Note 4 - DERIVATIVES AND HEDGING ACTIVITIES

9 Months Ended

Sep. 30, 2023

Notes to Financial Statements

DERIVATIVES AND HEDGING ACTIVITIES

NOTE 4 – DERIVATIVES AND HEDGING ACTIVITIES

Derivatives are summarized as follows as of September 30, 2023 and December 31, 2022:

	September 30, 2023		December 31, 2022
	(dollars in thousands)
Assets:
Hedged Derivatives
Cash Flow Hedges
Interest rate caps	$	5,196	$	8,327
Interest rate swaps		3,334		477
Fair Value Hedges
Interest rate swaps		3,977		—
Unhedged Derivatives
Interest rate caps		1,533		2,213
Interest rate swaps		277,255		166,614
	$	291,295	$	177,631
Liabilities:
Hedged Derivatives
Cash Flow Hedges
Interest rate swaps		(42,095)		(33,824)
Interest rate collars		(870)		(263)
Unhedged Derivatives
Interest rate swaps		(277,255)		(166,614)
	$	(320,220)	$	(200,701)

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 SOFR, 3-month SOFR 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, 2023		December 31, 2022
(dollars in thousands)
Deposits	1/1/2020	1/1/2023	Derivatives - Assets	$	25,000	1.75	%	$	-	$	(50)
Deposits	1/1/2020	1/1/2024	Derivatives - Assets		25,000	1.75	%		157		714
Deposits	1/1/2020	1/1/2024	Derivatives - Assets		50,000	1.57	%		474		1,566
Deposits	1/1/2020	1/1/2024	Derivatives - Assets		25,000	1.80	%		237		783
Deposits	1/1/2020	1/1/2025	Derivatives - Assets		25,000	1.75	%		1,010		1,264
Deposits	1/1/2020	1/1/2025	Derivatives - Assets		50,000	1.57	%		2,212		2,700
Deposits	1/1/2020	1/1/2025	Derivatives - Assets		25,000	1.80	%		1,106		1,350
				$	225,000			$	5,196	$	8,327

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, 2023		December 31, 2022
		(dollars in thousands)
QCR Holdings Statutory Trust II	9/30/2018		9/30/2028	Derivatives - Assets	$	10,000	8.51	%	5.85	%	$	710	$	464
QCR Holdings Statutory Trust III	9/30/2018		9/30/2028	Derivatives - Assets		8,000	8.51	%	5.85	%		568		372
QCR Holdings Statutory Trust V	7/7/2018		7/7/2028	Derivatives - Assets		10,000	7.12	%	4.54	%		691		459
Community National Statutory Trust II	9/20/2018		9/20/2028	Derivatives - Assets		3,000	7.83	%	5.17	%		212		140
Community National Statutory Trust III	9/15/2018		9/15/2028	Derivatives - Assets		3,500	7.42	%	4.75	%		247		163
Guaranty Bankshares Statutory Trust I	9/15/2018		9/15/2028	Derivatives - Assets		4,500	7.42	%	4.75	%		318		209
Guaranty Statutory Trust II*	5/23/2019		2/23/2026	Derivatives - Assets		10,310	7.09	%	4.09	%		588		477
					$	49,310					$	3,334	$	2,284
* Acquired on 4/1/2022 with GFED acquisition.

The Company has entered into interest rate swaps to hedge against the risk of declining interest rates on floating rate loans.    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, 2023		December 31, 2022
(dollars in thousands)
Loans	7/1/2021	7/1/2031	Derivatives - Liabilities	$	35,000	1.40	%	5.31	%	$	(6,776)	$	(5,646)
Loans	7/1/2021	7/1/2031	Derivatives - Liabilities		50,000	1.40	%	5.31	%		(9,680)		(8,066)
Loans	7/1/2021	7/1/2031	Derivatives - Liabilities		40,000	1.40	%	5.31	%		(7,755)		(6,464)
Loans	10/1/2022	7/1/2031	Derivatives - Liabilities		25,000	1.30	%	5.31	%		(4,877)		(4,018)
Loans	4/1/2022	4/1/2027	Derivatives - Liabilities		15,000	1.91	%	5.31	%		(1,301)		(1,144)
Loans	4/1/2022	4/1/2027	Derivatives - Liabilities		50,000	1.91	%	5.31	%		(4,335)		(3,812)
Loans	4/1/2022	4/1/2027	Derivatives - Liabilities		35,000	1.91	%	5.31	%		(3,035)		(2,669)
Loans	4/1/2022	4/1/2027	Derivatives - Liabilities		50,000	1.91	%	5.31	%		(4,336)		(3,812)
				$	300,000					$	(42,095)	$	(35,631)

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 collar is designated as a cash flow hedge in accordance with ASC 815. 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, 2023		December 31, 2022
Loans	10/1/2022	10/1/2026	Derivatives - Liabilities	$	50,000	4.40	%	2.44	%	$	(870)	$	(263)

The Company has entered into interest rate swaps to hedge against the risk of rising rates on loans.  The interest rate swaps are designated as fair value 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, 2023		December 31, 2022
(dollars in thousands)
Loans	7/12/2023	2/1/2026	Derivatives - Assets	$	25,000	5.31	%	4.38	%	$	204	$	N/A
Loans	7/12/2023	8/1/2026	Derivatives - Assets		30,000	5.31	%	4.21	%		304		N/A
Loans	7/12/2023	2/1/2027	Derivatives - Assets		32,500	5.31	%	4.08	%		409		N/A
Loans	7/12/2023	8/1/2027	Derivatives - Assets		32,500	5.31	%	3.98	%		488		N/A
Loans	7/12/2023	2/1/2028	Derivatives - Assets		30,000	5.31	%	3.90	%		532		N/A
Loans	7/12/2023	2/1/2026	Derivatives - Assets		15,000	5.31	%	4.38	%		123		N/A
Loans	7/12/2023	8/1/2026	Derivatives - Assets		15,000	5.31	%	4.21	%		152		N/A
Loans	7/12/2023	2/1/2027	Derivatives - Assets		15,000	5.31	%	4.08	%		189		N/A
Loans	7/12/2023	8/1/2027	Derivatives - Assets		15,000	5.31	%	3.98	%		225		N/A
Loans	7/12/2023	2/1/2028	Derivatives - Assets		15,000	5.31	%	3.90	%		267		N/A
Loans	7/12/2023	8/1/2025	Derivatives - Assets		15,000	5.31	%	4.60	%		90		N/A
Loans	7/12/2023	2/1/2026	Derivatives - Assets		20,000	5.31	%	4.38	%		163		N/A
Loans	7/12/2023	8/1/2026	Derivatives - Assets		20,000	5.31	%	4.21	%		203		N/A
Loans	7/12/2023	2/1/2027	Derivatives - Assets		20,000	5.31	%	4.08	%		252		N/A
Loans	7/12/2023	8/1/2027	Derivatives - Assets		25,000	5.31	%	3.98	%		376		N/A
				$	325,000					$	3,977	$	N/A

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.  Changes in fair values of derivative financial instruments accounted for as fair value hedges, to the extent that they are included in the assessment of effectiveness, are recorded as a component of interest income/expense.

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, 2023		December 31, 2022
(dollars in thousands)
1/1/2020	1/3/2023	Derivatives - Assets	$	25,000	1.90	%	$	-	$	3
2/1/2020	2/1/2024	Derivatives - Assets		25,000	1.90	%		310		822
3/1/2020	3/3/2025	Derivatives - Assets		25,000	1.90	%		1,223		1,388
			$	75,000			$	1,533	$	2,213

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, 2023			December 31, 2022
	Notional Amount		Estimated Fair Value		Notional Amount		Estimated Fair Value
	(dollars in thousands)
Non-Hedging Interest Rate Derivatives Assets:
Interest rate swap contracts	$	2,967,392	$	277,255	$	2,528,949	$	166,614
Non-Hedging Interest Rate Derivatives Liabilities:
Interest rate swap contracts	$	2,967,392	$	277,255	$	2,528,949	$	166,614

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, 2023 and 2022 are as follows:

	Three Months Ended September 30, 2023				Three Months Ended September 30, 2022
	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	$	108,568	$	53,313	$	79,267	$	18,498
The effects of cash flow hedging:
Gain on interest rate caps on deposits		-		(2,066)		-		(263)
Gain on interest rate swaps on junior subordinated debentures		-		(328)		-		73
Loss on interest rate swaps and collars on loans		(2,495)		-		(426)		-
The effects of fair value hedging:
Gain on interest rate swaps on loans		828		-		-		-

	Nine Months Ended September 30, 2023				Nine Months Ended September 30, 2022
	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	$	301,162	$	135,892	$	198,534	$	32,632
The effects of cash flow hedging:
Gain on interest rate caps on deposits		-		(5,522)		-		199
Gain on interest rate swaps on junior subordinated debentures		-		(830)		-		536
Loss on interest rate swaps and collars on loans		(6,757)		-		715		-
The effects of fair value hedging:
Gain on interest rate swaps on loans		828		-		-		-

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, 2023		December 31, 2022
	(dollars in thousands)
Cash	$	1,275	$	1,272
Municipal securities		3,945		8,227
Residential mortgage-backed and related securities		5,778		29,257
	$	10,998	$	38,756

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 ratings 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, below 65%.  The Company does not currently anticipate any losses from failure of interest rate derivative counterparties to honor their obligations.