Business

UMB Financial: A Look at a Super Regional Bank

UMB Financial: A Look at a Super Regional Bank

We entered into a long position in UMB Financial Corporation (NASDAQ:UMBF) towards the end of July 2011 because we were impressed with the results of the company from 2004-2010 and because it didn’t need a bailout, nor was it dragooned into taking TARP.  We think it is ridiculous for the Federal Reserve to include banks like UMB Financial Corporation (NASDAQ:UMBF) as part of the stress test because UMB Financial is a well-respected, steady-growing superregional banking and diversified financial services. Headquartered in Kansas City, it has a conservative, credit risk management oriented and deposit gathering centric business model.  UMB is also a well-capitalized bank with Tier One, Leverage and Total Risk-Based Capital Ratios of 11.69%, 7.15%, and 12.62% respectively.

UMB Financial Corporation (NASDAQ:UMBF) knocked the ball out of the park in Q1 2012 and Q2 2012, although Q3 2012 results missed expectations due to higher marketing and salary expenses.  We’ll give UMB the benefit of the doubt on this since these expenses are being used to build and develop the company’s operations; we expect this to translate into future revenue growth.  UMB achieved Q3 2012 quarterly net income of $26.125M, or $0.64 per share.  Non-Interest income grew by 5.3% and continues to drive UMB’s revenue and profit performance. UMB Financial Corporation (NASDAQ:UMBF) generated quarterly revenue of over $165M in Q3 2012 and was $5M shy of $500M in YTD 2012 revenue.

Despite facing a flattening yield curve, the company still managed to increase Net Interest Income by 1.63% versus Q3 2011.  This was due to increased earning assets and a continued reduction of Treasury Securities in favor of higher-yield municipal and other credit securities.  Non-Interest Income increased by 5.3% and this was driven by an 11.78% increase in revenue from its investment markets activities (asset management, asset servicing, brokerage, wealth management and I-Banking).  If we stripped out the change in nonrecurring gains from the sale of fixed income securities, non-interest income increased by 7.6%.  Although UMB saw an 8.9% decrease in bankcard fees due to headwinds from the Durbin Amendment limiting how much can be charged on PIN Debit transactions, we see that purchase volume across UMB’s entire suite of card products increased 38.6% to a record $1.83 billion when compared to the third quarter of 2011.

At the beginning of the year, UMB Financial Corporation (NASDAQ:UMBF) realigned its business reporting segments. They are as follows:

  • Institutional Investment Management (Scout Investments, Inc)
  • Asset Servicing (UMB Fund Services)
  • Payment Solutions (UMB’s card services business, institutional cash management and healthcare services)
  • UMB Bank, (commercial/consumer banking, wealth management, brokerage and investment banking)

Scout Investments’ Institutional Investment Management Fees increased by 14.8% versus Q3 2011 and were $24.8M in Q3 2012.  Scout had positive operating leverage as operating expenses only increased by 2.3% and this enabled pre-tax income to increase 58.3% to $7.6M in Q3 2012 versus $2.8M in Q3 2011.  Scout benefited from stronger capital markets during the quarter, which was offset by $600M in outflows relating to a client that changed its fixed income asset management strategy from core fixed income to a liability-driven-investment style and ultimately chose another manager pursuant to a consultant’s decision.  Scout ended the quarter with $22.6B in AUM, up 14% from Q1 2011.  Scout had $15.4M in positive fund flows from its equity mutual funds, $36.2M from its equity separate accounts and $58.5M from its fixed income mutual funds.  Scout generated a 30.65% operating margin and this was higher than State Street Global Advisors even though SSgA has 90X as much AUM as Scout.  In Q3, Scout released the Scout Low Duration Fund and in Q4, it released the Scout Emerging Markets Debt Fund.

Source: UMB’s Q3 2012 Earnings Call

UMB Fund Services Asset Servicing Fees increased by 6.9% versus Q3 2011 and were $18.7M in Q3 2012.  UMBFS assets under administration were $150B in Q3 2012, up 1.83% from Q3 2011 and down 20% from Q3 2011.  The decline in year-over-year asset levels was due to the defection of an $80B low-revenue custody-only legacy client that went to BNY Mellon (BK) because Mellon offered a much lower price and UMBFS has focused its business on pursuing asset management boutique.  Despite this client loss, Asset Servicing’s pre-tax income jumped by $931K (120.8%) and reached $1.7M in the quarter.  Pre-tax margin increased from 4.4% in Q3 2011 to 9.1% in Q3 2012.  Non-interest expenses increased by only 1.6% to $17M compared with $16.7M in Q3 2011.  This was driven by new higher margin clients replacing the low-margin legacy client as well as UMBFS’s new multiple series trust product.  Revenues actually increased by almost 6.9% even with the absence of this client’s assets in the current quarter.

Source: UMB’s Q3 2012 Earnings Call

UMBF’s Payment Solutions Business’s results faced negative headwinds due to the Dodd-Frank law’s Durbin Amendment taking effect in Q4 2011.  The business had operating income of $6.2M versus $9M in Q3 2011, a decrease of 31.2%.  Expenses and payment solutions include payment processing fees, which fluctuates based on transaction volumes. As the total number of credit and debit card accounts grows, the transactions and spending related to these accounts will drive additional processing fees. Also impacting non-interest expense for the segment this quarter were additional salary and benefit expense for newly added sales and operational positions, consulting and legal fees related to new products and services, and a timing difference of cash payments and accruals related to advertising initiatives. The pre-tax profit margin for payment solutions was 23.6% for the third quarter. UMB’s commercial credit card customers increased spending by 9.7% over the same period last year. Purchase volume in this area has grown consistently and commercial credit cards provided 45% of interchange revenue during the quarter and this represents the largest portion of UMB’s interchange revenue. UMB Financial Corporation (NASDAQ:UMBF) continues to develop new relationships, build pipeline strength and look at innovative products and technologies in the payment space.

On October 11th, UMB Financial Corporation (NASDAQ:UMBF) successfully launched a new technology called ePlate, an electronic payment device that allows the consumer to choose real time tangible rewards programs. Moving now to Healthcare Services, deposits in its custody accounts stood at $395.8 million at quarters’ end – an increase of 34.6% compared to the third quarter of 2011. Flexible spending arrangements in health saving accounts totaled 2.3 million, representing a 12% increase from a year ago. UMB had another strong quarter in the business with purchase volumes of $448 million, an increase of 13.8% over the same period last year.  Interchange revenue from healthcare card purchases increased 18.3% over last year to $1.8 million. Healthcare services continues to be a reliable, strategic and low cost source of deposits and a growing source of debit card interchange for the bank.

UMB Financial Corporation (NASDAQ:UMBF) is known for strong credit quality and the quality of its card portfolio is certainly no exception. Credit card quality remains superior to industry averages and has improved over the past several quarters, with delinquency rates dropping to 1.5% from 1.8% a year ago. Total credit card charge-offs were 2.3% of card balances for the third quarter versus 2.7% in the third quarter of 2011. According to Fitch Rating Services, second quarter 2012 industry credit card charge-offs averaged 5.4%, which is more than double our current credit card charge-off rate.

Sources: UMB’s Q2 2012 and Q3 2012 Earnings Calls

UMB Bank posted net income before tax of $20.8 million for the quarter compared to $21.5 million a year ago, a decrease of 3.4%. Total non-interest income for the segment decreased by 1.1% to $47.9 million and net interest income was up by 1.6% to $69.1 million. Non-interest expense for the bank increased by 1.3% to $94 million compared to a year ago. The pre-tax profit margin for the bank was 17.8% for the quarter.  The primary driver for this decrease was the reduced gains on the sale of fixed income securities held by the banks AL&M portfolio.  One bright spot was that Investment Banking increased revenues by nearly $2.2M year-over-year driven by stronger sales of fixed income securities.  Another bright spot was that investment brokerage revenues increased by $477K year-over-year and that assets under management for UMB Wealth Management and Prairie Capital increased by 21.2% year-over-year and reached $8.7B in the quarter.

Sources: S&P Capital IQ

UMB saw an increase in deposits of about 13% and the combination of this deposit increase, increase in stockholders equity and redemption of $1B in deposits held at other banks in order to fund a 13.1% increase in loans and a 12% increase in fixed income securities.  We just love the fact that UMB has a large proportion of non-interest bearing deposits.  UMB has more than 40% of its deposits as non-interest bearing, which is amongst the top 3% of the industry according to SNL Financial.  We believe that UMB’s high percentage of free funds is a competitive advantage and is reflected in its low overall cost of funds, which was 0.24% for the first quarter versus 0.36% a year ago.  This advantage will be even more important when rates begin to rise.

Source: UMB’s Last Seven Earnings Calls

UMB’s allowance for loan losses is $71.4 million and allowance as a percent of total loans is now 1.324% compared to 1.525% a year ago. UMB’s allowance for loan loss coverage is 2.6 times the amount of non-performing loans while the median industry allowance reported for the fourth quarter would cover just over half of non-performing loans.

Source: Morningstar Direct

The reason why we think it is ridiculous for UMB Financial and its cross-town rival Commerce Bancshares, Inc. (NASDAQ:CBSH) to be part of the extended Federal Reserve CCAR stress tests for $10B-$50B banks is because it wasn’t the $10B-$50B regional banks that were the big problem during the credit crisis, but rather the larger banks. UMB Financial Corporation (NASDAQ:UMBF) and Commerce are both run by different branches of the Kemper Family and considering that the family has 25% of UMB ($450M) and 5% of Commerce ($170M), we believe that the family has significant skin in the game and is most likely to be conducting its own stress tests and doesn’t need know-nothing know-it-all hack-a-demic egghead PhD Keynesian Fabian Socialist Globalist Statist Technocrats from the Federal Reserve telling them how to run a diversified financial enterprise.  While Commerce has higher regulatory capital ratios than UMB, UMB is a well-capitalized bank in its own right with Tier One, Leverage and Total Risk-Based Capital Ratios of 11.69%, 7.15%, and 12.62% respectively.

In conclusion, we were pleased with the performance of UMB Financial Corporation (NASDAQ:UMBF) during the year and since the price of the stock as of October 26th ($44.09/share) is similar to its previous price before it released blow-out numbers for Q1 2012, we will be taking advantage of the market volatility as well as the October sell-off to potentially add to our position.  We are pleased that UMB’s Board of Directors authorized the repurchase of up to 2 million shares of the Company’s common stock in Q1 during the next 12 months, though we wish that the company would take advantage of the decline in its share price to execute the share buyback.  We were also disappointed that the company only increased its dividend by 4.9% year-over-year.