10-K 1 qcrannual2005.txt 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, 2005. 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 Seventh Street, Suite 204, 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: None. Securities registered pursuant to Section 12(g)of the Exchange Act: Common stock, $1 Par Value 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 if disclosure of delinquent filers in response to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. Large accelerated filer [ ] Accelerated filer [ X ] Non-accelerated filer [ ] 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 SmallCap Market on June 30, 2005, the last business day of the registrant's most recently completed second fiscal quarter, was approximately $86,474,472. Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date: As of March 1, 2006, the Registrant had outstanding 4,537,711 shares of common stock, $1.00 par value per share. Documents incorporated by reference: Part III of Form 10-K - Proxy statement for annual meeting of stockholders to be held in May 2006. 1 Part I Item 1. Business General. QCR Holdings, Inc. (the "Company") is a multi-bank holding company headquartered in Moline, Illinois that was formed in February 1993 under the laws of the state of Delaware. The Company serves the Quad City, Cedar Rapids, and Rockford communities through its three wholly owned banking subsidiaries, which provide full-service commercial and consumer banking and trust and asset management services: o Quad City Bank and Trust Company, ("Quad City Bank & Trust") which is based in Bettendorf, Iowa and commenced operations in 1994, o Cedar Rapids Bank and Trust Company, ("Cedar Rapids Bank & Trust") which is based in Cedar Rapids, Iowa and commenced operations in 2001, and o Rockford Bank and Trust Company, (Rockford Bank & Trust") which is based in Rockford, Illinois and commenced operations in 2005. The Company also engages in merchant credit card processing through its wholly owned subsidiary, Quad City Bancard, Inc. ("Bancard"), based in Moline, Illinois and in direct financing lease contracts through its 80% equity investment in M2 Lease Funds, LLC ("M2 Lease Funds"), based in the Milwaukee, Wisconsin area. Quad City Bank & Trust was capitalized on October 13, 1993 and commenced operations on January 7, 1994. 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 (the "FDIC"). Quad City Bank & Trust provides full service commercial and consumer banking and trust and asset management services in the Quad Cities and adjacent communities through its five offices that are located in Bettendorf and Davenport, Iowa and in Moline, Illinois. At December 31, 2005, Quad City Bank & Trust had total assets of $718.5 million. 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 FDIC. The Company commenced operations in Cedar Rapids in June 2001 operating as a branch of Quad City Bank & Trust. The Cedar Rapids branch operation then began functioning under the Cedar Rapids Bank & Trust charter in September 2001. Cedar Rapids Bank & Trust provides full-service commercial and consumer banking and trust and asset management services to Cedar Rapids, Iowa and adjacent communities through its two new facilities, which were both completed in the summer of 2005. The headquarters for Cedar Rapids Bank & Trust is located in downtown Cedar Rapids, and its first branch location is located in northern Cedar Rapids. At December 31, 2005, Cedar Rapids Bank & Trust had total assets of $289.9 million. On January 3, 2005, Rockford Bank & Trust opened as the Company's third bank subsidiary. The Company commenced operations in Rockford, Illinois in September 2004 operating as a branch of Quad City Bank & Trust. Rockford Bank & Trust is an Illinois-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 FDIC. It provides full-service commercial and consumer banking to Rockford and adjacent communities through its original office located in downtown Rockford and its recently opened branch location in a temporary modular facility on Guilford Road at Alpine Road in Rockford. The Company plans to build a 20,000 square foot banking facility at a projected cost of $4.4 million with completion scheduled for October 2006. At December 31, 2005, Rockford Bank & Trust had total assets of $41.3 million. Bancard was capitalized in April 1995 as a Delaware corporation that provides merchant and cardholder credit card processing services. In October 2002, Bancard sold its independent sales organization ("ISO") related merchant credit card operations to iPayment, Inc. Until September 24, 2003, Bancard continued to process transactions for iPayment, Inc., and approximately 32,500 merchants. Since iPayment, Inc. discontinued processing with Bancard, processing volumes decreased significantly. Bancard does, however, continue to provide credit card processing for merchants and cardholders of the Company's subsidiary banks and agent banks. On August 26, 2005, the Quad City Bank & Trust acquired 80% of the membership units of M2 Lease Funds. John Engelbrecht, the President and Chief Executive Officer of M2 Lease Funds, retained 20% of the membership units. M2 Lease Funds, which is based in the Milwaukee, Wisconsin area, is engaged in the business of leasing machinery and equipment to commercial and industrial businesses under direct financing lease contracts. Quad City Bank & Trust acquired assets and assumed liabilities totaling $35.0 million and $30.0 million, respectively, for a purchase price of $5.0 million, which resulted in goodwill of $3.4 million and minority interest of $573 thousand. In accordance with the provisions of FAS Statement 142, goodwill is not being amortized, but will be evaluated annually for impairment. 2 In February 2004, the Company issued $12,000,000 of fixed/floating rate trust preferred securities (fixed at a rate of 6.93% for 7 years and floating rate for 23 years) and $8,000,000 of floating rate trust preferred securities through two newly formed subsidiaries, QCR Holdings Statutory Trust II ("Trust II") and QCR Holdings Statutory Trust III ("Trust III"), respectively. Trust II and Trust III are each 100% owned non-consolidated subsidiaries of the Company. Trust II and Trust III each used the proceeds from the sale of the trust preferred securities, along with the funds from their equity, to purchase junior subordinated debentures of the Company in the amounts of $8,248,000 and $12,372,000, respectively. On May 5, 2005, the Company issued $5,000,000 of floating rate capital securities through a newly formed subsidiary, QCR Holdings Statutory Trust IV ("Trust IV"). Trust IV is a 100% owned non-consolidated subsidiary of the Company. Trust IV used the proceeds from the sale of the trust preferred securities, along with the funds from its equity, to purchase junior subordinated debentures of the Company in the amount of $5,155,000. On February 24, 2006, the Company issued $10,000,000 of fixed/floating rate capital securities through a newly formed subsidiary, QCR Holdings Statutory Trust V ("Trust V"). Trust V is a 100% owned non-consolidated subsidiary of the Company. Trust V used the proceeds from the sale of the trust preferred securities, along with the funds from its equity, to purchase junior subordinated debentures of the Company in the amount of $10,310,000. The Company owns 100% of Quad City Bank & Trust, Cedar Rapids Bank & Trust, Rockford Bank & Trust and Bancard, and 100% of the common securities of Trust II, Trust III, Trust IV, and Trust V. The Company also holds an 80% equity interest in M2 Lease Funds. In addition to such ownership, the Company invests its capital in stocks of financial institutions and mutual funds, as well as participates in loans with the subsidiary banks. In addition, to its wholly-owned and majority-owned subsidiaries, the Company has an aggregate investment of $308 thousand in three associated companies, Nobel Electronic Transfer, LLC, Nobel Real Estate Investors, LLC, and Velie Plantation Holding Company, LLC. The Company owns 20% equity positions in each of these affiliated companies. In June 2005, Cedar Rapids Bank & Trust entered into a joint venture as a 50% owner of Cedar Rapids Mortgage Company, LLC ("Cedar Rapids Mortgage Company"). The Company and its subsidiaries collectively employed 305 individuals at December 31, 2005. No one customer accounts for more than 10% of revenues, loans or deposits. Business. The Company's principal business consists of attracting deposits from the public and investing those deposits in loans 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 and securities and the interest paid on deposits and borrowings. Its operating results are affected by merchant credit card fees, trust fees, deposit service charge fees, fees from the sale of residential real estate loans and other income. Operating expenses include employee compensation and benefits, occupancy and equipment expense, professional and data processing fees, advertising and marketing expenses, bank service charges, insurance, and other administrative expenses. The Company's operating results are also affected by economic and competitive conditions, particularly changes in interest rates, government policies and actions of regulatory authorities, as described more fully in this form 10-K. Competition. The Company currently operates in the highly competitive Quad City, Cedar Rapids, and Rockford markets. Competitors include not only other commercial banks, credit unions, thrift institutions, and mutual funds, but also, insurance 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 unregulated competitors compete across geographic boundaries and provide customers increasing access to meaningful alternatives to banking services. Additionally, the Company competes in markets with a number of much larger financial institutions with substantially greater resources and larger lending limits. These competitive trends are likely to continue and may increase as a result of the continuing reduction on restrictions on the interstate operations of financial institutions. Under the Gramm-Leach-Bliley Act of 1999, effective in March 2000, securities firms and insurance companies that elect to become financial holding companies may acquire banks and other financial institutions. The financial services industry is also likely to become more competitive as further technological advances enable more companies to provide financial services. The Board of Governors of the Federal Reserve System (the "Federal Reserve Board") is the primary regulator of the Company and its subsidiaries. In addition, Quad City Bank & Trust and Cedar Rapids Bank & Trust are regulated by the Iowa Superintendent of Banking (the "Iowa Superintendent") and the FDIC. Rockford Bank & Trust is regulated by the State of Illinois Department of Financial and Professional Regulation ("the Illinois DFPR") and the FDIC. 3 Lending. The Company and its subsidiaries provide a broad range of commercial and retail lending and investment services to corporations, partnerships, individuals and government agencies. The subsidiary banks actively market their services to qualified lending customers. Lending officers actively solicit the business of new borrowers entering their market areas as well as long-standing members of the local business community. The subsidiary banks have established lending policies which include a number of underwriting factors to be considered in making a loan, including location, loan-to-value ratio, cash flow, interest rate and the credit history of the borrower. Quad City Bank & Trust's current legal lending limit is approximately $9.4 million. As of December 31, 2005, commercial loans made up approximately 80% of the loan portfolio, while residential mortgages comprised approximately 10% and consumer loans comprised approximately 10%. Cedar Rapids Bank & Trust's current corporate lending limit is approximately $3.5 million. As of December 31, 2005, commercial loans made up approximately 88% of the loan portfolio, while residential mortgages comprised approximately 5% and consumer loans comprised approximately 7%. Rockford Bank & Trust's current corporate lending limit is approximately $2.3 million. As of December 31, 2005, commercial loans made up approximately 83% of the loan portfolio, while residential mortgages comprised approximately 9% and consumer loans comprised approximately 8%. As part of the loan monitoring activity at the three subsidiary banks, credit administration personnel interact closely with senior bank management. The Company has also instituted a separate loan review function to analyze credits of the subsidiary banks. Management has attempted to identify problem loans at an early stage and to aggressively seek a resolution of these situations. As noted above, the subsidiary banks are active commercial lenders. The areas of emphasis include loans to wholesalers, manufacturers, building contractors, developers, business services companies 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. Collateral for these loans generally includes accounts receivable, inventory, equipment and real estate. In addition, the subsidiary banks often take personal guarantees to help assure repayment. Loans may be made on an unsecured basis if warranted by the overall financial condition of the borrower. Terms of commercial business loans generally range from one to five years. A significant portion of the subsidiary banks' commercial business loans has floating interest rates or reprice within one year. The banks also make commercial real estate loans. Collateral for these loans generally includes the underlying real estate and improvement3, and may include additional assets of the borrower. Residential mortgage lending continues to be a focal point for the banks, and they sell the majority of their real estate loans in the secondary market. During the year ended December 31, 2005, the subsidiary banks originated $122.1 million of real estate loans and sold $99.6 million, or 82%, of these loans. During the year ended December 31, 2004, the subsidiary banks originated $124.6 million of real estate loans and sold $83.5 million, or 67%, of these loans. During the year ended December 31, 2003, the subsidiary banks originated $268.8 million of real estate loans and sold $241.6 million, or 90%, of these loans. Generally, the subsidiary banks' residential mortgage 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 mature in one to five years, and then retain these loans in their portfolios. The subsidiary banks' real estate loan portfolios, net of loans held for sale, were approximately $56.9 million at December 31, 2005. Servicing rights are not presently retained on the loans sold in the secondary market. The consumer lending departments of each bank provide a,l types of consumer loans including motor vehicle, home improvement, home equity, signature loans and small personal credit lines. Change in Fiscal Years. In August 2002, the Company's board of directors elected to change the Company's fiscal year end from June 30 to December 31. Due to this change, the Company filed a Form 10-K for the transition period from July 1, 2002 to December 31, 2002 and now holds its annual meetings in May of each year instead of October. The 2006 annual meeting will be held on May 3, 2006. The Company's subsidiaries have also changed their fiscal years, aligning their financial reporting with that of the Company. Throughout this document, references to fiscal 2005 are for the year ended December 31, 2005, and references to fiscal 2004 are for the year ended December 31, 2004, and references to fiscal 2003 are for the year ended December 31, 2003. References to the transition period are for the six months ended December 31, 2002. References to fiscal 2002 are for the year ended June 30, 2002. In most instances, results are shown for the fiscal years ended December 31, 2005, 2004, and 2003, along with the six-month transition period and the previous fiscal year ended June 30, 2002. 4 Appendices. The commercial banking business is a highly regulated business. See Appendix A for a summary of the federal and state statutes and regulations, which are applicable to the Company and its subsidiaries. Supervision, regulation and examination of banks and bank holding companies by bank regulatory agencies are intended primarily for the protection of depositors rather than stockholders of bank holding companies and banks. See Appendix B for tables and schedules that show selected comparative statistical information required pursuant to the securities laws, relating to the business of the Company. Consistent with the information presented in Form 10-K, results are presented for the fiscal years ended December 31, 2005, 2004 and 2003, along with the six-month transition period ended December 31, 2002, and the previous two fiscal years ended June 30. A second presentation shows comparative financial information restated in calendar year periods for 2000, 2001 and 2002 consistent with the Company's current fiscal year. Internet Site. The Company maintains Internet sites for itself and its three banking subsidiaries and the Company makes available free of charge through these sites its annual report 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 Exchange Act after it electronically files such material with, or furnishes it to, the Securities and Exchange Commission. Also available are many of our corporate governance documents, including our Code of Ethics. The sites are www.qcrh.com, www.qcbt.com, www.crbt.com, and www.rfrdbank.com. Item 1.A. 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: Our business is concentrated in and dependent upon the continued growth and welfare of the Quad City, Cedar Rapids and Rockford markets. We operate primarily in the Quad City, Cedar Rapids and Rockford markets, and as a result, our financial condition, results of operations and cash flows are subject to changes in the economic conditions in those areas. We have developed a particularly strong presence in Bettendorf, Cedar Rapids and Davenport, Iowa and Moline, Illinois and their surrounding communities. Our success depends upon the business activity, population, income levels, deposits and real estate activity in these markets. Although our customers' business and financial interests may extend well beyond these market areas, adverse economic conditions that affect these market areas could reduce our growth rate, affect the ability of our customers to repay their loans to us and generally affect our financial condition and results of operations. Because of our geographic concentration, we are less able than other regional or national financial institutions to diversify our credit risks across multiple markets. 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, money market mutual funds, credit unions and other non-bank financial service 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. Additionally, if the regulatory trend toward reducing restrictions on the interstate operations of financial institutions continues, we will continue to experience increased competition as a result. Increased competition in our markets may also result in a decrease in the amounts of our loans and deposits, reduced spreads between loan rates and deposit rates or loan 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 relax our underwriting standards, we could be exposed to higher losses from lending activities. Additionally, many of our competitors are much larger in total assets and capitalization, have greater access to capital markets and larger lending limits and offer a broader range of financial services than we can offer. Our community banking strategy relies heavily on our subsidiaries' independent management teams, and the unexpected loss of key managers may adversely affect our operations. 5 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 executive officers, the current management teams, branch managers and loan officers of our operating subsidiaries will continue to be important to the successful implementation of our strategy. It is also critical, as we 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, 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. Our continued pace of growth may require us to raise additional capital in the future, but that capital may not be available when it is needed. We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. We anticipate that our existing capital resources will satisfy our capital requirements for the foreseeable future. However, we may at some point need to raise additional capital to support our continued growth. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we cannot assure you of our ability to raise additional capital, if needed, on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth, branching, de novo bank formations and/or acquisitions could be materially impaired. We may experience difficulties in managing our growth and our growth strategy involves risks that may negatively impact our net income. As part of our general growth strategy, we may expand into additional communities or attempt to strengthen our position in our current markets by undertaking additional de novo bank formations or branch openings. Based on our experience, we believe that it generally takes several years for new banking facilities to achieve overall profitability, due to the impact of organization and overhead expenses and the start-up phase of generating loans and deposits. To the extent that we undertake additional branching and de novo bank and business formations, we are likely to continue to experience the effects of higher operating expenses relative to operating income from the new operations, which may have an adverse effect on our levels of reported net income, return on average equity and return on average assets. Other effects of engaging in such growth strategies may include potential diversion of our management's time and attention and general disruption to our business. In addition to branching and de novo bank formations, we may acquire banks and related businesses that we believe provide a strategic fit with our business. To the extent that we grow through acquisitions, we cannot assure you that we will be able to adequately and profitably manage this growth. Acquiring other banks and businesses will involve similar risks to those commonly associated with branching and de novo bank formations, but may also involve additional risks, including: o potential exposure to unknown or contingent liabilities of banks and businesses we acquire; o exposure to potential asset quality issues of the acquired bank or related business; o difficulty and expense of integrating the operations and personnel of banks and businesses we acquire; and o the possible loss of key employees and customers of the banks and businesses we acquire. Interest rates and other conditions impact our results of operations. Our profitability is in part a function of the spread between the interest rates earned on investments and loans 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 terms or the mix of adjustable and fixed rate loans in our portfolio could have a positive or negative effect on our net income, capital and liquidity. We measure interest rate risk under various rate scenarios and 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 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. We must effectively manage our credit risk. 6 There are risks inherent in making any loan, including risks inherent in dealing with individual 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. However, we cannot assure you that such approval and monitoring procedures will reduce these credit risks. The majority of our subsidiary banks' loan/lease portfolios are invested in commercial loans/leases, and we focus on lending to small to medium-sized businesses. The size of the loans/leases we can offer to commercial customers is less than the size of the loans/leases that our competitors with larger lending limits can offer. This may limit our ability to establish relationships with the area's largest businesses. As a result, we may assume greater lending risks than financial institutions that have a lesser concentration of such loans/leases and tend to make loans/leases to larger businesses. Collateral for these loans/leases 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 commercial loans/leases, our subsidiary banks are also active in residential mortgage and consumer lending. Commercial and industrial loans/leases make up a large portion of our loan/lease portfolio. Commercial and industrial loans/leases were $359.4 million, or approximately 48% of our total loan/lease portfolio as of December 31, 2005. Our commercial loans/leases 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 receiv!ble, inventory, or equipment. Credit support provided by the borrower for most of these loans/leases and the probability of repayment is based on the liquidation of the pledged collateral and enforcement of a personal guarantee, if any exists. As a result, 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 other loans/leases may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. Our loan/lease portfolio has a significant concentration of commercial real estate loans, which involve risks specific to real estate value. Commercial real estate lending comprised a significant portion of our loan/lease portfolio, $269.7 million or approximately 36%, as of December 31, 2005. The market value of real estate 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. Although a significant portion of such loans are secured by real estate as a secondary form of collateral, 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. If the loans that are collateralized by real estate become troubled during a time when market conditions are declining or have declined, then we may not be able to realize the amount of security that we anticipated at the time of originating the loan, which could cause us to increase our provision for loan losses and adversely affect our operating results and financial condition. Our allowance for loan/lease losses may prove to be insufficient to absorb potential losses in our loan/lease portfolio. We established our allowance for loan/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, 2005, our allowance for loan/lease losses as a percentage of total loans/leases was 1.17% and as a percentage of total non-performing loans/leases was approximately 254%. Although management believes that the allowance for loan/lease losses is 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 for loan/lease losses will prove sufficient to cover actual loan/lease losses in the future. Loan/lease losses in excess of our reserves may adversely affect our business, financial condition and results of operations. Additional information regarding our allowance for loan/lease losses and the methodology we use to determine an appropriate level of reserves is located in the "Management's Discussion and Analysis" section included under Item 5 of Part II of this Form 10-K. 7 Our Bancard operation faces other risks. Bancard, our credit card processing subsidiary, is subject to certain risks, which could have a negative impact on its operations. Primarily, for Bancard these risks are competition, credit risks and the possibility that merchants' willingness to accept credit cards will decline. Many of Bancard's competitors have greater financial, technological, marketing and personnel resources than Bancard and there can be no assurance that Bancard will be able to compete effectively with such entities. Bancard is also subject to credit risks. When a billing dispute arises between a cardholder and a merchant, and if the dispute is not resolved in favor of the merchant, the transaction is charged back to the merchant. If Bancard is unable to collect such chargeback from the merchant's account, and if the merchant refuses or is unable to reimburse Bancard for the chargeback due to bankruptcy or other reasons, Bancard bears the loss for the amount of the refund paid to the cardholder. Bancard, in general, handles processing for smaller, less seasoned merchants, which may present greater risk of loss. Although Bancard maintains a reserve against these losses, there is no assurance that it will be adequate. Additionally, VISA and MasterCard have the ability to increase the "interchange" rates charged to merchants for credit card transactions. There can be no assurance that merchants will continue to accept credit cards as payment if they feel rates are too high. Bancard is also subject to an approval process by the VISA and MasterCard credit card associations. In the event Bancard fails to comply with these standards, Bancard's designation as a certified processor could be suspended or terminated. There can be no assurance that VISA or MasterCard will maintain Bancard's registrations or that the current VISA or MasterCard rules allowing Bancard to provide transaction processing services will remain in effect. We have a continuing need for technological change and we may not have the resources to effectively implement new technology. The financial services industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. 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 and expand our market areas. 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. System failure or breaches /f 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, 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 encrypt and protect customer transaction data. A failure of such security measures could have a material adverse effect on our financial condition and results of operations. We are subject to certain operational risks, including, but not limited to, customer or employee 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. 8 We maintain a system of internal controls and insurance coverage to mitigate against operational risks, including data processing system failures and errors and customer or employee fraud. Should our internal controls fail to prevent or detect an occurrence, or if any resulting loss is not insured or exceeds applicable insurance limits, it could have a material adverse effect on our business, financial condition and results of operations. Government regulation can result in limitations on our operations. We operate in a highly regulated environment and are subject to supervision and regulation by a number of governmental regulatory agencies, including the Federal Reserve System, the FDIC, the Iowa Department of Banking ("IDOB") and the Illinois Department of Financial and Professional Regulation ("IDFPR"). Regulations adopted by these agencies, which are generally intended to provide protection for depositors and customers rather than for the benefit of stockholders, govern a comprehensive range of matters relating to ownership and control of our shares, our acquisition of other companies and businesses, permissible activities for us to engage in, maintenance of adequate capital levels and other aspects of our operations. These bank regulators possess broad authority to prevent or remedy unsafe or unsound practices or violations of law. The laws and regulations applicable to the banking industry could change at any time and we cannot predict the effects of these changes on our business and profitability. Increased regulation could increase our cost of compliance and adversely affect profitability. For example, new legislation or regulation may limit the manner in which we may conduct our business, including our ability to offer new products, obtain financing, attract deposits, make loans and achieve satisfactory interest spreads. Failure to pay interest on our debt may adversely impact our ability to pay dividends. As of December 31, 2005, we had $25.8 million of junior subordinated debentures held by three business trusts that we control. Interest payments on the debentures, which totaled $1.6 million for 2005, must be paid before we pay dividends on our capital stock, including our Common Stock. We have the right to defer interest payments on the debentures for up to 20 consecutive quarters. However, if we elect to defer interest payments, all deferred interest must be paid before we may pay dividends on our capital stock. Deferral of interest payments could also cause a decline in the market price of our Common Stock. There is a limited trading market for our common shares, and you may not be able to resell your shares at or above the price stockholders paid for them. Although our common shares are listed for quotation on the Nasdaq Capital Market, the trading in our common shares has substantially less liquidity than many other companies quoted on Nasdaq. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the market of willing buyers and sellers of our common shares at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. We cannot assure you that volume of trading in our common shares will increase in the future. Item 1.B. Unresolved Staff Comments There are no unresolved staff comments. Item 2. Properties The original office of Quad City Bank & Trust is in a 6,700 square foot facility, which was completed in January 1994. In March 1994, Quad City Bank & Trust acquired that facility, which is located at 2118 Middle Road in Bettendorf, Iowa. Construction of a second full service banking facility was completed in July 1996 to provide for the convenience of customers and to expand the market territory. Quad City Bank & Trust also owns that facility which is located at 4500 Brady Street in Davenport, Iowa. The two-story building is in two segments that are separated by an atrium. Originally, Quad City Bank & Trust owned the south half of the building, while the north half was owned by the developer. Quad City Bank & Trust acquired the northern segment of this facility in August 2003. Each segment has two floors that are 6,000 square feet. In addition, the southern segment has a 6,000 square foot basement level. In the southern segment, Quad City Bank & Trust occupies the first floor and utilizes the basement, which underwent remodeling during 2004, for operational functions, training and storage. At December 31, 2003, approximately 1,500 square feet on the second floor of the southern segment were leased to a professional services firm, and approximately 4,500 square feet were occupied by various operational and administrative functions, which prior to January 2003 had been located in an adjacent office building. Renovations were completed during 2004 on both floors of the northern segment of the building, which is now utilized by additional operational and administrative functions of Quad City Bank & Trust and the Company. 9 Renovation of a third full service banking facility was completed in February 1998 at the historic Velie Plantation Mansion, 3551 Seventh Street, located near the intersection of 7th Street and John Deere Road in Moline, Illinois near the Rock Island/Moline border. The building is owned by a third party limited liability company, in which the Company has a 20% interest. Quad City Bank & Trust and Bancard are the building's major tenants. Quad City Bank & Trust occupies the main floor of the structure and a portion of the lower level. Bancard relocated its operations to the lower level of the 30,000 square foot building in late 1997. The Company relocated its corporate headquarters to the building in February 1998 and occupies approximately 2,000 square feet on the second floor. Construction of a fourth full service banking facility was completed in October 2000 at 5515 Utica Ridge Road in Davenport, Iowa. Quad City Bank & Trust leases approximately 6,000 square feet on the first floor and 2,200 square feet on the lower level of the 24,000 square foot facility. The office opened in October 2000. In September 2003, the Company announced plans for a fifth Quad City Bank & Trust banking facility, to be located in west Davenport, Iowa at Five Points. Total costs were approximately $3.6 million. The facility was completed and began operations in March 2005. Quad City Bank & Trust's Five Points branch is a 12,000 square foot facility. The Company announced plans, in April 2001, to expand its banking operations to the Cedar Rapids, Iowa market. Initially, from June until mid-September 2001, the Cedar Rapids operation functioned as a branch of Quad City Bank & Trust while waiting for regulatory approvals for a new state bank charter. On September 14, 2001, the Cedar Rapids branch operation was converted into the new charter and began operations as Cedar Rapids Bank & Trust Company. Until the summer of 2005, Cedar Rapids Bank & Trust leased approximately 8,200 square feet in the GreatAmerica Building in downtown Cedar Rapids, which had served as its only office. In February 2004, Cedar Rapids Bank & Trust announced plans to build a four floor building in downtown Cedar Rapids. The bank's main office relocated to this site in July 2005, when construction was completed. Cedar Rapids Bank & Trust owns the lower three floors of the facility, and an unrelated third party owns the fourth floor in a condominium arrangement with the bank. In the summer of 2005, Cedar Rapids Bank & Trust also completed construction on a branch office in northern Cedar Rapids on Council Street. Cedar Rapids Bank & Trust's first branch facility began operations on June 2, 2005. The Company announced plans in June 2004 to expand banking operations to the Rockford, Illinois market. Initially, from September through December 2004, the Rockford operation functioned as a branch of Quad City Bank & Trust while waiting for regulatory approvals for a new state bank charter in Illinois. On January 3, 2005, the Rockford branch operation was converted into the Company's third charter and began operations as Rockford Bank and Trust Company. Rockford Bank & Trust leases approximately 7,800 square feet in the newly restored Morrissey Building at 127 North Wyman Street in downtown Rockford, which serves as its main office. In the third quarter of 2005, Rockford Bank & Trust moved forward with plans for a second banking location on Guilford Road at Alpine Road in Rockford. A temporary modular facility opened in December 2005. The Company plans to construct a 20,000 square foot building projected for completion in August 2006. 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 or mortgage amounts to 10% or more of consolidated assets. 10 Item 3. 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 4. Submission of Matters to a Vote of Security Holders There were no matters submitted to the stockholders of the Company for a vote during the fourth quarter of the fiscal year ended December 31, 2005. Part II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters The common stock, par value $1.00 per share, of the Company is listed for quotation on The Nasdaq Capital Market under the symbol "QCRH". The stock began trading on October 6, 1993. As of December 31, 2005, there were 4,531,224 shares of common stock outstanding held by approximately 2,600 holders of record. The following table sets forth the high and low sales prices of the common stock, as reported by The Nasdaq Capital Market, for the periods indicated. 2005 2004 2003 sales price sales price sales price --------------------- ------------------- ------------------ High Low High Low High Low -------------------------------------------------------------------- First quarter........ $22.000 $20.000 $22.000 $18.667 $12.100 $11.220 Second quarter....... 22.060 19.830 19.667 17.400 13.333 11.633 Third quarter........ 22.750 20.500 19.940 17.550 16.667 13.207 Fourth quarter....... 20.500 17.920 21.990 18.000 19.387 15.000
On April 28, 2005, the board of directors declared a cash dividend of $0.04 payable on July 6, 2005, to stockholders of record on June 15, 2005. On October 27, 2005, the board of directors declared a cash dividend of $0.04 per share payable on January 6, 2006, to stockholders of record on December 23, 2005. In the future, it is the Company's intention to continue 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 growth, but believes that operating results have reached a level that can sustain dividends to stockholders as well. The Company has issued junior subordinated debentures in four private placements. Under the terms of the debentures, the Company may be prohibited, under certain circumstances, from paying dividends on shares of its common stock. None of these circumstances currently exist. Under applicable state laws, the banks are restricted as to the maximum amount of dividends that they may pay on their common stock. Both Iowa law and Illinois law provide that state-chartered banks in those states may not pay dividends in excess of their undivided profits. Before declaring its first dividend, Rockford Bank & Trust, as a de novo institution, is required by Illinois law to carry at least one-tenth of its net profits since the issuance of its charter to its surplus until its surplus is equal to its capital. The Federal Reserve Act also imposes limitations on the amount of dividends that may be paid by state member banks, such as the banks. Generally, a member bank may pay dividends out of its undivided profits, in such amounts and at such times as the bank's board of directors deems prudent. Without prior Federal Reserve approval, however, a state member bank may not pay dividends in any calendar year that, in the aggregate, exceed the bank's calendar year-to-date net income plus the bank's retained net income for the two preceding calendar years. The Federal Reserve's approval for Rockford Bank & Trust to become a member bank is conditioned upon Rockford Bank & Trust's commitment that without prior Federal Reserve approval, it will not pay dividends until after it has been in operation for three years and has received two consecutive satisfactory composite CAMELS ratings. Notwithstanding the availability of funds for dividends, however, the banks' regulators may prohibit the payment of any dividends by the banks if they determine that such payment would constitute an unsafe or unsound practice. The Company's ability to pay dividends to its shareholders 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. The Company did not repurchase any of its common stock during the fourth quarter of 2005. 11 Item 6. Selected Financial Data The following "Selected Consolidated 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. SELECTED CONSOLIDATED FINANCIAL DATA (dollars in thousands, except per share data) Years Ended December 31, Six Year Ended June 30, ----------------------------------- Months ---------------------- Ended December 31, 2005 2004 2003 2002 2002 2001 ----------------------------------------------------------------------- Statement of Income Data: Interest income ........................ $ 48,688 $ 38,017 $ 33,378 $ 16,120 $ 28,520 $ 28,544 Interest expense ....................... 21,281 13,325 11,950 6,484 12,870 16,612 Net interest income .................... 27,407 24,692 21,428 9,636 15,650 11,932 Provision for loan/lease losses ........ 877 1,372 3,405 2,184 2,265 889 Noninterest income ..................... 10,073 8,682 11,168 8,840 7,915 6,313 Noninterest expenses ................... 29,433 24,281 21,035 11,413 17,023 13,800 Pre-tax net income ..................... 7,170 7,721 8,156 4,879 4,277 3,556 Minority interest in income of consolidated subsidiary ................ 78 -- -- -- -- -- Income tax expense ..................... 2,282 2,504 2,695 1,683 1,315 1,160 Net income ............................. 4,810 5,217 5,461 3,196 2,962 2,396 Per Common Share Data: Net income-basic ....................... $ 1.06 $ 1.23 $ 1.31 $ 0.77 $ 0.74 $ 0.71 Net income-diluted ..................... 1.04 1.20 1.28 0.76 0.72 0.69 Cash dividends declared ................ 0.08 0.08 0.07 0.03 -- -- Dividend payout ratio .................. 7.55% 6.50% 5.34% 3.90% --% --% Balance Sheet: Total assets ........................... $1,042,614 $ 870,084 $ 710,040 $ 604,600 $ 518,828 $ 400,948 Securities ............................. 182,365 149,561 128,843 81,654 76,231 56,710 Loans/leases ........................... 756,254 648,351 522,471 449,736 390,594 287,865 Allowance for estimated losses on loans/leases ....................... 8,884 9,262 8,643 6,879 6,111 4,248 Deposits ............................... 698,504 588,016 511,652 434,748 376,317 302,155 Stockholders' equity: Common ............................... 54,467 50,774 41,823 36,587 32,578 23,817 Key Ratios: Return on average assets ............... 0.51% 0.65% 0.83% 1.13% 0.64% 0.62% Return on average common equity .......................... 9.14 11.89 13.93 18.41 10.07 10.95 Net interest margin (TEY) (1) .......... 3.25 3.41 3.55 3.68 3.74 3.38 Efficiency ratio (2) ................... 78.53 72.75 64.53 61.71 72.20 75.64 Nonperforming assets to total assets ........................... 0.36 1.23 0.70 0.83 0.44 0.44 Allowance for estimated losses on loans/leases to total loans/leases ..... 1.17 1.43 1.65 1.53 1.56 1.48 Net charge-offs to average loans/leases ................... 0.25 0.13 0.34 0.34 0.12 0.10 Average stockholders' equity to average assets ......................... 5.63 5.49 5.94 6.12 6.38 5.69 Earnings to fixed charges Excluding interest on Deposits ............................. 1.78 x 2.11 x 2.51 x 2.90 x 1.95 x 1.90 x Including interest on Deposits ............................. 1.32 1.56 1.66 1.73 1.32 1.21
(1) Interest earned and yields on nontaxable investments are determined on a tax equivalent basis using a 34% tax rate. (2) Noninterest expenses divided by the sum of net interest income before provision for loan/lease losses and noninterest income. 12 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion provides additional information regarding our operations for the twelve-month periods ending December 31, 2005, 2004, and 2003, and financial condition at December 31, 2005 and 2004. This discussion should be read in conjunction with "Selected Consolidated Financial Data" and our consolidated financial statements and the accompanying notes thereto included or incorporated by reference elsewhere in this document. Overview The Company was formed in February 1993 for the purpose of organizing Quad City Bank & Trust. Over the past thirteen years, the Company has grown to include two additional banking subsidiaries and a number of nonbanking subsidiaries, which in aggregate totaled $1.04 billion in consolidated assets as of December 31, 2005. The Company reported earnings of $4.8 million or $1.06 basic earnings per share for 2005, as compared to $5.2 million or $1.23 basic earnings per share for 2004, and $5.5 million or $1.31 basic earnings per share for 2003. Earnings for 2005 were negatively impacted by anticipated increases in both personnel and facilities costs, as the subsidiary banks opened four new banking locations during the year, and by a related write-off of $332 thousand of tenant improvements at a previously occupied facility. Also during 2005, the Company absorbed the start-up losses experienced by Rockford Bank & Trust, which opened at the beginning of 2005. Earnings for 2004 reflected the Company's issuance of $8.0 million in floating rate and $12.0 million in fixed/floating rate trust preferred securities. In connection with this issuance, the Company redeemed, on June 30, 2004, $12.0 million of trust preferred securities originally issued in 1999. Prior to this redemption, the Company had expensed $747 thousand of unamortized issuance costs associated with the 1999 trust preferred securities in March 2004. The write-off of these costs, combined with the additional interest costs of supporting both the original and the new securities from February through June, resulted in an after-tax reduction to net income during 2004 of $729 thousand, or $0.17 in diluted earnings per share. Earnings for 2003 were positively impacted by the Company's continued merchant credit card processing through September 2003 for an ISO portfolio, which had been sold in October 2002. This ISO processing contributed $864 thousand, or $0.20 in diluted earnings per share, to the Company's net income during 2003. For 2004, excluding the one-time write-off of the unamortized issuance costs and the additional interest costs incurred for approximately four months, net income would have been $5.9 million, or diluted earnings per share of $1.37, a 9% improvement over earnings for 2003. Although excluding the impact of this event is a non-GAAP measure, management believes that it is important to provide such information due to the non-recurring nature of this expense and to more accurately compare the results of the periods presented. When compared to 2004, there was solid growth in 2005 in both net interest income and noninterest income for the Company. For 2005, net interest income and noninterest income improved by 11% and 16%, respectively, for a combined increase of $4.1 million when compared to 2004. A decrease in the provision for loan/lease losses of $495 thousand from 2004 to 2005 also contributed positively to net income. The successful resolution of several large credits in the subsidiary banks' loan portfolios, through foreclosure, payoff, or restructuring, resulted in reductions to both provision expense and the level of allowance for loan/lease losses. Merchant credit card fees, net of processing costs and trust department fees also contributed an additional $661 thousand, in aggregate, to the Company's noninterest income. Partially offsetting these revenue contributions for the Company was an increase in noninterest expense of $5.2 million. The primary contributors to the increase in noninterest expense were salaries and employee benefits, which increased $2.8 million from the same period in 2004 and occupancy and equipment expense, which increased $1.0 million with the addition of four new banking locations during the year. Also during 2005, the Company incurred $1.9 million of pretax operating costs associated with the start-up of the new banking operation in Rockford, Illinois. The Company's results of operations are dependent primarily on net interest income, which is the difference between interest income, principally from loans and investment securities, and interest expense, principally on customer deposits and borrowings. Changes in net interest income result from changes in volume, net interest spread and net interest margin. Volume refers to the average dollar level 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's averag% tax equivalent yield on interest earning assets increased 0.53% for 2005 as compared to 2004. With the same comparison, the average cost of interest-bearing liabilities increased 0.70%, which resulted in a 0.17% decrease in the net interest spread of 3.13% for 2004 to 2.96% for 2005. The significant narrowing of the net interest spread from year to year, in turn depressed net interest margin. For 2005, net interest margin was 3.25% compared to 3.41% for 2004. Management continues to closely monitor and manage net interest margin. From a profitability standpoint, an important challenge for the subsidiary banks is the maintenance of their net interest margins. Management continually addresses this issue with the use of alternative funding sources and pricing strategies. 13 The Company's operating results are also affected by sources of noninterest income, including merchant credit card fees, trust fees, deposit service charge fees, gains from the sales of residential real estate loans and other income. Operating expenses of the Company include employee compensation and benefits, occupancy and equipment expense and other administrative expenses. The Company's operating results are also affected by economic and competitive conditions, particularly changes in interest rates, government policies and actions of regulatory authorities. The majority of the subsidiary banks' loan portfolios are invested in commercial loans. Deposits from commercial customers represent a significant funding source as well. The Company has continued to add facilities and employees to accommodate both our historical growth and anticipated future growth. As such, overhead expenses have had a significant impact on earnings. This trend is likely to continue as the Company and our three banks continue to add the facilities and resources necessary to attract and serve additional customers. Trust department income continues to be a significant contributor to noninterest income. During 2005, trust department fees totaled $2.8 million. Trust department fees contributed $2.5 million in revenues during 2004. During 2003, trust department fees totaled $2.2 million. Income is generated primarily from fees charged based on assets under administration for corporate and personal trusts and for custodial services. Assets under administration at December 31, 2005 increased $32.8 million during the year to $811.2 million, resulting primarily from the development of existing relationships and the addition of new trust relationships. Assets under administration at December 31, 2004 were $778.4 million, which was an increase of $104.9 million from December 31, 2003, when assets totaled $673.5 million. 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/lease losses. The Company's allowance for loan/lease loss methodology incorporates a variety of risk considerations, both quantitative and qualitative in establishing an allowance for loan/lease 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, 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 throughout the Midwest and in particular, the state 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. Management may report a materially different amount for the provision for loan/lease losses in the statement of operations to change the allowance for loan/lease 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 section entitled "Financial Condition - Allowance for Loan/Lease Losses." Although management believes the levels of the allowance as of December 31, 2003, 2004, and 2005 were 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 2005 compared with 2004 Overview. Net income for 2005 was $4.8 million as compared to net income of $5.2 million for 2004 for a decrease of $407 thousand or 8%. Basic earnings per share for 2005 were $1.06 as compared to $1.23 for 2004. The decrease in net income was comprised of an increase in net interest income after provision for loan losses of $3.2 million in combination with an increase in aggregate noninterest income of $1.4 million and a decrease in federal and state income taxes of $222 thousand, offset by an increase in noninterest expenses of $5.1 million. Several specific factors contributed to the decline in net income from 2004 to 2005. Primary factors included a $2.8 million, or 21%, increase in salaries and employee benefits, an increase in occupancy and equipment expense of 32%, or $1.0 million, and $1.9 million of pretax operating costs associated with the start-up of the new banking operation in Rockford. 14 Interest income. Interest income grew from $38.0 million for 2004 to $48.7 million for 2005. The 28% increase in interest income was attributable to greater average outstanding balances in interest-earning assets, principally loans receivable, in combination with an improved aggregate asset yield. The average yield on interest earning assets for 2005 was 5.75% as compared to 5.22% for 2004. Interest expense. Interest expense increased by $8.0 million, from $13.3 million for 2004 to $21.3 million for 2005. The 60% increase in interest expense was primarily att2ibutable to an aggregate increase in interest rates, in combination with greater average outstanding balances in interest-bearing liabilities. The average cost on interest bearing liabilities was 2.79% for 2005 as compared to 2.09% for 2004. Provision for loan/lease losses. The provision for loan/lease losses is established based on a number of factors, including the local and national economy and the risk associated with the loans/leases in the portfolio. The Company had an allowance for estimated losses on loans/leases of approximately 1.17% of total gross loans/leases at December 31, 2005, as compared to approximately 1.43% of total gross loans at December 31, 2004, and 1.65% at December 31, 2003. The provision for loan/lease losses declined significantly to $877 thousand for 2005, as compared to $1.4 million for 2004. During both periods, management made monthly provisions for loan/lease losses based upon a number of factors, principally the increase in loans/leases and a detailed analysis of the loan/lease portfolio. During 2005, the successful resolution of several large credits primarily in Quad City Bank & Trust's loan/lease portfolio, through foreclosure, payoff, or restructuring, resulted in reductions to both provision expense and the level of allowance for loan/lease losses. During 2005, the net growth in the loan/lease portfolio generated a provision expense of $889 thousand; however, 44%, or $394 thousand, was offset by adjustments to the allowance for estimated losses on loans/leases based on the write-offs, payoffs, or restructures of several large credits within the portfolio. During 2005, there were transfers totaling $169 thousand of loans to other real estate owned. For 2005, commercial loans/leases had total charge-offs of $1.5 million, of which $926 thousand, or 61%, resulted from two customer relationships at Quad City Bank & Trust, and there were $245 thousand of commercial recoveries. Consumer loan charge-offs and recoveries totaled $359 thousand and $90 thousand, respectively, for 2005. For 2005, credit cards accounted for 49% of the consumer loan, net charge-offs. Real estate loans had $160 thousand of charge-offs and $25 thousand of recovery activity during 2005. The ability to grow profitably is, in part, dependent upon the ability to maintain asset quality. The Company continually focuses its efforts at the subsidiary banks to attempt to improve the overall quality of the Company's loan/lease portfolio. Noninterest income. Noninterest income increased by $1.4 million from $8.7 million for 2004 to $10.1 million for 2005. Noninterest income for both periods, along with other miscellaneous fees, consisted primarily of income from the merchant credit card operation, fees from the trust department, depository service fees, and gains on the sale of residential real estate mortgage loans. Making significant improvements from year to year in the noninterest income category were increases in merchant credit card fees, net of processing costs and trust department fees. Merchant credit card fees, net of processing costs for 2005 increased by 26% to $1.8 million from $1.4 million for 2004. Through September 2003, Bancard processed ISO-related Visa/Mastercard activity and carried ISO-specific reserves, which provided coverage for the related exposure. In the first and third quarters of 2004, the Company recognized aggregate recoveries of $277 thousand from the reduction of these ISO-specific reserves. For 2004, Bancard's ISO-related income was $327 thousand, and Bancard's core merchant credit card fees, net of processing costs, were $1.1 million, which included the expense of specific provisions of $196 thousand that were made for local merchant chargeback losses. For 2005, Bancard's core merchant credit card fees, net of processing costs, were $1.8 million, which was an improvement of $373 thousand when compared to 2004. Significantly contributing to the 26% increase from year to year were aggregate reversals during 2005 of $134 thousand of specific allocations to the allowance for local merchant chargeback losses, and $118 thousand in recoveries during 2005 of prior period expenses. In 2005, trust department fees grew to $2.8 million from $2.5 million in 2004. The $288 thousand, or 11%, increase from year to year was primarily a reflection of continued development of existing trust relationships and the addition of new trust customers, as well as an improvement in the market values of securities held in trust accounts, when compared to one year ago. Each of these factors had a resulting impact in the calculation and realization of trust fees. Total trust assets under management were $811.2 million at December 31, 2005 compared to $778.4 million at December 31, 2004. Deposit service fees decreased $49 thousand, or 3%, remaining at $1.6 million for 2005, as well as for 2004. This decrease was primarily a result of the reduction in collected service fees on commercial noninterest bearing demand deposit accounts at Quad City Bank & Trust due to earnings credit rates which more than doubled during 2005. The year-to-date average balance of consolidated noninterest bearing demand deposits at December 31, 2005 decreased $2.6 million from December 31, 2004. Service charges and NSF (non-sufficient funds or overdraft) charges related to demand deposit accounts were the main components of deposit service fees. 15 Gains on sales of loans, net, were $1.2 million for 2005, which reflected an increase of 9%, or $104 thousand, from $1.1 million for 2004. The slight increase was a result of stagnant volumes of residential real estate loan originations from year to year, and the effect on the subsequent sale of the majority of residential mortgages into the secondary market. During 2005, earnings on the cash surrender value of life insurance grew $28 thousand, or 4%, to $656 thousand from $628 thousand for 2005. During the first quarter of 2004, the Company made significant investments in bank-owned life insurance ("BOLI") on key executives at the two existing subsidiary banks. Quad City Bank & Trust purchased $8.6 million of BOLI, and Cedar Rapids Bank & Trust made a purchase of $3.6 million of BOLI. During 2005, Rockford Bank & Trust purchased $777 thousand of BOLI. Investment advisory and management fees increased $182 thousand from $510 thousand for 2004 to $692 thousand for 2005. The 36% increase from year to year was due to the increased volume of investment services provided by representatives of LPL Financial Services at the subsidiary banks, primarily at Quad City Bank & Trust. For 2005, other noninterest income increased $419 thousand, or 48%, to $1.3 million from $867 thousand for 2004. The increase in 2005 was primarily due to income from affiliated companies. During the first quarter of 2005, one of the Company's affiliated companies, Nobel Electronic Transfer, LLC, completed a large, one-time sales transaction, which contributed $219 thousand to other noninterest income. Income from affiliated companies, earnings on other assets, Visa check card fees, and ATM fees were primary contributors to other noninterest income during 2005. Noninterest expenses. Noninterest expenses for 2005 were $29.4 million as compared to $24.3 million for 2004 for an increase of $5.2 million, or 21%. For 2005, noninterest expenses for the new charter at Rockford Bank & Trust were $2.4 million. For both 2005 and 2004, the main components of noninterest expenses were primarily salaries and benefits, occupancy and equipment expenses, and professional and data processing fees. During the first quarter of 2004, there was also a loss of $747 thousand associated with the redemption of junior subordinated debentures at their earliest call date of June 30, 2004. The following table sets forth the various categories of noninterest expenses for the years 2005 and 2004. Twelve Months Ended December 31, --------------------------------------- 2005 2004 % Change --------------------------------------- Salaries and employee benefits .............................. $16,630,868 $13,773,439 21% Professional and data processing fees ....................... 2,865,064 2,199,984 30% Advertising and marketing ................................... 1,221,039 1,014,664 20% Occupancy and equipment expense ............................. 4,316,443 3,263,540 32% Stationery and supplies ..................................... 645,985 543,904 19% Postage and telephone ....................................... 842,779 684,964 23% Bank service charges ........................................ 516,537 570,374 (9%) Insurance ................................................... 594,282 420,080 41% Loss on disposals/sales of fixed assets ..................... 332,283 1,048 NA Loss on redemption of junior subordinated debentures ........ -- 747,490 NA Other ....................................................... 1,467,868 1,061,364 38% -------------------------- Total noninterest expenses .................... $29,433,148 $24,280,851 21% ==========================
16 For 2005, total salaries and benefits increased to $16.6 million, which was up $2.8 million from the previous year's total of $13.8 million. The increase of 21% was primarily due to the Company's increase in compensation and benefits related to an increase in employees from 243 full time equivalents ("FTEs") to 305 from year-to-year. The staffing of Rockford Bank & Trust created 18 FTEs and 38% of the increase in total salaries and benefits. Occupancy and equipment expense increased $1.0 million, or 32%, from year to year. The increase was a proportionate reflection of the Company's investment in new facilities at the subsidiary banks, in combination with the related costs associated with additional furniture, fixtures and equipment, such as depreciation, maintenance, utilities, and property taxes. In conjunction with Cedar Rapids Bank & Trust's move into their new main office facility, the Company took a one-time $332 thousand write-off of tenant improvements which had been made to the GreatAmerica Building, which had initially served as that subsidiary's main office. Professional and data processing fees experienced a 30% increase from $2.2 million for 2004 to $2.9 million for 2005. The $665 thousand increase was primarily the result of legal and other professional fees related to the organization of Rockford Bank & Trust, consulting fees incurred in conjunction with Sarbanes-Oxley compliance work, and increased legal fees incurred at the subsidiary banks. Other noninterest expense increased $406 thousand to $1.5 million for 2005 from $1.1 million for 2004. The increase was primarily the result of $327 thousand of write-downs on property values of other real estate owned (OREO) at the subsidiary banks, $128 thousand of other expense incurred on OREO property, $442 of other loan expense at the subsidiary banks, and $122 thousand of cardholder program expense at Bancard. For 2005, advertising and marketing expense increased to $1.2 million from $1.0 million for 2004. The $206 thousand increase was predominately due to the addition of Rockford Bank & Trust, in combination with special promotional events at Quad City Bank & Trust and Cedar Rapids Bank & Trust revolving around the openings of their new facilities. As a result of overall growth at the subsidiary banks, in combination with their increased investments in facilities throughout 2005, as well as an increase in the level of directors and officers insurance coverage, insurance expense grew 41% from $420 thousand in 2004 to $594 thousand in 2005. Income tax expense. The provision for income taxes was $2.3 million for 2005 compared to $2.5 million for 2004, a decrease of $222 thousand or 9%. The decrease was primarily attributable to decreased income before income taxes of $551 thousand or 7% for 2005, in combination with a slight decrease in the Company's effective tax rate for 2005 to 32.2% from 32.4% for 2004. 2004 compared with 2003 Overview. Net income for 2004 was $5.2 million as compared to net income of $5.5 million for 2003 for a decrease of $244 thousand or 4%. Basic earnings per share for 2004 were $1.23 as compared to $1.31 for 2003. The decrease in net income was comprised of an increase in net interest income after provision for loan losses of $5.3 million in combination with a decrease in federal and state income taxes of $191 thousand, totally offset by a decrease in noninterest income of $2.5 million, and an increase in noninterest expenses of $3.2 million. Several specific factors contributed to the decline in net income from 2003 to 2004. Primary factors included a $2.5 million, or 69%, decrease in gains on sale of loans, a $1.1 million, or 8%, increase in salaries and employee benefits, a decrease in merchant credit card fees of 36%, or $786 thousand, and the loss on redemption of junior subordinated debentures of $747 thousand. Interest income. Interest income grew from $33.4 million for 2003 to $38.0 million for 2004. The 14% increase in interest income was attributable to greater average outstanding balances in interest-earning assets, principally loans receivable, partially offset by a decrease in interest rates. The average yield on interest earning assets for 2004 was 5.22% as compared to 5.50% for 2003. Interest expense. Interest expense increased by $1.4 million, from $11.9 million for 2003 to $13.3 million for 2004. The 12% increase in interest expense was primarily attributable to greater average outstanding balances in interest-bearing liabilities, which was partially offset by a reduction in interest rates. The average cost on interest bearing liabilities was 2.09% for 2004 as compared to 2.35% for 2003. 17 Provision for loan losses. The provision for loan losses is established based on a number of factors, including the local and national economy and the risk associated with the loans in the portfolio. The Company had an allowance for estimated losses on loans of approximately 1.43% of total gross loans at December 31, 2004, as compared to approximately 1.65% at December 31, 2003, 1.53% at December 31, 2002, and 1.56% at June 30, 2002. The provision for loan losses declined significantly to $1.4 million for 2004, as compared to $3.4 million for 2003. During both periods, management made monthly provisions for loan losses based upon a number of factors, principally the increase in loans and a detailed analysis of the loan portfolio. During 2004, the successful resolution of several large credits in Quad City Bank & Trust's loan portfolio, through foreclosure, payoff, or restructuring, resulted in reductions to both provision expense and the level of allowance for loan losses. During 2004, the net growth in the loan portfolio actually generated provision expense of $1.8 million, however 24%, or $426 thousand, was offset by adjustments to the allowance for estimated losses on loans based on the write-offs, payoffs, or restructures of several large credits within the portfolio. During 2004, there were transfers totaling $1.9 million of loans to other real estate owned. For 2004, commercial loans had total charge-offs of $624 thousand, of which $419 thousand resulted from two customer relationships at Quad City Bank & Trust, and there were $137 thousand of commercial recoveries. Consumer loan charge-offs and recoveries totaled $292 thousand and $75 thousand, respectively, for 2004. For 2004, credit cards accounted for $93 thousand of the consumer loan charge-offs. Real estate loans had $49 thousand of charge-offs and no recovery activity during 2004. The ability to grow profitably is, in part, dependent upon the ability to maintain asset quality. The Company continually focuses its efforts at the subsidiary banks to attempt to improve the overall quality of the Company's loan portfolio. Noninterest income. Noninterest income decreased by $2.5 million from $11.2 million for 2003 to $8.7 million for 2004. Noninterest income for both periods, along with other miscellaneous fees, consisted primarily of income from the merchant credit card operation, fees from the trust department, depository service fees, and gains on the sale of residential real estate mortgage loans. Making significant improvements from year to year in the noninterest income category were increases in earnings on cash surrender value of life insurance and trust department fees. Merchant credit card fees, net of processing costs, for 2004 decreased by 36% to $1.4 million from $2.2 million for 2003. In October 2002, the Company sold Bancard's ISO related merchant credit card operations to iPayment, Inc., and Bancard's core business focus was shifted to processing for its agent banks, cardholders, and local merchants. Through September 2003, Bancard continued to process ISO related transactions for iPayment, Inc. for a fixed monthly service fee, which increased as the temporary processing period was extended. For 2003, net fixed monthly service fees collected from iPayment totaled $991 thousand, and Bancard's core merchant credit card fees, net of processing costs were $1.3 million. In September 2003, the transfer of the ISO related Visa/Mastercard processing activity to iPayment, Inc. was completed and significantly reduced Bancard's exposure to risk of credit card loss that the ISO activity carried with it. Bancard had established and carried ISO-specific reserves, which provided coverage for this exposure. In March 2004, the Company recognized a recovery of $144 thousand from a reduction in these ISO-specific reserves. In September 2004, the Company also recognized a recovery of $133 thousand from the elimination of the remaining balance in the ISO-specific reserves. Less these recoveries and an additional $50 thousand of service fees collected from iPayment, Bancard's core merchant credit card fees, net of processing costs were $1.1 million for 2004, or a decrease of 15% from the previous year. The $195 thousand decrease in core merchant credit card fees, net of processing costs from year to year was primarily due to provisions for merchant chargeback losses of $226 thousand made during 2004, which were the result of two merchant situations involving fraudulent activity. In 2004, trust department fees grew to $2.5 million from $2.2 million in 2003. The $288 thousand, or 13%, increase from year to year was primarily a reflection of continued development of existing trust relationships and the addition of new trust customers, as well as an improvement in the market values of securities held in trust accounts, when compared to one year ago. Each of these factors had a resulting impact in the calculation and realization of trust fees. Total trust assets under management were $778.4 million at December 31, 2004 compared to $673.5 million at December 31, 2003. Deposit service fees increased $127 thousand, or 8%, to $1.6 million from $1.5 million for 2004 and for 2003, respectively. This increase was primarily a result of the growth in service fees collected on the noninterest bearing demand deposit accounts of downstream correspondent banks of Quad City Bank & Trust, in combination with the growth in service fees collected on demand accounts at Cedar Rapids Bank & Trust. Service charges and NSF (non-sufficient funds or overdraft) charges related to demand deposit accounts were the main components of deposit service fees. Gains on sales of loans, net, were $1.1 million for 2004, which reflected a decrease of 69%, or $2.6 million, from $3.7 million for 2003. The decrease resulted from the steep decline in mortgage refinances, which was experienced throughout 2004, and its effect on the subsequent sale of the majority of residential mortgages into the secondary market. Management anticipates that the level of gains on sales of loans, net, will continue to be reduced significantly from those experienced throughout much of 2003. 18 During 2004, earnings on the cash surrender value of life insurance grew $421 thousand, or 203%, to $628 thousand from $207 thousand for 2003. During the first quarter of 2004, the Company made significant investments in bank-owned life insurance ("BOLI") on key executives at the two existing subsidiary banks. Quad City Bank & Trust purchased $8.6 million of BOLI, and Cedar Rapids Bank & Trust made a purchase of $3.6 million of BOLI. Investment advisory and management fees increased $169 thousand from $341 thousand for 2003 to $510 thousand for 2004. The 50% increase from year to year was due to the increased volume of investment services provided by representatives of LPL Financial Services at the subsidiary banks, primarily at Cedar Rapids Bank & Trust. For 2004, other noninterest income decreased $142 thousand, or 14%, to $$867 thousand from $1.0 million for 2003. The decrease, in 2004, was primarily due to a combination of decreased income from non-consolidated subsidiaries of the Company and from a gain realized during 2003 on the sale of foreclosed property at Quad City Bank & Trust. Noninterest expenses. For both 2004 and 2003, the main components of noninterest expenses were primarily salaries and benefits, occupancy and equipment expenses, and professional and data processing fees. Noninterest expenses for 2004 were $24.3 million as compared to $21.0 million for 2003 for an increase of $3.2 million, or 15%. The following table sets forth the various categories of noninterest expenses for the years 2004 and 2003. Twelve Months Ended December 31, ------------------------------------------- 2004 2003 % Change ------------------------------------------- Salaries and employee benefits .................................. $ 13,773,439 $ 12,710,505 8% Professional and data processing fees ........................... 2,199,984 1,962,243 12% Advertising and marketing ....................................... 1,014,664 786,054 29% Occupancy and equipment expense ................................. 3,263,540 2,640,602 24% Stationery and supplies ......................................... 543,904 460,421 18% Postage and telephone ........................................... 684,964 632,354 8% Bank service charges ............................................ 570,374 454,367 26% Insurance ....................................................... 420,080 444,947 (6%) Loss on disposals/sales of fixed assets ......................... 1,048 50,446 (98%) Loss on redemption of junior subordinated debentures ............ 747,490 -- NA Other ........................................................... 1,061,364 893,313 19% --------------------------- Total noninterest expenses ........................ $ 24,280,851 $ 21,035,252 15% ===========================
For 2004, total salaries and benefits, the largest component of noninterest expenses, increased to $13.8 million or $1.1 million over the $12.7 million for 2003. The 8% increase was primarily due to the Company's increase in employees from 213 full time equivalents to 243 from year-to-year, in combination with decreased expenses for both real estate loan officer commissions and for tax benefit rights and stock appreciation rights. The growth in personnel during 2004 mirrored a combination of Quad City Bank & Trust's expansion into the Rockford market and the strong growth occurring at Cedar Rapids Bank & Trust. 2004 reflected a $747 thousand loss on the redemption of the trust preferred securities issued in 1999 at their earliest call date of June 30, 2004. Occupancy and equipment expense increased $623 thousand, or 24%. The increase was a proportionate reflection of the additional furniture, fixtures and equipment and leasehold improvements at the subsidiary banks. Professional and data processing fees increased $238 thousand, or 12%, when comparing 2004 to 2003. The increase was primarily attributable to a combination of additional legal, director, and other professional fees incurred by the subsidiary banks and by the parent company. Advertising and marketing expense grew $229 thousand from $786 thousand to $1.0 million, respectively. The 29% increase was a result of the growth at the subsidiary banks along with special events and marketing materials showcasing the ten year anniversary of Quad City Bank & Trust, which occurred in the first quarter of 2004. Bank service charges increased $116 thousand, stationary and supplies expense grew $83 thousand, and postage and phone expense increased $53 thousand. All of these increases were proportionate reflections of the Company's growth during the year. Income tax expense. The provision for income taxes was $2.5 million for 2004 compared to $2.7 million for 2003, a decrease of $191 thousand or 7%. The decrease was primarily attributable to decreased income before income taxes of $435 thousand or 5% for 2004, in combination with a slight decrease in the Company's effective tax rate for 2004 to 32.4% from 33.0% for 2003. 19 Financial Condition Total assets of the Company increased by $172.5 million, or 20%, to $1.04 billion at December 31, 2005 from $870.1 million at December 31, 2004. Total assets of the Company increased by $160.0 million, or 23%, to $870.1 million at December 31, 2004 from $710.0 million at December 31, 2003. The growth over these years primarily resulted from an increase in the loan portfolio funded by deposits received from customers and by proceeds from Federal Home Loan Bank advances. Cash and Cash Equivalent Assets. Cash and due from banks increased by $17.6 million, or 82%, to $39.0 million at December 31, 2005 from $21.4 million at December 31, 2004. Cash and due from banks decreased by $3.0 million, or 13%, to $21.4 million at December 31, 2004 from $24.4 million at December 31, 2003. Cash and due from banks represented both cash maintained at the subsidiary banks, as well as funds that the Company and its subsidiaries had deposited in other banks in the form of noninterest-bearing demand deposits. At December 31, 2005 and December 31, 2004, cash maintained at the subsidiary banks totaled $15.4 million and $9.0 million. At December 31, 2005 and December 31, 2004, funds maintained as noninterest-bearing deposits at other banks totaled $23.5 million and $12.3 million. Federal funds sold are inter-bank funds with daily liquidity. Federal funds sold increased by $1.6 million to $4.5 million at December 31, 2005 from $2.9 million at December 31, 2004. Federal funds sold decreased by $1.1 million to $2.9 million at December 31, 2004 from $4.0 million at December 31, 2003. Fluctuations are attributed to a combination of both varying demands for Federal funds purchases by Quad City Bank & Trust's downstream correspondent banks and to varying levels of liquidity at the Company's subsidiary banks. Interest-bearing deposits at financial institutions decreased by $2.6 million, or 67%, to $1.3 million at December 31, 2005 from $3.9 million at December 31, 2004. Included in interest-bearing deposits at financial institutions are demand accounts, money market accounts, and certificates of deposit. The decrease was the result of decreases in money market accounts of $1.8 million and maturities of certificates of deposit totaling $822 thousand. Interest-bearing deposits at financial institutions decreased by $6.5 million, or 63%, to $3.9 million at December 31, 2004 from $10.4 million at December 31, 2003. The decrease was the result of decreases in money market accounts of $3.4 million and maturities of certificates of deposit totaling $3.1 million. As a result of the interest rate environment, during 2005 and 2004, the subsidiary banks reduced their deposits in other banks in the form of certificates of deposit, increased their utilization of Federal funds sold, gained liquidity and sacrificed modest yield. Investments. Securities increased by $32.8 million, or 22%, to $182.4 million at December 31, 2005 from $149.6 million at December 31, 2004. The net increase was the result of a number of transactions in the securities portfolio. The Company purchased additional securities, classified as available for sale, in the amount of $82.3 million. This increase was partially offset by paydowns of $1.2 million that were received on mortgage-backed securities, proceeds from calls and maturities of $45.8 million, the amortization of premiums, net of the accretion of discounts, of $525 thousand, and a decrease in unrealized gains on securities available for sale, before applicable income tax of $2.0 million. Securities increased by $20.7 million, or 16%, to $149.6 million at December 31, 2004 from $128.8 million at December 31, 2003. The net increase was the result of a number of transactions in the securities portfolio. The Company purchased additional securities, classified as available for sale, in the amount of $86.7 million. This increase was partially offset by paydowns of $1.8 million that were received on mortgage-backed securities, proceeds from calls and maturities of $53.0 million, proceeds from sales of $8.4 million, net losses of $45 thousand, the amortization of premiums, net of the accretion of discounts, of $983 thousand, and a decrease in unrealized gains on securities available for sale, before applicable income tax of $1.8 million. Certain investment securities at Quad City Bank & Trust were purchased with the intent to hold the securities until they mature. These held to maturity securities, comprised of municipal securities and other bonds, were recorded at amortized cost at December 31, 2005, 2004, and 2003. The balance at December 31, 2005 was $150 thousand, which was an increase of $50 thousand from the balance of $100 thousand at December 31, 2004. The balance at December 31, 2004 was $100 thousand, which was a decrease of $300 thousand from the balance of $400 thousand at December 31, 2003. Market values at December 31, 2005, 2004, and 2003 were $155, $108 thousand, and $417 thousand, respectively. All of the Company's, Cedar Rapids Bank & Trust's and Rockford Bank & Trust's securities, and a majority of Quad City Bank & Trust's securities are placed in the available for sale category as the securities may be liquidated to provide cash for operating, investing or financing purposes. These securities were reported at fair value and increased by $32.8 million, or 22%, to $182.2 million at December 31, 2005, from $149.5 million at December 31, 2004. These securities were reported at fair value and increased by $21.0 million, or 16%, to $149.5 million at December 31, 2004, from $128.4 million at December 31, 2003. The amortized cost of such securities at December 31, 2005, 2004, and 2003 was $183.1, $148.4, and $125.6 million. 20 As of December 31, 2005, there existed no security in the investment portfolio (other than U.S. Government and U.S. Government agency securities) that exceeded 10% of stockholders' equity at that date. Loans/leases. Total gross loans/leases receivable increased by $107.9 million, or 17%, to $756.3 million at December 31, 2005 from $648.4 million at December 31, 2004. The increase was the result of the origination or purchase of $716.9 million of commercial business, consumer and real estate loans/leases, less loans transferred to other real estate owned (OREO) of $169 thousand, loan/lease charge-offs, net of recoveries, of $1.7 million and loan/lease repayments or sales of loans of $607.4 million. Included in purchases, was the acquisition on August 26, 2005 of M2 Lease Fund's lease portfolio of $32.0 million. During 2005, Quad City Bank & Trust contributed $370.5 million, or 52%, Cedar Rapids Bank & Trust contributed $271.3 million, or 38%, Rockford Bank & Trust contributed $35.7 million, or 5%, and M2 Lease Funds contributed $39.3, or 5%, of the Company's loan/lease originations or purchases. As of December 31, 2005, Quad City Bank & Trust's legal lending limit was approximately $9.4 million, Cedar Rapids Bank & Trust's legal lending limit was approximately $3.5 million, and Rockford Bank & Trust's legal lending limit was approximately $2.3 million. Total gross loans receivable increased by $125.9 million, or 24%, to $648.4 million at December 31, 2004 from $522.5 million at December 31, 2003. The increase was the result of the origination or purchase of $568.7 million of commercial business, consumer and real estate loans, less loans transferred to other real estate owned (OREO) of $1.9 million, loan charge-offs, net of recoveries, of $753 thousand and loan repayments or sales of loans of $440.2 million. During 2004, Quad City Bank & Trust contributed $347.8 million, or 61%, and Cedar Rapids Bank & Trust contributed $220.9 million, or 39% of the Company's loan originations or purchases. During 2004, the Company established new customer relationships in Wisconsin, and at December 31, 2004, held gross loans of $11.6 million from these relationships. As expected, many of these loans were sold to a Wisconsin bank during 2005 with a balance remaining at December 31, 2005 of $5.8 million. As of December 31, 2004, Quad City Bank & Trust's legal lending limit was approximately $8.2 million and Cedar Rapids Bank & Trust's legal lending limit was approximately $3.1 million. Allowance for Loan/Lease Losses. The allowance for estimated losses on loans/leases was $8.9 million at December 31, 2005 compared to $9.3 million at December 31, 2004, for a decrease of $378 thousand, or 4%. The allowance for estimated losses on loans/leases was $9.3 million at December 31, 2004 compared to $8.6 million at December 31, 2003, for an increase of $619 thousand, or 7%. During 2005, the increased level of allowance required, as a result of net growth in the loan/lease portfolio, was more than offset by negative adjustments to the allowance based on the write-offs, payoffs, or restructures of several large credits within the portfolio. The adequacy of the allowance for estimated losses on loans/leases was determined by management based on factors that included the overall composition of the loan/lease portfolio, types of loans/leases, past loss experience, loan/lease delinquencies, potential substandard and doubtful credits, economic conditions and other factors that, in management's judgment, deserved evaluation in estimating loan/lease losses. To ensure that an adequate allowance was maintained, provisions were made based on the increase in loans/leases and a detailed analysis of the loan/lease portfolio. The loan/lease portfolio was reviewed and analyzed monthly utilizing the percentage allocation method with specific detailed reviews 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/leases was monitored by the credit administration staff, and reported to management and the board of directors. Net charge-offs for the years ended December 31, 2005, 2004, and 2003, were $1.7 million, $753 thousand, and $1.6 million, respectively. One measure of the adequacy of the allowance for estimated losses on loans/leases is the ratio of the allowance to the total loan/lease portfolio. Provisions were made monthly to ensure that an adequate level was maintained. The allowance for estimated losses on loans/leases as a percentage of total gross loans/leases was 1.17% at December 31, 2005, 1.43% at December 31, 2004, and 1.65% at December 31, 2003. Although management believes that the allowance for estimated losses on loans/leases at December 31, 2005 was at a level adequate to absorb probable losses on existing loans/leases, there can be no assurance that such losses will not exceed the estimated amounts or that the Company will not be required to make additional provisions for loan/lease losses in the future. Asset quality is a priority for the Company and its subsidiaries. The ability to grow profitably is in part dependent upon the ability to maintain that quality. The Company is focusing efforts at its subsidiary banks in an attempt to improve the overall quality of the Company's loan/lease portfolio. Future events could at any time 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/leases, and require further increases in the provision. 21 Nonperforming Assets. The policy of the Company is to place a loan/lease on nonaccrual status if: (a) payment in full of interest or principal is not expected or (b) principal or interest has been in default for a period of 90 days or more unless the obligation is both in the process of collection and well secured. Well secured is defined as collateral with sufficient market value to repay principal and all accrued interest. A debt is in the process of collection if collection of the debt is proceeding in due course either through legal action, including judgment enforcement procedures, or in appropriate circumstances, through collection efforts not involving legal action which are reasonably expected to result in repayment of the debt or in its restoration to current status. Nonaccrual loans/leases were $2.6 million at December 31, 2005 compared to $7.6 million at December 31, 2004, for a decrease of $5.0 million, or 66%. The decrease in nonaccrual loans/leases was comprised of decreases in commercial loans of $4.9 million and real estate loans of $205 thousand, and an increase in consumer loans of $69 thousand. Nonaccrual commercial loans totaled $1.7 million, of which $1.5 million was due to three large lending relationships at Quad City Bank & Trust. Nonaccrual loans at December 31, 2005 represented 0.3% of the Company's held for investment loan portfolio. All of the Company's nonaccrual loans were located in the loan portfolio at Quad City Bank & Trust. None of the loans in the loan portfolios at Cedar Rapids Bank & Trust or Rockford Bank & Trust were in nonaccrual status at December 31, 2005. Nonaccrual loans/leases were $7.6 million at December 31, 2004 compared to $4.2 million at December 31, 2003, for an increase of $3.4 million, or 81%. The increase in nonaccrual loans was comprised of increases in commercial loans of $2.8 million, real estate loans of $359 thousand, and consumer loans of $221 thousand. Nonaccrual commercial loans totaled $6.6 million, of which $6.4 million was due to four large lending relationships at Quad City Bank & Trust. Nonaccrual loans at December 31, 2004 represented 1.2% of the Company's held for investment loan portfolio. All of the Company's nonperforming loans were located in the loan portfolio at Quad City Bank & Trust. None of the loans in the loan portfolio at Cedar Rapids Bank & Trust were in nonaccrual status at December 31, 2004. As of December 31, 2005, 2004, and 2003, past due loans of 30 days or more amounted to $8.7 million, $10.2 million, and $6.9 million, respectively. Past due loans as a percentage of gross loans receivable were 1.2% at December 31, 2005, 1.6 % at December 31, 2004, and 1.3% at December 31, 2003. During 2005, the Company transferred $169 thousand from the loan portfolio into other real estate owned. At December 31, 2005, $545 thousand of other real estate was held at Quad City Bank & Trust. No assets were held in other real estate owned at Cedar Rapids Bank & Trust or Rockford Bank & Trust at December 31, 2005. During 2004, the Company transferred $1.9 million from the loan portfolio into other real estate owned. At December 31, 2004, $1.4 million was held at Quad City Bank & Trust and $506 thousand was held at Cedar Rapids Bank & Trust. At December 31, 2003, the Company held no assets in other real estate owned. Other Assets. Premises and equipment increased by $7.5 million, or 42%, to $25.6 million at December 31, 2005 from $18.1 million at December 31, 2004. During the year, there were purchases of additional land, furniture, fixtures and equipment and leasehold improvements of $9.8 million, which were partially offset by both depreciation expense of $2.0 million and a one-time $332 thousand write-off of Cedar Rapids Bank & Trust tenant improvements made to the Great America Building, which had initially served as that subsidiary's main office, but was vacated during the year. In September 2003, the Company announced plans for a fifth Quad City Bank & Trust banking facility, to be located in west Davenport at Five Points. Costs incurred during 2005 were $1.2 million, and total costs were approximately $3.6 million, when the facility was completed and began operations in March 2005. In February 2004, Cedar Rapids Bank & Trust announced plans to build a facility in downtown Cedar Rapids. The Bank's main office was relocated to this site in July 2005. Costs for this facility during 2005 were $4.0 million, and total costs for this project were $6.7 million. Cedar Rapids Bank & Trust also completed construction of a branch office located on Council Street, which opened for business in June 2005. The Company has incurred costs for this project of $1.7 million during 2005 and $2.4 million in total. During 2005, costs associated with the establishment of the full-service banking facility in leased space in downtown Rockford, which opened as the Company's third bank subsidiary on January 3, 2005, were $259 thousand, and total costs were $472 thousand. In the third quarter of 2005, Rockford Bank & Trust moved forward with plans for a second banking location on Guilford Road at Alpine Road in Rockford. A temporary modular facility opened in December 2005. The Company plans to construct a 20,000 square foot building projected for completion in October 2006. During 2005, $1.5 million of costs were incurred on this project. 22 Premises and equipment increased by $6.1 million, or 50%, to $18.1 million at December 31, 2004 from $12.0 million at December 31, 2003. This increase resulted primarily from a combination of construction costs of $1.9 million for Quad City Bank & Trust's fifth facility, $2.6 million for Cedar Rapids Bank & Trust's new main facility, and $664 thousand for Cedar Rapids Bank & Trust's first branch facility. Additionally, there were Company purchases of additional furniture, fixtures and equipment offset by depreciation expense. Additional information regarding the composition of this account and related accumulated depreciation is described in Note 5 to the consolidated financial statements. On August 26, 2005, Quad City Bank & Trust acquired 80% of the membership units of M2 Lease Funds. The purchase price of $5.0 million resulted in $3.2 million in goodwill. In accordance with the provisions of FAS statement 142, goodwill is not being amortized, but will be evaluated annually for impairment. Accrued interest receivable on loans, securities, and interest-bearing deposits at financial institutions increased by $777 thousand, or 19%, to $4.8 million at December 31, 2005 from $4.1 million at December 31, 2004. Accrued interest receivable on loans, securities, and interest-bearing deposits at financial institutions increased by $427 thousand, or 13%, to $4.1 million at December 31, 2004 from $3.6 million at December 31, 2003. Increases were due to a combination of greater average outstanding balances in interest-bearing assets, as well as increased average yields on interest-bearing assets. Bank-owned life insurance ("BOLI") increased by $1.5 million from $15.9 million at December 31, 2004 to $17.4 million at December 31, 2005. BOLI increased by $12.8 million from $3.1 million at December 31, 2003 to $15.9 million at December 31, 2004. Banks may generally buy BOLI as a financing or cost recovery vehicle for pre-and post-retirement employee benefits. During 2004, the subsidiary banks purchased $8.0 million of BOLI to finance the expenses associated with the establishment of supplemental retirement benefits plans ("SERPs") for the executive officers. Additionally in 2004, the subsidiary banks purchased BOLI totaling $4.2 million on the lives of a number of senior management personnel for the purpose of funding the expenses of new deferred compensation arrangements for senior officers. During the first quarter of 2005, Rockford Bank & Trust purchased $777 thousand of BOLI. These purchases combined with existing BOLI, resulted in each subsidiary bank holding investments in BOLI policies near the regulatory maximum of 25% of capital. As the owners and beneficiaries of these holdings, the banks monitor the associated risks, including diversification, lending-limit, concentration, interest rate risk, credit risk, and liquidity. Quarterly financial information on the insurance carriers is provided to the Company by its compensation consulting firm. Benefit expense associated with both the supplemental retirement benefits and deferred compensation arrangements was $176 thousand and $125 thousand, respectively, for 2005. Earnings on BOLI totaled $656 thousand for 2005. Benefit expense associated with the supplemental retirement benefits and deferred compensation arrangements was $134 thousand and $107 thousand, respectively, for 2004. Earnings on BOLI totaled $628 thousand for 2004. Other assets increased by $1.9 million, or 13%, to $17.1 million at December 31, 2005 from $15.2 million at December 31, 2004. The largest components of other assets at December 31, 2005 were $8.8 million in Federal Reserve Bank and Federal Home Loan Bank stocks, $3.7 million in deferred tax assets, $1.7 million in various prepaid expenses, $1.1 million in net equity in unconsolidated subsidiaries and $545 thousand in net other real estate owned (OREO). Other assets increased by $5.5 million, or 56%, to $15.2 million at December 31, 2004 from $9.7 million at December 31, 2003. The largest components of other assets at December 31, 2004 were $5.9 million in Federal Reserve Bank and Federal Home Loan Bank stocks, $2.8 million in deferred tax assets, $2.0 million in various prepaid expenses, $1.9 million in net other real estate owned (OREO) and $939 thousand in net equity in unconsolidated subsidiaries. At both December 31, 2005 and 2004, other assets also included accrued trust department fees, and other miscellaneous receivables. Deposits. Deposits increased by $110.5 million, or 19% , to $698.5 million at December 31, 2005 from $588.0 million at December 31, 2004. The increase resulted from a $95.9 million net increase in non-interest bearing, NOW, money market and savings accounts combined with a $14.6 million net increase in interest-bearing certificates of deposit. The subsidiary banks experienced a net increase in brokered certificates of deposit of $7.2 million during 2005. Deposits increased by $76.4 million, or 15%, to $588.0 million at December 31, 2004 from $511.7 million at December 31, 2003. The increase resulted from a $21.1 million net decrease in non-interest bearing, NOW, money market and savings accounts offset by a $97.5 million net increase in interest-bearing certificates of deposit. As anticipated for several quarters, the merchant credit card processing for the independent sales organization ("ISO") portfolio, which was sold to iPayment, Inc. in October 2001, was transferred to another processor on February 1, 2004. Funds related to this transfer accounted for $16.5 million of the decrease in non-interest bearing deposits from December 31, 2003 to December 31, 2004. The subsidiary banks also issued brokered certificates of deposit totaling $28.8 million during 2004. During 2004, the Company established new customer relationships in Wisconsin, and at December 31, 2004, held total deposits of $2.9 million for these customers. During 2005, approximately $2.4 million of these deposits were sold at book value to a de novo Wisconsin bank. 23 Short-term Borrowings. Short-term borrowings increased by $2.7 million, or 3%, from $104.8 million as of December 31, 2004 to $107.5 million as of December 31, 2005. Short-term borrowings increased by $53.2 million, or 103%, from $51.6 million as of December 31, 2003 to $104.8 million as of December 31, 2004. 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 their correspondent banks. As a result of the significant growth in assets during 2004, primarily the loan portfolio and securities available for sale, and the smaller increase in deposits, the subsidiary banks utilized additional short-term borrowings. Short-term borrowings were comprised of customer repurchase agreements of $54.7 million, $47.6 million, and $34.7 million at December 31, 2005, 2004, and 2003, respectively, as well as federal funds purchased from correspondent banks of $52.8 million at December 31, 2005, $57.2 million at December 31, 2004, and $16.9 million at December 31, 2003. FHLB Advances and Other Borrowings. FHLB advances increased $38.0 million, or 41%, from $92.0 million as of December 31, 2004 to $130.0 million as of December 31, 2005. FHLB advances increased $15.8 million, or 21%, from $76.2 million as of December 31, 2003 to $92.0 million as of December 31, 2004. As of December 31, 2005, the subsidiary banks held $7.3 million of FHLB stock in aggregate. As a result of their memberships in the FHLB of Des Moines and Chicago, the subsidiary banks have the ability to borrow funds for short-term or long-term purposes under a variety of programs. The subsidiary banks utilized FHLB advances for loan matching as a hedge against the possibility of rising interest rates or when these advances provided a less costly source of funds than customer deposits. Other borrowings increased to $10.8 million at December 31, 2005 for an increase of $4.8 million, or 79%, from December 31, 2004. In January 2005, the Company drew an additional $5.0 million advance as partial funding for the initial capitalization of Rockford Bank & Trust. In May 2005, with proceeds from the issuance of trust preferred securities, the Company made a payment to reduce the balance on the line of credit by $5.0 million. As part of the acquisition of M2 Lease Funds in August 2005, the Company acquired $289 thousand of nonrecourse loans. In September 2005, the Company drew an advance of $4.0 million to provide $2.5 million of additional capital to Quad City Bank & Trust and $1.5 million of additional capital to Cedar Rapids Bank & Trust for capital maintenance purposes at each of the subsidiaries. In December 2005, the Company drew an additional $500 thousand for general corporate purposes. Other borrowings decreased to $6.0 million at December 31, 2004 for a decrease of $4.0 million, or 40%, from December 31, 2003. In September 2001, the Company had drawn a $5.0 million advance on a line of credit at an upstream correspondent bank as partial funding for the initial capitalization of Cedar Rapids Bank & Trust. In February and July 2003, the Company drew additional advances of $2.0 million and $3.0 million, respectively, as funding to maintain the required level of regulatory capital at Cedar Rapids Bank & Trust in light of the bank's growth. In February 2004, the Company formed two trusts, which, in a private transaction, issued $8.0 million of floating rate trust preferred securities and $12.0 million of fixed/floating rate trust preferred securities. Partial proceeds from this transaction were used to pay off the $10.0 million credit note balance existing on that date. In June 2004, the Company drew an advance of $7.0 million as partial funding for the redemption of the $12.0 million in trust preferred securities, which had been issued in 1999. In December 2004, the Company made a payment to reduce the balance by $1.0 million. Junior subordinated debentures increased $5.2 million, or 25%, from $20.6 million at December 31, 2004 to $25.8 million at December 31, 2005. On May 5, 2005, the Company issued $5,000,000 of floating rate capital securities through a newly formed subsidiary, QCR Holdings Statutory Trust IV ("Trust IV"). Trust IV is a 100% owned non-consolidated subsidiary of the Company. Trust IV used the proceeds from the sale of the trust preferred securities, along with the funds from its equity, to purchase junior subordinated debentures of the Company in the amount of $5.2 million. Junior subordinated debentures increased $8.6 million, or 72%, from $12.0 million at December 31, 2003 to $20.6 million at December 31, 2004. In June 1999, the Company issued 1,200,000 shares of trust preferred securities through a newly formed subsidiary, Trust I. These securities were $12.0 million at December 31, 2003 and 2002. The Company redeemed these securities on June 30, 2004. In February 2004, the Company formed two new subsidiaries and issued, in a private transaction, $12.0 million of fixed/floating rate trust preferred securities and $8.0 million of floating rate trust preferred securities of QCR Holdings Statutory Trust II ("Trust II") and QCR Holdings Statutory Trust III ("Trust III"), respectively. Trust II and Trust III used the proceeds from the sale of the trust preferred securities, along with the funds from their equity, to purchase junior subordinated debentures of the Company in the amounts of $8.2 million and $12.4 million, respectively. 24 Other liabilities increased by $7.1 million, or 90%, to $15.0 million as of December 31, 2005 from $7.9 million as of December 31, 2004. The increase was primarily due to $3.6 million in accounts payable leases that was a portion of the acquisition of M2 Lease Funds. In the normal course of business, M2 Lease Funds often makes arrangements with vendors to pay for asset purchases in installments over periods of time, primarily less than one year. Other liabilities increased by $1.2 million, or 17%, to $7.9 million as of December 31, 2004 from $6.7 million as of December 31, 2003. The increase was primarily due to the increased balances in SERP and deferred compensation liabilities at the subsidiary banks. Other liabilities were comprised of unpaid amounts for various products and services, and accrued but unpaid interest on deposits. At both December 31, 2005 and December 31, 2004, the largest single component of other liabilities was accrued expenses of $4.5 million and $3.4 million, respectively. Stockholders' Equity. Common stock of $4.5 million as of December 31, 2004 increased by $34 thousand, or 1%, to remain at $4.5 million at December 31, 2005. The slight increase was the result of stock issued from the net exercise of stock options and stock purchased under the employee stock purchase plan. Common stock of $2.9 million as of December 31, 2003 increased by $1.6 million, or 57%, to $4.5 million at December 31, 2004. The increase was the net result of a private placement offering during the fourth quarter of 2004, which issued an additional 250,506 common shares, a three-for-two common stock split, which was paid in the form of a stock dividend on May 28, 2004, stock issued from the net exercise of stock options, stock purchased under the employee stock purchase plan, and the retirement of treasury shares. Additional paid-in capital increased to $20.8 million as of December 31, 2005 from $20.3 million at December 31, 2004. The increase of $447 thousand, or 2%, resulted primarily from proceeds received in excess of the $1.00 per share par value for the 34,494 net shares of common stock issued as the result of the exercise of stock options and purchases of stock under the employee stock purchase plan. Additional paid-in capital increased to $20.3 million as of December 31, 2004 from $17.1 million at December 31, 2003. The increase of $3.2 million, or 19%, resulted primarily from proceeds received in excess of the $1.00 per share par value for the shares of common stock issued as the result of a private placement offering, the exercise of stock options and purchases of stock under the employee stock purchase plan, partially offset by the three-for-two stock split and the retirement of treasury shares. Retained earnings increased by $4.4 million, or 18%, to $29.7 million at December 31, 2005 from $25.3 million at December 31, 2004. The increase reflected net income for the year reduced by the $362 thousand in dividends declared during 2005. On April 28, 2005, the board of directors declared a cash dividend of $0.04 payable on July 6, 2005, to stockholders of record on June 15, 2005. On October 27, 2005, the board of directors declared a cash dividend of $0.04 per share payable on January 6, 2006, to stockholders of record on December 23, 2005. Retained earnings increased by $4.4 million, or 21%, to $25.3 million at December 31, 2004 from $20.9 million at December 31, 2003. The increase reflected net income for the fiscal year reduced by a combination of the $349 thousand in dividends declared during 2004, the retirement of treasury shares, and the payout of fractional shares in conjunction with the stock split. A cash dividend of $0.04 was paid in July 2004. On October 29, 2004, the board of directors declared a cash dividend of $0.04 per share payable on January 7, 2005, to stockholders of record on December 24, 2004. Accumulated other comprehensive loss was $567 thousand as of December 31, 2005, as compared to $669 thousand of accumulated other comprehensive income as of December 31, 2004. The turnaround from comprehensive income to loss was attributable to the decrease during the period in the fair value of the securities identified as available for sale, primarily as a result of the steady climb in market interest rates. Accumulated other comprehensive income was $669 thousand as of December 31, 2004 as compared to $1.8 million as of December 31, 2003. The decrease was attributable to the decrease during the period in the fair value of the securities identified as available for sale, primarily as a result of increasing market interest rates. Liquidity and Capital Resources Liquidity measures the ability of the Company to meet maturing obligations and its existing commitments, to withstand fluctuations in deposit levels, to fund its operations, and to provide for customers' credit needs. One source of liquidity is cash and short-term assets, such as interest-bearing deposits in other banks and federal funds sold, which totaled $44.7 million at December 31, 2005, $28.1 million at December 31, 2004, and $38.9 million at December 31, 2003. The subsidiary banks have a variety of sources of short-term liquidity available to them, including federal funds purchased from correspondent banks, sales of securities available for sale, FHLB advances, lines of credit and loan participations or sales. The Company also generates liquidity from the regular principal payments and prepayments made on its portfolio of loans and mortgage-backed securities. 25 The liquidity of the Company is comprised of three primary classifications: cash flows from operating activities, cash flows from investing activities, and cash flows from financing activities. Net cash provided by operating activities, comprised predominately of net income and proceeds on the sale of loans, was $10.8 million for 2005 compared to $7.4 million for 2004. Net cash provided by operating activities, comprised predominately of net income and proceeds on the sale of loans, was $7.4 million for 2004 compared to net cash provided by operating activities, primarily net income and proceeds on the sale of loans, of $30.2 million for 2003. Net cash used in investing activities, consisting principally of loan funding and the purchase of securities, was $129.0 million for 2005 and $165.1 million for 2004. Net cash used in investing activities, consisting principally of loan funding and the purchase of securities, was $165.1 million for 2004 and $132.5 million for 2003, comprised predominately of loan originations and the purchase of securities. Net cash provided by financing activities, consisting primarily of deposit growth and proceeds from Federal Home Loan Bank advances, was $135.7 million for 2005 compared to $154.6 million, comprised predominately of growth in deposits and proceeds from short-term borrowings, for 2004. Net cash provided by financing activities, consisting primarily of deposit growth and proceeds from short-term borrowings, was $154.6 million for 2004 compared to $101.8 million, comprised predominately of growth in deposits and proceeds from short-term borrowings for 2003. At December 31, 2005, the subsidiary banks had fourteen lines of credit totaling $104.5 million, of which $13.0 million was secured and $91.5 million was unsecured. At December 31, 2005, Quad City Bank & Trust had drawn $19.5 million of their available balance of $83.0 million. As of December 31, 2005, the Company had two unsecured revolving credit notes totaling $15.0 million in aggregate. The Company had a 364-day revolving note, which matures December 21, 2006, for $10.0 million and had a balance outstanding of $5.5 million as of December 31, 2005. The Company also had a 3-year revolving note, which matures December 30, 2007, for $5.0 million and carried a balance of $5.0 million as of December 31, 2005. On January 3, 2005, the 3-year note was fully drawn as partial funding for the capitalization of Rockford Bank & Trust. For both notes, interest is payable monthly at the Federal Funds rate plus 1% per annum, as defined in the credit agreements. As of December 31, 2005, the interest rate on both notes was 5.19%. At December 31, 2004, the subsidiary banks had fourteen lines of credit totaling $99.5 million of which $13.0 million was secured and $86.5 million was unsecured. At December 31, 2004, Quad City Bank & Trust had drawn $21.1 million of their available balance of $83.0 million. As of December 31, 2004, the Company had two unsecured revolving credit notes totaling $15.0 million in aggregate, replacing a single note of $15.0 million previously held. The Company had a 364-day revolving note, which matures December 29, 2005, for $10.0 million and had a balance outstanding of $6.0 million as of December 31, 2004. The Company also had a 3-year revolving note, which matures December 30, 2007, for $5.0 million and carried no balance as of December 31, 2004. On January 3, 2005, the 3-year note was fully drawn as partial funding for the capitalization of Rockford Bank & Trust. For both notes, interest is payable monthly at the Federal Funds rate plus 1% per annum, as defined in the credit agreements. As of December 31, 2004, the interest rate on the 364-day note was 3.23%. On February 18, 2004, the Company issued $12.0 million of fixed/floating rate capital securities and $8.0 million of floating rate capital securities of Trust II and Trust III, respectively. The securities issued by Trust II and Trust III mature in 30 years. The fixed/floating rate capital securities are callable at par after seven years, and the floating rate capital securities are callable at par after five years. The fixed/floating rate capital securities have a fixed rate of 6.93%, payable quarterly, for seven years, at which time they have a variable rate based on the three-month LIBOR, reset quarterly, and the floating rate capital securities have a variable rate based on the three-month LIBOR, reset quarterly, with the rate set at 4.83% at December 31, 2004. Both Trust II and Trust III used the proceeds from the sale of the trust preferred securities to purchase junior subordinated debentures of QCR Holdings, Inc. Partial proceeds from the issuance were used for redemption in June 2004 of the $12.0 million of 9.2% cumulative trust preferred securities issued by Trust I in 1999. On May 5, 2005, the Company issued $5.0 million of floating rate capital securities through a newly formed subsidiary, Trust IV. The securities issued by Trust IV mature in 30 years, but are callable at par after five years. The floating rate capital securities have a variable rate based on the three-month LIBOR, reset quarterly, with the rate set at 6.40% for the first quarter of 2006. Interest is payable quarterly. Trust IV is a 100% owned non-consolidated subsidiary of the Company. Trust IV used the proceeds from the sale of the trust preferred securities, along with the funds from its equity, to purchase junior subordinated debentures of the Company in the amount of $5.2 million. The Company used the net proceeds for general corporate purposes, including the paydown of its other borrowings. Commitments, Contingencies, Contractual Obligations, and Off-balance Sheet Arrangements In the normal course of business, the subsidiary 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. 26 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 subsidiary 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 subsidiary 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 December 31, 2005 and 2004, no amounts had been recorded as liabilities for the banks' potential obligations under these guarantees. As of December 31, 2005 and 2004, commitments to extend credit aggregated $385.8 million and $257.6 million, respectively. As of December 31, 2005 and 2004, standby letters of credit aggregated $15.2 million and $12.7 million, respectively. Management does not expect that all of these commitments will be funded. The Company had also executed contracts for the sale of mortgage loans in the secondary market in the amount of $2.6 million and $3.5 million as of December 31, 2005 and 2004, respectively. These amounts were included in loans held for sale at the respective balance sheet dates. Residential mortgage loans sold to investors in the secondary market are sold with varying recourse provisions. Essentially, all loan sales agreements require the repurchase of a mortgage loan by the seller in situations such as, breach of representation, warranty, or covenant, untimely document delivery, false or misleading statements, failure to obtain certain certificates or insurance, unmarketability, etc. Certain loan sales agreements contain repurchase requirements based on payment-related defects that are defined in terms of the number of days/months since the purchase, the sequence number of the payment, and/or the number of days of payment delinquency. Based on the specific terms stated in the agreements of investors purchasing residential mortgage loans from the Company's subsidiary banks, the Company had $43.4 million and $35.6 million of sold residential mortgage loans with recourse provisions still in effect at December 31, 2005 and December 31, 2004, respectively. The subsidiary banks did not repurchase any loans from secondary market investors under the terms of loans sales agreements during the years ended December 31, 2005, 2004 or 2003. In the opinion of management, the risk of recourse to the subsidiary banks is not significant, and accordingly no liabilities have been established related to such. During 2004, Quad City Bank & Trust joined the Federal Home Loan Bank's (FHLB) Mortgage Partnership Finance (MPF) Program, which offers a "risk-sharing" alternative to selling residential mortgage loans to investors in the secondary market. Lenders funding mortgages through the MPF Program manage the credit risk of the loans they originate. The loans are funded by the FHLB and held within their portfolio, thereby managing the liquidity, interest rate, and prepayment risks of the loans. Lenders participating in the MPF Program receive monthly credit enhancement fees for managing the credit risk of the loans they originate. Any credit losses incurred on those loans will be absorbed first by private mortgage insurance, second by an allowance established by the FHLB, and third by withholding monthly credit enhancements due to the participating lender. At December 31, 2005, Quad City Bank & Trust had funded $13.8 million of mortgages through the FHLB's MPF Program with an attached credit exposure of $279 thousand. At December 31, 2004, Quad City Bank & Trust had funded $11.7 million of mortgages through the FHLB's MPF Program with an attached credit exposure of $240 thousand. In conjunction with its participation in this program, Quad City Bank & Trust has established an allowance for credit losses on these off-balance sheet exposures of $48 thousand at December 31, 2005 and $11 thousand at December 31, 2004. 27 Bancard is subject to the risk of cardholder chargebacks and its merchants 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 local merchant. Until 2004, Bancard had not experienced any noteable chargeback activity in which the local or agent bank merchant's cash reserves on deposit were not sufficient to cover the chargeback volumes. However, in 2004, two of Bancard's local merchants experienced cases of fraud and subsequent chargeback volumes that surpassed their cash reserves. As a result, Bancard incurred $196 thousand of chargeback loss expense due to the fraudulent activity on these two merchants and the establishment in August of an allowance for chargeback losses. Throughout 2005 monthly provisions were made to the allowance for chargeback losses based on the dollar volumes of merchant credit card activity. For the year ended December 31, 2005, monthly provisions were made totaling $48 thousand. An aggregate of $135 thousand of reversals of specific merchant reserves during 2005 more than offset these provisions. At Deccember 31, 2005 and 2004, Bancard had a merchant chargeback reserve of $77 thousand and $164 thousand, respectively. Management will continually monitor merchant credit card volumes, related chargeback activity, and Bancard's level of the allowance for chargeback losses. The Company also has a guarantee to MasterCard International Incorporated, which is backed by a $750 thousand letter of credit from Northern Trust Company. As of December 31, 2005 and 2004, there were no significant pending liabilities. Aside from cash on-hand and in-vault, the majority o& the Company's cash is maintained at upstream correspondent banks. The total amount of cash on deposit, certificates of deposit, and federal funds sold exceeded federal insured limits by approximately $9.8 million and $10.9 million as of December 31, 2005 and 2004, respectively. In the opinion of management, no material risk of loss exists due to the financial condition of the upstream correspondent banks. In an arrangement with Goldman, Sachs and Company, Cedar Rapids Bank & Trust offers a cash management program for select customers. Using this cash management tool, the customer's demand deposit account performs like an investment account. Based on a predetermined minimum balance, which must be maintained in the account, excess funds are automatically swept daily to an institutional money market fund distributed by Goldman Sachs. As with a traditional demand deposit account, customers retain complete check-writing and withdrawal privileges. If the demand deposit account balance drops below the predetermined threshold, funds are automatically swept back from the money market fund at Goldman Sachs to the account at Cedar Rapids Bank & Trust to maintain the required minimum balance. Balances swept into the money market funds are not bank deposits, are not insured by any U.S. government agency, and do not require cash reserves to be set against the balances. At December 31, 2005 and December 31, 2004, the Company had $36.1 million and $3.5 million, respectively, of customer funds invested in this cash management program. The Company has various financial obligations, including contractual obligations and commitments, which may require future cash payments. The following table presents, as of December 31, 2005, significant fixed and determinable contractual obligations to third parties by payment date. Further discussion of the nature of each obligation is included in the referenced note to the consolidated financial statements. Payments Due by Period (in thousands) ------------------------------------------------------------------ Description and One year After 5 Note reference Total Or less 1-3 years 4-5 years years ------------------------------------------------------------------ Deposits without a .................. $ 390,838 $ 390,838 $ -- $ -- $ -- stated maturity Certificates of deposits (6) ........ 307,666 246,128 44,810 16,728 -- Short-term borrowings (7) ........... 107,470 107,470 -- -- -- Federal Home Loan ................... 130,001 19,410 59,300 22,300 28,991 Bank advances (8) Other borrowings (9) ................ 10,765 10,765 -- -- -- Junior subordinated ................. 25,775 -- -- -- 25,775 debentures (10) Rental commitments (5) .............. 5,003 643 1,105 1,095 2,160 Purchase obligations (17) ........... 2,900 2,900 -- -- -- Operating contracts (17) ............ 4,513 1,547 2,951 7 8 ----------------------------------------------------------------- Total contractual cash obligations .................. $ 984,931 $ 779,701 $ 108,166 $ 40,130 $ 56,934 =================================================================
Purchase obligations represent obligations under agreements to purchase goods or services that are enforceable and legally binding on the Company and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. The purchase obligation amounts presented primarily relate to certain contractual payments for capital expenditures of facilities expansion. The Company's operating contract obligations represent short and long-term lease payments for data processing equipment and services, software, and other equipment and professional services. 28 Impact of Inflation and Changing Prices The consolidated financial statements and the accompanying notes have been prepared in accordance with Generally Accepted Accounting Principles, which require the measurement of financial position and operating results in terms of historical dollar amounts without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Company's operations. Unlike industrial companies, nearly all of the assets and liabilities of the Company are monetary in nature. As a result, interest rates have a greater impact on the Company's performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services. Impact of New Accounting Standards In December 2004, FASB published Statement No. 123 (revised 2004), Share-Based Payment ("FAS 123(R)"). FAS 123(R) requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. FAS 123(R) permits entities to use any option-pricing model that meets the fair value objective in the Statement. The Statement is effective for the Company on January 1, 2006. The Company will adopt the provisions of FAS 123(R) using a modified prospective application. Under that approach, FAS 123(R) will apply to new awards, the unvested portions of outstanding awards, and to awards that are outstanding on the effective date and are subsequently modified or cancelled. The Company will incur additional expense beginning in the first quarter of 2006 related to new awards granted and the unvested portions of earlier awards. The SFAS 123 pro forma compensation costs, presented in Note 14. of the Financial Statements, have been calculated using a Black-Scholes option-pricing model and may not be indicative of amounts which should be expected in future periods. FORWARD LOOKING STATEMENTS This document (including information incorporated by reference) contains, and future oral and written statements of the Company and its management may contain, forward-looking statements, within the meaning of such term in the Private Securities Litigation Reform Act of 1995, with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company's management and on information currently available to management, are generally identifiable by the use of words such as "believe," "expect," "anticipate," "bode," "predict," "suggest," "project," "appear," "plan," "intend," "estimate," "may," "will," "would," "could," "should" "likely," or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events. The Company's ability to predict results or the actual effect of future plans or strategies is inherently uncertain. The factors, which could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries are detailed in the "Risk Factors" section included under Item 1A. of Part I of this Form 10-K. In addition to the risk factors described in that section, there are other factors that may impact any public company, including ours, which could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries. These additional factors include, but are not limited to, the following: 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 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, the Financial Accounting Standards Board, the Securities and Exchange Commission and the Public Company Accounting Oversight Board. o The ability of the Company to manage the risks associated with the foregoing as well as anticipated. o These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. 29 Item 7A. Quantitative and Qualitative Disclosures About Market Risk The Company, like other financial institutions, is subject to direct and indirect market risk. Direct market risk exists from changes in interest rates. The Company's net income is dependent on its net interest income. Net interest income is susceptible to interest rate risk to the degree that interest-bearing liabilities mature or reprice on a different basis than interest-earning assets. When interest-bearing liabilities mature or reprice more quickly than interest-earning assets in a given period, a significant increase in market rates of interest could adversely affect net interest income. Similarly, when interest-earning assets mature or reprice more quickly than interest-bearing liabilities, falling interest rates could result in a decrease in net income. In an attempt to manage its exposure to changes in interest rates, management monitors the Company's interest rate risk. Each subsidiary bank has an asset/liability management committee of the board of directors that meets quarterly to review the bank's interest rate risk position and profitability, and to make or recommend adjustments for consideration by the full board of each bank . Management also reviews the subsidiary banks' securities portfolios, formulates investment strategies, and oversees the timing and implementation of transactions to assure attainment of the board's objectives in the most effective manner. Notwithstanding the Company's interest rate risk management activities, the potential for changing interest rates is an uncertainty that can have an adverse effect on net income. In adjusting the Company's asset/liability position, the board and management attempt to manage the Company's interest rate risk while maintaining or enhancing net interest margins. At times, depending on the level of general interest rates, the relationship between long-term and short-term interest rates, market conditions and competitive factors, the board and management may decide to increase the Company's interest rate risk position somewhat in order to increase its net interest margin. The Company's results of operations and net portfolio values remain vulnerable to increases in interest rates and to fluctuations in the difference between long-term and short-term interest rates. One method used to quantify interest rate risk is a short-term earnings at risk summary, which is a detailed and dynamic simulation model used to quantify the estimated exposure of net interest income to sustained interest rate changes. This simulation model captures the impact of changing interest rates on the interest income received and interest expense paid on all interest sensitive assets and liabilities reflected on the Company's consolidated balance sheet. This sensitivity analysis demonstrates net interest income exposure over a one year horizon, assuming no balance sheet growth and a 200 basis point upward and a 200 basis point downward shift in interest rates, where interest-bearing assets and liabilities reprice at their earliest possible repricing date. The model assumes a parallel and pro rata shift in interest rates over a twelve-month period. Application of the simulation model analysis at December 31, 2005 demonstrated a 4.03% decrease in interest income with a 200 basis point increase in interest rates, and a 1.98% increase in interest income with a 200 basis point decrease in interest rates. Both simulations are within the board-established policy limits of a 10% decline in value. Interest rate risk is the most significant market risk affecting the Company. For that reason, the Company engages the assistance of a national consulting firm and their risk management system to monitor and control the Company's interest rate risk exposure. Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company's business activities. 30 Item 8. Financial Statements McGladrey & Pullen, LLP Certified Public Accountants Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders QCR Holdings, Inc. Moline, Illinois We have audited the accompanying consolidated balance sheets of QCR Holdings, Inc. and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of QCR Holdings, Inc. and subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of QCR Holdings, Inc. and subsidiaries' internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated January 27, 2006 expressed an unqualified opinion on management's assessment of the effectiveness of QCR Holdings, Inc. and subsidiaries' internal control over financial reporting and an unqualified opinion on the effectiveness of QCR Holdings, Inc. and subsidiaries' internal control over financial reporting. /s/ McGladrey & Pullen, LLP Davenport, Iowa January 27, 2006 McGladrey & Pullen, LLP is a member firm of RSM International - an affiliation of separate and independent legal entities. 31 QCR Holdings, Inc. and Subsidiaries Consolidated Balance Sheets December 31, 2005 and 2004 Assets 2005 2004 ------------------------------------------------------------------------------------------------------ Cash and due from banks ......................................... $ 38,956,627 $ 21,372,342 Federal funds sold .............................................. 4,450,000 2,890,000 Interest-bearing deposits at financial institutions ............. 1,270,666 3,857,563 Securities held to maturity, at amortized cost (fair value 2005 $154,828; 2004 $108,254) (Note 3) ........................ 150,000 100,000 Securities available for sale, at fair value (Note 3) ........... 182,214,719 149,460,886 ---------------------------------- 182,364,719 149,560,886 ---------------------------------- Loans receivable, held for sale (Note 4) ........................ 2,632,400 3,498,809 Loans/leases receivable, held for investment (Note 4) ........... 753,621,630 644,852,018 ---------------------------------- 756,254,030 648,350,827 Less allowance for estimated losses on loans/leases (Note 4) .... 8,883,855 9,261,991 ---------------------------------- 747,370,175 639,088,836 ---------------------------------- Premises and equipment, net (Note 5) ............................ 25,621,741 18,100,590 Goodwill (Note 6) ............................................... 3,222,688 -- Accrued interest receivable ..................................... 4,849,378 4,072,762 Bank-owned life insurance ....................................... 17,367,660 15,935,000 Other assets .................................................... 17,139,874 15,205,568 ---------------------------------- Total assets .................................................... $ 1,042,613,528 $ 870,083,547 ================================== Liabilities and Stockholders' Equity ------------------------------------------------------------------------------------------------------ Liabilities: Deposits: Noninterest-bearing ......................................... $ 114,176,434 $ 109,361,817 Interest-bearing ............................................ 584,327,465 478,653,866 ---------------------------------- Total deposits (Note 7) .................................... 698,503,899 588,015,683 Short-term borrowings (Note 8) ................................ 107,469,851 104,771,178 Federal Home Loan Bank advances (Note 9) ...................... 130,000,854 92,021,877 Other borrowings (Note 10) .................................... 10,764,914 6,000,000 Junior subordinated debentures (Note 11) ...................... 25,775,000 20,620,000 Other liabilities ............................................. 14,981,346 7,881,009 ---------------------------------- Total liabilities .......................................... 987,495,864 819,309,747 ---------------------------------- Minority interest in consolidated subsidiary .................... 650,965 -- ---------------------------------- Commitments and Contingencies (Note 17) Stockholders' Equity (Note 15): Preferred stock, stated value of $1 per shares; shares authorized 250,000; shares issued none ................................. -- -- Common stock, $1 par value; shares authorized 10,000,000 2005 - 4,531,224 shares issued and outstanding 2004 - 4,496,730 shares issued and outstanding ............. 4,531,224 4,496,730 Additional paid-in capital .................................... 20,776,254 20,329,033 Retained earnings ............................................. 29,726,700 25,278,666 Accumulated other comprehensive income (loss) ................. (567,479) 669,371 ---------------------------------- Total stockholders' equity ................................. 54,466,699 50,773,800 ---------------------------------- Total liabilities and stockholders' equity ................. $ 1,042,613,528 $ 870,083,547 ==================================
See Notes to Consolidated Financial Statements. 32 QCR Holdings, Inc. and Subsidiaries Consolidated Statements of Income Years Ended December 31, 2005, 2004, and 2003 2005 2004 2003 ------------------------------------------------------------------------------------------------------------ Interest and dividend income: Loans/leases, including fees ............................... $ 42,427,118 $ 33,111,498 $ 28,984,000 Securities: Taxable .................................................. 5,345,980 4,067,826 3,248,115 Nontaxable ............................................... 579,817 571,405 493,162 Interest-bearing deposits at financial institutions ........ 129,460 224,293 432,119 Federal funds sold ......................................... 205,893 41,818 220,865 ------------------------------------------- Total interest and di6idend income ...................... 48,688,268 38,016,840 33,378,261 ------------------------------------------- Interest expense: Deposits ................................................... 12,842,421 6,852,108 7,005,306 Short-term borrowings ...................................... 2,181,997 1,208,494 326,916 Federal Home Loan Bank advances ............................ 4,168,077 3,464,122 3,255,416 Other borrowings ........................................... 501,241 159,165 228,433 Junior subordinated debentures ............................. 1,587,049 1,640,879 1,133,506 ------------------------------------------- Total interest expense .................................. 21,280,785 13,324,768 11,949,577 ------------------------------------------- Net interest income ..................................... 27,407,483 24,692,072 21,428,684 Provision for loan/lease losses (Note 4) ..................... 877,084 1,372,208 3,405,427 ------------------------------------------- Net interest income after provision for loan/lease losses 26,530,399 23,319,864 18,023,257 ------------------------------------------- Noninterest income: Merchant credit card fees, net of processing costs ......... 1,782,452 1,409,237 2,194,974 Trust department fees ...................................... 2,818,832 2,530,907 2,242,747 Deposit service fees ....................................... 1,582,530 1,631,713 1,505,200 Gains on sales of loans, net ............................... 1,254,242 1,149,791 3,667,513 Securities gains (losses), net ............................. 50 (45,428) 5 Earnings on bank-owned life insurance ...................... 656,005 627,796 206,893 Investment advisory and management fees .................... 691,800 509,988 340,812 Other ...................................................... 1,286,592 867,437 1,009,465 ------------------------------------------- Total noninterest income ................................ 10,072,503 8,681,441 11,167,609 ------------------------------------------- Noninterest expenses: Salaries and employee benefits ............................. 16,630,868 13,773,439 12,710,505 Professional and data processing fees ...................... 2,865,064 2,199,984 1,962,243 Advertising and marketing .................................. 1,221,039 1,014,664 786,054 Occupancy and equipment expense ............................ 4,316,443 3,263,540 2,640,602 Stationery and supplies .................................... 645,985 543,904 460,421 Postage and telephone ...................................... 842,779 684,964 632,354 Bank service charges ....................................... 516,537 570,374 454,367 Insurance .................................................. 594,282 420,080 444,947 Loss on disposals/sales of fixed assets .................... 332,283 1,048 50,446 Loss on redemption of junior subordinated debentures ....... -- 747,490 -- Other ...................................................... 1,467,868 1,061,364 893,313 ------------------------------------------- Total noninterest expenses .............................. 29,433,148 24,280,851 21,035,252 ------------------------------------------- Minority interest in income of consolidated subsidiary ....... 77,538 -- -- ------------------------------------------- Income before income taxes .............................. 7,092,216 7,720,454 8,155,614 Federal and state income taxes (Note 12) ..................... 2,282,201 2,503,782 2,694,687 ------------------------------------------- Net income .............................................. $ 4,810,015 $ 5,216,672 $ 5,460,927 =========================================== Earnings per common share (Note 16): Basic ...................................................... $ 1.06 $ 1.23 $ 1.31 Diluted .................................................... $ 1.04 $ 1.20 $ 1.28 Weighted average common shares outstanding ................. 4,518,162 4,234,345 4,173,063 Weighted average common and common equivalent shares outstanding ....................................... 4,616,556 4,344,765 4,282,583 Cash dividends declared per common share ..................... $ 0.08 $ 0.08 $ 0.07
See Notes to Consolidated Financial Statements. 33 QCR Holdings, Inc. and Subsidiaries Consolidated Statements of Changes in Stockholders' Equity Years Ended December 31, 2005, 2004, and 2003 Accumulated Additional Other Common Paid-In Retained Comprehensive Treasury Stock Capital Earnings Income (Loss) Stock Total ------------------------------------------------------------------------------------------------------------------------------------ Balance, December 31, 2002 ............................. $ 3,071,809 $16,512,675 $15,712,600 $ 2,144,054 $ (854,536) $36,586,602 Comprehensive income: Net income ......................................... -- -- 5,460,927 -- -- 5,460,927 Other comprehensive (loss), net of tax (Note 2) .... -- -- -- (341,390) -- (341,390) ------------ Comprehensive income .............................. 5,119,537 ------------ Cash dividends declared, $0.07 per share ............. -- -- (306,778) -- -- (306,778) Proceeds from issuance of 10,278 shares of common stock as a result of stock purchased under the Employee Stock Purchase Plan (Note 14) ............. 10,278 101,209 -- -- -- 111,487 Proceeds from issuance of 75,537 shares of common stock as a result of stock options exercised (Note 14)........................................... 75,537 300,941 -- -- -- 376,478 Exchange of 24,872 shares of common stock in connection with options exercised ......... (24,872) (314,590) -- -- -- (339,462) Tax benefit of nonqualified stock options exercised .. -- 274,871 -- -- -- 274,871 ------------------------------------------------------------------------- Balance, December 31, 2003 ............................. 3,132,752 16,875,106 20,866,749 1,802,664 (854,536) 41,822,735 Comprehensive income: Net income ......................................... -- -- 5,216,672 -- -- 5,216,672 Other comprehensive (loss), net of tax (Note 2) .... -- -- -- (1,133,293) -- (1,133,293) ------------ Comprehensive income .............................. 4,083,379 ------------ Retirement of 90,219 treasury shares, April 30, 2004.. (60,146) (341,028) (453,362) -- 854,536 -- 3:2 common stock split, May 28, 2004 ................. 1,133,019 (1,133,019) (2,549) -- -- (2,549) Proceeds from issuance of 250,506 shares of common stock ....................................... 250,506 4,537,713 -- -- -- 4,788,219 Cash dividends declared, $0.08 per share ............. -- -- (348,844) -- -- (348,844) Proceeds from issuance of 9,057 shares of common stock as a result of stock purchased under the Employee Stock Purchase Plan (Note 14) ............. 9,057 127,653 -- -- -- 136,710 Proceeds from issuance of 38,604 shares of common stock as a result of stock options exercised (Note 14)........................................... 38,604 206,636 -- -- -- 245,240 Exchange of 7,062 shares of common stock in connection with options exercised ......... (7,062) (134,276) -- -- -- (141,338) Tax benefit of nonqualified stock options exercised .. -- 190,248 -- -- -- 190,248 ------------------------------------------------------------------------- Balance, December 31, 2004 ............................. 4,496,730 20,329,033 25,278,666 669,371 -- 50,773,800 Comprehensive income: Net income ......................................... -- -- 4,810,015 -- -- 4,810,015 Other comprehensive (loss), net of tax (Note 2) .... -- -- -- (1,236,850) -- (1,236,850) ------------ Comprehensive income .............................. 3,573,165 ------------ Cash dividends declared, $0.08 per share ............. -- -- (361,981) -- -- (361,981) Proceeds from issuance of 10,584 shares of common stock as a result of stock purchased under the Employee Stock Purchase Plan (Note 14) ............. 10,584 181,458 -- -- -- 192,042 Proceeds from issuance of 25,335 shares of common stock as a result of stock options exercised (Note 14)........................................... 25,335 167,764 -- -- -- 193,099 Exchange of 1,425 shares of common stock in connection with options exercised ......... (1,425) (27,994) -- -- -- (29,419) Tax benefit of nonqualified stock options exercised .. -- 125,993 -- -- -- 125,993 ------------------------------------------------------------------------- Balance, December 31, 2005 ............................. $ 4,531,224 $20,776,254 $29,726,700 $ (567,479)$ -- $54,466,699 =========================================================================
See Notes to Consolidated Financial Statements. 34 QCR Holdings, Inc. and Subsidiaries Consolidated Statements of Cash Flows Years Ended December 31, 2005, 2004, and 2003 2005 2004 2003 ------------------------------------------------------------------------------------------------------------- Cash Flows from Operating Activities: Net income .............................................. $ 4,810,015 $ 5,216,672 $ 5,460,927 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation .......................................... 2,008,773 1,475,453 1,072,943 Provision for loan/lease losses ....................... 877,084 1,372,208 3,405,427 Deferred income taxes ................................. (109,452) (185,676) (674,681) Amortization of offering costs on junior subordinated debentures .......................................... 14,317 17,933 29,506 Loss on redemption of junior subordinated debentures .. -- 747,490 -- Minority interest in income of consolidated subsidiary 77,538 -- -- Amortization of premiums on securities, net ........... 524,808 983,256 788,263 Investment securities losses (gains), net ............. (50) 45,428 (5) Loans originated for sale ............................. (98,719,913) (83,176,326) (245,414,955) Proceeds on sales of loans ............................ 100,840,794 84,617,339 268,983,441 Net gains on sales of loans ........................... (1,254,242) (1,149,791) (3,667,513) Net losses on disposals/sales of premises and equipment 332,283 1,048 50,446 Tax benefit of nonqualified stock options exercised ... 125,993 190,248 274,871 Increase in accrued interest receivable ............... (776,616) (426,654) (424,862) (Increase) decrease in other assets ................... (883,573) (3,461,144) 2,075,198 Increase (decrease) in other liabilities .............. 2,973,423 1,146,173 (1,722,249) ----------------------------------------------- Net cash provided by operating activities ............ 10,841,182 7,413,657 30,236,757 ----------------------------------------------- Cash Flows from Investing Activities: Net decrease (increase) in federal funds sold ........... (1,560,000) 1,140,000 10,365,000 Net decrease in interest-bearing deposits at financial institutions ................................ 2,586,897 6,568,529 4,159,703 Activity in securities portfolio: Purchases ............................................. (82,280,843) (86,743,594) (91,746,856) Calls and maturities .................................. 45,787,488 53,006,001 39,195,000 Paydowns .............................................. 1,197,070 1,754,343 4,025,159 Sales of securities available for sale ................ -- 8,428,590 -- Activity in bank-owned life insurance: Purchases ............................................. (776,634) (12,221,428) (66,312) Increase in cash value ................................ (656,026) (627,775) (190,873) Net loans/leases originated and held for investment ..... (78,520,322) (128,849,187) (94,278,016) Purchase of premises and equipment ...................... (9,779,493) (7,611,586) (4,152,033) Proceeds from sales of premises and equipment ........... -- 63,027 224,654 Payment for acquisition of M2 Lease Funds, LLC (Note 6) . (4,967,300) -- -- ----------------------------------------------- Net cash used in investing activities ................ (128,969,163) (165,093,080) (132,464,574) ----------------------------------------------- Cash Flows from Financing Activities: Net increase in deposit accounts ........................ 110,488,216 76,363,820 76,904,240 Net increase in short-term borrowings ................... 2,698,673 53,161,377 18,747,355 Activity in Federal Home Loan Bank advances: Advances .............................................. 49,700,000 35,500,000 12,550,000 Payments .............................................. (11,721,023) (19,710,471) (11,305,972) Net (decrease) increase in other borrowings ............. (20,603,724) (4,000,000) 5,000,000 Proceeds from issuance of junior subordinated debentures ............................................ 5,155,000 20,620,000 -- Redemption of junior subordinated debentures ............ -- (12,000,000) -- Payment of cash dividends ............................... (360,598) (336,816) (277,086) Payment of fractional shares on 3:2 stock split ......... -- (2,549) -- Proceeds from issuance of common stock, net ............. 355,722 5,028,831 148,503 ----------------------------------------------- Net cash provided by financing activities ............ 135,712,266 154,624,192 101,767,040 ----------------------------------------------- Net increase (decrease) in cash and due from banks .. 17,584,285 (3,055,231) (460,777) Cash and due from banks: Beginning ............................................... 21,372,342 24,427,573 24,888,350 ----------------------------------------------- Ending .................................................. $ 38,956,627 $ 21,372,342 $ 24,427,573 ===============================================
35 QCR Holdings, Inc. and Subsidiaries Consolidated Statements of Cash Flows (Continued) Years Ended December 31, 2005, 2004, and 2003 2005 2004 2003 ---------------------------------------------------------------------------------------------------------------- Supplemental Disclosures of Cash Flow Information, cash payments for: Interest ................................................... $ 20,407,363 $ 13,024,698 $ 12,516,692 Income and franchise taxes ................................. 1,340,742 2,566,493 4,904,697 Supplemental Schedule of Noncash Investing Activities: Change in accumulated other comprehensive income, unrealized losses on securities available for sale, net ............. (1,236,850) (1,133,293) (341,390) Exchange of shares of common stock in connection with options exercised ................................... (29,419) (141,338) (339,462) Transfers of loans to other real estate owned .............. 169,441 1,925,320 -- Acquisition of M2 Lease Funds, LLC, cash paid at settlement (Note 6) ........................................ $ 4,967,300 ============= Fair value of assets acquired and liabilities assumed: Leases receivable held for investment, net ................. $ 31,673,951 Premises and equipment, net ................................ 82,714 Goodwill ................................................... 3,222,688 Other assets ............................................... 47,177 Other borrowings ........................................... (25,368,638) Other liabilities .......................................... (4,117,165) Minority interest .......................................... (573,427) ------------- $ 4,967,300 =============
See Notes to Consolidated Financial Statements. 36 QCR Holdings, Inc. and Subsidiaries Notes to Consolidated Financial Statements -------------------------------------------------------------------------------- Note 1. Nature of Business and Significant Accounting Policies Nature of business: QCR Holdings, Inc. (the Company) is a bank holding company providing bank and bank related services through its subsidiaries, Quad City Bank and Trust Company (Quad City Bank & Trust), Cedar Rapids Bank and Trust Company (Cedar Rapids Bank & Trust), Rockford Bank and Trust Company (Rockford Bank & Trust), Quad City Bancard, Inc. (Bancard), M2 Lease Funds, LLC (M2 Lease Funds), QCR Holdings Statutory Trust II (Trust II), QCR Holdings Statutory Trust III (Trust III), and QCR Holdings Statutory Trust IV (Trust IV). Quad City Bank & Trust is a commercial bank that serves the Iowa and Illinois Quad Cities and adjacent communities. Cedar Rapids Bank & Trust is a commercial bank that serves Cedar Rapids, Iowa, and adjacent communities. Rockford Bank & Trust is a commercial bank that serves Rockford, Illinois, and adjacent communities. Quad City Bank & Trust and Cedar Rapids Bank & Trust are chartered and regulated by the state of Iowa, and Rockford Bank & Trust is chartered and regulated by the state of Illinois. All three subsidiary banks are insured and subject to regulation by the Federal Deposit Insurance Corporation, and are members of and regulated by the Federal Reserve System. Bancard conducts the Company's credit card operation and is regulated by the Federal Reserve System. In August 2005, Quad City Bank & Trust acquired 80% of the equity interests of M2 Lease Funds. M2 Lease Funds, which is based in the Milwaukee, Wisconsin, area is engaged in the business of direct financing lease contracts (see Note 6). Trust II, III and IV were formed for the purpose of issuing various trust preferred securities (see Note 11). Significant accounting policies: Accounting estimates: The preparation of financial statements, in conformity with generally accepted accounting principles, requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Lease residual values and the allowance for estimat%d losses on loans/leases are inherently subjective as they require material estimates that are susceptible to significant change. The fair value disclosure of financial instruments is an estimate that can be computed within a range. Principles of consolidation: The accompanying consolidated financial statements include the accounts of the Company and all wholly-owned subsidiaries, except Trust II, III and IV, which do not meet the criteria for consolidation. All material intercompany accounts and transactions have been eliminated in consolidation. Presentation of cash flows: For purposes of reporting cash flows, cash and due from banks include cash on hand and non-interest bearing amounts due from banks. Cash flows from federal funds sold, interest bearing deposits at financial institutions, loans/leases, deposits, and short-term borrowings are treated as net increases or decreases. Cash and due from banks: The subsidiary banks are required by federal banking regulations to maintain certain cash and due from bank reserves. The reserve requirement was approximately $9,500,000 and $9,700,000 as of December 31, 2005 and 2004, respectively. Investment securities: Investment securities held to maturity are those debt securities that the Company has the ability and intent to hold until maturity regardless of changes in market conditions, liquidity needs, or changes in general economic conditions. Such securities are carried at cost adjusted for amortization of premiums and accretion of discounts. If the ability or intent to hold to maturity is not present for certain specified securities, such securities are considered available for sale as the Company intends to hold them for an indefinite period of time but not necessarily to maturity. Any decision to sell a security classified as available for sale would be based on various factors, including movements in interest rates, changes in the maturity mix of the Company's assets and liabilities, liquidity needs, regulatory capital considerations, and other factors. Securities available for sale are carried at fair value. Unrealized gains or losses are reported as increases or decreases in accumulated other comprehensive income. Realized gains or losses, determined on the basis of the cost of specific securities sold, are included in earnings. Loans receivable held for sale: Residential real estate loans, which are originated and intended for resale in the secondary market in the foreseeable future, are classified as held for sale. These loans are carried at the lower of cost or estimated market value in the aggregate. As assets specifically acquired for resale, the origination of, disposition of, and gain/loss on these loans are classified as operating activities in the statement of cash flows. 37 Loans receivable held for investment: Loans that management has the intent and ability to hold for the foreseeable future, or until pay-off or maturity occurs, are classified as held for investment. These loans are stated at the amount of unpaid principal adjusted for charge-offs, the allowance for estimated losses on loans, and any deferred fees and/or costs on originated loans. Interest is credited to earnings as earned based on the principal amount outstanding. Deferred direct loan origination fees and/or costs are amortized as an adjustment of the related loan's yield. As assets held for and used in the production of services, the origination and collection of these loans is classified as an investing activity in the statement of cash flows. Direct finance leases receivable held for investment: The Company leases machinery and equipment to customers under leases that qualify as direct financing leases for financial reporting and as operating leases for income tax purposes. Under the direct financing method of accounting, the minimum lease payments to be received under the lease contract, together with the estimated unguaranteed residual values (approximately 3% to 15% of the cost of the related equipment), are recorded as lease receivables when the lease is signed and the lease property delivered to the customer. The excess of the minimum lease payments and residual values over the cost of the equipment is recorded as unearned lease income. Unearned lease income is recognized over the term of the lease on a basis that results in an approximate level rate of return on the unrecovered lease investment. Lease income is recognized on the accrual basis. Residual is the estimated fair market value of the equipment on lease at lease termination. In estimating the equipment's fair value at lease termination, the Company relies on historical experience by equipment type and manufacturer and, where available, valuations by independent appraisers, adjusted for known trends. The Company's estimates are reviewed continuously to ensure reasonableness; however, the amounts the Company will ultimately realize could differ from the estimated amounts. When collection of lease payments is considered doubtful, income recognition is ceased and the lease receivable is placed on nonaccrual status. Previously recorded but uncollected amounts on nonaccrual leases are reversed at the time the lease is placed on nonaccrual status. Cash collected on nonaccrual leases is recorded as income unless the principal is doubtful of collection in which case cash received is applied to principal. The Company defers and amortizes fees and certain incremental direct costs over the contractual term of the lease as an adjustment to the yield. These initial direct leasing costs generally approximate 3% of the leased asset's cost. The unamortized direct costs are recorded as a reduction of unearned lease income. Allowance for estimated losses on loans/leases: The allowance for estimated losses on loans/leases is maintained at the level considered adequate by management of the Company and the subsidiaries to provide for losses that are probable. The allowance is increased by provisions charged to expense and reduced by net charge-offs. In determining the adequacy of the allowance, the Company, the subsidiary banks, and M2 Lease Funds consider the overall composition of the loan/lease portfolio. Loans/leases which have identified weaknesses are classified into higher risk groups, or are identified for continued monitoring. Historical and projected loss percentages are then applied to various classifications and, considering economic conditions and other factors that in management's judgment deserve evaluation, additional identified and unidentified loss amounts are added. Loans/leases are considered impaired when, based on current information and events, it is probable the Company and the bank involved will not be able to collect all amounts due. The portion of the allowance for loan/lease losses applicable to an impaired loan/lease is computed based on the present value of the estimated future cash flows of interest and principal discounted at the loan's/lease's effective interest rate or on the fair value of the collateral for collateral dependent loans/leases. The entire change in present value of expected cash flows of impaired loans/leases is reported as bad debt expense in the same manner in which impairment initially was recognized or as a reduction in the amount of bad debt expense that otherwise would be reported. The Company and subsidiaries recognize interest income on impaired loans/leases on a cash basis. Credit related financial instruments: In the ordinary course of business, the Company has entered into commitments to extend credit and standby letters of credit. Such financial instruments are recorded when they are funded. Transfers of financial assets: Transfers of financial assets are accounted for as sales only when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when: (1) the assets have been isolated from the Company, (2) the transferee obtains the right to pledge or exchange the assets it received, and no condition both constrains the transferee from taking advantage of its right to pledge or exchange and provides more than a modest benefit to the transferor, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets. Premises and equipment: Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed primarily by the straight-line method over the estimated useful lives. 38 Bank-owned life insurance: Bank-owned life insurance is carried at cash surrender value with increases/decreases reflected as income/expense in the statement of income. Foreclosed assets: Assets acquired through, or in lieu of, loan foreclosures, which are included in other assets on the consolidated balance sheets are held for sale and are initially recorded at fair value at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less costs to sell. Stock-based compensation plans: At December 31, 2005, the Company has three stock-based employee compensation plans, which are described more fully in Note 14. The Company currently accounts for those 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 (SFAS 123), to stock-based employee compensation. 2005 2004 2003 ----------------------------------------------- Net income, as reported ............... $ 4,810,015 $ 5,216,672 $ 5,460,927 Deduct total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects .. (174,598) (132,297) (96,447) ----------------------------------------------- Net income ....................... $ 4,635,417 $ 5,084,375 $ 5,364,480 =============================================== Earnings per share: Basic: As reported ....................... $ 1.06 $ 1.23 $ 1.31 Pro forma ......................... 1.03 1.20 1.29 Diluted: As reported ....................... 1.04 1.20 1.28 Pro forma ......................... 1.01 1.18 1.26
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 years ended December 31, 2005, 2004, and 2003: dividend rate of 0.36% to 0.58% for the years ended December 31, 2005, 2004, and 2003; risk-free interest rates based upon current rates at the date of grant (3.68% to 4.85% for stock options and 0.82% to 3.31% for the employee stock purchase plan); expected lives of 10 years for stock options and 3 months to 6 months for the employee stock purchase plan; and expected price volatility of 15.85% to 27.18%. In December 2004, FASB published Statement No. 123 (revised 2004), Share-Based Payment ("FAS 123(R)"). FAS 123(R) requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. FAS 123(R) permits entities to use any option-pricing model that meets the fair value objective in the Statement. The Statement is effective for the Company on January 1, 2006. The Company will adopt the provisions of FAS 123(R) using a modified prospective application. Under that approach, FAS 123(R) will apply to new awards, the unvested portions of outstanding awards, and to awards that are outstanding on the effective date and are subsequently modified or cancelled. The Company will incur additional expense beginning in the first quarter of 2006 related to new awards granted and the unvested portions of earlier awards. The SFAS 123 pro forma compensation costs presented previously in this note have been calculated using a Black-Scholes option-pricing model and may not be indicative of amounts which should be expected in future periods. Income taxes: The C/mpany files its tax return on a consolidated basis with its subsidiaries. The entities follow the direct reimbursement method of accounting for income taxes under which income taxes or credits which result from the inclusion of the subsidiaries in the consolidated tax return are paid to or received from the parent company. 39 Deferred income taxes are provided under the liability method whereby deferred tax assets are recognized for deductible temporary differences and net operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. Trust assets: Trust assets held by Quad City Bank & Trust and Cedar Rapids Bank & Trust in a fiduciary, agency, or custodial capacity for their customers, other than cash on deposit at the subsidiary banks, are not included in the accompanying consolidated financial statements since such items are not assets of the subsidiary banks. Earnings per common share: Basic earnings per share is computed by dividing net income by the weighted average number of common stock shares outstanding for the respective period. Diluted earnings per share is computed by dividing net income by the weighted average number of common stock and common stock equivalents outstanding for the respective period. Reclassifications: Certain amounts in the prior year financial statements have been reclassified, with no effect on net income or stockholders' equity, to conform with the current period presentation. Note 2. Comprehensive Income Comprehensive income is the total of net income and other comprehensive income (loss), which for the Company is comprised entirely of unrealized gains and losses on securities available for sale. Other comprehensive (loss) for the years ended December 31, 2005, 2004, and 2003 is comprised as follows: Tax Before Expense Net Tax (Benefit) of Tax ----------------------------------------- Year ended December 31, 2005: Unrealized (losses) on securities available for sale: Unrealized holding (losses) arising during the period ............................. $(1,967,594) $ (730,775) $(1,236,819) Less reclassification adjustment for gains included in net income .......................................................... 50 19 31 ----------------------------------------- Other comprehensive (loss) ...................................................... $(1,967,644) $ (730,794) $(1,236,850) ========================================= Year ended December 31, 2004: Unrealized (losses) on securities available for sale: Unrealized holding (losses) arising during the period ............................. $(1,853,560) $ (691,794) $(1,161,766) Less reclassification adjustment for (losses) included in net income .......................................................... (45,428) (16,955) (28,473) ----------------------------------------- Other comprehensive (loss) ...................................................... $(1,808,132) $ (674,839) $(1,133,293) ========================================= Year ended December 31, 2003: Unrealized (losses) on securities available for sale: Unrealized holding (losses) arising during the period ............................. $ (549,473) $ (208,086) $ (341,387) Less reclassification adjustment for gains included in net income .......................................................... 5 2 3 ----------------------------------------- Other comprehensive (loss) ...................................................... $ (549,478) $ (208,088) $ (341,390) =========================================
40 Note 3. Investment Securities The amortized cost and fair value of investment securities as of December 31, 2005 and 2004 are summarized as follows: Gross Gross Amortized Unrealized Unrealized Fair Cost Gains (Losses) Value --------------------------------------------------------------- December 31, 2005: Securities held to maturity: Other bonds ................................ $ 150,000 $ 5,063 $ (235) $ 154,828 =============================================================== Securities available for sale: U.S. Treasury securities ................... $ 100,090 $ -- $ (58) $ 100,032 U.S. govt. sponsored agency securities ..... 150,114,707 54,821 (1,629,892) 148,539,636 Mortgage-backed securities ................. 2,720,059 4,218 (54,532) 2,669,745 Municipal securities ....................... 18,485,304 368,495 (40,330) 18,813,469 Corporate securities ....................... 4,672,242 72,117 (1,877) 4,742,482 Trust preferred securities ................. 850,000 68,700 -- 918,700 Other securities ........................... 6,162,792 372,582 (104,719) 6,430,655 --------------------------------------------------------------- $ 183,105,194 $ 940,933 $ (1,831,408) $ 182,214,719 =============================================================== December 31, 2004: Securities held to maturity: Other bonds ................................ $ 100,000 $ 8,254 $ -- $ 108,254 =============================================================== Securities available for sale: U.S. Treasury securities ................... $ 100,214 $ -- $ (1,025) $ 99,189 U.S. govt. sponsored agency securities ..... 114,648,596 367,536 (392,337) 114,623,795 Mortgage-backed securities ................. 3,863,733 20,297 (18,636) 3,865,394 Municipal securities ....................... 15,922,863 653,714 (131,371) 16,445,206 Corporate securities ....................... 6,704,267 230,427 (9,409) 6,925,285 Trust preferred securities ................. 1,148,988 93,814 -- 1,242,802 Other securities ........................... 5,995,056 264,450 (291) 6,259,215 --------------------------------------------------------------- $ 148,383,717 $ 1,630,238 $ (553,069) $ 149,460,886 ===============================================================
Gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of December 31, 2005 and 2004, are summarized as follows: Less than 12 Months 12 Months or More Total ----------------------------- ------------------------- ---------------------------- Gross Gross Gross Fair Unrealized Fair Unrealized Fair Unrealized Value Losses Value Losses Value Losses ------------------------------------------------------------------------------------ December 31, 2005: Securities held to maturity: Other bonds ............................. $ 49,765 $ (235) $ -- $ -- $ 49,765 $ (235) ==================================================================================== Securities available for sale: U.S. Treasury securities ................ $ 100,032 $ (58) $ -- $ -- $ 100,032 $ (58) U.S. govt. sponsored agency securities ............................ 72,540,169 (550,284) 63,436,475 (1,079,608) 135,976,644 (1,629,892) Mortgage-backed securities .............. 304,813 (1,756) 1,934,980 (52,776) 2,239,793 (54,532) Municipal securities .................... 6,408,329 (38,636) 684,743 (1,694) 7,093,072 (40,330) Corporate securities .................... -- -- 500,877 (1,877) 500,877 (1,877) Other securities ........................ -- -- 4,895,855 (104,719) 4,895,855 (104,719) ------------------------------------------------------------------------------------ $ 79,353,343 $ (590,734) $71,452,930 $(1,240,674) $ 150,806,273 $ (1,831,408) ==================================================================================== December 31, 2004: Securities available for sale: U.S. Treasury securities ................ $ 99,189 $ (1,025) $ -- $ -- $ 99,189 $ (1,025) U.S. govt. sponsored agency securities ............................ 63,045,833 (387,973) 1,006,851 (4,364) 64,052,684 (392,337) Mortgage-backed securities .............. 2,739,543 (18,636) -- -- 2,739,543 (18,636) Municipal securities .................... 2,900,358 (128,622) 238,914 (2,749) 3,139,272 (131,371) Corporate securities .................... 1,276,752 (5,915) 256,705 (3,494) 1,533,457 (9,409) Other securities ........................ -- -- 283 (291) 283 (291) ------------------------------------------------------------------------------------ $ 70,061,675 $ (542,171) $ 1,502,753 $ (10,898) $ 71,564,428 $ (553,069) ===================================================================================
41 Management evaluates securities for other-than-temporary impairment on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Banks(s)/Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. At December 31, 2005, the investment portfolio included 270 securities. Of this number, 73 securities have current unrealized losses, which have existed for twelve months or more. All of these securities are considered to be acceptable credit risks. Based upon an evaluation of the available evidence, including recent changes in market rates, credit rating information and information obtained from regulatory filings, management believes the declines in fair value for those securities are temporary. In addition, the Bank(s)/Company have the intent and ability to hold these investment securities for a period of time sufficient to allow for an anticipated recovery. Should the impairment of any of these securities become other than temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net earnings in the period on which the other-than-temporary impairment is identified. During the year ended December 31, 2004, all sales of securities were from securities identified as available for sale. There were no sales of securities during the years ended December 31, 2005 and December 31, 2003. Information on proceeds received, as well as the gains and losses from the sale of those securities is as follows: 2005 2004 2003 ---------------------------------- Proceeds from sales of securities .......... $ -- $8,428,590 $ -- Gross gains from sales of securities ....... -- 26,188 -- Gross losses from sales of securities ...... -- 71,616 --
The amortized cost and fair value of securities as of December 31, 2005 by contractual maturity are shown below. Expected maturities of mortgage-backed securities may differ from contractual maturities because the mortgages underlying the mortgage-backed securities may be called or prepaid without any penalties. Therefore, these securities are not included in the maturity categories in the following summary. Other securities are excluded from the maturity categories as there is no fixed maturity date. Amortized Cost Fair Value --------------------------- Securities held to maturity: Due after one year through five years .......... $ 100,000 $ 100,166 Due after five years ........................... 50,000 54,662 --------------------------- $ 150,000 $ 154,828 =========================== Securities available for sale: Due in one year or less ........................ $ 49,882,321 $ 49,565,250 Due after one year through five years .......... 111,506,823 110,416,620 Due after five years ........................... 12,833,199 13,132,449 --------------------------- 174,222,343 173,114,319 Mortgage-backed securities ..................... 2,720,059 2,669,745 Other securities ............................... 6,162,792 6,430,655 --------------------------- $183,105,194 $182,214,719 ===========================
As of December 31, 2005 and 2004, investment securities with a carrying value of $135,757,114 and $117,144,212, respectively, were pledged on securities sold under agreements to repurchase and for other purposes as required or permitted by law. 42 Note 4. Loans/Leases Receivable The composition of the loan/lease portfolio as of December 31, 2005 and 2004 is presented as follows: 2005 2004 ------------------------------ Commercial and commercial real estate loans .......... $ 593,462,081 $ 532,517,321 Direct financing leases .............................. 34,911,537 -- Real estate loans held for sale - residential mortgage 2,632,400 3,498,809 Real estate loans - residential mortgage ............. 54,124,667 52,423,387 Real estate loans - construction ..................... 2,810,610 3,607,525 Installment and other consumer loans ................. 67,089,900 55,736,029 ------------------------------ 755,031,195 647,783,071 Deferred loan/lease origination costs, net ........... 1,222,835 567,756 Less allowance for estimated losses on loans/leases .. (8,883,855) (9,261,991) ------------------------------ $ 747,370,175 $ 639,088,836 ============================== Direct financing leases: Net minimum lease payments to be received .......... $ 35,447,343 $ -- Estimated residual values of leased assets ......... 7,633,646 -- Unearned lease/residual income ..................... (7,661,027) -- Fair value adjustment at acquisition ............... (508,425) -- ------------------------------ $ 34,911,537 $ -- ==============================
Loans on nonaccrual status amounted to $2,578,862 and $7,607,977 as of December 31, 2005 and 2004, respectively. Interest income in the amount of $570,055, $490,866, and $468,758 for the years ended December 31, 2005, 2004, and 2003, respectively, would have been earned on the nonaccrual loans had they been performing in accordance with their original terms. Cash interest collected on nonaccrual loans was $298,168, $230,810, and $262,819 for the years ended December 31, 2005, 2004, and 2003, respectively. There were no direct financing leases on nonaccrual status at December 31, 2005. Changes in the allowance for estimated losses on loans/leases for the years ended December 31, 2005, 2004, and 2003 are presented as follows: 2005 2004 2003 ----------------------------------------- Balance, beginning ................................ $ 9,261,991 $ 8,643,012 $ 6,878,953 Provisions charged to expense ................... 877,084 1,372,208 3,405,427 Loans/leases charged off ........................ (2,045,846) (964,708) (2,075,406) Recoveries on loans/leases previously charged off 357,172 211,479 434,038 Acquisition of M2 Lease Funds ................... 433,454 -- -- ----------------------------------------- Balance, ending ................................... $ 8,883,855 $ 9,261,991 $ 8,643,012 =========================================
Loans considered to be impaired as of December 31, 2005 and 2004 are as follows: 2005 2004 ---------------------- Impaired loans for which an allowance has been provided $1,826,429 $ 92,653 ====================== Allowance provided for impaired loans, included in the allowance for loan/lease losses ................. $1,096,493 $ 90,153 ====================== Impaired loans for which no allowance has been provided $ -- $ 96,944 ======================
Impaired loans for which no allowance has been provided have adequate collateral, based on management's current estimates. 43 The average recorded investment in impaired loans during the years ended December 31, 2005, 2004, and 2003 was $1,508,112, $3,485,989, and $5,213,072, respectively. Interest income on impaired loans of $120,120, $56,532, and $205,366 was recognized for cash payments received for the years ended December 31, 2005, 2004, and 2003, respectively. There were no impaired direct financing leases at December 31, 2005, or during the period August 26, 2005 to December 31, 2005. Loans past due 90 days or more and still accruing interest totaled $603,637 and $1,132,574 as of December 31, 2005 and 2004, respectively. There were no direct financing leases which were past due 90 days or more and still accruing interest as of December 31, 2005. Loans are made in the normal course of business to directors, officers, and their related interests. The terms of these loans, including interest rates and collateral, are similar to those prevailing for comparable transactions with other persons. An analysis of the changes in the aggregate amount of these loans during the years ended December 31, 2005, 2004, and 2003 was as follows: 2005 2004 2003 -------------------------------------------- Balance, beginning .............................. $ 17,533,546 $ 23,925,005 $ 23,267,366 Net increase (decrease) due to change in related parties ............................. 248,623 -- (359) Advances ...................................... 7,801,170 6,414,002 10,589,823 Repayments .................................... (14,197,146) (12,805,461) (9,931,825) -------------------------------------------- Balance, ending ................................. $ 11,386,193 $ 17,533,546 $ 23,925,005 ============================================
Note 5. Premises and Equipment The following summarizes the components of premises and equipment as of December 31, 2005 and 2004: 2005 2004 ----------------------------- Land ....................................... $ 4,088,126 $ 2,945,414 Buildings .................................. 17,726,327 12,052,192 Furniture and equipment .................... 12,185,429 9,566,067 ----------------------------- 33,999,882 24,563,673 Less accumulated depreciation .............. 8,378,141 6,463,083 ----------------------------- $25,621,741 $18,100,590 =============================
Certain facilities are leased under operating leases. Rental expense was $1,037,747, $866,581, and $837,271 for the years ended December 31, 2005, 2004, and 2003, respectively. Future minimum rental commitments under noncancelable leases are as follows as of December 31, 2005: Year ending December 31: 2006............................................... $ 642,941 2007............................................... 551,882 2008............................................... 552,626 2009............................................... 554,858 2010............................................... 540,085 Thereafter......................................... 2,160,535 ---------- $5,002,927 ==========
44 Note 6. Acquisition On August 26, 2005, Quad City Bank & Trust acquired 80% of the membership units of M2 Lease Funds. Quad City Bank & Trust acquired assets and assumed liabilities totaling $35.0 million and $30.0 million, respectively, for a purchase price of $5.0 million, which resulted in goodwill of $3.2 million and minority interest of $573 thousand. In accordance with the provisions of FAS Statement 142, goodwill is not being amortized, but will be evaluated annually for impairment. M2 Lease Funds, which is based in the Milwaukee, Wisconsin, area, is engaged in the business of leasing machinery and equipment to commercial and industrial businesses under direct financing lease contracts. M2 Lease Funds' operating results are included in the Company's Consolidated Statements of Income from August 26, 2005 through December 31, 2005. The following table summarizes the estimated fair values of assets acquired and liabilities assumed at the date of acquisition: Leases receivable held for investment, net ................ $ 31,673,951 Premises and equipment, net ............................... 82,714 Goodwill .................................................. 3,222,688 Other assets .............................................. 47,177 ------------ Total assets acquired ................................ $ 35,026,530 ------------ Other borrowings .......................................... (25,368,638) Other liabilities ......................................... (4,117,165) Minority interest ......................................... (573,427) ------------ Total liabilities assumed ............................ $(30,059,230) ------------ Net assets acquired .................................. $ 4,967,300 ============
Note 7. Deposits The aggregate amount of certificates of deposit, each with a minimum denomination of $100,000, was $170,994,735 and $165,685,917 as of December 31, 2005 and 2004, respectively. As of December 31, 2005, the scheduled maturities of certificates of deposit were as follows: Year ending December 31: 2006............................................ $246,127,949 2007............................................ 40,682,057 2008............................................ 4,127,720 2009............................................ 10,943,271 2010............................................ 5,785,018 ------------ $307,666,015 ============
Note 8. Short-Term Borrowings Short-term borrowings as of December 31, 2005 and 2004 are summarized as follows: 2005 2004 --------------------------- Overnight repurchase agreements with customers ... $ 54,659,851 $ 47,551,178 Federal funds purchased .......................... 52,810,000 57,220,000 --------------------------- $107,469,851 $104,771,178 ===========================
45 Information concerning repurchase agreements is summarized as follows as of December 31, 2005 and 2004: 2005 2004 ---------------------------- Average daily balance during the period ................. $ 55,092,272 $ 43,148,089 Average daily interest rate during the period ........... 1.43% 0.88% Maximum month-end balance during the period ............. $ 60,024,590 $ 48,354,535 Weighted average rate as of end of period ............... 1.47% 0.75% Securities underlying the agreements as of end of period: Carrying value ........................................ $104,145,318 $ 86,843,644 Fair value ............................................ 104,145,318 86,843,644
The securities underlying the agreements as of December 31, 2005 and 2004 were under the Company's control in safekeeping at third-party financial institutions. Information concerning federal funds purchased is summarized as follows as of December 31, 2005 and 2004: 2005 2004 -------------------------------- Average daily balance during the period ..... $ 51,536,446 $ 65,298,766 Average daily interest rate during the period .................................... 3.07% 1.76% Maximum month-end balance during the period . $ 83,125,000 $ 95,775,000 Weighted average rate as of end of period ... 3.15% 1.57%
Note 9. Federal Home Loan Bank Advances The subsidiary banks are members of either the Federal Home Loan Bank of Des Moines or the Federal Home Loan Bank of Chicago (FHLB). As of December 31, 2005 and 2004, the subsidiary banks held $7,270,300 and $5,586,800, respectively, of FHLB stock. Maturity and interest rate information on advances from the FHLB as of December 31, 2005 and 2004 is as follows: December 31, 2005 ---------------------------------- Weighted Average Interest Rate Amount Due at Year-End ---------------------------------- Maturity: Year ending December 31: 2006 ............................ $ 19,410,000 3.02% 2007 ............................ 42,200,000 3.84 2008 ............................ 17,100,000 3.69 2009 ............................ 14,200,000 4.05 2010 ............................ 8,100,000 5.16 Thereafter ...................... 28,990,854 4.22 ------------ Total FHLB advances $130,000,854 3.89 ============
46 Of the advances maturing after December 31, 2006, $30,000,000 have options which allow the FHLB, at its discretion, to terminate the advances and require the subsidiary banks to repay at predetermined dates prior to the stated maturity date of the advances. December 31, 2004 ---------------------------------- Weighted Average Interest Rate Amount Due at Year-End ---------------------------------- Maturity: Year ending December 31: 2005 ............................ $ 7,500,000 2.61% 2006 ............................ 18,410,000 2.96 2007 ............................ 16,200,000 3.58 2008 ............................ 15,100,000 3.60 2009 ............................ 11,700,000 3.95 Thereafter ...................... 23,111,877 4.65 ------------ Total FHLB advances $ 92,021,877 3.69 ============
Advances are collateralized by securities with a carrying value of $14,978,433 and $6,112,175 as of December 31, 2005 and 2004, respectively. Advances as of December 31, 2005 and 2004 are also collateralized by 1-to-4 unit residential, home equity 2nd mortgages, commercial real estate, home equity lines of credit, and business loans equal to 135%, 175%, 175%, 200%, and 250%, respectively, of total outstanding notes. At December 31, 2005, the aggregate total of loans pledged was $247,864,749. Note 10. Other Borrowings Other borrowings as of December 31, 2005 and 2004 are summarized as follows: 2005 2004 ------------------------ 364-day revolving note ............................... $ 5,500,000 $ 6,000,000 3-year revolving note ................................ 5,000,000 -- Non-recourse notes ................................... 264,914 -- ------------------------ $10,764,914 $ 6,000,000 ========================
As of December 31, 2005, the Company had two unsecured revolving credit notes totaling $15,000,000 in the aggregate. There was a 364-day revolving note, which matures December 21, 2006, for $10,000,000 and had a balance outstanding of $5,500,000 as of December 31, 2005. There was a 3-year revolving note, which matures December 30, 2007, for $5,000,000 and carried a balance of $5,000,000 at December 31, 2005. For both notes, interest is payable monthly at the Federal Funds rate plus 1% per annum, as defined in the credit agreements. As of December 31, 2005, the interest rate on both notes was 5.19%. At December 31, 2005, the Company held two fixed rate, non-recourse notes totaling $264,914, which were assumed in the acquisition of M2 Lease Funds in August 2005. Each of the notes is collateralized by leased machinery and equipment, and the terms of the notes are determined by the terms of the related leases. As of December 31, 2005, one note had an outstanding balance of $64,385 at an interest rate of 8.48% and a maturity date in May 2006. As of December 31, 2005, the second note had an outstanding balance of $200,529 at an interest rate of 6.00% and a maturity date in August 2007. The revolving credit note agreements contain certain covenants that place restrictions on additional debt and stipulate minimum capital and various operating ratios. 47 As of December 31, 2004, the Company had two unsecured revolving credit notes totaling $15,000,000 in aggregate. There was a 365-day revolving note, which matured December 22, 2005, for $10,000,000 and had a balance outstanding of $6,000,000 as of December 31, 2004. There was a 3-year revolving note, which matures December 30, 2007, for $5,000,000 and carried no balance at December 31, 2004. For both notes, interest was payable monthly at the Federal Funds rate plus 1% per annum, as defined in the credit agreements. As of December 31, 2004, the interest rate on both notes was 3.23%. Unused lines of credit of the subsidiary banks as of December 31, 2005 and 2004 are summarized as follows: 2005 2004 ----------------------------------- Secured .......................... $ 13,000,000 $ 13,000,000 Unsecured ........................ 91,500,000 86,500,000 ----------------------------------- $104,500,000 $ 99,500,000 ===================================
Note 11. Junior Subordinated Debentures Junior subordinated debentures are summarized as of December 31, 2005 and 2004 as follows: 2005 2004 ------------------------- Note Payable to Trust II ........................... $12,372,000 $12,372,000 Note Payable to Trust III .......................... 8,248,000 8,248,000 Note Payable to Trust IV ........................... 5,155,000 -- ------------------------- $25,775,000 $20,620,000 =========================
In June 1999, the Company issued 1,200,000 shares of 9.2% cumulative trust preferred securities through a newly formed subsidiary, Trust I, which used the proceeds from the sale of the trust preferred securities to purchase junior subordinated debentures of the Company. These securities were $12,000,000 at December 31, 2003. In February 2004, the Company issued, in a private transaction, $12,000,000 of fixed/floating rate capital securities and $8.0 million of floating rate capital securities through two newly formed subsidiaries, Trust II and Trust III, respectively. The securities issued by Trust II and Trust III mature in thirty years. The fixed/floating rate capital securities are callable at par after seven years, and the floating rate capital securities are callable at par after five years. The fixed/floating rate capital securities have a fixed rate of 6.93%, payable quarterly, for seven years, at which time they have a variable rate based on the three-month LIBOR, reset quarterly, and the floating rate capital securities have a variable rate based on the three-month LIBOR, reset quarterly, with the rate set at 7.38% for the first quarter of 2006. Trust II and Trust III used the proceeds from the sale of the trust preferred securities, along with the funds from their equity, to purchase junior subordinated debentures of the Company in the amounts of $12,400,000 and $8,200,000, respectively. These securities were $20,000,000 in aggregate at December 31, 2005. On June 30, 2004, the Company redeemed the $12,000,000 of 9.2% cumulative trust preferred securities issued by Trust I in 1999. During 2004, the Company recognized a loss of $747,490 on the redemption of these trust preferred securities at their earliest call date, which resulted from the one-time write-off of unamortized costs related to the original issuance of the securities in 1999. On May 5, 2005, the Company announced the issuance of $5,000,000 of floating rate capital securities of QCR Holdings Statutory Trust IV. The securities represent the undivided beneficial interest in Trust IV, which was established by the Company for the sole purpose of issuing the Trust Preferred Securities. The Trust Preferred Securities were sold in a private transaction exempt from registration under the Securities Act of 1933, as amended and were not registered under the Act. The securities issued by Trust IV mature in thirty years, but are callable at par after five years. The Trust Preferred Securities have a variable rate based on the three-month LIBOR, reset quarterly, with the rate set at 6.40% for the first quarter of 2006. Interest is payable quarterly. Trust IV used the $5,000,000 of proceeds from the sale of the Trust Preferred Securities, in combination with $155,000 of proceeds from its own equity, to purchase $5,155,000 of junior subordinated debentures of the Company. The Company incurred no issuance costs as a result of the transaction. The Company used the net proceeds for general corporate purposes, including the paydown of its other borrowings. 48 The current debentures were included on the balance sheet as liabilities; however, for regulatory purposes, approximately $16,619,000 and $16,702,000 were allowed in the calculation of Tier I capital at December 31, 2005 and 2004, respectively, with the remainder allowed as Tier II capital. The required deconsolidation of trust preferred subsidiaries, such as Trust II, Trust III, and Trust IV, under FIN 46R, calls into question the permissibility of including these securities in regulatory capital in the future. In February 2004, the Federal Reserve provided confirmation to the Company for their treatment of the new issuances as Tier 1 capital for regulatory capital purposes, subject to current established limitations. Note 12. Federal and State Income Taxes Federal and state income tax expense was comprised of the following components for the years ended December 31, 2005, 2004, and 2003: 2005 2004 2003 -------------------------------------------------- Current ............... $ 2,391,653 $ 2,689,458 $ 3,369,368 Deferred .............. (109,452) (185,676) (674,681) -------------------------------------------------- $ 2,282,201 $ 2,503,782 $ 2,694,687 =================================================
A reconciliation of the expected federal income tax expense to the income tax expense included in the consolidated statements of income was as follows for the years ended December 31, 2005, 2004, and 2003: Year Ended December 31, ----------------------------------------------------------------------------------- 2005 2004 2003 -------------------------- -------------------------- ----------------------------- % of % of % of Pretax Pretax Pretax Amount Income Amount Income Amount Income ----------------------------------------------------------------------------------- Computed "expected" tax expense ................................ $ 2,482,276 35.0% $ 2,702,159 35.0% $ 2,854,465 35.0% Effect of graduated tax rates interest ......................... (70,922) (1.0) (77,205) (1.0) (81,556) (1.0) Tax exempt income, net ....................... (231,370) (3.3) (220,560) (2.9) (212,105) (2.6) Bank-owned life insurance .................................. (213,388) (3.0) (212,060) (2.7) (62,390) (0.8) State income taxes, net of federal benefit ......................... 262,850 3.7 303,735 3.9 226,446 2.8 Other ........................................ 52,755 0.7 7,713 0.1 (30,173) (0.4) ----------------------------------------------------------------------------------- $ 2,282,201 32.1% $ 2,503,782 32.4% $ 2,694,687 33.0% ===================================================================================
The net deferred tax assets included with other assets on the consolidated balance sheets consisted of the following as of December 31, 2005 and 2004: 2005 2004 ----------------------- Deferred tax assets: Net unrealized losses on securities available for sale ................................. $ 322,996 $ -- Compensation ......................................... 1,465,821 1,291,563 Loan and credit card losses .......................... 3,039,498 3,309,991 Other ................................................ 120,704 116,997 ----------------------- 4,949,019 4,718,551 ----------------------- Deferred tax liabilities: Net unrealized gains on securities available for sale -- 407,798 Premises and equipment ............................... 920,329 1,052,783 Investment accretion ................................. 33,098 37,260 Deferred loan origination fees, net .................. 168,177 223,339 Other ................................................ 106,881 117,083 ----------------------- 1,228,485 1,838,263 ----------------------- Net deferred tax asset ........................... $3,720,534 $2,880,288 =======================
49 The change in deferred income taxes was reflected in the consolidated financial statements as follows for the years ended December 31, 2005, 2004, and 2003: 2005 2004 2003 ----------------------------------- Provision for income taxes .............. $(109,452) $(185,676) $(674,681) Statement of stockholders' equity- accumulated other comprehensive income, unrealized (losses) on securities available for sale, net . (730,794) (674,839) (208,088) ----------------------------------- $(840,246) $(860,515) $(882,769) ===================================
Note 13. Employee Benefit Plans The Company has a profit sharing plan which includes a provision designed to qualify under Section 401(k) of the Internal Revenue Code of 1986, as amended, to allow for participant contributions. All employees are eligible to participate in the plan. The Company matches 100% of the first 3% of employee contributions, and 50% of the next 3% of employee contributions, up to a maximum amount of 4.5% of an employee's compensation. Additionally, at its discretion, the Company may make additional contributions to the plan which are allocated to the accounts of participants in the plan based on relative compensation. Company contributions for the years ended December 31, 2005, 2004, and 2003 were as follows: 2005 2004 2003 ------------------------------- Matching contribution .......................... $557,299 $415,582 $377,854 Discretionary contribution ..................... 90,100 89,000 90,000 ------------------------------- $647,399 $504,582 $467,854 ===============================
The Company has offered nonqualified supplemental executive retirement plans (SERPs) with certain executive officers. The SERPs allow certain executives to accumulate retirement benefits beyond those provided by the qualified plans. During the years ended December 31, 2005 and 2004, the Company's contributions were $176,313 and $134,000, respectively. As of December 31, 2005 and 2004, the liability related to the SERPs was $310,313 and $134,000, respectively. The Company has entered into deferred compensation agreements with certain executive officers. Under the provisions of the agreements the officers may defer compensation and the Company matches the deferral up to certain maximums. The Company's matching contribution differs by officer and is a maximum of between $7,000 and $20,000 annually. Interest on the deferred amounts is earned at The Wall Street Journal's prime rate subject to a minimum of 4% and a maximum of 12% with such limits differing by officer. Upon retirement, the officer will receive the deferral balance in 180 equal monthly installments. During the years ended December 31, 2005, 2004, and 2003 the Company expensed $124,562, $107,420, and $86,275, respectively, related to the agreements. As of December 31, 2005 and 2004 the liability related to the agreements totals $830,222 and $627,160, respectively. The Company has also entered into deferred compensation agreements with certain management officers. Under the provisions of the agreements the officers may defer compensation and the Company matches the deferral up to certain maximums. The Company's matching contribution differs by officer and is a maximum between 4% and 10% of officer's compensation. Interest on the deferred amounts is earned at The Wall Street Journal's prime rate plus one percentage point, and has a minimum of 4% and shall not exceed 8%. Upon retirement, the officer will receive the deferral balance in 180 equal monthly installments. During the years ended December 31, 2005 and 2004, the Company expensed $44,111 and $21,448, respectively related to the agreements. As of December 31, 2005 and 2004, the liability related to the agreements totaled $170,949 and $62,152, respectively. 50 Note 14. Stock Based Compensation Stock option and incentive plans: The Company's Board of Directors and its stockholders adopted in June 1993 the QCR Holdings, Inc. Stock Option Plan (Stock Option Plan). Up to 225,000 shares of common stock may be issued to employees and directors of the Company and its subsidiaries pursuant to the exercise of incentive stock options or nonqualified stock options granted under the Stock Option Plan. All of the options have been granted under this plan, and on June 30, 2003, the plan expired. The Company's Board of Directors adopted in November 1996 the QCR Holdings, Inc. 1997 Stock Incentive Plan (1997 Stock Incentive Plan). Up to 225,000 shares of common stock may be issued to employees and directors of the Company and its subsidiaries pursuant to the exercise of nonqualified stock options and restricted stock granted under the 1997 Stock Incentive Plan. As of December 31, 2004, there are no remaining options available for grant under this plan. The Company's Board of Directors adopted in January 2004, and the stockholders approved in May 2004, the QCR Holdings, Inc. 2004 Stock Incentive Plan (2004 Stock Incentive Plan). Up to 225,000 shares of common stock may be issued to employees and directors of the Company and its subsidiaries pursuant to the exercise of nonqualified stock options and restricted stock granted under the 2004 Stock Incentive Plan. As of December 31, 2005, there are 170,312 remaining options available for grant under this plan. The Stock Option Plan, the 1997 Stock Incentive Plan, and the 2004 Stock Incentive Plan (stock option plans) are administered by the Executive Committee appointed by the Board of Directors (Committee). The number and exercise price of options granted under the stock option plans is determined by the Committee at the time the option is granted. In no event can the exercise price be less than the value of the common stock at the date of the grant for incentive stock options. All options have a 10-year life and will vest and become exercisable from 1-to-5 years after the date of the grant. Only nonqualified stock options have been issued to date. In the case of nonqualified stock options, the stock option plans provide for the granting of "Tax Benefit Rights" to certain participants at the same time as these participants are awarded nonqualified options. Each Tax Benefit Right entitles a participant to a cash payment equal to the excess of the fair market value of a share of common stock on the exercise date over the exercise price of the related option multiplied by the difference between the rate of tax on ordinary income over the rate of tax on capital gains (federal and state). A summary of the stock option plans as of December 31, 2005, 2004, and 2003 and changes during the years then ended is presented below: December 31, ---------------------------------------------------------------------------- 2005 2004 2003 ----------------------- ----------------------- ------------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price ---------------------------------------------------------------------------- Outstanding, beginning ............................ 244,816 $ 11.56 224,800 $ 8.57 300,566 $ 7.56 Granted ......................................... 34,400 21.08 60,100 19.33 7,350 13.47 Exercised ....................................... (25,335) 20.62 (38,604) 6.35 (75,998) 4.98 Forfeited ....................................... (1,223) 12.63 (1,480) 8.99 (7,118) 9.41 ---------------------------------------------------------------------------- Outstanding, ending ............................... 252,658 13.25 244,816 11.56 224,800 8.57 ============================================================================ Exercisable, ending ............................... 146,979 135,210 145,598 Weighted average fair value per option of options granted during the period ............................... $ 8.99 $ 8.29 $ 5.58
51 A further summary of options outstanding as of December 31, 2005 is presented below: Options Outstanding ------------------------------------------------- Options Exercisable Weighted ------------------------------- Average Weighted Weighted Remaining Average Average Range of Number Contractual Exercise Number Exercise Exercise Prices Outstanding Life Price Exercisable Price ---------------------------------------------------------------------------------------------------------- $5.89 to $6.90 22,722 $ 4.62 $ 6.61 19,242 $ 6.55 $7.00 to $7.13 35,450 5.22 7.01 26,000 7.01 $7.45 to $9.39 38,878 1.74 8.88 37,978 8.91 $9.87 to $11.64 34,892 5.70 10.33 25,782 10.40 $11.83 to $18.40 45,986 3.49 15.66 27,626 14.25 $18.67 to $20.90 45,130 8.44 19.78 10,351 19.68 $21.00 to $22.00 29,600 9.05 21.29 -- -- -------------- ------------- 252,658 146,979 ============== =============
Stock appreciation rights: Additionally, the 1997 Stock Incentive Plan and 2004 Stock Incentive Plan allow the granting of stock appreciation rights (SARs). SARs are rights entitling the grantee to receive cash having a fair market value equal to the appreciation in the market value of a stated number of shares from the date of grant. Like options, the number and exercise price of SARs granted is determined by the Committee. The SARs vest 20% per year, and the term of the SARs may not exceed 10 years from the date of the grant. As of December 31, 2005, 2004, and 2003 there were 104,775, 111,375, and 135,525 SARs, respectively, outstanding, with 93,435, 84,810, and 92,310, respectively, exercisable. During the years ended 2005, 2004, and 2003 the Company expensed ($137,026), $297,441, and $915,224, respectively, related to the SARs. As of December 31, 2005 and 2004 the liability related to the SARs totals $1,035,935 and $1,251,908, respectively. A further summary of SARs is presented below: December 31, 2005 Liability Recorded for SARs ------------------------------- -------------------------------- December 31, SARs SARs -------------------------------- Exercise Price Outstanding Exercisable 2005 2004 ----------------------------------------------------------------------------------------------- $6.90 32,250 25,410 $ 412,800 $ 488,565 $7.00 12,600 8,100 160,020 193,200 $9.11 12,750 12,750 134,980 151,555 $10.75 16,575 16,575 148,346 185,269 $11.83 4,425 4,425 34,810 54,313 $12.17 750 750 5,650 6,625 $13.55 -- -- -- -- $14.22 25,425 25,425 139,329 172,381 ---------------------------------------------------------------- 104,775 93,435 $ 1,035,935 $ 1,251,908 ================================================================
Stock purchase plan: The Company's Board of Directors and its stockholders adopted in October 2002 the QCR Holdings, Inc. Employee Stock Purchase Plan (the "Purchase Plan"). As of January 1, 2005 there were 128,185 shares of common stock available for issuance under the Purchase Plan. For each six-month offering period, the Board of Directors will determine how many of the total number of available shares will be offered. The purchase price is the lesser of 90% of the fair market value at the date of the grant or the investment date. The investment date, as established by the Board of Directors of the Company, is the date common stock is purchased after the end of each calendar quarter during an offering period. The maximum dollar amount any one participant can elect to contribute in an offering period is $5,000. Additionally, the maximum percentage that any one participant can elect to contribute is 5% of his or her compensation. During the year ended December 31, 2005, 10,516 shares were granted and 10,584 purchased. Shares granted during the year ended December 31, 2005 had a weighted average fair value of $3.09 per share. 52 Note 15. Regulatory Capital Requirements and Restrictions on Dividends The Company (on a consolidated basis) and the subsidiary banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company and subsidiary banks' financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the subsidiary banks must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies. Quantitative measures established by regulation to ensure capital adequacy require the Company and the subsidiary banks to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2005 and 2004, that the Company and the subsidiary banks met all capital adequacy requirements to which they are subject. As of December 31, 2005, the most recent notification from the Federal Deposit Insurance Corporation categorized the subsidiary banks as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following tables. There are no conditions or events since the notification that management believes have changed the subsidiary banks' categories. The Company and the subsidiary banks' actual capital amounts and ratios as of December 31, 2005 and 2004 are also presented in the table (dollars in thousands). To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions ----------------------------------------------------------------------------- Amount Ratio Amount Ratio Amount Ratio ----------------------------------------------------------------------------- As of December 31, 2005: Company: Total risk-based capital $ 86,515 10.14% $ 68,252 >= 8.0% N/A N/A Tier 1 risk-based capital 69,081 8.10% 34,126 >= 4.0 N/A N/A Leverage ratio 69,081 6.84% 40,373 >= 4.0 N/A N/A Quad City Bank & Trust: Total risk-based capital $ 60,670 10.22% $ 47,480 >= 8.0% $ 59,350 >= 10.0% Tier 1 risk-based capital 54,609 9.20% 23,740 >= 4.0 35,610 >= 6.0 Leverage ratio 54,609 7.84% 27,876 >= 4.0 34,845 >= 5.0 Cedar Rapids Bank & Trust: Total risk-based capital $ 23,476 10.26% $ 18,313 >= 8.0% $ 22,891 >= 10.0% Tier 1 risk-based capital 20,869 9.12% 9,156 >= 4.0 13,735 >= 6.0 Leverage ratio 20,869 7.46% 11,186 >= 4.0 13,983 >= 5.0 Rockford Bank & Trust (A): Total risk-based capital $ 9,019 29.77% $ 2,424 >= 8.0% $ 3,030 >= 10.0% Tier 1 risk-based capital 8,757 28.90% 1,212 >= 4.0 1,818 >= 6.0 Leverage ratio 8,757 24.16% 1,450 >= 4.0 1,813 >= 5.0
53 To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions ----------------------------------------------------------------------------- Amount Ratio Amount Ratio Amount Ratio ----------------------------------------------------------------------------- As of December 31, 2004: Company: Total risk-based capital $ 79,299 10.9% $ 58,066 >= 8.0% N/A N/A Tier 1 risk-based capital 66,807 9.2 29,033 >= 4.0 N/A N/A Leverage ratio 66,807 7.8 34,209 >= 4.0 N/A N/A Quad City Bank & Trust: Total risk-based capital $ 54,772 10.3% $ 42,513 >= 8.0% $ 53,141 > 10.0% Tier 1 risk-based capital 48,127 9.1 21,256 >= 4.0 31,885 > 6.0 Leverage ratio 48,127 7.6 25,476 >= 4.0 31,845 > 5.0 Cedar Rapids Bank & Trust: Total risk-based capital $ 20,680 10.8% $ 15,280 >= 8.0% $ 19,100 > 10.0% Tier 1 risk-based capital 18,292 9.6 7,640 >= 4.0 11,460 > 6.0 Leverage ratio 18,292 8.2 8,949 >= 4.0 11,186 > 5.0
(A) As a de novo bank, Rockford Bank & Trust cannot, without the prior consent of the Federal Reserve Bank, pay dividends until TTED] after the first three years of operations and two consecutive satisfactory CAMELS ratings. In addition, the Bank is required to maintain a tangible Tier I leverage ratio of at least 9% throughout its first three years of operations. The de novo period for Rockford Bank & Trust will expire in January 2008. Federal Reserve Bank policy provides that a bank holding company should not pay dividends unless (i) the dividends can be fully funded out of net income from the company's net earnings over the prior year and (ii) the prospective rate of earnings retention appears consistent with the company's (and its subsidiaries') capital needs, asset quality, and overall financial condition. In addition, the Delaware General Corporation Law restricts the Company from paying dividends except out of its surplus, or in the case there shall be no such surplus, out of its net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year. The Iowa Banking Act provides that an Iowa bank may not pay dividends in an amount greater than its undivided profits. In addition, the subsidiary banks, as members of the Federal Reserve System, will be prohibited from paying dividends to the extent such dividends declared in any calendar year exceed the total of its net profits of that year combined with its retained net profits of the preceding two years, or are otherwise determined to be an "unsafe and unsound practice" by the Federal Reserve Board. Note 16. Earnings Per Common Share The following information was used in the computation of basic and diluted earnings per common share for the years ended December 31, 2005, 2004, and 2003: 2005 2004 2003 ------------------------------------ Net income ....................................... $4,810,015 $5,216,672 $5,460,927 ==================================== Weighted average common shares outstanding ....... 4,518,162 4,234,345 4,173,063 Weighted average common shares issuable upon exercise of stock options and under the Employee Stock Purchase Plan ............................ 98,394 110,420 109,520 ------------------------------------ Weighted average common and common equivalent shares outstanding .................. 4,616,556 4,344,765 4,282,583 ====================================
Note 17. Commitments and Contingencies In the normal course of business, the subsidiary 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. 54 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 subsidiary banks evaluate each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the subsidiary banks upon extension of credit, is based upon management's credit evaluation of the counterparty. 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 subsidiary 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 subsidiary 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 subsidiary banks would be required to fund the commitments. The maximum potential amount of future payments the subsidiary banks could be required to make is represented by the contractual amount. If the commitment is funded, the subsidiary banks would be entitled to seek recovery from the customer. At December 31, 2005 and 2004 no amounts have been recorded as liabilities for the subsidiary banks' potential obligations under these guarantees. As of December 31, 2005 and 2004, commitments to extend credit aggregated $385,779,000 and $257,569,000, respectively. As of December 31, 2005 and 2004, standby letters of credit aggregated $15,242,000 and $12,653,000, 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 $2,632,400 and $3,498,809 as of December 31, 2005 and 2004, respectively. These amounts are included in loans held for sale at the respective balance sheet dates. Residential mortgage loans sold to investors in the secondary market are sold with varying recourse provisions. Essentially, all loan sales agreements require the repurchase of a mortgage loan by the seller in situations such as, breach of representation, warranty, or covenant, untimely document delivery, false or misleading statements, failure to obtain certain certificates or insurance, unmarketability, etc. Certain loan sales agreements contain repurchase requirements based on payment-related defects that are defined in terms of the number of days/months since the purchase, the sequence number of the payment, and/or the number of days of payment delinquency. Based on the specific terms stated in the agreements of investors purchasing residential mortgage loans from the Company's subsidiary banks, the Company had $43,439,000 and $35,587,000 of sold residential mortgage loans with recourse provisions still in effect at December 31, 2005 and 2004, respectively. The subsidiary banks did not repurchase any loans from secondary market investors under the terms of loans sales agreements during the years ended December 31, 2005, 2004, and 2003. In the opinion of management, the risk of recourse and the subsequent requirement of loan repurchase to the subsidiary banks is not significant, and accordingly no liabilities have been established related to such. During fiscal 2004, Quad City Bank & Trust joined the Federal Home Loan Bank's (FHLB) Mortgage Partnership Finance (MPF) Program, which offers a "risk-sharing" alternative to selling residential mortgage loans to investors in the secondary market. Lenders funding mortgages through the MPF Program manage the credit risk of the loans they originate. The loans are funded by the FHLB and held within their portfolio, thereby managing the liquidity, interest rate, and prepayment risks o& the loans. Lenders participating in the MPF Program receive monthly credit enhancement fees for managing the credit risk of the loans they originate. Any credit losses incurred on those loans will be absorbed first by private mortgage insurance, second by an allowance established by the FHLB, and third by withholding monthly credit enhancements due to the participating lender. At December 31, 2005, Quad City Bank & Trust had funded $13,800,000 of mortgages through the FHLB's MPF Program with an attached credit exposure of $279,000. At December 31, 2004, Quad City Bank & Trust had funded $11,700,000 of mortgages through the FHLB's MPF Program with an attached credit exposure of $240,000. In conjunction with its participation in this program, Quad City Bank & Trust had an allowance for credit losses on these off-balance sheet exposures of $48 thousand and $11 thousand at December 31, 2005 and December 31, 2004, respectively. 55 Bancard is subject to the risk of cardholder chargebacks and its merchants 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. Until 2004, Bancard had not experienced any notable chargeback activity in which local or agent bank merchant's cash reserves on deposit were not sufficient to cover the chargeback volumes. However, in 2004, two of these merchants experienced cases of fraud and subsequent chargeback volumes that surpassed their cash reserves. As a result, Bancard incurred $196,000 of chargeback loss expense due to the fraudulent activity on these two merchants and in the establishment in August of an allowance for chargeback losses. Throughout 2005 monthly provisions were made to the allowance for chargeback losses based on the dollar volumes of merchant credit card activity. For the year ended December 31, 2005, monthly provisions were made totaling $48,000. An aggregate of $135,000 of reversals of specific merchant reserves during 2005 more than offset these provisions. At December 31, 2005 and 2004, Bancard had a merchant chargeback reserve of $77,000 and $164,000, respectively. Management will continually monitor merchant credit card volumes, related chargeback activity, and Bancard's level of the allowance for chargeback losses. The Company also has a limited guarantee to MasterCard International, Incorporated, which is backed by a $750,000 letter of credit from The Northern Trust Company. As of December 31, 2005 and 2004, there were no significant pending liabilities. Aside from cash on-hand and in-vault, the majority of the Company's cash is maintained at upstream correspondent banks. The total amount of cash on deposit, certificates of deposit, and federal funds sold exceeded federal insured limits by approximately $9,800,000 and $10,900,000 as of December 31, 2005 and 2004, respectively. In the opinion of management, no material risk of loss exists due to the financial condition of the upstream correspondent banks. In an arrangement with Goldman, Sachs and Company (Goldman Sachs), Cedar Rapids Bank & Trust offers a cash management program for select customers. Using this cash management tool, the customer's demand deposit account performs like an investment account. Based on a predetermined minimum balance, which must be maintained in the account, excess funds are automatically swept daily to an institutional money market fund distributed by Goldman Sachs. As with a traditional demand deposit account, customers retain complete check-writing and withdrawal privileges. If the demand deposit account balance drops below the predetermined threshold, funds are automatically swept back from the money market fund at Goldman Sachs to the account at Cedar Rapids Bank & Trust to maintain the required minimum balance. Balances swept into the money market funds are not bank deposits, are not insured by any U.S. government agency, and do not require cash reserves to be set against the balances. At December 31, 2005 and December 31, 2004, the Company had $36,052,000 and $3,546,000, respectively, of customer funds invested in this cash management program. The Company has various financial obligations, including contractual obligations and commitments, which may require future cash payments. The Company has purchase obligations which represent obligations under agreements to purchase goods or services that are enforceable and legally binding on the Company and that specify all significant terms. At December 31, 2005, the Company's purchase obligations were primarily related to certain contractual payments for capital expenditures of facilities expansion. The Company has operating contract obligations which represent short and long-term payments for data processing equipment and services, software, and other equipment and professional services. The following table presents, as of December 31, 2005, significant fixed and determinable contractual obligations to these third parties by payment date. Purchase Operating Obligations Contracts ---------------------------------- Year ending December 31: 2006 ..................................... $ 2,900,000 $ 1,546,712 2007 ..................................... -- 1,072,451 2008 ..................................... -- 995,837 2009 ..................................... -- 883,113 2010 ..... ............................... -- 3,750 Thereafter ............................... -- 11,950 ---------------------------------- $ 2,900,000 $ 4,513,813 ==================================
The Company also has operating lease obligations under noncancelable leases for several of its facilities. See Note 5. In the third quarter of 2005, Rockford Bank & Trust initiated plans for a second banking location in Rockford, Illinois on Guilford Road at Alpine. A temporary modular facility opened in December providing a drive-up lane and drive-up ATM. The Company plans to build a 20,000 square foot banking facility at a projected cost of $4.4 million. Completion of the new facility is anticipated to occur in October of 2006. During 2005, capitalized costs associated with this project were $1.5 million. 56 Note 18. Quarterly Results of Operations (Unaudited) Year Ended December 31, 2005 ---------------------------------------------------------- March June September December 2005 2005 2005 2005 ---------------------------------------------------------- Total interest income ................................... $ 10,679,989 $ 11,538,870 $ 12,502,512 $ 13,966,897 Total interest expense .................................. 4,191,650 4,781,874 5,642,350 6,664,911 ---------------------------------------------------------- Net interest income ................................ 6,488,339 6,756,996 6,860,162 7,301,986 Provision for loan losses (gains) ....................... 301,206 (147,418) 382,752 340,544 Noninterest income ...................................... 2,516,475 2,434,878 2,508,535 2,612,615 Noninterest expenses .................................... 6,752,705 7,443,341 7,589,747 7,647,355 Minority interest in income of consolidated subsidiary ............................... -- -- 20,651 56,887 ---------------------------------------------------------- Net income before income taxes ....................................... 1,950,903 1,895,951 1,375,547 1,869,815 Federal and state income taxes .......................... 627,153 633,428 419,968 601,652 ---------------------------------------------------------- Net income ......................................... $ 1,323,750 $ 1,262,523 $ 955,579 $ 1,268,163 ========================================================== Earnings per common share: Basic ................................................. $ 0.29 $ 0.28 $ 0.21 $ 0.28 Diluted ............................................... 0.29 0.27 0.21 0.27
Year Ended December 31, 2004 ---------------------------------------------------------- March June September December 2004 2004 2004 2004 ---------------------------------------------------------- Total interest income $ 8,678,807 $ 9,225,725 $ 9,799,578 $ 10,312,730 Total interest expense 2,902,869 3,206,913 3,368,355 3,846,631 ---------------------------------------------------------- Net interest income 5,775,938 6,018,812 6,431,223 6,466,099 Provision for loan losses (gains) 856,841 467,659 411,385 (363,677) Noninterest income 2,358,736 2,379,412 2,019,557 1,923,736 Noninterest expenses 6,089,088 5,437,580 5,913,274 6,840,909 ---------------------------------------------------------- Net income before income taxes 1,188,745 2,492,985 2,126,121 1,912,603 Federal and state income taxes 352,828 821,773 703,464 625,717 --------------------------------------------------------- Net income $ 835,917 $ 1,671,212 $ 1,422,657 $ 1,286,886 ========================================================= Earnings per common share: Basic $ 0.20 $ 0.40 $ 0.33 $ 0.30 Diluted 0.19 0.39 0.33 0.29
57 Note 19. Parent Company Only Financial Statements The following is condensed financial information of QCR Holdings, Inc. (parent company only): Condensed Balance Sheets December 31, 2005 and 2004 Assets 2005 2004 ---------------------------------------------------------------------------------- Cash and due from banks ........................... $ 842,260 $ 6,125,728 Interest-bearing deposits at financial institutions .................................... 95,727 415,439 Securities available for sale, at fair value ...... 1,593,719 1,638,617 Investment in bank subsidiaries ................... 86,100,599 66,900,880 Investment in nonbank subsidiaries ................ 1,376,780 1,250,673 Net loans receivable .............................. -- 21,764 Other assets ...................................... 2,070,084 2,552,837 ---------------------------- Total assets ................................. $ 92,079,169 $ 78,905,938 ============================ Liabilities and Stockholders' Equity ---------------------------------------------------------------------------------- Liabilities: Other borrowings ................................ $ 10,500,000 $ 6,000,000 Junior subordinated debentures .................. 25,775,000 20,620,000 Other liabilities ............................... 1,337,470 1,512,138 ---------------------------- Total liabilities ............................ 37,612,470 28,132,138 ---------------------------- Stockholders' Equity: Common stock .................................... 4,531,224 4,496,730 Additional paid-in capital ...................... 20,776,254 20,329,033 Retained earnings ............................... 29,726,700 25,278,666 Accumulated other comprehensive income (loss) ... (567,479) 669,371 ---------------------------- Total stockholders' equity ................... 54,466,699 50,773,800 ---------------------------- Total liabilities and stockholders' equity ... $ 92,079,169 $ 78,905,938 ============================
Condensed Statements of Income Years Ended December 31, 2005, 2004, and 2003 2005 2004 2003 ------------------------------------------------------------------------------------ Total interest income ....................... $ 48,991 $ 114,731 $ 83,894 Securities gains, net ....................... 50 26,188 5 Equity in net income of bank subsidiaries ... 6,491,611 7,643,815 6,075,566 Equity in net income of nonbank subsidiaries 405,220 259,660 867,217 Other ....................................... 386,382 212,814 303,052 ------------------------------------ Total income ........................... 7,332,254 8,257,208 7,329,734 ------------------------------------ Interest expense ............................ 1,988,963 2,547,534 1,361,939 Salaries and employee benefits .............. 778,402 1,135,333 720,989 Professional and data processing fees ....... 508,237 361,063 288,217 Other ....................................... 344,280 423,347 292,914 ------------------------------------ Total expenses ......................... 3,619,882 4,467,277 2,664,059 ------------------------------------ Income before income tax benefit ....... 3,712,372 3,789,931 4,665,675 Income tax benefit .......................... 1,097,643 1,426,741 795,252 ------------------------------------ Net income ............................. $4,810,015 $5,216,672 $5,460,927 ====================================
58 Condensed Statements of Cash Flows Years Ended December 31, 2005, 2004, and 2003 2005 2004 2003 ---------------------------------------------------------------------------------------------------------- Cash Flows from Operating Activities: Net income .............................................. $ 4,810,015 $ 5,216,672 $ 5,460,927 Adjustments to reconcile net income to net cash (used in) provided by operating activities: Distributions in excess of (less than) earnings of: Bank subsidiaries ................................... (6,491,611) (6,643,815) (5,075,566) Nonbank subsidiaries ................................ 28,893 2,662,973 41,775 Depreciation .......................................... 3,877 4,507 4,506 Provision for loan losses ............................. 3,269 -- -- Loss on redemption of junior subordinated debentures .. -- 747,490 -- Investment securities gains, net ...................... (50) (26,188) (5) Tax benefit of nonqualified stock options exercised ... 125,993 190,248 274,871 (Increase) decrease in accrued interest receivable .... 26,788 (28,252) (6,715) (Increase) decrease in other assets ................... 424,737 (1,103,348) (299,820) Increase (decrease) in other liabilities .............. (176,051) 523,507 (47,516) -------------------------------------------- Net cash (used in) provided by operating activities (1,244,140) 1,543,794 352,457 -------------------------------------------- Cash Flows from Investing Activities: Net (increase) decrease in interest-bearing deposits at financial institutions ................................ 319,712 (281,648) 153,118 Purchase of securities available for sale ............... (167,736) (307,392) (28,496) Proceeds from calls and maturities of securities ........ 298,988 227,001 200,000 Capital infusion, bank subsidiaries ..................... (14,000,000) (4,000,000) (5,000,000) Capital infusion, nonbank subsidiaries .................. (155,000) (620,000) (500,000) Net loans (originated) repaid ........................... 22,084 -- (757) Purchase of premises and equipment ...................... (7,500) -- -- -------------------------------------------- Net cash used in investing activities ............. (13,689,452) (4,982,039) (5,176,135) -------------------------------------------- Cash Flows from Financing Activities: Net (decrease) increase in other borrowings ............. 4,500,000 (4,000,000) 5,000,000 Proceeds from issuance of junior subordinated debentures 5,155,000 20,620,000 -- Redemption of junior subordinated debentures ............ -- (12,000,000) -- Payment of cash dividends ............................... (360,598) (336,816) (277,086) Payment from fractional shares on 3:2 stock split ....... -- (2,549) -- Proceeds from issuance of common stock, net ............. 355,722 5,028,831 148,503 -------------------------------------------- Net cash provided by financing activities ......... 9,650,124 9,309,466 4,871,417 -------------------------------------------- Net increase (decrease) in cash and due from banks (5,283,468) 5,871,221 47,739 Cash and due from banks: Beginning ............................................... 6,125,728 254,507 206,768 -------------------------------------------- Ending .................................................. $ 842,260 $ 6,125,728 $ 254,507 ============================================
Note 20. Fair Value of Financial Instruments FASB Statement No. 107, Disclosures about Fair Value of Financial Instruments, requires disclosures of fair value information about financial instruments for which it is practicable to estimate that value. When quoted market prices are not available, fair values are based on estimates using present value or other techniques. Those techniques are significantly affected by the assumptions used, including the discounted rates and estimates of future cash flows. In this regard, fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in an immediate settlement. Some financial instruments and all nonfinancial instruments are excluded from the disclosures. The aggregate fair value amounts presented do not represent the underlying value of the Company. The following methods and assumptions were used by the Company in estimating the fair value of their financial instruments. Cash and due from banks, federal funds sold, and interest-bearing deposits at financial institutions: The carrying amounts reported in the balance sheets for cash and due from banks, federal funds sold, and interest-bearing deposits at financial institutions equal their fair values. 59 Investment securities: Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. Loans/leases receivable: The fair values for variable rate loans equal their carrying values. The fair values for all other types of loans/leases are estimated using discounted cash flow analyses, using interest rates currently being offered for loans/leases with similar terms to borrowers with similar credit quality. The fair value of loans held for sale is based on quoted market prices of similar loans sold in the secondary market. Accrued interest receivable and payable: The fair value of accrued interest receivable and payable is equal to its carrying value. Deposits: The fair values disclosed for demand deposits equal their carrying amounts, which represent the amount payable on demand. Fair values for time deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered on time deposits to a schedule of aggregate expected monthly maturities on time deposits. Short-term borrowings: The fair value for short-term borrowings is equal to its carrying value. Federal Home Loan Bank advances and junior subordinated debentures: The fair value of these instruments is estimated using discounted cash flow analyses, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements. Other borrowings: The fair value for variable rate other borrowings is equal to its carrying value. Commitments to extend credit: The fair value of these commitments is not material. The carrying values and estimated fair values of the Company's financial instruments as of December 31, 2005 and 2004 are presented as follows: 2005 2004 --------------------------- -------------------------- Carrying Estimated Carrying Estimated Value Fair Value Value Fair Value --------------------------------------------------------- Cash and due from banks .................................... $ 38,956,627 $ 38,956,627 $ 21,372,342 $ 21,372,342 Federal funds sold ......................................... 4,450,000 4,450,000 2,890,000 2,890,000 Interest-bearing deposits at financial institutions ............................................. 1,270,666 1,270,666 3,857,563 3,857,563 Investment securities: Held to maturity ......................................... 150,000 154,828 100,000 108,254 Available for sale ....................................... 182,214,719 182,214,719 149,460,886 149,460,886 Loans/leases receivable, net ............................... 747,370,175 745,921,173 639,088,836 639,212,836 Accrued interest receivable ................................ 4,849,379 4,849,379 4,072,762 4,072,762 Deposits ................................................... 698,503,899 696,761,899 588,015,683 587,509,683 Short-term borrowings ...................................... 107,469,851 107,469,851 104,771,178 104,771,178 Federal Home Loan Bank advances ............................ 130,000,854 128,861,854 92,021,877 92,107,877 Other borrowings ........................................... 10,764,914 10,764,914 6,000,000 6,000,000 Junior subordinated debentures ............................. 25,775,000 27,653,149 20,620,000 22,049,216 Accrued interest payable ................................... 2,410,398 2,410,398 1,536,976 1,536,976
60 Note 21. Business Segment Information Selected financial information on the Company's business segments, with all intercompany accounts and transactions eliminated, is presented as follows for the years ended December 31, 2005, 2004, and 2003: 2005 2004 2003 ------------------------------------------------- Commercial banking: Quad City Bank & Trust: Revenue ................ $ 36,732,246 $ 32,342,266 $ 32,624,650 Net income ............. 4,965,565 5,914,913 5,148,423 Assets ................. 668,896,016 634,206,797 555,403,875 Depreciation ........... 1,476,476 1,245,853 902,175 Capital expenditures ... 1,787,723 3,783,114 3,851,445 Intangible assets ...... -- -- -- Cedar Rapids Bank & Trust: Revenue ................ 14,627,423 9,809,878 6,920,826 Net income ............. 1,274,625 873,348 249,866 Assets ................. 288,537,122 228,249,176 149,673,720 Depreciation ........... 392,491 185,869 140,606 Capital expenditures ... 6,170,123 3,582,029 292,260 Intangible assets ...... -- -- -- Rockford Bank & Trust: Revenue ................ 1,084,242 16,476 -- Net (loss) ............. (1,297,322) (346,490) -- Assets ................. 41,206,869 1,660,473 -- Depreciation ........... 97,125 10,689 -- Capital expenditures ... 1,744,149 207,239 -- Intangible assets ...... -- -- --
2005 2004 2003 ------------------------------------------------- Credit card processing: Revenue ................... $ 2,056,474 $ 1,612,824 $ 2,372,619 Net income ................ 631,954 441,117 1,056,399 Assets .................... 575,974 889,407 736,710 Depreciation .............. 29,359 28,535 25,656 Capital expenditures ...... 32,533 39,204 8,328 Intangible assets ......... -- -- -- Trust management: Revenue ................... 2,818,832 2,530,907 2,242,747 Net income ................ 611,647 625,459 490,018 Assets .................... N/A N/A N/A Depreciation .............. N/A N/A N/A Capital expenditures ...... N/A N/A N/A Intangible assets ......... -- -- -- Leasing services: Revenue ................... 958,854 -- -- Net income ................ 663,084 -- -- Assets .................... 38,585,572 -- -- Depreciation .............. 9,445 -- -- Capital expenditures ...... 37,465 -- -- Intangible assets ......... 3,222,688 -- -- All other: Revenue ................... 482,700 385,930 385,028 Net (loss) ................ (2,039,538) (2,291,675) (1,483,779) Assets .................... 4,811,975 5,077,694 4,225,250 Depreciation .............. 3,877 4,507 4,506 Capital expenditures ...... 7,500 -- -- Intangible assets ......... -- -- --
61 Note 22. Subsequent Event On February 24, 2006, the Company announced the issuance of $10,000,000 of fixed/floating rate capital securities of QCR Holdings Statutory Trust V ("Trust V"). The securities represent the undivided beneficial interest in Trust V, which was established by the Company for the sole purpose of issuing the Trust Preferred Securities. The Trust Preferred Securities were sold in a private transaction exempt from registration under the Securities Act of 1933, as amended and were not registered under the Act. The securities issued by Trust V mature in thirty years, but are callable at par after five years. The Trust Preferred Securities have a fixed rate of 6.62%, payable quarterly, for five years, at which time they have a variable rate based on the three-month LIBOR, reset quarterly. Trust V used the $10,000,000 of proceeds from the sale of the Trust Preferred Securities, in combination with $310,000 of proceeds from its own equity, to purchase $10,310,000 million of junior subordinated debentures of the Company. The Company treats these issuances as Tier 1 capital for regulatory capital purposes, subject to current established limitations. The Company incurred no issuance costs as a result of the transaction. The Company used the net proceeds for general corporate purposes, including the paydown of its other borrowings. Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure None. Item 9A. Controls and Procedures Evaluation of disclosure controls and procedures. An evaluation was performed under the supervision and with the participation of the Company's management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Exchange Act) as of December 31, 2005. Based on that evaluation, the Company's management, including the Chief Executive Officer and Chief Financial Officer, concluded that the Company's disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports filed and submitted under the Exchange Act was recorded, processed, summarized and reported as and when required. Management's Report on Internal Control Over Financial Reporting. The Company's management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act). Internal control over financial reporting includes controls and procedures designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements. All internal control systems, no matter how well designed, have inherent limitations, including the possibility of human error and the circumvention of overriding controls. Accordingly, even effective internal control can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of internal control may vary over time. The Company's management assessed the effectiveness of the Company's internal control, over financial reporting as of December 31, 2005. Management's assessment is based on the criteria established in the Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and was designed to provide reasonable assurance that the Company maintained effective internal control over financial reporting as of December 31, 2005. Based on this assessment, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2005. McGladrey & Pullen, LLP, the Company's independent registered public accounting firm, has issued an attestation report on the Company's internal control over financial reporting as of December 31, 2005 and management's assessment of the internal control over financial reporting which is included following in this Form 10-K. 62 McGladrey & Pullen, LLP Certified Public Accountants Report of Independent Registered Public Accounting Firm. To the Board of Directors QCR Holdings, Inc. Moline, Illinois We have audited management's assessment, included in the accompanying Management's Report on Internal Control over Financial Reporting, that QCR Holdings, Inc. and subsidiaries (the Company) maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management's assessment that the Company maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company acquired an 80% ownership interest in M2 Lease Funds, LLC. (M2) during 2005, and management excluded from its assessment of the effectiveness of the Company's internal control over financial reporting as of December 31, 2005, M2's internal control over financial reporting associated with total assets of $38.6 million, total revenues of $948,000, and net income of $392,000 included in the consolidated financial statements of the Company as of and for the year ended December 31, 2005. Our audit of internal control over financial reporting of the Company also excluded an evaluation of the internal control over financial reporting of M2. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Company as of December 31, 2005 and 2004, and the related consolidated statements of income, changes in stockholder's equity, and cash flows for each of the years in the three-year period ended December 31, 2005, and our report dated January 27, 2006 expressed an unqualified opinion on those consolidated financial statements. /s/ McGladrey & Pullen, LLP Davenport, Iowa January 27, 2006 McGladrey & Pullen, LLP is a member firm of RSM International - an affiliation of separate and independent legal entities. 63 Changes in Internal Control over Financial Reporting. The Company recently underwent a comprehensive effort to ensure compliance with the requirements under Section 404 of the Sarbanes-Oxley Act of 2002. As a result, several enhancements to the Company's internal controls over financial reporting have been implemented, including, but not limited to, changes in wire transfer access, reviews of file maintenance reports, and changes in the access to the issuance of credit cards. During 2005, the Company implemented one of the more significant changes, which was a comprehensive Reconciliation and Account Certification Policy, creating a centralized reconciliation process throughout the Company, culminating in a consolidated reporting package that is submitted to the Chief Financial Officer. At December 31, 2005, the Company had fully completed its evaluation and the implementation of many significant control enhancements. These control enhancements were not made in response to material weaknesses in the Company's internal control over financial reporting, but rather as part of the Company's ongoing efforts to improve internal control over financial reporting. The Company will continue to work throughout 2006 to implement additional control enhancements. Other than changes as described above, there have been no other significant changes to the Company's internal control over financial reporting during the period covered by this report that have materially effected, or are reasonably likely to affect the Company's internal control over financial reporting. Item 9B. Other Information None. Part III Item 10. Directors and Executive Officers of the Registrant The information required by this item is set forth under the caption "Election of Directors" in the Proxy Statement, and is incorporated herein by reference. Item 11. Executive Compensation The information required by this item is set forth under the caption "Executive Compensation" in the Proxy Statement, and is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters The information required by this item is set forth under the caption "Security Ownership of Certain Beneficial Owners" in the Proxy Statement, and is incorporated herein by reference, or is presented below. Equity Compensation Plan Information The table below sets forth the following information as of December 31, 2005 for (i) all compensation plans previously approved by the Company's stockholders and (ii) all compensation plans not previously approved by the Company's stockholders: (a) the number of securities to be issued upon the exercise of outstanding options, warrants and rights; (b) the weighted-average exercise price of such outstanding options, warrants and rights; and (c) other than securities to be issued upon the exercise of such outstanding options, warrants and rights, the number of securities remaining available for future issuance under the plans. EQUITY COMPENSATION PLAN INFORMATION ------------------------------------------------------------------------------------------------------------------------------------ Number of securities remaining Number of securities Weighted-average exercise available for to be issued upon price of outstanding options, future issuance under Plan category exercise of warrants and rights equity compensation plans outstanding options, (b) (excluding securities warrants and rights reflected in column(a)) (a) (c) ------------------------------------------------------------------------------------------------------------------------------------ Equity compensation plans approved by security holders............... 255,102 $13.29 287,981 (1) Equity compensation plans not approved by security holders.. -- -- -- Total............................. 255,102 $13.29 287,981 (1)
(1) Includes 117,669 shares available under the QCR Holdings, Inc. Employee Stock Purchase Plan. 64 Item 13. Certain Relationships and Related Transactions The information required by this item is set forth under the captions "Security Ownership of Certain Beneficial Owners" and "Transactions with Management" in the Proxy Statement, and is incorporated herein by reference. Item 14. Principal Accounting Fees and Services The information required by this item is set forth under the caption "Independent Registered Public Accounting Firm" in the Proxy statement and is incorporated herein by reference. Part IV Item 15. Exhibits and Financial Statement Schedules (a) 1. Financial Statements These documents are listed in the Index to Consolidated Financial Statements under Item 8. (a) 2. Financial Statement Schedules Financial statement schedules are omitted, as they are not required or are not applicable, or the required information is shown in the consolidated financial statements and the accompanying notes thereto. (a) 3. Exhibits The following exhibits are either filed as a part of this Annual Report on Form 10-K or are incorporated herein by reference: Exhibit Number. Exhibit Description 3.1 Certificate of Incorporation of QCR Holdings, Inc., as amended (incorporated herein by reference to Exhibit 3(i) of Registrant's Annual Report on Form 10K for the year ended December 31, 2004). 3.2 Bylaws of QCR Holdings, Inc. (incorporated herein by reference to Exhibit 3(ii) of Registrant's Quarterly Report on Form 10Q for the quarter ended September 30, 2002). 4.1 Specimen Stock Certificate of QCR Holdings, Inc. (incorporated herein by reference to Exhibit 4.1 of Registrant's Form SB-2, File No. 33-67028). 4.2 Registration of Preferred Share Purchase Rights of QCR Holdings, Inc. (incorporated by reference to Item 1. of Registrant's form 8-A12G, File No. 000-22208). 10.1 Employment Agreement between QCR Holdings, Inc., Quad City Bank and Trust Company and Michael A. Bauer dated January 1, 2004 (incorporated herein by reference to Exhibit 10(i) of Registrant's Annual Report on Form 10K for the year ended December 31, 2003). 10.2 Employment Agreement between QCR Holdings, Inc., Quad City Bank and Trust Company and Douglas M. Hultquist dated January 1, 2004 (incorporated herein by reference to Exhibit 10(ii) of Registrant's Annual Report on Form 10K for the year ended December 31, 2003). 10.3 Executive Deferred Compensation Agreement between Quad City Bank and Trust Company and Michael A. Bauer dated January 1, 2004 (incorporated herein by reference to Exhibit 10(iii) of Registrant's Annual Report on Form 10K for the year ended December 31, 2003). 10.4 Executive Deferred Compensation Agreement between Quad City Bank and Trust Company and Douglas M. Hultquist dated January 1, 2004 (incorporated herein by reference to Exhibit 10(iv) of Registrant's Annual Report on Form 10K for the year ended December 31, 2003). 65 Exhibit Number. Exhibit Description 10.5 Lease Agreement between Quad City Bank and Trust Company and 56 Utica L.L.C. (incorporated herein by reference to Exhibit 10.5 of Registrant's Annual Report on Form 10-K for the year ended June 30, 2000). 10.6 Employment Agreement between Quad City Bank and Trust Company and Larry J. Helling dated January 1, 2004 (incorporated herein by reference to Exhibit 10(vi) of Registrant's Annual Report on Form 10K for the year ended December 31, 2003). 10.7 Executive Deferred Compensation Agreement for Todd A. Gipple, Executive Vice President and Chief Financial Officer of QCR Holdings, Inc. dated January 1, 2004 (incorporated herein by reference to Exhibit 10(viii) of Registrant's Annual Report on Form 10K for the year ended December 31, 2003). 10.8 Executive Deferred Compensation Agreement for Larry J. Helling, President and Chief Executive Officer of Cedar Rapids Bank and Trust Company dated January 1, 2004 (incorporated herein by reference to Exhibit 10(ix) of Registrant's Annual Report on Form 10K for the year ended December 31, 2003). 10.9 Employment Agreement between QCR Holdings, Inc. and Todd A. Gipple dated January 1, 2004 (incorporated herein by reference to Exhibit 10(xi) of Registrant's Annual Report on Form 10K for the year ended December 31, 2003). 10.10 QCR Holdings, Inc. Employee Stock Purchase Plan (incorporated herein by reference to Exhibit 5.1 of Registrant's Form S-8, file No. 333-101356). 10.11 Dividend Reinvestment Plan of QCR Holdings, Inc. (incorporated herein by reference to Exhibit 5.1 of Registrant's Form S-3, File No. 333-102699). 10.12 Indenture by and between QCR Holdings, Inc. / QCR Holdings Statutory Trust II and U.S. Bank National Association, as debenture and institutional trustee, dated February 18, 2004 (incorporated herein by reference to Exhibit 10(i) of Registrant's Quarterly Report on Form 10Q for the quarter ended March 31, 2004). 10.13 Indenture by and between QCR Holdings, Inc. / QCR Holdings Statutory Trust III and U.S. Bank National Association, as debenture and institutional trustee, dated February 18, 2004 (incorporated herein by reference to Exhibit 10(ii) of Registrant's Quarterly Report on Form 10Q for the quarter ended March 31, 2004). 10.14 Employment Agreement between QCR Holdings, Inc. and Thomas Budd dated June 2004 (incorporated herein by reference to Exhibit 10(i) of Registrant's Quarterly Report on Form 10Q for the period ended June 30, 2004). 10.15 Employment Agreement between QCR Holdings, Inc. and Shawn Way dated June 2004 (incorporated herein by reference to Exhibit 10(ii) of Registrant's Quarterly Report on Form 10Q for the period ended June 30, 2004). 10.16 Lease Agreement between Quad City Bank and Trust Company and 127 North Wyman Development, L.L.C. dated November 3, 2004 (incorporated herein by reference to Exhibit 10(i) of Registrant's Quarterly Report on Form 10-Q for the period ended September 30, 2004). 10.17 2004 Stock Incentive Plan of QCR Holdings, Inc. (incorporated herein by reference to Exhibit B of Registrant's Form Pre 14A, filed March 5, 2004, File No. 000-22208). 10.18 Director Compensation Schedule of QCR Holdings, Inc. (incorporated herein by reference to Registrant's Form 8-K, filed February 2, 2005, file No. 000-22208). 66 10.19 Non-Qualified Supplemental Executive Retirement Agreement between Quad City Bank and Trust Company and Certain Key Executives dated February 1, 2004 (incorporated herein by reference to Exhibit 10.20 of Registrant's Annual Report on form 10K for the year ended December 31, 2004). 10.20 Non-Qualified Supplemental Executive Retirement Agreement between Cedar Rapids Bank and Trust Company and Certain Key Executives dated February 1, 2004 (incorporated herein by reference to Exhibit 10(xxi) of Registrant's Annual Report on Form 10K for the year ended December 31, 2004). 10.21 Executive Deferred Compensation Agreement between QCR Holdings, Inc. and Thomas Budd dated July 15, 2004 (incorporated herein by reference to Exhibit 10(xxii) of Registrant's Annual Report on Form 10K for the year ended December 31, 2004). 10.22 Deferred Income Plan of Quad City Holdings, Inc. (incorporated herein by reference to Exhibit 99.1 of Registrant's Form S-8, filed October 21, 1997, File No. 333-38341). 10.23 Stock Option Plan of Quad City Holdings, Inc. (incorporated herein by reference to Exhibit 10.1 of Registrant's Form SB-2, File No. 33-67028). 10.24 1997 Stock Incentive Plan of Quad City Holdings, Inc. (incorporated herein by reference to Exhibit 10.1 of Registrant's Form S-8, File No. 333-87229). 10.25 Indenture by and between QCR Holdings, Inc./QCR Holdings Statutory Trust IV and Wells Fargo Bank, National Association, as debenture and institutional trustee, dated May 4, 2005 (incorporated herein by reference to Exhibit 10(i) of Registrant's Quarterly Report on Form 10Q for the quarter ended March 31, 2005). 10.26 Second Amended and Restated Operating Agreement between Quad City Bank and Trust Company and John Engelbrecht dated August 26, 2005 (incorporated herein by reference to Exhibit 10(i) of Registrant's Quarterly Report on Form 10Q for the quarter ended September 30, 2005). 10.27 Indenture by and between QCR Holdings, Inc./QCR Holdings Statutory Trust V and Wells Fargo Bank, National Association, as debenture and institutional trustee, dated February 24, 2006 (exhibit is being filed herewith). 12.1 Statement re: Computation of Ratios (exhibit is being filed herewith). 21.1 Subsidiaries of QCR Holdings, Inc. (exhibit is being filed herewith). 23.1 Consent of Independent Registered Public Accounting Firm - McGladrey and Pullen LLP (exhibit is being filed herewith). 31.1 Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a). 31.2 Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a). 32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 67 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. QCR HOLDINGS, INC. Dated: March 13, 2006 By: /s/ Douglas M. Hultquist Douglas M. Hultquist President and Chief Executive Officer Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the dates indicated. Signature Title Date ------------------------------------------------------------------------------------------------ /s/ Michael A. Bauer Chairman of the Board of Directors March 13, 2006 ---------------------------- Michael A. Bauer /s/ Douglas M. Hultquist President, Chief Executive March 13, 2006 ---------------------------- Douglas M. Hultquist Officer and Director /s Patrick S. Baird Director March 13, 2006 ---------------------------- Patrick Baird /s/ James J. Brownson Director March 13, 2006 ---------------------------- James J. Brownson /s/ Larry J. Helling Director March 13, 2006 ---------------------------- Larry J. Helling /s/ Mark C. Kilmer Director March 13, 2006 ---------------------------- Mark C. Kilmer /s/ John K. Lawson Director March 13, 2006 ---------------------------- John K. Lawson /s/ Ronald G. Peterson Director March 13, 2006 ---------------------------- Ronald G. Peterson /s/ Henry Royer Director March 13, 2006 ---------------------------- Henry Royer
68 Appendix A SUPERVISION AND REGULATION General Financial institutions, their holding companies and their affiliates are extensively regulated under federal and state law. As a result, the growth and earnings performance of the Company may be affected not only by management decisions and general economic conditions, but also by the requirements of federal and state statutes and by the regulations and policies of various bank regulatory authorities, including the Iowa Superintendent of Banking (the "Superintendent"), the Illinois Department of Financial and Professional Regulation (the "DFPR"), the Board of Governors of the Federal Reserve System (the "Federal Reserve") and the Federal Deposit Insurance Corporation (the "FDIC"). Furthermore, taxation laws administered by the Internal Revenue Service and state taxing authorities and securities laws administered by the Securities and Exchange Commission (the "SEC") and state securities authorities have an impact on the business of the Company. The effect of these statutes, regulations and regulatory policies may be significant, and cannot be predicted with a high degree of certainty. Federal and state laws and regulations generally applicable to financial institutions regulate, among other things, the scope of business, the kinds and amounts of investments, reserve requirements, capital levels relative to operations, the nature and amount of collateral for loans, the establishment of branches, mergers and consolidations and the payment of dividends. This system of supervision and regulation establishes a comprehensive framework for the respective operations of the Company and its subsidiaries and is intended primarily for the protection of the FDIC-insured deposits and depositors of the Banks, rather than shareholders. The following is a summary of the material elements of the regulatory framework that applies to the Company and its subsidiaries. It does not describe all of the statutes, regulations and regulatory policies that apply, nor does it restate all of the requirements of those that are described. As such, the following is qualified in its entirety by reference to applicable law. Any change in statutes, regulations or regulatory policies may have a material effect on the business of the Company and its subsidiaries. The Company General. The Company, as the sole shareholder of the Banks, is a bank holding company. As a bank holding company, the Company is registered with, and is subject to regulation by, the Federal Reserve under the Bank Holding Company Act of 1956, as amended (the "BHCA"). In accordance with Federal Reserve policy, the Company is expected to act as a source of financial strength to the Banks and to commit resources to support the Banks in circumstances where the Company might not otherwise do so. Under the BHCA, the Company is subject to periodic examination by the Federal Reserve. The Company is also required to file with the Federal Reserve periodic reports of the Company's operations and such additional information regarding the Company and its subsidiaries as the Federal Reserve may require. Acquisitions, Activities and Change in Control. The primary purpose of a bank holding company is to control and manage banks. The BHCA generally requires the prior approval of the Federal Reserve for any merger involving a bank holding company or any acquisition by a bank holding company of another bank or bank holding company. Subject to certain conditions (including deposit concentration limits established by the BHCA), the Federal Reserve may allow a bank holding company to acquire banks located in any state of the United States. In approving interstate acquisitions, the Federal Reserve is required to give effect to applicable state law limitations on the aggregate amount of deposits that may be held by the acquiring bank holding company and its insured depository institution affiliates in the state in which the target bank is located (provided that those limits do not discriminate against out-of-state depository institutions or their holding companies) and state laws that require that the target bank have been in existence for a minimum period of time (not to exceed five years) before being acquired by an out-of-state bank holding company. The BHCA generally prohibits the Company from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company that is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to banks and their subsidiaries. This general prohibition is subject to a number of exceptions. The principal exception allows bank holding companies to engage in, and to own shares of companies engaged in, certain businesses found by the Federal Reserve to be "so closely related to banking ... as to be a proper incident thereto." This authority would permit the Company to engage in a variety of banking-related businesses, including the operation of a thrift, consumer finance, equipment leasing, the operation of a computer service bureau (including software development), and mortgage banking and brokerage. The BHCA generally does not place territorial restrictions on the domestic activities of non-bank subsidiaries of bank holding companies. 69 Additionally, bank holding companies that meet certain eligibility requirements prescribed by the BHCA and elect to operate as financial holding companies may engage in, or own shares in companies engaged in, a wider range of nonbanking activities, including securities and insurance underwriting and sales, merchant banking and any other activity that the Federal Reserve, in consultation with the Secretary of the Treasury, determines by regulation or order is financial in nature, incidental to any such financial activity or complementary to any such financial activity and does not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally. As of the date of this filing, the Company has not applied for approval to operate as a financial holding company. Federal law also prohibits any person or company from acquiring "control" of an FDIC-insured depository institution or its holding company without prior notice to the appropriate federal bank regulator. "Control" is conclusively presumed to exist upon the acquisition of 25% or more of the outstanding voting securities of a bank or bank holding company, but may arise under certain circumstances at 10% ownership. Capital Requirements. Bank holding companies are required to maintain minimum levels of capital in accordance with Federal Reserve capital adequacy guidelines. If capital levels fall below the minimum required levels, a bank holding company, among other things, may be denied approval to acquire or establish additional banks or non-bank businesses. The Federal Reserve's capital guidelines establish the following minimum regulatory capital requirements for bank holding companies: (i) a risk-based requirement expressed as a percentage of total assets weighted according to risk; and (ii) a leverage requirement expressed as a percentage of total assets. The risk-based requirement consists of a minimum ratio of total capital to total risk-weighted assets of 8% and a minimum ratio of Tier 1 capital to total risk-weighted assets of 4%. The leverage requirement consists of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly rated companies, with a minimum requirement of 4% for all others. For purposes of these capital standards, Tier 1 capital consists primarily of permanent stockholders' equity less intangible assets (other than certain loan servicing rights and purchased credit card relationships). Total capital consists primarily of Tier 1 capital plus certain other debt and equity instruments that do not qualify as Tier 1 capital and a portion of the company's allowance for loan and lease losses. The risk-based and leverage standards described above are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual banking organizations. For example, the Federal Reserve's capital guidelines contemplate that additional capital may be required to take adequate account of, among other things, interest rate risk, or the risks posed by concentrations of credit, nontraditional activities or securities trading activities. Further, any banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios, including tangible capital positions (i.e., Tier 1 capital less all intangible assets), well above the minimum levels. As of December 31, 2005, the Company had regulatory capital in excess of the Federal Reserve's minimum requirements. Dividend Payments. The Company's ability to pay dividends to its shareholders may be affected by both general corporate law considerations and policies of the Federal Reserve applicable to bank holding companies. As a Delaware corporation, the Company is subject to the limitations of the Delaware General Corporation Law (the "DGCL"), which allow the Company to pay dividends only out of its surplus (as defined and computed in accordance with the provisions of the DGCL) or if the Company has no such surplus, out of its net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year. Additionally, policies of the Federal Reserve caution that a bank holding company should not pay cash dividends that exceed its net income or that can only be funded in ways that weaken the bank holding company's financial health, such as by borrowing. The Federal Reserve also possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends by banks and bank holding companies. Federal Securities Regulation. The Company's common stock is registered with the SEC under the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Consequently, the Company is subject to the information, proxy solicitation, insider trading and other restrictions and requirements of the SEC under the Exchange Act. The Banks The Iowa Banks are chartered under Iowa law and the Illinois Bank is chartered under Illinois law. The deposit accounts of the Banks are insured by the FDIC's Bank Insurance Fund ("BIF"). The Banks are members of the Federal Reserve System ("member banks"). As Iowa-chartered, FDIC-insured member banks, the Iowa Banks are subject to the examination, supervision, reporting and enforcement requirements of the Superintendent, as the chartering authority for Iowa banks. As an Illinois-chartered, FDIC-insured member bank, the Illinois Bank is subject to the examination, supervision, reporting and enforcement requirements of the DFPR, as the chartering authority for Illinois banks. The Banks are also subject to the examination, reporting and enforcement requirements of the Federal Reserve, the primary federal regulator of member banks. In addition, the FDIC, as administrator of the BIF, has regulatory authority over the Banks. 70 Deposit Insurance. As FDIC-insured institutions, the Banks are required to pay deposit insurance premium assessments to the FDIC. The FDIC has adopted a risk-based assessment system under which all insured depository institutions are placed into one of nine categories and assessed insurance premiums based upon their respective levels of capital and results of supervisory evaluations. Institutions classified as well-capitalized (as defined by the FDIC) and considered healthy pay the lowest premium while institutions that are less than adequately capitalized (as defined by the FDIC) and considered of substantial supervisory concern pay the highest premium. Risk classification of all insured institutions is made by the FDIC for each semi-annual assessment period. During the year ended December 31, 2005, BIF assessments ranged from 0% of deposits to 0.27% of deposits. For the semi-annual assessment period beginning January 1, 2006, BIF assessment rates will continue to range from 0% of deposits to 0.27% of deposits. FICO Assessments. Since 1987, a portion of the deposit insurance assessments paid by members of the FDIC's Savings Association Insurance Fund ("SAIF") has been used to cover interest payments due on the outstanding obligations of the Financing Corporation ("FICO"). FICO was created in 1987 to finance the recapitalization of the Federal Savings and Loan Insurance Corporation, the SAIF's predecessor insurance fund. As a result of federal legislation enacted in 1996, beginning as of January 1, 1997, both SAIF members and BIF members became subject to assessments to cover the interest payments on outstanding FICO obligations until the final maturity of such obligations in 2019. These FICO assessments are in addition to amounts assessed by the FDIC for deposit insurance. During the year ended December 31, 2005, the FICO assessment rate for BIF and SAIF members was approximately 0.01% of deposits. Supervisory Assessments. All Iowa banks are required to pay supervisory assessments to the Superintendent to fund the operations of the Superintendent and all Illinois banks are required to pay supervisory assessments to the DFPR to fund the operations of the DFPR. The amount of the assessment payable by each Bank is calculated on the basis of that Bank's total assets. During the year ended December 31, 2005, the Iowa Banks paid supervisory assessments to the Superintendent totaling $92 thousand and the Illinois Bank paid supervisory assessments to the DFPR totaling $6 thousand. Capital Requirements. Banks are generally required to maintain capital levels in excess of other businesses. The Federal Reserve has established the following minimum capital standards for state-chartered insured member banks, such as the Banks: (i) a leverage requirement consisting of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly-rated banks with a minimum requirement of at least 4% for all others; and (ii) a risk-based capital requirement consisting of a minimum ratio of total capital to total risk-weighted assets of 8% and a minimum ratio of Tier 1 capital to total risk-weighted assets of 4%. In general, the components of Tier 1 capital and total capital are the same as those for bank holding companies discussed above. The capital requirements described above are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual institutions. For example, regulations of the Federal Reserve provide that additional capital may be required to take adequate account of, among other things, interest rate risk or the risks posed by concentrations of credit, nontraditional activities or securities trading activities. Both the DFPR's order issuing a charter to the Illinois Bank and the FDIC's approval of deposit insurance for the Illinois Bank are conditioned upon the Illinois Bank maintaining a Tier 1 capital to assets ratio of not less than 8% for the first three years of operation; and the Federal Reserve's approval of the Illinois Bank's application to become a member bank is conditioned upon the Illinois Bank maintaining a Tier 1 capital to assets ratio of not less than 9% for the first three years of operation. If the Illinois Bank's Tier 1 capital to assets ratio falls below 9%, the Illinois Bank may need to raise additional capital to maintain the required ratio. Further, federal law and regulations provide various incentives for financial institutions to maintain regulatory capital at levels in excess of minimum regulatory requirements. For example, a financial institution that is "well-capitalized" may qualify for exemptions from prior notice or application requirements otherwise applicable to certain types of activities and may qualify for expedited processing of other required notices or applications. Additionally, one of the criteria that determines a bank holding company's eligibility to operate as a financial holding company is a requirement that all of its financial institution subsidiaries be "well-capitalized." Under the regulations of the Federal Reserve, in order to be "well-capitalized" a financial institution must maintain a ratio of total capital to total risk-weighted assets of 10% or greater, a ratio of Tier 1 capital to total risk-weighted assets of 6% or greater and a ratio of Tier 1 capital to total assets of 5% or greater. 71 Federal law also provides the federal banking regulators with broad power to take prompt corrective action to resolve the problems of undercapitalized institutions. The extent of the regulators' powers depends on whether the institution in question is "adequately capitalized," "undercapitalized," "significantly undercapitalized" or "critically undercapitalized," in each case as defined by regulation. Depending upon the capital category to which an institution is assigned, the regulators' corrective powers include: (i) requiring the institution to submit a capital restoration plan; (ii) limiting the institution's asset growth and restricting its activities; (iii) requiring the institution to issue additional capital stock (including additional voting stock) or to be acquired; (iv) restricting transactions between the institution and its affiliates; (v) restricting the interest rate the institution may pay on deposits; (vi) ordering a new election of directors of the institution; (vii) requiring that senior executive officers or directors be dismissed; (viii) prohibiting the institution from accepting deposits from correspondent banks; (ix) requiring the institution to divest cert!in subsidiaries; (x) prohibiting the payment of principal or interest on subordinated debt; and (xi) ultimately, appointing a receiver for the institution. As of December 31, 2005: (i) neither of the Iowa Banks was subject to a directive from the Federal Reserve to increase its capital to an amount in excess of the minimum regulatory capital requirements; (ii) each of the Iowa Banks exceeded its minimum regulatory capital requirements under Federal Reserve capital adequacy guidelines; and (iii) each of the Iowa Banks was "well-capitalized," as defined by Federal Reserve regulations. Liability of Commonly Controlled Institutions. Under federal law, institutions insured by the FDIC may be liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with the default of commonly controlled FDIC-insured depository institutions or any assistance provided by the FDIC to commonly controlled FDIC-insured depository institutions in danger of default. Because the Company controls each of the Banks, the Banks are commonly controlled for purposes of these provisions of federal law. Dividend Payments. The primary source of funds for the Company is dividends from the Banks. Under applicable Iowa and Illinois law, the Banks may not pay dividends in excess of their undivided profits. Before declaring its first dividend, the Illinois Bank, as a de novo institution, is required by Illinois law to carry at least one-tenth of its net profits since the issuance of its charter to its surplus until its surplus is equal to its capital. The Federal Reserve Act also imposes limitations on the amount of dividends that may be paid by state member banks, such as the Banks. Generally, a member bank may pay dividends out of its undivided profits, in such amounts and at such times as the bank's board of directors deems prudent. Without prior Federal Reserve approval, however, a state member bank may not pay dividends in any calendar year that, in the aggregate, exceed the bank's calendar year-to-date net income plus the bank's retained net income for the two preceding calendar years. The Federal Reserve's approval for the Illinois Bank to become a member bank is conditioned upon the Illinois Bank's commitment that without prior Federal Reserve approval, it will not pay dividends until after it has been in operation for three years and has received two consecutive satisfactory composite CAMELS ratings. 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. As described above, each of the Iowa Banks exceeded its minimum capital requirements under applicable guidelines as of December 31, 2005. As of December 31, 2005, approximately $1.9 million would have been available to be paid as dividends by the Iowa Banks. Notwithstanding the availability of funds for dividends, however, the Federal Reserve may prohibit the payment of any dividends by the Banks if the Federal Reserve determines such payment would constitute an unsafe or unsound practice. Insider Transactions. The Banks are subject to certain restrictions imposed by federal law on extensions of credit to the Company, on investments in the stock or other securities of the Company and the acceptance of the stock or other securities of the Company as collateral for loans made by the Banks. Certain limitations and reporting requirements are also placed on extensions of credit by the Banks to their respective directors and officers, to directors and officers of the Company and its subsidiaries, to principal shareholders of the Company and to "related interests" of such directors, officers and principal shareholders. In addition, federal law and regulations may affect the terms upon which any person who is a director or officer of the Company or one of its subsidiaries or a principal shareholder of the Company may obtain credit from banks with which the Banks maintain correspondent relationships. Safety and Soundness Standards. The federal banking agencies have adopted guidelines that establish operational and managerial standards to promote the safety and soundness of federally insured depository institutions. The guidelines set forth standards for internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset quality and earnings. 72 In general, the safety and soundness guidelines prescribe the goals to be achieved in each area, and each institution is responsible for establishing its own procedures to achieve those goals. If an institution fails to comply with any of the standards set forth in the guidelines, the institution's primary federal regulator may require the institution to submit a plan for achieving and maintaining compliance. If an institution fails to submit an acceptable compliance plan, or fails in any material respect to implement a compliance plan that has been accepted by its primary federal regulator, the regulator is required to issue an order directing the institution to cure the deficiency. Until the deficiency cited in the regulator's order is cured, the regulator may restrict the institution's rate of growth, require the institution to increase its capital, restrict the rates the institution pays on deposits or require the institution to take any action the regulator deems appropriate under the circumstances. Noncompliance with the standards established by the safety and soundness guidelines may also constitute grounds for other enforcement action by the federal banking regulators, including cease and desist orders and civil money penalty assessments. Branching Authority. The Iowa Banks have the authority under Iowa law to establish branches anywhere in the State of Iowa, subject to receipt of all required regulatory approvals. In 1997, the Company formed a de novo Illinois bank that was merged into the Quad City Bank and Trust Company, resulting in the Quad City Bank and Trust Company establishing a branch office in Illinois. Under Illinois law, the Quad City Bank and Trust Company may continue to establish offices in Illinois to the same extent permitted for an Illinois bank (subject to certain conditions, including certain regulatory notice requirements). Similarly, the Illinois Bank has the authority under Illinois law to establish branches anywhere in the State of Illinois, subject to receipt of all required regulatory approvals. Federal law permits state and national banks to merge with banks in other states subject to: (i) regulatory approval; (ii) federal and state deposit concentration limits; and (iii) state law limitations requiring the merging bank to have been in existence for a minimum period of time (not to exceed five years) prior to the merger. The establishment of new interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) is permitted only in those states the laws of which expressly authorize such expansion. State Bank Investments and Activities. The Iowa Banks and the Illinois Bank generally are permitted to make investments and engage in activities directly or through subsidiaries as authorized by Iowa law or Illinois law, respectively. However, under federal law and FDIC regulations, FDIC-insured state banks are prohibited, subject to certain exceptions, from making or retaining equity investments of a type, or in an amount, that are not permissible for a national bank. Federal law and FDIC regulations also prohibit FDIC-insured state banks and their subsidiaries, subject to certain exceptions, from engaging as principal in any activity that is not permitted for a national bank unless the bank meets, and continues to meet, its minimum regulatory capital requirements and the FDIC determines the activity would not pose a significant risk to the deposit insurance fund of which the bank is a member. These restrictions have not had, and are not currently expected to have, a material impact on the operations of the Banks. Federal Reserve System. Federal Reserve regulations, as presently in effect, require depository institutions to maintain non-interest earning reserves against their transaction accounts (primarily NOW and regular checking accounts), as follows: for transaction accounts aggregating $48.3 million or less, the reserve requirement is 3% of total transaction accounts; and for transaction accounts aggregating in excess of $48.3 million, the reserve requirement is $1.215 million plus 10% of the aggregate amount of total transaction accounts in excess of $48.3 million. The first $7.8 million of otherwise reservable balances are exempted from the reserve requirements. These reserve requirements are subject to annual adjustment by the Federal Reserve. The Banks are in compliance with the foregoing requirements. Recent Regulatory Developments. On February 8, 2006, President Bush signed the Federal Deposit Insurance Reform Act of 2005 ("FDIRA") into law as part of the Deficit Reduction Act of 2005 and on February 15, 2006, President Bush signed into law the technical and conforming amendments designed to implement FDIRA. FDIRA provides for legislative reforms to modernize the federal deposit insurance system. 73 Among other things, FDIRA: (i) merges the BIF and the SAIF of the FDIC into a new Deposit Insurance Fund (the "DIF"); (ii) allows the FDIC, after March 31, 2010, to increase deposit insurance coverage by an adjustment for inflation and requires the FDIC's Board of Directors, not later than April 1, 2010 and every five years thereafter, to consider whether such an increase is warranted; (iii) increases the deposit insurance limit for certain employee benefit plan deposits from $100,000 to $250,000, subject to adjustments for inflation after March 31, 2010, and provides for pass-through insurance coverage for such deposits; (iv) increases the deposit insurance limit for certain retirement account deposits from $100,000 to $250,000, subject to adjustments for inflation after March 31, 2010; (v) allows the FDIC's Board of Directors to set deposit insurance premium assessments in any amount the Board of Directors deems necessary or appropriate, after taking into account various factors specified in FDIRA; (vi) replaces the fixed designated reserve ratio of 1.25% with a reserve ratio range of 1.15%-1.50%, with the specific reserve ratio to be determined annually by the FDIC by regulation; (vii) permits the FDIC to revise the risk-based assessment system by regulation; (viii) requires the FDIC, at the end of any year in which the reserve ratio of the DIF exceeds 1.50% of estimated insured deposits, to declare a dividend payable to insured depository institutions in an amount equal to 100% of the amount held by the DIF in excess of the amount necessary to maintain the DIF's reserve ratio at 1.5% of estimated insured deposits or to declare a dividend equal to 50% of the amount in excess of the amount necessary to maintain the reserve ratio at 1.35% if the reserve ratio is between 1.35%-1.50% of estimated insured deposits; and (ix) provides a one-time credit based upon the assessment base of the institution on December 31, 1996 to each insured depository institution that was in existence as of December 31, 1996 and paid a deposit insurance assessment prior to that date (or a successor to any such institution). The merger of the BIF and SAIF will take effect no later than July 1, 2006, while the remaining provisions are not effective until the FDIC issues final regulations. FDIRA requires the FDIC to issue final regulations no later than 270 days after enactment: (i) designating a reserve ratio; (ii) implementing increases in deposit insurance coverage; (iii) implementing the dividend requirement; (iv) implementing the one-time assessment credit; and (v) providing for assessments in accordance with FDIRA. Appendix B GUIDE 3 INFORMATION The Following tables and schedules show selected comparative financial information required by the Securities and Exchange Commission Securities Act Guide 3, regarding the business of QCR Holdings, Inc. ("the Company") for the periods shown. Dual presentation of the tables in Items III and IV is provided. The first presentation is comparative financial information for periods as presented in the Company's December 31, 2005 10-K. The second presentation is comparative financial information restated in calendar year periods consistent with the Company's current fiscal year, which was adopted in August 2002. 74 I. Distribution of Assets, Liabilities and Stockholders Equity; Interest Rates and Interest Differential A. and B. Consolidated Average Balance Sheets and Analysis of Net Interest Earnings Years Ended December 31, ---------------------------------------------------------------------------------------- 2005 2004 2003 ---------------------------------------------------------------------------------------- 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 earnings assets: Federal funds sold ..................... $ 6,256 $ 206 3.29% $ 6,619 $ 42 0.63% $ 23,864 $ 221 0.93% Interest-bearing deposits at at financial institutions ............ 3,583 129 3.60 9,030 224 2.48 14,705 432 2.94 Investment securities (1) .............. 159,467 6,224 3.90 130,408 4,933 3.78 92,558 3,995 4.32 Gross loans/leases receivable (2) ..... 682,858 42,427 6.21 587,450 33,112 5.64 480,314 28,984 6.03 ------------------- -------------------- ------------------- Total interest earning assets .... 852,164 48,986 5.75 733,507 38,311 5.22 611,441 33,632 5.50 Noninterest-earning assets: Cash and due from banks ................ $ 29,576 $ 29,891 $ 28,394 Premises and equipment, net ............ 23,016 14,346 9,852 Less allowance for estimated losses on loans/leases ............... (9,048) (9,517) (7,997) Other .................................. 39,198 31,300 18,362 --------- --------- --------- Total assets ...................... $ 934,906 $ 799,527 $ 660,052 ========= ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities: Interest-bearing demand deposits ....... $ 198,359 3,356 1.69% $ 171,552 1,379 0.80% $ 158,287 1,450 0.92% Savings deposits ....................... 22,823 264 1.16 15,553 50 0.32 12,817 58 0.45 Time deposits .......................... 299,673 9,222 3.08 228,563 5,423 2.37 199,328 5,498 2.76 Short-term borrowings .................. 98,089 2,183 2.23 100,944 1,209 1.20 40,122 327 0.82 Federal Home Loan Bank advances ........ 107,927 4,168 3.86 91,912 3,463 3.77 77,669 3,255 4.19 Junior subordinated debentures ......... 23,842 1,587 6.66 23,293 1,641 7.05 12,000 1,134 9.45 Other borrowings ....................... 11,074 501 4.52 5,125 160 3.12 8,071 228 2.82 ------------------- -------------------- ------------------- Total interest-bearing liabilities ....................... 761,787 21,281 2.79 636,942 13,325 2.09 508,294 11,950 2.35 Noninterest-bearing demand ............. 108,116 110,748 102,825 Other noninterest-bearing liabilities .......................... 12,353 7,947 9,720 Total liabilities ...................... 882,256 755,637 620,839 Stockholders' equity ................... 52,650 43,890 39,213 --------- --------- --------- Total liabilities and stockholders' equity .............. $ 934,906 $ 799,527 $ 660,052 ========= ========= ========= Net interest income .................... $ 27,705 $ 24,986 $ 21,682 ======== ========= ======== Net interest spread .................... 2.96% 3.13% 3.15% ====== ====== ====== Net interest margin .................... 3.25% 3.41% 3.55% ====== ====== ====== Ratio of average interest earning assets to average interest- bearing liabilities .................. 111.86% 115.16% 120.29% ======== ======= ========
(1) Interest earned and yields on nontaxable investment securities are determined on a tax equivalent basis using a 34% tax rate in each year presented. (2) Loan/lease fees are not material and are included in interest income from loans/leases receivable. 75 C. Analysis of Changes of Interest Income/Interest Expense For the years ended December 31, 2005, 2004 and 2003 Components Inc./(Dec.) of Change (1) from ------------------- Prior Year Rate Volume --------------------------------- 2005 vs. 2004 --------------------------------- (Dollars in Thousands) INTEREST INCOME Federal funds sold ................................................ $ 164 $ 166 $ (2) Interest-bearing deposits at other financial institutions .......................................... (95) 75 (170) Investment securities (2) ......................................... 1,289 159 1,130 Gross loans/leases receivable (2) (3) ............................. 9,315 3,600 5,715 -------------------------------- Total change in interest income ......................... $ 10,673 $ 4,000 $ 6,673 -------------------------------- INTEREST EXPENSE Interest-bearing demand deposits .................................. $ 1,977 $ 1,732 $ 245 Savings deposits .................................................. 214 182 32 Time deposits ..................................................... 3,799 1,856 1,943 Short-term borrowings ............................................. 974 1,009 (35) Federal Home Loan Bank advances ................................... 705 89 616 Junior subordinated debentures .................................... (54) (92) 38 Other borrowings .................................................. 341 95 246 -------------------------------- Total change in interest expense ............................. $ 7,956 $ 4,871 $ 3,085 -------------------------------- Total change in net interest income ............................... $ 2,717 $ (871) $ 3,588 ================================ Components Inc./(Dec.) of Change (1) from ------------------- Prior Year Rate Volume --------------------------------- 2004 vs. 2003 --------------------------------- (Dollars in Thousands) INTEREST INCOME Federal funds sold ................................................ $ (179) $ (65) $ (114) Interest-bearing deposits at other financial institution ........................................... (208) (60) (148) Investment securities (2) ......................................... 938 (561) 1,499 Gross loans/leases receivable (2) (3) ............................. 4,128 (2,066) 6,194 -------------------------------- Total change in interest income .............................. $ 4,679 $ (2,752) $ 7,431 -------------------------------- INTEREST EXPENSE Interest-bearing demand deposits .................................. $ (71) $ (199) $ 128 Savings deposits .................................................. (8) (19) 11 Time deposits ..................................................... (75) (842) 767 Short-term borrowings ............................................. 882 197 685 Federal Home Loan Bank advances ................................... 208 (358) 566 Junior subordinated debentures .................................... 507 (346) 853 Other borrowings .................................................. (68) 22 (90) -------------------------------- Total change in interest expense ............................. $ 1,375 $ (1,545) $ 2,920 -------------------------------- Total change in net interest income ............................... $ 3,304 $ (1,207) $ 4,511 ================================
(1) The column "increase/decrease 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 are determined on a tax equivalent basis using a 34% tax rate in each year presented. (3) Loan/lease fees are not material and are included in interest income from loans/leases receivable. 76 II. Investment Portfolio A. Investment Securities The following tables present the amortized cost and fair value of investment securities as of December 31, 2005, 2004 and 2003. Gross Amortized Unrealized Unrealized Fair Cost Gains (Losses) Value ----------------------------------------------- (Dollars in Thousands) December 31, 2005 --------------------------------------------------------------- Securities held to maturity: Other bonds ................................................... $ 150 $ 5 $ -- $ 155 ----------------------------------------------- Totals .................................................. $ 150 $ 5 $ -- $ 155 =============================================== Securities available for sale: U.S. Treasury securities ...................................... $ 100 $ -- $ -- $ 100 U.S. gov't.sponsored agency securities .................................................. 150,115 55 (1,630) 148,540 Mortgage-backed securities .................................... 2,720 4 (54) 2,670 Municipal securities .......................................... 18,485 368 (40) 18,813 Corporate securities .......................................... 4,672 72 (2) 4,742 Trust preferred securities .................................... 850 69 -- 919 Other securities .............................................. 6,163 373 (105) 6,431 ----------------------------------------------- Totals ................................................... $ 183,105 $ 941 $ (1,831) $ 182,215 =============================================== December 31, 2004 --------------------------------------------------------------- Securities held to maturity: Other bonds ................................................... $ 100 $ 8 $ -- $ 108 ----------------------------------------------- Totals .................................................. $ 100 $ 8 $ -- $ 108 =============================================== Securities available for sale: U.S. Treasury securities ...................................... $ 100 $ -- $ (1) $ 99 U.S. gov't.sponsored agency securities .................................................. 114,649 368 (392) 114,625 Mortgage-backed securities .................................... 3,864 20 (19) 3,865 Municipal securities .......................................... 15,923 654 (132) 16,445 Corporate securities .......................................... 6,704 230 (9) 6,925 Trust preferred securities .................................... 1,149 94 -- 1,243 Other securities .............................................. 5,995 264 -- 6,259 ----------------------------------------------- Totals ................................................... $ 148,384 $ 1,630 $ (553) $ 149,461 =============================================== December 31, 2003 --------------------------------------------------------------- Securities held to maturity: Municipal securities .......................................... $ 250 $ 4 $ -- $ 254 Other bonds ................................................... 150 13 -- 163 ----------------------------------------------- Totals ................................................... $ 400 $ 17 $ -- $ 417 =============================================== Securities available for sale: U.S. Treasury securities ...................................... $ 1,002 $ 3 $ -- $ 1,005 U.S. gov't.sponsored agency securities .................................................. 86,732 1,105 (64) 87,773 Mortgage-backed securities .................................... 5,656 67 (8) 5,715 Municipal securities .......................................... 15,664 1,018 (1) 16,681 Corporate securities .......................................... 9,466 492 (4) 9,954 Trust preferred securities .................................... 1,350 105 -- 1,455 Other securities .............................................. 5,688 173 (1) 5,860 ----------------------------------------------- Totals .................................................. $ 125,558 $ 2,963 $ (78) $ 128,443 ===============================================
77 B. Investment Securities, Maturities, and Yields The following table presents the maturity of securities held on December 31, 2005 and the weighted average stated coupon rates by range of maturity: Weighted Amortized Average Cost Yield ------------------------ (Dollars in Thousands) U.S. Treasury securities: After 1 but within 5 years ........................ $ 100 4.30% ======================= U.S. Gov't.Sponsored Agency securities: Within 1 year ..................................... $ 46,876 3.65% After 1 but within 5 years ........................ 101,728 4.01% After 5 but within 10 years ....................... 1,511 3.87% ----------------------- Total ..................................... $150,115 3.89% ======================= Mortgage-backed securities: After 1 but within 5 years ........................ 2,294 3.99% After 5 but within 10 years ....................... 426 5.94% ----------------------- Total ..................................... $ 2,720 4.30% ======================= Municipal securities: Within 1 year ..................................... $ 703 6.10% After 1 but within 5 years ........................ 7,310 5.33% After 5 but within 10 years ....................... 8,673 6.86% After 10 years .................................... 1,799 4.93% ----------------------- Total ..................................... $ 18,485 6.03% ======================= Corporate securities: Within 1 year ..................................... $ 2,303 5.29% After 1 but within 5 years ........................ 2,369 6.14% ----------------------- Total ..................................... $ 4,672 5.72% ======================= Trust preferred securities: After 10 years .................................... $ 850 1.90% ======================= Other bonds: After 1 but within 5 years ........................ 100 5.00% After 5 but within 10 years ....................... 50 6.55% ----------------------- Total ..................................... $ 150 5.52% ======================= Other securities with no maturity or stated face rate ......................................... $ 6,163 ========
78 B. Investment Securities, Maturities, and Yields The following table presents the maturity of securities held on December 31, 2004 and the weighted average stated coupon rates by range of maturity: Weighted Amortized Average Cost Yield ------------------------ (Dollars in Thousands) U.S. Treasury securities: Within 1 year ..................................... $ 100 1.66% ======================= U.S. Gov't.Sponsored Agency securities: Within 1 year ..................................... $ 13,995 2.91% After 1 but within 5 years ........................ 95,590 3.36% After 5 but within 10 years ....................... 5,064 4.65% ----------------------- Total ..................................... $114,649 3.36% ======================= Mortgage-backed securities: Within 1 year ..................................... $ 33 5.09% After 1 but within 5 years ........................ 1,722 3.88% After 5 but within 10 years ....................... 2,109 4.37% ----------------------- Total ..................................... $ 3,864 4.16% ======================= Municipal securities: Within 1 year ..................................... $ 580 6.84% After 1 but within 5 years ........................ 6,081 5.57% After 5 but within 10 years ....................... 6,857 7.13% After 10 years .................................... 2,405 7.84% ----------------------- Total ..................................... $ 15,923 6.63% ======================= Corporate securities: Within 1 year ..................................... $ 2,001 4.29% After 1 but within 5 years ........................ 4,703 5.66% ----------------------- Total ..................................... $ 6,704 5.25% ======================= Trust preferred securities: After 10 years .................................... $ 1,149 8.81% ======================= Other bonds: After 1 but within 5 years ........................ 50 5.30% After 5 but within 10 years ....................... 50 6.55% ----------------------- Total ..................................... $ 100 5.93% ======================= Other securities with no maturity or stated face rate .................................. $ 5,995 ========
C. Investment Concentrations At December 31, 2005 and 2004, there were no securities in the investment portfolio above (other than U.S. Government, U.S. Government agencies, and corporations) that exceeded 10% of the stockholders' equity. 79 III. Loan/Lease Portfolio A. Types of Loans/Leases The composition of the loan/lease portfolio is presented as follows: December 31, June 30, -------------------------------------------------- ------------------------ 2005 2004 2003 2002 2002 2001 -------------------------------------------------- ------------------------ (Dollars in Thousands) Commercial and commercial real estate loans ................................ $ 593,462 $ 532,517 $ 435,345 $ 350,206 $ 305,019 $ 209,933 Direct financing leases ....................... 34,911 -- -- -- -- -- Real estate loans held for sale - residential mortgage ........................ 2,632 3,499 3,790 23,691 8,498 5,824 Real estate loans - residential mortgage ...... 54,125 52,423 29,604 28,761 34,034 32,191 Real estate loans - construction .............. 2,811 3,608 2,254 2,230 2,861 2,568 Installment and other consumer loans .......... 67,090 55,736 50,984 44,567 40,037 37,362 -------------------------------------------------------------------------- Total loans/leases ............ 755,031 647,783 521,977 449,455 390,449 287,878 Deferred loan/lease origination costs (fees), net ................................. 1,223 568 494 281 145 (13) Less allowance for estimated losses on loans/leases ...................... (8,884) (9,262) (8,643) (6,879) (6,111) (4,248) -------------------------------------------------------------------------- Net loans/leases .............. $ 747,370 $ 639,089 $ 513,828 $ 442,857 $ 384,483 $ 283,617 =========================================================================== Direct financing leases: Net minimum lease payments to be received ... 35,447 -- -- -- -- -- Estimated residual values of leased assets .. 7,633 -- -- -- -- -- Unearned lease/residual income .............. (7,661) -- -- -- -- -- Fair value adjustment at acquisition ........ (508) -- -- -- -- -- -------------------------------------------------------------------------- Total leases .................. $ 34,911 $ -- $ -- $ -- $ -- $ -- =========================================================================== December 31, June 30, -------------------------------------------------- ------------------------ 2005 2004 2003 2002 2002 2001 -------------------------------------------------- ------------------------ (Dollars in Thousands) Commercial and commercial real estate loans ................................ $ 593,462 $ 532,517 $ 435,345 $ 350,206 $ 255,486 $ 186,952 Direct financing leases ....................... 34,911 -- -- -- -- -- Real estate loans held for sale - residential mortgage ........................ 2,632 3,499 3,790 23,691 13,470 1,627 Real estate loans - residential mortgage ...... 54,125 52,423 29,604 28,761 30,457 37,388 Real estate loans - construction .............. 2,811 3,608 2,254 2,230 3,399 2,117 Installment and other consumer loans .......... 67,090 55,736 50,984 44,567 40,103 37,434 -------------------------------------------------------------------------- Total loans/leases ............ 755,031 647,783 521,977 449,455 342,915 265,518 Deferred loan/lease origination costs (fees), net ................................. 1,223 568 494 281 84 100 Less allowance for estimated losses on loans/leases ...................... (8,884) (9,262) (8,643) (6,879) (4,939) (3,972) -------------------------------------------------------------------------- Net loans/leases .............. $ 747,370 $ 639,089 $ 513,828 $ 442,857 $ 338,060 $ 261,646 =========================================================================== Direct financing leases: Net minimum lease payments to be received ... 35,447 -- -- -- -- -- Estimated residual values of leased assets .. 7,633 -- -- -- -- -- Unearned lease/residual income .............. (7,661) -- -- -- -- -- Fair value adjustment at acquisition ........ (508) -- -- -- -- -- -------------------------------------------------------------------------- Total leases .................. $ 34,911 $ -- $ -- $ -- $ -- $ -- ===========================================================================
80 III. Loan/Lease Portfolio B. Maturities and Sensitivities of Loans/Leases to Changes in Interest Rates Maturities After One Year ------------------------------ At December 31, 2005 Due in one Due after one Due after Predetermined Adjustable year or less through 5 years 5 years interest rates interest rates --------------------------------------------------------------------------- (Dollars in Thousands) Commercial and commercial real estate loans ................................... $ 184,853 $ 324,872 $ 83,737 $ 305,137 $ 103,472 Direct financing leases ................... 1,122 22,789 11,000 33,789 -- Real estate loans held for sale - residential mortgage .... -- -- 2,632 2,632 -- Real estate loans - residential mortgage .................. 909 531 52,685 6,855 46,361 Real estate loans - construction .......... 2,811 -- -- -- -- Installment and other consumer loans ...... 21,997 43,643 1,450 30,245 14,848 ------------------------------------------------------------------------- Total loans/leases ........ $ 211,692 $ 391,835 $ 151,504 $ 378,658 $ 164,681 ======================================================================== Maturities After One Year ------------------------------ At December 31, 2004 Due in one Due after one Due after Predetermined Adjustable year or less through 5 years 5 years interest rates interest rates --------------------------------------------------------------------------- (Dollars in Thousands) Commercial and commercial real estate loans ................................... $ 167,946 $ 309,430 $ 55,141 $ 250,590 $ 113,981 Direct financing leases ................... -- -- -- -- -- Real estate loans held for sale - residential mortgage .................... -- -- 3,499 3,471 28 Real estate loans - residential mortgage ................................ 1,042 231 51,150 4,568 46,813 Real estate loans - construction .......... 3,527 81 -- 81 -- Installment and other consumer loans ...... 13,760 40,334 1,642 28,638 13,338 ------------------------------------------------------------------------- Total loans/leases ........ $ 186,275 $ 350,076 $ 111,432 $ 287,348 $ 174,160 ========================================================================
81 III. Loan/Lease Portfolio C. Risk Elements 1. Nonaccrual, Past Due and Restructured Loans/Leases The following tables represent Nonaccrual, Past Due, Renegotiated Loans/Leases, and other Real Estate Owned: December 31, June 30, --------------------------------------------------------- 2005 2004 2003 2002 2002 2001 --------------------------------------------------------- (Dollars in Thousands) Loans/leases accounted for on nonaccrual basis ............ $ 2,579 $ 7,608 $ 4,204 $ 4,608 $ 1,560 $ 1,232 Accruing loans/leases past due 90 days or more ............ 604 1,133 756 431 708 495 Other real estate owned ................................... 545 1,925 -- -- -- 47 Troubled debt restructurings .............................. -- -- -- -- -- -- --------------------------------------------------------- Totals .................................... $ 3,728 $10,666 $ 4,960 $ 5,039 $ 2,268 $ 1,774 ========================================================= December 31, --------------------------------------------------------- 2005 2004 2003 2002 2001 2000 --------------------------------------------------------- (Dollars in Thousands) Loans/leases accounted for on nonaccrual basis ............ $ 2,579 $ 7,608 $ 4,204 $ 4,608 $ 1,846 $ 655 Accruing loans/leases past due 90 days or more ............ 604 1,133 756 431 1,765 1,197 Other real estate owned ................................... 545 1,925 -- -- 47 -- Troubled debt restructurings .............................. -- -- -- -- -- -- --------------------------------------------------------- Totals .................................... $ 3,728 $10,666 $ 4,960 $ 5,039 $ 3,658 $ 1,852 =========================================================
The policy of the company is to place a loan/lease on nonaccrual status if: (a) payment in full of interest or principal is not expected, or (b) principal or interest has been in default for a period of 90 days or more unless the obligation is both in the process of collection and well secured. Well secured is defined as collateral with sufficient market value to repay principal and all accrued interest. A debt is in the process of collection if collection of the debt is proceeding in due course either through legal action, including judgment enforcement procedures, or in appropriate circumstances, through collection efforts not involving legal action which are reasonably expected to result in repayment of the debt or in restoration to current status. 2. Potential Problem Loans/Leases. To management's best knowledge, there are no such significant loans/leases that have not been disclosed in the above table. 3. Foreign Outstandings. None. 4. Loan/Lease Concentrations. At December 31, 2005, there were no concentrations of loans/leases exceeding 10% of the total loans/leases which are not otherwise disclosed in Item III. A. D. Other Interest-Bearing Assets There are no interest-bearing assets required to be disclosed here. 82 IV. Summary of Loan/Lease Loss Experience A. Analysis of the Allowance for Estimated Losses on Loans/Leases The following tables summarize activity in the allowance for estimated losses on loans/leases of the Company: Six months Years ended ended Years ended December 31, December 31, June 30, -------------------------------------------------------------------------------- 2005 2004 2003 2002 2002 2001 -------------------------------------------------------------------------------- (Dollars in Thousands) Average amount of loans/leases outstanding, before allowance for estimated losses on loans/leases ................................ $ 682,858 $ 587,450 $ 480,314 $ 419,104 $ 334,205 $ 265,350 Allowance for estimated losses on loans/ leases: Balance, beginning of fiscal period .............. 9,262 8,643 6,879 6,111 4,248 3,617 Charge-offs: Commercial ................................... (1,530) (624) (1,777) (1,349) (437) (87) Real Estate .................................. (160) (49) -- -- -- -- Installment and other consumer ............... (356) (292) (298) (105) (204) (213) -------------------------------------------------------------------------------- Subtotal charge-offs .................. (2,046) (965) (2,075) (1,454) (641) (300) -------------------------------------------------------------------------------- Recoveries: Commercial ................................... 245 137 192 -- 101 2 Real Estate .................................. 25 -- -- -- -- -- Installment and other consumer ............... 87 75 242 38 138 39 -------------------------------------------------------------------------------- Subtotal recoveries ................... 357 212 434 38 239 41 -------------------------------------------------------------------------------- Net charge-offs ....................... (1,689) (753) (1,641) (1,416) (402) (259) Provision charged to expense ..................... 877 1,372 3,405 2,184 2,265 890 Acquisition of M2 Lease Funds, LLC ............... 434 -- -- -- -- -- -------------------------------------------------------------------------------- Balance, end of fiscal year ...................... $ 8,884 $ 9,262 $ 8,643 $ 6,879 $ 6,111 $ 4,248 ================================================================================ Ratio of net charge-offs to average loans/ leases outstanding ............................. 0.25% 0.13% 0.34% 0.34% 0.12% 0.10% Years ended December 31, -------------------------------------------------------------------------------- 2005 2004 2003 2002 2001 2000 -------------------------------------------------------------------------------- (Dollars in Thousands) Average amount of loans/leases outstanding, before allowance for estimated losses on loans/leases ................................ $ 682,858 $ 587,450 $ 480,314 $ 387,936 $ 294,708 $ 237,947 Allowance for estimated losses on loans/ leases: Balance, beginning of fiscal period .............. 9,262 8,643 6,879 4,939 3,972 3,341 Charge-offs: Commercial ................................... (1,530) (624) (1,777) (1,455) (332) (87) Real Estate .................................. (160) (49) -- -- -- -- Installment and other consumer ............... (356) (292) (298) (214) (205) (355) -------------------------------------------------------------------------------- Subtotal charge-offs .................. (2,046) (965) (2,075) (1,669) (537) (442) -------------------------------------------------------------------------------- Recoveries: Commercial ................................... 245 137 192 73 29 2 Real Estate .................................. 25 -- -- -- -- -- Installment and other consumer ............... 87 75 242 126 66 71 -------------------------------------------------------------------------------- Subtotal recoveries ................... 357 212 434 199 95 73 -------------------------------------------------------------------------------- Net charge-offs ....................... (1,689) (753) (1,641) (1,470) (442) (369) Provision charged to expense ..................... 877 1,372 3,405 3,410 1,409 1,000 Acquisition of M2 Lease Funds, LLC ............... 434 -- -- -- -- -- -------------------------------------------------------------------------------- Balance, end of fiscal year ...................... $ 8,884 $ 9,262 $ 8,643 $ 6,879 $ 4,939 $ 3,972 ================================================================================ Ratio of net charge-offs to average loans/leases outstanding ....................... 0.25% 0.13% 0.34% 0.38% 0.15% 0.16%
83 B. Allocation of the Allowance for Estimated Losses on Loans/Leases The following tables present the allowance for the estimated losses on loans/leases by type of loans/leases and the percentage of loans/leases in each category to total loans/leases: December 31, 2005 December 31, 2004 December 31, 2003 -------------------------------------------------------------------- % of % of % of Loans to Loans to Loans to Amount Total Loans Amount Total Loans Amount Total Loans -------------------------------------------------------------------- (Dollars in Thousands) Commercial and commercial real estate loans ............... $7,331 78.60% $8,423 82.21% $7,676 83.40% Direct financing leases ................................... 546 4.62% -- --% -- --% Real estate loans held for sale - residential mortgage ................................................ 16 0.35% 17 0.54% 4 0.73% Real estate loans - residential mortgage .................. 250 7.17% 205 8.09% 272 5.67% Real estate loans - construction .......................... 12 0.37% 21 0.56% 11 0.43% Installment and other consumer loans ...................... 725 8.89% 591 8.60% 678 9.77% Unallocated ............................................... 4 NA 5 NA 2 NA -------------------------------------------------------------------- Total ........................................ $8,884 100.00% $9,262 100.00% $8,643 100.00% ==================================================================== December 31, 2002 June 30, 2002 June 30, 2001 -------------------------------------------------------------------- % of % of % of Loans to Loans to Loans to Amount Total Loans Amount Total Loans Amount Total Loans -------------------------------------------------------------------- (Dollars in Thousands) Commercial and commercial real estate loans ............... $6,176 77.91% $5,240 78.12% $3,231 72.92% Direct financing leases ................................... -- --% -- --% -- --% Real estate loans held for sale - residential mortgage ................................................ 24 5.27% 1 2.18% -- 2.02% Real estate loans - residential mortgage .................. 159 6.40% 302 8.72% 182 11.18% Real estate loans - construction .......................... 11 0.50% 14 0.73% -- 0.89% Installment and other consumer loans ...................... 507 9.92% 554 10.25% 835 12.99% Unallocated ............................................... 2 NA -- NA -- NA -------------------------------------------------------------------- Total ........................................ $6,879 100.00% $6,111 100.00% $4,248 100.00% ==================================================================== December 31, 2005 December 31, 2004 December 31, 2003 --------------------------------------------------------------------- % of Loans/ % of Loans % of Loans Leases to Total Leases to Total Leases to Total Amount Loans/Leases Amount Loans/Leases Amount Loans/Leases --------------------------------------------------------------------- Commercial and commercial real estate loans ............... $7,331 78.60% $8,423 82.21% $7,676 83.40% Direct financing leases ................................... 546 4.62% -- --% -- --% Real estate loans held for sale - residential mortgage ................................................ 16 0.35% 17 0.54% 4 0.73% Real estate loans - residential mortgage .................. 250 7.17% 205 8.09% 272 5.67% Real estate loans - construction .......................... 12 0.37% 21 0.56% 11 0.43% Installment and other consumer loans ...................... 725 8.89% 591 8.60% 678 9.77% Unallocated ............................................... 4 NA 5 NA 2 NA ------------------------------------------------------------------- Total ........................................ $8,884 100.00% $9,262 100.00% $8,643 100.00% ==================================================================== December 31, 2002 December 31, 2001 December 31, 2000 -------------------------------------------------------------------- % of % of % of Loans to Loans to Loans to Amount Total Loans Amount Total Loans Amount Total Loans ------------------------------------------------------------------- (Dollars in Thousands) Commercial and commercial real estate loans ............... $6,176 77.91% $4,305 74.50% $3,339 70.41% Direct financing leases ................................... -- --% -- --% -- 0.00% Real estate loans held for sale - residential mortgage ................................................ 24 5.27% 14 3.93% 2 0.61% Real estate loans - residential mortgage .................. 159 6.40% 140 8.88% 183 14.08% Real estate loans - construction .......................... 11 0.50% 17 0.99% 11 0.80% Installment and other consumer loans ...................... 507 9.92% 461 11.70% 437 14.10% Unallocated ............................................... 2 NA 2 NA -- NA -------------------------------------------------------------------- Total ........................................ $6,879 100.00% $4,939 100.00% $3,972 100.00% ====================================================================
84 V. Deposits. The average amount of and average rate paid for the categories of deposits for the years ended December 31, 2005, 2004, and 2003 are discussed in the consolidated average balance sheets and can be found on pages 2 and 3 of Appendix B. Included in interest bearing deposits at December 31, 2005, 2004 and 2003 were certificates of deposit totaling $170,994,735 $165,685,917, and $73,799,534 respectively, that were $100,000 or greater. Maturities of these certificates were as follows: December 31, --------------------------------------- 2005 2004 2003 --------------------------------------- (Dollars in Thousands) One to three months $ 52,276 $ 39,352 $ 28,120 Three to six months 55,123 60,456 21,176 Six to twelve months 35,580 40,699 17,600 Over twelve months 28,016 25,179 6,904 --------------------------------------- Total certificates of deposit greater than $100,000 $ 170,995 $ 165,686 $ 73,800 ======================================= VI. Return on Equity and Assets. The following tables present the return on assets and equity and the equity to assets ratio of the Company: Years ended December 31, --------------------------------------- 2005 2004 2003 --------------------------------------- (Dollars in Thousands) Average total assets $ 934,906 $ 799,527 $ 660,052 Average equity 52,650 43,890 39,213 Net income 4,810 5,217 5,461 Return on average assets 0.51% 0.65% 0.83% Return on average equity 9.14% 11.89% 13.93% Dividend payout ratio 7.55% 6.50% 5.34% Average equity to average assets ratio 5.63% 5.49% 5.94% VII. Short Term Borrowings. The information requested is disclosed in Note 8 to the December 31, 2005 Consolidated Financial Statements. 85