qcrh20160818_10q.htm

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

For the quarterly period ended September 30, 2016

 

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

For the transition period from           to________

 

Commission file number 0-22208

 

QCR HOLDINGS, INC.

(Exact name of Registrant as specified in its charter)

 

Delaware 42-1397595

(State or other jurisdiction of incorporation or organization) 

(I.R.S. Employer Identification No.) 

                           

3551 7th Street, Moline, Illinois 61265

(Address of principal executive offices, including zip code)

 

(309) 743-7724

(Registrant’s telephone number, including area code)

 

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

 

Yes      [ X ]          No [   ]

   

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

 

Yes      [ X ]          No [   ]

 

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

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

 

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

 

Yes [   ]          No [ X ] 

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date: As of November 2, 2016, the Registrant had outstanding 13,075,670 shares of common stock, $1.00 par value per share.

 

 
 

 

  

QCR HOLDINGS, INC. AND SUBSIDIARIES

 

TABLE OF CONTENTS

 

       

Page

Number(s)

Part I

FINANCIAL INFORMATION

   
         
 

Item 1        Consolidated Financial Statements (Unaudited)

   
         
   

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

 

                   3

         
   

Consolidated Statements of Income For the Three Months Ended September 30, 2016 and 2015

    4
         
   

Consolidated Statements of Income For the Nine Months Ended September 30, 2016 and 2015

    5
         
   

Consolidated Statements of Comprehensive Income For the Three and Nine Months Ended September 30, 2016 and 2015

    6
         
   

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

    7
         
   

Consolidated Statements of Cash Flows For the Nine Months Ended September 30, 2016 and 2015

    9
         
   

Notes to Consolidated Financial Statements

   
         
   

Note 1. Summary of Significant Accounting Policies

 

                 11

   

Note 2. Investment Securities

 

                 13

   

Note 3. Loans/Leases Receivable

 

                 18

   

Note 4. Borrowings

 

                 28

   

Note 5. Earnings Per Share

 

30

   

Note 6. Fair Value

 

31

   

Note 7. Business Segment Information

 

34

   

Note 8. Regulatory Capital Requirements

 

36

   

Note 9. Acquisition of Community State Bank and Common Stock Offering

 

                 38

   

Note 10. Related Party Transactions

 

                 41

         
 

Item 2        Management's Discussion and Analysis of Financial Condition and Results of Operations

   
         
   

Introduction

 

                 42

   

General

 

                 42

   

Executive Overview

 

                 43

   

Long-Term Financial Goals

 

                 44

   

Strategic Developments

 

                 45

   

GAAP to Non-GAAP Reconciliations

 

                 47

   

Net Interest Income (Tax Equivalent Basis)

 

                 49

   

Critical Accounting Policies

 

                 54

 

 
1

 

 

   

Results of Operations

   
   

Interest Income

 

                 55

   

Interest Expense

 

                 55

   

Provision for Loan/Lease Losses

 

                 56

   

Noninterest Income

 

                 57

   

Noninterest Expense

 

                 61

   

Income Taxes

 

                 63

   

Financial Condition

 

                 64

   

Investment Securities

 

                 64

   

Loans/Leases

 

                 66

   

Allowance for Estimated Losses on Loans/Leases

 

                 68

   

Nonperforming Assets

 

                 70

   

Deposits

 

                 71

   

Borrowings

 

                 71

   

Stockholders' Equity

 

                 73

   

Liquidity and Capital Resources

 

                 73

   

Special Note Concerning Forward-Looking Statements

 

                 76

         
 

Item 3        Quantitative and Qualitative Disclosures About Market Risk

 

                 77

         
 

Item 4        Controls and Procedures

 

                 79

         

Part II

OTHER INFORMATION

   
         
 

Item 1        Legal Proceedings

 

                 80

         
 

Item 1A     Risk Factors

 

                 80

         
 

Item 2        Unregistered Sales of Equity Securities and Use of Proceeds

 

                 80

         
 

Item 3        Defaults upon Senior Securities

 

                 80

         
 

Item 4        Mine Safety Disclosures

 

                 80

         
 

Item 5        Other Information

 

                 80

         
 

Item 6        Exhibits

 

                 81

         

Signatures

 

 

 

                 82

 

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

 

 
2

 

 

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

As of September 30, 2016 and December 31, 2015

 

   

September 30,

   

December 31,

 
   

2016

   

2015

 

ASSETS

               

Cash and due from banks

  $ 61,213,134     $ 41,742,321  

Federal funds sold

    21,022,000       19,850,000  

Interest-bearing deposits at financial institutions

    75,025,417       36,313,965  
                 

Securities held to maturity, at amortized cost

    306,740,174       253,674,159  

Securities available for sale, at fair value

    258,190,081       323,434,982  

Total securities

    564,930,255       577,109,141  
                 

Loans receivable held for sale

    1,377,875       565,850  

Loans/leases receivable held for investment

    2,359,222,637       1,797,456,825  

Gross loans/leases receivable

    2,360,600,512       1,798,022,675  

Less allowance for estimated losses on loans/leases

    (28,826,835 )     (26,140,906 )

Net loans/leases receivable

    2,331,773,677       1,771,881,769  
                 

Bank-owned life insurance

    56,810,035       55,485,655  

Premises and equipment, net

    59,484,141       37,350,352  

Restricted investment securities

    14,999,425       14,835,925  

Other real estate owned, net

    5,807,603       7,150,658  

Goodwill

    13,631,626       3,222,688  

Core deposit intangible

    7,613,593       1,471,409  

Other assets

    68,675,203       26,784,392  

Total assets

  $ 3,280,986,109     $ 2,593,198,275  
                 

LIABILITIES AND STOCKHOLDERS' EQUITY

               

LIABILITIES

               

Deposits:

               

Noninterest-bearing

  $ 764,614,548     $ 615,292,211  

Interest-bearing

    1,830,298,205       1,265,373,973  

Total deposits

    2,594,912,753       1,880,666,184  
                 

Short-term borrowings

    60,015,417       144,662,716  

Federal Home Loan Bank advances

    138,642,529       151,000,000  

Other borrowings

    80,000,000       110,000,000  

Junior subordinated debentures

    33,446,578       38,499,052  

Other liabilities

    93,111,672       42,484,573  

Total liabilities

    3,000,128,949       2,367,312,525  
                 

STOCKHOLDERS' EQUITY

               

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

    -       -  

September 2016 and December 2015 - No shares issued or outstanding

               

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

    13,075,307       11,761,083  

September 2016 - 13,075,307 shares issued and outstanding

               

December 2015 - 11,761,083 shares issued and outstanding

               

Additional paid-in capital

    155,950,678       123,282,851  

Retained earnings

    110,610,144       92,965,645  

Accumulated other comprehensive income (loss):

               

Securities available for sale

    2,379,584       (1,324,408 )

Interest rate cap derivatives

    (1,158,553 )     (799,421 )

Total stockholders' equity

    280,857,160       225,885,750  

Total liabilities and stockholders' equity

  $ 3,280,986,109     $ 2,593,198,275  

 

See Notes to Consolidated Financial Statements (Unaudited)

 

 
3

 

 

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

Three Months Ended September 30,

 

   

2016

   

2015

 

Interest and dividend income:

               

Loans/leases, including fees

  $ 23,001,107     $ 19,278,335  

Securities:

               

Taxable

    1,057,204       1,639,534  

Nontaxable

    2,510,169       2,021,804  

Interest-bearing deposits at financial institutions

    103,216       66,604  

Restricted investment securities

    132,047       127,172  

Federal funds sold

    12,992       7,663  

Total interest and dividend income

    26,816,735       23,141,112  
                 

Interest expense:

               

Deposits

    1,472,031       1,140,419  

Short-term borrowings

    12,541       63,815  

Federal Home Loan Bank advances

    420,570       537,473  

Other borrowings

    974,634       944,903  

Junior subordinated debentures

    306,182       316,976  

Total interest expense

    3,185,958       3,003,586  
                 

Net interest income

    23,630,777       20,137,526  
                 

Provision for loan/lease losses

    1,607,986       1,635,263  

Net interest income after provision for loan/lease losses

    22,022,791       18,502,263  
                 

Noninterest income:

               

Trust department fees

    1,518,600       1,531,964  

Investment advisory and management fees

    765,977       782,442  

Deposit service fees

    1,150,869       984,631  

Gains on sales of residential real estate loans, net

    144,105       84,609  

Gains on sales of government guaranteed portions of loans, net

    218,785       759,668  

Swap fee income

    333,772       62,700  

Securities gains, net

    4,251,773       56,580  

Earnings on bank-owned life insurance

    450,251       407,018  

Debit card fees

    475,182       333,144  

Correspondent banking fees

    253,823       310,759  

Participation service fees on commercial loan participations

    237,456       201,822  

Fee income from early termination of leases

    95,129       89,332  

Credit card issuing fees

    137,620       133,904  

Lawsuit award

    -       387,045  

Other

    390,059       277,068  

Total noninterest income

    10,423,401       6,402,686  
                 

Noninterest expense:

               

Salaries and employee benefits

    11,202,460       10,583,361  

Occupancy and equipment expense

    2,086,331       1,863,648  

Professional and data processing fees

    1,931,329       1,742,268  

Acquisition costs

    2,046,036       -  

FDIC insurance, other insurance and regulatory fees

    582,835       702,136  

Loan/lease expense

    102,678       90,415  

Net cost of operations of other real estate

    133,055       (1,117,671 )

Advertising and marketing

    547,768       460,411  

Postage and communications

    237,569       220,895  

Stationery and supplies

    167,887       144,967  

Bank service charges

    415,401       392,352  

Losses on debt extinguishment, net

    4,137,310       -  

Correspondent banking expense

    205,998       176,977  

Other

    683,826       687,332  

Total noninterest expense

    24,480,483       15,947,091  
                 

Net income before income taxes

    7,965,709       8,957,858  

Federal and state income tax expense

    1,858,208       2,468,871  
                 

Net income

  $ 6,107,501     $ 6,488,987  
                 

Basic earnings per common share

  $ 0.47     $ 0.55  

Diluted earnings per common share

  $ 0.46     $ 0.55  
                 

Weighted average common shares outstanding

    13,066,777       11,713,993  

Weighted average common and common equivalent shares outstanding

    13,269,703       11,875,930  
                 

Cash dividends declared per common share

  $ 0.04     $ -  

 

See Notes to Consolidated Financial Statements (Unaudited) 

 

 
4

 

 

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

Nine Months Ended September 30,

 

   

2016

   

2015

 

Interest and dividend income:

               

Loans/leases, including fees

  $ 62,939,656     $ 55,528,578  

Securities:

               

Taxable

    3,605,948       5,317,794  

Nontaxable

    7,028,387       5,642,692  

Interest-bearing deposits at financial institutions

    225,775       208,323  

Restricted investment securities

    396,157       377,651  

Federal funds sold

    36,155       18,416  

Total interest and dividend income

    74,232,078       67,093,454  
                 

Interest expense:

               

Deposits

    4,106,227       3,296,351  

Short-term borrowings

    73,672       181,084  

Federal Home Loan Bank advances

    1,278,207       2,982,834  

Other borrowings

    2,624,154       3,285,231  

Junior subordinated debentures

    912,706       937,375  

Total interest expense

    8,994,966       10,682,875  
                 

Net interest income

    65,237,112       56,410,579  
                 

Provision for loan/lease losses

    4,878,821       5,694,384  

Net interest income after provision for loan/lease losses

    60,358,291       50,716,195  
                 

Noninterest income:

               

Trust department fees

    4,606,590       4,676,535  

Investment advisory and management fees

    2,117,100       2,250,918  

Deposit service fees

    3,028,758       2,790,456  

Gains on sales of residential real estate loans, net

    288,904       266,284  

Gains on sales of government guaranteed portions of loans, net

    2,701,203       899,987  

Swap fee income

    1,358,312       1,182,630  

Securities gains, net

    4,628,283       473,513  

Earnings on bank-owned life insurance

    1,324,380       1,318,909  

Debit card fees

    1,126,581       912,030  

Correspondent banking fees

    800,892       915,759  

Participation service fees on commercial loan participations

    694,175       647,598  

Fee income from early termination of leases

    172,922       250,892  

Credit card issuing fees

    413,348       403,713  

Lawsuit award

    -       387,045  

Other

    746,827       775,142  

Total noninterest income

    24,008,275       18,151,411  
                 

Noninterest expense:

               

Salaries and employee benefits

    32,920,840       32,709,765  

Occupancy and equipment expense

    5,797,875       5,507,533  

Professional and data processing fees

    4,921,064       4,683,480  

Acquisition costs

    2,401,005       -  

FDIC insurance, other insurance and regulatory fees

    1,866,804       2,151,756  

Loan/lease expense

    419,846       601,888  

Net cost of operations of other real estate

    513,149       (1,088,696 )

Advertising and marketing

    1,367,478       1,368,152  

Postage and communications

    711,226       683,993  

Stationery and supplies

    490,682       424,330  

Bank service charges

    1,246,682       1,088,806  

Losses on debt extinguishment, net

    4,220,507       6,894,185  

Correspondent banking expense

    564,763       517,770  

Other

    1,736,813       1,775,637  

Total noninterest expense

    59,178,734       57,318,599  
                 

Net income before income taxes

    25,187,832       11,549,007  

Federal and state income tax expense

    6,030,375       1,405,949  
                 

Net income

  $ 19,157,457     $ 10,143,058  
                 

Basic earnings per common share

  $ 1.55     $ 1.03  

Diluted earnings per common share

  $ 1.52     $ 1.01  
                 

Weighted average common shares outstanding

    12,398,491       9,878,882  

Weighted average common and common equivalent shares outstanding

    12,580,042       10,024,441  
                 

Cash dividends declared per common share

  $ 0.12     $ 0.04  

 

See Notes to Consolidated Financial Statements (Unaudited)

 

 
5

 

 

QCR HOLDINGS, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

Three and Nine Months Ended September 30, 2016 and 2015

 

    Three Months Ended September 30,  
    2016     2015  

Net income

  $ 6,107,501     $ 6,488,987  
                 

Other comprehensive income (loss):

               
                 

Unrealized gains (losses) on securities available for sale:

               

Unrealized holding gains arising during the period before tax

    3,682,514       4,155,252  

Less reclassification adjustment for gains included in net income before tax

    4,251,773       56,580  
      (569,259 )     4,098,672  

Unrealized losses on interest rate cap derivatives:

               

Unrealized holding losses arising during the period before tax

    (16,327 )     (419,219 )

Less reclassification adjustment for ineffectiveness and caplet amortization before tax

    33,246       20,099  
      (49,573 )     (439,318 )
                 

Other comprehensive income (loss), before tax

    (618,832 )     3,659,354  

Tax expense (benefit)

    (257,648 )     1,402,871  

Other comprehensive income (loss), net of tax

    (361,184 )     2,256,483  
                 

Comprehensive income

  $ 5,746,317     $ 8,745,470  

 

 

    Nine Months Ended September 30,  
   

2016

   

2015

 

Net income

  $ 19,157,457     $ 10,143,058  
                 

Other comprehensive income:

               
                 

Unrealized gains on securities available for sale:

               

Unrealized holding gains arising during the period before tax

    10,628,032       4,598,599  

Less reclassification adjustment for gains included in net income before tax

    4,628,283       473,513  
      5,999,749       4,125,086  

Unrealized losses on interest rate cap derivatives:

               

Unrealized holding losses arising during the period before tax

    (552,510 )     (672,169 )

Less reclassification adjustment for ineffectiveness and caplet amortization before tax

    82,281       30,562  
      (634,791 )     (702,731 )
                 

Other comprehensive income, before tax

    5,364,958       3,422,355  

Tax expense

    2,020,098       1,323,928  

Other comprehensive income, net of tax

    3,344,860       2,098,427  
                 

Comprehensive income

  $ 22,502,317     $ 12,241,485  

 

See Notes to Consolidated Financial Statements (Unaudited) 

 

 
6

 

 

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED)

Three and Nine Months Ended September 30, 2016 and 2015

 

                           

Accumulated

         
           

Additional

           

Other

         
   

Common

   

Paid-In

   

Retained

   

Comprehensive

         
   

Stock

   

Capital

   

Earnings

   

Income (Loss)

   

Total

 

Balance December 31, 2015

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

Net income

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

Other comprehensive income, net of tax

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

Common cash dividends declared, $0.04 per share

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

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

    5,054       94,560       -       -       99,614  

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

    46,020       729,473       -       -       775,493  

Stock compensation expense

    -       382,761                       382,761  

Tax benefit of nonqualified stock options exercised

    -       22,508       -       -       22,508  

Restricted stock awards

    22,382       (22,382 )     -       -       -  

Exchange of 15,689 shares of common stock in connection with stock options exercised

    (15,689 )     (346,834 )                     (362,523 )

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

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

Balance March 31, 2016

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

Net income

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

Other comprehensive income, net of tax

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

Common cash dividends declared, $0.04 per share

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

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

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

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

    6,982       142,887       -       -       149,869  

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

    20,975       230,671       -       -       251,646  

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

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

Stock compensation expense

    -       187,569                       187,569  

Tax benefit of nonqualified stock options exercised

    -       87,858       -       -       87,858  

Restricted stock awards

    (500 )     500       -       -       -  

Balance June 30, 2016

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

Net income

    -       -       6,107,501       -       6,107,501  

Other comprehensive loss, net of tax

    -       -       -       (361,184 )     (361,184 )

Common cash dividends declared, $0.04 per share

    -       -       (521,384 )     -       (521,384 )

Proceeds from issuance of 4,085 shares of common stock as a result of stock purchased under the Employee Stock Purchase Plan

    4,085       85,217       -       -       89,302  

Proceeds from issuance of 14,692 shares of common stock as a result of stock options exercised

    14,692       173,890       -       -       188,582  

Stock compensation expense

    -       190,211       -       -       190,211  

Tax benefit of nonqualified stock options exercised

    -       72,694       -       -       72,694  

Exchange of 838 shares of common stock in connection with stock options exercised

    (838 )     (25,115 )     -       -       (25,953 )

Balance September 30, 2016

  $ 13,075,307     $ 155,950,678     $ 110,610,144     $ 1,221,031     $ 280,857,160  

 

(Continued)

 

 
7

 

 

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED) - continued

Three and Nine Months Ended September 30, 2016 and 2015

 

                           

Accumulated

                 
           

Additional

           

Other

                 
   

Common

   

Paid-In

   

Retained

   

Comprehensive

   

Treasury

         
   

Stock

   

Capital

   

Earnings

   

Income (Loss)

   

Stock

   

Total

 

Balance December 31, 2014

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

Net income

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

Other comprehensive income, net of tax

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

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

    5,679       82,641       -       -       -       88,320  

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

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

Stock compensation expense

    -       367,775       -       -       -       367,775  

Tax benefit of nonqualified stock options exercised

    -       15,651       -       -       -       15,651  

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

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

Restricted stock awards

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

Balance March 31, 2015

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

Net loss

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

Other comprehensive loss, net of tax

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

Common cash dividends declared, $0.04 per share

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

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

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

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

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

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

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

Tax benefit of nonqualified stock options exercised

    -       15,827       -       -       -       15,827  

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

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

Stock compensation expense

    -       186,751       -       -       -       186,751  

Restricted stock awards

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

Balance June 30, 2015

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

Net income

    -       -       6,488,987       -       -       6,488,987  

Other comprehensive income, net of tax

    -       -       -       2,256,483       -       2,256,483  

Adjustment to common cash dividends declared

    -       -       (1,393 )     -       -       (1,393 )

Proceeds from issuance of 5,394 shares of common stock as a result of stock purchased under the Employee Stock Purchase Plan

    5,394       81,309       -       -       -       86,703  

Proceeds from issuance of 24,711 shares of common stock as a result of stock options exercised

    24,711       318,732       -       -       -       343,443  

Tax benefit of nonqualified stock options exercised

    -       39,632       -       -       -       39,632  

Retirement of treasury stock, 121,246 shares of common stock

    (121,246 )     (580,886 )     (904,378 )     -       1,606,510       -  

Stock compensation expense

    -       203,967       -       -       -       203,967  

Restricted stock awards

    228       (228 )     -       -       -       -  

Balance September 30, 2015

  $ 11,728,911     $ 122,573,712     $ 86,649,405     $ 163,211     $ -     $ 221,115,239  

 

See Notes to Consolidated Financial Statements (Unaudited) 

 

 
8

 

 

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

Nine Months Ended September 30, 2016 and 2015

 

   

2016

   

2015

 

CASH FLOWS FROM OPERATING ACTIVITIES

               

Net income

  $ 19,157,457     $ 10,143,058  

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

               

Depreciation

    2,422,257       2,283,558  

Provision for loan/lease losses

    4,878,821       5,694,384  

Stock-based compensation expense

    760,541       758,493  

Deferred compensation expense accrued

    910,439       767,292  

Losses (gains) on other real estate owned, net

    130,280       (1,204,016 )

Amortization of premiums on securities, net

    968,553       756,876  

Securities gains, net

    (4,628,283 )     (473,513 )

Loans originated for sale

    (57,160,485 )     (29,968,289 )

Proceeds on sales of loans

    59,838,717       31,154,335  

Gains on sales of residential real estate loans

    (288,904 )     (266,284 )

Gains on sales of government guaranteed portions of loans

    (2,701,203 )     (899,987 )

Losses on debt extinguishment, net

    4,220,507       6,894,185  

Amortization of core deposit intangible

    210,469       149,634  

Accretion of acquisition fair value adjustments, net

    (690,379 )     (334,990 )

Increase in cash value of bank-owned life insurance

    (1,324,380 )     (1,318,909 )

Increase in other assets

    (2,480,461 )     (5,211,555 )

Decrease in other liabilities

    1,614,477       4,269,482  

Net cash provided by operating activities

  $ 25,838,423     $ 23,193,754  
                 

CASH FLOWS FROM INVESTING ACTIVITIES

               

Net decrease (increase) in federal funds sold

    (474,000 )     12,450,000  

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

    (23,981,295 )     3,059,051  

Proceeds from sales of other real estate owned

    1,913,775       6,774,151  

Activity in securities portfolio:

               

Purchases

    (111,622,489 )     (200,249,686 )

Calls, maturities and redemptions

    109,421,584       187,029,003  

Paydowns

    21,939,878       11,859,406  

Sales

    87,772,898       65,889,838  

Activity in restricted investment securities:

               

Purchases

    (25,700 )     (2,806,650 )

Redemptions

    1,375,100       3,435,200  

Net increase in loans/leases originated and held for investment

    (144,605,204 )     (129,356,790 )

Purchase of premises and equipment

    (3,871,166 )     (4,327,671 )

Net cash paid for Community State Bank acquisition

    (69,905,355 )     -  

Net cash used in investing activities

  $ (132,061,974 )   $ (46,244,148 )
                 

CASH FLOWS FROM FINANCING ACTIVITIES

               

Net increase in deposit accounts

    227,918,002       175,656,866  

Net decrease in short-term borrowings

    (84,647,299 )     (100,787,458 )

Activity in Federal Home Loan Bank advances:

               

Term advances

    -       5,000,000  

Calls and maturities

    (19,000,000 )     (24,000,000 )

Net change in short-term and overnight advances

    1,300,000       24,000,000  

Prepayments

    (10,524,197 )     (81,192,185 )

Activity in other borrowings:

               

Proceeds from other borrowings

    35,000,000       -  

Calls, maturities and scheduled principal payments

    -       (7,350,000 )

Prepayments

    (50,320,407 )     (29,177,000 )

Retirement of junior subordinated debentures

    (3,955,000 )     -  

Payment of cash dividends on common stock

    (1,460,157 )     (782,054 )

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

    -       63,484,123  

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

    29,828,916       -  

Proceeds from issuance of common stock, net

    1,554,506       1,016,324  

Net cash provided by financing activities

  $ 125,694,364     $ 25,868,616  
                 

Net increase in cash and due from banks

    19,470,813       2,818,222  

Cash and due from banks, beginning

    41,742,321       38,235,019  

Cash and due from banks, ending

  $ 61,213,134     $ 41,053,241  

 

(Continued)

 

 
9

 

 

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) - continued

Nine Months Ended September 30, 2016 and 2015

 

   

2016

   

2015

 

Supplemental disclosure of cash flow information, cash payments for:

               

Interest

  $ 9,081,850     $ 10,880,589  
                 

Income/franchise taxes

  $ 9,487,002     $ 1,985,275  
                 

Supplemental schedule of noncash investing activities:

               

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

  $ 3,344,860     $ 2,098,427  
                 

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

  $ (477,387 )   $ (68,706 )
                 

Tax benefit of nonqualified stock options exercised

  $ 183,060     $ 71,110  
                 

Transfers of loans to other real estate owned

  $ 51,000     $ 942,782  
                 

Due from broker for sales of securities

  $ 32,078,011     $ -  
                 

Due to broker for purchases of securities

  $ 15,190,000     $ -  
                 

Due to counterparties for prepayment of FHLB advances and other borrowings

  $ (24,575,903 )   $ -  
                 

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

  $ 2,132,415     $ -  
                 

Supplemental disclosure of cash flow information for Community State Bank acquisition:

               

Fair value of assets acquired:

               

Cash and due from banks *

  $ 10,094,645     $ -  

Federal funds sold

    698,000       -  

Interest-bearing deposits at financial institutions

    14,730,157       -  

Securities

    102,640,029       -  

Loans/leases receivable held for investment, net

    419,029,277       -  

Premises and equipment, net

    20,684,880       -  

Core deposit intangible

    6,352,653       -  

Restricted investment securities

    1,512,900       -  

Other real estate owned

    650,000       -  

Other assets

    4,763,224       -  

Total assets acquired

  $ 581,155,765     $ -  
                 

Fair value of liabilities assumed:

               

Deposits

  $ 486,298,262     $ -  

FHLB advances

    20,368,877       -  

Other liabilities

    4,897,564       -  

Total liabilities assumed

  $ 511,564,703     $ -  
                 

Net assets acquired

  $ 69,591,062     $ -  

Consideration paid:

               

Cash paid *

  $ 80,000,000     $ -  

Total consideration paid

  $ 80,000,000     $ -  
                 

Goodwill

  $ 10,408,938     $ -  

* Net cash paid at closing totaled $69,905,355

 

See Notes to Consolidated Financial Statements (Unaudited)

 

 
10

 

 

Part I

Item 1

QCR HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

September 30, 2016

 

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of presentation: The interim unaudited consolidated financial statements contained herein should be read in conjunction with the audited consolidated financial statements and accompanying notes to the consolidated financial statements for the fiscal year ended December 31, 2015, included in the Company’s Annual Report on Form 10-K filed with the SEC on March 11, 2016. Accordingly, footnote disclosures, which would substantially duplicate the disclosures contained in the audited consolidated financial statements, have been omitted.

 

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

 

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

 

Allowance: Allowance for estimated losses on loans/leases

FRB: Federal Reserve Bank of Chicago

AOCI: Accumulated other comprehensive income (loss)

GAAP: Generally Accepted Accounting Principles

AFS: Available for sale

HTM: Held to maturity

ASC: Accounting Standards Codification

m2: m2 Lease Funds, LLC

ASC 805: Business Combinations Standard

MD&A: Management's Discussion & Analysis

ASU: Accounting Standards Update

NIM: Net interest margin

BOLI: Bank-owned life insurance

NPA: Nonperforming asset

Caps: Interest rate cap derivatives

NPL: Nonperforming loan

Community National: Community National Bancorporation

OREO: Other real estate owned

CNB: Community National Bank

OTTI: Other-than-temporary impairment

CRBT: Cedar Rapids Bank & Trust Company

PCI: Purchased credit impaired

CRE: Commercial real estate

Provision: Provision for loan/lease losses

CSB: Community State Bank

QCBT: Quad City Bank & Trust Company

C&I: Commercial and industrial

RB&T: Rockford Bank & Trust Company

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

ROAA: Return on Average Assets

     Consumer Protection Act

SBA: U.S. Small Business Administration

EPS: Earnings per share

SEC: Securities and Exchange Commission

Exchange Act: Securities Exchange Act of 1934, as amended

TA: Tangible assets

FASB: Financial Accounting Standards Board

TCE: Tangible common equity

FDIC: Federal Deposit Insurance Corporation

TDRs: Troubled debt restructurings

FHLB: Federal Home Loan Bank

The Company: QCR Holdings, Inc.

 

USDA: U.S. Department of Agriculture

 

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

 

The acquisition of CSB closed on August 31, 2016. CSB is headquartered in Ankeny, Iowa. The financial results of CSB for the period since acquisition are included in this report. See Note 9 to the Consolidated Financial Statements for additional information.

 

 
11

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

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

 

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

 

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

 

In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation. ASU 2016-09 aims to simplify the accounting for companies that issue share-based payment awards to their employees. Simplification includes the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows of share-based payment awards. ASU 2016-09 is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years and it is not expected to have a significant impact on the Company’s consolidated financial statements.

 

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

 

 
12

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

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

 

NOTE 2 – INVESTMENT SECURITIES

 

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

 

           

Gross

   

Gross

         
   

Amortized

   

Unrealized

   

Unrealized

   

Fair

 
   

Cost

   

Gains

   

(Losses)

   

Value

 

September 30, 2016:

                               

Securities HTM:

                               

Municipal securities

  $ 305,690,174     $ 5,533,151     $ (778,982 )   $ 310,444,343  

Other securities

    1,050,000       -       -       1,050,000  
    $ 306,740,174     $ 5,533,151     $ (778,982 )   $ 311,494,343  
                                 

Securities AFS:

                               

U.S. govt. sponsored agency securities

  $ 66,966,328     $ 992,084     $ (73,463 )   $ 67,884,949  

Residential mortgage-backed and related securities

    131,496,011       1,824,345       (147,552 )     133,172,804  

Municipal securities

    53,887,898       816,063       (63,499 )     54,640,462  

Other securities

    2,002,113       492,980       (3,227 )     2,491,866  
    $ 254,352,350     $ 4,125,472     $ (287,741 )   $ 258,190,081  
                                 

December 31, 2015:

                               

Securities HTM:

                               

Municipal securities

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

Other securities

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

Securities AFS:

                               

U.S. govt. sponsored agency securities

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

Residential mortgage-backed and related securities

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

Municipal securities

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

Other securities

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

 

 
13

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

The Company’s HTM municipal securities consist largely of private issues of municipal debt. The large majority of the municipalities are located within the Midwest. The municipal debt investments are underwritten using specific guidelines with ongoing monitoring.

 

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

 

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

 

   

Less than 12 Months

   

12 Months or More

   

Total

 
           

Gross

           

Gross

           

Gross

 
   

Fair

   

Unrealized

   

Fair

   

Unrealized

   

Fair

   

Unrealized

 
   

Value

   

Losses

   

Value

   

Losses

   

Value

   

Losses

 

September 30, 2016:

                                               

Securities HTM:

                                               

Municipal securities

  $ 23,632,888     $ (251,558 )   $ 14,150,396     $ (527,424 )   $ 37,783,284     $ (778,982 )
                                                 

Securities AFS:

                                               

U.S. govt. sponsored agency securities

  $ 9,547,746     $ (73,463 )   $ -     $ -     $ 9,547,746     $ (73,463 )

Residential mortgage-backed and related securities

    9,326,000       (78,305 )     8,464,738       (69,247 )     17,790,738       (147,552 )

Municipal securities

    25,921,780       (49,087 )     846,894       (14,412 )     26,768,674       (63,499 )

Other securities

    641,430       (3,227 )     -       -       641,430       (3,227 )
    $ 45,436,956     $ (204,082 )   $ 9,311,632     $ (83,659 )   $ 54,748,588     $ (287,741 )
                                                 

December 31, 2015:

                                               

Securities HTM:

                                               

Municipal securities

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

Securities AFS:

                                               

U.S. govt. sponsored agency securities

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

Residential mortgage-backed and related securities

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

Municipal securities

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

Other securities

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

 

At September 30, 2016, the investment portfolio included 526 securities. Of this number, 92 securities were in an unrealized loss position. The aggregate losses of these securities totaled less than 1% of the total amortized cost of the portfolio. Of these 92 securities, 17 securities had an unrealized loss for twelve months or more. All of the debt securities in unrealized loss positions are considered acceptable credit risks. Based upon an evaluation of the available evidence, including the recent changes in market rates, credit rating information and information obtained from regulatory filings, management believes the declines in fair value for these debt securities are temporary. In addition, the Company does not intend to sell these securities and it is not more-likely-than-not that the Company will be required to sell these debt securities before their anticipated recovery. At September 30, 2016 and December 31, 2015, equity securities represented less than 1% of the total portfolio.

 

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

 

 
14

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

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

 

   

Three Months Ended

   

Nine Months Ended

 
   

September 30, 2016

   

September 30, 2015

   

September 30, 2016

   

September 30, 2015

 
                                 

Proceeds from sales of securities*

  $ 58,775,764     $ 11,922,915     $ 119,850,909     $ 65,889,838  

Pre-tax gross gains from sales of securities

    4,281,828       102,766       4,815,373       672,317  

Pre-tax gross losses from sales of securities

    (30,055 )     (46,186 )     (187,090 )     (198,804 )

 

* Proceeds from sales of securities for the nine months ended September 30, 2016 includes $32.1 million receivable from broker for the sale of securities

 

In September 2016, the Company sold an equity security and recognized a pre-tax gross gain on the sale of $4,010,877. The equity security was acquired by the Company at no cost as part of a membership in the invested company in 2002.

 

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

 

 

   

Amortized Cost

   

Fair Value

 

Securities HTM:

               

Due in one year or less

  $ 9,333,827     $ 9,382,178  

Due after one year through five years

    30,899,427       31,047,261  

Due after five years

    266,506,920       271,064,904  
    $ 306,740,174     $ 311,494,343  
                 

Securities AFS:

               

Due in one year or less

  $ 2,345,063     $ 2,347,195  

Due after one year through five years

    55,691,033       56,456,647  

Due after five years

    62,818,130       63,721,569  
    $ 120,854,226     $ 122,525,411  

Residential mortgage-backed and related securities

    131,496,011       133,172,804  

Other securities

    2,002,113       2,491,866  
    $ 254,352,350     $ 258,190,081  

 

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

 

   

Amortized Cost

   

Fair Value

 

Securities HTM:

               

Municipal securities

  $ 178,052,716     $ 180,307,064  
                 

Securities AFS:

               

U.S. govt. sponsored agency securities

    11,042,867       11,073,088  

Municipal securities

    41,062,791       37,443,219  
    $ 52,105,658     $ 48,516,307  

 

 
15

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

As of September 30, 2016, the Company’s municipal securities portfolios were comprised of general obligation bonds issued by 114 issuers with fair values totaling $115.8 million and revenue bonds issued by 112 issuers, primarily consisting of states, counties, towns, villages and school districts with fair values totaling $249.3 million. The Company held investments in general obligation bonds in 24 states, including four states in which the aggregate fair value exceeded $5.0 million. The Company held investments in revenue bonds in 13 states, including five states in which the aggregate fair value exceeded $5.0 million.

 

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

 

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

 

September 30, 2016:

                               

U.S. State:

 

Number of Issuers

   

Amortized Cost

   

Fair Value

   

Average

Exposure Per

Issuer

(Fair Value)

 
                                 

Iowa

    27     $ 32,289,974     $ 32,746,465     $ 1,212,832  

Illinois

    19       30,063,690       30,437,115       1,601,953  

North Dakota

    6       19,403,728       19,906,421       3,317,737  

Missouri

    13       8,304,022       8,448,994       649,923  

Other

    49       23,934,196       24,247,257       494,842  

Total general obligation bonds

    114     $ 113,995,610     $ 115,786,252     $ 1,015,669  

 

 

 

December 31, 2015:

                               

U.S. State:

 

Number of Issuers

   

Amortized Cost

   

Fair Value

   

Average

Exposure Per

Issuer

(Fair Value)

 
                                 

Iowa

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

Illinois

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

North Dakota

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

Missouri

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

Other

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

Total general obligation bonds

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

 

 
16

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

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

 

September 30, 2016:

                               

U.S. State:

 

Number of Issuers

   

Amortized Cost

   

Fair Value

   

Average

Exposure Per

Issuer

(Fair Value)

 
                                 

Missouri

    44     $ 90,171,820     $ 91,084,628     $ 2,070,105  

Iowa

    30       75,440,709       77,216,784       2,573,893  

Indiana

    20       43,994,737       44,605,536       2,230,277  

Kansas

    6       13,480,269       13,587,744       2,264,624  

North Dakota

    4       8,114,931       8,175,230       2,043,808  

Other

    8       14,379,998       14,628,631       1,828,579  

Total revenue bonds

    112     $ 245,582,464     $ 249,298,553     $ 2,225,880  

 

 

 

December 31, 2015:                        

U.S. State:

 

Number of Issuers

   

Amortized Cost

   

Fair Value

   

Average

Exposure Per

Issuer

(Fair Value)

 
                                 

Missouri

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

Iowa

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

Indiana

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

Kansas

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

Other

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

Total revenue bonds

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

 

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

 

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

 

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

 

 
17

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

NOTE 3 – LOANS/LEASES RECEIVABLE

 

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

 

   

As of September 30,

   

As of December 31,

 
   

2016

   

2015

 
                 

C&I loans

  $ 804,307,562     $ 648,159,892  

CRE loans

               

Owner-occupied CRE

    317,899,011       252,523,164  

Commercial construction, land development, and other land

    160,527,094       49,083,844  

Other non owner-occupied CRE

    591,878,656       422,761,757  
      1,070,304,761       724,368,765  
                 

Direct financing leases *

    166,924,077       173,655,605  

Residential real estate loans **

    229,080,600       170,432,530  

Installment and other consumer loans

    81,917,732       73,669,493  
      2,352,534,732       1,790,286,285  

Plus deferred loan/lease origination costs, net of fees

    8,065,780       7,736,390  
      2,360,600,512       1,798,022,675  

Less allowance

    (28,826,835 )     (26,140,906 )
    $ 2,331,773,677     $ 1,771,881,769  
                 
                 

* Direct financing leases:

               

Net minimum lease payments to be received

  $ 186,183,516     $ 195,476,230  

Estimated unguaranteed residual values of leased assets

    1,085,154       1,165,706  

Unearned lease/residual income

    (20,344,593 )     (22,986,331 )
      166,924,077       173,655,605  

Plus deferred lease origination costs, net of fees

    6,018,484       6,594,582  
      172,942,561       180,250,187  

Less allowance

    (3,041,962 )     (3,395,088 )
    $ 169,900,599     $ 176,855,099  

 

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

 

**Includes residential real estate loans held for sale totaling $1,377,875 and $565,850 as of September 30, 2016, and December 31, 2015, respectively.

 

 
18

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

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

 

   

As of September 30, 2016

 

Classes of Loans/Leases

 

Current

   

30-59 Days Past

Due

   

60-89 Days Past

Due

   

Accruing Past Due

90 Days or More

   

Nonaccrual

Loans/Leases

   

Total

 
                                                 

C&I

  $ 796,943,072     $ 358,503     $ 232,297     $ 266,485     $ 6,507,205     $ 804,307,562  

CRE

                                               

Owner-Occupied CRE

    316,299,798       -       -       -       1,599,213       317,899,011  

Commercial Construction, Land Development, and Other Land

    160,034,828       -       -       -       492,266       160,527,094  

Other Non Owner-Occupied CRE

    585,545,037       4,617,055       -       -       1,716,564       591,878,656  

Direct Financing Leases

    162,556,659       1,180,356       998,896       -       2,188,166       166,924,077  

Residential Real Estate

    227,061,212       122,744       114,638       104,789       1,677,217       229,080,600  

Installment and Other Consumer

    81,576,782       89,104       41,332       20,492       190,022       81,917,732  
    $ 2,330,017,388     $ 6,367,762     $ 1,387,163     $ 391,766     $ 14,370,653     $ 2,352,534,732  
                                                 

As a percentage of total loan/lease portfolio

    99.05 %     0.27 %     0.06 %     0.02 %     0.61 %     100.00 %

 

 

   

As of December 31, 2015

 

Classes of Loans/Leases

 

Current

   

30-59 Days Past

Due

   

60-89 Days Past

Due

   

Accruing Past Due

90 Days or More

   

Nonaccrual

Loans/Leases

   

Total

 
                                                 

C&I

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

CRE

                                               

Owner-Occupied CRE

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

Commercial Construction, Land Development, and Other Land

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

Other Non Owner-Occupied CRE

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

Direct Financing Leases

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

Residential Real Estate

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

Installment and Other Consumer

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

As a percentage of total loan/lease portfolio

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

 

 
19

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

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

 

   

As of September 30, 2016

 

Classes of Loans/Leases

 

Accruing Past

Due 90 Days or

More

   

Nonaccrual

Loans/Leases *

   

Accruing

TDRs

   

Total NPLs

   

Percentage of

Total NPLs

 
                                         

C&I

  $ 266,485     $ 6,507,205     $ 170,113     $ 6,943,803       41.86 %

CRE

                                       

Owner-Occupied CRE

    -       1,599,213       -       1,599,213       9.64 %

Commercial Construction, Land Development, and Other Land

    -       492,266       -       492,266       2.97 %

Other Non Owner-Occupied CRE

    -       1,716,564       -       1,716,564       10.35 %

Direct Financing Leases

    -       2,188,166       1,138,335       3,326,501       20.05 %

Residential Real Estate

    104,789       1,677,217       390,039       2,172,045       13.09 %

Installment and Other Consumer

    20,492       190,022       126,998       337,512       2.03 %
    $ 391,766     $ 14,370,653     $ 1,825,485     $ 16,587,904       100.00 %

 

*Nonaccrual loans/leases included $4,859,420 of TDRs, including $2,241,205 in C&I loans, $1,937,655 in CRE loans, $463,859 in direct financing leases, $110,702 in residential real estate loans, and $105,999 in installment loans.

 

 

 

   

As of December 31, 2015

 

Classes of Loans/Leases

 

Accruing Past

Due 90 Days or

More

   

Nonaccrual

Loans/Leases

**

   

Accruing

TDRs

   

Total NPLs

   

Percentage of

Total NPLs

 
                                         

C&I

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

CRE

                            -          

Owner-Occupied CRE

    -       727,463       -       727,463       6.22 %

Commercial Construction, Land Development, and Other Land

    -       193,804       -       193,804       1.66 %

Other Non Owner-Occupied CRE

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

Direct Financing Leases

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

Residential Real Estate

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

Installment and Other Consumer

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

 

 

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

  

 
20

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

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

 

 

   

Three Months Ended September 30, 2016

 
   

C&I

   

CRE

   

Direct Financing

Leases

   

Residential Real

Estate

   

Installment and

Other Consumer

   

Total

 
                                                 

Balance, beginning

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

Provisions charged to expense

    859,031       8,962       641,435       79,221       19,337       1,607,986  

Loans/leases charged off

    (96,330 )     -       (847,668 )     (38,554 )     (4,530 )     (987,082 )

Recoveries on loans/leases previously charged off

    70,759       6,500       22,001       -       9,181       108,441  

Balance, ending

  $ 11,557,966     $ 11,002,524     $ 3,041,962     $ 2,055,654     $ 1,168,729     $ 28,826,835  

 

   

Three Months Ended September 30, 2015

 
   

C&I

   

CRE

   

Direct Financing

Leases

   

Residential Real

Estate

   

Installment and

Other Consumer

   

Total

 
                                                 

Balance, beginning

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

Provisions charged to expense

    520,058       573,119       361,071       130,742       50,273       1,635,263  

Loans/leases charged off

    (145,665 )     (1,813,973 )     (483,420 )     (25,928 )     (6,837 )     (2,475,823 )

Recoveries on loans/leases previously charged off

    136,909       19,913       18,679       4,107       49,296       228,904  

Balance, ending

  $ 10,532,168     $ 8,708,715     $ 3,248,633     $ 1,829,056     $ 1,215,772     $ 25,534,344  

 

 

   

Nine Months Ended September 30, 2016

 
                                                 
   

Commercial and

Industrial

   

Commercial Real

Estate

   

Direct Financing

Leases

   

Residential Real

Estate

   

Installment and

Other Consumer

   

Total

 
                                                 

Balance, beginning

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

Provisions (credits) charged to expense

    1,357,262       1,644,008       1,580,677       336,865       (39,991 )     4,878,821  

Loans/leases charged off

    (388,879 )     (23,101 )     (1,983,322 )     (72,261 )     (22,018 )     (2,489,581 )

Recoveries on loans/leases previously charged off

    105,503       6,500       49,519       900       134,267       296,689  

Balance, ending

  $ 11,557,966     $ 11,002,524     $ 3,041,962     $ 2,055,654     $ 1,168,729     $ 28,826,835  

 

   

Nine Months Ended September 30, 2015

 
                                                 
   

Commercial and

Industrial

   

Commercial Real

Estate

   

Direct Financing

Leases

   

Residential Real

Estate

   

Installment and

Other Consumer

   

Total

 
                                                 

Balance, beginning

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

Provisions charged to expense

    1,513,430       2,490,766       1,238,505       324,925       126,758       5,694,384  

Loans/leases charged off

    (391,303 )     (2,165,049 )     (1,496,010 )     (25,928 )     (40,886 )     (4,119,176 )

Recoveries on loans/leases previously charged off

    659,724       29,612       63,223       4,107       128,105       884,771  

Balance, ending

  $ 10,532,168     $ 8,708,715     $ 3,248,633     $ 1,829,056     $ 1,215,772     $ 25,534,344  

 

 
21

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

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

 

 

   

As of September 30, 2016

 
   

C&I

   

CRE

   

Direct Financing

Leases

   

Residential Real

Estate

   

Installment and

Other Consumer

   

Total

 
                                                 

Allowance for impaired loans/leases

  $ 1,114,680     $ 175,743     $ 739,207     $ 169,147     $ 148,320     $ 2,347,097  

Allowance for nonimpaired loans/leases

    10,443,286       10,826,781       2,302,755       1,886,507       1,020,409       26,479,738  
    $ 11,557,966     $ 11,002,524     $ 3,041,962     $ 2,055,654     $ 1,168,729     $ 28,826,835  
                                                 
                                                 

Impaired loans/leases

  $ 5,874,093     $ 3,495,386     $ 2,925,205     $ 2,230,829     $ 368,924     $ 14,894,437  

Nonimpaired loans/leases

    798,433,469       1,066,809,375       163,998,872       226,849,771       81,548,808       2,337,640,295  
    $ 804,307,562     $ 1,070,304,761     $ 166,924,077     $ 229,080,600     $ 81,917,732     $ 2,352,534,732  
                                                 
                                                 

Allowance as a percentage of impaired loans/leases

    18.98 %     5.03 %     25.27 %     7.58 %     40.20 %     15.76 %

Allowance as a percentage of nonimpaired loans/leases

    1.31 %     1.01 %     1.40 %     0.83 %     1.25 %     1.13 %

Total allowance as a percentage of total loans/leases

    1.44 %     1.03 %     1.82 %     0.90 %     1.43 %     1.22 %

 

 

   

As of December 31, 2015

 
   

C&I

   

CRE

   

Direct Financing

Leases

   

Residential Real

Estate

   

Installment and

Other Consumer

   

Total

 
                                                 

Allowance for impaired loans/leases

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

Allowance for nonimpaired loans/leases

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

Impaired loans/leases

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

Nonimpaired loans/leases

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

Allowance as a percentage of impaired loans/leases

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

Allowance as a percentage of nonimpaired loans/leases

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

Total allowance as a percentage of total loans/leases

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

 

 
22

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

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

 

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

 

Classes of Loans/Leases

 

Recorded

Investment

   

Unpaid

Principal

Balance

   

Related

Allowance

   

Average

Recorded

Investment

   

Interest Income

Recognized

   

Interest Income

Recognized for

Cash Payments

Received

 
                                                 

Impaired Loans/Leases with No Specific Allowance Recorded:

                                               

C&I

  $ 1,846,140     $ 1,987,082     $ -     $ 3,864,852     $ 8,644     $ 8,644  

CRE

                                               

Owner-Occupied CRE

    767,032       860,806       -       621,553       -       -  

Commercial Construction, Land Development, and Other Land

    -       -       -       -       -       -  

Other Non Owner-Occupied CRE

    2,042,391       2,042,391       -       1,789,571       -       -  

Direct Financing Leases

    1,860,773       1,860,773       -       1,755,969       52,595       52,595  

Residential Real Estate

    1,418,957       1,458,158       -       1,455,159       2,992       2,992  

Installment and Other Consumer

    208,916       208,916       -       430,322       -       -  
    $ 8,144,209     $ 8,418,126     $ -     $ 9,917,426     $ 64,231     $ 64,231  
                                                 

Impaired Loans/Leases with Specific Allowance Recorded:

                                               

C&I

  $ 4,027,953     $ 4,031,792     $ 1,114,680     $ 2,195,524     $ -     $ -  

CRE

                                               

Owner-Occupied CRE

    322,148       322,148       57,398       401,050       -       -  

Commercial Construction, Land Development, and Other Land

    186,681       186,681       77,611       190,208       -       -  

Other Non Owner-Occupied CRE

    177,134       177,134       40,734       67,571       -       -  

Direct Financing Leases

    1,064,432       1,064,432       739,207       653,884       -       -  

Residential Real Estate

    811,872       886,004       169,147       799,427       5,409       5,409  

Installment and Other Consumer

    160,008       160,008       148,320       145,962       4,426       4,426  
    $ 6,750,228     $ 6,828,199     $ 2,347,097     $ 4,453,626     $ 9,835     $ 9,835  
                                                 

Total Impaired Loans/Leases:

                                               

C&I

  $ 5,874,093     $ 6,018,874     $ 1,114,680     $ 6,060,376     $ 8,644     $ 8,644  

CRE

                                               

Owner-Occupied CRE

    1,089,180       1,182,954       57,398       1,022,603       -       -  

Commercial Construction, Land Development, and Other Land

    186,681       186,681       77,611       190,208       -       -  

Other Non Owner-Occupied CRE

    2,219,525       2,219,525       40,734       1,857,142       -       -  

Direct Financing Leases

    2,925,205       2,925,205       739,207       2,409,853       52,595       52,595  

Residential Real Estate

    2,230,829       2,344,162       169,147       2,254,586       8,401       8,401  

Installment and Other Consumer

    368,924       368,924       148,320       576,284       4,426       4,426  
    $ 14,894,437     $ 15,246,325     $ 2,347,097     $ 14,371,052     $ 74,066     $ 74,066  

 

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

 

 
23

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

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

 

   

Three Months Ended September 30, 2016

   

Three Months Ended September 30, 2015

 

Classes of Loans/Leases

 

Average

Recorded

Investment

   

Interest Income

Recognized

   

Interest Income

Recognized for

Cash Payments

Received

   

Average

Recorded

Investment

   

Interest Income

Recognized

   

Interest Income

Recognized for

Cash Payments

Received

 
                                                 

Impaired Loans/Leases with No Specific Allowance Recorded:

                                               

C&I

  $ 1,677,527     $ 3,301     $ 3,301     $ 365,798     $ 1,870     $ 1,870  

CRE

                                               

Owner-Occupied CRE

    767,032       -       -       451,851       -       -  

Commercial Construction, Land Development, and Other Land

    -       -       -       9,968       -       -  

Other Non Owner-Occupied CRE

    1,969,034       -       -       2,868,950       -       -  

Direct Financing Leases

    2,008,095       21,095       21,095       634,378       325       325  

Residential Real Estate

    1,481,340       941       941       900,938       1,362       1,362  

Installment and Other Consumer

    322,738       -       -       328,669       3,912       3,912  
    $ 8,225,766     $ 25,337     $ 25,337     $ 5,560,552     $ 7,469     $ 7,469  
                                                 

Impaired Loans/Leases with Specific Allowance Recorded:

                                               

C&I

  $ 4,188,621     $ -     $ -     $ 4,735,149     $ -     $ -  

CRE

                                               

Owner-Occupied CRE

    363,911       -       -       -       -       -  

Commercial Construction, Land Development, and Other Land

    187,831       -       -       335,707       -       -  

Other Non Owner-Occupied CRE

    135,141       -       -       -       -       -  

Direct Financing Leases

    793,769       -       -       488,860       -       -  

Residential Real Estate

    807,827       1,503       1,503       984,558       1,981       1,981  

Installment and Other Consumer

    160,301       1,458       1,458       723,674       1,391       1,391  
    $ 6,637,401     $ 2,961     $ 2,961     $ 7,267,948     $ 3,372     $ 3,372  
                                                 

Total Impaired Loans/Leases:

                                               

C&I

  $ 5,866,148     $ 3,301     $ 3,301     $ 5,100,947     $ 1,870     $ 1,870  

CRE

                                               

Owner-Occupied CRE

    1,130,943       -       -       451,851       -       -  

Commercial Construction, Land Development, and Other Land

    187,831       -       -       345,675       -       -  

Other Non Owner-Occupied CRE

    2,104,175       -       -       2,868,950       -       -  

Direct Financing Leases

    2,801,864       21,095       21,095       1,123,238       325       325  

Residential Real Estate

    2,289,167       2,444       2,444       1,885,496       3,343       3,343  

Installment and Other Consumer

    483,039       1,458       1,458       1,052,343       5,303       5,303  
    $ 14,863,167     $ 28,298     $ 28,298     $ 12,828,500     $ 10,841     $ 10,841  

 

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

 

 
24

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

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

 

 

Classes of Loans/Leases

 

Recorded

Investment

   

Unpaid Principal

Balance

   

Related

Allowance

 
                         

Impaired Loans/Leases with No Specific Allowance Recorded:

                       

C&I

  $ 234,636     $ 346,072     $ -  

CRE

                       

Owner-Occupied CRE

    256,761       350,535       -  

Commercial Construction, Land Development, and Other Land

    -       228,818       -  

Other Non Owner-Occupied CRE

    1,578,470       1,578,470       -  

Direct Financing Leases

    871,884       871,884       -  

Residential Real Estate

    613,486       649,064       -  

Installment and Other Consumer

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

Impaired Loans/Leases with Specific Allowance Recorded:

                       

C&I

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

CRE

                       

Owner-Occupied CRE

    -       -       -  

Commercial Construction, Land Development, and Other Land

    193,804       205,804       76,934  

Other Non Owner-Occupied CRE

    -       -       -  

Direct Financing Leases

    829,457       829,457       306,193  

Residential Real Estate

    805,301       805,301       185,801  

Installment and Other Consumer

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

Total Impaired Loans/Leases:

                       

C&I

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

CRE

                       

Owner-Occupied CRE

    256,761       350,535       -  

Commercial Construction, Land Development, and Other Land

    193,804       434,622       76,934  

Other Non Owner-Occupied CRE

    1,578,470       1,578,470       -  

Direct Financing Leases

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

Residential Real Estate

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

Installment and Other Consumer

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

 

 

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

 

 
25

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

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

 

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

 

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

 

   

As of September 30, 2016

 
           

CRE

                 
                   

Non Owner-Occupied

                 

Internally Assigned Risk Rating

 

C&I

   

Owner-Occupied

CRE

   

Commercial

Construction,

Land

Development,

and Other Land

   

Other CRE

   

Total

   

As a % of

Total

 
                                                 

Pass (Ratings 1 through 5)

  $ 770,822,390     $ 307,017,431     $ 153,401,738     $ 572,769,744     $ 1,804,011,303       96.24 %

Special Mention (Rating 6)

    10,160,760       1,737,127       1,780,000       5,894,259       19,572,146       1.04 %

Substandard (Rating 7)

    23,324,412       9,144,453       5,345,356       13,214,653       51,028,874       2.72 %

Doubtful (Rating 8)

    -       -       -       -       -       -  
    $ 804,307,562     $ 317,899,011     $ 160,527,094     $ 591,878,656     $ 1,874,612,323       100.00 %

 

 

    As of September 30, 2016          

Delinquency Status *

 

Direct Financing

Leases

   

Residential Real

Estate

   

Installment and

Other Consumer

   

Total

   

As a % of Total

         
                                                 

Performing

  $ 163,597,576     $ 226,908,556     $ 81,580,220     $ 472,086,352       98.78 %        

Nonperforming

    3,326,501       2,172,044       337,512       5,836,057       1.22 %        
    $ 166,924,077     $ 229,080,600     $ 81,917,732     $ 477,922,409       100.00 %        

 

 

   

As of December 31, 2015

 
           

CRE

                 
                   

Non Owner-Occupied

                 

Internally Assigned Risk Rating

 

C&I

   

Owner-Occupied

CRE

   

Commercial

Construction,

Land

Development, and

Other Land

   

Other CRE

   

Total

   

As a % of

Total

 
                                                 

Pass (Ratings 1 through 5)

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

Special Mention (Rating 6)

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

Substandard (Rating 7)

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

Doubtful (Rating 8)

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

 

 

    As of December 31, 2015          

Delinquency Status *

 

Direct Financing

Leases

   

Residential Real

Estate

   

Installment and

Other Consumer

   

Total

   

As a % of Total

         
                                                 

Performing

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

Nonperforming

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

 

*Performing = loans/leases accruing and less than 90 days past due. Nonperforming = loans/leases on nonaccrual, accruing loans/leases that are greater than or equal to 90 days past due, and accruing TDRs.

 

 
26

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

As of September 30, 2016 and December 31, 2015, TDRs totaled $6,684,905 and $2,587,413, respectively.

 

For each class of financing receivable, the following presents the number and recorded investment of TDRs, by type of concession, that were restructured during the three and nine months ended September 30, 2016 and 2015. The difference between the pre-modification recorded investment and the post-modification recorded investment would be any partial charge-offs at the time of the restructuring.

 

   

For the three months ended September 30, 2016

   

For the three months ended September 30, 2015

 

Classes of Loans/Leases

 

Number of

Loans /

Leases

   

Pre-

Modification

Recorded

Investment

   

Post-

Modification

Recorded

Investment

   

Specific

Allowance

   

Number of

Loans /

Leases

   

Pre-

Modification

Recorded

Investment

   

Post-

Modification

Recorded

Investment

   

Specific

Allowance

 
                                                                 

CONCESSION - Significant Payment Delay

                                                               

Direct Financing Leases

    2     $ 461,643     $ 461,643     $ -                     $ -     $ -  
      2     $ 461,643     $ 461,643     $ -       -     $ -     $ -     $ -  
                                                                 

CONCESSION - Interest Rate Adjusted Below Market

                                                               

Installment and Other Consumer

    -     $ -     $ -     $ -       1     $ 14,203     $ 14,203     $ -  
      -     $ -     $ -     $ -       1     $ 14,203     $ 14,203     $ -  
                                                                 

TOTAL

    2     $ 461,643     $ 461,643     $ -       1     $ 14,203     $ 14,203     $ -  

 

 

   

For the nine months ended September 30, 2016

   

For the nine months ended September 30, 2015

 

Classes of Loans/Leases

 

Number of

Loans /

Leases

   

Pre-

Modification

Recorded

Investment

   

Post-

Modification

Recorded

Investment

   

Specific

Allowance

   

Number of

Loans /

Leases

   

Pre-

Modification

Recorded

Investment

   

Post-

Modification

Recorded

Investment

   

Specific

Allowance

 
                                                                 

CONCESSION - Extension of Maturity

                                                               

C&I

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

Direct Financing Leases

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

CONCESSION - Significant Payment Delay

                                                               

C&I

    1     $ 62,140     $ 62,140     $ -       -     $ -     $ -     $ -  

Direct Financing Leases

    6       771,672       771,672       -       -       -       -       -  
      7     $ 833,812     $ 833,812     $ -       -     $ -     $ -     $ -  
                                                                 

CONCESSION - Interest Rate Adjusted Below Market

                                                               

CRE - Other

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

Installment and Other Consumer

    -       -       -       -       1       14,203       14,203       -  
      1     $ 1,233,740     $ 1,233,740     $ -       1     $ 14,203     $ 14,203     $ -  
                                                                 

TOTAL

    13     $ 2,530,491     $ 2,530,491     $ -       1     $ 14,203     $ 14,203     $ -  

 

 

Of the TDRs reported above, two with a post-modification recorded balance of $1,384,680 were on nonaccrual as of September 30, 2016. Not included in the table above, the Company had one TDR that was restructured and charged off in 2016, totaling $236,545.

 

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

 

 
27

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

NOTE 4 BORROWINGS

 

Maturity and interest rate information on advances from FHLB as of September 30, 2016 and December 31, 2015 is as follows:

 

   

September 30, 2016

 
           

Weighted

           

Weighted

 
           

Average

   

Amount Due

   

Average

 
           

Interest Rate

   

with

   

Interest Rate

 
   

Amount Due

   

at Quarter-End

   

Putable Option *

   

at Quarter-End

 

Maturity:

                               

Year ending December 31:

                               

2016

  $ 90,300,000       0.55 %   $ -       - %

2017

    23,342,549       2.59       -       -  

2018

    25,000,000       2.70       -       -  

Total FHLB advances

  $ 138,642,549       1.68 %   $ -       - %

 

 

 

   

December 31, 2015

 
           

Weighted

           

Weighted

 
           

Average

   

Amount Due

   

Average

 
           

Interest Rate

   

with

   

Interest Rate

 
   

Amount Due

   

at Year-End

   

Putable Option *

   

at Year-End

 

Maturity:

                               

Year ending December 31:

                               

2016

  $ 103,000,000       0.56 %   $ 2,000,000       4.00 %

2017

    18,000,000       2.89       -       -  

2018

    30,000,000       3.27       5,000,000       2.84  

Total FHLB advances

  $ 151,000,000       1.37 %   $ 7,000,000       3.17 %

 

Other borrowings as of September 30, 2016 and December 31, 2015 are summarized as follows:

 

   

As of

September 30,

2016

   

As of

December 31,

2015

 
                 

Wholesale structured repurchase agreements

  $ 45,000,000     $ 110,000,000  

Term note

    30,000,000       -  

Revolving line of credit

    5,000,000       -  
    $ 80,000,000     $ 110,000,000  

 

 
28

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

Maturity and interest rate information concerning wholesale structured repurchase agreements is summarized as follows:

 

   

September 30, 2016

   

December 31, 2015

 
           

Weighted

           

Weighted

 
           

Average

           

Average

 
           

Interest Rate

           

Interest Rate

 
   

Amount Due

   

at Quarter-End

   

Amount Due

   

at Year-End

 

Maturity:

                               

Year ending December 31:

                               

2016

  $ -       0.00 %   $ -       0.00 %

2017

    10,000,000       3.07       10,000,000       3.00  

2018

    -       -       10,000,000       3.97  

2019

    10,000,000       3.44       45,000,000       3.40  

2020

    25,000,000       2.48       45,000,000       2.66  

Total Wholesale Structured Repurchase Agreements

  $ 45,000,000       2.83 %   $ 110,000,000       3.11 %

 

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

 

During the third quarter of 2016, the Company executed further balance sheet restructuring at QCBT which included the repayment of $55.0 million of wholesale structured repurchase agreements and $5.0 million of FHLB advances with a combined weighted average interest rate of 3.24%. As a result of this restructuring, the Company incurred $4.1 million (pre-tax) in losses on debt extinguishment that are included in the statements of income. The weighted average duration of this combined debt was 2.95 years, with $5.0 million maturing in 2018, $35.0 million maturing in 2019, and $20.0 million maturing in 2020. This funding was replaced partially with proceeds from the sale of bonds previously pledged as collateral for the wholesale structured repurchase agreements ($27.8 million) and the rest with short-term borrowings at an average interest rate of 0.50%.

 

As of December 31, 2015, the Company maintained a $40.0 million revolving line of credit note, with interest calculated at the effective LIBOR rate plus 2.50% per annum (3.10% at December 31, 2015). At December 31, 2015, the Company had not borrowed on this revolving credit note and had the full amount available. At the renewal date in June 2016, the note was amended to provide a $10.0 million revolving line of credit note and a $30.0 million term note commitment with a five-year term. Interest on the revolving line of credit is calculated at the effective LIBOR rate plus 2.50% per annum (3.34% at September 30, 2016). Interest on the term note is calculated at the effective LIBOR rate plus 3.00% per annum (3.84% at September 30, 2016). Upon closing of the acquisition of CSB, the Company utilized the full $30.0 million term note commitment and borrowed $5.0 million on the revolving line of credit note. At September 30, 2016, the Company had $35.0 million in borrowings outstanding. For the term note, the Company is required to make quarterly principal payments of $1.5 million with maturity information as of September 30, 2016, summarized as follows:

 

   

As of September 30, 2016

 

2017

    6,000,000  

2018

    6,000,000  

2019

    6,000,000  

2020

    6,000,000  

2021

    6,000,000  
    $ 30,000,000  

 

 
29

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

 

Similar to the previous revolving note agreement, the amended agreement contains covenants that place restrictions on additional debt and stipulate minimum capital and various operating ratios.

 

In October 2016, the Company executed new agreements with the creditor on both the term note and the revolving line of credit, adjusting the rate index from 3-month LIBOR to 1-month LIBOR.

 

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

 

NOTE 5 - EARNINGS PER SHARE

 

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

 

   

Three months ended

   

Nine months ended

 
   

September 30,

   

September 30,

 
   

2016

   

2015

   

2016

   

2015

 
                                 

Net income

  $ 6,107,501     $ 6,488,987     $ 19,157,457     $ 10,143,058  
                                 

Basic EPS

  $ 0.47     $ 0.55     $ 1.55     $ 1.03  

Diluted EPS

  $ 0.46     $ 0.55     $ 1.52     $ 1.01  
                                 

Weighted average common shares outstanding*

    13,066,777       11,713,993       12,398,491       9,878,882  

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

    202,926       161,937       181,551       145,559  

Weighted average common and common equivalent shares outstanding

    13,269,703       11,875,930       12,580,042       10,024,441  

 

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

 

 
30

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

NOTE 6 – FAIR VALUE

 

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

 

 

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

 

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

 

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

 

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

 

 

           

Fair Value Measurements at Reporting Date Using

 
           

Quoted Prices

   

Significant

         
           

in Active

   

Other

   

Significant

 
           

Markets for

   

Observable

   

Unobservable

 
           

Identical Assets

   

Inputs

   

Inputs

 
   

Fair Value

   

(Level 1)

   

(Level 2)

   

(Level 3)

 
                                 

September 30, 2016:

                               

Securities AFS:

                               

U.S. govt. sponsored agency securities

  $ 67,884,949     $ -     $ 67,884,949     $ -  

Residential mortgage-backed and related securities

    133,172,804       -       133,172,804       -  

Municipal securities

    54,640,462       -       54,640,462       -  

Other securities

    2,491,866       1,107       2,490,759       -  

Interest rate caps

    221,233       -       221,233       -  

Interest rate swaps - assets

    9,386,262       -       9,386,262       -  

Total assets measured at fair value

  $ 267,797,576     $ 1,107     $ 267,796,469     $ -  
                                 

Interest rate swaps - liabilities

  $ 9,386,262     $ -     $ 9,386,262     $ -  

Total liabilities measured at fair value

  $ 9,386,262     $ -     $ 9,386,262     $ -  
                                 
                                 

December 31, 2015:

                               

Securities AFS:

                               

U.S. govt. sponsored agency securities

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

Residential mortgage-backed and related securities

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

Municipal securities

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

Other securities

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

Interest rate caps

    856,024       -       856,024       -  

Interest rate swaps - assets

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

Total assets measured at fair value

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

Interest rate swaps - liabilities

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

Total liabilities measured at fair value

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

 

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

 

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

 

 
31

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

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

 

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

 

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

 

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

 

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

 

           

Fair Value Measurements at Reporting Date Using

 
   

Fair Value

   

Level 1

   

Level 2

   

Level 3

 

September 30, 2016:

                               

Impaired loans/leases

  $ 7,870,032     $ -     $ -     $ 7,870,032  

OREO

    6,272,211       -       -       6,272,211  
    $ 14,142,243     $ -     $ -     $ 14,142,243  
                                 

December 31, 2015:

                               

Impaired loans/leases

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

OREO

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

 

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

 

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

 

 
32

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

The following table presents additional quantitative information about assets measured at fair value on a non-recurring basis for which the Company has utilized Level 3 inputs to determine fair value:

 

   

Quantitative Information about Level Fair Value Measurements

 
   

Fair Value

September 30, 2016

   

Fair Value

December 31, 2015

 

Valuation Technique

Unobservable Input

 

Range

 
                                 

Impaired loans/leases

  $ 7,870,032     $ 4,545,966  

Appraisal of collateral

Appraisal adjustments

    -10.00% to -50.00%  

OREO

    6,272,211       7,722,711  

Appraisal of collateral

Appraisal adjustments

    0.00% to -35.00%  

 

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

 

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

 

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

 

 

Fair Value

 

As of September 30, 2016

   

As of December 31, 2015

 
 

Hierarchy

 

Carrying

   

Estimated

   

Carrying

   

Estimated

 
 

Level

 

Value

   

Fair Value

   

Value

   

Fair Value

 
                                   

Cash and due from banks

Level 1

  $ 61,213,134     $ 61,213,134     $ 41,742,321     $ 41,742,321  

Federal funds sold

Level 2

    21,022,000       21,022,000       19,850,000       19,850,000  

Interest-bearing deposits at financial institutions

Level 2

    75,025,417       75,025,417       36,313,965       36,313,965  

Investment securities:

                                 

HTM

Level 2

    306,740,174       311,494,343       253,674,159       255,691,285  

AFS

See Previous Table

    258,190,081       258,190,081       323,434,982       323,434,982  

Loans/leases receivable, net

Level 3

    7,287,067       7,870,032       4,209,228       4,545,966  

Loans/leases receivable, net

Level 2

    2,324,486,610       2,327,955,000       1,767,672,541       1,764,178,772  

Interest rate caps

Level 2

    221,233       221,233       856,024       856,024  

Interest rate swaps - assets

Level 2

    9,386,262       9,386,262       3,044,525       3,044,525  

Deposits:

                                 

Nonmaturity deposits

Level 2

    2,103,706,174       2,103,706,174       1,516,599,081       1,516,599,081  

Time deposits

Level 2

    491,206,579       491,849,000       364,067,103       364,192,000  

Short-term borrowings

Level 2

    60,015,417       60,015,417       144,662,716       144,662,716  

FHLB advances

Level 2

    138,642,529       140,153,000       151,000,000       153,143,000  

Other borrowings

Level 2

    80,000,000       82,119,000       110,000,000       116,061,000  

Junior subordinated debentures

Level 2

    33,446,578       24,768,273       38,499,052       27,642,093  

Interest rate swaps - liabilities

Level 2

    9,386,262       9,386,262       3,044,525       3,044,525  

 

 
33

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

NOTE 7 – BUSINESS SEGMENT INFORMATION

 

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

 

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

 

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

 

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

 

 
34

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

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

 

   

Commercial Banking

   

Wealth

           

Intercompany

   

Consolidated

 
   

QCBT

   

CRBT

   

CSB

   

RB&T

   

Management

   

All Other

   

Eliminations

   

Total

 

Three Months Ended September 30, 2016

                                                               

Total revenue

  $ 18,026,215     $ 10,065,032     $ 2,675,741     $ 4,232,205     $ 2,284,577     $ 8,463,636     $ (8,507,270 )   $ 37,240,136  

Net interest income

  $ 11,225,414     $ 7,594,557     $ 2,191,862     $ 3,056,989     $ -     $ (438,045 )   $ -     $ 23,630,777  

Net income

  $ 3,596,469     $ 3,286,724     $ 188,608     $ 944,781     $ 398,859     $ 6,107,492     $ (8,415,432 )   $ 6,107,501  

Total assets

  $ 1,407,733,009     $ 887,592,695     $ 580,210,270     $ 393,191,774     $ -     $ 368,990,749     $ (356,732,388 )   $ 3,280,986,109  

Provision

  $ 1,137,986     $ -     $ 270,000     $ 200,000     $ -     $ -     $ -     $ 1,607,986  

Goodwill

  $ 3,222,688     $ -     $ 10,408,938     $ -     $ -     $ -     $ -     $ 13,631,626  

Core deposit intangible

  $ -     $ 1,321,775     $ 6,291,818     $ -     $ -     $ -     $ -     $ 7,613,593  
                                                                 

Three Months Ended September 30, 2015

                                                               

Total revenue

  $ 14,143,548     $ 10,047,658     $ -     $ 3,922,304     $ 2,314,406     $ 7,937,087     $ (8,821,205 )   $ 29,543,798  

Net interest income

  $ 10,728,143     $ 6,956,027     $ -     $ 2,771,214     $ -     $ (317,858 )   $ -     $ 20,137,526  

Net income (loss)

  $ 3,786,289     $ 2,893,397     $ -     $ 847,709     $ 373,801     $ 6,488,988     $ (7,901,197 )   $ 6,488,987  

Total assets

  $ 1,328,053,105     $ 867,064,041     $ -     $ 360,348,002     $ -     $ 277,001,408     $ (256,611,839 )   $ 2,575,854,717  

Provision

  $ 910,263     $ 550,000     $ -     $ 175,000     $ -     $ -     $ -     $ 1,635,263  

Goodwill

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

Core deposit intangible

  $ -     $ 1,521,287     $ -     $ -     $ -     $ -     $ -     $ 1,521,287  
                                                                 

Nine Months Ended September 30, 2016

                                                               

Total revenue

  $ 45,706,061     $ 31,342,345     $ 2,675,741     $ 11,945,081     $ 6,723,690     $ 23,567,906     $ (23,720,471 )   $ 98,240,353  

Net interest income

  $ 33,394,620     $ 21,755,270     $ 2,191,862     $ 8,914,380     $ -     $ (1,019,020 )   $ -     $ 65,237,112  

Net income

  $ 10,326,508     $ 9,366,441     $ 188,608     $ 2,334,735     $ 1,232,831     $ 19,157,447     $ (23,449,113 )   $ 19,157,457  

Total assets

  $ 1,407,733,009     $ 887,592,695     $ 580,210,270     $ 393,191,774     $ -     $ 368,990,749     $ (356,732,388 )   $ 3,280,986,109  

Provision

  $ 3,108,821     $ 700,000     $ 270,000     $ 800,000     $ -     $ -     $ -     $ 4,878,821  

Goodwill

  $ 3,222,688     $ -     $ 10,408,938     $ -     $ -     $ -     $ -     $ 13,631,626  

Core deposit intangible

  $ -     $ 1,321,775     $ 6,291,818     $ -     $ -     $ -     $ -     $ 7,613,593  
                                                                 

Nine Months Ended September 30, 2015

                                                               

Total revenue

  $ 39,893,713     $ 28,396,380     $ -     $ 11,095,899     $ 6,927,453     $ 14,487,857     $ (15,556,437 )   $ 85,244,865  

Net interest income

  $ 29,745,080     $ 19,836,835     $ -     $ 8,089,626     $ -     $ (1,260,962 )   $ -     $ 56,410,579  

Net income

  $ 6,578,479     $ 4,645,136     $ -     $ 1,895,933     $ 1,271,661     $ 10,143,059     $ (14,391,210 )   $ 10,143,058  

Total assets

  $ 1,328,053,105     $ 867,064,041     $ -     $ 360,348,002     $ -     $ 277,001,408     $ (256,611,839 )   $ 2,575,854,717  

Provision

  $ 3,466,384     $ 1,650,000     $ -     $ 578,000     $ -     $ -     $ -     $ 5,694,384  

Goodwill

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

Core deposit intangible

  $ -     $ 1,521,287     $ -     $ -     $ -     $ -     $ -     $ 1,521,287  

 

 
35

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

NOTE 8 – REGULATORY CAPITAL REQUIREMENTS

 

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

 

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

 

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

 

                   

For Capital

   

To Be Well

 
                   

Adequacy Purposes

   

Capitalized Under

 
                   

With Capital

   

Prompt Corrective

 
   

Actual

   

Conservation Buffer*

   

Action Provisions

 
   

Amount

   

Ratio

   

Amount

 

Ratio

   

Amount

 

Ratio

 

As of September 30, 2016:

                                                   

Company:

                                                   

Total risk-based capital

  $ 316,063       11.33 %   $ 240,629  

>

    8.625 %   $ 278,991  

>

    10.0 %

Tier 1 risk-based capital

    287,015       10.29 %     184,831  

>

    6.625       223,192  

>

    8.0  

Tier 1 leverage

    287,015       10.09 %     113,737  

>

    4.000       142,172  

>

    5.0  

Common equity Tier 1

    257,119       9.22 %     142,983  

>

    5.125       181,344  

>

    6.5  

Quad City Bank & Trust:

                                                   

Total risk-based capital

  $ 138,333       11.71 %   $ 101,861  

>

    8.625 %   $ 118,100  

>

    10.0 %

Tier 1 risk-based capital

    125,410       10.62 %     78,241  

>

    6.625       94,480  

>

    8.0  

Tier 1 leverage

    125,410       8.86 %     56,628  

>

    4.000       70,785  

>

    5.0  

Common equity Tier 1

    125,410       10.62 %     60,526  

>

    5.125       76,765  

>

    6.5  

Cedar Rapids Bank & Trust:

                                                   

Total risk-based capital

  $ 104,206       13.13 %   $ 68,474  

>

    8.625 %   $ 79,390  

>

    10.0 %

Tier 1 risk-based capital

    94,266       11.87 %     52,596  

>

    6.625       63,512  

>

    8.0  

Tier 1 leverage

    94,266       10.36 %     36,407  

>

    4.000       45,509  

>

    5.0  

Common equity Tier 1

    94,266       11.87 %     40,687  

>

    5.125       51,604  

>

    6.5  

Community State Bank:

                                                   

Total risk-based capital

  $ 67,008       14.09 %   $ 41,031  

>

    8.625 %   $ 47,572  

>

    10.0 %

Tier 1 risk-based capital

    66,735       14.03 %     31,516  

>

    6.625       38,058  

>

    8.0  

Tier 1 leverage

    66,735       11.74 %     22,745  

>

    4.000       28,431  

>

    5.0  

Common equity Tier 1

    66,735       14.03 %     24,381  

>

    5.125       30,922  

>

    6.5  

Rockford Bank & Trust:

                                                   

Total risk-based capital

  $ 41,130       11.95 %   $ 29,680  

>

    8.625 %   $ 34,412  

>

    10.0 %

Tier 1 risk-based capital

    36,821       10.70 %     22,798  

>

    6.625       27,529  

>

    8.0  

Tier 1 leverage

    36,821       9.45 %     15,587  

>

    4.000       19,484  

>

    5.0  

Common equity Tier 1

    36,821       10.70 %     17,636  

>

    5.125       22,367  

>

    6.5  

 

 
36

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

                                     

To Be Well

Capitalized Under

 
                   

For Capital

    Prompt Corrective  
   

Actual

   

Adequacy Purposes*

    Action Provisions  
   

Amount

   

Ratio

   

Amount

      Ratio    

Amount

      Ratio  

As of December 31, 2015:

                                                   

Company:

                                                   

Total risk-based capital

  $ 280,273       13.11 %   $ 170,969  

>

    8.0 %   $ 213,711  

>

    10.0 %

Tier 1 risk-based capital

    253,891       11.88 %     128,227  

>

    6.0       170,969  

>

    8.0  

Tier 1 leverage

    253,891       9.75 %     104,163  

>

    4.0       130,203  

>

    5.0  

Common equity Tier 1

    220,800       10.33 %     96,170  

>

    4.5       138,912  

>

    6.5  

Quad City Bank & Trust:

                                                   

Total risk-based capital

  $ 135,477       12.50 %   $ 86,726  

>

    8.0 %   $ 108,407  

>

    10.0 %

Tier 1 risk-based capital

    123,498       11.39 %     65,044  

>

    6.0       86,726  

>

    8.0  

Tier 1 leverage

    123,498       8.87 %     55,718  

>

    4.0       69,648  

>

    5.0  

Common equity Tier 1

    123,498       11.39 %     48,783  

>

    4.5       70,465  

>

    6.5  

Cedar Rapids Bank & Trust:

                                                   

Total risk-based capital

  $ 105,285       14.39 %   $ 58,537  

>

    8.0 %   $ 73,172  

>

    10.0 %

Tier 1 risk-based capital

    96,118       13.14 %     43,903  

>

    6.0       58,537  

>

    8.0  

Tier 1 leverage

    96,118       10.96 %     35,079  

>

    4.0       43,848  

>

    5.0  

Common equity Tier 1

    96,118       13.14 %     32,927  

>

    4.5       47,562  

>

    6.5  

Rockford Bank & Trust:

                                                   

Total risk-based capital

  $ 38,544       11.96 %   $ 25,772  

>

    8.0 %   $ 32,216  

>

    10.0 %

Tier 1 risk-based capital

    34,514       10.71 %     19,329  

>

    6.0       25,772  

>

    8.0  

Tier 1 leverage

    34,514       9.59 %     14,401  

>

    4.0       18,001  

>

    5.0  

Common equity Tier 1

    34,514       10.71 %     14,497  

>

    4.5       20,940  

>

    6.5  

 

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

 

On October 27, 2016, the Company filed a universal shelf registration statement on Form S-3 with the SEC. When declared effective by the SEC, the registration statement will allow the Company to offer and sell various types of securities, including common stock, preferred stock, debt securities and/or warrants, from time to time up to an aggregate amount of $100 million. The Company utilized $30.1 million of its previous $100 million shelf registration filing through the offer and sale of its common stock in the second quarter of 2016 to help fund the acquisition of CSB. This Form S-3 filing will replenish the amount available to the previous level of $100 million. The specific terms and prices of any securities offered pursuant to the registration statement will be determined at the time of any future offering and described in a separate prospectus supplement, which would be filed with the SEC at the time of the particular offering, if any.

 

 
37

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

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

 

On August 31, 2016, the Company acquired Community State Bank from Van Diest Investment Company. CSB is headquartered in Ankeny, Iowa and is an Iowa-chartered bank that operates ten banking locations throughout the Des Moines metropolitan area. The Company purchased 100% of the outstanding common stock of CSB for cash consideration of $80.0 million.

 

The acquisition of CSB allowed the Company to expand its footprint into the Des Moines market. CSB has an experienced and capable leadership team that is committed to leading the Company’s efforts in the Des Moines MSA. CSB has demonstrated significant improvement in earnings and asset quality during the last three years. Additionally, CSB has a strong core deposit base and retail franchise. Although CSB already has strong earnings with an expected ROAA of 1.00% in 2016, the Company has identified several opportunities for enhanced future earnings performance. With $581 million of assets acquired, the Company believes this acquisition is large enough to provide meaningful impact on the financial results, but is not too large to overstrain existing infrastructure. Lastly, financial metrics related to the transaction were favorable, as measured by EPS accretion and earn-back of tangible book value dilution.

 

In connection with the acquisition, during the second quarter of 2016, the Company sold 1,215,000 shares of its common stock at a price of $24.75 per share, for net proceeds of $29.8 million, after deducting expenses. The shares were offered to institutional investors in a registered direct offering conducted without an underwriter or placement agent. The offering was a partial take-down of a previously filed shelf registration and closed on May 23, 2016.

 

Cash received from the common stock offering was used to help finance the purchase price of the acquisition. Additionally, the Company drew $5.0 million on its $10.0 million revolving line of credit and fully funded its $30.0 million term facility. Both of these facilities are described further in Note 4 to the Consolidated Financial Statements. Cash dividends of $15.2 million from QCBT and CRBT were used to fund the remainder of the purchase price.

 

The Company accounted for the business combination under the acquisition method of accounting in accordance with ASC 805. The Company recognized the full fair value of the assets acquired and liabilities assumed at the acquisition date, net of applicable income tax effects. The Company considers all purchase accounting adjustments as provisional and fair values are subject to refinement for up to one year after the closing date.

 

The excess of the consideration paid over the fair value of the net assets acquired is recorded as goodwill. This goodwill is not deductible for tax purposes.

 

The Company has several areas of specialization, including government guaranteed lending, C&I lending, interest rate swaps, leasing, wealth management, private banking and municipal bond offerings that will be offered in this new market, increasing future earnings potential. There is also value added to the Company through having a footprint in a market that has strong growth potential. Additionally, there are qualitative benefits gained through the addition of a new charter including better leverage of centralized operations and increased lending limits. The experience and value of the personnel at CSB and their knowledge of the Des Moines MSA is also beneficial.

 

 
38

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

The fair values of the assets acquired and liabilities assumed including the consideration paid and resulting goodwill is as follows:

 

 

   

As of

 
   

August 31, 2016

 

ASSETS

       

Cash and due from banks

  $ 10,094,645  

Federal funds sold

    698,000  

Interest-bearing deposits at financial institutions

    14,730,157  

Securities

    102,640,029  

Loans/leases receivable, net

    419,029,277  

Premises and equipment

    20,684,880  

Core deposit intangible

    6,352,653  

Restricted investment securities

    1,512,900  

Other real estate owned

    650,000  

Other assets

    4,763,224  

Total assets acquired

  $ 581,155,765  
         

LIABILITIES

       

Deposits

  $ 486,298,262  

FHLB advances

    20,368,877  

Other liabilities

    4,897,564  

Total liabilities assumed

  $ 511,564,703  
         

Net assets acquired

  $ 69,591,062  
         

CONSIDERATION PAID:

       

Cash

  $ 80,000,000  

Total consideration paid

  $ 80,000,000  
         

Goodwill

  $ 10,408,938  

 

 

Loans acquired in a business combination are recorded and initially measured at their estimated fair value as of the acquisition date. Credit discounts are included in the determination of fair value. A third party valuation consultant assisted with the determination of fair value.

 

Purchased loans are segregated into two categories: PCI loans and non-PCI (performing) loans. PCI loans are accounted for in accordance with ASC 310-30, as they display significant credit deterioration since origination and it is probable, as of the acquisition date, that the Company will be unable to collect all contractually required payments from the borrower. Performing loans are accounted for in accordance with ASC 310-20, as these loans do not have evidence of significant credit deterioration since origination and it is probable that the contractually required payments will be received from the borrower.

 

For PCI loans, the difference between the contractually required payments at acquisition and the cash flows expected to be collected is referred to as the non-accretable discount. Further, any excess cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized in interest income over the expected remaining life of the loan. Subsequent to the purchase date, increases in cash flows over those expected at the purchase date are recognized as interest income prospectively. The present value of any decreases in expected cash flows after the purchase date is recognized by recording an allowance for loan and lease losses and provision for loan losses.

 

For performing loans, the difference between the estimated fair value of the loans and the principal balance outstanding is accreted over the remaining life of the loans.

 

 
39

 

 

 Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

The following table presents the purchased loans as of the acquisition date:

 

   

PCI

   

Performing

         
   

Loans

   

Loans

   

Total

 

Contractually required principal payments

  $ 3,662,431     $ 428,552,119     $ 432,214,550  

Nonaccretable discount

    (991,685 )     -       (991,685 )

Principal cash flows expected to be collected

  $ 2,670,746     $ 428,552,119     $ 431,222,865  

Accretable discount

    (277,579 )     (11,916,009 )     (12,193,588 )

Fair Value of acquired loans

  $ 2,393,167     $ 416,636,110     $ 419,029,277  

 

Changes in accretable yield for the loans acquired were as follows for the three and nine months ended September 30, 2016:

 

   

PCI

   

Performing

         
   

Loans

   

Loans

   

Total

 

Balance at the beginning of the period

    (277,579 )     (11,916,009 )     (12,193,588 )

Accretion recognized

    29,317       366,293       395,610  

Balance at the end of the period

  $ (248,262 )   $ (11,549,716 )   $ (11,797,978 )

 

During the current quarter, there was also $89 thousand of nonaccretable discount that was accelerated due to the early repayment of PCI loans.

 

Premises and equipment acquired with a fair value of $20,684,880 includes ten branch locations with a fair value of $19,735,000, including a write-up of $8,334,437. The fair value was determined with the assistance of a third party appraiser. The write-up of these properties will be recognized as an increase in depreciation expense over 39 years.

 

The Company recorded a core deposit intangible totaling $6,352,653 which is the portion of the acquisition purchase price which represents the value assigned to the existing deposit base. The core deposit intangible has a finite life and is amortized using an accelerated method over the estimated useful life of the deposits (estimated to be ten years).

 

The following table presents the changes in the carrying amount of core deposit intangibles, gross carrying amount, accumulated amortization, and net book value:

 

   

September 30,

2016

 

Balance at the beginning of the period

  $ 6,352,653  

Amortization expense

    (60,834 )

Balance at the end of the period

  $ 6,291,819  
         
         

Gross carrying amount

  $ 6,352,653  

Accumulated amortization

    (60,834 )

Net book value

  $ 6,291,819  

 

 
40

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

The following presents the estimated amortization expense of the core deposit intangible:

 

Years ending December 31,

 

Amount

 

2016

  $ 182,503  

2017

    723,955  

2018

    710,751  

2019

    694,374  

2020

    674,819  

Thereafter

    3,305,417  
    $ 6,291,819  

 

*There is another core deposit intangible on the balance sheet totaling $1,321,774 that is related to a previous acquisition.

 

During the first nine months of 2016, the Company incurred $2.4 million of expenses related to the acquisition, comprised primarily of legal, accounting, investment banking costs and personnel costs. These acquisition costs are presented on their own line within the consolidated statements of income. CSB results are included in the consolidated statements of income effective on the acquisition date. For the period 8/31/16 to 9/30/16, CSB reported revenues of $2.7 million and net income of $189 thousand, which included $473 thousand of after tax acquisition costs.

 

Unaudited pro forma combined operating results for the three and nine months ended September 30, 2016 and 2015, giving effect to the CSB acquisition as if it had occurred as of January 1, 2015, are as follows:

 

   

Three months ended

   

Nine months ended

 
   

September 30,

   

September 30,

 
   

2016

   

2015

   

2016

   

2015

 
   

(in thousands, except for per share data)

 
                                 

Interest income

  $ 27,615     $ 25,685     $ 80,755     $ 73,051  

Noninterest income

  $ 11,415     $ 8,074     $ 27,744     $ 23,167  

Net income

  $ 7,301     $ 8,216     $ 23,813     $ 15,324  
                                 

Earnings per common share:

                               

Basic

  $ 0.56     $ 0.64     $ 1.85     $ 1.38  

Diluted

  $ 0.55     $ 0.63     $ 1.82     $ 1.36  

 

The pro forma results do not purport to be indicative of the results of operations that actually would have resulted had the acquisition occurred on January 1, 2015 or of future results of operations of the consolidated entities.

 

NOTE 10 – RELATED PARTY TRANSACTIONS

 

Management reviews transactions with related parties on a quarterly basis, as part of Disclosure Committee procedures.

 

During 2016, the Company entered into a material related party transaction with a company that is owned and controlled by a CRBT director. That company was chosen as the general contractor for the remodel of the Waterloo branch. The company was the original contractor for the branch and is recognized as a leader in Iowa and the Midwest market for the design and construction of financial services and professional office buildings. Based on the company’s expertise, their experience as the original designer/builder of the branch location and a decline to bid from two other contractors, management chose the company as the general contractor. Management determined that the bids received from the company were at market rates.

 

The project total is estimated at $3.5 million. This is the full contract price, as subcontractors will be utilized to complete the work. It is estimated that the company will receive $2.1 million for their work as the general contractor, including payments for a portion of the actual construction costs as the company is completing a portion of the subcontracting work in addition to being the general contractor.  

 
41

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

 

INTRODUCTION

 

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

 

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

 

GENERAL

 

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


QCBT, CRBT and CSB are Iowa-chartered commercial banks, and RB&T is an Illinois-chartered commercial bank. QCBT, CRBT and RB&T are members of the Federal Reserve system with depository accounts insured to the maximum amount permitted by law by the FDIC. CSB is not a Federal Reserve system member at this time, however, CSB intends to file a membership application as soon as possible. CSB’s depository accounts are insured to the maximum amount permitted by law by the FDIC.

 

 

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

 

 

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

 

 

CSB was acquired in the third quarter of 2016, as further described in Note 9 to the Consolidated Financial Statements. CSB provides full-service commercial and consumer banking to the Des Moines, Iowa area and adjacent communities through its 10 branch locations, including its main office located on North Ankeny Boulevard in Ankeny, Iowa.

 

 

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

 

 
42

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

EXECUTIVE OVERVIEW

 

The Company reported net income of $6.1 million and diluted EPS of $0.46 for the quarter ended September 30, 2016. This included $1.5 million of acquisition costs (after-tax) related to the acquisition of CSB. By comparison, for the quarter ended June 30, 2016, the Company reported net income of $6.7 million and diluted EPS of $0.53. This included $231 thousand of acquisition costs (after-tax) related to CSB. For the third quarter of 2015, the Company reported net income of $6.5 million and diluted EPS of $0.55.

 

For the nine months ended September 30, 2016, the Company reported net income of $19.2 million and diluted EPS of $1.52. This included $1.7 million of acquisition costs (after-tax) related to the acquisition of CSB. By comparison, for the nine months ended September 30, 2015, the Company reported net income of $10.1 million and diluted EPS of $1.01. This included several nonrecurring items, including $4.5 million of losses on debt extinguishments (after-tax) related to the balance sheet restructuring that took place in the second quarter of 2015.

 

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

 

 

The successful closing of the acquisition of CSB, headquartered in Ankeny, Iowa;

 

Loan and lease growth at an annualized rate of 10.6% through the first nine months of the year (excluding the acquisition of CSB);

 

Strong swap fee income and gains on the sale of government guaranteed portions of loans, totaling $4.1 million year-to-date;

 

Further reductions in wholesale borrowings totaling $60 million in the third quarter; and

 

NIM improvement of 9 basis points quarter-over-quarter.

 

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

 

   

For the three months ended

   

For the nine months ended

 
   

September 30, 2016

   

June 30, 2016

   

September 30, 2015

   

September 30, 2016

   

September 30, 2015

 
                                         

Net income

  $ 6,107,501     $ 6,676,467     $ 6,488,987     $ 19,157,457     $ 10,143,058  
                                         

Diluted earnings per common share

  $ 0.46     $ 0.53     $ 0.55     $ 1.52     $ 1.01  
                                         
                                         

Weighted average common and common equivalent shares outstanding*

    13,269,703       12,516,474       11,875,930       12,580,042       10,024,441  

 

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

 

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

 

   

For the three months ended

   

For the nine months ended

 
   

September 30, 2016

   

June 30, 2016

   

September 30, 2015

   

September 30, 2016

   

September 30, 2015

 
                                         

Net interest income

  $ 23,630,777     $ 21,008,813     $ 20,137,526     $ 65,237,112     $ 56,410,579  

Provision expense

    1,607,986       1,197,850       1,635,263       4,878,821       5,694,384  

Noninterest income

    10,423,401       6,762,401       6,402,686       24,008,275       18,151,411  

Noninterest expense

    24,480,483       17,743,753       15,947,091       59,178,734       57,318,599  

Federal and state income tax expense

    1,858,208       2,153,144       2,468,871       6,030,375       1,405,949  

Net income

  $ 6,107,501     $ 6,676,467     $ 6,488,987     $ 19,157,457     $ 10,143,058  

 

 
43

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued 

 

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

 

 

Net interest income increased 12% compared to the second quarter of 2016 and increased 17% from the same period in 2015. Much of this increase was the result of the acquisition of CSB, which reported net interest income of $2.2 million for the partial quarter.

 

 

Provision increased 34% compared to the second quarter of 2016. Provision was flat from the same period of 2015. The increase in the third quarter was primarily the result of the acquisition of CSB, which reported provision expense of $270 thousand for the partial quarter.

 

 

Noninterest income increased 54% compared to the second quarter of 2016. Noninterest income increased 63% from the third quarter of 2015. The increase in noninterest income was primarily due to a one-time gain from the sale of an equity security totaling $4.0 million.

 

 

Noninterest expense increased 38% compared to the second quarter of 2016. Noninterest expense increased 54% from the third quarter of 2015. The third quarter of 2016 included $2.0 million of pre-tax acquisition costs related to CSB, as well as $4.1 million of losses on debt extinguishment. See Note 4 to the Consolidated Financial Statements for additional details.

 

 

Federal and state income tax expense decreased 14% compared to the second quarter of 2016. Federal and state income tax decreased 25% compared to the third quarter of 2015. See the Income Taxes section of this report for additional details.

 

LONG-TERM FINANCIAL GOALS

 

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

 

 

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

 

 

Improve profitability (measured by NIM and ROAA);

 

 

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

 

 

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

 

 

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

 

 

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

 

 
44

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued 

 

 

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

 

 

Grow wealth management segment net income by 10% annually.

 

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

 

 

     

For the Quarter Ending

 
 Goal  Key Metric     Target**     

September 30,

2016

   

June 30,

2016

   

September 30,

2015

 
                                   

Balance sheet efficiency

Gross loans and leases to total assets

    70 - 75%        72%       72%       68%  
 

NIM

 

> 3.75%

      3.71%       3.62%       3.51%  
Profitability

ROAA

 

> 1.10%

      0.85%       1.01%       1.01%  
 

Core ROAA (non-GAAP)

        1.05%       1.04%       0.97%  
 

NPAs to total assets

 

< 0.75%

      0.69%       0.70%       0.80%  
Asset quality

Net charge-offs to average loans and leases*

 

< 0.25% annually

      0.15%       0.12%       0.26%  

Lower reliance on wholesale funding

Wholesale funding to total assets

 

< 15%

      13%       18%       21%  

Funding mix

Noninterest bearing deposits as a percentage of total assets

 

> 30%

      23%       23%       23%  

m2 commercial loans and leases

Total loans and leases

 

$250 million

   

$206.8 million

   

$205.9 million

   

$194.9 million

 

Consistent, high quality noninterest income revenue streams

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

 

> $4 million annually

   

$5.4 million

   

$7.1 million

   

$2.8 million

 
 

Grow wealth management segment net income*

 

> 10% annually

      (3%)       (7%)       6%  

 

 

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

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

 

STRATEGIC DEVELOPMENTS

 

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

 

 

Loan and lease growth year-to-date was 10.6% when annualized (excluding CSB). This is within the Company’s target organic growth rate of 10-12%. A majority of this growth was in the C&I and CRE loan categories. Strong loan and lease growth continues to keep the Company’s loan and leases to asset ratio within the targeted range of 70-75%.

 

 

The Company intends to participate as an acquirer in the consolidation taking place in our markets to further boost ROAA and improve the Company’s efficiency ratio. In the third quarter of 2016, the Company acquired CSB, headquartered in Ankeny, Iowa. See Note 9 of the Consolidated Financial Statements for additional details.

 

 

The Company continued to focus on reducing the NPAs to total assets ratio and decreased this ratio from 0.74% at December 31, 2015 to 0.69% at September 30, 2016. Although NPAs increased as a result of the acquisition of CSB, the NPAs to total assets ratio decreased slightly as compared to the prior quarter and the Company remains committed to further improving asset quality ratios in 2016.

 

 
45

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued 

 

 

Management continued to focus on reducing the Company’s reliance on wholesale funding. The restructuring executed in the first and third quarters of 2016 (as described in Note 4 of the Consolidated Financial Statements) has further reduced the Company’s reliance on long-term wholesale funding. These prepayments, along with the addition of CSB, which has a very strong core funding base with minimal wholesale borrowings, assisted in lowering the Company’s reliance on wholesale funding as a percentage of assets down to 13% in the current quarter. Management continues to closely evaluate opportunities for continued reduction in wholesale funding.

 

 

Correspondent banking continues to be a core line of business for the Company. The Company is competitively positioned with experienced staff, software systems and processes to continue growing in the three states currently served – Iowa, Illinois and Wisconsin. The Company acts as the correspondent bank for 179 downstream banks with average total noninterest bearing deposits of $343.1 million during the third quarter of 2016. This line of business provides a strong source of noninterest bearing deposits, fee income, high-quality loan participations and bank stock loans.

 

 

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

 

 

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

 

 

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

 

 

Wealth management is another core line of business for the Company and includes a full range of products, including trust services, brokerage and investment advisory services, asset management, estate planning and financial planning. As of September 30, 2016 the Company had $1.85 billion of total financial assets in trust (and related) accounts and $727 million of total financial assets in brokerage (and related) accounts. Continued growth in assets under management will help to drive trust and investment advisory fees. The Company offers trust and investment advisory services to the correspondent banks that it serves. As management focuses on growing fee income, expanding market share will continue to be a primary strategy.

 

 
46

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued 

 

GAAP TO NON-GAAP RECONCILIATIONS

 

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

 

The tangible common equity to tangible assets ratio has been a focus for investors and management believes that this ratio may assist investors in analyzing the Company’s capital position without regard to the effects of intangible assets. In compliance with applicable rules of the SEC, this non-GAAP measure is reconciled to stockholders’ equity and total assets, which are the most directly comparable GAAP financial measures.

 

The table below also includes several “core” measurements of financial performance. The Company's management believes that these measures are important to investors as they exclude non-recurring income and expense items; therefore, they provide a better comparison for analysis and may provide a better indicator of future run-rates. In compliance with applicable rules of the SEC, these non-GAAP measures are reconciled to net income, which is the most directly comparable GAAP financial measure.

 

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

 

 
47

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued 

 

   

As of

 

GAAP TO NON-GAAP RECONCILIATIONS

 

September 30,

2016

   

June 30,

2016

   

March 31,

2016

   

December 31,

2015

   

September 30,

2015

 
   

(dollars in thousands, except per share data)

 

TCE / TA RATIO

                                       
                                         

Stockholders' equity (GAAP)

  $ 280,857     $ 275,117     $ 235,143     $ 225,886     $ 221,115  

Less: Intangible assets

    22,755       4,595       4,645       4,694       4,744  

TCE (non-GAAP)

  $ 258,102     $ 270,522     $ 230,498     $ 221,192     $ 216,371  
                                         

Total assets (GAAP)

  $ 3,280,986     $ 2,683,434     $ 2,640,673     $ 2,593,198     $ 2,575,855  

Less: Intangible assets

    22,755       4,595       4,645       4,694       4,744  

TA (non-GAAP)

  $ 3,258,231     $ 2,678,839     $ 2,636,028     $ 2,588,504     $ 2,571,111  
                                         

TCE / TA ratio (non-GAAP)

    7.92 %     10.10 %     8.74 %     8.55 %     8.42 %

 

   

For the Quarter Ended

   

For the Nine Months Ended

 
   

September 30,

   

June 30,

   

March 31,

   

December 31,

   

September 30,

   

September 30,

   

September 30,

 

CORE NET INCOME

 

2016

   

2016

   

2016

   

2015

   

2015

   

2016

   

2015

 
                                                         

Net income (GAAP)

  $ 6,108     $ 6,676     $ 6,373     $ 6,785     $ 6,489     $ 19,157     $ 10,143  
                                                         

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

                                                       

Income:

                                                       

Securities gains, net

  $ 2,764     $ 12     $ 233     $ 211     $ 37     $ 3,009     $ 308  

Lawsuit settlement

    -       -       -       -       252               252  

Total nonrecurring income (non-GAAP)

  $ 2,764     $ 12     $ 233     $ 211     $ 289     $ 3,009     $ 560  
                                                         

Expense:

                                                       

Losses on debt extinguishment

  $ 2,689     $ -     $ 54     $ 189     $ -     $ 2,743     $ 4,481  

Acquisition costs

    1,506       231       -       -       -       1,737       -  

Other non-recurring expenses

    -       -       -       -       -       -       513  

Accrual adjustments

    -       -       -       (487 )     -       -       -  

Total nonrecurring expense (non-GAAP)

  $ 4,195     $ 231     $ 54     $ (298 )   $ -     $ 4,480     $ 4,994  
                                                         

Core net income (non-GAAP)

  $ 7,539     $ 6,895     $ 6,194     $ 6,276     $ 6,200     $ 20,628     $ 14,577  
                                                         
                                                         

CORE EPS

                                                       
                                                         

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

  $ 7,539     $ 6,895     $ 6,194     $ 6,276     $ 6,200     $ 20,628     $ 14,577  
                                                         

Weighted average common shares outstanding

    13,066,777       12,335,077       11,793,620       11,744,495       11,713,993       12,398,491       9,878,882  

Weighted average common and common equivalent shares outstanding

    13,269,703       12,516,474       11,953,949       11,926,038       11,875,930       12,580,042       10,024,441  
                                                         

Core EPS (non-GAAP):

                                                       

Basic

  $ 0.58     $ 0.56     $ 0.53     $ 0.53     $ 0.53     $ 1.66     $ 1.48  

Diluted

  $ 0.57     $ 0.55     $ 0.52     $ 0.53     $ 0.52     $ 1.64     $ 1.45  
                                                         
                                                         

CORE ROAA

                                                       
                                                         

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

  $ 7,539     $ 6,895     $ 6,194     $ 6,276     $ 6,200     $ 20,628     $ 14,577  
                                                         

Average Assets

  $ 2,865,947     $ 2,640,678     $ 2,602,350     $ 2,611,276     $ 2,563,739     $ 2,702,992     $ 2,529,469  
                                                         

Core ROAA (annualized) (non-GAAP)

    1.05 %     1.04 %     0.95 %     0.96 %     0.97 %     1.02 %     0.77 %

 

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

 

 
48

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued 

 

NET INTEREST INCOME - (TAX EQUIVALENT BASIS)

 

Net interest income, on a tax equivalent basis, increased 18% to $25.2 million for the quarter ended September 30, 2016, compared to the same quarter of the prior year. For the nine months ended September 30, 2016, net interest income, on a tax equivalent basis, increased 16% to $69.5 million, compared to the same period of 2015. Net interest income improved due to several factors:

 

 

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

 

Organic loan and lease growth has been strong over the past twelve months, as evidenced by average gross loan/lease growth of 15% in that period;

 

The recent acquisition of CSB, whose strong margin will significantly contribute to the Company’s results; and

 

The Company’s balance sheet restructuring and deleveraging strategies executed throughout 2015 and 2016.

 

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

 

The average yield on interest-earning assets increased 18 basis points.

 

The average cost of interest-bearing liabilities decreased 2 basis points.

 

The net interest spread increased 20 basis points from 3.29% to 3.49%.

 

The NIM improved 20 basis points from 3.51% to 3.71%.

 

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

 

The average yield on interest-earning assets increased 15 basis points.

 

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

 

The net interest spread increased 30 basis points from 3.13% to 3.43%.

 

The NIM improved 28 basis points from 3.37% to 3.65%.

 

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

 

The improvement in margin in the third quarter of 2016 was primarily the result of the acquisition of CSB. Excluding CSB, the Company’s margin was flat from the second quarter of 2016. CSB’s margin will fluctuate based on the amortization and accretion of purchase accounting adjustments, mostly notably, the discount on the loan portfolio. This benefit can fluctuate based on prepayments of both PCI and performing loans. As loans prepay, the associated discount/premium is accelerated.

 

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

 

 
49

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued 

 

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

 

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

 

   

For the three months ended September 30,

 
   

2016

   

2015

 
           

Interest

   

Average

           

Interest

   

Average

 
   

Average

   

Earned

   

Yield or

   

Average

   

Earned

   

Yield or

 
   

Balance

   

or Paid

   

Cost

   

Balance

   

or Paid

   

Cost

 
                                                 
   

(dollars in thousands)

 

ASSETS

                                               

Interest earning assets:

                                               

Federal funds sold

  $ 17,685     $ 13       0.29 %   $ 22,435     $ 8       0.14 %

Interest-bearing deposits at financial institutions

    67,807       103       0.60 %     51,380       67       0.52 %

Investment securities (1)

    525,417       4,826       3.65 %     591,538       4,683       3.14 %

Restricted investment securities

    14,877       132       3.53 %     14,224       127       3.54 %

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

    2,077,376       23,330       4.47 %     1,744,043       19,564       4.45 %
                                                 

Total interest earning assets

  $ 2,703,162     $ 28,404       4.18 %   $ 2,423,620     $ 24,449       4.00 %
                                                 

Noninterest-earning assets:

                                               

Cash and due from banks

  $ 52,678                     $ 44,679                  

Premises and equipment

    42,986                       38,318                  

Less allowance

    (30,927 )                     (26,417 )                

Other

    98,048                       83,539                  
                                                 

Total assets

  $ 2,865,947                     $ 2,563,739                  
                                                 

LIABILITIES AND STOCKHOLDERS' EQUITY

                                               

Interest-bearing liabilities:

                                               

Interest-bearing deposits

  $ 1,116,325       717       0.26 %   $ 822,178       465       0.22 %

Time deposits

    422,603       755       0.71 %     414,393       675       0.65 %

Short-term borrowings

    30,208       12       0.16 %     147,880       64       0.17 %

FHLB advances

    118,564       421       1.41 %     131,343       537       1.62 %

Junior subordinated debentures

    33,430       306       3.64 %     40,510       317       3.10 %

Other borrowings

    116,856       975       3.32 %     115,017       945       3.26 %
                                                 

Total interest-bearing liabilities

  $ 1,837,986     $ 3,186       0.69 %   $ 1,671,321     $ 3,003       0.71 %
                                                 

Noninterest-bearing demand deposits

  $ 704,469                     $ 645,033                  

Other noninterest-bearing liabilities

    45,123                       30,932                  

Total liabilities

  $ 2,587,578                     $ 2,347,286                  
                                                 

Stockholders' equity

    278,369                       216,453                  
                                                 

Total liabilities and stockholders' equity

  $ 2,865,947                     $ 2,563,739                  
                                                 

Net interest income

          $ 25,218                     $ 21,446          
                                                 

Net interest spread

                    3.49 %                     3.29 %
                                                 

Net interest margin

                    3.71 %                     3.51 %
                                                 

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

    147.07 %                     145.01 %                

 

(1)

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

(2)

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

(3)

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

 

 
50

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued 

 

Analysis of Changes of Interest Income/Interest Expense

For the three months ended September 30, 2016

 

   

Inc./(Dec.)

   

Components

 
   

from

   

of Change (1)

 
   

Prior Period

   

Rate

   

Volume

 
   

2016 vs. 2015

 
   

(dollars in thousands)

 

INTEREST INCOME

                       

Federal funds sold

  $ 5     $ 16     $ (11 )

Interest-bearing deposits at financial institutions

    36       12       24  

Investment securities (2)

    143       2,551       (2,408 )

Restricted investment securities

    5       (3 )     8  

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

    3,766       75       3,691  
                         

Total change in interest income

  $ 3,955     $ 2,651     $ 1,304  
                         

INTEREST EXPENSE

                       

Interest-bearing deposits

  $ 252     $ 70     $ 182  

Time deposits

    80       67       13  

Short-term borrowings

    (52 )     (5 )     (47 )

Federal Home Loan Bank advances

    (116 )     (66 )     (50 )

Junior subordinated debentures

    (11 )     214       (225 )

Other borrowings

    30       16       14  
                         

Total change in interest expense

  $ 183     $ 296     $ (113 )
                         

Total change in net interest income

  $ 3,772     $ 2,355     $ 1,417  

 

(1)

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

(2)

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

(3)

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

(4)

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

 

 

 
51

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued 

 

   

For the nine months ended September 30,

 
   

2016

   

2015

 
           

Interest

   

Average

           

Interest

   

Average

 
   

Average

   

Earned

   

Yield or

   

Average

   

Earned

   

Yield or

 
   

Balance

   

or Paid

   

Cost

   

Balance

   

or Paid

   

Cost

 
                                                 
   

(dollars in thousands)

 

ASSETS

                                               

Interest earning assets:

                                               

Federal funds sold

  $ 16,364     $ 36       0.29 %   $ 18,549     $ 18       0.13 %

Interest-bearing deposits at financial institutions

    53,063       226       0.57 %     55,528       208       0.50 %

Investment securities (1)

    527,162       14,084       3.57 %     608,687       13,725       3.01 %

Restricted investment securities

    14,396       396       3.67 %     15,083       378       3.35 %

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

    1,937,086       63,784       4.40 %     1,688,605       56,452       4.47 %
                                                 

Total interest earning assets

  $ 2,548,070     $ 78,526       4.12 %   $ 2,386,451     $ 70,781       3.97 %
                                                 

Noninterest-earning assets:

                                               

Cash and due from banks

  $ 49,677                     $ 43,924                  

Premises and equipment

    39,637                       38,354                  

Less allowance

    (28,480 )                     (24,746 )                

Other

    94,087                       85,485                  
                                                 

Total assets

  $ 2,702,992                     $ 2,529,469                  
                                                 

LIABILITIES AND STOCKHOLDERS' EQUITY

                                               

Interest-bearing liabilities:

                                               

Interest-bearing deposits

  $ 994,476       1,931       0.26 %   $ 797,892       1,357       0.23 %

Time deposits

    415,808       2,175       0.70 %     391,218       1,939       0.66 %

Short-term borrowings

    55,623       74       0.18 %     163,091       181       0.15 %

FHLB advances

    125,319       1,278       1.36 %     170,520       2,983       2.34 %

Junior subordinated debentures

    33,825       913       3.61 %     40,475       937       3.10 %

Other borrowings

    106,201       2,624       3.30 %     131,278       3,286       3.35 %
                                                 

Total interest-bearing liabilities

  $ 1,731,251     $ 8,995       0.69 %   $ 1,694,474     $ 10,683       0.84 %
                                                 

Noninterest-bearing demand deposits

  $ 675,240                     $ 620,089                  

Other noninterest-bearing liabilities

    41,499                       32,771                  

Total liabilities

  $ 2,447,989                     $ 2,347,334                  
                                                 

Stockholders' equity

    255,002                       182,134                  
                                                 

Total liabilities and stockholders' equity

  $ 2,702,992                     $ 2,529,469                  
                                                 

Net interest income

          $ 69,531                     $ 60,098          
                                                 

Net interest spread

                    3.43 %                     3.13 %
                                                 

Net interest margin

                    3.65 %                     3.37 %
                                                 

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

    147.18 %                     140.84 %                

 

(1)

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

(2)

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

(3)

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

 

 
52

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued  

 

 

Analysis of Changes of Interest Income/Interest Expense

For the nine months ended September 30, 2016

 

   

Inc./(Dec.)

   

Components

 
   

from

   

of Change (1)

 
   

Prior Period

   

Rate

   

Volume

 
   

2016 vs. 2015

 
   

(dollars in thousands)

 

INTEREST INCOME

                       

Federal funds sold

  $ 18     $ 22     $ (4 )

Interest-bearing deposits at financial institutions

    18       32       (14 )

Investment securities (2)

    359       3,051       (2,692 )

Restricted investment securities

    18       44       (26 )

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

    7,332       (1,456 )     8,788  
                         

Total change in interest income

  $ 7,745     $ 1,693     $ 6,052  
                         

INTEREST EXPENSE

                       

Interest-bearing deposits

  $ 574     $ 209     $ 365  

Time deposits

    236       109       127  

Short-term borrowings

    (107 )     49       (156 )

Federal Home Loan Bank advances

    (1,705 )     (1,043 )     (662 )

Junior subordinated debentures

    (24 )     194       (218 )

Other borrowings

    (662 )     (45 )     (617 )
                         

Total change in interest expense

  $ (1,688 )   $ (527 )   $ (1,161 )
                         

Total change in net interest income

  $ 9,433     $ 2,220     $ 7,213  

 

(1)

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

(2)

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

(3)

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

(4)

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

 

 

 
53

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued  

 

 

CRITICAL ACCOUNTING POLICIES

 

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

 

ALLOWANCE FOR LOAN AND LEASE LOSSES

 

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

 

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

 

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

 

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

 

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

 

OTHER–THAN-TEMPORARY IMPAIRMENT

 

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

 

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

 

 
54

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued  

 

RESULTS OF OPERATIONS

 

INTEREST INCOME

 

Interest income increased 16%, comparing the third quarter of 2016 to the same period of 2015 and increased 11%, comparing the first nine months of 2016 to the same period of 2015.

 

A portion of this growth was the result of the Company’s strategy to redeploy funds from the securities portfolio into higher yielding loans and leases. In addition, organic loan and lease growth has been strong over the past twelve months. The acquisition of CSB also contributed to this increase. CSB’s interest income for the partial quarter totaled $2.3 million.

 

Overall, the Company’s average earning assets increased 12%, comparing the third quarter of 2016 to the third quarter of 2015. During the same time period, average gross loans and leases increased 19%, while average investment securities decreased 11%.

 

The securities portfolio yield continued to increase (from 3.14% for the third quarter of 2015 to 3.65% for the third quarter of 2016) as the Company continued to sell low-yielding investments taking advantage of favorable market opportunities. Call activity picked up in 2016, resulting in the call of some lower-yielding callable agency securities. Additionally, the Company continued to take actions to diversify its securities portfolio, including increasing its portfolio of tax-exempt municipal securities, in an effort to increase tax equivalent interest income without additional income tax expense.

 

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

 

INTEREST EXPENSE

 

Interest expense for the third quarter of 2016 increased 6% from the third quarter of 2015. The acquisition of CSB contributed to this increase, as their interest expense for the partial quarter was $83 thousand. For the first nine months of 2016, interest expense decreased 16% compared to the first nine months of 2015. The Company has been successful in maintaining pricing discipline on deposits and decreasing the cost of borrowings, which has more than offset the growth impact and contributed to the net decline in interest expense.

 

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

 

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

 

 
55

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued  

 

PROVISION FOR LOAN/LEASE LOSSES

 

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

 

The Company’s provision totaled $1.6 million for the third quarter of 2016, which was flat from the same quarter of the prior year. Notably, CSB incurred $270 thousand of provision expense in the partial quarter since acquisition. Provision for the first nine months of the year totaled $4.9 million, which was down $816 thousand, or 14%, compared to the first nine months of 2015. The decrease in provision expense was primarily due to stronger asset quality in recent periods.

 

The Company had provision of $1.6 million for the third quarter of 2016 which, when coupled with net charge-offs of $878 thousand, increased the Company’s allowance to $28.8 million at September 30, 2016. As of September 30, 2016, the Company’s allowance to total loans/leases was 1.22%, which was down from 1.46% at June 30, 2016 and down from 1.45% at September 30, 2015, respectively.

 

In accordance with generally accepted accounting principles for acquisition accounting, the loans acquired through the acquisition of CSB were recorded at market value; therefore, there was no allowance associated with CSB’s loans at acquisition. Management continues to evaluate the allowance needed on the acquired CSB loans factoring in the net remaining discount ($12.7 million at September 30, 2016). When factoring this remaining discount into the Company’s allowance to total loans and leases calculation, the Company’s allowance as a percentage of total loans and leases increases from 1.22% to 1.76%.

 

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

 

 
56

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued  

 

NONINTEREST INCOME

 

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

 

   

Three Months Ended

                 
   

September 30, 2016

   

September 30, 2015

   

$ Change

   

% Change

 
                                 

Trust department fees

  $ 1,518,600     $ 1,531,964     $ (13,364 )     (0.9

)%

Investment advisory and management fees

    765,977       782,442       (16,465 )     (2.1 )

Deposit service fees

    1,150,869       984,631       166,238       16.9  

Gains on sales of residential real estate loans, net

    144,105       84,609       59,496       70.3  

Gains on sales of government guaranteed portions of loans, net

    218,785       759,668       (540,883 )     (71.2 )

Swap fee income

    333,772       62,700       271,072       432.3  

Securities gains, net

    4,251,773       56,580       4,195,193       7,414.6  

Earnings on bank-owned life insurance

    450,251       407,018       43,233       10.6  

Debit card fees

    475,182       333,144       142,038       42.6  

Correspondent banking fees

    253,823       310,759       (56,936 )     (18.3 )

Participation service fees on commercial loan participations

    237,456       201,822       35,634       17.7  

Fee income from early termination of leases

    95,129       89,332       5,797       6.5  

Credit card issuing fees

    137,620       133,904       3,716       2.8  

Lawsuit award

    -       387,045       (387,045 )     (100.0 )

Other

    390,059       277,068       112,991       40.8  

Total noninterest income

  $ 10,423,401     $ 6,402,686     $ 4,020,715       62.8

%

 

   

Nine Months Ended

                 
   

September 30, 2016

   

September 30, 2015

   

$ Change

   

% Change

 
                                 

Trust department fees

  $ 4,606,590     $ 4,676,535     $ (69,945 )     (1.5

)%

Investment advisory and management fees

    2,117,100       2,250,918       (133,818 )     (5.9 )

Deposit service fees

    3,028,758       2,790,456       238,302       8.5  

Gains on sales of residential real estate loans

    288,904       266,284       22,620       8.5  

Gains on sales of government guaranteed portions of loans

    2,701,203       899,987       1,801,216       200.1  

Swap fee income

    1,358,312       1,182,630       175,682       14.9  

Securities gains, net

    4,628,283       473,513       4,154,770       877.4  

Earnings on bank-owned life insurance

    1,324,380       1,318,909       5,471       0.4  

Debit card fees

    1,126,581       912,030       214,551       23.5  

Correspondent banking fees

    800,892       915,759       (114,867 )     (12.5 )

Participation service fees on commercial loan participations

    694,175       647,598       46,577       7.2  

Fee income from early termination of leases

    172,922       250,892       (77,970 )     (31.1 )

Credit card issuing fees

    413,348       403,713       9,635       2.4  

Lawsuit award

    -       387,045       (387,045 )     (100.0 )

Other

    746,827       775,142       (28,315 )     (3.7 )

Total noninterest income

  $ 24,008,275     $ 18,151,411     $ 5,856,864       32.3

%

 

In recent years, the Company has been successful in expanding its wealth management customer base, which has helped drive increases in fee income. While trust department fees continue to be a significant contributor to noninterest income, due to poor market conditions early in 2016, coupled with a large amount of distributions to clients and beneficiaries, trust department fees decreased 1% compared to the third quarter of 2015 and decreased 2% when comparing the first nine months of 2016 to the same period of the prior year. Income is generated primarily from fees charged based on assets under administration for corporate and personal trusts and for custodial services. The majority of the trust department fees are determined based on the value of the investments within the fully managed trusts. Additionally, the Company recently started offering trust operations services to correspondent banks.

 

 
57

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued  

 

Management has placed a strong emphasis on growing its investment advisory and management services. Part of this initiative has been to restructure the Company’s Wealth Management Division to allow for more efficient delivery of products and services through selective additions of talent as well as leverage of and collaboration among existing resources (including the aforementioned trust department). Similar to trust department fees, these fees are largely determined based on the value of the investments managed. And, similar to the trust department, the Company has had some success in expanding its customer base. However, due to poor market conditions early in 2016, investment advisory fees decreased 2% from the third quarter of 2015 to the third quarter of 2016 and they decreased 6% when comparing the first nine months of 2015 to the first nine months of 2016.

 

Deposit service fees expanded 17%, comparing the third quarter of 2016 to the same period in 2015, and expanded 9% when comparing the first nine months of 2016 to the same period of the prior year. The majority of this increase is the result of the addition of CSB. Its deposit service fees for the partial quarter were $152 thousand. Additionally, the Company continues its emphasis on shifting the mix of deposits from brokered and retail time deposits to non-maturity demand deposits across all its markets. With this shift in mix, the Company has increased the number of demand deposit accounts, which tend to be lower in interest cost and higher in service fees. The Company plans to continue this shift in mix and to further focus on growing deposit service fees.

 

Gains on sales of residential real estate loans increased 70%, comparing the third quarter of 2016 to the third quarter of 2015 and increased 9% when comparing the first nine months of 2016 to the same period of the prior year. With the sustained historically low interest rate environment, refinancing activity has slowed, as many of the Company’s existing and prospective customers have already executed a refinancing. Therefore, this area has become a much smaller contributor to overall noninterest income. Nearly half of the increase in the third quarter was attributable to the addition of CSB, which recognized $27 thousand of gains on the sales of residential real estate in the partial quarter.

 

The Company’s gains on the sale of government-guaranteed portions of loans for the third quarter were down 71% from the prior year but were up 200% when comparing the first nine months of 2016 to the same period of 2015. Given the nature of these gains, large fluctuations can happen from quarter-to-quarter. Year-to-date results for the current year are reflective of the strong demand for these types of loans in 2016. As one of its core strategies, the Company continues to leverage its expertise by taking advantage of programs offered by the SBA and the USDA. The Company’s portfolio of government-guaranteed loans has grown as a direct result of the Company’s strong expertise in SBA and USDA lending. In some cases, it is more beneficial for the Company to sell the government-guaranteed portion on the secondary market for a premium rather than retain the loans in the Company’s portfolio. Sales activity for government-guaranteed portions of loans tends to fluctuate depending on the demand for loans that fit the criteria for the government guarantee. Further, the size of the transactions can vary and, as the gain is determined as a percentage of the guaranteed amount, the resulting gain on sale can vary. Lastly, a strategy for improved pricing is packaging loans together for sale. From time to time, the Company may execute on this strategy, which may delay the gains on sales of some loans to achieve better pricing. The Company has added additional talent and is executing on strategies in an effort to make this a more consistent and larger source of revenue. The pipelines for SBA and USDA lending are strong, and management believes that the Company will continue to have success in this category.

 

 
58

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued  

 

As a result of the sustained historically low interest rate environment, the Company was able to execute several interest rate swaps on select commercial loans. The interest rate swaps allow the commercial borrowers to pay a fixed interest rate while the Company receives a variable interest rate as well as an upfront fee dependent upon the pricing. Management believes that these swaps help position the Company more favorably for rising rate environments. Management will continue to review opportunities to execute these swaps at all of its subsidiary banks, as the circumstances are appropriate for the borrower and the Company. Swap fee income totaled $334 thousand in third quarter of 2016, as compared to $63 thousand in third quarter of 2015. Swap fee income totaled $1.4 million for the first nine months of 2016, compared to $1.2 million in the first nine months of 2015. Future levels of swap fee income are dependent upon prevailing interest rates.

 

Securities gains were $4.3 million for the third quarter of 2016, as compared to $57 thousand in the third quarter of 2015. Securities gains totaled $4.6 million for the first nine months of 2016, compared to $474 thousand for the first nine months of 2015. The Company took advantage of market opportunities by selling approximately $115.8 million of investments that were low-yielding during the nine months ended September 30, 2016. Proceeds were then used to purchase higher-yielding tax-exempt municipal bonds with a modest duration extension and to fund loan and lease growth. In the third quarter of 2016, the Company had the opportunity to sell an equity investment and recognize a gain of $4.0 million, which was then used to reduce wholesale borrowings and further de-lever the balance sheet.

 

Earnings on BOLI increased 11% from the third quarter of 2015 to the third quarter of 2016 and increased less than 1% comparing the first nine months of 2015 to the first nine months of 2016. There were no purchases of BOLI within the last twelve months. Notably, a small portion of the Company’s BOLI is variable in nature whereby the returns are determined by the performance of the equity market. 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. CSB has not invested in BOLI as of September 30, 2016.

 

Debit card fees are the interchange fees paid on certain debit card customer transactions. Debit card fees increased 43% comparing the third quarter of 2016 to the third quarter of 2015, and increased 24% comparing the first nine months of 2016 to the first nine months of 2015. The primary reason for this increase in debit card fees was the addition of CSB, which had debit card fees totaling $122 thousand for the partial quarter. Additionally, these fees can vary based on customer debit card usage, so fluctuations from period to period may occur. As an opportunity to maximize fees, the Company offers a deposit product with a modestly increased interest rate that incentivizes debit card activity.

 

 
59

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued  

 

Correspondent banking fees decreased 18%, comparing the third quarter of 2016 to the third quarter of 2015 and decreased 13% when comparing the first nine months of 2016 to the first nine months of 2015. As correspondent bank deposit balances rise, they receive a higher earnings credit, which then reduces the direct fees that the Company receives. There was an earnings credit rate increase implemented in the first quarter of 2016. Correspondent banking continues to be a core strategy for the Company, as this line of business provides a high level of noninterest bearing deposits that can be used to fund loan growth as well as a steady source of fee income.    The Company now serves approximately 179 banks in Iowa, Illinois and Wisconsin.

 

Participation service fees on commercial loan participations represent fees paid to the Company by the participant(s) to cover servicing expenses incurred by the Company. The fee is generally 0.25% of the participated loan amount. Additionally, the Company receives a mandated 1.00% servicing fee on the sold portion of government-guaranteed loans. Participation service fees increased 18%, comparing the third quarter of 2016 to the third quarter of 2015, and grew 7%, comparing the first nine months of 2016 to the first nine months of 2015.

 

The Company recognized $387 thousand of non-recurring income during the third quarter of 2015 from the favorable conclusion of a lawsuit.

 

 
60

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued  

 

NONINTEREST EXPENSE

 

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

 

   

Three Months Ended

                 
   

September 30, 2016

   

September 30, 2015

   

$ Change

   

% Change

 
                                 

Salaries and employee benefits

  $ 11,202,460     $ 10,583,361     $ 619,099       5.8

%

Occupancy and equipment expense

    2,086,331       1,863,648       222,683       11.9  

Professional and data processing fees

    1,931,329       1,742,268       189,061       10.9  

Acquisition costs

    2,046,036       -       2,046,036       100.0  

FDIC insurance, other insurance and regulatory fees

    582,835       702,136       (119,301 )     (17.0 )

Loan/lease expense

    102,678       90,415       12,263       13.6  

Net cost of operations of other real estate

    133,055       (1,117,671 )     1,250,726       (111.9 )

Advertising and marketing

    547,768       460,411       87,357       19.0  

Postage and communications

    237,569       220,895       16,674       7.5  

Stationery and supplies

    167,887       144,967       22,920       15.8  

Bank service charges

    415,401       392,352       23,049       5.9  

Losses on debt extinguishment, net

    4,137,310       -       4,137,310       100.0  

Correspondent banking expense

    205,998       176,977       29,021       16.4  

Other

    683,826       687,332       (3,506 )     (0.5 )

Total noninterest expense

  $ 24,480,483     $ 15,947,091     $ 8,533,392       53.5

%

 

   

Nine Months Ended

                 
   

September 30, 2016

   

September 30, 2015

   

$ Change

   

% Change

 
                                 

Salaries and employee benefits

  $ 32,920,840     $ 32,709,765     $ 211,075       0.6

%

Occupancy and equipment expense

    5,797,875       5,507,533       290,342       5.3  

Professional and data processing fees

    4,921,064       4,683,480       237,584       5.1  

Acquisition costs

    2,401,005       -       2,401,005       100.0  

FDIC insurance, other insurance and regulatory fees

    1,866,804       2,151,756       (284,952 )     (13.2 )

Loan/lease expense

    419,846       601,888       (182,042 )     (30.2 )

Net cost of operations of other real estate

    513,149       (1,088,696 )     1,601,845       (147.1 )

Advertising and marketing

    1,367,478       1,368,152       (674 )     (0.0 )

Postage and communications

    711,226       683,993       27,233       4.0  

Stationery and supplies

    490,682       424,330       66,352       15.6  

Bank service charges

    1,246,682       1,088,806       157,876       14.5  

Losses on debt extinguishment, net

    4,220,507       6,894,185       (2,673,678 )     (38.8 )

Correspondent banking expense

    564,763       517,770       46,993       9.1  

Other

    1,736,813       1,775,637       (38,824 )     (2.2 )

Total noninterest expense

  $ 59,178,734     $ 57,318,599     $ 1,860,135       3.2

%

 

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

 

Salaries and employee benefits, which is the largest component of noninterest expense, increased from the third quarter of 2015 to the third quarter of 2016 by 6%. This increase is related to the acquisition of CSB. CSB’s salaries and benefits for the partial quarter totaled $759 thousand. Salaries and employee benefits increased only 1% when comparing the first nine months of 2016 to the first nine months of 2015.

 

 
61

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued  

 

Occupancy and equipment expense increased 12%, comparing the third quarter of 2016 to the same period of the prior year and increased 5% when comparing the first nine months of 2016 to the same period of the prior year. The increased expense was mostly due to the addition of CSB for the partial quarter.

 

Professional and data processing fees increased 11%, comparing the third quarter of 2016 to the same period in 2015 and increased 5% comparing the first nine months of 2016 to the same period in 2015. This increased expense was mostly due to the addition of CSB for the partial quarter. CSB’s professional and data processing fees totaled $200 thousand for the period since acquisition. Generally, professional and data processing fees can fluctuate depending on certain one-time project costs. Management will continue to focus on minimizing such one-time costs and driving recurring costs down through contract renegotiation or managed reduction in activity where costs are determined on a usage basis.    

 

Acquisition costs for the third quarter of 2016 were $2.0 million. For the first nine months of 2016, acquisition costs totaled $2.4 million. These costs were related to the acquisition of CSB, as described in Note 9 to the Consolidated Financial Statements.

 

FDIC and other insurance expense decreased 17%, comparing the third quarter of 2016 to the third quarter of 2015, and decreased 13% comparing the first nine months of 2016 to the same period of 2015. The decrease in expense was due to a decrease in the assessment rate designated by the FDIC. Partially offsetting this was the acquisition of CSB, which has $45 thousand of FDIC and other insurance expense.

 

Loan/lease expense increased 14%, comparing the third quarter of 2016 to the same quarter of 2015 and decreased 30% when comparing the first nine months of 2016 to the same period of 2015. The Company incurred elevated levels of expense during 2015 for certain existing NPLs in connection with the work-out of these loans. Generally, loan/lease expense has a direct relationship with the level of NPLs; however, it may deviate depending upon the individual NPLs. 

 

Net cost of operations of other real estate includes gains/losses on the sale of OREO, write-downs of OREO and all income/expenses associated with OREO. Net costs of operations of other real estate totaled $133 thousand for the third quarter of 2016, compared to ($1.1) million for the third quarter of 2015. Net costs of operations of other real estate totaled $513 thousand for the first nine months of 2016, compared to ($1.1) million for the first nine months of 2015. The third quarter of 2015 included a large gain on the sale of an OREO property.

 

Bank service charges, a large portion of which includes indirect costs incurred to provide services to QCBT’s correspondent banking customer portfolio, increased 6% from the third quarter of 2015 to the third quarter of 2016 and increased 15% from the first nine months of 2015 to the first nine months of 2016. The increase was due, in large part, to the success QCBT has had in growing its correspondent banking customer portfolio. As transactions volumes continue to increase and the number of correspondent banking clients increases, the associated expenses will also increase. This may not directly correlate to correspondent banking balances, as quarter-end balances can fluctuate.

 

 
62

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued  

 

In the first nine months of 2016, the Company incurred $4.2 million of losses on debt extinguishment, net. This amount included $5.4 million of losses related to the prepayment of certain FHLB advances and whole structured repurchase agreements, as well as a $1.2 million gain recognized through the repurchase of trust preferred securities. For further details, please refer to Note 4 of the Consolidated Financial Statements. In the first nine months of 2015, the Company incurred $6.9 million of losses on debt extinguishment, net, due to the prepayment of certain FHLB advances and structured repurchase agreements, as described in detail within Note 12 of the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

 

Correspondent banking expense was up 16% when comparing the third quarter of 2016 to the third quarter of 2015 and up 9% when comparing the first nine months of 2016 to the same period of 2015. These are direct costs incurred to provide services to QCBT’s correspondent banking customer portfolio, including safekeeping and cash management services.

 

INCOME TAXES

 

In the third quarter of 2016, the Company incurred income tax expense of $1.9 million. For the first nine months of the year, the Company incurred income tax expense of $6.0 million. Following is a reconciliation of the expected income tax expense to the income tax expense included in the consolidated statements of income for the three and nine months ended September 30, 2016 and 2015.

 

 

   

For the Three Months Ended September 30,

   

For the Nine Months Ended September 30,

 
   

2016

   

2015

   

2016

   

2015

 
           

% of

           

% of

           

% of

           

% of

 
           

Pretax

           

Pretax

           

Pretax

           

Pretax

 
   

Amount

   

Income

   

Amount

   

Income

   

Amount

   

Income

   

Amount

   

Income

 
                                                                 

Computed "expected" tax expense

  $ 2,787,998       35.0 %   $ 3,135,250       35.0 %   $ 8,815,741       35.0 %   $ 4,042,152       35.0 %

Tax exempt income, net

    (1,180,470 )     (14.8 )     (832,287 )     (9.3 )     (3,135,276 )     (12.5 )     (2,541,017 )     (22.0 )

Bank-owned life insurance

    (157,587 )     (2.0 )     (142,456 )     (1.6 )     (463,532 )     (1.8 )     (461,618 )     (4.0 )

State income taxes, net of federal benefit, current year

    289,287       3.6       284,346       3.2       853,325       3.4       369,563       3.2  

Other

    118,980       1.5       24,018       0.3       (39,883 )     (0.2 )     (3,131 )     (0.0 )

Federal and state income tax expense

  $ 1,858,208       23.3 %   $ 2,468,871       27.6 %   $ 6,030,375       23.9 %   $ 1,405,949       12.2 %

 

The effective tax for the quarter ended September 30, 2016 was 23.3% which was a decrease from the effective tax rate of 27.6% for the quarter ended September 30, 2015. The effective tax rate for the nine months ended September 30, 2016 was 23.9%, which was an increase over the effective tax rate of 12.2% for the nine months ended September 30, 2015.

 

During the third quarter ended September 30, 2016, the Company incurred $2.0 million of acquisition costs (of which $1.5 million was deductible for income taxes) which contributed to a decline in pre-tax income comparing the third quarter of 2016 to the third quarter of 2015. In addition, the Company increased its income from tax exempt sources mostly from growth in tax-exempt municipal bonds and loans. Combining the impact of the acquisition costs and the increase in tax exempt income during the third quarter of 2016, the result is a larger portion of tax exempt income of the total pre-tax income which led to the reduced effective tax rate. Comparing the nine months ended September 30, 2016 to the same period in 2015, the Company’s pre-tax income more than doubled. In the first half of 2015, the Company incurred elevated deductible expenses (including $6.9 million of losses on debt extinguishment, net) which led to a significantly reduced effective tax rate for the first nine months of 2015.

 

 
63

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued  

 

FINANCIAL CONDITION

 

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

 

   

As of

 
   

September 30, 2016

   

June 30, 2016

   

December 31, 2015

   

September 30, 2015

 
   

(dollars in thousands)

 
                                                                 
   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

 

Cash and due from banks

  $ 61,213       2 %   $ 49,581       2 %   $ 41,742       2 %   $ 41,053       2 %

Federal funds sold and interest-bearing deposits

    96,047       3 %     68,432       3 %     56,164       2 %     66,606       3 %

Securities

    564,930       17 %     510,959       19 %     577,109       22 %     590,775       23 %

Net loans/leases

    2,331,774       71 %     1,894,676       70 %     1,771,882       68 %     1,730,138       67 %

Other assets

    227,022       7 %     159,786       6 %     146,301       6 %     147,283       6 %

Total assets

  $ 3,280,986       100 %   $ 2,683,434       100 %   $ 2,593,198       100 %   $ 2,575,855       100 %
                                                                 

Total deposits

  $ 2,594,913       79 %   $ 1,973,594       74 %   $ 1,880,666       72 %   $ 1,855,319       71 %

Total borrowings

    312,104       10 %     381,875       14 %     444,162       17 %     456,091       18 %

Other liabilities

    93,112       3 %     52,848       2 %     42,484       2 %     43,330       2 %

Total stockholders' equity

    280,857       8 %     275,117       10 %     225,886       9 %     221,115       9 %

Total liabilities and stockholders' equity

  $ 3,280,986       100 %   $ 2,683,434       100 %   $ 2,593,198       100 %   $ 2,575,855       100 %

 

During the third quarter of 2016, the Company’s total assets increased $597.6 million, or 22%, to a total of $3.3 billion. Most of this growth was attributable to CSB, which had $580.2 million in total assets as of September 30, 2016. Total gross loans and leases grew $437.8 million. Of the $437.8 million of loan growth, $419.5 million related to CSB, while the remaining $18.3 million was organic growth. The loan and lease growth was funded primarily by deposits, which increased $140.1 million in the third quarter, excluding the acquisition of CSB. This deposit growth allowed the Company to further reduce borrowings. Total borrowings decreased $69.8 million, or 18%, in the third quarter of 2016. Stockholders’ equity increased $5.7 million, or 2%, in the current quarter due to net income.

 

INVESTMENT SECURITIES 

 

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

 

 
64

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued  

 

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

 

   

As of

 
   

September 30, 2016

   

June 30, 2016

   

December 31, 2015

   

September 30, 2015

 
   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

 
   

(dollars in thousands)

 

U.S. govt. sponsored agency securities

  $ 67,885       12 %   $ 88,321       25 %   $ 213,537       37 %   $ 247,625       43 %

Municipal securities

    360,330       64 %     302,689       53 %     280,203       49 %     265,293       42 %

Residential mortgage-backed and related securities

    133,173       24 %     116,765       22 %     80,670       14 %     74,901       14 %

Other securities

    3,542       1 %     3,184       0 %     2,699       0 %     2,956       1 %
    $ 564,930       100 %   $ 510,959       100 %   $ 577,109       100 %   $ 590,775       100 %
                                                                 

Securities as a % of Total Assets

    17.22 %             19.04 %             22.25 %             22.94 %        

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

    1.53 %             1.95 %             (0.03 %)             0.41 %        

Duration (in years)

    5.7               5.1               5.1               4.5          

Yield on investment securities (tax equivalent)

    3.65 %             3.64 %             3.07 %             3.14 %        

 

As a result of fluctuations in longer-term interest rates, the fair value of the Company’s securities portfolio went from a net unrealized gain position of 1.95% of amortized cost at June 30, 2016 to a net unrealized gain position of 1.53% of amortized cost at September 30, 2016. Management performs an evaluation of the portfolio quarterly to understand the current market value as well as projections of market value in a variety of rising and falling interest rate scenarios. In addition, management has evaluated those securities with an unrealized loss position to determine whether the loss is derived from credit deterioration or the movement in interest rates. The evaluation determined that there were no securities in the portfolio with OTTI. See the “Critical Accounting Policies” section of this report for further discussion of this evaluation.

 

The duration of the securities portfolio has increased slightly during the current quarter. Duration was extended from the strong growth in longer term fixed rate municipal securities. Additionally, some shorter-duration agency securities were sold during the quarter, increasing the average duration of the overall portfolio.

 

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

 

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

 

 
65

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued  

 

LOANS/LEASES 

 

Total loans/leases grew 10.6% on an annualized basis during the first nine months of 2016 when excluding CSB. The mix of the loan/lease types within the Company’s loan/lease portfolio is presented in the following table.

 

 

   

As of

 
   

September 30, 2016

   

June 30, 2016

   

December 31, 2015

   

September 30, 2015

 
   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

 
                                                                 
   

(dollars in thousands)

 
                                                                 

C&I loans

  $ 804,308       34 %   $ 706,261       37 %   $ 648,160       36 %   $ 647,398       36 %

CRE loans

    1,070,305       45 %     784,379       41 %     724,369       40 %     692,569       41 %

Direct financing leases

    166,924       7 %     169,928       9 %     173,656       10 %     173,304       10 %

Residential real estate loans

    229,081       10 %     180,482       9 %     170,433       10 %     165,061       9 %

Installment and other consumer loans

    81,918       3 %     73,658       4 %     73,669       4 %     69,863       4 %
                                                                 

Total loans/leases

  $ 2,352,536       100 %   $ 1,914,708       100 %   $ 1,790,287       100 %   $ 1,748,195       100 %
                                                                 

Plus deferred loan/lease origination costs, net of fees

    8,065               8,065               7,736               7,477          

Less allowance

    (28,827 )             (28,097 )             (26,141 )             (25,534 )        
                                                                 

Net loans/leases

  $ 2,331,774             $ 1,894,676             $ 1,771,882             $ 1,730,138          

 

As CRE loans have historically been the Company’s largest portfolio segment, management places a strong emphasis on monitoring the composition of the Company’s CRE loan portfolio. For example, management tracks the level of owner-occupied CRE loans relative to non owner-occupied loans. Owner-occupied loans are generally considered to have less risk. As of September 30, 2016 and June 30, 2016, respectively, approximately 30% and 33% of the CRE loan portfolio was owner-occupied. The decrease in this percentage in the third quarter was mostly due to the addition of CSB, which had a slightly lower owner-occupied percentage as compared to the other three charters. CSB’s percentage of owner-occupied loans was 17% of their CRE portfolio, while the other three charters were collectively at 34%.

 

Over the past several quarters, the Company has been successful in shifting the mix of its commercial loan portfolio by adding more C&I loans. C&I loans grew $156.9 million, or 24% over the past twelve months. A portion of this growth was attributable to the acquisition of CSB, which had $101.0 million of C&I loans as of September 30, 2016.

 

 
66

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued  

 

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

 

   

As of September 30,

   

As of June 30,

   

As of December 31,

   

As of September 30,

 
   

2016

   

2016

   

2015

   

2015

 
   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

 
                                                                 
   

(dollars in thousands)

 
                                                                 

Lessors of Nonresidential Buildings

  $ 333,100       32 %   $ 285,522       36 %   $ 264,133       37 %   $ 250,202       36 %

Lessors of Residential Buildings

    141,051       13 %     104,395       13 %     89,189       12 %     92,986       13 %

New Single-Family Housing Construction

    86,560       8 %     7,024       1 %     5,406       1 %     7,717       1 %

Lessors of Other Real Estate Property

    23,521       2 %     21,803       3 %     22,009       3 %     18,056       3 %

Hotels

    24,509       2 %     19,804       3 %     19,228       3 %     19,190       3 %

Land Subdivision

    31,690       3 %     18,034       2 %     17,839       2 %     15,537       2 %

Nursing Care Facilities

    21,823       2 %     15,070       2 %     17,288       2 %     10,689       2 %

Other *

    408,051       38 %     312,727       40 %     289,277       40 %     278,192       40 %
                                                                 

Total CRE Loans

  $ 1,070,305       100 %   $ 784,379       100 %   $ 724,369       100 %   $ 692,569       100 %

 

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

 

The changes in concentrations in the current quarter were primarily attributable to the addition of CSB.

 

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

 

 

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

 

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

 

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

 

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

 

 
67

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued  

 

ALLOWANCE FOR ESTIMATED LOSSES ON LOANS/LEASES

 

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

 

   

Three Months Ended

   

Nine Months Ended

 
   

September 30, 2016

   

September 30, 2015

   

September 30, 2016

   

September 30, 2015

 
                                 
   

(dollars in thousands)

   

(dollars in thousands)

 
                                 

Balance, beginning

  $ 28,097     $ 26,146     $ 26,141     $ 23,074  

Provisions charged to expense

    1,608       1,635       4,879       5,694  

Loans/leases charged off

    (987 )     (2,476 )     (2,489 )     (4,119 )

Recoveries on loans/leases previously charged off

    109       229       296       885  

Balance, ending

  $ 28,827     $ 25,534     $ 28,827     $ 25,534  

 

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

 

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

 

 

   

As of

 

Internally Assigned Risk Rating *

 

September 30, 2016

   

June 30, 2016

   

December 31, 2015

   

September 30, 2015

 
                                 
   

(dollars in thousands)

 
                                 

Special Mention (Rating 6)

  $ 19,572     $ 16,231     $ 37,289     $ 30,463  

Substandard (Rating 7)

    51,029       44,636       27,962       23,217  

Doubtful (Rating 8)

    -       -       -       -  
    $ 70,601     $ 60,867     $ 65,251     $ 53,680  
                                 
                                 

Criticized Loans **

  $ 70,601     $ 60,867     $ 65,251     $ 53,680  

Classified Loans ***

  $ 51,029     $ 44,636     $ 27,962     $ 23,217  
                                 

Criticized Loans as a % of Total Loans/Leases

    2.99 %     3.17 %     3.63 %     3.06 %

Classified Loans as a % of Total Loans/Leases

    2.16 %     2.32 %     1.56 %     1.32 %

 

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

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

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

 

The Company experienced an increase in both criticized and classified loans during the first nine months of 2016. The increases during the first nine months of 2016 were primarily due to a limited number of relationship downgrades. A portion of the third quarter increase was due to the addition of CSB (approximately $2.6 million). The Company continues its strong focus on improving credit quality in an effort to limit NPLs.

 

 
68

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued  

 

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

 

   

As of

 
   

September 30, 2016

   

June 30, 2016

   

December 31, 2015

   

September 30, 2015

 
                                 
                                 

Allowance / Gross Loans/Leases

    1.22 %     1.46 %     1.45 %     1.45 %

Allowance / NPLs *

    173.78 %     223.42 %     223.33 %     207.39 %

 

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

 

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

 

In accordance with generally accepted accounting principles for acquisition accounting, the loans acquired through the acquisition of CSB were recorded at market value; therefore, there was no allowance associated with CSB’s loans at acquisition. Management continues to evaluate the allowance needed on the acquired CSB loans factoring in the net remaining discount ($12.7 million at September 30, 2016). When factoring this remaining discount into the Company’s allowance to total loans and leases calculation, the Company’s allowance as a percentage of total loans and leases increases from 1.22% to 1.76%. This elimination of CSB’s allowance also resulted in a decrease of the allowance to NPLs ratio, as CSB’s nonperforming loans no longer have reserves allocated to them and instead, have a loan discount amount that is separate from the allowance.

 

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

 

 
69

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued  

 

NONPERFORMING ASSETS 

 

The table below presents the amounts of NPAs.

  

   

As of September 30,

   

As of June 30,

   

As of December 31,

   

As of September 30,

 
   

2016

   

2016

   

2015

   

2015

 
                                 
   

(dollars in thousands)

 
                                 

Nonaccrual loans/leases (1) (2)

  $ 14,371     $ 10,737     $ 10,648     $ 11,269  

Accruing loans/leases past due 90 days or more

    392       86       3       3  

TDRs - accruing

    1,825       1,753       1,054       1,040  

Total NPLs

    16,588       12,576       11,705       12,312  

OREO

    5,808       6,179       7,151       8,140  

Other repossessed assets

    353       154       246       194  

Total NPAs

  $ 22,749     $ 18,909     $ 19,102     $ 20,646  
                                 

NPLs to total loans/leases

    0.70 %     0.65 %     0.65 %     0.70 %

NPAs to total loans/leases plus repossessed property

    0.96 %     0.98 %     1.06 %     1.17 %

NPAs to total assets

    0.69 %     0.70 %     0.74 %     0.80 %

Texas ratio (3)

    7.81 %     6.28 %     7.62 %     8.45 %

 

 

(1)

Includes government guaranteed portion of loans, as applicable.

 

(2)

Includes TDRs of $4.9 million at September 30, 2016, $1.6 million at June 30, 2016, $1.5 million at December 31, 2015, and $3.9 million at September 30, 2015.

 

(3)

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

 

NPAs at September 30, 2016 were $22.7 million, which were up $3.8 million from June 30, 2016 and up $2.1 million from September 30, 2015. The increase in the current quarter is primarily due to the acquisition of CSB. In addition, the ratio of NPAs to total assets was 0.69% at September 30, 2016, which was down from 0.70% at June 30, 2016, and down from 0.80% at September 30, 2015.

 

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

 

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

 

Additionally, a portion of several of the nonaccrual loans are guaranteed by the government. At September 30, 2016, government guaranteed amounts of nonaccrual loans totaled approximately $1.9 million, or 13% of the $14.4 million of total nonaccrual loans/leases.

 

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

 

 
70

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued  

 

DEPOSITS 

 

Deposits increased $621.3 million during the third quarter of 2016. Of this, $481.2 million was the result of CSB and $140.1 million was organic growth. The table below presents the composition of the Company’s deposit portfolio.

 

   

As of

 
   

September 30, 2016

   

June 30, 2016

   

December 31, 2015

   

September 30, 2015

 
                                                                 
   

(dollars in thousands)

 
                                                                 
   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

 

Noninterest bearing demand deposits

  $ 764,615       30 %   $ 615,764       31 %   $ 615,292       33 %   $ 585,300       34 %

Interest bearing demand deposits

    1,298,781       50 %     918,036       47 %     886,294       47 %     884,163       43 %

Time deposits

    420,470       16 %     337,584       17 %     309,974       16 %     302,978       18 %

Brokered deposits

    111,047       4 %     102,210       5 %     69,106       4 %     82,878       5 %
    $ 2,594,913       100 %   $ 1,973,594       100 %   $ 1,880,666       100 %   $ 1,855,319       100 %

 

Strong organic growth of $140.1 million was driven by the Company’s strong focus on core deposit growth. Of the $140.1 million in growth in the third quarter, $28.9 million was noninterest bearing, $94.2 million was interest bearing, $8.1 million was time deposits and $8.8 million was brokered deposits. The noninterest bearing deposit growth was led by the correspondent banking area, which grew deposits $22.6 million.

 

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

 

BORROWINGS 

 

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

 

   

As of

 
   

September 30, 2016

   

June 30, 2016

   

December 31, 2015

   

September 30, 2015

 
                                 
   

(dollars in thousands)

 
                                 

Overnight repurchase agreements with customers

  $ 8,265     $ 21,441     $ 73,873     $ 74,404  

Federal funds purchased

    51,750       30,120       70,790       93,160  
    $ 60,015     $ 51,561     $ 144,663     $ 167,564  

 

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

 

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

 

 
71

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued  

 

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

 

   

As of

 
   

September 30, 2016

   

June 30, 2016

   

December 31, 2015

   

September 30, 2015

 
                                 
   

(dollars in thousands)

 
                                 

Term FHLB advances

  $ 83,343     $ 78,000     $ 97,000     $ 102,000  

Overnight FHLB advances

    55,300       118,900       54,000       31,000  
    $ 138,643     $ 196,900     $ 151,000     $ 133,000  

 

Term FHLB advances increased in the current quarter, due to the addition of CSB, which had $15.3 million of FHLB advances as of September 30, 2016.

 

Other borrowings consist of structured repos which are utilized as an alternative funding source to FHLB advances and customer deposits. Structured repos are collateralized by certain U.S. government agency securities and residential mortgage backed and related securities. Structured repos totaled $45 million, $100 million, $110 million and $115 million as of September 30, 2016, June 30, 2016, December 31, 2015 and September 30, 2015, respectively.

 

It is management’s intention to continue to reduce its reliance on wholesale funding, including FHLB advances, structured repos, and brokered deposits. Replacement of this funding with core deposits helps to reduce interest expense as the wholesale funding tends to be higher cost. However, the Company may choose to utilize advances and/or brokered deposits to supplement funding needs, as this is a way for the Company to effectively and efficiently manage interest rate risk. The table below presents the maturity schedule including weighted average interest cost for the Company’s combined wholesale funding portfolio.

 

   

September 30, 2016

   

December 31, 2015

 
           

Weighted

           

Weighted

 
           

Average

           

Average

 

Maturity:

 

Amount Due

   

Interest Rate

   

Amount Due

   

Interest Rate

 
                                 

Year ending December 31:

 

(dollar amounts in thousands)

 
                                 

2016

  $ 159,883       0.59 %   $ 125,038       0.59 %

2017

    54,398       2.02       49,055       2.07  

2018

    38,459       2.70       57,283       2.87  

2019

    16,950       2.65       50,089       3.14  

2020

    25,000       2.66       45,000       2.66  

Thereafter

    -       -       3,641       2.51  

Total Wholesale Funding

  $ 294,690       1.38 %   $ 330,106       1.89 %

 

During the first nine months of 2016, wholesale funding decreased $35.4 million. Year-to-date, the Company has prepaid $80.0 million of borrowings and repaid $28.1 million of borrowings at maturity throughout the year. Offsetting these reductions in wholesale borrowings was a net increase in brokered funding of $56.1 million and the addition of CSB, which had $15.3 million of outstanding advance as of September 30, 2016. Short-term borrowings from the FHLB increased $1.3 million since December 31, 2015.

 

 
72

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued  

 

STOCKHOLDERS’ EQUITY

 

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

 

   

As of

 
   

September 30, 2016

   

June 30, 2016

   

December 31, 2015

   

September 30, 2015

 
   

Amount

   

Amount

   

Amount

   

Amount

 
                                 
   

(dollars in thousands)

 
                                 

Common stock

  $ 13,075     $ 13,057     $ 11,761     $ 11,729  

Additional paid in capital

    155,951       155,454       123,283       122,574  

Retained earnings

    110,610       105,024       92,966       86,649  

AOCI (loss)

    1,221       1,582       (2,124 )     163  

Total stockholders' equity

  $ 280,857     $ 275,117     $ 225,886     $ 221,115  
                                 

TCE* / TA

    7.92 %     10.10 %     8.55 %     8.42 %

 

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

 

The decrease in TCE/TA in the third quarter was due to the addition of CSB.

 

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 $138.2 million during the third quarter of 2016 and $129.5 million during 2015. The Company’s on balance sheet liquidity position can fluctuate based on short-term activity in deposits and loans.

 

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

 

At September 30, 2016, the subsidiary banks had 34 lines of credit totaling $393.6 million, of which $37.6 million was secured and $356.0 million was unsecured. At September 30, 2016, $354.6 million was available as $39.0 million was utilized for short-term borrowings needs at QCBT.

 

At December 31, 2015, the subsidiary banks had 32 lines of credit totaling $346.6 million, of which $14.6 million was secured and $332.0 million was unsecured. At December 31, 2015, $286.6 million was available as $60.0 million was utilized for short-term borrowing needs at QCBT.

 

 
73

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued 

 

The Company has emphasized growing the number and amount of lines of credit in an effort to strengthen this contingent source of liquidity. Additionally, the Company maintains a $10.0 million secured revolving credit note with a variable interest rate and a maturity of June 30, 2017. At September 30, 2016, the Company had borrowed $5.0 million on this revolving credit note and the remaining $5.0 million is available.

 

The Company currently has $320.7 million in correspondent banking deposits spread over 179 relationships. While the Company feels that these funds are very stable, there is the potential for large fluctuations that can impact liquidity. Seasonality and the liquidity needs of these correspondent banks can impact balances. Management closely monitors these fluctuations and runs stress scenarios to measure the impact on liquidity and interest rate risk with various levels of correspondent deposit run-off.

 

Investing activities used cash of $132.1 million during the first nine months of 2016, compared to $46.2 million for the same period of 2015. Proceeds from calls, maturities, paydowns, and sales of securities were $219.1 million for the first nine months of 2016, compared to $264.8 million for the same period of 2015. Purchases of securities used cash of $111.6 million for the first nine months of 2016, compared to $200.2 million for the same period of 2015. The net increase in loans/leases used cash of $144.6 million for the first nine months of 2016 compared to $129.4 million for the same period of 2015. The net cash paid for the acquisition of CSB was $69.9 million.

 

Financing activities provided cash of $125.7 million for the first nine months of 2016, compared to $25.9 million for same period of 2015. Net increases in deposits totaled $227.9 million for the first nine months of 2016, compared to $175.7 million for the same period of 2015. During the first nine months of 2016, the Company’s short-term borrowings decreased $84.6 million, while they decreased $100.8 million for the same period of 2015. During the first nine months of 2016, the Company used $64.8 million to prepay select FHLB advances and other borrowings, compared to $110.4 million for the same period of 2015. In the first nine months of 2016, the Company received $29.8 million of proceeds from the common stock offering of 1.2 million shares of common stock. During the first nine months of 2015, the Company received $63.5 million of proceeds from the common stock offering of 3.7 million shares of common stock. In the first nine months of 2016, the Company received $35.0 million in cash from the proceeds of other borrowings.

 

Total cash provided by operating activities was $25.8 million for the first nine months of 2016, compared to $23.2 million for the same period of 2015.

 

Throughout its history, the Company has secured additional capital through various sources, including the issuance of common and preferred stock, as well as trust preferred securities. Trust preferred securities are reported on the Company’s balance sheet as liabilities, but currently qualify for treatment as regulatory capital.

 

 
74

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued  

 

The following table presents the details of the trust preferred securities outstanding as of September 30, 2016 and December 31, 2015.

 

Name

Date Issued

 

Amount Outstanding

September 30, 2016

   

Amount Outstanding

December 31, 2015

 

Interest Rate

 

Interest Rate as of

September 30, 2016

   

Interest Rate as of

December 31, 2015

 
                                     

QCR Holdings Statutory Trust II

February 2004

  $ 10,310,000     $ 10,310,000  

2.85% over 3-month LIBOR

    3.48 %     3.18 %

QCR Holdings Statutory Trust III

February 2004

    8,248,000       8,248,000  

2.85% over 3-month LIBOR

    3.48 %     3.18 %

QCR Holdings Statutory Trust IV

May 2005

    -       5,155,000  

1.80% over 3-month LIBOR

    N/A       2.12 %

QCR Holdings Statutory Trust V

February 2006

    10,310,000       10,310,000  

1.55% over 3-month LIBOR

    2.23 %     1.87 %

Community National Statutory Trust II

September 2004

    3,093,000       3,093,000  

2.17% over 3-month LIBOR

    3.03 %     2.74 %

Community National Statutory Trust III

March 2007

    3,609,000       3,609,000  

1.75% over 3-month LIBOR

    2.60 %     2.26 %
      $ 35,570,000     $ 40,725,000  

Weighted Average Rate

    2.99 %     2.60 %

 

The Company assumed the trust preferred securities originally issued by Community National in connection with its acquisition in May 2013. As a result of acquisition accounting, the liabilities were recorded at fair value upon acquisition with the resulting discount being accreted as interest expense on a level yield basis over the expected term. The original discount totaled $2.6 million. As of September 30, 2016, the remaining discount was $2.1 million.

 

QCR Holdings Statutory Trust IV was extinguished in the first quarter of 2016. Refer to Note 4 of the Consolidated Financial Statements for additional information.

 

On October 27, 2016, the Company filed a universal shelf registration statement on Form S-3 with the SEC. When declared effective by the SEC, the registration statement will allow the Company to offer and sell various types of securities, including common stock, preferred stock, debt securities and/or warrants, from time to time up to an aggregate amount of $100 million. The Company utilized $30.1 million of its $100 million previous shelf registration filing through the offer and sale of its common stock in the second quarter of 2016 to help fund the acquisition of CSB. This Form S-3 filing will replenish the amount available to the previous level of $100 million. The specific terms and prices of any securities offered pursuant to the registration statement will be determined at the time of any future offering and described in a separate prospectus supplement, which would be filed with the SEC at the time of the particular offering, if any.

 

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.

 

 
75

 

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued  

 

 

SPECIAL NOTE CONCERNING FORWARD-LOOKING STATEMENTS

 

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

 

The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. The factors which could have a material adverse effect on the Company’s operations and future prospects are detailed in the “Risk Factors” sections included under Item 1A of Part I of the Company’s Annual Report on Form 10-K and Item 1A of Part II of this report. In addition to the risk factors described in that section, there are other factors that may impact any public company, including the Company, which could have a material adverse effect on the Company’s operations and future prospects of the Company and its subsidiaries. One should not consider the risk factors to be a complete discussion of risks, uncertainties and assumptions.

 

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

 

 
76

 

 

Part I

Item 3

 

QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

 

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

 

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

 

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

 

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

 

One method used to quantify interest rate risk is a short-term earnings at risk summary, which is a detailed and dynamic simulation model used to quantify the estimated exposure of net interest income to sustained interest rate changes. This simulation model captures the impact of changing interest rates on the interest income received and interest expense paid on all interest sensitive assets and liabilities reflected on the Company’s consolidated balance sheet. This sensitivity analysis demonstrates net interest income exposure annually over a five-year horizon, assuming no balance sheet growth and various interest rate scenarios including no change in rates; 200, 300, 400, and 500 basis point upward shifts; and a 100 basis point downward shift in interest rates, where interest-bearing assets and liabilities reprice at their earliest possible repricing date.

 

The model assumes parallel and pro rata shifts in interest rates over a twelve-month period for the 200 basis point upward shift and 100 basis point downward shift. For the 400 basis point upward shift, the model assumes a parallel and pro rata shift in interest rates over a twenty-four month period. For the 500 basis point upward shift, the model assumes a flattening and pro rata shift in interest rates over a twelve-month period where the short-end of the yield curve shifts upward greater than the long-end of the yield curve.

 

 
77

 

 

Part I

Item 3

 

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

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

 

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

 

Application of the simulation model analysis for select interest rate scenarios at the most recent quarter-end available is presented in the following table:

 

           

NET INTEREST INCOME EXPOSURE in YEAR 1

 

INTEREST RATE SCENARIO

 

POLICY LIMIT

   

As of June 30,

2016

   

As of December 31, 2015

   

As of December 31, 2014

 
                                 

100 basis point downward shift

    -10.0 %     -1.1 %     -2.1 %     -1.7 %

200 basis point upward shift

    -10.0 %     -2.3 %     -2.7 %     -5.0 %

300 basis point upward shock

    -25.0 %     -4.6 %     -7.1 %     -11.9 %

 

The simulation is within the board-established policy limits for all three scenarios. Additionally, for all of the various interest rate scenarios modeled and measured by management (as described above), the results at June 30, 2016 (the most recent quarter available) were within established risk tolerances as established by policy or by best practice (if the interest rate scenario didn’t have a specific policy limit).

 

In 2014, the Company executed two interest rate cap transactions, each with a notional value of $15.0 million, for a total of $30.0 million. The interest rate caps purchased essentially set a ceiling to the interest rate paid on the $30.0 million of short-term FHLB advances that are being hedged, minimizing the interest rate risk associated with rising interest rates. The Company will continue to analyze and evaluate similar transactions as an alternative and cost effective way to mitigate interest rate risk.

 

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

 

 
78

 

 

Part I

Item 4

 

 

CONTROLS AND PROCEDURES

 

 

Evaluation of disclosure controls and procedures. An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) promulgated under the Exchange Act of 1934) as of September 30, 2016. Based on that evaluation, the Company’s management, including the Chief Executive Officer and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective, as of the end of the period covered by this report, to ensure that information required to be disclosed in the reports filed and submitted under the Exchange Act was recorded, processed, summarized and reported as and when required.

 

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

 

 
79

 

 

Part II

QCR HOLDINGS, INC. AND SUBSIDIARIES

 

PART II - OTHER INFORMATION

 

 Item 1   Legal Proceedings
   

 

There are no material pending legal proceedings to which the Company or any of its subsidiaries is a party other than ordinary routine litigation incidental to their respective businesses.

   

 Item 1A

Risk Factors

   

 

There have been no material changes in the risk factors applicable to the Company from those disclosed in Part I, Item 1.A. “Risk Factors,” in the Company’s 2015 Annual Report on Form 10-K. Please refer to that section of the Company’s Form 10-K for disclosures regarding the risks and uncertainties related to the Company’s business.

   

 Item 2 

Unregistered Sales of Equity Securities and Use of Proceeds 

   

 

None 

   

 Item 3 

Defaults Upon Senior Securities 

   

 

None

   

 Item 4 

Mine Safety Disclosures

   

 

Not applicable

   

 Item 5 

Other Information

   

 

None  

 

 

 
80

 

 

Part II

QCR HOLDINGS, INC. AND SUBSIDIARIES

 

PART II - OTHER INFORMATION - continued

 

Item 6  Exhibits
   

10.1

Form of QCR Holdings, Inc. 2016 Equity Incentive Plan Nonqualified Stock Option Award Agreement incorporated by reference to the registrant’s Form S-8 filed with the Commission on October 27, 2016 (SEC file no. 333-214282).

 

10.2

Form of QCR Holdings, Inc. 2016 Equity Incentive Plan Restricted Stock Award Agreement incorporated by reference to the registrant’s Form S-8 filed with the Commission on October 27, 2016 (SEC file no. 333-214282).

 

10.3

Form of QCR Holdings, Inc. 2016 Equity Incentive Plan Restricted Stock Unit Award Agreement incorporated by reference to the registrant’s Form S-8 filed with the Commission on October 27, 2016 (SEC file no. 333-214282).

 

31.1

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

 

31.2

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

 

32.1

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

 

32.2

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

 

101

Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets as of September 30, 2016 and December 31, 2015; (ii) Consolidated Statements of Income for the three and nine months ended September 30, 2016 and September 30, 2015; (iii) Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2016 and September 30, 2015; (iv) Consolidated Statements of Changes in Stockholders’ Equity for the three and nine months ended September 30, 2016 and September 30, 2015; (v) Consolidated Statements of Cash Flows for the nine months ended September 30, 2016 and September 30, 2015; and (vi) Notes to the Consolidated Financial Statements.

 

 

 
81

 

 

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 November 8, 2016                     

 

/s/ Douglas M. Hultquist

 

 

 

 Douglas M. Hultquist, President

 

 

 

 Chief Executive Officer

 

 

 

 

 

 

 

 

 

 

 

 

 Date November 8, 2016                              

 

/s/ Todd A. Gipple

 

 

 

 Todd A. Gipple, Executive Vice President

 

 

 

 Chief Operating Officer

 

    Chief Financial Officer  

 

 

 

 

 

 

 

 

 

 

 

 Date November 8, 2016                       

 

/s/ Elizabeth A. Grabin

 

 

 

 Elizabeth A. Grabin, Vice President

 

 

 

 Controller & Director of Financial Reporting

 

    Principal Accounting Officer  

 

 

82