QCR Holdings, Inc.

Greetings and welcome to the QCR Holdings, Inc. earnings conference call for the first quarter of 2023. Yesterday, after market closed, the company distributed its first 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. With us today for management are Larry Helling, CEO, and Todd Gipple, President, COO, and CFO. Management will provide a 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 provided today falls under the guideline of forward-looking statements as defined by the Securities and Exchange Commission. As part of these guidelines, any statements made during this call concern 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 May 4th, 2023. Starting this afternoon, approximately one hour after the completion of this call, it will also be accessible on the company's website. I will now turn over the call to Mr. Larry Helling,

Thank you, Operator. Welcome, everyone. And thank you for taking the time to join us today. I will start the call by providing some highlights for the quarter, followed by a discussion about our deposit base, liquidity position, and capital levels, as well as a review of our specialty finance business. Todd will provide additional details on our financial results for the quarter. We are pleased with our operating performance for the first quarter. highlighted by increased fee income and carefully managed expenses. Our already strong capital levels continued to grow and credit quality remained excellent. Our core deposit base remained strong and we improved our liquidity position significantly in response to the recent events in the banking industry. We delivered net income of $27.2 million for the quarter or $1.50 per diluted share. Our adjusted net income for the quarter was $28 million, and our adjusted EPS was $1.65 for diluted share. We generated an adjusted ROAA of 1.42% and an adjusted ROAE of 14.11% for the quarter and believe that both metrics remain at the high end of our peer group. We have built a strong and diversified deposit franchise over the past 30 years, and our first quarter deposit activity was a reflection of the importance of that franchise. During the first quarter, our core deposits, excluding short-term broker deposits, grew nearly $20 million, or 1.4% annualized. Our core deposit growth in the quarter was notable because we typically experience seasonal deposit outflows in the first quarter, as our commercial clients draw down their deposits to pay bonuses, shareholder distributions, and taxes. Our core deposits grew $80 million from March 10th through the end of the quarter, a time when many banks may have experienced net deposit outflows. We believe that this is a testament to the relationships that we have built with our clients over the years. In addition, we intentionally bolstered our on-balance sheet liquidity with short-term broker deposits during the quarter using the proceeds to pay off our overnight borrowings from the Federal Home Loan Bank and add immediate on-balance sheet liquidity. Our level of uninsured and uncollateralized deposits improved by $170 million during the quarter to 23.8% of total deposits or 26.2% when excluding broker deposits, which compares favorably to our peers. We were an early adopter and have actively participated in the ICS Cedars program for nearly 20 years. The ICS Cedars program is a trusted resource that provides expanded FDIC insurance coverage for clients that maintain larger deposit balances. We have sufficient ICS Cedars capacity to ensure all uninsured or uncollateralized deposits if needed. More importantly, we have ample on balance sheet and immediately available off balance sheet liquidity to operate our business and meet client needs. At quarter end, our combined excess cash and borrowing capacity from the Federal Home Own Bank and the Federal Reserve Bank was $1.5 billion, which would more than cover our uninsured or uncollateralized deposits. Now turning to loan growth. During the quarter, we grew loans 3.3% on an annualized basis, driven primarily by our traditional commercial lending and leasing businesses and the continued strength in our low-income housing tax credit project lending business. We experienced more modest loan demand from our client base as a result of the macro headwinds being created by the Fed's sharp increase in rates. Therefore, given the ongoing economic uncertainty, we are now guiding to loan growth in the second quarter in the range of 0% to 5% on an annualized basis. which is net of the planned loan securitization. With the growing prominence of our specialty finance group and the interest it has received from analysts and investors, I would like to spend some time discussing the drivers of this high performing business and why we believe that we have an important competitive advantage that sets us apart from our peers. Our specialty finance team offers low income housing tax credit lending to a select group of developers and investors with whom we have built longstanding relationships. These developers and investors have deep experience, long track records and strong expertise in the development and construction of affordable multifamily housing. These are high quality loans bolstered by strong equity investment from banks and corporate investors. The industry has an excellent track record with negligible historical default rates. Since our program's inception in 2018, we are proud to have helped finance over 250 projects consisting of nearly 13,000 affordable housing units without experiencing any delinquency or defaults in this portfolio. The strong track record makes these loans ideal for securitization, which we expect to use as an alternative funding source for this lower-risk, attractive business. All of these loans are made on a floating rate basis, which has greatly improved our ability to manage interest rate risk. Due to the long-term ownership structure of these projects, our borrowers seek to lock in their financing costs over the life of the loan. As a result, our bankers arrange interest rate swap contracts to the borrowers, enabling them to secure the desired fixed rate financing. This LIHTC business has been a consistent and important component of our non-interest income in all economic cycles. In addition, as the economy has softened, some of the previous headwinds that our clients were experiencing in this space have eased. We saw a nice rebound in capital markets revenue in the first quarter, as the supply chain constraints and inflationary pressures on labor and raw materials that were impacting some client projects have begun to abate. Because of the strong underpinnings of this business, we are increasing our capital markets revenue guidance to a range of $40 to $50 million for the next 12 months. We have assembled the expertise and built a tax credit lending business over several years. There are significant barriers to entry in this business that provide us with a significant competitive advantage. In short, this is an extremely valuable business and we believe that it deserves a higher valuation multiple than traditional banking. Furthermore, based on decades of stability in the industry and our own experience, we believe that this business is countercyclical and will be very resilient in future recessionary environments. Our asset quality remains excellent, as the ratio of non-performing assets to total assets was 0.29% at the quarter end. We are comfortable with our reserve, which represents 1.43% of total loans and leases held for investment and continues to be at the high end of our peer group. We remain cautiously optimistic about the relative economic resiliency of our markets, and we are not seeing any meaningful signs of weakness across our footprint. Our capital levels are strong and increased during the quarter. We remain focused on growing capital throughout the remainder of 2023. We are targeting capital ratios in the top quartile of our peer group. We believe that our modest dividend and strong earnings power will allow us to grow capital faster than our peers. With that, I will now turn the call over to Todd to provide further detail regarding our first quarter results.

Thank you, Larry. Good morning, everyone. Thanks for joining us today. I'll start my comments with details on our balance sheet activity during the quarter. As Larry mentioned, we grew total loans by 3.3% annualized during the quarter, or $51 million of net growth. Notably, in anticipation of our first plan loan securitization, we have classified $139.2 million of LIHTC loans to loans held for sale. We expect to strategically access the securitization market to help fund the growth of our tax credit lending business, improve liquidity, and maintain the portfolio within our established concentration levels as needed. Total deposits grew 517 million in the quarter, driven primarily by a 498 million increase in short-term broker deposits, which substantially increased our on-balance sheet liquidity. We use these deposits to eliminate our reliance on overnight FHLB advances, which totaled $415 million at December 31st. Our core deposits, when excluding broker deposits, have strong diversification due to our separate charters and markets, as well as a commercial client base spread across many industries. Approximately 9% of our deposits are from our 194 correspondent banking partners, with an average balance of $2.1 million. Another 60% represent deposits from our commercial clients with an average balance of $232,000. The remaining 31% consist of consumer deposits with an average balance of $18,000. Our loan-to-deposit ratio improved to 95.2% at quarter end, down from 102.6% as of the fourth quarter. Historically, our long-term target for loans held for investment to deposits has been in the range of 95% to 100%. However, we expect to drive this ratio closer to the range of 90% to 95% in the coming quarters with additional core deposit growth. At quarter end, our total immediate liquidity was $1.5 billion and consisted of $254 million of excess cash $992 million of borrowing availability with the FHLB, and $290 million of borrowing availability at the Federal Reserve Bank. While we don't expect the need to draw on this liquidity, it does more than cover our current level of uninsured and uncollateralized deposits. Our securities portfolio totaled $879 million at quarter end, down from $928 million as of the fourth quarter. We sold approximately 30 million of securities and had pay downs and maturities contributing to the remaining net decline. The securities sold mid quarter were part of a small strategy to de-lever the balance sheet with a rapid earn back of the modest loss before the end of the calendar year. 36% of our securities portfolio is classified as available for sale and the remaining 64% is classified as health and maturity. Over 83% of the total portfolio consists of high quality municipal securities with a large portion from direct private placement transactions. These private placement municipal securities currently have a tax equivalent yield of 5.02%. The market value of our AFS and HTM bond portfolios improved to 86% and 94% of book value respectively with the decline in the intermediate and longer-term interest rates. If we were to realize all of the losses in the HTM portfolio, the impact on our TCE ratio would only be 32 basis points. During the quarter, we identified an impairment of $989,000 for a subordinated debt investment in one of the recently failed banks. This was a legacy investment that we acquired as part of the 2022 Guaranty Bank Acquisition. We established a full reserve for the impaired investment. Our remaining subordinated debt portfolio is $48 million, and after a thorough review of the entire portfolio, we believe that it consists of high-performing banks with no identified credit weaknesses. As Larry mentioned, we delivered net income of $27.2 million for the quarter. Unlike many of our peers, we have been successful in growing our pre-tax, pre-provision adjusted income. During the quarter, we grew our pre-tax, pre-provision adjusted income by $2 million, or 6.4%, when excluding the impact of loan discount accretion. Our adjusted net interest income on a tax equivalent basis was $62 million, down from $65.1 million in the fourth quarter. Adjusted NIM on a tax-equivalent yield basis was 3.47%, which was down 14 basis points from 3.61% in the prior quarter. Despite continued loan growth and the ongoing expansion of loan yields, we experienced a sharp increase in the cost of funds during the quarter. Our deposit data has accelerated more than anticipated this quarter as our mix shifted further from lower beta deposits to higher beta deposits. The change in deposit mix has shifted our interest rate risk position from asset sensitive to moderately liability sensitive, which has positioned us well to expand our net interest income and margin with potential rate cuts. As we look to the second quarter, we anticipate continued pressure on margin and net interest income due to our modest liability sensitivity and the dilutive impact of carrying more liquidity on balance sheet. Assuming another 25 basis point rate hike in May and continued yield curve inversion throughout the second quarter, we are guiding adjusted NEM TEY to compress in the range of 10 to 20 basis points. Turning to our non-interest income, which was 25.8 million for the quarter, up significantly from the 21.2 million we generated in the fourth quarter. Our capital markets revenue was 17 million an increase of $5.7 million from the fourth quarter and well ahead of our guidance range. Our capital markets pipeline remains healthy and many of the headwinds that some of our tax credit lending clients had been experiencing have begun to subside with several previously delayed projects now moving forward. As Larry mentioned, we are increasing our capital markets revenue guidance for the next 12 months to a range of $40 to $50 million. In addition, we generated $3.8 million of wealth management revenue in the first quarter, up 6% from the fourth quarter. Our wealth management team continues to onboard new client relationships, adding 340 new relationships and $585 million of new assets under management over the last 12 months. Now, turning to our expenses. Noninterest expense for the first quarter totaled $48.8 million, compared to $49.7 million for the fourth quarter and below the low end of our guidance range. The decrease from the prior quarter was primarily due to lower incentive-based compensation as we accrued a higher amount in the fourth quarter based on last year's record four-year performance. In addition, we experienced lower professional and data processing fees, insurance and regulatory fees, and advertising and marketing expenses. We remain diligent in controlling our expense growth and for the second quarter, we're adjusting our non-interest expense guidance downward to a range of 47 to 50 million. Turning to asset quality, which remains excellent with MPAs to total assets of 0.29%. We did have a modest increase in the first quarter as we moved one large credit to non-accrual status. This specific loan involves a newly constructed mixed-use property where the local developer experienced cost overruns that impacted their ability to fully fund the property. The property has been completed and is fully leased. Given the attractiveness of this property, we expect to resolve this credit promptly without any further impairment. We believe this credit is an isolated incident and not an indication of any systemic credit issues. The provision for credit losses was $3.9 million during the quarter. Of this amount, $2.5 million was added to the loan allowance, $989,000 was added to the bond allowance, and $481,000 was added to the allowance for off-balance sheet exposures. We expect to continue to maintain strong reserves given the economic uncertainty. Our reserves to loans held for investment remain strong at 1.43% and continues to be at the high end of our peer group. Our total loan ACL balance experienced a net decline during the quarter as a result of removing 1.7 million of the loan reserves related to the loans held for sale associated with our plan securitization. We strengthened our total risk-based capital ratio during the quarter, generating an improvement of 22 basis points to 14.50%. We also increased our tangible common equity to tangible assets ratio to 8.21%, up from 7.93% at the end of December. Our TCE ratio grew 28 basis points or 4% to 8.21% and our tangible book value per share increased by nearly $2 or 5% during the first quarter. This was due to both our solid earnings and the 9.3 million increase in AOCI. Tangible book value has increased by 12.5% since the end of the second quarter of 2022 following our acquisition of Guaranty Bank. During the first quarter, we purchased and retired 152,500 shares of our common stock at an average price of $50.61 per share as we continue to execute purchases under the share repurchase plan announced last year. In addition, many members of our senior leadership and board of directors have recently purchased shares in the open market. which is a demonstration of their strong belief in the future of our company. Our capital allocation priorities are focused on growing our capital to further enhance our already strong levels. We believe that we can accrete approximately 20 basis points of TCE each quarter with earnings at this level and assuming a static AOCI, growing capital at a faster rate than many of our peers due to our earnings power and our low dividend level. Finally, Our effective tax rate for the quarter improved to 9.3% from 15.9% in the fourth quarter. The rate was lower due to a higher ratio of tax exempt revenue to taxable earnings in the first quarter, primarily due to strong growth in tax exempt floating rate loans, as well as increased benefit from our tax credit portfolio. In addition, we recognized a stronger tax benefit on our stock based compensation, which tends to be elevated in the first quarter. We continue to benefit from our strong portfolio of tax exempt investments and loans, which has helped our effective tax rate remain one of the lowest in our peer group. We expect the effective tax rate to be in a range of 11% to 14% for the remainder of 2023. With that added context on our first quarter financial results, let's open up the call for your questions. Operator, we're ready for our first question.