QCR HOLDINGS INC annual report, FY2017

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QCR Holdings, Inc. — 2017 Form 10-K Summary

Business context and reporting period

QCR Holdings is a multi-bank holding company serving markets in Iowa, Illinois and Wisconsin through four banking subsidiaries, alongside equipment leasing and wealth-management businesses. This filing covers the fiscal year ended December 31, 2017, with comparisons to 2016 and 2015.

On October 1, 2017, QCR acquired Guaranty Bank for approximately $38.7 million in a mix of stock and cash; Guaranty was merged into CRBT on December 2. The acquisition added approximately $259.6 million of assets, including $212.5 million of deposits. Results include Guaranty only from acquisition through year-end. QCR also acquired Community State Bank (CSB) in 2016, whose results were included for all of 2017.

Financial performance and condition

  • Earnings: Net income was $35.7 million, up 29% from $27.7 million in 2016; diluted EPS was $2.61 versus $2.17. Core net income, a non-GAAP measure, was $36.3 million and core diluted EPS was $2.66. Fourth-quarter net income was $9.9 million versus $8.5 million a year earlier.
  • Revenue and margin: Net interest income increased 23% to $116.1 million. Tax-equivalent net interest margin rose to 3.78% from 3.75%; GAAP net interest margin was 3.50% versus 3.53%. Total noninterest income declined 1.8% to $30.5 million, partly reflecting the absence of 2016’s $4.6 million securities gains. Trust fees rose 17%, advisory fees 29%, deposit service fees 33%, and swap fees to $3.1 million; government-guaranteed loan sale gains fell 63% to $1.2 million.
  • Expenses and taxes: Noninterest expense rose 19.6% to $97.4 million, including $5.4 million of acquisition and integration costs. The efficiency ratio increased to 66.48% from 64.90%. Income tax expense fell to $4.9 million from $8.9 million; the 12.2% effective tax rate included a $2.9 million benefit from remeasuring deferred taxes after the Tax Act lowered the federal corporate rate.
  • Assets, loans and deposits: Total assets increased 21% to $4.0 billion. Gross loans and leases reached $2.96 billion, up 23% year over year, with reported organic growth of approximately 15%. Deposits rose 22% to $3.27 billion, including acquired deposits; organic deposit growth was 14.4%. Loans/leases were 74.43% of assets and 90.75% of deposits.
  • Credit quality: C&I loans were $1.13 billion (38% of loans/leases) and CRE loans $1.30 billion (44%). Nonperforming loans declined 12% to $18.6 million, but total nonperforming assets increased 20% to $32.3 million, mainly due to an $8.0 million increase in other real estate owned. The allowance was $34.4 million, or 1.16% of gross loans/leases; net charge-offs were $4.9 million, or 0.19% of average loans/leases. Management cited an additional $8.1 million of remaining acquired-loan discount, which would make the allowance-to-loans ratio 1.43% if included.
  • Liquidity, debt and capital: Cash, federal funds sold and interest-bearing bank deposits totaled $161.7 million. Borrowings totaled $309.5 million, including $192.0 million of FHLB advances; wholesale funding was 10% of assets. Subsidiary banks had $375.0 million of available lines of credit, and a separate $10.0 million holding-company revolver was undrawn. Consolidated total risk-based capital was 11.15%, common equity Tier 1 was 9.10%, and Tier 1 leverage was 8.98%; subsidiary banks were reported as well-capitalized. Tangible common equity to tangible assets was 8.01%.
  • Cash flow: Operating activities provided $33.7 million, investing activities used $410.5 million, and financing activities provided $382.0 million. Cash and due from banks increased $5.2 million during the year.
  • Shareholder returns: Cash dividends declared increased to $0.20 per share from $0.16 in 2016. The company issued 678,670 shares for the Guaranty acquisition; no common-stock repurchases were reported.

Material changes versus 2016

  • Growth reflected both organic expansion and acquisitions: CSB contributed for a full year, while Guaranty contributed from October. The company reported organic loan/lease growth of 15.2% and deposit growth of 14.4%.
  • Net interest income benefited from loan growth and a higher yield on earning assets, while funding costs increased: the average cost of interest-bearing liabilities rose to 0.81% from 0.65%.
  • Noninterest expense increased with acquired operations, staffing and integration. Conversely, 2016 included $4.6 million of net debt-extinguishment losses, while 2017 had none.
  • Credit indicators were mixed: NPLs and the NPL ratio improved, but NPAs increased, criticized loans rose 8%, and the allowance-to-gross-loans ratio declined from 1.28% to 1.16%.

Outlook, commentary, risks and unusual items

  • No specific earnings or revenue guidance for 2018 is provided. Management’s stated long-term goals include maintaining loans/leases at 73–78% of assets, NIM above 3.85%, ROAA above 1.10%, NPAs below 0.75% of assets, and annual net charge-offs below 0.25%. The 2017 results met the loan-to-assets and charge-off goals, but not the stated NIM, ROAA or NPA targets.
  • Management plans to continue measured acquisitions, grow core deposits, reduce wholesale-funding reliance, build fee income from wealth management, and pursue government-guaranteed loan sales and commercial interest-rate swaps. These are strategic intentions, not formal earnings guidance.
  • The 2017 results included a $2.9 million tax benefit from federal tax-rate remeasurement and $5.4 million of acquisition and post-acquisition costs. Core earnings exclude selected nonrecurring items and are non-GAAP.
  • Key risks include concentrated C&I and CRE lending, regional economic exposure, interest-rate and funding sensitivity, integration and execution of acquisitions, and cybersecurity and operational risks. CRE exposure is significant; CSB’s real-estate concentrations exceeded internal policy thresholds, with a credit-risk committee monitoring the portfolio.
  • The company disclosed elevated legal and data-processing costs related to a legal matter involving two RB&T employees charged with wrongdoing connected with an SBA loan application. Neither RB&T nor QCR was charged; management expected related legal costs to continue until proceedings were completed, anticipated in late 2018.
  • QCR reported no material pending legal proceedings other than routine litigation. It also reported no material weakness in internal controls; the auditor issued unqualified opinions on the financial statements and internal control. Guaranty Bank was excluded from the internal-control assessment because of its recent acquisition.
  • The company identified the expected-credit-loss standard (CECL), effective for it in 2020, as a potential source of higher allowances, expense and implementation costs; the impact had not yet been determined.

Important facts for investors to verify

  • How much of earnings and balance-sheet growth is sustainable organic performance versus acquisition contribution, purchase-accounting accretion and tax effects.
  • Whether asset quality remains sound as CRE and C&I portfolios grow, particularly the elevated OREO balance, criticized loans, CSB CRE concentrations and acquired-loan discount.
  • Whether deposit growth and pricing can fund loan growth while controlling rising deposit costs and maintaining the stated wholesale-funding and margin goals.
  • The remaining Guaranty integration costs, realization of acquisition benefits, and outcome and costs of the SBA-related legal matter involving two employees.
  • The effects of interest-rate changes, securities duration and municipal exposure, CECL adoption, and regulatory limits on capital distributions and dividends.