Umb Financial Corp Q1 FY2022 Earnings Call

Hello and welcome to UMB Financial's First Quarter 2022 Financial Results Conference Call. My name is Elliot and I will be coordinating your call today. I would now like to hand over to Kay Gregory, Investor Relations. Please go ahead when you are ready.

Good morning and welcome to our first quarter call. Mariner Kemper, President and CEO; and Ram Shankar, CFO, will share a few comments about our results. Jim Rine, CEO of UMB Bank; and Tom Terry, Chief Credit Officer, will also be available for the question-and-answer session. Before we begin, let me remind you that today’s presentation contains forward-looking statements, which are subject to assumptions, risks, and uncertainties. These risks are included in our SEC filings and are summarized on slide 43 of our presentation. Actual results may differ from those set forth in forward-looking statements, which speak only as of today. We undertake no obligation to update them except to the extent required by securities laws. 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 to everyone for joining us today. 2022 is off to a great start. Solid performance in the first quarter included 19.1% linked-quarter annualized growth in average loans. And we posted a $6.5 million provision release, reflecting the quality of our loan portfolio. Additionally, we had strong fee income, combined with expense levels that moderated from the previous quarter. For the first quarter, net income was $106 million or $2.17 per share. Pretax pre-provision income on an FTE basis was $125.7 million or $2.57 per share. First quarter net interest income was relatively flat on a linked-quarter basis. The positive impact from asset growth and balance sheet moves we made was offset by the sale of our factoring portfolio and the continued runoff of PPP balances, along with fewer days in the quarter. Non-interest income for the quarter totaled $123.7 million, an increase of 4.1%, compared to the fourth quarter. Ram will share more detail on the various drivers. But we saw positives across many of our fee businesses, highlighted in the line of business update in our presentation. In the current economic and regulatory environment, there are a few items that position us well from a fee income perspective. First, we don’t rely on mortgage gain on sale income, which is likely to be a drag for some of our peers heading into a raising rate environment. Second, NSF and OD fees are a very small portion of our deposit service charges and represent well less than 1% of total revenue. And while early, we’ve begun to see a return of 12b-1 fees as interest rates rise. For the full year 2019, brokerage income where those fees are booked was $31.3 million. As rates fell in subsequent years, that total dropped to just $12.2 million in 2021. A normalization of that income stream is a tailwind for us. Total non-interest expense fell 3.5% on a linked-quarter basis, as some of the higher than typical expenses we discussed in the fourth quarter moderated. Excluding contributions from PPP, we generated positive operating leverage in the first quarter of 2022 of 6.2% on a linked-quarter basis, and 7.8% versus first quarter of last year. Moving to the balance sheet, Slide 24 is a snapshot of our loan portfolio showing the drivers behind loan growth I mentioned. Average loans for the first quarter excluding PPP balances increased 15.6% year-over-year, and more than 19% on a linked-quarter annualized basis. We saw phenomenal growth in C&I balances with balances increasing 35% on a linked-quarter annualized basis. Commercial real estate loan demand is strong, particularly in industrial projects, although developers are closely monitoring the cost of materials and labor. Most of our year-to-date activity and real estate has been in our Salt Lake City, Kansas City, Denver, and St. Louis markets. Average residential mortgage balances grew 4.4% from the fourth quarter to just over 2 billion. As I mentioned, we don’t rely heavily on mortgage gain on sale revenue. However, we continue to grow our own portfolio and recently implemented a new Down Payment Assistance program. The program launched in December of 2021 is geared towards underserved markets, and it had 47 new applicants just in the first quarter. Total top-line loan production, as shown on slide 25, was again very strong, coming in at $1.1 billion for the quarter. Pay-offs and pay-downs were 5.1% of loans, in line with recent quarters. While estimating pay-off can be unpredictable, we continue to see opportunities across all verticals in the second quarter. Based on what we see now, gross loan production is likely to be stronger than the first quarter. Asset quality, as shown on slide 26 and 27, remains strong with net charge-offs at 20 basis points for the first quarter, consistent with our outlook and our historical averages. We did see an increase in nonaccruals from the fourth quarter levels, which is largely driven by one relationship. At this time, we feel like we’re in a good position there and expect a favorable resolution in the coming weeks. As we head into the cycle, I look back on previous periods and how our credit metrics have performed. The real test of quality comes when conditions are negative. Back to the balance sheet. Strong deposit growth continued in the quarter with average balances increasing nearly 12% on a linked-quarter annualized basis. Despite our strong loan growth, our average loan-to-deposit ratio remains low at just 53% for the first quarter. This provides us with flexibility in a raising rate environment. We have plenty of opportunity to fund the growth potential we see in our pipeline. Yesterday, our Board approved a quarterly dividend of $0.37 per share and renewed the standard annual 2 million share repurchase authorization. These remain important in our toolkit for capital deployment in addition to opportunistic M&A. Finally, our latest corporate citizen report has just been published and is available on our website. It highlights our continued efforts and actions related to environmental, social, and corporate governance issues. Our strong first quarter results position us well for the rest of the year, and we are encouraged by the activity we’ve seen so far in the second quarter. Now, I’ll turn it over to Ram.

Thank you, Mariner. Net interest income was relatively flat compared to the fourth quarter at $210.4 million. The impact of the $1.2 billion in average earning asset growth was offset by the $4 million reduction in PPP income and fewer days in the quarter. We amortized $1.7 million of PPP origination fees into income and the overall PPP contribution to the first quarter net interest income was just under $2 million compared to $6 million last quarter and $13.4 million in the first quarter of 2021. At quarter-end, our PPP balances stood at $77.2 million, down from $136.5 million at December 31st, with approximately $2 million in unamortized fees remaining. Average earning asset yields decreased 2 basis points to 2.47%, with loan yields impacted by the sale of the factoring book and the $118 million decline in average PPP balances. As shown on slide 21, our Fed account, reverse repo, and cash balances moderated slightly and now comprise 18% of average earning assets with a blended yield of 30 basis points compared to 26 basis points in the fourth quarter, as this reflects that liquidity balances still remain elevated from pre-pandemic levels. The 3% increase in average deposits from the fourth quarter was driven by growth in DDA balances. The total cost of deposits, including free funds, remained at 8 basis points. First quarter net interest margin fell 2 basis points from the fourth quarter to 2.35%, driven largely by changes in loan mix offset by positive impacts from changes in the AFS book, the decline in liquidity levels, and number of days in the quarter. We added slide 30 in our deck to show the estimated impact to net interest income in various rate scenarios. In a rate ramp scenario of plus 100 basis points on a static balance sheet, net interest income is predicted to rise 1.7% in year one and 7.5% in year two. On the asset side, 56% or about $9.7 billion of average loans are variable rate, and of those, 63% repriced within 12 months. They are tied to short-term rates with just under 60% tied to LIBOR. Additionally, the securities portfolio is expected to generate nearly $1 billion of cash flow in the next 12 months available to be reinvested at higher rates. Notwithstanding our strong loan growth, our securities portfolio has continued to grow. As we indicated in our press release, we transferred securities with a fair value of $2.9 billion from the AFS to HTM book in March to help manage tangible capital and reduce the impact of rising rates on our equity. At March 31st, 34% of our securities portfolio was classified as held to maturity. As expected, the rate environment drove changes in AOCI, which declined by $469 million from year-end. Although fluctuations in AOCI don’t affect earnings, we’re mindful of the impact on tangible book value and we’ll continue to evaluate potential opportunities to mitigate that impact. As you’ve heard us say before, we run our business by focusing on regulatory capital ratios, which remain strong with total risk-based capital at 13.55%, CET1 at 11.81%, and leverage ratio at 7.53%. Back to the income statement. Noninterest income for the first quarter was $123.7 million, an increase of $4.9 million from the fourth quarter. Deposit service charges increased $3 million and included a $3.5 million increase in client transfer and conversion fees in our healthcare business. As Mariner mentioned, NSF/OD fees included in this line represent less than 1% of our total revenue and came in at just $1.4 million for the first quarter. Derivative income increased $1.9 million from the prior quarter and company-owned life insurance income increased $823,000 on a linked-quarter basis. Both are included in the other income line and the COLI income has a similar offset in deferred compensation expense. Other drivers to fee income, including the $2.4 million gain on the sale of our factoring business and reduced investment security gains are shown on slide 22. Non-interest expense trends are shown on slide 23. The $7.7 million linked-quarter decrease was driven by reductions from the elevated fourth quarter levels in variable costs such as incentive compensation and lower legal consulting and marketing costs. These were partially offset by the typical seasonal reset of payroll taxes, the increased deferred compensation I mentioned, and higher bank card expense. Our effective tax rate was 15.7% for the first quarter. For the full year 2022, we anticipate it will approximate 17% to 19%. That concludes our prepared remarks. And I’ll turn it back to the operator to begin the Q&A portion of the call.

Our first question today comes from Jared Shaw from Wells Fargo. Your line is open.

Hi. Good morning. This is Timur Braziler filling in for Jared. Maybe just starting on the funding outlook. So clearly, with the 53% loan-to-deposit ratio, you guys have options. I’m just wondering as you look at the loan pipeline and the optimism that remains there, how are you thinking about funding that growth in a rising rate environment? Are you going to primarily keep utilizing cash to help fund that growth, maybe utilize some of those securities cash flows, or the expectation that period end or end of period deposit balances ramp higher as the year goes on?

Yes. Thanks for the question. I’d say, we’ve got obviously with the loan-to-deposit ratio and the shortness of our investment book and what we keep at the window, we’ve got lots of flexibility to fund the growth, and we can kind of tap what we need to tap.

Okay. And I guess, as you think about the deposit book and rising rates and deposit betas, is that going to be a driver of keeping betas lower for longer? How are you thinking about deposit betas in a rising rate environment?

Ram, you can take that. I mean, high level, we’ve shocked that. We’ve analyzed it in seven ways to Sunday. We’re just going to have to monitor it. And a lot of what happens to deposit betas will have to do with what the three or four largest banks do with their deposit rates. And we’ll have to follow. We have some index funds. 25% of them are hard index. And that’s going to do what it’ll do. So, deposit betas are something that we’ll just be monitoring. We have a history of being just around 50% on deposit betas. And we’ll see where all that ends up.

Yes. From a modeling perspective, Timur, we do assume a similar deposit beta experience as last time, so. But certainly, given the 53% loan-to-deposit ratio, the securities cash flow, there’s a lot more flexibility on the soft index and the non-index deposits for us to be a little bit more disciplined about it. So certainly, that will be part of our thinking for ‘22 and ‘23.

And then, Ram, I saw in the deck that the reinvestment yields in the first quarter were still kind of high 1%. I’m just wondering, what are you seeing today for reinvestment out of the bond book?

Yes. It’s about 70 basis points higher than where the roll-offs are going to be. So if you look at our one of our slides, for the next 12 months, we expect roll-offs to be under 2%. And based on where the two-year and the five-year are today, our yields are closer to 265 to 270. So, there’s a nice pick up assuming this stays the way it is.

Okay. And then, just last for me. Nice to see continued line usage ticking up in the commercial book. I’m just wondering, is there any particular industries that you’re seeing incremental optimism, or is much of that line usage coming from? And are we pretty close to level of stability there, or is the expectation that line utilization continues to ramp higher through the year?

We’ve got Tom Terry with us. Let’s let Tom take that.

Yes. It’s a good question. The utilization really has been across the board. Our C&I business has been very strong. So, there is not one particular industry to look at.

We now turn to Nathan Race from Piper Sandler.

Question just on the rate sensitivity. I appreciate the disclosures on slide 30. And I think Mariner just mentioned that about 25% of the deposit base is hard or soft indexed. I believe, Ram, you threw out a number of close to 30% a quarter or two ago. So just want to confirm that. And if the 100% beta on those deposits is contemplated in the interest rate sensitivity, NII increase that you guys disclosed on slide 30?

The hard index Mariner referred to is around 28%, with an additional 7% that is soft indexed. The hard index is formulaic, but it does not correlate directly to a 100% beta. This means that for every 25 basis points, a client may receive between 50% to 80% of that amount. The soft index, on the other hand, offers us more flexibility and is handled on a case-by-case basis rather than adjusting market rates. This is included in our projections on slide 30.

And then, just thinking about the securities portfolio balance on an absolute basis. We had some growth in this quarter. So just curious what the appetite is to continue to grow the securities book on an absolute dollar basis from here going forward versus maybe just allowing the cash that’s on the balance sheet to reprice higher as the Fed rate increases rates?

Yes. Our hope and strategy is to continue to increase the size of our securities book. So, what is understated in the period-end balances for investment securities, as I talked about in my prepared comments, is we had about $450 million of market value decline because of what happened with rate. So, each month we talk about in our asset liability committee about reinvesting cash flows based on the current conditions, and last few months, and we’ll probably continue this. We’ll also do some overbuy with expected cash flows, either from deposit flows or just the cash on balance sheet.

And we’re keeping it pretty short. So, that’s the other part of that.

If you examine our AFS portfolio, the swap adjusted duration is 52 months. Over the past 90 days, the two-year segment of the curve has risen by about 150 basis points. Therefore, we are investing 40% of our cash flows in the two to three-year part of the curve. We are managing duration amidst the extension risk that will affect us all, considering the direction of interest rates.

I mentioned in my prepared remarks that the second quarter loan growth pipeline appears even stronger than in the first quarter, which will also contribute positively.

Got it. Just maybe turning to fees, just maybe first one, clarifying question, the $3 million in healthcare solutions conversion costs, is that more one-time in nature? Is that more of a seasonal item that impacts one-time results each quarter?

Yes, Nate, this is Jim Rine. That was a one-time event, and we don’t expect it to occur again in any significant amount going forward.

We are at the conclusion of a few relationships we discussed in previous quarters, as some of our partner companies have chosen to operate independently. With that behind us, we can now focus on their growth.

Yes. The growth on the book, that was by design that those were going to go away. On the book that we have, the growth has been 12% year-over-year, and the card spend has been up 8% year-over-year as well, without those relationships.

That’s more of the forward-looking trajectory of the business versus what was left from those two relationships.

Understood, very helpful. Also on fees, as we look out over the next few quarters, I am curious where you see a lot of the growth opportunities. Fund services and the corporate trust and institutional asset management remain bright spots across the various fee income lines. I am just curious if you expect those two lines in particular to be primary drivers for overall fee income growth this quarter or going forward.

Yes. We are very enthusiastic about these areas. The potential for ongoing expansion and growth remains strong for both corporate trust and fund services. I want to reiterate what I have said previously: the current environment for fund services is driven by two main factors. First, the activity in public markets has positively impacted the private markets, and our business is predominantly focused on providing fund services for private equity, hedge funds, REITs, and real estate markets, where we see significant investor interest. We are well-positioned as a leading player in that sector. The second factor is the disruption caused by private equity firms, which has generated substantial opportunities for us. We are quite optimistic about this. Although the linked-quarter numbers show a decline due to market activity, we've seen an increase in the number of accounts and have over $100 billion in assets under administration year-over-year, indicating positive trends. Corporate trust is another strong area, with earnings growth expected as new activities emerge. The anticipated rise in 12b-1 fees and increased government spending on infrastructure projects positions us favorably in the market. Our presence in major markets like New York and Dallas has allowed us to gain market share, particularly in coastal areas where deal sizes are larger. For example, a water district deal in New York could reach billions compared to a few hundred million in states like Illinois or Iowa. Additionally, our aviation business, which has been affected by the pandemic, is starting to rebound as travel increases and transactions rise. We are very excited about the progress in both corporate trust and fund services. All of our institutional businesses show positive profiles right now. The trends in our healthcare business look promising for the future, and as our clients expand, our investor solutions business also grows. We are experiencing strong growth in the wealth sector as well. Overall, we are enthusiastic about the trends across all our fee-based businesses and what the future holds. Jim, would you like to add anything?

I would like to note that in fund services, there is an overlap with the commercial division through the liquidity lines we offer for those funds. This has allowed the commercial division to provide referrals to fund services. Furthermore, in more traditional areas, integrated payables is one of the best methods we have to boost commercial fee income. It has proven to be a successful product for us, generating 7-figure fees in the first quarter and maintaining a strong backlog.

Coupled with commercial card.

That’s great color. If I could just ask one more on investor solutions in particular. I noticed that you guys written that in the deck banking-as-a-service solution. So, I’m not sure if that implies kind of any shift in your strategy within that line or kind of how you guys are thinking about the opportunities. Obviously, it’s a term we hear increasingly among banks these days. They want to provide more depository services and such to nonbank entities. So, I was just curious if there is kind of an update along those lines and kind of how you think about the opportunities going forward within that in particular?

I’m not exactly sure. Banking-as-a-service is what our business is focused on. Historically, this business has catered to wirehouses and brokerage firms, which is its mature segment. We have observed significant growth, as highlighted in our presentations, particularly with fintech companies looking to offer banking services to their customers. We serve as a top provider for them by allowing them to white label our banking products for their clients. I hope that clarifies your question, but essentially, our business revolves around white labeling our banking products for broker-dealers, wirehouses, and fintechs.

Right. No, I understand that. The approach to that business isn’t really changeable. I’m not sure if there’s any kind of shift in strategy going forward in terms of maybe working with some other entities outside the historical wirehouses and fintechs historically, but I appreciate that color, Mariner.

Our next question comes from Chris McGratty from KBW.

Ram, I want to clarify the 12b-1 fees. Could you please confirm if it was $12 million last year? Also, can you remind us if that was before any cuts? Lastly, how should we understand the relationship between revenues and rates? Thanks.

Yes. So, in 2019, before the Fed cut rates by 150 points on the onset of COVID, our run rate for that line item was $31 million. So, $31 million dropped to $12 million. And the point that we also make is, back in 2019, the $31 million was based on a book that was significantly smaller than what it is today. So, the potential for revenue with interest rates being hiked the way they are is pretty significant on that line item for us. And we haven’t given specifics about the beta on that. There is a lag usually, typically between when the rate goes up and when we get to see the benefit of that. But it should be a nice tailwind for us to hit in 2023 and 2024, if the future rates are where we think they will be.

Rates have been rising sooner than we expected, which shortens the lag. I would also like to point out, as Ram mentioned, regarding the old and new businesses. For instance, back in 2019, our aviation trust business was very new. This is one example. We have experienced significant growth in aviation trust and will continue to see growth, along with corporate trust benefiting from 12b-1 fees.

Okay. So, will those revenues increase this year if you trust the forward curve? And where exactly would that appear in the fee income line?

It will be the brokerage and insurance line, and we expect to see some benefits starting the second quarter based on what transpired in March.

I have a question about the indexed deposits you mentioned, specifically the 20 kind of heard index. Can you remind us where the additional benefits of having these deposits lie? You certainly don’t need them from a liquidity standpoint, but where else do you see advantages in the overall relationship with these higher beta deposits?

Broadly speaking, deposits are essential to our business, and we are prepared to endure some challenges for long-term growth. Specifically regarding indexed money, it can involve government business opportunities such as treasury services, lockbox arrangements, and bond issuance. It’s important to assess our deposits not in isolation but by considering overall profitability. We are willing to let go of certain deposits if they do not contribute positively to our profits. However, we accept some indexed or higher beta deposits due to the broader benefits they provide, including opportunities in lending, treasury services, and bond issuance fees.

Yes. That’s what I was looking for.

Yes, car service income. You name it.

I would like to know if there are any specific areas of your deposit base that concern you, considering the significant amount of liquidity that has entered the system and our efforts to determine what will remain stable moving forward.

Sorry. We have a little technical issue. Can you repeat that?

Yes, no problem. I'm curious about the risk associated with deposits and parked money, especially with the Fed unwinding the balance sheet. Your deposit growth has been impressive compared to many banks. Have you conducted any analysis to determine if there are any sizable deposits that could be at risk of leaving?

If you look at the pre- and post-pandemic volumes, we are up about $4.5 billion. We often debate internally how much of that $4.5 billion is excess and how much is due to new customer growth and customer success, just the overall growth of our business. We all have different opinions on that. What you're describing reflects the broader conversation happening across the country regarding how much of this is excess liquidity. I'm not sure we want to claim expertise on that, but we are monitoring it closely. Ram, do you have anything to add?

Yes. No, we do alternative scenarios on the interest rate modeling for precisely that surge in deposits, right? So, if you just go back to history, during the last rate cycle, just before the Fed started cutting rates, our DDA balances were close to 43% of our total deposits, and what happened as the cycle transpired was it came down to 35%, right? So, we are assuming some kind of disintermediation from DDAs to money market or other types of deposits. So, that’s all built into our alternative scenario beta assumptions. So, we do expect some of that to transpire where our DDAs are not going to be always at 45%, because of the interest rate cycles.

But where that lands...

Where that lands is anybody’s guess, and where the DARP lies.

The good news for us is that with a 50% loan-to-deposit ratio, whether $1 billion goes into other products or off-balance sheet or $2 billion, we still have a significant amount of room for loan growth and feel very confident about our liquidity and loan-to-deposit ratio.

We now turn to David Long from Raymond James.

Good morning, everyone. I wanted to dig a little deeper into the drivers on your C&I growth, and your expectations and your pipeline there. Is it driven by the PPP relationships that you gain? Is it just traditional market share gains, obviously utilization? Have you been hiring veteran bankers within your footprint? Can you just talk about how some of those are impacting that growth and what really the core drivers are?

Well, this is Jim Rine. We’ve been consistently discussing market penetration over the last several quarters, and it’s evident across all regions. We are still under-penetrated in every market apart from Kansas City. Whether it's St. Louis, Dallas, Phoenix, or Colorado, we haven't focused on just one particular industry. We are bringing in the right talent who are reaching out to the right types of companies. As we've mentioned before, we have a strong narrative and can make quick turnarounds. We remain competitive on rates and other factors. Our strategy involves targeting the types of companies we want to partner with, and we successfully retain the top talent necessary to manage client relationships and foster business growth. This approach has been our formula and has contributed to our success over many years.

You cannot activate the Commercial and Industrial (C&I) business overnight. When your mortgage segment declines and you wish to shift your focus to C&I, it doesn't occur instantly unless you are willing to take on risks that you should avoid. It requires a long, extensive calling process with established clients, as we have been developing this business for 109 years and have established a strong pipeline. Many factors contribute to reaching our current standing.

But we’re not doing things we haven’t done. We’re doing more of what we do, so.

Yes. There are a couple of areas that are currently performing well. The energy sector is quite strong, and we've seen positive results from it. Agribusiness is also rebounding thanks to rising commodity prices, leading to increased activity. On the commercial real estate front, the industrial sector remains robust, with companies stockpiling inventories for same-day, last-mile distribution. Additionally, in our Mountain Midwest market, there is a housing shortage, which keeps the multifamily sector thriving. While our performance spans various areas, these are some sectors that are particularly successful and show strong trends.

Got it. No, that’s appreciated. Good color. And then, on the competitive side, how is the competition impacting spreads in the commercial side of the business?

It’s always strong, and I don't know if there's much more to add. We pursue the best business available, and everyone seeks the best opportunities, making it a competitive landscape.

So, the pricing is always competitive in this rising rate environment, people are willing to lock things in for longer periods of time. And so, we’re doing what we’re comfortable with. But when you see a 10-year, the request for the 10-year fixed rates, we would want to have those swaps versus fixing those on balance sheet. And so, you see some people stretching right now, and we’re not willing to do that. But outside of a few folks reaching, it’s as competitive as it’s ever been.

You might see some continued back-to-back swap income for us over the next handful of quarters grow because of what Jim just mentioned, which is as customers look to lock rates, we’ll be increasing our swap fees.

Got it. Thanks, guys. I appreciate you taking my questions.

I want to highlight the information on slide 21 regarding excess liquidity, which we discussed earlier. There's a new chart in the bottom right quadrant of that slide that I think is very useful for understanding the changes in excess liquidity and where it appears on our balance sheet as well as likely other companies' balance sheets. I recommend you take a look at it.

We have a follow-up question from Nathan Race from Piper Sandler.

Just curious on how we should think about the trajectory of the reserve? It doesn’t sound like charge-offs are likely to deviate from the historical ranges that you guys have talked about in the past. So, just I’m curious if we can expect the reserve to kind of hold around 1% over the next few quarters, or do you guys expect to build just given at least high-single-digit loan growth expectations going forward?

Thank you for the question. It's indeed a complex issue. Currently, with the uncertain economic outlook, it's difficult to predict whether we are heading towards a recession or the severity of any potential recession. As someone who has been in the CEO role for 18 years and has observed similar situations, it's clear to me that before the implementation of CECL, the industry tended to reduce reserves towards the end of economic cycles, leading to insufficient reserves, which has been a recurring mistake in our sector. We've consistently opposed that trend. CECL has changed the way we approach reserves, making it more of a systematic process tied closely to data from Moody’s. The insights from Moody’s significantly influence our reserve levels. I am concerned that many banks appear to take pride in their low charge-off rates during stable times, but the real test is how those rates perform during challenging periods, not when the economy is thriving. I worry that we're beginning to see a return to the practice of lowering reserves again. Specifically for us, I have concerns about the economic landscape towards the end of this year and into next year. While I'm not overly worried about our charge-offs or overall performance, I would prefer to maintain our reserve levels as they currently are. I trust that Moody’s will recognize the potential for increased unemployment and economic weakness, which will help justify keeping our reserves steady. We have various factors influencing our reserves, and I hope that Moody’s will make informed projections that allow us to maintain adequate reserves.

Yes. Until that happens, Nate, as you know, a lot of our provision comes from loan growth. So, we see a lot of organic loan growth, and that drives our provision expense. But clearly, with the Moody’s variables, the economic forecast becoming more and more favorable each subsequent quarter, the pressure on the allowance ratio to come down is there, right? So, if you look at what our day 1 CECL allowance was, it was 85 basis points. And I echo what Mariner said, is we get back to 85 basis points, but this is not the right time to get there. But that said, the quantitative part of the model is what it is, right? We use Moody’s forecast, and we have to wait until Moody’s changes their forecast in anticipation of any economic conditions. So, at this point, it’s hard to say. That’s a million-dollar question really.

Yes. The good news about us, though, is we have a very, very long track record of having industry-leading charge-offs, that being low charge-offs, right? So, we don’t expect our performance to be any different than it’s been the last 20 years, regardless of what the environment is.

Yes. Got it. That’s helpful. And I fully appreciate it’s difficult to predict under the CECL framework, particularly with all the uncertainty that exists out there. Perhaps maybe just one last one on capital. Obviously, TCE came down with the AOCI swing this quarter. So, just curious to get an update just in terms of the buyback appetite. Obviously, the stock has been under pressure over the last few months like a lot of your peers. So, just curious how you guys are thinking about the appetite for buybacks over the near term? And then, also just any update just in terms of what you’re seeing from an acquisition opportunity perspective these days?

Yes. To start, our main focus for capital deployment is investing in our business, which includes loan growth and hiring. We also prioritize maintaining updated technology. Following that, we are interested in mergers and acquisitions, looking for companies that align with our culture and contribute value in the long run. Additionally, we aim to perform well enough to consistently increase our dividend each year, which is a key goal for us. Lastly, we consider opportunistic buybacks, but this is a lower priority. We have a track record of executing buybacks at the right moments, and we will continue to evaluate this option if other priorities are not feasible and the market conditions are favorable.

Yes. The only thing I’d add is if you look at the period-end share count, we did have 200,000 shares bought back early on in the first quarter. So, to Mariner’s point, we will be opportunistic about buybacks. And then, I’ll just echo my comments from the script, which is even though TCE has gone down, what we focus on is more of the risk-based regulatory capital ratios. That’s what we base our capital decisions on. So, even though TCE temporarily might be impacted based on what’s happening with interest rates, our focus for running the business is primarily the risk-based capital ratios.

Okay, great. And if I could just actually ask one more on just the expense outlook. It seems like the salary line was seasonally impacted by the payroll impacts and so forth in the first quarter. So just Ram, maybe any thoughts on just directionally how expenses trend into the second quarter and just kind of overall expense growth expectations for 2022?

Yes. While I can't provide specific guidance, there are several factors to consider compared to our first quarter levels. The $214 million figure is a solid starting point. As you've noted, there was a significant increase in FICA and payroll expenses in the first quarter, particularly due to bonus payments, which should ease somewhat. However, the first quarter also had fewer days compared to the second quarter, which could counterbalance that. Additionally, our typical merit cycle begins in April, leading to some wage inflation reflected in salary numbers. Overall, I would suggest that $214 million serves as a reasonable baseline for the rest of this year.

Our final question comes from Jared Shaw from Wells Fargo. Please go ahead.

Hey, guys. Timur here with two more follow-up questions. Just maybe for, Ram, looking at the kind of the variable rate loans, what portion of that is currently at floors? And can you just give us an update on kind of floor run-offs schedule?

Yes. Of the approximately $10 billion in variable loans we have, we have floors on $1.8 billion of those loans. If the Fed raises rates by 50 basis points, more than $900 million will be profitable. Additionally, with another 50 basis point increase, most of the portfolio will benefit from the floor provisions.

Okay, great. And then, last for me, just the tick-up in non-performing loans, I know it’s called out in the prepared remarks. Can you give us any additional color on loan type or industry? Any additional color would be helpful there. Thank you.

Yes. I don’t think we’re really prepared to disclose that for various sundry reasons. But, it is one credit. And as we mentioned in the comments, we expect it to resolve itself favorably.

We have no further questions. I’ll now hand back to the management team for closing remarks.

All right. Well, thank you for joining us this morning. We appreciate your time and your interest. The recording replay will be on the website shortly. And if you have any follow-up calls, you may reach us at 816-860-7106. Thank you.

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