Good day, and welcome to UMB Financial's Second Quarter 2021 Financial Results Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Kay Gregory, Investor Relations. Please go ahead.

Good morning. And welcome to our second quarter 2021 call. Mariner Kemper, President and CEO; and Ram Shankar, CFO, will share a few comments about our results. Jim Rine, CEO of UMB Bank; and Tom Terry, Chief Credit Officer, will also be available for the question-and-answer session. Before we begin, let me remind you that today's presentation contains forward-looking statements, all of which are subject to assumptions, risks and uncertainties, including the longer-term potential impacts of the pandemic. The 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 any forward-looking statement, and forward-looking statements speak only as of today, and we undertake no obligation to update them, except to the extent required by securities laws. All earnings per share metrics discussed on this call 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. Our strong second quarter results again demonstrate the benefits of our diverse business model and our investment thesis, which includes above peer loan growth and solid net interest income and fee income growth in all environments, something that we've been able to do for many years. Second quarter highlights include 19% average loan growth on a linked-quarter annualized basis, excluding PPP balances, and a 21% increase in fee income. Additionally, we announced that the Board approved a $0.05 or 15.6% increase in our quarterly dividend. As you saw in our release, our provision expense was higher than previous levels due to strong loan growth and elevated charge-offs, which were driven entirely by one commercial factoring relationship. Excluding this credit event, we would have had net recoveries in the quarter. The underlying quality of our loan portfolio remains strong with non-performing loan balances down 24.1% from the first quarter. As we've shared in previous quarters, we have refocused our factoring efforts, targeting largely transportation companies and smaller receivables. And we are comfortable with the characteristics of this portfolio. Looking ahead, with what we know today and the quality we see across our portfolio, we expect charge-offs to come in closer to our historical level of about 25 to 30 basis points for the full year of 2021. Sentiment in our markets continues to move towards more normalized levels, and our customers remain cautiously optimistic. While keeping a close eye on the trajectory of the pandemic, modified loan balances are down to just a handful of loans, and those are slated to be resolved in the coming months. As with many of our peers, we have begun the transition to return our workforce to the office. Our banking centers have reopened. We've…

Thank you, Mariner. Net interest income of $201.1 million represented an increase of 3.6% from the first quarter. We realized $9.2 million of PPP fees. And the PPP contribution to the second quarter net interest income was $12.4 million compared to $13.4 million last quarter. At quarter end, our PPP balances stood at $766 million, down from $1.4 billion at March 31st. Approximately $18 million in unamortized fees remain at the end of the second quarter. Average earning asset yields decreased 4 basis points to 2.7% due to 6 basis point declines in both loan and security yields and asset mix changes, including the $137 million decline in average PPP balances. Our levels of liquidity remain elevated with our Fed account, reverse repo and cash balances comprising 14% of average earning assets with a yield of 30 basis points, down slightly from 32 basis points in the first quarter. The 3 basis point decline in net interest margin on a linked-quarter basis was driven by repricing pressure and mix changes in both the loan and securities portfolio, as well as the lower PPP income I noted. We continue to deploy a portion of excess liquidity as well as cash flows from our securities book into our AFS portfolio, as evidenced by the $2 billion increase in average balances from last year. Portfolio composition and activity trends are shown on slide 29. And during the quarter we had cash flows of $437 million at a yield of 1.77%, and we purchased $1.1 billion of securities that yielded 1.4%. So far in 2021 we've executed just over $900 million of fair value hedges with varying delayed starts and 7 year terms on average. These are designed to mitigate earnings and capital impact in a rising rate environment. These hedges are matched to…

Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question today will come from Jared Shaw with Wells Fargo Securities. Please go ahead.

Hey. Good morning, everybody.

Hey, Jared.

Good morning, Jared.

Maybe just to start, can we start with the factoring loss, can you give us any details around that? That seems like a larger loss. I'm guessing it's probably not tied to the targeted transportation small receivables, if it's that large. And then after that, could you also let us know what portion of the book is still maybe apart from transportation and smaller receivables after this charge?

Yes. Thanks, Jared. I guess to sort of level set the whole deal I'd take you to page 28, and just for all of those on the call, it's a really great page to sort of summarize what credit really looks like at UMB. And you'll notice on that slide that the past four quarters there were no losses in specialty lending where factoring lives. And that in this recent quarter, without that loss we would have had 9 basis points of recovery for the quarter. And as in previous comments we've made about factoring, dating back to the first original loss we had, this was an acquired business. We changed out the management. We've refocused the business, as you said, on transportation and smaller receivables. And so that - I guess I'd say that's all still true, still the case. We've refocused the business. This particular credit, as - was identified back then. And I guess I'd just re-point you to, everything has been changed, altered, and we feel good about the business that's left, it's a very small business. And it is, as you said, we focus on smaller and transportation credits. And really, overall, the reality is significant reductions in our non-performance of the company, an excellent quarter inclusive of this loss. And we expect to get back to our historic charge-off rate by the end of the year for the full year of 30 basis points or less in charge-offs.

Was that loan included in non-performing or classified loans before the charge-off?

It was not. It was not. And yes. So that echoes the performance of our non-performing loans. It is that much - even that much better, sort of describing the whole portfolio. I think [indiscernible] has a really nice pop of just talking about our long-term trends in our - and track record. On the call with me are the two guys that do that with me. One has been with us 34 years. I'm 20, 25. And Jim's here 27 years. So it's the same team doing the same thing, managing it the same way for a very long time.

Okay. And then just to finish this component up, are there any other components of factoring that were identified in 2018 that are more along the lines of this loss or the loss back in 2018?

No. Everything that's left in the portfolio is our conforming factoring loans and are all performing.

Okay. Maybe shifting a little bit to expenses. It's good to see expenses came in on target from commentary before. Going back to fourth quarter, you had expressed some potential optimism for positive operating leverage this year. Do you think we're on track to potentially see that on a full year basis?

Yes, If you back out PPP in future periods, yes.

Back out the revenue or…

Yes, I mean next year - you don't want to compare next year to this year with the PPP gains, right? So if you back that out, I would say yes.

Okay. And then I guess, Mariner, can you just - looking at - can you give any update on expectations or drivers for AUA growth as we go forward through the rest of the year?

Well, that's at some level hard to predict. A lot of that has to do with what's going on in the marketplace with asset values. If you're talking about new business specifically, the pipelines remain very, very strong across all those businesses. So I would say pipeline very strong, asset values is another question. But definitely…

New business and our private wealth management group is up 20%. And that's new business from new customers, not including market action on the organic book. We've seen unexpectedly strong sales activity. And when I say unexpectedly, just because we're still in the COVID environment, which shows our sales forces getting out there and finding new business and being able to have face-to-face appointments, which has been part of what has made it successful over time. So that has been nice to see. The fund services business has continued to be strong. There have been some delays in conversions just due to our clients being back in the office as well. But we have signed contracts. And a strong backlog there also.

And the only thing I'd add there, without naming names, is a couple of our competitors, major competitors in that space are struggling mightily right now. So the opportunity is fantastic for fund service on a go-forward basis.

Okay. Thanks a lot for that. Thanks.

The next question today will come from Nathan Race with Piper Sandler. Please go ahead.

Yes. Hi, guys. Good morning. Pretty impressive loan growth in the quarter, and it's encouraging to see apparently C&I line utilization increase in the quarter. And I think that is ahead of kind of what we see from some other of your peers so far in the quarter. So would just love to get some color on just the drivers for the increase in line utilization this quarter and just the overall C&I growth that was again impressive, and just kind of the outlook for overall loan growth in the back half of this year ex PPP?

Yes. Thanks. It's interesting, the loan growth question. I've been following the comments myself. And I actually - I'm just as interested as to why others aren't seeing loan growth, as to why people are interested as why we are seeing loan growth. And my comments around that are, we - as a backdrop you've got huge stimulus in the market. You've got PPP funds at the company level. You got a monster a level of liquidity. You have a recovering economy. And for me, that's a backdrop for loan growth. So I've actually struggled to understand why others are talking about not having loan growth. So for me, it's just kind of sort of the basic backdrop of a nice recovery as a backdrop for our loan growth, coupled with the fact that what we've said for years now is we're under penetrated geographically and under penetrated vertically. And we don't budget our loan growth based on multiple of GDP, like a lot of banks do, we do ours based on the ability of our loan officers to build - to execute on our pipelines and gain market share. So with that backdrop for our pipeline and what we've seen and been able to demonstrate year in and year out, that's what drives our loan growth. It comes across all categories. And as in the prepared comments, the C&I side, three quarters of that was new business from new customers. On the line utilization, I wouldn't get too excited one way or the other about that. I would - that's a point in time, that thing can go bounce around a little bit. What I would say is it's stable. I wouldn't point too much one way or the other. It's up slightly on a point-in-time basis, but what I'd say is it's stable. And so those would be my big comments there about it. It's business as usual for us on loan growth. And I think that we typically give you a quarter-ahead look, and Jim commented on that. It looks as strong as it has been, and just nothing new on the loan growth front.

And we did mention, Nate, that we anticipated more closings in the first quarter that did roll to second quarter. So that did have some impact on the outsized growth for second quarter. But third quarter remains strong. And we've also seen a lift from our consumer mortgage business that we've placed on balance sheet as well, roughly $100 million. So that's been additive also.

Okay. Great. And then just maybe shifting to capital. Would love to get some updated excess capital deployment priorities, what you're seeing in terms of acquisition opportunities as well. And just any thoughts on the buyback with a little bit of a retreat in sector-wide valuations recently?

So in our prepared comments we talked about our priorities. The increase in the dividend was really what I would call a catch-up dividend increase to get us kind of level set with the kind of experience that our shareholders have been used to from us. So that's what that was, sort of a catch-up, get us back to our payout ratio that we've historically demonstrated. As far as just the regular use of our capital, we would very much like to find a way to deploy capital to grow our business. Obviously with the loan growth that we have, that's the place it's going to go first. And secondly, we love to find M&A activity, M&A opportunities. It won't come as a surprise to you that there's nothing to announce to you. But we're active, right? We would very much like to add value to our business through some M&A activity. And all I can say about that is we remain active. We remain - we're making phone calls. We're pounding the street, using shoe leather, building relationships and doing everything we can. But we're not going to do something just to do something, right? So it's got to be something that fits culturally and really adds value. We're not going to do what I call a ticker tape acquisition, one just to announce something. It's got to fit.

Got it. That's great color. If I could just ask one more on overall balance sheet dynamics. The PPP forgiveness process continues to unfold. It looks like some of your commercial clients are working through excess liquidity and drawn online. Just any expectations for deposit flows and just the overall size of the balance sheet over the back half of 2021 as well?

Well, that's the million dollar question, isn't it? We debate that ourselves internally. So it's almost hard to answer that one when everybody on the phone on my end would probably give you a different answer. But I think we -- there's definitely excess liquidity on our balance sheet. Whether that's $1 billion, $2 billion or $4 billion is anybody's guess. And so I think there's some excess liquidity on our balance sheet. But from our vantage point, we are always focused on deposit growth, and we always have the ability to bring deposits back on balance sheet that is off balance sheet if that were ever something we needed. The other thing to think about for us which I think is kind of unique in the space is our loan-to-deposit ratio is so low to start with. I'm not sure it really matters how much excess liquidity we have because really if some of it were to roll off, our ratios would just look better anyway.

Right. Got it, okay. Thanks Kem for all the color.

[Operator Instructions] The next question will come from Chris McGratty with KBW. Please go ahead.

Morning, Chris.

This is Andrew Leisner [ph] on for Chris McGratty.

Hey, Andrew.

Just wondering, so I noticed your fee income came up a little higher than expected. Can you just go into, I guess, the pieces of fees this quarter and what that run rate looks like going into the back half of the year? Thank you.

Yes. I mean high level, and I'll let my team jump in if they want to add color. But high level, I'd say it came really across the board. So in all of our asset-based businesses there was great business development, new client activity. The markets have been stronger than I think we all thought they would be. And certainly in my shop we felt that, we have felt that way. So really across all the asset-backed asset-based businesses, the activity has been very strong. And in our Corporate Trust business, with the economy opening back up, aviation trust businesses come back on. Yes, I mean, just really saw it across the board in all of our businesses. Jim mentioned strong asset growth, client growth in our private wealth business. You want to add anything else, Jim, there?

Well, we had additional swap income this quarter commercially. We saw additional growth with the KCA. We announced that the -- in our capital markets group, the KCAS, another win in that group where you saw that fee income on -- what page would that be in the deck, 22?

An equity return on another investment.

Yes, another private investment, obviously not as large as Tattooed Chef but obviously outside return -- outsized returns for our investments. And really, and Mariner it's really across the board. Those would be a couple of the key highlights. And then also fee income on the account fees.

Yes. I would like to come back to the KCA Steel [ph] You've seen the returns from Tattooed Chef, we don't expect to see those kinds of returns in that business every time. But you should expect to see us see liquidity events in our equity investments on an ongoing basis and as events by having one in this quarter.

All right. Great. Thank you. And then just one more on the tax rate. It looks like it came in a little higher than last quarter in the previous two quarters. What do you think is a good run rate for the tax rate going forward? Thank you.

Yes. We would say 16% to 18%, Andrew, for the full year 2021. Every quarter we adjust the tax rate based on just expected earnings and everything else. So tends to jump around a little bit. But for the full year I would say 16% to 18%.

Thank you.

The next question is a follow-up from Nathan Race with Piper Sandler. Please go ahead.

Yes, hi. Just a question going back to the discussion around fee income. The public finance and trading line continues to perform I think fairly well. And in the past you've talked about the upside of that business with greater infrastructure spending. So I was just wondering if you guys could kind of quantify if an infrastructure bill ends up going done kind of what's the earnings power that's yet to be realized within that line going forward?

That's really hard to judge. They're still debating it in the first place, then you got to go through appropriations, and it's got to get distributed at the state levels and then they got a side where it's - I think it's a pretty long path. It's hard to tell you when we might see that. So I don't know when we might see it, certainly not in the next quarter. I mean, I don't know when we'll see that stuff. It still hasn't even made it out of Washington yet.

We can tell you though that we have approved and we are adding additional associates in that area or -- and we have seen success that's been documented as far as our activities, and we do anticipate it being beneficial for us.

Yes. I mean some of what we've seen there too is taxable municipals have made their way into the marketplace in a meaningful way. So that -- some of the business we've been underwriting is taxable municipals. So the market is changing, and there's a lot of liquidity. I think the real key here is regardless there's an enormous amount of liquidity. So institutions and banks are needing to deploy it. The commissions are different based on the kinds of securities that are being traded and built and sold, but there's a lot of activity still because of the liquidity, and that's what you're seeing. And I think you'll continue to see that probably up till the time through until the time that we do benefit from what might happen from infrastructure.

Got it. And just one other question around expenses. With the institutional segment still performing well, I'm curious if there's a shift in kind of the structure of incentive compensation. I believe historically that business has had a higher variable comp component to it historically. So I'm just curious if any of that shifted more recently that kind of supports kind of how expenses have been a little bit more controlled in terms of overall growth recently?

No. I would actually say the opposite. Some of the expense growth that we do have is from paying out on commissions and sales.

Right.

It's been more controlled than the other areas and the -- what expense increases we have had is because of sales activities. We've tried to be more balanced over time to make sure that our sales officers are bringing in the business that we - all the different types of business that we offer. So that's where we continue to tweak our sales incentives, is to make sure that our officers are become more generalists than specialists when it comes to selling all that we have to sell. And Jim?

Yes, no, we make sure that our incentives are balanced with what is in the best interest of the bank such as additional incentives for cross. And even though we -- I don't know that the industry likes this term very much anymore as far as cross-sell activities. But we make sure we're partnering with the other lines and exposing different lines of business to different customer bases where they can have referral activity that makes sense. We're rewarding that activity more handsomely than in the past, which -- where it benefits the bank. But just like any organization we constantly evaluate our programs, but they have not changed drastically or we're not seeing pressure from the market to do that. We believe we're extremely competitive and actually the employer of choice for all our divisions. That was a little plug for UMB for NA [ph]

Of course. You guys did your job. Super helpful. I appreciate all the color, again. Thanks, guys.

Yes. Thanks, Nate.

This will conclude today's question-and-answer session. And I would like to turn it back over to management for any closing remarks.

Well, thanks, we covered it all. Appreciate everybody's time.

Yes. Thanks for joining us today. You can access this replay on our website. And as always, you can contact Investor Relations at 816-860-7106 with any follow-up questions. Thanks for your interest and your time.

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