Earnings Call Transcript - UMBF Q4 2024

Operator, Operator

Good morning. Thank you for joining the UMB Financial Fourth Quarter 2024 Financial Results Conference Call. My name is Cole, and I will be your moderator for today. All lines will be muted during the presentation, and there will be a question and answer session at the end. I will now hand the call over to Kay Gregory. Please proceed.

Kay Gregory, Moderator

Good morning, and welcome to our fourth quarter 2024 call. Mariner Kemper, Chairman and CEO of UMB Financial Corporation, and Ram Shanker, CFO, will share a few comments about our results, and then we'll open the call for questions from our equity research analysts. Jim Rine, President of the Holding Company and CEO of UMB Bank, along with Tom Terry, Chief Credit Officer, will be available for the question-and-answer session. Before we begin, let me remind you that today's presentation contains forward-looking statements, including the discussion of future financial and operating results, benefits, synergies, gains, and costs that the company expects to realize from the pending acquisition, as well as other opportunities management foresees. Forward-looking statements and any pro-forma metrics are subject to assumptions, risks and uncertainties, as outlined in our SEC filings and summarized in our presentation beginning on Slide 49. 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. Presentation materials are available online at investorrelations.umb.com, and include reconciliations of non-GAAP financial measures. Now, I'll turn the call over to Mariner Kemper.

Mariner Kemper, CEO

Thank you, Kay, and good morning, everyone. First off, congratulations to our Kansas City Chiefs returning to the Super Bowl in a couple of weeks. Exciting times in Kansas City. At UMB, we're very excited to announce earlier in January that we received approval from the OCC and Fed to complete the acquisition of HTLF. We anticipate closing the deal on Friday, January 31st. I'm extremely proud of what our associates have achieved during the past several months, as evidenced by our fourth quarter and full year 2024 results. The team has remained focused on sustaining and growing our day-to-day business activities, while at the same time supporting integration efforts and conversion planning. I want to express my appreciation for the huge amount of energy and collaboration from both UMB and Heartland associates; both teams have been working very hard to ensure a successful transition for our new customers and associates. As you've seen, Heartland filed an 8-K yesterday afternoon with a summary of their fourth quarter results. We've included some of the key performance indicators in the appendix of our deck on Slide 46. The strong value proposition of the deposit franchise was evident, as seen by the 6% linked-quarter annualized increase in customer deposits and an attractive 2.13% cost of total deposits. In anticipation of the merger close, Heartland preemptively affected the resolution of certain non-core loans and bonds, resulting in lower loan balances and higher levels of net charge-offs during the fourth quarter. These credits, including those on Heartland's watchlist and all of the bonds were identified during our due diligence process, including the bonds we had earmarked for sale at close. The favorable resolution of these assets better positions our pro forma balance sheet at close, including a reduction in non-performing loans. Additionally, the deleveraging of the balance sheet included a near 50-basis-point boost in Heartland's regulatory capital ratios and further improved its loan-to-deposit ratio. As we discussed in our original acquisition modeling, we will maintain a conservative credit mark on Heartland's loans. And as a combined entity, we expect our ACL coverage ratio will also increase. Now, turning to our results released yesterday afternoon, we had a phenomenal quarter to end 2024 on a strong note. Our results, which contain several record-setting metrics, are even more impressive given the extra integration work completed by so many of our teams. We set new company records, with 2024 annual operating income of $461.7 million, net interest income that surpassed $1 billion, and fee income of $628.1 million. For the fourth quarter, we reported GAAP earnings of $120 million or $2.44 per share, driven by strong performance across the board. On an operating basis, we earned $2.49 per share. Net interest income increased 8.7% from the third quarter, driven by an 11-basis-point increase in net interest margin and strong earning asset growth. As expected, we benefited from strong balance sheet growth as well as deposit cost reductions on our indexed deposit book as short-term rates have come down. On a linked-quarter basis, the total cost of funds beta was 58% and our earning asset beta was just 37%. The beta on interest-bearing deposits was 55%. Balance sheet growth included a very strong 14.8% linked-quarter annualized increase in average loan balances, driven by yet another quarter of record top-line production of $1.6 billion. While C&I led the growth for the quarter, we also saw a solid increase in CRE and in consumer real estate. For comparison, banks that have reported so far have had a median annualized increase in average loan balances of just 3.1%. Credit quality in our portfolio remains excellent, with 14 basis points of net charge-offs for the quarter and just 10 basis points for the full year. C&I continues to perform well with just 3 basis points of net charge-offs for the full year. Non-owner-occupied CRE has had a net charge-off ratio of zero for the past four years. And in fact, our charge-offs are less than $900,000 in total in this category since 2016. Our non-performing ratio remained flat at 8 basis points for the fourth quarter. On a longer-term basis, I'm proud of our track record that puts us near the top of the industry. From 2004 to 2024, our non-performing loan ratio has averaged just 0.38% compared to 0.92% for our peers and approximately 1.9% for the industry as a whole. On the other side of the balance sheet, our average total deposits grew $2.7 billion or nearly 31% on a linked-quarter annualized basis, largely driven by the activity in our commercial and institutional customer base. Average DDA balances increased 48% linked-quarter annualized to $10.6 billion. For comparison, banks that have reported fourth quarter results so far have a median annualized average deposit increase of just 7.3%. The strength of our diversified financial model was evident this quarter with the continued fee income growth across all segments. The top contributors include 12b-1 fees, money market revenue, and trust and securities processing income. To highlight a couple of successes behind that growth, private wealth teams brought in a net new asset level of $1.3 billion in 2024, a 75% increase over '23, and institutional assets under administration continued to expand, up 18% year-over-year to stand at $526 billion. Corporate trust assets, part of the institutional totals, have grown significantly over the past 10 years to $42.4 billion, representing a compound annual growth rate of 14%. And in our healthcare business, the number of HSA accounts grew steadily from just 588,000 accounts at the end of 2014 to more than 1.6 million accounts at the end of 2024 for a CAGR of 11%. As you know, we focused on operating leverage rather than specific expense growth targets. Compared to the fourth quarter a year ago, we posted positive operating leverage of 3.8% on an operating basis. Ram will provide more detail on income and expense drivers shortly. Finally, our capital levels continue to build. We ended the quarter with a CET1 ratio of 11.29%, an increase of 7 basis points from the third quarter and 35 basis points from a year ago 2023. As a reminder, our capital levels don't include the $232 million forward equity offering agreement that we announced in April, which we expect to settle in full during the first quarter of 2025. We're very pleased with our strong results for the quarter, coupled with the opportunities we see for a combined UMB and HTLF in the first quarter. We're very excited about what 2025 and beyond will bring. We continue to believe that the addition of HTLF is a great fit from a strategic, financial and cultural perspective, and we look forward to reporting on a combined basis at the end of the first quarter. Now, I'll turn it over to Ram for more detail.

Ram Shankar, CFO

Thanks, Mariner. Net interest income of $269 million represented a linked-quarter increase of $21.6 million or 8.7%, reflecting balance sheet growth, favorable reinvestment yields, lower interest expense on indexed deposits that reprice, and a mix shift in funding composition including the strong DDA growth that we experienced during the quarter. These benefits were partially offset by the repricing of variable rate loans. The $1.6 billion or 3.9% increase in average earning assets was driven by strong loan growth Mariner mentioned, along with an additional $586 million in average securities and $102 million in Fed funds sold and resale agreements. During the last two quarters, we began pre-purchases of nearly $1 billion of U.S. treasuries and agency mortgage-backed securities in advance of our planned de-leveraging of certain bonds held by Heartland. The average impact of these pre-purchases was approximately $168 million in the fourth quarter. Average interest-bearing liabilities increased 1.6% from the linked-quarter, with increases in interest-bearing deposits, partially offset by the decrease of $1.1 billion in borrowed funds, reflecting the repayment of borrowings under the BTFP plan and FHLB advances. Average DDA growth was driven primarily by corporate trust and capital markets, where DDA can fluctuate based on tax or bond payments and other trustee activities, particularly at quarter- and year-end. The percentage of indexed deposits remained relatively flat, with approximately 35% of total deposits hard indexed to short-term interest rates. As Fed fund rate changes, these deposits reprice immediately. An additional 17% of our deposits are soft indexed, balances negotiated at current prevailing market rates. On these soft indexed deposits, we will generally move rates pretty quickly following Fed rate moves. Overall, we continue to expect our deposit betas on the way down to be steeper than peer banks as we experienced this quarter. Net interest margin for the fourth quarter increased 11 basis points sequentially to 2.57%. The primary drivers of the increase were the positive impacts of 31 basis points from repricing of interest-bearing deposits, 9 basis points from reduction in borrowing levels, partially offset by a negative 16 basis points related to loan repricing and mix, 6 basis points related to excess liquidity levels and 5 basis points related to changes in the benefit of free funds. Looking into the next quarter, given the anticipated closing date of January 31st, our first quarter results will include three months of UMB operations and two months of Heartland, and all the yet-to-be-determined impacts from purchase accounting accretion associated with the merger. Based on our outlook for no additional rate cuts this quarter, we expect UMB standalone core margin to be relatively flat to fourth quarter '24 levels. As shown on the right side of that Page 32, 70% of loans reprice within the next 12 months, with the majority of those indexed to short-term rates and adjusting monthly. Details on the hedges we have in place are also on that slide. During the fourth quarter, we added two floor spreads, each with $250 million of notional value. At year-end, we had $3 billion of notional value hedges comprised of three floor contracts and 10 floor spreads. Based on the forward start arrangements, $2.25 billion of these $3 billion hedges are within their payment windows, with the remainder becoming effective over the next 60 days. Assuming no additional rate cut, the net impact of these hedges on our net interest income is expected to be fairly modest. The combined AFS and HTM portfolios averaged $12.8 billion, an increase of 4.6% from the prior quarter. As I mentioned in the third and fourth quarters, we preemptively bought additional securities in advance of closing the HTLF acquisition. As discussed at the time of the announcement, we had identified a pool of securities in HTLF's portfolio that didn't match our investment profile, currently standing at approximately $2 billion. We expect to sell any remaining bonds in this pool at close, likely reinvesting the proceeds into agency mortgage-backed securities or U.S. treasuries. The average purchase yield in our portfolio was 4.54% for the quarter, while securities rolling-off had a yield of 3.39%. We expect $1.5 billion of securities with an average yield of 2.62% to roll-off over the next 12 months. The reinvestment of these cash flows at the current accretive yield in bonds or loans will help net interest margin regardless of any Fed action. Turning back to the income statement, noninterest income was $165.2 million, a linked-quarter increase of 4.1%. We recognized a pre-tax gain of $4.1 million in the fourth quarter on the sale of UMB Distribution Services, part of our asset servicing business. Fee income in the quarter also included $1 million in gains on the sale of other non-core assets. Excluding these two items, our core fee income of approximately $160 million reflected strong traction in our institutional and private wealth business lines. Brokerage income increased $2.9 million linked-quarter, driven by higher 12b-1 fees and money market revenue. Corporate trust's off-balance sheet money market balances have increased by nearly 35% in the past 12 months and now stand at $16.3 billion. This quarter has further demonstrated our ability to garner both on-balance sheet and off-balance sheet deposits, thanks to the strength of our diversified business model. Trust and securities processing income, where the strong private wealth and asset servicing activity Mariner mentioned is captured, increased $2.6 million or 3.6% from the third quarter. Partial offsets include some market-related variances in investment security gains and COLI income, which each decreased $2 million from the third quarter. Reported noninterest expense of $270.4 million for the quarter included pre-tax acquisition expenses of $3.7 million. Additionally, within the other expense line, we had $4.5 million of additional operating losses in the fourth quarter. On an operating basis, which excludes the merger charges, noninterest expense increased $15.8 million linked-quarter and included a $15.4 million increase in salary and bonus expense as our strong performance in several businesses continued, resulting in higher incentive accruals. While we calibrate our accruals on these performance-based measures throughout the year based on expected performance, our strong second half results, particularly our fourth quarter, meant that these accruals needed to be revised higher. Expense offsets included lower bankcard expense and lower supplies expense. The $1.8 million decrease in deferred compensation expense is the offset related to COLI income. Excluding some of the items I mentioned, we would put our quarterly normalized starting point for expenses closer to $250 million. Additional details are available in our slides and press release. Separately, in the first quarter, we expect to pay approximately $2 million in dividends on preferred stock that we will assume from Heartland. Finally, our effective tax rate was 18.5% for both the fourth quarter and full year 2024 compared to 17% for full year 2023. The 2024 increase is primarily related to a smaller portion of income from tax-exempt municipal securities and higher non-deductible acquisition costs versus 2023. For full year 2025, our preliminary estimate, including the HTLF acquisition, is an effective tax rate of 20% to 24%. Now, I'll turn it over to the operator for the Q&A session.

Operator, Operator

Our first question is from Jared Shaw with Barclays. Your line is now open.

Jared Shaw, Analyst

Hey, good morning.

Ram Shankar, CFO

Hey, good morning, Jared.

Mariner Kemper, CEO

Good morning.

Jared Shaw, Analyst

Can you discuss the Heartland deal and how their fourth quarter impacts the initial assumptions? Specifically, how does the change in non-performers affect your total assumed mark? Additionally, regarding the $2 billion of identified securities, how much remains to be sold compared to what has already been handled?

Mariner Kemper, CEO

Thank you for the question, Jared. We remain very enthusiastic about the impact Heartland will have. To set the stage for any future inquiries regarding Heartland, it's important to note that we operate separately as companies due to certain regulations. We've included a slide in our deck that summarizes the relevant details, and I won't provide much more than what's already been disclosed since we are maintaining our separate operations until we finalize the deal on Friday. However, I can offer some high-level insights. When we announced this transaction in April 2024, we made pro forma assumptions involving $72 billion in securities and capital levels around 10%. The significance of customer deposits remaining stable was a key reason for pursuing this transaction, and those assumptions still hold true. Overall, the main drivers of this transaction—capital levels and customer deposits—remain largely unchanged. In fact, customer deposits have increased since the announcement, and by the time we close, non-performing loans will have decreased from our initial assessment.

Jared Shaw, Analyst

Okay, thanks for that information. Regarding the expenses, did you mention that $250 million is a good starting point or a solid baseline for 2025? How should we consider incentive accruals at the beginning of the year and throughout the year for the UMB?

Mariner Kemper, CEO

Yeah, Ram, why don't you take that?

Ram Shankar, CFO

Yeah. Hey, Jared, it's Ram. So, yeah, $250 million is the normalized fourth quarter run rate for all the things that I mentioned, right? So, as we said, $15 million of the $270 million excess is just catch-up and accruals. So, those all get reset on day one to normal levels, typically 100%. And then, the only thing that happens in the first quarter, as you guys know, is about $8 million to $10 million of FICA resets and all the things that are part of the first quarter resets, payroll taxes, and all that. So, $250 million is the steady-state run rate. You might see some elevated expenses just because of the FICA payroll resets. Again, this is I'm talking about core UMB operations before we acquire Heartland. So, that will be slightly higher in the first quarter for core UMB just for usual seasonal resets.

Jared Shaw, Analyst

Thank you. If I could ask one more question, you mentioned targeted commercial real estate growth. Is this area more appealing to you now due to improved spreads, or are you experiencing better terms and conditions? What is making you more enthusiastic about commercial real estate at this time?

Mariner Kemper, CEO

I don't quite remember those comments, but I am more enthusiastic about it. I'm not entirely clear on what you are referring to, but we are in the same position as before. We appreciate the category and have consistently sought high-quality developers and partner sponsors, primarily in the industrial and multi-family sector. There's nothing new on that front. There is demand, but some supply-demand challenges stem from interest rates and market activity. Overall, our interest in this area remains unchanged.

Brian Wilczynski, Analyst

Hi. Good morning. Thanks for taking my question. First question is on the net interest margin. So, there's been a lot of volatility in the forward curve over the past several weeks. Can you just talk about what the range of potential outcomes is for NIM if we get, say, no cuts over the next few months versus the two that a lot of people are expecting for 2025? Thanks.

Ram Shankar, CFO

Good morning, Brian. This is Ram. Considering the current yield curve, we believe that a prolonged period of higher rates is favorable for us. We've mentioned that we have $1.5 billion in securities maturing at yields of 2.60%, which we acquired at 4.54% in the fourth quarter. As long as the curve remains stable and there are no further rate cuts, we won't see much pressure on loan yields, and deposit costs are also steady. This creates a conducive environment for us to grow net interest income without needing additional loan growth, along with the potential for extra loan growth. In our interest rate simulations, we are slightly sensitive to liabilities, but overall, this rate environment is advantageous for us. A prolonged period of higher rates is beneficial for net interest income and net interest margin. While we do not provide specific guidance on outcomes, there are many fixed-rate loans still adjusting at significantly higher rates and we have the $1.5 billion in securities cash flows. The only uncertainty remains regarding demand deposit account balances, which could influence deposit growth and affect net interest income in any given quarter.

Brian Wilczynski, Analyst

That's really helpful. Thank you. And then, 4Q was another really strong quarter for loan growth, specifically new loan production. Can you talk about any trends that you've noticed post-election specifically? Is there anything you're seeing in borrower sentiment or activity levels or anything that impacts your view on what loan growth looks like going forward?

Mariner Kemper, CEO

It's a little too early to determine the impact of the new administration on that. If we separate activity from sentiment, I think it's just too soon to say. Generally, there is a pretty positive sentiment suggesting a better business environment, which should drive more activity, but it's really too early to understand what that means.

Jim Rine, President

Yeah. The only thing I would add...

Brian Wilczynski, Analyst

Okay. Great. Thank you for taking my questions.

Jim Rine, President

Yeah, this is Jim Rine. The only thing I would add as a quick follow-up is, if you remember, our whole investment thesis is market penetration. Regardless of the political climate, we are underpenetrated in each market except Kansas City. Therefore, there's a runway to grow. What I mean by that is we're effectively attracting clients from other banks through market penetration rather than relying on additional economic activity. We feel quite optimistic about our position in 2025.

David Long, Analyst

Good morning, everyone. In the fee-based businesses, UMB has shown positive momentum in trust, securities processing, brokerage throughout the year. As we go into 2025, any headwinds that we need to think about in some of these fee-based business that could slow the momentum?

Mariner Kemper, CEO

No, I wouldn't say there are any headwinds at all. The growth in fund services mainly comes from the alternative space, which doesn't really correlate with what's happening in the public markets. Regardless of the public market conditions, our growth comes from asset generation and fund flows into our fund vehicles, which means our fees are tied to asset size rather than market fluctuations like public equities and fixed income. This growth is driven by fund flows, asset generation, and new fund creation, giving us a very strong business outlook. We've also experienced significant disruption in this area with private equity firms acquiring fund service providers, which has been beneficial for us. We continue to receive exceptional customer service ratings within the industry, and we maintain a strong forward-looking outlook for this business. Additionally, we control our technology and are assisting clients in finding new market strategies. Corporate trust also has a robust outlook, especially as government spending increases in infrastructure projects. Our position within corporate trust allows us to facilitate infrastructure work effectively, which enhances our growth prospects. The aviation sector is another strong area for corporate trust, especially as the travel industry recovers. There is a considerable shortage of airplanes, and as Boeing and Airbus ramp up production, we expect a solid influx of business. We launched CLOs last year and have started off well this year. Our wealth management business, as mentioned earlier, has also seen very positive results, along with our investor solutions and HSA offerings. Overall, I would characterize our outlook as excellent across all these business segments with no significant headwinds to consider. Would you like to add anything?

Jim Rine, President

No, the only thing I would add is, we've also continued to invest, as you know, not only in people, but we upgraded operating systems in our 40 Act side of fund services as well as corporate trust. So, we're making additional investments to handle increased volume.

Mariner Kemper, CEO

The new footprint that comes with Heartland should help corporate trust. Also, it's a very localized business, so doing business with local law firms. And so, as we put our signs up in our offices across all these new states and markets, that should benefit our corporate trust business as well.

Ram Shankar, CFO

Yeah, this is Ram. The second half of December is when we typically see inflows from public funds, which can range from $800 million to $1 billion. By early February, these inflows usually start to decrease due to actual municipal payments, such as bond and tax payments. This is the main factor influencing that trend. Additionally, as we mentioned regarding the fourth quarter, there is often some seasonality in the corporate trust business connected to bond and tax payments, making it difficult to predict. These are the main factors that could significantly affect our deposit pipeline and our outlook for the first quarter.

Ben Gerlinger, Analyst

Hey, good morning.

Ram Shankar, CFO

Hey, Ben.

Ben Gerlinger, Analyst

For UMB, or what I might call legacy UMB, there is strong loan growth, a solid funding mix, and healthy margins. Fees have been good, though expenses are somewhat higher than I expected. Overall, the results look quite healthy. I understand you need to approach Heartland questions tactically. Looking at Heartland's last few quarters, they seem to be experiencing some contraction, and the margin has decreased. You mentioned charge-offs and credit issues, which seem to align with expectations. Initially, when you announced, you projected over $200 million in net income from Heartland. However, I notice a significant gap when looking at the anticipated fourth quarter for 2025. Can you provide clarity on what you expect for pro forma UMB in 2025? I know there are opportunities for marks and cost savings in the next 18 months, but when combining the two balance sheets, I’m not seeing the figures you initially projected.

Mariner Kemper, CEO

I understand that you are focused on the loan balances as a potential factor in earnings. Loan balances have decreased. Is that what you're specifically asking about?

Ben Gerlinger, Analyst

Loan balances and net income in general show a significant gap, even when considering the provision for Heartland on an annualized basis.

Mariner Kemper, CEO

I believe that when discussing the pro forma, what we initially anticipated is largely still in place regarding the capital levels and other factors. The loan balances will initially hinder our pro forma expectations. It's challenging to predict what we can achieve moving forward, as it's too early to determine our future capabilities in that regard. Our legacy machine is quite strong. While we expect that prospects and customers may slow their growth rate in anticipation of a conversion, we aim to compensate for that by leveraging our sales force in both their and our markets. We can't make definitive predictions until we fully assess the situation as the year progresses, but our hope is to make up for some, if not all, of that shortfall. Additionally, we mentioned from the beginning that we anticipate seeing a boost in 2026, not in 2025. Therefore, our expectation is that, on a combined basis, we will be operating at full capacity in 2026.

Ben Gerlinger, Analyst

Got you. Okay. That is helpful. When considering the credit, a significant portion of the cost savings will come from the conversion later this year. You mentioned that by 2026, we should really start to see the pro forma numbers improve. Regarding the credit experience they've had, you noted that some issues were expected, but I'm assuming the rest of the loan portfolio underwent the same thorough assessment. Should we anticipate some integration challenges related to charge-offs once we achieve the pro forma status on Friday?

Mariner Kemper, CEO

Well, here's what I would say about that. We conducted thorough due diligence, which we communicated to the market. What happened in the third and fourth quarters was all captured through their current process and our diligence efforts. Everything was identified, and that's reflected in what you're seeing. Regarding what's left unaddressed, they had to handle that independently, using their own accountants. They were operating their own system, adhering to their protocols and policies for reserving against potential losses. To the best of our knowledge, they have made reserves for everything they've identified, in collaboration with their regulators and accountants, following their established procedures. Theoretical reserves have been made for all identified issues. That's the best information I can provide until it's under our oversight. Again, we are managing separate companies, and they are following their own processes. Based on what we understand, they have taken the necessary actions.

Ben Gerlinger, Analyst

Got you. That's really helpful color, Mariner. I appreciate it. Congrats on the 4Q.

Mariner Kemper, CEO

Yeah. Thank you.

Nathan Race, Analyst

Hey, everyone. Good morning. Thanks for taking the questions. Just going back to the loan growth discussion, I appreciate that it seems like you guys were able to get in front of some of the problem credits that maybe don't fit your credit box ahead of the deal closing later this week. And so, just curious with maybe less intentional runoff of the HTLF post-closing, if you think kind of the addition of HTLF is accretive or maybe just neutral to the overall kind of company's loan growth outlook going forward? I mean this year, you guys put up 8% loan growth, and historically, it's been at least in the high-single-digit range. So, just curious any thoughts on kind of the combined loan growth capacity of the combined entity going forward?

Mariner Kemper, CEO

I would refer back to a previous comment about our expectations for 2025. We anticipate that Heartland's contribution to overall loan growth will decline compared to the rates seen in the past couple of years, mainly because their clients will be awaiting a conversion. While we cannot predict the extent of this slowdown, we do expect it. However, we believe our performance will remain strong, as we have demonstrated sustained near double-digit loan growth each quarter and year for the past 21 years, and we do not foresee any changes in this trend. It is possible that we may compensate for the expected slowdown in Heartland's growth using our capabilities, although we cannot guarantee this. Overall, we expect that after the integration and conversion process, we will have a well-functioning operation that will start to deliver results more comprehensively in 2026.

Nathan Race, Analyst

Got it. That's helpful. And just going back to expenses, Ram, I think you alluded to like $250 million is kind of the core legacy run rate come out of the fourth quarter. Heartland has been running around $110 million. So, if you get two-thirds of an impact from Heartland in 1Q, is it fair to assume combined kind of core expenses are in that kind of $320 million to $330 million range for 1Q?

Ram Shankar, CFO

Generally, doing the math right there, Nate, yeah, I would expect. Again, some of the cost savings are coming in gradually. So, when we made the announcement, we still felt optimistic about it. We're projecting to realize 27.5% of their cost savings over time, with 40% expected in the first year, the year 2025. So, obviously, we're still navigating through that with the various work streams, but generally, you're thinking about it correctly.

Nathan Race, Analyst

Okay. Great. And is the expectation still that you'll be able to get 40% of the targeted cost saves completed by the end of this year? Or are you guys maybe tracking ahead of expectations on some of those fronts?

Ram Shankar, CFO

At this point, we feel good with what we announced.

Mariner Kemper, CEO

It's early. We still got to execute, right, but that's still our expectation.

Chris McGratty, Analyst

Great. Thanks. Good morning.

Ram Shankar, CFO

Good morning, Chris.

Chris McGratty, Analyst

Mariner or Ram, the UMB balance sheet is coming in bigger. You've talked about the smaller Heartland balance sheet, but you also mentioned because Heartland is coming in, they're coming in with more capital. How are you thinking about uses of capital once you get through the conversion beyond loan growth that you talked about? Is there a scenario where at close, you would look at your own bond portfolio like other banks have done because you've got the capital and maybe into '25, '26, is there a thought on a buyback?

Mariner Kemper, CEO

There are many possibilities ahead. In a year or two, while we are very conservative, we are comfortable with our current capital levels but aim to return them to where we are today. We have about a year to rebuild that capital. If we continue to perform well, we will generate capital consistently, allowing us to consider various options. Over the next year, our focus will be on regenerating that capital.

Ram Shankar, CFO

Yeah. And then, the only other thing I would add to your question is, we've evaluated bond portfolio restructurings and we're very comfortable with what we own, including what we're going to acquire from Heartland after we sell the bonds that we had originally targeted. So, I don't see a lot of opportunity, especially given our capital levels to take a loss on something and deplete our capital even more. So, don't see a whole lot of opportunity doing a balance sheet repositioning there.

Chris McGratty, Analyst

Okay. And if I could...

Mariner Kemper, CEO

Our perspective on repositionings, just it's us, okay, us talking is that, you're fixing a problem when you do it and we don't have any problems to fix.

Jon Arfstrom, Analyst

Hey, thanks. Good morning.

Ram Shankar, CFO

Good morning, Jon.

Jon Arfstrom, Analyst

Great. Mariner, what are you focused on initially with Heartland? I mean, it's obviously closing very soon, but what are the first couple of things that you want to get accomplished early?

Mariner Kemper, CEO

That's a great question. I would say culture is at the very top of our priorities. We want to assimilate the teams, ensuring they feel welcome and comfortable while learning our processes and procedures. A core foundational element of UMB is risk management, and we want them to understand our approach to risk so they can integrate smoothly and maintain that profile. Bringing families together, sharing meals, and ensuring everyone is aligned is probably the most important step. After that, we'll assess talent for growth and ensure we build our pipeline to add talent and enhance our growth profile. We are particularly excited about our retail expansion, as we are doubling our footprint, branch network, and deposit levels. Liz Lewis oversees that initiative, and we will work on optimizing the branch network, filling out markets where we have a strong presence. Key areas include Arizona, Kansas City, and Denver, where we aim to enhance our retail capabilities. We'll also maintain our investment in New Mexico, a key market for us. Additionally, we’re exploring opportunities in places like California's Central Valley, which has a population of 10 million, as well as in Minneapolis and Milwaukee. There are great potential markets near Chicago, such as Rockford, where we already have a branch network and can build further. Overall, the opportunities are extensive, and it's crucial for us to stay focused. My team will make sure I remain on track, given the vast potential ahead, and I've prioritized our initial focus areas.

Jon Arfstrom, Analyst

Okay. How long do you think it will take to integrate your lending process or lending engines into the Heartland footprint?

Mariner Kemper, CEO

We're really excited about this development. What I'm particularly enthusiastic about is how our risk profile connects with our ability to implement strategies and continue growing our business. We have a solid foundation, which allows us to deploy our regional credit officer model in the new areas. At UMB, our regional credit officers, who have been with us for over 20 years and understand our processes, have been given the authority to manage various aspects in their regions. As we integrate Heartland into our operations, we've identified individuals who fit that same profile, providing them career development opportunities. We've selected several regional credit officers to manage these new regions right away. For instance, one person currently in Kansas City will be relocating to Madison to become our Regional Credit Officer for the Upper Midwest. I'm genuinely excited about this because I believe it will guide our approach. When asked how long this will take, I'd say it will happen immediately. I anticipate that our ability to oversee operations in our manner will be swift, and while I don't yet know how loan growth will materialize, we do expect it to come as we put in the necessary effort.

Ram Shankar, CFO

I would say, as we mentioned, pro forma, we expect to be sensitive to liabilities on our standalone operations. Heartland was mainly asset-sensitive until they ended some of their hedges they discussed in the fourth quarter release. They are now slightly less asset-sensitive. When you combine the two balance sheets, we are pretty neutral. I'll return to my earlier point; this is actually a favorable rate environment. We have a higher and steeper curve with reinvestment rates significantly greater than what is rolling off. New loan yields are beneficial to our current position. Therefore, we feel optimistic about the implications for our margin outlook and net interest income.

Jon Arfstrom, Analyst

Okay. And then, Ram, just a quick one, a follow-up on Chris McGratty's question on Slide 32. On the right side, what's the message you want us to take away from that? It seems like most of the loans have repriced and you're protecting against further cuts. Is that what you want us to take away from that or am I misreading that? Thanks.

Ram Shankar, CFO

So, in the first part, we're describing our variable rate book. When you look at our earning assets and liabilities, we are well matched in terms of the percentage of variable earning assets compared to the percentage of variable indexed deposits. There’s a strong correlation there, which is why we maintain a neutral position regarding interest rates. Currently, the rate environment is very favorable for us. On the other hand, we have historically adopted a conservative approach to safeguard against falling rates. Over the past 18 months, we've implemented $3 billion of notional synthetic hedges to protect us from declining rates. My earlier point was that even if there are no rate cuts, these hedges won't significantly impact our net interest income and net interest margin because as some of these hedges mature, their benefits begin to materialize. Some of these hedges are already profitable due to recent movements in SOFR. If additional rate cuts occur, there could be some modest upside. These hedges have terms of four to five years, providing us with a long-term safeguard against falling interest rates. That's the essence of my message, and I hope it clarifies what you were asking.

Kay Gregory, Moderator

Thank you, everyone, for joining us today. We appreciate your time and your interest. If you have follow-up questions, you can reach us at 816-860-7106. Thanks, and have a great day.

Operator, Operator

That concludes today's call. Thank you all for your participation. You may now disconnect your line.