QCR Holdings, Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; financial statements are unaudited. QCR Holdings is a financial holding company operating four commercial banks, a leasing business and wealth-management operations, primarily in Iowa, Illinois and Missouri. Amounts below are in U.S. dollars; financial-statement amounts are generally in thousands unless noted.
Financial performance and condition
- Earnings: Net income was $11.2 million, versus $12.9 million in Q1 2019; diluted EPS was $0.70 versus $0.81. Adjusted net income, a non-GAAP measure, was $12.4 million and adjusted diluted EPS was $0.77.
- Net interest and margins: Net interest income was $37.7 million, up 2% year over year. Net interest margin was 3.40% (3.56% tax-equivalent); adjusted tax-equivalent margin excluding acquisition accretion was 3.50%. Tax-equivalent margin increased 5 basis points from Q4 2019.
- Fees and expenses: Noninterest income was $15.2 million, up 27% year over year, principally reflecting swap fee income of $6.8 million versus $3.2 million. Noninterest expense declined 3% to $31.4 million. The efficiency ratio was 59.39% (non-GAAP).
- Credit costs and asset quality: Provision expense rose to $8.4 million from $2.1 million in Q1 2019, primarily reflecting higher qualitative reserves for COVID-19-related economic deterioration. The allowance was $42.2 million, or 1.14% of loans and leases, compared with 0.98% at year-end. Nonperforming assets were $16.9 million, 0.32% of assets; nonperforming loans were $13.6 million, up from $8.9 million at year-end. Criticized loans rose to $71.4 million from $53.6 million.
- Balance sheet and funding: Total assets were $5.23 billion, up from $4.91 billion at December 31, 2019. Gross loans and leases were $3.70 billion; deposits were $4.17 billion, up $259.4 million during the quarter. Total borrowings were $244.4 million, down from $279.0 million at year-end. Cash, federal funds sold and interest-bearing bank deposits totaled $376.5 million.
- Cash flow: Operating activities provided $6.6 million; investing activities used $133.5 million; financing activities provided $220.4 million. Cash and due from banks increased $93.6 million to $169.8 million. Financing inflows included deposit growth; investment purchases contributed to investing outflows.
- Capital: The company’s common equity Tier 1 ratio was 10.31%; all subsidiary banks met the “well capitalized” requirements. Tangible common equity to tangible assets was 8.76% (non-GAAP), down from 9.25% at year-end, partly because of quarter-end balance-sheet expansion and derivative fair-value gross-ups.
Material changes and unusual items
- Compared with Q1 2019, net income declined despite higher net interest income and fee income, as the loan-loss provision increased materially. Interest expense fell 26%, while interest income fell 6%.
- Swap fee income more than doubled year over year. Management cautioned that future swap-fee levels depend partly on interest rates and transaction activity.
- The company repurchased and retired 100,932 shares for $3.8 million before suspending the repurchase program on March 16, 2020. The board had authorized repurchases of up to 800,000 shares.
- A $500,000 goodwill impairment charge was recorded in connection with the planned sale of the Bates Companies. Separately, management’s COVID-19-triggered interim goodwill assessment found no impairment at the time of that assessment.
- On April 2, 2020, the company agreed to sell the Bates Companies for $500,000 plus cancellation of approximately $1.6 million of future earn-out payments. The transaction was subject to regulatory approval and expected to close late in Q2 2020.
- Comparisons are affected by the November 2019 sale of substantially all assets and certain liabilities of RB&T.
Outlook, COVID-19 impacts and risks
- Management expected the pandemic to significantly and adversely affect financial condition, capital, asset quality and results. It highlighted borrowers in hotels, restaurants, entertainment and retail, as well as commercial real estate, equipment leasing and consumer lending. Loans and leases in identified higher-risk industries totaled $956.3 million, or 25.81% of gross loans and leases, at March 31.
- The company provided no specific guidance for future provisions and expected credit provisions to remain elevated. It warned that defaults, delinquencies and collateral-value declines could increase. Long-term targets—9% annual organic loan growth, 6% fee-income growth and operating-expense growth below 5%—might not be achieved in 2020.
- As of May 1, the company reported 2,158 loan modifications totaling $497.0 million and 1,627 PPP loans totaling $355.6 million. These are subsequent operational updates, not March 31 balance-sheet totals. PPP participation carries risks including application-related litigation and potential SBA denial or reduction of loan guarantees.
- The company deferred CECL implementation under the CARES Act. It estimated that the allowance would increase by $7 million at January 1, 2020 and $10 million at March 31, 2020 upon adoption; these were estimates, with model assumptions still being finalized.
- To build liquidity amid uncertainty, the company increased cash reserves and short-term funding. It reported $340.2 million of available bank credit lines and a fully available $20 million secured revolving credit note at March 31. Management also identified possible liquidity pressure from customer line-of-credit use and fluctuations in correspondent-bank deposits.
- Other key risks include the uncertain duration and severity of COVID-19, interest-rate and market movements, loan concentration and credit quality, operational continuity and third-party vendors, and PPP compliance and guarantee risks. Management stated that disclosure controls were effective and reported no significant changes in internal control over financial reporting.
Important facts for investors to verify
- Whether COVID-19-related borrower stress translates into higher delinquencies, charge-offs, criticized loans and additional reserve needs, particularly in the identified exposed industries.
- How many loan deferrals remain outstanding, their subsequent payment performance, and the treatment of modifications under applicable accounting rules.
- PPP loan balances, forgiveness and servicing outcomes, and any SBA guarantee or litigation exposure.
- Completion and final proceeds of the Bates Companies sale, including the earn-out cancellation and regulatory approval.
- Deposit stability and liquidity availability, including correspondent deposits, brokered funding, credit lines and the effects of ongoing PPP lending.
- Whether earnings and capital trends remain consistent with reported margins, credit costs and capital ratios as the economic impact develops.