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Edited Transcript of NBHC earnings conference call or presentation 23-Oct-19 3:00pm GMT

Q3 2019 National Bank Holdings Corp Earnings Call

Boston Nov 1, 2019 (Thomson StreetEvents) -- Edited Transcript of National Bank Holdings Corp earnings conference call or presentation Wednesday, October 23, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Aldis Birkans

National Bank Holdings Corporation - Executive VP, CFO & Treasurer

* G. Timothy Laney

National Bank Holdings Corporation - Chairman, President & CEO

* Richard U. Newfield

National Bank Holdings Corporation - Chief Risk Management Officer

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Conference Call Participants

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* Gordon Reilly McGuire

Stephens Inc., Research Division - Research Analyst

* Jeffrey Allen Rulis

D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst

* Kelly Ann Motta

Keefe, Bruyette, & Woods, Inc., Research Division - Associate

* Robert James Shone

Piper Jaffray Companies, Research Division - Research Analyst

* Timothy O'Brien

Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research

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Presentation

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Operator [1]

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Good morning, everyone, and welcome to the National Bank Holdings Corporation 2019 Third Quarter Earnings Call. My name is Mariama, and I will be your conference operator for today. (Operator Instructions) 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 noninterest expense. Actual results could differ materially from those discussed today. These forward-looking statements are subject to risks and 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.

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G. Timothy Laney, National Bank Holdings Corporation - Chairman, President & CEO [2]

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Thank you, Mariama. Good morning, and thank you for joining National Bank Holdings Third Quarter 2019 Earnings Call. I have with me our Chief Financial Officer, Aldis Birkans; and Rick Newfield, our Chief Risk Management Officer. We're pleased to report another record quarter of earnings on the strength of solid loan balance growth, strong growth in noninterest-bearing deposits and record fee income. More specifically, we grew loan balances at an annualized rate of 10.7%, while growing noninterest-bearing demand deposits at an annualized rate of 12.9%. Record fee income was driven by our residential banking group with a solid contribution from our consumer group.

Finally, it's important to note that we remained very focused on expense management and we believe we're setting ourselves up to realize additional operating efficiencies in 2020. Aldis?

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Aldis Birkans, National Bank Holdings Corporation - Executive VP, CFO & Treasurer [3]

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Thank you, and good morning. As Tim already mentioned, we are very pleased to be reporting another quarter of record earnings driven by solid loan and low-cost deposit growth and a great performance by our residential mortgage business.

For the third quarter, we reported record quarterly net income of $21.6 million and record earnings per diluted share of $0.69. This is an increase of $1.4 million or 6.7% on a linked-quarter basis and an 18.7% increase over the third quarter of 2018.

As we reported in our earnings release, this was a busy quarter for us on many fronts. And I will call out some of the key drivers as I cover various parts of the balance sheet and income statement.

In terms of organic loan growth, we are pleased with the trends we saw this quarter led by a strong commercial loan activity. Our new loan originations this quarter were $319.2 million, an increase of 9.9% over the second quarter 2019 and a 16.2% increase over the production levels during the same quarter last year. Originations continue to be well-diversified across various geographies and asset classes.

The regional economies in our markets remain solid and growing despite macro uncertainty around global economic growth. Our small business, middle market and consumer clients generally maintain a positive forward outlook.

However, given the increased uncertainty, we took the opportunity to groom portions of our loan portfolio this quarter and expect to continue these efforts during the fourth quarter as well.

Our strategic actions combined with increased client refinancing activity this quarter resulted in an elevated loan paydown and payoff levels. On year-to-date basis, our originated and acquired loan balances have grown a strong 10.7%, and we expect to achieve the full year 2019 loan growth guidance of 10%.

On the other side of the balance sheet, we continue to be very pleased with the growth of our low-cost relationship deposits. Average noninterest-bearing deposit balances grew 12.9% annualized on a linked-quarter basis, and our noninterest-bearing deposits now represent 26.1% of total deposits or a 2.5% improvement from a year ago.

Our total average transaction deposits grew 5.1% annualized, and we expect to deliver our -- on our full year guidance for average transaction deposit growth in the mid-single digits.

Our transaction deposit cost decreased 1 basis point from the prior quarter to a low 39 basis points in the third quarter.

Heading into the fourth quarter, we have taken actions to further lower interest rates in our deposit accounts. We have $2.4 billion in average money market savings and other interest-bearing deposit accounts to which we are rapidly responding with pricing adjustments.

We expect to realize a continued drop of transaction deposit costs in the fourth quarter as a result of these actions.

Fully taxable equivalent net interest margin for the quarter was 3.91%, a linked-quarter decrease of 9 basis points entirely driven by the 2 25 basis point Fed funds rate cuts. This decrease is in line with our expectations of a 5 to 7 basis point drop for each 25 basis point cut in the Fed interest rate target.

Looking ahead, if the Fed follows through with a widely expected interest rate cut at the end of October, our margin will continue to be impacted and we now project the fourth quarter's fully taxable equivalent net interest margin to be in the low 3.80s. Consistent with the prior guidance, earning assets should end the year at around $5.4 billion.

With regard to credit, our overall loan portfolio remains in very good shape. We moved swiftly to address the one problem loan that came over with the Peoples Bank acquisition, which we discussed during the second quarter's call. As a result, our annualized net charge-offs this quarter were 66 basis points. Excluding the charge-off related to this one acquired problem loan, the remaining portfolio net charge-offs remained very low at 3 basis points annualized year-to-date. The provision expense this quarter was $5.7 million on -- and included $4.2 million related to this problem loan.

Just to recap, at the time with Peoples Bank acquisition, the day 1 loan mark was $9.8 million, more than sufficient to cover this specific problem loan expense as well as the rest of Peoples loan portfolio. As of September 30, 2019, we still had $6.1 million of the purchase mark remaining that will continue to be amortized into our earnings over time.

We see no systemic issues across our diversified and granular loan portfolio. And in fact, nonperforming loans declined on quarter-over-quarter and on a year-over-year basis with a nonaccrual ratio improving to 58 basis points from 79 basis points at June 30, 2019.

For the fourth quarter, we are expecting provision expense to normalize to cover originated loan growth at 1% and annualized net charge-offs of 10 to 15 basis point.

During the third quarter, we realized record noninterest income of $24.8 million, which was $4.1 million higher than the second quarter 2019.

While we showed solid results in our service charges and bank card fees, this quarter's highlight was the $14.7 million in mortgage banking income, which exceeded our guidance.

Our core residential mortgage business is built on the purchase market, and we continue to benefit from operating in strong local markets. Additionally, this quarter, our teams capitalized in the low mortgage rates that had fueled the refinancing activity, which in turn provides a nice hedge to the margin pressures.

To give you some color, this quarter, refinancing activity represented 50% of the origination volume as compared to 26% during the second quarter 2019 or just 16% the same quarter last year.

Looking ahead, we project both the home buying and the refinancing activity to slow down, especially during the second half of the fourth quarter heading into the holiday season. We project our total noninterest income for the fourth quarter 2019 to be in the $17 million to $18 million range.

Regarding expenses, our third quarter's noninterest expense totaled $43.8 million and decreased $2.7 million from the prior quarter.

This quarter, we closed on 2 OREO property sales that had been in works for some time. The gain from these OREO sales totaled $6.5 million and was recorded as the contract expense within our noninterest expense. Our previous guidance projected these gains to cover this year's problem asset workout expenses, and we are very happy to have exceeded our guidance.

Additionally, this quarter, we announced the consolidation of 4 banking centers that will occur in the fourth quarter of 2019.

As part of this effort, we incurred a $900,000 impairment charge during the third quarter, which we expect to earn back within a year through improved operating efficiencies.

We do not expect these consolidations to have any material impact on our ability to grow and service our low-cost deposits.

Since 2015, we have either consolidated or closed a total of 22 banking centers as we continuously look to improve our operating leverage to allow us to invest in the digital conveniences that our clients expect.

Excluding OREO gains, problem asset workout expense and the banking center consolidation charge, noninterest expense in the third quarter increased $2.8 million. This increase was driven by a $2.9 million increase in the total compensation line as a result of the higher residential mortgage performance.

For the fourth quarter, we expect our total expenses to be in the $45 million to $46 million range. The effective tax rate for the quarter was 20% reflecting the higher taxable income. For the fourth quarter of 2019, we expect the effective tax rate to be in the previously guided 18.5% to 19.5% range. Tim, that concludes my comments.

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G. Timothy Laney, National Bank Holdings Corporation - Chairman, President & CEO [4]

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Thank you, Aldis. We are proud of having delivered another record quarter of earnings with increasing returns on tangible assets and tangible common equity. To be clear, we are not pleased with the expense taken during the quarter related to the previously discussed acquired loan.

We'll share with you that despite the reliance on audited financial statements and connection with this relationship, we've uncovered regularities if not suspect activity that continues to be investigated.

Moving on, as it relates to capital, we finished the quarter with a 10.9% Tier 1 leverage capital ratio. Our tangible book value per share was $20.45, and we're pleased to have increased tangible book value 13.4% over the past 12 months while having increased our quarterly dividend [35.6%] over the same period. On that point, we'll open the call up for questions. Mariama?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Jeff Rulis with D.A. Davidson.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [2]

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Following up on the credit side, sounds like an identified credit, obviously, from the Peoples, one that you discussed. I guess I'm just trying to get to the kind of the approach here and maybe some body language suggests. Is there more sort of processing of these type loans? Like you're going to get more aggressive to try to churn through that nonaccrual book? Or is this a true one-off and we should see more stability in the nonaccrual level and charge-offs?

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Richard U. Newfield, National Bank Holdings Corporation - Chief Risk Management Officer [3]

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Sure. Jeff, this is Rick. Let me answer your question. So yes, this is a loan that came over with the Peoples acquisition, and I will share the loan exposures related to a subcontractor, and this is a sector in which our bank has maintained minimal exposure. In fact, loans to any type of contractor or subcontractor are just over 1% of our total loan portfolio. I'll also point out, as Aldis said, we've had success in working through other problem loans acquired through Peoples and with better results than our initial credit marks. And finally, really to put perspective on the overall portfolio, I don't see any systemic issues or negative trends in our loan book. In fact, nonaccrual loans, classified loans and criticized loans all decreased during the third quarter, and we've been steadily decreasing our nonperforming assets over the last 18 months.

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Aldis Birkans, National Bank Holdings Corporation - Executive VP, CFO & Treasurer [4]

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And Jeff, I'll jump in, this is Aldis. Again, on the purchase mark that we had, we had $9.8 million mark on that portfolio. And to Tim's -- sorry, to Rick's point, is that, well, as disappointing this one credit one-off thing is the rest of the portfolio we've performed much better and accreting that mark in our earnings.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [5]

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Got you. The remaining $25 million nonaccrual, are there some lumpier credits in there? Is that pretty granular from here, this was one of a kind of moving through the snake? Or -- of the $25 million left, what's -- anything more chunky or sizable?

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Richard U. Newfield, National Bank Holdings Corporation - Chief Risk Management Officer [6]

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Jeff. No. This is Rick, again. Actually, it's very granular at this point. So no, there is nothing of size in a nice sort of distribution across different loan types. Again, no particular concentration.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [7]

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Got you. And then the -- I guess any thoughts on expectations. It sounds like you exceeded expectations on the gain on OREO outstripping problem asset workout. How about kind of rolling that forward to 2020 or Q4 thoughts on the expectations for the net of those 2 items?

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G. Timothy Laney, National Bank Holdings Corporation - Chairman, President & CEO [8]

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Right. Great question. We're not at a point where we're ready to provide 2020 guidance. But I think if you look at our track record on recoveries, managing OREO, it's nothing less than strong, and we expect that trend to continue in terms of working through anything we acquire and delivering a strong and economic return as we can.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [9]

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Got you. And Tim, you closed with kind of the capital levels pretty robust. Any way you could kind of gauge on deployment of that and alternatives there as well as, obviously, I don't know if you've got any initial CECL-related guidance or thoughts ahead of the next year?

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Richard U. Newfield, National Bank Holdings Corporation - Chief Risk Management Officer [10]

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Yes, the CECL first.

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Aldis Birkans, National Bank Holdings Corporation - Executive VP, CFO & Treasurer [11]

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CECL first, we not -- we haven't disclosed any CECL impact yet. I'm looking to do that with the fourth quarter's earnings call along with the rest of the 2020 outlook. We've been working feverishly behind the scenes on it. It's fair to assume that we do still, as of September 30, we had approximately just shy of $400 million of acquired loans that were accounted under purchase accounting that will require some allowance set aside for that, that could be $3 million to $4 million. But other than that, nothing specific at the moment.

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G. Timothy Laney, National Bank Holdings Corporation - Chairman, President & CEO [12]

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Aldis may kick me here, Jeff, but we're not seeing anything that would represent a surprise.

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Aldis Birkans, National Bank Holdings Corporation - Executive VP, CFO & Treasurer [13]

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No. I think our model --

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G. Timothy Laney, National Bank Holdings Corporation - Chairman, President & CEO [14]

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I know you want to wait until fourth quarter, but...

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Aldis Birkans, National Bank Holdings Corporation - Executive VP, CFO & Treasurer [15]

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Yes. Our models are coming out very consistent to what you start seeing some other banks, bigger banks reporting in terms of if you look at by asset classes, C&I loans are having little less maybe of loans needed anything consumer or mortgage type that has a longer life to it is a bit more. So we're not seeing anything surprising.

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G. Timothy Laney, National Bank Holdings Corporation - Chairman, President & CEO [16]

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Yes, I think we'd benefit here from having a robust, strong, short-term C&I loan book.

And then to your earlier question on capital, I typically give a bit of a robust answer around the focus on continued increase in our dividend on a semi-annual basis. The importance of optionality as it relates to M&A. And again, the belief that having a strong capital base does create that optionality for us. So I'm going to leave it at that right now, Jeff.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [17]

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And buybacks, is that part of your optionality, not a tool that's aggressive when used, but any thoughts on that specifically?

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G. Timothy Laney, National Bank Holdings Corporation - Chairman, President & CEO [18]

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Yes. I mean, of course, we had the history early on of buying back so many of our shares opportunistically at very low prices with a very short earn back. Right now, we actually would not target that unless there were some radical changes in the markets as an immediate opportunity.

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Operator [19]

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Your next question comes from Gordon McGuire with Stephens Inc.

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Gordon Reilly McGuire, Stephens Inc., Research Division - Research Analyst [20]

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Maybe start on the expenses. Aldis, can you clarify whether that $45 million to $46 million was a total expense level for 4Q or was it core?

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Aldis Birkans, National Bank Holdings Corporation - Executive VP, CFO & Treasurer [21]

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It's total. At this point, we're not expecting any -- the 2 OREO properties sales that we realized in third quarter have been -- we've been talking about those for a while. They were not related by the way. It just happened to hit in one quarter for us. So at this point, I'm just giving a total expense guidance.

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Gordon Reilly McGuire, Stephens Inc., Research Division - Research Analyst [22]

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Got it. And then you guys mentioned efficiency opportunities next year, saw the 4 branch closures in the release. But is there any way you can size up what the opportunity is or what's kind of top of mind when you talk about efficiency opportunities?

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G. Timothy Laney, National Bank Holdings Corporation - Chairman, President & CEO [23]

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Look, we continue to monitor the activity of our clients the way they are using our banking centers, the use of digital alternatives, finding that right balance, striking that right balance between appropriate levels of brick-and-mortar and options is important to us.

We've had a track record of consolidating banking centers where it's made sense. In fact, selling some in other situations where it's made sense. And that activity should be expected to continue at some levels. We're also moving away in many cases from a typical kind of consumer-oriented banking center identifying targeted locations to serve either small business with our business bankers, and we think that's very powerful in the markets where we do business.

We've been doing some testing around this, and it's yielded really nice results for us, so we're very big on that move. It does create -- excuse me, efficiencies in and of itself as we make some of those moves. And then targeting other centers for serving more affluent clients that do more business with us as well. So there is a mix of consolidation activity, transitioning to digital, leveraging some centers more as business centers and then others for clients that have -- consumer clients that have, I'll call, what much more robust relationships with us then something that might be considered transactional. So we're pretty optimistic. We're in about where we can go in terms of continuing to both drive revenue while taking expense down to do it as we look to 2020.

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Gordon Reilly McGuire, Stephens Inc., Research Division - Research Analyst [24]

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Okay. So this would provide the opportunity to potentially lower the expense base? Or is this just stemming the growth?

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Aldis Birkans, National Bank Holdings Corporation - Executive VP, CFO & Treasurer [25]

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Yes. Well, not ready yet to provide 2020 guidance, but I think the speed and efficiency of which we execute on this will drive some of that, but -- and directionally, you're right.

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Gordon Reilly McGuire, Stephens Inc., Research Division - Research Analyst [26]

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And then just any update on the Utah expansion, how that's going? Whether they're contributing pretty meaningfully? And what kind of inning you feel like you're at there as far as the build-out?

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G. Timothy Laney, National Bank Holdings Corporation - Chairman, President & CEO [27]

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Did you say what kind of inning?

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Gordon Reilly McGuire, Stephens Inc., Research Division - Research Analyst [28]

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Inning.

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G. Timothy Laney, National Bank Holdings Corporation - Chairman, President & CEO [29]

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Yes. I would say, look, clearly, we're just getting started, right, but we continue to really like what we see as a very strong team there and it's only going to get stronger. The focus, again, is middle market and small business as well as residential banking. It's a thriving market. I just -- I don't want to talk it up too much because I don't want to attract other competitors, but it's a -- my goodness, it is an attractive market.

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Aldis Birkans, National Bank Holdings Corporation - Executive VP, CFO & Treasurer [30]

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And to answer your question, it is starting to contribute already to the performance. We're still investing. We're still in expansion mode. So the expense is still a larger, so to say, than the contribution, but the contribution on the loan originations, deposit growth, the fee income is already there coming from that market.

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Operator [31]

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Your next question comes from Nathan Race with Piper Jaffray.

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Robert James Shone, Piper Jaffray Companies, Research Division - Research Analyst [32]

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It's Bob Shone on for Nate. I wanted to turn to loan growth, and maybe can you talk about which markets are doing the best for you right now? And if you're maybe seeing or projecting strength in specific markets over others in fourth quarter in 2020?

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G. Timothy Laney, National Bank Holdings Corporation - Chairman, President & CEO [33]

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Right. So we benefit both on a loan growth and deposit growth standpoint from the fact that virtually every one of our core markets are operating better than the national averages on virtually every metric. So I would say that's a tide that continue to lift all boats in those markets and our teams work very hard to capture our fair share.

Clearly, when you think about a market like the Front Range of Colorado, it's a stand-out. But I should also even call out some of our specialty groups that operate within our geography, within our markets that are doing quite well while doing a great job of managing risk -- managing the risk related to the businesses. So I would tell you we're actually seeing solid contribution at this point across all of our markets and remain pretty optimistic, as Aldis said at the front of the call. Aldis, would you add? Or Rick, anything you would add?

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Richard U. Newfield, National Bank Holdings Corporation - Chief Risk Management Officer [34]

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Tim, I think you hit it. I mean we continue to see very diversified in terms of industry type and maintaining low exposures on commercial real estate overall and contributing across, what you describe, again, is very strong markets.

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G. Timothy Laney, National Bank Holdings Corporation - Chairman, President & CEO [35]

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While our commercial real estate balance is still running at or just below 100% of Tier 1 capital, I will add that with the low rate market, and Aldis alluded to this, we have seen the natural refinancing into longer-term debt structure or a fair amount of our commercial real estate debt, and we're perfectly fine with that. We feel like as trusted advisers to our clients helping them find those opportunities to refinance into longer-term low rates makes all the sense in the world. At the same time, I think you know we conduct semiannual stress testing on the total loan portfolio and each year that drives a certain amount of what we describe as pruning activity that I think Aldis also touched on that is just about looking at the exposure of certain relationships that we're not comfortable with based on the latest stress testing and moving to proactively move it out of the bank. So that's a natural ebb and flow that's been occurring now. We're into our third year. And Rick, you may want to take just a moment and talk about some of the latest results of the stress testing.

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Richard U. Newfield, National Bank Holdings Corporation - Chief Risk Management Officer [36]

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Sure, Tim. I'll touch on it briefly. I think I've shared this a couple of times before on these calls. But while we're not required to do stress testing, at our asset size, we conduct twice a year testing. One with our internal teammates, and one using a third-party that we find to be very conservative and really takes a hard look, and we do this bottoms up. So we're looking at hundreds of individual loan files. We're not doing just sort of some kind of quantitative methodology. So Tim, to your point, it gives us insight into specific opportunities to exit loans that are performing just fine. But as we look at stress scenarios ranging from current sort of base all the way to very severe that would be on top of what we experience or worse than the Great Recession, we're able to take those actions. And to your point, Tim, year-over-year, we've actually seen improvement in loss rates in the overall stress under any of those economic scenarios.

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G. Timothy Laney, National Bank Holdings Corporation - Chairman, President & CEO [37]

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Which is quite encouraging. So to answer your question in terms of production, look, we feel good about the contribution of all of our markets. We're, obviously somewhat cautious with more and more talk of economic downturn. We're fortunate in that our markets are all performing better than the national averages on virtually every metric. And at least our internal testing on our loan portfolio as well as the third-party testing continues to support a strong book.

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Robert James Shone, Piper Jaffray Companies, Research Division - Research Analyst [38]

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That's awesome color. And if I could just follow up with one more. You talked about the pruning of certain relationships, would you say a majority of the paydowns came from that review and taking the opportunity to evaluate the loan portfolio? Or was it more payoffs due to rate of structure from competition?

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G. Timothy Laney, National Bank Holdings Corporation - Chairman, President & CEO [39]

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On the rate of structure from competition, I don't even think of the longer-term perm financiers as competition to us. I mean that's not our -- for us, long-term financing is for 5 years. And so I don't think of it as competition, I would say, in the commercial real estate space that certainly had its impact in terms of that natural transition. Rick, what would you add?

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Richard U. Newfield, National Bank Holdings Corporation - Chief Risk Management Officer [40]

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No. I think to your point, Tim, it's balanced in that some of that is natural and does necessarily reflect issues or view of those clients. But certainly, within real estate, we're taking advantage of a very aggressive market where we see there could be opportunity to prune. We're also doing that on more cyclically vulnerable and that tends to be client by client because our portfolio is so diversified, it's not like a single sector maybe that we're focused on.

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G. Timothy Laney, National Bank Holdings Corporation - Chairman, President & CEO [41]

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Right. I mean an example you may want to speak to which most of this activity has been conducted over the last 2 or 3 years, but talk about as an example where we're at on our ag exposure?

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Richard U. Newfield, National Bank Holdings Corporation - Chief Risk Management Officer [42]

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Yes. That's a great example, Tim. And not one that, to your point, is a recent -- more recent phenomena. We started probably over 3 years ago with not only a specialized team with the right portfolio management and underwriting approach but also with a view that we've got this long-term pressure on row crop, livestock and other ag producers, and we need to diversify and work our way out of that segment and more downstream into more diversified and better capitalized ag clients, which has resulted in really no issues within that ag portfolio. In fact, over the last year plus, I think less than $20,000 in total charge-offs. But that would be one example. Certainly, in real estate, we've remained selected for some time, and I think that's just prudent as you pointed out is an ongoing process.

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G. Timothy Laney, National Bank Holdings Corporation - Chairman, President & CEO [43]

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So maybe the short answer to your question would be, it's been a real balance between what we would view as natural payoffs or refinancing and then the kind of pruning activity that Rick has described.

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Operator [44]

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Your next question comes from Chris McGratty with KBW.

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Kelly Ann Motta, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [45]

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This is actually Kelly Motta on for Chris today. Maybe just staying on credit for one second, I was hoping you could provide an update on the size of the energy book as well as the reserve level on that.

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Richard U. Newfield, National Bank Holdings Corporation - Chief Risk Management Officer [46]

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Sure, Kelly. This is Rick. So a couple of comments there. I mean we ended the quarter at roughly $46 million in energy loans. To be clear, we haven't originated a new energy loan in over 4 years. We've been working that portfolio down over time. In fact, year-to-date, it's down nearly 10% from 12/31/2018. In terms of the performance, it's very stable. I mean we've managed that exposure down significantly over the last several years, and the clients that we have within that book are performing well. Expect us to continue, since we're not originating new to see that trend down further over the next number of quarters.

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G. Timothy Laney, National Bank Holdings Corporation - Chairman, President & CEO [47]

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Any specific reserve commentary on that or...

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Richard U. Newfield, National Bank Holdings Corporation - Chief Risk Management Officer [48]

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No. Not really, Tim. None.

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G. Timothy Laney, National Bank Holdings Corporation - Chairman, President & CEO [49]

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It's great. [They’re all] -- I mean there's nothing unusual there.

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Richard U. Newfield, National Bank Holdings Corporation - Chief Risk Management Officer [50]

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No. All stable. We do have one very small nonaccrual loan that we had for some time. We expect to finally work out, but that's really not any news and the rest of the portfolio is quite stable.

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Kelly Ann Motta, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [51]

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Great. And then maybe a question on deposits, I believe. Aldis, in your prepared remarks, you mentioned that you expect deposit -- transaction deposit cost to continue to trend lower given just how your deposit base are performed on the way up. I was hoping you guys could help us figure out a way to think about how deposit data should perform now that the Fed is cutting.

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Aldis Birkans, National Bank Holdings Corporation - Executive VP, CFO & Treasurer [52]

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Yes. And I don't know if it's going to be symmetrical on the way down where it was way up, but I can tell you that we have taken a very hard look through starting in June with the first rate cut for July, I should say, and in September, we've been proactive. We've been in touch to the extent that there being exception pricings with the clients. We've been in touch with every single client as they understand the rate environment is changing. And I can tell you that if we report it on average basis, 39 basis point transaction deposit cost for the quarter. On a spot basis, at the end of September, it was 36. So we already seeing another 3 basis point pickup in the run rate heading into this fourth quarter and that's before if the Fed continues to cutting again, we'll take further actions.

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G. Timothy Laney, National Bank Holdings Corporation - Chairman, President & CEO [53]

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Did you get that, Kelly, 39 at the end of the quarter? On the spot to date, 36. We feel good about the trends, particularly as we continue to grow core operating accounts, noninterest-bearing accounts with our small business and midsized business clients. That's just a huge, huge success story for us.

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Aldis Birkans, National Bank Holdings Corporation - Executive VP, CFO & Treasurer [54]

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I'll add one more thing on just -- for the time deposits, that's a book, obviously, that's been locked in and it has its time to run off. And that cost for time deposits went up 10 basis points. If you look on a linked quarter basis, it will continue drifting slightly higher, nowhere near to the extent of 10 basis points that we saw in the third quarter. But just the way the nature of that book is repricing, it's still expected to drift a little bit higher this quarter and then normalize and start coming down in 2020.

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G. Timothy Laney, National Bank Holdings Corporation - Chairman, President & CEO [55]

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And again, to be clear there, not the -- I mean we were already -- we had already aggressively priced down our CD rates. This is just the lag of that period where rates had gone up, while the lower previous rates were burning off. So we view that as temporary, and it's -- we're watching it work through the pipeline as one would expect.

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Operator [56]

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Your next question comes from Tim O'Brien with Sandler O'Neill + Partners.

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Timothy O'Brien, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [57]

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Couple odds and ends questions. First, on the -- on NII, were there any interest reversals either tied to the charge-off or perhaps prepaid benefit and any onetime items that affected NII this quarter?

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Aldis Birkans, National Bank Holdings Corporation - Executive VP, CFO & Treasurer [58]

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Nothing material, Tim.

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Timothy O'Brien, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [59]

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Okay. Great. And then you talked a little bit about the subcontractor, those loans that segment or portfolio being just over 1% of total loans. As most of that book of business, did most of it come from Peoples?

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Richard U. Newfield, National Bank Holdings Corporation - Chief Risk Management Officer [60]

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Tim, this is Rick. No, Peoples certainly had a handful, and we only have a handful total at National.

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Timothy O'Brien, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [61]

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So it's a combination?

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Richard U. Newfield, National Bank Holdings Corporation - Chief Risk Management Officer [62]

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Right.

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Timothy O'Brien, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [63]

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Okay. And then with regard to the energy book, and this is just that you follow on Kelly's question, there was a little upturn sequentially in quarterly balances $43 million to $46 million. Is that tied to like an operating line that was being utilized or something because you, obviously, haven't -- you didn't originate any new loans in the quarter. Is that what that is?

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Richard U. Newfield, National Bank Holdings Corporation - Chief Risk Management Officer [64]

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Tim, that's exactly right. We had some drawdowns. This quarter, we actually had paydowns on some of those same lines in the previous quarter. So again, some ups and downs, but overall trending down.

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Timothy O'Brien, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [65]

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And then one last question. With regard to commercial real estate, lending and how that fits into your overall strategy. And Tim has been -- all you guys have been pretty clear about that through the years, but with regard to -- like owner-occupied commercial real estate, when you're chasing a relationship that -- how do you view the market conditions and conduits trying to get -- put on 10-year sub 4% fixed-rate loans and stuff for commercial real estate. How do you balance that with bringing -- serving your clients, I guess, these commercial relationship clients, Tim? What's -- do you want to make those loans -- is there value in making a loan like that and giving on term and -- or extending term a little bit on that just to keep the whole relationship? And how do you balance that? What's your philosophy or thoughts there?

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G. Timothy Laney, National Bank Holdings Corporation - Chairman, President & CEO [66]

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We balance it with a long-term view of saying we're going to be the best-trusted advisers we can for our clients. And if there is an opportunity in the cycle in the market for our client to access longer-term low-cost financing, then we're going to work to move with them in that direction and support them as they make that move. We, in many respects, define the heart of the relationship is having those core operating accounts, the depository business and then again earning that trusted adviser status, so you're not going to find that we're inclined to stretch out of our policy limits on term or price to make that happen. But we'll work with our clients to help them achieve their goals if that's what's important. And I would turn to Rick to ask Rick if you got any other thoughts on that.

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Richard U. Newfield, National Bank Holdings Corporation - Chief Risk Management Officer [67]

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No. I think that's exactly right and I kind of reacted to the word chase. And again, Tim, as you said, it's earning a relationship based on trust and what's best for the client. And ultimately maintaining a win-win or quality for the bank. And if the best answer is financing elsewhere, then we're still in support of that with that long-term view of the client.

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G. Timothy Laney, National Bank Holdings Corporation - Chairman, President & CEO [68]

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And Tim, I know we've talked about this in the past and you know this, but a powerful tool we use at our banker level is every banker is looking at the returns they're creating from every client relationship. And frankly, if you start down that rabbit hole of chasing term and price, they quickly see their direct contribution or their proxy for profitability is actually going to be negatively impacted. So it's reinforced at the banker level all the way up through the organization, and I think that's pretty clear.

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Operator [69]

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And 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.

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G. Timothy Laney, National Bank Holdings Corporation - Chairman, President & CEO [70]

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Thank you, Mariama. I'll simply say, I know everyone on the line is busy, I'll say thank you for joining and will certainly take any follow-up calls should they come later. Have a great day.

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Operator [71]

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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 5, 2019, by dialing (855) 859-2056 or (404) 537-3406 and referencing the conference ID of 6784839. The earnings release and an online replay of this call will also 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.