QCR Holdings Inc (QCRH) 2017 Q2 法說會逐字稿

Greetings, and welcome to the QCR Holdings Inc. Second Quarter 2017 Conference Call. Yesterday, after market closed, QCR distributed its second quarter press release and we hope that you've had the opportunity to review the results. If there is anyone on the call who has not received a copy, you may access it at the company’s website, www.qcrh.com.

With us today from management are Doug Hultquist, President and CEO; and Todd Gipple, Executive Vice President, COO and CFO.

Management will provide a brief summary of the quarter, and then we will open up the call to questions from analysts.

Before we begin the call, 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, I must point out that 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, from time to time in the company's 10-K and 10-Q filings, which may be obtained on the company's website or the SEC's website.

As a reminder, this conference is being recorded and will be accessible on the company's website until August 4, 2017.

At this time, I will now turn the call over to Mr. Doug Hultquist at QCR. Please go ahead.

Good morning, everyone. Thank you for joining us today and we would like to welcome you to our quarterly earnings call for the quarter ended June 30, 2017.

Initially, I will recap some of the highlights for the second quarter, and then we'll turn the call over to our Chief Operating Officer and Chief Financial Officer, Todd Gipple, who will provide some additional color on our financial results.

I'm pleased to begin this morning's call with news that we completed another solid quarter with earnings of $8.8 million and diluted earnings per share of $0.65.

While earnings were down slightly from the prior quarter, earnings for the first half of the year were strong, with net income of $18 million and diluted EPS of $1.33 versus $13.1 million and $1.07 for the same period a year ago.

We continue to make solid progress in further improving our return on average assets, as our run rate is now 1.08% for the year-to-date compared to 1% for the first half of 2016.

These improved results from the prior year were driven by strong, organic loan growth, robust growth in core deposits and a corresponding reduction in our reliance on wholesale funding. In addition, we had margin improvement, solid fee income and modest operating expense growth.

During the second quarter, we also announced our planned acquisition of Guaranty Bank and Trust Company headquartered in Cedar Rapids, Iowa. We expect to close this transaction in late Q3 or early Q4 pending regulatory and shareholder approvals and other customary closing conditions. We are very pleased to have the opportunity to combine the great people and clients of Guaranty with our existing Cedar Rapids Bank & Trust charter, and further strengthen our market position in the Cedar Rapids community.

Before I ask Todd to provide some additional comments on our financial results, I did want to comment on our loan growth for the quarter. We had very strong, organic loan growth this past quarter of 19.2% on an annualized basis. With much of this growth in our C&I portfolio. This puts us at an annualized growth rate of 12.3% for the first half of the year, which is the higher end of our targeted growth rate of 10% to 12% annually. We continue to have success, taking market share from our competitors as we attract clients to our relationship-based community banking model.

Our long-term focus is on continued improvements and return on average assets and our strategic goals and related strategic initiatives are focused on achieving return on average assets results in the upper quartile of our peer group. We believe that we have made good progress on this strategic goal thus far in '17, within an ROAA of 1.08%.

And now, I'll turn it over to Todd for more detail on our financial results for the quarter.

Thanks, Doug. Good morning, everyone. Thanks, again for joining us on the call today.

While our second quarter results were down slightly from Q1, linked quarter net income was nearly identical for the quarters, if you exclude the impact of the tax benefit related to stock option exercises and restricted stock awards that vested in each of the quarters. The reduction in this tax benefit realized in Q2 compared to Q1 was $443,000, as fewer options were exercised and fewer stock awards vested in Q2.

Net interest margin percentage was reduced on a reported basis by 9 basis points, from 3.90% in Q1 to 3.81% in Q2. However, net interest margin, excluding the impact of acquisition accounting accretion, was down only 1 basis point at 3.62% for the second quarter, compared to 3.63% for the first quarter.

Net interest income was up slightly at $28 million versus $27.7 million in the prior quarter. While net interest margin excluding loan discount accretion was down about 1 basis point for the quarter and loan discount accretion was also reduced by $477,000 on a linked-quarter basis, this was more than offset by the very strong loan growth in Q2. We expect further improved net interest income from this strong loan growth, as much of the growth occurred in the last half of the quarter.

Provision expense was relatively flat this quarter as well due to a continued strong asset quality, which offset the additional provision needed for our strong loan growth this quarter.

Noninterest income was down approximately $500,000 on a linked-quarter basis, as gains on the sale of government-guaranteed loans was down more than $850,000 in Q2 versus Q1. As we have experienced in past years, given the nature and timing of these types of loans, this revenue source can fluctuate significantly from quarter-to-quarter.

Wealth management revenue has been strong and is up 19% year-over-year. We've added 217 new relationships and $183 million in assets under management thus far in 2017.

We now have $3.1 billion in assets under management, with $1.2 billion in trust assets, $954 million in brokerage and our RIA accounts and $894 million in custody assets.

Noninterest expenses continue to be well controlled and were relatively flat compared to the prior quarter. The impact of these results was a fairly consistent net income on a linked-quarter basis.

Net income of $18 million for the first half of 2017 represents core ROAA of 1.08%, and an efficiency ratio of 61.16%, which we consider to be continued good progress on our goal of achieving upper quartile ROAA.

Earnings per share for the first 6 months was $1.33 versus EPS of $1.07 for the same period in 2016, which represents a 24% increase in earnings per share.

As we look to the remainder of the year, we will continue to focus on our 7 key initiatives, which we have highlighted in our filings. Continued strong organic loan and lease growth to maintain loans and leases to total assets ratio in the range of 70% to 75%; continue to focus on growing core deposits to maintain our reliance on wholesale funding at less than 15% of total assets; continue to focus on generating gains on the sale of USDA and SBA loans, and fee income on swaps as a significant and consistent component of core revenue; grow wealth management net income by 10% annually, carefully manage noninterest expense growth; maintain asset quality metrics at better than peer levels; and finally, participate as an acquirer in the consolidation taking place in our markets to further boost return on assets, improve our efficiency ratio and increase earnings per share. Strong progress on these 7 initiatives the past 2 years has resulted in significant improvement in our financial performance, and the achievement of peer levels of ROAA. We will need to continue to execute on each of these initiatives to achieve our goal of upper quartile peer performance.

Now I'll turn it back to Doug to wrap up.

Thanks, Todd.

Again, we are pleased with our second quarter results and hope that our comments have provided a bit more insight into the numbers.

We can now open the phone lines for questions.

(Operator Instructions) Our first question comes from Jeff Rulis with D.A. Davidson.

Question on the loan growth. I guess -- any idea if that strong production in the later part of the quarter, did that pull or sort of cannibalize any growth out of Q3? Or do you -- your expectations for the back half still pretty positive.

Yes. Based on what we've seen so far in July, Jeff, it continues and the pipelines are strong.

Got it. Okay. And then on the expenses, in that -- one of the key initiatives of managing expense growth, is that indicative of kind of the growth pattern, Q1 to Q2, that is -- I guess, do you have a full year kind of figure that, that would signify that you're managing growth?

Yes, Jeff, we have a target of around 2% growth on an annualized basis in noninterest expense. We have some nice results here in Q2 compared to Q1. And so that really if you're asking, what our level of success measurement would be, it would be around the 2% number.

Great. And then maybe one last one, just -- it looks like a little pick up in interest-bearing costs. You're seeing any market pressure on deposits? And if so, do you -- would you expect further pressure there?

Yes, Jeff, great question. We've got $3.1 billion in funding from deposits. About $750 million of that would be noninterest bearing. The other 2.4-ish interest bearing. And of that, roughly $550 million would be fairly rate sensitive. So roughly 25% of our interest-bearing deposits are what we would consider fairly rate sensitive. That, we did see a pickup in cost of about 25 basis points on that $550 million last year. Those are fairly rate sensitive. The remaining balance of 75% of those interest-bearing liabilities have been quite flat. We've seen very little, if any pick up there. Our retail core deposits are not under pressure for pricing, which is a very good thing. And so -- while there will be some continued pricing pressure there, we don't believe it'll be all that extensive. We feel pretty good about our mix there.

The next question comes from Daniel Cardenas with Raymond James.

Couple of quick questions. Just maybe if you could give us a quick update on the ag portfolio and what you're seeing there? And there if there is any negative trends that are beginning to emerge within that portfolio that you're paying close attention to?

Yes, Dan. We don't have any direct ag exposure. Obviously, being located where we are there is a fair amount of indirect suppliers to John Deere and the like. But if anything, I would say they are feeling better over the last quarter, and Deere's last earnings report was pretty positive in terms of trends. So hopefully, we've bottomed out there.

Good, good. And then looking at deposit trends in the quarter, you guys were up quite nicely on the deposit side, ended with a loan-to-deposit ratio around 89%, 90%. Maybe thoughts about the ability of the deposit portfolio growth to keep up with loan growth in the second half of the year? And then, ideally, where do you like to see that loan-to-deposit ratio?

Yes, Dan. We feel really good about our prospects for future growth and core deposits. We are having a very good year thus far. Pipelines and our expectations for the last half of the year remain strong. We're not focused as much on our loan-to-deposit ratio, Dan, as may be little bit more telling is, we're very focused on holding down our reliance on wholesale. And we've driven that down below 10% now. We're working very hard to keep it there. Of course to do that, when you grow loans at the clip, we are, we are going to have to have very solid core deposit growth, and we have thus far. We believe that will continue. It is a huge focus for us. We believe that core deposit growth is a real indicator of franchise value. And maybe to get into the Guaranty discussions a little bit, but we're very much looking forward to that transaction closing later this year. And for example, they have a little over $200 million in core deposits priced at 26 basis points currently. So we are expecting to continue to fund primarily with core deposits.

Good, good. And then, how should we be thinking about yield accretion in the back half of the year? You're in about, what, $3.7 million in the first two quarters of '17. Can we expect that number to kind of shrink -- continue to shrink going forward? Or is that kind of a good run rate?

Yes, Dan, great question. Of course, as we pick up some early accretion from payoffs and renewals, that monthly run rate is flattening out a bit. So just to recap on where we're at with loan discount accretions specific to CSB, we have $1.6 million total for the quarter. About half of that was accelerated with the payoffs on renewals. That portfolio tends to churn a bit more due to the C&D nature of some of that portfolio. So $880,000 actually was due to early payoff. So our monthly run rate now is about $200,000 a month on scheduled accretion. That's down from about $250,000 last quarter. So that is trending closer to $600,000 a quarter now. We've got $6.3 million left. And that will continue to, on a scheduled basis, slow down as we pick up some of the one time.

Okay. Great. And then just last question and I'll step back here. But -- your FTEs on a sequential quarter basis went up by about 24 people. Was that on the lending side? Just maybe a little bit of color as to where you're adding staff?

You bet, Dan, we have a fairly robust internship program around our member banks and even at the Holding company, we tend to do a fair amount of summer interns. 14 of those FTEs are just summer interns that we would, of course, see roll off here before the end of the third quarter. Some of the other adds are producers. And we've had some good success in terms of adding some real talent really at each of our banks. So it's an outsized growth number this quarter primarily because of the interns.

The next question comes from Damon DelMonte with KBW.

Great. So just to touch on the loan growth again in the C&I portfolio, could you just talk a little bit about some of the types of loans that you're putting on? And maybe what size loans you're putting on?

Yes. It's very spread among the charters and among industries. C&I accounted for over 80% of the increase. And really not any significant concentrations, Damon.

Okay. And where these existing lines of credit that were drawn down on? Or are these new customers who immediately utilized the line of credit?

Yes. Fair amount of that would be new clients, Damon. We continue to have great success taking market share from our bigger bank competitors. And candidly, the vast majority of those new relationships would be coming from some of the large banks in our community as Wells Fargo, U.S. Bank and the like.

Okay. That's helpful. And also -- are most of these loans self originated? Or are you guys purchasing anything through the Shared National Credit Market?

Very modest there. We have had very little activity in the SNC Program the last couple of quarters. There's a few participations in here, but most of them are organic.

Okay. Have you disclosed the size of your SNC portfolio?

I believe it's in some of our Q filings. Damon, I'll check on that. And that's probably a great idea, if it's not already in our Q detail, and those pages and pages of loan footnotes, we should probably add it. So that's a great point. We'll make sure we do that.

Great. And then with regards to the fee income and the slowdown and the gain on sale government-guaranteed loans. I know in the past, you guys have said that you've targeted between the gain on sale government loans and swap fee income of about $4 million a year. Just wondering if you could provide an update on that guidance and that outlook. Do you expect any stronger second half of the year on the government side of this equation?

Yes, we have, wanted to be at around $4 million on a combined basis, and through the first half of the year, we're only at $1.5 million. Last year, we were at $3.5 million. Last year, we got off to a very fast start in the first half of the year. And then that slowed down a bit in the second half. We're optimistic that things will pick up, the USDA and SBA will always remain choppy, as much as we would like that to be large and consistent. It tends to be large but inconsistent. So that's going to remain choppy, Damon. What I can tell you is that our pipelines on swaps are very robust right now. The very slight yield curve has made swaps very attractive for our clients. And so we're looking at, likely, having a very strong second half in swaps. USDA and SBA, a little tough to predict that.

Okay. All right. And then I guess -- as most of my other questions were already asked and answered. I guess just lastly, any change to your outlook on margin with regards to interest-rate sensitivity? I know you guys historically have been more liability sensitive, but didn't know if anything has changed in the last quarter?

Yes, Damon, great question. That really is the issue for us, if we're going to start seeing some margin expansion. And I would tell you, we're optimistic about margin. Several reasons, 46% of our very significant loan growth this quarter, 46% of that happened in the last month of the quarter, in June. So we've yet to see the full impact of that benefit of loan growth. And we will, of course, here in Q3. Couple of other things. The total rate sensitive funds that I mentioned, about $550 million, that compares to our floating-rate loan portfolio, that's now about $750 million. So we do see in those 2 areas of our balance sheet some opportunity for margin expansion and feel pretty good about that. Our floating-rate loans over our true rate sensitive funds would be about 137%. So we do have some capacity there. I did mention the very low cost guarantee funds that we would expect to add to our balance sheet at close here for the fourth quarter of the year. That certainly will help as well.

Okay. So, absent the impact on the accretable yield, the core margin -- quarter-over-quarter, I think you said was down 1 basis point. It sounds like we'll see a little bit of lift coming in the third quarter, and hopefully into the fourth quarter based on what you just described.

Damon, that's fair. We would expect margin to expand a bit as a result of all those things I just pointed out.

The next question comes from Erik Zwick with Stephens Inc.

Maybe I'll start another one on the deposits. Looking at your deposit mix, noninterest-bearing deposit concentration. Still very healthy, about 27% of total deposits. But those balances have now declined 2 consecutive quarters. Can you talk about the factors that are at play there? Is there more than just higher rates?

Yes. Couple of things. Probably the most -- the single most significant impact on our noninterest bearing would be the correspondent banking relationships that we have. That number, in terms of noninterest bearing on correspondent would have peaked at $300 million to maybe even as high as $340 million, few quarters ago. That has tempered down to around $230 million to $240 million in noninterest bearing on correspondent. So virtually, that entire fall on noninterest bearing is attributed to the change there. And the reason for that is, while those are noninterest-bearing relationships, they do earn a earnings credit rate against the fees that we charge our correspondent banks. And Erik, as you might guess, as rates come up, the earnings credit rate comes up. That now ranges from 85 basis points to 130-some basis points, depending on the size of the relationships, size of the deposits, some other factors. So, Erik, I'm guessing you can follow the math. If the earnings credit rate goes up, those balances can shrink and still pay for their charges. So we're not losing clients. We're not losing relationships. But banks that are managing their noninterest-bearing deposits with us are certainly able to manage those down and still get the same earnings credit balance. So that's really what's happening there. We're offsetting that with some very strong growth in some other types of deposits. We've seen some very nice growth at CSB, and the Des Moines metro, and all of that is retail deposit growth. So we're very happy about that. But we have seen a tail off in noninterest-bearing DDA. And again, the vast majority of that could be attributed to correspondent.

That's great color. Appreciate it. And then, can you update us on whether any new lending teams were added in the quarter? And what the pipeline looks like for that today?

We brought on a new senior lender in the Cedar Rapids market. But to be honest with you, most of the growth came with our existing teams. And our Specialty Finance Group had a good quarter as well in terms of what they originated.

And given some of your earlier comments on focusing on deposit growth going forward, any desire to add any deposit-focused bankers in the future?

Absolutely. That drives long-term franchise value, as Todd indicated earlier. And those folks are extremely hard to find. But we're always on the lookout for them. And we did add one in the Des Moines Metro late in '16, and his team is having quite an impact already.

Okay. And then, within your commercial real estate portfolio, can you remind us of your exposure to the retail sector? As well as maybe provide your view of the credit quality of that book today?

Yes. We monitor that very closely, and we've accelerated the due diligence that we've been doing there the last couple of quarters. We think our exposure is moderate. We think the locations are good. But clearly, with what's going on in the whole retail sector, we've got to be very sensitive to that.

The next question comes from Nathan Race with Piper Jaffray.

A lot of my questions have been asked and answered already, but I just want to walk -- ask one last one on expenses. I know, initially you guys are planning to convert CSB later this year, and I was just looking for maybe an update on that contract negotiations. If we can expect that to occur a little quicker than what you guys are expecting?

Yes, Nate. Actually, we don't plan to convert CSB until sometime in '18, not '17. Which you might be thinking of, Nate, is we are working on our negotiations with Pfizer currently for our master contract for the company. We're actually out in an RFP situation. And -- so that's probably, Nate, what you have in mind, that what is going to happen this fall is we hope to resolve our long-term data-processing contract. That will have some implications for the timing of that converging with CSB. But we currently maintain a separate platform for them. We believe we have that working as efficiently as possible, considering it as a second operating system. And it is a second system in Premier, that we're familiar with. It was the data processor used by CNB that we acquired in 2013. They're actually being processed out of the Des Moines Pfizer market. So it's right there on site. So it's going okay, going well. We are all looking forward to getting us all on one core at some point, but that won't be until '18.

Okay. Got it. And then would the plan to be also convert Guaranty at the same time in 2018 that you would look to bring everyone on to the same system as well?

Yes, Nate. Great question. You would assume so, however, a little different fact pattern at Guaranty and actually a good one for them and for us. Their contract, also with Pfizer, but on a little different product, Pfizer DNA, actually expires almost exactly at our closing date. So they do not have a long-term contract in place where we have any exit cost, because they are on a third platform, Pfizer DNA. We expect to convert them before the end of the fourth quarter. So almost immediately, we're actually working on that right now. Assuming we get all the approvals and get closed. We'll be converting them probably 60 to 90 days after closing. Putting them on our signature platform, our core platform for Cedar Rapids Bank & Trust, because we're merging that charter into CRBT. So hope that makes sense.

(Operator Instructions) The next question comes from Brian Martin with FIG partners.

Just a couple of things for me. Just kind of late in the call here. Just -- with regard to the core margin, Todd, I guess, you or Doug, just -- it sounds as though -- it being down whatever touch this quarter, or kind of flattish this quarter, is that more a function of the funding cost being up is there a little bit of lag on the loan pickup, given a lot of it occurred late in the quarter. Is that kind of how to think about that or am I thinking about that wrong?

No, Brian. I think you're right on top of that. It really had to do with a simple fact. We entered the quarter very liquid. We had a lot of deposit growth in Q1 and very modest loan growth. We entered the quarter very liquid. You could look at the summarized balance sheet quarter-to-quarter and determine pretty quickly that we have a lot of liquidity to work off and while that happened, much of it happened in the last month of the quarter. So we are optimistic about margin going forward.

Okay. And then just the last one. The new loans you made this quarter, I guess, what kind of yields have those coming on versus kind of where the portfolio is at, I guess?

Yes, coming in pretty much right on top of the existing portfolio. We actually saw a little bit of expansion in core loan yield, was actually up 5 basis points when you strip out the accretion on both quarters. So loan yield is up about 5 basis points, part of that would be some of our floating-rate loans but the new loans are coming in really on top of -- and Brian, that's really the issue I think, for the entire industry is we're not seeing much pricing power in those new loans. We're not able to really get much additional yield, additional spread on those new loans but neither is it slipping backwards. So pretty much right on top of the existing portfolio.

Okay. And the biggest contributor going forward to that, if you call it some core margin expansion. I guess, what's the biggest driver of that right now, Todd? I guess if it's up incrementally in the future quarters, what's the biggest driver of that?

Yes. I think the biggest driver would be putting all these new loans to work that came in late in the quarter. That's going to be a part of it. Our pipelines are still very strong and we expect to continue in that 10% to 12% range for growth. And that's very strong organic growth for a company in the markets we're in. So continued loan growth, continued success with funding that with core deposits, versus reliance on wholesale. And I'd mentioned earlier in the call that the CSB portfolio and the Des Moines metro is performing extremely well from a deposit pricing perspective. Very low, if not zero beta there. We're very pleased to be partnering with Guaranty in the Cedar Rapids market. They have a great core deposit portfolio priced at 26 bps. So those are really the things, Brian, that make us optimistic about margin.

Okay. Perfect. That's helpful. And then just the last couple of things. Just -- I know you talked about the lenders -- not a whole a lot of lenders added. But on the SBA side, your optimism in the second half is that, just the function of the activity there? Or have there been people hired on that front?

Yes. No new hires there, just really a situation where that has always been for us a very choppy business and it tends to ebb and flow and what we're looking for is it to get back more to an average rate.

Brian, while also what we're running into there is loans that we would typically originate with the SBA, our competitors are doing traditionally.

Got you. Okay. Okay. And then maybe just the last 2 things for me. Just -- I know you talked about, Todd, about your outlook on expenses with these short-term but any big initiatives on the horizon in '18 that could drive up that rate -- that growth rate as you look out a little bit?

No. That's a fair question, Brine. If we have any significant plans for items that might create additional expenses and not really on the horizon, we are looking forward to having our data processor contract renewed and candidly improved later this year. And most of the initiatives we have are really focused on growing loans and growing noncore deposits, not really much in the way of having to grow expenses.

Perfect. Okay. And lastly, just 2 things, I guess, maybe, Todd, maybe just the tax rate come higher thinking about that? And then maybe for Doug, just on the M&A side, certainly you've got the one deal closing here but just as far as the level of opportunities you're seeing today and how quickly you'd expect or I guess, think you could be back into to looking at things, future opportunities?

Sure, first on tax rate, I'm still expecting us to be in that 23%, 24% range. That gets a little choppy with the new FASB on the tax benefits from options and RSAs, pulled us down closer to 20%, I believe in Q1. Little more normal this quarter. Probably in that 23%, 24% range that we typically are in, Brian.

And that's going forward quarterly, Todd, or that you are talking the annual numbers there, quarterly?

Oh, I'd say that'd be a good proxy for a quarter number -- quarter rate.

Okay. And then maybe just on the M&A side?

Yes. Certainly, continue with discussions, Brian. And as you've seen in the articles, price expectations have elevated a fair amount since the election. I think, I read yesterday, that a year ago, the average was 130% of book value and it's a 166% this year. And what we're finding is, some ownership groups think, all right, prices have elevated, now is a good time to create a liquidity event. Others think that with the promises that the new administration have made in terms of taxes going way down, interest rates going way up and regulation going away, they might as well stay in the business because it's going to be a piece of cake to make a lot of money.

Okay. That's helpful. And just the level of opportunities you're seeing, Doug, is it -- do you think that, that's up a little bit, it's down, any characterization of kind of what you're seeing there?

I think for us is pretty consistent with the last couple of years.

Okay. So nothing, no significant increase. Appreciate the color. Nice quarter guys.

Thank you.

This concludes our question-and-answer session. I would like to turn the conference back to Doug Hultquist for any closing remarks.

Well, I just appreciate all the interest and the good questions and support we received from our analysts and our investors. So we'll continue to focus on our 7 initiatives and hopefully continue to create shareholder value at the pace we have.

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