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UMB Financial 10-K 2008 Documents found in this filing:
Table of ContentsUNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark one)
For the fiscal year ended: December 31, 2007
For the transition period from to Commission file number: 0-4887 UMB FINANCIAL CORPORATION (Exact name of registrant as specified in its charter)
(Registrant’s telephone number, including area code): (816) 860-7000 Securities Registered Pursuant to Section 12(b) of the Act:
Securities Registered Pursuant to Section 12(g) of the Act: None Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. x Yes ¨ No Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. ¨ Yes x No Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes ¨ No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer x Accelerated filer ¨ Non- accelerated filer ¨ (Do not check if a smaller reporting company) Smaller reporting company ¨ Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes x No As of June 30, 2007, the aggregate market value of common stock outstanding held by nonaffiliates of the registrant was approximately $1,206,788,467 based on the NASDAQ closing price of that date. Indicate the number of shares outstanding of the registrant’s classes of common stock, as of the latest practicable date.
DOCUMENTS INCORPORATED BY REFERENCE Portions of the Company’s definitive Proxy Statement to be delivered to shareholders in connection with the Annual Meeting of Shareholders to be held on April 22, 2008, are incorporated by reference into Part III of this Form 10K.
Table of ContentsINDEX
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ITEM 1. BUSINESS
General
UMB Financial Corporation (the Company) was organized as a corporation in 1967 under Missouri law for the purpose of becoming a bank holding company registered under the Bank Holding Company Act of 1956 (BHCA). In 2001, the Company elected to become a financial holding company under the Gramm-Leach-Bliley Act of 1999 (GLB Act). The Company owns all of the outstanding stock of four commercial banks, a brokerage company, a community development corporation, a consulting company, a mutual fund servicing company and fourteen other subsidiaries.
The four commercial banks are engaged in general commercial banking business entirely in domestic markets. One of the banks is in Missouri, one bank in Kansas, one bank in Colorado, and one bank in Arizona. The principal subsidiary bank, UMB Bank, n.a., whose principal office is in Missouri, also has branches in Illinois, Kansas, Nebraska and Oklahoma. The banks offer a full range of banking services to commercial, retail, government and correspondent bank customers. In addition to standard banking functions, the principal subsidiary bank, UMB Bank, n.a., provides international banking services, investment and cash management services, data processing services for correspondent banks and a full range of trust activities for individuals, estates, business corporations, governmental bodies and public authorities.
The table below sets forth the names and locations of the Company’s affiliate banks, as well as their respective total assets, total loans, deposits and shareholders’ equity as of December 31, 2007.
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Table of ContentsSELECTED FINANCIAL DATA OF AFFILIATE BANKS (in thousands)
UMB Fund Services, Inc. located in Milwaukee, Wisconsin and Media, Pennsylvania, provides services to nearly 35 mutual fund groups representing approximately 140 funds and administrative and support services for a growing number of alternative investment products.
On a full-time equivalent basis at December 31, 2007, the Company and its subsidiaries employed 3,357 persons.
Segment Information. Financial information regarding the Company’s six segments is included in Note 13 to the Consolidated Financial Statements provided in Item 8, pages 74 through 77 of this report.
Competition. The Company faces intense competition from hundreds of financial service providers in the markets served. The Company competes with other traditional and non-traditional financial service providers including banks, thrifts, finance companies, mutual funds, mortgage banking companies, brokerage companies, insurance companies, and credit unions. Customers for banking services and other financial services offered by the Company are generally influenced by convenience of location, quality of service, personal contact, price of services and availability of products. The impact from competition is critical not only to pricing, but also to
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Table of Contentstransaction execution, products and services offered, innovation and reputation. Within the Kansas City banking market, the Company ranks third based on the amount of deposits at June 30, 2007, the most recent date for which deposit information is available from the Federal Deposit Insurance Corporation (FDIC). At June 30, 2007, the Company had 7.5 percent of the deposits in the Kansas City metropolitan area, compared to 9.2 percent at June 30, 2006.
Monetary Policy and Economic Conditions. The operations of the Company’s affiliate banks are affected by general economic conditions, as well as the monetary policy of the Board of Governors of the Federal Reserve System (the Federal Reserve Board or FRB), which affects interest rates and the supply of money available to commercial banks. Monetary policy measures by the FRB are effected through open market operations in U.S. government securities, changes in the discount rate on bank borrowings and changes in reserve requirements.
Supervision and Regulation. As a bank holding company and a financial holding company, the Company (and its subsidiaries) are subject to extensive regulation and are affected by numerous federal and state laws and regulations.
Supervision. The Company is subject to regulation and examination by the FRB. Its four subsidiary banks are subject to regulation and examination by the Office of the Comptroller of the Currency (OCC). UMB Scout Insurance Services, Inc. is regulated by state agencies in the states in which it operates. Scout Investment Advisors and UMB Fund Services are subject to the rules and regulations of the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) because of the UMB Scout Funds and the servicing of other mutual fund groups and alternative investment products. The FRB possesses cease and desist powers over bank holding companies if their actions represent unsafe or unsound practices or violations of law. In addition, the FRB is empowered to impose civil monetary penalties for violations of banking statutes and regulations. Regulation by the FRB is intended to protect depositors of the Company’s banks, not the Company’s shareholders. The Company is subject to a number of restrictions and requirements imposed by the Sarbanes-Oxley Act of 2002 relating to internal controls over financial reporting, disclosure controls and procedures, loans to directors or executive officers of the Company and its subsidiaries, the preparation and certification of the Company’s consolidated financial statements, the duties of the Company’s audit committee, relations with and functions performed by the Company’s independent auditors, and various accounting and corporate governance matters. The Company’s brokerage affiliate, UMB Financial Services, Inc., is regulated by the SEC, the Financial Industry Regulatory Authority (FINRA), and the Missouri Division of Securities; it is also subject to certain regulations of the various states in which it transacts business. It is subject to regulations covering all aspects of the securities business, including sales methods, trade practices among broker/dealers, capital structure of securities firms, uses and safekeeping of customers’ funds and securities, recordkeeping, and the conduct of directors, officers and employees. The SEC and the self-regulatory organizations to which it has delegated certain regulatory authority may conduct administrative proceedings that can result in censure, fines, suspension or expulsion of a broker/dealer, its directors, officers and employees. The principal purpose of regulation of securities broker/dealers is the protection of customers and the securities market, rather than the protection of stockholders of broker/dealers.
Limitation on Acquisitions and Activities. The Company is subject to the Bank Holding Company Act (BHCA), which requires the Company to obtain the prior approval of the Federal Reserve Board to (i) acquire substantially all the assets of any bank, (ii) acquire more than 5% of any class of voting stock of a bank or bank holding company which is not already majority owned, or (iii) merge or consolidate with another bank holding company. The BHCA also imposes significant limitations on the scope and type of activities in which the Company and its subsidiaries may engage. The activities of bank holding companies are generally limited to the business of banking, managing or controlling banks, and other activities that the FRB has determined to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In addition, under the GLB Act, a bank holding company, all of whose controlled depository institutions are “well-capitalized” and “well-managed” (as defined in federal banking regulations) and which obtains “satisfactory” Community Reinvestment Act (CRA) ratings, may declare itself to be a “financial holding company” and engage in a broader range of activities.
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Table of ContentsA financial holding company may affiliate with securities firms and insurance companies and engage in other activities that are financial in nature or incidental or complementary to activities that are financial in nature. “Financial in nature” activities include:
A financial holding company that desires to engage in activities that are financial in nature or incidental to a financial activity but not previously authorized by the FRB must obtain approval from the FRB before engaging in such activity. Also, a financial holding company may seek FRB approval to engage in an activity that is complementary to a financial activity if it shows that the activity does not pose a substantial risk to the safety and soundness of insured depository institutions or the financial system. Under the GLB Act, subsidiaries of financial holding companies engaged in non-bank activities are supervised and regulated by the federal and state agencies which normally supervise and regulate such functions outside of the financial holding company context.
A financial holding company may acquire a company (other than a bank holding company, bank or savings association) engaged in activities that are financial in nature or incidental to activities that are financial in nature without prior approval from the FRB. Prior FRB approval is required, however, before the financial holding company may acquire control of more than 5% of the voting shares or substantially all of the assets of a bank holding company, bank or savings association. In addition, under the FRB’s merchant banking regulations, a financial holding company is authorized to invest in companies that engage in activities that are not financial in nature, as long as the financial holding company makes its investment with the intention of limiting the duration of the investment, does not manage the company on a day-to-day basis, and the company does not cross market its products or services with any of the financial holding company’s controlled depository institutions. If any subsidiary bank of a financial holding company receives a rating under the CRA of less than “satisfactory”, then the financial holding company is limited with respect to its engaging in new activities or acquiring other companies, until the rating is raised to at least “satisfactory.”
Other Regulatory Restrictions & Requirements. A bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with the extension of credit, with limited exceptions. There are also various legal restrictions on the extent to which a bank holding company and certain of its non-bank subsidiaries can borrow or otherwise obtain credit from its bank subsidiaries. The Company and its subsidiaries are also subject to certain restrictions on issuance, underwriting and distribution of securities. FRB policy requires a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks. Under this “source of strength doctrine,” a bank holding company is expected to stand ready to use its available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity, and to maintain resources and the capacity to raise capital that it can commit to its subsidiary banks. Furthermore, the FRB has the right to order a bank holding company to terminate any activity that the FRB believes is a serious risk to the financial safety, soundness or stability of any subsidiary bank. Also, under cross-guaranty provisions of the Federal Deposit Insurance Act (FDIA), bank subsidiaries of a bank holding company are liable for any loss incurred by the FDIC insurance fund in connection with the failure of any other bank subsidiary of the bank holding company.
The Company’s bank subsidiaries are subject to a number of laws regulating depository institutions, including the Federal Deposit Insurance Corporation Improvement Act of 1991, which expanded the regulatory and enforcement powers of the federal bank regulatory agencies. These laws require that such agencies prescribe
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Table of Contentsstandards relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, and mandated annual examinations of banks by their primary regulators. The Company’s bank subsidiaries are also subject to a number of consumer protection laws and regulations of general applicability, as well as the Bank Secrecy Act and USA Patriot Act, which is designed to identify, prevent and deter international money laundering and terrorist financing.
The rate of interest a bank may charge on certain classes of loans is limited by law. At certain times in the past, such limitations have resulted in reductions of net interest margins on certain classes of loans. Federal laws also impose additional restrictions on the lending activities of banks, including the amount that can be loaned to one borrower or related group.
All four of the commercial banks owned by the Company are national banks and are subject to supervision and examination by the OCC. In addition, the national banks are subject to examination by The Federal Reserve System. All such banks are members of, and subject to examination by, the FDIC.
Payment of dividends by the Company’s affiliate banks to the Company is subject to various regulatory restrictions. For national banks, the OCC must approve the declaration of any dividends generally in excess of the sum of net income for that year and retained net income for the preceding two years. At December 31, 2007, approximately $24,265,000 of the equity of the Company’s bank and non-bank subsidiaries was available for distribution as dividends to the Company without prior regulatory approval or without reducing the capital of the respective banks below prudent levels.
Each of the Company’s subsidiary banks are subject to the CRA and implementing regulations. CRA regulations establish the framework and criteria by which the bank regulatory agencies assess an institution’s record of helping to meet the credit needs of its community, including low- and moderate-income neighborhoods. CRA ratings are taken into account by regulators in reviewing certain applications made by the Company and its bank subsidiaries.
Regulatory Capital Requirements Applicable to the Company. The FRB has promulgated capital adequacy guidelines for use in its examination and supervision of bank holding companies. If a bank holding company’s capital falls below minimum required levels, then the bank holding company must implement a plan to increase its capital, and its ability to pay dividends and make acquisitions of new bank subsidiaries may be restricted or prohibited. The FRB’s capital adequacy guidelines provide for the following types of capital:
Tier 1 capital, also referred to as core capital, calculated as:
Tier 2 capital, also referred to as supplementary capital, calculated as:
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The maximum amount of supplementary capital that qualifies as Tier 2 capital is limited to 100% of Tier 1 capital.
Total capital, calculated as:
The Company is required to maintain minimum amounts of capital to various categories of assets, as defined by the banking regulators. See Table 13 , Risk-Based Capital, on page 40 for additional detail on the computation of risk-based assets and the related capital ratios.
At December 31, 2007, the Company was required to have minimum Tier 1 capital, Total capital, and leverage ratios of 4.00%, 8.00%, and 4.00% respectively. The Company’s actual ratios at that date were 13.74%, 14.58%, and 9.63%, respectively.
Regulatory Capital Requirements Applicable to the Company’s Subsidiary Banks. In addition to the minimum capital requirements of the FRB applicable to the Company, there are separate minimum capital requirements applicable to its subsidiary national banks.
Federal banking laws classify an insured financial institution in one of the following five categories, depending upon the amount of its regulatory capital:
Federal banking laws require the federal regulatory agencies to take prompt corrective action against undercapitalized financial institutions. The Company’s banks must be well-capitalized and well-managed in
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Table of Contentsorder for the Company to remain a financial holding company. The capital ratios and classifications for the Company and each of the Company’s four banks as of December 31, 2007, are set forth below:
The Company is required to maintain minimum balances with the FRB for each of its subsidiary banks, and no interest is paid by the FRB on such balances. These balances are calculated from reports filed with the respective FRB for each affiliate. At December 31, 2007, the Company held $29,014,000 at the FRB.
Deposit Insurance and Assessments. The deposits of each of the Company’s four subsidiary banks are insured by an insurance fund administered by the FDIC, in general up to a maximum of $100,000 per insured deposit ($250,000 for certain retirement plan deposits). Under federal banking regulations, insured banks are required to pay quarterly assessments to the FDIC for deposit insurance. The FDIC’s risk-based assessment system requires members to pay varying assessment rates depending upon the level of the institution’s capital and the degree of supervisory concern over the institution. As a result of the Federal Deposit Insurance Reform Act of 2005 (FDIRA) signed into law February 8, 2006; the FDIC assessment is now separated into two parts. The first part is the FDIC Insurance with rates ranging from five cents to 43 cents per $100 of insured deposits. The second part is the assessment for the Financing Corporation (FICO) with assessment rates that range from zero cents to 27 cents per $100 of insured deposits. The FDIRA also provided for a one time assessment credit that would be used to pay for the quarterly premiums until the credit is fully used. The Company’s one time assessment credit was $7.3 million, of which $2.2 million was used for premiums assessed in 2007. As of December 31, 2007, the Company has a $5.1 million assessment credit outstanding, which will be used to pay future premiums. The FDIC has authority to increase the annual assessment rate and there is no cap on the annual assessment rate which the FDIC may impose.
Limitations on Transactions with Affiliates. The Company and its non-bank subsidiaries are “affiliates” within the meaning of Sections 23A and 23B of the Federal Reserve Act (FRA). The amount of loans or extensions of credit which a bank may make to non-bank affiliates, or to third parties secured by securities or obligations of the non-bank affiliates, are substantially limited by the FRA and the FDIA. Such acts further restrict the range of permissible transactions between a bank and an affiliated company. A bank and subsidiaries of a bank may engage in certain transactions, including loans and purchases of assets, with an affiliated company only if the terms and conditions of the transaction, including credit standards, are substantially the same as, or at least as favorable to the bank as, those prevailing at the time for comparable transactions with non-affiliated companies or, in the absence of comparable transactions, on terms and conditions that would be offered to non-affiliated companies.
Other Banking Activities. The investments and activities of the Company’s subsidiary banks are also subject to regulation by federal banking agencies, regarding investments in subsidiaries, investments for their own account (including limitations in investments in junk bonds and equity securities), loans to officers, directors and their affiliates, security requirements, anti-tying limitations, anti-money laundering, financial privacy and customer identity verification requirements, truth-in-lending, types of interest bearing deposit accounts offered, trust department operations, brokered deposits, audit requirements, issuance of securities, branching and mergers and acquisitions.
Fiscal & Monetary Policies. The Company’s business and earnings are affected significantly by the fiscal and monetary policies of the federal government and its agencies. It is particularly affected by the policies of the
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Table of ContentsFRB, which regulates the supply of money and credit in the United States. Among the instruments of monetary policy available to the FRB are: conducting open market operations in United States government securities; changing the discount rates of borrowings of depository institutions; imposing or changing reserve requirements against depository institutions’ deposits; and imposing or changing reserve requirements against certain borrowings by banks and their affiliates. These methods are used in varying degrees and combinations to directly affect the availability of bank loans and deposits, as well as the interest rates charged on loans and paid on deposits. The policies of the FRB have a material effect on the Company’s business, results of operations and financial condition.
Future Legislation. Various legislation, including proposals to change the financial institution regulatory system, is from time to time introduced in Congress. This legislation may change banking statutes and the Company’s (and its subsidiaries’) operating environment in substantial and unpredictable ways. If enacted, this legislation could increase or decrease the cost of doing business, limit or expand permissible activities, or affect the competitive balance among banks, savings associations, credit unions and other financial institutions. The Company cannot predict whether any of this potential legislation will be enacted and, if enacted, the effect that it, or any implementing regulations, could have on the business, results of operations or financial condition of the Company or its subsidiaries.
The references in the foregoing discussion to various aspects of statutes and regulations are merely summaries which do not purport to be complete and which are qualified in their entirety by reference to the actual statutes and regulations.
Statistical Disclosure. The information required by Guide 3, “Statistical Disclosure by Bank Holding Companies,” has been included in Items 6, 7, and 7A, pages 17 through 49 of this report.
Executive Officers of the Registrants. The following are the executive officers of the Company, each of whom is elected annually, and there are no arrangements or understandings between any of the persons so named and any other person pursuant to which such person was elected as an officer.
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A discussion of past acquisitions is included in Note 16 to the Consolidated Financial Statements provided in Item 8 on page 80 of this report.
The Company makes available free of charge on its website at www.umb.com/investor, its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to such reports, as soon as reasonably practicable after it electronically files or furnishes such material with or to the SEC.
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Table of ContentsITEM 1A. RISK FACTORS
Our business routinely encounters and addresses risks. Some of such risks may give rise to occurrences that cause our future results to be materially different than we presently anticipate. In the following paragraphs, we describe our present view of certain important strategic risks, although the risks below are not the only risks we face. If any such risks actually occur, our business, results of operations, financial condition and prospects could be affected materially and adversely. These risk factors should be read in conjunction with our management’s discussion and analysis, beginning on page 18 hereof, and our consolidated financial statements, beginning on page 50 hereof.
General economic conditions, such as economic downturns or recessions, could materially impair our customers’ ability to repay loans, harm our operating results and reduce our volume of new loans. Our profitability depends significantly on economic conditions. Economic downturns or recessions, either nationally, internationally or in the states within our footprint, could materially reduce our operating results. An economic downturn could negatively impact demand for our loan and deposit products, the demand for insurance and brokerage products and the amount of credit related losses due to customers who cannot pay interest or principal on their loans. To the extent loan charge-offs exceed our estimates, an increase to the amount of expense provided related to the allowance for loans would reduce income. See “Quantitative and Qualitative Disclosures About Market Risk—Credit Risk” in Part II, Item 7A for a discussion of how we monitor and manage credit risk.
General economic conditions, such as a stock market decline, could materially impair the number of investors in the equity and bond markets, the level of assets under management and the demand for our other fee-based services. Economic downturns or recessions could affect the volume of income from and demand for our other fee-based services. The fee revenue of our asset management segments including income from our Scout Investment Advisors, Inc. and UMB Fund Services, Inc. subsidiaries, are largely dependent on both inflows to, and the fair value of, assets invested in the UMB Scout Funds and the fund clients to whom we provide services. General economic conditions can affect investor sentiment and confidence in the overall securities markets which could adversely affect asset values, net flows to these funds and other assets under management. Our bankcard revenues are dependent on transaction volumes from consumer and corporate spending to generate interchange fees. An economic downturn could negatively affect the amount of such fee income. Our banking services group is affected by corporate and consumer demand for debt securities which can be adversely affected by changes in general economic conditions.
Changes in interest rates could affect our results of operations. A significant portion of our net income is based on the difference between interest earned on earning assets (such as loans and investments) and interest paid on deposits and borrowings. These rates are sensitive to many factors that are beyond our control, such as general economic conditions and policies of various governmental and regulatory agencies, such as the Federal Reserve Board. For example, policies and regulations of the Federal Reserve Board influence, directly and indirectly, the rate of interest paid by commercial banks on their interest-bearing deposits and also may affect the value of financial instruments held by us. The actions of the Federal Reserve Board also determine to a significant degree our cost of funds for lending and investing. In addition, these policies and conditions can adversely affect our customers and counterparties, which may increase the risk that such customers or counterparties default on their obligations to us. Changes in interest rates greatly affect the amount of income earned and the amount of interest paid. Changes in interest rates also affect loan demand, the prepayment speed of loans, the purchase and sale of investment bonds and the generation and retention of customer deposits. A rapid increase in interest rates could result in interest expense increasing faster than interest income because of differences in maturities of assets and liabilities. See “Quantitative and Qualitative Disclosures About Market Risk—Interest Rate Risk” in Part II, Item 7A for a discussion of how we monitor and manage interest rate risk.
We rely on our systems, employees and certain counterparties, and certain failures could adversely affect our operations. Our Company is dependent on our ability to process a large number of increasingly complex transactions. If any of our financial, accounting, or other data processing systems fail or have other
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Table of Contentssignificant shortcomings, we could be adversely affected. We are similarly dependent on our employees. We could be adversely affected if a significant number of our employees are unavailable due to a pandemic, natural disaster, war, act of terrorism, or other reason, or if, an employee causes a significant operational break-down or failure, either as a result of human error, purposeful sabotage or fraudulent manipulation of our operations or systems. Third parties with which we do business could also be sources of operational risk to us, including break-downs or failures of such parties’ own systems or employees. Any of these occurrences could result in a diminished ability of the Company to operate, potential liability to clients, reputational damage and regulatory intervention, which could adversely affect us. Operational risk also includes our ability to successfully integrate acquisitions into existing charters as an acquired entity will most likely be on a different system than ours. See “Quantitative and Qualitative Disclosures About Market Risk—Operational Risk” in Part II, Item 7A for a discussion of how we monitor and manage operational risk.
In a firm as large and complex as the Company, lapses or deficiencies in internal control over financial reporting are likely to occur from time to time and there is no assurance that significant deficiencies or material weaknesses in internal controls may not occur in the future.
In addition, there is the risk that our controls and procedures as well as business continuity and data security systems prove to be inadequate. Any such failure could affect our operations and could adversely affect our results of operations by requiring the Company to expend significant resources to correct the defect, as well as by exposing us to litigation or losses not covered by insurance.
If we do not successfully handle issues that may arise in the conduct of our business and operations our reputation could be damaged, which could in turn negatively affect our business. Our ability to attract and retain customers and transact with its counterparties could be adversely affected to the extent our reputation is damaged. The failure of the Company to deal with various issues that could give rise to reputational risk could cause harm to the Company and our business prospects. These issues include, but are not limited to potential conflicts of interest, legal and regulatory requirements, ethical issues, money-laundering, privacy, recordkeeping, sales and trading practices and proper identification of the legal, reputational, credit, liquidity and market risks inherent in our products. The failure to appropriately address these issues could make our clients unwilling to do business with us, which could adversely affect our results.
We face strong competition from other financial services firms, which could lead to pricing pressures that could materially adversely affect our revenue and profitability. In addition to the challenge of competing against local, regional and national banks in attracting and retaining customers, our competitors also include brokers, mortgage bankers, mutual fund sponsors, securities dealers, investment advisors and specialty finance and insurance companies. The financial services industry is intensely competitive, and we expect it to remain so. We compete on the basis of several factors, including transaction execution, products and services, innovation, reputation and price. We may experience pricing pressures as a result of these factors and as some of our competitors seek to increase market share by reducing prices on products and services or increasing rates paid on deposits.
The shift from paper-based to electronic-based payment business may be difficult and negatively affect earnings. In today’s payment environment, checks continue to be a payment choice; however, checks as a percent of the total payment volume are declining and the payment volume is shifting to electronic alternatives. Check products are serviced regionally due to the physical constraints of the paper document; however, electronic documents are not bound by the same constraints, thus opening the geographic markets to all providers of electronic services. To address this shift, new systems are being developed and marketed which involve significant software and hardware costs. It is anticipated that we will encounter new competition, and any competitor that attracts the payments business of our existing customers will compete strongly for the remainder of such customers’ banking business.
We are subject to extensive regulation in the jurisdictions in which we conduct our businesses. We are subject to extensive state and federal regulation, supervision and legislation that govern most aspects of our
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Table of Contentsoperations. Laws and regulations, and in particular banking, securities and tax laws, may change from time to time. For example, current federal law prohibits the payment of interest on corporate demand deposit accounts. Although a change to permit interest on corporate accounts would have a favorable impact on service-charge income, it would adversely affect net interest income as the cost of funds would increase. Changes in laws and regulations, lawsuits or actions by regulatory agencies could cause us to devote significant time and resources to compliance and could lead to fines, penalties, judgments, settlements, withdrawal of certain products or services offered in the market or other results adverse to us which could affect our business, financial condition or results of operation, or cause us serious reputational harm.
Our framework for managing our risks may not be effective in mitigating risk and loss to the Company. Our risk management framework is made up of various processes and strategies to manage our risk exposure. Types of risk to which we are subject include liquidity risk, credit risk, price risk, interest rate risk, operational risk, compliance and litigation risk, foreign exchange risk, and reputation risk and fiduciary risk, among others. There can be no assurance that our framework to manage risk, including such framework’s underlying assumptions, will be effective under all conditions and circumstances. If our risk management framework proves ineffective, we could suffer unexpected losses and could be materially adversely affected.
Liquidity is essential to our businesses and we rely on the securities market and other external sources to finance a significant portion of our operations. Liquidity affects our ability to meet our financial commitments. Our liquidity could be negatively affected should the need arise to increase deposits or obtain additional funds through borrowing to augment current liquidity sources. Factors that we cannot control, such as disruption of the financial markets or negative views about the general financial services industry could impair our ability to raise funding. If we are unable to raise funding using the methods described above, we would likely need to sell assets, such as our investment and trading portfolios, to meet maturing liabilities. We may be unable to sell some of our assets on a timely basis, or we may have to sell assets at a discount from market value, either of which could adversely affect our results of operations. Our liquidity and funding policies have been designed to ensure that we maintain sufficient liquid financial resources to continue to conduct our business for an extended period in a stressed liquidity environment. If our liquidity and funding policies are not adequate, we may be unable to access sufficient financing to service our financial obligations when they come due, which could have a material adverse franchise or business impact. See “Quantitative and Qualitative Disclosures About Market Risk—Liquidity Risk” in Part II, Item 7A for a discussion of how we monitor and manage liquidity risk.
Inability to hire or retain qualified employees could adversely affect our performance. Our people are our most important resource and competition for qualified employees is intense. Employee compensation is our greatest expense. We rely on key personnel to manage and operate our business, including major revenue generating functions such as our loan and deposit portfolios. The loss of key staff may adversely affect our ability to maintain and manage these portfolios effectively, which could negatively affect our results of operations. If compensation costs required to attract and retain employees become unreasonably expensive, our performance, including our competitive position, could be adversely affected.
Changes in accounting standards could impact reported earnings. The accounting standard setting bodies, including the Financial Accounting Standards Board and other regulatory bodies periodically change the financial accounting and reporting standards affecting the preparation of our consolidated financial statements. These changes are not within our control and could materially impact our consolidated financial statements.
Future events may be different than those anticipated by our management assumptions and estimates, which may cause unexpected losses in the future. Pursuant to current Generally Accepted Accounting Principles, we are required to use certain estimates in preparing our financial statements, including accounting estimates to determine loan loss reserves, and the fair value of certain assets and liabilities, among other items. Should our determined values for such items prove substantially inaccurate we may experience unexpected losses which could be material.
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Table of ContentsITEM 1B. UNRESOLVED STAFF COMMENTS
There are no unresolved comments from the staff of the SEC required to be disclosed herein as of the date of this Form 10-K.
ITEM 2. PROPERTIES
The Company’s headquarters building, the UMB Bank Building, is located at 1010 Grand Boulevard in downtown Kansas City, Missouri, and opened during July 1986. Of the 250,000 square feet, 218,000 square feet is occupied by departments and customer service functions of UMB Bank n.a. as well as offices of the parent company, UMB Financial Corporation. The remaining 32,000 square feet of space within the building is either leased or available for lease to third parties. Presently, the Company is seeking to lease 9,000 square feet of the headquarters building.
Other main facilities of UMB Bank, n.a. in downtown Kansas City, Missouri are located at 928 Grand Boulevard (185,000 square feet); 906 Grand Boulevard (140,000 square feet); and 1008 Oak Street (180,000 square feet). The 928 Grand and 906 Grand buildings house backroom support functions. The 928 Grand building underwent a major renovation during 2004/2005. The 928 Grand building is connected to the UMB Bank Building (1010 Grand) by an enclosed elevated pedestrian walkway. The 1008 Oak building, which opened during the second quarter of 1999, houses the Company’s operations and data processing functions.
UMB Bank, n.a. leases 64,263 square feet in the Equitable Building located in the heart of the commercial sector of downtown St. Louis, Missouri. This location has a full-service banking center and is home to some operational and administrative support functions.
UMB Bank, Colorado, n.a. leases 9,003 square feet on the first and third floors of the 1670 Broadway building located in the financial district of downtown Denver, Colorado. The location has a full-service banking center and is home to the operational and administrative support functions for UMB Bank, Colorado, n.a.
UMB Fund Services, Inc., a subsidiary of the Company, leases 72,135 square feet in Milwaukee, Wisconsin, at which its fund services operation is headquartered.
As of December 31, 2007, the Company’s affiliate banks operated a total of four main banking centers with 135 detached branch facilities, the majority of which are owned by the Company.
Additional information with respect to premises and equipment is presented in Note 1 and 8 to the Consolidated Financial Statements in Item 8, pages 56 and 66 of this report.
ITEM 3. LEGAL PROCEEDINGS
In the normal course of business, the Company and its subsidiaries are named defendants in various lawsuits and counter-claims. In the opinion of management, after consultation with legal counsel, none of these lawsuits are expected to have a materially adverse effect on the financial position, results of operations, or cash flows of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to the shareholders for a vote during the fourth quarter ended December 31, 2007.
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Table of Contents
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The Company’s stock is traded on the NASDAQ Stock Market (specifically the NASDAQ Global Select Market) under the symbol “UMBF.” As of February 21, 2008, the Company had 1,917 shareholders of record. Company stock information for each full quarter period within the two most recent fiscal years is set forth in the table below.
Information concerning restrictions on the ability of the Registrant to pay dividends and the Registrant’s subsidiaries to transfer funds to the Registrant is presented in Item 1, page 7 and Note 10 to the Consolidated Financial Statements provided in Item 8, pages 68 and 69 of this report. Information concerning securities the Company issued under equity compensation plans is contained in Item 12, pages 92 and 93 in Note 11 to the Consolidated Financial Statements provided in Item 8, pages 69 through 73 of this report.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
The following table provides information about share repurchase activity by the Company during the quarter ended December 31, 2007:
ISSUER PURCHASE OF EQUITY SECURITIES
On April 24, 2007 the Company announced a plan to repurchase up to two million shares of common stock. This plan will terminate on April 24, 2008. The Company has not made any repurchases other than through this
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Table of Contentsplan, which permits both open market and privately negotiated transactions. All open market share purchases under the share repurchase plans are intended to be within the scope of Rule 10b-18 promulgated under the Securities Exchange Act of 1934. Rule 10b-18 provides a safe harbor for purchases in a given day if the Company satisfies the manner, timing and volume conditions of the rule when purchasing its own common shares.
On April 25, 2006, the Company announced an amendment to the Company’s Articles of Incorporation authorizing an increase in the Company’s authorized shares of common stock from 33 million shares to 80 million shares. The Board of Directors subsequently declared a two-for-one stock split of UMB Financial Corporation common stock. On May 30, 2006, 21,430,099 of shares were distributed to shareholders of record on May 16, 2006.
ITEM 6. SELECTED FINANCIAL DATA
For a discussion of factors that may materially affect the comparability of the information below, please see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, pages 18 through 43, of this report.
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Table of ContentsFIVE-YEAR FINANCIAL SUMMARY (in thousands except per share data)
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
MANAGEMENT’S DISCUSSION AND ANALYSIS
The following presents management’s discussion and analysis of the Company’s consolidated financial condition, changes in condition, and results of operations. This review highlights the major factors affecting results of operations and any significant changes in financial conditions for the three-year period ended December 31, 2007. It should be read in conjunction with the accompanying Consolidated Financial Statements and other financial statistics appearing elsewhere in the report.
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Table of ContentsSPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS
The information included or incorporated by reference in this report contains forward-looking statements of expected future developments within the meaning of and pursuant to the safe harbor provisions established by Section 21E of the Securities Exchange Act of 1934, as amended by the Private Securities Litigation Reform Act of 1995. These forward-looking statements may refer to financial condition, results of operations, plans, objectives, future financial performance and business of the Company, including, without limitation:
Forward-looking statements are not guarantees of future performance or results. You are cautioned not to put undue reliance on any forward-looking statement which speaks only as of the date it was made. Forward-looking statements reflect management’s expectations and are based on currently available data; however, they involve risks, uncertainties and assumptions. Actual results may differ materially from those contemplated by the forward-looking statements due to, among others, the following factors:
Any forward-looking statements should be read in conjunction with information about risks and uncertainties set forth in this report and in documents incorporated herein by reference. Forward-looking statements speak only as of the date they are made, and the Company does not intend to review or revise any particular forward-looking statement in light of events that occur thereafter or to reflect the occurrence of unanticipated events.
Results of Operations
Overview
The Company continues to focus on the following five strategies which management believes will improve net income and strengthen the balance sheet.
The first strategy is a focus on net interest income. This is a multi-pronged strategy emphasizing the investment portfolio, loan portfolio and deposit base. During 2007, progress on this strategy was illustrated by an
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Table of Contentsincrease in net interest income of 7.1 percent from the previous year. This was accomplished through earning asset growth, as well as an overall increase in net interest margin. Average earning assets increased by $352.1 million, or 5.2 percent, from 2006. Most of this earning asset growth was through average loan growth of $322.2 million, or 9.0 percent. The mix of earning assets improved as a larger percentage of earning assets consisted of higher yielding loans. In part, the mix was affected by the Company’s decision to run-off the indirect auto loan portfolio and focus on higher yielding loan products. Average loans comprised 54.9 percent of average earning assets during 2007 compared to 53.0 percent in the prior year. Further, the average loan-to-deposit ratio was 68.3 percent in 2007 as compared to 65.2 percent in 2006. Net interest margin, on a tax-equivalent basis, increased 6 basis points as compared to 2006. Net interest spread increased 5 basis points from 2006 and the contribution from interest-free-funds increased 1 basis point.
The second strategy is to grow the Company’s fee-based businesses. The Company believes this strategy will help compensate for the average loan-to-deposit ratio of the Company’s subsidiary banks, which has been, and is expected to continue to be, lower than industry average. The Company continues to emphasize its fee-based operations to help reduce the Company’s exposure to changes in interest rates. During 2007, noninterest income increased $33.8 million, or 13.3 percent, as compared to 2006. The increase in noninterest income was attributable to higher trust and securities processing income and service charges on deposits. Additionally, the increase included a $7.2 million net gain on the sale of the securities transfer product. The Company continues to emphasize its asset management, credit card, health care services, and payments businesses. The focus in asset management continues to show improvement and is discussed in the fourth strategy below. Trust and securities processing increased $17.3 million, or 17.6 percent. This increase was primarily due to the increase in total assets under management by the UMB Scout Funds as discussed in the fourth strategy below. Service charges on deposits increased by $6.3 million, or 8.5 percent during 2007 due mostly to greater individual overdraft and return item charges. The Company also continues to focus on its wholesale health savings and flexible spending account strategy by servicing healthcare providers, third-party administrators and large employers.
The third strategy is to leverage the Company’s distribution network. At the end of 2007, the Company had 135 branches. Repositioning and increasing utilization of our regional distribution network remains a priority. In both St. Louis and Denver, the Company hired new leadership and sales support to focus on asset management and corporate trust. The Company’s focus is to provide a broad offering of services through our existing branch network. Although the Company decreased branches by a net of 4, the Company’s average deposits increased 4.1 percent from 2006.
The fourth strategy is to strengthen the asset management business of the Company. In particular, the focus is to continue growing the UMB Scout Funds (which are a family of proprietary mutual funds managed by a subsidiary of the Company) by adding and offering new products, achieving strong performance, and leveraging distribution networks. The Company continues to develop an investment advisory model. To that end, the Company will continue to evolve proprietary and non-proprietary products and services to support this approach. In addition, the Company continues to integrate private banking, wealth solutions, and brokerage capabilities for our customers. Total assets under management increased 8.6 percent to $11.0 billion, from $10.1 billion at the end of 2006. Leading this growth is the Company’s proprietary family of mutual funds, which continue to play a key role. Total assets in the UMB Scout Funds increased 16.4 percent from $5.0 billion at the end of 2006, to $5.8 billion at the end of 2007. As some of the revenue from the Company’s asset management business is the direct result of the market value of its customers’ investments, the overall health of the equity and financial markets continues to play an important role in the recognition of fee income as discussed in the Business Segment section on pages 30 through 32 below. Another important part of the Company’s asset management strategy is the implementation of an integrated wealth management business model. With twelve client managers, Private Banking has more than $47 million in loans and nearly $136 million in deposits. Brokerage fee income has been another strong performer. Brokerage services provided strong results with an increase of $1.8 million, or 28.8 percent, as compared to 2006.
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Table of ContentsThe fifth strategy is a focus on capital management. The Company places a significant emphasis on the maintenance of a strong capital position, which management believes promotes investor confidence, provides access to funding sources under favorable terms, and enhances the Company’s ability to capitalize on business growth and acquisition opportunities. The Company repurchased 1.1 million shares of common stock at an average price of $39.37 per share during 2007. Further, the Company increased dividends during 2007 to $23,854,000 ($0.57 per share), compared to $21,978,000 ($0.52 per share) in 2006. This was a 9.6 percent increase in per share dividends during 2007 as compared to 2006. At the end of 2007, the Company had a total risk-based capital ratio of 14.58 percent, which is substantially higher than the 10 percent regulatory minimum to be considered well-capitalized.
Earnings Summary
The Company recorded consolidated net income of $74.2 million for the year ended December 31, 2007. This represents a 24.2 percent increase over 2006. Net income for 2006 increased 6.1 percent compared to 2005. Basic earnings per share for the year ended December 31, 2007 were $1.78 per share compared to $1.40 per share in 2006 and $1.31 per share in 2005. Basic earnings per share for 2007 increased 27.1 percent over 2006 per share earnings, which had increased 6.9 percent over 2005. Fully diluted earnings per share for the year ended December 31, 2007, were $1.77 per share compared to $1.40 per share in 2006 and $1.30 per share in 2005.
The Company’s net interest income increased to $232.7 million in 2007 compared to $217.2 million in 2006 and $188.3 million in 2005. The $15.5 million increase in net interest income in 2007 as compared to 2006 is primarily a result of both a favorable rate and volume variance. See Table 1 on page 23. The favorable volume variance was led by a 9.0 percent increase in the average balance of loans and loans held for sale. Net interest spread improved by 5 basis points in 2007 as compared to 2006. The rate variance remained positive and continues to benefit from interest-free funds. The impact of this benefit is illustrated on Table 2 on page 24. The $28.9 million increase in net interest income in 2006 as compared to 2005 is primarily a result of both a favorable rate and volume variance. The volume variance was mostly driven by a 14.3 percent increase in loans and loans held for sale in 2006 as compared to 2005. Although the net interest spread declined by 7 basis points in 2006 as compared to 2005, the rate variance was positive and benefited from interest-free funds. The current credit environment has made it difficult to anticipate the future of the Company’s margins. If rates stay at current levels or continue to decline, the Company anticipates a negative impact to interest income as a result of the repricing of assets and liabilities. The magnitude of this impact will be largely dependent upon the Federal Reserve’s policy decisions and market movements. See Table 15 on page 45 for an illustration of the impact of a rate increase or decrease on net interest income as of December 31, 2007.
The Company had an increase of $33.8 million, or 13.3 percent, in noninterest income in 2007 as compared to 2006 and a $3.1 million, or 1.2 percent, increase in 2006 compared to 2005. During 2007, the increase in noninterest income is attributable to higher trust and securities processing income, service charges on deposits, and the gain on the sale of the securities transfer product. Trust and securities processing increased $17.3 million, or 17.6 percent. This increase in trust and securities processing income was primarily due to the increase in total assets under management, which increased 8.6 percent to $11.0 billion, from $10.1 billion at the end of 2006. Service charges on deposits increased by $6.3 million, or 8.5 percent during 2007 due mostly to greater individual overdraft and return item charges. During 2007, the Company recognized a $7.2 million net gain on the sale of the securities transfer product. The increase in noninterest income in 2007 from 2006, and 2006 from 2005 is illustrated on Table 5 on page 27.
Noninterest expense increased in 2007 by $25.7 million, or 6.8 percent, compared to 2006 and increased in 2006 by $23.3 million, or 6.5 percent, compared to 2005. Categories of noninterest expense with the most significant increases in 2007 as compared to 2006 include salaries and employee benefits (due to higher base salaries and increased commissions and bonuses related to our improved financial performance for the year and partially due to increases in employee benefit expenses), a covered litigation provision (due to the Company’s
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Table of Contentsestimated share of Visa, Inc.’s covered litigation), and equipment (primarily due to higher depreciation and maintenance costs associated with technology investments). The increase in noninterest income in 2007 from 2006, and 2006 from 2005 is illustrated on Table 6 on page 29.
Net Interest Income
Net interest income is a significant source of the Company’s earnings and represents the amount by which interest income on earning assets exceeds the interest expense paid on liabilities. The volume of interest earning assets and the related funding sources, the overall mix of these assets and liabilities, and the rates paid on each affect net interest income. Table 1 summarizes the change in net interest income resulting from changes in volume and rates for 2007, 2006 and 2005.
Net interest margin is calculated as net interest income on a fully tax equivalent basis (FTE) as a percentage of average earning assets. A critical component of net interest income and related net interest margin is the percentage of earning assets funded by interest free funding sources. Table 2 analyzes net interest margin for the three years ended December 31, 2007, 2006 and 2005. Net interest income, average balance sheet amounts and the corresponding yields earned and rates paid for the years 2005 through 2007 are presented in a table following the footnotes to the Consolidated Financial Statements. Net interest income is presented on a tax-equivalent basis to adjust for the tax-exempt status of earnings from certain loans and investments, which are primarily obligations of state and local governments.
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Table of ContentsTable 1
RATE-VOLUME ANALYSIS (in thousands)
This analysis attributes changes in net interest income either to changes in average balances or to changes in average rates for earning assets and interest-bearing liabilities. The change in net interest income is due jointly to both volume and rate and has been allocated to volume and rate in proportion to the relationship of the absolute dollar amount of the change in each. All rates are presented on a tax-equivalent basis and give effect to the disallowance of interest expense for federal income tax purposes, related to certain tax-free assets. The loan average balances and rates include nonaccrual loans.
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Table of ContentsTable 2
ANALYSIS OF NET INTEREST MARGIN (in thousands)
The Company experienced an increase in net interest income of $15.5 million, or 7.1 percent, for the year 2007 compared to 2006. This follows an increase of $28.9 million, or 15.4 percent, for the year 2006 compared to 2005. As illustrated in Table 1, the 2007 increase is due to both a favorable volume and a favorable rate variance. The most significant portion of this favorable volume variance is associated with higher loan balances in both 2007 and 2006. In 2006, the federal funds sold and resell agreements contributed to the favorable volume variance. The favorable volume and rate variances for earning assets were partially offset by corresponding higher volume and rate variances on the liability side of the balance sheet. Deposit gathering campaigns during late 2006 and 2007 increased both deposit balances and the rates paid on those balances. Even though the Company experienced continued rate competition throughout 2007, it only experienced slight rate increases for deposits due primarily to the rate decreases made by the Federal Reserve’s Open Market Committee.
The increase in the cost of funds has also increased the favorable impact from the benefit of interest-free funds. The Company has a significant portion of its deposit funding with noninterest-bearing demand deposits. Noninterest-bearing demand deposits represented 32.0 percent, 36.3 percent and 34.7 percent of total outstanding deposits at December 31, 2007, 2006 and 2005, respectively. As illustrated on Table 2, the impact from these interest-free funds was 90 basis points in 2007, compared to 89 basis points in 2006 and 60 basis points in 2005. Although the amount of these deposits has gone down as a percent of total deposits, the increase in the cost of funds causes the overall benefit to increase.
The 2006 increase in net interest income over 2005 is primarily due to both a favorable volume and a favorable rate variance. In addition to the significant favorable volume variance associated with higher loan balances in 2006, federal funds sold and resell agreements contributed to the favorable volume variance. The increase in interest rates during 2006 had a favorable impact on the rate variance for earning assets, which was mostly offset by the increase in rates repricing liabilities.
The Company has experienced a repricing of a majority of its liabilities during the recent interest rate cycle and continues to have its assets reprice. Loans have increased from an average of $3.6 billion in 2006 to an average of $3.9 billion in 2007. Loan-related earning assets tend to generate a higher spread than those earned in the Company’s investment portfolio. By design, the Company’s investment portfolio is relatively short in duration and liquid in its composition of assets. If the Federal Reserve’s Open Market Committee maintains rates at current levels or they continue to decline, the Company anticipates a negative impact to interest income as a result of this repricing. The magnitude of this impact will be largely dependent upon the Federal Reserve’s policy decisions and market movements.
During 2008, approximately $615 million of securities are expected to mature and be reinvested. This includes approximately $182 million which will mature during the first quarter of 2008. In late 2004,
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Table of Contentsmanagement adopted a portfolio modification plan designed to improve interest income by extending the average life of its investment portfolio. The Company implemented this extension strategy throughout 2005 and 2006. The total investment portfolio had an average life of 29.3 months and 28.9 months as of December 31, 2007 and December 31, 2006, respectively. It should be noted that the Company has a significant portfolio of extremely short-term discount notes as of the end of both 2007 and 2006. These securities are held due to the seasonal fluctuation related to public fund deposits which are expected to flow out of the bank in a relatively short period. At December 31, 2007, the amount of such discount notes was approximately $724 million, and without these discount notes, the average life of the core investment portfolio would have been 37.1 months. At December 31, 2006, the amount of such discount notes was approximately $608 million, and without these discount notes, the average life of the core investment portfolio would have been 35.3 months. Therefore, the core investment portfolio, without the short-term discount notes, had an increase in average life of 1.7 months in 2007.
Provision and Allowance for Loan Losses
The allowance for loan losses (ALL) represents management’s judgment of the losses inherent in the Company’s loan portfolio as of the balance sheet date. An analysis is performed quarterly to determine the appropriate balance of the ALL. This analysis considers items such as historical loss trends, a review of individual loans, migration analysis, current economic conditions, loan growth and characteristics, industry or segment concentration and other factors. This analysis is performed separately for each bank as regulatory agencies require that the adequacy of the ALL be maintained on a bank-by-bank basis. After the balance sheet analysis is performed for the ALL, the provision for loan losses is computed as the amount required to adjust the ALL to the appropriate level.
As illustrated on Table 4 below, the ALL slightly declined to 1.17% of total loans as of December 31, 2007 compared to 1.20% of total loans as of December 31, 2006. Based on the factors above, management of the Company expensed an additional $0.6 million, or 6.9 percent, related to the provision for loan losses in 2007 as compared to 2006. This compares to a $3.0 million, or 51.2 percent increase in the provision for loan losses in 2006 as compared to 2005.
As shown in Table 3, the ALL has been allocated to various loan portfolio segments. The Company manages the ALL against the risk in the entire loan portfolio and therefore, the allocation of the ALL to a particular loan segment may change in the future. Management of the Company believes the present ALL is adequate considering the Company’s loss experience, delinquency trends and current economic conditions, and does not anticipate material increases in the ALL or in the level of provisions to the ALL in the near future. Future economic conditions and borrowers’ ability to meet their obligations, however, are uncertainties which could affect the Company’s ALL and/or need to change its current level of provision.
Table 3
ALLOCATION OF ALLOWANCE FOR LOAN LOSSES (in thousands)
This table presents an allocation of the allowance for loan losses by loan categories. The breakdown is based on a number of qualitative factors; therefore, the amounts presented are not necessarily indicative of actual future charge-offs in any particular category.
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Table of ContentsTable 4 presents a five-year summary of the Company’s ALL. Also, please see “Quantitative and Qualitative Disclosures About Market Risk—Credit Risk” on pages 47 and 48 in this report for information relating to nonaccrual, past due, restructured loans, and other credit risk matters.
Table 4
ANALYSIS OF ALLOWANCE FOR LOAN LOSSES (in thousands)
Noninterest Income
A key objective of the Company is the growth of noninterest income to enhance profitability and provide steady income, as fee-based services are typically non-credit related and are not generally affected by fluctuations in interest rates. Noninterest income increased $33.8 million, or 13.3 percent, in 2007 as compared to 2006. During 2007, the Company recognized a $7.2 million net gain on the sale of the securities transfer product. However, the majority of the increase is attributable to higher trust and securities processing income and service charges on deposits. Trust and securities processing increased $17.3 million, or 17.6 percent. This increase in trust and securities processing income was primarily due to the increase in total assets under management, which increased 8.6 percent to $11.0 billion, from $10.1 billion at the end of 2006. Service charges on deposits increased by $6.3 million, or 8.5 percent, during 2007 due mostly to greater individual overdraft and return item
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Table of Contentscharges. Brokerage services also provided strong results with an increase of $1.8 million, or 28.8 percent, as compared to 2006.
The Company’s fee-based services provide the opportunity to offer multiple products and services to customers which management believes will more closely align the customer with the Company. The Company’s ongoing focus is to continue to develop and offer multiple products and services to its customers. The Company is currently emphasizing fee-based services including trust and securities processing, bankcard, securities trading/brokerage and cash/treasury management. Management believes that it can offer these products and services both efficiently and profitably, as most of these have common platforms and support structures. An example of this support structure is the implementation of an integrated wealth management business model. With twelve client managers, Private Banking has more than $47 million in loans and nearly $136 million in deposits. These Private Banking relationships provide an excellent opportunity to offer the client the Company’s fee-based services.
Table 5
SUMMARY OF NONINTEREST INCOME (in thousands)
Noninterest income and the year-over-year changes in noninterest income are summarized in Table 5 above. The dollar change and percent change columns highlight the respective net increase or decrease in the categories of noninterest income in 2007 as compared to 2006 and in 2006 as compared to 2005.
Trust and securities processing income consists of fees earned on personal and corporate trust accounts, custody of securities services, trust investments and money management services, and mutual fund assets servicing. These fees increased year-over-year for the past two years by 17.6 percent and 19.2 percent, respectively. The increase in trust and securities processing fees in 2007 as compared to 2006 was primarily a result of a $6.4 million increase in management fees earned by Scout Investment Advisors, Inc. (a subsidiary of the Company) and specifically related to the UMB Scout Funds, which are a family of proprietary mutual funds managed by Scout Investment Advisors, Inc. These fees are related to the total assets under management of these funds. The total assets under management for the UMB Scout Funds were $5.8 billion at December 31, 2007 as compared to $5.0 billion at December 31, 2006. Additionally, there was approximately a $6.0 million increase in
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Table of Contentsfund administration fees earned by UMB Fund Services. Trust and securities processing fees and fund administration fees were also the primary reasons for the respective increases in this category in 2006 as compared to 2005. As the income from these two services is highly correlated to the market value of assets, the related income will be affected by changes in the securities markets. Management continues to emphasize sales of services to both new and existing clients as well as increasing and improving the distribution channels which lead to increased inflows into the UMB Scout Funds.
Service charges on deposit accounts increased by 8.5 percent in 2007 as compared to 2006, whereas this category decreased by 7.3 percent in 2006 as compared to 2005. The increase in 2007 is due mostly to the greater individual overdrafts and return item charges. Pricing increases and changes (such as improved technology) in overdraft and collection procedures have been the primary reasons for this increase in 2007. The decrease in 2006 is primarily attributable to a decline in corporate service charge income, which was partially offset by an increase in overdraft and return item charges.
Brokerage fees increased $1.8 million, or 28.8 percent, and $0.3 million, or 5.0 percent, in 2007 and 2006, respectively. Management’s continued focus on its distribution network and the commercial customer base has yielded these improved results. The increase in brokerage fees in 2006 as compared to 2005 was primarily attributable to institutional money market and other asset-backed fee income.
Bankcard fees increased by 3.1 percent and 16.2 percent in 2007 and 2006, respectively. The increase in both years reflects both higher card volume and a greater average transaction dollar amount. In 2005, the credit card rebate programs were modified to encourage increased usage by both consumer and commercial customers. To illustrate the success of this program, commercial cardholder volume increased 22.6 percent in 2007.
During the third quarter of 2007, the Company sold the security transfer product to a third party for a net gain of $6.9 million. The agreement included residual payments not to exceed an additional $1.9 million, which the Company can receive if certain revenue targets are met over the twelve month period after the sale date. The agreement also included the sharing of certain revenues and expenses related to the transition of services and employees. During the fourth quarter of 2007, a residual payment of $0.7 million was received.
Other income decreased by 11.5 percent in 2006 as compared to 2005. This decrease was primarily a result of several reductions in miscellaneous fee income for such items as consulting fees with correspondent banks, home banking fees due to the switch to free on-line bill pay products, and a decrease in net fees related to selling mortgage loans. This category of income remained flat in 2007 as compared to 2006.
Noninterest Expense
Noninterest expense increased in both 2007 and 2006 as compared to the respective prior years. Table 6 below summarizes the components of noninterest expense and the respective year-over-year changes for each category.
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Table of ContentsTable 6
SUMMARY OF NONINTEREST EXPENSE (in thousands)
Salaries and employee benefits expense increased by 6.7 percent and 2.0 percent in 2007 and 2006, respectively. The increase in 2007 is primarily due to higher base salaries and an increase in commissions, bonuses and stock compensation expenses related to our improved financial performance for the year. During 2007, the Company also experienced increases in employee benefit expenses to include a $1.1 million increase in the Company match of the 401(k) and profit sharing plan and a $0.7 million increase in health insurance costs associated with the Company’s self-funded insurance plan. This increase in 2006 is attributable to several items including a $1.3 million increase in equity-based compensation as a result of the implementation of Statement of Financial Accounting Standards (SFAS) No. 123 (R), “Share-Based Payment”; a $1.8 million increase in the Company match of the 401(k) and profit sharing plan in 2006; and a $1.6 million increase in health insurance costs associated with the Company’s self-funded insurance plan.
Equipment costs increased by 7.6 percent and 11.2 percent in 2007 and 2006, respectively. For both years, the equipment costs increased primarily due to additional depreciation, amortization and maintenance on major software upgrades and acquisitions implemented during 2005, 2006 and early 2007. These projects include Check 21 imaging software, WebExchangeSM commercial treasury management software upgrades, voice-over internet protocol software, interactive voice response software upgrades, customer relationship management software, and the umb.com upgrade. Management anticipates that although the investment in technology will continue during 2008, it will occur at a decreasing rate.
Processing fees increased by 5.5 percent and 19.9 percent in 2007 and 2006, respectively. The increase in both years is primarily attributable to an increase in shareholder servicing and other administration fees paid to investment advisors related to the UMB Scout Funds as a result of increases in assets under management for both years. The amount of such fees paid in future years is dependent upon assets under management (affected by both fund inflows as well as market values), and is expected to generally correlate to trends in the equity markets. Additional processing fee increases in 2007 as compared to 2006 are attributable to third party custodial fees related to international transactions from mutual fund clients.
During the fourth quarter of 2007, the Company, as a member of Visa U.S.A. Inc. (Visa USA), received shares of restricted stock in Visa, Inc. (Visa) as a result of its participation in the global restructuring of Visa U.S.A., Visa Canada Association, and Visa International Service Association, in preparation for an initial public offering. Based on this participation, the Company and other Visa USA member banks became aware of an
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Table of Contentsobligation to provide indemnification to Visa in connection with its potential losses resulting from “covered litigation” as described in Visa’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC) on December 21, 2007.
The Company has recorded a pre-tax provision of $4.6 million as an estimate of its contingent indemnification liability to Visa, based upon its proportionate interest in Visa. Of this amount, $2.8 million relates to covered litigation which Visa has already settled. The remaining portion of the provision represents the Company’s estimate of the fair value of its contingent indemnification liability relating to the covered litigation which has not yet been settled or resolved. In accordance with generally accepted accounting principles, the Company’s estimates have been established based on available information with regard to Visa’s covered litigation. As new information becomes available, the Company will make any necessary adjustments to the provision.
As disclosed in Visa’s Form 8-K filed with the SEC on November 9, 2007, Visa intends that payments related to the covered litigation will be funded by Visa from an escrow account to be established with a portion of the proceeds from its planned initial public offering. However, there is no assurance that an initial public offering will occur or that the escrowed funds will be sufficient to relieve the covered litigation liability.
Other expenses increased in both 2007 and 2006. The increase in 2006 as compared to 2005 is primarily due to a $2.4 million increase in miscellaneous operational charge-offs. The remaining increase was mostly due to higher directors’ fees in 2006 as compared to 2005. During 2007, other expenses increased slightly as compared to 2006.
Income Taxes
Income tax expense totaled $30.8 million, $22.3 million and $20.0 million in 2007, 2006 and 2005, respectively. These amounts equate to effective rates of 29.3 percent, 27.1 percent, and 26.2 percent for 2007, 2006 and 2005, respectively. The primary reason for the difference between the Company’s effective tax rate and the statutory tax rate is the effect of non-taxable income from municipal securities and state and federal tax credits realized. The increase in the effective tax rate in 2007 and 2006 was primarily a result of tax-exempt income representing a smaller percentage of pre-tax net income.
Business Segments
The Company’s operations are strategically aligned into six major segments: Commercial Banking and Lending, Payment and Technology Solutions, Banking Services, Consumer Services, Asset Management, and Investment Services Group. The segments are differentiated by both the customers served and the products and services offered. Note 13 to the Consolidated Financial Statements describes how these segments are identified and presents financial results of the segments for the years ended December 31, 2007, 2006 and 2005. The Treasury and Other Adjustments category includes items not directly associated with any other segment.
Commercial Banking and Lending’s 2007 pre-tax net income increased from 2006 by $1.8 million, or 8.3 percent, to $23.7 million. In 2006, the pre-tax net income increased from 2005 by $2.2 million, or 11.2 percent, to $21.9 million. For 2007, the increase in net income was driven primarily by a greater net interest income of $2.5 million due mostly to higher loan volume and increased margin. The provision for loan losses decreased $2.0 million as the allowance for loan losses in this segment was adequately funded for the inherent risk in the loan portfolio. Noninterest expense increased $3.4 million, or 12.4 percent, from 2006. The increase was mostly attributable to increases in salary expense and to allocated technology costs associated with a customer relationship management system that aids in sales management, the identification of cross sale opportunities, and overall knowledge of a client’s banking relationship. The increase in pre-tax net income in 2006 as compared to 2005 was primarily a result of a $4.8 million increase in net interest income as a result of increased loan volume and increased margin. This was offset by an increase of $2.3 million in provision for loan losses and a $1.2
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Table of Contentsmillion increase in noninterest expense. Management anticipates continued competition for commercial loans in 2008 and, therefore, expects income growth in this segment to be at a measured pace during 2008.
Payment and Technology Solutions’ pre-tax net income increased $11.0 million, or 33.9 percent, to $43.4 million in 2007, as compared to an increase of $5.0 million, or 18.3 percent, to $32.4 million in 2006. A component of the increase in 2007 was the net gain on the sale of the securities transfer product, which contributed $7.2 million. The remainder of the increase in 2007 and the increase in 2006 was largely due to higher net interest income related to higher margins and improved noninterest income due to volume in the healthcare and commercial card services products. Net interest income increased by $5.3 million, or 9.5 percent, in 2007 as compared to 2006, and increased by $9.1 million, or 19.6 percent, in 2006 as compared to 2005. The increases in net interest income were primarily attributable to higher fund transfer pricing rates on deposits from this segment. In 2006, noninterest income within this segment decreased primarily from a reduction in deposit service charge income, but was partially offset by significant percentage increases in both healthcare income and commercial card income. In 2007, the healthcare income and commercial card income continued to improve as evidenced by the improvement in noninterest income. Challenges for this segment arise from competitive pressures, as well as the technological challenges due to the movement from paper to electronic processing. The Company has focused significant resources into creating and enhancing products and services to keep the Company in step with the clients’ changing needs. The primary example of this investment was the introduction of WebExchangeSM, an upgraded online banking software for businesses, in 2006. Investments in technology have helped this segment focus on product delivery and management anticipates these technologies will create efficiencies and customer satisfaction in the coming year.
Banking Services’ pre-tax net loss was $1.4 million for 2007, which was a $3.3 million decrease from 2006 pre-tax income of $1.9 million. The 2006 pre-tax net income for this segment was flat compared to 2005. For 2007, the decrease in pre-tax net income was primarily attributable to a decrease in noninterest income of $2.6 million, or 9.3 percent, from 2006. Inventory positions in fixed income securities were reduced substantially throughout the last half of the year as a part of management’s efforts to limit risks associated with the abnormal market volatility. Increases in lending by community banks reduced the volume of security purchases from the banking segment, also reducing trading income. Management believes that these continuing economic factors will make it difficult to increase net interest margin, deposit service charges, and trading income in this segment in 2008.
Consumer Services’ pre-tax net income decreased by $2.4 million to $1.1 million in 2007 as compared to 2006. The primary drivers of the decrease in pre-tax net income within this segment were increases in provision for loan losses and noninterest expense in 2007 as compared to 2006. Net interest income grew primarily because of a greater funds transfer pricing credit corresponding to higher rates and higher deposit levels within this segment. Noninterest income increased $4.6 million, primarily due to an increase in individual return item and overdraft activity. Noninterest expense increased in 2007 by $7.7 million, or 5.1 percent, and was attributable to increased salaries and bonuses to associates, telephone data line expense, and increased allocation of corporate technology costs. This segment has also been impacted by the decision to run-off the indirect loan portfolio and will continue to be impacted during 2008. See “Loans” on page 33 for additional discussion about indirect loans. In 2006, the decline in pre-tax net income is a direct result of noninterest expenses increasing at a greater rate than net interest income. This increase in noninterest expense in 2006 is mostly related to greater bankcard expense (related to the growth of the bankcard product); greater depreciation expense from new branch facilities, higher ATM network charges, marketing cost increases due to deposit gathering and consumer loan campaigns and increased allocations of corporate technology costs. The increase in noninterest expense was partially offset by a $12.6 million increase in net interest income. The increase in the net interest income occurred as assets reprice faster than liabilities in a higher interest rate environment. Management believes Consumer Services’ ability to maintain or grow net interest income levels in 2008 will depend upon its ability to grow deposits and higher yielding consumer loans.
Asset Management’s pre-tax net income in 2007 was $25.5 million, which is an increase of $11.6 million, or 83.4 percent, from 2006. This compares to a $5.0 million, or 55.8 percent, increase in pre-tax net income in 2006
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Table of Contentsas compared to 2005. The increase in pre-tax net income for both years was primarily attributable to increases in noninterest income, partially offset by increases in noninterest expense. Noninterest income increased mostly due to fees associated with the UMB Scout Funds, corporate and personal trust income, and brokerage service fees. Noninterest expense also increased because of higher distribution fees from the funds resulting from the increased asset base in the funds. Salaries and benefits were higher because increased base salaries, increased commissions, and the addition of strategic sales associates. Net flows to the UMB Scout Funds were $60 million for 2007 compared to $691 million for 2006. Management will continue to focus sales efforts to increase net flows to the UMB Scout Funds during 2008. The ability of the Company to maintain or grow the fee income from this segment is also related to the overall health of the equity and financial markets because a significant portion of the fee income from this segment is related to total assets under management. The assets under management in this segment are diversified across multiple asset classes with approximately 36 percent in the international class, 28 percent in the fixed income class, 20 percent in the U.S. large capital class, 9 percent in the short term investment class, and 7 percent in the small and middle capital class. Management believes this diversification helps provide protection against significant market changes in any one asset class. The revenues of the corporate trust business increased over 2006 by $1.1 million, or 8.0 percent, primarily because of growth in the bond market and the overall health of the economy.
Investment Services Group’s pre-tax net income increased in both 2007 and 2006 as compared to the respective prior years. Pre-tax net income increased by $5.2 million, or 53.6 percent, in 2007 as compared to 2006 primarily due to higher noninterest income partially offset by greater noninterest expense. Noninterest income was higher due to an increased mutual fund client base and higher asset based fees in 2007. Noninterest expense increased mostly due to higher third party custodian fees related to international transactions from mutual fund clients. For 2006, the increase in pre-tax net income is mostly due to a $4.1 million increase in noninterest income offset by a $2.3 million increase in noninterest expense.
The net loss before tax for the Treasury and Other Adjustments category was $2.3 million for 2007, compared to a net loss of $1.3 million for 2006 and a net gain of $3.1 million for 2005.
Balance Sheet Analysis
Loans and Loans Held For Sale
Loans represent the Company’s largest source of interest income. Loan balances increased by $161.8 million in 2007 due to management’s continued efforts to focus on new commercial and consumer loan relationships. Commercial, commercial real estate and residential real estate loans had the most significant growth in outstanding balances in 2007 as compared to 2006. These increases were offset by a decrease in consumer loans primarily related to the Company’s decision to run-off the indirect auto portfolio.
Included in Table 7 is a five-year breakdown of loans by type. Business-related loans continue to represent the largest segment of the Company’s loan portfolio, comprising approximately 68.3 percent and 63.9 percent of total loans and loans held for sale at the end of 2007 and 2006, respectively. The Company targets customers that will utilize multiple banking services and products.
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Table of ContentsTable 7
ANALYSIS OF LOANS BY TYPE (in thousands)
Commercial loans represent the largest percent of total loans. Commercial loans increased in volume and as a percentage of total loans compared to 2006. The volume increase was a result of management’s continued efforts to focus on new loan relationships.
As a percentage of total loans, commercial real estate and real estate construction loans now comprise 23.1% of total loans, compared to 22.2% at the end of 2006. Generally, these loans are made for working capital or expansion purposes and are primarily secured by real estate with a maximum loan-to-value of 80%. Many of these properties are owner-occupied and have other collateral or guarantees as security.
Bankcard loans have increased in 2007 as compared to 2006, both in balances outstanding and as a percentage of total loans. The increase in bankcard loans is due primarily to increased promotional activity and rewards programs. Bankcard loans continue to be an area of emphasis for the Company.
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Table of ContentsOther consumer installment loans have decreased in total amount outstanding and as a percentage of loans. During the third quarter of 2007, the Company made the decision to allow the indirect auto loan portfolio to run-off. This is part of a strategy to enhance asset yields. The Company will continue to service existing loans until maturity or payoff.
Real estate residential loans, although low in overall balances, have grown more rapidly than overall loan growth. The growth in these loans was primarily attributable to home equity lines of credits (HELOC). The HELOC growth was a result of the success of multiple promotions, as well as market penetration within the Company’s current customer base through its current distribution channels. Continued expansion of this portfolio is anticipated.
Nonaccrual, past due and restructured loans are discussed under “Credit Risk” within the Quantitative and Qualitative Disclosure about Market Risk in Item 7A on pages 47 and 48 of this report.
Securities
The Company’s security portfolio provides liquidity as a result of the composition and average life of the underlying securities. This liquidity can be used to fund loan growth or to offset the outflow of traditional funding sources. In addition to providing a potential source of liquidity, the security portfolio can be used as a tool to manage interest rate sensitivity. The Company’s goal in the management of its securities portfolio is to maximize return within the Company’s parameters of liquidity goals, interest rate risk and credit risk. The Company maintains high liquidity levels while investing in only high-grade securities. The security portfolio generates the Company’s second largest component of interest income.
Securities available for sale and securities held to maturity comprised 42.4% of earning assets as of December 31, 2007, compared to 41.4% at year-end 2006. Total investment securities totaled $3.5 billion at December 31, 2007, compared to $3.4 billion at year-end 2006. Management expects collateral pledging requirements for public funds and loan demand to be the primary factors impacting changes in the level of security holdings.
Securities available for sale comprised 97.1% of the Company’s investment securities portfolio at December 31, 2007, compared to 96.3% at year-end 2006. In order to improve the yields of the securities portfolio, the Company has altered the mix and duration of its portfolio. The mix has changed by reducing the outstanding balances of U.S. Treasury Notes and moving to Mortgage-Backed Securities of U.S. Agencies and State and Political Subdivisions. Securities available for sale had a net unrealized gain of $19.3 million at year-end, compared to a net unrealized loss of $27.3 million the preceding year. These amounts are reflected, on an after-tax basis, in the Company’s other comprehensive income in shareholders’ equity, as an unrealized gain of $12.2 million at year-end 2007 compared to an unrealized loss of $17.3 million for 2006.
The securities portfolio achieved an average yield on a tax-equivalent basis of 4.8% for 2007, compared to 4.4% in 2006 and 3.3% in 2005. The increase in yield is due to the replacement of lower yielding securities with higher yielding securities, as well as a small increase in the average life of the portfolio. A significant portion of the investment portfolio must be reinvested each year as a result of its liquidity. The average life of the securities portfolio was 29.3 months at December 31, 2007 compared to 28.9 months at year-end 2006. Management expects to continue to hold the average life of the investment portfolio at approximately the same level in 2008.
Included in Tables 8 and 9 are analyses of the cost, fair value and average yield (tax equivalent basis) of securities available for sale and securities held to maturity.
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Table of ContentsThe securities portfolio contains securities that have unrealized losses and are not deemed to be other-than-temporarily impaired (see the table of these securities in Note 4 to the Consolidated Financial Statements on pages 62 through 64 of this document). There are U.S. Treasury obligations, federal agency mortgage backed securities, and municipal securities that have had unrealized losses for greater than 12 months. These unrealized losses resulted from interest rate volatility in the markets and were not related to the credit quality of the investments. The Company has the ability and intent to hold these investments until a recovery of fair value is achieved, which may be maturity. Therefore, management does not consider these securities to be other-than-temporarily impaired at December 31, 2007.
Table 8
SECURITIES AVAILABLE FOR SALE (in thousands)
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Table of Contents
Table 9
SECURITIES HELD TO MATURITY (in thousands)
Other Earning Assets
Federal funds transactions essentially are overnight loans between financial institutions, which allow for either the daily investment of excess funds or the daily borrowing of another institution’s funds in order to meet short-term liquidity needs. The net sold position was $202.7 million at December 31, 2007 and $515.3 million at December 31, 2006.
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Table of ContentsThe Investment Banking Division of the Company’s principal affiliate bank buys and sells federal funds as agent for non-affiliated banks. Because the transactions are pursuant to agency arrangements, these transactions do not appear on the balance sheet and averaged $634.4 million in 2007 and $472.4 million in 2006.
At December 31, 2007, the Company held securities bought under agreements to resell of $509.3 million compared to $333.6 million at year-end 2006. The Company used these instruments as short-term secured investments, in lieu of selling federal funds, or to acquire securities required for a repurchase agreement. These investments averaged $224.0 million in 2007 and $209.7 million in 2006.
The Investment Banking Division also maintains an active securities trading inventory. The average holdings in the securities trading inventory in 2007 were $57.0 million, compared to $54.8 million in 2006, and were recorded at market value. As discussed at “Quantitative and Qualitative Disclosures About Market Risk — Trading Account” in Part II, Item 7A on page 46 below, the Company offsets the trading account securities by the sale of exchange-traded financial futures contracts, with both the trading account and futures contracts marked to market daily.
Deposits and Borrowed Funds
Deposits represent the Company’s primary funding source for its asset base. In addition to the core deposits garnered by the Company’s retail branch structure, the Company continues to focus on its cash management services, as well as its asset management and mutual fund servicing segments in order to attract and retain additional core deposits. Deposits totaled $6.6 billion at December 31, 2007 and $6.3 billion at year-end 2006. Deposits averaged $5.1 billion in 2007 and $5.5 billion in 2006. The Company continually strives to expand, improve and promote its cash management services in order to attract and retain commercial funding customers.
Noninterest–bearing demand deposits averaged $1.9 billion in 2007 and $1.8 billion in 2006. These deposits represented 36.5% of average deposits in 2007, compared to 33.5% in 2006. The Company’s large commercial customer base provides a significant source of noninterest–bearing deposits. Many of these commercial accounts do not earn interest; however, they receive an earnings credit to offset the cost of other services provided by the Company.
Table 10
MATURITIES OF TIME DEPOSITS OF $100,000 OR MORE (in thousands)
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Table of ContentsTable 11
ANALYSIS OF AVERAGE DEPOSITS (in thousands)
Securities sold under agreements to repurchase and fed funds purchased totaled $1.7 billion at December 31, 2007, and $1.6 billion at December 31, 2006. This liability averaged $1.3 billion in 2007 and $1.1 billion in 2006. Repurchase agreements are transactions involving the exchange of investment funds by the customer for securities by the Company, under an agreement to repurchase the same issues at an agreed-upon price and date. The Company enters into these transactions with its downstream correspondent banks, commercial customers, and various trust, mutual fund and local government relationships.
Table 12
SHORT-TERM DEBT (in thousands)
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Table of ContentsThe Company has twelve fixed-rate advances at December 31, 2007, from the Federal Home Loan Bank at rates of 3.80% to 7.13%. These advances, collateralized by the Company’s securities, are used to offset interest rate risk of longer-term fixed-rate loans.
Capital Resources and Liquidity
The Company places a significant emphasis on the maintenance of a strong capital position, which promotes investor confidence, provides access to funding sources under favorable terms, and enhances the Company’s ability to capitalize on business growth and acquisition opportunities. The Company is not aware of any trends, demands, commitments, events or uncertainties that would materially change its capital position or affect its liquidity in the foreseeable future. Capital is managed for each subsidiary based upon its respective risks and growth opportunities as well as regulatory requirements.
Total shareholders’ equity was $890.6 million at December 31, 2007, compared to $848.9 million one year earlier. During each year, management has the opportunity to repurchase shares of the Company’s stock if it concludes that the repurchases would enhance overall shareholder value. During 2007 and 2006, the Company acquired 1,099,998 and 850,997 shares, respectively, of its common stock.
Risk-based capital guidelines established by regulatory agencies establish minimum capital standards based on the level of risk associated with a financial institution’s assets. A financial institution’s total capital is required to equal at least 8% of risk-weighted assets. At least half of that 8% must consist of Tier 1 core capital, and the remainder may be Tier 2 supplementary capital. The risk-based capital guidelines indicate the specific risk weightings by type of asset. Certain off-balance-sheet items (such as standby letters of credit and binding loan commitments) are multiplied by credit conversion factors to translate them into balance sheet equivalents before assigning them specific risk weightings. Due to the Company’s high level of core capital and substantial portion of earning assets invested in government securities, the Tier 1 capital ratio of 13.74% and total capital ratio of 14.58% substantially exceed the regulatory minimums.
For further discussion of capital and liquidity, see the “Liquidity Risk” section of Item 7A, Quantitative and Qualitative Disclosures about Market Risk on page 48 of this report.
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Table of ContentsTable 13
RISK-BASED CAPITAL (in thousands)
This table computes risk-based capital in accordance with current regulatory guidelines. These guidelines as of December 31, 2007, excluded net unrealized gains or losses on securities available for sale from the computation of regulatory capital and the related risk-based capital ratios.
For further discussion of regulatory capital requirements, see note 10, “Regulatory Requirements” with the Notes to Consolidated Financial Statements under Item 8 on pages 68 and 69.
Commitments, Contractual Obligations and Off-balance Sheet Arrangements
The Company’s main off-balance sheet arrangements are loan commitments, commercial and standby letters of credit, futures contracts and forward exchange contracts, which have maturity dates rather than payment due dates. These commitments and contingent liabilities are not required to be recorded on the Company’s balance sheet. Since commitments associated with letters of credit and lending and financing arrangements may expire unused, the amounts shown do not necessarily reflect the actual future cash funding requirements. See Table 14 below, as well as Note 15, “Commitments, Contingencies and Guarantees” in the Notes to Consolidated Financial Statements under Item 8 on pages 78 and 79 for detailed information and further discussion of these arrangements. Management does not anticipate any material losses from its off-balance sheet arrangements.
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Table of ContentsTable 14
COMMITMENTS, CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS (in thousands)
The table below details the contractual obligations for the Company as of December 31, 2007. The Company has no capital leases or long-term purchase obligations.
On January 1, 2007, the Company adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes”. As of December 31, 2007, our total liabilities for unrecognized tax benefits were $1,477 million. We cannot reasonably estimate the timing of the future payments of these liabilities. Therefore, these liabilities have been excluded from the table above. See Note 17 to the consolidated financial statements for information regarding the liabilities associated with unrecognized tax benefits.
The table below details the commitments, contingencies and guarantees for the Company as of December 31, 2007.
Critical Accounting Policies and Estimates
Management’s Discussion and Analysis of financial condition and results of operations discusses the Company’s Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these Consolidated Financial Statements requires management to make estimates and assumptions that affect the reported amounts of assets
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Table of Contentsand liabilities and the disclosure of contingent liabilities at the date of the Consolidated Financial Statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments, including those related to customers and suppliers, allowance for loan losses, bad debts, investments, financing operations, long-lived assets, taxes, other contingencies and litigation. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which have formed the basis for making such judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Under different assumptions or conditions, actual results may differ from the recorded estimates.
Management believes that the Company’s critical accounting policies are those relating to: allowance for loan losses, goodwill and other intangibles, revenue recognition and accounting for stock-based compensation.
Allowance for Loan Losses
The Company’s allowance for loan losses represents management’s judgment of the loan losses inherent in the loan portfolio. The allowance is maintained and computed at each bank at a level that such individual bank management considers adequate. The allowance is reviewed quarterly, considering such factors as historical trends, internal ratings, migration analysis, current economic conditions, loan growth and individual impairment testing.
Larger commercial loans are individually reviewed for potential impairment. For larger commercial loans, if management deems it probable that the borrower cannot meet its contractual obligations with respect to payment or timing, such loans are deemed to be impaired under Statement of Financial Accounting Standards (SFAS) No. 114, “Accounting by Creditors for Impairment of a Loan”. Such loans are then reviewed for potential impairment based on management’s estimate of the borrower’s ability to repay the loan given the availability of cash flows, collateral and other legal options. Any allowance related to the impairment of an individually impaired loan is based on the present value of discounted expected future cash flows, the fair value of the underlying collateral, or the fair value of the loan. Based on this analysis, some loans that are classified as impaired under SFAS 114 do not have a specific allowance and there is no related impairment as the discounted expected future cash flows or the fair value of the underlying collateral exceeds the Company’s basis in the impaired loan.
The Company also maintains an internal risk grading system for other loans not subject to individual impairment. An estimate of the inherent loan losses on such risk-graded loans is based on a migration analysis which computes the net charge-off experience related to each risk category.
An estimate of inherent losses is computed on remaining loans based on the type of loan. Each type of loan is segregated into a pool based on the nature of such loans. This includes remaining commercial loans that have a low risk grade, as well as homogenous loans. Homogenous loans include automobile loans, credit card loans and other consumer loans. Allowances are established for each pool based on the loan type using historical loss rates, certain statistical measures and loan growth.
An estimate of the total inherent loss is based on the above three computations. From this an adjustment not to exceed 10 percent can be made based on other factors management considers to be important in evaluating the probable losses in the portfolio such as general economic conditions, loan trends, risk management and loan administration and changes in internal policies.
Goodwill and Other Intangibles
Goodwill is tested annually for impairment. Goodwill is assigned to various reporting units based on which units were expected to benefit from the synergies of the combination at the time of the acquisition. The Company tests impairment at the reporting unit level by estimating the fair value of the reporting unit. If management’s
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Table of Contentsestimate of the fair value of the reporting unit exceeds the carrying amount of the goodwill, there is no impairment. In order to estimate the fair value of the reporting units, management uses multiples of earnings and assets from recent acquisition of similar banking and fund servicing entities as such entities have comparable operations and economic characteristics. The Company has performed annual impairment tests of goodwill since the inception of SFAS 142, “Accounting for Goodwill”. As a result of such impairment tests, the Company has not recognized an impairment charge.
For customer-based identifiable intangibles, the Company amortizes the intangibles over their estimated useful lives of up to seventeen years.
Revenue Recognition
Revenue recognition includes the recording of interest on loans and securities and is recognized based on rate multiplied by the principal amount outstanding. Interest accrual is discontinued when, in the opinion of management, the likelihood of collection becomes doubtful, or the loan is past due for a period of ninety days or more unless the loan is both well-secured and in the process of collection. Other noninterest income is recognized as services are performed or revenue-generating transactions are executed.
Accounting for Stock-Based Compensation
Pursuant to the requirements of SFAS 123(R), “Accounting for Stock Based Compensation”, the amount of compensation recognized is based primarily on the value of the awards on the grant date. To value stock options, the Company uses the Black-Scholes model which requires the input of several variables. The expected option life is derived from historical exercise patterns and represents the amount of time that options granted are expected to be outstanding. The expected volatility is based on a combination of historical and implied volatilities of the Company’s stock. The interest rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The fair value of the stock on the grant date is used to value awards of restricted stock. Forfeitures are estimated at the grant date and reduce the expense recognized. The forfeiture rate is adjusted annually based on experience. The value of the awards, adjusted for forfeitures, is amortized using the straight-line method over the requisite service period. Management of the Company believes that it is probable that all current performance-based awards will achieve the performance target. Please see the discussion of the “Accounting for Stock-Based Compensation” under Note 1 in the Notes to the Consolidated Financial Statements under Item 8 on pages 57 and 58.
Accounting for Uncertainty in Income Taxes
Under FASB Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109”, the Company records the financial statement effects of an income tax position when it is more likely than not, based on the technical merits, that it will be sustained upon examination. A tax position that meets the more-likely-than-not recognition threshold is measured and recorded as the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with a taxing authority. Previously recognized tax positions are derecognized in the first period in which it is no longer more likely than not that the tax position will be sustained. The benefit associated with previously unrecognized tax positions are generally recognized in the first period in which the more-likely-than-not threshold is met at the reporting date, the tax matter is ultimately settled through negotiation or litigation or when the related statute of limitations for the relevant taxing authority to examine and challenge the tax position has expired. The recognition, derecognition and measurement of tax positions are based on management’s best judgment given the facts, circumstance and information available at the reporting date. See the discussion of “Liabilities Associated with Unrecognized Tax Benefits” under Note 17 in the Notes to the Consolidated Financial Statements.
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Table of ContentsITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Risk Management
Market risk is a broad term for the risk of economic loss due to adverse changes in the fair value of a financial instrument. These changes may be the result of various factors, including interest rates, foreign exchange prices, commodity prices or equity prices. Financial instruments that are subject to market risk can be classified either as held for trading or held for purposes other than trading.
The Company is subject to market risk primarily through the effect of changes in interest rates of its assets held for purposes other than trading. The following discussion of interest risk, however, combines instruments held for trading and instruments held for purposes other than trading because the instruments held for trading represent such a small portion of the Company’s portfolio that the interest rate risk associated with them is immaterial.
Interest Rate Risk
In the banking industry, a major risk exposure is changing interest rates. To minimize the effect of interest rate changes to net interest income and exposure levels to economic losses, the Company manages its exposure to changes in interest rates through asset and liability management within guidelines established by its Funds Management Committee (FMC) and approved by the Company’s Board of Directors. The FMC has the responsibility for approving and ensuring compliance with asset/liability management policies, including interest rate exposure. The Company’s primary method for measuring and analyzing consolidated interest rate risk is the Net Interest Income Simulation Analysis. The Company also uses a Net Portfolio Value model to measure market value risk under various rate change scenarios and a gap analysis to measure maturity and repricing relationships between interest-earning assets and interest-bearing liabilities at specific points in time. The Company does not use hedges or swaps to manage interest rate risk except for limited use of futures contracts to offset interest rate risk on certain securities held in its trading portfolio.
Overall, the Company attempts to manage interest rate risk by positioning the balance sheet to maximize net interest income while maintaining an acceptable level of interest rate and credit risk, remaining mindful of the relationship among profitability, liquidity, interest rate risk and credit risk.
Net Interest Income Modeling
The Company’s primary interest rate risk tool, the Net Interest Income Simulation Analysis, measures interest rate risk and the effect of interest rate changes on net interest income and net interest margin. This analysis incorporates all of the Company’s assets and liabilities together with forecasted changes in the balance sheet and assumptions that reflect the current interest rate environment. Through these simulations, management estimates the impact on net interest income of a 200 basis point upward or downward gradual change (e.g. ramp) of market interest rates over a one year period. Assumptions are made to project rates for new loans and deposits based on historical analysis, management outlook and repricing strategies. Asset prepayments and other market risks are developed from industry estimates of prepayment speeds and other market changes. Since the results of these simulations can be significantly influenced by assumptions utilized, management evaluates the sensitivity of the simulation results to changes in assumptions.
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Table of ContentsTable 15 shows the net interest income increase or decrease over the next twelve months as of December 31, 2007 and 2006.
Table 15
MARKET RISK (in thousands)
The Company is slightly liability sensitive at December 31, 2007 to increases or decreases in rates. A decrease in interest rates will have little impact on net interest income. Increases in interest rates will cause slightly larger decreases in net interest income than in the declining rate environment. The Company’s average life of the investment portfolio has lengthened slightly and the Company’s loan portfolio has grown with a slightly higher percentage of total loans being fixed rate as compared to 2006. These scenarios cause interest income from these assets to be less sensitive to rate changes because they reprice less frequently. The Company also has a greater percentage of interest expense from overnight liabilities and shorter rate sensitivity from deposits which contribute to interest expense from liabilities to reprice more frequently and be more sensitive to rate changes than assets. The Company is positioned with the current low rate environment to be very neutral to further interest rate decreases.
Repricing Mismatch Analysis
The Company also evaluates its interest rate sensitivity position in an attempt to maintain a balance between the amount of interest-bearing assets and interest-bearing liabilities which are expected to mature or reprice at any point in time. While a traditional repricing mismatch analysis (gap analysis) provides a snapshot of interest rate risk, it does not take into consideration that assets and liabilities with similar repricing characteristics may not, in fact, reprice at the same time or the same degree. Also, it does not necessarily predict the impact of changes in general levels of interest rates on net interest income.
Management attempts to structure the balance sheet to provide for the repricing of approximately equal amounts of assets and liabilities within specific time intervals. Table 16 is a static gap analysis, which presents the Company’s assets and liabilities, based on their repricing or maturity characteristics. This analysis shows that the Company is in a positive gap position because assets maturing or repricing exceed liabilities.
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Table of ContentsTable 16
INTEREST RATE SENSITIVITY ANALYSIS (in millions)
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