10-Q 1 qcrh32003_10q.txt U.S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [ x ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2003 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ---------------------- ----------------- Commission file number 0-22208 QCR HOLDINGS, INC. ------------------------------------------------------ (Exact name of Registrant as specified in its charter) Delaware 42-1397595 -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer ID Number) incorporation or organization) 3551 7th Street, Suite 204, Moline, Illinois 61265 -------------------------------------------------- (Address of principal executive offices) (309) 736-3580 ---------------------------------------------------- (Registrant's telephone number, including area code) Check whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ x ] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date: As of May 1, 2003, the Registrant had outstanding 2,775,576 shares of common stock, $1.00 par value per share. Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [ x ] 1 QCR HOLDINGS, INC. AND SUBSIDIARIES INDEX Page Number Part I FINANCIAL INFORMATION Item 1 Consolidated Financial Statements (Unaudited) Consolidated Balance Sheets, March 31, 2003 and December 31, 2002 3 Consolidated Statements of Income, For the Three Months Ended March 31, 2003 and 2002 4 Consolidated Statements of Cash Flows, For the Three Months Ended March 31, 2003 and 2002 5 Notes to Consolidated Financial Statements 6-9 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 10-19 Item 3 Quantitative and Qualitative Disclosures 20 About Market Risk Item 4 Controls and Procedures 20-21 Part II OTHER INFORMATION Item 1 Legal Proceedings 22 Item 2 Changes in Securities and Use of Proceeds 22 Item 3 Defaults Upon Senior Securities 22 Item 4 Submission of Matters to a Vote of Security Holders 22 Item 5 Other Information 22 Item 6 Exhibits and Reports on Form 8-K 22 Signatures 23-25 2 QCR HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED) March 31, 2003 and December 31, 2002 March 31, December 31, 2003 2002 ------------------------------ ASSETS Cash and due from banks ........................................................ $ 29,253,606 $ 24,906,003 Federal funds sold ............................................................. 12,685,000 14,395,000 Interest-bearing deposits at financial institutions ............................ 14,009,735 14,568,142 Securities held to maturity, at amortized cost ................................. 425,278 425,332 Securities available for sale, at fair value ................................... 87,442,298 81,228,749 ------------------------------ 87,867,576 81,654,081 ------------------------------ Loans receivable held for sale ................................................. 20,661,446 23,691,004 Loans receivable held for investment ........................................... 451,477,346 426,044,732 Less: Allowance for estimated losses on loans .................................. (7,440,700) (6,878,953) ------------------------------ 464,698,092 442,856,783 ------------------------------ Premises and equipment, net .................................................... 9,016,042 9,224,542 Accrued interest receivable .................................................... 3,348,686 3,221,246 Other assets ................................................................... 2,137,959 13,774,559 ------------------------------ Total assets ........................................................... $ 623,016,696 $ 604,600,356 ============================== LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Deposits: Noninterest-bearing ......................................................... $ 89,972,184 $ 89,675,609 Interest-bearing ............................................................ 357,582,704 345,072,014 ------------------------------ Total deposits ............................................................ 447,554,888 434,747,623 ------------------------------ Short-term borrowings .......................................................... 35,384,810 32,862,446 Federal Home Loan Bank advances ................................................ 77,444,012 74,988,320 Other borrowings ............................................................... 7,000,000 5,000,000 Company obligated manditorily redeemable preferred securities of subsidiary trust holding solely subordinated debentures ................... 12,000,000 12,000,000 Other liabilities .............................................................. 6,102,264 8,415,365 ------------------------------ Total liabilities ...................................................... 585,485,974 568,013,754 ------------------------------ STOCKHOLDERS' EQUITY Common stock, $1 par value; shares authorized 5,000,000; ....................... 2,833,358 2,823,061 March 2003 - shares issued 2,833,358 and outstanding 2,773,212 December 2002 - 2,823,061 and 2,762,915 respectively Additional paid-in capital ..................................................... 16,792,866 16,761,423 Retained earnings .............................................................. 16,539,548 15,712,600 Accumulated other comprehensive income ......................................... 2,219,486 2,144,054 ------------------------------ 38,385,258 37,441,138 Less cost of 60,146 common shares acquired for the treasury .................... (854,536) (854,536) ------------------------------ Total stockholders' equity ............................................. 37,530,722 36,586,602 ------------------------------ Total liabilities and stockholders' equity ............................. $ 623,016,696 $ 604,600,356 ==============================
See Notes to Consolidated Financial Statements 3 QCR HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) Three Months Ended March 31 2003 2002 ------------------------------------- Interest and dividend income: Loans, including fees .................................. $6,809,229 $5,842,513 Securities: Taxable .......................................... 806,169 818,673 Nontaxable ....................................... 120,257 107,022 Interest-bearing deposits at financial institutions .... 123,062 210,158 Federal funds sold ..................................... 47,350 103,619 ----------------------- Total interest and dividend income ................ 7,906,067 7,081,985 ----------------------- Interest expense: Deposits .............................................. 1,869,065 2,103,234 Short-term borrowings ................................. 87,308 120,251 Federal Home Loan Bank advances ....................... 766,247 556,910 Other borrowings ...................................... 51,960 66,114 Company obligated manditorily redeemable preferred securities ............................. 283,376 283,376 ----------------------- Total interest expense ............................ 3,057,956 3,129,885 ----------------------- Net interest income ............................... 4,848,111 3,952,100 Provision for loan losses .................................. 1,330,427 497,500 ----------------------- Net interest income after provision for loan losses 3,517,684 3,454,600 ---------------------- Noninterest income: Merchant credit card fees, net of processing costs ..... 337,493 414,260 Trust department fees .................................. 561,142 593,758 Deposit service fees ................................... 330,848 255,435 Gains on sales of loans, net ........................... 955,409 418,095 Other .................................................. 303,931 147,125 ----------------------- Total noninterest income .......................... 2,488,823 1,828,673 ----------------------- Noninterest expenses: Salaries and employee benefits ......................... 2,884,792 2,538,376 Professional and data processing fees .................. 429,070 326,536 Advertising and marketing .............................. 148,756 148,287 Occupancy and equipment expense ........................ 651,697 605,659 Stationery and supplies ................................ 110,277 125,271 Postage and telephone .................................. 153,565 126,673 Other .................................................. 405,686 524,385 ----------------------- Total noninterest expenses ........................ 4,783,843 4,395,187 ----------------------- Income before income taxes ........................ 1,222,664 888,086 Federal and state income taxes .............................. 395,716 274,003 ----------------------- Net income ........................................ $ 826,948 $ 614,083 ======================= Earnings per common share: Basic ............................................. $ 0.30 $ 0.22 Diluted ........................................... $ 0.29 $ 0.22 Weighted average common shares outstanding ........ 2,767,013 2,743,668 Weighted average common and common equivalent ..... 2,827,727 2,804,909 shares outstanding Comprehensive income ........................................ $ 902,380 $ 431,184
See Notes to Consolidated Financial Statements 4 QCR HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Three Months Ended March 31 2003 2002 -------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income ......................................................... $ 826,948 $ 614,083 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation ..................................................... 260,564 239,463 Provision for loan losses ........................................ 1,330,427 497,500 Amortization of offering costs on subordinated debentures ........ 7,376 7,376 Amortization of premiums on securities, net ...................... 113,510 40,993 Loans originated for sale ........................................ (62,183,071) (29,717,764) Proceeds on sales of loans ....................................... 66,168,038 37,526,773 Net gains on sales of loans ...................................... (955,409) (418,095) Net losses on sales of premises and equipment .................... 40,299 0 Tax benefit of nonqualified stock options exercised .............. 97,538 0 Increase in accrued interest receivable .......................... (127,440) (103,856) (Increase) decrease in other assets .............................. 11,608,294 (4,874,257) Increase (decrease) in other liabilities ......................... (2,174,955) 109,727 --------------------------- Net cash provided by operating activities ..................... $ 15,012,119 $ 3,921,943 --------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Net increase in federal funds sold ................................. 1,710,000 340,000 Net (increase) decrease in interest-bearing deposits at financial institutions ........................................... 558,407 (5,658,111) Activity in available-for-sale securities: Purchases ...................................................... (11,597,571) (9,133,140) Calls and maturities ........................................... 4,000,000 1,500,000 Paydowns ....................................................... 1,391,185 476,149 Activity in life insurance contracts: Purchases ..................................................... 0 (401,087) (Increase) decrease in cash value ............................. (24,257) 178,182 Net loans originated and held for investment ....................... (26,201,294) (24,578,211) Purchase of premises and equipment ................................. (314,430) (121,131) Proceeds from sales of premises and equipment ...................... 222,067 0 ---------------------------- Net cash used in investing activities ......................... $(30,255,893) $(37,397,349) --------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Net increase in deposit accounts ................................... 12,807,265 20,114,798 Net increase in short-term borrowings .............................. 2,522,364 4,844,322 Activity in Federal Home Loan Bank advances: Advances ...................................................... 3,900,000 7,500,000 Payments ...................................................... (1,444,308) (173,411) Net increase in other borrowings ................................... 2,000,000 0 Payment of cash dividend ........................................... (138,146) 0 Proceeds from issuance of common stock, net ........................ (55,798) (6,501) --------------------------- Net cash provided by financing activities ..................... $ 19,591,377 $ 32,279,208 --------------------------- Net increase (decrease) in cash and due from banks ............ 4,347,603 (1,196,198) Cash and due from banks, beginning ........................................... 24,906,003 19,691,318 --------------------------- Cash and due from banks, ending .............................................. $ 29,253,606 $ 18,495,120 =========================== Supplemental disclosure of cash flow information, cash payments for: Interest ........................................................... $ 3,449,277 $ 3,061,257 =========================== Income/franchise taxes ............................................. $ 1,624,553 $ 357,160 =========================== Supplemental schedule of noncash investing activities: Change in accumulated other comprehensive income, unrealized gains (losses) on securities available for sale, net .... $ 75,432 $ (182,899) ===========================
See Notes to Consolidated Financial Statements 5 Part I Item 1 QCR HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) MARCH 31, 2003 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of presentation: The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include information or footnotes necessary for a fair presentation of financial position, results of operations and changes in financial condition in conformity with accounting principles generally accepted in the United States of America. However, all adjustments that are, in the opinion of management, necessary for a fair presentation have been included. Any differences appearing between numbers presented in financial statements and management's discussion and analysis are due to rounding. Results for the period ended March 31, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003. Certain amounts in the prior period financial statements have been reclassified, with no effect on net income or stockholders' equity, to conform with the current period presentation. From the Company's formation in February 1993 through June 30, 2002, its fiscal year end had been June 30th. In 2002, the Company changed its fiscal year end to December 31st. The Company filed a Form 10-K with the Securities and Exchange Commission for the transition period July 1, 2002 through December 31, 2002. Principles of consolidation: The accompanying consolidated financial statements include the accounts of QCR Holdings, Inc. (the "Company"), a Delaware corporation, and its wholly owned subsidiaries, Quad City Bank and Trust Company ("Quad City Bank & Trust"), Cedar Rapids Bank and Trust Company ("Cedar Rapids Bank & Trust"), Quad City Bancard, Inc. ("Bancard"), Allied Merchant Services, Inc. ("Allied"), QCR Capital Trust I ("Capital Trust"), and Quad City Liquidation Corporation ("QCLC"). All significant intercompany accounts and transactions have been eliminated in consolidation. In addition to these six wholly owned subsidiaries, the Company has an aggregate investment of $325 thousand in four associated companies, Nobel Electronic Transfer, LLC, Nobel Real Estate Investors, LLC, Velie Plantation Holding Company, and Clarity Merchant Services, Inc. Stock-based compensation plans: The Company accounts for its stock-based employee compensation plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation. Three Months Three Months Ended Ended March 31, March 31, 2003 2002 ----------------------------- Net income, as reported ...................... $ 826,948 $ 614,083 Deduct total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects ......... (26,197) (22,469) ----------------------------- Net income ........................... $ 800,751 $ 591,614 ============================= Earnings per share: Basic: As reported .............................. $ 0.30 $ 0.22 Pro formsa ............................... 0.29 0.22 Diluted: As reported .............................. 0.29 0.22 Pro forma ................................ 0.28 0.21 6 In determining compensation cost using the fair value method prescribed in Statement No. 123, the value of each grant is estimated at the grant date with the following weighted-average assumptions for grants during the three months ended March 31, 2003 and 2002: dividend rate of 0.59% for the three months ended March 31, 2003 and 0% for the three months ended March 31, 2002; expected price volatility of 23.87% to 24.54%; risk-free interest rate based upon current rates at the date of grant (4.33% to 5.62% for stock options and 1.16% to 1.29% for employee stock purchase plan); and expected lives of 10 years for stock options and 3 months to 6 months for employee stock purchase plan. NOTE 2 - EARNINGS PER SHARE The following information was used in the computation of earnings per share on a basic and diluted basis. Three months ended March 31, --------------------------- 2003 2002 --------------------------- Net income, basic and diluted earnings ............................... $ 826,948 $ 614,083 =========================== Weighted average common shares outstanding ................................ 2,767,013 2,743,668 Weighted average common shares issuable upon exercise of stock options .................................... 60,714 61,241 --------------------------- Weighted average common and common equivalent shares outstanding ............................ 2,827,727 2,804,909 =========================== NOTE 3 - BUSINESS SEGMENT INFORMATION Selected financial information on the Company's business segments is presented as follows for the three-month periods ended March 31, 2003 and 2002, respectively. 2003 2002 --------------------------------- Revenue: Commercial banking ................ $ 9,354,948 $ 7,824,928 Credit card processing ............ 381,510 453,618 Trust management .................. 561,142 593,758 All other ......................... 97,290 38,354 --------------------------------- Total revenue ................ $ 10,394,890 $ 8,910,658 ================================= Net income (loss): Commercial banking ................ $ 879,706 $ 805,439 Credit card processing ............ 157,707 (45,493) Trust management .................. 128,652 173,492 All other ......................... (339,117) (319,355) --------------------------------- Total net income ............. $ 826,948 $ 614,083 ================================= NOTE 4 - COMMITMENTS AND CONTINGENCIES In the normal course of business, the Banks make various commitments and incur certain contingent liabilities that are not presented in the accompanying consolidated financial statements. The commitments and contingent liabilities include various guarantees, commitments to extend credit, and standby letters of credit. 7 Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Banks evaluate each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Banks upon extension of credit, is based upon management's credit evaluation of the counter-party. Collateral held varies but may include accounts receivable, marketable securities, inventory, property, plant and equipment, and income-producing commercial properties. Standby letters of credit are conditional commitments issued by the Banks to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements and, generally, have terms of one year, or less. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Banks hold collateral, as described above, supporting those commitments if deemed necessary. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Banks would be required to fund the commitments. The maximum potential amount of future payments the Banks could be required to make is represented by the contractual amount. If the commitment is funded the Banks would be entitled to seek recovery from the customer. At March 31, 2003 and December 31, 2002 no amounts have been recorded as liabilities for the Banks' potential obligations under these guarantees. As of March 31, 2003 and December 31, 2002, commitments to extend credit aggregated $154,693,000 and $165,163,000, respectively. As of March 31, 2003 and December 31, 2002, standby letters of credit aggregated $5,416,000 and $4,914,000, respectively. Management does not expect that all of these commitments will be funded. The Company has also executed contracts for the sale of mortgage loans in the secondary market in the amount of $20,661,446 and $23,691,004, at March 31, 2003 and December 31, 2002, respectively. These amounts are included in loans held for sale at the respective balance sheet dates. Bancard is subject to the risk of chargebacks from cardholders and the merchant being incapable of refunding the amount charged back. Management attempts to mitigate such risk by regular monitoring of merchant activity and in appropriate cases, holding cash reserves deposited by the merchant. The Company also has a guarantee to MasterCard International Incorporated, which is backed up by a performance bond in the amount of $1,000,000. As of March 31, 2003 and December 31, 2002 there were no significant pending liabilities. A significant portion of residential mortgage loans sold to investors in the secondary market are sold with recourse. Specifically, certain loan sales agreements provide that if the borrower becomes delinquent a number of payments or a number of days, within six months to one year of the sale, the Banks must repurchase the loan from the subject investor. The Banks did not repurchase any loans from secondary market investors under the terms of these loan sales agreements during the three and six months ended March 31, 2003 and December 31, 2002, respectively. In the opinion of management, the risk of recourse to the Banks is not significant and, accordingly, no liability has been established related to such. NOTE 5 - RECENT ACCOUNTING DEVELOPMENTS The Financial Accounting Standards Board has issued Statement 148, "Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of FASB No. 123. This Statement amends Statement No. 123 to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation and amends the disclosure requirements of Statement No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation were effective January 1, 2003 and implementation had no impact on the Company's consolidated financial statements. The amended interim disclosure requirements are effective for the Company for the quarter ending March 31, 2003 and have been adopted in the consolidated financial statements. 8 The Financial Accounting Standards Board has issued Statement 149, "Amendment of Statement 133 on Derivative Instruments and Hedging". This Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under Statement 133. The Statement is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. Implementation of the Statement is not expected to have a material impact on the financial statements. The Financial Accounting Standards Board has issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" - an interpretation of FASB Statements No. 5, 57 and 107 and rescission of FASB Interpretation No. 34." This Interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and measurement provisions of this Interpretation were applicable on a prospective basis to guarantees issued or modified after December 31, 2002. Implementation of these provisions of the Interpretation had no impact on the Company's consolidated financial statements. The disclosure requirements of the Interpretation were effective for financial statements of interim or annual periods ending after December 15, 2002, and were adopted in the consolidated financial statements for December 31, 2002 and these interim financial statements for the period ending March 31, 2003. The Financial Accounting Standards Board has issued Interpretation No. 46, "Consolidation of Variable Purpose Entities" - an interpretation of ARB No. 51. This Interpretation requires the consolidation of certain special purposes entities (SPE's) by a company if it is determined to be the primary beneficiary of the SPE's operating activities. The adoption of this Interpretation in January 2003 did not have an impact on the consolidated financial statements. 9 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL QCR Holdings, Inc. (the "Company") is the parent company of Quad City Bank & Trust, Cedar Rapids Bank & Trust, and Quad City Bancard, Inc. Quad City Bank & Trust is an Iowa-chartered commercial bank that is a member of the Federal Reserve System with depository accounts insured to the maximum amount permitted by law by the Federal Deposit Insurance Corporation. Quad City Bank & Trust commenced operations in January 1994 and provides full-service commercial and consumer banking, and trust and asset management services to the Quad City area and adjacent communities through its four offices that are located in Bettendorf and Davenport, Iowa and Moline, Illinois. Cedar Rapids Bank & Trust is an Iowa-chartered commercial bank that is a member of the Federal Reserve System with depository accounts insured to the maximum amount permitted by law by the Federal Deposit Insurance Corporation. The Company commenced operations in Cedar Rapids in June 2001 operating as a branch of Quad City Bank & Trust. The Cedar Rapids branch operation began functioning under the Cedar Rapids Bank & Trust charter in September 2001. Cedar Rapids Bank & Trust provides full-service commercial and consumer banking service to Cedar Rapids and adjacent communities through its office located in the GreatAmerica Building in downtown Cedar Rapids, Iowa. Quad City Bancard, Inc. ("Bancard") provides merchant and cardholder credit card processing services. On October 22, 2002, the Company announced Bancard's sale of its independent sales organization (ISO) related merchant credit card operations to iPayment, Inc. At March 31, 2003, Bancard continued to temporarily process transactions for iPayment, Inc., and approximately 30,000 merchants. When iPayment, Inc. discontinues processing with Bancard later in calendar 2003, it is expected that processing volumes will decrease significantly. Bancard will, however, continue to provide credit card processing for its local merchants and agent banks and for cardholders of the Company's subsidiary banks. In 1999, Bancard formed its own independent sales organization ("ISO") subsidiary, Allied Merchant Services, Inc. ("Allied"), to generate merchant credit card processing business. Bancard owns 100% of Allied. As a result of Bancard's sale of its ISO related merchant credit card operations to iPayment, Inc. in October 2002, Allied ceased its operations as an ISO. Included in the sale to iPayment, Inc., were all of the merchant credit card processing relationships owned by Allied. From the Company's formation in February 1993 through June 30, 2002, its fiscal year end had been June 30th. In 2002, the Company changed its fiscal year end to December 31st. The Company filed a Form 10-K with the Securities and Exchange Commission for the transition period July 1, 2002 through December 31, 2002. CRITICAL ACCOUNTING POLICY The Company's financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The financial information contained within these statements is, to a significant extent, financial information that is based on approximate measures of the financial effects of transactions and events that have already occurred. Based on its consideration of accounting policies that involve the most complex and subjective decisions and assessments, management has identified its most critical accounting policy to be that related to the allowance for loan losses. The Company's allowance for loan loss methodology incorporates a variety of risk considerations, both quantitative and qualitative in establishing an allowance for loan loss that management believes is appropriate at each reporting date. Quantitative factors include the Company's historical loss experience, delinquency and charge-off trends, collateral values, changes in nonperforming loans, and other factors. Quantitative factors also incorporate known information about individual loans, including borrowers' sensitivity to interest rate movements. Qualitative factors include the general economic environment in the Company's markets, including economic conditions throughout the Midwest and in particular, the state of certain industries. Size and complexity of individual credits in relation to loan structure, existing loan 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 portfolio, it will enhance its methodology accordingly. Management may report a materially different amount for the provision for loan losses in the statement of operations to change the allowance for loan losses if its assessment of the above factors were different. This discussion and analysis should be read in conjunction with the Company's financial statements and the accompanying notes presented elsewhere herein, as well as the portion of this Management's Discussion and Analysis, which discusses the allowance for loan losses in the section entitled "Financial Condition." Although management believes the levels of the allowance as of both March 31, 2003 and December 31, 2002 were adequate to absorb losses inherent in the loan portfolio, a decline in local economic conditions, or other factors, could result in increasing losses that cannot be reasonably predicted at this time. 10 FINANCIAL CONDITION Total assets of the Company increased by $18.4 million, or 3%, to $623.0 million at March 31, 2003 from $604.6 million at December 31, 2002. The growth resulted primarily from increases in the loan and securities portfolios funded by deposits received from customers. Cash and due from banks increased by $4.4 million, or 17%, to $29.3 million at March 31, 2003 from $24.9 million at December 31, 2002. The increase was primarily due to the receipt on the final day of the period of $11.5 million of funds from Visa/Mastercard. Cash and due from banks represented both cash maintained at its subsidiary banks, as well as funds that the Company and its banks had deposited in other banks in the form of non-interest bearing demand deposits. Federal funds sold are inter-bank funds with daily liquidity. At March 31, 2003, the subsidiary banks had $12.7 million invested in such funds. This amount decreased by $1.7 million, or 12%, from $14.4 million at December 31, 2002. This decrease was the result of a reduced liquidity position at Cedar Rapids Bank & Trust at March 31, 2003 when compared to December 31, 2002. Interest-bearing deposits at financial institutions decreased by $558 thousand, or 4%, to $14.0 million at March 31, 2003 from $14.6 million at December 31, 2002. Included in interest-bearing deposits at financial institutions are demand accounts, money market accounts, and certificates of deposit. The decrease was primarily the result of maturities of certificates of deposit totaling $1.2 million, which were partially offset by increases in money market accounts of $707 thousand. Securities increased by $6.2 million, or 8%, to $87.9 million at March 31, 2003 from $81.7 million at December 31, 2002. The increase was the result of a number of transactions in the securities portfolio. Paydowns of $1.4 million were received on mortgage-backed securities, and the amortization of premiums, net of the accretion of discounts, was $114 thousand. Maturities and calls of securities occurred in the amount of $4.0 million. These portfolio decreases were offset by the purchase of an additional $11.6 million of securities, classified as available for sale and a $121 thousand increase in the fair value of securities, classified as available for sale. Total loans receivable increased by $22.4 million, or 5%, to $472.1 million at March 31, 2003 from $449.7 million at December 31, 2002. The increase was the result of the origination or purchase of $156.0 million of commercial business, consumer and real estate loans, less loan charge-offs, net of recoveries, of $769 thousand, and loan repayments or sales of loans of $132.8 million. During the three months ended March 31, 2003, Quad City Bank & Trust contributed $120.6 million, or 74%, and Cedar Rapids Bank & Trust contributed $40.2 million, or 26%, of the Company's loan originations or purchases. Cedar Rapids Bank & Trust participated $4.8 million, or 9%, of their originations during the quarter to Quad City Bank & Trust. The mix of loan types within the Company's portfolio at March 31, 2003 reflected 80% commercial, 11% real estate and 9% consumer loans. The majority of residential real estate loans originated by the Company were sold on the secondary market to avoid the interest rate risk associated with long term fixed rate loans. Loans originated for this purpose were classified as held for sale. The allowance for estimated losses on loans was $7.4 million at March 31, 2003 compared to $6.9 million at December 31, 2002, an increase of $562 thousand, or 8%. The allowance for estimated losses on loans was determined based on factors that included the overall composition of the loan portfolio, types of loans, past loss experience, loan delinquencies, potential substandard and doubtful credits, economic conditions, and other factors that, in management's judgement, deserved evaluation. To ensure that an adequate allowance was maintained, provisions were made based on a number of factors, including the increase in loans and a detailed analysis of the loan portfolio. The loan portfolio was reviewed and analyzed monthly utilizing the percentage allocation method. In addition, specific reviews were completed on all credits risk-rated less than "fair quality" and carrying aggregate exposure in excess of $250 thousand. The adequacy of the allowance for estimated losses on loans was monitored by the loan review staff, and reported to management and the board of directors. Although management believes that the allowance for estimated losses on loans at March 31, 2003 was at a level adequate to absorb probable losses on existing loans, there can be no assurance that such losses will not exceed the estimated amounts or that the Company will not be required to make additional provisions for loan losses in the future. 11 Asset quality is a priority for the Company and its subsidiaries. The ability to grow profitably is in part dependent upon the ability to maintain that quality. Along with other financial institutions, management shares a concern for the outlook of the economy during the remainder of 2003. A slowdown in economic activity beginning in 2001 severely impacted several major industries as well as the economy as a whole. Even though there are indications of emerging strength, it is not certain that this strength is sustainable. In addition, consumer confidence may still be negatively impacted by the substantial decline in equity prices experienced over the last several months. These events could still adversely affect cash flows for both commercial and individual borrowers, as a result of which, the Company could experience increases in problem assets, delinquencies and losses on loans, and require further increases in the provision for loan losses. Net charge-offs for the three months ended March 31 were $769 thousand in 2003 and $32 thousand in 2002. One measure of the adequacy of the allowance for estimated losses on loans is the ratio of the allowance to the held for investment loan portfolio. The allowance for estimated losses on loans as a percentage of held for investment loans was 1.65% at March 31, 2003 and 1.61 % at December 31, 2002. At March 31 2003, total nonperforming assets were $5.6 million compared to $5.0 million at December 31, 2002. The $584 thousand increase was the result of a $132 thousand increase in nonaccrual loans in combination with an increase of $452 thousand in accruing loans past due 90 days or more. All of the nonperforming assets were located in the loan portfolio at Quad City Bank & Trust. The loans in the Cedar Rapids Bank & Trust loan portfolio have been originated fairly recently, and none of the loans have been categorized as nonperforming assets. As the loan portfolio at Cedar Rapids Bank & Trust matures, it is likely that there will be nonperforming loans or charge-offs associated with the portfolio. Nonaccrual loans were $4.7 million at March 31, 2003 compared to $4.6 million at December 31, 2002, an increase of $132 thousand. The increase in nonaccrual loans was comprised of increases in both commercial loans of $277 thousand and consumer loans of $25 thousand, partially offset by a decrease in real estate loans of $170 thousand. Three large commercial lending relationships at Quad City Bank & Trust, with an aggregate outstanding balance of $3.5 million, comprised 73% of the nonaccrual loans at March 31, 2003. Management is working closely with these customers in an attempt to remedy their individual situations. Like many other financial institutions, some of the Company's customers are experiencing difficulty in the lagging economy, which could lead to further increases in nonperforming assets and the need for an increased allowance for loan losses. Given the continued soft economy, management is closely monitoring the Company's loan portfolio and the need for increased provisions for possible loan losses. Nonaccrual loans represented approximately one percent of the Company's held for investment loan portfolio at March 31, 2003. From December 31, 2002 to March 31, 2003, accruing loans past due 90 days or more increased from $431 thousand to $883 thousand. The $452 thousand net increase was primarily due to seasonal and /or temporary setbacks experienced by a few commercial customers at Quad City Bank & Trust. Payments were received on a number of these loans just subsequent to quarter end, and the balance of loans in this category had been reduced to less than $300 thousand by mid-April 2003. Premises and equipment showed a decrease of $209 thousand, or 2%, to decline to $9.0 million at March 31, 2003 from $9.2 million at December 31, 2002. During the three-month period there were purchases of additional furniture, fixtures and equipment and leasehold improvements of $314 thousand, which were entirely offset by the combination of a property sale of $262 thousand and depreciation expense of $261 thousand. The property sale resulted in a net loss of $40 thousand. Accrued interest receivable on loans, securities and interest-bearing deposits with financial institutions increased by $127 thousand, or 4%, to $3.3 million at March 31, 2003 from $3.2 million at December 31, 2002. The increase was primarily due to greater average outstanding balances in interest-bearing assets. Other assets decreased by $11.7 million, or 84%, to $2.1 million at March 31, 2003 from $13.8 million at December 31, 2002. The decrease was primarily due to the receipt, on the final day of the period, of $11.5 million of funds from Visa/Mastercard. Other assets included Federal Reserve Bank and Federal Home Loan Bank stock, the cash surrender value of life insurance contracts, prepaid Visa/Mastercard processing charges, accrued trust department fees, other miscellaneous receivables, and various prepaid expenses. 12 Deposits increased by $12.8 million, or 3%, to $447.5 million at March 31, 2003 from $434.7 million at December 31, 2002. The increase resulted from a $19.4 million net increase in non-interest bearing, NOW, money market and savings accounts partially offset by a $6.6 million net decrease in interest-bearing certificates of deposit. Interest-bearing demand and money market accounts for commercial customers at the subsidiary banks accounted for essentially all of the increase in deposits for the period. Short-term borrowings increased $2.5 million, or 8%, from $32.9 million at December 31, 2002 to $35.4 million at March 31, 2003. The subsidiary banks offer short-term repurchase agreements to some of their major customers. Also, on occasion, the subsidiary banks purchase Federal funds for short-term funding needs from the Federal Reserve Bank, or from some of their correspondent banks. As of both March 31, 2003 and December 31, 2002, short-term borrowings were comprised entirely of customer repurchase agreements. Federal Home Loan Bank advances increased by $2.4 million, or 3%, to $77.4 million at March 31, 2003 from $75.0 million at December 31, 2002. As a result of their memberships in the FHLB of Des Moines, the subsidiary banks have the ability to borrow funds for short or long-term purposes under a variety of programs. FHLB advances are utilized for loan matching as a hedge against the possibility of rising interest rates, and when these advances provide a less costly or more readily available source of funds than customer deposits. Other borrowings increased to $7.0 million at March 31, 2003 for an increase of $2.0 million or, 40%, from December 31, 2002. In September 2001, the Company drew a $5.0 million advance on a line of credit at its primary correspondent bank as partial funding for the initial capitalization of Cedar Rapids Bank & Trust. In February 2003, the Company drew an additional $2.0 million advance as funding to maintain the required level of regulatory capital at Cedar Rapids Bank & Trust. In June 1999, the Company issued 1,200,000 shares of trust preferred securities through a newly formed subsidiary, QCR Capital Trust I. On the Company's balance sheet these securities are included with liabilities and are presented as "company obligated manditorily redeemable preferred securities of subsidiary trust holding solely subordinated debentures", and were $12.0 million at both March 31, 2003 and December 31, 2002. Other liabilities were $6.1 million at March 31, 2003 down $2.3 million, or 27%, from $8.4 million at December 31, 2002. Other liabilities were comprised of unpaid amounts for various products and services, and accrued but unpaid interest on deposits. At March 31, 2003, the most significant component of other liabilities was $1.4 million of interest payable. Common stock at March 31, 2003 was $2.8 million, which was unchanged from December 31, 2002. A slight increase of $10 thousand was the result of proceeds received from the exercise of stock options. Additional paid-in capital totaled $16.8 million at both March 31, 2003 and December 31, 2002. A slight increase of $31 thousand resulted primarily from proceeds received in excess of the $1.00 per share par value for the 10,297 shares of common stock issued as the result of the exercise of stock options. Retained earnings increased by $827 thousand, or 5%, to $16.5 million at March 31, 2003 from $15.7 million at December 31, 2002. The increase reflected net income for the three-month period. On October 23, 2002, the Company announced that the board of directors had declared a cash dividend of $0.05 per share, or approximately $138 thousand, which was paid on January 3, 2003, to stockholders of record on December 16, 2002. Unrealized gains on securities available for sale, net of related income taxes, totaled $2.2 million at March 31, 2003 as compared to $2.1 million at December 31, 2002. The increase in gains of $75 thousand was attributable to increases during the period in fair value of the securities identified as available for sale. In April 2000, the Company announced that the board of directors approved a stock repurchase program enabling the Company to repurchase approximately 60,000 shares of its common stock. This stock repurchase program was completed in the fall of 2000, and at both March 31, 2003 and December 31, 2002 the Company held 60,146 shares at a total cost of $855 thousand. The weighted average cost of the shares was $14.21. 13 RESULTS OF OPERATIONS OVERVIEW Net income for the quarter ended March 31, 2003 was $827 thousand as compared to net income of $614 thousand for the same period in 2002, an increase of $213 thousand or 35%. Basic earnings per share for the quarter ended March 31, 2003 increased to $0.30 from $0.22 for the same quarter one year ago. For the quarter ended March 31, 2003, net interest income improved by 23% while noninterest income improved by 36%, for a combined improvement of $1.6 million when compared to the same period in 2002. Quad City Bank & Trust generated much of the improvement in the Company's net interest income, as well as a large increase in the gains on sales of residential real estate loans during the period. Offsetting the improvements in revenue for the Company were increases in noninterest expense of $389 thousand and the provision for loan losses of $833 thousand. During the three-month period ended March 31, 2003, the climb in noninterest expense was primarily due to an increase in salaries and benefits expense of $346 thousand. After-tax losses at Cedar Rapids Bank & Trust were $54 thousand for the three months ended March 31, 2003, as compared to after-tax losses of $268 thousand for the same quarter in 2002. Losses at the new bank charter decreased at a pace anticipated by management, however Cedar Rapids Bank and Trust's growth was more rapid than expected, as total assets surpassed $100 million in February 2003. Management remains confident that the decision to enter the Cedar Rapids market will provide significant long-term benefits to the Company. 14 Consolidated Average Balance Sheets and Analysis of Net Interest Earnings For Three Months Ended March 31, ------------------------------------------------------------------------- 2003 2002 ------------------------------------------------------------------------- Interest Average Interest Average Average Earned Yield or Average Earned Yield or Balance or Paid Cost Balance or Paid Cost ------------------------------------------------------------------------- ASSETS Interest earnings assets: Federal funds sold .................................. $ 19,118 $ 47 0.98% $ 14,973 $ 104 2.78% Interest-bearing deposits at financial institutions ........................... 13,820 123 3.56% 14,173 210 5.93% Investment securities (1) ........................... 81,473 988 4.85% 65,586 981 5.98% Gross loans receivable (2) .......................... 451,251 6,809 6.04% 342,974 5,842 6.81% ------------------------------------------------------------------------- Total interest earning assets .................... 565,662 7,967 5.63% 437,705 7,137 6.52% Noninterest-earning assets: Cash and due from banks ............................. $ 26,063 $ 19,307 Premises and equipment .............................. 9,050 9,298 Less allowance for estimated losses on loans ........ (7,186) (5,030) Other ............................................... 14,259 19,354 --------- ---------- Total assets ..................................... $ 607,848 $ 480,634 ========= ========== LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities: Interest-bearing demand deposits .................... $ 141,034 365 1.04% $ 108,314 425 1.57% Savings deposits .................................... 11,977 17 0.57% 9,007 29 1.29% Time deposits ....................................... 193,312 1,488 3.08% 171,672 1,650 3.84% Short-term borrowings ............................... 38,119 87 0.91% 27,023 120 1.78% Federal Home Loan Bank advances ..................... 76,104 766 4.03% 42,765 557 5.21% COMR ................................................ 12,000 283 9.43% 12,000 283 9.43% Other borrowings .................................... 6,000 52 3.47% 5,000 66 5.28% ------------------------------------------------------------------------- Total interest-bearing liabilities .................................. 478,546 3,058 2.56% 375,780 3,130 3.33% Noninterest-bearing demand .......................... 86,112 62,505 Other noninterest-bearing liabilities ...................................... 6,090 11,593 Total liabilities ................................... 570,748 449,877 Stockholders' equity ................................ 37,100 30,757 --------- ---------- Total liabilities and stockholders' equity ......................... $ 607,848 $ 480,634 ========= ========== Net interest income ................................. $ 4,909 $ 4,007 ========= ========= Net interest spread ................................. 3.07% 3.19% ===== ===== Net interest margin ................................. 3.47% 3.66% ===== ===== Ratio of average interest earning assets to average interest- bearing liabilities .............................. 118.20% 116.48% ========== ========= (1) Interest earned and yields on nontaxable investment securities are determined on a tax equivalent basis using a 34% tax rate for each period presented. (2) Loan fees are not material and are included in interest income from loans receivable.
15 Analysis of Changes of Interest Income/Interest Expense For the three months ended March 31, 2003 Inc./(Dec.) Components from of Change (1) From ------------------ Prior Period Rate Volume ----------------------------- 2003 vs. 2002 ----------------------------- (Dollars in Thousands) INTEREST INCOME Federal funds sold ................................ $ (57) $ (201) $ 144 Interest-bearing deposits at financial institutions (87) (82) (5) Investment securities (2) ......................... 7 (831) 838 Gross loans receivable (3) ........................ 967 (3,661) 4,628 ----------------------------- Total change in interest income ......... $ 830 $(4,775) $ 5,605 ----------------------------- INTEREST EXPENSE Interest-bearing demand deposits .................. $ (60) $ (576) $ 516 Savings deposits .................................. (12) (56) 44 Time deposits ..................................... (162) (1,118) 956 Short-term borrowings ............................. (33) (231) 198 Federal Home Loan Bank advances ................... 209 (737) 946 COMR .............................................. -- -- -- Other borrowings .................................. (14) (76) 62 ----------------------------- Total change in interest expense ........ $ (72) $(2,794) $ 2,722 ----------------------------- Total change in net interest income ............... 902 $(1,981) 2,883 ============================= (1) The column "increase/decrease from prior period" is segmented into the changes attributable to variations in volume and the changes attributable to changes in interest rates. The variations attributable to simultaneous volume and rate changes have been proportionately allocated to rate and volume. (2) Interest earned and yields on nontaxable investment securities are determined on a tax equivalent basis using a 34% tax rate for each period presented. (3) Loan fees are not material and are included in interest income from loans receivable.
The Company's operating results are derived largely from net interest income. Net interest income is the difference between interest income, principally from loans and investment securities, and interest expense, principally on borrowings and customer deposits. Changes in net interest income result from changes in volume, net interest spread and net interest margin. Volume refers to the average dollar levels of interest-earning assets and interest-bearing liabilities. Net interest spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. Net interest margin refers to the net interest income divided by average interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities. The Company realized a 0.12% decrease in the net interest spread declining from 3.19% for the quarter ended March 31, 2002 to 3.07% for the quarter ended March 31, 2003. The average yield on interest-earning assets decreased 0.89% for the quarter ended March 31, 2003 when compared to the same quarter ended March 31, 2002. At the same time, the average cost of interest-bearing liabilities declined 0.77%. The narrowing of the net interest spread resulted in deterioration of the Company's net interest margin. For the three months ended March 31, 2003, the net interest margin was 3.47% compared to 3.66% for the same period in 2002. Management aggressively managed the Company's cost of funds during the dramatic drop in short-term interest rates in 2001 and the continuation of a low interest rate environment throughout 2002 and into 2003, and continues to closely monitor and manage net interest margin. 16 THREE MONTHS ENDED MARCH 31, 2003 AND 2002 Interest income increased by $824 thousand to $7.9 million for the three-month period ended March 31, 2003 when compared to $7.1 million for the quarter ended March 31, 2002. The increase of 12% in interest income was attributable to greater average, outstanding balances in interest earning assets, principally with respect to loans receivable, partially offset by reduced interest rates. The Company's average yield on interest-earning assets decreased 0.89% for the three months ended March 31, 2003 when compared to the three months ended March 31, 2002. Interest expense decreased by $72 thousand from $3.1 million for the three-month period ended March 31, 2002 to $3.0 million for the three-month period ended March 31, 2003. The 2% decrease in interest expense was caused by significant reductions in interest rates, almost entirely offset by greater average, outstanding balances in interest-bearing liabilities, principally with respect to customers' deposits in subsidiary banks, Federal Home Loan Bank advances and short-term borrowings. The Company's average cost of interest-bearing liabilities declined 0.77% for the three months ended March 31, 2003 when compared to the three months ended March 31, 2002. At March 31, 2003 and December 31, 2002, the Company had an allowance for estimated losses on loans approximately at 1.65% and 1.61 %, respectively, of held for investment loans. The provision for loan losses increased by $833 thousand from $497 thousand for the three-month period ended March 31, 2002 to $1.3 million for the three-month period ended March 31, 2003. During the first quarter of 2003, management made monthly provisions for loan losses based upon a number of factors, including principally the increase in loans and a detailed analysis of the loan portfolio. During the first quarter of 2003, the $1.3 million provision to the allowance for loan losses was attributed 27%, or $353 thousand, to net growth in the loan portfolio, and 73%, or $977 thousand, to downgrades and write-offs within the portfolio. For the three months ended March 31, 2003, commercial loan charge-offs totaled $758 thousand, which resulted entirely from a single customer relationship at Quad City Bank & Trust, and there were no commercial recoveries. The write-off of this relationship accounted for 57% of the provision for loans losses during the first quarter of 2003 and was in addition to a $1.2 million charge-off, which occurred during the quarter ended December 31, 2002. The additional losses are a result of environmental issues associated with the collateral for the loan, which were identified during the first quarter of 2003. The Company believes that these environmental issues have negatively impacted the value and salability of the business and has determined that it is appropriate to take a conservative approach and write-down the loan balance to reflect no value in the real estate and equipment collateral. Quad City Bank & Trust will proceed with efforts to liquidate all other collateral, and is pursuing a sale of the real estate and equipment, as well as all available legal remedies against the borrower. Consumer loan charge-offs and recoveries totaled $92 thousand and $81 thousand, respectively, during the quarter. Residential real estate loans had no charge-offs or recoveries for the three months ended March 31, 2003. Noninterest income of $2.5 million for the three-month period ended March 31, 2003 was a $660 thousand, or 36%, increase from $1.8 million for the three-month period ended March 31, 2002. Noninterest income during each of the quarters in comparison consisted primarily of income from the merchant credit card operation, fees from the trust department, depository service fees, gains on the sale of residential real estate mortgage loans, and other miscellaneous fees. The quarter ended March 31, 2003, when compared to the same quarter in 2002, posted a $77 thousand decrease in fees earned by the merchant credit card operations of Bancard. This 19% decline in merchant credit card fees was a result of the sale of independent sales organization (ISO) related merchant credit card activity to iPayment, Inc. in October 2002. Gains on the sale of residential real estate mortgage loans, net, increased $537 thousand from the quarter ended March 31, 2002 to the same quarter in calendar 2003. The activity within this area of the subsidiary banks was stimulated by interest rates consistent with or lower than those seen during the same period last year. Additional variations in noninterest income consisted of a $33 thousand decrease in trust department fees, a $75 thousand increase in deposit service fees, and a $157 thousand increase in other noninterest income. Other noninterest income in each quarter consisted primarily of investment advisory and management fees, fees collected from correspondent banks, item processing fees, ATM fees, and income from associated companies. 17 Merchant credit card fees, for the three months ended March 31, 2003 decreased by 19% reflecting the initial effects of the sale of the independent sales organization (ISO) related merchant credit card activity to iPayment, Inc. On October 22, 2002, the Company announced Bancard's sale of its ISO-related merchant credit card operations to iPayment, Inc. for $3.5 million. After contractual compensation and severance payments, transaction expenses, and income taxes, the transaction resulted in a gain of $1.3 million, or $0.47 per share, which was realized during the quarter ended December 31, 2002. Also included in the sale were all of the merchant credit card processing relationships owned by Allied. Bancard continues to provide credit card processing for its local merchants and cardholders of the subsidiary banks and agent banks. During the three-month period ended March 31, 2003, Bancard also temporarily continued to process ISO related transactions for iPayment, Inc. for a fixed monthly fee rather than a percentage of transaction volumes. The Company anticipates that this ISO processing will be transferred to another provider in the second quarter of 2003. As previously anticipated, the Company's sale of the ISO-related merchant credit card processing has reduced Bancard's monthly earnings. The Company continues to believe that Bancard will remain profitable with its narrowed business focus of continuing to provide credit card processing for its local merchants and agent banks and for cardholders of the Company's subsidiary banks. At that time, the Company anticipates that merchant credit card fees, net of processing costs, will be in a range of $50 thousand to $90 thousand a month from the Company's local merchant, cardholder, and agent bank portfolios. As a result, Quad City Bancard's net income will likely be approximately break even for a period after the iPayment processing is moved to another provider. For the quarter ended March 31, 2003, trust department fees decreased $33 thousand, or 5%, to $561 thousand from $594 thousand for the same quarter in 2002. Although there was continued development of existing trust relationships and the addition of new trust customers during the quarter, the impact of such was entirely offset by the reduced market values of securities held in trust accounts and the resulting impact in the realization of trust fees. Deposit service fees increased $76 thousand, or 30%, to $331 thousand from $255 thousand for the three-month periods ended March 31, 2003 and March 31, 2002, respectively. This increase was primarily a result of the growth in deposit accounts of $83.6 million, or 23%, since March 31, 2002. Service charges and NSF (non-sufficient funds) charges related to demand deposit accounts were the main components of deposit service fees. Gains on sales of loans, net, were $955 thousand for the three months ended March 31, 2003, which reflected an increase of 129%, or $537 thousand, from $418 thousand for the three months ended March 31, 2002. The increase resulted from larger numbers of home refinances and/or home purchases, and the subsequent sale of the majority of these loans into the secondary market. Depressed interest rates, which have existed for the last several months, continued to stimulate the activity within this area of the subsidiary banks throughout the first quarter of 2003. While mortgage rates remain at historically low levels, management does not anticipate that the level of gains on sales of loans, net will continue throughout the year. For the quarter ended March 31, 2003, other noninterest income increased $157 thousand, or 107%, to $304 thousand from $147 thousand for the same quarter in 2002. The increase was primarily due to a combination of increased earnings realized by Nobel Electronic Transfer, LLC, one of the four associated companies in which the Company holds an interest, and to improved fees generated from the usage of Visa check cards by customers of the subsidiary banks. The primary components of noninterest expenses were mainly salaries and benefits, occupancy and equipment expenses, and professional and data processing fees, for both quarters. Noninterest expenses for the three months ended March 31, 2003 were $4.8 million as compared to $4.4 million for the same period in 2002, for an increase of $389 thousand or 9%. The following table sets forth the various categories of noninterest expenses for the three months ended March 31, 2003 and 2002. Noninterest Expenses Three months ended March 31, ----------------------- 2003 2002 % Change -------------------------------- Salaries and employee benefits .............. $2,884,792 $2,538,376 13.7% Professional and data processing fees ....... 429,070 326,536 31.4% Advertising and marketing ................... 148,756 148,287 0.3% Occupancy and equipment expense ............. 651,697 605,659 7.6% Stationery and supplies ..................... 110,277 125,271 (12.0)% Postage and telephone ....................... 153,565 126,673 21.2% Other ....................................... 405,686 524,385 (22.6)% ----------------------- Total noninterest expenses .... $4,783,843 4,395,187 8.8% ======================= 18 Salaries and benefits experienced the most significant dollar increase of any noninterest expense component. For the quarter ended March 31, 2003, total salaries and benefits increased to $2.9 million or $346 thousand over the previous year's quarter total of $2.5 million. The increase was primarily due to the addition of employees at the subsidiary banks, in combination with increased incentive compensation to real estate officers proportionate to the increased volumes of gains on sales of loans. Professional and data processing fees increased from $327 thousand for the three months ended March 31, 2002 to $429 thousand for the same three-month period in 2003. The $102 thousand increase was predominately due to increases in data processing and auditing fees at the subsidiary banks, substantially offset by a decrease in legal fees at Bancard as a result of the conclusion of legal settlement proceedings in February 2002. Occupancy and equipment expense increased $46 thousand or 8% from quarter to quarter. The increase was predominately due to increased levels of rent, utilities, depreciation, maintenance, and other occupancy expenses associated with the Company's facilities. Postage and telephone increased $27 thousand from $127 thousand for the three months ended March 31, 2002 to $154 thousand for the same period in 2003. The increase was proportionate to the increased business activity throughout the Company. Other noninterest expense declined $119 thousand, or 23%, for the three months ended March 31, 2003 when compared to the like period in 2002. The decrease was primarily due to the elimination of Bancard's monthly provision for merchant credit card losses as a result of the sale of ISO related merchant credit card activity to iPayment, Inc. in October 2002. The provision for income taxes was $396 thousand for the three-month period ended March 31, 2003 compared to $274 thousand for the three-month period ended March 31, 2002 for an increase of $122 thousand or 44%. The increase was the result of an increase in income before income taxes of $335 thousand or 38% for the 2003 quarter when compared to the 2002 quarter, in combination with a slight increase in the Company's effective tax rate. LIQUIDITY Liquidity measures the ability of the Company to meet maturing obligations and its existing commitments, to withstand fluctuations in deposit levels, to fund its operations, and to provide for customers' credit needs. The liquidity of the Company primarily depends upon cash flows from operating, investing, and financing activities. Net cash provided by operating activities, consisting primarily of proceeds on sales of loans, was $15.0 million for the three months ended March 31, 2003 compared to $3.9 million net cash provided in the same period in 2002. Net cash used in investing activities, consisting principally of loan originations to be held for investment, was $30.3 million for the three months ended March 31, 2003 and $37.4 million for the three months ended March 31, 2002. Net cash provided by financing activities, consisting primarily of deposit growth, for the three months ended March 31, 2003 was $19.6 million and for the same period in 2002 was $32.3 million. The Company has a variety of sources of short-term liquidity available to it, including federal funds purchased from correspondent banks, sales of securities available for sale, FHLB advances, lines of credit and loan participations or sales. At March 31, 2003, the subsidiary banks had eight unused lines of credit totaling $43.0 million of which $4.0 million was secured and $39.0 million was unsecured. At December 31, 2002, the subsidiary banks had seven unused lines of credit totaling $38.0 million of which $4.0 million was secured and $34.0 million was unsecured. At both March 31, 2003 and December 31, 2002, the Company also had a secured line of credit at its primary correspondent bank for $10.0 million. At December 31, 2002, $5.0 million had been drawn and used as partial funding for the capitalization of Cedar Rapids Bank & Trust, and in February 2003 an additional $2.0 million was drawn as funding to maintain the required level of capital at Cedar Rapids Bank & Trust. The Company paid its first cash dividend of $0.05 per share on January 3, 2003, to stockholders of record on December 16, 2002. Going forward it is the Company's intention to consider the payment of dividends on a semi-annual basis. The Company anticipates an ongoing need to retain much of its operating income to help provide the capital for continued rapid growth, however believes that operating results have reached a level that can sustain dividends to stockholders as well. At the annual meeting of stockholders on May 7, 2003, the Company announced the declaration of a $0.05 per share cash dividend payable on July 3, 2003, to stockholders of record on June 16, 2003. 19 Part I Item 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company realizes income principally from the spread between the interest earned on loans, investments and other interest-earning assets and the interest paid on deposits and borrowings. Loan volumes and yields, as well as the volume of and rates on investments, deposits and borrowings, are affected by market interest rates. Additionally, because of the terms and conditions of many of the loan and deposit accounts, a change in interest rates could also affect the projected maturities in the loan portfolio and/or the deposit base, which could alter the Company's sensitivity to future changes in interest rates. Accordingly, management considers interest rate risk to be a significant market risk. Interest rate risk management focuses on maintaining consistent growth in net interest income within policy limits approved by the board of directors, while taking into consideration, among other factors, the Company's overall credit, operating income, operating cost, and capital profile. The subsidiary banks' ALM/Investment Committees, which includes senior management representatives and members of the board of directors, monitor and manage interest rate risk to maintain an acceptable level of change to net interest income as a result of changes in interest rates. One method used to quantify interest rate risk is the net portfolio value analysis. This analysis calculates the difference between the present value of liabilities and the present value of expected cash flows from assets and off-balance sheet contracts. The most recent net portfolio value analysis, as of December 31, 2002, projected that net portfolio value would decrease by approximately 5.40% if interest rates would rise 200 basis points over the next year. It projected an increase in net portfolio value of approximately 4.61% if interest rates would drop 200 basis points. Both simulations are within the board-established policy limits of a 10% decline in value. Part I Item 4 CONTROLS AND PROCEDURES Based upon an evaluation within the 90 days prior to the filing date of this report, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect the Company's internal controls subsequent to the date of the evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. There were no significant deficiencies or material weaknesses identified in the evaluation and therefore, no corrective actions were taken. SPECIAL NOTE CONCERNING FORWARD-LOOKING STATEMENTS Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995. This document (including information incorporated by reference) contains, and future oral and written statements of the Company and its management may contain, forward-looking statements, within the meaning of such term in the Private Securities Litigation Reform Act of 1995, with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company's management and on information currently available to management, are generally identifiable by the use of words such as "believe," "expect," "anticipate," "bode," "predict," "suggest," "appear," "plan," "intend," "estimate," "may," "will," "would," "could," "should" or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events. 20 The Company's ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries include, but are not limited to, the following: o The strength of the United States economy in general and the strength of the local economies in which the Company conducts its operations which may be less favorable than expected and may result in, among other things, a deterioration in the credit quality and value of the Company's assets. o The economic impact of past and any future terrorist attacks, acts of war or threats thereof, and the response of the United States to any such threats and attacks. o The effects of, and changes in, federal, state and local laws, regulations and policies affecting banking, securities, insurance and monetary and financial matters. o The effects of changes in interest rates (including the effects of changes in the rate of prepayments of the Company's assets) and the policies of the Board of Governors of the Federal Reserve System. o The ability of the Company to compete with other financial institutions as effectively as the Company currently intends due to increases in competitive pressures in the financial services sector. o The inability of the Company to obtain new customers and to retain existing customers. o The timely development and acceptance of products and services, including products and services offered through alternative delivery channels such as the Internet. o Technological changes implemented by the Company and by other parties, including third party vendors, which may be more difficult or more expensive than anticipated or which may have unforeseen consequences to the Company and its customers. o The ability of the Company to develop and maintain secure and reliable electronic systems. o The ability of the Company to retain key executives and employees and the difficulty that the Company may experience in replacing key executives and employees in an effective manner. o Consumer spending and saving habits which may change in a manner that affects the Company's business adversely. o Business combinations and the integration of acquired businesses which may be more difficult or expensive than expected. o The costs, effects and outcomes of existing or future litigation. o Changes in accounting policies and practices, as may be adopted by state and federal regulatory agencies and the Financial Accounting Standards Board. o The ability of the Company to manage the risks associated with the foregoing as well as anticipated. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Additional information concerning the Company and its business, including other factors that could materially affect the Company's financial results, is included in the Company's filings with the Securities and Exchange Commission. 21 Part II QCR HOLDINGS, INC. AND SUBSIDIARIES PART II - OTHER INFORMATION Item 1 Legal Proceedings There are no material pending legal proceedings to which the Company or its subsidiaries is a party other than ordinary routine litigation incidental to their respective businesses. Item 2 Changes in Securities and Use of Proceeds - None Item 3 Defaults Upon Senior Securities - None Item 4 Submission of Matters to a Vote of Security Holders - None Item 5 Other Information - None Item 6 Exhibits and Reports on Form 8-K (a) Exhibits 99.1 Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (exhibit is being filed herewith). 99.2 Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (exhibit is being filed herewith). (b) Reports on Form 8-K A report on Form 8-K was filed on February 10, 2003 under Item 5, which reported the Company's financial information, including earnings for both the quarter and six-month transition period ended December 31, 2002, in the form of a press release. A report on Form 8-K was filed on May 1, 2003 under Item 12, which reported the Company's financial information, including earnings for the quarter ended March 31, 2003, in the form of a press release. A report on Form 8-K was filed on May 8, 2003 under Item 12, which reported the Company's announcement of the declaration of a cash dividend and the results of the Annual Stockholders Meeting that was held May 7, 2003 in the form of a press release. 22 SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. QCR HOLDINGS, INC. (Registrant) Date May 14, 2003 /s/ Michael A. Bauer -------------------------- Michael A. Bauer, Chairman Date May 14, 2003 /s/ Douglas M. Hultquist -------------------------- Douglas M. Hultquist, President Chief Executive Officer Date May 14, 2003 /s/ Todd A. Gipple -------------------------- Todd A. Gipple, Executive Vice President Chief Financial Officer 23 SECTION 302 CERTIFICATION I, Douglas M. Hultquist, Chief Executive Officer of the Company, certify that: 1. I have reviewed this quarterly report on Form 10-Q of QCR Holdings, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in the Report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 14, 2003 /s/ Douglas M. Hultquist ----------------------- Douglas M. Hultquist Chief Executive Officer 24 SECTION 302 CERTIFICATION I, Todd A. Gipple, Chief Financial Officer of the Company, certify that: 1. I have reviewed this quarterly report on Form 10-Q of QCR Holdings, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in the Report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 14, 2003 /s/ Todd A. Gipple ---------------------- Todd A. Gipple Chief Financial Officer 25