QCR Holdings, Inc. (QCRH) Q2 2019 Earnings Report, Transcript and Summary

Good day, and welcome to the QCR Holdings, Incorporated's Second Quarter 2019 Conference Call and Webcast. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Larry Helling, CEO. Please go ahead.

Thank you, Operator. Welcome, ladies and gentlemen, and thank you for taking time to join us today. I will start the call with a brief overview of our second quarter, and Todd Gipple will finish up with additional details on our financial results. We are very pleased with our financial and operating performance for the quarter. We posted record quarterly net income, driven by strong organic loan and deposit growth, record fee income, excellent credit quality, and careful management of noninterest expenses. We successfully deployed our increase in core deposits during the quarter with solid loan and lease production, while maintaining disciplined underwriting. The higher average loan balances, combined with stable net interest margin, enabled us to generate an increase in net interest income from the prior quarter. Additionally, both our core Commercial business and our Specialty Finance Group delivered strong production, which led to a record $7.9 million in swap fee income for the quarter. Second quarter net income was $13.5 million and diluted earnings per share was $0.85, both quarterly highs. Adjusted earnings, excluding acquisition-related costs, were $14.1 million and adjusted diluted EPS was $0.88, a nice increase from the first quarter when we recorded adjusted earnings of $13 million and adjusted earnings per share of $0.82. On a year-over-year basis, our adjusted earnings for the quarter were up 29%. Our annualized loan growth was 11.7% during the second quarter, showing strong momentum from the first quarter. Year-to-date, we have produced an annualized growth rate of 9.5%, which when combined with our healthy pipelines, gives us confidence that we are on track to be at the upper end of our targeted loan growth range of between 8% and 10% for the full year. Our loan growth for the quarter was driven by strong broad-based demand for C&I, commercial real estate and construction loans across all of our charters. Production was driven by both our core commercial lending business as well as our Specialty Finance Group. We also experienced another quarter of more normalized payoffs, which were up modestly from the first quarter and relatively flat with the second quarter of 2018. While the competition for new loans continues to be high, we remain focused and disciplined in our origination and underwriting efforts and continue to grow loans organically by attracting customers that value our relationship-based community banking model. Our loan and lease growth was funded by strong core deposit growth. We continue to put a significant focus on core deposit gathering across our entire footprint. As a result, we reduced our reliance on wholesale funding down to 10% of total assets, a meaningful improvement from 12% in the first quarter. Core deposits, which we define as total deposits, excluding broker deposits, increased by $160 million or 4.1% on a linked-quarter basis. Broker deposits declined by $31 million in the quarter. Going forward, our goal remains funding our loan and lease growth with core deposit growth. However, we don't want to turn down the opportunity to bring attractive and high-quality loans on to the balance sheet. So we may choose to temporarily fund them with short-term borrowings. Despite robust competition for both loans and deposits, and the industry-wide pressure that has been put on pricing, we are pleased to have generated a stable net interest margin for the second quarter, which helped to contribute to our increased profitability. Todd will go into more detail on our NIM during his portion of the call. We continue to be very pleased with the performance of our noninterest income, which in the second quarter reached a record $17.1 million, up from $12 million in the first quarter. The increase was primarily driven by $4.7 million increase in swap fee income due to the strong production from our Commercial and Specialty Finance Group. Wealth Management revenue was $4.2 million during the quarter, comparable to the first quarter of 2019, which is generally higher due to the tax return preparation fees and other seasonal items. For the first half of the year, Wealth Management revenue grew by 34% year-over-year, driven mainly by increased assets under management. We continue to win new clients and our existing client retention remains high. We are encouraged by this growth as these fees help drive our earnings improvement and provide important diversification in our revenue mix without requiring additional capital. Finally, our asset quality continues to improve as we are not seeing any credit degradation in any of our portfolios. That being said, we did record a write-down this quarter as a result of reducing the carrying value of an existing OREO property that we are in the process of marketing for sale. Todd will provide more detail on this and other credit metrics. One thing that I would like to point out is that even though our franchises are all located here in the Midwest, we have virtually no direct exposure to the production agricultural sector. Approximately 90% of our loan and lease portfolio is in C&I or commercial real estate, and we feel very good about the credit quality of these portfolios. In summary, we are very encouraged by this quarter's performance and remain optimistic about the remainder of the year. As most of you know, I recently took over as CEO, and it's nice to start off strong. As I mentioned on last quarter's call, I'm excited to work closely with Todd and the rest of the senior management team to continue building upon the successful legacy that has been created over the past 25 years. We remain committed to pursuing the key initiatives that we have shared with you over the last several years, with the overwriting goal of delivering attractive results and increased shareholder value. I will now turn the call over to Todd for further discussion on our second quarter results.

Thank you, Larry. As I review our second quarter financial results, I'm just going to focus on those items where some additional discussion is warranted. I'll start with net interest margin, as we've worked very hard to stabilize and protect our NIM and those efforts paid off this quarter. Adjusted net interest margin, stripping out the acquisition accounting net accretion, remained static at 3.31% during the quarter when compared to the first quarter. Excluding the acquisition accounting net accretion and on a tax equivalent basis, our net interest income increased by $1.1 million or 3% on a linked-quarter basis as we had higher average loan balances and realized improved yields in our loan portfolio. This was offset by slightly higher funding costs driven by higher average rates paid and a change in the mix of our funding sources. Acquisition accounting net accretion was consistent on a linked-quarter basis at $1.1 million. We have proactively focused on initiatives to stabilize and improve NIM. These include reducing rates on some of our most rate-sensitive deposit products, gathering more core deposits in order to lessen our reliance on wholesale funding, and maintaining our pricing discipline on new loan production. As Larry mentioned, the competition for new loans is strong, yet even in this market environment we have been able to grow our loan portfolio and bring on new loans at attractive rates. Additionally, we feel that we are well positioned to benefit from a flat to even slightly down short-term interest rate environment as our balance sheet is modestly liability sensitive. Therefore, we are guiding to a continued static NIM in the third quarter. Now turning to our noninterest income results. As Larry mentioned, we are very pleased with the growth in our noninterest income during the quarter, which was mainly driven by record spot fees. Our spot fee income and gains on the sale of government guaranteed loans has averaged just under $5 million per quarter for the last 4 quarters, including a couple of outsized quarters. As we've indicated in the past, variability in these items will occur from quarter-to-quarter. Our current expectation is that for the remainder of 2019, this fee income source will be in a range of between $8 million and $9 million for the 6-month period. On the expense side, we remain focused on controlling expenses and improving our efficiency ratio. While our reported expense number came in at $36.6 million for the quarter, there were 3 noncore items that impacted the expenses. First, we incurred post-acquisition and conversion related cost of $708,000; second, we recorded a $1 million write-down on the OREO property that Larry mentioned; and third, we had an additional $2.5 million of bonus and commission expense, driven by the higher than anticipated fee income and strong year-to-date net income. Excluding these three line items, our noninterest expense came in at $32.4 million in the middle of the guidance range of $32 million to $33 million we provided on last quarter's earnings call. Our asset quality continues to be excellent with no material additions to NPAs in the second quarter. Additionally, we are seeing no early indications of credit deterioration as criticized and classified loans decreased $7.6 million from the first quarter. Our nonperforming assets declined by $3.2 million from the first quarter, primarily due to the $1 million other real estate write-down and $2.2 million in charge-offs for the quarter. Our loan-loss provision decreased on the linked-quarter basis primarily due to improved credit quality. As I mentioned, we further wrote down an existing OREO property that we have been marketing for sale. We remain committed to facilitating a sale of the property in this calendar year, and while we have had some activity and interest, we have not yet arranged for a sale. As a result, we wrote down its carrying value as we continue to try and move the property off our books. The last thing I want to mention is that our effective tax rate for the quarter came in at 18.5%. There were not any one-time items impacting this rate. However, it was slightly elevated due to the high fee income, which changed our mix with taxable versus nontaxable income. We expect that our tax rate for the third and fourth quarters will be in the range of 16% to 18%, not including the beneficial impact of stock options and RSAs. With that added color on our second quarter financial results, let's open up the call for your questions. Operator, we're ready for our first question.

[Operator Instructions]. Our first question today comes from Jeff Rulis with D.A. Davidson.

Todd, just wanted to circle back. It's sort of interrelated expense and swap income. I guess you provided some guidance on expense last quarter. Any thoughts on the third or fourth quarter?

Sure. I would really expect, Jeff, for us to be in that range of $32 million to $33 million, all in. That number will jump a bit if we were to have some outsized swap fees that move that number up a fair amount in Q2. But we're still feeling pretty comfortable with a core run rate of $32 million to $33 million.

So that was -- you touched on my -- just a follow-up question would be, right, if you're kind of guiding to $8 million to $9 million in fee income from -- I presume that's strictly swap or I guess you're coupling that both with loan sale as well.

Correct. The $8 million to $9 million for the last 6 months is really a combination of both. So say $4 million to $5 million a quarter, if it was in that $4.5 million range, we would expect expenses to be in the $32 million to $33 million range. If we were have an outsized quarter, then of course the noninterest expense might ramp that for commissions and other things related to that outsized fee income.

Okay. And just to clarify on the -- I mean, great color on the swap outlook, but is that a big quarter in the second quarter, does that not -- does that cannibalize kind of future performance? Or it's simply execution within any given quarter, that number could be volatile and a big quarter previously doesn't necessarily mean that steals from quarter following, in other words?

Yes. This is Larry. That was -- because it's a relatively small number of large transactions, due to timing, can move meaningful dollars between quarters, but I -- it certainly falls short of saying there's a correlation that we had a huge quarter this quarter and that next quarter's going to be smaller. I don't know if that's real because we're only getting started in the next quarter. It will depend on which transactions ultimately gets closed during the third quarter now. So unfortunately, not a real simple correlation because of the number of transactions.

Yes. Okay. I appreciate the color there. And maybe for, well, Larry or Todd, I guess you've been removed from an M&A acquisition for some time. You spoke on the maybe indirect, I guess, perceived credit strain in the region or ag strain I should say. Just kind of updating us on your M&A thoughts. I mean, weary of buying someone else's problems this late in the cycle, but still good conversations out there. How's the temperature on M&A from your perspective?

Well, on the M&A side as you know, certainly, activity level is a little bit lighter. Basically, probably the biggest issue is the seller's expectations of value relative to that multiple these days. We remain committed to our current shareholders and making sure we're doing something that's fair to them. And you're right, our credit quality feels really good right now, and we'd certainly be cautious about buying someone else's problems, but certainly still open in certain situations through the right opportunity.

Our next question comes from Damon DelMonte with KBW.

First question, Todd, on the margin. Can you give a little guidance on your expectation for accretable yield? The first 2 quarters of this year you said were consistent at $1.1 million. Does that trail off a bit?

Actually, that was right on top of schedule for budgeted accretion, Damon. And right now, that number still remains at about $1.1 million. We've got roughly $9.3 million in the remaining discount, really don't see a downward trend there in terms of run rate until we probably get into 2020, after a little bit more runoff. But scheduled is right on top of Q1 and Q2, another $1.1 million. So very consistent this year versus prior years we've had. Some pretty big swings on that.

Okay. And just to reiterate, you feel comfortable that you can kind of keep the margin steady given your liability sensitivity?

Yes. We do. And we have worked pretty hard to get to a fairly neutral balance sheet, but we do still have some modest liability sensitivity. We are very well prepared for a coming rate cut if one does happen, and we worked hard to put ourselves in a position to get at least 100 beta on rates down. So we're going to work really hard to take advantage of those cuts on the right side of the balance sheet. We are well prepared for that already. We actually do have a little bit of continued excess liquidity, loan-to-deposit ratio is just a touch over 90% at the end of Q2. It was close to 94% at the end of the calendar year. So we actually had a static margin near Q2 even though we did carry a fair amount of excess liquidity. The big wild card, of course, is what the Fed actually does here at the end of the month and maybe, more importantly, the language they use. As the market gets ahead of the cuts, and so I think everyone's wondering what the language was going to be for any continued cuts during the year, and then the impact that might have on LIBOR, treasury, FHLB rates. So we feel very bullish about margin and feel comfortable batting to a static one.

Okay. Great. And then, obviously, credit trends this quarter were pretty strong. How are you thinking about the provision for the back half of the year? Do you have an estimated range?

Yes. I'll let Todd speak to specific dollars, but certainly, probably, steady would be our mindset there, just normal provisions for normal growth, and the normal kind of things that happen at a credit portfolio on a quarterly basis.

Yes. So as a result, Damon, that would probably be in a range of $1.7 million to $2 million.

Okay. All right. Great. And then, I guess just lastly, are you guys fully integrated with the Springfield Bancshares deal? And can you just give an update on how those operations are doing right now?

Would love to, Damon. Actually, just spent the last 2 days down with the team in Springfield, and our conversion is scheduled for the middle of next month. So that team is working really, really hard on integration and conversion, incredibly hard. And what I'm very pleased, it really is a testament to the quality of that team. They've been working on that for last several quarters leading up to the conversion, and they posted a 1.37% ROA last quarter. Loans were up 19%. Deposits were up 24%. So while they do have all of that work going on, the team is still really doing a super job with loan and deposit growth and serving new clients. So could not be more pleased. We'll get some synergies after that conversion. Those would primarily be efficient fees related to some of the cost on data processing and some of the other overhead issues. But extremely pleased with the performance of the Springfield team. Couldn't say enough good things about how hard they are working.

Our next question comes from Nathan Race with Piper Jaffray.

Todd, I was hoping to just drill down on your record NIM outlook a bit more, and I appreciate your previous commentary. But I was just kind of curious where you guys are putting new loans on the books relative to the portfolio yield that's around 4.94 today on a core basis.

Yes, Nate. We continue to, for the most part have an average new loan rate that starts with a five. That is coming under pressure, as you might guess. So far, so good. We're still holding on to that. So you're seeing a small uptick in total loan yields as a result of new loans coming on with the 5 handle. That's some of the uncertainty I spoke about in terms of Fed language and what the market's reaction is to that. But so far, so good on loan pricing. And we are, as I mentioned earlier, well prepared to take advantage of any cut on the right side of the balance sheet.

Got it. And I guess along those lines, in terms of thinking about the impact of a Fed cut here in July. Curious, I mean, do you expect it to be a loss, essentially? Is that kind of what we're hearing?

Yes. I think in our guidance to static margin for Q3, we're expecting that the Fed does not surprise, I think, it's a 75% likelihood now over the quarter and 25% -- might be more. But if it were to be a quarter, and the market digest that and the language is fairly stable from the Fed, we expect that should help us with the static outlook on deposits.

Okay. Got it. And I'd just be curious to get an update on core deposit growth. Obviously, really impressive broad-based growth across the various banks with maybe the exception of Quad Cities. So just curious if you guys expect loan growth to keep pace with core deposits? Or if you guys kind of expect core deposit growth to lag a little bit and kind of grow into the excess liquidity that you guys have put on the balance sheet over the last few quarters now.

Yes. We have excess liquidity in Q1. We thought we may burn that up a bit in Q2, and we did have strong loan growth, but deposit growth was right on pace with it and that's a good thing. And we're going to continue to stay very focused on core deposit gathering. You know that it may provide a little bit up pressure on margin short term, but we are factoring that in to our guidance going forward, that we're going to continue core deposits. And we like where we settled in, the reliance on wholesale of about 10%. That's -- anything under 15% is pretty good for us. Getting it down to 10% is probably as high as we'll get it to, but anywhere in that 10%, 11%, 12%, and everything else being core deposit. That's very good for all of our charters.

Our next question comes from Daniel Cardenas with Raymond James.

Just maybe a couple of questions. As we think about loan growth on a forward-looking basis, do you kind of expect that growth to be kind of footprint-wide? Or does Missouri or Iowa hold kind of a bigger opportunity for growth for you guys.

Yes. Fortunately, I would say our growth prospects, I think, are pretty broad-based. Certainly our team in Springfield is our newest charter, had really done a nice job building into some scale under that marketplace. But we feel good, really, about the opportunities in each of our markets. The kind of markets we're in, these kind of midsized second and third tier cities in the Midwest, I think, have been pretty stable. So that bodes well for just our normal activity. And so we feel good about it. And then our specialty group is, because of the niches they serve, we believe that that's pretty recession-resistant. And so the kind of numbers we produce so far year-to-date are really just a continuation of what we've done, really, over many, many years.

Okay. And I know credit metrics are good right now, and it doesn't sound like you're overly concerned about anything near term, but are there any segments that maybe you're tapping the brakes on at the moment? Just kind of given a good, but maybe slow economy?

Yes. To tap on the brakes, the one thing that we pointed out, specifically, is because we're in the Midwest, people have always assumed we've got a lot of production ag lending, which we do almost none of. And so that wasn't tapping the brakes, that's just something we made up. Deliberate decision on 15 or 20 years ago that we didn't want to do that business for various reasons. The other part, certainly, in the commercial real estate space, the retail world and commercial real estate is changing. So we backed away years ago from the big box space because of what's going on just not necessarily -- I mean, there's a seachange going on in the way that world looks. And so we've been very cautious in that space. Now if it's a little neighborhood strip shopping center or something, that will probably still be fine because we haven't figured out that people are still going to pick up their Hobie sandwiches on a different spot than a strip shopping center, or something like that. So that -- we've been cautious there, and I think that will prove to be a good decision.

Okay. All right. And then maybe on deposit competition. Have you noticed a slowdown in Q2 and currently in Q3? Or is it still kind of been uber-competitive in your footprint?

No. My broad comment would be, it's at a little less activity, chasing the marginal deposits out there. So that feels good. It should allow us to be able to push our rates down, to pick with the Fed in those rates. So I would say it's softened a little. While our loan totals have grown really nicely, I think that's probably different than most of our competitors in some of the early press releases I've seen. Softness in loan totals is something that others have experienced. If that's true kind of broadly, that may help us on the depositing side because the demand won't be as great.

Great. And then, last question for me, kind of going back to the margin. So good to hear that, that 25 basis point cut is not going to really impact the margin in 3Q. But beyond that, would an additional 25 basis point cut in Q4 have the same effect? Or would that, perhaps, put some pressure on the margin?

Dan, I think we're pretty well adjusting for cuts, at least provide a static margin, if not, a little bit of a nice tailwind for us. So we're not overly concerned about Fed cuts. We feel like, compared to our peer group, we're probably better positioned for that just as we may have suffered a little harder and a little earlier than some of our peers on lease up. We feel like we're well positioned to take advantage of cuts and feel very good about that longer term.

Yes. Dan, additionally, I'd say when we get to 50 basis points down, as you know, we've got a lot of floating rate commercial prime-based loans will start bumping up against the floor to that point, and it actually could help us when we get to that spot.

[Operator Instructions]. Our next question comes from Evan Lisle with Janney Montgomery Scott.

This is Evan on for Brian Martin. Just a quick question on your Specialty Finance Group. How hard is that book today? And what type of growth do you see for the next 12 to 24 months?

Okay. The book on the deferred tax credit loan from tax credit side is a couple of hundred million. And so it's meaningful, but not certainly outsized relative to the size of our balance sheet. The direct municipal side, where we've done some lending there is probably in the couple of hundred million dollar range. And so those have been really steady and we expect that growth to kind of grow at least at the pace of our historic growth rates for our entire portfolio. So we expect that mix of our full assets to remain fairly steady and maybe go up slightly over the next couple of years.

Okay. Awesome. And then just following up. Can you give an outlook for your purchase accounting accretion?

Sure. We've got $9.3 million remaining in discount, and the actual accretion in Q1 was $1.1 million; Q2, that's the most recent quarter, was also $1.1 million; and scheduled in Q3 is another $1.1 million. So it's really flattened out and much more consistent this year. I don't really see -- see that failing of from scheduled perspective until we get into 2020.

Our next question is a follow-up from Jeff Rulis with D.A. Davidson.

Just, I guess you spoke on, Todd, about the swap income quite a bit. I guess for the full year, you're almost doubling the prior guidance from the beginning of the year. Any initial thoughts as you've clearly been executing pretty well on that front on 2020? I know that you don't want to get ahead of yourselves, but is it $8 million to $9 million for '19, is that extended maybe append that in '20?

Yes. Jeff, you said it best when you said we don't want to get ahead of ourselves. So we feel really good about the $8 million to $9 million for the rest of this year. As we articulated in our opening comments, it was a simple as taking the last 4 quarters and getting an average, realizing we had a couple of outsized quarters in there. That gets us to that $4.5 million, and so as a result, that $8 million to $9 million range. I think it's quite likely we're not going to be guiding in 2020 to $8 million to $12 million because we're going to beat that quite handily. And as Larry articulated, we feel very good about that pipeline. So I think for 2020, I hate to do this, Jeff, but we're probably going to wait and see what Q3 brings, and then for the first time, talk a little bit more about 2020. I know that doesn't help you with your models yet for next year, but I think it's safe to say that it would be more to $12 million. Just how far north of that, we probably want to get one more quarter behind us, if that's okay.

And just understand, Jeff, certainly, the interest rate environment has a lot to do with the ability to price into those swap and this interest rate environment is particularly attractive time, given low flat yield curve to be able to execute well on these. So that could have some impact over time, but if you can tell me what interest rates are going to do next year and what the yield curve is going to look like, we've come a lot closer.

This concludes our question-and-answer session. I would like to turn the conference back over to Larry Helling for any closing remarks.

Okay. Thanks to all of you that joined us today. We look forward to speaking with you all again soon. Thanks, and have a great day.

The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect.