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QCR HOLDINGS INC - Quarter Report: 2017 March (Form 10-Q)

qcrh20170331_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 March 31, 2017

 

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

For the transition period from           to________

 

Commission file number 0-22208

 

QCR HOLDINGS, INC.

(Exact name of Registrant as specified in its charter)

 

Delaware 42-1397595
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)

 

3551 7th Street, Moline, Illinois 61265

   (Address of principal executive offices, including zip code)

 

(309) 736-3580

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.           Yes      [ X ]          No [    ]

 

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

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,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.      (Check one): 

 

Large accelerated filer [     ]            Accelerated filer [ X ]            Non-accelerated filer [    ]     

Smaller reporting company [     ]          Emerging growth company [    ]

 

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

Yes [    ]          No [ X ] 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [   ]

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date: As of May 3, 2017, the Registrant had outstanding 13,170,214 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

3

   

As of March 31, 2017 and December 31, 2016

 
       
   

Consolidated Statements of Income

 
   

For the Three Months Ended March 31, 2017 and 2016

4

       
   

Consolidated Statements of Comprehensive Income

 
   

For the Three Months Ended March 31, 2017 and 2016

5

       
   

Consolidated Statements of Changes in Stockholders' Equity

 
   

For the Three Months Ended March 31, 2017 and 2016

6

       
   

Consolidated Statements of Cash Flows

 
   

For the Three Months Ended March 31, 2017 and 2016

7

       
   

Notes to Consolidated Financial Statements

 
       
   

Note 1. Summary of Significant Accounting Policies

9

   

Note 2. Investment Securities

11

   

Note 3. Loans/Leases Receivable

16

   

Note 4. Earnings Per Share

26

   

Note 5. Fair Value

26

   

Note 6. Business Segment Information

30

   

Note 7. Regulatory Capital Requirements

31

       
 

Item 2

Management's Discussion and Analysis of Financial Condition and

 
   

Results of Operations

 
       
   

Introduction

33

   

General

33

   

Executive Overview

34

   

Long-Term Financial Goals

35

   

Strategic Developments

36

   

GAAP to Non-GAAP Reconciliations

38

   

Net Interest Income (Tax Equivalent Basis)

41

   

Critical Accounting Policies

44

   

Results of Operations

 
   

Interest Income

45

   

Interest Expense

45

   

Provision for Loan/Lease Losses

46

   

Noninterest Income

47

   

Noninterest Expense

49

   

Income Taxes

51

 

1

 

 

   

Financial Condition

51

   

Investment Securities

52

   

Loans/Leases

53

   

Allowance for Estimated Losses on Loans/Leases

56

   

Nonperforming Assets

58

   

Deposits

59

   

Borrowings

59

   

Stockholders' Equity

61

   

Liquidity and Capital Resources

61

   

Special Note Concerning Forward-Looking Statements

64

       
 

Item 3

Quantitative and Qualitative Disclosures About Market Risk

65

       
 

Item 4

Controls and Procedures

67

       

Part II

OTHER INFORMATION

 
       
 

Item 1

Legal Proceedings

68

       
 

Item 1A

Risk Factors

68

       
 

Item 2

Unregistered Sales of Equity Securities and Use of Proceeds

68

       
 

Item 3

Defaults upon Senior Securities

68

       
 

Item 4

Mine Safety Disclosures

68

       
 

Item 5

Other Information

68

       
 

Item 6

Exhibits

69

       

Signatures

 

70

 

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 March 31, 2017 and December 31, 2016

 

   

March 31,

   

December 31,

 
   

2017

   

2016

 

ASSETS

               

Cash and due from banks

  $ 56,325,969     $ 70,569,993  

Federal funds sold

    15,798,000       22,257,000  

Interest-bearing deposits at financial institutions

    157,420,706       63,948,925  
                 

Securities held to maturity, at amortized cost

    306,694,063       322,909,056  

Securities available for sale, at fair value

    250,952,021       251,113,139  

Total securities

    557,646,084       574,022,195  
                 

Loans receivable held for sale

    1,051,000       1,135,500  

Loans/leases receivable held for investment

    2,434,799,415       2,404,351,485  

Gross loans/leases receivable

    2,435,850,415       2,405,486,985  

Less allowance for estimated losses on loans/leases

    (32,059,150 )     (30,757,448 )

Net loans/leases receivable

    2,403,791,265       2,374,729,537  
                 

Bank-owned life insurance

    57,726,738       57,257,051  

Premises and equipment, net

    61,143,458       60,643,508  

Restricted investment securities

    13,689,125       14,997,025  

Other real estate owned, net

    5,625,363       5,523,104  

Goodwill

    13,110,913       13,110,913  

Core deposit intangible

    7,150,346       7,381,213  

Other assets

    31,584,651       37,503,284  

Total assets

  $ 3,381,012,618     $ 3,301,943,748  
                 

LIABILITIES AND STOCKHOLDERS' EQUITY

               

LIABILITIES

               

Deposits:

               

Noninterest-bearing

  $ 777,150,245     $ 797,415,090  

Interest-bearing

    2,028,781,254       1,871,846,183  

Total deposits

    2,805,931,499       2,669,261,273  
                 

Short-term borrowings

    19,470,096       39,971,387  

Federal Home Loan Bank advances

    106,550,000       137,500,000  

Other borrowings

    72,000,000       80,000,000  

Junior subordinated debentures

    33,513,509       33,480,202  

Other liabilities

    47,707,884       55,690,087  

Total liabilities

    3,085,172,988       3,015,902,949  
                 

STOCKHOLDERS' EQUITY

               

Preferred stock, $1 par value; shares authorized 250,000 March 2017 and December 2016 - No shares issued or outstanding

    -       -  

Common stock, $1 par value; shares authorized 20,000,000 March 2017 - 13,161,219 shares issued and outstanding December 2016 - 13,106,845 shares issued and outstanding

    13,161,219       13,106,845  

Additional paid-in capital

    157,581,969       156,776,642  

Retained earnings

    127,145,292       118,616,901  

Accumulated other comprehensive loss:

               

Securities available for sale

    (1,167,142 )     (1,527,433 )

Interest rate cap derivatives

    (881,708 )     (932,156 )

Total stockholders' equity

    295,839,630       286,040,799  

Total liabilities and stockholders' equity

  $ 3,381,012,618     $ 3,301,943,748  

 

See Notes to Consolidated Financial Statements (Unaudited)

 

3

 

 

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

Three Months Ended March 31,

 

   

2017

   

2016

 

Interest and dividend income:

               

Loans/leases, including fees

  $ 27,211,417     $ 19,700,370  

Securities:

               

Taxable

    1,142,235       1,356,203  

Nontaxable

    2,647,722       2,242,015  

Interest-bearing deposits at financial institutions

    198,652       60,317  

Restricted investment securities

    130,430       130,564  

Federal funds sold

    14,643       12,590  

Total interest and dividend income

    31,345,099       23,502,059  
                 

Interest expense:

               

Deposits

    2,232,756       1,289,798  

Short-term borrowings

    23,960       43,066  

Federal Home Loan Bank advances

    403,469       441,704  

Other borrowings

    683,208       825,083  

Junior subordinated debentures

    332,823       304,886  

Total interest expense

    3,676,216       2,904,537  
                 

Net interest income

    27,668,883       20,597,522  
                 

Provision for loan/lease losses

    2,105,109       2,072,985  

Net interest income after provision for loan/lease losses

    25,563,774       18,524,537  
                 

Noninterest income:

               

Trust department fees

    1,740,207       1,575,907  

Investment advisory and management fees

    961,599       658,385  

Deposit service fees

    1,316,390       931,079  

Gains on sales of residential real estate loans

    96,323       60,386  

Gains on sales of government guaranteed portions of loans

    950,641       878,528  

Swap fee income

    113,520       856,958  

Securities gains, net

    -       358,480  

Earnings on bank-owned life insurance

    469,687       393,609  

Debit card fees

    702,801       307,651  

Correspondent banking fees

    245,189       302,130  

Other

    687,397       499,360  

Total noninterest income

    7,283,754       6,822,473  
                 

Noninterest expense:

               

Salaries and employee benefits

    13,307,331       10,800,907  

Occupancy and equipment expense

    2,502,219       1,826,988  

Professional and data processing fees

    2,083,392       1,447,413  

FDIC insurance, other insurance and regulatory fees

    621,242       634,365  

Loan/lease expense

    293,538       162,819  

Net cost of operations of other real estate

    14,230       102,183  

Advertising and marketing

    609,431       386,259  

Bank service charges

    423,901       415,931  

Losses on debt extinguishment, net

    -       83,197  

Correspondent banking expense

    198,351       176,989  

Other

    1,219,482       917,447  

Total noninterest expense

    21,273,117       16,954,498  
                 

Net income before income taxes

    11,574,411       8,392,512  

Federal and state income tax expense

    2,389,446       2,019,023  
                 

Net income

  $ 9,184,965     $ 6,373,489  
                 

Basic earnings per common share

  $ 0.70     $ 0.54  

Diluted earnings per common share

  $ 0.68     $ 0.53  
                 

Weighted average common shares outstanding

    13,133,382       11,793,620  

Weighted average common and common equivalent shares outstanding

    13,488,417       11,953,949  
                 

Cash dividends declared per common share

  $ 0.05     $ 0.04  

 

See Notes to Consolidated Financial Statements (Unaudited)

 

4

 

 

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

Three Months Ended March 31, 2017 and 2016

 

   

Three Months Ended March 31,

 
   

2017

   

2016

 

Net income

  $ 9,184,965     $ 6,373,489  
                 

Other comprehensive income:

               
                 

Unrealized gains on securities available for sale:

               

Unrealized holding gains arising during the period before tax

    598,190       4,863,718  

Less reclassification adjustment for gains included in net income before tax

    -       358,480  
      598,190       4,505,238  

Unrealized losses on interest rate cap derivatives:

               

Unrealized holding losses arising during the period before tax

    (45,202 )     (405,373 )

Less reclassification adjustment for ineffectiveness and caplet amortization before tax

    (122,813 )     (14,070 )
      77,611       (391,303 )
                 

Other comprehensive income, before tax

    675,801       4,113,935  

Tax expense

    265,062       1,588,524  

Other comprehensive income, net of tax

    410,739       2,525,411  
                 

Comprehensive income

  $ 9,595,704     $ 8,898,900  

 

See Notes to Consolidated Financial Statements (Unaudited)

 

5

 

 

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED)

Three Months Ended March 31, 2017 and 2016

 

                           

Accumulated

         
           

Additional

           

Other

         
   

Common

   

Paid-In

   

Retained

   

Comprehensive

         
   

Stock

   

Capital

   

Earnings

   

Income (Loss)

   

Total

 

Balance, December 31, 2016

  $ 13,106,845     $ 156,776,642     $ 118,616,901     $ (2,459,589 )   $ 286,040,799  

Net income

    -       -       9,184,965       -       9,184,965  

Other comprehensive income, net of tax

    -       -       -       410,739       410,739  

Common cash dividends declared, $0.05 per share

    -       -       (656,574 )     -       (656,574 )

Proceeds from issuance of 3,573 shares of common stock as a result of stock purchased under the Employee Stock Purchase Plan

    3,573       83,091       -       -       86,664  

Proceeds from issuance of 44,284 shares of common stock as a result of stock options exercised

    44,284       630,290       -       -       674,574  

Stock compensation expense

    -       388,753                       388,753  

Restricted stock awards - 13,289 shares of common stock

    13,289       (13,289 )     -       -       -  

Exchange of 6,772 shares of common stock in connection with stock options exercised and restricted stock vested

    (6,772 )     (283,518 )     -       -       (290,290 )

Balance, March 31, 2017

  $ 13,161,219     $ 157,581,969     $ 127,145,292     $ (2,048,850 )   $ 295,839,630  

 

                           

Accumulated

         
           

Additional

           

Other

         
   

Common

   

Paid-In

   

Retained

   

Comprehensive

         
   

Stock

   

Capital

   

Earnings

   

Income (Loss)

   

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 46,020 shares of common stock as a result of stock options exercised

    46,020       729,473       -       -       775,493  

Stock compensation expense

    -       382,761                       382,761  

Tax benefit of nonqualified stock options exercised

    -       22,508       -       -       22,508  

Restricted stock awards - 22,382 shares of common stock

    22,382       (22,382 )     -       -       -  

Exchange of 19,628 shares of common stock in connection with stock options exercised and restricted stock vested

    (19,628 )     (431,806 )     -       -       (451,434 )

Balance, March 31, 2016

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

 

See Notes to Consolidated Financial Statements (Unaudited)

 

6

 

 

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

Three Months Ended March 31, 2017 and 2016

 

   

2017

   

2016

 

CASH FLOWS FROM OPERATING ACTIVITIES

               

Net income

  $ 9,184,965     $ 6,373,489  

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

               

Depreciation

    896,952       766,069  

Provision for loan/lease losses

    2,105,109       2,072,985  

Stock-based compensation expense

    388,753       382,761  

Deferred compensation expense accrued

    404,723       318,796  

Losses (gains) on other real estate owned, net

    -       (7,740 )

Amortization of premiums on securities, net

    347,178       294,286  

Securities gains, net

    -       (358,480 )

Loans originated for sale

    (21,416,325 )     (18,901,618 )

Proceeds on sales of loans

    22,547,789       19,640,997  

Gains on sales of residential real estate loans

    (96,323 )     (60,386 )

Gains on sales of government guaranteed portions of loans

    (950,641 )     (878,528 )

Losses on debt extinguishment, net

    -       83,197  

Amortization of core deposit intangible

    230,867       49,878  

Accretion of acquisition fair value adjustments, net

    (1,915,001 )     (44,169 )

Increase in cash value of bank-owned life insurance

    (469,687 )     (393,609 )

Decrease (increase) in other assets

    5,427,798       (9,295,660 )

Increase (decrease) in other liabilities

    (5,852,341 )     5,079,831  

Net cash provided by operating activities

  $ 10,833,816     $ 5,122,099  
                 

CASH FLOWS FROM INVESTING ACTIVITIES

               

Net decrease in federal funds sold

    6,459,000       4,110,000  

Net increase in interest-bearing deposits at financial institutions

    (93,471,781 )     (5,175,206 )

Proceeds from sales of other real estate owned

    34,191       494,115  

Activity in securities portfolio:

               

Purchases

    (12,138,040 )     (45,070,780 )

Calls, maturities and redemptions

    17,385,968       47,573,001  

Paydowns

    8,486,628       6,428,508  

Sales

    -       55,526,851  

Activity in restricted investment securities:

               

Purchases

    (7,600 )     (485,250 )

Redemptions

    1,315,500       -  

Net increase in loans/leases originated and held for investment

    (29,236,438 )     (76,346,066 )

Purchase of premises and equipment

    (1,396,902 )     (1,558,171 )

Net cash used in investing activities

  $ (102,569,474 )   $ (14,502,998 )
                 

CASH FLOWS FROM FINANCING ACTIVITIES

               

Net increase in deposit accounts

    136,704,261       108,903,515  

Net decrease in short-term borrowings

    (20,501,291 )     (80,639,905 )

Activity in Federal Home Loan Bank advances:

               

Calls and maturities

    (4,000,000 )     (7,000,000 )

Net change in short-term and overnight advances

    (26,950,000 )     16,500,000  

Prepayments

    -       (10,524,197 )

Activity in other borrowings:

               

Calls, maturities and scheduled principal payments

    (8,000,000 )     -  

Prepayments

    -       (10,759,000 )

Retirement of junior subordinated debentures

    -       (3,955,000 )

Payment of cash dividends on common stock

    (522,574 )     (468,583 )

Proceeds from issuance of common stock, net

    761,238       512,584  

Net cash provided by financing activities

  $ 77,491,634     $ 12,569,414  
                 

Net increase (decrease) in cash and due from banks

    (14,244,024 )     3,188,515  

Cash and due from banks, beginning

    70,569,993       41,742,321  

Cash and due from banks, ending

  $ 56,325,969     $ 44,930,836  

 

(Continued)

 

7

 

 

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) - continued

Three Months Ended March 31, 2017 and 2016

 

   

2017

   

2016

 

Supplemental disclosure of cash flow information, cash payments for:

               

Interest

  $ 3,747,218     $ 2,944,839  
                 

Income/franchise taxes, net

  $ 4,842     $ 2,464,300  
                 

Supplemental schedule of noncash investing activities:

               

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

  $ 410,739     $ 2,525,411  
                 

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

  $ (290,290 )   $ (451,434 )
                 

Tax benefit of nonqualified stock options exercised

  $ -     $ 22,508  
                 

Transfers of loans to other real estate owned

  $ 136,450     $ 16,000  
                 

Due to broker for purchases of securities

  $ -     $ (20,104,340 )
                 

Dividends payable

  $ 656,574     $ 470,873  
                 

Decrease (increase) in the fair market value of interest rate swap assets and liabilities

  $ 303,383     $ (4,615,782 )

 

See Notes to Consolidated Financial Statements (Unaudited)

 

8

 

 

Part I

Item 1

QCR HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

March 31, 2017

 

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, 2016, included in the Company’s Annual Report on Form 10-K filed with the SEC on March 10, 2017. 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 March 31, 2017, are not necessarily indicative of the results expected for the year ending December 31, 2017, 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

FRB: Federal Reserve Bank of Chicago

AOCI: Accumulated other comprehensive income (loss)

GAAP: Generally Accepted Accounting Principles

AFS: Available for sale

HTM: Held to maturity

ASC: Accounting Standards Codification

m2: m2 Lease Funds, LLC

ASC 805: Business Combinations Standard

MD&A: Management's Discussion & Analysis

ASU: Accounting Standards Update

NIM: Net interest margin

BOLI: Bank-owned life insurance

NPA: Nonperforming asset

Caps: Interest rate cap derivatives

NPL: Nonperforming loan

Community National: Community National Bancorporation

OREO: Other real estate owned

CNB: Community National Bank

OTTI: Other-than-temporary impairment

CRBT: Cedar Rapids Bank & Trust Company

PCI: Purchased credit impaired

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.

 

USDA: U.S. Department of Agriculture

 

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries which include four commercial banks: QCBT, CRBT, CSB 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.

 

The acquisition of CSB occurred on August 31, 2016; therefore, the Consolidated Balance Sheets included herein for both March 31, 2017 and December 31, 2016 include CSB. The Consolidated Statements of Income included herein include CSB for the quarter ended March 31, 2017, however, did not include CSB for the comparative period ending March 31, 2016.

 

9

 

 

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 and it is not expected to have a significant impact on the Company’s consolidated financial statements.

 

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

 

Effective January 1, 2017, the Company adopted ASU 2016-09, Compensation – Stock Compensation. Under the standard, the excess tax benefit (deficiency) related to stock options exercised and restricted stock awards vested is recorded as an adjustment to income tax expense. In the past, this tax benefit (deficiency) was recorded directly to equity. This change in accounting resulted in $533 thousand of reduced income tax expense in the first quarter of 2017.

 

10

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

NOTE 2 – INVESTMENT SECURITIES

 

The amortized cost and fair value of investment securities as of March 31, 2017 and December 31, 2016 are summarized as follows:

 

           

Gross

   

Gross

         
   

Amortized

   

Unrealized

   

Unrealized

   

Fair

 
   

Cost

   

Gains

   

(Losses)

   

Value

 

March 31, 2017:

                               

Securities HTM:

                               

Municipal securities

  $ 305,644,063     $ 2,193,278     $ (4,690,335 )   $ 303,147,006  

Other securities

    1,050,000       -       -       1,050,000  
    $ 306,694,063     $ 2,193,278     $ (4,690,335 )   $ 304,197,006  
                                 

Securities AFS:

                               

U.S. govt. sponsored agency securities

  $ 47,720,622     $ 130,306     $ (294,847 )   $ 47,556,081  

Residential mortgage-backed and related securities

    149,968,905       160,174       (2,625,092 )     147,503,987  

Municipal securities

    51,104,318       454,505       (426,949 )     51,131,874  

Other securities

    4,056,248       760,936       (57,105 )     4,760,079  
    $ 252,850,093     $ 1,505,921     $ (3,403,993 )   $ 250,952,021  
                                 

December 31, 2016:

                               

Securities HTM:

                               

Municipal securities

  $ 321,859,056     $ 2,200,577     $ (4,694,734 )   $ 319,364,899  

Other securities

    1,050,000       -       -       1,050,000  
    $ 322,909,056     $ 2,200,577     $ (4,694,734 )   $ 320,414,899  
                                 

Securities AFS:

                               

U.S. govt. sponsored agency securities

  $ 46,281,306     $ 132,886     $ (330,585 )   $ 46,083,607  

Residential mortgage-backed and related securities

    150,465,222       174,993       (2,938,088 )     147,702,127  

Municipal securities

    52,816,541       425,801       (637,916 )     52,604,426  

Other securities

    4,046,332       703,978       (27,331 )     4,722,979  
    $ 253,609,401     $ 1,437,658     $ (3,933,920 )   $ 251,113,139  

 

11

 

 

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 private mortgage-backed securities or pooled trust preferred securities.

 

Gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of March 31, 2017 and December 31, 2016, 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

 

March 31, 2017:

                                               

Securities HTM:

                                               

Municipal securities

  $ 110,858,743     $ (3,751,123 )   $ 15,350,772     $ (939,212 )   $ 126,209,515     $ (4,690,335 )
                                                 

Securities AFS:

                                               

U.S. govt. sponsored agency securities

  $ 18,742,054     $ (230,974 )   $ 5,115,200     $ (63,873 )   $ 23,857,254     $ (294,847 )

Residential mortgage-backed and related securities

    124,401,508       (2,266,050 )     9,181,284       (359,042 )     133,582,792       (2,625,092 )

Municipal securities

    29,386,855       (408,233 )     337,522       (18,716 )     29,724,377       (426,949 )

Other securities

    2,901,563       (57,105 )     -       -       2,901,563       (57,105 )
    $ 175,431,980     $ (2,962,362 )   $ 14,634,006     $ (441,631 )   $ 190,065,986     $ (3,403,993 )
                                                 

December 31, 2016:

                                               

Securities HTM:

                                               

Municipal securities

  $ 122,271,533     $ (4,076,647 )   $ 13,010,803     $ (618,087 )   $ 135,282,336     $ (4,694,734 )
                                                 

Securities AFS:

                                               

U.S. govt. sponsored agency securities

  $ 21,788,139     $ (257,640 )   $ 5,499,012     $ (72,945 )   $ 27,287,151     $ (330,585 )

Residential mortgage-backed and related securities

    121,506,582       (2,641,664 )     7,437,615       (296,424 )     128,944,197       (2,938,088 )

Municipal securities

    34,152,822       (618,462 )     338,099       (19,454 )     34,490,921       (637,916 )

Other securities

    3,177,414       (27,331 )     -       -       3,177,414       (27,331 )
    $ 180,624,957     $ (3,545,097 )   $ 13,274,726     $ (388,823 )   $ 193,899,683     $ (3,933,920 )

 

 

At March 31, 2017, the investment portfolio included 554 securities. Of this number, 255 securities were in an unrealized loss position. The aggregate losses of these securities totaled approximately 1.5% of the total amortized cost of the portfolio. Of these 255 securities, 24 securities had an unrealized loss for twelve months or more. All of the debt securities in unrealized loss positions are considered acceptable credit risks. Based upon an evaluation of the available evidence, including the recent changes in market rates, credit rating information and information obtained from regulatory filings, management believes the declines in fair value for these debt securities are temporary. In addition, the Company lacks the intent to sell these securities and it is not more-likely-than-not that the Company will be required to sell these debt securities before their anticipated recovery. At March 31, 2017 and December 31, 2016, 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 months ended March 31, 2017 and 2016.   

 

12

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

There were no sales of securities for the three months ended March 31, 2017. All sales of securities for the three months ended March 31, 2016 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

 
   

March 31, 2016

 
         

Proceeds from sales of securities

  $ 55,526,851  

Pre-tax gross gains from sales of securities

    515,515  

Pre-tax gross losses from sales of securities

    (157,035 )

 

 

The amortized cost and fair value of securities as of March 31, 2017 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

  $ 8,580,563     $ 8,580,930  

Due after one year through five years

    16,946,533       17,027,273  

Due after five years

    281,166,967       278,588,803  
    $ 306,694,063     $ 304,197,006  
                 

Securities AFS:

               

Due in one year or less

  $ 3,228,439     $ 3,240,004  

Due after one year through five years

    43,980,525       44,165,961  

Due after five years

    51,615,976       51,281,990  
    $ 98,824,940     $ 98,687,955  

Residential mortgage-backed and related securities

    149,968,905       147,503,987  

Other securities

    4,056,248       4,760,079  
    $ 252,850,093     $ 250,952,021  

 

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

  $ 163,299,673     $ 161,458,045  
                 

Securities AFS:

               

U.S. govt. sponsored agency securities

    5,048,496       5,059,493  

Municipal securities

    39,611,651       39,404,492  
    $ 44,660,147     $ 44,463,985  

 

13

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

As of March 31, 2017, the Company’s municipal securities portfolios were comprised of general obligation bonds issued by 112 issuers with fair values totaling $99.3 million and revenue bonds issued by 123 issuers, primarily consisting of states, counties, towns, villages and school districts with fair values totaling $255.0 million. The Company held investments in general obligation bonds in 21 states, including five states in which the aggregate fair value exceeded $5.0 million. The Company held investments in revenue bonds in 12 states, including six states in which the aggregate fair value exceeded $5.0 million.

 

As of December 31, 2016, the Company’s municipal securities portfolios were comprised of general obligation bonds issued by 116 issuers with fair values totaling $116.5 million and revenue bonds issued by 120 issuers, primarily consisting of states, counties, towns, villages and school districts with fair values totaling $255.5 million. The Company held investments in general obligation bonds in 21 states, including five states in which the aggregate fair value exceeded $5.0 million. The Company held investments in revenue bonds in twelve states, including six 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:

 

March 31, 2017:

                               

U.S. State:

 

Number of

Issuers

   

Amortized Cost

   

Fair Value

   

Average

Exposure

Per Issuer
(Fair Value)

 
                                 

Iowa

    27     $ 32,227,250     $ 32,252,723     $ 1,194,545  

North Dakota

    7       22,169,480       21,572,627       3,081,804  

Illinois

    17       12,915,605       13,060,349       768,256  

Missouri

    15       8,060,239       8,097,352       539,823  

Ohio

    8       6,785,433       6,635,402       829,425  

Other

    38       17,657,322       17,700,070       465,791  

Total general obligation bonds

    112     $ 99,815,329     $ 99,318,523     $ 886,773  

 

December 31, 2016:

                               

U.S. State:

 

Number of

Issuers

   

Amortized Cost

   

Fair Value

   

Average

Exposure

Per Issuer

(Fair Value)

 
                                 

Iowa

    27     $ 32,258,612     $ 32,231,936     $ 1,193,775  

Illinois

    19       29,214,559       29,308,438       1,542,549  

North Dakota

    7       22,169,050       21,499,075       3,071,296  

Missouri

    14       8,291,192       8,323,245       594,518  

Ohio

    8       6,790,398       6,651,897       831,487  

Other

    41       18,481,496       18,458,044       450,196  

Total general obligation bonds

    116     $ 117,205,307     $ 116,472,635     $ 1,004,074  

 

14

 

 

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:

 

March 31, 2017:

                               

U.S. State:

 

Number of

Issuers

   

Amortized Cost

   

Fair Value

   

Average

Exposure

Per Issuer
(Fair Value)

 
                                 

Missouri

    50     $ 92,894,184     $ 91,892,614     $ 1,837,852  

Iowa

    31       70,400,232       70,771,347       2,282,947  

Indiana

    22       46,469,290       45,838,852       2,083,584  

Ohio

    3       13,650,000       13,380,921       4,460,307  

Kansas

    6       13,260,612       13,243,053       2,207,176  

North Dakota

    4       7,992,074       7,722,774       1,930,694  

Other

    7       12,266,660       12,110,796       1,730,114  

Total revenue bonds

    123     $ 256,933,052     $ 254,960,357     $ 2,072,848  

 

December 31, 2016:

                               

U.S. State:

 

Number of

Issuers

   

Amortized Cost

   

Fair Value

   

Average

Exposure

Per Issuer

(Fair Value)

 
                                 

Missouri

    47     $ 90,784,441     $ 89,664,013     $ 1,907,745  

Iowa

    31       70,788,393       71,142,393       2,294,916  

Indiana

    22       47,994,737       47,582,138       2,162,824  

Kansas

    6       13,476,366       13,427,491       2,237,915  

North Dakota

    4       8,089,067       7,796,381       1,949,095  

Ohio

    3       13,650,000       13,405,222       4,468,407  

Other

    7       12,687,286       12,479,052       1,782,722  

Total revenue bonds

    120     $ 257,470,290     $ 255,496,690     $ 2,129,139  

 

Both general obligation and revenue bonds are diversified across many issuers. As of March 31, 2017 and December 31, 2016, the Company did not hold general obligation or revenue bonds of any single issuer, the aggregate book or market value of which exceeded 6% of the Company’s stockholders’ equity. Of the general obligation and revenue bonds in the Company’s portfolio, the majority are unrated bonds that represent small, private issuances. All unrated bonds were underwritten according to loan underwriting standards and have an average loan risk rating of 2, indicating very high quality. Additionally, many of these bonds are funding essential municipal services such as water, sewer, education, and medical facilities.

 

The Company’s municipal securities are owned by each of the four charters, whose investment policies set forth limits for various subcategories within the municipal securities portfolio. Each charter is monitored individually, and as of March 31, 2017, all were well within policy limitations approved by the board of directors. Policy limits are calculated as a percentage of each charter’s total risk-based capital.

 

As of March 31, 2017, 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.

 

15

 

 

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 March 31, 2017 and December 31, 2016 is presented as follows:

 

   

As of March 31,

   

As of December 31,

 
   

2017

   

2016

 
                 

C&I loans

  $ 851,578,347     $ 827,637,263  

CRE loans

               

Owner-occupied CRE

    316,902,218       332,387,621  

Commercial construction, land development, and other land

    171,901,708       165,149,491  

Other non owner-occupied CRE

    618,037,795       595,921,748  
      1,106,841,721       1,093,458,860  
                 

Direct financing leases *

    159,368,425       165,419,360  

Residential real estate loans **

    231,325,899       229,233,104  

Installment and other consumer loans

    78,770,847       81,665,695  
      2,427,885,239       2,397,414,282  

Plus deferred loan/lease origination costs, net of fees

    7,965,176       8,072,703  
      2,435,850,415       2,405,486,985  

Less allowance

    (32,059,150 )     (30,757,448 )
    $ 2,403,791,265     $ 2,374,729,537  
                 
                 

* Direct financing leases:

               

Net minimum lease payments to be received

  $ 177,088,295     $ 184,274,802  

Estimated unguaranteed residual values of leased assets

    1,085,154       1,085,154  

Unearned lease/residual income

    (18,805,024 )     (19,940,596 )
      159,368,425       165,419,360  

Plus deferred lease origination costs, net of fees

    5,730,479       5,881,778  
      165,098,904       171,301,138  

Less allowance

    (2,978,260 )     (3,111,898 )
    $ 162,120,644     $ 168,189,240  

 

*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 months ended March 31, 2017 and 2016.

 

**Includes residential real estate loans held for sale totaling $1,051,000 and $1,135,500 as of March 31, 2017, and December 31, 2016, respectively.

 

16

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

Changes in accretable yield for acquired loans were as follows:

 

   

For the three months ended March 31, 2017

 
   

PCI

   

Performing

         
   

Loans

   

Loans

   

Total

 

Balance at the beginning of the period

  $ (194,306 )   $ (9,115,614 )   $ (9,309,920 )

Accretion recognized

    66,690       2,171,540       2,238,230  

Balance at the end of the period

  $ (127,616 )   $ (6,944,074 )   $ (7,071,690 )

 

 

 

The aging of the loan/lease portfolio by classes of loans/leases as of March 31, 2017 and December 31, 2016 is presented as follows:

 

   

As of March 31, 2017

 

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

  $ 846,264,365     $ 108,148     $ 165,831     $ 575,066     $ 4,464,937     $ 851,578,347  

CRE

                                               

Owner-Occupied CRE

    316,508,674       61,156       -       240       332,148       316,902,218  

Commercial Construction, Land Development, and Other Land

    167,552,441       -       -       -       4,349,267       171,901,708  

Other Non Owner-Occupied CRE

    616,480,649       304,500       -       -       1,252,646       618,037,795  

Direct Financing Leases

    154,874,086       1,428,446       666,661       -       2,399,232       159,368,425  

Residential Real Estate

    228,282,091       1,587,945       -       255,942       1,199,921       231,325,899  

Installment and Other Consumer

    77,719,561       662,626       57,833       123,676       207,151       78,770,847  
    $ 2,407,681,867     $ 4,152,821     $ 890,325     $ 954,924     $ 14,205,302     $ 2,427,885,239  
                                                 

As a percentage of total loan/lease portfolio

    99.17 %     0.17 %     0.04 %     0.04 %     0.59 %     100.00 %

 

   

As of December 31, 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

  $ 821,637,507     $ 1,455,185     $ 10,551     $ 346,234     $ 4,187,786     $ 827,637,263  

CRE

                                               

Owner-Occupied CRE

    331,812,571       -       242,902       -       332,148       332,387,621  

Commercial Construction, Land Development, and Other Land

    160,760,034       35,638       -       -       4,353,819       165,149,491  

Other Non Owner-Occupied CRE

    594,384,926       100,673       -       -       1,436,149       595,921,748  

Direct Financing Leases

    161,452,627       730,627       574,700       215,225       2,446,181       165,419,360  

Residential Real Estate

    227,023,552       473,478       365,581       294,854       1,075,639       229,233,104  

Installment and Other Consumer

    81,199,766       204,973       63,111       110,501       87,344       81,665,695  
    $ 2,378,270,983     $ 3,000,574     $ 1,256,845     $ 966,814     $ 13,919,066     $ 2,397,414,282  
                                                 

As a percentage of total loan/lease portfolio

    99.20 %     0.13 %     0.05 %     0.04 %     0.58 %     100.00 %

 

17

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

NPLs by classes of loans/leases as of March 31, 2017 and December 31, 2016 are presented as follows:

 

   

As of March 31, 2017

 

Classes of Loans/Leases

 

Accruing Past

Due 90 Days or

More

   

Nonaccrual

Loans/Leases *

   

Accruing
TDRs

   

Total NPLs

   

Percentage of

Total NPLs

 
                                         

C&I

  $ 575,066     $ 4,464,937     $ 4,766,131     $ 9,806,134       45.85 %

CRE

                                       

Owner-Occupied CRE

    240       332,148       -       332,388       1.55 %

Commercial Construction, Land Development, and Other Land

    -       4,349,267       -       4,349,267       20.33 %

Other Non Owner-Occupied CRE

    -       1,252,646       -       1,252,646       5.86 %

Direct Financing Leases

    -       2,399,232       864,169       3,263,401       15.26 %

Residential Real Estate

    255,942       1,199,921       580,853       2,036,716       9.52 %

Installment and Other Consumer

    123,676       207,151       17,576       348,403       1.63 %
    $ 954,924     $ 14,205,302     $ 6,228,729     $ 21,388,955       100.00 %

 

*Nonaccrual loans/leases included $2,444,944 of TDRs, including $278,391 in C&I loans, $1,353,634 in CRE loans, $759,346 in direct financing leases, $42,525 in residential real estate loans, and $11,048 in installment loans.

 

   

As of December 31, 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

  $ 346,234     $ 4,187,786     $ 4,733,997       9,268,017       43.65 %

CRE

                                       

Owner-Occupied CRE

    -       332,148       -       332,148       1.56 %

Commercial Construction, Land Development, and Other Land

    -       4,353,819       -       4,353,819       20.51 %

Other Non Owner-Occupied CRE

    -       1,436,149       -       1,436,149       6.77 %

Direct Financing Leases

    215,225       2,446,181       1,008,244       3,669,650       17.28 %

Residential Real Estate

    294,854       1,075,639       585,541       1,956,034       9.21 %

Installment and Other Consumer

    110,501       87,344       18,746       216,591       1.02 %
    $ 966,814     $ 13,919,066     $ 6,346,528     $ 21,232,408       100.00 %

 

**Nonaccrual loans/leases included $2,300,479 of TDRs, including $48,501 in C&I loans, $1,380,047 in CRE loans, $816,149 in direct financing leases, $43,579 in residential real estate loans, and $12,203 in installment loans.

 

18

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

Changes in the allowance by portfolio segment for the three months ended March 31, 2017 and 2016, respectively, are presented as follows:

 

   

Three Months Ended March 31, 2017

 
   

C&I

   

CRE

   

Direct Financing

Leases

   

Residential Real

Estate

   

Installment and

Other Consumer

   

Total

 
                                                 

Balance, beginning

  $ 12,545,110     $ 11,670,609     $ 3,111,898     $ 2,342,344     $ 1,087,487     $ 30,757,448  

Provisions (credits) charged to expense

    593,359       966,271       505,015       43,520       (3,056 )     2,105,109  

Loans/leases charged off

    (218,273 )     -       (658,684 )     (13,623 )     (2,046 )     (892,626 )

Recoveries on loans/leases previously charged off

    33,894       6,386       20,031       3,623       25,285       89,219  

Balance, ending

  $ 12,954,090     $ 12,643,266     $ 2,978,260     $ 2,375,864     $ 1,107,670     $ 32,059,150  

 

   

Three Months Ended March 31, 2016

 
   

C&I

   

CRE

   

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 charged to expense

    739,831       715,450       478,245       62,656       76,803       2,072,985  

Loans/leases charged off

    (243,566 )     -       (600,938 )     (16,184 )     (7,596 )     (868,284 )

Recoveries on loans/leases previously charged off

    11,634       -       14,836       -       23,365       49,835  

Balance, ending

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

 

19

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

The allowance by impairment evaluation and by portfolio segment as of March 31, 2017 and December 31, 2016 is presented as follows:

 

   

As of March 31, 2017

 
   

C&I

   

CRE

   

Direct Financing

Leases

   

Residential Real

Estate

   

Installment and

Other Consumer

   

Total

 
                                                 

Allowance for impaired loans/leases

  $ 1,751,774     $ 888,445     $ 795,840     $ 274,566     $ 37,932     $ 3,748,557  

Allowance for nonimpaired loans/leases

    11,202,316       11,754,821       2,182,420       2,101,298       1,069,738       28,310,593  
    $ 12,954,090     $ 12,643,266     $ 2,978,260     $ 2,375,864     $ 1,107,670     $ 32,059,150  
                                                 

Impaired loans/leases

  $ 9,188,454     $ 5,924,061     $ 3,082,068     $ 1,780,774     $ 224,727     $ 20,200,084  

Nonimpaired loans/leases

    842,389,893       1,100,917,660       156,286,357       229,545,125       78,546,120       2,407,685,155  
    $ 851,578,347     $ 1,106,841,721     $ 159,368,425     $ 231,325,899     $ 78,770,847     $ 2,427,885,239  
                                                 

Allowance as a percentage of impaired loans/leases

    19.06 %     15.00 %     25.82 %     15.42 %     16.88 %     18.56 %

Allowance as a percentage of nonimpaired loans/leases

    1.33 %     1.07 %     1.40 %     0.92 %     1.36 %     1.18 %

Total allowance as a percentage of total loans/leases

    1.52 %     1.14 %     1.87 %     1.03 %     1.41 %     1.31 %

 

 

   

As of December 31, 2016

 
   

C&I

   

CRE

   

Direct Financing

Leases

   

Residential Real

Estate

   

Installment and

Other Consumer

   

Total

 
                                                 

Allowance for impaired loans/leases

  $ 1,771,537     $ 693,919     $ 848,919     $ 289,112     $ 39,481     $ 3,642,968  

Allowance for nonimpaired loans/leases

    10,773,573       10,976,690       2,262,979       2,053,232       1,048,006       27,114,480  
    $ 12,545,110     $ 11,670,609     $ 3,111,898     $ 2,342,344     $ 1,087,487     $ 30,757,448  
                                                 

Impaired loans/leases

  $ 8,936,451     $ 6,112,114     $ 3,256,264     $ 1,661,180     $ 106,090     $ 20,072,099  

Nonimpaired loans/leases

    818,700,812       1,087,346,746       162,163,096       227,571,924       81,559,605       2,377,342,183  
    $ 827,637,263     $ 1,093,458,860     $ 165,419,360     $ 229,233,104     $ 81,665,695     $ 2,397,414,282  
                                                 

Allowance as a percentage of impaired loans/leases

    19.82 %     11.35 %     26.07 %     17.40 %     37.21 %     18.15 %

Allowance as a percentage of nonimpaired loans/leases

    1.32 %     1.01 %     1.40 %     0.90 %     1.28 %     1.14 %

Total allowance as a percentage of total loans/leases

    1.52 %     1.07 %     1.88 %     1.02 %     1.33 %     1.28 %

 

20

 

 

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 three months ended March 31, 2017 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

  $ 835,955     $ 846,392     $ -     $ 927,387     $ 7,352     $ 7,352  

CRE

                                               

Owner-Occupied CRE

    -       -       -       -       -       -  

Commercial Construction, Land Development, and Other Land

    -       -       -       -       -       -  

Other Non Owner-Occupied CRE

    1,174,260       1,174,260       -       1,183,813       -       -  

Direct Financing Leases

    1,593,104       1,593,104       -       1,868,355       18,895       18,895  

Residential Real Estate

    1,147,434       1,222,215       -       1,025,656       1,161       1,161  

Installment and Other Consumer

    175,957       175,957       -       115,846       -       -  
    $ 4,926,710     $ 5,011,928     $ -     $ 5,121,057     $ 27,408     $ 27,408  
                                                 

Impaired Loans/Leases with Specific Allowance Recorded:

                                               

C&I

  $ 8,352,499     $ 8,356,338     $ 1,751,774     $ 8,110,658     $ 62,666     $ 62,666  

CRE

                                               

Owner-Occupied CRE

    322,148       322,148       57,398       322,148       -       -  

Commercial Construction, Land Development, and Other Land

    4,349,267       4,349,267       823,061       4,351,542       -       -  

Other Non Owner-Occupied CRE

    78,386       78,386       7,986       39,193       -       -  

Direct Financing Leases

    1,488,964       1,488,964       795,840       1,300,811       -       -  

Residential Real Estate

    633,340       633,340       274,566       636,134       4,240       4,240  

Installment and Other Consumer

    48,770       48,770       37,932       49,563       112       112  
    $ 15,273,374     $ 15,277,213     $ 3,748,557     $ 14,810,049     $ 67,018     $ 67,018  
                                                 

Total Impaired Loans/Leases:

                                               

C&I

  $ 9,188,454     $ 9,202,730     $ 1,751,774     $ 9,038,045     $ 70,018     $ 70,018  

CRE

                                               

Owner-Occupied CRE

    322,148       322,148       57,398       322,148       -       -  

Commercial Construction, Land Development, and Other Land

    4,349,267       4,349,267       823,061       4,351,542       -       -  

Other Non Owner-Occupied CRE

    1,252,646       1,252,646       7,986       1,223,006       -       -  

Direct Financing Leases

    3,082,068       3,082,068       795,840       3,169,166       18,895       18,895  

Residential Real Estate

    1,780,774       1,855,555       274,566       1,661,790       5,401       5,401  

Installment and Other Consumer

    224,727       224,727       37,932       165,409       112       112  
    $ 20,200,084     $ 20,289,141     $ 3,748,557     $ 19,931,106     $ 94,426     $ 94,426  

 

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

 

21

 

 

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 March 31, 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

  $ 286,508     $ 477,450     $ -     $ 347,369     $ 1,824     $ 1,824  

CRE

                                               

Owner-Occupied CRE

    242,887       336,661       -       244,824       -       -  

Commercial Construction, Land Development, and Other Land

    -       -       -       -       -       -  

Other Non Owner-Occupied CRE

    1,512,198       1,512,198       -       1,545,334       -       -  

Direct Financing Leases

    1,314,779       1,314,779       -       1,176,588       11,603       11,603  

Residential Real Estate

    585,186       624,387       -       585,981       1,038       1,038  

Installment and Other Consumer

    47,480       47,480       -       212,392       -       -  
    $ 3,989,038     $ 4,312,955     $ -     $ 4,112,488     $ 14,465     $ 14,465  
                                                 

Impaired Loans/Leases with Specific Allowance Recorded:

                                               

C&I

  $ 4,891,938     $ 4,895,777     $ 2,168,454     $ 4,885,096     $ -     $ -  

CRE

                                               

Owner-Occupied CRE

    -       -       -       -       -       -  

Commercial Construction, Land Development, and Other Land

    191,366       203,366       82,296       192,585       -       -  

Other Non Owner-Occupied CRE

    -       -       -       -       -       -  

Direct Financing Leases

    938,267       938,267       483,193       800,606       -       -  

Residential Real Estate

    911,050       946,628       199,498       871,531       1,958       1,958  

Installment and Other Consumer

    402,120       402,120       246,413       306,279       1,500       1,500  
    $ 7,334,741     $ 7,386,158     $ 3,179,854     $ 7,056,097     $ 3,458     $ 3,458  
                                                 

Total Impaired Loans/Leases:

                                               

C&I

  $ 5,178,446     $ 5,373,227     $ 2,168,454     $ 5,232,465     $ 1,824     $ 1,824  

CRE

                                               

Owner-Occupied CRE

    242,887       336,661       -       244,824       -       -  

Commercial Construction, Land Development, and Other Land

    191,366       203,366       82,296       192,585       -       -  

Other Non Owner-Occupied CRE

    1,512,198       1,512,198       -       1,545,334       -       -  

Direct Financing Leases

    2,253,046       2,253,046       483,193       1,977,194       11,603       11,603  

Residential Real Estate

    1,496,236       1,571,015       199,498       1,457,512       2,996       2,996  

Installment and Other Consumer

    449,600       449,600       246,413       518,671       1,500       1,500  
    $ 11,323,779     $ 11,699,113     $ 3,179,854     $ 11,168,585     $ 17,923     $ 17,923  

 

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 December 31, 2016 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

  $ 841,895     $ 951,600     $ -  

CRE

                       

Owner-Occupied CRE

    -       93,774       -  

Commercial Construction, Land Development, and Other Land

    -       -       -  

Other Non Owner-Occupied CRE

    1,196,549       1,196,549       -  

Direct Financing Leases

    1,690,121       1,690,121       -  

Residential Real Estate

    853,294       892,495       -  

Installment and Other Consumer

    55,734       55,734       -  
    $ 4,637,593     $ 4,880,273     $ -  
                         

Impaired Loans/Leases with Specific Allowance Recorded:

                       

C&I

  $ 8,094,556     $ 8,098,395     $ 1,771,537  

CRE

                       

Owner-Occupied CRE

    322,148       322,148       57,398  

Commercial Construction, Land Development, and Other Land

    4,353,819       4,353,817       577,611  

Other Non Owner-Occupied CRE

    239,600       239,600       58,910  

Direct Financing Leases

    1,566,141       1,566,143       848,919  

Residential Real Estate

    807,886       882,018       289,112  

Installment and Other Consumer

    50,356       50,356       39,481  
    $ 15,434,506     $ 15,512,477     $ 3,642,968  
                         

Total Impaired Loans/Leases:

                       

C&I

  $ 8,936,451     $ 9,049,995     $ 1,771,537  

CRE

                       

Owner-Occupied CRE

    322,148       415,922       57,398  

Commercial Construction, Land Development, and Other Land

    4,353,819       4,353,817       577,611  

Other Non Owner-Occupied CRE

    1,436,149       1,436,149       58,910  

Direct Financing Leases

    3,256,262       3,256,264       848,919  

Residential Real Estate

    1,661,180       1,774,513       289,112  

Installment and Other Consumer

    106,090       106,090       39,481  
    $ 20,072,099     $ 20,392,750     $ 3,642,968  

 

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

 

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 March 31, 2017 and December 31, 2016:

 

   

As of March 31, 2017

 
           

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)

  $ 816,089,950     $ 298,438,590     $ 164,958,396     $ 605,282,623     $ 1,884,769,559       96.24 %

Special Mention (Rating 6)

    7,820,608       8,839,425       1,780,000       4,400,764       22,840,797       1.17 %

Substandard (Rating 7)

    27,667,789       9,624,203       5,163,312       8,354,408       50,809,712       2.59 %

Doubtful (Rating 8)

    -       -       -       -       -       0.00 %
    $ 851,578,347     $ 316,902,218     $ 171,901,708     $ 618,037,795     $ 1,958,420,068       100.00 %

 

   

As of March 31, 2017

         

Delinquency Status *

 

Direct Financing

Leases

   

Residential Real

Estate

   

Installment and

Other Consumer

   

Total

   

As a % of Total

         
                                                 

Performing

  $ 156,105,024     $ 229,289,183     $ 78,422,444     $ 463,816,651       98.80 %        

Nonperforming

    3,263,401       2,036,716       348,403       5,648,520       1.20 %        
    $ 159,368,425     $ 231,325,899     $ 78,770,847     $ 469,465,171       100.00 %        

 

   

As of December 31, 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)

  $ 796,568,451     $ 314,447,662     $ 158,108,465     $ 582,854,048     $ 1,851,978,626       96.40 %

Special Mention (Rating 6)

    6,305,772       7,559,380       1,780,000       4,437,122       20,082,274       1.05 %

Substandard (Rating 7)

    24,763,040       10,380,369       5,261,026       8,630,578       49,035,013       2.55 %

Doubtful (Rating 8)

    -       210       -       -       210       0.00 %
    $ 827,637,263     $ 332,387,621     $ 165,149,491     $ 595,921,748     $ 1,921,096,123       100.00 %

 

   

As of December 31, 2016

         

Delinquency Status *

 

Direct Financing

Leases

   

Residential Real

Estate

   

Installment and

Other Consumer

   

Total

   

As a % of Total

         
                                                 

Performing

  $ 161,749,710     $ 227,277,070     $ 81,449,104     $ 470,475,884       98.77 %        

Nonperforming

    3,669,650       1,956,034       216,591       5,842,275       1.23 %        
    $ 165,419,360     $ 229,233,104     $ 81,665,695     $ 476,318,159       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.

 

24

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

As of March 31, 2017 and December 31, 2016, TDRs totaled $8,673,673 and $8,647,007, 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 months ended March 31, 2017 and 2016. 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 March 31, 2017

   

For the three months ended March 31, 2016

 

Classes of Loans/Leases

 

Number of

Loans /

Leases

   

Pre-

Modification

Recorded

Investment

   

Post-

Modification

Recorded

Investment

   

Specific

Allowance

   

Number of

Loans /

Leases

   

Pre-

Modification

Recorded

Investment

   

Post-

Modification

Recorded

Investment

   

Specific

Allowance

 
                                                                 

CONCESSION - Extension of Maturity

                                                               

Direct Financing Leases

    1     $ 6,263     $ 6,263     $ -       4     $ 410,653     $ 410,653     $ -  
      1     $ 6,263     $ 6,263     $ -       4     $ 410,653     $ 410,653     $ -  
                                                                 

CONCESSION - Significant Payment Delay

                                                               

C&I

    2     $ 133,689     $ 133,689     $ -       -     $ -     $ -     $ -  

Direct Financing Leases

    8       669,861       669,861       -       1       45,939       45,939       -  
      10     $ 803,550     $ 803,550     $ -       1     $ 45,939     $ 45,939     $ -  
                                                                 

TOTAL

    11     $ 809,813     $ 809,813     $ -       5     $ 456,592     $ 456,592     $ -  

 

Of the TDRs reported above, none were on nonaccrual as of March 31, 2017.

 

For the three months ended March 31, 2017, two of the Company’s TDRs redefaulted within 12 months subsequent to restructure where default is defined as delinquency of 90 days or more and/or placement on nonaccrual status. These two TDRs were related to the same customer and were restructured in the fourth quarter of 2016 with pre-modification balances totaling $195 thousand.

 

For the three month ended March 31, 2016, none of the Company’s TDRs had redefaulted within 12 months subsequent to restructure.

 

25

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

NOTE 4 - EARNINGS PER SHARE

 

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

 

   

Three months ended

 
   

March 31,

 
   

2017

   

2016

 
                 

Net income

  $ 9,184,965     $ 6,373,489  
                 

Basic EPS

  $ 0.70     $ 0.54  

Diluted EPS

  $ 0.68     $ 0.53  
                 

Weighted average common shares outstanding

    13,133,382       11,793,620  

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

    355,035       160,329  

Weighted average common and common equivalent shares outstanding

    13,488,417       11,953,949  

 

The increase in weighted average common shares outstanding from March 31, 2016 to March 31, 2017 was primarily due to the common stock issuance discussed in Note 2 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

 

NOTE 5 – 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.

 

26

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

Assets and liabilities measured at fair value on a recurring basis comprise the following at March 31, 2017 and December 31, 2016:

 

           

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)

 
                                 

March 31, 2017:

                               

Securities AFS:

                               

U.S. govt. sponsored agency securities

  $ 47,556,081     $ -     $ 47,556,081     $ -  

Residential mortgage-backed and related securities

    147,503,987       -       147,503,987       -  

Municipal securities

    51,131,874       -       51,131,874       -  

Other securities

    4,760,079       1,345       4,758,734       -  

Interest rate caps

    531,325       -       531,325       -  

Interest rate swaps - assets

    2,034,898       -       2,034,898       -  

Total assets measured at fair value

  $ 253,518,244     $ 1,345     $ 253,516,899     $ -  
                                 

Interest rate swaps - liabilities

  $ 2,034,898     $ -     $ 2,034,898     $ -  

Total liabilities measured at fair value

  $ 2,034,898     $ -     $ 2,034,898     $ -  
                                 
                                 

December 31, 2016:

                               

Securities AFS:

                               

U.S. govt. sponsored agency securities

  $ 46,083,607     $ -     $ 46,083,607     $ -  

Residential mortgage-backed and related securities

    147,702,127       -       147,702,127       -  

Municipal securities

    52,604,426       -       52,604,426       -  

Other securities

    4,722,979       1,361       4,721,618       -  

Interest rate caps

    576,527       -       576,527       -  

Interest rate swaps - assets

    2,338,281       -       2,338,281       -  

Total assets measured at fair value

  $ 254,027,947     $ 1,361     $ 254,026,586     $ -  
                                 

Interest rate swaps - liabilities

  $ 2,338,281     $ -     $ 2,338,281     $ -  

Total liabilities measured at fair value

  $ 2,338,281     $ -     $ 2,338,281     $ -  

 

There were no transfers of assets or liabilities between Levels 1, 2, and 3 of the fair value hierarchy for the three months ended March 31, 2017 or 2016.

 

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).

 

27

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

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).

 

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, 2016. 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 March 31, 2017 and December 31, 2016:

 

           

Fair Value Measurements at Reporting Date Using

 
   

Fair Value

   

Level 1

   

Level 2

   

Level 3

 

March 31, 2017:

                               

Impaired loans/leases

  $ 12,581,982     $ -     $ -     $ 12,581,982  

OREO

    6,075,392       -       -       6,075,392  
    $ 18,657,374     $ -     $ -     $ 18,657,374  
                                 

December 31, 2016:

                               

Impaired loans/leases

  $ 12,823,121     $ -     $ -     $ 12,823,121  

OREO

    5,964,952       -       -       5,964,952  
    $ 18,788,073     $ -     $ -     $ 18,788,073  

 

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.

 

28

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

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
March 31, 2017

   

Fair Value
December 31, 2016

 

Valuation Technique

Unobservable Input

  Range
                             

Impaired loans/leases

  $ 12,581,982     $ 12,823,121  

Appraisal of collateral

Appraisal adjustments

   -10.00% to -50.00%

OREO

    6,075,392       5,964,952  

Appraisal of collateral

Appraisal adjustments

   0.00% to -35.00%

 

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

 

There have been no changes in valuation techniques used for any assets measured at fair value during the three months ended March 31, 2017 and 2016.

 

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 March 31, 2017

   

As of December 31, 2016

 
 

Hierarchy

 

Carrying

   

Estimated

   

Carrying

   

Estimated

 
 

Level

 

Value

   

Fair Value

   

Value

   

Fair Value

 
                                   

Cash and due from banks

Level 1

  $ 56,325,969     $ 56,325,969     $ 70,569,993     $ 70,569,993  

Federal funds sold

Level 2

    15,798,000       15,798,000       22,257,000       22,257,000  

Interest-bearing deposits at financial institutions

Level 2

    157,420,706       157,420,706       63,948,925       63,948,925  

Investment securities:

                                 

HTM

Level 2

    306,694,063       304,197,006       322,909,056       320,414,899  

AFS

See Previous Table

    250,952,021       250,952,021       251,113,139       251,113,139  

Loans/leases receivable, net

Level 3

    11,649,983       12,581,982       11,873,260       12,823,121  

Loans/leases receivable, net

Level 2

    2,392,141,282       2,368,029,017       2,362,856,277       2,344,462,740  

Interest rate caps

Level 2

    531,325       531,325       576,527       576,527  

Interest rate swaps - assets

Level 2

    2,034,898       2,034,898       2,338,281       2,338,281  

Deposits:

                                 

Nonmaturity deposits

Level 2

    2,288,265,733       2,288,265,733       2,188,683,349       2,188,683,349  

Time deposits

Level 2

    517,665,766       519,873,000       480,577,924       479,605,000  

Short-term borrowings

Level 2

    19,470,096       19,470,096       39,971,387       39,971,387  

FHLB advances

Level 2

    106,550,000       107,283,000       137,500,000       138,338,000  

Other borrowings

Level 2

    72,000,000       73,108,000       80,000,000       81,282,000  

Junior subordinated debentures

Level 2

    33,513,509       25,075,065       33,480,202       24,881,494  

Interest rate swaps - liabilities

Level 2

    2,034,898       2,034,898       2,338,281       2,338,281  

 

29

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

NOTE 6 – BUSINESS SEGMENT INFORMATION

 

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

 

The Company’s primary segment, Commercial Banking, is geographically divided by markets into the secondary segments comprised of the four subsidiary banks wholly owned by the Company: QCBT, CRBT, CSB and 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 four subsidiary banks in aggregate. This segment generates income primarily from fees charged based on assets under administration for corporate and personal trusts, custodial services, and investments managed. No assets of the subsidiary banks have been allocated to the Wealth Management segment.

 

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

 

Selected financial information on the Company’s business segments is presented as follows as of and for the three months ended March 31, 2017 and 2016.

 

 

   

Commercial Banking

   

Wealth

           

Intercompany

   

Consolidated

 
   

QCBT

   

CRBT

   

CSB

   

RB&T

   

Management

   

All Other

   

Eliminations

   

Total

 

Three Months Ended March 31, 2017

                                                               

Total revenue

  $ 13,535,941     $ 10,386,545     $ 8,131,706     $ 3,947,799     $ 2,701,806     $ 9,876,143     $ (9,951,087 )   $ 38,628,853  

Net interest income

  $ 11,301,482     $ 6,974,047     $ 7,026,508     $ 2,968,074     $ -     $ (601,228 )   $ -     $ 27,668,883  

Provision for loan/lease losses

  $ 931,109     $ 250,000     $ 774,000     $ 150,000     $ -     $ -     $ -     $ 2,105,109  

Net income

  $ 3,655,006     $ 2,892,560     $ 1,895,134     $ 844,569     $ 561,062     $ 9,184,968     $ (9,848,334 )   $ 9,184,965  

Goodwill

  $ 3,222,688     $ -     $ 9,888,225     $ -     $ -     $ -     $ -     $ 13,110,913  

Core deposit intangible

  $ -     $ 1,222,019     $ 5,928,327     $ -     $ -     $ -     $ -     $ 7,150,346  

Total assets

  $ 1,442,952,197     $ 929,111,309     $ 608,431,003     $ 398,454,864     $ -     $ 377,316,912     $ (375,253,667 )   $ 3,381,012,618  
                                                                 

Three Months Ended March 31, 2016

                                                               

Total revenue

  $ 13,516,932     $ 10,839,221     $ -     $ 3,794,247     $ 2,234,292     $ 6,859,775     $ (6,919,935 )   $ 30,324,532  

Net interest income

  $ 10,961,447     $ 7,024,988     $ -     $ 2,911,974     $ -     $ (300,887 )   $ -     $ 20,597,522  

Provision for loan/lease losses

  $ 1,222,985     $ 550,000     $ -     $ 300,000     $ -     $ -     $ -     $ 2,072,985  

Net income

  $ 2,831,696     $ 2,934,731     $ -     $ 617,785     $ 447,770     $ 6,373,488     $ (6,831,981 )   $ 6,373,489  

Goodwill

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

Core deposit intangible

  $ -     $ 1,421,531     $ -     $ -     $ -     $ -     $ -     $ 1,421,531  

Total assets

  $ 1,361,607,041     $ 885,858,279     $ -     $ 367,031,670     $ -     $ 288,814,613     $ (262,638,349 )   $ 2,640,673,254  

 

 

30

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

NOTE 7 – 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 March 31, 2017 and December 31, 2016, 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 March 31, 2017 and December 31, 2016 are also presented in the following table (dollars in thousands). As of March 31, 2017 and December 31, 2016, 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 March 31, 2017:

                                               

Company:

                                               

Total risk-based capital

  $ 336,993       11.90 %   $ 262,053     > 9.25 %   $ 283,300     > 10.0 %

Tier 1 risk-based capital

    304,594       10.75 %     205,393     > 7.25       226,640     > 8.0  

Tier 1 leverage

    304,594       9.37 %     129,996     > 4.00       162,495     > 5.0  

Common equity Tier 1

    273,076       9.64 %     162,898     > 5.75       184,145     > 6.5  

Quad City Bank & Trust:

                                               

Total risk-based capital

  $ 145,432       12.61 %   $ 106,664     > 9.25 %   $ 115,312     > 10.0 %

Tier 1 risk-based capital

    131,860       11.44 %     83,601     > 7.25       92,250     > 8.0  

Tier 1 leverage

    131,860       9.25 %     57,045     > 4.00       71,306     > 5.0  

Common equity Tier 1

    131,860       11.44 %     66,304     > 5.75       74,953     > 6.5  

Cedar Rapids Bank & Trust:

                                               

Total risk-based capital

  $ 107,776       12.79 %   $ 77,956     > 9.25 %   $ 84,277     > 10.0 %

Tier 1 risk-based capital

    97,230       11.54 %     61,101     > 7.25       67,421     > 8.0  

Tier 1 leverage

    97,230       10.74 %     36,206     > 4.00       45,257     > 5.0  

Common equity Tier 1

    97,230       11.54 %     48,459     > 5.75       54,780     > 6.5  

Community State Bank:

                                               

Total risk-based capital

  $ 66,300       13.50 %   $ 45,426     > 9.25 %   $ 49,109     > 10.0 %

Tier 1 risk-based capital

    64,052       13.04 %     35,604     > 7.25       39,287     > 8.0  

Tier 1 leverage

    64,052       10.99 %     23,317     > 4.00       29,146     > 5.0  

Common equity Tier 1

    64,052       13.04 %     28,238     > 5.75       31,921     > 6.5  

Rockford Bank & Trust:

                                               

Total risk-based capital

  $ 42,916       12.31 %   $ 32,256     > 9.25 %   $ 34,871     > 10.0 %

Tier 1 risk-based capital

    38,548       11.05 %     25,282     > 7.25       27,897     > 8.0  

Tier 1 leverage

    38,548       9.82 %     15,707     > 4.00       19,634     > 5.0  

Common equity Tier 1

    38,548       11.05 %     20,051     > 5.75       22,666     > 6.5  

 

31

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

                   

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 December 31, 2016:

                                               

Company:

                                               

Total risk-based capital

  $ 327,440       11.56 %   $ 244,289     > 8.625 %   $ 283,233     > 10.0 %

Tier 1 risk-based capital

    296,366       10.46 %     187,642     > 6.625       226,587     > 8.0  

Tier 1 leverage

    296,366       9.10 %     130,229     > 4.000       162,787     > 5.0  

Common equity Tier 1

    266,419       9.41 %     145,157     > 5.125       184,102     > 6.5  

Quad City Bank & Trust:

                                               

Total risk-based capital

  $ 142,990       12.27 %   $ 100,494     > 8.625 %   $ 116,515     > 10.0 %

Tier 1 risk-based capital

    129,524       11.12 %     77,191     > 6.625       93,212     > 8.0  

Tier 1 leverage

    129,524       9.18 %     56,445     > 4.000       70,556     > 5.0  

Common equity Tier 1

    129,524       11.12 %     59,714     > 5.125       75,735     > 6.5  

Cedar Rapids Bank & Trust:

                                               

Total risk-based capital

  $ 106,791       12.82 %   $ 71,828     > 8.625 %   $ 83,279     > 10.0 %

Tier 1 risk-based capital

    96,369       11.57 %     55,173     > 6.625       66,623     > 8.0  

Tier 1 leverage

    96,369       10.69 %     36,061     > 4.000       45,076     > 5.0  

Common equity Tier 1

    96,369       11.57 %     42,681     > 5.125       54,132     > 6.5  

Community State Bank:

                                               

Total risk-based capital

  $ 68,216       13.81 %   $ 42,609     > 8.625 %   $ 49,402     > 10.0 %

Tier 1 risk-based capital

    66,746       13.51 %     32,729     > 6.625       39,522     > 8.0  

Tier 1 leverage

    66,746       11.75 %     22,726     > 4.000       28,408     > 5.0  

Common equity Tier 1

    66,746       13.51 %     25,319     > 5.125       32,111     > 6.5  

Rockford Bank & Trust:

                                               

Total risk-based capital

  $ 42,007       12.26 %   $ 29,551     > 8.625 %   $ 34,262     > 10.0 %

Tier 1 risk-based capital

    37,716       11.01 %     22,699     > 6.625       27,410     > 8.0  

Tier 1 leverage

    37,716       9.57 %     15,772     > 4.000       19,716     > 5.0  

Common equity Tier 1

    37,716       11.01 %     17,559     > 5.125       22,270     > 6.5  

 

*The minimums under Basel III increase by .625% (the capital conservation buffer) annually until 2019. The fully phased-in minimums are 10.5% (Total risk-based capital), 8.5% (Tier 1 risk-based capital), and 7.0% (Common equity Tier 1).

 

32

 

 

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 months ending March 31, 2017. Some tables may include additional periods to comply with disclosure requirements or to illustrate trends. When reading this discussion, also refer to the Consolidated Financial Statements and related notes in this report. The page locations and specific sections and notes that are referred to are presented in the table of contents.

 

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

 

GENERAL

 

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


QCBT, CRBT and CSB 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).

 

 

CSB was acquired in 2016, as further described in Note 2 of the Annual Report on Form 10-K for the year ended December 31, 2016. CSB provides full-service commercial and consumer banking to the Des Moines, Iowa area and adjacent communities through its 10 branch locations, including its main office located on North Ankeny Boulevard in Ankeny, Iowa.

 

 

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

 

33

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued 

 

EXECUTIVE OVERVIEW

 

The Company reported net income of $9.2 million and diluted EPS of $0.68 for the quarter ended March 31, 2017. By comparison, for the quarter ended December 31, 2016, the Company reported net income of $8.5 million and diluted EPS of $0.64. For the quarter ended March 31, 2016, the Company reported net income of $6.4 million and diluted EPS of $0.53.

 

The first quarter of 2017 was highlighted by several significant items:

 

 

Deposit growth at an annualized rate of 20.5% through the first three months of the year;

 

Strong gains on the sale of government guaranteed portions of loans and swap fee income , totaling $1.1 million for the quarter ending March 31, 2017; and

 

Further reductions in wholesale borrowings totaling $38.3 million in the first quarter.

 

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

 

   

For the three months ended

 
   

March 31, 2017

   

December 31, 2016

   

March 31, 2016

 
                         

Net income

  $ 9,184,965     $ 8,529,330     $ 6,373,489  
                         

Diluted earnings per common share

  $ 0.68     $ 0.64     $ 0.53  
                         

Weighted average common and common equivalent shares outstanding

    13,488,417       13,323,883       11,953,949  

 

 

The increase in weighted average common shares outstanding from March 31, 2016 to March 31, 2017 was primarily due to the common stock issuance discussed in Note 2 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

 

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

 

   

For the three months ended

 
   

March 31, 2017

   

December 31, 2016

   

March 31, 2016

 
                         

Net interest income

  $ 27,668,883     $ 29,279,665     $ 20,597,522  

Provision expense

    2,105,109       2,599,345       2,072,985  

Noninterest income

    7,283,754       7,028,600       6,822,473  

Noninterest expense

    21,273,117       22,307,178       16,954,498  

Federal and state income tax expense

    2,389,446       2,872,412       2,019,023  

Net income

  $ 9,184,965     $ 8,529,330     $ 6,373,489  

 

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

 

 

Net interest income decreased 6% compared to the fourth quarter of 2016. This decrease was the result of reduced acquisition-related accretion and two fewer days in the first quarter of 2017 than the fourth quarter of 2016. Net interest income increased 34% compared to the first quarter of 2016.

 

34

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued 

 

 

Provision expense decreased 19% compared to the fourth quarter of 2016. Provision expense was flat from the same period of 2016. The decrease from the fourth quarter of 2016 to the first quarter of 2017 was primarily attributable to CSB. As acquired loans renew, the discount associated with those loans is eliminated and the Company must establish an allowance. This resulted in $774 thousand of provision expense in the first quarter of 2017 compared to $1.2 million of provision expense in the fourth quarter of 2016.

 

 

Noninterest income increased 4% compared to the fourth quarter of 2016, led by trust and investment advisory fees and gains on the sale of government guaranteed portions of loans. Noninterest income increased 7% from the first quarter of 2016, due mostly to the addition of CSB.

 

 

Noninterest expense decreased 5% compared to the fourth quarter of 2016. Noninterest expense increased 25% from the first quarter of 2016 due to the addition of CSB’s cost structure.

 

 

Federal and state income tax expense decreased 17% compared to the fourth quarter of 2016. Federal and state income tax increased 18% compared to the first quarter of 2016. See the Income Taxes section of this Report for additional details.

 

LONG-TERM FINANCIAL GOALS

 

As previously stated, the Company has established certain financial goals by which it manages its business and measures its performance. The goals are periodically updated to reflect changes in business developments. While the Company is determined to work prudently to achieve these goals, there is no assurance that they will be met. Moreover, the Company’s ability to achieve these goals will be affected by the factors discussed under “Forward Looking Statements” as well as the factors detailed in the “Risk Factors” section included under Item 1A. of Part I of the Company’s Annual Report on Form 10-K for the year ended December 31, 2016. The Company’s long-term financial goals are as follows:

 

 

Improve balance sheet efficiency by maintaining a gross loans and leases to total assets ratio in the range of 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;

 

 

Maintain reliance on wholesale funding at less than 15% of total assets;

 

 

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

 

 

Increase the m2 commercial loan and lease portfolio to $250 million;

 

 

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 10% annually.

 

35

 

 

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

Goal Key Metric Target**

March 31,
2017

December 31,
2016

March 31,
2016

Balance sheet efficiency

Gross loans and leases to total assets

70 - 75%

72%

73%

71%

Profitability

NIM (TEY)(non-GAAP)*

> 3.85%

3.90%

4.02%

3.59%

ROAA

> 1.10%

1.12%

1.04%

0.98%

Core ROAA (non-GAAP)*

1.12%

1.08%

0.95%

Asset quality

NPAs to total assets

< 0.75%

0.81%

0.82%

0.71%

Net charge-offs to average loans and leases***

< 0.25% annually

0.13%

0.14%

0.16%

Reliance on wholesale funding

Wholesale funding to total assets

< 15%

9%

11%

17%

Funding mix

Noninterest bearing deposits as a percentage of total assets

> 30%

23%

24%

24%

m2 commercial loans and leases

Total loans and leases

$250 million

$208.5 million

$211.0 million

$205.2 million

Consistent, high quality noninterest

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

> $4 million annually

$4.3 million

$4.9 million

$6.9 million

income revenue streams

Grow wealth management segment net income***

> 10% annually

25%

2%

-3%

 

* See GAAP to Non-GAAP reconciliations.

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

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

 

 

STRATEGIC DEVELOPMENTS

 

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

 

 

The Company grew loans and leases quarter-to-date by 5.0% on an annualized basis. While this was a slower start to the year relative to recent periods, the Company still aims to achieve targeted organic growth of 10-12% for the full year. Strong loan and lease growth for the remainder of the year will help keep the Company’s loan and leases to asset ratio within the targeted range of 70-75%.

 

 

The Company intends to continue 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 third quarter of 2016, the Company acquired CSB, headquartered in Ankeny, Iowa. See Note 2 of the Company’s 2016 Annual Report on Form 10-K for the year ended December 31, 2016 for additional details.

 

 

The Company continues to focus on reducing the NPAs to total assets ratio. While this ratio remained fairly flat this quarter, the Company remains committed to improving asset quality ratios in 2017.

 

 

Management continues to focus on reducing the Company’s reliance on wholesale funding. The strong core deposit growth in the first quarter of 2017 allowed the Company to further reduce wholesale borrowings and also provides liquidity for future loan and lease growth. Management also continues to evaluate opportunities for continued reduction in wholesale funding.

 

36

 

 

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 183 downstream banks with average total noninterest bearing deposits of $320.7 million during the first quarter of 2017. This line of business provides a strong source of noninterest bearing deposits, fee income, high-quality loan participations and bank stock loans.

 

 

The Company provides commercial leasing services through its wholly-owned subsidiary, m2 Lease Funds, which has lease specialists in Iowa, Wisconsin, Minnesota, North Carolina, South Carolina, Florida, California, Texas and Pennsylvania. Historically, this portfolio has been high yielding, with an average gross annualized yield in 2017 approximating 8.0%.

 

 

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 aims to continue to make this a more consistent source of noninterest income.

 

 

As a result of the 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 March 31, 2017 the Company had $1.98 billion of total financial assets in trust (and related) accounts and $916 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 wealth management fee income, expanding market share will continue to be a primary strategy.

 

37

 

 

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 “TCE/TA ratio”, “core net income”, “core net income attributable to QCR Holdings, Inc. common stockholders”, “core EPS”, “core ROAA”, “NIM (TEY)”, “efficiency ratio” and “Texas ratio”. In compliance with applicable rules of the SEC, all non-GAAP measures are reconciled to the most directly comparable GAAP measure, as follows:

 

 

TCE/TA ratio (non-GAAP) is reconciled to stockholders’ equity and total assets;

 

Core net income, core net income attributable to QCR Holdings, Inc. common stockholders, core EPS and core ROAA (all non-GAAP measures) are reconciled to net income;

 

NIM (TEY) (non-GAAP) is reconciled to NIM;

 

Efficiency ratio (non-GAAP) is reconciled to noninterest expense, net interest income and noninterest income; and

 

Texas ratio (non-GAAP) is reconciled to nonperforming loans and stockholders’ equity.

 

The TCE/TA non-GAAP ratio has been a focus for investors and management believes that this ratio may assist investors in analyzing the Company’s capital position without regard to the effects of intangible assets.

 

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

 

NIM (TEY) is a financial measure that the Company’s management utilizes to take into account the tax benefit associated with certain tax-exempt loans and securities. It is standard industry practice to measure net interest margin using tax-equivalent measures.

 

The efficiency ratio and Texas ratio are both ratios that management utilizes to compare the Company to peers. Both are also standard in the banking industry and widely utilized by investors.

 

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

 

38

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued 

 

   

As of

 
   

March 31,

   

December 31,

   

September 30,

   

June 30,

   

March 31,

 

GAAP TO NON-GAAP RECONCILIATIONS

 

2017

   

2016

   

2016

   

2016

   

2016

 
   

(dollars in thousands, except per share data)

 

TCE / TA RATIO

                                       
                                         

Stockholders' equity (GAAP)

  $ 295,840     $ 286,041     $ 280,857     $ 275,117     $ 235,143  

Less: Intangible assets

    20,261       22,522       22,755       4,595       4,645  

TCE (non-GAAP)

  $ 275,579     $ 263,519     $ 258,102     $ 270,522     $ 230,498  
                                         

Total assets (GAAP)

  $ 3,381,013     $ 3,301,944     $ 3,280,986     $ 2,683,434     $ 2,640,673  

Less: Intangible assets

    20,261       22,522       22,755       4,595       4,645  

TA (non-GAAP)

  $ 3,360,752     $ 3,279,422     $ 3,258,231     $ 2,678,839     $ 2,636,028  
                                         

TCE / TA ratio (non-GAAP)

    8.20 %     8.04 %     7.92 %     10.10 %     8.74 %

 

   

For the Quarter Ended

 
   

March 31,

   

December 31,

   

September 30,

   

June 30,

   

March 31,

 

CORE NET INCOME

 

2017

   

2016

   

2016

   

2016

   

2016

 
                                         

Net income (GAAP)

  $ 9,185     $ 8,530     $ 6,108     $ 6,676     $ 6,373  
                                         

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

                                       

Income:

                                       

Securities gains, net

  $ -     $ (24 )   $ 2,764     $ 12     $ 233  

Total nonrecurring income (non-GAAP)

  $ -     $ (24 )   $ 2,764     $ 12     $ 233  
                                         

Expense:

                                       

Losses on debt extinguishment

  $ -     $ 232     $ 2,689     $ -     $ 54  

Acquisition costs

    -       26       1,506       231       -  

Total nonrecurring expense (non-GAAP)

  $ -     $ 258     $ 4,195     $ 231     $ 54  
                                         

Core net income (non-GAAP)

  $ 9,185     $ 8,812     $ 7,539     $ 6,895     $ 6,194  
                                         
                                         

CORE EPS

                                       
                                         

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

  $ 9,185     $ 8,812     $ 7,539     $ 6,895     $ 6,194  
                                         

Weighted average common shares outstanding

    13,133,382       13,087,592       13,066,777       12,335,077       11,793,620  

Weighted average common and common equivalent shares outstanding

    13,488,417       13,323,883       13,269,703       12,516,474       11,953,949  
                                         

Core EPS (non-GAAP):

                                       

Basic

  $ 0.70     $ 0.67     $ 0.58     $ 0.56     $ 0.53  

Diluted

  $ 0.68     $ 0.66     $ 0.57     $ 0.55     $ 0.52  
                                         
                                         

CORE ROAA

                                       
                                         

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

  $ 9,185     $ 8,812     $ 7,539     $ 6,895     $ 6,194  
                                         

Average Assets

  $ 3,274,713     $ 3,277,814     $ 2,865,947     $ 2,640,678     $ 2,602,350  
                                         

Core ROAA (annualized) (non-GAAP)

    1.12 %     1.08 %     1.05 %     1.04 %     0.95 %

 

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

 

39

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued 

 

   

For the Quarter Ended

 
   

March 31,

   

December 31,

   

September 30,

   

June 30,

   

March 31,

 

GAAP TO NON-GAAP RECONCILIATIONS (CONTINUED)

 

2017

   

2016

   

2016

   

2016

   

2016

 
   

(dollars in thousands)

 

NIM (TEY)

                                       
                                         

Net interest income (GAAP)

  $ 27,669     $ 29,280     $ 23,631     $ 21,009     $ 20,597  
                                         

Plus: Tax equivalent adjustment

    1,950       1,727       1,587       1,364       1,342  
                                         

Net interest income - tax equivalent (Non-GAAP)

  $ 29,619     $ 31,007     $ 25,218     $ 22,373     $ 21,939  
                                         

Average earning assets

  $ 3,076,356     $ 3,069,122     $ 2,703,162     $ 2,484,721     $ 2,456,328  
                                         

NIM (GAAP)

    3.65 %     3.80 %     3.48 %     3.40 %     3.37 %

NIM (TEY) (Non-GAAP)

    3.90 %     4.02 %     3.71 %     3.62 %     3.59 %
                                         

EFFICIENCY RATIO

                                       
                                         

Noninterest expense (GAAP)

  $ 21,273     $ 22,308     $ 24,480     $ 17,744     $ 16,954  
                                         

Net interest income (GAAP)

  $ 27,669     $ 29,280     $ 23,631     $ 21,009     $ 20,597  

Noninterest income (GAAP)

    7,284       7,029       10,423       6,762       6,822  

Total income

  $ 34,953     $ 36,309     $ 34,054     $ 27,771     $ 27,419  
                                         

Efficiency ratio (noninterest expense/total income) (Non-GAAP)

    60.86 %     61.44 %     71.89 %     63.89 %     61.83 %
                                         

TEXAS RATIO

                                       
                                         

Nonaccrual loans/leases

  $ 14,205     $ 13,919     $ 14,371     $ 10,737     $ 10,772  

Accruing loans/leases past due 90 days or more

    955       967       392       86       47  

TDRs - accruing

    6,229       6,347       1,825       1,753       1,157  

OREO

    5,625       5,523       5,808       6,179       6,680  

NPLs (excluding other repossessed assets)

  $ 27,014     $ 26,756     $ 22,396     $ 18,755     $ 18,656  
                                         

Total stockholders' equity (GAAP)

  $ 295,840     $ 286,041     $ 280,857     $ 275,117     $ 235,143  
                                         

Less: Intangible assets

    20,261       22,522       22,755       4,595       4,645  
                                         

Plus: Allowance (GAAP)

    32,059       30,757       28,827       28,097       27,395  
                                         

Tangible equity plus allowance

  $ 307,638     $ 294,276     $ 286,929     $ 298,619     $ 257,893  
                                         

Texas Ratio (Non-GAAP)

    8.78 %     9.09 %     7.81 %     6.28 %     7.23 %

 

40

 

 

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 35% to $29.6 million for the quarter ended March 31, 2017, compared to the same quarter of the prior year. Net interest income improved due to several factors:

 

 

The acquisition of CSB, whose strong margin has significantly contributed to the Company’s results;

 

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

 

Organic loan and lease growth has been strong over the past twelve months, as evidenced by average gross loan/lease growth of 8% in that period (excluding CSB).

 

A comparison of yields, spread and margin from the first quarter of 2017 to the first quarter of 2016 is as follows (on a tax equivalent basis):

 

 

The average yield on interest-earning assets increased 32 basis points.

 

The average cost of interest-bearing liabilities decreased 1 basis point.

 

The net interest spread increased 33 basis points from 3.37% to 3.70%.

 

NIM improved 31 basis points from 3.59% to 3.90%.

 

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 net interest margins. Management continually addresses this issue with pricing and other balance sheet management strategies.

 

The improvement in margin was the result of the acquisition of CSB. CSB’s margin will fluctuate based on the amortization and accretion of purchase accounting adjustments, most notably, the discount on the loan portfolio. This benefit can fluctuate based on prepayments of both PCI and performing loans. As loans prepay, the associated discount/premium is accelerated.

 

The Company continues to place an emphasis on shifting its balance sheet mix. With a stated goal of maintaining loans/leases as a percentage of assets in a range of 70%-75%, the Company funded its loan/lease growth with a mixture of core deposits and cash from calls/maturities/redemptions in the investment securities portfolio. In 2016, 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 recognized net gains on these sales due to the previous rate environment. As rates rise, the Company should also have less market volatility in the investment securities portfolio, as this is a smaller portion of the balance sheet.

 

Although the Company’s wholesale borrowings portfolio has declined significantly, there still exists some higher cost legacy borrowings and the Company continues to monitor and evaluate both prepayment and debt restructuring opportunities, as executing on such a strategy could potentially increase NIM at a much quicker pace than holding the debt until maturity.

 

41

 

 

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 March 31,

 
   

2017

   

2016

 
           

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

  $ 11,092     $ 15       0.55 %   $ 17,232     $ 13       0.30 %

Interest-bearing deposits at financial institutions

    92,551       199       0.87 %     40,635       60       0.59 %

Investment securities (1)

    560,455       5,158       3.73 %     550,371       4,685       3.42 %

Restricted investment securities

    13,871       130       3.80 %     14,140       131       3.73 %

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

    2,398,387       27,793       4.70 %     1,833,950       19,955       4.38 %
                                                 

Total interest earning assets

  $ 3,076,356     $ 33,295       4.39 %   $ 2,456,328     $ 24,844       4.07 %
                                                 

Noninterest-earning assets:

                                               

Cash and due from banks

  $ 65,291                     $ 45,891                  

Premises and equipment

    60,977                       37,747                  

Less allowance

    (31,498 )                     (26,701 )                
Other     103,587                       89,085                  
                                                 

Total assets

  $ 3,274,713                     $ 2,602,350                  
                                                 

LIABILITIES AND STOCKHOLDERS' EQUITY

                                               

Interest-bearing liabilities:

                                               

Interest-bearing deposits

  $ 1,407,645       1,140       0.33 %   $ 925,246       615       0.27 %

Time deposits

    511,119       1,093       0.87 %     399,604       675       0.68 %

Short-term borrowings

    25,188       24       0.39 %     86,539       43       0.20 %

FHLB advances

    114,356       403       1.43 %     128,436       442       1.38 %

Other borrowings

    74,761       683       3.71 %     101,738       824       3.26 %

Junior subordinated debentures

    33,497       333       4.03 %     34,650       305       3.54 %
                                                 

Total interest-bearing liabilities

  $ 2,166,566     $ 3,676       0.69 %   $ 1,676,213     $ 2,904       0.70 %
                                                 

Noninterest-bearing demand deposits

  $ 773,245                     $ 655,206                  

Other noninterest-bearing liabilities

    43,996                       39,684                  

Total liabilities

  $ 2,983,807                     $ 2,371,103                  
                                                 

Stockholders' equity

    290,906                       231,247                  
                                                 

Total liabilities and stockholders' equity

  $ 3,274,713                     $ 2,602,350                  
                                                 

Net interest income

          $ 29,619                     $ 21,940          
                                                 

Net interest spread

                    3.70 %                     3.37 %
                                                 

Net interest margin

                    3.90 %                     3.59 %
                                                 

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

    141.99 %                     146.54 %                

 

(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.

 

42

 

 

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 March 31, 2017

 

   

Inc./(Dec.)

   

Components

 
   

from

   

of Change (1)

 
   

Prior Period

   

Rate

   

Volume

 
   

2017 vs. 2016

 
   

(dollars in thousands)

 

INTEREST INCOME

                       

Federal funds sold

  $ 2     $ 28     $ (26 )

Interest-bearing deposits at financial institutions

    139       37       102  

Investment securities (2)

    473       393       80  

Restricted investment securities

    (1 )     10       (11 )

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

    7,838       1,518       6,320  
                         

Total change in interest income

  $ 8,451     $ 1,986     $ 6,465  
                         

INTEREST EXPENSE

                       

Interest-bearing deposits

  $ 525     $ 160     $ 365  

Time deposits

    418       208       210  

Short-term borrowings

    (19 )     129       (148 )

Federal Home Loan Bank advances

    (39 )     80       (119 )

Other borrowings

    (141 )     552       (693 )

Junior subordinated debentures

    28       89       (61 )
                         

Total change in interest expense

  $ 772     $ 1,218     $ (446 )
                         

Total change in net interest income

  $ 7,679     $ 768     $ 6,911  

 

(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.

 

43

 

 

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 GAAP. The financial information contained within these statements is, to a significant extent, financial information that is based on approximate measures of the financial effects of transactions and events that have already occurred. Certain critical accounting policies are described below.

 

ALLOWANCE FOR LOAN AND LEASE LOSSES

 

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

 

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

 

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

 

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

 

Although management believes the level of the allowance as of March 31, 2017 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.

 

OTHERTHAN-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.

 

44

 

 

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 33%, comparing the first quarter of 2017 to the same period of 2016. Most of this increase was the result of the CSB acquisition during the third quarter of 2016.

 

Overall, the Company’s average earning assets increased 25%, comparing the first quarter of 2017 to the first quarter of 2016. During the same time period, average gross loans and leases increased 31%, while average investment securities increased 2%.

 

Additionally, the Company continued to diversify its securities portfolio, including increasing its portfolio of tax exempt municipal securities. The large majority of these are privately placed debt issuances by municipalities located in the Midwest and require a thorough underwriting process before investment. Execution of this strategy has led to increased interest income on a tax equivalent basis over the past several years. Management understands that this strategy has extended the duration of its securities portfolio and continually evaluates the combined benefit of increased interest income and reduced effective income tax rate and the impact on interest rate risk.

 

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 first quarter of 2017 increased 27% from the first quarter of 2016. The acquisition of CSB contributed to this increase. Additionally, the Company has rate sensitive deposits with select customers that have repriced with the increase in certain market interest rates.

 

Management has placed a strong focus on reducing the reliance on long-term wholesale funding as it tends to be higher in cost than deposits. Several balance sheet restructuring strategies were executed in 2016. Refer to Notes 10 and 11 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 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.

 

45

 

 

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 $2.1 million for the first quarter of 2017, which was flat from the same quarter of the prior year. This provision, when coupled with net charge-offs of $803 thousand, increased the Company’s allowance to $32.1 million at March 31, 2017. As of March 31, 2017, the Company’s allowance to total loans/leases was 1.32%, which was up from 1.28% at December 31, 2016 and down from 1.46% at March 31, 2016, respectively.

 

In accordance with GAAP for business combination accounting, the loans acquired through the acquisition of CSB were recorded at market value; therefore, there was no allowance associated with CSB’s loans at acquisition. Management continues to evaluate the allowance needed on the acquired CSB loans factoring in the net remaining discount ($8.0 million at March 31, 2017). When factoring this remaining discount into the Company’s allowance to total loans and leases calculation, the Company’s allowance as a percentage of total loans and leases increases from 1.32% to 1.64%.

 

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

 

46

 

 

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 months ended March 31, 2017 and 2016.

 

   

Three Months Ended

                 
   

March 31,

2017

   

March 31,

2016

   

$ Change

   

% Change

 
                                 

Trust department fees

  $ 1,740,207       1,575,907     $ 164,300       10.4

%

Investment advisory and management fees

    961,599       658,385       303,214       46.1  

Deposit service fees

    1,316,390       931,079       385,311       41.4  

Gains on sales of residential real estate loans

    96,323       60,386       35,937       59.5  

Gains on sales of government guaranteed portions of loans

    950,641       878,528       72,113       8.2  

Swap fee income

    113,520       856,958       (743,438 )     (86.8 )

Securities gains, net

    -       358,480       (358,480 )     (100.0 )

Earnings on bank-owned life insurance

    469,687       393,609       76,078       19.3  

Debit card fees

    702,801       307,651       395,150       128.4  

Correspondent banking fees

    245,189       302,130       (56,941 )     (18.8 )

Other

    687,397       499,360       188,037       37.7  

Total noninterest income

  $ 7,283,754     $ 6,822,473     $ 461,281       6.8

%

 

 

In recent years, the Company has been successful in expanding its wealth management customer base. Trust department fees continue to be a significant contributor to noninterest income and, due to favorable market conditions in early 2017 coupled with strong growth in assets under management, trust department fees increased 10%, comparing the first quarter of 2017 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.

 

Management has placed a stronger emphasis on growing its investment advisory and management services. Part of this initiative has been to restructure the Company’s Wealth Management Division to allow for more efficient delivery of products and services through selective additions of talent as well as 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. Due to favorable market conditions in early 2017, investment advisory and management fees increased 46%, comparing the first quarter of 2017 to the same period of the prior year. The acquisition of CSB also contributed to this increase, as they had an established investment advisory and management services department at acquisition.

 

Deposit service fees expanded 41% comparing the first quarter of 2017 to the same period of the prior year. This increase was the result of the acquisition of CSB. Additionally, the Company continues its emphasis on shifting the mix of deposits from brokered and retail time deposits to non-maturity demand deposits across all its markets. With this 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.

 

47

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued 

 

Gains on sales of residential real estate loans increased 60% when comparing the first quarter of 2017 to the same period of the prior year. The increase was attributable to the acquisition of CSB. Overall, with the 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 first quarter of 2017 increased 8%, compared to the first quarter of 2016. Given the nature of these gains, large fluctuations can happen from quarter-to-quarter and year-to-year. Results for the most recent quarter are reflective of the strong demand for these types of loans. 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 have success in this category.

 

As a result of the low interest rate environment, the Company was able to execute numerous interest rate swaps on select commercial loans over the past two years. 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 $114 thousand for the first quarter of 2017, compared to $857 thousand for the first quarter of 2016. Due to the rate environment in the first quarter of 2017, interest rate swap executions were minimal. Future levels of swap fee income are dependent upon prevailing interest rates.

 

The Company did not sell any securities gains during the first quarter of 2017. Securities gains were $358 thousand for the first quarter of 2016. The Company took advantage of market opportunities by selling approximately $55.5 million of investments that were low-yielding during the quarter ending March 31, 2016. Proceeds were then used to purchase higher-yielding bonds with a modest duration extension and to fund loan and lease growth.

 

Earnings on BOLI increased 19% comparing the first quarter of 2017 to the first quarter of 2016. There were no purchases of BOLI within the last twelve months. Notably, a small portion of the Company’s BOLI is variable rate whereby the returns are determined by the performance of the equity market. Equity market performance in the first quarter of 2016 resulted in a slight loss on this variable policy, whereas, equity performance in the first quarter of 2017 was strong and resulted in a gain. This swing accounted for the majority of the increase year-over-year. 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.

 

48

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued 

 

Debit card fees are the interchange fees paid on certain debit card customer transactions. Debit card fees increased 128% comparing the first quarter of 2017 to the first quarter of the prior year. The primary reason for the increase was the addition of CSB. CSB has a large retail customer base, therefore, has significant interchange revenue. Additionally, 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 higher interest rate that incentivizes debit card activity.

 

Correspondent banking fees decreased 19% comparing the first quarter of 2017 to the first quarter of the prior year. As correspondent bank deposit balances rise, they receive a higher earnings credit, which then reduces the direct fees that the Company receives. Management will continue to evaluate earnings credit rates and the resulting impact on deposit balances and fees while balancing the ability to grow market share. Correspondent banking continues to be a core strategy for the Company, as this line of business provides a high level of 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 183 banks in Iowa, Illinois and Wisconsin.

 

NONINTEREST EXPENSE

 

The following tables set forth the various categories of noninterest expense for the three months ended March 31, 2017 and 2016.

 

   

Three Months Ended

                 
   

March 31,

2017

   

March 31,

2016

   

$ Change

   

% Change

 
                                 

Salaries and employee benefits

  $ 13,307,331       10,800,907     $ 2,506,424       23.2

%

Occupancy and equipment expense

    2,502,219       1,826,988       675,231       37.0  

Professional and data processing fees

    2,083,392       1,447,413       635,979       43.9  

FDIC insurance, other insurance and regulatory fees

    621,242       634,365       (13,123 )     (2.1 )

Loan/lease expense

    293,538       162,819       130,719       80.3  

Net cost of operations of other real estate

    14,230       102,183       (87,953 )     (86.1 )

Advertising and marketing

    609,431       386,259       223,172       57.8  

Bank service charges

    423,901       415,931       7,970       1.9  

Losses on debt extinguishment, net

    -       83,197       (83,197 )     (100.0 )

Correspondent banking expense

    198,351       176,989       21,362       12.1  

Other

    1,219,482       917,447       302,035       32.9  

Total noninterest expense

  $ 21,273,117     $ 16,954,498     $ 4,318,619       25.5

%

 

 

Management places a strong emphasis on overall cost containment and is committed to improving the Company’s general efficiency. Most expenses were higher in the first quarter of 2017 compared to 2016 as a result of acquiring CSB as the Company’s fourth bank charter.

 

Salaries and employee benefits, which is the largest component of noninterest expense, increased from the first quarter of 2016 to the first quarter of 2017 by 23%. This increase is primarily related to the acquisition of CSB.

 

Occupancy and equipment expense increased 37%, comparing the first quarter of 2017 to the same period of the prior year. The increased expense was mostly due to the addition of CSB.

 

49

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued 

 

Professional and data processing fees increased 44%, comparing the first quarter of 2017 to the same period in 2016. This increased expense was mostly due to the addition of CSB. 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.

 

FDIC and other insurance expense decreased 2%, comparing the first quarter of 2017 to the first quarter of 2016. The decrease in expense was due to a decrease in the assessment rate designated by the FDIC partially offset by the acquisition of CSB.

 

Loan/lease expense increased 80%, comparing the first quarter of 2017 to the same quarter of 2016. The Company incurred elevated levels of expense in the first quarter of 2017 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 $14 thousand for the first quarter of 2017, compared to $102 thousand for the first quarter of 2016. Occupancy rates for one of the OREO properties managed by the Company have improved over the past year, increasing cash flow from that property and reducing net operating costs.

 

Bank service charges, a large portion of which includes indirect costs incurred to provide services to QCBT’s correspondent banking customer portfolio, increased 2% from the first quarter of 2016 to the first quarter of 2017. 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.

 

In the first three months 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.

 

Correspondent banking expense was up 12% when comparing the first quarter of 2017 to the first quarter of 2016 due to both increases in volume and increases in the number of correspondent banking clients. These are direct costs incurred to provide services to QCBT’s correspondent banking customer portfolio, including safekeeping and cash management services.

 

50

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued 

 

INCOME TAXES

 

In the first quarter of 2017, the Company incurred income tax expense of $2.4 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 months ended March 31, 2017 and 2016.

 

   

For the Three Months Ended March 31,

 
   

2017

   

2016

 
           

% of

           

% of

 
           

Pretax

           

Pretax

 
   

Amount

   

Income

   

Amount

   

Income

 
                                 

Computed "expected" tax expense

  $ 4,051,044       35.0 %   $ 2,937,379       35.0 %

Tax exempt interest income

    (1,305,427 )     (11.3 )     (966,318 )     (11.5 )

Bank-owned life insurance

    (164,391 )     (1.4 )     (137,763 )     (1.6 )

State income taxes, net of federal benefit, current year

    408,325       3.5       266,908       3.2  

Excess tax benefit on stock options exercised and restricted stock awards vested *

    (533,322 )     (4.6 )     -       -  

Other

    (66,783 )     (0.6 )     (81,183 )     (1.0 )

Federal and state income tax expense

  $ 2,389,446       20.6 %   $ 2,019,023       24.1 %

 

* As a result of the implementation of ASU 2016-09 effective January 1, 2017, the excess tax benefit on stock options exercised and restricted stock awards vested is now recorded as an adjustment to income tax expense in the income statement. Previously, the excess tax benefit was recorded as an adjustment to equity.

 

The effective tax rate for the quarter ended March 31, 2017 was 20.6% which was a decrease from the effective tax rate of 24.1% for the quarter ended March 31, 2016. This shift was primarily due to the implementation of ASU 2016-09, which resulted in a tax benefit of $533 thousand for the first quarter of 2017.

 

FINANCIAL CONDITION

 

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

 

   

As of

 
   

March 31, 2017

   

December 31, 2016

   

March 31, 2016

 
   

(dollars in thousands)

 
       
   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

 

Cash and due from banks

  $ 56,326       2 %   $ 70,570       2 %   $ 44,931       2 %

Federal funds sold and interest-bearing deposits

    173,219       5 %     86,206       3 %     57,229       2 %

Securities

    557,646       16 %     574,022       19 %     537,317       20 %

Net loans/leases

    2,403,791       71 %     2,374,730       70 %     1,846,428       70 %

Other assets

    190,031       6 %     196,416       6 %     154,768       6 %

Total assets

  $ 3,381,013       100 %   $ 3,301,944       100 %   $ 2,640,673       100 %
                                                 

Total deposits

  $ 2,805,931       83 %   $ 2,669,261       74 %   $ 1,989,573       71 %

Total borrowings

    231,534       7 %     290,952       14 %     347,901       18 %

Other liabilities

    47,708       1 %     55,690       2 %     68,056       2 %

Total stockholders' equity

    295,840       9 %     286,041       10 %     235,143       9 %

Total liabilities and stockholders' equity

  $ 3,381,013       100 %   $ 3,301,944       100 %   $ 2,640,673       100 %

 

51

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued 

 

During the first quarter of 2017, the Company’s total assets increased $79.1 million, or 2%, to a total of $3.4 billion. Total gross loans and leases grew $30.4 million. This loan and lease growth was funded by deposits, which increased $136.7 million in the first quarter of 2017. This deposit growth also allowed the Company to further reduce borrowings by $59.4 million in the first quarter of 2017. Stockholders’ equity increased $9.8 million, or 3%, in the current quarter due to net retained income.

 

INVESTMENT SECURITIES 

 

The composition of the Company’s securities portfolio is managed to meet liquidity needs while prioritizing the impact on interest rate risk and maximizing return, while minimizing credit risk. The Company has further diversified the portfolio by decreasing U.S government sponsored agency securities, while increasing residential mortgage-backed and related securities and tax-exempt municipal securities. Of the latter, the large majority are privately placed tax-exempt debt issuances by municipalities located in the Midwest (with some in or near the Company’s existing markets) and require a thorough underwriting process before investment.

 

Following is a breakdown of the Company’s securities portfolio by type, the percentage of unrealized gains (losses) to carrying value on the total portfolio, and the portfolio duration:

 

   

As of

 
   

March 31, 2017

   

December 31, 2016

   

March 31, 2016

 
   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

 
   

(dollars in thousands)

 
       

U.S. govt. sponsored agency securities

  $ 47,556       9 %   $ 46,084       8 %   $ 132,742       25 %

Municipal securities

    356,776       64 %     374,463       65 %     285,009       53 %

Residential mortgage-backed and related securities

    147,504       26 %     147,702       26 %     116,452       22 %

Other securities

    5,810       1 %     5,773       1 %     3,114       0 %
    $ 557,646       100 %   $ 574,022       100 %   $ 537,317       100 %
                                                 

Securities as a % of total assets

    16.49 %             17.38 %             20.35 %        

Net unrealized gains (losses) as a % of amortized cost

    (0.79 )%             (0.87 )%             1.05 %        

Duration (in years)

    6.1               6.0               5.2          

Yield on investment securities (tax equivalent)

    3.73 %             3.56 %             3.42 %        

 

Management monitors the level of unrealized gains/losses including performing quarterly reviews of individual securities for evidence of OTTI. Management identified no OTTI in any of the periods presented.

 

The duration of the securities portfolio stayed relatively flat in the current quarter, as compared to December 31, 2016.

 

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

 

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

 

52

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued 

 

LOANS/LEASES 

 

Total loans/leases grew 5.0% on an annualized basis during the first three months of 2017. The mix of the loan/lease types within the Company’s loan/lease portfolio is presented in the following table.

 

   

As of

 
   

March 31, 2017

   

December 31, 2016

   

March 31, 2016

 
   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

 
       
   

(dollars in thousands)

 
       

C&I loans

  $ 851,578       35 %   $ 827,637       34 %   $ 682,057       37 %

CRE loans

    1,106,842       46 %     1,093,459       46 %     766,159       41 %

Direct financing leases

    159,368       7 %     165,419       7 %     172,774       9 %

Residential real estate loans

    231,326       9 %     229,233       10 %     173,096       9 %

Installment and other consumer loans

    78,771       3 %     81,666       3 %     71,842       4 %

Total loans/leases

  $ 2,427,885       100 %   $ 2,397,414       100 %   $ 1,865,928       100 %

Plus deferred loan/lease origination costs, net of fees

    7,965               8,073               7,895          

Less allowance

    (32,059 )             (30,757 )             (27,395 )        

Net loans/leases

  $ 2,403,791             $ 2,374,730             $ 1,846,428          

 

 

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 March 31, 2017 and December 31, 2016, respectively, approximately 29% and 30% 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 $23.9 million in the current quarter, or an annualized rate of 12%.

53

 

 

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 March 31,

   

As of December 31,

   

As of March 31,

 
   

2017

   

2016

   

2016

 
   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

 
       
   

(dollars in thousands)

 
       

Lessors of Nonresidential Buildings

  $ 327,077       30 %   $ 322,337       30 %   $ 277,822       36 %

Lessors of Residential Buildings

    147,335       13 %     141,321       13 %     99,104       13 %

New Housing For-Sale Builders

    57,733       5 %     56,711       5 %     5,346       1 %

Nonresidential Property Managers

    57,112       5 %     70,914       7 %     17,003       2 %

Land Subdivision

    47,254       4 %     45,132       4 %     18,467       2 %

Hotels

    37,998       4 %     35,006       3 %     19,694       3 %

Nursing Care Facilities

    34,611       3 %     34,768       3 %     13,807       2 %

New Multifamily Housing Construction

    26,915       2 %     24,146       2 %     11,669       1 %

Lessors of Other Real Estate Property

    20,989       2 %     25,664       2 %     21,895       3 %

Other *

    349,818       32 %     337,460       31 %     281,352       37 %
                                                 

Total CRE Loans

  $ 1,106,842       100 %   $ 1,093,459       100 %   $ 766,159       100 %

 

* “Other” consists of all other industries. None of these had concentrations greater than $22.0 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.

 

54

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued 

 

Following is a listing of significant equipment types within the m2 loan and lease portfolio:

 

   

As of March 31,

   

As of December 31,

   

As of March 31,

 
   

2017

   

2016

   

2016

 
   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

 
                                                 
   

(dollars in thousands)

 
                                                 

Manufacturing - General

  $ 18,067       9 %   $ 17,434       8 %   $ 16,275       8 %

Construction - General

    17,914       9 %     16,815       8 %     13,734       7 %

Trucks & Vans

    14,657       7 %     13,806       7 %     7,993       4 %

Food Processing Equipment

    14,102       7 %     14,316       7 %     14,224       7 %

Computer Hardware

    10,094       5 %     10,443       5 %     9,552       5 %

Trailers

    9,465       5 %     10,003       5 %     6,389       3 %

Marine - Travelifts

    8,132       4 %     8,180       4 %     7,663       4 %

Restaurant

    7,841       4 %     7,950       4 %     7,472       4 %

Manufacturing - CNC

    6,812       3 %     7,164       3 %     8,675       4 %

Furniture

    6,259       3 %   $ 6,945       3 %   $ 6,002       3 %

Other

    95,116       46 %     97,989       46 %     107,235       52 %

Total m2 loans and leases

    208,459       100 %     211,045       100 %     205,214       100 %

 

* “Other” consists of all other equipment types. None of these had concentrations greater than 3% of total m2 loan and lease portfolio in the most recent period presented.

 

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

 

55

 

 

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 months ended March 31, 2017 and 2016 are presented as follows:

 

   

Three Months Ended

 
   

March 31, 2017

   

March 31, 2016

 
       
   

(dollars in thousands)

 
       

Balance, beginning

  $ 30,757     $ 26,141  

Provisions charged to expense

    2,105       2,073  

Loans/leases charged off

    (893 )     (868 )

Recoveries on loans/leases previously charged off

    90       49  

Balance, ending

  $ 32,059     $ 27,395  

 

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 *

 

March 31, 2017

   

December 31, 2016

   

March 31, 2016

 
                         
   

(dollars in thousands)

 
                         

Special Mention (Rating 6)

  $ 22,841     $ 20,082     $ 28,065  

Substandard (Rating 7)

    50,810       49,035       38,273  

Doubtful (Rating 8)

    -       -       -  
    $ 73,651     $ 69,117     $ 66,338  
                         
                         

Criticized Loans **

  $ 73,651     $ 69,117     $ 66,338  

Classified Loans ***

  $ 50,810     $ 49,035     $ 38,273  
                         

Criticized Loans as a % of Total Loans/Leases

    3.02 %     2.87 %     3.54 %

Classified Loans as a % of Total Loans/Leases

    2.09 %     2.04 %     2.04 %

 

 

* 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.

 

56

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued 

 

The Company experienced a modest increase in both criticized and classified loans during the first three months of 2017; however, as shown below, these increases did not translate to increased NPLs. The Company continues its strong focus on improving credit quality in an effort to limit NPLs.

 

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

 

   

As of

 
   

March 31, 2017

   

December 31, 2016

   

March 31, 2016

 
                         

Allowance / Gross Loans/Leases

    1.32 %     1.28 %     1.46 %

Allowance / NPLs *

    149.89 %     144.85 %     228.75 %

 

*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 March 31, 2017 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.

 

In accordance with GAAP for business combination accounting, the loans acquired through the acquisition of CSB were recorded at market value; therefore, there was no allowance associated with CSB’s loans at acquisition. Management continues to evaluate the allowance needed on the acquired CSB loans factoring in the net remaining discount ($8.0 million at March 31, 2017). When factoring this remaining discount into the Company’s allowance to total loans and leases calculation, the Company’s allowance as a percentage of total loans and leases increases from 1.32% to 1.64%. This elimination of CSB’s allowance also resulted in a decrease of the allowance to NPLs ratio, as CSB’s NPLs no longer have reserves allocated to them and instead, have a loan discount that is separate from the allowance.

 

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

 

57

 

 

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 March 31,

   

As of December 31,

   

As of March 31,

 
   

2017

   

2016

   

2016

 
       
   

(dollars in thousands)

 
       

Nonaccrual loans/leases (1) (2)

  $ 14,205     $ 13,919     $ 10,772  

Accruing loans/leases past due 90 days or more

    955       967       47  

TDRs - accruing

    6,229       6,347       1,157  

Total NPLs

    21,389       21,233       11,976  

OREO

    5,625       5,523       6,680  

Other repossessed assets

    285       202       46  

Total NPAs

  $ 27,299     $ 26,958     $ 18,702  
                         

NPLs to total loans/leases

    0.88 %     0.88 %     0.64 %

NPAs to total loans/leases plus repossessed property

    1.12 %     1.12 %     0.99 %

NPAs to total assets

    0.81 %     0.82 %     0.71 %

Texas ratio (3)

    8.78 %     9.09 %     7.23 %

 

 

(1)

Includes government guaranteed portion of loans, as applicable.

 

(2)

Includes TDRs of $2.4 million at March 31, 2017, $2.3 million at December 31, 2016, and $1.6 million at March 31, 2016.

 

(3)

Texas Ratio = Nonperforming Assets (excluding Other Repossessed Assets) / Tangible Equity plus Allowance. Texas Ratio is a non-GAAP financial measure. See GAAP to Non-GAAP Reconciliations for more information.

 

NPAs at March 31, 2017 were $27.3 million, which were relatively flat from December 31, 2016 and up $8.6 million from March 31, 2016. This increase was the result of two large credits added in the fourth quarter of 2016.

 

The ratio of NPAs to total assets was 0.81% at March 31, 2017, which was flat from 0.82% at December 31, 2016, and up from 0.71% at March 31, 2016.

 

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

 

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

 

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

 

58

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued 

 

DEPOSITS 

 

Deposits increased $136.7 million during the first quarter of 2017. The table below presents the composition of the Company’s deposit portfolio.

 

   

As of

 
   

March 31, 2017

   

December 31, 2016

   

March 31, 2016

 
       
   

(dollars in thousands)

 
       
   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

 

Noninterest bearing demand deposits

  $ 777,150       28 %   $ 797,415       30 %   $ 641,859       32 %

Interest bearing demand deposits

    1,486,047       53 %     1,369,226       51 %     916,455       46 %

Time deposits

    458,170       16 %     439,169       17 %     331,786       17 %

Brokered deposits

    84,564       3 %     63,451       2 %     99,473       5 %
    $ 2,805,931       100 %   $ 2,669,261       100 %   $ 1,989,573       100 %

 

In an effort to strengthen the relationship and maximize the liquidity potential of its correspondent banking clients, the Company introduced an interest-bearing money market deposit account to its correspondent banking clients and this generated strong deposit growth in the first quarter of 2017.   

 

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

 
   

March 31, 2017

   

December 31, 2016

   

March 31, 2016

 
       
   

(dollars in thousands)

 
       

Overnight repurchase agreements with customers

  $ 7,170     $ 8,131     $ 52,153  

Federal funds purchased

    12,300       31,840       11,870  
    $ 19,470     $ 39,971     $ 64,023  

 

The Company is nearing the completion of a process to transition its overnight repurchase agreements with customers into a comparable interest bearing demand deposit product that offers full FDIC insurance. This transition has freed up securities that were previously pledged as collateral to the overnight repurchase agreements with customers and has 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.

 

59

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued 

 

The table below presents the Company’s term FHLB advances and overnight FHLB advances.

 

   

As of

 
   

March 31, 2017

   

December 31, 2016

   

March 31, 2016

 
       
   

(dollars in thousands)

 
       

Term FHLB advances

  $ 59,000     $ 63,000     $ 80,000  

Overnight FHLB advances

    47,550       74,500       70,500  
    $ 106,550     $ 137,500     $ 150,500  

 

Term FHLB advances decreased in the current quarter due to a small maturity of $4.0 million. Overnight FHLB advances have decreased, as the Company grows core deposits and has less need for alternative funding.

 

The table below presents the composition of the Company’s other borrowings.

 

   

As of

 
   

March 31, 2017

   

December 31, 2016

   

March 31, 2016

 
       
   

(dollars in thousands)

 
       

Wholesale structured repurchase agreements

  $ 45,000     $ 45,000     $ 100,000  

Term note

    27,000       30,000       -  

Revolving line of credit

    -       5,000       -  
    $ 72,000     $ 80,000     $ 100,000  

 

Other borrowings include structured repos which are utilized as an alternative funding source to FHLB advances and customer deposits. Structured repos are collateralized by certain U.S. government agency securities and residential mortgage backed and related securities.

 

As described in Note 11 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, the Company has an outstanding five-year term note and revolving line of credit. As of March 31, 2017, the term debt had been paid down to $27.0 million. Also, in the first quarter of 2017, the Company paid off the full outstanding amount of the revolving line of credit. As of March 31, 2017, the full $10.0 million line of credit was available.

 

The Company executed several balance sheet restructuring strategies in 2016. Refer to Note 11 of the Annual Report on Form 10-K for the year ended December 31, 2016 for addition information regarding these prepayments.

 

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 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.

 

60

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued 

 

The table below presents the maturity schedule including weighted average interest cost for the Company’s combined wholesale funding portfolio.

 

   

March 31, 2017

   

December 31, 2016

 
           

Weighted

           

Weighted

 
           

Average

           

Average

 

Maturity:

 

Amount Due

   

Interest Rate

   

Amount Due

   

Interest Rate

 
       

 

 

(dollar amounts in thousands)

 
       
Year ending December 31:                                

2017

    155,705       1.05 %     165,543       0.91 %

2018

    38,459       2.70       38,459       2.70  

2019

    16,950       2.65       16,950       2.65  

2020

    25,000       2.66       25,000       2.66  

Total Wholesale Funding

  $ 236,114       1.38 %   $ 245,952       1.38 %

 

During the first three months of 2017, wholesale funding decreased $9.8 million. Year-to-date, the Company has repaid $21.2 million of borrowings at maturity. Offsetting these reductions in wholesale borrowings was a net increase in brokered deposits of $38.4 million, all with maturities less than one year. Short-term borrowings from the FHLB decreased $27.0 million since December 31, 2016.

 

STOCKHOLDERS’ EQUITY

 

The table below presents the composition of the Company’s stockholders’ equity.

 

   

As of

 
   

March 31, 2017

   

December 31, 2016

   

March 31, 2016

 
   

Amount

   

Amount

   

Amount

 
       
   

(dollars in thousands)

 
       

Common stock

  $ 13,161     $ 13,107     $ 11,815  

Additional paid in capital

    157,582       156,777       124,058  

Retained earnings

    127,145       118,617       98,868  

AOCI (loss)

    (2,048 )     (2,460 )     402  

Total stockholders' equity

  $ 295,840     $ 286,041     $ 235,143  
                         

TCE* / TA

    8.20 %     8.04 %     8.74 %

 

*TCE is defined as total common stockholders’ equity excluding goodwill and other intangibles. This ratio is a non-GAAP financial measure. See GAAP to Non-GAAP Reconciliations.

 

61

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued 

 

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 $168.9 million during the first quarter of 2017 and $139.5 million during the full year of 2016. The Company’s on balance sheet liquidity position can fluctuate based on short-term activity in deposits and loans.

 

The subsidiary banks have a variety of sources of short-term liquidity available to them, including federal funds purchased from correspondent banks, FHLB advances, wholesale structured repurchase agreements, brokered deposits, lines of credit, borrowing at the Federal Reserve Discount Window, sales of securities AFS, and loan/lease participations or sales. The Company also generates liquidity from the regular principal payments and prepayments made on its loan/lease portfolio, and on the regular monthly payments on its securities portfolio (both residential mortgage-backed securities and municipal securities).

 

At March 31, 2017, the subsidiary banks had 34 lines of credit totaling $395.7 million, of which $33.7 million was secured and $362.0 million was unsecured. At March 31, 2017, $395.7 million was available.

 

At December 31, 2016, the subsidiary banks had 33 lines of credit totaling $381.4 million, of which $34.4 million was secured and $347.0 million was unsecured. At December 31, 2016, $361.4 million was available as $20.0 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 March 31, 2017, the full $10.0 was available.

 

As of March 31, 2017, the Company has $442.4 million in correspondent banking deposits spread over 183 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 $102.6 million during the first three months of 2017, compared to $14.5 million for the same period of 2016. The net increase in interest-bearing deposits at financial institutions was $93.5 for the first three months of 2017, compared to $5.2 million for the same period of 2016. Proceeds from calls, maturities, paydowns, and sales of securities were $25.9 million for the first three months of 2017, compared to $109.5 million for the same period of 2016. Purchases of securities used cash of $12.1 million for the first three months of 2017, compared to $45.1 million for the same period of 2016. The net increase in loans/leases used cash of $29.2 million for the first three months of 2017 compared to $76.3 million for the same period of 2016.

 

62

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued 

 

Financing activities provided cash of $77.5 million for the first three months of 2017, compared to $12.6 million for same period of 2016. Net increases in deposits totaled $136.7 million for the first three months of 2017, compared to $108.9 million for the same period of 2016. During the first three months of 2017, the Company’s short-term borrowings decreased $20.5 million, while they decreased $80.6 million for the same period of 2016. In the first three months of 2017, the Company reduced FHLB advances and other borrowings by $39.0 million through a mixture of maturities, scheduled payments and the net change in short-term borrowings. In the first three months of 2016, the Company reduced FHLB advances and borrowings by $32.2 million through a mixture of maturities, prepayments, and debt retirement. Additionally, short-term borrowings increased by $16.5 million in the first three months of 2016.

 

Total cash provided by operating activities was $10.8 million for the first three months of 2017, compared to $5.1 million for the same period of 2016.

 

Throughout its history, the Company has secured additional capital through various sources, including the issuance of common and preferred stock, as well as trust preferred securities.

 

The following table presents the details of the trust preferred securities outstanding as of March 31, 2017 and December 31, 2016.

 

Name

Date Issued

 

Amount Outstanding
March 31,
2017

   

Amount Outstanding
December 31, 2016

 

Interest Rate

 

Interest Rate as of
March 31,
2017

   

Interest Rate as of
December 31,

2016

 
                                     

QCR Holdings Statutory Trust II

February 2004

  $ 10,310,000     $ 10,310,000  

2.85% over 3-month LIBOR

    3.85 %     3.85 %

QCR Holdings Statutory Trust III

February 2004

    8,248,000       8,248,000  

2.85% over 3-month LIBOR

    3.85 %     3.85 %

QCR Holdings Statutory Trust V

February 2006

    10,310,000       10,310,000  

1.55% over 3-month LIBOR

    2.57 %     2.43 %

Community National Statutory Trust II

September 2004

    3,093,000       3,093,000  

2.17% over 3-month LIBOR

    3.32 %     3.17 %

Community National Statutory Trust III

March 2007

    3,609,000       3,609,000  

1.75% over 3-month LIBOR

    2.88 %     2.71 %
      $ 35,570,000     $ 35,570,000  

Weighted Average Rate

    3.33 %     3.26 %

 

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 March 31, 2017, the remaining discount was $2.1 million.

 

The Company filed a universal shelf registration statement on Form S-3 with the SEC on October 27, 2016, as amended on January 11, 2017. Declared effective by the SEC on January 31, 2017, the registration statement allows the Company to offer and sell various types of securities, including common stock, preferred stock, debt securities and/or warrants, from time to time up to an aggregate amount of $100 million. The Company utilized $30.1 million of its $100 million previous shelf registration filing through the offer and sale of its common stock in the second quarter of 2016 to help fund the acquisition of CSB. This Form S-3 filing replenished the amount available to the previous level of $100 million. The specific terms and prices of any securities offered pursuant to the registration statement 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. There were no securities issued under this shelf registration statement during the quarter ended March 31, 2017.

 

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 7 of the Consolidated Financial Statements for additional information regarding regulatory capital.

 

63

 

 

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 for the year ended December 31, 2016 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. One should not consider the risk factors to be a complete discussion of risks, uncertainties and assumptions.

 

These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.

 

64

 

 

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.

 

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Part I

Item 3

 

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK - continued

 

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, 2017

   

As of December 31, 2016

   

As of December 31, 2015

 
                                 

100 basis point downward shift

    -10.0 %     -1.5 %     -1.7 %     -2.1 %

200 basis point upward shift

    -10.0 %     -0.9 %     -1.2 %     -2.7 %

300 basis point upward shock

    -25.0 %     -0.8 %     -1.4 %     -7.1 %

 

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, 2017 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.

 

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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 March 31, 2017. Based on that evaluation, the Company’s management, including the Chief Executive Officer and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective, as of the end of the period covered by this report, to ensure that information required to be disclosed in the reports filed and submitted under the Exchange Act was recorded, processed, summarized and reported as and when required.

 

Changes in Internal Control over Financial Reporting. There have been no significant changes to the Company’s internal control over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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Part II

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 2016 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

 

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 March 31, 2017 and December 31, 2016; (ii) Consolidated Statements of Income for the three months ended March 31, 2017 and March 31, 2016; (iii) Consolidated Statements of Comprehensive Income for the three months ended March 31, 2017 and March 31, 2016; (iv) Consolidated Statements of Changes in Stockholders’ Equity for the three months ended March 31, 2017 and March 31, 2016; (v) Consolidated Statements of Cash Flows for the three months ended March 31, 2017 and March 31, 2016; and (vi) Notes to the Consolidated Financial Statements.

 

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SIGNATURES

 

Pursuant to the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

QCR HOLDINGS, INC.

(Registrant)

 

 

 

 

Date May 9, 2017  

/s/ Douglas M. Hultquist

 

 

 

 

Douglas M. Hultquist, President

 

 

 

 

Chief Executive Office

 

 

 

 

Date May 9, 2017   /s/ Todd A. Gipple  
      Todd A. Gipple, Executive Vice President  
      Chief Operating Officer  
      Chief Financial Officer  

 

 

 

Date May 9, 2017   /s/ Elizabeth A. Grabin  
      Elizabeth A. Grabin, Vice President   
      Controller & Director of Financial Reporting   
      Principal Accounting Officer  

 

 

70