NBHC_2013.09.30_10Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2013
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number: 001-35654
 
NATIONAL BANK HOLDINGS CORPORATION
(Exact name of registrant as specified in its charter)
 
Delaware
 
27-0563799
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
7800 East Orchard, Suite 300, Greenwood Village, Colorado 80111
(Address of principal executive offices) (Zip Code)
Registrant’s telephone, including area code: (720) 529-3336
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “accelerated filer.” and “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
 
¨
  
Accelerated filer
 
¨
 
 
 
 
 
 
 
Non-accelerated filer
 
x  (do not check if a smaller reporting company)
  
Smaller Reporting Company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
As of November 7, 2013, NBHC had outstanding 42,325,987 shares of Class A voting common stock and 3,127,774 shares of Class B non-voting common stock, each with $0.01 par value per share.

1






Page
 
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
Item 3.
 
 
 
 
 
 
 
Item 4.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
Item 1A.
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
 
Item 6.
 
 
 
 
 
 
 
 
 
 
 
 
 
Exhibit 31.1
 
Certification of CEO Pursuant to Section 302 of Sarbanes- Oxley Act of 2002
 
 
 
 
 
 
 
Exhibit 31.2
 
Certification of CFO Pursuant to Section 302 of Sarbanes- Oxley Act of 2002
 
 
 
 
 
 
 
Exhibit 32
 
Certifications of CEO and CFO pursuant to 18 U.S.C. Section 1350
 
 


2


CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, notwithstanding that such statements are not specifically identified. Any statements about our expectations, beliefs, plans, predictions, forecasts, objectives, assumptions or future events or performance are not historical facts and may be forward-looking. These statements are often, but not always, made through the use of words or phrases such as “anticipate,” “believe,” “can,” “would,” “should,” “could,” “may,” “predict,” “anticipate,” “seek,” “potential,” “will,” “estimate,” “target,” “plan,” “project,” “continuing,” “ongoing,” “expect,” “intend” and similar words or phrases. These statements are only predictions and involve estimates, known and unknown risks, assumptions and uncertainties. We have based these statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, liquidity, results of operations, business strategy and growth prospects.

Forward-looking statements involve certain important risks, uncertainties and other factors, any of which could cause actual results to differ materially from those in such statements and, therefore, you are cautioned not to place undue reliance on such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to:

our ability to execute our business strategy, as well as changes in our business strategy or development plans;
business and economic conditions generally and in the financial services industry;
economic, market, operational, liquidity, credit and interest rate risks associated with our business;
effects of any changes in trade, monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve Board;
changes imposed by regulatory agencies to increase our capital to a level greater than the current level required for well-capitalized financial institutions (including the impact of the recent joint final rules promulgated by the Federal Reserve Board, Office of the Comptroller of the Currency and the FDIC revising certain regulatory capital requirements to align with the Basel III capital standards and meet certain requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act);
effects of inflation, as well as, interest rate, securities market and monetary supply fluctuations;
changes in the economy or supply-demand imbalances affecting local real estate values;
changes in consumer spending, borrowings and savings habits;
our ability to identify potential candidates for, obtain regulatory approval, and consummate, acquisitions of financial institutions on attractive terms, or at all;
our ability to integrate acquisitions and to achieve synergies, operating efficiencies and/or other expected benefits within expected time-frames, or at all, or within expected cost projections, and to preserve the goodwill of acquired financial institutions;
our ability to achieve organic loan and deposit growth and the composition of such growth;
changes in sources and uses of funds, including loans, deposits and borrowings;
increased competition in the financial services industry, nationally, regionally or locally, resulting in, among other things, lower risk-adjusted returns;
the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters;
continued consolidation in the financial services industry;
our ability to maintain or increase market share and control expenses;
costs and effects of changes in laws and regulations and of other legal and regulatory developments, including, but not limited to, changes in regulation that affect the fees that we charge, the resolution of legal proceedings or regulatory or other governmental inquiries, and the results of regulatory examinations, reviews or other inquires.
technological changes;
the timely development and acceptance of new products and services and perceived overall value of these products and services by our clients;
changes in our management personnel and our continued ability to hire and retain qualified personnel;
ability to implement and/or improve operational management and other internal risk controls and processes and our reporting system and procedures;
regulatory limitations on dividends from our bank subsidiary;
changes in estimates of future loan reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements;
political instability, acts of war or terrorism and natural disasters;
impact of reputational risk on such matters as business generation and retention; and
our success at managing the risks involved in the foregoing items.

1


Any forward-looking statement speaks only as of the date on which it is made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events or circumstances, except as required by applicable law.



2


PART I: FINANCIAL INFORMATION
Item 1: FINANCIAL STATEMENTS
NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
Consolidated Statements of Financial Condition (Unaudited)
(In thousands, except share and per share data)

 
September 30, 2013
 
December 31, 2012
ASSETS
 
 
 
Cash and due from banks
$
69,185

 
$
90,505

Due from Federal Reserve Bank of Kansas City
254,456

 
579,267

Interest bearing bank deposits
25,603

 
99,408

Cash and cash equivalents
349,244

 
769,180

Securities purchased under agreements to resell
75,000

 

Investment securities available-for-sale (at fair value)
1,889,962

 
1,718,028

Investment securities held-to-maturity (fair value of $664,578 and $584,551 at September 30, 2013 and December 31, 2012, respectively)
664,717

 
577,486

Non-marketable securities
31,725

 
32,996

Loans (including covered loans of $366,346 and $608,222 at September 30, 2013 and December 31, 2012, respectively)
1,742,813

 
1,832,702

Allowance for loan losses
(11,419
)
 
(15,380
)
Loans, net
1,731,394

 
1,817,322

Loans held for sale
5,265

 
5,368

Federal Deposit Insurance Corporation (“FDIC”) indemnification asset, net
58,086

 
86,923

Other real estate owned
70,753

 
94,808

Premises and equipment, net
117,285

 
121,436

Goodwill
59,630

 
59,630

Intangible assets, net
23,566

 
27,575

Other assets
85,342

 
100,023

Total assets
$
5,161,969

 
$
5,410,775

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Liabilities:
 
 
 
Deposits:
 
 
 
Non-interest bearing demand deposits
$
689,405

 
$
677,985

Interest bearing demand deposits
430,123

 
529,996

Savings and money market
1,297,585

 
1,240,020

Time deposits
1,534,390

 
1,752,718

Total deposits
3,951,503

 
4,200,719

Securities sold under agreements to repurchase
116,471

 
53,685

Due to FDIC
31,964

 
31,271

Other liabilities
30,781

 
34,541

Total liabilities
4,130,719

 
4,320,216

Stockholders’ equity:
 
 
 
Common stock, par value $0.01 per share: 400,000,000 shares authorized; 52,300,198 and 53,279,579 shares issued; 51,213,044 and 52,327,672 shares outstanding at September 30, 2013 and December 31, 2012, respectively
512

 
523

Additional paid in capital
989,614

 
1,006,194

Retained earnings
41,266

 
43,273

Treasury stock of 240 shares at December 31, 2012, at cost

 
(4
)
Accumulated other comprehensive income (loss), net of tax
(142
)
 
40,573

Total stockholders’ equity
1,031,250

 
1,090,559

Total liabilities and stockholders’ equity
$
5,161,969

 
$
5,410,775

See accompanying notes to the unaudited consolidated interim financial statements.

3


NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations (Unaudited)
(In thousands, except share and per share data)
 
For the three months ended
 
For the nine months ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Interest and dividend income:
 
 
 
 
 
 
 
Interest and fees on loans
$
35,328

 
$
40,105

 
$
105,783

 
$
129,290

Interest and dividends on investment securities
13,539

 
15,190

 
40,383

 
46,750

Dividends on non-marketable securities
388

 
377

 
1,170

 
1,142

Interest on interest-bearing bank deposits
267

 
370

 
762

 
1,595

Total interest and dividend income
49,522

 
56,042

 
148,098

 
178,777

Interest expense:
 
 
 
 
 
 
 
Interest on deposits
3,965

 
6,519

 
12,647

 
24,022

Interest on borrowings
42

 
27

 
80

 
88

Total interest expense
4,007

 
6,546

 
12,727

 
24,110

Net interest income before provision for loan losses
45,515

 
49,496

 
135,371

 
154,667

Provision for loan losses
437

 
5,263

 
3,524

 
25,325

Net interest income after provision for loan losses
45,078

 
44,233

 
131,847

 
129,342

Non-interest income:
 
 
 
 
 
 
 
FDIC indemnification asset negative accretion
(4,208
)
 
(2,832
)
 
(11,843
)
 
(9,165
)
FDIC loss sharing income
(1,191
)
 
1,503

 
3,278

 
9,278

Service charges
4,334

 
4,466

 
11,944

 
13,170

Bank card fees
2,482

 
2,484

 
7,509

 
7,168

Gain on sales of mortgages, net
345

 
283

 
1,125

 
886

Gain on sale of securities, net

 

 

 
674

Gain on previously charged-off acquired loans
224

 
837

 
1,118

 
2,627

Other non-interest income
1,352

 
1,322

 
4,682

 
3,744

Total non-interest income
3,338

 
8,063

 
17,813

 
28,382

Non-interest expense:
 
 
 
 
 
 
 
Salaries and employee benefits
22,639

 
27,182

 
69,363

 
72,226

Occupancy and equipment
6,556

 
5,570

 
18,391

 
14,845

Professional fees
791

 
2,669

 
3,045

 
8,612

Telecommunications and data processing
3,050

 
4,475

 
9,805

 
11,694

Marketing and business development
1,408

 
1,760

 
3,519

 
4,290

Supplies and printing
326

 
1,288

 
1,180

 
2,495

Other real estate owned expenses
459

 
3,468

 
7,675

 
12,152

Problem loan expenses
1,134

 
2,267

 
4,361

 
6,704

Intangible asset amortization
1,336

 
1,353

 
4,009

 
4,020

FDIC deposit insurance
1,021

 
1,152

 
3,074

 
3,664

ATM/debit card expenses
1,179

 
1,102

 
3,291

 
3,100

Banking center closure related expenses
3,389

 

 
3,389

 

Initial public offering related expenses

 
7,566

 

 
7,974

Acquisition related costs

 

 

 
870

Loss (gain) from the change in fair value of warrant liability
441

 
(1,154
)
 
138

 
(1,017
)
Other non-interest expense
2,884

 
1,259

 
8,487

 
6,602

Total non-interest expense
46,613

 
59,957

 
139,727

 
158,231

Income (loss) before income taxes
1,803

 
(7,661
)
 
9,933

 
(507
)
Income tax expense
856

 
230

 
4,006

 
3,039

Net income (loss)
$
947

 
$
(7,891
)
 
$
5,927

 
$
(3,546
)
Income (loss) per share—basic
$
0.02

 
$
(0.15
)
 
$
0.11

 
$
(0.07
)
Income (loss) per share—diluted
$
0.02

 
$
(0.15
)
 
$
0.11

 
$
(0.07
)
Weighted average number of common shares outstanding:
 
 
 
 
 
 
 
Basic
51,454,200

 
52,191,239

 
51,940,245

 
52,186,465

Diluted
51,501,980

 
52,191,239

 
51,973,161

 
52,186,465

See accompanying notes to the unaudited consolidated interim financial statements.

4


NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income (Loss) (Unaudited)
(In thousands)

 
For the three months ended
 
For the nine months ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Net income (loss)
$
947

 
$
(7,891
)
 
$
5,927

 
$
(3,546
)
Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Securities available-for-sale:
 
 
 
 
 
 
 
Net unrealized gains (losses) arising during the period, net of tax benefit (expense) of $5,141 and ($1,498) for the three months ended September 30, 2013 and 2012, respectively; and net of tax benefit (expense) of $22,852 and ($2,624) for the nine months ended September 30, 2013 and 2012, respectively
(8,214
)
 
2,357

 
(36,015
)
 
4,074

Reclassification adjustment for net securities gains included in net income, net of tax expense of $263 for the nine months ended September 30, 2012

 

 

 
(411
)
Reclassification adjustment for net unrealized holding gains on securities transferred between available-for-sale and held-to-maturity, net of tax expense of $15,159 for the nine months ended September 30, 2012

 

 

 
(23,711
)
 
$
(8,214
)
 
$
2,357

 
$
(36,015
)
 
$
(20,048
)
Net unrealized holding gains on securities transferred between available-for-sale to held-to-maturity:
 
 
 
 
 
 
 
Net unrealized holding gains on securities transferred, net of tax expense of $15,159 for the nine months ended September 30, 2012

 

 

 
23,711

Less: amortization of net unrealized holding gains to income, net of tax benefit of $738 and $1,302 for the three months ended September 30, 2013 and 2012, respectively; and net of tax benefit of $2,943 and $2,215 for the nine months ended September 30, 2013 and 2012, respectively
(1,178
)
 
(2,036
)
 
(4,700
)
 
(3,933
)
 
(1,178
)
 
(2,036
)
 
(4,700
)
 
19,778

Other comprehensive income (loss)
(9,392
)
 
321

 
(40,715
)
 
(270
)
Comprehensive loss
$
(8,445
)
 
$
(7,570
)
 
$
(34,788
)
 
$
(3,816
)
See accompanying notes to the unaudited consolidated interim financial statements.

5


NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)
Nine Months Ended September 30, 2013 and 2012
(In thousands, except share and per share data)
 
 
Common
stock
 
Additional
paid-in
capital
 
Retained
earnings
 
Treasury
stock
 
Accumulated
other
comprehensive
income, net
 
Total
Balance, December 31, 2011
$
522

 
$
994,705

 
$
46,480

 
$

 
$
47,022

 
$
1,088,729

Net income

 

 
(3,546
)
 

 

 
(3,546
)
Stock-based compensation

 
10,922

 

 

 

 
10,922

Other comprehensive loss

 

 

 

 
(270
)
 
(270
)
Balance, September 30, 2012
522

 
1,005,627

 
42,934

 

 
46,752

 
1,095,835

Balance, December 31, 2012
523

 
1,006,194

 
43,273

 
(4
)
 
40,573

 
1,090,559

Net income

 

 
5,927

 

 

 
5,927

Stock-based compensation

 
4,003

 

 

 

 
4,003

(Repurchase) /retirement of shares
(11
)
 
(20,583
)
 

 
4

 

 
(20,590
)
Dividends paid ($0.15 per share)

 

 
(7,934
)
 

 

 
(7,934
)
Other comprehensive loss

 

 

 

 
(40,715
)
 
(40,715
)
Balance, September 30, 2013
$
512

 
$
989,614

 
$
41,266

 
$

 
$
(142
)
 
$
1,031,250

See accompanying notes to the unaudited consolidated interim financial statements.

6


NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)
(In thousands)
 
For the nine months ended
 
September 30,
 
2013
 
2012
Cash flows from operating activities:
 
 
 
Net income (loss)
$
5,927

 
$
(3,546
)
Adjustments to reconcile net income to net cash used in operating activities:
 
 
 
Provision for loan losses
3,524

 
25,325

Depreciation and amortization
11,698

 
8,946

Gain on sale of securities, net

 
(674
)
Current income tax receivable
(11,249
)
 
(15,765
)
Deferred income tax receivable
(10,848
)
 
(10,421
)
Discount accretion, net of premium amortization
6,692

 
13,110

Loan accretion
(66,906
)
 
(93,497
)
Net gain on sale of mortgage loans
(1,125
)
 
(886
)
Origination of loans held for sale
(47,754
)
 
(42,678
)
Proceeds from sales of loans held for sale
47,832

 
39,844

Amortization of indemnification asset
11,843

 
9,165

Gain on the sale of other real estate owned, net
(7,384
)
 
(6,792
)
Impairment on other real estate owned
9,142

 
8,638

Impairment on fixed assets related to banking center closures
2,531

 

Stock-based compensation
4,003

 
10,922

Increase (decrease) in due to FDIC, net
693

 
(35,470
)
Decrease (increase) in other assets
1,739

 
(378
)
Increase (decrease) in other liabilities
1,338

 
(15,805
)
Net cash used in operating activities
(38,304
)
 
(109,962
)
Cash flows from investing activities:
 
 
 
Purchase of FHLB of Des Moines stock

 
(4,018
)
Sale of FHLB stock
1,271

 
89

Sales of investment securities available-for-sale

 
20,794

Maturities of investment securities held-to-maturity
149,991

 
113,590

Maturities of investment securities available-for-sale
456,122

 
352,137

Purchase of investment securities held-to-maturity
(244,502
)
 
(2,234
)
Purchase of investment securities available-for-sale
(693,977
)
 
(1,003,593
)
Increase in securities purchased under agreements to resell
(75,000
)
 

Net decrease in loans
118,052

 
363,479

Purchase of premises and equipment
(6,069
)
 
(35,994
)
Proceeds from sales of other real estate owned
54,705

 
57,186

Decrease in FDIC indemnification asset
72,634

 
67,822

Net cash used in investing activities
(166,773
)
 
(70,742
)
Cash flows from financing activities:
 
 
 
Net decrease in deposits
(249,216
)
 
(781,329
)
Increase (decrease) in repurchase agreements
62,786

 
(1,405
)
Payment of dividends
(7,839
)
 

Repurchase of shares
(20,590
)
 

Net cash used in financing activities
(214,859
)
 
(782,734
)
Decrease in cash and cash equivalents
(419,936
)
 
(963,438
)
Cash and cash equivalents at beginning of the year
769,180

 
1,628,137

Cash and cash equivalents at end of period
$
349,244

 
$
664,699

Supplemental disclosure of cash flow information:
 
 
 
Cash paid during the period for interest
$
13,741

 
$
30,428

Cash paid during the period for taxes
$
26,271

 
$
29,228


7


Supplemental schedule of non-cash investing activities:
 
 
 
Loans transferred to other real estate owned at fair value
$
32,408

 
$
67,741

FDIC indemnification asset claims transferred to other assets
$
24,460

 
$
109,142

Available-for-sale investment securities transferred to investment securities held-to-maturity
$

 
$
754,063

See accompanying notes to the unaudited consolidated interim financial statements.

8

Table of contents

NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013


Note 1 Basis of Presentation
National Bank Holdings Corporation (the “Company”) is a bank holding company that was incorporated in the State of Delaware in June 2009 with the intent to acquire and operate community banking franchises and other complementary businesses in targeted markets. The accompanying unaudited consolidated interim financial statements include the accounts of the Company and its wholly owned subsidiary, NBH Bank, N.A. NBH Bank, N.A. is the resulting entity from the Company's acquisitions to date and it offers consumer and commercial banking through banking centers that are predominately located in the greater Kansas City area and Colorado.

These interim financial statements serve to update the National Bank Holdings Corporation Annual Report on Form 10-K for the year ended December 31, 2012. The accompanying unaudited financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and where applicable, with general practices in the banking industry or guidelines prescribed by bank regulatory agencies. However, they may not include all information and notes necessary to constitute a complete set of financial statements under GAAP applicable to annual periods and accordingly should be read in conjunction with the financial information contained in the Form 10-K. The unaudited consolidated interim financial statements reflect all adjustments which are, in the opinion of management, necessary for a fair statement of the results presented. All such adjustments are of a normal recurring nature. All significant intercompany balances and transactions have been eliminated in consolidation. Certain reclassifications of prior years' amounts are made whenever necessary to conform to current period presentation. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the full year or any other interim period.

The Company's significant accounting policies followed in the preparation of the unaudited consolidated interim financial statements are disclosed in Note 2 of the audited financial statements and notes for the year ended December 31, 2012 are contained in the Company's Annual Report on Form 10-K, referenced above. During the nine months ended September 30, 2013, the Company began entering into agreements with certain financial institutions whereby the Company purchases securities under agreements to resell as of a specified future date at a specified price plus accrued interest. The securities purchased under agreements to resell are carried at the contractual amounts at which the securities will subsequently be resold, including accrued interest. The securities purchased under agreement to resell are subject to a master netting arrangement; however, the Company has not offset any of the amounts shown in the unaudited consolidated interim financial statements. The securities are pledged as collateral by the counterparties and are held by a third party custodian. The collateral is valued daily and additional collateral may be obtained or refunded as necessary to maintain full collateralization of these transactions. There have been no other significant changes to the application of significant accounting policies since December 31, 2012.

GAAP requires management to make estimates that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosures of contingent assets and liabilities. By their nature, estimates are based on judgment and available information. Management has made significant estimates in certain areas, such as the amount and timing of expected cash flows from assets, the valuation of the FDIC indemnification asset and clawback liability, the valuation of other real estate owned (“OREO”), the fair value adjustments on assets acquired and liabilities assumed, the valuation of core deposit intangible assets, the evaluation of investment securities for other-than-temporary impairment (“OTTI”), the fair values of financial instruments, the allowance for loan losses (“ALL”), and contingent liabilities. Because of the inherent uncertainties associated with any estimation process and future changes in market and economic conditions, it is possible that actual results could differ significantly from those estimates.
Note 2 Recent Accounting Pronouncements
Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income—In February 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2013-02, Comprehensive Income-Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. This guidance requires entities to provide information about the amounts reclassified out of accumulated other comprehensive income by component. Entities are also required to present significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income, but only if the amount reclassified is required to be reclassified to net income in its entirety in the same accounting period. Other amounts that are not required to be reclassified to net income are to be cross-referenced to other disclosures that provide additional detail about those amounts. The Company was required to adopt this update in 2013 with retrospective application. Adoption of this update affects the presentation of the components of comprehensive income in the

9

Table of contents

NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013

Company’s financial statements, but did not have an impact on the Company’s consolidated statements of financial condition, results of operations or liquidity.

Note 3 Investment Securities
The Company’s investment securities portfolio is comprised of available-for-sale and held-to-maturity investment securities. These investment securities totaled $2.6 billion at September 30, 2013, an increase from $2.3 billion at December 31, 2012. Included in the aforementioned $2.6 billion was $1.9 billion of available-for-sale securities and $0.7 billion of held-to-maturity securities.
Available-for-sale
Available-for-sale investment securities are summarized as follows as of the dates indicated (in thousands):
 
September 30, 2013
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
Asset backed securities
$
20,091

 
$
7

 
$

 
$
20,098

Mortgage-backed securities (“MBS”):
 
 
 
 
 
 
 
Residential mortgage pass-through securities issued or guaranteed by U.S. Government agencies or sponsored enterprises
514,584

 
9,525

 
(926
)
 
523,183

Other residential MBS issued or guaranteed by U.S. Government agencies or sponsored enterprises
1,376,453

 
11,211

 
(41,402
)
 
1,346,262

Other securities
419

 

 

 
419

Total
$
1,911,547

 
$
20,743

 
$
(42,328
)
 
$
1,889,962

 
 
December 31, 2012
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
U.S. Treasury securities
$
300

 
$

 
$

 
$
300

Asset backed securities
89,881

 
122

 

 
90,003

Mortgage-backed securities (“MBS”):
 
 
 
 
 
 
 
Residential mortgage pass-through securities issued or guaranteed by U.S. Government agencies or sponsored enterprises
658,169

 
19,849

 
(1
)
 
678,017

Other residential MBS issued or guaranteed by U.S. Government agencies or sponsored enterprises
931,979

 
17,630

 
(320
)
 
949,289

Other securities
419

 

 

 
419

Total
$
1,680,748

 
$
37,601

 
$
(321
)
 
$
1,718,028

At September 30, 2013 and December 31, 2012, mortgage-backed securities represented 98.9% and 94.7%, respectively, of the Company’s available-for-sale investment portfolio and all mortgage-backed securities were backed by government sponsored enterprises (“GSE”) collateral such as Federal Home Loan Mortgage Corporation (“FHLMC”) and Federal National Mortgage Association (“FNMA”), and the government sponsored agency Government National Mortgage Association (“GNMA”).


10

Table of contents

NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013

The table below summarizes the unrealized losses as of the dates shown, along with the length of the impairment period (in thousands):
 
September 30, 2013
 
Less than 12 months
 
12 months or more
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Mortgage-backed securities (“MBS”):
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage pass-through securities issued or guaranteed by U.S. Government agencies or sponsored enterprises
$
212,138

 
$
(925
)
 
$
14

 
$
(1
)
 
$
212,152

 
$
(926
)
Other residential MBS issued or guaranteed by U.S. Government agencies or sponsored enterprises
922,778

 
(40,928
)
 
17,302

 
(474
)
 
940,080

 
(41,402
)
Total
$
1,134,916

 
$
(41,853
)
 
$
17,316

 
$
(475
)
 
$
1,152,232

 
$
(42,328
)
 
 
December 31, 2012
 
Less than 12 months
 
12 months or more
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Mortgage-backed securities (“MBS”):
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage pass-through securities issued or guaranteed by U.S. Government agencies or sponsored enterprises
$
17

 
$

 
$
8

 
$
(1
)
 
$
25

 
$
(1
)
Other residential MBS issued or guaranteed by U.S. Government agencies or sponsored enterprises
130,686

 
(320
)
 

 

 
130,686

 
(320
)
Total
$
130,703

 
$
(320
)
 
$
8

 
$
(1
)
 
$
130,711

 
$
(321
)
Management evaluated all of the securities in an unrealized loss position and concluded that no other-than-temporary-impairment existed at September 30, 2013 or December 31, 2012. The Company had no intention to sell these securities before recovery of their amortized cost and believes it will not be required to sell the securities before the recovery of their amortized cost.
The Company pledges certain securities as collateral for public deposits, securities sold under agreements to repurchase and to secure borrowing capacity at the Federal Reserve Bank, if needed. The fair value of available-for-sale investment securities pledged as collateral totaled $188.6 million at September 30, 2013 and $89.2 million December 31, 2012. The increase of pledged available-for-sale investment securities was primarily attributable to the increase in securities sold under agreements to repurchase during the nine months ended September 30, 2013. Certain investment securities may also be pledged as collateral should the Company utilize its line of credit at the FHLB of Des Moines; however, no investment securities were pledged for this purpose at September 30, 2013 or December 31, 2012.


11

Table of contents

NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013

The table below summarizes the contractual maturities, as of the last scheduled repayment date, of the available-for-sale investment portfolio as of September 30, 2013 (in thousands):
 
Amortized
Cost
 
Fair Value
Due in one year or less
$

 
$

Due after one year through five years
20,101

 
20,107

Due after five years through ten years
206,538

 
206,575

Due after ten years
1,684,489

 
1,662,861

Other securities
419

 
419

Total investment securities available-for-sale
$
1,911,547

 
$
1,889,962

Actual maturities of mortgage-backed securities may differ from contractual maturities depending on the repayment characteristics and experience of the underlying financial instruments. The estimated weighted average life of the available-for-sale mortgage-backed securities portfolio was 4.4 years as of September 30, 2013 and 3.4 years as of December 31, 2012. This estimate is based on assumptions and actual results may differ. Other securities of $0.4 million have no stated contractual maturity date as of September 30, 2013.
Held-to-maturity
At September 30, 2013 and December 31, 2012 the Company held $664.7 million and $577.5 million of held-to-maturity investment securities, respectively. During the first quarter of 2012 the Company transferred securities with a fair value of $754.1 million from an available-for-sale classification to the held-to-maturity classification. During the nine months ended September 30, 2013, the Company purchased $244.5 million of held-to-maturity investment securities. Held-to-maturity investment securities are summarized as follows as of the dates indicated (in thousands):
 
September 30, 2013
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
Mortgage-backed securities (“MBS”):
 
 
 
 
 
 
 
Residential mortgage pass-through securities issued or guaranteed by U.S. Government agencies or sponsored enterprises
$
530,406

 
$
3,613

 
$
(555
)
 
$
533,464

Other residential MBS issued or guaranteed by U.S. Government agencies or sponsored enterprises
134,311

 
142

 
(3,339
)
 
131,114

Total investment securities held-to-maturity
$
664,717

 
$
3,755

 
$
(3,894
)
 
$
664,578

 
 
December 31, 2012
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Mortgage-backed securities (“MBS”):
 
 
 
 
 
 
 
Residential mortgage pass-through securities issued or guaranteed by U.S. Government agencies or sponsored enterprises
$
577,486

 
$
7,065

 
$

 
$
584,551

Total investment securities held-to-maturity
$
577,486

 
$
7,065

 
$

 
$
584,551


12

Table of contents

NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013

The table below summarizes the contractual maturities, as of the last scheduled repayment date, of the held-to-maturity investment portfolio at September 30, 2013 (in thousands):
 
Amortized
Cost
 
Fair Value
Due in one year or less
$

 
$

Due after one year through five years

 

Due after five years through ten years
19,012

 
19,235

Due after ten years
645,705

 
645,343

Other securities

 

Total investment securities held-to-maturity
$
664,717

 
$
664,578

The carrying value of held-to-maturity investment securities pledged as collateral totaled $54.4 million and $127.9 million at September 30, 2013 and December 31, 2012, respectively. Actual maturities of mortgage-backed securities may differ from scheduled maturities depending on the repayment characteristics and experience of the underlying financial instruments. The estimated weighted average expected life of the held-to-maturity mortgage-backed securities portfolio as of September 30, 2013 and December 31, 2012 was 4.3 and 3.8 years, respectively. This estimate is based on assumptions and actual results may differ.

Note 4 Loans
The loan portfolio is comprised of new loans originated by the Company and loans that were acquired in connection with the Company’s acquisitions of Bank of Choice and Community Banks of Colorado in 2011, and Hillcrest Bank and Bank Midwest in 2010. The majority of the loans acquired in the Hillcrest Bank and Community Banks of Colorado transactions are covered by loss sharing agreements with the FDIC, and covered loans are presented separately from non-covered loans due to the FDIC loss sharing agreements associated with these loans. Covered loans comprised 21.0% of the total loan portfolio at September 30, 2013, compared to 33.2% of the total loan portfolio at December 31, 2012.
 
The table below shows the loan portfolio composition including carrying value by segment of loans accounted for under ASC Topic 310-30 Receivables—Loans and Debt Securities Acquired with Deteriorated Credit Quality and loans not accounted for under this guidance, which includes our originated loans. The table also shows the amounts covered by the FDIC loss sharing agreements as of September 30, 2013 and December 31, 2012. The carrying value of loans are net of discounts on loans excluded from Accounting Standards Codification (“ASC”) Topic 310-30 , and fees and costs of $15.0 million and $20.4 million as of September 30, 2013 and December 31, 2012, respectively (in thousands):
 
 
September 30, 2013
 
ASC 310-30
Loans
 
Non 310-30
Loans
 
Total Loans
 
% of
Total
Commercial
$
68,250

 
$
272,114

 
$
340,364

 
19.5
%
Commercial real estate
325,701

 
288,752

 
614,453

 
35.3
%
Agriculture
37,882

 
117,464

 
155,346

 
8.9
%
Residential real estate
72,409

 
523,160

 
595,569

 
34.2
%
Consumer
8,768

 
28,313

 
37,081

 
2.1
%
Total
$
513,010

 
$
1,229,803

 
$
1,742,813

 
100.0
%
Covered
$
309,380

 
$
56,966

 
$
366,346

 
21.0
%
Non-covered
203,630

 
1,172,837

 
1,376,467

 
79.0
%
Total
$
513,010

 
$
1,229,803

 
$
1,742,813

 
100.0
%
 

13

Table of contents

NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013

 
December 31, 2012
 
ASC 310-30
Loans
 
Non 310-30
Loans
 
Total Loans
 
% of
Total
Commercial
$
83,169

 
$
187,419

 
$
270,588

 
14.8
%
Commercial real estate
566,035

 
238,964

 
804,999

 
43.9
%
Agriculture
47,733

 
125,674

 
173,407

 
9.5
%
Residential real estate
106,100

 
427,277

 
533,377

 
29.1
%
Consumer
18,984

 
31,347

 
50,331

 
2.7
%
Total
$
822,021

 
$
1,010,681

 
$
1,832,702

 
100.0
%
Covered
$
527,948

 
$
80,274

 
$
608,222

 
33.2
%
Non-covered
294,073

 
930,407

 
1,224,480

 
66.8
%
Total
$
822,021

 
$
1,010,681

 
$
1,832,702

 
100.0
%
Loans are considered past due or delinquent when the contractual principal or interest due in accordance with the terms of the loan agreement remains unpaid after the due date of the scheduled payment. All loans accounted for under ASC 310-30 were classified as performing assets at December 31, 2012, regardless of past due status, as the carrying value of all of the respective pools’ cash flows were considered estimable. During the nine months ended September 30, 2013, the Company determined that the cash flows of one covered commercial and industrial loan pool, with a balance of $16.9 million at September 30, 2013, were no longer reasonably estimable, and in accordance with the guidance in ASC 310-30, this pool was put on non-accrual status. Interest income was recognized on all accruing loans accounted for under ASC 310-30 through accretion of the difference between the carrying value of the loans and the expected cash flows.


14

Table of contents

NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013

Pooled loans accounted for under ASC 310-30 that are 90 days or more past due and still accreting are generally considered to be performing and are included in loans 90 days or more past due and still accruing. At September 30, 2013 and December 31, 2012, $14.0 million and $23.1 million, respectively, of loans excluded from the scope of ASC 310-30 were on non-accrual and $16.9 million of loans accounted for under ASC 310-30 were on non-accrual status at September 30, 2013. Loan delinquency for all loans is shown in the following tables at September 30, 2013 and December 31, 2012, respectively (in thousands):
 
Total Loans September 30, 2013
 
30-59
days  past
due
 
60-89
days
past
due
 
Greater
than 90
days past
due
 
Total  past
due
 
Current
 
Total
loans
 
Loans > 90
days past
due and
still
accruing
 
Non-
accrual
Loans excluded from ASC 310-30
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
$
410

 
$
57

 
$
448

 
$
915

 
$
271,199

 
$
272,114

 
$

 
$
1,288

Commercial real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Construction

 

 

 

 
1,652

 
1,652

 

 

Acquisition/development
46

 

 
148

 
194

 
7,900

 
8,094

 
148

 
1

Multifamily
952

 

 

 
952

 
7,384

 
8,336

 

 
1,129

Owner-occupied
154

 
17

 

 
171

 
88,846

 
89,017

 

 
728

Non owner-occupied
116

 

 
4,643

 
4,759

 
176,894

 
181,653

 

 
4,643

Total commercial real estate
1,268

 
17

 
4,791

 
6,076

 
282,676

 
288,752

 
148

 
6,501

Agriculture
84

 

 

 
84

 
117,380

 
117,464

 

 
203

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Senior lien
1,043

 
132

 
1,230

 
2,405

 
468,089

 
470,494

 

 
5,160

Junior lien
262

 
24

 
132

 
418

 
52,248

 
52,666

 

 
591

Total residential real estate
1,305

 
156

 
1,362

 
2,823

 
520,337

 
523,160

 

 
5,751

Consumer
427

 
8

 
24

 
459

 
27,854

 
28,313

 
21

 
251

Total loans excluded from ASC 310-30
3,494

 
238

 
6,625

 
10,357

 
1,219,446

 
1,229,803

 
169

 
13,994

Covered loans excluded from ASC 310-30
186

 
53

 
425

 
664

 
56,302

 
56,966

 

 
2,403

Non-covered loans excluded from ASC 310-30
3,308

 
185

 
6,200

 
9,693

 
1,163,144

 
1,172,837

 
169

 
11,591

Total loans excluded from ASC 310-30
3,494

 
238

 
6,625

 
10,357

 
1,219,446

 
1,229,803

 
169

 
13,994

Loans accounted for under ASC 310-30
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
325

 
564

 
5,000

 
5,889

 
62,361

 
68,250

 
4,964

 
16,857

Commercial real estate
12,943

 
8,731

 
52,773

 
74,447

 
251,254

 
325,701

 
52,773

 

Agriculture
3,289

 

 
2,669

 
5,958

 
31,924

 
37,882

 
2,669

 

Residential real estate
1,349

 
271

 
1,907

 
3,527

 
68,882

 
72,409

 
1,907

 

Consumer
585

 
6

 
11

 
602

 
8,166

 
8,768

 
11

 

Total loans accounted for under ASC 310-30
18,491

 
9,572

 
62,360

 
90,423

 
422,587

 
513,010

 
62,324

 
16,857

Covered loans accounted for under ASC 310-30
11,433

 
9,199

 
51,115

 
71,747

 
237,633

 
309,380

 
51,079

 
16,857

Non-covered loans accounted for under ASC 310-30
7,058

 
373

 
11,245

 
18,676

 
184,954

 
203,630

 
11,245

 

Total loans accounted for under ASC 310-30
18,491

 
9,572

 
62,360

 
90,423

 
422,587

 
513,010

 
62,324

 
16,857

Total loans
$
21,985

 
$
9,810

 
$
68,985

 
$
100,780

 
$
1,642,033

 
$
1,742,813

 
$
62,493

 
$
30,851

Covered loans
$
11,619

 
$
9,252

 
$
51,540

 
$
72,411

 
$
293,935

 
$
366,346

 
$
51,079

 
$
19,260

Non-covered loans
10,366

 
558

 
17,445

 
28,369

 
1,348,098

 
1,376,467

 
11,414

 
11,591

Total loans
$
21,985

 
$
9,810

 
$
68,985

 
$
100,780

 
$
1,642,033

 
$
1,742,813

 
$
62,493

 
$
30,851



15

Table of contents

NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013

 
Total Loans December 31, 2012
 
30-59
days  past
due
 
60-89
days
past
due
 
Greater
than 90
days past
due
 
Total  past
due
 
Current
 
Total
loans
 
Loans > 90
days past
due and
still
accruing
 
Non-
accrual
Loans excluded from ASC 310-30
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
$
846

 
$
148

 
$
1,122

 
$
2,116

 
$
185,303

 
$
187,419

 
$

 
$
4,500

Commercial real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Construction

 

 

 

 
3,915

 
3,915

 

 

Acquisition/development
1,948

 

 

 
1,948

 
8,485

 
10,433

 

 
75

Multifamily

 

 
34

 
34

 
13,387

 
13,421

 

 
237

Owner-occupied
97

 
106

 
1,074

 
1,277

 
56,490

 
57,767

 

 
3,365

Non owner-occupied

 
122

 
5,123

 
5,245

 
148,183

 
153,428

 

 
7,992

Total commercial real estate
2,045

 
228

 
6,231

 
8,504

 
230,460

 
238,964

 

 
11,669

Agriculture
33

 
40

 
11

 
84

 
125,590

 
125,674

 

 
251

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Senior lien
1,261

 
119

 
1,825

 
3,205

 
373,243

 
376,448

 
22

 
5,815

Junior lien
181

 

 
110

 
291

 
50,538

 
50,829

 

 
593

Total residential real estate
1,442

 
119

 
1,935

 
3,496

 
423,781

 
427,277

 
22

 
6,408

Consumer
447

 
48

 
3

 
498

 
30,849

 
31,347

 
3

 
291

Total loans excluded from ASC 310-30
4,813

 
583

 
9,302

 
14,698

 
995,983

 
1,010,681

 
25

 
23,119

Covered loans excluded from ASC 310-30
75

 
51

 
2,062

 
2,188

 
78,086

 
80,274

 

 
6,045

Non-covered loans excluded from ASC 310-30
4,738

 
532

 
7,240

 
12,510

 
917,897

 
930,407

 
25

 
17,074

Total loans excluded from ASC 310-30
4,813

 
583

 
9,302

 
14,698

 
995,983

 
1,010,681

 
25

 
23,119

Loans accounted for under ASC 310-30
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
521

 
563

 
5,621

 
6,705

 
76,464

 
83,169

 
5,621

 

Commercial real estate
10,060

 
3,928

 
129,656

 
143,644

 
422,391

 
566,035

 
129,656

 

Agriculture
1,247

 
16

 
2,768

 
4,031

 
43,702

 
47,733

 
2,768

 

Residential real estate
1,247

 
207

 
5,463

 
6,917

 
99,183

 
106,100

 
5,463

 

Consumer
297

 
327

 
3,253

 
3,877

 
15,107

 
18,984

 
3,253

 

Total loans accounted for under ASC 310-30
13,372

 
5,041

 
146,761

 
165,174

 
656,847

 
822,021

 
146,761

 

Covered loans accounted for under ASC 310-30
9,855

 
3,613

 
116,883

 
130,351

 
397,597

 
527,948

 
116,883

 

Non-covered loans accounted for under ASC 310-30
3,517

 
1,428

 
29,878

 
34,823

 
259,250

 
294,073

 
29,878

 

Total loans accounted for under ASC 310-30
13,372

 
5,041

 
146,761

 
165,174

 
656,847

 
822,021

 
146,761

 

Total loans
$
18,185

 
$
5,624

 
$
156,063

 
$
179,872

 
$
1,652,830

 
$
1,832,702

 
$
146,786

 
$
23,119

Covered loans
$
9,930

 
$
3,664

 
$
118,945

 
$
132,539

 
$
475,683

 
$
608,222

 
$
116,883

 
$
6,045

Non-covered loans
8,255

 
1,960

 
37,118

 
47,333

 
1,177,147

 
1,224,480

 
29,903

 
17,074

Total loans
$
18,185

 
$
5,624

 
$
156,063

 
$
179,872

 
$
1,652,830

 
$
1,832,702

 
$
146,786

 
$
23,119


 

16

Table of contents

NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013

Credit exposure for all loans as determined by the Company’s internal risk rating system was as follows as of September 30, 2013 and December 31, 2012, respectively (in thousands):
 
Total Loans September 30, 2013
 
Pass
 
Special
Mention
 
Substandard
 
Doubtful
 
Total
Loans excluded from ASC 310-30
 
 
 
 
 
 
 
 
 
Commercial
$
225,067

 
$
8,353

 
$
38,612

 
$
82

 
$
272,114

Commercial real estate
 
 
 
 
 
 
 
 
 
Construction
1,652

 

 

 

 
1,652

Acquisition/development
1,593

 
2,646

 
3,855

 

 
8,094

Multifamily
7,207

 

 
1,097

 
32

 
8,336

Owner-occupied
83,532

 
1,998

 
3,487

 

 
89,017

Non owner-occupied
140,405

 
32,143

 
9,105

 

 
181,653

Total commercial real estate
234,389

 
36,787

 
17,544

 
32

 
288,752

Agriculture
115,618

 
1,084

 
762

 

 
117,464

Residential real estate
 
 
 
 
 
 
 
 
 
Senior lien
461,003

 
1,547

 
7,467

 
477

 
470,494

Junior lien
50,113

 
203

 
2,350

 

 
52,666

Total residential real estate
511,116

 
1,750

 
9,817

 
477

 
523,160

Consumer
28,057

 

 
250

 
6

 
28,313

Total loans excluded from ASC 310-30
1,114,247

 
47,974

 
66,985

 
597

 
1,229,803

Covered loans excluded from ASC 310-30
27,826

 
3,557

 
25,133

 
450

 
56,966

Non-covered loans excluded from ASC 310-30
1,086,421

 
44,417

 
41,852

 
147

 
1,172,837

Total loans excluded from ASC 310-30
1,114,247

 
47,974

 
66,985

 
597

 
1,229,803

Loans accounted for under ASC 310-30
 
 
 
 
 
 
 
 
 
Commercial
25,073

 
2,865

 
39,520

 
792

 
68,250

Commercial real estate
134,979

 
11,757

 
170,988

 
7,977

 
325,701

Agriculture
26,883

 
1,724

 
9,275

 

 
37,882

Residential real estate
49,444

 
1,610

 
21,355

 

 
72,409

Consumer
7,515

 
504

 
749

 

 
8,768

Total loans accounted for under ASC 310-30
243,894

 
18,460

 
241,887

 
8,769

 
513,010

Covered loans accounted for under ASC 310-30
128,530

 
8,146

 
166,859

 
5,845

 
309,380

Non-covered loans accounted for under ASC 310-30
115,364

 
10,314

 
75,028

 
2,924

 
203,630

Total loans accounted for under ASC 310-30
243,894

 
18,460

 
241,887

 
8,769

 
513,010

Total loans
$
1,358,141

 
$
66,434

 
$
308,872

 
$
9,366

 
$
1,742,813

Total covered
$
156,356

 
$
11,703

 
$
191,992

 
$
6,295

 
$
366,346

Total non-covered
1,201,785

 
54,731

 
116,880

 
3,071

 
1,376,467

Total loans
$
1,358,141

 
$
66,434

 
$
308,872

 
$
9,366

 
$
1,742,813



17

Table of contents

NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013

 
Total Loans December 31, 2012
 
Pass
 
Special
Mention
 
Substandard
 
Doubtful
 
Total
Loans excluded from ASC 310-30
 
 
 
 
 
 
 
 
 
Commercial
$
137,537

 
$
9,776

 
$
38,696

 
$
1,410

 
$
187,419

Commercial real estate
 
 
 
 
 
 
 
 
 
Construction
3,915

 

 

 

 
3,915

Acquisition/development
6,727

 

 
3,706

 

 
10,433

Multifamily
8,409

 
3,798

 
1,201

 
13

 
13,421

Owner-occupied
44,129

 
4,006

 
9,632

 

 
57,767

Non owner-occupied
104,307

 
29,394

 
19,411

 
316

 
153,428

Total commercial real estate
167,487

 
37,198

 
33,950

 
329

 
238,964

Agriculture
120,471

 
1,359

 
3,844

 

 
125,674

Residential real estate
 
 
 
 
 
 
 
 
 
Senior lien
365,571

 
2,240

 
8,106

 
531

 
376,448

Junior lien
48,359

 
251

 
2,214

 
5

 
50,829

Total residential real estate
413,930

 
2,491

 
10,320

 
536

 
427,277

Consumer
31,050

 

 
276

 
21

 
31,347

Total loans excluded from ASC 310-30
870,475

 
50,824

 
87,086

 
2,296

 
1,010,681

Covered loans excluded from ASC 310-30
32,117

 
9,974

 
36,427

 
1,756

 
80,274

Non-covered loans excluded from ASC 310-30
838,358

 
40,850

 
50,659

 
540

 
930,407

Total loans excluded from ASC 310-30
870,475

 
50,824

 
87,086

 
2,296

 
1,010,681

Loans accounted for under ASC 310-30
 
 
 
 
 
 
 
 
 
Commercial
29,719

 
3,628

 
42,101

 
7,721

 
83,169

Commercial real estate
162,122

 
60,787

 
329,869

 
13,257

 
566,035

Agriculture
34,599

 
1,242

 
11,892

 

 
47,733

Residential real estate
57,697

 
6,614

 
41,789

 

 
106,100

Consumer
14,489

 
723

 
3,772

 

 
18,984

Total loans accounted for under ASC 310-30
298,626

 
72,994

 
429,423

 
20,978

 
822,021

Covered loans accounted for under ASC 310-30
159,430

 
57,056

 
292,174

 
19,288

 
527,948

Non-covered loans accounted for under ASC 310-30
139,196

 
15,938

 
137,249

 
1,690

 
294,073

Total loans accounted for under ASC 310-30
298,626

 
72,994

 
429,423

 
20,978

 
822,021

Total loans
$
1,169,101

 
$
123,818

 
$
516,509

 
$
23,274

 
$
1,832,702

Total covered
$
191,547

 
$
67,030

 
$
328,601

 
$
21,044

 
$
608,222

Total non-covered
977,554

 
56,788

 
187,908

 
2,230

 
1,224,480

Total loans
$
1,169,101

 
$
123,818

 
$
516,509

 
$
23,274

 
$
1,832,702

Impaired Loans
Loans are considered to be impaired when it is probable that the Company will not be able to collect all amounts due in accordance with the contractual terms of the loan agreement. Included in impaired loans are loans excluded from ASC 310-30 on non-accrual status and troubled debt restructurings (“TDRs”) described below. If a specific allowance is warranted based on the borrower’s overall financial condition, the specific allowance is calculated based on discounted cash flows using the loan’s initial contractual effective interest rate or the fair value of the collateral less selling costs for collateral dependent loans. At September 30, 2013, the Company measured $14.8 million of impaired loans using discounted cash flows and the loan’s initial contractual effective interest rate and $4.7 million of impaired loans based on the fair value of the collateral less selling costs.

18

Table of contents

NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013

$9.5 million of impaired loans that individually are less than $250 thousand each, are measured through our general ALL reserves due to their relatively small size.
At September 30, 2013, the Company’s recorded investment in impaired loans was $29.1 million, $8.4 million of which was covered by loss sharing agreements. Impaired loans had a collective related allowance for loan losses allocated to them of $0.7 million at September 30, 2013. Additional information regarding impaired loans at September 30, 2013 is set forth in the table below (in thousands):
 
Impaired Loans September 30, 2013
 
Unpaid
principal
balance
 
Recorded
investment
 
Allowance
for loan
losses
allocated
 
Average
recorded
investment
 
Interest
income
recognized
With no related allowance recorded:
 
 
 
 
 
 
 
 
 
Commercial
$
5,114

 
$
5,100

 
$

 
$
6,169

 
$
276

Commercial real estate
 
 
 
 
 
 
 
 
 
Construction

 

 

 

 

Acquisition/development

 

 

 

 

Multifamily
997

 
952

 

 
958

 

Owner-occupied
4,208

 
3,921

 

 
4,031

 
226

Non-owner occupied
6,262

 
4,941

 

 
5,188

 
8

Total commercial real estate
11,467

 
9,814

 

 
10,177

 
234

Agriculture

 

 

 

 

Residential real estate
 
 
 
 
 
 
 
 
 
Senior lien
762

 
751

 

 
752

 
6

Junior lien

 

 

 

 

Total residential real estate
762

 
751

 

 
752

 
6

Consumer

 

 

 

 

Total impaired loans with no related allowance recorded
17,343

 
15,665

 

 
17,098

 
516

With a related allowance recorded:
 
 
 
 
 
 
 
 
 
Commercial
2,712

 
2,570

 
92

 
2,744

 
53

Commercial real estate
 
 
 
 
 
 
 
 
 
Construction

 

 

 

 

Acquisition/development

 
1

 

 
1

 

Multifamily
184

 
177

 
32

 
187

 

Owner-occupied
843

 
634

 
4

 
668

 
11

Non-owner occupied
644

 
632

 
4

 
636

 
14

Total commercial real estate
1,671

 
1,444

 
40

 
1,492

 
25

Agriculture
244

 
223

 
1

 
224

 

Residential real estate
 
 
 
 
 
 
 
 
 
Senior lien
7,959

 
7,166

 
516

 
7,310

 
71

Junior lien
1,924

 
1,712

 
17

 
1,736

 
40

Total residential real estate
9,883

 
8,878

 
533

 
9,046

 
111

Consumer
319

 
295

 
7

 
313

 
3

Total impaired loans with a related allowance recorded
14,829

 
13,410

 
673

 
13,819

 
192

Total impaired loans
$
32,172

 
$
29,075

 
$
673

 
$
30,917

 
$
708


19

Table of contents

NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013

At September 30, 2012, the Company’s recorded investment in impaired loans was $37.6 million, $7.5 million of which was covered by loss sharing agreements. The impaired loans had a collective related allowance for loan losses allocated to them of $2.0 million at September 30, 2012. The table below shows additional information regarding impaired loans at September 30, 2012 (in thousands):
 
Impaired Loans September 30, 2012
 
Unpaid
principal
balance
 
Recorded
investment
 
Allowance
for loan
losses
allocated
 
Average
recorded
investment
 
Interest
income
recognized
With no related allowance recorded:
 
 
 
 
 
 
 
 
 
Commercial
$
19,544

 
$
9,521

 
$

 
$
13,038

 
$
179

Commercial real estate
 
 
 
 
 
 
 
 
 
Construction

 

 

 

 

Acquisition/development
6,904

 
799

 

 
830

 
27

Multifamily
198

 
191

 

 
191

 

Owner-occupied
5,814

 
5,450

 

 
5,455

 
118

Non owner-occupied
7,050

 
6,504

 

 
5,823

 
64

Total commercial real estate
19,966

 
12,944

 

 
12,299

 
209

Agriculture
185

 
178

 

 
181

 
1

Residential real estate
 
 
 
 
 
 
 
 
 
Senior lien
6,616

 
6,169

 

 
6,241

 
94

Junior lien
996

 
671

 

 
675

 
4

Total residential real estate
7,612

 
6,840

 

 
6,916

 
98

Consumer
206

 
193

 

 
195

 
1

Total impaired loans with no related allowance recorded
47,513

 
29,676

 

 
32,629

 
488

With a related allowance recorded:
 
 
 
 
 
 
 
 
 
Commercial
2,066

 
2,065

 
1,091

 
2,185

 
8

Commercial real estate
 
 
 
 
 
 
 
 
 
Construction

 

 

 

 

Acquisition/development

 

 

 

 

Multifamily

 

 

 

 

Owner-occupied

 

 

 

 

Non owner-occupied
5,688

 
5,123

 
517

 
5,284

 

Total commercial real estate
5,688

 
5,123

 
517

 
5,284

 

Agriculture

 

 

 

 

Residential real estate
 
 
 
 
 
 
 
 
 
Senior lien
445

 
421

 
421

 
440

 

Junior lien
271

 
271

 
3

 
271

 

Total residential real estate
716

 
692

 
424

 
711

 

Consumer

 

 

 

 

Total impaired loans with a related allowance recorded
8,470

 
7,880

 
2,032

 
8,180

 
8

Total impaired loans
$
55,983

 
$
37,556

 
$
2,032

 
$
40,809

 
$
496



20

Table of contents

NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013

Troubled debt restructurings
It is the Company’s policy to review each prospective credit in order to determine the appropriateness and the adequacy of security or collateral prior to making a loan. In the event of borrower default, the Company seeks recovery in compliance with state lending laws, the respective loan agreements, and credit monitoring and remediation procedures that may include restructuring a loan to provide a concession by the Company to the borrower from their original terms due to borrower financial difficulties in order to facilitate repayment. Additionally, if a borrower’s repayment obligation has been discharged by a court, and that debt has not been reaffirmed by the borrower, regardless of past due status, the loan is considered to be a troubled debt restructuring (“TDR”). At September 30, 2013 and December 31, 2012, the Company had $14.3 million and $17.7 million, respectively, of accruing TDR’s that had been restructured from the original terms in order to facilitate repayment. Of these, $6.0 million and $5.0 million, respectively, were covered by FDIC loss sharing agreements.
Non-accruing TDR’s at September 30, 2013 and December 31, 2012 totaled $7.6 million and $12.9 million, respectively. Of these, $1.7 million were covered by the FDIC loss sharing agreements as of September 30, 2013 and $3.6 million were covered by the FDIC loss sharing agreements as of December 31, 2012.
During the nine months ended September 30, 2013, the Company restructured forty-three loans with a recorded investment of $5.5 million to facilitate repayment. Substantially all of the loan modifications were an extension of term and rate modifications. Loan modifications to loans accounted for under ASC 310-30 are not considered troubled debt restructurings. The table below provides additional information related to accruing TDR’s at September 30, 2013 and December 31, 2012 (in thousands):
 
Accruing TDR’s
 
September 30, 2013
 
Recorded
investment
 
Average
year-to-
date
recorded
investment
 
Unpaid
principal
balance
 
Unfunded
commitments
to fund
TDR’s
Commercial
$
10,210

 
$
11,385

 
$
10,475

 
$
4,039

Commercial real estate
930

 
954

 
1,009

 
879

Agriculture
21

 
20

 
20

 

Residential real estate
3,085

 
3,131

 
3,096

 
20

Consumer
44

 
47

 
44

 

Total
$
14,290

 
$
15,537

 
$
14,644

 
$
4,938

 
 
Accruing TDR’s
 
December 31, 2012
 
Recorded
investment
 
Average
year-to-
date
recorded
investment
 
Unpaid
principal
balance
 
Unfunded
commitments
to fund
TDR’s
Commercial
$
11,474

 
$
13,171

 
$
11,794

 
$
6,908

Commercial real estate
3,597

 
3,708

 
3,734

 

Agriculture

 

 

 

Residential real estate
2,458

 
2,469

 
2,460

 
35

Consumer
191

 
195

 
191

 

Total
$
17,720

 
$
19,543

 
$
18,179

 
$
6,943


21

Table of contents

NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013

The following table summarizes the Company’s carrying value of non-accrual TDR’s as of September 30, 2013 and December 31, 2012 (in thousands):
 
Non - Accruing TDR’s
 
September 30, 2013
 
December 31, 2012
 
Covered
 
Non-covered
 
Covered
 
Non-covered
Commercial
$
89

 
$
655

 
$
1,736

 
$
1,215

Commercial real estate
178

 
4,439

 
313

 
6,823

Agriculture

 

 

 
21

Residential real estate
1,407

 
605

 
1,514

 
958

Consumer

 
248

 

 
291

Total
$
1,674

 
$
5,947

 
$
3,563

 
$
9,308

Accrual of interest is resumed on loans that were on non-accrual at the time of restructuring, only after the loan has performed sufficiently. The Company had two TDRs that had been modified within the past 12 months that defaulted on their restructured terms during the nine months ended September 30, 2013. For purposes of this disclosure, the Company considers “default” to mean 90 days or more past due on principal or interest. The defaulted TDRs were a commercial loan and a consumer loan totaling $328 thousand.
Loans accounted for under ASC Topic 310-30
Loan pools accounted for under ASC Topic 310-30 are periodically remeasured to determine expected future cash flows. In determining the expected cash flows, the timing of cash flows and prepayment assumptions for smaller homogeneous loans are based on statistical models that take into account factors such as the loan interest rate, credit profile of the borrowers, the years in which the loans were originated, and whether the loans are fixed or variable rate loans. Prepayments may be assumed on large loans if circumstances specific to that loan warrant a prepayment assumption. No prepayments were presumed for small homogeneous commercial loans; however, prepayment assumptions are made that consider similar prepayment factors listed above for smaller homogeneous loans. The re-measurement of loans accounted for under ASC 310-30 resulted in the following changes in the carrying amount of accretable yield during the nine months ended September 30, 2013 and 2012 (in thousands):
 
September 30,
2013
 
September 30,
2012
Accretable yield beginning balance
$
133,585

 
$
186,494

Reclassification from non-accretable difference
55,351

 
46,974

Reclassification to non-accretable difference
(5,234
)
 
(8,348
)
Accretion
(59,616
)
 
(76,252
)
Accretable yield ending balance
$
124,086

 
$
148,868

The accretable yield of $124.1 million at September 30, 2013 includes $1.4 million of accretable yield related to the loan pool that was put on non-accrual status during the nine months ended September 30, 2013. This accretable yield is not being accreted to income and its recognition will be deferred until full recovery of the carrying value of this pool is realized.

22

Table of contents

NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013

Below is the composition of the net book value for loans accounted for under ASC 310-30 at September 30, 2013 and December 31, 2012 (in thousands):
 
September 30,
2013
 
December 31,
2012
Contractual cash flows
$
1,075,652

 
$
1,444,279

Non-accretable difference
(426,101
)
 
(488,673
)
Non-accretable difference on retired pools
(12,455
)
 

Accretable yield
(124,086
)
 
(133,585
)
Loans accounted for under ASC 310-30
$
513,010

 
$
822,021

Note 5 Allowance for Loan Losses
The tables below detail the Company’s allowance for loan losses (“ALL”) and recorded investment in loans as of and for the three and nine months ended September 30, 2013 and 2012 (in thousands):
 
Three months ended September 30, 2013
 
Commercial
 
Commercial
real estate
 
Agriculture
 
Residential
real estate
 
Consumer
 
Total
Beginning balance
$
2,286

 
$
2,419

 
$
764

 
$
5,907

 
$
471

 
$
11,847

Non 310-30 beginning balance
2,240

 
2,113

 
495

 
4,333

 
471

 
9,652

Charge-offs
(401
)
 

 

 
(117
)
 
(276
)
 
(794
)
Recoveries
92

 
17

 

 
23

 
75

 
207

Provision
715

 
(205
)
 
27

 
27

 
186

 
750

Non 310-30 ending balance
2,646

 
1,925

 
522

 
4,266

 
456

 
9,815

ASC 310-30 beginning balance
46

 
306

 
269

 
1,574

 

 
2,195

Charge-offs

 

 
(221
)
 
(57
)
 

 
(278
)
Recoveries

 

 

 

 

 

Provision
43

 
(8
)
 
537

 
(885
)
 

 
(313
)
ASC 310-30 ending balance
89

 
298

 
585

 
632

 

 
1,604

Ending balance
$
2,735

 
$
2,223

 
$
1,107

 
$
4,898

 
$
456

 
$
11,419


23

Table of contents

NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013

 
Nine months ended September 30, 2013
 
Commercial
 
Commercial
real estate
 
Agriculture
 
Residential
real estate
 
Consumer
 
Total
Beginning balance
$
2,798

 
$
7,396

 
$
592

 
$
4,011

 
$
583

 
$
15,380

Non 310-30 beginning balance
2,798

 
3,056

 
323

 
4,011

 
540

 
10,728

Charge-offs
(1,654
)
 
(943
)
 

 
(741
)
 
(717
)
 
(4,055
)
Recoveries
187

 
129

 
13

 
64

 
224

 
617

Provision
1,315

 
(317
)
 
186

 
932

 
409

 
2,525

Non 310-30 ending balance
2,646

 
1,925

 
522

 
4,266

 
456

 
9,815

ASC 310-30 beginning balance

 
4,340

 
269

 

 
43

 
4,652

Charge-offs
(407
)
 
(2,796
)
 
(221
)
 
(623
)
 

 
(4,047
)
Recoveries

 

 

 

 

 

Provision
496

 
(1,246
)
 
537

 
1,255

 
(43
)
 
999

ASC 310-30 ending balance
89

 
298

 
585

 
632

 

 
1,604

Ending balance
$
2,735

 
$
2,223

 
$
1,107

 
$
4,898

 
$
456

 
$
11,419

Ending allowance balance attributable to:
 
 
 
 
 
 
 
 
 
 
 
Non 310-30 loans individually evaluated for impairment
$
92

 
$
40

 
$
1

 
$
533

 
$
7

 
$
673

Non 310-30 loans collectively evaluated for impairment
2,554

 
1,885

 
521

 
3,733

 
449

 
9,142

ASC 310-30 loans
89

 
298

 
585

 
632

 

 
1,604

Total ending allowance balance
$
2,735

 
$
2,223

 
$
1,107

 
$
4,898

 
$
456

 
$
11,419

Loans:
 
 
 
 
 
 
 
 
 
 
 
Non 310-30 individually evaluated for impairment
$
7,670

 
$
11,258

 
$
223

 
$
9,629

 
$
295

 
$
29,075

Non 310-30 collectively evaluated for impairment
264,444

 
277,494

 
117,241

 
513,531

 
28,018

 
1,200,728

ASC 310-30 loans
68,250

 
325,701

 
37,882

 
72,409

 
8,768

 
513,010

Total loans
$
340,364

 
$
614,453

 
$
155,346

 
$
595,569

 
$
37,081

 
$
1,742,813

 
Three months ended September 30, 2012
 
Commercial
 
Commercial
real estate
 
Agriculture
 
Residential
real estate
 
Consumer
 
Total
Beginning balance
$
3,318

 
$
7,797

 
$
660

 
$
4,872

 
$
647

 
$
17,294

Non 310-30 beginning balance
1,725

 
3,578

 
284

 
3,813

 
635

 
10,035

Charge-offs
(297
)
 
(35
)
 

 
(351
)
 
(566
)
 
(1,249
)
Recoveries
279

 
(195
)
 
4

 
(47
)
 
(41
)
 

Provision
842

 
(15
)
 
(22
)
 
274

 
521

 
1,600

Non 310-30 ending balance
2,549

 
3,333

 
266

 
3,689

 
549

 
10,386

ASC 310-30 beginning balance
1,593

 
4,219

 
376

 
1,059

 
12

 
7,259

Charge-offs
(1
)
 
(3,500
)
 
(144
)
 
(169
)
 

 
(3,814
)
Recoveries

 
2

 

 

 

 
2

Provision
(1,592
)
 
6,012

 

 
(747
)
 
(10
)
 
3,663

ASC 310-30 ending balance

 
6,733

 
232

 
143

 
2

 
7,110

Ending balance
$
2,549

 
$
10,066

 
$
498

 
$
3,832

 
$
551

 
$
17,496


24

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NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013

 
Nine months ended September 30, 2012
 
Commercial
 
Commercial
real estate
 
Agriculture
 
Residential
real estate
 
Consumer
 
Total
Beginning balance
$
2,959

 
$
3,389

 
$
282

 
$
4,121

 
$
776

 
$
11,527

Non 310-30 beginning balance
1,597

 
3,389

 
154

 
3,423

 
776

 
9,339

Charge-offs
(3,056
)
 
(2,448
)
 
(8
)
 
(815
)
 
(1,161
)
 
(7,488
)
Recoveries
279

 
24

 
4

 
49

 
252

 
608

Provision
3,729

 
2,368

 
116

 
1,032

 
682

 
7,927

Non 310-30 ending balance
2,549

 
3,333

 
266

 
3,689

 
549

 
10,386

ASC 310-30 beginning balance
1,362

 

 
128

 
698

 

 
2,188

Charge-offs
(216
)
 
(11,643
)
 
(144
)
 
(729
)
 
(19
)
 
(12,751
)
Recoveries

 
275

 

 

 

 
275

Provision
(1,146
)
 
18,101

 
248

 
174

 
21

 
17,398

ASC 310-30 ending balance

 
6,733

 
232

 
143

 
2

 
7,110

Ending balance
$
2,549

 
$
10,066

 
$
498

 
$
3,832

 
$
551

 
$
17,496

Ending allowance balance attributable to:
 
 
 
 
 
 
 
 
 
 
 
Non 310-30 loans individually evaluated for impairment
$
1,091

 
$
517

 
$

 
$
424

 
$

 
$
2,032

Non 310-30 loans collectively evaluated for impairment
1,458

 
2,816

 
266

 
3,265

 
549

 
8,354

ASC 310-30 loans

 
6,733

 
232

 
143

 
2

 
7,110

Total ending allowance balance
$
2,549

 
$
10,066

 
$
498

 
$
3,832

 
$
551

 
$
17,496

Loans:
 
 
 
 
 
 
 
 
 
 
 
Non 310-30 individually evaluated for impairment
$
11,586

 
$
18,067

 
$
178

 
$
7,532

 
$
193

 
$
37,556

Non 310-30 collectively evaluated for impairment
156,977

 
229,786

 
105,134

 
398,888

 
30,149

 
920,934

ASC 310-30 loans
97,664

 
664,771

 
55,944

 
126,294

 
26,363

 
971,036

Total loans
$
266,227

 
$
912,624

 
$
161,256

 
$
532,714

 
$
56,705

 
$
1,929,526

In evaluating the loan portfolio for an appropriate ALL level, non-impaired loans that were not accounted for under ASC 310-30 were grouped into segments based on broad characteristics such as primary use and underlying collateral. Within the segments, the portfolio was further disaggregated into classes of loans with similar attributes and risk characteristics for purposes of applying loss ratios and determining applicable subjective adjustments to the ALL. The application of subjective adjustments was based upon qualitative risk factors, including economic trends and conditions, industry conditions, asset quality, loss trends, lending management, portfolio growth and loan review/internal audit results.
The Company charged-off $0.6 million and $3.4 million, net of recoveries, of non 310-30 loans during the three and nine months ended September 30, 2013, respectively. The Company had previously provided specific reserves for $0.4 million and $1.7 million of the net charge-offs realized during the three and nine months ended September 30, 2013. Improvements in credit quality trends of the non 310-30 loan portfolio were seen in both past due and non-performing loans during the three and nine months ended September 30, 2013, and, through management's evaluation discussed above, resulted in a provision for loan losses on the non 310-30 loans of $0.8 million and $2.5 million, respectively.
During the nine months ended September 30, 2013, the Company re-estimated the expected cash flows of the loan pools accounted for under ASC 310-30 utilizing the same cash flow methodology used at the time of acquisition. The re-measurement resulted in a net reversal of impairment of $0.3 million and a net impairment of $1.0 million for the three and nine months ended September 30, 2013, respectively. During the three months ended September 30, 2013, the re-measurements resulted in a reversal of $0.9 million of impairment expense in the residential real estate segment and net impairments of $0.5 million in the agriculture segment. During the nine months ended September 30, 2013, the re-measurements resulted in a reversal of previous

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NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013

valuation allowances of $1.2 million in the commercial real estate segment and net impairments of $1.3 million, $0.5 million and $0.5 million in the residential real estate, agriculture, and commercial segments, respectively.
During the three and nine months ended September 30, 2012, the Company's re-measurement of expected future cash flows of ASC 310-30 loans resulted in impairments of $3.7 million and $17.4 million, respectively. The commercial real estate pool was the primary contributor to the total impairment with impairments of $6.0 million and $18.1 million for the three and nine months ended September 30, 2012, respectively. As a result of gross cash flow improvements during the three and nine months ended September 30, 2012, the re-measurements resulted in a reversal of $1.6 million and $1.1 million, respectively, of impairment expense in the commercial segment.
During the three and nine months ended September 30, 2012, the Company recorded $1.6 million and $7.9 million, respectively, of provision for loan losses for loans not accounted for under ASC 310-30 primarily to provide for changes in credit risk inherent in new loan originations and provide for charge-offs. The Company charged off $6.9 million, net of recoveries, of non 310-30 loans during the nine months ended September 30, 2012, $2.4 million of which was the result of a large commercial and industrial loan that was not considered indicative of future charge-offs in the commercial and industrial loan category. The Company also charged off $2.4 million of commercial real estate loans, primarily the result of three commercial real estate loans outside of the core market areas totaling $2.1 million.
Note 6 FDIC Indemnification Asset
Under the terms of the purchase and assumption agreement with the FDIC with regard to the Hillcrest Bank and Community Banks of Colorado acquisitions, the Company is reimbursed for a portion of the losses incurred on covered assets. As covered assets are resolved, whether it be through repayment, short sale of the underlying collateral, the foreclosure on and sale of collateral, or the sale or charge-off of loans or OREO, any differences between the carrying value of the covered assets versus the payments received during the resolution process, that are reimbursable by the FDIC, are recognized in the consolidated statements of operations as FDIC loss sharing income. Any gains or losses realized from the resolution of covered assets reduce or increase, respectively, the amount recoverable from the FDIC.
Below is a summary of the activity related to the FDIC indemnification asset during the nine months ended September 30, 2013 and 2012 (in thousands):
 
For the nine months ended
 
September 30,
2013
 
September 30,
2012
Balance at beginning of period
$
86,923

 
$
223,402

Accretion
(11,843
)
 
(9,165
)
FDIC portion of charge-offs exceeding fair value marks
7,466

 
8,100

Reduction for claims filed
(24,460
)
 
(109,142
)
Balance at end of period
$
58,086

 
$
113,195

During the nine months ended September 30, 2013, the Company recognized $11.8 million of negative accretion on the FDIC indemnification asset, and reduced the carrying value of the FDIC indemnification asset by $24.5 million as a result of claims filed with the FDIC. The negative accretion resulted from an overall increase in actual and expected cash flows on the underlying covered assets, resulting in lower expected reimbursements from the FDIC. The increase in overall expected cash flows from these underlying assets is reflected in increased accretion rates on covered loans and is being recognized over the expected remaining lives of the underlying covered loans as an adjustment to yield. The loss claims filed are subject to review and approval, including extensive audits, by the FDIC or its assigned agents for compliance with the terms in the loss sharing agreements. During the nine months ended September 30, 2013, the Company received $77.0 million in payments from the FDIC.
During the nine months ended September 30, 2012, the Company recognized $9.2 million of negative accretion on the FDIC indemnification asset, and reduced the carrying value of the FDIC indemnification asset by $109.1 million as a result of claims filed with the FDIC.

26

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NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013

Note 7 Other Real Estate Owned
A summary of the activity in the OREO balances during the nine months ended September 30, 2013 and 2012 is as follows (in thousands):
 
For the nine months ended September 30,
 
2013
 
2012
Beginning balance
$
94,808

 
$
120,636

Transfers from loan portfolio, at fair value
32,408

 
67,741

Impairments
(9,142
)
 
(8,638
)
Sales
(54,705
)
 
(57,186
)
Gain on sale of OREO, net
7,384

 
6,792

Ending balance
$
70,753

 
$
129,345

The OREO balances include the interests of several outside participating banks totaling $3.8 million at September 30, 2013 and $5.3 million at December 31, 2012, for which an offsetting liability is recorded in other liabilities. It excludes $10.6 million, for both of the respective periods, of the Company’s minority interests in OREO which are held by outside banks where the Company was not the lead bank and does not have a controlling interest, for which the Company maintains a receivable in other assets.
Of the $70.8 million of OREO at September 30, 2013, $44.1 million, or 62.3%, was covered by loss sharing agreements with the FDIC. Any losses on these assets are substantially offset by a corresponding change in the FDIC indemnification asset. During the nine months ended September 30, 2013, the Company sold $54.7 million of OREO and realized net gains on these sales of $7.4 million.

Of the $129.3 million of OREO at September 30, 2012, $64.5 million, or 49.9%, was covered by the loss sharing agreements with the FDIC. During the nine months ended September 30, 2012, the Company sold $57.2 million of OREO and realized net gains on these sales of $6.8 million.
Note 8 Deposits
As of September 30, 2013 and December 31, 2012, deposits totaled $4.0 billion and $4.2 billion, respectively. Time deposits decreased from $1.8 billion at December 31, 2012 to $1.5 billion at September 30, 2013. The following table summarizes the Company’s time deposits, based upon contractual maturity, at September 30, 2013 and December 31, 2012, by remaining maturity (in thousands):
 
September 30, 2013
 
December 31, 2012
 
Balance
 
Weighted
Average
Rate
 
Balance
 
Weighted
Average
Rate
Three months or less
$
341,794

 
0.58
%
 
$
356,446

 
0.78
%
Over 3 months through 6 months
343,463

 
0.58
%
 
259,097

 
0.68
%
Over 6 months through 12 months
438,725

 
0.57
%
 
583,209

 
0.67
%
Over 12 months through 24 months
289,159

 
0.95
%
 
373,283

 
0.88
%
Over 24 months through 36 months
72,360

 
1.66
%
 
111,599

 
1.77
%
Over 36 months through 48 months
27,653

 
1.51
%
 
43,967

 
1.83
%
Over 48 months through 60 months
16,275

 
1.33
%
 
19,278

 
1.44
%
Thereafter
4,961

 
1.69
%
 
5,839

 
2.32
%
Total time deposits
$
1,534,390

 
0.72
%
 
$
1,752,718

 
0.85
%
In connection with the Company’s FDIC-assisted transactions, the FDIC provided Hillcrest Bank, Bank of Choice and Community Banks of Colorado depositors with the right to redeem their time deposits at any time during the life of the time

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NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013

deposit, without penalty, unless the depositor accepts new terms. At September 30, 2013 and December 31, 2012, the Company had approximately $82.6 million and $164.3 million, respectively, of time deposits that were subject to penalty-free withdrawals.
The Company incurred interest expense on deposits as follows during the periods indicated (in thousands):
 
For the three months ended
 
For the nine months ended
 
September 30, 2013
 
September 30, 2012
 
September 30, 2013
 
September 30, 2012
Interest bearing demand deposits
$
157

 
$
271

 
$
536

 
$
1,007

Money market accounts
872

 
1,005

 
2,534

 
3,076

Savings accounts
56

 
65

 
170

 
226

Time deposits
2,880

 
5,178

 
9,407

 
19,713

Total
$
3,965

 
$
6,519

 
$
12,647

 
$
24,022

Note 9 Regulatory Capital
At September 30, 2013 and December 31, 2012, as applicable, NBH Bank, N.A. and the consolidated holding company exceeded all capital ratio requirements under prompt corrective action or other regulatory requirements, as is detailed in the table below (in thousands):
 
September 30, 2013
 
Actual
 
Required to be
considered well
capitalized (1)
 
Required to be
considered
adequately
capitalized
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
Tier 1 leverage ratio
 
 
 
 
 
 
 
 
 
 
 
Consolidated
18.5
%
 
$
948,196

 
N/A

 
N/A

 
4
%
 
$
205,349

NBH Bank, N.A.
17.1
%
 
865,682

 
10
%
 
$
507,279

 
4
%
 
202,912

Tier 1 risk-based capital ratio (2)
 
 
 
 
 
 
 
 
 
 
 
Consolidated
48.0
%
 
$
948,196

 
6
%
 
$
118,619

 
4
%
 
$
79,079

NBH Bank, N.A.
44.3
%
 
865,682

 
11
%
 
214,800

 
4
%
 
78,109

Total risk-based capital ratio (2)
 
 
 
 
 
 
 
 
 
 
 
Consolidated
48.6
%
 
$
960,415

 
10
%
 
$
197,698

 
8
%
 
$
158,158

NBH Bank, N.A.
45.0
%
 
877,901

 
12
%
 
234,328

 
8
%
 
156,218

 

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NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013

 
December 31, 2012
 
Actual
 
Required to be
considered well
capitalized (1)
 
Required to be
considered
adequately
capitalized
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
Tier 1 leverage ratio
 
 
 
 
 
 
 
 
 
 
 
Consolidated
18.2
%
 
$
962,779

 
N/A

 
N/A

 
4
%
 
$
211,439

NBH Bank, N.A.
16.4
%
 
851,365

 
10
%
 
$
518,244

 
4
%
 
207,298

Tier 1 risk-based capital ratio (2)
 
 
 
 
 
 
 
 
 
 
 
Consolidated
51.9
%
 
$
962,779

 
6
%
 
$
111,396

 
4
%
 
$
74,264

NBH Bank, N.A.
46.6
%
 
851,365

 
11
%
 
201,147

 
4
%
 
73,144

Total risk-based capital ratio (2)
 
 
 
 
 
 
 
 
 
 
 
Consolidated
52.7
%
 
$
978,535

 
10
%
 
$
185,659

 
8
%
 
$
148,527

NBH Bank, N.A.
47.4
%
 
867,121

 
12
%
 
219,433

 
8
%
 
146,289

(1)
These ratio requirements are reflective of the agreements the Company has made with its various regulators in connection with the approval of the de novo charter for NBH Bank, N.A., as described above.
(2)
Due to the conditional guarantee represented by the loss sharing agreements, the FDIC indemnification asset and covered assets are risk-weighted at 20% for purposes of risk-based capital computations.
Note 10 FDIC Loss Sharing Income (Expense)
In connection with the loss sharing agreements that the Company has with the FDIC with regard to the Hillcrest Bank and Community Banks of Colorado transactions, the Company recognizes the actual reimbursement of costs of resolution of covered assets from the FDIC through the statements of operations. The table below provides additional details of the Company’s FDIC loss sharing income (expense) during the three and nine months ended September 30, 2013 and 2012 (in thousands):
 
For the three months ended
 
For the nine months ended
 
September 30, 2013
 
September 30, 2012
 
September 30, 2013
 
September 30, 2012
Clawback liability amortization
$
(314
)
 
$
(355
)
 
$
(937
)
 
$
(1,066
)
Clawback liability remeasurement
(405
)
 
(820
)
 
244

 
247

Reimbursement to FDIC for gain on sale of and income from covered OREO
(2,514
)
 
(1,842
)
 
(4,615
)
 
(1,408
)
Reimbursement to FDIC for recoveries

 
(2
)
 
(22
)
 
(3
)
FDIC reimbursement of costs of resolution of covered assets
2,042

 
4,522

 
8,608

 
11,508

Total
$
(1,191
)
 
$
1,503

 
$
3,278

 
$
9,278

Note 11 Stock-based Compensation and Employee Benefits
The Company issued stock options in accordance with the NBH Holdings Corp. 2009 Equity Incentive Plan (the “Plan”) during the nine months ended September 30, 2013. These option awards vest on a graded basis over 1-4 years of continuous service and have 10-year contractual terms. The expense associated with the awarded stock options was measured at fair value using a Black-Scholes option-pricing model using the following weighted average assumptions:
 
Black-Scholes
Risk-free interest rate
1.15
%
Expected volatility
32.07
%
Expected term (years)
6.70

Dividend yield
1.09
%

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NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013

Expected volatility was calculated using a time-based weighted migration of the Company’s own stock price volatility coupled with those of a peer group of 9 comparable publicly traded companies for a period commensurate with the expected term of the options. The risk-free rate for the expected term of the options was based on the U.S. Treasury yield curve at the date of grant and based on the expected term. The expected term was estimated to be the average of the contractual vesting term and time to expiration. The dividend yield was assumed to be $0.05 per share per quarter. Options granted during the nine months ended September 30, 2013 had weighted average grant date fair values of $5.54 per share.
The following table summarizes option activity for the nine months ended September 30, 2013:
 
Options
 
Weighted
Average
Exercise
Price
 
Weighted
Average
Remaining
Contractual
Term in
Years
 
Aggregate
Intrinsic
Value
Outstanding at December 31, 2012
3,471,665

 
$
19.98

 
6.94
 
$
22,800

Granted during the nine months ended September 30, 2013
174,750

 
18.62

 
 
 
 
Forfeited
(47,570
)
 
19.35

 
 
 
 
Expired
(60,833
)
 
20.00

 
 
 
 
Exercised

 

 
 
 
 
Outstanding at September 30, 2013
3,538,012

 
$
19.92

 
6.37
 
$
2,238,176

Options fully vested and exercisable at September 30, 2013
2,602,082

 
$
20.00

 
6.19
 
$

Options expected to vest
933,800

 
$
19.74

 
6.43
 
$
2,111,363

Stock option expense is included in salaries and employee benefits in the accompanying consolidated statements of operations and totaled $0.5 million and $3.9 million for the three months ended September 30, 2013 and 2012, respectively, and $1.8 million and $5.9 million for the nine months ended September 30, 2013 and 2012, respectively. At September 30, 2013, there was $1.8 million of total unrecognized compensation cost related to non-vested stock options granted under the Plan. The cost is expected to be recognized over a weighted average period of 0.9 years.
Expense related to non-vested restricted stock totaled $0.8 million and $2.7 million during the three months ended September 30, 2013 and 2012, respectively, and $2.2 million and $5.0 million during the nine months ended September 30, 2013 and 2012, respectively, and is included in salaries and employee benefits in the Company’s consolidated statements of operations. As of September 30, 2013, there was $2.3 million of total unrecognized compensation cost related to non-vested restricted shares granted under the Plan, which is expected to be recognized over a weighted average period of 1.1 years. The following table summarizes restricted stock activity for the nine months ended September 30, 2013:
 
Total Restricted Shares
 
Weighted Average Grant-Date Fair Value
Unvested at December 31, 2012
951,668

 
14.79

Granted
146,218

 
18.25

Forfeited
(10,732
)
 
18.09

Unvested at September 30, 2013
1,087,154

 
15.22


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NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013

Note 12 Common Stock
The Company had 45,245,425 shares of Class A common stock and 5,967,619 shares of Class B common stock outstanding as of September 30, 2013 and 46,368,483 shares of Class A common stock and 5,959,189 shares of Class B common stock outstanding as of December 31, 2012. Additionally, as of September 30, 2013 and December 31, 2012, the Company had 1,087,154 and 951,668 shares, respectively, of restricted Class A common stock issued but not yet vested under the NBH Holdings Corp. 2009 Equity Incentive Plan. Class A common stock possesses all of the voting power for all matters requiring action by holders of common stock, with certain limited exceptions. The Company’s certificate of incorporation provides that, except with respect to voting rights and conversion rights, the Class A common stock and Class B non-voting common stock are treated equally and identically.
Note 13 Income Per Share
The Company calculates income per share under the two-class method, as certain non-vested share awards contain nonforfeitable rights to dividends. As such, these awards are considered securities that participate in the earnings of the Company. Non-vested shares are discussed further in note 11.
The Company had 51,213,044 and 52,191,239 shares outstanding (inclusive of Class A and B) as of September 30, 2013 and 2012, respectively. Additional information regarding share activity subsequent to September 30, 2013 can be found in note 18. Certain stock options and non-vested restricted shares are potentially dilutive securities, but are not included in the calculation of diluted earnings per share because to do so would have been anti-dilutive for three and nine months ended September 30, 2013 and 2012, respectively.
The following table illustrates the computation of basic and diluted income per share for the three and nine months ended September 30, 2013 and 2012 (in thousands, except share and earnings per share information):
 
 
For the three months ended
 
For the nine months ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Distributed earnings
$
2,622

 
$

 
$
7,934

 
$

Undistributed earnings (distributions in excess of earnings)
(1,675
)
 
(7,891
)
 
(2,007
)
 
(3,546
)
Net income (loss)
$
947

 
$
(7,891
)
 
$
5,927

 
$
(3,546
)
Less: earnings allocated to participating securities
(5
)
 

 
(12
)
 

Earnings allocated to common stockholders
$
942

 
$
(7,891
)
 
$
5,915

 
$
(3,546
)
Weighted average shares outstanding for basic earnings per common share
51,454,200

 
52,191,239

 
51,940,245

 
52,186,465

Dilutive effect of equity awards
45,301

 

 
32,916

 

Dilutive effect of warrants
2,479

 

 

 

Weighted average shares outstanding for diluted earnings per common share
51,501,980

 
52,191,239

 
51,973,161

 
52,186,465

Basic earnings (loss) per share
$
0.02

 
$
(0.15
)
 
$
0.11

 
$
(0.07
)
Diluted earnings (loss) per share
$
0.02

 
$
(0.15
)
 
$
0.11

 
$
(0.07
)
The Company had 3,538,012 and 3,443,332 outstanding stock options to purchase common stock at weighted average exercise prices of $19.92 and $20.00 per share at September 30, 2013 and 2012, respectively, which have time-vesting criteria, and as such, any dilution is derived only for the time frame in which the vesting criteria had been met and where the inclusion of those stock options is dilutive. Additionally, the Company had 830,750 outstanding warrants to purchase the Company’s common stock as of September 30, 2013 and 2012. The warrants have an exercise price of $20.00, which was out-of-the-money for purposes of dilution calculations during both the nine months ended September 30, 2013 and the three and nine months ended September 30, 2012. The Company had 1,087,154 and 1,169,792 unvested restricted shares outstanding as of September 30, 2013 and 2012, respectively, which have performance, market and time-vesting criteria, and as such, any dilution is derived only for the time frame in which the vesting criteria had been met and where the inclusion of those restricted shares is dilutive.

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NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013

Note 14 Derivatives
The Company manages economic risks, including interest rate, liquidity, and credit risk, primarily by managing the amount, sources, and duration of its assets and liabilities. During the nine months ended September 30, 2013, the Company began entering into interest rate swaps. The Company’s existing interest rate derivatives result from a service provided to certain qualifying clients in the extension of credit and, therefore, are not used to manage interest rate risk in the Company’s assets or liabilities. The Company manages a matched book with respect to its derivative instruments whereby it enters into offsetting swaps in order to minimize its net risk exposure resulting from such transactions. The Company’s swap derivatives are not designated as hedging relationships, and do not meet the strict hedge accounting requirements. Accordingly, changes in the fair value of both the client swaps and the offsetting swaps are recognized directly in earnings. At September 30, 2013, the Company had entered into one matched interest rate swap transaction with a notional amount of $2.1 million and a fair value of $83.0 thousand. Under this arrangement, the client pays the Company a fixed rate of 5.75%, while the Company pays the client a LIBOR rate plus 275 basis points.
Note 15 Fair Value Measurements
The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to disclose the fair value of its financial instruments. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. For disclosure purposes, the Company groups its financial and non-financial assets and liabilities into three different levels based on the nature of the instrument and the availability and reliability of the information that is used to determine fair value. The three levels are defined as follows:
Level 1—Includes assets or liabilities in which the inputs to the valuation methodologies are based on unadjusted quoted prices in active markets for identical assets or liabilities.
Level 2—Includes assets or liabilities in which the inputs to the valuation methodologies are based on similar assets or liabilities in inactive markets, quoted prices for identical or similar assets or liabilities in inactive markets, and inputs other than quoted prices that are observable, such as interest rates, yield curves, volatilities, prepayment speeds, and other inputs obtained from observable market input.
Level 3—Includes assets or liabilities in which the inputs to the valuation methodology are based on at least one significant assumption that is not observable in the marketplace. These valuations may rely on management’s judgment and may include internally-developed model-based valuation techniques.
Level 1 inputs are considered to be the most transparent and reliable and level 3 inputs are considered to be the least transparent and reliable. The Company assumes the use of the principal market to conduct a transaction of each particular asset or liability being measured and then considers the assumptions that market participants would use when pricing the asset or liability. Whenever possible, the Company first looks for quoted prices for identical assets or liabilities in active markets (level 1 inputs) to value each asset or liability. However, when inputs from identical assets or liabilities on active markets are not available, the Company utilizes market observable data for similar assets and liabilities. The Company maximizes the use of observable inputs and limits the use of unobservable inputs to occasions when observable inputs are not available. The need to use unobservable inputs generally results from the lack of market liquidity of the actual financial instrument or of the underlying collateral. Although, in some instances, third party price indications may be available, limited trading activity can challenge the observability of these quotations.
Changes in the valuation inputs used for measuring the fair value of financial instruments may occur due to changes in current market conditions or other factors. Such changes may necessitate a transfer of the financial instruments to another level in the hierarchy based on the new inputs used. The Company recognizes these transfers at the end of the reporting period that the transfer occurs. During the nine months ended September 30, 2013 and 2012, there were no transfers of financial instruments between the hierarchy levels.
The following is a description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of each instrument under the valuation hierarchy:

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NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013

Fair Value of Financial Instruments Measured on a Recurring Basis
Investment securities available-for-sale—Investment securities available-for-sale are carried at fair value on a recurring basis. To the extent possible, observable quoted prices in an active market are used to determine fair value and, as such, these securities are classified as level 1. At December 31, 2012 the Company classified its U.S. Treasury securities as level 1 in the fair value hierarchy. At September 30, 2013 the Company did not hold U.S. Treasury securities. When quoted market prices in active markets for identical assets or liabilities are not available, quoted prices of securities with similar characteristics, discounted cash flows or other pricing characteristics are used to estimate fair values and the securities are then classified as level 2. At September 30, 2013 and December 31, 2012, the Company’s level 2 securities included asset backed securities, mortgage-backed securities comprised of residential mortgage pass-through securities, and other residential mortgage-backed securities. All other investment securities are classified as level 3. There were no transfers between levels 1, 2 or 3 during the nine months ended September 30, 2013 or 2012.
Warrant liability—The Company measures the fair value of the warrant liability on a recurring basis using a Black-Scholes option pricing model. The Company’s shares became publicly traded on September 20, 2012 and prior to that, had limited private trading; therefore, expected volatility was estimated based on the median historical volatility, for a period commensurate with the expected term of the warrants, of 9 comparable companies with publicly traded shares, and is deemed a significant unobservable input to the valuation model.
Clawback liability—The Company periodically measures the net present value of expected future cash payments to be made by the Company to the FDIC that must be made within 45 days of the conclusion of the loss sharing. The expected cash flows are calculated in accordance with the loss sharing agreements and are based primarily on the expected losses on the covered assets, which involve significant inputs that are not market observable.
The tables below present the financial instruments measured at fair value on a recurring basis as of September 30, 2013 and December 31, 2012 on the consolidated statements of financial condition utilizing the hierarchy structure described above (in thousands):
 
September 30, 2013
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
Investment securities available-for-sale:
 
 
 
 
 
 
 
Asset backed securities
$

 
$
20,098

 
$

 
$
20,098

Mortgage-backed securities (“MBS”):
 
 
 
 
 
 
 
Residential mortgage pass-through securities issued or guaranteed by U.S. Government agencies or sponsored enterprises

 
523,183

 

 
523,183

Other residential MBS issued or guaranteed by U.S. Government agencies or sponsored enterprises

 
1,346,262

 

 
1,346,262

Other securities

 

 
419

 
419

Total assets at fair value
$

 
$
1,889,543

 
$
419

 
$
1,889,962

Liabilities:
 
 
 
 
 
 
 
Warrant liability
$

 
$

 
$
5,599

 
$
5,599

Clawback liability

 

 
31,964

 
31,964

Total liabilities at fair value
$

 
$

 
$
37,563

 
$
37,563



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NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013

 
December 31, 2012
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
Investment securities available-for-sale:
 
 
 
 
 
 
 
U.S. Treasury securities
$
300

 
$

 
$

 
$
300

Asset backed securities

 
90,003

 

 
90,003

Mortgage-backed securities (“MBS”):
 
 
 
 
 
 
 
Residential mortgage pass-through securities issued or guaranteed by U.S. Government agencies or sponsored enterprises

 
678,017

 

 
678,017

Other residential MBS issued or guaranteed by U.S. Government agencies or sponsored enterprises

 
949,289

 

 
949,289

Other securities

 

 
419

 
419

Total assets at fair value
$
300

 
$
1,717,309

 
$
419

 
$
1,718,028

Liabilities:
 
 
 
 
 
 
 
Warrant liability
$

 
$

 
$
5,461

 
$
5,461

Clawback liability

 

 
31,271

 
31,271

Total liabilities at fair value
$

 
$

 
$
36,732

 
$
36,732

The table below details the changes in level 3 financial instruments during the nine months ended September 30, 2013 (in thousands):
 
Warrant
liability
 
Clawback
liability
Balance at December 31, 2012
$
5,461

 
$
31,271

Change in value
138

 
(244
)
Accretion

 
937

Settlement

 

Net change in Level 3
138

 
693

Balance at September 30, 2013
$
5,599

 
$
31,964

Fair Value of Financial Instruments Measured on a Non-recurring Basis
Certain assets may be recorded at fair value on a non-recurring basis as conditions warrant. These non-recurring fair value measurements typically result from the application of lower of cost or fair value accounting or a write-down occurring during the period.
The Company records collateral dependent loans that are considered to be impaired at their estimated fair value. A loan is considered impaired when it is probable that the Company will be unable to collect all contractual amounts due in accordance with the terms of the loan agreement. Collateral dependent impaired loans are measured based on the fair value of the collateral. The Company relies on third-party appraisals and internal assessments in determining the estimated fair values of these loans. The inputs used to determine the fair values of loans are considered level 3 inputs in the fair value hierarchy. During the nine months ended September 30, 2013, the Company measured 28 loans not accounted for under ASC 310-30 at fair value on a non-recurring basis. These loans carried specific reserves totaling $0.6 million at September 30, 2013. During the nine months ended September 30, 2013, the Company added specific reserves of $0.6 million for eleven loans with carrying balances of $10.0 million at September 30, 2013. The Company also eliminated specific reserves of $1.9 million for twenty-seven loans during the nine months ended September 30, 2013, primarily due to paydowns on these loans.
The Company may be required to record fair value adjustments on loans held-for-sale on a non-recurring basis. The non-recurring fair value adjustments could involve lower of cost or fair value accounting and may include write-downs.

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NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013

OREO is recorded at the lower of the loan balance or the fair value of the collateral less estimated selling costs. The estimated fair values of OREO are updated periodically and further write-downs may be taken to reflect a new basis. The Company recognized $9.0 million of OREO impairments in its consolidated statements of financial condition during the nine months ended September 30, 2013, of which $6.6 million, or 73.2% , were on OREO that was covered by loss sharing agreements with the FDIC. The fair values of OREO are derived from third party price opinions or appraisals that generally use an income approach or a market value approach. If reasonable comparable appraisals are not available, then the Company may use internally developed models to determine fair values. The inputs used to determine the fair values of OREO are considered level 3 inputs in the fair value hierarchy.
The table below provides information regarding the assets recorded at fair value on a non-recurring basis during the nine months ended September 30, 2013 (in thousands):
 
September 30, 2013
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Losses
From
Fair
Value
Changes
Other real estate owned
$

 
$

 
$
70,753

 
$
70,753

 
$
9,049

Impaired loans
$

 
$

 
$
29,075

 
$
29,075

 
$
1,305

The Company did not record any liabilities for which the fair value was made on a non-recurring basis during the nine months ended September 30, 2013.
The following table provides information about the valuation techniques and unobservable inputs used in the valuation of financial instruments falling within level 3 of the fair value hierarchy as of September 30, 2013. The table below excludes non-recurring fair value measurements of collateral value used for impairment measures for OREO. These valuations utilize third party appraisal or broker price opinions, and are classified as level 3 due to the significant judgment involved (in thousands):
 
Fair Value at
September 30,
2013
 
Valuation Technique
 
Unobservable Input
 
Quantitative
Measures
Other securities
$
419

 
Cash investment in private equity fund
 
Cash investment
 
 
Impaired loans
29,075

 
Appraised value
 
Appraised values
 
 
 
 
 
 
 
Discount rate
 
0-25%
Clawback liability
31,964

 
Contractually defined discounted cash flows
 
Intrinsic loss estimates
 
$323.3 million -
$405 million
 
 
 
 
 
Expected credit losses
 
 
 
 
 
 
 
Asset purchase premium
 
$98 million-$182.7 million
 
 
 
 
 
Discount rate
 
4%
 
 
 
 
 
Discount period
 
73-85 months
Warrant liability
5,599

 
Black-Scholes
 
Volatility
 
16%-49%
Note 16 Fair Value of Financial Instruments
The fair value of a financial instrument is the amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is determined based upon quoted market prices to the extent possible; however, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques that may be significantly impacted by the assumptions used, including the discount rate and estimates of future cash flows. Changes in any of these assumptions could significantly affect the fair value estimates. The fair value of the financial instruments listed below does not reflect a premium or discount that could result from offering all of the Company’s holdings of financial instruments at one time, nor does it reflect the underlying value of the Company, as ASC Topic 825 excludes certain financial instruments and all non-

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NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013

financial instruments from its disclosure requirements. In connection with the Hillcrest Bank, Bank Midwest, Bank of Choice and Community Banks of Colorado acquisitions, the Company recorded all of the acquired assets and assumed liabilities at fair value at the respective dates of acquisition. The fair value of financial instruments at September 30, 2013 and December 31, 2012, including methods and assumptions utilized for determining fair value of financial instruments, are set forth below (in thousands):
 
 
 
September 30, 2013
 
December 31, 2012
 
Level in Fair
Value
Measurement
Hierarchy
 
Carrying
Amount
 
Estimated
Fair Value
 
Carrying
Amount
 
Estimated
Fair Value
ASSETS:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
Level 1
 
$
349,244

 
$
349,244

 
$
769,180

 
$
769,180

Securities purchased under agreements to resell
Level 2
 
75,000

 
75,016

 

 

U.S. Treasury securities available-for-sale
Level 1
 

 

 
300

 
300

Asset backed securities available-for-sale
Level 2
 
20,098

 
20,098

 
90,003

 
90,003

Mortgage-backed securities—residential mortgage pass-through securities issued or guaranteed by U.S. Government agencies or sponsored enterprises available-for-sale
Level 2
 
523,183

 
523,183

 
678,017

 
678,017

Mortgage-backed securities—other residential mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored enterprises available-for-sale
Level 2
 
1,346,262

 
1,346,262

 
949,289

 
949,289

Other securities
Level 3
 
419

 
419

 
419

 
419

Mortgage-backed securities—residential mortgage pass-through securities issued or guaranteed by U.S. Government agencies or sponsored enterprises held-to-maturity
Level 2
 
530,406

 
533,464

 
577,486

 
584,551

Mortgage-backed securities—other residential mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored enterprises held-to-maturity
Level 2
 
134,311

 
131,114

 

 

Capital stock of FHLB
Level 2
 
6,705

 
6,705

 
7,976

 
7,976

Capital stock of FRB
Level 2
 
25,020

 
25,020

 
25,020

 
25,020

Loans receivable, net
Level 3
 
1,731,394

 
1,742,595

 
1,817,322

 
1,829,987

Loans held-for-sale
Level 2
 
5,265

 
5,265

 
5,368

 
5,368

Accrued interest receivable
Level 2
 
11,670

 
11,670

 
12,673

 
12,673

LIABILITIES:
 
 
 
 
 
 
 
 
 
Deposit transaction accounts
Level 2
 
2,417,113

 
2,417,113

 
2,448,001

 
2,448,001

Time deposits
Level 2
 
1,534,390

 
1,538,608

 
1,752,718

 
1,759,886

Securities sold under agreements to repurchase
Level 2
 
116,471

 
116,471

 
53,685

 
53,685

Due to FDIC
Level 3
 
31,964

 
31,964

 
31,271

 
31,271

Warrant liability
Level 3
 
5,599

 
5,599

 
5,461

 
5,461

Accrued interest payable
Level 2
 
3,225

 
3,225

 
4,239

 
4,239

 


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NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013


Cash and cash equivalents
Cash and cash equivalents have a short-term nature and the estimated fair value is equal to the carrying value.
Securities purchased under agreements to resell
The fair value of securities purchased under agreements to resell is estimated by discounting contractual maturities utilizing current market rates for similar instruments.
Investment securities
The estimated fair value of investment securities is based on quoted market prices or bid quotations received from securities dealers. Other investment securities, including securities that are held for regulatory purposes are carried at cost, less any other than temporary impairment.
Loans receivable
The estimated fair value of the loan portfolio is estimated using a discounted cash flow analysis using a discount rate based on interest rates offered at the respective measurement dates for loans with similar terms to borrowers of similar credit quality. The allowance for loan losses is considered a reasonable estimate of any required adjustment to fair value to reflect the impact of credit risk. The estimates of fair value do not incorporate the exit-price concept prescribed by ASC Topic 820 Fair Value Measurements and Disclosures.
Loans held-for-sale
Loans held-for-sale are carried at the lower of aggregate cost or estimated fair value. The portfolio consists primarily of fixed rate residential mortgage loans that are sold within 45 days. The estimated fair value is based on quoted market prices for similar loans in the secondary market and are classified as level 2.
Accrued interest receivable
Accrued interest receivable has a short-term nature and the estimated fair value is equal to the carrying value.
Deposits
The estimated fair value of deposits with no stated maturity, such as non-interest bearing demand deposits, savings, NOW accounts, and money market accounts, is equal to the amount payable on demand. The fair value of interest-bearing time deposits is based on the discounted value of contractual cash flows of such deposits, taking into account the option for early withdrawal. The discount rate is estimated using the rates offered by the Company, at the respective measurement dates, for deposits of similar remaining maturities.
Securities sold under agreements to repurchase
The vast majority of the Company’s repurchase agreements are overnight transactions that mature the day after the transaction, and as a result of this short-term nature, the estimated fair value is equal to the carrying value.
Due to FDIC
The amount due to FDIC is specified in the purchase agreements and, as it relates to the clawback liability, is discounted to reflect the uncertainty in the timing and payment of the amount due by the Company.
Warrant liability
The warrant liability is estimated using a Black-Scholes model, the assumptions of which are detailed in note 19 of our audited consolidated financial statements.
Accrued interest payable
Accrued interest payable has a short-term nature and the estimated fair value is equal to the carrying value.

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Table of contents

NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2013

Note 17 Banking Center Closures
On September 30, 2013, the Company announced plans to integrate 32 limited-service retirement center locations (acquired in its 2010 purchase of Hillcrest Bank) and exit four banking centers in Northern California (acquired in its 2011 purchase of Community Banks of Colorado). The affected centers are expected to close by December 31, 2013. Included in the three and nine months ended September 30, 2013 operating results are $3.4 million of expenses incurred in connection with the closures, including $3.3 million related to facilities expense, which are included in the Banking center closure related expenses line on the consolidated statement of operations in the accompanying financial statements. Valuation adjustments to banking center properties and fixed assets were based on prices for similar assets and account for $2.5 million of the facilities expense and $0.8 million of the facilities expense relates to lease costs. No additional material charges or future cash expenditures are expected at this time.
As of September 30, 2013, the impacted centers had $0.2 million loans outstanding, the limited-service retirement center locations had $94.0 million in total deposits and the California banking centers had $65.8 million in total deposits.
Note 18 Subsequent Events
In October 2013, NBH Bank, N.A. received approval and a waiver from the OCC under the Operating Agreement to permanently reduce the bank's capital by $313.0 million. As a result, the bank paid a $313.0 million cash dividend to the Company.
On November 1, 2013, the Company repurchased 5,015,000 shares of its common stock, including 2,175,155 shares of Class A common stock and 2,839,845 shares of Class B nonvoting common stock, together representing approximately 9.8% of its outstanding shares, from an institutional stockholder.  The repurchase price of $20.00 per share resulted in a total transaction value of approximately $100.3 million.  On November 7, 2013, the Company repurchased 756,126 shares of Class A common stock, representing approximately 1.6% of its outstanding shares, from an institutional stockholder. The repurchase price of $20.00 per share resulted in a total transaction value of approximately $15.1 million. These repurchases were exclusive of and separate from the previously announced stock repurchase program in November 2012.










38


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 interim financial statements and related notes for the three and nine months ended September 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 September 30, 2013, we had $5.2 billion in assets, $4.0 billion in deposits and $1.0 billion in equity. Through our subsidiary, NBH Bank, N.A., we operate under the following brand names: Bank Midwest in Kansas and Missouri, Community Banks of Colorado in Colorado and Northern California, and Hillcrest Bank in Texas. We believe that our established presence positions us well for growth opportunities in our current and complementary markets. We currently operate a network of 101 full-service banking centers located in Colorado, the greater Kansas City region, Northern California, and Texas. During the third quarter of 2013 we announced plans to integrate 32 limited-service retirement center locations (acquired in our 2010 purchase of Hillcrest Bank) and exit four full-service banking centers in Northern California (acquired in our 2011 purchase of Community Banks of Colorado). These actions are a result of our decision to streamline our focus on servicing our clients through full-service banking centers across our core geography, as well as through online and mobile banking channels. Additional information about the banking center closures can be found in note 17 of our unaudited consolidated interim financial statements.

39


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 nine months ended September 30, 2013:
Low-risk balance sheet
As of September 30, 2013, 45.0%, or $0.8 billion, of our total loans (by dollar amount) carried acquisition discounts and were recorded at their estimated fair value at the time of acquisition.
As of September 30, 2013, 21.0%, or $366.3 million, of our total loans (by dollar amount) were covered by loss sharing agreements with the FDIC.
As of September 30, 2013, 62.3%, or $44.1 million, of our total other real estate owned (by dollar amount) was covered by loss sharing agreements with the FDIC.
Loan portfolio
For the first time in the short history of our company, an important milestone related to loan growth was reached, as total loans grew $19.5 million from June 30, 2013 to September 30, 2013.
As of September 30, 2013, we have $1.3 billion of loans outstanding that are associated with a “strategic” client relationship - a 24.7% annualized growth for the nine months ended September 30, 2013.
Organic loan originations totaled $469.8 million for the nine months ended September 30, 2013, representing a 59.5% increase from the same period of 2012.
On a year-to-date basis, an $89.9 million decrease in total loans was led by a $297.4 million decrease in our non-strategic loans during the nine months ended September 30, 2013 as we successfully worked out non-strategic loans acquired in our FDIC-assisted transactions.
29.4% 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 0.75% in non-performing loans as of September 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 2.31% at September 30, 2013 from 4.04% at December 31, 2012.
Net charge-offs on non 310-30 loans were 0.43% annualized.
ASC 310-30 loans
Accretable yield for the acquired loans accounted for under ASC 310-30 increased $50.1 million during the nine months ended September 30, 2013. This was partially offset by $1.0 million in impairments during the same period.
One commercial and industrial loan pool accounted for under ASC 310-30, totaling $16.9 million and covered by a loss-sharing agreement, was put on non-accrual status during the nine months ended September 30, 2013.

40


Client deposit funded balance sheet
As of September 30, 2013, total deposits and client repurchase agreements made up 98.5% of our total liabilities.
Transaction accounts improved to 61.2% of total deposits as of September 30, 2013 from 58.3% at December 31, 2012.
Average transaction account deposit balances grew 3.3% annualized.
As of September 30, 2013, we did not have any brokered deposits.
Yields, returns and revenue stream
Our average annual yield on our loan portfolio was 8.11% for the nine months ended September 30, 2013.
Cost of deposits improved 27 basis points to 0.42% for the nine months ended September 30, 2013 from 0.69% for the nine months ended September 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 nine months ended September 30, 2013, driven by the attractive yields on loans accounted for under ASC 310-30 loan pools, which includes the immediate one-time recognition of $2.5 million of accretable yield related to the early payoff of one loan pool, and lower cost of deposits.
Expenses before problem loan/OREO workout expenses declined $7.1 million during the nine months ended September 30, 2013, compared to the same period in 2012, adjusting for IPO expenses during 2012 and branch closure related expenses during 2013.
Problem loan/OREO workout expenses totaled $12.0 million for the nine months ended September 30, 2013, decreasing $6.8 million from the same period in 2012.
Strong capital position
As of September 30, 2013, our consolidated tier 1 leverage ratio was 18.5% and our consolidated tier 1 risk-based capital ratio was 48.0%.
As of September 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 $0.59 per share to our tangible book value per share as of September 30, 2013.
Tangible common book value per share was $18.60 before consideration of the excess accretable yield value of $0.59 per share.
During the nine months ended September 30, 2013, we repurchased 1,114,628 shares at a weighted average price of $18.45 per share.
In November 2013, we repurchased 5,771,126 shares of our common stock, including 2,931,281 shares of Class A common stock and 2,839,845 shares of Class B nonvoting common stock, together representing approximately 11.4% of our outstanding shares, from two institutional shareholders after the expiration of their respective three-year FDIC lock-up periods.  The $20.00 price per share was a cost effective means to reduce our overall share count, and to acquire shares for deployment in future M&A opportunities. 
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 nine 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,

41


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

42


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:

43


 
As of and for the three months ended
 
As of and for the nine months ended
 
September 30, 2013
 
December 31, 2012
 
September 30, 2012
 
September 30, 2013
 
September 30, 2012
Key Ratios (1)
 
 
 
 
 
 
 
 
 
Return on average assets
0.07
%
 
0.22
%
 
-0.56
 %
 
0.15
%
 
-0.08
 %
Return on average tangible assets (2)
0.14
%
 
0.28
%
 
-0.51
 %
 
0.22
%
 
-0.03
 %
Return on average equity
0.36
%
 
1.10
%
 
-2.86
 %
 
0.74
%
 
-0.43
 %
Return on average tangible common equity (2)
0.73
%
 
1.50
%
 
-2.78
 %
 
1.13
%
 
-0.15
 %
Return on risk weighted assets
0.19
%
 
0.64
%
 
-1.65
 %
 
0.40
%
 
-0.25
 %
Interest-earning assets to interest-bearing liabilities (end of period) (3)
139.44
%
 
134.44
%
 
133.44
 %
 
139.44
%
 
133.44
 %
Loans to deposits ratio (end of period)
44.24
%
 
43.76
%
 
45.26
 %
 
44.24
%
 
45.26
 %
Average equity to average assets
19.97
%
 
20.09
%
 
19.41
 %
 
20.41
%
 
18.52
 %
Non-interest bearing deposits to total deposits (end of period)
17.45
%
 
16.14
%
 
15.15
 %
 
17.45
%
 
15.15
 %
Net interest margin (4)
3.80
%
 
4.09
%
 
3.92
 %
 
3.82
%
 
3.95
 %
Interest rate spread (5)
3.68
%
 
3.94
%
 
3.76
 %
 
3.69
%
 
3.77
 %
Yield on earning assets (3)
4.14
%
 
4.51
%
 
4.44
 %
 
4.18
%
 
4.56
 %
Cost of interest bearing liabilities (3)
0.46
%
 
0.57
%
 
0.68
 %
 
0.49
%
 
0.79
 %
Cost of deposits
0.40
%
 
0.48
%
 
0.59
 %
 
0.42
%
 
0.69
 %
Non-interest expense to average assets
3.56
%
 
3.77
%
 
4.22
 %
 
3.57
%
 
3.58
 %
Efficiency ratio (6)
92.68
%
 
85.43
%
 
101.82
 %
 
88.60
%
 
84.25
 %
Dividend payout ratio
250.00
%
 
83.33
%
 
0.00
 %
 
136.36
%
 
0.00
 %
 
 
 
 
 
 
 
 
 
 
Asset Quality Data (7) (8) (9)
 
 
 
 
 
 
 
 
 
Non-performing loans to total loans
2.60
%
 
2.23
%
 
1.94
 %
 
2.60
%
 
1.94
 %
Covered non-performing loans to total non-performing loans
55.76
%
 
27.14
%
 
19.98
 %
 
55.76
%
 
19.98
 %
Non-performing assets to total assets
2.27
%
 
2.53
%
 
3.05
 %
 
2.27
%
 
3.05
 %
Covered non-performing assets to total non-performing assets
59.51
%
 
41.70
%
 
43.12
 %
 
59.51
%
 
43.12
 %
Allowance for loan losses to total loans
0.66
%
 
0.84
%
 
0.91
 %
 
0.66
%
 
0.91
 %
Allowance for loan losses to total non-covered loans
0.83
%
 
1.26
%
 
1.44
 %
 
0.83
%
 
1.44
 %
Allowance for loan losses to non-performing loans
25.20
%
 
37.64
%
 
46.52
 %
 
25.20
%
 
46.52
 %
Net charge-offs to average loans
0.20
%
 
1.00
%
 
1.03
 %
 
0.58
%
 
1.26
 %
 

(1)
Ratios are annualized.
(2)
Ratio represents non-GAAP financial measure. See non-GAAP reconciliation on page 47.
(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.

44


(7)
Non-performing loans consist of non-accruing loans, loans 90 days or more past due and still accruing interest and restructured loans, but exclude any loans accounted for under ASC 310-30 in which the pool is still performing. These ratios may, therefore, not be comparable to similar ratios of our peers.
(8)
Non-performing assets include non-performing loans, other real estate owned and other repossessed assets.
(9)
Total loans are net of unearned discounts and fees.


About Non-GAAP Financial Measures
Certain of the financial measures and ratios we present, including “tangible assets,” “return on average tangible assets,” “return on average tangible common equity,” “tangible common book value,” “tangible common book value per share,” and “tangible common equity,” are supplemental measures that are not required by, or are not presented in accordance with, U.S. generally accepted accounting principles, or “non-GAAP financial measures.” We consider the use of select non-GAAP financial measures and ratios to be useful for financial and operational decision making and useful in evaluating period-to-period comparisons. We believe that these non-GAAP financial measures provide meaningful supplemental information regarding our performance by excluding certain expenditures or assets that we believe are not indicative of our primary business operating results. We believe that management and investors benefit from referring to these non-GAAP financial measures in assessing our performance and when planning, forecasting, analyzing and comparing past, present and future periods.

These non-GAAP financial measures are presented for supplemental informational purposes only and should not be considered a substitute for financial information presented in accordance with GAAP. The non-GAAP financial measures we present may differ from non-GAAP financial measures used by our peers or other companies. In particular, the items that we exclude in our adjustments are not necessarily consistent with the items that our peers may exclude from their results of operations and key financial measures and therefore may limit the comparability of similarly named financial measures and ratios. We compensate for these limitations by providing the equivalent GAAP measures whenever we present the non-GAAP financial measures and by including a reconciliation of the impact of the components adjusted for in the non-GAAP financial measure so that both measures and the individual components may be considered when analyzing our performance.
A reconciliation of our non-GAAP financial measures to the comparable GAAP financial measures is as follows (in thousands, except share and per share information).


45


 
As of and for the three months ended
 
September 30, 2013
 
December 31, 2012
 
September 30, 2012
Total stockholders’ equity
$
1,031,250

 
$
1,090,559

 
$
1,095,835

Less: goodwill
(59,630
)
 
(59,630
)
 
(59,630
)
Add: deferred tax liability related to goodwill
4,284

 
3,121

 
2,733

Less: intangible assets, net
(23,566
)
 
(27,575
)
 
(28,901
)
Tangible common equity (1)
$
952,338

 
$
1,006,475

 
$
1,010,037

 
 
 
 
 
 
Total assets
$
5,161,969

 
$
5,410,775

 
$
5,522,826

Less: goodwill
(59,630
)
 
(59,630
)
 
(59,630
)
Add: deferred tax liability related to goodwill
4,284

 
3,121

 
2,733

Less: intangible assets, net
(23,566
)
 
(27,575
)
 
(28,901
)
Tangible assets (1)
$
5,083,057

 
$
5,326,691

 
$
5,437,028

 
 
 
 
 
 
Total stockholders’ equity to total assets
19.98
 %
 
20.16
 %
 
19.84
 %
Less: impact of goodwill and intangible assets, net
-1.24
 %
 
-1.27
 %
 
-1.26
 %
Tangible common equity to tangible assets (1)
18.74
 %
 
18.89
 %
 
18.58
 %
 
 
 
 
 
 
Common book value per share calculations:
 
 
 
 
 
Total stockholders' equity
$
1,031,250

 
$
1,090,559

 
$
1,095,835

Divided by: ending shares outstanding
51,213,044

 
52,327,672

 
52,191,239

Common book value per share
$
20.14

 
$
20.84

 
$
21.00

 
 
 
 
 
 
Tangible common book value per share calculations:
 
 
 
 
 
Tangible common equity
$
952,338

 
$
1,006,475

 
$
1,010,037

Divided by: ending shares outstanding
51,213,044

 
52,327,672

 
52,191,239

Tangible common book value per share (1)
$
18.60

 
$
19.23

 
$
19.35

 
 
 
 
 
 
Tangible common book value per share, excluding accumulated other comprehensive income (loss) calculations:
 
 
 
 
 
Tangible common equity
$
952,338

 
$
1,006,475

 
$
1,010,037

Less: accumulated other comprehensive income (loss)
142

 
(40,573
)
 
(46,752
)
Tangible common book value, excluding accumulated other comprehensive income (loss)
952,480

 
965,902

 
963,285

Divided by: ending shares outstanding
51,213,044

 
52,327,672

 
52,191,239

Tangible common book value per share, excluding accumulated other comprehensive income (loss)(1)
$
18.60

 
$
18.46

 
$
18.46


(1) During the three months ended September 30, 2013, we modified the calculation of tangible common book value to adjust for goodwill net of deferred tax liabilities, driven by the asset purchase structure used in our bank acquisitions. All prior periods have been restated.


46


 
As of and for the three months ended
 
As of and for the nine months ended
 
September 30, 2013
 
December 31, 2012
 
September 30, 2012
 
September 30, 2013
 
September 30, 2012
Return on average assets
0.07
%
 
0.22
%
 
-0.56
 %
 
0.15
%
 
-0.08
 %
Add: impact of goodwill and intangible assets, net
0.00
%
 
0.00
%
 
-0.01
 %
 
0.00
%
 
0.00
 %
Add: impact of core deposit intangible expense, after tax
0.07
%
 
0.06
%
 
0.06
 %
 
0.07
%
 
0.05
 %
Return on average tangible assets (1)
0.14
%
 
0.28
%
 
-0.51
 %
 
0.22
%
 
-0.03
 %
 
 
 
 
 
 
 
 
 
 
Return on average equity
0.36
%
 
1.10
%
 
-2.86
 %
 
0.74
%
 
-0.43
 %
Add: impact of goodwill and intangible assets, net
0.03
%
 
0.08
%
 
-0.24
 %
 
0.06
%
 
-0.04
 %
Add: impact of core deposit intangible expense, after tax
0.34
%
 
0.32
%
 
0.32
 %
 
0.33
%
 
0.32
 %
Return on average tangible common equity (1)
0.73
%
 
1.50
%
 
-2.78
 %
 
1.13
%
 
-0.15
 %




47


Application of Critical Accounting Policies
We use accounting principles and methods that conform to GAAP and general banking practices. We are required to apply significant judgment and make material estimates in the preparation of our financial statements and with regard to various accounting, reporting and disclosure matters. Assumptions and estimates are required to apply these principles where actual measurement is not possible or practical. The most significant of these estimates relate to the fair value determination of assets acquired and liabilities assumed in business combinations and the application of acquisition accounting, the accounting for acquired loans and the related FDIC indemnification asset, the determination of the ALL, and the valuation of stock-based compensation. These critical accounting policies and estimates are summarized in the sections captioned “Application of Critical Accounting Policies” in Management's Discussion and Analysis in our 2012 Annual Report on Form 10-K, and are further analyzed with other significant accounting policies in note 2, “Summary of Significant Accounting Policies” in the notes to our consolidated financial statements for the year ended 2012.
During the nine months ended September 30, 2013, we began entering into agreements with certain financial institutions whereby we purchase securities under agreements to resell as of a specified future date at a specified price plus accrued interest. The securities purchased under agreements to resell are carried at the contractual amounts at which the securities will subsequently be resold, including accrued interest. The securities are pledged as collateral by the counterparties and are held by a third party custodian. The collateral is valued daily and additional collateral may be obtained or refunded as necessary to maintain full collateralization of these transactions.
During the nine months ended September 30, 2013, we began entering into interest rate swaps. The existing interest rate derivatives result from a service provided to certain qualifying clients and, therefore, are not used to manage interest rate risk in our assets or liabilities and therefore are not considered hedges. We manage a matched book with respect to its derivative instruments in order to minimize its net risk exposure resulting from such transactions.
There have been no other significant changes to the application of critical accounting policies since December 31, 2012.
Financial Condition
Total assets at September 30, 2013 were $5.2 billion compared to $5.4 billion at December 31, 2012, a decrease of $0.2 billion. The decrease in total assets was largely driven by a decrease in non-strategic loan balances of $297.4 million, which was a reflection of our workout progress on troubled loans (many of which were covered) that we acquired. We also originated $469.8 million of loans during the nine months ended September 30, 2013, which offset normal client payments and grew the loan balances in our strategic portfolio at an annualized rate of 24.7%. We coupled the total loan balance decrease of $89.9 million with a $249.2 million decrease in total deposits, as we sought to retain only those depositors who were interested in time deposits at market rate and developing a banking relationship and continued our focus on migrating toward a client-based deposit mix with higher concentrations of lower cost demand, savings and money market (“transaction”) deposits. We also utilized available cash and purchased $938.5 million of investment securities during the nine months ended September 30, 2013. Our FDIC indemnification asset decreased $28.8 million during the nine months ended September 30, 2013 as a result of $24.5 million of payments from and claims submitted to the FDIC for reimbursement on continued workout progress on our covered loans and OREO, coupled with an increase in actual and expected cash flows on our covered assets. These increases in cash flows also contributed to a net reclassification of $50.1 million of non-accretable difference to accretable yield during the period, which is being accreted to income over the remaining life of the loans.

Investment Securities
Available-for-sale
Total investment securities available-for-sale were $1.9 billion at September 30, 2013, compared to $1.7 billion at December 31, 2012, an increase of $0.2 billion, or 10.0%. During the nine months ended September 30, 2013, we purchased $694.0 million of available-for-sale mortgage backed securities, which was partially offset by $456.1 million of maturities and paydowns. Our available-for-sale investment securities portfolio is summarized as follows for the periods indicated (in thousands):
 

48


 
September 30, 2013
 
December 31, 2012
 
Amortized
Cost
 
Fair
Value
 
Percent of
Portfolio
 
Weighted
Average
Yield
 
Amortized
Cost
 
Fair
Value
 
Percent of
Portfolio
 
Weighted
Average
Yield
U.S. Treasury securities
$

 
$

 
0.00
%
 
0.00
%
 
$
300

 
$
300

 
0.02
%
 
0.13
%
Asset backed securities
20,091

 
20,098

 
1.06
%
 
0.61
%
 
89,881

 
90,003

 
5.24
%
 
0.61
%
Mortgage-backed securities (“MBS”):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage pass-through securities issued or guaranteed by U.S. Government agencies or sponsored enterprises
514,584

 
523,183

 
27.68
%
 
2.04
%
 
658,169

 
678,017

 
39.46
%
 
2.03
%
Other residential MBS issued or guaranteed by U.S. Government agencies or sponsored enterprises
1,376,453

 
1,346,262

 
71.24
%
 
1.78
%
 
931,979

 
949,289

 
55.26
%
 
2.13
%
Other securities
419

 
419

 
0.02
%
 
0.00
%
 
419

 
419

 
0.02
%
 
0.00
%
Total investment securities available-for-sale
$
1,911,547

 
$
1,889,962

 
100.00
%
 
1.83
%
 
$
1,680,748

 
$
1,718,028

 
100.00
%
 
2.01
%
As of September 30, 2013, approximately 98.9% of the available-for-sale investment portfolio was backed by mortgages. The residential mortgage pass-through securities portfolio is comprised of both fixed rate and adjustable rate Federal Home Loan Mortgage Corporation (“FHLMC”), Federal National Mortgage Association (“FNMA”) and Government National Mortgage Association (“GNMA”) securities. The other mortgage-backed securities are comprised of securities backed by FHLMC, FNMA and GNMA securities.
At September 30, 2013, adjustable rate securities comprised 7.8% of the available-for-sale MBS portfolio and the remainder of the portfolio was comprised of fixed rate securities with 10 to 30 year maturities, with a weighted average coupon of 2.2% per annum.
The available-for-sale investment portfolio included $21.6 million of net unrealized losses and $37.3 million of net unrealized gains, at September 30, 2013 and December 31, 2012, respectively, inclusive of $20.7 million of unrealized gains and $321.0 thousand of unrealized losses, respectively. The change from a net unrealized gain at December 31, 2012 to a net unrealized loss at September 30, 2013 is primarily driven by rising interest rates during the period. We do not believe that any of the securities with unrealized losses were other-than-temporarily-impaired.
The table below summarizes the contractual maturities of our available-for-sale investment portfolio as of September 30, 2013 (in thousands):
 
Due in one year or less
 
Due after one year through five years
 
Due after five years through ten years
 
Due after ten years
 
Other securities
 
Total
 
Carrying
Value
 
Weighted
Average
Yield
 
Carrying
Value
 
Weighted
Average
Yield
 
Carrying
Value
 
Weighted
Average
Yield
 
Carrying
Value
 
Weighted
Average
Yield
 
Carrying
Value
 
Weighted
Average
Yield
 
Carrying
Value
 
Weighted
Average
Yield
Asset backed securities
$

 
0.00
%
 
$
20,098

 
0.62
%
 
$

 
0.00
%
 
$

 
0.00
%
 
$

 
0.00
%
 
$
20,098

 
0.62
%
Mortgage-backed
securities (“MBS”):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage
pass-through
securities issued
or guaranteed by
U.S. Government
agencies or
sponsored
enterprises

 
0.00
%
 
9

 
1.54
%
 
194,408

 
1.32
%
 
328,766

 
2.47
%
 

 
0.00
%
 
523,183

 
2.04
%
Other residential MBS
issued or
guaranteed by
U.S. Government
agencies or
sponsored
enterprises

 
0.00
%
 

 
0.00
%
 
12,167

 
2.50
%
 
1,334,095

 
1.77
%
 

 
0.00
%
 
1,346,262

 
1.78
%
Other securities

 
0.00
%
 

 
0.00
%
 

 
0.00
%
 

 
0.00
%
 
419

 
0.00
%
 
419

 
0.00
%
Total investment securities available-for-sale
$

 
0.00
%
 
$
20,107

 
0.62
%
 
$
206,575

 
1.39
%
 
$
1,662,861

 
1.91
%
 
$
419

 
0.00
%
 
$
1,889,962

 
1.83
%
The estimated weighted average life of the available-for-sale MBS portfolio as of September 30, 2013 and December 31, 2012 was 4.4 years and 3.4 years, respectively, the extension of which was largely due to slower expected prepayment speeds in response to the higher interest rate environment at September 30, 2013 compared to December 31, 2012. This estimate is based on various assumptions, including repayment characteristics, and actual results may differ. As of September 30, 2013, the duration of the total available-for-sale investment portfolio was 4.0 years and the asset-backed securities portfolio within the available-for-sale investment portfolio had a duration of 0.2 year.

49


 Held-to-maturity
At September 30, 2013, we held $664.7 million of held-to-maturity investment securities, compared to $577.5 million at December 31, 2012, an increase of $87.2 million or 15.1%. During the nine months ended September 30, 2013 we purchased $244.5 million held-to-maturity securities. Held-to-maturity investment securities are summarized as follows as of the date indicated (in thousands):

 
September 30, 2013
 
Amortized
Cost
 
Fair
Value
 
Percent of
Portfolio
 
Weighted
Average Yield
Residential mortgage pass-through securities issued or guaranteed by U.S. Government agencies or sponsored enterprises
$
530,406

 
$
533,464

 
80.27
%
 
3.26
%
Other residential MBS issued or guaranteed by U.S. Government agencies or sponsored enterprises
134,311

 
131,114

 
19.73
%
 
1.69
%
Total investment securities held-to-maturity
$
664,717

 
$
664,578

 
100.00
%
 
2.94
%
The residential mortgage pass-through and other residential MBS held-to-maturity investment portfolios are comprised of fixed rate FHLMC, FNMA and GNMA securities.
At September 30, 2013 and December 31, 2012, the fair value of the held-to-maturity investment portfolio was $664.6 million and $584.6 million, inclusive of $0.1 million of unrealized losses and $7.1 million of unrealized gains, respectively. The table below summarizes the contractual maturities, as of the last scheduled repayment date, of our held-to-maturity investment portfolio as of September 30, 2013 (in thousands):

 
Amortized
Cost
 
Weighted
Average
Yield
Due in one year or less
$

 
0.00
%
Due after one year through five years

 
0.00
%
Due after five years through ten years
19,012

 
2.03
%
Due after ten years
645,705

 
2.97
%
Other securities

 
0.00
%
Total
$
664,717

 
2.94
%
The estimated weighted average life of the held-to-maturity investment portfolio as of September 30, 2013 and December 31, 2012 was 4.3 years and 3.8 years, respectively. As of September 30, 2013, the duration of the total held-to-maturity investment portfolio was 3.9 years and the duration of the entire investment securities portfolio was 4.0 years.
 
Non-marketable securities
Non-marketable securities include Federal Reserve Bank stock and FHLB stock. At September 30, 2013 and December 31, 2012, we held $25.0 million of Federal Reserve Bank stock and at September 30, 2013 and December 31, 2012 we also held $6.7 million and $8.0 million of FHLB stock, respectively. We hold these securities in accordance with debt and regulatory requirements. These are restricted securities which lack a market and are therefore carried at cost.
Loans Overview
Our loan portfolio at September 30, 2013 was comprised of loans that were acquired in connection with our four acquisitions to date, in addition to new loans that we have originated. The majority of the loans acquired in the Hillcrest Bank and Community Banks of Colorado transaction are covered by loss sharing agreements with the FDIC.
As discussed in note 2 to our audited consolidated financial statements, in accordance with applicable accounting guidance, all acquired loans are recorded at fair value at the date of acquisition, and an allowance for loan losses is not carried over with the loans but, rather, the fair value of the loans encompasses both credit quality and market considerations. Loans that exhibit signs of credit deterioration at the date of acquisition are accounted for in accordance with the provisions of ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (“ASC 310-30”). Management accounted for all loans acquired in the Hillcrest Bank, Bank of Choice and Community Banks of Colorado acquisitions under ASC 310-30, with the exception of loans with revolving privileges which were outside the scope of ASC 310-30. In our Bank Midwest transaction, we

50


did not acquire all of the loans of the former Bank Midwest but, rather, selected certain loans based upon specific criteria of performance, adequacy of collateral, and loan type that were performing at the time of acquisition. As a result, none of the loans acquired in the Bank Midwest transaction are accounted for under ASC 310-30.
Consistent with differences in the accounting, the loan portfolio is presented in two categories: (i) ASC 310-30 loans and (ii) non 310-30 loans. The portfolio is further stratified based on (i) loans covered by FDIC loss sharing agreements, or “covered loans,” and (ii) loans that are not covered by FDIC loss sharing agreements, or “non-covered loans.” Additionally, inherent in the nature of acquiring troubled banks, only certain of our acquired clients conform to our long-term business model of in-market, relationship-oriented banking clients. We have developed a management tool to evaluate the progress of working out the troubled loans acquired in our FDIC-assisted acquisitions and the progress of organic loan growth, whereby we have designated loans as “strategic” or “non-strategic.” Strategic loans include all originated loans in addition to those acquired loans inside our operating markets that meet our credit risk profile. Identification as strategic for acquired loans was made at the time of acquisition. Criteria utilized in the designation of a loan as “strategic” include (a) geography, (b) total relationship with borrower and (c) credit metrics commensurate with our current underwriting standards. At September 30, 2013, strategic loans totaled $1.3 billion and had strong credit quality as represented by a non-performing loans ratio of 0.75%. We believe this presentation of our loan portfolio provides a meaningful basis to understand the underlying drivers of changes in our loan portfolio balances.
Due to the unique structure and accounting treatment in our loan portfolio, we utilize four primary presentations to analyze our loan portfolio, depending on the purpose of the analysis. Those are:

To analyze:
 
We look at:
Loan growth and production efforts
 
Strategic balances and loan originations
Workout efforts of our purchased non-strategic portfolio
 
Non-strategic balances and accretable yield
Risk mitigants of our non-performing loans
 
FDIC loss-share coverage and fair value marks
Interest income
 
ASC 310-30 and non 310-30 yields and accretable yield
The table below shows the loan portfolio composition and the breakdown of the portfolio between ASC 310-30 loans, non 310-30 loans, along with the amounts that are covered and non-covered, at September 30, 2013 and December 31, 2012 (in thousands):

 
September 30, 2013
 
ASC 310-30 
Loans
 
Non 310-30
Loans
 
Total Loans
 
% of
Total
Commercial
$
68,250

 
$
272,114

 
$
340,364

 
19.5
%
Commercial real estate
325,701

 
288,752

 
614,453

 
35.3
%
Agriculture
37,882

 
117,464

 
155,346

 
8.9
%
Residential real estate
72,409

 
523,160

 
595,569

 
34.2
%
Consumer
8,768

 
28,313

 
37,081

 
2.1
%
Total
$
513,010

 
$
1,229,803

 
$
1,742,813

 
100.0
%
Covered
$
309,380

 
$
56,966

 
$
366,346

 
21.0
%
Non-covered
203,630

 
1,172,837

 
1,376,467

 
79.0
%
Total
$
513,010

 
$
1,229,803

 
$
1,742,813

 
100.0
%
 

51


 
December 31, 2012
 
ASC 310-30 
Loans
 
Non 310-30
Loans
 
Total Loans
 
% of
Total
Commercial
$
83,169

 
$
187,419

 
$
270,588

 
14.8
%
Commercial real estate
566,035

 
238,964

 
804,999

 
43.9
%
Agriculture
47,733

 
125,674

 
173,407

 
9.5
%
Residential real estate
106,100

 
427,277

 
533,377

 
29.1
%
Consumer
18,984

 
31,347

 
50,331

 
2.7
%
Total
$
822,021

 
$
1,010,681

 
$
1,832,702

 
100.0
%
Covered
$
527,948

 
$
80,274

 
$
608,222

 
33.2
%
Non-covered
294,073

 
930,407

 
1,224,480

 
66.8
%
Total
$
822,021

 
$
1,010,681

 
$
1,832,702

 
100.0
%
Strategic loans comprised 76.3% of the total loan portfolio at September 30, 2013, compared to 61.2% at December 31, 2012. The table below shows the loan portfolio composition categorized between strategic and non-strategic at the respective dates (in thousands):
 
September 30, 2013
 
December 31, 2012
 
Strategic
 
Non-Strategic
 
Total
 
Strategic
 
Non-Strategic
 
Total
Commercial
$
262,384

 
$
77,980

 
$
340,364

 
$
163,193

 
$
107,395

 
$
270,588

Commercial real estate
326,679

 
287,774

 
614,453

 
278,907

 
526,092

 
804,999

Agriculture
144,784

 
10,562

 
155,346

 
160,963

 
12,444

 
173,407

Residential real estate
561,770

 
33,799

 
595,569

 
474,769

 
58,608

 
533,377

Consumer
34,002

 
3,079

 
37,081

 
44,266

 
6,065

 
50,331

Total
$
1,329,619

 
$
413,194

 
$
1,742,813

 
$
1,122,098

 
$
710,604

 
$
1,832,702

Total loans decreased $89.9 million from December 31, 2012, ending at $1.7 billion at September 30, 2013. The 4.9% decrease in total loans was primarily driven by a $297.4 million decrease in our non-strategic loan portfolio as our enterprise-level, dedicated special asset resolution team successfully worked out non-strategic loans acquired in our FDIC-assisted transactions, coupled with the repayment of non-strategic loans that do not conform to our business model of in-market, relationship-oriented loans with credit metrics commensurate with our current underwriting standards. Strategic loans increased $207.5 million, or 24.7% annualized, at September 30, 2013 compared to December 31, 2012, driven by strong originations. We successfully increased our balances in our strategic commercial, commercial real estate and residential real estate portfolios as we continued to generate new relationships with individuals and small to mid-sized businesses.
Commercial loans consist of loans made to finance business operations and are secured by inventory or other business-related collateral such as accounts receivable or equipment. Commercial real estate loans include loans on 1-4 family construction properties, owner-occupied and non-owner-occupied commercial properties such as office buildings, shopping centers, or free standing commercial properties, multi-family properties and raw land development loans. Agriculture loans include loans on farm equipment and farmland loans. Residential real estate loans include 1-4 family closed and open end loans, in both senior and junior collateral positions. Consumer loans include both secured and unsecured loans.
New loan origination is a direct result of our ability to recruit and retain top banking talent, connect with clients in our markets and provide needed services at competitive rates. New loan originations of $469.8 million were up $175.2 million, or 59.5% from the same period of the prior year as a result of the deployment of bankers and the development of our market presence. The following table represents new loan originations for the last five quarters (in thousands):  


52


 
Third quarter
 
Second quarter
 
First quarter
 
Fourth quarter
 
Third quarter
 
2013
 
2013
 
2013
 
2012
 
2012
Commercial
$
80,833

 
$
24,982

 
$
15,150

 
$
30,988

 
$
25,640

Commercial real estate
50,081

 
31,553

 
36,749

 
20,993

 
11,135

Agriculture
5,689

 
22,901

 
9,446

 
28,978

 
24,328

Residential real estate
51,749

 
86,161

 
45,808

 
52,778

 
60,320

Consumer
3,326

 
3,157

 
2,211

 
6,025

 
6,505

Total
$
191,678

 
$
168,754

 
$
109,364

 
$
139,762

 
$
127,928


The tables below show the contractual maturities of our loans for the dates indicated (in thousands):
 
 
September 30, 2013
 
Due within
1 Year
 
Due after 1 but
within 5 Years
 
Due after
5 Years
 
Total
Commercial
$
107,084

 
$
201,283

 
$
31,997

 
$
340,364

Commercial real estate
174,669

 
290,996

 
148,788

 
614,453

Agriculture
42,098

 
67,092

 
46,156

 
155,346

Residential real estate
39,407

 
57,208

 
498,954

 
595,569

Consumer
14,210

 
16,089

 
6,782

 
37,081

Total loans
$
377,468

 
$
632,668

 
$
732,677

 
$
1,742,813

Covered
$
184,437

 
$
138,460

 
$
43,449

 
$
366,346

Non-covered
193,031

 
494,208

 
689,228

 
1,376,467

Total loans
$
377,468

 
$
632,668

 
$
732,677

 
$
1,742,813

 
December 31, 2012
 
Due within
1 Year
 
Due after 1 but
within 5 Years
 
Due after
5 Years
 
Total
Commercial
$
83,093

 
$
147,356

 
$
40,139

 
$
270,588

Commercial real estate
403,179

 
277,625

 
124,195

 
804,999

Agriculture
41,205

 
77,683

 
54,519

 
173,407

Residential real estate
62,712

 
73,941

 
396,724

 
533,377

Consumer
23,842

 
17,668

 
8,821

 
50,331

Total loans
$
614,031

 
$
594,273

 
$
624,398

 
$
1,832,702

Covered
$
350,339

 
$
198,373

 
$
59,510

 
$
608,222

Non-covered
263,692

 
395,900

 
564,888

 
1,224,480

Total loans
$
614,031

 
$
594,273

 
$
624,398

 
$
1,832,702


53


The interest rate sensitivity of loans with maturities over one year is as follows at the dates indicated (in thousands):
 
 
September 30, 2013
 
Fixed
 
Variable
 
Total
Commercial
$
70,915

 
$
162,365

 
$
233,280

Commercial real estate
185,932

 
253,852

 
439,784

Agriculture
56,674

 
56,574

 
113,248

Residential real estate
323,461

 
232,701

 
556,162

Consumer
12,759

 
10,112

 
22,871

Total loans with > 1 year maturity
$
649,741

 
$
715,604

 
$
1,365,345

Covered
$
41,730

 
$
140,179

 
$
181,909

Non-covered
608,011

 
575,425

 
1,183,436

Total loans with > 1 year maturity
$
649,741

 
$
715,604

 
$
1,365,345

 
December 31, 2012
 
Fixed
 
Variable
 
Total
Commercial
$
51,171

 
$
136,324

 
$
187,495

Commercial real estate
161,200

 
240,620

 
401,820

Agriculture
60,194

 
72,008

 
132,202

Residential real estate
247,321

 
223,344

 
470,665

Consumer
15,295

 
11,194

 
26,489

Total loans with > 1 year maturity
$
535,181

 
$
683,490

 
$
1,218,671

Covered
$
73,925

 
$
183,958

 
$
257,883

Non-covered
461,256

 
499,532

 
960,788

Total loans with > 1 year maturity
$
535,181

 
$
683,490

 
$
1,218,671

Accretable Yield
The fair value adjustments assigned to loans that are accounted for under ASC 310-30 include both accretable yield and a non-accretable difference that are based on expected cash flows from the loans. Accretable yield is the excess of a pool's cash flows expected to be collected over the recorded balance of the related pool of loans. The non-accretable difference represents the expected shortfall in future cash flows from the contractual amount due in respect of each pool of such loans. Similar to the entire fair value adjustment for loans outside the scope of ASC 310-30, the accretable yield is accreted into income over the estimated remaining life of the loans in the applicable pool. Contractual fees not expected to be collected are not included in ASC 310-30 contractual cash flows. Should fees be subsequently collected, the cash flows are accounted for as non 310-30 fee income in the period they are received.
Below is the composition of the net book value for loans accounted for under ASC 310-30 at September 30, 2013 and December 31, 2012 (in thousands):

 
September 30, 2013
 
December 31, 2012
Contractual cash flows
$
1,075,652

 
$
1,444,279

Non-accretable difference
(426,101
)
 
(488,673
)
Non-accretable difference on retired pools
(12,455
)
 

Accretable yield
(124,086
)
 
(133,585
)
Loans accounted for
 under ASC 310-30
$
513,010

 
$
822,021

Loan pools accounted for under ASC Topic 310-30 are periodically remeasured to determine expected future cash flows. In determining the expected cash flows, we evaluate the credit profile, contractual interest rates, collateral values and expected prepayments of the loan pools. Prepayment assumptions are based on statistical models that take into account factors such as the loan interest rate, credit profile of the borrowers, the years in which the loans were originated, and whether the loans were

54


fixed or variable rate loans. Decreases to the expected future cash flows in the applicable pool generally result in an immediate provision for loan losses charged to the consolidated statements of operations. Conversely, increases in the expected future cash flows in the applicable pool result in a transfer from the non-accretable difference to the accretable yield, and have a positive impact on accretion income prospectively. This re-measurement process resulted in the following changes to the accretable yield during the nine months ended September 30, 2013 and 2012 (in thousands):
 
 
September 30, 2013
 
September 30, 2012
Accretable yield beginning balance
$
133,585

 
$
186,494

Reclassification from non-accretable difference
55,351

 
46,974

Reclassification to non-accretable difference
(5,234
)
 
(8,348
)
Accretion
(59,616
)
 
(76,252
)
Accretable yield ending balance
$
124,086

 
$
148,868


The accretable yield of $124.1 million at September 30, 2013 includes $1.4 million of accretable yield related to the loan pool that was put on non-accrual status during the nine months ended September 30, 2013.  This accretable yield is not being accreted to income and the recognition will be deferred until full recovery of the carrying value of this pool is realized.

During the nine months ended September 30, 2013 one of the loans pools accounted for under ASC 310-30 paid off early. The early pay off of this pool resulted in an immediate recognition of $2.5 million of accretion, which is included in the $59.6 million of accretion in the above table.
We re-measure the expected cash flows of all 28 of the accruing loan pools accounted for under ASC 310-30 utilizing the same cash flow methodology used at the time of acquisition. Increases in expected cash flows are reflected as an increase in the accretion rates as well as an increased amount of accretable yield that will be recognized over the expected remaining lives of the underlying loan pools. During the nine months ended September 30, 2013 and 2012, we reclassified $50.1 million, and $38.6 million, net, from non-accretable difference to accretable yield, respectively. The re-measurements also resulted in $1.0 million and $17.4 million of net impairment during the same respective periods. The impairments during the nine months ended September 30, 2013 were primarily driven by our commercial real estate and residential real estate pools. These impairments are reflected in provision for loan loss in the consolidated statement of operations.
 
In addition to the accretable yield on loans accounted for under ASC 310-30, the fair value adjustments on loans outside the scope of ASC 310-30 are also accreted to interest income over the life of the loans. At September 30, 2013 and 2012, our total remaining accretable yield and fair value mark was as follows (in thousands):

 
September 30, 2013
 
September 30, 2012
Remaining accretable yield on loans accounted for under ASC 310-30
$
124,086

 
$
148,868

Remaining accretable fair value mark on loans not accounted for under ASC 310-30
12,834

 
23,144

Total remaining accretable yield and fair value mark
$
136,920

 
$
172,012

Loss-Share Coverage
We have two loss sharing agreements with the FDIC for the assets related to the Hillcrest Bank acquisition and a separate loss sharing agreement that covers certain assets related to the Community Banks of Colorado acquisition, whereby the FDIC will reimburse us for a portion of the losses incurred as a result of the resolution and disposition of the covered assets of these banks. The details of these agreements are more fully described in Management's Discussion and Analysis in our 2012 Annual Report on Form 10-K.

55


The categories, and the respective loss thresholds and coverage amounts related to the Hillcrest Bank loss sharing agreement are as follows (in thousands):

Commercial
 
Single family
Tranche
 
Loss Threshold
 
Loss-Coverage
Percentage
 
Tranche
 
Loss Threshold
 
Loss-Coverage
Percentage
1
 
Up to $295,592
 
60%
 
1
 
Up to $4,618
 
60%
2
 
$295,593-405,293
 
0%
 
2
 
$4,618-8,191
 
30%
3
 
>$405,293
 
80%
 
3
 
>$8,191
 
80%
The categories, and the respective loss thresholds and coverage amounts related to the Community Banks of Colorado loss sharing agreement are as follows (in thousands):
 
Tranche
 
Loss Threshold
 
Loss-Coverage Percentage
1
 
Up to $204,194
 
80%
2
 
$204,195-308,020
 
30%
3
 
>$308,020
 
80%
Under the Hillcrest Bank and Community Banks of Colorado loss sharing agreements, the reimbursable losses from the FDIC are based on the book value of the related covered assets as determined by the FDIC at the date of acquisition, and the FDIC's book value does not necessarily correlate with our book value of the same assets. This difference is primarily because we recorded the loans at fair value at the date of acquisition in accordance with applicable accounting guidance.
As of September 30, 2013, we had incurred $203.4 million of losses on our Hillcrest Bank covered assets since the beginning of the loss sharing agreement as measured by the FDIC's book value, substantially all of which was related to the commercial assets. Additionally, as of September 30, 2013, we had incurred approximately $144.0 million of losses related to our Community Banks of Colorado loss sharing agreement. The loss claims filed are subject to review and approval, including extensive audits, by the FDIC or its assigned agents for compliance with the terms in the loss sharing agreements.
Asset Quality
All of the assets acquired in our acquisitions were marked to fair value at the date of acquisition, and the fair value adjustments to loans included a credit quality component. We utilize traditional credit quality metrics to evaluate the overall credit quality of our loan portfolio; however, our credit quality ratios are limited in their comparability to industry averages or to other financial institutions because:
1. Any asset quality deterioration that existed at the date of acquisition was considered in the original fair value adjustments; and
2. 59.5% of our non-performing assets (by dollar amount) at September 30, 2013 were covered by loss sharing agreements with the FDIC.
Asset quality is fundamental to our success. Accordingly, for the origination of loans, we have established a credit policy that allows for responsive, yet controlled lending with credit approval requirements that are scaled to loan size. Within the scope of the credit policy, each prospective loan is reviewed in order to determine the appropriateness and the adequacy of the loan characteristics and the security or collateral prior to making a loan. We have established underwriting standards and loan origination procedures that require appropriate documentation, including financial data and credit reports. For loans secured by real property, we require property appraisals, title insurance or a title opinion, hazard insurance and flood insurance, in each case where appropriate.
Additionally, we have implemented procedures to timely identify loans that may become problematic in order to ensure the most beneficial resolution to the Company. Asset quality is monitored by our credit risk management department and evaluated based on quantitative and subjective factors such as the timeliness of contractual payments received. Additional factors that are considered, particularly with commercial loans over $250,000, include the financial condition and liquidity of individual borrowers and guarantors, if any, and the value of our collateral. To facilitate the oversight of asset quality, loans are categorized based on the number of days past due and on an internal risk rating system, and both are discussed in more detail below.

56


Our internal risk rating system uses a series of grades which reflect our assessment of the credit quality of covered and non-covered loans based on an analysis of the borrower's financial condition, liquidity and ability to meet contractual debt service requirements. Loans that are perceived to have acceptable risk are categorized as “pass” loans. “Special mention” loans represent loans that have potential credit weaknesses that deserve close attention. Special mention loans include borrowers that have potential weaknesses or unwarranted risks that, unless corrected, may threaten the borrower's ability to meet debt service requirements. However, these borrowers are still believed to have the ability to respond to and resolve the financial issues that threaten their financial situation. Loans classified as “substandard” have a well-defined credit weakness and are inadequately protected by the current paying capacity of the obligor or of the collateral pledged, if any. Although these loans are identified as potential problem loans, they may never become non-performing. Substandard loans have a distinct possibility of loss if the deficiencies are not corrected. “Doubtful” loans are loans that management believes that collection of payments in accordance with the terms of the loan agreement are highly questionable and improbable. Doubtful loans are deemed impaired and put on non-accrual status.
In the event of borrower default, we may seek recovery in compliance with state lending laws, the respective loan agreements, and credit monitoring and remediation procedures that may include modifying or restructuring a loan from its original terms, for economic or legal reasons, to provide a concession to the borrower from their original terms due to borrower financial difficulties in order to facilitate repayment. Such restructured loans are considered “troubled debt restructurings” in accordance with ASC 310-40 Troubled Debt Restructurings by Creditors. Under this guidance, modifications to loans that fall within the scope of ASC 310-30 are not considered troubled debt restructurings, regardless of otherwise meeting the definition of a troubled debt restructuring. Assets that have been foreclosed on or acquired through deed-in-lieu of foreclosure are classified as OREO until sold, and are carried at the lower of the related loan balance or the fair value of the collateral less estimated costs to sell, with any initial valuation adjustments charged to the ALL and any subsequent declines in carrying value charged to impairments on OREO.
Non-performing Assets
Non-performing assets consist of covered and non-covered non-accrual loans, accruing loans 90 days or more past due, troubled debt restructurings, OREO and other repossessed assets. However, loans and troubled debt restructurings accounted for under ASC 310-30, as described below, may be excluded from our non-performing assets to the extent that the cash flows of the loan pools are still estimable. Our non-performing assets included $25.3 million and $11.1 million of covered loans at September 30, 2013 and December 31, 2012, respectively, and $44.1 million and $45.5 million of covered OREO at September 30, 2013 and December 31, 2012, respectively. In addition to being covered by loss sharing agreements, these assets were marked to fair value at the time of acquisition, mitigating much of our loss potential on these non-performing assets. As a result, the levels of our non-performing assets are not fully comparable to those of our peers or to industry benchmarks.
As of September 30, 2013 and December 31, 2012, 60.3% and 64.2%, respectively, of loans accounted for under ASC 310-30 were covered by the FDIC loss sharing agreements. Loans accounted for under ASC 310-30 were recorded at fair value based on cash flow projections that considered the deteriorated credit quality and expected losses. These loans are accounted for on a pool basis and any non-payment of contractual principal or interest is considered in our periodic re-estimation of the expected future cash flows. To the extent that we decrease our cash flow projections, we record an immediate impairment expense through the provision for loan losses. We recognize any increases to our cash flow projections on a prospective basis through an increase to the pool's yield over its remaining life once any previously recorded impairment expense has been recouped. As a result of this accounting treatment, these pools may be considered to be performing, even though some or all of the individual loans within the pools may be contractually past due.
During the nine months ended September 30, 2013, we identified one covered commercial and industrial loan pool accounted for under ASC 310-30 with a balance of $16.9 million at September 30, 2013, for which the cash flows were no longer reasonably estimable. In accordance with the guidance in ASC 310-30, this pool was put on non-accrual status.  As a result, we have ceased recognition of accretable yield to interest income on this loan pool. Income will now be recognized on this pool only after full recovery of the carrying value of the pool. This pool is now considered a non-performing asset and drove the increase in non-performing loans to 2.60% of total loans at September 30, 2013 from 2.23% at December 31, 2012.
All other loans accounted for under ASC 310-30 were classified as performing assets at September 30, 2013 and December 31, 2012, as the carrying values of the respective loan or pool of loans cash flows were considered estimatable and probable of collection. Therefore, interest income, through accretion of the difference between the carrying value of the loans in the pool and the pool's expected future cash flows, is being recognized on all other acquired loans accounted for under ASC 310-30.

57


The following table sets forth the non-performing assets as of the dates presented (in thousands):
 
 
September 30, 2013
 
December 31, 2012
 
Non-Covered
 
Covered
 
Total
 
Non-Covered
 
Covered
 
Total
Non-accrual loans:
 
 
 
 
 
 
 
 
 
 
 
Commercial
$
655

 
$
17,490

 
$
18,145

 
$
1,466

 
$
3,034

 
$
4,500

Commercial real estate
6,185

 
316

 
6,501

 
10,216

 
1,453

 
11,669

Agriculture
156

 
47

 
203

 
207

 
44

 
251

Residential real estate
4,344

 
1,407

 
5,751

 
4,894

 
1,514

 
6,408

Consumer
251

 

 
251

 
291

 

 
291

Total non-accrual loans
11,591

 
19,260

 
30,851

 
17,074

 
6,045

 
23,119

Loans past due 90 days or more and still accruing interest:
 
 
 
 
 
 
 
 
 
 
 
Commercial

 

 

 

 

 

Commercial real estate
148

 

 
148

 

 

 

Agriculture

 

 

 

 

 

Residential real estate

 

 

 
22

 

 
22

Consumer
21

 

 
21

 
3

 

 
3

Total accruing loans 90 days past due
169

 

 
169

 
25

 

 
25

Accruing restructured loans (1)
8,286

 
6,004

 
14,290

 
12,673

 
5,047

 
17,720

Total non-performing loans
20,046

 
25,264

 
45,310

 
29,772

 
11,092

 
40,864

OREO
26,671

 
44,082

 
70,753

 
49,297

 
45,511

 
94,808

Other repossessed assets
784

 
481

 
1,265

 
800

 
531

 
1,331

Total non-performing assets
$
47,501

 
$
69,827

 
$
117,328

 
$
79,869

 
$
57,134

 
$
137,003

Allowance for loan losses
 
 
 
 
$
11,419

 
 
 
 
 
$
15,380

Total non-performing loans to total non-covered, total covered, and total loans, respectively
1.46
%
 
6.90
%
 
2.60
%
 
2.43
%
 
1.82
%
 
2.23
%
Total non-performing assets to total assets
 
 
 
 
2.27
%
 
 
 
 
 
2.53
%
Allowance for loan losses to non-performing loans
 
 
 
 
25.20
%
 
 
 
 
 
37.64
%
 
(1)
Includes restructured loans less than 90 days past due and still accruing.
OREO of $70.8 million at September 30, 2013 includes $3.8 million of participant interests in OREO in connection with our repossession of collateral on loans for which we were the lead bank and we have a controlling interest. We have recorded a corresponding payable to those participant banks in other liabilities. The $70.8 million of OREO at September 30, 2013 excludes $10.6 million of minority interest in participated OREO in connection with the repossession of collateral on loans for which we were not the lead bank and we do not have a controlling interest. These properties have been repossessed by the lead banks and we have recorded our receivable due from the lead banks in other assets as minority interest in participated OREO.
 
During the nine months ended September 30, 2013, $32.4 million of OREO was foreclosed on or otherwise repossessed and $54.7 million of OREO was sold, including $1.5 million of non-covered gains and $5.9 million of covered gains that are subject to reimbursement to the FDIC at the applicable loss-share coverage percentage. OREO write-downs of $9.1 million were recorded during the nine months ended September 30, 2013, of which $6.6 million, or 72.5%, were covered by FDIC loss-sharing agreements. OREO balances decreased $24.1 million during the nine months ended September 30, 2013 to $70.8 million, 62.3% of which was covered by FDIC loss-sharing agreements, compared to OREO balances of $94.8 million at December 31, 2012, $45.5 million, or 48.0%, of which was covered by the FDIC loss-sharing agreements.


58


Past Due Loans
Past due status is monitored as an indicator of credit deterioration. Covered and non-covered loans are considered past due or delinquent when the contractual principal or interest due in accordance with the terms of the loan agreement remains unpaid after the due date of the scheduled payment. Loans that are 90 days or more past due and not accounted for under ASC 310-30 are put on non-accrual status unless the loan is well secured and in the process of collection. Pooled loans accounted for under ASC 310-30 that are 90 days or more past due and still accreting are included in loans 90 days or more past due and still accruing interest and are generally considered to be performing as is further described above under “Non-Performing Assets.” The one covered loan pool accounted for under ASC 310-30 that was put on non-accrual during the nine months ended September 30, 2013 is included in non-accrual loans. The table below shows the past due status of loans accounted for under ASC 310-30 and loans not accounted for under ASC 310-30, based on contractual terms of the loans as of September 30, 2013 and December 31, 2012 (in thousands):
 
 
September 30, 2013
 
December 31, 2012
 
ASC 310-30
Loans
 
Non ASC 
310-30 Loans
 
Total
Loans
 
ASC 310-30
Loans
 
Non ASC
310-30 Loans
 
Total
Loans
Loans 30-89 days past due and still accruing interest
$
27,900

 
$
2,247

 
$
30,147

 
$
18,412

 
$
4,581

 
$
22,993

Loans 90 days past due and still accruing interest
62,324

 
169

 
62,493

 
146,761

 
25

 
146,786

Non-accrual loans
16,857

 
13,994

 
30,851

 

 
23,119

 
23,119

Total past due and non-accrual loans
$
107,081

 
$
16,410

 
$
123,491

 
$
165,173

 
$
27,725

 
$
192,898

Total covered loans
$
88,406

 
$
2,642

 
$
91,048

 
$
130,350

 
$
6,172

 
$
136,522

Total past due and non-accrual loans to total ASC 310-30 loans, total non 310-30 loans and total loans, respectively
20.87
%
 
1.33
%
 
7.09
%
 
20.09
%
 
2.74
%
 
10.53
%
Total non-accrual loans to total ASC 310-30 loans, total non 310-30 loans, and total loans, respectively
3.29
%
 
1.14
%
 
1.77
%
 
0.00
%
 
2.29
%
 
1.26
%
% of total past due and non-accrual loans that carry fair value adjustments
100.00
%
 
38.65
%
 
91.85
%
 
100.00
%
 
57.78
%
 
93.93
%
% of total past due and non-accrual loans that are covered by FDIC loss sharing agreements
82.56
%
 
16.10
%
 
73.73
%
 
78.92
%
 
22.26
%
 
70.77
%

During the nine months ended September 30, 2013, total past due and non-accrual loans increased slightly for loans accounted for under ASC 310-30 to 20.87% at September 30, 2013 from 20.09% of total loans accounted for under ASC 310-30 at December 31, 2012. Total past due and non-accrual loans not accounted for under ASC 310-30 improved significantly to 1.33% at September 30, 2013 from 2.74% at December 31, 2012 driven by a decline in non-accrual loans. Total loans 30 days or more past due and still accruing interest and non-accrual loans represented 7.09% of total loans as of September 30, 2013 compared to 10.53% at December 31, 2012. Loans 30-89 days past due and still accruing interest increased $7.2 million at September 30, 2013 compared to December 31, 2012. Loans 90 days or more past due and still accruing interest decreased $84.3 million at September 30, 2013 compared to December 31, 2012. The collective decrease in past due loans of $77.1 million is reflective of improved credit quality in the broader loan portfolio and the successful workout strategies employed by our special assets division during the period. Non-accrual loans increased $7.7 million from December 31, 2012 to September 30, 2013 primarily due to the addition of the covered commercial and industrial loan pool accounted for under ASC 310-30, totaling $16.9 million, to non-accrual status during the period. Non-accrual loans not accounted for under ASC 310-30 decreased $9.1 million during the period primarily due to resolution of certain assets and foreclosures during the period. The non-accrual loans are primarily secured by real estate both in and outside of our market areas.

59


Allowance for Loan Losses
The ALL represents the amount that we believe is necessary to absorb probable losses inherent in the loan portfolio at the balance sheet date and involves a high degree of judgment and complexity. Determination of the ALL is based on an evaluation of the collectability of loans, the realizable value of underlying collateral and, to the extent applicable, prior loss experience. The ALL is critical to the portrayal and understanding of our financial condition, liquidity and results of operations. The determination and application of the ALL accounting policy involves judgments, estimates, and uncertainties that are subject to change. Changes in these assumptions, estimates or the conditions surrounding them may have a material impact on our financial condition, liquidity or results of operations.
In accordance with the applicable guidance for business combinations, acquired loans were recorded at their acquisition date fair values, which were based on expected future cash flows and included an estimate for future loan losses, therefore no ALL was recorded as of the acquisition date. Any estimated losses on acquired loans that arise after the acquisition date are reflected in a charge to the provision for loan losses. Losses incurred on covered loans are reimbursable at the applicable loss share percentages in accordance with the loss sharing agreements with the FDIC. Accordingly, any provision for loan losses relating to covered loans is partially offset by a corresponding increase to the FDIC indemnification asset and FDIC loss sharing income in non-interest income.
Loans accounted for under the accounting guidance provided in ASC 310-30 have been grouped into pools based on the predominant risk characteristics of purpose and/or type of loan. The timing and receipt of expected principal, interest and any other cash flows of these loans are periodically re-estimated and the expected future cash flows of the collective pools are compared to the carrying value of the pools. To the extent that the expected future cash flows of each pool is less than the book value of the pool, an allowance for loan losses will be established through a charge to the provision for loan losses and, for loans covered by loss sharing agreements with the FDIC, a related adjustment to the FDIC indemnification asset for the portion of the loss that is covered by the loss sharing agreements. If the re-estimated expected future cash flows are greater than the book value of the pools, then the improvement in the expected future cash flows is accreted into interest income over the remaining expected life of the loan pool. During the nine months ended September 30, 2013 and 2012, these re-estimations resulted in overall increases in expected cash flows in certain loan pools, which, absent previous valuation allowances within the same pool, is reflected in increased accretion as well as an increased amount of accretable yield and is recognized over the expected remaining lives of the underlying loans as an adjustment to yield.
For all loans not accounted for under ASC 310-30, the determination of the ALL follows a process to determine the appropriate level of ALL that is designed to account for changes in credit quality. This process provides an ALL consisting of a specific allowance component based on certain individually evaluated loans and a general allowance component based on estimates of reserves needed for all other loans, segmented based on similar risk characteristics.
 
Impaired loans less than $250,000 are included in the general allowance population. Impaired loans over $250,000 are subject to individual evaluation on a regular basis to determine the need, if any, to allocate a specific reserve to the impaired loan. Typically, these loans consist of commercial, commercial real estate and agriculture loans and exclude homogeneous loans such as residential real estate and consumer loans. Specific allowances are determined by collectively analyzing:
the borrower's resources, ability, and willingness to repay in accordance with the terms of the loan agreement;
the likelihood of receiving financial support from any guarantors;
the adequacy and present value of future cash flows, less disposal costs, of any collateral;
the impact current economic conditions may have on the borrower's financial condition and liquidity or the value of the collateral.
In evaluating the loan portfolio for an appropriate ALL level, unimpaired loans are grouped into segments based on broad characteristics such as primary use and underlying collateral. We have identified five primary loan segments that are further stratified into 10 loan classes to provide more granularity in analyzing loss history and to allow for more definitive qualitative adjustments based upon specific factors affecting each loan class. Following are the loan classes within each of the five primary loan segments:
 

60


Commercial
  
Commercial real estate
  
Agriculture
  
Residential real estate
  
Consumer
Total commercial
  
Construction
  
Total agriculture
  
Senior lien
  
Total consumer
 
  
Acquisition and development
  
 
  
Junior lien
  
 
 
  
Multi-family
  
 
  
 
  
 
 
  
Owner-occupied
  
 
  
 
  
 
 
  
Non-owner occupied
  
 
  
 
  
 
Appropriate ALL levels are determined by segment and class utilizing risk ratings, loss history, peer loss history and qualitative adjustments. The qualitative adjustments consider the following risk factors:
economic/external conditions;
loan administration, loan structure and procedures;
risk tolerance/experience;
loan growth;
trends;
concentrations;
other
Historical loss data is categorized by segment and class and a loss rate is applied to loan balances. The loss rates are based on loan segment and class and utilize a credit risk rating migration analysis. Due to our relatively short historical loss history, we incorporate not only our own historical loss rates since the beginning of 2012, but we also utilize peer historical loss data based on a 12-quarter historical average net charge-off ratio on each loan type, relying on the Uniform Bank Performance Reports compiled by the Federal Financial Institutions Examinations Council (“FFIEC”). While we use our own loss history and peer loss history for both purchased and originated loans, we assign a higher portion of our own loss history to our purchased loans, because those loans are more seasoned and more of the actual losses in the portfolio have historically been in the purchased portfolio. For originated loans, we assign a higher portion of the peer loss history, as we believe that this is likely more indicative of losses inherent in the portfolio.
 
The collective resulting ALL for loans not accounted for under ASC 310-30 is calculated as the sum of the specific reserves and the general reserves. While these amounts are calculated by individual loan or segment and class, the entire ALL is available for any loan that, in our judgment, should be charged-off.
During the three and nine months ended September 30, 2013, we recorded $0.7 million and $2.5 million of provision for loan losses for loans not accounted for under ASC 310-30, respectively, as we provided for $0.6 million and $3.4 million of net loan charge-offs and credit risks inherent in the non 310-30 balances. During the nine months ended September 30, 2013, $1.5 million, $0.8 million, and $0.7 million of the $3.4 million of net charge-offs were from the commercial, commercial real estate, and residential real estate segments, respectively. At September 30, 2013, there were eight impaired loans that carried specific reserves totaling $0.6 million compared to ten impaired loans that carried specific reserves totaling $1.9 million at December 31, 2012.
During the three months ended September 30, 2013, two loans pools accounted for under ASC 310-30 had previous valuation allowances of $0.9 million that were reversed as a result of an increase in expected cash flows. In addition, two pools had net impairments of $0.6 million as a result of decreases in expected cash flows, resulting in a net reversal of provision of $0.3 million.
During the nine months ended September 30, 2013, two loans pools accounted for under ASC 310-30 had previous valuation allowances of $1.3 million that were reversed as a result of an increase in expected cash flows. The remaining pools had net impairments of $2.3 million as a result of decreases in expected cash flows, resulting in a net of provision of $1.0 million.
Within the commercial real estate segment, $2.8 million of ASC 310-30 loans were charged-off during the nine months ended September 30, 2013. This resulted in an ending ALL for ASC 310-30 loans of $1.6 million at September 30, 2013, compared to $4.7 million at December 31, 2012.
During the three and nine months ended September 30, 2012, we recorded provisions for loan losses of $3.7 million and $17.4 million, respectively, as a result of net decreases in expected cash flow on loans accounted for under ASC 310-30. Additionally, we charged off $12.5 million, net of recoveries, of loans accounted for under ASC Topic 310-30 during the nine months ended

61


September 30, 2012, $11.4 million of which was from the commercial real estate segment. This resulted in an ending ALL for ASC 310-30 loans of $7.1 million at September 30, 2012.
During the three and nine months ended September 30, 2012, we recorded $1.6 million and $7.9 million, respectively, of provision for loan losses for loans not accounted for under ASC 310-30 as we provided for net loan charge-offs and risks inherent in the September 30, 2012 non 310-30 balances. Of the $6.9 million of net charge-offs during the nine months ended September 30, 2012, $2.8 million was in the commercial segment and $2.4 million was in the commercial real estate segment.
After considering the abovementioned factors, we believe that the ALL of $11.4 million and $15.4 million was adequate to cover probable losses inherent in the loan portfolio at September 30, 2013 and December 31, 2012, respectively. However, it is likely that future adjustments to the ALL will be necessary and any changes to the assumptions, circumstances or estimates used in determining the ALL could adversely affect the Company's results of operations, liquidity or financial condition.
The following schedule presents, by class stratification, the changes in the ALL during the three months ended September 30, 2013 and 2012 (in thousands):
 
September 30, 2013
 
September 30, 2012
 
ASC 310-30 Loans
 
Non 310-30 Loans
 
Total
 
ASC 310-30 Loans
 
Non 310-30 Loans
 
Total
Beginning allowance for loan losses
$
2,195

 
$
9,652

 
$
11,847

 
$
7,259

 
$
10,035

 
$
17,294

Charge-offs:
 
 
 
 
 
 
 
 
 
 
 
Commercial

 
(401
)
 
(401
)
 
(1
)
 
(297
)
 
(298
)
Commercial real estate

 

 

 
(3,500
)
 
(35
)
 
(3,535
)
Agriculture
(221
)
 

 
(221
)
 
(144
)
 

 
(144
)
Residential real estate
(57
)
 
(117
)
 
(174
)
 
(169
)
 
(351
)
 
(520
)
Consumer

 
(276
)
 
(276
)
 

 
(566
)
 
(566
)
Total charge-offs
(278
)
 
(794
)
 
(1,072
)
 
(3,814
)
 
(1,249
)
 
(5,063
)
Recoveries

 
207

 
207

 
2

 

 
2

Net charge-offs
(278
)
 
(587
)
 
(865
)
 
(3,812
)
 
(1,249
)
 
(5,061
)
Provision for loan loss
(313
)
 
750

 
437

 
3,663

 
1,600

 
5,263

Ending allowance for loan losses
$
1,604

 
$
9,815

 
$
11,419

 
$
7,110

 
$
10,386

 
$
17,496



62


The following schedule presents, by class stratification, the changes in the ALL during the nine months ended September 30, 2013 and 2012 (in thousands):

 
September 30, 2013
 
September 30, 2012
 
ASC 310-30 Loans
 
Non 310-30 Loans
 
Total
 
ASC 310-30 Loans
 
Non 310-30 Loans
 
Total
Beginning allowance for loan losses
$
4,652

 
$
10,728

 
$
15,380

 
$
2,188

 
$
9,339

 
$
11,527

Charge-offs:
 
 
 
 
 
 
 
 
 
 
 
Commercial
(407
)
 
(1,654
)
 
(2,061
)
 
(216
)
 
(3,056
)
 
(3,272
)
Commercial real estate
(2,796
)
 
(943
)
 
(3,739
)
 
(11,643
)
 
(2,448
)
 
(14,091
)
Agriculture
(221
)
 

 
(221
)
 
(144
)
 
(8
)
 
(152
)
Residential real estate
(623
)
 
(741
)
 
(1,364
)
 
(729
)
 
(815
)
 
(1,544
)
Consumer

 
(717
)
 
(717
)
 
(19
)
 
(1,161
)
 
(1,180
)
Total charge-offs
(4,047
)
 
(4,055
)
 
(8,102
)
 
(12,751
)
 
(7,488
)
 
(20,239
)
Recoveries

 
617

 
617

 
275

 
608

 
883

Net charge-offs
(4,047
)
 
(3,438
)
 
(7,485
)
 
(12,476
)
 
(6,880
)
 
(19,356
)
Provision for loan loss
999

 
2,525

 
3,524

 
17,398

 
7,927

 
25,325

Ending allowance for loan losses
$
1,604

 
$
9,815

 
$
11,419

 
$
7,110

 
$
10,386

 
$
17,496

Ratio of annualized net charge-offs to average total loans during the period, respectively
0.81
%
 
0.43
%
 
0.58
%
 
1.50
%
 
0.98
%
 
1.26
%
Ratio of allowance for loan losses to total loans outstanding at period end, respectively
0.31
%
 
0.80
%
 
0.66
%
 
0.73
%
 
1.08
%
 
0.91
%
Ratio of allowance for loan losses to total non-covered loans outstanding at period end, respectively
0.79
%
 
0.84
%
 
0.83
%
 
2.06
%
 
1.19
%
 
1.44
%
Ratio of allowance for loan losses to total non-performing loans at period end, respectively
9.52
%
 
34.50
%
 
25.20
%
 
0.00
%
 
27.62
%
 
46.52
%
Ratio of allowance for loan losses to total non-performing, non-covered loans at period end, respectively
0.00
%
 
48.96
%
 
56.96
%
 
0.00
%
 
34.51
%
 
58.14
%
Total loans
$
513,010

 
$
1,229,803

 
$
1,742,813

 
$
971,036

 
$
958,490

 
$
1,929,526

Average total loans outstanding during the period
$
669,623

 
$
1,068,194

 
$
1,737,817

 
$
1,113,860

 
$
942,231

 
$
2,056,091

Total non-covered loans
$
203,630

 
$
1,172,837

 
$
1,376,467

 
$
345,814

 
$
872,683

 
$
1,218,497

Total non-performing loans
$
16,857

 
$
28,453

 
$
45,310

 
$

 
$
37,606

 
$
37,606

Total non-performing, covered loans
$
16,857

 
$
8,407

 
$
25,264

 
$

 
$
7,514

 
$
7,514



63


The following table presents the allocation of the ALL and the percentage of the total amount of loans in each loan category listed as of the dates presented (in thousands):
 
 
September 30, 2013
 
Total Loans
 
% of total
Loans
 
Related
ALL
 
% of ALL
Commercial
$
340,364

 
19.5
%
 
$
2,735

 
24.0
%
Commercial real estate
614,453

 
35.3
%
 
2,223

 
19.5
%
Agriculture
155,346

 
8.9
%
 
1,107

 
9.7
%
Residential real estate
595,569

 
34.2
%
 
4,898

 
42.8
%
Consumer and overdrafts
37,081

 
2.1
%
 
456

 
4.0
%
Total
$
1,742,813

 
100.0
%
 
$
11,419

 
100.0
%
 
December 31, 2012
 
Total Loans
 
% of total
Loans
 
Related
ALL
 
% of ALL
Commercial
$
270,588

 
14.8
%
 
$
2,798

 
18.2
%
Commercial real estate
804,999

 
43.9
%
 
7,396

 
48.1
%
Agriculture
173,407

 
9.5
%
 
592

 
3.8
%
Residential real estate
533,377

 
29.1
%
 
4,011

 
26.1
%
Consumer and overdrafts
50,331

 
2.7
%
 
583

 
3.8
%
Total
$
1,832,702

 
100.0
%
 
$
15,380

 
100.0
%
During the nine months ended September 30, 2013, the ALL allocated to commercial real estate declined from 48.1% to 19.5% largely due to $2.8 million in charge-offs in our commercial real estate loans accounted for under ASC 310-30, coupled with a $1.2 million provision reversal related to our commercial real estate ASC 310-30 loans. Previously recorded impairments were recaptured in connection with an improvement in estimated cash flows. The ALL allocated to the residential real estate segment increased to 42.8% from 26.1% during the nine months ended September 30, 2013, which was largely the result of a $1.3 million impairment partially offset by $0.6 million in charge-offs in the residential real estate pool accounted for under ASC 310-30. In the non 310-30 residential real estate category we added $0.9 million of provision for loan growth, which was partially offset by $0.7 million in charge-offs.
FDIC Indemnification Asset and Clawback Liability
The FDIC indemnification asset represents the net present value of the expected reimbursements from the FDIC for probable losses on covered loans and OREO that were acquired in the Hillcrest Bank and Community Banks of Colorado transactions. The initial fair values were established by discounting the expected future cash flows with a market discount rate for like maturity and risk instruments. The discount is accreted to income in connection with the expected timing of the related cash flows, and may increase or decrease from period to period due to changes in amounts and timing of expected cash flows from covered loans and OREO. As covered assets are resolved, whether it be through repayment, short sale of the underlying collateral, the foreclosure on, and sale of collateral, or the sale or charge-off of loans or OREO, the portion of any loss incurred that is reimbursable by the FDIC is recognized as FDIC loss sharing income in non-interest income. Any gains or losses realized from the resolution of covered assets reduce or increase, respectively, the amount of the FDIC indemnification asset.
In the three and nine months ended September 30, 2013, we recognized $4.2 million and $11.8 million, respectively, of negative accretion on the FDIC indemnification asset as the performance of our covered assets improved. The negative accretion resulted from an increase in actual and expected cash flows on the underlying covered assets, resulting in lower expected reimbursements from the FDIC. The increase in expected cash flows from these underlying assets is reflected in increased accretion rates on covered loans as well as an increased amount of accretable yield on our covered loans accounted for under ASC 310-30 and is being recognized over the expected lives of the underlying covered loans as an adjustment to yield. The carrying value of the FDIC indemnification asset was further reduced by $24.5 million during the nine months ended September 30, 2013 as a result of claims filed with the FDIC. During the nine months ended September 30, 2013, we received $77.0 million in loss-share payments from the FDIC. The loss claims filed are subject to review and approval, including extensive audits, by the FDIC or its assigned agents for compliance with the terms in the loss sharing agreements.

64


During the three and nine months ended September 30, 2012, we recognized $2.8 million and $9.2 million, respectively, of negative accretion related to the FDIC indemnification asset as a result of improved performance of our covered assets. We also reduced the carrying value of the FDIC indemnification asset by $101.0 million as a result of claims filed with the FDIC during the nine months ended September 30, 2012. During the nine months ended September 30, 2012, we received $75.9 million from the FDIC related to losses incurred during the fourth quarter of 2011 and the first and second quarters of 2012.
Within 45 days of the end of each of the loss sharing agreements with the FDIC, we may be required to reimburse the FDIC in the event that our losses on covered assets do not reach the second tranche in each related loss sharing agreement, based on the initial discount received less cumulative servicing amounts for the covered assets acquired. At September 30, 2013 and December 31, 2012, this clawback liability was carried at $32.0 million and $31.3 million, respectively, and is included in Due to FDIC in our consolidated statements of financial condition.
Other real estate owned
OREO is comprised of properties acquired through the foreclosure or repossession process, or any other resolution activity that results in partial or total satisfaction of problem loans. We have a dedicated, enterprise-level problem asset resolution team that is actively working to resolve problem loans and to obtain and subsequently sell the underlying collateral. OREO includes the interests of several outside participating banks totaling $3.8 million at September 30, 2013 and $5.3 million at December 31, 2012, for which an offsetting liability is recorded in other liabilities. It excludes $10.6 million, for both of the respective periods, of the Company’s minority interests in OREO which are held by outside banks where the Company was not the lead bank and does not have a controlling interest, for which the Company maintains a receivable in other assets.
Of the $70.8 million of OREO at September 30, 2013, $44.1 million, or 62.3%, was covered by the loss sharing agreements with the FDIC. Any losses on these assets are substantially offset by a corresponding change in the FDIC indemnification asset. During the three and nine months ended September 30, 2013, we sold $17.0 million and $54.7 million of OREO and realized net gains of $3.5 million and $7.4 million, respectively. We sold $21.3 million and $57.2 million of OREO and realized net gains of $2.8 million and $6.8 million, respectively, during the three and nine months ended September 30, 2012. Changes in OREO during the nine months ended September 30, 2013 and 2012 were as follows (in thousands):
 
 
For the nine months ended September 30,
 
2013
 
2012
Beginning balance
$
94,808

 
$
120,636

Transfers from loan portfolio
32,408

 
67,741

Impairments
(9,142
)
 
(8,638
)
Sales
(54,705
)
 
(57,186
)
Gain on sale of OREO, net
7,384

 
6,792

Ending Balance
$
70,753

 
$
129,345

Other Assets
Significant components of other assets were as follows as of the periods indicated (in thousands):
 
September 30, 2013
 
December 31, 2012
FDIC indemnification-claimed
$
3,651

 
$
59,291

Minority interest in participated other real estate owned
10,627

 
10,627

Accrued interest on interest bearing bank deposits and investment securities
5,836

 
5,585

Accrued interest on loans
5,834

 
7,088

Accrued income taxes receivable and deferred tax asset
49,973

 
7,274

Other assets
9,421

 
10,158

Total other assets
$
85,342

 
$
100,023



65


Other assets decreased $14.7 million, or 14.7%, during the nine months ended September 30, 2013. The decrease was largely attributable to a $55.6 million decline in FDIC indemnification-claimed, as payments were received on outstanding loss-share claims submitted to the FDIC. Accrued income taxes receivable and the deferred tax assets increased $42.7 million during the nine months ended September 30, 2013 as a result of declines in unrealized gains on our available-for-sale securities and due to the current recognition of taxable income from the purchase discount related to loans acquired in the Hillcrest Bank, Bank of Choice and Community Banks of Colorado transactions that had previously been deferred for income tax purposes. These deferred gains are recognized for income tax purposes as the loans are collected and as covered loans are worked out through the FDIC indemnification process.
Other Liabilities
Significant components of other liabilities were as follows as of the dates indicated (in thousands):
 
 
September 30, 2013
 
December 31, 2012
Participant interest in other real estate owned
$
3,815

 
$
5,321

Accrued income taxes payable

 
4,972

Accrued interest payable
3,225

 
4,239

Accrued expenses
15,866

 
12,263

Warrant liability
5,599

 
5,461

Other liabilities
2,276

 
2,285

Total other liabilities
$
30,781

 
$
34,541

Other liabilities decreased $3.8 million during the nine months ended September 30, 2013. Included in total other liabilities is accrued income taxes payable which decreased by $5.0 million, primarily due to tax payments made during the period.
During the nine months ended September 30, 2013, we continued to lower the interest rates paid on our deposits, coupled with the shift from higher-cost time deposits to lower cost transaction accounts. The lower cost mix of deposits resulted in a decrease in accrued interest payable of $1.0 million during the period.
Accrued expenses for the nine months ended September 30, 2013 increased $3.6 million, or 29.4%, from December 31, 2012, primarily due to expenses accrued in connection with our announcement to integrate 32 limited-service retirement center locations (acquired in our 2010 purchase of Hillcrest Bank) and exit four banking centers in Northern California (acquired in our 2011 purchase of Community Banks of Colorado). Additionally, participant interests in other real estate owned, which represents participant banks' interests in properties that we have repossessed, decreased $1.5 million. These participant interests are also reflected in our other real estate owned balances.
We have outstanding warrants to purchase 830,750 shares of our common stock, which are classified as a liability and included in other liabilities in our consolidated statements of financial condition. The warrants were granted to certain lead stockholders and all warrants have an exercise price of $20.00 per share. The term of the warrants is for ten years and the expiration dates of the warrants range from October 20, 2019 to September 30, 2020. We revalue the warrants at the end of each reporting period using a Black-Scholes model and any change in fair value is reported in the statements of operations as “loss (gain) from change in fair value of warrant liability” in non-interest expense in the period in which the change occurred. The warrant liability increased $0.1 million during the nine months ended September 30, 2013 to $5.6 million. The value of the warrant liability, and the expense that results from an increase to this liability, is correlated to our stock price. Accordingly, an increase in our stock price results in an increase in the warrant liability and the associated expense. More information on the accounting and measurement of the warrant liability can be found in notes 2 and 19 in our audited consolidated financial statements in our 2012 Annual Report on Form 10-K.
Deposits
Deposits from banking clients serve as a primary funding source for our banking operations and our ability to gather and manage deposit levels is critical to our success. Deposits not only provide a low cost funding source for our loans, but also provide a foundation for the client relationships that are critical to future loan growth. The following table presents information regarding our deposit composition at September 30, 2013 and December 31, 2012 (in thousands):


66


 
September 30, 2013
 
December 31, 2012
Non-interest bearing demand deposits
$
689,405

 
17.5
%
 
$
677,985

 
16.1
%
Interest bearing demand deposits
430,123

 
10.9
%
 
529,996

 
12.6
%
Savings accounts
193,305

 
4.9
%
 
187,339

 
4.5
%
Money market accounts
1,104,280

 
27.9
%
 
1,052,681

 
25.1
%
Total transaction deposits
2,417,113

 
61.2
%
 
2,448,001

 
58.3
%
Time deposits < $100,000
1,002,747

 
25.4
%
 
1,121,757

 
26.7
%
Time deposits > $100,000
531,643

 
13.4
%
 
630,961

 
15.0
%
Total time deposits
1,534,390

 
38.8
%
 
1,752,718

 
41.7
%
Total deposits
$
3,951,503

 
100.0
%
 
$
4,200,719

 
100.0
%
During the nine months ended September 30, 2013, our total deposits decreased $249.2 million. Since the acquisition of the four problem banks, we have continued to focus our deposit base on clients who are interested in market rate deposits and developing a banking relationship, rather than the highly rate-sensitive time deposit clients of the predecessor banks. As a result, our time deposits decreased $218.3 million, or 12.5%, during the nine months ended September 30, 2013. At September 30, 2013, the mix of transaction deposits to total deposits improved to 61.2% from 58.3% at December 31, 2012. At September 30, 2013 and December 31, 2012, we had $1.1 billion and $1.2 billion, respectively, of time deposits that were scheduled to mature within 12 months. Of the $1.1 billion in time deposits scheduled to mature in within 12 months, $0.4 billion of which were in denominations of $100,000 or more, and $0.8 billion of which were in denominations less than $100,000. Note 8 to the unaudited consolidated interim financial statements provides a maturity schedule and weighted average rates of time deposits outstanding at September 30, 2013 and December 31, 2012.
In connection with our FDIC-assisted bank acquisitions, the FDIC provided Bank of Choice, Hillcrest Bank and Community Banks of Colorado depositors with the right to redeem their time deposits at any time during the life of the time deposit, without penalty, unless the depositor accepts new terms. At September 30, 2013 and December 31, 2012, the Company had approximately $82.6 million and $164.3 million, respectively, of time deposits that were subject to the penalty-free withdrawals.
Results of Operations
Our net income depends largely on net interest income, which is the difference between interest income from interest earning assets and interest expense on interest bearing liabilities. Our results of operations are also affected by provisions for loan losses and non-interest income, such as service charges, bank card income and FDIC loss sharing income. Our primary operating expenses, aside from interest expense, consist of salaries and employee benefits, professional fees, occupancy costs, and data processing expense.
Overview of Results of Operations
We recorded net income of $0.9 million and $5.9 million during the three and nine months ended September 30, 2013, respectively, compared to net losses of $7.9 million and $3.5 million during the three and nine months ended September 30, 2012, respectively. Net interest income declined $4.0 million and $19.3 million from the three and nine months ended September 30, 2012 to the three and nine months ended September 30, 2013, respectively, which resulted from the lower loan balances of ASC 310-30 loans as non-strategic loans were successfully moved to resolution, coupled with lower yields earned on the investment portfolio and on the non 310-30 loan portfolio.
Provision for loan loss expense was $0.4 million and $3.5 million during the three and nine months ended September 30, 2013, respectively, compared to $5.3 million and $25.3 million during the three and nine months ended September 30, 2012, respectively. The decrease in provision was due to lower impairment charges on the ASC 310-30 loan pools due to gross cash flow improvements resulting from the Company's re-measurement of expected future cash flows on those underlying pools, coupled with improved credit quality metrics in the non 310-30 portfolio. Non-interest income was $3.3 million and $17.8 million during the three and nine months ended September 30, 2013, respectively, compared to $8.1 million and $28.4 million during the same periods in 2012. The declines of $4.7 million and $10.6 million during the three and nine months ended September 30, 2013 compared to the same periods in 2012 was largely due to $4.1 million and $8.7 million declines in collective FDIC indemnification asset accretion and FDIC-related income, respectively.
Non-interest expense totaled $46.6 million and $139.7 million during the three and nine months ended September 30, 2013, respectively, compared to $60.0 million and $158.2 million during the three and nine months ended September 30, 2012, respectively. The decline in non-interest expense during the three months ended September 30, 2013 as compared to the three

67


months ended September 30, 2012, was largely attributable to expenses in connection with our initial public offering in September 2012, which included of $7.6 million of direct initial public offering related expenses and $4.9 million of stock-based compensation expense. Other decreases in non-interest expense during the aforementioned period included other real estate owned expenses and professional fees of $3.0 million and $1.9 million, respectively, which were partially offset by one-time banking center closure related expenses of $3.4 million, with the announcement to integrate 32 limited-service retirement center locations and exit four banking centers, and the change in the fair value of the warrant liability of $1.6 million, respectively. The decline in non-interest expense of $18.5 million from the nine months ended September 30, 2012 to the nine months ended September 30, 2013 was primarily due to expenses related to our initial public offering mentioned above in addition to decreases of $5.6 million, $4.5 million, and $2.3 million in professional fees, other real estate owned expenses, and problem loan expenses, respectively, as we have steadily worked out many of the acquired troubled loans. The aforementioned decreases for the nine months ended September 30, 2013 were slightly offset with increases during the same period of $3.5 million in occupancy and equipment expense, which was largely due to the additional depreciation of the premises and equipment purchased in the Bank of Choice and Community Banks of Colorado acquisitions, and $3.4 million in one-time banking center closure related expenses.
Net Interest Income
We regularly review net interest income metrics to provide us with indicators of how the various components of net interest income are performing. We regularly review: (i) our loan mix and the yield on loans; (ii) the investment portfolio and the related yields; (iii) our deposit mix and the cost of deposits; and (iv) net interest income simulations for various forecast periods.
 
The following tables present the components of net interest income for the periods indicated. The tables include: (i) the average daily balances of interest earning assets and interest bearing liabilities; (ii) the average daily balances of non-interest earning assets and non-interest bearing liabilities; (iii) the total amount of interest income earned on interest earning assets; (iv) the total amount of interest expense incurred on interest bearing liabilities; (v) the resultant average yields and rates; (vi) net interest spread; and (vii) net interest margin, which represents the difference between interest income and interest expense, expressed as a percentage of interest earning assets. The effects of trade-date accounting of investment securities for which the cash had not settled are not considered interest earning assets and are excluded from this presentation for time frames prior to their cash settlement, as are the market value adjustments on the investment securities available-for-sale. Non-accrual and restructured loan balances are included in the average loan balances; however, the forgone interest on non-accrual and restructured loans is not included in the dollar amounts of interest earned. All amounts presented are on a pre-tax basis.


68


The table below presents the components of net interest income for the three months ended September 30, 2013 and 2012 (in thousands):
 
For the three months ended September 30, 2013
 
For the three months ended September 30, 2012
 
Average
Balance
 
Interest
 
Average
Rate
 
Average
Balance
 
Interest
 
Average
Rate
Interest earning assets:
 
 
 
 
 
 
 
 
 
 
 
ASC 310-30 loans
$
554,750

 
$
19,603

 
14.14
%
 
$
990,661

 
$
24,008

 
9.64
%
Non 310-30 loans (1)(2)
1,149,312

 
15,725

 
5.43
%
 
968,652

 
16,097

 
6.61
%
Investment securities available-for-sale
1,983,108

 
8,851

 
1.79
%
 
1,747,254

 
9,302

 
2.12
%
Investment securities held-to-maturity
648,799

 
4,688

 
2.89
%
 
683,700

 
5,888

 
3.43
%
Other securities
31,754

 
388

 
4.89
%
 
33,067

 
377

 
4.54
%
Interest earning deposits and securities purchased under agreements to resell
379,537

 
267

 
0.28
%
 
595,383

 
370

 
0.25
%
Total interest earning assets
$
4,747,260

 
$
49,522

 
4.14
%
 
$
5,018,717

 
$
56,042

 
4.44
%
Cash and due from banks
60,410

 
 
 
 
 
66,467

 
 
 
 
Other assets
402,496

 
 
 
 
 
585,735

 
 
 
 
Allowance for loan losses
(11,668
)
 
 
 
 
 
(15,817
)
 
 
 
 
Total assets
$
5,198,498

 
 
 
 
 
$
5,655,102

 
 
 
 
Interest bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Interest bearing demand, savings and money market deposits
$
1,744,705

 
$
1,085

 
0.25
%
 
$
1,696,972

 
$
1,341

 
0.31
%
Time deposits
1,561,552

 
2,880

 
0.73
%
 
2,063,622

 
5,178

 
1.00
%
Securities sold under agreements to repurchase
120,654

 
42

 
0.14
%
 
53,073

 
27

 
0.20
%
Total interest bearing liabilities
$
3,426,911

 
$
4,007

 
0.46
%
 
$
3,813,667

 
$
6,546

 
0.68
%
Demand deposits
668,400

 
 
 
 
 
636,277

 
 
 
 
Other liabilities
65,219

 
 
 
 
 
107,415

 
 
 
 
Total liabilities
4,160,530

 
 
 
 
 
4,557,359

 
 
 
 
Stockholders’ equity
1,037,968

 
 
 
 
 
1,097,743

 
 
 
 
Total liabilities and stockholders’ equity
$
5,198,498

 
 
 
 
 
$
5,655,102

 
 
 
 
Net interest income
 
 
$
45,515

 
 
 
 
 
$
49,496

 
 
Interest rate spread
 
 
 
 
3.68
%
 
 
 
 
 
3.76
%
Net interest earning assets
$
1,320,349

 
 
 
 
 
$
1,205,050

 
 
 
 
Net interest margin
 
 
 
 
3.80
%
 
 
 
 
 
3.92
%
Ratio of average interest earning assets to average interest bearing liabilities
138.53
%
 
 
 
 
 
131.60
%
 
 
 
 
 
(1)
Originated loans are net of deferred loan fees, less costs, which are included in interest income over the life of the loan.
(2)
Non 310-30 loans include loans held-for-sale. Average balances during the three months ended September 30, 2013 and 2012 were $6.1 million and $7.2 million, and interest income was $101 thousand and $102 thousand for the same periods respectively.
Net interest income totaled $45.5 million for the three months ended September 30, 2013 and declined $4.0 million from $49.5 million during the same period in 2012. The net interest margin narrowed 12 basis points from the same period a year ago to 3.80% and the interest rate spread narrowed eight basis points to 3.68%. The year-over-year narrowing of the net interest margin was primarily driven by a 5.41% decrease in average interest earning assets which was largely attributable to $435.9 million in declining average balances on loans accounted for under ASC 310-30 as we continued to actively exit the non-strategic loan portfolio.
Average loans comprised $1.7 billion, or 35.9%, of total average interest earning assets during the three months ended September 30, 2013, compared to $2.0 billion, or 39.0%, of total average interest earning assets during the three months ended September 30, 2012. Loan balances at the beginning of 2012 were reflective of our failed bank acquisitions in the latter-half of 2011 and the decline in average balances is reflective of our exit strategy with respect to the non-strategic loans. The yield on the ASC 310-30 loan portfolio was 14.14% during the three months ended September 30, 2013, compared to 9.64% during the same period the prior year. This 4.5% increase was attributable to the effects of the favorable life-to-date transfers of non-

69


accretable difference to accretable yield that are being accreted to interest income over the remaining life of these loans, coupled with the early payoff of one loan pool, which resulted in an immediate one-time recognition of $2.5 million of accretable yield during the quarter and added 0.21% to the net interest margin of 3.80%.
Average investment securities comprised 55.4% of total interest earning assets during the three months ended September 30, 2013 compared to 48.4% during the three months ended September 30, 2012, as we have steadily reinvested excess cash into our investment securities portfolio. The continued low interest rate environment and lower re-investment yields have resulted in a 0.44% basis point decline in yields earned on the total investment portfolio during the three months ended September 30, 2013 compared to the same period of the prior year.
Average balances of interest earning liabilities declined $386.8 million from the three months ended September 30, 2012 to the three months ended September 30, 2013, driven by a $502.1 million decline in average time deposits. Since the acquisition of our four problem banks, we have continued to focus our deposit base on clients who are interested in market rate deposits and developing a banking relationship, rather than the highly rate-sensitive time deposit clients of the predecessor banks. The net interest margin benefited from a 0.22% decrease in the cost of interest bearing liabilities as we continued our strategy of transitioning high-priced time deposits to lower-cost transaction accounts. During the three months ended September 30, 2013, total interest expense related to interest bearing liabilities was $4.0 million compared to $6.5 million during the three months ended September 30, 2012, or an average cost of 0.46% and 0.68% during the respective periods. The largest component of interest expense in each period was related to time deposits, which carried an average rate of 0.73% and 1.00% during the three months ended September 30, 2013 and 2012, respectively.
The table below presents the components of net interest income for the nine months ended September 30, 2013 and 2012 (in thousands):
 
For the nine months ended September 30, 2013
 
For the nine months ended September 30, 2012
 
Average
Balance
 
Interest
 
Average
Rate
 
Average
Balance
 
Interest
 
Average
Rate
Interest earning assets:
 
 
 
 
 
 
 
 
 
 
 
ASC 310-30 loans
$
669,623

 
$
59,616

 
11.87
%
 
$
1,113,860

 
$
76,251

 
9.14
%
Non 310-30 loans (1)(2)
1,074,396

 
46,167

 
5.75
%
 
948,367

 
53,039

 
7.47
%
Investment securities available-for-sale
1,980,048

 
26,574

 
1.79
%
 
1,822,474

 
34,321

 
2.52
%
Investment securities held-to-maturity
578,413

 
13,809

 
3.18
%
 
482,466

 
12,429

 
3.44
%
Other securities
32,282

 
1,170

 
4.83
%
 
31,380

 
1,142

 
4.86
%
Interest earning deposits and securities purchased under agreements to resell
406,029

 
762

 
0.25
%
 
835,543

 
1,595

 
0.26
%
Total interest earning assets
$
4,740,791

 
$
148,098

 
4.18
%
 
$
5,234,090

 
$
178,777

 
4.56
%
Cash and due from banks
60,909

 
 
 
 
 
70,108

 
 
 
 
Other assets
440,709

 
 
 
 
 
618,800

 
 
 
 
Allowance for loan losses
(12,930
)
 
 
 
 
 
(11,192
)
 
 
 
 
Total assets
$
5,229,479

 
 
 
 
 
$
5,911,806

 
 
 
 
Interest bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Interest bearing demand, savings and money market deposits
$
1,736,981

 
$
3,240

 
0.25
%
 
$
1,690,942

 
$
4,309

 
0.34
%
Time deposits
1,629,059

 
9,407

 
0.77
%
 
2,313,238

 
19,713

 
1.14
%
Securities sold under agreements to repurchase
76,391

 
80

 
0.14
%
 
54,860

 
88

 
0.21
%
Total interest bearing liabilities
$
3,442,431

 
$
12,727

 
0.49
%
 
$
4,059,040

 
$
24,110

 
0.79
%
Demand deposits
654,625

 
 
 
 
 
634,881

 
 
 
 
Other liabilities
65,053

 
 
 
 
 
122,751

 
 
 
 
Total liabilities
4,162,109

 
 
 
 
 
4,816,672

 
 
 
 
Stockholders’ equity
1,067,370

 
 
 
 
 
1,095,134

 
 
 
 
Total liabilities and stockholders’ equity
$
5,229,479

 
 
 
 
 
$
5,911,806

 
 
 
 
Net interest income
 
 
$
135,371

 
 
 
 
 
$
154,667

 
 
Interest rate spread
 
 
 
 
3.69
%
 
 
 
 
 
3.77
%
Net interest earning assets
$
1,298,360

 
 
 
 
 
$
1,175,050

 
 
 
 
Net interest margin
 
 
 
 
3.82
%
 
 
 
 
 
3.95
%
Ratio of average interest earning assets to average interest bearing liabilities
137.72
%
 
 
 
 
 
128.95
%
 
 
 
 

70


(1)
Originated loans are net of deferred loan fees, less costs, which are included in interest income over the life of the loan.
(2)
Non 310-30 loans include loans held-for-sale. Average balances during the nine months ended September 30, 2013 and 2012 were $6.2 million and $6.1 million, and interest income was $262 thousand and $256 thousand for the same periods respectively.
Net interest income totaled $135.4 million and $154.7 million for the nine months ended September 30, 2013 and 2012, respectively. The net interest margin narrowed 13 basis points from the same period in the prior year from 3.95% to 3.82% and the interest rate spread narrowed 8 basis points to 3.69%. The year-over-year narrowing of the net interest margin was primarily driven by an 9.4% decrease in average interest earning assets which was largely attributable to a $444.2 million decrease in average balances of loans accounted for under ASC 310-30 as we continued to actively exit the non-strategic loan portfolio, coupled with lower yields earned on the investment portfolio and on the non 310-30 loan portfolio.
Average loans comprised $1.7 billion, or 36.8%, of total average interest earning assets during the nine months ended September 30, 2013, compared to $2.1 billion, or 39.4%, during the nine months ended September 30, 2012. The decline in average balances is reflective of our exit strategy of the non-strategic loans. The yield on the ASC 310-30 loan portfolio was 11.87% during the nine months ended September 30, 2013, compared to 9.14% during the same period the prior year. This 2.73% increase was attributable to the effects of the favorable life-to-date transfers of non-accretable difference to accretable yield that are being accreted to interest income over the remaining life of these loans, coupled with the early payoff of one loan pool, which resulted in an immediate recognition of $2.5 million of accretable yield during the nine months ended September 30, 2013, and benefited the net interest margin by 0.07%.
Average investment securities comprised 54.0% of total interest earning assets during the nine months ended September 30, 2013 compared to 44.0% during the nine months ended September 30, 2012, as we have steadily reinvested excess cash into our investment securities portfolio. The continued low interest rate environment and lower re-investment yields have resulted in a 60 basis point decline in yields earned on the total investment portfolio during the nine months ended September 30, 2013 compared to the same period of the prior year.
Average balances of interest bearing liabilities declined $616.6 million from the nine months ended September 30, 2012 compared to the nine months ended September 30, 2013, driven by a $684.2 million decrease in average time deposits and partially offset by a $65.8 million increase in transaction deposits. During the nine months ended September 30, 2013, total interest expense related to interest bearing liabilities was $12.7 million compared to $24.1 million during the nine months ended September 30, 2012. The average cost of interest bearing liabilities has decreased 30 basis points from 0.79% during the nine months ended September 30, 2012 to 0.49% during the nine months ended September 30, 2013. The decline was largely due to a 27 basis point decrease in the average cost of deposits at September 30, 2012 of 0.69% to 0.42% at September 30, 2013, as we continued our strategy of transitioning high-priced time deposits to lower-cost transaction accounts. The largest component of interest expense in each period was related to time deposits, which carried an average rate of 0.77% and 1.14% during the nine months ended September 30, 2013 and 2012, respectively.

The following table summarizes the changes in net interest income by major category of interest earning assets and interest bearing liabilities, identifying changes related to volume and changes related to rates for the three and nine months ended September 30, 2013 compared to the three and nine months ended September 30, 2012 (in thousands):


71


 
Three months ended September 30, 2013
 
Nine months ended September 30, 2013
 
compared to
 
compared to
 
Three months ended September 30, 2012
 
Nine months ended September 30, 2012
 
Increase (decrease) due to
 
Increase (decrease) due to
 
Volume
 
Rate (3)
 
Net
 
Volume
 
Rate (3)
 
Net
Interest income:
 
 
 
 
 
 
 
 
 
 
 
ASC 310-30 loans
$
(15,404
)
 
$
11,000

 
$
(4,404
)
 
$
(39,550
)
 
$
22,915

 
$
(16,635
)
Non 310-30 loans (1)(2)
2,472

 
(2,845
)
 
(373
)
 
5,415

 
(12,287
)
 
(6,872
)
Investment securities available-for-sale
1,053

 
(1,504
)
 
(451
)
 
2,115

 
(9,862
)
 
(7,747
)
Investment securities held-to-maturity
(252
)
 
(948
)
 
(1,200
)
 
2,291

 
(911
)
 
1,380

Other securities
(16
)
 
27

 
11

 
33

 
(5
)
 
28

Interest earning deposits and securities purchased under agreements to resell
(152
)
 
49

 
(103
)
 
(806
)
 
(27
)
 
(833
)
Total interest income
$
(12,299
)
 
$
5,779

 
$
(6,520
)
 
$
(30,502
)
 
$
(177
)
 
$
(30,679
)
Interest expense:
 
 
 
 
 
 
 
 
 
 
 
Interest bearing demand, savings and money market deposits
$
30

 
$
(286
)
 
$
(256
)
 
$
86

 
$
(1,155
)
 
$
(1,069
)
Time deposits
(926
)
 
(1,372
)
 
(2,298
)
 
(3,951
)
 
(6,355
)
 
(10,306
)
Securities sold under agreements to repurchase
24

 
(9
)
 
15

 
23

 
(31
)
 
(8
)
Total interest expense
(872
)
 
(1,667
)
 
(2,539
)
 
(3,842
)
 
(7,541
)
 
(11,383
)
Net change in net interest income
$
(11,427
)
 
$
7,446

 
$
(3,981
)
 
$
(26,660
)
 
$
7,364

 
$
(19,296
)
 
(1)
Originated loans are net of deferred loan fees, less costs, which are included in interest income over the life of the loan.
(2)
Non 310-30 loans include loans held-for-sale.
(3)
Includes changes for difference in number of days due to the leap year in 2012.

Our acquired banks had deposit rates, particularly time deposit rates, higher than market at the time we acquired them. We have been steadily lowering deposit rates as we shift towards a more consumer-based banking strategy and focusing on lower cost transaction accounts. We have done this through a particular emphasis on lowering the cost of time deposits. Below is a breakdown of deposits and the average rates paid during the periods indicated (in thousands):
 
 
For the three months ended:
 
September 30, 2013
 
June 30, 2013
 
March 31, 2013
 
December 31, 2012
 
September 30, 2012
 
Average
Balance
 
Average
Rate
Paid
 
Average
Balance
 
Average
Rate
Paid
 
Average
Balance
 
Average
Rate
Paid
 
Average
Balance
 
Average
Rate
Paid
 
Average
Balance
 
Average
Rate
Paid
Non-interest bearing demand
$
668,400

 
0.00
%
 
$
649,323

 
0.00
%
 
$
645,904

 
0.00
%
 
$
662,763

 
0.00
%
 
$
636,277

 
0.00
%
Interest bearing demand
460,971

 
0.14
%
 
478,922

 
0.15
%
 
486,015

 
0.17
%
 
484,178

 
0.18
%
 
500,240

 
0.22
%
Money market accounts
1,088,084

 
0.32
%
 
1,052,590

 
0.32
%
 
1,057,847

 
0.32
%
 
1,033,350

 
0.34
%
 
1,014,793

 
0.39
%
Savings accounts
195,650

 
0.11
%
 
196,248

 
0.11
%
 
194,548

 
0.13
%
 
176,209

 
0.13
%
 
181,939

 
0.14
%
Time deposits
1,561,552

 
0.73
%
 
1,628,332

 
0.77
%
 
1,698,801

 
0.82
%
 
1,832,790

 
0.85
%
 
2,063,622

 
1.00
%
Total average deposits
$
3,974,657

 
0.40
%
 
$
4,005,415

 
0.42
%
 
$
4,083,115

 
0.45
%
 
$
4,189,290

 
0.48
%
 
$
4,396,871

 
0.59
%
Provision for Loan Losses
The provision for loan losses represents the amount of expense that is necessary to bring the ALL to a level that we deem appropriate to absorb probable losses inherent in the loan portfolio as of the balance sheet date. The determination of the ALL, and the resultant provision for loan losses, is subjective and involves significant estimates and assumptions.
Losses incurred on covered loans are reimbursable at the applicable loss share percentages in accordance with the loss-sharing agreements with the FDIC. Accordingly, any provisions made that relate to covered loans are partially offset by a

72


corresponding increase to the FDIC indemnification asset and FDIC loss sharing income in non-interest income. Below is a summary of the provision for loan losses for the periods indicated (in thousands):
 
 
For the three months ended
 
For the nine months ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Provision for (reversals) impairment on loans accounted for under ASC 310-30
$
(313
)
 
$
3,663

 
$
999

 
$
17,398

Provision for loan losses
750

 
1,600

 
2,525

 
7,927

Total provision for loan losses
$
437

 
$
5,263

 
$
3,524

 
$
25,325

Through the re-measurement process, we recouped $0.3 million of provision and recorded $3.7 million of provision for loans accounted for under ASC 310-30 during the three months ended September 30, 2013 and 2012, respectively. For the nine months ended September 30, 2013 and 2012, we recorded $1.0 million and $17.4 million, respectively, of provision for loans accounted for under ASC 310-30. The net provisions on the loans accounted for under ASC 310-30 reflect $0.9 million and $1.3 million of provision reversals as a result of increased cash flows across several pools for the three and nine months ended September 30, 2013, respectively. These provision reversals, when coupled with decreased expected future cash flows primarily driven by our commercial, residential real estate, and agriculture pools, resulted in the net provision for the three and nine months ended September 30, 2013, respectively. The decreases in expected future cash flows are reflected immediately in our financial statements. Increases in expected future cash flows are reflected through an increase in accretable yield that is accreted to income in future periods.
Non-Interest Income
The table below details the components of non-interest income during the three and nine months ended September 30, 2013 and 2012, respectively (in thousands):  
 
For the three months ended
 
For the nine months ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
FDIC indemnification asset accretion
$
(4,208
)
 
$
(2,832
)
 
$
(11,843
)
 
$
(9,165
)
FDIC loss sharing income (expense)
(1,191
)
 
1,503

 
3,278

 
9,278

Service charges
4,334

 
4,466

 
11,944

 
13,170

Bank card fees
2,482

 
2,484

 
7,509

 
7,168

Gain on sale of mortgages, net
345

 
283

 
1,125

 
886

Gain on sale of securities, net

 

 

 
674

Gain on previously charged-off acquired loans
224

 
837

 
1,118

 
2,627

Other non-interest income
1,352

 
1,322

 
4,682

 
3,744

Total non-interest income
$
3,338

 
$
8,063

 
$
17,813

 
$
28,382

Non-interest income for the three and nine months ended September 30, 2013 totaled $3.3 million and $17.8 million, respectively, compared to $8.1 million and $28.4 million during the three and nine months ended September 30, 2012. We recognized negative accretion of $4.2 million and $11.8 million during the three and nine months ended September 30, 2013, respectively, related to the FDIC indemnification asset. The negative accretion resulted from an increase in actual and expected cash flows on the underlying covered assets, resulting in lower expected reimbursements from the FDIC. The increase in expected cash flows from these underlying assets is reflected in increased accretion rates on covered loans and is being recognized over the remaining expected lives of the underlying covered loans as an adjustment to yield.
FDIC loss sharing income represents the income recognized in connection with the actual reimbursement of costs/recoveries of resolution of covered assets from the FDIC. The primary drivers of the FDIC loss sharing income are the FDIC reimbursements of the costs of resolving covered assets.

73


Aside from the negative accretion recognized on the FDIC indemnification asset, FDIC loss sharing income activity during the three and nine months ended September 30, 2013 and 2012 was as follows (in thousands):
 
 
For the three months ended
 
For the nine months ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Clawback liability amortization
$
(314
)
 
$
(355
)
 
$
(937
)
 
$
(1,066
)
Clawback liability remeasurement
(405
)
 
(820
)
 
244

 
247

Reimbursement to FDIC for gain on sale of and income from covered OREO
(2,514
)
 
(1,842
)
 
(4,615
)
 
(1,408
)
Reimbursement to FDIC for recoveries

 
(2
)
 
(22
)
 
(3
)
FDIC reimbursement of costs of resolution of covered assets
2,042

 
4,522

 
8,608

 
11,508

Total
$
(1,191
)
 
$
1,503

 
$
3,278

 
$
9,278

Other FDIC loss sharing income in our statement of operations was primarily comprised of FDIC reimbursements of costs of resolution of covered assets of $2.0 million and $8.6 million, during the three and nine months ended September 30, 2013, respectively, offset with reimbursements to the FDIC for gains on sales of and income from covered OREO of $2.5 million million and $4.6 million, respectively. The activity in the FDIC loss sharing income line fluctuates based on specific loan and OREO workout circumstances and may not be consistent from period to period.
Service charges represent various fees charged to clients for banking services, including fees such as non-sufficient funds (“NSF”) charges and service charges on deposit accounts. Service charges decreased $0.1 million and $1.2 million, or 3.0% and 9.3%, during the three and nine months ended September 30, 2013 compared to the three and nine months ended September 30, 2012, respectively. The decrease was largely due to declines in NSF charges.
Bank card fees are comprised primarily of interchange fees on the debit cards that we have issued to our clients. Bank card fees totaled $2.5 million and $7.5 million during the three and nine months ended September 30, 2013, and $2.5 million and $7.2 million during the three and nine months ended September 30, 2012, respectively.
Gain on previously charged-off acquired loans represents recoveries on loans that were previously charged-off by the predecessor bank prior to takeover by the FDIC. During the three and nine months ended September 30, 2013, these gains were $0.2 million and $1.1 million, respectively, compared to $0.8 million and $2.6 million during the same periods in the prior year.
Other non-interest income for the three and nine months ended September 30, 2013 totaled $1.4 million and $4.7 million, respectively, compared to $1.3 million and $3.7 million for the three and nine months ended September 30, 2012. The increase in other non-interest income from the nine months ended September 30, 2012 to the nine months ended September 30, 2013 was primarily due to an increase in OREO related income.

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Non-Interest Expense
Our operating strategy is to capture the efficiencies available by consolidating the operations of our acquisitions and several of our key operating objectives affect our non-interest expense. We completed the conversion of the Community Banks of Colorado and Bank of Choice acquisitions to our new data processing platform in May 2012 and July 2012, respectively. The table below details non-interest expense for the periods presented (in thousands):
 
For the three months ended
 
For the nine months ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Salaries and employee benefits
$
22,639

 
$
27,182

 
$
69,363

 
$
72,226

Occupancy and equipment
6,556

 
5,570

 
18,391

 
14,845

Professional fees
791

 
2,669

 
3,045

 
8,612

Telecommunications and data processing
3,050

 
4,475

 
9,805

 
11,694

Marketing and business development
1,408

 
1,760

 
3,519

 
4,290

Supplies and printing
326

 
1,288

 
1,180

 
2,495

Other real estate owned expenses
459

 
3,468

 
7,675

 
12,152

Problem loan expenses
1,134

 
2,267

 
4,361

 
6,704

Intangible asset amortization
1,336

 
1,353

 
4,009

 
4,020

FDIC deposit insurance
1,021

 
1,152

 
3,074

 
3,664

ATM/debit card expenses
1,179

 
1,102

 
3,291

 
3,100

Banking center closure related expenses
3,389

 

 
3,389

 

Initial public offering related expenses

 
7,566

 

 
7,974

Acquisition related costs

 

 

 
870

Loss (gain) from change in fair value of warrant liability
441

 
(1,154
)
 
138

 
(1,017
)
Other non-interest expense
2,884

 
1,259

 
8,487

 
6,602

Total non-interest expense
$
46,613

 
$
59,957

 
$
139,727

 
$
158,231

The largest component of non-interest operating expense is salaries and employee benefits. Salaries and employee benefits totaled $22.6 million and $69.4 million for the three and nine months ended September 30, 2013, respectively, compared to $27.2 million and $72.2 million for the three and nine months ended September 30, 2012, respectively. The decrease is primarily due to decreases in stock-based compensation expense of $5.3 million and $6.9 million for the three and nine months ended, September 30, 2013, respectively. Stock-based compensation expense during the three and nine months ended September 30, 2012 was elevated because we incurred $4.9 million of stock-based compensation expense related to our initial public offering.
Occupancy and equipment expense totaled $6.6 million and $18.4 million for the three and nine months ended September 30, 2013, respectively, an increase of $1.0 million and $3.5 million over the three and nine months ended September 30, 2012, respectively. The increase was driven by an increase in depreciation expense as a result of the purchase and subsequent depreciation of the premises and equipment purchased from the FDIC in the first half of 2012 related to our Bank of Choice and Community Banks of Colorado acquisitions.
Professional fees totaled $0.8 million and $3.0 million during the three and nine months ended September 30, 2013 and decreased $1.9 million and $5.6 million from the three and nine months ended September 30, 2012, respectively. Professional fees were elevated during the three and nine months ended September 30, 2012 primarily due to professional fees incurred in conjunction with our acquisitions of Bank of Choice in the third quarter of 2011 and Community Banks of Colorado during the fourth quarter of 2011. Additionally, we have outsourced fewer professional functions as we have built out our internal management functions.
 
Marketing and business development expense totaled $1.4 million and $3.5 million for the three and nine months ended September 30, 2013, respectively, compared to $1.8 million and $4.3 million during the three and nine months ended September 30, 2012, respectively. These decreases were primarily due to consulting and advertising expenses, which were elevated during the three and nine months ended September 30, 2012 after the acquisitions of Bank of Choice during the third quarter of 2011 and Community Banks of Colorado during the fourth quarter of 2011.


75


Significant components of our non-interest expense are our problem loan expenses and OREO related expenses. We incur these expenses in connection with the resolution process of our acquired troubled loan portfolios. During the three and nine months ended September 30, 2013, we incurred $0.5 million and $7.7 million, respectively, of OREO related expenses and $1.1 million and $4.4 million, respectively, of problem loan expenses. Of the $1.6 million and $12.0 million in collective OREO and problem loan expenses incurred during the three and nine months ended September 30, 2013, $1.2 million and $7.9 million, respectively, were covered by loss sharing agreements with the FDIC. The losses on covered assets that are reimbursable from the FDIC are based on the book value of the related covered assets as determined by the FDIC at the date of acquisition, and the FDIC's book value does not necessarily correlate with our book value of the same assets. This difference is primarily because we recorded the OREO at fair value at the date of acquisition in accordance with applicable accounting guidance. Any losses recorded after the acquisition date are recorded at the full-loss value in other non-interest expense, and any related reimbursement from the FDIC is recorded in non-interest income as FDIC loss sharing income.
On September 30, 2013 the Company announced plans to integrate 32 limited-service retirement center locations and exit four banking centers. Included in the three and nine months ended September 30, 2013 operating results are $3.4 million of expenses in connection with the closures, including $3.3 million related to facilities expense. Valuation adjustments to banking center properties and fixed assets account for $2.5 million of the facilities expense and $0.8 million of the facilities expense relates to lease costs. The Company anticipates annualized expense savings of approximately $2.4 million as a result of the closures.
Income taxes
Income tax expense totaled $0.9 million for the three months ended September 30, 2013, as compared with $0.2 million for the three months ended September 30, 2012. These amounts equate to effective tax rates of 47.5% and 3.0% for the respective periods. Income tax expense for the nine months ended September 30, 2013 and 2012 totaled $4.0 million and $3.0 million, respectively, equating to effective tax rates of 40.3% and 599.4%.
The decrease in the effective tax rate for the nine months ended September 30, 2013, as compared to the nine months ended September 30, 2012, is primarily attributable to our initial public offering during September 2012. The effective tax rate for the nine months ended September 30, 2012 is elevated because we incurred $8.0 million of expenses associated with the initial public offering of our stock, during September 2012, which are non-deductible for income tax purposes. This amount represents a significant portion of the loss before income taxes for the nine months ended September 30, 2012 and no income tax benefit is recorded on these expenses. Additional information regarding income taxes can be found in note 22 of our audited consolidated financial statements in our 2012 Annual Report on Form 10-K.
Liquidity and Capital Resources
Liquidity is monitored and managed to ensure that sufficient funds are available to operate our business and pay our obligations to depositors and other creditors, while providing ample available funds for opportunistic and strategic investments. Liquidity is represented by our cash and cash equivalents, securities purchased under agreements to resell and pledgeable investment securities, and is detailed in the table below as of September 30, 2013 and December 31, 2012 (in thousands):
 

September 30, 2013
 
December 31, 2012
Cash and due from banks
$
69,185

 
$
90,505

Due from Federal Reserve Bank of Kansas City
254,456

 
579,267

Interest bearing bank deposits
25,603

 
99,408

Securities purchased under agreements to resell
75,000

 

Pledgeable investment securities, at fair value
2,312,291

 
2,084,046

Total
$
2,736,535

 
$
2,853,226

Total on-balance sheet liquidity decreased $116.7 million from December 31, 2012 to September 30, 2013. The decrease was largely due to a decrease in balances at the Federal Reserve Bank, offset by purchases of mortgage-backed securities.
Aside from the deployment of our capital and cash received from acquisitions, our primary sources of funds are deposits from clients, prepayments and maturities of loans and investment securities, the sale of investment securities, reimbursement of covered asset losses from the FDIC and the funds provided from operations. During the nine months ended September 30, 2013, we entered into a master repurchase agreement with a large financial institution and we anticipate that, through this agreement, we would have access to a significant amount of liquidity. Additionally, we anticipate having access to other third party funding sources, including the ability to raise funds through the issuance of shares of our common stock or other equity or

76


equity-related securities, incurrence of debt, and federal funds purchased, that may also be a source of liquidity. We anticipate that these sources of liquidity will provide adequate funding and liquidity for at least a 12 month period.
Our primary uses of funds are loan originations, investment security purchases, withdrawals of deposits, settlement of repurchase agreements, capital expenditures, operating expenses and debt payments, particularly subsequent to acquisitions. For additional information regarding our operating, investing, and financing cash flows, see our consolidated statements of cash flows in the accompanying unaudited consolidated interim financial statements.
Exclusive from the investing activities related to acquisitions, our primary investing activities are originations and pay-offs and pay downs of loans and sales and purchases of investment securities. At September 30, 2013, pledgeable investment securities represented our largest source of liquidity. Our available-for-sale investment securities are carried at fair value and our held-to-maturity securities are carried at amortized cost. Our collective investment securities portfolio totaled $2.6 billion at September 30, 2013 inclusive of pre-tax net unrealized losses of $21.6 million on the available-for-sale securities portfolio. Additionally, our held-to-maturity securities portfolio had $0.1 million of unrealized losses at September 30, 2013. The gross unrealized gains and losses are detailed in note 3 of our unaudited consolidated interim financial statements for the nine months ended September 30, 2013. As of September 30, 2013, our investment securities portfolio consisted primarily of mortgage-backed securities, all of which were issued or guaranteed by U.S. Government agencies or sponsored enterprises, and prime auto asset-backed securities. The anticipated repayments and marketability of these securities offer substantial resources and flexibility to meet new loan demand, reinvest in the investment securities portfolio, or provide optionality for reductions in our deposit funding base.
At present, financing activities are limited to changes in repurchase agreements, time deposits, and the clawback liability. Maturing time deposits, and holders of $82.6 million of time deposits assumed in the Hillcrest Bank, Bank of Choice and Community Banks of Colorado acquisitions that have not yet accepted new terms, represent a potential use of funds, as these depositors have the option to move the funds without penalty. As of September 30, 2013, $1.1 billion of time deposits were scheduled to mature within 12 months. Based on the current interest rate environment, market conditions, and our consumer banking strategy focusing on both lower cost transaction accounts and term deposits, we expect to replace a significant portion of those maturing time deposits with transaction deposits and market-rate time deposits.
As the Company matures, we expect that our liquidity at the holding company will subsequently decrease as we continue to deploy available capital and until such time that our subsidiary bank is permitted to pay, and does pay, dividends up to the holding company.

NBH Bank is currently prohibited from paying dividends to the holding company under the Operating Agreement with the OCC. However, in October 2013, NBH Bank received approval and a waiver from the OCC under the Operating Agreement to permanently reduce the bank’s capital by $313.0 million.  As a result, the bank paid a $313.0 million cash dividend to the holding company. At September 30, 2013, the holding company sources of funds were limited to cash and cash equivalents on hand, which totaled $69.4 million.  Taking into account the October 2013 dividend from the bank, the holding company had $382.4 million in cash and cash equivalents at September 30, 2013 on a pro forma basis.  See note 18 of our unaudited consolidated interim financial statements for additional information. The holding company may seek to borrow funds and raise capital in the future, the success and terms of which will be subject to market conditions and other factors.
Our stockholders' equity is impacted by the retention of earnings, changes in unrealized gains on securities, net of tax, share repurchases and the payment of dividends. We have agreed to maintain capital levels of at least 10% tier 1 leverage ratio, 11% tier 1 risk-based capital ratio and 12% total risk-based capital ratio at NBH Bank until at least the fourth quarter of 2013. At September 30, 2013 and December 31, 2012, NBH Bank and the consolidated holding company exceeded all capital requirements to which they were subject.
During the nine months ended September 30, 2013, we repurchased 1,114,628 shares of our common stock under the $25 million share repurchase previously authorized by our Board of Directors. Under this authorization through September 30, 2013, we have repurchased 1,114,868 shares at a weighted average price of $18.45 per share, and all shares have been retired.
On November 7, 2013, the Board of Directors authorized a new program to repurchase up to $35 million of our common stock through December 31, 2014. We completed our previously authorized $25 million stock repurchase program in November 2013, repurchasing $21.3 million of the Company's common stock and replacing the remaining buyback authorization of $3.7 million with the new program. Under the new program, the shares will be acquired from time to time either in the open market or in privately negotiated transactions in accordance with applicable regulations of the Securities and Exchange Commission. Also on November 7, 2013, our Board of Directors declared a quarterly dividend of $0.05 per share, payable on December 13, 2013 to shareholders of record on November 29, 2013.

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Asset/Liability Management and Interest Rate Risk
The principal objective of the Company's asset and liability management function is to evaluate the interest rate risk within the balance sheet and pursue a controlled assumption of interest rate risk while maximizing earnings and preserving adequate levels of liquidity and capital. The asset and liability management function is under the guidance of the Asset Liability Committee from direction of the Board of Directors. The Asset Liability Committee meets monthly to review, among other things, the sensitivity of the Company's assets and liabilities to interest rate changes, local and national market conditions and rates. The Asset Liability Committee also reviews the liquidity, capital, deposit mix, loan mix and investment positions of the Company.
Management and the Board of Directors are responsible for managing interest rate risk and employing risk management policies that monitor and limit this exposure. Interest rate risk is measured using net interest income simulations and market value of portfolio equity analyses. These analyses use various assumptions, including the nature and timing of interest rate changes, yield curve shape, prepayments on loans, securities and deposits, deposit decay rates, pricing decisions on loans and deposits, reinvestment/replacement of asset and liability cash flows.
Instantaneous parallel rate shift scenarios are modeled and utilized to evaluate risk and establish exposure limits for acceptable changes in net interest margin. These scenarios, known as rate shocks, simulate an instantaneous change in interest rates and use various assumptions, including, but not limited to, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment and replacement of asset and liability cash flows.
We also analyze the economic value of equity as a secondary measure of interest rate risk. This is a complementary measure to net interest income where the calculated value is the result of the market value of assets less the market value of liabilities. The economic value of equity is a longer term view of interest rate risk because it measures the present value of the future cash flows. The impact of changes in interest rates on this calculation is analyzed for the risk to our future earnings and is used in conjunction with the analyses on net interest income.
Our interest rate risk model indicated that the Company was asset sensitive in terms of interest rate sensitivity at September 30, 2013. During the nine months ended September 30, 2013, we decreased our asset sensitivity as a result of the declines in cash balances relative to the size of the balance sheet. The table below illustrates the impact of an immediate and sustained 200 and 100 basis point increase and a 50 basis point decrease in interest rates on net interest income based on the interest rate risk model at September 30, 2013 and December 31, 2012:
Hypothetical
 
 
 
 
Shift in Interest
 
% Change in Projected Net Interest Income
Rates (in bps)
 
September 30, 2013
 
December 31, 2012
200
 
5.32%
 
12.84%
100
 
3.55%
 
7.43%
-50
 
-0.92%
 
-2.88%
Many assumptions are used to calculate the impact of interest rate fluctuations. Actual results may be significantly different than our projections due to several factors, including the timing and frequency of rate changes, market conditions and the shape of the yield curve. The computations of interest rate risk shown above do not include actions that management may undertake to manage the risks in response to anticipated changes in interest rates and actual results may also differ due to any actions taken in response to the changing rates.
The federal funds rate is the basis for overnight funding and the market expectations for changes in the federal funds rate influence the yield curve. The federal funds rate is currently at 0.25% and has been since December 2008. Should interest rates decline further, net interest margin and net interest income would be compressed given the current mix of rate sensitive assets and liabilities.
As part of the asset/liability management strategy to manage primary market risk exposures expected to be in effect in future reporting periods, management has emphasized the origination of shorter duration loans as well as variable rate loans to limit the negative exposure to a rate increase. The strategy with respect to liabilities has been to emphasize transaction accounts, particularly non-interest or low interest bearing non-maturing deposit accounts which are less sensitive to changes in interest rates. In response to this strategy, non-maturing deposit accounts have been steadily increasing and totaled 61.2% of total deposits at September 30, 2013 compared to 58.3% at December 31, 2012. We currently have no brokered time deposits and intend to continue to focus on our strategy of increasing non-interest or low interest bearing non-maturing deposit accounts and accordingly, we have no current plans to use brokered deposits in the near future.

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Off-Balance Sheet Activities
In the normal course of business, we are a party to various contractual obligations, commitments and other off-balance sheet activities that contain credit, market, and operational risk that are not required to be reflected in our consolidated financial statements. The most significant of these are the loan commitments that we enter into to meet the financing needs of clients, including commitments to extend credit, commercial and consumer lines of credit and standby letters of credit. As of September 30, 2013 and December 31, 2012, we had loan commitments totaling $320.2 million and $305.9 million, respectively, and standby letters of credit that totaled $8.2 million and $10.7 million, respectively. Unused commitments do not necessarily represent future credit exposure or cash requirements, as commitments often expire without being drawn upon. We do not anticipate any material losses arising from commitments or contingent liabilities and we do not believe that there are any material commitments to extend credit that represent risks of an unusual nature.

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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information called for by this item is provided under the caption Asset/Liability Management and Interest Rate Risk in Part I, Item 2-Management's Discussion and Analysis of Financial Condition and Results of Operations and is incorporated herein by reference.
Item 4. CONTROLS AND PROCEDURES
Under the supervision and with the participation of the Company's management, including its principal executive officer and principal financial officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)). Based upon this evaluation, the principal executive officer and principal financial officer have concluded that, as of the end of the period covered by this report, the Company's disclosure controls and procedures were effective.
During the most recently completed fiscal quarter, there was no change made in the Company's internal controls over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.


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PART II: OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
From time to time we are a party to various litigation matters incidental to the conduct of our business. We are not presently party to any legal proceedings the resolution of which we believe would have a material adverse effect on our business, prospects, financial condition, liquidity, results of operation, cash flows or capital levels.
Item 1A. RISK FACTORS
There have been no material changes to the risk factors disclosed in Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2012.
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table sets forth information about our purchases of our $0.01 par value Class A common stock, our only class of stock registered pursuant to Section 12 of the Exchange Act, during the three months ended September 30, 2013:
 
Period
 
(a) Total Number
of Shares (or
Units) Purchased
 
(b) Average
Price Paid Per
Share (or Unit)
 
(c) Total Number of
Shares (or Units)
Purchased as Part of
Publicly Announced
Plans or Programs
 
(d) Maximum Number
(or Approximate Dollar
Value) of Shares (or
Units) that May Yet Be
Purchased Under the
Plans or Programs
July 1 - July 31, 2013
 

 

 

 
7,685,817

August 1 - August 31, 2013
 
22,398

 
19.90

 
22,398

 
7,240,108

September 1 - September 30, 2013
 
141,756

 
19.83

 
141,756

 
4,428,611

Total
 
164,154

 
$
19.84

 
164,154

 
$
4,428,611


On October 31, 2012, the Board of Directors authorized share repurchases of our common stock of up to $25 million, from time to time. The stock purchases detailed above were made under this authorization.

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Item 6. EXHIBITS
3.1
 
Second Amended and Restated Certificate of Incorporation (incorporated herein by reference to Exhibit 3.1 to our Form S-1 Registration Statement (Registration No. 333-177971), filed August 22, 2012)
 
 
 
3.2
 
Amended and Restated By-Laws (incorporated herein by reference to Exhibit 3.2 to our Form S-1 Registration Statement (Registration No. 333-177971), filed August 22, 2012)
 
 
 
10.1
  
Letter Agreement, dated June 5, 2013, by and among Zsolt K. Bessko and National Bank Holdings Corporation and NBH Bank, N.A.
 
 
 
31.1
  
Certification of CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
31.2
  
Certification of CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
32
  
Certifications of CEO and CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
101
  
Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operation, (iii) the Consolidated Statements of Comprehensive Income (Loss), (iv) the Consolidated Statements of Changes in Equity, (v) the Consolidated Statements of Cash Flows and (vi) the Notes to Consolidated Financial Statements, tagged as blocks of text and in detail*
*
 
This information is deemed furnished, not filed.


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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

NATIONAL BANK HOLDINGS CORPORATION
 
/s/ Brian F. Lilly
Brian F. Lilly
Chief Financial Officer
(Authorized Officer and Principal Financial Officer)
Date: November 12, 2013

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