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NBHC > SEC Filings for NBHC > Form 10-Q on 13-Aug-2013All Recent SEC Filings

Show all filings for NATIONAL BANK HOLDINGS CORP

Form 10-Q for NATIONAL BANK HOLDINGS CORP


13-Aug-2013

Quarterly Report


Item 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following management discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited consolidated financial statements and related notes for the three and six months ended June 30, 2013 and 2012, and with our annual report on Form 10-K (file number 001-35654), which includes our audited consolidated financial statements and related notes as of and for the years ended December 31, 2012, 2011, and 2010. Additional information, such as statements of assets acquired and liabilities assumed for each of our acquisitions and other financial and statistical data is also available in our prospectus included in Form S-1 filed with the Securities and Exchange Commission on September 19, 2012 (file number 333-177971). This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions that may cause actual results to differ materially from management's expectations. Factors that could cause such differences are discussed in the section entitled "Cautionary Note Regarding Forward-Looking Statements" located elsewhere in this quarterly report and in Item 1A"Risk Factors" in the annual report on Form 10-K, referenced above, and should be read herewith.
Readers are cautioned that meaningful comparability of current period financial information to prior periods may be limited. Prior to the completion of the Hillcrest Bank acquisition on October 22, 2010, we had no banking operations and our activities were limited to corporate organization matters and due diligence. Following our Hillcrest Bank acquisition, we completed three additional acquisitions: Bank Midwest on December 10, 2010, Bank of Choice on July 22, 2011 and Community Banks of Colorado on October 21, 2011. As a result, our operating results are limited to the periods since these acquisitions, and the comparability of periods is compromised due to the timing of these acquisitions. Additionally, the comparability of data related to our acquisitions prior to the respective dates of acquisition is limited because, in accordance with Accounting Standards Codification ("ASC") Topic 805, Business Combinations, the assets acquired and liabilities assumed were recorded at fair value at their respective dates of acquisition and do not have a significant resemblance to the assets and liabilities of the predecessor banking franchises. The comparability of pre-acquisition data is compromised not only by the fair value accounting applied, but also by the FDIC loss sharing agreements in place that cover a portion of losses incurred on certain assets acquired in the Hillcrest Bank and the Community Banks of Colorado acquisitions. In the Bank Midwest acquisition, only specific, performing loans were chosen for acquisition. Additionally, we acquired the assets of Bank of Choice at a substantial discount from the FDIC. We received a considerable amount of cash during the settlement of these acquisitions, we paid off certain borrowings, and we contributed significant capital to each banking franchise we acquired. All of these actions materially changed the balance sheet composition, liquidity, and capital structure of the acquired banking franchises.
In May 2012, we changed the name of Bank Midwest, N.A. to NBH Bank, N.A. ("NBH Bank" or the "Bank") and all references to NBH Bank, N.A. should be considered synonymous with references to Bank Midwest, N.A. prior to the name change.

Overview
National Bank Holdings Corporation is a bank holding company that was incorporated in the State of Delaware in June 2009. In October 2009, we raised net proceeds of approximately $974 million through a private offering of our common stock. We completed the initial public offering of our common stock in September 2012. We are executing a strategy to create long-term stockholder value through the acquisition and operation of community banking franchises and other complementary businesses in our targeted markets. We believe these markets exhibit attractive demographic attributes, are home to a substantial number of financial institutions, including troubled financial institutions, and present favorable competitive dynamics, thereby offering long-term opportunities for growth. Our emphasis is on creating meaningful market share with strong revenues complemented by operational efficiencies that we believe will produce attractive risk-adjusted returns.
We believe we have a disciplined approach to acquisitions, both in terms of the selection of targets and the structuring of transactions, which has been exhibited by our four acquisitions to date. As of June 30, 2013, we had $5.2 billion in assets, $4.0 billion in deposits and $1.0 billion in equity. We currently operate a network of 101 full-service banking centers, with the majority of those banking centers located in the greater Kansas City region and Colorado. We believe that our established presence positions us well for growth opportunities in our current and complementary markets.
Our strategic plan is to be a leading regional bank holding company through selective acquisitions of financial institutions, including troubled financial institutions, that have stable core franchises and significant local market share, as well as other complementary businesses, while structuring transactions to limit risk. We plan to achieve this through the growth of our existing banking franchise and through conservatively structured unassisted transactions and through the acquisition of banking franchises from the FDIC. We seek acquisitions that offer opportunities for clear financial benefits through add-on transactions, long-term organic growth opportunities and expense reductions. Additionally, our acquisition strategy is to identify markets that are relatively unconsolidated, establish a meaningful presence within those markets, and take advantage of operational efficiencies and enhanced market position. Our focus is on building strong banking relationships with small to mid-sized


businesses and consumers, while maintaining a low risk profile designed to generate reliable income streams and attractive returns. Through our acquisitions, we have established a solid core banking franchise with operations in the greater Kansas City region and in Colorado, with a sizable presence for deposit gathering and client relationship building necessary for growth.

Operating Highlights and Key Challenges
Our operations resulted in the following highlights as of and for the six months
ended June 30, 2013:
Low-risk balance sheet
        As of June 30, 2013, 58.7%, or $1.0 billion, of our total loans (by
         dollar amount) were acquired loans and all of those loans were recorded
         at their estimated fair value at the time of acquisition.


        As of June 30, 2013, 26.3%, or $453.8 million, of our total loans (by
         dollar amount) were covered by loss sharing agreements with the FDIC.


        As of June 30, 2013, 57.4%, or $45.5 million, of our total other real
         estate owned (by dollar amount) was covered by loss sharing agreements
         with the FDIC.

Loan portfolio

        As of June 30, 2013, we have $1.2 billion of loans outstanding that are
         associated with a "strategic" client relationship - an 18.8% annualized
         growth for the six months ended June 30, 2013.


        Organic loan originations totaled $278.1 million for the six months
         ended June 30, 2013, representing a 66.9% increase from the same period
         of 2012.


        A $109.4 million decrease in total loans was led by a $214.3 million
         decrease in our non-strategic loans during the six months ended June 30,
         2013 as we successfully worked out non-strategic loans acquired in our
         FDIC-assisted transactions.

35.8% of the loan portfolio is accounted for under ASC 310-30 (loan pools).

Credit quality
Strategic loans

?              Loans associated with our strategic client relationships had
               strong credit quality with only 0.80% in non-performing loans as
               of June 30, 2013.

Non 310-30 loans

?              Credit quality of the non 310-30 loan portfolio continued to
               improve with non-performing non 310-30 loans to total non 310-30
               loans improving to 2.63% at June 30, 2013 from 4.04% at December
               31, 2012.

? Net charge-offs on non 310-30 loans were 0.56% annualized.

310-30 loans

?              Accretable yield for the acquired loans accounted for under ASC
               310-30 increased $35.0 million during the six months ended June
               30, 2013. This was partially offset by $1.3 million in impairments
               during the same period.


?              One commercial and industrial loan pool accounted for under ASC
               310-30, totaling $18.7 million and covered by a loss-sharing
               agreement, was put on non-accrual status during the six months
               ended June 30, 2013. While the collectability of the carrying
               value of this loan pool is still considered probable, management
               determined that the cash flows and the timing of those cash flows
               were no longer estimable. As a result, this pool is now considered
               a non-performing asset.

Client deposit funded balance sheet

        As of June 30, 2013, total deposits and client repurchase agreements
         made up 98.4% of our total liabilities.


        Transaction accounts increased to 60.0% of total deposits as of June 30,
         2013 from 58.3% at December 31, 2012.

Average transaction account deposit balances grew 5.1% annualized.

As of June 30, 2013, we did not have any brokered deposits.

Yields, returns and revenue stream
Our average annual yield on our loan portfolio was 8.05% for the six months ended June 30, 2013.


        Cost of deposits improved 31 basis points to 0.43% for the six months
         ended June 30, 2013 from 0.74% for the six months ended June 30, 2012
         due to the continued emphasis on our commercial and consumer
         relationship banking strategy and lower cost transaction accounts.


        Net interest margin was 3.82% during the six months ended June 30, 2013,
         driven by the attractive yields on loans accounted for under ASC 310-30
         loan pools and lower cost of deposits.


        Expenses before problem loan/OREO workout expenses declined $2.1 million
         during the six months ended June 30, 2013 compared to the same period in
         2012, adjusting for IPO expenses incurred in 2012.


        Problem loan/OREO workout expenses totaled $10.4 million for the six
         months ended June 30, 2013, decreasing $2.7 million from the same period
         in 2012.

Strong capital position

        As of June 30, 2013, our consolidated tier 1 leverage ratio was 18.7%
         and our consolidated tier 1 risk-based capital ratio was 50.1%.


        As of June 30, 2013 we had approximately $400 million of capital
         available to deploy while maintaining a 10% leverage ratio, and we had
         approximately $475 million of available capital to deploy at an 8%
         leverage ratio.


        The after-tax accretable yield on ASC 310-30 loans plus the after-tax
         yield on the FDIC Indemnification asset, net, in excess of 4.5%, an
         approximate yield on new loan originations, and discounted at 5%, adds
         $0.68 per share to our tangible book value per share as of June 30,
         2013.


        Tangible book value per share was $18.68 before consideration of the
         excess accretable yield value of $0.68 per share.

Repurchased 950,474 shares at a weighted average price of $18.21 per share.

Key Challenges
There are a number of significant challenges confronting us and our industry. Economic conditions remain guarded and increasing bank regulation is adding costs and uncertainty to all U.S. banks. We face a variety of challenges in implementing our business strategy, including being a new entity, hiring talented people, the challenges of acquiring distressed franchises and rebuilding them, deploying our remaining capital on quality targets, low interest rates and low demand from borrowers and intense competition for loans. Continued uncertainty about the economic outlook has strained the advancement of an economic recovery, both nationally and in our core markets. Residential real estate values have largely recovered from their lows, and we continue to consider this with guarded optimism. Commercial real estate values have been recovering slightly slower than residential real estate, and it is difficult to determine how strong this recovery is and how long it will last. Any deterioration in credit quality or elevated levels of non-performing assets, would ultimately have a negative impact on the quality of our loan portfolio. The decrease of our total loan balances during the first six months of 2013 was the result of active resolution of problem and non-strategic loans acquired in our FDIC-assisted transactions outpacing organic loan growth. Additionally, the historically low interest rate environment and loan competition have been limiting the yields we are able to obtain on interest earning assets, including both new assets acquired as we grow and assets that replace existing, higher yielding assets as they are paid down or mature. For example, our acquired loans generally have produced higher yields than our originated loans due to the recognition of accretion of fair value adjustments and accretable yield. As a result, we expect the yields on our loans to decline as our acquired loan portfolio pays down or matures and we expect downward pressure on our interest income to the extent that the runoff on our acquired loan portfolio is not replaced with comparable high-yielding loans.
Increased regulation, such as the rules and regulations promulgated under the Dodd-Frank Act or potential higher required capital ratios, could reduce our competitiveness as compared to other banks or lead to industry-wide decreases in profitability. While certain external factors are out of our control and may provide obstacles during the implementation of our business strategy, we believe we are prepared to deal with these challenges. We seek to remain flexible, yet methodical, in our strategic decision making so that we can quickly respond to market changes and the inherent challenges and opportunities that accompany such changes.


Performance Overview
As a financial institution, we routinely evaluate and review our consolidated statements of financial condition and results of operations. We evaluate the levels, trends and mix of the statements of financial condition and statements of operations line items and compare those levels to our budgeted expectations, our peers, industry averages and trends. Within our statements of financial condition, we specifically evaluate and manage the following:
Loan balances - We monitor our loan portfolio to evaluate loan originations, payoffs, and profitability. We forecast loan originations and payoffs within the overall loan portfolio, and we work to resolve problem loans and OREO in an expeditious manner. We track the runoff of our covered assets as well as the loan relationships that we have identified as "non-strategic" and put particular emphasis on the buildup of "strategic" relationships.
Asset quality - We monitor the asset quality of our loans and OREO through a variety of metrics, and we work to resolve problem assets in an efficient manner. Specifically, we monitor the resolution of problem loans through payoffs, pay downs and foreclosure activity. We marked all of our acquired assets to fair value at the date of their respective acquisitions, taking into account our estimation of credit quality.
Many of the loans that we acquired in the Hillcrest Bank, Bank of Choice and Community Banks of Colorado acquisitions had deteriorated credit quality at the respective dates of acquisition. These loans are accounted for under ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. This guidance is described more fully below under "-Application of Critical Accounting Policies" and in note 2 in our consolidated financial statements in our 2012 Annual Report on Form 10-K.
Our evaluation of traditional credit quality metrics and the allowance for loan losses ("ALL") levels, especially when compared to industry averages or to other financial institutions, takes into account that any credit quality deterioration that existed at the date of acquisition was considered in the original valuation of those assets on our balance sheet. Additionally, many of these assets are covered by loss sharing agreements. All of these factors limit the comparability of our credit quality and ALL levels to peers or other financial institutions. Deposit balances - We monitor our deposit levels by type, market and rate. Our loans are funded through our deposit base, and we seek to optimize our deposit mix in order to provide reliable, low-cost funding sources.
Liquidity - We monitor liquidity based on policy limits and through projections of sources and uses of cash. In order to test the adequacy of our liquidity, we routinely perform various liquidity stress test scenarios that incorporate wholesale funding maturities, if any, certain deposit run-off rates and committed line of credit draws. We manage our liquidity primarily through our balance sheet mix, including our cash and our investment security portfolio, and the interest rates that we offer on our loan and deposit products, coupled with contingency funding plans as necessary.
Capital - We monitor our capital levels, including evaluating the effects of potential acquisitions, to ensure continued compliance with regulatory requirements and with the OCC Operating Agreement and FDIC Order that we entered into with our regulators in connection with our Bank Midwest acquisition, which is described under "Supervision and Regulation" in our 2012 Annual Report on Form 10-K. We review our tier 1 leverage capital ratios, our tier 1 risk-based capital ratios and our total risk-based capital ratios on a quarterly basis. Within our consolidated results of operations, we specifically evaluate the following:
Net interest income - Net interest income represents the amount by which interest income on interest earning assets exceeds interest expense incurred on interest bearing liabilities. We generate interest income through interest and dividends on investment securities, interest bearing bank deposits and loans. Our acquired loans have generally produced higher yields than our originated loans due to the recognition of accretion of fair value adjustments and accretable yield and, as a result, we expect downward pressure on our interest income to the extent that the runoff of our acquired loan portfolio is not replaced with comparable high-yielding loans. We incur interest expense on our interest bearing deposits and repurchase agreements and would also incur interest expense on any future borrowings, including any debt assumed in acquisitions. We strive to maximize our interest income by acquiring and originating loans and investing excess cash in investment securities. Furthermore, we seek to minimize our interest expense through low-cost funding sources, thereby maximizing our net interest income.

Provision for loan losses - The provision for loan losses includes the amount of expense that is required to maintain the ALL at an adequate level to absorb probable losses inherent in the loan portfolio at the balance sheet date. Additionally, we incur a provision for loan losses on loans accounted for under ASC 310-30 as a result of a decrease in the net present value of the expected future cash flows during the periodic remeasurement of the cash flows associated with these pools of loans. The determination of the amount of the provision for loan losses and the related ALL is complex and involves a high degree of judgment and subjectivity to maintain a level of ALL that is considered by management to be appropriate under GAAP.


Non-interest income - Non-interest income consists primarily of service charges, bank card fees, gains on sales of investment securities, and other non-interest income. Also included in non-interest income is FDIC indemnification asset accretion and other FDIC loss sharing income, which consists of reimbursement of costs related to the resolution of covered assets, and amortization of our clawback liability. For additional information, see "-Application of Critical Accounting Policies-Acquisition Accounting Application and the Valuation of Assets Acquired and Liabilities Assumed" in our 2012 Annual Report on Form 10-K and note 2 in our audited consolidated financial statements. Due to fluctuations in the accretion rates on the FDIC indemnification asset and the amortization of clawback liability and due to varying levels of expenses related to the resolution of covered assets, the FDIC loss sharing income is not consistent on a period-to-period basis and, absent additional acquisitions with FDIC loss sharing agreements, is expected to decline over time as covered assets are resolved.
Non-interest expense - The primary components of our non-interest expense are salaries and employee benefits, occupancy and equipment, professional fees and data processing and telecommunications. Any expenses related to the resolution of covered assets are also included in non-interest expense. These expenses are dependent on individual resolution circumstances and, as a result, are not consistent from period to period. We seek to manage our non-interest expense in order to maximize efficiencies.
Net income - We utilize traditional industry return ratios such as return on average assets, return on average equity and return on risk-weighted assets to measure and assess our returns in relation to our balance sheet profile. In evaluating the financial statement line items described above, we evaluate and manage our performance based on key earnings indicators, balance sheet ratios, asset quality metrics and regulatory capital ratios, among others. The table below presents some of the primary performance indicators that we use to analyze our business on a regular basis for the periods indicated:


                                                                                    As of and for the six
                                     As of and for the three months ended               months ended
                                  June 30,         December 31,      June 30,      June 30,        June 30,
                                    2013               2012            2012          2013            2012
Key Ratios (1)
Return on average assets                0.22 %           0.22 %         0.18 %       0.19 %           0.14 %
Return on average tangible
assets (2)                              0.29 %           0.28 %         0.25 %       0.26 %           0.20 %
Return on average equity                1.08 %           1.10 %         0.99 %       0.93 %           0.80 %
Return on average tangible
common equity (2)                       1.50 %           1.51 %         1.42 %       1.34 %           1.20 %
Return on risk weighted assets          0.61 %           0.64 %         0.55 %       0.53 %           0.44 %
Interest-earning assets to
interest-bearing liabilities
(end of period) (3)                   137.95 %         134.44 %       130.30 %     137.95 %         130.30 %
Loans to deposits ratio (end of
period)                                43.37 %          43.76 %        43.80 %      43.37 %          43.80 %
Average equity to average
assets                                 20.72 %          20.09 %        18.52 %      20.63 %          18.10 %
Non-interest bearing deposits
to total deposits (end of
period)                                16.75 %          16.14 %        14.00 %      16.75 %          14.00 %
Net interest margin (4)                 3.77 %           4.09 %         4.00 %       3.82 %           3.96 %
Interest rate spread (5)                3.64 %           3.94 %         3.83 %       3.69 %           3.78 %
Yield on earning assets (3)             4.13 %           4.51 %         4.61 %       4.20 %           4.62 %
Cost of interest bearing
liabilities (3)                         0.49 %           0.57 %         0.78 %       0.51 %           0.84 %
Cost of deposits                        0.42 %           0.48 %         0.69 %       0.43 %           0.74 %
Non-interest expense to average
assets                                  3.49 %           3.77 %         3.09 %       3.58 %           3.27 %
Efficiency ratio (6)                   85.05 %          85.43 %        70.96 %      86.69 %          76.19 %
Dividend payout ratio                  83.33 %          83.33 %         0.00 %     100.00 %           0.00 %

Asset Quality Data (7) (8) (9)
Non-performing loans to total
loans                                   2.77 %           2.23 %         2.51 %       2.77 %           2.51 %
Covered non-performing loans to
total non-performing loans             59.65 %          27.14 %        15.59 %      59.65 %          15.59 %
Non-performing assets to total
assets                                  2.46 %           2.53 %         3.26 %       2.46 %           3.26 %
Covered non-performing assets
to total non-performing assets         58.12 %          41.70 %        45.41 %      58.12 %          45.41 %
Allowance for loan losses to
total loans                             0.69 %           0.84 %         0.87 %       0.69 %           0.87 %
Allowance for loan losses to
total non-covered loans                 0.93 %           1.26 %         1.42 %       0.93 %           1.42 %
Allowance for loan losses to
non-performing loans                   24.81 %          37.64 %        34.69 %      24.81 %          34.69 %
Net charge-offs to average
loans                                   0.63 %           1.00 %         1.45 %       0.76 %           1.36 %

(1) Ratios are annualized.

(2) Ratio represents non-GAAP financial measure.

(3) Interest earning assets include assets that earn interest/accretion or dividends, except for the FDIC indemnification asset that may earn accretion but is not part of interest earning assets. Any market value adjustments on investment securities are excluded from interest-earning assets. Interest bearing liabilities include liabilities that must be paid interest.

(4) Net interest margin represents net interest income, including accretion income on interest earning assets, as a percentage of average interest earning assets.

(5) Interest rate spread represents the difference between the weighted average yield on interest earning assets and the weighted average cost of interest bearing liabilities.

(6) The efficiency ratio represents non-interest expense, less intangible asset amortization, as a percentage of net interest income plus non-interest income.


(7) Non-performing loans consist of non-accruing loans, loans 90 days or more . . .

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