QCR HOLDINGS INC annual report, FY2018

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QCR Holdings, Inc. — 2018 Form 10-K

Business and reporting period: Multi-bank holding company serving communities in Iowa, Illinois, Missouri and Wisconsin, with commercial and consumer banking, leasing and wealth management operations. This annual report covers the fiscal year ended December 31, 2018; 2017 is the primary comparison. Results include Springfield First Community Bank from its July 1, 2018 merger and the Bates Companies from their October 1, 2018 acquisition.

Financial performance and condition

  • Earnings and revenue: Net income was $43.1 million, up 20.8% from $35.7 million; diluted EPS rose to $2.86 from $2.61. Net interest income increased 22.7% to $142.4 million, while noninterest income rose 36.3% to $41.5 million. Together, these totaled $183.9 million, compared with $146.5 million in 2017. Adjusted net income, a non-GAAP measure, was $46.4 million, or $3.08 per diluted share.
  • Margins and efficiency: GAAP net interest margin fell to 3.46% from 3.50%; tax-equivalent NIM declined to 3.62% from 3.78%, and adjusted tax-equivalent NIM to 3.48% from 3.64%. The efficiency ratio improved to 64.77% from 66.48%. Return on average assets was 0.98%, below the company’s greater-than-1.10% goal.
  • Cash flow: Operating activities provided $64.3 million, versus $33.7 million in 2017. Investing activities used $333.6 million, principally reflecting $292.7 million of net loan growth; financing activities provided $279.2 million. Cash and due from banks ended the year at $85.5 million.
  • Balance sheet and funding: Total assets were $4.95 billion, up 24%; gross loans and leases were $3.73 billion, up 26%; deposits were $3.98 billion, up 22%. The loan-to-deposit ratio was 93.86%, compared with 90.75%. Total borrowings, including junior subordinated debentures, were approximately $405.0 million. At year-end, $343.7 million of subsidiary-bank credit lines was available; $1.0 million was available on the parent’s $10 million revolving line.
  • Credit quality: Nonperforming assets fell to $27.9 million from $32.3 million, and NPAs to total assets improved to 0.56% from 0.81%. The allowance was $39.8 million, or 1.07% of gross loans and leases, versus 1.16%; net charge-offs were 0.21% of average loans and leases. Commercial real estate represented 48% and commercial and industrial loans 38% of the loan portfolio.
  • Capital: The company reported a 10.69% total risk-based capital ratio and 8.89% common equity Tier 1 ratio at year-end. Subsidiary banks were reported well-capitalized. Tangible common equity to tangible assets, a non-GAAP measure, was 7.78%, down from 8.01%.

Material changes and notable items

  • 2018 acquisitions added Springfield Bancshares/SFC Bank and the Bates wealth-management business. The Springfield merger added $439.6 million in deposits and $477.3 million in acquired loans; Bates added approximately $704 million of assets under management. Total assets acquired in 2018 were reported at $578.9 million, and acquisition-related goodwill increased substantially.
  • Management reported organic loan and lease growth of 9.8% and organic deposit growth of 8.3%. Reported loan growth also includes acquisitions.
  • Interest expense increased 108% to $40.5 million, as funding balances and rates rose. Management cited higher-rate-sensitive commercial deposits, rate increases and temporary wholesale funding needs as factors pressuring margins.
  • Provision for loan and lease losses increased to $12.7 million from $8.5 million, including expense related to two unrelated borrowers at RB&T, loan growth and acquired-loan accounting.
  • Noninterest expense rose 22% to $119.1 million, driven in part by acquired operations, staffing and facility costs. It included $3.9 million of acquisition and post-acquisition costs and a $2.0 million write-down of an OREO property; another OREO property was sold at a $424,000 loss.
  • Swap fee income rose to $10.8 million from $3.1 million, contributing to record noninterest income; this source can vary with market conditions and customer activity. The 2017 comparison included a $2.9 million tax benefit from revaluing deferred taxes under the Tax Act.

Outlook, risks and contingencies

  • The filing provides no specific earnings or EPS forecast. Long-term management goals include maintaining loans and leases at 73%–78% of assets, NIM above 3.65%, ROAA above 1.10%, NPAs below 0.75%, annual net charge-offs below 0.25%, and wholesale funding below 15% of assets. The company met its loan-to-assets and NPA goals in 2018 but missed its NIM, ROAA and wholesale-funding goals; wholesale funding was 14% of assets.
  • Management emphasized prudent organic growth, core deposit growth, asset-quality improvement, selective acquisitions, wealth-management growth and fee income. It noted competition for deposits and loan pricing, and rising funding costs.
  • Key risks include concentrated C&I and CRE lending, regional economic weakness, borrower defaults and collateral values, interest-rate and funding risks, acquisition integration, regulatory requirements, cybersecurity and operational disruption, and the planned transition from LIBOR. Management identified elevated real-estate concentration at CSB and SFC Bank and said additional monitoring was in place.
  • Commitments to extend credit totaled $1.17 billion and standby letters of credit $20.3 million; management did not expect all commitments to be funded. Sold residential mortgage loans with recourse provisions still in effect totaled $12.4 million; no liability was recorded, and management considered the risk not significant.
  • A legal matter involving two RB&T employees charged with wrongdoing related to an SBA loan application may continue into late 2019. The company stated that neither RB&T nor QCR Holdings had been charged. The filing reports no other material pending legal proceedings beyond routine litigation.
  • Subsequent financing: On February 12, 2019, the company issued $65 million of 5.375% fixed-to-floating subordinated notes, receiving approximately $63.5 million net. It repaid $21.4 million of term notes and the $9 million revolving-line balance; remaining proceeds were intended for general corporate purposes, including potential acquisitions and debt repayment.
  • The financial statements received an unqualified audit opinion. Management and the auditor excluded SFC Bank and the Bates Companies from the 2018 internal-control assessment because of their recent acquisitions; the auditor reported effective internal control for the assessed company.

Important facts for investors to verify

  • How much of earnings growth and balance-sheet expansion is organic versus acquisition-related, and whether the acquisitions meet expected accretion and integration targets.
  • Whether NIM, funding costs and core deposit growth improve, particularly given the 93.86% loan-to-deposit ratio and increased brokered deposits.
  • Credit performance and allowance adequacy as CRE and C&I exposures grow; review the two borrower-related provision charges and elevated real-estate concentrations at CSB and SFC Bank.
  • The durability of swap fee income and other variable noninterest revenue, and the extent to which 2018’s expense growth and OREO charges recur.
  • The use and maturity profile of the 2019 subordinated-note proceeds, resulting debt costs and capital ratios after repayment of existing debt.
  • The status and financial exposure, if any, from the SBA-related legal proceedings and outstanding loan commitments.