Cullen/Frost Bankers Inc (CFR) 2012 Q3 法說會逐字稿

Good morning. My name is Sarah, and I will be your conference operator today. At this time, I would like to welcome everyone to the Cullen/Frost Bankers third-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. Mr. Greg Parker, you may begin your conference.

Thank you. This morning's conference call will be led by Dick Evans, Chairman and CEO, and Phil Green, Group Executive Vice President and CFO.

Before I turn the call over to Dick and Phil, I need to take a moment to address the Safe Harbor provisions. Some of the remarks made today will constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, as amended. We intend such statements to be covered by the Safe Harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, as amended. Please see the last page in 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 2012 third-quarter results. Our Chief Financial Officer, Phil Green, will then provide additional comments. After that, we'll be happy to answer your questions.

I am pleased to report another solid quarter for Cullen/Frost. Highlights include a 7.6% increase in net income, a 7.5% increase in average loans, new customer relationships that drove a 13.1% increase in deposits, and continued credit quality improvement. This quarter's earnings reflect our ability to operate effectively despite ongoing economic, regulatory, and low-interest-rate challenges. We are grateful to our dedicated employees and our loyal customers for another solid quarter. Our net income for the third quarter of 2012 was $58.7 million, up 7.6% over the $54.5 million reported in the third quarter of 2011. On a per-share basis, we reported $0.95 a share, versus $0.89 during the third quarter last year. Third-quarter returns on average assets and equity were 1.11% and 9.75%, respectively.

Deposits continue to grow significantly. For the quarter-ended September 30, 2012, average deposits were $17.5 billion, up $2 billion, or 13.1% over the $15.4 billion reported in the third quarter of last year. Throughout the recession, we have focused on building new relationships. Those new relationships account for much of our deposit growth, and are the foundation for the future growth, especially as the economy recovers.

Net interest income for the third quarter of 2012 was $167.3 million, compared to $160.6 million in the third quarter of last year. This is primarily related to an increase in average volume of interest-earning assets, and was partly offset by a decrease in net interest margin to 3.54%. Non-interest income for the third quarter of 2012 was $71.2 million, compared to $79.2 million a year ago. The difference was driven by two primary factors, a $6.4 million pretax gain on municipal securities in the third quarter of 2011, and a $4.5 million revenue decline in interchange and debit card transaction fees due to the Durbin Amendment to the Dodd-Frank Law.

Trust and investment fees were up $1.2 million from the third quarter of 2011, while insurance commissions and fees increased $395,000. Non-interest expenses for the third quarter of 2012 were $144.5 million, up $7.1 million from a year earlier. Salaries and benefits accounted for the vast majority of the increase. We also saw $1.1 million year-over-year increases in occupancy expense, and furniture and equipment expense. We will continue to evaluate and adjust our financial centers and distribution points according to customer needs. Our second-quarter ATM expansion agreement with Cardtronics and Valero Corner Stores enabled us to significantly increase customer access points in an efficient manner.

Turning to loan demand, the positive loan growth continues, with the best quarter for new loan commitments in four years. Average loans for the third quarter were $8.6 billion, up 7.5% from $8 billion a year ago. On a period-end basis, loans were up 9% to $8.8 billion. Year to date, we are seeing double-digit increases in the number of new relationships and new commitments over last year. New commitments are up 35% over last year. Loan requests are broad-based across all regions and across all categories in small to large loans. Our disciplined calling effort, focused on better teaming, preparation and collaboration are paying off significantly. Year to date, customers represented 87% of new loan commitments. However, last quarter we saw a decrease in loan requests from customers, so our relationship managers quickly increased their calling efforts on prospects.

To summarize, year to date we have seen increased funding rates, decreased loan runoffs, and an increase in the volume of opportunities. More recently, as the economy started to slow, we saw reduced customer requests, so we adjusted to focus more on prospects. Obviously, it's a longer process to increase outstandings.

This is a tough environment, with economic uncertainty, poor policy decisions in Washington, and the looming fiscal cliff. Even with this volatility, Frost entered the fourth quarter with an all-time high loan pipeline. Our credit quality continues its positive trend. Most credit measurements have returned to, or surpassed, their pre-recession levels.

Capital levels remain very strong. Tier 1 and total risk-based capital ratios for Cullen/Frost were 14.10% and 15.62%, respectively, at the end of the third quarter of 2012. The ratio of tangible common equity to tangible assets was 8.80% at the end of the third quarter of 2012.

It was another good quarter for Cullen/Frost despite challenging economic headwinds. Looking ahead, next month's general election should provide important clarity on future policy decisions, and on the role and scope of government in society. With more clarity on taxes, regulation, and healthcare, we can remove much of the uncertainty that has hampered businesses and the economy.

We are fortunate that Cullen/Frost operate in a business-friendly state that consistently outperforms the national economy. The Texas economy is expected to grow 2.4% this year, compared to anemic 1.4% growth for the United States economy. The unemployment rate in Texas will continue to be lower than the national average. Despite ongoing regulatory challenges from Dodd-Frank, we move forward with confidence in our value proposition, our unique culture, and our award-winning customer service. I am grateful to our dedicated employees who treat customers the right way, and help make our success possible.

In summary, it was another solid quarter for Cullen/Frost. We grew loans in all regions across all segments. We significantly increased our customer base in deposits. Our capital levels are very strong, and we have money to lend. Our credit quality is the best it's been in years, and continues to show positive trends for the future. We operate in Texas where the economy is stronger than the national average due to the business-friendly policies. Our outstanding customer service is recognized and validated by multiple third-party agencies. We have increased our dividend annually for 18 years. And we continue to deliver consistent, steady, solid returns for our shareholders.

And with that, I'll turn the call over to our CFO, Phil Green.

Thank you, Dick. Let me just comment briefly about our net interest margin and our earnings outlook, and then I will turn it back over to Dick for questions. As Dick pointed out, our net interest margin declined 7 basis points from the second quarter to 3.54%. However, this included an 11-basis-point impact from our strong deposit growth, so our core margin actually improved 4 basis points in the third quarter.

Last quarter, I described the interplay on our core margin going forward that would result from the competing factors of lower asset yields versus how well we are able to prudently expand the loan portfolio. And this quarter was a great example of this interplay. While the securities yield remains stable, we saw loan portfolio yields impact margin by 4 basis points. But they were offset by 8 basis points of improvement related to our strong loan growth. This interaction will continue to be played out over the coming quarters.

Regarding our loan growth, we were pleased at the 18% annualized average growth in link-quarter loans was broad-based. Two-thirds of the growth was from C&I lending, with the other one-third representing real estate loans, split between commercial mortgages and construction. On the deposit side, not only were our average balances up 13% from the previous year, but a significant portion of that growth, 42%, came from new deposit customers, continuing the past trend. Finally, as we look forward to the end of this year, we believe the current average of analyst estimates is reasonable.

And with that, I'll turn it back over to Dick for questions.

Thank you, Phil. We are happy to answer your questions now.

(Operator Instructions)

Brady Gailey; KBW.

So the last two quarters we've seen end of period loan growth up 18%, up 15% annualized. When you look out into 2013 and 2014, do you think this midteens level of loan growth is sustainable?

You know, I am having trouble looking out a quarter in this kind of environment. But, as I said to you, the pipeline going into this fourth quarter is good and strong and so you tell me what's going to happen and '13 and '14.

And what about participations? Were there any purchased participations in the third quarter that added to that growth?

Well our shared national credits were up. They increased $175 million, or 33%. It is mainly focused in energy, as has been, plus we did have -- so energy is the primary driver but we did have some increase in a construction credit. It's a company -- it's a private company, that -- I have been here 41 years and handled it when I came here and it had been here a long time then.

Okay, Dick, that $175 million, was that all added just in the third quarter?

No. The growth in shared national credits in the third quarter on a linked quarter basis was $62 million of the growth.

Okay. All right and then my last question, you know the reserve, year-to-date on a percentage basis, it's down about 18 basis points from 1.38% to 1.2%. At what level do you think about keeping that percentage flat?

Well, as we've said many times, the reserve is based on formula and it's most responsive to classifieds and so it's going to drive that. I think there is some level that optically everyone is going to want to keep the reserve at. It is lower than it is now. I can't tell you what that number is, but there is some level I think at some point we reach.

Okay. Thank you, guys.

Steven Alexopoulos; JPMorgan.

I wanted to start and follow-up on the comments that the loan pipeline's at a high and causing core NIM expansion. Banks we're hearing, more broadly, are talking about a pullback from businesses because of the cliff which you touched on a bit. Just wondering if you could share with us what you are seeing, hearing from your customers? And do you expect a pullback in loan growth here at least temporarily tied to what we are hearing around the cliff?

Well, it's really volatile. There is no doubt it's slowed down somewhat. I think the cliff that we're faced with, I just got the October Greenwich Associates research and it starts out that the market pessimism returned in the second quarter of '12 leaving small and midsize companies asking now what. And just four bullet points in there. It said the initial optimism among middle market companies that started in 2012 is fading. Positive signs at the start of '12 were tempered by the reality of a long slow recovery. And it went on to say that elections, uncertainty on taxes, and pending fiscal cliff spurring businesses to a wait and see instead of investing.

So I think we are going to continue to work hard and we have shown, our people have shown that we can grow the volume. We have not compromised structure. We have been more aggressive on rate because you have to. And I think we are going to go through certainly the next two weeks not much is going to happen. And then probably until the beginning of next year is going to be a little bit slow. But we are going to continue to hustle and the work that our people have done earlier in the year is what's paying off to that higher pipeline that we are going into the fourth quarter with.

Okay. That's good color. Phil, what was the balance of average and period end securities in the quarter? Can you talk about where you saw reinvestment rates this quarter for those?

Well, for the quarter we averaged on the portfolio $8.9 billion. It yielded 3.28 tax equivalent yield. As far as securities at period end, just give me a second here. Securities at period end were about $9.1 billion. As far as reinvestments, we didn't do a lot of investing during the quarter. But what we did was mainly in municipal securities. Hang on just one second. We did in the third quarter $250 million in municipal securities, just under 4% tax equivalent yield for those. And there is one other small $100 million, very short-term investment we made at 52 basis points, as a two-month deal. That really won't affect us very much. ¶ So our view on the market still continues to be that we don't like it, don't think anybody does. When you get to a certain level of liquidity you have to participate. I think we were up to almost $2 billion recently in liquidity, again, even after the purchases I discussed with you. And so, we'll be making some additional purchases over time to just to continue to manage that number.

Phil, maybe just to follow-up along those lines, in your opinion will the expiration of TAG have any meaningful impact on non- interest-bearing deposits and liquidity? What are you planning for there?

We historically always plan to have strong liquidity to meet any depositors demand for whatever reason and that continues to be the case. But we really don't expect any significant impact from TAG. But we had TAG once. We dropped out of it before. We're back in it now because they put everybody in it. We never really market FDIC. We've always marketed the financial strength of the Company, which really I don't think has ever been stronger. So, there are two views on it. If people view weaker players without TAG as being a place where they don't want to keep their money, it's possible we could see some inflow from that. As relates to people moving money out, I guess that's possible. We don't see it right now. However, we are extremely well-positioned in liquidity if that were to happen.

Okay. Thanks for all the answers.

John Pancari; Evercore Partners.

Can you talk a little bit more about your outlook for the margin, and just given the compression yields that you saw? And also can you talk about the loan yield compression you saw in the quarter? And then lastly, your ability to offset any incremental margin compression in coming quarters with balance sheet growth?

First of all, the loan portfolio yield was down about 10 basis points during the quarter. So when I mentioned that there was about a 4 basis point hit to margins as a result of that, that's what I was talking about. And that's the result of loan yields that are paying off that you can't replace in the current market and also I think just more competitive pricing.

As far as the outlook for the margin, what I've been saying for a while and said again today continues to be the situation. We are going to have rate-related pressure that's going to be negative. And the Fed's not doing anything to help that as we go forward. But we do have the ability and have demonstrated ability to grow loans in this environment. And, we have been successful in that and expect to continue to be and that's the offset.

The other thing that can happen, John, is, as I've mentioned, we do have a tremendous amount of liquidity in our balance sheet today and occasionally we'll take advantage of some additional securities purchases when it's the right thing to do. And when that comes out of liquidity that tends to help our margins as well. So I continue to be looking at the margins. I'll say on a core basis again I'll always have to peel out the deposit growth because it's so strong. But on a core basis, I am looking for margin hopefully to be pretty flat with all those factors right now seeming to impact each other, I mean, offset each other.

Okay. All right. And then, Dick, can you just talk a little bit about the overall M&A appetite and seller expectations as well? And I guess around the appetite, pretty much already writing down your typical answer, that you're an aggressive looker and a conservative buyer. But I'm just curious if at all that is changing, given the challenges that you are seeing on the rate front, as well as the challenges that some of the potential sellers are likely facing, and that you could have more looking for strategic alternatives here?

I think the potential sellers are still in denial about where the marketplace is. They just can't believe that it's changed that much as they begin to deal with the realities of the cost of compliance. And we haven't really seen any effects from paying interest on accounts, on commercial accounts, that's a part of the law because we are at a zero interest rate environment. But certainly that is in the future. And so, I think there are a lot of banks that just can't see the reality that's going to happen in the future. Now, whether that's six months or a year or two, but it's there unless there's some changes. Basel III on the mark-to-market of the investment portfolio is a big thing and so I think we're just kind of coasting along with people in denial.

Okay. Thank you.

Brett Rabatin; Sterne Agee.

I wanted to -- first, I had a request, I know the Q comes out a little later today. But if at all possible, I don't know if you guys can put the consolidated average balance sheet and net interest income analysis for the quarter in the press release. That would be hugely helpful if that's possible going forward. The questions I wanted to ask were just around the taxable portfolio yield for the quarter, I think it was 2.11% last quarter, didn't know what it was in 3Q? And then also just curious, it sounds like the loan-to-yield this quarter was 4.75%. Just kind of curious about origination rate, kind of where you're seeing stuff originated today?

The taxable rate on this quarter was at 2.05%.

2.05%. Okay.

If you're interested the tax-exempt rate was 6.69%. So both of those were down. But because of the mix of the two, we ended up having about a little over $200 million, say $220 million increase in tax-exempt securities as opposed to a drop in taxable maturities. We ended up with a better mix on the taxable side, the tax-exempt side, so that is why our rate actually was fairly flat. It was at 3.27% and actually up a basis point to 3.28%, but essentially flat in the quarter.

Right.

As far as what's going on with loan pricing, numerically, we've been I'd say for the year on our spread to prime on new and renewed loans, it's running about I'd say probably in the mid to high 90 basis points over prime. I would say more recently, we've seen more competition as far as that goes and probably also in some of the higher-quality deals that you see, you tend to get lower spreads on that. And we've seen an awful lot of those I think recently. So I think our numbers are down more recently to probably closer to 75 basis point renewal rate on new and renewed -- 75 basis points over prime for new and renewed loans. On the LIBOR side, we're also seeing some more, a little more LIBOR related deals than we've seen, and there's also been price pressure on that. So those are the factors we're seeing.

Okay. And then if I heard you correctly, Phil, you gave an outlook for kind of a flattish margin and that sounded like that was predicated on loans continuing to grow, and maybe some liquidity deployment, does that also assume that deposits, the pace of growth kind of slows from here? Can you give us a little color around that?

When I talk about that, I talk about it without, basically absent deposit growth. So looking at the core margin that way. It remains to be seen whether the deposits will take a little bit of a breather this quarter or not. We keep thinking they will, but they keep proving us wrong. So we tend to just look at the numbers without the deposit group.

Okay. Great. Thanks for the color.

Ken Zerbe; Morgan Stanley.

This is Mark for Ken Zerbe's team. Actually most of my questions were answered. One other thing, I guess, if you can elaborate a little bit on what happened on the non- accrual side in the quarter? That would be helpful. Thank you.

If you look, the non- accruals were up a little bit. However, the potential problems were down significantly. If you look at potential problems, past dues over 90 days, non performers, in the second quarter they added up to $143.6 million and they are down to $125.6 million. So, the rat's moving through the snake as we would expect it to do. There was a loan that moved through to -- from potential problems to non- accruals and we expect that rat to continue to move on through. We're optimistic about the outcome.

Thank you.

Emlen Harmon; Jefferies.

Just one quick question for you on the expense side of things. The Valero ATM agreement that was signed last quarter, could you help me understand any expenses that are affiliated with that rollout? I know typically there is interchange paid to the card network. I was trying to understand how we should expect to leg that in?

Well, let's see. It started in August. And so, you've got most of the impact -- most of the full quarterly impact in there in the third quarter. You are going to have a little bit -- when you get that third month for a full quarter, you're going to see that in the fourth quarter. So really it won't be much of an impact as it relates to that going forward from what you've already seen in the numbers. And it's an area where -- it is an additional expense but it's really there to basically lower what was a big barrier entry for potential customers by having a significant ATM network. Now we actually have more ATMs available in the state than Wells Fargo today. We saw that as a real opportunity. But I think most of that impact quarterly basis is already in the third. It won't be much of an increase from third to fourth, I don't believe.

Got it. Do we know how much that was in the third quarter?

Well, we haven't disclosed what the amount of the contract was, but it's in there.

Okay. All right. Thank you.

(Operator Instructions)

John Helfst; Schroder.

This may be a tough question to answer, but can you qualitatively guess, how much pent up demand there might be from borrowers regarding the uncertainty that's not reflected in the pipeline? Is there a risk to the upside for loan growth in the out next year or downside even?

Nobody knows how much the pent-up demand is. We know this, we've lived through the deleveraging part of this economy. We know that we are fortunate to be in Texas where there's a lot of growth and a lot happenings. I am very optimistic in that regard. You've got companies that are sitting on the sidelines waiting to invest and move forward and basically you've got two kinds of growth. You've got -- the money they are spending is to keep technologies up and equipment up and those sorts of things. I think there's a lot of pent up demand about buying companies, building, all the things that happen. And we will have more clarity in the next 60 days. We may not like the results, but clarity will give us the ability to move forward. We'll know more. We'll know about the election. We will know more about what is going to happen to the fiscal cliff. We are going to know more about what's going to happen to taxes. And so, I think that in this economy companies are lean and they're mean and they're ready to move forward. They are just scared to death of the insanity that has come out of Washington, DC.

Great. Appreciate that.

Matthew King; Barclays.

Update us on the competitive environment in Texas, particularly with the big four. In the past, you've talked to us of their impact on pricing and structure. If you could provide an update, it'd be very helpful?

It's pretty much the same. As everybody knows, this is the place to be. And so everybody wants their share of it. So they are very competitive. I wouldn't say it is less or more, I'd just think it's been very competitive for some period of time. And it's going to stay that way.

One quick follow-up question. The efficiency ratio has hovered around 50% for sometime. Where is your long-term outlook on where that ratio could fall over time? Thanks.

Probably down. Our margins are at an all-time low. So hopefully if we get some sanity in the interest rates and we see the net interest income that's really the capacity that we've got for that in our balance sheet begin to come to fruition. We'll see that grow and we'll see that grow at a faster rate than expenses grow. So that the math of that will tend to take that number down. But I think that our Company's done a really good job on expenses. Our people are generally very careful about that. We are going to continue to be, need to be in this environment. I guess I'd say I would expect it to head down some as we normalize margins.

At this time, there are no further questions. Presenters, do you have any closing remarks?

We thank everybody for their interest in Cullen/Frost. And we stand adjourned.

This concludes today's conference call. You may now disconnect.