National Bank Holdings Corp Q1 FY2023 Earnings Call

Good morning, everyone, and welcome to the National Bank Holdings Corporation 2023 First Quarter Earnings Call. My name is Anna, 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, access and non-interest expense. Actual results could differ materially from those discussed today. These forward-looking statements are subject to risks, 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 the date of this call, and National Bank Holdings Corporation undertakes no obligation to update or revise these statements. In addition, the call 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 introduce National Bank Holdings Corporation's Chairman, President and CEO, Mr. Tim Laney.

Thank you, Anna. Good morning, and welcome to National Bank Holdings first quarter 2023 earnings call. I'm joined by Aldis Birkans, our Chief Financial Officer. We delivered record net income during the quarter and a record return on tangible common equity of 20.86%. We maintained a net interest margin of 4.39% as a result of loan pricing discipline, offsetting the rise in cost of deposits. We benefit from a granular and well-diversified deposit base with a cost of funds coming in at 90 basis points. The loan portfolio performed extremely well during the quarter with annualized charge-offs of just 1 basis point and non-performing loans of just 13 basis points. We continue to build capital during the quarter, with CET1 of 11.32%. After the quarter, on April 3, we acquired Cambr Solutions. Cambr diversifies our funding and fee income while giving us the ability to grow FDIC insured deposits with very little incremental overhead. We look forward to discussing Cambr in greater detail during Q&A. And now I'll turn the call over to Aldis for more detail on the quarter.

All right. Well thank you, Tim, and good morning. As we reported yesterday afternoon, we delivered another strong quarter of financial performance, while also completing the strategically important acquisition of Cambr. The optionality provided by Cambr will diversify our sources of liquidity with FDIC-insured deposits and will provide us with an additional source of fee income. In fact, this acquisition is already contributing nicely to our financials, and we project our loan-to-deposit ratio to be at or below 90% by the end of the second quarter of 2023. Before I summarize our quarter's financial results, I would like to provide a few headlines with regard to our balance sheet. As reported on Q4 call reports, approximately 70% of our deposits are FDIC insured. Our deposit balances are granular, and we have no industry geography or single relationship concentrations. In fact, the average deposit balance on a full relationship basis is just $53,000 per relationship and $29,000 per account. This is before the incremental granularity benefit from the Cambr acquisition. Approximately 50% of our deposit balances are consumer deposits, which are nicely disbursed throughout our banking center network. For larger deposit relationships, we have been utilizing the ICS of multiple FDIC Sweep program already in place since 2019. As you know, we maintain a high quality and short duration loan book for loans with the average life longer than five years, we have been using fair value balance sheet hedges. Additionally, approximately 23% of the loan book was mark-to-market for the higher rate environment in the fourth quarter of 2022 in conjunction with the purchase accounting for our two acquisitions last year. Lastly, we consistently run various stress test scenarios as part of our capital management process. To that end, we ended the first quarter with a CET ratio of 11.3%. And if we were to adjust the CET ratio for the unrealized losses residing in our investment securities book, it still would be a very healthy 9.6%. Now turning to the financial results. For the first quarter, we reported record net income of $40.3 million or $1.06 of earnings per diluted share. The first quarter's return on tangible assets was a record 1.8% and the return on tangible equity was a record 20.9%. We continued to be pleased with the organic loan growth and our teammates continued focus on building robust new client relationships. During the first quarter, our loan balances grew $124.8 million or 7% annualized. New loan originations were $394 million, and given the higher rate environment, we also experienced a slight slowdown in prepaid activity. Having said that, we operate within markets with strong economies that are holding up nicely. Fully tax-equivalent net interest income for the quarter came in at $96.3 million, fairly consistent with the prior quarter despite two fewer calendar days. Net interest margin was 4.39% and remained unchanged from the prior quarter. We continue to benefit from the earning asset yields moving higher, which was aided by the continued Fed funds rate increases in Q1, as well as the loan pricing discipline by our bankers. Our new loan originations during the first quarter were at an average rate of 7.5%, which was clearly accretive to the existing originated loan book yields of mid-5s. The deposit balances during the quarter decreased $291 million on a spot basis as we experienced deposit outflows due to clients moving towards higher-yielding products. The cost of deposits increased just 25 basis points for the first quarter of 2023. Our total deposit beta this rate cycle to date has been less than 10%. Admittedly and by design, we were slow at raising our deposit product rates. And our belief is that in order to grow core deposit balances for the rest of the year, we will have to become more competitive with our deposit rate offerings. Our projections point to hitting a 4% margin by the third quarter of 2023. This does not assume any future interest rate hikes or cuts by the Fed. In terms of our asset quality, it remains strong. Our non-accrual loan ratio improved another 10 basis points to 0.13%, and our non-performing asset ratio improved to 0.18%. The first quarter's net charge-offs were just 1 basis point annualized. Given the improving credit metrics, provision expense this quarter was $900,000, primarily driven by new loan originations. Total non-interest income for the first quarter was $14.7 million or a $500,000 increase from the prior quarter. Core banking service charges and bankcard income typically have a seasonal slowdown in the first quarter. But when compared to the first quarter of 2022, both line items showed a nice double-digit growth. Non-interest expense for the first quarter totaled $58.3 million, which was lower than the fourth quarter's expense of $60.9 million when adjusted for M&A costs. The decrease in expenses this quarter was primarily due to $2.5 million of non-recurring payroll tax credits realized during the quarter. Looking ahead for the rest of 2023, we see our non-interest expenses trending towards our original full-year guidance of $243 million to $247 million. The additional operating expenses related to the Cambr acquisition on a full-year basis are expected to offset the first quarter's payroll tax benefit. And with that, I'll turn it back to you.

Great. Thank you, Aldis. While we're pleased to have delivered a solid performance during the first quarter, we'll continue to remain focused on the management of our capital and liquidity positions and remain highly vigilant with respect to our loan portfolio in light of the current economic environment. On that note, Anna, I would ask you to open up the line for any questions.

Yes, thank you. We'll take our first question from Jeff Rulis with D.A. Davidson.

Good morning, Jeff.

Hi. This is Clark Wright on for Jeff. Good morning. Maybe if you could just talk quickly on Cambr. Great acquisition just in terms of funding. Maybe you could just talk about the pricing of those deposits and how we can estimate total deposits going forward, from both a non-expense and a deposit expense, basically non-interest expense and deposit expense standpoint?

Great question. Thanks for asking. Yeah. I think Aldis and I can tag-team on this. I'll begin by saying that my Board and I have been focused on creating options around gathering liquidity for well over the last year. I'll review that in light of the Fed's posture on raising rates as well as contracting the balance sheet and the rundown in stimulus dollars that the industry was going to see pressure on liquidity, which obviously has come to fruition. And we wanted options beyond our traditional banking center network and commercial banking platform to develop those depository relationships. So at its essence, what we're really doing with Cambr technology is supporting banks of record. To be clear, we are not operating as a bank of record. We operate more in a custodial position, but working with banks of record to support their relationships with embedded finance companies. People have asked, well, what do you mean by embedded finance company? Imagine a company like Credit Karma that opens up checking accounts for their clients, and of course, they need a bank partner to handle that. When that bank partner, which becomes the bank of record takes on that relationship, oftentimes the level of deposits, while very granular, the cumulative total of those deposits exceed what that bank can hold from a capital perspective. Those banks of record then look to Cambr to help them distribute those excess balances. There's obviously fee income for the bank of record. Cambr is paid for its services. And a multitude of banks across the country then benefit from the deposits that are distributed to them in the form of brokered deposits. One interesting distinction is that as a custodial bank, we sit in the middle of that process in any balances that we choose to keep on our balance sheet are, in fact, treated as core deposits versus brokered deposits. But we also look at this, while that's the business today, with just a little bit of imagination, you can begin to think about ways that Cambr technology could be used to serve a wide range of other business sectors and interests, and perhaps even provide some interesting solutions for a broader set of community banks across the country. So that's how I would describe the business and why we felt it was strategically important. Aldis, do you want to talk a little bit about how we think about the cost of those deposits? And I will say because I think it's an important part of the business model. When we talk about the cost of the deposits, it's not just the cost, the embedded cost and what the rate may be on those deposits. The other way to think about it is this is a highly efficient deposit-gathering machine. Less than 10 people, really just a handful of people, running this technology that today is gathering between $1.5 billion and $1.7 billion in deposits. So when you strip away the cost of your typical branch or banking center network, et cetera., and then begin to compare that historical or traditional cost to something like Cambr, that's where it gets pretty interesting as well.

Yeah. And I'll just say that in terms of the actual cost of deposit on our balance sheet, for obvious competitive reasons, we will not talk about directly what it cost to acquire deposits. Directionally, certainly, these deposits are at much lower cost than what our next best wholesale alternative would be, which makes it more attractive, certainly for us. We'll continue to embed in forward guidance on a go-forward basis in terms of overall deposit cost movement and the fee income in terms of how we expect the fees to trend from that perspective. Love to live with this for a couple of quarters before we settle in the cadence.

I'd be remiss if I didn't also point out that we bought this from StoneCastle. StoneCastle could not have been a better partner through this transition. You may or may not know, StoneCastle develops platforms like Cambr. This wasn't their first, and it won't be their last. And again, we found them just to be a great partner as we work with them, really with first conversations beginning over a year ago and then working through the early part of the first quarter to reach terms and move this business ahead. So again, our thanks to the StoneCastle team as well.

Appreciate that color. Maybe if I could squeeze one more in real quick. Just in terms, of course, the guide that you have 4% NIM by year-end. Now in terms of strong Q1 and the addition of this deal. Is that still where you're expecting to end the year at?

Yeah. No, I think, in my remarks, I said that I expect that though, given the conditions in the marketplace and the competitive nature for liquidity that has really increased there, if you even look at the events that took place in March. I do expect we'll hit the 4% probably sooner than the fourth quarter, so what I said was the third quarter.

Got it. Thank you.

The good news is our loan book is yielding in the mid-5s, as I reported in Q1. Our new loan originations were at 7.5%, and in March, it was nearly 8%. I expect significant continued pricing increases of earning assets. However, the funding component of the balance sheet has changed dramatically in terms of competitiveness since the start of the first quarter.

Caller, did you have anything further?

No. I’m good. Thank you.

Great. Thank you. We'll now take our next question from Kelly Motta with KBW.

Hi. Thanks so much for the question. I apologize, I may have missed kind of your phrasing around the opportunity. I know you don't want to give specific numbers until you have a couple of quarters under belt. But I'm just wondering like how the dynamics work, like what generates the fee opportunity? Is there any possibility you can explain that or will that be more of a later event?

No. We can explain that.

We can clarify that. I prefer not to provide specific details about the amounts involved. However, regarding the dynamics, after reserving a portion of deposits for our own balance sheet, there will be a volume of deposits sold in the broker market, which is enabled by Cambr's technology that we had prior to the acquisition. This generates fee income. Overall, the business we acquired was positive in terms of EBITDA and net income, so there are no negative impacts associated with it. As Tim mentioned, it operates with high efficiency. Therefore, as this business expands, the operating leverage benefits to the company will be significant, with more details expected to emerge in the coming quarters.

And Kelly, what's interesting is the model is time-tested. I mean, StoneCastle ran this through virtually a zero-rate market. Obviously, the world's changed during the last couple of quarters. But that operational efficiency made this an effective business, both in a low-rate environment and certainly a high-rate environment, and where there's a demand for liquidity by other banks.

Got it. That's helpful. And with the borrowings, the approximate $600 million of FHLB advances you took on, I know you disclosed you took on a similar amount of deposits from Cambr. Should the assumption be that you pay down the borrowings with the incremental deposit funding that you got from this acquisition or are you going to continue to operate with that level of borrowing? Just trying to better understand the balance sheet dynamics on a go-forward basis.

Yeah. No. Great question. So really, on a spot basis, if you look at we were $1 billion at the quarter end. Now I'll say, first of all that to be conservative through as events took place in March, we brought on approximately $300 million of excess cash and balance sheet just to be prudent and safe. So the $1 billion mark on FHLB on a spot basis is, call it, exaggerated by $300 million to what we typically, normal environment would have. Now in terms of Cambr, yes, we brought on about $500 million to date and do expect to continue to work at FHLB balance down over the course of this quarter and the rest of the year. And really, to us, it comes down to the most efficient one. Secondly, the most liquidity prudent way of funding the balance sheet. But directionally, we will look to pay off all of the FHLB borrowings.

And needless to say, back to your question on profitability, meaningfully less expensive liquidity coming out of Cambr than what you would pay FHLB.

That makes a lot of sense. Looking ahead, you have a detailed loan portfolio and good diversification. Are there any categories you are monitoring more closely? Can you share some details about your office exposure? Any insights on that would be helpful.

Sure, let's start with the office segment, which has definitely been a key topic this year. Our exposure to office loans is less than 1.5% of our total loan portfolio. An important point to note is that our average loan-to-value ratio in this area is 48%. This aligns with our overall stance on commercial real estate. We maintain a low level of commercial real estate risk in relation to our total risk-based capital, especially compared to other banks of our size. Our retail exposure is about 2% of total loans, with an average loan-to-value ratio of around 56%. Multi-family loans, which haven't received much attention, make up approximately 3.8% of our total loans and have an average loan-to-value of 52%. These are three key categories that people may be particularly interested in. As you've noted, we continue to manage a very granular portfolio. Our average funded commercial or business banking loan this year has been $1.3 million. Our underwriting process remains stringent; we are utilizing conservative assumptions regarding interest rates and assessing global cash flow coverage as well as loan-to-value ratios, particularly in light of rising interest rates and their potential impact on real estate values. We are preparing for possible challenges in the industry given the current economic outlook. We believe we are well-positioned for any impending issues, and I hope these statistics reinforce that perspective.

Really helpful. Just one last question, if I could sneak in before stepping back. Given the pullback in the market and your shares, can you refresh us on any thoughts on the buyback here?

Yeah. Well, I will say that we have about $39 million of authorized, Board-authorized buyback capacity. We're certainly watching the markets very closely and we'll be opportunistic if it pulls back to the levels that make sense.

Thank you.

We'll now take our next question from Andrew Terrell with Stephens.

Hey, Tim. Hey, Aldis.

Good morning.

Good morning.

Good morning. Maybe just to start on Cambr. Number one, congrats on the acquisition. And I might have just totally missed this, but did you guys disclose the purchase pricing? Can you disclose that?

We did not. It was, again, a transaction with a private company, StoneCastle, and we mutually agreed that we would not be disclosing the acquisition price. What I can tell you is that if you look at this conventionally, in terms of the deposit premium that might be paid for a bank, this acquisition would be very, very attractive relative to kind of traditional run rates on deposit premiums.

I understand. That's helpful. I appreciate it. Now, going back to my question, I'm trying to get a sense from a modeling perspective about the efficiency ratio before considering the balance sheet and the impacts on spreads and non-interest income and expenses. What does that look like?

For this business specifically, Andrew or…

Yeah. For this business specifically, the efficiency ratio would come on up.

It's ridiculous.

Yeah. No, it's probably, it's accretive to our overall efficiency ratio, and we were at 53% this quarter, which again is $4 long-term balance sheet management purposes at very good levels. So it's very accretive. And to Tim's point of opportunities that we see for this business and the opportunity to use this technology, it becomes exponentially so.

Yeah. Understood. Okay. And then I also wanted to maybe appreciate just kind of the embedded growth here. So I think $1.7 billion of deposits under administration. What's that look like over the past couple of years? Like what's the growth rate been for Cambr? And then how do you see growth trending moving forward? Do you feel like you have opportunities to accelerate it? And then my second part of that question is, you've brought on $500 million of core funding to date on your balance sheet. Do you have capacity to bring all $1.7 billion on, if you would like, understanding that there'll be a trade-off there?

Certainly. The answer to your first question is that Cambr has experienced steady growth since it started. It clearly meets a market need and its unique technology makes it an appealing option. We haven't yet provided guidance on expected growth rates for these deposits, but I suspect we will as we move into 2024. As Aldis mentioned, we want to become more familiar with the business. We see a wide range of expansion opportunities for this technology. With our banking experience, we believe this capability can be utilized in exceptional ways. Additionally, regarding the cost structure of this business, it's currently managed by just five people, who are responsible for between $1.5 billion and $1.7 billion in deposits. Consider how many staff members a typical bank would require across its various physical branches to generate that same amount in deposits.

Yeah. No, I bet the numbers are more than five.

Regarding the expense, to address your initial question, this business operates with a highly efficient and low efficiency ratio. In terms of whether we could manage the full $1.7 billion, the answer is definitely yes; we could do that today or tomorrow. However, that is not our intention. Additionally, we want to consider that there are partners involved whose interests we do not want to jeopardize. Therefore, we aim to align with the business and understand its operations, interactions, and the dependencies of our partners. We need to evaluate how quickly or slowly we can incorporate this into our balance sheet planning. While we have the capability to pursue various options, it's important to do so in a manner that maintains strong relationships with our partners.

And it's just not the way we're going to operate. Number one, we're going to be focused on providing tremendous service to the banks of record. And then certainly in a tight liquidity environment, what we're not going to do is step in and pull broker deposits away from banks that have been relying on those deposits. And so part of living with this is seeing how we grow it determining, again, as Aldis said, how do we ensure that we're seriously satisfying both the banks of record and the recipients of these deposits over time.

Yeah. Understood. I really appreciate all the color there, guys. If I could sneak one more in. I wanted to ask on just the loan growth. Obviously, still pretty strong this quarter. And essentially in line with that mid to high-single digit kind of expectation you gave us last quarter. But it does feel like growth is really kind of slowing down across the industry. I was curious if you felt there was any need to recast growth expectations? Are you still seeing growth or still seeing new deals coming into the pipeline? Do you still feel good about mid to high-single digits? I just wanted to get an update on just overall kind of loan growth thoughts from you guys?

Yeah. Well, we entered the second quarter was still pretty strong pipelines that all else equal, will indicate that we are on track to meeting our previous guidance. Now having said that, the world has changed quite a bit over the last month. So the unpredictability worthy of maybe the potential probability of recession and the depth of that recession is the wildcard that has increased from when we provided the original guidance. But right now, the pipelines are strong.

What I would add is that with all of the concerns around liquidity and loan-to-deposit ratios, we found it interesting that we saw a range of banks from very large to small really pull back on their lending during the quarter. And to the degree there are opportunities to take market share with attractive targets that we’ve been interested in for some period of time, that’s where we’ll be focused.

Yeah. Understood. Okay. Well, thank you for taking the questions.

You bet. Great. Thank you.

We'll now take our next question from Andrew Liesch with Piper Sandler.

Hey. Good morning, guys.

Hey. Good morning.

Congrats on the Cambr deal here.

Thank you.

I wanted to ask about the fee income outside of Cambr. Is this sub-$15 million level a good run rate moving forward?

There are a few points to note. Overall, it was somewhat positive. Mortgage income was up $0.5 million compared to the previous quarter, aligning with our plans and budget. The service and bank card fees are typically at their lowest seasonally for us, making this the slowest quarter of the year. However, as I mentioned earlier, both areas saw double-digit growth year-over-year, and I anticipate continued improvement. If we take last year's performance and factor in double-digit growth, we can expect an increase. Other non-interest income is likely to maintain its current pace, totaling $2.7 million in the first quarter, which will benefit from the Cambr acquisition. I do have some concerns regarding lower SBA activity than we initially expected, particularly from the Rock Canyon Bank acquisition, which we had anticipated would generate some SBA business. We recorded approximately $400,000 in gains during the first quarter, and I'm curious to see how that will develop moving forward.

Okay. That's helpful. I understand that you're not ready to provide full guidance on Cambr yet. However, can you clarify if the fee rate is influenced by changes in interest rates? My experience suggests that when rates are higher, the business becomes more attractive, but if the Fed cuts rates, the fee rate you receive might trend lower. Is that the correct way to approach modeling this in the future?

Actually, I would keep it consistent regardless. I mean, unless we go back to the absolute zero-rate environment, call it, 200 basis points, 250 range. I don't feel like there's going to be sensitivity to that fee component other than volume. Again, how much is on versus off balance sheet.

Got you. Thanks. You’ve covered all other questions.

Great.

Thank you.

We'll now take our next question from Brett Rabatin with Hovde Group.

Hey, guys. Good morning.

Good morning.

I wanted to revisit the margin guidance and discuss your deposit costs compared to your peers. You've done a great job managing the rates. Considering the multibank platform, it seems like this environment could provide you an advantage, allowing for potentially higher rates at one subsidiary bank compared to others. I would like to hear more from you, Aldis, about the 4% margin target for the third quarter, specifically what betas you are assuming for that, and how you are managing the funding costs across the different subsidiary banks.

In terms of geographic factors, our ability to manage has decreased significantly this quarter. There is still a distinction between rural and urban markets, influenced by competition. Ultimately, it hinges on the competitive landscape that our clients and other banks are facing. Historically, our beta has been largely influenced by consumer deposits, which is similar across other banks. We're noticing that certain consumer segments are more sensitive to interest rates now than ever before in our company's history. This change in Q1 is why I am adjusting our 4% margin guidance. From a balance perspective, about 50% of our totals consist of true transaction deposits, including both non-interest-bearing and interest-bearing checking accounts. When examining these account types together, we see that they are almost flat. The shift involves moving excess balances from a zero-rate environment and pandemic-related inflows toward interest-bearing checking accounts. This transition has accelerated recently, particularly in March, and it does not reflect any concerns about the safety and soundness of our bank; it’s more about how people are responding to news about rising rates.

Okay. What's the assumption for the beta by the 3Q or 4Q? And then are you doing different promotions at the different subsidiary banks?

We are implementing various promotions and being strategic in our competitive approach. Regarding the beta, I can indicate that year-to-date, it stands at 8.5%. Previously, during the last rate cycle, our overall deposit beta was 21%. We anticipate that by the end of this year, the beta will be notably higher, closer to 30% or 35%, without committing to an exact figure. This expectation reflects our responsive strategy to the rapidly changing macroeconomic conditions we've seen over the past month.

I would also add, just to be clear, that not only do we have the flexibility to price differently across our different bank brands. The reality is, we take our approach to pricing down to the market level. So there are going to be differences between metropolitan markets. There are going to be differences between smaller community markets, resort markets. And our focus is on being tuned into where we can be competitive, what that inflection rate is, and how sensitive we need to be based on those market dynamics.

Okay, that's helpful. Tim, you're clearly excited about the Cambr transaction. Looking ahead, do you foresee any compliance requirements that will need to be integrated into your operations as a result of this? Also, will this transaction potentially lead you to explore becoming one of the banks that offers more Banking as a Service options, and are you considering additional products in both lending and deposits?

We prioritize managing operational risk and maintain a strong relationship with our regulators. We take pride in our work regarding BSA/AML compliance and have no intention of compromising our standing. We are confident in our teams' ability to manage these operational risks effectively. The technology we are using presents exciting potential for various applications. For instance, considering recent events, we could use Cambr technology to assist community banks in a state by keeping deposits within their local market and enabling collaboration to distribute excess deposits above the FDIC threshold. This would benefit the state politically, as it retains funds locally rather than shifting them to larger financial centers, ultimately helping community banks thrive. This is just one example of how we see the potential for leveraging this technology. Additionally, while we haven't addressed it in this call, we are actively developing 2UniFi. We believe that what we are learning from this technology will seamlessly integrate into how we manage deposits within 2UniFi. More updates will follow, but I hope this information is helpful.

Yeah. Appreciate it. Thanks so much guys.

You bet. Thank you.

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

Thank you, Anna, and I'll be brief. Just thank you for your time and your interest this morning. Do not hesitate to follow up with us directly should you have other questions. Wish you all a good day. Thank you.

And this concludes today's conference call. If you would like to listen to the telephone replay of this call, it will be available in approximately 24 hours, and the link will be on the company's website on the Investor Relations page. Thank you very much and have a great day. You may now disconnect.