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QCR HOLDINGS INC - Quarter Report: 2020 June (Form 10-Q)

Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2020

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

For the transition period from ______to________

Commission file number 0-22208

QCR HOLDINGS, INC.

(Exact name of Registrant as specified in its charter)

Delaware

42-1397595

(State or other jurisdiction of incorporation or organization)

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

3551 7th Street, Moline, Illinois 61265

(Address of principal executive offices, including zip code)

(309) 736-3580

(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock, $1.00 Par Value

QCRH

The Nasdaq Global Market

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

Yes       No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes       No

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

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

Emerging growth company

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

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

Yes       No

Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date: As of August 1, 2020, the Registrant had outstanding 15,791,536 shares of common stock, $1.00 par value per share.

1

Table of Contents

QCR HOLDINGS, INC. AND SUBSIDIARIES

TABLE OF CONTENTS

Page
Number(s)

Part I

    

FINANCIAL INFORMATION

Item 1

    

Consolidated Financial Statements (Unaudited)

Consolidated Balance Sheets
As of June 30, 2020 and December 31, 2019

4

Consolidated Statements of Income
For the Three Months Ended June 30, 2020 and 2019

5

Consolidated Statements of Income

For the Six Months Ended June 30, 2020 and 2019

6

Consolidated Statements of Comprehensive Income
For the Three and Six Months Ended June 30, 2020 and 2019

7

Consolidated Statements of Changes in Stockholders' Equity
For the Three and Six Months Ended June 30, 2020 and 2019

8

Consolidated Statements of Cash Flows
For the Six Months Ended June 30, 2020 and 2019

9

Notes to Consolidated Financial Statements

11

Note 1. Summary of Significant Accounting Policies

11

Note 2. Investment Securities

13

Note 3. Loans/Leases Receivable

17

Note 4. Derivatives and Hedging Activities

28

Note 5. Earnings Per Share

29

Note 6. Fair Value

30

Note 7. Business Segment Information

32

Note 8. Regulatory Capital Requirements

33

Note 9. Pending Sale

35

Item 2

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

Introduction

36

General

36

Impact of COVID-19

36

Executive Overview

40

Strategic Financial Metrics

42

Strategic Developments

43

GAAP to Non-GAAP Reconciliations

43

Net Interest Income - (Tax Equivalent Basis)

47

Critical Accounting Policies

51

Goodwill

51

Allowance for Loan and Lease Losses

52

2

Table of Contents

Results of Operations

52

Interest Income

52

Interest Expense

52

Provision for Loan/Lease Losses

53

Noninterest Income

54

Noninterest Expense

57

Income Taxes

59

Financial Condition

60

Investment Securities

60

Loans/Leases

61

Allowance for Estimated Losses on Loans/Leases

63

Nonperforming Assets

64

Deposits

65

Borrowings

66

Stockholders' Equity

67

Liquidity and Capital Resources

68

Special Note Concerning Forward-Looking Statements

69

Item 3

    

Quantitative and Qualitative Disclosures About Market Risk

71

Item 4

Controls and Procedures

73

Part II

    

OTHER INFORMATION

74

Item 1

Legal Proceedings

74

Item 1A

Risk Factors

74

Item 2

Unregistered Sales of Equity Securities and Use of Proceeds

78

Item 3

Defaults Upon Senior Securities

78

Item 4

Mine Safety Disclosures

78

Item 5

Other Information

78

Item 6

Exhibits

79

Signatures

80

Throughout this Quarterly Report on Form 10-Q, we use certain acronyms and abbreviations, as defined in Note 1 to the Consolidated Financial Statements.

3

Table of Contents

Part I

Item 1

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

As of June 30, 2020 and December 31, 2019

    

June 30, 

    

December 31, 

2020

2019

(dollars in thousands)

Assets

Cash and due from banks

$

88,577

$

76,254

Federal funds sold

 

2,125

 

9,800

Interest-bearing deposits at financial institutions

 

140,775

 

147,891

Securities held to maturity, at amortized cost

 

425,976

 

400,646

Securities available for sale, at fair value

 

322,907

 

210,695

Total securities

748,883

 

611,341

Loans receivable held for sale

 

8,327

 

3,673

Loans/leases receivable held for investment

 

4,131,932

 

3,686,532

Gross loans/leases receivable

 

4,140,259

 

3,690,205

Less allowance for estimated losses on loans/leases

 

(60,827)

 

(36,001)

Net loans/leases receivable

 

4,079,432

 

3,654,204

 

  

 

  

Bank-owned life insurance

 

59,645

 

58,834

Premises and equipment, net

 

72,915

 

73,859

Restricted investment securities

 

23,209

 

23,252

Other real estate owned, net

 

157

 

4,129

Goodwill

 

74,248

 

74,748

Intangibles

 

13,872

 

14,970

Derivatives

225,164

87,827

Assets held for sale

10,765

11,966

Other assets

 

64,994

 

59,975

Total assets

$

5,604,761

$

4,909,050

 

  

 

  

Liabilities and Stockholders' Equity

 

  

 

  

Liabilities:

 

  

 

  

Deposits:

 

  

 

  

Noninterest-bearing

$

1,177,482

$

777,224

Interest-bearing

 

3,172,293

 

3,133,827

Total deposits

 

4,349,775

 

3,911,051

 

  

 

  

Short-term borrowings

 

124,818

 

13,423

Federal Home Loan Bank advances

 

145,000

 

159,300

Subordinated notes

68,516

68,394

Junior subordinated debentures

 

37,916

 

37,838

Derivatives

233,589

88,437

Liabilities held for sale

1,588

5,003

Other liabilities

 

87,539

 

90,253

Total liabilities

 

5,048,741

 

4,373,699

 

  

 

  

 

  

 

  

Stockholders' Equity:

 

  

 

  

Preferred stock, $1 par value; shares authorized 250,000 June 2020 and December 2019 - no shares issued or outstanding

 

 

Common stock, $1 par value; shares authorized 20,000,000 June 2020 - 15,790,611 shares issued and outstanding December 2019 - 15,828,098 shares issued and outstanding

 

15,791

 

15,828

Additional paid-in capital

 

274,315

 

274,785

Retained earnings

 

267,081

 

245,836

Accumulated other comprehensive income (loss):

 

 

Securities available for sale

 

8,738

 

2,817

Derivatives

(9,905)

(3,915)

Total stockholders' equity

 

556,020

 

535,351

Total liabilities and stockholders' equity

$

5,604,761

$

4,909,050

See Notes to Consolidated Financial Statements (Unaudited)

4

Table of Contents

Part I

Item 1

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

Three Months Ended June 30, 2020 and 2019

    

2020

    

2019

(dollars in thousands, except share data)

Interest and dividend income:

Loans/leases, including fees

$

42,614

$

47,515

Securities:

Taxable

 

2,048

 

1,678

Nontaxable

 

3,565

 

3,474

Interest-bearing deposits at financial institutions

 

134

 

1,168

Restricted investment securities

 

288

 

290

Federal funds sold

 

1

 

56

Total interest and dividend income

 

48,650

 

54,181

Interest expense:

Deposits

 

5,766

 

13,825

Short-term borrowings

 

22

 

81

Federal Home Loan Bank advances

 

347

 

601

Other borrowings

 

 

92

Subordinated notes

994

993

Junior subordinated debentures

 

573

 

576

Total interest expense

 

7,702

 

16,168

Net interest income

 

40,948

 

38,013

Provision for loan/lease losses

 

19,915

 

1,941

Net interest income after provision for loan/lease losses

 

21,033

 

36,072

Noninterest income:

Trust department fees

 

2,227

 

2,361

Investment advisory and management fees

 

1,399

 

1,888

Deposit service fees

 

1,286

 

1,658

Gains on sales of residential real estate loans, net

 

1,196

 

489

Gains on sales of government guaranteed portions of loans, net

 

 

39

Swap fee income

 

19,927

 

7,891

Securities gains (losses), net

 

65

 

(52)

Earnings on bank-owned life insurance

 

612

 

412

Debit card fees

 

775

 

914

Correspondent banking fees

 

198

 

172

Other

 

941

 

1,293

Total noninterest income

 

28,626

 

17,065

Noninterest expense:

Salaries and employee benefits

 

21,304

 

22,749

Occupancy and equipment expense

 

3,748

 

3,533

Professional and data processing fees

 

3,646

 

3,031

Post-acquisition compensation, transition and integration costs

 

70

 

708

Disposition costs

(83)

FDIC insurance, other insurance and regulatory fees

 

908

 

926

Loan/lease expense

 

339

 

312

Net cost of (income from) and gains/losses on operations of other real estate

 

(332)

 

1,182

Advertising and marketing

 

552

 

1,037

Bank service charges

 

501

 

508

Losses on liability extinguishment

 

429

 

Correspondent banking expense

 

212

 

206

Intangibles amortization

 

548

 

615

Other

 

1,280

 

1,753

Total noninterest expense

 

33,122

 

36,560

Net income before income taxes

 

16,537

 

16,577

Federal and state income tax expense

 

2,798

 

3,073

Net income

$

13,739

$

13,504

Basic earnings per common share

$

0.87

$

0.86

Diluted earnings per common share

$

0.86

$

0.85

Weighted average common shares outstanding

 

15,747,056

 

15,714,588

Weighted average common and common equivalent shares outstanding

 

15,895,336

 

15,938,377

Cash dividends declared per common share

$

0.06

$

0.06

See Notes to Consolidated Financial Statements (Unaudited)

5

Table of Contents

Part I

Item 1

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

Six Months Ended June 30, 2020 and 2019

    

2020

    

2019

    

(dollars in thousands, except share data)

Interest and dividend income:

Loans/leases, including fees

$

85,774

$

93,082

Securities:

Taxable

 

3,775

 

3,344

Nontaxable

 

7,024

 

7,018

Interest-bearing deposits at financial institutions

 

495

 

2,091

Restricted investment securities

 

546

 

598

Federal funds sold

 

18

 

150

Total interest and dividend income

 

97,632

 

106,283

Interest expense:

Deposits

 

14,972

 

26,304

Short-term borrowings

 

86

 

152

Federal Home Loan Bank advances

 

796

 

1,662

Other borrowings

 

 

539

Subordinated notes

1,988

1,557

Junior subordinated debentures

 

1,144

 

1,148

Total interest expense

 

18,986

 

31,362

Net interest income

 

78,646

 

74,921

Provision for loan/lease losses

 

28,282

 

4,075

Net interest income after provision for loan/lease losses

 

50,364

 

70,846

Noninterest income:

Trust department fees

 

4,539

 

4,854

Investment advisory and management fees

 

3,126

 

3,624

Deposit service fees

 

2,763

 

3,212

Gains on sales of residential real estate loans, net

 

1,848

 

858

Gains on sales of government guaranteed portions of loans, net

 

 

70

Swap fee income

 

26,731

 

11,089

Securities gains (losses), net

 

65

 

(52)

Earnings on bank-owned life insurance

 

941

 

952

Debit card fees

 

1,533

 

1,706

Correspondent banking fees

 

413

 

388

Other

 

1,863

 

2,357

Total noninterest income

 

43,822

 

29,058

Noninterest expenses:

Salaries and employee benefits

 

39,823

 

43,628

Occupancy and equipment expense

 

7,780

 

7,227

Professional and data processing fees

 

7,015

 

5,781

Post-acquisition compensation, transition and integration costs

 

221

 

842

Disposition costs

 

434

 

FDIC insurance, other insurance and regulatory fees

 

1,591

 

1,890

Loan/lease expense

 

567

 

526

Net cost of (income from) and gains/losses on operations of other real estate

 

(319)

 

1,480

Advertising and marketing

 

1,234

 

1,822

Bank service charges

 

1,005

 

991

Losses on liability extinguishment

 

576

 

Correspondent banking expense

428

410

Intangibles amortization

1,097

1,147

Goodwill impairment

500

Other

 

2,585

 

3,251

Total noninterest expenses

 

64,537

 

68,995

Net income before income taxes

 

29,649

 

30,909

Federal and state income tax expense

 

4,682

 

4,487

Net income

$

24,967

$

26,422

Basic earnings per common share

$

1.58

$

1.68

Diluted earnings per common share

$

1.56

$

1.66

Weighted average common shares outstanding

 

15,771,926

 

15,703,967

Weighted average common and common equivalent shares outstanding

 

15,956,958

 

15,930,659

Cash dividends declared per common share

$

0.12

$

0.12

See Notes to Consolidated Financial Statements (Unaudited

6

Table of Contents

Part I

Item 1

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

Three and Six Months Ended June 30, 2020 and 2019

Three Months Ended June 30,

    

    

2020

    

2019

(dollars in thousands)

Net income

$

13,739

$

13,504

Other comprehensive income (loss):

Unrealized gains on securities available for sale:

Unrealized holding gains arising during the period before tax

5,336

 

4,669

Less reclassification adjustment for gains (losses) included in net income before tax

65

(52)

 

5,271

 

4,721

Unrealized losses on derivatives:

Unrealized holding losses arising during the period before tax

 

(654)

 

(1,780)

Less reclassification adjustment for caplet amortization before tax

(124)

 

(134)

 

(530)

 

(1,646)

Other comprehensive income, before tax

 

4,741

 

3,075

Tax expense

 

1,119

 

833

Other comprehensive income, net of tax

 

3,622

 

2,242

Comprehensive income

$

17,361

$

15,746

Six Months Ended June 30, 

    

2020

    

2019

(dollars in thousands)

Net income

$

24,967

$

26,422

Other comprehensive income (loss):

Unrealized gains on securities available for sale:

Unrealized holding gains arising during the period before tax

 

7,817

 

8,813

Less reclassification adjustment for gains (losses) included in net income before tax

65

(52)

 

7,752

 

8,865

Unrealized losses on derivatives:

Unrealized holding losses arising during the period before tax

 

(7,815)

 

(2,942)

Less reclassification adjustment for ineffectiveness and caplet amortization before tax

 

(234)

 

(291)

 

(7,581)

 

(2,651)

Other comprehensive income (loss), before tax

 

171

 

6,214

Tax expense

 

240

 

1,628

Other comprehensive income (loss), net of tax

 

(69)

 

4,586

Comprehensive income

$

24,898

$

31,008

See Notes to Consolidated Financial Statements (Unaudited)

7

Table of Contents

Part I

Item 1

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED)

Three and Six Months Ended June 30, 2020 and 2019

Accumulated

Additional

Other

Common

Paid-In

Retained

Comprehensive

    

Stock

    

Capital

    

Earnings

    

(Loss)

    

Total

(dollars in thousands)

Balance December 31, 2019

$

15,828

$

274,785

$

245,836

$

(1,098)

$

535,351

Net income

 

 

 

11,228

 

 

11,228

Other comprehensive loss, net of tax

 

 

 

 

(3,691)

 

(3,691)

Common cash dividends declared, $0.06 per share

 

 

 

(942)

 

 

(942)

Repurchase and cancellation of 100,932 shares of common stock

as a result of a share repurchase program

(101)

(1,844)

(1,835)

(3,780)

Issuance of 5,553 shares of common stock as a result of

stock purchased under the Employee Stock Purchase Plan

 

6

 

208

 

 

 

214

Issuance of 31,729 shares of common stock as a result of

 

 

 

 

 

stock options exercised

32

274

306

Stock-based compensation expense

 

 

641

 

 

 

641

Restricted stock awards and restricted stock units- 10,300 shares

 

 

of common stock , net of restricted stock units

withheld for payment for taxes

10

(8)

2

Exchange of 1,012 shares of common stock in connection

with payroll taxes for restricted stock and in connection

with stock options exercised

 

(1)

 

(189)

 

 

 

(190)

Balance, March 31, 2020

$

15,774

$

273,867

$

254,287

$

(4,789)

$

539,139

Net income

 

 

 

13,739

 

 

13,739

Other comprehensive income, net of tax

 

 

 

 

3,622

 

3,622

Common cash dividends declared, $0.06 per share

 

 

 

(945)

 

 

(945)

Issuance of 16,413 shares of common stock as a result of

stock purchased under the Employee Stock Purchase Plan

 

16

 

462

 

 

 

478

Issuance of 975 shares of common stock as a result of

stock options exercised

 

1

 

9

 

 

 

10

Stock-based compensation expense

 

 

423

 

 

 

423

Exchange of 513 shares of common stock in connection

with payroll taxes for restricted stock vested and in

connection with stock options exercised

 

 

(446)

 

 

 

(446)

Balance, June 30, 2020

$

15,791

$

274,315

$

267,081

$

(1,167)

$

556,020

Accumulated

Additional

Other

Common

Paid-In

Retained

Comprehensive

    

Stock

    

Capital

    

Earnings

    

(Loss)

    

Total

(dollars in thousands)

Balance December 31, 2018

$

15,718

$

270,761

$

192,203

$

(5,544)

$

473,138

Net income

 

 

 

12,918

 

 

12,918

Other comprehensive income, net of tax

 

 

 

 

2,344

 

2,344

Common cash dividends declared, $0.06 per share

 

 

 

(942)

 

 

(942)

Issuance of 4,446 shares of common stock as a result of

stock purchased under the Employee Stock Purchase Plan

 

4

 

124

 

 

 

128

Issuance of 25,238 shares of common stock as a result of

stock options exercised

 

25

 

263

 

 

 

288

Stock-based compensation expense

 

 

722

 

 

 

722

Restricted stock awards and restricted stock units - 12,719

shares of common stock, net of restricted stock units

withheld for payment of taxes

 

13

 

(50)

 

 

(37)

Exchange of 5,169 shares of common stock in connection

with payroll taxes for restricted stock vested and in

connection with stock options exercised

 

(5)

 

(147)

 

 

 

(152)

Balance, March 31, 2019

$

15,755

$

271,673

$

204,179

$

(3,200)

$

488,407

Net income

 

 

 

13,504

 

 

13,504

Other comprehensive income, net of tax

 

 

 

 

2,242

 

2,242

Common cash dividends declared, $0.06 per share

 

 

 

(942)

 

 

(942)

Issuance of 11,346 shares of common stock as a result of

stock purchased under the Employee Stock Purchase Plan

 

11

 

323

 

 

 

334

Issuance of 2,414 shares of common stock as a result of

stock options exercised

 

3

 

41

 

 

 

44

Stock-based compensation expense

 

 

719

 

 

 

719

Restricted stock awards and restricted stock units- 4,769

 

 

 

 

 

shares of common stock, net of restricted stock units

withheld for payment of taxes

5

(5)

Exchange of 1,032 shares of common stock in connection

with payroll taxes for restricted stock vested and in

connection with stock options exercised

 

(1)

 

(7)

 

 

 

(8)

Balance, June 30, 2019

$

15,773

$

272,744

$

216,741

$

(958)

$

504,300

See Notes to Consolidated Financial Statements (Unaudited)

8

Table of Contents

Part I

Item 1

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

Six Months Ended June 30, 2020 and 2019

    

2020

    

2019

(dollars in thousands)

CASH FLOWS FROM OPERATING ACTIVITIES

 

  

 

  

Net income

$

24,967

$

26,422

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

 

  

 

  

Depreciation

 

2,690

 

2,518

Provision for loan/lease losses

 

28,282

 

4,075

Stock-based compensation expense

 

1,064

 

1,441

Deferred compensation expense accrued

 

1,705

 

1,323

Losses (gains) on other real estate owned, net

 

(369)

 

1,214

Amortization of premiums on securities, net

 

557

 

854

Caplet amortization

234

Securities (gains) losses, net

 

(65)

 

52

Loans originated for sale

 

(98,837)

 

(45,926)

Proceeds on sales of loans

 

96,031

 

43,969

Gains on sales of residential real estate loans

 

(1,848)

 

(858)

Gains on sales of government guaranteed portions of loans

 

 

(70)

Loss on liability extinguishment, net

576

Gains on sales of premises and equipment

(8)

(67)

Amortization of intangibles

 

1,097

 

1,147

Accretion of acquisition fair value adjustments, net

 

(1,361)

 

(2,145)

Increase in cash value of bank-owned life insurance

 

(941)

 

(952)

Goodwill impairment

500

Decrease (increase) in other assets

 

(2,255)

 

942

Decrease in other liabilities

(12,729)

(4,615)

Net cash provided by operating activities

$

39,290

$

29,324

CASH FLOWS FROM INVESTING ACTIVITIES

 

  

 

  

Net decrease in federal funds sold

 

7,675

 

16,183

Net decrease (increase) in interest-bearing deposits at financial institutions

 

7,116

 

(62,084)

Proceeds from sales of other real estate owned

 

4,341

 

539

Activity in securities portfolio:

 

 

Purchases

 

(166,743)

 

(10,709)

Calls, maturities and redemptions

 

11,946

 

5,958

Paydowns

 

22,541

 

27,088

Sales

 

4,592

 

4,661

Activity in restricted investment securities:

 

  

 

  

Purchases

 

(4,274)

 

(3,868)

Redemptions

 

4,317

 

7,362

Net increase in loans/leases originated and held for investment

 

(447,385)

 

(176,394)

Purchase of premises and equipment

 

(1,828)

 

(6,032)

Proceeds from sales of premises and equipment

88

146

Net cash (used in) investing activities

$

(557,614)

$

(197,150)

CASH FLOWS FROM FINANCING ACTIVITIES

 

  

 

  

Net increase in deposit accounts

 

408,849

 

345,614

Net increase (decrease) in short-term borrowings

 

111,395

 

(9,583)

Activity in Federal Home Loan Bank advances:

 

  

 

  

Term advances

 

85,000

 

5,000

Calls and maturities

 

(40,000)

 

(35,000)

Net change in short-term and overnight advances

 

(59,300)

 

(130,865)

Activity in other borrowings:

 

  

 

  

Calls, maturities and scheduled principal payments

 

 

(11,937)

Prepayments

 

 

(46,313)

Paydown of revolving line of credit

 

 

(9,000)

Prepayments on brokered and public time deposits

29,359

Proceeds from subordinated notes

63,393

Payment of cash dividends on common stock

 

(1,884)

 

(1,881)

Proceeds from issuance of common stock, net

1,008

794

Repurchase and cancellation of shares

(3,780)

Net cash provided by financing activities

$

530,647

$

170,222

Net increase in cash and due from banks

 

12,323

 

2,396

Cash and due from banks, beginning

 

76,254

 

85,523

Cash and due from banks, ending

$

88,577

$

87,919

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Item 1

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) - continued

Six Months Ended June 30, 2020 and 2019

Supplemental disclosure of cash flow information, cash payments (receipts) for:

 

  

 

  

Interest

$

19,377

$

29,346

Income/franchise taxes

 

(1,099)

 

(1,032)

 

  

 

Supplemental schedule of noncash investing activities:

 

  

 

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

 

(69)

 

4,586

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

 

(636)

 

(160)

Transfers of loans to other real estate owned

 

 

1,012

Due to broker for purchases of securities

4,338

Due from broker for sales of securities

1,735

Increase (decrease) in the fair value of back-to-back interest rate swap assets and liabilities

 

140,048

 

43,628

Dividends payable

 

945

 

942

See Notes to Consolidated Financial Statements (Unaudited)

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Part I

Item 1

QCR HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

June 30, 2020

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of presentation:  The interim unaudited Consolidated Financial Statements contained herein should be read in conjunction with the audited Consolidated Financial Statements and accompanying notes to the consolidated financial statements for the fiscal year ended December 31, 2019, included in the Company's Annual Report on Form 10-K filed with the SEC on March 13, 2020. Accordingly, footnote disclosures, which would substantially duplicate the disclosures contained in the audited Consolidated Financial Statements, have been omitted.

The financial information of the Company included herein has been prepared in accordance with GAAP for interim financial reporting and has been prepared pursuant to the rules and regulations for reporting on Form 10-Q and Rule 10-01 of Regulation S-X. Such information reflects all adjustments (consisting of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the periods presented. Any differences appearing between the numbers presented in financial statements and management's discussion and analysis are due to rounding. The results of the interim period ended June 30, 2020 are not necessarily indicative of the results expected for the year ending December 31, 2020, or for any other period.

The acronyms and abbreviations identified below are used throughout this Quarterly Report on Form 10-Q. It may be helpful to refer back to this page as you read this report.

Allowance: Allowance for estimated losses on loans/leases

Guaranty: Guaranty Bancshares, Ltd.

AOCI: Accumulated other comprehensive income (loss)

Guaranty Bank: Guaranty Bank and Trust Company

AFS: Available for sale

HTM: Held to maturity

ASC: Accounting Standards Codification

LRP: Loan Relief Program

ASU: Accounting Standards Update

m2: m2 Lease Funds, LLC

Bates Companies: Bates Financial Advisors, Inc., Bates

MSELF: Main Street Expanded Loan Facility

Financial Services, Inc., Bates Securities, Inc. and

MSNLF: Main Street New Loan Facility

Bates Financial Group, Inc.

NIM: Net interest margin

BOLI: Bank-owned life insurance

NPA: Nonperforming asset

Caps: Interest rate cap derivatives

NPL: Nonperforming loan

CARES Act: Coronavirus Aid, Relief and Economy

OREO: Other real estate owned

Security Act

OTTI: Other-than-temporary impairment

CDI: Core deposit intangible

PCI: Purchased credit impaired

CECL: Current Expected Credit Losses

PPP: Paycheck Protection Program

Community National: Community National Bancorporation

Provision: Provision for loan/lease losses

COVID-19: Coronavirus Disease 2019

QCBT: Quad City Bank & Trust Company

CRBT: Cedar Rapids Bank & Trust Company

RB&T: Rockford Bank & Trust Company

CRE: Commercial real estate

ROAA: Return on Average Assets

CSB: Community State Bank

SBA: U.S. Small Business Administration

C&I: Commercial and industrial

SEC: Securities and Exchange Commission

EPS: Earnings per share

SFC Bank: Springfield First Community Bank

Exchange Act: Securities Exchange Act of 1934, as

Springfield Bancshares: Springfield Bancshares, Inc.

amended

TA: Tangible assets

FASB: Financial Accounting Standards Board

TCE: Tangible common equity

FDIC: Federal Deposit Insurance Corporation

TDRs: Troubled debt restructurings

FHLB: Federal Home Loan Bank

TEY: Tax equivalent yield

FRB: Federal Reserve Bank of Chicago

The Company: QCR Holdings, Inc.

GAAP: Generally Accepted Accounting Principles

USDA: U.S. Department of Agriculture

11

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Item 1

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – continued

The Consolidated Financial Statements include the accounts of the Company and its wholly-owned subsidiaries which include the accounts of four commercial banks:  QCBT, CRBT, CSB and SFC Bank. All are state-chartered commercial banks and all are members of the Federal Reserve system. The Company engages in direct financing lease contracts through m2, a wholly-owned subsidiary of QCBT. The Company also engages in wealth management services through its banking subsidiaries and its subsidiaries, the Bates Companies. All material intercompany transactions and balances have been eliminated in consolidation.

On November 30, 2019, the Company sold substantially all of the assets and transferred substantially all of the deposits and certain other liabilities of the Company’s wholly-owned subsidiary, RB&T. The financial results of RB&T prior to its sale are included in this report.  See Note 2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 for additional information about the sale.

Recent accounting developments: In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses.  Under the standard, assets measured at amortized cost (including loans, leases and AFS securities) will be presented at the net amount expected to be collected.  Rather than the “incurred” model that is currently being utilized, the standard will require the use of a forward-looking approach to recognizing all expected credit losses at the beginning of an asset’s life.  For public companies, ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, including items periods within those fiscal years. On March 27, 2020, the CARES Act, a stimulus package designed in response to the economic disruption created by COVID-19, was signed into law.  The CARES Act includes provisions that, if elected,  temporarily delay the required implementation date of ASU 2016-13.  Section 4014 of the CARES Act stipulates that no insured depository institution, bank holding company, or affiliate will be required to comply with ASU 2016-13, beginning on the date of the enactment, March 27, 2020 until the earlier of the two following dates: (1) the date on which the national emergency related to the COVID-19 outbreak is terminated or (2) December 31, 2020.  The Company has elected to defer its implementation of ASU 2016-13 as allowed by the CARES Act. The Company has developed a CECL allowance model which calculates allowances over the life of the loan and is largely driven by portfolio characteristics, risk-grading, economic outlook, and other key methodology assumptions.  Those assumptions are based upon the existing probability of default and loss given default framework.  The Company will utilize economic and other forecasts over a four quarter reasonable and supportable forecast period and then fully revert back to average historical losses.  The Company’s credit administration team will periodically refine the model as needed and is running parallel calculations. The Company anticipates increases in the allowance for credit losses on longer dated portfolios and decreases in the shorter dated portfolios.  The Company estimates an increase in the allowance for estimated losses on loans/leases in the range of $4 million to $6 million upon adoption of CECL at both January 1, 2020 and June 30, 2020. The Company continues to work on the process of finalizing the review of the most recent model run and on finalizing the assumptions, including qualitative adjustments and economic forecasts, which has resulted in adjustments to previous estimates.

Risks and Uncertainties: On January 30, 2020, the World Health Organization declared the COVID-19 outbreak a “Public Health Emergency of International Concern” and on March 11, 2020, declared it to be a pandemic.  Actions taken around the world to help mitigate the spread of COVID-19 include restrictions on travel, and quarantines in certain areas, and forced closures for certain types of public places and businesses. COVID-19 and actions taken to mitigate the spread of it have had and are expected to continue to have an adverse impact on the economies and financial markets of many countries, including the geographical area in which the Company operates. On March 27, 2020, the CARES Act was enacted to, among other things, provide emergency assistance for individuals, families and businesses affected by the COVID-19 pandemic.  The Company currently expects that the COVID-19 pandemic and the specific developments referred to above will have a significant impact on its business.  In particular, the Company anticipates that a significant portion of the subsidiary banks’ borrowers in the hotel, restaurant, entertainment and retail industries will continue to endure significant economic distress, and could adversely affect their ability and willingness to repay existing indebtedness, and could adversely impact the value of collateral pledged to the banks.  These developments, together with economic conditions generally, are also expected to impact the Company’s commercial real estate portfolio, particularly with respect to real estate with exposure to these industries, the Company’s equipment leasing business and loan portfolio, the Company’s consumer loan business and loan portfolio, and the value of certain collateral securing the Company’s loans.  As a result,

12

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Item 1

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – continued

the Company anticipates that its financial condition, capital levels, asset quality and results of operations will be adversely affected, as described in further detail on this report.

Due to the economic impact that COVID-19 has had on the Company, management concluded that factors such as the decline in macroeconomic conditions led to the occurrence of a triggering event during the first quarter of 2020, therefore an interim impairment test over goodwill was performed as of March 31, 2020.  When such an assessment is performed, should the Company conclude that all or a portion of goodwill is impaired, a non-cash charge for the amount of such impairment would be recorded to earnings.  Such a charge would have no impact on tangible capital or regulatory capital.  Based upon the results of the interim goodwill assessment during the first quarter of 2020, the Company concluded that an impairment did not exist on the bank reporting units as of the time of the assessment.  There was no occurrence of a triggering event during the second quarter of 2020 therefore no impairment test over goodwill was needed.  

NOTE 2– INVESTMENT SECURITIES

The amortized cost and fair value of investment securities as of June 30, 2020 and December 31, 2019 are summarized as follows:

Gross

Gross

Amortized

Unrealized

Unrealized

Fair

    

Cost

    

Gains

    

(Losses)

    

Value

(dollars in thousands)

June 30, 2020:

 

  

 

  

 

  

 

  

Securities HTM:

 

  

 

  

 

  

 

  

Municipal securities

$

424,926

$

21,323

$

(2,231)

$

444,018

Other securities

 

1,050

 

 

 

1,050

$

425,976

$

21,323

$

(2,231)

$

445,068

 

  

 

  

 

  

 

  

Securities AFS:

 

  

 

  

 

  

 

  

U.S. govt. sponsored agency securities

$

16,663

$

809

$

$

17,472

Residential mortgage-backed and related securities

 

138,044

 

7,659

 

(31)

 

145,672

Municipal securities

 

98,388

 

2,962

 

(84)

 

101,266

Asset-backed securities

39,712

414

(329)

39,797

Other securities

 

18,550

 

173

 

(23)

 

18,700

$

311,357

$

12,017

$

(467)

$

322,907

Gross

Gross

Amortized

Unrealized

Unrealized

Fair

    

Cost

    

Gains

    

(Losses)

Value

(dollars in thousands)

December 31, 2019:

 

  

 

  

 

  

 

  

Securities HTM:

 

  

 

  

 

  

 

  

Municipal securities

$

399,596

$

26,042

$

(143)

$

425,495

Other securities

 

1,050

 

 

 

1,050

$

400,646

$

26,042

$

(143)

$

426,545

 

  

 

  

 

  

 

  

Securities AFS:

 

  

 

  

 

  

 

  

U.S. govt. sponsored agency securities

$

19,872

$

283

$

(77)

$

20,078

Residential mortgage-backed and related securities

 

118,724

 

2,045

 

(182)

 

120,587

Municipal securities

 

46,659

 

1,602

 

(4)

 

48,257

Asset-backed securities

16,958

(71)

16,887

Other securities

 

4,749

 

138

 

(1)

 

4,886

$

206,962

$

4,068

$

(335)

$

210,695

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.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – continued

The Company's residential mortgage-backed and related securities portfolio consists entirely of government sponsored or government guaranteed securities. The Company has not invested in private mortgage-backed securities or pooled trust preferred securities.

Gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of June 30, 2020 and December 31, 2019, 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

(dollars in thousands)

June 30, 2020:

 

  

 

  

 

  

 

  

 

  

 

  

Securities HTM:

 

  

 

  

 

  

 

  

 

  

 

  

Municipal securities

$

47,822

$

(2,231)

$

$

$

47,822

$

(2,231)

Other securities

 

1,050

 

 

 

 

1,050

 

$

48,872

$

(2,231)

$

$

$

48,872

$

(2,231)

 

  

 

  

 

  

 

  

 

  

 

  

Securities AFS:

 

  

 

  

 

  

 

  

 

  

 

  

U.S. govt. sponsored agency securities

$

$

$

$

$

$

Residential mortgage-backed and related securities

 

19,127

 

(31)

 

 

 

19,127

 

(31)

Municipal securities

 

12,105

 

(84)

 

 

 

12,105

 

(84)

Asset-backed securities

16,611

(329)

16,611

(329)

Other securities

 

1,977

 

(23)

 

 

 

1,977

 

(23)

$

49,820

$

(467)

$

$

$

49,820

$

(467)

Less than 12 Months

12 Months or More

Total

Gross

Gross

Gross

Fair

Unrealized

Fair

Unrealized

Fair

Unrealized

    

Value

    

Losses

    

Value

    

Losses

    

Value

    

Losses

(dollars in thousands)

December 31, 2019:

 

  

 

  

 

  

 

  

 

  

 

  

Securities HTM:

 

  

 

  

 

  

 

  

 

  

 

  

Municipal securities

$

509

$

(1)

$

10,047

$

(142)

$

10,556

$

(143)

Other securities

 

550

 

 

 

 

550

 

$

1,059

$

(1)

$

10,047

$

(142)

$

11,106

$

(143)

Securities AFS:

 

  

 

  

 

  

 

  

 

  

 

  

U.S. govt. sponsored agency securities

$

1,431

$

(21)

$

2,117

$

(56)

$

3,548

$

(77)

Residential mortgage-backed and related securities

 

2,263

 

(17)

 

17,862

 

(165)

 

20,125

 

(182)

Municipal securities

 

 

 

724

 

(4)

 

724

 

(4)

Asset-backed securities

16,886

(71)

16,886

(71)

Other securities

 

249

 

(1)

 

 

 

249

 

(1)

$

20,829

$

(110)

$

20,703

$

(225)

$

41,532

$

(335)

At June 30, 2020, the investment portfolio included 609 securities. Of this number, 54 securities were in an unrealized loss position. The aggregate losses of these securities totaled approximately 0.4% of the total amortized cost of the portfolio. Of these 54 securities, no securities had an unrealized loss for twelve months or more. Asset-backed securities are comprised of collateralized loan obligations, which are debt securities backed by pools of senior secured commercial loans to a diverse group of companies across a broad spectrum of industries. At June 30, 2020, the Company only owned collateralized loan obligations that were AAA rated. All of the debt securities in unrealized loss positions are considered acceptable credit risks. Based upon an evaluation of the available evidence, including the recent changes in market rates, credit rating information and information obtained from regulatory filings, management believes the declines in fair value for these debt securities are temporary. In addition, the Company lacks the intent to sell these securities and it is not more-likely-than-not that the Company will be required to sell these debt securities before their anticipated recovery.

The Company did not recognize OTTI on any investment securities for the three or six months ended June 30, 2020 and 2019.

14

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Item 1

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – continued

All sales of securities for the three and six months ended June 30, 2020  and June 30, 2019 were securities identified as AFS.

Three and Six Months Ended

    

    

June 30, 2020

June 30, 2019

(dollars in thousands)

Proceeds from sales of securities

$

6,327

$

4,661

Gross gains from sales of securities

 

134

 

Gross losses from sales of securities

 

(69)

 

(52)

The amortized cost and fair value of securities as of June 30, 2020 by contractual maturity are shown below. Expected maturities of residential mortgage-backed and related securities and asset-backed securities may differ from contractual maturities because the residential mortgages underlying the securities may be prepaid without any penalties. Therefore, these securities are not included in the maturity categories in the following table.

    

Amortized Cost

    

Fair Value

(dollars in thousands)

Securities HTM:

 

  

 

  

Due in one year or less

$

3,448

$

3,469

Due after one year through five years

 

35,903

 

36,526

Due after five years

 

386,625

 

405,073

$

425,976

$

445,068

Securities AFS:

 

  

 

  

Due in one year or less

$

1,921

$

1,903

Due after one year through five years

 

14,976

 

15,411

Due after five years

 

116,704

 

120,124

133,601

137,438

Residential mortgage-backed and related securities

138,044

145,672

Asset-backed securities

 

39,712

 

39,797

$

311,357

$

322,907

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

    

Amortized Cost

    

Fair Value

(dollars in thousands)

Securities HTM:

 

  

 

  

Municipal securities

$

202,436

$

205,736

 

  

 

  

Securities AFS:

 

  

 

  

Municipal securities

84,011

86,534

Other securities

 

4,500

 

4,650

$

88,511

$

91,184

As of June 30, 2020, the Company's municipal securities portfolios were comprised of general obligation bonds issued by 97 issuers with fair values totaling $83.3 million and revenue bonds issued by 170 issuers, primarily consisting of states, counties, towns, villages and school districts with fair values totaling $462.0 million. The Company held investments in general obligation bonds in 23 states, including seven states in which the aggregate fair value exceeded $5.0 million. The Company held investments in revenue bonds in 22 states, including 12 states in which the aggregate fair value exceeded $5.0 million.

15

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Item 1

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – continued

As of December 31, 2019, the Company's municipal securities portfolios were comprised of general obligation bonds issued by 93 issuers with fair values totaling $77.2 million and revenue bonds issued by 154 issuers, primarily consisting of states, counties, towns, villages and school districts with fair values totaling $396.6 million. The Company held investments in general obligation bonds in 22 states, including six states in which the aggregate fair value exceeded $5.0 million. The Company held investments in revenue bonds in 17 states, including nine states in which the aggregate fair value exceeded $5.0 million.

Both general obligation and revenue bonds are diversified across many issuers. As of June 30, 2020 the Company did not hold any revenue bonds of one single issuer of which the aggregate book or market value exceeded 5% of the Company’s stockholders’ equity. As of December 31, 2019, the Company held revenue bonds of one single issuer, located in Ohio, of which the aggregate book or market value exceeded 5% of the Company’s stockholders’ equity. The issuer’s financial condition is strong and the source of repayment is diversified. The Company monitors the investment and concentration closely. Of the general obligation and revenue bonds in the Company's portfolio, the majority are unrated bonds that represent small, private issuances. All unrated bonds were underwritten according to loan underwriting standards and have an average loan risk rating of 2, indicating very high quality. Additionally, many of these bonds are funding essential municipal services such as water, sewer, education, and medical facilities.

The Company's municipal securities are owned by 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 June 30, 2020, all were within policy limitations approved by the board of directors. Policy limits are calculated as a percentage of each charter's total risk-based capital.

As of June 30, 2020, the Company's standard monitoring of its municipal securities portfolio had not uncovered any facts or circumstances resulting in significantly different credit ratings than those assigned by a nationally recognized statistical rating organization, or in the case of unrated bonds, the rating assigned using the credit underwriting standards.

16

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Item 1

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – continued

NOTE 3 – LOANS/LEASES RECEIVABLE

The composition of the loan/lease portfolio as of June 30, 2020 and December 31, 2019 is presented as follows:

    

2020

2019

(dollars in thousands)

C&I loans*

$

1,850,110

$

1,507,825

CRE loans

 

  

 

  

Owner-occupied CRE

 

467,537

 

443,989

Commercial construction, land development, and other land

 

441,364

 

378,797

Other non owner-occupied CRE

 

960,261

 

913,610

 

1,869,162

 

1,736,396

Direct financing leases **

 

79,105

 

87,869

Residential real estate loans ***

 

241,069

 

239,904

Installment and other consumer loans

 

99,150

 

109,352

 

4,138,596

 

3,681,346

Plus deferred loan/lease origination costs, net of fees

 

1,663

 

8,859

 

4,140,259

 

3,690,205

Less allowance

 

(60,827)

 

(36,001)

$

4,079,432

$

3,654,204

** Direct financing leases:

 

  

 

  

Net minimum lease payments to be received

$

87,389

$

97,025

Estimated unguaranteed residual values of leased assets

 

616

 

547

Unearned lease/residual income

 

(8,900)

 

(9,703)

 

79,105

 

87,869

Plus deferred lease origination costs, net of fees

 

1,448

 

1,892

 

80,553

 

89,761

Less allowance

 

(1,639)

 

(1,464)

$

78,914

$

88,297

*     Includes equipment financing agreements outstanding at m2, totaling $153.7 million and $142.0 million as of June 30, 2020 and December 31, 2019, respectively.

**   Management performs an evaluation of the estimated unguaranteed residual values of leased assets on an annual basis, at a minimum. The evaluation consists of discussions with reputable and current vendors, which is combined with management's expertise and understanding of the current states of particular industries to determine informal valuations of the equipment. As necessary and where available, management will utilize valuations by independent appraisers. The 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.

*** Includes residential real estate loans held for sale totaling $8.3 million and $3.7 million as of June 30, 2020 and December 31, 2019, respectively.

17

Table of Contents

Part I

Item 1

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – continued

Changes in accretable yield for acquired loans were as follows:

Three months ended June 30, 2020

Six months ended June 30, 2020

    

PCI

    

Performing

    

PCI

    

Performing

    

Loans

Loans

Total

    

Loans

    

Loans

    

Total

(dollars in thousands)

Balance at the beginning of the period

$

(59)

$

(5,725)

$

(5,784)

$

(57)

$

(6,378)

$

(6,435)

Reclassification of nonaccretable discount to accretable

(30)

(30)

Accretion recognized

 

1

 

790

 

791

 

29

 

1,443

 

1,472

Balance at the end of the period

$

(58)

$

(4,935)

$

(4,993)

$

(58)

$

(4,935)

$

(4,993)

Three months ended June 30, 2019

Six months ended June 30, 2019

    

PCI

    

Performing

    

PCI

    

Performing

    

Loans

Loans

Total

    

Loans

    

Loans

    

Total

(dollars in thousands)

Balance at the beginning of the period

$

(319)

$

(9,301)

$

(9,620)

$

(667)

$

(10,127)

$

(10,794)

Reclassification of nonaccretable discount to accretable

(159)

(159)

(159)

(159)

Accretion recognized

 

327

 

812

 

1,139

 

675

 

1,638

 

2,313

Balance at the end of the period

$

(151)

$

(8,489)

$

(8,640)

$

(151)

$

(8,489)

$

(8,640)

The aging of the loan/lease portfolio by classes of loans/leases as of June 30, 2020 and December 31, 2019 is presented as follows:

As of June 30, 2020

 

Accruing Past

 

30-59 Days

60-89 Days

Due 90 Days or

Nonaccrual

 

Classes of Loans/Leases

    

Current

    

Past Due

    

Past Due

    

More

    

Loans/Leases

    

Total

 

(dollars in thousands)

C&I

$

1,846,417

$

1,650

$

311

$

62

$

1,670

$

1,850,110

CRE

 

  

 

  

 

  

 

  

 

  

 

  

Owner-Occupied CRE

 

467,032

 

 

185

 

 

320

 

467,537

Commercial Construction, Land Development, and Other Land

 

441,336

 

28

 

 

 

 

441,364

Other Non Owner-Occupied CRE

 

950,993

 

1,776

 

 

 

7,492

 

960,261

Direct Financing Leases

 

77,637

 

277

 

151

 

 

1,040

 

79,105

Residential Real Estate

 

239,729

 

 

404

 

 

936

 

241,069

Installment and Other Consumer

 

98,435

 

11

 

27

 

37

 

640

 

99,150

$

4,121,579

$

3,742

$

1,078

$

99

$

12,099

$

4,138,596

 

  

 

  

 

  

 

  

 

  

 

  

As a percentage of total loan/lease portfolio

 

99.59

%  

 

0.09

%  

 

0.03

%  

 

%  

 

0.29

%  

 

100.00

%

As of December 31, 2019

 

Accruing Past

 

30-59 Days

60-89 Days

Due 90 Days or

Nonaccrual

 

Classes of Loans/Leases

    

Current

    

Past Due

    

Past Due

    

More

    

Loans/Leases

    

Total

 

(dollars in thousands)

C&I

$

1,499,891

$

6,126

$

572

$

$

1,236

$

1,507,825

CRE

 

  

 

  

 

  

 

  

 

  

 

  

Owner-Occupied CRE

 

443,707

 

177

 

71

 

 

34

 

443,989

Commercial Construction, Land Development, and Other Land

 

375,940

 

2,857

 

 

 

 

378,797

Other Non Owner-Occupied CRE

 

909,684

 

73

 

 

 

3,853

 

913,610

Direct Financing Leases

 

85,636

 

463

 

253

 

 

1,517

 

87,869

Residential Real Estate

 

235,845

 

2,939

 

414

 

 

706

 

239,904

Installment and Other Consumer

 

108,750

 

3

 

10

 

33

 

556

 

109,352

$

3,659,453

$

12,638

$

1,320

$

33

$

7,902

$

3,681,346

As a percentage of total loan/lease portfolio

 

99.41

%  

 

0.34

%  

 

0.04

%  

 

0.00

%  

 

0.21

%  

 

100.00

%

18

Table of Contents

Part I

Item 1

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – continued

NPLs by classes of loans/leases as of June 30, 2020 and December 31, 2019 are presented as follows:

As of June 30, 2020

Accruing Past

 

Due 90 Days or

Nonaccrual

Percentage of

Classes of Loans/Leases

    

More

    

Loans/Leases **

    

Accruing TDRs

    

Total NPLs

    

Total NPLs

 

 

(dollars in thousands)

C&I

$

62

$

1,670

$

652

$

2,384

 

18.17

%

CRE

 

 

 

 

  

 

  

Owner-Occupied CRE

 

 

320

 

 

320

 

2.44

%

Commercial Construction, Land Development, and Other Land

 

 

 

 

 

-

%

Other Non Owner-Occupied CRE

 

 

7,492

 

 

7,492

 

57.12

%

Direct Financing Leases

 

 

1,040

 

268

 

1,308

 

9.97

%

Residential Real Estate

 

 

936

 

 

936

 

7.14

%

Installment and Other Consumer

 

37

 

640

 

 

677

 

5.16

%

$

99

$

12,099

$

920

$

13,118

 

100.00

%

**   Nonaccrual loans/leases included $352 thousand of TDRs, including $129 thousand in commercial and industrial loans, $138 thousand in direct financing leases, $31 thousand in residential real estate loans, and $54 thousand in installment loans.

As of December 31, 2019

 

Accruing Past

 

Due 90 Days or

Nonaccrual

Percentage of

 

Classes of Loans/Leases

    

More

    

Loans/Leases **

    

Accruing TDRs

    

Total NPLs

    

Total NPLs

 

 

(dollars in thousands)

C&I

$

$

1,236

$

646

$

1,882

 

21.12

%

CRE

 

  

 

  

 

  

 

  

 

  

Owner-Occupied CRE

 

 

34

 

 

34

 

0.38

%

Commercial Construction, Land Development, and Other Land

 

 

 

 

 

-

%

Other Non Owner-Occupied CRE

 

 

3,853

 

 

3,853

 

43.22

%

Direct Financing Leases

 

 

1,517

 

333

 

1,850

 

20.75

%

Residential Real Estate

 

 

706

 

 

706

 

7.92

%

Installment and Other Consumer

 

33

 

556

 

 

589

 

6.61

%

$

33

$

7,902

$

979

$

8,914

 

100.00

%

**   Nonaccrual loans/leases included $747 thousand of TDRs, including $98 thousand in C&I loans, $269 thousand in CRE loans, $294 thousand in direct financing leases, $31 thousand in residential real estate loans, and $55 thousand in installment loans.

19

Table of Contents

Part I

Item 1

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – continued

Changes in the allowance by portfolio segment for the three and six months ended June 30, 2020 and 2019, respectively, are presented as follows:

Three Months Ended June 30, 2020

Direct Financing

Residential Real

Installment and

    

C&I

    

CRE

    

Leases

    

Estate

    

Other Consumer

    

Total

 

(dollars in thousands)

Balance, beginning

$

18,151

$

19,269

$

1,303

$

2,313

$

1,197

$

42,233

Provisions charged to expense

 

7,859

 

10,365

 

887

 

697

 

107

 

19,915

Loans/leases charged off

 

(340)

 

(511)

 

(595)

 

 

(4)

 

(1,450)

Recoveries on loans/leases previously charged off

 

78

 

 

44

 

 

7

 

129

Balance, ending

$

25,748

$

29,123

$

1,639

$

3,010

$

1,307

$

60,827

Three Months Ended June 30, 2019

Direct Financing

Residential Real

Installment and

    

C&I

    

CRE

    

Leases

    

Estate

    

Other Consumer

    

Total

(dollars in thousands)

Balance, beginning

$

17,260

$

18,303

$

1,606

$

2,538

$

1,457

$

41,164

Provisions (credits) charged to expense

 

1,116

 

414

 

331

 

86

 

(6)

 

1,941

Loans/leases charged off

 

(193)

 

(1,369)

 

(497)

 

(73)

 

(20)

 

(2,152)

Recoveries on loans/leases previously charged off

 

65

 

15

 

19

 

31

 

21

 

151

Balance, ending

$

18,248

$

17,363

$

1,459

$

2,582

$

1,452

$

41,104

Six Months Ended June 30, 2020

    

    

    

Direct Financing

    

Residential Real

    

Installment and

    

C&I

CRE

Leases

Estate

Other Consumer

Total

 

(dollars in thousands)

Balance, beginning

$

16,072

$

15,379

$

1,464

$

1,948

$

1,138

$

36,001

Provisions charged to expense

 

11,556

 

14,181

 

1,281

 

1,033

 

231

 

28,282

Loans/leases charged off

 

(1,979)

 

(511)

 

(1,195)

 

 

(100)

 

(3,785)

Recoveries on loans/leases previously charged off

 

99

 

74

 

89

 

29

 

38

 

329

Balance, ending

$

25,748

$

29,123

$

1,639

$

3,010

$

1,307

$

60,827

Six Months Ended June 30, 2019

Direct Financing

Residential Real

Installment and

    

C&I

    

CRE

    

Leases

    

Estate

    

Other Consumer

    

Total

(dollars in thousands)

Balance, beginning

$

16,420

$

17,719

$

1,792

$

2,557

$

1,359

$

39,847

Provisions (credits) charged to expense

 

2,123

 

948

 

776

 

68

 

160

 

4,075

Loans/leases charged off

 

(527)

 

(1,369)

 

(1,149)

 

(73)

 

(94)

 

(3,212)

Recoveries on loans/leases previously charged off

 

232

 

65

 

40

 

30

 

27

 

394

Balance, ending

$

18,248

$

17,363

$

1,459

$

2,582

$

1,452

$

41,104

20

Table of Contents

Part I

Item 1

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – continued

The allowance by impairment evaluation and by portfolio segment as of June 30, 2020 and December 31, 2019 is presented as follows:

As of June 30, 2020

 

Direct Financing

Residential Real

Installment and

 

    

C&I

    

CRE

    

Leases

    

Estate

    

Other Consumer

    

Total

 

(dollars in thousands)

Allowance for impaired loans/leases

$

341

$

1,692

$

20

$

23

$

78

$

2,154

Allowance for nonimpaired loans/leases

 

25,407

 

27,431

 

1,619

 

2,987

 

1,229

 

58,673

$

25,748

$

29,123

$

1,639

$

3,010

$

1,307

$

60,827

 

  

 

  

 

  

 

  

 

  

 

  

Impaired loans/leases

$

2,547

$

7,815

$

1,419

$

884

$

640

$

13,305

Nonimpaired loans/leases

 

1,847,563

 

1,861,347

 

77,686

 

240,185

 

98,510

 

4,125,291

$

1,850,110

$

1,869,162

$

79,105

$

241,069

$

99,150

$

4,138,596

 

  

 

  

 

  

 

  

 

  

 

  

Allowance as a percentage of impaired loans/leases

 

13.39

%  

 

21.65

%  

 

1.41

%  

 

2.60

%  

 

12.19

%  

 

16.19

%

Allowance as a percentage of nonimpaired loans/leases

 

1.38

%  

 

1.47

%  

 

2.08

%  

 

1.24

%  

 

1.25

%  

 

1.42

%

Total allowance as a percentage of total loans/leases

 

1.39

%  

 

1.56

%  

 

2.07

%  

 

1.25

%  

 

1.32

%  

 

1.47

%

 

As of December 31, 2019

 

Direct Financing

Residential Real

Installment and

 

    

C&I

    

CRE

    

Leases

    

Estate

    

Other Consumer

    

Total

 

 

(dollars in thousands)

Allowance for impaired loans/leases

$

170

$

125

$

270

$

15

$

80

$

660

Allowance for nonimpaired loans/leases

 

15,902

 

15,254

 

1,194

 

1,933

 

1,058

 

35,341

$

16,072

$

15,379

$

1,464

$

1,948

$

1,138

$

36,001

 

  

 

  

 

  

 

  

 

  

 

  

Impaired loans/leases

$

1,846

$

3,585

$

2,025

$

649

$

556

$

8,661

Nonimpaired loans/leases

 

1,505,979

 

1,732,811

 

85,844

 

239,255

 

108,796

 

3,672,685

$

1,507,825

$

1,736,396

$

87,869

$

239,904

$

109,352

$

3,681,346

 

  

 

  

 

  

 

  

 

  

 

  

Allowance as a percentage of impaired loans/leases

 

9.21

%  

 

3.49

%  

 

13.33

%  

 

2.31

%  

 

14.41

%  

 

7.62

%

Allowance as a percentage of nonimpaired loans/leases

 

1.06

%  

 

0.88

%  

 

1.39

%  

 

0.81

%  

 

0.97

%  

 

0.96

%

Total allowance as a percentage of total loans/leases

 

1.07

%  

 

0.89

%  

 

1.67

%  

 

0.81

%  

 

1.04

%  

 

0.98

%

 

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

21

Table of Contents

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 six months ended June 30, 2020 are presented as follows:

Six Months Ended June 30, 2020

Interest Income

Average

Recognized for

Recorded

Unpaid Principal

Related

Recorded

Interest Income

Cash Payments

Classes of Loans/Leases

    

Investment

    

Balance

    

Allowance

    

Investment

    

Recognized

    

Received

(dollars in thousands)

 

  

 

  

 

  

 

  

 

  

 

  

Impaired Loans/Leases with No Specific Allowance Recorded:

 

  

 

  

 

  

 

  

 

  

 

  

C&I

$

1,978

$

2,051

$

$

1,512

$

25

$

25

CRE

 

  

 

 

  

 

  

 

  

 

  

Owner-Occupied CRE

 

320

 

577

 

 

128

 

 

Commercial Construction, Land Development, and Other Land

 

 

 

 

 

 

Other Non Owner-Occupied CRE

 

965

 

965

 

 

742

 

14

 

14

Direct Financing Leases

 

1,364

 

1,364

 

 

1,379

 

11

 

11

Residential Real Estate

 

624

 

652

 

 

474

 

 

Installment and Other Consumer

 

562

 

562

 

 

525

 

 

$

5,813

$

6,171

$

$

4,760

$

50

$

50

 

  

 

  

 

  

 

  

 

  

 

  

Impaired Loans/Leases with Specific Allowance Recorded:

 

  

 

  

 

  

 

  

 

  

 

  

C&I

$

569

$

569

$

341

$

479

$

$

CRE

 

 

 

 

 

 

Owner-Occupied CRE

 

 

 

 

 

 

Commercial Construction, Land Development, and Other Land

 

 

 

 

 

 

Other Non Owner-Occupied CRE

 

6,530

 

6,530

 

1,692

 

5,329

 

 

Direct Financing Leases

 

55

 

55

 

20

 

59

 

 

Residential Real Estate

 

260

 

260

 

23

 

206

 

 

Installment and Other Consumer

 

78

 

78

 

78

 

67

 

 

$

7,492

$

7,492

$

2,154

$

6,140

$

$

 

  

 

  

 

  

 

  

 

  

 

  

Total Impaired Loans/Leases:

 

  

 

  

 

  

 

  

 

  

 

  

C&I

$

2,547

$

2,620

$

341

$

1,991

$

25

$

25

CRE

 

  

 

  

 

  

 

  

 

  

 

  

Owner-Occupied CRE

 

320

 

577

 

 

128

 

 

Commercial Construction, Land Development, and Other Land

 

 

 

 

 

 

Other Non Owner-Occupied CRE

 

7,495

 

7,495

 

1,692

 

6,071

 

14

 

14

Direct Financing Leases

 

1,419

 

1,419

 

20

 

1,438

 

11

 

11

Residential Real Estate

 

884

 

912

 

23

 

680

 

 

Installment and Other Consumer

 

640

 

640

 

78

 

592

 

 

$

13,305

$

13,663

$

2,154

$

10,900

$

50

$

50

22

Table of Contents

Part I

Item 1

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – continued

Loans/leases, by classes of financing receivable, considered to be impaired as of and for the three months ended June 30, 2020 and 2019 are presented as follows:

Three Months Ended June 30, 2020

Three Months Ended June 30, 2019

    

Interest Income

Interest Income

Average

Recognized for

Average

Recognized for

Recorded

Interest Income

Cash Payments

Recorded

Interest Income

Cash Payments

Classes of Loans/Leases

Investment

    

Recognized

    

Received

Investment

    

Recognized

    

Received

 

(dollars in thousands)

Impaired Loans/Leases with No Specific Allowance Recorded:

 

  

 

  

 

  

  

 

  

 

  

C&I

$

1,742

$

13

$

13

$

1,683

$

29

$

29

CRE

 

  

 

  

 

  

 

 

 

Owner-Occupied CRE

 

174

 

 

 

194

 

7

 

7

Commercial Construction, Land Development, and Other Land

 

 

 

 

603

 

6

 

6

Other Non Owner-Occupied CRE

 

978

 

7

 

7

 

3,985

 

22

 

22

Direct Financing Leases

 

1,411

 

6

 

6

 

1,795

 

7

 

7

Residential Real Estate

 

524

 

 

 

801

 

 

Installment and Other Consumer

 

550

 

 

 

816

 

3

 

3

$

5,379

$

26

$

26

$

9,877

$

74

$

74

 

  

 

  

 

  

 

  

 

  

 

  

Impaired Loans/Leases with Specific Allowance Recorded:

 

  

 

  

 

  

 

  

 

  

 

  

C&I

$

568

$

$

$

2,046

$

9

$

9

CRE

 

 

  

 

  

 

 

 

Owner-Occupied CRE

 

 

 

 

127

 

 

Commercial Construction, Land Development, and Other Land

 

 

 

 

143

 

 

Other Non Owner-Occupied CRE

 

6,560

 

 

 

1,980

 

 

Direct Financing Leases

 

57

 

 

 

227

 

 

Residential Real Estate

 

220

 

 

 

822

 

1

 

1

Installment and Other Consumer

 

70

 

 

 

150

 

 

$

7,475

$

$

$

5,495

$

10

$

10

 

  

 

  

 

  

 

  

 

  

 

  

Total Impaired Loans/Leases:

 

  

 

  

 

  

 

  

 

  

 

  

C&I

$

2,310

$

13

$

13

$

3,729

$

38

$

38

CRE

 

  

 

  

 

  

 

  

 

  

 

  

Owner-Occupied CRE

 

174

 

 

 

321

 

7

 

7

Commercial Construction, Land Development, and Other Land

 

 

 

 

746

 

6

 

6

Other Non Owner-Occupied CRE

 

7,538

 

7

 

7

 

5,965

 

22

 

22

Direct Financing Leases

 

1,468

 

6

 

6

 

2,022

 

7

 

7

Residential Real Estate

 

744

 

 

 

1,623

 

1

 

1

Installment and Other Consumer

 

620

 

 

 

966

 

3

 

3

$

12,854

$

26

$

26

$

15,372

$

84

$

84

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Item 1

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – continued

Loans/leases, by classes of financing receivable, considered to be impaired as of December 31, 2019 are presented as

follows:

Unpaid 

Recorded

Principal

Related

Classes of Loans/Leases

    

Investment

    

Balance

    

Allowance

 

(dollars in thousands)

Impaired Loans/Leases with No Specific Allowance Recorded:

 

  

 

  

 

  

C&I

$

1,607

$

1,647

$

CRE

 

  

 

  

 

  

Owner-Occupied CRE

 

34

 

50

 

Commercial Construction, Land Development, and Other Land

 

 

 

Other Non Owner-Occupied CRE

 

684

 

686

 

Direct Financing Leases

 

1,642

 

1,642

 

Residential Real Estate

 

469

 

614

 

Installment and Other Consumer

 

476

 

476

 

$

4,912

$

5,115

$

 

  

 

  

 

  

Impaired Loans/Leases with Specific Allowance Recorded:

 

  

 

  

 

  

C&I

$

239

$

239

$

170

CRE

 

  

 

  

 

  

Owner-Occupied CRE

 

 

 

Commercial Construction, Land Development, and Other Land

 

 

 

Other Non Owner-Occupied CRE

 

2,867

 

2,867

 

125

Direct Financing Leases

 

383

 

383

 

270

Residential Real Estate

 

180

 

180

 

15

Installment and Other Consumer

 

80

 

80

 

80

$

3,749

$

3,749

$

660

 

  

 

  

 

  

Total Impaired Loans/Leases:

 

  

 

  

 

C&I

$

1,846

$

1,886

$

170

CRE

 

 

 

Owner-Occupied CRE

 

34

 

50

 

Commercial Construction, Land Development, and Other Land

 

 

 

Other Non Owner-Occupied CRE

 

3,551

 

3,553

 

125

Direct Financing Leases

 

2,025

 

2,025

 

270

Residential Real Estate

 

649

 

794

 

15

Installment and Other Consumer

 

556

 

556

 

80

$

8,661

$

8,864

$

660

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

For C&I and CRE loans, the Company’s credit quality indicator consists of internally assigned risk ratings.  Each commercial loan is assigned a risk rating upon origination. The risk rating is reviewed every 15 months, at a minimum, and on an as-needed basis depending on the specific circumstances of the loan.

For certain C&I loans (equipment financing agreements), direct financing leases, residential real estate loans, and installment and other consumer loans, the Company’s credit quality indicator is performance determined by delinquency status.  Delinquency status is updated daily by the Company’s loan system.

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Item 1

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – continued

For each class of financing receivable, the following presents the recorded investment by credit quality indicator as of June 30, 2020 and December 31, 2019:

As of June 30, 2020

 

CRE

Non-Owner Occupied

Commercial

 

Construction,

 

Land

 

Owner-Occupied

Development,

As a % of

 

Internally Assigned Risk Rating

    

C&I

    

CRE

    

and Other Land

    

Other CRE

    

Total

    

Total

 

 

(dollars in thousands)

Pass (Ratings 1 through 5)

$

1,643,654

$

463,570

$

430,206

$

883,724

$

3,421,154

 

95.95

%

Special Mention (Rating 6)

 

29,046

 

857

 

11,158

 

63,547

 

104,608

 

2.93

%

Substandard (Rating 7)

 

23,755

 

3,110

 

 

12,990

 

39,855

 

1.12

%

Doubtful (Rating 8)

 

 

 

 

 

 

%

$

1,696,455

$

467,537

$

441,364

$

960,261

$

3,565,617

 

100.00

%

As of June 30, 2020

 

Direct Financing

Residential Real

Installment and

As a % of

 

Delinquency Status *

    

C&I

    

Leases

    

Estate

    

Other Consumer

    

Total

    

Total

 

(dollars in thousands)

Performing

$

151,242

$

77,797

$

240,133

$

98,472

$

567,644

 

99.07

%

Nonperforming

 

2,413

 

1,308

 

936

 

678

 

5,335

 

0.93

%

$

153,655

$

79,105

$

241,069

$

99,150

$

572,979

 

100.00

%

As of December 31, 2019

 

CRE

Non-Owner Occupied

Commercial

 

Construction,

 

Land

 

Owner-Occupied

Development,

As a % of

 

Internally Assigned Risk Rating

    

C&I

    

CRE

    

and Other Land

    

Other CRE

    

Total

    

Total

 

 

(dollars in thousands)

Pass (Ratings 1 through 5)

$

1,334,446

$

439,418

$

378,572

$

896,206

$

3,048,642

 

98.28

%

Special Mention (Rating 6)

 

12,962

 

3,044

 

41

 

3,905

 

19,952

 

0.65

%

Substandard (Rating 7)

 

18,439

 

1,527

 

184

 

13,499

 

33,649

 

1.09

%

Doubtful (Rating 8)

 

 

 

 

 

 

0.01

%

$

1,365,847

$

443,989

$

378,797

$

913,610

$

3,102,243

 

100.00

%

As of December 31, 2019

 

Direct Financing

Residential Real

Installment and

As a % of

 

Delinquency Status *

    

C&I

    

Leases

    

Estate

    

Other Consumer

    

Total

    

Total

 

(dollars in thousands)

Performing

$

140,992

$

86,019

$

239,198

$

108,763

$

574,972

 

99.29

%

Nonperforming

 

986

 

1,850

 

706

 

589

 

4,131

 

0.71

%

$

141,978

$

87,869

$

239,904

$

109,352

$

579,103

 

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.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – continued

As of June 30, 2020 and December 31, 2019, TDRs totaled $1.3 million and $1.7 million, respectively.

For each class of financing receivable, the following presents the number and recorded investment of TDRs, by type of concession, that were restructured during the three and six months ended June 30, 2020 and 2019. The difference between the pre-modification recorded investment and the post-modification recorded investment would be any partial charge-offs at the time of the restructuring.

For the three months ended June 30, 2020

For the three months ended June 30, 2019

   

   

Pre-

    

Post-

    

    

    

Pre-

    

Post-

    

Modification

Modification

Modification

Modification

Number of

Recorded

Recorded

Specific

Number of

Recorded

Recorded

Specific

Classes of Loans/Leases

Loans / Leases

Investment

Investment

Allowance

Loans / Leases

Investment

Investment

Allowance

(dollars in thousands)

CONCESSION - Significant Payment Delay

 

  

 

  

 

  

 

  

  

 

  

 

  

 

  

C&I

$

$

$

1

$

52

$

52

$

Direct Financing Leases

 

2

78

78

 

2

$

78

$

78

$

1

$

52

$

52

$

 

  

 

  

 

  

 

  

  

 

  

 

  

 

  

CONCESSION - Forgiveness of Principal

 

  

 

  

 

  

 

  

  

 

  

 

  

 

  

C&I

 

$

$

$

1

$

587

$

537

$

$

$

$

1

$

587

$

537

$

TOTAL

 

2

$

78

$

78

$

2

$

639

$

589

$

 

  

 

  

 

  

 

  

  

 

  

 

  

 

  

For the six months ended June 30, 2020

For the six months ended June 30, 2019

   

   

Pre-

    

Post-

    

    

    

Pre-

    

Post-

    

Modification

Modification

Modification

Modification

Number of

Recorded

Recorded

Specific

Number of

Recorded

Recorded

Specific

Classes of Loans/Leases

Loans / Leases

Investment

Investment

Allowance

Loans / Leases

Investment

Investment

Allowance

(dollars in thousands)

CONCESSION - Significant Payment Delay

 

  

 

  

 

  

 

  

  

 

  

 

  

 

  

C & I

2

$

111

$

111

$

2

$

71

$

71

$

Direct Financing Leases

 

3

145

145

3

103

103

5

 

5

$

256

$

256

$

5

$

174

$

174

$

5

CONCESSION - Forgiveness of Principal

 

  

 

  

 

  

 

  

  

 

  

 

  

 

  

C & I

 

$

$

$

1

587

537

TOTAL

 

5

 

$

256

$

256

$

6

$

761

$

711

$

5

Of the loans restructured during the six months ended June 30, 2020, none were on nonaccrual.  Of the loans restructured during the six months ended June 30, 2019, two with post-modification recorded balances of $65 thousand were on nonaccrual.

For the three months ended June 30, 2020, two of the Company's TDRs redefaulted within 12 months subsequent to restructure, where default is defined as delinquency of 90 days or more and/or placement on nonaccrual status. These TDRs were related to one equipment financing agreement customer whose loans were restructured in fourth quarter of 2019 with pre-modification balances totaling $93 thousand.  For the six months ended June 30, 2020, three of the Company's TDRs redefaulted within 12 months subsequent to restructure, where default is defined as delinquency of 90 days or more and/or placement on nonaccrual status. These TDRs included the two that defaulted in the current quarter as well as a lease that was restructured in the fourth quarter of 2019 with pre-modification balances totaling $55 thousand.

For the three and six months ended June 30, 2019, three of the Company's TDRs redefaulted within 12 months subsequent to restructure, where default is defined as delinquency of 90 days or more and/or placement on nonaccrual status.  Two of these TDRs were related to one customer whose leases were restructured in the first quarter of 2019 with pre-modification balances totaling $66 thousand.  The other TDR related to a customer whose loan was restructured in the third quarter of 2018 with an original pre-modification balance of $2.9 million and a current pre-modification balance of $1.5 million and a partial charge off of $879 thousand in the second quarter of 2019.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – continued

Not included in the table above, the Company had seven TDRs that were restructured and charged off for the six months ended June 30, 2020, totaling $354 thousand. The Company had three TDRs that were restructured and charged off for the six months ended June 30, 2019, totaling $161 thousand.

On March 22, 2020, federal banking regulators issued an interagency statement that included guidance on their approach for the accounting of loan modifications in light of the economic impact of the COVID-19 pandemic. The guidance interprets current accounting standards and indicates that a lender can conclude that a borrower is not experiencing financial difficulty if short-term modifications are made in response to COVID-19, such as payment deferrals, fee waivers, extensions of repayment terms or other delays in payment that are insignificant related to the loans in which the borrower is less than 30 days past due on its contractual payments at the time a modification program is implemented. The agencies confirmed in working with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not TDRs.

In addition, the CARES Act provides financial institutions the option to temporarily suspend certain requirements under GAAP related to TDRs for a limited period of time to account for the effects of COVID-19. To be eligible, the modification must be related to COVID-19, existing loan could not be more than 30 days past due as of December 31, 2019 and modification executed between March 1, 2020 and earlier of 60 days after the termination of the National Emergency or December 31, 2020. If a modification does not meet the criteria of the CARES act, a deferral can still be excluded from TDR treatment as long as the modifications meet the FASB criteria discussed in the preceding paragraph.

The Company implemented its LRP offering to extend qualifying customers’ payments for 90 days.  As of June 30, 2020, the program has provided 1,466 Bank modifications of loans to commercial and consumer clients totaling $491 million and 935 m2 modifications of loans and leases totaling $53 million, representing 11.86% and 1.2% of the total loan and lease portfolio, respectively.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – continued

NOTE 4 – DERIVATIVES AND HEDGING ACTIVITIES

The Company uses interest rate swap and cap instruments to manage interest rate risk related to the variability of interest payments due to changes in interest rates.

The Company entered into interest rate caps in December 2019 to hedge against the risk of rising interest rates on liabilities.  The liabilities consist of $375.0 million of deposits and the benchmark rates hedged vary at 1-month LIBOR, 3-month LIBOR and Prime. The interest rate caps are designated as cash flow hedges in accordance with ASC 815. An initial premium of $4.3 million was paid upfront for the caps executed in 2019.  The details of the interest rate caps are as follows:  

Balance Sheet

Fair Value as of

Hedged Item

Effective Date

Maturity Date

Location

Notional Amount

Strike Rate

June 30, 2020

December 31, 2019

(dollars in thousands)

Deposits

1/1/2020

1/1/2023

Other Assets

$

25,000

1.75

%  

$

13

$

112

Deposits

1/1/2020

1/1/2023

Other Assets

50,000

1.57

26

218

Deposits

1/1/2020

1/1/2023

Other Assets

25,000

1.90

12

96

Deposits

1/1/2020

1/1/2023

Other Assets

25,000

1.80

13

109

Deposits

1/1/2020

1/1/2024

Other Assets

25,000

1.75

26

214

Deposits

1/1/2020

1/1/2024

Other Assets

50,000

1.57

52

401

Deposits

2/1/2020

2/1/2024

Other Assets

25,000

1.90

26

202

Deposits

1/1/2020

1/1/2024

Other Assets

25,000

1.80

26

201

Deposits

1/1/2020

1/1/2025

Other Assets

25,000

1.75

48

337

Deposits

1/1/2020

1/1/2025

Other Assets

50,000

1.57

97

617

Deposits

3/1/2020

3/1/2025

Other Assets

25,000

1.90

50

332

Deposits

1/1/2020

1/1/2025

Other Assets

25,000

1.80

48

309

$

375,000

$

437

$

3,148

The Company has entered into interest rate swaps to hedge against the risk of rising rates on its rolling fixed rate short-term FHLB advances or brokered CDs and its variable rate trust preferred securities. All of the interest rate swaps are designated as cash flow hedges in accordance with ASC 815.  The details of the interest rate swaps are as follows:

Balance Sheet

Fair Value as of

Hedged Item

Effective Date

Maturity Date

Location

Notional Amount

Receive Rate

Pay Rate

June 30, 2020

December 31, 2019

(dollars in thousands)

CRBT - FHLB Advances or Brokered CDs

 

3/16/2020

3/16/2023

Derivatives - Liabilities

 

$

30,000

0.31

%  

 

1.12

%  

$

(730)

$

-

SFCB - FHLB Advances or Brokered CDs

 

3/16/2020

3/16/2023

Derivatives - Liabilities

 

10,000

0.32

%  

 

0.95

%  

(200)

-

QCR Holdings Statutory Trust II

 

9/30/2018

9/30/2028

Derivatives - Liabilities

 

10,000

3.16

%  

 

5.85

%  

(2,051)

(971)

QCR Holdings Statutory Trust III

 

9/30/2018

9/30/2028

Derivatives - Liabilities

 

8,000

3.16

%  

 

5.85

%  

(1,641)

(777)

QCR Holdings Statutory Trust V

 

7/7/2018

7/7/2028

Derivatives - Liabilities

 

10,000

2.77

%  

 

4.54

%  

(1,993)

(944)

Community National Statutory Trust II

 

9/20/2018

9/20/2028

Derivatives - Liabilities

 

3,000

2.48

%  

 

5.17

%  

(613)

(291)

Community National Statutory Trust III

 

9/15//2018

9/15/2028

Derivatives - Liabilities

 

3,500

2.06

%  

 

4.75

%  

(715)

(339)

Guaranty Bankshares Statutory Trust I

 

9/15/2018

9/15/2028

Derivatives - Liabilities

 

4,500

2.06

%  

 

4.75

%  

(919)

(436)

 

  

 

$

79,000

1.92

%  

 

5.24

%  

$

(8,862)

$

(3,758)

Changes in fair values of derivative financial instruments accounted for as cash flow hedges, to the extent that they are included in the assessment of effectiveness, are recorded as a component of AOCI.

The Company has also entered into interest rate swap contracts that are not designated as hedging instruments. These derivative contracts relate to transactions in which the Company enters into an interest rate swap with a customer while at the same time entering into an equal and offsetting interest rate swap with a third party financial institution. Additionally, the Company receives an upfront fee from the counterparty, dependent upon the pricing that is recognized upon receipt from the counterparty.  Because the Company acts as an intermediary for the customer, changes in the fair value of the

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Item 1

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – continued

underlying derivative contracts, for the most part, offset each other and do not significantly impact the Company’s results of operations.

Interest rate swaps that are not designated as hedging instruments are summarized as follows:

June 30, 2020

December 31, 2019

Notional Amount

Estimated Fair Value

Notional Amount

Estimated Fair Value

(dollars in thousands)

Non-Hedging Interest Rate Derivatives Assets:

Interest rate swap contracts

$

1,100,913

$

224,727

$

787,221

$

84,679

Non-Hedging Interest Rate Derivatives Liabilities:

Interest rate swap contracts

$

1,100,913

$

224,727

$

787,221

$

84,679

Swap fee income totaled $19.9 million and $7.9 million for the three months ended June 30, 2020 and 2019, respectively. Swap fee income totaled $26.7 million and $11.1 million for the six months ended June 30, 2020 and 2019, respectively.  

The Company’s hedged interest rate swaps and non-hedged interest rate swaps are collateralized with cash and investment securities with carrying values as follows:

    

June 30, 2020

December 31, 2019

(dollars in thousands)

Cash

$

80,250

$

10,990

U.S govt. sponsored agency securities

3,657

3,541

Municipal securities

41,863

68,089

Residential mortgage-backed and related securities

 

107,190

 

27,027

$

232,960

$

109,647

The Company may be exposed to credit risk in the event of non-performance by the counterparties to its interest rate derivative agreements.  The Company assesses the credit risk of its financial institution counterparties by monitoring publicly available credit rating and financial information.  Additionally, the Company enters into interest rate derivatives only with primary and highly rated counterparties, and uses ISDA master agreements,  central clearing mechanisms and counterparty limits.  The ISDA master agreements contain bilateral collateral agreements with the amount of collateral to be posted generally governed by the settlement value of outstanding swaps.  The Company manages the risk of default by its borrower counterparties through its normal loan underwriting and credit monitoring policies and procedures.  The Company does not currently anticipate any losses from failure of interest rate derivative counterparties to honor their obligations.

NOTE 5 - EARNINGS PER SHARE

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

Three months ended

Six months ended

June 30, 

June 30, 

2020

    

2019

    

2020

    

2019

(dollars in thousands, except share data)

Net income

$

13,739

$

13,504

$

24,967

$

26,422

Basic EPS

$

0.87

$

0.86

$

1.58

$

1.68

Diluted EPS

$

0.86

$

0.85

$

1.56

$

1.66

Weighted average common shares outstanding

 

15,747,056

 

15,714,588

 

15,771,926

 

15,703,967

Weighted average common shares issuable upon exercise of stock options

and under the employee stock purchase plan

 

148,280

 

223,789

 

185,032

 

226,692

Weighted average common and common equivalent shares outstanding

 

15,895,336

 

15,938,377

 

15,956,958

 

15,930,659

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Item 1

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – continued

NOTE 6 – FAIR VALUE

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

Level 1 – Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in markets;
Level 2 – Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument; and
Level 3 – Inputs to the valuation methodology are unobservable and significant to the fair value measurement.

Assets and liabilities measured at fair value on a recurring basis comprise the following at June 30, 2020 and December 31, 2019:

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)

(dollars in thousands)

June 30, 2020:

 

  

 

  

 

  

 

  

Securities AFS:

 

  

 

  

 

  

 

  

U.S. govt. sponsored agency securities

$

17,472

$

$

17,472

$

Residential mortgage-backed and related securities

 

145,672

 

 

145,672

 

Municipal securities

 

101,266

 

 

101,266

 

Asset-backed securities

39,797

39,797

Other securities

 

18,700

 

 

18,700

 

Derivatives

 

225,164

 

 

225,164

 

Total assets measured at fair value

$

548,071

$

$

548,071

$

 

  

 

  

 

  

 

  

Derivatives

$

233,589

$

$

233,589

$

Total liabilities measured at fair value

$

233,589

$

$

233,589

$

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

December 31, 2019:

 

  

 

  

 

  

 

  

Securities AFS:

 

  

 

  

 

  

 

  

U.S. govt. sponsored agency securities

$

20,078

$

$

20,078

$

Residential mortgage-backed and related securities

 

120,587

 

 

120,587

 

Municipal securities

 

48,257

 

 

48,257

 

Asset-backed securities

16,887

16,887

Other securities

 

4,886

 

 

4,886

 

Derivatives

 

87,827

 

 

87,827

 

Total assets measured at fair value

$

298,522

$

$

298,522

$

 

  

 

  

 

  

 

  

Derivatives

$

88,437

$

$

88,437

$

Total liabilities measured at fair value

$

88,437

$

$

88,437

$

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

Interest rate caps are used for the purpose of hedging interest rate risk.  The interest rate caps are further described in Note 4 to the Consolidated Financial Statements.  The fair values are determined by pricing models that consider observable market data for derivative instruments with similar structures (Level 2 inputs).

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Interest rate swaps are used for the purpose of hedging interest rate risk on FHLB advances, brokered deposits and junior subordinated debt. The interest rate swaps are further described in Note 4 to the Consolidated Financial Statements. The fair values are determined by comparing the contract rate on the swap with the then-current market rate for the remaining term of the transaction (Level 2 inputs).

Interest rate swaps are also executed for select commercial customers. The interest rate swaps are further described in Note 4 to the Consolidated Financial Statements. The fair values are determined by comparing the contract rate on the swap with the then-current market rate for the remaining term of the transaction (Level 2 inputs).

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

Assets measured at fair value on a non-recurring basis comprise the following at June 30, 2020 and December 31, 2019:

    

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

(dollars in thousands)

June 30, 2020:

 

  

 

  

 

  

 

  

Impaired loans/leases

$

5,821

$

$

$

5,821

OREO

 

170

 

 

 

170

$

5,991

$

$

$

5,991

December 31, 2019:

 

  

 

  

 

  

 

  

Impaired loans/leases

$

3,394

$

$

$

3,394

OREO

 

4,459

 

 

 

4,459

$

7,853

$

$

$

7,853

Impaired loans/leases are evaluated and valued at the time the loan/lease is identified as impaired, at the lower of cost or fair value, and are classified as Level 3 in the fair value hierarchy. Fair value is measured based on the value of the collateral securing these loans/leases. Collateral may be real estate and/or business assets, including equipment, inventory and/or accounts receivable, and is determined based on appraisals by qualified licensed appraisers hired by the Company. Appraised and reported values are discounted based on management's historical knowledge, changes in market conditions from the time of valuation, and/or management's expertise and knowledge of the client and client's business.

OREO in the table above consists of property acquired through foreclosures and settlements of loans. Property acquired is carried at the estimated fair value of the property, less disposal costs, and is classified as Level 3 in the fair value hierarchy.  The estimated fair value of the property is determined based on appraisals by qualified licensed appraisers hired by the Company. Appraised and reported values are discounted based on management's historical knowledge, changes in market conditions from the time of valuation, and/or management's expertise and knowledge of the property.

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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

Fair Value

 

June 30, 

December 31, 

 

    

2020

    

2019

    

Valuation Technique

    

Unobservable Input

    

Range

(dollars in thousands)

Impaired loans/leases

$

5,821

$

3,394

 

Appraisal of collateral

 

Appraisal adjustments

 

(10.00)

%  

to

 

(30.00)

%

OREO

 

170

 

4,459

 

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 or liabilities measured at fair value during the three and six months ended June 30, 2020 and 2019.

The following table presents the carrying values and estimated fair values of financial assets and liabilities carried on the Company's consolidated balance sheets, including those financial assets and liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis:

Fair Value

As of June 30, 2020

As of December 31, 2019

Hierarchy

Carrying

Estimated

Carrying

Estimated

    

Level

    

Value

    

Fair Value

    

Value

    

Fair Value

(dollars in thousands)

Cash and due from banks

 

Level 1

$

88,577

$

88,577

$

76,254

$

76,254

Federal funds sold

 

Level 2

 

2,125

 

2,125

 

9,800

 

9,800

Interest-bearing deposits at financial institutions

 

Level 2

 

140,775

 

140,775

 

147,891

 

147,891

Investment securities:

 

  

 

 

 

 

HTM

 

Level 2

 

425,976

 

445,068

 

400,646

 

426,545

AFS

 

*

 

322,907

 

322,907

 

210,695

 

210,695

Loans/leases receivable, net

 

Level 3

 

5,390

 

5,821

 

3,143

 

3,394

Loans/leases receivable, net

 

Level 2

 

4,074,042

 

4,049,076

 

3,651,061

 

3,606,520

Derivatives

 

Level 2

 

225,164

 

225,164

 

87,827

 

87,827

Deposits:

 

  

 

 

 

 

Nonmaturity deposits

 

Level 2

 

3,674,337

 

3,674,337

 

3,184,726

 

3,184,726

Time deposits

 

Level 2

 

675,438

 

682,827

 

726,325

 

742,444

Short-term borrowings

 

Level 2

 

124,818

 

124,818

 

13,423

 

13,423

FHLB advances

 

Level 2

 

145,000

 

146,788

 

159,300

 

159,193

Subordinated notes

Level 2

68,516

68,705

68,394

68,563

Junior subordinated debentures

 

Level 2

 

37,916

 

30,458

 

37,838

 

30,477

Derivatives

 

Level 2

 

233,589

 

233,589

 

88,437

 

88,437

*See previous table in Note 2.

NOTE 7 – BUSINESS SEGMENT INFORMATION

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

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The Company's primary segment, Commercial Banking, is geographically divided by markets into the secondary segments comprised of the four held for investment subsidiary banks wholly owned by the Company: QCBT, CRBT, CSB, and SFC Bank. Each of these secondary segments offers similar products and services, but is managed separately due to different pricing, product demand, and consumer markets. Each offers commercial, consumer, and mortgage loans and deposit services.

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

The Company's All Other segment includes the corporate operations of the parent and operations of all other consolidated subsidiaries and/or defined operating segments that fall below the segment reporting thresholds.  The financial results for RB&T prior to the sale of the majority of its assets and liabilities at November 30, 2019 are also included in the Company’s All Other Segment as are the assets held for sale at June 30, 2020.

Selected financial information on the Company's business segments is presented as follows as of and for the three and six months ended June 30, 2020 and 2019.

Commercial Banking

Wealth

Intercompany

Consolidated

QCBT

    

CRBT

    

CSB

    

SFC Bank

    

Management

    

All other

    

Eliminations

    

Total

(dollars in thousands)

Three Months Ended June 30, 2020

  

  

Total revenue

$

19,727

$

34,612

$

9,752

$

9,533

$

3,627

$

17,813

$

(17,788)

$

77,276

Net interest income

 

15,653

 

12,820

 

7,538

 

6,201

 

 

(1,509)

 

245

 

40,948

Provision for loan/lease losses

 

7,539

 

7,160

 

2,811

 

2,405

 

 

 

 

19,915

Net income (loss) from continuing operations

 

3,307

 

10,580

 

591

 

1,899

 

986

 

13,797

 

(17,421)

 

13,739

Goodwill

 

3,223

 

14,980

 

9,888

 

45,975

 

 

182

 

 

74,248

Intangibles

 

 

2,437

 

3,643

 

6,344

 

 

1,448

 

 

13,872

Total assets

 

1,984,245

 

2,021,043

 

903,648

 

745,470

 

 

715,740

 

(765,385)

 

5,604,761

 

  

 

  

 

  

 

 

  

 

 

  

 

Three Months Ended June 30, 2019

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

Total revenue

$

20,374

$

23,575

$

9,730

$

7,757

$

4,249

$

23,431

$

(17,870)

$

71,246

Net interest income

 

12,632

 

10,785

 

7,294

 

5,425

 

 

1,877

 

 

38,013

Provision for loan/lease losses

 

973

 

300

 

151

 

485

 

 

32

 

 

1,941

Net income (loss) from continuing operations

 

4,505

 

6,928

 

2,207

 

2,079

 

583

 

14,369

 

(17,167)

 

13,504

Goodwill

 

3,223

 

14,980

 

9,888

 

45,975

 

 

3,682

 

 

77,748

Intangibles

 

 

2,935

 

4,328

 

7,268

 

 

1,558

 

 

16,089

Total assets

 

1,637,115

 

1,527,521

 

806,704

 

671,644

 

 

1,164,901

 

(613,033)

 

5,194,852

Six Months Ended June 30, 2020

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

Total revenue

$

39,227

$

56,607

$

19,802

$

18,224

$

7,665

$

33,431

$

(33,502)

$

141,454

Net interest income

 

30,080

 

24,206

 

15,038

 

11,843

 

 

(2,998)

 

477

 

78,646

Provision for loan/lease losses

 

10,722

 

9,410

 

4,775

 

3,375

 

 

 

 

28,282

Net income (loss)

 

8,210

 

16,957

 

1,629

 

4,105

 

1,806

 

24,934

 

(32,674)

 

24,967

Goodwill

 

3,223

 

14,980

 

9,888

 

45,975

 

 

182

 

 

74,248

Intangibles

 

 

2,437

 

3,643

 

6,344

 

 

1,448

 

 

13,872

Total assets

 

1,984,245

 

2,021,043

 

903,648

 

745,470

 

 

715,740

 

(765,385)

 

5,604,761

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Six Months Ended June 30, 2019

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

Total revenue

$

38,918

$

42,819

$

19,000

$

15,045

$

8,478

$

43,609

$

(32,528)

$

135,341

Net interest income

 

24,771

 

21,193

 

14,260

 

10,651

 

 

4,046

 

 

74,921

Provision for loan/lease losses

 

1,993

 

725

 

301

 

985

 

 

71

 

 

4,075

Net income (loss) from continuing operations

 

8,690

 

12,028

 

4,363

 

3,732

 

1,741

 

27,485

 

(31,617)

 

26,422

Goodwill

 

3,223

 

14,980

 

9,888

 

45,975

 

 

3,682

 

 

77,748

Intangibles

 

 

2,935

 

4,328

 

7,268

 

 

1,558

 

 

16,089

Total assets

 

1,637,115

 

1,527,521

 

806,704

 

671,644

 

 

1,164,901

 

(613,033)

 

5,194,852

NOTE 8 – REGULATORY CAPITAL REQUIREMENTS

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

Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the subsidiary banks must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification

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are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the subsidiary banks to maintain minimum amounts and ratios (set forth in the following table) of total common equity Tier 1 and Tier 1 capital to risk-weighted assets and of Tier 1 capital to average assets, each as defined by regulation.  Management believes, as of June 30, 2020 and December 31, 2019, that the Company and the subsidiary banks met all capital adequacy requirements to which they are subject.

Under the regulatory framework for prompt corrective action, to be categorized as “well capitalized,” an institution must maintain minimum total risk-based, Tier 1 risk-based, Tier 1 leverage and common equity Tier 1 ratios as set forth in the following tables. The Company and the subsidiary banks' actual capital amounts and ratios as of June 30, 2020 and December 31, 2019 are presented in the following table (dollars in thousands). As of June 30, 2020 and December 31, 2019, each of the subsidiary banks met the requirements to be “well capitalized”.

For Capital

To Be Well

 

Adequacy Purposes

Capitalized Under

 

For Capital

With Capital

Prompt Corrective

 

Actual

Adequacy Purposes

Conservation Buffer

Action Provisions

 

    

Amount

    

Ratio

    

Amount

Ratio

    

Amount

Ratio

    

Amount

Ratio

As of June 30, 2020:

Company:

Total risk-based capital

$

630,347

13.71

%  

$

367,866

> 

8.00

%  

$

482,824

> 

10.50

%  

$

459,832

> 

10.00

%

Tier 1 risk-based capital

 

509,216

 

11.07

 

275,899

> 

6.00

 

390,858

> 

8.50

 

367,866

> 

8.00

Tier 1 leverage

 

509,216

 

8.91

 

228,572

> 

4.00

 

228,572

> 

4.00

 

285,716

> 

5.00

Common equity Tier 1

 

471,300

 

10.25

 

206,925

> 

4.50

 

321,883

> 

7.00

 

298,891

> 

6.50

Quad City Bank & Trust:

 

 

 

  

 

  

 

  

Total risk-based capital

$

200,053

12.40

%  

$

129,068

> 

8.00

%  

$

169,401

> 

10.50

%  

$

161,335

> 

10.00

%

Tier 1 risk-based capital

 

179,859

 

11.15

 

96,801

> 

6.00

 

137,134

> 

8.50

 

129,068

> 

8.00

Tier 1 leverage

 

179,859

 

7.57

 

95,014

> 

4.00

 

95,014

> 

4.00

 

118,767

> 

5.00

Common equity Tier 1

 

179,859

 

11.15

 

72,601

> 

4.50

 

112,934

> 

7.00

 

104,867

> 

6.50

Cedar Rapids Bank & Trust:

 

 

  

 

  

 

  

Total risk-based capital

$

200,479

12.15

%  

$

132,034

> 

8.00

%  

$

173,295

> 

10.50

%  

$

165,043

> 

10.00

%

Tier 1 risk-based capital

 

179,841

 

10.90

 

99,026

> 

6.00

 

140,287

> 

8.50

 

132,034

> 

8.00

Tier 1 leverage

 

179,841

 

9.66

 

74,475

> 

4.00

 

74,475

> 

4.00

 

93,094

> 

5.00

Common equity Tier 1

 

179,841

 

10.90

 

74,269

> 

4.50

 

115,530

> 

7.00

 

107,278

> 

6.50

Community State Bank:

 

 

  

 

  

 

  

Total risk-based capital

$

96,839

12.76

%  

$

60,732

> 

8.00

%  

$

79,710

> 

10.50

%  

$

75,915

> 

10.00

%

Tier 1 risk-based capital

 

87,338

 

11.50

 

45,549

> 

6.00

 

64,527

> 

8.50

 

60,732

> 

8.00

Tier 1 leverage

 

87,338

 

9.86

 

35,430

> 

4.00

 

35,430

> 

4.00

 

44,287

> 

5.00

Common equity Tier 1

 

87,338

 

11.50

 

34,162

> 

4.50

 

53,140

> 

7.00

 

49,344

> 

6.50

Springfield First Community Bank:

 

 

  

 

  

 

  

Total risk-based capital

$

79,054

13.43

%  

$

47,106

> 

8.00

%  

$

61,827

> 

10.50

%  

$

58,883

> 

10.00

%

Tier 1 risk-based capital

 

68,519

 

11.64

 

35,330

> 

6.00

 

50,050

> 

8.50

 

47,106

> 

8.00

Tier 1 leverage

 

68,519

 

9.29

 

29,494

> 

4.00

 

29,494

> 

4.00

 

36,867

> 

5.00

Common equity Tier 1

 

68,519

 

11.64

 

26,497

> 

4.50

 

41,218

> 

7.00

 

38,274

> 

6.50

For Capital

To Be Well

 

Adequacy Purposes

Capitalized Under

 

For Capital

With Capital

Prompt Corrective

 

Actual

Adequacy Purposes

Conservation Buffer

Action Provisions

 

    

Amount

    

Ratio

    

Amount

Ratio

    

Amount

Ratio

    

Amount

Ratio

 

As of December 31, 2019:

Company:

Total risk-based capital

$

581,234

13.33

%  

$

348,937

> 

8.00

%  

$

457,980

> 

10.500

%  

$

436,171

> 

10.00

%

Tier 1 risk-based capital

 

481,702

 

11.04

 

261,703

> 

6.00

 

370,746

> 

8.500

 

348,937

> 

8.00

Tier 1 leverage

 

481,702

 

9.53

 

202,207

> 

4.00

 

202,207

> 

4.000

 

252,758

> 

5.00

Common equity Tier 1

 

443,864

 

10.18

 

196,277

> 

4.50

 

305,320

> 

7.000

 

283,511

> 

6.50

Quad City Bank & Trust:

 

 

 

  

 

  

 

  

Total risk-based capital

$

183,855

11.83

%  

$

124,362

> 

8.00

%  

$

163,225

> 

10.500

%  

$

155,452

> 

10.00

%

Tier 1 risk-based capital

 

170,137

10.94

 

93,271

> 

6.00

 

132,134

> 

8.500

 

124,362

> 

8.00

Tier 1 leverage

 

170,137

9.94

 

68,479

> 

4.00

 

68,479

> 

4.000

 

85,598

> 

5.00

Common equity Tier 1

 

170,137

10.94

 

69,953

> 

4.50

 

108,817

> 

7.000

 

101,044

> 

6.50

Cedar Rapids Bank & Trust:

 

 

  

 

  

 

  

Total risk-based capital

$

175,498

11.90

%  

$

117,953

> 

8.00

%  

$

154,813

> 

10.500

%  

$

147,441

> 

10.00

%

Tier 1 risk-based capital

 

162,127

11.00

 

88,465

> 

6.00

 

125,325

> 

8.500

 

117,953

> 

8.00

Tier 1 leverage

 

162,127

10.41

 

62,286

> 

4.00

 

62,286

> 

4.000

 

77,857

> 

5.00

Common equity Tier 1

 

162,127

11.00

 

66,349

> 

4.50

 

103,209

> 

7.000

 

95,837

> 

6.50

Community State Bank:

 

 

  

 

  

 

  

Total risk-based capital

$

92,095

12.32

%  

$

59,813

> 

8.00

%  

$

78,504

> 

10.500

%  

$

74,766

> 

10.00

%

Tier 1 risk-based capital

 

85,437

11.43

 

44,860

> 

6.00

 

63,551

> 

8.500

 

59,813

> 

8.00

Tier 1 leverage

 

85,437

10.39

 

32,902

> 

4.00

 

32,902

> 

4.000

 

41,128

> 

5.00

Common equity Tier 1

 

85,437

11.43

 

33,645

> 

4.50

 

52,336

> 

7.000

 

48,598

> 

6.50

Springfield First Community Bank:

 

 

  

 

  

 

  

Total risk-based capital

$

71,074

12.72

%  

$

44,704

> 

8.00

%  

$

58,674

> 

10.500

%  

$

55,880

> 

10.00

%

Tier 1 risk-based capital

 

63,956

11.45

 

33,528

> 

6.00

 

47,498

> 

8.500

 

44,704

> 

8.00

Tier 1 leverage

 

63,956

9.70

 

26,379

> 

4.00

 

26,379

> 

4.000

 

32,974

> 

5.00

Common equity Tier 1

 

63,956

11.45

 

25,146

> 

4.50

 

39,116

> 

7.000

 

36,322

> 

6.50

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NOTE 9 – PENDING SALE

On April 2, 2020, the Company entered into a stock purchase agreement to sell all the issued and outstanding capital stock of the Bates Companies. The aggregate consideration to be paid to the Company shall be an amount equal to $500,000 plus cancellation of all future amounts otherwise to become payable to the purchaser by the Company under an earn-out agreement entered into between the same parties in 2018 with a non-discounted value of approximately $1.6 million at June 30, 2020.  

This transaction received regulatory approval and the closing date is scheduled for August 10, 2020.

Goodwill impairment related to the execution of the agreement to sell the Bates Companies was $500,000 in the first quarter of 2020.

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

INTRODUCTION

This section reviews the financial condition and results of operations of the Company and its subsidiaries as of and for the three and six months ending June 30, 2020. Some tables may include additional periods to comply with disclosure requirements or to illustrate trends. When reading this discussion, also refer to the Consolidated Financial Statements and related notes in this report. The page locations and specific sections and notes that are referred to in this discussion are presented in the table of contents.

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

GENERAL

QCR Holdings, Inc. is a financial holding company and the parent company of QCBT, CRBT, CSB and SFC Bank. QCBT, CRBT and CSB are Iowa-chartered commercial banks and SFC Bank is a Missouri-chartered commercial bank. All four charters are members of the Federal Reserve system with depository accounts insured to the maximum amount permitted by the FDIC.

QCBT commenced operations in 1994 and provides full-service commercial and consumer banking, and trust and asset management services to the Quad City area and adjacent communities through its five offices that are located in Bettendorf and Davenport, Iowa and Moline, Illinois. QCBT also provides leasing services through its wholly-owned subsidiary, m2, located in Brookfield, Wisconsin. In addition, QCBT owns 100% of Quad City Investment Advisors, LLC, which is an investment management and advisory company.
CRBT commenced operations in 2001 and provides full-service commercial and consumer banking, and trust and asset management services to Cedar Rapids, Iowa and adjacent communities through its five offices located in Cedar Rapids and Marion, Iowa. Cedar Falls and Waterloo, Iowa and adjacent communities are served through three additional CRBT offices (one in Cedar Falls and two in Waterloo).
CSB was acquired by the Company in 2016 and provides full-service commercial and consumer banking services to the Des Moines, Iowa area and adjacent communities through its 10 offices, including its main office located on North Ankeny Boulevard in Ankeny, Iowa.
SFC Bank became a subsidiary of the Company in 2018 and provides full-service commercial and consumer banking services to the Springfield, Missouri area through its main office located on Glenstone Avenue in Springfield, Missouri.

IMPACT OF COVID-19

The progression of the COVID-19 pandemic in the United States has had an adverse impact on the Company’s financial condition and results of operations as of and for the three and six months ended June 30, 2020, and could have a complex and significant adverse impact on the economy, the banking industry and the Company in future fiscal periods, all subject to a high degree of uncertainty.

Effects on the Company’s Market Areas

The Company offers commercial and consumer banking products and services primarily in Illinois, Missouri and Iowa.  Each of these three states has recently taken different steps to reopen since COVID-19 thrust the country into lockdown starting in March 2020. In Illinois, Governor J.B Pritzker has moved the state into Phase 4 of Restore Illinois which allows

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businesses to open with Illinois Department of Public Health approved safety guidance and requires certain businesses to open at reduced capacity.  This went into effect on June 26, 2020.  In Missouri, Governor Mike Parson announced the full opening of the state, effective June 16, 2020. In Iowa, Governor Kim Reynolds lifted all capacity limits on businesses effective June 10, 2020.  Despite these measures, the reopening of each jurisdiction is subject to change, delay and setbacks based on ongoing regional monitoring of the pandemic.  However, currently all of the subsidiary banks’ branches are open during normal business hours with the exception of four branch locations that are currently limiting lobby access to appointment only.

Each state has experienced rapidly increasing unemployment levels as a result of the curtailment of business activities, rising from an average of 4.6% in Illinois in March 2020 to an average of 15.2% in May 2020, according to the Illinois Department of Employment Security. The unemployment rate in Illinois improved slightly in June 2020 to an average of 14.6%.  Unemployment rose from an average of 4.5% in Missouri in March 2020 to 10.1% in May 2020, according to the Missouri Department of Labor and Industrial Relations.  The unemployment rate in Missouri improved in June 2020 to an average of 7.9%.  In Iowa, unemployment rose from an average of 3.7% in March 2020 to 10.0% in May 2020, according to the Iowa Workforce Development. The unemployment rate in Iowa improved in June 2020 to an average of 7.9%.  

Policy and Regulatory Developments

Federal, state and local governments and regulatory authorities have enacted and issued a range of policy responses to the COVID-19 pandemic, including the following:

The Federal Reserve decreased the range for the Federal Funds Target Rate by 0.50% on March 3, 2020, and by another 1.0% on March 16, 2020, reaching a current range of 0.0 – 0.25%.
On March 27, 2020, President Trump signed the CARES Act, which established a $2.0 trillion economic stimulus package, which provided for cash payments to individuals, supplemental unemployment insurance benefits and a $349 billion loan program administered through the SBA, referred to as the PPP.  On April 24, 2020, President Trump signed the Paycheck Protection Program and Health Care Enhancement Act, which authorized an additional $310 billion of PPP loans. Under the PPP, small businesses, sole proprietorships, independent contractors and self-employed individuals may apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to limitations and eligibility criteria.  The original timeframe for PPP lending expired on June 30, 2020, but Congress acted on June 30, 2020 to provide a 5-week PPP extension for lending to allow small businesses additional time to apply for the remaining PPP funds allocated by Congress in connection with the CARES Act. The subsidiary banks are participating as lenders in the PPP.
In addition, the CARES Act provides financial institutions the option to temporarily suspend certain requirements under GAAP related to TDRs for a limited period of time to account for the effects of COVID-19.  To be eligible, the modification must be related to COVID-19, existing loan could not be more than 30 days past due as of December 31, 2019 and modification executed between March 1, 2020 and earlier of 60 days after the termination of the National Emergency or December 31, 2020. If a modification does not meet the criteria of the CARES act, a deferral can still be excluded from TDR treatment as long as the modifications meet the FASB criteria discussed in Note 3 of the Consolidated Financial Statements.
On April 7, 2020, federal banking regulators issued a revised Interagency Statement on Loan Modifications and Reporting for Financial Institutions, which, among other things, encouraged financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations because of the effects of COVID-19, and stated that institutions generally do not need to categorize COVID-19-related modifications as TDRs, and the agencies will not direct supervised institutions to automatically categorize all COVID-19 related loan modifications as TDRs.  See Note 3 of the Consolidated Financial Statements for additional discussion on TDRs.

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On April 9, 2020, the Federal Reserve announced additional measures aimed at supporting small and midsized business, as well as state and local governments impacted by COVID-19. The Federal Reserve announced the Main Street Business Lending Program, which establishes two new loan facilities intended to facilitate lending to small and midsized businesses: the MSNLF and the MSELF. MSNLF loans are unsecured term loans originated on or after April 8, 2020, while MSELF loans are provided as upsized tranches of existing loans originated before April 8, 2020. The combined size of the program will be up to $600 billion. The program is designed for businesses with up to 10,000 employees or $2.5 billion in 2019 revenues. To obtain a loan, borrowers must confirm that they are seeking financial support because of COVID-19 and that they will not use proceeds from the loan to pay off debt. The Federal Reserve has provided additional funding to banks offering PPP loans to struggling small businesses. Lenders participating in the PPP will be able to exclude loans financed by the facility from their leverage ratio. In addition, the Federal Reserve created a Municipal Liquidity Facility to support state and local governments with up to $500 billion in lending, with the Treasury Department backing $35 billion for the facility using funds appropriated by the CARES Act. The facility will make short-term financing available to cities with a population of more than one million or counties with a population of greater than two million. The Federal Reserve expanded both the size and scope its Primary and Secondary Market Corporate Credit Facilities to support up to $750 billion in credit to corporate debt issuers. This will allow companies that were investment grade before the onset of COVID-19 but then subsequently downgraded after March 22, 2020 to gain access to such a facility. Finally, the Federal Reserve announced that its Term Asset-Backed Securities Loan Facility will be scaled up in scope to include the triple A-rated tranche of commercial mortgage-backed securities and newly issued collateralized loan obligations. The size of the facility is $100 billion. As of June 30, 2020, the Company is only participating in the PPP and not the Main Street Business Lending Program.

Effects on the Company’s Business

The Company currently expects that the COVID-19 pandemic and the specific developments referred to above could have a significant impact on its business.  In particular, the Company anticipates that a significant portion of the subsidiary banks’ borrowers in the hotel, restaurant, entertainment and retail industries will continue to endure significant economic distress, and could adversely affect their ability to repay existing indebtedness, and could adversely impact the value of collateral pledged to the banks.  These developments, together with economic conditions generally, may impact the Company’s commercial real estate portfolio, particularly with respect to real estate with exposure to these industries, the Company’s equipment leasing business and loan portfolio, the Company’s consumer loan business and loan portfolio, and the value of certain collateral securing the Company’s loans.  In addition, the Company’s loan and lease growth could slow exclusive of the PPP loans, while deposit growth could accelerate as businesses and consumers navigate the impact.  As a result, the Company anticipates that its financial condition, capital levels, asset quality and results of operations could be adversely affected, as described in further detail below.

The Company’s Response

The Company has taken numerous steps in response to the COVID-19 pandemic, including the following:

The Company implemented its LRP offering to extend qualifying customers’ payments for 90 days.  The program has provided 2,401 modifications of loans and leases totaling $544.0 million to commercial and consumer clients as of June 30, 2020.
As the Company moved to protect the health and safety of its employees and clients, digital collaboration and digital banking applications have become business critical.  The Company is using virtual meetings to stay connected with its clients and customers are leveraging the Company’s mobile banking capabilities.  The Company’s digital communications tool is a modern enterprise video application, with an easy, reliable and secure cloud platform for video and audio conferencing, chat and web conferencing across mobile, desktop and room systems.   It has enabled the Company to continue to collaborate in real-time across the enterprise and to meet face-to-face with our clients while working remotely to adhere to the Center for Disease Control’s

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physical distancing guidelines.  Clients are using the Company’s existing mobile banking and mobile payment capabilities including: on-line banking, remote deposit, on-line retail loan applications and person-to-person payment applications that are available across multiple form factors.  These applications have enabled customers to engage with the Company virtually to meet their community banking needs.  The Company proactively reached out to customers to make sure that they knew how to use these tools and increased their mobile deposit limits to enable expanded use of remote deposit features.  The Company also worked with primary digital banking solution providers to make adjustments to their hosting capabilities to accommodate the unprecedented levels of volume through this digital channel.
The Company began to execute on its Public Emergency Preparedness Plan (“PEP”) mid-February.  The PEP was created to coordinate resources in an organized manner to respond to any public emergency that may significantly affect staffing. One of the situations specifically called out in the plan is a health-related event such as a specific threat of influenza, or other disease, creating pandemic conditions.  This program is an important part of the Company’s Business Continuity Program, which specifically addresses rapid recovery from an occurrence that would disable any entity for a period exceeding 48 hours.  The goal of the plan is to protect employees, customers, facilities, systems, property and operations during any public emergency and maintain normal operations, to the extent possible, consistent with those goals. In the event that normal operations cannot be maintained, the goals will be to maximize the continuity of the essential services to our customers, protect the health and safety of employees and customers, and minimize adverse financial impact to our institutions. Finally, the plan will provide for a return to full operations and services as quickly as possible.  The plan was fully implemented during the first two weeks of March and the following strategies were executed:

oEmergency Preparedness Response Team critical members were identified to direct the Company’s planning, preparedness, training and response to lead the recovery effort with the COVID-19 pandemic;

oincreased cash reserves at all charters were established and the charters began monitoring cash outflows;

oIT testing began to ensure the Company’s systems were capable of handling traffic generated by employees working from home;

oreviewed cross training lists for each department in case of staff shortages;

osplit specific departments into shifts so not all employees were working together at the same time; and

ocommunication sites were activated in case emergency information needed to be communicated to employees.

The PPP was approved as part of the CARES Act and authorized up to $349 billion in forgivable loans to small businesses to pay their employees and for other operating expenses, during the COVID-19 crisis, and an additional $310 billion of loans were authorized to be made under the PPP in a second phase of funding. The Company has processed 1,655 loans for a total of $358.1 million as of June 30, 2020.  The Company is continuing to take PPP applications and is currently processing new loans under newly approved additional funding. PPP loans are included in the C&I category of loans in Note 3 of the Consolidated Financial Statements.

The Company has implemented a number of actions to support a healthy workforce, including:

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oadopting alternative work practices such as working in shifts, social distancing in our facilities and adding remote work options for approximately half of our workforce;
odiscontinued business travel, large events and meetings; and
outilizing online meeting platforms.
On February 28, 2020, the Company’s Board of Directors authorized a share repurchase program, permitting the repurchase of up to 800,000 shares of the Company’s outstanding common stock, or approximately 5% of the outstanding shares as of December 31, 2019.  As disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, the Company will not be permitted to make capital distributions (including for dividends and repurchases of stock) or pay discretionary bonuses to executive officers without restriction if the Company does not maintain 2.5% in Common Equity Tier 1 Capital attributable to a capital conservation buffer. The Company suspended the repurchase of shares on March 16, 2020 due to the uncertainties related to the COVID-19 pandemic and it is uncertain when the Company will resume the repurchase of shares as part of this program in the future.

EXECUTIVE OVERVIEW

The Company reported net income of $13.7 million and diluted EPS of $0.86 for the quarter ended June 30, 2020. By comparison, for the quarter ended March 31, 2020, the Company reported net income of $11.2 million and diluted EPS of $0.70.  For the quarter ended June 30, 2019, the Company reported net income of $13.5 million, and diluted EPS of $0.85.  For the six months ended June 30, 2020, the Company reported net income of $25.0 million, and diluted EPS of $1.56. By comparison, for the six months ended June 30, 2019, the Company reported net income of $26.4 million, and diluted EPS of $1.66.  

The second quarter of 2020 was also highlighted by the following results and events:

Net income of $13.7 million, or $0.86 per diluted share;
Adjusted net income (non-GAAP) of $14.0 million, or $0.88 per diluted share;
Noninterest income of $28.6 million;
Net interest margin was stable, excluding the impact of excess liquidity;
Pre-Provision/Pre-Tax Adjusted Net Income (non-GAAP) of $36.8 million;
Provision expense of $19.9 million for the quarter, increasing ALLL to Loans by 33 bps to 1.47%;
Nonperforming assets to total assets of 0.24%, improving 8 basis points from the prior quarter;
Annualized core loan and lease growth of 8.4% for the quarter, excluding newly originated SBA PPP loans;  
Annualized deposit growth of 17.2% for the quarter; and
PPP loan participation of 1,655 totaling $358.1 million to both new and existing clients.

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

For the three months ended

For the six months ended

June 30, 2020

March 31, 2020

June 30, 2019

June 30, 2020

June 30, 2019

(dollars in thousands)

Net income

$

13,739

$

11,228

$

13,504

$

24,967

$

26,422

Diluted earnings per common share

$

0.86

$

0.70

$

0.85

$

1.56

$

1.66

Weighted average common and common equivalent shares outstanding

 

15,895,336

 

16,011,456

 

15,938,377

 

15,956,958

 

15,930,659

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

For the three months ended

For the six months ended

    

June 30, 2020

    

March 31, 2020

    

June 30, 2019

    

June 30, 2020

    

June 30, 2019

 

(dollars in thousands)

Net interest income

$

40,948

$

37,698

$

38,013

$

78,646

$

74,921

Provision expense

 

19,915

 

8,367

 

1,941

 

28,282

 

4,075

Noninterest income

 

28,626

 

15,196

 

17,065

 

43,822

 

29,058

Noninterest expense

 

33,122

 

31,415

 

36,560

 

64,537

 

68,995

Federal and state income tax expense

 

2,798

 

1,884

 

3,073

 

4,682

 

4,487

Net income

$

13,739

$

11,228

$

13,504

$

24,967

$

26,422

Following are some noteworthy changes in the Company's financial results:

Net interest income in the second quarter of 2020 was up 9% compared to the first quarter of 2020.  The increase was primarily due to growth in average interest earning assets of $791.6 million, or 17.7% on a linked quarter basis, of which $404.9 million of the increase was due to excess cash derived from outsized deposit growth.   Net interest income increased 8% compared to the second quarter of 2019 and 5% when comparing the first six months of 2020 to the same period of the prior year.  The increase was primarily due to loan growth during the first six months of 2020.
Provision expense in the second quarter of 2020 increased $11.5 million compared to the first quarter of 2020.  Provision expense increased $18.0 million compared to the second quarter of 2019 and $24.2 million when comparing the first six months of 2020 to the same period in the prior year. The increase was primarily due to increased qualitative allocations in response to deteriorating economic conditions as related to the effects of COVID-19. See the Provision for Loan Lease Losses section of this report for additional details.
Noninterest income in the second quarter of 2020 increased 88% compared to the first quarter of 2020 primarily due to higher swap fee income. Noninterest income increased 68% compared to the second quarter of 2019 and 51% when comparing the first six months of 2020 to the same period in the prior year.  This increase was primarily attributable to higher swap fee income in the first six months of 2020.
Noninterest expense increased 5% in the second quarter of 2020 compared to the first quarter of 2020. Salaries and employee benefits were $21.3 million in the second quarter of 2020 as compared to $18.5 million in the first quarter of 2020 primarily due to higher incentive compensation as a result of the higher swap fee income.  FDIC and other insurance, and regulatory fees were $908 thousand in the second quarter of 2020 as compared to $683 thousand in the first quarter of 2020 due to FDIC insurance assessment credits included in first quarter 2020 totals.  Loss on liability extinguishment was $429 thousand in the second quarter of 2020 as compared to $147

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thousand in the first quarter of 2020 due to increased early payoffs of brokered certificate of deposits in the second quarter.   Noninterest expense decreased 9% compared to the second quarter of 2019 and decreased 6% when comparing the first six months of 2020 to the same period in the prior year.  Salaries and employee benefits were down 9% from prior year primarily due to reduced bonus compensation as a result of the impact of COVID-19 and the sale of RB&T.
Federal and state income tax expense in the second quarter of 2020 increased 49% compared to the first quarter of 2020. Federal and state income tax expense decreased 9% compared to the second quarter of 2019 and increased 4% when comparing the first six months of 2020 to the same period in the prior year. See the “Income Taxes” section of this report for additional details on these increases.

STRATEGIC FINANCIAL METRICS

The Company has established certain strategic financial metrics by which it manages its business and measures its performance. The goals are periodically updated to reflect changes in business developments. While the Company is determined to work prudently to achieve these metrics, there is no assurance that they will be met. Moreover, the Company's ability to achieve these metrics will be affected by the factors discussed under “Forward Looking Statements” as well as the factors detailed in the “Risk Factors” section included under Item 1A. of Part I of the Company's Annual Report on Form 10-K for the year ended December 31, 2019. The Company's long-term strategic financial metrics are as follows:

Organic loan and lease growth of 9% per year, funded by core deposits;
Grow fee-based income by at least 6% per year; and
Limit our annual operating expense growth to 5% per year.

The following table shows the evaluation of the Company’s strategic financial metrics:

Year to Date

Strategic Financial Metric

    

Key Metric

    

Target

June 30, 2020*

Loans and leases growth organically

 

Loans and leases growth

 

> 9% annually

5.0

%  

Fee income growth

 

Fee income growth

 

> 6% annually

31.7

%  

Improve operational efficiencies and hold noninterest expense growth

Noninterest expense growth

 

< 5% annually

(11.6)

%  

* Ratios and amounts provided for these measurements represent year-to-date actual amounts for the respective period that are then annualized for comparison. The calculations provided exclude non-core noninterest income and noninterest expense.

** Loans and leases growth excludes PPP loans.

It should be noted that these initiatives are long-term targets.  Due to the impact of the COVID-19 pandemic, the Company may not be able to achieve these goals for the full year 2020.

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STRATEGIC DEVELOPMENTS

The Company has taken the following actions during the second quarter of 2020 to support its corporate strategy:

The Company grew loans and leases organically in the second quarter of 2020 by 8.4% on an annualized basis, excluding PPP loans (non-GAAP), reflecting healthy demand across all markets.
Correspondent banking has continued to be a core line of business for the Company. The Company is competitively positioned with experienced staff, software systems and processes to continue growing in the four states currently served – Iowa, Illinois, Wisconsin and Missouri. The Company acts as the correspondent bank for 191 downstream banks with average total noninterest bearing deposits of $249.2 million and average total interest bearing deposits of $505.2 million during the first six months of 2020. By comparison, the Company acted as the correspondent bank for 192 downstream banks with average total noninterest bearing deposits of $168.9 million and average total interest bearing deposits of $310.1 million during the first six months of 2019. This line of business provides a strong source of noninterest bearing and interest bearing deposits, fee income, high-quality loan participations and bank stock loans.
As a result of the relatively low interest rate environment including a flat to inverted yield curve, the Company has focused on executing interest rate swaps on select commercial loans. The interest rate swaps allow commercial borrowers to pay a fixed interest rate while the Company receives a variable interest rate as well as an upfront fee dependent on the pricing. The Company will continue to review opportunities to execute these swaps at all of its subsidiary banks as appropriate for the borrowers and the Company. Swap fee income totaled $26.7 million for the six months ended June 30, 2020 as compared to $11.1 million for the six months ended June 30, 2019.  
Noninterest expense for the first six months of 2020 totaled $64.5 million as compared to $69.0 million in the first six months of 2019.  The decrease was primarily due to a decline in salaries and employee benefits as a result of reduced bonus and incentive compensation due to the impact of COVID-19.

GAAP TO NON-GAAP RECONCILIATIONS

The following table presents certain non-GAAP financial measures related to the “TCE/TA ratio”, “adjusted net income”, “adjusted EPS”, “adjusted ROAA”, “pre-provision/pre-tax adjusted income”, “NIM (TEY)”, “adjusted NIM”, “pre-provision/pre-tax adjusted ROAA”, “efficiency ratio”, “ALLL to total loans and leases excluding PPP loans” and “loan growth annualized excluding PPP loans”. In compliance with applicable rules of the SEC, all non-GAAP measures are reconciled to the most directly comparable GAAP measure, as follows:

TCE/TA ratio (non-GAAP) is reconciled to stockholders' equity and total assets;
TCE/TA ratio excluding PPP loans (non-GAAP) is reconciled to stockholders’ equity and total assets;
Adjusted net income, adjusted EPS and adjusted ROAA (all non-GAAP measures) are reconciled to net income;
Pre-provision/Pre-tax adjusted income and pre-provision/pre-tax adjusted ROAA (all non-GAAP measures) are reconciled to net income;
NIM (TEY) (non-GAAP) and adjusted NIM (non-GAAP) are reconciled to NIM;
Efficiency ratio (non-GAAP) is reconciled to noninterest expense, net interest income and noninterest income; and

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ALLL to total loans and leases excluding PPP loans and loan growth annualized excluding PPP loans are reconciled to ALLL and total loans and leases.

The TCE/TA non-GAAP ratio has been a focus for investors and management believes that this ratio may assist investors in analyzing the Company's capital position without regard to the effects of intangible assets.  The TCE/TA ratio excluding PPP loans non-GAAP ratio is provided as the Company’s management believes this financial measure is important to investors as total assets for the quarter ended June 30, 2020 was materially higher due to the addition of PPP loans.  By excluding the PPP loans, management believes the investor is provided a better comparison to prior periods for analysis.

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

The pre-provision/pre-tax adjusted income and pre-provision/pre-tax adjusted ROAA are measurements of the Company’s financial performance excluding provision and income taxes as well as non-recurring income and expense items.  The Company’s management believes this financial measure is important to investors as provision for the quarter ended June 30, 2020 was materially higher due to the impact of COVID-19 as well as its impact on income taxes.  By excluding the provision and income taxes as well as non-recurring income and expense items, the investor is provided a better comparison to prior periods for analysis.

NIM (TEY) is a financial measure that the Company's management utilizes to take into account the tax benefit associated with certain tax-exempt loans and securities. It is standard industry practice to measure net interest margin using tax-equivalent measures. In addition, the Company calculates NIM without the impact of acquisition accounting net accretion (adjusted NIM), as accretion amounts can fluctuate widely, making comparisons difficult.

The efficiency ratio is a ratio that management utilizes to compare the Company to its peers. It is a standard ratio used to calculate overhead as a percentage of revenue in the banking industry and is widely utilized by investors.

ALLL to total loans and leases, excluding PPP loans and loan growth annualized, excluding PPP loans are ratios that management utilizes to compare the Company to its peers. The Company’s management believes these financial measures are important to investors as total loans and leases for the quarter ended June 30, 2020 was materially higher due to the addition of PPP loans which are guaranteed by the government and therefore do not necessitate an increase in ALLL.  By excluding the PPP loans, the investor is provided a better comparison to prior periods for analysis.

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As of

GAAP TO NON-GAAP

    

June 30, 

    

March 31,

    

June 30, 

 

RECONCILIATIONS

2020

2020

2019

 

(dollars in thousands, except per share data)

TCE/TA RATIO

 

  

 

  

Stockholders' equity (GAAP)

$

556,020

$

539,139

$

504,300

Less: Intangible assets

 

88,120

 

88,669

 

93,837

TCE (non-GAAP)

$

467,900

$

450,470

$

410,463

Total assets (GAAP)

$

5,604,761

$

5,232,075

$

5,194,852

Less: Intangible assets

 

88,120

 

88,669

 

93,837

TA (non-GAAP)

$

5,516,641

$

5,143,406

$

5,101,015

TCE/TA ratio (non-GAAP)

 

8.48

%  

 

8.76

%

 

8.05

%

TCE/TA RATIO EXCLUDING PPP LOANS

 

  

 

  

Stockholders' equity (GAAP)

$

556,020

$

539,139

$

504,300

Less: PPP loan interest income (post-tax)

2,085

Less: Intangible assets

 

88,120

 

88,669

 

93,837

TCE (non-GAAP)

$

465,815

$

450,470

$

410,463

Total assets (GAAP)

$

5,604,761

$

5,232,075

$

5,194,852

Less: PPP loans

358,052

Less: Intangible assets

 

88,120

 

88,669

 

93,837

TA (non-GAAP)

$

5,158,589

$

5,143,406

$

5,101,015

TCE/TA ratio excluding PPP loans (non-GAAP)

 

9.03

%  

 

8.76

%

 

8.05

%

45

Table of Contents

Part I

Item 2

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

For the Quarter Ended

For the Six Months Ended

 

June 30, 

    

March 31, 

    

June 30, 

June 30, 

June 30, 

 

    

2020

    

2020

    

2019

    

2020

2019

 

(dollars in thousands, except per share data)

ADJUSTED NET INCOME

Net income (GAAP)

$

13,739

$

11,228

$

13,504

$

24,967

$

26,422

Less non-core items (post-tax) (*):

 

  

 

  

 

  

 

  

 

Income:

 

  

 

  

 

  

 

  

 

  

Securities gains (losses), net

$

51

$

$

(41)

$

51

$

(41)

Total non-core income (non-GAAP)

$

51

$

$

$

51

$

(41)

Expense:

 

  

 

  

 

  

 

  

 

  

Losses on debt extinguishment

$

339

$

116

$

$

455

$

Goodwill impairment

500

500

Disposition costs

(66)

408

343

Post-acquisition compensation, transition and integration costs

 

55

 

119

 

559

 

175

 

665

Total non-core expense (non-GAAP)

$

329

$

1,143

$

559

$

1,472

$

2,281

Adjusted net income (non-GAAP)

$

14,016

$

12,371

$

14,104

$

26,388

$

27,128

PRE-PROVISION/PRE-TAX ADJUSTED INCOME

Net income (GAAP)

$

13,739

$

11,228

$

13,504

$

24,967

$

26,422

Less: Non-core income not tax-effected

65

(52)

65

(52)

Plus: Non-core expense not tax-effected

416

1,315

708

1,731

842

Provision expense

19,915

8,367

1,941

28,282

4,075

Federal and state income tax expense

2,798

1,884

3,073

4,682

4,487

Pre-provision/pre-tax adjusted income (non-GAAP)

$

36,803

$

22,794

$

19,278

$

59,597

$

35,878

PRE-PROVISION/PRE-TAX ADJUSTED RETURN ON AVERAGE ASSETS (NON-GAAP)

Pre-provision/pre-tax adjusted income (non-GAAP)

$

36,803

$

22,794

$

19,278

$

59,597

$

35,878

Average assets

5,800,164

4,948,311

5,077,900

5,374,224

5,023,201

Pre-provision/pre-tax adjusted return on average assets (non-GAAP)

2.54

%

1.84

%

1.52

%

2.22

%

1.43

%

ADJUSTED EPS

 

  

 

  

 

  

 

  

 

  

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

$

14,016

$

12,371

$

14,104

$

26,388

$

27,128

Weighted average common shares outstanding

 

15,747,056

 

15,796,796

 

15,714,588

 

15,771,926

 

15,703,967

Weighted average common and common equivalent shares outstanding

 

15,895,336

 

16,011,456

 

15,938,377

 

15,956,958

 

15,930,659

Adjusted EPS (non-GAAP):

 

  

 

  

 

  

 

  

 

  

Basic

$

0.89

$

0.78

$

0.90

$

1.67

$

1.73

Diluted

$

0.88

$

0.77

$

0.88

$

1.65

$

1.70

ADJUSTED ROAA

 

  

 

  

 

  

 

  

 

  

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

$

14,016

$

12,371

$

14,104

$

26,388

$

27,128

Average Assets

$

5,800,164

$

4,948,311

$

5,077,900

$

5,374,224

$

5,023,201

Adjusted ROAA (annualized) (non-GAAP)

 

0.97

%  

 

1.00

%  

 

1.11

%  

 

0.98

%  

 

1.08

%  

ADJUSTED NIM (TEY)*

 

 

 

 

Net interest income (GAAP)

$

40,948

$

37,698

$

38,013

$

78,646

$

74,921

Plus: Tax equivalent adjustment

 

1,728

 

1,790

 

1,808

 

3,517

 

3,509

Net interest income - tax equivalent (non-GAAP)

$

42,676

$

39,488

$

39,821

$

82,163

$

78,430

Less: Acquisition accounting net accretion

736

625

1,076

1,361

2,145

Adjusted net interest income

41,940

38,863

38,745

80,802

76,285

Average earning assets

$

5,252,663

$

4,461,018

$

4,698,021

$

4,856,842

$

4,655,288

NIM (GAAP)

 

3.14

%  

 

3.40

%  

 

3.25

%  

 

3.26

%  

 

3.25

%  

NIM (TEY) (non-GAAP)

 

3.27

%  

 

3.56

%  

 

3.40

%  

 

3.40

%  

 

3.40

%  

Adjusted NIM (TEY) (non-GAAP)

3.21

%  

3.50

%  

3.31

%  

3.35

%  

3.30

%

  

EFFICIENCY RATIO

 

  

 

  

 

 

  

 

  

Noninterest expense (GAAP)

$

33,122

$

31,415

$

36,560

$

64,537

$

68,995

Net interest income (GAAP)

$

40,948

$

37,698

$

38,013

$

78,646

$

74,921

Noninterest income (GAAP)

 

28,626

 

15,196

 

17,065

 

43,822

 

29,058

Total income

$

69,574

$

52,894

$

55,078

$

122,468

$

103,979

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

 

47.61

%  

 

59.39

%  

 

66.38

%  

 

52.70

%  

 

66.35

%  

ALLLTO TOTAL LOANS AND LEASES, EXCLUDING PPP LOANS

ALLL

$

60,827

$

42,233

$

41,104

$

60,827

$

41,104

Total loans and leases

$

4,140,259

$

3,704,668

$

3,910,519

$

4,140,259

$

3,910,519

Less: PPP loans

358,052

358,052

Total loans and leases, excluding PPP loans

$

3,782,207

$

3,704,668

$

3,910,519

$

3,782,207

$

3,910,519

ALLL to total loans and leases, excluding PPP loans

1.61

%

1.14

%

1.05

%

1.61

%

1.05

%

LOAN GROWTH ANNUALIZED, EXCLUDING PPP LOANS

 

  

 

  

 

 

  

 

  

Total loans and leases

$

4,140,259

$

3,704,668

$

3,910,519

$

4,140,259

$

3,910,519

Less: PPP loans

 

358,052

 

 

 

358,052

 

Total loans and leases, excluding PPP loans

$

3,782,207

$

3,704,668

$

3,910,519

$

3,782,207

$

3,910,519

Loan growth annualized, excluding PPP loans

 

8.37

%  

 

1.57

%  

 

13.57

%  

 

4.99

%  

 

9.52

%  

*     Nonrecurring items (after-tax) are calculated using an estimated effective tax rate of 21% with the exception of goodwill impairment which is not deductible for tax and gain on sale of subsidiary which has an estimated effective tax rate of 30.5%.

46

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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 7% to $42.7 million for the quarter ended June 30, 2020 compared to the same quarter of the prior year, and increased 5% to $82.2 million for the six months ended June 30, 2020 compared to the same period of the prior year. Excluding the tax equivalent adjustments, net interest income increased 8% for the quarter ended June 30, 2020 compared to the same quarter of the prior year, and increased 5% for the six months ended June 30, 2020 compared to the same period of the prior year. Net interest income improved due to the following factors:

Continued organic loan and deposit growth;
Significant growth in PPP loans in the early part of the second quarter of 2020;
Reduction in higher cost wholesale funds with strong core deposit growth including noninterest bearing deposits; and
Significant reduction in cost of funds.

A comparison of yields, spread and margin on a tax equivalent and GAAP basis is as follows:

Tax Equivalent Basis

GAAP

For the Quarter Ended

For the Quarter Ended

 

June 30, 

March 31,

June 30, 

June 30, 

March 31,

June 30, 

2020

2020

2019

2020

2020

2019

Average Yield on Interest-Earning Assets

3.86

%  

4.58

%  

4.78

%  

3.70

%  

4.39

%  

4.63

%

Average Cost of Interest-Bearing Liabilities

0.80

%  

1.33

%  

1.76

%  

0.79

%  

1.33

%  

1.76

%

Net Interest Spread

3.06

%  

3.24

%  

3.02

%  

2.91

%  

3.07

%  

2.87

%

NIM

3.27

%  

3.56

%  

3.40

%  

3.14

%  

3.40

%  

3.25

%

NIM Excluding Acquisition Accounting Net Accretion

3.21

%  

3.50

%  

3.31

%  

3.10

%  

3.37

%  

3.15

%

Tax Equivalent Basis

GAAP

 

For the Six Months Ended

For the Six Months Ended

 

June 30, 

June 30, 

June 30, 

June 30, 

 

2020

2019

2020

2019

 

Average Yield on Interest-Earning Assets

4.19

%  

4.76

%  

4.02

%  

4.60

%

Average Cost of Interest-Bearing Liabilities

1.05

%  

1.74

%  

0.78

%  

1.74

%

Net Interest Spread

3.14

%  

3.02

%  

3.24

%  

2.86

%

NIM

3.40

%  

3.40

%  

3.26

%  

3.25

%

NIM Excluding Acquisition Accounting Net Accretion

3.35

%  

3.30

%  

3.21

%  

3.15

%

Acquisition accounting net accretion can fluctuate mostly depending on the payoff activity of the acquired loans.  In evaluating net interest income and NIM, it’s important to understand the impact of acquisition accounting net accretion when comparing periods. The above table reports NIM with and without the acquisition accounting net accretion to allow for more appropriate comparisons.  A comparison of acquisition accounting net accretion included in NIM is as follows:

For the Quarter Ended

For the Six Months Ended

June 30, 

March 31,

June 30, 

June 30, 

June 30, 

    

2020

    

2020

    

2019

    

2020

    

2019

    

(dollars in thousands)

(dollars in thousands)

Acquisition Accounting Net Accretion in NIM

$

736

$

625

$

1,076

$

1,361

$

2,145

NIM on a tax equivalent basis was down 29 basis points on a linked quarter basis.  Excluding acquisition accounting net accretion, NIM was down 29 basis points on a linked quarter basis.  The decrease in net interest margin during the quarter was due to a 72 basis point decline in the yield on earning assets, partially offset by a 53 basis point decline in total cost of interest-bearing funds (due to both mix and rate).  Due to significant core deposit growth outpacing loans throughout

47

Table of Contents

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Item 2

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

the quarter, the Company carried excess liquidity of approximately $400 million which contributed to 30 bps of the decline in NIM.   Excluding the impact of this excess liquidity, Adjusted NIM would have been stable with the first quarter.

The Company’s management closely monitors and manages NIM. From a profitability standpoint, an important challenge for the Company's subsidiary banks and leasing company is focusing on quality growth in conjunction with the improvement of their NIMs. Management continually addresses this issue with pricing and other balance sheet

strategies which include better loan pricing, reducing reliance on very rate-sensitive funding, closely managing deposit rate changes and finding additional ways to manage NIM through derivatives.

In response to the COVID-19 pandemic, the Federal Reserve decreased interest rates by a total of 150 basis points in March 2020.  These decreases impact the comparability of net interest income between 2019 and 2020.

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

For the Three Months Ended June 30,

2020

2019

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

$

865

$

1

 

0.46

%  

$

9,690

$

56

 

2.32

%

Interest-bearing deposits at financial institutions

 

533,483

 

134

 

0.10

%  

 

182,651

 

1,168

 

2.56

%

Investment securities (1)

 

697,559

 

6,536

 

3.77

%  

 

644,999

 

6,062

 

3.77

%

Restricted investment securities

 

21,234

 

288

 

5.46

%  

 

21,007

 

290

 

5.54

%

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

 

3,999,522

 

43,417

 

4.37

%  

 

3,839,674

 

48,413

 

5.06

%

Total interest earning assets

5,252,663

50,376

 

3.86

%  

4,698,021

55,989

 

4.78

%

Noninterest-earning assets:

  

 

  

 

  

  

 

  

 

  

Cash and due from banks

82,171

82,394

Premises and equipment

 

73,376

 

78,008

Less allowance

 

(42,878)

 

(41,224)

Other

 

434,865

 

260,701

Total assets

$

5,800,197

$

5,077,900

LIABILITIES AND STOCKHOLDERS' EQUITY

 

  

 

  

 

  

 

  

 

  

 

  

Interest-bearing liabilities:

 

  

 

  

 

  

 

  

 

  

 

  

Interest-bearing deposits

$

2,840,860

 

2,429

 

0.34

%  

$

2,461,768

 

8,271

 

1.35

%

Time deposits

 

809,233

 

3,337

 

1.66

%  

 

1,013,391

 

5,554

 

2.20

%

Short-term borrowings

 

25,064

 

22

 

0.35

%  

 

16,145

 

81

 

2.01

%

FHLB advances

 

95,616

 

347

 

1.46

%  

 

76,154

 

601

 

3.17

%

Other borrowings

 

 

 

%  

 

10,550

 

92

 

3.50

%

Subordinated notes

68,480

994

5.84

%  

68,239

993

5.84

%

Junior subordinated debentures

 

37,891

 

573

 

6.07

%  

 

37,731

 

576

 

6.12

%

Total interest-bearing liabilities

3,877,144

7,702

 

0.80

%  

3,683,978

16,168

 

1.76

%

Noninterest-bearing demand deposits

1,082,532

796,232

Other noninterest-bearing liabilities

284,461

99,427

Total liabilities

5,244,137

4,579,637

Stockholders' equity

 

556,060

 

498,263

Total liabilities and stockholders' equity

$

5,800,197

$

5,077,900

Net interest income

$

42,674

$

39,821

Net interest spread

 

 

 

3.06

%  

 

 

 

3.02

%

Net interest margin

 

 

 

3.14

%  

 

 

 

3.25

%

Net interest margin (TEY)(Non-GAAP)

 

 

 

3.27

%  

 

 

 

3.40

%

Adjusted net interest margin (TEY)(Non-GAAP)

3.21

%  

3.31

%

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

 

135.48

%  

 

 

 

127.53

%  

 

 

(1)Interest earned and yields on nontaxable investment securities and nontaxable loans are determined on a tax equivalent basis using a 21% tax rate.
(2)Loan/lease fees are not material and are included in interest income from loans/leases receivable in accordance with accounting and regulatory guidance.
(3)Non-accrual loans/leases are included in the average balance for gross loans/leases receivable in accordance with accounting and regulatory guidance.

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Item 2

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

Analysis of Changes of Interest Income/Interest Expense

For the Three Months Ended June 30, 2020

Inc./(Dec.)

Components

from

of Change (1)

    

Prior Period (1)

    

Rate

    

Volume

 

2020 vs. 2019

(dollars in thousands)

INTEREST INCOME

 

  

 

  

 

  

Federal funds sold

$

(55)

$

(26)

$

(29)

Interest-bearing deposits at financial institutions

 

(1,033)

 

(6,343)

 

5,310

Investment securities (2)

 

474

 

(14)

 

488

Restricted investment securities

 

(2)

 

(16)

 

14

Gross loans/leases receivable (2) (3)

 

(4,996)

 

(16,223)

 

11,227

Total change in interest income

(5,612)

(22,622)

17,010

INTEREST EXPENSE

  

  

  

Interest-bearing deposits

(5,842)

(13,308)

7,466

Time deposits

(2,217)

(1,218)

(999)

Short-term borrowings

(59)

(250)

191

Federal Home Loan Bank advances

(254)

(1,008)

754

Other borrowings

(92)

(46)

(46)

Subordinated notes

1

1

Junior subordinated debentures

(4)

(16)

12

Total change in interest expense

(8,467)

(15,846)

7,379

Total change in net interest income

$

2,855

$

(6,776)

$

9,631

(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 21% 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.

49

Table of Contents

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Item 2

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

For the Six Months Ended June 30,

2020

2019

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

$

3,095

$

18

 

1.17

%  

$

12,713

$

150

 

2.38

%  

Interest-bearing deposits at financial institutions

 

331,048

 

495

 

0.30

%  

 

169,057

 

2,091

 

2.49

%  

Investment securities (1)

 

658,433

 

12,616

 

3.85

%  

 

652,727

 

12,158

 

3.76

%  

Restricted investment securities

 

21,300

 

546

 

5.16

%  

 

21,146

 

598

 

5.70

%  

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

 

3,842,966

 

87,474

 

4.58

%  

 

3,799,645

 

94,795

 

5.03

%  

Total interest earning assets

4,856,842

 

101,149

 

4.19

%  

4,655,288

 

109,792

 

4.76

%  

Noninterest-earning assets:

  

 

  

 

  

  

 

  

 

  

Cash and due from banks

90,799

80,513

Premises and equipment, net

 

73,641

 

77,266

Less allowance for estimated losses on loans/leases

 

(39,439)

 

(40,843)

Other

 

392,401

 

250,978

Total assets

$

5,374,242

$

5,023,201

LIABILITIES AND STOCKHOLDERS' EQUITY

 

  

 

  

 

  

 

  

 

  

 

  

Interest-bearing liabilities:

 

  

 

  

 

  

 

  

 

  

 

  

Interest-bearing demand deposits

$

2,610,248

 

7,756

 

0.60

%  

$

2,374,939

 

15,445

 

1.31

%  

Time deposits

 

797,184

 

7,216

 

1.82

%  

 

1,012,925

 

10,859

 

2.16

%  

Short-term borrowings

 

22,190

 

86

 

0.78

%  

 

15,261

 

152

 

2.01

%  

Federal Home Loan Bank advances

 

103,512

 

796

 

1.55

%  

 

111,755

 

1,662

 

3.00

%  

Other borrowings

 

 

 

%  

 

27,126

 

539

 

4.01

%  

Subordinated notes

68,449

1,988

5.84

%  

53,438

1,557

5.88

Junior subordinated debentures

 

37,872

 

1,144

 

6.07

%  

 

37,709

 

1,148

 

6.14

%  

Total interest-bearing liabilities

3,639,455

 

18,986

 

1.05

%  

3,633,151

 

31,362

 

1.74

%  

Noninterest-bearing demand deposits

936,223

803,266

Other noninterest-bearing liabilities

247,697

96,441

Total liabilities

4,823,374

4,532,858

Stockholders' equity

 

550,869

 

490,343

Total liabilities and stockholders' equity

$

5,374,242

$

5,023,201

Net interest income

$

82,163

$

78,430

Net interest spread

 

 

 

3.14

%  

 

 

 

3.02

%  

Net interest margin

 

 

 

3.26

%  

 

 

 

3.25

%  

Net interest margin (TEY)(Non-GAAP)

 

 

 

3.40

%  

 

 

 

3.40

%  

Adjusted net interest margin (TEY)(Non-GAAP)

3.35

%  

3.30

%

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

 

133.45

%  

 

 

 

128.13

%  

 

 

(1)Interest earned and yields on nontaxable investment securities and nontaxable loans are determined on a tax equivalent basis using a 21% tax rate.
(2)Loan/lease fees are not material and are included in interest income from loans/leases receivable in accordance with accounting and regulatory guidance.
(3)Non-accrual loans/leases are included in the average balance for gross loans/leases receivable in accordance with accounting and regulatory guidance.

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Analysis of Changes of Interest Income/Interest Expense

For the six months ended June 30, 2020

Inc./(Dec.)

Components

from

of Change (1)

    

Prior Period (1)

    

Rate

    

Volume

2020 vs. 2019

(dollars in thousands)

INTEREST INCOME

 

  

 

  

 

  

Federal funds sold

$

(132)

$

(53)

$

(79)

Interest-bearing deposits at other financial institutions

 

(1,596)

 

(4,631)

 

3,035

Investment securities (2)

 

458

 

342

 

116

Restricted investment securities

 

(52)

 

(65)

 

13

Gross loans/leases receivable (2) (3)

 

(7,321)

 

(10,368)

 

3,047

Total change in interest income

(8,643)

(14,775)

6,132

INTEREST EXPENSE

  

  

  

Interest-bearing demand deposits

(7,689)

(11,727)

4,038

Time deposits

(3,643)

(1,552)

(2,091)

Short-term borrowings

(66)

(198)

132

Federal Home Loan Bank advances

(866)

(752)

(114)

Other borrowings

(539)

(270)

(269)

Subordinated notes

431

431

Junior subordinated debentures

(4)

(4)

Total change in interest expense

(12,376)

(14,499)

2,123

Total change in net interest income

$

3,733

$

(276)

$

4,009

(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 21% 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.

CRITICAL ACCOUNTING POLICIES

The Company's financial statements are prepared in accordance with GAAP. The financial information contained within these statements is, to a significant extent, financial information that is based on approximate measures of the financial effects of transactions and events that have already occurred.

Based on its consideration of accounting policies that involve the most complex and subjective decisions and assessments, management has identified the following as critical accounting policies:

GOODWILL

The Company records all assets and liabilities purchased in an acquisition, including intangibles, at fair value.  Goodwill is not amortized but is subject, at a minimum, to annual tests for impairment.  In certain situations, interim impairment tests may be required if events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. A more detailed discussion of this critical accounting policy can be found in the Company's Annual Report on Form 10-K for the year ended December 31, 2019.

Due to the economic impact of COVID-19 during the first quarter of 2020, management concluded that factors such as the decline in macroeconomic conditions led to the occurrence of a triggering event and therefore an interim impairment test over goodwill was performed as of March 31, 2020.  There was no occurrence of a triggering event in the second quarter of 2020, therefore no impairment test of goodwill was performed as of June 30, 2020. When such an assessment is

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performed, should the Company conclude that all or a portion of goodwill is impaired, a non-cash charge for the amount of such impairment would be recorded to earnings.  Such a charge would have no impact on tangible capital or regulatory capital.  Based upon the results of the interim goodwill assessment during the first quarter of 2020, the Company concluded that an impairment did not exist on the bank reporting units as of the time of the assessment.

During the first quarter of 2020, the Company incurred goodwill impairment expense of $500 thousand related to the Bates Companies.  This was the result of the announcement of a sale of the Bates Companies as discussed in Note 9 of the Consolidated Financial Statements.

ALLOWANCE FOR LOAN AND LEASE LOSSES

The Company's allowance methodology incorporates a variety of risk considerations, both quantitative and qualitative, in establishing an allowance that management believes is appropriate at each reporting date. A more detailed discussion of this critical accounting policy can be found in the Company's Annual Report on Form 10-K for the year ended December 31, 2019.

The Company believes the COVID-19 pandemic may have an adverse effect on the credit quality of its loan portfolio during the remainder of 2020. Disruption to the Company’s customers could result in increased loan delinquencies and defaults resulting in an increase in quantitative allocations. Management believes impaired loans may increase in the future as a result of the COVID-19 pandemic, having a direct impact on the specific component of the allowance for loan and lease losses.

RESULTS OF OPERATIONS

INTEREST INCOME

Interest income decreased 10%, comparing the second quarter of 2020 to the same period of 2019, and decreased 8% comparing the first half of 2020 to the same period of 2019. This decrease was primarily the result of a reduction in average yields on loans and leases.  

Overall, the Company's average earning assets increased 12%, comparing the second quarter of 2020 to the second quarter of 2019. During the same time period, excess liquidity increased by 15%.  Average gross loans and leases increased 4%, while average investment securities increased 8% during the same time period.   Average earning assets increased 4%, comparing the first half of 2020 to the same period of 2019.  Excess liquidity increased by $235 million comparing the first half of 2020 to the same period of 2019.  Average gross loans and leases and average investment securities both increased slightly during the same time period.  The increases in excess liquidity were the result of outsized growth in core deposits led by the Company’s correspondent banking client base.  

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

INTEREST EXPENSE

Interest expense for the second quarter of 2020 decreased 52% from the second quarter of 2019 and decreased 39%, comparing the first half of 2020 to the same period of 2019.  The cost of funds on the Company’s average interest-bearing liabilities has decreased with the current rate environment.  During the last month of the first quarter, market interest rates fell as the Federal Reserve cut the Federal Funds rate by 150 bps to a range of 0%-0.25%. As a direct result, the Company’s interest expense declined sharply on a linked-quarter basis.

The Company's management intends to continue to shift the mix of funding from wholesale funds to well-priced core deposits, including noninterest-bearing deposits. Continuing this trend is expected to strengthen the Company's franchise value, reduce funding costs and increase fee income opportunities through deposit service charges.

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PROVISION FOR LOAN/LEASE LOSSES

The Company’s provision for loan and lease losses totaled $19.9 million for the second quarter of 2020, which is significantly higher than $1.9 million for the second quarter of 2019.  Provision for the first six months of 2020 totaled $28.3 million, which was up from $4.1 million in the first six months of  2019. The increase in the provision for loan and lease losses was primarily due to increased qualitative allocations in response to deteriorating economic conditions related to the effects of COVID-19.

The Company anticipates the provision to be elevated in future periods due to the broad reach of COVID-19 across many impacted individuals and industries.  The dramatic slowdown in economic activity will likely negatively impact the credit quality of the Company’s loan portfolio with increased levels of loan defaults.  The CARES Act provides significant resources for individuals and industries that could lessen the impact of COVID-19, in addition to the Company’s own loan relief programs.

The Company has elected to defer its implementation of CECL as allowed by the CARES Act. See Note 1 of the Consolidated Financial Statements for further discussion.

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

In accordance with GAAP for business combination accounting, acquired loans are recorded at fair value; therefore, no allowance is associated with such loans at acquisition. As acquired loans renew, the discount associated with those loans is eliminated and the Company must establish an allowance through provision. This provision, when coupled with net charge-offs of $3.46 million for the first six months of 2020, increased the Company's allowance to $60.8 million at June 30, 2020. As of June 30, 2020, the Company's allowance to total loans/leases was 1.47%, which was up from 1.14% at March 31, 2020 and 1.05% at June 30, 2019. Management continues to evaluate the allowance needed on acquired loans factoring in the net remaining discount ($5.5 million and $9.3 million at June 30, 2020 and June 30, 2019, respectively).

The following table represents the current balance of loans to customers with concentrations in industries that management has deemed to have a higher risk of being impacted by COVID-19:

As of June 30, 

 

2020

    

% of Total Gross

 

Amount

    

Loans and Leases

(dollars in thousands)

 

Retail and Lessors of Property Secured by Retail Property

$

236,147

5.70

%

Hotels

86,543

2.09

Restaurants (full service and limited service only)

41,077

0.99

Arts & Entertainment

30,513

0.74

Aviation

0.00

Energy

0.00

$

394,280

9.52

%

Additional discussion of the Company's allowance can be found in the “Financial Condition” section of this Report.

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NONINTEREST INCOME

The following tables set forth the various categories of noninterest income for the three and six months ended June 30, 2020 and 2019.

Three Months Ended

 

June 30, 

June 30, 

 

    

2020

    

2019

    

$ Change

    

% Change

 

(dollars in thousands)

Trust department fees

$

2,227

$

2,361

$

(134)

(5.7)

%

Investment advisory and management fees

 

1,399

 

1,888

 

(489)

(25.9)

Deposit service fees

 

1,286

 

1,658

 

(372)

(22.4)

Gains on sales of residential real estate loans, net

 

1,196

 

489

 

707

144.6

Gains on sales of government guaranteed portions of loans, net

 

 

39

 

(39)

(100.0)

Swap fee income

 

19,927

 

7,891

 

12,036

152.5

Securities gains (losses), net

 

65

 

(52)

 

117

(100.0)

Earnings on bank-owned life insurance

 

612

 

412

 

200

48.5

Debit card fees

 

775

 

914

 

(139)

(15.2)

Correspondent banking fees

 

198

 

172

 

26

15.1

Other

 

941

 

1,293

 

(352)

(27.2)

Total noninterest income

$

28,626

$

17,065

$

11,561

67.7

%

Six Months Ended

 

June 30, 

June 30, 

 

    

2020

    

2019

    

$ Change

% Change

 

(dollars in thousands)

Trust department fees

$

4,539

$

4,854

$

(315)

(6.5)

%

Investment advisory and management fees

 

3,126

 

3,624

 

(498)

(13.7)

Deposit service fees

 

2,763

 

3,212

 

(449)

(14.0)

Gains on sales of residential real estate loans, net

 

1,848

 

858

 

990

115.4

Gains on sales of government guaranteed portions of loans, net

 

 

70

 

(70)

(100.0)

Swap fee income

 

26,731

 

11,089

 

15,642

141.1

Securities gains (losses), net

 

65

 

(52)

 

117

(100.0)

Earnings on bank-owned life insurance

 

941

 

952

 

(11)

(1.2)

Debit card fees

 

1,533

 

1,706

 

(173)

(10.1)

Correspondent banking fees

 

413

 

388

 

25

6.4

Other

 

1,863

 

2,357

 

(494)

(21.0)

Total noninterest income

$

43,822

$

29,058

$

14,764

50.8

%

In recent years, the Company has been successful in expanding its wealth management client base. Trust department fees continue to be a significant contributor to noninterest income. Assets under management increased by $291.3 million in the second quarter of 2020, however assets under management decreased $183.4 million in the first six months of 2020 due to deteriorating economic conditions caused by the COVID-19 pandemic. With the decrease in assets under management, trust department fees decreased 7%, comparing the first six months of 2020 to the same period of the prior year.  Income is generated primarily from fees charged based on assets under administration for corporate and personal trusts and for custodial services. The majority of the trust department fees are determined based on the value of the investments within the fully-managed trusts. The Company expects trust department fees to be negatively impacted during periods of significantly lower market valuations.

Investment advisory and management fees decreased 26%, comparing the second quarter of 2020 to the same period of the prior year and they decreased 14% when comparing the first half of 2020 to the first half of 2019.  Brokerage assets decreased $124.1 million in the first six months of 2020 due to deteriorating economic conditions caused by the COVID-

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19 pandemic. Similar to trust department fees, investment advisory and management fees are largely determined based on the value of the investments managed. As a result, fee income from this line of business fluctuates with market valuations. The levels of trust and brokerage assets under management were negatively impacted by the decline in the market as a result of COVID-19.  

Deposit service fees decreased 22% comparing the second quarter of 2020 to the same period of the prior year, and decreased 14% when comparing the first half of 2020 to the same period of the prior year. This decrease was primarily due to the sale of RB&T, as well as lower transactional volume due to current economic conditions. The Company continues to emphasize shifting the mix of deposits from brokered and retail time deposits to non-maturity demand deposits across all its markets. With this continuing shift in mix, the Company has increased the number of demand deposit accounts, which tend to be lower in interest cost and higher in service fees. The Company plans to continue this shift in mix and to further focus on growing deposit service fees.

Gains on sales of residential real estate loans, net, increased 145% when comparing the second quarter of 2020 to the same period of the prior year, and increased 115% when comparing the first half of 2020 to the same period of the prior year. The increase was primarily due to the refinancing of residential real estate loans with lower interest rates in the first half of 2020.

The Company did not have any gains on the sale of government-guaranteed portions of loans for the three or six months ended June 30, 2020.  Large fluctuations can occur from quarter-to-quarter and year-to-year. The Company continues to leverage its expertise by taking advantage of programs offered by the SBA and the USDA. In some cases, it is more beneficial for the Company to sell the government-guaranteed portion on the secondary market for a premium rather than retain the loans in the Company's portfolio. Sales activity for government-guaranteed portions of loans tends to fluctuate depending on the demand for loans that fit the criteria for the government guarantee. Further, the size of the transactions can vary and, as the gain is determined as a percentage of the guaranteed amount, the resulting gain on sale can vary.  Recently, competitors have been offering SBA loan candidates traditional financing without a guarantee and the Company is not willing to relax its structure for those lending opportunities.

As a result of the low interest rate environment and its continued focus across all subsidiary banks, the Company was able to execute numerous interest rate swaps on select commercial loans, including tax credit project loans. The interest rate swaps allow commercial borrowers to pay a fixed interest rate while the Company receives a variable interest rate as well as an upfront fee dependent upon the pricing. Management will continue to review opportunities to execute these swaps at all of its subsidiary banks, as the circumstances are appropriate for the borrowers and the Company. An optimal interest rate swap candidate must be of a certain size and sophistication which can lead to volatility in activity from quarter to quarter. Swap fee income totaled $19.9 million for the second quarter of 2020, compared to $7.9 million for the second quarter of 2019.  Swap fee income totaled $26.7 million for the first half of 2020, compared to $11.1 million in the first half of 2020.  The increase in swap fee income for the first six months of 2020, as compared to all prior periods, was due to both the volume and the size of the transactions executed.  Future levels of swap fee income are somewhat dependent upon prevailing interest rates.

Securities gains totaled $65 thousand for the three and six months ended June 30, 2020.  By comparison, securities losses totaled $52 thousand for the three and six months ended June 30, 2019.

Earnings on BOLI increased 49% comparing the second quarter of 2020 to the second quarter of 2019, and decreased 1% comparing the first half of 2020 to the first half of 2019. There were no purchases of BOLI within the last 12 months. Notably, a portion of the Company's BOLI is variable rate whereby returns are determined by the performance of the equity markets and can lead to volatility in earnings. Management intends to continue to review its BOLI investments to be consistent with policy and regulatory limits in conjunction with the rest of its earning assets in an effort to maximize returns while minimizing risk.

Debit card fees are the interchange fees paid on certain debit card customer transactions. Debit card fees decreased 15% comparing the second quarter of 2020 to the second quarter of the prior year, and decreased 10% comparing the first half

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of 2020 to the first half of 2019. These fees can vary based on customer debit card usage, so fluctuations from period to period may occur. As an opportunity to maximize fees, the Company offers a retail deposit product with a higher interest rate that incentivizes debit card activity.

Correspondent banking fees increased 15% comparing the second quarter of 2020 to the second quarter of the prior year, and increased 6% comparing the first half of 2020 to the first half of 2019. The fees are generally included in the earnings credit rates which incent the correspondent bank to maintain higher levels of noninterest bearing deposits to offset the correspondent banking fees. Management will continue to evaluate earnings credit rates and the resulting impact on deposit balances and fees while balancing the ability to grow market share. Correspondent banking continues to be a core strategy for the Company, as this line of business provides a high level of deposits that can be used to fund loan growth as well as a steady source of fee income. The Company now serves approximately 191 banks in Iowa, Illinois, Missouri and Wisconsin.

Other noninterest income decreased 27% comparing the second quarter of 2020 to the second quarter of the prior year, and decreased 21% comparing the first half of 2020 to the first half of 2019.  This decrease was primarily due to the sale of RB&T.

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NONINTEREST EXPENSE

The following tables set forth the various categories of noninterest expense for the three and six months ended June 30, 2020 and 2019.

Three Months Ended

 

June 30, 

June 30, 

 

    

2020

    

2019

    

$ Change

    

% Change

 

(dollars in thousands)

Salaries and employee benefits

$

21,304

$

22,749

$

(1,445)

 

(6.4)

%

Occupancy and equipment expense

 

3,748

 

3,533

 

215

 

6.1

Professional and data processing fees

 

3,646

 

3,031

 

615

 

20.3

Post-acquisition compensation, transition and integration costs

 

70

 

708

 

(638)

 

(90.1)

Disposition costs

(83)

 

 

(83)

 

100.0

FDIC insurance, other insurance and regulatory fees

 

908

 

926

 

(18)

 

(1.9)

Loan/lease expense

 

339

 

312

 

27

 

8.7

Net cost of (income from) and gains/losses on operations of other real estate

 

(332)

 

1,182

 

(1,514)

 

(128.1)

Advertising and marketing

 

552

 

1,037

 

(485)

 

(46.8)

Bank service charges

 

501

 

508

 

(7)

 

(1.4)

Loss on liability extinguishment

429

 

 

429

 

100.0

Correspondent banking expense

 

212

 

206

 

6

 

2.9

Intangibles amortization

 

548

 

615

 

(67)

 

(10.9)

Other

 

1,280

 

1,753

 

(473)

 

(27.0)

Total noninterest expense

$

33,122

$

36,560

$

(3,438)

 

(9.4)

%

Six Months Ended

 

June 30, 

June 30, 

 

    

2020

    

2019

    

$ Change

    

% Change

 

(dollars in thousands)

Salaries and employee benefits

 

$

39,823

 

$

43,628

 

$

(3,805)

 

(8.7)

%

Occupancy and equipment expense

 

 

7,780

 

 

7,227

 

 

553

 

7.7

Professional and data processing fees

 

 

7,015

 

 

5,781

 

 

1,234

 

21.3

Post-acquisition compensation, transition and integration costs

 

 

221

 

 

842

 

 

(621)

 

(73.8)

Disposition costs

434

 

 

434

 

100.0

FDIC insurance, other insurance and regulatory fees

 

 

1,591

 

 

1,890

 

 

(299)

 

(15.8)

Loan/lease expense

 

 

567

 

 

526

 

 

41

 

7.8

Net cost of (income from) and gains/losses on operations of other real estate

 

 

(319)

 

 

1,480

 

 

(1,799)

 

(121.6)

Advertising and marketing

 

 

1,234

 

 

1,822

 

 

(588)

 

(32.3)

Bank service charges

 

 

1,005

 

 

991

 

 

14

 

1.4

Losses on liability extinguishment, net

576

576

 

100.0

Correspondent banking expense

 

 

428

 

 

410

 

 

18

 

4.4

Intangibles amortization

 

 

1,097

 

 

1,147

 

 

(50)

 

(4.4)

Goodwill Impairment

500

500

100.0

Other

 

 

2,585

 

 

3,251

 

 

(666)

 

(20.5)

Total noninterest expense

 

$

64,537

 

$

68,995

 

$

(4,458)

 

(6.5)

%

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

Salaries and employee benefits, which is the largest component of noninterest expense, decreased from the second quarter of 2019 to the second quarter of 2020 by 6%.  This line item also decreased 9% when comparing the first half of 2020 to the first half of 2019. This decrease was primarily related to the sale of RB&T, deferred costs due to PPP loans and reduced bonus and incentive compensation due to the impact of COVID-19.

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Occupancy and equipment expense increased 6% comparing the second quarter of 2020 to the same period of the prior year, and increased 8% comparing the first half of 2020 to the same period of the prior year. The increased expense was due to higher information technology service contract costs and increases in repairs and maintenance costs to existing buildings.

Professional and data processing fees increased 20% comparing the second quarter of 2020 to the same period in 2019, and increased 21% comparing the first half of 2020 to the same period of the prior year. This increased expense was mostly due to higher data processing costs.

Post-acquisition costs totaled $70 thousand for the second quarter of 2020 as compared to $708 thousand for the same period of the prior year.  Post-acquisition costs totaled $221 thousand for the first half of 2020 as compared to $842 thousand for the same period of the prior year.  These costs were comprised primarily of personnel costs, IT integration and data conversion costs related to previous mergers/acquisitions.

Disposition costs totaled $434 thousand for the first half of 2020. The costs were primarily legal, accounting, personnel costs and IT deconversion costs related to the sale of RB&T in the fourth quarter of 2019.  There were no disposition costs for the first quarter or first half of 2019.

FDIC insurance, other insurance and regulatory fee expense decreased 2%, comparing the second quarter of 2020 to the second quarter of 2019, and decreased 16% comparing the first half of 2020 to the same period of the prior year. The decrease in expense was due to the award of assessment credits by the FDIC in September 2019 that carried forward into 2020.

Loan/lease expense increased 9% when comparing the second quarter of 2020 to the same quarter of 2019, and increased 8% comparing the first half of 2020 to the same period of the prior year. Generally, loan/lease expense has a direct relationship with the level of NPLs; however, it may deviate depending upon the individual NPLs.

Net cost of (income from) and gains/losses on operations of other real estate includes gains/losses on the sale of OREO, write-downs of OREO and all income/expenses associated with OREO. Net income from and gains/losses on operations of other real estate totaled $332 thousand for the second quarter of 2020, compared to net cost of and gains/losses on operations of other real estate of $1.2 million for the second quarter of 2019.  Net income from and gains/losses on operations of other real estate totaled $319 thousand for the first half of 2020 compared to net cost of and gains/losses on operations of other real estate of $1.5 million for the same period of the prior year.  In the first half of 2020, the Company has sold OREO property of $4 million with corresponding gains of $369 thousand.  

Advertising and marketing expense decreased 47% comparing the second quarter of 2020 to the second quarter of 2019, and decreased 32% comparing the second half of 2020 to the same period of the prior year. The decrease in expense was primarily due to the sale of RB&T.

Bank service charges, a large portion of which includes indirect costs incurred to provide services to QCBT's correspondent banking customer portfolio, decreased 1% when comparing the second quarter of 2020 to the same quarter of 2019, and increased 1% comparing the first half of 2020 to the same period of the prior year.  As transaction volumes continue to increase and the number of correspondent banking clients increases, the associated expenses will also increase.

Losses on liability extinguishment were $429 thousand for the second quarter of 2020 and $576 thousand for the first half of 2020.  These losses relate to the prepayment of certain high-cost brokered and public certificates of deposit.  There were no losses on debt extinguishment for the three and six months ended June 30, 2019.

Correspondent banking expense increased 3% when comparing the second quarter of 2020 to the second quarter of 2019 and increased 4% when comparing the first half of 2020 to the same period of the prior year.  These are direct costs incurred to provide services to QCBT's correspondent banking customer portfolio, including safekeeping and cash management services.

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Intangibles amortization expense decreased 11% when comparing the second quarter of 2020 to the same quarter of 2019 and decreased 4% when comparing the first half of 2020 to the same period of the prior year. The second quarter of 2019 included $82 thousand of intangible amortization expense related to the finalization of purchase accounting related to the acquisition of Bates Companies.

Goodwill impairment expense totaled $500 thousand in the first half of 2020 related to the sale of the Bates Companies.  There was no goodwill impairment expense in the first half of 2019.

Other noninterest expense decreased 27% when comparing the second quarter of 2020 to the second quarter of 2019, and decreased 21% when comparing the first half of 2020 to the same period of the prior year. This was primarily due to the sale of RB&T.  Included in other noninterest expense are items such as subscriptions, sales and use tax and expenses related to wealth management.

INCOME TAXES

In the second quarter of 2020, the Company incurred income tax expense of $2.8 million.  During the first half of the year, the Company incurred income tax expense of $4.7 million. Following is a reconciliation of the expected income tax expense to the income tax expense included in the consolidated statements of income for the three and six months ended June 30, 2020 and 2019.

For the Three Months Ended June 30, 

For the Six Months Ended June 30, 

2020

2019

2020

2019

% of

% of

% of

% of

Pretax

Pretax

Pretax

Pretax

    

Amount

    

Income

    

Amount

    

Income

    

Amount

    

Income

    

Amount

    

Income

 

(dollars in thousands)

Computed "expected" tax expense

$

3,472

 

21.0

%  

$

3,481

 

21.0

%  

$

6,226

 

21.0

%  

$

6,491

 

21.0

%

Tax exempt income, net

 

(1,247)

 

(7.5)

 

(1,068)

 

(6.5)

 

(2,472)

 

(8.3)

 

(2,175)

 

(7.1)

Bank-owned life insurance

 

(115)

 

(0.7)

 

(87)

 

(0.5)

 

(170)

 

(0.6)

 

(200)

 

(0.6)

State income taxes, net of federal benefit, current year

 

776

 

4.7

 

772

 

4.7

 

1,453

 

4.9

 

1,421

 

4.6

Tax credits

 

(116)

 

(0.7)

 

(38)

 

(0.2)

 

(232)

 

(0.8)

 

(77)

 

(0.3)

True-up adjustment to year-end provision

(715)

(2.3)

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

 

2

 

 

(54)

 

(0.3)

 

(262)

 

(0.9)

 

(154)

 

(0.5)

Other

 

26

 

0.1

 

67

 

0.3

 

139

 

0.5

 

(104)

 

(0.3)

Federal and state income tax expense

$

2,798

 

16.9

%  

$

3,073

 

18.5

%  

$

4,682

 

15.8

%  

$

4,487

 

14.5

%

The effective tax rate for the quarter ended June 30, 2020 was 16.9%, which was a decrease from the effective tax rate of 18.5% for the quarter ended June 30, 2019.   The effective tax rate for the six months ended June 30, 2020 was 15.8%, which was an increase over the effective tax rate of 14.5% for the six months ended June 30, 2019.  During the first quarter of 2019 and in conjunction with the Company’s year-end tax preparation process, the Company identified a one-time true-up adjustment of $715 thousand.  Excluding this, the Company’s effective tax rate was approximately 16.8% for the six months ended June 30, 2019.

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Item 2

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

FINANCIAL CONDITION

Following is a table that represents the major categories of the Company’s balance sheet.  On November 30, 2019, the Company sold substantially all of the assets and transferred substantially all of the deposits and certain other liabilities of the Company’s wholly-owned subsidiary, RB&T.  As a result, those assets and liabilities of RB&T are not included in the Company’s results of its financial condition as of June 30, 2020, March 31, 2020 and December 31, 2019, the removal of which impacts balance sheet comparisons to June 30, 2019.

As of

June 30, 2020

March 31, 2020

 

December 31, 2019

June 30, 2019

 

(dollars in thousands)

 

    

Amount

    

%

    

Amount

    

%

    

    

Amount

    

%

    

Amount

    

%

 

Cash, federal funds sold, and interest-bearing deposits

$

231,477

 

4

%  

$

376,535

 

7

%  

$

233,945

 

5

%  

$

293,416

 

6

%

Securities

748,883

 

13

%  

684,571

 

13

%  

611,341

 

12

%  

643,803

 

12

%

Net loans/leases

4,079,432

 

73

%  

3,662,435

 

70

%  

3,654,204

 

75

%  

3,869,415

 

75

%

Derivatives

225,164

4

%  

195,973

4

%  

87,827

2

%  

65,922

1

%  

Other assets

309,040

6

%  

301,803

6

%  

309,767

6

%  

322,296

6

%

Assets held for sale

10,765

 

-

%  

10,758

 

-

%  

11,966

 

-

%  

 

-

%

Total assets

$

5,604,761

 

100

%  

$

5,232,075

 

100

%  

$

4,909,050

 

100

%  

$

5,194,852

 

100

%

Total deposits

$

4,349,775

 

78

%  

$

4,170,478

 

80

%  

$

3,911,051

 

80

%  

$

4,322,510

 

84

%

Total borrowings

376,250

 

7

%  

244,399

 

5

%  

278,955

 

5

%  

230,953

 

4

%

Derivatives

233,589

4

%  

203,744

4

%  

88,437

2

%  

69,556

1

%  

Other liabilities

87,539

 

1

%  

71,185

 

1

%  

90,253

 

2

%  

67,533

 

1

%

Liabilities held for sale

1,588

-

%  

3,130

0

%  

5,003

-

%  

-

%

Total stockholders' equity

556,020

 

10

%  

539,139

 

10

%  

535,351

 

11

%  

504,300

 

10

%

Total liabilities and stockholders' equity

$

5,604,761

 

100

%  

$

5,232,075

 

100

%  

$

4,909,050

 

100

%  

$

5,194,852

 

100

%

During the second quarter of 2020, the Company's total assets increased $372.7 million, or 7% from March 31, 2020, to a total of $5.6 billion. The Company’s loans increased $417.0 million in the second quarter of 2020.  Included in this amount was $358.1 million of PPP loans made to both new and existing customers. Total deposits increased $179.3 million in the second quarter of 2020 primarily due to an increase in noninterest-bearing demand deposits.  Borrowings increased $131.9 million in the second quarter of 2020 which consisted primarily of an increase in overnight FRB borrowings of $70.0 million and an increase in short-term FHLB advances of $50.0 million. During the quarter, the Company had significant core deposit growth mostly from its correspondent banking clients.  The outsized deposit growth exceeded the strong loan growth and led to the Company carrying excess liquidity during the quarter.  At the end of the quarter, a large portion of the outsized correspondent banking deposits shifted off balance sheet temporarily which prompted some overnight borrowing.  Subsequently, the majority of the balances have returned to the balance sheet.

INVESTMENT SECURITIES

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

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Item 2

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

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

As of

June 30, 2020

March 31, 2020

December 31, 2019

 

June 30, 2019

 

    

Amount

    

%  

    

Amount

    

%  

    

Amount

    

%

    

Amount

    

%

(dollars in thousands)

 

U.S. govt. sponsored agency securities

$

17,472

 

2

%  

$

19,457

 

3

%  

$

20,078

 

3

%  

$

35,762

 

6

%

Municipal securities

 

526,192

 

71

%  

 

493,664

 

72

%  

 

447,853

 

73

%  

 

440,852

 

68

%

Residential mortgage-backed and related securities

 

145,672

 

19

%  

 

122,853

 

18

%  

 

120,587

 

20

%  

 

159,228

 

25

%

Asset-backed securities

39,797

5

%

28,499

4

%  

16,887

3

%

%

Other securities

 

19,750

 

3

%  

 

20,098

 

3

%  

 

5,936

 

1

%  

 

7,961

 

1

%

$

748,883

 

100

%  

$

684,571

 

100

%  

$

611,341

 

100

%  

$

643,803

 

100

%

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

Securities as a % of Total Assets

 

13.36

%  

  

 

13.11

%  

  

 

12.45

%  

  

 

12.39

%  

  

Net Unrealized Gains as a % of Amortized Cost

 

4.16

%  

  

 

3.73

%  

  

 

4.88

%  

  

 

3.23

%  

  

Duration (in years)

 

6.3

  

 

6.7

 

  

 

6.7

  

 

6.4

  

Yield on investment securities (tax equivalent)

3.77

%  

3.95

%  

3.80

%  

3.77

%  

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

The Company has not invested in non-agency commercial or residential mortgage-backed securities or pooled trust preferred securities. The asset-backed securities, which are comprised of collateral loan obligations, are backed by pools of senior secured commercial loans and were AAA rated as of June 30, 2020.

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

LOANS/LEASES

Total loans/leases, excluding PPP loans (non-GAAP), grew 8.4% on an annualized basis during the second quarter of 2020 and 5.0% year-to-date. The Company experienced several large payoffs during the first quarter, which impacted loan growth, as well as slower growth in the first half of the year due to the pandemic.  The mix of the loan/lease types within the Company's loan/lease portfolio is presented in the following table.  

As of

June 30, 2020

March 31, 2020

December 31, 2019

June 30, 2019

    

Amount

    

%

    

Amount

    

%

    

Amount

    

%

    

Amount

    

%

    

(dollars in thousands)

C&I loans*

$

1,850,110

 

45

%  

$

1,484,979

 

41

%  

$

1,507,825

 

41

%  

$

1,548,657

 

40

%

CRE loans

 

1,869,162

 

45

%  

 

1,783,086

 

48

%  

 

1,736,396

 

47

%  

 

1,837,473

 

46

%

Direct financing leases

 

79,105

 

2

%  

 

83,324

 

2

%  

 

87,869

 

2

%  

 

101,180

 

3

%

Residential real estate loans

 

241,069

 

6

%  

 

237,742

 

6

%  

 

239,904

 

7

%  

 

293,479

 

8

%

Installment and other consumer loans

 

99,150

 

2

%  

 

106,728

 

3

%  

 

109,352

 

3

%  

 

120,947

 

3

%

Total loans/leases

$

4,138,596

 

100

%  

$

3,695,859

 

100

%  

$

3,681,346

 

100

%  

$

3,901,736

 

100

%

Plus deferred loan/lease origination costs, net of fees

 

1,663

 

8,809

 

 

8,859

 

  

8,783

 

  

Less allowance

 

(60,827)

 

(42,233)

 

 

(36,001)

 

  

(41,104)

 

  

Net loans/leases

$

4,079,432

$

3,662,435

$

3,654,204

 

  

$

3,869,415

 

  

*Excludes PPP loans totaling $358.1 million as of June 30, 2020.

As CRE loans have historically been the Company's largest portfolio segment, management places a strong emphasis on monitoring the composition of the Company's CRE loan portfolio. For example, management tracks the level of owner-occupied CRE loans relative to non-owner-occupied loans. Owner-occupied loans are generally considered to have less risk. As of June 30, 2020 and March 31, 2020, approximately 25% and 26% of the CRE loan portfolio was owner-occupied, respectively.

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Item 2

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

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

As of June 30, 

As of March 31, 

 

As of December 31, 

 

As of June 30, 

 

2020

2020

2019

2019

    

Amount

    

%

    

Amount

    

%

 

    

Amount

    

%

    

Amount

    

%

 

(dollars in thousands)

 

Lessors of Nonresidential Buildings

$

593,063

 

32

%  

$

546,384

 

31

%

$

553,142

 

32

%  

$

612,526

 

33

%

Lessors of Residential Buildings

 

545,026

 

29

%  

 

500,871

 

28

%

 

465,172

 

27

%  

 

394,235

 

21

%

Hotels

 

70,675

 

4

%  

 

56,573

 

3

%

 

63,720

 

4

%  

 

82,180

 

5

%

New Housing For-Sale Builders

56,229

3

%  

56,916

3

%

55,525

3

%  

43,520

2

%

Land Subdivision

 

55,555

 

3

%  

 

53,899

 

3

%

 

46,318

 

2

%  

 

45,847

 

3

%

Nonresidential Property Managers

 

44,887

 

2

%  

 

48,069

 

3

%

 

48,059

 

3

%  

 

58,207

 

3

%

Lessors of Other Real Estate Property

 

40,248

 

2

%  

 

42,260

 

2

%

 

39,297

 

2

%  

 

36,706

 

2

%

Other Activities Related to Real Estate

38,044

2

%  

39,352

2

%

42,060

2

%

32,652

2

%

New Single-Family Housing Construction

36,837

2

%  

31,856

2

%

28,708

2

%

27,962

2

%

Other *

 

388,598

 

21

%  

 

406,906

 

23

%

 

394,395

 

22

%  

 

503,638

 

27

%

Total CRE Loans

$

1,869,162

 

100

%  

$

1,783,086

 

100

%

$

1,736,396

 

100

%  

$

1,837,473

 

100

%

*     “Other” consists of all other industries. None of these had concentrations greater than $23.8 million, or approximately 1.3% of total CRE loans in the most recent period presented.

The Company's residential real estate loan portfolio includes the following:

Certain loans that do not meet the criteria for sale into the secondary market. These are often structured as adjustable rate mortgages with maturities ranging from three to seven years to avoid long-term interest rate risk.
A limited amount of 15-year, 20-year and 30-year fixed rate residential real estate loans that meet certain credit guidelines.

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

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

As of June 30, 

As of March 31, 

As of December 31, 

As of June 30, 

2020

2020

2019

2019

Amount

    

%

    

Amount

    

%

    

Amount

    

%

    

Amount

    

%

 

(dollars in thousands)

Trucks, Vans and Vocational Vehicles

$

59,782

 

26

%  

$

57,225

 

25

%

$

55,749

 

24

%  

$

46,650

 

20

%

Manufacturing - General

16,939

 

7

%  

16,277

 

7

%

15,847

 

7

%  

17,879

 

8

%

Food Processing Equipment

16,244

 

7

%  

16,703

 

7

%

16,742

 

7

%  

15,863

 

7

%

Construction - General

15,156

 

7

%  

15,038

 

7

%

16,236

 

7

%  

16,026

 

7

%

Marine - Travelifts

11,642

 

5

%  

10,908

 

5

%

11,556

 

5

%  

11,659

 

5

%

Computer Hardware

11,385

 

5

%  

12,142

 

5

%

11,509

 

5

%  

6,282

 

3

%

Trailers

9,541

 

4

%  

9,469

 

4

%

9,907

 

4

%  

9,303

 

4

%

Other *

92,071

 

39

%  

90,821

 

40

%

92,301

 

41

%  

107,014

 

46

%

Total m2 loans and leases

$

232,760

 

100

%  

$

228,583

 

100

%

$

229,847

 

100

%  

$

230,676

 

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.

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Item 2

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

ALLOWANCE FOR ESTIMATED LOSSES ON LOANS/LEASES

Changes in the allowance for the three and six months ended June 30, 2020 and 2019 are presented as follows:

Three Months Ended

Six Months Ended

June 30, 2020

    

June 30, 2019

    

June 30, 2020

    

June 30, 2019

(dollars in thousands)

Balance, beginning

$

42,233

$

41,164

$

36,001

$

39,847

Provisions charged to expense

 

19,915

 

1,941

 

28,282

 

4,075

Loans/leases charged off

 

(1,450)

 

(2,152)

 

(3,785)

 

(3,212)

Recoveries on loans/leases previously charged off

 

129

 

151

 

329

 

394

Balance, ending

$

60,827

$

41,104

$

60,827

$

41,104

The adequacy of the allowance was determined by management based on factors that included the overall composition of the loan/lease portfolio, types of loans/leases, historical loss experience, loan/lease delinquencies, potential substandard and doubtful credits, economic conditions, collateral positions, government guarantees and other factors that, in management's judgment, deserved evaluation. To ensure that an adequate allowance was maintained, provisions were made based on a number of factors, including the increase in loans/leases and a detailed analysis of the loan/lease portfolio. The loan/lease portfolio is reviewed and analyzed quarterly with specific detailed reviews completed on all credits risk-rated less than “fair quality”, as described in Note 1 to the Consolidated Financial Statements contained in the Company's Annual Report  on Form 10-K for the year ended December 31, 2019, and carrying aggregate exposure in excess of $250 thousand. The adequacy of the allowance is monitored by the credit administration staff and reported to management and the board of directors.

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

As of

Internally Assigned Risk Rating *

    

June 30, 2020

    

March 31, 2020

    

December 31, 2019

    

June 30, 2019

 

(dollars in thousands)

Special Mention (Rating 6)

 

$

104,608

 

$

34,738

 

$

19,952

$

19,913

Substandard (Rating 7)

 

39,855

 

36,612

 

33,649

40,935

Doubtful (Rating 8)

 

 

 

 

$

144,463

 

$

71,350

 

$

53,601

$

60,848

Criticized Loans **

 

$

144,463

 

$

71,350

 

$

53,601

$

60,848

Classified Loans ***

 

$

39,855

 

$

36,612

 

$

33,649

$

40,935

Criticized Loans as a % of Total Loans/Leases

3.49

%

1.93

%

1.45

%

1.56

%

Classified Loans as a % of Total Loans/Leases

0.96

%

0.99

%

0.91

%

1.05

%

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

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

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

Criticized loans increased 102% and classified loans increased 9% from March 31, 2020 to June 30, 2020.  Criticized loans increased 170% during the first six months of 2020 primarily due to loans related to borrowers in industries impacted by COVID-19 including hotels.  Classified loan increased 18% during the first six months of 2020.  The increase in classified

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

loans was due to a few isolated relationships.    The Company continues its strong focus on improving credit quality in an effort to limit NPLs.

As of

    

June 30, 2020

    

March 31, 2020

    

December 31, 2019

    

June 30, 2019

Allowance / Gross Loans/Leases

 

1.47

%  

1.14

%  

0.98

%  

1.05

%

Allowance / NPLs

 

463.69

%  

310.72

%  

403.87

%  

283.10

%

Although management believes that the allowance at June 30, 2020 was at a level adequate to absorb losses on existing loans/leases, there can be no assurance that such losses will not exceed the estimated amounts or that the Company will not be required to make additional provisions in the future. Unpredictable future events could adversely affect cash flows for both commercial and individual borrowers, which could cause the Company to experience increases in problem assets, delinquencies and losses on loans/leases, and require further increases in the provision. Based on current economic indicators, the Company increased the economic allocations within the allowance for loan losses calculation.  The Company anticipates that the allowance for loan losses as a percent of total loans may increase in future periods based on the belief that the credit quality of the loan portfolio could decline and loan defaults may increase as a result of the COVID-19 pandemic.  Asset quality is a priority for the Company and its subsidiaries. The ability to grow profitably is in part dependent upon the ability to maintain that quality. The Company continually focuses efforts at its subsidiary banks and leasing company with the intention to improve the overall quality of the Company's loan/lease portfolio.

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

NONPERFORMING ASSETS

The table below presents the amount of NPAs and related ratios.

As of June 30, 

As of March 31, 

As of December 31, 

As of June 30, 

    

2020

    

2020

    

2019

    

2019

(dollars in thousands)

Nonaccrual loans/leases (1) (2)

$

12,099

$

11,628

$

7,902

$

13,148

Accruing loans/leases past due 90 days or more

 

99

 

1,419

 

33

 

58

TDRs - accruing

 

920

 

545

 

979

 

1,313

Total NPLs

 

13,118

 

13,592

 

8,914

 

14,519

OREO

 

157

 

3,298

 

4,129

 

8,637

Other repossessed assets

 

25

 

45

 

41

 

Total NPAs

$

13,300

$

16,935

$

13,084

$

23,156

NPLs to total loans/leases

    

 

0.32

%  

 

0.37

%  

 

0.24

%  

0.37

%  

NPAs to total loans/leases plus repossessed property

 

0.32

%  

 

0.46

%  

 

0.35

%  

0.59

%  

NPAs to total assets

 

0.24

%  

 

0.32

%  

 

0.27

%  

0.45

%  

(1)Includes government guaranteed portion of loans, as applicable.
(2)Includes TDRs of $352 thousand at June 30, 2020, $298 thousand at March 31, 2020, $747 thousand at December 31, 2019, and $2.8 million at June 30, 2019.

NPAs at June 30, 2020 were $13.3 million, down $3.6 million from March 31, 2020 and down $9.9 million from June 30, 2019.  The decrease in NPAs in the second quarter of 2020 was primarily due to the sale of one OREO property. The improvement from prior year was primarily attributed to the sale of RB&T.

The ratio of NPAs to total assets was 0.24% at June 30, 2020, down from 0.32% at March 31, 2020 and down from 0.45% at June 30, 2019.  

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

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

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

Due to the economic impacts of COVID-19, the Company established its LRP for its clients.  The LRP allows borrowers to request the deferral of principal and interest payments for an agreed upon term.  Those deferred payments will be added to the end of the original term of the loan through a three month extension of the maturity date.  The CARES Act includes provisions that allow financial institutions to elect to not apply GAAP requirements to loan modifications related to COVID-19 that would otherwise be categorized as a TDR, including arrangements that defer or delay payments of principal or interest for up to 90 days.  The relief from TDR guidance applies to modifications of loans that were not more than 30 days past due as of December 31, 2019, and that occur beginning on March 1, 2020 until the earlier of sixty days after the date on which the national emergency related to COVID-19 is terminated or December 31, 2020.  The Company expects that the majority of LRP participants will not be categorized as a TDR by meeting the CARES Act provisions. As of June 30, 2020, the program has provided 1,466 Bank modifications of loans to commercial and consumer clients totaling $491 million and 935 m2 modifications of loans and leases totaling $53 million, representing 11.86% and 1.2% of the total loan and lease portfolio, respectively.

DEPOSITS

Deposits increased $179.3 million during the second quarter of 2020, primarily due to an increase in noninterest bearing correspondent deposits, net of prepayment of large brokered certificates of deposits. The table below presents the composition of the Company's deposit portfolio.

As of

 

June 30, 2020

    

March 31, 2020

    

December 31, 2019

 

June 30, 2019

 

    

Amount

    

%

    

Amount

    

%

    

Amount

    

%

    

Amount

    

%

(dollars in thousands)

 

Noninterest bearing demand deposits

$

1,177,482

 

27

%  

$

829,782

 

20

%  

$

777,224

 

20

%  

$

795,951

 

18

%

Interest bearing demand deposits

 

2,488,755

 

57

%  

 

2,440,907

 

58

%  

 

2,407,502

 

61

%  

 

2,505,956

 

57

%

Time deposits

 

560,982

 

13

%  

 

617,979

 

15

%  

 

571,343

 

15

%  

 

733,135

 

17

%

Brokered deposits

 

122,556

 

3

%  

 

281,810

 

7

%  

 

154,982

 

4

%  

 

287,468

 

7

%

$

4,349,775

 

100

%  

$

4,170,478

 

100

%  

$

3,911,051

 

100

%  

$

4,322,510

 

100

%

Quarter-end balances can greatly fluctuate due to large customer and correspondent bank activity. During the quarter, the Company had significant core deposit growth mostly from its correspondent banking clients.  The outsized deposit growth exceeded the strong loan growth and led to the Company carrying excess liquidity during the quarter.  At the end of the quarter, a large portion of the outsized correspondent banking deposits shifted off balance sheet temporarily which prompted some overnight borrowing.  Subsequently, the majority of the balances have returned to the balance sheet. As a result of strong core deposit growth, the Company reduced its reliance on higher cost CDs and brokered deposits.

Management will continue to focus on growing its core deposit portfolio, including its correspondent banking business at QCBT, as well as shifting the mix from brokered and other higher cost deposits to lower cost core deposits. With the significant success achieved by QCBT in growing its correspondent banking business, QCBT has developed procedures to proactively monitor this industry concentration of deposits and loans. Other deposit-related industry concentrations and large accounts are monitored by the internal asset liability management committees.

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BORROWINGS

The subsidiary banks purchase federal funds for short-term funding needs from the FRB or from their correspondent banks. The table below presents the composition of the Company's short-term borrowings.

As of

    

June 30, 2020

    

March 31, 2020

    

December 31, 2019

    

June 30, 2019

 

(dollars in thousands)

Overnight repurchase agreements

$

2,368

$

2,377

$

2,193

$

2,181

Federal funds purchased

 

22,450

 

10,690

 

11,230

 

17,010

Overnight federal reserve borrowings

 

100,000

 

30,000

 

 

$

124,818

$

43,067

$

13,423

$

19,191

The Company's federal funds purchased and Federal Reserve borrowings fluctuate based on the short-term funding needs of the Company's subsidiary banks.  At the end of the quarter, a large portion of the outsized correspondent banking deposits shifted off balance sheet temporarily which prompted some overnight borrowing.  Subsequently, the majority of the balances have returned to the balance sheet.

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

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

As of

    

June 30, 2020

March 31, 2020

    

December 31, 2019

    

June 30, 2019

 

(dollars in thousands)

Term FHLB advances

 

$

90,000

$

55,000

 

$

50,000

 

$

46,433

Overnight FHLB advances

55,000

40,000

109,300

59,300

$

145,000

$

95,000

 

$

159,300

 

$

105,733

 

FHLB advances increased $50.0 million in the current quarter compared to the prior quarter due to the temporary liquidity need from the aforementioned temporary shift of excess liquidity straddling quarter-end.  All of the net growth in advances were either overnight or shorter term with maximum maturities of 3 months.

The Company renewed its revolving credit note in the second quarter of 2020.  At renewal, the line amount was increased from $20.0 million to $25.0 million.  The interest on the revolving line of credit is now calculated at a rate per annum equal to the greater of (a) Prime less 0.50% and (b) 3.00% per annum.  Prior to the renewal, the interest on the revolving line of credit was calculated at the effective LIBOR rate plus 2.25% per annum.  The collateral on the revolving line of credit is 100% of the outstanding stock of the Company’s bank subsidiaries.  There was no outstanding balance on the revolving line of credit at June 30, 2020.

The Company had subordinated notes totaling $68.5 million as of June 30, 2020, relatively unchanged from $68.4 million as of December 31, 2019.  

It is management's intention to reduce its reliance on wholesale funding, including FHLB advances and brokered deposits. Replacement of this funding with core deposits helps to reduce interest expense as wholesale funding tends to be higher cost. However, the Company may choose to utilize advances and/or brokered deposits to supplement funding needs, as this is a way for the Company to effectively and efficiently manage interest rate risk.

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The table below presents the maturity schedule including weighted average interest cost for the Company's combined wholesale funding portfolio (defined as FHLB advances and brokered deposits).

June 30, 2020

December 31, 2019

 

 

Weighted

 

Weighted

 

Average

 

Average

Maturity:

    

Amount Due

    

Interest Rate

    

Amount Due

    

Interest Rate

 

(dollars in thousands)

Year ending December 31:

2020

$

214,156

0.63

%  

$

200,110

0.85

%

2021

 

5,000

1.55

 

43,887

1.82

2022

28,400

1.65

50,285

1.79

2023

 

20,000

1.84

 

20,000

1.84

Total Wholesale Funding

 

$

267,556

0.85

%  

$

314,282

1.20

%

 

During the first six months of 2020, wholesale funding decreased $46.7 million as the Company grew core deposits to build on balance sheet liquidity and the Company used a portion of that excess liquidity to prepay brokered certificates of deposits. 

STOCKHOLDERS' EQUITY

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

As of

 

    

June 30, 2020

    

March 31, 2020

    

December 31, 2019

    

June 30, 2019

 

(dollars in thousands)

 

Common stock

$

15,791

$

15,774

$

15,828

$

15,773

Additional paid in capital

 

274,315

 

273,867

 

274,785

 

272,744

Retained earnings

 

267,081

 

254,287

 

245,836

 

216,741

AOCI (loss)

 

(1,167)

 

(4,789)

 

(1,098)

 

(958)

Total stockholders' equity

$

556,020

$

539,139

$

535,351

$

504,300

TCE / TA ratio (non-GAAP)

 

8.48

%  

 

8.76

%  

 

9.25

%  

 

8.05

%

*     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.

AOCI improved $3.6 million during the quarter for mark-to-market adjustments on interest rate caps and an interest rate swap on trust preferred securities and an increase in net unrealized gains on AFS securities portfolio.  Furthermore as it relates to the Company’s TCE/TA, the Company experienced net dilution as TCE/TA fell from 8.76% to 8.48% which was primarily driven by an inflated balance sheet at quarter-end.  Specifically, the balance sheet was inflated by PPP loans totaling $358.1 million. Excluding the impact of PPP loans, the adjusted TCE/TA at June 30, 2020 was 9.03% (non-GAAP). 

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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 $534.3 million during the second quarter of 2020 and $334.1 million during the first six months of 2020. The Company's on balance sheet liquidity position can fluctuate based on short-term activity in deposits and loans.

The Federal Reserve Bank has provided a lending facility that will allow the Company, if desired, to obtain funding specifically for loans that the Company makes under the PPP, which will allow the Company to retain existing sources of liquidity for traditional operations. The Company has been able to access available funding sources to address liquidity needs during the COVID-19 pandemic.

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

At June 30, 2020, the subsidiary banks had 29 lines of credit totaling $627.9 million, of which $294.4 million was secured and $333.5 million was unsecured. At June 30, 2020, the Company had $527.9 million of the $627.9 million available.

At December 31, 2019, the subsidiary banks had 27 lines of credit totaling $380.6 million, of which $45.3 million was secured and $335.3 million was unsecured. At December 31, 2019, the full $380.6 million was available.

The Company has emphasized growing the number and amount of lines of credit in an effort to strengthen this contingent source of liquidity. Additionally, the Company maintains a $25.0 million secured revolving credit note with a variable interest rate and a maturity of June 30, 2021. At June 30, 2020, the full $25.0 million was available.

As of June 30, 2020, the Company had $754.4 million in average correspondent banking deposits spread over 191 relationships. While the Company believes that these funds are relatively stable, there is the potential for large fluctuations that can impact liquidity. Seasonality and the liquidity needs of these correspondent banks can impact balances. Management closely monitors these fluctuations and runs stress scenarios to measure the impact on liquidity and interest rate risk with various levels of correspondent deposit run-off.

Investing activities used cash of $560.2 million during the first six months of 2020, compared to $197.1 million for the same period of 2019. The net decrease in federal funds sold was $7.7 million for the first six months of 2020, compared to a net decrease of $16.2 million for the same period of 2019. The net decrease in interest-bearing deposits at financial institutions was $7.1 million for the first six months of 2020, compared to a net increase of $62.1 million for the same period of 2019. Proceeds from calls, maturities, and paydowns of securities were $34.5 million for the first six months of 2020, compared to $33.0 million for the same period of 2019. Purchases of securities used cash of $171.1 million for the first six months of 2020, compared to $10.7 million for the same period of 2019. Proceeds from sales of securities were $6.3 million for the first six months of 2020, compared to $4.7 million in proceed from sales of securities for the first six months of 2019. The net increase in loans/leases used cash of $447.4 million for the first six months of 2020 compared to $176.4 million for the same period of 2019.

Financing activities provided cash of $530.6 million for the first six months of 2020, compared to $170.2 million for same period of 2019. Net increases in deposits totaled $409.0 million for the first six months of 2020, compared to $345.6 million for the same period of 2019. During the first six months of 2020, the Company's short-term borrowings increased

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$111.4 million, compared to a decrease in short-term borrowings of $9.6 million for the same period of 2019. Long-term FHLB advances increased $85.0 million during the first six months of 2020, compared to $5.0 million for the same period of 2020.  In the first six months of 2020, the Company decreased short-term and overnight FHLB advances by $59.3 million.  Maturities and principal payments on FHLB term advances totaled $40.0 million in the first six months of 2020. In the first six months of 2019, the Company decreased short-term and overnight FHLB advances by $130.9 million.  Maturities and principal payments on FHLB term advances totaled $35.0 million and on other borrowings totaled $11.9 million in the first six months of 2019.  Prepayments on other borrowings totaled $46.3 million in the first six months of 2019.  Prepayments on brokered and public time deposits totaled $29.2 million during the first six months of 2020.  During the first six months of 2019, proceeds from subordinated notes were $63.4 million.

Total cash provided by operating activities was $41.9 million for the first six months of 2020, compared to $29.3 million for the same period of 2019.

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

The Company (on a consolidated basis) and the subsidiary banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company and subsidiary banks' financial statements. Refer to Note 8 of the Consolidated Financial Statements for additional information regarding regulatory capital.

SPECIAL NOTE CONCERNING FORWARD-LOOKING STATEMENTS

This document (including information incorporated by reference) contains, and future oral and written statements of the Company and its management may contain, forward-looking statements, within the meaning of such term in the Private Securities Litigation Reform Act of 1995, with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company's management and on information currently available to management, are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “bode,” “predict,” “suggest,”  “project,” “appear,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should,” “likely,” or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events.

The Company's ability to predict results or the actual effect of future plans or strategies is inherently uncertain.  Factors that could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries include, but are not limited to, the following:

The strength of the local, state, and national economy (including the impact of the 2020 presidential election and the impact of tariffs, a U.S. withdrawal from or significant renegotiation of trade agreements, trade wars and other changes in trade regulation).
The economic impact of any future terrorist threats and attacks, widespread disease or pandemics (including the COVID-19 pandemic in the United States), or other adverse external events that could cause economic deterioration or instability in credit markets, and the response of the local, state and national governments to any such adverse events.

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Changes in accounting policies and practices, as may be adopted by state and federal regulatory agencies, the FASB, the SEC or the PCAOB (including the new CECL impairment standards, that will change how the Company estimates credit losses when implemented).
Changes in state and federal laws, regulations and governmental policies concerning the Company’s general business.
Changes in the interest rates and prepayment rates of the Company’s assets (including the impact of LIBOR phase-out.
Increased competition in the financial services sector and the inability to attract new customers.
Changes in  technology and the ability to develop and maintain secure and reliable electronic systems.
Unexpected results of acquisitions, which may include failure to realize the anticipated benefits of acquisitions and the possibility that transaction costs may be greater than anticipated.
The loss of key executives or employees.
Changes in consumer spending.
The costs, effects and outcomes of existing or future litigation.
The ability of the Company to manage the risks associated with the foregoing as well as anticipated.

These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. For a discussion of the factors that could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries, see the “Risk Factors” section included under Item 1A of Part I of the Company's Annual Report on Form 10-K for the year ended December 31, 2019.

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QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company, like other financial institutions, is subject to direct and indirect market risk. Direct market risk exists from changes in interest rates. The Company's net income is dependent on its net interest income. Net interest income is susceptible to interest rate risk to the degree that interest-bearing liabilities mature or reprice on a different basis than interest-earning assets. When interest-bearing liabilities mature or reprice more quickly than interest-earning assets in a given period, a significant increase in market rates of interest could adversely affect net interest income. Similarly, when interest-earning assets mature or reprice more quickly than interest-bearing liabilities, falling interest rates could result in a decrease in net interest income.

In an attempt to manage the Company's exposure to changes in interest rates, management monitors the Company's interest rate risk. Each subsidiary bank has an asset/liability management committee of the board of directors that meets quarterly to review the bank's interest rate risk position and profitability, and to make or recommend adjustments for consideration by the full board of each bank.

Internal asset/liability management teams consisting of members of the subsidiary banks' management meet weekly to manage the mix of assets and liabilities to maximize earnings and liquidity and minimize interest rate and other risks. Management also reviews the subsidiary banks' securities portfolios, formulates investment strategies, and oversees the timing and implementation of transactions to assure attainment of the board's objectives in an effective manner. Notwithstanding the Company's interest rate risk management activities, the potential for changing interest rates is an uncertainty that can have an adverse effect on net income.

In adjusting the Company's asset/liability position, the board of directors and management attempt to manage the Company's interest rate risk while maintaining or enhancing net interest margins. At times, depending on the level of general interest rates, the relationship between long-term and short-term interest rates, market conditions and competitive factors, the board of directors and management may decide to increase the Company's interest rate risk position somewhat in order to increase its net interest margin. The Company's results of operations and net portfolio values remain vulnerable to increases in interest rates and to fluctuations in the difference between long-term and short-term interest rates.

One method used to quantify interest rate risk is a short-term earnings at risk summary, which is a detailed and dynamic simulation model used to quantify the estimated exposure of net interest income to sustained interest rate changes. This simulation model captures the impact of changing interest rates on the interest income received and interest expense paid on all interest sensitive assets and liabilities reflected on the Company's consolidated balance sheet. This sensitivity analysis demonstrates net interest income exposure annually over a five-year horizon, assuming no balance sheet growth, no balance sheet mix change, and various interest rate scenarios including no change in rates; 100, 200, 300, and 400 basis point upward shifts; and a 100 and 200 basis point downward shifts in interest rates, where interest-bearing assets and liabilities reprice at their earliest possible repricing date.

The model assumes parallel and pro rata shifts in interest rates over a twelve-month period for the 200 basis point upward shift and 100 and 200 basis point downward shifts. For the 400 basis point upward shift, the model assumes a parallel and pro rata shift in interest rates over a twenty-four month period.

Further, in recent years, the Company added additional interest rate scenarios where interest rates experience a parallel and instantaneous shift  (“shock”) upward of 100, 200, 300, and 400 basis points and a parallel and instantaneous shock downward of 100 and 200 basis points. The Company will run additional interest rate scenarios on an as-needed basis.

The asset/liability management committees of the subsidiary bank boards of directors have established policy limits of a 10% decline in net interest income for the 200 basis point upward parallel shift and the 100 basis point downward parallel shift. For the 300 basis point upward shock, the established policy limit is a 25% decline in net interest income. The increased policy limit is appropriate as the shock scenario is extreme and unlikely and warrants a higher limit than the more realistic and traditional parallel/pro-rata shift scenarios.

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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

 

    

    

As of June 30, 

    

As of December 31, 

    

As of December 31, 

 

INTEREST RATE SCENARIO

POLICY LIMIT

 

2020

 

2019

 

2018

100 basis point downward shift

 

(10.0)

%  

0.6

%  

0.5

%  

0.7

%

200 basis point upward shift

 

(10.0)

%  

0.9

%  

1.2

%  

(2.7)

%

300 basis point upward shock

 

(25.0)

%  

7.2

%  

4.9

%  

(9.0)

%

The simulation is within the board-established policy limits for all three scenarios. Additionally, for all of the various interest rate scenarios modeled and measured by management (as described above), the results at June 30, 2020 were within established risk tolerances as established by policy or by best practice (if the interest rate scenario didn't have a specific policy limit).

Interest rate risk is considered to be one of the most significant market risks affecting the Company. For that reason, the Company engages the assistance of a national consulting firm and its risk management system to monitor and control the Company's interest rate risk exposure.  Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company's business activities.

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CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures. An evaluation was performed under the supervision and with the participation of the Company's management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) promulgated under the Exchange Act of 1934) as of June 30, 2020. Based on that evaluation, the Company's management, including the Chief Executive Officer and Chief Financial Officer, concluded that the Company's disclosure controls and procedures were effective, as of the end of the period covered by this report, to ensure that information required to be disclosed in the reports filed and submitted under the Exchange Act was recorded, processed, summarized and reported as and when required.

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

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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

In addition to the risk factors set forth under Part I, Item 1A “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, the following risk factors apply to the Company:

The outbreak of COVID-19 has led to an economic recession and other severe disruptions in the U.S. economy and has adversely disrupted banking and other financial activity and industries in the areas in which the Company operates.  As a result, we are starting to see the impact of COVID-19 on our business, and we believe that it could be significant, adverse and potentially material.

Currently, COVID-19 is spreading through the United States and the world. The spread of highly infectious or contagious diseases could cause, and the spread of COVID-19 has caused, severe disruptions in the U.S. economy at large, and for small businesses in particular, which could disrupt the Company’s operations. The resulting concerns on the part of the U.S. and global populations have resulted in a recessionary environment, reduced economic activity and caused significant volatility in the global stock markets. The Company has experienced disruptions across the Company’s business due to these effects, leading to decreased earnings and slowdowns in loan collections.

The outbreak of COVID-19 has resulted in a decline in our clients’ businesses, a decrease in consumer confidence, an increase in unemployment and a disruption in the services provided by our vendors.  Continued disruption to our clients’ businesses could result in increased risk of delinquencies, defaults, foreclosures and losses on our loans, declines in assets under management and wealth management revenues, negatively impact regional economic conditions, result in declines in local loan demand, liquidity of loan guarantors, loan collateral (particularly in real estate), loan originations and deposit availability and negatively impact the implementation of our growth strategy.  Although the U.S. government has introduced a number of programs designed to soften the impact of COVID-19 on small businesses, once these programs expire, our borrowers may not be able to satisfy their financial obligations to us.

COVID-19 has impacted and will likely continue to impact businesses’ and consumers’ financial ability to borrow money, which would negatively impact loan volumes. In addition, certain of the Company’s borrowers are in or have exposure to the hotel, restaurant, entertainment and retail  industries and are located in areas that are or were quarantined or under stay-at-home orders, and COVID-19 may also have an adverse effect on the Company’s direct lease financing, commercial real estate and consumer loan portfolios. Any new or prolonged quarantine or stay-at-home orders would have a negative adverse impact on these borrowers and their revenue streams, which consequently impacts their ability to meet their financial obligations and could result in loan defaults.

As a result of the COVID-19 pandemic we may experience adverse financial consequences due to a number of other factors, including, but not limited to:

a further and sustained decline in our stock price or the occurrence of what management would deem to be a triggering event that could, under certain circumstances, cause management to perform impairment testing on our goodwill and other intangible assets that could result in an impairment charge being

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recorded for that period, and adversely impact our results of operations and the ability of our subsidiary banks to pay dividends to us;
the negative effect on earnings resulting from the subsidiary banks modifying loans and agreeing to loan payment deferrals due to the COVID-19 crisis;
increased demand on our liquidity as we meet borrowers’ needs and cover expenses related to our business continuity plan;
the potential for reduced liquidity and its negative effect on our capital and leverage ratios;
increased cyber and payment fraud risk due to increased online and remote activity; and
other operational failures due to changes in our normal business practices because of the pandemic and governmental actions to contain it.

Overall, we believe that the economic impact from COVID-19 may be severe and could have a material and adverse impact on our business and result in significant losses in our loan portfolio, all of which would adversely and materially impact our earnings and capital.  Even after the COVID-19 pandemic has subsided, we may continue to experience materially adverse impacts to our business as a result of the global economic impact of the COVID-19 pandemic, including the availability of credit, adverse impacts on liquidity and any recession that has occurred or may occur in the future.  There are no comparable recent events that provide guidance as to the effect of the spread of COVID-19 as a global pandemic may have, and as a result, the ultimate impact of the pandemic is highly uncertain and subject to change.

The U.S. government and banking regulators, including the Federal Reserve, have taken a number of unprecedented actions in response to the COVID-19 pandemic, which could ultimately have a material adverse effect on our business and results of operations.

On March 27, 2020, President Trump signed into law the CARES Act, which established a $2.0 trillion economic stimulus package, including cash payments to individuals, supplemental unemployment insurance benefits and a $349 billion loan program administered through the SBA, referred to as the PPP.  In addition to implementing the programs contemplated by the CARES Act, the federal bank regulatory agencies have issued a steady stream of guidance in response to the COVID-19 pandemic and have taken a number of unprecedented steps to help banks navigate the pandemic and mitigate its impact. These include, without limitation:

requiring banks to focus on business continuity and pandemic planning;
adding pandemic scenarios to stress testing;
encouraging bank use of capital buffers and reserves in lending programs;
permitting certain regulatory reporting extensions;
reducing margin requirements on swaps;
permitting certain otherwise prohibited investments in investment funds;
issuing guidance to encourage banks to work with customers affected by the pandemic and encourage loan workouts; and
providing credit under the CRA for certain pandemic-related loans, investments and public service.

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The COVID-19 pandemic has significantly affected the financial markets, and the Federal Reserve has taken a number of actions in response. In March 2020, the Federal Reserve dramatically reduced the target federal funds rate and announced a $700 billion quantitative easing program in response to the expected economic downturn caused by the COVID-19 pandemic. In addition, the Federal Reserve reduced the interest that it pays on excess reserves. We expect that these reductions in interest rates, especially if prolonged, could adversely affect our net interest income and margins and our profitability. The Federal Reserve also launched the Main Street Lending Program, which will offer deferred interest on four-year loans to small and mid-sized businesses. The full impact of the COVID-19 pandemic on our business activities as a result of new government and regulatory laws, policies, programs and guidelines, as well as market reactions to such activities, remains uncertain but may ultimately have a material adverse effect on our business and results of operations.

COVID-19 has disrupted banking and other financial activities in the areas in which we operate and could potentially create widespread business continuity issues for us.  

The COVID-19 pandemic has negatively impacted the ability of our employees and clients to engage in banking and other financial transactions in the geographic area in which we operate and could create widespread business continuity issues for us. We also could be adversely affected if key personnel or a significant number of employees were to become unavailable due to the effects and restrictions of an outbreak or escalation of the COVID-19 pandemic in our market area, including because of illness, quarantines, government actions or other restrictions in connection with the COVID-19 pandemic. Although we have business continuity plans and other safeguards in place, there is no assurance that such plans and safeguards will be effective.  Further, we rely upon our third-party vendors to conduct business and to process, record, and monitor transactions. If any of these vendors are unable to continue to provide us with these services, it could negatively impact our ability to serve our clients.

As a participating lender in the PPP, the Company and the subsidiary banks are subject to additional risks of litigation from our customers or other parties regarding our processing of loans for the PPP and risks that the SBA may not fund some or all PPP loan guaranties.

The CARES Act included a $349 billion loan program administered through the SBA referred to as the PPP. Under the PPP, small businesses and other entities and individuals can apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. The subsidiary banks are participating as lenders in the PPP.  The PPP opened on April 3, 2020; however, because of the short timeframe between the passing of the CARES Act and the opening of the PPP, there is some ambiguity in the laws, rules and guidance regarding the operation of the PPP, which exposes the Company to risks relating to noncompliance with the PPP. On or about April 16, 2020, the SBA notified lenders that the $349 billion earmarked for the PPP was exhausted. Congress has authorized an additional $310 billion funding for PPP loans; however, it is unknown if and when this the additional authorized amount will be exhausted and whether Congress will again authorize additional PPP loan funding.

Since the opening of the PPP, several other larger banks have been subject to litigation regarding the process and procedures that such banks used in processing applications for the PPP and claims related to agent fees.  The Company and the subsidiary banks may be exposed to the risk of similar litigation, from both customers and non-customers that approached the banks regarding PPP loans, regarding their process and procedures used in processing applications for the PPP. If any such litigation is filed against the Company or the subsidiary banks and is not resolved in a manner favorable to the Company or the banks, it may result in significant financial liability or adversely affect the Company’s reputation. In addition, litigation can be costly, regardless of outcome. Any financial liability, litigation costs or reputational damage caused by PPP related litigation could have a material adverse impact on our business, financial condition and results of operations.

The subsidiary banks also have credit risk on PPP loans if a determination is made by the SBA that there is a deficiency in the manner in which the loan was originated, funded, or serviced by the banks, such as an

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issue with the eligibility of a borrower to receive a PPP loan, which may or may not be related to the ambiguity in the laws, rules and guidance regarding the operation of the PPP. In the event of a loss resulting from a default on a PPP loan and a determination by the SBA that there was a deficiency in the manner in which the PPP loan was originated, funded, or serviced by the Company, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of any loss related to the deficiency from the Company.

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Item 2           Unregistered Sales of Equity Securities and Use of Proceeds

On February 13, 2020, the Board of Directors of the Company approved a share repurchase program under which the Company is authorized to repurchase, from time to time as the Company deems appropriate, up to 800,000 shares of its outstanding common stock, or approximately 5% of the outstanding shares as of December 31, 2019.  The Company suspended the repurchase of shares on March 16, 2020 due to the uncertainties related to the COVID-19 pandemic and it is uncertain when the Company will resume the repurchase of shares as part of this program in the future. All shares repurchased under the share repurchase program were retired.

Total number of shares

Maximum number

 

purchased as part of

of shares that may yet

    

Total number of

Average price

publicly announced

be purchased under

 

Period

shares purchased

 

paid per share

 

plans or programs

 

the plans or programs

April 1-30, 2020

100,932

699,068

May 1-31, 2020

100,932

699,068

June 1-30, 2020

100,932

699,068

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

Item 6           Exhibits

31.1

Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a).

31.2

Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a).

32.1

Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2

Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101

Inline XBRL Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets as of June 30, 2020 and December 31, 2019; (ii) Consolidated Statements of Income for the three and six months ended June 30, 2020 and June 30, 2019; (iii) Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2020 and June 30, 2019; (iv) Consolidated Statements of Changes in Stockholders' Equity for the three and months ended June 30, 2020 and June 30, 2019; (v) Consolidated Statements of Cash Flows for the six months ended June 30, 2020 and June 30, 2019; and (vi) Notes to the Consolidated Financial Statements.

104

Inline XBRL cover page interactive data file pursuant to Rule 406 of Regulation S-T for the interactive data files referenced in Exhibit 101.

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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

 August 7, 2020

/s/ Larry J. Helling

Larry J. Helling

Chief Executive Officer

Date

August 7, 2020

/s/ Todd A. Gipple

Todd A. Gipple, President

Chief Operating Officer

Chief Financial Officer

Date

August 7, 2020

/s/ Nick W. Anderson

Nick W. Anderson

Chief Accounting Officer

(Principal Accounting Officer)

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