UMBF - UMB Financial: Solid Business But Not A Standout Valuation Today

2023-10-27 02:33:31 ET

Summary

• UMB's top-line results were weak, particularly on the net interest income line, but good operating expense control and lower provisioning expenses drove an EPS beat.
• Deposits costs remain high despite a strong core deposit base, but loan repricings are expected to improve the company's spread performance.
• UMB Financial's strong non-spread operations provide an invaluable offset to the vagaries of the rate and credit cycle, but the valuation has long reflected that.
• Like so many regional banks, UMB is almost certainly undervalued today, but I don't find the relative valuation so interesting.

Quality only matters up to a point. While UMB Financial (UMBF) is a high-quality bank by many metrics (including above-average historical growth rates and customer satisfaction scores), the bank has performed basically inline with the broader regional group since my last update … and likewise over the last decade. At least some of the latter, I believe, can be explained by an often relatively robust valuation that already reflects a lot of the positives here.

I was bullish on UMB's prospects given its strong fee-generating operations, specialty lending capabilities, and deployable capital, and those are still relevant drivers, but the relative valuation still isn't that exciting. Moreover, while this bank has businesses that operate on a national or almost-national basis, the core lending footprint is still one with below-average growth prospects for population and incomes. With an unspectacular valuation and so many options today, this isn't a top choice for me.

Weak Top-Line Results Offset By Much Lower Provisioning

UMB's quarter was a little out of the norm; spread pressure and sluggish earning asset growth isn't so unusual, but not many other companies that I've looked at so far saw earnings driven as much by lower-than-expected provisioning expense. This is generally considered a lower-quality beat, but I would nevertheless argue that it underlines a positive credit quality situation.

Revenue declined 2% year over year and 2% quarter over quarter, missing by around $0.13/share (or a little more than 2%) relative to the Street. Net interest income declined almost 5% yoy and more than 1%, not a bad result relatively speaking (the average for regional banks has been a little less than 1%), but weaker than expected and driving about $0.14/share of underperformance. Net interest margin was a little weaker than expected, but fell just 1bp qoq to 2.43% (lower than average, but that's not new), and earning asset performance was likewise weaker than expected (down more than 2% qoq).

Fee-generating businesses are a significant part of UMB's mix (more than a third), and adjusted non-interest income rose more than 2% yoy while falling about 3% qoq, more or less as expected. Trust income grew more than 8% sequentially, while card fees grew almost 4% and brokerage revenue declined about 2%.

Adjusted operating expenses fell 1% yoy and about 3% qoq, a solid performance relative to expectations (adding back about $0.12/share to earnings). Operating leverage has been hit-or-miss for regional banks, and this was a good performance.

Pre-provision operating profits fell more than 4% yoy and less than 1% qoq, missing by a little more than a penny. Provisions were considerably lower than expected, contributing almost $0.25/share relative to sell-side expectations. As I said, provision-driven beats aren't often well-rewarded, but it does support the thesis that UMB has quality underwriting and credit issues are well in check.

Deposit Costs Running High, But Loan Repricings Will Help

UMB has a lot of funding qualities that you'd normally like. The 32% ratio of non-interest-bearing deposits to total deposits is good, and the loan/deposit ratio of 73% or so isn't that high. Even so, funding costs remain elevated and continue to push an already-high deposit beta even higher.

Deposits rose about 5% yoy and fell slightly from the prior quarter, with NIB deposits down 19% yoy and more than 7% qoq (worse than average). Deposit costs rose about 27bp qoq to 2.45%, with interest-bearing deposits up 33bp qoq to 3.6%. The quarter-over-quarter change wasn't that steep, but UMB was running about 70bp above average for its deposit costs, and the cumulative interest-bearing deposit beta has expanded from 64% to 67% - quite high relative to many other comparable banks.

On the other side of the ledger, loans increased very slightly for the quarter, with loan production down about a third from the prior quarter. More than half of the loan growth seen came from construction drawdowns, while C&I lending growth (C&I loans were up about 1.3% qoq) accounted for most of the rest. CRE lending growth of 4.5% qoq was largely driven by construction, and mortgage growth of over 3% was also fairly strong.

Loan yields are pretty good, but should get better. Yields improved 21bp qoq to 6.41%, and the loan beta sits at over 56%, but 71% of the bank's loans are due to reprice in 2024, and that should improve the company's spread performance.

Credit quality remains quite good, with non-performing loans down 12% sequentially and making up a small (0.07%) percentage of loans. Charge-offs are likewise low, and while they did grow sequentially, that was largely driven by cards (a common occurrence this quarter). While UMB does have a somewhat meaningful office CRE loan book (4.5% of loans), more than half of that is in suburban areas (less pressured by current office trends), and 17% is medical offices.

If anything, I'm more concerned about the bank's syndicated loan exposure. This is a meaningful percentage of loans (11% to 13%), and I think there could still be surprises in store on the corporate credit side (everybody's paying attention to CRE office, which leads me to wonder if C&I will deliver the negative credit surprises this cycle).

The Outlook

Adjusting my model for third quarter earnings, I'm a few pennies below the Street for FY'23 core earnings and about $0.08 below for FY'24, where I expect a mid-single-digit decline in earnings. Longer term, I still like UMB's combination of specialty commercial lending (including asset-backed lending, factoring, aviation, and practice finance), in-footprint CRE lending, and fee-generating businesses, including its fund servicing operations and banking-as-a-service offerings. With that, I think around 5% long-term core earnings growth is a reasonable expectation now, and the bank does have deployable capital that could grow its earnings capacity.

Discounting those earnings back, though, I don't get a very compelling fair value. Likewise with multiples-based approaches; a 10.8x multiple on my FY'24 EPS estimate gets me to $75 and 1.5x tangible book gets me to $78 (in both cases UMB gets a premium for the sizable non-spread operations).

The Bottom Line

UMB reminds me of Commerce Bancshares (CBSH) in some respects (similar footprint, similar significant fee-generating businesses, and a similar focus on core lending capabilities). UMB has done a little better over the last one and five-year periods, while Commerce has outperformed over the last 10 years. In either case, while I understand why some investors may be willing to pay a premium, I don't share that inclination. I like UMB's business, but at today's valuation I can't work up a lot of excitement for the stock.

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