Note

Nature of Business and Significant Accounting Policies

Basis of presentation

The acronyms and abbreviations identified below are used in the Notes to the Consolidated Financial Statements

, as well as in the other sections of this Form

-K (including appendices). It

may

be helpful to refer back to this page as you read this report.

Allowance: Allowance for estimated losses on loans/leases	Goldman Sachs: Goldman Sachs and Company
AOCI: Accumulated other comprehensive income (loss)	HTM: Held to maturity
AFS: Available for sale	Iowa Superintendent: Iowa Superintendent of Banking
ASC: Accounting Standards Codification	LCR: Liquidity Coverage Ratio
ASC 805: Business Combination Standard	m2: m2 Lease Funds, LLC
ASU: Accounting Standards Update	MD&A: Management's Discussion & Analysis
BHCA: Bank Holding Company Act of 1956	MSA: Metropolitan Statistical Area
BOLI: Bank-owned life insurance	NIM: Net interest margin
Caps: Interest rate cap derivatives	NPA: Nonperforming asset
CFPB: Bureau of Consumer Financial Protection	NPL: Nonperforming loan
Community National: Community National Bancorporation	NSFR: Net Stable Funding Ratio
CNB: Community National Bank	OREO: Other real estate owned
CRA: Community Reinvestment Act	OTTI: Other-than-temporary impairment
CRBT: Cedar Rapids Bank & Trust Company	PCAOB: Public Company Accounting Oversight Board
CRE: Commercial real estate	PCI: Purchased credit impaired
CRE Guidance: Interagency Concentrations in Commercial Real Estate	Provision: Provision for loan/lease losses
Lending, Sound Risk Management Practices guidance	PUD LOC: Public Unit Deposit Letter of Credit
CSB: Community State Bank	QCBT: Quad City Bank & Trust Company
C&I: Commercial and industrial	RB&T: Rockford Bank & Trust Company
Dodd-Frank Act: Dodd-Frank Wall Street Reform and	ROAA: Return on Average Assets
Consumer Protection Act	ROACE: Return on Average Common Equity
IDFPR: Illinois Department of Financial & Professional Regulation	ROAE: Return on Average Equity
DGCL: Delaware General Corporation Law	SBA: U.S. Small Business Administration
DIF: Deposit Insurance Fund	SBLF: Small Business Lending Fund
EPS: Earnings per share	SEC: Securities and Exchange Commission
Exchange Act: Securities Exchange Act of 1934, as amended	SERPs: Supplemental Executive Retirement Plans
FASB: Financial Accounting Standards Board	TA: Tangible assets
FDIC: Federal Deposit Insurance Corporation	Tax Act: Tax Cuts and Jobs Act
Federal Reserve: Board of Governors of the Federal Reserve System	TCE: Tangible common equity
FHLB: Federal Home Loan Bank	TDRs: Troubled debt restructurings
FICO: Financing Corporation	TEY: Tax equivalent yield
FRB: Federal Reserve Bank of Chicago	The Company: QCR Holdings, Inc.
FTEs: Full-time equivalents	Treasury: U.S. Department of the Treasury
GAAP: Generally Accepted Accounting Principles	USA Patriot Act: Uniting and Strengthening America by
Guaranty: Guaranty Bankshares, Ltd.	Providing Appropriate Tools Required to Intercept and
Guaranty Bank: Guaranty Bank and Trust Company	Obstruct Terrorism Act of 2001
	USDA: U.S. Department of Agriculture

Nature of business

QCR Holdings, Inc.

is a bank holding company that has elected to operate as a financial holding company under the BHCA. The Company provides bank and bank-related services through its banking subsidiaries, QCBT, CRBT, CSB and RB&T. The Company also engages in direct financing lease contracts through its wholly-owned equity investment by QCBT in

m2,

headquartered in Milwaukee, Wisconsin.

October 1, 2017

the Company acquired Guaranty Bank, headquartered in Cedar Rapids, Iowa, from Guaranty

. On

December 2, 2017,

the Company merged Guaranty Bank with and into CRBT, with CRBT as the surviving bank.

August 31, 2016,

the Company acquired Community State Bank in Ankeny, Iowa (Des Moines MSA).

The financial results of the acquisitions of both Guaranty Bank and CSB for the periods since acquisition are included in this report. See Note

to the Consolidated Financial Statements for additional information.

QCBT

is a commercial bank that serves the Iowa and Illinois Quad Cities and adjacent communities. CRBT is a commercial bank that serves Cedar Rapids, Iowa, and adjacent communities including Cedar Falls and Waterloo, Iowa. CSB is a commercial bank that serves Des Moines, Iowa, and adjacent communities. RB&T is a commercial bank that serves Rockford, Illinois, and adjacent communities.

QCBT

, CRBT, and CSB are chartered and regulated by the state of Iowa, and RB&T is chartered and regulated by the state of Illinois. All

four

subsidiary banks are insured and subject to regulation by the FDIC and all are members of and regulated by the Federal Reserve System.

The remaining subsidiaries of the Company consist of

six

non-consolidated subsidiaries formed for the issuance of trust preferred securities. See Note

for a listing of these subsidiaries and additional information.

Significant accounting policies:

Accounting estimates

: The preparation of financial statements, in conformity with GAAP, 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. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance, OTTI of securities, the fair value of financial instruments, and the fair value of assets acquired/liabilities assumed in a business combination.

Principles of consolidation

: The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries, except those

six

subsidiaries formed for the issuance of trust preferred securities which do

not

meet the criteria for consolidation. See Note

for a detailed listing of these 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 include cash on hand and noninterest bearing amounts due from banks. Cash flows from federal funds sold, interest bearing deposits at financial institutions, loans/leases, deposits, and short-term borrowings are treated as net increases or decreases.

Cash and due from banks

: The subsidiary banks are required by federal banking regulations to maintain certain cash and due from bank reserves. The reserve requirement was approximately

$41,803,000

and

$42,233,000

as of

December 31, 2017

and

2016,

respectively.

Investment securities

: Investment securities held to maturity are those debt securities that the Company has the ability and intent to hold until maturity regardless of changes in market conditions, liquidity needs, or changes in general economic conditions. Such securities are carried at cost adjusted for amortization of premiums and accretion of discounts. If the ability or intent to hold to maturity is

not

present for certain specified securities, such securities are considered AFS 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 AFS would be based on various factors, including movements in interest rates, changes in the maturity mix of the Company's assets and liabilities, liquidity needs, regulatory capital considerations, and other factors. Securities AFS are carried at fair value. Unrealized gains or losses, net of taxes, are reported as increases or decreases in AOCI. Realized gains or losses, determined on the basis of the cost of specific securities sold, are included in earnings.

All securities are evaluated to determine whether declines in fair value below their amortized cost are other-than-temporary.

In estimating

OTTI losses on AFS debt securities, management considers a number of factors including, but

not

limited to, (

) the length of time and extent to which the fair value has been less than amortized cost, (

) the financial condition and near-term prospects of the issuer, (

) the current market conditions, and (

) the lack of intent of the Company to sell the security prior to recovery and whether it is

not

more-likely-than-

not

that it will be required to sell the security prior to recovery.

If the Company

lacks the intent to sell the security, and it is

not

more-likely-than-

not

the entity will be required to sell the security before recovery of its amortized cost basis, the Company will recognize the credit component of an OTTI of a debt security in earnings and the remaining portion in other comprehensive income. For held to maturity debt securities, the amount of an OTTI recorded in other comprehensive income for the noncredit portion would be amortized prospectively over the remaining life of the security on the basis of the timing of future estimated cash flows of the security.

Loans receivable

held for sale

: Residential real estate loans which are originated and intended for resale in the secondary market in the foreseeable future are classified as held for sale. These loans are carried at the lower of cost or estimated market value in the aggregate. As assets specifically acquired for resale, the origination of, disposition of, and gain/loss on these loans are classified as operating activities in the statement of cash flows.

Loans receivable, held for investment

: Loans that management has the intent and ability to hold for the foreseeable future, or until pay-off or maturity occurs, are classified as held for investment. These loans are stated at the amount of unpaid principal adjusted for charge-offs, the allowance, and any deferred fees and/or costs on originated loans. Interest is credited to earnings as earned based on the principal amount outstanding. Deferred direct loan origination fees and/or costs are amortized as an adjustment of the related loan’s yield. As assets held for and used in the production of services, the origination and collection of these loans are classified as investing activities in the statement of cash flows.

The Company discloses

the allowance for credit losses (also known as the allowance) by portfolio segment, and credit quality information, impaired financing receivables, nonaccrual status, and TDRs by class of financing receivable. A portfolio segment is the level at which the Company develops and documents a systematic methodology to determine its allowance for credit losses. A class of financing receivable is a further disaggregation of a portfolio segment based on risk characteristics and the Company’s method for monitoring and assessing credit risk. See the following information and Note

The Company

’s portfolio segments are as follows:

●

C&I

●

CRE

●

Residential real estate

●

Installment and other consumer

Direct financing leases

are considered a segment within the overall loan/lease portfolio.

The

Company’s classes of loans receivable are as follows:

●

C&I

●

Owner-occupied

CRE

●

Commercial construction, land development, and other land loans that are

not

owner-occupied

CRE

●

Other non-owner-occupied

CRE

●

Residential real estate

●

Installment and other consumer

Direct financing leases

are considered a class of financing receivable within the overall loan/lease portfolio. The accounting policies for direct financing leases are disclosed below.

Generally

, for all classes of loans receivable, loans are considered past due when contractual payments are delinquent for

days or greater.

For al

l classes of loans receivable, loans will generally be placed on nonaccrual status when the loan has become

days past due (unless the loan is well secured and in the process of collection); or if any of the following conditions exist:

●

It becomes evident that the borrower will

not

make payments, or will

not

or cannot meet the terms for renewal of a matured loan

;

●

When full repayment of principal and interest is

not

expected

;

●

When the loan is graded “doubtful”

;

●

When the borrower files bankruptcy and an approved plan of reorganization or liquidation is

not

anticipated in the near future

; or

●

When foreclosure action is initiated.

When a loan is placed on nonaccrual status, income recognition is ceased. Previously recorded but uncollected amounts of interest on nonaccrual loans are reversed at the time the loan is placed on nonaccrual status. Generally, cash collected on nonaccrual loans is applied to principal. Should full collection of principal be expected, cash collected on nonaccrual loans can be recognized as interest income.

For all classes of loans receivable, nonaccrual loans

may

be restored to accrual status provided the following criteria are met:

●

The loan is current, and all principal and interest amounts contractually due have been made

;

●

All principal and interest amounts contractually due, including past due payments, are reasonabl

y assured of repayment within a reasonable period; and

●

There is a period of minimum repayment performance, as follows, by the borrower in accordance with contractual terms:

○

Six months of repayment performance for contractual monthly payments, or

○

One year of repayment performance for contractual quarterly or semi-annual payments

Direct finance leases receivable, held for investment

: The Company leases machinery and equipment to customers under leases that qualify as direct financing leases for financial reporting and as operating leases for income tax purposes. Under the direct financing method of accounting, the minimum lease payments to be received under the lease contract, together with the estimated unguaranteed residual values (approximately

25%

of the cost of the related equipment), are recorded as lease receivables when the lease is signed and the lease property delivered to the customer. The excess of the minimum lease payments and residual values over the cost of the equipment is recorded as unearned lease income. Unearned lease income is recognized over the term of the lease on a basis that results in an approximate level rate of return on the unrecovered lease investment.

Lease income is recognized on the interest method. Residual

value is the estimated fair market value of the equipment on lease at lease termination. In estimating the equipment’s fair value at lease termination, the Company relies on historical experience by equipment type and manufacturer and, where available, valuations by independent appraisers, adjusted for known trends.

The Company

’s estimates are reviewed continuously to ensure reasonableness; however, the amounts the Company will ultimately realize could differ from the estimated amounts. If the review results in a lower estimate than had been previously established, a determination is made as to whether the decline in estimated residual value is other-than-temporary. If the decline in estimated unguaranteed residual value is judged to be other-than-temporary, the accounting for the transaction is revised using the changed estimate. The resulting reduction in the investment is recognized as a loss in the period in which the estimate is changed. An upward adjustment of the estimated residual value is

not

recorded.

he policies for delinquency and nonaccrual for direct financing leases are materially consistent with those described above for all classes of loan receivables.

The Company defers and amortizes fees and certain incremental direct costs over the contractual term of the lease as an adjustment to the yield. These initial direct leasing costs generally approximate

5.5%

of the leased asset’s cost. The unamortized direct costs are recorded as a reduction of unearned lease income.

TDRs

: TDRs exist when the Company, for economic or legal reasons related to the borrower’s/lessee’s financial difficulties, grants a concession (either imposed by court order, law, or agreement between the borrower/lessee and the Company) to the borrower/lessee that it would

not

otherwise consider. The Company attempts to maximize its recovery of the balances of the loans/leases through these various concessionary restructurings.

The following criteria,

related to granting a concession, together or separately, create a TDR:

●

A modification of terms of a debt such as

one

or a combination of:

○

The reduction of the stated interest rate

to a rate lower than the current market rate for new debt with similar risk.

○

The extension of the maturity date or dates at a stated interest rate lower than the current market rate for new debt with similar risk.

○

The reduction of the face amount or maturity amount of the debt as stated in the instrument or other agreement.

○

The reduction of accrued interest.

●

A transfer from the borrower

/lessee to the Company of receivables from

third

parties, real estate, other assets, or an equity position in the borrower to fully or partially satisfy a loan.

●

The issuance or other granting of an equity position to the

Company to fully or partially satisfy a debt unless the equity position is granted pursuant to existing terms for converting the debt into an equity position.

Allowance

For all portfolio segments, the allowance is established as losses are estimated to have occurred through a provision that is charged to earnings. Loan/lease losses, for all portfolio segments, are charged against the allowance when management believes the uncollectability of a loan/lease balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

For all portfolio segments

, the allowance is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans/leases in light of historical experience, the nature and volume of the loan/lease portfolio, adverse situations that

may

affect the borrower’s/lessee’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

A discussion of the risk characteristics and the allowance by each portfolio segment follows:

For

C&I loans, the Company focuses on small and mid-sized businesses with primary operations as wholesalers, manufacturers, building contractors, business services companies, other banks, and retailers. The Company provides a wide range of C&I loans, including lines of credit for working capital and operational purposes, and term loans for the acquisition of facilities, equipment and other purposes. Approval is generally based on the following factors:

●

Ability and stability of current

management of the borrower;

●

Stable earnings with positive financial trends;

●

Sufficient cash flow to support debt repayment;

●

Earnings projections based on reasonable assumptions;

●

Financial strength of the industry and business; and

●

Value and marketability of collateral.

Collateral for

C&I loans generally includes accounts receivable, inventory, equipment and real estate. The Company’s lending policy specifies approved collateral types and corresponding maximum advance percentages. The value of collateral pledged on loans must exceed the loan amount by a margin sufficient to absorb potential erosion of its value in the event of foreclosure and cover the loan amount plus costs incurred to convert it to cash.

The

Company’s lending policy specifies maximum term limits for C&I loans. For term loans, the maximum term is generally

years with average terms ranging from

years. For lines of credit, the maximum term is generally

365

days.

In addition, the

Company often takes personal guarantees or cosigners to help assure repayment. Loans

may

be made on an unsecured basis if warranted by the overall financial condition of the borrower.

CRE

loans are subject to underwriting standards and processes similar to C&I loans, in addition to those standards and processes specific to real estate loans. Collateral for CRE loans generally includes the underlying real estate and improvements, and

may

include additional assets of the borrower. The Company’s lending policy specifies maximum loan-to-value limits based on the category of CRE (CRE loans on improved property, raw land, land development, and commercial construction). These limits are the same limits established by regulatory authorities.

The

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

In addition, management tracks the level of owner-occupied

CRE loans versus non-owner occupied loans. Owner-occupied loans are generally considered to have less risk. As of

December 31, 2017

and

2016,

approximately

26%

and

30%,

respectively, of the CRE loan portfolio was owner-occupied.

The Company

’s lending policy incorporates regulatory guidelines which stipulate that non-owner occupied CRE lending in excess of

300%

of total risk-based capital, and construction, land development, and other land loans in excess of

100%

of total risk-based capital warrant the use of heightened risk management practices. As of

December 31, 2017

and

2016,

QCBT, CRBT and RB&T were in compliance with these limits. Although the CSB’s loan portfolio has historically been real estate dominated and its real estate portfolio levels exceed these policy limits, it has established a Credit Risk Committee to routinely monitor its real estate loan portfolio. CSB’s real estate levels, while still elevated at

December 31, 2017,

have declined since

December 31, 2016.

In some instances for all loans/leases, it

may

be appropriate to originate or purchase loans/leases that are exceptions to the guidelines and limits established within the

Company’s lending policy described above and below. In general, exceptions to the lending policy do

not

significantly deviate from the guidelines and limits established within the Company’s lending policy and, if there are exceptions, they are clearly noted as such and specifically identified in loan/lease approval documents.

For

C&I and CRE loans, the allowance consists of specific and general components.

The specific component relates to loans that are classified as impaired

, as defined below. For those loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan are lower than the carrying value of that loan.

For

C&I loans and all classes of CRE loans, a loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are

not

classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a case-by-case basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

The general component

consists of quantitative and qualitative factors and covers non-impaired loans. The quantitative factors are based on historical charge-off experience and expected loss given default derived from the Company’s internal risk rating process. See below for a detailed description of the Company’s internal risk rating scale. The qualitative factors are determined based on an assessment of internal and/or external influences on credit quality that are

not

fully reflected in the historical loss or risk rating data.

For

C&I and CRE loans, the Company utilizes the following internal risk rating scale:

. Highest Quality (Pass) – loans of the highest quality with

credit risk, including those fully secured by subsidiary bank certificates of deposit and U.S. government securities.

. Superior Quality (Pass) – loans with very strong credit quality. Borrowers have exceptionally strong earnings, liquidity, capital, cash flow coverage, and management ability. Includes loans secured by high quality marketable securities, certificates of deposit from other institutions, and cash value of life insurance. Also includes loans supported by U.S. government, state, or municipal guarantees.

. Satisfactory Quality (Pass)

–

loans with satisfactory credit quality. Established borrowers with satisfactory financial condition, including credit quality, earnings, liquidity, capital and cash flow coverage. Management is capable and experienced. Collateral coverage and guarantor support, if applicable, are more than adequate. Includes loans secured by personal assets and business assets, including equipment, accounts receivable, inventory, and real estate.

. Fair Quality (Pass)

–

loans with moderate but still acceptable credit quality. The primary repayment source remains adequate; however, management’s ability to maintain consistent profitability is unproven or uncertain. Borrowers exhibit acceptable leverage and liquidity.

May

include new businesses with inexperienced management or unproven performance records in relation to peer, or borrowers operating in highly cyclical or declining industries.

. Early Warning (Pass)

–

loans where the borrowers have generally performed as agreed, however unfavorable financial trends exist or are anticipated. Earnings

may

be erratic, with marginal cash flow or declining sales. Borrowers reflect leveraged financial condition and/or marginal liquidity. Management

may

be new and a track record of performance has yet to be developed. Financial information

may

be incomplete, and reliance on secondary repayment sources

may

be increasing.

. Special Mention – loans where the borrowers exhibit credit weaknesses or unfavorable financial trends requiring close monitoring. Weaknesses and adverse trends are more pronounced than Early Warning loans, and if left uncorrected,

may

jeopardize repayment according to the contractual terms. Currently,

loss of principal or interest is expected. Borrowers in this category have deteriorated to the point that it would be difficult to refinance with another lender. Special Mention should be assigned to borrowers in turnaround situations. This rating is intended as a transitional rating, therefore, it is generally

not

assigned to a borrower for a period of more than

one

year.

. Substandard

–

loans which are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if applicable. These loans have a well-defined weakness or weaknesses which jeopardize repayment according to the contractual terms. There is distinct loss potential if the weaknesses are

not

corrected. Includes loans with insufficient cash flow coverage which are collateral dependent, other real estate owned, and repossessed assets.

. Doubtful

–

loans which have all the weaknesses inherent in a Substandard loan, with the added characteristic that existing weaknesses make full principal collection, on the basis of current facts, conditions and values, highly doubtful. The possibility of loss is extremely high, but because of pending factors, recognition of a loss is deferred until a more exact status can be determined. All doubtful loans will be placed on non-accrual, with all payments, including principal and interest, applied to principal reduction.

The Company has certain loans risk-rated

(substandard), which are

not

classified as impaired based on the facts of the credit. For these non-impaired and risk-rated

loans, the Company does

not

follow the same allowance methodology as it does for all other non-impaired, collectively evaluated loans. Rather, the Company performs a more detailed analysis including evaluation of the cash flow and collateral valuations. Based upon this evaluation, an estimate of the probable loss in this portfolio is collectively evaluated under ASC

450

20.

These non-impaired risk-rated

loans exist primarily in the C&I and CRE segments.

For term

C&I and CRE loans greater than

$1,000,000,

a loan review is required within

months of the most recent credit review. The review is completed in enough detail to, at a minimum, validate the risk rating. Additionally, the review shall include an analysis of debt service requirements, covenant compliance, if applicable, and collateral adequacy. The frequency of the review is generally accelerated for loans with poor risk ratings.

The

Company’s Loan Quality area performs a documentation review of a sampling of C&I and CRE loans, the primary purpose of which is to ensure the credit is properly documented and closed in accordance with approval authorities and conditions. A review is also performed by the Company’s Internal Audit Department of a sampling of C&I and CRE loans for proper documentation, according to an approved schedule. Validation of the risk rating is also part of Internal Audit’s review (performed by Internal Loan Review). Additionally, over the past several years, the Company has contracted an independent outside

third

party to review a sampling of C&I and CRE loans. Validation of the risk rating is part of this review as well.

The Company

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

For direct financing leases, the allowance consists of specific and general components.

The specific component relates to leases that are classified as impaired, as defined for commercial loans above. For those leases that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired lease is lower than the carrying value of that lease.

The general component consists of quantitative and qualitative factors and covers nonimpaired leases. The quantitative factors are based on historical charge-off experience

for the entire lease portfolio. The qualitative factors are determined based on an assessment of internal and/or external influences on credit quality that are

not

fully reflected in the historical loss data.

Generally, the

Company’s residential real estate loans conform to the underwriting requirements of Freddie Mac and Fannie Mae to allow the subsidiary banks to resell loans in the secondary market. The subsidiary banks structure most loans that will

not

conform to those underwriting requirements as adjustable rate mortgages that mature or adjust in

one

five

years or fixed rate mortgages that mature in

years, and then retain these loans in their portfolios. Servicing rights are

not

presently retained on the loans sold in the secondary market. The Company’s lending policy establishes minimum appraisal and other credit guidelines.

The

Company provides many types of installment and other consumer loans including motor vehicle, home improvement, home equity, signature loans and small personal credit lines. The Company’s lending policy addresses specific credit guidelines by consumer loan type.

For

residential real estate loans, and installment and other consumer loans, these large groups of smaller balance homogenous loans are collectively evaluated for impairment. The Company applies a quantitative factor based on historical charge-off experience in total for each of these segments. Accordingly, the Company generally does

not

separately identify individual residential real estate loans, and/or installment or other consumer loans for impairment disclosures, unless such loans are the subject of a restructuring agreement due to financial difficulties of the borrower.

TDRs

are considered impaired loans/leases and are subject to the same allowance methodology as described above for impaired loans/leases by portfolio segment. Once a loan is classified as a TDR, it will remain a TDR until the loan is paid off, charged off, moved to OREO or restructured into a new note without a concession. TDR status

may

also be removed if the TDR was restructured in a prior calendar year, is current, accruing interest and shows sustained performance.

Credit related financial instruments

: In the ordinary course of business, the Company has entered into commitments to extend credit and standby letters of credit. Such financial instruments are recorded when they are funded.

Transfers of financial assets

: Transfers of financial assets are accounted for as sales only when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when: (

) the assets have been isolated from the Company, (

) the transferee obtains the right to pledge or exchange the assets it received, and

condition both constrains the transferee from taking advantage of its right to pledge or exchange and provides more than a modest benefit to the transferor, and (

) the Company does

not

maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets. In addition, for transfers of a portion of financial assets (for example, participations of loan receivables), the transfer must meet the definition of a “participating interest” in order to account for the transfer as a sale. Following are the characteristics of a “participating interest”:

●

Pro-rata ownership in an entire financial asset

●

From the date of the transfer, all cash flows received from entire financial assets are divided proportionately

among the participating interest holders in an amount equal to their share of ownership.

●

The rights of each participating interest holder have the same priority, and

participating interest holder

’s interest is subordinated to the interest of another participating interest holder. That is,

participating interest holder is entitled to receive cash before any other participating interest holder under its contractual rights as a participating interest holder.

●

party has the right to pledge or exchange the entire financial asset unless all participating interest holders agree to pledge or exchange the entire financial asset.

BOLI

: BOLI is carried at cash surrender value with increases/decreases reflected as income/expense in the statement of income.

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 of the assets.

Restricted investment securities

: Restricted investment securities represent FHLB and FRB common stock. The stock is carried at cost. These equity securities are “restricted” in that they can only be sold back to the respective institution or another member institution at par. Therefore, they are less liquid than other tradable equity securities. The Company views its investment in restricted stock as a long-term investment. Accordingly, when evaluating for impairment, the value is determined based on the ultimate recovery of the par value, rather than recognizing temporary declines in value. There have been

other-than-temporary write-downs recorded on these securities.

OREO

: Real estate acquired through, or in lieu of, loan foreclosures, is held for sale and initially recorded at fair value less costs to sell, establishing a new cost basis. Any writedown to fair value taken at the time of foreclosure is charged to the allowance. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less costs to sell. Subsequent write-downs to fair value are charged to earnings.

Repossessed assets

: Equipment or other non-real estate property acquired through, or in lieu of foreclosure, is held for sale and initially recorded at fair value less costs to sell.

Goodwill

: The Company recorded goodwill totaling

$3,222,688

from QCBT’s purchase of

80%

August 2005.

Goodwill totaling

$9,888,225

was also recognized as part of the acquisition of CSB in

2016.

The goodwill is

not

being amortized, but is evaluated at least annually for impairment. An impairment charge is recognized when the calculated fair value of the reporting unit, including goodwill, is less than its carrying amount. Based on the annual analysis completed as of

September 30, 2017,

the Company determined that the goodwill was

not

impaired. Goodwill totaling

$15,223,179

was also recognized as part of the acquisition of Guaranty Bank in

2017.

See Note

to the Consolidated Financial Statements for additional information. This goodwill is

not

being amortized, and will be evaluated annually for impairment beginning in

2018.

Core deposit intangible

: The Company has recorded a core deposit intangible from historical acquisitions including CNB, CSB and Guaranty Bank. The core deposit intangible was the portion of the acquisition purchase price which represented the value assigned to the existing deposit base at acquisition. See Notes

and

to the Consolidated Financial Statements for additional information. The core deposit intangibles have a finite life and are amortized over the estimated useful life of the deposits (estimated to be

ten

years).

Swap transactions

: The Company offers a loan swap program to certain commercial loan customers. Through this program, the Company originates a variable rate loan with the customer. The Company and the swap customer will then enter into a fixed interest rate swap. Lastly, an identical offsetting swap is entered into by the Company with a counterparty. These “back-to-back” swap arrangements are intended to offset each other and allow the Company to book a variable rate loan, while providing the customer with a contract for fixed interest payments. In these arrangements, the Company’s net cash flow is equal to the interest income received from the variable rate loan originated with the customer. These customer swaps are

not

designated as hedging instruments and are recorded at fair value in other assets and other liabilities. Additionally, the Company receives an upfront fee from the counterparty, dependent upon the pricing that is recognized upon receipt from the counterparty. Swap fee income totaled

$3.1

million,

$1.7

million and

$1.7

million for the years ending

December 31,

2017,

2016

and

2015,

respectively.

Derivatives and

hedging activities

: The Company enters into derivative financial instruments as part of its strategy to manage its exposure to changes in interest rates.

Derivative instruments represent contracts between parties that result in

one

party delivering cash to the other party based on a notional amount and an underlying index (such as a rate, security price or price index) as specified in the contract. The amount of cash delivered from

one

party to the other is determined based on the interaction of the notional amount of the contract with the underlying index.

The derivative financial instruments currently used by the Company to manage its exposure to interest rate risk include: (

) interest rate lock commitments provided to customers to fund certain mortgage loans to be sold into the secondary market (although this type of derivative is negligible); and (

) interest rate caps to manage the interest rate risk of certain

short-term fixed rate liabilities.

Interest rate caps are valued by the transaction counterparty on a monthly basis and corroborated by a

third

party annually. The company uses the hypothetical derivative method to assess and measure effectiveness in accordance with

ASC

815,

Derivatives and Hedging.

Preferred stock

: The Company currently has

250,000

shares of preferred stock authorized, but

none

outstanding as of

December 31, 2017

and

2016.

Should the Company have preferred stock outstanding in the future, dividends declared on those shares would be deducted from net income to arrive at net income available to common stockholders. Net income available to common stockholders would then be used in the earnings per share computations.

Treasury

tock

: Treasury stock is accounted for by the cost method, whereby shares of common stock reacquired are recorded at their purchase price. When treasury stock is reissued, any difference between the sales proceeds, or fair value when issued for business combinations, and the cost is recognized as a charge or credit to additional paid-in capital. The Company’s then outstanding treasury stock was retired in

2015.

Stock-based compensation plans:

The Company accounts for stock-based compensation with measurement of compensation cost for all stock-based awards at fair value on the grant date and recognition of compensation over the requisite service period for awards expected to vest.

As discussed in Note

15,

during the years ended

December 31,

2017,

2016,

and

2015,

the Company recognized stock-based compensation expense for the grant-date fair value of stock based awards that are expected to vest over the requisite service period of

$1,187,035,

$947,174

and

$941,469,

respectively. As required, management made an estimate of expected forfeitures and is recognizing compensation costs only for those equity awards expected to vest.

The Company use

s the Black-Scholes option pricing model to estimate the fair value of stock option grants with the following assumptions for the indicated periods:

	2017				2016				201 5
Dividend yield		0.36%	to	0.47%		0.35%	to	0.51%		0.37%	to	0.46%
Expected volatilit y		29.64%	to	29.95%		29.32%	to	29.37%		28.92%	to	29.32%
Risk-free interest rate		2.50%	to	2.81%		1.73%	to	2.18%		1.89%	to	2.37%
Expected life of option grants (in years)			6				6				6
Weighted-average grant date fair value			$14.75				$7.31				$5.11

The Compan

y also uses the Black-Scholes option pricing model to estimate the fair value of stock purchase grants with the following assumptions for the indicated periods:

	2017				2016				20 15
Dividend yield		0.37%	to	0.42%		0.33%	to	0.59%		0.37%	to	0.45%
Expect ed volatility		19.80%	to	19.86%		12.70%	to	15.60%		8.81%	to	13.10%
Risk-free interest rate		0.67%	to	1.18%		0.39%	to	0.57%		0.09%	to	.016%
Expected life of purchase grants (in months)		3	to	6		3	to	6		3	to	6
Weighted-average grant date fair value			$6.42				$3.28				$2.39

The fair value is amortized on a straight-line basis over the vesting periods of the grants and will be adjusted for subsequent changes in estimated forfeitures. The expected dividend yield assumption is based on the Company's current expectations about its anticipated dividend policy. Expected volatility is based on historical volatility of the Company's common stock price. The risk-free interest rate for periods within the contractual life of the option

or purchase is based on the U.S. Treasury yield curve in effect at the time of the grant. The expected life of the option and purchase grants is derived using the “simplified” method and represents the period of time that options and purchases are expected to be outstanding. Historical data is used to estimate forfeitures used in the model. Two separate groups of employees (employees subject to broad based grants, and executive employees and directors) are used.

As of

December 31,

2017,

there was

$961,972

of unrecognized compensation cost related to stock options granted, which is expected to be recognized over a weighted average period of

1.92

years.

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the quoted price of the Company's common stock for the

495,004

options that were in-the-money at

December 31, 2017.

The aggregate intrinsic value at

December 31, 2017

was

$13.2

million on options outstanding and

$10.5

million on options exercisable. During the years ended

December 31, 2017,

2016

and

2015,

the aggregate intrinsic value of options exercised under the Company's stock option plans was

$1,055,193,

$1,525,902,

and

$480,354,

respectively, and determined as of the date of the option exercise.

Restricted stock awards granted

may

not

be sold or otherwise transferred until the service periods have lapsed. During the vesting periods, participants have voting rights and receive dividends. Upon termination of employment, common shares upon which the service periods have

not

lapsed must be returned to the Company.

All restricted share awards are classified as equity awards. The

grant-date fair value of equity-classified restricted stock awards is amortized as compensation expense on a straight-line basis over the period restrictions lapse.

As of

December 31, 2017,

there was $

1,210,425

of unrecognized compensation cost related to nonvested restricted stock awards expected to be recognized over a period of

2.60

years.

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 eff

ects of changes in tax laws and rates on the date of enactment.

When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than

not

that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are

not

offset or aggregated with other positions. Tax positions that meet the more

likely than

not

recognition threshold are measured as the largest amount of tax benefit that is more than

percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.

Interest and penalties associated with unrecognized tax benefits are classified as additional income taxes in the statement

s of income.

Trust assets

: Trust assets held by the subsidiary banks in a fiduciary, agency, or custodial capacity for their customers, other than cash on deposit at the subsidiary banks, are

not

included in the accompanying consolidated financial statements since such items are

not

assets of the subsidiary banks.

Earnings per share

: See Note

for a complete description and calculation of basic and diluted earnings per share.

Reclassifications

: Certain amounts in the prior year financial statements have been reclassified, with

effect on net income, comprehensive income, or stockholders’ equity, to conform with the current period presentation.

New accounting pronouncements:

May 2014,

FASB issued ASU

2014

09,

Revenue from Contracts with Customers

. ASU

2014

implements a common revenue standard that clarifies the principles for recognizing revenue. The core principle of ASU

2014

is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply the following steps: (i) identify the contract(s) with a customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract and (v) recognize revenue when (or as) the entity satisfies a performance obligation. ASU

2014

was originally effective for the Company on

January 1, 2017,

however, FASB issued ASU

2015

which deferred the effective date in order to provide additional time for both public and private entities to evaluate the impact. ASU

2014

was adopted by the Company on

January 1, 2018

and had

significant financial impact on the Company’s consolidated financial statements. Under the standard, additional disclosures related to non-interest income will be required.

January 2016,

FASB issued ASU

2016

01,

Financial Instruments – Overall

. ASU

2016

makes targeted adjustments to GAAP by eliminating the available for sale classification for equity securities and requiring equity investments to be measured at fair value with changes in fair value recognized in net income. The standard also requires public business entities to use the exit price notion when measuring fair value of financial instruments for disclosure purposes. The standard clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. It also requires an entity to present separately (within other comprehensive income) the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. Additionally, the standard eliminates the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet. ASU

2016

01was

adopted by the Company on

January 1, 2018

and had

significant impact on the consolidated financial statements.

February 2016,

the FASB issued ASU

2016

02,

Leases

. Under ASU

2016

02,

lessees will be required to recognize a lease liability measured on a discounted basis and a right-of-use asset for all leases (with the exception of short-term leases). Lessor accounting is largely unchanged under ASU

2016

02.

However, the definition of initial direct costs was updated to include only initial direct costs that are considered incremental. This change in definition will change the manner in which the Company recognizes the costs associated with originating leases. ASU

2016

is effective for fiscal years beginning after

December 15, 2018,

including interim periods within those fiscal years. Early adoption is permitted for all entities. The Company is in the process of analyzing the impact of adoption on the Company’s consolidated financial statements. The Company is in the process of analyzing the impact of adoption on the Company’s consolidated financial statements.

Effective

January 1, 2017.

The Company adopted

ASU

2016

09,

Compensation – Stock Compensation

. Under the standard, the excess tax benefit (deficiency) related to stock options exercised and restricted stock awards vested is recorded as an adjustment to income tax expense. In the past, this tax benefit (deficiency) was recorded directly to equity. This change in accounting resulted in

$1.2

million of reduced income tax expense for

2017.

June 2016,

the FASB issued ASU

2016

13,

Financial Instruments – Credit Losses

. Under the standard, assets measured at amortized cost (including loans, leases and AFS securities) will be presented at the net amount expected to be collected. Rather than the “incurred” model that is currently being utilized, the standard will require the use of a forward-looking approach to recognizing all expected credit losses at the beginning of an asset’s life. For public companies, ASU

2016

is effective for fiscal years beginning after

December 15, 2019,

including interim periods within those fiscal years. Companies

may

choose to early adopt for fiscal years beginning after

December 15, 2018,

including interim periods within those fiscal years. The Company is in the process of analyzing the impact of adoption on the Company’s consolidated financial statements.

February 2018,

the FASB issued ASU

2018

02,

Income Statement – Reporting Comprehensive Income (Topic

220

): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.

Under the standard, entities are allowed to make a

one

-time reclassification from AOCI to retained earnings for the effect of remeasuring deferred tax liabilities and assets originally recorded in other comprehensive income as a result of the change in the federal tax rate as defined by the Tax Act. ASU

2018

is effective for fiscal years beginning after

December 15, 2018,

including interim periods within those years. Companies

may

choose to early adopt for fiscal years or interim periods that have

not

been issued or made available for issuance as of

February 14, 2018.

The Company chose to early adopt ASU

2018

and apply the guidance to the consolidated financial statements for the year ended

December 31, 2017.

The reclassification from AOCI to retained earnings for

2017

totaled

$304

thousand and is presented in the Consolidated Statements of Changes in Stockholders’ Equity.