UMB Financial Corporation (NASDAQ:UMBF) Q3 2023 Earnings Call Transcript

UMB Financial Corporation (NASDAQ:UMBF) Q3 2023 Earnings Call Transcript October 25, 2023

Operator: Hello, and welcome to today's UMB Financial Third Quarter 2023 Financial Results Conference Call. My name is Elliot, and I'll be coordinating your call today. [Operator Instructions] I would now like to hand over to Kay Gregory, Investor Relations. The floor is yours. Please go ahead.

Kay Gregory: Good morning, and welcome to our third quarter 2023 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. 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 46 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 will turn the call over to Mariner Kemper.

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Mariner Kemper: Thank you, Kay. Good morning. I'm happy to be here with you today to share the details of our strong third quarter performance. Our results reflect a strong disciplined loan growth, stable deposits, continued momentum in many of our fee-generating businesses, expense control, stable margin and solid asset quality. I continue to be extremely proud of the long track record and prudent underwriting that has produced these asset quality metrics, our loan portfolio remains healthy with 8 basis points net charge-offs for the third quarter and just 6 basis points year-to-date. Nonperforming loans, improved 7 basis points from 9 basis points prior quarter. Provision for credit losses was $5 million for the quarter compared to $13 million in the second quarter, driven largely by changes in macroeconomic variables and general improvement in the watch and classified categories.

The average charge-off ratio for the five quarter period, shown in our deck is the lowest in our history, impressive considering the 18% increase in average loan balances during that same time period. We saw improvement in the levels of both pass-watch loans and classified loans, which declined 13% and 6% respectively. From the second quarter. Our watch list levels fluctuate from time to time as we manage the book and historically we've seen very little migration to loss. Our current and historical credit performance has been achieved through our focus on risk management and consistent approach that comes from having the same team working together for multiple cycles and decades. We continue to closely monitor macroeconomic trends and have regular conversations with our clients across our footprints, something we do in all economic environments.

Despite uncertainty from the brewing geopolitical crisis, as well as the volatility in interest rates. Our commercial clients remain cautiously optimistic. Now I'll cover a few highlights from the quarter and Ram will follow up with a few details within drivers. GAAP net income for the third quarter was $96.6 million or $1.98 per share. Operating net income was $98.4 million or $2.02 per share. Net interest income decreased 1.5% from the second quarter as loan growth improved and asset mix and yields were offset by an increase in deposit costs. While net interest income for the industry continues to be impacted by higher funding costs our net interest margin in the third quarter, essentially flat on a linked quarter basis. The flexibility on the asset side of our balance sheet helps mitigate the continued impact of liability pricing.

We have low loan loss ratio, lower than our peers and industry medians. And largely variable asset base and strategically planned cash flows. In fee income, we saw positive results in several lines of business. Trust and securities processing income increased 8.2% driven by growth in all business contributing to this line. Fund services, corporate trust and private wealth. In fund services assets under administration reached $400 billion in the third quarter. Year-to-date, our team has added nearly 50 new clients, which helps drive the 9.2% increase in revenue as we saw in a linked quarter basis. Our non-interest expense levels fell by 3.8% and included variances in deferred compensation expense related to the reduced COLI income. Additionally, severance expense decline along with salary and wage expense reflecting the ongoing efforts to control operating expenses.

Ram will provide more additional color on these various drivers shortly. Turning to the balance sheet. The drivers behind our 10.1% annualized growth in average loan balances this quarter are shown on Slide 24. For a comparison, the banks that have reported results through October 20th, at a median linked quarter annualized increase of 5.3%. The Federal Reserve H.8 data have predicted an increase in industry wide average loan balances of just 0.4% or 1.6% annualized. Despite some caution surrounding the current environment, our relationship banking model continues to build a pipeline of quality plans and given what we've seen today. We expect some continued outperformance relative to the industry and loan growth metrics. Total top line loan production, as seen on Slide 25 was $649 million with payoffs and paydowns declining slightly representing 3.2% of loans for the quarter.

Credit quality is strong across our book, and the CRE portfolio remains well diversified by property classification, tenant type and geography. As shown on the slide on page 36 and 37. Looking ahead to the fourth quarter, we see opportunities across our various lending verticals and geographic regions. We continue to evaluate the best use for capital and we remain disciplined on pricing. Further emphasizing lending opportunities accompanied by meaningful deposit relationships. On the other side of the balance sheet. Average total deposits were essentially flat versus the second quarter, declines in brokered CD balances and typical seasonal reductions in public funds were offset by growth in commercial deposit balance. We expect public fund balances will begin to rebuild again in the fourth quarter.

As we've noted previously, deposit balances will naturally ebb and flow, as our largely commercial customer base uses funds for typical business purchases, including payroll, dividends and other activity. Finally, we've strengthened our liquidity and capital position even further during the quarter as depicted on Slide 32. Our quarter end CET1 and total capital ratios were at 10.77% and 12.68% improved by 12 basis points and 9 basis points respectively from June 30. Our CET1 ratio compares favorably to the peer median. And in our press release, we announced that the Board had approved a 2.6% increase in our dividend, bringing it to $0.39 per share payable in January. As we shown on Slide 15, of our presentation our quarterly dividend has increased 283% over the past 20 years.

So, we've 23 individual dividend increases during that period. To wrap it up. We're pleased with our results this quarter, the partners have varying opinions, but it seems clear than inflation levels, however you want to measure it, haven't reached the Federal Reserve's expectation. All indications are that the data dependent Fed will pause on further interest rate hikes. The variables now are win rate cuts may begin and how quickly they may happen. But we fully expect a higher for longer scenario at least through 2024 such a scenario would be favorable for our balance sheet as the pressure on deposit costs largely abate while asset repricing continues through that period. Additionally, earning asset yields will improve as we use cash flows from our securities portfolio to fund higher yielding loans.

With the uncertainty in the macro and geopolitical environment, we feel that our business model is prepared for a wide range of outcomes. It has proven itself over time as we've adapted to a changing environment and set of circumstances. Now I'll turn it over to Ram for a more detailed look at our results. Ram?

Ram Shankar: Thanks, Mariner. I'll share a few additional drivers for third quarter results. Then I'll discuss some key balance sheet items. Net interest margin for the third quarter was 2.43%, a decrease of just 1 basis point from the link quarter. The largest drivers included positive impacts of approximately 16 basis points from loan repricing and mix and 11 basis points from the benefit of free funds. These positives were mostly offset by a reduction of 25 basis points from changes in interest bearing deposit pricing. cycle-to-date, our earning asset beta has been 51%, keeping pace with the total cost of funds beta of 51%. Our deposit remix showed some signs of slowing this quarter, and we ended the quarter with 32% of total average deposits in DDA.

This level is in line with the low point during the 2015, 2017 tightening cycle. And although it's difficult to know for certain, we expect, we are approaching the bottom. The decline in DDA balances largely reflects corporate trust activity, which can be episodic. Commercial DDA balances increased approximately 1% over the linked quarter. With the current consensus that the Fed will hold rates for the time being, we continue to expect a terminal beta of approximately 50% for total deposits and 60% for loans through the end of this cycle. Looking ahead, for the fourth quarter. We expect NII to trend flat to slightly up. While we'll see some additional modest margin compression driven by mix shift as rate bearing public funds come on the balance sheet.

Our reported noninterest income of $133.3 million contains some market related variances as to second quarter levels, including a $3.5 million decrease in company owned life insurance income and $896,000 decrease in customer related derivative income as well as the impact of the $4 million gain on the sale of assets we discussed last quarter. These decreases were offset by a $5.1 million increase in trust and securities processing income driven largely by the new client acquisition in our fund services and corporate trust businesses. The detailed drivers of our $231.4 million in non-interest expense are shown in our slides and press release. A few items of note. We recorded, $133.4 million in salary and benefits expense, a decrease of $9.9 million compared to the second quarter.

Included were just $425,000 in deferred compensation expense, a reduction of $2.8 million from the prior quarter. This is the offset to decreased COLI income, $2.4 million in severance expense a reduction of $2.5 million, a $1.6 million decrease in salary and wages and $1.3 million reduction in various other employee benefit costs. These decreases were partially offset by a $1.3 million increase in operational losses. Considering the impact of $2.4 million of severance along with the deferred compensation expense and typical timing variances. We would put our quarterly starting point for expenses, close to $228 million. Looking ahead, we expect we'll make a typical fourth quarter charitable contribution of approximately $2 million. Our effective tax rate was 18.1% year-to-date compared to 18.8% in the same period in 2022.

The decreased rate was driven primarily by a larger portion of income from tax exempt securities and variations of the level of COLI income. For the full year 2023, we continue to expect a tax rate between 17% and 19%. Now turning to more detail the balance sheet. I'll start with our investment portfolio shown on slides 28 and 29, our average investment security balances declined 2.7% from the second quarter to $12.3 billion the held-to-maturity book included $1.2 billion of industrial revenue bonds. During the quarter, $240 million of securities, with an average yield of 1.90% rolled off. The yield on our total AFS portfolio increased to 2.74% and has a duration of just over four years. The held-to-maturity portfolio exclusive of the IRB bonds I mentioned had an average yield of 2.31% for the third quarter.

Additionally, the portfolio is expected to generate more than $1.6 billion of cash flows in the next 12 months, providing further funding flexibility. The rollout of these securities, which have a blended rate of 2.18% will also improve our AOCI position over that period. As of September 30th. The unrealized pre-tax loss of the AFS portfolio was $918 million or 12.7% of the amortized cost. For the HTM portfolio, this loss was $876 million, including the IRB bonds. Slide 32, highlights our liquidity position, along with the contingent sources of funding. As of September 30th we had $18.1 billion in available liquidity sources. Liquidity coverage of adjusted uninsured deposits increased 127% at quarter end. Our tangible common equity ratio was 6.13%.

at September 30th. When excluding the impact of AOCI that ratio improved to 8.06%. Tangible book value was $52.06 per share, an increase of 8% compared to the same period a year ago. Since September 30th, 2018, we have experienced a 5.3% annualized growth rate in tangible book value per share. As we noted last quarter, we maintain our focus as a growth company. While positioning our balance sheet to support that growth and provide the flexibility to address uncertainty in the industry. 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.

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