Greetings and welcome to the QCR Holdings, Inc. Earnings Conference Call for the Fourth Quarter and Full Year 2020. Yesterday, after market closed, the company distributed its fourth quarter and year-end earnings press release. If there is anyone on the call who has not received a copy, you may access it on the company's website www.qcrh.com.

In addition, the company has included a supplemental slide presentation with COVID-19 related disclosures that you can refer to during the call. You can also access these slides on the website. With us today from management are Larry Helling, CEO and Todd Gipple, President, COO and CFO.

Management will provide a brief summary of the financial results and then we'll open the call to questions from analysts. Before we begin, 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, any statements made during this 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 in the company's SEC filings, which are available on the company's website.

Additionally, management may refer to non-GAAP measures, which are intended to supplement but not substitute for the most directly comparable GAAP measures, the press release available on the website, contains the financial and other quantitative information to be discussed today as well as the reconciliation of the GAAP to non-GAAP measures.

As a reminder, this conference call is being recorded and will be available for replay through February 11, 2021 starting this afternoon. Approximately one hour after the completion of this call. It will also be accessible on the company's website. At this time, I'd like to turn the conference call over to Mr.

Larry Helling at QCR Holdings, sir, you may begin..

Thank you, operator. Welcome, ladies and gentlemen, and thank you for taking time to join us today. I will start the call with a brief discussion regarding our full year performance. Todd will follow with additional details on our financial results for the fourth quarter.

We are very pleased with our financial performance in the fourth quarter and for the year highlighted by record net income and a solid increase in adjusted earnings per share. These record results were driven by robust revenue growth including record fee income and solid organic loan growth that helped boost our net interest income.

The pandemic made it a challenging year but we adjusted to the new environment, helped our clients manage the impact of the crisis and continue to identify and capitalize on growth opportunities. Our adjusted net income increased 8% for the year and we grew our tangible book value by 14%.

After adjusting for non-core items, our revenues grew by 25% driven by strong swap fee income and higher net interest income while core expenses were down 1%, demonstrating strong operating leverage. We experienced healthy demand from our client base and grew loans by nearly 8%.

This does not include the $358 million of PPP loans for both new and existing clients. Our specialty finance group had an outstanding year generating record production volumes based on strong client demand for our niche lending products. Our loan pipelines remain healthy and our near-term outlook for loan growth, remains positive.

However, until we have better visibility on the economic recovery, we are targeting organic loan growth for the full year of 2021, between 6% and 8%, slightly lower than our long-term goal of 9%.

We funded our loan growth in 2020 with core deposits, which grew by very robust 22% for the year with strong contributions from our core commercial and correspondent banking clients. We continue to grow market share across our charters, which reflects the value that our clients place on relationship-based community-banking.

Additionally, we successfully protected our net interest margin in 2020, which was up slightly for the year, despite a significant drop in short-term interest rates as a result of the pandemic. Our balance sheet initiatives paid off as we drove down our interest cost by eliminating high cost wholesale funds.

We also increased non-interest bearing deposits meaningfully and capitalized on favorable deposit repricing opportunities. Our asset quality and credit metrics remained strong. We also significantly built our loan loss reserves over the course of the year and feel very good about our current reserve level.

As we discussed on our last three earnings calls, we proactively implemented our loan relief program early in the pandemic, offering loan payment deferrals to our impacted clients, helping them preserve cash and liquidity. Nearly, all of our borrowers, who received payment relief resumed payments, well before the year-ended.

As of December 31, we had only $28 million of loans remaining on deferral, or 0.66% of the total portfolio. We believe this speaks to the high quality of our loan portfolio and the resiliency of our local markets, which continue to exhibit improving economic activity.

While it remains difficult to predict the ultimate impact that the pandemic will have on our clients, our banks are well positioned to navigate this environment. We are monitoring our loan portfolio closely, and working with clients to help them adapt to the current economic environment.

We continue to believe that our client focus, combined with local decision making is the best way to serve our markets as the economy adapts and recovers. I would like to thank the entire QCR Holdings team for their hard work and dedication to outstanding customer service and for delivering record earnings performance for the year.

Our employees are the heart of our company, I am very proud of our entire team and for all they've accomplished in 2020. In summary, we continue to believe that we will emerge from this pandemic well positioned to pursue our long-term goal of profitable growth and value creation, both organically and through strategic acquisitions.

With that, I will turn the call over to Todd to provide further information about our fourth quarter results..

Thank you, Larry. As I review, our fourth quarter financial results, I'll focus on those items where some additional discussion is warranted. I'll start with our loan growth. Our annualized loan and lease growth was 9% during the fourth quarter.

It was largely driven by new production in our core commercial lending business primarily in commercial real estate loans. A key driver was strong loan production from our specialty finance group.

As Larry mentioned, we continue to experience healthy demand in this area and maintain a solid pipeline of opportunities, in particular with our relationships in tax credit project lending and municipal finance. Our strong loan and lease growth during the quarter was funded with some of our excess liquidity.

Our deposits declined slightly, as core deposit growth was offset by intentional reductions in our higher cost portfolio of broker deposits as well as some higher-cost CDs. Additionally, we continue to reduce our reliance on wholesale funds to now record lows.

At year-end, we had only $26 million of wholesale funding, excluding our subordinated debt which provides tier 2 capital. This is down from $328 million one year ago.

Over that same period, we grew non-interest bearing deposits by nearly $370 million driven by deposit gathering from our commercial clients as well as from our correspondent banking relationships. Non-interest bearing deposits now represent 25% of our total deposit base, up from 20% at the end of 2019.

Not only has our strong core deposit gathering activities significantly reduced our reliance on wholesale funding. It has also helped to enhance our net interest margin. Now turning to earnings, our net interest income for the quarter was $43.7 million, down 900,000 on a linked quarter basis. While average earning assets grew by 1.3%.

The yield on those assets declined by 8 basis points from the third quarter and our deposit cost declined by two basis points, driven by both rate and mix.

The lower yield on our assets was primarily due to one-time interest recoveries on previously charged off loans at $1.1 million that we experienced in the third quarter, which was not repeated in the fourth quarter.

As a result of this one time recovery in the third quarter, our reported NIM was down 11 basis points and our adjusted NIM was down seven basis points. Excluding the impact of the prior quarter's interest recoveries, adjusted NIM was actually up one basis point well ahead of our guidance on last quarter's call.

We are very pleased with our NIM performance throughout 2020. We have been successful in holding onto earning asset yields while driving down cost of funds aggressively through timely and strategic deposit rate reductions, as well as significant rotation from higher cost wholesale funds to low-cost core deposits.

As we move further into the sustained low interest rate environment, our ability to continue driving cost of funds lower is diminishing. While we continue to experience loan pricing pressure. Therefore, we do expect some modest NIM compression in 2021.

On a net basis, we expect first quarter adjusted NIM to decline in the range of four to six basis points. Now turning to our non-interest income, which was a strong $32 million for the quarter but lower than the record $38 million we generated in the third quarter.

We produced swap fee income of $21 million meaningfully above the $18 million level, we guided to, but below the record $26.7 million in the third quarter. We averaged almost $19 million per quarter of swap fee income in 2020.

As Larry mentioned, we continue to expect strong sustainable levels of swap production based on the demand we are seeing from the relationships within our Specialty Finance Group, as well as in our core commercial lending.

Many of our clients continue to want to lock in attractive fixed long-term rates by converting their variable-rate loans through the use of swaps. The pipeline of swap loans at our banks and our Specialty Finance Group remains healthy and we believe that this source of fee income is sustainable for the foreseeable future.

While we don't anticipate achieving the same high level of swap fees that we did in the third and fourth quarters, we do expect that swap fees will be approximately $14 million to $18 million per quarter for 2021. Now turning to our expenses.

Non-interest expense for the fourth quarter totaled $46.4 million compared to $40.8 million for the third quarter and higher than our guidance of $38 million to $40 million. There were a number of significant items that impacted expenses.

First, we incurred increased salary and benefits expense of $4.4 million with increased incentive compensation expense in the quarter driven by the strong financial results in the second half of the year. Second, we incurred $1.5 million of losses on debt extinguishment as we prepaid some high cost wholesale funds to improve future profitability.

And third, we incurred some other one-time year end charges totaling $1.6 million. Adjusting for all of these items, our non-interest expense came in at just below $39 million right in our guidance range.

Looking ahead to the first quarter, we anticipate that our level of noninterest expense will return to a more normalized level and we'll be back in that range of $38 million to $40 million. Our overall asset quality continues to be quite strong.

Nonperforming assets improved by 22% for the quarter and now represent only 26 basis points of total assets. One basis point lower than one year ago. The linked-quarter improvement was primarily due to a reduction in nonaccrual loans as a number of loans returned to performing status over either monetized or charged off during the quarter.

Our provision for loan and lease losses totaled $7.1 million for the fourth quarter, down from $20.3 million in the prior quarter. The level of our reserves excluding the impact of the $273 million in PPP loans that remain on the balance sheet was 2.12% to total loans and leases up seven basis points from the end of September.

This allowance now represents over five times our non-performing assets. We were fully prepared to implement CECL at 12/31/20 as planned. However, due to the lack of clarity from the SEC on their interpretation of the December CARES Act legislation, by the time we needed to close the year, we stayed on our incurred loss methodology at 12/31/20.

Our reserves under the incurred loss methodology and CECL were nearly identical at 12/31/20 and we intend to adopt CECL as of 1/1/21. With respect to capital. We continue to maintain very strong capital levels and have abundant liquidity to meet our client's needs.

Our tangible common equity to tangible assets ratio improved to 9.4% as compared to 8.89% at the end of September if you exclude the dilutive impact of the PPP loans.

Our overall earnings power remained significant and as a result, we are well positioned to continue to grow capital, provide solid earnings per share and take advantage of future M&A opportunities. Our effective tax rate for the quarter came in at 18%.

The rate was slightly lower on a linked quarter basis, due to a lower ratio of taxable earnings to tax-exempt revenue. With that added context on our fourth quarter financial results, let's open up the call for your questions. Operator, we are ready for our first question..

Again, ladies and gentlemen, at this time, we'll begin the question-and-answer session. [Operator Instructions] We will pause momentarily to assemble our roster. And our first question today comes from Jeff Rulis from D.A. Davidson. Please go ahead with your question..

Good morning, Larry and Todd..

Good morning, Jeff..

Good morning..

Wanted to ask about just the expense guide there and maybe to extend that a little further the 38 to 40, but then kind of a growth rate from there or is that kind of range bound for the year, any expectations for expense growth is potentially as we get longer in the tooth of sort of the pandemic.

And if things were to open up incrementally in the back half of the year.

What are you kind of seeing on the expense side?.

Sure, Jeff. Thanks for being on the call today. Great question. We would really anticipate staying in that 38 to 40 range throughout the year that feels like a pretty sustained run rate for us. We did have some expenses pulled forward into Q4 that was intentional, really trying to settle in at that 38 to 40.

If we're in that range of swap guidance that we provided that really should be where we land with respect to non-interest expense. With that being elevated if we have more significant swap fees as, we did see some incentives around that going up. But short answer is 38 to 40 feels pretty good for much of the year..

And Todd the -- your last comment there on CECL. So it doesn't sound like we're going to see a big sort of day one adjustment be somewhat immaterial or am I reading that wrong..

No. Jeff, spot on, it would be immaterial, we were disappointed that there were some uncertainty there at year-end. We didn't feel like it was appropriate to wait for the SEC to give their final opinion on that. We spooled -- incurred loss model back up.

I think, that at the end of the third quarter, they were very close, they were right on top of each other at 12/31. So should not be any significant day one impact for adoption here in the first quarter..

Got you. Okay and maybe one last one, perhaps for Larry. Just thinking about that growing capital level and I think you've been pretty consistent about you're marking that first organic growth, but if you keep your eye on M&A, if we -- if perhaps the M&A side goes kind of quiet and loan growth, a little bit under your expectations.

Do you -- at any point throughout the year, do you kind of increase sort of the buyback discussion of using that tool over some of your other --sort of capital methods? Thanks..

Yes, Jeff, another good question. I would say, first, we've had good organic growth even through the pandemic. So a lot of our discussion will depend on how much organic growth we see prospectively. Secondly, do we think there will be some M&A opportunities in the foreseeable future. That's hard to predict as you know.

But if things continue to normalize. I would expect there to be more dialog with potential M&A targets, but it's probably premature yet to anticipate anything.

But yes, if none of that materializes, if growth went a little slower and there is nothing on the horizon from M&A, it's certainly something we would discuss later in the year with regard to potential buyback..

Okay.

And could you remind us the authorization in place?.

Yes, we suspended however, so we would want to go back to our Board and talk about it later this year. If the dynamics changed throughout the year sometime..

Okay..

Jeff, we used much of the authorization we had back in the first quarter. And as Larry said, we suspended that mid-March. And if we were to do a buyback again, reinstitute one, we'd likely go back to the Board and settle in on a target, at a refresh target..

Okay. Great, thank you guys..

Thanks, Jeff..

Our next question comes from Nathan Race from Piper Sandler. Please go ahead with your question..

Yes, hi guys..

Good morning, Nate..

Good morning, Nate..

Maybe just hoping to continue the discussion on the adjusted margin outlook, Todd, I appreciate your guidance in terms of some compression from here. I guess within that, what are your expectations for PPP flows and volumes from this latest round.

And obviously while somewhere out from the volumes from last year, but just trying to kind of parse that out as we think about the outlook there?.

Sure. Nate, maybe I'll just start with a high level kind of burn down on forward NIM and then talk a little bit about PPP. Certainly the big headwind for us in providing that guidance of some compression in Q1 would be loan yields certainly fixed rate loans repricing.

We are also continuing to issue more floating rate with our slot program, so those are LIBOR floaters. So that will continue to provide a bit of a headwind. We are fortunate, we still have some opportunities to fight that off. We will continue to drive down our cost of funds. We are starting to bump into some floors.

As you might have noticed and looking at the table. So there is a bit of a diminished opportunity there, but we have some incredibly talented bankers all through the company fighting for every basis point, they can get in terms of cost of funds reduction.

So, still have a little bit of opportunity there, excess liquidity, while we work that down pretty successfully in Q3. And here again in Q4. Our estimate is it cost us roughly nine basis points in Q4, excess liquidity, that's not going to get any easier with new PPP funding, there is certainly going to be another wave of liquidity in the system.

So we'll continue to work hard at forcing down excess liquidity. But I mean to the extent we can, we'll see some benefit. And then we will have a full year or full quarter result from some of the delevering that we did and some of the prepayment we did in the fourth quarter. So those things will help offset that a bit.

But we just think, given the challenges, it's prudent to provide a little bit of softer guidance in that four to six range will do all we can to outperform that. And then, yes, a little bit about PPP. We have roughly 900 K in forgiveness in Q4 around $2.6 million total in net fees between accretion and the forgiveness.

We only have about $2 million in fees remaining. We would expect roughly $1 million of that in the first quarter. Again that's all dependent on forgiveness rates and activity, but that's going well. And then the rest will tail off. Really not speculating at this point, what we might see with round two PPP.

I know, Larry has some good insight on what our lenders are expecting. Larry, maybe you want to provide some of that in terms of where we think round two might have..

Yes, Nate. I would say that we've got a new portal in place which will make the process much easier. And so we feel good about our ability to respond. There is plenty of second round dollars available for our clients. There are, as -- though restrictions on the size of the loans and who can qualify this time.

So we would estimate that the PPP for round two will be roughly 30% of the volume of the first round of PPP for us, and we'll certainly be active. We are still trying to help our clients and proactively going to them, but it won't be of the same magnitude, as the first round of PPP..

Got it. That's very helpful. And then just kind of thinking about the provision outlook for this year with CECL implementing here in the first quarter. And you guys obviously have a pretty strong loan growth and pipeline, outlook for this year in your reserve is already at a pretty strong level.

I guess, should we expect any reserve releases, assuming kind of the steady recovery from here or do you guys continue to expect to need to provide on top of charge-offs, just given the loan growth outlook again as pretty strong entering this year..

Yes. Nate, I'd -- I'll start and I'll let Todd finish here if he has any additional color.

We're certainly in that part where it's -- we've had less credit issues and we would have anticipated, nine or 10 months ago, when this whole pandemic started our publicly available metrics that we talk about are improved in the fourth quarter so, that feels really good.

It's probably a little bit premature to declare victory over the pandemic yet because it's difficult to tell exactly which clients will be impacted in certain ways.

So we'd expect a little bit of challenges with a handful of clients that may result in some credit challenges later in the year or maybe even as late as 2022, but that's why we've been aggressive in building our reserve the way we have so that we've tried to get the meaningful component of the earnings impact behind us.

So I'd say, we -- from the very beginning, wanted to target our reserve getting over that 2% level. We're at those numbers. If charge offs normalize or go down, it's certainly possible that we'll need the reserve less later in the year, but it's probably too early to predict that [indiscernible]..

Yes, I think, Larry nailed that. We've been talking since April about getting up over 200 basis points. Now that we are there. It's -- to echo Larry's thought, it's a little early to declare victory. But we feel really good about the level of reserve and how pristine the portfolio is thus far..

Yes, understandable. Sounds good. I appreciate all the color, guys. Thank you..

Thanks, Nate..

Thanks, Nate..

And our next question comes from Damon DelMonte from KBW. Please go ahead with your question..

Good morning, guys. Hope everybody is doing well today. So my first question, just regards to the loan growth. You guys referenced the Specialty Finance Group as being a good source of growth.

Could you just remind us, I guess, first what the outstanding balances are and actually how much that contributed to the growth during the past year?.

Yes. Damon, it's been a meaningful component of our growth throughout the year. One of the things going on at almost all banks.

If you look at our C&I clients because of PPP and because of just tremendous liquidity in our borrower's hands, our normal lines of credit for our C&I operating and industrial clients, those numbers have actually backed up during the year.

So we've been able to overpower that because of meaningful expansion in both our SFG and other commercial real estate and equipment kind of finance activities. And so we are pleased with that because we still been able to have good growth in spite of our clients just borrowing less money on their lines of credit.

So, the growth really came from throughout the company, and, but mostly in commercial real estate and equipment finance because of clients deleverage on their own balance sheets..

Got it, okay.

And then, can you just kind of little perspective on how the relationship opportunities that came about through PPP have or maybe will be playing a role in your future loan growth? Has that been a good source of new leads and have you been able to capitalize on it?.

It's certainly been a good source of loan growth, I think it will be even more meaningful going forward once we get through the PPP phenomena. What I would say, it's probably created better treasury management and deposit opportunities in the short term.

And we talked about some of our metrics, particularly non-interest bearing deposits have grown substantially throughout the year, and so it's made a really good impact on our mix and our funding costs..

Got it, okay. I think, that's all that I had. Everything else had been asked and answered. So thank you very much..

Thanks, Damon..

Thanks, Damon..

[Operator Instructions] Our next question comes from Brian Martin from Janney Montgomery. Please go ahead with your question..

Hey guys, good morning..

Good morning, Brian..

Good morning, Brian..

Hey, Todd, two question. To your point on the asset quality and the reserve levels. I mean, I guess if you are, if -- or I guess if you guys wanted to get to that 2% level. I guess, do you think with the current levels if you -- where the reserve may trend to once you get past the pandemic, kind of in a post COVID world.

It seems justifying, 2% will get more challenging, but I guess, can you give some thought as to -- if you look where you were before versus where you are today, where you think that might end up at some point?.

Sure, Brian. I think to Larry's earlier comments, it's really all going to depend on the charge-offs we see and the pace of those. We would certainly expect to maintain elevated levels of reserves until we are all the way through this as a country.

We could maybe see it softening up a little bit from the 212-ish range that we have now, but that would only be if our longer-term expectations also softened a bit and if we feel like we're getting through some charge-offs in the most troubled areas and industries, getting through those and the sky seem to open up after that, I could see us maybe coming off of the 212 but our credit philosophy and discipline is quite strong, I think, you followed us for quite some time.

And we're just not ready to take the foot off the gas in terms of making sure we have plenty of reserves. It will be a bit more challenging in CECL, of course, I will tell you we enter CECL with roughly $40 million in unallocated reserves due to both COVID and economic factors. So we feel pretty good about CECL's ability to handle that.

Again we were right on top of the numbers at 12/31. I don't know that it's going to necessarily give us a lot of runway to increase those unless asset quality degradation really shows up. And at this point, we don't expect that.

But long term, next year, it's really going to depend on -- on level of charge-offs and if those don't show up, then you'll see some softened provision in reserves from us..

Yes, got you. Okay. And then maybe one or two more. Just the -- on the M&A side, I guess you talked a little bit about that.

I guess, would you say at this point, you've seen a pick-up in discussions or has it been more of a -- more distant opportunity on maybe second half of the year on M&A or just kind of wondering, where the dialog has been, given, it's been a struggle for a lot of other bankers out there that may be looking to find partners..

Sure, Larry, you want to start with that one..

Yes, I'll start, I would say. There is certainly -- there has been a pick-up in discussions, but it was, as you know unbelievably quiet the last three quarters or so, but people are starting to, I think because of the opportunity for things to normalize.

I think there will be some opportunities but when exactly, that's going to be -- it's going to be tough to predict, but people are willing to talk about it more than they were certainly the last few quarters..

Got you. Okay and then just last one, Todd, I appreciate the color on the margin. I mean, just wondering in 1Q, your four to six.

I mean in terms of basis points, I mean how much benefit do you have in therefore or just how are you thinking about the forgiveness? It sounds like forgiveness is mostly a first half event on the remaining credits or just kind of wondering, how the margin might look in the back half of the year based on kind of the liquidity, the continued forgiveness here and just big picture, how to think about what's driving the margin directionally beyond 1Q?.

Sure. Fair question, Brian. And again, our guidance for Q1 although little bit of softening in that four to six basis point range. I went through the puts and takes on that. Included in that would be that roughly $1 million of forgiveness and recognition of PPP fees.

While we don't have any clarity on just yet is what kind of PPP fees we might have from round two back half of the year, as Larry shared, our expectations, maybe 30% of the volume we had from round one. I believe that whatever we do see there will be fairly neutral with respect to margin outcome.

I don't expect there to be end of PPP drag or necessarily a big lift out of round two. I think, it's really not going to impact margin much. I think, if you were to look at that 3.37% adjusted number that we posted for Q4, in part, our Q1 guidance, I think we should be fairly static, I really do..

That's it. Okay. I appreciate you guys taking questions. Everything else has been answered, so thanks and nice quarter, and nice year..

Great. Thank you, Brian..

Thanks, Brian..

And ladies and gentlemen, at this time, I'm showing no additional questions, I'd like to turn the conference call back over to Mr. Helling for any closing comments..

Thank you, operator. And thanks to all of you for joining on our call today. We hope that everyone remains healthy and safe during the ongoing health crisis. Have a great day and we look forward to speaking with you all again soon..

Ladies and gentlemen, with that, we'll conclude today's conference call with you. Thank you for joining. You may now disconnect your lines..