Earnings Call Transcript - UMBF Q4 2020

Operator, Operator

Good day, and welcome to the UMB Financial Fourth Quarter and Full Year End 2020 Financial Results Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Kay Gregory. Please go ahead.

Operator, Operator

Good morning, and welcome to our fourth quarter and year-end 2020 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, all of which are subject to assumptions, risks, and uncertainties; including the currently unknown potential impacts of the COVID-19 crisis. These risks are included in our SEC filings and are summarized on Page 2 of our presentation. Actual results and other future circumstances or aspirations may differ from those set forth in any forward-looking statement. Forward-looking statements speak only as of today, and we undertake no obligation to update them except to the extent required by securities laws. All earnings per share metrics discussed on this call today 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, CEO

Thank you, Kay, and thanks to everyone for joining us today. I hope you and your families are safe and healthy. 2020 was certainly a year unlike any we have experienced. For banks, we saw the perfect storm. The timing of the implementation of CECL combined with the economic impact of the pandemic, including a 150 basis point cut in short-term interest rates and uncharacteristically low long-term interest rates, created additional uncertainty and variability across our industries. Initially, we were hopeful that we would see faster resolution, but almost a year later, the pandemic, along with the political and social concerns, persists. Despite all this turmoil, the strength of our diversified business model comes to the forefront, as evidenced by our strong pre-provision results. We have posted solid asset growth, helping to drive higher net interest income even as the industry data shows weaker trends in most categories. Our strategy to strengthen and build out our varied sources of fee income is paying off. Operationally, it’s status quo as our systems continue to perform well and most of our associate base remains remote. Even through the extended period of missing much of the face-to-face interaction that is so important to our business, our teams are working together and producing solid results. I am extremely proud of how our associates have adapted during this pandemic. I’ll repeat, because it’s so important: doing what’s right to support our workforce is a top priority. This in turn allows us to maintain our customer relationships and our commitment to high-quality underwriting standards and solid capital and liquidity levels. We see some bright spots heading into 2021 as our customers’ sentiment remains cautiously optimistic. Modified loan balances have dropped significantly and our strong credit metrics are holding steady. We had a great fourth quarter with net income of $156.3 million or $3.24 per share. Pretax, pre-provision income was $196.1 million for the fourth quarter. A quick side note about the metric: While it helps in comparing industry trends and highlighting earnings power, we don’t want to lose sight of the tax advantage we enjoy because of the composition of our securities portfolio and the strategic use of municipal securities. Pre-tax pre-provision income on a fully tax-equivalent basis was $202.9 million, showing a tax benefit of $6.8 million. The biggest driver of our outperformance for the quarter was the $108.8 million gain on our investment in Tattooed Chef that we discussed last quarter. This investment is a testament to the variety of capabilities that we have in our capital finance division, and we look forward to partnering with our other clients as opportunities arise in the future. Growing fee income, including opportunistically adding income sources, remains a key part of our strategy. A couple of competitive advantages we have are our lack of reliance on consumer service charges or on mortgage gain-on-sale income where margins have likely peaked in 2020. We’ve capitalized on an opportunity we had to add new customers through our mortgage platform, particularly in our private banking business. We’ve had great success in the early stages of our growth, building out our retail and private wealth offerings as evidenced by our 70% increase in average residential mortgage loans from the year-ago quarter. On balance sheet, mortgages contributed 33% of the year-over-year growth in average loans, excluding PPP. On the expense side, we had a few items in the fourth quarter that are not expected to repeat, including approximately $15 million in operating losses and other expenses from unrelated matters such as litigations, settlements, and some prior losses. After the initial low during the early days of the pandemic, we took a proactive approach in the fourth quarter to resolve some outstanding matters, resulting in favorable and expeditious outcomes. While most of these matters are typical for our business, the timing and impact of these were outsized in the fourth quarter. Additionally, salary and benefit expenses increased from the third quarter, driven by higher incentive compensation accruals based on company and line of business performance, as well as a $1 million increase in deferred compensation expense. As we shared in prior quarters, this is offset by a similar increase in income from company-owned life insurance designed to hedge against market fluctuations. Finally, we made $1.2 million in additional shareholder contributions in the fourth quarter. Excluding items that we do not expect to recur in the normal course of business, our quarterly expenses were consistent with prior fourth quarter levels. On the credit front, non-performing loans improved from the third quarter to 0.55%. Net charge-offs were just 4 basis points for the fourth quarter and 13 basis points for the full year of 2020, which is better than our long-term averages. Since 2000, annual net charge-offs to loans have averaged 31 basis points. 2020 was our best year since 2015 when average loan balances were roughly half of what they are today. The loan risk profile table shows the quality of our portfolio, and we’ve seen a reduction of 95% in modified loan balances compared to June 30. At December 31, loan modification balances had dropped to $68 million or 0.5% of loans, down from 9.6% and 4.8% in the prior two quarters. Our quarterly provision represents 2.8 times net charge-offs of just $1.8 million. We believe a negative provision may be imprudent given the uncertain operating environment. However, the impact of more stimulus, improved macroeconomic forecasts, and continued improvement in asset quality within our portfolio may make it untenable for us to leave our reserve coverage at current levels in the near future. The modest addition in the fourth quarter brings our total allowance for credit losses on loans to $215 million at year-end, with an allowance to loan coverage of 1.34%. Excluding PPP loans, that coverage is 1.45%, nearly two times what it was at year-end 2019 prior to the adoption of CECL. Average loans, excluding PPP balances, increased 11% on a linked-quarter annualized basis, led by consumer real estate, boosted by the low-interest rate environment and the work we’ve done to build our business. Loan production is typically strong in the fourth quarter and continued in 2020 with new originations of $1.1 billion outside of PPP balance changes. Looking ahead into the first quarter, we see a solid pipeline that looks to continue this growth. Given what we know today, in the history of any guide, it’s reasonable to expect our strong momentum and market opportunity should drive relative outperformance in loan growth and differentiated net interest income growth in the current low-interest rate environment.

Ram Shankar, CFO

Good morning. As Mariner noted, our pre-tax pre-provision results were impacted this quarter by elevated expenses due to operational losses, deferred compensation expenses, charitable contributions, the timing of certain invoices, and higher incentive accruals tied to company and line of business results. Those items, plus the impact of two additional salary days, drove the 14.6% linked-quarter increase in non-interest expense. Sequentially, net interest income increased 5.6%, driven by earning asset growth in both loans and the securities portfolio, along with $6 million from the acceleration of PPP loan fees. Total earning asset yields increased four basis points to 2.95% from the linked quarter, largely due to PPP origination fees helping to drive loan yields to 3.78% for the quarter. Average total deposits increased 3.5% on a linked-quarter basis and 22.5% year-over-year to $25 billion. DDA balances grew by $687 million due to the typical year-end buildup of cash in corporate trust for municipal payments, the ramp-up of public funds, and more customers leaving balances in DDA at low rates. The total cost of deposits, including three funds, was down from 15 basis points in the third quarter to 13 basis points. Both net interest spread and net interest margin expanded by five basis points from the third quarter. The fourth-quarter margin benefited 8 basis points from the acceleration of PPP origination fees and 2 basis points from deposit mix and rate changes. These were offset by the continued impacts of excess liquidity and lower reinvestment rates on cash flows from our bond portfolio. Excluding the benefit of PPP acceleration this quarter, the core net interest margin would have compressed approximately 3 basis points. Looking forward, the actual trajectory of our net interest margin will depend on multiple factors, including short-term and long-term interest rates, prepayments on agency mortgage-backed securities, excess liquidity in the economy, and the pace of PPP forgiveness. Given what we know now, we expect some additional margin compression relative to the 2.81% reported net interest margin in calendar year 2020, roughly in line with the current consensus outlook of 2.70%. Noninterest income was $228.3 million for the quarter, an increase of $115.3 million, of which $108.8 million was the gain on our Tattooed Chef investment. Because these and other market value adjustments will flow through our income statement in future quarters, we added a new line item called investment security gains and losses. Trends in our capital ratios are shown on Slide 16. Our tangible book value per share increased more than 20% during the year to $58.64 at December 31. For comparison, our peers that have reported so far have shown a median increase of 8.1%. 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

Our first question will come from Ebrahim Poonawala with Bank of America. Please go ahead.

Ebrahim Poonawala, Analyst

Hey. Good morning.

Mariner Kemper, CEO

Good morning, Ebrahim.

Ram Shankar, CFO

Good morning, Ebrahim.

Ebrahim Poonawala, Analyst

I guess, just first, Mariner, if you could just touch upon just the growth outlook. I think you had one of the better loan growth performances both for the fourth quarter and full year. Just talk to us in terms of what we’ve heard from other banks as relatively slow first half of the year and then some pickup in the back half. Just talk to us in terms of what your expectations are on loan growth? And also tied to that, as you think about business development, on the fee income side, is there anything in particular that you see exciting from a growth opportunity standpoint?

Mariner Kemper, CEO

Yes. Thank you, Ebrahim. As I said in my prepared comments, and as we have historically done, given a bit of a look into the first quarter, we expect to have the same kind of loan growth via the pipeline that we had in the fourth quarter. As it relates to the remainder of the year, all things remain true – we are underpenetrated across our geographic footprint and on an asset class basis related to getting our share within the markets that we do business. We have deep pipelines, uninterrupted sales activity, and no reason to expect anything different than what we’ve produced for many years related to the under-penetration and our exceptional sales force. On the fee income side, there are several things that continue to look promising for us. Our trading and underwriting business both on the public-private side and just the pure public side continues to be strong as we’ve built out offices in Dallas and New York. We expect to continue to see benefits from expanding that business over the last couple of years. Corporate trust, one of the most exciting opportunities, is still to be seen, but it appears that with the current administration moving quickly, an infrastructure bill would be very meaningful to our corporate trust and public underwriting business as we are one of the major players in that space. We are excited about the potential when that comes to fruition. Fund services continues to be well positioned as there is still a lot of consolidation in that business, and with that consolidation, it puts larger players on the sideline, presenting potential targets for business development. Our pipeline continues to grow there. We’ve seen year-over-year that businesses are growing nicely. In the latter half of the year, if the economy continues as expected, we anticipate our card business will perform well, particularly because it’s related to commercial spending. We agree with most other banks that the latter half of the year should show performance. Our Investor Solutions business continues to showcase opportunities with Fintechs, and our wire house and brokerage business remains strong. As market conditions remain favorable, we are investing in our wealth management business, having newly invested in a reporting and trading system and actively hiring. On the lending front, we also have two expansion markets, Minneapolis, which now represents 1% of our total loans, and we have just expanded into that market a year ago.

Ebrahim Poonawala, Analyst

That will help me, Mariner I think. And then just, as we talk about margin pressure, I was wondering if you could help us just in terms of your thought process around core NII outlook and remind how much of PPP fees are left around that you expect to accrete as these loans are forgiven? I am sorry if I missed it. I joined the call late. Thank you.

Mariner Kemper, CEO

Yes. So what I said, Ebrahim, on the margin was, if you exclude the PPP acceleration that we had in the months of November and December in the fourth quarter, our margin would have been down about three basis points on a core basis excluding PPP acceleration. Now, just over half of our PPP fees were recognized in 2020, so we have approximately 45% of those fees from round one of PPP still remaining to be recognized in our income statement. As for the core margin, as I said in my prepared comments, much will depend on what’s happening with excess liquidity and more stimulus coming our way, which may impact net interest margin. The other factor is obviously long-term rates. With the ten-year having moved up a little bit, the mortgage rates haven’t reacted. Therefore, prepayment fees and the reinvestment rates on our mortgage-backed securities book will also determine the path of margins.

Ram Shankar, CFO

And I would just add that we also do have round two on PPP. So we need to determine how much more we end up doing with that. We began submitting applications to the SBA starting last week.

Ebrahim Poonawala, Analyst

Any sense how big that could be?

Ram Shankar, CFO

Not yet. But it’s highly likely to be much smaller.

Ebrahim Poonawala, Analyst

Okay. And just, to follow up, I get what you said on the margin. In terms of the core net interest income, do you think you’ve bottomed out? Or do you still see more pressure on the NII?

Ram Shankar, CFO

No, and Mariner said in his prepared comments, the same comments regarding loan growth in terms of outperforming – a relative outperformance that’s still expected to be true for the net interest income side. We will certainly grow through the current rate environment, which is not very conducive to our balance sheet growth opportunities. Those comments that Mariner stated are similarly pertinent to NII.

Ebrahim Poonawala, Analyst

Understood. Thanks for taking my questions.

Mariner Kemper, CEO

Thanks, Ebrahim.

Operator, Operator

Our next question comes from Chris McGratty with KBW. Please go ahead.

Chris McGratty, Analyst

Thanks. Good morning, Mariner.

Mariner Kemper, CEO

Good morning, Chris.

Chris McGratty, Analyst

Ram, maybe start with you on the expenses. You called out in the deck some items not expected to recur, and you talked about it a little bit in your prepared remarks. I am interested in your view on the right jumping-off point for 2021 for expenses.

Ram Shankar, CFO

Yes. Sure, Chris. I mean, we don’t offer forward guidance like that. But I’ll go back to what Mariner said in his prepared comments. If you exclude some of the noise that we talked about in our script, the fourth quarter 2020 run rate would have been similar to the $202 million or so that we had in the fourth quarter of 2019. To exclude the noise, that would be probably a good run rate from which to start.

Chris McGratty, Analyst

Okay. And the operational expenses, what exactly is that? Operational losses?

Mariner Kemper, CEO

We are not prepared to discuss the nuances of it. But there are expenses that would typically happen anyway, and we took advantage of 2020 to get them out of the way. So, these outcomes will be expeditious in our favor.

Chris McGratty, Analyst

Okay. And you had to do that again this quarter. In terms of use of capital going forward, I hear you on the organic growth. Are there any comments about resuming the buyback that a lot of banks have done, and also thoughts on M&A?

Mariner Kemper, CEO

Sure. These comments are similar to what we’ve said for a long time. The first priority is to use our capital to build our business, that would be through investment in people, technology, and M&A. We continue to look and spend a lot of energy and time determining the right opportunity. We would like to be able to find something, but the energy is being focused there. As for buybacks and dividend increases, those would depend on whether we are successful investing and what opportunities arise. We’ve historically demonstrated our willingness for buybacks, but it’s lower on the priority list.

Ram Shankar, CFO

Just to add to that, in the fourth quarter, we did buy back approximately 67,000 shares when our stock was lower than where it’s trading now. We will be opportunistic about buybacks and have commenced the resumption.

Chris McGratty, Analyst

Yes. Okay. And Ram, if I could, just on the PPP, do you have total accelerated fees or the fees in the quarter, and then what’s 45% of interim dollar raise going forward?

Ram Shankar, CFO

That’s right. We disclosed that the fee acceleration part is about $6 million incremental to the fourth quarter, most of which occurred in November and December. Previously, we disclosed that we had approximately $1.5 billion of PPP loans based on the size of those loans and the number of loans. The average revenue expected was around 2.3%. You can do the calculation based on that.

Chris McGratty, Analyst

All right. So 45% of that, that’s correct. Got it. Thanks.

Operator, Operator

Our next question comes from Nathan Rice with Piper Jaffray. Please go ahead.

Nathan Rice, Analyst

Yes.

Mariner Kemper, CEO

Morning, Nathan.

Nathan Rice, Analyst

Good morning, guys.

Mariner Kemper, CEO

Good morning, Nate.

Nathan Rice, Analyst

A question on credit. It looks like most of the items that you all improved in the quarter – MPH is down, charge-offs were very low, and deferrals came down to less than 1%. But I guess, the ACL increased a little bit, and it looks like that was due to portfolio changes. Are there increases in criticized loans? If so, kind of what portfolios are driving those increases?

Ram Shankar, CFO

Right. Mariner, I’ll take this first. I mean, part of it is the balance sheet growth. If you look at our point-to-point basis, our balances were up about $400 million. So, when you look at our allowance coverage ratio, it actually came down a couple of basis points. So that’s the primary driver of why we had a reserve build.

Mariner Kemper, CEO

Yes. As far as criticized loans, we have very little migration from the watch list to doubtful, which has been the case for 25 years. We want to ensure stability in our portfolio.

Nathan Rice, Analyst

Got it. That’s helpful. And then just changing gears a little bit and going back to the growth in deposits in 2020, just curious if you guys have any updated thoughts in terms of the stickiness of that deposit growth entering 2021 and what your investment perspective is within the securities while you continue to reinvest.

Ram Shankar, CFO

Nate, I would say, all of the above. Right, obviously, we are trying to invest in the market. As you’ve heard comments from Mariner about the loan pipeline we see in the first quarter and into 2021, the first choice is to deploy those deposits into loans. We will continue to do that. And on the bond portfolio too, subject to all the due diligence that we perform on municipal securities and what we buy on the mortgage-backed side, we continue to see the portfolio grow, and the remainder sits on our balance sheet as liquidity. It will be a combination of those factors. This will continue into 2021 due to the stimulus programs and excess liquidity in the economy.

Mariner Kemper, CEO

For stickiness, we monitor that closely. We feel that the diversity of our deposit base makes us comfortable against any excess liquidity in institutional, corporate, or personal categories.

Nathan Rice, Analyst

Okay. All right. Appreciate all the color. Thank you.

Ram Shankar, CFO

Thanks, Nate.

Operator, Operator

Our next question comes from Jared Shaw with Wells Fargo Securities. Please go ahead.

Jared Shaw, Analyst

Hi, good morning.

Mariner Kemper, CEO

Good morning, Jared.

Jared Shaw, Analyst

Just looking at the ACL, you had pretty great info in there regarding how you’ve built that out, and about a third of the ACL is due to macroeconomic conditions. How should we be thinking about that going forward as we are starting to see some modest improvements? Are you sort of heavily depending on improving the quality of ratios a bit longer, or should we think maybe by the second half of the year you'll start reevaluating that excess, and we can see that back into earnings or growth?

Mariner Kemper, CEO

Well, I’ll take a first stab at this. The original purpose of the additional provision we did in the first quarter was tied to the pandemic. As far as I am concerned, we are still in the middle of that. So, it’s premature to think that we would do some of the releases that others have announced. However, relating to your question about when that would change, it will depend on how quickly vaccine delivery happens, what the stimulus and all additional government programs will do, and whether by the back half of the year we will feel that we are out of this. I’d say our algorithm for this is complex and includes things like loan growth and performance within those years, macroeconomics, and we have to stick to that algorithm. If the data improves materially, we will be hard-pressed to consider releasing provisions at some point during the year. We plan to monitor the data carefully.

Jared Shaw, Analyst

Okay. Thanks. And then, on expenses, if we use a sort of a 202 as the base for the first quarter, and then some of the growth you are talking about, should we expect 2021 to be a year of good positive operating leverage where we should expect to see some decline in the efficiency ratio?

Mariner Kemper, CEO

Well, improvement for sure. We may experience some headwinds related to the operational environment and interest rate conditions. Therefore, any meaningful improvement in operating leverage will be challenging. We will certainly work at it all year long, but the interest rate environment poses considerable challenges.

Jared Shaw, Analyst

Okay. Thank you.

Operator, Operator

Our next question comes from David Long with Raymond James. Please go ahead.

Ram Shankar, CFO

Good morning.

David Long, Analyst

Good morning, everyone.

Mariner Kemper, CEO

Good morning, Dave.

David Long, Analyst

Hey, Ram. The period-ending deposits were well above the average in the quarter. Now I know there is some seasonal impact. But looking at the first quarter here, how much of that growth in deposits looks to be seasonal versus sticky, and how do you expect to defend your NIM if you have this excess liquidity?

Ram Shankar, CFO

It’s really tough to analyze our quarter-end deposit balances, particularly due to the public funds business. As Mariner discussed, we have diverse businesses with various seasonal aspects, including organic growth and the impact of excess liquidity. The balance sheet was higher due to public fund season, which ramps up in November through February, occurring every year. Additionally, in asset servicing or fund services, there tends to be volatility depending on clients' activities. Nevertheless, we are optimistic that our diverse lines of business will help our core deposits remain sticky.

David Long, Analyst

Got it. And then, what are you looking at right now for reinvestment rates in securities? I think you said that the roll-off in the quarter was in the mid-180 range?

Ram Shankar, CFO

That’s right. The new mortgage backs and municipal securities can range from 1.25 to 1.40.

David Long, Analyst

Got it. Okay. And then, a second question I had is related to your deferrals. It’s great to see those numbers come down. If you're still on deferral, have those been downgraded, and where do they stand in the risk spectrum at this point?

Mariner Kemper, CEO

Ram, do you want to take that?

Ram Shankar, CFO

Yes. It’s case-by-case; some of those deferrals have been downgraded. Typically, those downgraded have gone to a watch status, especially in the hospitality sector. However, others on a second deferral haven’t necessarily been downgraded if we believe that it’s pandemic-related. We remain optimistic that targeted borrowers will return to normal as the economy improves.

David Long, Analyst

Got it. Thanks. I appreciate the color. Thanks, guys.

Mariner Kemper, CEO

Thanks, Dave.

Operator, Operator

Our next question is a follow-up from Chris McGratty with KBW. Please go ahead.

Chris McGratty, Analyst

Great. Thanks for the follow-up. Just want to make sure I got a couple of things written down right. Ram, the tax rate guide, is that an effective GAAP tax rate?

Ram Shankar, CFO

That’s a GAAP tax rate of 15% to 17%.

Chris McGratty, Analyst

Okay. And then, I think you referenced a 2.70% margin in your prepared remarks. I guess, I was interested to know if everyone got that right and whether that was a GAAP NIM or excluding the PPP?

Ram Shankar, CFO

That is on a reported basis. So it’s fully taxable equivalent at about 2.70%, which aligns with consensus models. This assumes a straight-line amortization of the PPP fees. If forgiveness accelerates, we could see some outperformance.

Chris McGratty, Analyst

Okay. And that was for the full year 2021, correct?

Ram Shankar, CFO

Correct.

Operator, Operator

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

Mariner Kemper, CEO

Hey, Kay, I am going to add something here at the end, because nobody asked about this. On the Tattooed Chef front, nobody really asked about that. It is a line of business we do expect to continue to see opportunities and gains in that line of business. So, anyway, nobody really asked about that. We don’t expect that to be a one-time opportunity. With that, I’ll turn it over to Kay.

Operator, Operator

Thanks, Mariner, and thanks, everyone, for joining us today. This call can be accessed via replay on our website. And as always, if you have further questions, you can reach us at 816-860-7106. Thank you.

Operator, Operator

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