QCR Holdings, Inc. (NASDAQ:QCRH) Q1 2024 Earnings Call Transcript

QCR Holdings, Inc. (NASDAQ:QCRH) Q1 2024 Earnings Call Transcript April 24, 2024

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Operator: Greetings, and welcome to the QCR Holdings, Inc. Earnings Conference Call for the First Quarter of 2024. Yesterday after market closed, the company distributed its first quarter earnings press release. If there’s anyone on the call who has not received a copy, you may access it on the company’s website at www.QCRH.com. With us today from management are Larry Helling, CEO and Todd Gipple, President and CFO. Management will provide a summary of the financial results and then we’ll open the call to questions from analysts. Before we begin, I would like to remind everyone that some of the information management we’ll be providing today falls under the guidelines of forward-looking statements as defined by the Securities and Exchange Commission.

As part of these guidelines, any statements made during this call concerning the company’s hopes, beliefs, expectations and predictions of future and forward-looking statements and actual results could be different materially from those projected. Additional information on these factors is included in the company’s SEC filings, which are available on the company’s website. Additionally, management may refer to non-GAAP measures which are intended to supplement, but not substitute for the most directly comparable GAAP measures. The press release available on the company’s website contains the financial and other quantitative information to be discussed today, as well as the reconciliation of GAAP to non-GAAP measures. And lastly, as a reminder, this conference is being recorded and will be available for replay through May 1, 2024, starting this afternoon approximately one hour after the completion of this call.

It will also be accessible on the company’s website. I will now turn the call over to Mr. Larry Helling at QCR Holdings.

Larry Helling : Thank you, operator. Welcome, everyone. And thanks for joining us today. I’ll begin by providing some highlights for the quarter, followed by a discussion on our strategic priorities. Todd will then follow with additional details regarding our financial results for the quarter. We delivered strong first quarter results, highlighted by significant fee income and continued growth in both our core deposit and loan balances. In addition, we continue to benefit from well-managed expenses, improved upon our already excellent asset quality, and further strengthened our capital ratios. In the first quarter, we produced adjusted net income of $26.9 million or $1.59 per diluted share. We generated an ROAA of 1.25% and an ROAE of 11.83% for the quarter, and believe that both metrics remain near the high end of our peer group.

We grew total loans 6.4% on an annualized basis during the quarter, driven primarily by our low-income housing tax credit lending program. We also grew core deposits significantly, increasing them by $316 million, or 20.3% on an annualized basis, adding to our strong and diversified deposit franchise. As a result, our loans held for investment to deposit ratio improved to 93.6%. The exceptional deposit growth achieved during the first quarter was driven by growth in our correspondent bank deposits. Our success in growing deposits underscores our commitment to expanding our market share with existing clients, and establishing new relationships within the communities we served. Our asset quality remains excellent as the ratio of non-performing assets to total assets improved by four basis points during the first quarter, and remains below our historical average levels at 36 basis points.

Our reserve for credit losses represents 1.33% of total loans and leases held for investment and continues to be near the high end of our peer group. We remain disciplined in our underwriting, maintain prudent reserves, and diligently monitor asset quality across all business lines. We also continued to see positive trends this quarter, and our total criticized and classified loans as a percentage of total loans and leases. We are cautiously optimistic in the economic resilience of our markets and the financial health of our clients. We are not seeing any meaningful signs of weakness across our footprint. Our exposure to commercial office buildings is minimal and well-controlled, constituting just 3% of total loans with average loan size of $859,000.

These properties are primarily situated in suburban locations, either within or adjacent to our markets. Importantly, they are well-collateralized and performing in line with expectations, and we have no significant repayment concerns. In addition, our construction and land development portfolio is performing well. Balances in this sector declined 19% from the prior quarter as projects reached completion and transferred into permanent financing. The majority of our construction and land development loans consist of financing on high-quality, low-income housing tax credit projects. The LIHTC lending program has been instrumental in creating affordable housing units and has been a significant strategic initiative for our company over recent years.

We consider this to be the best asset class in our loan portfolio. The entire LIHTC industry enjoys an outstanding historical track record and solid underpinnings. In recent years, we’ve navigated a challenging construction period, overcoming pandemic-related difficulties, supply chain disruptions, and inflationary pressures. Given the superior quality of the LIHTC construction portfolio, and despite the headwinds, we have had negligible credit issues from this sector of our business. We maintain disciplined underwriting and vigilant credit administration. It also underscores the strength of our risk management practices and commitment to prudent lending. Our remaining CRE portfolio is performing well, and it’s with clients we trust and in markets that we know and understand.

Our capital levels remain strong, and we believe that our modest dividend and solid earnings will enable us to continue to grow capital faster than our peers. As we delve into our strategic priorities for 2024 and beyond, it’s essential to highlight our 9-6-5 strategy. We crafted this long-term initiative in 2019 with the purpose of driving our financial results to enhance shareholder value. We have delivered on those goals, and our overall financial performance has been exceptional. Over the last three years, core diluted earnings per share has grown at a compounded annual rate of 21%, and tangible book value per share by 11% per year. Our adjusted ROAA was 1.41% in 2023, up 28 basis points over the three-year period, and near the top quartile of our peer group.

Our priority is to sustain this outstanding financial performance. We will achieve this by retaining the core of our 9-6-5 strategy. We remain committed to delivering top-tier financial performance across several key metrics, including earnings per share, tangible book value per share growth, ROAA, and continuing to increase our capital ratios. Additionally, we plan to fund future loan growth through core deposit growth and ongoing securitizations. Our qualitative goals encompass enhancing employee and client experiences by investing in best-in-class technology for greater efficiency, and continuing to invest in and support the communities in which we operate. In summary, we believe that our commitment to sustain top-tier financial performance will enhance shareholder value in the long run.

I will now turn the call over to Todd to provide further detail regarding our first quarter results.

Todd Gipple: Thank you, Larry. Good morning, everyone. Thanks for joining us today. I’ll start my comments with details on our balance sheet performance during the quarter. As Larry mentioned, our total loans grew 6.4% on an annualized basis during the quarter, or $105 million of net growth. In anticipation of our next loan securitization, we have designated $275 million of LIHTC loans as held for sale at the end of the quarter. As we have previously discussed, our long-term securitization strategy allows us to sustain the strong performance of our LIHTC lending business. In addition, this will continue to drive the corresponding capital markets revenue that we earn from this business, all while ensuring our portfolio remains within our established concentration levels.

Core deposits increased $316 million during the quarter, or just over 20% on an annualized basis. As Larry mentioned, growing our core deposits remains a top priority. This strategic focus enables us to sustain our future loan growth while reducing reliance on wholesale or higher-cost funding. During the first quarter, our exceptional deposit growth facilitated a combined reduction of $252 million in overnight borrowings and broker deposits. Our total uninsured and uncollateralized deposits remain very low at 20% of total deposits. In addition, the company maintained approximately $3.2 billion of available liquidity sources at quarter end, which includes $1.3 billion of immediately available liquidity. Now, turning to our income statement. We delivered net income of $26.7 million, or $1.58 per diluted share for the quarter.

Our adjusted net income was $26.9 million, or $1.59 per diluted share. Net interest income for the first quarter of 2024 totaled $54.7 million, a decrease of $1 million from the fourth quarter of 2023. This decrease was influenced by several non-client factors, including the maturity of $125 million of interest rate caps on our index deposits, and the conversion of $65 million of our subordinated debt to a higher floating rate, which contributed a combined $1.3 million of additional interest expense. We also had lower loan discount accretion by $310,000, and there was one less day in the quarter, which had an impact of approximately $600,000 decrease in net interest income. However, the company’s net interest income driven by core activity saw growth of approximately $1.2 million during the first quarter, led by continued expansion in loan and investment yields.

Our adjusted NIM on a tax equivalent basis declined by five basis points from the fourth quarter of 2023, and was at the low end of our guidance range. The decrease was driven primarily by a combination of non-client factors, including the expiration of interest rate caps and the repricing of a portion of our subordinated debt, which collectively contributed seven basis points of NIM dilution. However, we were able to partially offset this non-client impact with core NIM expansion of two basis points. Notably, our core NIM expansion was less than expected due to additional shifts in our deposit composition. Specifically, our non-interest bearing deposit portfolio has experienced a net decline over the past year as our commercial clients use more cash for operations and are investing excess cash in interest bearing deposits.

Looking ahead, we continue to use the forward yield curve as the baseline for our interest rate assumptions, which no longer includes any rate cuts for the second quarter. The inverted yield curve continues to pressure our NIM. However, we do not have any new non-client headwinds in the second quarter. Therefore, assuming a static funding mix, we anticipate that our expansion in loan and investment yields will generally offset any further increase in our funding costs, leading to growth in that interest income. As a result, we are reaffirming our guidance for a relatively static adjusted NIM TEY in the second quarter of 2024 with a range of five basis points of expansion on the high end and five basis points of compression on the low end. We continue to be well-positioned for a rates down scenario.

In the past year, our balance sheet has shifted from asset sensitive to firmly liability sensitive. This shift is primarily due to changes in our funding mix to more higher beta funding. Turning to our non-interest income of $26.9 million for the first quarter, which was down from our record $47.7 million in the fourth quarter of 2023. Our capital markets revenue was $16.5 million in the quarter as our LIHTC lending and revenue from swap fees continues to benefit from the strong demand for affordable housing. Our pipeline in this business remains healthy and therefore we are reaffirming our capital markets revenue guidance for the next 12 months to be in a range of $50 million to $60 million. We generated $4.3 million of wealth management revenue in the first quarter, up 16% on an annualized basis from the fourth quarter.

In addition to the expansion of our wealth management business at our guarantee bank charter in 2023, we are pleased to announce the recent launch of our wealth management business in the attractive Des Moines, Iowa metropolitan market at our community state bank charter. We have a highly experienced team in place and anticipate further growth of our already successful wealth management business model. Now turning to our expenses. Non-interest expense for the first quarter totaled $50.7 million compared to $60.9 million for the fourth quarter. The linked-quarter decrease was primarily due to lower variable employee compensation related to our record fourth quarter and full year performance in 2023. As we look ahead to the second quarter, we expect our non-interest expenses to continue to be in the range of $49 million to $52 million.

Our ongoing focus is on effective management of recurring non-interest expenses and we continue to benefit from our investments in technology and creating a best-in-class group operations team that supports our multi-charter community banking model. Now shifting to asset quality, which continues to be excellent. During the quarter, NPAs declined by $3 million to $31 million or 36 basis points of total assets. The provision for credit losses was $3 million during the quarter and our allowance for credit losses to total loans held for investment was static quarter over quarter at 1.33%. Net charge offs were also static to the fourth quarter and remain at historical lows at just five basis points of average loans and leases. Our tangible common equity of the tangible assets ratio increased by 19 basis points to 8.94% at quarter end, up from 8.75% at the end of December.

The first quarter improvement and our TCE ratio was primarily driven by our strong earnings and was only partially offset by a $5.4 million decrease in AOCI. Our total risk-based capital ratio was 14.30% at quarter end and our common equity tier one ratio was 9.91%, improving by one basis point and 24 basis points respectively on a linked-quarter basis. The improvement in both capital ratios was due to strong earnings. We are also pleased to deliver another meaningful increase in our tangible book value per share, which grew by $1.12 or just over 10% annualized during the quarter. Finally, our effective tax rate for the quarter was 4% compared to 12% in the prior quarter. The linked-quarter decline was due primarily to the sequentially lower capital markets revenue we earned during the quarter, decreasing the mix of our taxable income as compared to our tax-exempt income.

In addition, we recognized a stronger tax benefit on our stock-based compensation, which tends to be elevated in the first quarter. We also continue to benefit from our tax-exempt loan and bond portfolios. As a result, this has helped our effective tax rate to remain one of the lowest in our peer group. We continue to expect our effective tax rate to be in a range of 8% to 11% for the full year of 2024. With that added context on our first quarter financial results, let’s open the call for your questions. Operator, we’re ready for our first question.

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Q&A Session

Operator: We will now begin the question and answer session. [Operator Instructions]. At this time, we will take our first question which will come from Nathan Race with Piper Sandler. Please go ahead.

Nathan Race: Hi guys, good morning.

Larry Helling: Good morning, Nate.

Nathan Race: Want to start just in terms of kind of thinking about the impact of the upcoming LIHTC securitizations in terms of when you expect that to occur. And then also just in terms of how we should think about the core margin impact from that. I think from the last securitizations, you had some benefit there to the margin. And also trying to think about what kind of offset we can expect in terms of the reduction in earning assets relative to maybe some higher gain on sale revenue?

Todd Gipple: Sure. Nate, I think I’ll start, let Larry chime in a little bit with our longer term strategy on securizations. But we’ll tell you that 275 million securization, we do expect that to occur in the third quarter, not late here in the second. So for modeling purposes, you can expect that in the third quarter. As we’ve talked, for us, it’s less about ultimate gain or a loss on sale of those securitized loans. It’s more about the benefit it gives us in liquidity and therefore, core deposit pricing. So we do expect a lift in net interest margin in the third quarter when that securitization is complete. As we’ve seen in past securitizations, it really does help take the pressure off funding costs. And we’ve seen that in the past, we actually feel like perhaps that benefit will be a bit more in the third quarter, because the quarter-posit pricing really in our markets has eased a bit.

And we’re starting to see more core deposit generation in the fours versus fives. So combination of that and the $275 million in liquidity we’re very optimistic about that helping us with margin going forward. And then of course, all the benefits to allowing us to keep that LIHTC engine running and the capital markets revenue going. We’re very pleased to have securitization in hand. I know, Larry’s probably got some comments on the next securitization and a little more around our strategy in the future.

Larry Helling: Yes, Nate, of this securitization, the next one that we’ll do early in the third quarter is on tax-exempt loans. We’ll likely do a smaller one later in the year. But that will be taxable loans, so likely roughly half the size of this one, probably late in the year. Again, our focus is not, we certainly want efficient execution, but this is more about creating capacity for us. And so we’ve learned a lot, haven’t done two securitizations. I think we’ll need to do several more before we figure out the most efficient ways and the timing in the marketplace and how to package these to get the most efficient execution. Over time, we’ll certainly expect to get some gains on sale. Again, that was never the intent here.

And it’ll probably take us a few more to learn the best way to get more efficient with that. And then future securitizations, that’s something we would expect to do on an ongoing basis annually or semi-annually. It’ll depend the timing of that on what our liquidity looks like, other loan demand, all those kinds of things as we go forward. So it’s a little hard to tell, but certainly as Todd telegraphed, this first securitization early in the third quarter, likely another smaller one late in the year.

Nathan Race: Okay, great. Very helpful. And then just going back to Todd’s point in terms of deposit cost pressures, obviously a decline in non-interest deposits in the quarter. I’m curious in terms of the driver there and just in terms of what you saw in terms of the degree of deposit cost increases over the quarter. And in terms of if you’re seeing continued slowdown in that pressure?

Larry Helling: Sure, Nate, thanks for great questions around that. First, I’m going to talk about non-interest bearing. We did see that $79 million reduction in non-interest bearing that really cost us about five basis points of margin this past quarter. We are monitoring these very, very closely in all locations. And I’m pleased to say that so far this quarter we’re down only about $5 million in terms of average. So that stress seems to have abated a bit here in the second quarter. In terms of interest bearing deposit costs, if you look at our NIM table that went up, interest bearing deposits went up 18 bps, but really eight basis points of that was the expiration of those caps. So really more 10 basis points in terms of non-synthetic or really core margin impact.

And that 10 basis points is slowing from prior quarters. What I will tell you is we’re very excited about the fact that we are starting to reprice CDs and bring on new money in the fours versus the fives. We actually have CD rates somewhere between 435 and 474 at our four charters for new money. And we’re getting some traction at those pricing levels. We’re very pleased to see a little bit of the competition for deposits abating. Like that has a lot to do with the fact that many of our peers are not growing, not growing loans, not growing relationships, and so some of the edge has been taken off of deposit pricing in our market. So another reason, we’re guiding to a more static NIM in Q2. For example, we have $340 million of CDs repricing. They have a weighted average rate of $472.

And we actually expect to replace them at roughly that rate. So we think we’re hitting somewhere near the end of that creep in interest bearing deposit costs.

Nathan Race: Okay, super helpful. And if I could just ask last one on charge-offs. The last couple of quarters, they’re slowly elevates relative to your historical levels. Just curious kind of what the driver was in the first quarter and how you’re kind of thinking about charge-off levels or if we could maybe assume that there’s some additional normalization going on with charge-offs?

Todd Gipple: Yes, Nate, what I’d say is the charge offs are primarily common in what I’d call our micro business portion of our portfolio. There’s no big charge-offs in there. It’s really, you know, $100,000 average kind of charge offs and small deals that, and I think that’s the sector of the economy that’s suffered the most from the pandemic and probably didn’t have the kind of liquidity that little bit larger businesses had. So I’d say, there’s nothing unusual, these charge offs are still running well below our long-term 20-year historical averages, but I kind of expect them to stabilize and slowly move down here later this year based on what we’re seeing today. I’ve had conversations with our Chief Credit Officer in the last couple of days and I go, you see anything and yes, I mean, there’s just no movement from our clients portfolio.