National Bank Holdings Corp Q1 FY2024 Earnings Call

Good morning, everyone, and welcome to the National Bank Holdings Corporation 2024 First Quarter Earnings Conference Call. My name is Shelly, and I will be your conference operator for today. As a reminder, this conference is being recorded for replay purposes. I will now turn the call over to Emily Gooden, Director of Investor Relations. Please go ahead.

Thank you, Shelly, and good morning. We will begin today's call with prepared remarks, followed by a question-and-answer session. 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 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.

Thanks, Emily. Good morning, and thank you for joining us as we discuss National Bank Holdings' first quarter results. I'm joined by our Chief Financial Officer, Aldis Birkans. We delivered quarterly earnings of $0.82 per diluted share and a return on tangible common equity of 15.14%. Credit remains strong with 0 basis points of annualized charge-offs. We experienced a slow start with loan production early in the quarter, with business clients deferring action in anticipation of the Federal Reserve lowering interest rates. Once it became clear that rates were not coming down in the near future, client activity picked up, and we have a very strong pipeline for the second quarter. We grew our core deposits 6.8% over the first quarter of 2023 while preserving our low deposit beta across this entire rate cycle. Expenses were well managed, especially in light of the fact that this year, we are incurring over $18 million of expense related to the amortization of our investments to date in 2UniFi. And I'll cover a more detailed update on 2UniFi after Aldis takes us through the quarter. Aldis?

All right. Thanks, Tim, and good morning. During this call, I will cover the financial highlights for the first quarter as well as touch on our guidance for 2024. And just as a reminder, our guidance does not include any future interest rate policy changes by the Fed. Turning to the financial results. For the first quarter, we reported net income of $31.4 million or $0.82 of earnings per diluted share. The first quarter's return on tangible assets was 1.4%, and the return on tangible equity was 15.1%. During the quarter, our loan balances decreased $130 million or 1.7%. And as Tim already discussed, the feedback we have received from our commercial clients is that many projects and funding needs were delayed with the hope of achieving lower funding costs. This was especially evident early in the year when the interest rate cut expectations were still quite high. Similarly, our commercial lines of credit utilization ended the quarter at historically low levels. As we enter the second quarter, our pipelines are quite strong, and we expect to meet our full year loan portfolio growth guidance of mid-single digits. Fully taxable equivalent net interest income for the quarter came in at $85.7 million. The linked-quarter decrease was primarily driven by accelerated loan fee income of $2.9 million recognized in Q4 and 1 less day in the first quarter. Net interest margin in the first quarter was 3.78%. Our new loan originations during the quarter were at an average rate of 8.8% and continue to favorably benefit our earning asset yields. Our overall deposit beta this rate cycle to date is 37.5%, and the pressure on deposit pricing is abating. Looking ahead for the rest of 2024, we project our NIM to settle in the mid-3.70s. Deposit balances during the quarter grew $327 million on a spot basis and $90 million on an average balance basis. This quarter, we benefited from seasonal tax inflows in the Cambr platform deposits. As such, we paid off all of our FHLB borrowings as these deposits are more favorable to our funding costs. In terms of our asset quality, it remains strong. During the quarter, we incurred 0 basis points in net charge-offs and recorded no provision expense. We increased our overall allowance to total loan ratio to 1.29% and have built sufficient reserves to support any nonaccrual loans. Additionally, we still hold $26.2 million in marks against our acquired loan portfolio, which equates to approximately 35 basis points of loan loss coverage if applied across the whole loan portfolio. Total noninterest income for the first quarter was a strong $17.7 million or a $1.6 million increase from the prior quarter. And while we saw a seasonal slowdown in service charges and bank card fees, we are gaining momentum from our fee diversification efforts, driven by SBA loan gains on sale, trust income, and Cambr fees. This quarter, we also benefited from a $600,000 gain on the sale of a banking center building. For the rest of 2024, we project to meet our full year guidance for the fee income of $67 million to $72 million. Noninterest expense for the quarter totaled $62.8 million and included elevated payroll taxes. The yield-related expense this quarter was approximately $3 million, and we continue to be on budget and on plan with our targeted rollout dates. Looking ahead for the rest of 2024, we see our noninterest expenses trending towards our original full year guidance of $253 million to $258 million. In terms of capital, we continue to grow our excess capital with a TCE ratio ending the quarter at 9.2% and a Tier 1 leverage ratio coming in at 10%. Tangible book value per share grew 2.4%, ending the quarter at $23.32. Tim, with that, I will turn back to you.

Thanks, Aldis. Well, solid earnings resulted in tangible book value per share increasing $0.55 during the quarter, and our common equity Tier 1 capital ratio totaled 12.35% at quarter end. Now turning to 2UniFi, we remain highly enthusiastic about the progress being made in the build-out of a platform, a banking platform, that we believe can change the way small and medium-sized businesses access U.S. banking. Additionally, we're building tools within 2UniFi for these businesses that simply do not exist today. We believe 2UniFi will save business owners time and money and meaningfully reduce stress in their lives. All project work is tracking to target, and we expect to be in release 1 user testing by the fourth quarter of this year. Shelly, on that note, let's open up the call for questions and discussion.

And our first question is coming from Jeff Rulis with D.A. Davidson.

I guess on the influx of deposits from Cambr and the related paydown of FHLB, I guess there's no expectation that those flow out. It sounded tax-related, but just wanted to kind of get a sense for the stickiness of those staying on balance sheet.

Yes, this is Aldis. Obviously, we've looked at their seasonal patterns in the years before and do expect some of this to come out in the rest of April and coming months here in the second quarter. But there is a certain level that will be sticky as well.

The growing average balances across that platform is pretty impressive, so we expect that trend to continue.

Got it, okay. Turning to the margin, we have a mid-3.70% guide. Given the significant drop in FHLB and the building loan pipeline, particularly in the latter half of the year, what are your thoughts on the direction of the margin? It seems like there are some strong tailwinds for that. I just wanted to check in on the full year expectations.

Yes, it's difficult to provide a precise quarter-to-quarter outlook. There may be fluctuations, particularly concerning the timing of loan growth, as we are adding loans at rates up to 8%, which will enhance margin no matter how they are funded. Thus, the timing of these loans is significant. We are positioned for potential margin improvements in Q4, but we also want to temper our expectations.

And on a related front on the NII, I think you had a guide last quarter. Are you kind of at this point, kind of reassessing or should we think about that level or maybe the margin coming in? Any thoughts on the NII levels? And can those, I guess, recover before maybe the margin rebounds?

Yes. Well, I think certainly, again, the NII will be driven by earning asset growth. That's driven by loan growth. The first quarter certainly came in a bit lower than we expected, given the lighter loan performance. So whether we make that up in going into the rest of the year is hard to tell towards the full NII guidance. But again, if you look at the loan growth from here, what does that do to earning asset growth, holding margin to mid-3.70s, it will give you a pretty good estimate for the NII.

I would add that the current pipeline would suggest that by quarter end, if our teams deliver like I think they can, that we'll be back on plan as it relates to loan balances and then working hard to cover any NII gap from the first quarter.

Our next question is coming from Kelly Motta with KBW.

I apologize. I dropped off for a minute or two during the prepared remarks, and you just alluded to the loan pipeline. I was just wondering if you could share where you're seeing the best opportunities. I appreciate the color on where new loan yields are coming on. Just any sort of color as to how pipelines are shaping up now versus this time last quarter and the mix of that pipeline.

Yes, it's primarily in the commercial and industrial sector, specifically with middle market businesses in our regions. We're seeing a positive buildup in all our key markets. It's also important to mention that during the first quarter, in addition to a reduction in line usage—which we are still assessing by talking to clients to understand the reasons—we also intentionally reduced our loan portfolio in certain targeted industries. For example, in transportation, which makes up about 3% of our total lending, we are lowering our exposure due to the current state of that industry. Therefore, we are not bringing on new clients in that sector. On the other hand, core manufacturing and service-related businesses are performing well. I can't really comment on commercial real estate activity because it's not a focus for us in this market. I hope this provides some clarity.

Yes, certainly. That's very helpful. And maybe I love the color that 2UniFi, you have version 1 ready for testing in Q4. I know it's going to take some time for that to really shine through results. But as we start to think about what this platform could do, are you seeing about this as more of a fee opportunity? Will it add to balance sheet growth? Just wondering kind of how to frame the type of impact it could have to NBHC even if we're not ready to quantify that yet.

Yes, that's a great question. I would say we should view 2UniFi as the creation of an entirely new business, rather than just a generator of fee income or merely a product. It's a fresh approach to banking. For our investors, we will maintain the flexibility to operate both the core bank and 2UniFi. However, it’s possible that 2UniFi could evolve into such a significant entity that it operates independently. The advantage of developing it alongside the rest of the bank is that we are already witnessing valuable technical synergies that enhance the bank's operations, improve client experiences, and reduce costs. A key benefit in the current environment is the robust security features being integrated into 2UniFi, which can also be applied to the core bank. Additionally, with the increasing focus on artificial intelligence, I believe that AI's effectiveness relies heavily on its data sources. I'm extremely impressed with the data lakes our teams are constructing. Functionally, this system follows an API-first architecture, providing us with a level of adaptability that is rare in the banking industry today. This will enable us to be more agile and responsive to client needs and operate in innovative ways that have not been possible before.

Our next question is coming from Andrew Liesch with Piper Sandler.

Just a question on the Cambr deposits that came in, in the quarter. Just curious what the funding difference might be between those and the FHLB borrowings that you paid off.

Yes. Again, we don't necessarily talk to specific pricing, but I'll just say that if these deposit balances persisted at the same cost versus what we paid FHLB, the difference would be a couple of million dollar benefit annualized to our bottom line.

Got it. All right, that's helpful. And then Tim, what's the thought process on additional M&A right now? How are conversations with prospective targets going, the Cambr deal last year, the other deals not too far in the distant past? But just curious on your outlook for additional M&A right now.

Well, activity has certainly been high. And we have been clear in what we're targeting, which would be institutions in that $1 billion to $3 billion range in growth markets, ideally in growth markets that we know and understand. And that's where we've been spending our time.

And our next question is coming from Jeff Rulis with D.A. Davidson.

I was hoping to get a little more color on the flows of nonperforming loans linked quarter, what came in and the characteristics of those loans.

Yes. Thanks for asking because I do want to make the point that we don't believe this increase in NPAs over the quarter represents anything like a negative trend. In fact, we believe NPAs will be down below 50 basis points by year-end. There were just a couple of, I'll call them stagnant nonperformers that our special assets group has not moved out of the bank as quickly as, quite frankly, we expected, and they are receiving an intense amount of focus. I'll also point out that we believe that these NPAs are very well preserved for, and no concern on that front.

And that's a percent of loans, Tim, the 50 basis points?

Yes, yes.

Okay, great. And then one more follow-up. You briefly mentioned the service and card revenues being down from the previous quarter, which makes sense for the card. I wanted to understand what might be affecting that, as it used to be a strong growth area. Were there any changes or seasonal impacts that could explain this decline and when we might expect to see improvement?

Yes, the first quarter is primarily influenced by seasonality for both of those items. So actually...

If you compared first quarter last year to first quarter of this year, you would see that dip. We've seen it for years.

Right. So we do expect that to come back in here in the second quarter and already seeing good activity in bank card starting month of March into here in April.

It prompts another thought we should share because a lot of our card activity relates to personal banking relationships. And another encouraging point around deposits is we started to see a nice positive movement in personal banking deposits as we closed out the quarter and moved into the second. So that was certainly refreshing to see and that will contribute to additional fee income over time as well.

I guess while we're in the weeds, the mortgage banking had a nice sequential uptick. I don't know if you want to update sort of the outlook for the year in that line item.

Not specifically. Again, it's embedded in our total fee guidance, but I'll say that the market's changed, right? Even this morning, the rates are up quite a bit, given the GDP numbers. But I would say that what we guided, what we embedded in our plan for gain on sale for mortgage business has been somewhat conservative, have been at or better each month this year to our planned numbers. And again, if the markets don't really change that dramatically, we should be able to meet our planned numbers in that line item.

Yes. The full year noninterest income guide is great. I appreciate it.

Yes, of course. Thank you.

Our next question is coming from Kelly Motta with KBW.

I appreciate the color on M&A and understanding that maybe you want to keep some dry powder for that as well as some of the other initiatives you're working on. I did see that capital did build very nicely, and you guys have been active on the buyback in the past. Just wondering how you guys are approaching that method of capital deployment.

We're probably discussing buyback action at as high a frequency as I can recall. We do believe there could be some interesting opportunity there. We have an authorized buyback, and we'll watch the market and pull the trigger if we think we're in the right place. I'll also point out that with the kind of capital growth that we're realizing, it gives us confidence that we will continue to increase our dividend twice each year. And we're also, frankly, talking about whether or not a higher dividend at this point might be appropriate. So that's another consideration.

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, Shelly. I'll just thank those of you that asked thoughtful questions, and 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.