Douglas M. Hultquist - President and CEO Todd A. Gipple - EVP, COO, and CFO.

Jeffrey Rulis - D.A. Davidson Daniel Cardenas - Raymond James Financial Inc. Damon DelMonte - KBW Erik Zwick - Stephens Inc Nathan Race - Piper Jaffray Brian Martin - FIG Partners LLC.

Greetings and welcome to the QCR Holdings Incorporated Second Quarter 2017 Conference Call. Yesterday after market close, QCR distributed its second quarter press release and we hope that you have had an opportunity to review the results.

If there is anyone on the call who has not received a copy, you may access it at the company's website www.qcrh.com. With us today from management are Doug Hultquist, President and CEO; and Todd Gipple, Executive Vice President, COO and CFO.

Management will provide a brief summary of the quarter and then we will open up the call to questions from analysts. Before we begin the call, I would like to remind everyone that some of the information management will be providing today falls under the guidelines of forward-looking statements as defined by the Securities and Exchange Commission.

As part of these guidelines, I must point out that any statements made during the call concerning the company's hopes, beliefs, expectations, and predictions of the future are forward-looking statements and actual results could differ materially from those projected.

Additional information on these factors is included from time to time in the company's 10-K and 10-Q filings which may be obtained on the company's website or the SEC's website. As a reminder, this conference is being recorded and will be accessible on the company's website until August 4, 2017. At this time, I will now turn over the call to Mr.

Doug Hultquist at QCR. Please go ahead. .

Good morning everyone. Thank you for joining us today and we would like to welcome you to our quarterly earnings call for the quarter ended June 30, 2017.

Initially I will recap some of the highlights for the second quarter and then we'll turn the call over to our Chief Operating Officer and Chief Financial Officer, Todd Gipple who will provide some additional color on our financial results.

I am pleased to begin this morning's call with news that we completed another solid quarter with earnings of 8.8 million and diluted earnings per share of $0.65.

While earnings were down slightly from the prior quarter, earnings for the first half of the year were strong with net income of 18 million and diluted EPS $1.33 versus 13.1 million and $1.07 for the same period a year ago.

We continue to make solid progress in further improving our return on average assets as our run rate is now 1.08% for the year-to-date compared to 1% for the first half of 2016.

These improved results from the prior year were driven by strong organic loan growth, robust growth in core deposits, and a corresponding reduction in our reliance on wholesale funding. In addition we had margin improvement, solid fee income, and modest operating expense growth.

During the second quarter we also announced our planned acquisition of Guaranty Bank and Trust company headquartered in Cedar Rapids, Iowa. We expect to close this transaction in late Q3 or early Q4 pending regulatory and shareholder approvals and other customary closing conditions.

We are very pleased to have the opportunity to combine the great people and clients of Guaranty with our existing Cedar Rapids Bank and Trust charter and further strengthen our market position in the Cedar Rapids community.

Before I ask Todd to provide some additional comments on our financial results, I did want to comment on our loan growth for the quarter. We had very strong organic loan growth this past quarter of 19.2% on an annualized basis with much of this growth in our C&I portfolio.

This puts us at an annualized growth rate of 12.3% for the first half of the year which is the higher end of our targeted growth rate of 10% to 12% annually. We continue to have success taking market share from our competitors as we attract clients to our relationship based community banking model.

Our long term focus is on continued improvements in return on average assets and our strategic goals and related strategic initiatives are focused on achieving return on average asset results in the upper quartile of our peer group. We believe that we have made good progress on this strategic goal thus far in 2017 with an ROAA of 1.08%.

And now I will turn it over to Todd for more detail on our financial results for the quarter..

Thanks Doug, good morning everyone. Thanks again for joining us on the call today. While our second quarter results were down slightly from Q1 linked quarter net income was nearly identical for the quarters, if you exclude the impact of the tax benefit related to stock option exercises and restricted stock awards that vested in each of the quarters.

The reduction in this tax benefit realized in Q2 compared to Q1 was $443,000 as fewer options were exercised and fewer stock awards vested in Q2. Net interest margin percentage was reduced on a reported basis by 9 basis points from 3.90% in Q1 to 3.81% in Q2.

However, net interest margin excluding the impact of acquisition accounting accretion was down only 1 basis point at 3.62% for the second quarter compared to 3.63% for the first quarter.

Net interest income was up slightly at 28 million versus 27.7 million in the prior quarter while net interest margin excluding low discount accretion was down that 1 basis point for the quarter and loan discount accretion was also reduced by 477,000 on a linked quarter basis. This was more than offset by the very strong loan growth in Q2.

We expect further improved net interest income from the strong loan growth as much of the growth occurred in the last half of the quarter. Provision expense was relatively flat this quarter as well due to continued strong asset quality which offset the additional provision needed for our strong loan growth this quarter.

Non-interest income was down approximately 500,000 on a linked quarter basis as gains on the sale of government guaranteed loans was down more than 850,000 in Q2 versus Q1. As we have experienced in past years, given the nature and timing of these types of loans, this revenue source can fluctuate significantly from quarter to quarter.

Wealth management revenue has been strong and is up 19% year-over-year. We have added 217 new relationships and 183 million in assets under management thus far in 2017. We now have 3.1 billion in assets under management with 1.2 billion in trust assets, 954 million in brokerage and RIA accounts, and 894 million in custody assets.

Non-interest expenses continue to be well controlled and were relatively flat compared to the prior quarter. The impact of these results was a fairly consistent net income on a linked quarter basis.

Net income of 18 million for the first half of 2017 represents core ROAA of 1.08% and an efficiency ratio of 61.16%, which we consider to be continued good progress on our goal of achieving upper quartile ROAA.

Earnings per share for the first six months was $1.33 versus EPS of $1.07 for the same period in 2016 which represents a 24% increase in earnings per share. As we look to the remainder of the year we will continue to focus on our seven key initiatives which we have highlighted in our filings.

Continue strong organic loan and lease growth to maintain loans and leases to total assets ratio in the range of 70% to 75%. Continue to focus on growing core deposits to maintain our reliance on wholesale funding at less than 15% of total assets.

Continue to focus on generating gains on the sale of USDA and SBA loans and fee income on swaps as a significant and consistent component of core revenue.

Grow wealth management net income by 10% annually, carefully manage non-interest expense growth, maintain asset quality metrics at better than peer levels, and finally participate as an acquirer in the consolidation taking place in our markets to further boost return on assets, improve our efficiency ratio, and increase earnings per share.

Strong progress on these seven initiatives the past two years has resulted in significant improvement in our financial performance and achievement of peer levels of ROAA. We will need to continue to execute on each of these initiatives to achieve our goal of upper quartile peer performance. Now I'll turn it back to Doug to wrap up. .

Thanks Todd. Again we are pleased with our second quarter results and hope that our comments have provided a bit more insight into the numbers. We can now open the phone lines for questions. .

[Operator Instructions]. Our first question comes from Jeff Rulis with D.A. Davidson. Please go ahead. .

Thanks, good morning.

Question on the loan growth, I guess any idea if that strong production in the later part of the quarter, did that pull or sort of cannibalize any growth out of Q3 or your expectations for the back half is still pretty positive?.

Yeah, based on what we've seen so far in July, Jeff, it continues and the pipelines are strong. .

Got it, okay.

And then on the expenses in that one of the key initiatives of managing expense growth, is that indicative of kind of the growth pattern Q1 to Q2 that is -- I guess do you have a full year of kind of figure that would signify that you're managing growth?.

Jeff, we have a target of around 2% growth on an annualized basis and non-interest expense. We have some nice results here in Q2 compared to Q1 and so that really if you're asking what our level of success measurement would be it would be around a 2% number. .

Great, thanks and then maybe one last one just looks like a little pickup in interest bearing costs.

Do you see any market pressure on deposits and if so would you expect further pressure there?.

Jeff, great question. We've got 3.1 billion in funding from deposits about 750 of that would be non-interest bearing the other 2.4ish interest bearing and of that roughly 550 million would be fairly rate sensitive. So roughly 25% of our interest bearing deposits are what we would consider fairly rate sensitive.

That we did see a pickup in cost of about 25 basis points on that 550 million last year those are fairly rate sensitive. The remaining balance of 75% of those interest bearing liabilities have been quite flat. We've seen very little if any pickup there. Our retail core deposits are not under pressure for pricing which is a very good thing.

And so while there will be some continued pricing pressure there, we don't believe it will be all that extensive. We feel pretty good about our mix there..

Okay. Thank you..

You bet Jeff. Thank you..

The next question comes from Daniel Cardenas with Raymond James. Please go ahead..

Hey, good morning guys. .

Good morning Dan. .

A couple of quick questions, just maybe if you could give us a quick update on the AG portfolio and what you're seeing there and if there's any negative trends that are begin to emerge within that portfolio that you're paying close attention to?.

Yeah Dan, we don't have any direct AG exposure. Obviously being located where we are there's a fair amount of indirect suppliers to John Deere and the like but if anything I would say they are feeling better over the last quarter and Deere’s last earnings report was pretty positive in terms of trends. So hopefully we bottomed out there..

Good and then looking at the positive trends in the quarter you guys were up quite nicely on the deposit side ended with a loan-to-deposit ratio around 89% to 90%, maybe thoughts about the ability of the deposit portfolio growth to keep up with loan growth in the second half of the year and then ideally where do you like to see that loan to deposit ratio?.

Dan, we feel really good about the prospects for future growth in core deposits. We are having a very good year thus far, pipelines and our expectations for the last half of the year remain strong.

We're not focused as much on a loan-to-deposit ratio Dan as maybe a little bit more telling is we're very focused on holding down our reliance on wholesale. And we've driven that down below 10%. Now we're working very hard to keep it there.

Of course to do that when you grow the loans at the clip we are, we are going to have to have very solid core deposit growth and we have thus far we believe that will continue. It is a huge focus for us. We believe that core deposit growth is a real indicator of franchise value.

And maybe to get into the Guaranty discussion a little bit but we're very much looking forward to that transaction closing later this year and for example they have a little over 200 million in core deposits priced at 26 basis points currently. So we are expecting to continue to fund primarily with core deposits..

Good. And then how should we be thinking about yield accretion in the back half of the year.

You were about what 3.7 million in the first two quarters of 2017 is -- can we expect that number to kind of shrink, continue to shrink going forward or is that kind of a good run rate?.

Dan, great question. Of course as we pick up some early accretion from payoffs and renewals that monthly run rate is flattening out a bit. So, just to recap on where we’re at with loan discount accretion specific to CSB, we have 1.6 million total for the quarter.

About half of that was accelerated with the pay offs on renewals that portfolio tends to churn a bit more due to the CNB nature of some of that portfolio. So 880,000 actually was due to early payoff. So, our monthly run rate now is about 200 a month on scheduled accretion, that's down from about 250 last quarter.

So that is trending closer to 600 a quarter now. We've got 6.3 million left and that will continue to on a scheduled basis slow down as we pick up some of the one time..

Okay, great.

And then just last question and I'll step back here but your FTEs on a sequential quarter basis went up by about 24 people, was that on the lending side, just maybe a little bit of color as to where you're adding staff?.

You bet. Dan, we have a fairly robust internship program around our member banks and even at the holding company. We tend to do a fair amount of summer interns. 14 of those FTE's are just summer interns that we would of course see roll off here before the end of the third quarter.

Some of the other adds are producers and we've had some good success in terms of adding some real talent really at each of our banks. So it's an outsized growth number this quarter primarily because of the interns. .

Okay, good. Thanks guys, I'll step back. .

Thanks Dan. .

The next question comes from Damon DelMonte with KBW. Please go ahead..

Hey, good morning guys, how are you doing today?.

Great Damon. .

Great.

So just to touch on the loan growth again in the C&I portfolio, could you just talk a little bit about some of the types loans that you are putting on and maybe what size of loan you're putting on?.

Yeah, it is very spread among the charters and among industries. C&I accounted for over 80% of the increase and really not anything new in concentrations Damon. .

Okay and were these existing lines of credit that were drawn down on or are these new customers who immediately utilize the line of credit?.

Yeah, fair amount of that would be new clients Damon. We continue to have great success taking market share from our bigger bank competitors and candidly the vast majority of those new relationships would be coming from some of the large banks in our communities, Wells Fargo, U.S. Bank and the like. .

Thank you, okay, that's helpful, thanks.

And most of these loans like self originated or are you guys purchasing anything through the share national credit market?.

Very modest there. We have had very little activity in the SNC program the last couple of quarters. There's a few participations in here but most of them are organic. .

Okay, have you disclosed the size of your SNC portfolio?.

I believe it is in some of our Q filings Damon, I will check on that and that's probably a great idea if it's not already in our Q detail and those pages and pages of warm footnotes we should probably add it. So, that is a great point. We will make sure we do that. .

Great and then with regards to fee income and the slowdown and the gain on sale of government guaranteed loans. I know in the past you guys have said that you've targeted between the gain on sale of government loans and swap fee income about $4 million a year.

Just wondering if you could provide an update on that guidance and that outlook, do you expect a stronger second half of the year on the government side of this equation?.

We have wanted to be at around 4 million on a combined basis and through the first half of the year we are only at 1.5. Last year we were 3.5. Last year we got off to a very fast start in the first half of the year and then that slowed down a bit in the second half. We're optimistic that things will pick up.

The USDA and SBA will always remain choppy as much as we would like that to be large and consistent, it tends to be large but inconsistent. So that's going to remain choppy Damon. What I can tell you is our pipelines on swaps are very robust right now.

The very flat yield curve has made swaps very attractive for our clients and so we're looking at likely having a very strong second half in swaps, USDA and SBA little tough to predict that..

Okay, alright. And then I guess since most of my other questions were already asked and answered I guess just lastly you know any change to your outlook on margin with regards to interest rate sensitivity.

I know you guys historically have been more liability sensitive but, didn’t know if anything has changed in the last quarter?.

Damon, great question. That really is the issue for us if we're going to start seeing some margin expansion. And I would tell you we're optimistic about margin. Several reasons, 46% of our very significant loan growth this quarter, 46% of that happened in the last month of the quarter in June.

So we've yet to see the full impact of that benefit of loan growth and we will of course here in Q3. Couple of other things, the total rate sensitive funds that I mentioned about 550 million, that compares to our floating rate loan portfolio that's now about 750 million.

So we do see in those two areas of our balance sheet some opportunity for margin expansion and feel pretty good about that. Our floating rate loans over our true rate sensitive funds would be about 137%. So we do have some capacity there.

I did mention the very low cost guarantee funds that we would expect to add to our balance sheet at close here for the fourth quarter of the year, that certainly will help as well. .

Okay, so absent the impact on the accretable yield, the core margin quarter-over-quarter I think you said was down 1 basis point, it sounds like we'll see a little bit of a lift coming in the third quarter and hopefully into the fourth quarter based on what you just described?.

Damon that's fair. We would expect margin to expand a bit as a result of all those things I just pointed out..

Perfect, okay, that's all that I had. Thanks a lot, I appreciate it..

Thank you Damon..

The next question comes from Erik Zwick with Stephens Incorporated please go ahead. .

Good morning guys, how are you?.

Good Erik..

Maybe I'll start another one on the deposits looking at your deposit mix, non-interest bearing deposit concentration. Still very healthy about 27% of total deposits but those balances have now declined two consecutive quarters.

Can you talk about the factors that play there, is there more than just higher rates?.

Yeah, a couple of things. Probably the most, the single most significant impact on our non-interest bearing would be the correspondent banking relationships that we have.

That number in terms of non-interest bearing on correspond would have peaked at 300 million to maybe even as high as 340 million few quarters ago that has tempered down to around 230 to 240 in non-interest bearing on correspondent. So virtually that entire fall in non-interest bearing is attributed to the change there.

And the reason for that is while those are non-interest bearing relationships, they do earn a earnings credit rate against the fees that we charge our correspondent banks.

And Erik as you might guess, as rates come up the earnings credit rate comes up, that now ranges from 85 basis points to 130 some basis points depending on the size of the relationship, size of the deposits, some other factors. So Erik I'm guessing you can follow the math.

If the earnings credit rate goes up those balances can shrink and still pay for their charges. So we're not losing clients, we're not losing relationships but banks that are managing their non-interest bearing deposits with us are certainly able to manage those down and still get the same earnings credit balance.

So that's really what's happening there. We're offsetting that with some very strong growth and some other types of deposits. We've seen some very nice growth at CSB and the Des Moines metro and all of that is retail deposit growth so we're very happy about that.

But, we have seen a tail off in non-interest bearing DDA and again the vast majority of that could be attributed to correspondent..

That's great color, appreciate it.

And then can you update us on whether any new lending teams were added in the quarter and what the pipeline looks like for that today?.

We brought on a new senior lender in the Cedar Rapids market. But to be honest with you most of the growth came with our existing teams. And our specialty finance group had a good quarter as well in terms of what they originated..

And given some of your earlier comments on focusing on deposit growth going forward, any desire to add any deposit focused bankers in the future?.

Absolutely, at price long term franchise value as Todd indicated earlier and those folks are extremely hard to find but we're always on the lookout for them and we did add one in the Des Moines metro late in 2016 and his team is having quite an impact already..

Okay and then we've seen your commercial real estate portfolio, can you remind us of your exposure to the retail sector as well as maybe provide your view of the credit quality of that book today?.

Yeah, we monitor that very closely and we have accelerated the due diligence that we've been doing there over the last couple of quarters. We think our exposure is moderate, we think the locations are good. But clearly what's going on in the whole retail sector we've got to be very sensitive to that..

Right, thanks for taking my questions today..

You bet, thank you..

The next question comes from Nathan Race with Piper Jaffray. Please go ahead. .

Hey guys, good morning. A lot of my questions have been asked and answered already but I just want to well ask one last one on expenses.

I know initially you guys are planning to convert CSB later this year and I was just looking for maybe an update on that contract negotiations, if we can expect that to occur a little quicker than what you guys were expecting?.

Yeah Nate, actually we don't plan to convert CSB until sometime in 2018 not 2017. What you might be thinking of Nate is we are working on our negotiations with Fiserv currently for a master contract for the company.

We're actually in a RFP situation and so that's probably Nate what you have in mind that what is going to happen this fall is we hope to resolve our long-term data processing contract that will have some implications for the timing of that conversion with CSB. But we currently maintain a separate platform for them.

We believe we have that working as efficiently as possible considering it is a second operating system and it is a second system in premier that we're familiar with. It was data processor used by CNB that we acquired in 2013. They're actually being processed out of Des Moines Fiserv market. So it's right there on site. So it's going okay, going well.

We're looking forward to getting us all on one core at some point but that won't be until 2018. .

Okay, got it and then will the plan be to also convert Guaranty at the same time in 2018 that you would look to bring everyone onto the same system as well?.

Yeah Nate, we are aggressive and you would assume so however little different fact pattern at Guaranty and actually a good one for them and for us. Their contract also at Fiserv but on a little different product, Fiserv DNA actually expires almost exactly at our closing date.

So they do not have a long term contract in place where we have any exit cost because they are on a third platform, Fiserv DNA. We expect to convert them before the end of the fourth quarter so almost immediately. We're actually working on that right now assuming we get all the approvals and get closed.

We will be converting them probably 60 to 90 days after closing, putting them on our signature platform, our core platform for Cedar Rapids Bank and Trust because we're merging that charter into CRBT. So hope that makes sense. .

Right, no that is great color. I appreciate you guys taking the questions. .

You bet. Thanks Nate. .

[Operator Instructions]. The next question comes from Brian Martin with FIG Partners. Please go ahead. .

Good morning..

Hey Brian. .

Hey, just a couple things from me just kind of late in the call here, just with regard to the core margin Todd, I guess, or Doug just it sounds as though, I mean it being down whatever touch this quarter kind of flattish this quarter, is that more a function of the funding costs being up, there is a little bit of a lag on that -- on the loan pickup given a lot of it occurred late in the quarter, is that kind of how to think about that or am I my thinking about that wrong?.

No Brian I think you're right on top of that. It really had to do with simple fact we entered the quarter very liquid. We had a lot of deposit growth in Q1 and very modest loan growth. We entered the quarter very liquid.

You could look at the summarized balance sheet quarter-to-quarter and determine pretty quickly that we had a lot of liquidity to work off and while that happened much of it happened in the last month of the quarter. So we are optimistic about margin going forward. .

And then the just the last one, the new loans you made this quarter I guess what kind of yield are those coming on versus kind of where the portfolios are I guess?.

Yeah, coming in pretty much right on top of the existing portfolio. We actually saw a little bit of expansion in core loan yield, it was actually up five basis points when you strip out the accretion on both quarters.

So loan yield is up about five basis points, part of that would be some of our floating rate loans, but the new loans are coming in really on top of. And Brian that's really the issue I think for the entire industry, is we're not seeing much pricing power in those new loans.

We're not able to really get much additional yield, additional spread on those new loans but neither is it slipping backward. So pretty much right on top of the existing portfolio. .

Okay, and the biggest contributor going forward to that I guess if you call it some core margin expansion, I guess what's the biggest driver of that right now you have got, I guess if it is up incrementally in the future quarters kind of what’s the biggest driver of that?.

Yeah, I think the biggest driver would be putting all these new loans to work that came in late in the quarter, that's going to be part of it. Our pipelines are still very strong and we expect to continue in that 10% to 12% range for growth and that's very strong organic growth for a company in the markets we’re in.

So continued loan growth, continued success with funding that with core deposits versus reliance on wholesale. And I had mentioned earlier in the call that the CSB portfolio in the Des Moines metro is performing extremely well from a deposit pricing perspective. Very low if not zero data there.

We're very pleased to be partnering with Guaranty in the Cedar Rapids market, they have a great core deposits portfolio price of 26 bps. So those are really the things Brian that make us optimistic about margin. .

Okay, perfect that's helpful and then just the last couple things.

Just I know you talked about the lenders, not a whole lot of lenders added but on the SBA side, your optimism in the second half is that just a function of the activity there or have there been people hired on that front?.

No new hires there, just really a situation where that has always been for us a very choppy business. And it tends to ebb and flow and what we're looking for is it to get back to more to an average rate. .

Right..

Brian also what we're running into there is loans that we would typically originate with the SBA, our competitors are doing traditionally..

Got you, okay and then maybe just the last few things for me, just I know you talked about, Todd, about kind of your outlook on expenses over the short term but any big initiatives on the horizon in 2018 that could drive up that growth rate as you look out a little bit?.

No, that’s a fair question Brian. If we have any significant plans for items that might create additional expenses and not really on the horizon, we are looking forward to having our data processor contract renewed and candidly improved later this year.

And most of the initiatives we have are really focused on growing loans and growing on core deposits, not really much in the way of having to grow expenses. .

Perfect, okay and lastly just two things, maybe easy Todd, maybe just the tax rate kind of how you are thinking about that and then maybe for Doug just on the M&A side certainly you have got the one deal closing here but just as far as the level of opportunities you're seeing today and how quickly you'd expect or I guess think you could be back into looking at things future opportunities?.

Sure, first on tax rate I'm still expecting us to be in that 23% to 24% range. That gets a little choppy with the new FASB on the tax benefit from options and RSAs pulled us down closer to 20 I believe in Q1. A little more normal this quarter, probably in that 23% to 24% range that we typically are in Brian. .

And that's going forward quarterly Todd or are you talking annual numbers there, quarterly?.

I'd say that be a good proxy for a quarterly number core rate. .

Okay.

And then maybe just on the M&A side?.

Yeah, certainly continue with discussions Brian and as you've seen in the articles, price expectations have elevated a fair amount since the election. I think I read yesterday that a year ago the average was 130% of book value and it's 166% this year.

And what we're finding is some ownership groups think alright, prices have elevated now is a good time to create a liquidity event.

Others think that with the promises that the new administration made in terms of taxes going way down, interest rates going way up, and regulation going away they might as well stay in the business because it's going to be a piece of cake to make a lot of money..

Okay, that's helpful.

And just I guess the level of opportunities you're seeing Doug, I guess is it -- do you think that that's up a little bit, is it down, any characterization of kind of that, what you're seeing there?.

I think for us it is pretty consistent with the last couple of years. .

Okay, so nothing, no significant increase so, okay. I appreciate the color and nice quarter guys. .

Thank you, Brian. .

This concludes our question-and-answer session. I would like to turn the conference back over to Doug Hultquist for any closing remarks..

Well, just appreciate all the interest and the good questions and support we received from our analysts and our investors so we will continue to focus on our seven initiatives and hopefully continue to create shareholder value at the pace we have..

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect..