Q2 2019 Earnings Call

Good day and welcome to the Q CR Holdings incorporated second quarter 2019 conference call and webcast all participants will be in listen only mode.

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I would now like to turn the conference over to Larry Hamling CEO . Please go ahead.

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 overview of our second quarter.

And Todd Gimpel, well finish up with additional details on our financial results.

We are very pleased with our financial and operating performance for the quarter, we posted record quarterly net income.

Driven by strong organic loan and deposit growth.

Record fee income.

Excellent credit quality.

And careful management of non interest expenses.

We successfully deployed our increase in core deposits during the quarter.

With solid loan and lease or production.

Well maintaining disciplined underwriting.

The higher average loan balances.

Combined with stable net interest margin.

Enabled us to generate an increase in net interest income from the prior quarter.

Additionally.

Both our core commercial business.

And our specialty finance group delivered strong production.

Which led to a record 7.9 million and swap fee income for the quarter.

Second quarter net income was 13.5 million.

Diluted earnings per share was 85 cents both quarterly highs.

Adjusted earnings excluding acquisition related costs.

Were 14.1 million.

And adjusted diluted EPS was 88 cents.

A nice increase from the first quarter.

When we recorded adjusted earnings.

13 million.

And adjusted earnings per share of 82 cents.

On a year over year basis.

Our adjusted earnings for the quarter were up 29%.

Our annualized loan growth was 11.7% during the second quarter.

Showing strong momentum from the first quarter.

Year to date, we have produced an annualized growth rate of 9.5%.

Which when combined with our healthy pipelines.

Gives us confidence that we are on track to be at the upper end of our targeted loan growth range of between eight and 10% for the full year.

Our loan growth for the quarter was driven by strong broad based demand for Cnine commercial real estate and construction loans across all of our charters.

Production was driven by both our core commercial lending business as well as our specialty finance group.

We also experienced another quarter of more normalized pay offs.

Which were up modestly from the first quarter and relatively flat with the second quarter of 2018.

Well the competition for new loans continues to be high.

We remain focused and disciplined in our origination and underwriting efforts.

And continue to grow loans organically by attracting customers that value our relationship based community banking model.

Our loan and lease growth was funded by strong core deposit growth.

We continue to put a significant focus on core deposit gathering across our entire footprint.

As a result, we reduced our reliance on wholesale funding down to 10% of total assets.

A meaningful improvement from 12% in the first quarter.

Core deposits, which we defined as total deposits, excluding brokered deposits increased by $160 million or 4.1% on a linked quarter basis.

Broker deposits declined by 31 million in the quarter.

Going forward, our goal remains funding our loan and lease growth with core deposit growth.

However, we don't want to turn down the opportunity to bring attractive and high quality loans onto the balance sheet.

So we may choose to temporarily fund them with short term borrowings.

Despite robust competition for both loans and deposits in the industry wide pressure that has been put on pricing.

We are pleased to have generated a stable net interest margin for the second quarter, which helped to contribute to our increased profitability.

Todd will go into more detail on our NIM during his portion of the call.

We continue to be very pleased with the performance of our non interest income.

Which in the second quarter reached a record $17.1 million.

Up from 12 million in the first quarter.

The increase was primarily driven.

By a $4.7 million increase in swap fee income due to the strong production from our commercial and specialty Finance group.

Wealth management revenue was $4.2 million during the quarter.

Comparable to the first quarter of 2019.

Which is generally higher due to the tax return preparation fees and other seasonal items.

For the first half of the year wealth management revenue grew by 34% year over year.

Driven mainly by increased assets under management.

We continue to win new clients.

And our existing client retention remains high.

We are encouraged by this growth.

As these fees helped drive our earnings improvement.

And provide important diversification in our revenue mix without requiring additional capital.

Finally.

Our asset quality continues to improve.

As we are not seeing any credit degradation in any of our portfolios.

That being said.

We did record a write down this quarter as a result of reducing the carrying value of an existing Oreo property.

That we are in the process of marketing for sale.

Todd will provide more detail on this.

Another credit metrics.

One thing that I would like to point out is that even though our franchises are all located here in the Midwest.

We have virtually no direct exposure to the production agricultural sector.

Approximately 90% of our loan and lease portfolio is in Sienna.

Or commercial real estate and we feel very good about the credit quality of these portfolios.

In summary, we are very encouraged by this quarter's performance.

And remain optimistic about the remainder of the year.

As most of you know I recently took over as CEO .

Five years.

We remain committed to pursuing the key initiatives that we have shared with you over the last several years.

But the overriding goal of delivering attractive results in increased shareholder value.

I will now turn the call over to Todd.

For further discussion on our second quarter results.

Thank you Larry.

As I review, our second quarter financial results I'm, just going to focus on those items or some additional discussion is warranted.

I'll start with net interest margin as we've worked very hard to stabilize and protect our NIM and those efforts paid off this quarter.

Adjusted net interest margin stripping out the acquisition accounting net accretion remained static at 3.31% during the quarter when compared to the first quarter.

Excluding the acquisition accounting net accretion and on a tax equivalent basis, our net interest income increased by $1.1 million or 3% on a linked quarter basis, as we had higher average loan balances and realized improved yields in our loan portfolio.

This was offset by slightly higher funding costs, driven by higher average rates paid and a change in the mix of our funding sources.

Acquisition accounting net accretion was consistent on a linked quarter basis at $1.1 million.

We have proactively focused on initiatives to stabilize and improve NIM.

These include reducing rates on some of our most rate sensitive deposit products.

Gathering more core deposits in order to lessen our reliance on wholesale funding.

And maintaining our pricing discipline on new loan production.

As Larry mentioned the competition for new loans is strong.

Yet even in this market environment, we have been able to grow our loan portfolio and bring on new loans at attractive rates.

Additionally, we feel that we are well positioned to benefit from a flat to even slightly down short term interest rate environment as our balance sheet is modestly liability sensitive.

Therefore, we are guiding to a continued static NIM in the third quarter.

Now turning to our noninterest income results as Larry mentioned, we are very pleased with the growth in our non interest income during the quarter, which was mainly driven by record swap fees.

Our swap fee income and gains on the sale of government guaranteed loans has averaged just under 5 million per quarter for the last four quarters, including a couple of outsize quarters.

As we've indicated in the past variability in these items will occur from quarter to quarter.

Our current expectation is that for the remainder of 2019. This fee income sources will be in a range of between eight.

And $9 million for the six month period.

On the expense side, we remain focused on controlling expenses and improving our efficiency ratio.

While our reported expense number came in at $36.6 million for the quarter. There were three non core items that impacted expenses.

First we incurred post acquisition and conversion related cost of 708000.

Second we recorded a $1 million write down on the O.R.L. property that Larry mentioned.

And third we had an additional $2.5 million of bonus and commission expense driven by the higher than anticipated fee income and strong year to date net income.

Excluding these three line items, our non interest expense came in at $32.4 million in the middle of the guidance range of $32 million to $33 million, we provided on last quarter's earnings call.

Our asset quality continues to be excellent with no material additions to npls in the second quarter.

Additionally, we are seeing no early indications of credit deterioration as criticized and classified loans decreased $7.6 million from the first quarter.

Our nonperforming assets declined by $3.2 million from the first quarter, primarily due to the $1 million or other real estate right now.

And $2.2 million in charge offs for the quarter.

Our loan loss provision decreased on a linked quarter basis, primarily due to improved credit quality.

As I mentioned, we further wrote down an existing Oreo property that we have been marketing for sale.

We remain committed to facilitating a sale of the property in this calendar year and while we have had some activity and interest we have not yet arranged for sale.

As a result, we wrote down its carrying value as we continue to try and move the property off our books.

The last thing I want to mention is that our effective tax rate for the quarter came in at 18.5% there were not any onetime items impacting this rate. However, it was slightly elevated due to the high fee income, which changed our mix of taxable versus non taxable income.

We expect that our tax rate for the third and fourth quarters will be in the range of 16% to 18%.

Not including the beneficial impact of stock options and our assays.

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

We will now begin the question and answer session to ask a question you May Press Star then one on your Touchtone phone.

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Our first question today comes from Jeff Rulis with da Davidson. Please go ahead.

Thanks, Good morning.

Good morning, Jeff Good morning.

Hi, Todd just wanted to circle back it sorta inner related expense and swap income.

I guess you provided some guidance on expense last quarter any thoughts on on the third or fourth quarter.

Sure I would really expect yet for us to be in that range of 32 to 33 million all in.

That number will jump a bit if we were to have some outsized.

Swap fee.

That that move that number up a fair amount in Q2, but we're still feeling pretty comfortable with the core run rate of 32 to 33, though.

So that that was you touched on my kind of follow up question would be right, if you're kind of guiding to.

Eight to 9 million in fee income from from I. I presume, that's strictly swap or I guess, you're coupling that both with the.

Loan sale as well.

Correct the eight to nine over the last six months is really combination of though so.

Say four to five a quarter if it was in that the four and a half range we would expect.

<unk> expenses to be in the 30 to 33 range. If we were to have an outsized quarter that of course, the noninterest expense might ramp that for.

Commissions and other things related to that outsize.

Okay, and just to clarify on the great color on the on the swap outlook, but.

Is that a big quarter in in the second quarter that does that does that cannibalize.

Got a future performance or it's it's simply execution within any given quarter that number can be volatile and a big quarter previously doesn't necessarily mean.

That steals from from the quarter falling in other words.

Yes. This is Larry that one.

Because its a.

Relatively small number of large transactions due to the timing can move meaningful dollar between quarter.

But.

Certainly fall short of saying there is a correlation that we had a huge quarter. This quarter on that next quarter is going to be smaller I don't know that that's real because we're only getting started in the next quarter. It will depend on what's transactions ultimately get closed during.

The third quarter now so.

Unfortunately, not it's real simple correlation because of the number of transactions.

Yes, Okay I appreciate that.

The color there and maybe for Larry or Todd I guess as you have been removed from a from an M&A acquisition for some time you you spoke on a.

Maybe indirect.

I guess perceived credit strain in the in the region or AG strain I should say I, just kinda updating us on on your M&A thoughts I mean wary of buying someone elses problems. This late in the cycle, but.

I'm still.

Good conversations out there how's the temperature on on M&A from from your perspective.

Well on the M&A side as you know certainly activity levels, a little bit lighter.

Basically the probably the biggest issue is the sellers' expectations of value relative to stock multiples. These days.

We remain.

Committed to our current shareholders and making sure we're doing something thats fair to them.

And.

You're right our credit quality feels really good right now and we'd be certainly cautious about buying someone elses problems, but certainly still open in certain situations to the right opportunities.

Okay. Thank you.

Our next question comes from Damon Delmonte with KBW. Please go ahead.

Hey, good morning, guys has it gone.

Good good Damon.

Good to hear on the first question Todd on the on the margin on can you give a little guidance on your expectation for Accretable yield.

The first two quarters of this this year you said were consistent at 1.1 million does that start to trail off a bit.

Actually that was right on top of scheduled or budgeted accretion Damon and right now that number still remains at about 1.1.

You got a roughly 9.3 and a remaining discount or really don't see it.

Downward trend there.

In terms of run rate until we probably get into the 2020 after a little bit more run off the schedule is right on top of Q1 and Q2 and another 1.1, so very consistent this year versus.

Prior years, we've had some pretty big swings in that.

Okay, and just to reiterate you you you know you feel comfortable that you can kind of keep the margin steady given your liability sensitivity.

Yeah, we we do and we have worked pretty hard to get to a fairly neutral balance sheet, but we do still have some modest liability sensitivity.

We are very well prepared for a coming rate cut if one does happen and we worked hard to put ourselves in a position to get at least 100 beta on rates down. So we're going to work really hard to take advantage of those cuts on the right side of the balance sheet, we are well prepared for that already.

We actually do have a little bit of continued excess liquidity loan to deposit ratio is just a touch over 90% at the end of Q2.

It was close to 94% at the end of the calendar year.

So we actually had a static margin here in Q2, even though we didn't carry a fair amount of excess liquidity or the big wildcard of course is what the fed actually does here the end of the month and maybe more importantly, the language they use it.

You know the market gets ahead of the cuts and.

So I think everyone is wondering with the language is going to be for.

Any continued cuts during the year and then the impact that might have on the line or a treasury FHLB rates. So.

We feel very bullish about margin and you feel comfortable guiding to a static one.

Okay, Great and then obviously credit trends this quarter or pretty strong.

How are you thinking about the provision for the back half of the year you have a estimated range.

Yeah, I'll, let Todd speakers specific dollar has been certainly probably steady wouldn't be our mindset there.

Just normal.

Provision for normal growth and you know the normal kind of things that happen, having credit portfolio on a quarterly basis. Yeah. So as a result, Damon now that would probably be in a range of 172.

Okay.

All right, Great and then I guess, just lastly on.

Are you guys fully integrated with that with the Springfield Bancshares deal and.

Can you give an update on how those operations are doing right now.

I would love to Damon actually just spent the last two days down with the team in Springfield, and our conversion is scheduled for the middle of next month.

So that team is working really really hard.

On integration and conversion incredibly hard and what I'm very pleased with it.

It really is a testament to the quality of that team they've been working on that for last several quarters, leading up to the conversion.

And they posted a one three seminar away last quarter loans were up 19% deposits were up 24.

So while they do have all of that work going on the team is still really doing a super job with loan and deposit growth and.

Serving new clients, so could not be more pleased.

We'll get some synergies after that conversion those would primarily be efficiencies related to some of the costs on data processing and some of the other overhead issues, but.

Extremely pleased with the performance of the Springfield team.

Couldn't say enough good things about how hard they're working.

Okay, Great. That's all that I had thank you very much.

Thanks, Dan.

Our next question comes from Nathan race with Piper Jaffray. Please go ahead.

Hey, guys good morning.

Good morning, Hey.

So I was hoping just to drill down in your core NIM outlook a bit more I. Appreciate your previous commentary, but just kind of curious where you guys are putting new loans on the books a relative to the portfolio yield us around fourninety four today on a core basis.

And maybe we we continue to for the most part have an average new loan rate that starts with a five.

That is coming under pressure as you might guess.

So far so good we're still holding on to that so you're seeing a.

A small uptick in total loan yield as a result of new loans coming on with a five handle.

That's some of the uncertainty I spoke about in terms of Ah that language and what the market's reaction is to that but so far so good on loan pricing and we are.

As I mentioned earlier, well prepared to take advantage of any cut on the right side of the balance sheet.

Got it and I guess, along those lines in terms of thinking about the impact of a fed cut here in July curious.

Do you expect it to be a wash essentially that kind of what we're hearing.

Yeah, I think in our guidance to a static margin for Q3 were expecting if the fed does not surprise I think its a 75% likelihood now the quarter and 25 that it might be more but if it were to be a quarter in the market digests that and the language is fairly stable from the fed we expect that to help us with a static outlook on life.

Okay got it and then just be curious to get an update on the core deposit growth, obviously really impressive broad based growth across the various banks with maybe the excess excess of quad cities. So just curious if you guys expect loan growth to keep pace with core deposits or if you guys kind of expect core deposit growth the lag a little bit and kind of grow into the excess liquidity that you guys have put on the balance sheet over the last few quarters now.

Yeah, we had excess liquidity in Q1.

We thought we made burn that up a bit in Q2, and we did have strong loan growth, but deposit growth was right on pace with it and that's a good thing.

And we're going to continue to stay very focused on core deposit gathering we know that it may provide a little bit of pressure on margin short term.

But we're factoring that into our guidance going forward that were going to continue for fun with core deposits and we like where we settled in.

With the reliance on wholesale about 10% that's.

Anything under 15 is pretty good for us getting it down to 10 is probably about as low as well.

Get it too but anywhere in that 10 11, 12%.

And everything else being core deposit that's very good for for all our charters.

Understood I appreciate all that color congrats on a solid quarter.

Thanks Nate.

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

Morning, guys.

Hi, Dan.

Congrats on a good quarter.

Just maybe a couple of questions as we think about loan growth on a on a forward looking basis.

Ed do you kind of expect that growth to be kind of footprint wide or does.

Missouri area, or Iowa whole kind of a bigger opportunity for growth for you guys.

Yes, Fortunately I would say our our growth prospects I think are pretty broad based.

Certainly our team in Springfield, it's our newest.

Chartered has really done a nice job.

Building into some scale into that marketplace.

But we feel good really about the opportunities in each of our markets.

The kind of markets were enemies kind of.

Mid sized second or third tier cities in the mid West I think have been pretty stable, so that bodes well for just our normal activity.

And so we feel good about it and then our specialty group is.

Because of interest rates are we believe that that's pretty recession resistant and so the kind of numbers, we produced so far year to date.

I really just a continuation of what we've done really over many many years.

Okay, and I know credit metrics are good right now and it doesn't sound like you're overly concerned about anything near term, but are there any segments that maybe you're tapping the brakes on at the moment just kind of given the yeah.

A good but but may be slow economy.

Yeah, the tapping the brakes, a one thing that we pointed out specifically is because we're in the Midwest people always assume we did a lot of production AG lending, which we do almost no.

And so that wasn't tapping the brakes that is something we made a deliberate decision on 15 or 20 years ago that we didn't want to do that business for various reasons.

The other part certainly on the commercial real estate space.

You know the retail world in commercial real estate is changing so we backed away years ago from the big box space.

Because of what's going on just not necessarily there's I mean, there's a sea change going on in the way that world books, and so we've been very cautious in that space now, it's a little neighborhood strip shopping center or something that will probably still be fine because.

We haven't figured out that people are still going to pick up their hoagie sandwiches, you know in a different spot kind of strip shopping center or something like that so that.

You know we've been cautious there and I think that will prove to be a good decision.

Okay.

All right and then and then maybe on the on the deposit competition have you noticed a slowdown in Q2.

And currently in Q3 or is it still kind of been.

We're competitive in your footprint.

Yeah. My broad comments would be is there is a little less activity.

Jason you know the marginal.

Deposits out there so that feels good and should allow us to be able to push our rates down, particularly if the fed moves rate.

And so I would say, it's softened a little you know while our loan totals have grown really nicely I think thats probably.

Different than most of our competitors and some of the.

Early press releases, I've seen softness or more than doubled its something that others have experienced.

If that's true kind of broadly that may help us on the deposit side, because the demand wont be as great.

Great and then last question for me, a good kind of going back to the margin.

So good to hear that that.

A 25 basis point <unk> point cuts not going to really impact the margin in Q3, Q, but beyond that wouldn't an additional 25 basis point cut did Q4 have the same effect or would that.

Perhaps put some pressure on the margin.

Dan I think we're pretty well positioned for cuts to.

At least provide a static margin if not a little bit of a.

Nice tailwind for us so we're not overly concerned about.

Fed cuts, we feel like compared to our peer group, we're probably better positioned for that just as we may have suffered a little harder in a little earlier than some of our peers on rates up we feel like we're well positioned to.

Take advantage of cuts and feel very good about that longer term.

Yes, Dan. Additionally, I'd say, when we get to 50 basis points down.

As you know we've got a lot of floating rate commercial prime based loans will start bumping up against the floors at that point and it actually could help us when we get to that spot.

Great great. Thanks, guys.

Thanks, Dan.

As a reminder, if you would like to ask a question you May Press Star then one.

Our next question comes from Evan Lyon with January Janney Montgomery Scott. Please go ahead.

Hi, Good morning. This is Evan on for Brian Martin just a quick question on.

Good morning, just a quick question on your specialty Finance group, how large is that book today and what type of growth do you see for the next 12 to 24 months.

Okay.

The book on the historic tax credit credit loss income tax credit side.

It's a couple of hundred million and so it's a meaningful but not certainly outsized relative to the size of our balance sheet.

The direct municipal side.

Where we've done some running there's probably in the couple of hundred million dollar range and so those have been really steady and we expect that growth to kind of.

Grow at least at the pace of our historic growth rates for our entire portfolio. So.

We expect that mix of our total assets to remain fairly steady and maybe go up slightly as well over the next couple of years.

Okay Awesome and then just following up on 'em can you give an outlook for your purchase accounting accretion.

Sure.

We've got 9.3 million remaining in discount and the actual accretion in Q1 was 1.1 million due to this most recent quarter was also one one and scheduled in Q3 is another one one so it's really a flattened out and then much more consistent this year don't really see see that tailing off from the schedule perspective until we get into 2020.

All right awesome. Thank you.

Thanks Evan.

Our next question is a follow up from Jeff Rulis with da Davidson.

Please go ahead.

Hi, Thanks, just the I guess you spoke on taught about the swap income and quite a bit I guess for the full year you're almost.

Doubling the the prior guidance from from the beginning of the year.

Any initial thoughts as you as youve clearly been executing pretty well on that front on on 2020.

I know that you don't want to get ahead of yourself, but.

Is it eight to 12.

You know for for.

19 does that.

Extended maybe upping that in 20.

Yeah, Jeff you said it best when he said, we don't want to get ahead of ourselves.

So so we feel really good about the the eight to nine for the rest of this year.

As we articulated in our opening comments it was as simple as taking the last four quarters.

And getting an average realizing we had a couple of outsized quarters in there that gets us to that four and a half and so as a result that eight to nine range.

I I think it's.

Quite likely we're not going to be guiding and 2020 to eight to 12, because we're going to be that quite handily and as Larry are articulated we feel very good about that pipeline.

So I think for 2020.

Hate to do this Jeff, but we're probably going to wait and see what Q3 brings and then for the first time to talk a little bit more about 2020, I know that doesn't help you with your models yet for next year, but I think it's safe to say that it would be north of 12 million.

Just how far north of that we probably want to get one more quarter behind us if that are okay.

No I understand I just wanted to go ahead.

And just I understand you have to be certainly the interest rate environment has a lot to do with the ability to price into those slots. In this interest rate environment is particularly attractive time, given low flat yield curve to be able to execute well on the so that could have some impact over time, but.

You can tell me when interest rates are going to do next year and what the owner is going to look like we can come a lot closer.

[laughter] [laughter] alright fair enough good points. Thank you.

Thanks, Jeff.

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

Okay. Thanks to all of you that joined US today, we look forward to speaking with you all again soon thanks and have a great day.

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