Note 5 - DERIVATIVES AND HEDGING ACTIVITIES

9 Months Ended

Sep. 30, 2022

Notes to Financial Statements

DERIVATIVES AND HEDGING ACTIVITIES

NOTE 5 – DERIVATIVES AND HEDGING ACTIVITIES

Derivatives are summarized as follows as of September 30, 2022 and December 31, 2021:

	September 30, 2022		December 31, 2021
	(dollars in thousands)
Assets:
Interest rate caps - hedged	$	9,191	$	927
Interest rate caps		2,480		238
Interest rate swaps - hedged		506		—
Interest rate swaps		172,860		221,055
	$	185,037	$	222,220
Liabilities:
Interest rate collars - hedged	$	(541)	$	—
Interest rate swaps - hedged		(36,078)		(4,080)
Interest rate swaps		(172,860)		(221,055)
	$	(209,479)	$	(225,135)

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

The Company has 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, 2022		December 31, 2021
(dollars in thousands)
Deposits	1/1/2020	1/1/2023	Derivatives - Assets	$	25,000	1.75	%	$	120	$	5
Deposits	1/1/2020	1/1/2023	Derivatives - Assets		50,000	1.57	%		221		11
Deposits	1/1/2020	1/1/2023	Derivatives - Assets		25,000	1.80	%		111		5
Deposits	1/1/2020	1/1/2024	Derivatives - Assets		25,000	1.75	%		797		60
Deposits	1/1/2020	1/1/2024	Derivatives - Assets		50,000	1.57	%		1,593		125
Deposits	1/1/2020	1/1/2024	Derivatives - Assets		25,000	1.80	%		796		62
Deposits	1/1/2020	1/1/2025	Derivatives - Assets		25,000	1.75	%		1,379		161
Deposits	1/1/2020	1/1/2025	Derivatives - Assets		50,000	1.57	%		2,783		332
Deposits	1/1/2020	1/1/2025	Derivatives - Assets		25,000	1.80	%		1,391		166
				$	300,000			$	9,191	$	927

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, 2022		December 31, 2021
(dollars in thousands)
1/1/2020	1/1/2023	Derivatives - Assets	$	25,000	1.90	%	$	128	$	3
2/1/2020	2/1/2024	Derivatives - Assets		25,000	1.90	%		867		62
3/1/2020	3/1/2025	Derivatives - Assets		25,000	1.90	%		1,485		173
			$	75,000			$	2,480	$	238

The Company uses interest rate collars in an effort to manage future interest rate exposure on variable rate loans.  The collar hedging strategy stabilizes interest rate fluctuations by setting both a floor and a cap.  The details of the interest rate collars are as follows:

Fair Value as of

Hedged Item

Effective Date

Maturity Date

Location

Notional Amount

Cap Strike Rate

Floor Strike Rate

September 30, 2022

December 31, 2021

Loans

10/1/2022

10/1/2026

Derivatives - Liabilities

$

50,000

4.40

%

2.44

%

$

(541)

$

N/A

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, 2022		December 31, 2021
(dollars in thousands)
Loans	7/1/2021	7/1/2031	Derivatives - Liabilities	$	35,000	1.40	%	1.79	%	$	(5,968)	$	(17)
Loans	7/1/2021	7/1/2031	Derivatives - Liabilities		50,000	1.40	%	1.79	%		(8,527)		(25)
Loans	7/1/2021	7/1/2031	Derivatives - Liabilities		40,000	1.40	%	1.79	%		(6,833)		(34)
Loans	7/1/2021	7/1/2031	Derivatives - Liabilities		25,000	1.40	%	1.79	%		(4,263)		(13)
Loans	4/1/2022	4/1/2027	Derivatives - Liabilities		15,000	1.91	%	1.79	%		(1,248)		N/A
Loans	4/1/2022	4/1/2027	Derivatives - Liabilities		50,000	1.91	%	1.79	%		(4,159)		N/A
Loans	4/1/2022	4/1/2027	Derivatives - Liabilities		35,000	1.91	%	1.79	%		(2,911)		N/A
Loans	4/1/2022	4/1/2027	Derivatives - Liabilities		50,000	1.91	%	1.79	%		(4,159)		N/A
				$	300,000					$	(38,068)	$	(89)

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, 2022		December 31, 2021
		(dollars in thousands)
QCR Holdings Statutory Trust II	9/30/2018		9/30/2028	Derivatives - Liabilities	$	10,000	6.52	%	5.85	%	$	513	$	(1,035)
QCR Holdings Statutory Trust III	9/30/2018		9/30/2028	Derivatives - Liabilities		8,000	6.52	%	5.85	%		410		(828)
QCR Holdings Statutory Trust V	7/7/2018		7/7/2028	Derivatives - Liabilities		10,000	4.06	%	4.54	%		510		(996)
Community National Statutory Trust II	9/20/2018		9/20/2028	Derivatives - Liabilities		3,000	5.70	%	5.17	%		153		(309)
Community National Statutory Trust III	9/15//2018		9/15/2028	Derivatives - Liabilities		3,500	5.04	%	4.75	%		177		(360)
Guaranty Bankshares Statutory Trust I	9/15/2018		9/15/2028	Derivatives - Liabilities		4,500	5.04	%	4.75	%		227		(463)
Guaranty Statutory Trust II*	12/15/2005		2/23/2036	Derivatives - Assets		10,310	4.41	%	4.09	%		506		N/A
					$	49,310					$	2,496	$	(3,991)

*Acquired on 4/1/2022 with GFED acquisition.

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. Additionally, the Company receives an upfront, non-refundable 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:

		September 30, 2022			December 31, 2021
	Notional Amount		Estimated Fair Value		Notional Amount		Estimated Fair Value
	(dollars in thousands)
Non-Hedging Interest Rate Derivatives Assets:
Interest rate swap contracts	$	2,331,961	$	172,860	$	2,024,599	$	221,055
Non-Hedging Interest Rate Derivatives Liabilities:
Interest rate swap contracts	$	2,331,961	$	172,860	$	2,024,599	$	221,055

The effect of cash flow hedging and fair value accounting on the consolidated statements of income for the three and nine  months ended September 30, 2022 and September 30, 2021 are as follows:

	Three Months Ended September 30, 2022				Three Months Ended September 30, 2021
	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	$	79,267	$	18,498	$	51,667	$	5,438
The effects of cash flow hedging:
Gain (loss) on cash flow hedges:
Interest rate caps on deposits		-		(259)		-		181
Interest rate swaps on variable rate loans		(426)		-		-		-
Interest rate swaps on junior subordinated debentures		-		73		-		285

	Nine Months Ended September 30, 2022				Nine Months Ended September 30, 2021
	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	$	198,534	$	32,632	$	148,135	$	16,415
The effects of cash flow hedging:
Gain (loss) on cash flow hedges:
Interest rate caps on deposits		-		202		-		495
Interest rate swaps on variable rate loans		715		-		502		-
Interest rate swaps on junior subordinated debentures		-		536		-		830

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, 2022		December 31, 2021
	(dollars in thousands)
Cash	$	2,001	$	21,100
U.S treasuries and govt. sponsored agency securities		3,492		3,555
Municipal securities		101,588		139,166
Residential mortgage-backed and related securities		45,650		65,104
	$	152,731	$	228,925

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, and uses ISDA master agreements, central clearing mechanisms and counterparty limits.  The 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. The majority of the Company’s swapped loan portfolio consists of loans on projects, with loan-to-values including the potential swap exposure that is below 65%.  The Company does not currently anticipate any losses from failure of interest rate derivative counterparties to honor their obligations.