Cullen/Frost Bankers Inc (CFR) 2004 Q3 法說會逐字稿

Good morning. My name is Bridgett and I will be your conference facilitator. At this time, I would like to welcome everyone to the Cullen Frost third quarter earnings conference call. (OPERATOR INSTRUCTIONS)

I would now like to turn the call over to Mr. Greg Parker, Director of Investor Relations. Sir, you may begin your teleconference.

Thank you, Bridgett. This morning's conference call will be lead 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 the remarks made today will constitute forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995, as amended. The intent of such statements is 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 website -- frostbank.com 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.

Richard W. Evans, Jr.: Thank you, Greg. I'm pleased to report another good quarter's results. These are only possible because our staff continues to execute our plans very well.

To review some of the highlights -- the net income was $36 million, or .68 per diluted common share, up 9.7 percent. We're pleased to see the return on assets at a 150 percent; returnon equity, also a good return at 18.45 percent. Our margin increased to 4.09 percent, resulting from the Federal Reserve rate increase of 50 basis points during the third quarter and 25 basis points in the second quarter.

Also, earning asset volumes increased and average loans increased 8.7 percent versus last year, improving our earning asset mix.

Fee income continues to be a positive story for us at 40 percent of total revenues. And while the total fee income was up only slightly versus last year, the increase was net after security losses of $1.6 million and last year we had two large investment (technical difficulty) of $2.1 million. While investment fees are lumpy, we continue to be pleased with the performance of this business.

Trust income was up 13.5 percent; insurance commissions, up 10.6 percent. 70 percent of that increase was the result of our Sammons Insurance Agency acquisition in Dallas being brought into our Company.

On the expense side, they were up 5.1 percent, with most of the increase due to higher salaries and wages along with higher costs for a Director and also liability insurance.

Asset quality. Asset quality trends continue to be positive while non-performers increased $4 million on a link quarter basis. No additions to the allowance to loan losses was necessary. Obviously, the outlook is positive. Past dues were .47 percent. Net charge-off ratio to loans was 28 basis points for this quarter and year-to-date, we're running 25 basis points on an annualized basis.

Looking at non-performers plus past dues over 90 days and potential problems compared to last year, this quarter we had $57.2 million versus $81 million in the third quarter of last year, a decrease of $23.8 million, with the allowance to loan losses decreasing $6.3 million for the same period and currently stands at 1.56 percent for the quarter.

The balance sheet continues to expand with total assets almost $10 billion. Average loans grew 8.7 percent. Average deposits were flat versus the third quarter. However, correspondent banking deposits were down $543 million. You will remember we have talked for some time about a large mortgage processor who has moved out of the state of Texas that we used to handle, and that is the primary reason for the decrease in that $500 million plus.

On our commercial and industrial demand deposits, they're up 11.1 percent; again , I believe a very important number, because it represents our core business. And, timed deposits are up 7.3 percent.

Now I'd like to take a minute to talk about a few examples of growth initiatives. We talked for some time, but I will remind you that on our consumer side, our new account openings have grown 40 percent this year, since implementing free checking and lower fees last October.

On the business side, our sales activities continue to improve over last year. Year-to-date, calls are up 10 percent, loan pipelines are up 25 percent and new commitments booked are up 16 percent.

The total average loan growth was driven by a combination of new-booked loan commitments along with a higher percentage of fundings on these commitments,both commercial and consumer. This increase is even more impressive, in light of an increase in the pay-downs. Last year, the pay-downs were 17.9 percent and this year, year-to-date, they're running 19.4 percent.

We continue to diversify our core banking components by adding individuals with specialized industry expertise, as we have done in the past in insurance and energy. Our new lines will include public finance and residential, one-time closed contract construction loans. We have acquired eight individuals, four in each group. One from a local bank and a large national bank.

On the financial management group, we began building a new area known as the Frost Wealth Management Services, with a team of three individuals we hired from one of the big four accounting firms in January of this year. This area will focus on high net worth individuals with $5 million plus of investable assets. The area will cover a broad range of advisory capabilities; comprehensive planning, investment management, tax preparation and charitable giving advice, to mention a few.

Recruiting and telling the Frost philosophy story is an ongoing focus of our Company, year after year, and finding new opportunities, as I've just described above. However, at the same time, we never lose focus of the outstanding performance of our loyal staff. For example, our core relationship managers, those relationship mangers who have been in the job for at least 3 years, year-to-date, their calls are up 7 percent, their pipelines are up 18 percent, and their new loan commitments are up 27 percent. And because this group represents the largest number of relationship managers , they have produced 87 percent of the total dollars that we have brought in this year.

A few words about the environment where we operate. Texas is growing at about the same rate as the nation. The state's characteristics would suggest that we will return to growing about 1 percent above the nation, as history has shown. Texas job growth is about 1 percent. Austin's job growth is showing a growing trend and could suggest improvement in high tech. Dallas has shown some improvement. Fort Worth is stronger. Houston seems to be stuck at a little less than 1 percent job growth and San Antonio is growing stronger than the overall state.

Now I'll stop and ask Phil Green, our CFO, to make some comments.

Thanks, Dick. I'll make a few comments about our balance sheet and margin trends and discuss our earnings guidance for the rest of the year and then we'll open it up for questions on the call.

As Dick mentioned, average loans were up 8.7 percent from a year ago and on a link quarter basis. The annualized growth rate did slow somewhat to a little over 4 percent, partly due to the payoffs that we experienced and Dick described. However, if you look at the period end numbers, you'll see that the growth picked up near the end of the quarter and third quarter loans on a period-end basis were actually up 135 million or an annualized 11 percent growth rate. This period end growth has really spread throughout the portfolio. About half of the growth was split pretty evenly between C & I and (indiscernible) construction. And about a third of the growth for the quarter represented consumer loan growth in various forms. And the largest component of the consumer piece, a little over a third, was home equity related.

Our deposit growth, adjusted for the loss of the clearing account for the large mortgage banking processor which moved its operations out of state, was strong. Now that relationship DDA was up about 5 percent over the previous year. Time deposits increased 7 percent overall because of a 14 percent increase in money market deposit account balances. And we also had a 15 percent growth in consumer interest on the checking balances and those offset a drop of about 13 percent in CDs.

I want to turn now to our net interest margin for the quarter. And interest income did increase nicely in the third quarter from both the previous year and the previous quarter for the reasons that Dick previously ascribed. Just to remind you, those were increasing interest rates, and also, increased balance sheet volumes.

The margin did increase somewhat from a 402 in the second quarter to a 409 in the third. But remember that the second quarter margin adjusted for dollar (indiscernible) was actually a 410. So, it was actually fairly flat for the quarter, even given the higher net interest income and the higher rate environment. I wanted to point out that the reason this occurred is because of the higher levels of the liquidity that we've built up in the Company during the quarter.

In the third quarter, the average balance of our investment portfolio declined about $150 million. These funds, along with the net deposit growth that we had for the quarter, were only partially invested in a loan portfolio. The big majority of these funds were allowed to sit in our Fed funds net liquidity position, which increased by about $340 million during the third quarter. We realize this represents an opportunity cost to the Company by not investing these funds. However, we've allowed it to occur because we simply have not liked the market. Our view has been that interest rates are headed higher and that we'll have been happier holding out from investing until we have a better sense of the direction of the interest rates.

And you heard us discuss in the past that investment securities are a core asset for us and that we have to invest at some point. However, we will at times lean one way or the other in the timing of our investing depending upon our view of the value that's available in the market place. And we currently believe that we're better off waiting until we get past this election period and the uncertainty that it's created before making additional significant fixed-income investments.

I should point out that had we not had the increase in the Company's net Fed funds liquidity during the quarter, our margin would have been a little in excess of 420.

Finally, I'll note that we took a $1.7 million loss in securities during the quarter because we elected to sell our entire position in Fannie Mae callable agency securities. We had originally purchased these earlier this year with the expectation they'd be called. However, it appeared to us that they would not likely be called at this time, and we'd instead see them go to their maturity period, which would be an (indiscernible) of about 3 to 4 years.

What we did was sell the callables, which yielded a mid-3 percent range and extended the duration a little over a year by purchased and amortizing 15-year Fannie Maes, that's yielded in the mid 4 percent range. And this of course, helps our net interest income going forward.

Regarding our guidance for the year, we continue to be more comfortable with the lower end of the range of current Street estimates.

And with that, I'll turn it back over to Dick for questions.

Richard W. Evans, Jr.: Thank you, Phil. We'd be happy to entertain your questions now.

(OPERATOR INSTRUCTIONS). Your first question comes from the line of Jay Cunningham, Southcoast Capital.

Good morning. How are you all?

Richard W. Evans, Jr.: Good morning, Jay.

I guess can we just hit a little bit on credit? I mean, we continue to see good credit numbers out of Texas, but I guess at the same time, we're kind of hearing around the group that, you know, perhaps credit has gotten as good as it's going to get. So, what are you seeing and then you know what are we expecting then on reserve coverage?

Richard W. Evans, Jr.: Well, I think -- number one, I think the economy is doing well as I mentioned, even though you get great debate, particularly at this -- around election time, there's lots of different opinions. But if you sit down and talk to customers, quite frankly, they're doing well. They'd like to grow a little bit faster. They have to work hard for it. But I would tell you, throughout the state, I think the economy is very good and as a result, we feel that our reserve at a 156 certainly is -- we're very comfortable.

You and I both know that today and always, we've had to find the right level of reserve, and while our non-performers moved up about $4 million, if you really look at the detail and in the press release, you probably noticed that our -- in fact our (criticized) assets are less than they've been.

If you look, you'll find that -- I will tell you that our identification of new problems is less. I think that addresses your question in regard -- are more problems coming on? No, they're not. In fact, if you compare the inflow versus last year for us, there is less. And then, if you look at the rate of resolution, how we're resolving our problems, they're moving faster.

So, I'd comment also, you know, past dues,gosh, at .47 percent. I don't know that in my 35 -- 33 years of being here, I've seen them any lower. It's a really low percentage.

Net charge-offs on loans at 28 basis points for the quarter is up a little bit for us. We've been running in the low 20s. If you annualize this year, as I mentioned, we're at 25 basis points. And I really think, you know, if you look at peers, you'll find that when you're running in the low 20s basis points, that's a pretty good charge-off ratio. I don't like any charge-off.

And I guess the last thing I'd say to you is, we have used and began reporting in our Qs about potential problems. And they are at $1.5 million this quarter. Second quarter they were $4.2 million. First quarter they were $13.7 million. I think that is another very positive indication of the trends. And so I think the trends are very positive.

I'm just catching up with you a little bit. And then can you just kind of hit on, I guess on both sides, but deposits as well as loans,just under the pricing we're seeing and how aggressive people are? And then is there any difference geographically, you know, be it Houston versus San Antonio or Dallas?

Richard W. Evans, Jr.: Let me take the last part. As far as the -- I would say there's not a big difference geographically. We operate, as you well know, in all the major markets.

Moving to the first part of the question, this state is very competitive. You know that and everyone knows it and there seems -- it seems to be an attractive place for folks to come. So, it is -- it has been competitive and remains so today.

I have -- I was asked the last quarter some questions about our loan pricing and we come back and looked at it and I've almost been run out of the place for having indicated that we might be pricing loans too low, because our -- we don't win every deal. Some we win and some we lose, but obviously, we can't worry about the competition. We've got to make sure that we get good returns for our shareholders. So, it is a competitive market in all regards of loans and I think we're in there winning our share of it.

On the deposit side, time deposits were up. We try to be sure we can be competitive, but certainly not be the highest in the market. I think you would find, true for us, over a long history. Phil, is there anything you want to add to that discussion?

No, Dick. I think it's a good discussion of it.

Richard W. Evans, Jr.: Does that address your question?

Yes, sir. And then, Phil, just let me -- can you run through those numbers again on investment portfolio and Fed funds increases just so I can get those exact?

The investment portfolio on average for the quarter, effective to a third, was down about $150 million.

Okay.

The average portfolio was right at $2.9 billion, almost spot on. . At the same time, you know, our average loans were up by $150 million. It averaged -- I think you see it in the release, about 4.8 -- $4 million. Some of that investment security liquidity did go into funding the portfolio, but I think more important for our margin percentages, we saw our net Fed funds position increase on the more liquid side to about $340 million. Another way to look at that is we were about net purchasers of $240 million on averagefor the second quarter. We were net sellers of $100 million the third quarter.

Okay. And so --

Richard W. Evans, Jr.: Excuse me -- go ahead.

No. I was just going to say then to clarify --so adjusting for this again, you were at 420 now and in the quarter. And then can you give us an idea of where we ended?

If you had had - if you - if we hadn't had this additional liquidities in, say, in the mid $300 millions, if you just took that out and also took out the interest of the small arbitrage it would have been on that, we would have been around a 421.

Okay. And where did you end the quarter?

It would have been at about that level.

Okay. And then just a few more follow-ups. What was the total growth in home equity?

Let's see here. We had -- on a period end basis?

Yeah, that would be great.

Okay. We had home equity loans on a link quarter basis were up by -- they closed in and HELOCs were up by $18 million.

And then total pay-downs in the quarter?

Loan pay-downs, I don't have a number. I think Dick gave a percentage about what the increase was.

Richard W. Evans, Jr.: Yeah, what I mentioned earlier was that the rate of pay-downs has been faster than it was last year.

And is there any change in that? Are you seeing that through the year?

Richard W. Evans, Jr.: We talked about that last quarter. I think two things that you see happening is that you see that they're advancing. Customers are advancing more on commitments, a higher rate, but the level of pay-downs is a little faster. What I said was the pay-downs ran 17.9 percent in '03 and they're running 19.4 percent in '04. But the advance on new commitments is a little bit higher. So, you know, those -- you start shaving the cheese pretty thin, but 1 percent on, you know, almost $5 billion gets to be real money.

Sure. And then just a last one. Whatt was period end head count?

Richard W. Evans, Jr.: Let's see if we can find that.

I've got that.

Well, if not, I'll find you later.

Richard W. Evans, Jr.: Let me add one thing while we're looking at that number. Let me just add one thing in regard to the pay-down. They're not moving the debt. They just have liquidity in reducing the debt and that is particularly true in our energy loans. Withenergy prices being so high, obviously, their cash flows are higher and they're reducing pretty fast.

So is that then the majority of the pay-downs?

Not necessarily, no. I think we need -- it's just what I said. That's a component of it, but overall, the portfolio, when you make a loan today, they're advancing a little bit more and we're seeing a trends of pay-downs.

Okay. Okay.

This is Phil. The head-count at the end of the quarter was 3,372.

Okay. Thanks a lot, guys.

Let me mention one other thing before I lose you. On pricing, I left one important factor out, and that is, remember that this is a Company that focused on relationship profitability and we're looking at the total relationship of the loan, the deposit relationship and others when we look at our pricing.

Okay. Thanks a lot.

Jay, this is Phil. One more point of clarification because I'm not sure which one of these numbers you want to use. But if you're looking at full-time equivalent staff, that number would be 3,220. So, obviously, there's some part-time staff in our headcount number, but did that --

Yeah, the full time's great. Okay.

Okay. It's 3,220 (indiscernible).

Okay. Super. Thanks again.

Thank you.

Your next question comes from the line of Charlie Ernst (ph) of Sandler O'Neill Asset Management.

Hey, guys.

Richard W. Evans, Jr.: Hey, Charlie.

How are you doing?

Richard W. Evans, Jr.: Great.

Good. A couple -- you might have said these numbers, but I missed them if you did. Phil, did you say the absolute average for short-term earnings assets in the quarter -- what the overnight money was? And I know that you said it was up a couple hundred million but I just --

Yeah. Okay. I think you mean on our net -- on our Fed funds position?

Yes.

Yeah, we average for the quarter -- I didn't say, but it was $556 million for the quarter in Fed funds sold and resells.

Okay. And what was the September margin again?

The September margin on a --, if we did not have this additional liquidity, was at a 421.

Okay.

It was on a -- if you'd had looked -- and margin flips around a little bit during the quarter, so be careful looking at it on a monthly basis -- would have been around 4 percent.

It would have been -- it was 4 percent in reality.

It was 4 if you just -- yeah, if you just took the financial statements and did the number. But remember, the liquidity brings that down.

Right. Right. Okay.

And again, you'll see some movement around within the quarter. Well, I like not to focus too much on any one particular month, but that's what it was.

Okay. And could you say what the loan yield was for the quarter?

Average loan yield for the quarter was 529. That compared to 498 last quarter.

Yeah. Thanks. And the bond yield for the quarter?

Was at 480.

Are you all seeing any changes from your energy borrowers in terms of their desire to draw down credit?

Richard W. Evans, Jr.: Yes, some. We see that they're advancing and buying some properties from time to time.

It's hard to -- you know, Charlie, that -- I wouldn't want to mislead you and say there's a great activity, that there's a big change, but you're seeing some. And then, you know, we kind of -- you know, the economy kind of hit that soft spot in July and, of course, prices have gone up so much that it's kind of stopped the activity again. It's hard to tell what the real price is.

Right. And theoretically, this should have some positive effects on your trust income, if I'm not mistaken. Is that correct, just the level of energy prices today?

(Indiscernible) prices? Yeah, it is. It does. The one thing you have to remember about that our fees there, is there are two sources of fees.

One has to do with royalties,which is price based. The other has to do with bonuses, which we gave of properties that are leased. And there is some volatility in the bonus component. But for example, Charlie, if you were to look year-over-year in oil and gas fees, they've had strong growth compared to the third -- to the same quarter a year ago. They were up about 18 percent. If you look on a link quarter basis though, they're down about 6 and that's because we had some really nice bonus fees in the second quarter, which we didn't have in the third. But I think you can see with the 18 percent year-over-year growth, that is helping us.

Okay. And then, Phil, there was an insurance deal that closed this quarter, is that right?

Richard W. Evans, Jr.: Sammons.

We did Sammons Insurance.

And when did that close?

Richard W. Evans, Jr.: August.

August. So would you say that that is the big part of the reason for the increase in insurance fees this quarter?

Richard W. Evans, Jr.: I mentioned that it was 70 percent --

Okay.

Richard W. Evans, Jr.: -- of the increase.

And then your school renewals would have been another part of that or something?

Yeah, the third quarter is -- for some components of our insurance business, is a good quarter for them and schools have been a part of that.

Okay. And then lastly, could you comment on the impact of the mortgage customer going away, throughout, you know, the balance sheet and also whether there is an income statement impact?

Charlie, as we've talked about this over the quarters that we've discussed it, the balance sheet impact does show an impact on demand deposits, but you've got to remember that virtually all of that was in cash.

Right.

So whenever you look at the queue that's going to come out later today, and if you look at cash and due from banks, you'll see that those are down pretty sharply. Cash, for example, averaged $837 million in the second quarter. It averaged $678 million in the third, just on a link quarter basis. So when you see that large account relationship go away, it's basically coming out in cash because it was just a transit clearing account impacting mainly fee is on the service charge side. And I'm trying to remember what they were, Charlie. I think near the end, they were running in the high 60s, in thousands of dollars per month in service charges and we had a pretty decent profit margin on that business. Obviously, it was not all profit. It was a pretty decent margin.

All right. Great. I appreciate it.

Okay.

(OPERATOR INSTRUCTIONS) Your next question comes from Scott Alaniz from Sandler O'Neill.

Good morning.

Richard W. Evans, Jr.: Hi, Scott.

Two questions. First, Dick, could you talk about what new branch opening plans you may have for 2005? And the second question would be, if I could have you also comment on the M & A environment in Texas and whether or not that may be providing you with opportunities for growth?

Richard W. Evans, Jr.: Scott, in regard to branches, we traditionally open about 3 to 4 branches a year, and have, over the years. We'll sometimes, you know, update one and, you know, close an old one and make a new one. But that's pretty much what we do. And we really haven't changed that process except from the standpoints that are always working to be sure that we prioritize and spend our money in the best places.

And each of our cities, each of the cities in Texas, are very unique and different and to the kind of branch that you want to build and depending on the business. As you know, we have a really nice retail (technical difficulty) here in San Antonio and you take a city like a Dallas,where we're primarily a commercial and high net worth. You have variances like that, by cities. But that's pretty much what we do.

M & A, everybody on the phone I'm sure knows it's a hot market. It's very attractive. Having been here for over a hundred years, we're staying our course of, you know, looking for folks that -- and those acquisitions that really meet our culture and that we think we can bring together and grow from the point that we might make an acquisition.

There it's also no secret we're extremely particular. We're fortunate that we have an opportunity to look at most everything that comes on the block and we make a decision of whether we'll even go after it or not. And we'll continue to do that. But I think you'll continue to see activity in Texas be pretty robust for some period of time.

Okay. Thank you very much.

At this time, there are no further questions, sir. Do you have any closing comments?

Richard W. Evans, Jr. : Again, we want to thank you for your support and we will continue to execute our plans and grow shareholder value. We thank you. We stand adjourned.

Thank you for participating in today's Cullen Frost third quarter earnings conference call. At this time, you may now disconnect.