Timothy Laney - Chairman, CEO and President Richard Newfield - Chief Risk Management Officer Brian Lilly - CFO and Chief of M&A & Strategy.

Brett Rabatin - Piper Jaffray Companies Christopher McGratty - KBW Jeffrey Rulis - D.A. Davidson & Co. Brian Zabora - Hovde Group Timothy O'Brien - Sandler O'Neill + Partners Matthew Sealy - Stephens Inc..

Good morning, everyone, and welcome to the National Bank Holdings Corporation 2017 Third Quarter Earnings Call. My name is Lisa, and I will be your conference operator for today. [Operator Instructions]. As a reminder, this conference is being recorded for the 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 margins, taxes and noninterest expense. Actual results could differ materially from those discussed today.

These forward-looking statements are subject to risks, uncertainties and other factors, which 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 of this call, 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 Chairman, President and CEO, Mr. Tim Laney..

Thank you, Lisa, and good morning and thanks, everyone, for joining our third quarter earnings call. As usual, I have with me our Chief Financial Officer, Brian Lilly; and Rick Newfield, our Chief Risk Management Officer.

Our teammates continued to build and deepen relationships with our clients during the third quarter, resulting in another quarter of double-digit annualized revenue growth. Our relationship-based demand deposits grew 9.5% annualized.

And while our originated loans increased only 7.6% on an annualized basis, I am particularly proud of the pricing discipline that our bankers demonstrated during the quarter. While painful, we took charge-offs on the last of the previously identified problem energy loans during the quarter with the goal of putting the energy concerns behind us.

And on that point, I'll turn the call over to Rick, to discuss our actions in more detail, and equally important, to share his outlook on the remainder of 2017.

Rick?.

Thank you, Tim, and good morning, everyone. Let me jump right into our key credit metrics as of September 30, 2017. Nonaccrual loans are down nicely from $33 million at June 30, 2017, to just over $19 million at September 30, a decrease of 41%. Our nonaccrual ratio is down from 1.1% at June 30 to 0.64% at the end of the third quarter.

Likewise, our nonperforming asset ratio is down from 1.51% at June 30 to 1.01% at quarter-end. It's important to note that over half of our nonperforming asset ratio is driven by acquired problem loans and OREO. Excluding those, the ratio is a very good 0.45%. Past due loans of 30 days or greater were very low at 7 basis points.

I'll also note that we had our third consecutive quarter of declining classified loans, with classified loans decreasing $12 million. We took $8.8 million in net charge-offs for the quarter.

As I guided during last quarter's earnings call, we expected larger charge-offs in the second half of the year against reserves set aside in prior quarters and in contrast to the less than 1 basis point of annualized net charge-offs incurred in the first half of 2017.

Of the $8.8 million in net charge-offs, $8.6 million was against 3 loans, 2 energy loans and 1 general C&I loan. One of the energy loans and the C&I loan were fully reserved in prior quarters. The other energy loan is one of our remaining nonaccrual energy loans that was adversely rated in 2015 and moved to nonaccrual during first quarter of 2016.

While we continue to believe there's recoverable value, the protracted nature of the workout, which is now expected to carry well into 2018, and the absence of current payments prompted us to write the asset down to 0 value during the third quarter.

It's also worth noting that outside of the resolution and cleanup of our energy loan portfolio, total net charge-offs are expected to be 10 to 12 basis points for the year, a stable and favorable level and consistent with our experience over the last several years.

As we've previously guided, the third quarter did not produce any significant OREO gains. We do expect very accretive gains over the next several quarters.

I'll wrap up by pointing to our significantly lower nonaccrual and nonperforming asset ratios as of September 30, 2017, as strong leading indicators of our credit quality as we finish 2017 and head into 2018. Our goal is to end 2017 with no classified loans and no nonaccruals in our energy loan portfolio.

I believe the actions taken this year are putting our negative energy exposure behind us and positioning NBH to operate with very strong credit quality metrics in 2018. I'll now turn the call over to Brian Lilly.

Brian?.

Thank you, Rick, and good morning, everyone. As you saw on last night's release, we reported earnings per share of $0.26, with a return on tangible assets of 69 basis points.

We are very pleased to deliver double-digit annualized revenue growth adjusted for the banking center gain last quarter, solid expense control, and as Rick outlined, we had several items come together with the energy loan portfolio, putting the past issues of the portfolio behind us, while giving visibility to the favorable credit quality trends.

The quarter included a total of $0.10 negative impacts from three items, first, we had $400,000 of Peoples' merger cost; second, a net expense of $1.1 million resulting from a lighter quarter of OREO gains against the problem asset workout expenses; and finally, the additional provision for loan loss expense of $2.9 million related to finishing off the energy nonperforming assets.

These items had a $0.10 dampening effect on the third quarter, but we are well positioned for the fourth quarter. Total loans of $3.1 billion grew 4.2% annualized, with our $2.9 billion originated loan portfolio growing 7.6% annualized. Although we had good commercial loan growth of 8.3% annualized, it was below our expectations.

One of the primary drivers was a record amount of pay downs on the commercial revolving lines of credit. The line utilization percentage decreased.

For the last quarter, we had strong net increase in the commercial lines of credit totaling $68 million, whereas we experienced a net decrease of $13 million this quarter for a quarter-to-quarter swing of $81 million. The decrease in line of credit outstandings was the primary driver in the lower-than-usual loan originations of $181 million.

The line of credit clients are still with us, and the quarterly decline appears to be the result of normal cash flows in their businesses. The total fundings of $181 million had a weighted average yield of 4.3% with a 60% variable rate.

Our focus on variable rate pricing was again reflected this quarter, as our non 310-30 loan yield increased 11 basis points to 4.25%. For the fourth quarter, we continue to see good commercial loan demand, but we are being more cautious in our total loan growth outlook due to the projected higher levels of payoffs and pay downs.

We are forecasting linked-quarter annualized total loan growth in the low single digits. The originated loan portfolio is forecasted to end the year with full year mid-teens growth, but nets down for the total loans to approximately 10% for the year, given the acquired loan payoffs and pay downs. Turning to deposits.

Adjusting for the banking center sale last quarter, average transaction deposits grew 2.5% annualized, led by noninterest-bearing demand deposit growth of 9.5% annualized. In particular, our business accounts led the demand deposit growth with a 17% annualized growth rate.

We were also very pleased with our cost of deposits remained steady, increasing just 2 basis points. Our markets have continued to exhibit rational deposit pricing, as the slight increase in total deposit cost is primarily due to mix changes within the transaction deposit products as well as our clients moving to slightly longer-term time deposits.

We are reiterating our prior guidance of delivering average total deposit growth for the year, led by mid-single-digit average transaction deposit growth, while keeping time deposits flat after adjusting for the banking center sales.

Fully taxable equivalent net interest income totaled $39.4 million, increasing $1.1 million on the strength of growing earning assets and a 5 basis point widening of the fully taxable equivalent net interest margin to 3.6%.

This margin was above our prior guidance, as we realized a 4 basis point benefit from higher levels of income on acquired loans and we performed better on deposit pricing than we had forecasted. For the fourth quarter of 2017, we are forecasting a fully taxable equivalent net interest margin in the area of 3.5%.

We are also forecasting an accelerated reduction in the 310-30 accretion income, given the large pay downs that we expect. The accretion income for the fourth quarter is targeted at $4.6 million, representing a $1 million decrease from the third quarter.

Add in a flat to slightly increasing earning asset base, the net interest income is forecasted to decrease slightly from the third quarter strong level, as it will be a challenge to completely offset in one quarter the $1 million decrease in 310-30 accretion income. Rick provided the credit quality overview and our outlook for the fourth quarter.

Adding in the loan growth guidance and even with the third quarter's $2.9 million provision related to the energy credit, we are forecasting to stay within our range of prior guidance for the full year provision for loan loss expense, albeit with a tighter range of $11 million to $12 million.

Noninterest income totaled $9.6 million, increasing $0.5 million after adjusting for the $2.6 million gain realized last quarter. Generally, fee categories were consistent with the prior quarter, plus particular strength with swap fee income from commercial clients.

We reiterate our guidance for total noninterest income in the range of $39 million to $40 million for the year. Excluding the banking center gain in the second quarter, the full year range is expected to be $36 million to $37 million.

Expenses totaled $34.6 million and included a net expense of $1.1 million from OREO gains and problem asset workout expenses and $0.4 million related to the Peoples' merger. We are tracking better than our full year total expense target of $136 million before the impact of Peoples.

As we mentioned last quarter, we were not expecting to realize any material gains on OREO in the third quarter. We are cautiously optimistic to achieve a net 0 impact from net OREO gains and problem asset workout expenses for the full year, which would imply a net positive $1.1 million from OREO gains in the fourth quarter.

However, we would not be surprised to see some OREO gains push into next year. Regarding taxes, we continue to target a quarterly effective tax rate in the range of 20% to 22% and a fully taxable equivalent tax range in the range of 29% to 31%.

Of course, this is before any additional tax benefits realized on previously issued performance-based equity awards. Capital ratios remained strong with $60 million in excess capital at quarter-end, using a 9% leverage ratio. Tim, that concludes my comments..

Thank you, Brian. You covered a lot of ground there. We do look to close out this year with solid business momentum and great markets, and equally important, a very strong balance sheet capable of supporting future growth.

In addition, our pending acquisition with Peoples will deepen our presence in our core markets of the Colorado Front Range and the greater Kansas City region, while adding a best-in-class mortgage banking platform to our business. And on that note, Lisa, let's open up the lines for any questions..

[Operator Instructions]. And our first question comes from the line of Brett Rabatin from Piper Jaffray..

I wanted to first ask, I want to make sure I was clear, the NII that you were talking about being lower in the fourth quarter, is that inclusive of Peoples and can that still close in 4Q?.

I'd say there's two parts to that question. First part, the guidance we're giving is without the Peoples impact. So think about that as our core run rate here as we run from the third quarter. Peoples, to that topic, we're in the middle of application with our regulators and still hopeful, we don't totally control it, that fourth quarter is the close.

So that's what we're running towards, but we'll give you those details when they happen, on the peoples..

Okay. Okay. And then you've done a pretty good job managing the interest cost of deposits with higher rates.

Are you anticipating any catch-up, so to speak, in deposit betas? Or can you talk maybe about what you're looking at in terms of funding? And as you see a little higher rates, what impact that might have on your funding cost?.

You know what, Brett? This is Tim. What excites us most is what we're seeing as it relates to growth in our core demand deposits. Again, I would point out that 9.5% annualized growth we talked about in the third quarter was centered in demand deposits.

And we think that's a reflection of this continued focus on expanding relationships, particularly with our small business clients, but with our small business and commercial clients. So that will continue to be our focus. And there's no denying, at some point, there's going to be a pressure on interest-bearing deposits. We're prepared for that.

We assume we'll move with the market on that front. But our focus is on building a disproportionate level of balances in the transactional area..

Okay. And then just last one to make sure I was trying to write down the $0.10.

But could you run through that real quick again, the impact in 3Q?.

Yes, there was three items. Of course, Peoples' trickling of expenses for data processing and that type of stuff, $400,000. And then I always point out that the lumpiness of the OREO and the problem asset workout expenses that impacts each quarter.

In this quarter, we were breakeven for the first 6 months, Brett, but we're at a negative $1.1 million impact here in the third quarter. And that's over a couple pennies that comes and goes. And then last part, of course, was the $2.9 million for the energy credit that we put behind us there..

And I would remind you that we had guided to a slow down quarter on OREO resolution for the third quarter, but remain very optimistic as we look at this acquired OREO and the gains that are embedded. And that should be realized over the -- really over the next several quarters..

Our next question comes from the line of Chris McGratty from KBW..

Once we get through the energy, Tim and Brian or once again, Rick, when we get to the energy cleanup in the fourth quarter, can you speak to how you're thinking about credit costs and kind of expense relief going forward into '18? I think in the prepared remark, you said charge-offs ex energy were 10 to 12, this year, basis points.

I'm interested in kind of any color in terms of what you might be able to pick up from the expense side of the equation as you kind of work through these credits?.

Sure, Chris, it's Rick. Thanks for the question. So I'll reiterate again that as we look outside energy on a year-to-date basis, we're 13 basis points annualized on a year-to-date annualized basis, and we expect to stay below that range.

Again, I'm guiding to slightly lower than that on a full year basis in terms of any kind of ex energy type credit costs. And on the energy side, while painful, the actions we took really do position us to put energy behind us. And that's the way I'm thinking about our credit costs as we move into this quarter and then into 2018..

Chris, I'd add, of course, we'll give much more detailed guidance here in January. But a couple of things, trends that you could take from that -- we're real pleased. As you look at the last three years, we've been at 10 or below in net charge-offs, excluding that energy challenge that we went through.

So as we go forward, we're assessing the marketplace now. And then as you think down in the expense category, our problem asset workout expenses, those are coming down as we look forward. And we'll tighten that up for you here in January, but certainly, that's a place where we'll get some expense saves..

And maybe the last point, Chris, is both management and board are -- have conviction around maintaining a very strong, clean balance sheet, not sitting on legacy issues, and ensuring even to the point that, while not required, we self-stress our loan portfolios and balance sheet in ensuring ourselves that by any measure or any stress that this is a company that could weather any kind of a bubble or disturbance and move forward.

So we feel good about where we stand as we plan to enter '18..

That's helpful. Thanks for that. If I can sneak one in. Brian, once you put the two companies together, either late in the year or early next, can you speak of how it's kind of adjust the margin outlook? You guys have obviously been pretty active in originating variable rate loans.

Just kind of mathematically, I think they had a little bit of a higher margin. And obviously, you're kind of benefiting from deposit discipline.

But how do you see -- from that 3.50% jumping off point in the fourth quarter, how do you see that balancing into next year?.

Yes, it's a real good question. They and our -- on the models we put together, they're accretive to our current margin on kind of the weighting size -- as bringing them together. And that's the way we think about it. But we're not -- giving dollars and cents and margin bps at this time, Chris.

I'd like to get it closed and then we can size it up for you..

Our next question comes from the line of Jeff Rulis from D.A. Davidson..

Maybe a couple for Brian and just a follow-up on that margin discussion.

The -- what was the core, if you exclude accretion, I guess, sequentially, what margin, the last quarter and this?.

It's an interesting question. I think we've shared before, we do track that internally. If you take the 3.60%, it's about 46 basis points less. And let me just tell you the methodology that we use, because everybody measures it differently.

We just take those 310 or the higher-yielding loans that we've acquired, it's also in the non-310-30, some of the marks that we took. And we just push that to a 4% rate versus the 17%, 18% yields we're getting there and back that out. So if you look at it on that basis, about 3 -- about 3.14 here for the last quarter.

But it's been jumping 10 bps a quarter. And as you know, as that 310-30 burns off, those become exactly equal in the future here. But that's the facts around that..

So linked quarter, what's jumping 10 basis points, where you were 3.04 on a....

Yes, it was lower, and it's not hard to look at. When you see our non-310-30 yield move 11 basis points here in the last quarter to 4.25% in total. And I'd tell you that underneath that, the originated book, which is the dominant, is 4.15% here in the third quarter. So some of those acquired loans are boosting that yield 10 basis points.

And it's really fun to think about -- we put on all of our new loans this quarter at 4.3%. So we're picking up accretion in our new business as well as we're positioned well for future rate increases..

Yes, exactly..

That's great.

So obviously, the 3.50% in Q4 relates to the 3.60%, and that's just the step down in accretion?.

Right..

Yes, fine..

Okay. And then, Brian, you referenced the reduced line utilization. Maybe if you could comment on, one, what were the relative levels quarter-to-quarter, but then also just kind of a broad -- maybe the sense of the business community in your markets as to perhaps why that is pulling in? Is it antics in D.C.

or anything beyond that, that you'd comment on the business climate?.

I'll provide the numbers. So think about it this way, we've been -- I think Rick even mentioned last quarter, we were about 60% line utilization, and that was consistent quarter-to-quarter, and actually consistent year-over-year. So we've been running at that, and of course as we add business, that 60% line utilization. We're down in the mid-50s now.

So that's -- and it's been interesting to us, as we've seen that in the marketplace. But I'll ask Tim to comment..

I would tell you, perhaps the greatest tension, Jeff, we see is, as you know, we have self-imposed limits on how much, for example, commercial real estate we'll take in our portfolio. And we do see a tremendous amount of commercial real estate opportunity in our markets. But we're simply being very selective.

And look, I think for those that are pursuing that business, there's still -- actually we've seeing a return to very nice pricing and structure and opportunity in that space. And what we're going to do is continue to focus on building primarily a diverse C&I small business and consumer portfolio.

And we'll take what we think is our fair share of the market as long as it meets our credit parameters and pricing expectations. So look, there's absolutely no denying that we're in great markets. We're fortunate to be in the markets we're in. And look, I'm not sure what else there is to add. The business climate still remains strong..

I would add, Chris, as we were talking about this morning, Tim, you could connect, Jeff, the 17% increase in our business DDA as cash being built. And of course, if you're running your business, you're going to pay down some of your debt. So we see that as the ebbs and flows.

But to Tim's point, because we're in that C&I business, and that's our emphasis..

Yes, we're more subject to that in the commercial arena..

Okay. So a little combination of building cash and maybe some self-imposed on the loan front. Got it..

Our next question comes from the line of Brian Zabora from Hovde Group..

Just a question on your loan growth expectations.

Are you assuming that loan line utilization increases back to that 60%? Or do you think it maybe stays around this lower level?.

As we polled our bankers and are talking to their clients, we think there's a chance that, that will go up, but we stay conservative. It's hard for us to put out a low single digits total loan growth, although I will tell you we're still growing the originator portfolio because we've got some large pay downs and payoffs.

We still believe fundings will be relatively strong. But we're not trying to get too far out there in this quarter and see how it shapes up..

Understood. And then just a second question on Peoples. Could you give us maybe an update on -- we talked a little bit about the margin.

But just do you feel still comfortable about the cost savings that you had initially projected and just maybe any thoughts around revenue synergies now that you're getting closer to the closing?.

The more we live with it and get to know the people, the more impressed we are with the caliber of the talent in the organization. We're particularly impressed with their policies, practices and approaches to growing low-cost deposits.

We had a third party during diligence recognize their mortgage business as one of the best that this third party had never seen embedded in a community bank. We have no reason to think that we can't realize the kind of synergies that we reported when the deal was announced..

Our next question comes from the line of Tim O'Brien from Sandler O'Neill..

Questions, so the remaining nonaccrual energy loans totaled or marked at $3.6 million?.

Tim, yes, this is Rick. That's correct..

And that's one -- how many loans are left? It was 3.

Now it's 1?.

Was 3. Now it's 1, which we're working very deliberately with contracts and other efforts to sell and ultimately resolve this quarter..

And then remind me, is there a classified loan number tied to energy that's higher than that, because I think in your -- in the narrative, Tim, you alluded to clearing out all classified energy-related costs, so it's possibly by year-end?.

That's actually the only classified and the only nonaccrual..

And Tim, it's worth noting, to be clear, at the inception of the problem in the energy industry, we identified these 4 credits. The one you're now talking about is the last of the 4. And the team has goal to have that resolved and behind us before we go into 2018..

And can you -- I understand if you don't want to, but can you share detail, has any charge been taken at all against that $3.6 million remaining credit at this juncture? Or is it marked at full loan amount plus interest?.

No, we have, that -- that was the -- when I referred to 1 energy loan and 1 C&I loan that were reserved in prior quarters, this is the energy loan reserved in prior quarter. So we actually took that charge against the reserve..

Well, so what we're carrying -- the net of it is, Tim, it's after revalue as it's on the books at 9/30..

Okay, great. And then I got a little confused by the comments on loan guidance, on lending growth guidance and such.

Brian, can you clarify, so total loan growth guidance coming into the quarter from the second quarter call, what was that number and what did you realize that to?.

Tim, can you restate it, because I was with you until you said second quarter..

Yes, so in the second quarter, you updated guidance for loan growth, which you do every quarter pretty much, right? For 2017, you gave that number I believe.

And then I just want to -- I want to make sure that I explain that accurately so that we capture kind of the shift in the business that took place this quarter here in this quarter, because I think folks are going to be focused on that..

And our guidance for the fourth quarter. So in July--.

Yes. So this is full year '17, right? That's all I'm....

That's right. So in July, we were forecasting 15% to 20% total loan growth. Now the net of what we talked about today is in that 10% range for the year, with the originated portfolio being in the mid-teens level for the year, but coming down because of the acquired loans paying off.

And the reason that we're moving from that 15% to 20% down to 10% is because of a lower line of credit and the payoffs, pay downs we had in the third quarter. But we're also projecting some meaningful movement in acquired loans, which is why the 310-30 accretion is coming down so much and some other pay downs in our portfolio.

(Audio Gap) kind of normal business flows and certainly less than what we had hoped for as we were setting those more aggressive, but still feeling pretty good about our marketplaces, the clients, the business momentum.

It's just, I think if you look at all banks, as we're starting to see, there was an interesting little bit of a backup here in the third quarter that we're feeling also..

And then you -- the -- you broke off when you were updating guidance for full year deposit growth. I got some detail, but I didn't catch that full year number. I think you've -- for some reason, the call broke or something.

But did you update guidance for that?.

No, I just reiterated the exact same guidance that we had from the last quarter. We feel pretty good about our deposit....

Our next question comes from the line of Matt Olney from Stephens Inc..

This is Matt Sealy on for Olney.

So any update on the expense outlook? And is 3Q a good run rate for legacy NBHC expense base, excluding Peoples?.

Well, the guidance that -- what we've been tracking to in our guidance was $136 million we put out there at the beginning of the year, in our January guidance for the year. We are tracking better than that. And it really comes down to the OREO gains and net problem asset workout expenses as it impacts the fourth quarter here.

So as we're putting together our plans, you'll hear us give more guidance here as we get into January for 2018. But that's what I'd tell you for now..

And we're going to work very hard to also parse out the expense related to the Peoples acquisition as we did today and make that impact clear. But in terms of our core NBH run rate, as Brian said, we believe we can beat the $136 million we guided to..

Okay, great. Yes, and obviously, Peoples will be additive to that once it comes in the fold..

Yes..

So I want to make sure I heard you right on the fee income outlook being $36 million to $37 million for full year.

Is that right?.

That's netting out the $2.9 million we got on the banking center gain in the second quarter, just be careful, the in and out of that. Otherwise, it's $39 million to $40 million, you're taking that $3 million out..

Okay, great. And want to make sure I'm understanding the NIM guidance of 3.5% going forward, excluding Peoples, which -- this is down 10 bps from 3Q NIMs.

Does this reflect just lower accretion expectations? Or are there other drivers to this?.

It's primarily accretion, and we'll have just some little movements here in our deposits as it just rolls forward and CD pricing and others that we baked into that number..

Okay. Okay, great. And circling back on credit quality, I think you identified a troubled middle market commercial credit in 2Q.

Any update here with this specific credit? And was this the other credit that drove the higher charge-offs during the quarter?.

It is, Matt, and it is behind us effectively. So why I referenced it and the other energy loan that we had reserved in prior quarters..

Again, consistent with our theme of taking action as quickly, and then as prudently as possible, it was reserve [indiscernible] charge third behind us..

Okay. Okay, great. And lastly on capital deployment outlook going forward.

After Peoples is in the fold, will you focus more on M&A or reengage the buyback? How are you thinking about that going forward?.

We are very reluctant to reengage in buyback at these stock prices. We're very proud of having bought back over half of our initial shares at the public offering at an average price of right around $20. And the idea of the averaging that price up doesn't necessarily sit well with us or any of the other long-term investors.

Look, we are seeing an interesting -- and I would say high level of activity in terms of institutions having an interest in talking to us. And right now, our focus is on Peoples. But we would certainly be open to partnering up with the right institutions if it made sense for our investors..

I'm showing we have no further questions at this time. I will now turn the call back to Mr. Laney for his closing remarks..

Thank you, Lisa. And again, just thanks to everyone that took the time to ask questions. Great questions this morning, and we certainly look forward to any follow-up. Everyone, have a great day..

Thank you. 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 2 hours and will run through November 3, 2017 by dialing 855-859-2056 or 404-537-3406 and referencing the conference ID of 92242777.

The earnings release and an on-play replay of this call will be available on the company's website on the Investor Relations page. Thank you very much, and have a great day. You may now disconnect..