U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from July 1, 2002 to
December 31, 2002.
Commission file number: 0-22208
QCR HOLDINGS, INC.
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(Exact name of registrant as specified in its charter)
Delaware 42-1397595
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(State of incorporation) (I.R.S. Employer Identification No.)
3551 Seventh Street, Suite 204, Moline, Illinois 61265
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(Address of principal executive offices)
(309) 736-3580
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b)
of the Exchange Act:
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Preferred Securities of QCR Holdings Capital Trust I
Securities registered pursuant to Section 12(g)
of the Exchange Act:
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Common stock, $1 Par Value
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for past 90 days. Yes [ x ] No [ ]
Indicate by check mark if disclosure of delinquent filers in response to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ x ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [ x ]
The aggregate market value of the voting and non-voting common equity held by
non-affiliates of the registrant, based on the last sales price quoted on The
Nasdaq SmallCap Market on December 31, 2002, the last business day of the
registrant's most recently completed second fiscal quarter, was approximately
$43,700,000. As of March 3, 2003, the issuer had 2,773,062 shares of common
stock outstanding.
Documents incorporated by reference:
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Part III of Form 10-K - Proxy statement for annual meeting of
stockholders to be held in May 2003.
1
Part I
Item 1. Business
General. QCR Holdings, Inc. (the "Company") is a multi-bank holding company
headquartered in Moline, Illinois that was formed in February 1993 under the
laws of the state of Delaware. The Company serves the Quad City and Cedar Rapids
communities. Its wholly owned subsidiaries, Quad City Bank and Trust Company,
("Quad City Bank & Trust") which is based in Bettendorf, Iowa and commenced
operations in 1994, and Cedar Rapids Bank and Trust Company, ("Cedar Rapids Bank
& Trust") which is based in Cedar Rapids, Iowa and commenced operations in 2001,
provide full-service commercial and consumer banking and trust and asset
management services. The Company also engages in merchant credit card processing
through its wholly owned subsidiary, Quad City Bancard, Inc., based in Moline,
Illinois.
Quad City Bank & Trust was capitalized on October 13, 1993 and commenced
operations on January 7, 1994. Quad City Bank & Trust is organized as an
Iowa-chartered commercial bank that is a member of the Federal Reserve System
with depository accounts insured to the maximum amount permitted by law by the
Federal Deposit Insurance Corporation. Quad City Bank & Trust provides full
service commercial and consumer banking, and trust and asset management services
in the Quad Cities and adjacent communities through its four offices that are
located in Bettendorf and Davenport, Iowa and in Moline, Illinois.
Cedar Rapids Bank & Trust is an Iowa-chartered commercial bank that is a member
of the Federal Reserve System with depository accounts insured to the maximum
amount permitted by law by the Federal Deposit Insurance Corporation. The
Company commenced operations in Cedar Rapids in June 2001 operating as a branch
of Quad City Bank & Trust. The Cedar Rapids branch operation then began
functioning under the Cedar Rapids Bank & Trust charter in September 2001. Cedar
Rapids Bank & Trust provides full-service commercial and consumer banking, and
trust and asset management services to Cedar Rapids and adjacent communities
through its office located in downtown Cedar Rapids, Iowa.
Quad City Bancard, Inc. ("Bancard") was capitalized on April 3, 1995, as a
Delaware corporation that provides merchant and cardholder credit card
processing services. This operation had previously been a division of Quad City
Bank & Trust since July 1994. On October 22, 2002, the Company announced
Bancard's sale of its independent sales organization (ISO) related merchant
credit card operations to iPayment, Inc. At December 31, 2002, Bancard continued
to temporarily process transactions for iPayment, Inc., and approximately 28,000
merchants. When iPayment, Inc. discontinues processing with Bancard in calendar
2003, it is expected that processing volumes will decrease significantly.
Bancard will, however, continue to provide credit card processing for its local
merchants and agent banks and for cardholders of the Company's subsidiary banks.
On March 29, 1999, Bancard formed its own independent sales organization ("ISO")
subsidiary, Allied Merchant Services, Inc. ("Allied"), to generate merchant
credit card processing business. Bancard owns 100% of Allied. As a result of
Bancard's sale of its ISO related merchant credit card operations to iPayment,
Inc. in October 2002, Allied ceased its operations as an ISO. Included in the
sale to iPayment, Inc., were all of the merchant credit card processing
relationships owned by Allied.
QCR Holdings Capital Trust I ("Capital Trust") was formed in April 1999 and
capitalized in June 1999 in connection with the public offering of $12 million
of 9.2% trust preferred capital securities due June 30, 2029, which are callable
on June 30, 2004.
The Company owns 100% of Quad City Bank & Trust, Cedar Rapids Bank & Trust, and
Bancard, and 100% of the common securities of Capital Trust, and in addition to
such ownership invests its capital in stocks of financial institutions and
mutual funds, as well as participates in loans with the subsidiary banks. In
addition, to its wholly- owned subsidiaries, the Company has an aggregate
investment of $260 thousand in four associated companies, Nobel Electronic
Transfer, LLC, Nobel Real Estate Investors, LLC, Velie Plantation Holding
Company, LLC, and Clarity Merchant Services. Inc.
The Company and its subsidiaries collectively employed 215 individuals at
December 31, 2002. No one customer accounts for more than 10% of revenues, loans
or deposits. In August 2002, the Company's board of directors elected to change
the Company's fiscal year end from June 30 to December 31. Due to this change,
the Company is filing this Form 10-K for the transition period from July 1, 2002
to December 31, 2002 and will, in the future, hold its annual meetings in May of
each year instead of October. Therefore, the 2003 annual meeting will be held in
May 2003. The Company's subsidiaries have also changed their fiscal years
aligning their financial reporting with that of the Company. Throughout this
document references to the transition period are for the six months ended
December 31, 2002. References to fiscal 2002, fiscal 2001, and fiscal 2000 are
for the years ended June 30, 2002, 2001, and 2000, respectively. In most
instances, the six-month transition period results are shown in addition to the
three previous fiscal years ended June 30.
2
Competition. The Company currently operates in the highly competitive Quad City
and Cedar Rapids markets. Competitors include not only other commercial banks,
credit unions, thrift institutions, and mutual funds, but also, insurance
companies, finance companies, brokerage firms, investment banking companies, and
a variety of other financial services and advisory companies. Many of these
competitors are not subject to the same regulatory restrictions as the Company.
Many of these unregulated competitors compete across geographic boundaries and
provide customers increasing access to meaningful alternatives to banking
services. Additionally, the Company competes in markets with a number of much
larger financial institutions with substantially greater resources and larger
lending limits. These competitive trends are likely to continue and may increase
as a result of the continuing reduction on restrictions on the interstate
operations of financial institutions. Under the Gramm-Leach-Bliley Act of 1999,
effective in March of 2000, securities firms and insurance companies that elect
to become financial holding companies may acquire banks and other financial
institutions. The Gramm-Leach-Bliley Act may significantly change the
competitive environment in which the Company and its subsidiary banks conduct
business. The financial services industry is also likely to become more
competitive as further technological advances enable more companies to provide
financial services.
The Board of Governors of the Federal Reserve System (the "Federal Reserve
Board") regulates the Company and its subsidiaries. In addition, Quad City Bank
& Trust and Cedar Rapids Bank & Trust are regulated by the Iowa Superintendent
of Banking (the "Iowa Superintendent") and the Federal Deposit Insurance
Corporation (the "FDIC").
Business. The Company's principal business consists of attracting deposits from
the public and investing those deposits in loans and securities. The deposits of
Quad City Bank & Trust and Cedar Rapids Bank & Trust are insured to the maximum
amount allowable by the FDIC. The Company's results of operations are dependent
primarily on net interest income, which is the difference between the interest
earned on its loans and securities and the interest paid on deposits and
borrowings. Its operating results are affected by merchant credit card fees,
trust fees, deposit service charge fees, fees from the sale of residential real
estate loans and other income. Operating expenses include employee compensation
and benefits, occupancy and equipment expense, professional and data processing
fees, advertising and marketing expenses and other administrative expenses. The
Company's operating results are also affected by economic and competitive
conditions, particularly changes in interest rates, government policies and
actions of regulatory authorities.
Lending. The Company and its subsidiaries provide a broad range of commercial
and retail lending and investment services to corporations, partnerships,
individuals and government agencies. Quad City Bank & Trust and Cedar Rapids
Bank & Trust actively market their services to qualified lending customers.
Lending officers actively solicit the business of new borrowers entering their
market areas as well as long-standing members of the local business community.
The subsidiary banks have established lending policies which include a number of
underwriting factors to be considered in making a loan, including location,
loan-to-value ratio, cash flow, interest rate and the credit history of the
borrower.
Quad City Bank & Trust's current lending limit is approximately $6.4 million.
Its loan portfolio is comprised primarily of commercial, residential real estate
and consumer loans. As of December 31, 2002, commercial loans made up
approximately 76% of the loan portfolio, while residential mortgages comprised
approximately 13% and consumer loans comprised approximately 11%.
Cedar Rapids Bank & Trust's current lending limit is approximately $1.6 million.
Its loan portfolio is comprised primarily of commercial, residential real estate
and consumer loans. As of December 31, 2002, commercial loans made up
approximately 86% of the loan portfolio, while residential mortgages comprised
approximately 8% and consumer loans comprised approximately 6%.
As part of the loan monitoring activity at both subsidiary banks, credit
administration personnel interact with senior bank management weekly. The
Company has also instituted a separate loan review function to analyze credits
of Quad City Bank & Trust and Cedar Rapids Bank & Trust. Management has
attempted to identify problem loans at an early stage and to aggressively seek a
resolution of these situations.
3
As noted above, both subsidiary banks are active commercial lenders. The areas
of emphasis include loans to wholesalers, manufacturers, building contractors,
developers, business services companies and retailers. Quad City Bank & Trust
and Cedar Rapids Bank & Trust provide a wide range of business loans, including
lines of credit for working capital and operational purposes and term loans for
the acquisition of facilities, equipment and other purposes. Collateral for
these loans generally includes accounts receivable, inventory, equipment and
real estate. In addition, the subsidiary banks often take personal guarantees to
help assure repayment. Loans may be made on an unsecured basis if warranted by
the overall financial condition of the borrower. Terms of commercial business
loans generally range from one to five years. A significant portion of the
subsidiary banks' commercial business loans has floating interest rates or
reprice within one year. Commercial real estate loans are also made. Collateral
for these loans generally includes the underlying real estate and improvements,
and may include additional assets of the borrower.
Residential mortgage lending has been a focal point of Quad City Bank & Trust
and Cedar Rapids Bank & Trust as they continue to build their real estate
lending business. As a result of this focus, the subsidiary banks' real estate
loan portfolios have grown to approximately $54.7 million at December 31, 2002.
The subsidiary banks currently have 8 mortgage originators.
The subsidiary banks sell the majority of their real estate loans in the
secondary market. They typically sell virtually all of the fixed rate loans that
they originate. During the six months ended December 31, 2002, the subsidiary
banks originated $145.1 million of real estate loans and sold $121.5 million, or
84%, of these loans. During fiscal 2002, the subsidiary banks originated $175.5
million of real estate loans and sold $144.3 million, or 82%, of these loans.
Generally, the subsidiary banks' residential mortgage loans conform to the
underwriting requirements of Freddie Mac and Fannie Mae to allow the subsidiary
banks to resell loans in the secondary market. The subsidiary banks structure
most loans that will not conform to those underwriting requirements as
adjustable rate mortgages that mature in one to five years. The subsidiary banks
generally retain these loans in their portfolios. Servicing rights are not
presently retained on the loans sold in the secondary market.
The consumer lending departments of each bank provide all types of consumer
loans including motor vehicle, home improvement, home equity, signature loans
and small personal credit lines.
Appendices. The commercial banking business is a highly regulated business. See
Appendix A for a brief summary of the federal and state statutes and
regulations, which are applicable to the Company and its subsidiaries.
Supervision, regulation and examination of banks and bank holding companies by
bank regulatory agencies are intended primarily for the protection of depositors
rather than stockholders of bank holding companies and banks.
See Appendix B for tables and schedules that show selected comparative
statistical information required pursuant to the industry guides promulgated
under the Securities Act of 1933 and 1934, relating to the business of the
Company. The change in the fiscal year end from June 30 to December 31 resulted
in a six-month transition period ended December 31, 2002. The six-month
transition period results are shown in addition to the previous three fiscal
years ended June 30.
The Company maintains Internet sites for its two banking subsidiaries and the
Company makes available free of charge through these sites its annual report on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and other
reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange
Act after it electronically files such material with, or furnishes it to, the
Securities and Exchange Commission. The sites are and www.crbt.com.
Item 2. Property
The original office of Quad City Bank & Trust is in a 6,700 square foot
facility, which was completed in January 1994. In March 1994, Quad City Bank &
Trust acquired that facility, which is located at 2118 Middle Road in
Bettendorf, Iowa.
Construction of a second full service banking facility was completed in July
1996 to provide for the convenience of customers and to expand the market
territory. Quad City Bank & Trust also owns its portion of that facility which
is located at 4500 Brady Street in Davenport, Iowa. The two-story building is in
two segments that are separated by an atrium. Quad City Bank & Trust owns the
south half of the building, while the northern half is owned by the developer.
Each segment contains 6,000 square feet. Quad City Bank & Trust occupies its
first floor and utilizes the basement for operational functions, item processing
and storage. At December 31, 2002, approximately 1,500 square feet on the second
floor was leased to a professional services firm and approximately 4,500 square
feet was vacant and leasable. In January 2003, various operational and
administrative functions, previously located in an adjacent office building,
were moved to occupy the vacant space on the second floor. In addition, the
residential real estate department of Quad City Bank & Trust leases
approximately 2,500 square feet on the first floor in the north half of the
building.
4
Renovation of a third full service banking facility was completed in February
1998 at the historic Velie Plantation Mansion, 3551 Seventh Street, located near
the intersection of 7th Street and John Deere Road in Moline, Illinois near the
Rock Island/Moline border. The building is owned by a third party limited
liability company and Quad City Bank & Trust and Bancard are its major tenants.
The Company has purchased a 20% interest in the company that owns the building.
Quad City Bank & Trust occupies 10,000 square feet on the main floor of the
structure. Bancard relocated its operations to the lower level of the 30,000
square foot building in late 1997. The Company relocated its corporate
headquarters to the building in February 1998 and occupies approximately 2,000
square feet on the second floor.
In March 1999, Quad City Bank & Trust acquired a 3,000 square foot office
building adjacent to the Brady Street location. At December 31, 2002, the office
space was utilized for various operational and administrative functions. In
January 2003, this building was sold, and these operations were moved to occupy
vacant space on the second floor of the Brady street facility.
Construction of a fourth full service banking facility was completed in October
2000 at 5515 Utica Ridge Road in Davenport, Iowa. Quad City Bank & Trust leases
approximately 6,000 square feet on the first floor and 2,200 square feet on the
lower level of the 24,000 square foot facility. The office opened in October
2000.
The Company announced plans, in April 2001, to expand its banking operations to
the Cedar Rapids, Iowa market. Initially, from June until mid-September 2001,
the Cedar Rapids operation functioned as a branch of Quad City Bank & Trust
while waiting for regulatory approvals for a new state bank charter. On
September 14, 2001, the Cedar Rapids branch operation was converted into the new
charter and began operations as Cedar Rapids Bank and Trust Company. Cedar
Rapids Bank & Trust leases approximately 8,200 square feet in the GreatAmerica
Building, 625 First Street, S.E. in Cedar Rapids, which currently serves as its
only office.
Management believes that the facilities are of sound construction, in good
operating condition, are appropriately insured and are adequately equipped for
carrying on the business of the Company.
Quad City Bank & Trust and Cedar Rapids Bank & Trust intend to limit their
investment in premises to no more than 50% of their capital. The subsidiary
banks frequently invest in commercial real estate mortgages and also invest in
residential mortgages. Quad City Bank & Trust and Cedar Rapids Bank & Trust have
established lending policies which include a number of underwriting factors to
be considered in making a loan including, location, loan-to-value ratio, cash
flow, interest rate and credit worthiness of the borrower.
No individual real estate property or mortgage amounts to 10% or more of
consolidated assets.
Item 3. Legal Proceedings
There are no material pending legal proceedings to which the Company or its
subsidiaries is a party other than ordinary routine litigation incidental to
their respective businesses.
Item 4. Submission of Matters to a Vote of Security Holders
The annual meeting of stockholders was held at The Lodge (formerly Jumer's
Castle Lodge) located at 900 Spruce Hills Drive, Bettendorf, Iowa on Wednesday,
October 23, 2002 at 10:00 a.m. At the meeting, Article XII of the certificate of
incorporation was amended to change the number of directors from a range of
three to nine to a range of three to twelve. The certificate of incorporation
was also amended to permit the board of directors to consider non-stockholder
factors when considering a change in control proposal. At the meeting,
stockholders approved the adoption of the QCR Holdings, Inc. Employee Stock
Purchase Plan. Also at the meeting, Patrick S. Baird was elected and John K.
Lawson and Ronald G. Peterson were re-elected to serve as Class III directors,
with terms expiring in 2005. Continuing as Class I directors, with terms
expiring in 2003, are Michael A. Bauer, James J. Brownson, and Henry Royer.
Continuing as Class II directors, with terms expiring in 2004, are Larry J.
Helling, Douglas M. Hultquist, and John W. Schricker.
5
At the time of the annual meeting, there were 2,809,818 issued shares and
2,749,672 outstanding shares of common stock. Either in person or by proxy,
there were 2,323,455 common shares represented at the meeting, constituting
approximately 84% of the outstanding shares. The voting was as follows:
Votes Votes Votes Broker
For Against Abstained Non-votes
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Amendment of Article XII .... 2,212,189 86,085 25,181 0
Amendment regarding
consideration of
non-stockholder interests . 1,399,850 122,782 24,055 776,768
Approval of the QCR
Holdings, Inc. Employee
Stock Purchase Plan ....... 2,175,885 120,387 27,183 0
Votes Votes
For Withheld
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Patrick S. Baird ............................ 2,304,476 18,979
John K. Lawson .............................. 2,311,776 11,679
Ronald G. Peterson .......................... 2,304,776 18,679
6
Part II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The common stock, par value $1.00 per share, of the Company is traded on The
Nasdaq SmallCap Market under the symbol "QCRH". The stock began trading on
October 6, 1993. As of December 31, 2002, there were 2,762,915 shares of common
stock outstanding held by approximately 2,800 holders of record. The following
table sets forth the high and low sales prices of the common stock, as reported
by The Nasdaq SmallCap Market, for the periods indicated.
Six Months Ended
December 31, 2002 Fiscal 2002 Fiscal 2001
Sales Price Sales Price Sales Price
----------------- ----------------- ------------------
High Low High Low High Low
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First quarter ...... $ 15.50 $ 13.62 $ 12.50 $ 10.10 $ 17.25 $ 11.313
Second quarter ..... 17.00 14.56 11.79 10.80 12.25 9.938
Third quarter ...... NA NA 13.45 11.18 12.56 9.750
Fourth quarter ..... NA NA 15.15 13.00 10.81 9.250
On October 23, 2002, the board of directors declared the Company's first cash
dividend of $0.05 per share payable on January 3, 2003, to stockholders of
record on December 16, 2002. In the future, it is the Company's intention to
consider the payment of dividends on a semi-annual basis. The Company
anticipates an ongoing need to retain much of its operating income to help
provide the capital for continued growth, but believes that operating results
have reached a level that can sustain dividends to stockholders as well.
7
Under Iowa law, Quad City Bank & Trust and Cedar Rapids Bank & Trust are
restricted as to the maximum amount of dividends they may pay on their common
stock. The Iowa Banking Act provides that an Iowa bank may not pay dividends in
an amount greater than its undivided profits. Quad City Bank & Trust and Cedar
Rapids Bank & Trust are members of the Federal Reserve System. The total of all
dividends declared by the subsidiary banks in a calendar year may not exceed the
total of their net profits of that year combined with their retained net profits
of the preceding two years. In addition, the Federal Reserve Board, the Iowa
Superintendent and the FDIC are authorized under certain circumstances to
prohibit the payment of dividends by Quad City Bank & Trust and Cedar Rapids
Bank & Trust. In the case of the Company, further restrictions on dividends may
be imposed by the Federal Reserve Board.
Item 6. Selected Financial Data
The "Selected Consolidated Financial Data" of the Company set forth below is
derived in part from, and should be read in conjunction with, our consolidated
financial statements and the accompanying notes thereto. See Item 8 "Financial
Statements and Supplementary Data." Results for past periods are not necessarily
indicative of results to be expected for any future period.
SELECTED CONSOLIDATED FINANCIAL DATA
Six Months
Ended Years Ended June 30,
December 31, ---------------------------------------------------
2002 2002 2001 2000 1999 1998
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Statement of Income Data:
Interest income ....................... $ 16,120 $ 28,520 $ 28,544 $ 24,079 $ 20,116 $ 15,077
Interest expense ...................... 6,484 12,870 16,612 13,289 11,027 8,342
Net interest income ................... 9,636 15,650 11,932 10,790 9,089 6,735
Provision for loan losses ............. 2,184 2,265 889 1,052 892 902
Noninterest income (1) ................ 8,840 7,915 6,313 6,154 5,561 6,148
Noninterest expenses .................. 11,413 17,023 13,800 11,467 9,679 7,910
Pre-tax net income .................... 4,879 4,277 3,556 4,425 4,079 4,071
Income tax expense .................... 1,683 1,315 1,160 1,680 1,614 1,678
Net income ............................ 3,196 2,962 2,396 2,745 2,465 2,393
Per Common Share Data:
Net income-basic ...................... $ 1.16 $ 1.10 $ 1.06 $ 1.19 $ 0.98 $ 1.00
Net income-diluted .................... 1.13 1.08 1.04 1.15 0.93 0.93
Cash dividends declared ............... 0.05 -- -- -- -- --
Dividend payout ratio ................. 4.31% -- -- -- -- --
Balance Sheet:
Total assets .......................... $604,600 $518,828 $400,948 $367,622 $321,346 $250,151
Securities ............................ 81,654 76,231 56,710 56,129 50,258 33,276
Loans ................................. 449,736 390,594 287,865 241,853 197,977 162,975
Allowance for estimated losses on loans 6,879 6,111 4,248 3,617 2,895 2,350
Deposits .............................. 434,748 376,317 302,155 288,067 247,966 197,384
Stockholders' equity:
Common .............................. 36,587 32,578 23,817 20,071 18,473 16,602
Preferred ........................... -- -- -- -- -- 2,500
Key Ratios:
Return on average assets .............. 1.13% 0.64% 0.62% 0.82% 0.86% 1.14%
Return on average common equity ....... 18.41 10.07 10.95 14.17 13.69 16.40
Net interest margin ................... 3.68 3.74 3.38 3.56 3.42 3.55
Efficiency ratio (2) .................. 61.71 72.20 75.64 67.68 66.07 61.40
Nonperforming assets to total assets .. 0.83 0.44 0.44 0.20 0.51 0.51
Allowance for estimated losses on loans
to total loans ...................... 1.53 1.56 1.48 1.50 1.46 1.44
Net charge-offs to average loans ...... 0.34 0.12 0.10 0.16 0.26 0.13
Average common stockholders' equity
to average assets ................... 6.12 6.38 5.69 5.77 6.26 6.97
Average stockholders' equity
to average assets ................... 6.12 6.38 5.69 5.77 7.05 7.97
Earnings to fixed charges
Excluding interest on deposits ...... 2.90 x 1.95 x 1.90 x 2.29 x 2.81 x 3.78 x
Including interest on deposits ...... 1.73 1.32 1.21 1.33 1.36 1.48
(1) Year ended June 30, 1998 noninterest income includes a pre-tax gain of
$2,168 from Bancard's restructuring of an agreement with an independent
sales organization (ISO). Year ended June 30, 1999 noninterest income
includes amortization of $732 from Bancard's restructuring of an ISO
agreement. Six months ended December 31, 2002 noninterest income includes a
pre-tax gain of $3,460 from Bancard's gain on sale of merchant credit card
portfolio
(2) Noninterest expenses divided by the sum of net interest income before
provision for loan losses and noninterest income.
8
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion provides additional information regarding our
operations for the six months ended December 31, 2002 and 2001 and the fiscal
years ended June 30, 2002, 2001 and 2000, and financial condition at December
31, 2002, June 30, 2002, and June 30, 2001. In August 2002, the Company's board
of directors elected to change the Company's fiscal year end from June 30 to
December 31. Due to this change, the Company is filing for the transition period
from July 1, 2002 to December 31, 2002. Throughout this document, reference to
the transition period, fiscal 2002, 2001, and 2000 are for the six months ended
December 31, 2002 and the years ended June 30, 2002, 2001, and 2000,
respectively. This discussion should be read in conjunction with "Selected
Consolidated Financial Data" and our consolidated financial statements and the
accompanying notes thereto included or incorporated by reference elsewhere in
this document.
Overview
The Company was formed in February 1993 for the purpose of organizing Quad City
Bank & Trust and has grown to $604.6 million in consolidated assets as of
December 31, 2002. Management expects continued opportunities for growth, even
though the rate of growth may be slower than that experienced to date.
The Company reported earnings of $3.2 million or $1.16 basic earnings per share
for the six-month transition period ended December 31, 2002 as compared to $3.0
million or $1.10 basic earnings per share for fiscal 2002, $2.4 million and
$1.06 basic earnings per share for fiscal 2001, and $2.7 million and $1.19 basic
earnings per share for fiscal 2000. The sale of Bancard's ISO related merchant
credit card operations to iPayment, Inc. in October 2002, was a significant
contributor to the 139% increase in earnings for the six-months ended December
31, 2002 when compared to the same period in 2001. The 24% increase in fiscal
2002 earnings from fiscal 2001 was attributable primarily to significant
increases in both net interest income and noninterest income, partially offset
by an increase in noninterest expense. The decrease in fiscal 2001 earnings from
fiscal 2000 was attributable to an increase in noninterest expense partially
offset by increases in both noninterest income and net interest income.
When compared to the same period in 2001, the six months ended December 31, 2002
reflected significant growth in both net interest income and noninterest income
for the Company. For the 2002 period, net interest income and noninterest income
improved by 34% and 119%, respectively, for a combined increase of $7.2 million
when compared to the six months ended December 31, 2001. Both Quad City Bank &
Trust and Cedar Rapids Bank & Trust generated marked improvement in net interest
margin, as well as increases in the gains on sales of residential real estate
loans for the 2002 period. The sale of the ISO-related merchant credit card
portfolio at Bancard contributed $3.5 million of noninterest income. Offsetting
these revenue improvements for the Company were increases in noninterest expense
of $3.2 million and the provision for loan losses of $1.1 million. The primary
contributors to the increase in noninterest expense were contractual
compensation and severance payments at Bancard and Allied resulting from the
sale of the ISO-related merchant credit card operations. For the six months
ended December 31, 2002, operating costs associated with Cedar Rapids Bank &
Trust were approximately $1.5 million as compared to $1.1 million for the same
period in 2001. While the after-tax start-up losses at Cedar Rapids Bank & Trust
were $275 thousand for the six months ended December 31, 2002, these losses were
less than anticipated, and Cedar Rapids Bank and Trust's growth was more rapid
than expected. Management remains confident that the Cedar Rapids operations
will provide significant long-term benefits to the Company.
The Company's results of operations are dependent primarily on net interest
income, which is the difference between interest income, principally from loans
and investment securities, and interest expense, principally on customer
deposits and borrowings. Changes in net interest income result from changes in
volume, net interest spread and net interest margin. Volume refers to the
average dollar level of interest-earning assets and interest-bearing
liabilities. Net interest spread refers to the difference between the average
yield on interest-earning assets and the average cost of interest-bearing
liabilities. Net interest margin refers to the net interest income divided by
average interest-earning assets and is influenced by the level and relative mix
of interest-earning assets and interest-bearing liabilities. The Company's
average tax equivalent yield on interest earning assets decreased 0.92% for the
six months ended December 31, 2002 as compared to the same period in 2001. With
the same comparison, the average cost of interest-bearing liabilities decreased
0.99%, which resulted in a 0.07% increase in the net interest spread of 3.16% at
December 31, 2001 compared to 3.23% at December 31, 2002. The relative stability
in the net interest spread from year to year also carried over to the net
interest margin. For the six months ended December 31, 2002, net interest margin
was 3.68% compared to 3.70% for the like period in 2001. Management continues to
closely monitor and manage net interest margin. From a profitability standpoint,
an important challenge for the subsidiary banks in the near term is to maintain
their net interest margins. However, very competitive local loan rate
environments have resulted in the subsidiary banks' interest margins being below
their national peer groups. Management continues to address this issue with
alternative funding sources and pricing strategies.
9
The Company's operating results are also affected by sources of noninterest
income, including merchant credit card fees, trust fees, deposit service charge
fees, gains from the sales of residential real estate loans and other income.
Operating expenses of the Company include employee compensation and benefits,
occupancy and equipment expense and other administrative expenses. The Company's
operating results are also affected by economic and competitive conditions,
particularly changes in interest rates, government policies and actions of
regulatory authorities. The majority of the subsidiary banks' loan portfolios
are invested in commercial loans. Deposits from commercial customers represent a
significant funding source as well.
The Company has added facilities and employees to accommodate both its
historical growth and anticipated future growth. As such, overhead expenses have
had a significant impact on earnings. This trend is likely to continue as Cedar
Rapids Bank & Trust moved to its permanent facility in the fall of 2001, and
both banks continue to add the facilities and resources necessary to attract and
serve additional customers
During 1994, Quad City Bank & Trust began to develop internally a merchant
credit card processing operation and in 1995 transferred this function to
Bancard, a separate subsidiary of the Company. Bancard initially had an
arrangement to provide processing services exclusively to customers of a single
independent sales organization or ISO. This ISO was sold in 1998, and the
purchaser requested a reduction in the term of the contract. Bancard agreed to
amend the contract to reduce the term and accept a fixed monthly processing fee
of $25 thousand for merchants existing at the time the agreement was signed, and
a lower transaction fee for new merchants, in exchange for a payment of $2.9
million, the ability to transact business with other ISOs and the assumption of
the credit risk by the ISO. Approximately two thirds of the income from this
settlement, or $2.2 million, was reported in fiscal 1998, with the remainder of
$732 thousand being recognized during fiscal 1999. Bancard terminated its
processing for this ISO in May 2000, eliminating approximately 64% of its
average monthly processing volume. Prior to this ISO's termination, Bancard's
average monthly processing volume for fiscal 2000 was $91 million. During both
fiscal 2001 and 2002, Bancard worked to establish additional ISO relationships
and further develop the relationships with existing ISOs successfully rebuilding
and expanding processing volumes. Bancard's average monthly dollar volume of
transactions processed during fiscal 2001 was $76 million. During fiscal 2002,
the average monthly dollar volume of transactions processed by Bancard increased
36% to $104 million. Monthly processing volumes at Bancard during fiscal 2002
climbed to a level above that existing prior to the termination of all
processing with the initial ISO.
On October 22, 2002, the Company announced Bancard's sale of its ISO related
merchant credit card operations to iPayment, Inc. for $3.5 million. After
contractual compensation and severance payments, transaction expenses, and
income taxes, the transaction resulted in a net gain of $1.3 million, or $0.47
per share, which was realized during the quarter ended December 31, 2002. Also
included in the sale, were all of the merchant credit card processing
relationships owned by Bancard's subsidiary, Allied. Bancard will continue to
provide credit card processing for its local merchants and cardholders of the
subsidiary banks and agent banks. It is anticipated that the Company's
termination of ISO related merchant credit card processing will reduce Bancard's
future earnings. However, the Company believes that Bancard can be profitable
with its narrowed business focus of providing credit card processing for its
local merchants and agent banks and for cardholders of the Company's subsidiary
banks. Currently, Bancard continues to process transactions for iPayment, Inc.,
but it is anticipated that this activity will cease in the near future.
During fiscal 1998, Quad City Bank & Trust expanded its presence in the mortgage
banking market by hiring several experienced loan originators and an experienced
underwriter, and now has seven loan originators on staff. Cedar Rapids Bank &
Trust currently has one mortgage loan originator. Quad City Bank & Trust and
Cedar Rapids Bank & Trust originate mortgage loans on personal residences and
sell the majority of these loans into the secondary market to avoid the interest
rate risk associated with long-term fixed rate financing. The subsidiary banks
realize revenue from this mortgage banking activity from a combination of loan
origination fees and gains on the sale of the loans in the secondary market.
During the six months ended December 31, 2002, the subsidiary banks originated
$145.1 million of real estate loans and sold $121.5 million, or 84%, of these
loans resulting in gains of $1.9 million. During fiscal 2002, the subsidiary
banks originated $175.5 million of real estate loans and sold $144.3 million, or
82%, of these loans, which resulted in gains of $2.0 million. The depressed
interest rates during these periods have caused a significant increase in the
subsidiary banks' mortgage origination volume. In fiscal 2001, Quad City Bank &
Trust originated $97.6 million of real estate loans and sold $92.9 million, or
95%, of these loans resulting in gains of $1.1 million.
10
Trust department income continues to be a significant contributor to noninterest
income. In the six months ended December 31, 2002, trust department fees
contributed $1.0 million in revenues. Trust department fees grew from $1.9
million in fiscal 2000 to $2.1 million in fiscal 2001 and to $2.2 million in
fiscal 2002. Income is generated primarily from fees charged based on assets
under administration for corporate and personal trusts and for custodial
services. At December 31, 2002, assets under administration were $642.7 million.
The decrease of $23.0 million in trust assets from June 30 to December 31, 2002
was a reflection of the reduced market values of securities held in trust
accounts. Primarily the result of new trust relationships, assets under
administration had grown from $617.5 at June 30, 2001 to $665.7 million at June
30, 2002.
The Company's initial public offering during the fourth calendar quarter of 1993
raised approximately $14 million. In order to provide additional capital to
support the growth of Quad City Bank & Trust, the Company formed a statutory
business trust, which issued $12 million of capital securities to the public for
cash in June 1999. In conjunction with the formation of Cedar Rapids Bank &
Trust, the Company sold approximately $5.0 million of its common stock through a
private placement offering in September 2001, primarily to investors in the
Cedar Rapids area.
Critical Accounting Policy
The Company's financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America. The financial
information contained within these statements is, to a significant extent,
financial information that is based on approximate measures of the financial
effects of transactions and events that have already occurred. Based on its
consideration of accounting policies that involve the most complex and
subjective decisions and assessments, management has identified its most
critical accounting policy to be that related to the allowance for loan losses.
The Company's allowance for loan loss methodology incorporates a variety of risk
considerations, both quantitative and qualitative in establishing an allowance
for loan loss that management believes is appropriate at each reporting date.
Quantitative factors include the Company's historical loss experience,
delinquency and charge-off trends, collateral values, changes in nonperforming
loans, and other factors. Quantitative factors also incorporate known
information about individual loans, including borrowers' sensitivity to interest
rate movements. Qualitative factors include the general economic environment in
the Company's markets, including economic conditions throughout the Midwest and
in particular, the state of certain industries. Size and complexity of
individual credits in relation to loan structure, existing loan policies and
pace of portfolio growth are other qualitative factors that are considered in
the methodology. As the Company adds new products and increases the complexity
of its loan portfolio, it will enhance its methodology accordingly. Management
may report a materially different amount for the provision for loan losses in
the statement of operations to change the allowance for loan losses if its
assessment of the above factors were different. This discussion and analysis
should be read in conjunction with the Company's financial statements and the
accompanying notes presented elsewhere herein, as well as the portion of this
Management's Discussion and Analysis section entitled "Financial Condition -
Allowance for Loan Losses." Although management believes the levels of the
allowance as of December 31, 2002 and both June 30, 2002 and 2001 were adequate
to absorb losses inherent in the loan portfolio, a decline in local economic
conditions, or other factors, could result in increasing losses that cannot be
reasonably predicted at this time.
Results of Operations
Six months ended December 31, 2002 compared with six months ended December 31,
2001
Overview. Net income for the six months ended December 31, 2002 was $3.2 million
as compared to net income of $1.3 million for the six-month period ended
December 31, 2001 for an increase of $1.9 million or 139%. Basic earnings per
share for the six-month period ended December 31, 2002 were $1.16 as compared to
$0.51 for the comparable period in 2001. The increase in net income was
comprised of an increase in net interest income after provision for loan losses
of $1.3 million and an increase in noninterest income of $4.8 million, partially
offset by increases in noninterest expenses of $3.2 million and an increase in
federal and state income taxes of $1.1 million. Several specific factors
contributed to the improvement in net income from 2001 to 2002 for the six-month
periods. Primary factors included the $3.5 million gain on sale of the merchant
credit card portfolio, a 34% improvement in net interest margin prompted by
increased volumes, and a 51% increase in gains on sales of real estate loans.
Interest income. Interest income grew from $13.8 million for the six months
ended December 31, 2001 to $16.1 million for the comparable period in 2002. The
increase in interest income was attributable to greater average outstanding
balances in interest-earning assets, principally loans receivable, partially
offset by a decrease in interest rates. The average yield on interest earning
assets for the six months ended December 31, 2002 was 6.13% as compared to 7.05%
for the six-month period ended December 31, 2001.
11
Interest expense. Interest expense decreased by $150 thousand, from $6.6 million
for the six months ended December 31, 2001 to $6.5 million for the same period
in 2002. The 2% decrease in interest expense was primarily attributable to a
reduction in interest rates almost entirely offset by greater average
outstanding balances in interest-bearing liabilities. The average cost on
interest bearing liabilities was 2.90% for the six months ended December 31,
2002 as compared to 3.89% for the like period in 2001.
Provision for loan losses. The provision for loan losses is established based on
a number of factors, including the local and national economy and the risk
associated with the loans in the portfolio. The Company had an allowance for
estimated losses on loans of approximately 1.53% of total gross loans at
December 31, 2002, as compared to approximately 1.56% at June 30, 2002 and 1.43%
at December 31, 2001. The provision for loan losses increased by $1.2 million,
from $1.0 million for the six months ended December 31, 2001 to $2.2 million for
the six-month period ended December 31, 2002. During the period, management made
monthly provisions for loan losses based upon a number of factors, principally
the increase in loans and a detailed analysis of the loan portfolio. During the
six months ended December 31, 2002, $786 thousand, or 36%, of the provision for
loan losses resulted from the deterioration of a single, significant loan
relationship at Quad City Bank and Trust. For the six-month period ended
December 31, 2002, commercial loans had total, net charge-offs of $1.3 million.
The charge-off of a single commercial loan relationship at Quad City Bank and
Trust accounted for $1.1 million, or 82%, of the commercial loan charge-offs for
the period. Consumer loan charge-offs and recoveries totaled $105 thousand and
$37 thousand, respectively, for the six months ended December 31, 2002. Real
estate loans had no charge-off or recovery activity during this period in 2002.
The ability to grow profitably is, in part, dependent upon the ability to
maintain asset quality.
Noninterest income. Noninterest income increased by $4.8 million from $4.0
million for the six months ended December 31, 2001 to $8.8 million for the same
period in 2002. In the six months ended December 31, 2002, the primary component
of the increase in noninterest income was the gain on sale of the ISO related
portion of the merchant credit card portfolio of $3.5 million, which accounted
for 72% of the increase. Noninterest income for both periods consisted of income
from the merchant credit card operation, fees from the trust department,
depository service fees, gains on the sale of residential real estate mortgage
loans, and other miscellaneous fees. Also making significant contributions to
the 119% increase in noninterest income from year to year were increases in
gains on sales of loans and merchant credit card fees net of processing costs.
During the six-month period ended December 31, 2002, merchant credit card fees
net of processing costs, increased by $270 thousand to $1.3 million, from $1.0
million for the comparable period in 2001. The increase was due to a 66%
improvement from year to year in the volume of credit card transactions
processed during the six months ended December 31. During the six-month period
ended December 31, 2001, Bancard processed $568.3 million of transactions, which
grew to $941.6 million for the same period in 2002. As a result of the sale of
the ISO-related merchant credit card operations, processing volumes are expected
to decrease dramatically in future months. Bancard will operate with a narrowed
focus of processing for its local merchants and agent banks and for cardholders
of the Company's subsidiary banks.
For the six-month periods ended both December 31, 2002 and 2001, trust
department fees were $1.0 million. The $48 thousand, or 5%, increase from year
to year was primarily a reflection of the further development of existing trust
relationships and the addition of new trust relationships during the 2002
period, almost entirely offset by the reduced market value of securities held in
trust accounts and the resulting impact on the calculation of trust fees.
Gains on sales of loans were $1.9 million for the six months ended December 31,
2002, which reflected an increase of 51%, or $632 thousand, from $1.2 million
for the like period in 2001. The increase resulted from the decline in mortgage
rates during calendar year 2002. This situation created significantly more home
refinances during the period and the subsequent sale of the majority of these
loans into the secondary market. Because the gains on sales of loans have an
indirect relationship with interest and mortgage rates, it is unlikely that the
subsidiary banks will continue to maintain this level of activity in the long
term.
The $3.5 million gain on sale of merchant credit card portfolio made the most
significant contribution to the increase in noninterest income for the six
months ended December 31, 2002 over the comparable period in 2001. In October
2002, the Company sold Bancard's ISO related merchant credit card operations to
iPayment, Inc. Also included in the sale were all of the merchant credit card
processing relationships owned by Allied.
12
Noninterest expenses. For the six months ended December 31, 2002, the main
components of noninterest expenses were primarily salaries and benefits,
compensation and other expenses related to sale of merchant credit card
portfolio, occupancy and equipment expenses, and professional and data
processing fees. For the six months ended December 31, 2001 noninterest expenses
were comprised predominately of salaries and benefits, occupancy and equipment
expenses, and professional and data processing fees. Noninterest expenses for
the six-month period ended December 31, 2002 were $11.4 million as compared to
$8.2 million for the same period in 2001 for an increase of $3.2 million or 38%.
The following table sets forth the various categories of noninterest expenses
for the six months ended December 31, 2002 and 2001.
Six Months Ended December 31,
-----------------------------------------
2002 2001 % Change
-----------------------------------------
Salaries and employee benefits ............................ $ 6,075,885 $ 4,774,358 27%
Compensation and other expenses related to sale of ........
merchant credit card portfolio .......................... 1,413,734 -- NA
Professional and data processing fees ..................... 872,750 784,701 11%
Advertising and marketing ................................. 341,093 286,643 19%
Occupancy and equipment expense ........................... 1,322,826 1,137,585 16%
Stationery and supplies ................................... 229,066 235,766 -3%
Postage and telephone ..................................... 291,737 229,462 27%
Other ..................................................... 865,960 796,399 9%
----------------------------------------
Total noninterest expenses .................. $11,413,051 $ 8,244,914 38%
========================================
Compensation and other expenses related to sale of merchant credit card
portfolio of $1.4 million accounted for 45% of the $3.2 million increase
experienced in noninterest expenses in aggregate. Contractual bonus and
severance payments were based on the gain realized from the sale of Bancard's
ISO related merchant credit card operations to iPayment, Inc. in October 2002.
For the six months ended December 31, 2002, total salaries and benefits
increased to $6.1 million or $1.3 million over the $4.8 million for the
comparable period in 2001. The change was attributable to increased incentive
compensation to real estate officers and processors proportionate to the
increased volumes of gains on sales of loans, in combination with the addition
of employees at Cedar Rapids Bank & Trust and a slight increase in the number of
Quad City Bank & Trust employees. Occupancy and equipment expense increased $185
thousand, or 16%, for the period. The increase was predominately due to
increased levels of rent, property taxes, utilities, depreciation, maintenance,
and other occupancy expenses. Professional and data processing fees increased
$88 thousand, or 11%, when comparing the six months ended December 31, 2001 to
the comparable period in 2002. The increase was primarily attributable to the
additional data processing fees incurred by the subsidiary banks. For the
six-month period ended December 31, 2002, other noninterest expense increased
$70 thousand, or 9%, from the like period in 2001. The primary contributor to
the increase in other noninterest expense was increased expense incurred by
subsidiary banks for service charges from upstream banks. From 2001 to 2002,
postage and telephone expense for the six months ended December 31, increased
27%, or $62 thousand. The growth at Cedar Rapids Bank & Trust accounted for $40
thousand, or 65% of this increase.
Income tax expense. The provision for income taxes was $1.7 million for the six
months ended December 31, 2002 compared to $630 thousand for the comparable
period in 2001, an increase of $1.1 million or 167%. The increase was primarily
attributable to increased income before income taxes of $2.9 million or 148% for
the six-month period ended December 31, 2002, in combination with an increase in
the Company's effective tax rate for the 2002 period to 34.5% from 32.0% for the
same period in 2001. The increase in the Company's effective tax rate was due to
a much lower percentage of the Company's income coming from federal tax-exempt
securities, (primarily tax-free municipal bonds) in 2002 versus 2001.
Fiscal 2002 compared with fiscal 2001
Overview. Net income for fiscal 2002 was $3.0 million as compared to net income
of $2.4 million in fiscal 2001 for an increase of $567 thousand or 24%. Basic
earnings per share for fiscal 2002 were $1.10 as compared to $1.06 for fiscal
2001. The increase in net income was comprised of an increase in net interest
income after provision for loan losses of $2.3 million and an increase in
noninterest income of $1.6 million partially offset by increases in noninterest
expenses of $3.2 million and an increase in federal and state income taxes of
$155 thousand. Several factors contributed to the improvement in net income
during fiscal 2002. Primary factors included the significant improvement of 36
basis points in net interest margin and the 75% increase in gains on sales of
real estate loans.
13
Interest income. Interest income was $28.5 million for fiscal 2001 and fiscal
2002. The stability in interest income was attributable to greater average
outstanding balances in interest-earning assets, principally loans receivable,
that was offset by the reduction in interest rates. The average yield on
interest earning assets for fiscal 2002 was 6.77% as compared to 8.04% for
fiscal 2001.
Interest expense. Interest expense decreased by $3.7 million, from $16.6 million
for fiscal 2001 to $12.9 million for fiscal 2002. The 23% decrease in interest
expense was primarily attributable to significant reductions in interest rates
partially offset by greater average outstanding balances in interest-bearing
liabilities. The average cost on interest bearing liabilities was 3.56% for
fiscal 2002 as compared to 5.32% for fiscal 2001.
Provision for loan losses. The provision for loan losses is established based on
a number of factors, including the local and national economy and the risk
associated with the loans in the portfolio. The Company had an allowance for
estimated losses on loans of approximately 1.56% of total loans at June 30, 2002
as compared to approximately 1.48% at June 30, 2001. The provision for loan
losses increased by $1.4 million, from $900 thousand for fiscal 2001 to $2.3
million for fiscal 2002. During fiscal 2002, management made monthly provisions
for loan losses based upon a number of factors, principally the increase in
loans and a detailed analysis of the loan portfolio. For fiscal 2002, commercial
loans had total charge-offs of $437 thousand and total recoveries of $101
thousand. Consumer loan charge-offs and recoveries totaled $204 thousand and
$138 thousand, respectively, for fiscal 2002. Real estate loans had no
charge-off or recovery activity during fiscal 2002. The ability to grow
profitably is, in part, dependent upon the ability to maintain asset quality.
Noninterest income. Noninterest income increased by $1.6 million, from $6.3
million for fiscal 2001 to $7.9 million for fiscal 2002. Noninterest income for
fiscal 2002 and 2001 consisted of income from the merchant credit card
operation, fees from the trust department, depository service fees, gains on the
sale of residential real estate mortgage loans, and other miscellaneous fees.
The 25% increase was primarily due to the increases in gains on sales of loans,
merchant credit card fees net of processing costs, and deposit service fees
received during the period.
During fiscal 2002, merchant credit card fees net of processing costs, increased
by $424 thousand to $2.1 million, from $1.7 million for fiscal 2001. The
increase was due to a 36% increase in the volume of credit card transactions
processed during fiscal 2002, partially offset by the one-time charge during the
third quarter related to an arbitration settlement involving Bancard.
For fiscal 2002, trust department fees increased $90 thousand, or 4%, to $2.2
million from $2.1 million for fiscal 2001. The increase was primarily a
reflection of the development of existing trust relationships and the addition
of new trust relationships during the period, almost entirely offset by the
reduced market value of securities held in trust accounts and the resulting
impact on the calculation of trust fees.
Gains on sales of loans were $2.0 million for fiscal 2002, which reflected an
increase of 75%, or $855 thousand, from $1.1 million for fiscal 2001. The
increase resulted from a significant decline in mortgage rates, which was driven
by corresponding cuts by the Federal Reserve during calendar 2001. This created
significantly more home refinances and home purchases during the fiscal year and
the subsequent sale of the majority of these loans into the secondary market.
Noninterest expenses. The main components of noninterest expenses were primarily
salaries and benefits, occupancy and equipment expenses, and professional and
data processing fees for both periods. Noninterest expenses for fiscal 2002 were
$17.0 million as compared to $13.8 million for the same period in 2001 for an
increase of $3.2 million or 23%.
The following table sets forth the various categories of noninterest expenses
for the years ended June 30, 2002 and 2001.
Years Ended June 30,
----------------------------------------
2002 2001 % Change
----------------------------------------
Salaries and employee benefits ......................... $10,077,583 $ 8,014,268 26%
Professional and data processing fees .................. 1,410,770 1,159,929 22%
Advertising and marketing .............................. 604,002 579,524 4%
Occupancy and equipment expense ........................ 2,331,806 1,925,820 21%
Stationery and supplies ................................ 476,158 352,441 35%
Postage and telephone .................................. 486,053 409,626 19%
Other .................................................. 1,636,056 1,358,345 20%
----------------------------------------
Total noninterest expenses ............... $17,022,428 $13,799,953 23%
========================================
14
Salaries and benefits experienced the most significant dollar increase of any
noninterest expense component. For fiscal 2002, total salaries and benefits
increased to $10.1 million or $2.1 million over the fiscal 2001 total of $8.0
million. The change was primarily attributable to the addition of employees to
staff the Cedar Rapids Bank & Trust operation, which accounted for $1.7 million,
or 82%, of the increase. A slight increase in the number of Quad City Bank &
Trust employees, and increased incentive compensation to real estate officers
proportionate to the increased volumes of gains on sales of loans, comprised the
balance of the change. Occupancy and equipment expense increased $406 thousand
or 21% for the period. The increase was predominately due to the addition of
Quad City Bank & Trust's fourth full service banking facility in late October
2000, and Cedar Rapids Bank & Trust's permanent full service banking facility in
September 2001, and the resulting increased levels of rent, utilities,
depreciation, maintenance, and other occupancy expenses. Professional and data
processing fees increased $251 thousand, or 22%, during fiscal 2002. The
increase was primarily attributable to legal fees resulting from an arbitration
involving Bancard, combined with the additional professional and data processing
fees related to Cedar Rapids Bank & Trust. During fiscal 2002, stationary and
supplies increased 35%, or $124 thousand. The addition of Cedar Rapids Bank &
Trust accounted for $85 thousand, or 68% of this increase. Other noninterest
expense increased $278 thousand, or 20% for the fiscal year. Significantly
contributing to this increase was a $170 thousand merchant credit card loss
resulting from the settlement of an arbitration dispute between Bancard and Nova
Information Services, Inc. A settlement amount was paid to Bancard, which was
the receivable due from Nova less an amount that approximated the costs of
continued arbitration. Also contributing to the increase in noninterest expense
were increased insurance expense and increased expense incurred by subsidiary
banks for service charges from upstream banks.
Income tax expense. The provision for income taxes was $1.3 million for fiscal
2002 compared to $1.2 million for fiscal 2001, an increase of $155 thousand or
13%. The increase was primarily attributable to increased income before income
taxes of $722 thousand or 20% for fiscal 2002, partially offset by a reduction
in the Company's effective tax rate for fiscal 2002 of 30.7% versus 32.6% for
fiscal 2001.
Fiscal 2001 compared with fiscal 2000
Overview. Net income for fiscal 2001 was $2.4 million as compared to net income
of $2.7 million in fiscal 2000 for a decrease of $300,000 or 13%. Basic earnings
per share for fiscal 2001 were $1.06 as compared to $1.19 for fiscal 2000. The
decrease in net income was comprised of an increase in noninterest expenses of
$2.3 million partially offset by an increase in net interest income after
provision for loan losses of $1.3 million, an increase in noninterest income of
$200,000 and a decrease in federal and state income taxes of $500,000. Several
factors contributed to the reduction in net income. These factors included the
opening of the Company's fourth full-service banking facility on Utica Ridge
Road in Davenport, a reduction in processing volumes and profitability at Quad
City Bancard and initial start-up expenses associated with the Company's
expansion to the Cedar Rapids market.
Interest income. Interest income increased by $4.4 million, from $24.1 million
for fiscal 2000 to $28.5 million for fiscal 2001. The 19% rise in interest
income was basically attributable to greater average outstanding balances in
interest-earning assets, principally loans receivable. Despite the Federal
Reserve's dramatic reduction in short-term interest rates by 2.75% between
January and June of 2001, the average yield on interest earning assets for
fiscal 2001 was 8.04% as compared to 7.91% for fiscal 2000.
Interest expense. Interest expense increased by $3.3 million, from $13.3 million
for fiscal 2000 to $16.6 million for fiscal 2001. The 25% increase in interest
expense was primarily attributable to greater average outstanding balances in
interest-bearing liabilities and higher interest rates. Despite the Federal
Reserve's dramatic reduction in short-term interest rates by 2.75% between
January and June of 2001, the average cost on interest bearing liabilities was
5.32% for fiscal 2001 as compared to 4.90% for 2000.
15
Provision for loan losses. The provision for loan losses is established based on
a number of factors, including the local and national economy and the risk
associated with the loans in the portfolio. The Company had an allowance for
estimated losses on loans of approximately 1.48% of total loans at June 30, 2001
as compared to approximately 1.50% at June 30, 2000. The provision for loan
losses decreased by $200,000, from $1.1 million for fiscal 2000 to $900,000 for
fiscal 2001. During the year, management made monthly provisions for loan losses
based upon the increase in loans and a detailed analysis of the loan portfolio.
For fiscal 2001, commercial loans combined for total charge-offs of $87,000 and
total recoveries of $2,000. Consumer loan charge-offs and recoveries totaled
$214,000 and $39,000, respectively, for fiscal 2001. Indirect auto loans
accounted for a majority of the consumer loan charge-offs. Because asset quality
is a priority for the Company and its subsidiaries, management made the decision
in the first quarter of fiscal 1999 to downscale indirect auto loan activity
based on charge-off history. The average balance in the indirect auto loan
portfolio for fiscal 2001 was $3.4 million compared to $8.2 million for fiscal
2000. This 59% decrease in the average portfolio brought with it a 56% decrease
in the net charge-offs of indirect auto loans. Net charge-offs for the indirect
auto loan portfolio were $46,000 for fiscal 2001 compared to $77,000 for fiscal
2000, for a decrease of $31,000. The ability to grow profitably is, in part,
dependent upon the ability to maintain asset quality.
Noninterest income. Noninterest income increased by $200,000, from $6.1 million
for fiscal 2000 to $6.3 million for fiscal 2001. Noninterest income for fiscal
2001 and 2000 consisted of income from the merchant credit card operation, the
trust department, depository service fees, gains on the sale of residential real
estate mortgage loans, and other miscellaneous fees. The 3% increase was
primarily due to an increase in gains on sales of loans, and increased trust
fees and deposit service fees received during the period, offset by the decrease
in merchant credit card fees.
During fiscal 2001, merchant credit card fees, net of processing costs,
decreased by $600,000 to $1.7 million, from $2.3 million for fiscal 2000. The
decrease was due to decreased volumes of credit card transactions processed
during fiscal 2001. As previously discussed, Bancard terminated processing for
its largest ISO in May 2000.
For fiscal 2001, trust department fees increased $200,000, or 10%, to $2.1
million from $1.9 million for fiscal 2000. The increase was primarily a
reflection of the development of additional trust relationships during the
period.
Gains on sales of loans were $1.1 million for fiscal 2001, which reflected an
increase of 159%, or $700,000, from $400,000 for fiscal 2000. The increase
resulted from a dramatic decline in interest rates between January and June
2001, which was driven by corresponding cuts by the Federal Reserve during the
first half of calendar 2001. This created significantly more home refinances and
home purchases during the fiscal year and the subsequent sale of the majority of
these loans into the secondary market.
Noninterest expenses. The main components of noninterest expenses were primarily
salaries and benefits, occupancy and equipment expenses, and professional and
data processing fees for both periods. Noninterest expenses for fiscal 2001 were
$13.8 million as compared to $11.5 million for the same period in 2000 for an
increase of $2.3 million or 20%.
The following table sets forth the various categories of noninterest expenses
for the years ended June 30, 2001 and 2000.
Years Ended June 30,
--------------------------------------
2001 2000 % Change
--------------------------------------
Salaries and employee benefits ......................... $ 8,014,268 $ 6,878,213 17%
Professional and data processing fees .................. 1,159,929 860,216 35%
Advertising and marketing .............................. 579,524 410,106 41%
Occupancy and equipment expense ........................ 1,925,820 1,580,911 22%
Stationery and supplies ................................ 352,441 324,219 9%
Postage and telephone .................................. 409,626 361,623 13%
Other .................................................. 1,358,345 1,052,173 29%
-------------------------
Total noninterest expenses ............... $13,799,953 $11,467,461 20%
=========================
16
Salaries and benefits experienced the most significant dollar increase of any
noninterest expense component. For fiscal 2001, total salaries and benefits
increased to $8.0 million or $1.1 million over the fiscal 2000 total of $6.9
million. The change was primarily attributable to the addition of new Quad City
Bank & Trust employees during the period. Advertising and marketing increased
$200,000 or 41%. The increase was the result of the development and start-up of
Quad City Bank & Trust's new website (qcbt.com), the establishment of an online
partnership with America Online, Inc. creating local access to that website, and
media expenses incurred in support of marketing efforts for Quad City Bank &
Trust's Utica location and various Quad City Bank & Trust products and
departments. Professional and data processing fees increased $300,000 or 35%.
The increase was primarily attributable to legal fees resulting from an
arbitration involving Bancard, combined with increased fees to outside
consultants addressing compliance, efficiency and profitability issues for Quad
City Bank & Trust. Other noninterest expense increased $300,000 or 29% for the
fiscal year. The increase was primarily the result of increased service charges
from upstream banks incurred by Quad City Bank & Trust and increased expenses
related to Bancard's cardholder program.
Income tax expense. The provision for income taxes was $1.2 million for fiscal
2001 compared to $1.7 million for fiscal 2000, a decrease of $500,000 or 31%.
The decrease was primarily attributable to decreased net income generated in
fiscal 2001 compared to fiscal 2000, and a reduction in the effective tax rate
for fiscal 2001 of 32.6% versus 38.0% for fiscal 2000.
Financial Condition
Total assets of the Company increased by $85.8 million or 17% to $604.6 million
at December 31, 2002 from $518.8 million at June 30, 2002. The growth primarily
resulted from an increase in the loan portfolio funded by deposits received from
customers and by proceeds from Federal Home Loan Bank advances. Total assets of
the Company increased by $117.9 million or 29% to $518.8 million at June 30,
2002 from $400.9 million at June 30, 2001. Again, the growth primarily resulted
from an increase in the loan portfolio funded by deposits received from
customers and by proceeds from Federal Home Loan Bank advances and short-term
borrowings.
Cash and Cash Equivalent Assets. Cash and due from banks increased by $7.9
million or 30% to $34.1 million at December 31, 2002 from $26.2 million at June
30, 2002. Cash and due from banks increased by $6.0 million or 30% to $26.2
million at June 30, 2002 from $20.2 million at June 30, 2001. Cash and due from
banks represented both cash maintained at the subsidiary banks, as well as funds
that the Company and its subsidiaries had deposited in other banks in the form
of demand deposits.
Federal funds sold are inter-bank funds with daily liquidity. Federal funds sold
increased by $13.6 million to $14.4 million at December 31, 2002 from $760
thousand at June 30, 2002. Federal funds sold decreased by $7.0 million or 90%
to $760 thousand at June 30, 2002 from $7.8 million at June 30, 2001. These
fluctuations were attributable to the Company's varying levels of liquidity at
the subsidiary banks.
Certificates of deposit at financial institutions decreased by $1.9 million or
26% to $5.4 million at December 31, 2002 from $7.3 million at June 30, 2002.
During the six months ended December 31, 2002, the certificate of deposit
portfolio had 19 maturities totaling $1.9 million and no purchases. Certificates
of deposit at financial institutions decreased by $3.2 million or 31% to $7.3
million at June 30, 2002 from $10.5 million at June 30, 2001. During fiscal
2002, the certificate of deposit portfolio had 50 maturities totaling $4.9
million and 17 purchases totaling $1.7 million. As the result of depressed
interest rates and a strong loan demand, the subsidiary banks reduced their
deposits in other banks in the form of certificates of deposit and increased
their utilization of Federal funds sold.
Investments. Securities increased by $5.5 million or 7% to $81.7 million at
December 31, 2002 from $76.2 million at June 30, 2002. The net increase was the
result of a number of transactions in the securities portfolio. The Company
purchased additional securities, classified as available for sale, in the amount
of $14.8 million, and recognized an increase in unrealized gains on securities
available for sale, before applicable income tax of $1.4 million. These
increases were partially offset by paydowns of $1.2 million that were received
on mortgage-backed securities, proceeds from the sales of securities available
for sale of $2.1 million, proceeds from calls and maturities of $7.3 million,
and amortization of premiums, net of the accretion of discounts, of $149
thousand.
17
Securities increased by $19.5 million or 34% to $76.2 million at June 30, 2002
from $56.7 million at June 30, 2001. The net increase was the result of a number
of transactions in the securities portfolio. The Company purchased additional
securities, classified as available for sale, in the amount of $29.9 million and
classified as held to maturity, of $100 thousand, and recognized an increase in
unrealized gains on securities available for sale, before applicable income tax
of $1.2 million. These increases were partially offset by paydowns of $1.8
million that were received on mortgage-backed securities, proceeds from the
sales of securities available for sale of $101 thousand, proceeds from calls and
maturities of $9.7 million, and amortization of premiums, net of the accretion
of discounts, of $163 thousand.
Certain investment securities of the subsidiary banks are purchased with the
intent to hold the securities until they mature. These held to maturity
securities, comprised of municipal securities and other bonds were recorded at
amortized cost at December 31, 2002, June 30, 2002 and June 31, 2001. The
balance at both December 31, 2002 and June 30, 2002 was $425 thousand, a
decrease of $151 thousand from $576 thousand at June 30, 2001. Market values at
December 31, 2002, June 30, 2002 and June 31, 2001 were $451 thousand, $437
thousand, and $583 thousand, respectively.
All of the Company's and Cedar Rapids Bank & Trust's securities, and a majority
of Quad City Bank & Trust's securities are placed in the available for sale
category as the securities may be liquidated to provide cash for operating,
investing or financing purposes. These securities were reported at fair value
and increased by $5.4 million, or 7%, to $81.2 million at December 31, 2002,
from $75.8 million at June 30, 2002. These securities were reported at fair
value and increased by $19.7 million, or 35%, to $75.8 million at June 30, 2002,
from $56.1 million at June 30, 2001. The amortized cost of such securities at
December 31, 2002, June 30, 2002 and June 31, 2001 was $77.8 million, $73.7
million, and $55.3 million, respectively.
The Company does not use any financial instruments referred to as derivatives to
manage interest rate risk and as of December 31, 2002 there existed no security
in the investment portfolio (other than U.S. Government and U.S. Government
agency securities) that exceeded 10% of stockholders' equity at that date.
Loans. Total gross loans receivable increased by $59.1 million or 15% to $449.7
million at December 31, 2002 from $390.6 million at June 30, 2002. The increase
was the result of the origination or purchase of $305.1 million of commercial
business, consumer and real estate loans, less loan charge-offs, net of
recoveries, of $1.4 million and loan repayments or sales of loans of $244.6
million. During the six months ended December 31, 2002, Quad City Bank & Trust
contributed $231.4 million, or 76%, and Cedar Rapids Bank & Trust contributed
$73.7 million, or 24% of the company's loan originations or purchases. The
majority of residential real estate loans originated by the subsidiary banks
were sold on the secondary market to avoid the interest rate risk associated
with long-term fixed rate loans. As of December 31, 2002, Quad City Bank &
Trust's legal lending limit was approximately $6.4 million and Cedar Rapids Bank
& Trust's legal lending limit was approximately $1.6 million.
Total gross loans receivable increased by $102.7 million or 36% to $390.6
million at June 30, 2002 from $287.9 million at June 30, 2001. The increase was
the result of the origination or purchase of $556.5 million of commercial
business, consumer and real estate loans, less loan charge-offs, net of
recoveries, of $402 thousand and loan repayments or sales of loans of $453.3
million. During fiscal 2002, Quad City Bank & Trust contributed $452.3 million,
or 81%, and Cedar Rapids Bank & Trust contributed $104.2 million, or 19% of the
Company's loan originations or purchases. The majority of residential real
estate loans originated by the subsidiary banks were sold on the secondary
market to avoid the interest rate risk associated with long-term fixed rate
loans. As of June 30, 2002, Quad City Bank & Trust's legal lending limit was
approximately $5.7 million and Cedar Rapids Bank & Trust's legal lending limit
was approximately $1.5 million.
Allowance for Loan Losses. The allowance for estimated losses on loans was $6.9
million at December 31, 2002 compared to $6.1 million at June 30, 2002 for an
increase of $800 thousand or 13%. The allowance for estimated losses on loans
was $6.1 million at June 30, 2002 compared to $4.2 million at June 30, 2001 for
an increase of $1.9 million or 44%. The adequacy of the allowance for estimated
losses on loans was determined by management based on factors that included the
overall composition of the loan portfolio, types of loans, past loss experience,
loan delinquencies, potential substandard and doubtful credits, economic
conditions and other factors that, in management's judgment, deserved evaluation
in estimating loan losses. To ensure that an adequate allowance was maintained,
provisions were made based on the increase in loans and a detailed analysis of
the loan portfolio. The loan portfolio was reviewed and analyzed monthly with
specific detailed reviews completed on all credits risk-rated less than "fair
quality" and carrying aggregate exposure in excess of $250 thousand. The
adequacy of the allowance for estimated losses on loans was monitored by the
credit administration staff, and reported to management and the board of
directors.
18
Net charge-offs for the six months ended December 31, 2002 and 2001, were $1.4
million and $349 thousand respectively. Net charge-offs for the years ended June
30, 2002 and 2001, were $402 thousand and $260 thousand respectively. One
measure of the adequacy of the allowance for estimated losses on loans is the
ratio of the allowance to the total loan portfolio. Provisions were made monthly
to ensure that an adequate level was maintained. The allowance for estimated
losses on loans as a percentage of total gross loans was 1.53% at December 31,
2002, 1.56% at June 30, 2002, and 1.48% at June 31, 2001.
Although management believes that the allowance for estimated losses on loans at
December 31, 2002 was at a level adequate to absorb losses on existing loans,
there can be no assurance that such losses will not exceed the estimated amounts
or that the Company will not be required to make additional provisions for loan
losses in the future. Asset quality is a priority for the Company and its
subsidiaries. The ability to grow profitably is in part dependent upon the
ability to maintain that quality. Along with other financial institutions,
management shares a concern for the outlook of the economy during calendar 2003.
A slowdown in economic activity beginning in 2001 severely impacted several
major industries as well as the economy as a whole. Even though there are
numerous indications of emerging strength, it is not certain that this strength
is sustainable. In addition, consumer confidence may still be negatively
impacted by the recent substantial decline in equity security prices. These
events could still adversely affect cash flows for both commercial and
individual borrowers, as a result of which, the Company could experience
increases in problem assets, delinquencies and losses on loans, and require
further increases in the provision.
Nonperforming Assets. The policy of the Company is to place a loan on nonaccrual
status if: (a) payment in full of interest or principal is not expected or (b)
principal or interest has been in default for a period of 90 days or more unless
the obligation is both in the process of collection and well secured. Well
secured is defined as collateral with sufficient market value to repay principal
and all accrued interest. A debt is in the process of collection if collection
of the debt is proceeding in due course either through legal action, including
judgment enforcement procedures, or in appropriate circumstances, through
collection efforts not involving legal action which are reasonably expected to
result in repayment of the debt or in its restoration to current status.
Nonaccrual loans were $4.6 million at December 31, 2002 compared to $1.6 million
at June 30, 2002 for an increase of $3.0 million or 196%. The increase in
nonaccrual loans was comprised of increases in commercial loans of $2.9 million
and real estate loans of $143 thousand, partially offset by a decrease in
consumer loans of $10 thousand. The increase in nonaccrual commercial loans was
due primarily to the transfer to nonaccrual status of two commercial lending
relationships at Quad City Bank & Trust with an outstanding balance of $2.7
million. Nonaccrual loans at December 31, 2002 represented approximately one
percent of the Company's loan portfolio. All of the Company's nonperforming
assets are located in the loan portfolio at Quad City Bank & Trust. The loans in
the Cedar Rapids Bank & Trust loan portfolio have been made relatively recently,
and none of the loans have been categorized as nonperforming assets. As the loan
portfolio at Cedar Rapids Bank & Trust matures, it is likely that there will be
nonperforming loans or charge-offs associated with the portfolio.
Nonaccrual loans were $1.6 million at June 30, 2002 compared to $1.2 million at
June 30, 2001 for an increase of $328 thousand or 27%. The increase in
nonaccrual loans was comprised of increases in commercial loans of $760 thousand
partially offset by decreases in both real estate loans of $407 thousand and in
consumer loans of $25 thousand. The increase in nonaccrual commercial loans was
due primarily to the addition of a single, fully collateralized loan at Quad
City Bank & Trust with an outstanding balance of $737 thousand. Nonaccrual loans
at June 30, 2002 represented less than one half of one percent of the Company's
loan portfolio. All of the Company's nonperforming assets were located in the
loan portfolio at Quad City Bank & Trust.
As of December 31, 2002, June 30, 2002, and June 30, 2001 past due loans of 30
days or more amounted to $9.6 million, $4.3 million, and $3.2 million,
respectively. Past due loans as a percentage of gross loans receivable were 2.1%
at December 31, 2002 and 1.1% at both June 30, 2002 and 2001.
Other Assets. Premises and equipment increased by $18 thousand, or less than 1%,
to remain at $9.2 million at December 31, 2002 as at June 30, 2002. Premises and
equipment increased by $548 thousand or 6% to $9.2 million at June 30, 2002 from
$8.7 million at June 30, 2001. The increases resulted from the purchase of
additional furniture, fixtures and equipment offset by depreciation expense.
Additional information regarding the composition of this account and related
accumulated depreciation is described in footnote 5 to the consolidated
financial statements.
19
Accrued interest receivable on loans, securities, and interest-bearing cash
accounts increased by $95 thousand or 3% to $3.2 million at December 31, 2002
from $3.1 million at June 30, 2002. Accrued interest receivable on loans,
securities, and interest-bearing cash accounts increased by $263 thousand or 9%
to $3.1 million at June 30, 2002 from $2.9 million at June 30, 2001. Increases
were primarily due to greater average outstanding balances in interest-bearing
assets.
Other assets increased by $2.3 million or 19% to $13.8 million at December 31,
2002 from $11.5 million at June 30, 2002. The three largest components of other
assets at December 31, 2002 were $4.3 million in Federal Reserve Bank and
Federal Home Loan Bank stocks, $2.8 million in cash surrender value of life
insurance contracts, and $3.3 million in prepaid Visa/Mastercard processing
fees. Other assets increased by $948 thousand or 9% to $11.5 million at June 30,
2002 from $10.6 million at June 30, 2001. The three largest components of other
assets at June 30, 2002 were $3.0 million in Federal Reserve Bank and Federal
Home Loan Bank stocks, $2.6 million in cash surrender value of life insurance
contracts and $2.4 million in prepaid Visa/Mastercard processing fees. At both
December 31, and June 30, 2002, other assets also included accrued trust
department fees, other miscellaneous receivables, and various prepaid expenses.
Deposits. Deposits increased by $58.4 million or 16% to $434.7 million at
December 31, 2002 from $376.3 million at June 30, 2002. The increase resulted
from a $43.8 million net increase in noninterest bearing, NOW, money market and
other savings accounts and a $14.6 million net increase in certificates of
deposit. Deposits increased by $74.1 million or 25% to $376.3 million at June
30, 2002 from $302.2 million at June 30, 2001. The increase resulted from a
$12.8 million net increase in noninterest bearing, NOW, money market and other
savings accounts and a $61.3 million net increase in certificates of deposit.
Short-term Borrowings. Short-term borrowings decreased by $1.7 million or 5%
from $34.6 million as of June 30, 2002 to $32.9 million as of December 31, 2002.
Short-term borrowings increased by $6.3 million or 22% from $28.3 million as of
June 30, 2001 to $34.6 million as of June 30, 2002. The subsidiary banks offer
short-term repurchase agreements to some of their significant deposit customers.
Also, on occasion, the subsidiary banks must purchase Federal funds for
short-term funding needs from the Federal Reserve Bank, or from a correspondent
bank. Short-term borrowings were comprised of customer repurchase agreements of
$32.9 million, $29.1 million, and $28.3 million at December 31, 2002, June 30,
2002 and 2001, respectively, as well as federal funds purchased from
correspondent banks of $5.5 million at June 30, 2002 and none at both December
31, 2002 and June 30, 2001.
FHLB Advances and Other Borrowings. FHLB advances increased $22.6 million or 43%
from $52.4 million as of June 30, 2002 to $75.0 million as of December 31, 2002.
FHLB advances increased $22.7 million or 76% from $29.7 million as of June 30,
2001 to $52.4 million as of June 30, 2002. As of December 31, 2002, the
subsidiary banks held $3.9 million of FHLB stock in aggregate. As a result of
their memberships in the FHLB of Des Moines, the subsidiary banks have the
ability to borrow funds for short-term or long-term purposes under a variety of
programs. Both Quad City Bank & Trust and Cedar Rapids Bank & Trust utilized
FHLB advances for loan matching as a hedge against the possibility of rising
interest rates or when these advances provided a less costly source of funds
than customer deposits.
Other borrowings were $5.0 million at December 31, 2002 and at June 30, 2002. In
September 2001, the Company drew a $5.0 million advance on a line of credit at
its primary correspondent bank as partial funding for the initial capitalization
of Cedar Rapids Bank & Trust.
In June 1999, the Company issued 1,200,000 shares of trust preferred securities
through its newly formed Capital Trust subsidiary. On the Company's financial
statements, these securities are listed as company obligated mandatorily
redeemable preferred securities of subsidiary trust holding solely subordinated
debentures and were $12,000,000 at December 31, 2002 and June 30, 2002 and 2001.
Under current regulatory guidelines, these securities are considered to be Tier
1 capital, with certain limitations that are applicable to the Company.
Other liabilities increased by $2.5 million or 43% to $8.4 million as of
December 31, 2002 from $5.9 million as of June 30, 2002. The increase was
primarily the result of accrued severance compensation and income taxes related
to Bancard's sale of its ISO related merchant credit card operations in October
2002. Other liabilities increased by $971 thousand or 20% to $5.9 million as of
June 30, 2002 from $4.9 million as of June 30, 2001. Other liabilities were
comprised of unpaid amounts for various products and services, and accrued but
unpaid interest on deposits. At both December 31, 2002 and June 31, 2002, the
largest single component of other liabilities was interest payable at $1.8
million and $1.9 million, respectively.
Stockholders' Equity. Common stock at December 31, 2002 was $2.8 million, which
was unchanged from June 30, 2002. A slight increase of $13 thousand was the
result of proceeds received from the exercise of stock options. Common stock of
$2.3 million as of June 30, 2001 increased by $484 thousand, or 21%, to $2.8
million at June 30, 2002. The increase was primarily the result of the Company's
private placement of 475,424 additional shares of common stock at $11.00 per
share in September 2001. The funds received as a result of this issuance were
largely from residents of the Cedar Rapids area and were used as partial funding
for the capitalization of Cedar Rapids Bank & Trust. During fiscal 2001, the
Company acquired 18,650 treasury shares at a total cost of $255 thousand.
20
Additional paid-in capital totaled $16.8 million at December 31, 2002 compared
to $16.7 million at June 30, 2002. An increase of $76 thousand resulted
primarily from proceeds received in excess of the $1.00 per share par value for
the 13,468 shares of common stock issued as the result of the exercise of stock
options. Additional paid-in capital increased to $16.7 million as of June 30,
2002 from $12.1 million at June 30, 2001. The increase of $4.6 million, or 37%,
resulted primarily from proceeds received in excess of the $1.00 per share par
value, net of issuance costs, for the 475,424 shares of common stock issued as
the result of the Company's private placement offering.
Retained earnings increased by $3.0 million, or 24%, to $15.7 million at
December 31, 2002 from $12.7 million at June 30, 2002. The increase reflected
net income for the six-month period reduced by the $138 thousand dividend
declared in December. On October 23, 2002, the board of directors declared a
cash dividend of $0.05 per share payable on January 3, 2003, to stockholders of
record on December 16, 2002. Retained earnings increased by $3.0 million or 31%
to $12.7 million as of June 30, 2002 from $9.7 million as of June 30, 2001. The
increase reflected net income for the year.
Accumulated other comprehensive income consisting of net unrealized gains on
securities available for sale, net of related income taxes, was $2.1 million as
of December 31, 2002 as compared to $1.3 million as of June 30, 2002.
Accumulated other comprehensive income was $1.3 million as of June 30, 2002 as
compared to $506 thousand as of June 30, 2001. The increases in the gains were
both attributable to the increases during the periods in the fair value of the
securities identified as available for sale, primarily as a result of a decline
in market interest rates.
In April 2000, the Company announced that the board of directors approved a
stock repurchase program enabling the Company to repurchase approximately 60,000
shares of its common stock. This stock repurchase program was completed in the
fall of 2000 and at both December 31, 2002 and June 30, 2002 the Company held in
treasury 60,146 shares at a total cost of $855 thousand. The weighted average
cost of the shares was $14.21.
Liquidity
Liquidity measures the ability of the Company to meet maturing obligations and
its existing commitments, to withstand fluctuations in deposit levels, to fund
its operations, and to provide for customers' credit needs. One source of
liquidity is cash and short-term assets, such as interest-bearing deposits in
other banks and federal funds sold, which totaled $53.9 million at December 31,
2002, $34.2 million at June 30, 2002 and $38.5 million at June 30, 2001. Quad
City Bank & Trust and Cedar Rapids Bank & Trust have a variety of sources of
short-term liquidity available to them, including federal funds purchased from
correspondent banks, sales of securities available for sale, FHLB advances,
lines of credit and loan participations or sales. The Company also generates
liquidity from the regular principal payments and prepayments made on its
portfolio of loans and mortgage-backed securities.
The liquidity of the Company is comprised of three primary classifications: cash
flows from operating activities, cash flows from investing activities, and cash
flows from financing activities. Net cash used in operating activities,
consisting primarily of loan originations for sale, was $12.9 million for the
six months ended December 31, 2002 compared to net cash provided by operating
activities of $470 thousand for the six months ended December 31, 2001. Net cash
provided by operating activities was $3.5 million for fiscal 2002 compared to
net cash used in operating activities of $1.7 million for fiscal 2001. Net cash
used in investing activities, consisting principally of loan funding and the
purchase of securities and federal funds was $58.5 million for the six-month
period ended December 31, 2002 and $59.7 million for the comparable period in
2001. Net cash used in investing activities, consisting principally of loan
funding and the purchase of securities was $110.6 million for fiscal 2002 and
$21.9 million for fiscal 2001. Net cash provided by financing activities,
consisting primarily of deposit growth and proceeds from Federal Home Loan Bank
advances, was $79.2 million for the six months ended December 31, 2002 compared
to $60.2 million for the same period in 2001. Net cash provided by financing
activities, consisting primarily of deposit growth and proceeds from Federal
Home Loan Bank advances and short-term borrowings was $113.1 million for fiscal
2002 compared to $28.7 million for fiscal 2001.
At December 31, 2002, the subsidiary banks had seven unused lines of credit
totaling $38.0 million of which $4.0 million was secured and $34.0 million was
unsecured. At June 30, 2002, the subsidiary banks had seven unused lines of
credit totaling $36.0 million of which $4.0 million was secured and $32.0
million was unsecured. At both December 31, 2002 and June 30, 2002, the Company
also had a secured line of credit for $10.0 million, of which $5.0 million had
been used as partial funding for the capitalization of Cedar Rapids Bank and
Trust. At June 30, 2001, Quad City Bank & Trust had six unused lines of credit
totaling $31.0 million of which $8.0 million was secured and $23.0 million was
unsecured. Also at June 30, 2001, the Company had an unused line of credit for
$3.0 million, which was secured.
21
Impact of Inflation and Changing Prices
The consolidated financial statements and the accompanying notes have been
prepared in accordance with Generally Accepted Accounting Principles, which
require the measurement of financial position and operating results in terms of
historical dollar amounts without considering the changes in the relative
purchasing power of money over time due to inflation. The impact of inflation is
reflected in the increased cost of the Company's operations. Unlike industrial
companies, nearly all of the assets and liabilities of the Company are monetary
in nature. As a result, interest rates have a greater impact on the Company's
performance than do the effects of general levels of inflation. Interest rates
do not necessarily move in the same direction or to the same extent as the price
of goods and services.
Impact of New Accounting Standards
The Financial Accounting Standards Board has issued Statement 146, "Accounting
for Costs Associated with Exit or Disposal Activities." This statement addresses
financial accounting and reporting for costs associated with exit or disposal
activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3,
"Liability and Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." The Statement provides that a liability for a cost associated
with an exit or disposal activity be recognized and measured initially at fair
value only when the liability is incurred. For the Company, the provisions of
the Statement are effective for exit or disposal activities that are initiated
after December 31, 2002. Implementation of the Statement is not expected to have
a material impact on the Company's consolidated financial statements.
The Financial Accounting Standards Board has issued Statement 148, "Accounting
for Stock-Based Compensation - Transition and Disclosure - an amendment of FASB
No. 123. This Statement amends Statement No. 123 to provide alternative methods
of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation and amends the disclosure
requirements of Statement No. 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. The alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee compensation will
be effective for the fiscal year ending December 31, 2003 and implementation is
not expected to have a material impact on the Company's consolidated financial
statements. The amended annual disclosure requirements, which would have been
effective for the fiscal year ending December 31, 2003, have been early adopted
in the financial statements for the six-month period ending December 31, 2002.
The amended interim disclosure requirements are effective for the Company for
the quarter ending March 31, 2003 and implementation is not expected to have a
material impact on the financial statements.
The Financial Accounting Standards Board has issued Interpretation No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others" - an interpretation of FASB
Statements No. 5, 57 and 107 and rescission of FASB Interpretation No. 34." This
Interpretation elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under certain
guarantees that it has issued. It also clarifies that a guarantor is required to
recognize, at the inception of a guarantee, a liability for the fair value of
the obligation undertaken in issuing the guarantee. The initial recognition and
measurement provisions of this Interpretation are applicable on a prospective
basis to guarantees issued or modified after December 31, 2002. Implementation
of these provisions of the Interpretation is not expected to have a material
impact on the Company's consolidated financial statements. The disclosure
requirements of the Interpretation are effective for financial statements of
interim or annual periods ending after December 15, 2002, and have been adopted
in the consolidated financial statements for December 31, 2002.
FORWARD LOOKING STATEMENTS
Safe Harbor Statement Under the Private Securities Litigation Reform Act of
1995. This document (including information incorporated by reference) contains,
and future oral and written statements of the Company and its management may
contain, forward-looking statements, within the meaning of such term in the
Private Securities Litigation Reform Act of 1995, with respect to the financial
condition, results of operations, plans, objectives, future performance and
business of the Company. Forward-looking statements, which may be based upon
beliefs, expectations and assumptions of the Company's management and on
information currently available to management, are generally identifiable by the
use of words such as "believe," "expect," "anticipate," "bode," "predict,"
"suggest," "appear," "plan," "intend," "estimate," "may," "will," "would,"
"could," "should" or other similar expressions. Additionally, all statements in
this document, including forward-looking statements, speak only as of the date
they are made, and the Company undertakes no obligation to update any statement
in light of new information or future events.
22
The Company's ability to predict results or the actual effect of future plans or
strategies is inherently uncertain. Factors which could have a material adverse
effect on the operations and future prospects of the Company and its
subsidiaries include, but are not limited to, the following:
o The strength of the United States economy in general and the strength of
the local economies in which the Company conducts its operations which may
be less favorable than expected and may result in, among other things, a
deterioration in the credit quality and value of the Company's assets.
o The economic impact of past and any future terrorist attacks, acts of war
or threats thereof, and the response of the United States to any such
threats and attacks.
o The effects of, and changes in, federal, state and local laws, regulations
and policies affecting banking, securities, insurance and monetary and
financial matters.
o The effects of changes in interest rates (including the effects of changes
in the rate of prepayments of the Company's assets) and the policies of the
Board of Governors of the Federal Reserve System.
o The ability of the Company to compete with other financial institutions as
effectively as the Company currently intends due to increases in
competitive pressures in the financial services sector.
o The inability of the Company to obtain new customers and to retain existing
customers.
o The timely development and acceptance of products and services, including
products and services offered through alternative delivery channels such as
the Internet.
o Technological changes implemented by the Company and by other parties,
including third party vendors, which may be more difficult or more
expensive than anticipated or which may have unforeseen consequences to the
Company and its customers.
o The ability of the Company to develop and maintain secure and reliable
electronic systems.
o The ability of the Company to retain key executives and employees and the
difficulty that the Company may experience in replacing key executives and
employees in an effective manner.
o Consumer spending and saving habits which may change in a manner that
affects the Company's business adversely.
o Business combinations and the integration of acquired businesses which may
be more difficult or expensive than expected.
o The costs, effects and outcomes of existing or future litigation.
o Changes in accounting policies and practices, as may be adopted by state
and federal regulatory agencies and the Financial Accounting Standards
Board.
o The ability of the Company to manage the risks associated with the
foregoing as well as anticipated.
These risks and uncertainties should be considered in evaluating forward-looking
statements and undue reliance should not be placed on such statements.
Additional information concerning the Company and its business, including other
factors that could materially affect the Company's financial results, is
included in the Company's filings with the Securities and Exchange Commission.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company, like other financial institutions, is subject to direct and
indirect market risk. Direct market risk exists from changes in interest rates.
The Company's net income is dependent on its net interest income. Net interest
income is susceptible to interest rate risk to the degree that interest-bearing
liabilities mature or reprice on a different basis than interest-earning assets.
When interest-bearing liabilities mature or reprice more quickly than
interest-earning assets in a given period, a significant increase in market
rates of interest could adversely affect net interest income. Similarly, when
interest-earning assets mature or reprice more quickly than interest-bearing
liabilities, falling interest rates could result in a decrease in net income.
23
In an attempt to manage its exposure to changes in interest rates, management
monitors the Company's interest rate risk. Each subsidiary bank has an
asset/liability management committee of the board of directors that meets
quarterly to review the bank's interest rate risk position and profitability,
and to make or recommend adjustments for consideration by the full board of each
bank . Management also reviews Quad City Bank & Trust and Cedar Rapids Bank &
Trust's securities portfolios, formulates investment strategies, and oversees
the timing and implementation of transactions to assure attainment of the
board's objectives in the most effective manner. Notwithstanding the Company's
interest rate risk management activities, the potential for changing interest
rates is an uncertainty that can have an adverse effect on net income.
In adjusting the Company's asset/liability position, the board and management
attempt to manage the Company's interest rate risk while maintaining or
enhancing net interest margins. At times, depending on the level of general
interest rates, the relationship between long-term and short-term interest
rates, market conditions and competitive factors, the board and management may
decide to increase the Company's interest rate risk position somewhat in order
to increase its net interest margin. The Company's results of operations and net
portfolio values remain vulnerable to increases in interest rates and to
fluctuations in the difference between long-term and short-term interest rates.
One approach used to quantify interest rate risk is the net portfolio value
analysis. In essence, this analysis calculates the difference between the
present value of liabilities and the present value of expected cash flows from
assets and off-balance-sheet contracts. The following table sets forth, at
December 31, 2002 and June 30, 2002, an analysis of the Company's interest rate
risk as measured by the estimated changes in the net portfolio value resulting
from instantaneous and sustained parallel shifts in the yield curve (+ or - 200
basis points).
Estimated Increase
Change In (Decrease) in NPV
Interest Estimated -------------------------------------------------------------
Rates NPV Amount Amount Percent
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(Basis points) Dec.31, 2002 June 30, 2002 Dec.31, 2002 June 30, 2002 Dec.31, 2002 June 30, 2002
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