Apr 30, 2013
Executives
Tim Laney – President, Chief Executive Officer Frank Cahouet – Chairman Brian Lilly – Chief Financial Officer Rick Newfield – Chief Risk Officer. Don Gaiter – Head of M&A, Strategy,
Analysts
Paul Miller – FBR Capital Markets Ryan Nash – Goldman Sachs Chris McGratty – KBW Matt Olney – Stephens Peyton Green – Sterne Agee Gary Tenner – DA Davidson
Operator
Good morning, everyone, and welcome to the National Bank Holdings Corporation 2013 First Quarter Earnings Conference Call. My name is Candice, and I will be your operator for today.
At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session following the presentation.
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 statements regarding the Company’s loans and loan growth, deposits, strategic capital, potential income streams, gross margin, taxes, and non-interest expense.
Actual results could differ materially from those discussed today. These forward-looking statements are subject to risks and uncertainties, and they 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. It is now my pleasure to turn the call over and introduce National Bank Holdings Corporation’s President and Chief Executive Officer, Mr.
Tim Laney.
Tim Laney
Thank you, Candice. Well, good morning and thank you for joining our 2013 first quarter earnings call.
Today, I’m joined by our Chairman, Frank Cahouet, our Chief Financial Officer, Brian Lilly, our Chief Risk Officer, Rick Newfield, and our Head of M&A and Strategy, Don Gaiter. I need to share with you that Brian, has had a death in his family and he is joining our call remotely so please bear with us.
Turning to the first quarter, we realized solid organic growth during the period, growing loans to 11.4% annualized. As another reference point loan originations grew 32.7% over the same quarter a year ago.
More important, we did so while maintaining our prudent underwriting standards. Now, as a reminder, Rick Newfield is with us and he’s prepared to answer any questions that you might have during Q&A regarding our risk profile.
During the quarter, we grew our transaction accounts deposits, 4.8% annualized and we realized a 3-basis point improvement in total cost of deposits. Our non-interest expense totaled $47.9 million in the first quarter of 2013 compared to $53 million in the first quarter of 2012, a decrease of $6.4 million.
We have significant opportunity to improve our operating leverage both with continued revenue growth and expense reduction. Now, during the first quarter, we were engaged on a wide range of M&A activity, including work on potential whole bank cap positions, branch purchases and especially business acquisition opportunities.
Again, Don Gaiter is here and he’ll be providing an update on M&A activity following Brian. For now, I’ll turn the presentation over to Brian Lilly, for a more detailed review of the quarter.
Brian?
Brian Lilly
Thank you Tim and good morning everyone. We earned net income of $2.1 million in the first quarter, which equaled $0.04 per diluted share.
As you saw in our results, we continue to make progress in building the organic growth capabilities of our franchise or working out the non-strategic assets at attractive return. Within the loan portfolio, we are focused on two key objectives; the growth of the strategic loan outstanding, and the decrease of non-strategic loans while maximizing returns.
Strategic loans grew $31 million or 11% annualized through end of the quarter at $1.21 billion, and now comprise 65% of total loans outstanding. The increase was driven by organic loan growth, as we added loan fundings of $109 million.
The first quarter fundings represent a strong 33% increase over the prior year first quarter and a decrease in the fourth quarter. The linked quarter decrease is primarily attributable to the seasonality of some of the segments that we serve, segments such as agriculture, energy.
And consumers have historically been less active in the first quarter. We continue to attract talented bankers and the loan pipelines are building nicely.
We remain confident that we are making progress towards achieving our goals of $1 billion in annual originations. The credit quality of this strategic portfolio continues to be strong with only 0.6% of non-performing loans and is unchanged from the last quarter.
We continue to make steady progress exiting the non-strategic loan portfolio. These loans decreased $99 million or 56% annualized, and end the quarter at $612 million.
The key evidence points in the value pick-out from our workout efforts, is to continue quarterly accretable yield gains. The first quarter added $14.9 million in accretable yield transfers against only $0.3 million in loans hold impairment.
We’re very pleased with the balance between our organic growth and the results in pace of our problem credit resolution. We do foresee an inflection point, later this year or early 2014, whereby total loans will begin to grow.
Of course the economic landscape will have to be accommodative, but we feel very good about the change we now have in place and the moment that they are building. We continue to remain focused on organic growth as a key value creating strategy.
In terms of deposits, we have made progress with our strategy of growing transaction deposits, which averaged $2.4 billion in the first quarter growing 5% annualized over the fourth quarter and now represents 59% of total deposit. Quarter end time deposits decreased $96 million, due to our strategy of only retaining those acquired clients that we’re interested in developing a banking relationship inclusive of market rate time deposits.
I recall that we acquired problem banks that used high rate time deposits as a source of funding. We are pleased to be retaining approximately 70% of these balances with the most recent retention approaching 80%.
Our strategy is focused on client relationships that work to decrease our cost of deposits to 45 basis points in the first quarter and represented a 3 basis points improvement for the fourth quarter. Net interest income for the first quarter totaled $45.6 million and declined $4 million to the prior quarter.
The net interest margin there was 21 basis points to 3.88% and it was primarily driven by the decrease in non-strategic loans. Most of the non-strategic loans are accounted for in the 310-30 loan pools.
And as a group, these pools are yielding more than 10% annually. We expect to see continued downward pressure on the margin as we work out the non-strategic portfolio until we reach the inflection points of growing loans and deposits later this year to early next year.
Credit quality continues to trend favorably. As you know, we believe that it’s best to understand our credit quality and the provision for loan losses along the loan portfolios of 310-30 acquired loan pool accounting and all other loans labeled as non 310-30 loans.
We completed the quarterly re-measurement process with the 310-30 acquired loan pools and picked up net economic value of $14.6 million. The improved cash flows and forecasts of these loans resulted in favorable net transfer to accretable yields of $14.9 million, while only recoding to the provision for loan losses impairments of $23 million.
The favorable first quarter results spring to life to take net increase and the economic value of the 310-30 loans to $83.6 million. The non 310-30 loans also experienced positive credit quality trends.
These loans are primarily comprised of acquired non 310-30 loans, as well as all originated loans. Within this portfolio, the non-performing loans ratio declined to 3.6% from 4.0%, whereas the total past dues improved from 2.19% from 2.74% last quarter.
In addition, we’re very pleased that net annualized charge-offs for these loans were 44 basis points for the first quarter, reflecting continued good performance. The allowance for loan losses attributed to the non 310-30 loans was 1.04% as of March 31 and the provision for loan losses of $1.1 million covered net charge-offs and provided for new loan growth.
Excluding the FDIC related income non-interest income totaled $8.5 million and decreased $23 million compared to the fourth quarter. The decrease was driven by lower recoveries on assets, previously charged-off and lower service charges on deposits.
The largest part of the service charges decrease is seasonal. But we have implemented for order changes to comply our new standards and loss mitigation strategies that have lowered the number of lower draft currencies.
The impact of these initiatives was reflected in the first quarter results. Within the FDIC related income, we recorded an increase of $0.5 due to a $0.6 million favorable adjustment to the (inaudible) liability, as part of quarterly re-measurements of covered loans.
Operating expenses were down slightly quarter-to-quarter excluding the problem loan and OREO cost variances. Compensation related expenses increased as we reset the payroll taxes and incentive plans for 2013.
We did benefit in the quarterly comparison from our focus on lowering professional fees, decreasing these fees over $1 million from the fourth quarter. Total OREO and problem loan expenses decreased to $7 million in the quarter, and will continue to fluctuate going forward.
However we are seeing some stability in these costs that should benefit future periods. Capital ratios remained strong, improving slightly from the third quarter.
We ended the quarter with $400 million of strategic capital to deploy using a 10% leverage capital ratio. The tangible book value per share ended the quarter at $19.13, decreasing $0.04 from the end of the fourth quarter.
The primary driver of this decrease was the slightly higher yield curve as the fair value mark of the available for sale portfolio decreased equivalent of $0.08 per share from the end of the fourth quarter. That concludes my comments.
Now I’m going to turn it to Don Gaiter for an M&A update. Don?
Don Gaiter
Thank you, Brian, and good morning. The key part of our strategy is to deploy capital through acquisitions.
Our efforts have centered across four areas of opportunity. Whole-bank unassisted transactions, ranks divestitures, specialty businesses that will be complementary to our company by enhancing revenue through loan and/or fee generation and FDIC assisted transactions.
We have an active dialog across all areas except for FDIC transactions. The slowdown by the FDIC has been disappointing and we are not seeing activity in the pipeline for these types of transactions.
As we have stated before, our efforts are focused in transactions that will add market share in our primary markets of Colorado, Kansas and Missouri with an emphasis on the I25 quarter along the Front Range of Colorado from Colorado Springs to Denver and north into Fort Collins, and the I35 quarter from Kansas to Missouri and to the complementary market in Southern Iowa. We continue to see an attractive landscape with a full set of targets in our markets.
That includes a total of 92 institutions with a $110 billion of assets, including troubled institutions and banks with assets in the $500 million to $10 billion range. Our thesis for acquisition strategy remains very strong.
We have a significant set of targets. We have a limited number of active acquires in these markets, and we continue to find that our targets on the trust fund regulation, earnings headwinds and management fatigue.
We do however remain very disciplined both in terms of our diligent standards and our pricing standards. Our focus is to protect the quality of our balance sheet, while adding franchise value by structuring transactions that we believe will add to our market value.
We do remain optimistic that we will deploy capital to M&A given the present landscape, and are highly focused on actionable transactions. Let me now turn it back to Tim Laney.
Tim Laney
Thank you, Don. Candice, we are now clear to take questions.
Operator
(Operator Instructions) And your first question comes from Paul Miller with FBR Capital Markets. Your line is now open.
Paul Miller – FBR Capital Markets
Yeah. Thank you very much.
I think everybody understands the M&A side of it and how difficult it is out there. So I want to – and I’m sure you’re getting some more questions about, but I want to ask about your bankers.
How many – you said you’ve been able to check some good bankers, how many commercial lenders do you currently have and how many could you add over the quarter?
Tim Laney
Well, Paul, thank you for the question. This is Tim.
We have approximately 58 commercial bankers centered in our – and focused on our core markets of Kansas City and the State of Colorado, a smaller team and the markets of Dallas and Austin, Texas. We continue to top grade that set of bankers.
And this quarter, we brought in eight new bankers, we tend to source these bankers from what we believe are strong reputations with a focus on capturing the full relationship of the client and we are finding that we’re pulling bankers from institutions like Wells Fargo, Commerzbank in Kansas City and a number of other financial institutions in our landscape.
Paul Miller – FBR Capital Markets
And what’s the goal like if you don’t get any M&A done over the next couple quarters, what do you – what’s your goal with those commercial bankers, how big you want to grow that?
Tim Laney
It’s – our math works something like this. We are ramping up our focus on loans first.
We are ramping up to an average goal of loan production per banker of $15 million, $15 million a year per banker. So think of us at this point of really charging toward that $10 million point with an expectation that our full run rate over the next 24 months will be hitting that $15 million.
Of course, if you take that 58 number times, let’s call it $10 million, that’s $580 million of production a year. As a reminder, we have 101 branches or banking centers in our network and the goal for each of those our branches on an annual basis is $4 million in consumer and small business production.
That’s another $400 million. You put those together, and that’s what gives us to that $1 billion of annual production that the math tells us we need to offset the eventual runway on any accretable yield and push us toward that 1% return on assets.
Paul Miller – FBR Capital Markets
That was a very complete answer. I want to thank you very much.
You guys have a good day now.
Brian Lilly
Thank you, Paul.
Tim Laney
Thanks, Paul.
Operator
And your next question comes from Ryan Nash with Goldman Sachs. Your line is now open.
Ryan Nash – Goldman Sachs
Hey, good morning, guys.
Tim Laney
Hi, Ryan.
Brian Lilly
Hey, Ryan.
Ryan Nash – Goldman Sachs
Just as a follow-up on some of the things related to acquisitions, can you give us just a little bit more color on – I think it’s easy for us to understand the FDIC part of the equation, given that there has been a significant slowdown there. But we talked to – some of the quarters now about manager and other guys looking for exit strategy, I guess at this part what do you see as the biggest impediments to getting a deal done over the next couple of quarters?
Don Gaiter
Hey, Ryan. It’s Don Gaiter.
How are you?
Ryan Nash – Goldman Sachs
Good. How are you?
Don Gaiter
Well, as we’ve said it before, we’ve been very focused on across four channels. As you mentioned the FDIC has been disappointing to us.
I have to confess that the lack of activity there has been surprising to me given the number of banks that have elevated and chronically elevated taxes rate and the relatively low level capital. We have been very focused on whole-bank transactions, tax divestitures and specialty businesses and have had a very active pipeline there.
I would tell you that we’re very disciplined, we disciplined in terms of our diligence standards and our pricing standards and are really looking to enhance franchise values. So we have been very engaged and continue to do in our core markets.
Tim Laney
Brian, I would answer your question this way. This is Tim.
We’re still grappling our – we think some perspective sellers are grappling the fact that prior to going into this downturn and this troubled economic cycle, they were looking at stock prices of, let’s say, $30, $35 today, they are trading at a – we’re talking about a trade, call it, $1.25, $1.35 of tangible book, let’s say, that takes $11 on the other side. And there is still grappling with what they feel like they could absorb the company for pre-downturn and the pricing they’re seeing today.
Another factor that frankly, we grappled with is where we’ve had opportunities to make deals work is we looked at the reliability in the longer term earnings strength. For example, when we look at the dependence on something like mortgage revenue, we just simply couldn’t get comfortable with the transaction because we just didn’t feel like the transaction would deliver the ultimate long term EPS we needed in order to get comfortable with that type of acquisition.
And then, as we’ve all said, I think that’s a long way of saying that we’re still really working on that spread between the bid and the ask, and that’s where we believe patience will be rewarded. At the same time, I would expect this question how patient can you be, we’ve fancy ourselves as economic animals, we’ve approved – the board has approved $25 million payback, our buyback program thus far.
We’re more than prepared to increase that buyback if opportunity presents itself, but we’re not going to buy shares in at any price. We view ourselves as opportunistic and we will buy and shares where we believe it’ll be ultimately beneficial to long-term investors.
Ryan Nash – Goldman Sachs
Okay. And if I could ask a little bit of a different question.
I know in the release you guys talked about prudent underwriting standards and we’ve obviously heard from a lot of other banks that competition is accelerating at this point in time. And I guess I’d be interested to hear, I know you said that there was some seasonality that drove the lower quarter-over-quarter originations but I’d be interested to hear how much of the quarter-over-quarter declines do you think with seasonal versus how much is being driven by you guys stepping away from intensifying competition?
Rick Newfield
Sure. Ryan, this is Rick Newfield, so let me address that.
Let me talk a little bit about the seasonality as it relates to the mortgage business. So we know there is a steady increase in applications to the first quarter and the second quarter and actually saw those applications running at 400 during the month of March.
So we do expect that activity to pick up. As it relates to commercial, there is a cycle as you probably know around financial statement receipt, whether that’s coming from an external auditor which in many cases would be the situation or companies internally prepared.
So there simply is a timing. I would tell you that we’re not – it was not an issue in terms of competitive pressures rolling truly seasonality as we’re seeing more opportunities as we finish the month of March and heading into the second quarter.
Ryan Nash – Goldman Sachs
You may be mentioned on the consumer front what we’re seeing, continuing to see in terms of average FICO scores, one the value on the loan quality front there, then we can speak a little more to commercial as well?
Brian Lilly
Certainly and I’ll again. I guess that would be a segue to the consistency and the fact that we’re maintaining the discipline around our underwriting and structuring standards.
So with respect to residential and this may be helpful way to sort it, over 80% of our loans originated in the first quarter had FICOs of 760 or greater. I mentioned in the past calls that we’re averaging in the 750 range, but I think another useful way to look at simply the tranches or kind of have those segment out.
With respect to loan to value, over half of loan to values of 60% or less are continuing to see overall loan to values in the mid to upper 60s. That then comes maintaining wide with improved standards.
Tim Laney
And then on the commercial front, what – keep in mind, part of our thesis in moving into these markets is as we really did feel like we would ultimately be competing against more rational players. No better example than Kansas City where you have commerce and UMB and we respect both of those institutions.
We find them to be rational with their credit standards. I will tell you we’re seeing increasing pricing pressure on the best of the best deals and so that is, Ryan, the issue we grappled with in the middle market more than anything else.
Ryan Nash – Goldman Sachs
Great. Thanks for answering my questions.
Brian Lilly
Thank you.
Operator
And your next question comes from Chris McGratty with KBW. Your line is open.
Chris McGratty – KBW
Good morning, guys.
Tim Laney
Hi, Chris.
Chris McGratty – KBW
Hey, Tim. Can you speak to contingency plans?
Obviously, the acquisitions with everyone’s after today, it’s in seven or eight months since the IPO, it seems like FDIC aims no longer a viable option. Can you talk about your ability to get a deal done especially with the currency below book value?
Thanks.
Tim Laney
Yeah. Look, it is a bit of conundrum, right, it’s unfortunate that the stock is trading where that is.
We understand that having 400 plus million dollars of unlevered capital puts pressure on that stock price and we are very thoughtful in approaching the first acquisition that we intend to announce. We believe it’s got to be very solid in terms of the kind of financial return it will create for all of us as investors and we remain optimistic that we’re going to be able to demonstrate to the market that we put ourselves in a good area of the United States where there are more than enough opportunities to execute smart transactions.
Having said that, I’ll turn back to a point I made earlier which is while we’re not prepared to declare a date certain at which we would say, look, this landscape just doesn’t lend itself to small acquisitions, we’re conscious and the board is conscious of the fact that when that point comes we’ll be in a position to very thoughtfully buying shares and we believe that that can in its own way the – a very good move for our long term investors. Keep in mind another opportunity that presents itself is we have built an infrastructure to support a midsized bank.
To be clear, that is compliant with our deregulator to support an institution of $10 billion to $50 billion in assets. Should we find ourselves in a position not to execute on our acquisition strategy we would move to significantly reduce our operating infrastructure expense and right size our operations down to let’s call it a $5 to $6 billion community bank.
Chris McGratty – KBW
Okay. Just one more question on M&A, Tim.
The size, you, firstly and obviously we’re all looking for the first one. Is there a preferred size for your kind of first transaction, is it $0.5 billion, is it kind of a couple billion?
Any help would be great.
Tim Laney
Yeah. Why don’t, Don, I ask you to answer that.
Brian Lilly
Hey, Chris. So we – our true thought is really above that $1 billion level, that $1 billion to $2 billion.
Having said that, we are actively looking at transactions with $500 million. So that should give you an idea of the ranges here.
Chris McGratty – KBW
Okay. And then one last one.
On the expenses, maybe it’s one for Brian. How should we thinking about near term quarterly expense rates, obviously there is fluctuation in the workout costs.
But I think it was all-in about $48 million this quarter which is actually down in the quarter before. Can you help us on assuming no deal what we should be thinking about run rate expenses?
Thanks.
Brian Lilly
Okay. Chris, I think you’re right on, it’s carving out the OREO in the problem loan expense which will fluctuate.
The base should be pretty consistent as we look forward depending in the other actions of the management to take.
Chris McGratty – KBW
Great, thanks.
Operator
And your next question comes Matt Olney with Stephens. Your line is now open.
Matt Olney – Stephens
Hey, thanks. Good morning guys.
Tim Laney
Good morning.
Brian Lilly
Good morning.
Matt Olney – Stephens
Circling back on the M&A discussion. I think Don, one of the avenues you mentioned was acquiring some kind of specialty business that compliments the core bank.
Can you remind us what the ideal acquisition would like within this specialty business in terms of what type of business and what size?
Don Gaiter
Matt, happy to. Obviously, we build a lot of skill sets in our bank that can be levered through specialty businesses.
So we are looking at trades in the loan generation business. So it could be specialty finance, if you will, things like our asset-based lending, et cetera.
In addition to that, we are actively looking at few opportunities. And again, we are looking at a place there under consumer space as well as other unique opportunities.
And again, this will be leveraging the infrastructure that we built both from a risk management perspective, underwriting perspective, and the platform that we have.
Tim Laney
And Matt, this is Tim. I don’t want to get too far out over line skews, but I will tell you that we’re also looking at lifting out specialty teams and we believe we’ll be in a position to announce something on that front in the very near future.
Matt Olney – Stephens
Okay. That’s helpful.
And then circling back on the loan growth outlook, you’ve answered some good questions on this. A lot of your competitors are also making similar comments about 1Q just being very slow seasonally.
But some of your competitors are also making comments that the funding so far in April had picked up considerably from the first quarter levels. Can you give any commentary about what you’ve seen more recently over last few weeks in terms of the funding levels versus the first quarter?
Tim Laney
Our pipeline is stronger than it’s been in any point – short history of our company.
Matt Olney – Stephens
Okay. Thank you.
Tim Laney
Thank you, Matt.
Operator
And your next question comes from Peyton Green with Sterne Agee. Your line is now open.
Peyton Green – Sterne Agee
Hi, yes. I was just wondering Tim, why don’t you pick a good timeframe before we might see more active capital management because it makes clearly with $400 million of excess capital, there is plenty to do a combination with the M&A and recycling of the capital.
What’s the good timeframe to keep in mind for that?
Tim Laney
Yeah. So we’ve been frustrated with the current blackout period as we’ve watched recent pricing, we would have been buyers in the market.
We’ve targeted a price at which we would buy below and if we see that pricing once we come out of this earnings release blackout, we will be entering the market.
Peyton Green – Sterne Agee
Okay. And is there – how would you ballpark the expense base that you’re keeping in place to run a bigger company given the opportunity of the – the coming M&A cycle?
Brian Lilly
I think – hey, Peyton, this is Brian. As you – I think as we’ve related you a couple of times and tried to convey you through these conversations, we’re very encouraged and excited about the current pipeline and that is what we are really, really after.
We have a unique opportunity to build something special here. So before we give up the opportunities, we really want to play those out.
And so as we share it, I think it’s still early to put any type of timeframe on that and know that we believe strongly in the quality of the pipeline that we have, and it’s taken time. But once it happens in hindsight, that’s a short period of time.
So that’s what we’re really after.
Peyton Green – Sterne Agee
Okay. So I mean do you think 18 to 24 months is a reasonable amount of time?
Tim Laney
I’m not putting any timeframe on it but I think we are having those discussions actively and as we shared, it’s been the good jobs here sharing with you, we have options and we are assessing those options and the quality of those options as we move forward.
Peyton Green – Sterne Agee
Okay. Great.
Tim Laney
And Brian I can’t help myself, but 18 to 24 months sounds like a lifetime to me, I don’t know if I have that much of time left.
Brian Lilly
That’s fun.
Peyton Green – Sterne Agee
Okay. Fair enough.
I appreciate the color.
Operator
(Operator Instructions) Your next question comes from Gary Tenner with DA Davidson. Your line is now open.
Gary Tenner – DA Davidson
Thanks. Good morning, guys.
Tim Laney
Hi, Gary.
Brian Lilly
Hi, Gary.
Gary Tenner – DA Davidson
My questions have generally been answered. Just in terms of the 58 relationship managers you have on staff right now, can you just tell us how many have been there, say, for more than six months versus less than six months?
Tim Laney
Well, I think we will measure that, Gary. It’s that we’ve got currently about 33 of those, our need of the organization in the last couple of years and a number of those were still working through.
But you can see in total that’s quite a turn over, and that’s what makes us exciting is that in the last number of quarters, number of those bankers have come on board with their pipelines filling up and you can see as Tim mentioned the pipelines the best, not the biggest, and the best quality we’ve ever had, and it gives us encouraging feelings going forward.
Gary Tenner – DA Davidson
Can you quantify where the pipeline was at March 3rd when compared to say, year-end?
Tim Laney
We quantified on revenues and other pieces and it’s not consistent with where the – some other companies I’ve seen talk about it. So we captured internally.
I think you’ll see it in the results as we go forward.
Gary Tenner – DA Davidson
All right, guys. Thank you.
Operator
And we have no further questions at this time.
Tim Laney
Well, very well, Candice. Thank you.
And thank you for joining us and thank you for your interest in National Bank Holdings. Having a nice day.
Operator
And this concludes today’s conference call. You may now disconnect.
If you would like to listen to the telephone replay of this call, it will be available beginning in approximately two hours, and run through May 14, by dialing 855-859-2056 or 404-537-3406 and using conference ID of 33675559. The earnings release and an online replay of this call will also be available on the company’s website by visiting Investor Relations area.
Thank you very much, and have a great day.