Begonya Klumb – Director, IR
Mariner Kemper – Chairman and CEO
Mike Hagedorn – CFO
Peter deSilva – President and COO
Christopher McGratty – Keefe Bruyette & Woods
Peyton Green – FTN Midwest Securities
UMB Financial Corporation (UMBF) Q2 2008 Earnings Call Transcript July 23, 2008 9:30 AM ET
Good morning, ladies and gentlemen, thank you for standing by. Welcome to the UMB Financial Corporation second quarter conference call. During today’s presentation all parties will be in a listen-only mode. Following the presentation the conference will be opened for questions. (Operator instructions) As a reminder, this conference is being recorded today, July 23rd, 2008.
I would now like to turn the conference over to Begonya Klumb, Director of Investor Relations. Please go ahead, ma'am.
Good morning, everyone, and thank you for joining us for our conference call and webcast regarding our 2008 second quarter financial results. Before we begin, let me remind you that our comments in this conference call contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934, and within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements rely on a number of assumptions concerning future events and are subject to risks and uncertainties, which could cause actual results to differ materially from those indicated in our statements made during this call.
While management of UMB believes our assumptions are reasonable, UMB cautions that material changes in the interest rate, the equity markets, general economic conditions as they relate to the –'s loan and fee-based customers, competition in the financial services industry, the ability to integrate acquisitions, and other risks and uncertainties, which are detailed in our filings with the Securities and Exchange Commission, may cause actual results to differ materially from those discussed in this call.
UMB has no duty to update such statements and undertakes no obligation to update or supplement forward-looking statements that become untrue because of new information, future events or otherwise. By now, we hope most of you on the call or listening to the webcast have had a chance to review our earnings release dated July 22. If not, you will find it on our website at umb.com.
On the call today are Mariner Kemper, Chairman and Chief Executive Officer; Peter deSilva, President and Chief Operating Officer; and Mike Hagedorn, our Chief Financial Officer. The agenda for today's call is as follows: first, Mariner will highlight our results and strategies. Then Mike will review the details of our second quarter results. Peter will follow with a discussion of operating performance against our strategies. Following that, we will be happy to answer to your questions.
Now, I will turn the call over to Mariner Kemper.
Thank you, Begonya. Welcome, everyone, and thank you for joining us today. Following a record first quarter UMB continued to deliver strong net income growth in the second quarter of 2008. Net income totaled $23.7 million, or $0.58 per diluted share, an 18.2% increase from $20.1 million, or $0.48 for the second quarter of 2007.
EPS grew by more than 20% while industry average expected EPS growth was a negative 21.4%. We believe this is further proof that our time-tested model and operating principles will drive our success in any economic cycle.
This strong financial performance was driven by 12.2% revenue growth, which was comprised of net interest income growth of 16.1% and noninterest income growth of 9.2%. This quarter also saw a record Scout Funds flows of $549 million.
We continue to be well capitalized, something we believe is especially important in this current environment. As evidence of this, our Tier 1 leverage and total risk-based capital ratios as of June 30 were 14%, 10.1%, and 14.9%, respectively.
Our credit quality remained strong with nonperforming loans at 0.20% and net charge-offs and 0.41%. These ratios are strong when compared to the industry, which at the end of the first quarter reported average net charge-offs of 0.44% and average nonperforming loans of 1.43%.
The pressure on the financial services industry continues to validate our business model and prudent risk-based profile, and uncompromised underwriting standards. In addition to our solid foundation, we believe our performance is also evidence that our growth strategies are working. With disciplined execution, our associates are translating those strategies into improved performance and returns.
As a reminder, our first strategy is to focus on yield enhancement. And we continue to make progress optimizing the mix of our earning assets and liabilities. During the second quarter of 2008, end-of-period loans increased 3.8% over the same period in 2007 representing the 20th consecutive quarter of year-over-year loan growth. We ended the quarter with $4.1 billion in loan balances, which reflect continued growth in commercial, credit card, and home equity loans. These increases helped to offset the decline due to our decision to run off our indirect auto loan portfolio last summer. As of June 30, 2008, our indirect portfolio had balances of $379 million, a 42% decrease over the June 30 of 2007.
Our commercial loan portfolio continued to perform well in the second quarter with 11% increase in balance over the prior year. We are extremely pleased with this growth especially in light of the current environment.
Our credit card portfolio increased nearly 24% year-over-year with all of our segments, consumer, commercial, and private-label, recording strong double-digit growth in both balances and cardholder volumes.
While our credit card portfolio growth has been significant our credit quality metrics remained strong and our underwriting practices have not changed.
Our home equity loans grew 40%, continuing a strong trend over the last three years. We have increased HELOC loans from 1.1% of our loan portfolio at the end of 2002 to 7.6% of our loan portfolio at the end of the second quarter of 2008. The credit quality in this portfolio remains excellent, and we continue to focus our existing customer base and footprint to generate this new growth.
Average deposits grew 11.9% over the same period in 2007 and our end-of-period deposits grew 9.6%. Noninterest-bearing deposits were 31.3% of our total average deposits, well above the industry average. This remains a key strength of our deposit franchise. Our noninterest-bearing deposits grew 9.4% on an average basis quarter-over-quarter mainly driven by our Payment and Technology, Asset Management, and Fund Services group. Our deposit composition provides us with a competitive advantage in this current marketplace and allows us much flexibility.
Our core investment portfolio average life was 36 months at the end of the second quarter of 2008, same as the end of period 2007. Due to the current rate environment we expect our core investment portfolio average life to become somewhat shorter as we avoid locking in lower rates for longer periods of time.
Our second strategy is to grow our strong fee-based businesses. Noninterest income represent approximately 54% of total revenue in the second quarter of 2008, and grew 9.2% compared to the same period of 2007. Trust and securities processing income, trading, and investment banking, and card services income continue to be major drivers of growth. Peter will discuss this in more detail during his comments.
Our third strategy is to leverage our distribution network. To that end, on July 15th, we announced the acquisition of Citadel Bank in Colorado Springs. Citadel and UMB are a great cultural fit. Citadel’s lending policies fit well with ours, and they also have a deposit composition much like ours. Moreover, the acquisition will allow us to build out our existing distribution and add $82 million in deposits, and $25 million in loans to our Colorado Springs franchise.
This transaction will increase UMB’s deposit market share from number nine to number seven with an overall 4.3% market share, $235 million of deposits, and seven offices in this attractive market.
On March 10th, we launched a new 4.5% two-year fixed promotion for our HELOCs. As I mentioned earlier, HELOCs continue to drive our loan growth and we are very pleased with the results of this campaign as we set a quarterly record for number of applications.
Our fourth strategy is to strengthen our Asset Management business. During the second quarter trust and securities processing income increased 14.4% to $33.1 million. The improvement was primarily driven by increased assets under management and higher revenue from our Fund Services group. Peter will also discuss these results further in his comments.
Finally, our fifth strategy is to focus on capital management. Our priorities in this regard have not changed. They are first to invest in growth either through re-investment in our businesses or through acquisitions that are good strategic, financial, operational, and cultural fits. Citadel is a great example of an acquisition that fits these criteria. Second, to consider increasing our dividend over time, and third to repurchase stock when it makes sense to do so. To this end, in the second quarter we repurchased 51,770 shares at an average price of $49.52 per share for a total cost of $2.6 million. This brings our year-to-date total to 536,834 shares at an average price of $39.41 for a total cost of $21.2 million.
These five strategies along with our focus on efficiency will continue to drive performance in 2008 and beyond. With safety and soundness at our core, we remain committed to growing revenue while maintaining strong expense controls and prudent credit qualities.
Now, I will turn over the conference call to Mike Hagedorn, our CFO. Mike?
Thanks, Mariner, and welcome everyone. As Mariner indicated, we reported quarterly earnings of $23.7 million, or $0.58 per diluted share for the second quarter, up 18.2% from $20.1 million, or $0.48 per share in the same period last year. A key driver of our net income was our ability to effectively manage our funding costs.
Net interest income for the quarter increased $16.1 million, or 9.2% over the same period in 2007. As rates fell, our interest income declined 9.9%. However, this decline was more than offset by a 42.2% decrease in our total interest expense, leading to the 16.1% increase in our net interest income.
Net interest margins increased 28 basis points to 3.71% from 3.43% in the second quarter of 2007. This improvement was primarily due to lower cost of interest-bearing liabilities. In the second quarter of 2008, the cost of interest-bearing liabilities decreased 1.9% compared to 3.53% for the second quarter of 2007, a decline of 163 basis points. This offsets the 94 basis point decrease in average earning asset yields. Due to the declining rate environment free funds contribution declined 50 basis points from 91 basis points in the second quarter of 2007.
During the second quarter $155 million in core portfolio securities rolled off at an average yield of 4.59%. In turn, we purchased $104 million of securities at an average yield of 3.60%. Over the next three months, $138 million of core investments with an average yield of 4.05% will roll off. Over the next 12 months, $683 million of core investments with an average yield of $4.48% will roll off.
In the current lower rate environment, we expect the repricing of these securities to negatively impact our interest income. Nevertheless, thanks to the actions we took over the past three years to lengthen our core investment portfolio’s average life, we are pleased to have some higher yields locked in for longer periods of time. In addition, 63% of our loan portfolio is expected to reprice during the next 12 months.
Noninterest income increased $6.7 million, or 9.2% for the quarter ended June 30, 2008, compared with the same period in 2007. The improvement was primarily due to higher trust and securities processing income, bankcard fees, and bond trading income. Trust and securities processing fees were up 14.4% primarily due to an increase of $711 million in assets under management in the UMB Scout Funds from the second quarter of 2007.
Trading and investment banking fees were up 14.3% as we continue to see increased activity in this area due to the unstable equity market conditions.
Noninterest expense increased $8 million, or 8.2% for the second quarter compared with the same period in 2007. The most significant increases were in compensation expenses and processing fees.
Salaries and benefits increased $5.2 million, or 10.4% as a result of higher commissions and bonuses as well as equity bases compensation and employee benefit costs.
Credit quality ratios in the second quarter of 2008 reflected UMB’s continued strong commitment to high quality lending. Nonperforming loans including nonaccrual and restructured loans were $8.2 million as of June 30, 2008, or 0.2% of loans, from $7.9 million, or 0.2% for the same period last year. Net loan charge-offs increased slightly totally $4.2 million for the second quarter, or $0.41% of average loans when annualized compared to or compared with $1.5 million, or 0.16% of average loans when annualized during the same period last year. Much of the increase in charge-offs is due to one commercial loan that is not real estate related.
Our credit quality continues to remain strong especially when compared to the industry. As of the end of the first quarter industry average net charge-offs as a percent of total loans were $0.44%.
Our provision for loan losses increased to $4.9 million in the second quarter of 2008 from $2.0 million a year earlier. This increase partly reflects the growth experienced by our loan portfolio. Our provision remained stable as a percentage of loans at 1.17%.
Now, turning to the balance sheet, one of the key performance drivers for the quarter was loan growth. At the end of June, loan balances were $4.1 billion compared with $3.9 billion a year ago. Total end of period loans grew by 3.8% primarily driven by 11.1% increase in commercial loans, a 40% increase in home equity loans, and a 23.6% increase in credit card balances.
This growth was offset by a 42% planned decrease in our indirect auto portfolio. As of June 30th, our indirect auto portfolio stood at $378.6 million compared to $649.9 million a year ago. Again, this run off is part of our yield enhancement strategy that Mariner discussed earlier during his comments.
During the second quarter of 2008, average deposits were $6.3 billion compared with $5.6 billion a year ago, an 11.9% increase. We are particularly pleased that noninterest-bearing deposits increased 9.4%.
Our ratio of average loans as a percentage of earning assets decreased slightly to 54.9% for the quarter from 56.2% last year. This decline is partly related to the indirect portfolio run-off previously mentioned, coupled with strong deposit growth.
Return on average equity, and return on average assets during the second quarter of 2008 had solid improvement to 10.37% and 1.12%, respectively from 9.32% and 1.02% for the same period in 2007. We remain focused on continuing to increase our profitability metrics.
Finally, for the year-to-date, diluted EPS of $1.36 increased 52.8% compared with $0.89 for the first six months of 2007. This is based on net income of $56.1 million compared with $37.4 million for the same period last year.
With that, I will turn it over to Peter for some additional comments on our operating performance.
Thank you, Mike, and good morning, everyone. I would like to provide some additional details on our growth and operational strategies starting first with our strategy to grow our fee business. Being a broadly diversified financial services organization continues to be one of our greatest strengths. Driving improvement in our fee businesses continues to be a core strategy and we are pleased to report a 9.2% in noninterest income during the quarter.
During this quarter we continued to add to our position of strength in healthcare services. Specifically, we are focused on the administration, custody, and card processing for HSA and FSA products. We are committed to maintaining our leadership position by adding new HSA and FSA savings and investment accounts and the associated debit cards. The number of healthcare accounts grew 58% in the second quarter with deposits and assets increasing 46% as compared to the same period last year. At the end of the quarter, we had more than 822,000 HSA and FSA accounts and nearly $129 million in deposits and investment assets. We are pleased with the continual growth in this business.
Growing our card businesses is another key part of our fee business strategy. Critical element of this effort is to grow our commercial credit card program. Cardholder volume increased 19.6% over the same period last year. Commercial cardholder purchase volume posted another record in May with total volume of nearly $56 million. The growth in purchase volume also extends to our consumer and private-label customer segments. As a result, our total cardholder purchase volume increased by 18.3% to nearly $308 million in the second quarter of 2008 compared to $260 million in the second quarter of 2007.
Likewise, new accounts for all segments totaled over 16,000, a 38.5% increase over new accounts generated during the same period last year. New account volume was partly driven by successful sales campaigns and new product introductions. We continue to be focused on growing this business both organically and thru the acquisition of portfolios that fit our credit quality criteria.
As evidence of our commitment to this segment, we announced two key product initiatives during the second quarter. First, our unique Eco Rewards Card. This card provides single rewards for all purchases and double rewards for environmentally sustainable purchases. And second, we launched a micro-affinity card product in collaboration with our partner ServiceSide [ph]. While it’s too early to report specific results on either of these, early indications for both products looks extremely promising.
Our Payment and Technology Solutions businesses continue to be an area of focus. We remain positioned at the forefront of the transition from paper payments to electronic solutions. According to the most recent report on 2007 ACH payments from NACHA, The Electronic Payments Association, we ranked 25th among the top 50 ACH originators, and 45th among the top 50 ACH receivers in the country. Both rankings were an improvement from our rankings the year before.
UMB Fund Services continued to report strong double-digit revenue and earnings growth. Noninterest income increased 32.1% over the same period in 2007 due in part to deepening relationships with existing customers as well as new customer relationships. This resulted in higher fee income. Higher revenue coupled with increased efficiencies and better leverage of existing scale led to earnings growth of 159%.
During the quarter we announced the addition of Total Distribution Services in partnership with Access Discovery. This new product offering will enable our clients to take advantage of our enhanced distribution services for their mutual fund families.
I would also like to take a moment to talk about our strategy to grow our Asset Management business. Total assets under management increased 8.6% to $11.3 billion from $10.6 billion at June 30, 2007, despite a 13% decrease in the broader equity markets. Leading this growth continues to be our proprietary family of mutual funds.
Total assets in the UMB Scout Funds increased 13% from $5.5 billion at June 30, 2007 to $6.2 billion at June 30, 2008. During the second quarter, our UMB Scout Funds reported record quarterly net flows of $549 million, which helped to offset the adverse effect of our equity markets.
Our performance continues to be recognized by major publications. On July 14, USA Today noted our UMB Scout stock and International Discovery funds as two of the top-performing funds in the country during a recent three-month period.
Another important part of our asset management strategy has been building our Private Banking business. With 10 client managers, Private Banking now is more than $64 million in loans and nearly $160 million of deposits, almost double the $35 million in loans and $84 million in deposits during the same period just a year ago.
And we continue to focus on enhancing our operating efficiencies. Strong revenue growth of $12.2% led to an efficiency ratio of 71.6%. We are pleased with the positive operating leverage we continue to experience. Just three years ago, in the second quarter of 2005 our efficiency ratio was 80.2%.
We also continue to see improvements in our key productivity metrics. For example, average deposits per FTE and revenue per FTE increased 14.6% and 14.9%, respectively from the same period a year ago. Our end-of-period FTEs decreased by 95 to 3315 as of June 30, 2008, from 3410 as of June 30, 2007.
Overall, our operating strategies and focus on greater efficiencies continue to drive the – forward in this unsettled economy. Our associates continue to play a key role as responsible stewards of our customers’ money, and actively demonstrating the unparallel customer experience everyday. We believe, this is what makes our – so unique now more than ever.
With that, I would like to turn it back over to Mariner for some concluding remarks.
Thank you, Peter. As we demonstrated again this quarter, our business model is time-tested. For 95 years we have remained true to our legacy, business strategies, and leadership principles, and as a result, we have built a financial services – that is strong and stable in all type of economies. This strength and stability comes from the fact our – is built on uncompromised underwriting standards and prudent risk-taking. We also derive strength and stability from a diverse revenue stream as represented by our high noninterest income as a percent of total revenue.
As we mentioned earlier in the call, the industry average for nonperforming loans is 1.43% while UMB remained 86% lower at 0.20%. While others remain internally focused, UMB is out talking with customers and prospects and growing all of our lines of business. We have capital and liquidity, which allows us to make loans, service our customers’ needs, and act on strategic opportunities as they present themselves. As always, UMB remains focused on executing our growth strategies and deliver long-term shareholder value.
Thank you for being on the call today. And with that, I will turn it over to the conference call operator to open the call for your questions. Thanks again.
Thank you. (Operator instructions) Your first question comes from the line of Christopher McGratty from KBW. Please go ahead.
Christopher McGratty – Keefe Bruyette & Woods
Christopher McGratty – Keefe Bruyette & Woods
I notice a pretty material widening between the spread on your wholesale borrowing cost this quarter and securities yield, which obviously provide some support to the margin expansion. Wonder if can just comment on the outlook, the sustainability of this trend and then maybe a few comments on the outlook for the margin.
Yeah, good morning, this is Mike Hagedorn. First, I would say we don’t look at those two lines by themselves. We manage the entire balance sheet, and especially our funding sources and our outgo process in its totality. But admitting that, core deposit growth clearly makes us less dependant on wholesale funding, and you can see that when you look at the quarter-over-quarter numbers, they were down almost $100 million in Fed funds and repo. The yield leverage is basically driven by the Fed funds decrease. So, clearly the yield on our borrowed funds has gone down. But then again I would point out that our loan-to-deposit ratio being where it is today, clearly makes us much less dependant on net interest margin for our total bottom line growth. And so, while sequentially, yes, the investment portfolio was down 19 basis points and funding is down 119 basis points, and that certainly provides some net interest margin leverage. We don’t manage it that way. We manage it in its totality, and I think you should look at our other funding sources, especially the way we grew core funding and deposits in the second quarter.
Christopher McGratty – Keefe Bruyette & Woods
Okay. That’s helpful. Now, in terms of the reinvestment yields that you discussed (inaudible) of the balance sheet and what the incremental yield pickup or decline is and it seems this is the second quarter in a row that we have seen securities rolling off at a higher yield and the lower reimbursement yield. Now, obviously, it surprised me in terms of the margin this quarter and the degree of expansion, but is that going to weigh on the margin going forward?
Yeah, as I mentioned in my comments earlier, clearly it’s going to – we are not going to invest at least right now with our expectations for interest rates at the end of the year. To be reinvesting our investment portfolio run-off at yields that even come close to even equating what we had. However, that depends upon what the Fed does with interest rates and whether or not we shorten down to take advantage of potential increase in Fed fund rates in the future.
Christopher McGratty – Keefe Bruyette & Woods
Okay. That’s great. Just one quick question on the credit side. You are obviously – your credit performance is head and shoulders above a lot of your peers, but the 41 basis points of charge-off this quarter was higher than historically you guys have put up. And the provision as well is a little bit higher than our forecast. Is this a good – is this kind of a good run rate going forward to think about the credit outlook for your guys?
Hi, this is Mariner. I would say that we had one relationship that we took a loss on in the quarter. If you look at the overall data, it’s probably a better way to look at it. Our year-to-date number is 0.28% for the six months and all of last year the number was at 0.33%. So we are actually six months into the year running lower than we were for all of last year. So, I think you can expect continued solid credit performance from us.
Christopher McGratty – Keefe Bruyette & Woods
Okay. Thank you.
(Operator instructions) And our next question comes from the line of Peyton Green from FTN Midwest Securities. Please go ahead.
Peyton Green – FTN Midwest Securities
Good morning. I was wondering if you could comment a little bit in terms of the underlying credit quality. If you are seeing any trends in terms of the watch list that might bother you not necessarily in the next quarter or two but really six to 12 months out. And then separately, how much are you paying for the acquisition of Citadel? And then in terms of hitting your accretion goals is dependant on cost saves or is it out-of-the-gate accretive? Thanks.
Peyton, it’s Mariner. I think I somewhat answered the way we would probably answer the credit question with my last answer. I – we don’t foresee any further deterioration on our credit quality because of the way we underwrite. We continue to underwrite the same way. So, we are in the risk business, so who knows, but we feel pretty good about our credit quality as it stands today.
The question about the acquisition of Citadel, we would not make those – the premium public, nor intend to. I would say it’s a quality bank. We may – we paid a market premium for the bank. And as far as is it accretive, we expect it to be accretive next year modestly, and it folds right into our network down there. Not a whole lot of cost savings to be derived out of it. It’s just a bolt-on acquisition, fill-in acquisition for our presence in Colorado Springs.
Peyton Green – FTN Midwest Securities
Okay, great. Thank you.
(Operator instructions) And there are no further questions. I will turn the call back over to management for any closing remarks.
Thank you very much for your interest in UMB. The call can be accessed via a replay at our website beginning in about two hours and it will run through July 30. And as always, you can contact me at Investor Relations with any follow-up questions by calling 816-860-7906. Again, we appreciate your interest and time.
Ladies and gentlemen, this concludes the UMB Financial Corporation’s second quarter conference call. If you would like to listen to a replay of today’s conference, please dial 1-800-405-2236, and access code 11116662#. ACT would like to thank you for your participation. You may now disconnect.
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