National Bank Holdings Corp Q3 FY2023 Earnings Call

Good morning, everyone, and welcome to the National Bank Holdings Corporation 2023 Third Quarter Earnings Call. My name is Marjorie, and I'll 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, tax 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 today will reference certain non-GAAP measures, which National Bank Holdings Corporation believes provides 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.

Good morning and thank you for joining us as we discuss National Bank Holdings' third quarter 2023 financial results. I'm joined by Aldis Birkans, our Chief Financial Officer. We delivered a 10.8% increase in earnings for the quarter with year-over-year pre-provision revenues growing 54.6% while doubling net income during the same period. We continue to build capital, ending the quarter with a CET1 ratio of 11.61% and delivering a healthy 18.38% return on tangible common equity. I'll add that we continue to be pleased with our asset quality with just 1 basis point of charge-offs for the quarter. Further, we expect to reduce nonaccruals during the fourth quarter, having already experienced a nice reduction during the first three weeks of the fourth quarter. 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 third quarter of 2023, we delivered another quarter of strong financial performance with earnings of $36.1 million or $0.94 per diluted share. Overall, this resulted in a return on average tangible assets of 1.58% and a return on tangible common equity of 18.38%. On a linked quarter basis, we grew our pre-provision net revenue by $4 million. And on a year-to-date basis, adjusting for acquisition expenses incurred in the prior year, our pre-provision net revenue increased by $51.2 million or 55% driven by organic balance sheet growth, well executed acquisitions and as always, strong discipline on expenses. We continue to be pleased with the loan growth our teams have generated. New loan originations during the third quarter were $324.1 million at a weighted average yield of 8.6%. And on a year-to-date basis, we have funded $1.1 billion in new loans bringing our total loan balance growth to a 4.8% rate annualized. Several loan fundings pushed into the fourth quarter, and combined with the remaining loan pipeline for the fourth quarter, we expect to achieve our full year loan growth guidance. Our core deposit balances grew $28 million on a spot basis and $116 million or 5.8% annualized on average balance basis. Deposit pricing has continued to reflect the higher rates paid by the banking industry. Yet our cycle-to-date total deposit beta remains quite low at 28%. The third quarter's total deposit cost was 1.64%, and we do expect that to continue to drift higher. Fully taxable equivalent net interest income for the quarter came in at $89.4 million, a slight decrease to the second quarter and an $18.9 million increase over the last year's third quarter. The result in net interest margin for the quarter was 3.92%, and we project NIM to be in the range of 3.8% to 3.85% for the fourth quarter of 2023. In terms of asset quality, our loan portfolio continues to perform nicely with only 1 basis point annualized net charge-offs in the quarter. This quarter's provision expense was primarily driven by new loan growth. The portfolio trends remain well behaved on an overall basis, and consequently, our allowance to total loan loss coverage remained at 1.25% during the quarter. Both NPA and NPL ratios improved over the prior quarter as did our classified loan ratio. Total noninterest income for the third quarter was strong at $19.4 million, an increase of $5.5 million on a linked quarter basis. The core banking fees showed strong performance, resulting in 12.9% annualized growth in bank card and service charges combined. Other banking income benefited from a $1.1 million gain on sale of mortgage servicing rights this quarter and solid performance from our diversified fee generation businesses such as trust and wealth management, SBA loan sale gains and Cambr. Looking ahead, for the fourth quarter of 2023, we project noninterest income to be around $16 million, a linked quarter decrease, mostly driven by the seasonal slowdown in mortgage-related income. Noninterest expense for the third quarter totaled $60.6 million, a decrease of $0.4 million from the prior quarter. Expenses continue to be well controlled, and we continue to find efficiencies that allow us to fund our investment in 2U and other technologies. The third quarter's 2U expenses were approximately $2 million, and we expect them to grow to close to $3 million in the fourth quarter. The fourth quarter's total noninterest expenses are projected to be in the range of $60 million to $62 million, which will bring the full year 2023 expenses to be below the low end of our guidance. Finally, we continue to build our capital with TCE ratio increasing to 8.5% and Tier 1 leverage ratio increasing to 9.56%. Our tangible book value per share grew 9.2% annualized to $21.43, more than offsetting dividends paid and any increases in AOCI losses due to higher long-term interest rates. Tim, with that, I will turn it back to you.

Thank you, Aldis. Well, we believe we're set up for a solid finish to the year. Our pipeline of new business has been building as we approach year-end. And as previously covered, asset quality trends are positive, and we continue to deliver an attractive return while building capital. So on that note, let's go ahead and open up the lines for questions.

We'll take our first question from Jeff Rulis from D.A. Davidson.

Wanted to check on the timing of FHLB-advanced sort of reductions. Was that largely over the kind of gradual over the pace of the quarter?

It was with a bigger pop at the end of the quarter, but we continued to, given the average balances grew so much relative to spot, we were able to pay down a chunk of it throughout the quarter.

Okay. And strategy-wise, I guess, pending deposit success, that expectation would be to further reduce that? How do you feel on liquidity?

We feel very positive about our liquidity. With the addition of Cambr to our balance sheet, along with undrawn lines from the Federal Home Loan Bank, our unencumbered investment portfolio, and the cash we hold, we have multiple sources that we stress test for liquidity, and we feel confident. The evolution of FHLB balances as we approach the end of the year will primarily depend on our remaining loan growth and deposit growth.

It is noteworthy, Jeff, that we operate with zero broker deposits. This has historically been the case and continues to be true throughout the cycle.

And Aldis, I missed the full year guide on loan growth, I may have...

Yes. The full year guidance has been in the single digits, mid- to high range, and we are currently at 4.8% year-to-date. However, the fourth quarter is looking quite strong with several loans coming in, and we expect to be above 5%.

Got it. And did you have a September net interest margin average as it compares to the 3.92% for the whole quarter?

Yes. The margin for September was 3.90%.

3.90%. Okay. Got it. Just jumping to credit for a minute. It sounds like Tim, you've got some nice reductions coming in the fourth quarter. I can imagine, is there some progress on some of the nonaccruals that were brought forward in the second quarter?

That's exactly right. That's exactly right.

In any kind of size of that? Or you just at this point, expecting some wins, and we'll leave it at that.

Yes. I would say it's probably given where we're at into the fourth quarter, probably best we wait and report on that on the next earnings call. But we feel good about, frankly, all of our credit quality trends. And make no mistake, we believe as we look ahead to '24 that we're going to benefit from having a very little exposure in areas like office and retail. Again, in both of those cases, exposure is less than 2% of the total loan book for each.

I noticed there was a significant sequential drop in accruing modified loans this quarter, down by $13 million. Was there a payoff in that category?

There was.

We'll next go to Kelly Motta with KBW.

There seems to have been significant growth in owner-occupied commercial real estate. I'm curious about the opportunities you're observing in your market and whether this growth is widespread across all your markets or if you're noticing specific trends.

We aim to establish comprehensive banking relationships with our business clients, which often means financing the facilities they operate. The advantage of this approach is that, unlike traditional commercial real estate, we capture all of the depository business associated with that relationship. This allows us to have deep insight into their global cash flow and their capability to manage all debts, including facility-related debt.

Okay. That's helpful. Switching to the deposit side, it seems there has been some outflow of noninterest-bearing deposits. I'm wondering if you anticipate continued movement out of that category as borrowers use some of their liquidity to reduce lines of credit and cover operating costs, as well as shift to higher-cost funding sources. When do you expect that line item to reach its lowest point? Additionally, can you provide any guidance on what that should represent as a percentage of total deposits?

We really have seen a reduction in that glide ratio down. And I think for a little more color, where we've interestingly enough, seen the most pressure coming out of our consumer book of business. And back to the discussion point earlier with the success we're having growing commercial relationships, that's the opportunity to begin to grow through that decline on the consumer side with noninterest-bearing deposits that come out of core operating relationships. So we don't, at this point, expect any major changes in that particular part of the business.

Got it. Maybe a last question for me. I was hoping to hear about capital in the prepared remarks. The levels look pretty healthy, so I'm curious if you could outline your capital priorities, any interest in a buyback, and although you were very active in M&A last year, I'm wondering if there's a certain pace of conversation regarding that.

Yes, great question. Thanks for asking. Number one, we operate with an authorization to engage in buybacks. And we certainly have a targeted price at which we would engage. On the M&A front, we've committed to stand down really, when I say committed, we made the decision ourselves to stand down this year, ensure we had complete integration of the last acquisitions to rebuild capital and to put ourselves in a position to be opportunistic in '24, and that's unfolding nicely. That would be our expectation is to reengage and again, perhaps even on a more opportunistic basis.

Next, we'll go to Andrew Terrell from Stephens.

I had a few questions maybe on the margin. One, it sounds like loan growth or at least originations kind of shaping up to be pretty solid in the fourth quarter. Can you disclose what's the new yield is for originations right now? I think it was kind of high 8% range last quarter.

Last quarter was 8.6%. For September, it was 8.9%. This includes advances on existing lines, which are typically lower levels. New fixed-rate bonds were funded at over 9 percent.

Okay. Got it. I appreciate it. And then on the time deposit portfolio. It's really impressive that I mean, the cost was 2.48% this quarter just relative to the market that feels pretty low. Just wanted to get a sense of where you're pricing new CDs at today and how that compares to the market.

Yes, there's a mix of situations. Some time deposits simply roll over and have been around for years, even decades, at rates that are much more favorable for attracting new clients. The weighted average rate for new time deposits has been approximately 3.5% to 3.8%. Additionally, unlike certain brokered deposits, we have consistently prioritized time deposits and ensured that we offer duration on those deposits. As a result, there is a long-term pricing advantage that is contributing positively here.

And historically and currently, time deposits have not been a meaningful part of our marketing campaign. And I wouldn't expect to begin doing so in '24. So obviously, it's an important part of the balance sheet, but it's not an area that we heavily rely upon.

Yes, I understand. Regarding the margin, it seems that for September, the results are not far from the quarterly average. The guidance for the fourth quarter is fairly close to what you reported in late September. With new originations coming in at that pace and some ongoing pressure on deposits, do you believe you can maintain the margin in the 3.85% range moving forward, or is it more of a situation where we need to wait and see?

Well, outside of that, we feel optimistic about our guidance for the fourth quarter, and it is definitely indicating a slowdown in the pace of decreases, shifting from over 30 basis points to 15 last quarter and suggesting another slowdown. We will wait to share our guidance for 2024 until our January call.

Yes, understood. Okay, Aldis, can you provide details on the MSR sale this quarter, specifically the pricing? Also, do you expect any more MSR sales in the future?

Starting with the latter one. There's nothing in the near term. This is our second sale in the last three years, and we do these sell-downs not primarily for profit but to manage operational risk. Since we are not rebuilding that asset quickly due to the current state of the mortgage business, I don't expect any additional sales in the near term. Regarding pricing, we haven't disclosed that yet. I can share that we sold about half of our assets and half of our servicing portfolio. This will provide us opportunities to strategically allocate the resources that supported that portfolio moving forward.

We'll next go to Andrew Liesch with Piper Sandler.

I think you've covered nearly everything. On expenses, you mentioned the 2UniFi cost much stepping up to $3 million this quarter. Is $3 million a good run rate? I guess, how should we be looking at those costs going into next year?

For the full year, I will provide guidance on what 2024 will look like in January. Currently, the run rate is $3 million, which is where we were in September and will be in October in terms of quarterly run rate. I'll just leave it at that.

Got it. I guess as far as 2UniFi is concerned, I mean, when do you think we could start to see some revenue from that business falls to the bottom line earnings?

Yes. We believe we will be ready to take 2UniFi on the road and begin to showcase some of the friends and family initiatives we are working on in the second half of 2024. I do not anticipate significant revenue coming in during 2024. The primary focus will really be in 2025 and beyond.

And I am showing we have no further questions at this time. So, I'll now turn the call back to Mr. Laney for any closing remarks.

Thank you again. And I would just thank everyone for joining us today, and feel free to follow up if you have other questions. Have a good day.

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.