qcrh20180331_10q.htm
 

Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

For the quarterly period ended March 31, 2018

 

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

For the transition period from           to________

 

Commission file number 0-22208

 

QCR HOLDINGS, INC.

(Exact name of Registrant as specified in its charter)

 

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

                           

3551 7th Street, Moline, Illinois 61265

(Address of principal executive offices, including zip code)

 

(309) 736-3580

(Registrant’s telephone number, including area code)

 

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

Yes  [ X ]          No [    ]

 

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

Yes  [ X ]          No [    ]

 

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

 

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

Smaller reporting company [    ]             Emerging growth company [    ]

 

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

 

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

Yes [    ]          No [ 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 May 1, 2018, the Registrant had outstanding 13,952,800 shares of common stock, $1.00 par value per share.

 

 

 

 

QCR HOLDINGS, INC. AND SUBSIDIARIES

TABLE OF CONTENTS

 

       

Page

Number(s)

Part I

FINANCIAL INFORMATION

   
         
 

Item 1

Consolidated Financial Statements (Unaudited)

   
         
   

Consolidated Balance Sheets

 

                   3

   

As of March 31, 2018 and December 31, 2017

   
         
   

Consolidated Statements of Income

   
   

For the Three Months Ended March 31, 2018 and 2017

 

                   4

         
   

Consolidated Statements of Comprehensive Income

   
   

For the Three Months Ended March 31, 2018 and 2017

 

                   5

         
   

Consolidated Statements of Changes in Stockholders' Equity

   
   

For the Three Months Ended March 31, 2018 and 2017

 

                   6

         
   

Consolidated Statements of Cash Flows

   
   

For the Three Months Ended March 31, 2018 and 2017

 

                   7

         
   

Notes to Consolidated Financial Statements

   
         
   

Note 1. Summary of Significant Accounting Policies

 

                   9

   

Note 2. Investment Securities

 

                 11

   

Note 3. Loans/Leases Receivable

 

                 16

   

Note 4. Earnings Per Share

 

                 25

   

Note 5. Fair Value

 

                 25

   

Note 6. Business Segment Information

 

                 29

   

Note 7. Regulatory Capital Requirements

 

                 30

   

Note 8. Revenue Recognition

 

                 32

   

Note 9. Acquisitions

 

                 33

         
         
 

Item 2

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

   
         
   

Introduction

 

                 34

   

General

 

                 34

   

Executive Overview

 

                 35

   

Long-Term Financial Goals

 

                 36

   

Strategic Developments

 

                 37

   

GAAP to Non-GAAP Reconciliations

 

                 39

   

Net Interest Income (Tax Equivalent Basis)

 

                 41

   

Critical Accounting Policies

 

                 45

   

Results of Operations

  45
   

Interest Income

 

                 45

   

Interest Expense

 

                 46

   

Provision for Loan/Lease Losses

 

                 46

   

Noninterest Income

 

                 47

   

Noninterest Expense

 

                 49

   

Income Taxes

 

                 51

 

1

 

   

Financial Condition

 

                 51

   

Investment Securities

 

                 52

   

Loans/Leases

 

                 53

   

Allowance for Estimated Losses on Loans/Leases

 

                 55

   

Nonperforming Assets

 

                 57

   

Deposits

 

                 58

   

Borrowings

 

                 59

   

Stockholders' Equity

 

                 60

   

Liquidity and Capital Resources

 

                 61

   

Special Note Concerning Forward-Looking Statements

 

                 63

         
 

Item 3

Quantitative and Qualitative Disclosures About Market Risk

 

                 64

         
 

Item 4

Controls and Procedures

 

                 66

         

Part II

OTHER INFORMATION

   
         
 

Item 1

Legal Proceedings

 

                 67

         
 

Item 1A

Risk Factors

 

                 67

         
 

Item 2

Unregistered Sales of Equity Securities and Use of Proceeds

 

                 67

         
 

Item 3

Defaults upon Senior Securities

 

                 67

         
 

Item 4

Mine Safety Disclosures

 

                 67

         
 

Item 5

Other Information

 

                 67

         
 

Item 6

Exhibits

 

                 68

         

Signatures

 

 

                 69

         

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

 

2

 

 

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

As of March 31, 2018 and December 31, 2017

 

   

March 31,

   

December 31,

 
   

2018

   

2017

 

ASSETS

               

Cash and due from banks

  $ 61,845,988     $ 75,721,663  

Federal funds sold

    14,505,000       30,197,000  

Interest-bearing deposits at financial institutions

    45,051,555       55,765,012  
                 

Securities held to maturity, at amortized cost

    378,584,337       379,474,205  

Securities available for sale, at fair value

    259,644,940       272,907,907  

Total securities

    638,229,277       652,382,112  
                 

Loans receivable held for sale

    279,750       645,001  

Loans/leases receivable held for investment

    3,054,622,689       2,963,840,399  

Gross loans/leases receivable

    3,054,902,439       2,964,485,400  

Less allowance for estimated losses on loans/leases

    (36,532,602 )     (34,355,728 )

Net loans/leases receivable

    3,018,369,837       2,930,129,672  
                 

Bank-owned life insurance

    59,477,481       59,059,494  

Premises and equipment, net

    63,564,277       62,838,255  

Restricted investment securities

    22,413,075       19,782,525  

Other real estate owned, net

    12,750,023       13,558,308  

Goodwill

    28,334,092       28,334,092  

Core deposit intangible

    8,774,402       9,078,953  

Other assets

    52,999,407       45,817,687  

Total assets

  $ 4,026,314,414     $ 3,982,664,773  
                 

LIABILITIES AND STOCKHOLDERS' EQUITY

               

LIABILITIES

               

Deposits:

               

Noninterest-bearing

  $ 784,815,082     $ 789,547,696  

Interest-bearing

    2,495,186,410       2,477,107,360  

Total deposits

    3,280,001,492       3,266,655,056  
                 

Short-term borrowings

    16,859,753       13,993,122  

Federal Home Loan Bank advances

    216,345,000       192,000,000  

Other borrowings

    64,062,500       66,000,000  

Junior subordinated debentures

    37,534,402       37,486,487  

Other liabilities

    51,083,350       53,242,979  

Total liabilities

    3,665,886,497       3,629,377,644  
                 

STOCKHOLDERS' EQUITY

               

Preferred stock, $1 par value; shares authorized 250,000 March 2018 and December 2017 - No shares issued or outstanding

    -       -  

Common stock, $1 par value; shares authorized 20,000,000 March 2018 - 13,936,957 shares issued and outstanding December 2017 - 13,918,168 shares issued and outstanding

    13,936,957       13,918,168  

Additional paid-in capital

    189,684,858       189,077,550  

Retained earnings

    162,345,792       151,962,661  

Accumulated other comprehensive loss:

               

Securities available for sale

    (4,917,148 )     (866,223 )

Interest rate cap derivatives

    (622,542 )     (805,027 )

Total stockholders' equity

    360,427,917       353,287,129  

Total liabilities and stockholders' equity

  $ 4,026,314,414     $ 3,982,664,773  

 

See Notes to Consolidated Financial Statements (Unaudited)

 

3

 

 

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

Three Months Ended March 31,

 

   

2018

   

2017

 

Interest and dividend income:

               

Loans/leases, including fees

  $ 34,213,732     $ 27,211,417  

Securities:

               

Taxable

    1,555,884       1,142,235  

Nontaxable

    3,289,002       2,647,722  

Interest-bearing deposits at financial institutions

    197,003       198,652  

Restricted investment securities

    234,344       130,430  

Federal funds sold

    56,331       14,643  

Total interest and dividend income

    39,546,296       31,345,099  
                 

Interest expense:

               

Deposits

    4,881,149       2,232,756  

Short-term borrowings

    32,913       23,960  

Federal Home Loan Bank advances

    1,064,113       403,469  

Other borrowings

    718,176       683,208  

Junior subordinated debentures

    447,027       332,823  

Total interest expense

    7,143,378       3,676,216  

Net interest income

    32,402,918       27,668,883  
                 

Provision for loan/lease losses

    2,539,839       2,105,109  

Net interest income after provision for loan/lease losses

    29,863,079       25,563,774  
                 

Noninterest income:

               

Trust department fees

    2,237,081       1,740,207  

Investment advisory and management fees

    952,344       961,599  

Deposit service fees

    1,531,453       1,316,390  

Gains on sales of residential real estate loans, net

    100,815       96,323  

Gains on sales of government guaranteed portions of loans, net

    358,434       950,641  

Swap fee income

    958,694       113,520  

Earnings on bank-owned life insurance

    417,987       469,687  

Debit card fees

    766,108       702,801  

Correspondent banking fees

    264,827       245,189  

Other

    953,706       687,397  

Total noninterest income

    8,541,449       7,283,754  
                 

Noninterest expense:

               

Salaries and employee benefits

    15,977,975       13,307,331  

Occupancy and equipment expense

    3,065,811       2,502,219  

Professional and data processing fees

    2,707,716       2,083,392  

Acquisition costs

    92,539       5,630  

FDIC insurance, other insurance and regulatory fees

    756,211       621,242  

Loan/lease expense

    290,747       293,538  

Net cost of operations of other real estate

    131,742       14,230  

Advertising and marketing

    693,239       609,431  

Bank service charges

    440,571       423,901  

Correspondent banking expense

    204,754       198,351  

CDI amortization

    304,551       230,867  

Other

    1,197,641       982,985  

Total noninterest expense

    25,863,497       21,273,117  

Net income before income taxes

    12,541,031       11,574,411  

Federal and state income tax expense

    1,991,070       2,389,446  

Net income

  $ 10,549,961     $ 9,184,965  
                 

Basic earnings per common share

  $ 0.76     $ 0.70  

Diluted earnings per common share

  $ 0.74     $ 0.68  
                 

Weighted average common shares outstanding

    13,888,661       13,133,382  

Weighted average common and common equivalent shares outstanding

    14,205,584       13,488,417  
                 

Cash dividends declared per common share

  $ 0.06     $ 0.05  

 

See Notes to Consolidated Financial Statements (Unaudited)

 

4

 

 

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

Three Months Ended March 31, 2018 and 2017

 

   

Three Months Ended March 31,

 
   

2018

   

2017

 

Net income

  $ 10,549,961     $ 9,184,965  
                 

Other comprehensive income (loss):

               
                 

Unrealized gains (losses) on securities available for sale:

               
    Unrealized holding gains (losses) arising during the period before tax     (5,366,113 )     598,190  

Less reclassification for adoption of ASU 2016-01

    666,900      

-    

 
      (4,699,213 )     598,190  

Unrealized gains (losses) on interest rate cap derivatives:

               

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

    150,478       (45,202 )

Less reclassification adjustment for ineffectiveness and caplet amortization before tax

    (80,515 )     (122,813 )
      230,993       77,611  
                 

Other comprehensive income (loss), before tax

    (4,468,220 )     675,801  

Tax expense (benefit)

    (1,266,680 )     265,062  

Other comprehensive income (loss), net of tax

    (3,201,540 )     410,739  
                 

Comprehensive income

  $ 7,348,421     $ 9,595,704  

 

See Notes to Consolidated Financial Statements (Unaudited)

 

5

 

 

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED)

Three Months Ended March 31, 2018 and 2017

 

                           

Accumulated

         
           

Additional

           

Other

         
   

Common

   

Paid-In

   

Retained

   

Comprehensive

         
   

Stock

   

Capital

   

Earnings

   

(Loss)

   

Total

 

Balance December 31, 2017

  $ 13,918,168     $ 189,077,550     $ 151,962,661     $ (1,671,250 )   $ 353,287,129  

Net income

    -       -       10,549,961       -       10,549,961  

Other comprehensive loss, net of tax

    -       -       -       (3,201,540 )     (3,201,540 )

Impact of adoption of ASU 2016-01

    -       -       666,900       (666,900 )     -  

Common cash dividends declared, $0.06 per share

    -       -       (833,730 )     -       (833,730 )

Issuance of 2,669 shares of common stock as a result of stock purchased under the Employee Stock Purchase Plan

    2,669       100,262       -       -       102,931  

Issuance of 13,074 shares of common stock as a result of stock options exercised

    13,074       192,522       -       -       205,596  

Stock-based compensation expense

    -       495,493                       495,493  

Restricted stock awards - 6,860 shares of common stock

    6,860       (6,860 )     -       -       -  

Exchange of 3,814 shares of common stock in connection with stock options exercised and restricted stock vested

    (3,814 )     (174,109 )     -       -       (177,923 )

Balance March 31, 2018

  $ 13,936,957     $ 189,684,858     $ 162,345,792     $ (5,539,690 )   $ 360,427,917  

 

 

                           

Accumulated

         
           

Additional

           

Other

         
   

Common

   

Paid-In

   

Retained

   

Comprehensive

         
   

Stock

   

Capital

   

Earnings

   

(Loss)

   

Total

 

Balance December 31, 2016

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

Net income

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

Other comprehensive income, net of tax

    -       -       -       410,739       410,739  

Common cash dividends declared, $0.05 per share

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

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

    3,573       83,091       -       -       86,664  

Issuance of 44,284 shares of common stock as a result of stock options exercised

    44,284       630,290       -       -       674,574  

Stock-based compensation expense

    -       388,753       -       -       388,753  

Restricted stock awards - 13,289 shares of common stock

    13,289       (13,289 )     -       -       -  

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

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

Balance March 31, 2017

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

 

See Notes to Consolidated Financial Statements (Unaudited)

 

6

 

 

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

Three Months Ended March 31, 2018 and 2017

 

   

2018

   

2017

 

CASH FLOWS FROM OPERATING ACTIVITIES

               

Net income

  $ 10,549,961     $ 9,184,965  

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

               

Depreciation

    1,020,975       896,952  

Provision for loan/lease losses

    2,539,839       2,105,109  

Stock-based compensation expense

    495,493       388,753  

Deferred compensation expense accrued

    511,502       404,723  

Losses on other real estate owned, net

    118,159       -  

Amortization of premiums on securities, net

    438,641       347,178  

Loans originated for sale

    (12,939,466 )     (21,416,325 )

Proceeds on sales of loans

    13,763,966       22,547,789  

Gains on sales of residential real estate loans

    (100,815 )     (96,323 )

Gains on sales of government guaranteed portions of loans

    (358,434 )     (950,641 )

Amortization of core deposit intangible

    304,551       230,867  

Accretion of acquisition fair value adjustments, net

    (732,689 )     (1,915,001 )

Increase in cash value of bank-owned life insurance

    (417,987 )     (469,687 )

Decrease (increase) in other assets

    (4,403,592 )     5,427,798  

Decrease in other liabilities

    (2,886,830 )     (5,852,341 )

Net cash provided by operating activities

  $ 7,903,274     $ 10,833,816  
                 

CASH FLOWS FROM INVESTING ACTIVITIES

               

Net decrease in federal funds sold

    15,692,000       6,459,000  

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

    10,713,457       (93,471,781 )

Proceeds from sales of other real estate owned

    736,370       34,191  

Activity in securities portfolio:

               

Purchases

    (7,100,109 )     (12,138,040 )

Calls, maturities and redemptions

    4,540,000       17,385,968  

Paydowns

    9,085,377       8,486,628  

Activity in restricted investment securities:

               

Purchases

    (4,450,550 )     (7,600 )

Redemptions

    1,820,000       1,315,500  

Net increase in loans/leases originated and held for investment

    (90,378,382 )     (29,236,438 )

Purchase of premises and equipment

    (704,413 )     (1,396,902 )

Net cash used in investing activities

  $ (60,046,250 )   $ (102,569,474 )
                 

CASH FLOWS FROM FINANCING ACTIVITIES

               

Net increase in deposit accounts

    13,377,517       136,704,261  

Net increase (decrease) in short-term borrowings

    2,866,631       (20,501,291 )

Activity in Federal Home Loan Bank advances:

               

Calls and maturities

    -       (4,000,000 )

Net change in short-term and overnight advances

    24,345,000       (26,950,000 )

Activity in other borrowings:

               

Calls, maturities and scheduled principal payments

    (1,937,500 )     (8,000,000 )

Payment of cash dividends on common stock

    (692,874 )     (522,574 )

Proceeds from issuance of common stock, net

    308,527       761,238  

Net cash provided by financing activities

  $ 38,267,301     $ 77,491,634  

Net decrease in cash and due from banks

    (13,875,675 )     (14,244,024 )

Cash and due from banks, beginning

    75,721,663       70,569,993  

Cash and due from banks, ending

  $ 61,845,988     $ 56,325,969  

 

(Continued)

 

7

 

QCR HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) - continued

Three Months Ended March 31, 2018 and 2017

 

   

2018

   

2017

 

Supplemental disclosure of cash flow information, cash payments for:

               

Interest

  $ 3,654,713     $ 3,747,218  

Income/franchise taxes

  $ 74,604     $ 4,842  
                 

Supplemental schedule of noncash investing activities:

               

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

  $ (3,201,540 )   $ 410,739  

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

  $ (177,923 )   $ (290,290 )

Transfers of loans to other real estate owned

  $ 46,244     $ 136,450  

Dividends payable

  $ 833,730     $ 656,574  

Increase in the fair value of interest rate swap assets and liabilities

  $ 103,080     $ 303,383  

Transfer of equity securities from securities available for sale to other assets at fair value

  $ 2,614,261     $ -  

 

See Notes to Consolidated Financial Statements (Unaudited)

 

8

 

Part I

Item 1

QCR HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

March 31, 2018

 

 

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, 2017, included in the Company’s Annual Report on Form 10-K filed with the SEC on March 12, 2018. Accordingly, footnote disclosures, which would substantially duplicate the disclosures contained in the audited consolidated financial statements, have been omitted.

 

The financial information of the Company included herein has been prepared in accordance with GAAP for interim financial reporting and has been prepared pursuant to the rules and regulations for reporting on Form 10-Q and Rule 10-01 of Regulation S-X. Such information reflects all adjustments (consisting of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the periods presented. Any differences appearing between the numbers presented in financial statements and management’s discussion and analysis are due to rounding. The results of the interim period ended March 31, 2018 are not necessarily indicative of the results expected for the year ending December 31, 2018, or for any other period.

 

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

 

Allowance: Allowance for estimated losses on loans/leases

Guaranty: Guaranty Bankshares, Ltd.

AOCI: Accumulated other comprehensive income (loss)

Guaranty Bank: Guaranty Bank and Trust Company

AFS: Available for sale

HTM: Held to maturity

ASC: Accounting Standards Codification

m2: m2 Lease Funds, LLC

ASU: Accounting Standards Update

NIM: Net interest margin

Bates Companies: Bates Financial Advisors, Inc., Bates

NPA: Nonperforming asset

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

NPL: Nonperforming loan

     Bates Financial Group, Inc.

OREO: Other real estate owned

BOLI: Bank-owned life insurance

OTTI: Other-than-temporary impairment

Caps: Interest rate cap derivatives

PCI: Purchased credit impaired

CDI: Core deposit intangible

Provision: Provision for loan/lease losses

Community National: Community National Bancorporation

QCBT: Quad City Bank & Trust Company

CRBT: Cedar Rapids Bank & Trust Company

RB&T: Rockford Bank & Trust Company

CRE: Commercial real estate

ROAA: Return on Average Assets

CSB: Community State Bank

SBA: U.S. Small Business Administration

C&I: Commercial and industrial

SEC: Securities and Exchange Commission

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

SFC Bank: Springfield First Community Bank

     Consumer Protection Act

Springfield Bancshares: Springfield Bancshares, Inc.

EPS: Earnings per share

TA: Tangible assets

Exchange Act: Securities Exchange Act of 1934, as amended

Tax Act: Tax Cuts and Jobs Act of 2017

FASB: Financial Accounting Standards Board

TCE: Tangible common equity

FDIC: Federal Deposit Insurance Corporation

TDRs: Troubled debt restructurings

FHLB: Federal Home Loan Bank

TEY: Tax equivalent yield

FRB: Federal Reserve Bank of Chicago

The Company: QCR Holdings, Inc.

GAAP: Generally Accepted Accounting Principles

USDA: U.S. Department of Agriculture

 

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

 

The acquisition of Guaranty Bank, headquartered in Cedar Rapids, Iowa occurred on October 2, 2017 and Guaranty Bank was merged into CRBT on December 2, 2017. The financial results for the periods since acquisition are included in this report. See Note 2 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2017 for additional information about the acquisition.

 

 

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 was adopted by the Company on January 1, 2018 and did not 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. Upon adoption of ASU 2016-01 by the Company on January 1, 2018, the fair value of the Company’s loan portfolio is now presented using an exit price method. Also, the Company is no longer required to disclose the methodologies used for estimating fair value of financial assets and liabilities that are not measured at fair value on a recurring or nonrecurring basis. The remaining requirements of this update had no significant impact on the consolidated financial statements.

 

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

 

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

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

In February 2018, the FASB issued ASU 2018-02, Income Statement – Reporting Comprehensive Income: Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. Under the standard, entities are allowed to make a one-time reclassification from AOCI to retained earnings for the effect of remeasuring deferred tax liabilities and assets originally recorded in other comprehensive income as a result of the change in the federal tax rate as defined by the Tax Act. ASU 2018-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those years. Companies may choose to early adopt for fiscal years or interim periods that have not been issued or made available for issuance as of February 14, 2018. The Company chose to early adopt ASU 2018-02 and apply the guidance to the consolidated financial statements for the year ended December 31, 2017.

 

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 March 31, 2018 and December 31, 2017 are summarized as follows:

 

           

Gross

   

Gross

         
   

Amortized

   

Unrealized

   

Unrealized

   

Fair

 
   

Cost

   

Gains

   

(Losses)

   

Value

 

March 31, 2018:

                               

Securities HTM:

                               

Municipal securities

  $ 377,534,337     $ 2,244,218     $ (5,024,697 )   $ 374,753,858  

Other securities

    1,050,000       -       (11,175 )     1,038,825  
    $ 378,584,337     $ 2,244,218     $ (5,035,872 )   $ 375,792,683  
                                 

Securities AFS:

                               

U.S. govt. sponsored agency securities

  $ 37,591,155     $ 21,236     $ (744,881 )   $ 36,867,510  

Residential mortgage-backed and related securities

    162,453,605       60,222       (5,224,784 )     157,289,043  

Municipal securities

    61,862,665       238,583       (899,444 )     61,201,804  

Other securities

    4,254,716       31,867       -       4,286,583  
    $ 266,162,141     $ 351,908     $ (6,869,109 )   $ 259,644,940  
                                 

December 31, 2017:

                               

Securities HTM:

                               

Municipal securities

  $ 378,424,205     $ 2,763,718     $ (2,488,119 )   $ 378,699,804  

Other securities

    1,050,000       -       -       1,050,000  
    $ 379,474,205     $ 2,763,718     $ (2,488,119 )   $ 379,749,804  
                                 

Securities AFS:

                               

U.S. govt. sponsored agency securities

  $ 38,409,157     $ 37,344     $ (349,967 )   $ 38,096,534  

Residential mortgage-backed and related securities

    165,459,470       155,363       (2,313,529 )     163,301,304  

Municipal securities

    66,176,364       660,232       (211,100 )     66,625,496  

Other securities

    4,014,004       896,384       (25,815 )     4,884,573  
    $ 274,058,995     $ 1,749,323     $ (2,900,411 )   $ 272,907,907  

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

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

 

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

 

Gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of March 31, 2018 and December 31, 2017, are summarized as follows:

 

   

Less than 12 Months

   

12 Months or More

   

Total

 
           

Gross

           

Gross

           

Gross

 
   

Fair

   

Unrealized

   

Fair

   

Unrealized

   

Fair

   

Unrealized

 
   

Value

   

Losses

   

Value

   

Losses

   

Value

   

Losses

 

March 31, 2018:

                                               

Securities HTM:

                                               

Municipal securities

  $ 69,404,232     $ (2,881,032 )   $ 59,545,239     $ (2,143,665 )   $ 128,949,471     $ (5,024,697 )

Other securities

    1,038,825       (11,175 )     -       -       1,038,825       (11,175 )
    $ 70,443,057     $ (2,892,207 )   $ 59,545,239     $ (2,143,665 )   $ 129,988,296     $ (5,035,872 )
                                                 

Securities AFS:

                                               

U.S. govt. sponsored agency securities

  $ 29,643,497     $ (589,515 )   $ 3,634,609     $ (155,365 )   $ 33,278,106     $ (744,880 )

Residential mortgage-backed and related securities

    94,102,512       (2,858,578 )     55,394,159       (2,366,206 )     149,496,671       (5,224,784 )

Municipal securities

    36,845,821       (659,492 )     8,217,318       (239,952 )     45,063,139       (899,444 )
    $ 160,591,830     $ (4,107,585 )   $ 67,246,086     $ (2,761,523 )   $ 227,837,916     $ (6,869,108 )
                                                 

December 31, 2017:

                                               

Securities HTM:

                                               

Municipal securities

  $ 23,750,826     $ (354,460 )   $ 72,611,780     $ (2,133,659 )   $ 96,362,606     $ (2,488,119 )
                                                 
                                                 

Securities AFS:

                                               

U.S. govt. sponsored agency securities

  $ 28,576,258     $ (200,022 )   $ 3,640,477     $ (149,945 )   $ 32,216,735     $ (349,967 )

Residential mortgage-backed and related securities

    88,927,779       (871,855 )     57,931,731       (1,441,674 )     146,859,510       (2,313,529 )

Municipal securities

    10,229,337       (41,151 )     9,997,433       (169,949 )     20,226,770       (211,100 )

Other securities

    923,535       (25,815 )     -       -       923,535       (25,815 )
    $ 128,656,909     $ (1,138,843 )   $ 71,569,641     $ (1,761,568 )   $ 200,226,550     $ (2,900,411 )

 

 

At March 31, 2018, the investment portfolio included 604 securities. Of this number, 290 securities were in an unrealized loss position. The aggregate losses of these securities totaled approximately 1.8% of the total amortized cost of the portfolio. Of these 290 securities, 105 securities had an unrealized loss for twelve months or more. All of the debt securities in unrealized loss positions are considered acceptable credit risks. Based upon an evaluation of the available evidence, including the recent changes in market rates, credit rating information and information obtained from regulatory filings, management believes the declines in fair value for these debt securities are temporary. In addition, the Company lacks the intent to sell these securities and it is not more-likely-than-not that the Company will be required to sell these debt securities before their anticipated recovery.

 

The Company did not recognize OTTI on any investment securities for the three months ended March 31, 2018 and 2017. 

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

There were no sales of securities for the three months ended March 31, 2018 and 2017.

 

The amortized cost and fair value of securities as of March 31, 2018 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.

 

   

Amortized Cost

   

Fair Value

 

Securities HTM:

               

Due in one year or less

  $ 3,344,356     $ 3,345,990  

Due after one year through five years

    25,163,524       25,191,668  

Due after five years

    350,076,457       347,255,025  
    $ 378,584,337     $ 375,792,683  
                 

Securities AFS:

               

Due in one year or less

  $ 3,368,633     $ 3,381,748  

Due after one year through five years

    23,949,100       23,738,028  

Due after five years

    76,390,803       75,236,121  
      103,708,536       102,355,897  

Residential mortgage-backed and related securities

    162,453,605       157,289,043  
    $ 266,162,141     $ 259,644,940  

 

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

  $ 209,306,946     $ 207,262,788  
                 
                 

Securities AFS:

               

U.S. govt. sponsored agency securities

    5,048,812       4,947,644  

Municipal securities

    54,016,828       53,258,850  
    $ 59,065,640     $ 58,206,494  

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

As of March 31, 2018, the Company’s municipal securities portfolios were comprised of general obligation bonds issued by 128 issuers with fair values totaling $101.3 million and revenue bonds issued by 148 issuers, primarily consisting of states, counties, towns, villages and school districts with fair values totaling $334.6 million. The Company held investments in general obligation bonds in 26 states, including six states in which the aggregate fair value exceeded $5.0 million. The Company held investments in revenue bonds in 16 states, including seven states in which the aggregate fair value exceeded $5.0 million.

 

As of December 31, 2017, the Company’s municipal securities portfolios were comprised of general obligation bonds issued by 131 issuers with fair values totaling $108.0 million and revenue bonds issued by 145 issuers, primarily consisting of states, counties, towns, villages and school districts with fair values totaling $337.3 million. The Company held investments in general obligation bonds in 26 states, including six states in which the aggregate fair value exceeded $5.0 million. The Company held investments in revenue bonds in 16 states, including seven states in which the aggregate fair value exceeded $5.0 million.

 

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

 

March 31, 2018:

                               

U.S. State:

 

Number of

Issuers

   

Amortized Cost

   

Fair Value

   

Average

Exposure Per

Issuer
(Fair Value)

 
                                 

North Dakota

    7     $ 21,627,097     $ 20,756,566     $ 2,965,224  

Illinois

    20       18,532,776       18,513,766       925,688  

Iowa

    16       13,878,991       13,830,003       864,375  

Texas

    17       10,763,333       10,554,430       620,849  

Missouri

    17       8,314,872       8,323,476       489,616  

Ohio

    8       7,378,887       7,296,859       912,107  

Other

    43       22,261,263       22,068,390       513,218  

Total general obligation bonds

    128     $ 102,757,219     $ 101,343,490     $ 791,746  

 

 

December 31, 2017:

                               

U.S. State:

 

Number of

Issuers

   

Amortized Cost

   

Fair Value

   

Average

Exposure Per

Issuer
(Fair Value)

 
                                 

North Dakota

    7     $ 21,626,574     $ 21,724,197     $ 3,103,457  

Illinois

    20       19,328,700       19,514,024       975,701  

Iowa

    16       13,881,689       13,969,512       873,095  

Texas

    17       11,253,775       11,308,848       665,226  

Missouri

    17       9,243,355       9,308,287       547,546  

Ohio

    9       8,002,705       7,938,028       882,003  

Other

    45       24,000,278       24,215,119       538,114  

Total general obligation bonds

    131     $ 107,337,076     $ 107,978,015     $ 824,260  

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

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

 

March 31, 2018:

                               

U.S. State:

 

Number of

Issuers

   

Amortized Cost

   

Fair Value

   

Average

Exposure Per

Issuer
(Fair Value)

 
                                 

Missouri

    58     $ 108,311,804     $ 108,445,780     $ 1,869,755  

Iowa

    29       68,370,374       68,236,038       2,352,967  

Ohio

    10       55,757,914       55,699,375       5,569,938  

Indiana

    26       49,258,364       48,833,113       1,878,197  

Illinois

    2       17,205,951       17,373,994       8,686,997  

Kansas

    6       12,651,338       12,172,961       2,028,827  

North Dakota

    5       11,220,278       10,644,441       2,128,888  

Other

    12       13,863,760       13,206,470       1,100,539  

Total revenue bonds

    148     $ 336,639,783     $ 334,612,172     $ 2,260,893  

 

 

December 31, 2017:

                               

U.S. State:

 

Number of

Issuers

   

Amortized Cost

   

Fair Value

   

Average

Exposure Per

Issuer
(Fair Value)

 
                                 

Missouri

    56     $ 106,259,015     $ 106,232,837     $ 1,897,015  

Iowa

    29       68,724,899       69,079,470       2,382,051  

Ohio

    10       55,766,091       55,820,203       5,582,020  

Indiana

    26       51,171,818       50,861,336       1,956,205  

Illinois

    2       17,211,441       17,408,544       8,704,272  

Kansas

    6       12,873,329       12,877,087       2,146,181  

North Dakota

    5       11,451,560       11,351,676       2,270,335  

Other

    11       13,805,340       13,716,132       1,246,921  

Total revenue bonds

    145     $ 337,263,493     $ 337,347,285     $ 2,326,533  

 

Both general obligation and revenue bonds are diversified across many issuers. As of March 31, 2018 and December 31, 2017, the Company did not hold general obligation or revenue bonds of any single issuer, the aggregate book or market value of which exceeded 5% of the Company’s stockholders’ equity. Of the general obligation and revenue bonds in the Company’s portfolio, the majority are unrated bonds that represent small, private issuances. All unrated bonds were underwritten according to loan underwriting standards and have an average loan risk rating of 2, indicating very high quality. Additionally, many of these bonds are funding essential municipal services such as water, sewer, education, and medical facilities.

 

The Company’s municipal securities are owned by each of the four charters, whose investment policies set forth limits for various subcategories within the municipal securities portfolio. Each charter is monitored individually, and as of March 31, 2018, all were well within policy limitations approved by the board of directors. Policy limits are calculated as a percentage of each charter’s total risk-based capital.

 

As of March 31, 2018, 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.

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

 

NOTE 3 – LOANS/LEASES RECEIVABLE

 

The composition of the loan/lease portfolio as of March 31, 2018 and December 31, 2017 is presented as follows:

 

   

As of March 31,

   

As of December 31,

 
   

2018

   

2017

 
                 

C&I loans*

  $ 1,201,085,625     $ 1,134,516,315  

CRE loans

               

Owner-occupied CRE

    346,996,627       332,742,477  

Commercial construction, land development, and other land

    171,404,628       186,402,404  

Other non owner-occupied CRE

    839,302,131       784,347,000  
      1,357,703,386       1,303,491,882  
                 

Direct financing leases **

    137,614,465       141,448,232  

Residential real estate loans ***

    254,484,231       258,646,265  

Installment and other consumer loans

    95,911,569       118,610,799  
      3,046,799,276       2,956,713,493  

Plus deferred loan/lease origination costs, net of fees

    8,103,163       7,771,907  
      3,054,902,439       2,964,485,400  

Less allowance

    (36,532,602 )     (34,355,728 )
    $ 3,018,369,837     $ 2,930,129,672  
                 
                 

* Direct financing leases:

               

Net minimum lease payments to be received

  $ 152,430,047     $ 156,583,887  

Estimated unguaranteed residual values of leased assets

    929,932       929,932  

Unearned lease/residual income

    (15,745,514 )     (16,065,587 )
      137,614,465       141,448,232  

Plus deferred lease origination costs, net of fees

    4,350,767       4,624,027  
      141,965,232       146,072,259  

Less allowance

    (2,730,301 )     (2,382,098 )
    $ 139,234,931     $ 143,690,161  

 

* Includes equipment financing agreements outstanding at m2, totaling $78,911,791 and $66,758,397 as of March 31, 2018 and December 31, 2017, respectively.

 

**Management performs an evaluation of the estimated unguaranteed residual values of leased assets on an annual basis, at a minimum. The evaluation consists of discussions with reputable and current vendors, which is combined with management’s expertise and understanding of the current states of particular industries to determine informal valuations of the equipment. As necessary and where available, management will utilize valuations by independent appraisers. The large majority of leases with residual values contain a lease options rider, which requires the lessee to pay the residual value directly, finance the payment of the residual value, or extend the lease term to pay the residual value. In these cases, the residual value is protected and the risk of loss is minimal. There were no losses related to residual values for the three months ended March 31, 2018 and 2017.

 

***Includes residential real estate loans held for sale totaling $279,750 and $645,001 as of March 31, 2018, and December 31, 2017, respectively.

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

Changes in accretable yield for acquired loans were as follows:

 

   

Three months ended March 31, 2018

 
   

PCI

   

Performing

         
   

Loans

   

Loans

   

Total

 

Balance at the beginning of the period

  $ (191,132 )   $ (6,280,075 )   $ (6,471,207 )

Accretion recognized

    34,236       620,532       654,768  

Balance at the end of the period

  $ (156,896 )   $ (5,659,543 )   $ (5,816,439 )

 

 

   

Three months ended March 31, 2017

 
   

PCI

   

Performing

         
   

Loans

   

Loans

   

Total

 

Balance at the beginning of the period

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

Accretion recognized

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

Balance at the end of the period

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

 

 

The aging of the loan/lease portfolio by classes of loans/leases as of March 31, 2018 and December 31, 2017 is presented as follows:

 

   

As of March 31, 2018

 

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

  $ 1,197,675,583     $ 1,714,614     $ 210,724     $ 36,162     $ 1,448,542     $ 1,201,085,625  

CRE

                                               

Owner-Occupied CRE

    346,524,727       142,587       -       -       329,313       346,996,627  

Commercial Construction, Land Development, and Other Land

    168,928,348       55,561       568,523       -       1,852,196       171,404,628  

Other Non Owner-Occupied CRE

    834,328,826       105,223       -       -       4,868,082       839,302,131  

Direct Financing Leases

    133,012,415       1,196,302       599,350       -       2,806,398       137,614,465  

Residential Real Estate

    250,956,900       2,304,607       35,457       -       1,187,267       254,484,231  

Installment and Other Consumer

    95,435,771       190,027       13,806       4,778       267,187       95,911,569  
    $ 3,026,862,570     $ 5,708,921     $ 1,427,860     $ 40,940     $ 12,758,985     $ 3,046,799,276  
                                                 

As a percentage of total loan/lease portfolio

    99.34 %     0.19 %     0.05 %     0.00 %     0.42 %     100.00 %

 

   

As of December 31, 2017

 

Classes of Loans/Leases

 

Current

   

30-59 Days Past

Due

   

60-89 Days Past

Due

   

Accruing Past Due

90 Days or More

   

Nonaccrual

Loans/Leases

   

Total

 
                                                 

C&I

  $ 1,124,734,486     $ 8,306,829     $ 243,647     $ -     $ 1,231,353     $ 1,134,516,315  

CRE

                                               

Owner-Occupied CRE

    331,868,142       540,435       -       -       333,900       332,742,477  

Commercial Construction, Land Development, and Other Land

    181,558,092       -       -       -       4,844,312       186,402,404  

Other Non Owner-Occupied CRE

    782,526,249       572,877       4,146       -       1,243,728       784,347,000  

Direct Financing Leases

    137,708,397       1,305,191       259,600       -       2,175,044       141,448,232  

Residential Real Estate

    253,261,821       3,552,709       393,410       74,519       1,363,806       258,646,265  

Installment and Other Consumer

    117,773,259       517,537       56,760       14,152       249,091       118,610,799  
    $ 2,929,430,446     $ 14,795,578     $ 957,563     $ 88,671     $ 11,441,234     $ 2,956,713,493  
                                                 

As a percentage of total loan/lease portfolio

    99.08 %     0.50 %     0.03 %     0.00 %     0.39 %     100.00 %

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

NPLs by classes of loans/leases as of March 31, 2018 and December 31, 2017 are presented as follows:

 

   

As of March 31, 2018

 

Classes of Loans/Leases

 

Accruing Past

Due 90 Days or

More

   

Nonaccrual

Loans/Leases *

   

Accruing
TDRs

   

Total

NPLs

   

Percentage of

Total NPLs

 
                                         

C&I

  $ 36,162     $ 1,448,542     $ 4,714,450     $ 6,199,154       34.29 %

CRE

                                       

Owner-Occupied CRE

    -       329,313       107,322       436,635       2.42 %

Commercial Construction, Land Development, and Other Land

    -       1,852,196       -       1,852,196       10.25 %

Other Non Owner-Occupied CRE

    -       4,868,082       -       4,868,082       26.93 %

Direct Financing Leases

    -       2,806,398       169,198       2,975,596       16.46 %

Residential Real Estate

    -       1,187,267       271,694       1,458,961       8.07 %

Installment and Other Consumer

    4,778       267,187       12,828       284,793       1.58 %
    $ 40,940     $ 12,758,985     $ 5,275,492     $ 18,075,417       100.00 %

 

 

*Nonaccrual loans/leases included $2,637,483 of TDRs, including $25,984 in C&I loans, $1,312,469 in CRE loans, $1,208,050 in direct financing leases, $84,555 in residential real estate loans, and $6,425 in installment loans.

 

 

   

As of December 31, 2017

 

Classes of Loans/Leases

 

Accruing Past

Due 90 Days or

More

   

Nonaccrual

Loans/Leases **

   

Accruing
TDRs

   

Total

NPLs

   

Percentage of

Total NPLs

 
                                         

C&I

  $ -     $ 1,231,353     $ 5,224,182     $ 6,455,535       34.63 %

CRE

                                       

Owner-Occupied CRE

    -       333,900       107,322       441,222       2.37 %

Commercial Construction, Land Development, and Other Land

    -       4,844,312       -       4,844,312       25.99 %

Other Non Owner-Occupied CRE

    -       1,243,728       -       1,243,728       6.67 %

Direct Financing Leases

    -       2,175,044       1,494,448       3,669,492       19.68 %

Residential Real Estate

    74,519       1,363,806       272,493       1,710,818       9.18 %

Installment and Other Consumer

    14,152       249,091       14,027       277,270       1.49 %
    $ 88,671     $ 11,441,234     $ 7,112,472     $ 18,642,377       100.00 %

 

**Nonaccrual loans/leases included $2,282,495 of TDRs, including $122,598 in C&I loans, $1,336,871 in CRE loans, $700,255 in direct financing leases, $115,190 in residential real estate loans, and $7,581 in installment loans.

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

Changes in the allowance by portfolio segment for the three months ended March 31, 2018 and 2017, respectively, are presented as follows:

 

   

Three Months Ended March 31, 2018

 
   

C&I

   

CRE

   

Direct Financing

Leases

   

Residential Real

Estate

   

Installment and

Other Consumer

   

Total

 
                                                 

Balance, beginning

  $ 14,323,036     $ 13,962,688     $ 2,382,098     $ 2,466,431     $ 1,221,475     $ 34,355,728  

Provisions (credits) charged to expense

    808,161       965,383       604,783       (39,337 )     200,849       2,539,839  

Loans/leases charged off

    (95,499 )     -       (283,887 )     (52,325 )     (4,747 )     (436,458 )

Recoveries on loans/leases previously charged off

    29,547       9,949       27,307       450       6,240       73,493  

Balance, ending

  $ 15,065,245     $ 14,938,020     $ 2,730,301     $ 2,375,219     $ 1,423,817     $ 36,532,602  

 

   

Three Months Ended March 31, 2017

 
   

C&I

   

CRE

   

Direct Financing

Leases

   

Residential Real

Estate

   

Installment and

Other Consumer

   

Total

 
                                                 

Balance, beginning

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

Provisions charged to expense

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

Loans/leases charged off

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

Recoveries on loans/leases previously charged off

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

Balance, ending

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

 

 

The allowance by impairment evaluation and by portfolio segment as of March 31, 2018 and December 31, 2017 is presented as follows:

 

   

As of March 31, 2018

 
   

C&I

   

CRE

   

Direct Financing

Leases

   

Residential Real

Estate

   

Installment and

Other Consumer

   

Total

 
                                                 

Allowance for impaired loans/leases

  $ 567,321     $ 1,670,897     $ 628,379     $ 248,592     $ 112,177     $ 3,227,366  

Allowance for nonimpaired loans/leases

    14,497,924       13,267,123       2,101,922       2,126,627       1,311,640       33,305,236  
    $ 15,065,245     $ 14,938,020     $ 2,730,301     $ 2,375,219     $ 1,423,817     $ 36,532,602  
                                                 
                                                 

Impaired loans/leases

  $ 6,010,688     $ 7,094,483     $ 2,975,596     $ 1,556,817     $ 281,197     $ 17,918,781  

Nonimpaired loans/leases

    1,195,074,937       1,350,608,903       134,638,869       252,927,414       95,630,372       3,028,880,495  
    $ 1,201,085,625     $ 1,357,703,386     $ 137,614,465     $ 254,484,231     $ 95,911,569     $ 3,046,799,276  
                                                 
                                                 

Allowance as a percentage of impaired loans/leases

    9.44 %     23.55 %     21.12 %     15.97 %     39.89 %     18.01 %

Allowance as a percentage of nonimpaired loans/leases

    1.21 %     0.98 %     1.56 %     0.84 %     1.37 %     1.10 %

Total allowance as a percentage of total loans/leases

    1.25 %     1.10 %     1.98 %     0.93 %     1.48 %     1.20 %

 

   

As of December 31, 2017

 
   

C&I

   

CRE

   

Direct Financing

Leases

   

Residential Real

Estate

   

Installment and

Other Consumer

   

Total

 
                                                 

Allowance for impaired loans/leases

  $ 715,627     $ 1,429,460     $ 504,469     $ 355,167     $ 38,596     $ 3,043,319  

Allowance for nonimpaired loans/leases

    13,607,409       12,533,228       1,877,629       2,111,264       1,182,879       31,312,409  
    $ 14,323,036     $ 13,962,688     $ 2,382,098     $ 2,466,431     $ 1,221,475     $ 34,355,728  
                                                 

Impaired loans/leases

  $ 6,248,209     $ 6,529,262     $ 3,669,492     $ 1,704,846     $ 202,354     $ 18,354,163  

Nonimpaired loans/leases

    1,128,268,106       1,296,962,620       137,778,740       256,941,419       118,408,445       2,938,359,330  
    $ 1,134,516,315     $ 1,303,491,882     $ 141,448,232     $ 258,646,265     $ 118,610,799     $ 2,956,713,493  
                                                 

Allowance as a percentage of impaired loans/leases

    11.45 %     21.89 %     13.75 %     20.83 %     19.07 %     16.58 %

Allowance as a percentage of nonimpaired loans/leases

    1.21 %     0.97 %     1.36 %     0.82 %     1.00 %     1.07 %

Total allowance as a percentage of total loans/leases

    1.26 %     1.07 %     1.68 %     0.95 %     1.03 %     1.16 %

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

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

 

Loans/leases, by classes of financing receivable, considered to be impaired as of and for the three months ended March 31, 2018 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

  $ 5,038,888     $ 5,053,164     $ -     $ 5,297,775     $ 75,406     $ 75,406  

CRE

                                               

Owner-Occupied CRE

    289,261       289,261       -       289,261       5,822       5,822  

Commercial Construction, Land Development, and Other Land

    -       -       -       -       -       -  

Other Non Owner-Occupied CRE

    1,227,579       1,227,579       -       1,235,654       -       -  

Direct Financing Leases

    1,927,663       1,927,663       -       2,355,745       6,291       6,291  

Residential Real Estate

    911,804       986,583       -       884,441       -       -  

Installment and Other Consumer

    140,857       140,857       -       120,043       -       -  
    $ 9,536,052     $ 9,625,107     $ -     $ 10,182,919     $ 87,519     $ 87,519  
                                                 

Impaired Loans/Leases with Specific Allowance Recorded:

                                               

C&I

  $ 957,524     $ 957,524     $ 567,321     $ 824,536     $ 1,983     $ 1,983  

CRE

                                               

Owner-Occupied CRE

    147,375       147,375       43,875       149,669       -       -  

Commercial Construction, Land Development, and Other Land

    5,430,268       5,430,268       1,627,022       5,137,290       -       -  

Other Non Owner-Occupied CRE

    -       -       -       -       -       -  

Direct Financing Leases

    1,047,933       1,047,933       628,379       962,961       -       -  

Residential Real Estate

    547,158       570,234       248,592       544,558       2,934       2,934  

Installment and Other Consumer

    140,340       140,340       112,177       128,285       83       83  
    $ 8,270,598     $ 8,293,674     $ 3,227,366     $ 7,747,299     $ 5,000     $ 5,000  
                                                 

Total Impaired Loans/Leases:

                                               

C&I

  $ 5,996,412     $ 6,010,688     $ 567,321     $ 6,122,311     $ 77,389     $ 77,389  

CRE

                                               

Owner-Occupied CRE

    436,636       436,636       43,875       438,930       5,822       5,822  

Commercial Construction, Land Development, and Other Land

    5,430,268       5,430,268       1,627,022       5,137,290       -       -  

Other Non Owner-Occupied CRE

    1,227,579       1,227,579       -       1,235,654       -       -  

Direct Financing Leases

    2,975,596       2,975,596       628,379       3,318,706       6,291       6,291  

Residential Real Estate

    1,458,962       1,556,817       248,592       1,428,999       2,934       2,934  

Installment and Other Consumer

    281,197       281,197       112,177       248,328       83       83  
    $ 17,806,650     $ 17,918,781     $ 3,227,366     $ 17,930,218     $ 92,519     $ 92,519  

 

 

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

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

Loans/leases, by classes of financing receivable, considered to be impaired as of and for the three months ended March 31, 2017 are presented as follows:

 

Classes of Loans/Leases

 

Recorded

Investment

   

Unpaid Principal

Balance

   

Related

Allowance

   

Average

Recorded

Investment

   

Interest Income

Recognized

   

Interest Income

Recognized for

Cash Payments

Received

 
                                                 

Impaired Loans/Leases with No Specific Allowance Recorded:

                                               

C&I

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

CRE

                                               

Owner-Occupied CRE

    -       -       -       -       -       -  

Commercial Construction, Land Development, and Other Land

    -       -       -       -       -       -  

Other Non Owner-Occupied CRE

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

Direct Financing Leases

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

Residential Real Estate

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

Installment and Other Consumer

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

Impaired Loans/Leases with Specific Allowance Recorded:

                                               

C&I

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

CRE

                                               

Owner-Occupied CRE

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

Commercial Construction, Land Development, and Other Land

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

Other Non Owner-Occupied CRE

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

Direct Financing Leases

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

Residential Real Estate

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

Installment and Other Consumer

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

Total Impaired Loans/Leases:

                                               

C&I

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

CRE

                                               

Owner-Occupied CRE

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

Commercial Construction, Land Development, and Other Land

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

Other Non Owner-Occupied CRE

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

Direct Financing Leases

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

Residential Real Estate

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

Installment and Other Consumer

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

 

 

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

 

 

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, 2017 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

  $ 1,634,269     $ 1,644,706     $ -  

CRE

                       

Owner-Occupied CRE

    289,261       289,261       -  

Commercial Construction, Land Development, and Other Land

    -       -       -  

Other Non Owner-Occupied CRE

    1,171,565       1,171,565       -  

Direct Financing Leases

    2,944,540       2,944,540       -  

Residential Real Estate

    943,388       1,018,167       -  

Installment and Other Consumer

    134,245       134,245       -  
    $ 7,117,268     $ 7,202,484     $ -  
                         

Impaired Loans/Leases with Specific Allowance Recorded:

                       

C&I

  $ 4,613,940     $ 4,617,879     $ 715,627  

CRE

                       

Owner-Occupied CRE

    151,962       151,962       48,462  

Commercial Construction, Land Development, and Other Land

    4,844,312       4,844,312       1,379,235  

Other Non Owner-Occupied CRE

    72,163       72,163       1,763  

Direct Financing Leases

    724,953       724,953       504,469  

Residential Real Estate

    761,458       761,458       355,167  

Installment and Other Consumer

    68,109       68,109       38,596  
    $ 11,236,897     $ 11,240,836     $ 3,043,319  
                         

Total Impaired Loans/Leases:

                       

C&I

  $ 6,248,209     $ 6,262,585     $ 715,627  

CRE

                       

Owner-Occupied CRE

    441,222       441,222       48,462  

Commercial Construction, Land Development, and Other Land

    4,844,312       4,844,312       1,379,235  

Other Non Owner-Occupied CRE

    1,243,728       1,243,728       1,763  

Direct Financing Leases

    3,669,492       3,669,492       504,469  

Residential Real Estate

    1,704,846       1,779,625       355,167  

Installment and Other Consumer

    202,354       202,354       38,596  
    $ 18,354,163     $ 18,443,318     $ 3,043,319  

 

 

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

 

 

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

 

For each class of financing receivable, the following presents the recorded investment by credit quality indicator as of March 31, 2018 and December 31, 2017:

 

   

As of March 31, 2018

 
           

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)

  $ 1,079,132,775     $ 337,628,357     $ 166,752,090     $ 813,622,461     $ 2,397,135,683       96.66 %

Special Mention (Rating 6)

    20,327,365       5,576,201       1,780,000       15,242,642       42,926,208       1.73 %

Substandard (Rating 7)

    22,713,694       3,792,069       2,872,538       10,437,028       39,815,329       1.61 %

Doubtful (Rating 8)

    -       -       -       -       -       -  
    $ 1,122,173,834     $ 346,996,627     $ 171,404,628     $ 839,302,131     $ 2,479,877,220       100.00 %

 

   

As of March 31, 2018

         

Delinquency Status *

 

C&I

   

Direct Financing

Leases

   

Residential Real

Estate

   

Installment and

Other Consumer

   

Total

   

As a % of

Total

 
                                                 

Performing

  $ 77,987,539     $ 134,638,869     $ 253,025,270     $ 95,626,776     $ 561,278,454       99.00 %

Nonperforming

    924,252       2,975,596       1,458,961       284,793       5,643,602       1.00 %
    $ 78,911,791     $ 137,614,465     $ 254,484,231     $ 95,911,569     $ 566,922,056       100.00 %

 

   

As of December 31, 2017

 
           

CRE

                 
                   

Non Owner-Occupied

                 

Internally Assigned Risk Rating

 

C&I

   

Owner-Occupied

CRE

   

Commercial

Construction,

Land

Development,

and Other Land

   

Other CRE

   

Total

   

As a % of

Total

 
                                                 

Pass (Ratings 1 through 5)

  $ 1,031,963,703     $ 318,293,608     $ 179,142,839     $ 767,119,909     $ 2,296,520,059       96.85 %

Special Mention (Rating 6)

    10,944,924       8,230,060       1,780,000       10,068,870       31,023,854       1.31 %

Substandard (Rating 7)

    24,578,731       6,218,809       5,479,565       7,158,221       43,435,326       1.83 %

Doubtful (Rating 8)

    270,559       -       -       -       270,559       0.01 %
    $ 1,067,757,917     $ 332,742,477     $ 186,402,404     $ 784,347,000     $ 2,371,249,799       100.00 %

 

   

As of December 31, 2017

         

Delinquency Status *

 

C&I

   

Direct Financing

Leases

   

Residential Real

Estate

   

Installment and

Other Consumer

   

Total

   

As a % of

Total

 
                                                 

Performing

  $ 65,847,177     $ 137,778,740     $ 256,935,448     $ 118,333,529     $ 578,894,894       98.88 %

Nonperforming

    911,220       3,669,492       1,710,818       277,270       6,568,800       1.12 %
    $ 66,758,397     $ 141,448,232     $ 258,646,266     $ 118,610,799     $ 585,463,694       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.

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

As of March 31, 2018 and December 31, 2017, TDRs totaled $7,912,975 and $9,394,967, respectively.

 

For each class of financing receivable, the following presents the number and recorded investment of TDRs, by type of concession, that were restructured during the three months ended March 31, 2018 and 2017. The difference between the pre-modification recorded investment and the post-modification recorded investment would be any partial charge-offs at the time of the restructuring.

 

   

For the three months ended March 31, 2018

   

For the three months ended March 31, 2017

 

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

                                                               

C&I

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

Residential Real Estate

    1       46,320       46,320       -       -       -       -       -  

Direct Financing Leases

    2       47,524       47,524       -       8       669,861       669,861       -  
      3     $ 93,844     $ 93,844     $ -       10     $ 803,550     $ 803,550     $ -  
                                                                 

CONCESSION - Extension of Maturity

                                                               

Direct Financing Leases

    -     $ -     $ -     $ -       1     $ 6,263     $ 6,263     $ -  
      -     $ -     $ -     $ -       1     $ 6,263     $ 6,263     $ -  
                                                                 

TOTAL

    3     $ 93,844     $ 93,844     $ -       11     $ 809,813     $ 809,813     $ -  

 

 

Of the TDRs reported above, one with a post-modification recorded balance of $46,320 was on nonaccrual as of March 31, 2018. Of the TDRs reported above, none were on nonaccrual as of March 31, 2017.

 

For the three months ended March 31, 2018, eight of the Company’s TDRs redefaulted within 12 months subsequent to restructure where default is defined as delinquency of 90 days or more and/or placement on nonaccrual status. Three of these TDRs were related to one customer whose loans were restructured in the second quarter of 2017 with pre-modification balances totaling $78 thousand and the other TDRs related to other customers whose loans were restructured in the second and third quarters of 2017 with pre-modification balances totaling $378 thousand.

 

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

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

 

NOTE 4 - EARNINGS PER SHARE

 

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

 

   

Three months ended

 
   

March 31,

 
   

2018

   

2017

 
                 

Net income

  $ 10,549,961     $ 9,184,965  
                 

Basic EPS

  $ 0.76     $ 0.70  

Diluted EPS

  $ 0.74     $ 0.68  
                 

Weighted average common shares outstanding

    13,888,661       13,133,382  

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

    316,923       355,035  

Weighted average common and common equivalent shares outstanding

    14,205,584       13,488,417  

 

 

The increase in weighted average common shares outstanding when comparing the three months ended March 31, 2018 to March 31, 2017 was primarily due to the common stock issuance discussed in Note 2 to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

 

 

NOTE 5 – FAIR VALUE

 

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

 

 

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

 

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

 

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

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

Assets and liabilities measured at fair value on a recurring basis comprise the following at March 31, 2018 and December 31, 2017:

 

           

Fair Value Measurements at Reporting Date Using

 
           

Quoted Prices

   

Significant

         
           

in Active

   

Other

   

Significant

 
           

Markets for

   

Observable

   

Unobservable

 
           

Identical Assets

   

Inputs

   

Inputs

 
   

Fair Value

   

(Level 1)

   

(Level 2)

   

(Level 3)

 
                                 

March 31, 2018:

                               

Securities AFS:

                               

U.S. govt. sponsored agency securities

  $ 36,867,510     $ -     $ 36,867,510     $ -  

Residential mortgage-backed and related securities

    157,289,043       -       157,289,043       -  

Municipal securities

    61,201,804       -       61,201,804       -  

Other securities

    4,286,583       -       4,286,583       -  

Interest rate caps

    657,178       -       657,178       -  

Interest rate swaps - assets

    4,500,318       -       4,500,318       -  

Total assets measured at fair value

  $ 264,802,436     $ -     $ 264,802,436     $ -  
                                 

Interest rate swaps - liabilities

  $ 4,500,318     $ -     $ 4,500,318     $ -  

Total liabilities measured at fair value

  $ 4,500,318     $ -     $ 4,500,318     $ -  
                                 
                                 

December 31, 2017:

                               

Securities AFS:

                               

U.S. govt. sponsored agency securities

  $ 38,096,534     $ -     $ 38,096,534     $ -  

Residential mortgage-backed and related securities

    163,301,304       -       163,301,304       -  

Municipal securities

    66,625,496       -       66,625,496       -  

Other securities

    4,884,573       1,028       4,883,545       -  

Interest rate caps

    506,700       -       506,700       -  

Interest rate swaps - assets

    4,397,238       -       4,397,238       -  

Total assets measured at fair value

  $ 277,811,845     $ 1,028     $ 277,810,817     $ -  
                                 

Interest rate swaps - liabilities

  $ 4,397,238     $ -     $ 4,397,238     $ -  

Total liabilities measured at fair value

  $ 4,397,238     $ -     $ 4,397,238     $ -  

 

 

There were no transfers of assets or liabilities between Levels 1, 2, and 3 of the fair value hierarchy for the three months ended March 31, 2018 or 2017.

 

A small portion of the securities AFS 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).

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

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

 

Interest rate caps are used for the purpose of hedging interest rate risk. The 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 to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017. The fair values are determined by comparing the contract rate on the swap with the then-current market rate for the remaining term of the transaction (Level 2 inputs).

 

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

 

Assets measured at fair value on a non-recurring basis comprise the following at March 31, 2018 and December 31, 2017:

 

           

Fair Value Measurements at Reporting Date Using

 
   

Fair Value

   

Level 1

   

Level 2

   

Level 3

 

March 31, 2018:

                               

Impaired loans/leases

  $ 5,564,760     $ -     $ -     $ 5,564,760  

OREO

    13,770,025       -       -       13,770,025  
    $ 19,334,785     $ -     $ -     $ 19,334,785  
                                 

December 31, 2017:

                               

Impaired loans/leases

  $ 8,972,337     $ -     $ -     $ 8,972,337  

OREO

    14,642,973       -       -       14,642,973  
    $ 23,615,310     $ -     $ -     $ 23,615,310  

 

 

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.

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

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

 

   

Quantitative Information about Level Fair Value Measurements

 
   

Fair Value
March 31, 2018

   

Fair Value
December 31, 2017

 

Valuation Technique

Unobservable Input

 

Range

 
                                 

Impaired loans/leases

  $ 5,564,760     $ 8,972,337  

Appraisal of collateral

Appraisal adjustments

    -10.00% to -30.00%  

OREO

    13,770,025       14,642,973  

Appraisal of collateral

Appraisal adjustments

    0.00% to -35.00%  

 

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

 

There have been no changes in valuation techniques used for any assets measured at fair value during the three months ended March 31, 2018 and 2017.

 

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

 

 

Fair Value

 

As of March 31, 2018

   

As of December 31, 2017

 
 

Hierarchy

 

Carrying

   

Estimated

   

Carrying

   

Estimated

 
 

Level

 

Value

   

Fair Value

   

Value

   

Fair Value

 
                                   

Cash and due from banks

Level 1

  $ 61,845,988     $ 61,845,988     $ 75,721,663     $ 75,721,663  

Federal funds sold

Level 2

    14,505,000       14,505,000       30,197,000       30,197,000  

Interest-bearing deposits at financial institutions

Level 2

    45,051,555       45,051,555       55,765,012       55,765,012  

Investment securities:

                                 

HTM

Level 2

    378,584,337       375,792,683       379,474,205       379,749,804  

AFS

See Previous Table

    259,644,940       259,644,940       272,907,907       272,907,907  

Loans/leases receivable, net

Level 3

    5,152,556       5,564,760       8,307,719       8,972,337  

Loans/leases receivable, net

Level 2

    3,013,217,281       2,948,650,000       2,921,821,953       2,892,963,000  

Interest rate caps

Level 2

    657,178       657,178       506,700       506,700  

Interest rate swaps - assets

Level 2

    4,500,318       4,500,318       4,397,238       4,397,238  

Deposits:

                                 

Nonmaturity deposits

Level 2

    2,603,999,039       2,603,999,039       2,670,583,178       2,670,583,178  

Time deposits

Level 2

    676,002,453       670,297,000       596,071,878       591,772,000  

Short-term borrowings

Level 2

    16,859,753       16,859,753       13,993,122       13,993,122  

FHLB advances

Level 2

    216,345,000       216,397,000       192,000,000       192,115,000  

Other borrowings

Level 2

    64,062,500       64,583,000       66,000,000       66,520,000  

Junior subordinated debentures

Level 2

    37,534,402       29,318,931       37,486,487       29,253,624  

Interest rate swaps - liabilities

Level 2

    4,500,318       4,500,318       4,397,238       4,397,238  

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

 

NOTE 6 – BUSINESS SEGMENT INFORMATION

 

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

 

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

 

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

 

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

 

Selected financial information on the Company’s business segments is presented as follows as of and for the three months ended March 31, 2018 and 2017.

 

   

Commercial Banking

   

Wealth

           

Intercompany

   

Consolidated

 
   

QCBT

   

CRBT

   

CSB

   

RB&T

   

Management

   

All Other

   

Eliminations

   

Total

 

Three Months Ended March 31, 2018

                                                               

Total revenue

  $ 15,807,570     $ 15,997,332     $ 8,163,323     $ 4,997,945     $ 3,189,425     $ 12,532,043     $ (12,599,893 )   $ 48,087,745  

Net interest income

    12,120,302       10,835,848       6,743,947       3,465,154       -       (762,333 )     -       32,402,918  

Provision

    1,120,409       601,828       575,602       242,000       -       -       -       2,539,839  

Net income

    4,457,868       4,616,528       1,868,588       741,295       770,865       10,514,510       (12,419,693 )     10,549,961  

Goodwill

    3,222,688       15,223,179       9,888,225       -       -       -       -       28,334,092  

Core deposit intangible

    -       3,566,728       5,207,674       -       -       -       -       8,774,402  

Total assets

    1,526,829,646       1,331,208,620       696,978,705       468,112,032       -       447,591,932       (444,406,521 )     4,026,314,414  
                                                                 

Three Months Ended March 31, 2017

                                                               

Total revenue

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

Net interest income

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

Provision

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

Net income

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

Goodwill

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

Core deposit intangible

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

Total assets

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

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

 

NOTE 7 – REGULATORY CAPITAL REQUIREMENTS

 

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

 

Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the subsidiary banks must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the subsidiary banks to maintain minimum amounts and ratios (set forth in the following table) of total common equity Tier 1 and Tier 1 capital to risk-weighted assets and of Tier 1 capital to average assets, each as defined by regulation. Management believes, as of March 31, 2018 and December 31, 2017, that the Company and the subsidiary banks met all capital adequacy requirements to which they are subject.

 

Under the regulatory framework for prompt corrective action, to be categorized as “well capitalized,” an institution must maintain minimum total risk-based, Tier 1 risk-based, Tier 1 leverage and common equity Tier 1 ratios as set forth in the following tables. The Company and the subsidiary banks’ actual capital amounts and ratios as of March 31, 2018 and December 31, 2017 are presented in the following table (dollars in thousands). As of March 31, 2018 and December 31, 2017, each of the subsidiary banks met the requirements to be “well capitalized”.

 

                                   

For Capital

   

To Be Well

 
                                   

Adequacy Purposes

   

Capitalized Under

 
                   

For Capital

   

With Capital

   

Prompt Corrective

 
   

Actual

   

Adequacy Purposes

   

Conservation Buffer*

   

Action Provisions

 
   

Amount

   

Ratio

   

Amount

 

Ratio

   

Amount

 

Ratio

   

Amount

 

Ratio

 

As of March 31, 2018:

                                                               

Company:

                                                               

Total risk-based capital

  $ 395,160       11.25 %   $ 281,109  

>

  8.00 %   $ 346,994  

>

  9.875 %   $ 351,386  

>

  10.00 %

Tier 1 risk-based capital

    358,627       10.21 %     210,832  

>

  6.00       276,717  

>

  7.875       281,109  

>

  8.00  

Tier 1 leverage

    358,627       9.08 %     157,993  

>

  4.00       157,993  

>

  4.000       197,491  

>

  5.00  

Common equity Tier 1

    321,093       9.14 %     158,124  

>

  4.50       224,009  

>

  6.375       228,401  

>

  6.50  

Quad City Bank & Trust:

                                                               

Total risk-based capital

  $ 160,996       12.32 %   $ 104,544  

>

  8.00 %   $ 129,047  

>

  9.875 %   $ 130,680  

>

  10.00 %

Tier 1 risk-based capital

    147,618       11.30 %     78,408  

>

  6.00       102,911  

>

  7.875       104,544  

>

  8.00  

Tier 1 leverage

    147,618       9.63 %     61,343  

>

  4.00       61,343  

>

  4.000       76,678  

>

  5.00  

Common equity Tier 1

    147,618       11.30 %     58,806  

>

  4.50       83,309  

>

  6.375       84,942  

>

  6.50  

Cedar Rapids Bank & Trust:

                                                               

Total risk-based capital

  $ 142,034       11.96 %   $ 94,998  

>

  8.00 %   $ 117,264  

>

  9.875 %   $ 118,748  

>

  10.00 %

Tier 1 risk-based capital

    129,507       10.91 %     71,249  

>

  6.00       93,514  

>

  7.875       94,998  

>

  8.00  

Tier 1 leverage

    129,507       9.87 %     52,483  

>

  4.00       52,483  

>

  4.000       65,603  

>

  5.00  

Common equity Tier 1

    129,507       10.91 %     53,437  

>

  4.50       75,702  

>

  6.375       77,186  

>

  6.50  

Community State Bank:

                                                               

Total risk-based capital

  $ 67,996       11.39 %   $ 47,738  

>

  8.00 %   $ 58,926  

>

  9.875 %   $ 59,672  

>

  10.00 %

Tier 1 risk-based capital

    63,105       10.58 %     35,803  

>

  6.00       46,992  

>

  7.875       47,738  

>

  8.00  

Tier 1 leverage

    63,105       9.35 %     27,010  

>

  4.00       27,010  

>

  4.000       33,763  

>

  5.00  

Common equity Tier 1

    63,105       10.58 %     26,853  

>

  4.50       38,041  

>

  6.375       38,787  

>

  6.50  

Rockford Bank & Trust:

                                                               

Total risk-based capital

  $ 46,567       11.07 %   $ 33,644  

>

  8.00 %   $ 41,530  

>

  9.875 %   $ 42,055  

>

  10.00 %

Tier 1 risk-based capital

    41,305       9.82 %     25,233  

>

  6.00       33,119  

>

  7.875       33,644  

>

  8.00  

Tier 1 leverage

    41,305       8.93 %     18,498  

>

  4.00       18,498  

>

  4.000       23,123  

>

  5.00  

Common equity Tier 1

    41,305       9.82 %     18,925  

>

  4.50       26,810  

>

  6.375       27,336  

>

  6.50  

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

                                   

For Capital

   

To Be Well

 
                                   

Adequacy Purposes

   

Capitalized Under

 
                   

For Capital

   

With Capital

   

Prompt Corrective

 
   

Actual

   

Adequacy Purposes

   

Conservation Buffer*

   

Action Provisions

 
   

Amount

   

Ratio

   

Amount

 

Ratio

   

Amount

 

Ratio

   

Amount

 

Ratio

 

As of December 31, 2017:

                                                               

Company:

                                                               

Total risk-based capital

  $ 383,282       11.15 %   $ 275,090  

>

  8.00 %   $ 318,073  

>

  9.25 %   $ 343,862  

>

  10.00 %

Tier 1 risk-based capital

    348,530       10.14 %     206,317  

>

  6.00       249,300  

>

  7.25       275,090  

>

  8.00  

Tier 1 leverage

    348,530       8.98 %     155,256  

>

  4.00       155,256  

>

  4.00       194,070  

>

  5.00  

Common equity Tier 1

    313,012       9.10 %     154,738  

>

  4.50       197,721  

>

  5.75       223,510  

>

  6.50  

Quad City Bank & Trust:

                                                               

Total risk-based capital

  $ 160,112       12.35 %   $ 103,711  

>

  8.00 %   $ 119,916  

>

  9.25 %   $ 129,639  

>

  10.00 %

Tier 1 risk-based capital

    147,472       11.38 %     77,783  

>

  6.00       93,988  

>

  7.25       103,711  

>

  8.00  

Tier 1 leverage

    147,472       9.52 %     61,985  

>

  4.00       61,985  

>

  4.00       77,481  

>

  5.00  

Common equity Tier 1

    147,472       11.38 %     58,337  

>

  4.50       74,542  

>

  5.75       84,265  

>

  6.50  

Cedar Rapids Bank & Trust:

                                                               

Total risk-based capital

  $ 138,492       11.88 %   $ 93,272  

>

  8.00 %   $ 107,846  

>

  9.25 %   $ 116,590  

>

  10.00 %

Tier 1 risk-based capital

    126,601       10.86 %     69,954  

>

  6.00       84,528  

>

  7.25       93,272  

>

  8.00  

Tier 1 leverage

    126,601       11.68 %     43,348  

>

  4.00       43,348  

>

  4.00       54,185  

>

  5.00  

Common equity Tier 1

    126,601       10.86 %     52,465  

>

  4.50       67,039  

>

  5.75       75,783  

>

  6.50  

Community State Bank:

                                                               

Total risk-based capital

  $ 66,271       11.71 %   $ 45,293  

>

  8.00 %   $ 52,370  

>

  9.25 %   $ 56,616  

>

  10.00 %

Tier 1 risk-based capital

    61,941       10.94 %     33,970  

>

  6.00       41,047  

>

  7.25       45,293  

>

  8.00  

Tier 1 leverage

    61,941       9.77 %     25,354  

>

  4.00       25,354  

>

  4.00       31,693  

>

  5.00  

Common equity Tier 1

    61,941       10.94 %     25,477  

>

  4.50       32,554  

>

  5.75       36,801  

>

  6.50  

Rockford Bank & Trust:

                                                               

Total risk-based capital

  $ 45,684       11.28 %   $ 32,413  

>

  8.00 %   $ 37,477  

>

  9.25 %   $ 40,516  

>

  10.00 %

Tier 1 risk-based capital

    40,615       10.02 %     24,310  

>

  6.00       29,374  

>

  7.25       32,413  

>

  8.00  

Tier 1 leverage

    40,615       8.94 %     18,177  

>

  4.00       18,177  

>

  4.00       22,721  

>

  5.00  

Common equity Tier 1

    40,615       10.02 %     18,232  

>

  4.50       23,297  

>

  5.75       26,335  

>

  6.50  

 

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

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

 

NOTE 8 – REVENUE RECOGNITION

 

As of January 1, 2018, the Company adopted ASU 2014-09 using the modified retrospective approach. The adoption of the guidance had no material impact on the measurement or recognition of revenue as approximately 89% of the Company’s revenue (based on 2017 audited financial results) is outside the scope of this guidance; however, additional disclosures have been added in accordance with the ASU. See Note 1 for additional information on this new accounting standard.

Descriptions of our revenue-generating contracts with customers that are within the scope of ASU 2014-09, which are presented in our income statements as components of non-interest income are as follows:

 

Trust department and Investment advisory and management fees: This is a contract between the Company and its customers for fiduciary and/or investment administration services on trust and brokerage accounts. Trust services and brokerage fee income is determined as a percentage of assets under management and is recognized over the period the underlying trust account is serviced. Such contracts are generally cancellable at any time, with the customer subject to a pro-rated fee in the month of termination.

 

Deposit service fees: The deposit contract obligates the Company to serve as a custodian of the customer’s deposited funds and is generally terminable at will by either party. The contract permits the customer to access the funds on deposit and request additional services related to the deposit account. Deposit account related fees, including analysis charges, overdraft/nonsufficient fund charges, service charges, debit card usage fees, overdraft fees and wire transfer fees are within the scope of the guidance; however, revenue recognition practices did not change under the guidance, as deposit agreements are considered day-to-day contracts. Income for deposit accounts is recognized over the statement cycle period (typically on a monthly basis) or at the time the service is provided, if additional services are requested.

 

 

Correspondent banking fees: A contract between the Company and its correspondent banks for corresponding banking services. This line of business provides a strong source of noninterest bearing and interest bearing deposits, fee income, high-quality loan participations and bank stock loans. Correspondent banking fee income is tied to transaction activity and revenue is recognized monthly as earned for services provided.

 

 

Part I

Item 1

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

 

 

NOTE 9 –ACQUISITIONS

 

BATES COMPANIES

 

On March 20, 2018 the Company announced the signing of definitive agreements to acquire the Bates Companies, headquartered in Rockford, Illinois. The acquisition and subsequent merger of the Bates Companies into RB&T will enhance the wealth management services of RB&T by adding approximately $700.0 million of assets under management.

 

In the acquisition, the Company will acquire 100% of the Bates Companies’ outstanding common stock for an aggregate consideration of $3.0 million cash and up to $3.0 million of the Company’s common stock. In a private placement exempt from registration with the SEC, the Company expects to issue upon closing of the transaction approximately 21,528 common shares or $1.0 million of Company stock. Assuming all future performance based contingent consideration is realized total stock consideration can reach $3.0 million, which would result in the Company expecting to issue approximately 64,583 common shares based on closing stock price at the date of announcement.

 

This transaction is subject to regulatory approval and certain closing conditions. The transaction is expected to close late in second quarter or early third quarter of 2018. 

 

SPRINGFIELD BANCSHARES, INC.

 

On April 18, 2018, the Company announced the signing of a definitive agreement to purchase 100% of the outstanding common stock of Springfield Bancshares, the holding company of SFC Bank, headquartered in Springfield, Missouri. The Company will continue to operate SFC Bank, retaining its separate charter and brand within the Springfield, Missouri market. SFC Bank has one banking location and approximately $563.2 million in assets and $446.5 million in deposits as of March 31, 2018.

 

In the acquisition, the stockholders of Springfield Bancshares will receive 0.3060 shares of the Company’s common stock and $1.50 in cash in exchange for each common share of Springfield Bancshares held. Based upon the closing price of the Company’s common stock as of April 16, 2018, the transaction is valued at approximately $86.7 million.

 

This transaction is subject to regulatory approvals, approval by Springfield Bancshares’ stockholders and certain customary closing conditions. The transaction is expected to close in the third quarter of 2018.

 

 

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 as of and for the three months ending March 31, 2018. Some tables may include additional periods to comply with disclosure requirements or to illustrate trends. When reading this discussion, also refer to the Consolidated Financial Statements and related notes in this report. The page locations and specific sections and notes that are referred to are presented in the table of contents.

 

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

 

GENERAL

 

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


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

 

 

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

 

 

CRBT commenced operations in 2001 and provides full-service commercial and consumer banking, and trust and asset management services to Cedar Rapids, Iowa and adjacent communities through its five offices located in Cedar Rapids and Marion, Iowa. 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 by QCR in 2016, as further described in Note 2 to the Consolidated Financial Statements included in the Annual Report on Form 10-K for the year ended December 31, 2017. CSB provides full-service commercial and consumer banking to the Des Moines, Iowa area and adjacent communities through its 10 offices, including its main office located on North Ankeny Boulevard in Ankeny, Iowa.

 

 

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.

 

34

 

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 $10.5 million and diluted EPS of $0.74 for the quarter ended March 31, 2018. By comparison, for the quarter ended December 31, 2017, the Company reported net income of $9.9 million and diluted EPS of $0.70. For the quarter ended March 31, 2017, the Company reported net income of $9.2 million and diluted EPS of $0.68.

 

The first quarter of 2018 was highlighted by several significant items:

 

 

Annualized net interest income growth of 7.5%;

 

Annualized loan and lease growth of 12.2% ;

 

Annualized wealth management revenue growth of 10.8%;

 

Swap fee income and gains on the sale of government guaranteed loans of $1.3 million; and

 

A definitive agreement to enter the Springfield, Missouri market by merging with Springfield Bancshares.

 

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

 

   

For the three months ended

 
   

March 31, 2018

   

December 31, 2017

   

March 31, 2017

 
                         

Net income

  $ 10,549,961     $ 9,901,590     $ 9,184,965  
                         

Diluted earnings per common share

  $ 0.74     $ 0.70     $ 0.68  
                         
                         

Weighted average common and common equivalent shares outstanding

    14,205,584       14,193,191       13,488,417  

 

The increase in weighted average common shares outstanding when comparing the three months ended March 31, 2018 and December 31, 2017 to March 31, 2017 was primarily due to the common stock issued to Guaranty as consideration for the acquisition of Guaranty Bank.

 

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

 

   

For the three months ended

 
   

March 31, 2018

   

December 31, 2017

   

March 31, 2017

 
                         

Net interest income

  $ 32,402,918     $ 31,793,353     $ 27,668,883  

Provision expense

    2,539,839       2,255,381       2,105,109  

Noninterest income

    8,541,449       9,714,717       7,283,754  

Noninterest expense

    25,863,497       31,351,204       21,273,117  

Federal and state income tax expense (benefit)

    1,991,070       (2,000,105 )     2,389,446  

Net income

  $ 10,549,961     $ 9,901,590     $ 9,184,965  

 

35

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

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

 

 

Net interest income in the first quarter of 2018 was up 2% compared to the fourth quarter of 2017 and up 17% compared to the first quarter of 2017 due to strong loan and lease growth and the acquisition of Guaranty Bank.

 

 

Provision expense in the first quarter of 2018 increased 13% compared to the fourth quarter of 2017 and 21% from the same period of 2017 and was attributable to both strong loan growth and accounting for acquired loans. As acquired loans renew, the discount associated with those loans is eliminated and the Company must establish an allowance.

 

 

Noninterest income in the first quarter of 2018 decreased 12% compared to the fourth quarter of 2017, primarily due to lower swap fee income. Noninterest income in the first quarter of 2018 increased 17% from the first quarter of 2017, which was primarily attributable to higher swap fee income, as well as solid growth in wealth management fee income.

 

 

Noninterest expense decreased 18% from the fourth quarter of 2017. The fourth quarter of 2017 included $4.4 million of non-recurring costs related to the acquisition of Guaranty Bank and a core processor termination fee related to CSB. Noninterest expense increased 22% from the first quarter of 2017 primarily due to the acquisition of Guaranty Bank.

 

 

Federal and state income tax expense in the first quarter of 2018 increased significantly compared to the fourth quarter of 2017. The fourth quarter of 2017 included a one-time tax benefit of $2.9 million as a result of the Tax Act. Federal and state income tax expense in the first quarter of 2018 decreased 17% compared to the first quarter of 2017 primarily due to a lower federal tax rate. See the Income Taxes section of this report for additional details.

 

 

LONG-TERM FINANCIAL GOALS

 

As previously stated, the Company has established certain financial goals by which it manages its business and measures its performance. The goals are periodically updated to reflect changes in business developments. While the Company is determined to work prudently to achieve these goals, there is no assurance that they will be met. Moreover, the Company’s ability to achieve these goals will be affected by the factors discussed under “Forward Looking Statements” as well as the factors detailed in the “Risk Factors” section included under Item 1A. of Part I of the Company’s Annual Report on Form 10-K for the year ended December 31, 2017. The Company’s long-term financial goals are as follows:

 

 

Improve balance sheet efficiency by maintaining a gross loans and leases to total assets ratio in the range of 73 – 78%;

 

 

Improve profitability (measured by NIM and ROAA);

 

 

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

 

 

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

 

36

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

 

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

 

 

Continue to focus on generating 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**

March 31, 2018

December 31, 2017

March 31, 2017

Balance sheet efficiency

Gross loans and leases to total assets

73 - 78%

76%

74%

72%

 

NIM(TEY)(non-GAAP)*

> 3.65%

3.64%

3.69%

3.90%

Profitability

ROAA

> 1.10%

1.06%

1.01%

1.12%

 

Core ROAA (non-GAAP)*

 

1.06%

1.01%

1.12%

 

NPAs to total assets

< 0.75%

0.77%

0.81%

0.81%

Asset quality

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

< 0.25% annually

0.05%

0.19%

0.13%

Reliance on wholesale funding

Wholesale funding to total assets****

< 15%

14%

10%

9%

Funding mix

Noninterest bearing deposits as a percentage of total assets

> 30%

19%

20%

23%

Consistent, high quality noninterest income revenue streams

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

> $4 million annually

$5.3 million

$4.3 million

$4.3 million

 

Grow wealth management segment net income***

> 10% annually

37%

35%

25%

 

 

See GAAP to Non-GAAP reconciliations.

  ** 

Targets will be re-evaluated and adjusted as appropriate.

  *** 

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

  **** 

Wholesale funding to total assets is calculated by dividing total borrowings and brokered deposits by total assets.

 

STRATEGIC DEVELOPMENTS

 

The Company took the following actions during the first quarter of 2018 to support its corporate strategy and the long-term financial goals shown above.

 

 

The Company grew loans and leases in the first three months of 2018 by 12.2% on an annualized basis. This growth exceeded the targeted organic growth of 10-12% for the full year. Strong loan and lease growth for the remainder of the year will help keep the Company’s loan and leases to asset ratio within the targeted range of 73-78%.

 

 

The Company has participated, and intends to continue to participate, in a prudent manner as an acquirer in the consolidation taking place in our markets to continue to grow EPS, further boost ROAA and improve the Company’s efficiency ratio. The Company announced in March 2018 the signing of definitive agreements to acquire and merge the Bates Companies into RB&T. The Company announced in April 2018 the signing of a definitive agreement to acquire Springfield Bancshares. See Note 9 to the Consolidated Financial Statements for additional details about these strategic transactions.

 

37

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

 

The Company has continued to focus on lowering the NPAs to total assets ratio. This ratio decreased by four basis points to 0.77%, as compared to the fourth quarter 2017. The Company remains committed to improving asset quality ratios in 2018 and beyond.

 

 

Management has continued to focus on reducing the Company’s reliance on wholesale funding. Wholesale funding increased in the first quarter 2018 due to the strong loan and lease growth which outpaced the Company’s deposit growth. All increases to wholesale funding were short-term in nature. Management continues to prioritize core deposit growth through a variety of strategies including growth in correspondent banking.

 

 

Correspondent banking has continued to be a core line of business for the Company. The Company is competitively positioned with experienced staff, software systems and processes to continue growing in the three states currently served – Iowa, Illinois and Wisconsin and to expand into the Missouri market. The Company acts as the correspondent bank for 192 downstream banks with average total noninterest bearing deposits of $220.9 million and average total interest bearing deposits of $206.1 million during the first quarter of 2018. The Company acted as the correspondent bank for 183 downstream banks with average total noninterest bearing deposits of correspondents of $320.7 million during the first quarter of 2017. This line of business provides a strong source of noninterest bearing and interest bearing deposits, fee income, high-quality loan participations and bank stock loans.

 

 

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

 

 

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

 

 

Wealth management is another core line of business for the Company and includes a full range of products, including trust services, brokerage and investment advisory services, asset management, estate planning and financial planning. As of March 31, 2018, the Company had $2.65 billion of total financial assets in trust (and related) accounts and $1.05 billion of total financial assets in brokerage (and related) accounts. Continued growth in assets under management will help drive trust and investment advisory fees. The Company offers trust and investment advisory services to the correspondent banks that it serves. As management continues to focus on growing wealth management fee income, expanding market share will continue to be a primary strategy, both through organic growth as well as the acquisition of managed assets. The Company announced in March 2018 the signing of definitive agreements to acquire and merge the Bates Companies into RB&T. The acquisition and subsequent merger of the Bates Companies into RB&T will add approximately $700 million of assets under management.

 

38

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

GAAP TO NON-GAAP RECONCILIATIONS

 

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

 

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

The efficiency ratio is a ratio that management utilizes to compare the Company to peers. It is a standard ratio in the banking industry and widely utilized by investors.

 

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

 

39

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

   

As of

 
   

March 31,

   

December 31,

   

September 30,

   

June 30,

   

March 31,

 

GAAP TO NON-GAAP RECONCILIATIONS

 

2018

   

2017

   

2017

   

2017

   

2017

 
   

(dollars in thousands, except per share data)

 

TCE / TA RATIO

                                       
                                         

Stockholders' equity (GAAP)

  $ 360,428     $ 353,287     $ 313,039     $ 305,083     $ 295,840  

Less: Intangible assets

    37,108       37,413       19,800       20,030       20,261  

TCE (non-GAAP)

  $ 323,320     $ 315,874     $ 293,239     $ 285,053     $ 275,579  
                                         

Total assets (GAAP)

  $ 4,026,314     $ 3,982,665     $ 3,550,463     $ 3,457,187     $ 3,381,013  

Less: Intangible assets

    37,108       37,413       19,800       20,030       20,261  

TA (non-GAAP)

  $ 3,989,206     $ 3,945,252     $ 3,530,663     $ 3,437,157     $ 3,360,752  
                                         

TCE / TA ratio (non-GAAP)

    8.10 %     8.01 %     8.31 %     8.29 %     8.20 %

 

   

For the Quarter Ended

 
   

March 31,

   

December 31,

   

September 30,

   

June 30,

   

March 31,

 

CORE NET INCOME

 

2018

   

2017

   

2017

   

2017

   

2017

 
                                         

Net income (GAAP)

  $ 10,550     $ 9,902     $ 7,854     $ 8,766     $ 9,185  
                                         

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

                                       

Income:

                                       

Securities gains, net

  $ -     $ (41 )   $ (41 )   $ 25     $ -  

Total nonrecurring income (non-GAAP)

  $ -     $ (41 )   $ (41 )   $ 25     $ -  
                                         

Expense:

                                       

Acquisition costs

  $ 73     $ 430     $ 265     $ -     $ -  

Post-acquisition compensation, transition and integration costs

    -       2,462       340       -       -  

Total nonrecurring expense (non-GAAP)

  $ 73     $ 2,892     $ 605     $ -     $ -  
                                         
                                         

Adjustment of tax expense related to the Tax Act

  $ -     $ 2,919     $ -     $ -     $ -  
                                         

Core net income (non-GAAP)

  $ 10,623     $ 9,916     $ 8,500     $ 8,741     $ 9,185  
                                         
                                         

CORE EPS

                                       
                                         

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

  $ 10,623     $ 9,916     $ 8,500     $ 8,741     $ 9,185  
                                         

Weighted average common shares outstanding

    13,888,661       13,845,497       13,151,350       13,170,283       13,133,382  

Weighted average common and common equivalent shares outstanding

    14,205,584       14,193,191       13,507,955       13,532,324       13,488,417  
                                         

Core EPS (non-GAAP):

                                       

Basic

  $ 0.76     $ 0.72     $ 0.65     $ 0.66     $ 0.70  

Diluted

  $ 0.75     $ 0.70     $ 0.63     $ 0.65     $ 0.68  
                                         
                                         

CORE ROAA

                                       
                                         

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

  $ 10,623     $ 9,916     $ 8,500     $ 8,741     $ 9,185  
                                         

Average Assets

  $ 3,994,691     $ 3,923,337     $ 3,503,148     $ 3,378,195     $ 3,274,713  
                                         

Core ROAA (annualized) (non-GAAP)

    1.06 %     1.01 %     0.97 %     1.03 %     1.12 %

 

 

Nonrecurring items (after-tax) are calculated using an estimated effective tax rate of 35% for periods prior to March 31, 2018 and 21% for periods including and after March 31, 2018.

 

40

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

   

For the Quarter Ended

 
   

March 31,

   

December 31,

   

September 30,

     

June 30,

   

March 31,

 

GAAP TO NON-GAAP RECONCILIATIONS (CONTINUED)

 

2018

   

2017

   

2017

     

2017

   

2017

 
   

(dollars in thousands)

 

NIM (TEY) *

                                         
                                           

Net interest income (GAAP)

  $ 32,403     $ 31,793     $ 28,556       $ 28,047     $ 27,669  
                                           

Plus: Tax equivalent adjustment

    1,353       2,585       2,311         2,201       1,950  
                                           

Net interest income - tax equivalent (Non-GAAP)

  $ 33,756     $ 34,378     $ 30,867       $ 30,248     $ 29,619  
                                           

Average earning assets

  $ 3,759,475     $ 3,699,193     $ 3,303,014       $ 3,180,779     $ 3,076,356  
                                           

NIM (GAAP)

    3.50 %     3.41 %     3.43 %       3.54 %     3.65 %

NIM (TEY) (Non-GAAP)

    3.64 %     3.69 %     3.71 %       3.81 %     3.90 %
                                           

EFFICIENCY RATIO

                                         
                                           

Noninterest expense (GAAP)

  $ 25,863     $ 31,351     $ 23,395       $ 21,405     $ 21,273  
                                           

Net interest income (GAAP)

  $ 32,403     $ 31,793     $ 28,556  

#

  $ 28,047     $ 27,669  

Noninterest income (GAAP)

    8,541       9,714       6,702         6,782       7,284  

Total income

  $ 40,944     $ 41,507     $ 35,258       $ 34,829     $ 34,953  
                                           

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

    63.17 %     75.53 %     66.35 %       61.46 %     60.86 %

 

 

Nonrecurring items (after-tax) are calculated using an estimated effective tax rate of 35% for periods prior to March 31, 2018 and 21% for periods including and after March 31, 2018.

 

 

 

NET INTEREST INCOME - (TAX EQUIVALENT BASIS)

 

As part of the Tax Act, the Company’s federal income tax rate was cut from 35% down to 21% effective January 1, 2018. In order to compare periods before and after the effective date of the Tax Act, it’s important to note the difference in the federal income tax rate and the impact on the Company’s tax exempt earning assets (loans and securities) and the related tax equivalent yield reporting.

 

Net interest income, on a tax equivalent basis, increased 14% to $33.8 million for the quarter ended March 31, 2018, compared to the same quarter of the prior year. Excluding the tax equivalent adjustments, net interest income increased 17% over the same period. Net interest income improved due to several factors:

 

 

Organic loan and lease growth has been strong over the past 12 months pushing loans/leases up to 76% of total assets;

 

The acquisition of Guaranty Bank, whose strong NIM has contributed to the Company’s results; and

 

The Company’s continued strategy to redeploy funds from the lower yielding taxable securities portfolio into higher yielding loans and municipal bonds, especially with the Company’s most recent acquisitions of CSB and Guaranty Bank.

 

41

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

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

 

   

Tax Equivalent Basis

   

GAAP

 
   

For the Quarter Ended

   

For the Quarter Ended

 
   

March 31,

2018

   

December 31,

2017

   

March 31,

2017

   

March 31,

2018

   

December 31,

2017

   

March 31,

2017

 
                                                 

Average Yield on Interest-Earning Assets

    4.41 %     4.34 %     4.39 %     4.27 %     4.06 %     4.13 %

Average Cost of Interest-Bearing Liabilities

    1.03 %     0.88 %     0.69 %     1.03 %     0.88 %     0.69 %

Net Interest Spread

    3.38 %     3.46 %     3.70 %     3.24 %     3.18 %     3.44 %

NIM

    3.64 %     3.69 %     3.90 %     3.50 %     3.41 %     3.65 %

NIM Excluding Acquisition Accounting Net Accretion

    3.56 %     3.61 %     3.65 %     3.42 %     3.33 %     3.39 %

 

NIM on a tax equivalent basis was down five basis points on a linked quarter basis. However, excluding the tax equivalent adjustment, NIM expanded nine basis points on the same linked quarter basis. The Company’s expansion of yield on earning assets outpaced the increased cost of funds. The Company’s success in expanded yields on earning assets is the result of the following:

 

 

Floating rate loans and securities repricing with recent rate hikes,

 

Growing certain niches (loans and securities) that tend to have higher spreads, and

 

Improved pricing on C&I and CRE term loans.

 

Acquisition accounting net accretion can fluctuate depending on the payoff activity of the acquired loans. In evaluating net interest income and NIM, it’s important to understand the impact of acquisition accounting net accretion when comparing periods. The acquisition accounting net accretion was relatively flat on a linked quarter basis; however, the acquisition accounting net accretion in the first quarter of 2017 was significant and totaled approximately $1.9 million which added 25 basis points to NIM for that quarter. The above table reports NIM with and without the acquisition accounting net accretion to allow for more appropriate comparisons.

 

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 NIMs. Management continually addresses this issue with pricing and other balance sheet management strategies.

 

42

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

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

 

   

For the three months ended March 31,

 
   

2018

   

2017

 
           

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

  $ 19,703     $ 56       1.15 %   $ 11,092     $ 15       0.55 %

Interest-bearing deposits at financial institutions

    49,531       197       1.61 %     92,551       199       0.87 %

Investment securities (1)

    649,035       5,839       3.65 %     560,455       5,158       3.73 %

Restricted investment securities

    21,830       234       4.35 %     13,871       130       3.80 %

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

    3,019,376       34,573       4.64 %     2,398,387       27,793       4.70 %
                                                 

Total interest earning assets

  $ 3,759,475     $ 40,899       4.41 %   $ 3,076,356     $ 33,295       4.39 %
                                                 

Noninterest-earning assets:

                                               

Cash and due from banks

  $ 67,224                     $ 65,291                  

Premises and equipment

    63,394                       60,977                  

Less allowance

    (35,136 )                     (31,498 )                

Other

    139,734                       103,587                  
                                                 

Total assets

  $ 3,994,691                     $ 3,274,713                  
                                                 

LIABILITIES AND STOCKHOLDERS' EQUITY

                                               

Interest-bearing liabilities:

                                               

Interest-bearing deposits

  $ 1,828,228       3,019       0.67 %   $ 1,407,645       1,140       0.33 %

Time deposits

    616,661       1,862       1.22 %     511,119       1,093       0.87 %

Short-term borrowings

    17,271       33       0.77 %     25,188       24       0.39 %

FHLB advances

    236,689       1,064       1.82 %     114,356       403       1.43 %

Other borrowings

    64,680       718       4.50 %     74,761       683       3.71 %

Junior subordinated debentures

    37,510       447       4.83 %     33,497       333       4.03 %
                                                 

Total interest-bearing liabilities

  $ 2,801,039     $ 7,143       1.03 %   $ 2,166,566     $ 3,676       0.69 %
                                                 

Noninterest-bearing demand deposits

  $ 794,673                     $ 773,245                  

Other noninterest-bearing liabilities

    42,454                       43,996                  

Total liabilities

  $ 3,638,166                     $ 2,983,807                  
                                                 

Stockholders' equity

    356,525                       290,906                  
                                                 

Total liabilities and stockholders' equity

  $ 3,994,691                     $ 3,274,713                  
                                                 

Net interest income

          $ 33,756                     $ 29,619          
                                                 

Net interest spread

                    3.38 %                     3.70 %
                                                 

Net interest margin

                    3.64 %                     3.90 %
                                                 

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

    134.22 %                     141.99 %                

 

(1)

Interest earned and yields on nontaxable investment securities and nontaxable loans are determined on a tax equivalent basis using a 35% tax rate for periods prior to March 31, 2018 and 21% for periods including and after March 31, 2018.

(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.

 

43

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

Analysis of Changes of Interest Income/Interest Expense

For the three months ended March 31, 2018

 

   

Inc./(Dec.)

   

Components

 
   

from

   

of Change (1)

 
   

December 31, 2017

   

Rate

   

Volume

 
   

(dollars in thousands)

 

INTEREST INCOME

                       

Federal funds sold

  $ 41     $ 24     $ 17  

Interest-bearing deposits at financial institutions

    (2 )     484       (486 )

Investment securities (2)

    681       (738 )     1,419  

Restricted investment securities

    104       21       83  

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

    6,780       (2,266 )     9,046  
                         

Total change in interest income

  $ 7,604     $ (2,475 )   $ 10,079  
                         

INTEREST EXPENSE

                       

Interest-bearing deposits

  $ 1,879     $ 1,459     $ 420  

Time deposits

    769       512       257  

Short-term borrowings

    9       54       (45 )

Federal Home Loan Bank advances

    661       135       526  

Other borrowings

    35       481       (446 )

Junior subordinated debentures

    114       71       43  
                         

Total change in interest expense

  $ 3,467     $ 2,712     $ 755  
                         

Total change in net interest income

  $ 4,137     $ (5,187 )   $ 9,324  

 

(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 for periods prior to March 31, 2018 and 21% for periods including and after March 31, 2018.

(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.

 

44

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

CRITICAL ACCOUNTING POLICIES

 

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

 

ALLOWANCE FOR LOAN AND LEASE LOSSES

 

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

 

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

 

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

 

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

 

Although management believes the level of the allowance as of March 31, 2018 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.

 

RESULTS OF OPERATIONS

 

INTEREST INCOME

 

Interest income increased 26%, comparing the first quarter of 2018 to the same period of 2017. This increase was primarily the result of strong organic loan growth and the acquisition of Guaranty Bank.

 

Overall, the Company’s average earning assets increased 22%, comparing the first quarter of 2018 to the first quarter of 2017. During the same time period, average gross loans and leases increased 26%, while average investment securities increased 16% with a portion being private placement tax-exempt municipal securities. These increases were also the result of the acquisition of Guaranty Bank.

 

45

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

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

 

INTEREST EXPENSE

 

Interest expense for the first quarter of 2018 increased 94% from the first quarter of 2017. The acquisition of Guaranty Bank contributed to this increase. Additionally, the Company has rate sensitive deposits with select major customers that have repriced with the increase in certain market interest rates. With strong loan growth outpacing deposit growth in the first quarter of 2018, short-term borrowings increased and the cost of these funds have increased with the rising rate environment.

 

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.

 

PROVISION FOR LOAN/LEASE LOSSES

 

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

 

The Company’s provision totaled $2.5 million for the first quarter of 2018, which was an increase of $435 thousand or 21% from the same quarter of the prior year. The increase from the first quarter of 2017 to the first quarter of 2018 was primarily attributable to loan growth and the accounting for the loans acquired through the acquisitions of CSB and Guaranty Bank. As acquired loans renew, the discount associated with those loans is eliminated and the Company must establish an allowance through provision. This provision, when coupled with net charge-offs of $363 thousand for the first three months of 2018, increased the Company’s allowance to $36.5 million at March 31, 2018. As of March 31, 2018, the Company’s allowance to total loans/leases was 1.20%, which has increased from 1.16% at December 31, 2017 and decreased from 1.32% at March 31, 2017.

 

In accordance with GAAP for business combination accounting, acquired loans are recorded at fair value; therefore, no allowance is associated with such loans at acquisition. Management continues to evaluate the allowance needed on acquired loans factoring in the net remaining discount ($7.3 million and $8.0 million at March 31, 2018 and March 31, 2017, respectively). 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 1.20% to 1.43% as of March 31, 2018 and increases from 1.32% to 1.64% as of March 31, 2017.

 

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

 

46

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

NONINTEREST INCOME

 

The following tables set forth the various categories of noninterest income for the three months ended March 31, 2018 and 2017.

 

   

Three Months Ended

                 
   

March 31,

2018

   

March 31,

2017

   

$ Change

   

% Change

 
                                 

Trust department fees

  $ 2,237,081     $ 1,740,207     $ 496,874       28.6

%

Investment advisory and management fees

    952,344       961,599       (9,255 )     (1.0 )

Deposit service fees

    1,531,453       1,316,390       215,063       16.3  

Gains on sales of residential real estate loans, net

    100,815       96,323       4,492       4.7  

Gains on sales of government guaranteed portions of loans, net

    358,434       950,641       (592,207 )     (62.3 )

Swap fee income

    958,694       113,520       845,174       744.5  

Earnings on bank-owned life insurance

    417,987       469,687       (51,700 )     (11.0 )

Debit card fees

    766,108       702,801       63,307       9.0  

Correspondent banking fees

    264,827       245,189       19,638       8.0  

Other

    953,706       687,397       266,309       38.7  

Total noninterest income

  $ 8,541,449     $ 7,283,754     $ 1,257,695       17.3

%

 

 

In recent years, the Company has been successful in expanding its wealth management customer base. Trust department fees continue to be a significant contributor to noninterest income and, due to favorable market conditions in early 2018 coupled with strong growth in assets under management, trust department fees increased 29%, comparing the first quarter of 2018 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 started offering trust operations services to correspondent banks. Investment advisory and management fees decreased 1%, comparing the first quarter of 2018 to the same period of the prior year.

 

Management has placed a stronger emphasis on growing its investment advisory and management services. Part of this initiative has been to restructure the Company’s Wealth Management Division to allow for more efficient delivery of products and services through selective additions of talent as well as the 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. The Company announced in March 2018 the signing of definitive agreements to acquire and merge the Bates Companies into RB&T. The acquisition and subsequent merger of the Bates Companies into RB&T will add approximately $700 million of assets under management.

 

Deposit service fees expanded 16% comparing the first quarter of 2018 to the same period of the prior year. This increase was primarily the result of the growth in deposits due to the acquisition of Guaranty Bank. 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 continuing shift in mix, the Company has increased the number of demand deposit accounts, which tend to be lower in interest cost and higher in service fees. The Company plans to continue this shift in mix and to further focus on growing deposit service fees.

 

47

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

Gains on sales of residential real estate loans increased 5% when comparing the first quarter of 2018 to the same period of the prior year. Overall, with the continued 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 generally become a smaller contributor to overall noninterest income.

 

The Company’s gains on the sale of government-guaranteed portions of loans for the first quarter of 2018 decreased 62% compared to the first quarter of 2017. Given the nature of these gains, large fluctuations can occur from quarter-to-quarter and year-to-year. 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. In the past several years, 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.

 

As a result of the continued relatively low interest rate environment including a flat yield curve, the Company was able to execute numerous interest rate swaps on select commercial loans over the past several years. The interest rate swaps allow the commercial borrowers to pay a fixed interest rate while the Company receives a variable interest rate as well as an upfront fee dependent upon the pricing. Management believes that these swaps help position the Company more favorably for rising rate environments. Management will continue to review opportunities to execute these swaps at all of its subsidiary banks, as the circumstances are appropriate for the borrower and the Company. An optimal interest rate swap candidate must be of a certain size and sophistication which can lead to volatility in activity from quarter to quarter. Swap fee income totaled $959 thousand for the first quarter of 2018, compared to $114 thousand for the first quarter of 2017. Future levels of swap fee income are also dependent upon prevailing interest rates.

 

Earnings on BOLI decreased 11% comparing the first quarter of 2018 to the first quarter of 2017. There were no purchases of BOLI within the last 12 months. Notably, a small portion of the Company’s BOLI is variable rate whereby the returns are determined by the performance of the equity market. Equity market performance accounted for the majority of the volatility. Management intends to continue to review its BOLI investments to be consistent with policy and regulatory limits in conjunction with the rest of its earning assets in an effort to maximize returns while minimizing risk.

 

Debit card fees are the interchange fees paid on certain debit card customer transactions. Debit card fees increased 9% comparing the first quarter of 2018 to the first quarter of the prior year. This increase was primarily related to the acquisition of Guaranty Bank in the fourth quarter of 2017. These fees can vary based on customer debit card usage, so fluctuations from period to period may occur. As an opportunity to maximize fees, the Company offers a retail deposit product with a higher interest rate that incentivizes debit card activity, which has been taken advantage of by the Company's customers.

 

Correspondent banking fees increased 8% comparing the first quarter of 2018 to the first quarter of the prior year. Management will continue to evaluate earnings credit rates and the resulting impact on deposit balances and fees while balancing the ability to grow market share. Correspondent banking continues to be a core strategy for the Company, as this line of business provides a high level of deposits that can be used to fund loan growth as well as a steady source of fee income. The Company now serves approximately 192 banks in Iowa, Illinois and Wisconsin.

 

48

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

Other noninterest income increased 39% comparing the first quarter of 2018 to the first quarter of the prior year. The primary reason for the increase was gain on disposal of leased assets which totaled $106 thousand in the first quarter of 2018 as compared to $2 thousand in the first quarter of 2017.

 

 

NONINTEREST EXPENSE

 

The following tables set forth the various categories of noninterest expense for the three months ended March 31, 2018 and 2017.

 

   

Three Months Ended

                 
   

March 31,

2018

   

March 31,

2017

   

$ Change

   

% Change

 
                                 

Salaries and employee benefits

  $ 15,977,975     $ 13,307,331     $ 2,670,644       20.1

%

Occupancy and equipment expense

    3,065,811       2,502,219       563,592       22.5  

Professional and data processing fees

    2,707,716       2,083,392       624,324       30.0  

Acquisition costs

    92,539       5,630       86,909       1,543.7  

FDIC insurance, other insurance and regulatory fees

    756,211       621,242       134,969       21.7  

Loan/lease expense

    290,747       293,538       (2,791 )     (1.0 )

Net cost of operations of other real estate

    131,742       14,230       117,512       825.8  

Advertising and marketing

    693,239       609,431       83,808       13.8  

Bank service charges

    440,571       423,901       16,670       3.9  

Correspondent banking expense

    204,754       198,351       6,403       3.2  

CDI amortization expense

    304,551       230,867       73,684       31.9  

Other

    1,197,641       982,985       214,656       21.8  

Total noninterest expense

  $ 25,863,497     $ 21,273,117     $ 4,590,380       21.6

%

 

Management places a strong emphasis on overall cost containment and is committed to improving the Company’s general efficiency. One-time charges relating to the acquisition of Springfield Bancshares are expected to impact expense in later periods of 2018.

 

Salaries and employee benefits, which is the largest component of noninterest expense, increased from the first quarter of 2017 to the first quarter of 2018 by 20%. This increase was primarily related to new hires, merit increases and the addition of the Guaranty Bank employees. New hires throughout 2017 included roles in Information Technology, Accounting, Internal Audit, Trust and Commercial Banking.

 

Occupancy and equipment expense increased 23%, comparing the first quarter of 2018 to the same period of the prior year. The increased expense was mostly due to the addition of Guaranty Bank.

 

49

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

Professional and data processing fees increased 30%, comparing the first quarter of 2018 to the same period in 2017. This increased expense was partially due to the addition of Guaranty Bank. Additionally, legal expense was also elevated due to a legal matter at RB&T where two employees have been charged with wrongdoing in connection with an SBA loan application. The Company anticipates these legal expenses will continue to increase until the court proceedings are completed, which the Company expects to be in late 2018. Neither RB&T nor the Company have been charged in the case. Generally, professional and data processing fees can fluctuate depending on certain one-time project costs. Management will continue to focus on minimizing 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 totaled $93 thousand and $6 thousand for the first quarter of 2018 and 2017, respectively.

 

FDIC insurance, other insurance and regulatory fee expense increased 22%, comparing the first quarter of 2018 to the first quarter of 2017. The increase in expense was due to the acquisition of Guaranty Bank.

 

Loan/lease expense decreased 1%, comparing the first quarter of 2018 to the same quarter of 2017. 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 cost from operations of other real estate totaled $132 thousand for the first quarter of 2018, compared to net costs of operations of $14 thousand for the first quarter of 2017.

 

Advertising and marketing expense increased 14%, comparing the first quarter of 2018 to the first quarter of 2017. The increase in expense was primarily due to the addition of Guaranty Bank.

 

Bank service charges, a large portion of which includes indirect costs incurred to provide services to QCBT’s correspondent banking customer portfolio, increased 4% from the first quarter of 2017 to the first quarter of 2018. 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.

 

Correspondent banking expense increased 3% when comparing the first quarter of 2018 to the first quarter of 2017 due to both increases in volume and in the number of correspondent banking clients. These are direct costs incurred to provide services to QCBT’s correspondent banking customer portfolio, including safekeeping and cash management services.

 

CDI amortization expense increased 32% when comparing the first quarter of 2018 to the first quarter of 2017. The increase was due to the acquisition of Guaranty Bank.

 

Other noninterest expense was up 22% when comparing the first quarter of 2018 to the first quarter of 2017. Included in other noninterest expense are items such as subscriptions, sales and use tax and expenses related to wealth management. A portion of this increase is related to the addition of Guaranty Bank.

 

50

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

INCOME TAXES

 

In the first quarter of 2018, the Company incurred income tax expense of $2.0 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 months ended March 31, 2018 and 2017.

 

   

For the Three Months Ended March 31,

 
   

2018

   

2017

 
           

% of

           

% of

 
           

Pretax

           

Pretax

 
   

Amount

   

Income

   

Amount

   

Income

 
                                 

Computed "expected" tax expense

  $ 2,633,669       21.0 %   $ 4,051,044       35.0 %

Tax exempt income, net

    (943,101 )     (7.5 )     (1,305,427 )     (11.3 )

Bank-owned life insurance

    (87,777 )     (0.7 )     (164,391 )     (1.4 )

State income taxes, net of federal benefit, current year

    551,468       4.4       408,325       3.5  

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

    (132,361 )     (1.1 )     (533,322 )     (4.6 )

Other

    (30,828 )     (0.2 )     (66,783 )     (0.6 )

Federal and state income tax expense

  $ 1,991,070       15.9 %   $ 2,389,446       20.6 %

 

The effective tax rate for the quarter ended March 31, 2018 was 15.9% which was a 4.7% decrease from the effective tax rate of 20.6% for the quarter ended March 31, 2017. The Tax Act was enacted on December 22, 2017 and was effective January 1, 2018 reducing the federal corporate tax rate from 35% to 21%.

 

FINANCIAL CONDITION

 

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

 

   

As of

 
   

March 31, 2018

   

December 31, 2017

   

March 31, 2017

 
   

(dollars in thousands)

 
   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

 

Cash and due from banks

  $ 61,846       2 %   $ 75,722       2 %   $ 56,326       2 %

Federal funds sold and interest-bearing deposits

    59,557       1 %     85,962       2 %     173,219       5 %

Securities

    638,229       16 %     652,382       16 %     557,646       16 %

Net loans/leases

    3,018,370       75 %     2,930,130       74 %     2,403,791       71 %

Other assets

    248,312       6 %     238,469       6 %     190,031       6 %

Total assets

  $ 4,026,314       100 %   $ 3,982,665       100 %   $ 3,381,013       100 %
                                                 

Total deposits

  $ 3,280,001       82 %   $ 3,266,655       82 %   $ 2,805,931       83 %

Total borrowings

    334,802       8 %     309,480       8 %     231,534       7 %

Other liabilities

    51,083       1 %     53,243       1 %     47,708       1 %

Total stockholders' equity

    360,428       9 %     353,287       9 %     295,840       9 %

Total liabilities and stockholders' equity

  $ 4,026,314       100 %   $ 3,982,665       100 %   $ 3,381,013       100 %

 

 

During the first quarter of 2018, the Company’s total assets increased $43.6 million, or 1%, to a total of $4.0 billion. Net loans/leases grew $88.2 million. This loan and lease growth was funded by a combination of excess cash, deposits, which increased $13.3 million in the first quarter of 2018, and borrowings, which increased $25.3 million in the first quarter of 2018. Stockholders’ equity increased $7.1 million, or 2%, in the current quarter due to net retained income.

 

51

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

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. Over the past five years, the Company has further diversified the portfolio by decreasing U.S government sponsored agency securities, while increasing residential mortgage-backed and related securities and tax-exempt municipal securities. Of the latter, the large majority are privately placed tax-exempt debt issuances by municipalities located in the Midwest (with some in or near the Company’s existing markets) and require a thorough underwriting process before investment.

 

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

 

   

As of

 
   

March 31, 2018

   

December 31, 2017

   

March 31, 2017

 
   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

 
   

(dollars in thousands)

 

U.S. govt. sponsored agency securities

  $ 36,868       6 %   $ 38,097       6 %   $ 47,556       9 %

Municipal securities

    438,736       69 %     445,049       68 %     356,776       64 %

Residential mortgage-backed and related securities

    157,289       25 %     163,301       25 %     147,504       26 %

Other securities

    5,336       1 %     5,935       1 %     5,810       1 %
    $ 638,229       100 %   $ 652,382       100 %   $ 557,646       100 %
                                                 

Securities as a % of Total Assets

    15.85 %             16.38 %             16.49 %        

Net Unrealized Losses as a % of Amortized Cost

    (1.01 )%             (0.13 )%             (0.79 )%        

Duration (in years)

    6.9               7.0               6.1          

Quarterly Yield on Investment Securities (TEY)

    3.65 %             3.82 %             3.73 %        

Quarterly Yield on Investment Securities (GAAP)

    3.03 %             2.77 %             2.74 %        

 

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

 

The duration of the securities portfolio shortened modestly with the TEY on the portfolio decreasing 17 bps in the first quarter of 2018; however, excluding the tax benefit and the related variance due to the lower tax rate, the portfolio yield expanded 26 basis points.

 

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

 

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

 

52

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

LOANS/LEASES 

 

Total loans/leases grew 12.2% on an annualized basis during the first quarter of 2018. The mix of the loan/lease types within the Company’s loan/lease portfolio is presented in the following table.

 

   

As of

 
   

March 31, 2018

   

December 31, 2017

   

March 31, 2017

 
   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

 
   

(dollars in thousands)

 

C&I loans

  $ 1,201,087       39 %   $ 1,134,516       38 %   $ 851,578       35 %

CRE loans

    1,357,703       45 %     1,303,492       44 %     1,106,842       46 %

Direct financing leases

    137,614       5 %     141,448       5 %     159,368       7 %

Residential real estate loans

    254,484       8 %     258,646       9 %     231,326       9 %

Installment and other consumer loans

    95,912       3 %     118,611       4 %     78,771       3 %
                                                 

Total loans/leases

  $ 3,046,800       100 %   $ 2,956,713       100 %   $ 2,427,885       100 %
                                                 

Plus deferred loan/lease origination costs, net of fees

    8,103               7,773               7,965          

Less allowance

    (36,533 )             (34,356 )             (32,059 )        
                                                 

Net loans/leases

  $ 3,018,370             $ 2,930,130             $ 2,403,791          

 

As CRE loans have historically been the Company’s largest portfolio segment, management places a strong emphasis on monitoring the composition of the Company’s CRE loan portfolio. For example, management tracks the level of owner-occupied CRE loans relative to non owner-occupied loans. Owner-occupied loans are generally considered to have less risk. As of March 31, 2018 and December 31, 2017, approximately 26% of the CRE loan portfolio was owner-occupied.

 

Over the past several quarters, the Company has been successful in shifting the mix of its commercial loan portfolio by adding more C&I loans. C&I loans grew $66.6 million in the current quarter.

 

A syndicated loan is a commercial loan provided by a group of lenders and is structured, arranged and administered by one or several commercial or investment banks known as arrangers. The nationally syndicated loans invested in by the Company consist of fully funded, highly liquid term loans for which there is a liquid secondary market. As of March 31, 2018 and December 31, 2017, the amount of nationally syndicated loans totaled $39.9 million and $51.2 million, respectively.

 

 

 

53

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

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

 

   

As of March 31,

   

As of December 31,

   

As of March 31,

 
   

2018

   

2017

   

2017

 
   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

 
   

(dollars in thousands)

 

Lessors of Nonresidential Buildings

  $ 435,919       32 %   $ 388,648       30 %   $ 327,077       30 %

Lessors of Residential Buildings

    221,978       16 %     199,047       15 %     147,335       13 %

Hotels

    70,887       5 %     70,447       5 %     37,998       4 %

Nonresidential Property Managers

    56,572       4 %     51,621       4 %     57,112       5 %

New Housing For-Sale Builders

    52,951       4 %     61,480       5 %     57,733       5 %

Land Subdivision

    45,356       3 %     44,192       3 %     47,254       4 %

Nursing Care Facilities

    38,830       3 %     47,008       4 %     34,611       3 %

Lessors of Other Real Estate Property

    31,121       2 %     29,078       2 %     20,989       2 %

Other *

    404,089       30 %     411,971       32 %     376,733       34 %
                                                 

Total CRE Loans

  $ 1,357,703       100 %   $ 1,303,492       100 %   $ 1,106,842       100 %

 

* “Other” consists of all other industries. None of these had concentrations greater than $27.2 million, or approximately 2% of total CRE loans in the most recent period presented.

 

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

 

 

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

 

A limited amount of 15-year and 20-year fixed rate residential real estate loans that meet certain credit guidelines.

 

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

 

54

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

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

 

   

As of March 31,

   

As of December 31,

   

As of March 31,

 
   

2018

   

2017

   

2017

 
   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

 
   

(dollars in thousands)

 

Trucks, Vans and Vocational Vehicles

  $ 28,219       13 %   $ 19,927       9 %   $ 14,657       7 %

Construction - General

    18,067       8 %     18,705       9 %     17,914       9 %

Manufacturing - General

    16,624       7 %     16,571       8 %     18,067       9 %

Food Processing Equipment

    13,270       6 %     12,965       6 %     14,102       7 %

Marine - Travelifts

    12,843       6 %     10,802       5 %     8,132       4 %

Computer Hardware

    10,694       5 %     11,340       5 %     10,094       5 %

Trailers

    9,161       4 %     8,983       4 %     9,465       5 %

Manufacturing - CNC

    7,239       3 %     6,742       3 %     6,812       3 %

Restaurant

    6,844       3 %     7,107       3 %     7,841       4 %

Other *

    100,693       45 %     102,094       47 %     101,375       49 %
                                                 

Total m2 loans and leases

  $ 223,654       100 %   $ 215,236       100 %   $ 208,459       100 %

 

 

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

 

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

 

ALLOWANCE FOR ESTIMATED LOSSES ON LOANS/LEASES

 

Changes in the allowance for the three months ended March 31, 2018 and 2017 are presented as follows:

 

   

Three Months Ended

 
   

March 31, 2018

   

March 31, 2017

 
   

(dollars in thousands)

 

Balance, beginning

  $ 34,356     $ 30,757  

Provisions charged to expense

    2,540       2,105  

Loans/leases charged off

    (436 )     (893 )

Recoveries on loans/leases previously charged off

    73       90  

Balance, ending

  $ 36,533     $ 32,059  

 

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”, as described in Note 1 to the Consolidated Financial Statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, 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.

 

55

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

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

 

   

As of

 

Internally Assigned Risk Rating *

 

March 31, 2018

   

December 31, 2017

   

March 31, 2017

 
   

(dollars in thousands)

 

Special Mention (Rating 6)

  $ 42,926     $ 31,024     $ 22,841  

Substandard (Rating 7)

    39,815       43,435       50,810  

Doubtful (Rating 8)

    -       271       -  
    $ 82,741     $ 74,730     $ 73,651  
                         
                         

Criticized Loans **

  $ 82,741     $ 74,730     $ 73,651  

Classified Loans ***

  $ 39,815     $ 43,706     $ 50,810  
                         
                         

Criticized Loans as a % of Total Loans/Leases

    2.79 %     2.52 %     3.02 %

Classified Loans as a % of Total Loans/Leases

    1.34 %     1.47 %     2.09 %

 

 

* 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 a decrease in classified loans during the first three months of 2018. Criticized loans increased 11% during the same period due to one large credit that was added in the third quarter 2017. The Company continues its strong focus on improving credit quality in an effort to limit NPLs.

 

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

 

   

As of

 
   

March 31, 2018

   

December 31, 2017

   

March 31, 2017

 
                         

Allowance / Gross Loans/Leases

    1.20 %     1.16 %     1.32 %

Allowance / NPLs *

    202.11 %     184.28 %     149.89 %

 

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

 

Although management believes that the allowance at March 31, 2018 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.

 

56

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

In accordance with GAAP for business combination accounting, loans acquired through the acquisitions of CSB and Guaranty Bank are recorded at fair value; therefore, no allowance is associated with the acquired loans at acquisition. Management continues to evaluate the allowance needed on the acquired loans factoring in the net remaining discount ($7.3 million and $8.0 million at March 31, 2018 and March 31, 2017, respectively). 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 1.20% to 1.43% as of March 31, 2018 and increases from 1.32% to 1.64% as of March 31, 2017.. This elimination of the allowance associated with acquired loans also resulted in a decrease of the allowance to NPLs ratio, as the acquired NPLs no longer have an allowance allocated to them and instead, have a loan discount that is separate from the allowance.

 

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

 

NONPERFORMING ASSETS 

 

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

 

   

As of March 31,

   

As of December 31,

   

As of March 31,

 
   

2018

   

2017

   

2017

 
   

(dollars in thousands)

 

Nonaccrual loans/leases (1) (2)

  $ 12,759     $ 11,441     $ 14,205  

Accruing loans/leases past due 90 days or more

    41       89       955  

TDRs - accruing

    5,276       7,113       6,229  

Total NPLs

    18,076       18,643       21,389  

OREO

    12,750       13,558       5,625  

Other repossessed assets

    200       80       285  

Total NPAs

  $ 31,026     $ 32,281     $ 27,299  
                         

NPLs to total loans/leases

    0.59 %     0.63 %     0.88 %

NPAs to total loans/leases plus repossessed property

    1.01 %     1.08 %     1.12 %

NPAs to total assets

    0.77 %     0.81 %     0.81 %

 

 

(1)

Includes government guaranteed portion of loans, as applicable.

 

(2)

Includes TDRs of $2.6 million at March 31, 2018, $2.3 million at December 31, 2017, and $2.4 million at March 31, 2017.

NPAs at March 31, 2018 were $31.0 million, which was down $1.3 million from December 31, 2017 and up $3.7 million from March 31, 2017. This increase from prior year was due to the addition of one large credit that was added in the third quarter 2017.

 

The ratio of NPAs to total assets was 0.77% at March 31, 2018, which was down from 0.81% at both December 31, 2017 and March 31, 2017.

 

57

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

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

 

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

 

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

 

DEPOSITS 

 

Deposits increased $13.3 million during the first quarter of 2018. The table below presents the composition of the Company’s deposit portfolio.

 

   

As of

 
   

March 31, 2018

   

December 31, 2017

   

March 31, 2017

 
   

(dollars in thousands)

 
   

Amount

   

%

   

Amount

   

%

   

Amount

   

%

 

Noninterest bearing demand deposits

  $ 784,815       24 %   $ 789,548       24 %   $ 777,150       28 %

Interest bearing demand deposits

    1,789,019       55 %     1,855,893       57 %     1,486,047       53 %

Time deposits

    496,644       15 %     516,058       16 %     458,170       16 %

Brokered deposits

    209,523       6 %     105,156       3 %     84,564       3 %
    $ 3,280,001       100 %   $ 3,266,655       100 %   $ 2,805,931       100 %

 

Quarter-end balances can greatly fluctuate due to large customer and correspondent bank activity.

 

The Company experienced seasonal declines in commercial deposits with several large deposit customers in the first quarter 2018. To offset this, the Company accessed short-term brokered deposits, which drove the majority of the linked quarter increase in that category. The Company believes this situation is temporary and expects those deposits to return in the second quarter.

 

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

 

Management will continue to focus on growing its core deposit portfolio, including its correspondent banking business at QCBT, as well as shifting the mix from brokered and other higher cost deposits to lower cost core deposits.

 

58

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

BORROWINGS 

 

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

 

   

As of

 
   

March 31, 2018

   

December 31, 2017

   

March 31, 2017

 
   

(dollars in thousands)

 

Overnight repurchase agreements with customers

  $ 3,820     $ 7,003     $ 7,170  

Federal funds purchased

    13,040       6,990       12,300  
    $ 16,860     $ 13,993     $ 19,470  

 

 

The Company’s federal funds purchased fluctuates based on the short-term funding needs of the Company’s subsidiary banks.

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. Generally, 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.

 

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

 

   

As of

 
   

March 31, 2018

   

December 31, 2017

   

March 31, 2017

 
   

(dollars in thousands)

 

Term FHLB advances

  $ 56,600     $ 56,600     $ 59,000  

Overnight FHLB advances

    159,745       135,400       47,550  
    $ 216,345     $ 192,000     $ 106,550  

 

 

Term FHLB advances remained the same in the current quarter as in the prior quarter. Overnight FHLB advances have increased by $24.3 million due to the strong loan and lease growth, which outpaced the Company’s deposit growth in the first quarter of 2018.

 

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

 

   

As of

 
   

March 31, 2018

   

December 31, 2017

   

March 31, 2017

 
   

(dollars in thousands)

 

Wholesale structured repurchase agreements

  $ 35,000     $ 35,000     $ 45,000  

Term notes

    29,063       31,000       27,000  
    $ 64,063     $ 66,000     $ 72,000  

 

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

 

59

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

As described in Note 11 to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, the Company has outstanding term notes and an available revolving line of credit. As of March 31, 2018, the term debt had been paid down to $29.1 million, as scheduled. The term notes and revolving line of credit were used to help fund the CSB and Guaranty Bank acquisitions. As of both March 31, 2018 and December 31, 2017, the full $10.0 million line of credit was available. If the line of credit is used, interest is calculated at the effective LIBOR rate plus 2.50% per annum (4.82% at March 31, 2018).

 

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

 

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

 

   

March 31, 2018

   

December 31, 2017

 
           

Weighted

           

Weighted

 
           

Average

           

Average

 

Maturity:

 

Amount Due

   

Interest Rate

   

Amount Due

   

Interest Rate

 

Year ending December 31:

 

(dollar amounts in thousands)

 

2018

  $ 387,594       1.87 %   $ 273,677       1.68 %

2019

    41,973       2.26       31,950       2.32  

2020

    30,694       2.42       26,600       2.44  

Total Wholesale Funding

  $ 460,261       1.94 %   $ 332,227       1.80 %

 

During the first three months of 2018, wholesale funding increased $128.0 million. Year-to-date, the Company has repaid $25.4 million of term borrowings at maturity. However, this was more than offset by growth in short-term borrowings used to temporarily fund strong earning asset growth.

 

STOCKHOLDERS’ EQUITY

 

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

 

   

As of

 
   

March 31, 2018

   

December 31, 2017

   

March 31, 2017

 
   

Amount

   

Amount

   

Amount

 
   

(dollars in thousands)

 

Common stock

  $ 13,937     $ 13,918     $ 13,161  

Additional paid in capital

    189,685       189,078       157,582  

Retained earnings

    162,346       151,962       127,145  

AOCI (loss)

    (5,540 )     (1,671 )     (2,048 )

Total stockholders' equity

  $ 360,428     $ 353,287     $ 295,840  
                         

TCE* / TA

    8.10 %     8.01 %     8.20 %

 

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

 

60

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

LIQUIDITY AND CAPITAL RESOURCES

 

Liquidity measures the ability of the Company to meet maturing obligations and its existing commitments, to withstand fluctuations in deposit levels, to fund its operations, and to provide for customers’ credit needs. The Company monitors liquidity risk through contingency planning stress testing on a regular basis. The Company seeks to avoid over-concentration of funding sources and to establish and maintain contingent funding facilities that can be drawn upon if normal funding sources become unavailable. One source of liquidity is cash and short-term assets, such as interest-bearing deposits in other banks and federal funds sold, which averaged $136.5 million during the first quarter of 2018 and $164.0 million during the full year of 2017. The Company’s on balance sheet liquidity position can fluctuate based on short-term activity in deposits and loans.

 

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

 

At March 31, 2018, the subsidiary banks had 33 lines of credit totaling $372.2 million, of which $3.2 million was secured and $369.0 million was unsecured. At March 31, 2018, the full $372.2 million was available.

 

At December 31, 2017, the subsidiary banks had 34 lines of credit totaling $375.0 million, of which $3.0 million was secured and $372.0 million was unsecured. At December 31, 2017, the full $375.0 million was available.

 

The Company has emphasized growing the number and amount of lines of credit in an effort to strengthen this contingent source of liquidity. Additionally, the Company maintains a $10.0 million secured revolving credit note with a variable interest rate and a maturity of June 30, 2018. At March 31, 2018, the full $10.0 million was available.

 

As of March 31, 2018, the Company had $417.5 million in correspondent banking deposits spread over 192 relationships. While the Company believes that these funds are relatively stable, there is the potential for large fluctuations that can impact liquidity. Seasonality and the liquidity needs of these correspondent banks can impact balances. Management closely monitors these fluctuations and runs stress scenarios to measure the impact on liquidity and interest rate risk with various levels of correspondent deposit run-off.

 

Investing activities used cash of $60.0 million during the first three months of 2018, compared to $102.6 million for the same period of 2017. The net decrease in federal funds sold was $15.7 million for the first three months of 2018, compared to a net decrease of $6.5 million for the same period of 2017. The net decrease in interest-bearing deposits at financial institutions was $10.7 million for the first three months of 2018, compared to a net increase of $93.5 million for the same period of 2017. Proceeds from calls, maturities, and paydowns of securities were $13.64 million for the first three months of 2018, compared to $25.9 million for the same period of 2017. Purchases of securities used cash of $7.1 million for the first three months of 2018, compared to $12.1 million for the same period of 2017. The net increase in loans/leases used cash of $90.4 million for the first three months of 2018 compared to $29.2 million for the same period of 2017.

 

61

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

Financing activities provided cash of $38.3 million for the first three months of 2018, compared to $77.5 million for same period of 2017. Net increases in deposits totaled $13.4 million for the first three months of 2018, compared to $136.7 million for the same period of 2017. During the first three months of 2018, the Company’s short-term borrowings increased $2.9 million, while they decreased $20.5 million for the same period of 2017. In the first three months of 2018, the Company increased FHLB advances by $24.3 million short-term and overnight advances, while borrowing maturities and principal payments on borrowings totaled $1.9 million. In the first three months of 2017, the Company reduced FHLB advances and borrowings by $39.0 million through a mixture of maturities, prepayments, and debt retirement.

 

Total cash provided by operating activities was $7.0 million for the first three months of 2018, compared to $10.8 million for the same period of 2017.

 

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

 

The following table presents the details of the trust preferred securities outstanding as of March 31, 2018 and December 31, 2017.

 

Name

Date Issued

 

Amount Outstanding
March 31, 2018

   

Amount Outstanding
December 31, 2017

 

Interest Rate

 

Interest Rate as of
March 31, 2018

   

Interest Rate as of
December 31, 2017

 
                                     

QCR Holdings Statutory Trust II

February 2004

  $ 10,310,000     $ 10,310,000  

2.85% over 3-month LIBOR

    5.16%       4.54%  

QCR Holdings Statutory Trust III

February 2004

    8,248,000       8,248,000  

2.85% over 3-month LIBOR

    5.16%       4.54%  

QCR Holdings Statutory Trust V

February 2006

    10,310,000       10,310,000  

1.55% over 3-month LIBOR

    3.27%       2.91%  

Community National Statutory Trust II

September 2004

    3,093,000       3,093,000  

2.17% over 3-month LIBOR

    4.37%       3.80%  

Community National Statutory Trust III

March 2007

    3,609,000       3,609,000  

1.75% over 3-month LIBOR

    3.87%       3.32%  

Guaranty Bankshares Statutory Trust I

May 2005

    4,640,000       4,640,000  

1.75% over 3-month LIBOR

    3.87%       3.34%  
      $ 40,210,000     $ 40,210,000  

Weighted Average Rate

    4.35%       3.82%  

 

 

The Company assumed the trust preferred securities originally issued by Community National in connection with its acquisition in May 2013. The Company assumed the trust preferred securities originally issued by Guaranty in connection with the acquisition in October 2017. 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. As of March 31, 2018, the remaining discount was $2.7 million.

 

The Company (on a consolidated basis) and the subsidiary banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company and subsidiary banks’ financial statements. Refer to Note 7 of the Consolidated Financial Statements for additional information regarding regulatory capital.

 

62

 

Part I

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

 

SPECIAL NOTE CONCERNING FORWARD-LOOKING STATEMENTS

 

 

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

 

The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. The factors that could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries are detailed in the “Risk Factors” section included under Item 1A of Part I of the Company’s Annual Report on Form 10-K for the year ended December 31, 2017 and Item 1A of Part II of this report. In addition to the risk factors described in that section, there are other factors that could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries. These additional factors include, but are not limited to, the following:

 

 

The strength of the local and national economy.

 

Changes in the interest rate environment.

 

The economic impact of past and any future terrorist attacks, acts of war or threats thereof and the response of the United States to any such threats and attacks.

 

The impact of cybersecurity risks.

 

The costs, effects and outcomes of existing or future litigation.

 

Changes in accounting policies and practices, as may be adopted by state and federal regulatory agencies, the FASB, the SEC or the PCAOB.

 

Unexpected results of acquisitions, which may include failure to realize the anticipated benefits of the acquisition.

 

The economic impact of exceptional weather occurrences such as tornadoes, floods and blizzards.

 

The ability of the Company to manage the risks associated with the foregoing as well as anticipated.

 

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

 

63

 

Part I

Item 3

 

             QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

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

 

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

 

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

 

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

 

One method used to quantify interest rate risk is a short-term earnings at risk summary, which is a detailed and dynamic simulation model used to quantify the estimated exposure of net interest income to sustained interest rate changes. This simulation model captures the impact of changing interest rates on the interest income received and interest expense paid on all interest sensitive assets and liabilities reflected on the Company’s consolidated balance sheet. This sensitivity analysis demonstrates net interest income exposure annually over a five-year horizon, assuming no balance sheet growth and various interest rate scenarios including no change in rates; 200, 300, 400, and 500 basis point upward shifts; and a 100 basis point downward shift in interest rates, where interest-bearing assets and liabilities reprice at their earliest possible repricing date.

 

The model assumes parallel and pro rata shifts in interest rates over a twelve-month period for the 200 basis point upward shift and 100 basis point downward shift. For the 400 basis point upward shift, the model assumes a parallel and pro rata shift in interest rates over a twenty-four month period. For the 500 basis point upward shift, the model assumes a flattening and pro rata shift in interest rates over a twelve-month period where the short-end of the yield curve shifts upward greater than the long-end of the yield curve.

 

64

 

Part I

Item 3

 

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK - continued

 

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

 

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

 

Application of the simulation model analysis for select interest rate scenarios at the most recent quarter-end available is presented in the following table:    
                

           

NET INTEREST INCOME EXPOSURE in YEAR 1

 

INTEREST RATE SCENARIO

 

POLICY LIMIT

   

As of March 31,

2018

   

As of December 31,

2017

   

As of December 31,

2016

 
                                 

100 basis point downward shift

    -10.0%       0.3%       0.3%       -1.7%  

200 basis point upward shift

    -10.0%       -3.5%       -3.7%       -1.2%  

300 basis point upward shock

    -25.0%       -8.6%       -8.4%       -1.4%  

 

The simulation is well within the board-established policy limits for all three scenarios. Additionally, for all of the various interest rate scenarios modeled and measured by management (as described above), the results at March 31, 2018 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.

 

65

                                                                                    

Part I

Item 4

 

CONTROLS AND PROCEDURES

 

Evaluation of disclosure controls and procedures. An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) promulgated under the Exchange Act of 1934) as of March 31, 2018. 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.

 

66

 

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 Annual Report on Form 10-K for the year ended December 31, 2017. 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

 

67

 

Part II

QCR HOLDINGS, INC. AND SUBSIDIARIES

 

PART II - OTHER INFORMATION - continued

 

Item 6             Exhibits

 

31.1

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

 

31.2

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

 

32.1

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

 

32.2

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

 

101

Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets as of March 31, 2018 and December 31, 2017; (ii) Consolidated Statements of Income for the three months ended March 31, 2018 and March 31, 2017; (iii) Consolidated Statements of Comprehensive Income for the three months ended March 31, 2018 and March 31, 2017; (iv) Consolidated Statements of Changes in Stockholders’ Equity for the three months ended March 31, 2018 and March 31, 2017; (v) Consolidated Statements of Cash Flows for the three months ended March 31, 2018 and March 31, 2017; and (vi) Notes to the Consolidated Financial Statements.

 

68

 

SIGNATURES

 

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

 

 

QCR HOLDINGS, INC.

(Registrant)

 

 

 

 

Date    May 9, 2018                                    

/s/ Douglas M. Hultquist                        

 

Douglas M. Hultquist, President

 

Chief Executive Officer

 

 

 

 

 

 

Date    May 9, 2018                                    

/s/ Todd A. Gipple                                  

 

Todd A. Gipple, Executive Vice President

 

Chief Operating Officer

 

Chief Financial Officer

 

 

 

 

Date    May 9, 2018                                    

/s/ Elizabeth A. Grabin                           

 

Elizabeth A. Grabin, First Vice President

 

Director of Financial Reporting

 

Principal Accounting Officer

 

69