QCR Holdings, Inc. (NASDAQ:QCRH) Q4 2022 Earnings Call Transcript

QCR Holdings, Inc. (NASDAQ:QCRH) Q4 2022 Earnings Call Transcript January 25, 2023

Operator: Greetings, and welcome to the QCR Holdings, Inc. Earnings Conference Call for the Fourth Quarter of Full-Year 2022. Yesterday, after market close, the company disbursed its fourth 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, COO, and CFO. Management will provide a brief summary of the financial results, and then we’ll open up the call to questions from analysts. Before we begin, I would like to remind everyone that some of the information 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 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 through February 1, 2023, starting this afternoon approximately one hour after the completion of this call.

It will also be accessible on the company’s website. At this time, 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 with a high-level overview of our 2022 performance, a review of our business model, and the factors that drive our success. Todd will follow with additional details on our financial results for the fourth quarter. Our record net income in 2022 was driven by robust loan growth and increased net interest margin and excellent credit quality. Our team accomplished this while successfully closing and integrating our largest acquisition to date where we significantly strengthened our company’s position in the vibrant Southwest Missouri region. Our growth in earnings over the last five years has been exceptional.

This is a result of our differentiated business model and commitment to relationship banking. Our multi-charter model provides our bankers with the agility to serve our clients. We delivered banking at the local level, which creates opportunities to strengthen current relationships and establish new relationships that drive our growth. In the last five years, we have nearly doubled our size, outperforming many of our peers. Our total loans have grown at a compounded annual rate of 15.7% and our deposits at 12.9%. These results support the 20.7% compounded annual growth in our core diluted earnings per share and the 10.2% compounded annual growth rate and our tangible book value per share over the same period. Importantly, while we’ve been able to grow at a consistent pace, we’ve also significantly increased our profitability and our ROAA is now in the top quartile of our peer group.

There are many factors that contribute to our success, including our dedicated employees, our economically vibrant markets, and our differentiated business model. Recruiting and retaining the right employees is critical to our success. We have strong corporate cultures that extend through each of our local charters. Our employees are engaged with our clients and involved in our communities. Our reputation and culture attract the best bankers and clients in our market. This leads to important outcomes such as reduced turnover, improved productivity, higher profitability, and enhanced shareholder value. We continue to receive high employee engagement scores, which are measured annually across our company. Our local charters have won numerous awards throughout our footprint for being a great place to work and do business.

This has resulted in consistent and sustained growth. We operate in some of the most vibrant midsized markets in the Midwest. They are part of regional economies with a diverse mix of commercial, industrial, and technology-focused activity along with highly educated workforces, which helps drive steady economic growth, high relative household income, and low unemployment. Our unique model enables our local management teams to operate with the speed and agility to respond to client needs, which results in a better client experience that outperforms larger national and regional banking alternatives. This has created great outcomes for our employees, our clients, our communities, and our shareholders. Our management teams think and act like owners, which drives shareholder value.

In addition, we have built high performing business lines that provide additional opportunities for growth and profitability. Our Specialty Finance Group provides municipal and tax credit specialty lending, which drives strong growth in bonds and loans, as well as fee income. On the deposit side, our correspondent banking team serves the banking needs of nearly 200 downstream correspondent banks, which generates meaningful core deposits and related fee income. Lastly, we’ve grown our wealth management significantly over the years with assets under management of $4.6 billion. The combination of our traditional banking and our high performance business lines creates a diverse revenue stream, which has helped us outperform in a variety of economic environments.

We support our local charters with centralized group operations teams providing the required operational infrastructure, expertise, and benefits of scale. We aim to be a market leader in each of our markets as this scale improves our efficiency and enables us to attract the best bankers and clients. Relationships build on expertise and trust matter in our markets and that is why we place such importance on high touch client service that is delivered at the local level. Now, a few comments on our full-year 2022 results. We delivered net income of $99.1 million for the year or $5.87 per diluted share. After adjusting for the one-time costs associated with the Guaranty Bank acquisition, our adjusted net income for the year was $114.9 million and our adjusted EPS was $6.80 per diluted share, up 14.8% and 8.5% respectively over our 2021 results.

Our team accomplished this, while successfully closing and integrating our largest acquisition to date as mentioned earlier. Organic loan and lease growth for the full-year was 14.6% when excluding PPP and acquired loans and was driven by strength in our traditional commercial lending, leasing, and specialty finance businesses. Given our current pipelines and relative strength of our markets, we are targeting loan growth of between 8% and 10% for 2023, consistent with our long-term goals, while continuing to be vigilant on maintaining our exceptional credit quality. While our deposits for the year were relatively static when excluding deposits acquired in the Guaranty acquisition, the number of net new accounts continue to grow, which will lead to consistent deposit growth over time.

Core deposits are our long-term focus, which will drive long-term franchise value. bankers are to grow both loans and deposits. During the year, we expanded our tax equivalent yield net interest margin by 24 basis points, driven primarily by our asset sensitive balance sheet in this rising interest rate environment. Our asset quality remains as the ratio of non-performing assets to total assets was 11 basis points at the end of the year. We had modest net charge-offs during the year and are comfortable with our reserves, which represent 1.43% of total loans and leases. We are mindful of recessionary concerns, but remain cautiously optimistic about the relative economic resiliency of our markets. Additionally, our strong asset quality and consistent credit culture prepares us well to weather economic uncertainty.

In conclusion, I would like to thank the entire QCR Holdings team for their engagement and dedication to outstanding client service and for delivering record adjusted earnings for the year. Our employees are the key to our success and I’m immensely proud of all that we have accomplished in 2022. With that, I will now turn the call over to Todd, to discuss our strategy to drive shareholder value and our strong financial results.

Todd Gipple: Thank you, Larry. Good morning, everyone. Thanks for joining us today. When Larry and I began our new roles with the company in early 2019, we developed an initiative to drive our financial results and enhance shareholder value. We call this our 9, 6, 5 strategy, a plan to grow earnings and drive attractive long-term results for shareholders. This strategy includes at a minimum generating organic loan and lease growth of 9% per year funded by core deposits, growing fee-based income by at least 6% per year, and limiting annual operating expense increases to 5% per year. These are long-term targets and not short-term quarterly benchmarks. Our 9, 6, 5 strategy creates a common language across the company that unites our teams and aligns our actions for long-term success.

Photo by Nastuh Abootalebi on Unsplash

We believe that the true measure of our success will be our ability to consistently deliver on our strategic initiatives over time and this will translate into greater shareholder value in the long run. As a result of our performance on our strategic 9, 6, 5 initiatives, combined with our successful acquisition of Guaranty Bank this year, since 2018 we have grown adjusted net income and EPS at a compounded annual growth rate of 25.4% and 21.9% respectively. And we are proud to have achieved top quartile ROAA and NIM within our high performing peer group. While our historical performance has been impressive, we remain focused on the future and expect to continue to perform at the top of our peer group over the long-term. Now, I would like to provide some color regarding our fourth quarter results, starting with net interest income.

Our net interest income on a tax equivalent basis was 70.8 million, an increase of 5.5 million from the third quarter. The increase was primarily due to higher acquisition related net accretion of 4.6 million due to loan renewals, restructurings, and pay-offs from our Guaranty Bank acquisition. And the impact of multiple interest rate hikes on our asset sensitive balance sheet, partially offset by the impact of increased deposit costs. With our strong growth in earning assets and improved loan yields, we significantly grew interest income for the current quarter. However, we also experienced higher interest expense as a result of higher deposit costs, a shift in the mix of our deposits, and the full quarter impact of our recent subordinated debt issuance.

Our NIM on a tax equivalent yield basis improved by 22 basis points during the fourth quarter, driven by the higher loan yields and higher acquisition-related net accretion and partially offset by higher deposit costs. As we have mentioned before, NIM is impacted typically in nonlinear patterns during periods of rapid rate increases. In the first half of 2022, we experienced the benefits of slower and lower deposit betas as we posted a NIM, TEY increase of 24 basis points during that period. However, those deposit betas accelerated as we progress through the second half of the year before additional Fed rate increases. For the first half of the year, our beta on total deposits was 8%. For the third quarter, our beta on total deposits moved to 31%.

And for the fourth quarter, it was 44% as a result of an accelerated shift in our deposit mix for noninterest-bearing to interest-bearing accounts and from demand deposits to CDs. For the full current rate height cycle to date, our beta on total deposits is 27%, which is comparable to our beta from the last period of rising rates that ended in 2019. With robust organic loan growth and NIM expansion for the year, our net interest income has also experienced significant growth, and we have achieved a NIM at or near the top of our peer group. Looking ahead, we project our NIM, excluding the impact of acquisition-related net accretion, to remain fairly static in the first quarter of 2023. Additionally, we expect acquisition-related net accretion to return to a more normalized level of approximately 500,000 per quarter.

Turning to our noninterest income, which was 21.2 million for the quarter, up slightly from the 21.1 million we generated in the third quarter. Notably, our capital markets revenue was 11.3 million, an increase of 800,000 from the third quarter and within our guidance range of 10 million to 12 million. Despite the project delays that some of our clients have been experiencing, our pipeline remains strong. Capital markets revenue has averaged just over 10 million per quarter for the last four quarters, and therefore, we expect this source of fee income to be in a range of 40 million to 48 million for the full-year 2023. In addition, we generated 3.6 million of wealth management revenue in the fourth quarter, up slightly from the third quarter.

Our wealth management team continues to generate meaningful new client relationships and is adding significant new assets under management, adding 340 new clients and 481 million in AUM this past year. This strong growth in new clients helped offset the sharp decline in stock market valuations that occurred in 2022. Now, turning to our expenses. Noninterest expense for the fourth quarter totaled 49.7 million, compared to 47.7 million for the third quarter. The increase from the prior quarter was primarily due to higher incentive-based compensation related to our record full-year performance, partially offset by lower professional and data processing fees due to the completion of the core conversion at Guaranty Bank and other merger cost savings.

Looking ahead to the first quarter of 2023, we anticipate that our level of noninterest expense will be in the range of 49 million to 51 million. This guidance range reflects less than a 5% increase in our fourth quarter noninterest expense run rate after excluding acquisition-related items and is consistent with our strategic 9, 6, 5 initiatives. Turning to asset quality, which improved significantly in the fourth quarter and continues to be quite strong. Nonperforming assets declined by 51% to 8.9 million at the end of the fourth quarter driven by payoffs of several NPAs during the quarter. The ratio of NPAs to total assets was at quarter-end, compared to 0.23% for the prior quarter. In addition, the company’s criticized loans and classified loans to total loans and leases at the end of the fourth quarter were fairly static at 2.68% and 1.08%, respectively, as compared to 2.35% and 1.29% from the prior quarter.

As a result of continued improvements in overall credit quality, the company recorded no provision for credit losses in the fourth quarter. Our allowance for credit losses remained strong at 1.43% of total loans and leases. This allowance represents 10x our nonperforming loans and leases. We strengthened our total risk-based capital ratio during the quarter, posting an improvement of 9 basis points to 14.47%. We also increased our tangible common equity to tangible assets ratio to 7.93% at quarter-end, up from 7.68% at the end of September. Our tangible book value per share increased by 6.8% during the fourth quarter. This was due to both our strong earnings and a $10 million increase in AOCI as a result of an increase in the value of our available-for-sale securities portfolio and certain derivatives due to changes in long-term interest rates during the quarter.

During the fourth quarter, we purchased and retired 100,000 shares of our common stock at an average price of $50.37 per share, as we executed purchases under the share repurchase plan announced during the second quarter of 2022. Finally, our effective tax rate for the quarter increased to 15.9% and from 14.1% in the third quarter. The rate was higher due to a higher ratio of taxable earnings to tax-exempt revenue in the fourth quarter. Our effective tax rate for the full-year 2022 was 12.8%, an improvement from 18.6% in 2021. This was primarily due to strong growth in tax-exempt revenue, mostly from tax exempt floating rate loans, as well as increased benefit from our tax credit portfolio. We expect the effective tax rate to be in the range of 12% to 14% for the full-year 2023.

With that added context on our fourth quarter financial results, let’s open up the call for your questions.

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Q&A Session

Operator: Our first question comes from Jeff Rulis with D.A. Davidson. Please go ahead.

Jeff Rulis: Thanks. Good morning, Larry and Todd.

Larry Helling: Good morning, Jeff.

Todd Gipple: Good morning.

Jeff Rulis: On the nonperformers, kind of the cleanup there, could we get any more color on the payoffs were those credits that you’ve been working on for some time or just, sort of what type of loans were those looking for any, kind of color?

Larry Helling: Yes. The only one, Jeff, that was over 7 figures, was one commercial real estate loan that we had fully reserved for several quarters. And we just thought there’s a dispute between, not us, between the borrower and a contractor, and we decided that it would be best just to charge it off. And so, we would hope to get some recovery in 2023, but because of the dispute, we decided it’s best just to clean it up. The other couple of credits, there were a couple that were 6 figures that we decided just to clean up, and so you saw some really nice improvement in our NPAs. We had one large NPA that just paid-off that was middle 7 figures. It’s been on our list for a long time that we got paid off in the fourth quarter. So, over the last two quarters, we’ve dropped our NPAs by two-thirds down to what a number I didn’t think was possible a few years ago down to 11 basis points. So, our team has done a great job there.

Jeff Rulis: Okay. And were there any associated recoveries of a meaningful amount on some of that cleanup?

Larry Helling: No substantial recoveries. We expect a couple of those in 2023 because of the cleanups here, but just small odds stuff, nothing substantial, Jeff.

Jeff Rulis: Okay. Todd, just to kind of narrow in on the margin, do you have the average in the month of December, what that ?

Todd Gipple: Sure. Jeff, great question. That’s one of the reasons we were guiding to a static margin intra-quarter, we actually saw improvement each month in margin. Our core margin was for the full quarter. It was in October, in November and in December. So, we got some nice run there intra-quarter. Part of that was €“ for the first time, we were really seeing the improvement in new loan yields that we had expected candidly to start in the fourth quarter. It was really more towards the end. Our yields on new loan fundings in December were 80 basis points higher than October. So, part of the run up there towards the end of the quarter.

Jeff Rulis: Okay. And I know that you, kind of gave us a little read on Q1, but thereafter, it’s €“ any expectation would be near at, kind of that level as maybe deposits, kind of chew into earning asset yield improvement or kind of what would be the further around expectation?

Todd Gipple: Sure, Jeff. I think static is going to continue to be the right word for us, whether it’s Q1 or looking a little further into the year. We feel really good about not only the intra-quarter improvement and that traction on fixed rate loan pricing, but part of the challenge we have with margin in the fourth quarter is, we saw a very significant, more than we had forecasted, shift from noninterest-bearing and low beta deposits into higher beta and CDs. We saw a pretty significant runoff in correspondent balances, 55 million in noninterest-bearing, 66 million in money market, but that has reversed already here in January, which gave us significant confidence in talking about a static margin. So, correspondent deposits have started to come back quickly in January.

Noninterest-bearing is up 33 million, money market up 221 million, and we feel really good about the start to the quarter. So, kind of long answer to your short question, Jeff, I think static is really the word not just for Q1, but as we look a little deeper into 2023.