National Bank Holdings Corp Q3 FY2022 Earnings Call

Good morning, everyone. And welcome to the National Bank Holdings Corporation 2022 Third Quarter Earnings Call. My name is Keith and I will be your conference operator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session following the prepared remarks. As a reminder, this conference is being recorded for replay purposes. I would like to remind you that this conference call will contain forward-looking statements, including, but not limited to statements regarding the company's strategy, loans, deposits, capital, net interest income, non-interest income, margins, allowance, taxes, and non-interest expense. Actual results could differ materially from those discussed today. These forward-looking statements are subject to risks and uncertainties, and other factors which are disclosed in more detail in the company’s most recent filings with the U.S. Securities and Exchange Commission. These statements speak only as of this date of this call. And National Bank Holdings Corporation undertakes no obligation to update or revise these statements. In addition, the call today will reference certain non-GAAP measures which National Bank Holdings Corporation believes provide useful information for investors. Reconciliations of these non-GAAP financial measures to the GAAP measures are provided in the news release posted on the Investor Relations section of www.nationalbankholdings.com. It is now my pleasure to turn the call over and introduce National Bank Holdings Corporation Chairman, President and CEO, Mr. Tim Laney. Please go ahead, sir.

Thanks, Keith. Good morning. And thank you for joining us. As we discuss National Bank Holdings' third quarter 2022 financial results, I'm joined by Aldis Birkans, our Chief Financial Officer. We are pleased to deliver quarterly core earnings of $0.80 per share. We recorded organic loan growth of 30.2% and increased average total deposits 10.3% annualized. It's noteworthy that to date we have experienced a nominal increase in the cost of deposits. It's also important to point out that all asset quality metrics remain strong, and that we have prudently increased the conservativeness of our underwriting standards in light of questions around the economy. On that note, I’ll turn the call over to our CFO Aldis Birkans. Aldis?

Alright, thanks, Tim. And good morning. We delivered another strong quarter of financial performance while also completing the acquisition of Rock Canyon Bank. Just to bring you up to date, so far in October, we also have closed on the Bank of Jackson Hole acquisition and successfully completed the Rock Canyon Bank system integration. The integration of Bank of Jackson Hole systems is scheduled for later this quarter and will allow us to enter the next year well positioned to build on the opportunities each bank presents. Overall, our strong results during the quarter were driven by exceptional loan growth, expanding net interest margin, and as always, carefully managed expenses. For the third quarter 2022, we reported net earnings of $15.8 million or $0.50 per diluted share. During the quarter, we realized approximately $7 million of transaction-related expenses, as well as increased our loan loss provision expense by $5.4 million as part of the day-one CECL reserve for the Rock Canyon loan portfolio. Excluding these transaction-related items, our adjusted core income was $25.3 million or $0.80 per diluted share, which is a 16% increase over the prior quarter’s adjusted results. Our pre-tax pre-provision net revenue excluding the transaction expenses grew $11.3 million or 38% on a quarter basis. And as a reminder, this quarter included only one month of Rock Canyon's and Bank's financial performance. We are capitalizing on the economic resilience of our markets and continue to gain market share across all geographies. During the quarter, we funded $631.6 million in loan originations, which was another quarterly record. The total loan portfolio grew $905 million during the third quarter, and after adjusting for the Rock Canyon Bank loan book, the addition of $538 million, our loan portfolio grew a strong 30.2% annualized. Net interest margin expanded 63 basis points and fully taxable net interest income increased $13.1 million or 90.9% annualized on a quarter basis. And while average earning assets grew $180 million, or 10.5% annualized during the quarter, the main driver for the net interest income growth was the loan portfolio pricing. The total average rate for loans held for investment increased from 4.4% in the second quarter to 5.0% in Q3. We were successful in managing deposit betas during the quarter and the total cost of deposits increased just two basis points. Looking ahead for the fourth quarter 2022, at this time, we project NBH's net interest margin to remain around 4%. In terms of our asset quality, it remains strong with decreases in both the classified and criticized loan ratios. The third quarter's net charge-offs were just one basis point annualized and both the non-performing assets ratio and the NPL ratio remained low. During the quarter, we recorded a provision expense of $12.7 million. And as I already mentioned earlier, $5.4 million was driven by the establishment of day-one allowance for credit losses for the Rock Canyon Bank loan portfolio. Approximately $3.9 million of the provision expense was to support the strong organic loan growth, and the remainder was a CECL model-driven increase that reflects the increased economic uncertainty as indicated by the Moody's forecast scenarios. As a result, our ACL ratio on total loans ended the quarter at 1.15%. Total third quarter non-interest income was $17.4 million, or a $600,000 increase from the second quarter. The continued slowdown upon mortgage business was more than offset by record quarterly bankcard revenues, and strong core banking service charge income, as well as nice unrealized gains from our equity method investments. Looking ahead, for the fourth quarter 2022, we are projecting our total fee income to be in the $15 to $17 million range. Non-interest expense totaled $53.9 million and included approximately $7 million of acquisition-related costs. On a year-to-date basis, we have realized approximately $8.3 million of acquisition-related expenses. At this time, we are projecting to come in well below our total model transaction costs for both transactions. Our non-interest expense run-rate remains under control. Excluding these acquisition-related expenses, the third quarter's core banking expense was $47 million compared to $44.5 million in core expense in the second quarter. The fourth quarter of 2022 we are projecting non-interest expense to be in the range of $64 million to $66 million. Included in this projection is an estimated $5 million to $6 million of transaction-related expenses yet to be realized, as well as a full quarter of expense run-rate from both acquisitions. Most of the cost-saving efficiencies from the two bank acquisitions have been realized gradually and will continue through the fourth quarter and into 2023. As such, I will provide more guidance with the full-year 2023 projections on January's earnings call. Our capital ratios remain strong at 12.8% common equity tier one ratio and 9.6% tangible common equity ratio. Our tangible book value per share was $22.40 as of September 30 and reflects the full impact of the Rock Canyon Bank acquisition. We closed the Bank of Jackson Hole acquisition on October 1, and the purchase accounting impact of this transaction will be reflected in the Q4 results. Our effective tax rate for the quarter was 20.1% and increased due to the higher than projected pre-tax income through September 30. For the fourth quarter, we project the tax rate to return to the 18% to 19% range. We ended the quarter with 33.2 million shares outstanding. After incorporating the share issuance for the Bank of Jackson Hole acquisition, we project the fourth quarter's average diluted to be around 38 million shares outstanding. And with that, I'll turn it back to Tim.

Thanks, Aldis. We cannot be more pleased with our recent acquisitions of Rock Canyon Bank and the Bank of Jackson Hole. Both banks operate in very attractive markets and each deliver strategically important services that we intend to sell across the remainder of our enterprise. Again, I couldn't be more pleased with these two acquisitions and the caliber of our new teammates. I believe these two acquisitions have the potential to meaningfully exceed our initial earnings expectations. And on that note, Keith let’s open up the line for questions.

Thank you. We'll take our first question from Jeff Rulis with D.A. Davidson. Please go ahead.

Tim mentioned a rather nominal increase in deposit costs. Could you share with us again what your beta assumptions for the cycle on deposit beta are?

Yes, well, let me start by saying that we could not be more pleased with how we positioned the balance sheet through the cycle and through all the excess liquidity that was gathered through the post-pandemic environment. As you recall, we maintained most of it in cash, which allowed us not only to gather huge margin expansion here and be prudent on deposit betas, but it certainly has helped our AOCI impact as well. So looking ahead, we have not been price leaders on the rates. So if you look at ours, and we've talked about it before, we are the relationship type of bank. We strive for primary transaction accounts. And we’ve been able to manage our betas quite nicely to date. How it’s going to go from here, certainly we will have to respond to markets as they adjust. However, we are not going to be the price leader.

So should we expect a similar prior-cycle beta again this time around? Do you think you're better positioned to potentially improve upon that?

Well, I think on the interest-bearing deposits, it will probably be similar. If you look at our balance sheet composition, prior to this cycle, we had a smaller DDA to total balance or non-interest-bearing deposit to total balance mix. So overall, beta should be a little bit better if you're looking at the 40% non-interest-bearing deposit mix that we have today. Again, going back to the relationship-based model. So overall, I think it might be slightly better, but no reason to think that we would be different once that cycle is over.

And I guess leading to the margin discussion of around 4%. I guess that surprises me that it is just going to flatten out here, given the pace of the earning asset increase, I guess. Does that number include accretion, the 4%? And then, does that assume you see a pretty rapid increase in the funding or the liability costs linked quarter?

Yes. You pointed out a few things there. There are multiple items for our balance sheet that take place in the fourth quarter that makes it tricky to forecast where the margin will be. Certainly, we have Bank of Jackson Hole coming on that balance sheet. Rock Canyon Bank had one month now, and will have a full quarter's balance sheet impact. The purchase accounting impact... Suddenly it doesn’t seem like the Fed has done yet, looking at another rate hike next week. That impact then, certainly to your original question on beta, somewhat deposit costs do. So at this point, best incorporating all that, it does feel like it’s going to be 4%. But again, there are so many moving pieces that I don’t want... we will be providing more guidance in 2023 for the full year next year.

And, Tim, I wanted to check in with you on the big picture. Think about 2023 organic growth. Early in the pandemic, your bank was pretty cautious in unique times. Lending was smaller than historical. How do you see the upcoming environment given your perspective on the economic outlook and where you think big picture organic growth on a net basis is in 2023?

Jeff, great question. It begins with a bias toward more conservative underwriting. In any case, we’re using our balance sheet. We’ve actually, while we certainly hope this doesn’t come to fruition in the marketplace, we’ve now moved to underwriting debt serviceability on a global cash flow basis for any borrowing client using double-digit interest rate scenarios. Again, I hope that doesn’t happen. But we’re not banking on hope. We’re prepared to understand that our clients could cover debt at those kinds of rates if need be. The pipeline for the fourth quarter in our core commercial and small business arenas are as solid as ever. As we’ve said before, we continue to benefit from operating in very healthy and strong markets. I could not be more pleased with what I’ve seen in the early days of bringing Rock Canyon and Bank of Jackson Hole on board. This includes some pretty interesting dynamics around gathering additional low-cost deposits in the market. So I genuinely feel very good about the strength of our capital position as we face uncertain times with the economy. I feel very good about the markets we are operating in. I feel like in many respects, the teams are operating at or near a point of running on all cylinders. While my teammates have certainly worked very hard to bring these two acquisitions to close in such a short timeframe, no one has taken their eye off the ball in terms of taking care of clients and profitably growing the business. What you should be hearing there, Jeff, is quite a bit of optimism despite the uncertainty. I think I mentioned in my talking points that I'm already, and I have to use the word believe, but I believe that we are really well positioned to realize stronger returns from these two acquisitions than we had modeled in any of our acquisition scenarios. So keep in mind that we now have a trust business that we are confident we can leverage across our entire enterprise coming out of Bank of Jackson Hole. If you’re not familiar with Wyoming Trust law, everyone on this call should have their trust based in Wyoming, and Bank of Jackson Hole stands ready to help you accomplish those goals. Secondly, we are absolutely impressed with the processes in place for providing SBA loans to small and medium-sized businesses that have been brought to us by Rock Canyon Bank. It’s noteworthy that they remain the number one bank in the state of Utah. Talking about punching above your weight, number one state in the Bank of Utah for production of SBA lending. So if you don’t detect a little bit of optimism in what you’re hearing, Jeff, you’re not listening.

We'll take our next question from Kelly Motta with KBW. Please go ahead.

Hi, thank you so much for the question. And congrats on closing both deals relatively recently. I wanted to circle back to loan growth because on an organic basis that was incredibly strong. Tim, I’m wondering if you could provide any color on the granularity of what you added. I know your loan book tends to be on the more granular side, but I’m wondering if there was anything chunky or unusual in that composition because it was just so strong?

No, I mean, back to my reference of firing on all cylinders. We’ve seen solid production really across all of our specialty teams when I say that, teams focused on particular industries. Our geographies have been strong. I want to emphasize that this is all relationship-oriented business and our bankers are rewarded for capturing the full relationship, or earning the full relationship of these clients. You can expect to see, or I certainly expect to see, nice growth in our treasury management services, and capturing those transaction deposit accounts is important to us in terms of keeping cost of deposits down. But I will tell you that it remains pretty granular. We’re making inroads in many of these markets that we’ve invested time in, and brought relationships over from other institutions for a number of different reasons. I will say, Kelly, that getting back into the office and beginning to get out in front of clients as early as Labor Day of 2020 seems to really be paying dividends. At the end of the day, when you’re working to earn a new relationship, it’s not just true for banking. But I think, for any important relationship, you’ve got to be willing to get face to face. You’ve got to be willing to put in the time together to strategize what makes sense. I’m proud of my bankers because they’ve been doing it since Labor Day of 2020.

That’s super helpful. Maybe in terms of the size of the balance sheet. I know there’s a lot going on with these full quarter impacts of the first deal and the second one just closing on October 1. But it looks like you still have plenty of balance sheet flexibility. Wondering how we should be thinking about funding loan growth going forward? Any color maybe Aldis on cash flows off of the securities book, and just kind of managing the size of the balance sheet to support what is clearly been a really strong production engine that you have there?

So certainly, first and foremost, we would love to finance any loan funding with core deposit growth, and that will be and continues to be our primary focus. As I mentioned, we’re not necessarily going to go pay up for deposits, but it is, as Tim mentioned, on a combined relationship scorecard for our bankers, and they get paid on bringing both sides of the balance sheet together. So deposits are number one. In terms of the investment portfolio, that continues. As you know, we historically have built it with a cash flow in mind. That cash flow says about $18 million, $20 million a month that is projected for the next 12 months or so. So that’s a nice source if there's need to be funding for any loan growth as well. We certainly have a little bit more excess liquidity left, you know, we didn’t deploy that. So those are kind of the three main sources in the near term. It still says that 84% loan deposit ratio. I think historically, we’ve bumped it up to 95%. I think that’s probably where we feel comfortable going to when we fully leverage the balance sheet. So certainly, we don’t look to breach the 100% loan deposit ratio, but we still have some room to move there too.

Maybe last question from me, has to do with asset sensitivity. I really appreciate the guidance around the margin for 4Q. There is some full quarter impacts of both deals coming through on that. Just thinking from a high level, is this setting up for more neutral to rising rates going forward? Any help on that would be great.

Sure. No, we continue to be asset sensitive, not as much as we were a quarter or two ago. Some of the asset sensitivity came out as we lowered the cash, which a big chunk of the asset sensitivity was sitting in cash, right? To the extent that cash has been invested in fixed-rate loans, that’s been taken off the table, locked in with very good yields now. But we still, between the two banks, I’d say Rock Canyon was more asset sensitive, given the nature of their business of SBA and Bank of Jackson Hole is a little less asset sensitive than us. So on a net basis, I think they complement us well. But on a go-forward basis from here on out, I’d say we’re probably half, if not less, asset sensitive than we were two quarters ago.

We'll take our next question from Andrew Terrell with Stephens Inc. Please go ahead.

Thanks for the time today. I don’t want to beat a dead horse. So maybe just to start on the margin. Aldis, do you have what the margin was for the NIM in the month of September?

It was slightly above 4%.

And then, can you just remind us how accretive or dilutive Bank of Jackson Hole was to the margin just pro forma?

So Bank of Jackson Hole didn’t come on the books until October 1. So it was neither; it was not. The Rock Canyon Bank added to the net interest income line approximately $3 million to $3.5 million.

So maybe I’ll just shift gears over to capital. I guess with both acquisitions out of the way at this point, capital is still in a pretty solid position. Tim, can you maybe just update us on how you’re thinking about your capital positioning from here? And then can you remind us if there’s any buyback in place, and whether or not you have any appetite there moving forward?

We will certainly maintain optionality around buying back shares. We happen to believe that we’re going to be generating very strong earnings that would support a meaningful move in stock price in 2023. Should the market move against us, and we have an opportunity to buy, we’ll pursue that. But we also remain focused on some other, I’ll describe them as very strategic partnerships or acquisitions. We are just as focused on our work around to unify. I couldn’t be more pleased with the progress the team is making on that front. So I guess it might be helpful to talk about what we’re not as inclined to do. We are not going to be the acquirer of, say, less than $1 billion banks that are not operating in growth markets. We will not fall trap to simply acquiring banks because we can acquire them at a good price and realize some accretion of earnings over a couple of years due to expense savings. Any bank acquisitions will be strategic, will be in growth markets and will fit our culture and approach to underwriting credit. Outside of that, we’ll be focused on specialty businesses that would benefit both the core bank and unify. So I know, Andrew, that’s probably a little more than you were looking for. But that’s about as much detail as I’ve provided in a while.

No. That was a great color. I really appreciate it, Tim. Okay, and then if I can ask just one more on the loan growth this quarter, did you see any improvement in line utilization? Did that play much of a role in the strong level of growth and then where does utilization sit overall? How does that compare to pre-pandemic and then your outlook for commercial line utilization?

Yes, so on page 10, on the loan table, you can see in a footnote that details the last five quarters of line draws that we've seen. You can see it was a bit elevated this quarter. We are higher than historically, but both just as many commitments. The line utilization itself, the way we measure for commercial, all of our commercial lines is sitting at 62%, and that’s been right where we’ve historically been on average.

We'll take our next question from Andrew Liesch with Piper Sandler. Please go ahead.

I’m thinking quarter ago you mentioned there’d be a couple million dollars per quarter of to unify expenses in the third and fourth quarters. Did that get realized in the third quarter?

In the third quarter, it was about $1 million of unify-related expenses. My guidance is in continuation of that, and then, as we entered 2023, I’ll be more detailed on that projection in January’s earnings call.

Got it. And then on the fee income guidance, does that include both acquisitions that are within the $15 million to $17 million?

In terms of guidance, it does. So in terms of certainly being seen in the mortgage continue to slow down. So it reflects that in the third quarter, we had the unrealized gain pickup in equity method investments. So not counting and not necessarily repeating, and that's why you can see a little bit of a step down there, but it does include all banks.

We'll take our next question from Jeff Rulis with D.A. Davidson. Please go ahead.

Thanks. Just a couple of follow-ups. I don’t know if you’ve referenced this. Just wanted to confirm the thought that as you close the year-end, certainly it looks like you’ll stay below 10 billion. Is that fair to assume?

Well, on a pro forma basis, as we identified in the earnings release. On day one, we were $9.4 billion in assets as we applied the company to grow $600 million, which I at this point say that we will stay below 10. Plus back to the optionality and flexibility. I think that’s why we are so cautious and prudent on deposit betas. That allows us to make sure that we make all the right calls.

And I’ll just remind everyone around the timing of crossing over the 10 billion threshold in terms of impact on any fee income. So really, once we do cross, and again, it doesn’t seem likely for the end of this year. It’s really 15 months out. But in today’s run rate basis, it would impact us about $8 million to $9 million in interchange income from Durbin, which is suddenly like 2% of October revenues. So very manageable amount.

Yes. I think the real point is that you’re talking about an impact that would be 15 months out in terms of regulatory standings or standards around our core bank processes. That investment was made years ago. We’re in a good place with our regulators on that front in terms of infrastructure and the position of the bank. We do benefit from the fact that we’re not a heavily consumer-focused institution, hence the smaller impact on the fees that Aldis mentioned.

And just to clarify a couple of the guides. Aldis, the $64 million to $66 million on expense, again, that includes further merger expense. So the core is closer to $60 million all in.

Sure, closer to $60 million. So to build it up, you got it. First of all, yes, it does include the transaction expenses that we still yet to incur here in the fourth quarter. If you take those out, the quarter’s closer to $60 million. And to build that up, just for clarity. As we know, NBH has been running on a standalone basis about $45 million quarterly run rate higher than the quarters when we had high mortgage commissions lower. Now that that component’s gone down somewhat upset by the unify components, so call it $45 million, which implies about 15-ish or so million dollars between the two banks. They have been running with a pre-purchase or pre-acquisition. They’ve been running at $16 million to maybe even $17 million trend. We’re already incorporating about 10% to 20% cost savings here in the fourth quarter and certainly that’s not done yet.

No. That was more than I bargained for. I appreciate it. And just also on the margin guidance. I can’t remember, Aldis, are you including the assumption of Fed hikes still, kind of consensus view that still comes year-to-date in that fourth quarter guidance margin?

Yes. It’s all inclusive. Let’s put it this way. Just for clarity perspective, for example, on the deposit side, if we were to combine both Rock Canyon and Bank of Jackson Hole's cost of deposits, which came on between 40 to 50 basis points to our 18, certainly, that will have an impact in itself too just in terms of forecasting and projecting for the fourth quarter. Deposit beta still looks like they went up. But it’s just incorporating their current cost of funds without us moving into deposits. So my attempt here was to incorporate all of that in that 4% guidance, including whatever the auctions may be coming.

And Jeff, just on that last point around Rock Canyon Bank and the Bank of Jackson Hole, just as I talked about certain capabilities, we expect to scale from those banks into the rest of our enterprise. We see really nice opportunities for low-cost deposit gathering as we drive our treasury management capabilities and the focus on capturing full relationships in those markets with those banks. So my full expectation is that we will see the cost of deposits in those markets actually come down from relative basis to where they had operated historically.

Thank you. I am showing we have no further questions at this time. I will now turn the call back to Mr. Laney for his closing remarks.

Well, I’ll just simply say thank you. I do want to thank all of my teammates again for just delivering what I view as brilliant results and more to come folks. We’re excited about our future. Have a good day.

And this concludes today’s conference call. The earnings release and an online replay link of this call will be available on the company’s website on the Investor Relations page. Thank you very much and have a great day. You may now disconnect.