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National Bank Holdings Corp (NYSE:NBHC)

Q2 2013 Earnings Conference Call

July 26, 2013, 11:00 AM ET

Executives

G. Timothy Laney – President and Chief Executive Officer

Brian F. Lilly – Chief Financial Officer

Analysts

Ryan M. Nash – Goldman Sachs & Co.

Christopher McGratty – Keefe, Bruyette & Woods, Inc.

Gary Tenner – D.A. Davidson & Co.

Operator

Good morning, everyone, and welcome to the National Bank Holdings Corporation 2013 Second Quarter Earnings Call. My name is Jay, and I will be your conference 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 U.S. Securities and Exchange Commission. These statements speak only as of the date July 26, 2013, 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 CEO, Mr. Tim Laney.

G. Timothy Laney

Thank you, Jay. Well, good day, and thank you for joining National Bank Holdings 2013 second quarter earnings call. I’m joined today by Brian Lilly, our Chief Financial Officer; and Rick Newfield, our Chief Risk Officer.

We are reporting another quarter of increased loan production of continued reduction in cost of deposits and increased earnings. Equally important, we believe that there remains significant capacity for improvement in these areas, as well as others.

We remain focused on building the quality relationships with consumer and business clients that were resolved in the continued ramp up of our loan production, fee income, and low cost deposit growth. We will also be very focused on realizing expense reductions over the remainder of the year, while remaining well positioned to leverage our operating and risk management infrastructure through additional acquisitions.

With respect to acquisitions, we agree with observations that a number of the recently announced deals that have demonstrated the pricing discipline required to achieve appropriate earnings accretion and tangible book value impact have represented win-win scenarios for buyers and sellers with the surviving company stock benefiting all of the merged company shareholders. We believe some more deals will be constructed and announced in our markets and we fully expect to be a part of that mix.

Now, before turning the call over to Brian, I’ll also point out that during the quarter, we repurchased over 900,000 shares at a weighted average price of $18.21 and our intent is to remain opportunistic on this front. Brian?

Brian F. Lilly

Thank you, Tim, and good morning, everyone. We earned net income of $2.9 million in the second quarter, which equaled $0.06 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 of the non-strategic assets at attractive returns.

Strategic loans grew $73 million or 26% annualized to end the quarter at $1.2 billion, and now comprised 71% of total loans outstanding. The increase is driven by organic loan growth as we had loan originations of $169 million, continuing progress to our quarterly goal of $250 million.

The second quarter originations represented strong 54% increase over the first quarter, and it’s doubling from the second quarter last year. The linked quarter increase was led by both consumer and commercial lending. Within consumer banking, both the Colorado and Kansas City markets combined for record quarterly originations and then closing in on our goal of $400 million in annual originations from the banking centers.

Commercial banking had good linked quarter growth in loan originations. But we are more excited by the opportunities represented in their pipelines and the quality of the associates choosing to join the NBH team. Our focus continues to be on driving to over $1 billion in annual originations.

The credit quality of the strategic portfolio continues to be strong with only 0.8% as non-performing loans at the end of the second quarter. We continue to make steady progress exiting the non-strategic loan portfolio. These loans decreased to $116 million or 76% annualized to end the quarter at $496 million. The key evidence point in value pickup from our workout efforts is the continued quarterly accretable yield gain. The second quarter added $20 million in accretable yield transfers against only $1 million in loan pool impairments.

It is worth noting that the cumulative life-to-date accretable yield pickup is now $127.9 million against impairments of only $25.3 million. The net economic impact total variable $102.6 million and reflects our conservative day one acquisition marks and the excellent results of ongoing workout efforts. We are pleased with the balance between our organic growth and the result and pace of our problem credit resolution.

We do foresee an inflection point in the first half of 2014, whereby total loans will begin to grow, of course, the economic landscape left to be accommodative, but we feel very good about the piece we have in place and the momentum that they are building. We continue to remain focused on organic growth as a key value creating strategy.

In terms of deposits, our treasury management and group added some nice business this quarter leading to growth in average transaction deposits and client repurchase agreement. The mix of transaction deposits or total deposits improved to 60% this quarter, an 8 percentage point improvement from June 30 last year.

The growth in improved mix lowered the cost of deposits deployed 42% and represents an improvement of 3 basis points from the first quarter. Net interest income for the second quarter totaled $44.3 million and declined $1.3 million from the prior quarter. The net interest margin narrowed a 11 basis points to 377 and was primarily driven by the decrease in non-strategic loans and lower reinvestment yields for the investment portfolio. Most of the non-strategic loans are accounted for in the 310-30 loan pools, and as a group, these loans – these pools are yielding more than a 11% annually.

We expect to see continued downward pressure on the margin as we workout of the non-strategic portfolio until we reach the inflection points in growing total loans and deposits next year. However, given the steeper yield curve, we do expect stability in the investment portfolio yields as our current reinvestment rate approximates the current portfolio yield of about 2%.

Credit quality continues to trend favorably. As you know, we believe that it is best to understand our credit quality and the provision for loan losses, along the loan portfolio as a 310-30 acquired loan pool accounting and all other loans labeled as non 310-30 loans. With regard to the credit quality of the 310-30 acquired loan pools, I mentioned earlier that we completed the quarterly remeasurement process and picked up a favorable net economic value of $19 million during the quarter, resulting a life-to-date net pickup accretable yield of a favorable $102.6 million.

This statistics help us cut through the complex accounting of disclosures and shows the value being created from these problem assets. During the quarter, we did place one commercial loan pool on non-accrual totaling $18.7 million. We carry the balance at 44% of the unpaid client balances, and it is covered by loss share.

We do not see any concern with the collection of the our book balance, but felt that there was enough uncertainty in the future cash flows, I would be appropriately conservative to discontinue the interest accretion recognition. The non 310-30 loans also experienced positive credit quality trends. These loans are primarily comprised of all originated loans, as well as the acquired non 310-30 loans. Within this portfolio, our non-performing loans ratio improved to 2.6% from 3.6%, whereas the total past dues improved to 1.59% from 2.19% last quarter.

Net charge-offs increased slightly to $1.8 million, or 0.67% of total non 310-30 loans. Included in the $1.8 million were charge-offs of $1.3 million on two loans that we previously provided specific reserves. Given the use of a specific reserve, the allowances for loan losses on the non 310-30 loans decreased to 0.87% at the end of the quarter.

Let me add that the 0.87% significantly influenced by the over 50% weighting of the lower risk consumer mortgages and agriculture loan portfolios. And the fact that, we still have $14 million in purchase loan fair value marks protecting against future charges-offs. In fact, the $14 million more than doubled the $9.7 million in the allowance for loan losses on the non 310-30 loans.

Turning to non-interest income and excluding the FDIC-related income, banking related non-interest income totaled $9.1 million and increased $600,000 or 26% annualized. Half of the increase was due to client growth in the service charges and bank card fees, with another $200,000 increase in gains on the sale of mortgages.

Total FDIC-related non-interest income decreased to net $400,000. We reduced the negative amortization of the FDIC indemnification asset by $1.7 million, as our remeasurement of a loss share cash flow suggested that we collect more from the FDIC loss share agreement. However, the negative amortization continued as we expect lower losses than we had projected at the time of acquisition.

In addition, the other FDIC loss share income decreased $2.1 million directly related to the lower OREO and problem loan expenses incurred this quarter. Total expenses decreased $2.7 million from the first quarter as we managed to a lower level of OREO and problem loan costs.

Operating expenses, excluding the OREO and problem loan expenses increased $1 million compared to the first quarter and was primarily driven by a charge to increase the value of the warrant liability. As you may recall, we have $831,000 warrants outstanding and our stock price increased to $1.45 per share during the second quarter, thereby driving the increase.

Compensation cost increased slightly due to our April annual salary actions and additions to our revenue generating teams, most notably the asset-based lending group. Professional fees continued the downward trend improving over $500,000 compared to the first quarter. Capital ratios remain strong improving slightly from the first quarter with leverage ratio of 18.69%. We ended the quarter with $400 million of strategic capital deployed using the 10% leverage capital ratio.

Recall, that the 10% leverage is part of our regulatory start-up operating agreement. The tangible book value per share ended the quarter at $18.68 decreasing $0.45 from the end of the first quarter. The driver of the decrease was the higher yield curve as the unrealized per value mark and the available for sale portfolio decreased the equivalents of $0.51 per share from the end of the first quarter.

The tangible book value per share, excluding the OCI marks, in other words, excluding the held-to-maturity and available for sale investment portfolio unrealized fair value marks ended the quarter at $18.50, increasing $0.06 from the first quarter. As Tim shared during the quarter we purchased 938,000 of our shares at attractive weighted average price of $18.21. We have $7.7 million remaining of the initial $25 million buyback authorization and we’ll continue to be price opportunistic.

Tim, that concludes my comments.

G. Timothy Laney

Good, thank you, Brian. Jay, we are now ready to take questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from the line of Paul Miller with FBR. Your line is open.

Unidentified Analyst

Hey, good morning, guys. This is actually Tom [Laterno] on behalf of Paul.

G. Timothy Laney

Hi, Tom.

Unidentified Analyst

Hi, how are you? Brian, I think you mentioned sort of $1 billion of originations per year sort of a goal. Do you guys feel like you’re getting pretty closer to achieving that given the strong second quarter and would you sort of be expecting to grow on a net basis at that level?

Brian F. Lillys

Yes, most definitely. That’s been a focus of ours really through a year now. As we have put the resources in place to drive to that and as we model it getting to that level covers the runoff in our non-strategic portfolio and begins to add loan balances, but more importantly begins to add to the net interest income. So the progress that we make in each quarter is encouraging to that. The resources and teams that we put in place are building their books. And as we look as I mentioned, we are more excited about the pipelines that are sitting out there. So yes, we realized that is going to drive us to that level than the production that we’ve accomplished today.

Unidentified Analyst

Okay, great. And then one quick follow-up, on the expense reduction side, but I think you guys mentioned in your opening comments. Do you expect most of that to come through sort of reduced credit costs or are there other things you are looking at? Can you just provide a little more color there?

Brian F. Lilly

I think, it comes to maybe to broaden that. When you put together the four banks that we have in many cases failed and they will not just on a credit side, but even into the systems. It’s taken us time to pull together all the reporting and tracking and we have at the end of last year put in place all of the measures and the responsibility center accounting that we could align all the loan deposits expenses with the various operating groups.

What that’s allowed us to do in the first six months of this year is track our performance and really get granular, look at our network, the banking network where we’re making it, where we’re not and asking ourselves when can we get those operations, which in many cases were failed to hurdle. And so we look at it in a broader perspective not just the credit related costs, but the number of our business segments and taking actions on those as we go forward.

Unidentified Analyst

Okay, prefect. Thanks very much, Brian.

Brian F. Lilly

Thank you, Thomas.

Operator

Next we have the line of Ryan Nash with Goldman Sachs. Your line is open.

Ryan M. Nash – Goldman Sachs & Co.

Hey, good morning, guys.

G. Timothy Laney

Good morning, Ryan.

Brian F. Lilly

Good morning.

Ryan M. Nash – Goldman Sachs & Co.

I guess, first question on the net-interest margin, it sounds like from your comments that we’re going to see continued declines until we see – potentially see the inflection loan growth, and obviously you have continued declines from the strategic run-offs there. I guess the first question I have is, shouldn’t we expect the pace of decline to remain similar to what we’ve seen this quarter or given the fact that reinvestment yields have improved, should we see the pace of decline slow from here?

G. Timothy Laney

Ryan, that’s very good question. I’m glad you’ve asked that. When we look forward kind of a normal pace would be about 10 basis points range of a decrease from that non-strategic portfolio. A little bit of wild card though as you know is in that staff accounting and purchase accounting, there is a number of pieces that when loans will prepay, we get accelerated income recognition. And that’s a steady contributor in our quarterly, so we expect that contributor and we’ll bring that up, because it can be lumpy. And that would impact that 10 basis points as we go forward.

Ryan M. Nash – Goldman Sachs & Co.

Okay. And then I guess, Tim, more of a big picture question. I think your opening comment sounded a little bit more optimistic about M&A I think than you were last quarter. So I guess, a couple of questions; have we seen the regulatory bar raised such that it’s hard to get deals done at this point. And given that, you said in your opening remarks you anticipate that you guys will be participating. I think last quarter you talked about whether it was bank acquisitions potentially buying branches or even looking for specialty finance base. Where the efforts focus right now and given the regulatory environment, do you see any issues with getting deals done?

G. Timothy Laney

Look, I would tell you that we were actually confident in our pipeline in the first quarter, our M&A pipeline in the first quarter of this year. I will tell you, we’re more confident as we close out the second quarter. I think to your question around the regulatory bar, I think it’s reasonable to say that regulators are probably appropriately very careful coming out of the downturn that we’ve all experienced. I will tell you that the process is appropriately very methodical. At times it’s easy to come in patient with it. But we understand it, and we have been methodically working through – what we think is an appropriate process.

Look, we just strongly believe that you have to construct mergers that are accretive to earnings based on reasonable revenue and expense assumptions. We think you have to have earned back periods within that three to five-year range in order to be well received in the marketplace. And, of course, our focus is on building franchise value in the area of the United States where we already operate.

I will also add that while we have a bias to use cash in acquisitions, where we do end up using stock. Our plan is to immediately move into the market and use our capital to buy-in an equivalent number of shares. We have no intention of diluting ourselves in an acquisition.

So that I think gives you a little color on our view on the regulator environment, gives you a little color on what we think about as it relates to the bars we need to hurdle to really create value for our company and maybe even a little color on how we might engineer a transaction to use our shares, but to do it in a way that we think will be smart for all of us and investors.

Ryan M. Nash – Goldman Sachs & Co.

Got it. Thanks for the color. And if I could just squeeze in one, I guess related follow-up. I just want to make sure I heard your opening remarks referred that you would expect that any transaction that you would do would be within the footprint. So are you currently not looking, I know you talked about contiguous states even during the IPO process. Are you not looking at any of those any more? And also just given that we have seen significant improvement in credit across the industry, which I would gather, puts a damper on your ability to buy distressed institutions, is that becoming a bigger impediment as times passes to get something done?

Brian F. Lilly

To your first question, I think we’ve been pretty consistent in saying 95% of our focus has been on the markets where we operated. It’s really Missouri, Kansas, and Colorado. We like that I-70 corridor. We like certainly the attractive markets of Kansas City, Denver, Boulder, et cetera, but our core markets are Missouri, Kansas, and Colorado and that represents 95% of our focus.

What’s interesting as it relates to the trouble banks that remain in our markets and the trouble banks that remain across the United States, they are not in our focus. But those that are in our markets obviously are, I will tell you that, we are increasingly interested in those institutions that we think represent smart merger partners that perhaps have less baggage and where we have greater confidence that they can immediately contribute to earnings on a traditional basis.

Ryan M. Nash – Goldman Sachs & Co.

Great. Thanks for taking my question.

G. Timothy Laney

You bet, Ryan.

Operator

(Operator Instructions) Your next question comes from Chris McGratty with KBW. Your line is open.

Christopher McGratty – Keefe, Bruyette & Woods, Inc.

Hey, good morning, guys.

G. Timothy Laney

Hi, Chris.

Brian F. Lilly

Hi, Chris.

Christopher McGratty – Keefe, Bruyette & Woods, Inc.

Tim, on your acquisition comments the color on geography was helpful as is the financing aspect. Can you talk about size of things you are looking at today?

G. Timothy Laney

We still believe that it takes just as much work to integrate $1 billion and $1.5 billion acquisition as it does $0.5 billion. We are going to be opportunistic with around all of the right partners – perspective partners in our markets. But we still lean toward some of the – you might say, larger community banks in our markets.

Christopher McGratty – Keefe, Bruyette & Woods, Inc.

So couple of billion dollars is certainly on the table, okay.

Brian F. Lilly

I would say, let’s say that 500 to $1.5 billion with the preference toward the large size.

Christopher McGratty – Keefe, Bruyette & Woods, Inc.

Okay, that’s helpful. And then Brian on the expense guidance or the expense commentary aside from the credit numbers that are somewhat volatile. Should we be expecting kind of the core expense run rate to be growing from here, or maybe I missed the comment on the expense outlook.

Brian F. Lilly

We wouldn’t expect that it would be growing and we’re expecting that we’ll be able to take actions to bring that down as we go forward.

Christopher McGratty – Keefe, Bruyette & Woods, Inc.

Okay. And then lastly on the securities book, how should we thinking about the overall? Did I hear you say, it was going to be flat essentially?

Brian F. Lilly

Yeah. I think comments on the side, but that would be fair to assume that the size of the balance sheet and the securities book would be similar.

Christopher McGratty – Keefe, Bruyette & Woods, Inc.

Okay. Thanks.

G. Timothy Laney

Thank you, Chris.

Operator

Your next question comes from the line of Gary Tenner with DA Davidson. Your line is open.

Gary Tenner – D.A. Davidson & Co.

Thanks, good morning, guys.

G. Timothy Laney

Good morning, Gary.

Gary Tenner – D.A. Davidson & Co.

Just a follow-up question on your comments in terms of regulators and M&A. Have you gotten to the point on any perspective transactions over the first six months of the year where you kind of run things out the flagpole with regulators and it come back with comments that maybe were not as positive as you may have thought, I mean, are they conservative to that degree or cautious to that degree?

G. Timothy Laney

Gary, I appreciate the question. We are always tentative to comment on conversations with our regulators. What I would tell you is that, we don’t believe we have or would bring, I’m going to say this pretty definitively. We do not believe we would take a perspective acquisition to our regulators that they would find inappropriate. We believe our filters are appropriately, let’s say, conservative.

Gary Tenner – D.A. Davidson & Co.

Okay. And then second question, in terms of the non-strategic loan runoff the paces remain pretty high. How do you think of in terms of the progression from here, does it stay high for other two maybe three quarters? And then there is a long tail at the end of it, maybe just some color on that?

Brian F. Lilly

Gary, that’s a good questions. We obviously we report each and every quarter and we even exceeded our estimates every quarter in a month that our team can pickup. We are certainly not putting any breaks on exiting these problem credits. We’ve done $200 million plus the first six months, as we currently forecasted out another $150 million approximately for the next six moths, and cutting the balance at the end of the year and half with another $200 next year.

There is a life to it, but we also have some loss share agreements. So we have our teams focused on to get out of. We have plenty of run way to get the assets resolved before losing loss share, that’s why we’ve been into it. I would say the best guess at this point, but our teams have been very successful in exiting very attractive returns and we want to continue that.

Gary Tenner – D.A. Davidson & Co.

And Brain, on a related note, you covered it in your comments, but should we reiterate where we are at on the economic value creation. I mean it’s not any significant.

G. Timothy Laney

Sure. And that’s a $100 million plus that we picked up since the day one and both acquisition conservative due diligence, but really lot of credit to the team for the way we’ve worked it out over the last few years. Every quarter that we have remeasured for our accretable yield we picked up net positive on that and that’s kind of what we would like that to continue. Those 11% yields are very good and it’s given us time to go after the opportunities that will create long-term value.

Gary Tenner – D.A. Davidson & Co.

All right, thanks.

G. Timothy Laney

Thank you, Gary.

Operator

There are no further questions at this time. I turn the call back to the presenters.

G. Timothy Laney

All right. Well, everyone, thank you for your time and attention today. Thank you for your questions and have a good day.

Operator

And this concludes today’s conference call. 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 August 9, 2013, by dialing 855-859-2056 or 404-537-3406 and using conference ID of 12961794. The earnings release and then online replay of this call will also be available on the company’s website by visiting the Investor Relations area.

Thank you very much and have a great day. You may now disconnect.

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