National Bank Holdings Corp Q2 FY2023 Earnings Call

Good morning, everyone, and welcome to the National Bank Holdings Corporation 2023 Second Quarter Earnings Call. My name is Anna, and I will be your conference operator for today. 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, noninterest income, margins, allowance, taxes and noninterest 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 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's Chairman, President and CEO, Mr. Tim Laney. Please go ahead, sir.

Thank you, Anna. Good morning, and welcome to National Bank Holdings' Second Quarter 2023 Earnings Call. I'm joined by Aldis Birkans, our Chief Financial Officer. We delivered solid earnings for the quarter, representing a year-to-date increase of $34.1 million or 88% over prior year same period earnings. Our core earnings engine remains strong and adjusting for the impact of investment valuations met our expectations. Our credit quality is excellent, and our core deposits grew 29% annualized during the second quarter. With a common equity Tier 1 ratio of 11.08% and ample liquidity, we continue to serve as a source of strength in our markets. And on that note, I'll turn the call over to Aldis.

All right. Well, thank you, Tim, and good morning. Thank you for joining our earnings call this quarter. For the second quarter 2023, we reported net earnings of $32.6 million or $0.85 per diluted share. The closing and integration of the Cambr acquisition has gone extremely well, and it already is contributing nicely to our financial results. The core deposits grew by $539 million this quarter or 29% annualized. On a year-over-year basis, we have grown our quarterly pre-provision net revenue by $14.5 million or 49%, driven by strong organic balance sheet growth, well-executed acquisitions, and strong discipline on expenses. We continue to be pleased with the organic loan growth our teams have generated. During the second quarter, our loan balances grew 3.8% annualized. And on a year-to-date basis, our loan growth has been 5.4% annualized. Entering the second half of 2023, our loan pipelines are strong, which should allow us to achieve our full-year loan growth guidance of mid- to high single digits. As I previously mentioned, our core deposit balances grew $539 million during the quarter, which allowed us to pay down the more expensive FHLB debt and bring our loan-to-deposit ratio down to 91%. During our first quarter's earnings call, we mentioned that market conditions were demanding more aggressive deposit pricing, and that is reflected in this quarter's cost of deposits. Nevertheless, our total deposit beta to date through this cycle remains quite low at 22%. Fully taxable equivalent net interest income for the quarter came in at $91.2 million, down $5.1 million from the prior quarter, driven by higher cost of deposits. The second quarter's new loan originations of $362 million came in at an average weighted yield of 8.2%, which resulted in our loan book yield increasing 24 basis points to 6.15%. The resulting net interest margin was 4.07%, and we project NIM to dip slightly below 4% for the second half of 2023. In terms of our asset quality, it remains strong with just 2 basis points of annualized net charge-offs and 1.25% allowance to total loans. This quarter's provision expense covered new loan growth, nominal charge-offs, and supported the slight increase in the reserve requirements based on the CECL model macroeconomic outlook changes. Total noninterest income for the second quarter was $13.8 million. Included in this quarter's results was $4.1 million in impairments related to our venture capital investments. This was a result of our quarterly equity investment assessment process, where we review the financial performance and market dynamics underlying our investments. Excluding this impact, our core banking fees grew $3.3 million versus the prior quarter with an impressive 89% annualized. Service and bank card income increased $797,000 on a linked quarter basis and $1 million over the same quarter last year. Other banking income increased $2.5 million on a linked quarter basis, mainly driven by Cambr fees and a pickup in our mortgage banking income. Looking ahead for the second half of 2023, we project noninterest income to be in the range of $34 million to $36 million. Noninterest expense for the second quarter totaled $61 million, which was effectively flat with the prior quarter excluding the first quarter's one-time $2.5 million payroll tax credit benefits. Expenses continue to be well controlled, and for the second half of 2023, we are projecting noninterest expense to be in the range of $123 million to $125 million. Finally, our capital ratios remained strong with an 11.08% common equity Tier 1 ratio and a 9.15% Tier 1 leverage ratio. We maintained sufficient excess capital to provide for various strategic options. Tim, with that, I'll turn it back to you.

Thank you, Aldis. We remain focused on earning the full relationship of our clients. A focus on deposit growth and treasury management is not new to us. It's, in fact, a core strength. We operate with zero broker deposits and a high level of noninterest-bearing deposits. With regard to credit, we have a comparatively low CRE exposure, and we continue to build and manage a diversified and granular loan portfolio. Finally, we operate in attractive markets that we believe will support tremendous growth opportunities for NBH. And on that note, Anna, we are ready to open up the line for questions.

We will now take our first question from Jeff Rulis with D.A. Davidson.

This is Brett Thompson speaking for Jeff. Could you provide more details about the $24 million increase in non-performing assets this quarter? Which loan segment or segments is contributing to this increase? Is it due to several borrowers or a few large relationships? What type of relationships are involved, whether they are legacy or acquired? Lastly, could you share your thoughts on similar loans that are nonaccrual and might be affected?

Yes, sure. Very good question. Look, the nonaccrual increase was driven really by one asset-based lending relationship. We believe we've already adequately reserved for any potential loss exposure there. So look, it's been well managed. It was asset-based. We feel comfortable with our advance rates. But as we've historically done, we're going to be aggressive on dealing with any emerging problems.

Yes. And Brett, I would add that when we look at total criticized loans, bulk actually came down this quarter. So this loan had been accounted in that rate for a period of time already.

So again, we believe we have already set aside enough reserves for this situation, and I expect it to be resolved by the end of the year, if not by the third quarter.

Great. And then if I could just ask one more. You guys touched on it a bit more in the remarks, but just to revisit it. The increase in deposits, were those largely from the Cambr acquisition? And if so, should we assume that those deposit transfers are largely done? And then lastly, just as an outlook for deposit growth going forward. You have a goal to get to a 90% loan-to-deposit ratio, which was achieved. Is that going to drift back up again?

The last part of your question will depend on loan growth and deposit growth. Deposits have seen significant activity over the last several months. To address the first part, yes, a substantial portion is related to Cambr. We will not provide more detailed guidance to maintain flexibility in managing the balance sheet. Additionally, we will not offer further guidance on Cambr fees moving forward to preserve our ability to manage the balance sheet and the program without compromising our competitive advantage.

Yes. And I would add, one, we're not going to provide specific guidance. Obviously, we've got the flexibility to hold larger levels of non-brokered deposits from Cambr, we choose to do so. But we like the business model. We like supporting other financial institutions, the spreads that come along with that. And so we've got flexibility there, but we certainly intend to strike a balance.

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

Kelly, your voice has changed.

Sorry, this is Matt standing in for Kelly. I wanted to ask about noninterest-bearing deposits for a moment. I'm curious if you are observing any trends regarding whether the pace of those deposits running off is slowing down or what they may stabilize at. Any insights you could share about noninterest-bearing deposits would be appreciated.

Yes. Timing-wise, the most significant shift occurred in late March and early April, which corresponds to the early part of the second quarter. That situation has since stabilized. As of today, our noninterest-bearing deposits have remained flat throughout July. Therefore, we believe that the trends have normalized.

All right. Great. And then if you guys could give any more color just on margin. If you've seen the pace of margin decreasing, slowing down at all? Or any kind of guidance you can give us on that.

Yes. Actually, very similar comments on that, where the biggest repricing of the book did take place in late March and the month of April. I'll say that we are entering here, month of July or third quarter with a margin right around 4%. So still holding in to the 4%. No monthly margin for the last quarter was below 4%. So again, while on a linked quarter basis, it may appear a significant decrease, we forecasted that and signaled that and feel pretty good about where margin is stabilizing.

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

Could you provide details on the monthly or spot interest-bearing deposit costs at the end of the second quarter? Additionally, regarding your beta commentary, previously we discussed a potential range of 30% to 35% for deposit beta. Do you still view that as an achievable target throughout the cycle, or are you experiencing more pressure than expected?

We are definitely experiencing more pressure in the industry than we initially expected. As I stated earlier, we are targeting a 22% beta through the cycle, which is quite strong. However, I am hesitant to predict where we will land at this point. Regarding deposit costs as we enter the third quarter, they are approximately 1.45, compared to 1.27 in the second quarter. This is certainly an increase. Nonetheless, the margins from our earning assets are compensating for this rise, and we are starting the third quarter with a 4% margin.

I would just add that certainly, the focus on rates has become less intense from the end of the first quarter to now. We've seen more stabilization. Could factors like additional Fed moves or marketplace issues increase rates again? Possibly. However, we felt that we may have been too slow to raise rates at the beginning of the second quarter. We pride ourselves on our discipline and believe in the strength of our core deposits. Yet, as we progressed through the second quarter, we encountered competitive pricing pressures from both banks and nonbanks that forced us to move more quickly than anticipated. Do I expect that to happen again? Not really. But as Aldis mentioned, we don't have a crystal ball.

Yes, totally understood. I appreciate the color. And it does feel like, I guess, if deposit costs are around that 1.45 territory coming into the third quarter, that it does feel like the pricing pressure has slowed a little bit. Maybe, Tim, I know you mentioned maybe a little bit last quarter, but with Cambr now kind of completely in the fold and integration done, you guys have hit the ground running. Can you just talk about how you see this fitting within the overall 2UniFi build-out? And then maybe an overall status update on progress you've made in the second quarter to start the year on 2UniFi, just the overall build-out and how that plays in the bank?

No. Thank you for asking. We have weekly deep assessments of our projects all related to 2UniFi, and I'm pleased to report that we are tracking on time against more than 90% of the work streams there. We still believe we'll be in friends and family testing in 2024. And just given what we've seen, even here in the first six months of this year in terms of bank client behavior, we think 2UniFi is going to be incredibly important in the future of banking. So I really want to applaud our team that's leading and working on 2UniFi because they're driving toward the kind of projected deliverables and the time frames for those deliverables that we expected. And we're increasingly optimistic about the strategy and what it can do to serve small- and medium-sized businesses across the country.

And then I think we've also discussed a little bit in the past the ability to kind of leverage some of what you're building there and the work the team is doing into the core bank in terms of improving workflows or efficiency. Is that something we could also see if 2UniFi is moving to friends and family in '24, could we see potential for an increase or improved efficiency at the core bank as a result of that as well?

Yes. I seriously doubt it. I mean, because we actually see the potential impact on the core to be much greater than just a revision of processes. And we're working with a challenger core that's much more fluid, flexible and low-cost than what you would get from a traditional provider. The opportunity after we fully lift with it and believe in it to shift our core bank to that platform could be a game changer. So I don't see that happening in '24 because we're going to live with what we've built for a while before we make such a big bet.

Understood. If I could ask just one more modeling question. Aldis, the release mentioned the Cambr-related acquisition expenses, which include $500,000 for transactions and $600,000 for intangible amortization. Is the $500,000 mentioned a recurring item, or is it more of a one-time transitory expense?

No, that's a one-time transitory expense. And obviously, the $600,000 intangible amortization, that is unfortunately with us, but given how the accounting works. But the $500,000 is one-time.

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

A question on the Cambr revenue, that $1.2 million that came on. When you guys closed the deal at the beginning of April, was that in line with your expectations? Or was that a little high or a little low or just right?

Well, for the amount of, call it, excess deposits that we didn't keep that were flowing through there, that's exactly in line with where we're expecting.

Is it fair to add that while we don’t want to provide too much guidance, we haven’t yet fully optimized the revenue opportunities that will arise from Cambr?

Yes, what Tim is alluding to is in terms of other opportunities where we see potential fee and program growth opportunities, that is not part of this. This is just kind of taking over the program and hitting our financials the way we expected, and that is hitting the way we're expecting it. But we do believe there's ability to continue to expand the capabilities and our revenues.

Got it. So it's safe to assume that maybe this $1.2 million number is already captured in the guidance at least for the back half of this year?

That is yes.

Okay. And then on the expense side, the guidance suggests an increase, and I'm curious about what is causing that. Is it more investments in UniFi? What is prompting this uptick?

Yes, I think you are correct. The continued investment and expansion in 2UniFi is what is contributing to the slight increase in our expense guidance. As I mentioned, if we exclude the $2.5 million retention credit expected in the first quarter, our auto expenses have remained relatively flat compared to the previous quarter. I would say this is our current run rate, although there are some nuances with improved processing fees and certain one-time items related to Cambr. However, we do plan to maintain our investments in 2UniFi, and this is reflected in our guidance for the second half of the year.

Got you. And then can you just remind us, how is the balance sheet position right now for any additional changes in rates that the Fed might undertake?

Yes. As time has gone by, we have reduced our asset sensitivity. While we might see a slight benefit if the Fed makes a move next week, it won't be significant anymore because we are approaching the upper range of what futures suggest for the Fed rate cycle. We want to ensure we can protect our margin in a declining rate environment as well. Most of the asset sensitivity has been accounted for in our models.

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

Could you provide more insight into the venture capital write-downs and whether they were related to specific businesses where you had to make some adjustments?

Yes. Let me say broadly, we expect our investments to do well over time and frankly, contribute to the build-out 2UniFi. I think most know that tech valuations are very challenging in the current market. And then the absence of fresh capital raises, it's pretty difficult to nail down those valuations. Candidly, I'll probably get in trouble for saying this, but it feels like at this point in the cycle, it's as much art as it is science. But we're going to continue to take a conservative approach to the way we think about the business and work hard to validate that. We're not going to address, obviously, any specific names in that portfolio. But Aldis, you may want to just talk broadly to our total exposure there. And that might help answer Brett's question.

Yes. In terms of our total exposure to whether the direct equity-type investment or venture fund that many other banks may be part of, we have approximately $50 million, a little shy of $50 million in terms of investments and exposure.

Okay. That's helpful. And then wanted to talk about the balance sheet and the funding going forward. Obviously, you used Cambr and were a little more aggressive with deposits to lower the FHLB advances this quarter. Do you have a goal of getting those off the balance sheet completely as you try and remix a little bit? Or can you give us some thoughts on your funding sources from here and how you manage that?

Yes, absolutely. If we examine the items on our balance sheet, the most significant cost of funding is associated with federal home loan bank advances. Our objective is to reduce these advances as much as possible to maximize our net income. We appreciate having that capacity for liquidity and access, so maintaining a small amount on our balance sheet is essential for ensuring we have that access available. While we’re not focused on eliminating every last penny of these advances, we are actively seeking ways to expand our deposit relationships and reduce our more expensive debt.

Okay. And then just lastly, I wanted to clarify if the fee income guidance of $34 million to $36 million includes any potential improvement in the Cambr revenue going forward.

That's our outlook for the rest of the year, which includes all our lines of business, such as Cambr, mortgage banking, and core banking fees.

But I think his question was whether it includes any optimization of Cambr. And the answer is no. We've just taken our expected run rate based on what we saw coming in the second quarter.

Okay. And if I could sneak in one last one. Tim, I'm curious, I've had a few banks tell me that they're starting to have a few conversations. I'm curious if you've had any that reach out to you or if you were in any early rumblings of maybe some deal activity at some point in the next few quarters?

I'm not going to speak to specific conversations. We're always in conversations. Candidly, some are interested in buying, others interested in selling. And I would say in terms of our own view around acquisitions, we're really in a capital building mode. We really have a lot to absorb as we work through the remainder of this year. We're going to remain conservatively postured as it relates to questions around where the economy might go. I think it will set us up nicely for 2024 with a lot of optionality.

Okay. That's great color. Appreciate it.

You bet. Thanks for the questions.

Thank you. And 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.

Thank you, Anna. As we noted, pipelines are strong as we look into the second half of the year. We continue to feel great about the markets that we operate in. The cost of deposits appears to be stabilizing, and knock on wood, we won't see any more dramatic action in the marketplace. Criticized assets actually came down in the quarter, and we feel very good about the quality of the loan portfolio and its performance and our ability to resolve issues quickly when they do present themselves. And again, we're well-positioned for a solid second half of the year. So thanks, everyone, for your questions and your time today. Have a good day. Bye now.

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.