National Bank Holdings Corp quarterly report, Q3 FY2018

Business context and reporting period

National Bank Holdings Corporation (NBHC), a bank holding company operating through NBH Bank, filed this unaudited Form 10-Q for the quarter ended September 30, 2018. It serves commercial and consumer clients primarily in Colorado and the greater Kansas City region. On January 1, 2018, NBHC acquired Peoples, adding 20 banking centers and approximately $842 million in assets, $543 million in loans and $730 million in deposits. Comparisons with 2017 are therefore affected by the acquisition and are not purely organic.

Financial results and condition

Metric	Q3 2018	Q3 2017	Nine months 2018	Nine months 2017
Net interest income	$49.8 million	$37.9 million	$146.8 million	$109.5 million
Provision for loan losses	$0.8 million	$3.9 million	$2.7 million	$9.7 million
Non-interest income	$18.1 million	$9.6 million	$55.5 million	$30.2 million
Non-interest expense	$44.4 million	$34.6 million	$146.5 million	$102.7 million
Net income	$18.2 million	$7.2 million	$44.2 million	$24.7 million
Diluted EPS	$0.58	$0.26	$1.41	$0.89

Net interest margin on a fully taxable equivalent basis was 3.96% in Q3 and 3.92% for the first nine months, up from 3.60% and 3.53%, respectively, in 2017. The nine-month FTE net interest income was $150.1 million, up 32.0%.
Nine-month results included $8.0 million of pre-tax Peoples acquisition costs ($6.3 million after tax). Management’s non-GAAP adjusted net income was $50.5 million, or $1.61 diluted EPS, excluding those costs; these adjusted figures are not GAAP results.
Total assets were $5.59 billion at September 30, up from $4.84 billion at year-end 2017. Loans were $3.91 billion, up 22.8%; deposits were $4.61 billion, up 15.9%. Transaction deposits were 75.7% of deposits, versus 71.9% at year-end.
Cash and cash equivalents were $111.5 million. Unencumbered on-balance-sheet liquidity, including eligible investment securities, was $694.2 million, down from $858.2 million at year-end. NBHC reported $1.0 billion of available FHLB credit, of which $144.5 million was used.
For the nine months, operating cash flow was $23.1 million, investing cash flow was $34.1 million and financing cash flow was negative $193.1 million. Cash, cash equivalents and restricted cash decreased $135.9 million to $121.5 million; this cash-flow measure includes restricted cash.
Repurchase agreements and FHLB advances totaled $200.2 million at quarter-end, compared with $259.6 million at December 31, 2017. Total deposits, the primary funding source, were $4.61 billion.
Regulatory capital remained above applicable requirements: consolidated Tier 1 leverage was 10.3%, common equity Tier 1 was 12.9% and total risk-based capital was 13.8%. Tangible common equity to tangible assets, a non-GAAP measure, was 10.15%.

Material changes versus prior periods

Profitability increased substantially year over year, reflecting higher net interest income, acquisition-related scale and mortgage banking activity. Q3 mortgage banking income was $7.8 million versus $0.7 million; nine-month income was $24.7 million versus $1.7 million, primarily due to Peoples.
Expenses also rose, primarily with the acquisition: nine-month non-interest expense increased 42.7%, including the $8.0 million acquisition charge. Q3 had no acquisition costs.
Loan growth included the acquired portfolio and organic originations. Management reported originated-loan growth of 16.8% annualized since year-end, particularly in commercial lending.
Allowance for loan losses rose to $33.8 million from $31.3 million, while the allowance-to-total-loans ratio declined to 0.87% from 0.96%, in part because acquired loans were initially recorded at fair value. Nine-month net charge-offs were $0.2 million, compared with $8.8 million in 2017.
Non-performing assets increased to $59.6 million from $31.5 million, and the ratio to loans and OREO rose to 1.51% from 0.99%. This was largely driven by a $24.1 million acquired problem loan transferred to OREO. Excluding that transfer, management reported a 0.76% ratio.
Available-for-sale securities fell to $796.5 million from $855.3 million. Their gross unrealized losses increased to $31.9 million from $18.2 million, which management attributed to interest rates and did not consider other-than-temporary impairment.
Accumulated other comprehensive loss widened to $20.2 million from $6.2 million, primarily reflecting securities valuation changes. The company issued 3.4 million shares from treasury stock as acquisition consideration.

Outlook, commentary, risks and unusual items

No quantified earnings or growth guidance is provided. Management said it expects available liquidity sources to be adequate for at least 12 months and intends to replace a significant portion of $711.4 million in time deposits maturing within 12 months with transaction and market-rate deposits.
Management described the company as asset-sensitive: its model projected net interest income changes of +6.84% for an immediate 200-basis-point rate increase, +3.49% for +100 basis points and -5.42% for a 100-basis-point decrease. These are modeled estimates dependent on assumptions, not forecasts.
Management identified competition, execution and integration of acquisitions, loan and deposit growth, interest-rate changes, regulation, liquidity and capital constraints, cybersecurity, and real-estate values as challenges. It noted the agricultural portfolio faces depressed commodity prices, though agriculture loans were 5.5% of total loans and diversified by crop and livestock.
Mortgage banking carries repurchase and indemnification exposure for breaches of loan-sale representations and warranties; the recorded reserve was $3.9 million. Falling rates may reduce mortgage servicing rights values; a $0.1 million valuation allowance was recorded at quarter-end.
The company reported $773.9 million of unfunded commitments, including loan commitments and standby letters of credit. It does not expect material losses from these commitments. Management stated pending litigation was not expected to have a material adverse effect.
Purchase accounting for Peoples remained provisional and could be adjusted during the measurement period. The company recorded $55.4 million of goodwill from the acquisition and reported no goodwill impairment. Management also cautioned that acquired-loan discount accretion can support current yields but decline as acquired loans pay down.
The board declared a $0.17-per-share quarterly dividend on November 7, 2018, payable December 14, 2018. No shares were repurchased under the public buyback program during the quarter; $12.6 million of authorization remained.
Management concluded disclosure controls were effective at September 30, 2018, and reported no material change in internal control over financial reporting during the quarter.

Most important facts for investors to verify

How much of loan, deposit, revenue and expense growth is sustainable and organic after the Peoples acquisition and system conversions.
Whether the elevated OREO balance, acquired problem loan resolution and non-performing asset ratio improve, and how credit costs evolve as the portfolio grows.
Whether deposit growth and repricing can support loan growth while controlling funding costs, especially with $711.4 million of time deposits maturing within a year.
How interest-rate movements affect net interest income, securities values and mortgage servicing rights relative to the company’s modeled scenarios.
Whether acquisition purchase accounting, integration costs, contingent liabilities and the mortgage repurchase reserve require material future adjustments.
How liquidity, regulatory capital and shareholder distributions develop, including the impact of the fully phased-in capital conservation buffer.