UMB Financial Corporation

Hello, everyone, and welcome to the UMB Financial Fourth Quarter 2022 Financial Results Call. My name is Daisy, and I'll be coordinating your call today. If you would like to register a question, please press star followed by one on your telephone keypad. I would now like to hand the call over to your host, Kay Gregory, with Investor Relations to begin. So, Kay, please go ahead.

Good morning, and welcome to our fourth quarter and year-end 2022 call. Mariner Kemper, President and CEO, and Ron Chalker, CFO, will share a few comments about our results. Jim Rhine, 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.

Thank you, Kay, and Happy New Year, everyone. Thanks for joining us today. I'll make some brief comments about our quarter in 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, from our differentiated fee income sources. Net income for the fourth quarter was $100.2 million, or $2.06 per share. For the full year of 2022, net income was $431.7 million, or $8.86 per share, an increase of 22.3% compared to 2021. Operating pre-tax, pre-provisioned 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. This was 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-to-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. during this cycle is generally in line with our internal expectations and consistent with what we've been talking about 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. And we benefit on the asset side as well, with a cycle-to-date beta of 53% on loan yields. 60% of our loans repriced 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 for the opportunities we see in 2023 and beyond. Updates on our various lines of business are included in our slides, and Ron 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, remains 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 fear banks have seen some slowdown in the sale and 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. CNI 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 a 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. Net charge-offs were just four basis points of average loans for the fourth quarter and 21 basis points for the full year. Non-performing assets comprise a modest five 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 of the quarter increased 5.3% or 21% on an annualized basis compared to the third quarter. Our deposit initiatives and 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 good pipelines, and many are reporting that supply chain issues have mitigated somewhat. However, caution remains as finding talent to support growth may be a head end. As I mentioned, we see good growth opportunities in the first quarter, and although 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 continues to perform well, and we're off and running as we start the 2023 year, with the goal to maintain positive operating leverage regardless of the health and direction of the economy. Now I'll turn it over to Ram with some additional comments. Ram?

Thanks, Mariner. Let me start with some commentary on balance sheet trends with our liquidity profile shown on slide 20. Our Fed account, reverse repo, and cash balances rebounded slightly to $1.8 billion and now comprise 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 campaign as well as seasonal inflow of public funds deposits. Cash flows from our securities portfolio continue 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 link 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 seven basis points from 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 seven basis points from reduced liquidity balances and rate. 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 Fed's tightening cycle, outlook for equity markets, and that 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 own simulations, we expect our first quarter net interest margin to be flat to slightly up from fourth quarter levels. Additionally, we stand to benefit when the Fed pauses as the pressures on our index deposit book abate and asset yields benefit from the current repricing environment and rotation from investment securities. As Mariner noted, while the focus on deposit betas and NIMs 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 pace 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 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. Colby income, which was just $21,000 in the fourth quarter versus $2.3 million in the third quarter, had a similar offset in deferred compensation expense. For the full year 2022, the 18.6% increase And fee income included investment security gains and losses driven largely by the 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 12B1 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 security 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 wholly income with a similar decrease in deferred compensation expense. Slide 22 shows trends in non-interest expense. The 2.8% link order increase was primarily driven by an increase of $2.6 million in processing 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 expense. Additionally, as I mentioned last quarter, our amortization expense increased related to the acquisition of HSA deposits completed in the fourth quarter. A few items to note for the expense levels going forward. As is typical, fourth quarter expenses included several timing-related variances along with some non-recurring items. Considering those variances, we would put our quarterly starting point closer to the $225 to $247 million range. Also, keep in mind that first quarter expenses are typically higher due to seasonal reset of payroll, taxes, and other benefits expenses. The acquisition of HSA deposits approximately $4.5 million of additional amortization expense annually. And as previously mentioned, the increase in FDIC assessment rates takes effect in the first quarter. As a reminder, we estimate to still have an approximate annual impact of $6 million free tax. As Mariner noted, our focus remains on generating positive operating leverage while crudely 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 COLE evaluations. 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.

Thank you. As a reminder, if anyone would like to register a question, please press star followed by one on your telephone keypad. If you would like to withdraw your question, please star followed by two. When preparing to ask your question, please ensure you are unmuted locally. So that's star followed by one on your telephone keypad. Our first question today comes from Jared Shaw from Wells Fargo. Jared, please go ahead, your line is open.

Hi, this is John Rowan for Jared Shaw. I guess just 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?

John, uh, thanks for the question. This is Mariner. I would, you know, for us, for those of you who followed us for a while, you know, we really don't do anything different in any type of environment. We, so we stick to our knitting and, um, look for the good quality opportunities and, uh, we don't reach during the good times and we don't retract during the tougher times. So we're kind of just stick to what we know and stick to doing it how we do it. And, um, So that's the backdrop for how we're making decisions. As it relates to kind of what we're hearing and seeing on the ground, customers and prospects are still talking cautiously, optimistically about the environment for the year. Revenue projections and conversations seem to still be pretty steady. I think the challenge that we hear from our customers really is about the hiring environment. But as it relates to you know, selling goods and moving goods. Everybody seems to be cautiously optimistic about that. And we, as we normally do, we give you a little look into what we see for the first quarter and pipeline remains strong for the first quarter.

Okay, great. Thanks. That's a 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 your competitive position, I guess, in that market with some pretty large players kind of dominating at this point?

Hi, this is Jim Ryan. We did close the conversion, went extremely well. We picked up, they have a very successful direct-to-employer model, and that has been our strategy moving forward. 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, and this will allow us to deliver a better experience throughout our footprint. With what the competitors are doing, we're truly more focused on us, 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. We feel very good about our position going forward, and we're in this space to stay, and we're excited about it.

The only thing I'd add is the technology platform and the backdrop for the business is really using the rails we have already for all of our other businesses. So it's a very leverageable business. And being a big commercial bank, largely that's being largely what we do, 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.

Okay, great. Thank you for answering my questions. Thank you.

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

Oh, great morning. 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 this, the total deposits at the company struck about 8% this year. How do I, I guess, how should we think about just the pace of incremental runoff? Because it feels like you've got, you know, roughly a billion dollars of cash flow coming off the bond book to fund loan growth. I'm just trying to get a sense of the moving pieces here.

Yeah, Chris is Mariner. A couple of high-level comments, and if there's more detail you want, Ram can add some color. But I think really what I would focus on, we don't really expect runoff. We expect rotation. and uh so it's really more about what happens to demand deposits we have a very very strong pipeline and ability to grow deposits so we can bring deposits on at market rates and and fund growth no problem so really really the challenge for us which we think we're good at is being disciplined at pricing the assets so as we bring on loan growth um kind of as we just as we discussed last quarter our ability to be disciplined on maintaining and slightly growing margin is more important than what the absolute costs of the deposits are 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.

The only thing I would add, Chris, to that is, as we said, our loan-to-deposit ratio is now 65%. If you look 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 of what we see on the loan growth? Probably not, but that's where the billion dollars of securities that you talked about in terms of outflows comes in. And as Mariner said, we're focused on making sure we stay liquid on the balance sheet with customer acquisitions.

That's really great. Thanks, Ram and Mariner. On the mix of your deposits, I'm looking back, you know, pre-COVID, you were kind of in the mid-30s, not interspersing. You got as high as 46. You're kind of low 40s. Now, I guess, how do I, how are you thinking about just internal migration, given the competitive alternatives for rates today?

Yeah, so I think, you know, that's the million-dollar question, Chris. And when you get the answer, give us a call so we can, you know, so we can plan. But I think, you know, the conservative way to think about it, right, is, We got down to 32 last time. Could it get to 35 or something this time? Probably, maybe, based on just history, that's possible. However, there are a lot of other things going on from the growth of our customer base in general. You know, we've added a lot of small business customers that have a low loan to deposit ratio over the last few years. You know, we've got a lot of other initiatives and customer bases. Our aviation corporate trust business is relatively new, and those demand-deposit balances have been growing. So, you know, last cycle we got down to 32. Does history repeat itself? Is the world different? Is our customer base different? You know, we're not sure exactly 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, because we already saw a lot of that last year, is has it already happened, right? So that's one of the questions that we debate internally is has that shift taken place? Has everybody who wants to move to higher interest-bearing deposits already taken that action? We don't really know the answer to that. So those are some of the internal debates. But to be conservative, you know, think about last year. you know, think about the last cycle, I suppose.

That's helpful. I really appreciate it. The last one I would have is just kind of zooming out, right? If I think about the bullish comments on loan growth, called stable comments on margins, 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 a lot of your peers are seeing margins and revenues top out. I guess, would you agree or offer any thoughts on that?

We expect to see net interest income continue to grow because we're a growth company. Like I said earlier, two things we focus on would be net interest income growth based on just growth period as well as growth of the balance sheet. And then the other thing we think we can do during this environment is 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. And then on the other side, because we have a long track record of building pipeline, we think we'll continue to grow. We've been doing double-digit loan growth since 2015. And there's nothing about our business model that would suggest that we can't continue to do that. We have new markets, great new markets we've expanded into. Utah, Minneapolis, Texas are three young markets for us that we have fabulous track records in and great people on the ground. And we're seeing really good traction there. And along with all of our other great markets, we see the same great opportunities and traction there. And remember, we don't project or predict our loan growth based on what's happening to GDP anyway. Our loan growth is based on market share gains. So depending on regardless of what's going on economically, we think we can continue to deliver the same kind of loan growth that we've been delivering.

Great. Thank you very much.

Thanks, Chris.

Thank you.

Thank you. As a reminder, if anyone would like to register a question, please press star followed by one on your telephone keypad now. Our next question today comes from Nathan Race from Piper Sandler. Nathan, please go ahead. Your line is open.

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

Morning, Nathan.

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

Yeah. Yeah, Nate, this is Ron. Yeah, definitely we see some opportunity for margin expansion if the Fed does pause and hold, right? So 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. So when you think about what happened last cycle, the same thing repeated itself where Our margin did expand when the Fed paused.

Okay, great.

And some of the margin expansion benefit also comes from the rotation that we talked about from, you know, if you look at the next 12 months cash flows from the securities book, that has a 2% exit yield, and obviously our loan pricing is much better than that, and we pick up yield on that.

Gotcha. within that context you guys have the spot rate on deposits you know at the end of the quarter um if you can exclude or isolate the index deposits uh we don't disclose that nate we don't get into that kind of the details okay fair enough and changing gears rama i think in your prepared comments you mentioned um a starting point for expenses in the 245 to 240 range for the fourth quarter did i correctly 225 to 227. Okay. Great. And within that guidance, I mean, as you guys kind of think about some additional modernization initiatives that you guys are outlining on the core system side of things or otherwise, how does that kind of factor into just kind of overall expense growth for this year, you know, in light of the, you know, inflationary environment that we're seeing for, you know,

wages and so forth these days so i mean high level i mean so the the run rate that ron's talking about is inclusive of of whatever spending we're doing to modernize investment business it's all in there in that in that step off that he's referring to yeah the step on the 227 that i talked about obviously there's inflation on top of that new contracts are coming out we are making some

selective investments in people or in technology. And then, as they said in the first quarter, we'll have the reset of payroll taxes and other benefits expense, and then there's obviously a couple of less salary days. So I would expect the trajectory from the 227 for the first quarter to go up just because of the pressure from primarily seasonal increase in expenses.

Yeah. Mm-hmm. Cool. and as you guys look at you know kind of criticize classified trends across portfolio obviously you know non-performers are pretty negligible amount as the end of the year um are you seeing anything across portfolios and you're in discussions with clients that would perhaps cause you guys to come in kind of below your historical charge off uh guidance i think you guys have spoken to around the you know 25 to 35 uh uh uh basically historically

Are you, when you say below, do you mean more losses or do you mean better, better performance? I might ask that question, which way you're asking the question.

I would just, I would think that, you know, perhaps charge offs this year can come in below or better than, you know, that historical kind of talked about.

Well, I guess I would suggest, you know, that, you know, we would, As has been referenced on the call already, it's a softer environment. I mean, I wouldn't suggest us to, you know, we're going to do a lot better or anything because for any reason. I mean, we expect that we can continue to perform the way we have been performing. Don't see anything that on the horizon 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.

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

Thank you. This is all the questions we have today, so I'll now hand back over to the management team for any closing remarks.

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 816-825-8000. 860-7106. Thank you and have a great day.

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