UMB Financial Q4 2023 Earnings Call Transcript

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January 31, 2024

There are 8 speakers on the call.

Operator

Hello all, and welcome to UMB Financial's 4th Quarter and Full Year 2023 Financial Results Call. My name is Lydia, and I'll be your operator today. I'll now hand you over to Kay Gregory with Investor Relations to begin. Please go ahead.

Speaker 1

Good morning, and welcome to our Q4 2023 call. Mariner Kemper, President and CEO and Ram Shankar, CFO, will share a few comments about our results. Jim Rime, CEO of UMB Bank and Tom Terry, Chief Credit Officer will also be available for the question and answer session. 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 45 of our presentation.

Speaker 1

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, And unless otherwise indicated, comparisons are versus Q3 2023. Net operating income discussed here and in our slides excludes the FDIC special assessment and certain other expenses and is reconciled in our press release and slide deck. Presentation materials are available online at investorrelations.umb.com.

Speaker 1

Now I'll turn the call over to Mariner Kemper.

Speaker 2

Thank you, Kay, and good morning. Before I get started, I got to talk about some very important business by congratulating our hometown heroes, the Kansas City Chiefs, We're yet again headed to the Super Bowl in a couple of weeks. Now I'd like to discuss our Q4 and full year performance for 2023, A year that played out very differently from what we were expecting and I think the rest of you are expecting last year. During a particularly challenging period for the banking industry, UMB delivered strong results, demonstrating the power and resilience of our diversified business model. We closed out the year with a solid Q4.

Speaker 2

I'll review a few highlights and then Ram will add more detail in the Financial and Driver section. As you know, most banks recognize the expense for the FDIC special assessment in the Q4. Our share of the assessment was $52,800,000 an impact of about $1.08 per share pretax to net income. We presented our financial metrics both on a GAAP basis and adjusted to exclude this charge. For the full year of 2023, net income was $350,000,000 or $7.18 a share.

Speaker 2

On an adjusted basis, net operating income was $397,100,000 or $8.14 per share. For the Q4, we earned $70,900,000 or $1.45 a share. However, as adjusted, Net operating income was $112,000,000 or $2.29 per share, representing an increase of 13.9% compared to the Q3 of 2023 and 10.8% compared to the 4th quarter a year ago. Our results reflected strong loan growth and deposit growth, expanding net interest margin and net interest income, solid fee income growth and exceptional asset quality. Average loan balances increased 6.3% on an annualized basis from the 3rd quarter to $23,100,000,000 For comparison, banks between $10,000,000,000 $100,000,000,000 in assets that had reported results so far have shown an annualized increase of 3.6%.

Speaker 2

We posted strong top line production, 40% above 3rd quarter and in line with our levels in recent quarters. Construction and commercial real estate drove most of our loan growth in the 4th quarter with continued draws on previously approved construction loans. Payoff levels increased to 4.4 percent of loans impacting C and I balances. CRE growth has been largely In Multifamily and Industrial Projects, once again, we've included more detail on the portfolio in our slides showing the mix of loans by type and geography along with LTVs and other metrics. Asset quality in the book remains strong.

Speaker 2

We adhere to conservative standards, which includes Underwriting to imputed or stressed interest rates and moderate loan to value ratios. We don't use trended rents We have very strong liquid sponsors with great cash flow. 90% of our investment CRE portfolio is recourced. Speaking of asset quality, we reported excellent metrics with improvements across the board. Nonperforming loan levels improved again to 6 basis points, delinquency levels declined and we saw an 11% decrease in classified loans.

Speaker 2

Net charge offs were 2 basis points of average loans for the quarter and just five basis points for the full year of 2023. Again, we outperformed peer banks, which have reported a median net charge off rate for the 4th quarter of 15 basis points so far. On Slide 26, we included a longer term history of charge offs, which has averaged just 28 basis points over the last 20 years. In 2023, we experienced a 16 basis point reduction in our annual charge off rate compared to 2022, reflecting the active management of our portfolio. I'm pleased with this result, especially given the environment and cautious narrative we're hearing across the industry.

Speaker 2

Again, we compare favorably to peer banks, which have reported a median 6 basis point increase and net charge off levels year over year. Moving to deposits. Average balances increased 17.2% on an annualized basis from the 3rd quarter. This growth was led by commercial customers, including 11% annualized increase in commercial DDA balances. We are seeing traction from our efforts to bring clients Total banking relationships to UMB.

Speaker 2

Peer so far have seen average annualized deposit growth of just 2.5% thus far in the quarter. Net interest income increased 3.7% as margin improved 3 basis points sequentially. From industry reports so far, Our NIM expansion compares favorably with peers reporting a median decline of 4 basis points. We continue to deploy cash flows from the securities into loans and the pace of increased funding costs has slowed each of the past two quarters. Ram will share more detail and drivers on our margin outlook for 2024.

Speaker 2

Non interest income for the Q4 was $148,300,000 representing 38% of revenue, more than 2 times the 17% median reported by peers. Our fee businesses continue to build scale and we're seeing momentum in several areas. A few highlights include fund services where assets under administration have eclipsed $411,000,000,000 a $48,000,000,000 improvement over 2022 levels. And in our custody business, we have had a 27% increase in net new accounts this year. Our fixed income and trading team saw increased activity as that the Fed has finished raising rates and has provided a little more clarity and brought some participants back into the market.

Speaker 2

We've shared additional detail on our fee income businesses and the revenue that provided by them in our slides, and Ram will add more detail when he speaks. Total revenue for the Q4 increased 4.3% from a linked quarter basis. We posted positive operating leverage of 1.3% on a linked quarter basis and 0.3% in the year over year quarter. As seen on Slide 31, our capital position improved during the 4th quarter with a 17 basis point increase in both CET1 and total capital ratios, which stood at 10.94% and 12.85%, respectively. Our earnings continue to support our capital position in spite of the impact of the FDIC special assessment.

Speaker 2

Finally, we saw increased profitability ratios with operating ROTCE of 16.62% versus 14.96% in the 3rd quarter. Tangible book value improved nearly 12% from September 30 to $58.12 per share. Peer banks so far have reported a median tangible book value increase of 6.9% in the quarter. Overall, We had a very solid quarter, especially given the challenging year we all had. Before I turn it over to Ram, I'd like to share a few thoughts on the events of last spring that ultimately led to the FDIC's special assessment we recognized in the Q4.

Speaker 2

It has become very clear that the underlying cause of the 2023 bank failures With interest rate mismatch, primarily on the asset side, a few banks were ill positioned and poorly managed for the interest rate environment we found ourselves in, with a largely fixed asset base that lacked flexibility. One lesson learned during that time was the power of various market participants to fuel a largely media based crisis in circus. As the panic spread across media outlets, The risk of a self fulfilling prophecy became real. Our reputation with our clients and in our market is something we have earned and cherished over 110 years of history. It was extremely frustrating for us to watch these industry observers pontificate Based on a lack of understanding of how the industry works and continue to focus on the wrong symptoms like unadjusted, uninsured deposits or AOCI.

Speaker 2

This was a classic case of facts getting in the way of a good narrative. As I've said before, thank you To you, the analysts and the investors on the call with us today, who took the time and care to understand the somatic of what transpired in the spring. Year end reports have confirmed what we already knew to be true. The fundamentals in this industry remain steady. The demise of regional banks didn't happen as predicted and banks like ours that were well prepared have not only weathered the storm, but emerged stronger and with positive results.

Speaker 2

The resiliency of the banking industry has been evident and on display in recent months and the liquidity, regulatory capital levels, loan portfolio asset quality and funding sources remain strong. In closing, I'm incredibly proud of our UMB associates that drove this performance and I'm deeply grateful to our loyal client base that grew with us through this much exaggerated industry noise in 2023. It was extremely rewarding to see how our company and customers came together support each other. As always, we run our company with a strong focus on both the short term and the long term performance through every stage and every economic cycle, and we feel good about our strategy. Looking ahead into 2024, we see a muted but resilient macro environment and we remain well positioned for any environment with an attractive loan to deposit level, strong capital ratios and high quality loan portfolio.

Speaker 2

With that, I'll turn it over to Ram to give you more details on our results. Ram?

Speaker 3

Thanks, Mariner. Net interest income increased $8,200,000 in the 4th quarter to $230,500,000 driven primarily by loan growth and repricing along with higher levels of liquidity. Net interest margin was 2.46%, an increase of 3 basis points from the linked quarter. Loan repricing and mix provided a 9 basis point benefit. Other positives included 3 basis points from the benefit of free funds and liquidity levels, including stable levels of DDA balances, 2 basis points from the securities portfolio and one basis point from changes in borrowing levels.

Speaker 3

These benefits were partially offset by higher deposit costs. Cycle to date, our earning asset beta has been tracking along with our total cost of funds beta both now at 53%. Average deposits increased 17.2% annualized from the 3rd quarter benefiting from the ongoing deposit gathering initiatives across all our lines of businesses. The typical seasonal increase in public fund balances during the month of December added $157,000,000 in average deposits for the quarter. These increases were partially offset by the intentional reduction in brokered CD balances.

Speaker 3

Excluding those brokered deposits, Average deposits increased 22% annualized from the prior quarter. Additionally, corporate trust deposits tend to be a little bit lumpy as clients build up cash and make payments throughout the year. As the 3rd largest municipal trustee in the U. S, Balances will ebb and flow driven by municipal bond distributions and other activity. I'll note that on an end of period basis, Corporate Trust deposits increased pointing to the timing differences throughout the quarter in our escrow, specialty trust and paying agent businesses.

Speaker 3

Our deposit remix continued at its slower pace this quarter. DDA balances increased 1% from the 3rd quarter and now represent 31% of total average deposits providing the benefit to margin I noted. Cycle to date betas on total deposits and on loan yields are 48% 59% respectively. This is on track with our previously discussed expectations for terminal betas of approximately 50% for deposits and 60% for loans. Looking ahead into the Q1, we expect our loan yields will continue to benefit from the flexibility we built into our balance sheet through repricing as loans come up for renewal and from higher yields on new origination.

Speaker 3

Overall, we Our loan yields to meet or exceed the increases in cost of funds. Additionally, we have approximately $1,600,000,000 in cash flows from our securities portfolio Rolling off at 2.2% that will be reinvested in higher yielding loans or securities. In the 4th quarter, We began legging back in with some modest repurchases of mortgage backed and treasury securities. We will continue to assess based on collateral needs, loan growth and overall market conditions. As liquidity and public fund balances seasonally dissipate and given one less day in the Q1, We expect net interest income and margin to compress modestly from 4th quarter levels.

Speaker 3

Actual performance will be driven by material shifts in funding mix, especially DDA balances and the shape of the curve. Details and activities in our securities portfolio are shown on Slides 2728. The combined AFS and held to maturity portfolios averaged $12,100,000,000 during the quarter, a decline of 1.5% from the 3rd quarter. The average roll off yield was 2.38 percent for the quarter. The new purchases of $154,000,000 shown on the table Excluded $500,000,000 of short term T bills purchased at 5.39% as additional collateral for public funds deposit.

Speaker 3

Excluding those treasuries, we expect $1,600,000,000 of securities with a yield of $223,000,000 to roll off over the next 12 months. The unrealized loss position in our combined securities book improved this quarter to $1,100,000,000 representing approximately 8.5 percent of the total portfolio, down from 14% in the 3rd quarter. Back to the income statement, Our provision expense of 0 this quarter was the result of the impact of payoffs on net loan growth, the quality of our portfolio, including the low level of net charge offs and macroeconomic variables that seem to expect a softer landing. As we look into the Q1, we expect provision to be impacted by a small acquisition of a co brand credit card portfolio expected to close in March, which will add approximately $125,000,000 in balances with a day 1 provision of roughly $6,000,000 an ongoing provision based on portfolio performance, growth and macroeconomic variables. This acquisition will also add approximately $10,000,000 in net interest income, dollars 2,000,000 in interchange fees and a breakeven pretax pre provision in the 1st year excluding conversion and integration costs.

Speaker 3

On the fee income side, reported results included some market related variances including increases of $3,700,000 in company owned life insurance income and $567,000 in customer related derivative income. Trading and Investment Banking income increased $2,000,000 primarily related to municipal trading volume. The detailed drivers of non interest expense are shown in our slides and press release And on a GAAP basis included the recognition of the $52,800,000 FDIC special assessment. On an operating basis, expenses increased $6,900,000 or 3% from the 3rd quarter to $235,900,000 Detailed variances are included on Slide 22, but the largest impacts were $3,100,000 in deferred compensation expense, an increase of $2,700,000 from the prior quarter. This is the offset to the increased COLI income, dollars 2,300,000 related to the pre buy of computers in the 4th quarter and $1,500,000 in additional charitable contributions.

Speaker 3

Partial offsets included a $1,600,000 decrease in payroll taxes, insurance and 401 expense and a $467,000 reduction in bonus and commissions expense. Excluding the one time items and timing related variances, Our core expense run rate in the Q4 was approximately $230,000,000 Please note that in addition to the impact of the Co brand card portfolio acquisition, 1st quarter salary and benefits expense will increase with the impact of the extra leap year day and for the typical seasonal reset of FICA and payroll taxes. Our effective tax rate was 17% for the full year 2023 compared to 18.9% in 2022. The decrease rate was driven primarily by a larger portion of income from tax exempt securities and variations in levels of COLI income. For 2024, we would expect a similar tax rate ranging from 17% to 19%.

Speaker 3

That concludes our prepared remarks, and I'll now turn it back over to the operator to begin the Q and A portion of the call.

Operator

Thank you. Our first question comes from Chris McGratty of KBW. Please go ahead.

Speaker 4

Hi, this is Nick Metopik is on for Chris.

Speaker 5

Hey, good morning, Nick.

Speaker 2

Hey, there.

Speaker 4

Hi. Maybe just to start out on the margin, given the potential for I think rate cuts coming later in this year in 2024, can we see the margin continue to expand into 'twenty four with more back book repricing and continued mix shift?

Speaker 3

Sure, Nick. This is Ram. We don't give any forward guidance other than what

Speaker 6

I said in my prepared comments about There might be some modest compression in the Q1 because of the excess liquidity that we saw in the Q4 going away. But as we've said in the past calls, right, the higher for longer scenario is a good scenario for us because as you've seen in the last couple of quarters, The pressure on deposit costs have largely abated for us. And then our loan yields are still repricing higher. So loan yields will at least do better than cost of funds for us. And then there's the $1,600,000,000 of securities that are rolling off at 2.2 saying that we can invest in the current rate environment.

Speaker 6

So I think we're close to the trough on margin. Any particular quarter, it might Have been flow a little bit a few basis points here and there, but feel good about our margin trajectory until the pit starts cutting at some point in 2024.

Speaker 2

And some of the nuance one way or the other, the strength of what happens to our demand deposits also hangs in the balance.

Speaker 4

Great. Thank you. And maybe also depends on the revenue outlook, I guess a little bit, but could we see positive operating leverage in 2024 depending on the expense growth?

Speaker 2

Well, I think the we remain focused on operating leverage. And again, based On the guidance question, we don't really give guidance. What I would say is that the environment that we come into 2024 with from 2023 remains from a standpoint of elevated interest expense and the interest rate environment. And because of that, demonstrating absolute strength on the Operating leverage remains challenging. We'll continue to do everything we can and work against it.

Speaker 2

We believe on a relative basis that will outperform on operating leverage.

Speaker 4

Great. Thank you for taking my questions.

Speaker 3

Thanks, Dick.

Operator

We have a question from Nathan Race of Piper Sandler. Please go ahead. Your line is open.

Speaker 5

Yes. Hi, guys. Good morning and congrats on the win. Just a question on the NII sensitivity. I appreciate the disclosure in the deck around 100 basis point decline in rates is about a 3.1% impact to NII in year 2.

Speaker 5

Just curious how to what extent you think that can be offset by just the volume of kind of continued Margin accretive growth in both loans and deposits going forward and also with the cash flow you have coming off the securities portfolio as well?

Speaker 6

Yes. You hit the nail on the head there, Nate. That is a static analysis, as you know, right? So it's all on just cash flows coming in and being reinvested in a new environment. And so the net interest income projected in that baseline scenario of minus 100 And year 2 does not include the impact of any growth.

Speaker 6

And any actions we might take, right? You've seen us and you've seen our disclosures that we put on some swaps, Synthetic hedges as well. So we'll do additional we'll evaluate it on a periodic basis and put on additional hedges to protect ourselves from a downgraded environment. But That's just a statistical modeling of what would happen to our balance sheet of all things were kept the same on a static balance sheet basis. So we can take steps to mitigate it.

Speaker 6

And so that's another layer that we'll add on to it.

Speaker 2

And as you think about looking forward into 2024, we typically give you a 90 day look forward loan growth In the Q1, it looks stronger than it did in the Q4. So signs continue to be good.

Speaker 5

Okay, great. And then just within that context around kind of the NII trajectory and Deposit costs, I think you guys have about $2,500,000,000 in wholesale funding maturing in the first half of this year. How are you guys thinking about replacing the cash flow of securities book going to be one lever? And then, any other kind of thoughts on Just how we should think about those wholesale sources in the first half of

Speaker 3

the year? Yes. On Page 31, Yes. On Page 31, on

Speaker 6

the bottom right, we have all the wholesale funding. Obviously, as you can see, we have about $1,600,000,000 of brokered CDs. Given our deposit pipeline, which remains strong, we might not need all of it, right? So but there's a potential the way one market rates are at that point We may leg in for half of it or something less than that. The other one that's maturing that will mature in the second quarter is the $1,000,000,000 of club advances And then we have BTSB, which will extend into January.

Speaker 6

Again, we'll evaluate it based on collateral needs. We'll based it on where market rates are, we'll look for spread and all those things. But we don't need any of those tools really given our liquidity position and all over deposits, but we'll take it as the environment evolves.

Speaker 2

Yes. I think Ram's comment about The brokered CDs, we may we don't need them, but we may roll back into some of them just because by the time they come due, Rates will likely have come down and we can have positive arbitrage on them. So it might make sense to roll back into some of them just from a profitability standpoint.

Speaker 5

Okay, got it. Very helpful. Maybe just turning to credit, curious to hear perhaps from Tom in terms of What occurred in the quarter in terms of criticized classified trends and obviously charge offs have been very low over the last few quarters. And I think in the past, we've talked about a normalized charge off range in the 20 to 30 range. So just curious, just given where NPAs stand and based on the commentary on criticized trends, If you think we're going to get back to that historical range at some point this year or into 2025?

Speaker 2

Nate, that's my favorite question, because it's the thing that we're really most proud of. And I think that when you think, I think about this investor community and looking at your alternatives and the investment pieces looking into banks, the thing that you look at with us is, I'm sitting at the table right here with 2 other guys that have been making credit decisions with me for 20 years through all of the cycles that we've looked at and we've outperformed the peer group in all of those cycles. And when we talk about 27.8 basis points, we're just using math history. If you look at Page 26, You're just looking at our history. And one thing I would note about that in our investment deck is, well, yes, The average over 20 years is higher than the 2 basis points we have in the Q4.

Speaker 2

You have to recognize That comes with a lot of growth. So if you go back 20 years ago, the 1st year I was CEO, we had $2,700,000,000 and loans with 20 basis points of charge off. Today, we have $23,000,000,000 in loans with 2 basis points of charge off. So in the context of much greater opportunity for loss, we've maintained a very, very low charge off rate and that's because of consistency and continuity of approach. And We make this easy for you guys because you can look at the history.

Speaker 2

Most of the banks you look at have different teams and turnover and change and strategy change and acquisitions or whatever it is, you're staring at the same company with the same team with the same results. And what I would say about When you think about this year and wherever we end up, we will outperform. And if you look at the charge offs history over the last 20 years us against the peer. We have a chart the second the page before that shows that and it's in a different it's in We have a chart that shows us against peer group. And if you the point is, if you look at a recessionary period, Our line, our delta line stays very close to the bottom axis of the chart, while there's a sharp fin that takes place with the industry.

Speaker 2

So that's what happened in the last crisis. We expect that to happen. If you look at it through the Q4, you can see it already taking place. Our numbers don't move and the peer groups and the industry is starting to move up. We expect that to be the case Again, whatever the absolute numbers are, I can't tell you, but the relationship to the peer group and the industry, we expect to remain the same.

Speaker 5

Okay, great. Very helpful. And just one last one. It seems like a lot of the growth in Quarter came on the commercial real estate side of things. So just curious in terms of the composition of the pipeline entering 2024 and Where you guys are seeing pretty pronounced opportunities to grow loans today?

Speaker 2

Loan growth, we've been saying this for a really long time. We call it the we have a long runway for growth, both geographically, vertically across our footprint and our national footprint related to our ABL business, Largely because of market share gains. We expect that to remain the same. The caveat to that would be if we do have a softening economy, The rate at which we would grow on an absolute basis may come down from what our expectations are of ourselves. But on a relative basis, we would expect ourselves to continue to outperform on loan growth for the same reasons we always have for 20 years we've done that.

Speaker 2

And we expect that to continue again for the same very same reasons, which would be more market driven, then they are economic conditions driven. So nothing new there. The absolute number could come down a bit from what we did last year based on what economic conditions are. But again, you're buying on a relative basis, We would expect ourselves to outperform on a relative basis again.

Speaker 7

Mark, market Pacific, it's still coming from the major metros. Utah has been a nice growth market for us where we have low production office And that seems to continue to build, but we are seeing a strong traditional operating company C and I. And as Merer stated, it's market share driven.

Speaker 2

And Q1, as I said, looks stronger than Q4, if that's any indication, right? We have a harder time ourselves looking beyond the Q1, but first quarter If Q1 is an indication of the rest of the year, it's stronger than Q4, pipeline wise.

Speaker 5

Okay. Understood. Very helpful. And if I could just ask one last one. You guys see any change in credit ratings Across I think around 4% of loans that are tied to office CRE.

Speaker 2

I'm not sure I understand the credit rating question. What do you help me understand that?

Speaker 5

Risk rating, excuse me, Mariner.

Speaker 6

So We've seen it with negative migration

Speaker 5

and size classified risk rating, excuse me.

Speaker 7

Okay. Go ahead. Yes. We've had Very little if any deterioration in our office portfolio. It's remained strong.

Speaker 7

It's 4.5% of the portfolio, as you said. A couple of statistics, 45% of our office portfolio is single tenant, which adds a layer of strength there in terms of rollover, Strong sponsors, which we've talked about in the past. We have seen basically no deterioration in that portfolio and don't really see anything coming on the horizon. They're performing a lot of the leases, the underlying leases on these office projects go out to 27 and beyond, Roughly 70% of those leases are 27% and beyond. So in terms of rollover in the short term, very manageable.

Speaker 5

Okay, perfect. I appreciate the color. Thank you. Thanks, David.

Speaker 2

Yes. Thanks, everybody. It looks like that's The last question, just want to reiterate something. We're really proud of the year we had in the quarter. And I think at the end of the day, We do what we say and we say what we do and we've been doing it for a long time.

Speaker 2

And we've demonstrated strong outsized loan growth, deposit growth, Fees, expense control, year in and year out. And I think the good news for the investor population as they think about us is you should know what to expect from us. And we did it again in the Q4 and we're More thrilled than ever about the Q4 because we were able to sort of put to bed a lot of the nonsense and the narrative. As I like to say, don't let facts get in the way of a real exciting narrative that the pundits like to deliver last year. And so on behalf of everybody on the call, we're happy to have delivered what we did in the Q4 to kind of put some of that nonsense to bed.

Speaker 2

And so we'll just keep doing it for you. And we're really proud and excited about what we delivered and we're just going to keep doing it for you. So thanks.

Speaker 1

Thanks Mariner. If anyone has follow-up, you can always reach us at 816-860-7106

Operator

This concludes today's call. Thank you for joining. You may now disconnect your

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UMB Financial Q4 2023
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