UMB Financial Corporation

Good morning and welcome to UMB Financial Third Quarter 2021 Financial Results Conference Call. All participants will be in listen-only mode. If you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. Please note that this event is being recorded. I'd now like to turn the call over to Ms. Kay Gregory of Investor Relations. Please go ahead.

Good morning and welcome to our third quarter 2021 call. Mariner Kemper, President and CEO, and Ram Shankar, CFO, will share a few comments about our results. Jim Rhine, CEO of UMB Bank, and Tom Terry, Chief Credit Officer, will also be available for the question and answer session. Before we begin, let me remind you that today's presentation contains forward-looking statements, all of which are subject to assumptions, risks, and uncertainties. These risks are included in our SEC filings and are summarized on slide 43 of our presentation. Actual results and circumstances may differ from those set forth in any forward-looking statement. Forward-looking statements speak only as of today, and we undertake no obligation to update them unless required by securities laws. Our presentation materials and press release are available online at investorrelations.umb.com. Now, I'll turn the call over to Mariner Kemper.

Thank you, Kay, and thanks, everyone, for joining us today. We continue to see the benefits of our diverse business model, which helps us derive key points of our investment thesis, above peer loan growth, solid net interest income, and strong fee income contributions. For the third quarter, we posted 15.3% average loan growth on a linked quarter of annualized basis, excluding PPP balances. Asset quality remains strong, with net charge-offs of just seven basis points and a $5 million negative provision for credit losses. Sentiment in our markets continues to move towards more normalized levels. While supply chain dynamics and rising material costs weigh on businesses across our footprint, pricing and customer demand led to strong loan growth. Turning to our third quarter results, net income was $94.5 million, or $1.94 per share. And pre-tax, pre-provision income on an FTE basis was $115.3 million, or $2.37 per share. Slide 18 shows primary drivers behind our results, and I'll provide some high-level comments and then turn it over to Ram for more details. Net interest income increased 4.3% from the second quarter, driven by strong earning asset growth and controlled liability costs. Net interest margin increased was 2.52% versus 2.56% last quarter, impacted by continued elevated liquidity levels, reinvestment rates, core loan mix, and repricing. We are working to deploy the excess liquidity as prudently as possible as the rate environment changes. While reported non-interest income declined for the link quarter, it was largely driven by unrealized mark-to-market adjustments in the equity holdings, including a $10.7 million swing to our tattooed chef position in the second quarter. We saw positive momentum in fund services income and bank card fees with increases of 8.5 percent and 7.1 percent respectively. Trading and investment banking income fell during the quarter on lower trading volumes after an extremely strong second quarter. Moving to the balance sheet, slide 24 is a snapshot of our loan portfolio showing the drivers behind our loan growth. CNI led the growth in average balances this quarter as we continue to gain share across our footprint. Prospects are recognizing us as a consistent, stable player in our markets. More than half of our commercial loan growth came from new customers this quarter. During the quarter, we saw some return of CapEx spending. And while the growing number of middle market companies selling to private equity firms contributes to payoffs, we've had success in building relationships with PE firms and are often able to participate in those purchases. Average mortgage balances increased 7.4% from the second quarter to $1.8 billion. Funded mortgage loans for the quarter were $236 million, including $30 million in the secondary market. Year-to-date, we've seen 53% in secondary market mortgages compared to the same period in 2020. Top-line loan production, as shown on slide 25, was $905 million for the quarter outside of PPP balance changes. Payoffs and paydowns were 5.9% of loans above recent levels. We do expect acquisition activity among middle market companies to continue, which makes estimating payoffs unpredictable. However, we see a robust pipeline for the fourth quarter with opportunities across all verticals. On slide 26, we've updated our exposure to sensitive industries. We continue to monitor our hotel and senior living portfolios. which stood at a combined $885 million at quarter end, representing 5.5% of loans, excluding PPP. After analysis of mitigating factors, including strong sponsors and guarantors, we feel approximately $419 million, or 2.6% of loans, warrant closer monitoring. We've included this analysis again this quarter. However, as the economy continues to improve, this will be less of a focus going forward. Slide 27 and 28 show asset quality trends. I'm pleased with the reported seven basis points of net charge-offs for the quarter. And as I mentioned last quarter, given what we know today and the quality we see across our portfolio, we expect charge-offs to come in near our historical levels of 25 to 30 basis points for the full year of 2021. You will see that non-performing loans ticked up this quarter to 0.59% of loans. in line with the third quarter of 2020. This increase was largely driven by one credit relationship. As we've talked about often, we'll see peaks and valleys as we manage credit, moving them to watch lists or MPAs, but our historical track record has shown limited migration to loss. Moving to capital, we saw improvement in our already strong ratios, with total capital of 14.17% compared to 13.84% in the second quarter. While we returned additional capital to shareholders through the increased dividend payment announced in July, our top priority for use of capital remains supporting strong organic growth. And as market conditions allow, we'll continue to look for opportunities to augment that growth with strategic acquisitions. Along these lines, we recently announced a single branch acquisition with approximately $250 million in deposits. in the Kansas City market. Finally, we recently announced the formal launch of our family wealth offering. This is a registered investment advisor which focuses on providing entrepreneurial investment strategies, sophisticated tax planning, and generational wealth guidance to families with significant wealth. We were already providing many of these services within private wealth management, and we decided it was time to formalize the offering, including hiring and developing a dedicated team of investment professionals. Additionally, UMB Capital Corporation, which holds our SBIC, will be part of our family wealth offering and will focus on investment opportunities in private equity, direct investments, and other alternatives for our clients. To wrap it up, we continue to see positive momentum across the company, and I'm pleased with our third quarter performance, and I'm excited by the opportunities we see as we head into the fourth quarter and beyond into 2022. Now I'll turn it over to Ram for a few comments.

Ram Ramakrishnan Thank you, Mariner. Net interest income of $209.8 million represented an increase of 4.3 percent from the second quarter. We amortized $8.8 million of PPP auto-donation fees into income, and the overall PPP contribution to the third quarter net interest income was $10.1 million compared to $12.4 million last quarter. At quarter end, our PPP balances stood at $318 million down from $766 million at June 30. Approximately $9.3 million in un-iamortized fees remain at the end of the third quarter. Average earning asset yields decreased five basis points to 2.65 percent due to a three basis point decline in security yields and asset mix changes, including increased liquidity and a $659 million decline in average PPP balances. Our Fed account, reverse repo and cash balances now comprise 16% of average earning assets compared to 14% last quarter with a yield of 30 basis points. This increased liquidity along with core loan repricing pressure and mixed changes drove the decline in net interest margin. We continue to deploy a portion of excess liquidity as well as cash flows from our securities book back into our AFS portfolio, driving an increase of $643 million in average balances from the prior quarter and nearly $2 billion compared to the third quarter of 2020. Looking ahead, our internal outlook for any Fed actions are in line with the current consensus for an early 2023 increase. We remain modestly asset sensitive with more than 50% of our loan portfolio tied to short-term interest rates and over a third of our deposits in interest-free demand deposits. Actual experience when rates do rise will depend on a number of factors, including the pace and source of liquidity reductions, overall size of our investment portfolio, mixed shift within the deposit book, steepness of the yield curve to include the 10-year Treasury yields, and the number of rate increases as pertinent to our $1 billion in pay fixed received float swap portfolio. As we've noted in our investment thesis, we believe that our ability to grow our loan portfolio through market share gains Potential to redeploy our over $4 billion in excess liquidity, coupled with opportunities to rotate within our earning asset base, will also add to net interest income outperformance relative to our peers. Additionally, a few of our fee income businesses benefit from higher interest rates, such as 12B1 money market fees in our corporate trust business. The portfolio composition and activity trends are shown on slide 29, And during the quarter, we had cash flows of $375 million at a yield of 1.98%. We purchased $1.1 billion of securities that yielded 1.28%. Non-interest income for the third quarter was $107.9 million, down $23.7 million from the last quarter, driven largely by market-related adjustments. The market value of our investment in Tattooed Chef, TTCF, resulted in a 3.5 million unrealized loss in the third quarter compared to a 7.2 million right up in the second quarter. Additionally, as noted last quarter, our second quarter fees had included over $5 million in investment gains from liquidity events on portfolio companies held at UMB Capital Corporation. Other drivers to fee income for the quarter are shown on slide 22. Non-interest expense trends are shown on slide 23, Expenses increased $7.5 million or 3.7% from the second quarter to $208.9 million, driven by larger performance-related incentive expense and $2.7 million in operational losses. Our effective tax rate for both the third quarter and year-to-date was 17%. For the full year 2021, we anticipate it will be approximately 16% to 18%. Our tangible book value per share has increased nearly 10% during the past 12 months to $60.44 at September 30th. That concludes our prepared remarks, and I'll now turn it back over to the operator to begin the Q&A portion of the call.

I'll begin the question and answer session. To ask a question, you may press star then 1 on your touch-tone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. This time will pause momentarily to assemble the roster. First question comes from Jared Shaw, Wells Fargo Security. Please go ahead.

Hey, good morning, everybody.

Good morning, Jared.

I guess maybe first with the loan growth and outlook, you know, good growth on an average basis quarter over quarter. I mean, I see the slide with the pay down, pay off activity. How should we be thinking about loan growth going into the end of the year? Should we, you know, can we expect to see average growth from third quarter with the impact of PPP rolling off? Or, you know, I guess how should we be thinking about those strong pipelines versus some of the structural headwinds there?

Well, I think the news, this is Mariner. Morning, Jared. I think the news is similar to what we've already talked about, which is our top-line growth. We expect to continue to be strong. Pay-off, pay-down activity against that is an unknown. This last quarter was, I think, representative of a build-up from the coronavirus from last year, where we got low cap rates and low interest rates, and there's some sales activity taking place within largely our CRE book. But otherwise, top line growth continues to look strong. Obviously, XPPP, we continue to have the same trends as we always do with our loan growth.

Okay.

And then you'd mentioned some strength with PE firm customers. Are you doing capital call lending with them, or what's the type of lending relationship that that's driving? Okay.

Well, we do do some lending into our fund services clients, but that's not really what we're referencing. We're really talking more about M&A-driven PE lending. So as companies in our portfolio or through relationships with PE firms get bought or sold, we're participating in that acquisition debt. Okay, great.

And then looking at loan yields, do you think that Overall, we've sort of hit a bottom here, assuming a stable rate environment, or could there be maybe a little more incremental squeeze on loan yields?

Things remain very competitive. They always do. I don't know, Tom, if you want to add. We're near the bottom, I suppose.

Yeah, no, I would agree with that. It's still a very aggressive environment, and I don't expect that part of it to change. If rates stabilize, you know, however you define that, we may be near the bottom, but it's still always a competitive environment.

Probably not a lot of downward pressure, but it certainly remains competitive.

Okay, thanks. And then just finally for me, any color you can give on that increase in CNI and PL, you know, whether it's, you know, detail on the sector, and then I guess what gives you confidence that the lost content could be low on that?

So it is, as we mentioned in the call, it is one credit. What I would tell you, which has been true for some time, you know, I've been in credit leadership at UMB for 25 years, as have the two other gentlemen on the call with me today, Jim Ryan and Tom Terry. And what has always been true about the way we manage credits is we're quick to take action, quick to recognize trouble, and quick to manage credits. And our history is very strong and long in not seeing much material migration from troubled credits to loss. And we don't expect that to be any different on a go-forward basis as there are peaks and valleys from time to time, and typically very few credits. So they're not really trends in any one. It's never a trend in an industry. It's usually a particular credit or two.

Okay. Is that growth this quarter?

We would expect, you know, full-year charge-offs to remain within our 10-year averages of 25 to 30 basis points.

Okay. And was that growth in the factoring unit?

No, it is not from factoring.

Okay. Great. Thank you.

It would be in our core portfolio, you know.

Thank you. Next question comes from Nathan Rice. Piper Sandler, please go ahead.

Yep. Hi, everyone.

Good morning.

Good morning, Nathan. Just a few questions on the income growth outlook. You know, it looks like the fund services unit is continuing to post, you know, pretty impressive growth, you know, over the last several quarters here, and I appreciate the additional breakouts on slide 22 along those lines. I'm just curious as you guys maybe look out over the next several quarters, You know, total fee income growth has been kind of a low to mid-single-digit range over the last couple of years. Is that still a reasonable expectation to think about for 2022? And where do you see a lot of that growth coming from across the overall composition of the year?

Nate, this is Jim Ryan. We have had great growth in the fund services area, and half of that is coming from new clients. won't really give forward guidance on what we see for fee income. I can tell you, though, through our institutional business, our public finance area is up. We anticipate additional strong growth there through the rest of the year. They're already having a record year. Corporate trust is up 61 percent over 2020. We've continued to expand and add additional associates in that area. And we've made additional investments in our healthcare services area to expand our direct-to-employer network to where we're expecting additional growth in the future there. Keep in mind, through our fund services, as well as some of the other business, we are absent 12B1 fees due to the rate environment. And if you go back to pre-2021, 2020, we had roughly $30 million in 12B1 fees on a run rate. So, again, not providing guidance, but as rates do tick up, we would see additional fee income from that category as well.

And the drivers, the backdrop for all of those businesses continue to be strong. There's a lot of disruption in our competitors in the fund services business. We've been benefiting handsomely from that disruption, and we're a real strong player in the PE space. So alternatives have been very strong right in this low-interest rate environment. Alternatives have been a very strong asset class. So there's a lot of growth there, both in formation as well as asset growth within our customer base. And then infrastructure, and real rates are headed up. And the anticipation of an infrastructure bill is speeding up activity in the public and corporate trust space. And as travel has recovered, our aviation business is also starting to see some positive outlook. So a lot of really good drivers as we look forward. And, you know, also our mortgage business is, as we've talked in the past, we have a lot of runway across all of our business lines. And that's true for mortgage for us, too. Even if the refi business slows down on an industry-wide level, our business is so nascent that we have a lot of opportunity and runway just within our customer base to participate in the purchase volume. Wow. And so we see some legs for our mortgage business on a relative basis, even if rates rise and the refi business slows down. Along with our card business, which is for a company our size, is a pretty big business. And we're starting to see some nice momentum in card spend driving interchange revenue for us.

Got it. That's a very helpful color. Maybe just changing gears and thinking about the trajectory of the reserves. over the next several quarters. You know, you guys are back below kind of pre-pandemic will-to-reserve levels as we sit here today, XPPP. How do you guys kind of think about the need to provide for additional growth going forward kind of within the context of the charge-off outlook, you know, kind of remaining in that 25 to 35 basis point range going forward?

Ron, do you want to take that?

Yeah, I mean, we're still not at pre-pandemic level. So on day one, our CECL number was, you know, 85 basis points coverage. And if you look at where we are today, we're close to 120, right? So there's still, at the macro environment and the Moody's forecast gets better, there's going to be pressure on the allowance coverage ratio to go down further from where we are. But a lot of our provision, typically, to your point, happens because of the outsized loan growth that we have. So on that basis, I think our relative recapture of the reserve might be slower than peers because of that, because we continue to grow our balance sheet on the loan side. And so that will be a good differentiating factor, if you will.

Got it. Makes sense. And maybe just one last one for me. Any additional color on the operational loss and the other expense line item here in the third quarter? And I assume that doesn't recur going forward, but would it just appreciate any additional color on the driver there?

Yeah, that's something that'll, you know, I think you see this on other income statements, just bounces around a little bit. It's not regulatory. It's not a regulatory loss. It's just a, you know, typical kind of business operating type losses that we will bump into from one quarter to the next based on our business activities and breadth and depth of our business.

Got it. I appreciate the color.

I will step back. Thank you, guys. Thank you. Next question comes from Chris McGrady, KBW. Please go ahead.

Hey, good morning.

Hey, Chris.

Good morning. Ron or Mariner, the deposit growth has been just off the charts. I'm interested in kind of an outlook for deposit flows. you know, particularly non-transparent, how much do you think is sustainable versus a little bit transitory? Because those numbers are pretty strong.

It's a great question. And when you get the answer, will you give us a call? No, we're, you know, we've benefited. I think one of the reasons ours is outsized is a mix of business, right? So we have a large commercial and institutional business. So the question, you know, so that's certainly a big driver, which would be less transitory, right? So the growth of our asset servicing business, the growth of our new aviation trust business, the coming back of our regular corporate trust business and 12B1 fees. So those kind of comments around corporate trust and public finance business picking up in a raising rate environment, all of those things, would be the non-transitory part of the increased levels of liquidity on our balance sheet. If you just look at the pre and the post sort of numbers, the range, right, we've got an additional $4.5 billion on our balance sheet. The question, right, the million-dollar question for everybody, is it $4.5 million in excess transitory liquidity or something less? we certainly believe that it's less than that because of the growth in our business lines and the complexity of our balance sheet and income statement. Certainly there is some excess liquidity on the balance sheet, but we have internal debate ourselves really about how much there is. So I know you're looking for more than that, but I think A lot of it is going to be driven by the complexity in all of the institutional businesses adding core balances, but there's certainly some excess liquidity on there.

Okay. Yeah, it's a guess, but I appreciate the color. My follow-up would be on expenses. I've heard from many of your peers this quarter just inflationary wages, pressures to run the business. I'm interested in how you're thinking about – you know, retention and the cost to retain and also recruit.

Thanks. Another great question, right, is where we're all sort of feeling our way through this, the pressure to work from home and the regions from the coast and just the competitive landscape for employment. I think it's early, right, to understand some of the longer-term implications of coming out of COVID and, some of the, I think, more permanent implications of the way we've been working the last couple years. But I would say that we have seen some wage inflation, and we do not believe that is transitory. You can't unring that bell. But I think from a competitive landscape, we have a great culture. We're not losing people. voluntary turnover rate and turnover rates in general are not much different than they were prior to the period we've gone through. So we've been watching that. And so we don't feel like there's any signs on the turnover side where we have been able to maintain and hold the people that we have competitively on the hiring side. You know, that's the biggest challenge because everybody's looking, everybody's in need. But again, we feel pretty good about the culture and the strength of kind of the consistency of our company as we look to hiring.

Yeah, Chris, Jim Ryan. The one thing that we've also been just dealing with, I think most of our peers are dealing with too, is just getting our mix of flexibility correctly. I think that's what associates are really looking for in the workplace right now, and that's something that we're addressing and putting a lot and being very thoughtful about. with also as much as the wage inflation. It's just what the new work environment looks like. And that's where you're going to see a lot of changes in the industry, quite frankly. Yeah.

And we want to be a thoughtful leader in that space. So we're not going to dig our heels in. We're going to make some real changes and adapt.

Okay, and then thank you for that. The last one would be Ram on the PPP. Can you just remind us the fee that we're in the quarter and then what's left?

Yeah, so it was $10 million in the quarter, Chris. That includes both the origination fee and interest income. We still have $9 million of fees left on the PPP program on balances of about $320 million at quarter end. Great, thanks.

Again, if you have a question, please press star, then 1. Next question comes from David Long, Raymond James. Please go ahead.

Good morning, everyone.

Hey, morning, David.

The utilization rate, can you talk about where your utilization rate was here at the quarter end and how you, you know, if you expect that to change here anytime soon? So...

It was at 32 at the end of the quarter. And it ranges from 29 to 35. And I would say that the way to think about it is, you know, the average is a low for us is low 30s. And, you know, if you think about an environment where there's a lot of liquidity in the system, my take for the industry is that it's likely that that liquidity gets spent first. before we would see something on the higher end of our range.

Gotcha. Okay. And then, you know, looking at the average balances in loans, pretty good growth there in the quarter, but the period end didn't show the same. Was there some accelerated payoffs or paydowns near the end of the quarter?

Yeah. This is Tom Terry. as Mariner mentioned earlier in his comments, we're seeing a greater amount of payoffs in our commercial real estate book principally due to low cap rates, a low rate environment. They're either being refinanced in the non-recourse market or there are a lot of just outright sales of commercial real estate properties. And so we are seeing a greater amount of that this year and certainly in the third quarter than we've seen historically.

But that point in time question though, that's just a, That's literally just the point in time. The growth, I pay more attention to the averages than the point in time.

And Dave, 525 has the roll-off roll-on on that, and you can see those numbers in there. And as a percentage of loans, as Mariner and Tom both alluded to, was a little elevated at 5.9% of total loans.

Got it. Okay. All right. That's all I had. Thanks, guys.

All right. I might add that it wasn't asked, but it's something we're pretty proud of. We're going to have a new tear sheet coming out in a week or so on our community development and our ESG efforts. We spent a lot of time on it. We're really proud of the things we're doing. As a matter of fact, I'd say ESG is a new term, really, for some things that we as a company have always really cared about. We're pretty excited about that, so keep an eye out. You can go to our website, see our community development statement, and within a week or so, you'll see our new tariff sheet where we're making sure we're getting recognized for a lot of the things we've been doing by detailing them in the statement. We're doing some real neat things. We're rolling out here in December a down payment assistance program to reach into LMI neighborhoods and help lift people up and help increased home ownership. And in our fourth quarter expenses, we think that if things continue the way they have for us this year into the fourth quarter, we're likely to share some of our profits with our communities in the fourth quarter, as we have been doing. And anyway, we're real proud of what our team's doing and what our company's doing to make a difference in the communities we're serving. And we'd love for you all as investors to take a look at what we're doing on our website and keep an eye out for those efforts going forward. So thanks for everybody joining today.

All right. It looks like we have no further questions. Thank you, everybody, for joining us. The replay will be on our website shortly. And as always, you can contact UMB Investor Relations at 816- 860-7106 with any follow-up questions, and we appreciate your interest and time. Thank you.

Thank you. Conference is now concluded. Thank you for attending today's presentation. You may now disconnect.