Cullen/Frost Bankers Inc (CFR) 2003 Q4 法說會逐字稿

Good morning. My name is Taneka (ph), and I will be your conference facilitator. At this time I would like to welcome everyone to the Cullen/Frost Bankers, Inc. fourth quarter and annual conference call. (OPERATOR INSTRUCTIONS) I would now like to turn the call over to Mr. Greg Parker. Sir, you may begin.

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 moment to address the Safe Harbor provisions.

Some of remarks made today will constitute forward-looking statements as defined in the Private Securities Litigation 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 Reform Act of 1995 as amended. Please see the last page of the text in this morning's earning 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 to Dick Evans.

I'm pleased to share with you another good quarter and a record annual earnings for 2003. In the fourth quarter we made $32.6 million, or 61 cents per diluted share, an 8.2 percent increase over the fourth quarter of 2002. For the year 2003, we made $130.5 million, or $2.48 per diluted share. That is 11.6 percent increase over 2002, and a return on assets of 1.36 percent, and a return on equity of 17.78 percent.

Again, thanks to our outstanding staff for this good performance. They grew revenues. They lowered credit costs, and they managed expenses. We were also pleased that three major -- that the three major rating agencies upgraded our ratings, or our ratings outlook. Cullen/Frost was also added to the S&P 600 MidCap Index.

And strategically a few highlights. We opened four DeNovo offices, one in Fort Worth, Austin and two in San Antonio. We continually look for acquisitions that fit our culture, both banks and insurance agencies. Last week was the celebration of our new landmark downtown location in Austin, Texas known as the Frost Bank Tower. I am also pleased with our Company occupancy expense remained flat with this move.

I was very pleased with the discipline we have added in assigning commercial and retail goals and objectives with established processes in measuring success. What I mean by this, on the retail side we have improved the value of our checking account products. And more and more of our retail customers are choosing our e-commerce and Internet channel, where we are always adding new functions and enhancements.

Also on the retail side, home equity and home equity lines of credit, which you will remember in Texas is new to us, the law changed in September. We see this as a great opportunity in growing loans. At the same time it is really a wild-card. Like all new products that a state has never had, it is hard to predict its outstandings, but we do think it is a great opportunity.

On the commercial side of assigning goals and objectives, we have established a process of calls and pipelines and weekly reporting that gives us the ability to act rather than react, because we're really managing our volumes about 60 or 90 days in advance. This discipline has helped us drive our expected loan growth to be in the low double digits, excluding home equity loans for the year 2004. \

At the same time, asset quality is very manageable. And in an ideal world, the balance sheet risk would improve as we grew loans into the allowance for loan losses. Looking at today's facts, the allowance for loan losses is strong at a 1.82 percent. The net charge-offs are 12 basis points for the quarter, and are also low for the year at 21 basis points.

Our nonperformers are up from 41 million in the third quarter to 53 million in the fourth quarter. Potential problem loans are down from 27.5 million to 6.9 million. And our past dues are again less than 1 percent at .85 percent. And over 90 days past dues stand at $14.5 million.

In summary, the reserve is strong, the charge-offs low, and nonperformers are up. If you totaled the nonperformers, the potential loans and the 90 day past dues, you would find that we are down some $7 million versus the third quarter. As I have stated since last summer, I believe asset quality is very manageable, and the risk levels from the bottom line, that is the charge-offs, are relatively the same.

Some thoughts about our economy. Most all of the markets we serve are improving, and we expect all will pick up as the U.S. economy strengthens. Furthermore, the conditions look good for Texas to outperform the U.S. We are saying that technology is showing signs of coming back, and is an important factor in our economy and recovery.

Obviously, the wild-cards we all know. On the downside some unknown shock as a terrorist attack would be a downside, even though our country has been amazing how it has gone through the shocks of war and terrorist attacks.

On the upside wild-card, I would say that there's lots of money on the sideline and could move into investments quickly. One example of this -- one of our customers in Austin, who was one of the few survivors and successful software companies over the last years, is starting a new company, and has had no problem attracting some $20 million in new capital for this company.

I thought we would take a closer look at the markets in which we serve and get a feel of how they're performing. I chose to use the payroll employment annualized growth rates to understand these trends, and look at them from what happened over the 12 months in '03 versus the last quarter of '03.

If you look at Texas overall, it was really flat for the whole year. But if you look at the last quarter, the annualized growth rates were improving by about three-quarters of 1 percent. Moving to Austin, it grew at about half a percent, and in fact was stronger towards the end of the year at a 1 percent in the last quarter.

Again, I think this employment growth is a good proxy for improvement in technology. As you know, most technology companies outsource so much of their work that it is hard to just look at that one industry and understand what is happening. I think when you look at Austin that it has a great concentration of technology. I think it is a positive for the technology.

Moving to the Gulf of Mexico and Corpus Christi. This is a market that was flat and had little or no growth for the year, and in fact weakened a little bit in the last quarter. This is also a city in transition, moving from energy and refineries to tourism.

Moving to the more northern part of the state, a big city, Dallas. It was really negative growth for the whole year, and then at the last quarter started to be positive. This is possibly some early signs of telecommunications starting to improve. And we know that the airlines, which are important, particularly American Airlines in this market, are losing less money than they did in the earlier part of the year.

The neighboring city, Fort Worth, is a very stable market. But it also has a larger concentration of manufacturing. I think from that perspective, it is understandable that for the year they really had a negative growth rate of about 1.25 percent. But in the last quarter it is positive and has moved to positive numbers.

Houston, Texas, as we all know, is about 50 percent energy and with a large healthcare. Their economy was flat for the year, but showed about a 1 percent increase in the last quarter.

Moving to the Rio Grande Valley and McAllen, Texas, and Harlingen where we operate, they totally missed the whole recession. They have had about a 2 to 4 percent growth all along. And the strong peso has added to their retail sales. And because the maquiladoras in this area are related to the automobile industry, and we know how strong it has been, this is an area that has been very positive in our state.

And last but not least, our home base, San Antonio, Texas, is a market that is usually always stable, and has operated pretty much flat all year. But you'll find that over the long-term San Antonio will follow the trends of the state as a whole. And if you looked at a group of lines of all these cities I have talked about, you would find that San Antonio is really stable, and its line would be in the right middle.

So in summary, Texas is the place to be, and we expect further improvement. Looking forward, we have an outstanding staff. We have a staff that is committed to our strong values of integrity, caring and excellence. We continue to recruit top banking talent from throughout the state. We're focused on profitable growth. We continue to review all segments of our business to make sure we get the proper return on our investment, and if not, we reduce the expense. Obviously, managing expenses is also a high priority. It means making sure that we keep up with growth.

Technology, we have invested in imaging, which we think is extremely important for the long term growth of this Company. And certainly, always looking for people who can help us grow our Company and produce efficient quality work will be added.

As we look at the year '04, it is about executing the playbook, following the disciplines and processes that are proven and work to make us a more focused and productive Company. In conclusion, our outlook is positive. The counterbalance is timing. How fast will the business environment change from low interest rates to higher rates, and from modest business expansion to expansion that requires borrowing money?

Next, I will ask Phil Green, our Chief Financial Officer, to make a few comments.

I would like to make a few comments on the quarterly results, and then briefly discuss our outlook for 2004, and then turn it back over to Dick for some Q&A.

As you have said, we're happy to report another solid quarter. And we had record earnings for the year. And a net income of 32.6 million was up 8.2 percent from the quarter a year ago. And it was driven by increasing revenues in a tough market, and also keeping operating credit costs under control. Our revenue growth came from a 6.3 percent increase in noninterest income and a 1 percent increase in net interest income. And meanwhile our operating costs increased 3.8 percent, and provision expenses dropped two-thirds from the quarter to a year ago.

Growth in fee income was from two important sources. First, trust income grew its largest quarterly level in some time, and was up by 10 percent from a year ago. Fifty percent of that growth was from higher investment fees. We had markets that continued to improve, but practically all categories of trustees were up.

The other major component of fee growth was from the service charges, which were up by 8 percent. And that was split pretty much between the commercial and the consumer segments. Commercial fee growth was a combination of higher services performed and lower interest rates. And the consumer component increased because of greater customer usage of our overdraft courtesy product primarily.

Also, compared to the third quarter this year, and as we discussed with you in last quarter's call, we did see a drop in our service charge income as we cut fees on several of our consumer deposit accounts. We began offering free bill pay, and we introduced a free checking account. And all these have the goal in mind, a longer-term goal of increasing our value proposition to these customers, and increasing our number of consumer accounts.

With regard to net interest income, as I mentioned, is up about 1 percent. But it was the first increase in some time, and we were glad to see it. It was due primarily to investing in some of our excess funds, liquidity and the 15 year Fannie Mae securities. We also had a premium amortization reduction of about $1 million from the third quarter's as well. And all this served to overcome a $1.2 million drop in net interest income related to our dollar roll (ph) program in this quarter compared to the third.

Regarding the increase in loans, compared to the previous quarter, they were up $86 million on average. I will point out that about 90 percent of this was from growth in the C&I loan component.

Looking now at expenses. They were up 3.8 percent from a year ago, the biggest part of that from salaries. This was from merit increases and some additional employees. And additionally, we did see a $1.1 million increase in other expenses from last year. And in this component what we're seeing is that we're increasing our marketing related expenses. We're also seeing some higher insurance premiums as we renewed some three-year-old major insurance policies, which were at great rates before and now we're experiencing the current market environment for insurance premiums. And we're also seeing some higher costs from depreciation for our assets involved in our operating lease portfolio.

Finally, provisions were $1.5 million. We exceeded charge-offs slightly for the quarter. As I mentioned, they were down by two-thirds from last year, and down the third quarter of about 25 percent. And the reserve, I agree, does stand at a very solid 1.82 percent of loans at year end.

Regarding our outlook for the current year, I will draw from the words we used last year and say that we're once again more comfortable guiding towards lower end of the range of estimates. Dick mentioned timing will play an important factor in what actually happens. We foresee a continued low interest rate environment for the year with practically no change in interest rates for the first half of the year. Businesses are recovering, but it remains to be seen just how fast it is going to lead to robust expansion this year. And also, just how fast the economy develops will impact the risk profile, the loan portfolio and required level of reserves against them.

Meanwhile, we are managing expenses closely, but we are committed to preparing for the growth in the business that we see coming. And we don't believe that we can delay moving forward on important initiatives. All this is to say that while we definitely see improvement for 2004, caution is warranted during the early part of year, as we see just how fast things develop.

And with that I will turn it back over to Dick.

We will open the meeting up for questions.

(OPERATOR INSTRUCTIONS) Charlie Ernst from KPW.

Could you first talk about your loan comments, Dick? It seemed fairly optimistic, about low double digits, and just add a little color to that maybe?

I think it is again a balancing act of how fast it is going to come on. I would interpret my comments about the economy as I think it is really improving. It is hard to see people actually borrowing money to make those capital investments yet.

But I think another thing that I am really saying is that, first of all, I am really pleased, Charlie, with our disciplines. We got a calling program and measuring of what we're doing. And weekly we know exactly what happened the previous week and where you're going. And plus we're looking out 90 days ahead of time and acting rather than reacting.

And then I think we can be encouraged by loans being up. As you heard Phil talk about, the loans did increase from the third to fourth quarter. You and I have been talking about that in this conference call of seeing improvement really since last summer. And we're constantly seeing some improvement. So based on our history of the last half of the year, we feel good about the growth. And as we look into the future, we feel good.

Could you say what the level of syndicated credits is at period end? And also just give us some color on NPA's and your feelings about the strength in the collateral behind those positions?

First of all, the shared national credits were $176 million at year end. And as you know, we've talked about shared national credits for over a year. We feel good about where our outstandings are. We've got about 400 million in commitments. Haven't really seen a lot of activity in the energy part of it that represents almost half of it. And we were optimistic about that growth in that market. The second part of your question, I believe, was related to non-performing loans?

Yes.

As I stated, the non-performing loans are up from 41 million to 53 million from the third to the fourth quarter. However, it is important to note we have talked about potential problems, which we have all year disclosed to you. I'm very pleased they are down from 27.5 million to 6.9 million. What has happened is the process is working. I would have loved for these two loans to have gotten better, but they moved into nonperformers.

And as I reported to you at the end of the third quarter, 81 percent of that $27.5 million is in two credits. And one of them has filed bankruptcy. Quite frankly, that has turned out to probably be the good news. It is a private company in the retail business that we have banked for over 25 years. And it is performing extremely well through this -- through the holiday season of reducing inventory, closing about half of their stores. And we feel good about that performance, and the loan is coming down.

The second loan is also a private company in the equipment distribution business. They have a workout plan that we have accepted. And it is our understanding that everybody else has accepted. And what they are attempting to do is accept the plan outside of bankruptcy. If everybody doesn't, then they will file bankruptcy and submit the same plan in bankruptcy. The difference is, it just costs all of us less money to agree to it without going through the court.

And we feel that there is no question we've got strong reserves on both of these credits. It has already been specifically allocated. And bottom line, when you add all the things up of the process, of whether it is 90 days past due, it is nonperformers, it is potential problems. As I said to you, in fact, the overall is down about $7 million. And if the rubber meets the road in the charge-offs, and we feel very comfortable with our charge-offs. I think you'll find them run lower than peer. And we feel comfortable with that in that range of moving forward.

Should my interpretation be what whatever charge-off exposure you might have to these credits, you feel very well reserved for. And we could see the reserve come down and not really have an impact on the income statement?

Let me answer you this way. Number one, I said that there is no question about the reserves being adequate for these two credits and for all of our portfolio. We feel that at 182 we have a good reserve and it is proper for where we are. We also believe that our charge-off range -- the risk in the overall portfolio level will be relatively the same. I said that at the end of the second quarter, third quarter, and I continue to say that.

Jennifer Demba from Sun Trust Robinson Humphrey.

I was wondering if you could give us your thoughts on the outlook for the net interest margin this year, assuming no movements by the Fed? And also I was wondering if you could comment on the competitive opportunities that make this -- the JP Morgan Bank One merger?

Jennifer, this is Phil. I would say our net interest margin we would see being fairly stable without the Fed moving interest rates. As we said, our expectation is that we won't see any rates for sure for the first half. And we don't expect to see much in rates -- rate movements at all during the entire year. We did see an improvement in the margin from the fourth compared to the third quarter.

If you take out the impact of dollar roll transactions, which gives you a little cleaner picture of the margin, adjusted for those, margin would have been 3.99 percent in the third quarter. It was 4.08 percent in the fourth quarter. So we've gotten some improvement there. I think without an increase in interest rates by the Fed, we might be a little bit more improvement. But I would look for it to be more stable.

If I understood the second part of the question, it was related to the JP Morgan Banc One?

Yes, I was just wondering if you could comment on the competitive opportunities from that merger?

Obviously there are a lot of bugs about it in Texas. And I think there will be opportunities. Also, I would comment that this isn't the first time that a merger, or significant mergers, have happened in this state, as you well know, our history of going through the '80s.

I would say to you that it is an opportunity. I think we've got to look at it from kind of three groups. Certainly, bottom line are the customers. And I think they will be some opportunities immediately with some customers just because of the uncertainty that is created of who is going to take care of them and what happens and all; all of the things that happen out of uncertainty.

From the staff standpoint, I think there will also be opportunities from the staff. I don't think they will be, in the near future, certainly, it will probably happen after the acquisition is closed and they see all the facts and where they stand financially.

And then third, certainly there appears to be some overlap of offices, and that is a third opportunity that needs to be considered. I think it is important that we use our disciplines and get out and continue to call on all prospects. And certainly the J.P. Morgan Banc One prospects have a more unique opportunity because of this change. And we are also planning and looking at all of our opportunities and being sure we are organized about addressing this issue.

(OPERATOR INSTRUCTIONS) Charlie Ernst with KVW.

Could you comment on the average deposit link quarter trend, how much of that was related to escrow balances, and also the strength in period end deposits? And then secondly, could you say what the short-term earning asset position was on average during the quarter?

Charlie, this is Phil. We had, on average deposits first of all, on a link quarter basis we were down about $99 million. And demand deposits were down 229 million. The average was 3 -- excuse me, $2.97 billion. And time deposits were up by about 11 percent. They were up 130 million to 4.7 billion, round numbers.

You are correct in suspecting some of that variation to be from that large account. It is actually not escrow balances. It is a clearing balance we have. As they process the payments they receive both for regular payments and for payoffs on refinancing, we clear those checks throughout the country for them. And that account relationship was down on average about $250 million. From the third quarter to the fourth, down to an average of about $240 million for the fourth quarter. So without that, we would have been up slightly on the demand component. And instead of having deposits down about $99 million on average, we would then up about $150 million, again in round numbers.

The reduction in that one account relationship makes sense when you consider that refinancings peaked in the third quarter. So just a tremendous amount of dollar volumes that were coming through their paid in full account did slow down. We still have a great relationship with them in providing a valuable resource of clearing their items for a big service center that they have. And so it continues to be a good relationship.

One thing to keep in mind, as we have said before, since this is a clearing account, really what you see is a reduction pretty much dollar for dollar in their balances coming from our cash on our balance sheet, because these items are in the process of collection. So again, we make our money on these kinds of relationships mainly through the fees for the services that we're providing.

I think you mentioned period end as well, Charlie? Is that right?

I was surprised given the decline on an average basis that period end looked actually to be up during the quarter?

You know, period end can be so volatile in times of just what you see with levels of demand deposits. They move around an awful lot. Period end deposits, let's see, I guess we've got -- we have them on the schedules for the press release, but on a period end basis, let's see, we were down from a link quarter basis about $84 million on demand.

Time was up by 412 million on a period end basis. So we were up about 328 on a combined total deposit basis. And one of the things that we've seen, which is a little unusual this year, is public fund deposits were up an awful lot. Probably I am going say up two-thirds of that growth in time deposits.

And some of the taxing authorities where we have some large public fund relationships changed the deal with taxpayers this year so that they no longer offer a discount for paying early. It used to be you could pay and get a discount if you paid in October, November, December. It went down depending on how late the date you paid. And then, of course, you had penalties for late payment. People just didn't take advantage of paying early. And so we saw a fairly large build up in public funds near the end of the year. But I think that is very seasonal, and will tend to smooth out as those entities utilize those funds.

The short-term earning asset position? Could you say what that was on average for the quarter?

Short-term rating assets, which I will say -- let's that would be Fed funds sold in the repos. In the third quarter they averaged 1,013,000,000. And in the fourth quarter they averaged 567 million. And those funds basically went into securities and went into the increased loans.

One last question, Phil. Could you comment on the insurance line this quarter? The drop, I was a little bit surprised by.

Yes. There is a couple of things going on their. One on an operating basis, we do have some pressure on some of the accounts that we have in there that are -- particularly school districts where we have got a large business. And also some of the institutional nonprofit types of accounts where with the increase in premiums being so high over the last couple of years, they're moving into -- in some cases they have access to -- I want to call them state-sponsored programs where they can utilize alternatives. We're seeing some movement there and some pressure there.

But, in addition though we did have -- we have been acquiring agencies and we have had to move these agencies onto new systems. We had some major system conversions where they went from their own to our own systems. Sometimes they will be on cash basis, and we always move them to accrual. And so that tended to increase the fourth quarter of last year a little bit. So I think it is both of those things. But I think that our outlook is for continued growth in 2004 over 2003 in insurance premiums.

Justin Miller (ph) with Abbott.

A couple of things. First on the charge-offs, just to follow-up on that. Relative to the one bankruptcy and one potential bankruptcy, or hopefully not, but could you follow-up relative to your earlier response on the flow-through to the P&L? In both those cases are they well collateralized to the point that you don't think there's going to be extra trimming required on those? Or nothing unusual, I guess relative to what you guys have been running in charge-offs?

Nothing unusual.

Secondly, branch plans for '04? Any DeNovos?

We take them just as they come along. If you look back over the last probably five years, we do three to four every year. And I think you can expect us to be in that range going forward.

(OPERATOR INSTRUCTIONS) At this time there are no further questions.

Okay. We, as always, appreciate your interest in our Company. And we look forward to a good year. And we look forward to this economy turning quicker than slower, and continue to grow our business. Thank you very much. We stand adjourned.

Thank you for participating in today's conference call. You may now disconnect.