National Bank Holdings Corporation — Q2 2013 Form 10-Q
Business context and period: Unaudited results for the quarter and six months ended June 30, 2013. The bank holding company operated 101 full-service banking centers, primarily in the greater Kansas City area and Colorado. The business combines relationship-based banking with the workout of acquired, FDIC-assisted loan portfolios; comparisons are affected by acquisition accounting and the runoff of acquired assets.
Key financial results
Amounts below are in millions of dollars unless stated otherwise.
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net interest income, before provision | $44.3 | $51.9 | $89.9 | $105.2 |
| Provision for loan losses | $1.7 | $12.2 | $3.1 | $20.1 |
| Non-interest income | $7.3 | $10.0 | $14.5 | $20.3 |
| Non-interest expense | $45.2 | $45.3 | $93.1 | $98.3 |
| Net income | $2.9 | $2.7 | $5.0 | $4.3 |
| Diluted earnings per share | $0.06 | $0.05 | $0.10 | $0.08 |
| Net interest margin | 3.77% | 4.00% | 3.82% | 3.96% |
- Profitability and revenue: Q2 net income rose modestly year over year despite lower net interest income and non-interest income, primarily reflecting the much smaller loan-loss provision. For the first half, net income increased to $5.0 million from $4.3 million. Six-month net interest income fell $15.3 million, mainly due to fewer acquired ASC 310-30 loans and lower yields on investments and other loans. Lower deposit interest expense partly offset the decline.
- Margins and operating costs: Net interest margin narrowed year over year. The efficiency ratio was 85.05% for Q2 and 86.69% for the first half, versus 70.96% and 76.19%, respectively, in 2012. Lower professional and workout expenses were offset in part by higher salaries and occupancy costs.
- Cash flow: First-half operating cash flow was negative $22.7 million, investing cash flow negative $277.4 million, and financing cash flow negative $166.3 million. Cash and cash equivalents declined $466.4 million to $302.8 million. Investing included $821.8 million of securities purchases, partly offset by maturities, loan reductions, OREO sales and FDIC-related cash receipts; financing reflected $213.0 million of deposit outflows, share repurchases and dividends.
- Balance sheet and funding: Total assets were $5.22 billion at June 30, down from $5.41 billion at year-end 2012. Deposits were $3.99 billion, down $213.0 million; transaction deposits increased to 60.0% of deposits from 58.3%. Repurchase-agreement liabilities were $122.9 million, up from $53.7 million. The filing does not present conventional long-term borrowing as a material funding source.
- Liquidity and capital: Management reported $2.72 billion of on- and specified pledgeable liquidity, including $2.32 billion of pledgeable investment securities; this is not equivalent to cash on hand. Consolidated Tier 1 leverage and Tier 1 risk-based capital ratios were 18.7% and 50.1%. Management said liquidity sources should be adequate for at least 12 months. The bank was subject to restrictions on dividends to the holding company until at least Q4 2013.
- Credit and allowance: Loans were $1.72 billion, down $109.4 million from year-end, as $214.3 million of non-strategic balances ran off, partly offset by $278.1 million in originations. Strategic loans grew 18.8% annualized. The allowance for loan losses was $11.8 million, or 0.69% of loans, versus $15.4 million, or 0.84%, at year-end. Net charge-offs were $6.6 million for the first half, compared with $14.3 million in 2012.
- Problem assets: Non-performing assets were $128.3 million, or 2.46% of assets, versus $137.0 million and 2.53% at year-end. Non-performing loans were 2.77% of loans versus 2.23% at year-end, partly because a covered $18.7 million acquired commercial loan pool was placed on non-accrual when its cash flows could no longer be reasonably estimated. OREO declined to $79.3 million from $94.8 million.
- Equity and securities: Stockholders’ equity declined to $1.04 billion from $1.09 billion. First-half other comprehensive loss was $31.3 million, largely reflecting unrealized losses on available-for-sale securities; comprehensive loss was $26.3 million despite positive net income. The available-for-sale portfolio was $2.05 billion, with a pre-tax net unrealized loss of $8.2 million. Management concluded the securities in unrealized-loss positions were not other-than-temporarily impaired.
Material changes, outlook and risks
- Improving acquired-asset cash-flow expectations shifted $35.0 million, net, from non-accretable difference to accretable yield during the first half, supporting future loan interest income. The acquired-loan yield was higher than the yield on originated loans, but management expects loan yields and interest income to face downward pressure as acquired loans pay down or mature unless replaced with comparable-yielding assets.
- FDIC indemnification asset declined to $59.9 million from $86.9 million at year-end. The company received $67.6 million of FDIC payments during the first half; claims remain subject to FDIC review and audit. Negative accretion reflected improved expected cash flows on covered assets and lower expected reimbursements.
- Management expects to replace a significant portion of time deposits maturing within 12 months with transaction deposits and market-rate time deposits. At June 30, $1.2 billion of time deposits were scheduled to mature within 12 months, and $111.9 million of certain acquired time deposits could be withdrawn without penalty.
- No quantitative earnings or margin guidance was provided. Management cited low interest rates, loan competition, subdued borrower demand, potential credit deterioration, real-estate market uncertainty, regulatory changes and acquisition/integration execution as key challenges. It also noted FDIC loss-sharing income is variable and expected to decline over time as covered assets are resolved absent further qualifying acquisitions.
- The company repurchased 950,474 shares during the first half at a weighted average $18.21 per share, leaving $7.7 million under the authorization. The board declared a $0.05-per-share quarterly dividend in August 2013. No material litigation was reported; the filing said risk factors were unchanged from the 2012 Form 10-K.
Important facts for investors to verify
- Whether strategic loan originations can offset acquired-loan runoff and sustain net interest income as the acquired portfolio’s higher-yielding assets decline.
- Trends in non-performing loans, particularly the $18.7 million non-accrual covered pool, and whether the lower allowance remains adequate as acquired and originated credit risks evolve.
- Actual deposit retention and funding costs as the $1.2 billion of time deposits mature, including deposits eligible for penalty-free withdrawal.
- FDIC reimbursement approvals, claim timing and the remaining indemnification and clawback exposures.
- Interest-rate and securities valuation sensitivity: the portfolio is heavily mortgage-backed, unrealized losses reduced accumulated other comprehensive income, and the reported liquidity total includes pledgeable securities.
- Holding-company liquidity and capital distributions, given the bank’s dividend restriction through at least Q4 2013 and continued share repurchases and dividends.