National Bank Holdings Q3 2024 Earnings Call - Credit Cleanup Complete, Core Expenses Trimmed

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This conference will be recorded.

Nicole, Chief Financial Officer, National Bank Holdings: We remain disciplined in managing deposit costs with only 1 basis point of deposit cost increase for the quarter and ended September with a low cost of deposits of 1.96%. Total cost of funds increased 2 basis points to 2.03% for the quarter. The loan-to-deposit ratio ended the quarter at 93.8%. Turning to asset quality. We recorded $40.6 million of provision expense to cover the quarter’s elevated net charge-offs. As previously disclosed, third quarter net charge-offs totaled $46.3 million, reflecting actions taken on specific commercial loans following adverse credit events during the quarter. These credits also resulted in non-performing assets increasing by 15 basis points or $15 million.

Additionally, we hold $14.3 million of marks against our acquired loan portfolio, which provides an additional 15 basis points of loan loss coverage if applied across the entire loan book. Turning to fee income. Non-interest income totaled $13.5 million, and as previously disclosed, was impacted by a $4 million impairment on one third-party fintech investment. Aldis will share more on fee income momentarily. We expect fourth quarter fee income to be in the range of $17 million-$18 million. Non-interest expense totaled $97.8 million for the quarter and included $15.2 million of acquisition and restructuring expenses. Excluding these one-time items, non-interest expense was $82.6 million, a decrease of $1.1 million from the prior quarter.

The third quarter included one additional payroll day compared to the second quarter and included elevated problem loan expense of $1.4 million for the quarter. We have fully executed on our cost-saving strategies. As a result of our strong execution, we expect a clean expense run rate in the fourth quarter, with core non-interest expense in the range of $75 million-$77 million. Our capital levels remain well in excess of well-capitalized regulatory thresholds. Common equity tier 1 ratio ended the quarter at 11.7%, and our total capital ratio was 14.7%. The tangible common equity ratio ended the quarter at 9.2%. Tangible book value per share was $25.37, reflecting the quarterly dividend payout and $12 million of share repurchases during the quarter. Importantly, we continue to target quarterly earnings in excess of $1 per share in the fourth quarter.

With that, I will turn the call over to Aldis.

Aldis, Chief Executive Officer, National Bank Holdings: Thank you, Nicole. Let me begin with credit. As Tim shared, this was a disappointing quarter for us, and we recognize the importance of addressing both the immediate issues and their underlying causes. This quarter’s loan losses were concentrated in the franchise and healthcare verticals within our specialty banking group. Over the past 12 months, we have upgraded our specialty banking team leadership, and during the third quarter, we conducted additional in-depth reviews and implemented further enhancements across our credit risk governance. These steps are intended to strengthen accountability and improve consistency on how risk is identified, escalated, and managed. Throughout the year, we also have diversified these portfolios, and our current exposure is limited to approximately 5% of total loans in franchise and approximately 3% in healthcare finance. During the quarter, we also executed on a new model for serving small business clients.

Under the new model, we will lean more heavily into our banking center network with an increased focus on deposit gathering. The objective is to create a more consistent client experience and align resources more closely with the needs and economics of this segment. We expect these organizational changes to reduce our operating expenses by approximately $4 million annually. Turning to the loan book. On an annualized basis, loans grew 5% during the quarter, bringing year-to-date growth to 8.1%. Early in the quarter, our team successfully completed the Vista core system integration, an important milestone that positions us to operate on a unified platform and focus fully on serving clients. With this achievement behind us, our teams are focused on growth and our pipelines continue to build heading into the fourth quarter. We remain on track to deliver 10% loan growth for full year 2026.

Achieving that level of growth would take our total loans outstanding to above $10.1 billion by year-end. Average deposits grew a solid 3.7% annualized during the quarter, led by 4.6% annualized growth in average transaction deposits, reflecting continued strength in our core deposit franchise and our focus on growing high-quality relationship-based funding. This favorable deposit mix, combined with disciplined balance sheet management, contributed to a strong 4% net interest margin for the quarter. Finally, turning to the fee income, the underlying performance of our core banking business remains solid. During the quarter, combined service charges and bank card fees grew at an annualized rate of 12%, reflecting continued momentum from these recurring revenue streams. Additionally, we continue to see solid contributions from our Cambr and trust and wealth teams.

On the strength of our core franchise, improving operating discipline, and growing client pipelines, we enter the fourth quarter with the confidence in our ability to build on this momentum. Tim, with that, I will turn it back to you.

Tim, Executive Leadership, National Bank Holdings: Thanks, Aldis. We have covered a lot of detail in our opening comments, so why don’t I go ahead and open up the call for questions?

Conference Call Operator: Thank you. Ladies and gentlemen, if you would like to ask a question, you can signal by pressing star one on your telephone keypad. Again, press star one to ask a question. We will pause for just a moment to allow everyone an opportunity to signal. We will go first to Jeff Rulis with D.A. Davidson.

Jeff Rulis, Analyst, D.A. Davidson: Thanks. Good morning.

Tim, Executive Leadership, National Bank Holdings: Good morning.

Jeff Rulis, Analyst, D.A. Davidson: Just to, I guess the first bit on credit, just to kind of, if you could you itemize the size of those credits, both in the franchise and healthcare, the resolution path ahead, and then lastly, expectation for net charge-off levels going forward, or is this sort of in the rearview? Thanks.

Tim, Executive Leadership, National Bank Holdings: You bet.

Nicole, Chief Financial Officer, National Bank Holdings: Yeah. Jeff, good morning. This is Nicole. Related to your charge-off question on the credits that we addressed in the third quarter, we addressed a principal balance of credits totaling about $65 million, and we took net charge-offs on those credits of about $47 million. That leaves a remaining balance of $18 million on our books related to those credits, and those are supported by collateral and personal guarantees of the borrowers.

Jeff Rulis, Analyst, D.A. Davidson: Okay. Just the makeup of the $65 million in credits. What was franchise and what was healthcare?

Tim, Executive Leadership, National Bank Holdings: Yeah.

Jeff Rulis, Analyst, D.A. Davidson: Or what is left is fine.

Tim, Executive Leadership, National Bank Holdings: Jeff, I will start with high level and then perhaps Aldis can fill in with a bit more detail. When you size this up and we talk about a handful of credits, the reality is this was an event primarily centered in two credits, one franchise, one healthcare. The franchise, of course, was this Qdoba Dave’s Hot Chicken franchise that we have dealt with, where the first issues, frankly, came to light in July. By August, we were in a process of seeing some retrading on really the sell of the collateral involved to cover our loan exposure and found ourselves with a deficit and quite frankly, found ourselves in that situation in a position where we believed it was merited to file suspicious activity reports and address what we believe is client fraud.

In the other situation, it was a healthcare-related event that we had dealt with in the fourth quarter of last year, had conducted a full restructure with the client, brought in a third-party consultant, believed management was in a position to move the company forward with one of its other divisions. Frankly, the process ran out of steam and left us in a position of working with the borrower to take the company into bankruptcy. Those are the two big drivers. I do not know if you want to discuss the breakdown as it relates to the rest of the franchise. By the way, we do not view these as some indication of systemic problems. As a practical matter, when we review our credit policies and practices, our risk management policies and practices over the life of our company, they have served us well.

These were cases where, frankly, the bankers involved did not execute on our policies and practices, and those bankers are no longer with us.

Aldis, Chief Executive Officer, National Bank Holdings: Yeah. Jeff, of that 65 that Nicole mentioned, approximately 45% is healthcare, 45% is franchise.

Jeff Rulis, Analyst, D.A. Davidson: Thank you, Aldis. The net charge-off question was going forward. We got it in the release what you charged off. But the expectation for just the overall bank ahead and the charge-off expectations, is there any further cleanup, or we revert to sort of historical levels Q4 and beyond?

Nicole, Chief Financial Officer, National Bank Holdings: Yeah. Our expectation is that we’ve addressed what needed to be addressed this quarter such that we expect normalized levels going forward.

Jeff Rulis, Analyst, D.A. Davidson: Thanks. Aldis, if I could hop to the margin. Nicole, sorry. Was there any impact on the margin in terms of loans placed on non-accrual in terms of lost interest? On the outlook, sounds like around 4%. If you could outline, should we have another rate hike, what the impact of that would be. Thanks.

Nicole, Chief Financial Officer, National Bank Holdings: Yes. I’ll take that one, Jeff. You’re hitting on a few good points of consistently there will be puts and takes to our margin. We did have some interest reversals in margin for the quarter. We also had some pickup from accelerated accretion. I will say those two kind of washed in the quarter. We exited September with a 4% margin. Our expectation is that we’ll be able to hold that for Q4. Regarding your question of what do we expect the impact to margin will be with future rate changes, I will take us back to the last time that we were in a rate-up environment. We were successful at maintaining our deposit costs, and through that rate-up cycle, we held a deposit beta of under 40%. We believe we’ll continue to be able to be disciplined on our deposit pricing.

Jeff Rulis, Analyst, D.A. Davidson: Thanks, Nicole. If I could squeeze one more in there. On the merger costs, any chance you could map those in terms of, did a lot of that come in the comp or other? Just trying to back that out of the current quarter.

Nicole, Chief Financial Officer, National Bank Holdings: Yeah. I’ll say it’s largely been concentrated within the compensation and benefits line. There are really impacts hitting in all lines. Occupancy and equipment, processing fees, and professional fees. But the bulk of what hit the third quarter, and frankly for the year, has been in personnel expense.

Jeff Rulis, Analyst, D.A. Davidson: Okay. Thank you. Appreciate it.

Aldis, Chief Executive Officer, National Bank Holdings: Thank you, Jeff Rulis.

Conference Call Operator: We will go next to Kelly Motta with KBW.

Kelly Motta, Analyst, KBW: Hey, good morning.

Aldis, Chief Executive Officer, National Bank Holdings: Good morning.

Kelly Motta, Analyst, KBW: On your core expense guide of $75 million-$77 million for Q4, you also noted there was about $4 million annual benefit from some of the changes you’ve made in the business. I know you have the benefit of the post-conversion expense run rate. Just wondering what of the $4 million benefit might be already baked into that Q4 number. Thanks.

Aldis, Chief Executive Officer, National Bank Holdings: It is, Kelly. So that $4 million that I talked about in terms of the reorganization and how we go to market for business banking or small business is embedded. Along to what Nicole was saying, it will show up mostly in the benefits and salaries line.

Kelly Motta, Analyst, KBW: Got it. That is helpful. With the credit, it was obviously a disappointing quarter. You have noted you have made some changes, some changes in personnel and exposure is fairly limited at this point. Just wondering if as part of the identified issues and changes, if you have done a third-party review of these books or what gives you comfort that this is now behind you? Thanks.

Aldis, Chief Executive Officer, National Bank Holdings: No, as I mentioned in my prepared remarks, we delved in quite closely to the full portfolio with a very much closer eye to the portfolio originated by the bankers that Tim mentioned. Our loan review team, our SAG team, our chief credit officers have gone through it and we feel very comfortable where we are today with portfolio looking forward. I will say also that throughout the year, we have worked very hard on churning that book away from either brands or the operators that we did not like, to put it bluntly, and $150 million of the franchise book is being turned over year to date.

Tim, Executive Leadership, National Bank Holdings: I think that is an important point, Kelly, is this is not a process that just began in the third quarter. We have been working this franchise exposure since the fourth quarter of last year, and again, have methodically exited over $150 million of exposure that we felt was not originated against the standards that we are comfortable with.

Kelly Motta, Analyst, KBW: Okay. Got it. Your release noted the expected sale of the Palm Beach location. Just wondering if I think you gave the loans and I believe the deposits associated with this action expected to take place next year, but wondering overall financial impact, if there is maybe some additional expenses that come out. Thanks.

Nicole, Chief Financial Officer, National Bank Holdings: Yeah, I’ll take that. It will end up having minimal impact to our EPS. There will be some expenses that come out. I think it should be right around half a million. No, it’s $2 million.

Aldis, Chief Executive Officer, National Bank Holdings: It’s $2 million. Half a million, you’re thinking, because of the timing of this. But on an annualized basis, it’s about $2 million of operating expense that comes off the books on an annualized basis. As we mentioned in the release, about $200 million of loans and deposits. You apply 4% margin, you can see what the revenue is given up. So to Nicole’s point, once you net that out, it’s really nominal EPS impact.

Tim, Executive Leadership, National Bank Holdings: I would just add strategically, look, it’s a fine operation, a solid smaller team, and what we believe is we can generate greater returns focusing on our core markets and continuing to build those core markets. We were able to really create a win-win transaction here with the team that has run that bank, and we think we’ve ended up in a very transaction for both parties. That’s where I would leave that.

Kelly Motta, Analyst, KBW: Got it. That’s helpful. I guess last question for me. It looks like the fee guidance is a bit lighter than maybe what was implied for the full year. I imagine maybe some weakness in mortgage obviously has something to do with that. Just wondering if you could kind of break down the changes in the outlook here today versus what you may have been expecting a quarter or two ago. Thanks.

Aldis, Chief Executive Officer, National Bank Holdings: Kelly, this is Aldis. You picked up on the main driver in the change, and that one is the mortgage, is residential mortgage business suddenly has been impacted by the steeper and higher rate environment. Conventional mortgages being about 7% again on sale is, or secondary market is quite tough. Having said that, we have seen a bit more volume go on the portfolio. You can see that in our loan tables. We had a nice portfolio growth in residential mortgage. But in terms of gain on sale, it is tougher going, especially going into fourth quarter, that seasonally low quarter.

Kelly Motta, Analyst, KBW: Got it. Thank you so much.

Tim, Executive Leadership, National Bank Holdings: Thank you, Kelly.

Conference Call Operator: We will go next to Matthew Clark with Piper Sandler.

Matthew Clark, Analyst, Piper Sandler: Hey, thank you. Good morning.

Aldis, Chief Executive Officer, National Bank Holdings: Good morning.

Matthew Clark, Analyst, Piper Sandler: You mentioned churning about $150 million on the franchise side. How much did you churn or de-risk within the healthcare portfolio? I guess that’s my first question. Thanks.

Aldis, Chief Executive Officer, National Bank Holdings: Sure. Yeah, Matthew, actually, a similar dollar amount, $150 million exit in healthcare throughout the year. The portfolio is down on healthcare $100 million year-to-date. So back to getting 10% loan growth. That’s something that we consciously have been working behind the scenes to de-risk the portfolio in general, but continue to meet our loan growth targets.

Matthew Clark, Analyst, Piper Sandler: Okay. Great. Just around the series of personnel changes, did that include a new chief credit officer? If so, has he had a look at the overall portfolio and blessed it, or is that process still underway?

Tim, Executive Leadership, National Bank Holdings: We have brought in a new chief credit officer over the last year and a half, and he has certainly engaged unlike ever before in all of the detailed reviews that have been conducted. We did exit a number of senior credit officers that were involved in, frankly, the oversight of the bankers that have also moved on. Obviously, those are painful actions, but actions we felt necessary to ensure that our policies and practices when it comes to risk management are respected and well executed.

Matthew Clark, Analyst, Piper Sandler: Great. Just criticized loans or assets, where they stood at the end of September. I think they were, according to the Q, $298 million or 3.05% at the end of June.

Nicole, Chief Financial Officer, National Bank Holdings: Yeah. Criticized assets at end of September were 3.4%, so a slight uptick, but classified, I will say, were flat to prior quarter at 1.38%.

Matthew Clark, Analyst, Piper Sandler: Great. Then just the purchase accounting accretion impact to dollars this quarter.

Nicole, Chief Financial Officer, National Bank Holdings: Yeah. Good morning, Matthew. I will touch on that one. As I mentioned previously, we did have some puts and takes to margin this quarter. We had some impact of accelerated loan accretion that impacted the quarter, but that was largely offset by some non-accrual interest reversals. The NIM that you are seeing is a core NIM.

Matthew Clark, Analyst, Piper Sandler: Right. But in terms of dollars, so we can model the yield and the accretion. Interest reversals, how much was that in dollars and how much in accretion in dollars, given that they offset?

Nicole, Chief Financial Officer, National Bank Holdings: We have not historically provided that, and the reason is it has never been really material to our margin or loan yields. We would like to keep it that way unless we do an acquisition that it is so material that it makes a difference. We will certainly disclose at that time, but historically has not been, and we will keep it that way.

Matthew Clark, Analyst, Piper Sandler: Okay. Fair enough. Thanks.

Nicole, Chief Financial Officer, National Bank Holdings: Thank you.

Conference Call Operator: Thank you. I am showing we have no further questions at this time. I will now turn the call back to Mr. Laney for his closing remarks.

Tim, Executive Leadership, National Bank Holdings: Well, again, thank you for your continued interest in National Bank Holdings, and I wish you all a good day.

Conference Call Operator: Thank you, sir. This concludes today’s conference call. If you would like to listen to the telephone replay of this call, it will be available in approximately 24 hours, and the link will be on the company’s website on the Events and Presentations page. Thank you very much and have a great day. You may now disconnect.