QCR Holdings, Inc.

Greetings, and welcome to the QCR Holdings, Inc. Earnings Conference Call for the fourth quarter and full year 2020. Yesterday, after market closed, the company distributed its fourth quarter and year-end 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 Gipple, President, COO, and CFO. Management will provide a brief summary of the financial results, and then we'll open 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 call is being recorded and will be available for replay through February 11th, 2021, starting this afternoon, approximately one hour after the completion of this call. We'll also be accessible on the company's website. At this time, I'd like to turn the conference call over to Mr. Larry Helling at QCR Holdings. Sir, you may begin.

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 full year performance. Todd will follow with additional details on our financial results for the fourth quarter. We are very pleased with our financial performance in the fourth quarter and for the year, highlighted by record net income and a solid increase in adjusted earnings per share. These record results were driven by robust revenue growth, including record fee income and solid organic loan growth that helped boost our net interest income. The pandemic made it a challenging year, but we adjusted to the new environment, helped our clients manage the impact of the crisis, and continued to identify and capitalize on growth opportunities. Our adjusted net income increased 8% for the year, and we grew our tangible book value by 14%. After adjusting for non-core items, our revenues grew by 25%, driven by strong swap fee income and higher net interest income, while core expenses were down 1%, demonstrating strong operating leverage. We experienced healthy demand from our client base and grew loans by nearly 8%. This does not include the $358 million of PPP loans for both new and existing clients. Our specialty finance group had an outstanding year, generating record production volumes based on strong client demand for our niche lending products. Our loan pipelines remain healthy, and our near-term outlook for loan growth remains positive. However, until we have better visibility on the economic recovery, we are targeting organic loan growth for the full year of 2021 of between 6% and 8%. slightly lower than our long-term goal of 9%. We funded our loan growth in 2020 with core deposits, which grew by a very robust 22% for the year, with strong contributions from our core commercial and correspondent banking clients. We continue to grow market share across our charters, which reflects the value that our clients place on relationship-based community banking. Additionally, we successfully protected our net interest margin in 2020, which was up slightly for the year, despite a significant drop in short-term interest rates as a result of the pandemic. Our balance sheet initiatives paid off as we drove down our interest costs by eliminating high-cost wholesale funds. We also increased non-interest-bearing deposits meaningfully and capitalized on favorable deposit repricing opportunities. Our asset quality and credit metrics remain strong. We also significantly built our loan loss reserves over the course of the year and feel very good about our current reserve level. As we discussed in our last three earnings calls, we proactively implemented our loan relief program early in the pandemic, offering loan payment deferrals to our impacted clients, helping them preserve cash and liquidity. Nearly all of our borrowers who received payment relief resumed payments well before the year ended. As of December 31st, we had only $28 million of loans remaining on deferral, or 0.66% of the total portfolio. We believe this speaks to the high quality of our loan portfolio and the resiliency of our local markets, which continue to exhibit improving economic activity. While it remains difficult to predict the ultimate impact that the pandemic will have on our clients, our banks are well positioned to navigate this environment. We are monitoring our loan portfolio closely and working with clients to help them adapt to the current economic 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 outstanding customer service and for delivering record earnings performance for the year. Our employees are the heart of our company, and I am very proud of our entire team and for all they've accomplished in 2020. In summary, we continue to believe that we will emerge from this pandemic well 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 fourth quarter results.

Thank you, Larry. As I review our fourth quarter financial results, I'll focus on those items where some additional discussion is warranted. I'll start with our loan growth. Our annualized loan and lease growth was 9% during the fourth quarter. It was largely driven by new production in our core commercial lending business, primarily in commercial real estate loans. A key driver was strong loan production from our specialty finance group. As Larry mentioned, we continue to experience healthy demand in this area and maintain a solid pipeline of opportunities, in particular with our relationships in tax credit project lending and municipal finance. Our strong loan and lease growth during the quarter was funded with some of our excess liquidity. Our deposits declined slightly as core deposit growth was offset by intentional reductions in our higher cost portfolio of broker deposits, as well as some higher cost CDs. Additionally, we continued to reduce our reliance on wholesale funds to now record lows. At year end, we had only $26 million of wholesale funding, excluding our subordinated debt, which provides Tier 2 capital. This is down from $328 million one year ago. Over that same period, we grew non-interest-bearing deposits by nearly $370 million, driven by deposit gathering from our commercial clients as well as from our correspondent banking relationships. Non-interest-bearing deposits now represent 25% of our total deposit base, up from 20% at the end of 2019. Not only has our strong core deposit gathering activity significantly reduced our reliance on wholesale funding, it has also helped to enhance our net interest margin. Now turning to earnings. Our net interest income for the quarter was $43.7 million, down $900,000 on a one-quarter basis. While average earning assets grew by 1.3%, the yield on those assets declined by eight basis points from the third quarter, and our deposit costs declined by two basis points, driven by both rate and mix. The lower yield on our assets was primarily due to one-time interest recoveries on previously charged-off loans of $1.1 million that we experienced in the third quarter, which was not repeated in the fourth quarter. As a result of this one-time recovery in the third quarter, our reported NIM was down 11 basis points and our adjusted NIM was down seven basis points. Excluding the impact of the prior quarter's interest recoveries, adjusted NIM was actually up one basis point, well ahead of our guidance on last quarter's call. We are very pleased with our NIM performance throughout 2020. We have been successful in holding on to earning asset yields while driving down cost of funds aggressively through timely and strategic deposit rate reductions, as well as significant rotation from higher cost wholesale funds to low cost core deposits. As we move further into this sustained low interest rate environment, our ability to continue driving cost of funds lower is diminishing while we continue to experience loan pricing pressure. Therefore, we do expect some modest NIM compression in 2021. On a net basis, we expect first quarter adjusted NIM to decline in the range of four to six basis points. Now turning to our non-interest income, which was a strong $32 million for the quarter, but lower than the record $38 million we generated in the third quarter. We produced swap fee income of $21 million, meaningfully above the $18 million level we guided to, but below the record $26.7 million in the third quarter. We averaged almost $19 million per quarter of SWOT fee income in 2020. As Larry mentioned, we continue to expect strong, sustainable levels of SWOT production based on the demand we are seeing from the relationships within our specialty finance group, as well as in our core commercial lending. Many of our clients continue to want to lock in attractive fixed long-term rates by converting their variable rate loans through the use of swaps. 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 high level of swap fees that we did in the third and fourth quarters, we do expect that swap fees will be approximately 14 to 18 million per quarter for 2021. Now turning to our expenses. Non-interest expense for the fourth quarter totaled 46.4 million compared to 40.8 million for the third quarter and higher than our guidance of 38 to 40 million. There were a number of significant items that impacted expenses. First, We incurred increased salary and benefits expense of $4.4 million with increased incentive compensation expense in the quarter driven by the strong financial results in the second half of the year. Second, we incurred $1.5 million of losses on debt extinguishment as we prepaid some high-cost wholesale funds to improve future profitability. And third, we incurred some other one-time year-end charges totaling $1.6 million. Adjusting for all of these items, our non-interest expense came in at just below $39 million right in our guidance range. Looking ahead to the first quarter, we anticipate that our level of non-interest expense will return to a more normalized level and will be back in that range of $38 to $40 million. Our overall asset quality continues to be quite strong. Non-performing assets improved by 22% for the quarter. and now represent only 26 basis points of total assets, one basis point lower than one year ago. The late quarter improvement was primarily due to a reduction in non-recrual loans as a number of loans returned to performing status or were either monetized or charged off during the quarter. Our provision for loan and lease losses totaled 7.1 million for the fourth quarter, down from 20.3 million in the prior quarter. The level of our reserves, excluding the impact of the $273 million in PPP loans that remain on the balance sheet, was 2.12% to total loans and leases, up seven basis points from the end of September. This allowance now represents over five times our non-performing assets. We were fully prepared to implement CECL at 1231.20 as planned. However, Due to the lack of clarity from the SEC on their interpretation of the December CARES Act legislation, by the time we needed to close the year, we stayed on our incurred loss methodology at 1231.20. Our reserves under the incurred loss methodology in CECL were nearly identical at 1231.20, and we intend to adopt CECL as of 1-1-21. With respect to capital, we continue to maintain very strong capital levels and have abundant liquidity to meet our clients' needs. Our tangible common equity to tangible assets ratio improved to 9.4% as compared to 8.89% at the end of September, if you exclude the dilutive impact of the PPP loans. Our overall earnings power remains significant, and as a result, We are well positioned to continue to grow capital, provide solid earnings per share, and take advantage of future M&A opportunities. Our effective tax rate for the quarter came in at 18%. The rate was slightly lower on a late quarter basis due to a lower ratio of taxable earnings to tax exempt revenue. With that added context on our fourth quarter financial results, let's open up the call for your questions. Operator, we are ready for our first question.