-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Vof+0aYhVISvXRUqr0yAgakJ6Gre6EuWiCNmrXm1dYZ/Sxkd1dbKJKSxhnYIHldQ nUH9dLlVVf9IRwnKoqD0NA== 0000743530-99-000038.txt : 19990916 0000743530-99-000038.hdr.sgml : 19990916 ACCESSION NUMBER: 0000743530-99-000038 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19990630 FILED AS OF DATE: 19990915 FILER: COMPANY DATA: COMPANY CONFORMED NAME: QUAD CITY HOLDINGS INC CENTRAL INDEX KEY: 0000906465 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 421397595 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-15021 FILM NUMBER: 99711735 BUSINESS ADDRESS: STREET 1: 3551 7TH STREET CITY: MOLINE STATE: IL ZIP: 61265 BUSINESS PHONE: 3097363580 10-K 1 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 JUNE 30, 1999 Commission file number: 0-22208 QUAD CITY 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 100, 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 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. [ x ] The aggregate market value of the voting common stock held by non-affiliates as of August 25, 1999 was approximately $38,202,000. As of August 25, 1999, the issuer had 2,296,251 shares of Common Stock issued and outstanding. Documents incorporated by reference: ------------------------------------------------------------- Part III of Form 10-K - Proxy statement for annual meeting of stockholders to be held in 1999. Part I Item 1. Business Quad City Holdings, Inc. ("Quad City") was formed in February of 1993 under the laws of the state of Delaware for the purpose of becoming the bank holding company of Quad City Bank and Trust Company (the "Bank"). The Bank was capitalized on October 13, 1993 and commenced operations on January 7, 1994. The Bank is organized as an Iowa-chartered commercial bank that is a member of the Federal Reserve System with depository accounts insured by the Federal Deposit Insurance Corporation. The Bank provides full-service commercial and consumer banking, and trust and asset management services in the Quad City area through its three offices that are located in Bettendorf and Davenport, Iowa and in Moline, Illinois. Quad City Bancard, Inc. ("Bancard") was capitalized on April 3, 1995, as a Delaware corporation that provides merchant credit card processing services. This operation had previously been a division of the Bank since July 1994. Currently, approximately 15,000 merchants process transactions with Bancard. Quad City Holdings Capital Trust I ("Capital Trust") was formed in April, 1999 and capitalized in June, 1999 in connection with the public offering of $12 million of 9.2% trust preferred capital securities due June 30, 2029. Quad City owns 100% of the Bank and Bancard and 100% of the common securities of Capital Trust, and in addition to such ownership invests its capital in stocks of financial institutions and mutual funds, as well as participates in loans with the Bank. The Bank operates in a highly competitive environment in the Quad Cities area. Competitors include not only other commercial banks, credit unions, savings banks, savings and loan 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 Quad City. Many of these unregulated competitors compete across geographic boundaries and provide customers increasing access to meaningful alternatives to banking services. These competitive trends are likely to continue. Additionally, Quad City competes in a market with a number of much larger financial institutions with substantially greater resources and larger lending limits. The Board of Governors of the Federal Reserve System (the "Federal Reserve Board") regulates Quad City and its subsidiaries. In addition, the Bank is regulated by the Iowa Superintendent of Banking (the "Iowa Superintendent") and the Federal Deposit Insurance Corporation (the "FDIC"). Quad City's principal business consists of attracting deposits from the public and investing those deposits in loans and securities. The deposits of the Bank are insured to the maximum amount allowable by the FDIC. Quad City'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. It's operating results are affected by merchant credit card fees, trust fees, deposit service charge fees, fees from the sales 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 and other administrative expenses. Quad City's operating results are also affected by economic and competitive conditions, particularly changes in interest rates, government policies and actions of regulatory authorities. The commercial banking business is a highly regulated business. See Appendix A for a brief summary regarding federal and state statutes and regulations, which are applicable to Quad City 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. Quad City, the Bank and Bancard have a June 30th fiscal year end and employ 140 individuals. No one customer accounts for more than 10% of revenues, loans or deposits. See Appendix B for tables and schedules that show selected comparative statistical information required pursuant to the industry guides promulgated under the Securities Act of 1933 and 1934, relating to the business of Quad City. Item 2. Property The main office of the Bank is in a 6,700 square foot facility, which was completed in January of 1994. In March of 1994, the Bank acquired that facility, which is located at 2118 Middle Road in Bettendorf. Construction of a second full service banking facility was completed in July of 1996 to provide for the convenience of customers and to expand its market territory. The Bank also owns its portion of that facility which is located at 4500 Brady Street in Davenport. The two-story building is in two segments that are separated by an atrium. The Bank owns the south half of the building, while the northern portion is owned by the developer. Each floor is 6,000 square feet. The Bank occupies its first floor and utilizes the basement for operational functions, item processing and storage. The entire second floor has been leased to two professional services firms. In addition, the residential real estate department of the Bank leases approximately 2,500 square feet on the first floor in the north half of the building. Renovation of a third full service banking facility was completed in February of 1998 at the historic Velie Plantation Mansion, 3551 Seventh Street, located near the intersection of 7th Street and John Deere Road in Moline near the Rock Island/Moline border. The building is owned by a third party limited liability company and the Bank and Bancard are its major tenants. Quad City has purchased a 20% interest in the company that owns the building. Bancard relocated its operations to the lower level of the 30,000 square foot building in late 1997. The Bank began its operations and Quad City relocated its corporate headquarters to the first floor of the building on February 17, 1998. The business office of a medical clinic is sub-leasing approximately 3,500 square feet on the first floor. In March, 1999, the Bank acquired a 3,000 square foot office building adjacent to the Davenport facility at a cost of $225,000. It is expected that improvements will be made at a cost of approximately $60,000. The office space will be utilized for various operational and administrative functions. Management is of the opinion that the facilities are of sound construction, in good operating condition, are appropriately insured and are adequately equipped for carrying on the business of Quad City. The Bank intends to limit its investment in premises to no more than 50% of Bank capital. The Bank frequently invests in commercial real estate mortgages. The Bank also invests in residential mortgages. The Bank has 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 credit worthiness of the borrower. No individual real estate property or mortgage amounts to 10% or more of consolidated assets. Item 3. Legal Proceedings Quad City is not aware of any legal proceedings against it or its subsidiaries. Item 4. Submission of Matters to a Vote of Security Holders There were no matters submitted to the stockholders of Quad City for a vote during the fourth quarter of the fiscal year ended June 30, 1999. Part II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters The common stock, par value $1.00 per share ("Common Stock") of Quad City is traded on The Nasdaq SmallCap Market under the symbol "QCHI". The stock began trading on October 6, 1993. As of June 30, 1999, there were 2,296,251 shares of Common Stock outstanding held by approximately 2,500 holders of record. The following table sets forth the high and low sales prices of the Common Stock, as reported by The Nasdaq SmallCap Market, for the periods indicated. The prices set forth below have been adjusted to reflect the three-for-two stock split effected in the form of a stock dividend paid on November 30, 1998. A total of 760,262 shares of Common Stock were issued. No cash dividends were declared during the periods indicated. Fiscal 1999 Fiscal 1998 sales price sales price ----------------- ----------------- High Low High Low ----------------- ----------------- First quarter .......... $21.750 $18.000 $14.750 $13.500 Second quarter ......... 25.500 17.333 19.333 14.167 Third quarter .......... 23.500 19.125 25.833 17.250 Fourth quarter ......... 20.500 16.125 22.000 19.333 Quad City expects that all earnings will be retained to finance the growth of Quad City, the Bank and Bancard, and that no cash dividends will be paid in the near future. If and when dividends are declared, Quad City will probably be largely dependent upon dividends from the Bank and Bancard for funds to pay dividends on the common stock. Under Iowa law, the Bank will be restricted as to the maximum amount of dividends it may pay on its common stock. The Iowa Banking Act provides that an Iowa bank may not pay dividends in an amount greater than its undivided profits. The Bank is a member of the Federal Reserve System. The total of all dividends declared by the Bank in a calendar year may not exceed the total of its net profits of that year combined with its retained net profits of the preceding two years. In addition, the Federal Reserve Board, the Iowa Superintendent and the FDIC are authorized under certain circumstances to prohibit the payment of dividends by the Bank. In the case of Quad City, further restrictions on dividends may be imposed by the Federal Reserve Board. Item 6. Selected Financial Data The "Selected Consolidated Financial Data" of Quad City set forth below 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 and Supplementary Data." Results for past periods are not necessarily indicative of results to be expected for any future period. SELECTED CONSOLIDATED FINANCIAL DATA Years Ended June 30, --------------------------------------------------- 1999 1998 1997 1996 1995 --------------------------------------------------- (Dollars in thousands) Statement of Income Data: Interest income ....................... $ 20,116 $ 15,077 $ 9,706 $ 6,529 $ 3,550 Interest expense ...................... 11,027 8,342 4,994 3,486 1,896 Net interest income ................... 9,089 6,735 4,712 3,043 1,654 Provision for loan losses ............. 892 902 844 500 283 Noninterest income (1) ................ 5,561 6,148 2,807 1,716 548 Noninterest expenses .................. 9,679 7,910 5,291 3,576 2,293 Pre-tax net income (loss) ............. 4,079 4,071 1,384 683 (374) Income tax expense .................... 1,614 1,678 165 0 0 Net income (loss) ..................... 2,465 2,393 1,219 683 (374) Balance Sheet: Total assets .......................... $321,346 250,151 $168,379 $111,475 $ 80,800 Securities ............................ 51,666 34,619 31,812 34,189 26,051 Loans ................................. 197,977 162,975 108,365 56,810 31,508 Allowance for estimated losses on loans 2,895 2,350 1,633 853 472 Deposits .............................. 247,966 197,384 135,960 92,918 61,098 Stockholders' equity: Common ........................... 18,473 16,602 13,613 11,669 11,590 Preferred ........................ 0 2,500 1,000 0 0 Key Ratios: Return on average assets .............. 0.86% 1.14% 0.86% 0.70% (0.65)% Return on average common equity ....... 13.69 16.40 9.85 5.82 (3.26) Net interest margin ................... 3.42 3.55 3.74 3.47 3.15 Efficiency ratio (2) .................. 66.07 61.40 70.37 75.14 104.13 Nonperforming assets to total assets .. 0.51 0.51 0.27 0.28 0.00 Allowance for estimated losses on loans to total loans ...................... 1.46 1.44 1.51 1.50 1.50 Net charge-offs to average loans ...... 0.26 0.13 0.08 0.27 0.01 Average common stockholders' equity to average assets ................... 6.26 6.97 8.73 12.10 19.89 Average stockholders' equity to average assets ................... 7.05 7.97 9.15 12.10 19.89 Earnings to fixed charges (3) Excluding interest on deposits (4) 2.81 x 3.78 x 3.17 x 5.71 x N/A Including interest on deposits (4) 1.36 1.48 1.28 1.20 N/A - ------------------------------------------------------------------- (1) Year ended June 30, 1998 noninterest income includes a pre-tax gain of $2,168 from Bancard's restructuring of an agreement with an independent sales organization (ISO). Year ended June 30, 1999 noninterest income includes amortization of $732 from Bancard's restructuring of an ISO agreement. (2) Noninterest expenses divided by the sum of net interest income before provision for loan losses and noninterest income. (3) Dividends were not payable on Quad City's Series A Preferred Stock, and all the outstanding balance was redeemed in June 1999. (4) Earnings were inadequate to cover fixed charges in the amount of $374 for the year ended June 30, 1995.
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 fiscal years ended June 30, 1999, 1998 and 1997, and financial condition for the fiscal years ended June 30, 1999 and 1998. 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 Quad City was formed in February 1993 for the purpose of organizing the Bank. The Bank opened in January 1994 with $4.5 million in assets and grew to approximately $321.3 million as of June 30, 1999. Management expects continued opportunities for growth, even though the rate of growth will probably be slower than that experienced to date. Quad City reported earnings of $2.5 million or $1.08 basic earnings per share for fiscal 1999 as compared to $2.4 million and $1.09 per share for fiscal 1998 and $1.2 million and $0.56 per share for fiscal 1999. The slight improvement in fiscal 1999 from fiscal 1998 was attributable to increased net interest income and increased volumes of business for the Bank, reduced by a decrease in noninterest income. The decrease in noninterest income was primarily due to the one time gain in fiscal 1998 resulting from the restructuring of Bancard's merchant broker agreement. The 95% improvement in fiscal 1998 from fiscal 1997 was also attributable to increase net interest income and increased volumes of business for the Bank, as well as the one time gain resulting from the restructuring of Bancard's merchant broker agreement. Quad City'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. Quad City's operating results are also affected by sources of non-interest income, including merchant credit card fees, trust fees, deposit service charge fees, fees from the sales of residential real estate loans and other income. Operating expenses of Quad City include employee compensation and benefits, occupancy and equipment expense and other administrative expenses. Quad City'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 Bank's loan portfolio is invested in commercial loans. Deposits from commercial customers represent a significant funding source as well. The Bank has added facilities and employees to accommodate both its historical growth and anticipated future growth. As such, overhead expenses have had a significant impact on earnings. The primary challenge for the Bank currently, from a profitability standpoint, is to increase its net interest margin. Large commercial depositors create a relatively high cost of funds and this fact, along with a very competitive loan rate environment, have resulted in the Bank's interest margin being below its peer group. Management is addressing this issue with alternative funding sources and pricing strategies. During 1994, the Bank began to develop internally a merchant credit card processing operation and in 1995 transferred this activity to Bancard, a separate subsidiary of Quad City. Bancard initially had an arrangement to provide processing services exclusively to clients of a single ISO. This ISO was sold in 1998 and the purchaser requested a reduction in the term of the contract. Bancard agreed to amend the contract to reduce the term and accept a fixed monthly processing fee of $25,000 for merchants existing at the time the agreement was signed and a lower transaction fee for new merchants in exchange for a payment of $2.9 million, the ability to transact business with other ISOs and the assumption of the credit risk by the ISO. Approximately two thirds of the income from this settlement, or $2.2 million, was reported in fiscal 1998, with the remainder of $732,000 being recognized as an adjustment to the fixed processing fee during fiscal 1999. Bancard's net income was $565,000 in fiscal 1999 compared to $1.3 million in fiscal 1998. Bancard expects its merchant credit card fee income to remain below previous levels until such time as Bancard can develop relationships with additional ISOs or Allied Merchant Services, Inc., Bancard's newly formed independent sales organization, can generate processing business revenues comparable to those Bancard experienced prior to amendment of its ISO contract. This reduction in processing fees and cessation of the settlement income at Bancard is expected to adversely affect comparisons of consolidated net income in fiscal 2000 with fiscal 1999. During fiscal 1998, the Bank expanded its presence in the mortgage banking market by hiring several experienced loan originators and an experienced underwriter. The Bank originates mortgage loans on personal residences and sells the majority of these loans into the secondary market to avoid the interest rate risk associated with long term fixed rate financing. The Bank realizes revenue from this mortgage banking activity from a combination of loan origination fees and gain on sale of the loans in the secondary market. During fiscal 1999, the Bank originated $85.0 million of real estate loans and sold $87.8 million of loans, which resulted in gains of $1.0 million. In fiscal 1998 and 1997, the Bank originated $57.2 million and $6.9 million of real estate loans and sold $53.3 million and $6.0 million of loans, which resulted in gains of $713,000 and $44,000, respectively. Mortgage banking operations have benefited from significant refinancing activity as a result of the relatively low interest rate environment in which it has been operating. Trust department income has become a significant contributor to noninterest income, growing from approximately $736,000 in fiscal 1997 to $1,521,000 in fiscal 1999. Income is generated primarily from fees charged based on assets under management for corporate and personal trusts and for custodial services. Assets under administration have grown from $213.5 at June 30, 1997 to $506.8 million at June 30, 1999. Growth in the current fiscal year resulted primarily from the establishment of a custodial relationship with a large pension fund. Quad City's initial public offering during the fourth calendar quarter of 1993 raised approximately $14 million. In order to provide additional capital to support the growth of the Bank, Quad City formed a statutory business trust to issue $12 million of capital securities to the public for cash. On June 9, 1999, the Company received all the proceeds from the sale of the public offering. Approximately $1.0 of the proceeds were used to pay expenses related to the offering, approximately $2.5 million were used to repay the outstanding balance on a revolving credit note and approximately $3.0 million was used to redeem all outstanding preferred stock, including the redemption premium. Results of Operations Fiscal 1999 compared with fiscal 1998 Overview. Net income for the year ended June 30, 1999 was $2.5 million as compared to net income of $2.4 million for the same period in 1998 for a slight increase of $72,000 or 3%. Basic earnings per share for fiscal 1999 were $1.08 as compared to $1.09 for fiscal 1998. The increase in net income was comprised of an increase in net interest income after provision for loan losses of $2.4 million reduced by a decrease in noninterest income of $588,000 and an increase in noninterest expenses of $1.8 million. The decrease in noninterest income was primarily due to the one time gain in fiscal 1998 resulting from the restructuring of Bancard's merchant broker agreement. Interest income. Interest income increased by $5.0 million, from $15.1 million for fiscal 1998 to $20.1 million for fiscal 1999. The 33% rise in interest income was basically attributable to greater average outstanding balances in interest earning assets, principally loans receivable. Interest expense. Interest expense increased by $2.7 million, from $8.3 million for fiscal 1998 to $11.0 million for fiscal 1999. The 32% increase in interest expense was primarily attributable to greater average outstanding balances in interest bearing liabilities. Provision for loan losses. The provision for loan losses is established based on factors such as the local and national economy and the risk associated with the loans in the portfolio. Quad City had an allowance for estimated losses on loans of approximately 1.46% of total loans at June 30, 1999 as compared to approximately 1.44% at June 30, 1998. The provision for loan losses decreased slightly by $10,000, from $902,000 for the year ended June 30, 1998 to $892,000 for the year ended June 30, 1999. The primary loan growth for the year ended June 30, 1999 was in the commercial loan portfolio, as opposed to our consumer loan portfolio, which has historically carried a greater degree of risk, allowing a decrease in the provision necessary for the period. For fiscal 1999, commercial and real estate loans combined for total charge-offs of $130,000 and total recoveries of $53,000. Consumer loan charge-offs and recoveries totaled $349,000 and $79,000, respectively, for fiscal 1999. Indirect auto loans accounted for a majority of the consumer loan charge-offs. Because asset quality is a priority for Quad City and its subsidiaries, management has made the decision to downscale indirect auto loan activity based on charge-off history. The ability to grow profitably is, in part, dependent upon the ability to maintain asset quality. Noninterest income. Noninterest income decreased by $588,000, from $6.1 million for fiscal 1998 to $5.6 million fiscal 1999. Noninterest income at June 30, 1998 consisted of the gain on the restructuring of a merchant broker agreement, income from the merchant credit card operation, the trust department, depository service fees, gains on the sale of residential real estate mortgage loans, and other miscellaneous fees. Noninterest income at June 30, 1999 consisted of the amortization of deferred income resulting from the restructuring of a merchant broker agreement, income from the merchant credit card operation, the trust department, depository service fees, gains on the sale of residential real estate mortgage loans, and other miscellaneous fees. The 10% decrease was primarily due to the one time gain in fiscal 1998 resulting from the restructuring of Bancard's merchant broker agreement offset by an increase in loan sales activity in the residential real estate department of the Bank, increased trust relationships received during the period and the recognition of deferred income resulting from a gain on the restructuring of Bancard's merchant broker agreement. In June 1998, Quad City recognized $2.2 million of gross income as a result of the amendment of the merchant broker agreement with its current, major ISO. The amended agreement is for a minimum term of one year and revised a prior agreement that was to expire in the year 2002. In consideration for the reduction in term from four years to one year, Quad City received total compensation of $2.9 million, of which $732,000 was deferred and recognized in income during fiscal 1999. In the prior agreement, Quad City and the ISO had shared both merchant-servicing fees and related merchant credit risk. The amended agreement exchanges a substantial reduction in merchant servicing income for a like reduction in the related merchant credit risk. With the amended agreement, Quad City receives a fixed, monthly fee of $25,000 for servicing the current merchants and is relieved of responsibility for any merchant credit risk. In an effort to offset the reduced merchant servicing income, Quad City has been actively pursuing other ISO relationships and has recently begun processing for additional ISOs. During fiscal 1999, merchant credit card fees, net of processing costs, decreased by $73,000 to $1.3 million, from $1.4 million for fiscal 1998. The reduction reflected terms of the amended merchant broker agreement. Also as a result of the amended merchant broker agreement, Quad City recognized $732,000 of the deferred income and earned $300,000 of merchant servicing fees for fiscal 1999. For fiscal 1999, trust department fees increased $382,000, or 34%, to approximately $1.5 million from $1.1 million for fiscal 1998. The increase was primarily a reflection of the development of additional trust relationships during the period. Gain on sales of loans, net, was $1.0 million for fiscal 1999, which reflected an increase of 46%, or $331,000, from $713,000 for fiscal 1998. The increase resulted from low interest rates, which created large numbers of both home refinances and first-time home purchases, and the subsequent sale of the majority of these loans into the secondary market. Noninterest expenses. The main components of noninterest expenses were primarily salaries and benefits, occupancy and equipment expenses, and professional and data processing fees for both periods. Noninterest expenses for fiscal 1999 were $9.7 million as compared to $7.9 million for the same period in 1998, or an increase of $1.8 million. The following table sets forth the various categories of noninterest expenses for the years ended June 30, 1999 and 1998. Years Ended June 30, ----------------------------------- 1999 1998 % Change ----------------------------------- Salaries and employee benefits ......................... $5,801,670 $4,571,126 26.92% Professional and data processing fees .................. 598,457 504,344 18.66 Advertising and marketing .............................. 359,571 238,160 50.98 Occupancy and equipment expense ........................ 1,453,040 1,045,349 39.00 Stationery and supplies ................................ 267,739 219,523 21.96 Provision for merchant credit card losses .............. 21,777 105,910 (79.44) Postage and telephone .................................. 298,208 231,049 29.07 Other .................................................. 878,437 994,354 (11.66) ---------------------------------- Total noninterest expenses ............................. $9,678,899 $7,909,815 22.37 ==================================
Salaries and benefits experienced the most significant dollar increase of any noninterest expense component. For fiscal 1999, total salaries and benefits increased to $5.8 million or $1.2 million over the fiscal 1998 total of $4.6 million. The change was primarily attributable to the addition of new Bank employees during the period and increased commission expense in the residential real estate department proportionate to the large volume of residential mortgage loan originations and subsequent loan sales. Advertising and marketing expense increased $121,000 or 51% and postage and telephone expense increased $67,000 or 29%. The increases were the result of the overall increase in business volume of the Bank. For fiscal 1999, occupancy and equipment expense increased $408,000 or 39% over fiscal 1998. The increase was largely due to rent expense for the new Moline location. The provision for merchant credit card losses during fiscal 1999 decreased $84,000 or 79% from fiscal 1998, which reflected Bancard's amended merchant broker agreement and the resulting reduction in Bancard's responsibility for merchant credit risk. Income tax expense. The provision for income taxes was $1.6 million for fiscal 1999 compared to $1.7 million for fiscal 1998, a decrease of $64,000 or 4%. The decrease was attributable to an effective tax rate of 39.6% in fiscal 1999 compared to 41.2% in fiscal 1998. Fiscal 1998 compared with fiscal 1997 Overview. Net income for the year ended June 30, 1998 was $2.4 million, compared to $1.2 million for the year ended June 30, 1997, for an increase of 96%. Results improved primarily because of a $2.0 million increase in net interest income after provision for loan losses, and a $3.3 million increase in noninterest income, of which $2.2 million related to a one-time gain on the restructuring of a merchant broker agreement. These increases were offset by a $2.6 million increase in other expenses due primarily to the increased number of employees and higher operating costs related to the increased volume of business, as well as an increase in income taxes of $1.5 million. Interest income. Interest income increased to $15.1 million in fiscal 1998 from $9.7 million in fiscal 1997, an increase of $5.4 million. The 55% rise was primarily due to greater average outstanding balances in interest bearing assets. Interest income is comprised primarily of interest income on loans (including loan fees), securities, federal funds sold and Quad City's own deposits maintained at other financial institutions. Interest income should continue to grow as the loan portfolio and other assets increase, and would also increase as a result of a rise in interest rates. Interest expense. Interest expense increased to $8.3 million in fiscal 1998 from $5.0 million in fiscal 1997, an increase of $3.3 million, or 67%, and represented interest paid primarily to depositors, as well as interest paid on Federal Home Loan Bank advances and federal funds purchased. The increase in interest expense was again primarily due to greater average outstanding balances in interest bearing liabilities. Interest expense will continue to increase as deposits and Federal Home Loan Bank advances and other borrowings grow and would also increase as a result of a rise in interest rates. Net interest income for the years ended June 30, 1998 and June 30, 1997 amounted to $6.7 million and $4.7 million, respectively, and represented the difference between interest income earned on earning assets and interest expense paid on interest bearing liabilities. Provision for loan losses. The provision for loan losses is established based on factors such as the local and national economy and the risk associated with the loans in the portfolio. Quad City's provision for loan losses was $902,000 for the year ended June 30, 1998, compared to $844,000 for the year ended June 30, 1997. The $58,000, or 7%, increase in the provision for loan losses was primarily in response to greater growth in the loan portfolio during fiscal 1998. Noninterest income. Noninterest income increased by $3.3 million, or 119%, to $6.1 million in fiscal 1998 from $2.8 million in fiscal 1997. In June 1998, Quad City recognized $2.2 million of income as a result of signing an amendment to a merchant broker agreement with its principal ISO. The term of the amended agreement is for a minimum one-year period, and revised a prior agreement that had an expiration date in the year 2002. In consideration for reducing the term from four years to one year, Quad City received total compensation of $2.9 million. The remaining $732,000 was recognized in income during the fiscal year ending June 30, 1999. Additionally, Quad City will receive a monthly fee of $25,000 for servicing the current merchants during the remaining term of the agreement. In future years, if agreements with other ISOs are not established, there could be a significant reduction in income. It is Quad City's intent, to actively pursue relationships with additional ISOs. Another component of noninterest income is gains on sales of loans, which totaled $713,000 and $44,000 in fiscal 1998 and 1997, respectively. The $669,000 increase experienced in fiscal 1998 reflected the increased volume of residential mortgage loans originated for sale by the Bank to be sold on the secondary market. Trust income increased by 55% to $1.1 million in fiscal 1998 from $736,000 in fiscal 1997. The $402,000 increase reflected the development of new trust relationships and increased trust account balances, as well as strong stock and bond markets. Other noninterest income increased $162,000 in fiscal 1998 to $434,000 from $272,000 in fiscal 1997. The 59% increase was primarily due to the fees generated by the receipt of lease income on the second floor of the Davenport building, the growth in the commission income generated by the investment center and fees generated by the item processing department. Noninterest expenses. Concurrent with Quad City's growth, noninterest expenses increased to $7.9 million in fiscal 1998 from $5.3 million in fiscal 1997. The $2.6 million, or 50%, increase was primarily due to higher overhead expenses on the increased volume of business attained during fiscal 1998. The following table sets forth the various categories of noninterest expenses for the years ended June 30, 1998 and 1997. Years Ended June 30, ----------------------- 1998 1997 % Change ----------------------------------- Salaries and employee benefits ......................... $4,571,126 $2,934,758 55.76% Professional and data processing fees .................. 504,344 437,259 15.34 Advertising and marketing .............................. 238,160 126,061 88.92 Occupancy and equipment expense ........................ 1,045,349 654,010 59.84 Stationery and supplies ................................ 219,523 191,682 14.52 Provision for merchant credit card losses .............. 105,910 176,476 (39.99) Postage and telephone .................................. 231,049 168,890 36.80 Other .................................................. 994,354 601,667 65.27 ----------------------- Total noninterest expenses ............................. $7,909,815 $5,290,803 49.50 =======================
In fiscal 1998, salaries and employee benefits experienced the most significant dollar increase of any noninterest expense component. For the twelve months ended June 30,1998, total salaries and benefits increased to $4.6 million or $1.7 million over the June 30, 1997 amount of $2.9 million. The change was primarily attributable to the increase in the staff for the new Moline location and increased incentive compensation based on business volume. In fiscal 1998, advertising and marketing expense experienced the largest single percentage increase within the noninterest expense category. For the twelve months ended June 30, 1998, total advertising and marketing expense increased to $238,000 or $112,000 over the June 30, 1997 total of $126,000. The change was primarily attributable to the promotional and marketing efforts of Quad City's expansion to the new Moline Velie Plantation location. In fiscal 1998, the provision for merchant credit card losses decreased to $106,000 or $70,000 from the June 30, 1997 amount of $176,000. As mentioned above, the decrease was primarily due to Bancard restructuring its merchant portfolio to focus on smaller merchants with less corresponding risk, and as a result experienced reduced losses. Income tax expense. Quad City's federal and state income tax expense totaled $1.7 million and $165,000 in fiscal 1998 and 1997, respectively. The $1.5 million increase was the result of higher income before income taxes. Additionally, during the year ended June 30, 1997, Quad City was able to reduce its income tax expense in the first three fiscal quarters due to pre-opening expenses and initial loss carryforwards, therefore it was only during the fiscal fourth quarter of 1997 that income tax expense was recorded. Financial Condition Total assets of Quad City increased by $71.1 million or 28% to $321.3 million at June 30, 1999 from $250.2 million at June 30, 1998. The growth primarily resulted from an increase in the loan portfolio funded by deposits received from customers, FHLB advances and short-term borrowings. The largest increase in Quad City's balance sheet as of June 30, 1999, was in deposits received from customers. This was a result of an aggressive program to attract deposits through increased marketing efforts and the hiring of new personnel to staff a business development department to fund the increase in loans. Cash and Cash Equivalent Assets. Cash and due from banks decreased by $3.1 million or 27% to $8.5 million at June 30, 1999 from $11.6 million at June 30, 1998. Cash and due from banks represented both cash maintained at the Bank, as well as funds that the Bank and Quad City had deposited in other banks in the form of demand deposits. Federal funds sold are inter-bank funds with daily liquidity. Federal funds sold increased by $16.1 million or 70% to $39.1 million at June 30, 1999 from $23.0 million at June 30, 1998. The increase was attributable to Quad City's increased liquidity needs at the end of the fiscal year. Quad City made the decision to increase its liquidity position in order to meet anticipated loan demand, large deposit maturities and to begin to increase liquidity in case Bank customers begin to withdraw funds in anticipation of problems associated with the Year 2000. Certificates of deposit at financial institutions increased by $4.1 million or 50% to $12.5 million at June 30, 1999 from $8.4 million at June 30,1998. The Bank continued to make new deposits in other banks in the form of certificates of deposit. Investments. Securities increased by $17.1 million or 49% to $51.7 million at June 30, 1999 from $34.6 million at June 30, 1998. The increase was the result of a number of transactions in the securities portfolio. Paydowns of $1.7 million were received on mortgage-backed securities, and the amortization of premiums, net of the accretion of discounts, was $39,000. Maturities, calls, and sales of securities occurred in the amount of $14.7 million, and an increase in unrealized losses on securities available for sale, before applicable income tax, of $345,000. These decreases were offset by the purchase of additional securities, classified as available for sale, in the amount of $34.0 million. Portions of the investment securities of the Bank are purchased with the intent to hold the securities until they mature. These held to maturity securities were recorded at amortized cost at June 30, 1999 and June 30, 1998. At June 30, 1999, municipal securities and other bonds made up the $724,000 balance. This was a decrease of $1.7 million, or 70%, from June 30, 1998, when mortgage-backed securities, municipal securities and other bonds made up the $2.4 million balance. Market values at June 30, 1999 and June 30, 1998 were $727,000 and $2.4 million, respectively. All of Quad City's and a portion of the Bank's securities are placed in the available for sale category as the securities may be liquidated to provide cash for operating or financing purposes. These securities were reported at fair value and increased by $18.7 million, or 58%, to $50.9 million at June 30, 1999, from $32.2 million at June 30, 1998. The amortized cost of such securities at June 30, 1999 and June 30, 1998 was $51.4 million and $32.2 million, respectively. Quad City does not use any financial instruments referred to as derivatives to manage interest rate risk and as of June 30, 1999 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. Loans receivable increased by $35.0 million or 21% to $198.0 million at June 30, 1999 from $163.0 million at June 30, 1998. The increase was the result of the origination or purchase of $263.7 million of commercial business, consumer and real estate loans, less loan charge-offs, net of recoveries, of $346,000, and loan repayments or sales of loans of $228.3 million. The majority of residential real estate loans originated by the Bank were sold on the secondary market to avoid the interest rate risk associated with long term fixed rate loans. As of June 30, 1999, the Bank's legal lending limit was $3.5 million. Allowance for Loan Losses. The allowance for estimated losses on loans was $2.9 million at June 30, 1999 compared to $2.3 million at June 30, 1998 for an increase of $546,000 or 23%. The adequacy of the allowance for estimated losses on loans was determined by management based on factors that included the overall composition of the loan portfolio, types of loans, past loss experience, loan delinquencies, potential substandard and doubtful credits, and other factors that, in management's judgment, deserved evaluation in estimating loan losses. The adequacy of the allowance for estimated losses on loans was monitored by the loan review staff, and reported to management and the Board of Directors. Net charge-offs for the years ended June 30, 1999 and 1998, were $346,000 and $185,000, respectively. The increase was primarily due to the losses resulting from auto loans purchased from dealers. Quad City has since scaled back on this type of lending. One measure of the adequacy of the allowance for estimated losses on loans is the ratio of the allowance to the total loan portfolio. Provisions were made monthly to ensure that an adequate level was maintained. The allowance for estimated losses on loans as a percentage of total loans was 1.46% at June 30, 1999 and 1.44% at June 30, 1998. Although management believes that the allowance for estimated losses on loans at June 30, 1999 was at a level adequate to absorb losses on existing loans, there can be no assurance that such losses will not exceed the estimated amounts or that Quad City will not be required to make additional provisions for loan losses in the future. Asset quality is a priority for Quad City and its subsidiaries. The ability to grow profitably is in part dependent upon the ability to maintain that quality. Nonperforming Assets. The policy of Quad City is to place a loan 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 were $1.3 million at June 30, 1999 compared to $1.0 million at June 30, 1998 for an increase of $262,000 or 26%. The increase in nonaccrual loans was comprised of increases in commercial loans of $254,000 and consumer loans of $56,700 offset by a decrease in real estate loans of $48,700. Nonaccrual loans at June 30, 1999 consisted primarily of loans that were well collateralized and were not expected to result in material losses. As of June 30, 1999 and 1998, past due loans of 30 days or more amounted to $4.0 million and $2.3 million, respectively. Quad City anticipated an increase in the dollar amount of this category in fiscal 1999 from the prior years. In prior years, much of the loan portfolio had been on the books for a relatively short time, thus an increase in past due loans was likely as the portfolio matured. Past due loans as a percentage of gross loans receivable was 2.0% and 1.4% at June 30, 1999, and 1998, respectively. Other Assets. Premises and equipment decreased by $107,000 or 1% to $7.6 million at June 30, 1999 from $7.7 million at June 30, 1998. The decrease resulted from depreciation expense offset by the purchase of additional furniture, fixtures and equipment. Additional information regarding the composition of this account and related accumulated depreciation is described in footnote 5 to the consolidated financial statements. Accrued interest receivable on loans, securities and interest-bearing cash accounts increased by $233,000 or 13% to $2.0 million at June 30, 1999 from $1.8 million at June 30, 1998. The increase was primarily due to greater average outstanding balances in interest-bearing assets. Other assets increased by $2.3 million or 93% to $4.8 million at June 30, 1999 from $2.5 million at June 30, 1998. The increase consisted primarily of an increase in accrued trust department fees, miscellaneous receivables and prepaid expenses associated with the growth of Quad City. Deposits. Deposits increased by $50.6 million or 26% to $248.0 million at June 30, 1999 from $197.4 million at June 30, 1998. The increase resulted from a $29.4 million net increase in noninterest bearing, NOW, money market and other savings accounts and a $21.2 million net increase in certificates of deposit. The increase was a result of periodic aggressive pricing programs for deposits, increased marketing efforts and the hiring of new personnel to staff a business development department. Management also believes the increases were a reaction by customers to the acquisitions and mergers of local banks by transferring their financial business to community banks. Short-term Borrowings. Short-term borrowings increased $7.7 million from $2.0 million as of June 30, 1998 to $9.7 million as of June 30, 1999. As of June 30, 1998 short-term borrowings represented federal funds purchased from correspondent banks. In recent months, the Bank began offering short-term repurchase agreements to some of its major customers. As of June 30, 1999 short-term borrowings were comprised of these customer repurchase agreements of $9.6 million, as well as federal funds purchased from correspondent banks of $140,000. FHLB Advances and Other Borrowings. FHLB advances decreased slightly to $24.6 million as of June 30, 1999 from $24.7 million at June 30, 1998. As of June 30, 1999, the Bank held $1.2 million of FHLB stock. As a result of its membership in the FHLB of Des Moines, the Bank has the ability to borrow funds for short or long-term purposes under a variety of programs. In June, 1999, Quad City issued 1,200,000 shares of trust preferred securities through its newly formed Capital Trust subsidiary. On Quad City's financial statements, these securities are listed as company obligated mandatorily redeemable preferred securities of subsidiary trust holding solely subordinated debentures and were $12,000,000 at June 30, 1999. Under current regulatory guidelines, these securities are considered to be Tier 1 capital, with certain limitations that are applicable to Quad City. Other borrowings consisted of the amount outstanding on a revolving credit note with a third party lender, which is secured by all the outstanding stock of the Bank. On July 1, 1998, Quad City increased the amount available under the credit note to $4.5 million and extended the expiration date to July 1, 2000. The borrowed funds were utilized to provide additional capital to the Bank to maintain a 7.5% aggregate capital ratio. On June 10, 1999, using the proceeds from the sale of the trust preferred securities, Quad City paid off the balance of its outstanding line of credit, which was $2.5 million. After the outstanding balance was paid off, the note was rewritten and decreased the amount available under the credit note to $3.0 million while maintaining the July 1, 2000 expiration date. Other liabilities increased by $3.1 million or 57% to $8.6 million as of June 30, 1999 from $5.5 million as of June 30, 1998. Other liabilities were comprised of unpaid amounts for various products and services, and accrued but unpaid interest on deposits. Stockholders' Equity. At June 30, 1999, Quad City had no shares of perpetual, nonvoting, Series A preferred stock, par value $1.00 per share, issued and outstanding. On June 10, 1999, using the proceeds from the sale of the trust preferred securities, Quad City redeemed all the outstanding balance of preferred stock, which was $2.5 million, plus a redemption premium of $478,000. At June 30, 1998, Quad City had 25 shares of Series A preferred stock issued and outstanding. In anticipation of continued asset growth, Quad City had privately placed these 25 shares of preferred stock with a limited number of institutional investors at a price of $100,000 per share, for an aggregate of $2,500,000. The Series A preferred stock paid no dividends, and carried a cumulative liquidation and redemption value equal to the original purchase price plus an annual premium of 9.75%. Common stock increased by $786,000 or 52% to $2.3 million as of June 30, 1999 from $1.5 million as of June 30, 1998. The increase was caused by (i) exercises of stock warrants and options resulting in the issuance of 30,720 additional shares of common stock, and (ii) a 3 for 2 stock split, effected in the form of a stock dividend, effective November 30, 1998, which resulted in the issuance of an additional 760,262 shares of common stock. Additional paid-in capital decreased by $3.0 million or 20% to $12.0 million as of June 30, 1999 from $15.0 million as of June 30, 1998. The decrease resulted from the excess of the $1.00 per share par value for the 25 shares of Series A preferred stock redeemed, and the transfer of $760,000 from additional paid-in capital to common stock representing the issuance of additional common shares from the 3 for 2 stock split. The decrease was offset by $197,000 received in excess of the $1.00 per share par value for 30,720 shares of common stock issued as the result of the exercise of stock warrants and options. Retained earnings increased by $2.0 million or 77% to $4.6 million as of June 30, 1999 from $2.6 million as of June 30, 1998. The increase reflected net income for the year offset by the redemption premium payment to preferred stockholders of $478,000 plus the payment to common stockholders which represented the cash value of fractional shares created by the 3 for 2 stock split. Accumulated other comprehensive income (loss), consisting of unrealized gains and losses on securities available for sale, net of related income taxes, was a $332,000 loss as of June 30, 1999 as compared to a $12,000 gain as of June 30, 1998. The decrease was attributable to the decrease during the period in fair value of the securities identified as available for sale mainly as a result of an increase in interest rates. Liquidity Liquidity measures the ability of Quad City 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 $60.2 million at June 30, 1999, compared with $43.0 million at June 30, 1998. Another source of liquidity is borrowing capability. The Bank has a variety of sources of short-term liquidity available to it, including federal funds purchased from correspondent banks, sales of securities available for sale, FHLB advances and loan participations or sales. Quad City also generates liquidity from the regular principal payments and prepayments made on its portfolio of loans and mortgage-backed securities. The liquidity of Quad City 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, was $7.5 million for the year ended June 30, 1999 compared to $4.4 million of cash used, primarily for loans originated for sale, for the year ended June 30, 1998. Net cash used in investing activities, consisting principally of loan funding and the purchase of securities, was $76.5 million for the year ended June 30, 1999 and $70.3 million for the year ended June 30, 1998. Net cash provided by financing activities, consisting primarily of deposit growth, proceeds from the issuance of preferred securities of the subsidiary trust, and proceeds from short-term borrowings, for the year ended June 30, 1999 was $66.0 million and for the year ended June 30, 1998 was $79.3 million, consisting principally of deposit growth and proceeds from Federal Home Loan Bank advances. Net outflows used in operating activities were $4.4 million for the year ended June 30, 1998 compared to providing cash of $4.7 million for the year ended June 30, 1997. The decrease of cash flow during the year resulted primarily from an increase in loans originated for sale, but not yet sold at the end of the fiscal year. Net cash outflows from investing activities totaled $70.3 million for the year ended June 30, 1998, compared to cash outflows of $55.3 million for the year ended June 30, 1997. The net outflows of cash were largely associated with the growth in the loan portfolio. Net cash inflows from financing activities totaled $79.3 million for the year ended June 30, 1998, compared to cash inflows of $51.0 million for the year ended June 30, 1997. The components of the net cash inflows were primarily from the growth of deposit accounts as well as the increase in FHLB advances and other borrowings. Impact of Inflation and Changing Prices The consolidated financial statements and the accompanying notes thereto included have been prepared in accordance with GAAP, 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 Quad City's operations. Unlike industrial companies, nearly all of the assets and liabilities of Quad City are monetary in nature. As a result, interest rates have a greater impact on Quad City'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 June 1998, the FASB issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities." This statement addresses the accounting for derivative instruments and certain derivative instruments embedded in other contracts, and hedging activities. The statement standardizes the accounting for derivative instruments by requiring that an entity recognize those items as assets or liabilities in the statement of financial position and measure them at fair value. This statement is effective for all fiscal years beginning after June 15, 1999 and is not expected to have a material effect on Quad City's consolidated financial position or results of operation. Forward Looking Statements Certain statements contained in this report that are not historical facts are forward looking statements that are subject to certain risks and uncertainties. When used herein, the terms "anticipates", "plans", "expects", "believes", and similar expressions as they relate to Quad City or its management are intended to identify such forward looking statements. Quad City's actual results, performance or achievements may materially differ from those expressed or implied in the forward-looking statements. Risks and uncertainties that could cause or contribute to such material differences include, but are not limited to, general economic conditions, interest rate environment, competitive conditions in the financial services industry, changes in law, unforeseen business risks related to Year 2000 computer systems issues, government policies and regulations, and rapidly changing technology affecting financial services. Year 2000 The Year 2000 has posed a unique set of challenges to those industries reliant on information technology. As a result of methods employed by early programmers, many software applications and operational programs may be unable to distinguish the Year 2000 from the Year 1900. If not effectively addressed, this problem could result in the production of inaccurate data, or, in the worst cases, the inability of the systems to continue to function altogether. Financial institutions are particularly vulnerable due to the industry's dependence on electronic data processing systems. In 1997, Quad City started the process of identifying the hardware and software issues required to be addressed to assure Year 2000 compliance. Quad City began by assessing the issues related to the Year 2000 and the potential for those issues to adversely affect Quad City's operations and those of its subsidiaries. Since that time, Quad City has established a Year 2000 committee to deal with this issue. The committee meets with and utilizes various representatives from key areas throughout the organization to aid in analysis and testing. It is the mission of this committee to identify areas subject to complications related to the Year 2000 and to initiate remedial measures designed to eliminate any adverse effects on Quad City's operations. The committee has identified all mission-critical software and hardware that may be adversely affected by the Year 2000 and has requested vendors to represent that the systems and products provided are or will be Year 2000 compliant. Quad City licenses all software used in conducting its business from third party vendors. None of Quad City's software has been internally developed. Quad City has developed a comprehensive list of all software, all hardware and all service providers used by Quad City. Every vendor has been contacted regarding the Year 2000 issue, and Quad City continues to closely track the progress each vendor is making in resolving the problems associated with the issue. The vendor of the primary software in use at Quad City released its Year 2000 compliant software in May 1998. Testing standards were formulated and comprehensive testing is now finalized. Quad City actively took part in a peer users group to aid the testing process. Users of the primary software continue to meet regularly to discuss Year 2000 testing issues and results. In addition, Quad City continues to monitor all other major vendors of services to Quad City for Year 2000 issues in order to avoid shortages of supplies and services in the coming months. Quad City has not had any material delay regarding its information systems projects as a result of the Year 2000 project. There are four third party utilities with which Quad City has an important relationship, Ameritech, McLeod and US West (phone service), and MidAmerican Energy Corporation (electricity and natural gas). Quad City has not identified any practical, long-term alternatives to relying on these companies for basic utility services. In the event that the utilities significantly curtail or interrupt their services to Quad City, it would have a significant adverse effect on Quad City's ability to conduct business. Information received from these utilities indicates that they have significantly completed remediation and validation of their mission critical applications. Quad City also has tested such things as vault doors, fax machines, security systems, elevators, stand-alone personal computers, networks, etc. for Year 2000 functionality and is not aware of any significant problems with such systems. Although Quad City does not believe that the failure of these systems would have a material adverse effect on the financial condition of the company, it is addressing deficiencies in these systems and expects compliance to be achieved by September 30, 1999. Quad City's cumulative costs of the Year 2000 project through fiscal 1999 were $122,000. The estimated total cost of the Year 2000 project is $250,000. This includes costs to upgrade equipment specifically for the purpose of Year 2000 compliance and certain administrative expenditures. At the present time, no situations that will require material cost expenditures to become fully compliant have been identified. However, the Year 2000 problem is pervasive and complex and can potentially affect any computer process. Accordingly, no assurance can be given that Year 2000 compliance can be achieved without additional unanticipated expenditures and uncertainties that might affect future financial results. It is not possible at this time to quantify the estimated future costs due to possible business disruption caused by vendors, suppliers, customers, or even the possible loss of electric power or phone service; however, such costs could be substantial. Quad City is committed to a plan for achieving compliance, focusing not only on its own data processing systems, but also on its loan and depository customers. The Year 2000 committee has taken steps to educate and assist its customers with identifying their Year 2000 compliance problems, if any. In addition, the management committee has proposed policy and procedure changes to help identify potential risks to Quad City and to gain an understanding of how customers are managing the risks associated with the Year 2000. Quad City is assessing the impact, if any, of the Year 2000 risk in its credit analysis. Quad City also utilizes loan agreements and other legal documentation to ensure large corporate borrowers acknowledge Year 2000 compliance requirements. In connection with potential credit risk related to the Year 2000 issue, Quad City has contacted its large commercial loan and depository customers regarding their level of preparedness for the Year 2000. Through these questionnaires and resulting assessments, Quad City believes that overall credit and liquidity risk to its large corporate borrowers and depositors is not excessive. Quad City has developed contingency plans for various Year 2000 problems in the event that unforeseen events beyond its control adversely impact our ability to provide financial services to our customers. In the event of such a failure, these plans outline the steps that will be taken to minimize the effect on customers and losses to Quad City. The plan will be continually updated as more information becomes available based on testing results and vendor notifications. The federal banking regulators issued guidelines establishing minimum safety and soundness standards for achieving Year 2000 compliance. The guidelines, which took effect October 15, 1998 and apply to all FDIC-insured depository institutions, establish standards for developing and managing Year 2000 project plans, testing remediation efforts and planning for contingencies. The guidelines are based upon guidance previously issued by the agencies under the auspices of the Federal Financial Institutions Examination Council but are not intended to replace or supplant the Federal Financial Institutions Examination Council guidance which will continue to apply to all federally insured depository institutions. The guidelines were issued under Section 39 of the Federal Deposit Insurance Act, which requires the federal banking regulators to establish standards for the safe and sound operation of federally insured depository institutions. Under Section 39 of the Federal Deposit Insurance Act, if an institution fails to meet any of the standards established in the guidelines, the institution's primary federal regulator may require the institution to submit a plan for achieving 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. Such an order is enforceable in court in the same manner as a cease and desist order. 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. In addition to the enforcement procedures established in Section 39 of the Federal Deposit Insurance Act, noncompliance with the standards established by the guidelines may also be grounds for other enforcement action by the federal banking regulators, including cease and desist orders and civil money penalty assessments. Quad City's management believes its Year 2000 planning has been consistent with regulatory guidelines. Item 7A. Quantitative and Qualitative Disclosures About Market Risk Quad City, like other financial institutions, is subject to direct and indirect market risk. Direct market risk exists from changes in interest rates. Additionally, Quad City'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 Quad City's interest rate risk. The Asset/Liability Committee meets quarterly to review Quad City's interest rate risk position and profitability, and to make or recommend adjustments for consideration by the Board of Directors. Management also reviews the Bank's securities portfolio, 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 Quad City'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 Quad City's asset/liability position, the Board and management attempt to manage Quad City'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- and short-term interest rates, market conditions and competitive factors, the Board and management may determine to increase Quad City's interest rate risk position somewhat in order to increase its net interest margin. Quad City's results of operations and net portfolio values remain vulnerable to increases in interest rates and to fluctuations in the difference between long- and short-term interest rates. One approach used to quantify interest rate risk is the net portfolio value ("NPV") analysis. In essence, this analysis calculates the difference between the present value of liabilities and the present value of expected cash flows from assets and off-balance-sheet contracts. The following table sets forth, at June 30, 1999 and June 30, 1998, an analysis of Quad City's interest rate risk as measured by the estimated changes in NPV resulting from instantaneous and sustained parallel shifts in the yield curve (+ or - 200 basis points). Change In Estimated Increase (Decrease) in NPV Interest ---------------------------------------------------------- Rates Estimated NPV Amount Amount Percent - -------------- ---------------------------- ---------------------------- ---------------------------- (Basis points) June 30, 1999 June 30, 1998 June 30, 1999 June 30, 1998 June 30, 1999 June 30, 1998 - -------------- ------------- ------------- ------------- ------------- ------------- ------------- (Dollars in thousands) +200 $29,554 $22,717 $(1,709) $(349) (5.47)% (1.51)% --- 31,263 23,066 -200 31,710 22,742 447 (324) 1.43% (1.40)%
Quad City does not currently engage in trading activities or use derivative instruments to control interest rate risk. Even though such activities may be permitted with the approval of the Board of Directors, Quad City does not intend to engage in such activities in the immediate future. Interest rate risk is the most significant market risk affecting Quad City. Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of Quad City's business activities. Item 8. Financial Statements and Supplementary Data QUAD CITY HOLDINGS, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Independent Auditor's Report........................................ Consolidated Balance Sheets at June 30, 1999 and 1998............... Consolidated Statements of Income for the years ended June 30, 1999, 1998 and 1997 .............................................. Consolidated Statements of Stockholders' Equity for the years ended June 30, 1999, 1998 and 1997 ............................... Consolidated Statements of Cash Flows for the years ended June 30, 1999, 1998 and 1997 .............................................. Notes to Consolidated Financial Statements.......................... Independent Auditor's Report To the Board of Directors and Stockholders Quad City Holdings, Inc. Moline, Illinois We have audited the accompanying consolidated balance sheets of Quad City Holdings, Inc. and subsidiaries as of June 30, 1999 and 1998, and the related consolidated statements of income, changes in stockholders' equity and cash flows for the years ended June 30, 1999, 1998 and 1997. These financial statements are the responsibility of Quad City's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. 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 Quad City Holdings, Inc. and subsidiaries as of June 30, 1999 and 1998, and the results of their operations and their cash flows for the years ended June 30, 1999, 1998 and 1997, in conformity with generally accepted accounting principles. /s/ McGladrey & Pullen, LLP - --------------------------- Davenport, Iowa July 23, 1999 Quad City Holdings, Inc. and subsidiaries Consolidated Balance Sheets June 30, 1999 and 1998 ASSETS 1999 1998 - -------------------------------------------------------------------------------------------------------- Cash and due from banks ................................................. $ 8,528,195 $ 11,640,813 Federal funds sold ...................................................... 39,125,000 22,960,000 Certificates of deposit at financial institutions ....................... 12,535,193 8,366,123 Securities held to maturity, at amortized cost (Note 3) ................. 724,415 2,380,309 Securities available for sale, at fair value (Note 3) ................... 50,941,759 32,238,245 ---------------------------- 51,666,174 34,618,554 ---------------------------- Loans receivable (Note 4) ............................................... 197,976,692 162,975,136 Less allowance for estimated losses on loans (Note 4) ................ 2,895,457 2,349,838 ---------------------------- 195,081,235 160,625,298 ---------------------------- Premises and equipment, net (Note 5) .................................... 7,553,616 7,660,268 Accrued interest receivable ............................................. 2,006,503 1,773,223 Other assets ............................................................ 4,850,299 2,506,710 ---------------------------- Total assets .............................................. $321,346,215 $250,150,989 ============================ LIABILITIES AND STOCKHOLDERS' EQUITY - -------------------------------------------------------------------------------------------------------- Liabilities: Deposits: Noninterest-bearing ............................................... $ 35,833,094 $ 26,605,138 Interest-bearing .................................................. 212,132,785 170,778,826 ---------------------------- Total deposits (Note 6) ................................... 247,965,879 197,383,964 Short-term borrowings (Note 7) ....................................... 9,685,877 2,000,000 Federal Home Loan Bank advances (Note 8) ............................. 24,605,890 24,667,174 Company obligated mandatorily redeemable preferred securities of subsidiary trust holding solely subordinated debentures (Note 9) 12,000,000 - - Other borrowings (Note 10) ........................................... - - 1,500,000 Other liabilities .................................................... 8,615,098 5,497,633 ---------------------------- Total liabilities ......................................... 302,872,744 231,048,771 ---------------------------- Commitments and Contingencies (Note 18) Stockholders' Equity (Note 16): Preferred stock, $1 par value; shares authorized 250,000; shares issued and outstanding 1999 - none; 1998 - 25 (Note 15) .................................. - - 25 Common stock, $1 par value; shares authorized 5,000,000; shares issued and outstanding 1999 - 2,296,251; 1998 - 2,265,561 (Note 1) ....................... 2,296,251 1,510,374 Additional paid-in capital ........................................... 11,959,080 15,014,884 Retained earnings .................................................... 4,550,490 2,564,443 Accumulated other comprehensive income (loss) ........................ (332,350) 12,492 ---------------------------- Total stockholders' equity ................................ 18,473,471 19,102,218 ---------------------------- Total liabilities and stockholders' equity ................ $321,346,215 $250,150,989 ============================
See Notes to Consolidated Financial Statements. Quad City Holdings, Inc. and subsidiaries Consolidated Statements of Income Years Ended June 30, 1999, 1998, and 1997 1999 1998 1997 - ---------------------------------------------------------------------------------------------------------- Interest income: Interest and fees on loans ..................................... $15,642,235 $12,083,990 $ 6,905,590 Interest and dividends on securities ........................... 2,285,267 1,905,668 2,139,263 Interest on federal funds sold ................................. 1,492,173 645,929 286,264 Other interest ................................................. 696,245 440,980 374,527 ------------------------------------- Total interest income ............................... 20,115,920 15,076,567 9,705,644 ------------------------------------- Interest expense: Interest on deposits ........................................... 9,009,724 6,971,153 4,358,476 Interest on company obligated mandatorily redeemable preferred securities ........................................ 63,518 - - - - Interest on short-term and other borrowings .................... 1,953,444 1,370,868 635,392 ------------------------------------- Total interest expense .............................. 11,026,686 8,342,021 4,993,868 ------------------------------------- Net interest income ................................. 9,089,234 6,734,546 4,711,776 Provision for loan losses (Note 4) ................................ 891,800 901,976 844,391 ------------------------------------- Net interest income after provision for loan losses . 8,197,434 5,832,570 3,867,385 ------------------------------------- Noninterest income: Merchant credit card fees, net of processing costs ............. 1,322,658 1,395,574 1,531,728 Trust department fees .......................................... 1,520,518 1,138,502 736,461 Deposit service fees ........................................... 433,056 290,721 201,163 Gains on sales of loans, net ................................... 1,043,763 713,121 44,441 Securities gains, net .......................................... 3,757 8,734 21,938 Amortization of deferred income resulting from restructuring of merchant broker agreement (Note 11) ........ 732,000 - - - - Gain on restructuring of merchant broker agreement (Note 11) ... - - 2,168,000 - - Other .......................................................... 504,699 433,765 272,023 ------------------------------------- Total noninterest income ............................ 5,560,451 6,148,417 2,807,754 ------------------------------------- Noninterest expenses: Salaries and employee benefits ................................. 5,801,670 4,571,126 2,934,758 Professional and data processing fees .......................... 598,457 504,344 437,259 Advertising and marketing ...................................... 359,571 238,160 126,061 Occupancy and equipment expense ................................ 1,453,040 1,045,349 654,010 Stationery and supplies ........................................ 267,739 219,523 191,682 Provision for merchant credit card losses ...................... 21,777 105,910 176,476 Postage and telephone .......................................... 298,208 231,049 168,890 Other .......................................................... 878,437 994,354 601,667 ------------------------------------- Total noninterest expenses .......................... 9,678,899 7,909,815 5,290,803 ------------------------------------- Income before income taxes .......................... 4,078,986 4,071,172 1,384,336 Federal and state income taxes (Note 12) .......................... 1,614,165 1,677,900 165,000 ------------------------------------- Net income .......................................... $ 2,464,821 $ 2,393,272 $ 1,219,336 ===================================== Earnings per common share (Notes 1 and 17): Basic .......................................................... $ 1.08 $ 1.09 $ 0.56 Diluted ........................................................ $ 1.03 $ 1.02 $ 0.54 Weighted average common shares outstanding ..................... 2,285,500 2,196,297 2,162,490 Weighted average common and common equivalent shares outstanding 2,398,525 2,353,932 2,250,368
See Notes to Consolidated Financial Statements. Quad City Holdings, Inc. and subsidiaries Consolidated Statements of Changes in Stockholders' Equity Years Ended June 30, 1999, 1998, and 1997 Accumulated Additional Retained Other Preferred Common Paid-In Earnings Comprehensive Stock Stock Capital (Deficit) Income (Loss) Total - -------------------------------------------------------------------------------------------------------------------------------- Balance, year ended June 30, 1996 ................ $ - - $1,437,824 $11,764,416 $(1,048,165) $ (485,469) $11,668,606 --------------------------------------------------------------------------- Comprehensive income: Net income ................................. - - - - - - 1,219,336 - - 1,219,336 Other comprehensive income, net of tax (Note 2) ................................. - - - - - - - - 425,284 425,284 ----------- Comprehensive income ............... 1,644,620 ----------- Proceeds from sale of 10 shares of preferred stock........................................ 10 - - 999,990 - - - - 1,000,000 Proceeds from issuance of 37,500 shares of common stock as a result of warrants exercised (Notes 1 and 14) .................. - - 25,000 275,000 - - - - 300,000 --------------------------------------------------------------------------- Balance, year ended June 30, 1997 ................ 10 1,462,824 13,039,406 171,171 (60,185) 14,613,226 --------------------------------------------------------------------------- Comprehensive income: Net income ................................. - - - - - - 2,393,272 - - 2,393,272 Other comprehensive income, net of tax (Note 2) ................................. - - - - - - - - 72,677 72,677 ----------- Comprehensive income ............... 2,465,949 ----------- Proceeds from sale of 15 shares of preferred stock ....................................... 15 - - 1,499,985 - - - - 1,500,000 Proceeds from issuance of 71,325 shares of common stock as a result of warrants and stock options exercised (Notes 1 and 14) .... - - 47,550 475,493 - - - - 523,043 --------------------------------------------------------------------------- Balance, year ended June 30, 1998 ................ 25 1,510,374 15,014,884 2,564,443 12,492 19,102,218 --------------------------------------------------------------------------- Comprehensive income: Net income ................................. - - - - - - 2,464,821 - - 2,464,821 Other comprehensive (loss), net of tax (Note 2) ................................. - - - - - - - - (344,842) (344,842) ----------- Comprehensive income ............... 2,119,979 ----------- Stock split (3 for 2) (Note 1) ................ - - 760,262 (760,262) (890) - - (890) Proceeds from issuance of 30,720 shares of common stock as a result of warrants and stock options exercised (Notes 1 and 14) .... - - 25,615 201,215 - - - - 226,830 Tax benefit of nonqualified stock options exercised ................................... - - - - 3,218 - - - - 3,218 Redemption of preferred stock ................. (25) - - (2,499,975) (477,884) - - (2,977,884) --------------------------------------------------------------------------- Balance, year ended June 30, 1999 ................ $ - - $2,296,251 $11,959,080 $4,550,490 $ (332,350) $18,473,471 ===========================================================================
See Notes to Consolidated Financial Statements. Quad City Holdings, Inc. and subsidiaries Consolidated Statements of Cash Flows Years Ended June 30, 1999, 1998, and 1997 1999 1998 1997 - ----------------------------------------------------------------------------------------------------------------- Cash Flows from Operating Activities: Net income ....................................................... $ 2,464,821 $ 2,393,272 $ 1,219,336 Adjustment to reconcile net income to net cash provided by (used in) operating activities: Depreciation .................................................. 627,075 422,357 334,409 Provision for loan losses ..................................... 891,800 901,976 844,391 Provision for merchant credit card losses ..................... 21,777 105,910 176,476 Amortization of premiums (accretion of discounts) on securities, net ............................................. 38,697 (16,742) 899 Investment securities gains, net .............................. (3,757) (8,734) (21,938) Loans originated for sale ..................................... (85,027,675) (57,206,140) (6,851,715) Proceeds on sales of loans .................................... 88,804,656 54,008,203 6,040,971 Net gains on sales of loans ................................... (1,043,763) (713,121) (44,441) Amortization of deferred income resulting from restructuring of merchant broker agreement .................. (732,000) - - - - Gain on restructuring of merchant broker agreement ............ - - (2,168,000) - - Increase in accrued interest receivable ....................... (233,280) (398,916) (253,039) Increase in other assets ...................................... (2,171,547) (826,685) (847,702) Increase (decrease) in other liabilities ...................... 3,830,679 (872,533) 4,064,359 ----------------------------------------- Net cash provided by (used in) operating activities ... 7,467,483 (4,379,153) 4,662,006 ----------------------------------------- Cash Flows from Investing Activities: Net increase in federal funds sold ............................... (16,165,000) (13,770,000) (6,462,000) Net (increase) decrease in certificates of deposit at financial institutions ........................................ (4,169,070) (3,006,999) 112,888 Purchase of securities available for sale ........................ (34,015,760) (16,444,294) (5,926,816) Purchase of securities held to maturity .......................... - - (276,398) - - Proceeds from calls and maturities of securities ................. 14,400,000 9,500,000 2,250,000 Proceeds from paydowns on securities ............................. 1,732,539 4,531,123 1,250,667 Proceeds from sales of securities available for sale ............. 280,786 14,020 5,249,967 Proceeds from restructuring of merchant broker agreement ......... - - 2,900,000 - - Net loans originated ............................................. (38,080,955) (50,883,287) (50,764,915) Purchase of premises and equipment, net .......................... (520,423) (2,833,936) (1,052,060) ------------------------------------------ Net cash used in investing activities ................. (76,537,883) (70,269,771) (55,342,269) ------------------------------------------ Cash Flows from Financing Activities: Net increase in deposit accounts ................................. 50,581,915 61,423,769 43,042,077 Net increase (decrease) in short-term borrowings ................. 7,685,877 2,000,000 (1,190,000) Proceeds from Federal Home Loan Bank advances .................... 1,480,000 25,955,000 11,961,000 Payments on Federal Home Loan Bank advances ...................... (1,541,284) (12,065,538) (4,594,758) Net increase (decrease) in other borrowings ...................... (1,500,000) - - 500,000 Proceeds from issuance of preferred securities of subsidiary trust 12,000,000 - - - - Redemption of preferred stock .................................... (2,977,884) - - - - Proceeds from issuance of preferred stock ........................ - - 1,500,000 1,000,000 Proceeds from issuance of common stock ........................... 229,158 523,043 300,000 ----------------------------------------- Net cash provided by financing activities ............. $65,957,782 $79,336,274 $51,018,319 ----------------------------------------- Net increase (decrease) in cash and due from banks .... $(3,112,618) $ 4,687,350 $ 338,056 Cash and due from banks: Beginning ....................................................... 11,640,813 6,953,463 6,615,407 ----------------------------------------- Ending .......................................................... $ 8,528,195 $11,640,813 $ 6,953,463 ========================================= Supplemental Disclosures of Cash Flow Information, cash payments for: Interest ........................................................ $10,735,683 $ 7,769,512 $ 4,861,558 Income taxes .................................................... 1,527,171 1,974,000 249,000 Supplemental Schedule of Noncash Investing Activities: Change in accumulated other comprehensive income, unrealized gains (losses) on securities available for sale, net ......... (344,842) 72,677 425,284 Investment securities transferred from held to maturity portfolio to available for sale portfolio, at fair value ............... 1,030,743 - - - -
See Notes to Consolidated Financial Statements. QUAD CITY HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Nature of Business and Significant Accounting Policies Nature of business: Quad City Holdings, Inc. (Company) is a bank holding company providing bank and bank related services through its subsidiaries, Quad City Bank and Trust Company (Bank), Quad City Bancard, Inc. (Bancard), and Quad City Holdings Capital Trust I. The Bank is a commercial bank that services the Quad Cities area, is chartered and regulated by the state of Iowa, is insured and subject to regulation by the Federal Deposit Insurance Corporation and is a member of and regulated by the Federal Reserve System. Bancard is an entity formed in April 1995 to conduct the Company's merchant credit card operation and is regulated by the Federal Reserve System. This activity was previously conducted by the Bank. Quad City Holdings Capital Trust I was capitalized in June 1999 for the purpose of issuing Company Obligated Mandatorily Redeemable Preferred Securities. 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. The allowance for estimated losses on loans is inherently subjective as it requires material estimates that are susceptible to significant change. Principles of consolidation: The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. 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 includes cash on hand and amounts due from banks. Cash flows from federal funds sold, certificates of deposit at financial institutions, loans, deposits, short-term borrowings, and other borrowings are treated as net increases or decreases. 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 significant movements in interest rates, changes in the maturity mix of the Company's assets and liabilities, liquidity needs, regulatory capital considerations, and other similar 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. Pursuant to SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities" the Company transferred at fair value $1,030,743 of investment securities from held to maturity to available for sale on January 4, 1999. Loans held for sale: Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated market value in the aggregate. Loans and allowance for estimated losses on loans: Loans are stated at the amount of unpaid principal, reduced by an allowance for estimated losses on loans. The allowance for estimated losses on loans is maintained at the level considered adequate by management of the Company and the Bank to provide for losses that can be reasonably anticipated. The allowance is increased by provisions charged to expense and reduced by net charge-offs. In determining the adequacy of the allowance, the Company and the Bank make continuous evaluations of the loan portfolio and related off-balance sheet commitments, and consider current economic conditions and other factors that may affect a borrower's ability to repay. In accordance with FASB Statement No. 114 "Accounting for Creditors for Impairment of a Loan" loans are considered impaired when, based on current information and events, it is probable the Company and the Bank will not be able to collect all amounts due. The portion of the allowance for loan losses applicable to an impaired loan is computed based on the present value of the estimated future cash flows of interest and principal discounted at the loan's effective interest rate or on the fair value of the collateral for collateral dependent loans. The entire change in present value of expected cash flows of impaired loans 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 the Bank recognize interest income on impaired loans on a cash basis. 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. Income taxes: The Company 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. 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 the Bank in a fiduciary, agency, or custodial capacity for its customers, other than cash on deposit at the Bank, are not included in the accompanying consolidated financial statements since such items are not assets of the Bank. Earnings per common share: Basic earnings per share are computed by dividing net income by the weighted average number of common stock shares outstanding for the respective period. Diluted earnings per share are computed by dividing net income by the weighted average number of common stock and common stock equivalents outstanding for the respective period. Common stock split: On November 30, 1998, the Company issued an additional 760,262 shares necessary to effect a 3 for 2 common stock split. All share and per share data has been retroactively adjusted to reflect the split. Note 2. Comprehensive Income Effective July 1, 1998, the Company adopted SFAS No. 130 "Reporting Comprehensive Income". This Statement establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. The Statement requires that all items that are required to be recognized under accounting standards as components of comprehensive income be disclosed in the financial statements. Comprehensive income is defined as the change in equity during a period from transactions and other events from nonowner sources. Comprehensive income is the total of net income and other comprehensive income, which for the Company is comprised entirely of unrealized gains and losses on securities available for sale. Other comprehensive income is comprised as follows: Tax Before Expense Net Tax (Benefit) of Tax ------------------------------------ Year ended June 30, 1999: Unrealized (losses) on securities available for sale: Unrealized holding (losses) arising during the year . $(517,765) $(175,407) $(342,358) Less, reclassification adjustment for gains included in net income ............................ 3,757 1,273 2,484 ------------------------------------ Other comprehensive (loss) .................. $(521,522) $(176,680) $(344,842) ==================================== Year ended June 30, 1998: Unrealized gains on securities available for sale: Unrealized holding gains arising during the year .... $ 114,505 $ 35,827 $ 78,678 Less, reclassification adjustment for gains included in net income ............................ 8,734 2,733 6,001 ------------------------------------ Other comprehensive income .................. $ 105,771 $ 33,094 $ 72,677 ==================================== Year ended June 30, 1997: Unrealized gains (losses) on securities available for sale: Unrealized holding gains arising during the year .......................................... $ 418,766 $ (21,592) $ 440,358 Less, reclassification adjustment for gains included in net income ............................ 21,938 6,864 15,074 ------------------------------------ Other comprehensive income .................. $ 396,828 $ (28,456) $ 425,284 ====================================
Note 3. Investment Securities The amortized cost and fair value of investment securities as of June 30, 1999 and 1998 are summarized as follows: Gross Gross Amortized Unrealized Unrealized Fair Cost Gains (Losses) Value -------------------------------------------------------- June 30, 1999: Securities held to maturity: Municipal securities ............... $ 699,415 $ 2,115 $ - - $ 701,530 Other bonds ........................ 25,000 585 - - 25,585 -------------------------------------------------------- $ 724,415 $ 2,700 $ - - $ 727,115 ======================================================== Securities available for sale: U.S. treasury securities ........... $ 9,001,845 $ 47,862 $ (4,866) $ 9,044,841 U.S. agency securities ............. 29,267,483 1,267 (390,870) 28,877,880 Mortgage-backed securities ......... 8,390,795 5,319 (183,867) 8,212,247 Municipal securities ............... 3,180,714 40,741 (12,139) 3,209,316 Other securities ................... 1,605,314 102 (7,941) 1,597,475 -------------------------------------------------------- $51,446,151 $ 95,291 $ (599,683) $50,941,759 ======================================================== June 30, 1998: Securities held to maturity: Mortgage-backed securities ......... $ 1,506,569 $ - - $ (5,534) $ 1,501,035 Municipal securities ............... 848,740 1,704 (13,557) 836,887 Other bonds ........................ 25,000 776 - - 25,776 -------------------------------------------------------- $ 2,380,309 $ 2,480 $ (19,091) $ 2,363,698 ======================================================== Securities available for sale: U.S. treasury securities ........... $17,007,239 $ 54,811 $ (3,867) $17,058,183 U.S. agency securities ............. 11,247,822 4,020 (31,050) 11,220,792 Mortgage-backed securities ......... 1,847,496 1,265 (346) 1,848,415 Municipal securities ............... 617,752 (11,193) 606,559 Other securities ................... 1,500,806 6,733 (3,243) 1,504,296 -------------------------------------------------------- $32,221,115 $ 66,829 $ (49,699) $32,238,245 ========================================================
All sales of securities during the years ended June 30, 1999, 1998, and 1997 were from securities identified as available for sale. Information on proceeds received, as well as the gains and losses from the sale of those securities is as follows: 1999 1998 1997 -------------------------------- Proceeds from sales of securities ... $280,786 $ 14,020 $5,249,967 Gross losses from sales of securities 1,717 - - 8,486 Gross gains from sales of securities 5,474 8,734 30,424 The amortized cost and fair value of securities as of June 30, 1999 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 in one year or less ....................... $ 200,000 $ 200,011 Due after one year through five years ......... 273,327 274,393 Due after five years .......................... 251,088 252,711 ------------------------ $ 724,415 $ 727,115 ======================== Securities available for sale: Due in one year or less ....................... $ 3,998,831 $ 4,017,679 Due after one year through five years ......... 27,444,671 27,156,231 Due after five years .......................... 10,006,540 9,958,127 ------------------------ 41,450,042 41,132,037 Mortgage-backed securities .................... 8,390,795 8,212,247 Other securities .............................. 1,605,314 1,597,475 ------------------------ $51,446,151 $50,941,759 ======================== As of June 30, 1999 and 1998, investment securities with a carrying value of $23,399,384 and $19,024,656, respectively, were pledged on public deposits and for other purposes as required or permitted by law. The Company transferred securities with an amortized cost of $1,029,096 and an unrealized gain of $1,647 from the held to maturity portfolio to the available for sale portfolio on January 4, 1999, based on management's reassessment of their previous designations of securities giving consideration to liquidity needs, management of interest rate risk, and other factors. Note 4. Loans Receivable The composition of the loan portfolio as of June 30, 1999 and 1998 is presented as follows: 1999 1998 -------------------------- Commercial ...................................... $136,206,893 $ 99,097,297 Real estate ..................................... 30,959,344 31,145,517 Installment and other consumer .................. 30,810,455 32,732,322 -------------------------- 197,976,692 162,975,136 Less allowance for estimated losses on loans .... 2,895,457 2,349,838 -------------------------- $195,081,235 $160,625,298 ========================== Real estate loans include loans held for sale with a carrying value of $2,033,025 and $4,766,243 as of June 30, 1999 and 1998, respectively. The market value of these loans exceeded its carrying value at those dates. Loans on nonaccrual status amounted to $1,287,727 and $1,025,761 as of June 30, 1999 and 1998, respectively. Foregone interest income and cash interest collected on nonaccrual loans was not material during the years ended June 30, 1999, 1998, and 1997. Changes in the allowance for estimated losses on loans for the years ended June 30, 1999, 1998, and 1997 are presented as follows: 1999 1998 1997 ---------------------------------- Balance, beginning .......................... $2,349,838 $1,632,500 $ 852,500 Provisions charged to expense ............ 891,800 901,976 844,391 Loans charged off ........................ (478,515) (205,234) (64,913) Recoveries on loans previously charged off 132,334 20,596 522 ---------------------------------- Balance, ending ............................. $2,895,457 $2,349,838 $1,632,500 ==================================
Impaired loans were not material as of June 30, 1999 and 1998. The loan portfolio includes a concentration of loans in certain industries as of June 30, 1999 as follows: Industry Balance --------------------------------------------------------------------- Commercial banks $10,015,866 Physicians 5,795,526 Real estate operators and lessors 8,624,661 Generally these loans are collateralized by assets of the borrowers. The loans are expected to be repaid from cash flows or from proceeds from the sale of selected assets of the borrowers. Credit losses arising from lending transactions with these entities compare favorably with the Bank's credit loss experience on its loan portfolio as a whole. 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 June 30, 1999 and 1998 was as follows: 1999 1998 ----------------------- Balance, beginning ...................... $4,831,491 $2,027,150 Advances ............................. 3,188,483 4,016,294 Repayments ........................... (2,190,787) (1,211,953) ----------------------- Balance, ending ......................... $5,829,187 $4,831,491 ======================= Note 5. Premises and Equipment The following summarizes the components of premises and equipment as of June 30, 1999 and 1998: 1999 1998 ---------------------- Land ........................................ $ 630,699 $ 554,379 Buildings ................................... 4,634,608 4,476,425 Furniture and equipment ..................... 3,955,489 3,669,569 ---------------------- 9,220,796 8,700,373 Less accumulated depreciation ............... 1,667,180 1,040,105 ---------------------- $7,553,616 $7,660,268 ====================== Certain facilities are leased under operating leases. Rental expense was $429,932, $176,057, and $9,971 for the years ended June 30, 1999, 1998, and 1997, respectively. Future minimum rental commitments under noncancelable leases on a fiscal year basis were as follows as of June 30, 1999: 2000 $ 413,556 2001 413,556 2002 413,556 2003 402,701 2004 381,156 Thereafter 1,370,496 ---------- $3,395,021 ========== Note 6. Deposits The aggregate amount of certificates of deposit each with a minimum denomination of $100,000 was $37,103,749 and $31,937,377 as of June 30, 1999 and 1998, respectively. As of June 30, 1999, the scheduled maturities of certificates of deposit were as follows: In one year or less $ 94,486,929 After one year through two years 18,535,480 After two years through three years 6,739,025 After three years through four years 3,690,224 After four years 2,195,386 ------------ $125,647,044 ============ Note 7. Short-Term Borrowings Short-term borrowings as of June 30, 1999 of $9,685,877 consisted of federal funds purchased of $140,000 and overnight repurchase agreements with customers of $9,545,877. As of June 30, 1998 short-term borrowings of $2,000,000 represented federal funds purchased. Information concerning repurchase agreements is summarized as follows as of June 30, 1999: Average daily balance during the year ......................... $ 4,248,238 Average daily interest rate during the year ................... 4.14% Maximum month-end balance during the year ..................... 11,418,714 Weighted average rate as of June 30, 1999 ..................... 3.99% Securities underlying the agreements as of June 30, 1999: Carrying value ............................................. $11,934,561 Fair value ................................................. 11,934,561 The securities underlying the agreements as of June 30, 1999 were under the Company's control. Note 8. Federal Home Loan Bank Advances The Bank is a member of the Federal Home Loan Bank of Des Moines (FHLB). As of June 30, 1999 and 1998, the Bank held $1,299,100 and $1,234,600, respectively, of FHLB stock. Maturity and interest rate information on advances from the FHLB as of June 30, 1999 and 1998 is as follows: June 30, 1999 ---------------------------------- Amount Due Interest Rate ---------------------------------- 2000 ............................... $ 3,500,000 5.61% to 5.95% 2001 ............................... 3,250,000 5.43% to 6.02% 2002 ............................... 2,057,063 6.51% to 7.06% 2003 ............................... 6,989,575 5.33% to 6.57% 2004 and thereafter ................ 8,809,252 4.88% to 7.11% ----------- Total FHLB advances ........... $24,605,890 =========== June 30, 1998 ---------------------------------- Amount Due Interest Rate ---------------------------------- 2000 .............................. $ 2,000,000 5.80% to 5.95% 2001 .............................. 5,750,000 5.43% to 6.02% 2002 .............................. 2,085,004 6.51% to 7.06% 2003 and thereafter ............... 14,832,170 4.88% to 7.11% ----------- Total FHLB advances ........... $24,667,174 =========== Advances from the FHLB are collateralized by 1 to 4 unit residential mortgages equal to 130% of total outstanding notes. Additionally, securities with a carrying value of approximately $6.3 million as of June 30, 1999 and $12.5 million as of June 30, 1998 were pledged as collateral on these advances. Note 9. Company Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust Holding Solely Subordinated Debentures The Company has issued all of the 1,200,000 authorized shares of Company Obligated Mandatorily Redeemable (COMR) Preferred Securities of Quad City Holdings Capital Trust I Holding Solely Subordinated Debentures. Distributions will accumulate from June 10, 1999 and will be paid quarterly on March 31, June 30, September 30, and December 31 of each year beginning September 30, 1999. Cumulative cash distributions are calculated at a 9.2% annual rate. The Company may, at one or more times, defer interest payments on the capital securities for up to 20 consecutive quarters, but not beyond June 30, 2029. At the end of any deferral period, all accumulated and unpaid distributions will be paid. The capital securities will be redeemed on June 30, 2029, however, the Company has the option to shorten the maturity date to a date not earlier than June 30, 2004. The redemption price is $10 per capital security plus any accrued and unpaid distributions to the date of redemption. Holders of the capital securities will have no voting rights, and are unsecured and rank junior in priority of payment to all of the Company's indebtedness and senior to the Company's capital stock. The debentures are included on the balance sheet as of June 30, 1999 as liabilities. For regulatory purposes, a portion of the capital securities are allowed in the calculation of Tier I capital. The capital securities are traded on the American Stock Exchange under the symbol "CQP.PR.A". Note 10. Other Borrowings The Company has a revolving credit note for $3,000,000, which is secured by all the outstanding stock of the Bank. There was no outstanding balance on this note as of June 30, 1999 and as of June 30, 1998, the balance was $1,500,000. The revolving credit note expires on July 1, 2000. Interest is payable quarterly at the adjusted LIBOR rate. Adjusted LIBOR rate is defined as a rate of interest equal to 2% per annum in excess of the per annum rate of interest at which U.S. dollar deposits in an amount comparable to the amount of the relevant LIBOR Loan are offered generally to the Bank in the London Interbank Eurodollar market at 11:00 a.m. (London time) two banking days prior to the commencement of each interest period. The rate was 7% as of June 30, 1999. The revolving credit note agreement contains certain covenants that place restrictions on additional debt and stipulate minimum capital and various operating ratios. The Company complied with all of the covenants as of June 30, 1999 and 1998. Note 11. Restructuring of Merchant Broker Agreement In June 1998, the Company recognized $2,168,000 of income as a result of signing a new merchant broker agreement with an ISO. The term of the new agreement was for a minimum one-year period, and replaced a prior agreement that had an expiration date in the year 2002. In consideration for reducing the term from four years to a minimum of one year, the Company received total compensation of $2,900,000. The Company recognized $732,000 and $2,168,000 of the income during the years ended June 30, 1999 and 1998, respectively. In addition, the Company receives monthly fees of $25,000 for servicing the current merchants during the remaining term of the agreement, which expires May 31, 2000. In future years, if agreements with any other ISOs is not established, there could be a significant reduction in income. The Company is actively pursuing relationships with other ISOs. Note 12. Federal and State Income Taxes Federal and state income tax expense was comprised of the following components for the years ended June 30, 1999, 1998, and 1997: Year Ended June 30, ------------------------------------ 1999 1998 1997 ------------------------------------ Current ................................ $1,381,903 $2,231,183 $ 472,385 Deferred ............................... 232,262 (553,283) (307,385) ------------------------------------ $1,614,165 $1,677,900 $ 165,000 ==================================== A reconciliation of the expected federal income tax expense to the income tax expense included in the statements of income was as follows for the years ended June 30, 1999, 1998, and 1997: Year Ended June 30, ---------------------------------------------------------------- 1999 1998 1997 ---------------------------------------------------------------- % of % of % of Pretax Pretax Pretax Amount Income Amount Income Amount Income ---------------------------------------------------------------- Computed "expected" tax expense .............. $ 1,427,645 35.0% $ 1,424,910 35.0% $ 484,517 35.0% Effect of graduated tax rates (40,790) (1.0) (40,712) (1.0) (13,843) (1.0) Tax exempt income, net ...... (46,853) (1.1) (19,759) (0.5) (3,853) (0.3) State income taxes, net of federal benefit .......... 126,123 3.1 268,796 6.6 44,320 3.2 Change in valuation allowance - - - - - - - - (358,934) (25.9) Other ....................... 148,040 3.6 44,665 1.1 12,793 0.9 ---------------------------------------------------------------- $ 1,614,165 39.6% $ 1,677,900 41.2% $ 165,000 11.9% ================================================================
The net deferred tax assets included with other assets on the balance sheet consisted of the following as of June 30, 1999 and 1998: 1999 1998 ----------------------- Deferred tax assets: Organization and startup costs .................... $ - - $ 27,183 Net unrealized losses on securities available for sale ........................................ 172,042 - - Capital loss carryforwards ........................ 7,162 13,830 Deferred income ................................... - - 292,800 Loan and credit card losses ....................... 1,063,999 792,127 Other ............................................. 16,639 7,460 ----------------------- 1,259,842 1,133,400 ----------------------- Deferred tax liabilities: Accrual to cash conversion ........................ - - 58,818 Premises and equipment ............................ 406,302 199,035 Net unrealized gains on securities available for sale ........................................ - - 4,638 Investment securities accretion ................... 27,282 13,692 Other ............................................. 25,810 1,187 ----------------------- 459,394 277,370 ----------------------- Net deferred tax asset ................. $ 800,448 $ 856,030 ======================= The change in deferred income taxes was reflected in the financial statements as follows for the years ended June 30, 1999, 1998, and 1997: 1999 1998 1997 -------------------------------- Provision for income taxes ................. $232,262 $(553,283) $(307,385) Statement of stockholders' equity- accumulated other comprehensive income, unrealized gains (losses) on securities available for sale, net ... (176,680) 33,094 (28,456) -------------------------------- $ 55,582 $(520,189) $(335,841) ================================ Note 13. Employee Benefit Plan 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 2% of employee contributions, 50% of the next 2% of employee contributions, and 25% of the next 2% of employee contributions, up to a maximum amount of 3.5% 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 June 30, 1999, 1998, and 1997 were as follows: 1999 1998 1997 ------------------------------ Matching contribution ................. $132,835 $100,164 $ 64,535 Discretionary contribution ............ 45,000 45,000 30,000 ------------------------------ $177,835 $145,164 $ 94,535 ============================== Note 14. Warrants and Stock Based Compensation Warrants: As part of the underwriting agreement for its initial public offering, the Company issued warrants to the underwriters for the purchase of 37,500 shares of common stock at $8 per share. The underwriters exercised all of the warrants on May 6, 1997. The warrants became exercisable on October 13, 1994 (the date commencing one year from the date of the public offering) and would have remained exercisable for a period of four years after such date. Common stock of $75,000 as of June 30, 1993 represented 112,500 shares of the Company's common stock issued in a private placement in 1993. Each stockholder who purchased stock in the private placement received a unit (at a price of $6.67 per unit) which consisted of one and one half shares of the Company's common stock and one and one half warrants. Each warrant entitled the holder to purchase an additional share of Company common stock for $7.33, exercisable by October 13, 1999. During the years ended June 30, 1999 and 1998, 30,000 and 71,250, respectively, of the warrants were exercised leaving 11,250 remaining as of June 30, 1999. Stock option and incentive plans: The Company's Board of Directors and its stockholders adopted in June 1993 the Quad City Holdings, Inc. Stock Option Plan (Stock Option Plan). Up to 150,000 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. The Company's Board of Directors adopted in November 1996 the Quad City Holdings, Inc. 1997 Stock Incentive Plan (Stock Incentive Plan). Up to 150,000 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 Stock Incentive Plan. The Stock Option Plan and the Stock Incentive Plan are administered by the compensation committee appointed by the Board of Directors (Committee). The number and exercise price of options granted under the Stock Option Plan and the Stock Incentive Plan 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. The stock options will generally vest 20% per year. The term of an incentive stock option may not exceed 10 years from the date of the grant. In the case of nonqualified stock options, the Stock Option Plan and the Stock Incentive Plan 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). As permitted under generally accepted accounting principles, grants under the plan are accounted for following the provisions of APB Opinion No. 25 and its related interpretations. Accordingly, no compensation cost has been recognized for grants made to date. Had compensation cost been determined based on the fair value method prescribed in FASB Statement No. 123, reported net income would not have changed by a material amount and earnings per share would not have changed by more than $0.02, $0.01, and $0.01 for the years ended June 30, 1999, 1998, and 1997, respectively. 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 June 30, 1999, 1998, and 1997: dividend rate of 0%: risk-free interest rates based upon current rates at the date of grant (5.62% to 7.90%); expected lives of 10 years, and expected price volatility of 13.37% to 20.65%. A summary of the stock option plans as of June 30, 1999, 1998, and 1997 and changes during the years ended on those dates is presented below: 1999 1998 1997 ---------------- ----------------- ------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price ---------------- ----------------- ------------------- Outstanding, beginning 190,887 $ 9.12 175,155 $ 7.89 147,030 $ 6.79 Granted ........... 8,500 18.03 19,062 20.92 28,650 13.51 Exercised ......... (720) 9.49 (75) 7.23 - - Forfeited ......... (8,496) 12.67 (3,255) 12.15 (525) 6.85 ------- ------- ------- Outstanding, ending .. 190,171 9.36 190,887 9.12 175,155 7.89 ======= ======= ======= Exercisable, ending .. 149,109 130,455 96,345 Weighted average fair value per option of options granted during the year ... $ 8.88 $ 9.72 $ 6.69 A further summary of options outstanding as of June 30, 1999 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 - -------------------------------------------------------------------------------- $6.00 to $6.83 132,720 5.6 years $ 6.67 130,410 $ 6.67 $7.83 to $8.83 8,805 6.9 years 8.76 5,430 8.75 $10.00 to $11.67 750 7.8 years 11.67 600 10.84 $13.33 to $13.67 23,190 8.0 years 13.66 9,480 13.66 $14.09 to $21.33 24,706 9.5 years 19.96 3,189 20.97 ------- ------- 190,171 149,109 ======= ======= Stock appreciation rights: Additionally, the Stock Incentive Plan allows 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 will vest 20% per year, and the term of the SAR may not exceed 10 years from the date of the grant. As of June 30, 1999 there were 39,625 SARs granted, with 9,675 currently exercisable. Note 15. Preferred Stock In June 1999, the Company redeemed all 25 outstanding shares of Preferred Stock for cash of $2,977,884. The stock was senior to common stock as to dividends, liquidation, and redemption rights, and did not confer general voting rights. The redemption amount was equal to the sum of (i) $100,000; plus (ii) a premium in the amount of $9,750 multiplied by a fraction, the numerator of which was the total number of calendar days the Preferred Stock being redeemed had been outstanding and the denominator of which was 365. Note 16. Regulatory Capital Requirements and Restrictions on Dividends Federal regulatory agencies have adopted various capital standards for financial institutions, including risk-based capital standards. The primary objectives of the risk-based capital framework are to provide a more consistent system for comparing capital positions of financial institutions and to take into account the different risks among financial institutions' assets and off-balance sheet items. Risk-based capital standards have been supplemented with requirements for a minimum Tier 1 capital to average total assets ratio (leverage ratio). In addition, regulatory agencies consider the published capital levels as minimum levels and may require a financial institution to maintain capital at higher levels. The actual amounts and capital ratios as of June 30, 1999 and 1998 with the minimum requirements for the Company and Bank are presented below: To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions --------------------------------------------------------------- Amount Ratio Amount Ratio Amount Ratio --------------------------------------------------------------- As of June 30, 1999: Company: Total risk based capital $33,695,000 13.8% $19,476,000 => 8.0% $24,345,000 => 10.0% Tier 1 risk based capital 25,060,000 10.3 9,738,000 => 4.0 14,607,000 => 6.0 Leverage ratio .......... 25,060,000 8.0 12,523,000 => 4.0 15,603,000 => 5.0 Bank: Total risk based capital $25,139,000 11.3% $17,875,000 => 8.0% $22,344,000 => 10.0% Tier 1 risk based capital 22,244,000 10.0 8,938,000 => 4.0 13,406,000 => 6.0 Leverage ratio .......... 22,244,000 7.2 12,374,000 => 4.0 15,467,000 => 5.0 As of June 30, 1998: Company: Total risk based capital $21,275,000 12.2% $13,979,000 => 8.0% $17,474,000 => 10.0% Tier 1 risk based capital 19,089,000 10.9 6,990,000 => 4.0 10,484,000 => 6.0 Leverage ratio .......... 19,089,000 7.9 9,603,000 => 4.0 12,004,000 => 5.0 Bank: Total risk based capital $20,167,000 11.8% $13,649,000 => 8.0% $17,062,000 => 10.0% Tier 1 risk based capital 18,032,000 10.6 6,824,000 => 4.0 10,236,000 => 6.0 Leverage ratio .......... 18,032,000 7.6 9,453,000 => 4.0 11,817,000 => 5.0
Federal Reserve Board 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 Bank, as a member 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 17. Earnings Per Common Share The following information was used in the computation of basic and diluted earnings per common share for the years ended June 30, 1999, 1998, and 1997. 1999 1998 1997 ---------------------------------- Basic and diluted earnings, net income ..... $2,464,821 $2,393,272 $1,219,336 ================================== Weighted average common shares outstanding . 2,285,500 2,196,297 2,162,490 Weighted average common shares issuable upon exercise of stock options and warrants .. 113,025 157,635 87,878 ---------------------------------- Weighted average common and common equivalent shares outstanding ........... 2,398,525 2,353,932 2,250,368 ================================== Note 18. Commitments and Contingencies In the normal course of business, the Bank makes various commitments and incurs 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. 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 Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based upon management's credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties. Standby letters of credit and financial guarantees written are conditional commitments issued by the Bank to guarantee the performance of a customer to a third-party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. As of June 30, 1999 and 1998 commitments to extend credit aggregated $58,119,081 and $38,024,001, respectively. As of June 30, 1999 and 1998 standby letters of credit aggregated $551,500 and $1,278,000, respectively. Management does not expect that all of these commitments will be funded. Bancard is subject to the risk of chargebacks from cardholders and the merchant being incapable of refunding the amount charged back. Management attempts to mitigate such risk by regular monitoring of merchant activity and in appropriate cases, holding cash reserves deposited by the merchant. The Company also has a guarantee to MasterCard International Incorporated, which is backed up by a performance bond in the amount of $1,000,000. As of June 30, 1999 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 $44,004,699 and $26,727,204 as of June 30, 1999 and 1998, respectively. In the opinion of management, no material risk of loss exists due to the financial condition of the upstream correspondent banks. Note 19. Quarterly Results of Operations (Unaudited) Year Ended June 30, 1999 ---------------------------------------------- September December March June 1998 1998 1999 1999 ---------------------------------------------- Total interest income ........... $4,785,014 $4,949,961 $4,948,755 $5,432,190 Total interest expense .......... 2,692,979 2,718,434 2,673,931 2,941,342 ---------------------------------------------- Net interest income 2,092,035 2,231,527 2,274,824 2,490,848 Provision for loan losses ....... 252,000 174,200 218,200 247,400 Noninterest income .............. 1,191,066 1,329,819 1,437,189 1,602,377 Noninterest expenses ............ 2,301,829 2,376,376 2,472,977 2,527,717 ---------------------------------------------- Net income before income taxes ...... 729,272 1,010,770 1,020,836 1,318,108 Federal and state income taxes .. 290,451 391,314 406,889 525,511 ---------------------------------------------- Net income ........ $ 438,821 $ 619,456 $ 613,947 $ 792,597 ============================================== Earnings per common share: Basic ........................ $ 0.19 $ 0.27 $ 0.27 $ 0.35 Diluted ...................... 0.18 0.26 0.25 0.34 Year Ended June 30, 1998 ----------------------------------------------- September December March June 1997 1997 1998 1998 ----------------------------------------------- Total interest income .......... $3,305,107 $3,617,832 $3,797,383 $4,356,245 Total interest expense ......... 1,757,272 1,963,477 2,157,917 2,463,355 ---------------------------------------------- Net interest income .. 1,547,835 1,654,355 1,639,466 1,892,890 Provision for loan losses ...... (304,355) (215,643) (233,260) (148,718) Noninterest income ............. 922,495 872,117 1,134,103 3,219,702 Noninterest expenses ........... (1,606,833) (1,706,098) (2,048,517) (2,548,367) ----------------------------------------------- Net income before income taxes ..... 559,142 604,731 491,792 2,415,507 Federal and state income taxes . 218,200 237,075 191,425 1,031,200 ----------------------------------------------- Net income ....... $ 340,942 $ 367,656 $ 300,367 $1,384,307 =============================================== Earnings per common share: Basic ....................... $ 0.15 $ 0.17 $ 0.14 $ 0.63 Diluted ..................... 0.14 0.15 0.13 0.60 Year Ended June 30, 1997 ----------------------------------------------- September December March June 1996 1996 1997 1997 ----------------------------------------------- Total interest income ........ $2,014,237 $2,308,760 $2,499,725 $2,882,922 Total interest expense ....... 1,008,269 1,202,258 1,325,463 1,457,878 ----------------------------------------------- Net interest income .. 1,005,968 1,106,502 1,174,262 1,425,044 Provision for loan losses .... (157,400) (146,325) (222,775) (317,891) Noninterest income ........... 519,208 599,095 790,345 899,106 Noninterest expenses ......... (1,108,592) (1,257,025) (1,392,010) (1,533,176) ---------------------------------------------- Net income before income taxes ... 259,184 302,247 349,822 473,083 Federal and state income taxes - - - - - - 165,000 ----------------------------------------------- Net income ..... $ 259,184 $ 302,247 $ 349,822 $ 308,083 =============================================== Earnings per common share: Basic ..................... $ 0.12 $ 0.14 $ 0.16 $ 0.14 Diluted ................... 0.12 0.13 0.15 0.14 Note 20. Parent Company Only Financial Statements The following is condensed financial information of Quad City Holdings, Inc. (parent company only): Condensed Balance Sheets June 30, -------------------------- ASSETS 1999 1998 - ------------------------------------------------------------------------------------- Cash and due from banks ................................ $ 4,911,367 $ 433,928 Securities available for sale, at fair value ........... 189,625 160,946 Investment in Quad City Bank and Trust Company ......... 21,916,436 18,040,231 Investment in Quad City Bancard, Inc. .................. 1,432,802 367,916 Investment in Quad City Holding Capital Trust .......... 380,000 - - Net loans receivable ................................... - - 502,844 Other assets ........................................... 1,984,519 1,217,502 -------------------------- Total assets ............................. $30,814,749 $20,723,367 ========================== LIABILITIES AND STOCKHOLDERS' EQUITY - ------------------------------------------------------------------------------------- Liabilities: Other borrowings .................................... $ - - $ 1,500,000 COMR preferred securities of subsidiary trust ....... 12,000,000 - - Other liabilities ................................... 341,278 121,149 -------------------------- Total liabilities ........................ 12,341,278 1,621,149 -------------------------- Stockholders' Equity: Preferred stock ..................................... - - 25 Common stock ........................................ 2,296,251 1,510,374 Additional paid-in capital .......................... 11,959,080 15,014,884 Retained earnings ................................... 4,550,490 2,564,443 Accumulated other comprehensive income (loss) ....... (332,350) 12,492 -------------------------- Total stockholders' equity ............... 18,473,471 19,102,218 -------------------------- Total liabilities and stockholders' equity $30,814,749 $20,723,367 ==========================
Condensed Statements of Income Years Ended June 30, ---------------------------------- 1999 1998 1997 - ----------------------------------------------------------------------------------- Total interest income ......................... $ 78,763 $ 48,178 $ 84,431 Investment securities gains, net .............. 5,474 8,734 23,437 Equity in net income of Quad City Bank and Trust Company .............................. 2,212,931 1,208,090 844,915 Equity in net income of Quad City Bancard, Inc. 564,886 1,325,992 356,318 Other ......................................... 85,945 81,435 63,516 ---------------------------------- Total income .................... 2,947,999 2,672,429 1,372,617 ---------------------------------- Interest expense .............................. 220,794 129,271 122,885 Other ......................................... 495,284 304,186 342,396 ---------------------------------- Total expenses .................. 716,078 433,457 465,281 ---------------------------------- Income before income tax benefit ......................... 2,231,921 2,238,972 907,336 Income tax benefit ............................ 232,900 154,300 312,000 ---------------------------------- Net income ...................... $2,464,821 $2,393,272 $1,219,336 ==================================
Condensed Statements of Cash Flows Years Ended June 30, ----------------------------------------- 1999 1998 1997 - --------------------------------------------------------------------------------------------------- Cash Flows from Operating Activities: Net income ......................................... $ 2,464,821 $ 2,393,272 $ 1,219,336 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Distributions in excess of (less than) earnings of: Quad City Bank and Trust Company .............. (2,212,931) (1,208,090) (844,915) Quad City Bancard, Inc. ....................... (564,886) 574,008 (356,318) Depreciation .................................... 4,036 3,520 2,647 Provision for loan losses ....................... (7,500) - - (10,000) Accretion of discount on securities, net ........ - - - - (5,495) Investment securities gains, net ................ (5,474) (8,734) (23,437) Decrease in accrued interest receivable ......... 4,780 749 2,676 (Increase) in other assets ...................... (770,199) (605,877) (560,689 Increase (decrease) in other liabilities ........ 220,129 (14,606) 35,115 ---------------------------------------- Net cash provided by (used in) operating activities ................... (867,224) 1,134,242 (541,080) ---------------------------------------- Cash Flows from Investing Activities: Purchase of securities available for sale .......... (67,400) (5,958) (49,515) Proceeds from sale of securities available for sale 32,865 14,020 95,691 Proceeds from paydowns on securities ............... - - - - 5,496 Capital infusion, Quad City Bank and Trust Company ................................... (2,000,000) (3,200,000) (2,100,000) Capital infusion, Quad City Bancard, Inc. .......... (500,000) - - - - Capital infusion, Quad City Holdings Capital Trust I (380,000) - - - - Net loans (originated) repaid ...................... 510,344 (169,850) 809,702 (Purchase) disposal of premises and equipment ...... (2,420) 10,623 64,326 ---------------------------------------- Net cash (used in) investing activities . (2,406,611) (3,351,165) (1,174,300) ---------------------------------------- Cash Flows from Financing Activities: Net increase (decrease) in other borrowings ........ (1,500,000) - - 500,000 Proceeds from issuance of preferred securities of subsidiary trust ................................ 12,000,000 - - - - Redemption of preferred stock ...................... (2,977,884) - - - - Proceeds from issuance of preferred stock .......... - - 1,500,000 1,000,000 Proceeds from issuance of common stock ............. 229,158 523,043 300,000 Cash dividends received, Quad City Bancard, Inc .... - - - - 200,000 ---------------------------------------- Net cash provided by financing activities .............................. 7,751,274 2,023,043 2,000,000 ---------------------------------------- Net increase (decrease) in cash and due from banks .......................... 4,477,439 (193,880) 284,620 Cash and due from banks: Beginning .......................................... 433,928 627,808 343,188 ---------------------------------------- Ending ............................................. $4,911,367 $ 433,928 $ 627,808 ========================================
Note 21. 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 certificates of deposit at financial institutions: The carrying amounts reported in the balance sheets for cash and due from banks, federal funds sold, and certificates of deposit at financial institutions equal their fair values. 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 receivable: The fair values for variable rate loans equal their carrying values. The fair values for all other types of loans are estimated using discounted cash flow analysis, using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality. 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 represents the amount payable on demand. Fair values for time deposits are estimated using a discount 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 Company obligated mandatorily redeemable preferred securities: The fair value of the Company's Federal Home Loan Bank advances and Company obligated mandatorily redeemable preferred securities is estimated using discounted cash flow analysis, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements. Other borrowings: For variable rate debt, the carrying amount is a reasonable estimate of fair value. Commitments to extend credit: The majority of the Company's commitment agreements contain variable interest rates, therefore, the carrying amount is a reasonable estimate of fair value. The carrying values and estimated fair values of the Company's financial instruments as of June 30, 1999 and 1998 are presented as follows: 1999 1998 -------------------------- -------------------------- Carrying Estimated Carrying Estimated Value Fair Value Value Fair Value ------------------------------------------------------ Cash and due from banks .......................... $ 8,528,195 $ 8,528,195 $ 11,640,813 $ 11,640,813 Federal funds sold ............................... 39,125,000 39,125,000 22,960,000 22,960,000 Certificates of deposit at financial institutions 12,535,193 12,535,193 8,366,123 8,366,123 Investment securities: Held to maturity .............................. 724,415 727,115 2,380,309 2,363,698 Available for sale ............................ 50,941,759 50,941,759 32,238,245 32,238,245 Loans receivable, net ............................ 195,081,235 196,217,000 160,625,298 162,770,000 Accrued interest receivable ...................... 2,006,503 2,006,503 1,773,223 1,773,223 Deposits ......................................... 247,965,879 248,312,000 197,383,964 197,378,000 Short-term borrowings ............................ 9,685,877 9,685,877 2,000,000 2,000,000 Federal Home Loan Bank advances .................. 24,605,890 24,742,000 24,667,174 25,334,000 Company obligated mandatorily redeemable preferred securities of subsidiary trust holding solely subordinated debentures ....................... 12,000,000 12,000,000 - - - - Other borrowings ................................. - - - - 1,500,000 1,500,000 Accrued interest payable ......................... 1,588,263 1,588,263 1,297,260 1,297,260
Note 22. Business Segment Information Selected financial information on the Company's business segments is presented as follows for the years ended June 30, 1999, 1998, and 1997: Year Ended June 30, ------------------------------------------ 1999 1998 1997 ------------------------------------------ Quad City Holdings, Inc.: Revenue ........................................ $ 48,485 $ 114,347 $ 147,384 Net income (loss) .............................. (312,996) (140,810) 18,103 Identifiable assets ............................ 5,059 6,675 20,818 Depreciation ................................... 4,036 3,520 2,647 Capital expenditures ........................... 2,420 - - - - Quad City Bank and Trust Company: Revenue ........................................ 22,040,065 16,408,561 10,081,155 Net income ..................................... 1,881,433 947,510 678,869 Identifiable assets ............................ 7,397,567 7,535,319 5,108,723 Depreciation ................................... 589,287 389,177 315,312 Capital expenditures ........................... 451,535 2,870,009 1,027,073 Quad City Bancard, Inc.: Revenue ........................................ 2,067,303 3,563,574 1,548,397 Net income ..................................... 564,886 1,325,992 356,318 Identifiable assets ............................ 150,990 118,274 119,148 Depreciation ................................... 33,752 29,660 16,450 Capital expenditures ........................... 66,468 28,786 89,313 Trust Department, Quad City Bank and Trust Company: Revenue ........................................ 1,520,518 1,138,502 736,462 Net income ..................................... 331,498 260,580 166,046 Identifiable assets ............................ N/A N/A N/A Depreciation ................................... N/A N/A N/A Capital expenditures ........................... N/A N/A N/A
Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure None. Part III Item 10. Directors, Executive Officers, Promoters and Control Persons 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 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. 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. Part IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (a) 1. Financial Statements These documents are listed in the Index to Consolidated Financial Statements under Item 8. 2. Financial Statement Schedules Financial Statement Schedules have been omitted because they are not applicable or the required information is shown in the consolidated financial statements and the accompanying notes thereto. (b) Reports on Form 8-K None. (c) Exhibits The Index to Exhibits appears at page 51 of this report. APPENDIX A SUPERVISION AND REGULATION General Financial institutions and their holding companies are extensively regulated under federal and state law. As a result, the growth and earnings performance of the Company can be affected not only by management decisions and general economic conditions, but also by the requirements of applicable state and federal statutes and regulations and the policies of various governmental regulatory authorities, including the Iowa Superintendent of Banking (the "Superintendent"), the Board of Governors of the Federal Reserve System (the "Federal Reserve"), the Federal Deposit Insurance Corporation (the "FDIC"), the Internal Revenue Service and state taxing authorities and the Securities and Exchange Commission (the "SEC"). The effect of applicable statutes, regulations and regulatory policies can be significant, and cannot be predicted with a high degree of certainty. Federal and state laws and regulations generally applicable to financial institutions, such as the Company and its subsidiaries, regulate, among other things, the scope of business, investments, reserves against deposits, capital levels relative to operations, the nature and amount of collateral for loans, the establishment of branches, mergers, consolidations and dividends. The system of supervision and regulation applicable to the Company and its subsidiaries establishes a comprehensive framework for their respective operations and is intended primarily for the protection of the FDIC's deposit insurance funds and the depositors, rather than the shareholders, of financial institutions. 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 to the Company and its subsidiaries, nor does it restate all of the requirements of the statutes, regulations and regulatory policies that are described. As such, the following is qualified in its entirety by reference to the applicable statutes, regulations and regulatory policies. Any change in applicable law, regulations or regulatory policies may have a material effect on the business of the Company and its subsidiaries. Recent Regulatory Developments Pending Legislation. Legislation is pending in the Congress that would allow bank holding companies to engage in a wider range of nonbanking activities, including greater authority to engage in securities and insurance activities. The expanded powers generally would be available to a bank holding company only if the bank holding company and its bank subsidiaries remain well-capitalized and well-managed. At this time, the Company is unable to predict whether the proposed legislation will be enacted and, therefore, is unable to predict the impact such legislation may have on the Company and the Bank. The Company General. The Company, as the sole shareholder of the Bank, 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, as amended (the "BHCA"). In accordance with Federal Reserve policy, the Company is expected to act as a source of financial strength to the Bank and to commit resources to support the Bank 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. Investments and Activities. Under the BHCA, a bank holding company must obtain Federal Reserve approval before: (i) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after the acquisition, it would own or control more than 5% of the shares of the other bank or bank holding company (unless it already owns or controls the majority of such shares); (ii) acquiring all or substantially all of the assets of another bank; or (iii) merging or consolidating with another bank holding company. Subject to certain conditions (including certain 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 without regard to whether the acquisition is prohibited by the law of the state in which the target bank is located. In approving interstate acquisitions, however, 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 which 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 also generally prohibits the Company from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which 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." Under current regulations of the Federal Reserve, the Company and its non-bank subsidiaries are permitted to engage in a variety of banking-related businesses, including the operation of a thrift, sales and 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. Federal law also prohibits any person or company from acquiring "control" of a bank or bank 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 issued and outstanding shares of any class of voting stock of a bank or bank holding company, although under certain circumstances, a person or company may be found to have acquired control upon the acquisition of 10% or more of the issued and outstanding shares of any class of voting stock of a bank or bank holding company. Capital Requirements. Bank holding companies are required to maintain minimum levels of capital in accordance with Federal Reserve capital adequacy guidelines. If capital falls below minimum guideline 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: a risk-based requirement expressed as a percentage of total risk-weighted assets, and 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%; at least one-half of which must be Tier 1 capital. 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 mortgage servicing rights and purchased credit card relationships). Total capital consists primarily of Tier 1 capital plus certain other debt and equity instruments which 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 June 30, 1999, the Company had regulatory capital in excess of the Federal Reserve's minimum requirements, with a risk-based capital ratio of 13.8% and a leverage ratio of 8.0%. Dividends. The Delaware General Corporation Law (the "DGCL") allows 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, the Federal Reserve has issued a policy statement with regard to the payment of cash dividends by bank holding companies. The policy statement provides that a bank holding company should not pay cash dividends which exceed its net income or which 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 Bank General. The Bank is an Iowa-chartered bank, the deposit accounts of which are insured by the FDIC's Bank Insurance Fund ("BIF"). The Bank is also a member of the Federal Reserve System ("member bank"). As an Iowa-chartered, FDIC-insured member bank, the Bank is subject to the examination, supervision, reporting and enforcement requirements of the Superintendent, as the chartering authority for Iowa banks, the Federal Reserve, as the primary federal regulator of member banks, and the FDIC, as administrator of the BIF. Deposit Insurance. As an FDIC-insured institution, the Bank is 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 semiannual assessment periods ended December 31, 1998 and June 30, 1999, BIF assessments ranged from 0% of deposits to 0.27% of deposits. For the semi-annual assessment period beginning July 1, 1999, BIF assessment rates continue to range from 0% of deposits to 0.27% of deposits. The FDIC may terminate the deposit insurance of any insured depository institution if the FDIC determines, after a hearing, that the institution (i) has engaged or is engaging in unsafe or unsound practices, (ii) is in an unsafe or unsound condition to continue operations or (iii) has violated any applicable law, regulation, order, or any condition imposed in writing by, or written agreement with, the FDIC. The FDIC may also suspend deposit insurance temporarily during the hearing process for a permanent termination of insurance if the institution has no tangible capital. Management of the Company is not aware of any activity or condition that could result in termination of the deposit insurance of the Bank. 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. These FICO assessments are in addition to amounts assessed by the FDIC for deposit insurance. Until January 1, 2000, the FICO assessments made against BIF members may not exceed 20% of the amount of the FICO assessments made against SAIF members. Between January 1, 2000 and the final maturity of the outstanding FICO obligations in 2019, BIF members and SAIF members will share the cost of the interest on the FICO bonds on a pro rata basis. During the calendar year ended December 31, 1998, the FICO assessment rate for SAIF members ranged between approximately 0.058% of deposits and approximately 0.063% of deposits, while the FICO assessment rate for BIF members ranged between approximately 0.012% of deposits and approximately 0.013% of deposits. The FICO assessment rate for BIF members for the first and second quarters of 1999 was approximately 0.012% of deposits. The FICO assessment rate for SAIF members for the first and second quarters of 1999 was approximately 0.061% of deposits and 0.058% of deposits, respectively. During the fiscal year ended June 30, 1999, the Bank paid FICO assessments totaling $24,114. Capital Requirements. The Federal Reserve has established the following minimum capital standards for state-chartered Federal Reserve System member banks, such as the Bank: 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 a risk-based capital requirement consisting of a minimum ratio of total capital to total risk-weighted assets of 8%, at least one-half of which must be Tier 1 capital. For purposes of these capital standards, Tier 1 capital and total capital consist of substantially the same components as Tier 1 capital and total capital under the Federal Reserve's capital guidelines for bank holding companies (see "--The Company--Capital Requirements"). 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, the 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. During the fiscal year ended June 30, 1999, the Bank was not required by the Federal Reserve to increase its capital to an amount in excess of the minimum regulatory requirement. As of June 30, 1999, the Bank exceeded its minimum regulatory capital requirements with a leverage ratio of 7.2% and a risk-based capital ratio of 11.3%. Federal law 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 "well capitalized," "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: requiring the institution to submit a capital restoration plan; limiting the institution's asset growth and restricting its activities; requiring the institution to issue additional capital stock (including additional voting stock) or to be acquired; restricting transactions between the institution and its affiliates; restricting the interest rate the institution may pay on deposits; ordering a new election of directors of the institution; requiring that senior executive officers or directors be dismissed; prohibiting the institution from accepting deposits from correspondent banks; requiring the institution to divest certain subsidiaries; prohibiting the payment of principal or interest on subordinated debt; and ultimately, appointing a receiver for the institution. As of June 30, 1999, the Bank was well capitalized, as defined by Federal Reserve regulations. Dividends. The Iowa Banking Act provides that an Iowa bank may not pay dividends in an amount greater than its undivided profits. The Federal Reserve Act also imposes limitations on the amount of dividends that may be paid by a state member bank, such as the Bank. 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 which, 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 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, the Bank exceeded its minimum capital requirements under applicable guidelines as of June 30, 1999. Notwithstanding the availability of funds for dividends, however, the Federal Reserve may prohibit the payment of any dividends by the Bank if the Federal Reserve determines such payment would constitute an unsafe or unsound practice. Insider Transactions. The Bank is subject to certain restrictions imposed by federal law on extensions of credit to the Company and its subsidiaries, on investments in the stock or other securities of the Company and its subsidiaries and the acceptance of the stock or other securities of the Company or its subsidiaries as collateral for loans. Certain limitations and reporting requirements are also placed on extensions of credit by the Bank to its directors and officers, to directors and officers of the Company and its subsidiaries, to principal stockholders of the Company, and to "related interests" of such directors, officers and principal stockholders. In addition, federal law and regulations may affect the terms upon which any person becoming a director or officer of the Company or one of its subsidiaries or a principal stockholder of the Company may obtain credit from banks with which the Bank maintains a correspondent relationship. 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. In addition, in October 1998, the federal banking regulators issued safety and soundness standards for achieving Year 2000 compliance, including standards for developing and managing Year 2000 project plans, testing remediation efforts and planning for contingencies. 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. Iowa law strictly regulates the establishment of bank offices. Under Iowa law, a state bank generally may not establish a bank office outside the boundaries of the counties contiguous to or cornering upon the county in which the principal place of business of the state bank is located. The number of offices that a state bank may establish in a particular municipality is also limited depending upon the municipality's population. Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Riegle-Neal Act"), both state and national banks are allowed to establish interstate branch networks through acquisitions of other banks, subject to certain conditions, including certain limitations on the aggregate amount of deposits that may be held by the surviving bank and all of its insured depository institution affiliates. 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 allowed by the Riegle-Neal Act only if specifically authorized by state law. The legislation allowed individual states to "opt-out" of certain provisions of the Riegle-Neal Act by enacting appropriate legislation prior to June 1, 1997. Iowa has enacted legislation permitting interstate mergers beginning on June 1, 1997, subject to certain conditions, including a condition prohibiting an Iowa bank that has been in existence and continuous operation for fewer than five years from merging into an out-of-state bank. In 1997, the Company formed a de novo Illinois bank that was merged into the Bank, resulting in the Bank establishing a branch office in Illinois. Under Illinois law, the Bank 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). State Bank Activities. 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 or its subsidiary, respectively, 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 Bank. 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 $46.5 million or less, the reserve requirement is 3% of total transaction accounts; and for transaction accounts aggregating in excess of $46.5 million, the reserve requirement is $1.395 million plus 10% of the aggregate amount of total transaction accounts in excess of $46.5 million. The first $4.9 million of otherwise reservable balances are exempted from the reserve requirements. These reserve requirements are subject to annual adjustment by the Federal Reserve. The Bank is in compliance with the foregoing requirements. 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 the Quad City Holdings, Inc. ("the Company") for the periods shown. All average amounts in these tables and schedules were determined by using month end data, which management believes provides a fair representation of the daily operations of the Company. 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 June 30, ------------------------------------------------------------------------------------------ 1999 1998 1997 --------------------------- ------------------------------ ---------------------------- Interest Average Interest Average Interest Average Average Earned Yield Or Average Earned Or Yield Or Average Earned Or Yield Or Balance Or Paid Cost Balance Paid Cost Balance Paid Cost -------- -------- -------- -------- --------- -------- ------- --------- -------- (Dollars in Thousands) ASSETS Interest earnings assets: Federal funds sold .................... $ 30,224 $ 1,492 4.94% $ 11,005 $ 646 5.87% $ 5,693 $ 286 5.02% Certificates of deposit at financial institutions ............ 11,814 696 5.89 7,173 441 6.15 5,649 375 6.64 Investment securities (1) ............. 41,468 2,286 5.51 31,457 1,906 6.06 34,574 2,139 6.19 Net loans receivable (2) .............. 182,130 15,642 8.59 139,860 12,084 8.64 80,033 6,906 8.63 ------------------ ------------------- ------------------- Total Interest earning assets ..... 265,636 20,116 7.57 189,495 15,077 7.96 125,949 9,706 7.71 Noninterest-earning assets: Cash and due from banks ............... $ 9,431 $ 9,595 $ 7,682 Premises and equipment ................ 7,536 6,527 5,114 Other ................................. 5,157 3,756 3,053 -------- -------- -------- Total assets ........................ $287,760 $209,373 $141,798 ======== ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Interest bearing liabilities: Interest-bearing demand deposits ..... $ 75,530 2,559 3.39% $ 56,612 2,053 3.63% $ 41,184 1,381 3.35% Savings deposits ..................... 4,654 93 2.00 2,954 65 2.20 2,322 53 2.28 Time deposits ........................ 113,752 6,358 5.59 83,790 4,853 5.79 52,511 2,925 5.57 Short-term borrowings ................ 5,414 258 4.77 166 9 5.42 517 28 5.42 Federal Home Loan Bank advances ..... 25,393 1,539 6.06 20,220 1,234 6.10 7,718 484 6.27 COMR ................................. 1,000 63 6.30 0 0 0.00 0 0 0.00 Other borrowings ..................... 2,125 157 7.39 1,500 128 8.53 1,417 123 8.68 ------------------ ------------------- ------------------- Total Interest bearing liabilities .. 227,868 11,027 4.84 165,242 8,342 5.05 105,669 4,994 4.73 Noninterest-bearing demand ............ 33,619 23,545 19,263 Other noninterest-bearing liabilities . 5,974 3,896 3,887 Total liabilities ................... 267,461 192,683 128,819 Stockholders' equity .................. 20,299 16,690 12,979 -------- -------- -------- Total liabilities and stockholders' equity .. $287,760 $209,373 $141,798 ======== ======== ======== Net interest income ................... $ 9,089 $ 6,735 $ 4,712 ======== ======== ======== Net interest spread ................... 2.73% 2.91% 2.98% ===== ===== ===== Net interest margin ................... 3.42% 3.55% 3.74% ===== ===== ===== Ratio of average interest earning assets to average interest-bearing liabilities .............. 116.57% 114.68% 119.19% ======== ======== ========
Interest earned and yields on nontaxable investment securities are stated at face rate. Loan fees are not material and are included in interest income from loans receivable. I. Interest Rates and Interest Differential. C. Analysis of Changes of Interest Income/Interest Expense For the years ended June 30, 1999 and 1998 Components Inc./(Dec.) of Change (1) from ------------------ Prior Year Rate Volume ------------------------------ 1999 vs. 1998 ------------------------------ INTEREST EARNING ASSETS Federal funds sold ................................................ $ 846 $ (118) $ 964 Certificates of deposit at financial institutions ................. 255 (19) 274 Total securities (2) .............................................. 380 (184) 564 Net loans receivable (3) .......................................... 3,558 (73) 3,631 ----------------------------- Total interest earning assets ............................. $ 5,039 $ (394) $ 5,433 ----------------------------- INTEREST BEARING LIABILITIES Interest-bearing demand deposits .................................. $ 506 $ (143) $ 649 Savings deposits .................................................. 28 (6) 34 Time deposits ..................................................... 1,505 (175) 1,680 Short-term borrowings ............................................. 249 (2) 251 Federal Home Loan Bank advances ................................... 305 (9) 314 COMR .............................................................. 63 0 63 Other borrowings .................................................. 29 (18) 47 ----------------------------- Total interest bearing liabilities ........................ 2,685 $ (353) $ 3,038 ----------------------------- Total ............................................................. $ 2,354 $ (41) $ 2,395 ============================= 1998 vs 1997 ----------------------------- INTEREST EARNING ASSETS Federal funds sold ................................................ $ 360 $ 55 $ 305 Certificates of deposit at financial institutions ................. 66 (29) 95 Investment securities (2) ......................................... (233) (44) (189) Net loans receivable (3) .......................................... 5,178 9 5,169 ----------------------------- Total interest earning assets ............................. $ 5,371 $ (9) $ 5,380 ----------------------------- INTEREST BEARING LIABILITIES Interest-bearing demand deposits .................................. $ 672 $ 120 $ 552 Savings deposits .................................................. 12 (2) 14 Time deposits ..................................................... 1,928 121 1,807 Federal funds purchased ........................................... (19) 0 (19) Federal Home Loan Bank advances ................................... 750 (13) 763 Other borrowings .................................................. 5 (2) 7 ----------------------------- Total interest bearing liabilities ........................ $ 3,348 $ 224 $ 3,124 ----------------------------- Total ............................................................. $ 2,023 $ (233) $ 2,256 ============================= (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 stated at face rate. (3) Loan fees are not material and are included in interest income from loans receivable.
II. Investment Portfolio. A. Investment Securities The following table presents the amortized cost and fair value of investment securities held on June 30, 1999, 1998 and 1997. Gross Gross Amortized Unrealized Unrealized Fair Cost Gains (Losses) Value ------------------------------------------------------ June 30, 1999 - ------------- Securities held to maturity: Municipal securities .................... $ 699,415 $ 2,115 $ 0 $ 701,530 Other bonds ............................. 25,000 585 0 25,585 ------------------------------------------------------ Totals .............................. $ 724,415 $ 2,700 $ 0 $ 727,115 ====================================================== Securities available for sale: U.S. treasury securities ................ $ 9,001,845 $ 47,862 $ (4,866) $ 9,044,841 U.S. agency securities .................. 29,267,483 1,267 (390,870) 28,877,880 Mortgage-backed securities .............. 8,390,795 5,319 (183,867) 8,212,247 Municipal securities .................... 3,180,714 40,741 (12,139) 3,209,316 Other securities ........................ 1,605,314 102 (7,941) 1,597,475 ------------------------------------------------------ Totals .............................. $51,446,151 $ 95,291 $ (599,683) $50,941,759 ====================================================== June 30, 1998 - ------------- Securities held to maturity: Mortgage-backed securities .............. $ 1,506,569 $ 0 $ (5,534) $ 1,501,035 Municipal securities .................... 848,740 1,704 (13,557) 836,887 Other bonds ............................. 25,000 776 0 25,776 ------------------------------------------------------ Totals .............................. $ 2,380,309 $ 2,480 $ (19,091) $ 2,363,698 ====================================================== Securities available for sale: U.S. treasury securities ................ $17,007,239 $ 54,811 $ (3,867) $17,058,183 U.S. agency securities .................. 11,247,822 4,020 (31,050) 11,220,792 Mortgage-backed securities .............. 1,847,496 1,265 (346) 1,848,415 Municipal securities .................... 617,752 0 (11,193) 606,559 Other securities ........................ 1,500,806 6,733 (3,243) 1,504,296 ------------------------------------------------------ Totals .............................. $32,221,115 $ 66,829 $ (49,699) $32,238,245 ====================================================== June 30, 1997 - ------------- Securities held to maturity: Mortgage-backed securities .............. $ 2,317,513 $ 673 $ (15,871) $ 2,302,315 Municipal securities .................... 596,616 1,581 (12,450) 585,747 ------------------------------------------------------ Totals .............................. $ 2,914,129 $ 2,254 $ (28,321) $ 2,888,062 ====================================================== Securities available for sale: U.S. treasury securities ................ $14,496,366 $ 45,514 $ (20,226) $14,521,654 U.S. agency securities .................. 9,742,495 8,462 (120,306) 9,630,651 Mortgage-backed securities .............. 2,357,376 9,388 (6,526) 2,360,238 Other securities ........................ 2,390,033 8,971 (13,918) 2,385,086 ------------------------------------------------------ Totals .............................. $28,986,270 $ 72,335 $ (160,976) $28,897,629 ======================================================
B. Investment Securities Maturities and Yields The following table presents the maturity of securities held on June 30, 1999 and the weighted average rates by range of maturity: Average Amount Yield ------------------------ U.S. treasury securities: Within 1 year .................................. $ 3,998,831 5.79% After 1 but within 5 years ..................... 5,003,014 5.61% ------------------------ Total ..................................... $ 9,001,845 5.69% ======================== U.S. agency securities: After 1 but within 5 years ..................... $22,221,657 5.52% After 5 but within 10 years .................... 6,045,826 6.02% After 10 years ................................. 1,000,000 7.28% ------------------------ Total ..................................... $29,267,483 5.69% ======================== Mortgage-backed securities: After 1 but within 5 years ..................... $ 1,531,176 6.18% After 5 but within 10 years .................... 2,512,532 5.87% After 10 years ................................. 4,347,087 5.93% ------------------------ Total ..................................... $ 8,390,795 5.96% ======================== Municipal securities: Within 1 year ................................... $ 200,000 7.45% After 1 but within 5 years ..................... 468,327 6.08% After 5 but within 10 years .................... 1,397,637 6.26% After 10 years ................................. 1,814,165 7.43% ------------------------ Total ..................................... $ 3,880,129 6.85% ======================== Other bonds: After 1 but within 5 years ..................... $ 25,000 6.30% ======================== Other securities with no maturity or stated face rate ......................................... $ 1,605,314 =========== The Company does not use any financial instruments referred to as derivatives to manage interest rate risk. C. Investment Concentrations As of June 30, 1999, there existed no security in the investment portfolio above (other than U.S. Government and U.S. Government agencies) that exceeded 10% of stockholders' equity at that date. III. Loan Portfolio. A. Types of Loans The composition of the loan portfolio at June 30, 1999, 1998, 1997, 1996 and 1995 is presented as follows: 1999 1998 1997 1996 1995 --------------------------------------------------------------------------------- Commercial ......................... $ 136,206,893 $ 99,097,297 $ 68,634,556 $ 40,338,645 $ 24,748,659 Real estate ........................ 30,959,344 31,145,517 20,293,440 9,011,608 2,879,530 Installment and other consumer ........................ 30,810,455 32,732,322 19,437,433 7,459,467 3,879,388 --------------------------------------------------------------------------------- Total loans ................... 197,976,692 162,975,136 108,365,429 56,809,720 31,507,577 Less allowance for estimated losses on loans ....... (2,895,457) (2,349,838) (1,632,500) (472,475) (852,500) --------------------------------------------------------------------------------- Net loans ..................... $ 195,081,235 $ 160,625,298 $ 106,732,929 $ 55,957,220 $ 31,035,102 =================================================================================
B. Maturities and Sensitivities of Loans to Changes in Interest Rates The following table presents consolidated loan maturities by yearly ranges. Also included for loans after one year are the amounts that have predetermined interest rates and floating or adjustable rates. Maturities After One Year ------------------------------ At June 30, 1999 Due in one Due after one Due after Predetermined Adjustable year or less through 5 years 5 years interest rates interest rates -------------------------------------------------------------------------- Commercial ..................... $ 48,049,184 $ 60,083,833 $ 28,073,876 $ 76,401,243 $ 11,756,466 Real estate .................... 4,712,528 1,996,153 24,250,663 9,289,902 16,956,914 Installment and other consumer .............. 5,404,120 23,584,309 1,822,026 23,168,321 2,238,014 ------------------------------------------------------------------------- Totals .................... $ 58,165,832 $ 85,664,295 $ 54,146,565 $108,859,466 $ 30,951,394 =========================================================================
C. Risk Elements 1. Nonaccrual, Past Due and Renegotiated Loans. 1999 1998 1997 1996 1995 -------------------------------------------------------------- Loans accounted for on nonaccrual basis .. $1,287,727 $1,025,761 $ 230,591 $ 0 $ 0 Accruing loans past due 90 days or more .... 238,046 259,277 223,966 306,774 1,678 Other real estate owned 119,600 0 0 0 0 Troubled debt restructurings 0 0 0 0 0 ---------- ---------- ---------- ---------- ---------- Total ............ $1,645,373 $1,285,038 $ 454,557 $ 306,774 $ 1,678 ========== ========== ========== ========== ==========
The policy of the Company is to place a loan 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. 2. Potential Problem Loans. To management's best knowledge, there are no such significant loans that have not been disclosed in the above table. 3. Foreign Outstandings. None 4. Loan Concentrations. Loan concentrations are disclosed in the Notes to Consolidated Financial Statements in Note 4 on page 31. D. Other Interest Bearing Assets There are no interest bearing assets required to be disclosed here. IV. Summary of Loan Loss Experience. A. Analysis of the Allowance for Estimated Losses on Loans The following table summarizes activity in the allowance for estimated losses on loans of the Company for the fiscal years ending June 30, 1999, 1998, 1997, 1996 and 1995: 1999 1998 1997 1996 1995 ------------------------------------------------------------------------ Average amount of loans outstanding, before allowance for estimated losses on loans ........................... $184,756,698 $141,974,417 $ 81,251,090 $ 44,749,454 $ 23,451,527 Allowance for estimated losses on loans: Balance, beginning of fiscal year ............ $ 2,349,838 $ 1,632,500 $ 852,500 $ 472,475 $ 191,500 Charge-offs: Commercial .............................. (104,596) (62,763) (26,141) (117,555) 0 Real estate ............................ (25,142) 0 0 0 0 Installment and other consumer ............................ (348,777) (142,471) (38,772) (2,817) (1,725) ------------------------------------------------------------------------ Subtotal charge-offs .................... (478,515) (205,234) (64,913) (120,372) (1,725) ------------------------------------------------------------------------ Recoveries: Commercial .............................. 53,314 13,146 266 0 0 Real estate ............................ 0 0 0 0 0 Installment and other consumer ......... 79,020 7,450 256 0 100 ------------------------------------------------------------------------ Subtotal recoveries ..................... 132,334 20,596 522 0 100 ------------------------------------------------------------------------ Net charge-offs ......................... (346,181) (184,638) (64,391) (120,372) (1,625) Provision charged to expense ................. 891,800 901,976 844,391 500,397 282,600 ------------------------------------------------------------------------ Balance, end of fiscal year .................. $ 2,895,457 $ 2,349,838 $ 1,632,500 $ 852,500 $ 472,475 ======================================================================== Ratio of net charge-offs to average loans outstanding ................. 0.19% 0.13% 0.08% 0.27% 0.01%
B. Allocation of the Allowance for Estimated Losses on Loans The following table presents the allowance for estimated losses on loans by type of loans and the percentage of loans in each category to total loans: % % Of Loans Of Loans to Total to Total Amount Loans Amount Loans -------------------- --------------------- 1999 1998 -------------------- --------------------- Commercial ............................. $2,164,668 68.80% $1,213,439 60.81% Real estate ............................ 102,693 15.64% 79,198 19.11% Installment and other .................. 578,937 15.56% 515,489 20.08% consumer Unallocated ............................ 49,159 N/A 541,712 N/A -------------------- --------------------- Total ............................. $2,895,457 100.00% $2,349,838 100.00% ==================== ===================== 1997 1996 -------------------- -------------------- Commercial ............................. $ 799,566 63.34% $ 0 71.01% Real estate ............................ 66,742 18.73% 0 15.86% Installment and other .................. 387,096 17.93% 0 13.13% consumer Unallocated ............................ 379,096 N/A 852,500 N/A -------------------- --------------------- Total ............................. $1,632,500 100.00% $ 852,500 100.00% ==================== ===================== 1995 -------------------- Commercial ............................. $ 0 78.55% Real estate ............................ 0 9.14% Installment and other .................. 0 12.31% consumer Unallocated ............................ 472,475 N/A -------------------- Total ............................. $ 472,475 100.00% ====================
V. Deposits. The average amount of and average rate paid for the categories of deposits for the years 1999, 1998 and 1997 are disclosed in the consolidated average balance sheets and can be found on page 2 of Appendix B. Included in interest bearing deposits at June 30, 1999, 1998 and 1997 were certificates of deposit totaling $37,103,749, $31,937,377 and $22,978,123, respectively, that were $100,000 or greater. Maturities of these certificates were as follows: 1999 1998 1997 ------------------------------------- One to three months ..................... $13,313,388 $ 8,633,273 $10,745,903 Three to six months ..................... 6,339,507 9,647,980 4,324,058 Six to twelve months .................... 9,901,595 10,997,407 4,131,882 Over twelve months ...................... 7,549,259 2,658,717 3,776,280 ------------------------------------ Total certificates of deposit greater than $100,000 .... $37,103,749 $31,937,377 $22,978,123 ===================================== VI. Return on Equity and Assets. The following table presents the return on assets and equity and the equity to assets ratio of the Company for the years ended June 30, 1999, 1998 and 1997. 1999 1998 1997 -------------------------------------------- Average total assets ... $287,760,434 $209,373,383 $141,797,885 Average equity ......... $ 20,299,371 $ 16,690,420 $ 12,978,982 Net income ............. $ 2,464,821 $ 2,393,272 $ 1,219,336 Return on average assets .86% 1.14% 0.86% Return on average equity 12.14% 14.34% 9.39% Average equity to assets ratio ................ 7.05% 7.97% 9.15% VII. Short Term Borrowings. The information requested is disclosed in the Notes to Consolidated Financial Statements in Note 7 on page 33. 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. QUAD CITY HOLDINGS, INC. Dated: September 14, 1999 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 September 14, 1999 Michael A. Bauer /s/ Douglas M. Hultquist President, Chief Executive September 14, 1999 Douglas M. Hultquist and Financial Officer and Director /s/ Richard R. Horst Director and Secretary September 14, 1999 Richard R. Horst /s/ James J. Brownson Director September 14, 1999 James J. Brownson /s/ Ronald G. Peterson Director September 14, 1999 Ronald G. Peterson /s/ John W. Schricker Director September 14, 1999 John W. Schricker /s/ Robert A. Van Vooren Director September 14, 1999 Robert A. Van Vooren INDEX TO EXHIBITS Incorporated Herein by in Filed Sequential Exhibit No. Description Reference To Herewith Page No. - --------------------------------------------------------------------------------------------- 3.1 Certificate of Exhibit 3.1 to the Incorporation of Quad Registration City Holdings, Inc., as Statement of Quad amended City Holdings, Inc. on Form SB-2, File No. 33-67028 3.2 Bylaws of Quad City Exhibit 3.2 to the Holdings, Inc. Registration Statement of Quad City Holdings, Inc. on Form SB-2, File No. 33-67028 4.1 Specimen Stock Exhibit 4.1 to the Certificate of Quad Registration City Holdings, Inc.(See Statement of Quad also Articles VIII, XII City Holdings, Inc. and XIII of Exhibit 3.1 on Form SB-2, File and Articles II, VI, IX No. 33-67028 and XII of Exhibit 3.2) 10.1 Quad City Holdings, Exhibit 10.1 to the Inc. Stock Option Plan Registration Statement of Quad City Holdings, Inc. on Form SB-2, File No. 33-67028 10.2 Form of Stock Option Exhibit 10.2 to the Agreement between Registration Quad City Holdings, Inc. Statement of Quad and each of Michael A. City Holdings, Inc. Bauer, Douglas M. on Form SB-2, File Hultquist and Victor J. No. 33-67028 Quinn 10.3 Employment Agreement Exhibit 10.3 to the between Quad City Registration Holdings, Inc. and Statement of Quad Michael A. Bauer dated City Holdings, Inc. May 4, 1993 on Form SB-2, File No. 33-67028 10.4 Employment Agreement Exhibit 10.4 to the between Quad City Registration Holdings, Inc. and Statement of Quad Michael A. Bauer dated City Holdings, Inc. July 1, 1993 on Form SB-2, File No. 33-67028 10.5 Employment Agreement Exhibit 10.5 to the between Quad City Registration Holdings, Inc. and Statement of Quad Douglas M. Hultquist City Holdings, Inc. dated April 30, 1993 on Form SB-2, File No. 33-67028 10.6 Employment Agreement Exhibit 10.6 to the between Quad City Registration Holdings, Inc. and Statement of Quad Douglas M. Hultquist City Holdings, Inc. dated July 1, 1993 on Form SB-2, File No. 33-67028 Incorporated Herein by in Filed Sequential Exhibit No. Description Reference To Herewith Page No. - --------------------------------------------------------------------------------------------- 10.7 Development Agreement Exhibit 10.7 to the between Quad City Registration Holdings, Inc. and Statement of Quad Kaizen, Inc. City Holdings, Inc. on Form SB-2, File No. 33-67028 10.8 Lease/Option Exhibit 10.8 to the Agreement between Registration Quad City Holdings, Inc. Statement of Quad and Kaizen, Inc. City Holdings, Inc. on Form SB-2, File No. 33-67028 12.1 Statement re: Computation of Ratios X 53 21.1 Subsidiaries of Quad City Holdings, Inc. X 54 23.1 Consent of McGladrey and Pullen X 55 27 Financial Data Schedule X
EX-12 2 Exhibit 12.1 Quad City Holdings, Inc. Calculation of earnings to fixed charges Jun-99 Jun-98 Jun-97 Jun-96 Jun-95 ------------------------------------------- Earnings before income taxes .................................... 4,079 4,071 1,384 683 (374) ------------------------------------------ Add: preferred dividends on a pretax basis ...................... 0 0 0 0 0 Add: fixed charges .............................................. 11,269 8,437 4,997 3,495 1,896 ------------------------------------------ Earnings including interest expense on deposits (1) ............. 15,348 12,508 6,381 4,178 1,522 Less: interest expense on deposits .............................. 9,010 6,971 4,358 3,350 1,793 ------------------------------------------ Earnings excluding interest expense on deposits (2) ............. 6,338 5,537 2,023 828 (271) Fixed charges: Interest expense on deposits ................................. 9,010 6,971 4,358 3,350 1,793 Interest expense on borrowings ............................... 2,017 1,371 635 137 103 Portion of rents representative of interest factor ........... 242 95 4 8 0 ------------------------------------------ Fixed charges including interest expense on deposits (3) ........ 11,269 8,437 4,997 3,495 1,896 Less interest expense on deposits ............................... 9,010 6,971 4,358 3,350 1,793 Fixed charges excluding interest expense on deposits (4) ........ 2,259 1,466 639 145 103 ========================================== Rents ........................................................... 430 176 10 20 0 Portion of rents representative of interest factor .............. 242 95 4 8 0 Ratio of earnings to fixed charges and preferred stock dividends: Excluding interest expense on deposits ( (2)/(4) ) ........... 2.81 3.78 3.17 5.71 N/A Including interest expense on deposits ( (1)/(3) ) ........... 1.36 1.48 1.28 1.20 N/A
EX-21 3 21.1 Exhibit 21 Subsidiaries of the Registrant Subsidiaries State of Incorporation - ----------------------------------------------------- ---------------------- Quad City Bank and Trust Company .................... Iowa Quad City Bancard, Inc. ............................. Delaware Quad City Holdings Capital Trust I .................. Delaware EX-23 4 MCGLADREY & PULLEN, LLP Certified Public Accountants and Consultants We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 pertaining to the Quad City Holdings, Inc. 401(k)/Profit Sharing Plan (File No. 33-77420) and Stock Option Plan (File No. 33-78024) of our report dated July 23, 1999 relating to the June 30, 1999 financial statements of Quad City Holdings, Inc. and to the reference to our Firm under the caption "Experts" contained therein. /s/ MCGLADREY & PULLEN, LLP Davenport, Iowa September 14, 1999 EX-27 5
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE JUNE 30, 1999 FORM 10-K OF QUAD CITY HOLDINGS, INC. AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS 1,000 YEAR JUN-30-1999 JUN-30-1999 8,528 12,535 39,125 0 50,942 724 727 197,977 2,895 321,346 247,966 13,186 8,615 33,106 0 0 2,296 16,177 321,346 15,642 2,285 2,188 20,116 9,010 11,027 9,089 892 4 9,679 4,079 2,465 0 0 2,465 1.08 1.03 3.42 1,288 238 0 0 2,350 479 132 2,895 2,895 0 379
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