Cullen/Frost Bankers Inc (CFR) 2005 Q2 法說會逐字稿

Good afternoon, my name is Joy and I will be your conference facilitator. At this time, I would like to welcome everyone to the Cullen/Frost Bank, Inc. second 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 and Director of Investor Relations. Please go ahead, sir.

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'd like to turn the call over to Dick Evans.

Thank you, Greg. I'm pleased to report record earnings for Cullen/Frost Bankers, Inc., $40.7million, or $0.77 per diluted share, a 19% increase versus the same quarter last year. Return on assets was 1.67%, and return on equity 19.35%. As always, this strong performance is possible because of our dedicated and outstanding staff. I appreciate each member of our staff choosing our relationship culture and their hard work. Today, we'll talk about first some of the highlights for the quarter. Secondly, a word about the Texas economy, and, third, Management's focus to maintain the balance between the fundamentals of profitability and growth.

The highlights. Net interest income was up 16.2%. Net interest margin increased to 4.42%, a level we haven't seen for two years. This is to be expected in a rising rate environment with a company such as Cullen/Frost Bankers with an asset sensitive balance sheet. It was also great to see the average loans for the quarter increase 14% for the last year, to $5.5 billion. Taking a closer look at loans, our growth is good in all our markets. San Antonio up 9%, Houston 15%, Ft. Worth 12%, Corpus Christi 13%, Austin 17% and Dallas 38%. While we're pleased with the loan growth, obviously, we want to maintain quality and Texas is extremely competitive.

Two things we watch, and that is that we maintain the same loan mix, or where we have new areas of expansion that they must be well-planned and properly staffed with expertise in that area. Our loan mix, so far, of new business is consistent with our history. And our two new areas of insurance and public finance meet our plans. Secondly, we're spending more time with the risk, or quality measurements of our new loans that we put on the books. We see no change for the last six quarters, which shows consistent underwriting standards. Asset quality for the total portfolio continues to be manageable. Charge-offs at 12 basis points, it doesn't get much better, and while non-performers seem to be stuck in the mud for the first six months of this year at $41 million, there's hope that the last six months will be better.

Moving on with the highlights, our average deposits for the quarter grew 2.2% versus last year. Non-interest income increased 2.5% over last year with trustees of $14.5 million, up 6.1%. Service charges on deposits decreased to $19.5 million as the earnings credit rate increased on commercial accounts. This area also included pre-tax income of $2.4 million net proceeds from the settlement of legal claims. We are pleased that we could come to a quick resolution of our legal claims with the group of revenue producing employees and our benefits area of our Austin insurance operation who left the company in the first quarter. The total settlement was $4.5 million, and after write downs of related intangible assets the net income was 2.4 million. We are also pleased with our new leadership and staff in Austin, which is rebuilding the Austin business, and we are most grateful to our statewide benefits team that maintained and grew their benefits accounts while supporting our Austin office during this difficult time.

Non-interest expense was impacted by 7.3%, or a $1.6 million increase and other expenses related to the increased funding of our charitable foundation and professional services primarily related to increased regulatory expenses. Liquidity continues to be strong and we made only minimal investments and securities in the second quarter.

Next a word about the Texas economy. Texas jobs are growing about the same as last year. Growth can best be described as moderate, steady, not too fast that would result in a boom-bust environment. Overall, the growth is very manageable. The last six months, job growth in Texas was 1.3%, Austin was 2.9%, one of the stronger markets. If you talk to folks in Austin you will find that it doesn't feel that good because they're used to those four years where they had growth of 6%. Houston and San Antonio are growing at about 1.5%, and Dallas and Ft. Worth around 1%.

In summary, the outlook is good with the expectations for the second half will be stronger than that of the first half. Finally, Management's focus is on a balance of profitability and growth. As we often say in our Company, if we can't make money, there's no time for practice. For our company today, our focus is to build around four priorities. First, people and a relationship culture. People who are interested in making alliance and not just making a living; relationships versus transactions, and a culture philosophy based on values proven to work for our Company 138 years. Secondly, customer orientation. To bring value to our customers by listening carefully to their needs and matching our sophisticated skills and products so they can accomplish their goals.

Third, performance management and processes, and area, I believe, we have made great progress over the last few years and the better disciplines of accountability and measurements of performance. For example, on the deposit side, with existing customers, we will continue a robust cross-selling program. We've also put more emphasis on programs to build new business. One of these programs is called Onboarding, which is focused on those accounts in the first year where banks normally lose about one-third of their accounts, and through better communications with this program in year one in our branches and calls from our call center and direct mail, we will improve retention of these customers. Another program is Bank At Work. We're calling on commercial relationships and signing up groups of employees, and always better referrals through all relationships.

We talked about the deposit growth, but these programs will make sure our numbers of accounts are growing. As we look at the second quarter of last year versus this year, the numbers of consumer checking accounts are up 7%. The numbers of business checking accounts are up 3%, and, as you know, during this period of time we have had no acquisitions so that's core growth. On the commercial relationships sales side, our calls are up 22%, the pipeline is up 7%, and new loan commitments are up 30%.

I think it's interesting to note that we had to look at 20% more volume to achieve this 30% increase in loan commitments. In the second quarter, we had a special calling program on small businesses and we made over 3,000 calls. And we will continue to mature this sales process.

Why is performance management and process so important today? Texas is a great market, but it's also very competitive. To give you an example, year-to-date we have lost approximately $240 million of our pipeline due to pricing and structure. But at the same time, we won $330 million of pipeline from new perspective clients. We held our spreads and quality but it requires greater volume of commitments in this competitive state. While it is a daily challenge and loan-by-loan, so far the average spreads on commercial loans have held, and as I stated earlier the risk levels on new business has held flat for the last six quarters. Obviously, the disciplines are a necessity in this environment today to have profitable quality growth.

Our fourth priority, risk management. In today's regulatory environment we continue to successfully manage to protect our outstanding reputation we have maintained for 138 years. Last quarter we expanded the responsibilities of our Chief Credit Officer to include Chief Risk Officer. And significant other necessary organizational changes to meet the high standards of our many regulators and develop programs that comply with regulatory requirements. In closing, I am very pleased with the record earnings for the quarter. At the same time, I think now is the time to prepare for the next cycle and to keep the balance of profitability and quality growth. We will continue to invest in the best people, processes, and systems for the future. Next, I'll ask Phil Green to make some comments.

Thanks, Dick. I'll make a few comments about our operations and interest rate outlook and then review our current earnings guidance, and then we'll open it up for questions. As Dick mentioned, our earnings for the quarter increased 19% over last year, and we once again increased revenue at twice the rate of non-interest expenses. Revenue increased 10.6%, compared to an increase in expenses of 5. Revenue was primarily driven by a 16% increase in non-interest income. Our interest rates accounted for about two-thirds of this, however, higher volumes, including an increase of 14% in loan volumes from last year, accounted for a third of the growth, and our loan volume was split fairly evenly between CNI (ph) and real estate.

As a result, our ROA for the quarter of 1.67% was once again an all-time high for the Company, and it was up from 1.54% from the first quarter this year. We realize that quarter results included a couple of out-of-ordinary items including the $2.4 million net gain from the Austin insurance settlement, and, also, our special $750,000 contribution to our charitable foundation, but even adjusting for these items ROA would still have been an all-time high in the second quarter. Our second quarter deposits were up 2.2% from the previous year, but they were impacted by the loss last year of the clearing account of a large mortgage servicing company that we discussed many times in the past. Without the loss of this account, deposits would have increased 4.6%. I point that out because remember that because of the nature of this account all these balances were made up of float in our balance sheet. So when the balances left , they reduced the amount of non-earning cash in our balance sheet by an equal amount, and did not impact the funding of our earning assets.

Our interest margin was up by 13 basis points from the first quarter, to 4.42% with the increase split fairly evenly between the impact of higher volumes and then the increasing rates on our asset-sensitive balance sheet. Our outlook for interest rates going forward calls for two additional 25-basis-point increases by the Feds. One in August, and then one more in September. Looking at provisions, we recognized $2.2 million during the second quarter which exceeded charge-offs by $600,000, and, as Dick mentioned, charge-offs were very controlled in the experience, or third consecutive quarter of 13 basis points or less. I might mention at this time that the Horizon acquisition continues to proceed along and we currently expect to close the transaction and complete the conversion of their systems somewhere around the first week of October. Finally, with regard to earnings guidance for the year, we currently feel more comfortable with the high end of the range of estimates. With that I'll turn it back over to Dick for questions.

Thank you, Phil. We're ready to entertain questions.

[Operator Instructions.] We will pause for just a moment to compile the Q-and-A roster. Our first question comes from the line of John Pancari with JP Morgan.

Good morning, guys.

Good morning. [Simultaneous with Phillip Green.]

I just have a couple of questions around loan growth. If you can give us a little bit more color in terms of link quarter growth, like where did you see the real solid growth in terms of your footprint, and if it was as equally spread out as you had noted in terms of year-over-year trends, and then, also, by type as well?

Let me make some general comments and then I'll let Phil hit some specific numbers. I would comment it's important to recognize in Dallas, where we had 38% growth, we've started a couple of new areas there. We've added an energy individual that is complementary to our good team that we have in Ft. Worth. In fact, they're working very closely together so that was a big part of it. We also have a really nice real estate team in the Dallas market and so that helps to build that. Overall, the markets are pretty steady as we go. As I mentioned, I'll let Phil give you some specific numbers.

Okay. With regard to the markets, Dick mentioned the year-over-year growth to you. I think you mentioned what's going on on a link quarter basis. I'll give you rough, annualized numbers. Our Austin market is about 9%, on a link quarter annualized basis. Corpus Christi was 11. Dallas annualized about 60%, so it had another good growth over, as Dick mentioned, a smaller base. Ft. Worth about 12%; Houston, 10%; San Antonio, 10%; and our Valley operation, also a small operation, increasing 15. That's link quarter annualized average growth.

As far as on an average basis taking a look at where the growth comes from, we mentioned the breakdown being split fairly evenly between commercial and real estate. And that's true on a prior year to current year average-over-average basis for the second quarter. It's also fairly true for the link quarter basis. Loans were up, of the $197 million we had in increase in link quarter average, the CNI loans were 92 million of it. Real estate loans were 112. That includes consumer and commercial real estate and that pretty much accounts for the growth there.

Just add when you look at all the numbers at the end of the day, and you look at the end of June last year versus this year, we still have the same loan mix that we've had so it means we stand in that same category 50% of our loans are CNI, 45% real estate, now that includes consumer, home equity, and then about 5% in other consumers, so there's not really a big change. That's so important, particularly in a fast-moving environment.

Right. Okay. And that's very helpful. And then one other question around the margin, did you use any dollar rolls in the quarter that impacted the margin in any way?

No, there were no dollar rolls.

Okay, and then, lastly on deposits, I just wanted to get some color regarding what happened in deposits on a link quarter basis during the quarter?

Okay, on an average basis, our deposits were down about $80 million in round numbers. First quarter tends to be higher seasonally. Our demand deposits were fairly flat, they were down about 1% on a link quarter basis, and we were down about 1% in time deposits. Some of that is seasonal, as it relates to public funds, which were down on average about $30 million in round numbers. We saw a little bit of decline in our money market deposit accounts by about $30 million, so really not a lot of change, down overall on an actual basis link quarter by 1%. I can tell you that just as we go through July, the first part of this quarter, we have seen growth in our deposits. We are up about $40 million on a month-to-date basis for July for demand deposits. Up about $80 million in total deposits, and as far as that goes, our loans are up about $100 million on a month-to-date basis in July. So I think we've continued to see good growth for our companies, as Dick has pointed out.

Great, thank you.

Your next question comes from the line of Michael Turner with Suntrust.

Hi, this is Jennifer Demba. Good morning. You mentioned you made a charitable contribution of about $750,000. Did you have a contribution in the first quarter of this year?

We have normal rates of contributions, but this was a special one that we made to really just build the amount up and it allows us to make contributions out of there in the future.

So it was substantially higher than first quarter?

Yes.

Thank you. And, secondly, Dick, you mentioned earlier in the call that you felt like the second half of the year was going to be stronger than the first half. Can you elaborate there what you're thinking?

That was in regard to the economy. Did I mention that? Is that what you're talking about?

Yes, I think so.

I said two times, one, I said, in regard to non-performers I hope we can get out of being stuck in the mud there. Also, really I was just talking about the economy. What that relates to, we're growing in Texas about 1.3% in jobs. The expectations were 2%. Not any really good reason things seem to be really doing well, and so that's, any time you start projecting, obviously, it's a judgment factor, but I just think we'll pick up a little bit in job growth the second half. I think it will be a little bit better, and maybe we'll be able to come out to about the 2%. As you well know, when you start talking about these kinds of statistics, it wouldn't surprise me if the first half wasn't revised to around 2%, or a little stronger than that 1.3.

Okay, thanks for the clarification. Good quarter.

Thank you.

Your next question comes from the line of Scott Alaniz with Sandler O'Neill.

Good morning.

Good morning. [Simultaneous with Phillip Green.]

A couple of questions. First, with respect to the loan mix, Dick, San Antonio appears to be fairly vibrant in terms of real estate development and activity, particularly over the last six months. I'm curious as to how you're able to keep your loan mix balance given the increased activity there within San Antonio?

Are you saying why don't we have more real estate?

Correct.

It's pretty consistent that we have managed to keep our commercial real estate at about a third of the total portfolio and half of that in owner occupied. We still have high standards in that regard and, yes, the San Antonio market is very good. In fact, we've had some good loan growth in that regard and Phil may have some -- Do you have a specific number there?

If you look at year-over-year for quarterly average loans. San Antonio's growth was, let's say in round numbers $100 million, and their CNI growth was about a third of that, at $34 million. On the consumer real estate side, we've had good growth on home equity loans et cetera there, so that's about a third of it, and a third is what I would call commercial real estate. So the mix there has been fairly consistent and has really not weighted, I'd say, Scott, towards the commercial side. It just continues to be fairly consistent mix, as Dick pointed out.

I see. Secondly, Dick, you had mentioned earlier during the call that, I want to say it was 240 million in business that was in the pipeline, had moved on because of either terms or structure and I was wondering if you could amplify on that comment, specifically as to whether it was more so in terms, or structure, and then, perhaps, geography if that was occurring more so in Houston or Dallas or San Antonio, and just help us out there.

What I was trying to do is just demonstrate the reality of kind of the environment. There's a lot of talk about pricing and structure. First, to answer your question, structure is where we draw the line in the sand greater than on pricing. We really don't want to compromise structure. Any time you get in this discussion with anybody, none of us are perfect and certainly in a competitive and negotiating loans you have to give and take, so it's not a perfect science. In this view, we recognize that, sure, we lost 240 million that we said we're just not going to do that, and I would say the majority is over structure and less of it on pricing. Our philosophy on pricing is, quite frankly, it's not complicated. If somebody down the street will do it at x, then x is the price. Our decision then, is do we feel we can make money for that risk level, and if it is then we do it. If we don't, then we've got to pass on the deal and we've had some of that. The majority is on structure. Let me say the other thing on price is that we are a relationship bank, not a transaction bank. So the key to that, when we look at price we're looking at the total relationship. What are the deposits we're going to get, the trust business, 401(k), asset management, all the things we do and then we look at that and it is in the relationship that has given us the ability to meet pricing because we can have a broader and deeper relationship with the customer. But at the end of the day sometimes it's just not there. But most of that 240 million I would say to you was lost over structure. And the other point that I made there was that what we've got to do is we hold our standards up on structure. We've just got to get out and work harder and call on more customers and look at more volume in order to build it and that's exactly what's happened.

Dick, do you have plans to initiate a similar small business calling effort in Dallas and Houston and Ft. Worth that, like you did in San Antonio, I believe?

I'm sorry I misled you. All the things I talk about are statewide. Those 3,000 calls on small businesses are in all the markets and everything I'm talking about applies to the whole state.

I see. Very good. Oh, last question. There's about 7-8 million in other real estate on the books at the end of the quarter. Has any of that moved off the books?

That's where we're stuck in the mud. There might be a little movement but it's not moving and I'm hopeful we can get some of that pushed out.

Thank you.

Your next question comes from the line of Kerstin Ramstrom with Bear, Stearns.

Hi, Dick. How are you today?

Fine.

I have a couple questions for you. First, on Horizon Capital. I had originally believed that that was going to close in third quarter and sounds like now that's going to be right at the beginning of fourth quarter?

That's correct. It just takes longer. Nothing wrong, just longer to do things.

Okay. In terms of earning assets, when I look at the earning asset growth on the quarter, it's only a third of a percent, but, obviously, average loans came up quite a bit. What was the offset? Did you run off some securities, or was there something else?

It was really two things. We had a slight decline in securities. They were down about 20 million. I'm going to look at average numbers here for you. If you look at the average balance sheets on a link quarter basis, we have been up $197 million in loans, $20 million would have been funded from reduced securities, but fed funds sold were down about $105 million, so what we are doing is seizing up excess liquidity to fund the growth in our loan portfolio. And then there's some other miscellaneous things in our balance sheet that would have, on a net basis, taken care of the rest of it.

Okay. And then could you comment a little bit on advertising expenses in the quarter? It's, obviously, not something you break out, but could we get a couple comments on how the numbers look this quarter versus last quarter?

On a link quarter basis?

Yes.

Link quarter basis, advertising costs were down about 415,000 from the first quarter.

Okay.

You're going to move, does that include direct mail? They'll move a little bit.

That's more traditional.

I'm sorry, what?

That's more traditional advertising.

Okay, okay. No, that's great. Thanks so much.

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

Hey, guys.

Hey, Charlie. [Simultaneously with Phillip Green.]

A couple numbers questions. Can you actually give the absolute number on the bottom portfolio, how big it was in the quarter, and also what the yield was?

On an average basis, Charlie?

Yes.

On an average basis, the bond portfolio, in total was 2,000,000,902, and the yield for the quarter was 4.83%.

So you said, again, the charitable contribution was 750,000 in the quarter, is that right?

That was for the foundation and that was the main reason for our increase in donation expenses.

Okay. And it looks like your tangible capital levels are building up pretty nicely, obviously, Horizon will use some of that. Are there any thoughts about ways of using that capital, or do you just anticipate that loan growth will absorb most of that?

We continue to look at opportunities, Charlie, as you well know. We found one with Horizon and for those organizations that meet our culture standards, obviously, our first priority with capital is to make acquisitions, and, as you know, we are steady on the dividend and adjusted it last quarter and we will also continue to, I think, in a good economy we will continue to grow our loans some. So there's a lot of opportunities, but the capital is strong, and I think that gives us the ability to make choices that are good for the shareholders.

Okay, and, Phil, on the bond portfolio it seems to me that you all reinvested, probably, most of the cash flow during the quarter? Is that a fair statement?

Really what happened was, we didn't buy any bonds in the second quarter. We might have bought 10 million in munis, but we didn't buy any bonds. What we did was, almost on the last day of the first quarter we bought $170 million. You might remember split between [inaudible] Treasuries and 15-year Fannie Maes. So what happened was the increase in the average related to those very late purchases last quarter sort of made up for the reduced cash flow in average in the current quarter.

And does the lift in the long end of the curve, does that give you any interest again to reinvest the cash flows, or are we still a little bit too low?

We're always looking. I long for the days of that steeper yield curve, but the nice thing about what's going on right now is that loan growth is solid enough that we're able to take most of these cash flows and be reinvesting it in the loan portfolio. But I think that while we've got this wind at our back here with volumes and, also, rates I'd sure like to see a little bit better yield curve before we make many large commitments.

Okay, great. Thanks a lot, you guys. Nice quarter.

Thank you.

Your next question comes from the line of Beth Messmore with Merrill Lynch.

Good morning.

Good morning.

Could you please update us on your energy exposure?

We can. We have committed about $800 million, $813 million, and we have outstanding $452 million, and the majority of that is, always over 50%, is in energy production loans. Is that what you were asking?

Yes, thank you. And then, finally, the excess liquidity on your balance sheet, Phil. Is that close to 350 million? The fed funds?

They average 306 for the second quarter, and we're probably at least that level today.

Thank you.

Your next question from the line of Ben Crabtree with Piper Jaffray.

Thanks, actually, all my questions have been answered. Thank you.

Thank you.

You have no further questions at this time, sir.

Okay. Okay, well we as, always, support the, appreciate the support of our shareholders and we will continue to work hard to build value. We stand adjourned.

This does conclude today's conference call. Thank you for attending. You may now disconnect.