Earnings Call Transcript - QCRH Q1 2023

Operator, Operator

Greetings, and welcome to the QCR Holdings, Inc. Earnings Conference Call for the First Quarter of 2023. Yesterday, after market close, 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 from 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 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 but do 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 4, 2023, starting this afternoon approximately 1 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 at QCR Holdings.

Larry Helling, CEO

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 continue to grow, and credit quality remains excellent. 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 per diluted share. We generated an adjusted ROAA of 1.42% and an adjusted ROE of 14.11% for the quarter and believe that both metrics remain at the high end of our peer group. Our core deposit base remains strong, and we improved our liquidity position significantly in response to the recent events in the banking industry. 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 10 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 those 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. At quarter end, our combined excess cash and borrowing capacity from the Federal Home Loan Bank and the Federal Reserve Bank was $1.5 billion, which would more than cover our uninsured or uncollateralized deposits. 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. However, we believe that our specialty finance team has significant competitive advantages. Our asset quality remains excellent, and we expect to continue to maintain strong reserves, given the economic uncertainty. Our total risk-based capital ratio during the quarter improved by 22 basis points to 14.50%. We also increased our tangible common equity to tangible assets ratio to 8.21%, which was up from 7.93% at the end of December. With that, I will now turn the call over to Todd to provide further detail regarding our first quarter results.

Todd Gipple, CFO

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 planned 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 brokered 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 31. 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. Our loan-to-deposit ratio improved to 95.2% at quarter end, down from 102.6% as of the fourth quarter. At quarter end, our total immediate liquidity was $1.5 billion. 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 paydowns and maturities contributing to the remaining net decline. During the quarter, we identified an impairment of $989,000 for a subordinated debt investment in one of the recently failed banks. Our remaining subordinated debt portfolio is $48 million. During the quarter, we delivered net income of $27.2 million and experienced a sharp increase in the cost of funds during the quarter. Our adjusted net interest income on a tax-equivalent basis was $62 million, down from $65.1 million in the fourth quarter. However, our capital markets revenue was $17 million, an increase of $5.7 million from the previous quarter and well ahead of our guidance range. Our capital markets pipeline remains healthy, and many headwinds we faced have begun to subside. As Larry mentioned, we are increasing our capital markets revenue guidance for the next 12 months to a range of $40 million to $50 million. For the second quarter, we are adjusting our noninterest expense guidance downward to a range of $47 million to $50 million. Our asset quality remains excellent, and we are committed to maintaining strong reserves. Our provision for credit losses was $3.9 million during the quarter. With that, I will now turn it back to the operator.

Operator, Operator

We will now start the question-and-answer session. Our first question will come from Damon DelMonte with KBW.

Damon DelMonte, Analyst

Just wanted to start off with the margin outlook. Todd, I think you said you're expecting additional pressure here in the second quarter of around 10 to 20 basis points. Do you feel that the margin will likely bottom after that? Or do you feel that accelerating betas throughout the remainder of the year will add a little bit more pressure as we go through?

Todd Gipple, CFO

Yes. Thanks, Damon. Yes, we are guiding to that 10 to 20 basis points of compression here in Q2. It really depends on the Fed's action. As the Fed does, in fact, do a 25 basis point increase here and then stop. We would expect to see a more static margin for the back half of the year.

Damon DelMonte, Analyst

Got it. Okay. So I think your cumulative deposit beta cycle to date is for total deposits around 38%. Where do you kind of see the full cycle going as we get to the end of the year?

Todd Gipple, CFO

Yes. I think it will be right in that high 30%, low 40% range. I don't expect it to jump significantly. Most of the challenge that we've had with beta has not been the underlying product.

Damon DelMonte, Analyst

Got it. Okay. And then with regard to the securitization, that will occur during the second quarter here. And then can you just talk a little bit about maybe some of the balance sheet dynamics after that.

Larry Helling, CEO

Should I take that one? I'll start with that, and then you can just follow up. Yes, we've got a planned date to securitize late in the second quarter. We don’t expect a gain or loss on that first securitization because there's a lot of front-end costs to do the first one. After that, we do expect to have some gains. If the liquidity environment stays static, we have roughly an additional $700 million of assets we could securitize quickly if we needed to.

Damon DelMonte, Analyst

Got it. Okay. And then, I guess, just lastly, one more for me on the expense outlook. I think you said, Todd, the guidance kind of $47 million to $50 million. Was that going to hold for the remainder of the year?

Todd Gipple, CFO

Yes. That would really be our guidance for the remainder of the year, certainly subject to some adjustment after we do get through Q2. We're having a lot of success with efficiency and automation, while improving client service at the same time.

Nathan Race, Analyst

Yes. Going back to David's question around some of the balance sheet dynamics. Is the expectation with the securitization occurring here likely in the second quarter, that there's the opportunity to maybe reduce some of the broker CDs that were added in the quarter, particularly just given some of the softer loan growth outlook for 2Q?

Larry Helling, CEO

Yes. That's one of the ways we will use the securitization to lower the brokered reliance. We have probably the largest deposit pipeline of activity I've seen in our company's history, and we think we can move the needle on that. Our deposits since quarter end have continued to grow.

Todd Gipple, CFO

So Nate, Larry did a great job telling you how. We intentionally set up these brokered as a very short ladder. Of the $525 million, all the $25 million actually mature during this calendar year. So we're going to use that strong pipeline to bring core deposits on and let these broker roll off.

Damon DelMonte, Analyst

Got it. And then is the kind of debt margin guidance for the back half of the year, does that just contemplate one more Fed rate hike in May and then the Fed on hold in 3Q and 4Q?

Todd Gipple, CFO

Correct, Nat. That would be the assumption that rates would be held steady by the Fed. If the Fed is done here in May and pauses, we think things would stabilize more in the back half of the year on margin.

Larry Helling, CEO

Yes. Our focus is to continue to grow capital and strengthen our total risk-based capital ratio. We're excited about the opportunities we have ahead and feel optimistic about our well-positioned business.

Brian Martin, Analyst

Just a couple of things for me. Just on the loan growth, kind of the guidance and just kind of the outlook. Maybe just a little conversation about what you're hearing, kind of beyond next quarter.

Larry Helling, CEO

Yes. Some of our clients are hitting pause on projects because of the current interest rates. We think 0% to 5% loan growth makes sense for the rest of the year. Our C&I clients, however, are still moving ahead. Line utilization is improving and closer to normal levels.

Daniel Tamayo, Analyst

My questions have been answered at this point, but just a quick clarification. Outside of the capital markets revenue in terms of fee income, curious if you had any comments on the rest of fee income and where your outlook lies?

Todd Gipple, CFO

The other thing we did mention was Wealth Management had a really nice first quarter, up 6% from Q4. We're optimistic about Wealth Management continuing to grow. In this past quarter alone, we had nearly 100 new clients and $185 million in new AUM.

Jeffrey Rulis, Analyst

Just a quick question on the deposit side. I see excluding those brokered deposits, deposits were up over the quarter. Just curious if you guys have seen anything unusual with the deposit flows in April or just more recently?

Larry Helling, CEO

The concerns that money was going to flow to the big banks did not happen for us. Our deposits since quarter end have continued to grow. We're excited about the opportunity to build through relationships at a faster rate. Office is not a big exposure for us. Our total exposure is 3%. We don’t have an office building that’s higher than 3 stories. We've seen no issues in that space and don't expect to.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Larry Helling for any closing remarks.

Larry Helling, CEO

Thanks to all of you for joining our call today. We appreciate your interest in QCRH. Have a great day, and we look forward to connecting with many of you in the coming months.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.