Umb Financial Corp Q2 FY2025 Earnings Call

Good morning. Thank you for joining today's UMB Financial Second Quarter 2025 Financial Results Conference Call. My name is Jalyn and I'll be your moderator for today. I would now like to pass the conference over to our host, Kay Gregory with Investor Relations. Kay, please proceed.

Good morning, and welcome to our second quarter 2025 call. Mariner Kemper, Chairman and CEO; and Ram Shankar, CFO, will share a few comments about our results, then we will open the call for questions from our equity research analysts. Jim Rine, President of the holding company and CEO of UMB Bank; along with Tom Terry, Chief Credit Officer, will be available for the question-and-answer session. Before we begin, let me remind you that today's presentation contains forward-looking statements, including the discussion of future financial and operating results, benefits, synergies, gains and costs that the company expects to realize from the acquisition as well as other opportunities management foresees. Forward-looking statements and any pro forma metrics are subject to assumptions, risks, and uncertainties as outlined in our SEC filings and summarized in our presentation on Slide 50. 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. Presentation materials are available online at investorrelations.umb.com and include reconciliations of non-GAAP financial measures. All per share metrics refer to common shares and are on a diluted share basis. Now I'll turn the call over to Mariner Kemper.

Thank you, Kay, and good morning, everyone. Thank you for joining us to discuss our second quarter results. We'll share some brief comments and open up for questions. Compared to 90 days ago, the business environment and economic landscape remains positive as perceived real headwinds post liberation day have largely subsided. While there are still some uncertainties in ever brewing geopolitical tension, the sticker shock from the headlines seems to be wearing off. Borrower sentiment continues to be strong, especially as you consider the financial strength of our customer base. Regardless of uncertainties, we remain focused on what we can control, leveraging our business model, which has proven effective in all economic environments, as evidenced by our strong performance in the quarter. Our reported net income available for common shareholders of $215.4 million included $13.5 million of acquisition expense compared to $53.2 million in the first quarter. Excluding these and some smaller nonrecurring items, our second quarter net operating income was $225.4 million or $2.96 per share. One of the drivers for the quarter's strong results was a $37.7 million pretax gain on prior investments made through our various private investment entities included with a pretax gain of $29.4 million on our investment in Voyager Technologies, which went public in June. This equates to a multiple on invested capital of 5.8x and an internal rate of return of 59%. This investment, made over the past five years, is another success story from our private investment team. Through this team, UMB partners with private businesses that have strong long-term growth potential by taking equity, subordinated, or mezzanine positions. We have a successful track record of financing businesses and have invested more than $200 million across more than 50 businesses to date. Other highlights of the quarter include an 8 basis point expansion in our core net interest margin, double-digit balance sheet growth, solid credit metrics, and strong positive operating leverage. On a linked quarter basis, average loans increased 12.7% to $36.4 billion, while average deposits increased 10.7% to $55.6 billion. This reflects solid organic growth as well as the impact of the additional month of Heartland operations in the second quarter. Legacy UMB average loan balances increased 15.3% on an annualized basis from the prior quarter, once again outpacing many peer banks. Banks that have reported second quarter results so far have reported a 5.2% median annualized increase in average loan balances. Our loan balances were relatively flat quarter-over-quarter as top line production was offset by elevated payoff activity as we continue to align the portfolio to our standards. Looking ahead into the third quarter, the loan pipeline remains strong both on legacy UMB and in Heartland markets. Quarterly top line production was a new record, coming in at $1.9 billion in the second quarter. We saw strong growth in commercial and industrial (C&I) loans and commercial real estate (CRE) as well as an 11% increase in residential mortgage balances as we begin offering mortgage products in our new regions. We've been encouraged by the activity and production of our new Heartland associates. Net charge-offs attributed to the legacy UMB portfolio in the second quarter were $9 million or just 13 basis points of average UMB loans for the quarter, with the largest portion being credit card. Total net charge-offs for the quarter, including acquired loans, were 17 basis points. Given what we know today, we continue to expect charge-off levels to remain near or below our historical averages in the second half of the year. Total nonperforming loans to total loans improved 2 basis points from the prior quarter to 26 basis points. Nonperforming loans related to legacy UMB were just 10 basis points. For reference, banks that have reported second quarter results so far have reported a 0.50% median nonperforming loan (NPL) ratio. We continue to rebuild capital following the acquisition with a CET1 ratio of 10.39%, a 28 basis point increase from March 31. During the second quarter, we completed an offering of Series B preferred stock netting $294 million of Tier 1 capital. On July 15, we redeemed $115 million in outstanding Series A preferred that was acquired in the HTLF deal. Finally, over the weekend of July 11, we successfully executed our pilot conversion of Heartland's Minnesota franchise, bringing it onto the core UMB platform. This initial conversion of a small set of locations allowed us to test our conversion plans and procedures. The process went smoothly and positions us well for the full conversion slated for mid-October. I extend a huge shout out to our teams, especially the technology and product and operations teams as well as our client-facing associates who have worked tirelessly around the clock enabling the seamless conversion. Now I'll turn it over to Ram for more detail.

Thanks, Mariner. I'll begin with the purchase accounting update included on Slides 9 and 10 of our materials. On Page 9, you can see that our second quarter results included $42.2 million in net accretion to net interest income, $13.1 million of which was related to an accelerated accretion from early payoffs of acquired loans. The net benefit to margin from total accretion was approximately 27 basis points. Our operating expenses included $23.4 million in acquisition-related amortization of intangibles. On Slide 10 is the projected contractual accretion for the rest of 2025 as well as for full years '26 and '27. On Slides 12 and 13, we've included some key highlights and drivers of our quarter-over-quarter variances as well as breaking out one-time costs by expense categories. I hope this is helpful, especially with all the moving pieces related to the acquisition and market-related variances. You'll see the accretion income there along with the investment security gains Mariner mentioned. Other notable items impacting fee income in the second quarter included a $3.5 million increase in trust and securities processing, led by fund services, which brought on several new clients. Assets under administration (AUA) and fund services and custody grew to $543 billion, while AUA for all institutional banking businesses topped $600 billion in the quarter. Additionally, credit and debit card purchase volumes reached $5.6 billion, with the related interchange income driving a 10.4% increase in bank card fees compared to the first quarter. On the expense side, we had $13.5 million of merger-related costs, and we've included the line item breakdown for those costs. We remain on track with our announced acquisition-related expenses. Excluding the impact of merger and other one-time costs, salaries and benefits expense increased by $21.3 million, largely driven by a full quarter of expenses for the new associates from Heartland. Also, as noted, we made charitable contributions of $8.3 million in the quarter compared to $524,000 in the first quarter. Looking ahead, we would expect third quarter operating expenses to be slightly higher in the $380 million to $385 million range, driven primarily by the full impact of the mid-second quarter merit increases and increased incentive accruals for strong company performance as well as an additional day count. Our third quarter fee income will be impacted by changes in market value through every quarter end of our 904,000 share ownership in Voyager stock relative to the June 30 closing price of $39.25; this will continue in subsequent periods until we choose to exit our position. Turning to the balance sheet, we had strong deposit growth, both organic and related to the full quarter of HTLF balances. Interest-bearing and demand deposit account (DDA) balances increased 11.9% and 7.3%, respectively, from the first quarter. The cost of interest-bearing deposits remained flat at 3.34%, while total deposit costs increased 2 basis points, reflecting the mix shift. Relative to the core margin of $2.83 in the second quarter, that excludes all accretion, we expect third quarter margin to be essentially flat. The positive impact from fixed asset repricing on bonds and fixed rate loans will likely be offset by increased interest expense from the strong interest-bearing deposit growth I just mentioned, combined with a typical third quarter low point for DDA balances. Finally, our preferred dividend in the second quarter was $2 million. Dividends on the newly issued Series B shares will commence in the third quarter with a payment of $7.9 million, including a portion for the stub period that spans the issue date of June 12 through the interest payment date on July 15. Subsequent quarter preferred dividends will be $5.8 million. And our effective tax rate for the full year 2025 is expected to be between 19% and 21%. Now I'll turn it back over to the operator to begin the Q&A session.

Our first question comes from Jon Arfstrom with RBC.

This all looks good. And I just wanted to talk a little bit about loan growth. Maybe Mariner, Jim, that gross loan production number jumped quite a bit. And can you just deconstruct that a little bit for us? How much of it is Heartland? How much of it is the rebound from 90 days ago? And how do you expect that to trend generally going forward?

Yes. I think what I'd say about it is it's kind of in line with our expectations. And the next quarter looks very similar. On a combined basis, we're seeing strong production out of Heartland and just as strong as we ever have been with our own team. So it was a nearly $2 billion quarter on the top line, and we expect a similar number in the second quarter, coming across all categories, all verticals, all regions, just the solid same story we've been telling for 20 years.

And we've seen nice activity from the Heartland team as well, not just legacy UMB.

Yes, their activity is very solid coming through across the board. So we're really excited about what we're seeing from their team. I think there was some pent-up demand. And obviously, also, you have the higher hold limits, etc. So it opened the door for them quite a bit.

Okay. Very good. And then just a follow-up. Mariner, you made a comment about continuing to align the two portfolios. Curious how much of that is left to do? And then if you could comment a little bit on payoffs and pay downs, if you feel like they're still a little bit elevated?

Yes. So we do expect, without being able to identify any particular number or credit for you to continue to align being sort of there are some credits that aren't done the way ours are, and that may be a few that may or may not be here at the end of the year. But the payoffs on a combined basis should be immaterial to the balance sheet on whatever happens. So I guess that's really the key. I would tell you is whatever does come from that realignment will not materially change our payoff levels on a combined basis.

Our next question comes from Jared Shaw with Barclays.

Maybe first question, just have you given any thought to the impact of the HSA changes under the new budget bill and what that could potentially do for a longer-term growth rate in deposits and fees?

Jared, we've been monitoring it closely. As you know, originally, it was going to be much more sweeping and would open it up to roughly 20 million folks that have not previously been eligible; right now, we anticipate that number to be around 7 million. While we do view it as an opportunity, it would be more marginal. There will be a lot of education that will go along with the folks that are really eligible, but we don't anticipate it being a huge windfall for our HSA business. We feel it will be more on the margin. We do have the sales teams and various individuals who will be able to provide that education as needed, but we do feel like it will be just more marginal.

Good color. And then as my follow-up, just on expenses. If we look at expenses excluding merger costs as we go into '26 after the integration, how should we think about sort of a longer-term expense growth rate, getting the cost saves from the deal but then offsetting that with some of the investments as you build out commercial? How should we think about sort of a longer-term expense rate?

Yes. We're not giving specific guidance, Jared. I would say, so we'll get the second slug of cost saves from the transaction in the fourth and first quarters as we consolidate vendors and we complete our conversion process. And then I know we don't specifically give guidance on expense growth rate because of our business model. It's all about positive operating leverage, and we want to keep improving operating leverage based on what the revenue environment is. So without giving specific numbers, I would just say we're going to achieve all the cost saves that we targeted generally from the Heartland transaction. And then in terms of investments, we have a pretty robust process in terms of how we intake projects. So there's not a large pipeline of investments. And if there are investments, they always have a revenue component or an ROI associated with it. So there's not a lot of pent-up demand in that fashion for us to be spending and investing.

Okay. But maybe the way to think then is continued positive operating leverage from the combined operations as we...

Absolutely. Yes. Yes. And ultimately improved operating leverage.

Our next question comes from Chris McGratty with KBW.

Ram, regarding the $124 million in cost savings you mentioned during the announcement, how much of that have you been able to realize so far? In light of Jared's question, it seems that by Q1, you will have gone through most of it. I'm just trying to gauge the level of expenses before you begin.

Last quarter, I mentioned that we achieved a run rate of $17 million on a quarterly basis, which exceeded our initial expectations when we announced the transaction. As I noted then, the second and third quarters offered limited opportunities for additional cost synergies, since the significant savings will primarily come from the conversion and consolidation of vendors in the fourth quarter. While there were some cost savings realized in the second and third quarters, they were not substantial. Therefore, from the total expected savings of $124 million on a quarterly basis, we have realized $17 million so far, with the remaining savings anticipated in the fourth and first quarters. Looking ahead to 2026, we expect some nominal growth in both the legacy UMB and Heartland franchises, and while I cannot provide specific figures, we are aiming for improved operating leverage.

But we do expect to achieve the full savings that we projected at the time of the announcement.

Okay. And then just on the balance sheet, you talked about the DDA hitting the trough in the third quarter, I think. Can you just remind us of the pro forma seasonality with your deposit base? And then also what you plan to do with the investment portfolio, growing the portfolio, funding organic growth? Just trying to put a finer point on that.

If you examine the past couple of years, they serve as a good indicator for the potential trends with DDAs. We've experienced a moderate contraction in DDA balances during the third quarter. This is likely due to seasonal factors, particularly related to bond payments, which tend to make changes predictable. There are no major seasonal variables in the third quarter, as public funds typically accumulate in the fourth and first quarters. As reflected in our third quarter results, we observed notable growth in interest-bearing deposits in the second quarter, primarily driven by business activities. Regarding our bond portfolio, at the end of the quarter, we had approximately $10 billion in cash on our balance sheet, generating $440 million in earnings. We have since deployed a significant portion of that cash, leaving us with around $5 billion. We have continued our pre-buy and overbuy activities related to our bond portfolio purchases. We anticipate our bond portfolio will total around $17 billion, with additional excess liquidity of about $6 billion to $7 billion. This gives us a clearer picture of our earning asset base for the third quarter.

Our next question comes from Ben Gerlinger with City.

I found your previous answer on security very helpful. I was wondering if we could focus specifically on the front and back book of deposit pricing, considering Heartland was added around the middle of the first and second quarters. It feels a bit like comparing different things. Regarding the core margin, Ram, I know you mentioned it would remain flat compared to the previous quarter, but I’m curious about the core margin in June. I’m trying to understand the overall run rate for the quarter.

I’m not sure if I have that information available or if it’s significant, Ben, regarding what June looked like. There were many factors involved, and obviously, purchase accounting adjustments can occur. I understand you inquired about our core margin. My guidance for a flat net interest margin, as I mentioned in my prepared remarks, takes into account several positive factors and a few negative ones, including the DDA seasonality I discussed. So, I’m not certain what else I can provide on that.

Got you. Okay. And then I know you've had some larger, shall we say, unscheduled purchase accounting or early payoffs, I should say? Is there something that's causing that because we haven't seen much rate movement? I know it's usual with deals. Just kind of curious, is there an underlying driver?

Yes, we discussed the alignment on the Heartland portfolio, and we have moved some credits that were expected earlier in the year.

Our next question comes from Nathan Race with Piper Sandler.

Just coming back to the discussion, I appreciate the flat guide for the third quarter. But just given that it seems like both loan and deposit growth is somewhat margin accretive. I know you had the benefit from Heartland as well in the quarter, but assuming the Fed remains on pause, do you think there is an upward bias to the margin in the fourth quarter and maybe thereafter, again, assuming the Fed remains on pause? But even if we got some cuts, I imagine the margin could still expand just given what you have repricing on the deposit side?

Yes, potentially, Nate. And as you know, we have 45% of our deposits indexed. In the short term, the Fed actually cutting is a positive for margin because these index deposits reprice down, right? Internally right now and it might be subject to change, we have 2 more rate cuts, one in September and one in December, but it sounds like there are more reasons for pausing that. So I would say at the margin, not having rate cuts can be neutral to slightly down for margin expectations because deposit costs won't move. I mean, as we said in the call before, our deposit pricing doesn't change unless the Fed starts cutting rates. And then in terms of the other positive tailwinds, if you will, for the margin. We've talked about fixed asset repricing. If you look at our treasury waterfall that we say on Page 20, we have $1.8 billion of cash flows coming from our bond portfolio that are being reinvested at 120 basis points higher. We have a similar phenomenon going on with the fixed rate loans that can also go up 200 basis points. And then as you look at the third quarter, the only tailwind besides the day effect, the other day effect on average can impact our margins by 2 to 3 basis points because we have a lot of 3360 products. The only thing that can act negatively or possibly is the level of DDAs, which I discussed could be down mid-single digits.

Right. That's very helpful. Maybe switching to fee income and specifically fund services. That revenue line has grown at least at a high single-digit pace over the last handful of years. Just curious with the law of large numbers, maybe catch up with you guys, if you think that rate of growth is still sustainable going forward within fund services?

Yes, I believe there are significant advantages for that business. We receive outstanding service ratings from both our clients and the industry, and our technology is strong. The disruption I’ve mentioned in previous calls is still ongoing. Our alternative side is busy; we are acquiring a considerable amount of new business and benefiting from many successful platforms. This success stems from our flourishing client base and the influx of new business. Our pipeline is very robust. We have a leading position in the private sector, winning nearly every bid we participate in, and the factors helping us are excellent.

Our next question comes from Brian Wilczynski with Morgan Stanley.

I was wondering if we could circle back to credit quality at Heartland. So good to see nonperforming loans down quarter-over-quarter. I was wondering if you could just elaborate on what you're seeing in that portfolio and how you're thinking about the path for noncharge-offs as you work through that?

Yes, regarding nonperforming loans, we have already seen a decline compared to the previous quarter. We anticipate that this trend will continue on a month-over-month and quarter-over-quarter basis as we manage the portfolio. On charge-offs, I refer back to my earlier comments about the company on a combined basis. As we better understand their portfolio, which is performing well, we expect the second half of the year to align with or be close to our historical averages based on what we currently know. We are confident in our ability to manage their portfolio and are pleased with our progress. The team they have is exceptional, and we are enthusiastic about the results we're achieving from them. Overall, we are optimistic about the direction and the positive improvements we are seeing month-over-month and quarter-over-quarter regarding nonperforming loans.

That's really helpful. And then I was wondering if you could comment on what you're seeing in terms of deposit competition across your markets as the macro environment gets better, maybe industry-wide loan growth picks up? Just wondering what you're seeing and what you're expecting from a deposit pricing perspective?

We have divided our business into two main segments: commercial and institutional, as well as consumer. The commercial and institutional sides are straightforward for us to develop, but they come with competitive pricing that's fairly standard. We can expand in that area as much as we like, as long as we offer rates similar to institutional money market rates. In terms of growth, we can dictate how much we want to grow that segment. For small business and consumer, we've seen growth rates between 1% and 2%, which is something we can manage more effectively. With the recent expansion of our branch network and the integration of the Heartland team, along with a complete refresh of our branches, we're actively engaging the market with campaigns. We believe we can capture a greater share of consumer deposits in our current markets, especially since we've doubled our branch presence and entered six new states. While it's too early to predict specific outcomes, we are optimistic about our potential to improve our consumer business through these initiatives.

Our next question comes from David Long with Raymond James.

With the HTLF acquisition, you talked about some of the credit and loan demand and what have you. But what's going on in the fee revenue side? Are you realizing any synergies there from the HTLF franchise at this point?

We're beginning to see progress. It will take some time before we fully recognize the impact. However, we have already initiated the sale of credit cards. Do you remember that?

Credit cards, we've had an additional 270 mortgage loan applications throughout the HTLF network. We also feel like it's going to be a great opportunity for Corporate Trust referrals. So again, as Mariner said, more to come, but we're already seeing nice activity.

Yes. The energy level and the pipelines are building, conversations are taking place, not a lot to report on in the results yet, but feeling good about the activity levels and the direction.

The next question comes from Timur Braziler with Wells Fargo.

Keeping on the Heartland team, just the contribution to balance sheet growth this quarter was a little surprising as to how fast it came online. I'm just wondering, are they at capacity here? Is there additional ramp in terms of that growth rate? And ultimately, when it is at full capacity, how much more contribution are you expecting for the balance sheet growth rate from Heartland relative to the Q2 levels?

Yes. I think there's probably a bit of a misunderstanding on maybe how we've talked about that or what that looks like. I think we are at the very beginning of what's possible. They had a good quarter, but we're just at the beginning. I mean, there's huge potential out of the whole franchise, great team. I think we underestimated how much they can contribute. We're barely seeing what's possible there. They had a good quarter. But there is a lot more potential ahead.

Okay. Got it. And then I guess going back to the deposit pricing competition. Just looking at the linked quarter change in interest-bearing deposit costs, I would have thought the added contribution or the full contribution from Heartland would have brought that down maybe a little bit more. Can you just talk to what core kind of interest-bearing deposit costs increased in 2Q? And as we head into the third quarter, what that expectation is for deposit costs going higher given the seasonality in DDA plus the competition on the commercial deposit side?

Yes. Timur, the cost didn't go up or was stable, right, at 3.34% quarter-over-quarter. You're right. With the addition of Heartland, it should have gone down a couple of basis points. But as I noted in my prepared comments, we had strong interest-bearing deposit growth, both in the middle market and institutional space. Those tend to come in slightly priced higher than where our current portfolio yield of 3.34% is, and versus the new money rates are more like 4%. So it's not like the costs are increasing; it's just a mix of getting more of these deposits coming in that changed the trajectory of our interest-bearing deposit costs.

More growth of the balance sheet than competition. I mean...

Yes, it's not driven by competition, right.

At this time, there are no more questions registered in the queue. I would like to pass the conference over to our management team for closing remarks.

Thanks, everyone, for joining the call. We're really excited about the quarter, and the results were strong across the board at every level. We're also very enthusiastic about the acquisition and the team involved. We didn’t focus much on capital markets during the discussion, so I want to clarify that while we can't predict the timing of these developments, we have a strong private investments team and look forward to sharing updates from that group. Thanks for listening, and we're thrilled about how everything is coming together with Heartland.

Thanks, Mariner, and thanks, everyone, for joining us today. If you have follow-up questions, you can always reach us at (816) 860-7106. Thank you, and have a great day.

That will conclude today's conference call. Thank you for your participation, and enjoy the rest of your day.