Cullen/Frost Bankers Inc (CFR) 2010 Q2 法說會逐字稿

Good morning, my name is Christian and I'm be your conference operator today. At this time, I would like to welcome everyone to the Cullen/Frost Bankers 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 session. (Operator Instructions) Thank you. I will now turn the call over to our host, Mr Greg Parker, Executive Vice President and Director of Investor Relations. Sir, please go ahead.

Thank you. This morning's conference call will be led by Dick Evans, Chairman and CEO and Phillip 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.

Thank you, Greg. Good morning and thanks for joining us. It's my pleasure today to review Cullen/Frost's second quarter 2010 results, then our CFO, Phil Green will offer additional details behind the numbers and after that, we will both be happy to answer your questions. When we spoke in April, we commented on the relatively strong performance of both Texas and Cullen/Frost in a time of economic change. The results we will share today show that trend has continued.

As the national economy continues its journey from recession to recovery, we remain in a time of transition. While the US economy is off the bottom, we expect to see a rollercoaster recovery with shallow ups and downs, not a series of sharp changes. Growth is happening, but that growth will be slow. Everybody is holding on, businesses are operating conservatively, reducing spending and paying down debt. While we expect the Texas economy to continue its growth, we also believe that growth will be slow somewhat in the second half of 2010. However job growth here in Texas will remain above the US average. If you look at Texas over the last 12 months, jobs grew 0.55%, over the last six months 2.92% and over the last three months jobs were up 3.82%.

Austin's outlook is improving as technology companies add jobs, Dallas' diversified economy is being helped along on the strength of the telecom industry, Houston is still reporting solid growth though consequences of the Gulf spill may begin to have some modest impact. For the year we anticipate 2.5% to 3% job growth here in Texas, continuing the historical 30-year Texas trend of outperforming national job growth by roughly 1 percentage point. In the midst of this economic uncertainty, only days ago, the Financial Reform Bill was passed. Clearly this legislation will have a significant impact on how Frost and other banks conduct business. But the passing of the bill is just the beginning. The actual impact to our business will only be known as the provisions are studied, interpreted and then implemented.

I can tell you there is a lot in the bill I don't agree with. While it was developed with good intentions, many provisions of the bill will penalize a lot of good banks that were performing and serving customers well, even as the legislation seeks to eliminate bad practices. But the fact is we are facing a new set of rules. At Cullen/Frost we choose to see those rules as an opportunity to continue to achieve better performance and deliver greater value to our customers in the future. Before or after the financial reform, a key truth remains. People are looking for a bank that they can depend on, trust and respect. Frost is that bank. In a few moments, Phil Green will give you specifics about the volumes that will be affected by this bill.

Now let's look at the second quarter 2010 results. Our net income for the second quarter was $52.9 million. That's up 39.7%, from the $37.9 million reported in the second quarter of '09. On a per share basis, earnings were $0.87 per diluted common share compared to $0.63 per diluted common share from a year ago. Return on average assets and equity were 1.26%, and 10.67% respectively, compared to 0.98% and 8.35% for the period of '09. Strong growth in deposits helped to fund the increase in the volume of earning assets which was used in part to purchase high-quality high-yielding tax exempt securities.

For the second quarter of '10, net interest income grew to $155.1 million on a taxable equivalent basis, a 7.4% increase over the $144.3 million reported in the second quarter of '09, reflecting the impact of higher earning assets. The net interest margin was 4.18% for the second quarter of '10 compared to 4.28%, for the second quarter of '09, and 4.19% for the first quarter of '10. Deposit growth continues to increase and we were also glad to see growth in the net interest income. Even in this near zero-rate environment, we have been able to strategically deploy some of our liquidity into quality investments. Average deposit growth has stayed strong, increasing 13.4%, to $13.8 billion during the second quarter of '10 versus $12.2 billion during the first -- during the same quarter of last year and up 2.4%, from the $13.5 billion reported in the first quarter of 2010.

Loaning money is our business. However it's difficult when you can't find many people or businesses who are interested in borrowing. This should not be a surprise. Over the last two years, the world has moved from over-leverage to deleveraging, which is a painful process and it takes time. Adding to the problem nationally, over the past 30 months, one out of every two American workers has either lost a job or experienced reductions in wages or work hours as reported in the New York Times. Change always creates uncertainty. When ever there are new regulations, businesses are going to react very cautiously, and we continue to see a crisis of confidence.

Amid these economic head-winds, we are taking full advantage of our strong capital and liquidity positions to continue to remain focused on building new relationships, making our -- making more quality loans today and building a foundation for tomorrow. As I discuss the various activities that we have tracked for years, and that are key to projecting outstanding loans in the future, keep in mind they show mix directions and no consistent trend. Activities to grow the business all began with making more calls on customers and prospects than in the previous years. That's exactly what we have done. Year-to-date we made 16% more in-person calls on prospects and 7% more in-person calls on customers. As a result, we saw improvement in loan requests in nearly ever region for the last two quarters.

While the increase in loan requests from existing customers was slight, it is the first positive sign of movement from our business customers. This is very important because in normal times over 70% of the loan growth comes from existing customers. Even though the pipeline has stopped the downward trend and leveled off, it still has not been sufficient to grow loan outstandings. However, as a result of this activity, we are ahead of last year in booked, new loan commitments which are up 10%, the best quarter since the fourth quarter of 2008.

I know our calling effort is paying off even though loan outstandings have yet to show increases. Most encouraging is how our entire organization has a high level of energy and commitment to team-selling. This allows customers and prospects to rely on Frost as their financial provider. This is what relationship-building is about. With more and more new commercial relationships coming to Frost each day, our base of customers has expanded and is ahead of last year by 3%. When the economy turns, we are ready, as we have been helping our new and existing customers prepare for the future.

Turning now to credit quality. In the second quarter, Cullen/Frost experienced continued improvement in credit quality. For the third consecutive quarter, credit quality improved and problem loan outflow exceeded inflow. Net charge-offs of $8.6 million represented a continued decline when compared to levels recognized in the first quarter of '10, which was $13 million, and for the third and fourth quarters of '09, $16 million and $20 million respectively. Like previous quarters, the second quarter write-downs were adequately reserved for and prior reporting periods.

Delinquencies ended the quarter at $100 million or 1.24% of total loans. On March 31 these figures were $122 million and 1.49% respectively. The quarter end dollar total is the lowest in at least the last six quarters. Nonperforming assets of $159 million represents a decrease of $31 million from last year's second quarter. This also compares favorably to the previous quarter. That's our third consecutive quarter of decrease after increasing for at least eight quarters. For the second quarter of 2010, the loan loss provision decreased by $8 million compared to a year ago, and equaled net charge-offs. Our allowance for possible loan losses as a percentage of total loans was 1.56% at the end of the second quarter.

I am also pleased with how aggressively our people have managed our other real estate owned. At the end of 2009, the book value was $33.3 million, plus additions of $9.5 million in first six months of 2010, and at the end of the second quarter the balance was $24.7 million. More than $18.5 million dollars was sold in the first six months of 2010, with less than $400,000 in additional write-downs, giving me confidence in our book value of OREO. Non-interest income for the second quarter of 2010 was $69.9 million, up 2.8% compared to the $68 million reported a year earlier. Other components of non-interest income include trust income of $17 million. While these total trust fees were relatively flat, it was refreshing to see that oil and gas fees were up more than $300,000.

Securities lending fees were up $160,000, and real estate fees increased $106,000 from the first quarter. These and other positives offset a $1.1 million decrease in investment fees as the market pulled back in the second quarter. Moving now to consumer banking activity, the second quarter produced solid growth in the number of net new checking accounts. Up 6.3% compared to last year's second quarter and balances grew 7.3% over that same period.

I've got three final points to cover before I turn the call over to Phil. First, during the second quarter, our entire IT and Systems staff completed the move into new Frost technology center, which was designed for state-of-the-art security and performance with a space to meet this Company's technology infrastructure expansion needs for the foreseeable future. We also opened a new financial center in Houston region this quarter and are strategically relocating several centers later this year to better serve our customers.

The second item. We've heard a lot from other financial institutions about restoring trust, and this is not a problem that Frost faces. In fact, this quarter we saw some validation of our way of doing business as Frost was one of only five companies in the nation to receive the Allegiance 2010 Customer Engagement Award for excellent customer engagement and loyalty. And finally, here is my take on financial reform, and Frost's place in this time of economic change. Banks need clarity on what the rules are in moving forward. The signing of the legislation into law means we are moving in a general direction of clarity but we are not yet there. Until then, we can tell you it's a negative but exactly how much of a negative we don't know at this time.

It's been said that change such as financial reform and healthcare legislation recently passed can inhibit growth by creating uncertainty. During this period of economic and regulatory uncertainty, Frost will continue to make good decisions based on our core values. At Cullen/Frost we know we do not have to build a better mousetrap. We have a value proposition that is relevant today and also timeless. Quite simple -- quite simply, our value proposition is our culture. It involves treating everyone as significant no matter who they are and how much money they have. Offering a square deal, excellence at a fair price, which means giving customers value for services received, and providing a safe, sound place for doing business. A safe haven amid this economic uncertainty.

These simple yet powerful points guide us and keep us focused on what matters. I'm enthusiastic about our Company, our people and our business. I'm optimistic that in the middle of the storm and all the uncertainty we will adjust, we will go forward, and so will the economic engine of this great nation. When you do things right, you get ahead of the curve. It's something we've always done and always will. And now let me turn the call over to Phil.

Thanks Dick. I'm going to make a few additional comments about the quarter and talk briefly about our investment portfolio, focusing primarily on our holdings in municipals, and I'm also going to discuss some of the scope of our operations potentially impacted by the Dodd-Frank law. And I'm also going to comment on the outlook for the year before I turn back over to Dick for questions. And as Dick noted, it was a strong quarter for us on several fronts. We saw a 6% increase in revenue and it was led by higher net interest income, and our net was versus a drop in non-essential expenses of 1%, which was helped by reduction in the FDI special assessment but also good overall expense management.

In addition, our improving credit quality allowed us to experience lower provision levels from a year ago, while still covering charge-offs for the quarter. And all these contributed to increase our quarterly ROA to 1.27%. Looking at margin, it was fairly flat compared to the first quarter, only changing a basis point to 4.18%. If we look behind the numbers there were positives and negatives that continued growth in deposits, much of which is finding its way into our fed account, put 7 basis points of pressure on the margin. However this is basically offset by lower deposit costs and slightly better yields on loans and investments. Volumes of deposits continue to be very strong and were up an annualized 10% on a linked quarter basis, with demand deposits up an annualized 19%.

Dick talked about our challenges building good loan volume, which dropped an annualized 6% on a period end basis versus the first quarter. I'll say as an aside that the latest number I have for loans showed a slightly increase $33 million since quarter end. As we discussed in the past, to fill the GAAP we used selective purchases of investments. Early in the second quarter, we've purchased a little over $500 million in US treasuries, and those were split between five and seven year maturities at an average yield of just over 3%. Even with that we still ended the quarter with just over $2.1 billion in our fed account. We continue to selectively purchase full faith and credit government agency securities as necessary, although I expect that somewhat short of maturities. As well we are going to continue to purchase smaller amounts of tax exempt municipals.

Speaking of municipals, I did want to take a moment to review our extremely high-quality portfolio. Our portfolio is just under $1.9 billion and 97% of that are Texas holdings. That's good. But remember also that we buy almost exclusively general obligation bonds of Texas school districts insured by the Texas Permanent School Fund or what people know as the PSF. The PSF holds $20 billion in liquid assets and today insures only about $50 billion in bonds. So you get the picture. 95% of our Texas holdings are PSF-insured and of course they are all AAA with I might add, strong underlying issuer ratings. Of the only [$54] million of non-Texas bonds we hold, they are spread over seven states and are highly rated. In short, we feel great about our municipal portfolio and we also feel great about its 6.9% tax equivalent yield.

As Dick mentioned, the impact of the new Dodd-Frank law is going to be difficult to determine with any certainty and it's going to take years to implement. So, rather than offer up any arbitrary estimates, let me take a moment and outline the current extent of areas which may be affected. First, having missed the exemption level by only $1 billion in asset-size, we will continue to phase out the Tier 1 treatment of our trust preferred securities beginning in 2013. Our $120 million of these securities currently contributes about 120 basis points to our risk-based capital, about 80 basis points to our leverage ratio. This impact will be diluted as we grow asset from capital for the phase-out period.

In addition, our current capital ratios were all extremely strong with an 8.8% leverage ratio, 13.2% Tier 1, 15.5% total and 12% Tier 1 Common. And given the low rate on these securities of LIBOR floating plus [155] and their extended maturity, we don't currently plan on paying them off. And it's also possible they may be eligible for Tier 2 capital treatment in the future.

It remains to be seen what the fed will compute for allowable debit card interchange fees, although in my estimation it will be less than current levels. Our current level of interchange revenue for the first half of 2010 was $2.7 million for PIN-based transactions and $10.2 million for signature-based transactions. The impact of the repeal of Reg Q allowing the payment of interest on business demands deposits is difficult to measure. There is no immediate impact due to the fact that it does not become effective until one year after passage. And also at current interest rate levels, accounts that are on analysis will have little free balance to earn interest on, and the current low rate environment should mean that nonaccounted (inaudible) customers won't receive a particularly higher rate.

With that being said we estimate that around $3 billion of our current demand deposit balances will be eligible for some kind of interest credit in the future. In my mind, this means that we will move from our current interest -- our asset-sensitive position to a more balanced position, meaning that as rates go up over time, unless we restructure our sensitivity, we will forego most of the future benefit we would have had from our asset-sensitive position.

Finally, while not a part of Dodd-Frank, we currently completing our work on our fed opt-in rules for overdrafts, and with 87% of all decisions in, we are experiencing a overall opt-in rate of about two-thirds, while for those who've actually utilized overdrafts in the past, the opt-in rate is almost 80%, with heavier users exceeding 90% opt-in levels. While I'm not aware of any bankers who are happy with the impact of the new reform act, we are where we are. But just like Dick, I firmly believe that we will continue to be successful if we stick to our culture and philosophy that have guided us through significant change for over 142 years.

And we continue to offer our value proposition which provides that everyone is significant at Frost, we offer a square deal that provides excellence at a fair price, and we are safe, sound place to do business for our employees and our customers. Finally, looking forward to the end of the year, we currently believe our expectations point to a slightly higher level than the current full-year consensus for our Company. With that I will turn it back over to Dick for questions.

Thank you Phil, and thank you Phil for spending 30 years with Cullen/Frost today. Happy 30th anniversary.

Thank you.

Now we will be happy to entertain any questions you have.

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

Hey good morning guys.

Good morning.

Nice quarter.

Thank you.

I know loan growth in this market's very difficult to predict. You mentioned positives about the 10% increase and commitments loans up in July, but there is still caution in the market. But can we generally read be between the lines that you're saying that you're thinking the worst of the loan runoff is over and you could potentially see some modest growth in the back half of the year?

I think so. It is difficult, don't let me -- I'm trying to make that very clear.

I think one of the things you got to recognize is, you heard us -- heard me talk about how aggressive we have been in calling on prospects. Certainly we have been taking care of customers. But that has been important in building the base of this company so when they start to do borrow money, we got a bigger base to work off of.

The other thing that's important is that 70% of loan growth historically comes from existing customers so the line usage is way down. You can look at lots of different aspects.You can look at shared national credits. I mean they've been just coming down since a year ago, $518 million to $480 million to $463 million to $439 million to $424 million, this past quarter. 60% of that are energy loans, which is a factor as they have been building up cash and so you know I -- we went through a period of time and it looked like in the first quarter that we were going to get a spurt and then it leveled off a little bit.

I think we looked at the economy and we all saw inventory start to buildup. We know after delaying -- businesses have delayed for two years buying capital investments and particularly technology and there finally comes a point in any business that you got update that technology.

And the other thing, I'm pleased with the good results of how we have worked problem loans and 40% of the decrease in our loans for the first six months has been moving problem loans out and getting paid. And so there is a lot of different factors going.

So as this is -- and I'm optimistic. You always have to be careful with problem loans situations but the trends look good and it's three quarters, and I think those trends will continue.

So as that starts to bottom out, as there is a little bit more confidence in businesses to build up, and as we are going forward and start to work out of this, well I don't think as I said earlier this is a economy that's going to go straight up. I think it's going to be slow growth but in that environment that's a long way to tell you. Yes I have some optimism about the last six months.

Great, thanks for that. And one last one. We've heard from some other banks and this makes sense given the excess liquidity in capital out there, that there's is word of greater competition for C&I loans, maybe amongst the larger credits, maybe creeping in the middle market. Are you seeing any of this competition, where is it coming from? And could you talk about where you're pricing loans today?

Well, we -- yes, there is competition, and I think banks have got to take a moment and think about what they are doing. I have been talking about for two years that the industry was not pricing properly related to risk. And we were starting to get some of that back in line. And I don't think the competition is worse than it's been, it's always competitive.

I looked and you know I talked about for a number of years how much -- how many loans that we chose not to make or they chose someone else related to price and structure. It's still running 50/50. So that's the reason I say I don't really see a change in what is happening in that regard.

But as we go through this, and there is pressure to make more loans, I think it takes a lot of discipline and we've got a good pricing matrix that keeps discipline with us, and -- but we are not confused about competition and for that right credit we are going to meet competition. And remember this is not a transaction organization, this is a relationship organization and the profitability is made out of broadening and deepening the relationships, of having that major checking account, doing a 401k, selling insurance, all the things that we do.

All right. Great, thanks, guys.

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

Good afternoon, guys.

Thank you.

Can you provide any color around what drove the drop in delinquencies quarter to quarter? Was it by market or certain loan types or any successes that you've had in reducing those balances?

It's a lot of hard work. And secondly, there is no specific area. I think one of the things to always remember bout our company, we try to stay ahead of the curve. We try to identify problems early. And we try to resolve those problems for both the customer and the bank when you have options to reserve -- to resolve, and not let it get to where it's a big, serious issue. And so it's a combination of a lot of things but you really can't point to any one particular sector.

Okay, and just as a follow up, can you give us your updated thoughts on the M&A landscape and are you putting some of excess capital to work?

Well, as I've always said, we are an aggressive looker and a conservative buyer, so we continue to look for those opportunities and certainly with the new financial reform, that's another element you got to take into consideration but we will continue to look at what is good for our shareholders.

Great, thank you.

Our next question comes from Tom Alonso with Macquarie.

Good morning gentlemen.

Good morning.

Just a -- sort of a quick modeling question, the sundry expenses that you guys noted several one-time charges, could you just quantify that?

Well, first of all, there is always going to be some one-time and sundry stuff, right?

Sure.

You know, some will move out and some will come in. But the larger sundry things that we had, I would say over -- versus a year ago, sundry was in total $1.7 million. And there were -- some of the larger items were write-offs I would say a couple in the $0.5 million range, that type of thing.

Okay.

But again, not unusual to have some sundry items in any quarter.

Fair enough, I just wanted to see if there was anything in there that was sort of a little bit more unusual. Okay, thank you gentlemen.

Thank you.

(Operator Instructions) Our next question comes from Jon Arfstrom with RBC Capital Markets.

Good morning, guys.

Good morning Jon.

I don't know if you touched this at all. Can you talk a little bit about line utilization and some of the trends that you are seeing there?

Line utilization has been down and continues to be -- we have been running around 47%, you know and it kind of ranges from 45% to 55%, in a great economy it would be about 55%, and weak economy 45%. Those are very general terms. But I think the concept is correct. It's still weakness in line usage.

But you are seeing some of those signs of life from borrowers, I guess is that a fair assessment?

Not seeing so much the signs of line usage going up as much as new commitments. Let me talk about what a new commitment is. A new commitment can be a prospect that's never banked here, a new commitment can be someone who had a $1 million line and paid it off and canceled the commitment and came back and asked us for a new line. And it's in that area that we are up 10%, and so you are seeing a little bit of activity. So it's better than a flashlight at the end of the tunnel but it's -- you can't see a train yet.

Okay. And would you say the type of competitor has changed? I know a few years ago on your call, you talked about some of the transactional type of providers of credit that would cause you to pass on some of your commercial real estate for example. Are you just seeing straight-up bank competition and is most of it coming from in-state or out-of state-banks?

It's about the same. Just like I said, looking at what we are losing or choosing not to do, it's running 50/50, 50% because pricing is too low, in our opinion, 50% because of the structure is too liberal.

But that's where it was running two years ago. So its -- there is competition, there will always be competition. But I wouldn't come to the conclusion there is a big change of any kind.

Okay, and then just one more question, which really doesn't have a lot to do with the quarter. But you are one of the few banks that's I guess been left in a position the raise your dividend. Other banks seem to be trying to do it, are getting rejected or told to wait. Can you just talk a little about your decision to do that and then talk about longer term what kind of payout ratio you might consider?

We feel like that we are in a good place on our dividends. It's hard to say what peer is because there is no much dislocation in earnings in the marketplace. But you go back a couple of years ago, our payout ratios were about what others were, we were about over 50%, which would put us right in the median of what it used to be.

Same thing I think with the yield. We feel good about our prospects. We know we are a strong company and felt frankly a year ago it was important to signal the bank -- signal the market that that's how we felt. And so that penny was a lot of money, was a big statement on our part and we weren't -- significance wasn't lost on us.

Our recent increase really just followed on with keeping the payout ratio about where it has been, I think it may be a little bit less, but very slightly. So I think to summarize we feel good about the level of payout ratio that we have. And I think we will hope to see it increase as the prospects of our company continue to improve.

All right, thank you.

(Operator Instructions) There seems to be no further questions at this time. Are there any closing remarks?

Thank you for your interest and support of Cullen/Frost, and we stand adjourned.

Ladies and gentlemen, this does conclude today's Cullen/Frost Bankers, second quarter earnings conference call. You may now disconnect.