Cullen/Frost Bankers Inc (CFR) 2010 Q1 法說會逐字稿

Thank you. This is Cullen/Frost Bankers, Inc. first-quarter conference call. 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 will turn the call over to Dick Evans.

Thank you, Greg. Good morning and thanks to everyone who has joined us today on this call. I would like to begin by stating how delighted I am to present Cullen/Frost first-quarter 2010 results in this current economy. After I finish, our Chief Financial Officer, Phil Green, will provide some additional detail.

When we last met with you some 91 days ago, we talked about a steady, stable performance. And we asserted our belief that amid a still cloudy economic environment, the outlook for the nation, for Texas, and for Cullen/Frost was clearing. I'm pleased to report that Cullen/Frost is making progress we anticipated. As Americans, we always believe the best is yet to come. My colleagues and I believe that the worst of the recession is now behind us. While economic reports vary widely, the majority are now trending positively. For example, the index of leading economic indicators posted a gain in March, capping a year of increases.

As Texans, we are always finding energy and optimism in the mounting reports that show our often independent state economy is leading the way forward. The Texas economy continues to outpace the rest of the country. Jobs are growing again, increasing about 1% in the first quarter. For the year, we anticipate a 2% growth, continuing the historical trend of outperforming national job growth by about 1 percentage point. The housing market remains stronger than the rest of the nation and is improving. As you know, housing in Texas never overheated, and the state's housing market, like the nation's, has benefited from the housing tax credits and low interest rate environment. But more importantly, fewer people are struggling with mortgage payments in Texas because of the overall strength of the economy.

There are unique features to the Texas economy that have enabled us to fare relatively well entering and now emerging from the recession. Such as the strength of our energy industry. But the presence of that industry does not tell the whole story. The state's energy industry is part of a larger technology and manufacturing capability that is built on the exports of technology and services globally and is giving rise to emerging industries such as wind energy. The fact is, that Texas exports are diverse with chemicals, electronics, and machinery accounting for the largest portions. Though uncertainty remains, the underlying strength and diversity of the state's economy has positioned Frost well to achieve the performance we expect.

I am encouraged to see our nonperforming assets down by $8.6 million and chargeoffs down by $6.6 million from the previous quarter. Our asset quality is at very manageable levels and capital levels remain strong. Back in January, we said that we would base our 2010 forecast in no small part on the strength of Cullen/Frost's values and culture. Equally important is our ability to execute around a well defined strategy. Our attention to this critical combination has sustained this organization through periods of turbulence and times of calm. And we will continue to do so.

Now let's take a look at the first-quarter results. Our net income for the first quarter was $47.8 million. That's up 6.3% from the $45 million reported in the first quarter of '09. On a per share basis, earnings were $0.79 per diluted common share compared to $0.76 per diluted common share a year ago. Return on average assets and equity were 1.17% and 10.7% respectively, compared to 1.23% and 10.33% for the same period of '09.

Nonperforming assets, as I referenced earlier, experienced favorable movement in the first quarter. This marks the second conservative quarterly decrease of nonperformers. On the final day of 2009, the total was $180 million. And as of the first quarter in, nonperformers were $172 million. Nonperforming levels peaked in the third quarter of 2009 and have declined $49 million, or 22% since that date.

Net interest income on a taxable equivalent basis for the first quarter of 2010 totaled $150 million, an increase of 9.2% compared to the first quarter of '09. This increase primarily resulted from growth in average volume of interest earning assets. The net interest margin was 4.19% for the first quarter of 2010, compared to 4.33% for the first quarter of '09, and 4.20% for the fourth quarter of '09.

Deposits have grown 18% from a year ago. Average deposits for the quarter were $13.5 billion, an increase of 17.7% from the $11.5 billion reported in the first quarter of '09, and a 2.1% from the $13.2 billion the previous quarter. Average loans for the quarter were $8.3 billion, down from $8.8 billion reported a year earlier. We are seeing signs that suggest that we have reached an inflection point in loan demand. Our hope is that it is the beginning of a continued increase. However, increases so far have been slight. The fact is, loan demand is not at a level that is sufficient to provide our desired loan growth. Business owners remain uncertain and have lack of confidence in the economy they need to access their existing lines and open new ones.

We are not just waiting around in this environment, however. We are actively working to build a larger pipeline of relationships that will yield higher volumes of quality loans as we go through the year. That's not a new activity for us. In fact, it has long been our practice. Over time, it will expand our opportunity to increase our loans to a growing customer base.

We are constantly studying our business, our opportunities, and our trends. For example, a positive indicator that customers may be experiencing revenue growth that drives loan demand is the slight increase in the advance rate on their lines of credit. This could be a good sign, but at this point, it's a small indication. Historically, increased advance rates have been associated with economic growth as customers need additional financing to cover their higher levels of receivables and inventory. In loan requests, we have also seen a double digit percentage increase versus a single digit last year on link quarter basis. While this increase is more in line with traditional increases in the first quarter, the trend is not isolated. It crosses all size segments and in all regions.

Turning now to credit quality, for the second consecutive quarter credit quality has improved. Problem loan outflow exceeded inflow for the second straight quarter. We are encouraged by improvement in net chargeoffs to $13.5 billion -- $13.5 million, a decrease from the numbers reported in the third and fourth quarters of '09 which were $16 million and $20 million, respectively. Also worth noting, is that first-quarter chargeoffs were adequately reserved for in prior reporting periods.

Additionally for the first quarter, 2010, the provision for possible loan losses was $13.6 million compared to net chargeoffs for the quarter of $13.5 million, or 66 basis points of average loans on an annualized basis. The allowance for possible loan losses as a percentage of loans increased to 1.53% at March 31, 2010, compared to 1.30% at the end of the first quarter of '09 and 1.50% at December 31, 2009.

Noninterest income was $71 million compared to $70 million reported a year earlier. A component of noninterest income includes trust income of $17 million, up from $16 million reported in the first quarter of '09. Impacting trust fees was a $1.9 million increase in investment fees which was partially offset by lower securities lending income down $568,000, and oil and gas trust management fees down $372,000. Insurance commissions and fees were $11.1 million for the quarter, an increase of 3.6% from the $10.8 million reported a year earlier. Noninterest expense for the first quarter of 2010 was $134.6 million, up $5.1 million, or 3.9%, from the $129.5 million reported in the first quarter of '09. In addition, total salaries and employee benefits were up $2.8 million, or 3.9%, over the same period a year ago due primarily to annual merit increases and an increase in incentive compensation.

Net occupancy expense was $11 million for the first quarter of 2010, up $445,000 or 4.2%, compared to the same period in '09. The increase was due primarily to an increase in the building depreciation up $435,000 and property taxes up $340,000. These increases were primarily related to a new technology center placed into service during the first quarter of this year. Designed for optimum performance and security of the Corporation's technology systems and data operations, this $50 million facility insures Frost capacity to meet data and information technology needs as the Company grows. Furniture and equipment expense was $11.5 million for the first three months of 2010, an increase of $1.1 million from the same period a year ago. The increase from the first quarter of last year was primarily related to increases in software amortization up $520,000 and equipment rentals up $433,000.

FDIC deposit insurance. Expense was $5.4 million for the first quarter of 2010, increasing $1.1 million from the same quarter of last year. In our consumer banking activity, the first quarter produced solid growth in the number of checking accounts up 7.2% quarter one, '09 versus 2010, and contributed to the 18% increase in deposit balances over the same period.

While we are on the topic of consumers, I would also point out J.D. Power and Associates ranks Frost highest in retail banking customer satisfaction in Texas. We also score among the highest in the country. Additionally, we continue to work hard to develop new business customer relationships. We increased in-person calls to prospects by 24% compared to last year and 20% more than in the fourth quarter of last year. These efforts continue to be rewarded as we set a record for the number of new relationships in the first quarter.

Let me offer a couple of closing points before I turn the call over to Phil Green. Although there will be certainly more starts and pauses as we emerge from the recession, the US economy is nothing, if not resilient. Texas current overall activity suggests that our state's resilience and resolve may well be the catalyst for the nationwide turnaround to come. Employment increased 1% in March making three straight months of job growth. Energy, always a Texas strength, is now seeing more positive trends with increases in activity and acquisitions.

On the other side of the coin, challenges in health care legislation have raised doubts. Clearly many questions still need to be answered, and we continue to educate ourselves on this complex issue and the associated cost. Still, in all, we are seeing signs of forward progress. The economic head winds are no longer pushing people back. At Cullen/Frost, we began 2010 focused on putting ourselves in a position for stronger performance in the quarters to come. We are on that path. We have expanded our leadership position in the industry on the strength of our decision 18 months ago to not take TARP funds. For us, it was a sound business decision. And as a result, we have been able to focus unabated on building our business.

Today, and every day at Cullen/Frost, we are continuing to build new and existing relationships while helping our customers navigate the storm and prepare for a brighter future ahead. We understand that everything we do today affects whether others will do business with us tomorrow. We take it seriously, and we will be there for our customers in the future. And now I would like to turn the call over to Phil Green, and after that, he and I will be glad to take your questions.

Thank you, Dick. Just a couple of additional comments, and then we will open it up for questions. As Dick noted, we were pleased with this quarter, and there really weren't any unusual items to speak of. Revenue up almost 7%. Noninterest expenses up just under 4%. Provisions were still higher than we'd like, but they exceeded chargeoffs. We were down by 40% in provisions from the fourth quarter. At the same time, the reserve increased 3 basis points to 1.53% and NPAs had their second consecutive decline. And that's pretty much the story.

We would like to see loans increasing more, and we were hopeful that by this time they would be. But there is still, as Dick said, a lot of uncertainty in our customer base and in the market in general. As he also mentioned, we are working extremely hard to generate the good volume that is out there, and we hope that we may be reaching an inflection point on volumes. Our loans are currently only about $13 million lower than the end of the quarter, so let's hope we are getting near the bottom, and we can begin to see some growth in the second half of the year.

At the same time, deposit growth continues to be very strong. Historically, the fourth quarter has been the strongest for banks with some seasonal dropoff in the first quarter. However, average deposits continued up in the first quarter of this year, and our demand deposits increased 9.6% on a linked quarter annualized basis. At the same time, time increased 7.5% for a total annualized deposit increase of 8.2% for the first quarter on a linked quarter basis. I think our consistently strong growth in demand deposits through this downturn demonstrates our success in growing and developing customer relationships in this time, and we are extremely proud of it.

In the area of timed deposits, our largest growth by far has been in our money market deposit accounts which were up a combined $245 million from the previous quarter as they offset a decline in more expensive CDs. Obviously with the kind of loan growth we are experiencing along with our strong deposit growth, we are going to experience some strong liquidity levels, and for the first quarter we averaged $1.5 billion in our [fed] account. And that includes the impact of the $718 million in securities we purchased in the latter part of the fourth quarter. So we still have lots of money to deal with.

As Dick mentioned, our margin for the quarter was only different by 1 basis point from the fourth. So we are pretty happy with the stability, but there were various things that impacted it. Our higher liquidity, our lower loans, the sale of the prime swap, or at least a part of it -- combined to cost us 11 basis points in the quarter. But the purchase of securities in the fourth quarter and lower deposit costs as we saw market rates decline offset this impact. Right now, our current expectation is for flat rates for the remainder of the year and a fairly flat net interest margin. Finally, regarding our outlook for 2010, we continue to feel the current consensus for 2010 estimates is reasonable. And with that, I will turn it back over to Dick for questions.

Thank you, Phil. We will be happy to entertain your questions.

(Operator Instructions) Your first question comes from the line of Dave Rochester with RBC Capital Markets.

It's FBR Capital Markets. How are you doing?

Good morning.

Given your positive comments on the Texas economy and your decision not to build a reserve, are you thinking at this point you will be releasing reserves by the end of the year?

We would look at our formula and find out. It guides us, and we have a good discipline to do that. I think what you have got to look at is any time there is a good positive trend -- you have got to also remember while the problem loan trend is down, we are also talking about the growth of loans going up, or we are hoping that that's what happens. So that relates to the formula, too, and balances out as you go through cycles.

I guess you are saying by releasing reserves we have reserved less in chargeoffs, or are you actually talking about negative provisions?

Not negative provisions. Just like you said, chargeoffs exceeding the provision expense. Second question, can you update us on your focus now with regard to M&A? I know you typically look at everything. Are you looking more at more normal non-FDIC bank M&A at this point or are you looking at opportunities to bolster your fee-based businesses right now. Any color there?

We continue -- we have been making some small insurance acquisitions. They are more like hiring people than a whole acquisition, but you are actually bringing the business over. So we have done -- we continue to do those. But I think the important thing is that just what you said earlier. We feel it's our responsibility to look at everything and what will complement our business and our culture that will fit into our culture. So we are pretty broad-base.

Okay. And last one, at what point do you expect to start working that liquidity down more meaningfully? Whether it's deploying that and securities, and you have already given us your loan growth outlook there, but when does that come out of fed funds and cash?

Well, it's going to depend a lot on two things. One, if loan growth is there we would love to see it. As we have said in the past, we would love to see that money go into building of loans. Since loan growth has been slower for the first part of this year, we are doing some investing. Actually, at the beginning of this quarter, we began to buy some treasury securities. Nothing too dramatic. We bought -- in round numbers, $250 million -- or $275 million in five years. Treasuries, we bought $250 million in seven-year treasuries. We still, though, are running $1.4 billion in our fed account after those purchases. So we continue to get strong deposit growth in, and loans as we said have been flat.

So we began to utilize some of that liquidity, but still have strong levels. You can do the math, and if our deposit rates continue at this level and our loans continue to be flat, we are going to end up with a lot more liquidity we are going to have to deal with. Our position has been we have done as little as we can to make up for what we are seeing in earning asset growth and other areas. And we are trying to be as conservative as we can with what we are buying. That's the way we are looking at it right now.

I might just add something. There is a lot of components as Phil has just gone over, and I might just talk about funding rates on commitments. That's what I was referring to in the call that we have seen a slight increase. The funding rates are at 45.5%, up from about 45.333%. That's how slight it was in the first quarter. But it is -- it's after a line that just goes almost straight down from 48% to 45% since a year ago.

The other thing that -- the first time that I have seen is that not only in this recession did the funding rate go down, but also the commitment started dropping. And in fact, the commitment started dropping in September of '08. And funding still stayed a little strong for a while there. So it's a phenomena that I think is kind of unique in this recession from the standpoint that people realized that it was so weak that rather than ask for $1 million commitment, they asked for $750,000. Typically in a pretty even environment, you will run 50% of commitments. In a weak environment, you will be about where we are today. The industry around 45%. In a real strong cycle, you will be around 55%. But I think we have got to look at commitments.

This thing -- when the turn happens -- as much as it pushed down both the advance on the commitments as well as the commitments outstanding, I'm optimistic that it will start building as soon as people get confidence in the future.

Okay. Great. That's good color. Thanks. Good quarter.

Your next question comes from the line of Steven Alexopoulos with JPMorgan.

Hello, everyone. Maybe I will start just following up on these comments on loan demand. Maybe first, could you provide just more color on what signs you are seeing that at least loan demand has reached an inflection point? Then I'm curious as you have been through other cycles like this in Texas, once you reach this point, what's your best guess as to when to loan volumes more meaningfully come back?

If you listened to me, it's a -- you ask a good question, and I tried hard to find the balance of talking about this. Because one thing I said to you, I'm seeing little bitty signs as I mentioned through the call. They are not a trend yet. But I believe -- I think -- I'm very confident that we have come out of the recession. There is a lot of different kind of factors. The energy which is an important part of our lending base of a little less than 10% today. Oil is strong. Gas prices have been weak. You know how important the shale plays are in the whole United States, and not just Texas.

Currently, it takes about -- well, we have been at $5 or $6 to make the shales work. They are marginal at $5, and at $6 they are profitable. On the other hand, at $4 gas today or around there, they just pretty well set these things down. This swing is big dollars. You are also seeing -- we are seeing that conventional gas which has a flatter yield curve than shale gas. Shale gas drops off really fast in about 30 months, and then levels off for a long period of time. On the other factor that's in this is technology continues to improve. There is good signs that $5 and $6 will move down to $4 and $5 over time. So I think you are going to see drilling activity move all over the board. It has been climbing. If you follow drilling rig usage, they have been climbing almost [15] or [20] a week consistently for a long period of time. I think as you see this price in gas drop, you will start seeing that come down, and then, if price of gas goes back up you will see it come back up.

Obviously, oil has stayed strong. There is a lot of different factors affecting it. If you come back, we know that inventory levels got awfully low. As you look at those national numbers, they have started moving back up. Are they back up at a level of where sales are going to be is kind of the big question. Or do they need to continue to build up? Certainly, I think the signs are very slight, but I think they are positive. And as we work through this, I'm optimistic about positive trends in the second half. But I can't prove it to you.

Okay. Some banks have talked about -- that was helpful, by the way. Some banks have talked about pressure on credit coming from residential development loans in Texas this quarter. Did you see any of that pressure on your resi development borrowers?

You're talking about people wanting to do residential development?

No, your borrowers that -- basically, your residential construction loans getting worse in terms of quality in the first quarter.

No.

No. Okay. And then just finally, with the investment going on in the tax-exempt securities, what's a reasonable run rate for the tax rate here?

I think low 20%.

Low 20%. Perfect. Thanks.

Your next question comes from the line of Ken Zerbe with Morgan Stanley.

Great, thanks. Just on the NIM briefly, if you are wrong in terms of the assumption about the flattening, what's going to drive that? Is it -- obviously, I can understand if loan growth picks up obviously you have better asset yield opportunities. But what are the other swing factors that might lead NIM to be above or below your flat expectations?

The math of it is probably if we see liquidity grow, and we hold in at the fed and with any meaningful increase that's going to put pressure on the net interest income. Offsetting that though is the investments that we make out of that liquidity. When we do that is going to tend to offset. Just like the fourth quarter tended to help us in the first quarter with our net interest margin not falling because of some of these other factors, I think that will be the case going forward. And you are right, if loans move up, and we don't have to do the investing and we see our balance sheet get more efficient in that way, that is going to help the net interest margin as well. Those are the factors, I think, that play off against each other.

And then, I think you mentioned you're investing in both five- and seven-year treasuries. That said, if you continue to do that to help reduce some of the excess liquidity, does that put -- given where yields are -- does that put a downward pressure or more specifically, a ceiling on your longer term NIM?

No, I don't think so. Obviously, those are rates that won't be going up, but they will be at higher rates, and we will make the investment. If you look at -- after the investments we have made recently, we have still got a 3% positive outlook for higher interest rates if you look at the volatility of our net interest income. We are still asset sensitive even with that. At the same time, we are continuing to build liquidity really on a daily basis the way deposits have grown. I still know that we are favorably positioned to higher interest rates, and quite frankly, looking forward to that. And at the same time, we can't just sit by with multiple billions of dollars at 25 basis points in this market.

All right, great. Thanks.

Your next question comes from the line of Michael Rose with Raymond James.

Good morning, everyone.

Good morning.

Can you talk about your outlook for service charges given the upcoming legislation impact?

Let me just talk about the upcoming legislation a little bit and where we stand on it. We feel pretty good about where we are. We were about halfway through the contacts that we need to make with our customers in order to see if they want to opt in or not. We are about -- overall, we are seeing about 75% of the people opt in, 25% not. If you look at the people that actually use overdrafts or have used overdrafts they are coming in at just under 90% now. We are seeing about two-thirds of our responses come in over the Internet with our log in interrupt system. So I feel that we have got a pretty good handle on what's happening having been halfway through the process.

I don't think that shows there is going to be a great dislocation with regard to service charges. There could be some leakage, but I feel like customers are choosing that they want to continue that service, and that it's fairly offered and it's provided in a good way. I want to take this opportunity to really thank our staff for the work they have done. Our IT group, our Internet group, our customer service and contact group, our marketing group. They have done a fantastic job of putting us in a position to be this far along in this process. And I feel like the important thing is we are allowing the customer to make a choice in terms of the service that he wants and continue to provide him excellence. And so I'm feeling pretty good about it right now.

Okay. That's helpful. And secondarily, if I may, this is a broader question. But you have stepped up your calling efforts over the past couple quarters. Is that focused on any certain geography or any particular loan type, particularly as you have said that we are coming out of the recession here?

It's very broad-based. And it's in all of our regions that we operate in. So we are trying real hard to cover all segments.

Okay. Thank you.

(Operator Instructions) Your next question comes from the line of Ken [Easton] with Bank of America, Merrill Lynch.

Good morning. It's actually Casey in place of Ken.

Okay, Casey.

Just a question on expenses. They came in pretty good and could actually decline given the FICA balance in the first quarter. Is this something you see as sustainable going forward? And then also, you mentioned the technology center came along in the first quarter. I was wondering if you could provide any -- quantify any efficiencies you expect out of this initiative?

Well, I think the -- you did highlight some important factors. Seasonally, we do have high FICA costs at this point of the year. We should see that reduce somewhat. But I think the impact of the technology center is going to be to increase our expenses. As Dick mentioned, it did put some pressure on our FF&E and on our net occupancy cost. And I wouldn't say there are any efficiencies. There may be some modest efficiencies out there, but basically it's just upgrading some capabilities that we needed to put in place.

I think that the positive thing overall to me is that we could put in a facility that is that big a deal for us and still have the kind of modest growth in expenses that we are experiencing. The reason we are able to do it is you look at things like we are down 108 people full-time from a year ago. We are down 62 people part-time from a year ago. So our people are operating very efficiently. You look at other expenses versus a year ago, and it's -- we are flat, and that's a $30 million expense item. Again, just really proud of the staff in terms of how they are managing expenses. Always looking for ways to be more efficient and handle our customers better. By doing that, we are able to bring on some of these other bigger expense items and continue to have a fairly modest growth.

Great. And then in terms of loan growth, could you comment a little bit on each of the regions that you operate and which area you might expect to lead loan growth? On the contrary, which region might lag based on what's going on in each local economy?

If you look at San Antonio, it pretty well follows the state economic trends. And so, it's right in there. It doesn't move as much. Houston and Fort Worth -- Fort Worth we also have a large energy presence. As well as, obviously, energy is important to Houston. And so you will see as those lines -- as you look at the advance rate on energy loans that are around 44% or something in that range. So they are way down, that could -- those could swing.

Our markets -- we made a decision years ago to operate in Texas where 70% of the population is. All our markets are growing. And certainly, we have some smaller markets such as the Rio Grande Valley and Corpus Christi that are smaller, but are growing well. Austin is an important technology area -- really important in that regard So as you see tech move. You jump back to Houston, the port is doing well. Corpus also has an important port.

So all of the markets I feel good about. I don't think there is any one -- from just moving to the consumer side a minute. Just to remind everybody that Texas is that state that has that conservative home equity law that we can't loan over 80% of the first and second liens. And we have seen modest growth in our home equity products and home improvement products because of the law and because prices didn't go way up. So they didn't come way down on home values. So they have continued to move up somewhat, and the quality is very good.

I really see -- it's really broad-based. I would just add, medical is a strong field. It's ironic in this uncertainty of the new bill. But there is a strong feeling that there is going to be a lot more expansion over the next few years just to handle a broader base of people.

Thank you.

(Operator Instructions) And we have no further questions. I will turn the call back over to Mr. Evans for closing remarks.

Thank you for your interest in our Company. We stand adjourned.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.