Umb Financial Corp Q1 FY2020 Earnings Call

Welcome to the UMB Financial Corp. First Quarter 2020 Earnings Conference Call. Please note, this event is being recorded. I would now like to turn the conference over to Kay Gregory with Investor Relations. Please go ahead.

Good morning, and welcome to our first 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, 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 statement. Forward-looking statements speak only as of today and we undertake no obligation to update them except to the extent required by applicable 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. I hope you and all your family and friends are safe and healthy. Our thoughts are with those most impacted by this pandemic, and our deepest gratitude goes to those on the frontlines, including healthcare workers and first responders. I'm going to go off script a bit this morning. Like everyone on this call, I've had a great deal of time over the last 45 days to think and prepare for what lies ahead. In my 25 years at UMB, 16 of those as CEO, I've primarily been a risk manager. I believe we are likely to experience several simple truths over the next couple of years. I believe that CECL is the worst designed accounting rule in U.S. history, poorly timed and horribly mismanaged by FASB and the accounting industry. If we were to return to the incurred loss model, investors would have a much easier time understanding the underlying risk at any particular bank. But that's not a reality, and with CECL now deployed, it will nearly be impossible to understand the actual risk that exists in a bank's portfolio. However, the unintended consequence of this should be that we're all more prepared for the unknown risks ahead. What I do know is that it's better to be prepared for the worst rather than only preparing for outcomes that would be better. With all that as a backdrop, I'll share with you the three most important things to focus on as we look at what lies ahead. First, capital liquidity are king. None of us has any idea how bad this crisis will be, no matter what any self-proclaimed genius will tell you, and you can't have enough capital or liquidity right now. Second, doing what's right actually matters, not only because it feels good, but it builds franchise value by bonding both employees and our customers at UMB. We're laser-focused on helping our associates and customers manage through these very difficult times. More on that in my prepared comments. Lastly, and importantly to you our investors, our primary mission is to make sure that our current investors can count on us to remain strong at the end of this crisis and benefit alongside us when we take advantage of the opportunities that will surely present themselves in recovery, only to those of us who are not too badly wounded to capitalize on it. Here is where our track record as lenders comes into play. I can't make any promises about how we'll perform during this situation, but what I can tell you is that I will treat the money we lend out as my own. It happens to be the only investment I have. I, along with most of our loan committee, have been overseeing our lending activities together for 25 years. It's easy to look good when things are good. The real test of credit quality is how it performs when conditions are negative. We have a track record on that issue. We outperformed nearly every bank in the '08 crisis. In conclusion, UMB is always preparing for the worst. We have strong capital levels and a very strong liquidity position, along with a loan deposit ratio that allows us to be there for our customers. We've demonstrated to our customers and employees that we put them first. Lastly, most importantly, we have a credit team that is battle-tested with superior results when it matters during times of crisis. Now, I'll return to the comments that we prepared. This quarter's release and investor call are certainly not routine. Our focus today is less on quarterly results and more on how we're responding to protect and support our associates, customers, and communities, along with details on our portfolio and how we're positioned to operate through this crisis. We came into this crisis in a good position, with healthy capital levels and a balance sheet that provides us flexibility. While we don't know how long this current environment will last, we are prepared and true to our style; we have taken a conservative stance with our positioning. First, I'd like to share some of the actions we've taken in light of the rapidly changing environment. Operationally, we activated our business continuity plans on March 16th and took steps to protect our associates and customers. UMB was one of the first in our region to move to drive-through only service in our branches, and we were able to quickly transition much of our team to a remote work model. We've implemented additional safety practices and added supplemental compensation and additional PTO days for roles that can't be performed offsite. Our technology, digital, and online banking platforms have performed well, and we've been able to continue to serve and support our customers on an uninterrupted basis. Now, I'll turn to our first quarter results announced yesterday afternoon. You'll see that on a GAAP basis we recorded a net loss of $3.4 million driven by the impact and adoption of CECL, which resulted in significantly higher provision expense based on how the economic models calculate the possibility of future credit losses under the extreme conditions created by the COVID-19 crisis. Excluding this impact, business and financial results remained strong and demonstrated by a 5.6% increase in pre-tax, pre-provision income to $83.7 million from the linked quarter. Today, we've seen our peer group report a median increase of 3% in PTPP income. Unfortunately, the ill-timed adoption of CECL methodology during this unprecedented macro environment has resulted in additional volatility at a critical time. This has made comparing financial institutions across the banking industry extremely difficult, if not impossible. Given all the subjectivity that has gone into these calculations, including the source and date of economic forecasts, the industry has spent months creating and testing CECL models. But they weren't meant to operate with such significant movements in unemployment rates, GDP expectations, interest rates, and economic forecasts, especially in such a compressed timeframe. Arguably, not all unemployment rates are created equal. While today's rate has now exceeded the peak levels seen during the 2007-2009 recession, different industries are being impacted this time at varying degrees. Each bank's loan portfolio is inherently different, and national unemployment rates aren't always relevant. Additionally, banks such as UMB, who have less reliance on consumer lending, including credit cards and mortgages, will likely see their portfolios react differently. Another consideration is the extraordinary amount of fiscal stimulus that has been injected into addressing this crisis. For context, during the prior financial crisis when employment rates jumped from 4% to 10% over a 12-quarter period, our cumulative losses were only 1% of our balances, with over half of that in the card portfolio. Our performance was the second best in our mid-sized peer group. For comparison, credit card balances were 7% of our loans in the 2009 crisis compared to just under 3% during this crisis. UMB has always had a reputation for being responsive, consistent, and conservative as it relates to credit. We are quick to get in front of problems, quick to move credit to the watch list. But most importantly, we have a good track record of keeping ranked credits from moving to loss, based on our relationships with our clients. The CECL methodology makes it more difficult to provision in a way that we feel is appropriate for what we know about the quality of our portfolio. We've provided some additional information beginning on Slide 9 of our materials, and Ram will discuss those in more detail shortly. Aside from the percentage impact, our asset quality was strong with net charge-offs of 0.23% of average loans. Our provision of $88 million under CECL equates to 11.5 times net charge-offs of $7.7 million for the first quarter and nearly 11 times the last four quarters' average provision. Another compelling statistic is our reserves to non-performing assets, which have historically been above peer averages and stand at 1.9 times compared to a peer median of 1.6 times. Average loans increased 11.6% on a linked quarter annualized basis. On an end-of-period basis, growth was 3.9% compared to the year-end of 2019. Our top-line loan production of $816 million and a net increase in revolving balances of $321 million were partially offset by $611 million of payoffs and paydowns. The growth in commercial loans in the first quarter included approximately $388 million in net line draw activity. Line utilization at March 31st was 41% compared to 39% at year-end. Similar to what we've heard from other banks, draw activity has slowed in April, as shown on Slide 13. In early March, we began proactively reaching out to our clients we knew could be more severely impacted by the impending economic crisis. Our entire business banking customer base, largely our practice finance portfolio of dentists, doctors, and professionals, was offered a six-month deferral to help them weather the storm. Through our usual relationship management process, we've been working towards customized solutions for other borrowers. Including the business banking deferrals I mentioned before, we have received requests for modifications on approximately $1.7 billion of our loan portfolio, or about 12% of the book. The breakdown of those requests by client type can be found on Slide 13. This is similar to the levels reported in industry service. When the SBA's Paycheck Protection Plan program opened up, we were ready and moved quickly. We were able to process and get approved 3,000 applications for more than $1.4 billion in funded loans. These loans have ranged in size from $2,000 to $10 million, with the median of $122,000. I'm extremely proud of how our team stepped up to provide this critical support to our clients, and we were ready to step back in with a backlog of another 1,700 applications when the second phase of the program began on Monday. Now, I'll turn it over to Ram to discuss some of the drivers of our results and I'll come back to provide a little more detail on the composition of our loan portfolio.

Thanks, Mariner. I'll begin with comments on CECL and the drivers of our increased allowance for credit losses which began back on Slide 9. At adoption on January 1, our allowance for credit losses increased by 8.8% or $9 million to $110.8 million. Net charge-offs drove a reduction of $7.7 million, and portfolio changes, including loan growth, mix and qualitative changes, added $21.2 million. For the economic outlook adjustment of $66.8 million under the CECL model, we used the March 27th Moody's Baseline economic forecast. This brings our total allowance to $191.1 million at March 31st. The reserve build added 59 basis points to our allowance to loan coverage, which was 1.4% at quarter end. Our econometric models are built on regressions and correlations during the prior financial crisis to changes in some of the key economic variables applied to our loan portfolio. As we disclosed last quarter, some key variables considered in our model today include the unemployment rate and treasury rates. We have taken a conservative approach to our CECL modeling in light of the volatility and frequent changes in economic expectations, especially when you consider the modest at-risk portfolio disclosures that Mariner will address shortly. Approximately two-thirds of the increase in our allowance can be attributed to our commercial and industrial portfolio. Since the end of the first quarter and subsequent to finalizing our CECL estimate, the economic forecasts have deteriorated further than our model inputs, including conditions that are materially worse than prior recessionary periods and what most models were built on. But we've also seen an unprecedented amount of fiscal stimulus being injected to address the crisis with likely more to come. Additionally, unlike prior recessions, this crisis has the potential to correct meaningfully in a very shortened timeframe. The direction of our future reserves will depend on observable trends within our portfolio and loan growth, coupled with macroeconomic forecasts that will be available at the measurement date at the end of the quarter. Other factors such as the shape, timing, and magnitude of the recovery will also play a part in assessing future allowance levels. It is important to note that our first quarter provision isn't an indicator of a run rate for the remainder of the year. Now, looking at the quarterly results, net interest income of $173.9 million represents an increase of $1.6 million from the fourth quarter driven by 11.6% annualized growth in average loans and excess liquidity, along with decreased deposit costs. Total earning asset yields fell 18 basis points to 3.58% from the linked quarter, driven largely by a 23 basis point decline in loan yields. Interest bearing deposit costs also declined 18 basis points for a beta of 44%. As the rate cuts were in March, we'll see this impact more clearly in the second quarter. Net interest spread increased 1 basis point despite a 150 basis point reduction in short-term interest rates. Net interest margin compressed by 5 basis points from the fourth quarter, driven almost entirely by the declining benefit of free funds. The positive impact from lower interest bearing liabilities was offset by loan yields repricing. As stated, fee income was $98.4 million for the quarter and reflected some impacts from the volatile markets, including negative market valuation adjustments to a few line items. The largest reduction was in company-owned life insurance or COLI income, which decreased $16.6 million compared to the fourth quarter. Additionally, derivative income and the valuation of some other investments in our trading inventory were impacted as discussed in our earnings release. Expenses for the quarter decreased 7.3% or $14.8 million compared to the fourth quarter, largely related to a $15.7 million reduction in deferred compensation expense, the offset to the reduced COLI income I mentioned. Partial offsets include a typical and seasonal increase of $8.1 million in payroll taxes, medical insurance, and 401(k) expense in the first quarter. Additional details on non-interest income and expense can be found on Slides 5 through 7 as you analyze our results. We continue to maintain strong regulatory capital ratios with the CET1 ratio of 11.9% based on the adoption of interagency guidance for regulatory capital transition and average tangible common equity to tangible assets of 9.7%. During the quarter, we purchased just over 1 million shares at an average price of $53.79 through both open market repurchases and an accelerated share repurchase program. We have no additional plans for share repurchases at this time other than the completion and settlement of the ASR entered into in early March. Our tangible book value per share increased to $51.04 at the end of the quarter, up 16.1% from a year ago. For comparison, our peers that have reported so far have shown an increase of 9.1%. Regulatory capital ratios are shown on Slide 16. Finally, in addition to our lower loan to deposit ratio, we have multiple primary and secondary sources of liquidity to support our customers. Now, I'll hand it back to Mariner to go into the details on our loan book.

Thanks, Ram. A snapshot of our loan composition at the end of the first quarter is shown on Slide 21 and we have a breakdown of our commercial portfolios by asset class on the following pages. Our commercial and industrial book, shown on Slide 23, stood at $6.2 billion at the end of the quarter, representing 44.2% of our total book. The portfolio was well diversified by industry. Our commercial real estate portfolio detail begins on Page 24. Our total CRE portfolio stood at $5.3 billion at the end of the quarter, and approximately 40% is comprised of owner-occupied real estate, farmland, and residential construction. The remaining 60% is investment CRE where our largest exposures are multifamily, industrial properties, and office buildings. While loan-to-value ratios vary by property type, the average is 63%. You'll see the full mix and other detail on Slide 25. We have many long-term relationships with sponsors who have managed through prior economic cycles, and we're primarily a recourse lender. Our investment CRE portfolio overall is 90% recourse. Next, on Slide 26, we've called out our exposure to industries that are viewed as having more exposure to the pandemic, with additional detail on how we're viewing those. We identified the five categories shown, then looked at each for specific characteristics or specific credits that we feel comfortable with, as well as those which we may think carry more risk if the current environment is prolonged. The balance shown in the column labeled 'Potentially More Impacted Subset' is what we're monitoring more closely, and you'll see that amounts to just under 9% of our total loan book. I don't think it's appropriate to make a blanket statement about a particular industry or category as that's not how we look at our book. We know our customers well and have an active dialogue with them in all environments. We generally have strong sponsors, and as I mentioned, our CRE book is largely recourse. I'll begin with our oil and gas portfolio, and the breakdown by segment is shown on that same slide. We had $457 million outstanding at the end of the quarter, representing 3.3% of total loans, which has remained steady since the last focus on oil prices in 2014 and 2015. Many of our energy clients have been with us for years, and we've worked with them through the last cycle. We have strong equity sponsors in place for much of the book, and many customers are well hedged against oil price volatility. As shown in the table, $215 million of the oil and gas portfolio is currently receiving more scrutiny and is comprised of credits in the service sector and those customers most impacted in this environment, and a few of our upstream credits that are more heavily dependent on oil prices and possibly have less protection in place. This brings us to a total in the more impacted column for our oil and gas loans down to 1.5% of total loans. In CRE, our multifamily and student housing portfolios had a combined $664 million outstanding at quarter-end, with 14% of which is for projects under construction that are not expected to come to market within the next six months. A largest portion of our multifamily loans are for Class A developments. We have not yet heard of significant stress, but a longer shutdown or deeper recession could obviously impact the professional workforce as well, and we are in close communication with our clients. This book is 87% recourse and has weighted average LTVs of 59% for multifamily and 67% for student housing. This brings the total in the more impacted column for multifamily down to 2.6% of total loans. Retail CRE of $445 million is broadly diversified, and a substantial portion carries guarantees from top sponsors. 38% is grocery-anchored retail centers, and less than 5% is for properties that are majority occupied by restaurants. This book is 90% recourse and has a weighted average LTV of 61%. This brings the total in the more impacted column for retail CRE down to 1.7% of total loans. Our total hotel portfolio is $328 million, representing 2.4% of total loans, and you'll see that the portion we currently have under closer scrutiny is $201 million, or 1.4% of loans. 16% of our outstanding hotel balances are under construction, and again, that excludes any that may come to market within six months. Our entire hotel portfolio is recourse. All properties are flagged with major brand families, and the majority are limited service hotels versus full service. The weighted average loan to value is 62%, and the average debt to service coverage ratio on our stabilized hotel portfolio in 2019 was 1.90x. In our transportation service category, the largest portion of the $293 million in balances are truck transportation and warehouse clients. Much of that group are leaders in their industry with strong net worth and liquidity. We have minimal exposure to passenger travel or tour companies, which are less than 1% of total loans. After review, the more impacted portion of that book is just about 1.5% of total loans. After an in-depth analysis, the portion of balances in these five categories that we view as being highly impacted represents about 9% of total loan balances. Of course, this isn't any indication that we think those will all be losses, but we will continue to keep a close watch as conditions evolve throughout this crisis. Finally, we have a strong capital and liquidity position and a history of prudent risk management and believe our diverse revenue sources help provide a buffer in this interest rate environment. We've been through many crises in our 107-year history, and we're proud to work alongside our peer banks to help navigate through this one. To wrap up, after digesting other banks' earnings this season, it's abundantly clear that there is a great deal of subjectivity that goes into the allowance process more so than ever. As you've heard us say, our credit management team has been together for a long time, with an average tenure of 21 years at UMB. We take a conservative approach and a proactive approach to credit management and remain confident that our credit quality will remain one of our key differentiators, especially during periods of stress. I want to recognize and thank our team members who continue to go above and beyond every day as we serve our clients. It has brought everyone together during a difficult time, and it has reinforced what we've always known: relationships matter. That concludes my prepared remarks, and I'll turn it over to the conference call operator for the Q&A portion of the call. Thanks a lot.

At this time, our first question comes from Ebrahim Poonawala of Bank of America.

First, I want to address credit. I appreciate the insights provided, and I have a two-part question. From a quantitative viewpoint, Ram, on Slide 10, you noted reserve levels at 150 basis points of projected loss in a stress scenario. We've observed a range in reserve levels among banks, from 40% to as high as 70%. Could you elaborate on the severity of the downturn or economic conditions assumed in that loss scenario? Is it fair to say that unless the macro outlook worsens, you should be finished with the reserve building phase?

Yes, Ram, why don't you take that? It seems to be primarily a modeling question.

So, we’ve seen some of the peer data on that same metric, and I can’t speak for others in terms of our coverage of DFAST losses. First thing, DFAST and CECL are two different tracks. They’re completely for two different purposes, right? Obviously, DFAST is a 9-quarter outlook versus the life of the loan contract. But I’ll go back to what I said in the script. I mean, Mariner mentioned this too. We have taken a pretty conservative approach based on the volatility that we saw at measurement date of March 27th in the Moody’s economic forecast looking ahead. So those are considered in. We didn’t lay any negative overlays on what the model output was in terms of some of these stimulus programs that are out there and how shallow this recession could potentially be. So this is pretty much a straight-up model exercise in terms of how we approach CECL with it and then DFAST, which is, as I said, completely different ball game.

So, if I understood correctly, you did not factor in any loan losses based on the model's projections concerning the stimulus actions?

And the stimulus actions that all the things that Mariner just walked us through in terms of the at-risk portfolios, right? Within the at-risk portfolios that people have generally labeled, there’s only half of that we think we need to monitor a little bit more closely because we have recourse and we have a lot of different things that can protect us. So that’s not truly taken into account either.

I believe, Ebrahim, your question relates to the second quarter. While it's still early to provide too many specifics about what might occur then, it's evident that various banks have implemented numerous qualitative overlays regarding CECL. As we approach the second quarter, given our conservative approach, we think we've positioned ourselves for it by being cautious in the first quarter. We plan to conduct thorough analysis regarding the second quarter, focusing on the unemployment rate, potential stimulus, and how unemployment affects different segments of our portfolio. We will keep utilizing qualitative analysis as we move into the second and third quarters.

And I guess, just a reminder following up. So you mentioned the difference in the portfolio. Credit loans much smaller. They were the big driver of losses last cycle. I guess the other side of this is you've grown the bank a lot in terms of commercial lending. A lot of that has been CRE and C&I out of market. Just to talk to us in terms of your level of confidence going into this cycle relative to your CEO going into the cycle. And just in terms of your borrower base, your confidence in customer credit quality?

First of all, you mentioned something about out of market. We have very little exposure to that, so there seems to be a misunderstanding about our portfolio. Most of our loans are in a different category.

I guess, I meant all of the legacy markets, so expansionary markets, be Texas, Denver et cetera?

Okay. We've been in Denver since 1995, so I don't really consider any of our markets to be particularly expansion markets except possibly Texas, which has been under ten years. However, we were lending in Texas before we opened offices there. We've previously discussed our loan growth, and around ten years ago we took steps to better penetrate our existing markets without increasing risk. We transitioned from being generalists to hiring marketing professionals, attending conferences, and creating marketing materials along with tailored pricing to compete in specific market segments. We also invested in personnel in markets where we had less exposure and adjusted our compensation structures 15 to 20 years ago to support our teams' efforts. So, what I've been emphasizing for quite some time is that we were under-penetrated, and a significant part of our substantial growth stems from that under-penetration, which enables us to capture more market share. We are not weak; the only change in our growth rates over the last 20 to 15 years is that the strategies I've mentioned have not altered our credit underwriting, which remains consistent. The same team manages that, and we have enhanced our marketing and sales efforts over the past decade to claim our rightful share of the market. We possess very low market share in all the markets we operate in, which we refer to as a runway for growth during our discussions. We believe we can continue to penetrate those markets without taking on additional risks. Regarding commercial real estate, we've thoroughly discussed our approach. We are a recourse lender, focusing on sponsors and global liquidity, which gives me a high level of comfort. The most important point is that we haven't significantly changed our operations. I'm the same CEO I was 16 years ago, overseeing our credit processes for that entire duration. Tom Terry, our Chief Credit Officer, has been with us for 34 years, and Jim Rine has been with us for 26 years, among others. As I mentioned in my prepared remarks, I can't make any guarantees, but I can assure you that we maintain a high level of consistency.

And just separately, if I could, Ram. In terms of the margin, understand there’s a lot of volatility, but if the rate environment stays where it is, what’s your sense in terms of the cadence of margin compression from this point on? And do we see stabilization at a higher level relative to where we were when rates were zero back in 2015?

Yes, as you mentioned, Ebrahim, there are many factors affecting the margin outlook. We have disclosed that we have done $1.4 billion in PPP loans so far. These fees will be amortized over a 24-month period until a significant portion of these loans is either repaid, forgiven, or matures, which will affect our margins in the third and fourth quarters. Excluding PPP, we have been successful in establishing loan floors on most of our new production, and we've also done well with renewals in our existing portfolio. This quarter, we were cautious about our deposit pricing, with cost of deposits in March being 20 basis points lower than in the first quarter. We're carefully evaluating deposit costs, which is a good use of our excess liquidity and should have a positive effect on margins. Additionally, regarding LIBOR, one-month LIBOR was around 99 basis points on March 31 and has now decreased to about 40 basis points. Some of our loans are tied to this index, but we have been successful in adjusting rates upon renewal. Lastly, concerning yields on our portfolio, the 10-year yield is currently below 60 basis points, and we observe a roll-off yield of about 2.25%. We're earning slightly less than that, influenced by a mix of mortgage-backed securities and municipal bonds. I want to highlight that our net interest spread, as you saw this quarter, is expected to remain fairly stable. The impact of free funds and the value of our DDA balances, which represent over 30% of our debt, may lead to a reduced benefit in the future. That’s a lengthy way to say that we typically do not provide standard margin guidance.

Yes, I believe a significant portion of our deposit repricing occurred in late March, so you will notice much of the positive impact in the second quarter.

Our next question comes from John Rodis with FIG Partners.

I appreciate all the detail, Ram. I have a modeling question. Regarding the share count, you mentioned in the press release that you will complete the ASR in the second quarter. How will the share count change from the end of March to June?

So the way the ASR works is 85% of the 30 million through the ASR has already been retired or put in treasury stock. So the 15% the broker-dealer just holds back for any volatility in the stock price, the other 15% could be another 100,000 and 150,000 shares from where March 31 ended.

Okay, so not a big difference. But is the buyback on hold?

Yes.

Correct.

You mentioned the PPP loan program. What is sort of the average fee that we should expect? I assume, it's probably in the 2% to 3% range, but can you narrow it down?

Yes, I’ll provide that information. Based on the profile we’ve seen and what we disclosed, the average loan size is approximately $122,000. Currently, we are trending towards a loan origination fee of about 2.50 percent, which is gross. Additionally, we need to consider the funding cost, which could involve the PPP lending facility that funds these loans at 35 basis points. There are also various incremental and marginal costs associated with the program, such as legal, regulatory, and the costs of new systems that we have purchased to serve our customers effectively. These are the key factors influencing the economics of the PPP program.

Yes, John, just as a reminder too. This is really a service we’re providing. We don't really see this as something we’re making any money on at all. This is a government program. We’re an agent. If we cover our costs at the end of this thing, I'll be surprised.

No, listen, I understand, it's obviously extraordinary times. The banks are part of the solution this time around.

Yes.

I have two questions for you. First, I’d like your thoughts on the loan pipeline moving forward. The first quarter was robust, but I believe we may have seen a significant slowdown since then. Secondly, could you address the increase in service charges related to health care? Do you anticipate this to be a recurring trend, or is it likely more of a one-time occurrence?

I’ll address the first question about the pipeline and then I’ll hand the second one over to Jim Rine. We have a long history of providing our investors insights into the upcoming quarter, and that’s about the extent of our forward-looking guidance. The second quarter appears to be as strong as the first quarter based on the pipeline, indicating a solid performance. However, I cannot predict the third and fourth quarters due to current conditions that limit our ability to engage with potential borrowers. If things do not improve significantly, I anticipate some slowdown in the latter quarters. But for now, the second quarter looks promising.

Mariner, I apologize. The pipeline is strong. However, do you think the pull-through rate might be lower due to the current situation?

No, the way we handle our pipeline indicates that we have a strong chance of accepting and booking opportunities. Therefore, we expect the second quarter to be quite strong, similar to the first quarter. However, there are no guarantees.

I fully understand.

Yes. And then, other refers to fees, I’ve got Jim Rine, our CEO of the bank who has prepared. Those businesses roll to him. He can give you a little color on the fees.

So on healthcare, you saw a spike in the service charges and that was related to one relationship that we still have the deposits and the business that was transferring the actual custodial relationship on the accounts. The deposits still are growing in our health care space. The pandemic is still remains to be seen as far as how it will impact the industry in general. But high deductible plans should become much more favorable as employers look to continue to reduce costs going forward. So we’re -– while right now, we don’t see full impact of how things will play out through the course of the year, we did see some of the card activity reduce also in March. But we will know more in the next few months how the rest of the year plays out there.

Okay. So the move over, though, from that one relationship is sort of a one-time item, I guess?

It was one-time, and we continue to maintain those deposits.

The next question comes from David Long of Raymond James.

The first question I have relates to these large commercial customers you talked about that caused an increase in your non-accruals. Can you talk about maybe what industry that was or what changed with that relationship or if there’s anything else you can disclose that caused that move?

There are actually two relationships that led to that change. Let me take a moment to explain how non-performing and criticized credits function at UMB. We have a long history that shows some volatility in this area. The reason for this is our proactive approach; we are quick to identify and address problems. We have a solid track record in doing this. If you examine the chart that tracks the transition from criticized to doubtful or loss credits, you will notice that the migration from non-performing or criticized to loss is minimal. Occasionally, you may see two or three credits classified as non-performing, which can cause a spike in those numbers. This typically happens because we identify and address them early on. In this instance, there are two credits—one in the energy sector and one in agriculture. For the agricultural credit, we believe we have sufficient collateral to manage the situation. As for the energy credit, we have already set aside reserves for what we currently estimate to be our exposure. Over time, I expect our numbers to return to historical averages. This summarizes the situation and our views on these two credits.

And then my second question relates to your trust and securities processing line. Is that more driven by market values, transaction volumes, or a mix there? And then what type of trends have you seen in that business?

Hey, Jim, why don't you take that? We’ve got some good news there to share. And then, of course, market impact is definitely part of it.

The fees in that business come from two sources; some are due to market movements. However, we have maintained a strong backlog in that area. In our wealth management sector, new business from customers has increased by 50% compared to Q1 of 2019, and assets under management from new clients have risen by 79%. In our fund services segment, we have successfully onboarded new clients and are experiencing significant growth. We are optimistic about our positioning. In terms of market decline, equities dropped approximately 35%, while our portfolio values decreased by only about 10%. Therefore, our declines did not reflect the overall market trends, and some fees depend on market performances, although others are more consistent flat fees, resulting in a mix. Nonetheless, the business continues to thrive. We are investing in it and will be launching a new platform for private wealth management this year, which will enhance our ability to accommodate additional alternative investments and improve the client experience. We have many positive developments in this area, and we are committed to further investments without scaling back on growth-related projects.

And our next question comes from Christopher McGratty, KBW.

Ram, I have a question about the expenses. I understand the offsets on the COLI that affected both fees and expenses. If I remove that $16 million and consider the $8 million in seasonal expenses you mentioned, is that the correct way to think about where expenses might be in the near term, knowing that you might reduce some costs due to restrictions on travel and marketing?

You got this, Ram, go ahead.

Yes, the $8 million represents seasonal expenses. Jim Rine mentioned that in this environment, we haven't reduced our investments. We remain committed to our strategy, so you can expect some inflation related to that. However, as we've always stated, we will closely monitor discretionary spending. The lockdown has created opportunities for synergies in travel, entertainment, and marketing, so we will be vigilant about our expenses in that area.

Yeah, we should definitely continue to outperform there as both the lockdown conditions persist. As well as we've continued to, through this environment, learn that we can continue to be more efficient in the way we're operating.

And then, of course, in the disclosures we also have some of the expenses that we track related to the COVID crisis and in the first quarter we had 250,000 or so or less of that. Some of the programs that Mariner talked about, whether it’s the supplemental pay or just in terms of our readiness and preparedness for COVID, you'll see some of that impact our expense line. But, again, it depends on how long this lasts. So those will impact our expense trajectory as well.

Okay, and just a couple small ones. The disclosures were great in the deck. The reserve ratios, we're getting some questions just for banks on specific of those portfolios that you deemed somewhat higher risk. Do you have the reserve that you have set aside on both the hotel and the energy portfolio?

The energy portfolio has a qualitative reserve of about $13 million, which is 3.5% of that portfolio. As for the hotel, I'm not sure of the specifics. However, referring back to what Mariner mentioned, we have been able to reduce the hotel portfolio. After considering recourse, it represents a very small portion of our overall exposure.

I have noticed that many announcements recently have been quite standard, resembling a simple accounting exercise. It seems a bit lazy to me, just taking the entire portfolio and saying that everyone is focused on hotels, so here is our hotel portfolio, and that's it. We made an extra effort to highlight what really concerns us because I don't believe the correct approach is to label the whole portfolio as at risk, as that's not accurate. Instead of merely performing a basic accounting task and displaying what we have in each category, we broke it down to explain our real concerns and how we perceive the actual risks, which are detailed in the two columns on the right of Page 26, where we outline reasons for exclusions. The further column to the right provides additional comments on why we may or may not be concerned about items on that list. Just because something is included doesn't mean we anticipate a loss; for instance, some entries have strong sponsors, or they may not come to market within the next six months, allowing us to reassess the situation later on.

No, no, that level of disclosure was helpful. I appreciate it. Maybe the last one, Ram. Could you help us on the effective tax rate going forward?

It's tough because of all the volatility in earnings and the percentage of tax-free income as it relates to pre-tax. So my best guess, Chris, at this point would be closer to 14%.

Is that FTE or is that non-FTE, sorry?

Yes, ETR.

I think it’s important for everyone to know about our exposure to oil and gas, as it remains similar to what it was during the 2014 energy pricing crisis. The same clients are still involved in that segment. Approximately 30% of our business is in service, which is where most concerns lie. The majority of our portfolio is hedged, and the customers we were worried about last cycle are the same ones this cycle. Those sponsors stepped up during the previous downturn, so we have strong confidence in the clients that are still with us, as they are the same ones who supported the credits during the last crisis.

Our next question comes from Ebrahim Poonawala from Bank of America.

Just a follow-up, Mariner or Jim, and it might be a tough one to answer. But I was wondering if you've seen any improvement in customer sentiment activity through the course of the last month? Means, everything, obviously, shut down in a big way in the middle of March. I'm just wondering, as things have kind of steadied in the last few weeks, is there any kind of green shoots or any pickup in activity that you’ve noticed that might be worth calling out?

The one thing I would highlight is line utilization. As the crisis began, we saw utilization increase from 39 to 41, but that has since dropped back down to 39 as of today. This may reflect customer sentiment. Generally speaking, from our conversations with clients, everyone seems to remain nervous and cautious. I don’t see anyone behaving as if they believe there’s light at the end of the tunnel right now. That’s my perspective. I'll let Tom elaborate on this. In my opinion, and I believe our customers would agree, there’s a long road ahead and not much change in sentiment to report. Tom, would you like to add anything?

No, I think you said it just right. I think there’s a wait-and-see attitude. And I think we have a very patient client base, and I think people are going to walk before they run, certainly before they start borrowing and expanding too quickly.

I would just add that our borrowers are generally on the stronger side, with better balance sheets and liquidity, which reflects the type of lender we are. Overall, our borrowers tend to operate with the mindset that things could worsen, and that's the appropriate perspective to have.

And Ebrahim, this is Jim Rine. We also have a lot of borrowers that are also essential businesses that are still active, that are quite busy, that are also going through the motions of employing safe workspaces, while going about construction contracts and things like that. While they're busy, they're certainly experiencing the new normal they haven’t experienced. They’ve experienced some delays in projects, but not outright cancellations yet. So it really is a mixed bag, which isn’t the exact answer you would be looking for, but I’m sure that's a consistent answer that you’re hearing from others.

I also think you didn’t really ask it this way, but I’ll offer it as it relates to how this is unfolding. I don’t believe that when we go back, it will look like what we left behind in February. There’s a lot of conversation about when we will return, and to me, it’s going to be a very slow process. For example, Texas is fully open but only at 25% capacity. Until we have a vaccine, when things do open broadly, it’s likely to resemble the situation in Texas rather than prior conditions. The road ahead will be long and challenging, as coming out doesn’t mean returning to 80% capacity; it may only look like 25% or 30%. That’s my personal opinion until we have a vaccine.

Our next question comes from Jared Shaw, Wells Fargo.

This is actually Timur Braziler filling in for Jared. Just a couple of questions remain here. Looking at Slide 13, the in-process modifications. The composition of that $448 million, is that any different from the existing modifications or is it pretty similar?

You want to ask that again, I’m sorry.

So for the $448 million of in-process modifications on Slide 13, I’m just saying if the industries those are in are similar to the existing modification or if that’s skewed to any particular industry?

No, there's nothing. There's no skewing occurring. I also want to mention that in my opinion, regarding modifications and forbearance in general, I’m not sure how the investor population is perceiving it. However, it seems like you are interested in understanding any potential existing problems. From my perspective, at least for UMB, modifications and forbearance are aimed at being forward-looking and providing relief to help people avoid issues rather than addressing current problems.

And just in terms of clients seeking modifications. Has that also slowed similar to the utilization rates, or is that pace still fairly similar to quarter-end?

Tom, do you have any color on that?

Yes, it has slowed. We had quite a few right at the beginning. I think PPP may have caught some people's attention. In discussions with various chief credit officers, there is a sentiment that if the recovery takes longer than May or June, we might see another wave of issues. However, we haven't observed that yet.

Yes, and by the way, my comments a moment ago, just to clear them up about the 25% or 30% comeback. That would be, I was thinking more along the lines of service, not GDP, like the utilization of what restaurant activity and concerts and such and things like that, not so much GDP. So just clarification.

And then just one last one from me, may be a big-picture question as it relates to CECL methodology. Do you actually need to see an improvement in the GDP and unemployment rates, or is there enough qualitative overlay where you can preemptively begin to lower reserve levels in advance of those metrics actually coming down?

So this is Ram. And it's a little bit early to talk about it. But if you look at the Moody's forecast, we have a little synopsis of what the forecast entails, right? So it has the unemployment rate peaking to an average of 8.7%, at least as of the March 27th forecast, and then coming down back to 6% level. So that kind of recovery is already built into how we've modeled it. And we call it may be a bathtub U recovery as opposed to any kind of V recovery. That’s not what we’re assuming in terms of unemployment getting back to normal. Whatever the new normal will be.

To reiterate Ram's comments, if that were the case, that answers your question. However, the opposite scenario is that if Moody’s changes its forecast in the second quarter to align more closely with what JP Morgan is projecting, such as 20% unemployment and a 40% reduction, we would need to respond to that. This is when we begin to evaluate the qualitative impact of the $9 trillion in stimulus. We start analyzing how unemployment affects various categories within our portfolio and consider how national data influences our book, particularly in the central part of the country, among other factors.

The next question will come from Nathan Race of Piper Sandler.

Mariner has answered my first question just on the oil and gas book in terms of how that portfolio has changed in both size and client compositions since the 2015-2016 downturn. But, I guess, I'm just curious if you guys have a sense or when you look back at that period what Optum loss content looked like across that portfolio?

We had very little losses in it. It actually, you know, we ranked credits and worried about them, but ultimately had very little in the way of losses.

And then just going back to the PPP loans that you guys have funded. Any sense for that $1.4 billion-$1.5 billion that you’ve funded, how much of that has actually been kind of geared towards those clients that you guys outlined on that slide that have been more so impacted?

I don't think we have the details needed to match those two up, Tom.

We don’t.

I have a couple of housekeeping questions, Tom. The securities book saw a slight increase this quarter. Clearly, there was strong seasonal deposit growth as well. Do you have any insights on how you expect the securities portfolio to develop over the upcoming quarters, especially with the PPP loans being added to the balance sheet and how you anticipate funding them?

I would say it will remain consistent with current levels. Each month, we are assessing whether to reinvest in this market. As I mentioned earlier, the yields on roll on, roll off securities, especially mortgage-backed securities, will vary. Therefore, we will proceed with caution regarding reinvestment. Ultimately, we may have excess liquidity because we expect to see the positive effects of excess liquidity similar to what we experienced during the last crisis, particularly from a deposit perspective. Eventually, we may need to allocate this excess liquidity between municipal bonds and mortgage-backed securities. Looking ahead to the next quarter or two, I intend to keep it similar to what it has been.

We have definitely observed a trend towards safety deposit gathering, similar to what we experienced during the last crisis, and we expect this trend to continue. Particularly, there have been issues within the industry regarding the rollout of PPP, which has allowed us to benefit as we acted early and began including non-customers in our pipeline, who were not being served elsewhere. I believe that we will keep seeing this movement towards safety, quality, and deposit gathering.

And if I could just add one more, just with an expense line. I know you guys don’t give guidance. But marketing was down pretty substantially sequentially and then during 2019 you guys obviously had a ramp in legal and consulting fees. So just a sense for how those line items could trend this year? It sounds like you guys have some delays in the timing of some projects and so forth. So just trying to put them in context in terms of the run rate of those items.

Go ahead Ram.

Yes. So you can see that it’s consistent with what the last first quarter was. So there is always a seasonal drop off in the first quarter. We did accelerate some of the spending for concepts in the fourth quarter, so that's why it's a little bit higher than usual as well. But as we said earlier, that’s one of the discretionary items that we will consider as we look at our expenses. Obviously, in a lockdown, some of the things that roll up into that line item are more travel and entertainment and sponsorships and things like that. So to the extent those don’t happen you might see those trending lower. But once we come out of the crisis, it's our every intent to go back on the customer acquisition side and start to market for both the consumer and card portfolio specifically.

This concludes the question and answer session. I would now like to turn the conference back over to Kay Gregory for any closing remarks.

Thanks, everybody, for joining us today. As always, you can reach us at 816-860-7106 if you have any follow-ups. And thanks for your interest and have a great day.

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