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

QCR Holdings, Inc. (NASDAQ:QCRH) Q4 2023 Earnings Call Transcript January 24, 2024

QCR Holdings, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Greetings and welcome to the QCR Holdings Incorporated Earnings Conference Call for the Fourth Quarter and Full-Year 2023. Yesterday after market close, the company distributed its fourth quarter earnings press release. If there is anyone on the call who has not received the 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 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 management will 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 January 31, 2024 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, CEO. Please go ahead.

Larry Helling: Thank you, operator. Welcome everyone. And thank you for joining us today. I will start the call with a high-level overview of our 2023 performance and the factors that continue to drive our success. Todd will follow with additional details on our financial results for the fourth quarter and the full year. We delivered record fourth quarter and full-year results highlighted by significant fee income and robust loan growth. In addition, for the full-year 2023, we completed our first two securitizations of low-income housing tax credit loans, grew core deposits and maintain our strong asset quality. We continue to benefit from our diverse revenue sources which includes capital markets and wealth management fees.

The expansion in our non-interest income for the year overpowered the pressure on our net interest income. We also continue to strengthen our capital levels with exceptional earnings performance. As previously announced on December 12, we successfully closed our first two low income housing tax credit loan securitizations. The ability to securitize these loans is an important and effective tool in managing our liquidity and capital. It also enhances the sustainability and continued growth of our LIHTC lending and the related capital markets revenue. Our outstanding performance in 2023 is the result of our differentiated relationship-based community banking model. Our multi-chartered model enabled our local management teams to respond with speed and agility to our client needs.

This results in a superior client experience that outperformed the larger national and regional banking alternatives. Our team of dedicated employees has driven our success. We have a strong corporate culture throughout our company and our employees are engaged with our clients and heavily involved in our communities. Recruiting and retaining talented employees is a top priority for us. Our reputation and culture attract the best bankers in our markets. We continue to receive high employee engagement scores, which are measured annually across our company. In addition, our local charters have won numerous awards throughout our footprint for being great places to work and do business. We believe that this leads to important outcomes, such as low turnover, improved productivity, higher profitability and enhanced shareholder value.

Finally, we operate in some of the most vibrant and mid-sized markets in the Midwest. Our markets include regional economies with a diverse mix of commercial, industrial, and technology-focused activity. These areas attract highly educated workforces which helps drive steady economic growth, high relative household income and low employment. 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 12% and our deposits at 10%. These results have supported the 17% compounded annual growth in our core diluted earnings per share and the 30% compounded annual growth in our tangible book value per share over the same period. We have grown at a consistent pace but we’ve also significantly increased our profitability delivering annual core ROAA of 1.59% in 2022 and 1.41% in 2023 which is near the top of our peers.

For the full year 2023, we delivered record net income of $113.6 million or $6.73 per diluted share. After adjusting for non-core items, our adjusted net income for the year was $115.1 million and our adjusted diluted EPS was $6.82. Total loan and lease growth for the full year was 11% prior to securitizing $265 million of low income housing tax credit loans and 7% on a net basis. Our full-year loan growth exceeded our guidance range of 8% to 10% provided at the beginning of the year. The robust loan growth was driven by our LIHTC lending program and solid performance from our traditional lending business. Given our current pipelines and ongoing strength of our markets, we are targeting loan growth of between 8% and 10% for 2024 prior to our planned loan securitizations.

We are planning our next securitization of LIHTC loans of approximately $200 million in the middle of 2024. We intend to use securitizations to manage our net annual loan growth in the range of 4% to 6%. Our total deposits for the year grew $530 million or 9% as we continued to expand the number of client relationships and grew balances from existing client accounts. Core deposits excluding short term-broker deposits increased $346 million or 6% for the year. We have built a strong and diversified deposit franchise over the past 30-years. And our full-year activity in 2023 reflects the importance of that franchise. Growing core deposits remains a significant focus which we believe will drive long-term shareholder value. Accordingly, our bankers are incented to grow both deposits and loans.

During the year, we grew non-interest income by $52 million or 64% driven primarily by the strong growth in our capital markets revenue. Strong fee income overpowered the pressure on net interest income. Our asset quality remains excellent as the ratio of non-performing assets to total assets was 40 basis points at the end of the year. We are comfortable with our reserves, which represents 1.33% of total loans and leases held for investment. We remain disciplined with our reserves and continue to diligently monitor asset quality across all of our business lines. While we are mindful of the impact that elevated interest rates may have on the economy, we 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 potential economic uncertainty.

Our capital levels are strong and we are focused on building upon our capital base in the year ahead. We continue to target capital ratios in the top quartile of our peer group. We believe that our modest dividend, strong earnings power and access to the securitization market will allow us to continue to grow capital faster than our peers. In conclusion, I would like to thank our entire QCR Holdings team for their hard work and dedication to outstanding client service and for delivering record financial results. Our employees fuel our success. And I’m very proud of all that we’ve accomplished together in 2023. With that, I will now turn the call over to Todd to discuss our financial results in more detail.

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. We grew total loans held for investment 13% on an annualized basis in the fourth quarter. This was primarily driven by continued strength in our LIHTC lending program and solid contributions from our traditional lending business. As Larry mentioned, we successfully completed our first two loan securitizations in the fourth quarter, totaling $265 million. The first securitization consisted of $130 million of tax-exempt LIHTC loans and was part of the Freddie Mac sponsored M-Series. The second securitization consisted of $135 million of taxable LIHTC loans that was part of the Freddie Mac sponsored Q-Series.

Upon closing of the securitizations and selling of these loans, we recognized a net gain on sale of $664,000. More importantly, the securitization strengthened our liquidity by lessening the pressure on higher cost funding which further stabilized our deposit mix and enhanced our TCE ratio. Our securitization strategy will enable us to continue to fund the growth of our LIHTC lending business. In addition, securitizations will add to the long-term sustainability of 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. Our Correspondent Bank deposit portfolio typically falls temporarily in the fourth quarter as our clients position their balance sheets at year-end.

Total Correspondent deposits declined $55 million or 9% at quarter end. And have since rebounded significantly increasing $188 million or 35% by mid-January. As Larry mentioned, we grew core deposits $346 million or 6% during 2023 which has allowed us to fund our strong loan growth. We place a high importance on the mix and diversification of our deposit base to provide the most cost effective path and funding our growth. We believe that our focus on growing core deposits will generate long-term value for our shareholders. Our total uninsured and uncollateralized deposits remain very low at 18% of total deposits. In addition, the company maintain approximately $3.1 billion of available liquidity sources at year-end, which includes $1.2 billion of immediately available liquidity.

Now turning to our income statement. We delivered record net income of $32.9 million or $1.95 per diluted share for the quarter. Our record results were driven by very strong non-interest income from capital markets revenue. Our adjusted net income was $33.3 million or $1.97 per diluted share. Net interest income was $55.7 million a modest increase from the prior quarter as we overpowered the securitization and sale of $265 million of loans. We are pleased that adjusted NIM on a tax equivalent yield basis improved by 1 basis point on a linked quarter basis to 3.29% which was above the midpoint of our guidance range. During the quarter, our loan and investment yields continued to expand and modestly outpaced the increase in our cost of funds.

We experienced a lower increase in our cost of funds with a slowing in the shift of the composition of our deposits from non-interest and lower beta deposits to higher beta deposits. We are pleased to see continued stabilization in our deposit mix. In addition, our securitizations help lessen the pressure on higher cost funding further stabilizing our deposit mix. Looking ahead, we anticipate a continued pause from the Fed and a yield curve that continues to be partially inverted for the next quarter. At this point in the interest rate cycle, we expect that the increase in our average loan and investment yields will generally offset any further increase in our funding costs. As a result, we are guiding to a relatively static adjusted NIM TEY in the first quarter of 2024 with a range of 5 basis points of expansion on the high end and 5 basis points of compression on the low end.

We do expect that the Fed will begin to cut short-term interest rates later in the year. During 2023, our balance sheet has shifted from asset-sensitive to a more moderate liability-sensitive position with the funding mix shift to more higher beta funding. As a result, we are well positioned for a rates down scenario, particularly if the yield curve becomes less inverted at the same time. Turning to our non-interest income of $47.7 million for the fourth quarter, which increased $21.1 million or 80%. Our capital markets revenue was a record $37 million this quarter, up from $15.6 million in the prior quarter. For the year our capital markets revenue was $92.1 million, significantly in excess of our $45 million to $55 million annualized guidance range.

Capital markets revenue surged late in the fourth quarter and was $37 million for the quarter. Our clients took advantage of the significant decrease in long-term interest rates late in the quarter to lock in attractive financing terms. Capital markets revenue from swap fees continues to benefit from the strong demand for affordable housing. Even with our strong results in the fourth quarter, our LIHTC lending and capital markets revenue pipelines remain healthy. As a result, we are increasing our capital markets revenue guidance for the next 12 months to be in a range of $50 million to $60 million. In addition, we generated $4.1 million of wealth management revenue in the fourth quarter, up 9% from the third quarter. For the full-year, wealth management revenue was up $1.1 million or 7%.

Our wealth management teams continue to create new relationships, adding 340 new client relationships and 700 million in assets under management this past year. We are also pleased with the early results from our new wealth management business in the Southwest Missouri market at our guarantee bank charter. We have a highly experienced team in place that is already expanding the reach of our current wealth management business. Now turning to our expenses. Non-interest expense for the fourth quarter totaled $60.9 million compared to $51.1 million for the third quarter. The linked quarter increase was primarily due to higher variable employee compensation based on our strong full-year results. After adjusting for the higher variable compensation, our normalized expenses were $51.9 million just above our guidance range.

Looking ahead to the first quarter of 2024, we anticipate that our level of non-interest expense will be in the range of $49 million to $52 million. This guidance range reflects our focus on closely managing our recurring noninterest expenses during 2024. Now turning to asset quality, which continues to be quite strong. During the quarter, NPAs declined by $500,000 to $34.2 million or 40 basis points of total assets. The provision for credit losses was $5.2 million during the quarter, which included $2.5 million of provision for loans and leases and $2.7 million of provision for unfunded commitments. The increased provision for credit losses on unfunded commitments was driven by the surge in commitments in our LIHTC lending business. Our allowance for credit losses to total loans held for investment was 1.33%.

We expect to continue to maintain strong reserves, given the uncertain economic environment. We increased our tangible common equity to tangible assets ratio by 70 basis points to 8.75% at quarter end, up from 8.05% at the end of September. The fourth quarter improvement in our TCE ratio was driven by a combination of our strong earnings, loan securitizations and a $25.4 million increase in AOCI. The increase in AOCI was the result of growth in the value of our available for sale securities portfolio and certain derivatives due to the decline in long-term interest rates. Our total risk-based capital ratio was 14.15% at quarter end a decline of 33 basis points. This was a result of the significant increase in total risk-weighted assets due to the growth in unfunded commitments related to our LIHTC lending business as well as growth in total loans and leases during the quarter.

We are pleased to have increased our tangible book value per share by $3.48, or 35% annualized during the fourth quarter and 19% for the full year. Finally, our effective tax rate for the quarter was 12%, compared to 7% in the prior quarter. The linked quarter increase was due primarily to the significantly higher capital markets revenue we earned during the quarter increasing the mix of our taxable income as compared to our tax-exempt income. For the full year, our effective tax rate was 10%. We 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 expect the effective tax rate to continue to be in a range of 8% to 11% for the full-year 2024.

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

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Q&A Session

Operator: We will now begin the question-and-answer session. [Operator Instructions] Our first question is from Nathan Race with Piper Sandler. Please go ahead.

Nathan Race: Hi guys, good morning. Thanks for taking the questions.

Larry Helling: Good morning, Nath.

Todd Gipple: Good morning, Nath.

Nathan Race: I appreciate the commentary Todd for the kind of static margin and consistent guidance that you provided last quarter there for the first quarter, but just curious how you’re kind of thinking about the margin impact from Fed rate cuts occurring at some point this year. I imagine with some of the LIHTC securitization that you guys completed in the fourth quarter that that maybe reduces your rate sensitive assets, but would just be curious to kind of get your thoughts on kind of how the rate sensitivity stacks up today in terms of rate sensitive assets and on the other side of the balance sheet as well.

Todd Gipple: Sure. Nath, the securitization does impact both sides of the balance sheet, obviously, but really it’s a bigger win for us in terms of taking pressure off of funding cost and that’s a big part of the benefit we saw in the fourth quarter with a static NIM and our guide for Q1. I’ll get to potential rate cuts here in a moment. But candidly, just to be transparent, we’re really expecting static here in the first quarter and that has a lot to do with again the dramatic slowing in the mix shift of our core deposit portfolio and that’s where securitization has really helped us. So I’ll just be candid. My notes say relatively static deposit portfolio, it was actually very static, very little movement and that’s really benefited us, and we expect that to continue here in the first quarter.

So given the thousands of items that impact margin, we think it’s prudent to give a collar around that. Hence the 5 up or 5 down. What makes us feel comfortable with a relatively static NIM though is most of our loan growth in the fourth quarter was very late in the year in December and we do — we guided to another 8% to 10% loan growth pace, so good loan growth is coming with some good pricing. So we’re starting to get better pricing power on loan yields. That deposit mix I talked about is very static. And when we look at our CD repricing whether it’s core or brokered, we think we can be fairly neutral on repricing rates when we replace those with core deposits, so for all those reasons, we’re very comfortable really effectively guiding to a static margin.

We’ll get some better results if we can claw back a few basis points on some of our higher beta deposits and we expect to do that. And if we can get even better new loan pricing, we may have poorer results than that if we don’t get some cost of funds relief and if we don’t see that yield expansion. But we certainly believe that we will. And then maybe to get to your end question, where do we sit in terms of sensitivity now with the change in our deposit mix and securitization? We do present as slightly liability-sensitive and not a high degree of precision around this yet. But a 25 basis point cut might give us $2 million to $3 million in NII annually and maybe three to five basis points of NIM accretion. So we are situated from a balance sheet perspective to take advantage of rate cuts should they come later in the year.

Nathan Race: Okay, great. And then just within the context of the 8% to 10% loan growth guidance for this year, curious how you guys are thinking about core deposit gathering prospects if that can largely keep pace with loan growth, or do you expect kind of a moderate lag just given the likelihood for an additional securitization or two at some point this year?

Todd Gipple: Sure, Nate, we are incredibly focused on core deposit growth. I’ll let Larry tag on a little bit here, but we’ll just tell you that while our loan to deposit ratio floated up right at quarter end, we have seen some nice inflows back in of deposits more seasonally here at the first of the quarter. And our loan to deposit ratio is back down to 97 and we do expect to keep pace with our loan growth with core deposits. I know, Larry has got some other comments around that.

Larry Helling: Yes. What I’d add Nate is we’re in the middle of resetting incentives for 2024 with both staff and certainly there won’t be any dramatic shift in how we look at things, but a greater emphasis on deposits generation and incentives for our staff in 2024 to make sure that we keep pace.

Nathan Race: Okay, great. And then just turning to capital markets revenue obviously really, really strong quarter here in 4Q. It sounds like the pipeline is still pretty strong just based on the increase in unfunded commitments within the loan provision this quarter. So would just be curious to hear if there was any pull through in activity, which, again, it doesn’t seem like was the case here in 4Q. And obviously, you raised guidance, so would just love some updated commentary in terms of what you’re seeing in terms of opportunities across that asset class today.

Larry Helling: Sure, Nate, I’ll give it a crack here. First of all, as you know, incredibly strong quarter and the stars kind of aligned and what really happened is if you look back a little more historically at our ability to produce new business and fees, there was a dip in 2022 and that was really caused by several factors. Inflation, inability to get materials, availability of labor and a spike in interest rates back in 2022, and then those variable started to ease in 2023 and we were on track to have a really solid tick up in swap fee income and capital markets revenue. And then the long end of the yield curve dropped dramatically in the fourth quarter, which caused our clients to say, hey, I want to lock in my funding costs as quickly as they could.

So they were pushing on. They were in our pipeline and now they are going, we want to get our — all of our variables lined up as quickly as we can. So we had a really strong fourth quarter and stronger than we anticipated. Most of it was the ’22 business that got closed in 2023 because of all those other historic variables we talked about. So we were confident enough in our overall pipeline to look at it and say, okay, we’re going to increase our guidance by $5 million for the year. And there is seasonal variability here, as you know, so I’d encourage you to maybe look back at the swap fee income quarter-to-quarter. It’s generally a little bit lighter in the first quarter of the year as our clients kind of reset their activities in the LIHTC space and so annually, we feel really good about our guidance and our pipeline of business but if you look back at the history, the first quarter generally may perform maybe in the lower end of our annual guidance range, but certainly we feel strongly about the ability to produce the guidance that we’ve given to you.