QCR Holdings, Inc.

and welcome to the QCR Holdings, Inc. Earnings Conference Call for the third quarter of 2020. Yesterday, after market close, the company distributed its third quarter earnings press release. If there is anyone on the call who has not received a copy, you may access it on the company's website, www.qcrh.com. In addition, the company has included a supplemental slide presentation with COVID-19-related disclosures that you can refer to during the call. You can also access these slides on the website. With us today for management are Larry Helling, CEO, and Todd Gippel, President, COO, and CFO. Management will provide a brief summary of the financial results, and then we will open up the call to questions from analysts. Before we begin, I would like to remind everyone that some of the information management will be providing 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 November 11, 2020, 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.

Thank you, operator. Welcome, ladies and gentlemen, and thank you for taking time to join us today. I will start the call with a brief discussion regarding our third quarter performance. Todd will follow with additional details on our financial results. As the pandemic continues to impact our country and the economy, we hope that everyone is staying healthy and safe. Our top priority remains the health of our employees and clients, and I am proud of our entire team for continuing to do what it takes to support each other, our clients, and our communities in times of need. We are very pleased to report a record quarter of net income, pre-provision, pre-tax adjusted net income, and non-interest income driven by continued strong loan growth, record fee income, and an expanded net interest margin. Our net income and diluted EPS increased 26% from the second quarter, while our tangible book value grew 4% on a linked quarter basis and 14% year-over-year. We achieved these record results despite recording another quarter of elevated provision for loan losses and continuing to build our reserves due to the ongoing economic uncertainty created by the pandemic. We delivered solid loan growth for the quarter, up 11.5% on an annualized basis, driven primarily by strong production and our specialty finance group. This group is having another banner year, generating record production volumes based on our strong client demand for our niche lending products, particularly in the area of municipal and tax credit finance. We also generated healthy production from our core commercial lending business during the quarter. Overall, we feel good about the quality of our commercial lending portfolio. Generally, our clients are performing well as economic conditions are better in our local markets than in the rest of the country. As a point of reference, our current unemployment rates in our primary markets of Iowa and Missouri are significantly lower than both the national average as well as the Midwest regional average. In addition, many of our clients have strong liquidity positions, which is a good indicator of their financial health. Excluding our PPP loan production, loan and lease growth for the first nine months of 2020 was 7.2% on an annualized basis. Given our current pipeline, we now believe that we will be able to achieve organic loan growth of between 6% and 8% for the full year, higher than our previous guidance. As we discussed on our last two earnings calls, we proactively implemented our loan relief program offering three-month loan payment deferrals to our impacted clients, helping them preserve cash and liquidity. The total amount of loan and lease deferrals granted during the first round was $575 million, representing approximately 13.5% of our total loans and leases. Beginning in July, many of our clients started to roll off the program, and we continued to experience a significant reduction in loan deferrals throughout the quarter. We are pleased to report that by quarter end, approximately 90% of our clients who requested payment relief early in the pandemic had resumed making payments, outperforming our guidance provided in July. The total loan and lease balances participating in round two is now just 1.95% of loans, which we believe speaks to the high quality of our loan portfolio and the resiliency of our local markets. Additionally, this low level of loan balances remaining on deferrals is among the very best in our peer group. Our core deposit growth was strong again this quarter. We posted annualized growth of 36.4%, and this was driven mainly by our correspondent bank clients who grew liquidity during the quarter. Our outsized deposit growth contributed to some excess liquidity on our balance sheet, but we were able to shed higher cost non-core funds and repriced deposits. This helped lower our overall funding cost during the quarter, which enhanced our net interest margin. Todd will provide more detail on NIM in his remarks. Our asset quality remains strong and our banks continue to be well capitalized. While we are not currently experiencing meaningful degradation of specific credits in our portfolio, we chose once again to be prudent and booked a provision for loan losses of $20 million this quarter in order to continue to build reserves against future potential credit issues related to COVID-19. While it continues to be difficult to predict the ultimate impact that the pandemic will have on our clients, Our banks are well positioned to help them navigate this environment. We continue to believe that our client focus combined with local decision making is the best way to serve our markets as the economy adapts and recovers. I would like to thank the entire QCR Holdings team for their hard work and dedication to excellent customer service and delivering record earnings performance during the quarter. We appreciate their flexibility and cooperation and are very proud of all that has been accomplished during this time. In summary, we continue to believe that we will emerge from this pandemic as a stronger company and will be positioned to pursue our long-term goal of profitable growth and value creation, both organically and through strategic acquisitions. With that, I will turn the call over to Todd to provide further information about our third quarter results.

Thank you, Larry. As I review our third quarter financial results, I will focus on those items where some additional discussion is warranted. Larry already discussed our loan growth, so I'll start with deposits. We generated very strong deposit growth again this quarter. Total deposits increased by $322 million, or 7.4%, on a linked quarter basis, with increases particularly strong in interest-bearing demand deposits, which were up $449 million. Our time deposits and broker deposits declined by $125 million as we continue to let higher cost CDs run off the balance sheet. Our strong core deposit gathering activities, which have significantly reduced our reliance on wholesale funding, also helped to enhance our net interest margin. The majority of our deposit growth was sourced primarily from our correspondent banking relationships and our commercial clients. We believe these core deposit relationships are an indication of our true franchise value. This is a significant benefit, as we don't have to rely on wholesale funding to support our stronger than pure loan growth, which will allow us to continue to drive long-term shareholder value. Now turning to earnings. With the strong growth in our average loans during the quarter, funded with core deposits, and combined with the increase in our net interest margin, our net interest income grew $3.6 million, or 8.9% on a linked quarter basis. The yield on our average earning assets increased by 13 basis points from the second quarter and our deposit costs decreased significantly as we gathered a higher mix of lower cost core deposits and reduced our higher cost wholesale funding. This resulted in a reduction in our total cost of interest bearing funds at 14 basis points. These strong results led to a 22 basis point improvement in reported NIM and a 23 basis point improvement in adjusted NIM. Also positively impacting NIM this quarter was a larger than normal amount of interest recoveries on previously charged off loans that were repaid during the quarter, providing 11 basis points of the NIM improvement. Therefore, after accounting for the positive impact of these recoveries, our true core margin improved by 12 basis points this quarter. While we continue to be well positioned to navigate a prolonged low interest rate environment, there will be some puts and takes impacting NIM in the fourth quarter. First, we do not expect the same level of one-time interest recoveries that created 11 basis points of margin accretion in Q3 to reoccur in Q4. Additionally, we will experience some dilution from the full quarter impact of our opportunistic subordinated debt issuance in mid-September. Finally, we expect some loan yield compression due to the mix and pricing of our new loans coming onto the balance sheet. Positive factors impacting the fourth quarter will be ongoing progress in reducing excess liquidity and a further decline in the cost of funds as we continue to improve mix and reprice our deposits slower. Therefore, on a net basis, we expect fourth quarter adjusted NIM to modestly decline in the range of three to five basis points. Now turning to our non-interest income, which was $38 million, up significantly from the second quarter. We produced record swap fee income, which came in at $26.7 million for the quarter, up 34% from the second quarter. As Larry mentioned, we are seeing robust swap production created by the strong relationships our specialty finance group have developed. Demand for our lending products remains strong, particularly in the tax credit space where we are making high-quality, long-term variable rate loans and are enabling our clients to lock in attractive fixed long-term rates through the use of swaps. We are also experiencing better pricing execution on our swap transactions due to the low interest rate environment and the flat yield curve. The pipeline of swap loans at our banks and our specialty finance group remains healthy, and we believe that this source of fee income is sustainable for the foreseeable future. While we don't anticipate achieving the same record level of swap fees that we did in the third quarter, we have averaged nearly $18 million in swap fees per quarter this year and expect swap fees will approximate that level in the fourth quarter. We will provide swap fee guidance for 2021 on our year-end conference call. Now, turning to our expenses. Non-interest expense for the third quarter totaled $40.8 million compared to $33.1 million for the second quarter and higher than our guidance of 31 to 33 million. There were a number of significant items that impacted expenses. First, we incurred increased salary and benefits expense of 4.7 million with increased commission and incentive compensation expense in the quarter driven by the strong financial results and higher than anticipated SWOT fee income. Second, we recorded a 1.9 million loss on debt extinguishment as we paid off high-cost wholesale funds to benefit future earnings. Third, we incurred disposition costs and a final loss on sale of $497,000 as a result of closing the Bates Company's disposition. And finally, we had $393,000 in higher FDIC insurance and fees due to our higher cash balances. Adjusting for these items, our noninterest expense came in at $33 million, at the upper end of the guidance range we provided on last quarter's earnings call. Looking ahead to the fourth quarter, we anticipate that our level of noninterest expense will be similar to third quarter levels in the $38 to $40 million range. This range is higher than our long-term run rate expectations, primarily due to higher year-end incentive compensation driven by our outlook for strong full-year pre-provisioned pre-tax earnings and swap fee income. Our overall asset quality continues to be solid. While we did experience a modest linked quarter increase in non-performing assets in the quarter, it was primarily due to a few isolated relationships that experienced degradation not directly related to COVID-19. The ratio of NPAs to total assets increased to 32 basis points at September 30, compared to 24 basis points at June 30 and returned to Q1 levels. While our local economies are doing better than much of the rest of the nation, we are still providing heavily for potential losses in the future. And therefore, we again recorded 20 million in provision for loan losses this quarter. I would note that the majority of this significant provision was a result of increasing qualitative factors due to the pandemic. The level of our reserves, excluding the impact of the $358 million in PPP loans, was 2.05% to total loans and leases, up 44 basis points from the end of June. This allowance now represents over four times our non-performing assets. With respect to capital, we continue to maintain strong capital levels and have abundant liquidity to meet our clients' needs. Our opportunistic subordinated debt issuance at the end of the third quarter further strengthened our total risk-based capital ratio to nearly 15% at quarter end. Our tangible common equity to tangible assets ratio at quarter end is roughly 9% if you exclude the dilutive impact of the PPP loans. Our overall earnings power remains significant as we generated a pre-provision, pre-tax ROAA of 2.9% in the third quarter. As a result, we are well positioned to continue to fund reserves, grow capital and tangible book value per share, and provide solid earnings per share. Additionally, with the aforementioned subordinated debt offering, we were able to further build our capital base to support the organic growth of our subsidiary banks and be well positioned for future M&A opportunities. Our effective tax rate for the quarter came in at 18.8%. The rate was higher on a length quarter basis due to a higher ratio of taxable earnings to tax-exempt revenue. With that added color on our third quarter financial results, let's open up the call for your questions. Operator, we're ready for our first question.