QCR Holdings, Inc. (NASDAQ:QCRH) Q3 2023 Earnings Call Transcript

QCR Holdings, Inc. (NASDAQ:QCRH) Q3 2023 Earnings Call Transcript October 27, 2023

Operator: Greetings and welcome to the QCR Holdings Inc. Earnings Conference Call for the Third Quarter of 2023. Yesterday after market close the company distributed its third quarter earnings press release. If there is anyone on the call who has not received a copy, you may access it on the company’s website 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 will open up the call to questions from analysts. Before we begin, I would like to remind everyone that some of the information management will be providing 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 the call concerning the company’s hopes, beliefs, expectations and predictions of the future are forward-looking statements and actual results could differ 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 website contains the financial and other quantitative information to be discussed today as well as the reconciliation of the GAAP to non-GAAP measures. As a reminder, this conference is being recorded and will be available for replay for November 2, 2023 starting this afternoon approximately 1 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 thank you for taking the time to join us today. I will start the call by providing some highlights for the quarter. We will also include a review of our specialty finance business with an update on our loan securitization strategy. Todd will provide additional details on our financial results for the quarter. We delivered solid third quarter results, highlighted by a static net interest margin, robust loan growth and significant fee income. In addition, our deposit base is stable, our capital ratios are strong and our asset quality remains sound. Our third quarter and year-to-date results demonstrate the continued strength of our franchise our commitment to relationship banking, and the successful execution of our strategic initiatives.

Our net interest income grew 3.9% from the second quarter. The increase was driven by a static net interest margin and strong loan growth. In the third quarter, we delivered reported net income of $25.1 million or a $1.49 per diluted share. Our adjusted net income for the quarter was $25.4 million and our adjusted EPS was $1.51 per diluted share. We generated an adjusted ROAA of 1.23% and an adjusted ROAE of 12.12% for the quarter. And we continue to target performance near the high end of our peer groups. Loan growth was stronger in the quarter, growing 14.2% on an annualized basis. Our loan growth was driven by solid activity from our traditional lending business and even stronger contributions from our low-income housing and tax credit lending program.

During the third quarter, our core deposits excluding short term broker deposits were relatively stable. Core deposits declined slightly by $9 million after growing $339 million or 23% on an annualized basis during the second quarter. Our experienced team of bankers continues to add relationships to our strong and diversified deposit franchise. Our uninsured and uncollateralized deposits remain low at 20.1% of total deposits at quarter end. Our substantial on balance sheet liquidity combined with available liquidity at the Federal Home Loan Bank, fed and other upstream and brokered sources more than cover our uninsured and uncollateralized deposits. Our asset quality remains strong as the ratio of non-performing assets to total assets was 41 basis points at quarter end.

Our reserve for credit losses represents 1.39% of total loans and leases held for investment and continues to be near the upper quartile of our peer group. Our reserve levels reflect our conservative approach and provide a buffer against potential economic challenges. While we are cautious given elevated interest rates and economic uncertainty, we remain optimistic about the resilience of our Midwest markets. Unemployment remains below the national average across our footprint and business activity has continued at a steady pace. As we mentioned last quarter, our exposure to commercial office billing is very low at just 3% of total loans with an average loan size of $859,000. These properties are predominantly located in suburban locations within or adjacent to our markets.

They’re well collateralized and are performing in line with expectations with no significant repayment concerns. We continue to maintain strong levels of capital that have supported another robust year of growth. We are focused on further building our capital levels. With a modest dividend, strong earnings and our pending securitization, we continue to target capital ratios in the top quartile of our peer group. During the quarter, we grew loans 14.2% on an annualized basis, with year-to-date loan growth being 10.2% on an annualized basis. As I noted, this was driven primarily by ongoing strength in our low income housing tax credit lending business. With the growing prominence of our Specialty Finance Group and LIHTC lending business, I will again spend some time discussing the drivers of this high performing business.

As we have stated in prior quarters, our specialty finance team offers low-income housing tax credit lending to a select group of developers and investors with whom we have built long standing relationships. Our clients continue to experience strong demand for their projects as the need for affordable multifamily housing far exceeds supply. The industry has an excellent track record with negligible historical default rates. Based on decades of stability in the industry and our own experience, these high-quality loans are ideal for securitization. As we have previously discussed, our intent is to securitize a portion of our existing LIHTC loan portfolio with plans to continue this on an ongoing basis. We view this as an effective tool in managing our liquidity and capital.

It will also provide ongoing capacity for continued LIHTC production and the corresponding capital markets revenue that we receive from this business. I’m pleased to announce that we have two LIHTC loan securitizations scheduled to close in the fourth quarter, a tax exempt pool of $130 million dollars and a taxable pool totaling $135 million. Both are now scheduled for closing prior to the end of November. The financial outcome of these first securitizations will be approximately breakeven subject to final valuation and transaction costs. We believe that our LIHTC lending business is extremely valuable and that it deserves a higher valuation multiple than traditional banking. While our third quarter loan growth was exceptional, we are maintaining our guidance for growth in loans held for investment for the fourth quarter to be in a range of 9% to 12% on an annualized basis, as our pipeline continues to be strong.

While economic headwinds remain a risk, we have demonstrated excellent historical credit quality, robust fee income sources, a valuable core deposit franchise and a strong capital position. In addition, we believe that we have the ability to defend our net interest margins in a higher for longer interest rate environment. These qualities, when combined with our current valuation, have positioned our company and shareholders to benefit as we continue to execute on our strategic initiatives. I will now turn the call over to Todd to provide further detail regarding our second 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, we grew total loans 14.2% on an annualized basis during the quarter, or $227 million of net growth. In anticipation of our loan securitizations, as of the end of the quarter, we have classified $278 million of LIHTC loans as held-for-sale. Our loan securitizations in the fourth quarter will improve our liquidity and enhance our TCE ratio. In addition, our long-term securitization strategy will enable us to continue to fund the growth of our LIHTC lending business and the corresponding capital markets revenue that we receive from this business, while maintaining the portfolio within our established concentration levels.

Core deposits were relatively stable for the quarter. We have grown core deposits nearly 8% on an annualized basis during 2023 which has allowed us to fund our strong loan growth. We also successfully rolled off $103 million of broker deposits in that third quarter. As Larry mentioned, our total uninsured and uncollateralized deposits were at a very low level at quarter end at 20.1% of total deposits. In addition, the company maintain approximately $3 billion of available liquidity sources at quarter end, which includes $1.1 billion of immediately available liquidity. Now turning to our income statement, we deliver net income of $25.1 million or $1.49 in diluted earnings per share for the quarter, driven by higher net interest income and strong non-interest income, along with well controlled expenses.

A woman signing papers with her banker for her first home mortgage.

Our adjusted net income was $25.4 million or $1.51 per diluted share. Net interest income was $55.3 million, an increase of 3.9% from the prior quarter. Adjusted NIM on a tax equivalent yield basis remained static on a linked-quarter basis at 3.28%, which was at the top end of our guidance range. During the third quarter, our loan yield expansion accelerated while we experienced a more modest increase on our cost of funds for the slowing and the shift of the composition of our deposits from non-interest and lower beta deposits to higher beta deposits. We are pleased to see the stabilization in our deposit mix and believe that it will continue to benefit our net interest margin going forward. As we look to the fourth quarter, we are anticipating a pause from the Fed and a yield curve that continues to be partially inverted.

We expect our loan and deposit betas will continue to increase but more slowly at offsetting levels. Our loan securitizations in the fourth quarter will also help lessen the pressure on higher funding costs and further stabilize our deposit mix. As a result, we’re getting to a relatively static adjusted NIM TEY in the fourth quarter within a range of 5 basis points of expansion on the high-end and 5 basis points of compression on the low-end. Turning to our non-interest income, which was $26.6 million in the third quarter. Our capital markets revenue was $15.6 million this quarter. And while down from the outsized performance of $22.5 million in the prior quarter, the $15.6 million of production outperformed our annualized guidance range.

Capital markets revenue from swaps continues to benefit from the strong demand for affordable housing and stabilization in the supply chain and construction costs. In addition, developers have been successful in restructuring their project capital stacks in the current interest rate environment. Capital markets revenue from swap fees has been a consistent and strong source of fee income. Based on decades of stability in the LIHTC industry and our own experience, we believe that this business will perform well throughout various economic cycles. Our LIHTC lending and capital markets revenue pipeline remains healthy as our clients continue to experience strong demand for new projects. As a result, we are maintaining our capital markets revenue guidance for the next 12 months in a range of $45 million to $55 million.

In addition, we generated $3.8 million of wealth management revenue in the third quarter consistent with the second quarter. On a year-to-date basis, wealth management revenue was up $488,000 or nearly 6% on an annualized basis. Our wealth management team continues to benefit from new relationships, adding 220 new clients and $577 million in assets under management in the first 9 months of this year. Our continued growth in new relationships helped offset market volatility during the third quarter. We’re also pleased to announce the start of our new wealth management business in the Southwest Missouri market at our guarantee bank charter. We have a highly experienced team in place that will expand the reach of our current wealth management business.

Now turning to our expenses. Non-interest expense for the third quarter totaled $51.1 million compared to $49.7 million for the second quarter and at the high-end of our guidance range of $48 million to $51 million. The increase from the prior quarter was primarily due to higher variable employee compensation for year-to-date performance, increased professional and data processing fees and other expenses related to fixed asset disposals. These increases were partially offset by lower advertising and marketing expenses. We remain diligent in controlling our expense growth. For the fourth quarter we are reaffirming our non-interest expense guidance again this quarter to be in a range of $48 million to $51 million. Our asset quality remains strong.

During the quarter, NPAs increased by $8.6 million to $34.7 million or 41 basis points of total assets. Majority of the increase was driven primarily by three client relationships from unrelated industries. Approximately one-third of our NPAs consist of one relationship and we believe that this credit will be resolved without a loss. Our 20-year historical NPA percentage has averaged approximately 90 basis points on total assets. We remain significantly below those levels today, and believe that we’re well positioned given our historical experience and the uncertain economic environment that continues to exist. Classified and criticized loans as the percentage of loans and leases also remain quite low at 1.05% and 2.98%, respectively. Our 20-year historical average of classified and criticized loan percentages are approximately 2.7% and 4.6%.

Similar to our NPAs, we remain well below historical averages in these categories, and they have remained relatively stable over the course of 2023. The provision for credit losses was $3.8 million during the quarter which included $3.3 million of provision for loans and leases, primarily driven by the loan growth during the quarter. We expect to continue to maintain strong reserves given the economic environment. Our reserves to loans held for investment was fairly static at 1.39% and continues to be at the higher end of our peer group. We continue to maintain solid levels of capital that have supported another robust year of growth. Our total risk-based capital ratio declined by 29 basis points to 14.4% due to the very strong loan growth during the quarter.

Our tangible common equity to tangible assets ratio declined 23 basis points to 8.05%. The decline in the TCE ratio was due to the rise in interest rates during the quarter and the resulting negative impact on AOCI related to our securities and derivative portfolios. With continued strong earnings coupled with our modest dividend, our tangible book value per share increased by $0.34 during the third quarter. The decline in AOCI partially offset the growth in our tangible book value. Our capital allocation priorities remain focused on growing our capital and targeting capital levels in the top quartile of our peer group. Finally, our effective tax rate for the quarter was 6.8% compared to 12.2% in the second quarter. We benefited this quarter from a full quarter, a strong growth in our tax exempt loan and bond portfolios that was added during the late portion of the second quarter and throughout the third quarter.

As a result, this has helped drive our effective tax rate even lower and remains one of the lowest in our peer group. We expect the effective tax rate to be in a range of 8% to 11% for the fourth quarter. With that added context on our third quarter financial results, let’s open the call for your questions. Operator, we are ready for our first question.

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Q&A Session

Operator: Thank you. [Operator Instructions] Today’s first question comes from Damon DelMonte with KBW. Please go ahead.

Damon DelMonte: Hey, good morning, guys. I hope everybody is doing well today.

Larry Helling: Good morning, Damon.

Damon DelMonte: Good morning, Larry. Just wanted to start off on the margin commentary. Todd, I think you said in your remarks that you’re anticipating the margin could be plus or minus 5 basis points here in the fourth quarter. Just kind of wondering under like which scenarios are you expecting that to change? Like, is there something on the deposit mix side which could have a bigger impact on which direction that the margin goes?

Todd Gipple: Sure, Damon. Thanks for the question. So our base assumptions on static would be no Fed hikes in November, December. The loan growth of that 9% to 12% that we’ve guided to having the loan sold up to 65% roll off in November, as we’ve guided to, securitization will give us a couple basis points of lift in the fourth quarter. But the big assumption around deposit mix is that it’s going to remain fairly static, we did see a real positive slowdown in terms of mix shift in the third quarter, and candidly that’s continued here in October. Our non-interest bearing is actually up $20 million thus far in the quarter. So with all of that we’re feeling very optimistic about static margin. The reason for the goalposts on both sides of that up and down would be just how effectively we’re going to continue to get some loan yield pop.

We are starting to see some really nice loan yields on new loans. And to the extent we can continue that and also hold on to a more static mix of deposits, then we’re a little more optimistic ahead of that static guide. I hope that gives you enough color around what our assumptions are.

Damon DelMonte: Yes, that was helpful. Thank you. And do you happen to have like what – and I’m sorry if I missed this, but what new production? So new loans coming on books, generally are coming out what kind of yields?

Todd Gipple: Sure. Thanks for that question too, Damon. So in the third quarter our average new fundings were $747 million but that’s actually also accelerated into a quarter. And in September alone those were up to $756 million. Floating rate loans, which most of – well, actually all of our LIHTC production would be in that category. That was $810 million yield for the third quarter, and that also was ramping up during the quarter, had a terminal rate of $819 million in September. So we are starting to see some real nice lift in new loan production. And as I said, in terms of the NIM guidance, that’s a big part of us being able to hold on to NIM.

Damon DelMonte: Got it. It’s great. It’s helpful. And then I guess regards to the credit in those three relationships that that kind of came under the books this quarter, was one of those part of the one-third of the overall NPAs or no?

Larry Helling: No, Damon. They were three new ones that came on. The one-third ones the one we’ve been working on for a couple quarters. The three new deals that came on totally different industries, one in the hospitality space, one small homebuilder. One was actually a daycare. And if you step back and look at it we’re moving toward what I consider slowly toward a normalization of credit, which was absent the last couple of years because of all the PPP money and those kinds of things. So if there were management issues, it got covered up by excess liquidity that borrowers had. That’s kind of gone now for most people, especially the really small businesses. So we don’t see any broad base trends. But management decisions are showing up a little bit more than they did 2 years ago.

Damon DelMonte: Got it. Okay, that’s helpful. That’s all I had; I will step back for now. Thanks a lot.

Todd Gipple: Thanks, Damon.

Larry Helling: Thanks, Damon.

Operator: And our next question comes from Nathan Race, Piper Sandler. Please go ahead.

Nathan Race: Great. Hey, guys. Good morning.

Larry Helling: Good morning, Nate.

Todd Gipple: Hi, Nate.