Cullen/Frost Bankers Inc (CFR) 2004 Q4 法說會逐字稿

Good day and welcome to the Summit Bancshares, Inc. fourth quarter and year end conference call. Today's call is being recorded.

Before I turn the call over, I would like to make the Safe Harbor announcement. Certain statements made during this conference call which are not historical in nature, including statements regarding the company and/or management's intentions, strategies, beliefs, expectations, representations, plans, projections or predictions of the future are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and are intended to be covered by the Safe Harbor provisions for forward-looking statements contained in such Act.

We are including this statement for purposes of invoking these Safe Harbor provisions. Forward-looking statements are made based on assumptions involving certain known and unknown risks and uncertainties, many of which are beyond the company's control, and other important factors that could cause actual results, performance or achievements to differ materially from the expectations expressed or implied by such forward-looking statements. These risk factors and uncertainties are listed from time to time in the company's filings with the Securities and Exchange Commission, including, but not limited to, the annual report on Form 10K.

I will now turn the call over to Mr. Philip Norwood, chairman, president and CEO. Please go ahead, sir.

Thank you. And thank you for joining us for Summit Bancshares fourth quarter conference call.

We're pleased to report very positive results for the fourth quarter and the year-ended December 31st, 2004, with net income for the year increasing 10.4% over 2003 and 21% over the third quarter of 2003. Bob will discuss the financial results in more detail in his report, but I will point out that the increased earnings performance was a result of the progress we have made in several areas, including a successful integration of the Arlington Bank acquisition into our systems and culture, loan growth of 27% from period end December 31st, 2003 to period end 2004, and an increase in total earning assets of 24% and an increase in non-interest income of 21% for the same period.

While we were really pleased with our financial and strategic performance for 2004, the earnings were negatively impacted by approximately $350,000 in legal and accounting expenses related to compliance with Sarbanes-Oxley. In addition to being a significant out-of-pocket expense, the activities involved to ensure that we are in compliance with Sarbanes-Oxley Section 404 has been a distraction for our operational and support staff members. This followed many of these same employees being heavily involved in the consolidation of Arlington. With these tasks about to be behind us, these staff members can now concentrate on our strategic issues of growth and profitability.

Our non-interest income was negatively impacted by a decrease in service charges on deposits totaling almost $100,000 for the year. This decrease is primarily attributable to the increased earnings credit on our commercial deposit accounts (inaudible) analysis due to the increase in interest rates. The drop in service fees is offset by the increase in net interest income realized from the higher rates on earning assets.

The fee income from our loan origination operation declined slightly in the fourth quarter as a result of delayed closings in the month of December. This is attributable to the holiday season as is evidenced by a strong pipeline of mortgage closings scheduled for January and February. With housing starts and sales forecasted to remain strong in Tarrant County for 2005, our mortgage operation has an excellent opportunity to increase revenues during the year.

Our non-interest income increased 21% in 2004 compared to 2003. This increase is attributable to the Arlington acquisition and increases in deposit account service fees and miscellaneous other fee income services such as insurance, merchant card fees and ATM fees. We will be discussing operating expenses in more detail later in the report, but I will just note that during the year we had an increase of 25%. Summit Bank Arlington had an increase of 11%. Contributing to the increase in non-interest expense was the opening of the Euless branch in May and our new motor bank to service our Hulen location, which opened in October.

As you may recall, our acquisition of the Arlington Bank included a small trust department. The trust officer who also served as the Arlington Bank's chief operating officer has specialized in employee benefit products with all administrative functions being outsourced. He is now focused on development and growth of the trust department full time. We are currently in the process of developing a business and strategic plan for trust through a committee of our Board of directors and management, which we anticipate will include a plan to develop personal trust directed primarily to our business owner and professional customers.

As we announced earlier in 2004, we were successful in hiring an experienced investment broker to grow our investment brokerage operation. After joining Summit in April, the revenue from these brokerage activities has steadily improved with total revenue of 18% over the last year. The total assets in customer brokerage accounts has increased from $54 million to $81 million in 2004 compared to 2003. We anticipate assets and revenues from this line of business to continue to increase as we gain more business from our existing customer base.

Our new Euless branch is off to a great start, having generated approximately 13 million in new loan growth and deposits of $12 million. This branch is located in the heart of the Euless medical community and is adjacent to a large industrial park. Both of these markets fit some strategic market and provide a good source of growth for the future.

As mentioned earlier, we had excellent loan growth in 2004, with the average from December 2003 to December 2004 increasing 29%. Excluding the impact of Arlington, loans grew 16%, which was in line with our expectations for the year. Also, on a positive note, Arlington's loans grew at an annualized rate of almost 10% after the acquisition, which is excellent given the distractions of the integration into Summit. Our loan growth did slow in the fourth quarter compared to the third quarter, with an increase of 1.8% period end to period end and 2.2% on the average balance of each quarter. The slowdown occurred during the months of October and November and picked up in December, with average loans increasing $10 million over November's average.

At last quarter's conference call we discussed our plan to recruit experienced commercial lenders in the Arlington market. In December, we were successful in attracting such a candidate in Steve Crosby, who has been in the market for 6 years with a national banking organization in their middle market commercial lending group. Steve's customer base and lending experience are a great fit for Summit. Steve has been in banking for 19 years, serving in several capacities for the same organization.

Our deposits grew 10% for the year excluding Arlington, and 26% including Arlington, comparing averages for 2003 and 2004. This represents a very good growth rate in our market compared to our peers. However, the rate of growth has not kept up with our loan growth, which has resulted in our continued use of the Federal Home Loan Bank advances to balance our funding needs. Our loan to deposit ratio has continued to be in the 88% range, which is in line with our peers. Our deposit growth for the fourth quarter compared to the third quarter was somewhat slower, with the average increasing 1.6%.

Our asset quality continues to be excellent, with 2.6 million in non-performing assets, which represents a 0.37% of total loans compared to 0.43% in 2003. $1.2 million of the non-performing asset total is the guaranteed portion of SBA loans that are on non-accrual. Our loan loss reserve represents 394% of non-performing loans and is a healthy 1.45% of total loans.

Total (inaudible) loans ended the year at $35 million, which equals 5% of total loans, the same percentage as December 31st, 2003. Our loan losses for 2004 were nominal at 0.1% of total loans. Gross charge-offs were $1.04 million, with recoveries totaling $400,000 for net charge-offs of 640,000. Our lenders, along with the support of our Chief Credit Officer and the Risk Management staff, have done an excellent job of maintaining strong asset quality. In addition, the level of recoveries is indicative of our conservative approach to recognizing losses, as well as the continued collection efforts by our lenders and our support staffs after the loans have been charged off.

Our focus for 2005 will be directed to the continued internal growth of our core business of building total relationships with targeted commercial prospects, executives and professionals, their families and employees. In addition, we will expand the relationships of our existing customers through an enhanced officer-calling program that will include a referral system for the products and services those customers do not presently utilize but have an apparent need. As we continue to analyze our existing customer base, we believe there's a significant opportunity to attract additional deposits and to sell fee-based services we have put into place. We will also continue to improve the efficiencies of our operations as we absorb our existing overhead through growth, as well as streamlining more of our backroom operations.

Although our priorities for 2005 will be to maximize the return on our existing resources, we will continue to explore our expansion opportunities through internal and external growth by identifying those markets we want to have a presence in and developing a plan of action for entry into those markets. We'll also be prepared to take advantage of any unforeseen opportunities that may arise during the year.

Overall, we are very proud of our performance for 2004 and are on target to meet the long-term growth in earnings we targeted for Summit when we restructured the company in 2001.

Now I'll turn over the call to Bob Scott to review our financial performance in more detail.

Good morning and thank you for joining us today. My remarks today will primarily focus on fourth quarter financial results of the company compared to the third quarter of this year. Hopefully, you've had an opportunity to review the news release of yesterday, which explained many of the comparative results for the fourth quarter of 2004 and the year of 2004 compared to the same periods of 2003. As mentioned in the news release, all per share data has been restated for the 2 for 1 stock split that was effective December 31, 2004. Also, I would remind you that when comparing fourth quarter 2004 data to the prior year, you must consider the Arlington acquisition that was effective May 1 of 2004.

As Phil mentioned, net income per share for the fourth quarter was 23 cents per diluted share, an increase of 21 cents -- or 21% over the fourth quarter of 2003, and 4.5% increase over the third quarter of 2004. For the year 2004, net income was 85 cents, a 10.4% increase over the prior year. Net interest margin was 4.41% for the fourth quarter compared to 4.29% for the third quarter of this year of 2004, a 12 basis point increase. This increase, of course, reflects the increasing prime rate that has occurred since June of 2004. This increase follows an 11 basis point increase in net interest margin between the second and third quarters of 2004.

The yield on earnings assets taxable equivalent was 5.61% for the fourth quarter, a 22 basis point increase over the third quarter of 2004, and reflected a 23 basis point increase in the yield on loans over the same linked quarters. The cost of funds, including short-term and long-term borrowings, were 1.65% for the fourth quarter, a 16 basis point increase for the third quarter -- over the third quarter of 2004. The increase in cost of funds reflects a 14 basis point increase in the cost of interest bearing deposits and this followed only a 1 basis point increase in the cost of interest bearing deposits in the third quarter over the second quarter. After having increased the posted deposit rates modestly in the third quarter of 2004, competitive pressures caused us to increase the posted deposit rates somewhat more aggressively in the fourth quarter, therefore resulting in the greater increase in cost of funds.

Net interest income tax of equivalent was 10,248,000 in the fourth quarter, increasing 381,000, or 3.9%, over the third quarter of 2004. Over the same period, average earning assets increased only 1.1%, while average loans increased 2.2%. Contributing to the modest linked quarter increase in average earning assets was the company's decision to use less leverage in this rising interest rate environment and, therefore, we reduced the reliance on Federal Home Loan Bank borrowings by 12.6 million, with a similar reduction in short term investments.

You may notice that interim construction loans decreased by 16% in the quarter when comparing December 31, 2004 (ph) to December 30th, 2004. This is attributable to some large interim construction loans being moved to the commercial real estate loan classification after the construction phase of these projects was completed. After considering this classification change, all categories of loans, except consumer loans, contributed to the increase in loans.

Total average deposits increased 1.6% for the linked quarter and this included a 4.1% increase in loan -- non-interest bearing deposits, or DDA deposits. For the fourth quarter of 2004, non-interest bearing deposits averaged 29.6% of total deposits. For the fourth quarter of 2004, non-interest bearing deposits averaged 29.6% of total deposits. Also in the fourth quarter, average repurchase agreements, a core funding source for the company, increased 15% and ended the quarter at $44 million. Several of our commercial customers use this product in their cash management programs. This funding source has a reasonable cost of funds, which averaged 1.33% for the fourth quarter.

As we have discussed in the past, Summit is interest sensitive -- is interest rate sensitive, with 51% of the loan portfolio maturing or re-pricing in 30 days. An additional 17% of the loan portfolio matures or re-prices within 1 year. In addition, 12.5% of the investment portfolio matures or re-prices in 1 year. Assuming interest rates continue to improve over the next year, the company will benefit from this interest sensitive position. Also, because of the company's high level of non-interest bearing deposits supporting earning assets, a continuing increase in interest rates will further benefit the company's net interest income.

Non-interest income, excluding extraordinary items of $245,000 that were recorded in the third quarter of 2004, declined 4.5% in the fourth quarter compared to the third quarter, with service charges on deposit accounts declining 8.1%. As Phil noted, this decrease was partly due to a higher interest -- higher earnings rate credit paid on commercial deposit accounts that are on analysis, which is driven by the current higher interest rate environment, and also due to the fact that following the Arlington acquisition, some of those customers were in the wrong Summit Bank deposit product and, during the following few months, were moved to products that resulted in lower deposit fees. Other non-interest income increased slightly in the fourth quarter over the third quarter. However, there were decreases in mortgage origination fees, as Phil mentioned, and trust fees. However, these are offset by increases in other income areas, including a $66,000 increase in recoveries of interest on previously charged-off or non-accrual loans.

Non-interest expenses increased 1.3% in the fourth quarter compared to the third quarter. The fourth quarter expenses included the additional expenses related to the move in October of the Euless branch to new quarters -- they were moving from temporary offices to a new facility -- and the opening of the remote motor bank for Hulen branch. These additions contributed to a 4.8% increase in occupancy (inaudible) expense for the fourth quarter over the third quarter. The opening of these facilities, which required additional staff, plus a company-wide increase in healthcare costs and a somewhat higher accrual for incentive bonus in the quarter, all contributed to a 3.3% linked quarter increase in salary and benefits. Also, there was a $79,000 increase in legal and professional expense, of which 50,000 was directly related to the compliance efforts towards SOX 404.

A provision for loan losses in the fourth quarter was 290,000, while a provision in the third quarter was 495,000. In the fourth quarter, there were net loan charge-offs of 182,000, which represented 0.3 of 1% -- I'm sorry, 0.03% of average loans for the quarter. In the third quarter, net charge-offs were $260,000.

In summary, I think we are positioned for a very positive year in 2005. With a positive economic outlook for Tarrant County and the probability of rising interest rates, the current structure of the company should benefit. Currently, the Street is projecting a range of earnings for the company for 2005 from 95 cents to $1.06, with a mean of $1.01. We are comfortable with the mean of these estimates at this time.

Now I'd like to turn the call back to the operator for questions.

Thank you, sir. (OPERATOR INSTRUCTIONS)

We go first to Joe Stieven with Stifel Nicolaus.

Joe Stieven. Hi, guys. First of all, good quarter. I joined a couple of minutes late, so I hope I don't ask questions that you covered. But I noticed in the non-performing categories, which were already great anyway, but you had a nice reduction in your 90-day past due. That's question number one, can you talk about that, which is obviously positive? Number two, Bob, can you give us the margin trend on a month-by-month basis during the fourth quarter? And then, related to that, if you go forward in '05, you sort of gave us your comments on the margin. I guess one of my questions is, is that sort of factoring in not only a rising rate environment, but a flattening yield curve environment? So those are my three questions. Thanks, guys. Good quarter.

Thank you.

OK, as to the 90 day, if you'll recall this time last quarter we had a large loan that we actually collected even before the conference call. It was on 90 days past due, so it was one large credit, it was in excess of $2 million ...

That's right, OK.

On your comments regarding margin, let's see, October's margin was 436. November was 444, and December was 443. And our projections, what we're looking for going forward as we're wrapping up our budgeting process right now, is we've programmed three 25 basis point increases in prime, primarily in the first nine months, trying to be somewhat conservative in our outlook.

And if it was higher than that, you'd even be happier ...

Oh yes.

Oh yes, yes.

OK, even with the curve flattening though?

Yes, with most of our assets and liabilities being on the shorter end ...

It doesn't matter, right?

... it's not going to bother us. Yes, it may -- it'll have a positive impact just because we have the week pricing a little faster on the asset side. The one thing we have to kind of - where there is a question mark however, is the competitive piece of the deposit pricing, which, you know -- you know, there's certainly other alternatives besides -- on pricing besides deposit, but you know, if the competitions days in line with where it has so far, you know, with -- you know, we see a positive impact on margin.

OK. Guys, good quarter, thanks.

Thank you.

Thank you.

We go next to Scott Alaniz, with Sandler O'Neill.

Scott.

Good morning.

Good morning.

A couple of questions. First, is Euless, is it breakeven now or near breakeven?

Last year, we showed a negative contribution of about $400,000, and that was after we fully resolved this loan portfolio. Now, that includes -- the total loan portfolio today is about $23 million, and part of that was loans that were booked in another one of our banks, while he was still (ph) and was not complete. And we were just taking his customers, as his former bank didn't want them, and so we -- they included before reserve of that. Had we -- going forward , assuming it's fully reserved, (inaudible) it would have about a breakeven contribution of the next save six months. We expected to be profitable before the end of the year.

I see. OK, good. And ...

It won't lose a lot in the next six months, but ...

OK, terrific. And can you say where Steve Cosby (ph) came from?

Wells Fargo.

OK, now, I'm assuming that you guys plan to continue to grow the -- you know, grow the loans, so I guess my question is, you know, with the increased competition for deposits, what is your funding strategy as you look into 2005? And related to that, talk a little bit about the competitive pressures for deposits that you mentioned earlier, and what your outlook may be for funding costs in the first quarter.

From the funding side of it, we've actually sat down and identified like five initiatives that we need to work on to grow deposits. One, and the primary one which I mentioned in my discussion, was the focus on our key customer base, which is our core customer base, which are the business owners, families, and their employees. We -- in our strategic planning sessions we did throughout the year -- actually, we started in the fall of the year before, 2003, and throughout the year kind of had a strategic initiative to do two things.

One was to identify who our customers are, and number two, what our market niches, if we were just to say in one line. In the know your customer piece, we discovered that we had a significant opportunity for additional deposits from the relations that we already had been the bank, and that's going to be the number one initiative. Yes, we can be just costs driven, although we have to remain competitive, but you know, anybody can go out there and raise a price to take the deposits, but all of this needs to be relationship driven.

The second would be to initiate some employee campaigns for deposit growth, which we think can motivate the staff. We're going to change our incentive model to put more emphasis that this is (inaudible) change our incentive model to put a great deal more emphasis on deposit growth, where in the past perhaps we've had a pretty big rating on obviously the growth on income and loan growth, and earning asset growth.

So those are going to be our primary strategies, Scott, and it's sort of like what we've always done in this bank, which is kind of build it one brick at that time, and we feel like we've got to get back to the fundamentals of how we grow deposits, you know, for the last 30 years, and that's how we're going to do it going forward.

I see, I see. And on the ...

On the other side, you asked a question I think about our deposit pricing in the first quarter or next year. Our budget has been fairly aggressive, I think, with recognizing the growth and where we need to be with our deposit pricing. Obviously, you know, that may or may not change during the year, depending on how the competitive environment is, but -- and a lot of it's going to depend, again, about the outflow of demand accounts, balances into the equities markets and other investment alternatives. So -- which we haven't seen too much of that yet. So all in all, yes, we feel pretty positive that we can continue to grow our deposit base, you know, hopefully in that double-digit range, and then -- and we will continue to utilize the federal home loan bank if we have to, to balance out the funding on our balance sheet.

I see, and have you all aggressively marketed free checking for consumers?

Yes, we've had free checking now for three years, I believe. It has been a good product for us. I wouldn't say that we've been aggressively marketing it. We got into the game with free checking a little -- at the kind of late end of it, and you know, pretty interesting, you know, now free checking product, a large percentage of the people coming in for free checking actually choose a different product, but there was certainly a defensive measure when we began to offer it. It also has some options for (inaudible) protection and that sort of thing, and ...

I see. OK, will good, thank you.

...we do have those. You bet.

All right, thanks.

Scott, one other thing. Taking a look at our customer base, one of the other initiatives is the development of a higher net worth relationship account, that we think has some merit for us, in trying to gain a bigger share of the wallet of the customers we have in our bank plus attracting our core customer base. So that's another one of the strategies we're trying to get implemented.

OK, I see. All right, good, thank you.

Yes.

Once again, if you would like to ask a question today, please press the star key followed by the digit one. We go next to Charlie Ernst (ph), with Sandler O'Neill.

Hey guys.

Hey.

Hi Charlie.

Could you talk a little bit about your bond yield and just kind of what you're thinking and there? You know, it's a fair amount below the industry, and I calculate if you were kind of that a normal bond yield you'd have about $0.04 more in earnings per quarter. When do you really extend that? I mean is there kind of a magic level for you or do you just reextend some as rates head up?

Well, right now, you know, the portfolio is -- as you may know, we maintain it fairly short, it's weighted average life of three years, duration of 2.75, current yield of the portfolio, you know, as of the moment is 3.73. We carry only about 60 -- about 75 percent of our portfolio are in agency bullets, and you know, pretty conservative, and that pretty much has been our position for quite some time, and maintaining a pretty much five-year ladder within that. This is really, you know, our liquid the source, and when we're, you know, at a 85, 90 percent loan deposit ratio, that's the comfort level that we're with.

So what -- so from your perspective the peer group or the market average to be (inaudible)?

I just look at the yield been around for the quarter at a 4.3 percent, and you know, I would think that given your inherent asset sensitivity that you would be able to actually handle a little bit more extension as sort of a hedge in the bond portfolio.

Yes, probably, but it's a good point. Bob and I have been spending quite a bit more time trying to build exactly what -- that part of it, without getting too uncomfortable with the change in the asset liability mix, but we realize there's some opportunity perhaps with the yield.

OK great, thanks.

We take our next question from Bain Slack, with KPW.

Hey, good morning, good afternoon.

Hey.

Good quarter. I wanted to ask just quickly, I noticed your comment on the Sarbanes-Oxley expenses for the year. I mean do you all see any further expenses going forward into 05 on going?

Yes, you know, we have yet to really determine what that's going to be on a quarter to quarter basis. As you may know, we outsource our internal audit function, and maintain a fairly, you know, lean staff in our accounting area. So we have to rely on outside quite a bit. We have been using a regional accounting firm to assist us in this, and just, you know, pretty much at the end of that process, but have yet to really defined exactly what it is we're going to need to be doing on a quarter to quarter basis using someone other than our own staff or outsourced internal audit stuff. But there will be, you know, obviously, some increased expense in that area, but certainly not what we have seen so far through 2004.

You know, in that same light, even our internal audit function has had an increase in costs related to this, as has our external audit costs. So there's other issues -- I mean expenses that have just kind of built into the mainstream of our operating costs, other than the outsourcing of the -- to the consultants.

OK great, and the other question I'm just looking at loan growth going forward, your comment on a little bit of a slowdown that picked up in December. Now, how does the (inaudible) on the commercial side does demand and loan growth look like in the first quarter?

You know, this time last year was -- we were really on an upswing. We aren't at that level at this point. I do see and predict that we will have the internal loan growth to be very similar to what we had last year, pre-Arlington acquisition. You know, I'm pretty excited about our opportunities in that area, as a matter of fact. With additional staff numbers we've added in the Euless location, with a couple lenders in the Arlington opportunities we have, I think we'll be building a lot of momentum going forward in the year. Now, the first quarter may not be as robust as I'd like for it to be, but I think it will still be very good from that standpoint.

OK.

We have a lot of activity right now, and a lot of backlog.

Great, thank you.

You bet.

There are no further questions at this time, I'd like to turn the call back over to senior management for any additional closing comments.

I'd just like to say that we are really excited about everything Summit Bank has in place today, and also the market we're in. All indications are that our economic environment's going to continue to be good. I think we're very well situated to take advantage of those opportunities and look forward to having a good year in 2005 and beyond. Thanks again for you guys and your support.

If any of you are in midtown Manhattan and why don't you put on your snowshoes and go down to Times Square, the city's Mayor and a herd of Longhorns is touting everything good about Fort Worth Times Square today. Might even get a free lunch.

That concludes today's conference call. Thank you for your participation. You may now disconnect.

Thank you.