Earnings Call Transcript - UMBF Q4 2022

Operator, Operator

Hello, everyone, and welcome to the UMB Financial Fourth Quarter 2022 Financial Results Call. My name is Davey, and I'll be coordinating your call today. I would now like to hand the call over to your host, Kay Gregory with Investor Relations to begin. So, Kay, please go ahead.

Kay Gregory, Investor Relations

Good morning, and welcome to our fourth quarter and year-end 2022 call. Mariner Kemper, President and CEO; and Ram Shankar, CFO will share a few comments about our results. Jim Rine, CEO of UMB Bank and Tom Terry, Chief Credit Officer will also be available for the question-and-answer session. Before we begin, let me remind you that today’s presentation contains forward-looking statements, which are subject to assumptions, risks, and uncertainties. These risks are included in our SEC filings and are summarized on slide 42 of our presentation. Actual results may differ from those set forth in forward-looking statements, which speak only as of today. We undertake no obligation to update them, except to the extent required by securities laws. All earnings per share metrics discussed on this call are on a diluted share basis. Our presentation materials and press release are available online at investorrelations.umb.com. Now, I’ll turn the call over to Mariner Kemper.

Mariner Kemper, President and CEO

Thank you, Kay, and Happy New Year, everyone. Thanks for joining us today. I'll make some brief comments about our quarter and 2022 and then turn the call over to Ram for a review of our results in more detail before we take your questions. Our fourth quarter results closed out another record year of earnings driven by strong balance sheet growth, solid credit metrics, and differentiated fee income sources. Net income for the fourth quarter was $100.2 million or $2.06 per share. For the full-year 2022, net income of $431.7 million or $8.86 per share, an increase of 22.3%, compared to 2021. Operating pre-tax, pre-provision EPS for the year was $11.73 per share, compared to $9.26 per share for the prior year. Net interest income for the fourth quarter increased 5% sequentially, driven largely by an over $1 billion increase in average loans, which is a 21% increase on an annualized basis, the impact of rising rates, positive asset mix shift, and loan fees. This was partially negated by an increase in deposit costs, largely driven by deposit initiatives to attract new bank customers, particularly in our commercial business. Additionally, we saw some continued market pressures in our rate-sensitive institutional business. As we've noted in the past, our business profile and funding mix is uniquely skewed in favor of commercial and institutional customers. These sources experience different pace and timing than some of our more retail-heavy peers in the repricing environment we are in today. Cycle-to-date, we've had a beta of 54% on interest-bearing deposits and 33% on total deposits. Our deposit pricing during this cycle is generally in line with our internal expectations and consistent with what we've been discussing publicly. We tend to focus more on total funding costs, which considers the benefit of DDA balances and the impact of borrowing levels. That beta is 36% cycle-to-date. We benefit on the asset side as well with the cycle-to-date beta of 3% on loan yields, 60% of our loans reprice within the next quarter and 70% in the next 12 months. We expect this repricing combined with our outlook for loan growth will continue to drive good growth in net interest income. Pipelines and sales activity in our fee businesses continue to be strong across the company, driving year-over-year non-interest income growth notwithstanding some market-related variances. I'm excited about the opportunities we see in 2023 and beyond. Updates on our various lines of business are included in our slides, and Ram will share a few details shortly. We've long focused on our goal of positive operating leverage rather than specific revenue and expense levels. For the full year of 2022, we generated leverage of 6.7%. This continues to be a focus for us, and we expect to generate positive operating leverage again in 2023. Moving to lending, the drivers behind our 21% linked quarter annualized growth in average balances this quarter are on slide 23. Total top-line loan production as shown on slide 24 remained strong at $1.3 billion for the quarter, bringing full-year 2022 originations to a record $5 billion. Payoffs and paydowns represent 3.4% of loans for the fourth quarter. While we and fewer banks have seen some slowdown in the sale on refi markets, payoffs are hard to predict from quarter to quarter. The average for the year was just over 4% in line with our longer-term trends. C&I lending provided nearly half of our $1 billion of average loan growth for the quarter, with balances increasing 21% on a linked quarter annualized basis. Commercial demand continues to be strong, and we're seeing robust activity within our existing customer base. Line utilization has ticked up from last year and was at 37% for the fourth quarter. Commercial real estate and construction loans posted 25% annualized growth in the fourth quarter, predominantly in multifamily and industrial properties. Construction represented a large portion of new commitments in 2022, so we'll see the additional impact and balances as those loans begin to fund. Average residential mortgage balances have increased 21% over the fourth quarter of last year, despite the impact of the rising rate environment. Our down payment assistance program for first-time homebuyers had more than 1,600 new applications resulting in $2.9 million in assistance in 2022. Looking ahead to the first quarter, we see opportunity in our various verticals across the footprint, and we expect continued strong growth to kick off 2023. Credit quality remains excellent, with net charge-offs at just 4 basis points of average loans for the fourth quarter and 21 basis points for the full-year. Non-performing assets comprised a modest 5 basis points of total assets. Provision for the quarter of $9 million was driven by our continued strong loan growth, portfolio metrics, and changes in the macroeconomic environment. Our reserve coverage is now at 0.91% of total loans. Back to the balance sheet, average total deposits for the quarter increased 5.3% or 21% on an annualized basis, compared to the third quarter. Our deposit initiatives in commercial banking brought in more than $1 billion during the quarter. DDA balances remained steady from the last quarter and represent 40% of average deposits, compared to 42% in the third quarter and 41% in the fourth quarter of last year. The economic data continues to be a paradox with the labor market signaling a soft landing, but other indicators like the LEI index are signaling a more prolonged recession. We have ongoing dialogue with our clients about their business and outlooks, and borrowers are generally seeing a good pipeline, with many reporting that supply chain issues have mitigated somewhat. However, caution remains as talent acquisition to support growth may become more challenging. As I mentioned, we see good growth opportunities in the first quarter, and while we continue to closely monitor early warning indicators, we're not seeing any broad concerns. Overall, 2022 was a very strong year. While the unpredictability of the current rate environment is challenging, our time-tested business model and relationship-based culture continue to perform well, and we're off and running as we start the 2023 year with a goal to maintain positive operating leverage regardless of the health and direction of the economy. Now I'll turn it over to Ram for some additional comments.

Ram Shankar, CFO

Thanks, Mariner. Let me start with some commentary on balance sheet trends, with our liquidity profile shown on slide 40. Our Fed account, reverse repo, and cash balances rebounded slightly to $1.8 billion, and constitute 5.1% of average earning assets with a blended yield of 3.65%, compared to 2.3% in the third quarter. This was driven by our deposit campaigns, as well as seasonal inflow of public fund deposits. Cash flows from our securities portfolio continued to help fund loan growth opportunities during the quarter. As shown on slide 27, the portfolio roll-off for the fourth quarter was $246 million with a yield of 1.94%, while we purchased $84 million in securities, primarily CLOs with a yield of 5.04%. Additionally, the portfolio is expected to generate over $1 billion of cash flows in the next 12 months. The yield of those securities rolling off is approximately 2.03%. While treasury yields present very attractive reinvestment levels, our priority is to fund the opportunities we continue to see in our lending verticals. Loan yields increased 89 basis points from the third quarter to 5.35% with a linked quarter beta of approximately 61%. The total cost of deposits, including DDAs, was 1.23%, up from 65 basis points last quarter. Net interest margin expanded by 7 basis points for the third quarter. The largest positive NIM impacts included approximately 52 basis points from loan repricing, loan fees, and mix, 34 basis points for the benefit of free funds, and 7 basis points from reduced liquidity balances and rates. Offsets included a negative 94 basis point impact related to the cost and mix of interest-bearing liabilities. As we look ahead, there are a lot of variables at play that will impact the trajectory of our net interest margin, including the depth and duration of the Fed tightening cycle, outlook for equity markets, and the impact on deposits expected disintermediation of DDA balances as ECR rates further increase, and our own need to generate additional deposits through targeted campaigns to fund loan growth. Based on our simulations, we expect our first quarter net interest margin to be flat to slightly up from fourth quarter levels. Additionally, we stand to benefit from the Fed's positive pressures on our index deposit bill, which should convey an asset yield benefit that arises from the current repricing environment and rotation from investment securities. As Mariner noted, while the focus on deposit beta at NIM is important, we also focus on net interest income growth facilitated primarily by loan growth. Additionally, we typically manage to a loan-to-deposit ratio limit of 75%. In the fourth quarter, average deposit growth kept in line with loan growth, keeping our ratio steady at just under 65%. Given our strong loan growth outlook, we will continue to focus on deposit and client acquisition across all our lines of businesses. Back to the income statement, total fee income for the quarter was $125.5 million compared to $128.7 million for the third quarter. We saw some market-related declines, including a $2.3 million decrease in company-owned life insurance income, along with a $900,000 decrease in customer-related derivative income. COLI income was just $21,000 in the fourth quarter versus $2.3 million in the third quarter, which had a similar offset in deferred compensation expense. For the full year 2022, the 18.6% increase in fee income included investment security gains and losses, driven largely by a gain on our sale of Visa Class B shares in the second quarter. Outside of these gains, we saw positive results from several businesses, including $31 million of additional brokerage fees related to higher 12b-1 and money market revenue share income, despite market-related compression of 11% in the underlying money market balances, compared to year-end 2021. Trust and securities processing income increased 5.8% year-over-year and included strong contributions from fund services and corporate trust. For the full year, we had a decrease of $10 million of COLI income with a similar decrease in deferred compensation expense. Slide 22 shows trends in non-interest expense. The 2.8% linked quarter increase was primarily driven by an increase of $2.6 million in processing fees, largely software costs related to the ongoing modernization of core systems, $2.1 million in additional marketing and business development expense driven by increased advertising for various campaigns and projects, and $1.8 million of increased charitable giving included in other expenses. Additionally, as I mentioned last quarter, our amortization expense increase related to the acquisition of HSA deposits completed in the fourth quarter. A few items to note from the expense levels going forward. The fourth quarter expenses included several timing-related variances along with some non-recurring items. Considering those variances, we have put our quarterly starting point closer to the $225 million to $247 million range. Also, keep in mind that first-quarter expenses are typically higher due to seasonal resets of payroll taxes and other benefits expenses. The acquisition of HSA deposits will add approximately $4.5 million of additional amortization expense annually. As previously mentioned, the increase in the FDIC assessment rate takes effect in the first quarter. As a reminder, we estimate this will have an approximate annual impact of $6 million pre-tax. As Mariner noted, our focus remains on generating positive operating leverage while prudently investing in our businesses. Our effective tax rate was 19.1% for the fourth quarter and 18.9% for the full year, reflecting a smaller portion of income from tax-exempt municipal securities along with changes in COLI valuations. For the full year 2023, we anticipate it will be approximately 19% to 20%. That concludes our prepared remarks, and I'll now turn it back over to the operator to begin the Q&A portion of the call.

Operator, Operator

Thank you. Our first question today comes from Jared Shaw from Wells Fargo. Jared, please go ahead. Your line is open.

Unidentified Participant, Analyst

Hi, this is John on for Jared Shaw.

Mariner Kemper, President and CEO

Hey, Joe. Good morning.

Unidentified Participant, Analyst

Good. How are you? I guess, big picture, going into potentially a recessionary environment, we've heard a few banks talk about maybe tightening the credit box a little bit. I guess, could you just talk about if you're thinking about doing anything similar if you're seeing any signs of hesitation or caution from borrowers on the ground?

Mariner Kemper, President and CEO

John, thanks for the question. This is Mariner. For those of you who have followed us for a while, we really don't do anything different in any type of environment. So we stick to our knitting, look for good quality opportunities, and we don't reach during the good times, nor do we retract during the tougher times. We stick to what we know and how we do it. So that's the backdrop for how we're making decisions. As it relates to what we're hearing and seeing on the ground, customers and prospects are still talking cautiously optimistic about the environment for the year. Revenue projections and conversations seem steady. I think the challenge that we hear from our customers really is about the hiring environment. But as it relates to selling goods and moving goods, everybody seems to be cautiously optimistic about that. And as we normally do, we give you a little look into what we see for the first quarter, and the pipeline remains strong.

Unidentified Participant, Analyst

Okay, great. Thanks, that's good color. And I guess just one other area. You closed the HSA acquisition in the fourth quarter. Could you just talk a little about the outlook for that—your competitive positioning, I guess, in that market with some pretty large players, dominating at this point?

Jim Rine, CEO of UMB Bank

Hi, this is Jim Rine. We did close the conversion, and it went extremely well. We picked up a very successful direct-to-employer model, and that has been our strategy moving forward. The backdrop looks good. As far as on a national level, the government and those entities have been very quiet. We don't anticipate any changes as far as the need for HSAs or HSAs going away. Our pipeline looks extremely strong. Regarding our competitors, we're obviously more focused on what we're doing, but we feel like we have an extremely competitive platform, which will allow us to deliver a better experience throughout our footprint. With what the competitors are doing, we're truly more focused on ourselves. But we've been able to compete in this space for a long time and we're one of the original pioneers in the space, so we feel very good about our position going forward, and we're excited about it.

Mariner Kemper, President and CEO

Yes, the only thing I'd add is that the technology platform and the backdrop for the business are really using the rails we already have for all of our other businesses. So it's a very leverageable business. And being a big commercial bank, that's largely what we do with this direct-to-business model. There's a lot of opportunity within our own customer base to continue to grow, and it's all about the enrollment season and just current customers and new commercial customers adding employees to the enrollment season.

Unidentified Participant, Analyst

Okay, great. Thank you for answering my questions.

Mariner Kemper, President and CEO

Thanks, Joe.

Operator, Operator

Thank you. Our next question is from Chris McGratty from KBW. Chris, please go ahead. Your line is open.

Chris McGratty, Analyst

Great, good morning. Ram, maybe a question for you. Just on the balance sheet, if I'm thinking about your comments on loan to deposit, you have room there and you can be more selective on deposits. But if I look at just the total deposits, the company shrunk about 8% this year. How should we think about the pace of incremental runoff? Because it feels like you've got roughly $1 billion of cash flow coming up the bond book to fund loan growth. I'm just trying to get a sense of the moving pieces here.

Mariner Kemper, President and CEO

Yes, Chris, this is Mariner. A couple of high-level comments, and Ram can add some color. But I think really what I would focus on, we don't really expect runoff; we expect rotation. It's really more about what happens to demand deposits. We have a very strong pipeline and the ability to grow deposits. So we can bring deposits on at market rates and fund growth, no problem. The challenge for us, which we think we're good at, is maintaining discipline at pricing the assets. So as we bring on loan growth, as we discussed last quarter, our ability to stay disciplined on maintaining and slightly growing margin is more important than the absolute cost of deposits coming on. So we're not concerned about that, and we feel strongly that we can continue to price appropriately on the asset side to maintain our margin, if not grow it slightly. If you want to add anything, Ram?

Ram Shankar, CFO

No, the only thing I would add, Chris, to that is, as we stated, our loan-to-deposit ratio is now 65%. Looking at the last couple of quarters of loan production and what's happened there, if the same pace continues, we could see our loan-to-deposit ratio trickle up to close to 70%, which we're comfortable with. As I said in my prepared comments, we managed to stay below 75% on the loan-to-deposit ratio. Will deposits fund one-to-one with what we see on the loan growth? Probably not, but that's where the $1 billion of securities that you talked about in terms of outflows comes in. So—and as Mariner said, we're focused on ensuring we remain liquid to fund the balance sheet with customer acquisitions.

Chris McGratty, Analyst

That's really great. Thanks, Ram. And on the mix of your deposits, I'm looking back pre-COVID, you were in the mid-30s for non-interest-bearing; you got as high as 46%, and you are now kind of in low 40%. How are you thinking about just internal migration given competitive alternatives for rates today?

Mariner Kemper, President and CEO

Yes, so I think that's the million-dollar question, Chris. When you get the answer, give us a call so we can plan. But I think the conservative way to think about it, we got down to 32% last time. Could it get to 35% or something this time? Probably, based on just history, if that's possible. However, there are a lot of other things going on from the growth of our customer base in general. We've added many small business customers that have a low loan-to-deposit ratio over the last few years. We have a lot of other initiatives, and our aviation and corporate trust business is relatively new; those demand deposit balances have been growing. Last cycle, we got down to 32%. So is history repeating itself, or is the world different? Our customer base remains different. We're not sure what happens. We do believe there will be some rotation from demand this year still to interest-bearing. We're just not sure how much. The internal debate we have here is, because we already saw a lot of that last year, has it already happened? So that's one of the budgets we debate internally is whether that shift has already taken place.

Chris McGratty, Analyst

That's helpful. I really appreciate it. The last one I would have is just to be kind of zooming out, right? If I think about the bullish comment on loan growth, and a stable comment on margin, it would feel like the net interest income for your company has yet to peak. Because I think that's a narrative that's going around among bank investors, where many of your peers are seeing margins and revenues top out. Would you agree or offer any thoughts on that?

Mariner Kemper, President and CEO

We expect to see net interest income continue to grow because we're a growth company. Like I said earlier, the two things we focus on would be net interest income growth based on optimal growth, as well as the growth of the balance sheet. We also think during this environment we can produce operating leverage, so we're less worried about the absolute expense levels of the company because we're investing in our business for growth. On the other side, because we have a long track record of building pipeline, we believe will continue to grow. We've been doing double-digit loan growth since 2015, and there's nothing about our business model that suggests that we can't continue to do that. We have new markets—Utah, Minneapolis, and Texas—which are young markets for us, so we have fabulous track records and great people on the ground. We're seeing really good traction there. Along with all of our other great markets, we see the same opportunities and traction. Remember, we don't project or predict our loan growth based on what's happening in GDP anyway. Our loan growth is based on market share gains. Regardless of what's going on economically, we think we can continue to deliver the same kind of loan growth we've been delivering.

Chris McGratty, Analyst

Great. Thank you very much.

Mariner Kemper, President and CEO

Thanks, Chris.

Operator, Operator

Thank you. Our next question today comes from Nathan Race from Piper Sandler. Nathan, please go ahead. Your line is open.

Nathan Race, Analyst

Yes. Good morning, everyone. I appreciate you guys taking the questions.

Mariner Kemper, President and CEO

Good morning, Nathan.

Nathan Race, Analyst

Question on just kind of the longer-term or perhaps full-year margin trajectory over the course of this year. As you guys think about what you're paying on incremental deposits outside of the index deposits, do you see some additional margin expansion potential in the back half of this year, just given maybe some lagging repricing within the loan book relative to the incremental cost of deposits that you guys are gathering based on some of the initiatives that you outlined earlier in the prepared comments? Assuming the Fed policy...

Ram Shankar, CFO

Yes, Nathan, this is Ram. Yes, definitely, we'd see some opportunity for margin expansion if the Fed does pause and hold. The pressure on our index deposits and, as Mariner said earlier, where we are being disciplined on the loan side and paying market rates on the deposit side, that will still be accretive to our margin. So that's been our focus. The same thing will repeat itself where our margin did expand when the Fed paused.

Nathan Race, Analyst

Okay, great.

Ram Shankar, CFO

Some of the margin expansion benefits also come from the rotation that we talk about from, you know, looking at the next 12 months cash flows from the securities book that have the 2% exit yield, and obviously, our loan pricing is much better than that, so we pick up yield on that.

Nathan Race, Analyst

Got you. And within that context, you guys had the spot rate on deposits at the end of the quarter. If you can exclude or isolate the index deposits?

Ram Shankar, CFO

We don't disclose that, Nate. We don't get into that kind of detail.

Nathan Race, Analyst

Okay, fair enough. And changing gears, Ram, I think in your prepared comments, you mentioned a starting point for expenses in the $245 million to $240 million range for the fourth quarter, did I correctly?

Ram Shankar, CFO

No, $225 million to $227 million.

Nathan Race, Analyst

Okay, great. And within that guidance, as you guys think about some additional monetization initiatives that you outlined on the core system side of things or otherwise, how does that factor into just overall expense growth for this year in light of the inflationary environment that we're seeing for wages and so forth these days?

Mariner Kemper, President and CEO

So, I mean, high level, the run rate that Ram is talking about is inclusive of whatever spending we're doing to modernize and invest in the business. It's all in there.

Ram Shankar, CFO

Yes. The step-off of the $227 million that I talked about, obviously, the inflation on top of that—new contracts are coming up. We are making some selective investments in people or in technology. As we said in the first quarter, we'll have the reset of payroll taxes and other benefits expenses, and there are obviously a couple of less salary days. So I would expect the trajectory from the $227 million for the first quarter to increase just because of the pressure from primarily seasonal increases in expenses.

Nathan Race, Analyst

Yes. And as you look at criticized classified trends across the portfolio—obviously, non-performers are a negligible amount as we ended the year. Are you seeing anything across portfolios and are you in discussions with clients that would perhaps cause you guys to come in below your historical charge-off guidance? I think you guys have spoken to around the $25 million to $35 million—historically?

Mariner Kemper, President and CEO

When you say below, do you mean more losses or better performance? I might ask that question, which way you're asking it?

Nathan Race, Analyst

I would just think that perhaps charge-offs this year can come in below or better than that historic kind of talked about.

Mariner Kemper, President and CEO

Well, I guess, I would suggest, you know that—as has been referenced on the call already, it's a softer environment. I wouldn't suggest we're going to do a lot better or anything for any reason. I mean, we expect that we can continue to perform the way we have been performing. I don't see anything rising that makes it anything better based on any information that's out there. I think we can just keep doing what we've been doing.

Nathan Race, Analyst

Okay, great. I appreciate you guys taking the questions. Thanks for the color.

Mariner Kemper, President and CEO

Thanks, Nate.

Operator, Operator

Thank you. This is all the questions we have today. So I will now hand back over to the management team for any closing remarks.

Kay Gregory, Investor Relations

All right. Well, thank you everyone for joining us today. The replay will be up on the website shortly, and if you have follow-up questions, you can reach us at 816-860-7106. Thank you and have a great day.

Operator, Operator

Thank you everyone for joining today's call. You may now disconnect your lines and have a lovely day.