QCR HOLDINGS INC quarterly report, Q3 FY2017

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QCR Holdings, Inc. — Q3 2017 Form 10-Q

Business context and reporting period. Unaudited results cover the three and nine months ended September 30, 2017. QCR is a Midwestern financial holding company operating commercial banks, wealth-management businesses and an equipment-leasing subsidiary. Community State Bank (CSB), acquired in August 2016, is included in the reported periods; Guaranty Bank is not, because its acquisition became effective October 1, 2017.

Financial performance

  • Q3 earnings: Net income was $7.9 million, versus $6.1 million in Q3 2016 and $8.8 million in Q2 2017. Diluted EPS was $0.58, versus $0.46 and $0.65, respectively. The declared quarterly dividend was $0.05 per share.
  • Nine-month earnings: Net income was $25.8 million, up from $19.2 million in the prior-year period; diluted EPS was $1.91, versus $1.52.
  • Interest income and margin: Q3 net interest income was $28.6 million, up 21% year over year. Tax-equivalent net interest margin (NIM) was 3.71%, unchanged from Q3 2016 and down from 3.81% in Q2 2017. Nine-month tax-equivalent NIM was 3.81%, compared with 3.65% in 2016. Management cited CSB, loan growth and redeployment from securities into loans as contributors to higher net interest income.
  • Other income and costs: Q3 noninterest income was $6.7 million, down 36% year over year, largely because Q3 2016 included about $4.3 million of securities gains. Q3 noninterest expense was $23.4 million, down 4% year over year, partly because 2016 included $4.1 million of debt-extinguishment losses. Sequentially, expense rose 9%, with acquisition-related costs, higher compensation and elevated legal/professional expense among the reasons.
  • Credit costs and taxes: Q3 provision for loan and lease losses was $2.1 million, up 30% year over year; nine-month provision was $6.2 million, up 27%. The effective tax rate was 19.7% for Q3 and 21.2% year to date. Adoption of stock-compensation accounting guidance reduced tax expense by about $191,000 in Q3 and $813,000 year to date.
  • Margins and efficiency: The reported non-GAAP efficiency ratio was 66.35% in Q3, versus 61.46% in Q2 and 61.44% in Q3 2016. GAAP return on average assets was 0.90% in Q3; management’s long-term target is above 1.10%.

Balance sheet, cash flow and capital

  • Growth and composition: Total assets were $3.55 billion at September 30, up from $3.30 billion at year-end 2016. Gross loans and leases were $2.68 billion, versus $2.41 billion at year-end; Q3 growth was 19.2% annualized. Net loans and leases were 74% of assets. Deposits were $2.89 billion, up from $2.67 billion at year-end.
  • Funding and debt: Total borrowings were $296.1 million, compared with $291.0 million at year-end. Wholesale funding, including brokered deposits, was $347.6 million; management said loan growth had outpaced deposit growth and increased reliance on short-term funding. Noninterest-bearing deposits were 25% of deposits, or 20% of assets, below management’s goal of more than 30% of assets.
  • Cash flow: For the first nine months, operating activities provided $27.2 million, investing activities used $271.1 million and financing activities provided $229.6 million. Cash and due from banks ended the period at $56.3 million, compared with $70.6 million at year-end. Lending growth was the main investing cash use; deposit growth was the principal financing source.
  • Liquidity and capital: The banks had $375 million of available credit lines at quarter-end, and the company’s separate $10 million revolving line was also fully available. Consolidated regulatory capital ratios included 11.49% total risk-based capital, 10.35% Tier 1 risk-based capital and 9.33% common equity Tier 1. The subsidiary banks met the stated “well capitalized” requirements. Tangible common equity to tangible assets, a non-GAAP measure, was 8.31%.
  • Credit quality: Nonperforming assets were $33.7 million, or 0.95% of assets, up from $25.9 million and 0.75% at Q2 2017. Management attributed the increase principally to one large non-owner-occupied commercial real estate relationship. Nonperforming loans were 1.06% of loans and leases. The allowance was $35.0 million, or 1.31% of loans and leases; management calculated 1.52% when including the remaining CSB acquired-loan discount.

Changes, outlook and risks

  • Drivers and comparisons: Growth in interest income and loans reflects both the CSB acquisition and organic lending. Rising deposit costs contributed to higher interest expense. Noninterest income was affected by unusually large prior-year securities-sale gains; prior-year debt-restructuring losses also distort expense comparisons. YTD gains on sales of government-guaranteed loan portions and swap fees were below 2016 levels.
  • Management goals, not earnings guidance: Long-term targets include gross loans and leases of 73–78% of assets, NIM above 3.85%, NPAs below 0.75% of assets, annual net charge-offs below 0.25%, wholesale funding below 15% of assets, and annual wealth-management net-income growth above 10%. Q3 NIM and asset-quality metrics were outside those stated targets. Management reported 15% annualized loan growth for the first nine months, above its 10–12% full-year organic-growth target. The filing does not provide a specific earnings forecast.
  • Guaranty acquisition: The October 1 acquisition consideration was $38.7 million: 678,670 QCR shares valued at $30.9 million and $7.8 million cash. Guaranty reported book assets of $257.2 million, loans of $196.1 million and deposits of $212.3 million. Purchase accounting valuations were still in process; the expected core deposit intangible was $2.5–$4.5 million. QCR planned to merge the bank into CRBT and close two branches.
  • Other risks and unusual items: Legal expense increased due to proceedings involving two RB&T officers charged with wrongdoing related to an SBA loan application; neither RB&T nor QCR was charged. The company expected those expenses to continue into 2018. Management cautioned that credit losses may exceed estimates and identified interest-rate sensitivity, funding concentration and loan growth as risks. Its modeled year-one NII exposure was within policy limits under the presented rate scenarios.
  • Accounting changes: The company was assessing the future effects of lease-accounting and expected-credit-loss standards; it did not expect a significant impact from the revenue-recognition and financial-instruments standards described in the filing. The interim results are not necessarily indicative of full-year results.

Important facts for investors to verify

  1. Whether the rise in NPAs from the large CRE relationship is contained, and how criticized/classified loans and charge-offs develop.
  2. Whether deposit growth can keep pace with lending and reduce reliance on overnight FHLB advances, brokered deposits and other wholesale funding.
  3. Whether QCR sustains margin and earnings growth as deposit costs rise and acquired-loan discount accretion changes.
  4. Guaranty’s final fair-value adjustments, integration costs, branch closures and contribution to earnings and capital after consolidation.
  5. The duration and financial exposure of the legal proceedings, and whether elevated legal costs continue as management expected.