UMB Financial Corporation (UMBF) Q4 2011 Earnings Report, Transcript and Summary

Welcome to the Fourth Quarter and Year-End 2011 Earnings Results Conference Call. [Operator Instructions] This conference is being recorded today, Wednesday January 25, 2012. I would now like to turn the conference over to Abby Wendel, Director, 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 fourth quarter and full year 2011 financial results. Before we begin, let me remind you that our comments on 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. By now, we hope most of you on the call or listening via webcast have had a chance to review our earnings release which was issued last evening. 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: Mariner will provide high-level commentary on our results, and Mike will review the details of our financials. Then Peter will review key fee income business drivers. Following that, 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. I’m very pleased to talk with you today about both our fourth quarter and full year 2011 results. Not only did we see improvement in our fourth quarter results but we also achieved record revenue and net income on a full year basis. For the year, we surpassed $100 million in earnings for the first time in our history. Net income was $106.5 million on total revenue of $731.3 million. Diluted EPS was $2.64 per share for the quarter. We generated net income of $23.3 million or $0.58 per diluted share on total revenue of $177.3 million. We continue to execute on our strategies to accelerate fee business growth, grow loans and deposits, maximize efficiencies, and deploy capital effectively by sticking to our business model and doing what we believe is right. As you have come to expect from us, we manage the company for the decades, not for the quarter, and return consistent results to shareholders. Non-interest income was the primary driver behind the increase in total revenue and net income compared to the same period a year ago. Non-interest income increased 3.2% to $97.8 million for the quarter, and 15% to $414.3 million for 2011, both led by increases in trusts and securities processing revenue. Later in the call, Mike will provide additional detail on our revenue and Peter will discuss with you the drivers affecting these businesses. Fortunately, we do not have to rely entirely on spread income to grow the company, and we were pleased that non-interest income comprised 55.1% of total revenue. In a time when loan growth is difficult to come by, I’m proud to report that we once again ended the period with increased loan balances. Net loans for December 31, 2011, were 8.4% higher than the prior period. Compared to the industry the nearly 1,200 regulated depositories that announced 2011 results as of January 24th reported a median decrease in loan balances of 0.4%. We’ve posted loan growth for 7 consecutive quarters. We achieved increased loan balances year-over-year in spite of the $41 million run-off in our indirect auto loan portfolio which we exited in August of 2007. As we expected, these balances were nearly 0 at year-end 2011 so we will discontinue reporting on the status of this portfolio in future calls. Portfolios with strong growth include C&I and commercial real estate loans which increased by more than $397 million on a combined basis when compared to last year. At the end of 2011, commercial loan balances were $2.2 billion, and commercial real estate balances were $1.4 billion. As a reminder, our CRE loans are primarily owner-occupied real estate and are underwritten similarly to how we underwrite all commercial loans. C&I lending has been a core competency of our business for nearly a century. Key aspects of our business model are pristine credit quality and solid, consistent underwriting standards. Doing what we believe is right is central to our success and operating principles. Our commercial loan officers remain outwardly focused, continuing to generate new business primarily through increased market share. We are seeing some signs that the economy within our footprint is improving, but companies continue to hold significant cash balances and will likely use that source of funding before drawing down debt. At December 31 commercial loan commitments had increased 15.5% compared to the same point in time a year ago, but utilization had fallen to 26% from 30.3%. We continue to see competitive pricing pressure and some loosening of terms and conditions within our market. However, we're able to compete effectively because of our low cost of funding. Credit quality at UMB remains as strong as ever and continues to differentiate us from our peers. Overall non-performing loans as a percent of total loans were 0.52%, and net charges year-to-year were 0.51%. In consumer lending, home equity lines of credit balances increased 12% to $533 million. Utilization in this portfolio remains 59% borrowed. The HELOC delinquency rate was 0.31% in the fourth quarter compared to the industry average of just over 3%. Turning to our credit card portfolio. Commercial credit card balances increased 12.8% to $95 million while consumer balances rose 3.5% to $334 million. Card net charge-offs for 2011 were 2.7%, well below the industry average of 8.2% reported in the third quarter of 2011. As we discussed previously, our balance sheet is larger. This is due primarily to the seasonal inflows in public funds. However, we also believe strong deposit growth is due in part to continued economic uncertainty and a lack of other attractive alternatives for cash. Either way, we remain committed to core deposits. Later in the call, Mike will discuss deposit growth in more detail. Turning back to the income statement for a moment. Expenses grew 2.7% compared to the fourth quarter of 2010. Offsetting some of the impact of higher expenses was the accelerated growth in non-interest income I discussed earlier. Salary and benefit expense was the main driver of year-over-year increase in expenses for the quarter. And as indicated in our press release, approximately 36% of salary and benefit increase is due to acquisitions. We continually look for ways to maximize efficiencies, but because we view ourselves as a growth company we also seek opportunities to make investments in people and technology. We believe investments such as these and progress made on other growth strategies will positively impact our results over the long run. For the fourth quarter our efficiency ratio increased slightly from 77.8% to 78% over the same period last year. For the full year the efficiency ratio was 75%. As we told you at the beginning of the quarter, we took a pause in 2011 from making acquisitions to digest what we had already acquired. However, we continue to deploy capital effectively. Throughout the year we repurchased nearly 240,000 shares at the average purchase price of $38.28 for a total cash outlay of $9.1 million. With that I’ll turn the call over to Mike Hagedorn, who will discuss the balance sheet and income statement in further detail. Mike?

Thanks, Mariner, and welcome, everyone. Picking up where Mariner left off in this discussion of the balance sheet, the increase in our balance sheet from $12.4 billion to $13.5 billion was driven primarily by deposit growth. As you know, we typically experience a seasonal influx of public funds in the fourth quarter, which started approximately $200 million higher than last year. These balances currently are about $140 million higher than historical levels. The rate environment and less attractive yield opportunities have resulted in additional funds remaining in deposit [indiscernible] accounts. When combined with increases in deposits from other funding sources, average deposits had increased 13.5% at year end. Non-interest bearing deposits comprise nearly 39% of our total deposits, which puts us in the top 3% of the industry according to SNL Financial. Our high percentage of free funds is a competitive advantage and is reflected in our low overall cost of funds which was 0.32% for the fourth quarter and 0.35% for the year. This advantage will be even more important when rates begin to rise. Allowance for loan losses is $72 million and allowances as a percent of total loans is now 1.45% compared to 1.61% a year ago. Our allowance for loan loss coverage is more than 2.5x the amount of non-performing loans while the median industry allowance reported for the third quarter would cover just over half of non-performing loans. During 2011 we had gains on the sale of investment securities of $16.1 million. We harvest gains as part of our overall intentional approach to manage the investment portfolio when interest rates in the economy make this a prudent decision. Through gains we're able to offset lower margin associated with holding shorter-duration securities. In effect, we trade one type of risk for another by supplementing what we lose in net interest margin with gains. The average balance in our investment portfolio increased 13.8% to $5.8 billion, and activity during the fourth quarter included the roll-off of $335 million in core portfolio securities at an average yield of 2.62%. In turn, we purchased $688 million of securities at an average yield of 1.72%. These purchases shortened the portfolio duration slightly. The average life is now 28.17 months down from 33.8 months in the third quarter 2011. Over the next 3 months, $410 million of core investments with an average yield of 2.27% will mature. Over the next 12 months, $1.4 billion of core investments with an average yield of 2.45% will mature. Additionally, 73% of our total loan portfolio is expected to reprice or mature in the next 12 months. As we’ve discussed previously, the components of our capital have shifted slightly impacted by our acquisitions, with goodwill and intangibles increasing relative to Tier 1 capital. We remain well capitalized with Tier 1, leverage and total risk-based capital ratios of 11.2%, 6.71%, and 12.2%, respectively. Average shareholder equity was $1.2 billion, a 12.3% increase. Since the beginning of 2008, equity has increased by 33.7%. We have grown equity without any dilutive capital actions, and we’ve been able to deploy it effectively to make acquisitions. Further, total shareholder returns since year-end 2006 to year-end 2011 was 11.4%. For the same period returns from the S&P 500 and SNL US Bank Index were negative 1.6% and 69.1%, respectively. Reviewing other financial highlights. Return on average assets was 0.74% for the quarter, up from 0.65% in the fourth quarter 2010. For the full year 2011, return on average assets improved from 0.82% in 2010 to 0.86% in 2011. Return on average equity for the fourth quarter was 7.83%, an increase from 6.92% a year ago. For the full year, return on average equity was 9.35%. Turning to the income statement for the fourth quarter 2011. Net income was $23.3 million or $0.58 per diluted share. Total revenue increased 2.2% to $177.3 million for the quarter. Net interest income for the quarter was virtually unchanged, up 1% to $79.5 million. Although average earning assets increased by 8.8%, the changing mix resulted in a lower overall yield of 3.11% versus 3.42% for the fourth quarter 2010. Average net interest margin for the quarter decreased 21 basis points to 2.91%. For the year ended December 21 2011, net income was $106.5 million or $2.64 per diluted share. Total revenue increased 9% to $731.3 million for the year. Net interest income for 2011 was up slightly to $317 million compared to $310.6 million in 2010. Average net interest margin for the year decreased 27 basis points to 2.94%. Provision expense decreased by $2.4 million or 32.4% compared to the fourth quarter 2010. For the full year, provision was 30% or $9.3 million lower than 2010. As we’ve discussed in several prior quarters' calls our provision expense is a reflection of our consistent methodology, which considers the inherent risk in our loan portfolio as well as other qualitative factors. As Mariner mentioned, non-interest income increased 3.2% to $97.8 million comparing favorably to $94.8 million for the fourth quarter 2010. The increase in non-interest income was driven largely by a 10.3% increase in trust and securities processing revenue, which for the quarter was $51.1 million compared to $46.3 million for the fourth quarter 2010. Within this category advisory fee income from the Scout Funds increased 8.6% to $15.1 million, fund accounting and administration income increased 4.2% to $17 million, and income from personal and institutional wealth management increased 50% to $8 million. For the year, total non-interest income increased by 15% driven by a 30% increase in trust and securities processing. Partly offsetting this increase in trust and securities processing revenue for the fourth quarter was a 9.5% decrease in bank card fees related primarily to debit interchange rules which went into effect in October. For the full year 2011, we reported a 9.1% increase in bank card fees. Peter will discuss the details of our interchange fees and full impact from the Durbin Amendment later in the call. Although total deposit service charges increased by 7.3% in the fourth quarter 2011, mostly due to deposit growth, consumer NSF OD income was 3% lower than a year ago. The full year impact of the reduction in consumer NSF OD income was 6.5% or 33% resulting in a 3.8% decrease in total deposit service charges for the year despite the year-over-year growth in deposits. As a reminder, Reg E went into effect in July 2010. As Mariner discussed earlier, we continue to focus on achieving operating leverage. However, as a growth company we continue to make investments, which increases non-interest expense while the corresponding increase in revenue should follow in subsequent periods. For the fourth quarter, non-interest expense increased by 2.7% compared to the fourth quarter 2010, and for the full year expenses were up 9.8%. I want to point out an acquisition-related item that impacts our expenses. As a reminder, we have earn-out agreements on many of our larger acquisitions. Accounting standards require that we review and potentially adjust our liabilities related to these earn-out payments. As you may know, there are 2 variables that affect these adjustments: one, the recalculation of liabilities using actual results instead of estimates; and two, expected future performance. In 2011 the total impact of this adjustment was a charge of $2.6 million with $1.7 million taking place in the fourth quarter. Earn-out liabilities are analyzed on a quarterly basis, and you should expect to have future adjustments either up or down throughout the earn-out period. With that, I’ll turn the call over to Peter to discuss the business drivers behind this quarter’s results.

Thank you, Mike. Welcome, everyone. As you’ve seen in our press release, our results continue to demonstrate the long-term value of our diversified business model. To provide additional context, I’d like to discuss the sources and drivers of our fee income, beginning with our Asset Management and Asset Servicing businesses. As noted in previous calls, revenue in these areas is largely dependent on 3 key drivers: first, new business; second, mutual funds and separate account net flows; and third, equity and fixed income market performance. Our asset management businesses have fared well over the past few quarters despite turbulence in the markets. We ended the year with total company assets under management of $28 billion, a slight increase over 2010. Despite the market headwinds, Scout Investments had a very good year. Net flows from the Scout Funds and fixed income separately managed accounts were just over $1.1 billion for the year. The Scout Mid Cap and the Scout International Funds accounted for substantially all of the net flows for the year. During the fourth quarter the Scout Funds experienced net outflows of $2 million. However, during the quarter the fund’s assets under management increased $469 million due to market appreciation. At the end of 2011 total assets in Scout mutual funds stood at $8.7 billion. Scout fixed income separately managed accounts had $10.4 billion in assets under management and Scout equity separately managed accounts had $583 million. A growth strategy within Scout investments is to launch select new products as appropriate to round out our product offering. We launched 2 new funds in 2011: First, the Scout Global Equity Fund. This fund combines the strengths and stock selection capabilities of Scout’s 5 equity teams. And second, the Scout Unconstrained Bond fund. This fixed income fund is allowed to pursue investment opportunities in the market over the long term without the constraints of a particular benchmark. As a reminder, we also acquired 2 Frontegra Bond Funds and rebranded them into the Scout family of funds during 2011. Moving on to our asset management businesses for individuals. Total personal assets under management stood at $8.3 billion at December 31, an increase of 3.9% or $313 million from a year ago. Comprising the $8.3 billion is $5.4 billion in assets under management within our trust and personal wealth management group and $2.9 billion in assets managed by Prairie Capital Management. Looking now at our Asset Servicing businesses. UMB fund services ended the year with $206.4 billion in assets under administration, an increase of 15.2% over 2010. The headwinds in the equity markets this year also affected growth in our Asset Servicing businesses. However, fund administration and custody revenue for the fourth quarter increased 4.2% when compared to a year ago. We are pleased with a variety of new clients and services added in 2011 and believe our capabilities, customer focus, and innovative new product offerings will continue to set us apart. In our Corporate Trust business, assets under administration finished the quarter at $11.2 billion, an 8.6% decline from a year ago. This business continues to be challenged from reduced revenue-sharing arrangements resulting from historically low money market yields and a limited volume of new municipal offerings coming to the market. However, according to a Securities Industry and Financial Markets Association survey, industry expectations are for an increase in municipal issuances in 2012 of 20.5%. Additionally, to combat these near-term pressures we continue to diversify the business and strengthen existing client relationships while building new ones. For example, the revenue stream from default administration services has increased by almost 87% over the past year, one result of our continued efforts to offset the negative effects of the rate-driven revenue-sharing arrangements and the low-issuance environment. Our company includes several other, more traditional fee-based businesses as well. And these areas within UMB Bank continue to provide a key source of core funding and revenue growth. Looking at our credit card business there are 2 important metrics that we track. First, we track revenue from bank card fees which are comprised primarily of interchange revenue; and second, we look at the underlying purchase volume that drives this revenue. As Mike mentioned, bank card fees decreased 9.5% over the fourth quarter of 2010 to $12.9 million. Total debit card interchange for the fourth quarter was just over $3.8 million with interchange from healthcare debit cards comprising 37% of that total. For the full year of 2011 total debit card interchange was $22 million, and healthcare made up 28% of that total. We group purchase volume into 4 major categories: commercial credit, consumer credit, consumer debit, and healthcare debit. Card purchase volume is a key driver of the revenue in these businesses, and for the fourth quarter purchase volume across our entire suite of card products increased 19.7% to $1.3 billion when compared to the same period last year. For the full year, total card purchase volume increased 25.4% to $5.4 billion. At the end of the fourth quarter, deposits in our healthcare services custody accounts stood at $323.3 million, an increase of 36.1% compared to the fourth quarter of 2010. Flexible spending arrangements in health savings accounts totaled $2.5 million representing a 37.9% increase from just 1 year ago. We had another strong year in this business and it continues to be a reliable, strategic, and low-cost source of deposits and a growing source of debit card interchange for us. UMB is known for strong credit quality, and the quality of our card portfolio is no exception. Credit card quality remains superior to industry averages and has improved over the past several quarter with delinquency rates dropping to 1.8% from 2.3% a year ago. As Mariner mentioned, total credit card charge-offs were 2.7% of card balances for 2011 versus 3.9% in 2010. According to Fitch Rating Services, third quarter 2011 industry credit card charge-offs averaged 8.2% or more than triple our credit card charge-off rate. Finally, our private banking and wealth advisor teams continue to deepen relationships with our existing client base. Private banking deposits at the end of December 2011 had increased 65% to $645 million and private banking loans had increased another 18% to $151 million when compared to year-end 2010. Deposits attributed to consumer and private banking accounts stood at $4.3 billion at December 31 and represented 43% of the company’s total deposit base. Overall, deposits from consumers increased 6.5%. With that, I’d like to hand the call back over to Mariner, who's going to close our prepared remarks and open the line for your questions. Mariner.

Thank you, Peter. In closing, we are pleased to report a record year for UMB. We believe we win in all economic environments by sticking to what we’ve always done. We’ve increased capital, our dividend, and grown our balance sheet throughout a time when our industry was under significant pressure. Over the past several years, we’ve invested in people and technology. We recognize that this has a short-term negative impact based on the investments we’ve made but we think that these investments will pay off in the long term. We’re cautiously optimistic about what we’re seeing, and while there are signs of slight economic recovery, we will continue to focus on our business and achieve solid results. We appreciate your interest, and I’m going to turn the call over to the operator. Thanks again.

[Operator Instructions] And our first question comes from the line of Christopher McGratty with KBW.

Peter, just a question, I missed the numbers on the debit card. Could you just review what was in the numbers and what was the impact on Durbin?

Sure, so we disclosed last quarter that the full year impact from Durbin we estimated to be $9.1 million on an annualized basis. If you look at it 2 different ways, in the fourth quarter of 2011 our total debit interchange was $12.9 million versus $14.3 million in the fourth quarter of 2010 or a $1.4 million reduction or roughly 9.5%. On a link quarter basis we had $12.9 million in the fourth quarter of 2011 versus $15.9 million in the third quarter of 2011 or a $3 million reduction, of which about $2.3 million of that $3 million reduction on a link quarter basis was related to Durbin.

So the $9 million is the number that we should use before any kind of mitigation?

Correct.

All right. And then the only other question I had was in terms of pipeline for growth. You continue to put up pretty good growth in this environment. What’s the kind of outlook? Should we assume similar type growth organically for ’12?

Are you talking about any specific part of the company?

I’m talking just loan growth.

Loan growth...

I mean, you put up -- the growth accelerated a bit this quarter.

Sure. As we've kind of -- as we said in the past, our loan growth to date has really been mostly about our pipeline and our market share gains. No economic activity really to speak of driving loan growth. But we expect to continue to deliver loan growth through those similar efforts in 2012.

[Operator Instructions] And our next question comes from the line of Ebrahim Poonawala from Morgan Keegan.

Mariner, you mentioned about pricing competition in your markets. And if you could give some color in terms of where is the competition coming from. Is it the larger banks? And where you’re booking these loans in terms of if you could give some color on pricing today versus maybe 3, 6 months ago?

The competitors are somewhat different from market to market, but for the most part we are competing with the larger banks. And the mix is somewhat different from market to market so there’s no silver bullet as it relates to who our competitors are. The pressure does continue downward on pricing and terms. I feel like we're -- it seems like we might be bottoming out on that pressure, but it is -- if you talk about 6 months ago to where we are today there certainly has been more pricing pressure. The -- it’s pretty much obvious, right, what the -- our alternatives are as an industry. So if you think about putting your funding into investment securities versus loans there’s obvious room for pressure on loan pricing. And I mean -- and I mentioned that the -- our ability to compete has a lot to do with having very competitive cost of funding with the larger banks.

Well, just, I guess in instances where you win over them it’s primarily due to better pricing?

Well, I wouldn't -- it’s never better. We never sell on better pricing. So we can match pricing, and we win with better service.

And I’m showing no further questions in the queue, and turn the call back over to Abby Wendel for any closing comments.

Thank you very much for your interest in UMB. This call can be accessed via a replay at our website beginning in about 2 hours, and it will run through February 8th. And as always, you can contact UMB investor relations with any follow-up questions by calling (816) 860-1685. Again, we appreciate your interest and time.

Thank you. Ladies and gentlemen, if you’d like to listen to a replay of today’s conference please dial (303) 590-3030 or 1 (800) 406-7325 and enter the pass code 4503730. That does conclude today’s fourth quarter and year-end 2011 earnings results conference call. Thank you for your participation. You may now disconnect.