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Edited Transcript of QCRH earnings conference call or presentation 30-Oct-18 3:00pm GMT

Q3 2018 QCR Holdings Inc Earnings Call

Moline Nov 6, 2018 (Thomson StreetEvents) -- Edited Transcript of QCR Holdings Inc earnings conference call or presentation Tuesday, October 30, 2018 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Douglas M. Hultquist

QCR Holdings, Inc. - Co-Founder, President, CEO & Director

* Todd A. Gipple

QCR Holdings, Inc. - Executive VP, COO, CFO & Director

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Conference Call Participants

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* Brian Joseph Martin

FIG Partners, LLC, Research Division - VP & Research Analyst

* Damon Paul DelMonte

Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director

* Daniel Edward Cardenas

Raymond James & Associates, Inc., Research Division - Research Analyst

* Jeffrey Allen Rulis

D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst

* Nathan James Race

Piper Jaffray Companies, Research Division - VP & Senior Research Analyst

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Presentation

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Operator [1]

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Greetings, and welcome to the QCR Holdings, Inc. Third Quarter 2018 Conference Call. Yesterday, after the market close, QCR distributed its third quarter press release, and we hope that you've had the opportunity to review the results. 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.

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 quarterly results, and then we will open the call up to your questions.

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 on 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 and non-GAAP measures.

As a reminder, this conference is being recorded and will be available for replay through November 13, 2018, starting this afternoon, approximately 1 hour after the completion of this call. It will also be accessible on the company's website.

At this time, I will now turn the call over to Mr. Doug Hultquist at QCR. Please go ahead, sir.

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Douglas M. Hultquist, QCR Holdings, Inc. - Co-Founder, President, CEO & Director [2]

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Thank you, operator. Welcome, ladies and gentlemen, and thank you for taking the time to join us today. I will start the call with a brief overview of some of the highlights of our third quarter and Todd Gipple will finish up with additional details on our financial results.

At the beginning of the third quarter, we successfully closed our strategic merger with Springfield Bancshares, Inc., the holding company of Springfield First Community Bank, or SFC Bank, providing us entry into the attractive Springfield, Missouri market. We have now had the benefit of 1 full quarter of SFC Bank being part of the QCR family, and as such, its financial results for the third quarter are included in our consolidated results.

We couldn't be more pleased with the talented Springfield team joining our group of strong, independent-minded community bank charters as they have an outstanding reputation in their marketplace, an exceptional client base and a strong balance sheet.

We believe that SFC Bank is an ideal cultural fit with our company. As I have noted several times, this merger fits well with our strategic growth plans by combining 2 high-performing financial institutions that have similar values and approaches to client service and community involvement. We also have shared commitments to strong underwriting standards and asset quality. We believe that SFC Bank will continue to build upon its strong brand and grow its market share in the Springfield market. Additionally, we are working to ensure that we are all well positioned to capitalize on all the expected benefits of this combination including greater scale, operational support and improved funding. We also are able to offer SFC Bank clients additional products and services that have been valued at our other charters. Again, we are delighted to welcome aboard our SFC Bank colleagues, and importantly, all of our new clients.

We are off to a good start and are positioned well to pursue continued growth in commercial lending, revenue enhancements and greater value for our shareholders. Additionally, I am also pleased to welcome the team at the Bates Companies and their clients to the QCR Holdings family. We closed this strategic acquisition on October 1 and are excited about the new partnership. This group of professionals leads a well-respected financial advisory and wealth management firm in the greater Rockford region, which will bolster Rockford Bank & Trust's comprehensive product offerings, enabling it to expand in its market and provide incremental noninterest income to the company. Importantly, the Bates Companies have a very experienced leadership team that shares our mission to deliver exceptional service and comprehensive wealth management options locally.

Now to our third quarter results. We're generally pleased with our core operating performance. We delivered another quarter of solid loan growth, driven in part by the SFC Bank transaction as well as broad-based demand for commercial and industrial and commercial real estate loans across our charters. That being said, we experienced some isolated credit issues at Rockford Bank & Trust, which required us to record a higher-than-expected provision for loan losses, resulting in lower-than-expected net income. Todd will go into further detail on this issue, but I will state that we believe it is truly an isolated event and not an indication of any systemic credit issues.

Third quarter net income was $8.8 million and diluted earnings per share was $0.55. Core earnings, excluding acquisition-related costs, were $10.4 million and core diluted EPS was $0.65, down from the second quarter when we recorded core earnings of $10.9 million and core diluted EPS of $0.77. The primary driver of the lower net income was the higher provision due to the credit issues I mentioned.

Our annualized organic loan growth was 7.9% during the third quarter, about the same as the second quarter. On a year-to-date basis, annualized growth was 10.5%, so it's still tracking within our stated goal of 10% to 12%. Our legacy QCR loan growth for the quarter was also 8% on an annualized basis and largely driven by healthy demand for our commercial real estate loans, and to a lesser extent, our commercial and industrial loans. This was somewhat offset by a higher level of payoffs. The competition for new loans continues to be intense and we were particularly disciplined in our origination and underwriting efforts during the quarter, which also helped mitigate the pressure on our NIM. Our focus remains on attracting clients that value our relationship-based community banking model. And as we have said, SFC has the same culture and commitment.

Our legacy loan growth was funded by an increase in wholesale funding, primarily through an increase in broker deposits. Total legacy deposits, which exclude the deposits added to our balance sheet as a result of the SFC Bank transaction, grew at an annualized rate of 6% during the quarter. And while we saw a decline in core deposits on the legacy side, when you include SFC Bank, they actually increased 12.1% on a linked-quarter basis due to the attractive deposit mix at SFC. Todd will discuss this in more detail.

We continue to strive toward funding all of our loan and lease growth with core deposit growth, but 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. As the competition for deposits remains high, and with the Federal Reserve's plan to continue increasing short-term rates, we, like the rest of the industry, are facing higher deposit costs, which puts pressure on our NIM. However, we've been able to offset the higher funding costs with higher loan yields. And as a result, our core NIM held in quite well this quarter, declining just 2 basis points to 3.44%. Additionally, we believe we are close to seeing an inflection point with margin pressure.

Noninterest income was $8.8 million in the third quarter, essentially flat from last quarter. We experienced a $500,000 decline in swap fees, which was partially offset by higher trust department fees and a gain on the sales of residential real estate loans, mostly from SFC Bank.

Wealth management revenue was $3.3 million for the quarter, a 4.5% increase from the second quarter. Year-to-date wealth management revenue growth is over 20%, and with Bates Companies onboard, we are excited to see incremental growth starting in the fourth quarter, and importantly, revenue that doesn't require additional capital.

Turning to our expenses. We maintain our focus on controlling expenses, which continues to enhance our profitability. Our noninterest expenses for the third quarter increased $4.1 million, the majority of which was due to the increased personnel at SFC and acquisition-related expenses. Excluding these 2 line items, expenses increased by $700,000 from the second quarter. Nearly half of that increase was due to higher salaries and benefits as we have been making some organic hires in select markets and had success during the third quarter in capitalizing on some of the disruption in the Rockford market due to industry consolidation. We believe these hires will drive incremental revenue and earnings growth.

Overall, we're encouraged by the progress we are making on most of the 7 key initiatives that we have shared with you over the last 3 years. We remain committed to the pursuit of these objectives with the overriding goal of delivering consistent upper quartile peer performance, which we believe will ultimately translate into increased shareholder value.

I will now turn the call over to Todd for further discussion on our third quarter results.

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Todd A. Gipple, QCR Holdings, Inc. - Executive VP, COO, CFO & Director [3]

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Thank you, Doug. As I review our third quarter financial results, I will focus on those items where some additional discussion is warranted. I want to start with asset quality. As Doug referred to, and as was stated in the press release, we moved 2 credits at Rockford Bank & Trust and 1 at Quad City Bank & Trust to nonaccrual status. This resulted in NPAs increasing by $14.8 million and NPAs to total assets increased to 0.87% from 0.65% at June 30, 2018, but down from 0.95% a year ago. The 2 credits in the Rockford Bank & Trust portfolio requires significant loan loss provisions totaling $4.7 million. As a result, our provision for loan and lease losses increased by $3.9 million to $6.2 million when compared to the second quarter.

Even with this outsized provision, our GAAP allowance to total loans and leases decreased slightly to 1.18% from 1.21% at June 30, 2018, due to the SFC merger and related GAAP accounting adjustments. However, when you consider the loan discounts that we have recorded for our recent M&A transactions, our reserves increased significantly from a 1.18% to 1.57%. While unfortunate, we believe these 2 credits are isolated incidents and not reflective of any larger asset quality degradation. We are not seeing an increase in our special mention or substandard loans, which gives us confidence that overall credit quality remains stable.

We continue to believe that we have a very strong credit quality culture and will remain vigilant on asset quality. I do think it's important to note that had we not incurred the additional provision of $4.7 million this quarter, which reduced reported core EPS by $0.23 per share, our core EPS would have been $0.88.

Now turning to net interest margin. We were relatively pleased with the -- our margin this quarter as core net interest margin, stripping out the acquisition accounting, net accretion for recent acquisitions, decreased by just 2 basis points in Q3 to 3.44% versus 3.46% in the second quarter. While we did experience 2 basis points of compression in Q3, this was a more favorable result in our guidance coming out of the second quarter that was a range of between 3 and 5 basis points of possible compression. Excluding the acquisition accounting net accretion of $1.7 million in the third quarter, our net interest income increased by $5.1 million on a linked-quarter basis. This includes $4.5 million from SFC Bank, while legacy net interest income increased $600,000 from the second quarter. This was due to higher yields on the loan portfolio, up 10 basis point excluding acquisition-related accretion and higher average loan balances. These results were partially offset by a 14 basis point increase in funding costs.

The lending environment remains very competitive. Price competition for high-quality credits is intense, yet we were able to organically grow our loan portfolio, bringing our new loans at higher rates. We did have a high level of payoffs again this quarter as some clients are experiencing strong financial results and cash flow and are therefore paying down their credit facilities accordingly. As Doug mentioned, we were selective in originations this quarter as we work hard to improve overall loan yield, which resulted in lower organic production. However, our overall pipelines remain healthy and we continue to expect loan growth for the year to be within our stated goal of 10% to 12%.

Our loan growth in the quarter was funded by an increase in wholesale funding, primarily due to an increase in short-term brokered deposits. As we worked hard to manage our funding costs this quarter, at times, short-term brokered deposits were more cost effective than certain sources of core funding.

Our total deposits increased by $490 million in the quarter, which included $440 million from SFC Bank. Core deposits, our legacy charters declined $47 million due to lower noninterest-bearing and prime deposits partially offset by higher interest-bearing and short-term brokered deposits.

Given the ongoing competition for deposits, growing our deposit base at the same pace with our loan growth remains a challenge. We continue to focus on initiatives to organically grow our core deposits, including promoting our improved treasury management platform, which we believe will enable us to continue to increase commercial deposits.

Now turning to our noninterest income results, which were essentially flat versus last quarter. Our swap fee income and gain on the sales of government guaranteed loans totaled $1.2 million in the quarter, bringing the total to $4.1 million year-to-date, above what we had expected for the full year. As we've indicated in the past, significant variability in these items can and will occur from quarter-to-quarter. Given the results we've already seen here early in the fourth quarter and our current pipeline, we do anticipate strong swap fee results in the fourth quarter.

As Doug mentioned, our wealth management fees grew by over 20% year-to-date. Growing this as part of our business by at least 10% per year on a net income basis remains one of our key strategic goals, and we're very pleased to be exceeding this objective thus far in 2018. We look forward to the Bates Companies accelerating this growth as they produced approximately $2.7 million in wealth management revenue in 2017.

The final thing I want to mention is that our effective tax rate for the quarter came in at just over 15%, and there were not any unusual items impacting it. We still expect that our tax rate for the full year will be in the range of 15% to 16%.

With that, let's open up the call for your questions. Operator, we're ready for those questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question today will come from Jeff Rulis of D.A. Davidson.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [2]

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Question on the NPAs, looking for a little more detail. So the 2 from Rockford and the 1 Quad City, what was the -- maybe the type of loans those were by sector and size?

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Douglas M. Hultquist, QCR Holdings, Inc. - Co-Founder, President, CEO & Director [3]

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Yes. So one in Rockford C&I was about $4 million. The one at Quad City was a series of single-family homes. That was about $4 million, and then the majority of the remainder would have been a commercial real estate property near Rockford.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [4]

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And any early expectations on resolution timing? Are these that you intend to have in the books for a while? Or are there any expedited cleanup on any of them?

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Douglas M. Hultquist, QCR Holdings, Inc. - Co-Founder, President, CEO & Director [5]

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I think the one on the Quad City will move fairly quickly. I think the CRE loan in Rockford, we will be looking to increase the occupancy there. And then on the C&I credit, there's a number of entities and affiliates involved and we could be into 2019 before we really realize a resolution on that one, Jeff.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [6]

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Got it. Okay. So as you guys have identified, isolated non-systemic, I guess, the expectation -- well, from a provisioning standpoint, I think you talked about these specific credits added $4.7 million. Any kind of provisioning or thoughts about credit going forward, just broadly speaking?

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Todd A. Gipple, QCR Holdings, Inc. - Executive VP, COO, CFO & Director [7]

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Jeff, we did have roughly $3.8 million reserved on the one C&I credit that was Rockford based. We were very aggressive in reserving for that this quarter. We would not expect any additional provisioning there. As Doug said, we have a number of folks involved in getting some resolution or, at least, further faster on that here in Q4. Similarly, the C&I property also in Rockford, we did get a new appraisal that resulted in a roughly $800,000 additional provision. And once again, we thought we were being very conservative in that level of provision. So the goal there is to get that property better leased up and improve the valuation there and improve the performance. So we certainly don't anticipate these credits becoming more of an income statement issue going forward.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [8]

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Right. Yes, I guess, I was looking at the rest of the portfolio and provisioning going forward. You would expect to kind of revert back to the $2 million to $3 million provision per quarter. Is that a fair assessment?

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Todd A. Gipple, QCR Holdings, Inc. - Executive VP, COO, CFO & Director [9]

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Yes, very much so, Jeff. We expect to return to more modest levels, more the past level's provisioning on a quarterly basis. I do want to give a little bit of color behind the comments that we made, in the opening comments, with respect to overall portfolio quality. It'll be in the Q filed relatively soon here, but our level of criticized loans to total loans actually dropped in Q3. Went from 2.79% of the portfolio in Q2 to 2.6% of the portfolio here in Q3, and that's criticized. Classifieds went from 1.37% down to 1.25%. So ratios on criticized and classifieds are trending the right way. And the gross amounts of criticized and classified loans actually grew in Q3 less than the sum total of these 3 credits. So we actually have very solid underlying asset quality.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [10]

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Got you. Excellent detail there. And then maybe my last one just on the expense side. I think you guys slated for conversion of the Springfield acquisition in mid-'19. Maybe you could give us a look on, if we back out merger costs this quarter, you're at about a $28.7 million, call it, kind of base on expenses. Through the conversion, could you maybe talk about expected cost saves versus expense growth?

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Todd A. Gipple, QCR Holdings, Inc. - Executive VP, COO, CFO & Director [11]

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Sure, Jeff. I think in answering that, I might give a little bit of color on the entire quarter compared to our guidance because we actually came in very close to the guidance that we have provided on core operating expenses. So I think this will connect the dots for you on this current quarter and what we expect going forward. Our total noninterest expense was $30.5 million. SFC was roughly $2.6 million of that. So we ended up at around $27.9 million for the legacy organization. Roughly $1.8 million of that was acquisition and post-acquisition costs that came true this quarter. So we finished at -- right at $26.1 million in terms of legacy expenses. Ex acquisition and post-acquisition costs, our guidance coming out of Q2 was $26 million flat, so roughly $100,000 higher than that. We did have some additional onetime expenses that were pretty modest and not really significant enough to mention in the press release, but felt pretty good about coming in at that $26.1 million. Now your bigger question going forward, we really don't anticipate much in the way of cost saves until that conversion occurs. Right now, it's scheduled for August of next year. Little sidebar, we actually did accomplish our conversion for Ankeny, CSB, this past weekend and that went very well. We're still in the early stages of reacting to our clients' needs there, but by all accounts, that's gone very well. So our talented folks did a good job with that. We'll take a little bit of a breather here, but soon to come in early parts of '19, we'll get teed up for the conversion in Springfield to happen in August, and we expect that to go well also. But really, the last part of '19 is when those cost saves will start showing up.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [12]

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Okay. So the $28.7 million with Springfield onboard, we could assume kind of measured expense growth or kind of modest and then the cost saves, Q3 and beyond of next year?

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Todd A. Gipple, QCR Holdings, Inc. - Executive VP, COO, CFO & Director [13]

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Exactly, Jeff.

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Operator [14]

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The next question comes from Nathan Race of Piper Jaffray.

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Nathan James Race, Piper Jaffray Companies, Research Division - VP & Senior Research Analyst [15]

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Going back to the credit quality discussion. I'm curious if some of the isolated issues that we had in Rockford this quarter, if that's, in any way, related to a SBA issue that you guys also had, I believe, a couple of quarters ago.

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Douglas M. Hultquist, QCR Holdings, Inc. - Co-Founder, President, CEO & Director [16]

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Great question. Totally unrelated, Nate.

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Nathan James Race, Piper Jaffray Companies, Research Division - VP & Senior Research Analyst [17]

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Okay. Great. And then, Doug, I'm kind of surprised to see some residential real estate issues perk up in the Quad Cities. So I guess I'm just curious, what were kind of the drivers there? And what's the outlook for housing in general in around the Quad Cities? Not sure if some of these are being driven by some of the softness in the ag space and whatnot, but any additional color on that would be appreciated.

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Todd A. Gipple, QCR Holdings, Inc. - Executive VP, COO, CFO & Director [18]

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Yes. Nate, I -- this is Todd. I might actually take that one. It's single-family rental, and really, a side business of the owner of those properties. His core business has become pressured a bit and so we're actually taking over those properties and liquidating those. As Doug indicated, we expect some fairly quick resolution note there. A big chunk of those properties are slated for sale in December. Some of those will close before the end of the fourth quarter, so we expect to see a decrease there. I'm really glad you asked the question, Nate, because it doesn't have anything to do with the housing market here. It's very robust in the Quad Cities. But these are rental properties owned by someone that has a core business that's a bit under pressure, so we're liquidating these.

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Nathan James Race, Piper Jaffray Companies, Research Division - VP & Senior Research Analyst [19]

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Okay, got it. That's great color. And then just changing gears a little bit and thinking about the core margin trajectory from here. We had the September rate hike also come through and should benefit your core loan yields again. So just curious how you're thinking about kind of the margin trajectory from here, obviously, you guys are having to pay up for deposits on certain brokered segments and so forth at this point, so just curious how we should think about the margin in 4Q and 1Q as well.

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Todd A. Gipple, QCR Holdings, Inc. - Executive VP, COO, CFO & Director [20]

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Sure, Nate. We feel very optimistic about the margin in the fourth quarter. By that, I would say a static margin. As you know, it's difficult to maintain margin with this flat of a yield curve. So we would be looking for a more static margin in Q4. Some of the reasons for that optimism, our September margin was actually 1 basis point greater than the margin for the entire quarter, so a good trend there. 58% of our loan growth actually happened in September for the quarter. And as you know, that bodes well for fourth quarter net interest income dollars. We're back to a situation where floating rate loans fully cover our rate-sensitive liabilities. As you might recall, last quarter, we got upside down on that. We're back to where, on an average basis during Q3, our floating rate loans covered rate-sensitive liabilities by 112%. So that certainly helped us in Q3 and that's another reason for optimism in Q4. A couple of other things. Our Q3 originations, the rate on our fixed loans average 5%, which was up 8 basis points over the originations in the prior quarter, good trend there. And then our Q3 originations also, 40% of those were floating versus only 33% in Q2. So our shift to more floating rate assets is going to help us in the future. And really, just overall, both the results here in Q3 and our relatively optimistic outlook going forward for static margin, all of our bankers at all 5 charters are extremely focused on every single basis point on both sides of the balance sheet. So we're working very, very hard to maintain margin in this difficult environment. So that's a fair amount of color on Q4. Not really in a position to give a whole lot of guidance on 2019. We'll have more to talk about there come January, I'm sure. But at least short term here, we're optimistic.

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Nathan James Race, Piper Jaffray Companies, Research Division - VP & Senior Research Analyst [21]

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Understood. That's great color, Todd. I really appreciate that. And if I could just sneak one last one on the impact of Bates that closed here in the fourth quarter. I think you said the revenue that they recorded in 2017 was $2.7 million, so just curious how we should kind of think about the expense impact of Bates in 4Q as well and if you expect this acquisition to be kind of accretive to your efficiency ratio kind of longer term.

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Todd A. Gipple, QCR Holdings, Inc. - Executive VP, COO, CFO & Director [22]

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Yes, great question. We expect Bates to be fairly neutral early on with respect to efficiency ratio and bottom line EPS. We paid roughly 2x revenue, paid $6 million for current run rate close to $3 million in revenue. They did $2.7 million in the prior year. $3 million of that is in stock, $3 million in cash. The cash, half of that was paid upfront. The other half is accreted over the next 5 years. The $3 million in stock proceeds -- or consideration, I should say, $1 million was upfront and the other $2 million is earnout. So we feel very well protected in terms of future earnings potential and cost here. So very modest amount of shares will be issued here this quarter. I would expect there certainly to be some positive lift in bottom line. But early on, as we expense the earn-out alongside of this, candidly, it's a pretty modest early impact here in Q4. We expect that benefit to start ramping up probably in the latter half of '19, if that makes sense.

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Nathan James Race, Piper Jaffray Companies, Research Division - VP & Senior Research Analyst [23]

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Yes. No, that's helpful. So it sounds like maybe their pretax margin was running somewhere in the maybe 20% to 30% range recently. Is that a fair assumption?

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Todd A. Gipple, QCR Holdings, Inc. - Executive VP, COO, CFO & Director [24]

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Yes, closer to 20%. Our core wealth management practice, certainly the trust business has a net gross of closer to 40%. So that's part of the strategy here, is to get them better aligned with our typical net-to-gross, which is about double what they've been running.

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Operator [25]

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And next, we have a question from Damon DelMonte of KBW.

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Damon Paul DelMonte, Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director [26]

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Most of my questions have been asked and answered but just wondering if we could talk a little bit about the capital levels. I know, with the inclusion of Springfield this quarter, capital did come down and I believe total capital ratio is now sub-11%. I believe you mentioned in the release about organically growing that back, but could you give us some color on your thoughts and expectations for capital levels and potential thoughts on raising new common equity to kind of boost levels a little bit?

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Todd A. Gipple, QCR Holdings, Inc. - Executive VP, COO, CFO & Director [27]

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Sure, Damon. Great question. We were hoping somebody might ask that so we could provide a little more forward color on capital. So at 9/30, our total risk-based is 10.84% and TCE is 7.82%. Those are actually right on top of what we announced when we announced the SFC merger and right on top of the guidance we talked about in Q2 when I suggested 10.8% and 7.8%. So right on top of what we expected. Our expectation is we will be greater than 11% by the end of Q4 organically and TCE would be a touch over 8%, so we do accrete it fairly quickly. Longer term, our expectations would be without any common equity or any other capital sources, just organically. We'd get pretty close to 12% by the end of '19 and over 8.5% TCE by the end of '19. So I think those future expectations on capital ratios, Damon, are why we're pretty comfortable with the ability to stand pat, at least for now, on capital raise, if that makes sense.

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Damon Paul DelMonte, Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director [28]

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Got it. Okay. Would you consider doing a capital raise if another deal opportunity came along before the end of '19? Or are you on the sideline for many future M&A while you fully integrate and execute on the conversion of Springfield?

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Todd A. Gipple, QCR Holdings, Inc. - Executive VP, COO, CFO & Director [29]

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Yes, great question. I don't believe our capital ratios are putting us on the sidelines at all. We used up a fair amount of any excess capital that we would have had with both the Guaranty and the SFC transactions. We funded the cash component of both of those, I think roughly $16 million, without raising additional capital to do that. So that was part and parcel the drawing down the capital ratios to where we are today. And we would likely do an alongside raise for any additional M&A that would happen relatively soon just to bolster capital a bit and build up a little bit more of a cushion there, if you will. I think the only thing impacting M&A timing right now, candidly, would be our stock price and we certainly would expect to see that improve if we improve our earnings.

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Damon Paul DelMonte, Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director [30]

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Got it. Okay. And then just to circle back on the expenses. So you're expecting to convert -- do the systems conversion in the middle part of 2019. So the -- what can we expect the -- again, I'm sorry if I missed when, I think, Jeff Rulis was asking the question before. What can we expect for like an expense base kind of from the next couple of quarters until that conversion happens?

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Todd A. Gipple, QCR Holdings, Inc. - Executive VP, COO, CFO & Director [31]

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Yes. I would say something in that $28.5 million range that we talked about with Jeff's prior question.

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Damon Paul DelMonte, Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director [32]

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Got it. Okay. And then we can start to see some of those savings kick in as we get towards the back end of 2019?

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Todd A. Gipple, QCR Holdings, Inc. - Executive VP, COO, CFO & Director [33]

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Exactly, yes. And as a reminder, the announced cost saves -- they're fairly modest, but we would certainly expect to take advantage of the integration and conversion work the back half of '19.

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Operator [34]

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And the next question comes from Daniel Cardenas of Raymond James.

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Daniel Edward Cardenas, Raymond James & Associates, Inc., Research Division - Research Analyst [35]

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So just kind of a quick follow-up question on the capital side, and I appreciate the color that you guys gave. But as your capital levels build, I mean, what are your thoughts on potential stock buyback initiatives?

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Todd A. Gipple, QCR Holdings, Inc. - Executive VP, COO, CFO & Director [36]

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Yes. Could certainly be a measure that we would implement it and take, Dan, as the valuation on our stock price would warrant that. It's certainly something that our board looks at and considers, just like we consider everything in our capital planning and strategy. So as we get to building those capital levels organically, if there is still an opportunity in the market to do the right thing for our shareholders and implement a buyback, we would certainly be open to that. It's, again, something that we have to be mindful of and consider when we get together as a board and talk about capital strategy.

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Daniel Edward Cardenas, Raymond James & Associates, Inc., Research Division - Research Analyst [37]

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But there's -- if you could remind me if there's any -- do you have an outstanding plan right now?

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Todd A. Gipple, QCR Holdings, Inc. - Executive VP, COO, CFO & Director [38]

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No. We do have an outstanding shelf, but we do not have an announced buyback in place.

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Daniel Edward Cardenas, Raymond James & Associates, Inc., Research Division - Research Analyst [39]

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Okay. Great, great. So then, looking at Springfield, maybe a quick update in terms of how integration is progressing, what you're seeing in terms of loan and deposit runoffs and is that within your expectations?

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Todd A. Gipple, QCR Holdings, Inc. - Executive VP, COO, CFO & Director [40]

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Yes. Integration is going very, very well. We are really pleased that folks in Springfield are working really hard with all of the folks at the holding company to get the integration going. The big project, of course, in '19 will be conversion of the systems, but we are integrating a fair amount of policy procedures in how we do things. I will tell you there's been no loss of clients in Springfield. They're extremely focused on continuing their rapid pace of growth, and our expectation is for them to continue to grow very quickly and profitably as they have through their entire existence. They're very focused on core deposit generation. Their President, Rob Fulp, is really working very hard on that every single day and the rest of his team, just like the rest of our charters, so we're extremely pleased with how things are going in Springfield. Doug, I don't know if you have any other color you want to add to that.

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Douglas M. Hultquist, QCR Holdings, Inc. - Co-Founder, President, CEO & Director [41]

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No. Totally agree with Todd. Talented team. They're pleased to be part of us and we're really pleased to have them on our team. And we think we're going to really be able to grow that franchise in Southern Missouri.

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Operator [42]

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And the next question will come from Brian Martin of FIG Partners.

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Brian Joseph Martin, FIG Partners, LLC, Research Division - VP & Research Analyst [43]

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Just a couple last-minute things here. Just, Todd, maybe I hopped off for a minute, maybe I missed this, but back to -- just on the expenses. Was there an add this quarter -- or I guess, for the fourth quarter, with regard to Bates? Or is that -- is it kind of netted out in the -- on the revenue side? I guess maybe I just missed that part, but I heard you said about $28.5 million was the expense number. So is that not -- is there not a pickup for Bates this quarter?

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Todd A. Gipple, QCR Holdings, Inc. - Executive VP, COO, CFO & Director [44]

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Yes. I think that's really embedded in that number, Brian.

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Brian Joseph Martin, FIG Partners, LLC, Research Division - VP & Research Analyst [45]

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Okay. Got you. Okay. Perfect. And then just the other 2 were just on the loan growth, just organic loan growth. I mean, you guys are on pace to hit your 10% to 12% this year and it sounds like pipelines are good. I mean, but the last couple of quarters have been kind of more in that 8% range with payoffs. I guess, as you guys kind of look going out, I mean, is there a thought the payoff's lower? Or I guess, are you still comfortable with that low double-digit type of growth? Just trying to understand how to think about the growth going forward. Certainly, with Springfield coming on and getting an acceleration there, but any color you can give on how you're thinking about that with integrating the payoffs in there?

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Todd A. Gipple, QCR Holdings, Inc. - Executive VP, COO, CFO & Director [46]

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You bet, Brian. And payoffs have been elevated the past 2 quarters, both in Q2 and Q3. We've had $165 million of payoffs. And so that's certainly netting us down to something just under 10%, roughly 8% the last 2 quarters. Springfield is part and parcel to one of the reasons we have optimism for low double digits. I think this will be our fourth or fifth consecutive year of growing loans in that 10% to 12% range organically. We were pretty good at it. Our bankers are exceptionally good at it. And so we still believe that 10% to 12% going into '19 is a good range.

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Brian Joseph Martin, FIG Partners, LLC, Research Division - VP & Research Analyst [47]

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Okay. All right. And then just the last one was on the funding side. I mean, I know you guys talked about the shift this quarter being more effective to do the wholesale side. But as you think about transitioning back to core funds and the pressure you're seeing, can you give any thoughts on how you're thinking about the -- it sounds like the margin's positive in fourth quarter or flattish. But just as you kind of replace the wholesale with core funding, how are you thinking about that impact on the margin, especially as you get into '19?

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Todd A. Gipple, QCR Holdings, Inc. - Executive VP, COO, CFO & Director [48]

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Yes. We would certainly like to see some rotation out of some of those short-term wholesale sources of funding into more core funding. We do have all the bankers and all the charters very, very focused on that. Getting past the conversion at CSB and getting fully implemented there in terms of new technology, we believe, will help us in the Des Moines market and that's a very vibrant market. So our expectation is, Brian, for us to rotate down some of those levels of wholesale and get back more into core. Your question on pricing is really the question. And so we took an opportunity to fund a little more inexpensively in Q3 with some very short-term wholesale versus some of the pressure we were seeing on some of the more rate-sensitive funds, municipal, deposits and other things that have literally 100% beta. And so the key for us is to find other sources of core funding outside of those very high, if not 100%, beta sources. Those don't always keep pace with our loan growth, but that's our focus going forward even if they are somewhat expensive. They can be far less expensive than that overnight funding if they're a total relationship and that's really what our bankers are working on, obtaining better market share and wallet share of some of our existing clients. And even though those new funds migrating over may be fairly expensive, we need to bring down the total cost of funds doing that.

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Brian Joseph Martin, FIG Partners, LLC, Research Division - VP & Research Analyst [49]

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Yes, okay. So your optimism on the margin, at least stability this fourth quarter. I mean, you're not necessarily expressing optimism on '19 at this point on the margin, on the core margin?

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Todd A. Gipple, QCR Holdings, Inc. - Executive VP, COO, CFO & Director [50]

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Right, Brian. I think we feel very good about Q4, knowing what we know and what we saw in Q3 for all the reasons we talked about. I think there's just a whole lot of uncertainty in many respects for '19. So we'll likely have more color on '19 expectations come January.

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Operator [51]

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(Operator Instructions) And our next question is a follow-up from Jeff Rulis of D.A. Davidson.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [52]

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Just a quick follow-up on the accretion side. I guess I was a little surprised that accretion was only a 2 basis point contributor to margin. Is there anything in the timing of the close of the deal that -- I mean, being early in the quarter, I would have expected we would have seen the full impact. Accretion's a tougher number to peg, but I guess pretty modest expectations for accretion kind of going forward as a contributor to margin.

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Todd A. Gipple, QCR Holdings, Inc. - Executive VP, COO, CFO & Director [53]

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Yes. Jeff, great question. I'm not sure what you have modeled and what your expectations were, but SFC generated $1.2 million in loan accretion in the quarter, which was actually a little greater than our expectation or our budget going forward, which is about $1 million a quarter. So total loan purchase discount at SFC was just a shade under $10 million. We accreted $1.2 million of that in the first quarter of the merger in Q3. Going forward, roughly $1 million a quarter is our expectation.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [54]

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Okay, that's helpful. And then, Todd, I think you mentioned -- you talked about the swap, so far, in Q4 looks positive. Any early indicator on the kind of the government-guaranteed loan sales in the fourth quarter?

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Todd A. Gipple, QCR Holdings, Inc. - Executive VP, COO, CFO & Director [55]

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Yes. Those, a little bit tougher to predict. We have a pipeline of those that continues to have a fair amount of fee opportunities on it. The government-guaranteed part of our business is much harder to make come true and that makes it much harder to predict versus swaps. Those pipelines are typically with existing or maybe, in some cases, new clients. It's a lot easier to predict close. I would just tell you, our gains on sale of government-guaranteed could swing a fair amount as they have in the past. Our optimism in Q4 is really more focused on swaps.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [56]

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Got it. And just to reiterate the government-guaranteed. Typically, those loan sales, are those not heavier in the first and fourth quarters historically?

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Todd A. Gipple, QCR Holdings, Inc. - Executive VP, COO, CFO & Director [57]

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Yes, great memory. They have been, at times, fairly big in the first quarter of each year.

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Operator [58]

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

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Douglas M. Hultquist, QCR Holdings, Inc. - Co-Founder, President, CEO & Director [59]

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I would like to thank all of you for joining our call today. We look forward to speaking with you soon, and have a great day.

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Operator [60]

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