Abby Mayer – SVP, IR
Mariner Kemper – CEO
Mike Hagedorn – CFO
Peter deSilva – President & COO
Chris McGratty – KBW
UMB Financial Corporation (UMBF) Q4 2008 Earnings Call Transcript January 28, 2009 9:00 AM ET
Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the UMB Financial Corporation fourth quarter conference call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator instructions). As a reminder, this conference is being recorded today, Wednesday, January 28, 2009.
I would now like to turn the conference over to Abby Mayer, Senior Vice President, Investor Relations. Please go ahead, ma’am.
Thank you. Good morning, everyone, and thank you for joining us for our conference call and webcast regarding our 2008 fourth quarter and year to date financial results.
Before we begin, let me remind you that our comments in this conference call contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934, and within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements rely on a number of assumptions concerning future events and are subject to risks and uncertainties, which could cause actual results to differ materially from those indicated in our statements made during this call.
While management of UMB believes our assumptions are reasonable, UMB cautions that material changes in interest rates, the equity markets, general economic conditions as they relate to the company’s loan and fee based customers, competition in the financial services industry, the ability to integrate acquisitions and other risks and uncertainties, which are detailed in our filings with the Securities and Exchange Commission, may cause actual results to differ materially from those discussed in this call. UMB has no duty to update such statements and undertakes no obligation to update or supplement forward-looking statements that become untrue because of new information, future events or otherwise.
Our earnings release includes both our GAAP based income statement and reconciliation to the non-GAAP measures discussed in the release, which includes certain pre-tax adjustments to non-interest income and non-interest expense, the tax effect of those adjustments, and adjusted net income. These adjustments comprise a gain on the sale of our securities transfer product, the majority of which was recognized in the third quarter of 2007, with the remainder recognized during the third quarter of 2008, as well as Visa related transactions in 2007 and 2008. The reconciliation for these items can also be found on our website at umb.com.
The non-GAAP results are a supplement to the financial statements based upon Generally Accepted Accounting Principles. UMB believes this non-GAAP presentation and the elimination of these items is useful in order to focus on what we deem to be a more reliable indicator of ongoing operating performance. By now, we hope most of you on the call or listening to the webcast have had a chance to review our earnings release dated January 27. If not, you will find it on our website at umb.com.
On the call today are Mariner Kemper, Chairman and Chief Executive Officer, Peter deSilva, President and Chief Operating Officer, and Mike Hagedorn, our Chief Financial Officer. The agenda for today’s call is as follows. First, Mariner will highlight our results and strategies. Then Mike will review the details of our fourth quarter and full year results. Peter will follow with a discussion of operating performance against our strategies. Finally, we’ll be happy to answer your questions.
Now I’ll turn the call over to Mariner Kemper.
Thank you, Abby. Welcome everyone and thank you for joining us today. In 2008, UMB delivered strong net income growth. These results reflect our continued focus on executing our business strategies despite the turmoil in the banking system. We achieved another year of record net income of $98.1 million, or $2.38 per diluted share, an increase of 32% from the $74.2 million a year ago, or $1.77 per diluted share reported in 2007.
Fourth quarter net income totaled $20.2 million or $0.49 per diluted share, also a 32% increase from $15.3 million or $0.37 per diluted share for the fourth quarter of 2007. These results reflect the sale of our securities transfer product and transactions related to Visa. Excluding the impact of these non-recurring items for both 2007 and 2008, UMB reported net income of $17.8 million or growth of 13.7% for the fourth quarter of 2008, and net income of $89.1 million or growth of 22.8% for the year.
Our strong performance for the year was driven by double-digit growth in net interest income as well as higher fee income. Net interest income for the year was $275 million or 18.2% higher than 2007. This growth was due primarily to higher average earning assets, including strong loan growth while maintaining our credit quality standards. We also achieved record non-interest income of $313 million, which is 8.3% higher than 2007.
2008 was an unprecedented year for the industry, and we are especially proud of our results in this environment. Our dedicated employees and management team continued to deliver and exceed the high standards we set for ourselves. We are confident that our business model demonstrates a commitment to our customers and shareholders by protecting deposits and maintaining a high quality balance sheet and strong capital ratios.
As previously announced on November 3 of 2008, UMB decided not to participate in Treasury Capitals Purchase Program. We chose not to apply for the government funding, both on principle and because of our sound tradition of maintaining strong capital levels, which continues to enable us to execute against our growth strategies. First, we believe that healthy banks should not accept taxpayers’ money to fund ongoing operations. Second, our fourth quarter tier 1 capital ratio was a healthy 13.2% and remains well above the industry average of 10.8%.
As reported on September 30 of 2008, we are well capitalized, continue to make loans, and continue to demonstrate excellent credit quality. Our ratio of non-performing loans to total loans stood at 0.20% at the end of the quarter, well below the industry average of 1.45%.
Now, I would like to discuss our progress against the company’s key strategies. Our first strategy is to focus on yield enhancement. Despite pressure on earning asset yields, we were able to increase our net interest margin by 16 basis points to 3.60% at the end of 2008 from 3.44% at the end of 2007. Effectively managing our investment portfolio enabled us to reduce our cost of funds throughout the fourth quarter, which contributed to our increased margin. Our CFO, Mike Hagedorn, will discuss our approach to managing both sides of our balance sheet later in the call.
During 2008, end of period loan balances increased 12.2% over 2007. The improvement reflects continued growth in our commercial, HELOC, and credit card portfolio, offset by the run off in our indirect auto loan portfolio, where balances stood at $280 million at the end of year, down from $531 million from the same period of last year. Excluding this impact, and the impact of our recently completed acquisition of Citadel Bank in Colorado Springs, total loans increased 6.2% on a linked quarter basis, and 20.8% for the year. This growth is proof that we continue to meet our customers’ credit needs.
Commercial loans continued to perform well in 2008, with a 20.3% increase in balances over the prior year, and represents 48% of our total loan portfolio. This growth demonstrates UMB’s continued focus on business development activities. Our sales team is out there calling on our competition’s customers. There’s no better proof of this than the fact that in 2008, 75% of our commercial loan growth came from new customers.
Credit card balances increased 11.9% on a year over year basis and stood at $254 million at the end of the year. While we saw some deterioration in the credit card portfolio, as net charge offs increased $2.3 million to $6.8 million, our annualized credit card charge offs ratio of 3.18% continues to remain below the industry average. Peter will provide more detail on our credit card portfolio in his remarks.
Home equity loans increased 36.1% for the year and exceeded $367 million in balances. While the industry has seen deterioration in HELOC loans, our net charge offs in the portfolio were at zero. By focusing our business development efforts within our footprint, we are able to manage our credit card portfolio risk parameters effectively. Growth in our loan portfolio while maintaining strong credit card quality is a core part of our operating strategy. Our ability to achieve these results is based on four key principles. We know our customers, we lend to businesses with strong balance sheets and income statements, we lend within our footprint, and we do not go through intermediaries. Loans stay on our balance sheet. While it may sound simplistic, we stick to what we know, a philosophy that has served us nearly 100 years.
Turning to deposits, our end of period deposits were $7.7 billion, an increase of 17.9% over the end of 2007. Public funds, mutual funds and treasury management were major contributors to this growth. Non-interest bearing deposits were 30.9% of total deposits and grew more than $289 million during the year. Core deposits continue to be a key strength of our deposit franchise. This deposit base provides us with liquidity and a competitive advantage in the marketplace, allowing us much flexibility.
Turning to the investment portfolio, the average life of our core portfolio was 25.3 months at the end of the year compared to 37.1 months at the end of 2007. We expect re-investment rates to remain low, and therefore may impact our portfolios yield. Mike will provide additional detail on our investment portfolio during his portion of the call.
Our second strategy is to continue growing our fee-based businesses. Due to the decline in assets under management, our Scout Funds, and the decline in assets serviced in our mutual funds service business, non-interest income for the quarter fell 4.4%. However non-interest income for the year increased 8.3%, reflecting growth in bankcard income, deposit service charges and bond trading. Peter will review our fee businesses in more detail during his comments.
The third strategy is to optimize our distribution network. We continue to add staff throughout our footprint and to expand nationwide in our strategic businesses, such as corporate trust, private banking and UMB fund services. As evidence of this, we entered the Indianapolis Indiana market in the fourth quarter by hiring a team of seasoned corporate trust professionals. We also increased our banking center network by 1 to 137 branches following the acquisition of Citadel Bank of Colorado Springs in Colorado during the quarter. For the year, we opened two branches and closed one.
Our fourth strategy is to continue to strengthen our asset management business. Trust and securities processing income increased 5.8% to $122.3 million in 2008 from $115.6 million in 2007. Much of this income is generated from fees in our asset management business, which are derived from assets under management. During the fourth quarter of 2008, trust and securities processing income fell 13.4% or $4.1 million compared to the fourth quarter of 2007. We were not surprised by these results given the S&P 500 fell almost 29% for the quarter. While we cannot control the performance of the equity markets, the strength of our Scout Funds has resulted in full year record net fund flows of $1.1 billion
Finally, our fifth strategy is to focus on capital management. We continue to focus our capital strategy on maximizing shareholder value through a combination of acquisitions, share buybacks, dividend and internal investments. We continue to search for businesses within our footprint and business lines that match our strategic financial and cultural objectives. To further demonstrate our commitment in this area, we established an in-house M&A department in September to proactively identify businesses that will be a good fit.
During the fourth quarter, we repurchased 17,245 shares at an average cost of $48.24 for the year. We bought back approximately 580,000 shares at an average price $40.35 for a total cost of $23.4 million. Yesterday, our Board of Directors declared a quarterly dividend of $0.175 per share. For the year, total dividends paid were $26.8 million, a 12.5% increase from 2007 with a payout ratio of 27.2%.
Now I would like to turn it over to Mike Hagedorn for a detailed review of our fourth quarter and full-year financial results. Mike?
Thanks, Mariner, and also thank you to everyone joining us on the call this morning.
First I will provide a recap of the fourth quarter and then turn to a few brief remarks regarding the full-year. As Mariner indicated, we reported diluted EPS of $0.49 for the fourth quarter, up from $0.37 in the same period in 2007. Net income of $20.2 million increased 32.2% quarter over quarter. Higher revenue was largely driven by a $17.5 million or 29% increase in net interest income. This increase is primarily due to the strong loan growth that Mariner mentioned earlier as well as increased liquidity.
Net interest margin increased to 3.6% from 3.44% at the end of last year and from 3.57% on a linked quarter basis. Despite overall declining interest rates, we have been able to decrease total interest expense at a rate faster than declining earning asset income. We ended the year with more than $738 million in public fund deposits. Public funds create higher deposits and repo balances and are negotiated products subject to market based pricing.
Core investment portfolio re-pricing also had an impact on margin during the fourth quarter. $157 million rolled off with an average yield of 4.59%. Also during the quarter, we repurchased $440 million of securities with an average yield of 3.57%. As we expected interest rates to decline combined with higher funding balances, we pre-bought core investment portfolio securities. At year-end, the average life of the core investment portfolio was 25.3 months compared to 37.1 months at the end of 2007. As Mariner mentioned, we will continue to monitor the investment portfolio given the low re-investment rates in the marketplace. We will refine our approach as market conditions change.
The combination of higher roll off balances and lower re-investment rates will continue to impact margin going forward. In the first quarter, roughly $300 million of core portfolio holdings will roll off with a yield of 4.4%. During the next 12 months, approximately $984 million will roll off with a yield between 4.08% and 4.28%. However, if our mortgage-backed security holdings experienced pre-payment acceleration, we could have as much as $1.3 billion in portfolio cash flow to reinvest.
We are slightly liability sensitive as the fed rate cuts provided a short-term margin boast. In a sustained low rate environment, however, we expect a reduction in net interest income as we see a larger negative impact of 12 months as the downward re-pricing of our asset yields will more than offset the short-term benefit.
Non-interest income declined $3.2 million for the quarter. The decline is primarily due to lower fees earned in our Scout Funds and fund services groups. Fee income fell by $2.7 million and $1.2 million respectively in the asset management segment and fund administration and custody services businesses. For the year, non-interest income rose 8.3%. Driving the increase was trust and securities processing income, which rose 5.8%. Income from card services grew 8.5%, and deposit service charges increased 6.5%, also contributing to the gain on the year. Excluding the gain on the sale of our securities transfer business in both years, and the gain on Visa’s mandatory redemption, non-interest income grew by 7.5%.
Non-interest expense increased by 5.7% for the year and 4.3% on a quarterly basis. Excluding the $4.6 million charge related to the Visa covered litigation provision in the fourth quarter of 2007, non-interest expenses would have risen 7.9% for the year, and 8.2% on the quarter. Salary and benefit expense increased 10.2% in 2008 and 11.5% in the quarter, which was driven by higher commission payments on revenue growth of 12.7% for the year. As Mariner discussed, we are pleased with the loan portfolio’s continued strong credit quality. Non-performing loans stood at 0.2%, up from 0.17% the year before. Net charge-offs were 0.28% of average loans for the year, up from 0.21% in 2007. Our allowance for loan losses covered non-performing loans by 593%.
Given the current environment, our income statement and balance sheet continued to benefit from both non-performing loan and net charge off metrics that are well below industry averages. The slightly higher net charge off rate for the fourth quarter was primarily due to increases in the commercial loan and credit card portfolios. In spite of this, our traditional credit underwriting standards continued to result in strong overall credit quality. Our loan loss provision stood at 1.19% at the end of 2008.
Turning to the balance sheet, we saw solid long growth as Mariner discussed. Excluding our indirect auto portfolio, which we decided to run off starting in August 2007, average loans grew 20.8% for the quarter. At the end of the quarter, our indirect loan balance was $280 million or just 6.4% of total loans, which is down from $531 million in the same period last year. At the end of December, total deposits were $7.7 billion compared with $6.6 billion a year ago, a 17.9% increase. While all deposit categories experienced an increase, the most notable was the 31.1% growth in interest bearing demand in saving accounts and 13.8% growth in non-interest bearing deposits.
Our average loan to deposit ratio for the quarter was 60.8%, down from 66.4% in the prior fourth quarter. The loan to deposit ratio for the year was 64.2%, compared to 68.3% the year before. Our loan to earning asset ratio was 48.7% in the quarter compared to 54.6% in the fourth quarter of 2007, due to growth in the securities portfolio. Return on average equity and return on average assets for 2008 were 10.51% and 1.10% respectively compared to 8.49% and 0.93% for 2007. We are pleased with the progress we continue to make on both of these key metrics. Capital ratios remained strong during 2008 with tier 1, total capital and leverage ratios at 13.2%, 14.1%, and 8.5% respectively.
I will now turn the call over to Peter for further comments on our operating performance.
Thanks Mike. Good morning everyone.
Following up on Mariner’s comments, let me begin by reviewing some details on our core operating strategies. First, some comments regarding our goal to expand our fee businesses. We faced strong equity market related headwinds during the quarter. Total trust and mutual fund assets fell $1.3 billion or 11.8% compared to 2007 and ended the year at $9.7 billion. On a linked quarter basis, assets fell 9.3%. This decline includes both assets in our equity funds and our trust customer balances. This reduction however compares favorably to a drop of nearly 29% in the S&P 500 during the period. This reduction in assets under management was the primary contributor in our non-interest income decline of 4.4%.
For the year, UMB reported strong net flows of $1.1 billion in the Scout Fund complex. For the quarter, assets in the Scout Funds decreased from $5.7 billion in the fourth quarter of 2007 to $4.9 billion in the fourth quarter of 2008. We remain focused on our strategy to grow our Scout Fund family of mutual funds, and indeed our entire money management businesses regardless of volatility in the equity markets.
As evidence of this commitment, on the December 31, we launched our new global equity core product, targeted to large institutional investors with an investment minimum of $3 million. UMB Fund Services reported a $1.2 million decline in non-interest income for the quarter, based upon lower asset levels due to equity market declines, and resulting asset-based fee income. Despite the recent developments in the hedge fund and mutual fund industry, we’re optimistic that we continue to have the right strategy and the right team in place for the long-term success of this business. One positive trend is the increasing of pressure on money managers to utilize independent fund administrators, accountants and custodians, which we believe will benefit us going forward.
As I mentioned earlier, the declines we experienced in non-interest income this quarter were largely the result of the larger phenomena currently affecting the broader financial markets. We are pleased that overall yearly non-interest income grew 8.3%.
Turning to healthcare services, we continue to leverage our position in this marketplace. Our focus has paid off with strong growth in HAS and FSA accounts, deposits and mutual fund assets. We provide a full range of services from administration, custody and card processing. We ended the year with more than $140 million in deposits and assets, up from slightly more than $100 million at the end of 2007. Additionally, total healthcare accounts grew by 39%, ending the year with a total of $1.1 million. In December alone, more than 228,000 accounts were added.
Our card businesses continue to perform well. While bankcard income for the fourth quarter decreased 0.8%, it increased 8.5% for the full year. The key driver in this business has been our commercial card program. Commercial cards continue to drive volume growth, which increased 14% on a quarter over quarter basis and 15.8% for the full year. Also we added 11,400 new bankcard accounts during the quarter. As a reminder, we continue to underwrite all of our credit card products, and we’re closely monitoring credit scores in the entire portfolio. We have strong underwriting standards and our portfolio continues to score above industry standards. At the end of 2008, our annualized credit card charge-offs were 3.18%, which was less than half of the industry average of 6.84%.
Another key strategy is to better leverage our distribution network. For example, we recently re-launched our insurance product suite through our branch network, and as a result, revenue increased 34% for the year. We anticipate further growth from this business as we better penetrate our existing customer base. Our private banking team continued to perform well in 2008. Deposits increased 82% for the year. End of period deposit balances were in excess of $247 million. Loans grew 92% and ended with a balance of $91 million. Private banking was a new business line for us in 2005, and we’re very pleased with the level of growth we have achieved in such a relatively short period of time.
We continue to drive improvements in our operating efficiencies. Our efficiency ratio improved to 71.5% in the fourth quarter of 2008, down from 76.3% in the fourth quarter of 2007. Average deposits per FTE for the quarter increased 23.8% over the same period a year ago. And loans per FTE increased 13.4% for the same period. We are pleased with the improvements in these metrics and remain focused on this area.
With that, let me turn it back to Mariner for some concluding remarks. Mariner?
Thanks Peter. The recent financial distress has raised the level of awareness among the public that where you bank is very important. Our reputation as a strong financial institution is serving us as well today as in any other time in our history. Each day, our associates and management team are working hard to serve our customers and execute against our strategies.
We are pleased with the strength of our business, especially our banks, and we have strong revenue streams from fee-based business that don’t entirely rely on bank customers to grow. Not only will we continue to make investments in the bank, but also in our fee-based businesses.
We believe there will be a continued opportunity for us with our strong liquidity and capital position to take advantage of strategic acquisitions and enhance our position. In the coming quarters, we will talk in depth about these opportunities, and we will talk further about our overall strategy of operating as a financial-services company. Thank you very much and we look forward to your questions.
Thank you very much for your interest in UMB. The call can be accessed via replay at our website beginning in about two hours and it will run through February 11. And as always, you can contact UMB Investor Relations with any follow questions by calling 816-860-1685. Again we appreciate your interest and time.
Thank you. Ladies and gentlemen, we will now begin the question and answer session. (Operator instructions). And our first question comes from Chris McGratty with KBW. Go ahead please.
Chris McGratty – KBW
Chris McGratty – KBW
You indicated in your prepared remarks that you pre-bought some securities in the quarter. I guess how should I think about the size of the balance sheet, I guess, in the first and second quarter? Was fourth quarter the peak in size of the investment portfolio, and will the public funds run out of the bank I guess typically as they do in the first half of the year, and just trying to get a sense of the size of the balance sheet going forward?
Sure. This is Mike. I'll take a stab at that one. You should expect the normal public fund accounts to leave the bank as they do in the first quarter of any following year. It is no different right now, at least from an expectation standpoint that that won't happen again. The portfolio holdings and the pre-buy that we’re talking about, those are core portfolio holdings. So we do separate our portfolio between core and non-core, and clearly we don't buy core portfolio holdings with public funds. So the assets that we do buy with those non-core funds or public funds are very short term in nature.
Chris McGratty – KBW
I might add that our balance sheet has grown related to both the inflow of public funds as well as the flight to safety and quality through our deposit growth in general.
Chris McGratty – KBW
Okay. So the $700 million that you alluded to, that will run out in the first quarter. You added about a little over a $1 billion in the fourth quarter, so I should assume that you’ve put on a little bit of securities leverage and that is a sustainable piece of portfolio going forward, or you grow that core piece?
I think that is a fair estimate right now. There has been some – there has been some uptick in our deposits that are not related to public funds, and those are core holdings that are funding the core portfolio, yes.
Chris McGratty – KBW
Okay. So I guess going forward and the bigger picture, what is your comfort size with the core portfolio? Did I sense that over time given where rates are today that the size may come down?
It's a function of whether or not loan demand man is there. So that will be the first answer. It is a function of what happens with deposits, so it's awfully hard to answer that because you’ve got a lot of moving parts in the balance sheet on both sides that could impact the holding. We don't have a stated that we say, okay, that's the limit, we don't want any more investment securities.
Chris McGratty – KBW
Okay. And my other question is on the loan portfolio, what percentage re-prices, what is floating?
On the loan portfolio?
Chris McGratty – KBW
Yes, about 50% in a year, and of that 50%, roughly 85% is tied to prime, 14% is tied to fed funds, and the rest very small amount is made up mostly of treasuries.
Chris McGratty – KBW
Okay. And what portion of that re-prices I guess in the first half of the year? Or will we see additional impact I guess? You alluded to some pressure on earnings asset yields.
Well, I think – the comment about earning asset yields was both loans and the security portfolio. I think it is more the security portfolio, just because of the large amount that comes due in 2009. And obviously the ability to re-invest that at rates that would even come close to equaling the roll off which is not possible right now.
Chris McGratty – KBW
Right, thank you.
Okay, thank you. (Operator instructions). And we have no further audio questions, I would like to turn the conference back over to management for any closing comments.
Thank you again for your interest and time. If you have any further questions, please feel free to contact UMB Investor Relations at 816-860-1685.
Ladies and gentlemen, this concludes the UMB Financial Corporation fourth quarter conference call. If you would like to listen to a replay of today's conference, please dial 800-405-2236 or 303-590-3000 with the pass code 11123985. ACP would like to thank you for your participation, and you may now disconnect.
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