjusted NIM (TEY) (non-GAAP)
3.21
3.41
3.38
3.33
EFFICIENCY RATIO
Noninterest expense (GAAP)
Noninterest income (GAAP)
Total income
82,540
69,574
60,625
205,024
164,604
Efficiency ratio (noninterest expense/total income) (non-GAAP)
49.48
47.61
65.89
51.40
66.18
ALLLTO TOTAL LOANS AND LEASES, EXCLUDING PPP LOANS
ALLL
Total loans and leases
4,140,259
3,610,270
Total loans and leases, excluding PPP loans
3,890,471
3,782,207
ALLL to total loans and leases, excluding PPP loans
2.05
1.61
LOAN GROWTH ANNUALIZED, EXCLUDING PPP LOANS
Loan growth annualized, excluding PPP loans
8.37
(30.71)
16.28
(9.84)
* Nonrecurring items (after-tax) are calculated using an estimated effective tax rate of 21% with the exception of goodwill impairment which is not deductible for tax and gain/loss on sale of subsidiary which has an estimated effective tax rate of 30.5%.
47
NET INTEREST INCOME - (TAX EQUIVALENT BASIS)
Net interest income, on a tax equivalent basis, increased 9% to $46.5 million for the quarter ended September 30, 2020 compared to the same quarter of the prior year, and increased 7% to $128.8 million for the nine months ended September 30, 2020 compared to the same period of the prior year. Excluding the tax equivalent adjustments, net interest income increased 10% for the quarter ended September 30, 2020 compared to the same quarter of the prior year, and increased 7% for the nine months ended September 30, 2020 compared to the same period of the prior year. Net interest income improved due to the following factors:
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
3.99
3.86
4.85
3.70
4.70
Average Cost of Interest-Bearing Liabilities
0.66
0.80
1.71
0.67
0.79
Net Interest Spread
3.06
3.19
2.91
2.99
NIM
NIM Excluding Acquisition Accounting Net Accretion
3.10
4.12
4.78
3.96
4.64
0.91
1.73
3.05
3.24
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 was up 24 basis points on a linked quarter basis. Excluding acquisition accounting net accretion, NIM was up 23 basis points on a linked quarter basis. The increase in net interest margin during the quarter
was due to a 13 basis point increase in the yield on earning assets combined with a 14 basis point decline in the total cost of interest-bearing 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
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.
In response to the COVID-19 pandemic, the Federal Reserve decreased interest rates by a total of 150 basis points in March 2020. These decreases impact the comparability of net interest income between 2019 and 2020.
The Company's average balances, interest income/expense, and rates earned/paid on major balance sheet categories, as well as the components of change in net interest income, are presented in the following tables:
For the Three Months Ended September 30,
Earned
Yield or
or Paid
Interest earning assets:
2,205
7,234
2.30
321,679
0.11
172,386
2.19
Investment securities (1)
749,425
6,836
3.66
626,471
6,080
3.85
19,714
4.94
22,719
5.12
Gross loans/leases receivable (1) (2) (3)
4,185,275
45,654
4.34
3,962,464
51,214
5.13
Total interest earning assets
52,832
58,580
Noninterest-earning assets:
75,480
85,262
Premises and equipment
72,618
79,646
(61,892)
(41,673)
456,051
303,254
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Interest-bearing deposits
2,932,988
2,086
0.28
2,505,383
7,907
1.25
638,031
2,399
1.50
975,736
5,486
2.23
26,996
0.17
17,333
98
2.24
57,078
1.45
123,107
3.30
77,783
5.30
68,299
5.83
37,936
571
5.89
37,774
6.10
Total interest-bearing liabilities
3,770,812
3,727,632
Noninterest-bearing demand deposits
1,155,862
821,876
Other noninterest-bearing liabilities
318,890
152,060
5,245,564
4,701,568
Stockholders' equity
574,991
516,195
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
139.98
128.53
49
Analysis of Changes of Interest Income/Interest Expense
For the Three Months Ended September 30, 2020
Inc./(Dec.)
Components
from
of Change (1)
Prior Period (1)
Rate
Volume
2020 vs. 2019
INTEREST INCOME
(41)
(23)
(18)
(859)
(3,864)
3,005
Investment securities (2)
756
(1,754)
2,510
(44)
(9)
(35)
Gross loans/leases receivable (2) (3)
(5,560)
(20,816)
15,256
Total change in interest income
(5,748)
(26,466)
20,718
INTEREST EXPENSE
(5,821)
(13,543)
7,722
(3,087)
(1,505)
(1,582)
(87)
(325)
(812)
(415)
(397)
(10)
(27)
Total change in interest expense
(9,789)
(15,815)
6,026
Total change in net interest income
4,041
(10,651)
14,692
For the Nine Months Ended September 30,
2,795
10,887
2.35
327,902
170,167
2.39
688,985
19,567
3.78
643,975
18,237
3.79
20,767
5.03
21,670
5.50
3,957,903
133,141
4.49
3,853,918
145,682
5.05
154,109
168,043
85,655
82,096
73,298
78,059
(46,978)
(41,119)
413,760
268,403
Interest-bearing demand deposits
2,718,613
9,920
0.49
2,418,420
23,351
1.29
743,746
9,537
1,000,529
16,346
2.18
23,804
0.45
15,952
87,920
115,539
3.11
18,084
71,582
5.63
58,392
5.86
37,894
5.95
37,730
6.13
3,683,559
3,664,646
1,009,970
809,469
271,639
114,980
4,965,168
4,589,095
558,919
498,960
3.40
Ratio of average interest earning assets to average interest-bearing liabilities
135.69
128.27
(172)
(78)
(94)
Interest-bearing deposits at other financial institutions
(2,455)
(4,924)
2,469
1,330
(49)
1,379
(96)
(64)
(32)
(12,541)
(18,546)
6,005
(13,934)
(23,661)
9,727
(13,431)
(17,660)
4,229
(6,809)
(3,110)
(3,699)
(194)
(345)
(1,678)
(1,147)
(531)
(512)
(256)
458
(14)
(22,180)
(22,518)
338
8,246
(1,143)
9,389
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. In certain situations, interim impairment tests may be required if events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. 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, 2019.
Due to the economic impact of COVID-19 during the first quarter of 2020, management concluded that factors such as the decline in macroeconomic conditions led to the occurrence of a triggering event and therefore an interim impairment test over goodwill was performed as of March 31, 2020. There was no occurrence of a triggering event in the second or third quarters of 2020. Therefore no impairment test of goodwill was performed as of June 30, 2020 or September 30, 2020.
When such an assessment is performed, should the Company conclude that all or a portion of goodwill is impaired, a non-cash charge for the amount of such impairment would be recorded to earnings. Such a charge would have no impact on tangible capital or regulatory capital. Based upon the results of the interim goodwill assessment during the first quarter of 2020, the Company concluded that an impairment did not exist on the bank reporting units as of the time of the assessment.
During the first quarter of 2020, the Company incurred goodwill impairment expense of $500 thousand related to the Bates Companies. This was the result of the announcement of a sale of the Bates Companies as discussed in Note 10 of the Consolidated Financial Statements.
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, 2019.
The Company believes the COVID-19 pandemic could have an adverse effect on the credit quality of its loan portfolio during the remainder of 2020. Disruption to the Company’s customers could result in increased loan delinquencies and defaults resulting in an increase in quantitative allocations. Management believes impaired loans may increase in the future as a result of the COVID-19 pandemic, having a direct impact on the specific component of the allowance for loan and lease losses.
RESULTS OF OPERATIONS
Interest income decreased 10%, comparing the third quarter of 2020 to the same period of 2019, and decreased 9% comparing the first nine months of 2020 to the same period of 2019. This decrease was primarily the result of a reduction in average yields on loans and leases. During the last month of the first quarter, market rates fell as the Federal Reserve cut the Federal Funds Rate by 150 basis points to a range of 0.00%-0.25%.
Overall, the Company's average earning assets increased 10%, comparing the third quarter of 2020 to the third quarter of 2019. During the same time period, average excess liquidity increased by 87%. Average gross loans and leases increased 6%, while average investment securities increased 20% during the same time period. Average earning assets increased 6%, comparing the first nine months of 2020 to the same period of 2019. Average excess liquidity increased by $158 million comparing the first nine months of 2020 to the same period of 2019. Average gross loans and leases increased 3%, while average investment securities increased 7% during the same time period. The increases in excess liquidity were the result of outsized growth in core deposits led by the Company’s correspondent banking client base.
The Company intends to continue to grow quality loans and leases as well as its private placement tax-exempt securities portfolio to maximize yield while minimizing credit and interest rate risk.
Interest expense for the third quarter of 2020 decreased 61% from the third quarter of 2019 and decreased 47% comparing the first nine months of 2020 to the same period of 2019. The cost of funds on the Company’s average interest-bearing liabilities declined sharply on a linked-quarter basis with the current interest 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 Company’s provision for loan and lease losses totaled $20.3 million for the third quarter of 2020, which is significantly higher than $2.0 million for the third quarter of 2019. Provision for the first nine months of 2020 totaled $48.6 million, which was up from $6.1 million in the first nine months of 2019. The increase in the provision for loan and lease losses was primarily due to increased qualitative allocations in response to deteriorating economic conditions related to the effects of COVID-19.
The Company anticipates the provision could be elevated in future periods due to the broad reach of COVID-19 across many impacted individuals and industries. The dramatic slowdown in economic activity will likely continue to negatively impact the credit quality of the Company’s loan portfolio with increased levels of loan defaults. The CARES Act provides significant resources for individuals and industries that could lessen the impact of COVID-19, in addition to the Company’s own loan relief programs.
The Company has elected to defer its implementation of CECL as allowed by the CARES Act. See Note 1 of the Consolidated Financial Statements for further discussion.
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 and securities in the portfolio as described in more detail in the “Critical Accounting Policies” section.
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 $5.0 million for the first nine months of 2020, increased the Company's allowance to $79.6 million at September 30, 2020. As of September 30, 2020, the Company's allowance to total loans/leases was 1.87%, which was up from 1.47% at June 30, 2020 and 1.00% at September 30, 2019. Management continues to evaluate the allowance needed on acquired loans factoring in the net remaining discount ($4.5 million and $7.7 million at September 30, 2020 and September 30, 2019, respectively).
The following table represents the current balance of loans to customers with concentrations in industries that management has deemed to have a higher risk of being impacted by COVID-19:
As of September 30,
% of Total Gross
Loans and Leases
Hotels
83,759
1.97
Restaurants (full service and limited service only)
40,393
Arts, Entertainment and Recreation
28,162
152,314
3.59
Additional discussion of the Company's allowance can be found in the “Financial Condition” section of this Report.
NONINTEREST INCOME
The following tables set forth the various categories of noninterest income for the three and nine months ended September 30, 2020 and 2019.
$ Change
% Change
(60)
(2.6)
(516)
(29.0)
(410)
(22.6)
480
53.9
(519)
(100.0)
16,891
172.4
1,805
60,166.7
2.7
6.8
16.4
278
23.1
18,053
90.7
(375)
(5.2)
(1,014)
(18.8)
(17.1)
1,470
84.1
32,533
155.8
1,923
3,433.9
0.1
(112)
(4.3)
9.5
(217)
(6.1)
32,817
67.0
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 by $164.3 million in the third quarter of 2020. However, assets under management decreased $19.1 million in the first nine months of 2020 due to deteriorating economic conditions caused by the COVID-19 pandemic. With the decrease in assets under management, trust department fees decreased 5%, comparing the first nine months of 2020 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. The Company expects trust department fees to be negatively impacted during periods of significantly lower market valuations.
Investment advisory and management fees decreased 29%, comparing the third quarter of 2020 to the same period of the prior year, and decreased 19% when comparing the first nine months of 2020 to the same period of 2019. Brokerage
assets, excluding brokerage assets of the Bates Companies, decreased $25.1 million in the first nine months of 2020 due to deteriorating economic conditions caused by the COVID-19 pandemic. Similar to trust department fees, investment advisory and management fees are largely determined based on the value of the investments managed. As a result, fee income from this line of business fluctuates with market valuations. The levels of trust and brokerage assets under management were negatively impacted by the decline in the market as a result of COVID-19 as well as the sale of the Bates Companies in August 2020.
Deposit service fees decreased 23% comparing the third quarter of 2020 to the same period of the prior year, and decreased 17% when comparing the first nine months of 2020 to the same period of the prior year. This decrease was primarily due to the sale of RB&T, as well as lower transactional volume due to current economic conditions. The Company continues to emphasize 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 54% when comparing the third quarter of 2020 to the same period of the prior year, and increased 84% when comparing the first nine months of 2020 to the same period of the prior year. The increase was primarily due to the refinancing of residential real estate loans with lower interest rates in the first nine months of 2020.
The Company did not have any gains on the sale of government-guaranteed portions of loans for the three or nine months ended September 30, 2020. Over the past few years, competitors have been offering SBA loan candidates traditional financing without a guarantee and the Company is not willing to relax its structure for those lending opportunities. And, for USDA loans, the governmental regulations have tightened which has led to sharply reduced supply for non-governmental lenders.
As a result of the low interest rate environment and its continued focus across all subsidiary banks, 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 $26.7 million for the third quarter of 2020, compared to $9.8 million for the third quarter of 2019. Swap fee income totaled $53.4 million for the first nine months of 2020, compared to $20.9 million in the first nine months of 2019. The increase in swap fee income for the first nine months of 2020, 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 gains totaled $1.8 million and $1.9 million for the three and nine months ended September 30, 2020, respectively. By comparison, securities losses totaled $3 thousand and $56 thousand for the three and nine months ended September 30, 2019. As part of a balance sheet deleverage strategy in the third quarter 2020, the Company sold select securities at gains to help offset the cost of prepaying select high-cost borrowings.
Earnings on BOLI increased 3% comparing the third quarter of 2020 to the third quarter of 2019, and remained constant comparing the first nine months of 2020 to the first nine months of 2019. 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 markets 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 7% comparing the third quarter of 2020 to the third quarter of the prior year, and decreased 4% comparing the first nine months
of 2020 to the first nine months of 2019. 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 increased 16% comparing the third quarter of 2020 to the third quarter of the prior year, and increased 10% comparing the first nine months of 2020 to the first nine months of 2019. The fees are generally included in the earnings credit rates which incent the correspondent bank to maintain higher levels of noninterest bearing deposits to offset the correspondent banking fees. 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, Missouri and Wisconsin.
Other noninterest income increased 23% comparing the third quarter of 2020 to the third quarter of the prior year, and decreased 6% comparing the first nine months of 2020 to the first nine months of 2019. The increase in the third quarter of 2020 was primarily due to one-time VISA conversion fee income.
57
NONINTEREST EXPENSE
The following tables set forth the various categories of noninterest expense for the three and nine months ended September 30, 2020 and 2019.
1,784
7.4
(53)
(1.4)
(272)
(6.7)
(916)
(103.6)
100.0
759
140.0
182
82.4
(2,062)
(99.2)
(306)
(2.8)
Loss on liability extinguishment
1,726
1,166.2
(1.9)
Loss on sale of subidiary
1,241
(399)
(24.3)
893
2.2
(2,021)
(3.0)
4.5
962
9.8
(1,538)
(89.1)
460
18.9
222
29.7
(3,860)
(108.5)
(894)
(31.1)
(0.1)
Losses on liability extinguishment, net
2,302
1,555.4
2.3
(4.6)
Goodwill Impairment
(1,049)
(21.4)
(3,550)
(3.3)
Management places a strong emphasis on overall cost containment and is committed to improving the Company's general efficiency.
Salaries and employee benefits, which is the largest component of noninterest expense, increased from the third quarter of 2019 to the third quarter of 2020 by 7%. The increased expense was primarily related to increased incentive compensation driven by strong financial results and higher swap fee income. This line item decreased 3% when comparing the first nine months of 2020 to the first nine months of 2019. The decrease was primarily related to the sale of RB&T and deferred costs due to PPP loans.
Occupancy and equipment expense decreased 1% comparing the third quarter of 2020 to the same period of the prior year, and increased 5% comparing the first nine months of 2020 to the same period of the prior year. The increased expense for the nine months of 2020 was due to higher information technology service contract costs and increases in repairs and maintenance costs to existing buildings.
Professional and data processing fees decreased 7% comparing the third quarter of 2020 to the same period in 2019. The decrease was primarily due to legal fees incurred in the third quarter of 2019 related to the sale of RB&T. Professional and data processing fees increased 10% comparing the first nine months of 2020 to the same period of the prior year. This increased expense was mostly due to higher data processing costs.
Post-acquisition costs decreased 104% comparing the third quarter of 2020 to the same period in 2019. Post-acquisition costs totaled $189 thousand for the first nine months of 2020 as compared to $1.7 million for the same period of the prior year. These costs were comprised primarily of personnel costs, IT integration and data conversion costs related to previous mergers/acquisitions.
Disposition costs totaled $192 thousand for the third quarter of 2020 and $626 thousand for the first nine months of 2020. The costs were comprised primarily of legal, accounting, personnel costs and IT deconversion costs related to the sale of Bates Companies in the third quarter of 2020 and the sale of RB&T in the fourth quarter of 2019. There were no disposition costs for the third quarter or first nine months of 2019.
FDIC insurance, other insurance and regulatory fee expense increased 140%, comparing the third quarter of 2020 to the third quarter of 2019, and increased 19% comparing the first nine months of 2020 to the same period of the prior year. The increase in expense was due to an increase in the asset size of the Company in 2020 as well as a credit to FDIC insurance assessments received in 2019.
Loan/lease expense increased 82% when comparing the third quarter of 2020 to the same quarter of 2019, and increased 30% comparing the first nine months of 2020 to the same period of the prior year. Generally, loan/lease expense has a direct relationship with the level of NPLs; however, it may deviate depending upon the individual NPLs.
Net cost of (income from) 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 from and gains/losses on operations of other real estate totaled $16 thousand for the third quarter of 2020, compared to net cost of and gains/losses on operations of other real estate of $2.1 million for the third quarter of 2019. Net income from and gains/losses on operations of other real estate totaled $303 thousand for the first nine months of 2020 compared to net cost of and gains/losses on operations of other real estate of $3.6 million for the same period of the prior year. In the first nine months of 2020, the Company has sold OREO property of $4 million with corresponding gains of $369 thousand. In the third quarter of 2019, the Company wrote down an OREO property by $2.0 million.
Advertising and marketing expense decreased 29% comparing the third quarter of 2020 to the third quarter of 2019, and decreased 31% comparing the first nine months of 2020 to the same period of the prior year. The decrease in expense was primarily due to the sale of RB&T.
Bank service charges, a large portion of which includes indirect costs incurred to provide services to QCBT's correspondent banking customer portfolio, decreased 3% when comparing the third quarter of 2020 to the same quarter of 2019, and remained stable when comparing the first nine months of 2020 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 is expected to also increase.
Losses on liability extinguishment were $1.9 million for the third quarter of 2020 and $2.5 million for the first nine months of 2020. These losses relate to the prepayment of certain FHLB advances, high-cost brokered and public certificates of deposit. Losses on liability extinguishment were $148 thousand for the three and nine months ended September 30, 2019. These losses relate to the prepayment of certain FHLB advances.
59
Correspondent banking expense decreased 2% when comparing the third quarter of 2020 to the third quarter of 2019 and increased 2% when comparing the first nine months of 2020 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.
Intangibles amortization expense decreased 5% when comparing the third quarter of 2020 to the same quarter of 2019, and decreased 5% when comparing the first nine months of 2020 to the same period of the prior year. The first nine months of 2019 included $109 thousand of an adjustment to intangible amortization expense related to the finalization of purchase accounting related to the acquisition of the Bates Companies.
Goodwill impairment expense totaled $500 thousand in the first nine months of 2020 related to the sale of the Bates Companies. There was no goodwill impairment expense in the first nine months of 2019.
Loss on sale of subsidiary totaled $305 thousand in the first three and nine months of 2020 related to the sale of the Bates Companies. See Note 10 to the Consolidated Financial Statements for further discussion on the sale of the Bates Companies. There was no loss on sale of subsidiary in the first nine months of 2020.
Other noninterest expense decreased 24% when comparing the third quarter of 2020 to the third quarter of 2019, and decreased 21% when comparing the first nine months of 2020 to the same period of the prior year. This was primarily due to the sale of RB&T. Included in other noninterest expense are items such as subscriptions, sales and use tax and expenses related to wealth management.
INCOME TAXES
In the third quarter of 2020, the Company incurred income tax expense of $4.0 million. During the first nine months of the year, the Company incurred income tax expense of $8.7 million. Following is a reconciliation of the expected income tax expense to the income tax expense included in the consolidated statements of income for the three and nine months ended September 30, 2020 and 2019.
% of
Pretax
Income
Computed "expected" tax expense
4,486
21.0
3,920
10,712
10,411
Tax exempt income, net
(1,350)
(6.3)
(1,169)
(3,822)
(7.5)
(3,344)
(0.5)
(103)
(0.6)
(271)
State income taxes, net of federal benefit, current year
4.7
964
5.2
2,456
4.8
Tax credits
(116)
(39)
(0.2)
(348)
(0.7)
True-up adjustment to year-end provision
(715)
Excess tax benefit on stock options exercised and restricted stock awards vested
(0.3)
(248)
(208)
(0.4)
0.4
0.3
0.5
18.8
19.1
17.1
16.3
The effective tax rate for the quarter ended September 30, 2020 was 18.8%, which was a modest decrease from the effective tax rate of 19.1% for the quarter ended September 30, 2019. The effective tax rate for the nine months ended September 30, 2020 was 17.1%, which was an modest increase over the effective tax rate of 16.3% for the nine months ended September 30, 2019. 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 17.7% for the nine months ended September 30, 2019.
FINANCIAL CONDITION
Following is a table that represents the major categories of the Company’s balance sheet. On November 30, 2019, the Company sold substantially all of the assets and transferred substantially all of the deposits and certain other liabilities of the Company’s wholly-owned subsidiary, RB&T. As a result, those assets and liabilities of RB&T are not included in the Company’s results of its financial condition as of September 30, 2020, June 30, 2020 and December 31, 2019, the removal of which impacts balance sheet comparisons to September 30, 2019.
Cash, federal funds sold, and interest-bearing deposits
371,600
231,477
233,945
288,934
Securities
748,883
555,409
Net loans/leases
4,079,432
3,574,154
225,164
104,418
306,096
309,040
309,767
303,920
10,765
465,547
4,349,775
78
3,802,241
Total borrowings
226,962
376,250
278,955
320,457
233,589
109,242
87,539
70,169
1,588
0
470,530
During the third quarter of 2020, the Company's total assets increased $259.8 million, or 5% from June 30, 2020, to a total of $5.9 billion. The Company’s net loans/leases increased $89.0 million in the third quarter of 2020. Total deposits increased $322.5 million in the third quarter of 2020 primarily due to an increase in noninterest-bearing demand deposits. Borrowings decreased $149.3 million in the third quarter of 2020 which consisted primarily of a decrease in FRB borrowings of $100.0 million, a decrease in overnight FHLB advances of $55.0 million and a decrease in short-term FHLB advances of $50.0 million of which all were offset by an issuance of $50.0 million of subordinated notes. During the quarter, the Company had significant core deposit growth mostly from its correspondent banking clients. The outsized deposit growth exceeded the strong loan growth and led to the Company carrying excess liquidity during the quarter.
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.
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:
17,472
21,268
569,075
526,192
447,853
391,329
145,672
123,880
39,797
10,957
19,764
19,750
5,936
7,975
Securities as a % of Total Assets
13.34
13.36
12.45
11.51
Net Unrealized Gains as a % of Amortized Cost
4.62
4.16
4.88
Duration (in years)
6.6
6.3
6.7
6.5
Yield on investment securities (tax equivalent)
3.77
3.80
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 Company has not invested in non-agency commercial or residential mortgage-backed securities or pooled trust preferred securities. The asset-backed securities, which are comprised of collateral loan obligations, are backed by pools of senior secured commercial loans and were AAA rated as of September 30, 2020.
See Note 2 to the Consolidated Financial Statements for additional information regarding the Company's investment securities.
LOANS/LEASES
Total loans/leases, excluding PPP loans (non-GAAP), grew 11.5% on an annualized basis during the third quarter of 2020 and 7.2% year-to-date. The mix of the loan/lease types within the Company's loan/lease portfolio is presented in the following table.
1,850,110
1,469,978
1,869,162
1,687,922
Direct financing leases
79,105
92,307
Residential real estate loans
241,069
245,667
99,150
106,540
Total loans/leases
4,138,596
3,602,414
1,663
7,856
(60,827)
(36,116)
*Includes PPP loans totaling $357.5 million and $358.1 million as of September 30, 2020 and June 30, 2020, respectively.
As CRE loans have historically been the Company's largest portfolio segment, management places a strong emphasis on monitoring the composition of the Company's CRE loan portfolio. For example, management tracks the level of owner-occupied CRE loans relative to non-owner-occupied loans. Owner-occupied loans are generally considered to have less risk. As of September 30, 2020 and June 30, 2020, approximately 24% and 25% of the CRE loan portfolio was owner-occupied, respectively.
Following is a listing of significant industries within the Company's CRE loan portfolio:
As of June 30,
As of December 31,
Lessors of Residential Buildings
661,562
545,026
465,172
403,766
Lessors of Nonresidential Buildings
578,837
593,063
553,142
544,337
71,435
70,675
63,720
61,199
New Housing For-Sale Builders
47,733
56,229
55,525
45,419
Land Subdivision
46,877
55,555
46,318
46,144
Nonresidential Property Managers
44,293
44,887
48,059
53,581
Lessors of Other Real Estate Property
41,883
40,248
39,297
38,492
Other Activities Related to Real Estate
41,403
38,044
42,060
36,212
Other *
465,692
425,435
423,103
458,772
Total CRE Loans
99
* “Other” consists of all other industries. None of these had concentrations greater than $34.8 million, or approximately 1.7% of total CRE loans in the most recent period presented.
The Company's residential real estate loan portfolio includes the following:
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
59,906
59,782
55,749
Manufacturing - General
18,914
16,939
15,847
16,952
Food Processing Equipment
16,219
16,244
16,742
15,622
Construction - General
14,198
15,156
16,236
16,295
Marine - Travelifts
12,666
11,642
11,556
11,819
Computer Hardware
10,930
11,385
11,509
8,350
Trailers
9,071
9,541
9,907
9,603
93,194
92,071
92,301
107,931
Total m2 loans and leases
235,098
232,760
229,847
230,061
* “Other” consists of all other equipment types. None of these had concentrations greater than 3% of total m2 loan and lease portfolio in the most recent period presented.
See Note 3 to the Consolidated Financial Statements for additional information regarding the Company's loan and lease portfolio.
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ALLOWANCE FOR ESTIMATED LOSSES ON LOANS/LEASES
Changes in the allowance for the three and nine months ended September 30, 2020 and 2019 are presented as follows:
Reclassification of allowance related to held for sale loans
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, 2019, 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 *
104,608
23,195
39,855
31,386
149,996
144,463
53,601
54,581
Criticized Loans **
Classified Loans ***
Criticized Loans as a % of Total Loans/Leases
3.53
Classified Loans as a % of Total Loans/Leases
0.87
* 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.
Criticized loans increased 4% and classified loans increased 77% from June 30, 2020 to September 30, 2020. Criticized loans increased 180% during the first nine months of 2020 primarily due to loans related to borrowers in industries impacted by COVID-19. Classified loan increased 109% during the first nine months of 2020. The increase in classified loans was primarily due to loans related to borrowers in industries impacted by COVID-19. The Company continues its strong focus on improving credit quality in an effort to limit NPLs. See further discussion on industries impacted by COVID-19 in the “Provision for Loan/Lease Losses” section of this report.
Allowance / Gross Loans/Leases
1.87
1.47
Allowance / NPLs
424.57
463.69
403.87
401.56
Although management believes that the allowance at September 30, 2020 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. Based on current economic indicators, the Company increased the economic allocations within the allowance for loan losses calculation. The Company anticipates that the allowance for loan losses as a percent of total loans may increase in future periods based on the belief that the credit quality of the loan portfolio could decline and loan defaults may increase as a result of the COVID-19 pandemic. 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)
12,099
8,231
Accruing loans/leases past due 90 days or more
TDRs - accruing
920
763
13,118
8,994
157
4,248
Other repossessed assets
110
Total NPAs
18,979
13,300
13,084
13,242
NPLs to total loans/leases
0.44
0.32
0.25
NPAs to total loans/leases plus repossessed property
0.37
NPAs to total assets
0.27
NPAs at September 30, 2020 were $19.0 million, up $5.7 million from June 30, 2020 and up $5.7 million from September 30, 2019. The increase in NPAs in the third quarter of 2020 was primarily due to several isolated relationships that experienced degradation not directly related to COVID-19. The ratio of NPAs to total assets was 0.32% at September 30, 2020, up from 0.24% at June 30, 2020 and up from 0.27% at September 30, 2019.
The large majority of the NPAs consist of nonaccrual loans/leases and accruing TDRs. 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.
Due to the economic impacts of COVID-19, the Company established its LRP for its clients. The LRP allows borrowers to request the deferral of principal and interest payments for an agreed upon term. Those deferred payments will be added to the end of the original term of the loan through a three month extension of the maturity date. The CARES Act includes provisions that allow financial institutions to elect to not apply GAAP requirements to loan modifications related to COVID-19 that would otherwise be categorized as a TDR, including arrangements that defer or delay payments of principal or interest for up to 90 days. The relief from TDR guidance applies to modifications of loans that were not more than 30 days past due as of December 31, 2019, and that occur beginning on March 1, 2020 until the earlier of sixty days after the date on which the national emergency related to COVID-19 is terminated or December 31, 2020. The Company expects that the majority of LRP participants will not be categorized as a TDR by meeting the CARES Act provisions. Since implementing the program, the Company has provided 1,498 bank modifications of loans to commercial and consumer clients totaling $522 million and 953 m2 modifications of loans and leases totaling $53 million for a combined 2,451 modifications totaling $575 million, representing 13.53% of the total loan and lease portfolio. As of September 30, 2020, the majority of customers have resumed regularly scheduled payments with only 238 total loans/leases representing $83 million, or 1.95% of total loans/leases, receiving a second deferral under the LRP.
DEPOSITS
Deposits increased $322.5 million during the third quarter of 2020, primarily due to an increase in interest bearing correspondent deposits, net of prepayment of large brokered certificates of deposits. The table below presents the composition of the Company's deposit portfolio.
Noninterest bearing demand deposits
1,177,482
782,232
Interest bearing demand deposits
2,938,194
2,488,755
2,407,502
2,245,557
499,021
560,982
571,343
536,352
Brokered deposits
59,968
122,556
154,982
238,100
Quarter-end balances can greatly fluctuate due to large customer and correspondent bank activity. During the quarter, the Company had significant core deposit growth mostly from its correspondent banking clients. The outsized deposit growth exceeded the strong loan growth and led to the Company carrying excess liquidity during the quarter. As a result of strong core deposit growth, the Company reduced its reliance on higher cost CDs and brokered deposits.
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 industry 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
2,368
2,193
2,421
Federal funds purchased
22,450
11,230
16,105
Overnight federal reserve borrowings
100,000
124,818
18,526
The Company's federal funds purchased and Federal Reserve borrowings fluctuate based on the short-term funding needs of the Company's subsidiary banks.
As a result of their memberships in the FHLB of Des Moines, 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
90,000
60,000
Overnight FHLB advances
55,000
109,300
135,800
145,000
195,800
FHLB advances decreased $105.0 million in the current quarter compared to the prior quarter due to the increase in core deposits that allowed for overnight and term FHLB advances to mature without renewal.
The Company renewed its revolving credit note in the second quarter of 2020. At renewal, the line amount was increased from $20.0 million to $25.0 million. The interest on the revolving line of credit is now calculated at a rate per annum equal to the greater of (a) Prime less 0.50% and (b) 3.00% per annum. Prior to the renewal, the interest on the revolving line of credit was calculated at the effective LIBOR rate plus 2.25% per annum. The collateral on the revolving line of credit is 100% of the outstanding stock of the Company’s bank subsidiaries. There was no outstanding balance on the revolving line of credit at September 30, 2020.
On September 14, 2020, the Company completed a private offering of $50.0 million in aggregate principal amount of fixed-to-floating subordinated notes that mature on September 15, 2030. The subordinated notes, which qualify as Tier 2 capital for the Company, will bear interest at a fixed rate of 5.125% per year, from and including September 14, 2020 to, but excluding September 15, 2025 or earlier redemption. From and including September 15, 2025 to, but excluding the maturity date or earlier redemption date, the interest rate will reset quarterly at a variable rate, which is expected to be the then three-month Term SOFR, plus 500 basis points. Interest on the subordinated notes is payable quarterly, commencing on December 15, 2020. The notes are redeemable, in whole or in part, at any time upon the occurrence of certain events. The subordinated notes may be redeemed at the Company’s option, in whole or in part, on any interest payment date on or after September 15, 2025, at a redemption price equal to 100% of the principal amount of the notes to be redeemed plus accrued and unpaid interest to, but excluding, the date of redemption. 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. The
Company had subordinated notes totaling $118.6 million as of September 30, 2020, up from $68.4 million as of December 31, 2019.
It is management's intention to reduce its reliance on wholesale funding, including FHLB advances 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 and brokered deposits).
Weighted
Maturity:
Amount Due
Year ending December 31:
99,968
200,110
0.85
2021
43,887
2022
50,285
1.79
2023
20,000
1.84
Total Wholesale Funding
314,282
1.20
During the first nine months of 2020, wholesale funding decreased $214.3 million as the Company grew core deposits to build on balance sheet liquidity and the Company used a portion of that excess liquidity to prepay FHLB advances and brokered certificates of deposits.
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)
9.25
* 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.
As it relates to the Company’s TCE/TA, the Company experienced modest net dilution as TCE/TA fell slightly from 8.48% to 8.42%, which was primarily driven by an inflated balance sheet at quarter-end. Excluding the impact of PPP loans, the adjusted TCE/TA at September 30, 2020 was 8.89% (non-GAAP).
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 $321.7 million during the third quarter of 2020 and $327.9 million during the first nine months of 2020. The Company's on balance sheet liquidity position can fluctuate based on short-term activity in deposits and loans.
The Company has been able to access available funding sources to address liquidity needs during the COVID-19 pandemic. In addition, the Company has been able to pledge the PPP loans to the Federal Reserve as part of its operational line of credit.
The subsidiary banks have a variety of sources of short-term liquidity available to them, including federal funds purchased from correspondent banks, FHLB advances, wholesale structured repurchase agreements, brokered deposits, lines of credit, borrowing at the Federal Reserve Discount Window, sales of securities AFS, and loan/lease participations or sales. The Company also generates liquidity from the regular principal payments and prepayments made on its loan/lease portfolio, and on the regular monthly payments on its securities portfolio.
At September 30, 2020, the subsidiary banks had 28 lines of credit totaling $749.9 million, of which $293.9 million was secured and $456.0 million was unsecured. At September 30, 2020, the Company had $749.9 million of the $749.9 million available.
At December 31, 2019, the subsidiary banks had 27 lines of credit totaling $380.6 million, of which $45.3 million was secured and $335.3 million was unsecured. At December 31, 2019, the full $380.6 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 $25.0 million secured revolving credit note with a variable interest rate and a maturity of June 30, 2021. At September 30, 2020, the full $25.0 million was available.
As of September 30, 2020, the Company had $849.6 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 $837.8 million during the first nine months of 2020, compared to $235.1 million for the same period of 2019. The net decrease in federal funds sold was $9.3 million for the first nine months of 2020, compared to a net decrease of $17.1 million for the same period of 2019. The net increase in interest-bearing deposits at financial institutions was $154.2 million for the first nine months of 2020, compared to a net increase of $57.2 million for the same period of 2019. Proceeds from calls, maturities, and paydowns of securities were $72.3 million for the first nine months of 2020, compared to $45.7 million for the same period of 2019. Purchases of securities used cash of $255.5 million for the first nine months of 2020, compared to $28.1 million for the same period of 2019. Proceeds from sales of securities were $28.6 million for the first nine months of 2020, compared to $33.1 million in proceed from sales of securities for the first nine months of 2019. The net increase in loans/leases used cash of $555.3 million for the first nine months of 2020 compared to $237.3 million for the same period of 2019.
Financing activities provided cash of $701.2 million for the first nine months of 2020, compared to $206.1 million for same period of 2019. Net increases in deposits totaled $731.4 million for the first nine months of 2020, compared to $277.0 million for the same period of 2019. During the first nine months of 2020, the Company's short-term borrowings increased
$17.0 million, compared to a decrease in short-term borrowings of $9.1 million for the same period of 2019. Long-term FHLB advances increased $125.0 million during the first nine months of 2020, compared to $25.0 million for the same period of 2019. In the first nine months of 2020, the Company decreased short-term and overnight FHLB advances by $109.3 million. Maturities and principal payments on FHLB term advances totaled $81.6 million in the first nine months of 2020. Prepayments of FHLB advances totaled $55.3 million in the first nine months of 2020. In the first nine months of 2019, the Company decreased short-term and overnight FHLB advances by $16.0 million. Maturities and principal payments on FHLB term advances totaled $35.0 million and on other borrowings totaled $20.99 million in the first nine months of 2019. Prepayments on FHLB term advances totaled $33.2 million and on other borrowings totaled $46.3 million in the first nine months of 2019. Prepayments on brokered and public time deposits totaled $29.4 million during the first nine months of 2020. During the first nine months of 2020, proceeds from subordinated notes were $50.0 million. During the first nine months of 2019, proceeds from subordinated notes were $63.4 million.
Total cash provided by operating activities was $129.3 million for the first nine months of 2020, compared to $46.1 million for the same period of 2019.
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 Company (on a consolidated basis) and the subsidiary banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company and subsidiary banks' financial statements. Refer to Note 8 of the Consolidated Financial Statements for additional information regarding regulatory capital.
SPECIAL NOTE CONCERNING FORWARD-LOOKING STATEMENTS
This document (including information incorporated by reference) contains, and future oral and written statements of the Company and its management may contain, forward-looking statements, within the meaning of such term in the Private Securities Litigation Reform Act of 1995, with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company's management and on information currently available to management, are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “bode,” “predict,” “suggest,” “project,” “appear,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should,” “likely,” or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events.
The Company's ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors that could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries include, but are not limited to, the following:
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, 2019.
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
2018
100 basis point downward shift
(10.0)
0.7
200 basis point upward shift
2.1
1.2
(2.7)
300 basis point upward shock
(25.0)
11.4
4.9
(9.0)
The simulation is within the board-established policy limits for all three scenarios. Additionally, for all of the various interest rate scenarios modeled and measured by management (as described above), the results at September 30, 2020 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 September 30, 2020. 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
In addition to the risk factors set forth under Part I, Item 1A “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, the following risk factors apply to the Company:
The outbreak of COVID-19 has led to an economic recession and other severe disruptions in the U.S. economy and has adversely disrupted banking and other financial activity and industries in the areas in which the Company operates. As a result, we are seeing the impact of COVID-19 on our business, and we believe that it could be significant, adverse and potentially material.
Currently, COVID-19 is continuing to spread through the United States and the world. The spread of highly infectious or contagious diseases could cause, and the spread of COVID-19 has caused, severe disruptions in the U.S. economy at large, and for small businesses in particular, which could disrupt the Company’s operations. The resulting concerns on the part of the U.S. and global populations have resulted in a recessionary environment, reduced economic activity and caused significant volatility in the global stock markets. The Company has experienced disruptions across the Company’s business due to these effects, leading to decreased earnings and slowdowns in loan collections.
The outbreak of COVID-19 has resulted in a decline in our clients’ businesses, a decrease in consumer confidence, an increase in unemployment and a disruption in the services provided by our vendors. Continued disruption to our clients’ businesses could result in increased risk of delinquencies, defaults, foreclosures and losses on our loans, declines in assets under management and wealth management revenues, negatively impact regional economic conditions, result in declines in local loan demand, liquidity of loan guarantors, loan collateral (particularly in real estate), loan originations and deposit availability and negatively impact the implementation of our growth strategy. Although the U.S. government has introduced a number of programs designed to soften the impact of COVID-19 on small businesses, once these programs expire, our borrowers may not be able to satisfy their financial obligations to us.
COVID-19 has impacted and will likely continue to impact businesses’ and consumers’ financial ability to borrow money, which would negatively impact loan volumes. In addition, certain of the Company’s borrowers are in or have exposure to the hotel, restaurant, arts/entertainment/recreation and retail industries and are located in areas that are or were quarantined or under stay-at-home orders, and COVID-19 may also have an adverse effect on the Company’s direct lease financing, commercial real estate and consumer loan portfolios. Any new or prolonged quarantine or stay-at-home orders would have a negative adverse impact on these borrowers and their revenue streams, which consequently impacts their ability to meet their financial obligations and could result in loan defaults.
As a result of the COVID-19 pandemic we may experience adverse financial consequences due to a number of other factors, including, but not limited to:
Overall, we believe that the economic impact from COVID-19 may be severe and could have a material and adverse impact on our business and result in significant losses in our loan portfolio, all of which would adversely and materially impact our earnings and capital. Even after the COVID-19 pandemic has subsided, we may continue to experience materially adverse impacts to our business as a result of the global economic impact of the COVID-19 pandemic, including the availability of credit, adverse impacts on liquidity and any recession that has occurred or may occur in the future. There are no comparable recent events that provide guidance as to the effect of the spread of COVID-19 as a global pandemic may have, and as a result, the ultimate impact of the pandemic is highly uncertain and subject to change.
The U.S. government and banking regulators, including the Federal Reserve, have taken a number of unprecedented actions in response to the COVID-19 pandemic, which could ultimately have a material adverse effect on our business and results of operations.
On March 27, 2020, President Trump signed into law the CARES Act, which established a $2.0 trillion economic stimulus package, including cash payments to individuals, supplemental unemployment insurance benefits and a $349 billion loan program administered through the SBA, referred to as the PPP. In addition to implementing the programs contemplated by the CARES Act, the federal bank regulatory agencies have issued a steady stream of guidance in response to the COVID-19 pandemic and have taken a number of unprecedented steps to help banks navigate the pandemic and mitigate its impact. These include, without limitation:
The COVID-19 pandemic has significantly affected the financial markets, and the Federal Reserve has taken a number of actions in response. In March 2020, the Federal Reserve dramatically reduced the target federal funds rate and announced a $700 billion quantitative easing program in response to the expected economic downturn caused by the COVID-19 pandemic. In addition, the Federal Reserve reduced the interest that it pays on excess reserves. We expect that these reductions in interest rates, especially if prolonged, could adversely affect our net interest income and margins and our profitability. The Federal Reserve also launched the Main Street Lending Program, which will offer deferred interest on four-year loans to small and mid-sized businesses. The full impact of the COVID-19 pandemic on our business activities as a result of new government and regulatory laws, policies, programs and guidelines, as well as market reactions to such activities, remains uncertain but may ultimately have a material adverse effect on our business and results of operations.
COVID-19 has disrupted banking and other financial activities in the areas in which we operate and could potentially create widespread business continuity issues for us.
The COVID-19 pandemic has negatively impacted the ability of our employees and clients to engage in banking and other financial transactions in the geographic area in which we operate and could create widespread business continuity issues for us. We also could be adversely affected if key personnel or a significant number of employees were to become unavailable due to the effects and restrictions of an outbreak or escalation of the COVID-19 pandemic in our market area, including because of illness, quarantines, government actions or other restrictions in connection with the COVID-19 pandemic. Although we have business continuity plans and other safeguards in place, there is no assurance that such plans and safeguards will be effective. Further, we rely upon our third-party vendors to conduct business and to process, record,
and monitor transactions. If any of these vendors are unable to continue to provide us with these services, it could negatively impact our ability to serve our clients.
As a participating lender in the PPP, the Company and the subsidiary banks are subject to additional risks of litigation from our customers or other parties regarding our processing of loans for the PPP and risks that the SBA may not fund some or all PPP loan guaranties.
The CARES Act included a $349 billion loan program administered through the SBA referred to as the PPP. Under the PPP, small businesses and other entities and individuals can apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. The subsidiary banks are participating as lenders in the PPP. The PPP opened on April 3, 2020; however, because of the short timeframe between the passing of the CARES Act and the opening of the PPP, there is some ambiguity in the laws, rules and guidance regarding the operation of the PPP, which exposes the Company to risks relating to noncompliance with the PPP. On or about April 16, 2020, the SBA notified lenders that the $349 billion earmarked for the PPP was exhausted. Although Congress authorized an additional $310 billion funding for PPP loans, the program was closed on August 8, 2020 prior to the exhaustion of these additional funds. It is unknown whether Congress will again authorize additional PPP loan funding.
Since the opening of the PPP, several other larger banks have been subject to litigation regarding the process and procedures that such banks used in processing applications for the PPP and claims related to agent fees. The Company and the subsidiary banks may be exposed to the risk of similar litigation, from both customers and non-customers that approached the banks regarding PPP loans, regarding their process and procedures used in processing applications for the PPP. If any such litigation is filed against the Company or the subsidiary banks and is not resolved in a manner favorable to the Company or the banks, it may result in significant financial liability or adversely affect the Company’s reputation. In addition, litigation can be costly, regardless of outcome. Any financial liability, litigation costs or reputational damage caused by PPP related litigation could have a material adverse impact on our business, financial condition and results of operations.
The subsidiary banks also have credit risk on PPP loans if a determination is made by the SBA that there is a deficiency in the manner in which the loan was originated, funded, or serviced by the banks, such as an issue with the eligibility of a borrower to receive a PPP loan, which may or may not be related to the ambiguity in the laws, rules and guidance regarding the operation of the PPP. In the event of a loss resulting from a default on a PPP loan and a determination by the SBA that there was a deficiency in the manner in which the PPP loan was originated, funded, or serviced by the Company, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of any loss related to the deficiency from the Company.
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds
On February 13, 2020, the Board of Directors of the Company approved a share repurchase program under which the Company is authorized to repurchase, from time to time as the Company deems appropriate, up to 800,000 shares of its outstanding common stock, or approximately 5% of the outstanding shares as of December 31, 2019. The Company suspended the repurchase of shares on March 16, 2020 due to the uncertainties related to the COVID-19 pandemic. It is undecided whether or when the Company will resume the repurchase of shares under this program in the future. All shares repurchased under the share repurchase program were retired.
Total number of shares
Maximum number
purchased as part of
of shares that may yet
Total number of
Average price
publicly announced
be purchased under
Period
shares purchased
paid per share
plans or programs
the plans or programs
July 1-31, 2020
100,932
699,068
August 1-31, 2020
September 1-30, 2020
Item 3 Defaults Upon Senior Securities
None
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).
32.1
Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2
Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101
Inline XBRL Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets as of September 30, 2020 and December 31, 2019; (ii) Consolidated Statements of Income for the three and nine months ended September 30, 2020 and September 30, 2019; (iii) Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2020 and September 30, 2019; (iv) Consolidated Statements of Changes in Stockholders' Equity for the three and nine months ended September 30, 2020 and September 30, 2019; (v) Consolidated Statements of Cash Flows for the nine months ended September 30, 2020 and September 30, 2019; and (vi) Notes to the Consolidated Financial Statements.
104
Inline XBRL cover page interactive data file pursuant to Rule 406 of Regulation S-T for the interactive data files referenced in Exhibit 101.
SIGNATURES
Pursuant to the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
(Registrant)
Date
November 6, 2020
/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/ Nick W. Anderson
Nick W. Anderson
Chief Accounting Officer
(Principal Accounting Officer)