QCRH 10-Q Quarterly Report Sept. 30, 2012 | Alphaminr
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QCRH 10-Q Quarter ended Sept. 30, 2012

Balance Sheet
Cash Flow
Income Statement
QCR HOLDINGS INC
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10-Q 1 qcr_10q-093012.htm FORM 10-Q qcr_10q-093012.htm
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-Q

[ X ]          QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ending September 30, 2012

[    ]           TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to________

Commission file number 0-22208

QCR HOLDINGS, INC.
(Exact name of Registrant as specified in its charter)
Delaware
(State or other jurisdiction of incorporation or organization)
42-1397595
(I.R.S. Employer ID Number)
3551 7 th Street, Moline, Illinois 61265
(Address of principal executive offices)

(309) 743-7761
(Registrant’s telephone number, including area code)

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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes [ X ]  No [    ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definition of “accelerated filer,” “large accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer [   ]     Accelerated filer  [   ]     Non-accelerated filer  [   ]     Smaller reporting company [ X ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes [    ] No [ X ]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date: As of November 1, 2012, the Registrant had outstanding 4,878,317 shares of common stock, $1.00 par value per share.

QCR HOLDINGS, INC. AND SUBSIDIARIES

INDEX

Page Number(s)
Part I
FINANCIAL INFORMATION
Item 1.
Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheets
2
As of September 30, 2012 and December 31, 2011
Consolidated Statements of Income
3
For the Three Months Ended September 30, 2012 and 2011
Consolidated Statements of Income
4
For the Nine Months Ended September 30, 2012 and 2011
Consolidated Statements of Comprehensive Income
5
For the Three and Nine Months Ended September 30, 2012 and 2011
Consolidated Statement of Changes in Stockholders' Equity
6-7
For the Nine Months Ended September 30, 2012 and 2011
Consolidated Statements of Cash Flows
8
For the Nine Months Ended September 30, 2012 and 2011
Notes to the Consolidated Financial Statements
9-28
Item 2.
Management's Discussion and Analysis of Financial Condition and
29-58
Results of Operations
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
59-60
Item 4.
Controls and Procedures
61
Part II
OTHER INFORMATION
Item 1.
Legal Proceedings
62
Item 1.A.
Risk Factors
62
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
62
Item 3.
Defaults upon Senior Securities
62
Item 4.
Mine Safety Disclosures
62
Item 5.
Other Information
62
Item 6.
Exhibits
63
Signatures
64
1
QCR HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
As of September 30, 2012 and December 31, 2011
September 30,
2012
December 31,
2011
ASSETS
Cash and due from banks
$ 40,564,561 $ 53,136,710
Federal funds sold
5,725,000 20,785,000
Interest-bearing deposits at financial institutions
49,436,938 26,750,602
Securities held to maturity, at amortized cost
650,000 200,000
Securities available for sale, at fair value
590,701,449 565,029,291
Total securities
591,351,449 565,229,291
Loans receivable held for sale
6,285,131 3,832,760
Loans/leases receivable held for investment
1,238,007,078 1,196,912,737
Gross loans/leases receivable
1,244,292,209 1,200,745,497
Less allowance for estimated losses on loans/leases
(19,416,748 ) (18,789,262 )
Net loans/leases receivable
1,224,875,461 1,181,956,235
Premises and equipment, net
31,589,347 31,740,751
Goodwill
3,222,688 3,222,688
Bank-owned life insurance
43,208,268 42,011,281
Restricted investment securities
14,780,800 15,253,600
Other real estate owned, net
5,002,791 8,385,758
Other assets
14,188,769 18,138,138
Total assets
$ 2,023,946,072 $ 1,966,610,054
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest-bearing
$ 417,284,214 $ 357,183,481
Interest-bearing
925,951,220 848,274,307
Total deposits
1,343,235,434 1,205,457,788
Short-term borrowings
140,888,698 213,536,450
Federal Home Loan Bank advances
196,350,000 204,750,000
Other borrowings
138,237,737 136,231,663
Junior subordinated debentures
36,085,000 36,085,000
Other liabilities
30,027,917 26,116,451
Total liabilities
1,884,824,786 1,822,177,352
STOCKHOLDERS' EQUITY
Preferred stock, $1 par value; shares authorized 250,000 September 2012 - 54,867 shares issued and outstanding December 2011 - 65,090 shares issued and outstanding
54,867 65,090
Common stock, $1 par value; shares authorized 20,000,000 September 2012 - 4,984,024 shares issued and 4,862,778 outstanding December 2011 - 4,879,435 shares issued and 4,758,189 outstanding
4,984,024 4,879,435
Additional paid-in capital
78,342,963 89,702,533
Retained earnings
51,077,870 44,585,902
Accumulated other comprehensive income
6,122,102 4,754,714
Noncontrolling interests
145,970 2,051,538
Less treasury stock, September 2012 and December 2011 - 121,246 common shares, at cost
(1,606,510 ) (1,606,510 )
Total stockholders' equity
139,121,286 144,432,702
Total liabilities and stockholders' equity
$ 2,023,946,072 $ 1,966,610,054
See Notes to Consolidated Financial Statements
2
QCR HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three Months Ended September 30,
2012
2011
Interest and dividend income:
Loans/leases, including fees
$ 15,804,330 $ 16,215,725
Securities:
Taxable
2,781,889 2,877,574
Nontaxable
690,466 244,209
Interest-bearing deposits at financial institutions
75,818 97,714
Restricted investment securities
131,967 126,333
Federal funds sold
3,055 7,875
Total interest and dividend income
19,487,525 19,569,430
Interest expense:
Deposits
1,488,749 2,201,070
Short-term borrowings
60,500 65,502
Federal Home Loan Bank advances
1,809,888 1,931,259
Other borrowings
1,238,254 1,301,144
Junior subordinated debentures
260,616 241,751
Total interest expense
4,858,007 5,740,726
Net interest income
14,629,518 13,828,704
Provision for loan/lease losses
1,496,194 2,456,965
Net interest income after provision for loan/lease losses
13,133,324 11,371,739
Noninterest income:
Trust department fees
914,586 762,133
Investment advisory and management fees
575,711 549,515
Deposit service fees
847,343 893,685
Gains on sales of loans, net
684,546 408,364
Securities gains
- 443,614
Gains (losses) on other real estate owned, net
(745,799 ) 42,262
Earnings on bank-owned life insurance
399,925 331,440
Credit card issuing fees, net of processing costs
140,542 178,636
Other
1,300,328 725,658
Total noninterest income
4,117,182 4,335,307
Noninterest expense:
Salaries and employee benefits
8,201,323 7,651,695
Occupancy and equipment expense
1,459,901 1,359,758
Professional and data processing fees
1,065,780 1,077,435
FDIC and other insurance
599,422 578,776
Loan/lease expense
273,166 839,993
Advertising and marketing
437,130 277,376
Postage and telephone
190,868 242,103
Stationery and supplies
139,592 122,582
Bank service charges
211,378 186,351
Other
452,957 437,080
Total noninterest expense
13,031,517 12,773,149
Net income before income taxes
4,218,989 2,933,897
Federal and state income tax expense
1,034,479 667,296
Net income
$ 3,184,510 $ 2,266,601
Less: Net income attributable to noncontrolling interests
127,177 103,446
Net income attributable to QCR Holdings, Inc.
$ 3,057,333 $ 2,163,155
Less: Preferred stock dividends
810,837 2,188,058
Net income attributable to QCR Holdings, Inc. common stockholders
$ 2,246,496 $ (24,903 )
Earnings per common share attributable to QCR Holdings, Inc. common shareholders
Basic
$ 0.45 $ (0.01 )
Diluted
$ 0.44 $ (0.01 )
Weighted average common shares outstanding
4,978,699 4,866,692
Weighted average common and common equivalent shares outstanding
5,080,288 4,866,692
Cash dividends declared per common share
$ - $ -
See Notes to Consolidated Financial Statements
3
QCR HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Nine Months Ended September 30,
2012
2011
Interest and dividend income:
Loans/leases, including fees
$ 47,748,276 $ 48,466,331
Securities:
Taxable
8,353,482 8,035,495
Nontaxable
1,624,577 743,368
Interest-bearing deposits at financial institutions
288,400 311,807
Restricted investment securities
378,067 427,818
Federal funds sold
3,055 97,919
Total interest and dividend income
58,395,857 58,082,738
Interest expense:
Deposits
4,834,006 6,948,265
Short-term borrowings
202,731 248,079
Federal Home Loan Bank advances
5,503,329 6,053,134
Other borrowings
3,719,730 3,870,062
Junior subordinated debentures
787,597 974,637
Total interest expense
15,047,393 18,094,177
Net interest income
43,348,464 39,988,561
Provision for loan/lease losses
3,325,109 5,196,850
Net interest income after provision for loan/lease losses
40,023,355 34,791,711
Noninterest income:
Trust department fees
2,650,552 2,607,668
Investment advisory and management fees
1,776,499 1,630,976
Deposit service fees
2,626,822 2,623,018
Gains on sales of loans, net
1,965,957 1,923,185
Securities gains
104,600 1,472,528
Losses on other real estate owned, net
(1,324,468 ) (90,492 )
Earnings on bank-owned life insurance
1,196,987 1,032,493
Credit card issuing fees, net of processing costs
409,730 397,132
Other
2,734,890 1,969,304
Total noninterest income
12,141,569 13,565,812
Noninterest expense:
Salaries and employee benefits
24,581,642 22,480,731
Occupancy and equipment expense
4,177,076 4,017,506
Professional and data processing fees
3,342,847 3,338,935
FDIC and other insurance
1,756,493 2,149,093
Loan/lease expense
755,066 1,772,290
Advertising and marketing
1,057,246 836,459
Postage and telephone
716,050 703,803
Stationery and supplies
417,769 380,754
Bank service charges
609,599 525,007
Prepayment fees on Federal Home Loan Bank advances
- 832,099
Other-than-temporary impairment losses on securities
62,400 118,847
Other
1,402,492 1,185,443
Total noninterest expense
38,878,680 38,340,967
Net income before income taxes
13,286,244 10,016,556
Federal and state income tax expense
3,425,506 2,745,257
Net income
$ 9,860,738 $ 7,271,299
Less: Net income attributable to noncontrolling interests
494,431 308,215
Net income attributable to QCR Holdings, Inc.
$ 9,366,307 $ 6,963,084
Less: Preferred stock dividends
2,685,248 4,256,171
Net income attributable to QCR Holdings, Inc. common stockholders
6,681,059 $ 2,706,913
Earnings per common share attributable to QCR Holdings, Inc. common shareholders
Basic
$ 1.37 $ 0.56
Diluted
$ 1.35 $ 0.56
Weighted average common shares outstanding
4,871,626 4,795,382
Weighted average common and common equivalent shares outstanding
4,938,514 4,847,433
Cash dividends declared per common share
$ 0.04 $ 0.04
See Notes to Consolidated Financial Statements
4
QCR HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
Three and Nine Months Ended September 30,
Three Months Ended September 30,
2012
2011
Net income
$ 3,184,510 $ 2,266,601
Other comprehensive income:
Unrealized gains on securities available for sale:
Unrealized holding gains arising during the period before tax
2,660,251 4,340,017
Less reclassification adjustment for gains included in net income before tax
- 443,614
2,660,251 3,896,403
Tax expense
1,016,673 1,492,108
Other comprehensive income, net of tax
1,643,578 2,404,295
Comprehensive income attributable to QCR Holdings, Inc.
$ 4,828,088 $ 4,670,896
Nine Months Ended September 30,
2012
2011
Net income
$ 9,860,738 $ 7,271,299
Other comprehensive income:
Unrealized gains on securities available for sale:
Unrealized holding gains arising during the period before tax
2,313,706 7,091,919
Less reclassification adjustment for gains included in net income before tax
104,600 1,472,528
2,209,106 5,619,391
Tax expense
841,718 2,150,922
Other comprehensive income, net of tax
1,367,388 3,468,469
Comprehensive income attributable to QCR Holdings, Inc.
$ 11,228,126 $ 10,739,768
See Notes to Consolidated Financial Statements
5
QCR HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED)
Nine Months Ended September 30, 2012 and 2011
Preferred
Stock
Common
Stock
Additional
Paid-In
Capital
Retained
Earnings
Accumulated
Other
Comprehensive
Income (Loss)
Noncontrolling
Interests
Treasury
Stock
Total
Balance December 31, 2011
$ 65,090 $ 4,879,435 $ 89,702,533 $ 44,585,902 $ 4,754,714 $ 2,051,538 $ (1,606,510 ) $ 144,432,702
Comprehensive income:
Net income
- - - 3,236,818 - 166,031 - 3,402,849
Other comprehensive loss, net of tax
- - - - (1,517,235 ) - - (1,517,235 )
Comprehensive income
1,885,614
Preferred cash dividends declared
- - - (938,625 ) - - - (938,625 )
Proceeds from issuance of 7,767 shares of common stock as a result of stock purchased under the Employee Stock Purchase Plan
- 7,767 55,566 - - - - 63,333
Proceeds from issuance of 276 shares of common stock as a result of stock options exercised
- 276 2,374 - - - - 2,650
Exchange of 576 shares of common stock in connection with payroll taxes for restricted stock
- (576 ) (2,103 ) - - - - (2,679 )
Stock compensation expense
- - 326,245 326,245
Restricted stock awards
- 57,770 (57,770 ) - - - - -
Other adjustments to noncontrolling interests
- - - - - (2,066 ) - (2,066 )
Balance March 31, 2012
$ 65,090 $ 4,944,672 $ 90,026,845 $ 46,884,095 $ 3,237,479 $ 2,215,503 $ (1,606,510 ) $ 145,767,174
Comprehensive income:
Net income
- - - 3,072,156 - 201,223 - 3,273,379
Other comprehensive income, net of tax
- - - - 1,241,045 - - 1,241,045
Comprehensive income
4,514,424
Common cash dividends declared, $0.04 per share
- - - (189,091 ) - - - (189,091 )
Preferred cash dividends declared
- - - (935,786 ) - - - (935,786 )
Redemption of 10,223 shares of Series F Noncumulative Perpetual Preferred Stock
(10,223 ) - (10,212,777 ) - - - - (10,223,000 )
Proceeds from issuance of 10,856 shares of common stock as a result of stock purchased under the Employee Stock Purchase Plan
- 10,856 78,055 - - - - 88,911
Proceeds from issuance of 9,090 shares of common stock as a result of stock options exercised
- 9,090 79,902 - - - - 88,992
Exchange of 611 shares of common stock in connection with stock options exercised
- (611 ) (7,125 ) - - - - (7,736 )
Proceeds from exercise of warrants to purchase 4,300 shares of common stock issued in conjunction with the Series A Subordinated Notes
- 4,300 38,700 - - - - 43,000
Stock compensation expense
- - 177,269 177,269
Other adjustments to noncontrolling interests
- - - - - (2,065 ) - (2,065 )
Balance June 30, 2012
$ 54,867 $ 4,968,307 $ 80,180,869 $ 48,831,374 $ 4,478,524 $ 2,414,661 $ (1,606,510 ) $ 139,322,092
Comprehensive income:
Net income
- - - 3,057,333 - 127,177 - 3,184,510
Other comprehensive income, net of tax
- - - - 1,643,578 - - 1,643,578
Comprehensive income
4,828,088
Preferred cash dividends declared
- - - (810,837 ) - - - (810,837 )
Purchase of noncontrolling interest
- - (2,133,417 ) - - (2,393,802 ) - (4,527,219 )
Proceeds from issuance of 7,642 shares of common stock as a result of stock purchased under the Employee Stock Purchase Plan
- 7,642 58,326 - - - - 65,968
Proceeds from issuance of 7,075 shares of common stock as a result of stock options exercised
- 7,075 58,996 - - - - 66,071
Proceeds from exercise of warrants to purchase 1,000 shares of common stock issued in conjunction with the Series A Subordinated Notes
- 1,000 9,000 - - - - 10,000
Stock compensation expense
- - 169,189 169,189
Other adjustments to noncontrolling interests
- - - - - (2,066 ) - (2,066 )
Balance September 30, 2012
$ 54,867 $ 4,984,024 $ 78,342,963 $ 51,077,870 $ 6,122,102 $ 145,970 $ (1,606,510 ) $ 139,121,286
(continued)
6
QCR HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED) (continued)
Nine Months Ended September 30, 2012 and 2011
Preferred
Stock
Common
Stock
Additional
Paid-In
Capital
Retained
Earnings
Accumulated
Other
Comprehensive
Income (Loss)
Noncontrolling
Interests
Treasury
Stock
Total
Balance December 31, 2010
$ 63,237 $ 4,732,428 $ 86,478,269 $ 40,550,900 $ 704,165 $ 1,648,219 $ (1,606,510 ) $ 132,570,708
Comprehensive income:
Net income
- - - 2,124,960 - 106,524 - 2,231,484
Other comprehensive loss, net of tax
- - - - (1,345,554 ) - - (1,345,554 )
Comprehensive income
885,930
Preferred cash dividends declared
- - - (915,462 ) - - - (915,462 )
Discount accretion on cumulative preferred stock
- - 116,909 (116,909 ) - - - -
Proceeds from issuance of 9,081 shares of common stock as a result of stock purchased under the Employee Stock Purchase Plan
- 9,081 49,249 - - - - 58,330
Proceeds from issuance of 24,300 shares of common stock as a result of stock options exercised
- 24,300 146,067 - - - - 170,367
Exchange of 2,171 shares of common stock in connection with stock options exercised
- (2,171 ) (14,070 ) - - - - (16,241 )
Stock compensation expense
- - 206,569 206,569
Restricted stock awards
- 69,924 (69,924 ) - - - - -
Other adjustments to noncontrolling interests
- - - - - (2,065 ) - (2,065 )
Balance March 31, 2011
$ 63,237 $ 4,833,562 $ 86,913,069 $ 41,643,489 $ (641,389 ) $ 1,752,678 $ (1,606,510 ) $ 132,958,136
Comprehensive income:
Net income
- - - 2,674,969 - 98,245 - 2,773,214
Other comprehensive income, net of tax
- - - - 2,409,728 - - 2,409,728
Comprehensive income
5,182,942
Common cash dividends declared, $0.04 per share
- - - (185,863 ) - - - (185,863 )
Preferred cash dividends declared and accrued
- - - (915,462 ) - - - (915,462 )
Discount accretion on cumulative preferred stock
- - 120,280 (120,280 ) - - - -
Proceeds from issuance of 11,355 shares of common stock as a result of stock purchased under the Employee Stock Purchase Plan
- 11,355 61,582 - - - - 72,937
Proceeds from issuance of 10,967 shares of common stock as a result of stock options exercised
- 10,967 65,205 - - - - 76,172
Exchange of 379 shares of common stock in connection with stock options exercised
- (379 ) (3,033 ) - - - - (3,412 )
Stock compensation expense
- - 141,370 141,370
Other adjustments to noncontrolling interests
- - - - - (2,066 ) - (2,066 )
Balance June 30, 2011
$ 63,237 $ 4,855,505 $ 87,298,473 $ 43,096,853 $ 1,768,339 $ 1,848,857 $ (1,606,510 ) $ 137,324,754
Comprehensive income:
Net income
- - - 2,163,155 - 103,446 - 2,266,601
Other comprehensive income, net of tax
- - - - 2,404,295 - - 2,404,295
Comprehensive income
4,670,896
Preferred cash dividends declared
- - - (835,802 ) - - - (835,802 )
Discount accretion on cumulative preferred stock
- - 1,352,256 (1,352,256 ) - - - -
Proceeds from the issuance of 40,090 shares of Series F Non-Cumulative Perpetual Preferred Stock
40,090 - 40,034,251 - - - - 40,074,341
Redemption of 38,237 shares of Series D Cumulative Perpetual Preferred Stock
(38,237 ) - (38,198,763 ) - - - - (38,237,000 )
Proceeds from issuance of 7,975 shares of common stock as a result of stock purchased under the Employee Stock Purchase Plan
- 7,975 43,251 - - - - 51,226
Stock compensation expense
- - 149,160 149,160
Restricted stock awards
- 5,000 (5,000 ) -
Other adjustments to noncontrolling interests
- - - - - (28,702 ) - (28,702 )
Balance September 30, 2011
$ 65,090 $ 4,868,480 $ 90,673,628 $ 43,071,950 $ 4,172,634 $ 1,923,601 $ (1,606,510 ) $ 143,168,873
See Notes to Consolidated Financial Statements
7
QCR HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Nine Months Ended September 30,
2012
2011
CASH FLOWS FROM OPERATING ACTIVITIES
Net income
$ 9,860,738 $ 7,271,299
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation
1,740,621 1,866,403
Provision for loan/lease losses
3,325,109 5,196,850
Amortization of offering costs on subordinated debentures
10,738 10,738
Stock-based compensation expense
672,703 547,087
Losses on other real estate owned, net
1,324,468 90,492
Amortization of premiums on securities, net
2,950,609 2,541,408
Securities gains
(104,600 ) (1,472,528 )
Other-than-temporary impairment losses on securities
62,400 118,847
Loans originated for sale
(90,563,711 ) (65,240,469 )
Proceeds on sales of loans
90,077,297 75,960,589
Gains on sales of loans, net
(1,965,957 ) (1,923,185 )
Prepayment fees on Federal Home Loan Bank advances
- 832,099
Increase in cash value of bank-owned life insurance
(1,196,987 ) (1,032,493 )
Decrease in other assets
3,090,716 707,321
Increase in other liabilities
1,467,552 955,174
Net cash provided by operating activities
$ 20,751,696 $ 26,429,632
CASH FLOWS FROM INVESTING ACTIVITIES
Net decrease in federal funds sold
15,060,000 56,170,000
Net (increase) decrease in interest-bearing deposits at financial institutions
(22,686,336 ) 15,080,252
Proceeds from sales of other real estate owned
4,201,516 8,376,898
Activity in securities portfolio:
Purchases
(363,501,993 ) (458,081,700 )
Calls, maturities and redemptions
292,291,109 302,145,002
Paydowns
25,174,348 4,977,152
Sales
19,215,075 54,326,191
Activity in restricted investment securities:
Purchases
(3,466,800 ) (245,000 )
Redemptions
3,939,600 1,675,700
Purchases of bank-owned life insurance
- (7,000,000 )
Net increase in loans/leases originated and held for investment
(45,934,981 ) (48,043,333 )
Purchase of premises and equipment
(1,589,217 ) (1,693,870 )
Net cash used in investing activities
$ (77,297,679 ) $ (72,312,708 )
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposit accounts
137,777,646 92,653,389
Net increase (decrease) in short-term borrowings
(72,647,752 ) 2,431,992
Activity in Federal Home Loan Bank advances:
Advances
14,000,000 5,000,000
Calls and maturities
(22,400,000 ) (24,000,000 )
Prepayments
- (15,832,099 )
Net increase (decrease) in other borrowings
2,006,074 (9,941,030 )
Payment of cash dividends on common and preferred stock
(3,278,112 ) (3,274,991 )
Redemption of 10,223 shares of Series F Noncumulative Perpetual Preferred Stock
(10,223,000 ) -
Proceeds from issuance of 40,090 shares of Series F Noncumulative Perpetual Preferred Stock
- 40,074,341
Redemption of Series D Cumulative Perpetual Preferred Stock
- (38,237,000 )
Proceeds from issuance of common stock, net
418,510 409,379
Purchase of noncontrolling interest
(1,679,532 ) -
Net cash provided by financing activities
$ 43,973,834 $ 49,283,981
Net increase (decrease) in cash and due from banks
(12,572,149 ) 3,400,905
Cash and due from banks, beginning
53,136,710 42,030,806
Cash and due from banks, ending
$ 40,564,561 $ 45,431,711
Supplemental disclosure of cash flow information, cash payments for:
Interest
$ 15,225,564 $ 18,521,222
Income/franchise taxes
$ 916,000 $ 1,196,948
Supplemental schedule of noncash investing activities:
Change in accumulated other comprehensive income, unrealized gains on securities available for sale, net
$ 1,367,388 $ 3,468,469
Transfers of loans to other real estate owned
$ 2,143,017 $ 8,220,271
Liability for purchase of noncontrolling interest
$ 2,847,687 $ -
See Notes to Consolidated Financial Statements
8
Part I
Item 1
QCR HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

September 30, 2012

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of presentation :  The interim unaudited consolidated financial statements contained herein should be read in conjunction with the audited consolidated financial statements and accompanying notes to the consolidated financial statements for the fiscal year ended December 31, 2011, including QCR Holdings, Inc.’s (the “Company”) Form 10-K filed with the Securities and Exchange Commission on March 8, 2012.  Accordingly, footnote disclosures, which would substantially duplicate the disclosures contained in the audited consolidated financial statements, have been omitted.

The financial information of the Company included herein has been prepared in accordance with U.S. generally accepted accounting principles for interim financial reporting and has been prepared pursuant to the rules and regulations for reporting on Form 10-Q and Rule 10-01 of Regulation S-X.  Such information reflects all adjustments (consisting of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the periods presented.  Any differences appearing between the numbers presented in financial statements and management’s discussion and analysis are due to rounding.  The results of the interim period ended September 30, 2012, are not necessarily indicative of the results expected for the year ending December 31, 2012.

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries which include three state-chartered commercial banks:  Quad City Bank & Trust Company (“QCBT”), Cedar Rapids Bank & Trust Company (“CRBT”), and Rockford Bank & Trust Company (“RB&T”).  The Company also engages in direct financing lease contracts through its now wholly-owned equity investment by QCBT in m2 Lease Funds, LLC (“m2 Lease Funds”).  QCBT previously owned 80% of m2 Lease Funds.  In August 2012, QCBT entered into an amendment to the operating agreement of m2 Lease Funds and purchased the 20% noncontrolling interest.  See Note 8 for a more detailed discussion of this transaction.  The Company engages in real estate holdings through its 91% equity investment in Velie Plantation Holding Company, LLC (“VPHC”).  All material intercompany transactions and balances have been eliminated in consolidation.

Recent accounting developments : In December 2011, the Financial Accounting Standards Board issued ASU 2011-11, Disclosures about Offsetting Assets and Liabilities. ASU 2011-11 requires entities to disclose both gross information and net information about both instruments and transactions eligible for offset in the balance sheet, and instruments and transactions subject to an agreement similar to a master netting arrangement.  ASU 2011-11 is effective for annual periods beginning on or after January 1, 2013, and interim periods within those annual periods.  Adoption is not expected to have a significant impact on the Company’s consolidated financial statements.

Reclassifications :  Certain amounts in the prior year financial statements have been reclassified, with no effect on net income or stockholders’ equity, to conform with the current period presentation.
9
Part I
Item 1
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

NOTE 2 – INVESTMENT SECURITIES

The amortized cost and fair value of investment securities as of September 30, 2012 and December 31, 2011 are summarized as follows:
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
(Losses)
Fair
Value
September 30, 2012:
Securities held to maturity:
Other bonds
$ 650,000 $ - $ - $ 650,000
Securities available for sale:
U.S. govt. sponsored agency securities
$ 340,538,125 $ 2,712,996 $ (7,499 ) $ 343,243,622
Residential mortgage-backed and related securities
151,264,044 4,450,612 (24,081 ) 155,690,575
Municipal securities
87,579,277 2,478,687 (26,333 ) 90,031,631
Trust preferred securities
86,200 44,200 - 130,400
Other securities
1,329,191 301,728 (25,698 ) 1,605,221
$ 580,796,837 $ 9,988,223 $ (83,611 ) $ 590,701,449
December 31, 2011:
Securities held to maturity:
Other bonds
$ 200,000 $ - $ - $ 200,000
Securities available for sale:
U.S. govt. sponsored agency securities
$ 426,581,913 $ 2,428,994 $ (55,687 ) $ 428,955,220
Residential mortgage-backed and related securities
105,373,614 3,488,350 (8,215 ) 108,853,749
Municipal securities
23,937,118 1,752,246 - 25,689,364
Trust preferred securities
86,200 - (5,400 ) 80,800
Other securities
1,354,940 140,022 (44,804 ) 1,450,158
$ 557,333,785 $ 7,809,612 $ (114,106 ) $ 565,029,291
The Company’s residential mortgage-backed and related securities portfolio consists entirely of government sponsored or government guaranteed securities.  The Company has not invested in commercial mortgage-backed securities or pooled trust preferred securities.
10
Part I
Item 1

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

Gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of September 30, 2012 and December 31, 2011, are summarized as follows:
Less than 12 Months
12 Months or More
Total
Fair
Value
Gross
Unrealized
Losses
Fair
Value
Gross
Unrealized
Losses
Fair
Value
Gross
Unrealized
Losses
September 30, 2012:
Securities available for sale:
U.S. govt. sponsored agency securities
$ 10,988,570 $ (7,499 ) $ - $ - $ 10,988,570 $ (7,499 )
Residential mortgage-backed and related securities
5,430,389 (24,081 ) - - 5,430,389 (24,081 )
Municipal securities
3,455,797 (26,333 ) - - 3,455,797 (26,333 )
Other securities
- - 215,000 (25,698 ) 215,000 (25,698 )
$ 19,874,756 $ (57,913 ) $ 215,000 $ (25,698 ) $ 20,089,756 $ (83,611 )
December 31, 2011:
Securities available for sale:
U.S. govt. sponsored agency securities
$ 59,979,620 $ (55,687 ) $ - $ - $ 59,979,620 $ (55,687 )
Residential mortgage-backed and related securities
4,906,398 (8,215 ) - - 4,906,398 (8,215 )
Trust preferred securities
- - 80,800 (5,400 ) 80,800 (5,400 )
Other securities
251,957 (44,332 ) 2,778 (472 ) 254,735 (44,804 )
$ 65,137,975 $ (108,234 ) $ 83,578 $ (5,872 ) $ 65,221,553 $ (114,106 )
At September 30, 2012, the investment portfolio included 360 securities.  Of this number, 13 securities had current unrealized losses with aggregate depreciation of less than 1% from the amortized cost basis.  Of these 13, only one had unrealized losses for twelve months or more.  All of the debt securities in unrealized loss positions are considered acceptable credit risks.  Based upon an evaluation of the available evidence, including the recent changes in market rates, credit rating information and information obtained from regulatory filings, management believes the declines in fair value for these debt securities are temporary.  In addition, the Company does not intend to sell these securities and it is not more-likely-than-not that the Company will be required to sell these debt securities before their anticipated recovery.  At September 30, 2012 and December 31, 2011, equity securities represented less than 1% of the total portfolio.

The Company did not recognize other-than-temporary impairment on any debt securities for the three and nine months ended September 30, 2012 and 2011.

The Company did not recognize other-than-temporary impairment on any equity securities for the three months ended September 30, 2012 and 2011.

During the second quarter of 2012, the Company’s evaluation determined that one privately held equity security experienced a decline in fair value that was other-than-temporary.  As a result, the Company wrote down the value of this security and recognized a loss in the amount of $62,400.  The Company did not recognize other-than-temporary impairment on any of its equity securities during the first quarter of 2012.

During the second quarter of 2011, the Company’s evaluation determined that two privately held equity securities experienced declines in fair value that were other-than-temporary.  As a result, the Company wrote down the value of these securities and recognized losses in the amount of $118,847.  The Company did not recognize other-than-temporary impairment on any of its equity securities during the first quarter of 2011.
11
Part I
Item 1

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

All sales of securities, as applicable, for the three and nine months ended September 30, 2012 and 2011, respectively, were from securities identified as available for sale.  Information on proceeds received, as well as pre-tax gross gains from sales of those securities is as follows:
Three Months Ended
Nine Months Ended
September 30, 2012
September 30, 2011
September 30, 2012
September 30, 2011
Proceeds from sales of securities
$ - $ 8,601,107 $ 19,215,075 $ 54,326,191
Pre-tax gross gains from sales of securities
- 443,614 104,600 1,472,528
The amortized cost and fair value of securities as of September 30, 2012 by contractual maturity are shown below.  A portion of the Company’s U.S. government sponsored agency securities contain call options which allow the issuer, at its discretion, to call the security at predetermined dates prior to the contractual maturity date. Expected maturities of residential mortgage-backed and related securities may differ from contractual maturities because the residential mortgages underlying the residential mortgage-backed and related securities may be called or prepaid without any penalties.  Therefore, these securities are not included in the maturity categories in the following table.  “Other securities” are excluded from the maturity categories as there is no fixed maturity date.
Amortized Cost
Fair Value
Securities held to maturity:
Due in one year or less
$ 100,000 $ 100,000
Due after one year through five years
550,000 550,000
$ 650,000 $ 650,000
Securities available for sale:
Due in one year or less
$ 2,251,717 $ 2,257,998
Due after one year through five years
40,236,390 40,681,663
Due after five years
385,715,495 390,465,992
$ 428,203,602 $ 433,405,653
Residential mortgage-backed and related securities
151,264,044 155,690,575
Other securities
1,329,191 1,605,221
$ 580,796,837 $ 590,701,449
12
Part I
Item 1

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

NOTE 3 – LOANS/LEASES RECEIVABLE

The composition of the loan/lease portfolio as of September 30, 2012 and December 31, 2011 is presented as follows:
As of September 30, 2012
As of December 31, 2011
Commercial and industrial loans
$ 355,003,888 $ 350,794,278
Commercial real estate loans
Owner-occupied commercial real estate
199,788,124 167,790,621
Commercial construction, land development, and other land
49,191,909 60,384,738
Other non owner-occupied commercial real estate
345,923,717 349,628,491
594,903,750 577,803,850
Direct financing leases *
102,038,868 93,212,362
Residential real estate loans **
112,492,219 98,107,051
Installment and other consumer loans
76,837,989 78,223,080
1,241,276,714 1,198,140,621
Plus deferred loan/lease origination costs, net of fees
3,015,495 2,604,876
1,244,292,209 1,200,745,497
Less allowance for estimated losses on loans/leases
(19,416,748 ) (18,789,262 )
$ 1,224,875,461 $ 1,181,956,235
* Direct financing leases:
Net minimum lease payments to be received
$ 115,931,555 $ 106,389,988
Estimated unguaranteed residual values of leased assets
1,111,627 1,043,326
Unearned lease/residual income
(15,004,314 ) (14,220,952 )
102,038,868 93,212,362
Plus deferred lease origination costs, net of fees
3,727,752 3,217,011
105,766,620 96,429,373
Less allowance for estimated losses on leases
(1,884,985 ) (1,339,496 )
$ 103,881,635 $ 95,089,877
**Includes residential real estate loans held for sale totaling $6,285,131 and $3,832,760 as of September 30, 2012, and December 31, 2011, respectively.

Management performs an evaluation of the estimated unguaranteed residual values of leased assets on an annual basis, at a minimum.  The evaluation consists of discussions with reputable and current vendors and management’s expertise and understanding of the current states of particular industries to determine informal valuations of the equipment.  As necessary and where available, management will utilize valuations by independent appraisers.  The large majority of leases with residual values contain a lease options rider which requires the lessee to pay the residual value directly, finance the payment of the residual value, or extend the lease term to pay the residual value.  In these cases, the residual value is protected and the risk of loss is minimal.

13
Part I
Item 1

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

For the three and nine months ended September 30, 2012 and 2011, there were no losses on residual values.  At September 30, 2012, the Company had 37 leases remaining with residual values totaling $1,111,627 that were not protected with a lease end options rider.  At December 31, 2011, the Company had 39 leases remaining with residual values totaling $1,043,326 that were not protected with a lease end options rider.  Management has performed specific evaluations of these residual values and determined that the valuations are appropriate.

The aging of the loan/lease portfolio by classes of loans/leases as of September 30, 2012 is presented as follows:
Classes of Loans/Leases
Current
30-59 Days Past Due
60-89 Days Past Due
Accruing Past Due 90 Days or More
Nonaccrual Loans/Leases
Total
Commercial and Industrial
$ 352,308,795 $ 872,105 $ 15,252 $ 149,750 $ 1,657,986 $ 355,003,888
Commercial Real Estate
Owner-Occupied Commercial Real Estate
198,070,105 - 1,046,835 - 671,184 199,788,124
Commercial Construction, Land Development, and Other Land
47,080,534 - - - 2,111,375 49,191,909
Other Non Owner-Occupied Commercial Real Estate
332,708,671 2,325,809 733,442 - 10,155,795 345,923,717
Direct Financing Leases
100,205,091 632,458 106,595 - 1,094,724 102,038,868
Residential Real Estate
111,142,654 - - - 1,349,565 112,492,219
Installment and Other Consumer
75,805,776 255,048 33,730 52,733 690,702 76,837,989
$ 1,217,321,626 $ 4,085,420 $ 1,935,854 $ 202,483 $ 17,731,331 $ 1,241,276,714
As a percentage of total loan/lease portfolio
98.07 % 0.33 % 0.16 % 0.02 % 1.43 % 100.00 %

The aging of the loan/lease portfolio by classes of loans/leases as of December 31, 2011 is presented as follows:
Classes of Loans/Leases
Current
30-59 Days Past Due
60-89 Days Past Due
Accruing Past Due 90 Days or More
Nonaccrual Loans/Leases
Total
Commercial and Industrial
$ 347,417,683 $ 226,394 $ 239,991 $ 120,000 $ 2,790,210 $ 350,794,278
Commercial Real Estate
Owner-Occupied Commercial Real Estate
166,632,318 146,847 - - 1,011,456 167,790,621
Commercial Construction, Land Development, and Other Land
55,741,827 211,878 486,802 968,919 2,975,312 60,384,738
Other Non Owner-Occupied Commercial Real Estate
336,080,128 522,323 3,732,935 - 9,293,105 349,628,491
Direct Financing Leases
91,273,406 826,187 396,344 - 716,425 93,212,362
Residential Real Estate
95,456,433 1,127,465 389,678 - 1,133,475 98,107,051
Installment and Other Consumer
76,376,399 737,543 12,122 22,160 1,074,856 78,223,080
$ 1,168,978,194 $ 3,798,637 $ 5,257,872 $ 1,111,079 $ 18,994,839 $ 1,198,140,621
As a percentage of total loan/lease portfolio
97.57 % 0.32 % 0.44 % 0.09 % 1.59 % 100.00 %
14
Part I
Item 1

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

Nonperforming loans/leases by classes of loans/leases as of September 30, 2012 is presented as follows:
Classes of Loans/Leases
Accruing Past Due 90 Days or More
Nonaccrual Loans/Leases *
Troubled Debt Restructurings - Accruing
Total Nonperforming Loans/Leases
Percentage of Total Nonperforming Loans/Leases
Commercial and Industrial
$ 149,750 $ 1,657,986 $ 184,813 $ 1,992,549 8.32 %
Commercial Real Estate
Owner-Occupied Commercial Real Estate
- 671,184 - 671,184 2.80 %
Commercial Construction, Land Development, and Other Land
- 2,111,375 337,500 2,448,875 10.23 %
Other Non Owner-Occupied Commercial Real Estate
- 10,155,795 5,303,365 15,459,160 64.57 %
Direct Financing Leases
- 1,094,724 - 1,094,724 4.57 %
Residential Real Estate
- 1,349,565 167,739 1,517,304 6.34 %
Installment and Other Consumer
52,733 690,702 16,043 759,478 3.17 %
$ 202,483 $ 17,731,331 $ 6,009,460 $ 23,943,274 100.00 %

*Nonaccrual loans/leases includes $5,749,193 of troubled debt restructurings, including $141,886 in commercial and industrial loans,  $5,212,247 in commercial real estate loans, $64,726 in direct financing leases, and $330,334 in installment loans.

Nonperforming loans/leases by classes of loans/leases as of December 31, 2011 is presented as follows:
Classes of Loans/Leases
Accruing Past Due 90 Days or More
Nonaccrual Loans/Leases **
Troubled Debt Restructurings - Accruing
Total Nonperforming Loans/Leases
Percentage of Total Nonperforming Loans/Leases
Commercial and Industrial
$ 120,000 $ 2,790,210 $ 187,407 $ 3,097,617 9.68 %
Commercial Real Estate
Owner-Occupied Commercial Real Estate
- 1,011,456 - 1,011,456 3.16 %
Commercial Construction, Land Development, and Other Land
968,919 2,975,312 6,076,143 10,020,374 31.30 %
Other Non Owner-Occupied Commercial Real Estate
- 9,293,105 5,049,795 14,342,900 44.81 %
Direct Financing Leases
- 716,425 590,238 1,306,663 4.08 %
Residential Real Estate
- 1,133,475 - 1,133,475 3.54 %
Installment and Other Consumer
22,160 1,074,856 - 1,097,016 3.43 %
$ 1,111,079 $ 18,994,839 $ 11,903,583 $ 32,009,501 100.00 %

**Nonaccrual loans/leases includes $8,622,874 of troubled debt restructurings, including $198,697 in commercial and industrial loans, $8,074,777 in commercial real estate loans, $64,726 in direct financing leases, and $284,674 in installment loans.
15
Part I
Item 1

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

Changes in the allowance for estimated losses on loans/leases by portfolio segment for the three and nine months ended September 30, 2012 and 2011, respectively, are presented as follows:
Three Months Ended September 30, 2012
Commercial and Industrial
Commercial Real Estate
Direct Financing Leases
Residential Real Estate
Installment and Other Consumer
Total
Balance, beginning
$ 4,180,792 $ 10,709,991 $ 1,610,999 $ 986,714 $ 1,236,039 $ 18,724,535
Provisions charged to expense
136,766 721,358 350,194 233,226 54,650 1,496,194
Loans/leases charged off
(214,036 ) (552,959 ) (111,326 ) (183,031 ) (88,378 ) (1,149,730 )
Recoveries on loans/leases previously charged off
69,959 175,467 35,118 - 65,205 345,749
Balance, ending
$ 4,173,481 $ 11,053,857 $ 1,884,985 $ 1,036,909 $ 1,267,516 $ 19,416,748
Three Months Ended September 30, 2011
Commercial and Industrial
Commercial Real Estate
Direct Financing Leases
Residential Real Estate
Installment and Other Consumer
Total
Balance, beginning
$ 7,124,444 $ 8,602,639 $ 1,591,309 $ 757,075 $ 1,727,165 $ 19,802,632
Provisions charged to expense
(211,491 ) 2,645,457 159,965 92,032 (228,998 ) 2,456,965
Loans/leases charged off
(1,465,577 ) (852,174 ) (701,658 ) - (84,358 ) (3,103,767 )
Recoveries on loans/leases previously charged off
174,013 212,683 2,344 - 33,616 422,656
Balance, ending
$ 5,621,389 $ 10,608,605 $ 1,051,960 $ 849,107 $ 1,447,425 $ 19,578,486
Nine Months Ended September 30, 2012
Commercial and Industrial
Commercial Real Estate
Direct Financing Leases
Residential Real Estate
Installment and Other Consumer
Total
Balance, beginning
$ 4,878,006 $ 10,596,958 $ 1,339,496 $ 704,946 $ 1,269,856 $ 18,789,262
Provisions charged to expense
(637,852 ) 2,254,732 924,109 519,751 264,369 3,325,109
Loans/leases charged off
(669,778 ) (1,980,946 ) (454,590 ) (187,788 ) (416,179 ) (3,709,281 )
Recoveries on loans/leases previously charged off
603,105 183,113 75,970 - 149,470 1,011,658
Balance, ending
$ 4,173,481 $ 11,053,857 $ 1,884,985 $ 1,036,909 $ 1,267,516 $ 19,416,748
Nine Months Ended September 30, 2011
Commercial and Industrial
Commercial Real Estate
Direct Financing Leases
Residential Real Estate
Installment and Other Consumer
Total
Balance, beginning
$ 7,548,922 $ 9,087,315 $ 1,530,572 $ 748,028 $ 1,449,819 $ 20,364,656
Provisions charged to expense
1,005,002 3,038,359 463,850 101,079 588,560 5,196,850
Loans/leases charged off
(3,256,194 ) (1,773,711 ) (945,104 ) - (701,390 ) (6,676,399 )
Recoveries on loans/leases previously charged off
323,659 256,642 2,642 - 110,436 693,379
Balance, ending
$ 5,621,389 $ 10,608,605 $ 1,051,960 $ 849,107 $ 1,447,425 $ 19,578,486
16
Part I
Item 1

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

The allowance for estimated losses on loans/leases by impairment evaluation and by portfolio segment as of September 30, 2012 and December 31, 2011 is presented as follows:

As of September 30, 2012
Commercial and Industrial
Commercial Real Estate
Direct Financing Leases
Residential Real Estate
Installment and Other Consumer
Total
Allowance for loans/leases individually evaluated for impairment
$ 274,666 $ 3,482,125 $ 157,900 $ 169,196 $ 68,673 $ 4,152,560
Allowance for loans/leases collectively evaluated for impairment
3,898,815 7,571,732 1,727,085 867,713 1,198,843 15,264,188
$ 4,173,481 $ 11,053,857 $ 1,884,985 $ 1,036,909 $ 1,267,516 $ 19,416,748
Loans/leases individually evaluated for impairment
$ 1,071,050 $ 18,450,756 $ 1,094,724 $ 1,517,304 $ 759,478 $ 22,893,312
Loans/leases collectively evaluated for impairment
353,932,838 576,452,994 100,944,144 110,974,915 76,078,511 1,218,383,402
$ 355,003,888 $ 594,903,750 $ 102,038,868 $ 112,492,219 $ 76,837,989 $ 1,241,276,714
Allowance as a percentage of loans/leases individually evaluated for impairment
25.64 % 18.87 % 14.42 % 11.15 % 9.04 % 18.14 %
Allowance as a percentage of loans/leases collectively evaluated for impairment
1.10 % 1.31 % 1.71 % 0.78 % 1.58 % 1.25 %
1.18 % 1.86 % 1.85 % 0.92 % 1.65 % 1.56 %
As of December 31, 2011
Commercial and Industrial
Commercial Real Estate
Direct Financing Leases
Residential Real Estate
Installment and Other Consumer
Total
Allowance for loans/leases individually evaluated for impairment
$ 903,187 $ 4,297,738 $ 66,675 $ 55,884 $ 22,819 $ 5,346,303
Allowance for loans/leases collectively evaluated for impairment
3,974,819 6,299,220 1,272,821 649,062 1,247,037 13,442,959
$ 4,878,006 $ 10,596,958 $ 1,339,496 $ 704,946 $ 1,269,856 $ 18,789,262
Loans/leases individually evaluated for impairment
$ 2,152,855 $ 24,281,365 $ 1,306,663 $ 1,133,474 $ 984,806 $ 29,859,163
Loans/leases collectively evaluated for impairment
348,641,423 553,522,485 91,905,699 96,973,577 77,238,274 1,168,281,458
$ 350,794,278 $ 577,803,850 $ 93,212,362 $ 98,107,051 $ 78,223,080 $ 1,198,140,621
Allowance as a percentage of loans/leases individually evaluated for impairment
41.95 % 17.70 % 5.10 % 4.93 % 2.32 % 17.91 %
Allowance as a percentage of loans/leases collectively evaluated for impairment
1.14 % 1.14 % 1.38 % 0.67 % 1.61 % 1.15 %
1.39 % 1.83 % 1.44 % 0.72 % 1.62 % 1.56 %
17
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

Information for impaired loans/leases is presented in the tables below.  The recorded investment represents customer balances net of any partial charge-offs recognized on the loan/lease.  The unpaid principal balance represents the recorded balance outstanding on the loan/lease prior to any partial charge-offs.

Information for impaired loans/leases by classes of financing receivable as of and for the nine months ended September 30, 2012 is as follows:
Classes of Loans/Leases
Recorded Investment
Unpaid Principal Balance
Related Allowance
Average Recorded Investment
Interest Income Recognized
Interest Income Recognized for Cash Payments Received
Impaired Loans/Leases with No Specific Allowance Recorded:
Commercial and Industrial
$ 845,703 $ 1,635,373 $ - $ 787,146 $ - $ -
Commercial Real Estate
Owner-Occupied Commercial Real Estate
542,721 542,721 - 657,327 - -
Commercial Construction, Land Development, and Other Land
1,027,200 1,027,200 - 4,441,935 5,552 5,552
Other Non Owner-Occupied Commercial Real Estate
1,498,599 2,298,599 - 6,613,234 894 894
Direct Financing Leases
853,974 853,974 - 774,855 - -
Residential Real Estate
948,653 1,131,684 - 861,102 5,037 5,037
Installment and Other Consumer
646,466 646,466 - 1,014,236 245 245
$ 6,363,316 $ 8,136,017 $ - $ 15,149,835 $ 11,728 $ 11,728
Impaired Loans/Leases with Specific Allowance Recorded:
Commercial and Industrial
$ 225,347 $ 247,599 $ 274,666 $ 543,668 $ 5,935 $ 5,935
Commercial Real Estate
Owner-Occupied Commercial Real Estate
- - - - - -
Commercial Construction, Land Development, and Other Land
2,031,823 2,055,057 1,373,340 1,598,548 - -
Other Non Owner-Occupied Commercial Real Estate
13,350,413 13,603,372 2,108,785 9,859,148 237,408 237,408
Direct Financing Leases
240,750 240,750 157,900 177,551 - -
Residential Real Estate
568,651 568,651 169,196 463,361 - -
Installment and Other Consumer
113,012 113,012 68,673 68,286 - -
$ 16,529,996 $ 16,828,441 $ 4,152,560 $ 12,710,562 $ 243,343 $ 243,343
Total Impaired Loans/Leases:
Commercial and Industrial
$ 1,071,050 $ 1,882,972 $ 274,666 $ 1,330,814 $ 5,935 $ 5,935
Commercial Real Estate
Owner-Occupied Commercial Real Estate
542,721 542,721 - 657,327 - -
Commercial Construction, Land Development, and Other Land
3,059,023 3,082,257 1,373,340 6,040,483 5,552 5,552
Other Non Owner-Occupied Commercial Real Estate
14,849,012 15,901,971 2,108,785 16,472,382 238,302 238,302
Direct Financing Leases
1,094,724 1,094,724 157,900 952,406 - -
Residential Real Estate
1,517,304 1,700,335 169,196 1,324,463 5,037 5,037
Installment and Other Consumer
759,478 759,478 68,673 1,082,522 245 245
$ 22,893,312 $ 24,964,458 $ 4,152,560 $ 27,860,397 $ 255,071 $ 255,071
Impaired loans/leases for which no allowance has been provided have adequate collateral, based on management’s current estimates.
18
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

Information for impaired loans/leases by classes of financing receivable for the three months ended September 30, 2012 and 2011 is as follows:
Three Months Ended September 30, 2012
Three Months Ended September 30, 2011
Classes of Loans/Leases
Average Recorded Investment
Interest Income Recognized
Interest Income Recognized for Cash Payments Received
Average Recorded Investment
Interest Income Recognized
Interest Income Recognized for Cash Payments Received
Impaired Loans/Leases with No Specific Allowance Recorded:
Commercial and Industrial
$ 754,844 $ - $ - $ 2,236,289 $ - $ -
Commercial Real Estate
Owner-Occupied Commercial Real Estate
550,725 - - 1,774,342 11,909 11,909
Commercial Construction, Land Development, and Other Land
1,323,689 1,701 1,701 286,339 - -
Other Non Owner-Occupied Commercial Real Estate
5,798,404 - - 1,730,764 - -
Direct Financing Leases
680,817 - - 668,944 - -
Residential Real Estate
943,926 1,691 1,691 942,011 - -
Installment and Other Consumer
1,063,519 121 121 710,560 - -
$ 11,115,924 $ 3,513 $ 3,513 $ 8,349,249 $ 11,909 $ 11,909
Impaired Loans/Leases with Specific Allowance Recorded:
Commercial and Industrial
$ 223,917 $ 1,984 $ 1,984 $ 1,534,968 $ - $ -
Commercial Real Estate
Owner-Occupied Commercial Real Estate
- - - 360,894 - -
Commercial Construction, Land Development, and Other Land
2,157,696 - - 5,595,484 473 473
Other Non Owner-Occupied Commercial Real Estate
12,036,134 86,744 86,744 7,488,032 - -
Direct Financing Leases
210,299 - - 983,131 - -
Residential Real Estate
524,031 - - 200,625 - -
Installment and Other Consumer
68,898 - - 108,859 - -
$ 15,220,975 $ 88,728 $ 88,728 $ 16,271,993 $ 473 $ 473
Total Impaired Loans/Leases:
Commercial and Industrial
$ 978,761 $ 1,984 $ 1,984 $ 3,771,257 $ - $ -
Commercial Real Estate
Owner-Occupied Commercial Real Estate
550,725 - - 2,135,236 11,909 11,909
Commercial Construction, Land Development, and Other Land
3,481,385 1,701 1,701 5,881,823 473 473
Other Non Owner-Occupied Commercial Real Estate
17,834,538 86,744 86,744 9,218,796 - -
Direct Financing Leases
891,116 - - 1,652,075 - -
Residential Real Estate
1,467,957 1,691 1,691 1,142,636 - -
Installment and Other Consumer
1,132,417 121 121 819,419 - -
$ 26,336,899 $ 92,241 $ 92,241 $ 24,621,242 $ 12,382 $ 12,382
Impaired loans/leases for which no allowance has been provided have adequate collateral, based on management’s current estimates.
19
Part I
Item 1

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

Information for impaired loans/leases by classes of financing receivable as of December 31, 2011 is as follows:
Classes of Loans/Leases
Recorded Investment
Unpaid Principal Balance
Related Allowance
Impaired Loans/Leases with No Specific Allowance Recorded:
Commercial and Industrial
$ 360,947 $ 979,901 $ -
Commercial Real Estate
Owner-Occupied Commercial Real Estate
736,610 736,610 -
Commercial Construction, Land Development, and Other Land
- - -
Other Non Owner-Occupied Commercial Real Estate
3,936,826 3,986,820 -
Direct Financing Leases
1,094,178 1,094,178 -
Residential Real Estate
788,685 862,298 -
Installment and Other Consumer
593,987 593,987 -
$ 7,511,233 $ 8,253,794 $ -
Impaired Loans/Leases with Specific Allowance Recorded:
Commercial and Industrial
$ 1,791,908 $ 1,791,908 $ 903,187
Commercial Real Estate
Owner-Occupied Commercial Real Estate
217,059 217,059 47,911
Commercial Construction, Land Development, and Other Land
9,051,455 9,051,455 3,002,450
Other Non Owner-Occupied Commercial Real Estate
10,339,415 10,839,415 1,247,377
Direct Financing Leases
212,485 212,485 66,675
Residential Real Estate
344,789 344,789 55,884
Installment and Other Consumer
390,819 390,819 22,819
$ 22,347,930 $ 22,847,930 $ 5,346,303
Total Impaired Loans/Leases:
Commercial and Industrial
$ 2,152,855 $ 2,771,809 $ 903,187
Commercial Real Estate
Owner-Occupied Commercial Real Estate
953,669 953,669 47,911
Commercial Construction, Land Development, and Other Land
9,051,455 9,051,455 3,002,450
Other Non Owner-Occupied Commercial Real Estate
14,276,241 14,826,235 1,247,377
Direct Financing Leases
1,306,663 1,306,663 66,675
Residential Real Estate
1,133,474 1,207,087 55,884
Installment and Other Consumer
984,806 984,806 22,819
$ 29,859,163 $ 31,101,724 $ 5,346,303

Impaired loans/leases for which no allowance has been provided have adequate collateral, based on management’s current estimates.
20
Part I
Item 1

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

For each class of financing receivable, the following presents the recorded investment by credit quality indicator as of September 30, 2012 and December 31, 2011:
As of September 30, 2012
Commercial Real Estate
Non Owner-Occupied
Internally Assigned Risk Rating
Commercial and Industrial
Owner-Occupied Commercial Real Estate
Commercial Construction, Land Development, and Other Land
Other Commercial Real Estate
Total
Pass (Ratings 1 through 5)
$ 331,637,518 $ 193,587,897 $ 42,177,159 $ 311,918,867 $ 879,321,441
Special Mention (Rating 6)
7,920,533 4,213,076 560,086 8,660,810 21,354,505
Substandard (Rating 7)
15,445,837 1,987,151 6,454,664 25,344,040 49,231,692
Doubtful (Rating 8)
- - - - -
$ 355,003,888 $ 199,788,124 $ 49,191,909 $ 345,923,717 $ 949,907,638
As of September 30, 2012
Delinquency Status *
Direct Financing Leases
Residential Real Estate
Installment and Other Consumer
Total
Performing
$ 100,944,144 $ 110,974,915 $ 76,078,511 $ 287,997,570
Nonperforming
1,094,724 1,517,304 759,478 3,371,506
$ 102,038,868 $ 112,492,219 $ 76,837,989 $ 291,369,076

*Performing = loans/leases accruing and less than 90 days past due.  Nonperforming = loans/leases on nonaccrual, accruing loans/leases that are greater than or equal to 90 days past due, and accruing troubled debt restructurings.
As of December 31, 2011
Commercial Real Estate
Non Owner-Occupied
Internally Assigned Risk Rating
Commercial and Industrial
Owner-Occupied Commercial Real Estate
Commercial Construction, Land Development, and Other Land
Other Commercial Real Estate
Total
Pass (Ratings 1 through 5)
$ 324,225,905 $ 158,955,618 $ 46,268,554 $ 310,401,972 $ 839,852,049
Special Mention (Rating 6)
8,814,497 2,700,496 764,586 13,754,798 26,034,377
Substandard (Rating 7)
17,753,876 6,134,507 13,351,598 25,471,721 62,711,702
Doubtful (Rating 8)
- - - - -
$ 350,794,278 $ 167,790,621 $ 60,384,738 $ 349,628,491 $ 928,598,128
As of December 31, 2011
Delinquency Status *
Direct Financing Leases
Residential Real Estate
Installment and Other Consumer
Total
Performing
$ 91,905,699 $ 96,973,576 $ 77,126,064 $ 266,005,339
Nonperforming
1,306,663 1,133,475 1,097,016 3,537,154
$ 93,212,362 $ 98,107,051 $ 78,223,080 $ 269,542,493
*Performing = loans/leases accruing and less than 90 days past due.  Nonperforming = loans/leases on nonaccrual, accruing loans/leases that are greater than or equal to 90 days past due, and accruing troubled debt restructurings.
21
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Item 1

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

For commercial and industrial and commercial real estate loans, the Company’s credit quality indicator is internally assigned risk ratings.  Each commercial loan is assigned a risk rating upon origination.  The risk rating is reviewed every 15 months, at a minimum, and on an as needed basis depending on the specific circumstances of the loan.

For direct financing leases, residential real estate loans, and installment and other consumer loans, the Company’s credit quality indicator is performance determined by delinquency status.  Delinquency status is updated daily by the Company’s loan system.

As of September 30, 2012 and December 31, 2011, troubled debt restructurings totaled $11,758,653 and $20,526,457, respectively.

For each class of financing receivable, the following presents the number and recorded investment of troubled debt restructurings, by type of concession, that were restructured during the three and nine months ended September 30, 2012 and 2011.  The difference between the pre-modification recorded investment and the post-modification recorded investment would be any partial charge-offs at the time of the restructuring.
For the three months ended September 30, 2012
For the three months ended September 30, 2011
Classes of Loans/Leases
Number of Loans / Leases
Pre-Modification Recorded Investment
Post-Modification Recorded Investment
Specific Allowance
Number of Loans / Leases
Pre-Modification Recorded Investment
Post-Modification Recorded Investment
Specific Allowance
CONCESSION - Extension of maturity
Other Non Owner-Occupied Commercial Real Estate
4 $ 1,184,289 $ 1,184,289 $ 325,923 - $ - $ - $ -
4 $ 1,184,289 $ 1,184,289 $ 325,923 - $ - $ - $ -
CONCESSION - Interest rate adjusted below market
Other Non Owner-Occupied Commercial Real Estate
2 $ 1,542,784 $ 1,289,825 $ 55,187 - $ - $ - $ -
2 $ 1,542,784 $ 1,289,825 $ 55,187 - $ - $ - $ -
TOTAL
6 $ 2,727,073 $ 2,474,114 $ 381,110 - $ - $ - $ -
For the nine months ended September 30, 2012
For the nine months ended September 30, 2011
Classes of Loans/Leases
Number of Loans / Leases
Pre-Modification Recorded Investment
Post-Modification Recorded Investment
Specific Allowance
Number of Loans / Leases
Pre-Modification Recorded Investment
Post-Modification Recorded Investment
Specific Allowance
CONCESSION - Extension of maturity
Other Non Owner-Occupied Commercial Real Estate
4 $ 1,184,289 $ 1,184,289 $ 325,923 1 $ 2,851,134 $ 2,851,134 $ -
4 $ 1,184,289 $ 1,184,289 $ 325,923 1 $ 2,851,134 $ 2,851,134 $ -
CONCESSION - Significant payment delay
Commercial and Industrial
- $ - $ - $ - 4 $ 1,175,819 $ 1,175,819 $ -
Commercial Construction, Land Development, and Other Land
2 200,000 200,000 - - - - -
2 $ 200,000 $ 200,000 $ - 4 $ 1,175,819 $ 1,175,819 $ -
CONCESSION - Interest rate adjusted below market
Commercial Construction, Land Development, and Other Land
1 $ 337,500 $ 337,500 $ - - $ - $ - $ -
Other Non Owner-Occupied Commercial Real Estate
2 1,542,784 1,289,825 55,187 - - - -
Residential Real Estate
1 167,739 167,739 - - - - -
Installment and Other Consumer
1 16,043 16,043 - - - - -
5 $ 2,064,066 $ 1,811,107 $ 55,187 - $ - $ - $ -
TOTAL
11 $ 3,448,355 $ 3,195,396 $ 381,110 5 $ 4,026,953 $ 4,026,953 $ -

Of the troubled debt restructurings reported above, four with post-modification recorded investments totaling $4,337,321 were on nonaccrual as of September 30, 2012.

For the three and nine months ended September 30, 2012, none of the Company’s troubled debt restructurings has redefaulted within 12 months subsequent to restructure where default is defined as delinquency of 90 days or more and/or placement on nonaccrual status.
22
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Item 1

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

NOTE 4 - EARNINGS PER SHARE

The following information was used in the computation of earnings per share on a basic and diluted basis:

Three months ended September 30,
Nine months ended September 30,
2012
2011
2012
2011
Net income
$ 3,184,510 $ 2,266,601 $ 9,860,738 $ 7,271,299
Less:  Net income attributable to noncontrolling interests
127,177 103,446 494,431 308,215
Net income attributable to QCR Holdings, Inc.
$ 3,057,333 $ 2,163,155 $ 9,366,307 $ 6,963,084
Less:  Preferred stock dividends and discount accretion
810,837 2,188,058 * 2,685,248 4,256,171 *
Net income attributable to QCR Holdings, Inc. common stockholders
$ 2,246,496 $ (24,903 ) $ 6,681,059 $ 2,706,913
Earnings per common share attributable to QCR Holdings, Inc. common stockholders
Basic
$ 0.45 $ (0.01 ) $ 1.37 $ 0.56
Diluted
$ 0.44 $ (0.01 ) $ 1.35 $ 0.56
Weighted average common shares outstanding
4,978,699 4,866,692 4,871,626 4,795,382
Weighted average common shares issuable upon exercise of stock options and under the employee stock purchase plan
101,589 - ** 66,888 52,051
Weighted average common and common equivalent shares outstanding
5,080,288 4,866,692 ** 4,938,514 4,847,433
* For the three and nine months ended September 30, 2011, includes approximately $1.2 million of accelerated accretion of discount on the U.S. Department of the Treasury ("Treasury") Captial Purchase Program preferred shares repurchased during the third quarter of 2011.
** In accordance with U.S. GAAP, the common equivalent shares are not considered in the calculation of diluted earnings per share as the numerator is a loss.
NOTE 5 – BUSINESS SEGMENT INFORMATION

Selected financial and descriptive information is required to be disclosed for reportable operating segments, applying a “management perspective” as the basis for identifying reportable segments.  The management perspective is determined by the view that management takes of the segments within the Company when making operating decisions, allocating resources, and measuring performance.  The segments of the Company have been defined by the structure of the Company’s internal organization, focusing on the financial information that the Company’s operating decision-makers routinely use to make decisions about operating matters.

The Company’s primary segment, Commercial Banking, is geographically divided by markets into the secondary segments which are the three subsidiary banks wholly-owned by the Company:  QCBT, CRBT, and RB&T.  Each of these secondary segments offers similar products and services, but is managed separately due to different pricing, product demand, and consumer markets.  Each offers commercial, consumer, and mortgage loans and deposit services.

The Company’s Wealth Management segment represents the trust and asset management and investment management and advisory services offered at the Company’s three subsidiary banks in aggregate.  This segment generates income primarily from fees charged based on assets under administration for corporate and personal trusts, custodial services, and investments managed.  No assets of the subsidiary banks have been allocated to the Wealth Management segment.
23
Part I
Item 1

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

The Company’s All Other segment includes the operations of all other consolidated subsidiaries and/or defined operating segments that fall below the segment reporting thresholds.  This segment includes the corporate operations of the parent company and the 91% owned real estate holding operations of VPHC.

Selected financial information on the Company’s business segments is presented as follows for the three and nine months ended September 30, 2012 and 2011.
Commercial Banking
Quad City
Bank & Trust
Cedar Rapids
Bank & Trust
Rockford
Bank & Trust
Wealth
Management
All Other
Intercompany
Eliminations
Consolidated
Total
Three Months Ended September 30, 2012
Total revenue
$ 11,643,674 $ 6,706,485 $ 2,897,098 $ 1,490,297 $ 4,542,612 $ (3,675,459 ) $ 23,604,707
Net interest income
$ 8,602,967 $ 4,027,693 $ 2,368,483 $ - $ (369,625 ) $ - $ 14,629,518
Net income attributable to QCR Holdings, Inc.
$ 2,586,303 $ 1,532,946 $ (313,019 ) $ 108,950 $ 3,077,515 $ (3,935,362 ) $ 3,057,333
Total assets
$ 1,134,296,418 $ 587,057,961 $ 299,947,837 $ - $ 196,448,244 $ (193,804,388 ) $ 2,023,946,072
Provision for loan/lease losses
$ 350,194 $ 300,000 $ 846,000 $ - $ - $ - $ 1,496,194
Goodwill
$ 3,222,688 $ - $ - $ - $ - $ - $ 3,222,688
Three Months Ended September 30, 2011
Total revenue
$ 12,147,213 $ 7,110,970 $ 3,377,454 $ 1,311,647 $ 3,319,882 $ (3,362,429 ) $ 23,904,737
Net interest income
$ 7,944,108 $ 3,873,339 $ 2,355,471 $ - $ (344,214 ) $ - $ 13,828,704
Net income attributable to QCR Holdings, Inc.
$ 1,854,914 $ 1,375,114 $ (243,710 ) $ 257,611 $ 2,192,761 $ (3,273,535 ) $ 2,163,155
Total assets
$ 1,056,656,935 $ 565,822,310 $ 287,574,174 $ - $ 193,059,135 $ (204,152,062 ) $ 1,898,960,492
Provision for loan/lease losses
$ 1,158,965 $ 250,000 $ 1,048,000 $ - $ - $ - $ 2,456,965
Goodwill
$ 3,222,688 $ - $ - $ - $ - $ - $ 3,222,688
Nine Months Ended September 30, 2012
Total revenue
$ 36,196,909 $ 19,829,521 $ 9,665,950 $ 4,427,051 $ 13,533,609 $ (13,115,614 ) $ 70,537,426
Net interest income
$ 25,524,594 $ 11,691,876 $ 7,259,522 $ - $ (1,127,528 ) $ - $ 43,348,464
Net income attributable to QCR Holdings, Inc.
$ 7,603,033 $ 4,214,081 $ 482,950 $ 425,356 $ 9,484,700 $ (12,843,813 ) $ 9,366,307
Total assets
$ 1,134,296,418 $ 587,057,961 $ 299,947,837 $ - $ 196,448,244 $ (193,804,388 ) $ 2,023,946,072
Provision for loan/lease losses
$ 1,138,109 $ 875,000 $ 1,312,000 $ - $ - $ - $ 3,325,109
Goodwill
$ 3,222,688 $ - $ - $ - $ - $ - $ 3,222,688
Nine Months Ended September 30, 2011
Total revenue
$ 35,990,157 $ 21,482,485 $ 10,046,334 $ 4,238,644 $ 10,776,476 $ (10,885,546 ) $ 71,648,550
Net interest income
$ 22,772,375 $ 11,859,003 $ 6,641,533 $ - $ (1,284,350 ) $ - $ 39,988,561
Net income attributable to QCR Holdings, Inc.
$ 5,777,707 $ 3,964,627 $ 45,697 $ 741,263 $ 7,054,192 $ (10,620,402 ) $ 6,963,084
Total assets
$ 1,056,656,935 $ 565,822,310 $ 287,574,174 $ - $ 193,059,135 $ (204,152,062 ) $ 1,898,960,492
Provision for loan/lease losses
$ 2,236,850 $ 1,035,000 $ 1,925,000 $ - $ - $ - $ 5,196,850
Goodwill
$ 3,222,688 $ - $ - $ - $ - $ - $ 3,222,688
24
Part I
Item 1

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

NOTE 6 – FAIR VALUE

The measurement of fair value under U.S. GAAP uses a hierarchy intended to maximize the use of observable inputs and minimize the use of unobservable inputs.  This hierarchy includes three levels and is based upon the valuation techniques used to measure assets and liabilities.  The three levels are as follows:

1.
Level 1 – Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in markets;
2.
Level 2 – Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument; and
3.
Level 3 – Inputs to the valuation methodology are unobservable and significant to the fair value measurement.

There were no transfers of assets or liabilities between Levels 1, 2, and 3 of the fair value hierarchy for the three and nine months ended September 30, 2012 or 2011.

Assets measured at fair value on a recurring basis comprise the following at September 30, 2012 and December 31, 2011:
Fair Value Measurements at Reporting Date Using
Fair Value
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
September 30, 2012:
Securities available for sale:
U.S. govt. sponsored agency securities
$ 343,243,622 $ - $ 343,243,622 $ -
Residential mortgage-backed and related securities
155,690,575 - 155,690,575 -
Municipal securities
90,031,631 - 90,031,631 -
Trust preferred securities
130,400 - 130,400 -
Other securities
1,605,221 235,027 1,370,194 -
$ 590,701,449 $ 235,027 $ 590,466,422 $ -
December 31, 2011 :
Securities available for sale:
U.S. govt. sponsored agency securities
$ 428,955,220 $ - $ 428,955,220 $ -
Residential mortgage-backed and related securities
108,853,749 - 108,853,749 -
Municipal securities
25,689,364 - 25,689,364 -
Trust preferred securities
80,800 - 80,800 -
Other securities
1,450,158 191,506 1,258,652 -
$ 565,029,291 $ 191,506 $ 564,837,785 $ -
25
Part I
Item 1

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

A small portion of the securities available for sale portfolio consists of common stock issued by various unrelated bank holding companies.  The fair values used by the Company are obtained from an independent pricing service and represent quoted market prices for the identical securities (Level 1 inputs).

The large majority of the securities available for sale portfolio consists of U.S. government sponsored agency securities for which the Company obtains fair values from an independent pricing service.  The fair values are determined by pricing models that consider observable market data, such as interest rate volatilities, LIBOR yield curve, credit spreads and prices from market makers and live trading systems (Level 2 inputs).

Certain financial assets are measured at fair value on a non-recurring basis; that is, the assets are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).

Assets measured at fair value on a non-recurring basis comprise the following at September 30, 2012 and December 31, 2011:
Fair Value Measurements at Reporting Date Using
Fair Value
Level 1
Level 2
Level 3
September 30, 2012:
Impaired loans/leases
$ 13,367,633 $ - $ - $ 13,367,633
Other real estate owned
5,403,014 - - 5,403,014
$ 18,770,647 $ - $ - $ 18,770,647
December 31, 2011:
Impaired loans/leases
$ 18,361,757 $ - $ - $ 18,361,757
Other real estate owned
9,056,619 - - 9,056,619
$ 27,418,376 $ - $ - $ 27,418,376

Impaired loans/leases are evaluated and valued at the time the loan/lease is identified as impaired, at the lower of cost or fair value, and are classified as Level 3 in the fair value hierarchy.  Fair value is measured based on the value of the collateral securing these loans/leases.  Collateral may be real estate and/or business assets, including equipment, inventory and/or accounts receivable, and is determined based on appraisals by qualified licensed appraisers hired by the Company.  Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and client’s business.

Other real estate owned in the table above consists of property acquired through foreclosures and settlements of loans.  Property acquired is carried at the lower of the principal amount of loans outstanding, or the estimated fair value of the property, less disposal costs, and is classified as Level 3 in the fair value hierarchy.

For the impaired loans/leases and other real estate owned, the Company records carrying value at fair value less disposal or selling costs.  The amounts reported in the tables above are fair values before the adjustment for disposal or selling costs.

There have been no changes in valuation techniques used for any assets measured at fair value during the three and nine months ended September 30, 2012 or 2011.
26
Part I
Item 1
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

The following table presents the carrying values and estimated fair values of financial assets and liabilities carried on the Company’s consolidated balance sheets, including those financial assets and liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis:
As of September 30, 2012
As of December 31, 2011
Carrying
Value
Estimated
Fair Value
Carrying
Value
Estimated
Fair Value
Cash and due from banks
$ 40,564,561 $ 40,564,561 $ 53,136,710 $ 53,136,710
Federal funds sold
5,725,000 5,725,000 20,785,000 20,785,000
Interest-bearing deposits at financial institutions
49,436,938 49,436,938 26,750,602 26,750,602
Investment securities:
Held to maturity
650,000 650,000 200,000 200,000
Available for sale
590,701,449 590,701,449 565,029,291 565,029,291
Loans/leases receivable, net
1,224,875,461 1,243,192,000 1,181,956,235 1,202,817,000
Accrued interest receivable
6,640,822 6,640,822 6,510,021 6,510,021
Deposits
1,343,235,434 1,346,256,000 1,205,457,788 1,209,197,000
Short-term borrowings
140,888,698 140,888,698 213,536,450 213,536,450
Federal Home Loan Bank advances
196,350,000 216,052,000 204,750,000 223,678,000
Other borrowings
138,237,737 154,663,000 136,231,663 151,813,000
Junior subordinated debentures
36,085,000 18,753,000 36,085,000 18,444,000
Accrued interest payable
1,373,671 1,373,671 1,551,842 1,551,842
The methodologies for estimating the fair value of financial assets and liabilities that are measured at fair value on a recurring or non-recurring basis are discussed above.  For certain financial assets and liabilities, carrying value approximates fair value due to the nature of the financial instrument.  These instruments include:  cash and due from banks, federal funds sold, interest-bearing deposits at financial institutions, accrued interest receivable and payable, demand and other non-maturity deposits, and short-term borrowings.  The Company used the following methods and assumptions in estimating the fair value of the following instruments:

Loans/leases receivable: The fair values for variable rate loans equal their carrying values.  The fair values for all other types of loans/leases are estimated using discounted cash flow analyses, using interest rates currently being offered for loans/leases with similar terms to borrowers with similar credit quality.  The fair value of loans held for sale is based on quoted market prices of similar loans sold on the secondary market.  All of the above are classified as Level 2 in the fair value hierarchy as presented in the table below.

Deposits: The fair values disclosed for demand and other non-maturity deposits equal their carrying amounts, which represent the amount payable on demand.  Fair values for time deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered on time deposits to a schedule of aggregate expected monthly maturities on time deposits, and are classified as Level 2 in the fair value hierarchy as presented in the table below.

Federal Home Loan Bank advances and junior subordinated debentures: The fair value of these instruments is estimated using discounted cash flow analyses, based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements, and are classified as Level 2 in the fair value hierarchy as presented in the table below.
Other borrowings: The fair value for the wholesale repurchase agreements and fixed rate other borrowings is estimated using rates currently available for debt with similar terms and remaining maturities.  The fair value for variable rate other borrowings is equal to its carrying value.  All of the above are classified as Level 2 in the fair value hierarchy as presented in the table below.
27
Part I
Item 1

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-continued

Commitments to extend credit: The fair value of these instruments is not material.
The following table presents the level in the fair value hierarchy for the estimated fair values of the Company’s financial instruments that are not already on the Consolidated Balance Sheet at fair value at September 30, 2012.
Fair Value
Level 1
Level 2
Level 3
Loans/leases receivable, net *
$ 1,229,824,367 $ - $ 1,229,824,367 $ -
Time deposits
361,397,000 - 361,397,000 -
Federal Home Loan Bank advances
216,052,000 - 216,052,000 -
Other borrowings
154,663,000 - 154,663,000 -
Junior subordinated debentures
18,753,000 - 18,753,000 -
*Excludes impaired loans/leases totaling $13,367,633 measured at fair value on a non-recurring basis and reported separately.

NOTE 7 – PARTIAL REDEMPTION OF SERIES F PREFERRED STOCK

On June 29, 2012, the Company redeemed 10,223 shares of Series F Preferred Stock from Treasury for an aggregate redemption amount of $10,223,000 plus unpaid dividends to the date of redemption of $124,948.  Previously, on September 15, 2011, the Company issued 40,090 shares of Series F Preferred Stock to Treasury for an aggregate purchase price of $40,090,000.  The sale of Series F Preferred Stock was the result of an investment by Treasury from the Small Business Lending Fund (“SBLF”), a $30 billion fund established under the Small Business Jobs Act of 2010, which was intended to encourage lending to small business by providing capital to qualified community banks with assets of less than $10 billion.

The remaining Series F Preferred Stock may be redeemed at any time at the option of the Company, subject to the approval of the Company’s primary federal banking regulator.  All redemptions must be in amounts equal to at least 25% of the number of originally issued shares, or 100% of the then-outstanding shares (if less than 25% of the originally issued shares).

NOTE 8 – ACQUISITION OF 20% NONCONTROLLING INTEREST IN M2 LEASE FUNDS

On August 27, 2012, the Company’s largest subsidiary bank, QCBT, entered into an amendment to the operating agreement of m2 Lease Funds and purchased the 20% noncontrolling interest in m2 Lease Funds.  QCBT previously owned an 80% equity interest in m2 Lease Funds.  The acquisition is structured in two payments with the initial payment of $1,653,755 made on September 11, 2012 and the final payment to be made in September 2015.  The initial payment represented a 50% premium over the book value of the 20% equity interest of $3,307,509 as of August 31, 2012, calculated in accordance with the operating agreement.  The final payment will consist of the book value of the 20% equity interest as of August 31, 2012 plus 20% of the earnings from m2 Lease Funds for the period September 2012 through August 2015.  As a result, for the portion of the final payment related to the book value of the 20% equity interest as of August 31, 2012, QCBT calculated the present value of the future payment using a discount rate of 5% and recorded the resulting liability of $2,847,687.  QCBT will accrete the discount using the effective yield method over three years.  For the portion of the final payment related to the 20% of earnings from m2 Lease Funds for the period September 2012 through August 2015, QCBT will record compensation cost and increase the liability on a monthly basis.  As a result of acquiring additional equity in a majority-owned company, the premium paid is reflected as a reduction of additional paid-in capital.  The total premium paid and resulting reduction of additional paid-in capital totaled $2,133,417 which consists of the 50% premium over the book value as defined by the operating agreement ($1,653,755) and the difference between the discounted book value and the equity in the 20% noncontrolling interest as of August 31, 2012 ($453,884).
28
Part I
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued
GENERAL

QCR Holdings, Inc. is the parent company of QCBT, CRBT, and RB&T.
QCBT and CRBT are Iowa-chartered commercial banks, and RB&T is an Illinois-chartered commercial bank.  All are members of the Federal Reserve System with depository accounts insured to the maximum amount permitted by law by the Federal Deposit Insurance Corporation (“FDIC”).
·
QCBT commenced operations in 1994 and provides full-service commercial and consumer banking, and trust and asset management services, to the Quad City area and adjacent communities through its five offices that are located in Bettendorf and Davenport, Iowa and Moline, Illinois.  QCBT also provides leasing services through its now wholly-owned subsidiary, m2 Lease Funds, located in Brookfield, Wisconsin.  In August 2012, QCBT entered into an amendment to the operating agreement of m2 Lease Funds and purchased the 20% noncontrolling interest in m2 Lease Funds.  In addition, QCBT owns 100% of Quad City Investment Advisors, LLC (formerly known as CMG Investment Advisors, LLC), which is an investment management and advisory company.

·
CRBT commenced operations in 2001 and provides full-service commercial and consumer banking, and trust and asset management services, to Cedar Rapids, Iowa and adjacent communities through its main office located on First Avenue in downtown Cedar Rapids, Iowa and its branch facility located on Council Street in northern Cedar Rapids.  CRBT also provides residential real estate mortgage lending services through its 50%-owned joint venture, Cedar Rapids Mortgage Company.

·
RB&T commenced operations in January 2005 and provides full-service commercial and consumer banking, and trust and asset management services, to Rockford, Illinois and adjacent communities through its main office located in downtown Rockford and its branch facility on Guilford Road at Alpine Road in Rockford.

The Company engages in real estate holdings through its 91% equity investment in Velie Plantation Holding Company, LLC, based in Moline, Illinois.
29
Part I
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

OVERVIEW

The Company recognized net income of $3.2 million for the quarter ended September 30, 2012, and net income attributable to QCR Holdings, Inc. of $3.1 million, which excludes the net income attributable to noncontrolling interests of $127 thousand.  After preferred stock dividends of $811 thousand, the Company reported net income attributable to common stockholders of $2.2 million, or diluted earnings per common share of $0.44.  By comparison, for the third quarter of 2011, the Company recognized net income of $2.3 million and net income attributable to QCR holdings, Inc. of $2.2 million, which excludes the net income attributable to noncontrolling interests of $103 thousand.  After preferred stock dividends and discount accretion of $2.2 million, the Company reported a net loss attributable to common stockholders of $25 thousand, or diluted loss per common share of ($0.01).  The 2011 preferred stock dividends included a one-time deemed dividend of $1.2 million as a result of the Company’s repurchase of all of the preferred shares issued to Treasury under the Troubled Asset Relief Program (“TARP”).

For the nine months ended September 30, 2012, the Company reported net income of $9.9 million, and net income attributable to QCR Holdings, Inc. of $9.4 million, which excludes the net income attributable to noncontrolling interests of $494 thousand.  After preferred stock dividends of $2.7 million, the Company reported net income attributable to common stockholders of $6.7 million, or diluted earnings per common share of $1.35.  For the same period in 2011, the Company recognized net income of $7.3 million and net income attributable to QCR Holdings, Inc. of $7.0 million, which excludes the net income attributable to noncontrolling interests of $308 thousand.  After preferred stock dividends and discount accretion of $4.3 million, the Company reported net income attributable to common stockholders of $2.7 million, or diluted earnings per common share of $0.56.

Following is a table that represents the various net income measurements for the three and nine months ended September 30, 2012 and 2011, respectively.
For the three months ended
For the nine months ended
September 30, 2012
September 30, 2011
September 30, 2012
September 30, 2011
Net income
$ 3,184,510 $ 2,266,601 $ 9,860,738 $ 7,271,299
Less:  Net income attributable to noncontrolling interests
127,177 103,446 494,431 308,215
Net income attributable to QCR Holdings, Inc.
$ 3,057,333 $ 2,163,155 $ 9,366,307 $ 6,963,084
Less: Preferred stock dividends and discount accretion
810,837 2,188,058 2,685,248 4,256,171
Net income attributable to QCR Holdings, Inc. common stockholders
$ 2,246,496 $ (24,903 ) $ 6,681,059 $ 2,706,913
Diluted earnings per common share
$ 0.44 $ (0.01 ) $ 1.35 $ 0.56
Weighted average common and common equivalent shares outstanding
5,080,288 4,866,692 4,938,514 4,847,433
Following is a table that represents the major income and expense categories.
For the three months ended
For the nine months ended
September 30, 2012
June 30, 2012
September 30, 2011
September 30, 2012
September 30, 2011
Net interest income
$ 14,629,518 $ 14,515,493 $ 13,828,704 $ 43,348,464 $ 39,988,561
Provision for loan/lease losses
(1,496,194 ) (1,048,469 ) (2,456,965 ) (3,325,109 ) (5,196,850 )
Noninterest income
4,117,182 4,067,509 4,335,307 12,141,569 13,565,812
Noninterest expense
(13,031,517 ) (13,109,083 ) (12,773,149 ) (38,878,680 ) (38,340,967 )
Federal and state income tax
(1,034,479 ) (1,152,071 ) (667,296 ) (3,425,506 ) (2,745,257 )
Net income
$ 3,184,510 $ 3,273,379 $ 2,266,601 $ 9,860,738 $ 7,271,299

30
Part I
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued
NET INTEREST INCOME

Net interest income, on a tax equivalent basis, increased $1.1 million, or 8%, to $15.1 million for the quarter ended September 30, 2012, from $14.0 million for the same period of 2011.  The increase in net interest income was driven primarily by reduced interest expense.  This was the result of continued reductions in the cost of deposits as well as growth in noninterest bearing deposits, which funded the earning asset growth and allowed the level of interest-bearing funding to remain relatively flat.  Interest income grew slightly as growth in loans and securities more than offset the continued decline in yields.

A comparison of yields, spread and margin from the third quarter of 2012 to the third quarter of 2011 is as follows (on a tax equivalent basis):

·
The average yield on interest-earning assets decreased 25 basis points.
·
The average cost of interest-bearing liabilities decreased 27 basis points.
·
The net interest spread improved 2 basis points from 2.82% to 2.84%.
·
The net interest margin expanded 3 basis points from 3.13% to 3.16%.

Net interest income, on a tax equivalent basis, increased $3.9 million, or 10%, to $44.3 million for the first nine months of 2012, from $40.4 million for the same period of 2011.  The growth was primarily a function of reductions in the rates paid on all interest-bearing liabilities with most of the impact from declining cost of deposits.  Additionally, interest income grew as growth in loans and securities more than offset the decline in yields.

A comparison of yields, spread and margin from the first nine months of 2012 to the same period of 2011 is as follows (on a tax equivalent basis):

·
The average yield on interest-earning assets decreased 22 basis points.
·
The average cost of interest-bearing liabilities decreased 30 basis points.
·
The net interest spread improved 8 basis points from 2.73% to 2.81%.
·
The net interest margin expanded 8 basis points from 3.06% to 3.14%.

The Company’s management closely monitors and manages net interest margin.  From a profitability standpoint, an important challenge for the Company’s subsidiary banks and leasing company is the improvement of their net interest margins.  Management continually addresses this issue with pricing and other balance sheet management strategies.  Over the past two years, the Company’s management has emphasized improving its funding mix by reducing its reliance on wholesale funding, which tends to be at a higher cost than deposits. In addition, with loan growth continuing to be modest, the Company’s management has focused on growing and diversifying its securities portfolio.
31
Part I
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued
The Company’s average balances, interest income/expense, and rates earned/paid on major balance sheet categories, as well as the components of change in net interest income, are presented in the following tables:

For the three months ended September 30,
2012
2011
Average
Balance
Interest
Earned
or Paid
Average
Yield or
Cost
Average
Balance
Interest
Earned
or Paid
Average
Yield or
Cost
(dollars in thousands)
ASSETS
Interest earning assets:
Federal funds sold
$ 6,199 $ 3 0.19 % $ 18,996 $ 8 0.17 %
Interest-bearing deposits at financial institutions
33,446 76 0.90 % 26,124 98 1.49 %
Investment securities (1)
619,650 3,930 2.52 % 516,617 3,243 2.49 %
Restricted investment securities
15,419 132 3.41 % 15,305 126 3.27 %
Gross loans/leases receivable (2) (3) (4)
1,227,326 15,804 5.12 % 1,190,313 16,216 5.40 %
Total interest earning assets
$ 1,902,040 19,945 4.17 % $ 1,767,355 19,691 4.42 %
Noninterest-earning assets:
Cash and due from banks
$ 38,376 $ 46,947
Premises and equipment
31,401 30,446
Less allowance for estimated losses on loans/leases
(18,922 ) (19,693 )
Other
77,314 79,293
Total assets
$ 2,030,209 $ 1,904,348
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Interest-bearing deposits
$ 557,216 625 0.45 % $ 537,887 1,006 0.74 %
Time deposits
357,734 864 0.96 % 363,181 1,195 1.31 %
Short-term borrowings
164,775 60 0.14 % 145,147 66 0.18 %
Federal Home Loan Bank advances
201,328 1,810 3.58 % 204,911 1,931 3.74 %
Junior subordinated debentures
36,085 261 2.88 % 36,085 242 2.66 %
Other borrowings (4)
138,105 1,238 3.57 % 140,774 1,301 3.67 %
Total interest-bearing liabilities
$ 1,455,243 4,858 1.33 % $ 1,427,985 5,741 1.60 %
Noninterest-bearing demand deposits
$ 406,597 $ 311,044
Other noninterest-bearing liabilities
29,147 26,315
Total liabilities
$ 1,890,987 $ 1,765,344
Stockholders' equity
139,222 139,004
Total liabilities and stockholders' equity
$ 2,030,209 $ 1,904,348
Net interest income
$ 15,087 $ 13,950
Net interest spread
2.84 % 2.82 %
Net interest margin
3.16 % 3.13 %
Ratio of average interest-earning assets to average interest-bearing liabilities
130.70 % 123.77 %
(1) Interest earned and yields on nontaxable investment securities are determined on a tax equivalent basis using a 34% tax rate for each period presented.
(2) Loan/lease fees are not material and are included in interest income from loans/leases receivable in accordance with accounting and regulatory guidance.
(3) Non-accrual loans/leases are included in the average balance for gross loans/leases receivable in accordance with accounting and regulatory guidance.
(4) In accordance with ASC 860, effective January 1, 2010, the Company accounts for some participations sold, including sales of SBA-guaranteed portions of loans during the recourse period, as secured borrowings.  As such, these amounts are included in the average balance for gross loans/leases receivable and other borrowings.  For the three months ended September 30, 2012 and 2011, this totaled $0.0 million and $0.6 million, respectively.  During the second quarter of 2011, SBA removed the recourse provision for sales which allowed for sale accounting treatment at the time of sale; thus, the decline in average balance.
32
Part I
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued
Analysis of Changes of Interest Income/Interest Expense
For the three months ended September 30, 2012
Components of Change (1)
Inc./(Dec.)
from
Prior Period
Rate
Volume
2012 vs. 2011
(dollars in thousands)
INTEREST INCOME
Federal funds sold
$ (5 ) $ 7 $ (12 )
Interest-bearing deposits at financial institutions
(22 ) (141 ) 119
Investment securities (2)
687 51 636
Restricted investment securities
6 5 1
Gross loans/leases receivable (3) (4) (5)
(412 ) (2,733 ) 2,321
Total change in interest income
$ 254 $ (2,811 ) $ 3,065
INTEREST EXPENSE
Interest-bearing deposits
$ (381 ) $ (615 ) $ 234
Time deposits
(331 ) (313 ) (18 )
Short-term borrowings
(6 ) (46 ) 40
Federal Home Loan Bank advances
(121 ) (85 ) (36 )
Junior subordinated debentures
19 19 -
Other borrowings (5)
(63 ) (36 ) (27 )
Total change in interest expense
$ (883 ) $ (1,076 ) $ 193
Total change in net interest income
$ 1,137 $ (1,735 ) $ 2,872
(1) The column "Inc./(Dec.) from Prior Period" is segmented into the changes attributable to variations in volume and the changes attributable to changes in interest rates.  The variations attributable to simultaneous volume and rate changes have been proportionately alloctaed to rate and volume.
(2) Interest earned and yields on nontaxable investment securities are determined on a tax equivalent basis using a 34% tax rate for each period presented.
(3) Loan/lease fees are not material and are included in interest income from loans/leases receivable in accordance with accounting and regulatory guidance.
(4) Non-accrual loans/leases are included in the average balance for gross loans/leases receivable in accordance with accounting and regulatory guidance.
(5) In accordance with ASC 860, effective January 1, 2010, the Company accounts for some participations sold, including sales of SBA-guaranteed portions of loans during the recourse period, as secured borrowings.  As such, these amounts are included in the average balance for gross loans/leases receivable and other borrowings.  For the three months ended September 30, 2012 and 2011, this totaled $0.0 million and $0.6 million, respectively.  During the second quarter of 2011, SBA removed the recourse provision for sales which allowed sale accounting treatment at the time of sale; thus, the decline in average balance.
33
Part I
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued
For the nine months ended September 30,
2012
2011
Average
Balance
Interest
Earned
or Paid
Average
Yield or
Cost
Average
Balance
Interest
Earned
or Paid
Average
Yield or
Cost
(dollars in thousands)
ASSETS
Interest earning assets:
Federal funds sold
$ 2,066 $ 3 0.19 % $ 58,959 $ 98 0.22 %
Interest-bearing deposits at financial institutions
51,430 288 0.75 % 30,991 312 1.35 %
Investment securities (1)
603,756 10,890 2.41 % 489,184 9,146 2.50 %
Restricted investment securities
15,327 378 3.29 % 15,677 428 3.65 %
Gross loans/leases receivable (2) (3) (4)
1,212,323 47,748 5.26 % 1,171,331 48,466 5.53 %
Total interest earning assets
1,884,903 59,307 4.20 % $ 1,766,142 58,450 4.42 %
Noninterest-earning assets:
Cash and due from banks
$ 39,764 $ 43,077
Premises and equipment
31,533 30,696
Less allowance for estimated losses on loans/leases…
(19,005 ) (19,979 )
Other
76,330 72,884
Total assets
$ 2,013,525 $ 1,892,820
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Interest-bearing deposits
$ 543,723 2,090 0.51 % $ 530,425 3,013 0.76 %
Time deposits
352,606 2,744 1.04 % 364,712 3,935 1.44 %
Short-term borrowings
174,578 203 0.16 % 140,312 248 0.24 %
Federal Home Loan Bank advances
204,209 5,503 3.60 % 213,565 6,053 3.79 %
Junior subordinated debentures
36,085 787 2.91 % 36,085 975 3.61 %
Other borrowings (4)
136,884 3,720 3.63 % 143,617 3,870 3.60 %
Total interest-bearing liabilities
1,448,085 15,047 1.39 % $ 1,428,716 18,094 1.69 %
Noninterest-bearing demand deposits
396,031 $ 301,829
Other noninterest-bearing liabilities
27,081 27,327
Total liabilities
1,871,196 $ 1,757,872
Stockholders' equity
142,329 134,948
Total liabilities and stockholders' equity
2,013,525 $ 1,892,820
Net interest income
$ 44,260 $ 40,356
Net interest spread
2.81 % 2.73 %
Net interest margin
3.14 % 3.06 %
Ratio of average interest-earning assets to average interest-bearing liabilities
130.17 % 123.62 %
(1) Interest earned and yields on nontaxable investment securities are determined on a tax equivalent basis using a 34% tax rate for each period presented.
(2) Loan/lease fees are not material and are included in interest income from loans/leases receivable in accordance with accounting and regulatory guidance.
(3) Non-accrual loans/leases are included in the average balance for gross loans/leases receivable in accordance with accounting and regulatory guidance.
(4) In accordance with ASC 860, effective January 1, 2010, the Company accounts for some participations sold, including sales of SBA-guaranteed portions of loans during the recourse period, as secured borrowings.  As such, these amounts are included in the average balance for gross loans/leases receivable and other borrowings.  For the nine months ended September 30, 2012 and 2011, this totaled $0.0 million and $3.4 million, respectively.  During the second quarter of 2011, SBA removed the recourse provision for sales which allowed for sale accounting treatment at the time of sale; thus, the decline in average balance.
34
Part I
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued
Analysis of Changes of Interest Income/Interest Expense
For the nine months ended September 30, 2012
Components of Change (1)
Inc./(Dec.)
from
Prior Period
Rate
Volume
2012 vs. 2011
(dollars in thousands)
INTEREST INCOME
Federal funds sold
$ (95 ) $ (11 ) $ (84 )
Interest-bearing deposits at financial institutions
(24 ) (230 ) 206
Investment securities (2)
1,744 (497 ) 2,241
Restricted investment securities
(50 ) (40 ) (10 )
Gross loans/leases receivable (3) (4) (5)
(718 ) (2,987 ) 2,269
Total change in interest income
$ 857 $ (3,765 ) $ 4,622
INTEREST EXPENSE
Interest-bearing deposits
$ (923 ) $ (1,044 ) $ 121
Time deposits
(1,191 ) (1,064 ) (127 )
Short-term borrowings
(45 ) (121 ) 76
Federal Home Loan Bank advances
(550 ) (286 ) (264 )
Junior subordinated debentures
(188 ) (188 ) -
Other borrowings (5)
(150 ) 60 (210 )
Total change in interest expense
$ (3,047 ) $ (2,643 ) $ (404 )
Total change in net interest income
$ 3,904 $ (1,122 ) $ 5,026
(1) The column "Inc./(Dec.) from Prior Period" is segmented into the changes attributable to variations in volume and the changes attributable to changes in interest rates.  The variations attributable to simultaneous volume and rate changes have been proportionately alloctaed to rate and volume.
(2) Interest earned and yields on nontaxable investment securities are determined on a tax equivalent basis using a 34% tax rate for each period presented.
(3) Loan/lease fees are not material and are included in interest income from loans/leases receivable in accordance with accounting and regulatory guidance.
(4) Non-accrual loans/leases are included in the average balance for gross loans/leases receivable in accordance with accounting and regulatory guidance.
(5) In accordance with ASC 860, effective January 1, 2010, the Company accounts for some participations sold, including sales of SBA-guaranteed portions of loans during the recourse period, as secured borrowings.  As such, these amounts are included in the average balance for gross loans/leases receivable and other borrowings.  For the nine months ended September 30, 2012 and 2011, this totaled $0.0 million and $3.4 million, respectively.  During the second quarter of 2011, SBA removed the recourse provision for sales which allowed sale accounting treatment at the time of sale; thus, the decline in average balance.
35
Part I
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued
CRITICAL ACCOUNTING POLICIES

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 estimated losses on loans/leases.  The Company’s allowance for estimated losses on loans/leases methodology incorporates a variety of risk considerations, both quantitative and qualitative, in establishing an allowance for estimated losses on loans/leases 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/leases, and other factors.  Quantitative factors also incorporate known information about individual loans/leases, 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/lease structure, existing loan/lease policies and pace of portfolio growth are other qualitative factors that are considered in the methodology.  Management may report a materially different amount for the provision for loan/lease losses in the statement of operations to change the allowance for estimated losses on loans/leases 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 in the section entitled “Financial Condition” of this Management’s Discussion and Analysis that discusses the allowance for estimated losses on loans/leases.  Although management believes the level of the allowance as of September 30, 2012 is adequate to absorb losses inherent in the loan/lease portfolio, a decline in local economic conditions, or other factors, could result in increasing losses that cannot be reasonably predicted at this time.

The Company’s assessment of other-than-temporary impairment of its available-for-sale securities portfolio is another critical accounting policy as a result of the level of judgment required by management.  Available-for-sale securities are evaluated to determine whether declines in fair value below their cost are other-than-temporary.  In estimating other-than-temporary impairment losses, management considers a number of factors including, but not limited to, (1) the length of time and extent to which the fair value has been less than amortized cost, (2) the financial condition and near-term prospects of the issuer, (3) the current market conditions, and (4) the intent of the Company to not sell the security prior to recovery and whether it is not more-likely-than-not that the Company will be required to sell the security prior to recovery.  The discussion regarding the Company’s assessment of other-than-temporary impairment should be read in conjunction with the Company’s financial statements and the accompanying notes presented elsewhere herein.
36
Part I
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued
RESULTS OF OPERATIONS

INTEREST INCOME

Interest income declined slightly comparing the third quarter of 2012 to the third quarter of 2011.  The effect of declines in loan yields effectively offset the growth in loans/leases and securities.  Specifically, over the year, the average balance for loans/leases grew $37.0 million, or 3%, while yields declined 28 basis points.  As deposit growth continues to outpace loan growth, the Company has focused on growing and diversifying its securities portfolio, including increasing its portfolio of agency-sponsored mortgage-backed securities as well as municipal securities.  Of the latter, the large majority are located in or near our existing markets with strong underwriting conducted before investment.  Over the year, the average balance for securities grew $103.0 million, or 20%, and yields improved 3 basis points.  With the continuing historical low interest rate environment, management’s execution of its strategy to diversify the securities portfolio has contributed to this yield gain.

For the first nine months of 2012, interest income grew slightly compared to the first nine months of 2011.  Growth and diversification of the securities portfolio (average balances grew $114.6 million, or 23%) more than offset the effect of declining yields (decline of 9 basis points year over year).  The impact of loan/lease growth (average balances grew $41.0 million, or 4%) fell short of the effect of declining yields (decline of 27 basis points year over year) leading to a net decline in interest income on loans/leases.

Management understands the importance of quality, well-priced loan/lease growth and has worked hard to grow assets in a prudent and sustainable manner.

INTEREST EXPENSE

Interest expense for the third quarter of 2012 declined $883 thousand, or 15%, from the third quarter of 2011, and declined $3.0 million, or 17%, comparing the first nine months of 2012 to the same period of 2011.   The Company continued to grow noninterest bearing deposits, whichhas provided management increased flexibility to decrease pricing on its interest-bearing deposits.  The Company has been successful in decreasing the cost of borrowings, which has also contributed to the decline in interest expense.  Management has placed a strong focus on reducing the reliance on wholesale funding as it tends to be higher cost than deposits.  In recent years, the majority of maturing wholesale funds have not been replaced, or, to a lesser extent, have been replaced at significantly reduced cost.  In addition, management executed on three separate strategies during 2011 and 2012 which strongly contributed to the declining borrowing costs:

1.
During the first quarter of 2011, QCBT utilized excess liquidity and prepaid $15.0 million of FHLB advances with a weighted average interest rate of 4.87% and a weighted average maturity of May 2012.
2.
The Company modified $33.4 million ($20.4 million in first quarter of 2011 and $13.0 million in the fourth quarter of 2011) of fixed rate FHLB advances into new fixed rate FHLB advances at significantly reduced interest rates and extended maturities.
3.
During the second quarter of 2012, the Company modified $25.0 million of fixed rate wholesale structured repurchase agreements (“structured repos”) into new fixed rate structured repos at significantly reduced interest rates and extended maturities.

Management continues to consider strategies to accelerate the reduction of the reliance on wholesale funding and continue the shift in mix to a funding base consisting of a higher percentage of core deposits.
37
Part I
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued
PROVISION FOR LOAN/LEASE LOSSES

The provision for loan/lease losses is established based on a number of factors, including the Company’s historical loss experience, delinquencies and charge-off trends, the local and national economy and risk associated with the loans/leases in the portfolio as described in more detail in the “Critical Accounting Policies” section.

The Company’s provision for loan/lease losses totaled $1.5 million for the third quarter of 2012, a decline of $961 thousand from the third quarter of 2011.  For the first nine months of 2012, the Company’s provision totaled $3.3 million, which was a decline of $1.9 million from the first nine months of 2011.  The declines were the result of continued improvement in loan quality as evidenced by a declining trend in the level of classified and criticized loans (see table and further discussion in the “Financial Condition” section), as well as a declining trend in nonperforming loans/leases.  The latter fell $8.1 million, or 25%, since September 30, 2011.

In comparison to the second quarter of 2012, the Company’s provision for loan/lease losses of $1.5 million for the third quarter of 2012 reflected an increase of $448 thousand.  The Company experiencedloan/lease growth during the third quarter of 2012 which warranted an increased provision.  Specifically, loans/leases grew $31.0 million, or 3%, with the majority of this growth in commercial and commercial real estate.

With the provision of $1.5 million more than offsetting net charge-offs totaling $804 thousand, the Company’s allowance for estimated losses on loans/leases to total loans/leases increased slightly to 1.56% at September 30, 2012 from 1.54% at June 30, 2012.  A more detailed discussion of the Company’s allowance for estimated losses on loans/leases can be found in the “Financial Condition” section of this report.
38
Part I
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued
NONINTEREST INCOME

The following tables set forth the various categories of noninterest income for the three and nine months ended September 30, 2012 and 2011.
Three Months Ended
September 30, 2012
September 30, 2011
$ Change
% Change
Trust department fees
$ 914,586 $ 762,133 $ 152,453 20.0 %
Investment advisory and management fees
575,711 549,515 26,196 4.8
Deposit service fees
847,343 893,685 (46,342 ) (5.2 )
Gains on sales of loans, net
684,546 408,364 276,182 67.6
Securities gains
- 443,614 (443,614 ) (100.0 )
Gains (losses) on other real estate owned, net
(745,799 ) 42,262 (788,061 ) (1,864.7 )
Earnings on bank-owned life insurance
399,925 331,440 68,485 20.7
Credit card fees, net of processing costs
140,542 178,636 (38,094 ) (21.3 )
Other
1,300,328 725,658 574,670 79.2
$ 4,117,182 $ 4,335,307 $ (218,125 ) (5.0 ) %
Nine Months Ended
September 30, 2012
September 30, 2011
$ Change
% Change
Trust department fees
$ 2,650,552 $ 2,607,668 $ 42,884 1.6 %
Investment advisory and management fees
1,776,499 1,630,976 145,523 8.9
Deposit service fees
2,626,822 2,623,018 3,804 0.1
Gains on sales of loans, net
1,965,957 1,923,185 42,772 2.2
Securities gains
104,600 1,472,528 (1,367,928 ) (92.9 )
Losses on other real estate owned, net
(1,324,468 ) (90,492 ) (1,233,976 ) 1,363.6
Earnings on bank-owned life insurance
1,196,987 1,032,493 164,494 15.9
Credit card fees, net of processing costs
409,730 397,132 12,598 3.2
Other
2,734,890 1,969,304 765,586 38.9
$ 12,141,569 $ 13,565,812 $ (1,424,243 ) (10.5 ) %
Trust department fees continue to be a significant contributor to noninterest income.  Trust department fees grew 20% from the third quarter of 2011 to the third quarter of 2012, and grew slightly by 2% for the first nine months of 2012 compared to the same period of 2011.  The majority of the trust department fees are determined based on the value of the investments within the managed trusts.  As markets have experienced volatility with the national economy’s recovery from recession, the Company’s fee income has experienced similar volatility and fluctuation.  In recent years, the Company has been successful in expanding its customer base, which has helped to offset some of the effect of volatility and drive the recent increases.
39
Part I
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued
In recent years, the Company has placed a stronger emphasis on growing its investment advisory and management services.  Part of this initiative has been to restructure the Company’s Wealth Management Division to allow for more efficient delivery of products and services through selective additions of talent as well as the leverage of and collaboration among existing resources (including the aforementioned Trust Department).  Fee income for investment advisory and management services grew 5% comparing third quarter of 2012 to the same period of 2011, and grew 9% year over year.  Similar to trust department fees, these fees are largely determined based on the value of the investments managed.  Continued expansion of the customer base more than offset the impact of market volatility.

As management understands the importance of growing fee income, expanding market share in trust and investment advisory services will continue to be a primary strategic focus.

Although deposit service fees are down 5% from the third quarter of 2011 to the third quarter of 2012, deposit service fees have generally expanded over the past several years.  The Company has placed an emphasis on shifting the mix of deposits from brokered and retail time deposits to non-maturity demand deposits.  With this shift in mix, the Company has increased the number of demand deposit accounts, which tend to be lower in interest cost and higher in service fees.  The Company plans to continue this shift in mix and to further focus on growing deposit service fees.  Management periodically evaluates fee levels and fully understands the importance of this recurring source of fee income.

Gains on sales of loans, net, consists of sales of residential mortgages and the government guaranteed portions of small business loans.  Following is the breakdown of the gains recognized for these types of sales for the three and nine months ended September 30, 2012 and 2011.

For the three months ended
For the nine months ended
September 30, 2012
September 30, 2011
September 30, 2012
September 30, 2011
Gains on sales of residential mortgages
$ 424,255 $ 233,163 $ 987,021 $ 529,696
Gains on sales of government guaranteed portions of loans
260,291 175,201 978,936 1,393,489
$ 684,546 $ 408,364 $ 1,965,957 $ 1,923,185
Growth in the sales of residential mortgages is the result of an increase in refinancing activity caused by the continued flattening of the yield curve driving mortgage rates downward and allowing opportunities for additional refinancing.  In addition, there appears to be a slow and steady recovery in the residential mortgage market with increased buying and selling activity.  Sales activity for government guaranteed portions of loans tends to fluctuate depending on the demand for small business loans that fit the criteria for the government guarantee.  Further, some of the transactions can be large and, as the gain is determined as a percentage of the guaranteed amount, the resulting gain on sale can be large.  Lastly, a strategy for improved pricing is packaging loans together for sale.  From time to time, the Company may execute on this strategy, which may delay the gains on sales of some loans to achieve better pricing.  Despite the fluctuation, the Company will continue to focus on growing small business lending and selling the government guaranteed portion as it continues to be beneficial.
40
Part I
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued
During the third quarter of 2011, as a result of favorable market conditions, QCBT sold $8.6 million of government agency securities for a pre-tax gain totaling $444 thousand.  The related sales proceeds were reinvested into agency-sponsored residential mortgage-backed securities with higher yields and similar credit risk to the sold securities.  During the second quarter of 2011, as a result of favorable market conditions, RB&T sold $8.3 million of government agency securities for a pre-tax gain totaling $149 thousand,.  Additionally, the sales proceeds were utilized to diversify RB&T’s securities portfolio and fund loan growth.  Separately, during the first quarter of 2011, in an effort to offset the $832 thousand of fees for prepaying $15.0 million of FHLB advances, QCBT sold $37.4 million of government agency securities for a pre-tax gain totaling $880 thousand.

In 2012, the Company incurred increased write-downs of existing other real estate owned as the result of further declines in appraised values.  Of the net losses for the current quarter, the Company wrote down $527 thousand of existing other real estate owned and recognized net losses on sales of $219 thousand.  For the first nine months of 2012, the Company had write-downs of $1.2 million and net losses on sales of $165 thousand.  Management continues to proactively manage its other real estate owned portfolio in an effort to sell timely at minimal loss.

Earnings on bank-owned life insurance experienced strong growth quarter-over-quarter and year-over-year.  The Company purchased $1.6 million, or 4%, of additional bank-owned life insurance since September 30, 2011.  Additionally, a small portion of the Company’s bank-owned life insurance is variable rate whereby the returns are determined by the performance of the equity market.

Included in ‘other’ noninterest income, the Company recognized a $580 thousand pre-tax gain on the sale of a small equity interest in a company that provided data processing services to the Company’s merchant credit card acquiring business that was previously sold in 2008.  In addition, CRBT recognized $303 thousand of fee income for the execution of interest rate swaps related to three commercial loans during the first nine months of 2012 ($207 thousand in first quarter of 2012, and $96 thousand in the third quarter of 2012).  The interest rate swaps allow the commercial borrowers to pay a fixed interest rate while CRBT receives a variable interest rate.  Management believes that these swaps help position CRBT more favorably for rising rate environments.
41
Part I
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued
NONINTEREST EXPENSE

The following table sets forth the various categories of noninterest expense for the three and nine months ended September 30, 2012 and 2011.
Three Months Ended
September 30, 2012
September 30, 2011
$ Change
% Change
Salaries and employee benefits
$ 8,201,323 $ 7,651,695 $ 549,628 7.2 %
Occupancy and equipment expense
1,459,901 1,359,758 100,143 7.4
Professional and data processing fees
1,065,780 1,077,435 (11,655 ) (1.1 )
FDIC and other insurance
599,422 578,776 20,646 3.6
Loan/lease expense
273,166 839,993 (566,827 ) (67.5 )
Advertising and marketing
437,130 277,376 159,754 57.6
Postage and telephone
190,868 242,103 (51,235 ) (21.2 )
Stationery and supplies
139,592 122,582 17,010 13.9
Bank service charges
211,378 186,351 25,027 13.4
Other
452,957 437,080 15,877 3.6
$ 13,031,517 $ 12,773,149 $ 258,368 2.0 %
Nine Months Ended
September 30, 2012
September 30, 2011
$ Change
% Change
Salaries and employee benefits
$ 24,581,642 $ 22,480,731 $ 2,100,911 9.3 %
Occupancy and equipment expense
4,177,076 4,017,506 159,570 4.0
Professional and data processing fees
3,342,847 3,338,935 3,912 0.1
FDIC and other insurance
1,756,493 2,149,093 (392,600 ) (18.3 )
Loan/lease expense
755,066 1,772,290 (1,017,224 ) (57.4 )
Advertising and marketing
1,057,246 836,459 220,787 26.4
Postage and telephone
716,050 703,803 12,247 1.7
Stationery and supplies
417,769 380,754 37,015 9.7
Bank service charges
609,599 525,007 84,592 16.1
Prepayment fees on Federal Home Loan Bank advances
- 832,099 (832,099 ) (100.0 )
Other-than-temporary impairment losses on securities
62,400 118,847 (56,447 ) (47.5 )
Other
1,402,492 1,185,443 217,049 18.3
$ 38,878,680 $ 38,340,967 $ 537,713 1.4 %
42
Part I
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued
Salaries and employee benefits, which is the largest component of noninterest expense, increased from prior year.  This increase is largely the result of:

·
Customary annual salary and benefits increases for the majority of the Company’s employee base in 2012.
·
Continued increases in health insurance-related employee benefits for the majority of the Company’s employee base.
·
Higher accrued incentive compensation based on improved performance for the first nine months of 2012.
·
Targeted talent additions in late 2011 and early 2012.  Specifically, the Company added four business development officers (three in the Wealth Management Division and one in the Correspondent Banking Division) in an effort to continue to grow market share.

Occupancy and equipment expense increased from the prior year with the purchases of additional technology for enhanced customer service and for improved fraud detection and prevention systems.  In addition, the largest branch of RB&T was renovated to allow for existing and future expansion.

Although the FDIC and other insurance expense increased quarter-over-quarter, FDIC and other insurance expense has generally fallen over the past two years.  FDIC insurance premiums are calculated using a variety of factors, including, but not limited to, balance sheet levels, funding mix, and regulatory compliance.  The subsidiary banks have been successful in managing these factors and driving down FDIC insurance cost.  In addition, the FDIC modified the calculation for premiums effective during the second quarter of 2011.  The modification was favorable for the Company’s subsidiary banks.

Loan/lease expense declined significantly in the first nine months of 2012.  Generally, loan/lease expense has a direct relationship with the level of nonperforming loans/leases.  Over the past several quarters, the Company has been successful in resolving several nonperforming loans that had previously incurred significant recurring costs.

The Company incurred additional expenses for advertising and marketing during 2012 in an effort to gain market share across all three markets.  The largest costs were incurred by QCBT as management sponsored two high profile community events.

Bank service charges, which include costs incurred to provide services to QCBT’s correspondent banking customer portfolio, have increased year over year.  The increase is due, in large part, to the success QCBT has had in growing its correspondent banking customer portfolio over the past year.

In an effort to utilize some of its excess liquidity and improve net interest margin by eliminating some of its higher cost wholesale funding, QCBT prepaid $15.0 million of FHLB advances during the first quarter of 2011.  As a result, QCBT incurred a prepayment fee totaling $832 thousand.  To offset these fees, QCBT sold $37.4 million of government sponsored agency securities for a pre-tax gain totaling $880 thousand.

Overall, management has placed a strong emphasis on prudent cost control through improved efficiency.
43
Part I
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued
INCOME TAXES

The provision for income taxes totaled $1.0 million, or an effective tax rate of 25%, for the third quarter of 2012 compared to $667 thousand, or an effective tax rate of 23%, for the same quarter in 2011.  The increase in effective tax rate is the result of the proportion of taxable to nontaxable income.  The Company’s growth in taxable income comparing the third quarter of 2012 to the third quarter of 2011 more than offsets the impact of the growth in nontaxable income (the Company grew its tax exempt municipal securities portfolio over threefold during 2012).

For the first nine months of 2012, the provision for income taxes totaled $3.4 million, or an effective tax rate of 26%, compared to $2.7 million, or an effective tax rate of 28%, for the first nine months of 2011.  The decline in the effective tax rate is primarily the result of the following:

·
The continued application of tax credits that were acquired in the third quarter of 2011.
·
The increase in tax-exempt municipal securities during the first nine months of 2012, which, in turn, resulted in an increase in nontaxable income.  Specifically, the Company grew its municipal securities portfolio from $25.7 million at December 31, 2011 to $90.0 million at September 30, 2012.


FINANCIAL CONDITION

Following is a table that represents the major categories of the Company’s balance sheet.
As of
September 30, 2012
December 31, 2011
September 30, 2011
(dollars in thousands)
Amount
%
Amount
%
Amount
%
Cash, federal funds sold, and interest-bearing deposits
$ 95,727 5 % $ 100,673 5 % $ 75,887 4 %
Securities
591,351 29 % 565,229 29 % 525,912 28 %
Net loans/leases
1,224,875 61 % 1,181,956 60 % 1,178,003 62 %
Other assets
111,993 6 % 118,752 6 % 119,158 6 %
Total assets
$ 2,023,946 100 % $ 1,966,610 100 % $ 1,898,960 100 %
Total deposits
$ 1,343,235 66 % $ 1,205,458 61 % $ 1,207,469 64 %
Total borrowings
511,561 25 % 590,603 30 % 524,551 28 %
Other liabilities
30,029 2 % 26,116 1 % 23,771 1 %
Total stockholders' equity
139,121 7 % 144,433 8 % 143,169 7 %
Total liabilities and stockholders' equity
$ 2,023,946 100 % $ 1,966,610 100 % $ 1,898,960 100 %
During the first nine months of 2012, the Company’s total assets increased $57.3 million, or 3%, to a total of $2.02 billion.   The Company experienced loan/lease growth over the year totaling $42.9 million, or 4%, with most of this growth in the third quarter ($31.0 million, or 3%).  Additionally, the Company continued to grow its securities portfolio with an increase of $26.1 million, or 5%, during the first nine months of 2012.  The asset growth during the first nine months of 2012 was funded by strong and continued growth of the Company’s deposit portfolio (as balances grew $137.8 million, or 11%) partially offset by reductions in federal funds purchased and FHLB advances.
44
Part I
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

The composition of the Company’s securities portfolio is managed to meet liquidity needs while prioritizing the impact on asset-liability position and maximizing return.  With the strong growth in deposits more than offsetting the pace of loan growth over the past two years, the Company has grown and diversified its securities portfolio, including increasing the portfolio of agency-sponsored mortgage-backed securities as well as more than tripling the portfolio of municipal securities.  Of the latter, the large majority are located in or near the Company’s existing markets and require a thorough underwriting process before investment.  As the portfolio has grown over recent years, management has elevated its focus on maximizing return while minimizing credit and interest rate risk.

Following is a breakdown of the Company’s securities portfolio by type, the percentage of unrealized gains to amortized cost on the total portfolio, and the portfolio duration:
As of
September 30, 2012
December 31, 2011
September 30, 2011
Amount
%
Amount
%
Amount
%
(dollars in thousands)
U.S. govt. sponsored agency securities
$ 343,244 59 % $ 428,955 76 % $ 414,784 79 %
Residential mortgage-backed and related securities
155,691 26 % 108,854 19 % 83,452 16 %
Municipal securities
90,032 15 % 25,689 5 % 25,991 5 %
Other securities, including held-to-maturity
2,384 0 % 1,731 0 % 1,685 0 %
$ 591,351 100 % $ 565,229 100 % $ 525,912 100 %
Net Unrealized Gains as a % of Amortized Cost
1.7 % 1.4 % 1.3 %
Duration (in years)
2.7 1.8 1.6

The Company has not invested in commercial mortgage-backed securities or pooled trust preferred securities.

See Note 2 for additional information regarding the Company’s investment securities.
45
Part I
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued
Total loans/leases grew $31.0 million, or 3%, in the third quarter of 2012, and grew $42.9 million, or 4%, during the first nine months of 2012.  This marked the sixth consecutive quarter of net loan/lease growth.  The mix of the loan/lease types within the Company’s loan/lease portfolio is presented in the following table.
As of
September 30, 2012
December 31, 2011
September 30, 2011
Amount
%
Amount
%
Amount
%
(dollars in thousands)
Commercial and industrial loans
$ 355,004 29 % $ 350,794 29 % $ 363,998 30 %
Commercial real estate loans
594,904 48 % 577,804 48 % 568,487 48 %
Direct financing leases
102,039 8 % 93,212 8 % 88,893 7 %
Residential real estate loans
112,492 9 % 98,107 8 % 94,073 8 %
Installment and other consumer loans
76,838 6 % 78,223 7 % 79,893 7 %
Total loans/leases
$ 1,241,277 100 % $ 1,198,140 100 % $ 1,195,344 100 %
Plus deferred loan/lease origination costs, net of fees
3,015 2,605 2,238
Less allowance for estimated losses on loans/leases
(19,417 ) (18,789 ) (19,579 )
Net loans/leases
$ 1,224,875 $ 1,181,956 $ 1,178,003
Regarding the Company’s levels of qualified small business lending as defined by Treasury as part of the Company’s participation in SBLF, see the discussion later in this section of the Management’s Discussion and Analysis.

As commercial real estate loans are the largest portfolio segment, management places a strong emphasis on monitoring the composition of the Company’s commercial real estate loan portfolio.  Management tracks the level of owner-occupied commercial real estate loans versus non owner-occupied loans.  Owner-occupied loans are generally considered to have less risk.  As of September 30, 2012 and December 31, 2011, approximately 34% and 29%, respectively, of the commercial real estate loan portfolio was owner-occupied.  The Company’s commercial real estate portfolio grew $17.1 million, or 3%, over the first nine months of 2012.  Further, there was a favorable shift in mix as owner-occupied loans grew $32.0 million, or 19%, while non owner-occupied loans (including commercial construction and land development) declined $14.9 million, or 4%.
46
Part I
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued
Following is a listing of significant industries within the Company’s commercial real estate loan portfolio as of September 30, 2012 and December 31, 2011:
As of September 30, 2012
As of December 31, 2011
Amount
%
Amount
%
(dollars in thousands)
Lessors of Nonresidential Buildings
$ 182,190 31 % $ 179,511 31 %
Lessors of Residential Buildings
49,599 8 % 50,029 9 %
Land Subdivision
28,553 5 % 33,252 6 %
Hotels
27,300 5 % 19,061 3 %
New Car Dealers
26,378 4 % 25,223 4 %
Lessors of Other Real Estate Property
14,638 2 % 15,830 3 %
Other *
266,246 45 % 254,898 44 %
Total Commercial Real Estate Loans
$ 594,904 100 % $ 577,804 100 %

*   “Other” consists of all other industries.  None of these had concentrations greater than $15 million, or 2.5% of total commercial real estate loans.

The Company’s residential real estate loan portfolio consists of the following:

·
Certain loans that do not meet the criteria for sale into the secondary market.  These are often structured as adjustable rate mortgages with maturities ranging from three to seven years to avoid the long-term interest rate risk.
·
A limited amount of 15-year fixed rate residential real estate loans that met certain credit guidelines.

The remaining residential real estate loans originated by the Company were sold on the secondary market to avoid the interest rate risk associated with longer term fixed rate loans.  Loans originated for this purpose were classified as held for sale and are included in the residential real estate loans above.  In addition, the Company has not originated any subprime, Alt-A, no documentation, or stated income residential real estate loans throughout its history.

See Note 3 for additional information regarding the Company’s loan/lease portfolio.

Changes in the allowance for estimated losses on loans/leases for the three and nine months ended September 30, 2012 and 2011 are presented as follows:
Three Months Ended
Nine Months Ended
September 30, 2012
September 30, 2011
September 30, 2012
September 30, 2011
(dollars in thousands)
Balance, beginning
$ 18,725 $ 19,803 $ 18,789 $ 20,365
Provisions charged to expense
1,496 2,457 3,325 5,197
Loans/leases charged off
(1,150 ) (3,104 ) (3,709 ) (6,676 )
Recoveries on loans/leases previously charged off
346 423 1,012 693
Balance, ending
$ 19,417 $ 19,579 $ 19,417 $ 19,579

47
Part I
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued
The allowance for estimated losses on loans/leases was $19.4 million at September 30, 2012 compared to $18.8 million at December 31, 2011 and $19.6 million at September 30, 2011.  The allowance for estimated losses on loans/leases was determined based on factors that included the overall composition of the loan/lease portfolio, types of loans/leases, past loss experience, loan/lease delinquencies, potential substandard and doubtful credits, economic conditions, collateral positions, governmental guarantees and other factors that, in management’s judgment, deserved evaluation. To ensure that an adequate allowance was maintained, provisions were made based on a number of factors, including the increase/decrease in loans/leases and a detailed analysis of the loan/lease portfolio.  The loan/lease portfolio was reviewed and analyzed monthly with specific detailed reviews completed on all loans risk-rated worse than “fair quality” and carrying aggregate exposure in excess of $100 thousand.  The adequacy of the allowance for estimated losses on loans/leases is monitored by the loan review staff and reported to management and the board of directors.

The Company continued to strengthen its core loan portfolio as the levels of criticized and classified loans declined further in the third quarter of 2012, as reported in the following table.
As of
Internally Assigned Risk Rating *
September 30, 2012
December 31, 2011
September 30, 2011
(dollars in thousands)
Special Mention (Rating 6)
$ 21,355 $ 26,034 $ 31,969
Substandard (Rating 7)
49,232 62,712 73,429
Doubtful (Rating 8)
- - -
$ 70,587 $ 88,746 $ 105,398
Criticized Loans **
$ 70,587 $ 88,746 $ 105,398
Classified Loans ***
$ 49,232 $ 62,712 $ 73,429
* Amounts above include the government guaranteed portion, if any.  For the calculation of allowance for estimated losses on loans/leases, the Company assigns internal risk ratings of Pass (Rating 2) for the government guaranteed portion.
** Criticized loans are defined as commercial and industrial and commercial real estate loans with internally assigned risk ratings of 6, 7, or 8, regardless of performance.
*** Classified loans are defined as commercial and industrial and commercial real estate loans with internally assigned risk ratings of 7 or 8, regardless of performance.

The declining trend in criticized and classified loans over the past several years translated to a reduction in nonperforming loans/leases and that trend continued during the third quarter of 2012 as nonperforming loans/leases fell $3.4 million, or 12%.  Furthermore, nonperforming loans/leases have declined $23.4 million, or 50%, from their peak at September 30, 2010.  As a direct result, the level of allowance has declined.  Notably, the decline in nonperforming loans/leases has outpaced the decline in allowance for estimated losses on loans/leases and strengthened the Company’s ratio of allowance to nonperforming loans/leases.  The following table summarizes the trend in allowance as a percentage of gross loans/leases and as a percentage of nonperforming loans/leases as of September 30, 2012, December 31, 2011, and December 31, 2010.
48
Part I
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued
As of
September 30, 2012
December 31, 2011
December 31, 2010
Allowance / Gross Loans/Leases
1.56 % 1.56 % 1.74 %
Allowance / Nonperforming Loans/Leases *
81.10 % 58.70 % 49.49 %
*Nonperforming loan/leases consist of nonaccrual loans/leases, accruing loans/leases past due 90 days or more, and accruing troubled debt restructurings.

Although management believes that the allowance for estimated losses on loans/leases at September 30, 2012 was at a level adequate to absorb losses on existing loans/leases, 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/lease losses in the future.  Unpredictable future events could adversely affect cash flows for both commercial and individual borrowers, which could cause the Company to experience increases in problem assets, delinquencies and losses on loans/leases, and require further increases in the provision.  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.  The Company continually focuses efforts at its subsidiary banks and leasing company with the intention to improve the overall quality of the Company’s loan/lease portfolio.

See Note 3 for additional information regarding the Company’s allowance for estimated losses on loans/leases.

The table below presents the amounts of nonperforming assets.
As of September 30, 2012
As of December 31, 2011
As of September 30, 2011
As of December 31, 2010
(dollars in thousands)
Nonaccrual loans/leases (1) (2)
$ 17,731 $ 18,995 $ 29,006 $ 37,427
Accruing loans/leases past due 90 days or more
203 1,111 333 320
Troubled debt restructures - accruing
6,009 11,904 2,675 3,405
Other real estate owned
5,003 8,386 8,288 8,535
Other repossessed assets
116 109 160 366
$ 29,062 $ 40,505 $ 40,462 $ 50,053
Nonperforming loans/leases to total loans/leases
1.92 % 2.67 % 2.67 % 3.51 %
Nonperforming assets to total loans/leases plus reposessed property
2.33 % 3.35 % 3.35 % 4.24 %
Nonperforming assets to total assets
1.44 % 2.06 % 2.13 % 2.73 %
Texas ratio (3)
18.66 % 25.58 % 25.58 % 33.57 %
(1)
Includes government guaranteed portion of loans, as applicable.
(2)
Includes troubled debt restructurings of $5.7 million at September 30, 2012, $8.6 million at December 31, 2011, $8.6 million at September 30, 2011, and $12.6 million at December 31, 2010.
(3)
Texas Ratio = Nonperforming Assets (excluding Other Repossessed Assets) / Tangible Equity plus Allowance for Estimated Losses on Loans/Leases.  Texas Ratio is a non-GAAP financial measure.  Management included this ratio as this is considered to be a critical metric with which to analyze and evaluate asset quality.  Other companies may calculate this ratio differently.

The large majority of the nonperforming assets consist of nonaccrual loans/leases, accruing troubled debt restructurings, and other real estate owned.  For nonaccrual loans/leases and accruing troubled debt restructurings, management has thoroughly reviewed these loans/leases and has provided specific allowances as appropriate.  Other real estate owned is carried at the fair value less costs to sell.
49
Part I
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued
Nonperforming assets at September 30, 2012 were $29.1 million which is a decline of $11.4 million, or 28%, from December 31, 2011.  Further, nonperforming assets have declined $30.3 million, or 51%, from their peak position of $59.4 million at September 30, 2010.  Most of the decline from December 31, 2011 was the result of improved performance on nonperforming loans ($4.4 million) and sales of other real estate owned ($2.1 million), with the remainder due to charge-offs ($3.7 million) and write-downs of other real estate owned ($1.2 million).

Deposits grew $137.8 million, or 11%, during the first nine months of 2012.  The table below presents the composition of the Company’s deposit portfolio.
As of
September 30, 2012
December 31, 2011
September 30, 2011
(dollars in thousands)
Amount
%
Amount
%
Amount
%
Noninterest bearing demand deposits
$ 417,284 31 % $ 357,184 30 % $ 326,710 27 %
Interest bearing demand deposits
567,578 42 % 510,788 42 % 528,552 44 %
Time deposits
308,083 23 % 292,575 24 % 304,674 25 %
Brokered time deposits
50,290 4 % 44,911 4 % 47,533 4 %
$ 1,343,235 100 % $ 1,205,458 100 % $ 1,207,469 100 %

The Company has been successful in growing its noninterest bearing deposit portfolio over the past few years and this continued into the first nine months of 2012 with an increase of $60.1 million, or 17%. Most of this growth continues to be derived from QCBT’s correspondent banking business.  The continued strength of the noninterest bearing deposit portfolio has provided flexibility to manage down deposit pricing and reduce reliance on higher cost wholesale funds which has helped drive down the Company’s interest expense.
The subsidiary banks offer short-term repurchase agreements to some of their significant customers.  Also, the subsidiary banks purchase federal funds for short-term funding needs from the Federal Reserve Bank or from their correspondent banks.  The table below presents the composition of the Company’s short-term borrowings.
As of
September 30, 2012
December 31, 2011
September 30, 2011
(dollars in thousands)
Overnight repurchase agreements with customers
$ 114,248 $ 110,236 $ 101,886
Federal funds purchased
26,640 103,300 41,700
$ 140,888 $ 213,536 $ 143,586

The Company’s federal funds purchased position was temporarily elevated at December 31, 2011, as a result of short-term fluctuations in noninterest bearing correspondent deposit balances for several customers over the end of the year.
As a result of their memberships in either the FHLB of Des Moines or Chicago, the subsidiary banks have the ability to borrow funds for short or long-term purposes under a variety of programs.  FHLB advances are utilized for loan matching as a hedge against the possibility of rising interest rates, and when these advances provide a less costly or more readily available source of funds than customer deposits.  FHLB advances declined $8.4 million, or 4%, during the first nine months of 2012.
50
Part I
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued

Other borrowings consist largely of structured wholesale repurchase agreements which are utilized as an alternative funding source to FHLB advances and customer deposits.  The table below presents the composition of the Company’s other borrowings.
As of
September 30, 2012
December 31, 2011
September 30, 2011
(dollars in thousands)
Wholesale repurchase agreements
$ 130,000 $ 130,000 $ 135,000
364-day revolving note
5,600 3,600 2,500
Series A subordinated notes
2,638 2,632 2,630
$ 138,238 $ 136,232 $ 140,130
The increase in borrowing on the 364-day revolving note of $2.0 million was the result of funding needed to execute on the partial redemption of the Series F Preferred Stock previously issued to Treasury under the SBLF program.  For a detailed discussion of this partial redemption, see below.

It is management’s intention to continue to reduce the reliance on wholesale funding, including FHLB advances, wholesale structured repurchase agreements, and brokered time deposits.  Replacement of this funding with core deposits helps to reduce interest expense as the wholesale funding tends to be higher funding cost.  The table below presents the maturity schedule including weighted average cost for the Company’s combined wholesale funding portfolio.
September 30, 2012
December 31, 2011
Maturity:
Amount Due
Weighted Average Interest Rate at Quarter-End
Amount Due
Weighted Average Interest Rate at Year-End
(dollar amounts in thousands)
Year ending December 31:
2012
$ 8,000 1.80 % $ 34,601 2.93 %
2013
25,508 1.73 18,000 2.24
2014
39,170 2.88 39,170 2.87
2015
66,000 2.59 67,000 2.97
2016
85,962 3.72 82,890 3.81
2017
46,000 3.70 42,000 3.91
Thereafter
106,000 3.66 96,000 3.75
Total Wholesale Funding
$ 376,640 3.24 $ 379,661 3.41
Importantly, a large portion of the above FHLB advances and wholesale structured repurchase agreements have putable options which allow the lender (FHLB or counterparty), at its discretion, to terminate the borrowing and require the subsidiary banks to repay at predetermined dates prior to the stated maturity.
51
Part I
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued
The table below presents the composition of the Company’s stockholders’ equity, including the common and preferred equity components.
As of
September 30, 2012
December 31, 2011
September 30, 2011
Amount
%
Amount
%
Amount
%
(dollars in thousands)
Common stock
$ 4,984 $ 4,879 $ 4,868
Additional paid in capital - common
25,234 26,381 25,098
Retained earnings
51,078 44,586 43,072
Accumulated other comprehensive income
6,122 4,755 4,173
Noncontrolling interests
146 2,052 1,924
Less:  Treasury stock
(1,606 ) (1,606 ) (1,606 )
Total common stockholders' equity
85,958 62 % 81,047 56 % 77,529 54 %
Preferred stock
55 65 65
Additional paid in capital - preferred
53,108 63,321 65,575
Total preferred stockholders' equity
53,163 38 % 63,386 44 % 65,640 46 %
Total stockholders' equity
$ 139,121 100 % $ 144,433 100 % $ 143,169 100 %
Tangible common equity* / total tangible assets
4.09 % 3.85 % 3.82 %
*Tangible common equity is defined as total common stockholders’ equity excluding equity of noncontrolling interests and excluding goodwill and other intangibles.  This ratio is a non-GAAP financial measure.  Management included this ratio as it is considered by many investors and analysts to be a metric with which to analyze and evaluate the equity composition.  Other companies may calculate this ratio differently.

Stockholders’ equity declined $5.3 million, or 4%, during the first nine months of 2012 as a result of the partial redemption of Series F Preferred Stock.  On June 29, 2012, the Company redeemed $10.2 million of the $40.1 million of outstanding Series F Preferred Stock.  The Company originally issued this preferred capital to Treasury in September of 2011.  Net income of $9.4 million grew retained earnings; however, this was partially offset by declaration of preferred stock dividends totaling $2.7 million ($1.3 million for Series E Preferred Stock, and $1.4 million for Series F Preferred Stock).  As part of the purchase of the 20% noncontrolling interest in m2 Lease Funds, the equity in noncontrolling interest decreased $1.9 million.  In addition, as further discussed in Note 8, the Company’s additional paid-in capital declined $2.1 million for the premium paid on the purchase of the 20% noncontrolling interest in m2 Lease Funds.  Lastly, the available for sale portion of the securities portfolio experienced an increase in fair value for the first nine months of 2012 totaling $1.4 million as a result of declines in certain market interest rates.
52
Part I
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued
The following table presents the details of the preferred stock issued and outstanding as of September 30, 2012.
Date Issued
Aggregate Purchase Price
Stated Dividend Rate
Annual Dividend
Series E Non-Cumulative Convertible Perpetual Preferred Stock
June 2010
$ 25,000,000 7.00 % $ 1,750,000
Series F Non-Cumulative Perpetual Preferred Stock
September 2011
29,867,000 5.00 % 1,493,350
$ 54,867,000 $ 3,243,350
The Series E Preferred Stock is perpetually convertible by the holder into shares of common stock at a per share conversion price of $12.15, subject to anti-dilution adjustments upon the occurrence of certain events.  In addition, the Company can exercise a conversion option on or after the third anniversary of the issue date (June 30, 2013) at the same $12.15 conversion price if the Company’s common stock price equals or exceeds $17.22 for at least 20 trading days in a period of 30 consecutive trading days.

Regarding the Series F Preferred Stock, non-cumulative dividends are payable quarterly, and the dividend rate is based on changes in the level of “Qualified Small Business Lending” or “QSBL” by the Company’s wholly owned bank subsidiaries, QCBT, CRBT and RB&T.  Based upon the change in the banks’ level of QSBL over the baseline level (defined below), the dividend rate remained at 5% through the third quarter of 2012.  With the partial redemption, assuming a 5% dividend rate, the Company’s preferred dividends will be reduced by $511 thousand annually.

As of September 30, 2012, the Company reported its QSBL in accordance with SBLF guidelines and calculated a net decline from the baseline of $68.8 million, or 15%.  SBLF defines the baseline as the average of the Company’s QSBL for the last two quarters of 2009 and the first two quarters of 2010.  As a result of the decline, the dividend rate on the Series F Preferred Stock remains at 5%.  Although the Company continues to experience a net decline in QSBL since the baseline, it continues to support small businesses in its communities.  One example of this support is through its significant participation in the SBA and USDA lending programs.  Notably, for 2011, all three of the subsidiary banks were ranked in the top 10 in their respective states for SBA lending volume.  CRBT was ranked first in the state of Iowa for both SBA and USDA lending volume.  The government guaranteed portions of these loans (typically 70% to 85% of the total principal balance) do not qualify as QSBL, as defined by SBLF guidelines.  Through continued participation in these programs and the efforts of the Company’s experienced small business bankers, the Company is well positioned to continue to support the lending needs of small businesses in the communities it serves.

LIQUIDITY AND CAPITAL RESOURCES

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.  The Company monitors liquidity risk through contingency planning stress testing on a regular basis.  The Company seeks to avoid over concentration of funding sources and to establish and maintain contingent funding facilities that can be drawn upon if normal funding sources become unavailable.  One source of liquidity is cash and short-term assets, such as interest-bearing deposits in other banks and federal funds sold, which totaled $95.7 million at September 30, 2012, an increase over $83.7 million at June 30, 2012, and down slightly from $100.7 million at December 31, 2012.  These levels are approximately 5% of total assets.
53
Part I
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued
The Company has a variety of sources of short-term liquidity available, including federal funds purchased from correspondent banks, FHLB advances, structured wholesale repurchase agreements, brokered certificates of deposit, lines of credit, borrowing at the Federal Reserve Discount Window, sales of securities available for sale, and loan/lease participations or sales.  The Company also generates liquidity from the regular principal payments and prepayments made on its loan/lease portfolio, and on the regular monthly payments on its residential mortgage-backed securities portfolio. At September 30, 2012, the subsidiary banks had 31 lines of credit totaling $301.9 million, of which $52.9 million was secured and $249.0 million was unsecured.  At September 30, 2012, the full $301.9 million was available.  Additionally, the Company has a single $20.0 million secured revolving line of credit with a maturity date of April 1, 2013.  As of September 30 2012, the Company had $14.4 million available as the line of credit carried an outstanding balance of $5.6 million.

Throughout its history, the Company has secured additional capital through various resources, including the issuance of preferred stock (discussed above) and the issuance of trust preferred securities.  Trust preferred securities are reported on the Company’s balance sheet as liabilities, but do qualify for treatment as regulatory capital.

The following table presents the details of the trust preferred securities issued and outstanding as of September 30, 2012.
Name
Date Issued
Amount Issued
Interest Rate
Interest Rate as of 9/30/12
Interest Rate as of 12/31/11
QCR Holdings Statutory Trust II
February 2004
$ 12,372,000
2.85% over 3-month LIBOR
3.31 % 3.22 %
QCR Holdings Statutory Trust III
February 2004
8,248,000
2.85% over 3-month LIBOR
3.31 % 3.22 %
QCR Holdings Statutory Trust IV
May 2005
5,155,000
1.80% over 3-month LIBOR
2.25 % 2.20 %
QCR Holdings Statutory Trust V
February 2006
10,310,000
1.55% over 3-month LIBOR
2.00 % 1.95 %
$ 36,085,000
Weighted Average Rate
2.78 % 2.71 %

54
Part I
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued
The Company (on a consolidated basis) and the subsidiary banks are subject to various regulatory capital requirements administered by the federal banking agencies.  Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company and subsidiary banks’ financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the subsidiary banks must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices.  The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.  Quantitative measures established by regulation to ensure capital adequacy require the Company and the subsidiary banks to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to average assets, each as defined by regulation.  Management believes, as of September 30, 2012 and December 31, 2011, that the Company and the subsidiary banks met all capital adequacy requirements to which they were subject.

Under the regulatory framework for prompt corrective action, to be categorized as “well capitalized,” an institution must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following tables.  The Company and the subsidiary banks’ actual capital amounts and ratios as of September 30, 2012 and December 31, 2011 are also presented in the following table (dollars in thousands).  As of September 30, 2012 and December 31, 2011, the subsidiary banks met the requirements to be “well capitalized”.

Actual
For Capital
Adequacy Purposes
To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
Amount
Ratio
Amount
Ratio
Amount
Ratio
As of September 30, 2012:
Company:
Total risk-based capital
$ 185,396 12.98 % $ 114,294
≥
8.0 % N/A N/A
Tier 1 risk-based capital
164,598 11.52 % 57,147
≥
4.0 N/A N/A
Leverage ratio
164,598 8.12 % 81,078 ≥ 4.0 N/A N/A
Quad City Bank & Trust:
Total risk-based capital
$ 98,164 12.51 % $ 62,795
≥
8.0 % $ 78,493
≥
10.00 %
Tier 1 risk-based capital
90,009 11.47 % 31,397
≥
4.0 47,096
≥
6.00 %
Leverage ratio
90,009 7.76 % 46,409
≥
4.0 58,011
≥
5.00 %
Cedar Rapids Bank & Trust:
Total risk-based capital
$ 53,832 13.17 % $ 32,694
≥
8.0 % $ 49,042
≥
10.00 %
Tier 1 risk-based capital
48,700 11.92 % 16,347
≥
4.0 24,521
≥
6.00 %
Leverage ratio
48,700 8.43 % 23,103
≥
4.0 28,879
≥
5.00 %
Rockford Bank & Trust:
Total risk-based capital
$ 36,428 15.67 % $ 18,593
≥
8.0 % $ 23,241
≥
10.00 %
Tier 1 risk-based capital
33,506 14.42 % 9,296
≥
4.0 13,945
≥
6.00 %
Leverage ratio
33,506 11.19 % 11,972
≥
4.0 14,965
≥
5.00 %

55
Part I
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued
Actual
For Capital
Adequacy Purposes
To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
Amount
Ratio
Amount
Ratio
Amount
Ratio
As of December 31, 2011:
Company:
Total risk-based capital
$ 191,419 13.84 % $ 110,686
≥
8.0 % N/A N/A
Tier 1 risk-based capital
169,360 12.24 % 55,343
≥
4.0 % N/A N/A
Tier 1 leverage
169,360 8.70 % 77,857
≥
4.0 % N/A N/A
Quad City Bank & Trust:
Total risk-based capital
$ 98,382 13.03 % $ 60,391
≥
8.0 % $ 75,488
≥
10.00 %
Tier 1 risk-based capital
90,336 11.97 % 30,195
≥
4.0 45,293
≥
6.00 %
Tier 1 leverage
90,336 8.21 % 44,009
≥
4.0 55,012
≥
5.00 %
Cedar Rapids Bank & Trust:
Total risk-based capital
$ 56,312 14.44 % $ 31,198
≥
8.0 % $ 38,998
≥
10.00 %
Tier 1 risk-based capital
51,415 13.18 % 15,599
≥
4.0 23,399
≥
6.00 %
Tier 1 leverage
51,415 9.02 % 22,807
≥
4.0 28,509
≥
5.00 %
Rockford Bank & Trust:
Total risk-based capital
$ 36,259 15.27 % $ 19,001
≥
8.0 % $ 23,752
≥
10.00 %
Tier 1 risk-based capital
33,277 14.01 % 9,501
≥
4.0 14,251
≥
6.00 %
Tier 1 leverage
33,277 11.31 % 11,770
≥
4.0 14,713
≥
5.00 %
The federal bank regulatory agencies recently issued joint proposed rules that would implement an international capital accord called “Basel III,” developed by the Basel Committee on Banking Supervision, a committee of central banks and bank supervisors.  The proposed rules would apply to all depository organizations in the United States and most of their parent companies and would increase minimum capital ratios, add a new minimum common equity ratio, add a new capital conservation buffer, and would change the risk-weightings of certain assets for the purposes of calculating certain capital ratios.  The proposed changes, if implemented, would be phased in from 2013 through 2019.  The comment period with respect to the proposed rules expired on October 22, 2012.  Various banking associations and industry groups provided comments on the proposed rules to the regulators, and it is unclear when the final rules will be adopted and what changes, if any, may be made to the proposed rules.  Management continues to assess the effect of the proposed rules on the Company and the subsidiary banks’ capital positions and will monitor developments regarding the proposed rules.
56
Part I
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS – continued
SPECIAL NOTE CONCERNING 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,” “project,” “appear,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should,” “likely,” 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.

The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. The factors which could have a material adverse effect on the Company’s operations and future prospects are detailed in the “Risk Factors” section included under Item 1.A. of Part I of the Company’s Form 10-K. In addition to the risk factors described in that section, there are other factors that may impact any public company, including the Company, which could have a material adverse effect on the Company’s operations and future prospects of the Company and its subsidiaries.

These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.
57
Part I
Item 3

QUANTITATIVE AND QUALITATVE DISCUSSION 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 interest income.

In an attempt to manage the Company’s 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.  Internal asset/liability management teams consisting of members of the subsidiary banks’ management meet weekly to manage the mix of assets and liabilities to maximize earnings and liquidity and minimize interest rate and other risks.  Management also reviews the subsidiary banks’ 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 of directors 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 of directors 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 method used to quantify interest rate risk is a short-term earnings at risk summary, which is a detailed and dynamic simulation model used to quantify the estimated exposure of net interest income to sustained interest rate changes.  This simulation model captures the impact of changing interest rates on the interest income received and interest expense paid on all interest sensitive assets and liabilities reflected on the Company’s consolidated balance sheet.  This sensitivity analysis demonstrates net interest income exposure annually over a five-year horizon, assuming no balance sheet growth and various interest rate scenarios including no change in rates; 200, 300, 400, and 500 basis point upward shifts; and a 100 basis point downward shift in interest rates, where interest-bearing assets and liabilities reprice at their earliest possible repricing date.  The model assumes parallel and pro rata shifts in interest rates over a twelve-month period for the 200 basis point upward shift and 100 basis point downward shift.  For the 300 basis point upward shift, the model assumes an instantaneous and parallel upward shift in rates.  For the 400 basis point upward shift, the model assumes a parallel and pro rata shift in interest rates over a twenty-four month period.  For the 500 basis point upward shift, the model assumes a flattening and pro rata shift in interest rates over a twelve-month period where the short-end of the yield curve shifts upward greater than the long-end of the yield curve.  The asset/liability management committee of the board of directors has established policy limits of a 10% decline in net interest income for the 200 and the newly added 300 basis point upward shifts and the 100 basis point downward shift.
58
Part I
Item 3

QUANTITATIVE AND QUALITATVE DISCUSSION ABOUT MARKET RISK
Application of the simulation model analysis at the most recent quarter-end available is presented in the following table.  Please note the simulation model analysis as of September 30, 2012 is not yet available.
NET INTEREST INCOME EXPOSURE in YEAR 1
INTEREST RATE SCENARIO
As of June 30, 2012
As of December 31, 2011
As of December 31, 2010
100 basis point downward shift
-1.3 % -1.5 % -1.9 %
200 basis point upward shift
-2.9 % -3.1 % -3.0 %
300 basis point upward shock
-6.8 % -4.2 % -1.6 %

The simulation is within the board-established policy limit of a 10% decline in net interest income for all three scenarios.

Interest rate risk is considered to be one of the most significant market risks affecting the Company.  For that reason, the Company engages the assistance of a national consulting firm and its risk management system to monitor and control the Company’s interest rate risk exposure.   Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company’s business activities.
59
Part I
Item 4

CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures. An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Exchange Act) as of September 30, 2012.  Based on that evaluation, the Company’s management, including the Chief Executive Officer and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports filed and submitted under the Exchange Act was recorded, processed, summarized and reported as and when required.

Changes in Internal Control over Financial Reporting. There have been no significant changes to the Company’s internal control over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to affect, the Company’s internal control over financial reporting.
60
Part II
QCR HOLDINGS, INC. AND SUBSIDIARIES

PART II - OTHER INFORMATION

Item 1 Legal Proceedings

There are no material pending legal proceedings to which the Company or any of its subsidiaries is a party other than ordinary routine litigation incidental to their respective businesses.

Item 1.A. Risk Factors

There have been no material changes in the risk factors applicable to the Company from those disclosed in Part I, Item 1.A. “Risk Factors,” in the Company’s 2011 Annual Report on Form 10-K.  Please refer to that section of the Company’s Form 10-K for disclosures regarding the risks and uncertainties related to the Company’s business.

Item 2 Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3 Defaults Upon Senior Securities

None

Item 4 Mine Safety Disclosures

Not applicable

Item 5 Other Information

None
61
Part II
QCR HOLDINGS, INC. AND SUBSIDIARIES

PART II - OTHER INFORMATION - continued
Item 6 Exhibits
10.1
Amendment No. 1 to Second Amended and Restated Operating Agreement of m2 Lease Funds, LLC between Quad City Bank & Trust Company and John Engelbrecht dated August 27, 2012.

31.1
Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a).

31.2
Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a).

32.1
Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2
Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of  2002.

101*
Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets as of September 30, 2012 and December 31, 2011; (ii) Consolidated Statements of Income for the three and nine months ended September 30, 2012 and September 30, 2011; (iii) Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2012 and September 30, 2011; (iv) Consolidated Statements of Changes in Stockholders’ Equity for the nine  months ended September 30, 2012 and September 30, 2011; (v) Consolidated Statements of Cash Flows for the nine months ended September 30, 2012 and September 30, 2011; and (vi) Notes to Consolidated Financial Statements.
* As provided in Rule 406T of Regulation S-T, this information shall not be deemed “filed” for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934, or otherwise subject to liability under those sections.

62

SIGNATURES

Pursuant to the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
QCR HOLDINGS, INC.
(Registrant)

Date November 6, 2012
/s/ Douglas M. Hultquist
Douglas M. Hultquist, President
Chief Executive Officer

Date November 6, 2012
/s/ Todd A. Gipple
Todd A. Gipple, Executive Vice President
Chief Operating Officer
Chief Financial Officer
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TABLE OF CONTENTS