National Bank Holdings Corp annual report, FY2018

National Bank Holdings Corporation — FY 2018 Form 10-K

Reporting period: Fiscal year ended December 31, 2018. The filing is an annual report; fourth-quarter figures are identified separately where available. NBHC is a bank holding company operating through NBH Bank, with 104 banking centers and online and mobile services. Its principal markets are Colorado and the greater Kansas City region, with operations also in New Mexico and Texas. The company completed its acquisition of Peoples, Inc. on January 1, 2018.

Financial performance and position

Metric	FY 2018 / Dec. 31, 2018	FY 2017 / Dec. 31, 2017
Total assets	$5.68 billion	$4.84 billion
Total loans	$4.09 billion	$3.18 billion
Total deposits	$4.54 billion	$3.98 billion
Net interest income	$197.4 million; $201.9 million FTE	$146.3 million; $152.2 million FTE
Non-interest income	$70.8 million	$39.2 million
Net income	$61.5 million; $1.95 diluted EPS	$14.6 million; $0.53 diluted EPS
Net interest margin	3.85%; 3.93% FTE	3.36%; 3.50% FTE
Efficiency ratio	69.78%; 68.64% FTE	70.80%; 68.63% FTE
Shareholders’ equity	$695.0 million	$532.4 million

Profitability: Return on average assets was 1.10%, versus 0.31%; return on average equity was 9.28%, versus 2.67%. Management reported adjusted net income of $67.8 million, or $2.16 diluted EPS, excluding $6.3 million after-tax acquisition costs. These are non-GAAP measures.
Cash flow: Operating activities provided $73.6 million; investing activities used $102.0 million; financing activities used $109.4 million. Cash and cash equivalents ended the year at $109.6 million, down from $257.4 million.
Asset quality: Provision for loan losses was $5.2 million, compared with $13.0 million. Net charge-offs were 0.02% of average loans, versus 0.36%; non-performing loans were 0.60% of loans, versus 0.66%. The allowance was $35.7 million, or 0.87% of loans.
Funding and liquidity: Transaction deposits were 76.2% of deposits, up from 71.9%; the loan-to-deposit ratio rose to 90.23% from 80.00%. Management reported $683.2 million of on-balance-sheet liquidity, including cash and unencumbered securities, compared with $858.2 million a year earlier. It stated that available sources were expected to provide adequate liquidity for at least 12 months.
Borrowings: At year-end, FHLB advances were $301.7 million, including $234.3 million in line-of-credit advances, and repurchase-agreement borrowings were $66.0 million. FHLB credit availability was $1.1 billion, of which $301.7 million was used.
Capital: Consolidated Tier 1 leverage was 10.5%, common equity Tier 1 was 12.9%, and total risk-based capital was 13.8%. NBH Bank also exceeded applicable well-capitalized thresholds. Tangible common equity to tangible assets was 10.39% (non-GAAP).
Dividends: Cash dividends were $0.54 per share for 2018, compared with $0.34 in 2017. The board declared a $0.17 quarterly dividend in January 2019.

Material changes versus the prior comparable period

Net income increased to $61.5 million from $14.6 million. The comparison is affected by the 2017 $18.5 million non-cash deferred-tax-asset remeasurement charge and 2018 Peoples acquisition costs of $8.0 million pretax. Reported 2018 income tax expense was $12.2 million, versus $21.3 million in 2017.
Peoples added approximately $875 million of assets, $543 million of loans and $730 million of deposits at acquisition. Consideration was $146.4 million, comprising $110.2 million in NBHC stock and $36.2 million in cash. The acquisition added $55.4 million of goodwill and expanded the mortgage business.
Loans grew 28.7%, deposits 14.0%, and assets 17.2% year over year. NBHC originated a record $1.2 billion of loans; commercial and industrial originations were $693.4 million.
FTE net interest income increased 32.7%, reflecting the acquisition, loan growth, higher originated-loan yields and rising short-term rates. The FTE margin widened 0.43 percentage points; deposit costs increased as well.
Non-interest income rose 80.5%, primarily because mortgage banking income increased by $28.0 million after the Peoples mortgage business was added. Non-interest expense rose 38.5%, primarily due to the acquired operations and $8.0 million of acquisition costs.
Year-end cash fell as cash held for the acquisition was used and loan growth was funded. FHLB advances increased $172.5 million from year-end 2017 to fund originations.

Outlook, commentary, risks and unusual items

Management emphasized continued organic loan and deposit growth, relationship banking, fee-income development and operating efficiencies, with selective acquisitions as a possible part of the strategy. It announced expansion into Utah in January 2019, focused on commercial and business banking along Salt Lake City’s Wasatch Front. The filing provides no specific earnings, revenue or margin guidance.
Management said continued interest-income growth depends on originating sufficient high-quality loans to replace runoff in acquired, higher-yielding loan portfolios. The remaining accretable yield and fair-value mark on loans was $44.6 million at year-end, down from $48.3 million.
Management described credit quality as strong but identified real-estate values, economic conditions and agriculture as relevant exposures. Food and agriculture loans were 5.4% of total loans; management noted depressed commodity prices and described the portfolio as diversified.
Interest-rate sensitivity modeling indicated an asset-sensitive position: a modeled immediate, sustained 200-basis-point increase would raise projected net interest income 5.86%, while a 100-basis-point decrease would reduce it 4.84%. These are model estimates, not forecasts; actual results may differ.
Key risks include credit and collateral deterioration; deposit competition and liquidity needs; interest-rate changes; acquisition integration and goodwill; mortgage loan repurchase and servicing obligations; regulatory and capital requirements; cyber and third-party technology risks; and competition from banks and financial technology providers. The filing also notes potential impacts from government shutdowns on SBA and FHA-related activities.
Unfunded loan commitments and lines of credit totaled $773.5 million, with $10.6 million of standby letters of credit. A mortgage repurchase reserve of $3.4 million was recorded. Management did not anticipate material losses from commitments and reported no litigation expected to have a material adverse effect.
Implementation of the new lease standard on January 1, 2019 was expected to add $32.6 million of right-of-use assets and lease liabilities, with a $0.3 million adjustment to opening retained earnings. The expected impact of the CECL credit-loss standard, scheduled for adoption in 2020, was still under evaluation and was not quantified.
The independent auditor issued an unqualified opinion on the financial statements and internal controls. Management and the auditor concluded internal control over financial reporting was effective as of December 31, 2018.

Important facts for investors to verify

How much of earnings growth and revenue depends on Peoples, mortgage banking activity, purchase-accounting accretion and other items that may not recur?
Can organic loan growth and low-cost deposit gathering sustain margins as acquired high-yield loans run off and deposit costs rise?
How will the higher loan-to-deposit ratio, reduced cash balance and $685.4 million of time deposits maturing within 12 months affect funding costs and liquidity?
Do allowance levels and reported non-performing-loan measures adequately reflect underlying credit risk, including acquired-loan accounting and commercial real-estate exposure?
What will the eventual CECL adoption do to the allowance, earnings and regulatory capital, and will lease-standard adoption match management’s estimate?
Can the Peoples integration and Utah expansion deliver expected growth without materially increasing operating costs, execution risk or capital needs?