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QCRH QCR Holding

Filed: 12 Mar 21, 1:04pm
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U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

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

For the fiscal year ended December 31, 2020.

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

Commission file number: 0-22208

QCR HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

Delaware

42-1397595

(State of incorporation)

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

3551 7th Street, Moline, Illinois 61265

(Address of principal executive offices)

(309) 736-3580

(Registrant’s telephone number, including area code)

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

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock, $1.00 Par Value

QCRH

The Nasdaq Global Market

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

Preferred Share Purchase Rights

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes  [ ]  No  [ X ]

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.

Yes  [ ]  No  [ X ]

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 past 90 days.  Yes  [ X ]  No  [ ]

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T 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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer [ ]

Accelerated filer  [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 has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. [X]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes  [   ]  No  [ X ]

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, based on the last sales price quoted on The Nasdaq Global Market on June 30, 2020, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $474,998,914.

As of February 28, 2021 the Registrant had outstanding 15,826,953 shares of common stock, $1.00 par value per share.

Documents incorporated by reference:

Part III of Form 10-K  incorporates by reference portions of the proxy statement for annual meeting of stockholders to be held in May 2021.

QCR HOLDINGS, INC. AND SUBSIDIARIES

INDEX

Page
Number(s)

Part I

4

Item 1.

Business

4

Item 1A.

Risk Factors

13

Item 1B.

Unresolved Staff Comments

27

Item 2.

Properties

27

Item 3.

Legal Proceedings

27

Item 4.

Mine Safety Disclosures

27

Part II

28

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

28

Item 6.

Selected Financial Data

30

Item 7.

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

31

General

31

Executive Overview

34

Strategic Financial Metrics

35

Strategic Developments

36

GAAP to Non-GAAP Reconciliations

36

Net Interest Income and Margin (Tax Equivalent Basis)(Non-GAAP)

39

Critical Accounting Policies

41

Results of Operations

43

Interest Income

43

Interest Expense

43

Provision for Loan/Lease Losses

43

Noninterest Income

44

Noninterest Expenses

46

Income Tax Expense

47

Financial Condition

48

Overview

48

Investment Securities

48

Loans/Leases

49

Allowance for Estimated Losses on Loans/Leases

51

Nonperforming Assets

53

Deposits

54

Short-Term Borrowings

54

FHLB Advances and Other Borrowings

55

Subordinated Notes

55

Stockholders’ Equity

56

Liquidity and Capital Resources

56

Commitments, Contingencies, Contractual Obligations, and Off-Balance Sheet Arrangements

57

Impact of Inflation and Changing Prices

58

Forward-Looking Statements

58

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

59

Item 8.

Consolidated Financial Statements

62

Consolidated Balance Sheets as of December 31, 2020 and 2019

67

Consolidated Statements of Income for the years ended December 31, 2020, 2019 and 2018

68

2

Consolidated Statements of Comprehensive Income for the years ended December 31, 2020, 2019 and 2018

69

Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2020, 2019 and 2018

70

Consolidated Statements of Cash Flows for the years ended December 31, 2020, 2019 and 2018

71

Notes to Consolidated Financial Statements

73

Note 1: Nature of Business and Significant Accounting Policies

73

Note 2: Sales/Mergers/Acquisitions

88

Note 3: Investment Securities

95

Note 4: Loans/Leases Receivable

99

Note 5: Premises and Equipment

111

Note 6: Goodwill and Intangibles

112

Note 7: Derivatives and Hedging Activities

114

Note 8: Deposits

117

Note 9: Short-Term Borrowings

118

Note 10: FHLB Advances

119

Note 11: Other Borrowings and Unused Lines of Credit

120

Note 12: Subordinated Notes

120

Note 13: Junior Subordinated Debentures

122

Note 14: Federal and State Income Taxes

123

Note 15: Employee Benefit Plans

125

Note 16: Stock-Based Compensation

126

Note 17: Regulatory Capital Requirements and Restrictions on Dividends

129

Note 18: Earnings Per Share

131

Note 19: Commitments and Contingencies

131

Note 20: Quarterly Results of Operations (Unaudited)

132

Note 21: Parent Company Only Financial Statements

134

Note 22: Fair Value

137

Note 23: Business Segment Information

140

Item 9.

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

141

Item 9A.

Controls and Procedures

141

Item 9B.

Other Information

144

Part III

145

Item 10.

Directors, Executive Officers and Corporate Governance

145

Item 11.

Executive Compensation

145

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

145

Item 13.

Certain Relationships and Related Transactions, and Director Independence

145

Item 14.

Principal Accountant Fees and Services

146

Part IV

146

Item 15.

Exhibits and Financial Statement Schedules

146

Item 16.

Form 10-K Summary

149

Signatures

150

Appendix A. Supervision and Regulation

152

Appendix B. Guide 3 Information

165

Throughout the Notes to the Consolidated Financial Statements, Management's Discussion and Analysis of Financial Condition and Results of Operations, and remaining sections of this Form 10-K (including appendices), we use certain acronyms and abbreviations, as defined in Note 1 to the Consolidated Financial Statements.

3

Part I

Item 1.    Business

General. QCR Holdings, Inc. is a multi-bank holding company headquartered in Moline, Illinois, that was formed in February 1993 under the laws of the state of Delaware. In 2016, the Company elected to operate as a financial holding company under the BHCA. The Company serves the Quad Cities, Cedar Rapids, Waterloo/Cedar Falls, Des Moines/Ankeny and Springfield communities through the following four wholly-owned banking subsidiaries (collectively, the “Banks”), which provide full-service commercial and consumer banking and trust and asset management services:

Quad City Bank & Trust (QCBT), which is based in Bettendorf, Iowa, and commenced operations in 1994;
Cedar Rapids Bank & Trust (CRBT), which is based in Cedar Rapids, Iowa, and commenced operations in 2001;
Community State Bank (CSB), which is based in Ankeny, Iowa, and was acquired in 2016; and
Springfield First Community Bank (SFCB), which is based in Springfield, Missouri, and was acquired in 2018.

On August 12, 2020, the Company sold the Bates Companies, headquartered in Rockford, Illinois.  Since October 1, 2018, the date of acquisition, the Company provided wealth management services to the Rockford community through the Bates Companies.

On November 30, 2019, the Company sold substantially all of the assets and transferred substantially all of the deposits and certain other liabilities of the Company’s wholly-owned subsidiary, RB&T.  Prior to this time, the Company provided full service banking services to the Rockford community through RB&T.

On July 1, 2018, the Company merged with Springfield Bancshares, the holding company of SFCB, headquartered in Springfield, Missouri.  From that time, the Company has operated SFCB as an independent banking subsidiary.

See Note 2 to the Consolidated Financial Statements for further discussion on mergers, acquisitions and sales.

The Company engages in direct financing lease contracts through m2, a wholly-owned subsidiary of QCBT based in Brookfield, Wisconsin.

Subsidiary Banks. Segments of the Company have been established by management as 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 Commercial Banking business is geographically divided by markets into the operating segments corresponding to the four subsidiary banks wholly-owned by the Company: QCBT, CRBT, CSB and SFCB. See the Consolidated Financial Statements incorporated herein generally, and Note 23 to the Consolidated Financial Statements specifically, for additional business segment information.

QCBT was capitalized on October 13, 1993, and commenced operations on January 7, 1994. QCBT is an Iowa-chartered commercial bank that is a member of the Federal Reserve System. QCBT provides full service commercial, correspondent, and consumer banking and trust and asset management services in the Quad Cities and adjacent communities through its five offices located in Bettendorf and Davenport, Iowa and in Moline, Illinois. QCBT, on a consolidated basis with m2, had total segment assets of $2.15 billion and $1.68 billion as of December 31, 2020 and 2019, respectively.

CRBT is an Iowa-chartered commercial bank that is a member of the Federal Reserve System. The Company commenced operations in Cedar Rapids in June 2001, operating as a branch of QCBT. The Cedar Rapids branch operation then began functioning under the CRBT charter in September of 2001. Acquired branches of CNB operate as a division of CRBT under the name “Community Bank & Trust.”  CRBT provides full-service commercial and consumer banking and trust and asset management services to Cedar Rapids, Marion and Waterloo/Cedar Falls, Iowa and adjacent communities through its eight facilities. The headquarters for CRBT is located in downtown Cedar Rapids with three other branches located in Cedar Rapids, one branch in Marion, two branches located in Waterloo and one branch located in Cedar Falls. CRBT had total segment assets of $1.95 billion and $1.57 billion as of December 31, 2020 and 2019, respectively.

CSB is an Iowa-chartered commercial bank that is a member of the Federal Reserve System. CSB was acquired by the Company in 2016. CSB provides full-service commercial and consumer banking to Des Moines, Iowa and adjacent communities through its headquarters located in Ankeny, Iowa and its nine other branch facilities throughout the greater Des Moines area. CSB had total segment assets of $1.0 billion and $853.8 million as of December 31, 2020 and 2019, respectively.

4

SFCB is a Missouri-chartered commercial bank that is a member of the Federal Reserve System. SFCB was acquired by the Company in 2018 through a merger with Springfield Bancshares.  SFCB provides full-service commercial and consumer banking to the Springfield, Missouri area through its headquarters located on Glenstone Avenue in Springfield and its branch facility located on East Primrose in Springfield.  SFCB had total segment assets of $780.0 million and $748.8 million as of December 31, 2020 and 2019, respectively.

Other Operating Subsidiaries. m2, which is based in Brookfield, Wisconsin, is engaged in the business of leasing machinery and equipment to C&I businesses under direct financing lease contracts.  

Trust Preferred Subsidiaries. Following is a listing of the Company’s non-consolidated subsidiaries formed for the issuance of trust preferred securities, including pertinent information as of December 31, 2020 and 2019:

    

    

Amount Outstanding

    

Amount Outstanding

    

    

Interest

Interest

as of

as of

Rate as of

Rate as of

Name

Date Issued

December 31, 2020

December 31, 2019

Interest Rate

December 31, 2020

December 31, 2019

QCR Holdings Statutory Trust II

 

February 2004

$

10,310

$

10,310

 

2.85% over 3-month LIBOR

 

3.10

%  

4.79

%

QCR Holdings Statutory Trust III

 

February 2004

 

8,248

 

8,248

 

2.85% over 3-month LIBOR

 

3.10

%  

4.79

%

QCR Holdings Statutory Trust V

 

February 2006

 

10,310

 

10,310

 

1.55% over 3-month LIBOR

 

1.79

%  

3.54

%

Community National Statutory Trust II

 

September 2004

 

3,093

 

3,093

 

2.17% over 3-month LIBOR

 

2.41

%  

4.08

%

Community National Statutory Trust III

 

March 2007

 

3,609

 

3,609

 

1.75% over 3-month LIBOR

 

1.97

%  

3.64

%

Guaranty Bankshares Statutory Trust I

 

May 2005

 

4,640

 

4,640

 

1.75% over 3-month LIBOR

 

1.97

%  

3.64

%

 

$

40,210

$

40,210

 

Weighted Average Rate

 

2.48

%  

4.18

%

Securities issued by all of the trusts listed above mature 30 years from the date of issuance, but are all currently callable at par at any time. Interest rate reset dates vary by trust.  

Business. The Company’s principal business consists of attracting deposits and investing those deposits in loans/leases and securities. The deposits of the subsidiary banks are insured to the maximum amount allowable by the FDIC. The Company’s results of operations are dependent primarily on net interest income, which is the difference between the interest earned on its loans/leases and securities and the interest paid on deposits and borrowings. The Company’s operating results are affected by economic and competitive conditions, particularly changes in interest rates, government policies and the actions of regulatory authorities, as described more fully in this Form 10-K, including in Appendix A “Supervision and Regulation.”  Its operating results also can be affected by trust fees, investment advisory and management fees, deposit service charge fees, swap fee income, gains on the sale of residential real estate and government guaranteed loans, earnings from BOLI and other noninterest income. Operating expenses include employee compensation and benefits, occupancy and equipment expense, professional and data processing fees, advertising and marketing expenses, bank service charges, FDIC and other insurance, loan/lease expenses and other administrative expenses.

The Company and its subsidiaries collectively employed 714 and 697 FTEs at December 31, 2020 and 2019, respectively. The increase in FTEs during 2020 was primarily due to the addition of new positions created to build scale.

The Federal Reserve is the primary federal regulator of the Company, QCBT, CRBT, CSB and SFCB.  QCBT, CRBT and CSB are also regulated by the Iowa Superintendent of Banking and SFCB is regulated by the Missouri Division of Finance. The FDIC, as administrator of the DIF, also has regulatory authority over the subsidiary banks. See Appendix A “Supervision and Regulation” for more information on the federal and state statutes and regulations that are applicable to the Company and its subsidiaries.

Lending/Leasing. The Company and its subsidiaries provide a broad range of commercial and retail lending/leasing and investment services to corporations, partnerships, individuals, and government agencies. The subsidiary banks actively market their services to qualified lending and deposit clients. Officers actively solicit the business of new clients entering their market areas as well as long-standing members of the local business community. The Company has an established lending/leasing policy which includes a number of underwriting factors to be considered in making a loan/lease, including, but not limited to, location, loan-to-value ratio, cash flow, collateral and the credit history of the borrower.

In accordance with Iowa regulation, the legal lending limit to one borrower for QCBT, CRBT and CSB, calculated as 15% of aggregate capital, was $31.4 million, $36.5 million, and $17.3 million, respectively, as of December 31, 2020. In accordance with Missouri regulation, the legal lending limit to one borrower for SFCB, calculated as 15% of aggregate capital, totaled $13.6 million as of December 31, 2020.

5

The Company recognizes the need to prevent excessive concentrations of credit exposure to any one borrower or group of related borrowers. As such, the Company has established an in-house lending limit, which is lower than each subsidiary bank’s legal lending limit, in an effort to manage individual borrower exposure levels.

The in-house lending limit is the maximum amount of credit each subsidiary bank will extend to a single borrowing entity or group of related entities. The Company implements a tiered approach, based on the risk rating of the borrower. Under the most recent in-house limit, total credit exposure to a single borrowing entity or group of related entities will not exceed the following, subject to certain exceptions:

High Quality

Medium Quality

Low Quality

    

(Risk Ratings 1-3)

    

(Risk Rating 4)

    

(Risk Ratings 5-8)

(dollars in thousands)

QCBT

$

17,250

$

14,750

$

10,000

CRBT

$

16,000

$

13,500

$

9,250

CSB

$

9,500

$

8,000

$

5,500

SFCB

$

9,000

$

7,500

$

5,000

QCRH Consolidated

$

25,000

$

19,000

$

12,500

The QCRH Consolidated amount represents the maximum amount of credit that all affiliated banks, when combined, will extend to a single borrowing entity or group of related entities, subject to certain exceptions.

In addition, m2’s in-house lending limit is $2.5 million to a single leasing entity or group of related entities, subject to certain exceptions.

As part of the loan monitoring activity at the four subsidiary banks, credit administration personnel interact closely with senior bank management. For example, the internal loan committee of each subsidiary bank meets weekly. The Company has a separate in-house loan review function to analyze credits of the subsidiary banks.   To complement the in-house loan review, an independent third-party performs external loan reviews. Historically, management has attempted to identify problem loans at an early stage and to aggressively seek a resolution of those situations.

The Company recognizes that a diversified loan/lease portfolio contributes to reducing risk in the overall loan/lease portfolio. The specific loan/lease portfolio mix is subject to change based on loan/lease demand, the business environment and various economic factors. The Company actively monitors concentrations within the loan/lease portfolio to ensure appropriate diversification and concentration risk is maintained.

Specifically, each subsidiary bank’s total loans as a percentage of average assets may not exceed 85%. In addition, following are established policy limits and the actual allocations for the subsidiary banks as of December 31, 2020 for the loan portfolio organized by loan type, reflected as a percentage of the subsidiary bank’s gross loans:

QCBT

CRBT

CSB

SFCB

 

Maximum

    

    

Maximum

    

    

Maximum

    

    

Maximum

    

 

Percentage

As of

Percentage

As of

Percentage

As of

Percentage

As of

 

per Loan

December 31, 

per Loan

December 31, 

per Loan

December 31, 

per Loan

December 31, 

 

Type of Loan *

Policy

2020

Policy

2020

Policy

2020

Policy

2020

 

One-to-four family residential

30

%  

11

%  

25

%  

7

%  

35

%  

10

%  

30

%  

14

%

Multi-family

15

%  

5

%  

15

%  

11

%  

15

%  

8

%  

20

%  

11

%

Farmland

5

%  

%  

5

%  

%  

15

%  

1

%  

5

%  

1

%

Non-farm, nonresidential

50

%  

20

%  

50

%  

24

%  

50

%  

25

%  

50

%  

37

%

Construction and land development

20

%  

11

%  

15

%  

13

%  

35

%  

22

%  

15

%  

10

%

C&I

60

%  

34

%  

60

%  

36

%  

50

%  

25

%  

20

%  

20

%

Loans to individuals

10

%  

1

%  

10

%  

1

%  

10

%  

1

%  

5

%  

1

%

Lease financing

30

%  

4

%  

5

%  

%  

5

%  

%  

5

%  

%

Bank stock loans

**

 

 

10

%  

%  

%

%  

20

%  

%

All other loans

15

%  

14

%  

10

%  

8

%  

15

%  

8

%  

15

%  

6

%

  

 

100

%  

  

 

100

%  

  

 

100

%  

  

 

100

%

*   The loan types above are as defined and reported in the subsidiary banks’ quarterly Reports of Condition and Income (also known as Call Reports).

** QCBT’s maximum percentage for bank stock loans is 150% of risk-based capital (bank stock loan commitments are limited to 200% of risk-based capital). At December 31, 2020, QCBT’s bank stock loans totaled 41% of risk-based capital.

6

The following table presents total loans/leases by major loan/lease type and subsidiary as of December 31, 2020 and 2019. Residential real estate loans held for sale are included in residential real estate loans below.

Consolidated

 

QCBT

CRBT

CSB

SFCB

Total

 

    

$

    

%

    

$

    

%

    

$

    

%

    

$

    

%

    

$

%

 

(dollars in thousands)

 

As of December 31, 2020

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

C&I loans

$

732,363

 

46

%  

$

601,387

 

44

%  

$

230,835

 

32

%  

$

162,138

 

26

%  

$

1,726,723

 

41

%

CRE loans

 

588,167

 

38

%  

 

690,539

 

51

%  

 

423,029

 

60

%  

 

405,894

 

65

%  

 

2,107,629

 

50

%

Direct financing leases

 

66,016

 

4

%  

 

 

%  

 

 

%  

 

 

%  

 

66,016

 

1

%

Residential real estate loans

 

134,712

 

9

%  

 

45,493

 

3

%  

 

41,673

 

6

%  

 

30,243

 

5

%  

 

252,121

 

6

%

Installment and other consumer loans

 

26,916

 

2

%  

 

25,986

 

2

%  

 

12,376

 

2

%  

 

26,024

 

4

%  

 

91,302

 

2

%

Deferred loan/lease origination costs, net of fees

 

8,588

 

1

%  

 

(1,349)

 

%  

 

(231)

 

%  

 

330

 

%  

 

7,338

 

%  

$

1,556,762

 

100

%  

$

1,362,056

 

100

%  

$

707,682

 

100

%  

$

624,629

 

100

%  

$

4,251,129

 

100

%

As of December 31, 2019

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

C&I loans

$

616,241

 

43

%  

$

536,294

 

46

%  

$

234,527

 

37

%  

$

120,763

 

22

%  

$

1,507,825

 

41

%

CRE loans

 

455,389

 

42

%  

 

554,101

 

47

%  

 

350,159

 

55

%  

 

376,747

 

69

%  

 

1,736,396

 

47

%

Direct financing leases

 

87,869

 

%  

 

 

%  

 

 

%  

 

 

%  

 

87,869

 

2

%

Residential real estate loans

 

122,675

 

11

%  

 

49,544

 

4

%  

 

40,224

 

6

%  

 

27,461

 

5

%  

 

239,904

 

7

%

Installment and other consumer loans

 

38,706

 

4

%  

 

35,362

 

3

%  

 

14,272

 

2

%  

 

21,012

 

4

%  

 

109,352

 

3

%

Deferred loan/lease origination costs, net of fees

 

8,786

 

%  

 

(338)

 

%  

 

88

 

%  

 

323

 

%  

 

8,859

 

%  

$

1,329,666

 

100

%  

$

1,174,963

 

100

%  

$

639,270

 

100

%  

$

546,306

 

100

%  

$

3,690,205

 

100

%

Proper pricing of loans is necessary to provide adequate return to the Company’s stockholders. Loan pricing, as established by the subsidiary banks’ internal loan committees, includes consideration for the cost of funds, loan maturity and risk, origination and maintenance costs, appropriate stockholder return, competitive factors, and the economic environment. The portfolio contains a mix of loans with fixed and floating interest rates. Management attempts to maximize the use of interest rate floors on its variable rate loan portfolio. Refer to “Item 7A. Quantitative and Qualitative Disclosures about Market Risk for more discussion on the Company’s management of interest rate risk.

In an effort to manage interest rate risk, the subsidiary banks will consider entering into back-to-back interest rate swaps with select commercial borrowers. 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. The Banks enter an interest rate swap with the commercial borrower and an equal and offsetting interest rate swap with a larger financial institution counterparty. The Company has increased its focus on this business which has led to significantly increased noninterest income, stronger overall loan growth, and improved management of its interest rate risk.  The Company will continue to review opportunites 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 year to year.  Future levels of swap fee income can be dependent upon prevailing interest rates and other market activity.

C&I Lending

As noted above, the subsidiary banks are active C&I lenders. The current areas of emphasis include loans to small and mid-sized businesses with a wide range of operations such as wholesalers, manufacturers, building contractors, business services companies, other banks, and retailers. The Banks provide a wide range of business loans, including lines of credit for working capital and operational purposes, and term loans for the acquisition of facilities, equipment and other purposes. Since 2010, the subsidiary banks have been active in participating in lending programs offered by the SBA and USDA. Under these programs, the government entities will generally provide a guarantee of repayment ranging from 50% to 85% of the principal amount of the qualifying loan.

Loan approval is generally based on the following factors:

Ability and stability of current management of the borrower;
Stable earnings with positive financial trends;
Sufficient cash flow to support debt repayment;
Earnings projections based on reasonable assumptions;
Financial strength of the industry and business; and
Value and marketability of collateral.

7

For C&I loans, the Company assigns internal risk ratings which are largely dependent upon the aforementioned approval factors. The risk rating is reviewed annually or on an as needed basis depending on the specific circumstances of the loan. See Note 1 to the Consolidated Financial Statements for additional information, including the internal risk rating scale.

As part of the underwriting process, management reviews current borrower financial statements. When appropriate, certain C&I loans may contain covenants requiring maintenance of financial performance ratios such as, but not limited to:

Minimum debt service coverage ratio;
Minimum current ratio;
Maximum debt to tangible net worth ratio; and/or
Minimum tangible net worth.

Establishment of these financial performance ratios depends on a number of factors, including risk rating and the specific industry in which the borrower is engaged.

Collateral for these loans generally includes accounts receivable, inventory, equipment, and real estate. The Company’s lending policy specifies approved collateral types and corresponding maximum advance percentages. The value of collateral pledged on loans must exceed the loan amount by a margin sufficient to absorb potential erosion of its value in the event of foreclosure and cover the loan amount plus costs incurred to convert it to cash. Approved non-real estate collateral types and corresponding maximum advance percentages for each collateral type are listed below.

Approved Collateral Type

    

Maximum Advance %

Financial Instruments

 

  

U.S. Government Securities

 

90% of market value

Securities of Federal Agencies

 

90% of market value

Municipal Bonds rated by Moody’s As “A” or better

 

80% of market value

Listed Stocks

 

75% of market value

Mutual Funds

 

75% of market value

Cash Value Life Insurance

 

95%, less policy loans

Savings/Time Deposits (Bank)

 

100% of current value

Penny Stocks

 

0%

General Business

 

  

Accounts Receivable

 

80% of eligible accounts

Inventory

 

50% of value

Crop and Grain Inventories

 

80% of current market value

Livestock

 

80% of purchase price, or current market value; or higher if cross-collateralized with other assets

Fixed Assets (Existing)

 

50% of net book value, or 75% of orderly liquidation appraised value

Fixed Assets (New)

 

80% of cost, or higher if cross-collateralized with other assets

Leasehold Improvements

 

0%

Generally, if the above collateral is part of a cross-collateralization with other approved assets, then the maximum advance percentage may be higher.

The Company’s lending policy specifies maximum term limits for C&I loans. For term loans, the maximum term is generally seven years. Generally, term loans range from three to five years. For lines of credit, the maximum term is typically 365 days. For low income housing tax credits permanent loans, the maximum term is generally up to 20 years.

In addition, the subsidiary banks often take personal guarantees or cosigners to help assure repayment. Loans may be made on an unsecured basis if warranted by the overall financial condition of the borrower.

8

Following is a summary of the five largest industry concentrations within the C&I portfolio as of December 31, 2020 and 2019:

    

2020

    

2019

Amount

Amount

(dollars in thousands)

Administration of urban planning & rural development

$

138,514

$

133,157

Bank holding companies

 

80,383

 

92,185

Hotels & motels

 

76,194

 

64,867

Offices of physicians

38,569

25,090

Skilled nursing care facilities

 

35,867

 

39,881

These loan categories are defined by industry-standard NAICS codes – refer to NAICS.com for a description of each category.

CRE Lending

The subsidiary banks also make CRE loans. CRE loans are subject to underwriting standards and processes similar to C&I loans, in addition to those standards and processes specific to real estate loans. Collateral for these loans generally includes the underlying real estate and improvements, and may include additional assets of the borrower. The Company’s lending policy specifies maximum loan-to-value limits based on the category of CRE (commercial real estate loans on improved property, raw land, land development, and commercial construction). These limits are the same limits as, or in some situations, more conservative than, those established by regulatory authorities. Following is a listing of these limits as well as some of the other guidelines included in the Company’s lending policy for the major categories of CRE loans:

    

    

Maximum

CRE Loan Types

Maximum Advance Rate **

Term

CRE Loans on Improved Property *

 

80%

 

7 years

Raw Land

 

Lesser of 90% of project cost, or 65% of "as is" appraised value

 

12 months

Land Development***

 

Lesser of 85% of project cost, or 75% of "as-completed" appraised value

 

24 months

Commercial Construction Loans

 

Lesser of 85% of project cost, or 80% of "as-completed" appraised value

 

12 months

Residential Construction Loans to Builders

 

Lesser of 90% of project cost, or 80% of "as-completed" appraised value

 

12 months

*     Generally, the debt service coverage ratio must be a minimum of 1.25x for non-owner occupied loans and 1.15x for owner-occupied loans. For loans greater than $500 thousand, the subsidiary banks sensitize this ratio for deteriorated economic conditions, major changes in interest rates, and/or significant increases in vacancy rates.

**  These maximum rates are consistent with, or in some situations, more conservative than those established by regulatory authorities.

*** Generally, the maximum term for land development loans is 12 months but there are some situations where the maximum term would be 24 months.

The Company’s lending policy also includes guidelines for real estate appraisals and evaluations, including minimum appraisal and evaluation standards based on certain transactions. In addition, the subsidiary banks often take personal guarantees to help assure repayment.

In addition, management tracks the level of owner-occupied CRE loans versus non-owner occupied CRE loans. Owner-occupied CRE loans are generally considered to have less risk. As of December 31, 2020 and 2019, approximately 24% and 26%, respectively, of the CRE loan portfolio was owner-occupied.

In accordance with regulatory guidelines, the Company exercises heightened risk management practices when non-owner occupied CRE lending exceeds 300% of total risk-based capital or construction, land development and other land loans exceed 100% of total risk-based capital. Although CSB’s loan portfolio has historically been real estate dominated and its real estate portfolio levels exceed these policy limits, it has established a Credit Risk Committee to routinely monitor its real estate loan portfolio.

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Following is a listing of the significant industries within the Company’s CRE loan portfolio as of December 31, 2020 and 2019:

 

2020

2019

Amount

    

%

    

Amount

    

%

 

(dollars in thousands)

 

Lessors of Residential Buildings

$

786,066

 

37

%  

$

465,172

 

27

%

Lessors of Nonresidential Buildings

567,759

 

27

%  

553,142

 

32

%

Hotels

 

72,718

 

4

%  

 

63,720

 

4

%

Nonresidential Property Managers

 

46,764

 

2

%  

 

48,059

 

3

%

New Housing For-Sale Builders

45,619

2

%

55,525

3

%

Other Activities Related to Real Estate

41,197

2

%

42,060

2

%

Land Subdivision

 

40,720

 

2

%  

 

46,318

 

3

%

Lessors of Other Real Estate Property

 

39,344

 

2

%  

 

39,297

 

2

%

Other *

 

467,442

 

22

%  

 

423,103

 

23

%

Total CRE Loans

$

2,107,629

 

100

%  

$

1,736,396

 

100

%

*   “Other” consists of all other industries. None of these had concentrations greater than $29.6 million, or 1.4%, of total CRE loans as of December 31, 2020.

Following is a breakdown of non owner-occupied income-producing CRE by property type as of December 31, 2020 and 2019:

2020

2019

    

Amount

    

%

    

Amount

    

%

 

(dollars in thousands)

 

Multi-family

$

599,774

 

38

%  

$

359,469

 

29

%

Office

 

174,578

 

11

%  

 

193,381

 

15

%

Retail

 

156,589

 

10

%  

 

175,602

 

14

%

Industrial/warehouse

 

82,568

 

5

%  

 

68,978

 

6

%

Hotel/motel

 

77,165

 

5

%  

 

71,611

 

6

%

Other

 

480,292

 

31

%  

 

381,762

 

31

%

Total income-producing CRE

$

1,570,966

 

100

%  

$

1,250,803

 

100

%

A portion of the Company’s construction portfolio is considered non-residential construction. Following is a summary of industry concentrations within that category as of December 31, 2020 and 2019:

2020

2019

    

Amount

    

%

    

Amount

    

%

 

(dollars in thousands)

 

Multi-family

$

281,986

 

57

%  

$

169,523

 

50

%

Office

 

17,126

 

3

%  

 

24,950

 

7

%

Industrial/warehouse

 

10,884

 

2

%  

 

8,388

 

2

%

Retail

 

8,665

 

2

%  

 

14,584

 

4

%

Hotel/motel

 

5,715

 

1

%  

 

5,715

 

2

%

Other

 

170,153

 

35

%  

 

115,349

 

33

%

Total non-residential construction loans

$

494,529

 

100

%  

$

338,509

 

100

%

Additionally, the Company had approximately $48.8 million and $48.4 million of residential construction loans outstanding as of December 31, 2020 and 2019, respectively. Of this amount, approximately 54% was considered speculative, while 46% was pre-sold at December 31, 2020, and approximately 66% was considered speculative, while 34% was pre-sold at December 31, 2019.

10

Direct Financing Leasing

m2 leases machinery and equipment to C&I customers under direct financing leases. All lease requests are subject to the credit requirements and criteria as set forth in the lending/leasing policy. In all cases, a formal independent credit analysis of the lessee is performed.

The following private and public sector business assets are generally acceptable to consider for lease funding:

Computer systems;
Photocopy systems;
Fire trucks;
Specialized road maintenance equipment;
Medical equipment;
Commercial business furnishings;
Vehicles classified as heavy equipment;
Trucks and trailers;
Equipment classified as plant or office equipment; and
Marine boat lifts.

m2 will generally refrain from funding leases of the following type:

Leases collateralized by non-marketable items;
Leases collateralized by consumer items, such as vehicles, household goods, recreational vehicles, boats, etc.;
Leases collateralized by used equipment, unless its remaining useful life can be readily determined; and
Leases with a repayment schedule exceeding seven years.

Residential Real Estate Lending

Generally, the subsidiary banks’ residential real estate loans conform to the underwriting requirements of Freddie Mac and Fannie Mae to allow the subsidiary banks to resell loans in the secondary market. The subsidiary banks structure most loans that will not conform to those underwriting requirements as adjustable rate mortgages that adjust in one to five years, and then retain these loans in their portfolios. Servicing rights are generally not retained on the loans sold in the secondary market. The Company’s lending policy establishes minimum appraisal and other credit guidelines.

The following table presents the originations and sales of residential real estate loans for the Company. Included in originations is activity related to the refinancing of previously held in-house mortgages.

For the year ended December 31, 

2020

2019

2018

(dollars in thousands)

 

Originations of residential real estate loans

$

281,662

$

183,491

$

87,133

Sales of residential real estate loans

$

234,512

$

141,195

$

51,010

Percentage of sales to originations

 

83

%  

 

77

%  

 

59

%

Installment and Other Consumer Lending

The consumer lending department of each subsidiary bank provides many types of consumer loans, including home improvement, home equity, motor vehicle, signature loans and small personal credit lines. The Company’s lending policy addresses specific credit guidelines by consumer loan type. In particular, for home equity loans and home equity lines of credit, the minimum credit bureau score is 650. For both home equity loans and lines of credit, the maximum advance rate is 90% of value with a minimum credit bureau score of 650. The maximum term on home equity loans is 10 years and maximum amortization is 15 years. The maximum term on home equity lines of credit is 10 years.

11

In some instances for all loans/leases, it may be appropriate to originate or purchase loans/leases that are exceptions to the guidelines and limits established within the Company’s lending policy described above. In general, exceptions to the lending policy do not significantly deviate from the guidelines and limits established within the lending policy and, if there are exceptions, they are generally noted as such and specifically identified in loan/lease approval documents.

Human Capital Resources. As of December 31, 2020, the Company employed 668 full-time employees and 71 part-time employees across all locations.  The employees are not represented by a collective bargaining unit. The Company is a relationship driven company and its ability to attract and retain exceptional employees is key to its success.  

The Company encourages and supports the growth and development of its employees and, wherever possible, seek to fill positions by promotion and transfer from within the organization. Continual learning and career development is advanced through ongoing performance and development conversations with employees, internally developed training programs and external training opportunities. Educational reimbursement is available to employees enrolled in degree or certification programs and for seminars, conferences, and other training events employees attend in connection with their job duties.

As part of its compensation philosophy, the Company believes that it must offer and maintain market competitive total rewards programs for its employees in order to attract and retain exceptional talent. In addition to competitive base wages, additional programs include annual bonus opportunities, an Employee Stock Purchase Plan, Company matched 401(k) Plan, healthcare and insurance benefits, health savings and flexible spending accounts, paid time off, family leave, sabbaticals, flexible work schedules, an employee assistance program, and various wellness programs.

The Company is committed to fostering and preserving a culture of diversity, equity, and inclusion, and believe its differences of every kind make the company and its communities better.  During the year, the Company focused on  several initiatives to promote diversity, equity, and inclusion across its organization.  A few specific actions were adding inclusion as a core value for the organization, rolling out a diversity assessment to gather feedback from all employees, and a company-wide training on unconscious bias.  Additionally the Company provided webcasts and videos to raise awareness and educate its employees on diversity and inclusion.

 

The safety, health and wellness of the Company’s employees is a top priority. The COVID-19 pandemic presented a unique challenge with regard to maintaining employee safety while continuing successful operations. Through teamwork and the adaptability of management and staff, the Company was able to quickly transition half of its employees to effectively work from remote locations and incorporated safety measures in its locations for employees performing customer-facing activities. All employees are asked not to come to work when they experience signs or symptoms of a possible COVID-19 illness.  In addition, the Company incorporated frequent communication updates using a variety of methods to ensure that all employees were kept informed of updates regarding the ongoing pandemic.  

Competition. The Company currently operates in the highly competitive Quad Cities, Cedar Rapids, Marion, Waterloo/Cedar Falls, Des Moines, Iowa and Springfield, Missouri markets. Competitors include not only other commercial banks, credit unions, thrift institutions, and mutual funds, but also insurance companies, FinTech companies, finance companies, brokerage firms, investment banking companies, and a variety of other financial services and advisory companies. Many of these competitors are not subject to the same regulatory restrictions as the Company. Many of these competitors compete across geographic boundaries and provide customers increasing access to meaningful alternatives to traditional banking services. The Company also competes in markets with a number of much larger financial institutions with substantially greater resources and larger lending limits.

Appendices. The commercial banking business is a highly regulated business. See Appendix A “Supervision and Regulation” for a discussion of the federal and state statutes and regulations that are applicable to the Company and its subsidiaries.

See Appendix B for tables and schedules that show selected financial statistical information relating to the business of the Company required to be presented pursuant to federal securities laws. Consistent with the information presented in this Annual Report on Form 10-K, results are presented as of and for the fiscal years ended December 31, 2020, 2019, and 2018, as applicable.

Internet Site, Securities Filings and Governance Documents. The Company maintains an Internet site at www.qcrh.com. The Company makes available free of charge through this site its Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and other reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as soon as reasonably practicable after it electronically files such material

12

with, or furnishes it to, the SEC. These filings are available at http://www.snl.com/IRW/Docs/1024092. Also available are many of the Company’s corporate governance documents, including its Business Code of Conduct and Ethics Policy (https://qcrh.q4ir.com/governance/documents/default.aspx).

Item 1A.    Risk Factors

In addition to the other information in this Annual Report on Form 10-K, stockholders or prospective investors should carefully consider the following risk factors:

COVID-19 Pandemic-Related Risks

The COVID-19 pandemic has had an adverse impact on our business, financial condition and results of operations, and the duration and extent of this impact is subject to a high degree of uncertainty.

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

The outbreak of COVID-19 has resulted in a decline in certain of our clients’ businesses, a decrease in consumer confidence, an increase in unemployment and a disruption in the services provided by our vendors. Certain of the Company’s borrowers are in or have exposure to the hotel, restaurant, arts/entertainment/recreation and retail industries and are located in areas that are or were quarantined or under stay-at-home orders  Continued disruption to our clients’ businesses could result in increased risk of delinquencies, defaults, foreclosures and losses on our loans, declines in assets under management and wealth management revenues, negatively impact regional economic conditions, result in declines in local loan demand, liquidity of loan guarantors, loan collateral (particularly in real estate), loan originations and deposit availability and negatively impact the implementation of our growth strategy.

The initial distribution of vaccines has been slow, and there may continue to be challenges with producing and distributing sufficient quantities of the vaccines. If the general public is unwilling or unable to access effective vaccines and therapies, this may also prolong the COVID-19 pandemic. In addition, new variants of COVID-19 may increase the spread or severity of COVID-19 and previously developed vaccines and therapies may not be as effective against new COVID-19 variants.

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

increased unemployment and decreased consumer confidence and business generally, leading to an increased risk of delinquencies, defaults and foreclosures;
ratings downgrades, credit deterioration and defaults in many industries, including hotel, restaurant, transportation, long-term healthcare, retail and commercial real estate, which may lead to increased provision expense;
a sudden and significant reduction in the valuation of the equity, fixed-income and commodity markets and the significant increase in the volatility of those markets;
as a result of the decline in the Federal Reserve’s target federal funds rate to near 0% (or possibly below 0% in the future), the yield on our assets may decline to a greater extent than the decline in our cost of interest-bearing liabilities, reducing our net interest margin and reducing net income;
a further and sustained decline in our stock price or the occurrence of what management would deem to be a triggering event that could, under certain circumstances, cause management to perform impairment testing on our goodwill and other intangible assets that could result in an impairment charge being recorded for that period, and adversely impact our results of operations and the ability of our subsidiary banks to pay dividends to us;

13

the negative effect on earnings resulting from the subsidiary banks modifying loans and agreeing to loan payment deferrals due to the COVID-19 crisis;
a decrease in fees for customer services;
a reduction in the value of the assets that the Company manages or otherwise administers or services for others, affecting related fee income and demand for the Company’s services;
increased demand on our liquidity as we meet borrowers’ needs and cover expenses related to our business continuity plan;
the potential for reduced liquidity and its negative effect on our capital and leverage ratios;
federal and state taxes may increase, including as a result of the effects of the pandemic on governmental budgets, which could reduce our net income;
FDIC premiums could increase if the agency experiences additional resolution costs;
increased cyber and payment fraud risk due to increased online and remote activity; and
other operational failures due to changes in our normal business practices because of the pandemic and governmental actions to contain it.

Overall, we believe that the economic impact from COVID-19 may be severe and could have a material and adverse impact on our business and result in significant losses in our loan portfolio, all of which would adversely and materially impact our earnings and capital. The speed and strength of any economic recovery from the pandemic is subject to a high degree of uncertainty, but is expected to be affected by further developments in the pandemic.  Among other things, this will depend on the duration of the COVID-19 pandemic, particularly in our markets, the development, distribution and supply of vaccines, therapies and other public health initiatives to control the spread of the disease, the nature and size of federal economic stimulus and other governmental efforts, and the possibility of additional state lockdown or stay-at-home orders in our markets in response to the recent surge in the number of COVID-19 cases.  Even after the COVID-19 pandemic has subsided, we may continue to experience materially adverse impacts to our business as a result of the global economic impact of the COVID-19 pandemic, including the availability of credit, adverse impacts on liquidity and any recession that has occurred or may occur in the future. There are no comparable recent events that provide guidance as to the effect of the spread of COVID-19 as a global pandemic may have, and as a result, the ultimate impact of the pandemic is highly uncertain and subject to change.

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

The federal bank regulatory agencies have issued a steady stream of guidance in response to the COVID-19 pandemic and have taken a number of unprecedented steps to help banks navigate the pandemic and mitigate its impact. These include, without limitation:

requiring banks to focus on business continuity and pandemic planning;
adding pandemic scenarios to stress testing;
encouraging bank use of capital buffers and reserves in lending programs;
permitting certain regulatory reporting extensions;
reducing margin requirements on swaps;

14

permitting certain otherwise prohibited investments in investment funds;
issuing guidance to encourage banks to work with customers affected by the pandemic and encourage loan workouts; and

providing credit under the CRA for certain pandemic-related loans, investments and public service.

The full impact of the COVID-19 pandemic on our business activities as a result of new government and regulatory laws, policies, programs and guidelines, as well as market reactions to such activities, remains uncertain but may ultimately have a material adverse effect on our business and results of operations.

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

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

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

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

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

Economic and Market Risks

Conditions in the financial market and economic conditions, including conditions in the markets in which we operate, generally may adversely affect our business.

We operate primarily in the Quad Cities, Cedar Rapids, Waterloo/Cedar Falls, Des Moines/Ankeny, Iowa and Springfield, Missouri markets.  Our general financial performance is highly dependent upon the business environment in the markets where we operate and in particular, the ability of borrowers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, as well as demand for loans and other products and services it offers. A favorable business environment is generally characterized by, among other factors, economic growth, efficient capital markets, low inflation, low unemployment, high business and investor confidence, and strong business earnings. Unfavorable or uncertain economic and market conditions can be caused by declines in economic growth, business activity

15

or investor or business confidence; limitations on the availability or increases in the cost of credit and capital; increases in inflation or interest rates; high unemployment, natural disasters, pandemics or a combination of these or other factors.

Uncertainty regarding economic conditions may result in changes in consumer and business spending, borrowing and savings habits. Downturns in the markets where our banking operations occur could result in a decrease in demand for our products and services, an increase in loan delinquencies and defaults, high or increased levels of problem assets and foreclosures and reduced wealth management fees resulting from lower asset values. Such conditions could adversely affect the credit quality of our loans, financial condition and results of operations.

Interest rates and other conditions impact our results of operations.

Our profitability is in large part a function of the spread between the interest rates earned on investments and loans/leases and the interest rates paid on deposits and other interest bearing liabilities. Like most banking institutions, our net interest spread and margin will be affected by general economic conditions and other factors, including fiscal and monetary policies of the federal government that influence market interest rates and our ability to respond to changes in such rates. At any given time, our assets and liabilities will be such that they are affected differently by a given change in interest rates. As a result, an increase or decrease in rates, the length of loan/lease terms, and the mix of adjustable and fixed rate loans/leases in our portfolio, the length of time deposits and borrowings and the rate sensitivity of our deposit customers could have a positive or negative effect on our net income, capital and liquidity. We measure interest rate risk under various rate scenarios using specific criteria and assumptions. A summary of this process, along with the results of our net interest income simulations is presented at "Quantitative and Qualitative Disclosures about Market Risk" included under Item 7A of Part II of this Annual Report on Form 10-K. Although we believe our current level of interest rate sensitivity is reasonable and effectively managed, significant fluctuations in interest rates may have an adverse effect on our business, financial condition and results of operations.

Monetary policies and regulations of the Federal Reserve could adversely affect our business, financial condition and results of operations.

In addition to being affected by general economic conditions, our earnings and growth are affected by the policies of the Federal Reserve. An important function of the Federal Reserve is to regulate the money supply and credit conditions. Among the instruments used by the Federal Reserve to implement these objectives are open market operations in U.S. government securities, adjustments of the discount rate and changes in reserve requirements against bank deposits. These instruments are used in varying combinations to influence overall economic growth and the distribution of credit, bank loans, investments and deposits. Their use also affects interest rates charged on loans or paid on deposits.

In March 2020, the Federal Reserve reduced the target federal funds rate and announced a $700 billion quantitative easing program in response to the expected economic downturn caused by the COVID-19 pandemic. In addition, the Federal Reserve reduced the interest it pays on excess reserves. The reductions in interest rates, especially if prolonged, is likely to continue to have an adverse effect our net interest income and margins and our profitability. In December 2020, the Federal Open Market Committee held the target rate at its effective floor of 0.00-0.25% with panelists projecting the target rate to remain at these levels through 2021 and potentially 2022. There is potential that the rate cuts could pose additional risks to the economy primarily through higher inflation and financial-stability concerns driven by low borrowing costs. There is a possibility that labor markets could tighten causing inflationary pressures to build faster than the expected gradual pace. There is additional risk that persistently low interest rates could lead consumers and firms to take on riskier financial investments in search of better returns, increasing asset prices to unsustainable levels. The potential rise in asset prices to unsustainable levels could pose potential financial-stability risks in the commercial real estate and corporate borrowing sectors. Sustained low interest rate periods were something that preceded the 1990 and 2007 recessions, placing significant pressure on real estate asset prices through reach-for-yield investor behavior.

The monetary policies and regulations of the Federal Reserve have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. The effects of such policies upon our business, financial condition and results of operations cannot be predicted.

Declines in asset values may result in impairment charges and adversely affect the value of our investments, financial performance and capital.

The market value of investments in our securities portfolio has become increasingly volatile in recent years, and as of December 31, 2020, we had gross unrealized losses of $772 thousand, or 0.9% of amortized cost, in our investment

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portfolio (offset by gross unrealized gains of $57.8 million). The market value of investments may be affected by factors other than the underlying performance of the servicer of the securities or the mortgages underlying the securities, such as ratings downgrades, adverse changes in the business climate and a lack of liquidity in the secondary market for certain investment securities. On a quarterly basis, we formally evaluate investments and other assets for impairment indicators. We may be required to record additional impairment charges if our investments suffer a decline in value that is considered other-than-temporary. If we determine that a significant impairment has occurred, we would be required to charge against earnings the credit-related portion of the OTTI, which could have a material adverse effect on our results of operations in the periods in which the write-offs occur. Based on management's evaluation, it was determined that the gross unrealized losses at December 31, 2020 were temporary and primarily a function of the changes in certain market interest rates.

The stock market can be volatile, and fluctuations in our operating results and other factors could cause our stock price to decline.

The stock market has experienced, and may continue to experience, fluctuations that significantly impact the market prices of securities issued by many companies. Market fluctuations could also adversely affect our stock price. These fluctuations have often been unrelated or disproportionate to the operating performance of particular companies. These broad market fluctuations, as well as general economic, systemic, political and market conditions, such as recessions, loss of investor confidence, interest rate changes, or international currency fluctuations, may negatively affect the market price of our common stock. Moreover, our operating results may fluctuate and vary from period to period due to the risk factors set forth herein. As a result, period-to-period comparisons should not be relied upon as an indication of future performance. Our stock price could fluctuate significantly in response to our quarterly or annual results and the impact of these risk factors on our operating results or financial position.

Secondary mortgage, government guaranteed loan and interest rate swap market conditions could have a material impact on our financial condition and results of operations.

Currently, we sell a portion of the residential real estate and government guaranteed loans we originate. The profitability of these operations depends in large part upon our ability to make loans and to sell them in the secondary market at a gain. Thus, we are dependent upon the existence of an active secondary market and our ability to profitably sell loans into that market.

In addition to being affected by interest rates, the secondary markets are also subject to investor demand for residential mortgages and government guaranteed loans and investor yield requirements for those loans. These conditions may fluctuate or even worsen in the future. As a result, a prolonged period of secondary market illiquidity may reduce our loan production volumes and could have a material adverse effect on our financial condition and results of operations.

The interest rate swap market is dependent upon market conditions. If interest rates move, interest rate swap transactions may no longer make sense for the Company and/or its customers. Interest rate swaps are generally appropriate for commercial customers with a certain level of expertise and comfort with derivatives, so our success is dependent upon the ability to make loans to these types of commercial customers. Additionally, our ability to execute interest rate swaps is also dependent upon counterparties that are willing to enter into the interest rate swap that is equal and offsetting to the interest rate swap we enter into with the commercial customer.

Regulatory and Legal Risks

We may be materially and adversely affected by the highly regulated environment in which we operate.

The Company and its bank subsidiaries are subject to extensive federal and state regulation, supervision and examination. Banking regulations are primarily intended to protect depositors' funds, FDIC funds, customers and the banking system as a whole, rather than stockholders. These regulations affect our lending practices, capital structure, investment practices, dividend policy and growth, among other things.

As a bank holding company, we are subject to regulation and supervision primarily by the Federal Reserve. QCBT, CRBT and CSB, as Iowa-chartered state member banks, are subject to regulation and supervision primarily by both the Iowa Superintendent and the Federal Reserve. SFCB, as a Missouri-chartered commercial bank, is subject to regulation by both the Missouri Division of Finance and the Federal Reserve. We and our banks undergo periodic examinations by these regulators, who have extensive discretion and authority to prevent or remedy unsafe or unsound practices or violations of law by banks and bank holding companies.  The primary federal and state banking laws and regulations that affect us are

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described in Appendix A “Supervision and Regulation” to this report. These laws, regulations, rules, standards, policies and interpretations are constantly evolving and may change significantly over time.

U.S. financial institutions are also subject to numerous monitoring, recordkeeping, and reporting requirements designed to detect and prevent illegal activities such as money laundering and terrorist financing. These requirements are imposed primarily through the Bank Secrecy Act which was most recently amended by the USA Patriot Act. We have instituted policies and procedures to protect us and our employees, to the extent reasonably possible, from being used to facilitate money laundering, terrorist financing and other financial crimes. There can be no guarantee, however, that these policies and procedures are effective.

Failure to comply with applicable laws, regulations or policies could result in sanctions by regulatory agencies, civil monetary penalties, and/or damage to our reputation, which could have a material adverse effect on us. Although we have policies and procedures designed to mitigate the risk of any such violations, there can be no assurance that such violations will not occur.

Future legislation, regulation, and government policy could affect the banking industry as a whole, including our business and results of operations, in ways that are difficult to predict. In addition, our results of operations also could be adversely affected by changes in the way in which existing statutes and regulations are interpreted or applied by courts and government agencies.

We are required to maintain capital to meet regulatory requirements, and if we fail to maintain sufficient capital, whether due to losses, an inability to raise additional capital or otherwise, our financial condition, liquidity and results of operations, as well as our ability to maintain regulatory compliance, would be adversely affected.

The Company and each of its banking subsidiaries are required by federal and state regulatory authorities to maintain adequate levels of capital to support their operations, which have recently increased due to the effectiveness of the Basel III regulatory capital reforms. We intend to grow our business organically and to explore opportunities to grow our business by taking advantage of attractive acquisition opportunities, and such growth plans may require us to raise additional capital to ensure that we have adequate levels of capital to support such growth on top of our current operations. Our ability to raise additional capital, when and if needed or desired, will depend on conditions in the capital markets, economic conditions and a number of other factors, including investor perceptions regarding the banking industry and market conditions, and governmental activities, many of which are outside our control, and on our financial condition and performance. Accordingly, we cannot assure you that we will be able to raise additional capital if needed or on terms acceptable to us. Our failure to meet these capital and other regulatory requirements could affect customer confidence, our ability to grow, our costs of funds and FDIC insurance costs, our ability to pay dividends on common and preferred stock and to make distributions on our trust preferred securities, our ability to make acquisitions, and our business, results of operations and financial condition.

Climate change and related legislative and regulatory initiatives may result in operational changes and expenditures that could significantly impact our business.

The current and anticipated effects of climate change are creating an increasing level of concern for the state of the global environment. As a result, political and social attention to the issue of climate change has increased. In recent years, governments across the world have entered into international agreements to attempt to reduce global temperatures, in part by limiting greenhouse gas emissions. The U.S. Congress, state legislatures and federal and state regulatory agencies have continued to propose and advance numerous legislative and regulatory initiatives seeking to mitigate the effects of climate change. Consumers and businesses may also change their behavior on their own as a result of these concerns. The impact on our customers will likely vary depending on their specific attributes, including reliance on or role in carbon intensive activities. Our efforts to take these risks into account in making lending and other decisions, including by increasing our business with climate-friendly companies, may not be effective in protecting us from the negative impact of new laws and regulations or changes in consumer or business behavior.

Given the lack of empirical data on the credit and other financial risks posed by climate change, it is difficult to predict how climate change may impact our financial condition and operations; however, as a banking organization, the physical effects of climate change may present certain unique risks. For example, weather disasters, shifts in local climates and other disruptions related to climate change may adversely affect the value of real properties securing our loans, which could diminish the value of our loan portfolio. Such events may also cause reductions in regional and local economic

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activity that may have an adverse effect on our customers, which could limit our ability to raise and invest capital in these areas and communities.

Evolving law impacting cannabis-related businesses in Illinois may have an impact on the Company's operations and risk profile.

The Controlled Substances Act makes it illegal under federal law to manufacture, distribute, or dispense marijuana. Starting January 1, 2020, however, the Illinois Cannabis Regulation and Tax Act began permitting adults to legally purchase marijuana for recreational use from licensed dispensaries. It is the Banks' current policy to avoid knowingly providing banking products or services to entities or individuals that: (i) directly or indirectly manufacture, distribute, or dispense marijuana or hemp products, or those who have a significant financial interest in such entities; and (ii) derive a significant percentage of revenue from providing products or services to, or other involvement with, such entities. The Banks are taking reasonable measures, including appropriate new account screening and customer due diligence measures, to ensure that existing and potential customers do not engage in any such activities. Nonetheless, the shift in Illinois law is increasing the number of direct and indirect cannabis-related businesses in Illinois, and therefore increasing the likelihood that the Banks could interact with such businesses, as well as their owners and employees. Such interactions could create additional legal, regulatory, strategic, and reputational risk to the Banks and the Company.

Credit and Lending Risks

We must effectively manage our credit risk.

There are risks inherent in making any loan, including risks inherent in dealing with specific borrowers, risks of nonpayment, risks resulting from uncertainties as to the future value of collateral and risks resulting from changes in economic and industry conditions. We attempt to minimize our credit risk through prudent loan application approval procedures, careful monitoring of the concentration of our loans within specific industries and periodic independent reviews of outstanding loans by our credit review department and an external third party. However, we cannot assure you that such approval and monitoring procedures will reduce these credit risks.

The majority of our subsidiary banks' loan portfolios are invested in C&I and CRE loans, and we focus on lending to small to medium-sized businesses. The size of the loans we can offer to commercial customers is less than the size of the loans that our competitors with larger lending limits can offer. This may limit our ability to establish relationships with the area's largest businesses. Smaller companies tend to be at a competitive disadvantage and generally have limited operating histories, less sophisticated internal record keeping and financial planning capabilities and fewer financial resources than larger companies. As a result, we may assume greater lending risks than financial institutions that have a lesser concentration of such loans and tend to make loans to larger, more established businesses. Collateral for these loans generally includes accounts receivable, inventory, equipment and real estate. However, depending on the overall financial condition of the borrower, some loans are made on an unsecured basis. In addition to C&I and CRE loans, our subsidiary banks are also active in residential mortgage and consumer lending. Our borrowers may experience financial difficulties, and the level of nonperforming loans, charge-offs and delinquencies could rise, which could negatively impact our business through increased provision, reduced interest income on loans/leases, and increased expenses incurred to carry and resolve problem loans/leases.

C&I loans make up a large portion of our loan/lease portfolio.

C&I loans were $1.7 billion, or approximately 41% of our total loan/lease portfolio, as of December 31, 2020. Our C&I loans are primarily made based on the identified cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. Most often, this collateral is accounts receivable, inventory, equipment and real estate. Credit support provided by the borrower for most of these loans and the probability of repayment is based on the liquidation value of the pledged collateral and enforcement of a personal guarantee, if any exists. Whenever possible, we require a personal guarantee or cosigner on commercial loans. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. The collateral securing these loans may lose value over time, may be difficult to appraise, and may fluctuate in value based on the success of the business. In addition, a prolonged recovery period could harm or continue to harm the businesses of our C&I customers and reduce the value of the collateral securing these loans.

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Our loan/lease portfolio has a significant concentration of CRE loans, which involve risks specific to real estate values.

CRE lending comprises a significant portion of our lending business. Specifically, CRE loans were $2.1 billion, or approximately 50% of our total loan/lease portfolio, as of December 31, 2020. Of this amount, $496.5 million, or approximately 24%, was owner-occupied. The market value of real estate securing our CRE loans can fluctuate significantly in a short period of time as a result of market conditions in the geographic area in which the real estate is located. Adverse developments affecting real estate values in one or more of our markets could increase the credit risk associated with our loan portfolio. Additionally, real estate lending typically involves higher loan principal amounts and the repayment of the loans generally is dependent, in large part, on sufficient income from the properties securing the loans to cover operating expenses and debt service. Economic events or governmental regulations outside of the control of the borrower or lender could negatively impact the future cash flow and market values of the affected properties.

Capital and Liquidity Risks

Liquidity risks could affect operations and jeopardize our business, results of operations and financial condition.

Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of securities and/or loans and other sources could have a substantial negative effect on our liquidity. Our primary sources of funds consist of cash from operations, deposits, investment maturities, repayments, and calls, and loan/lease repayments. Additional liquidity is provided by federal funds purchased from the FRB or other correspondent banks, FHLB advances, wholesale and customer repurchase agreements, brokered deposits, and the ability to borrow at the FRB's Discount Window. Our access to funding sources in amounts adequate to finance or capitalize our activities or on terms that are acceptable to us could be impaired by factors that affect us directly or the financial services industry or economy in general, such as disruptions in the financial markets or negative views and expectations about the prospects for the financial services industry.

During periods of economic turmoil, the financial services industry and the credit markets generally may be materially and adversely affected by significant declines in asset values and depressed levels of liquidity. Furthermore, regional and community banks generally have less access to the capital markets than do the national and super-regional banks because of their smaller size and limited analyst coverage. Any decline in available funding could adversely impact our ability to originate loans/leases, invest in securities, meet our expenses, pay dividends to our stockholders, or fulfill obligations such as repaying our borrowings or meeting deposit withdrawal demands, any of which could have a material adverse impact on our liquidity, business, results of operations and financial condition.

As a bank holding company, our sources of funds are limited.

We are a bank holding company, and our operations are primarily conducted by our subsidiary banks, which are subject to significant federal and state regulation. When available, cash to pay dividends to our stockholders is derived primarily from dividends received from our subsidiary banks. Our ability to receive dividends or loans from our subsidiary banks is restricted. Dividend payments by our subsidiaries to us in the future will require generation of future earnings by them and could require regulatory approval if any proposed dividends are in excess of prescribed guidelines. Further, as a structural matter, our right to participate in the assets of our subsidiary banks in the event of a liquidation or reorganization of any of the banks would be subject to the claims of the creditors of such bank, including depositors, which would take priority except to the extent we may be a creditor with a recognized claim. As of December 31, 2020, our subsidiary banks had deposits, borrowings and other liabilities in the aggregate of approximately $5.2 billion.

Our allowance may prove to be insufficient to absorb losses in our loan/lease portfolio.

We establish our allowance for loan and lease losses in consultation with management of our subsidiaries and maintain it at a level considered adequate by management to absorb loan/lease losses that are inherent in the portfolio. The amount of future loan/lease losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, which may be beyond our control, and such losses may exceed current estimates. At December 31, 2020, our allowance as a percentage of total gross loans/leases was 1.98%, and as a percentage of total NPLs was 574.61%. In accordance with GAAP for acquisition accounting, the loans acquired through the acquisitions of SFCB, Guaranty Bank and CSB were recorded at fair value; therefore, there was no allowance associated with SFCB's, Guaranty Bank's and CSB's loans at acquisition. Management continues to evaluate the allowance needed on the acquired loans factoring in the net remaining discount ($3.1 million at December 31, 2020).

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In addition, we had net charge-offs as a percentage of gross average loans/leases of 0.18% for the year ended December 31, 2020. Because of the concentration of C&I and CRE loans in our loan portfolio, which tend to be larger in amount than residential real estate and installment loans, the movement of a small number of loans to nonperforming status can have a significant impact on these ratios. Although management believes that the allowance as of December 31, 2020 was adequate to absorb losses on any existing loans/leases that may become uncollectible, we cannot predict loan/lease losses with certainty, and we cannot assure you that our allowance will prove sufficient to cover actual loan/lease losses in the future, particularly if economic conditions are more difficult than what management currently expects. Additional provisions and loan/lease losses in excess of our allowance may adversely affect our business, financial condition and results of operations.

Competitive and Strategic Risks

We face intense competition in all phases of our business from other banks and financial institutions.

The banking and financial services businesses in our markets are highly competitive. Our competitors include large regional banks, local community banks, savings and loan associations, securities and brokerage companies, mortgage companies, insurance companies, finance companies, Fintech companies, money market mutual funds, credit unions, online lenders and other non-bank financial services providers. Many of these competitors are not subject to the same regulatory restrictions as we are. Many of our unregulated competitors compete across geographic boundaries and are able to provide customers with a feasible alternative to traditional banking services.

Technology and other changes are allowing consumers and businesses to complete financial transactions that historically have involved banks through alternative methods. For example, the wide acceptance of Internet-based commerce has resulted in a number of alternative payment processing systems and lending platforms in which banks play only minor roles. Customers can now maintain funds in prepaid debit cards or digital currencies, and pay bills and transfer funds directly without the direct assistance of banks.

Increased competition in our markets may result in a decrease in the amounts of our loans and deposits, reduced spreads between loan/lease rates and deposit rates or loan/lease terms that are more favorable to the borrower. Any of these results could have a material adverse effect on our ability to grow and remain profitable. If increased competition causes us to significantly discount the interest rates we offer on loans or increase the amount we pay on deposits, our net interest income could be adversely impacted. If increased competition causes us to modify our underwriting standards, we could be exposed to higher losses from lending and leasing activities. Additionally, many of our competitors are much larger in total assets and capitalization, have greater access to capital markets, have larger lending limits and offer a broader range of financial services than we can offer.

Potential future acquisitions could be difficult to integrate, divert the attention of key personnel, disrupt our business, dilute stockholder value and adversely affect our financial results.

As part of our business strategy, we may consider acquisitions of other banks or financial institutions or branches, assets or deposits of such organizations. There is no assurance, however, that we will determine to pursue any of these opportunities or that if we determine to pursue them that we will be successful. Acquisitions involve numerous risks, any of which could harm our business, including:

difficulties in integrating the operations, technologies, products, existing contracts, accounting processes and personnel of the target company and realizing the anticipated synergies of the combined businesses;
difficulties in supporting and transitioning customers of the target company;
diversion of financial and management resources from existing operations;
the price we pay or other resources that we devote may exceed the value we realize, or the value we could have realized if we had allocated the purchase price or other resources to another opportunity;
risks of entering new markets or areas in which we have limited or no experience or are outside our core competencies;

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potential loss of key employees, customers and strategic alliances from either our current business or the business of the target company;
risks of acquiring loans with deteriorated credit quality;
assumption of unanticipated problems or latent liabilities; and
inability to generate sufficient revenue to offset acquisition costs.

Future acquisitions may involve the issuance of our equity securities as payment or in connection with financing the business or assets acquired, and as a result, could dilute the ownership interests of existing stockholders. In addition, consummating these transactions could result in the incurrence of additional debt and related interest expense, as well as unforeseen liabilities, all of which could have a material adverse effect on our business, results of operations and financial condition. The failure to successfully evaluate and execute acquisitions or otherwise adequately address the risks associated with acquisitions could have a material adverse effect on our business, results of operations and financial condition.

New lines of business or new products and services may subject us to additional risks.

From time to time, we may seek to implement new lines of business or offer new products and services within existing lines of business in our current markets or new markets. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In developing and marketing new lines of business and/or new products and services, we may invest significant time and resources. Initial timetables for the introduction and development of new lines of business and/or new products or services may not be achieved and price and profitability targets may not prove feasible, which could in turn have a material negative effect on our operating results.

If securities or industry analysts do not publish or cease publishing research reports about us, if they adversely change their recommendations regarding our stock or if our operating results do not meet their expectations, the price of our stock could decline.

The trading market for our common stock can be influenced by the research and reports that industry or securities analysts may publish about us, our business, our market or our competitors. If there is limited or no securities or industry analyst coverage of us, the market price for our stock could be negatively impacted. Moreover, if any of the analysts who elect to cover us downgrade our common stock, provide more favorable relative recommendations about our competitors or if our operating results or prospects do not meet their expectations, the market price of our common stock may decline. If one or more of these analysts ceases coverage of us or fails to publish reports on us regularly, demand for our stock could decrease, which could cause our stock price and trading volume to decline.

Our reputation could be damaged by negative publicity.

Reputational risk, or the risk to our business, financial condition or results of operations from negative publicity, is inherent in our business. Negative publicity can result from actual or alleged conduct in a number of areas, including legal and regulatory compliance, lending practices, corporate governance, litigation, inadequate protection of customer data, ethical behavior of our employees, and from actions taken by regulators, ratings agencies and others as a result of that conduct. Damage to our reputation could impact our ability to attract new or maintain existing loan and deposit customers, employees and business relationships.

Accounting and Tax Risks

The FASB has issued an accounting standard update that will result in a significant change in how the Company recognizes credit losses and may have a material impact on our financial condition or results of operations.  

In June 2016, the FASB issued an accounting standard update, "Financial Instruments-Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments," which replaced the current "incurred loss" model for recognizing credit losses with an "expected loss" model referred to as the CECL model. Under the CECL model, the Company will be required to present certain financial assets carried at amortized cost, such as loans held for investment and held-to-maturity investment securities, at the net amount expected to be collected. The measurement of expected credit losses is to be based

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on information from past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset initially recorded on the balance sheet and periodically thereafter. This differs significantly from the "incurred loss" model required under current GAAP, which delays recognition until it is probable a loss has been incurred. The CECL model may create more volatility in the level of the allowance for loan losses.

The new CECL standard became effective for the Company for fiscal years beginning after December 15, 2019 and for interim periods within those fiscal years. On March 27, 2020, the CARES Act, a stimulus package designed in response to the economic disruption created by COVID-19, was signed into law.  The CARES Act includes provisions that, if elected, temporarily delay the required implementation date of ASU 2016-13.  Section 4014 of the CARES Act stipulates that no insured depository institution, bank holding company, or affiliate will be required to comply with ASU 2016-13, beginning on the date of the enactment, March 27, 2020 until the earlier of the two following dates: (1) the date on which the national emergency related to the COVID-19 outbreak is terminated or (2) December 31, 2020.  The Company elected to defer its implementation of ASU 2016-13 as allowed by the CARES Act. On December 27, 2020, former President Trump signed the Consolidated Appropriations Act, which extended this relief to the earlier of the first day of the Company’s fiscal year after the date of the national emergency terminates or January 1, 2022. The Company anticipates recognizing a one-time cumulative-effect adjustment to retained earnings and our allowance for loan losses as of January 1, 2021, as allowed by guidance in 2020. The Company incurred transition costs and expects to incur ongoing costs in maintaining the additional CECL models and methodology, including acquiring forecasts used within the models, which will result in increased capital costs upon initial adoption and over time. The Company estimates an increase in the allowance for estimated losses on loans/leases in the range of $1 million to $3 million upon adoption of CECL at January 1, 2021. See Note 1 to the Consolidated Financial Statements “Summary of Significant Accounting Policies,” for additional information on the Company’s impact of adopting CECL.

The preparation of our Consolidated Financial Statements requires us to make estimates and judgments, which are subject to an inherent degree of uncertainty and which may differ from actual results.

Our Consolidated Financial Statements are prepared in accordance with U.S. GAAP and general reporting practices within the financial services industry, which require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. Some accounting policies, such as those pertaining to our allowance, require the application of significant judgment by management in selecting the appropriate assumptions for calculating financial estimates. By their nature, these estimates and judgments are subject to an inherent degree of uncertainty and actual results may differ from these estimates and judgments under different assumptions or conditions, which may have a material adverse effect on our financial condition or results of operations in subsequent periods.

From time to time, the FASB and the SEC change the financial accounting and reporting standards or the interpretation of those standards that govern the preparation of our external financial statements. These changes are beyond our control, can be difficult to predict and could materially impact how we report our financial condition and results of operations.

Operational Risks

The transition to an alternative reference rate could cause instability and have a negative effect on financial market conditions.

LIBOR represents the interest rate at which banks offer to lend funds to one another in the international interbank market for short-term loans. On July 27, 2017, the U.K. Financial Conduct Authority announced that it will no longer persuade or compel banks to submit rates for the calculation of LIBOR rates after 2021 (the "July 27th Announcement"). The July 27th Announcement indicated that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021, and on November 30, 2020 the Federal Reserve Board, the FDIC and the OCC issued supervisory guidance encouraging banks to cease entering into new contracts that use LIBOR as a reference rate as soon as practicable and in any event by December 31, 2021. The Alternative Reference Rates Committee (“ARRC”) has proposed that the Secured Overnight Financing Rate (“SOFR”) is the rate that represents best practice as the alternative to U.S. dollar-LIBOR for use in derivatives and other financial contracts that are currently indexed to LIBOR. The ARRC has proposed a paced-market transition plan to SOFR from U.S. dollar-LIBOR and organizations are working on industry-wide and company-specific transition plans relating to derivatives and cash markets exposed to LIBOR.

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At this time, it is not possible to predict whether and to what extent any additional reforms to LIBOR may be enacted. Similarly, it is not possible to predict whether SOFR or another rate or rates may become accepted alternatives to LIBOR or the effect of any such changes in views or alternatives on the value of LIBOR-linked securities.

Although the Financial Stability Oversight Council has recommended a transition to an alternative reference rate in the event LIBOR is no longer available after 2021, such plans are still in development and, if enacted, could present challenges. Moreover, contracts linked to LIBOR are vast in number and value, are intertwined with numerous financial products and services, and have diverse parties. The downstream effect of unwinding or transitioning such contracts could cause instability and negatively impact the financial markets and individual institutions. The uncertainty surrounding the sustainability of LIBOR more generally could undermine market integrity and threaten individual financial institutions and the U.S. financial system more broadly.

The Company's information systems may experience an interruption or breach in security and cyber-attacks, all of which could have a material adverse effect on the Company's business.

The Company relies heavily on internal and outsourced technologies, communications, and information systems to conduct its business. Additionally, in the normal course of business, the Company collects, processes and retains sensitive and confidential information regarding our customers. As the Company's reliance on technology has increased, so have the potential risks of a technology-related operation interruption (such as disruptions in the Company's customer relationship management, general ledger, deposit, loan, or other systems) or the occurrence of a cyber-attacks (such as unauthorized access to the Company's systems). These risks have increased for all financial institutions as new technologies, the use of the Internet and telecommunications technologies (including mobile devices) to conduct financial and other business transactions and the increased sophistication and activities of organized crime, perpetrators of fraud, hackers, terrorists and others have also increased. In addition to cyber-attacks or other security breaches involving the theft of sensitive and confidential information, hackers have engaged in attacks against financial institutions, retailers and government agencies, particularly denial of service attacks that are designed to disrupt key business or government services, such as customer-facing web sites. The Company is not able to anticipate or implement effective preventive measures against all security breaches of these types, especially because the techniques used change frequently and because attacks can originate from a wide variety of sources. It is also possible that a cyber incident, such as a security breach, may remain undetected for a period of time, further exposing the Company to technology-related risks.

The Company also faces risks related to cyber-attacks and other security breaches in connection with credit card and debit card transactions that typically involve the transmission of sensitive information regarding the Company's customers through various third parties, including merchant acquiring banks, payment processors, payment card networks and its processors. Some of these parties have in the past been the target of security breaches and cyber-attacks, and because the transactions involve third parties and environments such as the point of sale that the Company does not control or secure, future security breaches or cyber-attacks affecting any of these third parties could impact the Company through no fault of its own, and in some cases it may have exposure and suffer losses for breaches or attacks relating to them. Further cyber-attacks or other breaches in the future, whether affecting the Company or others, could intensify consumer concern and regulatory focus and result in increased costs, all of which could have a material adverse effect on the Company's business. To the extent we are involved in any future cyber-attacks or other breaches, the Company's reputation could be affected, which could also have a material adverse effect on the Company's business, financial condition or results of operations.

System failure or breaches of our network security could subject us to increased operating costs as well as litigation and other liabilities.

The computer systems and network infrastructure we use could be vulnerable to unforeseen problems. Our operations are dependent upon our ability to protect our computer equipment against damage from physical theft, fire, power loss, telecommunications failure or a similar catastrophic event, as well as from security breaches, denial of service attacks, viruses, worms and other disruptive problems caused by hackers. Any damage or failure that causes an interruption in our operations could have a material adverse effect on our financial condition and results of operations. Computer break-ins, phishing and other disruptions could also jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, as well as that of our customers engaging in internet banking activities, which may result in significant liability to us and may cause existing and potential customers to refrain from doing business with us. Although we, with the help of third-party service providers, intend to continue to implement security technology and establish operational procedures to prevent such damage, there can be no assurance that these security measures will be successful. In addition, advances in computer capabilities, new discoveries in the field of cryptography or other developments could result in a compromise or breach of the algorithms we and our third-party service providers use to

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encrypt and protect customer transaction data. Any interruption in, or breach of security of, our computer systems and network infrastructure, or that of our internet banking customers, could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations. The Company may also need to spend additional resources to enhance protective and detective measures or to conduct investigations to remediate any vulnerabilities that arise.

We are subject to certain operational risks, including, but not limited to, customer or employee misconduct or fraud and data processing system failures and errors.

Employee errors and employee and customer misconduct could subject us to financial losses or regulatory sanctions and seriously harm our reputation. Misconduct by our employees could include hiding unauthorized activities from us, improper or unauthorized activities on behalf of our customers or improper use of confidential information. It is not always possible to prevent employee errors and misconduct, and the precautions we take to prevent and detect this activity may not be effective in all cases. Employee errors could also subject us to financial claims for negligence.

We maintain a system of internal controls and insurance coverage to mitigate operational risks, including data processing system failures and errors and customer or employee fraud. Despite having business continuity plans and other safeguards, the Company could still be affected. Should our internal controls fail to prevent or detect an occurrence, and if any resulting loss is not insured or exceeds applicable insurance limits, such failure could have a material adverse effect on our business, financial condition and results of operations.

The success of our SBA lending program is dependent upon the continued availability of SBA loan programs, our status as a preferred lender under the SBA loan programs and our ability to comply with applicable SBA lending requirements.

As an SBA Preferred Lender, we enable our clients to obtain SBA loans without being subject to the potentially lengthy SBA approval process necessary for lenders that are not SBA Preferred Lenders. The SBA periodically reviews the lending operations of participating lenders to assess, among other things, whether the lender exhibits prudent risk management. When weaknesses are identified, the SBA may request corrective actions or impose other restrictions, including revocation of the lender's SBA Preferred Lender status. If we lose our status as an SBA Preferred Lender, we may lose our ability to compete effectively with other SBA Preferred Lenders, and as a result we would experience a material adverse effect to our financial results. Any changes to the SBA program, including changes to the level of guaranty provided by the federal government on SBA loans or changes to the level of funds appropriated by the federal government to the various SBA programs, may also have an adverse effect on our business, results of operations and financial condition.

Historically we have sold the guaranteed portion of our SBA loans in the secondary market. These sales have resulted in our earning premium income and/or have created a stream of future servicing income. There can be no assurance that we will be able to continue originating these loans, that a secondary market will exist or that we will continue to realize premiums upon the sale of the guaranteed portion of these loans. When we sell the guaranteed portion of our SBA loans, we incur credit risk on the retained, non-guaranteed portion of the loans.

In the event of a loss resulting from default and the SBA determines there is a deficiency in the manner in which the loan was originated, funded or serviced by the us, the SBA may require us to repurchase the loan, deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of the principal loss related to the deficiency from us, any of which could adversely affect our business, results of operations and financial condition.

Our community banking strategy relies heavily on our subsidiaries' independent management teams, and the unexpected loss of key managers may adversely affect our operations.

We rely heavily on the success of our bank subsidiaries' independent management teams. Accordingly, much of our success to date has been influenced strongly by our ability to attract and to retain senior management experienced in banking and financial services and familiar with the communities in our market areas. Our ability to retain the executive officers and current management teams of our operating subsidiaries will continue to be important to the successful implementation of our strategy. It is also critical, as we manage our existing portfolio and grow, to be able to attract and retain qualified additional management and loan officers with the appropriate level of experience and knowledge about our market areas to implement our community-based operating strategy. The unexpected loss of services of any key management personnel,

25

or the inability to recruit and retain qualified personnel in the future, could have an adverse effect on our business, financial condition and results of operations. Effective succession planning is also important to our long-term success. Failure to ensure effective transfer of knowledge and smooth transitions involving key employees could hinder our strategic planning and execution.

We have a continuing need for technological change, and we may not have the resources to effectively implement new technology.

The financial services industry continues to undergo rapid technological changes with frequent introductions of new technology-driven products and services. In addition to enabling us to better serve our customers, the effective use of technology increases efficiency and the potential for cost reduction. Our future success will depend in part upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in our operations as we continue to grow our market share. Many of our larger competitors have substantially greater resources to invest in technological improvements. As a result, they may be able to offer additional or superior products to those that we will be able to offer, which would put us at a competitive disadvantage. Accordingly, we cannot provide you with assurance that we will be able to effectively implement new technology-driven products and services or be successful in marketing such products and services to our customers.

We have a substantial amount of debt outstanding and may incur additional indebtedness in the future, which could restrict our operations.

As of December 31, 2020, we had approximately $151.7 million of total indebtedness outstanding at the holding company level. In the future, it is possible that we may not generate sufficient revenues to service or repay our debt, and have sufficient funds left over to achieve or sustain profitability in our operations, meet our working capital and capital expenditure needs, and to pay dividends to our common stockholders.  Moreover, the degree to which we are leveraged could have important consequences for our stockholders, including:

limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;
making it more difficult for us to satisfy our debt and other obligations;
limiting our ability to borrow additional funds, or to sell assets to raise funds, if needed, for working capital, capital expenditures, acquisitions or other purposes;
increasing our vulnerability to general adverse economic and industry conditions, including changes in interest rates; and
placing us at a competitive disadvantage compared to our competitors that have less debt.

Severe weather, natural disasters, pandemic, acts of terrorism or war or other adverse external events could significantly impact the Company's business.

As the Company's operating and market footprint continues to grow, severe weather, natural disasters, pandemic, acts of terrorism or war and other adverse external events could have a significant impact on the Company's ability to conduct business. The Company's current footprint poses a wide variety of potential weather, natural disaster, or other adverse events that could impact the Company in various ways. In addition, such events could affect the stability of the Company's deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue and/or cause the Company to incur additional expenses. The occurrence of any such event could have a material adverse effect on the Company's business, which in turn, could have a material adverse effect on the financial condition and results of operation.

26

Item 1B.    Unresolved Staff Comments

There are no unresolved staff comments.

Item 2.    Properties

The Company’s headquarters is located at 3551 7th Street, Moline, Illinois. The Company and its subsidiaries maintain numerous other facilities, including bank branch locations, which are occupied by the Company and its subsidiaries and which house the executive and primary administrative offices of each respective entity or otherwise facilitate the business operations of the Company and its subsidiaries. Each such property is leased or owned by the Company or its subsidiaries and no such property is subject to any material encumbrance.

The subsidiary banks intend to limit their investment in premises to no more than 50% of their capital. Management believes that the facilities are of sound construction, in good operating condition, are appropriately insured, and are adequately equipped for carrying on the business of the Company.

No individual real estate property amounts to 10% or more of consolidated assets.

Item 3.    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 4.    Mine Safety Disclosures

Not applicable.

27

Part II

Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information.  The common stock, par value $1.00 per share, of the Company is listed on The Nasdaq Global Market under the symbol “QCRH”. The stock began trading on Nasdaq on October 6, 1993. As of February 28, 2021, there were 15,826,953 shares of common stock outstanding held by 684 holders of record. Additionally, there are an estimated 3,500 beneficial holders whose stock was held in the street name by brokerage houses and other nominees as of that date.

Dividends on Common Stock. The Company is heavily dependent on dividend payments from its subsidiary banks to provide cash flow for the operations of the holding company and dividend payments on the Company’s common stock. Under applicable state laws, the banks are restricted as to the maximum amount of dividends that they may pay on their common stock. Applicable Iowa and Missouri laws provide that state-chartered banks in those states may not pay dividends in excess of their undivided profits.

The Company’s ability to pay dividends to its stockholders may be affected by both general corporate law considerations and policies of the Federal Reserve applicable to bank holding companies. The payment of dividends by any financial institution or its holding company is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations, and a financial institution generally is prohibited from paying any dividends if, following payment thereof, the institution would be undercapitalized. See Appendix A “Supervision and Regulation” for additional information regarding regulatory restrictions on the payment of dividends.

The Company also has certain contractual restrictions on its ability to pay dividends. The Company has issued debt securities in public offerings and in private placements. Under the terms of the securities, the Company may be prohibited, under certain circumstances, from paying dividends on shares of its common stock. None of these circumstances existed through the date of filing of this Annual Report on Form 10-K. See Note 17 to the Consolidated Financial Statements for additional information regarding dividend restrictions.

Purchase of Equity Securities by the Company. On February 18, 2020, the Board of Directors of the Company approved a share repurchase program under which the Company is authorized to repurchase, from time to time as the Company deems appropriate, up to 800,000 shares of its outstanding common stock, or approximately 5% of the outstanding shares as of December 31, 2019.   The Company suspended the repurchase of shares on March 16, 2020 due to the uncertainties related to the COVID-19 pandemic and it is uncertain whether or when the Company will resume the repurchase of shares as part of this program in the future.  All shares that were repurchased under the share repurchase program were retired. There were no repurchases of common stock by the Company during the fourth quarter of 2020.

Total number of shares

Maximum number

 

purchased as part of

of shares that may yet

    

Total number of

Average price

publicly announced

be purchased under

 

Period

shares purchased

 

paid per share

 

plans or programs

 

the plans or programs

October 1-31, 2020

100,932

699,068

November 1-30, 2020

100,932

699,068

December 1-31, 2020

100,932

699,068

There were no purchases of common stock by the Company during the years ended December 31, 2019 and 2018.

28

Stockholder Return Performance Graph. The following graph indicates, for the period commencing December 31, 2015 and ending December 31, 2020, a comparison of cumulative total returns for the Company, the Nasdaq Composite Index, and the SNL Bank Nasdaq Index prepared by S&P Global, Charlottesville, Virginia. The graph was prepared at the Company’s request by S&P Global. The information assumes that $100 was invested at the closing price on December 31, 2015 in the common stock of the Company and in each index, and that all dividends were reinvested.

QCR Holdings, Inc.

Graphic

Index

    

12/31/15

    

12/31/16

    

12/31/17

    

12/31/18

    

12/31/19

    

12/31/20

QCR Holdings, Inc.

 

100.00

 

179.22

 

178.16

 

134.20

 

184.62

 

167.92

Nasdaq Composite Index

 

100.00

 

108.87

 

141.13

 

137.12

 

187.44

 

271.64

SNL Bank Nasdaq Index

 

100.00

 

138.65

 

145.97

 

123.04

 

154.47

 

132.56

29

Item 6.    Selected Financial Data

The following “Selected Financial Data” of the Company is derived in part from, and should be read in conjunction with, our Consolidated Financial Statements and the accompanying notes thereto. See Item 8. Financial Statements. Results for past periods are not necessarily indicative of results to be expected for any future period.

Year Ended December 31, 

    

2020

    

2019

    

2018

    

2017

    

2016

 

 

(dollars in thousands, except per share data)

STATEMENT OF INCOME DATA

Interest income

$

198,373

$

216,076

$

182,879

$

135,517

$

106,468

Interest expense

 

31,423

 

60,517

 

40,484

 

19,452

 

11,951

Net interest income

 

166,950

 

155,559

 

142,395

 

116,065

 

94,517

Provision for loan/lease losses

 

55,704

 

7,066

 

12,658

 

8,470

 

7,478

Non-interest income

 

113,798

 

78,768

 

41,541

 

30,482

 

31,037

Non-interest expense (1)

 

151,755

 

155,234

 

119,143

 

97,424

 

81,486

Income tax expense

 

12,707

 

14,619

 

9,015

 

4,946

 

8,903

Net income

 

60,582

 

57,408

 

43,120

 

35,707

 

27,687

PER COMMON SHARE DATA

 

  

 

  

 

  

 

  

 

  

Net income - Basic (2)

$

3.84

$

3.65

$

2.92

$

2.68

$

2.20

Net income - Diluted (2)

 

3.80

 

3.60

 

2.86

 

2.61

 

2.17

Cash dividends declared

 

0.24

 

0.24

 

0.24

 

0.20

 

0.16

Dividend payout ratio

 

6.25

%  

 

6.58

%  

 

8.22

%  

 

7.46

%  

 

7.27

%

Closing stock price

$

39.59

$

43.86

$

32.09

$

42.85

$

43.30

BALANCE SHEET DATA

 

  

 

  

 

  

 

  

 

  

Total assets

$

5,682,797

$

4,909,050

$

4,949,710

$

3,982,665

$

3,301,944

Securities

 

838,131

 

611,341

 

662,969

 

652,382

 

574,022

Total loans/leases

 

4,251,129

 

3,690,205

 

3,732,754

 

2,964,485

 

2,405,487

Allowance

 

84,376

 

36,001

 

39,847

 

34,356

 

30,757

Deposits

 

4,599,137

 

3,911,051

 

3,977,031

 

3,266,655

 

2,669,261

Borrowings

 

177,114

 

278,955

 

404,968

 

309,480

 

290,952

Stockholders' equity: common

 

593,793

 

535,351

 

473,138

 

353,287

 

286,041

KEY RATIOS

 

  

 

  

 

  

 

  

 

  

ROAA (2)

 

1.08

%  

 

1.12

%  

 

0.98

%  

 

1.01

%  

 

0.97

%

ROACE (2)

 

10.70

 

11.31

 

10.62

 

11.51

 

10.56

ROAE (2)

 

10.70

 

11.31

 

10.62

 

11.51

 

10.56

Loans/leases to assets

 

74.81

 

75.36

 

75.41

 

74.43

 

72.85

Loans/leases to deposits

 

92.43

 

94.35

 

93.86

 

90.75

 

90.12

NPAs to total assets

 

0.26

 

0.27

 

0.56

 

0.81

 

0.82

Allowance to total loans/leases

 

1.98

 

0.98

 

1.07

 

1.16

 

1.28

Allowance to NPLs

 

574.61

 

403.87

 

214.79

 

184.28

 

144.85

Net charge-offs to average loans/leases

 

0.18

 

0.11

 

0.21

 

0.19

 

0.14

Average total stockholders' equity to average total assets

 

10.10

 

9.94

 

9.24

 

8.81

 

9.21

(1)Non-interest expense includes several one-time expenses - most notably, $904 thousand, $6.9 million and $3.9 million of acquisition, disposition and post-acquisition compensation, transition and integration costs for 2020, 2019 and 2018, respectively.  See Note 2 to the Consolidated Financial Statements for additional information regarding sales/mergers/acquisitions. In addition, $500 thousand and $3.0 million of goodwill impairment expense is included in non-interest expense for 2020 and 2019, respectively.  See Note 6 to the Consolidated Financial Statements for additional information.  Additionally, non-interest expense includes $3.9 million and $4.6 million of losses on liability extinguishment were related to the prepayment of certain borrowings and deposits for 2020 and 2016, respectively.
(2)Numerator is net income.

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Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

This section generally discusses 2020 and 2019 items and annual comparison between our fiscal 2020 performance compared to our fiscal 2019 performance.  A detailed review of our fiscal 2019 performance compared to our fiscal 2018 performance can be found in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”  This discussion should be read in conjunction with Part II, Item 6 hereof, “Selected Financial Data” and our Consolidated Financial Statements and the accompanying notes thereto included or incorporated by reference elsewhere in this document.

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

GENERAL

The Company was formed in February 1993 for the purpose of organizing QCBT. Over the past twenty-seven years, the Company has grown to include four banking subsidiaries and a number of nonbanking subsidiaries. As of December 31, 2020, the Company had $5.7 billion in consolidated assets, including $4.3 billion in total loans/leases, and $4.6 billion in deposits. The financial results of acquired/merged entities for the periods since their acquisition/merger are included in this report. Further information related to acquired/merged entities has been presented in the Annual Reports previously filed with the SEC corresponding to the year of each acquisition/merger.

IMPACT OF COVID-19

The progression of the COVID-19 pandemic in the United States has had an adverse impact on the Company’s financial condition and results of operations as of and for the year ended December 31, 2020, and could continue to have a complex and significant adverse impact on the economy, the banking industry and the Company in future fiscal periods, all subject to a high degree of uncertainty.

Effects on the Company’s Market Areas

The Company offers commercial and consumer banking products and services primarily in Iowa, Missouri and Illinois.  Each of these three states has recently taken different steps to reopen since COVID-19 thrust the country into lockdown starting in March 2020. The continuation and scope of re-openings in each jurisdiction are subject to change, delay and setbacks based on ongoing regional monitoring of the pandemic. Currently all of the subsidiary banks’ branches are limiting lobby access to appointment only.  

Each state experienced rapidly increasing unemployment levels as a result of the curtailment of business activities, rising from an average of 4.6% in Illinois in March 2020 to an average of 7.5% in December 2020, according to the Illinois Department of Employment Security. The unemployment rate in Illinois has improved from its highest point this year in May 2020 of an average of 15.2%.  Unemployment rose from an average of 4.5% in Missouri in March 2020 to 5.8% in December 2020, according to the Missouri Department of Labor and Industrial Relations.  The unemployment rate in Missouri has improved from its highest point this year in May 2020 of an average of 10.1%.  In Iowa, the unemployment rate dropped to pre-pandemic levels from an average of 3.7% in March 2020 to 3.1% in December 2020, according to the Iowa Workforce Development. The unemployment rate in Iowa improved from its highest point this year in May 2020 of an average of 10.0%.  

Policy and Regulatory Developments

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

The Federal Reserve decreased the range for the Federal Funds Target Rate by 0.50% on March 3, 2020, and by another 1.0% on March 16, 2020, reaching a current range of 0.0 – 0.25%.
On March 27, 2020, former President Trump signed the CARES Act, which established a $2.0 trillion economic stimulus package, which provided for cash payments to individuals, supplemental unemployment

31

insurance benefits and a $349 billion loan program administered through the SBA, referred to as the PPP.  On April 24, 2020, President Trump signed the Paycheck Protection Program and Health Care Enhancement Act, which authorized an additional $310 billion of PPP loans. Under the PPP, small businesses, sole proprietorships, independent contractors and self-employed individuals may apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to limitations and eligibility criteria.  In December 2020, former President Trump signed into law a $900 billion pandemic relief bill to extend several aid programs in the CARES Act that were set to expire on December 31, 2020. The SBA reopened the PPP in January 2021 to allow certain eligible borrowers that previously received a PPP loan to apply for a second draw PPP loan. At least $25 billion has been set aside from second draw PPP loans. The subsidiary banks are participating as lenders in the PPP.
In addition, the CARES Act provides financial institutions the option to temporarily suspend certain requirements under GAAP related to TDRs for a limited period of time to account for the effects of COVID-19.  To be eligible, the modification must be related to COVID-19, existing loan could not be more than 30 days past due as of December 31, 2019 and modification executed between March 1, 2020 and earlier of 60 days after the termination of the National Emergency or December 31, 2020. On December 27, 2020, former President Trump signed the Consolidated Appropriations Act, which extended this relief to the earlier of the first day of the Company’s fiscal year after the date of the national emergency terminates or January 1, 2022.  If a modification does not meet the criteria of the CARES act, a deferral can still be excluded from TDR treatment as long as the modifications meet the regulatory criteria discussed in Note 4 of the Consolidated Financial Statements.
On April 7, 2020, federal banking regulators issued a revised Interagency Statement on Loan Modifications and Reporting for Financial Institutions, which, among other things, encouraged financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations because of the effects of COVID-19, and stated that institutions generally do not need to categorize COVID-19-related modifications as TDRs, and the agencies will not direct supervised institutions to automatically categorize all COVID-19 related loan modifications as TDRs. The regulators have clarified that this guidance may continue to be applied in 2021.
On April 9, 2020, the Federal Reserve announced additional measures aimed at supporting small and midsized business, as well as state and local governments impacted by COVID-19. The Federal Reserve announced the Main Street Business Lending Program, which establishes two new loan facilities intended to facilitate lending to small and midsized businesses: the MSNLF and the MSELF. The combined size of the program will be up to $600 billion. In addition, the Federal Reserve created a Municipal Liquidity Facility to support state and local governments with up to $500 billion in lending, with the Treasury Department backing $35 billion for the facility using funds appropriated by the CARES Act. Finally, the Federal Reserve announced that its Term Asset-Backed Securities Loan Facility will be scaled up in scope to include the triple A-rated tranche of commercial mortgage-backed securities and newly issued collateralized loan obligations. The size of the facility is $100 billion. As of December 31, 2020, the Company is only participating in the PPP and not the Main Street Business Lending Program.

Effects on the Company’s Business

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

32

The Company’s Response

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

The Company implemented its LRP offering to extend qualifying customers’ payments for 90 days.  As of December 31, 2020 there were 126 Bank modifications of loans to commercial and consumer clients totaling $21 million and 71 m2 modifications of loans and leases totaling $7 million for a combined 197 modifications totaling $28 million, representing 0.66% of the total loan and lease portfolio that were currently on deferral.
As the Company moved to protect the health and safety of its employees and clients, digital collaboration and digital banking applications have become business critical.  The Company is using virtual meetings to stay connected with its clients and customers are leveraging the Company’s mobile banking capabilities.  The Company’s digital communications tool is a modern enterprise video application, with an easy, reliable and secure cloud platform for video and audio conferencing, chat and web conferencing across mobile, desktop and room systems.   It has enabled the Company to continue to collaborate in real-time across the enterprise and to meet face-to-face with our clients while working remotely to adhere to the Center for Disease Control’s physical distancing guidelines.  Clients are using the Company’s existing mobile banking and mobile payment capabilities including: on-line banking, remote deposit, on-line retail loan applications and person-to-person payment applications that are available across multiple form factors.  These applications have enabled customers to engage with the Company virtually to meet their community banking needs.  The Company proactively reached out to customers to make sure that they knew how to use these tools and increased their mobile deposit limits to enable expanded use of remote deposit features.  The Company also worked with primary digital banking solution providers to make adjustments to their hosting capabilities to accommodate the unprecedented levels of volume through this digital channel.
The Company implemented its Public Emergency Preparedness Plan (“PEP”).  The PEP was created to coordinate resources in an organized manner to respond to any public emergency that may significantly affect staffing. One of the situations specifically called out in the plan is a health-related event such as a specific threat of influenza, or other disease, creating pandemic conditions.  The goals were to maximize the continuity of the essential services to our customers, protect the health and safety of employees and customers, and minimize adverse financial impact to our institutions. The following strategies were executed:

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

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

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

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

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

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

The Company has processed 1,698 loans for a total of $357.5 million as of December 31, 2020 under the PPP.  The Company is continuing to take PPP applications and is currently processing new loans under newly approved additional funding. PPP loans are included in the C&I category of loans in Note 3 of the Consolidated Financial Statements.

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

33

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

EXECUTIVE OVERVIEW

The Company reported net income of $60.6 million for the year ended December 31, 2020, and diluted EPS of $3.80. For the same period in 2019 the Company reported net income of $57.4 million and diluted EPS of $3.60.

The year ended December 31, 2020 was highlighted by several significant items:

Record net income of $60.6 million, or $3.80 per diluted share
Adjusted net income (non-GAAP) of $63.2 million, or $3.96 per diluted share;
Adjusted NIM (TEY)(non-GAAP) at 3.38%;
Noninterest income of $113.8 million for the year;
Core deposit growth of 22.3% for the year;
Core loan and lease growth of 7.8% for the year, excluding PPP loans;
Provision expense of $55.7 million for the year, increasing ALLL to total loans and leases, excluding PPP loans (non-GAAP) by 114 basis points to 2.12%; and
Nonperforming assets to total assets improved to 0.26% at December 31, 2020.

Following is a table that represents the various net income measurements for the years ended December 31, 2020 and 2019.

Year Ended December 31, 

2020

2019

(dollars in thousands, except per share data)

Net income

$

60,582

$

57,408

Diluted earnings per common share

$

3.80

$

3.60

Weighted average common and common equivalent shares outstanding

 

15,952,637

 

15,967,775

The Company reported adjusted net income (non-GAAP) of $63.2 million, with adjusted diluted EPS of $3.96. See section titled “GAAP to Non-GAAP Reconciliations” for additional information. Adjusted net income for the year excludes a number of non-recurring items, after-tax, most significantly:

$3.1 million of liability extinguishment losses;
$2.0 million of securities gains;
$545 thousand of disposition costs; and
$500 thousand of goodwill impairment expense.

34

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

Year Ended December 31, 

 

2020

    

2019

    

(dollars are in thousands)

Net interest income

$

166,950

$

155,559

Provision expense

 

55,704

 

7,066

Noninterest income

 

113,798

 

78,768

Noninterest expense

 

151,755

 

155,234

Federal and state income tax expense

 

12,707

 

14,619

Net income

$

60,582

$

57,408

The following are some noteworthy developments in the Company’s financial results:

Net interest income grew $11.4 million, or 7.3%, in 2020 compared to the prior year. The increase in 2020 was primarily due to loan growth led by the Company’s specialty finance group and new relationships from PPP loan customers.

Provision expense increased $48.6 million when comparing 2020 to 2019.  The increase in 2020 was primarily attributable to increased qualitative allocations in response to deteriorating economic conditions as related to the effects of COVID-19.  See the “Provision for Loan/Lease Losses” section of this report for additional details.

Noninterest income increased $35.0 million, or 44%, when compared to the prior year.  The increase in 2020 was primarily attributable to higher swap fee income.

Noninterest expense decreased $3.5 million, or 2.2%, in 2020 compared to the prior year, primarily due to a decrease in post-acquisition compensation, transition and integration costs as well as disposition costs, goodwill impairment expense and net cost and gains/losses on operations of other real estate.

STRATEGIC FINANCIAL METRICS

The Company has established strategic financial metrics by which it manages its business and measures its performance. The goals are periodically updated to reflect 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 this Annual Report on Form 10-K. The Company’s strategic financial metrics are as follows:

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

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

Year to Date

Strategic Financial Metric*

    

Key Metric

    

Target

December 31, 2020*

Loans and leases growth organically **

 

Loans and leases growth

 

> 9% annually

7.8

%  

Fee income growth

 

Fee income growth

 

> 6% annually

67.8

%  

Improve operational efficiencies and hold noninterest expense growth

Noninterest expense growth

 

< 5% annually

1.5

%  

* The calculations provided exclude non-core noninterest income and noninterest expense.

** Loans and leases growth excludes PPP loans.

35

STRATEGIC DEVELOPMENTS

The Company took the following actions in 2020 to support our corporate strategy and further the strategic financial metrics shown above:

The Company grew loans and leases organically in 2020 by 7.8%, excluding PPP loans (non-GAAP), reflecting healthy demand across all markets.

Correspondent banking continues to be a core line of business for the Company. The Company is competitively positioned with experienced staff, software systems and processes to continue growing in the four states it currently serves – Iowa, Wisconsin, Missouri and Illinois.  The Company acts as the correspondent bank for 192 downstream banks with total average noninterest bearing deposits of $280.4 million and total average interest bearing deposits of $547.6 million for 2020. This line of business provides a strong source of noninterest bearing and interest bearing deposits, fee income, high-quality loan participations and bank stock loans.

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

Noninterest expense in 2020 totaled $151.8 million as compared to $155.2 million in 2019. Post-acquisition compensation, transition and integration costs were $3.4 million higher in 2019 from the acquisition of SFCB.  Disposition expenses from the sale of RB&T were $3.3 million in 2019 as compared to disposition costs in 2020 of $690 thousand from the sale of the Bates Companies.  Goodwill impairment expense decreased $2.5 million in 2020 as compared to 2019 for goodwill impairment related to the Bates Companies.  Net cost of (income from) and gains/losses on operations of other real estate decreased $4.1 million in 2020 as compared to 2019 from a write-down of OREO property in 2019.

GAAP TO NON-GAAP RECONCILIATIONS

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

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

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

Adjusted net income, adjusted EPS and adjusted ROAA (all non-GAAP measures) are reconciled to net income;

Pre-provision/pre-tax adjusted income and pre-provision/pre-tax adjusted ROAA (all non-GAAP measures) are reconciled to net income;

NIM (TEY) (non-GAAP) and adjusted NIM (non-GAAP) are reconciled to NIM;

Efficiency ratio (non-GAAP) is reconciled to noninterest expense, net interest income and noninterest income; and
ALLL to total loans and leases excluding PPP loans and loan growth annualized excluding PPP loans (all non-GAAP measures) are reconciled to ALLL and total loans and leases.

36

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

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

The pre-provision/pre-tax adjusted income and pre-provision/pre-tax adjusted ROAA are measurements of the Company’s financial performance excluding provision and income taxes as well as non-recurring income and expense items.  The Company’s management believes this financial measure is important to investors as the provision for the year ended December 31, 2020 was materially higher due to the impact of COVID-19.  By excluding the provision and income taxes as well as non-recurring income and expense items, the investor is provided a better comparison to prior periods for analysis.  

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

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

ALLL to total loans and leases, excluding PPP loans, and loan growth annualized, excluding PPP loans, are ratios that management utilizes to compare the Company to its peers.  The Company’s management believes these financial measures are important to investors as total loans and leases for the year ended December 31, 2020 were materially higher due to the addition of PPP loans which are guaranteed by the government and therefore do not necessitate an increase in ALLL.  By excluding the PPP loans, the investor is provided a better comparison to prior years for analysis.

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.

As of

 

GAAP TO NON-GAAP

    

December 31, 

    

December 31, 

 

RECONCILIATIONS

2020

2019

 

 

(dollars in thousands, except per share data)

TCE/TA RATIO

 

  

 

  

Stockholders' equity (GAAP)

$

593,793

$

535,351

Less: Intangible assets

 

85,447

 

89,717

TCE (non-GAAP)

$

508,346

$

445,634

Total assets (GAAP)

$

5,682,797

$

4,909,050

Less: Intangible assets

 

85,447

 

89,717

TA (non-GAAP)

$

5,597,350

$

4,819,333

TCE/TA ratio (non-GAAP)

 

9.08

%  

 

9.25

%

TCE/TA RATIO EXCLUDING PPP LOANS

 

Stockholders' equity (GAAP)

593,793

535,351

Less: PPP loan interest income (post-tax)

7,691

Less: Intangible assets

85,447

89,717

TCE (non-GAAP)

500,655

445,634

Total assets (GAAP)

5,682,797

4,909,050

Less: PPP loans

273,146

Less: Intangible assets

85,447

89,717

TA (non-GAAP)

5,324,204

4,819,333

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

9.40

%  

9.25

%

37

For the Year Ended

 

December 31, 

December 31, 

 

    

2020

2019

 

ADJUSTED NET INCOME

Net income (GAAP)

$

60,582

$

57,408

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

 

  

 

Income:

 

  

 

  

Securities gains (losses), net

$

1,962

$

(22)

Loss on syndicated loan

(210)

Gain on sale of assets and liabilities of subsidiary

8,539

Total non-core income (non-GAAP)

$

1,752

$

8,517

Expense:

 

  

 

  

Losses on liability extinguishment

$

3,087

$

345

Goodwill impairment

500

3,000

Disposition costs

545

2,627

Tax expense on expected liquidation of RB&T BOLI

790

Post-acquisition compensation, transition and integration costs

 

169

 

2,828

Loss on sale of subsidiary

 

110

 

Total non-core expense (non-GAAP)

$

4,411

$

9,590

Adjusted net income (non-GAAP)

$

63,240

$

58,480

PRE-PROVISION/PRE-TAX ADJUSTED INCOME

Net income (GAAP)

$

60,582

$

57,408

Less: Non-core income not tax-effected

2,218

12,258

Plus: Non-core expense not tax-effected

5,469

11,132

Provision expense

55,704

7,066

Federal and state income tax expense

12,707

14,619

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

$

132,244

$

77,966

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

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

$

132,244

$

77,966

Average assets

5,604,074

5,102,980

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

2.36

%

1.53

%

ADJUSTED EPS

 

  

 

  

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

$

63,240

$

58,480

Weighted average common shares outstanding

 

15,771,650

 

15,730,016

Weighted average common and common equivalent shares outstanding

 

15,952,637

 

15,967,775

Adjusted EPS (non-GAAP):

 

  

 

  

Basic

$

4.01

$

3.72

Diluted

$

3.96

$

3.66

ADJUSTED ROAA

 

  

 

  

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

$

63,240

$

58,480

Average Assets

$

5,604,074

$

5,102,980

Adjusted ROAA (annualized) (non-GAAP)

 

1.13

%  

 

1.15

%  

ADJUSTED NIM (TEY)*

 

 

Net interest income (GAAP)

$

166,950

$

155,559

Plus: Tax equivalent adjustment

 

8,216

 

6,727

Net interest income - tax equivalent (non-GAAP)

$

175,166

$

162,286

Less: Accquisition accounting net accretion

3,271

4,344

Adjusted net interest income

171,895

157,942

Average earning assets

$

5,085,659

$

4,703,289

NIM (GAAP)

 

3.28

%  

 

3.31

%  

NIM (TEY) (non-GAAP)

 

3.44

%  

 

3.45

%  

Adjusted NIM (TEY) (non-GAAP)

3.38

%  

3.36

%

EFFICIENCY RATIO

 

  

 

  

Noninterest expense (GAAP)

$

151,755

$

155,234

Net interest income (GAAP)

$

166,950

$

155,559

Noninterest income (GAAP)

 

113,798

 

78,768

Total income

$

280,748

$

234,327

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

 

54.05

%  

 

66.25

%  

ALLLTO TOTAL LOANS AND LEASES, EXCLUDING PPP LOANS

ALLL

$

84,376

$

36,001

Total loans and leases

$

4,251,129

$

3,690,205

Less: PPP loans

273,146

Total loans and leases, excluding PPP loans

$

3,977,983

$

3,690,205

ALLL to total loans and leases, excluding PPP loans

2.12

%

0.98

%

LOAN GROWTH ANNUALIZED, EXCLUDING PPP LOANS

 

  

 

  

Total loans and leases

$

4,251,129

$

3,690,205

Less: PPP loans

 

273,146

 

Total loans and leases, excluding PPP loans

$

3,977,983

$

3,690,205

Loan growth annualized, excluding PPP loans

 

7.80

%  

 

(0.07)

%  

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

38

NET INTEREST INCOME AND MARGIN (TAX EQUIVALENT BASIS) (Non-GAAP)

Net interest income, on a tax equivalent basis, increased 8% to $175.2 million for the year ended December 31, 2020, as compared to the prior year. Excluding the tax equivalent adjustments, net interest income increased 7% for the year ended December 31, 2020 compared to the prior year. Net interest income improved due to several factors:

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

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

Tax Equivalent Basis

GAAP

 

For the Year Ended

For the Year Ended

 

December 31, 

December 31, 

December 31, 

December 31, 

 

2020

2019

2020

2019

 

Average Yield on Interest-Earning Assets

4.06

%  

4.74

%  

3.97

%  

4.46

%

Average Cost of Interest-Bearing Liabilities

0.85

%  

1.66

%  

0.63

%  

1.44

%

Net Interest Spread

3.21

%  

3.08

%  

3.34

%  

3.02

%

NIM

3.44

%  

3.45

%  

3.28

%  

3.31

%

NIM Excluding Acquisition Accounting Net Accretion

3.38

%  

3.36

%  

3.27

%  

3.28

%

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

For the Year Ended

December 31, 

December 31, 

    

2020

    

2019

    

(dollars in thousands)

Acquisition Accounting Net Accretion in NIM

$

3,271

$

4,344

NIM on a tax equivalent basis was down one basis point on a linked-year basis.  Excluding acquisition accounting net accretion, NIM was up two basis points on a linked-year basis.  

The Company's management closely monitors and manages NIM. From a profitability standpoint, an important challenge for the Company's subsidiary banks and leasing company is focusing on quality growth in conjunction with the improvement of their NIMs. Management continually addresses this issue with pricing and other balance sheet management strategies which included better loan pricing, reducing reliance on very rate-sensitive funding, closely managing deposit rate increases and finding additional ways to manage cost of funds through derivatives.

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

39

The Company’s average balances, interest income/expense, and rates earned/paid on major balance sheet categories are presented in the following table:

Year Ended December 31, 

 

2020

2019

2018

 

Interest

Average

Interest

Average

Interest

Average

 

Average

Earned

Yield or

Average

Earned

Yield or

Average

Earned

Yield or

 

Balance

    

or Paid

    

Cost

    

Balance

    

or Paid

    

Cost

    

Balance

    

or Paid

    

Cost

 

(dollars in thousands)

 

ASSETS

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

Interest earning assets:

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

Federal funds sold

$

2,398

$

19

 

0.79

%  

$

8,898

$

203

 

2.29

%

$

20,472

$

338

 

1.65

%

Interest-bearing deposits at financial institutions

 

315,616

 

669

 

0.21

 

179,635

 

3,910

 

2.18

 

66,275

 

1,267

 

1.91

Investment securities (1)

 

715,808

 

26,773

 

3.74

 

635,650

 

24,151

 

3.80

 

659,017

 

23,621

 

3.58

Restricted investment securities

 

20,270

 

1,031

 

5.00

 

21,559

 

1,174

 

5.45

 

22,023

 

1,093

 

4.96

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

 

4,031,567

 

178,097

 

4.42

 

3,857,547

 

193,365

 

5.01

 

3,352,357

 

163,197

 

4.87

Total interest earning assets

$

5,085,659

 

206,589

 

4.06

$

4,703,289

 

222,803

 

4.74

$

4,120,144

 

189,516

 

4.60

Noninterest-earning assets:

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

Cash and due from banks

$

80,208

$

81,645

$

72,920

 

Premises and equipment

 

73,063

 

78,189

 

68,602

 

Less allowance

 

(55,275)

 

(40,953)

 

(38,200)

 

Other

 

420,419

 

280,810

 

168,655

 

Total assets

$

5,604,074

$

5,102,980

$

4,392,121

 

LIABILITIES AND STOCKHOLDERS' EQUITY

 

  

 

  

 

  

 

  

 

  

  

 

  

 

  

 

  

Interest-bearing liabilities:

 

  

 

  

 

  

 

  

 

  

  

 

  

 

  

 

  

Interest-bearing deposits

$

2,797,669

 

11,980

 

0.43

%  

$

2,443,989

 

29,898

1.22

%

$

2,043,314

 

18,651

 

0.91

%

Time deposits

 

690,222

 

11,289

 

1.64

 

966,745

 

20,977

2.17

 

766,020

 

12,024

 

1.57

Short-term borrowings

 

22,625

 

84

 

0.37

 

16,837

 

363

2.16

 

19,458

 

293

 

1.51

FHLB advances

 

74,167

 

1,087

 

1.44

 

108,536

 

2,895

2.67

 

202,715

 

4,768

 

2.35

Other borrowings

 

 

 

 

13,563

 

512

3.77

 

69,623

 

2,749

 

3.95

Subordinated notes

83,404

4,697

5.63

60,883

3,564

5.85

Junior subordinated debentures

 

37,913

 

2,286

 

5.93

 

37,751

 

2,308

6.11

 

37,578

 

1,999

 

5.32

Total interest-bearing liabilities

$

3,706,000

 

31,423

 

0.85

$

3,648,304

 

60,517

1.66

$

3,138,708

 

40,484

 

1.29

Noninterest-bearing demand deposits

$

1,052,375

$

817,473

$

792,885

 

Other noninterest-bearing liabilities

 

279,459

 

129,794

 

54,555

 

Total liabilities

$

5,037,834

$

4,595,571

$

3,986,148

 

Stockholders' equity

 

566,240

 

507,409

 

405,973

 

Total liabilities and stockholders' equity

$

5,604,074

$

5,102,980

$

4,392,121

 

Net interest income

$

175,166

 

$

162,286

 

$

149,032

 

Net interest spread

 

 

 

3.21

%  

 

 

3.08

%

 

 

 

3.31

%

Net interest margin

 

 

 

3.28

%  

 

 

3.31

%

 

 

 

3.46

%

Net interest margin (TEY)(Non-GAAP)

 

 

 

3.44

%  

 

 

3.45

%

 

 

 

3.62

%

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

3.38

%

3.36

%

3.48

%

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

 

137.23

%  

 

 

 

128.92

%  

 

131.27

%  

 

 

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

40

The Company’s components of change in net interest income are presented in the following table:

For the years ended December 31, 2020 and 2019

Inc./(Dec.)

Components

from

of Change (1)

 

Prior Year

    

Rate

    

Volume

2020 vs. 2019

(dollars in thousands)

INTEREST INCOME

  

 

  

 

  

Federal funds sold

$

(184)

$

(88)

$

(96)

Interest-bearing deposits at financial institutions

 

(3,241)

 

(4,985)

 

1,744

Investment securities (2)

 

2,622

 

(382)

 

3,004

Restricted investment securities

 

(143)

 

(83)

 

(60)

Gross loans/leases receivable (2) (3)

 

(15,268)

 

(23,679)

 

8,411

Total change in interest income

$

(16,214)

$

(29,217)

$

13,003

INTEREST EXPENSE

 

  

 

  

 

  

Interest-bearing deposits

$

(17,918)

$

(21,725)

$

3,807

Time deposits

 

(9,688)

 

(4,462)

 

(5,226)

Short-term borrowings

 

(279)

 

(372)

 

93

Federal Home Loan Bank advances

 

(1,808)

 

(1,071)

 

(737)

Other borrowings

 

(512)

 

(256)

 

(256)

Subordinated notes

1,133

1,133

Junior subordinated debentures

 

(22)

 

 

(22)

Total change in interest expense

$

(29,094)

$

(27,886)

$

(1,208)

Total change in net interest income

$

12,880

$

(1,331)

$

14,211

(1)The column "Inc/(Dec) from Prior Year" 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 loans are determined on a tax equivalent basis using a 21% tax rate.
(3)Loan/lease fees are not material and are included in interest income from loans/leases receivable in accordance with accounting and regulatory guidance.

The Company’s operating results are also impacted by various sources of noninterest income, including trust department fees, investment advisory and management fees, deposit service fees, swap fee income, gains from the sales of residential real estate loans and government guaranteed loans, earnings on BOLI and other income. Offsetting these items, the Company incurs noninterest expenses, which include salaries and employee benefits, occupancy and equipment expense, professional and data processing fees, FDIC and other insurance expense, loan/lease expense and other administrative expenses.

The Company’s operating results are also affected by economic and competitive conditions, particularly changes in interest rates, income tax rates, government policies and actions of regulatory authorities.

CRITICAL ACCOUNTING POLICIES

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

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

GOODWILL

The Company records all assets and liabilities purchased in an acquisition, including intangibles, at fair value. Goodwill is not amortized but is subject, at a minimum, to annual tests for impairment. In certain situations, interim impairment tests may be required if events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.

The initial recognition of goodwill and subsequent impairment analysis requires us to make subjective judgments concerning estimates of how the acquired assets will perform in the future using valuation methods, which may include using the current market price of stock or discounted cash flow analyses. Additionally, estimated cash flows may extend

41

beyond five years and, by their nature, are difficult to determine over an extended timeframe. Events and factors that may significantly affect the estimates include, among others, competitive forces, customer behaviors, changes in revenue growth trends, cost structures, technology, changes in discount rates and market conditions. In determining the reasonableness of cash flow estimates, the Company reviews historical performance of the underlying assets or similar assets in an effort to assess and validate assumptions utilized in its estimates.

In assessing the fair value of reporting units, we may consider the stage of the current business cycle and potential changes in market conditions. We may also utilize other information to validate the reasonableness of our valuations, including public market comparables and multiples of recent mergers and acquisitions of similar businesses. Valuation multiples may be based on tangible capital ratios of comparable companies and business segments. These multiples may be adjusted to consider competitive differences, including size, operating leverage and other factors. The carrying amount of a reporting unit is determined based on the capital required to support the reporting unit’s activities, including its tangible and intangible assets. The determination of a reporting unit’s capital allocation requires judgment and considers many factors, including the regulatory capital regulations and capital characteristics of comparably situated companies in relevant industry sectors. In certain circumstances, the Company will engage a third-party to independently validate our assessment of the fair value of our reporting units.

The Company assesses the impairment of goodwill whenever events or changes in circumstances indicate the carrying value may not be recoverable. Factors considered important, which could trigger an impairment review, include the following:

Significant under-performance relative to expected historical or projected future operating results;
Significant changes in the manner of use of the acquired assets or the strategy for the overall business;
Significant negative industry or economic trends;
Significant decline in the market price for our common stock over a sustained period; or
Market capitalization relative to net book value.

Due to the economic impact of COVID-19 during the first quarter of 2020, management concluded that factors such as the decline in macroeconomic conditions led to the occurrence of a triggering event and therefore an interim impairment test over goodwill was performed as of March 31, 2020.  Based upon the results of the interim goodwill assessment during the first quarter of 2020, the Company concluded that an impairment did not exist on the bank reporting units as of the time of the assessment. There was no occurrence of a triggering event in the second or third quarter of 2020, therefore no impairment test of goodwill was performed as of June 30, 2020 or September 30, 2020. When such an assessment is performed, should the Company conclude that all or a portion of goodwill is impaired, a non-cash charge for the amount of such impairment would be recorded to earnings.  Such a charge would have no impact on tangible capital or regulatory capital.  

During the first quarter of 2020, the Company incurred goodwill impairment expense of $500 thousand related to the Bates Companies.  This was the result of the announcement of the sale of the Bates Companies as discussed in the Company’s financial statements and the accompanying notes presented elsewhere in this Annual Report on Form 10-K.

As of November 30, 2020 the Company’s management performed an annual assessment at the reporting unit level and determined no goodwill impairment existedfo.

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, governmental guarantees, payment status, changes in nonperforming loans/leases, and other factors. Quantitative factors also incorporate known information about individual loans/leases, including borrowers’ sensitivity to interest rate movements.

Qualitative factors include the general economic environment in the Company’s markets, including economic conditions both locally and nationally, and in particular the economic health of certain industries. Size and complexity of individual credits in relation to loan/lease structure, existing loan/lease policies and pace of portfolio growth are other qualitative factors that are considered in the methodology. As the Company adds new products and increases the complexity of its loan/lease portfolio, it enhances its methodology accordingly.

42

Management may report a materially different amount for the provision in the statement of operations to change the allowance if its assessment of the above factors were different. The discussion regarding the Company’s allowance should be read in conjunction with the Company’s financial statements and the accompanying notes presented elsewhere in this Annual Report on Form 10-K, as well as the portion of this MD&A section entitled “Financial Condition – Allowance for Estimated Losses on Loans/Leases.”

The Company believes that as a result of the COVID-19 pandemic losses have been incurred that are not yet known and this could have an adverse effect in the future.  Disruption to the Company’s customers could result in increased loan delinquencies and defaults resulting in an increase in quantitative allocations.  Management believes impaired loans may increase in the future as a result of the COVID-19 pandemic, having a direct impact on the specific component of the allowance for loan and lease losses.

Although management believes the level of the allowance as of December 31, 2020 was adequate to absorb losses inherent 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 FOR THE YEARS ENDED DECEMBER 31, 2020 and 2019

INTEREST INCOME

For 2020, interest income decreased $17.7 million, or 8% primarily due to a decline in the yield of average loans/leases of 59 basis points. In total, the Company’s average interest-earning assets increased $382.4 million, or 8%, year-over-year. Average loans/leases grew 5%, while average securities increased 13%.

In 2020, the Company continued to grow its securities portfolio with increases in its portfolio of tax exempt municipal securities. The large majority of these securities are privately placed debt issuances by municipalities located in the Midwest and require a thorough underwriting process before investment. Execution of this strategy has led to increased interest income on a tax equivalent basis over the past several years. Management understands that this strategy has extended the duration of its securities portfolio and continually evaluates the combined benefit of increased interest income and reduced effective income tax rate and the impact on interest rate risk.

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

INTEREST EXPENSE

Comparing 2020 to 2019, interest expense decreased $29.1 million, or 48%, year-over-year. Average interest-bearing liabilities increased 2% in 2020. The Company has grown organically at a significant pace over the past several years. Loan growth has been funded by core deposits and has also allowed the Company to prepay brokered deposits and FHLB advances.  In the second half of 2019 and the full year of 2020, the Company’s cost of funds declined in conjunction with the now declining rate environment.  The Company’s cost of funds was 0.85% at December 31, 2020, which was down from 1.66% at December 31, 2019.

Cost of funds decreased 81 basis points when comparing cost of funds in 2020 to cost of funds in 2019.

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 Company’s provision totaled $55.7 million for 2020, an increase of $48.6 million from 2019. The increase in 2020 was primarily attributable to increased qualitative allocations in response to deteriorating economic conditions as related to the effects of COVID-19 and new qualitative allocations on acquired loans that previously had no allowance. The Company anticipates the provision could remain elevated in future periods due to the broad reach of COVID-19 across many impacted individuals and industries.  The dramatic slowdown in economic activity will likely continue to negatively impact the credit quality of the Company’s loan portfolio with increased levels of loan defaults.  The CARES Act provides

43

significant resources for individuals and industries that could lessen the impact of COVID-19, in addition to the Company’s own loan relief programs.

The allowance for loan/lease losses 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 the risk associated with the loans/leases in the portfolio as described in more detail in the “Critical Accounting Policies” section.

The Company had an allowance of 1.98% of total gross loans/leases at December 31, 2020, compared to 0.98% of total gross loans/leases at December 31, 2019.  Management evaluates the allowance needed on the acquired loans factoring in the remaining discount, which was $3.1 million and $7.0 million at December 31, 2020 and 2019, respectively.

The Company’s allowance to total NPLs was 574.61% at December 31, 2020, which was up from 403.87% at December 31, 2019.

The fluctuations in these ratios were the result of the increase in ALLL related to the effects of COVID-19.

The Company estimates an increase in the allowance for estimated losses on loans/leases in the range of $1 million to $3 million upon adoption of CECL at January 1, 2021. The after-tax charge will result in an adjustment to the stockholders' equity effective January 1, 2021. See Note 1 Summary of Significant Accounting Policies of the notes to consolidated financial statements for additional information on the Company’s impact of adoption.

NONINTEREST INCOME

The following tables set forth the various categories of noninterest income for the years ended December 31, 2020 and 2019.

Year Ended

 

December 31, 

December 31, 

 

2020

    

2019

    

$ Change

    

% Change

 

Trust department fees

$

9,207

$

9,559

$

(352)

 

(3.7)

%

Investment advisory and management fees

 

5,318

 

6,995

 

(1,677)

 

(24.0)

Deposit service fees

 

6,041

 

6,812

 

(771)

 

(11.3)

Gains on sales of residential real estate loans, net

 

4,680

 

2,571

 

2,109

 

82.0

Gains on sales of government guaranteed portions of loans, net

 

224

 

748

 

(524)

 

(70.1)

Swap fee income

 

74,821

 

28,295

 

46,526

 

164.4