UMB Financial Corporation

Good morning or good afternoon all and welcome to the UMB Financial Second Quarter Investor Call. My name is Adam and I'll be your operator for today. If you'd like to ask a question during the Q&A portion of today's call, please press star followed by one on your telephone keypad. I will now hand the floor to Kay Gregory, SVP and Director of Investor Relations to begin. So Kay, please go ahead when you are ready.

Good morning and welcome to our second quarter 2023 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, which are subject to assumptions, risks, and uncertainties. These risks are included in our SEC filings and are summarized on slide 47 of our presentation. Actual results may differ from those set forth in forward-looking statements, which speak only as of today. we undertake no obligation to update them except to the extent required by securities laws. All earnings per share metrics discussed on this call are on a diluted share basis. 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 good morning. Thanks, everyone, for joining us today. Despite the exaggerated noise from the recent crisis, that has largely subsided, our second quarter results reflect strong trends highlighted by strong asset quality and overall portfolio health, strong and consistent fee income that helps us navigate this elevated interest rate environment, continued yet prudent opportunities in loan growth, particularly in commercial and industrial lending, strong client engagement and traction across our diverse lines of business. These solid results in several areas were masked by higher interest expense, driven by the Federal Reserve's monetary tightening actions and the resulting increases in funding costs in the interest rate environment we live with today. As noted in our last call, the deposit pricing pressures the industry is experiencing is not dissimilar to the price of commodity or raw materials for other industries. As other industries would, we are reacting to our cost of raw material by pricing our products for this environment. As we have noted, 62% of our existing loans also reprice with movements in rates. Like others in the industry, we also maintained elevated levels of excess liquidity during the second quarter. This resulted in brokered CDs and borrowing levels higher than we've typically carried, which also impacted interest expense and our margin. To help mitigate the continued impact of liability pricing, we maintain flexibility on the asset side of our balance sheet. We have a loan to deposit ratio on the lower side of peer averages, a largely variable asset base, and strategically planned cash flows. This is not to diminish the challenges the industry faces from higher interest expense or the rotation of deposits to rate-bearing options. This has had an impact on margins and spread as evident during this earnings season. On the macro front, the economy continues to be resilient, with some pressures in isolated pockets and industries. It also seems that the bulk of the tightening cycle may be behind us. And the prevailing questions are, how long will the Fed maintain rates at these elevated levels? And do we end up with a soft landing? Through the recent industry volatility, we've maintained our focus as a growth company. We've reported double-digit annualized loan growth, excellent credit metrics, solid few businesses, and largely stable and diverse deposit base. As our costs increase, we remain disciplined in pricing our loans and continue our efforts to control operating expenses. UMB has a track record of sticking to the business model that has proven itself over time, even as we adapt to changing circumstances. Now I'll cover a few highlights from the quarter. GAAP net income for the second quarter was $90.1 million, or $1.85 per share. Operating net income was $93.8 million, or $1.93 per share. Net interest income decreased for the first quarter as strong loan growth and improved asset yields were offset by increased deposit costs and liability mix shifts. We have continued to benefit from asset repricing with a linked quarter beta on loan yields of nearly 70%. This is in line with the beta on the total client deposits, which excludes brokered deposits. Both the income and expense levels contained a few factors that impacted link quarter and year over year comparisons. As a reminder, second quarter of last year contained a $66.2 million pre-tax gain on the sale of our Visa B shares. Ron will provide more color on the drivers in his discussion. We posted average quarterly loan growth of 17.3% on a link quarter annualized basis. Even as we've grown loan balances, asset quality remains strong, with net recoveries of $139,000 for the quarter. Non-performing loans were just 0.09% of loans as of June 30, and provision for credit losses was just $13 million for the quarter, driven by loan growth and macroeconomic variables. We are incredibly proud of our current and historical credit performance. If you look at our 20-year history ending with the full year of 2022, our annual losses have averaged just 29 basis points and our 10-year average was 26 basis points. What makes it even more impressive is that over these periods, we have enhanced our reach and footprint through market and vertical expansion and are generally a more complex organization. We've achieved this through our focus on risk management and with consistent approach that comes from having the same team. Our allowance to loan coverage ratio further increased two basis points sequentially to 99 basis points of total loans at a level we believe to be prudent. Criticized loans were essentially flat from the prior quarter. Our total watch list levels, including past loans, will fluctuate from quarter to quarter But as evidenced by our recoveries this quarter, we continue to have very little migration to loss. The drivers behind our growth in average loan balances this quarter are on slide 24. Nearly half the increase was driven by C&I customers, followed by construction lending and residential real estate. While customer sentiment is mixed with some uncertainty about the economy, commercial pipeline remains steady. Total top line loan production, as shown on slide 25, was $986 million, while payoffs and paydowns represent 3.4% of loans in the first quarter. The average for the past five quarters was 3.6%, in line with our longer term trends. Commercial real estate and construction growth in the second quarter came in predominantly in the multifamily and industrial categories. Credit quality is strong across our book. And the CRE portfolio is well diversified by property classification, tenant type, and geography, as shown in the line of business section of this presentation on slide 37 and 38. As we did last quarter, we've included LTVs, recourse, and other statistics by property type, as well as geographic detail on the portfolio. The office portfolio represents just 4.5% of total loans with only an average size of 8.5 million. Looking ahead into the third quarter, we see opportunities in our various lending verticals across our footprint. We will continue to remain disciplined on pricing, further emphasizing lending accompanied by meaningful deposit relationships. On the other side of the balance sheet, average total deposits decreased 87 million or 1.1% on an annualized basis from the first quarter to 31.5 billion. Included in the length quarter reduction in average deposits were typical public fund fluctuations of $284 million and normal course of business activities such as tax payments. As we point out each quarter, activity in our commercial and institutional customer base, along with seasonal public fund balance fluctuations, differentiates us from peers with large retail businesses. Deposit balances will naturally ebb and flow for typical business purposes. including payroll, dividends, and other activity. We have deep relationships with long-term clients who rely on UMB not only for deposits, but for multiple financial products and services to manage and grow their businesses. Our pipeline for new to bank deposit relationships also remains healthy. And while nominal, we continue to add commercial accounts despite the common industry narrative. While cost of deposit acquisition will mimic current market rates, we also benefit from cheaper sources of funding in our corporate trusts and aviation businesses that can be lumpy from time to time. To reiterate, as I noted earlier, we've been diligent and successful in pricing our loans for the market dynamics around our funding costs. Slide 30 and 31 show the composition and other characteristics of our deposit portfolio. At the end of June, deposits stood at $33.5 billion, an increase of 5% from March 31st. And uninsured deposits adjusted to exclude affiliated and collateralized deposits were at 41% of total deposits as of June 30th. Now I'll turn it over to Ram for a more detailed look at our results. Ram?

Thanks, Mariner. I'll share a few additional drivers of our second quarter results, then I'll discuss some of the key balance sheet items that continue to be top of mind in the current environment. Net interest margin for the second quarter was 2.44%, a decrease of 32 basis points from the link quarter. Drivers included negative impacts of approximately 45 basis points from deposit pricing and mix, and 14 basis points related to changes in Fed funds purchased, repurchase agreements, and short-term borrowing levels. Offsets included a positive 21 basis points from loan mix and repricing and 10 basis points from the benefit of free funds and changes in liquidity balances. The cost of total deposits for the quarter was 2.17%. Excluding broker deposits that we added to enhance our liquidity levels, that cost was 1.95% compared to 1.62% in the first quarter for a link quarter beta of 70%. As Mariner mentioned, betas on loan yields kept pace with this quarterly beta. We continue to benefit from the shorter tenor of our asset base, including the fact that 69% of our loan portfolio reprices within 12 months. Cycle to date, we've seen betas on loans and total earning assets of 56% and 50%, respectively. Similarly, the beta on total funding costs, which consider the benefit of DDAs and the impact of borrowing levels has been 50%, while the cost of total deposits has experienced a 43% beta cycle to date. Our outlook for net interest income going forward will be impacted by a variety of factors, including the shape of the yield curve, anticipated Fed hikes, along with the timing of those hikes, the length of the Fed pause, timing of rotation out of wholesale funding sources and the replacement costs, and potential for any additional disintermediation of DDAs to rate-bearing categories and continued competition from deposit alternatives. Our DDAs average 33% of total deposits, down from 38% in the first quarter, driven both by increase in interest-bearing deposits and decline in DDA balances. The current percentage of DDA to total deposit mimics the low point during the 2015 to 2017 tightening cycle. While we do not anticipate any material changes to these levels, the migration can be episodic and vary from quarter to quarter due to the nature of some of our business lines. A July rate hike seems to be priced in. Looking ahead to the second half of the year, we would expect a terminal beta of 50% for total deposits and 60% for loans through the end of the cycle. We would expect some additional modest margin compression in the third quarter driven by the timing of the July rate hike. Our reported non-interest income of $138.1 million contains some market-related variances, including a $1.3 million decrease in customer-related derivative income and a $902,000 decrease in company-owned life insurance income. The $6.2 million link quarter increase in net investment security gains relates to the impairment of a sub-debt security last quarter, along with the increased valuation of equity investments this quarter. Additionally, we recognize the gain of $4 million on the sale of some non-core assets in the second quarter. The detailed drivers of our $241 million in non-interest expense are shown in our slides and press release. A few items of note. We recorded $7.4 million in additional salary and bonus expense, largely driven by a $4.9 million severance expense in the quarter and higher salaries related to annual merit increases that were effective in the second quarter. These increases in salary and benefits line were partially offset by seasonal decreases in payroll taxes and insurance and lower 401 accruals. Excluding $3.2 million of deferred compensation and the $4.9 million of severance costs, as well as other typical timing variances, we would put our quarterly starting point expense run rate closer to 230 million. Our effective tax rate was 18.1% for the second quarter, compared to 20.8% in the second quarter of 2022. The decrease rate was driven primarily by a larger portion of income on tax exempt securities. For the full year 2023, we anticipate that the tax rate will be approximately 17 to 19%. Now turning to more detail on the balance sheet, I'll start with our investment securities portfolio shown on slides 28 and 29. Our average investment securities balances remain relatively flat from the first quarter at $11.4 billion, excluding the $1.2 billion of industrial revenue bonds in the health and maturity category. During the quarter, $243 million of securities with an average yield of 2.07% rolled off. The yield on our total AFS portfolio increased to 2.70%, and the HTM portfolio, excluding the IRBs that I mentioned, had an average yield of 2.33% for the second quarter. The portfolio is split roughly 60-40 between available for sale and held to maturity, and the AFS book has a duration of just under four years. Additionally, the portfolio is expected to generate more than $1.6 billion of cash flows in the next 12 months, providing further funding flexibility and opportunity to deploy in assets that have more attractive yields. The roll-off of these securities, which have a blended rate of 2.16%, will also improve our AOCI position over that period. As of June 30th, the unrealized pre-tax loss on the AFS portfolio was $766 million, or 10.3% of the amortized cost. For the HTM portfolio, this loss was $576 million, including the IRBs. Slide 33 highlights our liquidity position. along with the contingent sources of funding available to meet customer and operational needs. As of June 30th, we had $16 billion in available liquidity sources. Liquidity coverage of adjusted uninsured deposits increased to 117% at quarter end. Additionally, if needed, we have some further capacity to add broker deposits, which could boost the coverage ratio to 129% of adjusted uninsured deposits. Also on that slide, we've included our regulatory capital ratios for June 30th. Our CET1 ratio improved to 10.65% and compares favorably to the peer median. Tangible book value per share was $52.54, an increase of 3.8% compared to the same period a year ago. Since 2018, we've experienced a 5.6% annualized growth rate in tangible book value per share. Our tangible common equity ratio was 6.22% on June 30th, improving to 7.90% when excluding the impact of AOCI. We believe our strong capital and liquidity levels provide the flexibility to support our customers, grow our business, and deliver returns for our shareholders, while giving us the ability to address uncertainty in the industry as well as any upcoming regulatory changes. That concludes our prepared remarks, and I'll now turn it over back to the operator to begin the Q&A portion of the call.

Thank you. If you'd like to ask a question today, please press star followed by one on your telephone keypad to enter the queue. When preparing to ask your question, please ensure your headset is fully plugged in and unmuted locally. That's star followed by one to ask a question today. And our first question comes from Chris McGrathie from KBW. Chris, your line is open. Please go ahead.

Oh, great morning. Ron, maybe just starting with the top line, you talked about a little bit more pressure on the margin. How should we think about just the level of NII? Feels like we're, you know, the trough was near given Mariner's growth comments, but interested in comments of where you see the cadence of NII going over the back half of the year. Thanks.

I'll take that, Chris Mariner, and if Rahm has something to add, he can. We've said in the previous comments, mid-single digits growth, and I think that's probably still reasonable. A lot of things, a lot of variables, both headwinds and tailwinds to shake out for the rest of the year, but for what we can see right now, that holds true. with uh you know maybe some um you know the headwinds remain right they're persistent see how they play out but it's it's a it's a a fair starting place the just so i'm clear the uh the net that's mid single digits is full year net interest income growth compared to 2022 right

Correct. That's year over year. Last year's base is about $913 million. Again, a lot of moving parts, some of which I highlighted, when the Fed is done, how long they keep it, what might happen with DDAs, some big deals that come our way from our pipeline, things like that.

As you know, because of the institutional and corporate, it's pretty lumpy. We can have a big corporate trust deal come in just as easily as we can have tax payments go out. It's hard to tell exactly what happens from one quarter to the next.

Okay, but that would seemingly imply that the step down from Q1 to Q2 would reverse and you'd have growth off of these levels by math, right? That's kind of what you're messaging?

Again, a lot of moving parts, but to Mariner's earlier point about that mid-single, a lot of these things need to come together for that to happen, but I'm not ready to call a bottom out on NII, but at the same time, I'm not saying it's going to be, you know, much lower than where we are. The loan growth is going to be certainly a driver of an interest income. What happens?

Yeah.

And with the step down from 1Q to 2Q, as we highlight, was a lot of, you know, the excess liquidity that we carried, the brokered CDs that we issued in response to some of the things going on in March.

And those are, you know, those are coming down, right, as we go into the back half of the year.

Okay. Maybe just one more on your capital. Your balance sheet's in great shape from a capital perspective. I saw the million share in the release last night for the buyback. Any updated thoughts on the capital return given the market seems to settle a bit?

Well, you know, the share repurchase approval is to give us that flexibility. We obviously don't have any plans to do that, but we want to have that flexibility as we watch the stock price in the market and our company perform in the back half of the year.

I'm not sure how to... Yeah, what we did yesterday was the annual cadence that we have for the board to approve some share repurchase authorization. Typically, we've done it in April for 2 million shares and this time around out of prudence and just given the circumstances and environment we all find ourselves in, we just ask the board to approve a million share authorization. At this point, I would say probably not a lot of appetite to do that because we still see loan growth opportunity. Like we've said, our capital stack is largely going to be used up for loan growth.

Yeah, that's why the main answer is loan growth. You know, that's where the capital's going. Thanks a lot for the call.

Thanks, Chris.

As a reminder, that's star followed by one on your telephone keypad to ask a question. And the next question comes from Nathan Race from Piper Sandler. Nathan, please go ahead. Your line is open.

Great. Thank you. Hope everyone's doing well. Question just in terms of what you guys are seeing from a deposit pricing perspective outside of the portion of the funding base that's indexed to short-term rates. We've heard from some banks that deposit pricing pressures have slowed to some degree more recently. Curious if you guys are seeing that and to what extent you guys would maybe be more competitive on some rates into the second quarter.

Well, you know, it's hard really to predict a lot of that. I think from my vantage point, I think we are coming to the back end. A lot of it has to do with what the Fed's yet to do, still to do. I think from our, we believe that we went through most of this cycle early, right, having more of a commercial and institutional deposit base. So if what the Fed's doing is leveling off, which it seems to be with, you know, with an announcement of another 25 today, maybe another 50, another 25, so 50 total, right, that the level of increases to the deposit rates for us should be leveling out. We've taken most of that pain, I believe. So that doesn't mean they're not going to go up slightly, but I just think that the rate of increase is definitely coming off.

Okay, great. And then maybe just one longer term question on the market. Sorry.

I was just going to add that when it does level off, and the deposit increase rates level off, we should still see the increases on the loan side.

Yeah, that kind of answers my second question, Mariner, in terms of, you know, in a theoretical higher for longer interest rate environment, I imagine, you know, we should see, you know, some pretty substantial margin expansion just given that lagging repricing impact on loans and with those short-term deposits, I'm sorry, those short-term short-term index deposit repricing slowing. Is that a fair way to kind of think about cadence of the margin and then type of rate environment?

Directionally, yes. Yes, for sure.

Okay. And I understand and I appreciate that you guys don't pay much attention to end-of-period balances versus average, but end-of-period deposit growth was fairly pronounced in the quarter. And just curious, you know, how you guys are thinking about the pipeline for deposit growth. And it sounds like, you know, the loan growth pipeline remains pretty solid, but should we kind of expect deposit growth to lag loan growth going forward? And, you know, I think some of the margin or NII lift that you guys are speaking to for this year should be a function of just some of the remix and maybe less deposit growth relative to loan growth going forward, or at least over the next couple of quarters, if that makes sense.

Yeah, I mean, I think the way to think about it is in this environment with an inverted yield curve and the attractiveness of money market funds, off-balance sheet funds in this environment, it is more challenging, right, to grow your deposits at the rate that we were before the inverted yield curve. So, you know, we always have the broker CDs and we can always do campaign money. to keep up with loan growth in this short period before the rate cycle normalizes. And when that happens, we should be able to pick up the deposit rate of growth again. But I think for the standpoint of UMB, it's important to note that we come into this cycle with a very low loan to deposit ratio. So we have a lot of room to run with loan growth without feeling like we are stressing our balance sheet. So, you know, we're sitting at, what, 70-ish in loan and deposit rates? Yeah, 70%. So we have, you know, we have room to run there during this rate cycle that we're in to protect us there, to wait for the environment to change and normalize deposit growth. I wish you'd add anything to that comment.

The prepared comments that we said about, you know, on the institutional side particularly, we have an active deposit pipeline that we're pursuing. So to your question, yes, it's a difficult deposit environment, but unlike, you know, most peers, we have a lot of different sources of funding that's available to us that Mariner walked us through. So I would go back to what we said in our prepared comment.

Yeah, I think I was reacting to his specific question about keeping up with the same rate. Our deposit growth will not keep up with the same rate. We will not grow at the same rate of our loans, and we're protected by our loan-to-deposit ratio with that. We definitely expect our deposits to grow, and I think that to Ram's point about the nuance of all our institutional businesses, from one month or quarter to the next, we can have an $800 million, $900 million growth. T. Corporate trust piece of business come in and sit on our balance sheet for six or nine months, you know, just as easily as we can have attack a tax payment go out on the other end. So it's, that's why we focus on the average is instead of the point point in time.

T. Gotcha. Okay. One last one for me, just in terms of what you're seeing from a lending competition perspective, you know, imagine know some of the consistency in your pipelines of function maybe competitors pulling back that are maybe more liquidity constrained as you guys but we're just curious to kind of hear where you guys are seeing particular growth and what's going on competitively that's also kind of supporting the strong pipeline coming out of the second quarter yeah this is jim ryan we're seeing plenty of opportunity still and rates remain competitive as they ever happen we have seen

competitors pulling back. I think it's a common theme right now as it relates to banks are looking for full relationship more than transactional lending. And if it doesn't come, if the opportunity doesn't come with additional funding, folks are taking a much stronger look at whether or not they want to take on a particular large opportunity like CRE, for instance, or even participation. So especially in the syndication, Banks without additional fee income or additional deposits are definitely pulling away from those. Regarding pricing, banks are still looking for loans and the good credits are still able to command a decent rate.

Marginally, we're seeing more rate on everything though, obviously, which is why our betas are doing so well. We expect, as we've been doing in the past, we tell you what the next quarter looks like pipeline-wise, and this coming quarter's pipeline looks just as good as last quarter.

Okay, great. I appreciate all the color. Thank you. Thanks, Nate.

We have no further questions at this time, so I'll hand the call back to the management team for any concluding remarks.

Thank you everyone for joining us today. And as usual, if you have any further questions, you can reach us at 860-7106. Thanks and have a great day.

This concludes today's call. Thank you very much for your attendance. You may now disconnect.