UMB Financial Corporation (NASDAQ:UMBF) Q3 2020 Earnings Conference Call October

28, 2020 9:30 AM ET

Company Participants

Kay Gregory - Investor Relations

Mariner Kemper - President & Chief Executive Officer

Ram Shankar - Chief Financial Officer

Jim Rine - Chief Executive Officer of UMB Bank

Conference Call Participants

Chris McGratty - KBW

Nathan Rice - Piper Sandler

Ebrahim Poonawala - Bank of America

Operator

Good morning, and welcome to the UMB Financial Third Quarter 2020 Financial Results
Conference Call. All participants will be in listen-only mode. [Operator
Instructions] After today's presentation, there will be an opportunity to ask
questions. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Kay Gregory, Investor Relations.
Please go ahead.

Kay Gregory

Good morning, and welcome to our third quarter 2020 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, all of which are subject to assumptions, risks and
uncertainties; including the currently unknown potential impacts of the COVID-19
crisis. These risks are included in our SEC filings and are summarized on page 2 of
our presentation. Actual results and other future circumstances or aspirations may
differ from those set forth in any forward-looking statements. Forward-looking
statements speak only as of today and we undertake no obligation to update them
except to the extent required by securities laws. All earnings per share metrics
discussed on this call today are on a diluted share basis. Our presentation
materials and press release are available online@investorrelations.umb.com.

Now, I'll turn the call over to Mariner Kemper.

Mariner Kemper

Thank you, Kay, and thanks everyone for joining us today. I hope you and your
families are safe and well. As we approach the ninth month of this adjusted way of
doing business and serving our customers, our systems are performing well and we're
continuing our measured approach to the return to the workplace. We have a multi-
phased plan and currently have about 18% of our non-branch associates in our
corporate facilities. The majority of our associate base still remains remote.
We continue to meet with our customers and our branches by appointment or through
our drive-up operations at most locations. Our teams are very adept at virtual
meetings and have had success with calling efforts, but I know we'll all be ready
for an eventual return to in-person interactions and a handshake. These times have
reinforced what we've always known; relationships matter.

I'm extremely proud and impressed with how our associates continue to adapt, while
maintaining those relationships with our customers and each other. Doing what's
right to support our workforce, customers and communities is one of our priorities,
along with maintaining our high-quality underwriting standards and solid capital
and liquidity levels.

Our third quarter results reflect those priorities with net charge-offs of just
0.13% of total loans, improving past due trends and double-digit year-over-year
growth on both sides of the balance sheet. On the credit front, provision for the
quarter was $16 million, reflecting the quality of our loan book and the reduction
in modified loan balances. Third quarter provision represents 3.1x net charge-offs
of $5.1 million. The reserve build in the third quarter brings our total allowance
for credit losses on loans to $211.7 million at September 30 with an allowance to
loan coverage of 1.33%. Excluding PPP loans that coverage is 1.46% or nearly 2x
what it was at year-end 2019 prior to the adoption of CECL.

Total reserves were $214.5 million or 2.2x nonperforming assets compared to the
peer median of 1.7x based on those who have reported to date. We expect the bulk of
our reserve build may be behind us. Our portfolio is well positioned and we haven't
seen material signs of deterioration in our markets to date. However, there are
several significant factors including the election, the next round of stimulus and
the duration of the pandemic that will impact the economy and our borrowers. This
underscores the importance of our strong credit and capital position.

During the quarter, we completed our first subordinated debt issuance with $200
million of 3.7% fixed to fixed rate notes. The opportunity to bring in this Tier 2
capital at an attractive rate strengthens our already solid capital levels and
reduces our overall cost of capital. Our total risk-based capital ratios improved
100 basis points to 14.17% for the third quarter. Our top priority for use of
capital remains organic growth, as we have opportunities for deeper penetration in
many of our markets and lending verticals. And as market conditions allow, we'll
continue to look for the opportunities to augment that growth with strategic
acquisitions.

Returning capital to our shareholders has long been important to us. And as stated
in the press release, the board just approved a 3.2% dividend increase payable in
January. Another anecdotal share today is that next spring marks our 50th
anniversary of our listing on the NASDAQ. We went public in 1971 and have paid a
dividend for each of the past 49 years. More recently, we've increased our annual
dividend uninterrupted since 2002. That's 19 years of increases, even through the
great recession for a total increase of nearly 229%. That's something I'm very
proud of.

Now moving back to our results. We posted net income of $73.1 million or $1.52 per
share for the third quarter, pre-tax pre-provision income of $99.4 million
represents a 10.2% increase over the linked quarter and a 23.5% increase compared
to the third quarter of 2019. Total fee income was strong at $113 million. The
quarter-over-quarter decrease of $7.5 million was largely driven by market related
adjustments including cool evaluations along with decreased gains on sale of
securities.
But we have positive trends in the trust and securities processing line and card
spending volume increased from the lower levels in the second quarter, driving
improved interchange income. Ram will share more details on those drivers shortly.

Net interest income, increased 3.5% from the second quarter as we posted strong
loan volumes and growth in the AFS book, while lower deposits and borrowing costs
helped us partially mitigate reduced earning asset yields. Despite these
unprecedented times, average loans excluding PPP balances increased 9.4% on a
linked-quarter annualized basis. And I'll note that we surpassed for the first time
$30 billion in assets.

New loan production outside of PPP was $924 million, the highest origination level
year-to-date. Commercial line utilization remained stable from the prior quarter at
31%. This is similar to the recent averages after the spike in March and April.

Average loan growth was again driven largely by commercial and consumer real
estate. Last quarter, I mentioned the mortgage prequalification applications hit
record highs and we saw some of that in resulting growth with average consumer real
estate loans increasing 14.8% linked quarter. Our loan portfolio remains diverse
and well-balanced across several product lines, geographies and industries.

Total composition is shown on slide 20 followed by loan activity during the quarter
and breakdowns of our commercial portfolio by asset class. Our $1.5 billion PPP
loan portfolio is shown by industry and geography on slide 24. We're preparing to
accept forgiveness applications in the next few days.

On slide 25, you'll see updated our exposure to sensitive industries. At June 30,
we reported that approximately 10.3% of our total loans excluding PPP balances were
in what we call a potentially more impacted category. At the end of September that
was down to 9.6%. Total loans in these categories are $2.6 billion, representing
17.7% of our loan portfolio.

However, after analysis we feel there's approximately $1.4 billion or 9.6% to

possibly carry more risk if the crisis is prolonged. We are closely monitoring
these relationships and have regular communication with these borrowers. The
granular look at these loan types is included in the loan risk table on page 27 in
the Asset Quality section. This data shows the quality of our loan portfolio and
contains details on our modified loans by category.

On the following slide, you'll see that we have a reduction of more than 47% in
modified loan balances compared to the second quarter. As you recall based on
initial requests, we approved approximately $2.1 billion in modifications. However,
many of those were ultimately not needed by the customers.

At September 30, loan modification balances had dropped to $698 million or 4.8% of
loans, down from $1.3 billion or 9.6% of loans last quarter. And if you exclude the
portion related to our business banking portfolio we had just $322 million
remaining in Business Banking, which includes our practice solution clients largely
dental offices, we proactively offered 6-month deferrals. Many were made in April
and May, therefore, the deferrals are scheduled to expire during the fourth
quarter. We expect the vast majority of our clients to return to normal payment
status and early indications are very positive.

Finally, as you may have seen in our press release early last week, we're excited
about a recent success story in our small business investment company UMB Capital
Corporation. Our $7 million investment in Ittella International initiated in 2019,
resulted in a 7% ownership stake in Tattooed Chef following its IPO, which was
completed on October 15. This is truly a life cycle investment for us showcasing
the capabilities of our Capital Finance division.

Our relationship with Ittella began in our asset based lending group and we were
able to partner with them as they grew. Our capabilities allow us to meet a variety
of capital needs for our clients at each stage of development from mezzanine to
working capital.

In closing, I reiterate that we continue to manage for the long-term with a strong
capital and liquidity position, a history of prudent risk management and diverse
revenue sources. This helps provide buffers in the interest rate environment and
serves us well as we navigate through the crisis.

Now I'll turn it back over to Ram. Ram?

Ram Shankar

Thank you Mariner. Looking at the quarterly results. Net interest income of $184.4
million represents an increase of $6.2 million from the second quarter, driven by
strong growth in C&I and CRE loans and a larger AFS portfolio.

Total earning asset yields fell 10 basis points to 2.91% from the linked-quarter,
driven by yield declines of 13 basis points in both loans and total securities. Net
interest spread decreased four basis points from the second quarter and was down
only one basis point from a year ago. Net interest margin compressed by six basis
points on a linked-quarter basis.

Drivers of this change included, negative four basis points from lower reinvestment
rates and market changes in the AFS portfolio, a three basis point reduction from
the reduced benefit of free funds and negative two basis points related to earning
asset mix shift partially offset by a three basis point impact from deposit mix
along with CD and money market rate changes.

Liquidity levels remain elevated and consistent with the second quarter levels, but
at over 2.3 times level seen a year ago. As we noted in the release, we terminated
our $750 million interest rate floor hedge for $34.1 million during the third
quarter. The unrealized gain remaining in AOCI was $18.4 million, which will be
amortized into net interest income through September of 2024.

Non-interest income, as shown on slide 9, was $113 million for the quarter, a
reduction of $7.5 million. Valuation adjustments in company-owned life insurance
income accounted for $6.2 million of the sequential decline. This decrease is
offset by a similar decrease in deferred compensation expense.

Gains on sale of securities accounted for an additional $3.7 million decline from
the linked-quarter. We saw improved trends in asset servicing with our alternative
investment, registered funds administration, and custody businesses, driving the
largest portion of the $4.2 million increase in trust and securities processing
income.

Bank card fees improved 18.4% or $2.4 million from the second quarter driven by a
21% linked-quarter increase in card spending volume. We've seen spending levels
improve from April lows, but they remain below pre-pandemic levels. We believe
there has been some catch-up in routine medical and dental care following the
shutdowns earlier in the year and healthcare spending surpassed year-over-year
levels.

Commercial credit purchase volumes improved 24% over the second quarter, but are
still below prior year levels with corporate travel and entertainment still on hold
for many companies. Public sector spending is down due to significant decreases in
new fiscal year budgets and many schools across our footprint are either not open
or at limited capacity.

The $4.2 million linked-quarter reduction in investment banking fee income was
driven largely by lower municipal and corporate bond volumes after a very strong
second quarter. Additionally, market valuation adjustments in our trading
portfolio, accounted for $1.9 million of the decrease.

Beginning in the fourth quarter, our fee income will be subject to some volatility
from market value adjustments to our position in Tattooed Chef. As part of the
transaction, we received $9 million in cash and just over four million shares of
TTCF, a publicly traded entity.

Changes in market values on our share ownership will flow through our income
statement as unrealized gains or losses at each reporting period. Based on recent
trading levels, our fourth quarter gains maybe approximately $68 million to $70
million, but obviously will be adjusted to reflect the stock price at quarter end.

Expenses for the quarter decreased 5.1% or $10.5 million compared to the second
quarter, largely driven by an $8 million decrease in deferred compensation expense,
the offset to the decreased COLI income, I mentioned. Further detail is shown on
slide 12. The tax rate for the quarter was 12.3%. And for the full year 2020, we
anticipate it will be approximately 14% to 15%.

Moving to the balance sheet, average deposits increased 5.9% on a linked-quarter

basis and DDA balances grew by 7.8%. Three funds now comprise just over 34% of
total deposits. We continue to maintain strong regulatory capital ratios, bolstered
by the sub-debt offering during the quarter, with our total risk-based capital at
14.17%, CET1 ratio at 11.93% and a leverage ratio at 8.19%. Tangible common equity
to assets was 8.8%. Trends in our capital ratios are shown on Slide 15.

Our tangible book value per share increased to $55.19 at the end of the quarter, up
14.5% from a year ago. For comparison, our peers that have reported so far have
shown an increase of 5.9%.

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.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. [Operator Instructions] Our

first question today comes from Chris McGratty with KBW.

Mariner Kemper

Good morning, Chris.

Chris McGratty

Hey, good morning, Ram. Good morning, Mariner. Nice quarter, overall. I'm hoping to
talk a little bit about expenses to start. You guys had them pretty well controlled
this quarter, but rereading the transcript from last quarter, you talked about just
a really big focus on expenses, given the revenue environment. Interested in your
thoughts about expenses, investments you may need to make and potential sources of
rationalizations in 2021? Thanks.
Mariner Kemper

Yes. This is Mariner. Thanks for the question. As we've been talking the last few
quarters, we remain very focused on being an efficient company and we've undertaken
over time any number of exercises. But really, it's more of the way we're operating
and we are able to -- with digitization and acceptance of digitization from the
customer base, we've been able to continue to find efficiencies through the use of
technology. We continue to manage staffing levels based on performance and continue
to look at our physical plan. And you should expect us to continue to focus on
expenses, without giving you any particular guidance.

Chris McGratty

Maybe, just on one line item and then expenses. The personnel number, Ram, was
somewhat high in the last couple of quarters. I'm interested how much of that was
kind of a catch-up from really low first quarter and bonus accruals and maybe that
line item, is that in this mid-120's is that a bit decent jumping off point to kind
of forecast growth?

Ram Shankar

Yes. The one thing that flows through that line item is also our deferred comp
expense, right? So quarter-over-quarter, we saw some movement over there, depending
on what happens with the market. But usually there’s an equal offset on the COLI
side. So if you look at just what happened this particular quarter, we had deferred
comp expenses of just under $4 million, which was down about $8 million from the
prior quarter.

But if you exclude that noise, there's always usual seasonal resets and FICA. But
the overall incentives were just impacted by some of the trading volumes that you
see, the bond trading has been a pretty strong headline for us. Other fee income
opportunities have also been a strong headline. So anything volume-related will
always increase salaries from one period to another period, but the salaries, just
when you look at salaries and wages what you see in the fourth quarter is probably
a good starting point enter 2021.

Chris McGratty

Great. And if I could, just on a couple of modeling questions; the PPP. Can you let
us know what was in the quarter for the fees, what remains? And then, I guess, into
2021, like, the cadence of the fees?

Mariner Kemper

Ram, do you want to take that?

Ram Shankar

Yes, I'll take that. So what's in our fees right now is just the plain vanilla
finance charge of 1% and the amortization of the origination fee. As you know, as
Mariner said, we're gearing up to take forgiveness applications. And so, none of
that is really in our fee income -- or net interest income base for the third
quarter. Chances are, with the way the process is playing out, there will be a very
little impact, if any, in the fourth quarter and most of it will be probably in
2021.

Chris McGratty
Okay. And then, on the taxes, if I could. It sounds like the fourth quarter, a
little bit of a higher tax rate, Ram. And then, how do we think about the
sensitivity if we do get a change in administration to some of the proposals that
are being floated in Washington with the tax hikes? Is it a -- yes.

Ram Shankar

On the first part, so we said 14% to 15%, yes, a higher tax rate for the fourth
quarter, a lot of it will depend on our pretax income, as I said in my script, we
might have as much as a $70 million, $75 million gain from our investment in
Tattooed Chef. So when -- if pretax income goes up, your tax rate -- effective tax
rate will also go up.

On the second part about, if corporate tax rate went from 21% to 28%, we'll see
probably about a 400 basis point increase in our ETR when that goes into effect.

Chris McGratty

Awesome. Thank you very much.

Mariner Kemper

Thanks, Chris.

Operator

Our next question comes from Nathan Rice with Piper Sandler.

Nathan Rice

Yes. Hi, guys. Good morning.

Mariner Kemper

Hey.

Nathan Rice

I was hoping to start on credit. It looks like this quarter's reserve build was
largely a function of criticized classified trends in the quarter. So just curious
to get a sense of how that trended during 3Q and if a lot of that criticized
classified inflow was just concentrated in that at risk portfolios that have been
outlined in the slide deck, or if there's some other areas that also saw some
inflows?

Mariner Kemper

On the provision expense, largely, it is definitely based on mostly credit

performance, don't have much macro modeling related provision expense in the third
quarter to speak of, not much. So it's mostly just credit performance. And it was a
good quarter from that perspective, with 13 basis points in charge-offs and the
typical growth level we've been seeing. So its nice growth in the quarter too. So
performance was strong and growth was strong and that's basically what you saw on
the provision expense for the most part, if that answers the question?

Nathan Rice

Yes. That's helpful. Thanks Mariner. I guess, I was also just hoping to get some
color, just in terms of broader criticized classified trends in the quarter. I
don't think those slides --

Mariner Kemper

Sure. You noticed. So there -- you'll see this in the Q our criticized are down. So
overall criticized are slightly down, nothing to note as it relates to overall –
the way we think about it so NPA's ticked up slightly but credit size in total are
down. Nothing to note. Really, we don't expect anything different when it comes to
charge-offs in the coming periods that we don't see or expect today as we look at
the data. It's the same kind of comment, I've made before, which is we'll see some
spikes along the top as it relates to putting credits on the watch list or a credit
loan to NPA as we are very quick to manage credits at UMB.

We're quick to identify problems, we're quick to manage them. So you'll see peaks
and valleys along the top. But what's really important the way we look at it and
the way we think about it, is there's very little migration to doubtful and loss.
And that's what we care about and that's what we think about. And we don't expect
anything different as far as we can see out right now as it relates to migration to
doubtful and loss.

Nathan Rice

Okay. Great. Yeah, that's super helpful. And then just thinking about the margin
trajectory going forward PPP fees. Ram, any thoughts obviously securities –
reinvestment rates are a challenge these days. But it seems like the loan growth
outlook remains pretty solid. So hopefully that that should change earned assets
should help going forward but just kind of any thoughts on, how you see that core
margin trajecting through the fourth quarter and early 2021?

Ram Shankar

Yeah. Sure. I can take that. If you think about the two main reasons for margin
compression today, right? As you mentioned, it's the reinvestment rates on our AFS
book are lower than what's rolling off and we have some data in our slide deck that
shows, we have close to $1.7 billion of maturities coming over the next 12 months
at a 1.93 rate. And for instance, what we reinvested in September had a 160 handle
on it right? So there's some compression.

And then the other thing that's happening is also the earning asset mix shift not
only within the loan book, but between loans and earning assets, a lot of it is
because of the liquidity bill. So the big wildcards as you rightly pointed will be
the pace of PPP runoffs, right? And for instance, if you assumed all our PPP
balances ran off in the third quarter and were replaced by non PPP loans, our
margin would have been 7 basis points higher this quarter. But that's not how it's
going to play out in the short run. So as PPP loans exit, we would expect our loan-
to-deposit ratio probably come down a point or two and that's going to probably
drive a little bit more of the unfavorable earnings mix shift that I talked about.

And then the other wild card is also the excess liquidity part. So while it was
stable, as I said on a linked-quarter basis it's still about 2.5 times, where it
was pre-pandemic levels. And for us in our businesses as you all know, we'll see
more liquidity in the fourth and first quarters from public funds business.

So all said I would say, I probably expect margin to trough in the next couple of
quarters because of excess liquidity and this other PPP dynamic, I'm talking about.
But what did we do? We always said this in these low environments low interest rate
environments we tend to focus on net interest income growth. So that always will be
a differentiator for us. We'll keep the dry powder in terms of deposits to deploy
later.

Nathan Rice

Got it. That's great color. I appreciate taking the questions. Thank you.

Ram Shankar

Thanks, Nate.

Operator

[Operator Instructions] Our next question comes from Ebrahim Poonawala with Bank of
America.

Ebrahim Poonawala

Hey, good morning, guys.

Mariner Kemper

Hey, Ebrahim.

Ebrahim Poonawala

Hey. Very quickly to follow-up on the NII focus. Is it safe to assume just given
the kind of growth that you guys are seeing ex-PPP we should expect NII growth to
continue, or do you see any reason why NII could actually decline over the coming
quarters?

Mariner Kemper

I mean, just based on what Ram just said, it's likely that it will continue to
increase.

Ebrahim Poonawala

Got it. Got it. And I guess just on credit manner, if you take a step back, I know
you feel very good about your loan book for a bank that is actually growing the
loan portfolio. Just talk to us as you think about the puts and takes in terms of
the macro outlook looking into the next year, do you see -- are you more worried
about credit or are you more optimistic about growth when you think about 2021?

Mariner Kemper

So, Ebrahim, you know me pretty well. You've watched us for a while. I'm a career
pessimist. So we -- the thing about the way we underwrite is, we're always
underwriting for the next crisis.

So as it relates to how we underwrite in general, we're always prepared for the

worst. We always underwrite to the worst case scenario. So, we're really not doing
anything different in the way that we underwrite.

We're -- we want to bank customers that know that things can get bad and have build
equity and have global cash flow and sponsor strength and all those kinds of
things. People that -- we bank people who believe what we believe is that we
believe in gravity, we believe that what goes up, must come down. And so we're
always underwriting that way. So we don't wait for a crisis to operate like there's
a crisis.

And so as we think of the first quarter, a couple of comments first quarter and
second quarter, a couple of comments I would make about our outlook for that. I
don't we don't believe that the economy cares who the President is. We also don't
believe that we're going to go into the New Year without another stimulus package.

And so we believe that there'll be stimulus, and we don't believe that the market's
care who's President. What we worry about is if the coronavirus pandemic were to
get worse that would likely apply some pressure to our more sensitive impacted
credit list that we've provided for you the investor community.

So that's what we worry about. We -- I think that as it relates to the rest of our
book, I think, we'll go on into the next year uninterrupted with the rest of the --
with the book. But as it relates to some of those industries that we've identified
that are sensitive to the pandemic, we would likely see some stress there. However,
I would revert back to my original comment, which is that when we originated those
credits, we originated them knowing that things could get worse. And so we assess
global cash flows, sponsor strength, loan to values, location, cap rates. We're
very conservative about the way we look at those things. And so we know that there
-- while there will be stress, we don't worry particularly about higher than normal
loss levels.

Ebrahim Poonawala

Got it. That is helpful. Thanks.

Mariner Kemper

Thanks, Ebrahim.

Operator

[Operator Instructions.] Seeing no further questions, I'd like to hand the call
back over to Kay Gregory for any closing remarks.

Kay Gregory

Thank you and thanks for joining us today. This call can be accessed via replay at
our website. And as always you can contact UMB Investor Relations at 816-860-7106
with any follow-up questions. Again, we appreciate your interest and time. Thank
you and have a great day.

Operator

The conference has now concluded. Thank you for attending today's presentation. You
may now disconnect.