National Bank Holdings Corp Q2 FY2024 Earnings Call

Good morning, everyone, and welcome to the National Bank Holdings Corporation 2024 Second Quarter Earnings Call. My name is Maddie and I will be your conference operator for today. At this time, all participants are in a listen-only mode. 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.

Thank you, Maddie, 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, 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, uncertainties, and other factors which are disclosed in more detail in the company's most recent filings with the US 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.

Thank you, Emily. Well, good morning, and thank you for joining us as we discuss National Bank Holdings' second quarter results. I'm joined by Aldis Birkans, our Chief Financial Officer. We delivered quarterly earnings of $0.68 per diluted share on the back of a 3.7% net interest margin, as well as increases in our diversified sources of fee revenue. Loans increased 8.1% annualized during the quarter and credit quality continues to benefit from having built a diversified and granular loan portfolio. We also realized a 7.9% annualized increase in average deposits, with transactional deposits representing 87.8% of total deposits. Expenses were well managed, particularly in light of the investments we're making to build 2UniFi, increases in our defenses against emerging fraud threats, and also expanding the capabilities of Cambr. We feel very good about what we're seeing and hearing in our markets and we enter the third quarter with a solid pipeline and strong momentum. And on that note, I'll turn the call over to Aldis.

All right. Well, thank you, Tim, and good morning. During this call, I will cover the financial highlights for the second quarter as well as touch on our guidance for the rest of 2024, which does not include any future interest rate policy changes by the Fed. For the second quarter, we reported net income of $26.1 million, or $0.68 of earnings per diluted share. This quarter was highlighted by strong loan growth and significant progress in reducing outstanding NPLs and NPAs. In terms of loan growth, loan fundings totaled a strong $505 million, which resulted in an annualized portfolio growth of 8.1%. The second quarter's loan production, combined with robust loan pipelines, puts us on a trajectory to meet the full-year loan growth guidance of mid-single digits. Second quarter's loan production was granular with an average commercial loan funding size of $1.3 million diversified across all of our geographies and lines of business. We also saw a stabilization and a small recovery in drawdowns of our unutilized lines of credit. Fully taxable equivalent net interest income for the quarter came in at $85.3 million, fairly consistent with the prior quarter. We expect earning assets and net interest income to grow in the second half of 2024, driven by the projected loan growth. Net interest margin in the second quarter was 3.76% and we experienced the lowest quarterly cost of funds increase since the beginning of this rate cycle. Consistent with these trends, our NIM outlook for the rest of 2024 remains intact for the mid-3 range. During the quarter, we made great progress in bringing down our non-performing loan and NPA ratios to the lowest level since early 2023. Our remaining order balances are at the lowest levels in the company's history. And during the quarter, we decreased our classified loans. Annualized net charge-offs for the quarter were 22 basis points, or just 11 basis points on a year-to-date basis, driven by one previously reserved credit. As a result, this quarter's provision expense of $2.8 million was primarily driven by loan growth and changes in CECL models underlying economic forecast, specifically the unemployment rate outlook. The allowance to total loan ratio ended the quarter at 1.25%, and we continue to hold $25.4 million in marks against our acquired loan portfolio, which equates to 33 basis points of additional loan loss coverage if applied across the whole loan portfolio. Total non-interest income for the second quarter was $14 million. This quarter, we recorded $3.9 million of impairment related to venture capital investments. The driving force behind this valuation adjustment was the continued weakness in venture capital markets, resulting in downturns in capital raises. Adjusted for this one-off impairment and Q1's gain on sale of a banking center property, the quarter's non-interest income grew nicely by $900,000 with solid growth from core banking fees, mortgage banking revenues, Cambr fees, and SBA gains on sale. For the second half of 2024, we project our fee income to be in the range of $33 million to $35 million. Non-interest expense for the quarter totaled $63.1 million, a $200,000 increase relative to the first quarter. The linked quarter to unified related expenses increased approximately $0.5 million, with core bank expenses decreasing slightly. Looking ahead for the rest of 2024, we see our second half 2024 non-interest expense to be in the range of $127 million to $130 million. The increase, relative to the $126 million expense realized during the first six months of this year, is entirely due to a step up in unified related expenses. In terms of capital, we continue to grow our excess capital with a TCE ratio, ending the quarter at 9.4%, tier 1 leverage ratio of 10.2%, and CET1 ratio of 12.4%, which provides us with various strategic alternatives. Tangible book value per share grew another 2 percentage points, ending the quarter at $23.74. Tim, with that, I'll turn it back to you.

Thanks, Aldis. As Aldis just shared, solid earnings resulted in tangible common equity increasing $0.42 to $23.74 per share. The strength of our balance sheet provides NBH with broad optionality, including a substantial investment in the build-out of 2UniFi. With respect to 2UniFi, I'm pleased to report that we are moving into user acceptance testing in a production environment and continue to project that we will enter controlled beta testing with friends and family during the fourth quarter of this year. I'll stop there and ask Maddie to open up the lines for questions.

Of course. Jeff Rulis, your line is live.

Okay. Hello. Can you hear me?

Very well, thank you.

Okay, there's a big pause. I couldn't hear anything.

Nor could we. I'm glad you're here, Jeff. Okay, what can we do? Eight questions can we answer for you this morning?

Yeah. I wanted to ask about the margin a bit. First, how do you feel about the current cash balances? They seem to be decreasing, so do you think you're at a sustainable level, or could they drop further? Also, Aldis, could you provide the June average margin compared to the quarterly average? Thanks.

Right. So in terms of the cash, I think cash is going to be around the levels that you're seeing here, where we ended the quarter on a go-forward basis, that provides us with plenty of on-balance sheet liquidity. Now, having said that, I will say that last, going through the CrowdStrike event, we built up cash going over the weekend just to be safe. But in the long run, be running cash where we are. In terms of the margin for June, June was right exactly where the quarter is, at 3.76%.

Got it. Okay. And so back on that kind of earning asset and NII expectation for growth, if cash is sort of settled in here, expect those balances to grow in the second half, is sort of part of the guide?

That's correct.

Okay. And maybe on the credit side, first, any kind of color of type, and maybe what occurred in the non-accrual declines. And then second, the 30 to 89-day bucket was up a bit and wanting to know if there was anything timing related with those balances lifting.

Yeah. Very good questions. The reduction in non-performers was largely related to one credit that we've previously discussed and where it had been previously reserved. So that was the driver on non-performing loans. With respect to the past dues, more than half of that, I'm embarrassed to say, was administrative in nature. We have a track record of not letting that kind of thing happen, and I don't intend to let it happen again. And more than half of those past dues have already been resolved. So I don't think it's an indication of a negative credit trend. I'm embarrassed to say, in a number of cases, it was just sloppy work on our part.

Got it. So, Tim, back to that decline in the non-accrual, it's the same loan that both drove the decline in non-accrual and the net charge-offs in the quarter?

You're exactly right.

Okay. Maybe a last one for you, Tim, while I have you. The absence of M&A, I think last quarter you talked about the buyback as an option. Clearly, we've seen a nice lift in the stock and maybe valuation is restrictive to a degree. Just checking back in on use of capital and you could open book on either M&A or buyback appetite?

You're correct about the buyback. We have a target price, but given the current market conditions and our stock price, we aren’t looking to engage in that right now. Regarding M&A, I can say that I am more active in M&A and partnership discussions than at any other time in the company's history, in terms of the transaction sizes we are interested in.

Okay. And again, broadly speaking, can you provide a summary of the contributors to fee income or the ideal candidate, Tim?

Yes. Look, we've said for some time, ideally the candidate would be part of our existing market and expand our contiguous markets that we find attractive to us. We've always believed that investing in markets that are growing faster than the national average is key to success, so we're always going to be drawn to those stronger markets here in the US. And again, either already in market or contiguous to markets. We think culture is incredibly important, probably not talked about enough in terms of ensuring there's the right attitude toward credit risk management, in fact, all risk management, and the right attitude toward the way we work together. We certainly continue to look at it from a return metric on a crossover method, expecting transactions to come in under three years and earn back, and we've certainly seen our last few transactions do much better than three years. So we're holding ourselves to a high standard there. And I don't know. Aldis, anything else you would add?

No, I think you summarized it well.

Great, thank you.

You bet. Thank you for your questions.

We'll take our next question from Kate Ashley with KBW.

Hi.

Good morning.

This is Kate on for Kelly Motta.

Hi, Kate.

Yes. So since loan growth was really strong, I was just wondering how your pipelines are holding up and where you're still seeing good demand from borrowers? And any areas you're pulling back from?

Thank you for the question. We started the third quarter with a very strong pipeline, and we're encouraged by the positive conversations we're having with clients in the marketplaces. Our outlook is increasingly optimistic regarding our activities in the small business and middle market sectors. Additionally, in several markets, there appears to be pent-up demand for mortgage banking activity. We believe that interest rates need to decrease to a point where we are discussing loans with a five-handle. If that occurs, we could potentially see a significant increase in activity that we haven't anticipated in our guidance. However, the demand is certainly there, closely tied to reaching that five-handle interest rate. Regarding areas of concern, the trucking and transportation industry, which makes up only about 2.5% of our loan portfolio, is problematic. This sector is facing severe pressure in terms of rates and expenses, along with an oversupply of vehicles, leading to declining collateral values due to significant bankruptcies. Interestingly, this situation resembles a tale of two cities; our stronger clients are becoming even stronger, while those who were less careful with their capital during the COVID period are experiencing more difficulties. We are monitoring a few loan-related credits closely, and while we have some concerns there, I can't identify any other industries that are worrying us at this time.

Great. Thank you for all the color. I'll step back.

Yes, you bet.

We'll take our next question now.

I'm sorry. Maddie, we are having a hard time hearing you. The other speakers are coming in loud and clear. Can you speak up or check your line?

Yes, I apologize. Can you hear me better?

We can.

Yes. We have Andrew Terrell with Stephens on the line.

Hey, good morning.

Good morning, Andrew.

Hey. Tim, maybe just to start, you talked about just briefly in the prepared remarks, mentioned that the kind of increasing the capabilities of Cambr investing to that extent. Any incremental color you can provide on kind of the investments you're making there and then what type of future benefits you might expect.

I will ask Aldis to provide more details. At a high level, we are enhancing our network capabilities, which will ultimately lead to increased fee income or spread income for NBH. I know we need to be careful discussing pricing elements, but you may want to elaborate.

Yes, Andrew, hi. In addition to developing our network capabilities and direct distribution methods, we are also focusing on enhancing our product offerings. One example of this is the FDIC-insured deposit capabilities, which have gained popularity since SVB's collapse, and we are exploring that option as well.

But more immediately, the investment has been around network expansion, network optionality, and we do expect to see fee income increases related to that.

Understood. Okay. I would assume that's not contemplated in your back-half fee income guidance. Then also, if I could just sneak it in on the fee guide? It looks like the second-half guidance implies maybe stable or slight moderation in the fee income run rate from here. Is that mainly softer mortgage banking in the back half of the year or what's driving the fee income guide?

Yes. So Tim kind of touched on the mortgage where we feel like the pivot point is in terms of that market, all of a sudden opening up, we are being careful in guiding in terms of second half, you got it. It's the mortgage fee income that's pulling that a little bit back in terms of what we realized in let's say second quarter. In terms of Cambr, back to that first part of that question, no, it's not embedded yet in the guidance. I do expect that to really kind of start coming through in 2025. But it's a near-term, it's a 2025 early opportunity.

Yes. Okay, very good. And then on just more broadly to the point on the dam breaking, if you will, on mortgage banking or just any kind of pickup in activity, should mortgage rates come down more significantly? Can you help me think about just, I don't know if framing the upside is the right question to ask, but any changes you've made in terms of staffing or how the mortgage division is structured while rates have gone up and mortgage production has obviously come in, just as we think about like mortgage production increasing for the industry over time. Any change to your kind of participation in that?

Yes, it's an important question. I would tell you I'm incredibly proud of our residential mortgage leadership. They've demonstrated the ability to flex up and down on personnel as markets grow active or as markets decline. And so, we have a track record now of being able to make those adjustments and are certainly always prepared in a scenario like we're in now, to increase talent and increase focus on that area should we see the market start to come back to us. With respect to underwriting credit metrics, no changes at all. We continue to operate with an average FICO of right around 760, average loan-to-value of 73%, and the average of our first mortgage loans is right around $470,000. So again, a granular portfolio of high quality, and we're making no changes to our underwriting standards. If anything, in the last two years, we've tightened them somewhat. So what we're really speaking to is just again, what we're hearing from our bankers in the market, and this belief that psychologically, if we hit something with a five-handle, there could be some upside, and to the point that's already been made, that is not currently contemplated in our projections.

Yes, got it. Okay. I appreciate it. And if I could just sneak one more in, Aldis, on the back half of the year, margin guidance. Is that inclusive or exclusive of any rate cuts that might be in the forward curve? And then just more broadly, with the kind of position of the balance sheet today, would you expect really much of a fluctuation if rates do start to come down?

As I mentioned in the opening remarks, we are not anticipating any changes to the Fed rate. That said, we have structured our balance sheet to remain relatively neutral in response to rate movements. Ultimately, like most banks, we would prefer an upward-sloping yield curve, which would enhance our margins over time. While it is too early to make projections for 2025, we will provide our guidance later, and an upward-sloping yield curve would definitely be advantageous for our margins.

Yes, understood. Sorry for missing out in the prepared remarks, but thank you guys for taking the questions.

Yes, thank you.

We will take our next question from Andrew Leisch with Piper Sandler.

Good morning.

Good morning. Sorry to stick with the mortgage question for a bit, even though it's probably a ways out still, but will this be for portfolio growth or for gain on sale?

Both.

Got it.

Both sides of...

Got you. And then, Aldis, just correct me, just points of clarification here. It sounded like your lines of credit, maybe the utilization rate increased. Did I hear you correctly? And if I did, I mean, how is that trending so far this quarter?

Yes, it did increase and stabilized slightly. We had four consecutive quarters of decline, and the second quarter marked the first signs of stabilization. There was a small increase in the percentage points. We are still about 8 to 9 percentage points below our typical average line utilization. There is still a significant gap before our clients fully utilize their lines of credit. So far in July, there haven't been any noticeable trends in either direction based on what I discussed.

Got it. Very helpful. All my other questions have been asked and answered. Thanks so much.

Thank you.

Thanks.

Hi. Thanks, just one quick one. Good morning. This might be a tough question, but do you have any visibility on the BC impairments? From our perspective, how can we gauge this, aside from knowing that the segments may face challenges? Are there any forward-looking indicators we should monitor, or should we expect these to be inconsistent?

Yes. I think you're probably right, you know, and lumpy in terms of upside as well as down. This was downside. But, you know, we certainly have a mixed portfolio there. As you know, there are many banks that are exposed to fintech funds for one reason or another, and I would suspect more downward pressure until we start to see valuations and capital raises starting to make the turn. And I don't know, Aldis, is there anything else you would add to it? Again, I think from what we're seeing at a granular level, it'll be a mixed bag. I mean, when we see companies sell, there's upside if they're still building, and in a capital raise, there's downside. So if we look at it over the life of the portfolio, we still feel very good about it. In the interim, I think, as you described it, it's a bit lumpy. Aldis?

Yes. The last part really depends on the lifecycle of the company. We did see a few companies needing to raise capital in the second quarter, which led to our evaluation adjustments. Looking ahead, we are optimistic about the valuations in our portfolio as of now. However, the next round will determine if those valuations increase or decrease. I agree with Tim; we are generally confident about our portfolio.

Thanks, guys.

You bet.

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.

As always, thank you for joining us today. If you have any additional questions, do not hesitate to reach out to us. We hope you 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.