Cullen/Frost Bankers Inc (CFR) 2002 Q3 法說會逐字稿

I would like to turn this Cullen/Frost Bankers third quarter earnings conference call over to your host, Director of Investor Relations, Mr. Greg Parker.

Thank you. This morning's conference call will be led by Dick Evans, Chairman and CEO and Phil Green, Group Executive Vice President and CFO. Before I turn the call over to Dick and Phil, I need to take a few moments to address the Safe Harbor provisions.

Some of the remarks made today will constitute forward looking statements, as defined in the Private Securities Act Litigation Reform Act of 1995, as amended. We intend such statement to be covered by the Safe Harbor provisions for forward looking statements contained in the Private Securities Litigation Reform Act of 1995, as amended. Please see the last page of the text in this morning's earnings release for additional information about the risk factors associated with these forward looking statements. If needed, a copy of the release is available at our web site or by calling the Investor Relations department at 210-220-5632. At this time, I'd like to turn the call over to Dick Evans.

Thank you, Greg. I'm pleased with our results for the third quarter. Earnings from continued operations are $30.8 million or 59 cents per diluted common share. Return on average assets, 1.47 percent. Return on average equity, 18.30 percent. As you will remember, we announced on July the 23rd, we were exiting all capital market related activities of Frost securities and recognized an after-tax loss, this quarter, on the disposal of the discontinued operation of [inaudible] $4.4 million, or eight cents per diluted common share.

I continue to be proud of our staff and their ability to increase earnings in a tough interest rate environment and volatile financial markets. The key elements for the good performance, this quarter, were first, the fee income growth. Growth in our insurance commissions were strong. Deposit services continue steady growth.

Secondly was good cost management. We managed expenses. In fact, we were flat in operating expenses this quarter versus last year. And, also, on the cost side, we had lower credit-related costs. As we look further at asset quality trends, our past-dues are 1.01 percent, which is low. Charge offs, .26 percent, a reasonable level. Our loan reserve at 1.78 percent is good and meets our goal this year to build the reserve ahead of problems. Our allowance to non-performers is 214.68 percent. Our non-performers are at .46 percent of assets. They did increase from 33.7 million to 40.5 million. We also noted in the Q, that potential problems are at a level of $19.7 million. In our opinion, these are all very manageable levels.

A few comments about Texas. Texas continues to be a great place to do business. As we have discussed before, Texas is our diversified, more than it has been in the past and, therefore, follows the trends of the United States, performing slightly better than the U.S. economy over a long period of time and we expect it will continue. However, in more recent months, the U.S. has showed a mild recovery, while Texas is still in a mild decline causing the lines to come closer together, and now both the U.S. and Texas are growing at relatively the same level. We do expect Texas to be more of the same in the fourth quarter. High tech and telecom are still weak and because Texas is one of the top four of high tech states, this industry's weakness has had an effect on our economy.

Additionally, while oil and gas prices are strong, the industry is very cautious due to the high uncertainty. Now, even though short-term we expect a flat Texas economy, we believe long-term Cullen/Frost is well-positioned in a state that continues to attract new companies has less regulation, and has overall a better business environment. As to the future, if I was to choose one word, I would say it's uncertainty. Now, let me ask Phil Green to make some comments.

Thanks, Dick. I agree with Dick. It was a solid quarter. Our 59 cents from continuing operations was up by 84 percent from last year. And that was, as Dick said, mostly from reduced credit cost. But there were some other improvements, as well, that I'll go over in a moment. Earnings for the second quarter, excluding the gain that we had from student loans, were 58 cents. We also made progress from the second quarter, as well. I want to provide a few details about our operation for the quarter, and then, we'll open it up for questions in a moment. As we said, the biggest factor in our improvement was lower credit costs lower provisions in particular, as we were up from last year. And just remember that last year, we did have a large provision for the company that was involved in advertising and promotion that went south after the 9/11 incident, last year.

And so we put about $10 million in provision aside for that credit, last year. And in addition, we built the reserve by another $5 million strictly because of uncertainties that we saw in the economy, in the aftermath of all that. And just to bring full circle on that credit, you will remember that we charged that credit down in the fourth quarter, and we sold it in the second quarter of this year and booked a small recovery, a little over a million dollars of the net book value, at that time. Our provision for the third quarter was down sharply from last year at $5.9 million, but it was still double the level of charge offs that we had for the quarter, so you recall we've been steadily building our reserves since the late last year period. And this quarter's no exception. We've gone from the end of year last year a reserve level of a 1.61 percent, and we ended up at third quarter at a 1.78 percent. So we feel good about the reserve level.

An overall comment that I wanted to just reiterate about the quarter was the relationship of revenue in non-interest expenses. Revenue was up about three percent, and it's all non-interest income related, but non-interest expenses were down about three percent, and that does not include the reductions in credit costs. So that helped us be able to improve our earnings in what was really and continues to be, I think, a tough environment for everybody.

I want to take a look, now, at a few of the components of our operation, and I want to start with net interest margin. Margin was down from a 4.8 percent last year to 4.5 percent in the third quarter and, obviously, interest rates continue to affect us. We are asset sensitive, and this is an old story for those of you who are familiar with our company.

But I think a positive is volumes helped us stay fairly close, within a $200,000 amount of the level of net interest income last year. So while the margin percentage is down, volumes have helped us keep the dollars pretty much flat. And the reason we've been able to do that is because of good deposit growth, which is up by three-and-a-half percent on average, versus last year. And included in that is DDA growth, which is up 12 percent. And that money, given the fact loan growth has been pretty flat, has found its way into the investment portfolio, and we've been trying to link the durations in order to protect ourselves from continued drops in rates, and that's helped somewhat. It has allowed us to maintain that margin at fairly flat levels.

When we talked last time, we said we thought margin could be flat or down. And of course, it went down. We were down by about 16 basis points from the second quarter, but I think that's exaggerated somewhat by some balance sheet activity, particularly as an expansion that we had in the balance sheet. So what I'll say is really from what I'll call spread compression was about seven basis points drop in margin. And that, about, roughly half on that was asset rates that dropped faster than deposit rates. And secondly, our loan volumes, which were down, on average, about $75 million from the previous quarter. And the remaining nine basis points was from expansion of the balance sheet when EDA, which has been very strong, was up about $150 million. For the quarter, it was pretty much kept in liquidity, so we made money on it but it just tended to dilute our margin. And then, in addition, we had increase in the carrying value of our investment portfolio, strictly because the market value increased. That brought that up about $50 million, and that increases your carrying value, but it doesn't increase interest income, so that tended to reduce margin somewhat.

So the real point, though, is that there is some compression. There is some tightening, and we expect it to be under pressure, as long as rates continue the way they're going, and we're not expecting rates to increase in the foreseeable future. We'd like to see that, but right now, we're not planning on that and expect to see some continued pressure on margin. Not to the extent that we had in the third quarter, but some.

While I'm talking about margin, and I've already talked about deposits, I'd like to focus on loans for just a minute. On an average basis, loans were pretty much exactly flat from last year on a stated basis. They were down by about seven percent on a [inaudible] quarter annualized basis. But remember that we do have this - directive run off, that, primarily being mortgage run off where we're not making those loans anymore. Indirect run off. We sold the student loans, last quarter. A little under a hundred million dollars in student loans. And then, we have had some reductions in our shared national credit. So if you adjust that out, we have had some growth in the portfolio. It's in the single-digit range. It's, on an annual basis, about six percent. On a quarter basis, it's about four percent. So if you look at where it's coming from, the growth that we have had has been pretty consistent. It's in C&I loans, and it's in commercial real estate, but that's primarily in the commercial real estate mortgages, which are largely owner-occupied credits. I think that's really no different from what we have had.

And if you look at where the growth is coming from within our markets, you got a couple of markets, which are experiencing double-digit loan growth, continuing to do that. That being both those in north Texas, the Ft. Worth and Dallas markets. We got a number of markets - most of the rest have single-digit loan growth of around seven percent, or so, and the exception has been year-over-year San Antonio, which is down by about eight percent. As you recall, San Antonio is an area where we have a large market share. It's more difficult for us to take business away from the big guys. We are the big guys in San Antonio, and the impacts of the market tend to effect us, when the economy slows in that market. But I will say that we have been making progress in that market, more recently.

I want to take a look at non-interest income and expense, briefly. Non-interest income, as we said, is where our revenue growth has come from. And it was up 8% year-over-year, and insurance commissions are up 45 percent.

Now, we did have an acquisition in the third quarter of last year, within that quarter, so it effects us some, but even adjusting that acquisition, they were up about 33 percent. So we're very pleased with the revenue growth in this business. We are still happy with the profitability of it. We were 20 percent pretax margin on that business before intangibles. We hope to get higher, and we tend to be closing a little over 60 percent of the qualified referrals that the bank is making into the insurance company. So I think it shows that it is working very well in terms of how it is fitting and meshing with our customer base.

The other area of non-interest income that was up was deposit service charges. It was up 11 percent, and here's an area where lower rates have tended to increase fees because people who maintain the same balances in their DDA, it pays for less services, and so they have to make up the difference with fees. And we, also, have had some volume growth in our treasury management services. Dick talked about trusts, briefly. It's not up. It's actually under pressure. When you consider that about three-quarters of our trust fees are from investment management fees, as long as the market is under pressure the way it is, we're going to continue to have some pressure in the trust component. But we're hoping for a turnaround in that, as everybody is, I think, before too long. And that would - it would turn into a positive for us.

Finally, looking at expenses, we are down. I realize that intangible amortization is about $2 million of the difference, but even taking that out, we still would be down slightly, and that doesn't happen by accident. That's good work by our people doing a good job of managing costs and proactively managing businesses that we're in. And we feel really good about that.

Salaries is really the only component that's up. It's up by about four percent over last year. We, actually, are down in the numbers of FTEs we have. But we have reinstated accruals for incentive compensation, which weren't there, last year. And then, remember that the insurance business is primarily a commission-driven business and we great fees there. So we've seen some growth in the compensation levels of the insurance division.

Really, every other category of non-interest expense, on a broad basis, is down, so I think it's, again, good control of expenses.

So in light of that, in light of our third quarter performance, we are keeping with the guidance, which we gave out last quarter, which said that we comfortable with midpoint, or around the middle of the range of earnings estimates that are out there. As we see them, they range from $2.22 for the year to $2.31. Somewhere in the middle of that range is where we're most comfortable. And with that, I'll turn it back over to Dick for questions.

Well, that gives you, I hope, the feel of why we feel good about the third quarter, and we'll open it up for questions.

Very good. If you would like to ask a question, at this time, please press one key on your touch-tone telephone. To remove yourself from the queue, please press pound. Once again, to ask a question, please press one on your touch-tone telephone.

Thank you. The Q&A session will be led by Dick Evans, Chairman and CEO and Phil Green, Group Executive Vice President and CFO.

Before I turn this Q&A session over to Dick and Phil, let me take a moment and address our Safe Harbor provisions.

Some of the remarks made today will constitute forward looking statements, as defined in the Private Securities Act Litigation Reform Act of 1995, as amended. We intend such statement to be covered by the Safe Harbor provisions for forward looking statements contained in the Private Securities Litigation Reform Act of 1995, as amended. Please see the last page of the text in this morning's earnings release for additional information about the risk factors associated with these forward looking statements. If needed, a copy of the release is available at our web site or by calling the Investor Relations at 210-220-5632.

At this time, I'll turn it over to Dick Evans.

Well, welcome back. I'm a great believer that communications works best when it's two ways, and I'm relieved to find out that we're going to have that opportunity. I, also, think technology is wonderful, but I've learned it, too, requires some patience. I couldn't believe there weren't any questions, but at the same time, no one was talking. And I, now, understand that you were trying to push those buttons. Well, it's my understanding that we've worked out the technical problems. I will say, for any reason, don't hang up, if you're pushing that button, and it doesn't work. Call and we'll do something about it. So we're going to stick around. With that, we're ready for questions.

At this time, if you do have a question, please press the one on your touch-tone phone and press pound to withdraw your question. Once again, if you do have a question, please press the one on your touch-tone phone and press pound to withdraw your question. We'll take our first question from Jennifer [Demba] from Robinson Humphrey. Please go ahead.

Good afternoon.

Good afternoon.

If you could give us some detail on where the shared national credit portfolio stands, right now, and what the results of the review were?

The results of the review - I assume you're talking about the August announcement. There were no effects to our balance sheet or income statement, as a result of the national review. Today, we stand with outstandings of shared national credits purchased of $233 million. That's up to about $32 million, which we've been saying that we expected all year long, as a result of our energy credits. We've had a few new ones and a few advances.

OK, thank you.

Thank you. We'll take our next question from Charlie Ernst from Putnam Lovell. Please go ahead, sir.

Hi, guys.

Hi, Charlie.

Hey, Charlie.

Hi. I'll start off with a couple and, then, pass it out to Tom and somebody else. Just a question on the income statement. I assume that excludes all divestitures, now, and the extra items are kind of an afterthought, that the expenses aren't actually in the line items. That's true, right?

Charlie, if I understand your question correctly, what you're looking at on the income statement in the press release is for continuing operations. It doesn't have any of the discontinued part of the capital markets subsidiary.

And, Phil, if I remember correctly, there was about a month from, you know, from the time the last quarter closed till you actually shut down the operation, so that has, also, been all cleared out?

That's correct, as far as all prior activities.

OK and could you talk about the NPA situation, what you're seeing there? Also, give us, maybe a fresh guidance update. I believe the range is still 40 to 50 basis points? And then, maybe go into a little bit more about the policy that's (inaudible) over provide by almost $3 million?

First of all, the non-performers were up about $7 million, still within the range. About half of that is one loan, and the rest of the balance is several small credits scattered out that make up the balance. So there's no - Charlie, there's no specific trend, other than an economy that, you know, is weaker, and as a result of it, you're going to have some flatter sales and create some of these problems. As you know, it is our attitude to address things as fast as we can and get on with it. As far as guidance goes, I would - the guidance that we've had - I think that with the information that we provided, this time with the potential problem loan in the Q, and I mentioned it in the conference call, that that fits at about $19 million really is the information I would give you to think about what might happen. It is a potential, exactly what it says. At this point, I can't tell you it will or it won't. What I can tell you that I'm extremely comfortable with is that we have accomplished our goal of building our reserve to the point of what we have said all along of getting ahead of the curve. And so, any exposure that we have in the current non-performers are the potential problems we're very comfortable that that's already been provided for.

Charlie, this is Phil. With regard to your question about the level of provision versus charge offs in the quarter, I wouldn't say it's a policy so much. It's, actually, pretty consistent with what we've done through this year. If you look, we've, on a year-to-date basis, charged off a little over $9 million, and we've provided a little over 18, so we were about double charge offs, this quarter and about double charge offs for the year. And really, all we're trying to do is what Dick said. We've been trying to build a reserve because we think things are uncertain. We've thought that since last year. And we just want to build some strength in the balance sheet, and that's really what we've been doing.

OK, I'll let some other people have a chance to ask questions. Thanks.

Thank you. Once again, if you do have a question, please press the one on your touch-tone phone and press pound to withdraw your question. Once again, if you do have a question, please press the one on your touch-tone phone and press pound to withdraw your question.

We'll take our next question from Baine [Slat] from KBW. Please go ahead.

Mr. Slat, please go ahead.

Sorry. This morning, you all talked about lengthening the duration in the security portfolio. Can you describe what the strategy is and what exactly you all are buying there?

OK. Actually, the duration of our investment portfolio, today, is just a little over three years. What we've been buying is a combination of various securities. We've been buying five-year agency with three year calls on them, which are probably going to be five years. We've been buying anywhere from seven to 15 30-year mortgage-backs. Haven't done much of the 15 and 30 until more recently. And that's, mainly, what we're doing. As you know, we're a big mortgage-back holder, and we've just been trying to mix the portfolio to begin moving that duration out as rates go down. I will tell you that it's hard to extend duration, these days, with the speeds that are in the mortgage-backed portfolio, today. We're seeing, not only payoffs in our own portfolio on the loan side, which we talk about on a quarterly basis, but a mortgage-backed investment portfolio is running off, fairly quickly as well. So we're riding our bicycle pretty fast to stay even.

OK. Second question is can you talk about the share account a little bit? It went down. Was that a result of any buybacks or?

We did not have any buybacks in the third quarter ...

OK. I was just wondering ...

... Anything would have been - they would have just been priced with regard to the computation of the treasury stock method for options.

OK. I know you'll get guidance, this morning, for '02. Just looking at - I mean, what's out there for '03 is 270, which I think is to the effect of a 67 percent run rate. I was wondering how comfortable you all feel with that, sort of looking at the environment, as you all see it, today.

Well, honestly, our practice has never been to give guidance on a coming year. We don't have our budget plan fixed at this point, and we just decline guidance on a coming year.

All right, thanks, that's all.

Thank you. We'll take our next question from Charlie Ernst from Putnam Lovell. Please go ahead, sir.

Hey, Charlie.

Yeah, just wanted to talk a little bit more about the margin, get a sense for when you actually made the addition to the balance sheet and, from the securities, whether it was throughout the quarter or, you know, any one point n the quarter. And that's the beginning of the question.

Charlie, the investments we've been doing have really been throughout the last 12 months, and, honestly, the average security portfolio position is fairly flat on a link quarter basis, so we haven't done a lot. We've done some purchases. They've been really more maintenance, you know, as things have matured. We didn't really make any strategic purchases during the quarter. You know, since the end of the quarter, we've looked at the liquidity that's built up. We've taken some positions. Nothing that I would say is particularly material, but for the quarter itself there weren't a lot of large positions taken, and, as I said, the average investment portfolio was - well, I just got the numbers, here. Portfolio average, two billion 152, in this quarter, and in the link quarter, is the second quarter, it averaged two billion 136. So it's up 31 million.

OK. So could you talk about, give a little bit more color behind the margin, and you know, we have seen the yield curve steeping up a little bit, since, I guess, quarter's end, and has that had - what kind of impact has that had on your asset liability situation, these days?

Well, I think the steepening of the curve has really just served to open up some opportunities on the investment side more recently, and that's in this month, as opposed to the previous quarter. I don't think it's had a big impact on our asset liability management. We are going to continue to be asset-sensitive even as we make investments here and there to try and protect ourselves, and the thing that's going to make our margin be much better is whenever rates begin to turn around.

OK, and as far as the loan portfolio, could you update us as to exactly what the auto number was and what the other categories were in, kind of, the run off pools?

OK. Look on a period-end number for the quarter. The indirect portfolio is $33 million and about half of that is indirect auto. So the indirect auto portfolio is down almost to nothing. The indirect portfolio was down about $10 million for the quarter. And if you looked at mortgage loans, one to four-family residential, that was $197 million, and it was down from $212, or a drop of $14 million.

And what do you all estimate that cost you during the quarter, in term so the loan number?

Well, I think when we said we thought that the drops in loans of 75 million would have been about a, what did I say, three basis points? Hold on a second. The loans were four basis points. We assumed that at an average portfolio rate.

And that average portfolio rate for the quarter, is about 5.9 percent.

Can you all provide any color from your commercial lenders, as to their mood? Are you still seeing a fair amount of pay downs, or is that starting to slow, and, you know, or even are people talking about maybe starting that, some leverage, again?

I think the real expansion, in the portfolio, which our core growth was four percent for link quarters, second to the third, really comes from taking business away. And I think, if you really look across all the markets... In this kind of economy you don't see people really borrowing to expand. They're mainly borrowing to restructure their debt, or, like I said, move to another buying. Fortunately, we've been able to grow some.

If you look at the fourth quarter, in this kind of uncertain environment, it's kind of interesting. You look at October. We're really having a good month. You look at November. It looks weak, and December looks extremely strong. So, you know, how all that's going to average out is, probably, somewhere between a flat quarter and a four percent growth. I feel good about our disciplines. I feel excellent about our disciplines and making calls, and getting before customers and continuing to build it. It's just an environment to where customers aren't going to borrow money, until they feel more comfortable and certain about what's going to happen.

Thank you. We'll take our next question from Robert Lacoursiere from Lehman Brothers. Please go ahead, sir.

Good afternoon. Just a quick question about recoveries and 90 days past due. If you could just fill in those data points for me, I'd appreciate it.

Let me grab that real quick for you. The 90 days past due has been really very conservative. It's about $7.3 million.

The recoveries for the quarter were 1.1 million.

Great, thank you.

Thank you. At this time, there are no further questions.

OK. Having been through this experience once before, I do just want to take a minute to make sure that we have given an opportunity, and I assume all the technical things are working.

Thank you so much. We appreciate your interest in our company.