UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
For the quarterly period ended June 30, 2011
OR
For the transition period from to
Commission file number 0-4887
UMB FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. – Employer
Identification Number)
(Registrant’s telephone number, including area code): (816) 860-7000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨_
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨_
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨
Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.
As of July 29, 2011, UMB Financial Corporation had 40,481,169 shares of common stock outstanding.
INDEX
PART I – FINANCIAL INFORMATION
ITEM 1.
CONDENSED CONSOLIDATED BALANCE SHEETS
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
STATEMENTS OF CHANGES IN CONDENSED CONSOLIDATED SHAREHOLDERS’ EQUITY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 3.
ITEM 4.
PART II – OTHER INFORMATION
ITEM 1A.
ITEM 5.
ITEM 6.
SIGNATURES
CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
2
ITEM 1. FINANCIAL STATEMENTS
(unaudited, dollars in thousands, except share and per share data)
Loans:
Allowance for loan losses
Net loans
Loans held for sale
Securities:
Available for sale
Held to maturity (market value of $74,720 and $68,752, respectively)
Trading
Federal Reserve Bank stock and other
Total investment securities
Federal funds sold and securities purchased under agreements to resell
Interest-bearing due from banks
Cash and due from banks
Bank premises and equipment, net
Accrued income
Goodwill
Other intangibles
Other assets
Total assets
LIABILITIES
Deposits:
Noninterest-bearing demand
Interest-bearing demand and savings
Time deposits under $100,000
Time deposits of $100,000 or more
Total deposits
Federal funds purchased and repurchase agreements
Short-term debt
Long-term debt
Accrued expenses and taxes
Other liabilities
Total liabilities
SHAREHOLDERS’ EQUITY
Common stock, $1.00 par value; 80,000,000 shares authorized; 55,056,730 shares issued; and 40,499,385 and 40,430,081 shares outstanding, respectively
Capital surplus
Retained earnings
Accumulated other comprehensive income
Treasury stock, 14,557,345 and 14,626,649 shares, at cost, respectively
Total shareholders’ equity
Total liabilities and shareholders’ equity
See Notes to Condensed Consolidated Financial Statements.
3
Loans
Taxable interest
Tax-exempt interest
Total securities income
Federal funds and resell agreements
Trading securities
Total interest income
INTEREST EXPENSE
Deposits
Federal funds and repurchase agreements
Other
Total interest expense
Net interest income
Provision for loan losses
Net interest income after provision for loan losses
NONINTEREST INCOME
Trust and securities processing
Trading and investment banking
Service charges on deposits
Insurance fees and commissions
Brokerage fees
Bankcard fees
Gain on sales of securities available for sale, net
Total noninterest income
NONINTEREST EXPENSE
Salaries and employee benefits
Occupancy, net
Equipment
Supplies and services
Marketing and business development
Processing fees
Legal and consulting
Bankcard
Amortization of intangible assets
Regulatory fees
Class action litigation settlement
Total noninterest expense
Income before income taxes
Income tax provision
NET INCOME
PER SHARE DATA
Net income – basic
Net income – diluted
Dividends
Weighted average shares outstanding
4
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(unaudited, dollars in thousands, except per share data)
Balance – January 1, 2010
Comprehensive income
Net income
Change in unrealized gains on securities
Total comprehensive income
Cash dividends ($0.37 per share)
Purchase of treasury stock
Issuance of equity awards
Recognition of equity based compensation
Net tax benefit related to equity compensation plans
Sale of treasury stock
Exercise of stock options
Balance – June 30, 2010
Balance – January 1, 2011
Cash dividends ($0.39 per share)
Balance – June 30, 2011
5
(unaudited, dollars in thousands)
Operating Activities
Net Income
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization
Deferred income tax benefit
Net increase in trading securities
Gains on sales of securities available for sale, net
Gains on sales of assets
Amortization of securities premiums, net of discount accretion
Originations of loans held for sale
Net gains on sales of loans held for sale
Proceeds from sales of loans held for sale
Equity based compensation
Changes in:
Other assets and liabilities, net
Net cash provided by operating activities
Investing Activities
Proceeds from maturities of securities held to maturity
Proceeds from sales of securities available for sale
Proceeds from maturities of securities available for sale
Purchases of securities held to maturity
Purchases of securities available for sale
Net increase in loans
Net decrease in fed funds sold and resell agreements
Net decrease in interest-bearing balances due from other financial institutions
Purchases of bank premises and equipment
Net cash paid for acquisitions
Proceeds from sales of bank premises and equipment
Net cash provided by investing activities
Financing Activities
Net increase in demand and savings deposits
Net decrease in time deposits
Net decrease in fed funds purchased and repurchase agreements
Net decrease in short-term debt
Repayment of long-term debt
Cash dividends paid
Proceeds from exercise of stock options and sales of treasury shares
Purchases of treasury stock
Net cash provided by (used) in financing activities
Increase (decrease) in cash and due from banks
Cash and due from banks at beginning of period
Cash and due from banks at end of period
Supplemental Disclosures:
Income taxes paid
Total interest paid
6
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2011 (UNAUDITED)
1. Financial Statement Presentation
The condensed consolidated financial statements include the accounts of UMB Financial Corporation and its subsidiaries (collectively, the “Company”) after elimination of all significant intercompany transactions. In the opinion of management of the Company, all adjustments, which were of a normal recurring nature and necessary for a fair presentation of the financial position and results of operations, have been made. The results of operations and cash flows for the interim periods presented may not be indicative of the results of the full year. The financial statements should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010.
2. Summary of Accounting Policies
The Company is a multi-bank financial holding company, which offers a wide range of banking and other financial services to its customers through its branches and offices in the states of Missouri, Kansas, Colorado, Illinois, Oklahoma, Arizona, Nebraska, Pennsylvania, South Dakota, Indiana, Wisconsin, New Jersey, and Massachusetts. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. These estimates and assumptions also impact reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. A summary of the significant accounting policies to assist the reader in understanding the financial presentation is listed in the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010.
Interest-bearing Due From Banks
Amounts due from the Federal Reserve Bank which are interest-bearing for all periods presented, and amounts due from certificates of deposits held at other financial institutions are included in interest-bearing due from banks. The amount due from the Federal Reserve Bank totaled $1,238.5 million and $446.5 million at June 30, 2011 and June 30, 2010, respectively, and is considered cash and cash equivalents. The amounts due from certificates of deposit totaled $133.0 million and $271.9 million at June 30, 2011 and June 30, 2010, respectively.
This table provides a summary of cash and due from banks as presented on the Consolidated Statement of Cash Flows as of June 30, 2011 and June 30, 2010 (in thousands):
Due from the Federal Reserve
Per Share Data
Basic income per share is computed based on the weighted average number of shares of common stock outstanding during each period. Diluted quarterly per share data includes the dilutive effect of 323,509 and 287,458 shares issuable upon the exercise of options granted by the Company and outstanding at June 30, 2011 and 2010, respectively. Diluted year-to-date income per share includes the dilutive effect of 318,004 and 280,809 shares issuable upon the exercise of stock options granted by the Company and outstanding at June 30, 2011 and 2010, respectively.
Options issued under employee benefit plans to purchase 765,818 shares of common stock were outstanding at June 30, 2011, but were not included in the computation of quarterly and year-to-date diluted EPS because the options were anti-dilutive. Options issued under employee benefit plans to purchase 688,640 shares of common stock were outstanding at June 30, 2010, but were not included in the computation of quarterly diluted EPS because the options were anti-dilutive. Options issued under employee benefit plans to purchase 874,914 shares of common stock were outstanding at June 30, 2010, but were not included in the computation of year-to-date diluted EPS because the options were anti-dilutive.
7
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
3. New Accounting Pronouncements
Credit Quality of Financing Receivables and the Allowance for Credit Losses In July 2010, the FASB issued ASU No. 2010-20, “Disclosures About the Credit Quality of Financing Receivables and the Allowance for Credit Losses” (ASU 2010-20), which amends ASC 310 by requiring more robust and disaggregated disclosures about the credit quality of an entity’s financial receivables and its allowance for credit losses. ASU 2010-20 was effective for the Company for the annual reporting period ended December 31, 2010. The Company adopted this statement on December 31, 2010 with no impact on its financial position or results of operations except for additional financial statement disclosures. In January 2011, the FASB issued ASU No. 2011-01, “Deferral of the Effective Date of Disclosures About Troubled Debt Restructurings (TDRs) in Update No. 2010-20”, which temporarily defers the effective date in ASU 2010-20 for disclosures about TDRs by creditors until the FASB finalizes its project on determining what constitutes a TDR for a creditor. In April 2011, the FASB issued ASU No. 2011-02, “A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring,” which adds clarification to ASC 310 about which loan modifications constitute TDRs. It is intended to assist creditors in determining whether a modification of the terms of a receivable meets the criteria to be considered a TDR, both for purposes of recording an impairment loss and for disclosure of TDRs. ASU 2011-02 will be effective for the Company for the interim reporting period ending September 30, 2011. The Company cannot currently quantify with precision the effect that this standard will have on the financial position or results of operations in the future.
Presentation of Comprehensive Income In June 2011, the FASB issued ASU No. 2011-05, “Comprehensive Income: Presentation of Comprehensive Income” (ASU 2011-05), which amends the FASB Standards Codification to allow the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. These amendments do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. ASU 2011-05 will be effective for the Company for the interim reporting period ending March 31, 2012. The Company does not expect this standard to have a material impact on its financial position or results of operations except for a change in presentation.
8
4. Loans and Allowance for Loan Losses
Loan Origination/Risk Management
The Company has certain lending policies and procedures in place that are designed to minimize the level of risk within the loan portfolio. Diversification of the loan portfolio manages the risk associated with fluctuations in economic conditions. The Company maintains an independent loan review department that reviews and validates the credit risk program on a continual basis. Management regularly evaluates the results of the loan reviews. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company’s policies and procedures.
Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business. Commercial loans are made based on the identified cash flows of the borrower and on the underlying collateral provided by the borrower. The cash flows of the borrower, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts from its customers. Commercial credit cards are generally unsecured and are underwritten with criteria similar to commercial loans including an analysis of the borrower’s cash flow, available business capital, and overall credit-worthiness of the borrower.
Commercial real estate loans are subject to underwriting standards and processes similar to commercial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. The Company requires an appraisal of the collateral be made at origination, on an as-needed basis, in conformity with current market conditions and regulatory requirements. The underwriting standards address both owner and non-owner occupied real estate.
Construction loans are underwritten using feasibility studies, independent appraisal reviews, sensitivity analysis or absorption and lease rates and financial analysis of the developers and property owners. Construction loans are based upon estimates of costs and value associated with the complete project. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term borrowers, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their repayment being sensitive to interest rate changes, governmental regulation of real property, economic conditions and the availability of long-term financing.
Underwriting standards for residential real estate and home equity loans are based on the borrower’s loan-to-value percentage, collection remedies, and overall credit history.
Consumer loans are underwritten based on the borrower’s repayment ability. The Company monitors delinquencies on all of its consumer loans and leases and periodically reviews the distribution of FICO scores relative to historical periods to monitor credit risk on its credit card loans. The underwriting and review practices, combined with the relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Consumer loans and leases that are 90 days past due or more are considered non-performing.
9
This table provides a summary of loan classes and an aging of past due loans at June 30, 2011 and December 31, 2010 (in thousands):
Commercial:
Commercial
Commercial – credit card
Real estate:
Real estate – construction
Real estate – commercial
Real estate – residential
Real estate – HELOC
Consumer:
Consumer – credit card
Consumer – other
Leases
Total loans
The Company sold $103.0 million and $87.6 million of loans during the six month periods ended June 30, 2011 and June 30, 2010, respectively. The Company has ceased the recognition of interest on loans with a carrying value of $15.3 million and $24.9 million at June 30, 2011 and December 31, 2010, respectively. Restructured loans totaled $0.1 million and $0.2 million at June 30, 2011 and December 31, 2010, respectively. Loans 90 days past due and still accruing interest amounted to $7.4 million and $5.5 million at June 30, 2011 and December 31, 2010, respectively. There was an insignificant amount of interest recognized on impaired loans during 2011 and 2010.
10
Credit Quality Indicators
As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators including trends related to the risk grading of specified classes of loans, net charge-offs, non-performing loans, and general economic conditions.
The Company utilizes a risk grading matrix to assign a rating to each of its commercial, commercial real estate, and construction real estate loans. The loan rankings are summarized into the following categories: Non-watch list, Watch, Special Mention, and Substandard. Any loan not classified in one of the categories described below is considered to be a Non-watch list loan. A description of the general characteristics of the loan ranking categories is as follows:
Watch – This rating represents credit exposure that presents higher than average risk and warrants greater than routine attention by Company personnel due to conditions affecting the borrower, the borrower’s industry or the economic environment. These conditions have resulted in some degree of uncertainty that results in higher than average credit risk.
Special Mention – This rating reflects a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or the institution’s credit position at some future date. The rating is not adversely classified and does not expose an institution to sufficient risk to warrant adverse classification.
Substandard – This rating represents an asset inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged, if any. Assets so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. Loans in this category are characterized by the distinct possibility that the bank will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified substandard. This category may include loans where the collection of full principal is doubtful or remote.
All other classes of loans are generally evaluated and monitored based on payment activity. Non-performing loans include restructured loans, impaired loans, and loans greater than 90 days past due.
11
This table provides an analysis of the credit risk profile of each loan class at June 30, 2011 and December 31, 2010 (in thousands):
Corporate Credit Exposure
Credit Risk Profile by Risk Rating
Non-watch list
Watch
Special Mention
Substandard
Total
Credit Risk Profile Based on Payment Activity
Performing
Non-performing
2011
12
Allowance for Loan Losses
The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s judgment of losses within the Company’s loan portfolio as of the balance sheet date. The allowance is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. Accordingly, the methodology is based on historical loss trends adjusted for the current environment. The Company’s process for determining the appropriate level of the allowance for loan losses is designed to account for credit deterioration as it occurs. The provision for possible loan losses reflects loan quality trends, including the levels of and trends related to non-accrual loans, past due loans, potential problem loans, criticized loans and net charge-offs or recoveries, among other factors.
The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. Portions of the allowance may be allocated for specific loans; however, the entire allowance is available for any loan that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the adequacy of the allowance is dependent upon a variety of factors beyond the Company’s control, including, among other things, the performance of the Company’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.
The Company’s allowance for loan losses consists of specific valuation allowances and general valuation allowances based on historical loan loss experience for similar loans with similar characteristics and trends, general economic conditions and other qualitative risk factors both internal and external to the Company.
The allowances established for probable losses on specific loans are based on a regular analysis and evaluation of problem loans. Loans are classified based on an internal risk grading process that evaluates the obligor’s ability to repay, the underlying collateral, if any, and the economic environment and industry in which the borrower operates. When a loan is considered impaired, the loan is analyzed to determine the need, if any, to specifically allocate a portion of the allowance for loan losses to the loan. Specific valuation allowances are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk ranking of the loan and economic conditions affecting the borrower’s industry.
General valuation allowances are calculated based on the historical loss experience of specific types of loans including an evaluation of the time span and volume of the actual charge-off. The Company calculates historical loss ratios for pools of similar loans with similar characteristics based on the proportion of actual charge-offs experienced to the total population of loans in the pool. The historical loss ratios are updated based on actual charge-off experience. A valuation allowance is established for each pool of similar loans based upon the product of the historical loss ratio, time span to charge-off, and the total dollar amount of the loans in the pool. The Company’s pools of similar loans include similarly risk-graded groups of commercial loans, commercial real estate loans, commercial credit card, home equity loans, consumer real estate loans and consumer and other loans. The Company also considers a loan migration analysis for criticized loans. This analysis includes an assessment of the probability that a loan will move to a loss position based on its criticized category. In addition, a portion of the allowance is determined by a review of qualitative factors by Management.
13
ALLOWANCE FOR LOAN LOSSES AND RECORDED INVESTMENT IN LOANS (in thousands)
This table provides a rollforward of the allowance for loan losses by portfolio segment for the three and six months ended June 30, 2011 (in thousands):
Allowance for loan losses:
Beginning balance
Charge-offs
Recoveries
Provision
Ending Balance
Ending Balance: individually evaluated for impairment
Ending Balance: collectively evaluated for impairment
Ending Balance: loans acquired with deteriorated credit quality
Ending Balance: loans
14
This table provides a rollforward of the allowance for loan losses for the three and six months ended June 30, 2010 (in thousands):
Beginning allowance
Additions (deductions):
Net charge-offs
Provision charged to expense
Ending allowance
Impaired Loans
This table provides an analysis of impaired loans by class at June 30, 2011 and December 31, 2010 (in thousands):
15
5. Securities
Securities Available for Sale
This table provides detailed information about securities available for sale at June 30, 2011 and December 31, 2010 (in thousands):
June 30, 2011
U.S. Treasury
U.S. Agencies
Mortgage-backed
State and political subdivisions
Corporates
December 31, 2010
16
The following table presents contractual maturity information for securities available for sale at June 30, 2011 (in thousands):
Due in 1 year or less
Due after 1 year through 5 years
Due after 5 years through 10 years
Due after 10 years
Mortgage-backed securities
Total securities available for sale
Securities may be disposed of before contractual maturities due to sales by the Company or because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
For the six months ended June 30, 2011, proceeds from the sales of securities available for sale were $884.3 million compared to $416.9 million for the same period in 2010. Securities transactions resulted in gross realized gains of $13.6 million and $6.7 million for the six months ended June 30, 2011 and 2010. The gross realized losses for the six months ended June 30, 2011 and 2010 were $0.1 million and $0.2 million, respectively.
Trading Securities
The net unrealized gains on trading securities at June 30, 2011 and June 30, 2010 were $746.9 thousand and $281.0 thousand respectively, and were included in trading and investment banking income.
Securities Held to Maturity
The table below provides detailed information for securities held to maturity at June 30, 2011 and December 31, 2010 (in thousands):
The following table presents contractual maturity information for securities held to maturity at June 30, 2011 (in thousands):
Total securities held to maturity
Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
There were no sales of securities held to maturity during the first six months of 2011 and 2010.
17
Securities available for sale and held to maturity with a market value of $4.0 billion at June 30, 2011, and $4.6 billion at December 31, 2010, were pledged to secure U.S. Government deposits, other public deposits and certain trust deposits as required by law.
The following table shows the Company’s available for sale investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at June 30, 2011 and December 31, 2010 (in thousands).
Description of Securities
U.S. Treasury Obligations
Direct obligations of U.S. government agencies
Federal agency mortgage backed securities
Municipal securities
Total temporarily-impaired debt securities available for sale
U.S. Treasury obligations
The unrealized losses in the Company’s investments in direct obligations of U.S. treasury obligations, U.S. government agencies, federal agency mortgage-backed securities, and municipal securities were caused by changes in interest rates. Because the Company does not have the intent to sell these securities, it is more likely than not that the Company will not be required to sell these securities before a recovery of fair value. The Company expects to recover its cost basis in the securities and does not consider these investments to be other-than-temporarily impaired at June 30, 2011.
18
6. Goodwill and Other Intangibles
Changes in the carrying amount of goodwill for the periods ended June 30, 2011 and December 31, 2010 by operating segment are as follows (in thousands):
Balances as of January 1, 2010
Prairie Capital Management, LLC acquired during period
Reams Asset Management, LLC acquired during period
Balances as of December 31,2010
Balances as of January 1, 2011
Balances as of June 30, 2011
Following are the intangible assets that continue to be subject to amortization as of June 30, 2011 and December 31, 2010 (in thousands):
Core deposit intangible assets
Customer relationships
Other intangible assets
Total intangible assets
Following is the aggregate amortization expense recognized in each period (in thousands):
Aggregate amortization expense
19
Estimated amortization expense of intangible assets on future years (in thousands):
For the six months ended December 31, 2011
For the year ended December 31, 2012
For the year ended December 31, 2013
For the year ended December 31, 2014
For the year ended December 31, 2015
7. Other Comprehensive Income
The Company’s only component of other comprehensive income for the three and six months ended June 30, 2011 and 2010 was the net unrealized gains and losses on available for sale securities (in thousands):
Change in unrealized holding gains, net
Less: Reclassification adjustments for gains included in income
Net unrealized holding gains
Income tax expense
Other comprehensive income
8. Commitments, Contingencies and Guarantees
In the normal course of business, the Company is party to financial instruments with off-balance-sheet risk in order to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit, commercial letters of credit, standby letters of credit, futures contracts, forward foreign exchange contracts and spot foreign exchange contracts. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheet. The contract or notional amount of those instruments reflects the extent of involvement the Company has in particular classes of financial instruments. Many of the commitments expire without being drawn upon, therefore, the total amount of these commitments does not necessarily represent the future cash requirements of the Company.
The Company’s exposure to credit loss in the event of nonperformance by the counterparty to the financial instruments for commitments to extend credit, commercial letters of credit, and standby letters of credit is represented by the contract or notional amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.
The following table summarizes the Company’s off-balance sheet financial instruments.
Contract or Notional Amount (in thousands):
Commitments to extend credit for loans (excluding credit card loans)
Commitments to extend credit under credit card loans
Commercial letters of credit
Standby letters of credit
Futures contracts
Forward foreign exchange contracts
Spot foreign exchange contracts
20
During 2010, two suits were filed against UMB Bank, N.A. (the “Bank”) in Missouri state court alleging that the Bank’s deposit account posting practices resulted in excessive overdraft fees in violation of Missouri’s consumer protection statute and the account agreement. Both suits sought class-action status for the Bank’s Missouri customers who may have been similarly affected. The Bank removed the first of the two suits (Johnson, et. al. vs. UMB Bank N.A.) to the U.S. District Court for the Western District of Missouri. The action was then transferred to the multidistrict litigation in the U.S. District Court for the Southern District of Florida, where similar claims against other financial institutions are pending. The second suit (Allen, et. al. vs. UMB Bank N.A., et. al.) was also filed in Missouri state court by another Bank customer alleging substantially identical facts. The Allen suit was subsequently amended to add the Company and all of its other bank subsidiaries as defendants, and to seek to include customers of all of the defendant banks in a class action. During the first quarter of 2011, a third suit (Downing vs. UMB Bank N.A., et. al.) was filed in the U.S. District Court for the Western District of Oklahoma by another bank customer alleging similar facts and also seeking class action status. On May 10, 2011, the Company began mediation with the plaintiffs in the Allen suit, and on May 13, 2011, the Company and all of its bank subsidiaries entered into an agreement to settle the Allen suit. To resolve the litigation, and without admitting any wrongdoing, the Company agreed to establish a $7.8 million escrow settlement fund, and recognized the related expense in its consolidated statements of income for the period ended June 30, 2011. The settlement is subject to approval by the Circuit Court of Jackson County, Missouri, and a fairness hearing has been scheduled for October 31, 2011.
9. Business Segment Reporting
The Company has strategically aligned its operations into the following three reportable segments (collectively, “Business Segments”): Commercial Financial Services, Institutional Financial Services, and Personal Financial Services. The management accounting system assigns balance sheet and income statement items to each business segment using methodologies that are refined on an ongoing basis. For comparability purposes, amounts in all periods are based on methodologies in effect at June 30, 2011.
The following summaries provide information about the activities of each segment:
Commercial Financial Services serves the commercial lending and leasing, capital markets, and treasury management needs of the Company’s mid-market businesses and governmental entities by offering various products and services. Such services include commercial loans, letters of credit, loan syndication services, consultative services, and a variety of financial options for companies that need non-traditional banking services. Capital markets services include asset-based financing, asset securitization, equity and mezzanine financing, factoring, private and public placement of senior debt, as well as merger and acquisition consulting. Treasury management services include depository services, account reconciliation services, electronic fund transfer services, controlled disbursements, lockbox services, and remote deposit capture services.
Institutional Financial Services is a combination of Banking Services, Fund Services, and Asset Management services provided to institutional clients. This segment also includes consumer and commercial credit card services in addition to healthcare services, mutual fund cash management, and international payments. Institutional Financial Services includes businesses such as the Company’s institutional investment services functions, Scout Investment Advisors, UMB Fund Services, corporate trust and escrow services as well as correspondent banking, investment banking, and UMB Healthcare Services. Products and services include bond trading transactions, cash letter collections, FiServ account processing, investment portfolio accounting and safekeeping, reporting for asset/liability management, and Fed funds transactions. UMB Fund Services provides fund administration and accounting, investor services and transfer agency, marketing and distribution, custody and alternative investment services.
Personal Financial Services combines Consumer Services and Asset Management services provided to personal clients. This segment combines the Company’s consumer bank with the individual investment and wealth management solutions. The range of services offered to UMB clients extends from a basic checking account to estate planning and trust services. Products and services include the Company’s bank branches, call center, internet banking and ATM network, deposit accounts, private banking, installment loans, home equity lines of credit, residential mortgages, small business loans, brokerage services, and insurance services in addition to a full spectrum of investment advisory, trust, and custody services.
21
Treasury and Other Adjustments includes asset and liability management activities and miscellaneous other items of a corporate nature not allocated to specific business lines. The assets within this segment include the Company’s investment portfolio. Corporate eliminations are also allocated to this segment.
Business Segment Information
Segment financial results were as follows (in thousands):
Noninterest income
Noninterest expense
Average assets
Expenditures for additions to premises and equipment
22
23
10. Fair Value Measurements
The following table presents information about the Company’s assets measured at fair value on a recurring basis as of June 30, 2011, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value.
Fair values determined by Level 1 inputs utilize quoted prices in active markets for identical assets and liabilities that the Company has the ability to access. Fair values determined by Level 2 inputs utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets or liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the hierarchy. In such cases, the fair value is determined based on the lowest level input that is significant to the fair value measurement in its entirety.
Assets measured at fair value on a recurring basis as of June 30, 2011 and December 31, 2010 (in thousands):
Description
Trading – other
Available for sale securities
24
Valuation methods for instruments measured at fair value on a nonrecurring basis
The following methods and assumptions were used to estimate the fair value of each class of financial instruments measured on a non-recurring basis:
Impaired loans While the overall loan portfolio is not carried at fair value, adjustments are recorded on certain loans to reflect partial write-downs that are based on the value of the underlying collateral. In determining the value of real estate collateral, the Company relies on external appraisals and assessment of property values by its internal staff. In the case of non-real estate collateral, reliance is placed on a variety of sources, including external estimates of value and judgments based on the experience and expertise of internal specialists. Because many of these inputs are not observable, the measurements are classified as Level 3.
Other real estate owned Other real estate owned consists of loan collateral which has been repossessed through foreclosure. This collateral is comprised of commercial and residential real estate and other non-real estate property, including auto, recreational and marine vehicles. Other real estate owned is recorded as held for sale initially at the lower of the loan balance or fair value of the collateral. Subsequent to foreclosure, valuations are updated periodically, and the assets may be marked down further, reflecting a new cost basis. Fair value measurements may be based upon appraisals or third-party price opinions and, accordingly, those measurements may be classified as Level 2. Other fair value measurements may be based on internally developed pricing methods, and those measurements may be classified as Level 3.
25
Assets measured at fair value on a non-recurring basis as of June 30, 2011 and December 31, 2010 (in thousands):
Impaired loans
Other real estate owned
The fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis is required to be disclosed. The following methods and assumptions were used to estimate the fair value of each class of financial instruments:
Cash and Short-Term Investments The carrying amounts of cash and due from banks, federal funds sold and resell agreements are reasonable estimates of their fair values.
Securities Available for Sale Fair values are based on quoted market prices or dealer quotes, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
Trading Securities Fair values for trading securities (including financial futures), are based on quoted market prices where available. If quoted market prices are not available, fair values are based on quoted market prices for similar securities.
Loans Fair values are estimated for portfolios with similar financial characteristics. Loans are segregated by type, such as commercial, real estate, consumer, and credit card. Each loan category is further segmented into fixed and variable interest rate categories. The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit rating and for the same remaining maturities.
Deposit Liabilities The fair value of demand deposits and savings accounts is the amount payable on demand at June 30, 2011 and December 31, 2010. The fair value of fixed-maturity certificates of deposit is estimated by discounting the future cash flows using the rates that are currently offered for deposits of similar remaining maturities.
Short-Term Debt The carrying amounts of federal funds purchased, repurchase agreements and other short-term debt are reasonable estimates of their fair value because of the short-term nature of their maturities.
26
Long-Term Debt Rates currently available to the Company for debt with similar terms and remaining maturities are used to estimate fair value of existing debt.
Other Off-Balance Sheet Instruments The fair value of loan commitments and letters of credit are determined based on the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreement and the present creditworthiness of the counterparties. Neither the fees earned during the year on these instruments nor their fair values at June 30, 2011 are significant to the Company’s consolidated financial position.
The estimated fair value of the Company’s financial instruments at June, 30, 2011 and December 31, 2010 are as follows (in millions):
FINANCIAL ASSETS
Cash and short-term investments
Securities available for sale
Securities held to maturity
Federal Reserve Bank and other stock
Loans (exclusive of allowance for loan loss)
FINANCIAL LIABILITIES
Demand and savings deposits
Time Deposits
OFF-BALANCE SHEET ARRANGEMENTS
Commitments to extend credit for loans
The fair value estimates presented herein are based on pertinent information available to management as of June 30, 2011 and December 31, 2010. The estimated market values have not been updated since June 30, 2011; therefore, current estimates of fair value may differ significantly from the amounts presented above.
27
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This review highlights the material changes in the results of operations and changes in financial condition for the three-month and six-month periods ended June 30, 2011. It should be read in conjunction with the accompanying condensed consolidated financial statements, notes to condensed consolidated financial statements and other financial statistics appearing elsewhere in this report. Results of operations for the periods included in this review are not necessarily indicative of results to be attained during any future period.
SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS
The information included or incorporated by reference in this report contains forward-looking statements of expected future developments within the meaning of and pursuant to the safe harbor provisions established by Section 21E of the Securities Exchange Act of 1934, as amended by the Private Securities Litigation Reform Act of 1995. These forward-looking statements may refer to financial condition, results of operations, plans, objectives, future financial performance and business of the Company, including, without limitation:
Statements that are not historical in nature; and
Statements preceded by, followed by or that include the words “believes,” “expects,” “may,” “should,” “could,” “anticipates,” “estimates,” “intends,” or similar words or expressions.
Forward-looking statements are not guarantees of future performance or results. You are cautioned not to put undue reliance on any forward-looking statement which speaks only as of the date it was made. Forward-looking statements reflect management’s expectations and are based on currently available data; however, they involve risks, uncertainties and assumptions. Actual results may differ materially from those contemplated by the forward-looking statements due to, among others, the following factors:
General economic and political conditions, either nationally, internationally or in the Company’s footprint, may be less favorable than expected;
Legislative or regulatory changes;
Changes in the interest rate environment;
Changes in the securities markets impacting mutual fund performance and flows;
Changes in operations;
Changes in accounting rules;
The ability to successfully and timely integrate acquisitions;
Competitive pressures among financial services companies may increase significantly;
Changes in technology may be more difficult or expensive than anticipated;
Changes in the ability of customers to repay loans;
Changes in loan demand may adversely affect liquidity needs; and
Changes in employee costs.
Any forward-looking statements should be read in conjunction with information about risks and uncertainties set forth in this report and in documents incorporated herein by reference. Forward-looking statements speak only as of the date they are made, and the Company does not intend to review or revise any particular forward-looking statement in light of events that occur thereafter or to reflect the occurrence of unanticipated events.
28
Overview
The Company focuses on the following four core strategies. Management believes these strategies will continue to improve net income and strengthen the balance sheet.
The first strategy is to grow the Company’s fee-based businesses. The emphasis on fee-based operations helps reduce the Company’s exposure to changes in interest rates. During the second quarter of 2011, noninterest income increased $18.8 million, or 21.1 percent, for the three months ended June 30, 2011 compared to the same period in 2010. This increase is primarily attributed to increased trust and securities processing income of $15.0 million, or 38.9 percent, for the three months ended June 30, 2011 compared to the same period in 2010. Bankcard fees increased $2.6 million, or 18.4 percent, compared to the second quarter of 2010 from increased processing fee income. Gains of $6.0 million on securities available for sale were recognized in the second quarter of 2011 compared to $1.1 million during the same period in 2010.
The second strategy is a focus on net interest income through loan and deposit growth. This is not just a growth strategy and includes a focus on rate, volume and mix. Net interest income increased $2.3 million, or 2.9 percent, compared to the same period in 2010. Average earning assets increased by $1.4 billion, or 14.0 percent, compared to the second quarter of 2010. This increase was due to a $791.0 million, or 16.1 percent, increase in average total securities, including trading securities and a $305.2 million, or 6.9 percent, increase in average loans. Average total deposits increased $1.2 billion, or 14.9 percent, compared to second quarter of 2010, which positions the Company well to fund customer credit needs when the demand for loans increases.
The third strategy is a focus on improving operating efficiencies. Repositioning and increasing utilization of our distribution network remains a priority. The Company continues to emphasize increasing its customer base by providing a broad offering of services through our existing network. These efforts have resulted in the total deposits growth previously discussed. The Company’s efficiency ratio for the quarter was 75.8 percent in 2011 and 73.9 percent in 2010. Throughout 2010, the Company invested in technological advances that will help management drive operating efficiencies through improved data analysis and automation. On January 3, 2011, the Company converted to a new financial and human resource software that is integrated and enterprise wide. In addition to the use of automation technology, the Company will continue to evaluate its cost structure for opportunities to moderate expense growth without sacrificing growth initiatives.
The fourth strategy is a focus on capital management. The Company places a significant emphasis on the maintenance of a strong capital position, which management believes promotes investor confidence, provides access to funding sources under favorable terms, and enhances the Company’s ability to capitalize on business growth and acquisition opportunities. The Company continues to maximize shareholder value through a mix of reinvesting in organic growth, investing in acquisitions, evaluating increased dividends over time and utilizing a share buy-back strategy when appropriate. As of June 30, 2011, UMB had total shareholders’ equity of $1.1 billion, an increase of 6.0 percent over June 30, 2010. The Company repurchased 48,695 shares at an average price of $41.27 per share during the second quarter of 2011.
Earnings Summary
The Company recorded consolidated net income of $26.3 million for the three-month period ended June 30, 2011, compared to $23.0 million for the same period a year earlier. This represents a 14.4 percent increase over the three-month period ended June 30, 2010. Basic earnings per share for the second quarter of 2011 were $0.66 per share ($0.65 per share fully-diluted) compared to $0.57 per share ($0.57 per share fully-diluted) for the second quarter of 2010. Return on average assets and return on average common shareholders’ equity for the three-month period ended June 30, 2011 were 0.85 and 9.59 percent, respectively, compared to 0.85 and 8.77 percent for the three-month period ended June 30, 2010.
The Company recorded consolidated net income of $57.2 million for the six-month period ended June 30, 2011, compared to $49.2 million for the same period a year earlier. This represents a 16.3 percent increase over the six-month period ended June 30, 2010. Basic earnings per share for the six-month period ended June 30, 2011 were $1.43 per share ($1.42 per share fully-diluted) compared to $1.23 per share ($1.22 per share fully-diluted) for the period in 2010. Return on average assets and return on average common shareholders’ equity for the six-month period ended June 30, 2011 were 0.92 and 10.47 percent, respectively, compared to 0.91 and 9.50 percent for the same period in 2010.
29
Net interest income for the three and six-month periods ended June 30, 2011 increased $2.3 million, or 2.9 percent, and $4.9 million, or 3.2 percent, respectively, compared to the same period in 2010. These increases are primarily due to the reduced level of interest expense on deposits. For the three-month period ended June 30, 2011, average earning assets increased by $1.4 billion, or 14.0 percent, and for the six-month period ended June 30, 2011, they increased by $1.6 billion, or 14.2 percent, compared to the same periods in 2010. Net interest margin, on a tax-equivalent basis, decreased to 2.98 percent and 2.94 percent for the three and six-months periods ended June 30, 2011, compared to 3.29 percent and 3.24 percent for the same periods in 2010. These changes are discussed in greater detail below under Net Interest Income.
The provision for loan losses decreased by $2.5 million and $3.7 million for the three and six-month periods ended June 30, 2011, compared to the same periods in 2010. These changes are a direct result of applying the Company’s methodology for computing the allowance for loan losses. With the decreased provision, the allowance for loan losses as a percentage of total loans decreased by 5 basis points to 1.53 percent as of June 30, 2011, compared to June 30, 2010. For a description of the Company’s methodology for computing the allowance for loan losses, please see the summary discussion of the Allowance for Loan Losses within the Critical Accounting Policies and Estimates subsection of the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section in the Company’s 2010 Annual Report on Form 10-K.
Noninterest income increased by $18.8 million, or 21.1 percent, for the three-month period ended June 30, 2011 and increased by $40.1 million, or 22.9 percent, for the six-month period ended June 30, 2011, compared to the same periods one year ago. These increases are discussed in greater detail below under Noninterest Income.
Noninterest expense increased by $19.5 million, or 15.4 percent, for the three-month period ended June 30, 2011, and increased by $37.6 million, or 15.5 percent, for the six-month period ended June 30, 2011, compared to the same periods in 2010. These increases are discussed in greater detail below under Noninterest Expense.
Net Interest Income
Net interest income is a significant source of the Company’s earnings and represents the amount by which interest income on earning assets exceeds the interest expense paid on liabilities. The volume of interest-earning assets and the related funding sources, the overall mix of these assets and liabilities, and the rates paid on each affect net interest income. For the three-month period ended June 30, 2011, net interest income increased $2.3 million, or 2.9 percent, compared to the same period in 2010. For the six-month period ended June 30, 2011, net interest income increased $4.9 million, or 3.2 percent, compared to the same period in 2010.
Table 1 shows the impact of earning asset rate changes compared to changes in the cost of interest-bearing liabilities. The Company continues to experience a repricing of these earning assets and interest-bearing liabilities during the recent interest rate cycle. While the Company continues to see declining rates, it has been able to improve net interest income. As illustrated in this table, net interest spread for the three months ended June 30, 2011 decreased by 25 basis points and net interest margin decreased by 31 basis points compared to the same period in 2010. Net interest spread for the six months ended June 30, 2011 decreased by 23 basis points and net interest margin decreased by 30 basis points compared to the same period in 2010. These results are primarily due to an unfavorable rate variance on loans and securities, offset by a favorable volume variance on earning assets. The combined impact of these variances has led to decreases in interest expense and flat interest income, or an increase in the Company’s net interest income as compare to results one year ago.
The favorable rate variance on deposits is bolstered by the contribution from free funds. For the impact of the contribution from free funds, see the Analysis of Net Interest Margin within Table 2 below. Table 2 also illustrates how the changes in volume and rates have resulted in an increase in net interest income.
30
Table 1
AVERAGE BALANCES/YIELDS AND RATES (tax-equivalent basis) (unaudited, dollars in thousands)
The following table presents, for the periods indicated, the average earning assets and resulting yields, as well as the average interest-bearing liabilities and resulting yields, expressed in both dollars and rates. All average balances are daily average balances. The average yield on earning assets without the tax equivalent basis adjustment would have been 3.06 percent for the three-month period ended June 30, 2011 and 3.50 percent for the same period in 2010. The average yield on earning assets without the tax equivalent basis adjustment would have been 3.03 percent for the six-month period ended June 30, 2011 and 3.47 percent for the same period in 2010.
Assets
Loans, net of unearned interest
Taxable
Tax-exempt
Total securities
Total earning assets
Liabilities and Shareholders’ Equity
Interest-bearing deposits
Borrowed funds
Total interest-bearing liabilities
Noninterest-bearing demand deposits
Shareholders’ equity
Net interest spread
Net interest margin
31
Table 2 presents the dollar amount of change in net interest income and margin due to volume and rate. Table 2 also reflects the effect that interest-free funds have on net interest margin. Although interest-free funds (total earning assets less interest-bearing liabilities) increased $433.8 million for the three-month period ended June 30, 2011 compared to the same period in 2010 and increased $346.5 million for the six-month period ended June 30, 2011 compared to the same period in 2010, the benefit from interest free funds declined by 6 basis points from the three months ended June 30, 2010, and declined by 7 basis points from the six months ended June 30, 2010, due to decreases in interest rates.
32
Table 2
ANALYSIS OF CHANGES IN NET INTEREST INCOME AND MARGIN (unaudited, dollars in thousands)
ANALYSIS OF CHANGES IN NET INTEREST INCOME
Change in interest earned on:
Federal funds sold and resell agreements
Interest income
Change in interest incurred on:
Interest expense
ANALYSIS OF NET INTEREST MARGIN
Average earning assets
Average interest-bearing liabilities
Average interest free funds
Free funds ratio (free funds to earning assets)
Tax-equivalent yield on earning assets
Cost of interest-bearing liabilities
Benefit of interest-free funds
33
Provision and Allowance for Loan Losses
The allowance for loan losses (ALL) represents management’s judgment of the losses inherent in the Company’s loan portfolio as of the balance sheet date. An analysis is performed quarterly to determine the appropriate balance of the ALL. This analysis considers items such as historical loss trends, a review of individual loans, migration analysis, current economic conditions, loan growth and characteristics, industry or segment concentration and other factors. This analysis is performed separately for each bank as regulatory agencies require that the adequacy of the ALL be maintained on a bank-by-bank basis. After the balance sheet analysis is performed for the ALL, the provision for loan losses is computed as the amount required to adjust the ALL to the appropriate level.
Based on the factors above, management of the Company expensed $5.6 million and $12.7 million related to the provision for loan losses for the three and six-month periods ended June 30, 2011, compared to $8.1 million and $16.4 million for the same periods in 2010. As illustrated in Table 3 below, the ALL decreased to 1.53 percent of total loans as of June 30, 2011, compared to 1.58 percent of total loans as of the same period in 2010.
Table 3 presents a summary of the Company’s ALL for the six months ended June 30, 2011 and 2010 and for the year ended December 31, 2010. Net charge-offs were $14.2 million for the first six months of 2011, compared to $10.4 million for the same period in 2010. See “Credit Risk Management” under “Item 3. Quantitative and Qualitative Disclosures About Market Risk” in this report for information relating to nonaccrual loans, past due loans, restructured loans and other credit risk matters.
Table 3
ANALYSIS OF ALLOWANCE FOR LOAN LOSSES (unaudited, dollars in thousands)
Allowance-January 1
Charge-offs:
Real estate
Total charge-offs
Recoveries:
Total recoveries
Allowance-end of period
Average loans, net of unearned interest
Loans at end of period, net of unearned interest
Allowance to loans at end of period
Allowance as a multiple of net charge-offs
Net charge-offs to:
Average loans
34
Noninterest Income
A key objective of the Company is the growth of noninterest income to enhance profitability and provide steady income. Fee-based services are typically non-credit related and not generally affected by fluctuations in interest rates.
The Company’s fee-based services provide the opportunity to offer multiple products and services, which management believes will more closely align the customer with the Company. The Company is currently emphasizing fee-based services including trust and securities processing, bankcard, brokerage, health care services, and treasury management. Management believes it can offer these products and services both efficiently and profitably, as most share common platforms and support structures. Table 4 below summarizes the components of noninterest income and the respective year-over-year comparison for each category.
Table 4
SUMMARY OF NONINTEREST INCOME (unaudited, dollars in thousands)
Service charges on deposit accounts
Fee-based, or noninterest income (summarized in Table 4), increased by $18.8 million, or 21.1 percent, during the three months ended June 30, 2011, and increased by $40.1 million, or 22.9 percent, during the six months ended June 30, 2011, compared to the same periods in 2010.
Trust and securities processing consists of fees earned on personal and corporate trust accounts, custody of securities services, trust investments and money management services, and servicing of mutual fund assets. The increase in these fees for the three and six-month periods compared to the same periods last year was primarily due to changes in the following three categories of income. Fee income from the Scout Funds for the three and six-month periods ended June 30, 2011, increased by $4.7 million, or 39.1 percent, and by $9.4 million, or 41.9 percent,
35
respectively. Fund administration and custody services fees for the three and six-month periods ended June 30, 2011, increased by $2.6 million, or 16.3 percent, and $4.9 million, or 16.1 percent, respectively. Institutional and personal investment management services fees for the three and six-month periods ended June 30, 2011, increased by $7.5 million, or 791.3 percent, and $14.5 million, or 704.6 percent, respectively. Trust and securities processing fees are asset-based. As such, they are highly correlated to the change in market value of the assets. Thus, the related income for the remainder of the year will be affected by changes in the securities markets. Management continues to emphasize sales of services to both new and existing clients as well as increasing and improving the distribution channels, which lead to increased inflows into the Scout Funds.
Bankcard fees increased by $2.6 million, or 18.4 percent, and by $5.0 million, or 19.2 percent for the three and six months ended June 30, 2011, compared to the same periods one year ago. This increase is directly associated with the acquisition of credit card portfolios during the period.
During the three and six-month periods ended June 30, 2011, $6.0 million and $13.5 million in pre-tax gains were recognized on the sales of securities available for sale. These sales are part of an objective to monitor and control the Company’s interest rate sensitivity in an anticipated rising interest rate environment.
Other noninterest income decreased $3.5 million, or 52.0 percent, for the three months ended June 30, 2011, and by $3.4 million, or 35.6 percent, for the six months ended June 30, 2011, compared to the same period in 2010. This decrease is attributable to the pre-tax gain of $3.5 million on the sale of art, which was contributed to a charitable foundation during the second quarter of 2010 (see other non-interest expense below).
Noninterest Expense
The components of noninterest expense are shown below on Table 5.
Table 5
SUMMARY OF NONINTEREST EXPENSE (unaudited in thousands)
Amortization of other intangible assets
36
Noninterest expense increased by $19.5 million, or 15.4 percent, for the three months ended June 30, 2011, and by $37.6 million, or 15.5 percent, for the six months ended June 30, 2011, compared to the same period in 2010. Table 5 above summarizes the components of noninterest expense and the respective year-over-year comparison for each category.
Salaries and employee benefits increased by $9.4 million, or 14.7 percent, for the three months ended June 30, 2011, and by $20.0 million, or 15.9 percent, for the six months ended June 30, 2011, compared to the same period in 2010. These increases are primarily due to higher base salary, commission, and health insurance costs. Salaries increased by $4.3 million, or 10.3 percent, and $8.9 million, or 10.9 percent, for the three and six months ended June 30, 2011, compared to the same periods in 2010. Commissions and bonuses increased by $4.6 million, or 39.3 percent, and $7.5 million, or 32.9 percent, for the three and six months ended June 30, 2011, compared to the same periods in 2010. More than 40 percent of these increases are directly attributable to salaries and benefits acquired from acquisitions conducted in the last two quarters of 2010.
Processing fees increased $2.1 million, or 18.8 percent, for the three months ended June 30, 2011, and by $3.3 million, or 14.6 percent, for the six months ended June 30, 2011, compared to the same period in 2010. This increase, which is correlated to the increase in trust and securities processing income noted above, is due to increased third party custodian fees related to international transactions from mutual fund clients and fees paid by the advisor to third-party distributors of the Scout Funds.
During the second quarter of 2011, the Company and its subsidiaries, UMB Bank, n.a., UMB Bank Colorado, n.a., UMB Bank Arizona, n.a., and UMB National Bank of America entered into an agreement to settle a class action lawsuit, filed in Missouri, in November 2010 and amended in May 2011, arising from the Company’s consumer personal deposit account posting practices, which allegedly resulted in excessive overdraft fees in violation of Missouri’s consumer protection statute and the account agreement. While admitting no wrongdoing, in order to fully and finally resolve the litigation and avoid any further expense and distraction caused by the litigation, the Company established a $7.8 million escrow fund in accordance with this agreement.
Other noninterest expense decreased $3.4 million, or 37.8 percent, for the three months ended June 30, 2011, and by $3.1 million, or 21.3 percent, for the six months ended June 30, 2011, compared to the same period in 2010. This increase is attributable to the contribution of $3.5 million in proceeds from the sale of art to a charitable foundation during the second quarter of 2010.
37
Income Tax Expense
The effective tax rate is 28.7 percent for the six months ended June 30, 2011, compared to 28.8 percent for the same period in 2010.
Strategic Lines of Business
Table 6
NET INCOME (LOSS) BEFORE TAXES BY SEGMENT (in thousands):
Segment
Commercial Financial Services
Institutional Financial Services
Personal Financial Services
Treasury and Other Adjustments
Total Consolidated Company
Commercial Financial Services’ net income before taxes increased $1.3 million, or 4.4 percent, to $31.1 million from the prior year. The increase in net income was driven primarily by an increase net interest income and noninterest income, offset by a increase in noninterest expense and an increase in provision for loan losses. Total earning asset balances are up over the prior year by $289.6 million, or 8.4 percent; additionally, deposits and repurchase agreements increased by $772.3 million, or 22.5 percent. Net interest income increased by $3.6 million, or 4.7 percent, due to the balance sheet increases. Noninterest income increased $0.8 million, or 4.5 percent, due to increased fees from the sales of commercial credit cards, deposit service charges, and letters of credit. Noninterest expense increased by $1.5 million, or 2.5 percent, primarily due to an increase in allocated technology expenses. Provision for loan loss increased by $1.6 million, or 59.1 percent, primarily due to loan growth in this segment and additional allocation of provision to ensure the allowance for loan loss is maintained at an appropriate level given the inherent risk in the loan portfolio in this segment.
Institutional Financial Services’ net income before taxes increased $11.3 million, or 43.2 percent, to $37.5 million from the first six months of 2010. Noninterest income increased $25.8 million, net interest income increased $2.0 million, provision decreased by $4.9 million, offset by a $21.3 million increase in noninterest expense. Noninterest income increased due to a $9.4 million increase in advisory fees from Scout Investments, $4.9 million increase in fund administration and custody services income, $8.6 million increase in institutional management fee income and a $3.7 million increase in card services income. Fee income increased due largely to acquisitions and net inflows of $811.0 million for the year to date 2011. Fee income from new sales and market appreciation are the drivers of the increase in fund administration and alternative investments. Card services income increased due to increased sales volume in commercial card, healthcare services and consumer credit card. Salary and benefit expense increased $12.6 million related to the increase to staffing primarily due to acquisitions and growth in the fund servicing businesses. Amortization of intangibles expense increased by $2.7 million. Overhead and service cost allocations increased to this segment of $2.8 million primarily from processing, technology and occupancy costs. Net interest income increased by $2.0 million due to an increase in deposits of $497.4 million and loans of $17 million.
Personal Financial Services’ net income before taxes decreased by $3.6 million to $7.5 million compared to the prior year. Net interest income decreased $1.1 million, or 2.1 percent, over 2010. Overall loan balances were flat compared to the same period in 2010. Consumer loan balances decreased due to the continued runoff of the indirect automobile portfolio and was offset by the growth in home equity, commercial real estate, and residential real estate loan portfolios. Deposit balances have also increased in this segment compared to 2010, by $251.0
38
million, primarily in demand and money market accounts offset by decreases in time deposits. Noninterest income increased $5.7 million, or 12.2 percent, from 2010. This increase was due primarily to an increase in investment management fee income related to acquisitions and growth in trust fee income of $9.5 million. This increase was offset by a reduction in deposit service charges of $5.3 million driven by overdraft and insufficient fund fees. Noninterest expense increased $8.7 million, or 10.0 percent, over 2010. The increase was primarily due to an increase in salary and benefit costs of $5.1 million and increased amortization of intangibles related to acquisitions of $1.0 million. Overhead and service cost allocations increased to this segment of $2.8 million primarily from occupancy and technology costs.
The net income before tax for the Treasury and Other Adjustments category was $4.0 million for the first six months of 2011, compared to net loss before tax of $1.9 million for the same period in 2010.
Balance Sheet Analysis
Total assets of the Company as of June 30, 2011 increased $365.6 million, or 3.0 percent, compared to December 31, 2010 and increased $1.7 billion, or 15.4 percent, compared to June 30, 2010. The increase in total assets from June 2010 to June 2011 is a result of increased due from Federal Reserve balances of $792.0 million, or 177.4 percent, an increase in investment securities balances including trading securities of $593.0 million, or 11.7 percent, and an increase in loans of $282.9 million, or 6.4 percent. The increase in total assets from December to June is primarily result of increased due from Federal Reserve balances of $561.0 million, or 82.8 percent, offset by a decrease in securities purchased under agreements to resell of $189.6 million, or 82.1 percent. The overall increase in total assets is directly related to a corresponding increase in deposit balances of $1.5 billion, or 17.7 percent, when comparing June 30, 2010 to June 30, 2011 and $885.1 million, or 9.8 percent, when comparing December 31, 2010 to June 30, 2011. The increase from December 2010 to June 2011 is offset by a decrease in federal funds purchased and securities sold under agreement to repurchase of $578.4 million, or 27.8 percent, due to the run-off of seasonal public fund tax deposits, as such tax deposits are generally higher around the end of the calendar year.
Table 7
SELECTED BALANCE SHEET INFORMATION (unaudited, dollars in thousands)
Total borrowed funds
Loans represent the Company’s largest source of interest income. In addition to growing the commercial loan portfolio, management believes its middle market commercial business and its consumer business, including home equity and credit card loan products, are the market niches that represent its best opportunity to cross-sell fee-related services.
Total loan balances have increased $147.6 million, or 3.2 percent, compared to December 31, 2010 and increased $282.9 million, or 6.4 percent, at June 30, 2011 compared to June 30, 2010. The increase from December 31, 2010 is primarily a result of a $75.9 million, or 3.9 percent, increase in commercial loans, a $42.3 million, or 3.3 percent, increase in commercial real estate loans, and a $26.9 million, or 5.7 percent, increase in home equity loans. Compared to June 30, 2010, commercial loans increased $140.3 million, or 7.5 percent, commercial real estate increased $94.2 million, or 7.6 percent, home equity loans increased $42.4 million, or 9.2 percent, offset by a decrease in consumer loans of $31.3 million, or 19.6 percent.
39
Nonaccrual, past due and restructured loans are discussed under “Credit Risk Management” within “Item 3. Quantitative and Qualitative Disclosures About Market Risk” in this report.
Securities
The Company’s securities portfolio provides liquidity as a result of the composition and average life of the underlying securities. This liquidity can be used to fund loan growth or to offset the outflow of traditional funding sources. In addition to providing a potential source of liquidity, the securities portfolio can be used as a tool to manage interest rate sensitivity. The Company’s goal in the management of its securities portfolio is to maximize return within the Company’s parameters of liquidity goals, interest rate risk and credit risk. The Company maintains strong liquidity levels while investing in only high-grade securities. The securities portfolio generates the Company’s second largest component of interest income.
Investment securities totaled $5.6 billion at June 30, 2011, compared to $5.1 billion at June 30, 2010, and $5.7 billion at December 31, 2010. Collateral pledging requirements for public funds, loan demand, and deposit funding are the primary factors impacting changes in the level of security holdings. Investment securities comprised 48.1 percent, 50.6 percent, and 49.6 percent, respectively, of the earning assets as of June 30, 2011, December 31, 2010, and June 30, 2010. There were $4.0 billion of these securities pledged to secure U.S. Government deposits, other public deposits, securities sold under repurchase agreements, and certain trust deposits as required by law at June 30, 2011.
Investment securities had an average tax-equivalent yield of 2.49 percent for the first six months of 2011 compared to 2.88 percent for the same period in 2010, or a decrease of 39 basis points. The average life of the securities portfolio was 34.9 months at June 30, 2011 compared to 28.7 months at December 31, 2010 and 23.8 months at June 30, 2010. The increase in average life from June 30, 2010 and December 31, 2010 was primarily related to an increase in the percentage of investments invested in the core portfolio resulting in a lower percentage of short term investments held compared to the same period last year due to excess liquidity being retained in the continued low rate environment.
Deposits and Borrowed Funds
Deposits increased $885.1 million, or 9.8 percent, from December 31, 2010 to June 30, 2011 and increased $1.5 billion, or 17.7 percent, from June 30, 2010. Noninterest-bearing deposits increased $929.70 million offset by decreased interest-bearing deposits of $44.6 million from December 31, 2010. Noninterest-bearing deposits increased $952.8 million and interest-bearing deposits increased $540.6 million from June 30, 2010. The increase in noninterest-bearing deposits from June 30, 2010 and December 31, 2010 came primarily from our public funds, mutual fund processing and treasury management businesses. The increase in interest-bearing deposits compared to June 30, 2010 is primarily related to increases in money market accounts.
Deposits represent the Company’s primary funding source for its asset base. In addition to the core deposits garnered by the Company’s retail branch structure, the Company continues to focus on its cash management services, as well as its trust and mutual fund services in order to attract and retain additional core deposits. Management believes a strong core deposit composition is one of the Company’s key strengths given its competitive product mix.
Borrowed funds decreased $591.2 million from December 31, 2010. Borrowed funds are typically higher at year end due to repurchase agreements related to public funds. Borrowings, other than repurchase agreements, are a function of the source and use of funds and will fluctuate to cover short term gaps in funding. Borrowed funds increased $98.4 million from June 30, 2010.
Federal funds purchased and securities sold under agreement to repurchase totaled $1.5 billion at June 30, 2011, compared to $2.1 billion at December 31, 2010 and $1.4 billion at June 30, 2010. Repurchase agreements are transactions involving the exchange of investment funds by the customer for securities by the Company under an agreement to repurchase the same or similar issues at an agreed-upon price and date.
40
Capital and Liquidity
The Company places a significant emphasis on the maintenance of a strong capital position, which promotes investor confidence, provides access to funding sources under favorable terms, and enhances the Company’s ability to capitalize on business growth and acquisition opportunities. Higher levels of liquidity, however, bear corresponding costs, measured in terms of lower yields on short-term, more liquid earning assets and higher expenses for extended liability maturities. The Company manages capital for each subsidiary based upon the subsidiary’s respective risks and growth opportunities as well as regulatory requirements.
Total shareholders’ equity was $1.1 billion at June 30, 2011, a $72.1 million increase compared to December 31, 2010. The Company’s Board of Directors authorized, at its April 26, 2011, April 27, 2010, and April 21, 2009 meetings, the repurchase of up to two million shares of the Company’s common stock during the twelve months following the meetings. During the six months ended June 30, 2011 and 2010, the Company acquired 82,032 shares and 132,334 shares, respectively, of its common stock under these plans. The Company has not made any purchases other than through these plans.
On July 26, 2011, the Board of Directors declared a dividend of $0.195 per share. The dividend will be paid on October 3, 2011 to shareholders of record on September 9, 2011.
Risk-based capital guidelines established by regulatory agencies set minimum capital standards based on the level of risk associated with a financial institution’s assets. A financial institution’s total capital is required to equal at least 8 percent of risk-weighted assets. At least half of that 8 percent must consist of Tier 1 core capital, and the remainder may be Tier 2 supplementary capital. The risk-based capital guidelines indicate the specific risk weightings by type of asset. Certain off-balance-sheet items (such as standby letters of credit and binding loan commitments) are multiplied by credit conversion factors to translate them into balance sheet equivalents before assigning them specific risk weightings. Due to the Company’s high level of core capital and substantial portion of earning assets invested in government securities, the Tier 1 capital ratio of 11.54 percent and total capital ratio of 12.63 percent substantially exceed the regulatory minimums.
For further discussion of capital and liquidity, see “Liquidity Risk” under “Item 3. Quantitative and Qualitative Disclosures About Market Risk” in this report.
41
Table 8
The Company’s capital position is summarized in the table below and exceeds regulatory requirements:
RATIOS
Return on average assets
Return on average equity
Average equity to assets
Tier 1 risk-based capital ratio
Total risk-based capital ratio
Leverage ratio
The Company’s per share data is summarized in the table below.
Earnings basic
Earnings diluted
Cash dividends
Dividend payout ratio
Book value
Off-balance Sheet Arrangements
The Company’s main off-balance sheet arrangements are loan commitments, commercial and standby letters of credit, futures contracts and forward exchange contracts, which have maturity dates rather than payment due dates. Please see Note 8, “Commitments, Contingencies and Guarantees” in the Notes to Condensed Consolidated Financial Statements for detailed information on these arrangements.
Critical Accounting Policies and Estimates
Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses the Company’s condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these condensed consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments, including those related to allowance for loan losses, investments, long-lived assets, contingencies and litigation. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which have formed the basis for making such judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from the recorded estimates under different assumptions or conditions. A summary of critical accounting policies is listed in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of the Company’s Annual Report Form 10-K for the fiscal year ended December 31, 2010.
42
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Risk Management
Market risk is a broad term for the risk of economic loss due to adverse changes in the fair value of financial instruments. These changes may be the result of various factors, including interest rates, foreign exchange prices, commodity prices or equity prices. Financial instruments that are subject to market risk can be classified either as held for trading or held for purposes other than trading.
The Company is subject to market risk primarily through the effect of changes in interest rates of its assets held for purposes other than trading. The following discussion of interest rate risk, however, combines instruments held for trading and instruments held for purposes other than trading, because the instruments held for trading represent such a small portion of the Company’s portfolio that the interest rate risk associated with them is immaterial.
Interest Rate Risk
In the banking industry, a major risk exposure is changing interest rates. To minimize the effect of interest rate changes to net interest income and exposure levels to economic losses, the Company manages its exposure to changes in interest rates through asset and liability management within guidelines established by its Funds Management Committee (“FMC”) and approved by the Company’s Board of Directors. The FMC has the responsibility for approving and ensuring compliance with asset/liability management policies, including interest rate exposure. The Company’s primary method for measuring and analyzing consolidated interest rate risk is the Net Interest Income Simulation Analysis. The Company also uses a Net Portfolio Value model to measure market value risk under various rate change scenarios and a gap analysis to measure maturity and repricing relationships between interest-earning assets and interest-bearing liabilities at specific points in time. On a limited basis, the Company uses hedges or swaps to manage interest rate risk by using futures contracts on certain loans and trading securities.
Overall, the Company manages interest rate risk by positioning the balance sheet to maximize net interest income while maintaining an acceptable level of interest rate and credit risk, remaining mindful of the relationship among profitability, liquidity, interest rate risk and credit risk.
Net Interest Income Modeling
The Company’s primary interest rate risk tool, the Net Interest Income Simulation Analysis, measures interest rate risk and the effect of interest rate changes on net interest income and net interest margin. This analysis incorporates substantially all of the Company’s assets and liabilities together with forecasted changes in the balance sheet and assumptions that reflect the current interest rate environment. Through these simulations, management estimates the impact on net interest income of a 200 basis point upward or downward gradual change of market interest rates over a one year period. Assumptions are made to project rates for new loans and deposits based on historical analysis, management outlook, and repricing strategies. Asset prepayments and other market risks are developed from industry estimates of prepayment speeds and other market changes. Since the results of these simulations can be significantly influenced by assumptions utilized, management evaluates the sensitivity of the simulation results to changes in assumptions.
Table 9 shows the net interest income increase or decrease over the next twelve months as of June 30, 2011 and 2010 based on hypothetical changes in interest rates.
43
Table 9
MARKET RISK (unaudited, dollars in thousands)
Hypothetical change
in interest rate
(Rates in Basis Points)
Amount of change
June 30, 2010
300
200
100
Static
(100)
The Company is positioned close to neutral with respect to interest rate changes and slightly positive in rapidly rising rate environments at June 30, 2011. Large increases in interest rates are projected to cause increases in net interest income with smaller changes having little impact. Due to the already low interest rate environment interest rates on liabilities are so low that there is little room for further rate reductions. The Company did not include a 100 basis point falling scenario. For projected increases in rates, net interest income is projected to increase due to the Company being positioned to adjust yields on assets with changes in market rates more than the cost of paying liabilities is projected to increase. Higher balances in short term liquid assets like Fed Funds have increased the company’s projected benefit in a rising rate environment. After adjusting for the beneficial impact of these assets the Company is positioned in the current low rate environment to be relatively neutral to further interest rate changes over the next twelve months.
Repricing Mismatch Analysis
The Company also evaluates its interest rate sensitivity position in an attempt to maintain a balance between the amount of interest-bearing assets and interest-bearing liabilities which are expected to mature or reprice at any point in time. While a traditional repricing mismatch analysis (“gap analysis”) provides a snapshot of interest rate risk, it does not take into consideration that assets and liabilities with similar repricing characteristics may not in fact reprice at the same time or the same degree. Also, it does not necessarily predict the impact of changes in general levels of interest rates on net interest income.
Trading Account
The Company’s subsidiary UMB Bank, n.a. carries taxable government securities in a trading account that is maintained according to a board-approved policy and relevant procedures. The policy limits the amount and type of securities that UMB Bank, n.a. can carry in the trading account and also requires that UMB Bank, n.a. comply with any limits under applicable law and regulations. The policy also mandates the use of a value at risk methodology to manage price volatility risks within financial parameters. The risk associated with carrying trading securities is offset by the sale of exchange traded futures contracts, with both the trading account and futures contracts marked to market daily. This account had a balance of $43.3 million as of June 30, 2011 compared to $42.5 million as of December 31, 2010.
Documentation of the methodology used in determining value at risk is maintained and reviewed in compliance banking laws and regulations. The aggregate value at risk is reviewed quarterly. The aggregate value at risk in the trading account was insignificant as of June 30, 2011 and December 31, 2010.
Other Market Risk
The Company does not have material commodity price risks or derivative risks. The Company does have minimal foreign currency risk as a result of foreign exchange contracts. See Note 8 “Commitments, Contingencies and Guarantees” in the notes to the Condensed Consolidated Financial Statements.
44
Credit Risk Management
Credit risk represents the risk that a customer may not perform in accordance with contractual terms. Credit risk is inherent in the financial services business and results from extending credit to customers. The Company utilizes a centralized credit administration function, which provides information on affiliate bank risk levels, delinquencies, an internal ranking system and overall credit exposure. In addition, the Company centrally reviews loan requests to ensure the consistent application of the loan policy and standards. The Company has an internal loan review staff that operates independently of the affiliate banks. This review team performs periodic examinations of each bank’s loans for credit quality, documentation and loan administration. The respective regulatory authority of each affiliate bank also reviews loan portfolios.
A primary indicator of credit quality and risk management is the level of nonperforming loans. Nonperforming loans include both nonaccrual loans and restructured loans. The Company’s nonperforming loans decreased $7.8 million to $15.4 million at June 30, 2011, compared to June 30, 2010 and decreased $9.8 million, compared to December 31, 2010.
The Company had $6.7 million of other real estate owned as of June 30, 2011 compared to $6.7 million as of June 30, 2010 and $4.4 million as of December 31, 2010. Loans past due more than 90 days totaled $7.4 million as of June 30, 2011, compared to $14.6 million at June 30, 2010 and $5.5 million as of December 31, 2010.
A loan is generally placed on nonaccrual status when payments are past due 90 days or more and/or when management has considerable doubt about the borrower’s ability to repay on the terms originally contracted. The accrual of interest is discontinued and recorded thereafter only when actually received in cash.
Certain loans are restructured to provide a reduction or deferral of interest or principal due to deterioration in the financial condition of the respective borrowers. The Company had $0.1 million of restructured loans at June 30, 2011, $2.0 million at June 30, 2010 and $0.2 million at December 31, 2010.
Table 10
LOAN QUALITY (unaudited, dollars in thousands)
Nonaccrual loans
Restructured loans
Total nonperforming loans
Total nonperforming assets
Loans past due 90 days or more
Ratios
Nonperforming loans as a percent of loans
Nonperforming assets as a percent of loans plus other real estate owned
Nonperforming assets as a percent of total assets
Loans past due 90 days or more as a percent of loans
Allowance for loan losses as a percent of loans
Allowance for loan losses as a multiple of nonperforming loans
45
Liquidity Risk
Liquidity represents the Company’s ability to meet financial commitments through the maturity and sale of existing assets or availability of additional funds. The most important factor in the preservation of liquidity is maintaining public confidence that facilitates the retention and growth of a large, stable supply of core deposits and wholesale funds. Ultimately, public confidence is generated through profitable operations, sound credit quality and a strong capital position. The primary source of liquidity for the Company is regularly scheduled payments and maturity of assets, which include $5.5 billion of high-quality securities available for sale. Investment securities with a market value of $4.0 billion at June 30, 2011 were pledged to secure U.S. Government deposits, other public deposits, securities sold under repurchase agreements, and certain trust deposits as required by law. The liquidity of the Company and its affiliate banks is also enhanced by its activity in the federal funds market and by its core deposits. Neither the Company nor its subsidiaries are active in the debt market. The traditional funding source for the Company’s subsidiary banks has been core deposits. Based upon regular contact with investment banking firms, management believes it can raise debt or equity capital on favorable terms, should the need arise.
The Company also has other commercial commitments that may impact liquidity. These commitments include unused commitments to extend credit, standby letters of credit and financial guarantees, and commercial letters of credit. The total amount of these commercial commitments at June 30, 2011 was $4.3 billion. Since many of these commitments expire without being drawn upon, the total amount of these commercial commitments does not necessarily represent the future cash requirements of the Company.
The Company’s cash requirements consist primarily of dividends to shareholders, debt service and treasury stock purchases. Management fees and dividends received from subsidiary banks traditionally have been sufficient to satisfy these requirements and are expected to be sufficient in the future. The Company’s subsidiary banks are subject to various rules regarding payment of dividends to the Company. For the most part, all banks can pay dividends at least equal to their current year’s earnings without seeking prior regulatory approval. From time to time, approvals have been requested to allow a subsidiary bank to pay a dividend in excess of its current earnings.
Operational Risk
Operational risk generally refers to the risk of loss resulting from the Company’s operations, including those operations performed for the Company by third parties. This would include but is not limited to the risk of fraud by employees or persons outside the Company, the execution of unauthorized transactions by employees or others, errors relating to transaction processing, breaches of the internal control system and compliance requirements, and unplanned interruptions in service. This risk of loss also includes the potential legal or regulatory actions that could arise as a result of an operational deficiency, or as a result of noncompliance with applicable regulatory standards. Included in the legal and regulatory issues with which the Company must comply are a number of imposed rules resulting from the enactment of the Sarbanes-Oxley Act of 2002.
The Company operates in many markets and places reliance on the ability of its employees and systems to properly process a high number of transactions. In the event of a breakdown in the internal control systems, improper operation of systems or improper employee actions, the Company could suffer financial loss, face regulatory action and suffer damage to its reputation. In order to address this risk, management maintains a system of internal controls with the objective of providing proper transaction authorization and execution, safeguarding of assets from misuse or theft, and ensuring the reliability of financial and other data.
The Company maintains systems of controls that provide management with timely and accurate information about the Company’s operations. These systems have been designed to manage operational risk at appropriate levels given the Company’s financial strength, the environment in which it operates, and considering factors such as competition and regulation. The Company has also established procedures that are designed to ensure that policies relating to conduct, ethics and business practices are followed on a uniform basis. In certain cases, the Company has experienced losses from operational risk. Such losses have included the effects of operational errors that the Company has discovered and included as expense in the statement of income. While there can be no assurance that the Company will not suffer such losses in the future, management continually monitors and works to improve its internal controls, systems and corporate-wide processes and procedures.
46
ITEM 4. CONTROLS AND PROCEDURES
The Sarbanes-Oxley Act of 2002 requires Chief Executive Officers and Chief Financial Officers to make certain certifications with respect to this report and to the Company’s disclosure controls and procedures and internal control over financial reporting. The Company has a Code of Ethics that expresses the values that drive employee behavior and maintains the Company’s commitment to the highest standards of ethics.
Disclosure Controls and Procedures
The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s “Disclosure Controls and Procedures” (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by the report, the Company’s disclosure controls and procedures are effective for ensuring that information the Company is required to report in its periodic SEC filings. SEC filings are recorded, processed, summarized, and reported within the time period required and that information required to be disclosed by the Company is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.
Internal Control Over Financial Reporting
There has been no change in the Company’s internal control over financial reporting (as such term is defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act) during the three months ended June 30, 2011 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
47
ITEM 1. LEGAL PROCEEDINGS
In the normal course of business, the Company and its subsidiaries are named defendants in various lawsuits and counter-claims. Except as stated below, in the opinion of management, after consultation with legal counsel, none of these lawsuits are expected to have a materially adverse effect on the financial position, results of operations, or cash flows of the Company.
ITEM 1A. RISK FACTORS
There were no material changes to the risk factors as previously disclosed in response to Item 1A to Part 1 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010.
48
The table below sets forth the information with respect to purchases made by or on behalf of the Company or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Exchange Act) of our common stock during the three months ended June 30, 2011.
ISSUER PURCHASE OF EQUITY SECURITIES
Period
April 1-April 26, 2011
April 27-April 30, 2011
May 1-May 31, 2011
June 1-June 30, 2011
On April 27, 2010, the Company announced a plan to repurchase up to two million shares of common stock. This plan terminated on April 26, 2011. All open market share purchases under the share repurchase plans are intended to be within the scope of Rule 10b-18 promulgated under the Exchange Act. Rule 10b-18 provides a safe harbor for purchases in a given day if the Company satisfies the manner, timing and volume conditions of the rule when purchasing its own common shares. On April 26, 2011, the Company announced a plan to repurchase up to two million shares of common stock. This plan will terminate on April 25, 2012. The Company has not made any repurchases other than through these plans.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. RESERVED
ITEM 5. OTHER INFORMATION
49
ITEM 6. EXHIBITS
a) The following exhibits are filed herewith:
50
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
/s/ Brian J. Walker
Senior Vice President, Corporate Controller
(Authorized Officer and Chief Accounting Officer)
51