Note 7 - Derivatives and Hedging Activities

12 Months Ended

Dec. 31, 2020

Notes to Financial Statements

Derivatives and Hedging Activities

Note 7. Derivatives and Hedging Activities

Derivatives are summarized as follows as of December 31, 2020 and 2019:

	2020		2019
	(dollars in thousands)
Assets:
Interest rate caps - hedged	$	259	$	3,148
Interest rate caps		67		—
Interest rate swaps		222,431		84,679
	$	222,757	$	87,827
Liabilities:
Interest rate swaps - hedged	$	(6,839)	$	(3,758)
Interest rate swaps		(222,431)		(84,679)
	$	(229,270)	$	(88,437)

Note 7. Derivatives and Hedging Activities (continued)

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 to hedge against the risk of rising interest rates on liabilities.  The liabilities consist of $300.0 million of deposits and the benchmark rates hedged vary at 1-month LIBOR, 3-month LIBOR and the Prime Rate. The interest rate caps are designated as cash flow hedges in accordance with ASC 815.  An initial premium of $3.5 million was paid upfront for the caps summarized below.    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		December 31, 2020		December 31, 2019
(dollars in thousands)
Deposits	1/1/2020	1/1/2023	Other Assets	$	25,000	1.75	%	$	3	$	112
Deposits	1/1/2020	1/1/2023	Other Assets		50,000	1.57			5		218
Deposits	1/1/2020	1/1/2023	Other Assets		25,000	1.80			3		109
Deposits	1/1/2020	1/1/2024	Other Assets		25,000	1.75			15		214
Deposits	1/1/2020	1/1/2024	Other Assets		50,000	1.57			31		401
Deposits	1/1/2020	1/1/2024	Other Assets		25,000	1.80			15		201
Deposits	1/1/2020	1/1/2025	Other Assets		25,000	1.75			46		337
Deposits	1/1/2020	1/1/2025	Other Assets		50,000	1.57			94		617
Deposits	1/1/2020	1/1/2025	Other Assets		25,000	1.80			47		309
				$	300,000			$	259	$	2,518

In December 2020, the Company redesignated three of its interest rate caps, which had been purchased in 2019 for $800 thousand.  The caps, which were designated as cash flow hedges at the time of purchase, are now designated as unhedged.  A loss of $649 thousand was recognized due to the change in designation as the underlying hedged item no longer exists. For derivative instruments that are designated as unhedged, the change in fair value of the derivative instrument is recognized into current earnings.  There was no change in value recognized into current earnings for 2020 as the change in designation was effective December 31, 2020. The details of the unhedged interest rate caps are as follows:

		Balance Sheet					Fair Value as of
Effective Date	Maturity Date	Location	Notional Amount		Strike Rate		December 31, 2020		December 31, 2019
(dollars in thousands)
1/1/2020	1/1/2023	Other Assets	$	25,000	1.90	%	$	2	$	96
2/1/2020	2/1/2024	Other Assets		25,000	1.90			15		202
3/1/2020	3/1/2025	Other Assets		25,000	1.90			50		332
			$	75,000			$	67	$	630

The Company entered into interest rate swaps to hedge against the risk of rising rates on 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		December 31, 2020		December 31, 2019
(dollars in thousands)
QCR Holdings Statutory Trust II	9/30/2018	9/30/2028	Derivatives - Liabilities		10,000	3.10	%	5.85	%		(1,767)		(971)
QCR Holdings Statutory Trust III	9/30/2018	9/30/2028	Derivatives - Liabilities		8,000	3.10	%	5.85	%		(1,414)		(777)
QCR Holdings Statutory Trust V	7/7/2018	7/7/2028	Derivatives - Liabilities		10,000	1.79	%	4.54	%		(1,721)		(944)
Community National Statutory Trust II	9/20/2018	9/20/2028	Derivatives - Liabilities		3,000	2.41	%	5.17	%		(529)		(291)
Community National Statutory Trust III	9/15//2018	9/15/2028	Derivatives - Liabilities		3,500	1.97	%	4.75	%		(616)		(339)
Guaranty Bankshares Statutory Trust I	9/15/2018	9/15/2028	Derivatives - Liabilities		4,500	1.97	%	4.75	%		(792)		(436)

$ 39,000 2.48 %   5.24 %   $ (6,839) $ (3,758)

Note 7. Derivatives and Hedging Activities (continued)

In the first quarter of 2020, the Company entered into $40 million of interest rate swaps which were then terminated in the fourth quarter of 2020, resulting in a loss of $808 thousand.

Changes in the fair values of derivative financial instruments accounted for as cash flow hedges to the extent they are included in the assessment of effectiveness, are recorded as a component of AOCI. The following is a summary of how AOCI was impacted during the reporting periods:

	Year Ended
	December 31, 2020		December 31, 2019
	(dollars in thousands)
Unrealized loss at beginning of period, net of tax	$	(3,915)	$	(1,276)
Amount reclassified from accumulated other comprehensive income to noninterest expense related to unhedging caplet		513		—
Amount reclassified from accumulated other comprehensive income to noninterest expense related to swap termination		625		—
Amount reclassified from accumulated other comprehensive income to interest expense related to caplet amortization		551		422
Amount of loss recognized in other comprehensive income, net of tax		(5,406)		(3,061)
Unrealized loss at end of period, net of tax	$	(7,632)	$	(3,915)

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 offsetting interest rate swap with a third party financial institution. Additionally, the Company receives an upfront fee from the counterparty, dependent upon the pricing that is recognized upon receipt from the 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:

		December 31, 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	$	1,539,602	$	222,431	$	787,221	$	84,679
Non-Hedging Interest Rate Derivatives Liabilities:
Interest rate swap contracts	$	1,539,602	$	222,431	$	787,221	$	84,679

Swap fee income totaled $74.8 million, $28.3 million and $10.8 million for the years ended December 31, 2020, 2019, and 2018, 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:

	December 31, 2020		December 31, 2019
	(dollars in thousands)
Cash	$	45,719	$	—
U.S govt. sponsored agency securities		3,628		3,541
Municipal securities		85,937		22,924
Residential mortgage-backed and related securities		89,646		72,090
	$	224,930	$	98,555

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 manages financial institution counterparty credit risk by entering into interest rate derivatives only with primary and highly rated counterparties, the use of ISDA master agreements, central clearing mechanisms and counterparty limits.  The agreements contain bilateral collateral arrangements 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 counterparties through its normal loan underwriting and credit monitoring policies and procedures.  The Company underwrites the combination of the

Note 7. Derivatives and Hedging Activities (continued)

base loan amount and potential swap exposure and focuses on high quality borrowers with strong collateral values.  For the large majority of the Company’s swapped loan portfolio, the loan-to-value including the potential swap exposure is below 65%.  The Company does not currently anticipate any losses from failure of interest rate derivative counterparties to honor their obligations.