QCR Holdings, Inc.

Greetings and welcome to the QCR Holdings, Inc. Earnings Conference Call for the second quarter of 2023. Yesterday, after market close, the company distributed its second 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 Gippel, President and CFO. Management will provide a summary of 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 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. Additionally, 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 direct 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 August 3rd, 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 the call over to Mr. Larry Helling at QCR Holdings. Please go ahead.

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 strong balance sheet performance, liquidity position, and capital levels, as well as a review of our specialty finance business and our loan securitization strategy. Todd will provide additional details on our financial results for the quarter. We continue to be pleased with our operating performance in 2023. We delivered outstanding second quarter results, highlighted by robust loan and core deposit growth, and significant fee income. In addition, we maintained strong asset quality. Our diverse revenue sources, which included capital markets and wealth management fees, more than offset the pressure on our net interest income. We also continued to improve upon our already solid capital levels with exceptional earnings performance. In the second quarter, we delivered both reported and adjusted net income $28.4 million or $1.69 per diluted share. We generated an ROAA of 1.44% and an ROAE of 13.97% for the quarter and believe that both metrics remain near the high end of our peer group. Loan growth was exceptional during the quarter, growing 12.2% on an annualized basis. and driven primarily by our low income housing tax credit lending program. I'll expand on our success in growing loans shortly. Our experienced bankers grew core deposits significantly during the quarter, building upon our strong and diversified deposit franchise. As a result, our loans held for investment to deposits further improved to 92.1% uninsured and uncollateralized deposits also improved to 19.9% and remain at very manageable levels. Our elevated on balance sheet liquidity bind with other immediately available liquidity at the federal home loan bank that more than cover our uninsured and uncollateralized. We have assembled a strong and diversified deposit franchise over the years. And our second quarter deposit activity continued to reflect the importance of the relationships that we have developed. During the second quarter, our core deposits, excluding short-term broker deposits, grew $339 million, 23% annual assets. Our asset quality remains excellent as the ratio of non-performing assets, the total assets, increased slightly by three basis points during the second quarter. yet remains near historic lows at 32 basis points. Our reserve for credit losses represents 1.41% of total loans and leases held for investment and continues to be at the high end of . We remain confident that our reserve for credit losses are adequate to weather future economic uncertainty. We plan to be disciplined and maintain prudent reserves as we continue to diligently monitor asset quality across all of our businesses. We remain cautiously optimistic about the economic resiliency of our markets and the financial health of our clients. We are not seeing any meaningful signs of weakness across our footprint. As we mentioned last quarter, our exposure to commercial office buildings is very low and quite manageable at just 3% of total loans with an average loan size of $800,000. These properties are predominantly located in suburban locations within or adjacent to our markets. They are well collateralized and are performing in line with expectations with no significant repayment concerns. Our capital levels are strong and we remain focused on growing capital throughout the remainder of the year. we continue to target capital ratios in the top quartile of our peer group. We believe that our modest dividend and strong earnings power allow us to continue to grow capital faster than our peers. During the quarter, we grew loans 12.2% on an annualized basis, driven primarily by the ongoing strength in our low-income housing tax credit lending business. With the growing prominence of our specialty finance group and the LIHTC lending businesses, I would like to spend some time discussing the drivers of this high-performing business. 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. Our clients continue to experience strong demand for their project as the need for affordable multi-family housing exceeds supply in the market that we serve. These high-quality loans are bolstered by strong equity investment from other banks and corporate investors. The industry has an excellent track record with negligible historical default rates. Strong track record makes these loans ideal for securitization. In addition, 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, borrowers seek to lock in their financing costs over the life of the loan. As a result, our bankers arrange interest rate swaps for the borrowers, enabling them to secure the desired fixed rate financing and generating significant capital markets revenue for our company. The LIHTC business has been a consistent and important component of our non-interest income. 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 from swap fees in the first half of 2023, as the supply chain constraints and inflationary pressures on the construction costs have begun to abate. In short, this is an extremely valuable business, and we believe that it deserves a higher valuation multiple than traditional banking. based on decades of stability in the industry and our own experience, we believe that this business is counter-cyclical and will be very resilient in future recessionary environments. We are increasing the size of our planned securitizations of LIHTC loans to achieve improved pricing and execution. We now expect to close on the transactions early in the fourth quarter. The securitization of our LIHTC assets will be an effective tool in managing our liquidity and capital. In addition, it will provide expanded capacity for continued LIHTC production and the resulting capital markets revenue. While economic headwinds remain a risk, we experienced strong loan growth during the second quarter. As a result, we are increasing our guidance for loan growth for the remainder of the year to be in the range of 9% to 12% on an annualized basis. which would result in a 0% to 3% growth on an annualized basis, net of planned LIHTC loan securitizations. I will now turn the call over to Todd to provide further detail regarding our second quarter results.

Thank you, Larry. Good morning, everyone. Thanks for joining us today. I'll start my comments with details on our balance sheet performance during the quarter. As Larry mentioned, we grew total loans by 12.2%. on an annualized basis during the quarter, or $189 million of net growth. In anticipation of our first loan securitizations, we have classified $291 million of LIHTC loans as held for sale. We added an additional $152 million of LIHTC loans to the held for sale category during the quarter as we continue to build towards the first securitizations later this year. Executing our long-term securitization strategy will enable us to continue to fund the significant growth of our tax credit lending business and maintain the portfolio within our established concentration levels. Total deposits grew $105 million during the quarter, driven by strong core deposit growth from a mix of commercial, retail, and municipal deposits. The growth in core deposits of $339 million, which excludes broker deposits, increased total available liquidity and allowed us to reduce the amount of our broker deposits by $234 million. Our core deposits continue to have strong diversification due to our separate charters and markets, as well as a commercial client base that is spread across a variety of industries. Fifty-five percent of our core deposits represent deposits from our commercial clients and have an average balance of $214,000. Approximately 35% of our deposits consist of consumer deposits and have an average balance of $21,000. The remaining 10% of our deposits are from our 181 correspondent banking partners with an average balance of $2.3 million. Now turning to our income statement. We deliver net income of $28.4 million for the quarter, an annualized increase of 18.7%. as the decrease in our net interest margin was overpowered by strong capital markets revenue and well-controlled expenses. Our adjusted net interest income on a tax equivalent basis decreased $2.4 million to $59.5 million, down from $62 million in the first quarter. Adjusted NIM on a tax equivalent yield basis was 3.28%, which was down 19 basis points from 3.47% in the prior quarter and within our guidance range. As we anticipated and guided last quarter, we experienced a continued increase in the cost of funds during the second quarter. This was primarily the result of a shift in the composition of our deposits from lower beta to higher beta deposits. We've been pleased with the beta performance of our low beta deposits throughout the cycle. However, the continued shift from non-interest and lower beta deposits to higher beta deposits has been more than expected and has led to an outsized increase in our cost of funds. As we look to the third quarter, including the 25 basis point rate hike announced yesterday and a yield curve that continues to be sharply inverted, our moderate liability sensitive balance sheet creates an interest rate environment that continues to be challenging. However, we expect the pressure on margin to lessen as the deposit mix shift has slowed and we benefit from strong late second quarter loan growth. We are guiding adjusted NIM TEY in the range of static to down 10 basis points for the third quarter. Turning to our non-interest income, which increased 6.7 million or 26% during the second quarter. Our capital markets revenue was 22.5 million compared to 17 million for the first quarter, which outperformed our annualized guidance range. Capital markets revenue from swaps continues to benefit from stabilization in the supply chain and construction costs. In addition, developers have been successful in restructuring their capital stacks in the new interest rate environment. Capital markets revenue from swap fees has been a consistent and strong source of fee income. And importantly, this revenue source has provided significant countercyclical benefits during the pandemic, and is expected to do so in future economic downturns. Our tax credit lending and capital markets revenue pipeline remains healthy as our clients continue to experience strong demand for new projects. As a result, we are increasing our capital markets revenue guidance for the next 12 months to a range of $45 to $55 million. In addition, we generated $3.8 million of wealth management revenue in the second quarter, consistent with the first quarter. Our wealth management team continues to benefit from new relationships, adding 148 new clients and $455 million in assets under management in the first half of this year. Now turning to our expenses. Non-interest expense for the second quarter totaled $49.7 million compared to $48.8 million for the first quarter and within our guidance range of $48 to $51 million. The increase from the prior quarter was primarily due to higher variable compensation, increased FDIC insurance rates, and higher direct costs from holding more deposits in the ICS program. Our strong fee-based performance in the second quarter led to an increase in variable compensation, while other salary and benefit-related expenses decreased. We remained diligent in controlling our expense growth. For the third quarter, we are reaffirming our non-interest expense guidance again this quarter to be in a range of 48 to 51 million. Our asset quality remains exceptional and better than our historical average. During the quarter, NPAs increased modestly. NPAs for the quarter were 26.1 million, or only 32 basis points of total assets. Approximately half of our total NPAs consist of one relationship, and we believe that this credit will be resolved without a loss. The provision for credit losses was $3.6 million during the quarter. We expect to continue to maintain strong reserves given the economic uncertainty. Our reserve to loans held for investment was fairly static at 1.41% and continues to be at the higher end of our peer group. Our total risk-based capital ratio declined slightly by two basis points to 14.66%. due to the strong loan growth during the quarter. We increased our tangible common equity to tangible assets ratio to 8.28%, up from 8.21% at the end of the prior quarter. With our continued strong earnings coupled with our modest dividend, our tangible book value per share increased by $1.28, or 13.2% annualized during the second quarter. As interest rates moved higher during the quarter, Our AOCI declined sequentially, which partially diluted some of the growth in our tangible common equity and tangible book value. During the quarter, we repurchased a modest number of shares. Our capital allocation priorities remain focused on growing our capital and targeting capital levels near the top of our peer group. Finally, our effective tax rate for the quarter was 12.2% compared to 9.3% in the first quarter. The increase was due to a higher mix of taxable income, primarily from the significant growth in capital markets revenue this 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 second quarter financial results, Let's open the call for your questions. Operator, we're ready for our first question.