Earnings Call Transcript - NBHC Q3 2020

Operator, Operator

Good morning, everyone, and welcome to the National Bank Holdings Corporation 2020 Third Quarter Earnings Call. My name is Mariama, 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, allowances, 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 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.

Tim Laney, CEO

Thank you, Mariama. Good morning, and thank you for joining National Bank Holdings third quarter 2020 earnings call. I have with me our Chief Financial Officer, Aldis Birkans; and Rick Newfield, our Chief Risk Management Officer. I’m pleased to share with you that despite pandemic-related challenges, we delivered record earnings during the third quarter on the strength of record-breaking fee income. We continued to maintain a risk-off position on our balance sheet with the goal of being well-prepared to address any further economic downturns should they occur. Having said this, we clearly benefit from operating in markets that are performing better than most of the country. The diversity and granularity of our credit portfolio continues to produce solid results with annualized net charge-offs of just 4 basis points. In fact, we have experienced continued improvement across a broad set of credit metrics during the quarter. While growth in deposit balances has practically been a given during these times, I’m particularly pleased with the growth in new treasury management relationships we’ve experienced. Finally, we continue to prudently support our clients and communities. And we’re proud to have recently been named Colorado’s 2020 Job Creation Bank of the Year by the Small Business Administration. And on that note, Rick, I’ll hand off the call to you.

Rick Newfield, Chief Risk Management Officer

Thank you, Tim, and good morning, everyone. I’ll cover three areas in my comments. First, I’ll briefly summarize our third quarter credit metrics and performance. Second, I’ll discuss the status of our COVID-related modifications. And third, I’ll describe the actions we continue to take to reduce risk on our balance sheet while working to prudently support our clients. With respect to our credit metrics, trends held up well during the quarter. I’ll note that the asset quality ratios I’m about to cover exclude the Paycheck Protection Program loans, thereby showing a more conservative view of asset quality. While our non-accrual loans decreased during the quarter, a corresponding decrease in loan balances led to our non-accrual ratio remaining flat at 0.45%. Our criticized loans also decreased during the quarter. Our total non-performing asset ratio improved from 0.6% at June 30 to 0.56% as we not only experienced a decrease in non-accrual loans but had meaningful reductions in OREO during the quarter. 30-day plus past dues remained very low at 16 basis points. And net charge-offs for the quarter were only $486,000 or 4 basis points annualized. The stable credit trends reflect our conservative underwriting standards and our enhanced loan portfolio management as the pandemic and economic stress continue. As Tim said, I believe being in markets which have generally fared better with the pandemic is evidenced by unemployment levels lower than national averages, which are also favorably impacting our loan book and underlying clients. During the third quarter, loan modifications declined by $327 million to $165 million or 3.9% of our total loans, excluding PPP exposure. It’s important to point out that 95% of these modifications still require monthly interest payments versus full payment deferrals. Regarding any second modifications we have extended to clients, those have generally been predicated on receiving cash equity infusions to build reserve accounts, loan pricing considerations, and more restrictive loan covenants. The vast majority of our clients have stabilized revenue and expenses at sufficient levels to cover debt service to contractual levels. In fact, outside of our hotel loans, we have COVID modifications in place for less than 1% of our loans. As a reminder, back in June, we began working with our hotel clients on a conservatively forecasted path to sufficient occupancy and average daily rates to represent restabilization. Based on any operating deficits and ongoing interest-only loan payments, each client was required to infuse additional cash equity and agree to certain additional loan terms. To date, we’ve successfully negotiated such agreements with the majority of our hotel clients. We benefit from our conservative underwriting of this portfolio and are further protected by an average loan-to-value of 58%. Given the additional equity infusions and other enhancements to our loan structures, I believe our hotel exposure is well-positioned to weather the protracted stress from the pandemic. Tim, my banking teams and I continued our intensified portfolio management during the third quarter and are maintaining this robust vigilance currently. To put this effort in perspective, on a weekly basis, we’re reviewing all commercial and specialty banking clients and business banking clients with larger credit exposures or within high-risk sectors. During these reviews, we assess each client’s current weekly revenue versus revenue levels required to cover the clients’ expenses and full contractual debt payments. We discuss operating status to the extent impacted by pandemic-driven jurisdiction mandated restrictions, as well as weekly and trailing 4-week trends. This enables us to quickly detect credit deterioration and take action proactively where needed as we continue a risk-off approach to our loan portfolio. Given the pandemic’s continuing impact, it’s noteworthy where we have no direct exposure: aviation, cruise lines, malls, energy services, casinos, gaming, convention centers, and hedge funds. We have no dealer floor plan, no indirect auto, no car leasing, and no consumer credit card exposure. I believe maintaining a diverse granular loan portfolio is a strength. Also, we’ve conducted twice-a-year stress tests on our commercial loan book. The most recent of those tests was completed in June by an outside party, with a focus on lingering impact and stress from the COVID-19 pandemic and an elongated path to recovery over the coming years. In the most severe scenario modeled, which assumes a weak L-shaped recovery, we remain very well capitalized. Given the risk that commercial real estate, particularly office and retail, will experience further pressure, I’ll also point out that non-owner-occupied commercial real estate is only 15% of our total loan portfolio, excluding PPP loans. Furthermore, it is only 85% of our risk-based capital. And what we have is conservatively underwritten relative to loan-to-cost, loan-to-value, and other key metrics. We’re well-diversified across industry sectors with most industry concentrations at 5% or less of total loans, and all concentration levels remain well below our self-imposed limits. And with that, I’ll turn the call over to Aldis.

Aldis Birkans, CFO

Thank you, Rick, and good morning. In my remarks, I will review this quarter’s financial performance, which once again highlights the strength and resiliency of our bank. Also, during this call, I tend to provide limited guidance for the rest of the year with the recognition that we are still facing a great deal of economic uncertainty. As Tim shared with you, for the third quarter, we reported record quarterly net income of $27.9 million or $0.90 per diluted share. After adjusting for the previously announced banking center consolidation expense, the third quarter’s adjusted EPS was $0.91, a $0.29 increase from the prior quarter’s adjusted results. This quarter’s FTE pretax pre-provision net revenue totaled a record $37.2 million as we took advantage of favorable mortgage market conditions, which more than offset the headwinds resulting from the zero rate environment. The third quarter’s new loan production reflects our careful approach to evaluating and taking on new credit risk. As we continue to operate in a risk-off mode, the new loan fundings this quarter were $132.9 million, which combined with careful client management in regards to credit and yield, resulted in a total loan balance decrease of $226.3 million during the quarter. Moving to deposits, we continue to see strong deposit inflows from both our existing clients as well as newly opened accounts. Our average transaction deposit balances grew a very strong $316.6 million or 30.3% annualized. Total deposits grew $306.8 million or 23.4% annualized. And total deposit cost decreased 7 basis points to 40 basis points this quarter. The continued deposit growth contributed to a solid 12.3% annualized increase in our average earning assets. However, the earning asset mix this quarter moved towards lower yielding cash and investment securities, which resulted in the fully taxable equivalent net interest margin decreasing to 3.21%. We estimate approximately 13 basis points of the contraction this quarter was due to the excess cash balances. And given the lack of attractive investment alternatives, we expect the elevated cash position to remain through at least the end of 2020. Rick already provided a detailed summary of our credit trends, so I will just touch on the provision expense and allowance this quarter. As a reminder, our CECL model incorporates Moody’s macroeconomic forecast, and the impact of the forecast changes this quarter did not result in material changes in the allowance requirement. As such, this quarter’s provision expense totaled $1.2 million and included coverage for the quarter’s net charge-offs of just $486,000 and unfunded loan commitment provision expense of $200,000. We finished the quarter with an ACL to total loan ratio, excluding PPP loans of 1.45%. Factoring in existing loan marks against previously acquired loans, it takes our loan loss coverage to 1.75%. Turning to fees, our residential mortgage group had another strong quarter with both elevated loan originations and strong gain on sales spreads. During the third quarter, we realized record non-interest income of $44.5 million, which was $5.7 million or 14.7% higher than the prior quarter. And while we benefited from strong mortgage market activity, I’m also pleased to report that our core banking fees are showing signs of recovery after being significantly impacted by the pandemic-related economic slowdown. Service charges and bank card fees grew on a linked-quarter basis, and the bank card fees this quarter exceeded the prior year’s third quarter revenue by 7.6%. With respect to mortgage loan production this quarter, it was another all-time high for the Company with $752 million in loan origination, or an increase of 55% from the same quarter last year. $323 million or 42.9% of this quarter’s production was in the purchase market as we continued to benefit from operating in strong local economies. During the quarter, we were also able to maintain elevated gain on sale margins, as both primary and secondary spreads remain wide. Going into the fourth quarter, we expect some of that margin to come down as the purchase lines decline, given the typical seasonal slowdown during the winter months. As we discussed during last quarter’s call, we are taking several actions this year to manage expenses. And I’m happy to report that the banking center consolidation efforts announced last quarter are progressing smoothly, and we expect virtually all 12 banking centers to be successfully absorbed within the rest of our network by the end of the fourth quarter. As part of this transition, during the quarter, we realized $400,000 in consolidation-related expenses, compared to $1.7 million of such expense in the second quarter. Total non-interest expense this quarter was $55.3 million, an increase of $1.6 million from the prior quarter. Adjusting for the banking center consolidations, the linked quarter expense increase was primarily driven by the variable compensation related to the strong mortgage banking activity. Finally, during the quarter, we once again improved our regulatory capital and liquidity positions. Our CET1 ratio increased 104 basis points to 14.25%, and we grew our tangible book value to $22.4. Our loan-to-deposit ratio improved to 81.1%, and our excess cash position at quarter end was approximately $400 million. We believe we are very well-positioned to weather any further downturns in the economy. Tim, with this, I will turn it back to you.

Tim Laney, CEO

Thank you, Aldis. As Aldis pointed out, we believe that our strong common equity Tier 1 ratio of 14.25% enables the bank to navigate this challenging economy from a position of strength. We remain flexible and opportunistic with a focus on delivering our dividend while growing our tangible book value and delivering a solid return on tangible common equity. Risk management policies and practices are producing desirable results, and our residential banking business continues to be an effective hedge against lower yields on the loan book. I’m very proud of my teammates’ efforts to support our clients and communities while working to deliver solid results for our investors. Mariama, we’re ready to open up the call for questions.

Operator, Operator

Thank you. Your first question comes from Jeff Rulis with D.A. Davidson. Your line is open.

Tim Laney, CEO

Good morning, Jeff.

Jeff Rulis, Analyst

Good morning, Tim. I'd like to start with a question regarding the local situation, particularly in Colorado. Considering the wildfires, which are mostly north of Denver, and the increase in COVID cases, there's a possibility of a delay in reopening or a slowdown. Given these challenges and the overall positive long-term demographic trends in the west, could you share your thoughts on the potential short-term impacts of these issues over the next few quarters?

Tim Laney, CEO

Not unlike most states in the United States, we’ve seen an ebb and flow in terms of the rise and fall of COVID rates. And I think your broader observation is what’s important. We’re seeing on a month-by-month, week-by-week basis a very positive net inflow, not only into Colorado, one of our core markets, but we’re seeing the same thing in Utah, as well as in the Dallas and Austin markets where we’re operating. So, while I’m not ready to speak to where, let’s say, COVID infection rates may be reported week-to-week, what I can tell you is the fundamental positive impact is that we operate in markets that opened up more than certainly the coastal markets in the United States. So, we’ve benefited from the more back-to-business attitude there. At the same time, COVID rates have been manageable, and we’re certainly benefiting from this inflow of new residents that continues to be very powerful.

Jeff Rulis, Analyst

Tim, you've adopted a cautious approach over the past few quarters regarding your risk commentary. As we move into 2021, do you have any insights on what might trigger a shift towards a risk-on or even a risk-neutral stance in the market? There's certainly a lot that could unfold, but I would like to hear your thoughts on how growth may return and what could influence that.

Tim Laney, CEO

It’s really a great question. And I’m reminded of that answer that someone once gave on some topic where they said, I’m not sure I can explain it, but I’ll tell you, I’ll know it when I see it. And it feels that way. I’ll tell you where we’re cautious. And it doesn’t have much to do with the markets that we do business in, but it’s a broader macro question. And that is if corporate America continues to announce these larger, call it, white-collar job layoffs, the question is what impact does that ultimately have on the economy in 2021? And while we, like most people, want to be very optimistic and celebrate a return to solid growth rates, we’re going to be cautious. We feel like that’s our job, and we’ll continue to protect the balance sheet. Now, here’s the good news. Given the markets we’re operating in, our bankers are active, our bankers are back out in the market, and we’re seeing a nice growth in opportunity. I would just simply say that the filters, the added filters we’ve put in place as it relates to bringing new clients into the bank are greater. And will that come to a close at the end of the fourth quarter of this year, at the end of the first quarter next year? I can’t really answer that question today. I think, we’ll know, all of us, all of us will know more as time goes by here. But very good question. And that’s the way we think about it.

Jeff Rulis, Analyst

Got it. Maybe just the last one for Aldis, and it’s kind of two-part, and maybe not super specific. But, I’m trying to mesh the outlook for fee income and expenses, and obviously, mortgage has a lot to do with that. I appreciate your commentary about what you think margins do in the fourth quarter. But, we extend into ‘21, you’ve had your branch consolidations that have kind of filtered in. I guess, the thoughts of what you’ve done on the expense side, the variable inputs from the mortgage units, I don’t know if it’s run rate specific. I think you’ve kind of pulled back guidance of those specifics given the environment. But, anything you could point us to on the fee and expense side would be helpful.

Aldis Birkans, CFO

I’ll begin with the expenses. This quarter, we experienced elevated expenses due to the variable compensation tied to our record earnings from the mortgage sector, which we view positively. We are benefiting from the higher spreads in that market, although the relationship between variable compensation related to mortgages and revenue is somewhat skewed, impacting our efficiency ratio. If you compare the line items from this year’s third quarter to last year’s, you’ll see that we managed to keep all other expenses under control, except for salaries and benefits, which reflects our ongoing focus on expense management. Going forward, we intend to maintain this effort. The consolidation of our 12 banking centers is a prime example of this strategy, and we anticipate seeing the benefits of these closures starting next year. Regarding mortgage compensation and its impact on salary expenses, typically, for every dollar of gain on sale we report, about 40% would flow into salaries and benefits. However, due to the current elevated margins, that figure has decreased to 30%. This should give you some insight into our approach. Moving on to fees, I’m excited to see our core banking fees returning to more normalized levels. While our service charges and analysis fees are increasing, the fee line item that remains below expectations is not overdraft fees, which is understandable given the high deposit balances, so we're not overly concerned about that. Bank card fees showed strong performance in the third quarter and are likely to continue in the fourth quarter. As for mortgages, we've benefited from this area, serving as a good hedge for margins as we move into the winter months. However, we do anticipate a slowdown in the fourth quarter. We’re beginning to notice this trend already in October, although it’s tough to quantify how much. Our guidance is aligned with what the MBA suggests, indicating that we can expect about 25% to 35% higher volumes this fourth quarter compared to last year, which should serve as a useful benchmark for that line item.

Tim Laney, CEO

I’ve just got to come back and say on expenses that we’re going to continue to work to realize additional expense reductions in our Company. We have a track record for doing that, pandemic or not. That’s a focus, and it will continue to be a focus. And as it relates to our margin, I still believe we’ve got room at 40 basis points of cost on deposits to continue to bring our deposit costs down as well, particularly as they continue to grow at the rates we’re experiencing.

Operator, Operator

Your next question comes from Andrew Liesch with Piper Sandler. Your line is open.

Andrew Liesch, Analyst

Just looking at the mortgage line. If you look at where the pipeline stands right now and the capacity that you guys have to move it through the pipeline and do the refis and approved purchases. I mean, how stressed are your employees? I mean, are you having to push out and maybe delay some of the production until the first quarter? Just kind of curious like where this pipeline stands, how busy your folks are? And if we could continue to see big refi volumes going into the next year?

Tim Laney, CEO

I believe we will continue to see new homeowner acquisition alongside refinancing, especially with the influx of new customers in our markets. To answer your question directly, yes, I am extremely proud of our team in this area. They have been working tirelessly and have shown strong leadership. Our focus has been on helping people achieve the dream of homeownership, which is incredibly impactful. I couldn't be prouder of our mortgage bankers. When I look at what our teams are doing behind the scenes, it exceeds expectations. We are exploring various ways to reward and recognize our teammates, who are ready for the challenge. As the saying goes, we understand the importance of capitalizing on opportunities while they arise. That reflects our mindset.

Andrew Liesch, Analyst

Understood, makes sense. On the credit front, there are positive trends regarding non-performers and charge-offs. With loans declining, this supports the lower provision along with a risk-off mentality. I realize that much of the provisioning and reserves is influenced by CECL. However, do you have any expectations on where the provision might come in until you potentially return to a risk-neutral stance?

Aldis Birkans, CFO

I’ll start. This is Aldis. I’ll say that given where the Moody’s outlook is, we certainly did not have to record the huge provision expense this quarter. The model actually showed to be adequately reserved. And currently, that’s very difficult to answer where the future will be. It will be driven by really two points, right, where the economic developments go and the future outlook for it because if there is another W type of path, certainly you could see further pressure to build ACL. That’s one. And secondly, the loan growth and/or mix of the loans will drive that quite a bit too.

Tim Laney, CEO

And I would just add, again, when you factor in existing loan marks against previously acquired loans, it does take our loan coverage to 1.75%. Some might argue, given performance of the portfolio, that’s high. But I would rather be in a position of maintaining a high level of reserve while we wait to have more of these questions answered around the economy and be in a position where the model was telling us to release later than to do something prematurely. And we’re certainly not, in any way, shape, or form, going to be pressing on the model to try to create early releases. That’s just not our game plan.

Rick Newfield, Chief Risk Management Officer

And Andrew, this is Rick. Just to add quickly, I've mentioned this a couple of times. Due to the uncertainty in the economy that we've discussed, we are being diligent with our existing loan book to be proactive. I think this, along with what Aldis mentioned regarding the Moody’s forecast, will significantly influence our view on CECL.

Operator, Operator

Your next question comes from Chris McGratty with KBW.

Kelly Motta, Analyst

This is actually Kelly Motta on for Chris. Hi. I was hoping to ask this question on capital. You obviously built a lot of capital this quarter. And kind of in a high-cost problem that you probably will continue to build, all else equal. As you look to next year, and as the issue becomes clearer, how are you speaking about deploying your strong capital base? And if you could also perhaps comment on M&A and what it would take to get that market kind of up and going again, that would be great.

Rick Newfield, Chief Risk Management Officer

Thank you, Kelly. We didn’t anticipate the rapid capital accumulation we've achieved, especially during a year challenged by the pandemic. Having our tangible book value at $22.40 per share is quite interesting. Let me explain further. First, we are committed to protecting our dividend during these times, which is a top priority. Second, it’s crucial for us to maintain a robust position in the market by supporting our reserves and ensuring a strong balance sheet to manage any potential market impacts. Regarding mergers and acquisitions, we believe there will be some intriguing tactical opportunities in the next 18 months to enhance our presence in our current markets. We will pursue these opportunities when we are confident in assessing the risks associated with the portfolios we would acquire and in accurately valuing them. Consistent with our acquisition history, we aim for transactions that are mutually beneficial, where any impact on tangible book value would be manageable. Lastly, if bank stock prices, including our own, experience another decline, we have an authorized buyback. We don't anticipate any regulatory issues with repurchasing shares, and I see no better acquisition than buying back our own shares at specific price points. This option is certainly on the table as we consider how to use our capital.

Operator, Operator

Your next question comes from Andrew Liesch with Piper Sandler. Your line is open.

Andrew Liesch, Analyst

Thank you for the follow-up. Do you have any expectations regarding the timing of PPP forgiveness and the fees that have yet to impact the margin?

Tim Laney, CEO

Yes. I’ll start and then hand it off to Rick. It’s been interesting. We’ve heard that there are some banks operating with this mindset of carrying those balances of maintaining those balances on their balance sheet. I don’t know if that’s for optical reasons or other reasons. But our approach is to position ourselves to clear as many of those PPP loans off our balance sheet as rapidly as possible with the idea of driving yield or return on those loans as high as possible. Obviously, that means working with our clients. The good news is Rick is in a position to give you some detailed stats on where we’re at on all of that. And we’re feeling good about our progress. So, with that high level, Rick, I’ll turn it to you for some details.

Rick Newfield, Chief Risk Management Officer

Yes. Sure, Tim. So, Andrew, maybe a couple of additional facts there. So, as Tim said, our banking teams have been working very diligently with our clients to get the applications in and execute on the forgiveness, which ultimately means loading all that into the SBA portal. In terms of where we stand as of end of day last Friday, and this is a daily sort of progress for us. We had uploaded a total of $145 million of PPP loan forgiveness applications. That’s about 40% of our total PPP balances. Our focus, just given the potential for changes in the under $150,000 loan processing has been on the larger loans, and we’ve processed 61% of those loans greater than $150,000. So, some really good progress that we’ve made over the last several weeks, particularly given that, as I’m sure you know, we’ve only had the rules for forgiveness laid out here in the last couple of weeks. So, we feel like we’re off to a solid start.

Operator, Operator

Thank you. 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.

Tim Laney, CEO

Thank you, Mariama. I will just thank you for your interest and wish you all a good day. Thank you.

Operator, Operator

And this concludes today’s conference call. If you would like to listen to the telephone replay of this call, it will be available beginning in approximately two hours and will run through November 4, 2020, by dialing 855-859-2056 or 404-537-3406, and referencing the conference ID of 2471788. The earnings release and an online replay of this call will also be available on the Company’s website on the Investor Relations page. Thank you very much. And have a great day. You may now disconnect.