QCR HOLDINGS INC annual report, FY2016

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QCR Holdings, Inc. — 2016 Form 10-K Summary

Business context and reporting period

QCR Holdings is a multi-bank holding company serving Iowa and Illinois markets, with commercial and consumer banking, wealth management, and equipment leasing operations. This filing covers the fiscal year ended December 31, 2016; financial comparisons are primarily with 2015. On August 31, 2016, QCR acquired Community State Bank (CSB), expanding into the Des Moines market. CSB’s results are included from the acquisition date.

Financial performance and position

  • Income: Net interest income was $94.5 million, up 24% from $76.3 million. Noninterest income was $31.0 million, up 27%; net interest income plus noninterest income totaled $125.6 million, up about 25%.
  • Profit: Net income was $27.7 million, versus $16.9 million in 2015. Diluted EPS was $2.17, versus $1.61. Management’s non-GAAP core net income was $29.4 million and core diluted EPS was $2.31; these exclude specified nonrecurring items.
  • Margins and efficiency: Tax-equivalent net interest margin rose 38 basis points to 3.75%. The non-GAAP efficiency ratio improved to 64.90% from 72.71%. Return on average assets was 0.97%, below management’s 1.10% goal.
  • Credit costs and asset quality: Provision for loan and lease losses increased to $7.5 million from $6.9 million. Net charge-offs were $2.9 million, or 0.14% of average loans/leases. Nonperforming assets rose to $27.0 million and 0.82% of assets, from $19.1 million and 0.74%; management attributed the increase primarily to two large fourth-quarter credits and said it did not anticipate significant losses on them.
  • Balance sheet: Total assets were $3.30 billion, up 27%; loans/leases were $2.41 billion, up 34%; deposits were $2.67 billion, up 42%; and borrowings were $291.0 million, down 35%. Acquired CSB assets and deposits contributed substantially to the increases. Loans/leases were 90.12% of deposits.
  • Funding and liquidity: Cash, federal funds sold, and interest-bearing deposits totaled $156.8 million at year-end. Noninterest-bearing deposits were $797.4 million, 30% of deposits. The company reported $361.4 million of available subsidiary-bank credit lines. Operating cash flow was $43.4 million, compared with $30.1 million in 2015; investing activities used $169.0 million and financing activities provided $154.4 million.
  • Capital and dividends: Stockholders’ equity was $286.0 million, compared with $225.9 million. Subsidiary banks were reported as well-capitalized. The company issued 1.215 million shares for net proceeds of $29.8 million to help fund CSB. Declared common dividends doubled to $0.16 per share.

Material changes versus 2015

  • CSB’s acquisition added $581.7 million of assets and $486.3 million of deposits at acquisition; the purchase price was $80.0 million, with $9.9 million of goodwill recorded.
  • Net income increased about 64%, but weighted-average diluted shares also increased, principally due to the stock offering. CSB contributed $2.1 million of net income for the post-acquisition period, including acquisition costs.
  • Loan growth and balance-sheet restructuring, along with CSB, supported margin expansion. The company also shifted assets from lower-yielding securities toward loans and leases.
  • Noninterest income included $4.6 million of securities gains, including a $4.0 million gain from selling an equity investment. Net losses on debt extinguishment were $4.6 million, mainly associated with prepaying borrowings; acquisition costs were $2.4 million.
  • Credit indicators weakened in certain respects: nonperforming assets increased, and classified loans rose to $49.0 million from $28.0 million. Management cited the CSB acquisition as a key reason the allowance-to-loans ratio fell to 1.28% from 1.45%; it said this ratio would be 1.70% when factoring in CSB’s remaining loan discount.

Outlook, risks, and unusual items

  • Management set long-term goals, not specific earnings guidance: maintain loans/leases at 70%–75% of assets; improve profitability; reduce NPAs below 0.75% of assets; keep net charge-offs below 0.25%; maintain wholesale funding below 15% of assets; grow noninterest-bearing deposits above 30% of assets; and grow wealth-management fees 10% annually. At year-end, some goals were unmet, including ROAA, NPAs, deposit mix, and wealth-fee growth.
  • Management reported 10.5% organic loan/lease growth and targeted 10%–12% organic growth. It plans to focus on core deposits, asset quality, fee income, and integrating CSB. CSB’s CRE-heavy loan portfolio exceeded company policy concentration limits; a credit risk committee monitors it.
  • Credit exposure is concentrated in commercial lending: C&I loans were 34% and CRE loans 46% of total loans/leases. Other risks include economic conditions in the company’s regional markets, interest-rate and funding changes, acquisition integration, competition, cybersecurity, and regulatory requirements.
  • The securities portfolio had $8.6 million of gross unrealized losses, partly offset by $3.6 million of gross unrealized gains. Management considered the losses temporary and reported no other-than-temporary impairment.
  • Commitments to extend credit totaled $666.8 million and standby letters of credit $15.7 million; management did not expect all to be funded. There were no material pending legal proceedings beyond routine litigation.
  • The independent auditor gave an unqualified opinion on the financial statements and internal controls. Management and the auditor excluded CSB from the 2016 internal-control assessment because it had been acquired during the year.

Important facts for investors to verify

  • Whether CSB integration and earnings benefits support growth after acquisition-related costs, purchase-accounting accretion, and share dilution.
  • Performance and potential loss exposure of the two large fourth-quarter credits, CSB’s elevated real-estate concentrations, and the adequacy of the allowance alongside acquired-loan discounts.
  • How much of reported earnings growth and noninterest income is repeatable, given securities gains, debt-extinguishment costs, and other adjustments used in core measures.
  • Whether deposit growth, funding costs, and interest-rate exposure sustain the improved margin; review the filing’s sensitivity scenarios and upcoming borrowing maturities.
  • Progress toward management’s asset-quality, profitability, funding-mix, and wealth-fee goals, and the effect of future capital needs or additional acquisitions.