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NOTE 4 - DERIVATIVES AND HEDGING ACTIVITIES

9 Months Ended

Sep. 30, 2020

NOTE 4 – DERIVATIVES AND HEDGING ACTIVITIES

The Company uses interest rate swap and cap instruments to manage interest rate risk related to the variability of interest payments due to changes in interest rates.

The Company entered into interest rate caps in December 2019 to hedge against the risk of rising interest rates on liabilities. The liabilities consist of $375.0 million of deposits and the benchmark rates hedged vary at 1-month LIBOR, 3-month LIBOR and Prime. The interest rate caps are designated as cash flow hedges in accordance with ASC 815. An initial premium of $4.3 million was paid upfront for the caps executed in 2019. The details of the interest rate caps are as follows:


			Balance Sheet					Fair Value as of
Hedged Item	Effective Date	Maturity Date	Location	Notional Amount		Strike Rate		September 30, 2020		December 31, 2019
(dollars in thousands)

Deposits	1/1/2020	1/1/2023	Other Assets	$	25,000	1.75	%	$	6	$	112
Deposits	1/1/2020	1/1/2023	Other Assets		50,000	1.57			11		218
Deposits	1/1/2020	1/1/2023	Other Assets		25,000	1.90			5		96
Deposits	1/1/2020	1/1/2023	Other Assets		25,000	1.80			6		109
Deposits	1/1/2020	1/1/2024	Other Assets		25,000	1.75			17		214
Deposits	1/1/2020	1/1/2024	Other Assets		50,000	1.57			35		401
Deposits	2/1/2020	2/1/2024	Other Assets		25,000	1.90			17		202
Deposits	1/1/2020	1/1/2024	Other Assets		25,000	1.80			17		201
Deposits	1/1/2020	1/1/2025	Other Assets		25,000	1.75			37		337
Deposits	1/1/2020	1/1/2025	Other Assets		50,000	1.57			75		617
Deposits	3/1/2020	3/1/2025	Other Assets		25,000	1.90			40		332
Deposits	1/1/2020	1/1/2025	Other Assets		25,000	1.80			38		309
				$	375,000			$	304	$	3,148

The Company has entered into interest rate swaps to hedge against the risk of rising rates on its rolling fixed rate short-term FHLB advances or brokered CDs and its variable rate trust preferred securities. All of the interest rate swaps are designated as cash flow hedges in accordance with ASC 815. The details of the interest rate swaps are as follows:


			Balance Sheet							Fair Value as of
Hedged Item	Effective Date	Maturity Date	Location	Notional Amount		Receive Rate		Pay Rate		September 30, 2020		December 31, 2019
(dollars in thousands)
CRBT - FHLB Advances or Brokered CDs	3/16/2020	3/16/2023	Derivatives - Liabilities	$	30,000	0.23	%	1.12	%	$	(660)	$	-
SFCB - FHLB Advances or Brokered CDs	3/16/2020	3/16/2023	Derivatives - Liabilities		10,000	0.24	%	0.95	%		(181)		-
QCR Holdings Statutory Trust II	9/30/2018	9/30/2028	Derivatives - Liabilities		10,000	3.07	%	5.85	%		(1,963)		(971)
QCR Holdings Statutory Trust III	9/30/2018	9/30/2028	Derivatives - Liabilities		8,000	3.07	%	5.85	%		(1,570)		(777)
QCR Holdings Statutory Trust V	7/7/2018	7/7/2028	Derivatives - Liabilities		10,000	1.83	%	4.54	%		(1,909)		(944)
Community National Statutory Trust II	9/20/2018	9/20/2028	Derivatives - Liabilities		3,000	2.40	%	5.17	%		(587)		(291)
Community National Statutory Trust III	9/15//2018	9/15/2028	Derivatives - Liabilities		3,500	2.00	%	4.75	%		(684)		(339)
Guaranty Bankshares Statutory Trust I	9/15/2018	9/15/2028	Derivatives - Liabilities		4,500	2.00	%	4.75	%		(879)		(436)
				$	79,000	1.34	%	5.24	%	$	(8,433)	$	(3,758)

Changes in fair values of derivative financial instruments accounted for as cash flow hedges, to the extent that they are included in the assessment of effectiveness, are recorded as a component of AOCI.

The Company has also entered into interest rate swap contracts that are not designated as hedging instruments. These derivative contracts relate to transactions in which the Company enters into an interest rate swap with a customer while at the same time entering into an equal and offsetting interest rate swap with a third party financial institution counterparty. Additionally, the Company receives an upfront fee from the financial institution counterparty, dependent upon the pricing that is recognized upon receipt from the financial institution counterparty. Because the Company acts as an intermediary for the customer, changes in the fair value of the underlying derivative contracts, for the most part, offset each other and do not significantly impact the Company’s results of operations.

Interest rate swaps that are not designated as hedging instruments are summarized as follows:


		September 30, 2020				December 31, 2019
	Notional Amount		Estimated Fair Value		Notional Amount		Estimated Fair Value

	(dollars in thousands)
Non-Hedging Interest Rate Derivatives Assets:
Interest rate swap contracts	$	1,435,379	$	236,077	$	787,221	$	84,679
Non-Hedging Interest Rate Derivatives Liabilities:
Interest rate swap contracts	$	1,435,379	$	236,077	$	787,221	$	84,679

Swap fee income totaled $26.7 million and $9.8 million for the three months ended September 30, 2020 and 2019, respectively. Swap fee income totaled $53.4 million and $20.9 million for the nine months ended September 30, 2020 and 2019, respectively.

The Company’s hedged interest rate swaps and non-hedged interest rate swaps are collateralized with cash and investment securities with carrying values as follows:


	September 30, 2020		December 31, 2019

	(dollars in thousands)

Cash	$	81,373	$	10,990
U.S govt. sponsored agency securities		3,650		3,541
Municipal securities		50,730		68,089
Residential mortgage-backed and related securities		105,631		27,027
	$	241,384	$	109,647

The Company may be exposed to credit risk in the event of non-performance by the counterparties to its interest rate derivative agreements. The Company assesses the credit risk of its financial institution counterparties by monitoring publicly available credit rating and financial information. Additionally, the Company enters into interest rate derivatives only with primary and highly rated counterparties, and uses ISDA master agreements, central clearing mechanisms and counterparty limits. The ISDA master agreements contain bilateral collateral agreements with the amount of collateral to be posted generally governed by the settlement value of outstanding swaps. The Company manages the risk of default by its borrower/customer counterparties through its normal loan underwriting and credit monitoring policies and procedures. Specifically, the underwriting considers collateral value, including the excess collateral over the loan value and swap exposure, and debt service capacity for the underlying loan as well as the exposure from the interest rate swap. Ongoing credit monitoring policies and procedures are current. As of September 30, 2020, the Company does not currently anticipate any losses from failure of interest rate derivative counterparties to honor their obligations.