UMB Financial Corp
NASDAQ:UMBF
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UMB Financial Corp
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Good morning, and thank you for attending today's UMB Financial Second Quarter 2022 Conference Call. My name is Daniel and I will be your moderator for today's call. [Operator Instructions].
I would now like to pass the conference over to our host, Kay Gregory, UMB Investor Relations. You may now proceed.
Good morning and welcome to our second quarter call. Mariner Kemper, President and CEO; and Ram Shankar, CFO will share a few comments about our results. Jim Rine, 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 43 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 thanks everyone for joining us today. Our second quarter results included a 23% linked quarter annualized increase in average loans, solid net interest margin expansion, and continued momentum in our fee businesses. Income from bond trading activities and 12b-1 fees were strong while we saw some market-related pressure in trust and securities processing and in the valuation of our equity positions. Additional drivers are included in our slides and Ram will share more detail shortly.
Net income for the quarter was $137.6 million or $2.83 per share. Operating pre-tax pre-provision income was $187.1 million or $3.84 per share. Financials for the second quarter included a pre-tax gain of $66.2 million from the sale of our Visa Class B ownership, included in fee income. In conjunction with the gain, we made a onetime contribution of $5 million to our charitable foundation, included in other expenses.
Pipeline and sales activity continue to be strong across the company. In private wealth, we brought in nearly $750 million in new assets year-to-date, on track to significantly outpace 2021 full-year sales of $836 million. Our institutional banking teams are continuing to perform well. Year-to-date new business volume has increased 15% in corporate trust and escrow services and 68% in specialty trust and public finance has closed 68 deals so far in 2022 compared to 52 for the same period last year.
The team recently closed its largest bond issue to-date, a $146 million general obligation bond. As you may have seen in June, we announced the agreement to acquire Old National Bancorp's HSA business. As healthcare services continues to focus on direct to employer space, this acquisition provides an extremely strong team along with more than $400 million in deposits that will complement our organic growth efforts.
Moving to lending, you'll see the drivers behind the growth this quarter on Slide 24. Top line loan production, as shown on Slide 25, again, was very strong, coming in at $1.3 billion for the quarter. Payoffs and paydowns moderated some and were 3.1% of loans. Given the opportunities we see across the footprint, we expect continued strong growth in the third quarter. We saw phenomenal growth in C&I, with balances increasing nearly 30% on a linked-quarter annualized basis, while line utilization ticked up slightly in the second quarter. Much of the growth is due to consistent sales efforts paying off in new customers as well as our relationships with strong companies needing capital to continue to grow.
Average residential mortgage balances have increased 27% over the second quarter of last year. As we've discussed previously, we don't rely heavily on mortgage gain on sale revenue. However, we continue to grow our own portfolio and have seen strong activity through our down payment assistance program of late. The program launched in December of 2021 and is geared towards underserved markets and it had more than 500 new applications year-to-date.
On the other side of the balance sheet, average total deposits for the quarter decreased 3% or 12.2% on an annualized basis compared to the first quarter, while average DDA balances increased slightly and comprised 45% of average deposits. While we've seen cycle-to-date beta on interest-bearing deposits of approximately 34%, I think this metric alone gives an incomplete view, as it ignores the benefit of DDA balances which has zero beta and the impact of borrowing levels, which have 100% beta. I'd encourage you to look at our total cost of funds instead, which had a beta of 22% thus far.
Additionally, we benefit on the earning asset side with cycle-to-date betas of nearly 54% and a linked quarter beta of 61%. This compares favorably to others we've seen reported so far. Our net interest margin expanded 25 basis points from prior quarter, driven by asset repricing and favorable mix shift in earning assets. I'll note that the deposit pricing we're seeing is so far outperforming our internal expectations. We'll continue to manage these costs as we can while opportunistically funding organic loan growth.
As you know, we have a larger commercial institutional customer base relative to many peers. As such, we have some index deposits that tend to move more quickly with the interest rate changes, but we look to the entire relationship and overall profitability of these relationships. For example, many public fund customers bring treasury management, lockbox, card programs and bond issuances opportunities. And in addition to lending relationships, our commercial clients may also have corporate cards for healthcare service products. Similarly, many of our institutional clients have asset servicing or suite product relationships in addition to the lending relationships.
Moving to asset quality, our net charge-offs were elevated in the quarter, driven entirely by a $27.7 million write-down related to one single commercial credit. While this quarter's charge-offs were elevated, we expect that our full year loss rate will be consistent with our long-term historical averages of approximately 30 basis points or less. Non-performing loans declined 84% from the prior quarter to 10 basis points of total loans as the overall portfolio continues to perform well. Our reserve coverage ratio is now 0.87% of total loans, in line with post CECL day one implementation levels.
I'll close by thanking our associates across the country for their hard work and dedication to our customers and communities. I'm excited to execute on the opportunities we see in the second half of the year and beyond.
Now, I will turn it over to Ram for some additional comments. Ram?
Thank you, Mariner. Our strong loan growth coupled with the benefits of higher short-term and long-term interest rates drove a 6.9% linked quarter increase in net interest income. We amortized $1.6 million of PPP origination fees into income and the overall PPP contribution to second quarter net interest income was $1.7 million compared to $2 million last quarter and $12.4 million in the second quarter of 2021. At quarter end, our PPP balances stood at $26.4 million, down from $77.2 million at March 31, approximately $400,000 in unamortized fees remain.
As shown on Slide 21, our Fed account, reverse repo, and cash balances declined to $3.7 billion and now comprised 10.5% of average earning assets, with a blended yield of 83 basis points compared to 30 basis points in the first quarter. The 3% decrease in average deposits from the first quarter was driven by outflows of commercial deposits, including the typical seasonal trends in public funds along the capital markets and corporate trust deposits. The total cost of deposits, including DDAs was 20 basis points, up from 8 basis points last quarter and the cycle-to-date beta is approximately 18%.
Net interest spread and net interest margin expanded from the first quarter by 13 basis points and 25 basis points, respectively. Net interest margin benefited 21 basis points from reduced liquidity balances at rate, 16 basis points from loan repricing, and 11 basis points from the benefit of free funds, offset by a negative 26 basis points related to the cost of interest bearing liabilities.
The estimated impact in net interest income at various rates scenarios is shown on Slide 30. In a rate ramp scenario of plus 200 basis points on a static balance sheet, net interest income is predicted to rise 3.1% in year 1 and 12.8% in year 2. This is predicated on repricing of our variable rate loans based on underlying changes to LIBOR, SOFR and other indices as well as deposit betas and mix shifts consistent with the prior cycle.
While it's early days, our second quarter beta experience was in line to slightly better than our model assumptions. And as Mariner noted, while the focus on deposit beta is important, we focus primarily on net interest spread management, given that our future funding needs will depend on our continued efforts to fund our organic loan growth engine. As we've done in prior cycles, using cash flows from our high quality securities portfolio is another lever available to us to fund the loan growth opportunities.
Our average loan to deposit ratio remains attractive at 58%, below our past highs in the low 70s. Loan yields increased 23 basis points from the first quarter to 3.72%. 58% or about $10.6 billion of average loans are variable rates, with 57% repricing in the next quarter and 64% repricing within the next 12 months. As I noted, these are largely tied to indices at the short end of the curve. Additionally, the securities portfolio is expected to generate $1.2 billion of cash flow in the next 12 months. The yield on those securities rolling off is approximately 1.84%, while purchases this past quarter were made at an average of 2.96%. Those details are shown on Slide 28.
We continue to reclassify securities to the held-to-maturity portfolio during the second quarter to help manage tangible capital and reduce the impact of rising rates on our equity. Average HTM balances for the second quarter, excluding the $1.1 billion of revenue bonds that we've long held in that book, were $4.1 billion. The composition of our HTM portfolio is shown on Slide 28. Our regulatory capital ratios remain strong with a total risk based capital at 13%, CET1 at 11.44%, and leverage at 8.17%, respectively.
Back to the income statement, total fee income for the quarter, as shown on Slide 22, was $176.3 million, including the gain on the sale of our Visa Class B shares. Fee income compared to the first quarter was impacted by the $66.2 million gain on that sale as well as other market-related valuations, including a reduction of $10.5 million in company-owned life insurance income and a $4.9 million negative change in the security gain or loss line related to other equity positions and a $4.2 million reduction in derivative income from back to back swaps.
Additionally, the first quarter of 2022 included a $2.4 million gain on the sale of our factoring business, as well as $3 million of healthcare services convergent fees. Excluding those variances, second quarter fee income compared favorably to the first quarter levels. One of the biggest drivers of the fee income momentum in the second quarter was the $9 million quarter-over-quarter increase in brokerage fees where 12b-1 and money market revenue share fees are included in our income statement. The decline in equity valuations had a modest impact on fees tied to AUA and AUM levels in the trust and securities processing line.
Non-interest expense trends are shown on Slide 23. The linked-quarter decrease was driven primarily by a $10.7 million reduction in deferred compensation expense related to the reduced COLI income I had mentioned, along with lower payroll taxes, insurance and 401(k) costs. Offsetting these reductions were the charitable contribution we made during the quarter, $4.4 million in additional legal expenses related to general corporate activities, and $4.5 million of increased incentive costs for company performance. Our effective tax rate was 20.8% for the second quarter and reflected a smaller proportion of income from tax exempt municipal securities. For the full year 2022, we anticipate that the tax rate will be between 19% and 21%.
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.
[Operator Instructions] First question comes from Jared Shaw of Wells Fargo.
This is Timur Braziler filling in for Jared. Maybe starting off on the deposit side, just as you're thinking about funding this continued strong loan growth, clearly you have plenty of on balance sheet liquidity with a 60% loan to deposit ratio, you have $400 million of deposits coming on later this year from the ONB deal. I guess, how are you thinking about kind of funding the loan growth over the next couple of quarters? How aggressive will you be in chasing new kind of deposit relationships in the interim here?
This is Mariner. I'll take that and if Ram or Jim, anybody else has anything to add, they can jump in. But I think it's important to sort of pay attention to what our balance sheet looks like and has looked like for a long time. The first quarter, we always have our seasonal deposits run-off. And if you take the run-off piece on through the first half of the year here, really it comes down to about a $0.5 billion, $500 million that would be indicative of what's happened to the whole industry as opposed to the whole you're seeing because the rest of it would have been kind of that typical seasonality of our deposits.
So I would focus on it being about $0.5 billion that went off. And I think a couple of things I note about that. One, you see utilization rates go up. Borrowers are through their cash and are starting to borrow. Energy costs and inventory costs, costs were up in general. So I think it's an indicative of customers really using their cash as opposed to money leaving our balance sheet is what -- how I really describe more what has taken place with our deposits.
In addition to that, we've talked many times in the past about the $14-plus billion we manage for customers off balance sheet. And we can bring any of that on at any time and pay competitive rates as we've demonstrated that we can manage spread and margin expansion, while also paying market competitive rates. So the complexity of our customer base, institutional, commercial, large corporate really allows us a lot of flexibility to bring deposits on hand off our balance sheet and flex our balance sheet when we need to. So really not worried about it at all and we've seen this before.
And I'm just wondering, in terms of the higher interest bearing deposit cost, how much of that was due to the mix shift with maybe some of the lower-cost deposits exiting to other vehicles versus either customers calling in and asking for higher rates or just posting higher rates across the board?
I would say, we talked about this from a 29% of hard index of our total. And so that obviously moves immediately with rate changes. The rest of it, we're able to manage. Obviously 45% of our deposits are non-interest bearing. So I think I kind of maybe switch the story on you a little bit, focus on more on what we focus on. If you think about the whole balance sheet instead of just deposits, we are only up 12 basis points on total on the liability side and we're up 39 basis points on the asset side.
We were able to demonstrate, as we always are, spread expansion of 13 basis points and margin expansion of 25. So -- and then you think about net income ultimately being the ultimate driver. So you think about spread and margin being up along with NII being up 7%. That's what we focus on. So, we're focused on being able to manage the expansion of margin spread and ultimately manage the increase of net interest income, which ultimately results in a bigger bottom line.
Okay. And then switching gears to asset quality, any additional color you can provide on that $27.7 million charge-off, maybe what industry it was in, what's the remaining balance on that credit and how much you had previously reserved against it?
I'd say, there's limited comments here because the credit happens to be in bankruptcy. We talked about this credit in the first quarter, identified it and mentioned on our call in the first quarter that we thought we might be able to resolve it positively. As the bankruptcy procedures progressed into the second quarter, we realized there's still complexities and changes that that wasn't going to be the case anymore and we ultimately made a decision to take the charge. There is nothing. What I would say, nothing that you could comment about it that would relate to any industry issues, vertical issues, underwriting issues per se. And so it doesn't really -- there's no trending 2.2 here. And as we've said before, it's a one-off. We have a long history of sort of demonstrating that we have a one-off situation now.
And then if you look at Page 27, you will see the history in our deck. You look at 27, sort of tells the story. Sitting here with Tom Terry, our Chief Credit Officer, Jim Rine, our CEO and myself, 3 of us have been running credit, non-credit committee for more than 2 decades together and this is nothing new and nothing different. We expect to return in the back half of the year to our historic levels of 27 to 30 basis points of charge-offs on an annualized basis, which is in line with our 15-year history. So that's pretty much what I would say. And I will also add prospectively in the data, you'll see that our NPLs has gone back down to 10 basis points which I think is, from all the reports I've seen, the lowest prospective number of our peer group for NPLs.
That's perfect corollary to my last question. I guess, that linked quarter decline in non-performing assets, I mean, what drove that? Was that return to payment, was that just kind of relooking at the underlying credits and moving them back to performing status? I mean, that was a pretty exceptional move there. What drove that?
Largely again because of how we operate. It had peaked, it has jumped because of this credit and now it's declined back down to its normal levels, largely.
The next question comes from Nathan Race of Piper Sandler.
Ram, perhaps a question. If we kind of add back the COLI impact within salaries in terms of the overall operating expense run rate going forward, any thoughts just kind of directionally in terms of kind of how the total run rate trends in the back half of 2022?
I would say, I would use the $214 million that we reported this quarter and as we noted, $10 million of deferred comp expense was a credit to expense this quarter. So if you add $10 million, it's $224 million and then take $5 million away from the charitable account foundation, so we will get to $219 million. I would say, off the $4.5 million of legal expense increase, some of it was tied to some extraneous factors that we don't expect to recur. So we're talking about a run rate of $217 million to $218 million, plus or minus for operating expenses.
Okay, perfect. And then just going back to the charge-offs in the quarter, was the loan that was charged-off here in 2Q, was that the same one that you guys flagged last quarter in terms of expecting some favorable occurrence on?
Yes. And I just mentioned a moment -- yes, it is and I was just mentioning a moment ago, as the bankruptcy procedures progressed from first quarter to second quarter, the situation has changed and evolved.
Okay. Understood. And then just in terms of -- it sounds like pipelines are in good shape and you guys are still expecting above average loan growth going forward. And with the reserve now down to the CECL day 1 level, how you guys kind of thinking about the need to provide for growth and just the overall macro uncertainty that exists today assuming charge-offs go back to that 27 to 30 basis point range that you talked to earlier?
Yes. So, yes, first answer, we do expect loan growth to continue at favorable levels as they have been. And as it relates to how we reserve against it, as you know, and we talked about this since CECL. The algorithm is a lot more complex than it used to be. We had to rely on Moody's for -- as we look forward into this unemployment data, if that evolves and we go into recession, there's lot of unknowns about how all of us will have to factor in the economic data factors and how we build that into our algorithm. So there are some unknowns there about how that -- I would suggest, from my vantage point, we're staring at, at least marginally unfavorable economic data which would -- which from an algorithm standpoint that will drive us to preserve a little. Loan growth should drive us to reserve.
And the thing that works against it related to the algorithms is if our data continues to get better and bad data rolls off and exchange for good data on our portfolio, that pushes against us reserving. So it's the connection and the relationship between the 2 of those. But I would suggest that we would probably, marginally see us reserving a little bit against the economic conditions and the loan growth that we see and as would be the prudent and right thing to do anyway. And how that plays off against 87 basis points? I mean, our preference would be not to see it go down as a ratio, but we've got an algorithm that we have to live with. And so I hope that's helpful.
I don't know, Ram, if you'll add anything.
Super helpful. And if I could just ask one more, just going back to the balance sheet discussion from the earlier question. I just want to make sure I understand kind of the expectations for deposit levels and the earning asset base going forward. It sounds like you're expecting some additional outflows maybe in 3Q and then you have the HSA deposits coming on in 4Q. So just overall, Ram, perhaps how should we kind of be thinking about the earning asset base going forward with those deposit dynamics at play?
I don't think we expect to see further outflows in the third quarter necessarily. So, I would say, stable to maybe grow a little bit based on our ability to bring on. As I talked about earlier, we can bring on as much of the $14 billion we have off balance sheet by paying competitive rates. So I don't see us going backwards, more of a stabilizing approach for the rest of the year and then having the HSA deposits coming on. And then again, remember we can rotate investments into loans which is right. So we have a $13 billion investment portfolio and 58% loan to deposit ratio. So we've got that also working for us.
There'll be some real-time thinking on the portfolio side, Nate, in terms of just whether we reinvest our cash flows from our securities portfolio every month. We talk about it at our asset liability committee, sometimes which is to reinvest, sometimes depending on what the deposit outlook looks and loan growth outlook looks, we might decide not to reinvest.
[Operator Instructions] The next question comes from Chris McGratty of KBW.
This is Nick Moutafakis on for Chris McGratty, KBW. I wanted to start -- could you guys just remind me what the monthly cash flow runoff is for your bond book?
Yes. On Page 28, you will see the portfolio statistics, Nick, and for the next 12 months, we expect about $1.2 billion to come from our portfolio.
Okay, that's great. And then just on the cash level, obviously you guys kind of reduced cash, you're down to about 10% of average earning assets. Could we look at this as kind of the floor for the cash levels or could we potentially run that down even further to fund future loan growth?
If you look at the bottom of Slide Page 21, we show the pre-pandemic levels, right. So if you look at the interest-bearing deposits, it's slightly higher than where we were pre-pandemic. So we could expect some additional contraction in those balances. But obviously, as you see on a quarter-over-quarter basis in response to what happened on the deposit side of the equation, we did see some normalization of these balances.
Okay, that's helpful. And then maybe just on the loan growth side, as you look into the back half of 2022, is there any portfolios where we could see some upside surprise and also potential slowdowns as far as different categories?
Well, I think, I mean, from a growth standpoint, we give you a picture into the upcoming quarter as we always do, so third quarter looks strong as it has. I would say, it seems to be coming across the board from all categories and all regions. We don't really get too far beyond one quarter look as far as guidance goes, but just the indicators for growth seem to be good as you look into the whole back half of the year.
And as far as upside or downside, we're all kind of dealing with the same fact there as it relates to, we've got the Fed decision today, what happens with the labor markets, what happens with back half of this year. I think, as I said, I think last quarter, companies are doing pretty well, they are sort of sold out from last year on into through this year. So I think the impact of a recession is really a '23 impact. So loan growth feels pretty good for the remainder of this year.
This is Jim Rine. The only -- one of the things that could be a downside surprise for banks would be the increase in rates and at what point people decide not to take on the next project or that will backlog be canceled that is already booked. But that isn't happening yet and we're staying in close contact with our clients and they're already baking those increases into their projections. It payoffs slow. That could also be another factor.
Yes, it's a benefit, right? We've seen it from first quarter to second quarter, we are already seeing that moderate because of higher rate. So we went from mid-4s to 3.1 on payoffs, paydowns. You also have utilization rates up marginally. And I think both of those things will buoy based on the current book, also about 60% of our new business in the second quarter was from new customers. So that also we should see sort of buoy things for the back half of the year.
We've talked to construction companies about their backlogs, Jim talks about that, they'll all say they are still very strong. And the only thing they see, the developers, there is a bit of softening in the forward-looking pipeline for developers, but that's being made up for larger projects, public, private and kind of large data farms and distribution facilities and multifamily and areas where there is still a lot of need, kind of making up for logistics and things like that are making up for some of that more expensive borrowing and land costs.
Let's not forget also that rates are still at historically low levels, right? Talking heads talk about all the crazy stuff going on with rates, we are still at historically low levels. So that I think bears saying.
The next question comes from John Rodis of Janney.
Ram, on the margin, obviously nice expansion. Can you talk about maybe just give a little more detail? Do you have what the margin was maybe in June and how we should think about the margin going forward?
I don't think we get specific into, just because of deposit inflows and outflows, it's hard to just use any month data. But I would say, obviously with the 25 basis points that we got in the second quarter, those are probably a little faster than probably for the industry and for us as well, but we continue to expect modest margin expansion going forward based on where we see loan pricing. We're going to be fairly disciplined on the deposit side and managing that. As you heard Mariner talk about, we're going to manage to net interest spread and make sure that, that translates to margins being maintained or expanding from here. But a more moderate pace than the second quarter.
Okay, makes sense. And, Ram, just one more question on the brokerage fees. I mean, I get the higher rates in the 12b-1 fees, but I guess I was a bit surprised to see the jump from the first to the second quarter. And if we -- I think in prior quarters, you've talked about looking back to 2019, I think when where brokerage fees were in -- for the whole year, they were $31 million. Can you just talk about what was the net number this quarter and then moving forward, what do you see in the brokerage line item to the extent you can?
Yes. I think, it was a pleasant surprise for all of us. Obviously, with the Fed raising rates by 75 basis points and the back end of these investments being really short term in nature and where the treasury curve is, it was a nice surprise for us. So what we said relative to the $31 million back in 2019 was that book of off-balance sheet deposits where we get revenue share and 12b-1 fees has doubled. So clearly, we see some opportunities as interest rates stay elevated, to be able to mimic the $12 million, $12.5 million run rate you saw in the second quarter.
And then ultimately have it quicker. Ram, alluded to it, because the short end came up and so we've just -- the yield curve has made a big difference in how quickly that happen and how quickly money markets were able to invest and make money on the shorter end of the yield curve, which allowed it to share with us sooner.
So, Ram, Mariner, just to clarify, though, again, so it should stay at this level if we get no further rate increases or even with further rate increases, just given where the forward curve is, I guess?
Yes. I guess, it could marginally increase depending on what happens with our off balance sheet deposits, right? You heard Mariner answer about deposit question, about we can actually tap some of these off balance sheet deposits, so balances go down. On the other hand, if our aviation and corporate trust businesses pick up faster than we expect, we could see more deposits being added in the off balance sheet category and we can see more volume-driven increases to this line item. But I think just like my question about margin, I think the -- any ongoing increases will be modest compared to second quarter level.
Yes, there is the size of the off balance sheet book and then there's a rate pay rate. So on the rate pay side, that's going to moderate. So I think there is really -- it kind of depends on what happens with short end of the yield curve. It's likely to moderate, but I think there is some increase still in there with rates still rising and then it ties to the size of the book. I expect, we expect it to continue to grow. A lot of that has to do with what's happening with municipal underwriting on a national basis. It has to do with what happens with aviation, planes being bought, sold, moved, things like that. And so I -- again also still expect that to grow a bit.
Okay. Makes sense.
There are currently no further questions registered at this time. I will pass the conference back over to the management team for closing remarks.
Thank you and thanks for joining us today and for your interest in UMB. As always, if you have follow-up questions, you can reach us at 816-860-7106. Thank you.
That concludes the conference call. Thank you for your participation.