Cullen/Frost Bankers Inc (CFR) 2005 Q1 法說會逐字稿

Good morning. My name is Tonya and I will be your conference facilitator. At this time I would like to welcome everyone to the Cullen/Frost Bankers first quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer period.

[Operator Instructions]

I would now like to turn the call over to Mr. Greg Parker, Executive Vice President, Director of Investor Relations.

Thank you, Mr. Parker you may begin your conference.

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

Thank you, Greg. I am pleased to report first quarter '05 net income of $37.4 million, up 13.6% from the first quarter of '04 or $0.70 per diluted common share; return on assets of 1.54%; return on equity of 18.31%. I continue to have the highest respect for our staff, who has made these results possible. I appreciate their commitment to Cullen/Frost and their hard work.

It is good to finally see more momentum in the net interest margin, up 15% or $11.8 million compared to the year earlier. Net interest margin increased to 4.29% or 26 basis points over last year. Average loans increased 14.2% to $5.3 billion versus last year and average deposits for the quarter were $8 billion, up 4.5%.

Sales disciplines continue to be a high priority throughout our company. On the business banking side, calls are up 13% versus the fourth quarter and our new pipelines up 20% versus the fourth quarter.

On the consumer side, I shared with you last quarter that we would return to more normal industry growth rates of net new consumer checking accounts opened and we are on plan of mid-single digit growth. Non-interest income rose slightly with mixed results. Trust fees were strong at $14.3 million, up 9%.

Last year we had a $1.7 million loss on security transactions and none this year. Service charges on deposits decreased 10.7% or $2.3 million versus last year. The decrease related to commercial accounts, resulting from an increase in the earnings credit rate compared to a year ago. As we all know, in a rising rate environment, customers earn more credit for their deposit balances and this in turn reduces the amount of service charges to be paid through fees.

Challenging our operation, insurance commissions and fees decreased $1.6 million or 15.3% from last year. This decrease is primarily the result of certain revenue producing employees in the benefits area in our Austin insurance operation leaving the company.

Other benefits areas and property and casualty businesses throughout the state are performing better than last year. Furthermore, the Austin benefits area is in the rebuilding process, and that is well under way.

Our non-interest expense was up 4.5% primarily resulting from the increased growth in the company. In today's regulatory environment, it should not be a surprise that professional services are up approximately $300,000 from the first quarter of last year.

Asset quality continues to remain manageable. The trends of the allowance, net charge-offs, non-performers, past dues are basically flat with last quarter. The only exception is potential problems are up, primarily because of one $10 million credit whose management lost focus on cost controls and is now correcting the problem. However, the company continued to have strong revenues through this period of time.

Looking forward, I feel good about '05 and the opportunities for Cullen/Frost. As we look at the Texas economy, we can expect the state to grow faster than the US in '05 after some three years of trailing the country. I think some of the drivers are, first of all, oil and gas properties being up -- oil and gas prices being up. One example, if you have $50 oil and $7 gas, it adds approximately $600 million in royalty payments in Texas.

Secondly, Texas is a less expensive place to live. For example, the home prices have not increased as much as other areas such as California, New York, and Florida. Also, we are a high-tech state and job growth numbers would indicate the technology sector is showing some strength. We always take a look at Austin. As we know, Austin is in the early stage of technology. If you look at the last three months their payroll employment annualized growth rate is 3.75%, one of the highest in the state compared to -- if you look at 24 months for Austin, it was a little over 2%.

If you move to Dallas, where technology and communications has been a big factor, for last three months that market has grown 1.66% versus 24 months just a little over 1%. I think it is also important when you talk about Dallas is the increases also with the downward pull of the airline industry, which continues to pull on Dallas in a downward motion.

Moving on, on our announcement of the Horizon Capital Bank in Houston, we are excited about the opportunity to merge our teams together and reach more customers in that market. It will also give the Horizon officers the ability to offer a larger range of products and broaden and deepen those relationships that they have done such a good job with. We look forward to this transaction closing in the third quarter. In closing, I feel the first quarter was a good start for '05. The Texas economy should grow at a steady pace, faster than the US, but not robust, just steady.

Next I’ll ask Phil Green, our CFO, to make some comments.

Phil?

Thanks Dick. As Dick mentioned, I believe the first quarter was a good one for the company and we saw the benefit of an improving margin on our operations. Overall our revenue growth of 9.3% versus the same quarter last year was just over twice the rate of our non-interest expense growth. The ROA that we posted for the quarter of 1.54% was one of the highest on record and I'm very proud of the hard work of our staff in creating a company that not only generates great growth, but does it in a very profitable way.

Let's look now at a few additional points about our operations before opening the call up for questions. First of all net interest income was up over $12 million from the first quarter a year ago, no question that rising interest rates helped our asset-sensitive balance sheet. But earning assets were up by over 8.5% from the previous year, 95% of that growth coming in the loan portfolio. Over half our net interest income growth was related to volumes.

At the same time that loan growth was funded by increases in core deposits. And we're glad to see our loan to deposit ratio at the end of the quarter increase to a little over 67%. But we recognize that we still have a way to go to approach anything like typical pure numbers for this ratio. And I think that is a positive for us.

As Dick mentioned, we did see a marked improvement in our net interest margin. Compared to the fourth quarter it increased 25 basis points to 4.29%. However, you may remember from our last two calls that we had been seeing some improvements in our margin which were somewhat hidden because of the increases in our short-term liquidity, and our occasional use of dollar roll borrowings. This quarter we did not have any dollar roll borrowings and we saw our fed funds liquidity decline as loans grew. So you got a clearer view of the improvements in our margin which have helped to fuel the increase in our net interest income.

Our growth in average loans was strong for the quarter. As we mentioned, we were up 14% from the year ago and 21% on an annualized linked quarter basis. In both cases the largest component of the growth was in C&I loans, which in round numbers accounted for about 60% of the dollar growth.

We did do a little investing during the quarter in the bond portfolio, as we saw some opportunity but essentially we just replaced maturities and paydowns. We purchased about $85 million in two-year treasuries at 3.85% yield and a similar amount of 15-year Fannie Mae mortgage backs at a 5.01% yield.

Looking at our provision for loan losses for the quarter of 2.4 million we exceeded charge-offs by about 700,000 and our reserve ended the quarter at 1.42% of loans, which was down slightly from the previous quarter due to loan growth. Looking forward, we're still anticipating a 3.5% fed funds rate by August of this year, which means 25 basis points per Fed meeting and we continue to feel the current mean estimate for 2005 is reasonable.

With that I will turn it over to Dick.

We now would be happy to entertain any questions you have.

[Operator instructions].

Your first question comes from Charlie Ernst of Sandler O'Neill.

Can you hear me?

Yes, Charlie I can hear you now.

Okay good. I had a couple numbers questions. Can you all say what the average size of the bond portfolio was and also what the yield was on the portfolio for the quarter?

Yes Charlie, let's see -- on the bond portfolio for total securities it averaged 2. 922 billion. And average yield was 4.79, pretty close to what it was at the last quarter. It averaged 2.913 billion and it averaged a 4.81 yield.

And the loan yield, Phil can you tell me what that was for the quarter?

Loans yield for the quarter was at 5.90%.

So that was a 35 basis point jump in the quarter?

Last quarter it was 5.52.

Okay. So that was very strong. And can you also comment on the net interest margin during the month of March?

During the month of March? Let's see. I have it -- was at 4.30.

Okay. And then lastly, FICA taxes in the quarter, can you comment on how high those were?

They were up from a year ago. Let me actually do the linked quarter, maybe what you're looking for. On a linked quarter basis they were up by 1.5 million from the fourth quarter.

Okay, great.

Another thing just kind of an FYI, our 401(k) contributions were up by about 600,000 from the fourth quarter.

Is that included in the run rate going forward now on the 401(k) or is that--?

The 401(k) tends to be up some because, you know you can only contribute so much and by the time you get to the fourth quarter, some have maxed out. But also the bonus payments that we make in the first quarter tend to balloon that number up. So we're going to see both those numbers come down. And as we talked about many times, these are somewhat seasonal items.

Okay. And lastly, can you just comment on your appetite for buyback at this point?

Well we do still have our plan in place. We did about -- I want to say around $14 million in buybacks in the first quarter. As you know, what we would like to do is to do acquisitions that make sense for us, but when we don't have those opportunities we will buy stock back. We have a plan in place right now that goes on for another year-and-a-half or so.

Great. Nice loan quarter, guys.

Thank you.

The next question comes from John Pancari of J.P. Morgan.

Good morning. A question on the insurance business, if you can give us more color on what happened in Austin in terms of the departures? Did any relationships follow those departures? Do you expect that as you replace those people you could see a bounce back eventually in these numbers?

Obviously we are in the midst of a dispute. That process has already begun and we're trying to resolve our differences. Therefore, it is going to be difficult and even inappropriate to get into much detail. But let me try to address your question this way to leave you with a few facts.

First of all, I would look at that part of the business that represented about 15% of our business last year as gone, people gone and the decrease in the fees that we reported to you of the 1.6 million. We took our hit in the first quarter, and we have addressed that problem.

I would ask-- say secondly, it is important to focus on the 85% of the insurance business that is, in fact, performing better than last year. It is this 85% of the staff that has really been my focus. I really appreciated their outstanding performance. As you look going forward, think of the business of a new base that is about 85% and continuing to grow and build that as we have over the last few years.

Last but not least, moving forward on the Austin benefits business, we have a new highly respected manager that has been in the business over 20 years, good experience, and as I said highly respected. That is well under way to build the staff and build the customer base. So that is pretty much what I can comment in that regard.

Okay. Can you add any color to any pricing pressure that you're seeing in commercial line -- insurance pricing in terms of how that could impact commissions going forward?

I think we have seen more competition for some time now. I do not know of anything recently that is any different than we have seen in the last quarter. It is competitive.

Okay. And then my last question, if you could just give us some detail on loan growth by region, like where you have seen some of the key strengths across your franchise.

Okay. Are you interested, for example, linked quarter basis or year-over-year?

Yes linked quarter.

Linked quarter? These are going to be unannualized numbers. So you can do what you want with the annualization of it. We saw our Austin market grow about 9%. Our Dallas market was a little over 10. Our Fort Worth market was about 9%. Our Houston market was about 4. Our San Antonio market was about 3. And then we have our Corpus Christi market that is a little over 2. And our -- we have a small presence in the valley, which was just under 4%. And those are unannualized numbers.

Your next question comes from Kirsten Ramstorm (ph) of Bear Stearns.

Thanks for taking my call. My first question was, you saw a pretty big increase in other non-interest expense in the quarter. And I was wondering if you could provide any detail on that. I think it was up about 1.5 million over fourth quarter.

Yes, one of the biggest factors on a linked quarter basis there was in our marketing area. I'm going to say this is mainly seasonal. Advertising was up about 640,000. Sales promotion and direct mail and other ads were up about 250,000 or so. And so that was the biggest factor.

We also had some increase in other professional types of expenses. We're utilizing some consultants in various areas in the company to make sure that we are operating as effectively as we can be. Some of that includes in the regulatory area. That is a big focus for banks today. I would say those two areas were probably the areas that caused the most change from the previous quarter other than our regular run rate.

And so you would anticipate that some of the advertising and sales promotion would drop off, that this really was just a first quarter event?

Yes, I think that we have got somewhat of a high number in the first quarter.

My next question is do you have an estimate of what the elimination of additional dollar rolls did to your average earning assets in the quarter? Obviously they were down quarter-over-quarter. I am assuming that is from that.

About $173 million was related to dollar rolls.

Okay.

The other thing on deposits, you have a little bit of seasonality in deposits. They are typically high in the fourth quarter and first quarter is typically the weakest. Then you build back up from there.

Okay. And then in terms of the insurance folks down in Austin, how many people were there that left?

17.

Okay. Are we going to see any--?

That is the entire staff. There were four principals.

Okay, so the entire staff left.

Not the entire, almost.

Can we look forward to some lumpiness in your salary and wage expense as that office is rebuilt?

Really I do not know about the word lumpy. I think what you have got to do is take what I just said and you take the 15% out and then you start building on an 85% base is probably the best way to look at it. Just as I said, we have a great new manager and we will start to build that staff. Obviously it will get a little bit ahead of revenues, but we will manage to where we build the staff in order to take care of the revenue flow, just like you would in any other business.

Right. I guess my underlying question there is, do you generally have to pay up-front bonuses to the people in this business to attract the good talent that you would need to rebuild that office, therefore causing a quarter where you would see a bigger increase in compensation expense because of that?

I would not focus on that issue.

Now that you have completed the -- or at least announced the Horizon acquisition, do you have further thoughts on bank acquisitions going forward?

Always. While we had not bought a bank about five years, as we have said consistently we look at a lot of banks. Obviously, we are very impressed with the people and culture at Horizon and have been talking to them for over a year. We are pleased with that. We continue to plant seeds throughout the state with those organizations that we have a lot of respect for, that we think can blend well with our organization. Some of it happens quick and some of it takes long periods of time.

Okay that's great. I appreciate your time. Thank you.

Thank you.

[Operator instructions]

Your next question comes from Abbott Keller, Kestrel Investment Management.

Can you talk about why the Horizon transaction was structured as a combination stock and cash deal as opposed to an all cash transaction?

It was a number of things. We think that utilizing stock in the transaction helps on a tax basis for the Horizon people, so there is an advantage there. Including stock in the transaction also helps us with our capital ratios so that it cushions the impact of the intangibles that are on our books. We also think that our stock has done fairly well and it is a good investment. It is not thrown around a lot, so when we do, we think it is an advantage for us. The cash, given the fact we are generating a lot of capital and we have utilized -- in fact we generated so much we're utilizing buybacks at times. There is sufficient cash to throw into the deal to add a little bit of leverage to help our returns for our returns for our shareholders, so that's some of the general thinking.

Okay, thank you.

Your next question comes from Jennifer Demba of Sun Trust Robinson Humphrey.

Thank you. I was wondering if you could give us some background with how long you have known Horizon and the background of the transaction.

We have known Horizon -- as we know most all the banks in the state because of our corresponding banking relationship -- I do not even know how long, I guess since they were in existence. Certainly we have known the people and got to know their culture and understand those people for over a year and have obviously been very impressed with who they are and how they represent themselves. We're happy to have them as a part of our family.

Will you be opening up any more de novo offices in Houston or looking for more acquisitions there specifically?

We continue to look for the right de novos in all the markets in which we serve. So that's kind of an ongoing process. And also the second part of your question, we continue to look for the right acquisitions in the markets. We're not making those decisions mathematically of so many in each market, but basically we do a great deal of analysis in each of the markets to see those areas that are complementary to the business that we are in. When we see that right acquisition or that right location, we will do it.

Second question is on your insurance fees line. Did you have any contingency fees in the first quarter?

Yes, we did. Let me see if I have those. For the first quarter -- about 2.6 million.

Thank you.

Your next question comes from Tom Hain of BAM.

Good morning. A couple quarters straight now of kind of 200 million-plus of loan growth. I am hoping you could give us more color on whether you think that type of loan growth is sustainable. I would even go further than that and say -- ask whether you think it could accelerate from there?

I think that, first of all, it all goes back to the environment in which you are operating. As I shared with you, Texas economy is really doing pretty well. I do not think it is going to be robust. I don't think it’s going to just pick up a lot more, it is going to be steady and a good environment. It is the first time I have said this in a couple of years. I think we will get back to growing a little faster than the US. I think there are some positive signs in that regard.

Secondly, as far as loan growth, I think the thing that we watch very closely and we're pleased with is that the loan growth is really coming in all the sectors in which we already operate. The only exception to that is what I mentioned to you on public finance. That is a new business we started last year. We are extremely pleased with it. As you look at that, that is coming on and doing well.

We’ve got a good environment. Our mixes stand much the same with the addition of the public finance. I think we can expect to see in an environment that continues to be steady growth to continue to have our loans grow at a good pace.

I think we had obviously really good growth in the first quarter. On a linked quarter basis, it annualized a little over 20%. I do not think we expect to have 20% sustainable loan growth. We will have -- double-digit loan growth would be our expectation.

I would just add, too, as I mentioned at the first of the call, this business --banking disciplines of this calling (ph) effort is where we really focused. The calls are up good, up 13% versus the fourth quarter, and the pipeline is up 20%. We've tried to level off the growth through the year.

We're getting ready to go into the summer months, the natural vacations and all those things that happen. The last year we did a good job of not slowing down during that period of time. We did see the fourth quarter of last year slow down a little bit. It is awful hard to keep driving through that holiday season. We continue to. The most important thing I would say to you is our awareness of the time of the year and what's happening is very high, and to help our people be aware of that and continue that calling effort. At the end of the day, if you're out asking for business you're going to grow new business.

That sounds excellent. That sounds great. My second question is on the credit. You've had several quarters of now very stable nonperformers. The charge-off levels look very stable here. Yet you guys still added to reserves. I assume that that is just a function of loan growth or is there something more behind it?

That is a big function. As you know, we are now -- all financial organizations are driven by the formula. And as things start to adjust in that, you're always going to have some adjustments throughout. That is going to build the reserve a little bit. We said last quarter we thought this year would get back to a more normalized a kind of environment, and I think that is pretty much where we are. With the loan growth, the formula is going to have you build your reserve a little bit as you go forward.

The other thing I would say, I am really pleased with that 10 and 13 basis points of charge offs, 10 the fourth quarter and 13 this quarter. That is awfully low. You and I both got to realize it. Even in the low 20s is very good, is where we pretty much operated over a longer period of time. Do not read into that that I am telling you charge offs are going to go up. I'm just looking at the facts. We've got a good, strong reserve. We have good coverage. The percentage of coverage of total loans is about 76 basis points, the same as it has been. I think it is held in there.

I think one other thing to keep in mind -- and we said this a long time now-- is that the formula is, it is not something you have absolute control over and you have a methodology and its responses to various things, it’s (ph) most responses to classify and criticize asset levels. Loan growth will affect it, but I would say it is probably most responsive to levels of -- classified and criticized in the portfolio. We have to be cognizant of those factors, as well.

I think Phil is really right. I think this is a new environment that our industry has really been in and whereas used to -- you can have a loan that you classify that has no loss but because of the formula you can -- have to allocate obviously a reserve. I think what the SEC wanted was more volatility in this particular sector of our business, and I think they're going to get what they wished for.

Thank you. And then, my final question -- I apologize for taking -- asking so many questions -- but the margin was pleasant to see. And I guess I'm wondering, are we in a situation where we can get back to the good times of 1999 and 2000 when you were running 5% plus margins as the Fed was moving rates up?

Well, I think we're definitely in a period of time as long as rates keep moving that we're going to see increases in the margin. I don't know if -- let's say if in the next 12 months we saw rates go up, what was it? Fed funds at six, I guess is what it was when it was at its peak. And we would immediately see a similar margin as well as our peak. I think our peak was at 5.32.

And the reason for that I think is, we've all sort of built securities portfolios during that period of time when rates were going down. We had to do investing in a lower rate environment. So that has to work its way through a little bit. And our bond duration is about 2.8 years. And so I think it would be way up there and higher than where we are now. It may not be at the 5.32 level. But I'd consider that the good times would be rolling at that point.

Thank you very much.

Thank you.

[Operator instructions].

At this time there are no further questions. Mr. Parker, are there any closing remarks?

This is Dick Evans. Let me just say thank you for your interest in our company. We appreciate the support of our shareholders and we will continue to build this company. We stand adjourned.

This concludes today's Cullen/Frost conference call.

You may now disconnect.