QCR Holdings Inc (QCRH) 2017 Q3 法說會逐字稿

Greetings, and welcome to the QCR Holdings, Inc. Third Quarter 2017 Conference Call. Yesterday after market close, QCR distributed its third quarter press release, and we hope that you have had an 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 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 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 November 3, 2018.

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

Good morning, everyone. Thank you for joining us today, and I would like to welcome you to our quarterly earnings call for the quarter ended September 30, 2017. Initially, I will recap some of the highlights for the third 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.

Yesterday, we announced third quarter reported earnings of $7.9 million and diluted earnings per share of $0.58, with core earnings excluding acquisition-related costs of $8.5 million and diluted earnings per share of $0.63.

While core earnings were down slightly from the prior quarter, this was primarily due to 3 factors: First, acquisition-related loan discount accretion was down $1.1 million from the second quarter; second, swap fee income and gains from the sale of government-guaranteed loans continue to be slow and was down slightly from Q2 levels; finally, salaries and benefits and legal expense were elevated this quarter.

On a positive note, we continue to demonstrate very strong loan growth and further expanded our core net interest margin. Additionally, Wealth Management revenue continues to be strong and increased another 5% when comparing Q3 to Q2 and is up 18% on a year-over-year basis.

Earnings for the first 9 months of the year were strong, with core net income of $26.4 million and diluted earnings per share of $1.96 versus $20.6 million and $1.64 for the same period a year ago. This represents an increase in EPS of nearly 20% on a year-to-date basis. We have made solid progress in further improving our return on average assets as our run rate is now 1.02% year-to-date compared to 0.94% for the first 9 months of 2016.

Right after the third quarter, we also announced the closing of our acquisition of Guaranty Bank and Trust Company headquartered in Cedar Rapids, Iowa. 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 a few items from Q3. We again 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 loan growth rate of 15% year-to-date, which is higher than our targeted growth rate of 10% to 12% annually. We continue to have significant success taking market share from our competitors as we attract clients to our relationship-based community banking model.

As discussed in our press release, nonperforming assets increased this past quarter to 0.95% of total assets. This increase was due to 1 large CRE credit in the amount of $9.7 million that was placed on nonaccrual right at the end of Q3. We believe that this is an isolated issue and not indicative of any deterioration in the overall portfolio as other credit metrics remain strong. We are working to acquire title to this property very quickly so we can begin work to stabilize the project, and as a result, we anticipate the property moving into other real estate by year-end.

Legal expenses for the past quarter are elevated due to a legal matter in Rockford, where 2 bank officers have been charged with wrongdoing in connection with an SBA loan application. We anticipate these legal expenses will continue until the court proceedings are completed, which we expect some time in 2018. Neither Rockford Bank nor the company were charged in the case.

Our long-term focus is continued improvements in return on average assets, and our strategic goals and related strategic initiatives are focused on achieving ROAA results in the upper quartile of our peer group. We believe that we have made good progress on this strategic goal thus far in 2017 with a core ROAA of 1.04%.

Now I will 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.

I wanted to begin with a high-level review of some of the key variances in our financial results on a linked-quarter basis. These comments provide more color on the linked-quarter results presented on Page 3 of our press release financial tables.

Net interest income was up approximately $500,000 on a reported basis. If you remove the impact of loan discount accretion, which was actually down more than $1 million in Q3 versus Q2, our core net interest income grew more than $1.6 million on a linked-quarter basis. This solid increase in net interest income was driven by our continued strong loan growth and it further expanded core NIM percentage of 3.65% versus the Q2 core NIM percentage of 3.62%.

Provision expenses were relatively flat this quarter. While we did see an increase in NPAs on a linked-quarter basis and strong loan growth, absent the 1 large isolated loan moving to nonaccrual, we continued to see strong asset quality.

Noninterest income was nearly identical on a linked-quarter basis at $6.7 million. Gains on the sale of government-guaranteed loans were again negligible in Q3 at approximately $100,000. As we have experienced in the past years, given the nature and the timing of these types of loans, this revenue source can fluctuate significantly from quarter-to-quarter. We have now had 2 consecutive quarters of modest results after reporting $951,000 in gains in Q1. Swap fees were also modest in Q3, down approximately $130,000 from Q2.

Wealth Management revenue continues to be very strong and grew another $130,000 in Q3. Wealth Management revenue is now up 18% year-over-year. And we have added 297 new relationships and $303 million in assets under management thus far in 2017. We now have $3.4 billion in assets under management with $1.3 billion in trust assets, $956 million in brokerage and RIA accounts and $1.1 billion in custody assets.

Noninterest expenses increased in Q3 primarily in 3 areas: First, salaries and benefits increased $490,000, primarily due to filling open positions and some increased incentive compensation, consistent with our strong loan growth and year-to-date operating results; second, professional and data processing fees were up $610,000, due primarily to increased legal fees as Doug discussed previously; finally, we recorded $930,000 in acquisition and other onetime integration costs related to our acquisition that closed on October 1. We will incur additional acquisition cost in Q4 but expect to have the majority of these costs wrapped up by the end of 2017.

Our tax rate was reduced slightly to just under 20% as we recognized approximately $200,000 in tax benefit from the exercise of the stock options in Q3.

The impact of these results was slightly reduced core net income on a linked-quarter basis of $8.5 million in Q3 versus $8.7 million on Q2. Core net income of $26.4 million for the first 9 months of 2017 represents core ROAA of 1.04% and efficiency ratio of 62.90%, which we consider to be continued good progress on our goal of achieving upper-quartile ROAA. Core EPS for the first 9 months of 2017 was $1.96 versus EPS of $1.64 for the same period in 2016, which, as Doug mentioned earlier, is an increase of approximately 20% 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: Continue strong organic loan and lease growth to maintain our loans and leases to total assets ratio in a range of 73% to 78%; continue to focus on growing core deposits to maintain our reliance on wholesale funding at less than 15% of assets; 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 at least 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 ROAA, 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.

While it occurred just after quarter end, on October 1, we did continue to execute on our M&A initiative with the closing of the Guaranty Bank acquisition in the Cedar Rapids market. Guaranty Bank's long legacy of great bankers, exceptional client service and support of the community had a strong cultural fit with Cedar Rapids Bank & Trust. This negotiated transaction was a great outcome for our now combined shareholders as it further strengthens our position as the dominant community bank in Cedar Rapids and adds talented people and important clients to our company.

With this transaction, we have added $196 million in loans, $212 million in core deposits priced at 33 basis points and $178 million in assets under management to our Wealth Management platform. We are pleased to welcome the employees, clients and shareholders of Guaranty Bank to our company.

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

Thanks, Todd. I hope that our comments have provided a bit more insight into the numbers. We can now open the phone lines for questions.

(Operator Instructions) The first question will come from Jeff Rulis of D.A. Davidson.

This is Matt on for Jeff. Question about fee income. Swap income and loan gain sales were lower than expected, and I know you said that this line item -- these line items could be volatile. But from my understanding, they generally tend to be higher in 3Q due to seasonality. Why didn't that occur this time around?

Yes. This is Todd. Great question. And tends to be less about seasonality and more just about the choppy nature of these deals. And just to recap, we had total around $286,000 from all 3 components of that fee revenue -- or that fee income in Q3, down from around $400,000 in Q2. We actually had a fast start of a little over $1 million in Q1. So it tends to be less about seasonality, more just about the choppy nature of getting these deals done. We don't typically provide a lot of color on the forward expectations here, but I can tell you that we are expecting much stronger results here in Q4 based on deals that have already been booked here in October and the pipeline. So little less about seasonality, more just about some of these deals being very large in nature and hard to get to the finish line. Hope that makes sense.

Yes, that's very helpful. And then moving on to loan growth. You said that 4Q growth would be at a more normalized level. Could you quantify that for us?

Yes, I think realistically, back-to-back quarters at 19% would be at the very high end of our expectations. And while we're very pleased with that, I don't know that we could say that, that pace would continue. I think we're going to have a very strong year this year, considering what we've accomplished in the first 3 quarters. But it's not likely we are going to have a third quarter of 19%.

So would you say maybe mid- to high-single digits annualized for the fourth quarter?

Yes, we don't typically provide forward guidance on loan growth, but would suggest that based on pipelines, we certainly don't expect this to fall off a cliff in Q4, just to be down from the 19% range. So we're at 15% year-to-date. Our typical range has been, over the last 3 years, 10% to 12%. My guess is we might migrate back down a little closer to the upper end of the range versus increasing with 15%.

(Operator Instructions) The next question comes from Nathan Race of Piper Jaffray.

Just wanted to start on the expenses. It sounds like they're still going to be a little elevated based on what's transpired in Rockford here. But was just curious kind of in terms of when you guys expect to convert Guaranty here in the fourth quarter. And then kind of what you are thinking about in terms of a normalized expense run rate as we get into early '18.

Sure, Nate. The good news is we expect to convert Guaranty on December 2. We've had that scheduled for some time. And as you know, that has a pretty long cycle in terms of schedule. At that point, we'd be merging the Guaranty Bank into CRBT. We will not have all the expected cost saves implemented by year-end, but the fair -- but the vast majority of those should be accomplished by year-end. Some will leak into the early part of '18. But probably best to think about it that we're bringing on roughly $250 million in assets. We expect this to be accretive to ROAA, so somewhere in the 105 to 110 basis points range once converted, once all the saves are implemented. So we expect that announced 30% cost saves number to be primarily cooked in by 12/31, might roll a little bit into Q1 of '18. But our expectation is to have things moving along pretty efficiently early in the year.

Okay, got it. And then kind of just changing gears and thinking about credit quality this quarter. Would appreciate any other color in terms of what -- it looks like this credit was at Quad City Bank & Trust. So just curious, any other details around the underlying collateral, what industry it is and so forth?

Yes, Nate, it's Doug. And typically, we don't provide information regarding the borrower. This was one that paid as agreed for 3 years. And due to some political issues, this developer decided they weren't going to continue to invest in the property. So the next couple of weeks, we'll get through all the legal matters and get working on better performance out of that property.

Okay, got it. And just lastly, just thinking about deposit growth. Obviously, it slowed a little bit relative to last quarter. So just thinking about what the pipeline looks like in terms of bringing on some decent-sized core deposit relationships going forward, and kind of how you guys are thinking about just the overall funding opportunities. It looks like FHLB balances increased a little bit sequentially, so just curious how you guys are thinking about funding loan growth into 2018.

Sure, Nate. Great question. Growing loans at 19% did stress our funding a bit and our liquidity after doing it back-to-back quarters. And you're right, we did have to fund a bit more of that growth in Q3 with wholesale than we typically like. Primarily, that was overnight borrowings at FHLB. We ended the quarter at roughly $110 million in those borrowings. Good news is deposit growth has started to catch up here in Q4 already, and those borrowings are primarily paid off and paid down. And we're back to relying much more on core funding. We did talk about, last quarter, that we had some big wins in the Quad City market in terms of some very large deposit relationships. And part of the benefit here in Q4 has been that transition has started on a couple of those large relationships. They're roughly $100 million to $120 million in size. We've got about $40 million of that moved over now, but more to come. And that bodes well for our shift back down into more core funding versus wholesale. But it was elevated at the end of the quarter, has since been paid down a fair amount.

The next question will come from Brian Martin of FIG Partners.

Todd, maybe could you just -- or maybe Doug, I guess. I'm not sure. The -- just the added expenses this quarter as we think about that legal component. I mean, can you strip out, I guess, just a range of how much is additional this quarter, and when you look at the expense line, that maybe will be continued for a couple of quarters? But just as far as kind of a core number versus what was additive for what may be ongoing up in Rockford for a little bit.

Yes, sure can, Brian. And the good news is what I think everyone's most interested in, and you certainly would be most interested in, is where this goes from here. We have burned through the retention amount on our insurance coverage here, so now we're going to start seeing some recovery from insurance proceeds on this litigation matter. And candidly, going forward, we expect this to be very neutral to the expense line going forward. What I'm really trying to say is now that we're in a bit of arrears and recovery on the insurance proceeds, and those are going to start coming in here in Q4, we expect that to pretty much mirror what we're going to be spending on a go-forward basis. So I believe Q3, we saw an increase of roughly $400,000 in those legal expenses, primarily due to just production of documents. And I don't anticipate this being a drag on earnings going forward, if that makes sense.

Yes. So I guess the -- [too few], I guess. But we should assume, at some point in '18, it should kind of more moderate. And I think the level last quarter was around $2 million -- and a little bit under $2.5 million. So maybe it kind of goes back to more to that level as kind of things work themselves out as you get into '18? Later in '18 maybe?

Certainly.

Okay, fair enough. And then just is there anything on the SBA, USDA? I guess, when you kind of look at the trends that are going on in that market today and kind of the swap income, I mean, is there any need to -- I guess, it sounds like fourth quarter is strong, but as far as opportunities, how is that business, I guess, doing? And you're still optimistic, longer term, that you kind of achieve the targets you have out there. Just some lumpiness this year. Maybe you don't get to quite the level you normally would expect to get to. Just trying to understand how that business is doing.

Yes, that's a good question, Brian. And as you know, it's very unpredictable. We're finding more of our competitors are doing small business loans conventionally that we would have preferred to do with the SBA. And we've also found, as we've mentioned before with the USDA, they're typically large projects and take a lot of time to come to consummation, so very difficult to predict. Really expected swap income to be higher because if you think about what's going on, what the Fed said yesterday and so forth -- or Wednesday, should be a good time for the borrowers to be fixing rates. And I think we're off to a good start in Q4 and hope that continues. But we're out there talking to our commercial borrowers all the time about the opportunity that we think they should be considering taking advantage of.

Okay, fair enough. And just back to the SBA for a minute. Is there -- are there other opportunities to add folks? I mean, you talked about hiring this quarter, Doug. I guess, I don't know, were these more producers you hired this quarter? Was it more operational? And were any of them tied to the SBA kind of unit? Or is it more broadly maybe on the commercial side?

Yes, pretty broadly as I look at the list, Brian, and really nothing on SBA. We've actually contemplated doing some outsourcing of that function but haven't decided if that's quite the right path yet or not either.

Okay. In the hiring you did this quarter, you kind of called out in the release, is most of that reflected in the salary line this quarter? So I guess, there's not additive to -- in fourth quarter from whoever came aboard?

Yes, I think we would not expect another big jump in Q4 in that line item. We have most of that cooked into Q3. It was really primarily filling some open positions that we had carried through Q2.

Got you, okay. And then just the -- maybe for you, Todd, just on the margin and kind of how you're thinking about it here as kind of both the core margin and just kind of the accretion piece, it was down a fair amount this quarter. Can you give any context on just kind of how you're thinking about -- it sounds like the borrowings have come down a bit in the fourth quarter thus far. So it seems like maybe there's a little bit of benefit there on the margin side. If you're shifting that mix and maybe just the Fed increase in the accretion, just whatever commentary you can offer on the margin would be helpful.

You bet, Brian. And you're right. We do see some upside in margin here in Q4 again from reduced reliance on those overnights that we had on the books at the end of the quarter. Guaranty is going to help us there, too. Public information in their call report, but their margin at 3.74% is a touch higher than our 3.65% at the end of the quarter. When we get that all blended in, that will immediately add 1 basis point to our consolidated margin. We do expect some other improvements to come as mix changes on funding. And we see some other traction in terms of the loans booked in Q3 helping us. So our expectations are that we will continue to see some modest margin expansion on a core basis, and we're very pleased about that. The wildcard, as we all know, in terms of net interest income dollars, happens to be loan discount accretion. And so in this third quarter, it was really the first time we didn't see any accelerated accretion out of that portfolio at CSB. So it was very much just the steady normalized accretion, a little over $600,000 of that in Q3. Right now, our expectation is around $600,000 in Q4 coming off that portfolio, absent any other onetime acceleration. And then, of course, (technical difficulty) now the (inaudible) issue when we get Guaranty booked here in Q4. And we're working on those numbers, as you might guess. And we'll have that all polished up when we report Q4.

Okay, that's helpful. I appreciate it. And then maybe last thing and I'll hop off was just, from an M&A perspective, now that you've -- I guess you continue to work through Guaranty here and kind of get it to the finish line as far as getting it integrated and converted, I guess, where do the -- are there still good opportunities you guys are seeing out there from an M&A perspective? And maybe just talk, and maybe it's more for Doug, just kind of big picture, how you're thinking about M&A as you get into '18.

Yes, we're still certainly interested, Brian, and had some conversations with a few folks, which we always do, try to keep those pipelines open. Nothing imminent obviously, but we continue to see the advantage of scale in the right markets. So we will be opening -- open to continuing down that path.

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

Well, appreciate all your interest. Obviously, we were hoping for somewhat better results, but hopefully, we were able to explain where the shortfalls occurred. And we still feel good heading into the fourth quarter. So appreciate all your interest and support. And have a good weekend, everybody.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines. Have a great day.