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QCR HOLDINGS INC - Quarter Report: 2016 June (Form 10-Q)

qcrh20160630_10q.htm

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2016

 

[ ]      TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from           to________

 

Commission file number 0-22208

 

QCR HOLDINGS, INC.

(Exact name of Registrant as specified in its charter)

 

Delaware

42-1397595

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

                                                             

3551 7th Street, Moline, Illinois 61265

(Address of principal executive offices, including zip code)

 

(309) 743-7724

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes      [ X ]          No [ ]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes      [ X ]          No [ ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.      (Check one):               

Large accelerated filer [ ] Accelerated filer [ X ] Non-accelerated filer [ ] Smaller reporting company [ ]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes [ ]          No [ X ]   

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date: As of August 1, 2016, the Registrant had outstanding 13,062,382 shares of common stock, $1.00 par value per share.

 

 
 

 

 

QCR HOLDINGS, INC. AND SUBSIDIARIES

 

TABLE OF CONTENTS

 

       

Page

Number(s)

Part I

FINANCIAL INFORMATION

 
         
 

Item 1

Consolidated Financial Statements (Unaudited)

 
         
   

Consolidated Balance Sheets As of June 30, 2016 and December 31, 2015

3

     

 

 
   

Consolidated Statements of Income (Loss) For the Three Months Ended June 30, 2016 and 2015

                   4

     

 

 
   

Consolidated Statements of Income For the Six Months Ended June 30, 2016 and 2015

                   5

     

 

 
   

Consolidated Statements of Comprehensive Income (Loss) For the Three and Six Months Ended June 30, 2016 and 2015

                   6

     

 

 
   

Consolidated Statements of Changes in Stockholders' Equity For the Three and Six Months Ended June 30, 2016 and 2015

                   7

     

 

 
   

Consolidated Statements of Cash Flows For the Six Months Ended June 30, 2016 and 2015

                   8

         
   

Notes to Consolidated Financial Statements

 
         
    Note 1.

Summary of Significant Accounting Policies

                 10

    Note 2.

Investment Securities

                 12

    Note 3.

Loans/Leases Receivable

                 17

    Note 4.

Borrowings

                 27

    Note 5.

Earnings Per Share

                 27

    Note 6.

Fair Value

                 28

    Note 7.

Business Segment Information

                 31

    Note 8.

Regulatory Capital Requirements

                 33

    Note 9.

Acquisition of Community State Bank and Common Stock Offering

                 35

         
 

Item 2

Management's Discussion and Analysis of Financial Condition and Results of Operations

 
         
   

Introduction

                 36

   

General

                 36

   

Executive Overview

                 36

   

Long-Term Financial Goals

                 38

   

Strategic Developments

                 39

   

GAAP to Non-GAAP Reconciliations

                 41

   

Net Interest Income (Tax Equivalent Basis)

                 43

   

Critical Accounting Policies

                 48

 

 

 
1

 

 

 

   

Results of Operations

 
   

Interest Income

                 49

   

Interest Expense

                 49

   

Provision for Loan/Lease Losses

                 50

   

Noninterest Income

                 51

   

Noninterest Expense

                 54

   

Income Taxes

                 56

   

Financial Condition

                 57

   

Investment Securities

                 57

   

Loans/Leases

                 59

   

Allowance for Estimated Losses on Loans/Leases

                 61

   

Nonperforming Assets

                 63

   

Deposits

                 64

   

Borrowings

                 64

   

Stockholders' Equity

                 66

   

Liquidity and Capital Resources

                 66

   

Special Note Concerning Forward-Looking Statements

                 69

       
 

Item 3

Quantitative and Qualitative Disclosures About Market Risk

                 70

       
 

Item 4

Controls and Procedures

                 72

       

Part II

OTHER INFORMATION

 
       
 

Item 1

Legal Proceedings

                 73

       
 

Item 1A

Risk Factors

                 73

       
 

Item 2

Unregistered Sales of Equity Securities and Use of Proceeds

                 73

       
 

Item 3

Defaults upon Senior Securities

                 73

       
 

Item 4

Mine Safety Disclosures

                 73

       
 

Item 5

Other Information

                 73

       
 

Item 6

Exhibits

                 74

       

Signatures

 

 

                 75

 

Throughout the Notes to the Consolidated Financial Statements and Management's Discussion and Analysis of Financial Condition and Results of Operations, we use certain acronyms and abbreviations, as defined in Note 1.

 

 
2

 

  

 

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

As of June 30, 2016 and December 31, 2015

 

   

June 30,

   

December 31,

 
   

2016

   

2015

 

ASSETS

               

Cash and due from banks

  $ 49,581,154     $ 41,742,321  

Federal funds sold

    20,825,000       19,850,000  

Interest-bearing deposits at financial institutions

    47,607,304       36,313,965  
                 

Securities held to maturity, at amortized cost

    280,345,532       253,674,159  

Securities available for sale, at fair value

    230,613,784       323,434,982  

Total securities

    510,959,316       577,109,141  
                 

Loans receivable held for sale

    1,558,500       565,850  

Loans/leases receivable held for investment

    1,921,214,897       1,797,456,825  

Gross loans/leases receivable

    1,922,773,397       1,798,022,675  

Less allowance for estimated losses on loans/leases

    (28,097,490 )     (26,140,906 )

Net loans/leases receivable

    1,894,675,907       1,771,881,769  
                 

Bank-owned life insurance

    56,359,784       55,485,655  

Premises and equipment, net

    38,751,532       37,350,352  

Restricted investment securities

    16,693,125       14,835,925  

Other real estate owned, net

    6,179,102       7,150,658  

Goodwill

    3,222,688       3,222,688  

Core deposit intangible

    1,371,653       1,471,409  

Other assets

    37,207,723       26,784,392  

Total assets

  $ 2,683,434,288     $ 2,593,198,275  
                 

LIABILITIES AND STOCKHOLDERS' EQUITY

               

LIABILITIES

               

Deposits:

               

Noninterest-bearing

  $ 615,764,311     $ 615,292,211  

Interest-bearing

    1,357,829,473       1,265,373,973  

Total deposits

    1,973,593,784       1,880,666,184  
                 

Short-term borrowings

    51,561,748       144,662,716  

Federal Home Loan Bank advances

    196,900,000       151,000,000  

Other borrowings

    100,000,000       110,000,000  

Junior subordinated debentures

    33,412,643       38,499,052  

Other liabilities

    52,848,722       42,484,573  

Total liabilities

    2,408,316,897       2,367,312,525  
                 

STOCKHOLDERS' EQUITY

               

Preferred stock, $1 par value; shares authorized 250,000

    -       -  
June 2016 and December 2015 - No shares issued or outstanding                

Common stock, $1 par value; shares authorized 20,000,000

    13,057,368       11,761,083  
June 2016 - 13,057,368 shares issued and outstanding                
December 2015 - 11,761,083 shares issued and outstanding                

Additional paid-in capital

    155,453,781       123,282,851  

Retained earnings

    105,024,027       92,965,645  

Accumulated other comprehensive income (loss):

               

Securities available for sale

    2,730,155       (1,324,408 )

Interest rate cap derivatives

    (1,147,940 )     (799,421 )

Total stockholders' equity

    275,117,391       225,885,750  

Total liabilities and stockholders' equity

  $ 2,683,434,288     $ 2,593,198,275  

 

See Notes to Consolidated Financial Statements (Unaudited)

 

 
3

 

 

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (LOSS) (UNAUDITED)

Three Months Ended June 30,

 

   

2016

   

2015

 

Interest and dividend income:

               

Loans/leases, including fees

  $ 20,238,179     $ 18,245,724  

Securities:

               

Taxable

    1,192,541       1,735,495  

Nontaxable

    2,276,203       1,890,320  

Interest-bearing deposits at financial institutions

    62,242       64,665  

Restricted investment securities

    133,546       108,161  

Federal funds sold

    10,573       6,247  

Total interest and dividend income

    23,913,284       22,050,612  
                 

Interest expense:

               

Deposits

    1,344,398       1,083,487  

Short-term borrowings

    18,065       53,244  

Federal Home Loan Bank advances

    415,933       1,001,646  

Other borrowings

    824,437       1,108,442  

Junior subordinated debentures

    301,638       312,957  

Total interest expense

    2,904,471       3,559,776  
                 

Net interest income

    21,008,813       18,490,836  
                 

Provision for loan/lease losses

    1,197,850       2,348,665  

Net interest income after provision for loan/lease losses

    19,810,963       16,142,171  
                 

Noninterest income:

               

Trust department fees

    1,512,083       1,511,176  

Investment advisory and management fees

    692,738       758,433  

Deposit service fees

    946,810       924,642  

Gains on sales of residential real estate loans, net

    84,413       95,535  

Gains on sales of government guaranteed portions of loans, net

    1,603,890       69,346  

Swap fee income

    167,582       393,723  

Securities gains, net

    18,030       -  

Earnings on bank-owned life insurance

    480,520       433,152  

Debit card fees

    343,748       255,000  

Correspondent banking fees

    244,939       285,379  

Participation service fees on commercial loan participations

    246,010       223,827  

Fee income from early termination of leases

    66,043       76,722  

Credit card issuing fees

    139,073       135,649  

Other

    216,522       298,650  

Total noninterest income

    6,762,401       5,461,234  
                 

Noninterest expense:

               

Salaries and employee benefits

    10,917,473       11,091,952  

Occupancy and equipment expense

    1,884,556       1,865,552  

Professional and data processing fees

    1,542,322       1,470,695  

Acquisition costs

    354,969       -  

FDIC insurance, other insurance and regulatory fees

    649,604       730,563  

Loan/lease expense

    154,349       208,552  

Net cost of operations of other real estate

    277,911       (47,876 )

Advertising and marketing

    433,451       489,504  

Postage and communications

    256,567       214,142  

Stationery and supplies

    157,924       136,808  

Bank service charges

    415,350       358,996  

Losses on debt extinguishment, net

    -       6,894,185  

Correspondent banking expense

    181,776       165,091  

Other

    517,501       523,470  

Total noninterest expense

    17,743,753       24,101,634  
                 

Net income (loss) before income taxes

    8,829,611       (2,498,229 )

Federal and state income tax expense (benefit)

    2,153,144       (1,974,411 )
                 

Net income (loss)

  $ 6,676,467     $ (523,818 )
                 

Basic earnings (loss) per common share

  $ 0.54     $ (0.05 )

Diluted earnings (loss) per common share

  $ 0.53     $ (0.05 )
                 

Weighted average common shares outstanding

    12,335,077       9,946,744  

Weighted average common and common equivalent shares outstanding

    12,516,474       9,946,744  
                 

Cash dividends declared per common share

  $ 0.04     $ 0.04  

 

See Notes to Consolidated Financial Statements (Unaudited)

 

 
4

 

  

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

Six Months Ended June 30,

 

   

2016

   

2015

 

Interest and dividend income:

               

Loans/leases, including fees

  $ 39,938,549     $ 36,250,243  

Securities:

               

Taxable

    2,548,744       3,678,260  

Nontaxable

    4,518,218       3,620,888  

Interest-bearing deposits at financial institutions

    122,559       141,719  

Restricted investment securities

    264,110       250,479  

Federal funds sold

    23,163       10,753  

Total interest and dividend income

    47,415,343       43,952,342  
                 

Interest expense:

               

Deposits

    2,634,196       2,155,932  

Short-term borrowings

    61,131       117,269  

Federal Home Loan Bank advances

    857,637       2,445,361  

Other borrowings

    1,649,520       2,340,328  

Junior subordinated debentures

    606,524       620,399  

Total interest expense

    5,809,008       7,679,289  
                 

Net interest income

    41,606,335       36,273,053  
                 

Provision for loan/lease losses

    3,270,835       4,059,121  

Net interest income after provision for loan/lease losses

    38,335,500       32,213,932  
                 

Noninterest income:

               

Trust department fees

    3,087,990       3,144,571  

Investment advisory and management fees

    1,351,123       1,468,476  

Deposit service fees

    1,877,889       1,825,998  

Gains on sales of residential real estate loans, net

    144,799       181,675  

Gains on sales of government guaranteed portions of loans, net

    2,482,418       140,319  

Swap fee income

    1,024,540       1,119,930  

Securities gains, net

    376,510       416,933  

Earnings on bank-owned life insurance

    874,129       911,891  

Debit card fees

    651,399       493,000  

Correspondent banking fees

    547,069       605,000  

Participation service fees on commercial loan participations

    456,719       445,776  

Fee income from early termination of leases

    77,793       161,560  

Credit card issuing fees

    275,728       269,810  

Other

    356,768       498,073  

Total noninterest income

    13,584,874       11,683,012  
                 

Noninterest expense:

               

Salaries and employee benefits

    21,718,380       22,126,404  

Occupancy and equipment expense

    3,711,544       3,659,723  

Professional and data processing fees

    2,989,735       2,941,212  

Acquisition costs

    354,969       -  

FDIC insurance, other insurance and regulatory fees

    1,283,969       1,449,620  

Loan/lease expense

    317,168       511,475  

Net cost of operations of other real estate

    380,094       28,975  

Advertising and marketing

    819,710       907,741  

Postage and communications

    473,657       463,098  

Stationery and supplies

    322,795       279,363  

Bank service charges

    831,281       696,454  

Losses on debt extinguishment, net

    83,197       6,894,185  

Correspondent banking expense

    358,765       340,794  

Other

    1,052,987       1,006,751  

Total noninterest expense

    34,698,251       41,305,795  
                 

Net income before income taxes

    17,222,123       2,591,149  

Federal and state income tax expense (benefit)

    4,172,167       (1,062,922 )
                 

Net income

  $ 13,049,956     $ 3,654,071  
                 

Basic earnings per common share

  $ 1.08     $ 0.41  

Diluted earnings per common share

  $ 1.07     $ 0.40  
                 

Weighted average common shares outstanding

    12,064,349       8,961,327  

Weighted average common and common equivalent shares outstanding

    12,235,212       9,098,697  
                 

Cash dividends declared per common share

  $ 0.08     $ 0.04  

 

See Notes to Consolidated Financial Statements (Unaudited)

 

 
5

 

  

QCR HOLDINGS, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)

Three and Six Months Ended June 30, 2016 and 2015

 

   

Three Months Ended June 30,

 
   

2016

   

2015

 

Net income (loss)

  $ 6,676,467     $ (523,818 )
                 

Other comprehensive income (loss):

               
                 

Unrealized gains (losses) on securities available for sale:

               

Unrealized holding gains (losses) arising during the period before tax

    2,081,800       (3,954,857 )

Less reclassification adjustment for gains included in net income before tax

    18,030       -  
      2,063,770       (3,954,857 )

Unrealized gains (losses) on interest rate cap derivatives:

               

Unrealized holding gains (losses) arising during the period before tax

    (159,691 )     119,433  

Less reclassification adjustment for ineffectiveness and caplet amortization before tax

    20,154       9,561  
      (179,845 )     109,872  
                 

Other comprehensive income (loss), before tax

    1,883,925       (3,844,985 )

Tax expense (benefit)

    703,292       (1,466,064 )

Other comprehensive income (loss), net of tax

    1,180,633       (2,378,921 )
                 

Comprehensive income (loss)

  $ 7,857,100     $ (2,902,739 )

 

   

Six Months Ended June 30,

 
    2016     2015  

Net income

  $ 13,049,956     $ 3,654,071  
                 

Other comprehensive income (loss):

               
                 

Unrealized gains on securities available for sale:

               

Unrealized holding gains arising during the period before tax

    6,945,518       443,347  

Less reclassification adjustment for gains included in net income before tax

    376,510       416,933  
      6,569,008       26,414  

Unrealized losses on interest rate cap derivatives:

               

Unrealized holding losses arising during the period before tax

    (549,627 )     (252,950 )

Less reclassification adjustment for ineffectiveness and caplet amortization before tax

    35,591       10,463  
      (585,218 )     (263,413 )
                 

Other comprehensive income (loss), before tax

    5,983,790       (236,999 )

Tax expense (benefit)

    2,277,746       (78,943 )

Other comprehensive income (loss), net of tax

    3,706,044       (158,056 )
                 

Comprehensive income

  $ 16,756,000     $ 3,496,015  

 

See Notes to Consolidated Financial Statements (Unaudited)

 

 
6

 

 

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED)

Three and Six Months Ended June 30, 2016 and 2015

 

                           

Accumulated

                 
           

Additional

           

Other

                 
   

Common

   

Paid-In

   

Retained

   

Comprehensive

   

Treasury

         
   

Stock

   

Capital

   

Earnings

   

Income (Loss)

   

Stock

   

Total

 

Balance December 31, 2015

  $ 11,761,083     $ 123,282,851     $ 92,965,645     $ (2,123,829 )   $ -     $ 225,885,750  

Net income

    -       -       6,373,489       -       -       6,373,489  

Other comprehensive income, net of tax

    -       -       -       2,525,411       -       2,525,411  

Common cash dividends declared, $0.04 per share

    -       -       (470,873 )     -       -       (470,873 )

Proceeds from issuance of 5,054 shares of common stock as a result of stock purchased under the Employee Stock Purchase Plan

    5,054       94,560       -       -       -       99,614  

Proceeds from issuance of 30,331 shares of common stock as a result of stock options exercised

    30,331       382,639       -       -       -       412,970  

Stock compensation expense

    -       382,761                               382,761  

Tax benefit of nonqualified stock options exercised

    -       22,508       -       -       -       22,508  

Restricted stock awards

    22,382       (22,382 )     -       -       -       -  

Exchange of 3,939 shares of common stock in connection with restricted stock vested, net

    (3,939 )     (84,972 )     -       -       -       (88,911 )

Balance March 31, 2016

  $ 11,814,911     $ 124,057,965     $ 98,868,261     $ 401,582     $ -     $ 235,142,719  

Net income

    -       -       6,676,467       -       -       6,676,467  

Other comprehensive income, net of tax

    -       -       -       1,180,633       -       1,180,633  

Common cash dividends declared, $0.04 per share

    -       -       (520,701 )     -       -       (520,701 )

Proceeds from the issuance of 1,215,000 shares of common stock, net of issuance costs

    1,215,000       28,613,916       -       -       -       29,828,916  

Proceeds from issuance of 6,982 shares of common stock as a result of stock purchased under the Employee Stock Purchase Plan

    6,982       142,887       -       -       -       149,869  

Proceeds from issuance of 20,975 shares of common stock as a result of stock options exercised

    20,975       230,671       -       -       -       251,646  

Tax basis adjustment related to the acquistion of noncontrolling interest in m2 Lease Funds

    -       2,132,415       -       -       -       2,132,415  

Stock compensation expense

    -       187,569                               187,569  

Tax benefit of nonqualified stock options exercised

    -       87,858       -       -       -       87,858  

Restricted stock awards

    (500 )     500       -       -       -       -  

Balance June 30, 2016

  $ 13,057,368     $ 155,453,781     $ 105,024,027     $ 1,582,215     $ -     $ 275,117,391  

 

                           

Accumulated

                 
                   

Additional

   

Other

                 
   

Common

   

Paid-In

   

Retained

   

Comprehensive

   

Treasury

         
   

Stock

   

Capital

   

Earnings

   

Income (Loss)

   

Stock

   

Total

 

Balance December 31, 2014

  $ 8,074,443     $ 61,668,968     $ 77,876,824     $ (1,935,216 )   $ (1,606,510 )   $ 144,078,509  

Net income

    -       -       4,177,889       -       -       4,177,889  

Other comprehensive income, net of tax

    -       -       -       2,220,865       -       2,220,865  

Proceeds from issuance of 5,679 shares of common stock as a result of stock purchased under the Employee Stock Purchase Plan

    5,679       82,641       -       -       -      

-

88,320

 

Proceeds from issuance of 9,688 shares of common stock as a result of stock options exercised

    9,688       94,728       -       -       -       104,416  

Stock compensation expense

    -       367,775       -       -       -       367,775  

Tax benefit of nonqualified stock options exercised

    -       15,651       -       -       -       15,651  

Exchange of 3,272 shares of common stock in connection with restricted stock vested, net

    (3,272 )     (54,188 )     -       -       -       (57,460 )

Restricted stock awards

    26,502       (26,502 )     -       -       -       -  

Balance March 31, 2015

  $ 8,113,040     $ 62,149,073     $ 82,054,713     $ 285,649     $ (1,606,510 )   $ 150,995,965  

Net loss

    -       -       (523,818 )     -       -       (523,818 )

Other comprehensive loss, net of tax

    -       -       -       (2,378,921 )     -       (2,378,921 )

Common cash dividends declared, $0.04 per share

    -       -       (464,706 )     -       -       (464,706 )

Proceeds from issuance of 3,680,000 shares of common stock, net of issuance costs

    3,680,000       59,804,123       -       -       -       63,484,123  

Proceeds from issuance of 8,558 shares of common stock as a result of stock purchased under the Employee Stock Purchase Plan

    8,558       128,927       -       -       -       137,485  

Proceeds from issuance of 17,240 shares of common stock as a result of stock options exercised

    17,240       238,717       -       -       -       255,957  

Tax benefit of nonqualified stock options exercised

    -       15,827       -       -       -       15,827  

Exchange of 630 shares of common stock in connection with stock options exercised

    (630 )     (10,616 )     -       -       -       (11,246 )

Stock compensation expense

    -       186,751       -       -       -       186,751  

Restricted stock awards

    1,616       (1,616 )     -       -       -       -  

Balance June 30, 2015

  $ 11,819,824     $ 122,511,186     $ 81,066,189     $ (2,093,272 )   $ (1,606,510 )   $ 211,697,417  

 

See Notes to Consolidated Financial Statements (Unaudited)

 

 
7

 

 

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

Six Months Ended June 30, 2016 and 2015

 

   

2016

   

2015

 

CASH FLOWS FROM OPERATING ACTIVITIES

               

Net income

  $ 13,049,956     $ 3,654,071  

Adjustments to reconcile net income to net cash provided by operating activities:

               

Depreciation

    1,552,176       1,520,380  

Provision for loan/lease losses

    3,270,835       4,059,121  

Stock-based compensation expense

    570,330       554,526  

Deferred compensation expense accrued

    623,831       767,292  

Losses (gains) on other real estate owned, net

    157,739       (69,923 )

Amortization of premiums on securities, net

    611,900       485,085  

Securities gains, net

    (376,510 )     (416,933 )

Loans originated for sale

    (43,526,263 )     (15,205,967 )

Proceeds on sales of loans

    45,160,830       14,532,761  

Gains on sales of residential real estate loans

    (144,799 )     (181,675 )

Gains on sales of government guaranteed portions of loans

    (2,482,418 )     (140,319 )

Losses on debt extinguishment, net

    83,197       6,894,185  

Amortization of core deposit intangible

    99,756       99,756  

Accretion of acquisition fair value adjustments, net

    (61,065 )     (267,414 )

Increase in cash value of bank-owned life insurance

    (874,129 )     (911,891 )

Increase in other assets

    (4,330,548 )     (4,767,394 )

Increase (decrease) in other liabilities

    1,386,323       (1,722,759 )

Net cash provided by operating activities

  $ 14,771,141     $ 8,882,902  
                 

CASH FLOWS FROM INVESTING ACTIVITIES

               

Net decrease (increase) in federal funds sold

    (975,000 )     24,225,000  

Net increase in interest-bearing deposits at financial institutions

    (11,293,339 )     (12,348,141 )

Proceeds from sales of other real estate owned

    864,817       1,723,317  

Activity in securities portfolio:

               

Purchases

    (97,132,279 )     (181,272,218 )

Calls, maturities and redemptions

    96,704,276       177,366,721  

Paydowns

    13,321,512       8,003,250  

Sales

    61,075,145       54,966,923  

Activity in restricted investment securities:

               

Purchases

    (1,857,200 )     (1,338,650 )

Redemptions

    -       3,431,700  

Net increase in loans/leases originated and held for investment

    (124,972,098 )     (85,814,353 )

Purchase of premises and equipment

    (2,953,356 )     (3,927,981 )

Net cash used in investing activities

  $ (67,217,522 )   $ (14,984,432 )
                 

CASH FLOWS FROM FINANCING ACTIVITIES

               

Net increase in deposit accounts

    92,920,820       157,102,985  

Net decrease in short-term borrowings

    (93,100,968 )     (99,776,818 )

Activity in Federal Home Loan Bank advances:

               

Term advances

    -       5,000,000  

Maturities

    (9,000,000 )     (22,000,000 )

Net change in short-term and overnight advances

    64,900,000       21,500,000  

Prepayments

    (10,524,197 )     (81,192,185 )

Activity in other borrowings:

               

Maturities and scheduled principal payments

    -       (7,350,000 )

Prepayments

    (10,759,000 )     (29,177,000 )

Retirement of junior subordinated debentures

    (3,955,000 )     -  

Payment of cash dividends on common stock

    (939,456 )     (315,954 )

Net proceeds from the common stock offering, 3,680,000 shares issued

    -       63,484,123  

Net proceeds from the common stock offering, 1,215,000 shares issued

    29,828,916       -  

Proceeds from issuance of common stock, net

    914,099       586,178  

Net cash provided by financing activities

  $ 60,285,214     $ 7,861,329  
                 

Net increase in cash and due from banks

    7,838,833       1,759,799  

Cash and due from banks, beginning

    41,742,321       38,235,019  

Cash and due from banks, ending

  $ 49,581,154     $ 39,994,818  

 

(Continued)

 

 
8

 

 

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) - continued

Six Months Ended June 30, 2016 and 2015

 

   

2016

   

2015

 

Supplemental disclosure of cash flow information, cash payments for:

               

Interest

  $ 5,852,789     $ 7,903,945  
                 

Income/franchise taxes

  $ 4,869,300     $ 1,940,275  
                 

Supplemental schedule of noncash investing activities:

               

Change in accumulated other comprehensive income, unrealized gains (losses) on securities available for sale and derivative instruments, net

  $ 3,706,044     $ (158,056 )
                 

Exchange of shares of common stock in connection with payroll taxes for restricted stock and in connection with stock options exercised

  $ (88,911 )   $ (68,706 )
                 

Tax benefit of nonqualified stock options exercised

  $ 110,366     $ 31,478  
                 

Transfers of loans to other real estate owned

  $ 51,000     $ 837,782  
                 

Due to broker for purchases of securities

  $ (1,500,000 )   $ -  
                 

Tax basis adjustment related to the acquisition of noncontrolling interest in m2 Lease Funds

  $ 2,132,415     $ -  

 

See Notes to Consolidated Financial Statements (Unaudited)

 

 
9

 

 

Part I

Item 1

QCR HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

June 30, 2016

 

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, 2015, included in the Company’s Annual Report on Form 10-K filed with the SEC on March 11, 2016. Accordingly, footnote disclosures, which would substantially duplicate the disclosures contained in the audited consolidated financial statements, have been omitted.

 

The financial information of the Company included herein has been prepared in accordance with U.S. GAAP for interim financial reporting and has been prepared pursuant to the rules and regulations for reporting on Form 10-Q and Rule 10-01 of Regulation S-X. Such information reflects all adjustments (consisting of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the periods presented. Any differences appearing between the numbers presented in financial statements and management’s discussion and analysis are due to rounding. The results of the interim period ended June 30, 2016, are not necessarily indicative of the results expected for the year ending December 31, 2016, 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

GAAP: Generally Accepted Accounting Principles

AOCI: Accumulated other comprehensive income (loss)

HTM: Held to maturity

AFS: Available for sale

m2: m2 Lease Funds, LLC

ASU: Accounting Standards Update

MD&A: Management's Discussion & Analysis

BOLI: Bank-owned life insurance

NIM: Net interest margin

Caps: Interest rate cap derivatives

NPA: Nonperforming asset

Community National: Community National Bancorporation

NPL: Nonperforming loan

CNB: Community National Bank

OREO: Other real estate owned

CRBT: Cedar Rapids Bank & Trust Company

OTTI: Other-than-temporary impairment

CRE: Commercial real estate

Provision: Provision for loan/lease losses

CSB: Community State Bank

QCBT: Quad City Bank & Trust Company

C&I: Commercial and industrial

RB&T: Rockford Bank & Trust Company

Dodd-Frank Act: Dodd-Frank Wall Street Reform and

ROAA: Return on Average Assets

     Consumer Protection Act

SBA: U.S. Small Business Administration

EPS: Earnings per share

SEC: Securities and Exchange Commission

Exchange Act: Securities Exchange Act of 1934, as 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

The Company: QCR Holdings, Inc.

FRB: Federal Reserve Bank of Chicago

USDA: U.S. Department of Agriculture

 

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries which include three commercial banks: QCBT, CRBT, and RB&T. All are state-chartered commercial banks. The Company also engages in direct financing lease contracts through m2 Lease Funds, a wholly-owned subsidiary of QCBT. All material intercompany transactions and balances have been eliminated in consolidation.

 

On May 23, 2016, the Company announced the signing of a definitive agreement to acquire CSB, headquartered in Ankeny, Iowa, from Van Diest Investment Company. The transaction is expected to close during the third quarter of 2016, subject to certain customary closing conditions. The financial results of CSB are not recognized in this Report. See Note 9 to the Consolidated Financial Statements for additional information about the planned acquisition.

 

 
10

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

Recent accounting developments: In May 2014, FASB issued ASU 2014-09, Revenue from Contracts with Customers. ASU 2014-09 implements a common revenue standard that clarifies the principles for recognizing revenue. The core principle of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply the following steps: (i) identify the contract(s) with a customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract and (v) recognize revenue when (or as) the entity satisfies a performance obligation. ASU 2014-09 was originally effective for the Company on January 1, 2017, however, FASB issued ASU 2015-14 which defers the effective date in order to provide additional time for both public and private entities to evaluate the impact. ASU 2014-09 will now be effective for the Company on January 1, 2018 and it is not expected to have a significant impact on the Company’s consolidated financial statements.

 

In January 2016, FASB issued ASU 2016-01, Financial Instruments – Overall. ASU 2016-01 makes targeted adjustments to GAAP by eliminating the AFS classification for equity securities and requiring equity investments to be measured at fair value with changes in fair value recognized in net income. The standard also requires public business entities to use the exit price notion when measuring fair value of financial instruments for disclosure purposes. The standard clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to AFS securities in combination with the entity’s other deferred tax assets. It also requires an entity to present separately (within other comprehensive income) the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. Additionally, the standard eliminates the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet. ASU 2016-01 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is in the process of analyzing the impact of adoption.

 

In February 2016, the FASB issued ASU 2016-02, Leases. Under ASU 2016-02, lessees will be required to recognize a lease liability measured on a discounted basis and a right-of-use asset for all leases (with the exception of short-term leases). Lessor accounting is largely unchanged under ASU 2016-02. However, the definition of initial direct costs was updated to include only initial direct costs that are considered incremental. This change in definition will change the manner in which the Company recognizes the costs associated with originating leases. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted for all entities. The Company is in the process of analyzing the impact of adoption on the Company’s consolidated financial statements.

 

In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation. ASU 2016-09 aims to simplify the accounting for companies that issue share-based payment awards to their employees. Simplification includes the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows of share-based payment awards. ASU 2016-09 is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The Company is in the process of analyzing the impact of adoption on the Company’s consolidated financial statements.

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses. Under the standard, assets measured at amortized costs (including loans, leases and AFS securities) will be presented at the net amount expected to be collected. Rather than the “incurred” model that is currently being utilized, the standard will require the use of a forward-looking approach to recognizing all expected credit losses at the beginning of an asset’s life. For public companies, ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Companies may choose to early adopt for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is in the process of analyzing the impact of adoption on the Company’s consolidated financial statements.

 

 
11

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

Reclassifications: Certain amounts in the prior year’s consolidated financial statements have been reclassified, with no effect on net income or stockholders’ equity, to conform with the current period presentation.

 

NOTE 2 – INVESTMENT SECURITIES

 

The amortized cost and fair value of investment securities as of June 30, 2016 and December 31, 2015 are summarized as follows:

 

           

Gross

   

Gross

         
   

Amortized

   

Unrealized

   

Unrealized

   

Fair

 
   

Cost

   

Gains

   

(Losses)

   

Value

 

June 30, 2016:

                               

Securities HTM:

                               

Municipal securities

  $ 279,295,532     $ 6,194,753     $ (731,170 )   $ 284,759,115  

Other securities

    1,050,000       -       -       1,050,000  
    $ 280,345,532     $ 6,194,753     $ (731,170 )   $ 285,809,115  
                                 

Securities AFS:

                               

U.S. govt. sponsored agency securities

  $ 87,068,743     $ 1,332,981     $ (80,276 )   $ 88,321,448  

Residential mortgage-backed and related securities

    114,990,076       1,855,710       (80,276 )     116,765,510  

Municipal securities

    22,463,188       945,994       (16,365 )     23,392,817  

Other securities

    1,684,787       449,222       -       2,134,009  
    $ 226,206,794     $ 4,583,907     $ (176,917 )   $ 230,613,784  
                                 

December 31, 2015:

                               

Securities HTM:

                               

Municipal securities

  $ 252,624,159     $ 3,190,558     $ (1,173,432 )   $ 254,641,285  

Other securities

    1,050,000       -       -       1,050,000  
    $ 253,674,159     $ 3,190,558     $ (1,173,432 )   $ 255,691,285  
                                 

Securities AFS:

                               

U.S. govt. sponsored agency securities

  $ 216,281,416     $ 104,524     $ (2,848,561 )   $ 213,537,379  

Residential mortgage-backed and related securities

    81,442,479       511,095       (1,283,439 )     80,670,135  

Municipal securities

    26,764,981       872,985       (59,378 )     27,578,588  

Other securities

    1,108,124       540,919       (163 )     1,648,880  
    $ 325,597,000     $ 2,029,523     $ (4,191,541 )   $ 323,434,982  

 

 
12

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

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 commercial mortgage-backed securities or pooled trust preferred securities.

 

Gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of June 30, 2016 and December 31, 2015, are summarized as follows:

 

   

Less than 12 Months

   

12 Months or More

   

Total

 
           

Gross

           

Gross

           

Gross

 
   

Fair

   

Unrealized

   

Fair

   

Unrealized

   

Fair

   

Unrealized

 
   

Value

   

Losses

   

Value

   

Losses

   

Value

   

Losses

 

June 30, 2016:

                                               

Securities HTM:

                                               

Municipal securities

  $ 5,805,354     $ (384,457 )   $ 14,508,402     $ (346,713 )   $ 20,313,756     $ (731,170 )
                                                 

Securities AFS:

                                               

U.S. govt. sponsored agency securities

  $ 5,825,476     $ (80,276 )   $ -     $ -     $ 5,825,476     $ (80,276 )

Residential mortgage-backed and related securities

    4,337,187       (7,492 )     8,829,330       (72,784 )     13,166,517       (80,276 )

Municipal securities

    380,749       (206 )     850,050       (16,159 )     1,230,799       (16,365 )

Other securities

    -       -       -       -       -       -  
    $ 10,543,412     $ (87,974 )   $ 9,679,380     $ (88,943 )   $ 20,222,792     $ (176,917 )
                                                 

December 31, 2015:

                                               

Securities HTM:

                                               

Municipal securities

  $ 14,803,408     $ (294,438 )   $ 19,927,581     $ (878,994 )   $ 34,730,989     $ (1,173,432 )
                                                 

Securities AFS:

                                               

U.S. govt. sponsored agency securities

  $ 112,900,327     $ (1,397,591 )   $ 64,476,661     $ (1,450,970 )   $ 177,376,988     $ (2,848,561 )

Residential mortgage-backed and related securities

    40,356,921       (730,466 )     19,836,637       (552,973 )     60,193,558       (1,283,439 )

Municipal securities

    2,220,800       (31,807 )     848,329       (27,571 )     3,069,129       (59,378 )

Other securities

    411       (163 )     -       -       411       (163 )
    $ 155,478,459     $ (2,160,027 )   $ 85,161,627     $ (2,031,514 )   $ 240,640,086     $ (4,191,541 )

 

At June 30, 2016, the investment portfolio included 447 securities. Of this number, 30 securities were in an unrealized loss position. The aggregate losses of these securities totaled less than 1% of the total amortized cost of the portfolio. Of these 30 securities, 17 securities had an unrealized loss for twelve months or more. All of the debt securities in unrealized loss positions are considered acceptable credit risks. Based upon an evaluation of the available evidence, including the recent changes in market rates, credit rating information and information obtained from regulatory filings, management believes the declines in fair value for these debt securities are temporary. In addition, the Company does not intend to sell these securities and it is not more-likely-than-not that the Company will be required to sell these debt securities before their anticipated recovery. At June 30, 2016 and December 31, 2015, equity securities represented less than 1% of the total portfolio.

 

The Company did not recognize OTTI on any debt or equity securities for the three or six months ended June 30, 2016 and 2015.   

 

 
13

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

All sales of securities for the three and six months ended June 30, 2016 and 2015, respectively, were from securities identified as AFS. Information on proceeds received, as well as pre-tax gross gains and losses from sales on those securities are as follows:

 

   

Three Months Ended

   

Six Months Ended

 
   

June 30, 2016

   

June 30, 2015

   

June 30, 2016

   

June 30, 2015

 
                                 

Proceeds from sales of securities

  $ 5,548,294     $ -     $ 61,075,145     $ 54,966,923  

Pre-tax gross gains from sales of securities

    18,030       -       533,545       569,551  

Pre-tax gross losses from sales of securities

    -       -       (157,035 )     (152,618 )

 

The amortized cost and fair value of securities as of June 30, 2016 by contractual maturity are shown below. Expected maturities of residential mortgage-backed and related securities may differ from contractual maturities because the residential mortgages underlying the residential mortgage-backed and related securities may be prepaid without any penalties. Therefore, these securities are not included in the maturity categories in the following table. “Other securities” AFS are excluded from the maturity categories as there is no fixed maturity date for those securities.

 

   

Amortized Cost

   

Fair Value

 

Securities HTM:

               

Due in one year or less

  $ 4,972,563     $ 4,993,619  

Due after one year through five years

    20,232,407       20,415,409  

Due after five years

    255,140,562       260,400,087  
    $ 280,345,532     $ 285,809,115  
                 

Securities AFS:

               

Due in one year or less

  $ 2,133,829     $ 2,141,186  

Due after one year through five years

    54,381,038       55,669,426  

Due after five years

    53,017,064       53,903,653  
    $ 109,531,931     $ 111,714,265  

Residential mortgage-backed and related securities

    114,990,076       116,765,510  

Other securities

    1,684,787       2,134,009  
    $ 226,206,794     $ 230,613,784  

 

Portions of the U.S. government sponsored agency securities and municipal securities contain call options, at the discretion of the issuer, to terminate the security at par and at predetermined dates prior to the stated maturity. These callable securities are summarized as follows:

 

   

Amortized Cost

   

Fair Value

 

Securities HTM:

               

Municipal securities

  $ 153,065,142     $ 156,170,970  
                 

Securities AFS:

               

U.S. govt. sponsored agency securities

    23,616,009       23,718,901  

Municipal securities

    13,844,290       14,296,378  
    $ 37,460,299     $ 38,015,279  

 

 
14

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

As of June 30, 2016, the Company’s municipal securities portfolios were comprised of general obligation bonds issued by 77 issuers with fair values totaling $69.0 million and revenue bonds issued by 99 issuers, primarily consisting of states, counties, towns, villages and school districts with fair values totaling $239.1 million. The Company held investments in general obligation bonds in 19 states, including four states in which the aggregate fair value exceeded $5.0 million. The Company held investments in revenue bonds in nine states, including four states in which the aggregate fair value exceeded $5.0 million.

 

As of December 31, 2015, the Company’s municipal securities portfolios were comprised of general obligation bonds issued by 82 issuers with fair values totaling $67.8 million and revenue bonds issued by 92 issuers, primarily consisting of states, counties, towns, villages and school districts with fair values totaling $214.4 million. The Company held investments in general obligation bonds in 19 states, including four states in which the aggregate fair value exceeded $5.0 million. The Company held investments in revenue bonds in nine states, including four states in which the aggregate fair value exceeded $5.0 million.

 

The amortized cost and fair values of the Company’s portfolio of general obligation bonds are summarized in the following tables by the issuer’s state:

 

June 30, 2016:

                               

U.S. State:

 

Number of Issuers

   

Amortized Cost

   

Fair Value

   

Average Exposure Per Issuer (Fair Value)

 
                                 

Iowa

    13     $ 19,441,057     $ 19,965,926     $ 1,535,840  

Illinois

    9       10,127,747       10,527,337       1,169,704  

Missouri

    12       7,349,505       7,519,474       626,623  

North Dakota

    6       16,208,320       16,872,189       2,812,032  

Other

    37       13,738,908       14,133,036       381,974  

Total general obligation bonds

    77     $ 66,865,537     $ 69,017,962     $ 896,337  

 

December 31, 2015:

                               

U.S. State:

 

Number of Issuers

   

Amortized Cost

   

Fair Value

   

Average Exposure Per Issuer (Fair Value)

 
                                 

Iowa

    15     $ 19,974,939     $ 20,247,108     $ 1,349,807  

Illinois

    9       10,928,700       11,264,348       1,251,594  

North Dakota

    5       10,890,000       11,050,235       2,210,047  

Missouri

    12       7,924,800       7,986,856       665,571  

Other

    41       16,965,393       17,229,485       420,231  

Total general obligation bonds

    82     $ 66,683,832     $ 67,778,032     $ 826,561  

 

 
15

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

The amortized cost and fair values of the Company’s portfolio of revenue bonds are summarized in the following tables by the issuer’s state:

 

June 30, 2016:

                               

U.S. State:

 

Number of Issuers

   

Amortized Cost

   

Fair Value

   

Average Exposure Per Issuer (Fair Value)

 
                                 

Missouri

    41     $ 89,033,470     $ 90,174,695     $ 2,199,383  

Iowa

    26       73,076,794       74,933,480       2,882,057  

Indiana

    18       40,009,789       40,615,477       2,256,415  

Kansas

    5       13,172,824       13,315,662       2,663,132  

North Dakota

    4       8,161,630       8,359,661       2,089,915  

Other

    5       11,438,676       11,734,995       2,346,999  

Total revenue bonds

    99     $ 234,893,183     $ 239,133,970     $ 2,415,495  

 

December 31, 2015:

                               

U.S. State:

 

Number of Issuers

   

Amortized Cost

   

Fair Value

   

Average Exposure Per Issuer (Fair Value)

 
                                 

Missouri

    41     $ 78,593,590     $ 79,015,378     $ 1,927,204  

Iowa

    26       70,773,660       71,659,410       2,756,131  

Indiana

    17       40,018,381       40,210,320       2,365,313  

Kansas

    3       11,748,679       11,821,055       3,940,352  

Other

    5       11,570,998       11,735,678       2,347,136  

Total revenue bonds

    92     $ 212,705,308     $ 214,441,841     $ 2,330,890  

 

Both general obligation and revenue bonds are diversified across many issuers. As of June 30, 2016 and December 31, 2015, the Company did not hold general obligation or revenue bonds of any single issuer, the aggregate book or market value of which exceeded 4% of the Company’s stockholders’ equity. Of the general obligation and revenue bonds in the Company’s portfolio, the majority are unrated bonds that represent small, private issuances. All unrated bonds were underwritten according to loan underwriting standards and have an average loan risk rating of 2, indicating very high quality. Additionally, many of these bonds are funding essential municipal services such as water, sewer, education, and medical facilities.

 

The Company’s municipal securities are owned by each of the three charters, whose investment policies set forth limits for various subcategories within the municipal securities portfolio. Each charter is monitored individually, and as of June 30, 2016, all were well within policy limitations approved by the board of directors. Policy limits are calculated as a percentage of total risk-based capital.

 

As of June 30, 2016, the Company’s standard monitoring of its municipal securities portfolio had not uncovered any facts or circumstances resulting in significantly different credit ratings than those assigned by a nationally recognized statistical rating organization, or in the case of unrated bonds, the rating assigned using the credit underwriting standards.

 

 
16

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

NOTE 3 – LOANS/LEASES RECEIVABLE

 

The composition of the loan/lease portfolio as of June 30, 2016 and December 31, 2015 is presented as follows:

 

   

As of June 30,

   

As of December 31,

 
   

2016

   

2015

 
                 

C&I loans

  $ 706,261,186     $ 648,159,892  

CRE loans

               

Owner-occupied CRE

    258,688,445       252,523,164  

Commercial construction, land development, and other land

    48,948,825       49,083,844  

Other non owner-occupied CRE

    476,741,839       422,761,757  
      784,379,109       724,368,765  
                 

Direct financing leases *

    169,927,481       173,655,605  

Residential real estate loans **

    180,482,005       170,432,530  

Installment and other consumer loans

    73,658,172       73,669,493  
      1,914,707,953       1,790,286,285  

Plus deferred loan/lease origination costs, net of fees

    8,065,444       7,736,390  
      1,922,773,397       1,798,022,675  

Less allowance

    (28,097,490 )     (26,140,906 )
    $ 1,894,675,907     $ 1,771,881,769  
                 
                 

* Direct financing leases:

               

Net minimum lease payments to be received

  $ 190,107,687     $ 195,476,230  

Estimated unguaranteed residual values of leased assets

    1,085,154       1,165,706  

Unearned lease/residual income

    (21,265,360 )     (22,986,331 )
      169,927,481       173,655,605  

Plus deferred lease origination costs, net of fees

    6,339,871       6,594,582  
      176,267,352       180,250,187  

Less allowance

    (3,226,194 )     (3,395,088 )
    $ 173,041,158     $ 176,855,099  

 

*Management performs an evaluation of the estimated unguaranteed residual values of leased assets on an annual basis, at a minimum. The evaluation consists of discussions with reputable and current vendors, which is combined with management’s expertise and understanding of the current states of particular industries to determine informal valuations of the equipment. As necessary and where available, management will utilize valuations by independent appraisers. The large majority of leases with residual values contain a lease options rider, which requires the lessee to pay the residual value directly, finance the payment of the residual value, or extend the lease term to pay the residual value. In these cases, the residual value is protected and the risk of loss is minimal. There were no losses related to residual values for the three and six months ended June 30, 2016 and 2015.

 

**Includes residential real estate loans held for sale totaling $1,558,500 and $565,850 as of June 30, 2016, and December 31, 2015, respectively.

 

 
17

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

The aging of the loan/lease portfolio by classes of loans/leases as of June 30, 2016 and December 31, 2015 is presented as follows:

 

   

As of June 30, 2016

 

Classes of Loans/Leases

 

Current

   

30-59 Days Past

Due

   

60-89 Days Past

Due*

   

Accruing Past

Due 90 Days or More

   

Nonaccrual Loans/Leases

   

Total

 
                                                 

C&I

  $ 687,859,076     $ 400,711     $ 13,225,353     $ -     $ 4,776,046     $ 706,261,186  

CRE

                                               

Owner-Occupied CRE

    257,503,344       141,571       -       -       1,043,530       258,688,445  

Commercial Construction, Land Development, and Other Land

    48,759,844       -       -       -       188,981       48,948,825  

Other Non Owner-Occupied CRE

    473,256,279       530,808       1,384,387       84,500       1,485,865       476,741,839  

Direct Financing Leases

    165,927,453       1,036,764       1,230,235       -       1,733,029       169,927,481  

Residential Real Estate

    179,075,229       -       215,561       -       1,191,215       180,482,005  

Installment and Other Consumer

    72,831,797       446,971       59,391       1,868       318,145       73,658,172  
    $ 1,885,213,022     $ 2,556,825     $ 16,114,927     $ 86,368     $ 10,736,811     $ 1,914,707,953  
                                                 

As a percentage of total loan/lease portfolio

    98.46 %     0.13 %     0.84 %     0.00 %     0.56 %     100.00 %

 

   

As of December 31, 2015

 

Classes of Loans/Leases

 

Current

   

30-59 Days Past

Due

   

60-89 Days Past

Due

   

Accruing Past

Due 90 Days or More

   

Nonaccrual Loans/Leases

   

Total

 
                                                 

C&I

  $ 640,725,241     $ 1,636,860     $ 5,816     $ -     $ 5,791,975     $ 648,159,892  

CRE

                                               

Owner-Occupied CRE

    251,612,752       182,949       -       -       727,463       252,523,164  

Commercial Construction, Land Development, and Other Land

    48,890,040       -       -       -       193,804       49,083,844  

Other Non Owner-Occupied CRE

    420,819,874       614,732       219,383       -       1,107,768       422,761,757  

Direct Financing Leases

    170,021,289       1,490,818       439,314       2,843       1,701,341       173,655,605  

Residential Real Estate

    166,415,118       2,800,589       200,080       -       1,016,743       170,432,530  

Installment and Other Consumer

    73,134,197       412,052       14,127       -       109,117       73,669,493  
    $ 1,771,618,511     $ 7,138,000     $ 878,720     $ 2,843     $ 10,648,211     $ 1,790,286,285  
                                                 

As a percentage of total loan/lease portfolio

    98.96 %     0.40 %     0.05 %     0.00 %     0.59 %     100.00 %

 

* Inflated due to a small number of loans that were not renewed timely. Since June 30, 2016, these loans were renewed without issue.

 

 
18

 

  

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

NPLs by classes of loans/leases as of June 30, 2016 and December 31, 2015 are presented as follows:

 

   

As of June 30, 2016

 

Classes of Loans/Leases

 

Accruing Past Due 90 Days or More

   

Nonaccrual Loans/Leases *

   

Accruing

TDRs

   

Total NPLs

   

Percentage of Total NPLs

 
                                         

C&I

  $ -     $ 4,776,046     $ 171,108     $ 4,947,154       39.34 %

CRE

                                       

Owner-Occupied CRE

    -       1,043,530       -       1,043,530       8.30 %

Commercial Construction, Land Development, and Other Land

    -       188,981       -       188,981       1.50 %

Other Non Owner-Occupied CRE

    84,500       1,485,865       -       1,570,365       12.49 %

Direct Financing Leases

    -       1,733,029       1,059,919       2,792,948       22.21 %

Residential Real Estate

    -       1,191,215       393,799       1,585,014       12.60 %

Installment and Other Consumer

    1,868       318,145       128,151       448,164       3.56 %
    $ 86,368     $ 10,736,811     $ 1,752,977     $ 12,576,156       100.00 %

 

*Nonaccrual loans/leases included $2,351,137 of TDRs, including $767,261 in C&I loans, $1,422,722 in CRE loans, $34,850 in direct financing leases, $113,031 in residential real estate loans, and $13,273 in installment loans.

 

   

As of December 31, 2015

 

Classes of Loans/Leases

 

Accruing Past Due 90 Days or More

   

Nonaccrual Loans/Leases **

   

Accruing

TDRs

   

Total NPLs

   

Percentage of Total NPLs

 
                                         

C&I

  $ -     $ 5,791,975     $ 173,087     $ 5,965,062       50.96 %

CRE

                          $ -          

Owner-Occupied CRE

    -       727,463       -     $ 727,463       6.22 %

Commercial Construction, Land Development, and Other Land

    -       193,804       -     $ 193,804       1.66 %

Other Non Owner-Occupied CRE

    -       1,107,768       -     $ 1,107,768       9.46 %

Direct Financing Leases

    2,843       1,701,341       -     $ 1,704,184       14.56 %

Residential Real Estate

    -       1,016,743       402,044     $ 1,418,787       12.12 %

Installment and Other Consumer

    -       109,117       478,625     $ 587,742       5.02 %
    $ 2,843     $ 10,648,211     $ 1,053,756     $ 11,704,810       100.00 %

  

**Nonaccrual loans/leases included $1,533,657 of TDRs, including $1,164,423 in C&I loans, $193,804 in CRE loans, $42,098 in direct financing leases, $119,305 in residential real estate loans, and $14,027 in installment loans.

 

 
19

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

Changes in the allowance by portfolio segment for the three and six months ended June 30, 2016 and 2015, respectively, are presented as follows:

 

   

Three Months Ended June 30, 2016

 
   

C&I

   

CRE

   

Direct Financing Leases

   

Residential Real Estate

   

Installment and Other Consumer

   

Total

 
                                                 

Balance, beginning

  $ 10,991,979     $ 10,090,567     $ 3,287,231     $ 1,836,622     $ 1,189,043     $ 27,395,442  

Provisions (credits) charged to expense

    (241,600 )     919,596       460,997       194,988       (136,131 )     1,197,850  

Loans/leases charged off

    (48,983 )     (23,101 )     (534,716 )     (17,523 )     (9,892 )     (634,215 )

Recoveries on loans/leases previously charged off

    23,110       -       12,682       900       101,721       138,413  

Balance, ending

  $ 10,724,506     $ 10,987,062     $ 3,226,194     $ 2,014,987     $ 1,144,741     $ 28,097,490  

 

   

Three Months Ended June 30, 2015

 
   

C&I

   

CRE

   

Direct Financing Leases

   

Residential Real Estate

   

Installment and Other Consumer

   

Total

 
                                                 

Balance, beginning

  $ 9,093,650     $ 8,838,204     $ 3,310,973     $ 1,597,754     $ 1,042,693     $ 23,883,274  

Provisions charged to expense

    604,731       1,081,753       473,982       122,381       65,818       2,348,665  

Loans/leases charged off

    (45,337 )     -       (465,098 )     -       (25,255 )     (535,690 )

Recoveries on loans/leases previously charged off

    367,822       9,699       32,446       -       39,784       449,751  

Balance, ending

  $ 10,020,866     $ 9,929,656     $ 3,352,303     $ 1,720,135     $ 1,123,040     $ 26,146,000  

 

   

Six Months Ended June 30, 2016

 
                                                 
   

Commercial and Industrial

   

Commercial Real Estate

   

Direct Financing Leases

   

Residential Real Estate

   

Installment and Other Consumer

   

Total

 
                                                 

Balance, beginning

  $ 10,484,080     $ 9,375,117     $ 3,395,088     $ 1,790,150     $ 1,096,471     $ 26,140,906  

Provisions (credits) charged to expense

    498,231       1,635,046       939,242       257,644       (59,328 )     3,270,835  

Loans/leases charged off

    (292,549 )     (23,101 )     (1,135,654 )     (33,707 )     (17,488 )     (1,502,499 )

Recoveries on loans/leases previously charged off

    34,744       -       27,518       900       125,086       188,248  

Balance, ending

  $ 10,724,506     $ 10,987,062     $ 3,226,194     $ 2,014,987     $ 1,144,741     $ 28,097,490  

 

   

Six Months Ended June 30, 2015

 
                                                 
   

Commercial and Industrial

   

Commercial Real Estate

   

Direct Financing Leases

   

Residential Real Estate

   

Installment and Other Consumer

   

Total

 
                                                 

Balance, beginning

  $ 8,750,317     $ 8,353,386     $ 3,442,915     $ 1,525,952     $ 1,001,795     $ 23,074,365  

Provisions charged to expense

    993,372       1,917,647       877,434       194,183       76,485       4,059,121  

Loans/leases charged off

    (245,638 )     (351,076 )     (1,012,590 )     -       (34,049 )     (1,643,353 )

Recoveries on loans/leases previously charged off

    522,815       9,699       44,544       -       78,809       655,867  

Balance, ending

  $ 10,020,866     $ 9,929,656     $ 3,352,303     $ 1,720,135     $ 1,123,040     $ 26,146,000  

 

 
20

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

The allowance by impairment evaluation and by portfolio segment as of June 30, 2016 and December 31, 2015 is presented as follows:

 

   

As of June 30, 2016

 
   

C&I

   

CRE

   

Direct Financing Leases

   

Residential Real Estate

   

Installment and Other Consumer

   

Total

 
                                                 

Allowance for impaired loans/leases

  $ 1,242,430     $ 123,079     $ 555,819     $ 198,020     $ 138,490     $ 2,257,838  

Allowance for nonimpaired loans/leases

    9,482,076       10,863,983       2,670,375       1,816,967       1,006,251       25,839,652  
    $ 10,724,506     $ 10,987,062     $ 3,226,194     $ 2,014,987     $ 1,144,741     $ 28,097,490  
                                                 
                                                 

Impaired loans/leases

  $ 4,454,638     $ 2,616,301     $ 2,678,521     $ 1,585,013     $ 446,297     $ 11,780,770  

Nonimpaired loans/leases

    701,806,548       781,762,808       167,248,960       178,896,992       73,211,875       1,902,927,183  
    $ 706,261,186     $ 784,379,109     $ 169,927,481     $ 180,482,005     $ 73,658,172     $ 1,914,707,953  
                                                 
                                                 

Allowance as a percentage of impaired loans/leases

    27.89 %     4.70 %     20.75 %     12.49 %     31.03 %     19.17 %

Allowance as a percentage of nonimpaired loans/leases

    1.35 %     1.39 %     1.60 %     1.02 %     1.37 %     1.36 %

Total allowance as a percentage of total loans/leases

    1.52 %     1.40 %     1.90 %     1.12 %     1.55 %     1.46 %

 

   

As of December 31, 2015

 
   

C&I

   

CRE

   

Direct Financing Leases

   

Residential Real Estate

   

Installment and Other Consumer

   

Total

 
                                                 

Allowance for impaired loans/leases

  $ 2,592,270     $ 76,934     $ 306,193     $ 185,801     $ 143,089     $ 3,304,287  

Allowance for nonimpaired loans/leases

    7,891,810       9,298,183       3,088,895       1,604,349       953,382       22,836,619  
    $ 10,484,080     $ 9,375,117     $ 3,395,088     $ 1,790,150     $ 1,096,471     $ 26,140,906  
                                                 

Impaired loans/leases

  $ 5,286,482     $ 2,029,035     $ 1,701,341     $ 1,418,787     $ 587,742     $ 11,023,387  

Nonimpaired loans/leases

    642,873,410       722,339,730       171,954,264       169,013,743       73,081,751       1,779,262,898  
    $ 648,159,892     $ 724,368,765     $ 173,655,605     $ 170,432,530     $ 73,669,493     $ 1,790,286,285  
                                                 

Allowance as a percentage of impaired loans/leases

    49.04 %     3.79 %     18.00 %     13.10 %     24.35 %     29.98 %

Allowance as a percentage of nonimpaired loans/leases

    1.23 %     1.29 %     1.80 %     0.95 %     1.30 %     1.28 %

Total allowance as a percentage of total loans/leases

    1.62 %     1.29 %     1.96 %     1.05 %     1.49 %     1.45 %

 

 
21

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

Information for impaired loans/leases is presented in the tables below. The recorded investment represents customer balances net of any partial charge-offs recognized on the loan/lease. The unpaid principal balance represents the recorded balance outstanding on the loan/lease prior to any partial charge-offs.

 

Loans/leases, by classes of financing receivable, considered to be impaired as of and for the six months ended June 30, 2016 are presented as follows:

 

Classes of Loans/Leases

 

Recorded Investment

   

Unpaid Principal Balance

   

Related Allowance

   

Average Recorded Investment

   

Interest Income Recognized

   

Interest Income Recognized for Cash Payments Received

 
                                                 

Impaired Loans/Leases with No Specific Allowance Recorded:

                                               

C&I

  $ 639,448     $ 780,390     $ -     $ 3,197,308     $ 5,343     $ 5,343  

CRE

                                               

Owner-Occupied CRE

    -       93,774       -       163,216       -       -  

Commercial Construction, Land Development, and Other Land

    -       -       -       -       -       -  

Other Non Owner-Occupied CRE

    1,516,555       1,516,555       -       1,243,616       -       -  

Direct Financing Leases

    1,652,661       1,652,661       -       1,398,419       31,500       31,500  

Residential Real Estate

    672,061       711,262       -       627,715       2,051       2,051  

Installment and Other Consumer

    231,730       231,730       -       281,740       -       -  
    $ 4,712,455     $ 4,986,372     $ -     $ 6,912,014     $ 38,894     $ 38,894  
                                                 

Impaired Loans/Leases with Specific Allowance Recorded:

                                               

C&I

  $ 3,815,190     $ 3,819,029     $ 1,242,430     $ 1,775,881     $ -     $ -  

CRE

                                               

Owner-Occupied CRE

    -       -       -       -       -       -  

Commercial Construction, Land Development, and Other Land

    188,981       200,981       79,911       191,384       -       -  

Other Non Owner-Occupied CRE

    910,765       910,765       43,168       595,714       -       -  

Direct Financing Leases

    1,025,860       1,025,860       555,819       866,749       -       -  

Residential Real Estate

    912,952       948,530       198,020       872,297       3,906       3,906  

Installment and Other Consumer

    214,567       214,567       138,490       212,806       2,968       2,968  
    $ 7,068,315     $ 7,119,732     $ 2,257,838     $ 4,514,831     $ 6,874     $ 6,874  
                                                 

Total Impaired Loans/Leases:

                                               

C&I

  $ 4,454,638     $ 4,599,419     $ 1,242,430     $ 4,973,189     $ 5,343     $ 5,343  

CRE

                                               

Owner-Occupied CRE

    -       93,774       -       163,216       -       -  

Commercial Construction, Land Development, and Other Land

    188,981       200,981       79,911       191,384       -       -  

Other Non Owner-Occupied CRE

    2,427,320       2,427,320       43,168       1,839,330       -       -  

Direct Financing Leases

    2,678,521       2,678,521       555,819       2,265,168       31,500       31,500  

Residential Real Estate

    1,585,013       1,659,792       198,020       1,500,012       5,957       5,957  

Installment and Other Consumer

    446,297       446,297       138,490       494,546       2,968       2,968  
    $ 11,780,770     $ 12,106,104     $ 2,257,838     $ 11,426,845     $ 45,768     $ 45,768  

 

Impaired loans/leases for which no allowance has been provided have adequate collateral, based on management’s current estimates.

 

 
22

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

Loans/leases, by classes of financing receivable, considered to be impaired as of and for the three months ended June 30, 2016 and 2015, respectively, are presented as follows:

 

   

Three Months Ended June 30, 2016

   

Three Months Ended June 30, 2015

 

Classes of Loans/Leases

 

Average Recorded Investment

   

Interest Income Recognized

   

Interest Income Recognized for Cash Payments Received

   

Average Recorded Investment

   

Interest Income Recognized

   

Interest Income Recognized for Cash Payments Received

 
                                                 

Impaired Loans/Leases with No Specific Allowance Recorded:

                                               

C&I

  $ 2,524,056     $ 3,519     $ 3,519     $ 320,187     $ 1,860     $ 1,860  

CRE

                                               

Owner-Occupied CRE

    121,444       -       -       550,374       -       -  

Commercial Construction, Land Development, and Other Land

    -       -       -       222,926       -       -  

Other Non Owner-Occupied CRE

    1,311,540       -       -       2,474,448       -       -  

Direct Financing Leases

    1,510,987       19,897       19,897       582,316       1,878       1,878  

Residential Real Estate

    621,354       1,013       1,013       969,580       -       -  

Installment and Other Consumer

    229,207       -       -       705,750       475       475  
    $ 6,318,588     $ 24,429     $ 24,429     $ 5,825,581     $ 4,213     $ 4,213  
                                                 

Impaired Loans/Leases with Specific Allowance Recorded:

                                               

C&I

  $ 2,292,483     $ -     $ -     $ 4,912,917     $ -     $ -  

CRE

                                               

Owner-Occupied CRE

    -       -       -       -       -       -  

Commercial Construction, Land Development, and Other Land

    190,174       -       -       139,250       -       -  

Other Non Owner-Occupied CRE

    658,220       -       -       1,657,506       -       -  

Direct Financing Leases

    995,446       -       -       561,840       -       -  

Residential Real Estate

    919,271       1,948       1,948       869,073       1,967       1,967  

Installment and Other Consumer

    218,742       1,468       1,468       608,277       2,252       2,252  
    $ 5,274,336     $ 3,416     $ 3,416     $ 8,748,863     $ 4,219     $ 4,219  
                                                 

Total Impaired Loans/Leases:

                                               

C&I

  $ 4,816,539     $ 3,519     $ 3,519     $ 5,233,104     $ 1,860     $ 1,860  

CRE

                                               

Owner-Occupied CRE

    121,444       -       -       550,374       -       -  

Commercial Construction, Land Development, and Other Land

    190,174       -       -       362,176       -       -  

Other Non Owner-Occupied CRE

    1,969,760       -       -       4,131,954       -       -  

Direct Financing Leases

    2,506,433       19,897       19,897       1,144,156       1,878       1,878  

Residential Real Estate

    1,540,625       2,961       2,961       1,838,653       1,967       1,967  

Installment and Other Consumer

    447,949       1,468       1,468       1,314,027       2,727       2,727  
    $ 11,592,924     $ 27,845     $ 27,845     $ 14,574,444     $ 8,432     $ 8,432  

 

Impaired loans/leases for which no allowance has been provided have adequate collateral, based on management’s current estimates.

 

 
23

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

Loans/leases, by classes of financing receivable, considered to be impaired as of December 31, 2015 are presented as follows:

 

Classes of Loans/Leases

 

Recorded Investment

   

Unpaid Principal Balance

   

Related Allowance

 
                         

Impaired Loans/Leases with No Specific Allowance Recorded:

                       

C&I

  $ 234,636     $ 346,072     $ -  

CRE

                       

Owner-Occupied CRE

    256,761       350,535       -  

Commercial Construction, Land Development, and Other Land

    -       228,818       -  

Other Non Owner-Occupied CRE

    1,578,470       1,578,470       -  

Direct Financing Leases

    871,884       871,884       -  

Residential Real Estate

    613,486       649,064       -  

Installment and Other Consumer

    377,304       377,304       -  
    $ 3,932,541     $ 4,402,147     $ -  
                         

Impaired Loans/Leases with Specific Allowance Recorded:

                       

C&I

  $ 5,051,846     $ 5,055,685     $ 2,592,270  

CRE

                       

Owner-Occupied CRE

    -       -       -  

Commercial Construction, Land Development, and Other Land

    193,804       205,804       76,934  

Other Non Owner-Occupied CRE

    -       -       -  

Direct Financing Leases

    829,457       829,457       306,193  

Residential Real Estate

    805,301       805,301       185,801  

Installment and Other Consumer

    210,438       210,438       143,089  
    $ 7,090,846     $ 7,106,685     $ 3,304,287  
                         

Total Impaired Loans/Leases:

                       

C&I

  $ 5,286,482     $ 5,401,757     $ 2,592,270  

CRE

                       

Owner-Occupied CRE

    256,761       350,535       -  

Commercial Construction, Land Development, and Other Land

    193,804       434,622       76,934  

Other Non Owner-Occupied CRE

    1,578,470       1,578,470       -  

Direct Financing Leases

    1,701,341       1,701,341       306,193  

Residential Real Estate

    1,418,787       1,454,365       185,801  

Installment and Other Consumer

    587,742       587,742       143,089  
    $ 11,023,387     $ 11,508,832     $ 3,304,287  

 

Impaired loans/leases for which no allowance has been provided have adequate collateral, based on management’s current estimates.

 

 
24

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

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 direct financing leases, residential real estate loans, and installment and other consumer loans, the Company’s credit quality indicator is performance determined by delinquency status. Delinquency status is updated daily by the Company’s loan system.

 

For each class of financing receivable, the following presents the recorded investment by credit quality indicator as of June 30, 2016 and December 31, 2015:

 

   

As of June 30, 2016

 
           

CRE

                 
                   

Non Owner-Occupied

                 

Internally Assigned Risk Rating

 

C&I

   

Owner-Occupied CRE

   

Commercial Construction, Land Development, and Other Land

   

Other CRE

   

Total

   

As a % of Total

 
                                                 

Pass (Ratings 1 through 5)

  $ 678,225,838     $ 247,914,237     $ 44,672,408     $ 458,961,143     $ 1,429,773,626       95.92 %

Special Mention (Rating 6)

    6,381,586       2,114,505       1,780,000       5,954,788       16,230,879       1.09 %

Substandard (Rating 7)

    21,653,762       8,659,703       2,496,417       11,825,908       44,635,790       2.99 %

Doubtful (Rating 8)

    -       -       -       -       -       -  
    $ 706,261,186     $ 258,688,445     $ 48,948,825     $ 476,741,839     $ 1,490,640,295       100.00 %

 

   

As of June 30, 2016

 

Delinquency Status *

 

Direct Financing Leases

   

Residential Real Estate

   

Installment and Other Consumer

   

Total

   

As a % of Total

 
                                         

Performing

  $ 167,134,533     $ 178,896,991     $ 73,210,008     $ 419,241,532       98.86 %

Nonperforming

    2,792,948       1,585,014       448,164       4,826,126       1.14 %
    $ 169,927,481     $ 180,482,005     $ 73,658,172     $ 424,067,658       100.00 %

 

   

As of December 31, 2015

 
           

CRE

                 
                   

Non Owner-Occupied

                 

Internally Assigned Risk Rating

 

C&I

   

Owner-Occupied CRE

   

Commercial Construction, Land Development, and Other Land

   

Other CRE

   

Total

   

As a % of Total

 
                                                 

Pass (Ratings 1 through 5)

  $ 616,200,797     $ 238,119,608     $ 46,929,876     $ 406,027,442     $ 1,307,277,723       95.24 %

Special Mention (Rating 6)

    18,031,845       8,630,658       1,780,000       8,846,286       37,288,789       2.72 %

Substandard (Rating 7)

    13,927,250       5,772,898       373,968       7,888,029       27,962,145       2.04 %

Doubtful (Rating 8)

    -       -       -       -       -       -  
    $ 648,159,892     $ 252,523,164     $ 49,083,844     $ 422,761,757     $ 1,372,528,657       100.00 %

 

   

As of December 31, 2015

 

Delinquency Status *

 

Direct Financing Leases

   

Residential Real Estate

   

Installment and Other Consumer

   

Total

   

As a % of Total

 
                                         

Performing

  $ 171,951,421     $ 169,013,743     $ 73,081,751     $ 414,046,915       99.11 %

Nonperforming

    1,704,184       1,418,787       587,742       3,710,713       0.89 %
    $ 173,655,605     $ 170,432,530     $ 73,669,493     $ 417,757,628       100.00 %

 

*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.

 

 
25

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

As of June 30, 2016 and December 31, 2015, TDRs totaled $4,104,114 and $2,587,413, respectively.

 

For each class of financing receivable, the following presents the number and recorded investment of TDRs, by type of concession, that were restructured during the three and six months ended June 30, 2016. There were no TDRs that were restructured during the three and six months ended June 30, 2015. The difference between the pre-modification recorded investment and the post-modification recorded investment would be any partial charge-offs at the time of the restructuring.

 

   

For the three months ended June 30, 2016

 

Classes of Loans/Leases

 

Number of Loans / Leases

   

Pre-Modification Recorded Investment

   

Post-Modification Recorded Investment

   

Specific Allowance

 
                                 

CONCESSION - Extension of Maturity

                               

C&I

    1     $ 52,286     $ 52,286     $ -  
      1     $ 52,286     $ 52,286     $ -  
                                 

CONCESSION - Significant Payment Delay

                               

C&I

    1     $ 62,140     $ 62,140     $ -  

Direct Financing Leases

    4       494,692       494,692       -  
      5     $ 556,832     $ 556,832     $ -  
                                 

CONCESSION - Interest Rate Adjusted Below Market

                               

CRE - Other

    1     $ 1,233,740     $ 1,233,740     $ -  
      1     $ 1,233,740     $ 1,233,740     $ -  
                                 

TOTAL

    7     $ 1,842,858     $ 1,842,858     $ -  

 

   

For the six months ended June 30, 2016

 

Classes of Loans/Leases

 

Number of Loans / Leases

   

Pre-Modification Recorded Investment

   

Post-Modification Recorded Investment

   

Specific Allowance

 
                                 

CONCESSION - Extension of Maturity

                               

C&I

    1     $ 52,286     $ 52,286     $ -  

Direct Financing Leases

    4       410,653       410,653       -  
      5     $ 462,939     $ 462,939     $ -  
                                 

CONCESSION - Significant Payment Delay

                               

C&I

    1     $ 62,140     $ 62,140     $ -  

Direct Financing Leases

    5       540,631       540,631       -  
      6     $ 602,771     $ 602,771     $ -  
                                 

CONCESSION - Interest Rate Adjusted Below Market

                               

CRE - Other

    1     $ 1,233,740     $ 1,233,740     $ -  
      1     $ 1,233,740     $ 1,233,740     $ -  
                                 

TOTAL

    12     $ 2,299,450     $ 2,299,450     $ -  

 

Of the TDRs reported above, one with a post-modification recorded balance of $1,233,740 was on nonaccrual as of June 30, 2016.

 

For the three and six months ended June 30, 2016 and 2015, none of the Company’s TDRs had redefaulted within 12 months subsequent to restructure where default is defined as delinquency of 90 days or more and/or placement on nonaccrual status.

 

 
26

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

NOTE 4 BORROWINGS

 

During the first quarter of 2016, the Company extinguished $5.1 million of the QCR Holdings Capital Trust IV junior subordinated debentures (the full balance outstanding) and recorded a $1.2 million gain on extinguishment (pre-tax), as the Company was able to acquire the related security at a discount through auction. This gain is included in the statements of income within losses on debt extinguishment. The interest rate on these debentures floated at 3-month LIBOR plus 1.80% and had a rate of 2.42% at the time of extinguishment. QCR Holdings Capital Trust IV was dissolved after the extinguishment.

 

Also during the first quarter of 2016, the Company executed balance sheet restructuring strategies at QCBT and CRBT, which included the repayment of $10.0 million of wholesale structured repurchase agreements and $10.0 million of FHLB advances with a combined weighted average interest rate of 3.92%. As a result of this restructuring, the Company incurred $1.3 million (pre-tax) in losses on debt extinguishment that are included in the statements of income. The weighted average duration of this combined debt was 2.17 years, with $10.0 million maturing in 2017 and $10.0 maturing in 2018. This funding was replaced with short-term borrowings at an average interest rate of 0.50%.

 

As of December 31, 2015, the Company maintained a $40.0 million revolving line of credit note, with interest calculated at the effective LIBOR rate plus 2.50% per annum (3.10% at December 31, 2015). At December 31, 2015, the Company had not borrowed on this revolving credit note and had the full amount available. At the renewal date in June 2016, the note was amended to provide a $10.0 million revolving line of credit note and a $30.0 million term note commitment with a 5-year term. Interest on both facilities is calculated at the effective LIBOR rate plus 2.50% per annum (3.13% at June 30, 2016). At June 30, 2016, the Company had not borrowed on either of these facilities and had the full amounts available. Similar to the previous revolving note agreement, the amended agreement contains covenants that place restrictions on additional debt and stipulate minimum capital and various operating ratios.

 

NOTE 5 - EARNINGS PER SHARE

 

The following information was used in the computation of EPS on a basic and diluted basis:

 

   

Three months ended

   

Six months ended

 
   

June 30,

   

June 30,

 
   

2016

   

2015

   

2016

   

2015

 
                                 

Net income (loss)

  $ 6,676,467     $ (523,818 )   $ 13,049,956     $ 3,654,071  
                                 

Basic EPS

  $ 0.54     $ (0.05 )   $ 1.08     $ 0.41  

Diluted EPS

  $ 0.53     $ (0.05 )   $ 1.07     $ 0.40  
                                 

Weighted average common shares outstanding*

    12,335,077       9,946,744       12,064,349       8,961,327  

Weighted average common shares issuable upon exercise of stock options and under the employee stock purchase plan**

    181,397       -       170,863       137,370  

Weighted average common and common equivalent shares outstanding**

    12,516,474       9,946,744       12,235,212       9,098,697  

 

*The increase in the weighted average common shares outstanding was primarily due to the common stock issuance discussed in Note 9 to the Consolidated Financial Statements.

**In accordance with U.S. GAAP, the common equivalent shares are not considered in the calculation of diluted EPS in periods when the numerator is a net loss.

 

 
27

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

NOTE 6 – FAIR VALUE

 

Accounting guidance on fair value measurement uses a hierarchy intended to maximize the use of observable inputs and minimize the use of unobservable inputs. This hierarchy includes three levels and is based upon the valuation techniques used to measure assets and liabilities. The three levels are as follows:

 

 

Level 1 – Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in markets;

 

Level 2 – Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument; and

 

Level 3 – Inputs to the valuation methodology are unobservable and significant to the fair value measurement.

 

Assets and liabilities measured at fair value on a recurring basis comprise the following at June 30, 2016 and December 31, 2015:

 

           

Fair Value Measurements at Reporting Date Using

 
           

Quoted Prices

   

Significant

         
           

in Active

   

Other

   

Significant

 
           

Markets for

   

Observable

   

Unobservable

 
           

Identical Assets

   

Inputs

   

Inputs

 
   

Fair Value

   

(Level 1)

   

(Level 2)

   

(Level 3)

 
                                 

June 30, 2016:

                               

Securities AFS:

                               

U.S. govt. sponsored agency securities

  $ 88,321,448     $ -     $ 88,321,448     $ -  

Residential mortgage-backed and related securities

    116,765,510       -       116,765,510       -  

Municipal securities

    23,392,817       -       23,392,817       -  

Other securities

    2,134,009       1,353       2,132,656       -  

Interest rate caps

    270,806       -       270,806       -  

Interest rate swaps - assets

    9,867,856       -       9,867,856       -  

Total assets measured at fair value

  $ 240,752,446     $ 1,353     $ 240,751,093     $ -  
                                 

Interest rate swaps - liabilities

  $ 9,867,856     $ -     $ 9,867,856     $ -  

Total liabilities measured at fair value

  $ 9,867,856     $ -     $ 9,867,856     $ -  
                                 
                                 

December 31, 2015:

                               

Securities AFS:

                               

U.S. govt. sponsored agency securities

  $ 213,537,379     $ -     $ 213,537,379     $ -  

Residential mortgage-backed and related securities

    80,670,135       -       80,670,135       -  

Municipal securities

    27,578,588       -       27,578,588       -  

Other securities

    1,648,880       411       1,648,469       -  

Interest rate caps

    856,024       -       856,024       -  

Interest rate swaps - assets

    3,044,525       -       3,044,525       -  

Total assets measured at fair value

  $ 327,335,531     $ 411     $ 327,335,120     $ -  
                                 

Interest rate swaps - liabilities

  $ 3,044,525     $ -     $ 3,044,525     $ -  

Total liabilities measured at fair value

  $ 3,044,525     $ -     $ 3,044,525     $ -  

 

There were no transfers of assets or liabilities between Levels 1, 2, and 3 of the fair value hierarchy for the three and six months ended June 30, 2016 or 2015.

 

A small portion of the securities available for sale portfolio consists of common stock issued by various unrelated bank holding companies. The fair values used by the Company are obtained from an independent pricing service and represent quoted market prices for the identical securities (Level 1 inputs).

 

The remainder of the securities available for sale portfolio consists of securities whereby the Company obtains fair values from an independent pricing service. The fair values are determined by pricing models that consider observable market data, such as interest rate volatilities, LIBOR yield curve, credit spreads and prices from market makers and live trading systems (Level 2 inputs).

 

 
28

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

Interest rate caps are used for the purpose of hedging interest rate risk. The fair values are determined by pricing models that consider observable market data for derivative instruments with similar structures (Level 2 inputs).

 

Interest rate swaps are executed for select commercial customers. The interest rate swaps are further described in Note 1 of the Company’s annual report filed on form 10-K as of December 31, 2015. The fair values are determined by comparing the contract rate on the swap with the then-current market rate for the remaining term of the transaction (Level 2 inputs).

 

Certain financial assets are measured at fair value on a non-recurring basis; that is, the assets are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).

 

Assets measured at fair value on a non-recurring basis comprise the following at June 30, 2016 and December 31, 2015:

 

           

Fair Value Measurements at Reporting Date Using

 
   

Fair Value

   

Level 1

   

Level 2

   

Level 3

 

June 30, 2016:

                               

Impaired loans/leases

  $ 5,669,757     $ -     $ -     $ 5,669,757  

OREO

    6,673,430       -       -       6,673,430  
    $ 12,343,187     $ -     $ -     $ 12,343,187  
                                 

December 31, 2015:

                               

Impaired loans/leases

  $ 4,545,966     $ -     $ -     $ 4,545,966  

OREO

    7,722,711       -       -       7,722,711  
    $ 12,268,677     $ -     $ -     $ 12,268,677  

 

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

 
   

Fair Value

June 30, 2016

   

Fair Value

December 31, 2015

 

Valuation Technique

Unobservable Input

 

Range

 
                               

Impaired loans/leases

  $ 5,669,757     $ 4,545,966  

Appraisal of collateral

Appraisal adjustments

  -10.00% to -50.00%  

OREO

    6,673,430       7,722,711  

Appraisal of collateral

Appraisal adjustments

  0.00% to  -35.00%  

 

 
29

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

For the impaired loans/leases and OREO, the Company records carrying value at fair value less disposal or selling costs. The amounts reported in the tables above are fair values before the adjustment for disposal or selling costs.

 

There have been no changes in valuation techniques used for any assets measured at fair value during the three and six months ended June 30, 2016 and 2015.

 

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:

 

   

Fair Value

   

As of June 30, 2016

   

As of December 31, 2015

 
   

Hierarchy

   

Carrying

   

Estimated

   

Carrying

   

Estimated

 
   

Level

   

Value

   

Fair Value

   

Value

   

Fair Value

 
                                         

Cash and due from banks

 

Level 1

    $ 49,581,154     $ 49,581,154     $ 41,742,321     $ 41,742,321  

Federal funds sold

 

Level 2

      20,825,000       20,825,000       19,850,000       19,850,000  

Interest-bearing deposits at financial institutions

 

Level 2

      47,607,304       47,607,304       36,313,965       36,313,965  

Investment securities:

                                       

HTM

 

Level 2

      280,345,532       285,809,115       253,674,159       255,691,285  

AFS

 

See Previous Table

      240,481,640       240,481,640       323,434,982       323,434,982  

Loans/leases receivable, net

 

Level 3

      5,249,775       5,669,757       4,209,228       4,545,966  

Loans/leases receivable, net

 

Level 2

      1,889,426,132       1,897,957,225       1,767,672,541       1,764,178,772  

Interest rate caps

 

Level 2

      270,806       270,806       856,024       856,024  

Interest rate swaps - assets

 

Level 2

      9,867,856       9,867,856       3,044,525       3,044,525  

Deposits:

                                       

Nonmaturity deposits

 

Level 2

      1,554,404,101       1,554,404,101       1,516,599,081       1,516,599,081  

Time deposits

 

Level 2

      419,189,683       420,107,000       364,067,103       364,192,000  

Short-term borrowings

 

Level 2

      51,561,748       51,561,748       144,662,716       144,662,716  

FHLB advances

 

Level 2

      196,900,000       198,373,000       151,000,000       153,143,000  

Other borrowings

 

Level 2

      100,000,000       106,692,000       110,000,000       116,061,000  

Junior subordinated debentures

 

Level 2

      33,412,643       24,627,848       38,499,052       27,642,093  

Interest rate swaps - liabilities

 

Level 2

      9,867,856       9,867,856       3,044,525       3,044,525  

 

 
30

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

NOTE 7 – BUSINESS SEGMENT INFORMATION

 

Selected financial and descriptive information is required to be disclosed for reportable operating segments, applying a “management perspective” as the basis for identifying reportable segments. The management perspective is determined by the view that management takes of the segments within the Company when making operating decisions, allocating resources, and measuring performance. The segments of the Company have been defined by the structure of the Company’s internal organization, focusing on the financial information that the Company’s operating decision-makers routinely use to make decisions about operating matters.

 

The Company’s primary segment, Commercial Banking, is geographically divided by markets into the secondary segments comprised of the three subsidiary banks wholly owned by the Company: QCBT, CRBT, and RB&T. Each of these secondary segments offers similar products and services, but is managed separately due to different pricing, product demand, and consumer markets. Each offers commercial, consumer, and mortgage loans and deposit services.

 

The Company’s Wealth Management segment represents the trust and asset management and investment management and advisory services offered at the Company’s three subsidiary banks in aggregate. This segment generates income primarily from fees charged based on assets under administration for corporate and personal trusts, custodial services, and investments managed. No assets of the subsidiary banks have been allocated to the Wealth Management segment.

 

The Company’s All Other segment includes the operations of all other consolidated subsidiaries and/or defined operating segments that fall below the segment reporting thresholds. This segment includes the corporate operations of the parent company.

 

 
31

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

Selected financial information on the Company’s business segments is presented as follows as of and for the three and six months ended June 30, 2016 and 2015.

 

   

Commercial Banking

   

Wealth

           

Intercompany

   

Consolidated

 
   

QCBT

   

CRBT

   

RB&T

   

Management

   

All Other

   

Eliminations

   

Total

 

Three Months Ended June 30, 2016

                                                       

Total revenue

  $ 14,162,914     $ 10,438,092     $ 3,918,629     $ 2,204,821     $ 8,244,495     $ (8,293,266 )   $ 30,675,685  

Net interest income

  $ 11,207,759     $ 7,135,725     $ 2,945,417     $ -     $ (280,088 )   $ -     $ 21,008,813  

Net income

  $ 3,898,343     $ 3,144,986     $ 772,169     $ 386,202     $ 6,676,467     $ (8,201,700 )   $ 6,676,467  

Total assets

  $ 1,390,025,232     $ 904,367,275     $ 402,157,473     $ -     $ 328,099,700     $ (341,215,392 )   $ 2,683,434,288  

Provision

  $ 747,850     $ 150,000     $ 300,000     $ -     $ -     $ -     $ 1,197,850  

Goodwill

  $ 3,222,688     $ -     $ -     $ -     $ -     $ -     $ 3,222,688  

Core deposit intangible

  $ -     $ 1,371,653     $ -     $ -     $ -     $ -     $ 1,371,653  
                                                         

Three Months Ended June 30, 2015

                                                       

Total revenue

  $ 12,930,582     $ 8,777,259     $ 3,627,740     $ 2,269,609     $ 718,325     $ (811,669 )   $ 27,511,846  

Net interest income

  $ 9,741,899     $ 6,522,511     $ 2,684,330     $ -     $ (457,904 )   $ -     $ 18,490,836  

Net income (loss)

  $ 229,577     $ (316,567 )   $ 529,567     $ 438,530     $ (523,818 )   $ (881,107 )   $ (523,818 )

Total assets

  $ 1,299,556,911     $ 860,403,296     $ 363,049,771     $ -     $ 268,874,722     $ (248,915,854 )   $ 2,542,968,846  

Provision

  $ 1,673,665     $ 500,000     $ 175,000     $ -     $ -     $ -     $ 2,348,665  

Goodwill

  $ 3,222,688     $ -     $ -     $ -     $ -     $ -     $ 3,222,688  

Core deposit intangible

  $ -     $ 1,571,165     $ -     $ -     $ -     $ -     $ 1,571,165  
                                                         

Six Months Ended June 30, 2016

                                                       

Total revenue

  $ 27,679,846     $ 21,277,313     $ 7,712,876     $ 4,439,113     $ 15,104,270     $ (15,213,201 )   $ 61,000,217  

Net interest income

  $ 22,169,206     $ 14,160,713     $ 5,857,391     $ -     $ (580,975 )   $ -     $ 41,606,335  

Net income

  $ 6,730,039     $ 6,079,717     $ 1,389,954     $ 833,972     $ 13,049,955     $ (15,033,681 )   $ 13,049,956  

Total assets

  $ 1,390,025,232     $ 904,367,275     $ 402,157,473     $ -     $ 328,099,700     $ (341,215,392 )   $ 2,683,434,288  

Provision

  $ 1,970,835     $ 700,000     $ 600,000     $ -     $ -     $ -     $ 3,270,835  

Goodwill

  $ 3,222,688     $ -     $ -     $ -     $ -     $ -     $ 3,222,688  

Core deposit intangible

  $ -     $ 1,371,653     $ -     $ -     $ -     $ -     $ 1,371,653  
                                                         

Six Months Ended June 30, 2015

                                                       

Total revenue

  $ 25,732,000     $ 18,302,906     $ 7,169,330     $ 4,613,047     $ 6,334,768     $ (6,516,697 )   $ 55,635,354  

Net interest income

  $ 19,016,937     $ 12,880,808     $ 5,318,412     $ -     $ (943,104 )   $ -     $ 36,273,053  

Net income

  $ 2,792,190     $ 1,751,739     $ 1,048,224     $ 897,860     $ 3,654,071     $ (6,490,013 )   $ 3,654,071  

Total assets

  $ 1,299,556,911     $ 860,403,296     $ 363,049,771     $ -     $ 268,874,722     $ (248,915,854 )   $ 2,542,968,846  

Provision

  $ 2,556,121     $ 1,100,000     $ 403,000     $ -     $ -     $ -     $ 4,059,121  

Goodwill

  $ 3,222,688     $ -     $ -     $ -     $ -     $ -     $ 3,222,688  

Core deposit intangible

  $ -     $ 1,571,165     $ -     $ -     $ -     $ -     $ 1,571,165  

 

 

 
32

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

NOTE 8 – REGULATORY CAPITAL REQUIREMENTS

 

The Company (on a consolidated basis) and the subsidiary banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company and subsidiary banks’ financial statements.

 

Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the subsidiary banks must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the subsidiary banks to maintain minimum amounts and ratios (set forth in the following table) of total common equity Tier 1 and Tier 1 capital to risk-weighted assets and of Tier 1 capital to average assets, each as defined by regulation. Management believes, as of June 30, 2016 and December 31, 2015, that the Company and the subsidiary banks met all capital adequacy requirements to which they are subject.

 

Under the regulatory framework for prompt corrective action, to be categorized as “well capitalized,” an institution must maintain minimum total risk-based, Tier 1 risk-based, Tier 1 leverage and common equity Tier 1 ratios as set forth in the following tables. The Company and the subsidiary banks’ actual capital amounts and ratios as of June 30, 2016 and December 31, 2015 are also presented in the following table (dollars in thousands). As of June 30, 2016 and December 31, 2015, 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

   

Amount

    Ratio    

Amount

    Ratio  

As of June 30, 2016:

                                               

Company:

                                               

Total risk-based capital

  $ 322,562       14.29 %   $ 194,670   >   8.625 %   $ 225,705   >   10.0 %

Tier 1 risk-based capital

    294,265       13.04 %     149,529   >   6.625       180,564   >   8.0  

Tier 1 leverage

    294,265       11.18 %     105,263   >   4.000       131,578   >   5.0  

Common equity Tier 1

    264,422       11.72 %     115,674   >   5.125       146,708   >   6.5  

Quad City Bank & Trust:

                                             

Total risk-based capital

  $ 143,744       12.76 %   $ 97,131   >   8.625 %   $ 112,616   >   10.0 %

Tier 1 risk-based capital

    131,003       11.63 %     74,608   >   6.625       90,093   >   8.0  

Tier 1 leverage

    131,003       9.42 %     55,618   >   4.000       69,523   >   5.0  

Common equity Tier 1

    131,003       11.63 %     57,716   >   5.125       73,200   >   6.5  

Cedar Rapids Bank & Trust:

                                               

Total risk-based capital

  $ 110,325       13.82 %   $ 68,850   >   8.625 %   $ 79,826   >   10.0 %

Tier 1 risk-based capital

    100,331       12.57 %     52,885   >   6.625       63,861   >   8.0  

Tier 1 leverage

    100,331       11.20 %     35,830   >   4.000       44,788   >   5.0  

Common equity Tier 1

    100,331       12.57 %     40,911   >   5.125       51,887   >   6.5  

Rockford Bank & Trust:

                                               

Total risk-based capital

  $ 40,108       11.87 %   $ 29,154   >   8.625 %   $ 33,801   >   10.0 %

Tier 1 risk-based capital

    35,877       10.61 %     22,393   >   6.625       27,041   >   8.0  

Tier 1 leverage

    35,877       9.50 %     15,099   >   4.000       18,874   >   5.0  

Common equity Tier 1

    35,877       10.61 %     17,323   >   5.125       21,971   >   6.5  

 

 
33

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

                                   

To Be Well

Capitalized Under

 
                   

For Capital

    Prompt Corrective  
   

Actual

   

Adequacy Purposes*

    Action Provisions  
   

Amount

   

Ratio

   

Amount

    Ratio    

Amount

    Ratio  

As of December 31, 2015:

                                               

Company:

                                               

Total risk-based capital

  $ 280,273       13.11 %   $ 170,969   >   8.0 %   $ 213,711   >   10.0 %

Tier 1 risk-based capital

    253,891       11.88 %     128,227   >   6.0       170,969   >   8.0  

Tier 1 leverage

    253,891       9.75 %     104,163   >   4.0       130,203   >   5.0  

Common equity Tier 1

    220,800       10.33 %     96,170   >   4.5       138,912   >   6.5  

Quad City Bank & Trust:

                                               

Total risk-based capital

  $ 135,477       12.50 %   $ 86,726   >   8.0 %   $ 108,407   >   10.0 %

Tier 1 risk-based capital

    123,498       11.39 %     65,044   >   6.0       86,726   >   8.0  

Tier 1 leverage

    123,498       8.87 %     55,718   >   4.0       69,648   >   5.0  

Common equity Tier 1

    123,498       11.39 %     48,783   >   4.5       70,465   >   6.5  

Cedar Rapids Bank & Trust:

                                               

Total risk-based capital

  $ 105,285       14.39 %   $ 58,537   >   8.0 %   $ 73,172   >   10.0 %

Tier 1 risk-based capital

    96,118       13.14 %     43,903   >   6.0       58,537   >   8.0  

Tier 1 leverage

    96,118       10.96 %     35,079   >   4.0       43,848   >   5.0  

Common equity Tier 1

    96,118       13.14 %     32,927   >   4.5       47,562   >   6.5  

Rockford Bank & Trust:

                                               

Total risk-based capital

  $ 38,544       11.96 %   $ 25,772   >   8.0 %   $ 32,216   >   10.0 %

Tier 1 risk-based capital

    34,514       10.71 %     19,329   >   6.0       25,772   >   8.0  

Tier 1 leverage

    34,514       9.59 %     14,401   >   4.0       18,001   >   5.0  

Common equity Tier 1

    34,514       10.71 %     14,497   >   4.5       20,940   >   6.5  

 

*The minimums under Basel III phase in higher by .625% (the capital conservation buffer) annually until 2019. The fully phased-in minimums are 10.5% (Total risk-based capital), 8.5% (Tier 1 risk-based capital), and 7.0% (Common equity Tier 1). At December 31, 2015, the New Basel III minimums mirrored the minimums required for capital adequacy purposes. The first phase-in of the Basel III capital conservation buffer occured in 2016.

 

 
34

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

NOTE 9 – ACQUISITION OF COMMUNITY STATE BANK AND COMMON STOCK OFFERING

 

On May 23, 2016, the Company announced the signing of a definitive agreement to acquire CSB, headquartered in Ankeny, Iowa, from Van Diest Investment Company. CSB is an Iowa-chartered bank that operates ten banking locations throughout the Des Moines metropolitan area. As of June 30, 2016, CSB had $571 million in assets, $433 million in loans and $481 million in deposits.

 

In the acquisition, the Company will acquire from Van Diest Investment Company 100% of the outstanding common stock of CSB for cash consideration of $80 million. The transaction is subject to certain customary closing conditions and is expected to close during the third quarter of 2016. The Company intends to maintain CSB as an independent banking charter.

 

In connection with the planned acquisition, during the second quarter the Company sold 1,215,000 shares of its common stock at a price of $24.75 per share, for approximate gross proceeds of $30 million, before deducting anticipated expenses. The shares were offered to institutional investors in a registered direct offering conducted without an underwriter or placement agent. The offering was a take-down of a previously filed shelf registration and closed on May 23, 2016.

 

Cash received from the common stock offering will be used to help finance the purchase price of the pending acquisition. Additionally, the Company plans to draw approximately $5 million on its $10 million revolving line of credit and fully fund the $30 million term facility it has available. Both of these facilities are described further in Note 4 to the Consolidated Financial Statements. Cash dividends of approximately $15 million from QCBT and CRBT will be used to finance the remainder of the purchase price.

 

During the second quarter of 2016, the Company incurred $355 thousand of expenses related to the planned acquisition, comprised primarily of legal and investment banking costs.

 

 

 
35

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

INTRODUCTION

 

This section reviews the financial condition and results of operations of the Company and its subsidiaries for the three and six months ending June 30, 2016. Some tables may include additional periods to comply with disclosure requirements or to illustrate trends. When reading this discussion, also refer to the Consolidated Financial Statements and related notes in this report. The page locations and specific sections and notes that are referred to are presented in the table of contents.

 

Additionally, a comprehensive list of the acronyms and abbreviations used throughout this discussion is included in Note 1 to the Consolidated Financial Statements.

 

GENERAL

 

QCR Holdings, Inc. is the parent company of QCBT, CRBT, and RB&T.


QCBT and CRBT are Iowa-chartered commercial banks, and RB&T is an Illinois-chartered commercial bank. All are members of the Federal Reserve system with depository accounts insured to the maximum amount permitted by law by the FDIC.

 

 

QCBT commenced operations in 1994 and provides full-service commercial and consumer banking, and trust and asset management services to the Quad City area and adjacent communities through its five offices that are located in Bettendorf and Davenport, Iowa and Moline, Illinois. QCBT also provides leasing services through its wholly-owned subsidiary, m2, located in Brookfield, Wisconsin. In addition, QCBT owns 100% of Quad City Investment Advisors, LLC, which is an investment management and advisory company.

 

 

CRBT commenced operations in 2001 and provides full-service commercial and consumer banking, and trust and asset management services to Cedar Rapids, Iowa and adjacent communities through its main office located on First Avenue in downtown Cedar Rapids, Iowa and its branch facility located on Council Street in northern Cedar Rapids. Cedar Falls and Waterloo, Iowa and adjacent communities are served through three additional CRBT offices (two in Waterloo and one in Cedar Falls).

 

 

RB&T commenced operations in January 2005 and provides full-service commercial and consumer banking, and trust and asset management services to Rockford, Illinois and adjacent communities through its main office located on Guilford Road at Alpine Road in Rockford and its branch facility in downtown Rockford.

 

EXECUTIVE OVERVIEW

 

The Company reported net income of $6.7 million for the quarter ended June 30, 2016, and diluted EPS of $0.53. By comparison, for the quarter ended March 31, 2016, the Company reported net income of $6.4 million, and diluted EPS of $0.53. For the second quarter of 2015, the Company reported a net loss of $524 thousand, and diluted EPS of ($0.05).

 

 
36

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

For the six months ended June 30, 2016, the Company reported net income of $13.0 million, and diluted EPS of $1.07. By comparison, for the six months ended June 30, 2015, the Company reported net income of $3.7 million, and diluted EPS of $0.40.

 

The second quarter of 2016 was highlighted by several significant items:

 

 

Loan and lease growth at an annualized rate of 13.9% through the first six months of the year;

 

Strong swap fee income and gains on the sale of government guaranteed portions of loans, totaling $3.5 million year-to-date;

 

NIM improvement of 3 basis points quarter-over-quarter; and

 

ROAA improvement to 1.01% for the current quarter.

 

Following is a table that represents the various net income measurements for the Company. 

 

   

For the three months ended

   

For the six months ended

 
   

June 30, 2016

   

March 31, 2016

   

June 30, 2015

   

June 30, 2016

   

June 30, 2015

 
                                         

Net income (loss)

  $ 6,676,467     $ 6,373,489     $ (523,818 )   $ 13,049,956     $ 3,654,071  
                                         

Diluted earnings (loss) per common share

  $ 0.53     $ 0.53     $ (0.05 )   $ 1.07     $ 0.40  
                                         

Weighted average common and common equivalent shares outstanding*

    12,516,474       11,953,949       9,946,744       12,235,212       9,098,697  

 

*The increase in the weighted average common and common equivalent shares outstanding was primarily due to the common stock issuance discussed in Note 9 to the Consolidated Financial Statements.

 

Following is a table that represents the major income and expense categories for the Company.

 

   

For the three months ended

   

For the six months ended

 
   

June 30, 2016

   

March 31, 2016

   

June 30, 2015

   

June 30, 2016

   

June 30, 2015

 
                                         

Net interest income

  $ 21,008,813     $ 20,597,522     $ 18,490,836     $ 41,606,335     $ 36,273,053  

Provision expense

    1,197,850       2,072,985       2,348,665       3,270,835       4,059,121  

Noninterest income

    6,762,401       6,822,473       5,461,234       13,584,874       11,683,012  

Noninterest expense

    17,743,753       16,954,498       24,101,634       34,698,251       41,305,795  

Federal and state income tax expense (benefit)

    2,153,144       2,019,023       (1,974,411 )     4,172,167       (1,062,922 )

Net income (loss)

  $ 6,676,467     $ 6,373,489     $ (523,818 )   $ 13,049,956     $ 3,654,071  

 

In comparing quarter-over-quarter, following are some noteworthy changes in the Company’s financial results:

 

 

Net interest income increased 2% compared to the first quarter of 2016 and increased 14% from the same period in 2015.

 

 

Provision decreased 42% compared to the first quarter of 2016. Provision decreased 49% from the same period of 2015. Both decreases were primarily due to continued strong asset quality.

 

 

Noninterest income decreased less than 1% compared to the first quarter of 2016. Noninterest income increased 24% from the second quarter of 2015. Noninterest income fluctuations are primarily driven by swap fee income and gains on the sale of government guaranteed portions of loans (totaling $1.8 million for the quarter ended June 30, 2016 compared to $1.7 million and $463 thousand for the quarters ending March 31, 2016 and June 30, 2015, respectively).

 

 
37

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

 

Noninterest expense increased 5% compared to the first quarter of 2016. The second quarter of 2016 included higher commissions and incentive accruals directly related to the swap fee income and gains on the sale of government guaranteed loans. Noninterest expense decreased 26% from the second quarter of 2015. The second quarter of 2015 included several nonrecurring expense items totaling approximately $7.7 million, $6.9 million of which related to the extinguishment of debt.

 

 

Federal and state income tax expense increased 7% compared to the first quarter of 2016. Federal and state income tax increased significantly compared to the second quarter of 2015. See the Income Taxes section of this report for additional details.

 

LONG-TERM FINANCIAL GOALS

 

As previously stated, the Company has established certain financial goals by which it manages its business and measures its performance. The goals are periodically updated to reflect changes in business developments. While the Company is determined to work prudently to achieve these goals, there is no assurance that they will be met. Moreover, the Company’s ability to achieve these goals will be affected by the factors discussed under “Forward Looking Statements” as well as the factors detailed in the “Risk Factors” section included under Item 1A. of Part I of the Company’s Form 10-K. The Company’s long-term financial goals are as follows:

 

 

Improve balance sheet efficiency by targeting a gross loans and leases to total assets ratio in the range of 70 – 75%;

 

 

Improve profitability (measured by NIM and ROAA);

 

 

Continue to improve asset quality by reducing NPAs to total assets to below 0.75% and maintain charge-offs as a percentage of average loans/leases of under 0.25% annually;

 

 

Reduce reliance on wholesale funding to less than 15% of total assets;

 

 

Grow noninterest bearing deposits to more than 30% of total assets;

 

 

Increase the commercial lease portfolio so that it represents 10% of total assets;

 

 

Grow gains on sales of government guaranteed portions of loans and swap fee income to more than $4 million annually; and

 

 

Grow wealth management segment net income by 15% annually.

 

 
38

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued 

 

The following table shows the evaluation of the Company’s long-term financial goals.

 

 

 

 

For the Quarter Ending

     

June 30,

2016

March 31,

2016

June 30,

2015

Goal Key Metric Target**

(dollars in thousands)

Balance sheet efficiency

Gross loans and leases to total assets

70 - 75%

72%

71%

67%

Profitability

NIM

> 3.50%

3.62%

3.59%

3.33%

ROAA

> 1.00%

1.01%

0.98%

-0.08%

Asset quality

NPAs to total assets

< 0.75%

0.70%

0.71%

1.07%

Net charge-offs to average loans and leases*

< 0.25% annually

0.12%

0.16%

0.12%

Lower reliance on wholesale funding

Wholesale funding to total assets

< 15%

18%

17%

22%

Funding mix

Noninterest bearing deposits as a percentage of total assets

> 30%

23%

24%

25%

Commercial leasing

Leases as a percentage of total assets

10%

6%

7%

7%

Consistent, high quality noninterest income revenue streams

Gains on sales of government guaranteed portions of loans and swap fee income*

> $4 million annually

$7.1 million

$6.9 million

$2.5 million

Grow wealth management segment net income*

> 15% annually

2%

10%

8%

 

* Ratios and amounts provided for these measurements represent year-to-date actual amounts for the respective period, that are then annualized for comparison.

** Targets will be re-evaluated and adjusted as needed.

 

STRATEGIC DEVELOPMENTS

 

The Company took the following actions to support its corporate strategy and the long-term financial goals shown above.

 

 

Loan and lease growth year-to-date was 6.9%, or an annualized rate of 13.9%. This exceeded the Company’s target organic growth rate of 10-12%. A majority of this growth was in the C&I and CRE loan categories. This loan and lease growth has continued to help move the loan and lease to total asset ratio upward to 72%, from 71% in the prior quarter and 67% a year ago.

 

 

The Company intends to participate as an acquirer in the consolidation taking place in our markets to further boost ROAA and improve the Company’s efficiency ratio. In the second quarter of 2016, the Company announced the acquisition of Community State Bank, headquartered in Ankeny, Iowa. Refer to Note 9 of the Consolidated Financial Statements for more details.

 

 

The Company continued to focus on reducing the NPAs to total assets ratio and decreased this ratio from 0.74% at December 31, 2015 to 0.70% at June 30, 2016. Although NPAs remained relatively flat from the prior quarter, the Company remains committed to further improving asset quality ratios in 2016.

 

 

Management continued to focus on reducing the Company’s reliance on wholesale funding. The modest restructuring executed in the first quarter of 2016 (as described in Note 4 of the Consolidated Financial Statements) has further reduced the Company’s reliance on long-term wholesale funding. In the second quarter of 2016, the Company utilized overnight FHLB advances as a cost-effective alternative funding source. Management continues to closely evaluate opportunities for continued reduction in wholesale funding.

 

 
39

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

 

Correspondent banking continues to be a core line of business for the Company. The Company is competitively positioned with experienced staff, software systems and processes to continue growing in the three states currently served – Iowa, Illinois and Wisconsin. The Company acts as the correspondent bank for 176 downstream banks with average total noninterest bearing deposits of $299.8 million during the second quarter of 2016. This line of business provides a strong source of noninterest bearing deposits, fee income and high-quality loan participations.

 

 

The Company provides commercial leasing services through its wholly-owned subsidiary, m2 Lease Funds, which has lease specialists in Iowa, Wisconsin, Minnesota, South Carolina, Georgia, Florida, Colorado, Texas and Pennsylvania. Historically, this portfolio has been high yielding, with an average gross yield in 2016 approximating 8.2%. This portfolio has also shown strong asset quality throughout its history.

 

 

SBA and USDA lending is a specialty lending area on which the Company has focused. Once these loans are originated, the government-guaranteed portion of the loan can be sold to the secondary market for premiums. The Company intends to make this a more significant and consistent source of noninterest income.

 

 

As a result of the historically low interest rate environment, the Company is focused on executing interest rate swaps on select commercial loans. The interest rate swaps allow the commercial borrowers to pay a fixed interest rate while the Company receives a variable interest rate as well as an upfront fee dependent on the pricing. Management believes that these swaps help position the Company more favorably for rising rate environments. The Company will continue to review opportunities to execute these swaps at all of its subsidiary banks, as the circumstances are appropriate for the borrower and the Company.

 

 

Wealth management is another core line of business for the Company and includes a full range of products, including trust services, brokerage and investment advisory services, asset management, estate planning and financial planning. As of June 30, 2016 the Company had $1.76 billion of total financial assets in trust (and related) accounts and $702 million of total financial assets in brokerage (and related) accounts. Continued growth in assets under management will help to drive trust and investment advisory fees. The Company offers trust and investment advisory services to the correspondent banks that it serves. As management focuses on growing fee income, expanding market share will continue to be a primary strategy.

 

 
40

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued 

 

GAAP TO NON-GAAP RECONCILIATIONS

 

The following table presents certain non-GAAP financial measures related to the “tangible common equity to tangible assets ratio”, “core net income”, “core net income attributable to QCR Holdings, Inc. common stockholders”, “core earnings per common share” and “core return on average assets”. The table also reconciles the GAAP performance measures to the corresponding non-GAAP measures.

 

The tangible common equity to tangible assets ratio has been a focus for investors and management believes that this ratio may assist investors in analyzing the Company’s capital position without regard to the effects of intangible assets.

 

The table below also includes several “core” measurements of financial performance. The Company's management believes that these measures are important to investors as they exclude non-recurring income and expense items; therefore, they provide a better comparison for analysis and may provide a better indicator of future run-rates.

 

Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied, and are not audited. Although these non-GAAP financial measures are frequently used by investors to evaluate a company, they have limitations as analytical tools and should not be considered in isolation, or as a substitute for analyses of results as reported under GAAP.

 

 
41

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

   

As of

 
   

June 30,

   

March 31,

   

December 31,

 

GAAP TO NON-GAAP RECONCILIATIONS

 

2016

   

2016

   

2015

 
   

(dollars in thousands, except per share data)

 
 

TCE / TA RATIO

                       
                         

Stockholders' equity (GAAP)

  $ 275,117     $ 235,143     $ 225,886  

Less: Intangible assets

    4,595       4,645       4,694  

TCE (non-GAAP)

  $ 270,522     $ 230,498     $ 221,192  
                         

Total assets (GAAP)

  $ 2,683,434     $ 2,640,673     $ 2,593,198  

Less: Intangible assets

    4,595       4,645       4,694  

TA (non-GAAP)

  $ 2,678,839     $ 2,636,028     $ 2,588,504  
                         

TCE / TA ratio (non-GAAP)

    10.10 %     8.74 %     8.55 %

 

   

For the Quarter Ended

   

For the Six Months Ended

 
   

June 30,

   

March 31,

   

December 31,

   

June 30,

   

June 30,

 

CORE NET INCOME

 

2016

   

2016

   

2015

   

2016

   

2015

 
                                         

Net income (GAAP)

  $ 6,676     $ 6,373     $ 6,785     $ 13,050     $ 3,654  
                                         

Less nonrecurring items (post-tax) (*):

                                       

Income:

                                       

Securities gains, net

  $ 12     $ 233     $ 211     $ 245     $ 274  

Total nonrecurring income (non-GAAP)

  $ 12     $ 233     $ 211     $ 245     $ 274  
                                         

Expense:

                                       

Losses on debt extinguishment

  $ -     $ 54     $ 189     $ 54     $ 4,481  

Acquisition costs

    231       -       -       231       -  

Other non-recurring expenses

    -       -       -       -       513  

Accrual adjustments

    -       -       (487 )     -       -  

Total nonrecurring expense (non-GAAP)

  $ 231     $ 54     $ (298 )   $ 285     $ 4,994  
                                         

Core net income (non-GAAP)

  $ 6,895     $ 6,194     $ 6,276     $ 13,090     $ 8,374  
                                         
                                         

CORE EPS

                                       
                                         

Core net income (non-GAAP) (from above)

  $ 6,895     $ 6,194     $ 6,276     $ 13,090     $ 8,374  
                                         

Weighted average common shares outstanding

    12,335,077       11,793,620       11,744,495       12,064,349       8,961,327  

Weighted average common and common equivalent shares outstanding

    12,516,474       11,953,949       11,926,038       12,235,212       9,098,697  
                                         

Core EPS (non-GAAP):

                                       

Basic

  $ 0.56     $ 0.53     $ 0.53     $ 1.09     $ 0.93  

Diluted

  $ 0.55     $ 0.52     $ 0.53     $ 1.07     $ 0.92  
                                         
                                         

CORE ROAA

                                       
                                         

Core net income (non-GAAP) (from above)

  $ 6,895     $ 6,194     $ 6,276     $ 13,090     $ 8,374  
                                         

Average Assets

  $ 2,640,678     $ 2,602,350     $ 2,611,276     $ 2,621,514     $ 2,512,334  
                                         

Core ROAA (annualized) (non-GAAP)

    1.04 %     0.95 %     0.96 %     1.00 %     0.67 %

 

* Nonrecurring items (after-tax) are calculated using an estimated effective tax rate of 35%.

 

 
42

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

NET INTEREST INCOME - (TAX EQUIVALENT BASIS)

 

Net interest income, on a tax equivalent basis, increased 14% to $22.4 million for the quarter ended June 30, 2016, compared to the same quarter of the prior year. For the six months ended June 30, 2016, net interest income, on a tax equivalent basis, increased 15% to $44.3 million, compared to the same period of 2015. Net interest income improved due to several factors:

 

 

The Company’s strategy to redeploy funds from the taxable securities portfolio into higher yielding loans and leases;

 

Organic loan and lease growth has been strong over the past twelve months, as evidenced by average gross loan/lease growth of 13% in that period; and

 

The Company’s balance sheet restructuring and deleveraging strategy executed throughout 2015 and the first quarter of 2016.

 

A comparison of yields, spread and margin from the second quarter of 2016 to the second quarter of 2015 is as follows (on a tax equivalent basis):

 

The average yield on interest-earning assets increased 16 basis points.

 

The average cost of interest-bearing liabilities decreased 15 basis points.

 

The net interest spread increased 31 basis points from 3.08% to 3.39%.

 

The NIM improved 29 basis points from 3.33% to 3.62%.

 

A comparison of yields, spread and margin from the first half of 2016 to the first half of 2015 is as follows (on a tax equivalent basis):

 

The average yield on interest-earning assets increased 13 basis points.

 

The average cost of interest-bearing liabilities decreased 21 basis points.

 

The net interest spread increased 34 basis points from 3.04% to 3.38%.

 

The NIM improved 32 basis points from 3.29% to 3.61%.

 

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 the improvement of their NIM. Management continually addresses this issue with pricing and other balance sheet management strategies.

 

The Company continues to place an emphasis on shifting its balance sheet mix. With a stated goal of increasing loans/leases as a percentage of assets to a range of 70-75%, the Company funded its loan/lease growth with a mixture of short-term borrowings and cash from the investment securities portfolio. Cash from called securities and the targeted sales of securities was redeployed into the loan portfolio, resulting in a significant increase in yield, while minimizing any extension of duration. Additionally, the Company has recognized net gains on these sales due to the current rate environment. As rates rise, the Company should also have less market volatility in the investment securities portfolio, as this becomes a smaller portion of the balance sheet.

 

The Company continues to monitor and evaluate both prepayment and debt restructuring opportunities within the wholesale funding portion of the balance sheet, as executing on such a strategy could potentially increase NIM more quickly than holding the debt until maturity.

 

 
43

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

The Company’s average balances, interest income/expense, and rates earned/paid on major balance sheet categories, as well as the components of change in net interest income, are presented in the following tables:

 

   

For the three months ended June 30,

 
   

2016

   

2015

 
           

Interest

   

Average

           

Interest

   

Average

 
   

Average

   

Earned

   

Yield or

   

Average

   

Earned

   

Yield or

 
   

Balance

   

or Paid

   

Cost

   

Balance

   

or Paid

   

Cost

 
                                                 
   

(dollars in thousands)

 

ASSETS

                                               

Interest earning assets:

                                               

Federal funds sold

  $ 14,174     $ 11       0.31 %   $ 19,523     $ 6       0.12 %

Interest-bearing deposits at financial institutions

    50,747       62       0.49 %     45,229       65       0.58 %

Investment securities (1)

    505,697       4,573       3.64 %     608,688       4,548       3.00 %

Restricted investment securities

    14,171       134       3.80 %     15,083       108       2.87 %

Gross loans/leases receivable (1) (2) (3)

    1,899,932       20,497       4.34 %     1,686,068       18,541       4.41 %
                                                 

Total interest earning assets

  $ 2,484,721     $ 25,277       4.09 %   $ 2,374,591     $ 23,268       3.93 %
                                                 

Noninterest-earning assets:

                                               

Cash and due from banks

  $ 50,461                     $ 42,810                  

Premises and equipment

    38,178                       38,666                  

Less allowance

    (27,811 )                     (24,405 )                

Other

    95,129                       86,508                  
                                                 

Total assets

  $ 2,640,678                     $ 2,518,170                  
                                                 

LIABILITIES AND STOCKHOLDERS' EQUITY

                                               

Interest-bearing liabilities:

                                               

Interest-bearing deposits

  $ 941,856       600       0.26 %   $ 784,148       450       0.23 %

Time deposits

    425,216       744       0.70 %     384,895       634       0.66 %

Short-term borrowings

    50,122       18       0.14 %     160,479       53       0.13 %

FHLB advances ..

    128,956       416       1.30 %     173,742       1,002       2.31 %

Junior subordinated debentures

    33,396       302       3.64 %     40,475       313       3.10 %

Other borrowings

    100,008       824       3.31 %     129,802       1,108       3.42 %
                                                 

Total interest-bearing liabilities

  $ 1,679,554     $ 2,904       0.70 %   $ 1,673,541     $ 3,560       0.85 %
                                                 

Noninterest-bearing demand deposits

  $ 666,044                     $ 629,744                  

Other noninterest-bearing liabilities

    39,689                       33,074                  

Total liabilities

  $ 2,385,287                     $ 2,336,359                  
                                                 

Stockholders' equity

    255,391                       181,811                  
                                                 

Total liabilities and stockholders' equity

  $ 2,640,678                     $ 2,518,170                  
                                                 

Net interest income

          $ 22,373                     $ 19,708          
                                                 

Net interest spread

                    3.39 %                     3.08 %
                                                 

Net interest margin

                    3.62 %                     3.33 %
                                                 

Ratio of average interest-earning assets to average interest-bearing liabilities

    147.94 %                     141.89 %                

 

(1) Interest earned and yields on nontaxable investment securities and nontaxable loans are determined on a tax equivalent basis using a 35% tax rate.

 

(2) Loan/lease fees are not material and are included in interest income from loans/leases receivable in accordance with accounting and regulatory guidance.

 

(3) Non-accrual loans/leases are included in the average balance for gross loans/leases receivable in accordance with accounting and regulatory guidance.

 

 
44

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

Analysis of Changes of Interest Income/Interest Expense

For the three months ended June 30, 2016

 

   

Inc./(Dec.)

   

Components

 
   

from

   

of Change (1)

 
   

Prior Period

   

Rate

   

Volume

 
   

2016 vs. 2015

 
   

(dollars in thousands)

 

INTEREST INCOME

                       

Federal funds sold

  $ 5     $ 16     $ (11 )

Interest-bearing deposits at financial institutions

    (3 )     (36 )     33  

Investment securities (2)

    25       3,459       (3,434 )

Restricted investment securities

    26       66       (40 )

Gross loans/leases receivable (2) (3) (4)

    1,956       (1,921 )     3,877  
                         

Total change in interest income

  $ 2,009     $ 1,584     $ 425  
                         

INTEREST EXPENSE

                       

Interest-bearing deposits

  $ 150     $ 54     $ 96  

Time deposits

    110       42       68  

Short-term borrowings

    (35 )     30       (65 )

Federal Home Loan Bank advances

    (586 )     (369 )     (217 )

Junior subordinated debentures

    (11 )     213       (224 )

Other borrowings

    (284 )     (35 )     (249 )
                         

Total change in interest expense

  $ (656 )   $ (65 )   $ (591 )
                         

Total change in net interest income

  $ 2,665     $ 1,649     $ 1,016  

 

(1) The column "Inc./(Dec.) from Prior Period" is segmented into the changes attributable to variations in volume and the changes attributable to changes in interest rates. The variations attributable to simultaneous volume and rate changes have been proportionately allocated to rate and volume.

 

(2) Interest earned and yields on nontaxable investment securities and nontaxable loans are determined on a tax equivalent basis using a 35% tax rate.

 

(3) Loan/lease fees are not material and are included in interest income from loans/leases receivable in accordance with accounting and regulatory guidance.

 

(4) Non-accrual loans/leases are included in the average balance for gross loans/leases receivable in accordance with accounting and regulatory guidance.

 

 
45

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

   

For the six months ended June 30,

 
   

2016

   

2015

 
           

Interest

   

Average

           

Interest

   

Average

 
   

Average

   

Earned

   

Yield or

   

Average

   

Earned

   

Yield or

 
   

Balance

   

or Paid

   

Cost

   

Balance

   

or Paid

   

Cost

 
                                                 
   

(dollars in thousands)

 

ASSETS

                                               

Interest earning assets:

                                               

Federal funds sold

  $ 15,703     $ 23       0.29 %   $ 16,606     $ 11       0.13 %

Interest-bearing deposits at financial institutions

    45,691       123       0.54 %     57,602       142       0.50 %

Investment securities (1)

    528,034       9,257       3.53 %     617,261       9,037       2.95 %

Restricted investment securities

    14,156       264       3.75 %     15,513       250       3.25 %

Gross loans/leases receivable (1) (2) (3)

    1,866,941       40,454       4.36 %     1,660,887       36,893       4.48 %
                                                 

Total interest earning assets

  $ 2,470,525     $ 50,121       4.08 %   $ 2,367,867     $ 46,333       3.95 %
                                                 

Noninterest-earning assets:

                                               

Cash and due from banks

  $ 48,176                     $ 43,547                  

Premises and equipment

    37,963                       38,373                  

Less allowance

    (27,256 )                     (23,911 )                

Other

    92,107                       86,458                  
                                                 

Total assets

  $ 2,621,514                     $ 2,512,334                  
                                                 

LIABILITIES AND STOCKHOLDERS' EQUITY

                                               

Interest-bearing liabilities:

                                               

Interest-bearing deposits

  $ 933,551       1,214       0.26 %   $ 785,749       892       0.23 %

Time deposits

    412,410       1,420       0.69 %     379,630       1,264       0.67 %

Short-term borrowings

    68,331       61       0.18 %     170,697       117       0.14 %

FHLB advances

    128,696       858       1.34 %     190,109       2,446       2.59 %

Junior subordinated debentures

    34,023       606       3.58 %     40,458       620       3.09 %

Other borrowings

    100,873       1,650       3.29 %     139,408       2,340       3.38 %
                                                 

Total interest-bearing liabilities

  $ 1,677,884     $ 5,809       0.70 %   $ 1,706,051     $ 7,679       0.91 %
                                                 

Noninterest-bearing demand deposits

  $ 660,625                     $ 607,617                  

Other noninterest-bearing liabilities

    39,687                       33,691                  

Total liabilities

  $ 2,378,195                     $ 2,347,359                  
                                                 

Stockholders' equity

    243,319                       164,975                  
                                                 

Total liabilities and stockholders' equity

  $ 2,621,514                     $ 2,512,334                  
                                                 

Net interest income

          $ 44,312                     $ 38,654          
                                                 

Net interest spread

                    3.38 %                     3.04 %
                                                 

Net interest margin

                    3.61 %                     3.29 %
                                                 

Ratio of average interest-earning assets to average interest-bearing liabilities

    147.24 %                     138.79 %                

 

(1) Interest earned and yields on nontaxable investment securities and nontaxable loans are determined on a tax equivalent basis using a 35% tax rate.

 

(2) Loan/lease fees are not material and are included in interest income from loans/leases receivable in accordance with accounting and regulatory guidance.

 

(3) Non-accrual loans/leases are included in the average balance for gross loans/leases receivable in accordance with accounting and regulatory guidance.

 

 
46

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

Analysis of Changes of Interest Income/Interest Expense                   

For the six months ended June 30, 2016  

 

   

Inc./(Dec.)

   

Components

 
   

from

   

of Change (1)

 
   

Prior Period

   

Rate

   

Volume

 
   

2016 vs. 2015

 
   

(dollars in thousands)

 

INTEREST INCOME

                       

Federal funds sold

  $ 12     $ 14     $ (2 )

Interest-bearing deposits at financial institutions

    (19 )     29       (48 )

Investment securities (2)

    220       3,146       (2,926 )

Restricted investment securities

    14       65       (51 )

Gross loans/leases receivable (2) (3) (4)

    3,561       (2,680 )     6,241  
                         

Total change in interest income

  $ 3,788     $ 574     $ 3,214  
                         

INTEREST EXPENSE

                       

Interest-bearing deposits

  $ 322     $ 139     $ 183  

Time deposits

    156       42       114  

Short-term borrowings

    (56 )     76       (132 )

Federal Home Loan Bank advances

    (1,588 )     (952 )     (636 )

Junior subordinated debentures

    (14 )     192       (206 )

Other borrowings

    (690 )     (64 )     (626 )
                         

Total change in interest expense

  $ (1,870 )   $ (567 )   $ (1,303 )
                         

Total change in net interest income

  $ 5,658     $ 1,141     $ 4,517  

 

(1) The column "Inc./(Dec.) from Prior Period" is segmented into the changes attributable to variations in volume and the changes attributable to changes in interest rates. The variations attributable to simultaneous volume and rate changes have been proportionately allocated to rate and volume.

 

(2) Interest earned and yields on nontaxable investment securities and nontaxable loans are determined on a tax equivalent basis using a 35% tax rate.

 

(3) Loan/lease fees are not material and are included in interest income from loans/leases receivable in accordance with accounting and regulatory guidance.

 

(4) Non-accrual loans/leases are included in the average balance for gross loans/leases receivable in accordance with accounting and regulatory guidance.

 

 
47

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

CRITICAL ACCOUNTING POLICIES

 

The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The financial information contained within these statements is, to a significant extent, financial information that is based on approximate measures of the financial effects of transactions and events that have already occurred. Certain critical accounting policies are described below.

 

ALLOWANCE FOR LOAN AND LEASE LOSSES

 

Based on its consideration of accounting policies that involve the most complex and subjective decisions and assessments, management has identified its most critical accounting policy to be that related to the allowance.

 

The Company’s allowance methodology incorporates a variety of risk considerations, both quantitative and qualitative, in establishing an allowance that management believes is appropriate at each reporting date. Quantitative factors include the Company’s historical loss experience, delinquency and charge-off trends, collateral values, changes in NPLs, and other factors. Quantitative factors also incorporate known information about individual loans/leases, including borrowers’ sensitivity to interest rate movements.

 

Qualitative factors include the general economic environment in the Company’s markets, including economic conditions throughout the Midwest, and in particular, the state of certain industries. Size and complexity of individual credits in relation to loan/lease structures, existing loan/lease policies and pace of portfolio growth are other qualitative factors that are considered in the methodology.

 

Management may report a materially different amount for the provision in the statement of income to change the allowance if its assessment of the above factors were different. This discussion and analysis should be read in conjunction with the Company’s financial statements and the accompanying notes presented elsewhere herein, as well as the section entitled “Financial Condition” of this Management’s Discussion and Analysis that discusses the allowance.

 

Although management believes the level of the allowance as of June 30, 2016 was adequate to absorb losses in the loan/lease portfolio, a decline in local economic conditions, or other factors, could result in increasing losses that cannot be reasonably predicted at this time.

 

OTHER–THAN-TEMPORARY IMPAIRMENT

 

The Company’s assessment of OTTI of its investment securities portfolio is another critical accounting policy due to the level of judgment required by management. Investment securities are evaluated to determine whether declines in fair value below their cost are other-than-temporary.

 

In estimating OTTI losses, management considers a number of factors including, but not limited to, (1) the length of time and extent to which the fair value has been less than amortized cost, (2) the financial condition and near-term prospects of the issuer, (3) the current market conditions, and (4) the Company’s lack of intent to sell the security prior to recovery and whether it is not more-likely-than-not that the Company will be required to sell the security prior to recovery. The discussion regarding the Company’s assessment of OTTI should be read in conjunction with the Company’s financial statements and the accompanying notes presented elsewhere herein.

 

 
48

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

RESULTS OF OPERATIONS

 

INTEREST INCOME

 

Interest income increased 8%, comparing the second quarter of 2016 to the same period of 2015 and comparing the first half of 2016 to the same period of 2015.

 

A portion of this growth was the result of the Company’s strategy to redeploy funds from the securities portfolio into higher yielding loans and leases. In addition, organic loan and lease growth has been strong over the past twelve months.

 

Overall, the Company’s average earning assets increased 5%, comparing the second quarter of 2016 to the second quarter of 2015. During the same time period, average gross loans and leases increased 13%, while average investment securities decreased 17%.

 

The securities portfolio yield continued to increase (from 3.00% for the second quarter of 2015 to 3.64% for the second quarter of 2016) as the Company continued to sell low-yielding investments taking advantage of favorable market opportunities. Call activity picked up in the second quarter of 2016, resulting in the call of some lower-yielding callable agency securities. Additionally, the Company continued to take actions to diversify its securities portfolio, including increasing its portfolio of tax-exempt municipal securities, in an effort to increase tax equivalent interest income without additional income tax expense.

 

The Company intends to continue to grow quality loans and leases as well as diversify its securities portfolio to maximize yield while minimizing credit and interest rate risk.

 

INTEREST EXPENSE

 

Interest expense for the second quarter of 2016 decreased 18% from the second quarter of 2015. For the first six months of 2016, interest expense decreased 24% compared to the first six months of 2015. The Company has been successful in maintaining pricing discipline on deposits and decreasing the cost of borrowings, which has more than offset the growth impact and contributed to the net decline in interest expense.

 

Management has placed a strong focus on reducing the reliance on long-term wholesale funding as it tends to be higher cost than deposits. In the second quarter of 2015, the Company executed a balance sheet restructuring that is saving approximately $4.2 million of interest expense annually. Continued balance sheet restructurings in the fourth quarter of 2015 and first quarter of 2016 (refer to Note 4 of the Consolidated Financial Statements) have further reduced interest expense. Refer to Note 12 in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015 for additional details.

 

The Company’s management intends to continue to shift the mix of funding from wholesale funds to 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.

 

 
49

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

PROVISION FOR LOAN/LEASE LOSSES

 

The provision is established based on a number of factors, including the Company’s historical loss experience, delinquencies and charge-off trends, the local and national economy and risk associated with the loans/leases in the portfolio as described in more detail in the “Critical Accounting Policies” section.

 

The Company’s provision totaled $1.2 million for the second quarter of 2016, which was down $1.2 million, or 49%, from the same quarter of the prior year. Provision for the first half of the year totaled $3.3 million, which was down $788 thousand, or 19%, compared to the first half of 2015. The decrease in provision expense was primarily due to stronger asset quality in recent periods.

 

The Company had net charge-offs of $496 thousand for the second quarter of 2016 which, when coupled with the provision of $1.2 million, increased the Company’s allowance to $28.1 million at June 30, 2016. As of June 30, 2016, the Company’s allowance to total loans/leases was 1.46%, which was flat from 1.46%at March 31, 2016 and down from 1.52% at June 30, 2015, respectively.

 

A more detailed discussion of the Company’s allowance can be found in the “Financial Condition” section of this report.

 

 
50

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

NONINTEREST INCOME

 

The following tables set forth the various categories of noninterest income for the three and six months ended June 30, 2016 and 2015.

 

   

Three Months Ended

                 
   

June 30, 2016

   

June 30, 2015

   

$ Change

   

% Change

 
                                 

Trust department fees

  $ 1,512,083     $ 1,511,176     $ 907       0.1

%

Investment advisory and management fees

    692,738       758,433       (65,695 )     (8.7 )

Deposit service fees

    946,810       924,642       22,168       2.4  

Gains on sales of residential real estate loans, net

    84,413       95,535       (11,122 )     (11.6 )

Gains on sales of government guaranteed portions of loans, net

    1,603,890       69,346       1,534,544       2,212.9  

Swap fee income

    167,582       393,723       (226,141 )     (57.4 )

Securities gains, net

    18,030       -       18,030       100.0  

Earnings on bank-owned life insurance

    480,520       433,152       47,368       10.9  

Debit card fees

    343,748       255,000       88,748       34.8  

Correspondent banking fees

    244,939       285,379       (40,440 )     (14.2 )

Participation service fees on commercial loan participations

    246,010       223,827       22,183       9.9  

Fee income from early termination of leases

    66,043       76,722       (10,679 )     (13.9 )

Credit card issuing fees

    139,073       135,649       3,424       2.5  

Other

    216,522       298,650       (82,128 )     (27.5 )

Total noninterest income

  $ 6,762,401     $ 5,461,234     $ 1,301,167       23.8

%

 

   

Six Months Ended

                 
   

June 30, 2016

   

June 30, 2015

   

$ Change

   

% Change

 
                                 

Trust department fees

  $ 3,087,990     $ 3,144,571     $ (56,581 )     (1.8

)%

Investment advisory and management fees

    1,351,123       1,468,476       (117,353 )     (8.0 )

Deposit service fees

    1,877,889       1,825,998       51,891       2.8  

Gains on sales of residential real estate loans

    144,799       181,675       (36,876 )     (20.3 )

Gains on sales of government guaranteed portions of loans

    2,482,418       140,319       2,342,099       1,669.1  

Swap fee income

    1,024,540       1,119,930       (95,390 )     (8.5 )

Securities gains, net

    376,510       416,933       (40,423 )     (9.7 )

Earnings on bank-owned life insurance

    874,129       911,891       (37,762 )     (4.1 )

Debit card fees

    651,399       493,000       158,399       32.1  

Correspondent banking fees

    547,069       605,000       (57,931 )     (9.6 )

Participation service fees on commercial loan participations

    456,719       445,776       10,943       2.5  

Fee income from early termination of leases

    77,793       161,560       (83,767 )     (51.8 )

Credit card issuing fees

    275,728       269,810       5,918       2.2  

Other

    356,768       498,073       (141,305 )     (28.4 )

Total noninterest income

  $ 13,584,874     $ 11,683,012     $ 1,901,862       16.3

%

 

In recent years, the Company has been successful in expanding its wealth management customer base, which has helped drive increases in fee income. While trust department fees continue to be a significant contributor to noninterest income, due to poor market conditions early in 2016, coupled with a large amount of distributions to clients and beneficiaries, trust department fees were flat compared to the first quarter of 2016. Trust department fees decreased 2% when comparing the first half of 2016 to the same period of the prior year. Income is generated primarily from fees charged based on assets under administration for corporate and personal trusts and for custodial services. The majority of the trust department fees are determined based on the value of the investments within the fully managed trusts. Additionally, the Company recently started offering trust operations services to correspondent banks. Fees are expected to grow in light of this new offering.

 

 
51

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

Management has placed a strong emphasis on growing its investment advisory and management services. Part of this initiative has been to restructure the Company’s Wealth Management Division to allow for more efficient delivery of products and services through selective additions of talent as well as leverage of and collaboration among existing resources (including the aforementioned trust department). Similar to trust department fees, these fees are largely determined based on the value of the investments managed. And, similar to the trust department, the Company has had some success in expanding its customer base. However, due to poor market conditions early in 2016, investment advisory fees decreased 9% from the second quarter of 2015 to the second quarter of 2016 and they decreased 8% when comparing the first half of 2015 to the first half of 2016.

 

Deposit service fees expanded 2%, comparing the second quarter of 2016 to the same period in 2015 and expanded 3% when comparing the first half of 2016 to the same period of the prior year. The Company continues its emphasis on shifting the mix of deposits from brokered and retail time deposits to non-maturity demand deposits across all its markets. With this shift in mix, the Company has increased the number of demand deposit accounts, which tend to be lower in interest cost and higher in service fees. The Company plans to continue this shift in mix and to further focus on growing deposit service fees.

 

Gains on sales of residential real estate loans decreased 12%, comparing the second quarter of 2016 to the second quarter of 2015 and decreased 20% when comparing the first half of 2016 to the same period of the prior year. With the sustained historically low interest rate environment, refinancing activity has slowed, as many of the Company’s existing and prospective customers have already executed a refinancing. Therefore, this area has become a much smaller contributor to overall noninterest income.

 

The Company’s gains on the sale of government-guaranteed portions of loans for the second quarter and first six months of 2016 were up significantly, compared to the same periods of 2015, due to the strong demand for these types of loans in 2016. As one of its core strategies, the Company continues to leverage its expertise by taking advantage of programs offered by the SBA and the USDA. The Company’s portfolio of government-guaranteed loans has grown as a direct result of the Company’s strong expertise in SBA and USDA lending. In some cases, it is more beneficial for the Company to sell the government-guaranteed portion on the secondary market for a premium rather than retain the loans in the Company’s portfolio. Sales activity for government-guaranteed portions of loans tends to fluctuate depending on the demand for loans that fit the criteria for the government guarantee. Further, the size of the transactions can vary and, as the gain is determined as a percentage of the guaranteed amount, the resulting gain on sale can vary. Lastly, a strategy for improved pricing is packaging loans together for sale. From time to time, the Company may execute on this strategy, which may delay the gains on sales of some loans to achieve better pricing. The Company has added additional talent and is executing on strategies in an effort to make this a more consistent and larger source of revenue. The pipelines for SBA and USDA lending are strong, and management believes that the Company will continue to post solid numbers in this category.

 

As a result of the sustained historically low interest rate environment, the Company was able to execute several interest rate swaps on select commercial loans. The interest rate swaps allow the commercial borrowers to pay a fixed interest rate while the Company receives a variable interest rate as well as an upfront fee dependent upon the pricing. Management believes that these swaps help position the Company more favorably for rising rate environments. Management will continue to review opportunities to execute these swaps at all of its subsidiary banks, as the circumstances are appropriate for the borrower and the Company. Swap fee income totaled $168 thousand in second quarter of 2016, as compared to $394 thousand in second quarter of 2015. Swap fee income totaled $1.0 million for the first half of 2016, compared to $1.1 million in the first half of 2015. Future levels of swap fee income are dependent upon prevailing interest rates.

 

 
52

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

Securities gains were $18 thousand for the second quarter of 2016. There were no gains recognized in the second quarter of 2015. Securities gains totaled $377 thousand for the first six months of 2016, compared to $417 thousand for the first six months of 2015. The Company took advantage of market opportunities by selling approximately $5.5 million of investments that were low-yielding during the quarter ended June 30, 2016 and $61.1 million for the first six months of 2016. Proceeds were then used to purchase higher-yielding tax-exempt municipal bonds with a modest duration extension and to fund loan and lease growth.

 

Earnings on BOLI increased 11% from the second quarter of 2015 to the second quarter of 2016 and decreased 4% comparing the first half of 2015 to the first half of 2016. There were no purchases of BOLI within the last twelve months. Notably, a small portion of the Company’s BOLI is variable in nature whereby the returns are determined by the performance of the equity market. The poor market performance in the first half of 2016 contributed to the decrease in earnings on BOLI year-to-date. 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 35% comparing the second quarter of 2016 to the second quarter of 2015 and increased 32% comparing the first half of 2016 to the first half of 2015. These fees can vary based on customer debit card usage, so fluctuations from period to period may occur. As an opportunity to maximize fees, the Company offers a deposit product with a modestly increased interest rate that incentivizes debit card activity.

 

Correspondent banking fees decreased 14%, comparing the second quarter of 2016 to the second quarter of 2015 and decreased 10% when comparing the first half of 2016 to the first half of 2015. As correspondent bank deposit balances rise, they receive a higher earnings credit, which then reduces the direct fees that the Company receives. There was an earnings credit rate increase implemented in the first quarter of 2016. Correspondent banking continues to be a core strategy for the Company, as this line of business provides a high level of noninterest bearing deposits that can be used to fund loan growth as well as a steady source of fee income.    The Company now serves approximately 176 banks in Iowa, Illinois and Wisconsin.

 

 
53

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

NONINTEREST EXPENSE

 

The following tables set forth the various categories of noninterest expense for the three and six months ended June 30, 2016 and 2015.

 

   

Three Months Ended

                 
   

June 30, 2016

   

June 30, 2015

   

$ Change

   

% Change

 
                                 

Salaries and employee benefits

  $ 10,917,473     $ 11,091,952     $ (174,479 )     (1.6

)%

Occupancy and equipment expense

    1,884,556       1,865,552       19,004       1.0  

Professional and data processing fees

    1,542,322       1,470,695       71,627       4.9  

Acquisition costs

    354,969       -       354,969       100.0  

FDIC insurance, other insurance and regulatory fees

    649,604       730,563       (80,959 )     (11.1 )

Loan/lease expense

    154,349       208,552       (54,203 )     (26.0 )

Net cost of operations of other real estate

    277,911       (47,876 )     325,787       (680.5 )

Advertising and marketing

    433,451       489,504       (56,053 )     (11.5 )

Postage and communications

    256,567       214,142       42,425       19.8  

Stationery and supplies

    157,924       136,808       21,116       15.4  

Bank service charges

    415,350       358,996       56,354       15.7  

Losses on debt extinguishment, net

    -       6,894,185       (6,894,185 )     (100.0 )

Correspondent banking expense

    181,776       165,091       16,685       10.1  

Other

    517,501       523,470       (5,969 )     (1.1 )

Total noninterest expense

  $ 17,743,753     $ 24,101,634     $ (6,357,881 )     (26.4

)%

 

   

Six Months Ended

                 
   

June 30, 2016

   

June 30, 2015

   

$ Change

   

% Change

 
                                 

Salaries and employee benefits

  $ 21,718,380     $ 22,126,404     $ (408,024 )     (1.8

)%

Occupancy and equipment expense

    3,711,544       3,659,723       51,821       1.4  

Professional and data processing fees

    2,989,735       2,941,212       48,523       1.6  

Acquisition costs

    354,969       -       354,969       100.0  

FDIC insurance, other insurance and regulatory fees

    1,283,969       1,449,620       (165,651 )     (11.4 )

Loan/lease expense

    317,168       511,475       (194,307 )     (38.0 )

Net cost of operations of other real estate

    380,094       28,975       351,119       1,211.8  

Advertising and marketing

    819,710       907,741       (88,031 )     (9.7 )

Postage and communications

    473,657       463,098       10,559       2.3  

Stationery and supplies

    322,795       279,363       43,432       15.5  

Bank service charges

    831,281       696,454       134,827       19.4  

Losses on debt extinguishment, net

    83,197       6,894,185       (6,810,988 )     (98.8 )

Correspondent banking expense

    358,765       340,794       17,971       5.3  

Other

    1,052,987       1,006,751       46,236       4.6  

Total noninterest expense

  $ 34,698,251     $ 41,305,795     $ (6,607,544 )     (16.0

)%

 

Management places a strong emphasis on overall cost containment and is committed to improving the Company’s general efficiency.

 

 
54

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

Salaries and employee benefits, which is the largest component of noninterest expense, decreased from the second quarter of 2015 to the second quarter of 2016 by 2%. This line item also decreased 2% when comparing the first half of 2016 to the first half of 2015. This was primarily due to the acquisition of the noncontrolling interest in m2 in 2015, thus eliminating the related salary expense. This amount represented the former minority owner’s 20% interest in the earnings of m2, as further described in Note 23 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2015. Additionally, management focused on taking steps to reduce salary and employee benefits expense during the last half of 2015 and the first half of 2016, consistent with the Company’s stated goal of carefully managing noninterest expense growth.

 

Occupancy and equipment expense increased slightly, comparing the second quarter of 2016 to the same period of the prior year and comparing the first half of 2016 to the same period of the prior year. The increased expense was mostly due to higher service contract-related expenses.

 

Professional and data processing fees increased 5%, comparing the second quarter of 2016 to the same period in 2015 and increased 2% comparing the first half of 2016 to the same period in 2015. Generally, professional and data processing fees can fluctuate depending on certain one-time project costs. Management will continue to focus on minimizing such one-time costs and driving recurring costs down through contract renegotiation or managed reduction in activity where costs are determined on a usage basis.    

 

Acquisition costs for the second quarter of 2016 and for the first half of 2016 total $355 thousand. These costs are related to the planned acquisition of Community State Bank, as described in Note 9 to the Consolidated Financial Statements.

 

FDIC and other insurance expense decreased 11%, comparing the second quarter of 2016 to the second quarter of 2015, and decreased 11% comparing the first half of 2016 to the same period of 2015. The decrease in expense was due to a decrease in the assessment rate designated by the FDIC.

 

Loan/lease expense decreased 26%, comparing the second quarter of 2016 to the same quarter of 2015 and decreased 38% when comparing the first half of 2016 to the same period of 2015. The Company incurred elevated levels of expense during 2015 for certain existing NPLs in connection with the work-out of these loans. 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 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 costs of operations of other real estate totaled $278 thousand for the second quarter of 2016, compared to ($48) thousand for the second quarter of 2015. Net costs of operations of other real estate totaled $380 thousand for the first six months of 2016, compared to $29 thousand for the first six months of 2015.

 

Bank service charges, a large portion of which includes indirect costs incurred to provide services to QCBT’s correspondent banking customer portfolio, increased 15% from the second quarter of 2015 to the second quarter of 2016 and increased 19% from the first half of 2015 to the first half of 2016. The increase was due, in large part, to the success QCBT has had in growing its correspondent banking customer portfolio. As transactions volumes continue to increase and the number of correspondent banking clients increases, the associated expenses will also increase. This may not directly correlate to correspondent banking balances, as quarter-end balances can fluctuate.

 

 
55

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

In the first half of 2016, the Company incurred $83 thousand of losses on debt extinguishment, net. This amount included $1.3 million of losses related to the prepayment of certain FHLB advances and whole structured repurchase agreements, as well as a $1.2 million gain recognized through the repurchase of trust preferred securities. For further details, please refer to Note 4 of the Consolidated Financial Statements. In the first half of 2015, the Company incurred $6.9 million of losses on debt extinguishment, net, due to the prepayment of certain FHLB advances and structured repurchase agreements, as described in detail within Note 12 of the Company’s annual report on Form 10-K for the year ended December 31, 2015.

 

Correspondent banking expense was up 10% when comparing the second quarter of 2016 to the second quarter of 2015 and up 5% when comparing the first six months of 2016 to the same period of 2015. These are direct costs incurred to provide services to QCBT’s correspondent banking customer portfolio, including safekeeping and cash management services.

 

INCOME TAXES

 

In the second quarter of 2016, the Company incurred income tax expense of $2.2 million. For the first half of the year, the Company incurred income tax expense of $4.2 million. Following is a reconciliation of the expected income tax expense to the income tax expense included in the consolidated statements of income for the three and six months ended June 30, 2016 and 2015.

 

   

For the Three Months Ended June 30,

   

For the Six Months Ended June 30,

 
   

2016

   

2015

   

2016

   

2015

 
           

% of

           

% of

           

% of

           

% of

 
           

Pretax

           

Pretax

           

Pretax

           

Pretax

 
   

Amount

   

Income

   

Amount

   

Income

   

Amount

   

Income

   

Amount

   

Income

 
                                                                 

Computed "expected" tax expense

  $ 3,090,364       35.0 %   $ (874,380 )     35.0 %   $ 6,027,743       35.0 %   $ 906,902       35.0 %

Tax exempt income, net

    (988,488 )     (11.2 )     (882,613 )     35.3       (1,954,806 )     (11.4 )     (1,708,730 )     (65.9 )

Bank-owned life insurance

    (168,182 )     (1.9 )     (151,603 )     6.1       (305,945 )     (1.8 )     (319,162 )     (12.3 )

State income taxes, net of federal benefit, current year

    297,130       3.4       (85,113 )     3.4       564,038       3.3       85,217       3.3  

Other

    (77,680 )     (0.9 )     19,298       (0.8 )     (158,863 )     (0.9 )     (27,149 )     (1.1 )

Federal and state income tax expense

  $ 2,153,144       24.4 %   $ (1,974,411 )     79.0 %   $ 4,172,167       24.2 %   $ (1,062,922 )     (41.0 )%

 

The effective tax for the quarter ended June 30, 2016 was 24.4% which was an increase over the effective tax rate of 79% for the quarter ended June 30, 2015. The effective tax rate for the six months ended June 30, 2016 was 24.2%, which was an increase over the effective tax rate of (41.0%) for the six months ended June 30, 2015. The increase in pre-tax income was derived from a larger portion of taxable income which drove the increase in the effective tax rate. The Company’s tax-exempt income sources include interest income from tax-exempt municipal bonds and loans as well as earnings on BOLI. Tax-exempt income grew over the past year; however, the growth in taxable income far outpaced the growth in non-taxable income. In 2015, the Company had more nontaxable income and deductible expenses (including $6.9 million of losses on debt extinguishment, net) than taxable income, which led to tax benefits in both periods presented above.

 

 
56

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

FINANCIAL CONDITION

 

Following is a table that represents the major categories of the Company’s balance sheet.

 

   

As of

 
   

June 30, 2016

   

March 31, 2016

   

December 31, 2015

   

June 30, 2015

 
                                                                 
   

(dollars in thousands)

 
                                                                 
   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

 

Cash and due from banks

  $ 49,581       2 %   $ 44,931       2 %   $ 41,742       2 %   $ 39,995       2 %

Federal funds sold and interest-bearing deposits

    68,432       3 %     57,229       2 %     56,164       2 %     70,238       3 %

Securities

    510,959       19 %     537,317       20 %     577,109       22 %     592,368       23 %

Net loans/leases

    1,894,676       71 %     1,846,428       70 %     1,771,882       68 %     1,689,238       66 %

Other assets

    159,786       6 %     154,768       6 %     146,301       6 %     151,130       6 %

Total assets

  $ 2,683,434       100 %   $ 2,640,673       100 %   $ 2,593,198       100 %   $ 2,542,969       100 %
                                                                 

Total deposits

  $ 1,973,594       74 %   $ 1,989,573       75 %   $ 1,880,666       72 %   $ 1,836,767       72 %

Total borrowings

    381,875       14 %     347,901       13 %     444,162       17 %     456,567       18 %

Other liabilities

    52,848       2 %     68,056       3 %     42,484       2 %     37,938       2 %

Total stockholders' equity

    275,117       10 %     235,143       9 %     225,886       9 %     211,697       8 %

Total liabilities and stockholders' equity

  $ 2,683,434       100 %   $ 2,640,673       100 %   $ 2,593,198       100 %   $ 2,542,969       100 %

 

During the second quarter of 2016, the Company’s total assets increased $42.8 million, or 2%, to a total of $2.7 billion, while total gross loans and leases grew $48.2 million, or 3%. The loan and lease growth was funded primarily by called securities and short-term borrowings. Deposits decreased $16.0 million, or 1%, during the quarter. Borrowings increased $34.0 million (mostly overnight FHLB advances) in the second quarter to $381.9 million. Stockholders’ equity increased $40.0 million, or 17%, in the current quarter due to net income, as well as the common stock offering described in Note 9 to the Consolidated Financial Statements.

 

INVESTMENT SECURITIES 

 

The composition of the Company’s securities portfolio is managed to meet liquidity needs while prioritizing the impact on interest rate risk and maximizing return, while minimizing credit risk. The Company has further diversified the portfolio by decreasing U.S government sponsored agency securities, while increasing residential mortgage-backed 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. Additionally, management will continue to diversify the portfolio with further growth strictly dictated by the pace of growth in deposits and loans.

 

 
57

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

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:

 

   

As of

 
   

June 30, 2016

   

March 31, 2016

   

December 31, 2015

   

June 30, 2015

 
   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

 
   

(dollars in thousands)

 

U.S. govt. sponsored agency securities

  $ 88,321       17 %   $ 132,742       25 %   $ 213,537       37 %   $ 256,444       43 %

Municipal securities

    302,689       59 %     285,009       53 %     280,203       49 %     251,992       42 %

Residential mortgage-backed and related securities

    116,765       23 %     116,452       22 %     80,670       14 %     80,844       14 %

Other securities

    3,184       1 %     3,114       0 %     2,699       0 %     3,088       1 %
    $ 510,959       100 %   $ 537,317       100 %   $ 577,109       100 %   $ 592,368       100 %
                                                                 

Securities as a % of Total Assets

    19.04 %             20.35 %             22.25 %             23.29 %        

Net Unrealized Gains (Losses) as a % of Amortized Cost

    1.95 %             1.05 %             (0.03% )             (0.69% )        

Duration (in years)

    5.1               5.2               5.1               4.9          

Yield on investment securities (tax equivalent)

    3.64 %             3.42 %             3.07 %             3.00 %        

 

As a result of fluctuations in longer-term interest rates, the fair value of the Company’s securities portfolio went from a net unrealized gain position of 1.05% of amortized cost at March 31, 2016 to a net unrealized gain position of 1.95% of amortized cost at June 30, 2016. Management performs an evaluation of the portfolio quarterly to understand the current market value as well as projections of market value in a variety of rising and falling interest rate scenarios. In addition, management has evaluated those securities with an unrealized loss position to determine whether the loss is derived from credit deterioration or the movement in interest rates. The evaluation determined that there were no securities in the portfolio with OTTI. See the “Critical Accounting Policies” section of this report for further discussion of this evaluation.

 

The duration of the securities portfolio has stayed relatively flat over the past several quarters. Duration was extended from the strong growth in longer term fixed rate municipal securities, but was mostly offset by the duration shortening of agency and mortgage-backed securities portfolios resulting from targeted sales of longer duration investments and as the remaining agency portfolio rolled closer to maturities or call dates.

 

The Company has not invested in commercial mortgage-backed securities or pooled trust preferred securities. Additionally, the Company has not invested in the types of securities subject to the Volcker Rule (a provision of the Dodd-Frank Act).

 

See Note 2 to the Consolidated Financial Statements for additional information regarding the Company’s investment securities.

 

 
58

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

LOANS/LEASES 

 

Total loans/leases grew 13.9% on an annualized basis during the first six months of 2016. The mix of the loan/lease types within the Company’s loan/lease portfolio is presented in the following table.

 

   

As of

 
   

June 30, 2016

   

March 31, 2016

   

December 31, 2015

   

June 30, 2015

 
   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

 
                                                                 
   

(dollars in thousands)

 
                                                                 

C&I loans

  $ 706,261       37 %   $ 682,057       37 %   $ 648,160       36 %   $ 606,826       36 %

CRE loans

    784,379       41 %     766,159       41 %     724,369       40 %     696,122       41 %

Direct financing leases

    169,928       9 %     172,774       9 %     173,656       10 %     170,799       10 %

Residential real estate loans

    180,482       9 %     173,096       9 %     170,433       10 %     161,985       9 %

Installment and other consumer loans

    73,658       4 %     71,842       4 %     73,669       4 %     72,448       4 %
                                                                 

Total loans/leases

  $ 1,914,708       100 %   $ 1,865,928       100 %   $ 1,790,287       100 %   $ 1,708,180       100 %
                                                                 

Plus deferred loan/lease origination costs, net of fees

    8,065               7,895               7,736               7,204          

Less allowance

    (28,097 )             (27,395 )             (26,141 )             (26,146 )        
                                                                 

Net loans/leases

  $ 1,894,676             $ 1,846,428             $ 1,771,882             $ 1,689,238          

 

As CRE loans have historically been the Company’s largest portfolio segment, management places a strong emphasis on monitoring the composition of the Company’s CRE loan portfolio. For example, management tracks the level of owner-occupied CRE loans relative to non owner-occupied loans. Owner-occupied loans are generally considered to have less risk. As of June 30, 2016 and March 31, 2016, respectively, approximately 33% and 34% of the CRE loan portfolio was owner-occupied.

 

Over the past several quarters, the Company has been successful in shifting the mix of its commercial loan portfolio by adding more C&I loans. C&I loans grew $99.4 million, or 16% over the past twelve months, which increased its percentage to total loans/leases from 36% to 37%.

 

 
59

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

Following is a listing of significant industries within the Company’s CRE loan portfolio:

 

   

As of June 30,

   

As of March 31,

   

As of December 31,

   

As of June 30,

 
   

2016

   

2016

   

2015

   

2015

 
   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

 
                                                                 
   

(dollars in thousands)

 
                                                                 

Lessors of Nonresidential Buildings

  $ 285,522       37 %   $ 277,822       36 %   $ 264,133       37 %   $ 248,315       35 %

Lessors of Residential Buildings

    104,395       13 %     99,104       13 %     89,189       12 %     87,424       12 %

Lessors of Other Real Estate Property

    21,803       3 %     21,895       3 %     22,009       3 %     18,251       3 %

Hotels

    19,804       3 %     19,694       3 %     19,228       3 %     17,648       3 %

Land Subdivision

    18,034       2 %     18,467       2 %     17,839       2 %     15,494       2 %

Nonresidential Property Managers

    17,517       2 %     17,003       2 %     10,500       1 %     5,360       1 %

Nursing Care Facilities

    15,070       2 %     13,807       2 %     17,288       2 %     15,293       2 %

New Car Dealers

    10,856       1 %     11,430       2 %     11,656       2 %     12,978       2 %

Other *

    291,378       37 %     286,937       37 %     272,527       38 %     275,359       40 %
                                                                 

Total CRE Loans

  $ 784,379       100 %   $ 766,159       100 %   $ 724,369       100 %   $ 696,122       100 %

 

* “Other” consists of all other industries. None of these had concentrations greater than $15.0 million, or approximately 2% of total CRE loans in the most recent period presented.

 

The Company’s residential real estate loan portfolio consists of the following:

 

 

Certain loans that do not meet the criteria for sale into the secondary market. These are often structured as adjustable rate mortgages with maturities ranging from three to seven years to avoid the long-term interest rate risk.

 

A limited amount of 15-year fixed rate residential real estate loans that meet certain credit guidelines.

 

The remaining residential real estate loans originated by the Company were sold on the secondary market to avoid the interest rate risk associated with longer term fixed rate loans. Loans originated for this purpose were classified as held for sale and are included in the residential real estate loans above. In addition, the Company has not originated any subprime, Alt-A, no documentation, or stated income residential real estate loans throughout its history.

 

See Note 3 to the Consolidated Financial Statements for additional information regarding the Company’s loan/lease portfolio.

 

 
60

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

ALLOWANCE FOR ESTIMATED LOSSES ON LOANS/LEASES

 

Changes in the allowance for the three and six months ended June 30, 2016 and 2015 are presented as follows:

 

   

Three Months Ended

   

Six Months Ended

 
   

June 30, 2016

   

June 30, 2015

   

June 30, 2016

   

June 30, 2015

 
                                 
   

(dollars in thousands)

   

(dollars in thousands)

 
                                 

Balance, beginning

  $ 27,395     $ 23,883     $ 26,141     $ 23,074  

Provisions charged to expense

    1,198       2,349       3,271       4,059  

Loans/leases charged off

    (634 )     (536 )     (1,502 )     (1,643 )

Recoveries on loans/leases previously charged off

    138       450       187       656  

Balance, ending

  $ 28,097     $ 26,146     $ 28,097     $ 26,146  

 

The allowance was determined based on factors that included the overall composition of the loan/lease portfolio, types of loans/leases, past loss experience, loan/lease delinquencies, potential substandard and doubtful credits, economic conditions, collateral positions, governmental guarantees and other factors that, in management’s judgment, deserved evaluation. To ensure that an adequate allowance was maintained, provisions were made based on a number of factors, including the increase in loans/leases and a detailed analysis of the loan/lease portfolio. The loan/lease portfolio is reviewed and analyzed monthly with specific detailed reviews completed on all loans risk-rated worse than “fair quality” and carrying aggregate exposure in excess of $250 thousand. The adequacy of the allowance is monitored by the loan review staff and reported to management and the board of directors.

 

The Company’s levels of criticized and classified loans are reported in the following table.

 

   

As of

 

Internally Assigned Risk Rating *

 

June 30, 2016

   

March 31, 2016

   

December 31, 2015

   

June 30, 2015

 
                                 
   

(dollars in thousands)

 
                                 

Special Mention (Rating 6)

  $ 16,231     $ 28,065     $ 37,289     $ 35,093  

Substandard (Rating 7)

    44,636       38,273       27,962       24,688  

Doubtful (Rating 8)

    -       -       -       -  
    $ 60,867     $ 66,338     $ 65,251     $ 59,781  
                                 
                                 

Criticized Loans **

  $ 60,867     $ 66,338     $ 65,251     $ 59,781  

Classified Loans ***

  $ 44,636     $ 38,273     $ 27,962     $ 24,688  
                                 

Criticized Loans as a % of Total Loans/Leases

    3.17 %     3.54 %     3.63 %     3.48 %

Classified Loans as a % of Total Loans/Leases

    2.32 %     2.04 %     1.56 %     1.44 %

 

* Amounts above include the government guaranteed portion, if any. For the calculation of allowance, the Company assigns internal risk ratings of Pass (Rating 2) for the government guaranteed portion.

** Criticized loans are defined as commercial and industrial and commercial real estate loans with internally assigned risk ratings of 6, 7, or 8, regardless of performance.

*** Classified loans are defined as commercial and industrial and commercial real estate loans with internally assigned risk ratings of 7 or 8, regardless of performance.

 

The Company experienced an increase in classified loans during the first half of 2016, while criticized loans decreased during this same period. The increase in classified loans during the first half of 2016 was primarily due to a limited number of relationship downgrades. The Company continues its strong focus on improving credit quality in an effort to limit NPLs.

 

 
61

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

The following table summarizes the trend in the allowance as a percentage of gross loans/leases and as a percentage of NPLs.

 

   

As of

 
   

June 30, 2016

   

March 31, 2016

   

December 31, 2015

   

June 30, 2015

 
                                 
                                 

Allowance / Gross Loans/Leases

    1.46 %     1.46 %     1.45 %     1.52 %

Allowance / NPLs *

    223.42 %     228.75 %     223.33 %     176.02 %

 

*NPLs consist of nonaccrual loans/leases, accruing loans/leases past due 90 days or more, and accruing TDRs.

 

Although management believes that the allowance at June 30, 2016 was at a level adequate to absorb losses on existing loans/leases, there can be no assurance that such losses will not exceed the estimated amounts or that the Company will not be required to make additional provisions in the future. Unpredictable future events could adversely affect cash flows for both commercial and individual borrowers, which could cause the Company to experience increases in problem assets, delinquencies and losses on loans/leases, and require further increases in the provision. Asset quality is a priority for the Company and its subsidiaries. The ability to grow profitably is in part dependent upon the ability to maintain that quality. The Company continually focuses efforts at its subsidiary banks and leasing company with the intention to improve the overall quality of the Company’s loan/lease portfolio.

 

See Note 3 to the Consolidated Financial Statements for additional information regarding the Company’s allowance.

 

 
62

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

NONPERFORMING ASSETS 

 

The table below presents the amounts of NPAs.

 

   

As of June 30,

   

As of March 31,

   

As of December 31,

   

As of June 30,

 
   

2016

   

2016

   

2015

   

2015

 
                                 
   

(dollars in thousands)

 
                                 

Nonaccrual loans/leases (1) (2)

  $ 10,737     $ 10,772     $ 10,648     $ 13,542  

Accruing loans/leases past due 90 days or more

    86       47       3       46  

TDRs - accruing

    1,753       1,157       1,054       1,266  

Total NPLs

    12,576       11,976       11,705       14,854  

OREO

    6,179       6,680       7,151       11,952  

Other repossessed assets

    154       46       246       297  

Total NPAs

  $ 18,909     $ 18,702     $ 19,102     $ 27,103  
                                 

NPLs to total loans/leases

    0.65 %     0.64 %     0.65 %     0.87 %

NPAs to total loans/leases plus repossessed property

    0.98 %     0.99 %     1.06 %     1.57 %

NPAs to total assets

    0.70 %     0.71 %     0.74 %     1.07 %

Texas ratio (3)

    6.28 %     7.23 %     7.62 %     11.50 %

 

 

(1)

Includes government guaranteed portion of loans, as applicable.

 

(2)

Includes TDRs of $2.4 million at June 30, 2016, $1.6 million at March 31, 2016, $1.5 million at December 31, 2015, and $3.9 million at June 30, 2015.

 

(3)

Texas Ratio = Nonperforming Assets (excluding Other Repossessed Assets) / Tangible Equity plus Allowance. Texas Ratio is a non-GAAP financial measure. Management included this ratio as it is considered by many investors and analysts to be a metric with which to analyze and evaluate asset quality. Other companies may calculate this ratio differently.

 

NPAs at June 30, 2016 were $18.9 million, which were flat from March 31, 2016 and down $8.2 million from June 30, 2015. In addition, the ratio of NPAs to total assets was 0.70% at June 30, 2016, which was down from 0.71% at March 31, 2016, and down from 1.07% at June 30, 2015.

 

The large majority of the NPAs consist of nonaccrual loans/leases, accruing TDRs, and OREO. For nonaccrual loans/leases and accruing TDRs, management has thoroughly reviewed these loans/leases and has provided specific allowances as appropriate.

 

OREO is carried at the lower of carrying amount or fair value less costs to sell.

 

Additionally, a portion of several of the nonaccrual loans are guaranteed by the government. At June 30, 2016, government guaranteed amounts of nonaccrual loans totaled approximately $713 thousand, or 7% of the $10.7 million of total nonaccrual loans/leases.

 

The Company’s lending/leasing practices remain unchanged and asset quality remains a top priority for management.

 

 
63

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

DEPOSITS 

 

Deposits decreased $16.0 million during the second quarter of 2016. The table below presents the composition of the Company’s deposit portfolio.

 

   

As of

 
   

June 30, 2016

   

March 31, 2016

   

December 31, 2015

   

June 30, 2015

 
                                                                 
   

(dollars in thousands)

 
                                                                 
   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

 

Noninterest bearing demand deposits

  $ 615,764       31 %   $ 641,859       32 %   $ 615,292       33 %   $ 633,370       34 %

Interest bearing demand deposits

    918,036       47 %     916,455       46 %     886,294       47 %     785,705       43 %

Time deposits

    337,584       17 %     331,786       17 %     309,974       16 %     322,826       18 %

Brokered deposits

    102,210       5 %     99,473       5 %     69,106       4 %     94,866       5 %
    $ 1,973,594       100 %   $ 1,989,573       100 %   $ 1,880,666       100 %   $ 1,836,767       100 %

 

The Company has been successful in growing its noninterest bearing deposit portfolio over the past several years, although during the second quarter, noninterest bearing demand deposits decreased 4%.

 

Quarter-end balances can greatly fluctuate due to large customer and correspondent bank activity. Management will continue to focus on growing its noninterest bearing deposit portfolio, including its correspondent banking business at QCBT, as well as shifting the mix from brokered and other higher cost deposits to lower cost core deposits.

 

BORROWINGS 

 

The subsidiary banks offer short-term repurchase agreements to some of their significant customers. Also, the subsidiary banks purchase federal funds for short-term funding needs from the Federal Reserve Bank of Chicago or from their correspondent banks. The table below presents the composition of the Company’s short-term borrowings.

 

   

As of

 
   

June 30, 2016

   

March 31, 2016

   

December 31, 2015

   

June 30, 2015

 
                                 
   

(dollars in thousands)

 
                                 

Overnight repurchase agreements with customers

  $ 21,441     $ 52,153     $ 73,873     $ 118,795  

Federal funds purchased

    30,120       11,870       70,790       49,780  
    $ 51,561     $ 64,023     $ 144,663     $ 168,575  

 

The Company is nearing the end of transitioning its overnight repurchase agreements with customers into a comparable interest bearing demand deposit product that offers full FDIC insurance. This transition freed up securities that were previously pledged as collateral to the overnight repurchase agreements with customers. This enhanced the Company’s ability to further rotate its earning assets from securities to loans.

 

As a result of their memberships in either the FHLB of Des Moines or Chicago, the subsidiary banks have the ability to borrow funds for short or long-term purposes under a variety of programs. FHLB advances are utilized for loan matching as a hedge against the possibility of rising interest rates, and when these advances provide a less costly or more readily available source of funds than customer deposits.

 

 
64

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

Other borrowings consist of structured repos which are utilized as an alternative funding source to FHLB advances and customer deposits. Structured repos are collateralized by certain U.S. government agency securities and residential mortgage backed securities. Structured repos totaled $100 million, $100 million, $110 million and $115 million as of June 30, 2016, March 31, 2016, December 31, 2015 and June 30, 2015, respectively.

 

It is management’s intention to continue to reduce its reliance on wholesale funding, including FHLB advances, structured repos, and brokered deposits. Replacement of this funding with core deposits helps to reduce interest expense as the 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.

 

   

June 30, 2016

   

December 31, 2015

 
           

Weighted

           

Weighted

 
           

Average

           

Average

 

Maturity:

 

Amount Due

   

Interest Rate

   

Amount Due

   

Interest Rate

 
                                 

Year ending December 31:

 

(dollar amounts in thousands)

 
                                 

2016

  $ 222,873       0.56 %   $ 125,038       0.59 %

2017

    39,055       1.61       49,055       2.07  

2018

    45,233       2.70       57,283       2.87  

2019

    46,950       3.21       50,089       3.14  

2020

    45,000       2.66       45,000       2.66  

Thereafter

    -       0.00       3,641       2.51  

Total Wholesale Funding

  $ 399,111       1.45 %   $ 330,106       1.89 %

 

During the first six months of 2016, wholesale funding increased $69.0 million. While the Company increased overall wholesale funding, the increase was all short-term in nature, as 2016 maturities increased $97.8 million, while all future year maturities saw a decrease due to brokered CDs that were called and prepayments of certain FHLB advances and structured repos (as further described in Note 4 of the Consolidated Financial Statements).

 

The table below presents the Company’s term FHLB advances and overnight FHLB advances.

 

   

As of

 
   

June 30, 2016

   

March 31, 2016

   

December 31, 2015

   

June 30, 2015

 
                                 
   

(dollars in thousands)

 
                                 

Term FHLB advances

  $ 78,000     $ 80,000     $ 97,000     $ 104,000  

Overnight FHLB advances

    118,900       70,500       54,000       28,500  
    $ 196,900     $ 150,500     $ 151,000     $ 132,500  

 

 
65

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

STOCKHOLDERS’ EQUITY

 

The table below presents the composition of the Company’s stockholders’ equity.

 

   

As of

 
   

June 30, 2016

   

March 31, 2016

   

December 31, 2015

   

June 30, 2015

 
   

Amount

   

Amount

   

Amount

   

Amount

 
                                 
   

(dollars in thousands)

 
                                 

Common stock

  $ 13,057     $ 11,815     $ 11,761     $ 11,820  

Additional paid in capital

    155,454       124,058       123,283       122,511  

Retained earnings

    105,024       98,868       92,966       81,066  

AOCI (loss)

    1,582       402       (2,124 )     (2,094 )

Less: Treasury stock

    -       -       -       (1,606 )

Total stockholders' equity

  $ 275,117     $ 235,143     $ 225,886     $ 211,697  
                                 

TCE* / TA

    10.10 %     8.74 %     8.55 %     8.15 %

 

*TCE is defined as total common stockholders’ equity excluding goodwill and other intangibles. This ratio is a non-GAAP financial measure.

 

During the second quarter of 2015, the Company finalized its acquisition of the 20% noncontrolling interest in m2 (further described in Note 23 of the Company’s annual report filed on Form 10-K as of December 31, 2015). As final 2015 tax returns were filed in early 2016, the Company made necessary final adjustments to the related deferred tax accounts. This resulted in an increase of $2.1 million to deferred tax assets and additional paid in capital during the second quarter of 2016.

 

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 $115.4 million during the second quarter of 2016 and $129.5 million during 2015. The Company’s on balance sheet liquidity position can fluctuate based on short-term activity in deposits and loans.

 

The subsidiary banks have a variety of sources of short-term liquidity available to them, including federal funds purchased from correspondent banks, FHLB advances, wholesale structured repurchase agreements, brokered deposits, lines of credit, borrowing at the Federal Reserve Discount Window, sales of securities available for sale, and loan/lease participations or sales. The Company also generates liquidity from the regular principal payments and prepayments made on its loan/lease portfolio, and on the regular monthly payments on its securities portfolio (both residential mortgage-backed securities and municipal securities).

 

At June 30, 2016, the subsidiary banks had 33 lines of credit totaling $359.0 million, of which $12.0 million was secured and $347.0 million was unsecured. At June 30, 2016, $339.0 million was available as $20.0 million was utilized for short-term borrowings needs at QCBT.

 

 
66

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

At December 31, 2015, the subsidiary banks had 32 lines of credit totaling $346.6 million, of which $14.6 million was secured and $332.0 million was unsecured. At December 31, 2015, $286.6 million was available as $60.0 million was utilized for short-term borrowing needs at QCBT.

 

The Company has emphasized growing the number and amount of lines of credit in an effort to strengthen this contingent source of liquidity. Additionally, the Company maintains a $10.0 million secured revolving credit note with a variable interest rate and a maturity of June 30, 2017. At June 30, 2016, the Company had not borrowed on this revolving credit note and had the full amount available.

 

The Company currently has $299.8 million in correspondent banking deposits spread over 176 relationships. While the Company feels that these funds are very stable, there is the potential for large fluctuations that can impact liquidity. Seasonality and the liquidity needs of these correspondent banks can impact balances. Management closely monitors these fluctuations and runs stress scenarios to measure the impact on liquidity and interest rate risk with various levels of correspondent deposit run-off.

 

Investing activities used cash of $67.2 million during the first six months of 2016, compared to $15.0 million for the same period of 2015. Proceeds from calls, maturities, paydowns, and sales of securities were $171.1 million for the first six months of 2016, compared to $240.3 million for the same period of 2015. Purchases of securities used cash of $97.1 million for the first six months of 2016, compared to $181.3 million for the same period of 2015. The net increase in loans/leases used cash of $125.0 million for the first six months of 2016 compared to $85.8 million for the same period of 2015.

 

Financing activities provided cash of $60.3 million for the first six months of 2016, compared to $7.9 million for same period of 2015. Net increases in deposits totaled $92.9 million for the first six months of 2016, compared to $157.1 million for the same period of 2015. During the first six months of 2016, the Company’s short-term borrowings decreased $93.1 million, while they decreased $99.8 million for the same period of 2015. During the first six months of 2016, the Company used $25.2 million to prepay select FHLB advances and other borrowings. In the same period, the Company received $29.8 million of proceeds from the common stock offering of 1.2 million shares of common stock. During the first six months of 2015, the Company received $63.5 million of proceeds from the common stock offering of 3.7 million shares of common stock. In the same period, the Company used $110.4 million to prepay select FHLB advances and other borrowings.

 

Total cash provided by operating activities was $14.8 million for the first six months of 2016, compared to $8.9 million for the same period of 2015.

 

Throughout its history, the Company has secured additional capital through various sources, including the issuance of common and preferred stock, as well as trust preferred securities. Trust preferred securities are reported on the Company’s balance sheet as liabilities, but currently qualify for treatment as regulatory capital.

 

 
67

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

The following table presents the details of the trust preferred securities outstanding as of June 30, 2016 and December 31, 2015.

 

Name

Date Issued

Amount Outstanding

6/30/16

Amount Outstanding

12/31/15

Interest Rate

Interest Rate

as of

6/30/16

Interest Rate

as of

12/31/2015

             

QCR Holdings Statutory Trust II

February 2004

$10,310,000

$10,310,000

2.85% over 3-month LIBOR

3.48%

3.18%

QCR Holdings Statutory Trust III

February 2004

8,248,000

8,248,000

2.85% over 3-month LIBOR

3.48%

3.18%

QCR Holdings Statutory Trust IV

May 2005

                          -

5,155,000

1.80% over 3-month LIBOR

N/A

2.12%

QCR Holdings Statutory Trust V

February 2006

10,310,000

10,310,000

1.55% over 3-month LIBOR

2.18%

1.87%

Community National Statutory Trust II

September 2004

3,093,000

3,093,000

2.17% over 3-month LIBOR

2.82%

2.74%

Community National Statutory Trust III

March 2007

3,609,000

3,609,000

1.75% over 3-month LIBOR

2.40%

2.26%

   

$35,570,000

$40,725,000

Weighted Average Rate

2.94%

2.60%

 

The Company assumed the trust preferred securities originally issued by Community National in connection with its acquisition in May 2013. As a result of acquisition accounting, the liabilities were recorded at fair value upon acquisition with the resulting discount being accreted as interest expense on a level yield basis over the expected term. The original discount totaled $2.6 million. As of June 30, 2016, the remaining discount was $2.2 million.

 

QCR Holdings Statutory Trust IV was extinguished in the first quarter of 2016. Refer to Note 4 of the Consolidated Financial Statements for additional information.

 

On August 27, 2015, the Company filed a universal shelf registration statement on Form S-3 with the SEC. This registration statement, declared effective by the SEC on October 5, 2015, allows the Company to issue various types of securities, including common stock, preferred stock, debt securities or warrants, from time to time, up to an aggregate amount of $100 million. The specific terms and prices of the securities will be determined at the time of any future offering and described in a separate prospectus supplement, which would be filed with the SEC at the time of the particular offering, if any. On May 23, 2016, the Company completed a $30 million takedown from its shelf registration statement for the common stock issuance discussed in Note 9 of the Consolidated Financial Statements, leaving $70 million for future offerings. 

 

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.

 

 
68

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

SPECIAL NOTE CONCERNING FORWARD-LOOKING STATEMENTS

 

Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995. This document (including information incorporated by reference) contains, and future oral and written statements of the Company and its management may contain, forward-looking statements, within the meaning of such term in the Private Securities Litigation Reform Act of 1995, with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company’s management and on information currently available to management, are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “bode,” “predict,” “suggest,” “project,” “appear,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should,” “likely,” or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events.

 

The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. The factors which could have a material adverse effect on the Company’s operations and future prospects are detailed in the “Risk Factors” sections included under Item 1A of Part I of the Company’s Annual Report on Form 10-K and Item 1A of Part II of this report. In addition to the risk factors described in that section, there are other factors that may impact any public company, including the Company, which could have a material adverse effect on the Company’s operations and future prospects of the Company and its subsidiaries.

 

These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.

 

 
69

 

 

Part I

Item 3

 

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The Company, like other financial institutions, is subject to direct and indirect market risk. Direct market risk exists from changes in interest rates. The Company’s net income is dependent on its net interest income. Net interest income is susceptible to interest rate risk to the degree that interest-bearing liabilities mature or reprice on a different basis than interest-earning assets. When interest-bearing liabilities mature or reprice more quickly than interest-earning assets in a given period, a significant increase in market rates of interest could adversely affect net interest income. Similarly, when interest-earning assets mature or reprice more quickly than interest-bearing liabilities, falling interest rates could result in a decrease in net interest income.

 

In an attempt to manage the Company’s exposure to changes in interest rates, management monitors the Company’s interest rate risk. Each subsidiary bank has an asset/liability management committee of the board of directors that meets quarterly to review the bank’s interest rate risk position and profitability, and to make or recommend adjustments for consideration by the full board of each bank.

 

Internal asset/liability management teams consisting of members of the subsidiary banks’ management meet weekly to manage the mix of assets and liabilities to maximize earnings and liquidity and minimize interest rate and other risks. Management also reviews the subsidiary banks’ securities portfolios, formulates investment strategies, and oversees the timing and implementation of transactions to assure attainment of the board's objectives in an effective manner. Notwithstanding the Company’s interest rate risk management activities, the potential for changing interest rates is an uncertainty that can have an adverse effect on net income.

 

In adjusting the Company’s asset/liability position, the board of directors and management attempt to manage the Company’s interest rate risk while maintaining or enhancing net interest margins. At times, depending on the level of general interest rates, the relationship between long-term and short-term interest rates, market conditions and competitive factors, the board of directors and management may decide to increase the Company’s interest rate risk position somewhat in order to increase its net interest margin. The Company’s results of operations and net portfolio values remain vulnerable to increases in interest rates and to fluctuations in the difference between long-term and short-term interest rates.

 

One method used to quantify interest rate risk is a short-term earnings at risk summary, which is a detailed and dynamic simulation model used to quantify the estimated exposure of net interest income to sustained interest rate changes. This simulation model captures the impact of changing interest rates on the interest income received and interest expense paid on all interest sensitive assets and liabilities reflected on the Company’s consolidated balance sheet. This sensitivity analysis demonstrates net interest income exposure annually over a five-year horizon, assuming no balance sheet growth and various interest rate scenarios including no change in rates; 200, 300, 400, and 500 basis point upward shifts; and a 100 basis point downward shift in interest rates, where interest-bearing assets and liabilities reprice at their earliest possible repricing date.

 

The model assumes parallel and pro rata shifts in interest rates over a twelve-month period for the 200 basis point upward shift and 100 basis point downward shift. For the 400 basis point upward shift, the model assumes a parallel and pro rata shift in interest rates over a twenty-four month period. For the 500 basis point upward shift, the model assumes a flattening and pro rata shift in interest rates over a twelve-month period where the short-end of the yield curve shifts upward greater than the long-end of the yield curve.

 

 
70

 

 

Part I

Item 3

 

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Further, in recent years, the Company added additional interest rate scenarios where interest rates experience a parallel and instantaneous shift upward 100, 200, 300, and 400 basis points and a parallel and instantaneous shift downward 100 basis points. The Company will run additional interest rate scenarios on an as-needed basis.

 

The asset/liability management committees of the subsidiary bank boards of directors have established policy limits of a 10% decline in net interest income for the 200 basis point upward parallel shift and the 100 basis point downward parallel shift. For the 300 basis point upward shock, the established policy limit has been increased to 25% decline in net interest income. The increased policy limit is appropriate as the shock scenario is extreme and unlikely and warrants a higher limit than the more realistic and traditional parallel/pro-rata shift scenarios.

 

Application of the simulation model analysis for select interest rate scenarios at the most recent quarter-end available is presented in the following table:

 

   

NET INTEREST INCOME EXPOSURE in YEAR 1

INTEREST RATE SCENARIO

POLICY LIMIT

As of March 31, 2016

As of December 31, 2015

As of December 31, 2014

         

100 basis point downward shift

-10.0%

-1.2%

-2.1%

-1.7%

200 basis point upward shift

-10.0%

-3.4%

-2.7%

-5.0%

300 basis point upward shock

-25.0%

-7.1%

-7.1%

-11.9%

 

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 March 31, 2016 (the most recent quarter available) were within established risk tolerances as established by policy or by best practice (if the interest rate scenario didn’t have a specific policy limit).

 

In 2014, the Company executed two interest rate cap transactions, each with a notional value of $15.0 million, for a total of $30.0 million. The interest rate caps purchased essentially set a ceiling to the interest rate paid on the $30.0 million of short-term FHLB advances that are being hedged, minimizing the interest rate risk associated with rising interest rates. The Company will continue to analyze and evaluate similar transactions as an alternative and cost effective way to mitigate interest rate risk.

 

Interest rate risk is considered to be one of the most significant market risks affecting the Company. For that reason, the Company engages the assistance of a national consulting firm and its risk management system to monitor and control the Company’s interest rate risk exposure. Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company’s business activities.

 

 
71

 

 

Part I

Item 4

 

CONTROLS AND PROCEDURES

 

 

Evaluation of disclosure controls and procedures. An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) promulgated under the Exchange Act of 1934) as of June 30, 2016. 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.

 

 
72

 

 

Part II

QCR HOLDINGS, INC. AND SUBSIDIARIES

 

PART II - OTHER INFORMATION

 

Item 1              Legal Proceedings                                       

 

There are no material pending legal proceedings to which the Company or any of its subsidiaries is a party other than ordinary routine litigation incidental to their respective businesses.

 

Item 1A           Risk Factors

 

There have been no material changes in the risk factors applicable to the Company from those disclosed in Part I, Item 1.A. “Risk Factors,” in the Company’s 2015 Annual Report on Form 10-K. Please refer to that section of the Company’s Form 10-K for disclosures regarding the risks and uncertainties related to the Company’s business.

 

Item 2              Unregistered Sales of Equity Securities and Use of Proceeds                         

 

None 

 

Item 3             Defaults Upon Senior Securities                         

 

None

 

Item 4             Mine Safety Disclosures

 

Not applicable

 

Item 5            Other Information                                        

 

               None               

 

 
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Part II

QCR HOLDINGS, INC. AND SUBSIDIARIES

 

PART II - OTHER INFORMATION - continued

 

Item 6           Exhibits

 

2.1

Stock Purchase Agreement, between QCR Holdings, Inc. and Van Diest Investment Company, dated May 23, 2016 (incorporated by reference to Exhibit 2.1 of the Company’s Current Report on Form 8-K filed on May 23, 2016).

 

10.1

2016 Equity Incentive Plan (incorporated by reference to Appendix A of the Company’s definitive proxy statement on Schedule 14A filed on April 1, 2016).

 

10.2

Form of Securities Purchase Agreement, between the Company and certain investors, dated May 20, 2016 ((incorporated by reference to Exhibit 2.1 of the Company’s Current Report on Form 8-K filed on May 23, 2016).

 

31.1

Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a).

 

31.2

Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a).

 

32.1

Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

32.2

Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

101

Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets as of June 30, 2016 and December 31, 2015; (ii) Consolidated Statements of Income for the three and six months ended June 30, 2016 and June 30, 2015; (iii) Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2016 and June 30, 2015; (iv) Consolidated Statements of Changes in Stockholders’ Equity for the three and six months ended June 30, 2016 and June 30, 2015; (v) Consolidated Statements of Cash Flows for the six months ended June 30, 2016 and June 30, 2015; and (vi) Notes to the Consolidated Financial Statements.

 

 
74

 

  

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.

 

 

QCR HOLDINGS, INC.

(Registrant)

  

 

Date August 5, 2016

 

/s/ Douglas M. Hultquist 

 

 

 

Douglas M. Hultquist, President

 

 

 

Chief Executive Officer

 

 

 

Date August 5, 2016

 

/s/ Todd A. Gipple

 

 

 

Todd A. Gipple, Executive Vice President

 

 

 

Chief Operating Officer

 

    Chief Financial Officer  

                                                        

 

Date August 5, 2016

 

/s/ Elizabeth A. Grabin

 

 

 

Elizabeth A. Grabin, Vice President

 

 

 

Controller & Director of Financial Reporting

 

    Principal Accounting Officer  


 

 75