Cullen/Frost Bankers Inc (CFR) 2003 Q3 法說會逐字稿

Good day. You are in a listen-only mode. I will be your conference coordinator. If you need my assistance, press the star and zero at any time.. I will turn the meeting over to Mr. Greg Parker.

Thank you. Welcome to this morning's conference call. It will be led by Dick Evans, Chairman and,CEO, and Phil Green, Group EVP and CFO. I need to take a moment to address the Safe Harbor provisions. Some of the remarks made today will constitute forward-looking statements as defined in the Private Securities Litigation and Reform Act of 1995 as amended. We intend such statements to be covered by the Safe Harbor provisions for forward looking statements contained in the Private Securities Litigation and 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 website or by calling the investor relations department at 210-220-5632. At this time, I would like to turn the call over for Dick Evans.

Thank you, Greg. We are pleased to share with you another good quarter of solid earnings. The third quarter we made $32.8 million, 62 cents per diluted share, or 24% increase over last year. Our return on assets is a 1.33%, and return on equity is 17.78%. Fee base income grew 9.3%, and it represents 41% of our total revenues. We also saw double digit growth and average deposits, and our noninterest bearing deposits are 41% of the total. As always, this is only possible with an outstanding staff, and I appreciate their good performance.

A word about the economy. We continue to be positive about the economy. We're seeing signs that this economy is improving. I think it is important to recognize that this downturn was long but also shallow. Also, over the long term, Texas will outgrow the United States. Energy is important, particularly in Houston. We're starting to see signs of stability and more confidence in pricing, and the activity is beginning to pick up. We are a high tech state. One of the top ten in the United States. Certainly, a month does not make a trend, but I'm happy to report that September showed employment growth in Austin, also in Houston, HP's operation is beginning to hire people. More and more positive signs in technology are good for Texas. A few notes on our highlights. A 40-year low interest rates continues to challenge this 135-year-old asset sensitive company. However, the increased deposit volumes and a $1.1 billion increase in average earning assets has helped offset this pressure. As mentioned earlier, our fee, our noninterest income continues s to have good growth and represents 41% of our total income. This is a major focus of our company, and we plan to continue to grow this diversified stream of income. For this quarter, two important segments to mention. Our service charge on deposit accounts grew 14.5%. Driven primarily by the customer acceptance of service charge resulting from -- of our enhanced overdraft curtsy product, and the growth and commercial service charges resulting from lower environment which lowered the earnings credit rate.

I'm also pleased to report our investment banking arm for all securities generated over $2 million in fees in the third quarter. Most important, the majority came from a commercial loan customer who was selling his company to management. He gave us the ability to keep the loan. We made a fee, and we helped with the management of some of these proceeds. Noninterest expense was up 5.4%, due primarily to an increase in salary and benefit expense. Controlling expenses continues to be a priority of management. Asset quality is at manageable levels, and risks remain relatively the same as last quarter. Our charge-offs as a percentage of loans were down to 18 basis points. The allowance is 1.84% with a 244% coverage of nonperforming loans.

Potential problems increased to 27.5 million with 81% and two credits. Past due loans were less than 1%. 90-day past due loans increased $5.3 million. However, with all these factors considered, we believe asset quality is very manageable, and risk levels are relatively the same as in the previous quarter. Now, let's look at going forward. We are positive about the Texas markets. Our period end loans grew to 5.7% from the second to third quarter on an annualized basis, excluding mortgages and indirect, which are two businesses we've exited, this growth was 8.3%. Our commercial calling effort is up 23%. In this area we have booked commitments. Our booked commitments are up 8.7% year-to-date. However, people still seem to be cautious about this recovery. I think an example that shows this is the new fundings on loans was 54% in 2002, and it is running 49% in 2003. Hopefully, we'll see greater fundings in the future.

Cullen/Frost is investing in the future. We'll open three new financial centers in the fourth quarter, one in Austin and two in San Antonio. The Texas voters approved adding home equity lines of credit, a new loan product now offered by Frost. We have adjusted pricing down on our checking account products, and added a new free checking account. With the economy improving and Frost expanding and growing, we're optimistic about the long-term prospects of our company. Now, I'll ask our Chief Financial Officer, Phil Green, to make some comments.

Thanks, Dick. I want to make a few comments on recent trends in our quarterly performance and then update our earning guidance for the year and open it up to some questions. We are pleased with our performance for the quarter in what continues to be a challenging interest rate environment, although that's not anything new. Our earnings from continuing operations, as Dick mentioned, were up 6% from last year. The growth continues to be fueled by strong noninterest income and lower credit costs, primarily provision. We're continuing to see compression in our net interest margin. It averaged 3.88% for the quarter, and we were down by 7 basis points from the second quarter.

Looking at some of the factors behind that drop, we did have the feds interest rate cut late in the second quarter of 25 basis points. We also had strong deposit growth again, which went into feds funds sold. We had higher prepayments on mortgage backed securities which increased our premium amortization of a million dollars over the previous quarter. These factors were offset by an 11 basis point reduction in the impact on dollar rolled borrowings in the third quarter compared to the second.

Taking a look at noninterest income, as Dick mentioned we were up 9% from the previous year. We were about even with the second quarter of this year. Remember, the second quarter included a million and a half dollars in gains from our student loan sales. We also had a million dollars in gains on sale on bank premises and Oreo property. Our fee growth in the second quarter was in deposit service charges. Those were split pretty evenly between commercial and consumer service charges.

We had higher insurance commissions compared to the second quarter and the third quarter is a better quarter seasonally than the second quarter for that business. We also had the other service charges up by -- really because of the $2.5 million increase in fees from investment banking activities that Dick mentioned. Then we had $560,000 reduction in trust fees for the quarter, but 90% of that drop was lower tax preparation fees, which are generally collected in the second quarter.

Looking at noninterest expenses, we were up by 2.6% from the second quarter, and our biggest increase came from a $1.9 million increase in salary expense. In the third quarter, we did have compensation that was related to the much higher investment banking fees that we recognize as well as the growth that we had in insurance commissions, and these were in addition to the regular company merit increases in growth and employees. Our provision to loan losses were $2 million in the quarter, down about a million and a half dollars in the second quarter and in line with charge-offs.

We do feel our reserve at 1.84% of loans continues to be strong. Regarding the outlook for the rest of the year, we are currently comfortable with somewhere around the middle of the current range of analyst estimates for the year. With that, I'll turn it back over to Dick.

Thank you, Phil. Now, we'll open the call for questions.

At this time, if you would like to register for a question, press the star and one on your touchtone phone. To withdraw the question, press the pound sign. If you would like to register for a question, press the star and one on your touchtone phone. Okay. We will take our first question from Charlie Ernst with KVW.

Hey, guys. How you doing?

Fine, Charlie

Nice credit quarter. Just wanted to go through a couple things. One, Dick, you said the 90 days past due number. I missed it. Could you say that number again?

I'd be happy to. I said that it increased $5.3 million. It was running around 6 million last quarter. 12 million is a round number. The increase was 5.3. We got a couple of credits in there that, quite frankly, I'm not that concerned about. One is in bankruptcy. The cash is here in the bank. It is about a million and a half dollars. It is just delayed from the typical things you go through in bankruptcy. We've got the money here in the bank. The judge just need to turn it over to us. Also, there is another credit, Charlie, that went in there that has substantial guarantees, and we expect that loan. It's about $3.4 million expected to be paid off this quarter.

Okay. And, Phil, could you say what kind of the Delta in the investment banking was between this quarter and last quarter?

Well, let's see. We didn't have a lot of fees last quarter. Let me see if I can refer to the previous quarter here. We had only about $150,000 in fees in the second quarter. So the fees we had this time were pretty much all built in

What was that level again?

$2.5 million

2.5 million. Okay.

It was a couple transactions

Charlie, and all of you who know our company, know that business is pretty lumpy. I'm just happy that we had a heavy lump this quarter. We talked to you a lot about the other ways as we've gone through. It is working well for us. What we have described for you has lengthened in the life cycle with our customers, and we're pleased with the relationship between our investment banking people and our commercial people and being sure we take care of those customers as they need to enter the private equity or have opinions or help them with mergers and acquisitions. In this particular case, this was a $100 million transaction that we helped the owner of this company sell to management.

Okay. Phil, my last question is, in terms of the net interest margin. First, can we just go through the specifics again about this quarter, and then if you have any thoughts, that would be great. The specifics I've got, the dollar roll, I'm assuming, because of less dollar rolls, caused the 11 basis point incremental improvement. The preamortization, you said, was a million. Then the rate cut was the remainder?

Yeah, Charlie. Let me go through it the way I'm looking at it here. I think we're together. I just want to make sure. First of all, since we've been saying what the impact has been adjusted for the dollar rolls, let me get that out on the table. Our margin for this year was a 399, if we take out the dollar rolls, compared to the 388 we reported. I said this year. It is for the third quarter. The second quarter our margin adjusted was 417. So you're looking at about, on an adjusted basis, an 18-basis point drop without the dollar rolls. You are right.

The dollar rolls, because they were less and an improvement quarter to quarter in terms of impact on margin. The premium amortization was around 5, 6 basis points. Probably closer to 5 basis points when the margin dropped. Just the fact we did have higher deposits and in heavier fed funds, it was probably about 6 basis points, and then the fed funds rate dropped late in the second quarter as it worked its way through was most of the remainder

Could you say why you made the decision to lower the dollar rolls in the quarter, and, also, update us on where the mortgage escrow balances stand.

Okay. The dollar roll decision was really a function of the market. You'll recall that we expect those -- the advantage of borrowing under those dollar roll transactions to be going away. In fact, they are. The market is tightening up. There's not quite the same advantage as there has been. For the third quarter, we had -- we averaged $391 million in dollar rolls. That compared to 600 million in the second quarter. We did have a very good borrowing rate in the third quarter.

We borrowed at a negative 59 basis points in the third quarter compared to a negative 2 basis point in the second. So it has been a great ride, but we see that market, as I say, tightening up. Looking forward in the fourth quarter, we should be, probably, less than half, the way it stands right now, in dollar roll balances than we are going to be in the third quarter. And the borrowing rate won't be near the advantage it was in the third quarter. Probably be closer to flat to 10 basis points positive. Did that get your question on the dollar rolls?

Yes, it did, Phil. Thanks. On the escrow balances.

Okay. That primarily relates to that large customer relationship we have for a mortgage processor -- hang on just one second, Charlie. For the late quarter, I guess is what you're talking about?

Yeah.

Okay.

On a link quarter basis, we had a slight reduction in those balances. They were $522 million the previous quarter, and they were down to about 493 in the third quarter. Remember, most of those balances are in cash through clearings. We are clearing the items for this customer and what we receive is the income for the processing.

Great. Thanks a lot, guys.

You're welcome.

At this time, if you would like to register for a question, press the star and one on your touchtone phone. To withdraw, press the pound sign. Again, if you would like to register for a question, press the star and one on your touchtone phone. Okay. We will take our question from Scott Alanis.

Good morning, gentlemen.

Good morning, Scott.

A quick question on the home equity opportunity. I was wondering if you could spend a moment talking about what you think of that opportunity with the change in the law and maybe where you all are at from a training stand point for your employees.

This is Dick. It's a good question. There's a lot Texans need to learn about in this market. There's a lot to start off and kind of frame who borrows in this market. Your greatest usage of credit on seconds and revolvers is in the age group from 26 to 40. Many of those -- of that market are, certainly, using different products. So that's kind of the negative side of it.

On the other hand, I think the real opportunity lies in people that have, you know -- you know, sending children to college, buying cars, and, certainly, recognize there's no question it is the preferred consumer product for borrowing money because you, obviously, get to deduct the interest and the other factors. So it is a good product that will open up to markets beyond that age group and, certainly, there's going to be those that qualify within that group. So I think there's a good opportunity there. We're optimistic about it. To answer your question, our people are trained. We expect to fund our first loans within a week. We've been working to make sure we have the technology to spend that out and we see a good opportunity there.

Scott, this is Phil. Just to add on to some of what Dick said. If you look nationally, the numbers that we've seen are that home equity loans have about a 14% penetration rate nationally. The fixed rate component of those loans are about a 6% penetration rate. Texas runs about 8% on the closed-in fixed rate side. That's because we probably haven't had a home equity alternative for them. If you lock at what opportunities are, if we were to go in Texas up closer to what the national penetration is, we might go from an 8% to a 14% penetration. So I think just for the state and for financial institutions in the state, there's a good opportunity there. It remains to be seen what we'll see because the Texas law is fairly specific and different than you see in some other places.

We will begin funding during this week because the law is brand new and you have to wait a certain amount of time after approval before you can fund. I can give you a little color in terms of what we're seeing right now. For this month -- and home equity lines of credit have been available this month. Of our home equity loan applications, 43% represent home equity lines of credit. 57% are fixed home equity loans. There is a demand for the fixed product. I think we're seeing a good demand for the line of credit. It's interesting that the average deal size is larger for the home equity line of credit right now. Our fixed rate, on average, is about $68,000, a little north of that and a little north of $80,000 on the line of credit. Now, those are averages. So we've got big ones and small ones and all. That gives you flavor in terms of what we've seen so far

Scott, I might just further comment that I think it's obviously the way the law is structured. The credit part is easy. You can't go over 80%. The -- on total debt and not over 50% on the revolver. So the law pretty well protects the industry from making any bad decisions, to a large extent

I guess the other thing I will mention, just to give you the idea of the scope, in the first three weeks or so of the month, we have approved $5.3 million in home equity lines of credit

Good. I believe, Dick, you also mentioned that you might introduce a new free checking product. Is that correct?

What I said was we adjusted our pricing downward on our checking account products in total. I think one of the things that may be a little bit different about our company is how we look at that. Obviously, free checking has been around, and there's lots of banners. That's not really what we're going to do. What we did about five years ago was go through and simplify all our checking products and saving products. Because of mergers and acquisitions we have done through the years, we had over 30 different checking product lines, and we simplified those down to five checking accounts and three savings products. I think that was a really important step for us.

As we have observed and watched what's been happening with checking products, we went through and looked at these five or six checking products and adjusted the pricing on all of them and added the free checking. What reality really brings is -- and what we've trained our people to do is to really look at the best value for our customers. Quite frankly, what we expect to happen is some growth in the free checking, but we really expect all our checking products to grow as we match our customers up with their best valued account.

I see. Terrific. Thank you.

Scott, this is Phil. Just, again, to make a couple points on what Dick is saying. We're really hopeful that by introducing these lower fees and free checking product that competes with some of what you constantly hear out there in the marketplace, we'll not only continue to grow balances like we have on our deposits but increase a number of account relationships we have with customers. We think that's a vehicle to do it. So we're putting some money on the table by lowering our service charge revenue on an annual basis. I think it will be about a million dollar reduction, and that just makes our products more competitive.

We're also committed to some more -- some stronger marketing in terms of customer acquisition, in terms of new accounts. That's going to take some direct marketing dollars for us. We'll begin that effort in the fourth quarter. So that's something that we're putting some money on the table to do and represents one of those initiatives like Dick was talking about when he talked about building for the future. In the deposit area, home equity loans is another example where we're building up and gearing up for what we think will be a pretty nice product line for the future.

We can't overemphasize that our real focus is on all our checking accounts and the training of our staff to properly match them with the appropriate account. I say that because it seems to be -- the buzz word is free checking. I will take the emphasis off of free checking and all the accounts and the different values that they bring.

Okay. Good.

We will take a follow up question from Charlie Ernst from KVW.

Could you talk a little bit about the credit outlook? You had a great quarter. First, were recoveries kind of at a normal rate, or were they maybe a little higher this quarter? Going forward, your MPAs are coming down. Does that mean somewhere around this level is somewhat sustainable?

Charlie, I'm certainly pleased that our nonperformers is 41.2 and 43.5 million last quarter. I think what's really important is what I've said. I think the risk level is about the same. The economy is improving. Whenever the economy is improving, you ought to see asset quality. We're optimistic about the future. You got to work through some of these signs. They never happen quite as fast as you want to, but, all in all, I'm pleased about the improvement.

We've moved from the first quarter at 48 million to 43.5 to 41.2. All along I've said to you that, you know, we're going to work with those. Those are nonperformers. On the other hand, you know that it is our philosophy to be an early identifier of problems, to not hide behind and identify them quickly. You can see that our potential problems are up to $27.5 million. There's two credits in there that are 81% of that. One is one that we've talked about. It is a distributor of compressed gas. It's not getting any worse, not getting a lot better. So that's kind of the good and bad news. We've got a new credit in there that's a retail customer that's got some problems. It's a customer we've had for 20 years. We know them well. We just need to work through that. It's properly identified. It is a potential problem. It could get a little worse.

Again, I'm comfortable with who we're dealing with and the circumstances. You know, this economy, while it's improving, what I said was it was pretty shallow of a recession. It was long, but it was shallow. There's not a great jump that everything is going to be wonderful overnight. I think things are going to continue to get better a little bit everyday, and I'm optimistic in that regard. I'm very pleased with our charge-off level of 18 basis points. We were 31 last quarter, 25 the quarter before, and that's where the rubber meets the road. Certainly, when you get down to charging off. Our inflow of new problems on loans has slowed. I said that to you last quarter, and it continues to be true. So there's less coming into the pipeline.

Dick, can you just comment on what the recovery looked like this quarter? My sense is, given where your reserve is, if there were a little bit higher charge-offs, then maybe you would absorb that through the reserve?

Well, we take that each quarter. There's no question that we do have a really good reserve that we're pleased with. Our recoveries in the third quarter were 2,000,484. So -- our charge-offs were 1.9 million. He saw we matched our provision with charge-offs.

Also, Dick, could you just talk about the opening of the three new branches and how you expect the impact on kind of the expense side, how that will flow through in the next quarter or two?

Well, the -- you know, a lot of it relates to promotion. We'll try to balance that out. There's no question that three coming on in the fourth quarter -- there's a lot happening in the fourth quarter. We talked about home equity. We talked about free checking. We talked about opening three offices. You have a little bit of a squeeze as we go through this fourth quarter. We really feel good we're doing the right things. The office in Austin is right off of I-35 on the opposite side of where you turn in to go towards Dell computer. A really good area that we've owned a piece of land there. We have a new office on the south side of San Antonio that we planned for some time and moving right into the middle of the medical center here in San Antonio. Charlie, if you look at our company, while we don't talk a lot about it, we open three to four offices every year. They don't all come in one quarter. It's not unusual from an annualized basis of what I think you would expect over a long period of time

Okay. Could you say where the snik portfolio stood as of third quarter? Also, give a comment on your energy borrowers. Are you seeing any more willingness to actually draw down credit, or are they in a paydown mode?

I wish the sniks would go up. They are $169 million. They keep moving down a little bit. We had moved out a couple of large credits in the professional sports arena which, across the nation, we've consolidated those kinds of credits, really large credits. Our energy portfolio still is a major part of our shared national credits. We feel very good about it. We feel good about the level of our shared national credits. As you know, we have a relationship, a direct relationship with those customers. I would tell you that I hope that I'll be reporting to you in the future that this -- that portfolio is growing because we're advancing.

Now, specifically on the energy, as I said in my opening comments, I see signs of positive. There's more discussion about buying properties and negotiating than there was before. Obviously, the gas market is more confident in the level of pricing there. There's been a lot of hold as oil was around $30 that many felt it probably should be $25. It's held there for some time. Bottom line, to answer your question, I'm hopeful that that will grow. Is it growing a lot right now? No. There's more discussion, and you got to start with a dream and try it before it converts. We have the commitments there, and we're ready to advance on the lines.

Sorry. Lastly, could you comment on just general M & A Activity, what you're seeing, and if you are focused on doing more insurance-type acquisitions versus, possibly, doing a bank acquisition? Thanks.

Let me just correct that statement. The one thing that we haven't done is we haven't bought a bank for five years, except for the small office down in Arlington a year or two ago. That doesn't mean we have ever stopped focusing on acquisition of banks. We continue to look. As we've said, we are very particular about culture, but we look at several deals every month, and we'll continue to as we move forward on banks. Secondly, you are correct that most of our activity has been in the insurance agency area, and we continue to be committed to build that business with our priorities in the Dallas and expanding our presence in Houston to help with a size to match our business in Houston. So we're interested in acquisitions, have been, and will continue to be in the future.

Any thoughts on the current environment? Are you seeing much willingness from seller, what are you seeing?

Everybody is pretty proud of what they have. As I told you, I think our Texas markets are really outstanding markets. Texas will outperform the nation. As a result, I'm not the only one that knows that. So everybody across the country is looking to move to Texas. So it makes the competition a little higher, although it's always been -- I'm glad where we're we are. The Colonel did a great favor bringing us to Texas. It is a great market. There are other folks finding out about it. We've got a great brand. We've been here 135 years. We will be here competing.

Charlie, one of the things we're seeing is that a lot of the deals that we're seeing are smaller deals, particularly in the larger metropolitan markets right now. It doesn't mean a big deal couldn't decide they wanted to do something. Most of the things you're seeing are smaller.

Thanks a lot, guys.

At this time, if you would like to register for a question, press the star and one on your touchtone phone. To withdraw the question, press the pound sign. If you would like to register for a question, press the star and one on your touchtone phone. It appears we have no further questions. I will now turn the program back over to Dick Evans for concluding comments.

Well, again, thank you for your interest in Cullen/Frost, and we appreciate the support of our shareholders. We look forward to the future. We stand adjourned. Thank you.

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