QCR Holdings, Inc. (QCRH) Q4 2021 Earnings Report, Transcript and Summary

Good day, and welcome to the QCR Holdings Inc Fourth Quarter 2021 Financial Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After todays presentation there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mr. Larry Helling, CEO. Please go ahead, sir.

Thank you, operator. Welcome, ladies and gentlemen, and thank you for taking the time to join us today. I will start the call with a brief discussion regarding our full year performance. Todd will follow with additional details on our financial results for the fourth quarter. We are very pleased with our financial performance in the fourth quarter and for the full year, highlighted by record net income and earnings per share. Our 2021 record results were driven by robust loan growth and expanded net interest margin, solid fee income, carefully managed expenses and excellent credit quality. Our adjusted net income increased 58% for the year and diluted EPS by 63%. We grew our tangible book value per share by nearly $6 and to just over $38 per share, representing 18% year-over-year growth. Additionally, we strengthened our capital ratios in 2021 with our tangible common equity to tangible assets ratio improving by 82 basis points to 9.87% at year-end. We experienced healthy demand from our client base and grew loans by nearly 17% when excluding PPP loans. We capitalized on strengthening economic conditions in our markets and continue to gain market share across our charters. Our clients value our local charter model, which is reflected in our robust growth in both loans and deposits. Our Specialty Finance Group had another outstanding year generating strong production in our niche lending products. Additionally, our traditional lending business finished the year strong with fourth quarter annualized loan growth of 8%, accelerating the trend that we began to see in the third quarter. Our loan pipelines remain healthy, and our near-term outlook for loan growth remains positive. Therefore, we are targeting organic loan growth of between 8% and 10% for the full year 2022, consistent with our long-term goals. We funded our loan growth in 2021 with core deposits and excess liquidity that we were carrying on the balance sheet as we began the year. Core deposits grew by 7% for the year, with strong contributions from our core commercial and correspondent banking clients. In addition, the composition of those deposits continued to improve as noninterest-bearing demand deposits increased by nearly 11% year-over-year, while interest-bearing demand deposits grew by over 8%. Additionally, we successfully protected our net interest margin in 2021, which was up 9 basis points for the year on an adjusted basis despite the challenging interest rate environment. Our balance sheet initiatives paid off as we constructed a more efficient balance sheet, combined with strong loan growth funded with core deposits and utilization of excess liquidity. We successfully drove down our interest cost by significantly increasing noninterest-bearing deposits and capitalizing on favourable deposit repricing opportunities. We had another year of solid revenue generation with strong contributions from both net interest income and fee-based income, which adds diversity to our revenue stream. We are particularly proud of our wealth management group, which grew assets under management by 23% in 2021. This team added more than 1,000 relationships over the past 3 years. Our asset quality and credit metrics improved significantly during the year and remain extremely strong. Nonperforming assets improved 80% over the course of the year to just $2.8 million at year-end and represents a record low of 5 basis points of total assets. We had minimal net charge-offs during the year, and we feel very good about our current reserve level, which when excluding PPP loans, is 1.69%. Our excellent credit quality is a function of our disciplined and consistent underwriting along with improving economic conditions across our markets. Before turning the call over to Todd, I would like to provide an update on our anticipated acquisition of Guaranty Federal Bancshares. We are excited about this transaction as it will significantly enhance our market position in the vibrant Springfield and Southwest Missouri markets. Guaranty Bank has a deep-rooted and prominent brand, a long history of profitable growth and a talented team of bankers. Guaranty is also known for its commitment to exceptional client service and relationship banking, including outstanding community support. We share these same values, making the combination a natural fit. Bringing the 2 teams together from both banks will enable us to extend our high-performing and profitable niche business lines into those markets, serve our combined client base more effectively, accelerate our earnings growth and improve shareholder returns. We expect this transaction to close early in the second quarter and look forward to welcoming the Guaranty Bank to the team. In conclusion, I would like to thank the entire QCR Holdings team for their hard work and dedication to outstanding client service and for delivering record earnings performance for the year. Our employees are the heart of our company, and I am proud of all they have accomplished in 2021. With that, I will turn the call over to Todd to provide further information about our fourth quarter results.

Thank you, Larry. Good morning, everyone. Thanks for joining us today. As I review our fourth quarter financial results, I will focus on those items where some additional discussion is warranted. . Let's start with net interest income. Our adjusted net interest income for the quarter was a record $49.2 million and up $744,000 or 1.5% from our previous record set in the third quarter. This strong performance was due to the continued strong loan and lease growth that Larry discussed as well as our ability to protect our net interest margin in this challenging interest rate environment. We funded our robust loan and lease growth during the quarter with a combination of core deposit growth and excess liquidity. Core deposits increased $52 million during the quarter, driven by a $72 million increase in non-maturity deposits, partially offset by a $20 million decrease in time deposits. We continue to intentionally rotate out of higher cost CD balances and improve the mix of our deposit base. While the cost of our total interest-bearing deposits improved a modest 1 basis point from the third quarter, for the full year, we created a 26 basis point improvement. These lower deposit costs have helped us protect and actually expand our net interest margin during 2021. While adjusted NIM compressed by 4 basis points this quarter, we were able to improve NIM by 9 basis points for the full year. The quarterly decline in adjusted NIM was closer to 2 basis points after excluding the impact of lower PPP income and elevated excess liquidity, matching our guidance for the quarter. We had elevated liquidity during much of the quarter, driven by strong seasonal deposit growth with the majority of our strong loan growth occurring in December. We are very pleased with our NIM performance throughout 2021. We have been successful in holding on to earning asset yields while driving down our cost of funds. As we near a potential rising rate environment, our ability to further drive down our cost of funds has diminished and we continue to experience loan pricing pressure. Therefore, we do expect some modest NIM compression in the first quarter with adjusted NIM expected to decline in the range of 2 basis points to 4 basis points. That being said, we are well positioned for rising rates as our balance sheet is solidly asset-sensitive. Now turning to our noninterest income of $23 million for the quarter, which was lower than the near-record noninterest income of $34.7 million we generated in the third quarter. We produced capital markets revenue from swap fees of $13 million, slightly below the lower end of our guidance range of $14 million. Our full year swap revenue was $61 million, averaging just over $15 million per quarter and within our guidance range. Over the last 8 quarters, capital markets revenue from swap fees has averaged $17 million, which gives us continued confidence in the sustainability of this important source of fee income and supports our reaffirmed guidance range of $14 million to $18 million per quarter. We continue to expect strong sustainable levels of swap production based on the demand we are seeing from the relationships within our Specialty Finance Group as well as in our traditional commercial lending business. Many of our clients continue to lock in attractive fixed long-term rates by converting their variable rate loans through the use of swaps. Now turning to our expenses. Noninterest expense for the fourth quarter totaled $39.4 million compared to $41.4 million for the third quarter and within our guidance range of $38 million to $40 million. The linked quarter improvement was primarily due to lower incentive-based salary and benefits expense of $3.4 million as a result of a decrease in capital markets revenue. Partially offsetting this decrease was a $584,000 increase in advertising and marketing and a $624,000 increase in acquisition costs. For the year, we are pleased with our overall cost control as noninterest expenses increased by just 1.3% year-over-year, well within our long-term goal of keeping expense growth below 5% per year. While we will remain disciplined in managing our operating expenses, like many other companies, we are experiencing some upward pressure in compensation and other direct costs. However, we still believe that we will be able to keep our annual expense growth below 5%. Looking ahead to the first quarter, we anticipate that our level of noninterest expense will be in a range of $39 million to $41 million. Our overall asset quality continues to be quite strong. Nonperforming assets improved by 60% for the quarter and 80% for the year. And as Larry mentioned, now represent only 5 basis points of total assets, 20 basis points lower than 1 year ago. The linked quarter improvement was primarily due to the payoff of one nonaccrual loan during the quarter. Additionally, we recorded a $3.2 million negative provision for credit losses in the fourth quarter, primarily due to continued strong asset quality and a corresponding reduction in the qualitative factor related to the pandemic. Our allowance for credit losses, excluding the impact of the remaining $28 million in PPP loans, was 1.69% to total loans and leases, down 10 basis points from the end of September. This allowance now represents over 28x our nonperforming assets. With respect to capital, we continue to grow our strong capital levels as our tangible common equity to tangible assets ratio improved to 9.87% at year-end compared to 9.54% at the end of September. Finally, our effective tax rate for the quarter was 18.9% and 18.6% for the full year. The rate was slightly lower on a linked-quarter basis due to a lower ratio of taxable earnings to tax-exempt revenue in the fourth quarter. We are very pleased with our 2021 financial performance that resulted in a 63% increase in earnings per share and a $6 increase in tangible book value per share. We are well positioned both financially and strategically to continue to grow tangible book value and produce strong earnings per share. With that added context on our fourth quarter and full year financial results, let's open up the call for your questions. Operator, we're ready for our first question.

[Operator Instructions] And the first question will come from Nathan Race with Piper Sandler. Please go ahead.

Hoping to just expand on the outlook for capital markets and swap revenue for this year. I appreciate that the guidance range is unchanged. I guess just curious to get some color in terms of how you guys expect this revenue source to respond as the Fed raises short-term rates just in terms of thinking about the overall durability of this revenue line over varied interest rate environments? .

Yes, Nate, great question. Certainly, as you know here, the amount of fee income is a little more variable on a quarter-to-quarter basis than we would prefer. It's kind of the nature of the business. These are clients that want fixed rate loans for long-term transactions. And so the interest rates may have some marginal impact on it, but there are still transactions for us to do. Todd and I met with the two people that managed this business for us just yesterday and try to get a sense for how they were feeling about things. And the headwinds that probably are facing this niche in the business and any business right now that build buildings is the supply chain and inflation. It will create a little bit of uncertainty about the capital stack needed to put these deals together. So that's probably why there's a little bit more delay on some of these things because of the changes that are going on in the economy, not so much affected by the interest rate because we'd expect that impact to be modest on this business. So again, we reaffirmed our guidance because we feel confident in the business and we delved into that just yesterday and still feel good about 2022.

Changing gears a little bit. Maybe, Todd, I appreciate the margin guidance for the first quarter this year. But maybe looking out to the back half of this year, assuming the Fed actually does raise short-term rates a couple of times before the end of the year. How are you thinking the margin will respond thereafter just based on all the core deposit gathering that you guys have held or have gathered over the last several quarters and been able to run off, I imagine some higher rate-sensitive deposits in the process? So I would just love to get some color just in terms of how you're thinking about the margin responding to the first couple hikes later this year, presumably?

We are feeling very good about where our balance sheet sits with respect to asset sensitivity. We've got roughly $2.1 billion in RSAs, $1.3 billion in RSLs, so about $800 million of net asset sensitivity. We've run the modeling. And with the 25 basis point hike, that would provide somewhere between $2 million and $2.2 million of additional NII dollars for an annual number and roughly 4 or 5 basis points of margin expansion. And that's per 25 basis point rate hike. Of course, that assumes no significant negative trajectory in terms of curve inversion or anything like that. But we feel very bullish about how our balance sheet will perform and impact on NII dollars and NIM percentage with 25 basis point rate hikes.

And I assume that contemplates lower deposit betas due the first few rate hikes than what we saw coming out of the gates in 2015 and into '16 and '17?

It actually -- those numbers are relatively conservative with respect to deposit beta performance. We would like to see some very good performance on deposit betas on the way up. Certainly, all the excess liquidity in the market, and for us, will allow us to be a little more diligent there and hold the line on deposit betas. So we're feeling pretty good about our opportunities there as well.

And then just maybe one last one and then I'll step back. Just on the tax rate for this year. Is it safe to assume it's going to be at a similar level from what we saw in '21 within the context of capital markets and swap revenue remaining kind of within the guidance range on a kind of average quarterly basis going forward?

Yes, I would expect somewhere in the 18 to 19 range just as we performed throughout the year.

The next question will come from Daniel Tamayo with Raymond James. Please go ahead.

Maybe we just dig into the loan growth a little bit, certainly a nice quarter in the fourth quarter, but just wanted to see how you're thinking about or what the pipeline looks like at the end of the year and how you're thinking about growth going forward in 2022?

Yes. First off to talking to our bank presidents in several of our locations in the last 48 hours, and the pipelines appear to be improving. The other positive factor going on is line of credit utilization is not back to pre-pandemic levels yet, but our clients are starting to burn through some of that excess liquidity that was created by PPP. And so we are starting to see some elevated line usage, but certainly more runway there. So we feel certainly comfortable with our 8% to 10% guidance range on growth as we look forward for 2022.

And then as we think about kind of overall balance sheet growth may be impacted by deposits, you've certainly remixed the deposit base and just talk about how that's going to impact the asset sensitivity. But as we think about the impact of the correspondent banking relationships and the associated deposits there, how are you budgeting for or thinking about overall deposit growth? Or if it's easier, just overall asset growth for the year, earning asset growth.

Yes, Daniel, I'll take that one. We feel like we're going to be able to grow in that 8% to 10% range on loans. We certainly expect to continue to be able to fund that with core deposit growth and not have to dip back into wholesale funding. We're feeling very good about the progress we made on funding everything with core deposits and really getting almost entirely out of wholesale funding. We still have a tremendous amount of off-balance sheet liquidity available to us in the correspondent banking business at year-end. We had noninterest-bearing from correspondent of around $340 million, money market interest-bearing about $220 million and about $1.3 billion in off-balance sheet in EBA. So again, that just-in-time inventory of deposits is available to us. That $1.3 billion has actually grown inter-quarter, stands at about $1.7 billion right now. So we feel very good about our ability to fund our strong loan growth with core deposits. And as a result, that makes us optimistic about go-forward margin with some rate hikes.

So I guess another way of saying, but the securities portfolio has been relatively flat over the last year or so, you'd expect that to continue then? .

Yes, that would be my expectation.

The next question will come from Brian Martin with Janney Montgomery. Please go ahead.

I just wondered, can you just talk a little bit about the, I guess, kind of the step down, if you will, in loan growth going from the 17 to 10 and just kind of understanding, certainly, 17 is a great number. But just kind of what's leading to that? And then maybe just talk a little bit about just where the Specialty Finance business. Can you give some color on that business; kind of what percentage of loans is it today? Kind of where does that stand relative to kind of concentrations and how you guys are thinking about that going forward. .

So yes, good question, Brian. I'll take the first line and let Todd insert any thoughts as he might have. Certainly, what we're -- numbers we're telegraphing here with regard to 8% to 10% are what we've done consistently over a long period of time. And so that's what we would expect to continue to do. And so it was nice to see in the fourth quarter that our traditional lending business grew 8% clip. So there's starting to be some more organic growth in the traditional business as we burn through some of the excess PPP funds with our clients' accounts. From the Specialty Finance Group business, we've talked about doing a potential securitization to make sure that we have continued runway and capacity to grow that business at the pace we like. That's likely a second quarter event before we do the first securitization. So that's taken the top off the loan growth just a little bit. And we would basically securitize a portion of our LIHTC portfolio, and it's perfectly suited to go into a securitized kind of asset. And so that's something we'd expect to tell you much more about when we get to the next quarterly earnings call. We have a lot of runway certainly to continue to grow our Specialty Finance Group business. The largest concentration there is in the LIHTC loans, low income tax credit housing loans. Within the next year or so, we get to a concentration level where we probably wouldn't want to grow that a lot more just from a percentage of assets. So that's, hence, why we're getting the securitization in place to lay part of that portfolio up. So then it all out, we still think you can grow the on-balance sheet business in that 8% to 10% rate throughout the year.

That's really helpful, Larry. And just as far as where that portfolio stands today, the Specialty Finance with all the growth you guys have seen, can you give us some idea of where those balances are or just kind of where that's at, at year-end?

Yes. So if you look at the biggest components, the biggest components would be historic tax credit lending, around $280 million the LIHTC portfolio is about $1 billion now. That would be stabilized projects and projects under construction. Some of the direct municipal stuff that we've done is a couple of hundred million and then kind of a mixture of others would be another $100 million. So it's a meaningful part of our balance sheet.

And just line utilization, Todd, you mentioned that? Or I guess, just kind of where is that at today relative to kind of pre-pandemic levels?

Sure. Yes, Brian, it has improved. And at the end of last year, our revolving line utilization was around $240 million. It ended this year at $340 million. So it was up $100 million. It's still a bit short of pre-pandemic levels, maybe another $40 million or $50 million to get us back to pre-pandemic. So that has improved. And Larry mentioned that in his comments. We feel good about that. Maybe the only other color I'd give you on loans in addition to Larry's detailed comments, and again, just reaffirm that 8% to 10% is, one, historically, what we've done for years and years. We feel very good about that. And that would be net of any offtake that we accomplished this year. So you wouldn't have to net that down further for securitization. But we actually had the highest level of loan fundings in our history this past quarter with $650 million in new loans funded. We actually had very significant payoffs and paydowns in the quarter of over $500 million. So just wanted to give you a little bit of information about directionally there. Pipelines are strong, production is strong, still seeing some elevated payoffs and paydowns given all that liquidity in the market. Fair number of business sales taking place in some of our markets, things like that. But feel very solid about being able to continue our history of 8% to 10% loan growth.

It sounds optimistic. So just the -- maybe the last one for me was just on capital. And just kind of now that the Guaranty deal has been announced. Just kind of how you're thinking about buybacks? And secondly, I guess, additional potential M&A as you go into 2022?

Yes, I'll take the first line, Todd. Certainly, we feel good about our capital levels. Because we've got a pending acquisition, we've been kind of on the sidelines with regard to buyback. We have capacity in our currently announced plan to continue to buy back. We'll be revisiting that with our Board during this next quarter to talk about potentially increasing the amount of capacity we have to buy back because of our capital levels. And we just need to determine what price it makes sense. So we'll be creating a little more clarity on that as we go forward.

Perfect. And then just on the M&A piece, just to kind of how you're thinking about that. .

Yes. Our first choice is probably to continue to digest the GFA deal for a while before we tackle another one. We certainly, in the right opportunity, we want to be attentive. And if the right opportunity came up, we certainly have the capital to do it, but certainly nothing on the very near-term horizon.

The next question will come from Damon DelMonte with KBW. Please go ahead.

So a lot of my questions have been asked and answered, but I just wanted to touch base on the credit front. I mean, obviously, things continue to go very well for you guys. You had a sizable reserve release this quarter. Todd, can you kind of just help us frame out the outlook for provision as we go through 2022? I mean your reserve is still like 169 ex PPP, which is very healthy. So it kind of feels like we're going to have low levels of provisioning, possibly another reversal? How would you characterize that?

Yes, Damon, I think that would be our expectation as well that continuing the very pristine asset quality we have and even the further improvement here we had in Q4. We really had to soften up our qualitative factor around the pandemic. And as a result, we did release, I guess, I would call it modest at $3 million-ish. But our expectation, just as we stated, for the last several quarters of the past year is to really grow into that reserve. . I think all of you know us pretty well in terms of our credit culture and how we view asset quality and reserve levels. We like to be very conservative there. And so our preference would be to grow into it. It really depends on the level of growth we do see in loans. It really depends on what, if any, credit degradation does show up. But I would say either no or modest provision or modest releases would not be our preference or our style to have a significant release of reserves. And right now, we don't see anything in the portfolio that gives us concern about coming charge-offs. So as a result, given those factors, we thought it was appropriate to have a modest release in Q4. And it would be either no provisioning and growing into it or if we do have to release, it would be a fairly modest amount again.

Damon, I may add just a couple of things. First of all, you're right. Our credit quality is one of the very best in the peer group. That's not just now, it's kind of -- that's been a consistent theme for us for many years. And our reserve is one of the highest. And certainly, over time, as we grow into the reserve, we'd expect to go toward the median of the peer group at a reserve level. So that meeting of the peer group we'll look at when the quarter is over, but it's probably more in the 140 range today. But we don't plan to get there quickly, but over time.

And then could you just kind of give a little bit more perspective on the swap fee income expectations? I mean is the first quarter typically like seasonally slow? Did you maybe have some built up loans in the pipeline in 4Q that didn't come through? I know you're providing the $14 million to $18 million per quarter average, but can you help us maybe think a little bit about seasonality as we look at the quarters ahead?

Yes. It's certainly variable more than we would prefer, certainly. But if you look back to the third quarter, as you know, we had an outstanding quarter in fee income in the third quarter. So probably everything good that could happen, happened and some of the deals that we thought would happen in the second quarter last year and went into the third and a couple of deals that we thought would happen in the fourth happened in the third. And so we basically -- that number in the third quarter is a little bit bigger than we expected. And so it's really driven by lots of variables and the uncertainty that's going on in the supply chain and the cost of projects right now is probably just slowing down. It's not stopping deals from happening, but it's probably slowing down, the developer is getting their capital stacks organized in the right way. So it's really tough to predict. It's not exactly seasonal. It's kind of impacted by other economic variables going on. So certainly, the demand for the product has never been better. The projects that we have are performing extraordinarily well, occupancy is really strong. So it's certainly holding up well and demand for new product has never been larger than it is now. So again, it's hard to tell exactly what's going to happen quarter-to-quarter why we're giving that range, but we expect to give you that total number for the year as we've telegraphed.

The next question will come from Nathan Race with Piper Sandler. Please go ahead.

Just a quick housekeeping question on the PPP revenue. Todd, I apologize if you touched on it, but do you have the dollar amount in the fourth quarter and then just the remaining that's yet to be recognized?

Sure, Nate. Happy to give that. So in Q3, just to give you some context, in Q3, our total PPP income was $1.9 million with about 300 of that coming from interest and the rest coming from released fees. And then in Q4, that was down to 1.4. And the interest was only a little over $100 million of that, so about another $1.2 million in fees released there. But we're ending the year '21 with only around $600,000 in remaining PPP fees. And only $28 million in remaining PPP loans. So we would certainly expect all those to be forgiven and gone and released by the end of Q1 here.

Our next question will be a follow-up from Daniel Tamayo with Raymond James. Please go ahead.

Just wanted to follow up on the asset sensitivity a little stronger than I had expected. Obviously, you guys have done a great job of moving a lot of those time deposits out. But just wanted to see how you're thinking about given the chance for multiple hikes this year, if that's the impact on the first hike or -- and if there's any change for incremental hikes either for deposit beta assumptions or floors or anything like that in the loan portfolio?

I'm confident in that guidance of 4 to 5 bps in NIM and to the $2.2 million in NII on an annual basis. For the first three 25 basis point increases, we get out beyond that a little bit. It may have some variability to it. But that wouldn't be just for the first, but I think we're pretty comfortable with that guidance for the first three 25 basis point increases.

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

Thank you, operator. I would like to thank all of you for joining our call today. We hope everyone remains healthy and safe during the pandemic. Have a great day. We look forward to speaking with all of you again soon.

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