Greetings, and welcome to the QCR Holdings, Inc. Earnings Conference Call for the First Quarter of 2021. Yesterday after market close, the Company distributed its first quarter 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 at 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 those 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 up 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 a reconciliation of the GAAP to non-GAAP measures.

As a reminder, this conference is being recorded and will be available for replay through May 12, 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'll now turn the call over to Mr. Larry Helling at QCR Holdings..

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

We are pleased to deliver another quarter of strong net income, driven by robust loan growth, expanded net interest margin and carefully managed expenses. Despite a competitive lending environment, we grew core loans by 14% on an annualized basis, while maintaining disciplined underwriting and excellent credit quality.

We continue to attract new clients and deepen ties with existing clients, which validates our relationship-based community banking model. For the first quarter, adjusted net income was $18.6 million and diluted adjusted earnings per share was $1.16 both just shy of the record results we posted for the fourth quarter of last year.

On a year-over-year basis, our adjusted earnings for the quarter were up 50%. Our double-digit core loan growth in the first quarter was driven by strong productions in both our core commercial business and in our Specialty Finance Group.

There continues to be strong client demand for our niche lending products, particularly in the area of municipal and tax credit finance. Additionally, our lending teams have been active in providing loans under the second round of PPP, both to new and existing clients.

We expect to fund over $100 million of PPP loans in this second round, bringing our total funding for the program to nearly $500 million. As a result of our successful execution of this program, we have added many new highly valued commercial client relationships both on the loan and the deposit side of our business.

Given our strong first quarter production combined with our current pipeline, we are now targeting organic loan growth for the full-year of 2021 of between 8% and 10% consistent with our long-term goal of 9%.

We funded our loan growth in the quarter with excess liquidity combined with growth in our core deposits, which grew by just over 3% on an annualized basis. Core deposit growth was deliberately muted as we successfully shifted some of our excess correspondent banking deposits off balance sheet with the ability to bring them back as needed.

At quarter end, our correspondent banks have total deposits under management of $2.35 billion with over $600 million on our balance sheet and over $1.7 billion being held in reserves at the Federal Reserve Bank. As we continue to grow loans, we have the ability to move a portion of these deposits back onto our balance sheet.

During the quarter, we continued to reduce higher cost non-core funds, reprice deposits lower and increase our non-interest-bearing deposits. This helped to lower our overall funding costs during the quarter, which was key to our success in growing our net interest margin. Todd will provide more detail on NIM in his remarks.

Our asset quality remains very strong and our banks continue to be well capitalized. Our loan deferrals remain immaterial with only $7 million on deferral at the end of the quarter. Our net charge-offs continue to be negligible, and we feel very good about our current reserve level, which when excluding PPP loans is approximately 2%.

As always, I want to thank our employees for their efforts in delivering strong financial results. Their hard work and dedication to building relationships with our clients remains the key to our ongoing success.

In summary, we are optimistic about the rest of the year and have a favorable outlook for our local markets as we emerge from the pandemic and the economy further reopens.

Having supported our clients with financial assistance and exceptional service during these challenging times, we are well positioned to continue pursuing our long-term goal of profitable growth and value creation, both organically and through strategic acquisitions. And now I'll turn it over to Todd for a bit more detail..

Thank you, Larry. As I review our first quarter financial results, I will focus on those items where some additional discussion is warranted. I'll start with our loan growth.

As Larry mentioned, excluding our PPP loans, our annualized loan and lease growth was 14% during the first quarter, which was driven by new production in our Specialty Finance Group, particularly in tax credit project lending and municipal finance.

Our core commercial lending business was also very solid most notably in commercial real estate loans as some of our clients are funding projects that were previously put on hold due to the pandemic.

We are also seeing increased C&I demand as our client's utilization of revolving lines increased in March, which we believe reflects business optimism across our client base as we enter the second quarter. Our very strong loan and lease growth during the quarter was funded with some of our excess liquidity as well as with growth in our core deposits.

As Larry mentioned, we proactively managed our deposit growth by shifting a significant amount of our correspondent deposits offer balance sheet to the Federal Reserve EBA program, which helped to reduce excess liquidity and enhanced our net interest margin.

Additionally, we continue to grow our non-interest-bearing deposits during the quarter as they increased by $124 million or nearly 11% from the prior quarter. Non-interest-bearing deposits now represent 27% of our total deposit base. Now turning to earnings.

Our net interest income for the quarter was $42 million, down $1.7 million from the fourth quarter of 2020. However, after excluding the impact of acquisition-related net accretion and PPP income, net interest income was static on a linked quarter basis.

With respect to PPP loans, $207 million in balances have been forgiven through the end of the first quarter of 2021. We recorded PPP income of $2.3 million in the first quarter with $3.6 million remaining to be recognized. New PPP clients have resulted in more than $80 million of additional new loan and deposit business to-date.

While average loan balances were relatively stable during the quarter, our cash balances declined driving average earning assets down 2.4% and creating a more efficient balance sheet. Additionally, the yield on those assets declined by 5 basis points from the fourth quarter, driven by both rate and mix.

Our deposit costs declined by 1 basis point and when combined with the strong growth in non-interest-bearing deposits, we were able to grow our adjusted net interest margin by 3 basis points exceeding the guidance we provided on our year-end call.

Looking forward, given the ongoing low interest rate environment, combined with the possibility of some excess liquidity build from seasonality and expected continued PPP forgiveness, we do anticipate a possible 1 to 3 basis points of NIM compression in the second quarter.

However, we will continue to work hard to protect loan yields, drive down cost of funds and proactively manage excess liquidity in an attempt to outperform that guidance. Now turning to our non-interest income.

Non-interest income was $23.5 million in the first quarter, which included $13.6 million in swap fee income effectively right at the lower end of our guidance. This compares to non-interest income of $32 million in the fourth quarter, which included very strong swap fee income of $21.4 million.

Our pipeline for swap loans continues to be healthy and we fully expect this source of fee income to be sustainable for the long-term. As a result, we are reaffirming our guidance and expect our levels of swap fee income to continue to be approximately $14 million to $18 million per quarter for the remainder of 2021.

We generated robust growth in wealth management income during the first quarter, which was up nearly 13% on a linked quarter basis. Our performance was driven by $457 million increase in assets under management, bringing total AUM to $4.8 billion.

New client generation continues to be strong as well as sizable increases in our existing client portfolios. Now turning to our expenses. Non-interest expense for the first quarter totaled $37.2 million down from $46.4 million in the fourth quarter.

The linked quarter decline was primarily due to lower salary and benefits expense of $5.6 million driven by lower commission and incentive compensation expense. We also experienced modestly lower occupancy and equipment expense, advertising and marketing expense and professional and data processing fees.

Additionally, in the fourth quarter of 2020, we booked a loss on liability extinguishment of $1.5 million, which did not reoccur in the first quarter. We were pleased to outperform our guidance on non-interest expense in the first quarter and we are reaffirming our guidance for the second quarter in the range of $38 million to $40 million.

Our overall asset quality continues to be very strong. Both our non-performing assets and the ratio of NPAs to total assets remain consistent with the prior quarter and our net charge-offs were once again, very minimal.

We successfully implemented CECL in the first quarter, which translated into a modestly lower credit loss provision on a linked quarter basis and an ACL to total loans and leases of 1.99% excluding PPP loans. With respect to capital, we continue to build capital through strong earnings and maintained robust capital levels.

Our tangible common equity to tangible assets ratio improved to 9.67% as compared to 9.4% at year-end, if you exclude the impact of the PPP loans. Our effective tax rate for the quarter came in at 16.5%. The rate was lower on a linked quarter basis due to a higher ratio of tax-exempt revenue.

With that added context on our first quarter financial results, let's open up the call for your questions. Operator, we are ready for our first question..

We will now begin the question-and-answer session. [Operator Instructions] Our first question today comes from Jeff Rulis with D.A. Davidson..

Thanks. Good morning, Larry and Todd..

Good morning, Jeff..

Good morning, Jeff..

I was hoping to get a sense of the commissions tied to swap income.

If we do kind of bounce between $14 million to $18 million a quarter, is there any kind of key that you could offer in terms of what the comp expense would do in – or the variable commissions at those levels?.

Sure, Jeff. Good question. So when we get to the low-end or maybe even the midpoint of our guidance range, typically around 75% of that's going to get to the bottom line pretax of 25% carry-on commissions and other costs.

As we approached the higher end of guidance and if we have a quarter where we have outsized swap revenue and we get above that guidance, that's probably going to get more like 65%, 70% getting to the bottom line.

At that point, we're starting to impact broad-based incentives as more of the midpoint of our guidance would be build into our incentive targets – targeted incentives. We get stronger performance in that. We're going to have a little bit more incentive comp around that. So probably 65% to 70% as we get past the midpoint.

Is that makes sense?.

Yes. That's great. I appreciate it, Todd. Turning to the loan growth, look like it was really backend loaded in the quarter and very strong at that. I guess as that pull forward growth in the second quarter or as you said, C&I lines perking up in March, we're through April here.

I guess expectations on kind of reset to the 8% to 10% for the full-year, but just curious as to the near-term loan momentum into the second quarter..

Yes. Jeff, the positive part of this was the growth was really pretty broad-based. So in our core business, I think because of our really strong PPP activity, we moved a lot of relationships over that we'd worked on for years and maybe decades that I think that helped our core business grow.

Secondly, if you look at the unemployment in our markets, the Iowa unemployment rate is in the 3s and in Southern Missouri, where our Springfield market – that's in the 3s. So our clients maybe are feeling better than some other places in the country.

And that's translated to our clients, particularly in the manufacturing assembly space, those kind of things, being willing to spend money on capital goods, plant and equipment. And just anecdotally, one of the spaces where we would have seen that we have an equipment finance company and two; that's inside the Quad City Bank charter.

They had a record loan and lease production in the month of March. So I think our markets are generally feeling more positive. So that's why we adjust their guidance in that 8% to 10% range for the year.

In addition, the Specialty Finance niche, which has been strong for us historically, continues to be very solid really across all those sectors, the light tax, the historic tax credit, the municipal all grew in the first quarter.

And so it's really broad-based and so we feel good about that barring something that we can't see today with the pandemic..

Sounds good. I'll step back. Thanks guys..

Thanks, Jeff..

Thank you..

Our next question comes from Nathan Race with Piper Sandler..

Hi, guys. Good morning..

Good morning, Nate..

Good morning, Nate..

Just hoping to kind of dive into the outlook for the provision and just overall reserves, I should say ACL level going forward at this point. The decline in the 1Q provision versus 4Q wasn't maybe as substantial as we've seen from some peers.

So just trying to get some understanding in terms of the drivers in the provision this quarter? And just maybe where you guys see the reserve kind of shaken out to over the next few quarters as I imagine you guys are kind of growing into – a lot of the unallocated reserves that were built up over the course of last yea?.

Sure. Good question. Let me start kind of broadly and maybe let Todd to talk a little more specifically. Certainly, as you know, we've been what we perceive to be prudent in building our reserves and maintaining it given the newness of dealing with the pandemic.

Certainly, the parameters under which we built our reserve are certainly looking better, but we're trying to take a thoughtful approach before we would release reserves particularly given the 14% loan growth we had in the first quarter. So we've tried to be thoughtful about how we approach that.

As we look forward long-term, we're at 2% adjusted reserves after PPP. Long-term, we think, where do we run in normal times, 150 down the road sometime. But we wouldn't plan to get there necessarily very quickly because we want to make sure we're being prudent and how we think about that.

And hopefully that speaks well to the consistency of our earnings as we look toward the rest of the year. So we certainly do believe that our provision expense will be more modest in the next few quarters given what we see in our analytics and the unemployment rates and the other things going on in our economy. So we think we're well positioned..

Understood..

Yes. Nate, I think Larry nailed that in terms of our philosophy around reserving. I think you and the other analysts have come to know that our credit culture has us getting on top of reserving very quickly.

When circumstances dictate that, we tend to be very conservative about how we approach reserving and we would expect to stay on top of it here, not declaring victory just yet over the pandemic. But expectation would be for lower level of provisioning going forward. We know that some of our peers were taking reserves back already.

We're just not entirely comfortable with that given our credit culture. And we think it rewards shareholders better over the long-term and we have that approach..

Understood. That's really helpful. I appreciate that, guys. Just as a follow-up.

In terms of the provision that we saw this quarter, was there anyway a reflection of the increase in classified loans that we saw in the quarter? Or any other items from underlying credit? Probably perspective or more so just providing for the growth that we saw that was pretty impressive here in 1Q..

Yes. Nate, great question. It was a little ladder. It was really around loan growth. No degradation really of any sort, yes, we did see a little bit of a shift in the composition of criticized assets, but no growth there. Asset quality continues to be very strong. So really just 14% annualized loan growth was driving that..

Okay, great. And if I could just ask one more around capital. And your reserve is still – I would argue, nicely above peers to some 2% ex-PPP. You guys are building capital at pretty strong clips just given the profitability profile. But yet the stock is still trading somewhat below peers these days on tangible book basis.

So I would just love to hear any thoughts on – just thoughts around buybacks over the near-term and kind of within the context of other capital deployment priorities..

Yes. I'll start and then let Todd wrap up if he had got other thoughts.

Certainly because we've had really strong organic growth and we expect as we've indicated to continue to have good growth, we've probably been a little more deliberate in how we analyze our capital levels and particularly given the newness of the pandemic and how the economy is going to react.

And is it going to continue to grow at the kind of pace that we've experienced in the lending niches that we have. So our first priority would be to fund growth with capital, after that it's really M&A. And as you know, the M&A market is getting more active and we certainly are having more discussions.

But do we – we really can't predict when discussions will turn into activity, but there are certainly more activities.

So it's probably made us be more deliberate on how we think about buybacks, but we will be continuing to analyze buybacks and consider it in the future when we think it's prudent given our capital build, which is substantial and so – something we'll continue to look back in the next quarter and quarters in the future..

Yes. Nate, we continue to have solid M&A discussions. It's certainly on our to-do list to look for partners in Des Moines and Springfield in particular. We want to remain well positioned to take advantage of those when they happen.

So between M&A preparedness for a good transaction and perhaps some buyback, if we continue to be undervalued and we believe that today to be the case, I guess. So we'll be looking at those with our holding company board here through the rest of the year..

Got it. Agreed on the undervalued point there and I appreciate all the color. Thank you, guys..

Thanks, Nate..

Thank you..

Our next question comes from Damon DelMonte with KBW..

Hey, Damon..

Good morning, guys. I hope everybody is doing well. So first question, I just wanted to circle back on the margin side. I think you said you’re talking about 1 to 3 basis point headwind on the core margin potentially. And I was wondering if you could just go over the drivers of that potential headwind..

Sure. Yes. Thanks for the question, Damon. Good to hear from you. So some of the headwinds, of course, would be a decline in loan yield. Just to give you a little color around that challenge. In the first quarter, payoffs were a net yield of around 420 or 429. New came on at 390, so continue a bit of a burn down there. The good news is our Q1 yield was 404.

So not a huge delta there in terms of where new are coming on, but certainly we're going to continue to see some roll down in loan yield. Excess liquidity is maybe perhaps the biggest wild card in that 1 to 3. We’re doing a really good job.

Our bankers are doing a great job of keeping that pretty well under control, but that would be another headwind and liquidity in the markets where we’re going to get a little more significant here with continued PPP forgiveness.

Some tailwinds, some good things for us, we will be able to continue to drive down our cost of funds, but we're getting very close to some floors in certain cases. I would just applaud our bankers across the entire company for doing a great job with loan yields and deposit costs.

We have fantastic bankers and fantastic people in our leasing company and they're battling for every basis point they can get. We will continue to try to push liquidity down and if we can do a little bit more of that, that will help us with a bit of a tailwind in Q2.

And then maybe the big wild card in terms of us suggesting in our scripted comments that we might try to do all we can to outperform that guidance. If we can continue to grow loans at the strong clip that we'll continue to move our mix on the asset side and increased loans to total assets.

We went from 74.8 loans to total assets at the end of the year to a little over 77 in Q1. So if we can continue to do that that will provide a bit more help to margin. But when you put all that together, we think it's prudent to be transparent about the fact that we're going to continue to have to fight off some margin pressure.

We may see a bit of a decline in margin here in Q2..

Great. Appreciate that color.

And could you remind us what the PPP impact was this quarter on the margin?.

Sure. So PPP in Q4 actually provided about $3.5 million both fees and interest. In Q1, that was down about $1.2 million to [indiscernible] Q2. So a decline here in the first quarter. That's a big driver related to the drop in NII, of course, between that and a reduction in discount accretion.

So right now I would anticipate maybe a further declines in the PPP number perhaps a further drop a little under $2 million in Q2 as we start burning through those fees as those loans get forgiven..

Got it. Okay. That's great stuff. Thank you. And then just to kind of follow-on the M&A discussion. Exciting to hear that there's some discussions and maybe we could see something happening later this year.

Can you just kind of give us some parameters or remind us of the parameters of kind of what the characteristics that you're looking for both from like a size and a location and some of those factors?.

Yes. Certainly, we've been consistent in indicating that our first focus is building out our franchises in Des Moines and in the Springfield market. And so that's our first priority. We've talked about that for a couple of years now.

We continue to make sure that we're positioning in the appropriate places to be ready for one of those opportunities when they become available. And so we consider certainly anything in the $300 million, $400 million size range all the way up to probably $1.5 billion here.

So those are kind of the ranges of the size of opportunities that could present themselves hopefully as soon as later this year..

Excellent. Good stuff. That's all I had. Thanks a lot, guys. Appreciate it..

Thanks, Damon..

Thanks, Damon..

[Operator Instructions] Our next question comes from Brian Martin with Janney Montgomery..

Hey. Good morning, guys..

Hi, Brian..

Hi, Brian..

Hey, guys. Most of my stuff was asked there. But just one thing, Todd, just on the PPP. I know you mentioned second quarter, just kind of big picture.

How are you thinking about the forgiveness, I guess as you get later in the year? I mean, if you – most of it gets kind of baked in this year or I guess, are you expecting some of that to bleed into next year? Just any thoughts on that would be helpful..

Sure, Brian. Great question. So in terms of remaining fee, we've got about $3.6 million. I would anticipate about $1.5 million of that in Q2. And then probably the remaining $2 million or so would be in Q3 and Q4. I would expect the vast majority of that to be was through NII by the end of the calendar year..

Okay. So mostly coming through..

Yes..

Okay. And then just – on back to the loan yields, Todd, just a question. Can you remind us how much of your portfolio has floors added in? Just kind of talk about the competitive environment, I mean, there's a lot of – the strong growth you saw in the quarter, it was all the liquidity in the market.

If you can just give a little context on the competitiveness? And it certainly doesn't sound like it prevents you from achieving your goals, especially with the great growth this quarter?.

Sure. Yes. Brian, about 20% would have floors and a fair amount of that spread among prime floors and LIBOR floors. We're really – I would tell you having a fair amount of success, obviously growing loans.

But really holding on to yield to the extent we can that 390 of new production that's really watered down a fair amount, of course, with the amount of floating rate that we're doing. So I don't want anyone to think we're doing a whole lot of fixed at 390.

But I'm pretty optimistic that we are getting closer to really the floor in terms of what loan yields will be for us. Certainly, if we could get some slope and help ourselves there in terms of loan yields, we'd love to see that happen..

Brian, I've been doing this a long time and I would say every year, the bankers talk about competitive the pricing is, and it is, and it's probably accentuated because of the current conditions. But the biggest driver as Todd mentioned, is the slope to the yield curve.

And we've already seen when the long end of the yield curve ticked up a little, a little pressure come off. If we get a little more slope there, certainly that would allow us to get better pricing down the yield curve.

But it's always competitive, maybe incrementally more competitive today than normal because of all the excess liquidity that's been pumped into the economy that you can see flowing through our numbers as we talked about off-balance sheet deposits and all the things that we've got going on.

But over time, we should eat through some of that and hopefully a little steepness in the yield curve will help all the bankers feel a little better..

Okay. Perfect. Okay. That's all I had guys. I appreciate it. Thanks. Nice quarter..

Thank you..

Thank you, Brian..

Our next question comes from David Long with Raymond James..

Good morning, everyone..

Good morning..

Just really quick.

On the off-balance sheet deposits, can you give us a little bit of color of the economics behind that and what should we – what are you guys getting for when you move those off of your balance sheet from a financial perspective?.

Sure. Great question. So just to give a little color around the order of magnitude here. At 331, we added roughly $350 million of correspondent bank deposits in non-interest-bearing. We added about another $290 million in money market and right now we've really driven that pricing down near floors single-digit pricing on that money market account.

So roughly $640 million total on balance sheet. At the end of the quarter, we had $1.7 billion in correspondent deposits that were moved off to the Fed excess balance account program. We actually manage those funds for our downstream correspondents. We manage the level of non-interest-bearing they need – targeted for their earnings credit.

We manage how much will be in the money market product. And then the balance, we manage into the Fed EBA to really keep it off our balance sheet and not the pace we’re trying to put, $1.7 billion to work at very low spread. We do get a fee for managing that. It's very modest one. We're talking a few basis points.

So really how we view it, David, is more really good, solid access to continued liquidity. When we continue to grow loans at 8% to 10% clip that we guided to, we feel very confident. We will continue to fund that with core deposits..

Got it. Thanks for the color. Appreciate it. Thanks, guys..

Thank you..

This concludes our question-and-answer session. I'd like to turn the call back over to Mr. Larry Helling for any closing remarks..

Thank you, operator. I'd like to thank all of you for joining our call today. Have a great day. And we look forward to speaking with you again soon..

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