NOTE 4 - DERIVATIVES AND HEDGING ACTIVITIES

9 Months Ended

Sep. 30, 2021

Notes to Financial Statements

DERIVATIVES AND HEDGING ACTIVITIES

NOTE 4 – DERIVATIVES AND HEDGING ACTIVITIES

Derivatives are summarized as follows as of September 30, 2021 and December 31, 2020:

	September 30, 2021		December 31, 2020
	(dollars in thousands)
Assets:
Interest rate caps - hedged	$	517	$	259
Interest rate caps		141		67
Interest rate swaps - hedged		807		—
Interest rate swaps		196,928		222,431
	$	198,393	$	222,757
Liabilities:
Interest rate swaps - hedged	$	(4,522)	$	(6,839)
Interest rate swaps		(196,928)		(222,431)
	$	(201,450)	$	(229,270)

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 executed.  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, 2021		December 31, 2020
(dollars in thousands)
Deposits	1/1/2020	1/1/2023	Derivatives - Assets	$	25,000	1.75	%	$	1	$	3
Deposits	1/1/2020	1/1/2023	Derivatives - Assets		50,000	1.57			2		5
Deposits	1/1/2020	1/1/2023	Derivatives - Assets		25,000	1.80			1		3
Deposits	1/1/2020	1/1/2024	Derivatives - Assets		25,000	1.75			26		15
Deposits	1/1/2020	1/1/2024	Derivatives - Assets		50,000	1.57			53		31
Deposits	1/1/2020	1/1/2024	Derivatives - Assets		25,000	1.80			26		15
Deposits	1/1/2020	1/1/2025	Derivatives - Assets		25,000	1.75			101		46
Deposits	1/1/2020	1/1/2025	Derivatives - Assets		50,000	1.57			205		94
Deposits	1/1/2020	1/1/2025	Derivatives - Assets		25,000	1.80			102		47
				$	300,000			$	517	$	259

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, were redesignated as unhedged.  For derivative instruments that are designated as unhedged, the change in fair value of the derivative instrument is recognized into current earnings.  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		September 30, 2021		December 31, 2020
(dollars in thousands)
1/1/2020	1/1/2023	Derivatives - Assets	$	25,000	1.90	%	$	1	$	2
2/1/2020	2/1/2024	Derivatives - Assets		25,000	1.90			26		15
3/1/2020	3/1/2025	Derivatives - Assets		25,000	1.90			114		50
			$	75,000			$	141	$	67

The Company has entered into interest rate swaps to hedge against the risk of declining interest rates on floating rate loans.    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, 2021		December 31, 2020
(dollars in thousands)
QCBT - Loans	7/1/2021	7/1/2031	Derivatives - Assets		35,000	1.40	%	2.81	%		192		N/A
CRBT - Loans	7/1/2021	7/1/2031	Derivatives - Assets		50,000	1.40	%	2.81	%		274		N/A
CSB - Loans	7/1/2021	7/1/2031	Derivatives - Assets		40,000	1.40	%	2.81	%		204		N/A
SFCB - Loans	7/1/2021	7/1/2031	Derivatives - Assets		25,000	1.40	%	2.81	%		137		N/A
				$	150,000					$	807	$	N/A

The Company has 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		September 30, 2021		December 31, 2020
(dollars in thousands)
QCR Holdings Statutory Trust II	9/30/2018	9/30/2028	Derivatives - Liabilities		10,000	2.98	%	5.85	%		(1,169)		(1,767)
QCR Holdings Statutory Trust III	9/30/2018	9/30/2028	Derivatives - Liabilities		8,000	2.98	%	5.85	%		(936)		(1,414)
QCR Holdings Statutory Trust V	7/7/2018	7/7/2028	Derivatives - Liabilities		10,000	1.68	%	4.54	%		(1,135)		(1,721)
Community National Statutory Trust II	9/20/2018	9/20/2028	Derivatives - Liabilities		3,000	2.29	%	5.17	%		(350)		(529)
Community National Statutory Trust III	9/15//2018	9/15/2028	Derivatives - Liabilities		3,500	1.87	%	4.75	%		(408)		(616)
Guaranty Bankshares Statutory Trust I	9/15/2018	9/15/2028	Derivatives - Liabilities		4,500	1.87	%	4.75	%		(524)		(792)
				$	39,000					$	(4,522)	$	(6,839)

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, 2021			December 31, 2020
	Notional Amount		Estimated Fair Value		Notional Amount		Estimated Fair Value
	(dollars in thousands)
Non-Hedging Interest Rate Derivatives Assets:
Interest rate swap contracts	$	3,609,566	$	196,928	$	1,539,602	$	222,431
Non-Hedging Interest Rate Derivatives Liabilities:
Interest rate swap contracts	$	3,609,566	$	196,928	$	1,539,602	$	222,431

The effect of cash flow hedging and fair value accounting on the consolidated statements of income for the three months ended September 30, 2021 and September 30, 2020 are as follows:

	Three Months Ended September 30, 2021				Three Months Ended September 30, 2020
	Interest and		Interest		Interest and		Interest
	Dividend Income		Expense		Dividend Income		Expense
	(dollars in thousands)
Income and expense line items presented in the consolidated statements of income	$	51,667	$	5,438	$	50,890	$	6,309
The effects of cash flow hedging:
Gain (loss) on cash flow hedges:
Interest rate swap on wholesale funding		-		-		-		79
Interest rate swap on variable rate loans		502		-		-		-
Interest rate cap on deposits		-		181		-		128

The effect of cash flow hedging and fair value accounting on the consolidated statements of income for the nine months ended September 30, 2021 and September 30, 2020 are as follows:

	Nine Months Ended September 30, 2021				Nine Months Ended September 30, 2020
	Interest and		Interest		Interest and		Interest
	Dividend Income		Expense		Dividend Income		Expense
	(dollars in thousands)
Income and expense line items presented in the consolidated statements of income	$	148,135	$	16,415	$	148,522	$	25,279
The effects of cash flow hedging:
Gain (loss) on cash flow hedges:
Interest rate swap on wholesale funding		-		-		-		114
Interest rate swap on variable rate loans		502		-		-		-
Interest rate cap on deposits		-		495		-		336

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, 2021		December 31, 2020
	(dollars in thousands)
Cash	$	13,220	$	45,719
U.S treasuries and govt. sponsored agency securities		3,579		3,628
Municipal securities		69,397		85,937
Residential mortgage-backed and related securities		122,606		89,646
	$	208,802	$	224,930

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. The Company underwrites the combination of the base loan amount and potential swap exposure and focuses on high quality borrowers with strong collateral values.   For the 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.