Cullen/Frost Bankers Inc (CFR) 2005 Q3 法說會逐字稿

At this time I would like to welcome everyone to the third quarter earnings conference call. [OPERATOR INSTRUCTIONS] Thank you, Mr. Parker, you may begin your conference.

Thank you. And welcome to Cullen/Frost third quarter earnings conference call. This morning's 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 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 mornings'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 210-220-5563 - - excuse me 5632. At this time I will turn the call over to Dick Evans.

Thank you Greg. Cullen/Frost third quarter results, $42.5 million was another record quarter for our Company. Net interest income continues to be strong and the performance is broadbased with solid loan and deposit growth, plus increases in fees, particularly trust. These good results are possible because our staff continues to execute our plans very well. Also at Cullen/Frost assets in to the balance sheet, the good economy and rising interest rate environment along with our great staff have put us is in a good position.

Reviewing some of the highlights. As I said, our net income was $42.5 million, or $0.79 per diluted common share. That's 18% increase over last year's third quarter. Return on assets was 1.68%, return on equity 18.98%. Net interest income was up 18.5% versus the same period a year ago. And the net interest margin increased from 4.09% to 4.52%. The average loans grew 15.5% to $5.6 billion and helped contribute to the margin improvement. Along with the prime interest rate increasing 50 basis points in the third quarter.

Loan growth has good diversity. All regions are growing at a good pace and by category; commercial, industrial, commercial real estate and consumer all at double digit growth rates. We were also pleased to see solid growth in average total deposits to $8 billion or a 3.2% increase over last year. Retail deposit strategy for us at Cullen/Frost focuses on retention. On the business side our treasury management products are state of the art and competitive with the large financial service companies. Noninterest income increased 4.3% versus last year.

Trust fees were up 9.5%, with our trust assets at a new high over $18 billion as of September 30. This was driven by both new accounts and improvements in the value of the equity market. As expected, with the events in the first half of this year with our Austin benefits operation, insurance revenues are down. And also service charges on deposit accounts as rates increase. Other noninterest income was up with a major contributors coming from Visa Check Card usage and unity sales and gain from student loan sales.

Noninterest expense were up 6.4%, impacted by a 4.9% increase in combined salary and benefits. These are normal annual merit increases, increases in headcount and incentive compensation accruals. Our loan provision expense was $2.7 million compared to $2.7 million in chargeoffs, or 19 basis point annualized as a percentage of average loans.

Looking forward, the Texas economy continues to look very healthy but also very competitive. First a word about Texas. It's stable, we're having moderate growth and we're operating at a steady pace. Houston and Dallas are slightly better, Austin about the same, San Antonio continues to run at about the state average. As we all know, we have had some major events in the southern part of the United States and Texas has been fortunate with the hurricanes. I will say we still have over 45,000 students in our schools in Texas from refugees. And if you look, all in all, bottom line, we think the hurricane will be a slightly positive to the state in the short term.

Obviously, another big factor in our country is energy costs. For the U.S. it will be a negative. At the end of the day for Texas it will be neutral. All in all Texas is a good market for business. On the competitive side and looking at the business loan area, since December of '04 we have increased commitments by $865 million or better than 16%. To accomplish this we had to look at 40% more volume than we did last year. Approximately 75% of our new commitments came from existing customers who always provide a solid base of growth. However, we lost over $350 million in customer loan opportunities because we were not willing to meet the price or structure offered by our competition. This is almost double last year's $178 million.

The good news is we must be successful with prospects and we are. We booked $570 million in new loan commitments to prospects. That's double last year's $285 million. Frost reviews monthly how we're doing in maintaining our credit and pricing disciplines. The results so far are good. Credit quality measures are stable and overall profitability of new relationships are meeting our expectations.

In summary, this was a good quarter. Texas has a good economic environment in which to operate. And Cullen/Frost Bankers is able to grow and prosper in a very competitive environment. Now, I'll ask Phil Green our CFO to make some comments.

Thanks Dick, I'll make just a few additional comments and then turn it back over to Dick for questions. As Dick mentioned, our Company once again posted a record level of EPS during the quarter. However in addition, our level of overall profitability also achieved a new all time high as our return on assets hit 1.68% for the quarter. This quarter was also pretty much free of any unusual items such as the legal settlement we received in the second quarter of this year. This also marked our third consecutive quarter in which revenue increased at more than twice the rate of our operating expenses. Revenue increased 12.9% once given driven primarily by increases in net income. And that compared to a 6.4% in increase in noninterest expenses.

The impact of higher interest rates on our asset sensitive balance sheet accounted for about 60% of the increase in net interest income. While higher volumes of earning assets accounted for the remaining 40%. Loan growth actually exceeded our earning asset growth as we employed liquid assets and investment securities into the loan portfolio over the last year. Over the 750 million in loan growth over the last year, approximately 300 million each came from C&I loans and commercial real estate loans. With most of the balance coming from consumer real estate. Deposits increased 3.2% over last year. With time deposits up 3.6% and demand deposits up 2.5%. However, commercial and individual demand deposits were up by 7% over last year.

And importantly noninterest bearing demand deposits continue to represent a significant part of our funding base at 37% of deposits. During the third quarter, our net interest margin increased to 4.52%, a 10 basis point increase from the second quarter. This represented about 80% from the 25 basis point increases the Fed made in August and September. The remainder came primarily from additional loan growth. Our outlook calls for an additional - - two additional 25 basis point rate increases by the Fed in November and December.

Our provision for loan loss is at $2.7 million in third quarter was about equal to chargeoffs for the quarter and it compared to no provision taken in the third quarter of last year. Finally, regarding our guidance for the year. Since we are now down to just one more quarter, we will just say that the range of estimates appears to be equal to us. With that I'll turn it back over to Dick for questions.

We're happy to entertain any questions you might have now.

[OPERATOR INSTRUCTIONS] Your first question comes from Charlie Ernst.

In looking at the average it looks like the earning assets are up a little more than loans, were there bonds or short term assets added during the quarter?

Charlie, the - - on an average basis, if you looked at the comparison on linked quarter basis, our bonds were actually down about $50 million in the third compared to the second. We actually added liquidity on Fed funds sold to the tune of about $160 million. So what we had was an - - we funded that with an increase in deposits of 140 million. We had downstream customer repos increase about 60 million.

So, that mathematically hurt the margin a little bit in the quarter I would assume.

The increase in Fed funds, yes arithmetically would have had an impact. But probably been offset a little bit. Like I said probably about two basis points from the increase in higher earning - - higher yield on the loan earning assets.

Okay. And then Dick, could you caulk a little bit about Hurricane Rita and what happened with the franchise during those days when people were preparing for it, how many branches were closed and for long?

Charlie, we were so fortunate, it was very minor to us. Obviously we shut Galveston down I think on Thursday.

And some Houston branches that were closed. But just for the - - as we were looking for where the storm was going to hit. But the actual branch closures because of the storm itself we really just had one in Galveston that had some problems with electrical and that was pretty much it.

We were just very fortunate. And I will also say that it tested emergency team and what we do. And I was extremely proud of our organization and the great job they did of being ready and fortunately we didn't have to use all the things we had.

Okay. Okay. And then lastly, can you talk about - - some of the expense items occupancy and equipment and then amortization were a little bit volatile in the quarter and even other. Can you talk about whether there was anything extra in those lines? Amortization being a little bit lower than expected.

Charlie, on a linked quarter basis the intangibles were down for a couple reasons. One is you remember that we had the settlement on the legal dispute we had on the Austin insurance side. And that was I think on a gross basis was a little over $4 million. But we wrote off some intangibles and noncompetes associated with that, which netted that down to 2.4 million. So we weren't amortizing those intangibles any longer. Then in addition, we dropped off some CDI from some bank acquisitions we made in the past. So, that's the deal on intangibles. On the FF&E side - - or let's see, I think you asked about net occupancy. On a linked quarter basis the biggest difference is electricity. We had an unusually hot October in Texas. We had had some 104 degree days, which is pretty crazy even for us. Which really caused us to run a lot more electrical and of course the cost of it's a lot higher. We are seeing that trend as well. Let me think what else.

And then the other expenses looks like its up over $1 million.

Yes, on a link quarter basis other expenses are up by around $800,000. Just a lot of different things in there. We have some costs associated with the Horizon conversion, which were about $0.25 million. We've got just a lot of sundry items. We have had things like additional marketing, donations, that type of thing. Just as I look down the list it's a fairly - - it's a list of small items on the positive side and on the negative side. But those are some of the larger ones.

Okay, great, thanks a lot you guys.

Your next question comes from Jennifer Demba.

Good morning. I was wondering if you could give us a flavor of where most of the loan growth came from geographically and by category?

Well, as I mentioned earlier it's really balanced. All the markets were growing really at double digit. If you look at average loan. Average loan growth last year, year-to-date versus year-to-date this year we've had good growth, over double digits in all the markets at San Antonio and it's right at 10%, 9.7%. So, we've had good diversification. And as I mentioned, also, as far as the categories, C&I, commercial real estate were also all double digits in that regard. So I'm real pleased. If you - - when you look at the diversification in the portfolio there's no major change. The energy still a little bit less than 10%, but right at it. And as far as our commercial real estate growth, 1-to-4 family is strong and land, and land and development continues to grow. We look at that category very closely obviously because of - - you should. We still see development continuing strong in our state and inventories of houses and lots are low. And we feel comfortable in that regard. We're also - - the land that we do make loans to is primarily to support 1-to-4 family growth. On the consumer side we are pleased that our home equity lines and lines and loans continue to grow.

Okay, thank you.

Your next question comes from Jefferson Harralson.

Thanks, I was going to ask you about your Fed funds position and the liquidity. Any increasing in this quarter, what type of yield curve environment would it take to have you go out and invest some of this excess liquidity?

Jefferson, we are - - we have built some liquidity. We actually have made some investments in October as we saw some of the 15 year mortgage back and actually some 10 year amortizing mortgage backs get well over 5%. So, we have made some investments there. We will probably make about $200 million in the month of October. So, we don't particularly like the curve. But it's the only one we have got and so we have got to participate. And when we think we do see enough value and we have gun to do that.

We also Jefferson, historically, in this Company believe you have got to continually be into the market at all times on the curve. Obviously we have not liked the curve at all lately. But again as Phil described it we are where we are.

What was the yield advantage to the 15 year paper that you bought versus the overnight money when you did it?

The yields we were seeing were just under 520.

All right, thanks, that's very helpful.

Your next question comes from Justin Maurer.

Just relative to loan to deposit say it isn't so, but you guys are actually pushing toward 70%. Just a little bit of visibility, you talked about deposits. And I see that noninterest bearing was up nicely. I don't know if there were any particular programs you guys are running. I'm trying to get a sense presumably if loan growth keeps moving along nicely, what - - if you look out over the next 12 months or so where do you think that percentage goes?

On loan to deposit?

Yes.

First of all on the program side, it's just good work by the staff. We just continue to press relationships. And we don't like to make loans without the relationship, without deposits. And that's how we have gotten to 37% demand deposits as a percentage of our total deposit base. And we want to continue to maintain that there. As far as what our number is going to be, I think we see it going up. We would like it it to go up slowly because we are really pressing for us to continue to keep growing our core deposit base. Depending upon how successful we are that will drive what that ratio is. I think probably in another year we're going to be somewhere in the higher 70's would be my guess. but I would like it to be mid-70's if we can grow our deposits faster.

Justin let me just add to that. The - - if you look at our organization there is no doubt that we have a very strong commitment . And one of the fundamentals of this Company is to fund loans with core deposits. I will tell you it is very much of a focus with us. Obviously, our relationship managers' incentives are tied to deposit growth and building relationships. Phil started off and really described it well. It's really blocking and tackling. It's the basic business of us is to continue to grow both sides of the balance sheet. We are not a Company that pays extra high to attract money and moves in and out of programs. We are consistently in the market competitive in our prices but really focused on retention. We don't have strong advertising campaigns as the big guys do to swing those both ways. It's a very steady commitment to be sure we fund it. So, I know you asked where the percentage is going. It has moved up, we're pleased with where it is. I think we will continue to have good growth in our loans. But I think we will certainly be able to continue to build relationships and grow our deposits.

Yes, well, it's good to see you guys have had that model of keeping it relatively low, not necessarily on purpose, but to see the nice margin benefits now as it moves forward. Just Phil, on the follow up on the hurricane issue, I think you mentioned limited damage. But do you guys have a sense of number of branches that were down, number of days type of thing, was there any business disruption per se or not so much?

The not so much. The only one you can say is the one Phil mentioned in Galveston and just because of electrical problems it was down.

For any time that's true. But as the hurricane was coming in, I'm trying to remember the days, but I think we were closed, we closed early on a number of branches in Houston and Galveston. And so there might have been a 24 hour period for parts of 24 hours that we would have had more limited service, but most people are on the road trying to get out of Houston.

That's what I was going to say. Relative to, it was a nonevent, there wasn't anybody to come into the branch when we were closed.

I was just thinking relative to any lost opportunities, obviously short term in nature, but stuff that could be made up in subsequent quarters.

We were very fortunate.

All right guys, thanks a lot. Thank you.

Your next question comes from Kevin Reynolds.

Morning guys. I've got a couple quick questions. I may have missed this as you went through them a little earlier. Could you give me a period end balance on noninterest bearing deposits and then also 90 day past dues to start with?

On the period end basis, hang on just one second, period end noninterest bearing deposits were - - you know these fly around a lot on the DDA side, but they were 3.202 billion.

Okay.

And 90 days past due, June 30 we were 5.5 and we were 8.6 the end of September.

Okay. Thanks for that. Then the question I've got for you is having completed the most recent acquisition and I know you have probably got a little bit of work to do on that one to get it sort of integrated and all. But what is your appetite now as you look out? Is this something that would maybe cause you to pause if an opportunity were to arise in the very short term? Just kind of expand on that if you could. And then maybe look at specific markets in Texas that you would like to see bolstered.

Okay. Well with regard to integration, I'll let Dick talk on the going forward side. On the - - we converted all the systems into our systems on the date of closing, so it is integrated today.

Kevin, in regard to acquisitions, really nothing has changed in our philosophy. And we have continually been looking at those organizations that meet our culture and that would fit our organization. And I have got to tell you nothing has changed in 20 years. You will see us more in the market and less. But that's really related to us just finding the right organizations to bring in. We're very pleased with Horizon. And as Phil said it's all done and we're out building the Houston market together as one team. The - - we will continue to look for those organizations. Markets do change, there's been more activity you have observed and I have observed in Texas as far as banks selling. So, that may bring us some opportunity of those that we are attracted to might be more willing sellers. Other than that we're staying the course. Focused on those organizations that have the kind of people that we would like to bring together and be a part of our team. And as far as geographic locations, just look at where we are, know all those markets are important to us. And we'd be interested in any of those markets that we currently operate in. We really don't have any plans to leave the state of Texas or to leave the markets where we currently operate. That's where our focus is and will continue to be.

Okay. And I guess if - - on a going forward basis, as you're looking out there. If you are constrained in terms of finding the right partners, do you think the bigger constraint would be pricing restrictions now or the cultural fit?

Well, it's always culture. Culture is first, if you can make that work. I think we all know the pricing and it's - - and nothing is cheap in Texas. And good quality banks are not going to be cheap. So that's pretty consistent. But if they're the right bank, I think we have the right mix to make it work financially.

Okay, thanks a lot and great quarter.

Thank you. Your next question comes from Kerstin Ramstrom.

Hi, how are you today?

Fine, thank you.

Hi, could you give me some more detail on the credit picture and what you're seeing? I noticed that chargeoffs ticked up a little bit this quarter. 90 days past due seemed to be up, NPA seemed to be about flat. But I wanted to get an idea of; A) where the chargeoffs are coming from? And what are the underlying trends you're seeing in your market in terms of credit?

Kerstin, I think first we have got to say we would be slicing the cheese pretty thin to kind of distinguish. At 19 basis points last quarter was 12, the quarter before that was 13, then 10, and then 28 basis points a year ago. Quite frankly, credit quality is very good. There's no specific trends as you will look at the - - and as far as $5 million going to $8 million and over 90 days past dues, those two are very much in check, there's no trend there. I know it's up but there's nothing specific causing it.

So, you would say that this is more of a reversion to kind of a normal amount from an excellent environment rather than the beginning of some other problem.

I definitely would say that. Because there's - - we operated in chargeoffs in kind of a low 20's historically. Gosh, that's really good and yes we're kind of getting back. If you look at the Q and potential problems you will see they are down from 21 million to 16 million, But to just give you a flavor, about half of that is to insurance related credit, about 20% is to a hotel and others to a software. So it's kind of all over the board related.

Okay.

No trends.

Okay.

If you look at just specifics to your question, third quarter charge-offs just by category there were 2.711 million on a net charge-off basis, commercial was most of that, 2.017 million, the next largest was consumer 604, and then there was mortgage a 100. The vast majority was 2.017 million for commercial chargeoffs and that compared to 2.961million in the third quarter a year ago.

Okay. That's great. And then if you could also comment on the rebuilding of your insurance operation in Austin, just an update of what has been proceeding down there? And also just in terms of income statement impact, could you talk about the seasonality in that business? I know generally in the first quarter we see contingent - - commission fees come in, but it looks like it gets a little lumpy through the year, specifically with the third quarter as well. And I just wanted to understand that trend a little bit better.

Well, let me make a general comment, then I'll let Phil talk about the specifics of it. We're very pleased with the rebuilding of our insurance operation, not only in Austin but statewide. We have - - obviously, we have been in the business about 6.5 years. We bought several agencies. And we have with our management team have really pulled it together and it's more focused than ever before. And I'm very pleased. We have a great new team. Obviously, we don't have 17 people because we don't have that volume in our Austin benefits. But we have got a good team in the neighborhood of five people and we're very pleased with the expertise we have. So, I feel that there's no doubt this has been adjustment year for our insurance and we have gone through some tough times. But as always, tough times always seem to make you better and I think that's true of our insurance. I'll let Phil kind of comment on specifics.

I think that you have a good feel for really what happens. The first quarter is also always the best in this business because of the contingencies. If you look at it, the next best quarter it's the third quarter in terms of timing for us. But again because the contingencies aren't there it's much weaker on a profitability basis than the first quarter.

What is the thing that drives the uptick generally in the third quarter?

I think we have some school districts that we have a big business in that tend to have their policies come due there. I mean, it's not a huge increase versus the other quarters, but it does tend to be about I'd say 20% or so greater than the fourth quarter as an example.

Okay. That's great, thank you very much.

[OPERATOR INSTRUCTIONS] Your next question comes from Terry McEvoy.

A question if I could on the Horizon Bank acquisition. Do you still expect that acquisition to be about $0.01 diluted in the fourth quarter and about $0.02 accretive next year? And are you still looking for about 15% cost saves?

I think the thing to say is that it looks consistent with what the pro forma numbers were that we released before. I think we expected it to be early on about - - and actually it was for 2005 we had a partial year about $0.01 dilutive. And frankly I can't remember off the top of my head when the specific accretion number was for the first full year after that. But it is meeting our pro forma that we announced before.

Thank you.

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

Just to say we appreciate the support of all our shareholders and we will continue to build value for our shareholders, customers and staff. We stand adjourned, thank you very much.

That concludes today's conference call, you may now disconnect.