UMB Financial Corporation (UMBF) Q2 2017 Earnings Report, Transcript and Summary

Good morning, and welcome to the UMB Financial Second Quarter 2017 Financial Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Kay Gregory, Director of Investor Relations. Please go ahead.

Good morning and thank you for joining us. On the call today are Mariner Kemper, President and CEO, Ram Shankar, CFO; and Mike Hagedorn, CEO of UMB Bank. 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. Actual results and other future events, circumstances, or aspirations may differ materially from those set forth in any forward-looking statement. Information about factors that may cause them to differ is contained in our Form 10-K and subsequent Form 10-Qs and other SEC filings. Forward-looking statements made in today's presentation speak only as of today, and we undertake no obligation to update them except the extent required by Securities law. Our earnings release, as well as the supporting slide deck is available on our Web site at umbfinancial.com, under news and events in the Investor Section. Reconciliations of non-GAAP financial measures have been included in the earnings release, and on Pages five through seven of the supporting slides. All earnings per share metrics discussed in the call are on a diluted share basis. Please refer to the tables contained in the press release for details related to basic and diluted earnings per share. With that, I'll turn the call over to Mariner Kemper.

Thank you, Kay. Welcome everyone, and thanks for joining us. I'll start this morning's call with some of our high-level results which reflect improved operating leverage driven by net interest income growth as well as solid contributions from fund services, and our bank asset management businesses. As you've seen in our press release, due to the pending sale of Scout Investments second quarter results are presented in a discontinued operations format. Our slides contain more detail on the income and expenses related to Scout. And Ram will discuss them further later in the call. On slide four, you'll see that net income from continued operations was $44.8 million or $0.90 per share. Discontinued operations posted a net loss of $2 million or $0.04 a share, which included pretax divestiture expense of $7.1 million. On a non-GAAP basis, as shown in the reconciliations, net operating income was $44.9 million or $0.90 per share. And net income from discontinued operations was $2.6 million or $0.05 per share, for a combined $0.95 per share. Our efforts to drive positive operating leverage are paying off. For the first half of 2017, revenue growth outpaced operating expense growth compared to 2016, resulting in leverage of 3.7%. On a year-over-year quarterly basis operating leverage was 4.7% as revenues increased 10.6%, while operating non-interest expense grew 5.9%. We remain focused on generating and improving the positive operating leverage rather than a specific expense number as we continue to invest in our business to drive profitable revenue growth. Slide eight and nine show a balance sheet snapshot and our strong loan growth, with average balances for the second quarter increasing 9.5% on a linked quarter annualized basis led by C&I. As we've anticipated and shared over the past several quarters, the more focused growth in our CRE and construction book that began in mid-2015 may have an impact on our level of payoffs and paydowns in a particular quarter. In the second quarter that total was $569 million. Approximately $200 million of that $569 million were payoffs related to one industrial developer who had some recent success selling multiple projects into the secondary market. Mike will share further details in his discussion of the bank later in the call. Turning to slide 10 you'll see the chart that I share every quarter showing a long-term track record of which I'm very proud. During the past 13 years our net charge-off ratio has averaged 0.29%, while our loan book has more than tripled. More recently net charge-offs have averaged just 0.23% quarterly over the past five years. That said, credit trends can be inconsistent from one quarter to another, and as such net charge-offs of second quarter came in at $10 million or 0.37% of loans. This increase in commercial charge-offs was driven primarily by one credit to a manufacturing and distribution company, which accounted for more than half of the charge-offs in the quarter. We periodically have anomalies in our charge-offs. However, given what we know today and the characteristics of our portfolio we expect our net charge-offs to return to levels more in line with historical rates. Provision for loan losses was $14.5 million for the quarter, an increase from $9 million last quarter. In looking at the next slide, loan classification trends showed non-performing loans improved to 0.47% of loans for the second quarter from 0.53% in the first quarter. Finally, work continues on the divestiture of Scout, and we still expect the transaction to close by year-end. As we discussed at the time of the announcement, we are evaluating the actions for deployment of the sales proceeds. This is just one part of our ongoing analysis to determine the best use of capital, whether it is supporting our organic growth strategies and investing in our people and technology, funding potential acquisitions, and/or returning more to shareholders opportunistically. We have an active M&A team which continues to review opportunities and have conversations with potential bank partners as well as other business lines. However, as we've said in the past, the current M&A activity is being impacted by the industry's more volatile operating environment which includes political and regulatory uncertainties. The anticipated changes to the economic environment haven't come to fruition as quickly as many had hoped. And while there is still some optimism that we'll see regulatory or fiscal relief in the future, it seems to be waning as gridlock slows the process. Sellers, especially those we'd be interested in, seem to be hesitant to pull the trigger in this environment. Now, I'll turn the call over to Ram for a discussion on the drivers behind our results, and an adjusted look at our segments. Ram?

Thanks, Mariner, and good morning everyone. As Mariner mentioned, we are presenting our Scout financials in a discontinued operations view. Most of my discussion will focus on continuing operations, but before the segment discussion later in the call I'll share some details on the results from Scout. Looking first at the income statement, net interest income of $137.4 million for the quarter represents a linked-quarter increase of 2.3%, and a year-over-year increase of 13.4%. Mix shift combined with the recent rate hikes and increased volumes drove the $3.1 million increase in additional interest income during the second quarter. Net interest margin for the second quarter was 3.12% versus 3.09% in the first quarter as the 10 basis point increase in earning asset yields was partially offset by a seven basis point increase in the cost of interest-bearing deposits. The three basis points of improvement over the first quarter included approximately five basis points related to loan interests driven largely by higher short-term rates, as well as newer volumes at increased yields, two basis points related to investment securities impacted by higher purchase yields, and a large portion of mortgage-backed and municipal securities offset by four basis points from increased liability costs. Compared to the second quarter of 2016, the margin expanded 26 basis points. Approximately eight basis points of this expansion was driven by benefit from free funds as our deposits become more valuable in a rising rate environment. Slide 14 details the changes in non-interest income, which increased 7.2% on a linked-quarter basis. Bankcard fees were $2.5 million higher compared to the first quarter due to nearly $1 million of additional interchange income, and a $1.4 million decrease in card program rewards and rebate expense recorded as contract revenues. Trust and securities processing income increased $2.3 million over the first quarter driven by a $1.3 million improvement in asset management fees within the Bank segment, and $1 million in additional servicing and custody revenue from fund services. Those increases were partially offset by a $710,000 decrease in bond trading fees, and $660,000 decrease in the income related to the company's seed capital held in certain Scout funds, both of which are included in the trading and investment banking line on the income statement. The adjustments on our seed capital in the second quarter were a positive $788,000 compared to adjustments for the first quarter of a positive $1.4 million, and a positive $202,000 for the second quarter of 2016. We shared last quarter that we expected the return of this seed capital prior to the closing of sale of Scout, and that occurred during the second quarter. Other items driving the linked-quarter increase in fee income include a $986,000 gain on the sale of a branch building, and $428,000 of increased derivative income in the other income line item. Details on the primary drivers of the year-over-year increase in non-interest income are also included on this slide. For the second quarter non-interest income represented 45% of revenue from continuing operations compared to 43% in the first quarter, and significantly better than the peer median of 25%. Slide 16 in the press release contain detailed drivers of the changes in non-interest expense, which on an as-stated basis increased $3.1 million or 1.8% compared to the first quarter. The linked-quarter increase was driven by timing-related variances in marketing and business development expense, higher business activity related processing fees, and increased legal and consulting expense. These were offset by decreases in other expenses driven you lower operating losses, and by lower salaries and benefits expense as FICA and other benefits expenses tempered from first quarter highs. Finally, our lower effective year-to-date tax rate of 21.6% resulted largely from an increase in excess tax benefits associated with stock compensation recorded in the first and second quarters compared to the same period last year. We expect the tax rate for full-year 2017 to be approximately 23% for continuing operations. Before we move to the balance sheet I'll comment on the components of net income from discontinued operations which are shown on slide 17. Revenue from Scout investments was $17.9 million for the second quarter, unchanged from the prior quarter. Total expenses for the quarter were $20.5 million, which included $7.1 million in divestiture costs that Mariner mentioned earlier. We moved the details on Scout and drivers of changes to assets under management to the appendix beginning on slide 43. Scout AUM stood at $27.5 billion at June 30 and experience positive market impact of $402 million during the quarter with contributions from both equity and fixed income markets. Scout experienced total net outflows of $720 million during the quarter comprised of new sales of $555 million and liquidations of $1.2 billion. Additionally $28.5 million was liquidated from three funds at the end of June. The planned closing of these funds emerging markets, global equity and equity opportunity was detailed in the Scout divestiture agreement. Now turning to the balance sheet, we posted a 9.5% link quarter annualized increase in loan balances and Michael provide more color on our loan portfolio in the bank segment discussion. Slide 18 shows the composition of our investment portfolio, the average balances of securities available for sale in the second quarter was $6.3 billion a reduction of $113 million from the first quarter as we continue to rotate from the portfolio and funded loan growth. The average yield in our AFS portfolio increased 3 basis points to 2.16% compared to the first quarter as purchase were made at accretive yields. Details related to the past quarters activities and portfolio statistics are shown on slide 19. Turning to liabilities at $15.6 billion average deposits for the quarter were essentially flat compared to the prior quarter. Link quarter increases in healthcare of deposits, were primarily offset by DDA and MMDA declines at institutional customers continue to deploy funds into the market. The cost of interest bearing deposits for the second quarter was 32 basis point and increase of seven basis points from the prior quarter primarily reflecting mix changes between deposit categories. Including DDA, the cost of our deposit base increased five basis points to 20 basis points while our all in cost of funds increased seven basis points from the link quarter. Since December 2015 when the Fed rate hikes began our cost of interest bearing deposits has increased 14 basis points from 18 to 32 bips while earning asset yields have increased 53 basis points to 3.41%. Compared to the first quarter average demand deposits decreased $160 million while interest bearing deposits increased $90 million driven equally by growth in savings and time deposits, while we've seen more movement in institutional and commercial deposits beta is still in line with or slower than our modeling simulation. Moving to segment results, you'll see the financials for the bank and asset servicing segments on slide 23 followed by details on each. In our asset servicing segment UMB fund services assets under administrations stood at $201.5 billion at quarter end compared to $182.3 billion a year ago. The pretax margin for the quarter was 17.2% compared to 16.5% for the first quarter and 16.8% in the second quarter of 2016. Non-interest income increased $1 million on a link quarter basis related to new alternative servicing business and the increase custody fees. The fund services team continues to market newer solutions to serve the high growth market segment including a white label product to accommodate ETF. In the private equity space we currently service approximately $13 billion in assets and our investment manager series trust which provides a turnkey cost effective method for advisors to get into liquid alternative businesses now have $18.5 billion in assets compared to $16.1 billion a year ago. Details related to this segment on slide 24 to through 26. I'll now hand it to Mike to cover the details and drivers for the bank and then we'll be happy to take your questions Mike.

Thanks, Ram. The Bank segment posted pretax net income of $51.6 million for the quarter and increase of $1.4 million or 2.9% on a link quarter basis. The $9.2 million improvement in revenue was purposely offset by the increase provision discussed earlier. Strong performance from our private wealth and corporate trust seems along with the credit and debit card related income Ram mentioned help drive non-interest income of $86.1 million for the bank a linked quarter increase of 8%. Average loan balances increased 9.5% on a linked quarter analyze basis with average yields on the total portfolio rising by 9 basis points. Drivers of the increased yield included nine basis points related to increased LIBOR and prime rates as C&I loans with their shorter re-pricing terms led the growth during the quarter. One basis point to new loans booked during the quarter and two basis points from acceleration of deferred loan fees. Reductions from loans paid off during the quarter partially offset these increases. Turning to Slide 29, we saw gross loan production of $556 million plus increases in revolving balances of $105 million in the second quarter, total payoffs and pay downs for the quarter were $569 million reflecting the impact of CRE and construction payoffs, it is typical for these projects to be sold or refinanced within 18 to 24 months and we are at about the two year mark from the start of our push to build out this lending vertical, while we do expect to see some level of payoffs each quarter, the timing is hard to predict. We're optimistic that strong top line production and our robust pipeline will help offset these trends. The composition of our loan book in a regional view are shown on Slide 30 and 31, our commercial banking teams continue to leave in terms of loan growth with average balances of C&I loans increasing $200 million or 4.6% during the second quarter. The top categories for the quarter were manufacturing companies along with finance and insurance, our national lending platforms had a strong second quarter combining to add $24.1 million in average balances, in asset base lending new business and retention in growth of existing client relationships combine to drive a 7.5% increase in average balances compared to the first quarter. Year-to-date, our ABL team disclosed 153 million in new client commitments on phase to more than double the levels in 2015, when we acquired the business, a big part of this success has been our cross referral from UMB's traditional commercial lenders, a process that has been gaining traction since we closed the acquisition of Marquette. In our commercial and transportation related factory verticals, we added 17 new borrowers during the second quarter and increased average balances by 4.8% compared to last quarter. As a reminder, in addition to balances throughput or turning those balances several times throughout the quarter helps drive revenue in this business. Commercial finance which represents nearly 58% of the factoring book had strong deal flow this quarter in a wide variety of industries including digital advertising, beef processing and regional airlines. Transportation finance continue to show improvement in industry statistics show that transportation deal flow is trending back to historical levels experienced prior to 2012 helped by an increase in M&A. CRE in construction production and pipelines remain strong even these balances are impacted by payoffs, industrial and multifamily projects continue to be the top categories funded followed by office space and home builders, within our footprint Kansas, Texas and Arizona were the volume leaders for the second quarter. Consistent with prior quarters, multifamily and other investments CRE represents 31% of the average CRE and construction loans on our balance sheet and just over 11% of our total average loans. For further context, our CRE balances are approximately 112% of risk based capital. Our personal banking division private wealth and consumer continues to provide approximately a third of our funding with deposits averaging $5.2 billion for the second quarter. On the lending side, we added $25 million of private banking mortgages during the quarter; in our consumer bank we continue to make changes to improve efficiency. During the second quarter, we consolidated five branch locations bring our total to 99 banking centers and three commercial and private wealth facilities, four locations are scheduled for consolidation in the remainder of 2017. Our efforts to improve operating leverage include strategic decisions about our property holdings including consolidations, the sale of branch buildings and some prudent investments where it makes sense. We removed underperforming and redundant branches while utilizing our enhanced online and mobile banking capabilities to help retain those deposits. As we've mentioned in prior calls, we like review of branches with 4000 or fewer transactions that we call the 4K Model which looks at all metrics including staffing, operating hours, and incentives and we're pleased to report that we continue to make progress on a retail delivery model. As a result, this structure focuses less on the number of widgets, and more on results using measure such as efficiency ratio, customer satisfaction, and associate engagement. We are conducting training based on lessons learned from branches that have been through the 4K process, and now we're turning our focus to those branches with fewer than 7,000 transactions. Through the end of June, 46 locations had transitioned to the new model with two others currently beginning the program. Slide 34 depicts the assets under management in our private wealth, institutional asset management, brokerage, and Prairie Capital Management businesses that are within the Bank segment. Combined AUM now stands at $14.3 million, representing a five-year CAGR of 11.6% from second quarter 2012 AUM of $8.3 billion. We have seen AUM levels expand as we lead with financial planning, focus on wealth transfer within our trust business, and build expertise in areas such as business transition planning. Our commitment to asset management for the families and the institutions we serve remains as strong as ever. In institutional banking, our non-bank channel sales teams continue to build relationships and pipeline with results that helped hold the line on lower municipal underwriting revenue overall. This is consistent with that we're hearing from clients and industry peers as customer expectations for higher interest rates, and the uncertain political and regulatory environment has people on the sidelines. Our FDIC sweep program which offers clients a liquidity alternative to overnight money funds stood at $53 billion as of June 30th. Just five years ago this program had $15.7 billion. Turning to our healthcare business on slide 37, the number of HSA accounts surpassed the one million mark in the second quarter, and HSA deposits increased 30% compared to a year ago to $1.8 billion, and now represent 11.5% of total deposits. These deposits are an important part of our funding, and in our experience they tend to have similar characteristics as core deposits. Slide 38 shows the year-end 2016 rankings released by Devenir Research and UMB ranks fifth in the U.S. in terms of accounts, and sixth in terms of deposits and assets. We continue to follow the rapidly changing discussions in Washington related to healthcare reform. Some of the potential changes that have been discussed, such as increased contribution limits and the expansion of HSAs to include Medicare recipients could have a positive impact on our business, but now we're taking a wait-and-see approach particularly given the news over the past week. With that I'll conclude our prepared remarks, and turn it back over to the operator who will open up the line for questions.

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Chris McGratty with KBW. Please go ahead.

Hi, good morning. Thanks for taking the question.

Good morning, Chris.

Good morning. Ram, maybe I'll start with you on the deposits. Obviously the HSA growth has been really tremendous. The question I have is on the network deposits and the index deposits. How big is that portfolio that's kind of more sensitive to Fed funds' changes? And kind of conceptually, what's the ability to reduce that reliance given how favorable your loan-to-deposit ratio is? Thanks.

Chris, I'll take a stab at it and Mike might jump in. So as we talked last time, some of these institutional money and some of the commercial deposits are hard indexed, so you will see some reaction to Fed moves directly correlated, either one-to-one or slightly less. So typically these have higher betas than what a consumer deposit would have. And what was your second question, could you repeat that?

Yes, I was interested in the dollar -- like how much of the portfolio is indexed, and the ability to kind of move away from that to enable the margin to perform a little bit better? Thanks.

We haven't disclosed specifics on that, Chris, but clearly we model that. And as I said in my prepared comments, the betas on those, while rising, are still in line or better than what we modeled.

Okay. If I could follow-up on loan growth, the color, Mike, you provided about the gestation period for the payoffs was helpful. How should we be thinking about growth over the next few quarters? Are you kind of seeing that growth might be a little bit more subdued maybe for the back half of the year or is pipeline commentary constructive enough where you could see a decent resumption in growth?

So, Chris, this is Mariner. Mike could add to this as well, but as I've done in the past, giving you a little bit of look into the next quarter based on what the pipeline is. And I would say that the pipeline remains strong as it has been. And obviously we made some remarks about the unusual nature of what happened in the quarter related to payoffs.

Great. And finally, help on the effective tax rate in the back half of the quarter, just understanding the moving parts with continued ops and discontinued would be great. Thanks.

So, as I said in the prepared comments, the full-year tax rate should be about 23% on continuing operations, and consistent with the second quarter on disc ops. The biggest driver of that and one that we can't forecast is just because of the stock compensation expense and what happens to activity and executives and employees doing their exercises. So I would say there's almost an offset. Not an equal offset, but there's an offset in FICO-related expenses because that really pulls forward some of those expenses in FICA from the third and fourth quarters into second quarter. When we give you a forecast it's based on no unusual activity in stock comp, and that's 23% for the full-year, Chris.

Great. Thanks, Ram.

The next question comes from Matt Olney with Stephens. Please go ahead.

Hi, thanks. Good morning guys.

Good morning, Matt.

Going back to the loan growth commentary, Mariner, I appreciate the strong loan growth pipeline that you mentioned, but what do you think about these payoffs, so are we entering a level -- a time period now when these payoffs could continue at this higher level given we're entering year two, and now year three of this CRE build out?

So we don't know exactly what the ongoing levels will look like. We're getting a little bit of history with that. But we don't know exactly what that'll look like. I will say -- reiterate what we already mentioned, that there's approximately $200 million in there related to one particular relationship we had, it had multiple projects that was able to reposition their portfolio and sell into the secondary market, so that $200 million or a large part of the payoffs was what we would theme as unusual related to payoff activity.

Okay, that's helpful. And then I'm curious, sticking with this commercial real estate build out, you've grown the book quite a bit over the last few years. I'm curious, how much more of an appetite do you have from these current levels? And are there any internal concentrations that you're managing to?

So we don't make those -- we do have them, we don't make any of our internal guidelines public, but we do have them. And there are lots of things at play related to what our deposit growth is, and how fast other parts of the asset allocation are growing. I would say that we have plenty of room given where we are right now. But we do pay attention to our concentrations, and there are many variables.

Matt, this is Ram. And as Mike said, our CRE exposure as a percentage of total risk-based capital is just 112%. And that's before all the gains that we're going to get from Scout sometime in the fourth quarter as well. So just echo what Mariner said about a lot of room.

Well below our peer numbers.

This is Mike. I would just add that it isn't as simple as are you close to or exceeding some internal guidelines. And that's important. And as Mariner mentioned, we clearly have them and we manage that way, but it also depends on the borrower, the collateral position they have, guarantees. So it's not as simple as they're just up against the guideline.

Understood, thank you for that. And then last question for me on the bankcard fees, really nice improvement this quarter. Did you update this strategy at all? I'm asking because I'm curious about the commentary in the press release about the program rewards and rebate expense changes. I'm trying to figure out how sustainable these 2Q levels are with the card fees.

Yes, that could take me an hour to answer that question, so I'll try to not do it in an hour. So we have replaced our vendor on the rewards side of the program with a more robust offering that we think is both offers better choice but also offers a better digital experience. That's probably what you're referring to. As it related to rebates, it is very hard to comment specifically around how those work because they're negotiated on a contract-by-contract basis. So you might see, for instance, a slowing in the growth rate, and this is hypothetical. You might see a slowing in the growth rate and assume that there is less volume, and then you look at the volume and go, well, the line is going up, it's because the rebating has changed based upon the size of the customer. And commercial card is a very big part of our card business, so volume is a big driver, and we have to balance that off against the rebates.

Got it, okay.

Activity has been strong which is -- that's part of the answer, so, yes.

Thank you.

The next question comes from Ebrahim Poonawala with Bank of America Merrill Lynch. Please go ahead.

Good morning.

Good morning. Just a quick question, I joined late. I'm sorry if I missed it. Did you disclose how much of the provisioning expense this quarter was related to that commercial credit which sort of hit charge-offs?

What I said in my comments, Ebrahim, is off the $10 million in charge-offs this quarter, more than half of it was related to this one single credit. So we're not obviously saying what that number is, but it's higher than we would normally expect.

And safe to assume that that wasn't something that was fully reserved for in previous quarters so it did have an impact on the elevated provisioning this quarter?

You might have to do that again, sorry Ebrahim.

So I'm just wondering what was the amount that was charged off fully reserved again, so did we take incremental reserves in 2Q?

This charge-off was all completely within the second quarter. I think if you are asking was there a portion of it in the first quarter and then, no, there was not a portion of first quarter. This is all being recognized in the second quarter. And at this point in time is all of the known loss that we have related to this one credit.

Understood. Moving to deposits, I'm not sure if you talked about it in terms of should we expect as we move forward, like deposit growth, we had the seasonal rebound on period-end basis. Should deposit growth sort of continue on a net basis looking out into the third and fourth quarter? And what's your appetite to runoff some of these higher cost deposits given your sub-70% loan-to-deposit ratio?

Okay, I'll take a stab at the last part because I heard that. The beginning you may have to repeat. So what is our appetite to, if I heard the question right, what is our appetite to runoff quote unquote high-cost deposits. And that may be related kind of to Chris' question earlier as well. As long as the spread provides us a proper return we're not particularly interested in doing that. I know we're in a rising rate environment, so people might look at that and go, well you have this lower loan-to-deposit ratio, you have some room for that. But remember we also have a large public fund business. We need a very large portion of our investment portfolio for collateral purposes for that business. So it's not as simple as just looking at the loan-to-deposit ratio.

And they are short-term in nature, a lot of them on relationship basis.

Yes. I would argue it's actually one of the strengths of UMB that we have access to those institutional sources of funds. And as long as they have positive carry and give us the right returns, as I said, we're going to do that.

Right, and our loan yields is improving, et cetera. So we think that -- and margin is expanding still, so we think it all still works pretty well.

Understood. And yes, I guess my initial part of that question was I was trying to understand the deposit growth trend in the back half of the year. Should we expect deposit growth as we look into period-end third quarter and fourth quarter from here on?

Well, we're obviously always in the market trying to grow our franchise. So to the extent that we're successful with those strategies, and the rates make sense for our expectation for future interest rate increases, I would say yes, we should expect deposits to grow. Well, we're not doing anything to curtail that, let's put it that way. So it would be more the normal course of business, yes.

Okay, and there's nothing seasonal in the back half of the year that we should be sort of mindful of?

There might be a little bit of dip, at the very end you'll see just historically looking backwards maybe late August, September, early October for public funds a little bit. Other than that there's no seasonality.

Understood. And one last question, the efficiency ratio again improved a little bit at 68%. Any sort of outlook on that in terms -- I know you don't want to give a specific guidance, but where do you see this going down a year from now if you had to sort of guess?

Yes, we're more full -- we're more focused on the operating leverage, making sure that we're growing revenue faster than we are expenses. So we've been highlighting that, and you can see that in our prepared comments, and we're seeing that. So the efficiency ratio, as you've mentioned, we aren't providing specific guidance there. I would tell you that we do expect to continue to make improvement. I think we can still make improvement without giving specific guidance.

Got it. Thanks for taking my questions.

The next question comes from John Rodis with FIG Partners. Please go ahead.

Good morning, guys.

Good morning, John.

Ram, maybe just a follow-up question for you on trading and securities processing fees, I guess they were up nicely in the quarter. Is there anything -- it looks like it's normal increases, but is there anything unusual about those, I guess, increases sort of similar to bankcard fees the increase there?

No, there's nothing abnormal about that line item. As Mariner said in his prepared remarks, our fund services, our asset servicing business which is almost half of that line item grew nicely as we added new clients; there was increased custody fees and servicing fees associated with just normal business activity.

Okay. And just to be sure, I mean so Scout is not in that at all obviously the…

Correct. That number used to run around $60 million before we announced cardinal. Now it's running at 40-ish because caps is gone.

Okay, makes sense. Okay, thanks guys.

Thanks.

[Operator Instructions] The next question comes from Peyton Green with Piper Jaffray. Please go ahead.

Yes, good morning. I was just wondering, Ram, if you could comment on the likelihood that loan yield should continue to move up in the third quarter relative to the June move in Fed funds versus the cost of interest-bearing deposits. You'll had very favorable movement of that relationship, and I was just wondering if you thought it would be favorable in the third quarter or if it's more of a push?

I would say similar dynamic as what happened to the March rate hike, right. So the March rate hike flowed through the second quarter, 60% of our loan book is still variable and tied to short-term LIBOR and the prime rate. So you should see that pick up in the loan yields. And obviously we are managing our costs selectively under the deposit side, some are hard indexed, but still 37%-38% of our deposits is DDAs. And the cost of those free funds or the benefit of those free funds will continue to increase as interest rates increase. And that's what you're seeing on a year-over-year basis.

Okay. And then looking back through my notes on 1Q I think you'll referenced in the conference about one quarter results that 75% of your deposits were administered are non-interest bearing. Is that still accurate?

That's generally in the ballpark, yes.

Okay. And did you -- I mean could you characterize, was there any movement from, say, administered accounts to maybe these hard or soft indexed type accounts during the quarter or is that not really the driver, it's just simply market rates moving through and catching up a little bit on the interest-bearing side?

So on the deposit side, I don't know if you missed our comments earlier, but if you look at our deposit base the institutional money is being redeployed in the markets. So that's the biggest driver of what's happening in the deposit side, there's a mix shift happening. So depends on what happens in the market, but we expect that'll continue to happen a little bit. But offsetting that should be the initiative that we have to grow our private wealth and commercial deposits.

Okay.

Did I answer your question, Peyton?

Yes. No, great. And then I guess just kind of stepping back, if we looked at opportunities for UMB over the next two to three years, and based on kind of the segment disclosure of both the profitability within the bank itself. I mean it would still seem like personal banking is still way under punching relative to the balance sheet that it has in terms of its pretax profit contribution. Institutional is doing quite well; the commercial bank is doing better. But maybe how could you characterize where you're emphasizing growth at the margin, for example, I mean, UMB has a lot smaller residential loan portfolio relative to peers. What opportunities are you all focused on over the next couple of years that can help drive the overall profit contribution from those lines?

Peyton, this is Mike, I'll take a stab, and I'm sure Mariner will jump in. I don't think that the strategy is really all that different than what we've communicated in the past. We're still interested in looking at whole bank acquisitions that in particular have strong deposit franchises that can help fuel our lending growth in certain geographies and certain verticals that we have. Within the Bank segment itself, as we've talked about in the past again, our healthcare business and our institutional business are number two and number three, and as far as contribution in those places what we would like to make investments if we could find the right things. I do want to say one thing on personal, just as a reminder, that's our private wealth business and our consumer business together and while I know we don't disaggregate that for you to see the differences don't necessarily draw the conclusion that, that's indicative of the any one of those two segments, consumer had the overall returns within personal banking.

I would just add to you to talk about mortgages and other things that we might be doing to improve the personal part of retail part of our business. Those efforts are underway. We're having success with them. We don't think about our retail business separate from being a part of the whole, so while we are improving the efficiency ratio, Mike talked about in 4K and moving to 7K process continue to have opportunity to make that part of organization more effective as well as expanding our consumer lending practices. But we don't think about it independently, we think about it as a part of the whole and systems and gathering assets across our other parts of the business as well.

Yes, I mean it contributed. So I think Ram said in his prepared remarks, a third of our funding. So we do remiss if we did anything to disrupt that. It's a very important part of our balance sheet. And as Mariner said, and I want to reiterate this, the consumer part of our business has contributed significantly to the efficiency initiative that we've talked about in prior quarters and prior years.

No problem, I just guessed looking at the segment disclosure, it's got an efficiency ratio of 90% relative to the commercial bank, which is sub-60 in the quarter.

Yes, we get it.

Okay. And then maybe stepping back kind of to the expense growth question in general, on a continuing ops basis it was up about 7% year-over-year and 7% linked quarter annualized, and there still seems to be heavy expense on the equipment side, the processing side, things that are big changes, but hard to see revenue attached to them beyond bank card. Is there anything, I mean, would you expect a slowing of that at some point because it seems awfully high relative to the efficiency initiative that was implemented over the last six or seven quarters?

You know Peyton, thanks for the question we not at liberty to probably give you the kind of the forward-looking about when that ends, it is elevated, it's absolutely elevated right now; sorry, I can tell you that. It's related to just investing in our systems, and hardening, and core systems and modernization and things like that. So, we're going through some of those efforts. So it is elevated. I can't really give you too much more detail as it relates to how elevated or when it might come back down but it is elevated. And again, I think what we'd really like you to focus on more because, we are a complex organization is the operating leverage more than really what our expense levels are. And so, we are focused on operating leverage and you're seeing that expansion, and that's where we like to point your direction.

And a couple of things I'll add to that, Peyton, this is Ram. Obviously, some of those expenses even the processing expense line item that you mentioned, that is directly tied to revenue. So, variable expenses is a little bit more than -- just because if you use the same periods that you quoted on a year-over-year basis just 2Q revenues are up 10.6%. On the first half, it's up 10.3%. So, included in that is also bonus and incentive payment that go to our people that are crushing it here. And so, you'll see some variable costs like would be revenue. So that's why we have to manage to an operating leverage, as opposed to just plain expense growth.

Okay, thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Kay Gregory for any closing remarks.

Thank you for joining us today. This call can be accessed via replay at our Web site and it will run through August 10th. As always you can contact UMB Investor Relations at 816-860-7106 with any follow-up questions. Again, we appreciate your interest and time. Thank you.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.