Cullen/Frost Bankers Inc (CFR) 2016 Q3 法說會逐字稿

Good morning. My name is Kelly and I will be facilitating the audio portion of today's interactive broadcast. At this time, I would like to welcome everyone to the Cullen/Frost Bank's third-quarter earnings conference call. (Operator Instructions)

Thank you. I would now like to turn today's call over to Mr. Greg Parker, Executive Vice President and Director of Investor Relations. Mr. Parker, you may begin.

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

Before I turn the call over to Phil and Jerry, 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 on our website or by calling the investor relations department at 210-220-5632.

At this time, I'll turn the call over to Phil.

Thanks, Greg. Good morning and thanks for joining us. Today I'll review third-quarter 2016 results for Cullen/Frost. Our Chief Financial Officer Jerry Salinas will also provide additional comments before we open it up to your questions.

In the third quarter, Cullen/Frost earned $1.24 per diluted common share, which is up from $1.17 in the same quarter last year and was up from $1.11 reported in the second quarter this year. Overall, our third-quarter results showed general improvements compared with previous quarter and with the third quarter of 2015.

Credit quality was stable and continued to show signs of improvement over the first half of this year. Net charge-offs in the third quarter of 2016 fell to $5 million, which was down from $21.4 million in the previous quarter. Energy-related charge-offs in the third quarter totaled less than $1 million.

Our provision for loan losses was $5 million and that was the lowest level since the second quarter of 2015. Nonperforming assets totaled $101 million, an increase from $89.5 million in the second quarter. And this was mostly due to a credit in shared national credit exam that had been classified as a potential problem loan for about a year.

I'll talk about growth in more detail a little later, but I wanted to point out that this has been the best year ever for new loan opportunities, with our total in the third quarter up 10% compared with this time last year. But first, let me offer some details on the third-quarter credit quality.

Regarding the nonperforming assets I mentioned earlier, one energy-related credit accounted for the majority of the increase from the second quarter to the third. Total remained at about half the total reported in -- at the end of the first quarter.

And at their current level, nonperforming assets represent only 34 basis points of total assets and only 87 basis points of total loans. Despite continued regulatory sensitivity, conditions are moving in the right direction as commodity prices have stabilized.

Loans placed on nonaccrual during the third quarter totaled $24.1 million compared to $16.5 million in the second quarter. That increase also largely is related to one energy sector borrower that I mentioned earlier.

Annualized charge-offs represent 33 basis points year to date and 17 basis points for the third quarter. Earlier this year, we said net charge-offs for 2016 could reach 50 basis points of total loans. Currently we believe third-quarter levels to be more representative of what we'll see in the near term.

On problem loans, defined as a risk rate higher -- risk rate 10 and higher, nonenergy-related were $461 million for the third quarter, representing only 4.5% of total nonenergy loans. We've seen only a very modest contagion from the energy sector, and given the recent rebound in energy prices as well as Texas's economic advantages, we continue to believe that significant contagion is unlikely.

As I mentioned, despite some lingering effects, rebounding energy prices are removing headwinds. Here is some additional detail about our energy portfolio.

Outstanding energy loans at the end of third quarter totaled $1.38 billion or 12% of total loans. That compares with the peak at over 16% in early 2015, and since year end, the energy portfolio has decreased by nearly $400 million or almost 22%. No material change from prior quarters has occurred in the proportions of energy segments in our portfolio.

Energy-related problem loans decreased to $556 million in the third quarter from $566 million in the second quarter. Production-based borrowers made up about 75% of the third-quarter total and service manufacturing made up the remainder.

Energy-related borrowers that are on nonaccrual totaled $51.4 million at the end of the third quarter and that was compared to $42.8 million at the end of the second quarter. The specific loan-loss allocation for these credits totaled $2.5 million for the third quarter, which is flat compared with the second.

Now I'd like to turn briefly to growth in the third quarter. Our total loan commitments have grown at an annualized rate of about 3%. Compared with the third quarter of 2015, total average nonenergy loans grew by 5.6%. 71% of the growth in non-energy loans was commercial real estate, 11% was in C&I, and the remaining 18% was in consumer and other.

Regarding commercial real estate, the vast majority of the new extension of credit has been to strong existing customers. A significant portion of this is financing for retail centers in Houston, where retail development has lagged behind population growth for some time now. We also are working with customers on projects supporting major corporate relocations in the North DSW sector.

Runoff rates in the energy sector continue to offset some of the gains, but our nonenergy C&I commitments have grown at an annualized rate of 5% and our CRE commitments and consumer lines of credit have both grown at an annualized rate of about 13%.

Year to date, new relationships are up by 9% compared with this time last year. Also year to date, customer calls were up by 9% and prospect calls are up by 13%.

We booked 13% more new non-energy C&I commitments year to date than last year. This total represents 41% of the total new commitments.

Since year end, we've increased our personal lines of credit and home-equity lines by $163 million or an annualized rate of 13%. The balances under those lines have increased at an annualized rate of 11%. Consumer loan growth is supported by expanded penetration in the Texas home-equity market, which is underdeveloped compared to the rest of the country.

With a strong product mix and exceptional asset quality, Frost is positioned well in Texas. We're maintaining our credit discipline and that served us well. We are also pleased to see good growth in our current weighted pipeline and that growth is split between C&I, commercial real estate, and public finance.

You've heard us say many times through our 148-year history: Frost has grown and expanded through good times and bad. And has endured wars, depressions, recessions, and financial crises. It's worth noting that despite the headwinds from recent low energy prices, Frost has posted solid earnings, increased its dividend, and kept earning accolades for its customer experience.

During the third quarter, Frost opened five new financial centers in growing attractive markets. None of that could be achieved without a strong team and a strong corporate culture.

So in closing, I'd like to thank our people for all their hard work and dedication through the headwinds of the previous quarters. They are the ones interacting with our customers on a daily basis and nurturing the long-term relationships that have been part of the Frost customer experience and which gives us such optimism as we move through the end of 2016 and into the new year.

Now I'll turn the call over to our Chief Financial Officer Jerry Salinas for some additional details.

Thank you, Phil. I'm going to make some comments about the economy and I'll give some additional color on our financial performance before giving an update on 2016 guidance. I'll then turn the call back over to Phil for questions.

The Texas economy continues to improve and expand, a testament to its diversity and resiliency. The Dallas Fed reports that Texas employment grew 2.1% in September and is expected to expand at a similar pace in the fourth quarter.

The Dallas Fed now projects 1.2% employment growth for the entire year in Texas, with more than 142,000 new jobs. That's a significant improvement from the first quarter when Texas jobs declined 1.3%. In September alone, Texas gained more than 38,000 jobs, which was the biggest monthly jump in almost 2 years.

According to the US Bureau of Labor Statistics, Texas led the nation in September job growth. Stabilization in the energy sector and continued strength in the service sectors suggest ongoing moderate growth in Texas in the months ahead. The state unemployment rate is 4.8% compared to the 5% national average.

Looking at individual markets, Dallas has the highest job growth in Texas this year. In recent months, jobs in the metroplex increased at a 4.1% annual rate. Growth is broad-based across sectors; employment is particularly strong in construction due in part to the new corporate relocations in the metroplex. The unemployment rate in Dallas-Fort Worth is 4.1%.

Annualized job growth in Austin 3%, which is a bit slower than earlier this year. The unemployment rate is the lowest in the state at 3.5%. Construction in Austin grew 60.5% in August, while tech-related industry expanded at double-digit rates.

San Antonio employment slowed a bit during the past three months, with declines in manufacturing, retail jobs, and a sharp drop in outpatient healthcare services. Construction, however, remained strong. San Antonio unemployment rate ticked up to 4% due largely to a recent surge in the labor force.

Houston's economic outlook is showing improvement, with several months of employment growth and stabilization in the energy sector. That said, there's still some caution about the potential for more layoffs.

Jobs in Houston grew an annualized 1.9% over the past 3 months, with notable gains in leisure, hospitality, and transportation and utilities. Thanks to recent gains, overall employment in Houston is nearly level for the year.

Houston's unemployment rate increased to 5.1% due to an increase in the labor force. For Texas overall, the Dallas Fed once again expects 2.1% growth in the fourth quarter of this year.

Looking at our financial performance. Our net interest margin for the quarter was 3.53%, down 4 basis points from the 3.57% reported last quarter. The decrease in the net interest margin was impacted by a proportionately higher level of balances at the Fed earning only 50 basis points compared to the previous quarter.

The taxable equivalent loan yields for the quarter was 4.02%, up 2 basis points from the second quarter. The taxable equivalent yield on the investment portfolio was 3.97%, down 3 basis points from 4% for the previous quarter and was impacted by a lower taxable equivalent yield on our municipal portfolio, which was down 11 basis points from the previous quarter to 5.53%.

The duration of the investment portfolio at the end of the third quarter was 4.8 years, the same as last quarter. The total investment portfolio averaged $12.38 billion during the third quarter, up about $582 million from the second-quarter average of $11.79 billion.

Our municipal portfolio at the end of the third quarter was $7.2 billion, up $120 million from the $7.1 billion at the end of June. At the end of the third quarter, about 68% of the municipal portfolio was pre-refunded or PSF insured.

Regarding income taxes, during the third quarter, we chose to early adopt an accounting standard which becomes effective next year related to the recognition of income tax effects associated with a settlement of share-based payments, like when a stock option gets exercised. Previously, those tax-related effects were recorded as increases or decreases in paid in capital.

Under the new standard, the tax-affected settlement go through income tax expense. The early adoption of that statement had a favorable impact on income tax expense for the quarter of $1.5 million. Without that discrete tax item, our effective tax rate for the quarter would have been 13.6%.

Our capital levels remain strong, with our common equity Tier 1 ratio at 12.4% at the end of September. Regarding full-year 2016 earnings, we currently believe given year-to-date reported earnings through the third quarter of $3.42 that the current full-year mean of analyst estimates of $4.50 is low. Estimates a little higher than the current mean of $4.50 would be more reasonable.

I'll now turn the call back over to Phil for questions.

Thank you Jerry. Now we'll open up the call for questions.

(Operator Instructions) Steve Alexopoulos, JPMorgan.

This is Scott Murphy on for Steve Alexopoulos. Could you give a little more color around where you expect the runoff from the energy portfolio to stabilize? Is there any idea of where that portfolio might be headed?

The portfolio -- actually, I don't believe it will decline a lot more. That's going to depend on some specific yields and what happens with specific customers, but we are seeing good opportunities today.

The thing is we are just being really selective. Deals that are coming in are mainly higher-equity deals, some acquisition loans. And so there's lots of opportunity. We could grow it as much as we wanted, but we're just being careful.

We've talked before: we want to prune the hedge in the downtime. Make sure that the customers that you are adding are the cream of the crop, and sort of cut off the stuff on the bottom that doesn't make sense for you to be in. So I don't think we'll have a lot of drop in the energy portfolio unless we get some one-off customer that moves a deal or cashes out.

Great. Thank you. That's helpful. And then can you give a little more color regarding that larger energy credit that moved into nonperforming this quarter?

Yes, it's a deal that is a offshore deal. It's gas field. It's a shallow offshore. It's natural gas. It's got more leverage than it needs, and it needs a higher gas price to really be effective in its business model. So it's that kind of thing.

But like I said, it had been a potential problem loan for us and one that's not a new credit for us. We've been watching and working with them for I'd say a year to year and a half. So it will work its way out. You know or not, depending upon the environment, but not too worried about it.

Okay. Well, great. Thank you very much.

Brady Gailey, KBW.

So it looks like -- your loan growth was kind of flat linked quarter. And now we know why. The energy book was down a decent amount. Was there anything else going on besides energy paydowns that impacted the flat loan growth into 3Q?

I think payoffs in general have been higher, and we've been experience (sic) that all year long. And you are just seeing people finance deals long term. You are seeing people sell businesses. I think our amortization and payoffs have been about double what we expected going into the year. So I think that's the main thing.

And do you see that changing as we move into 2017?

I hope so. It's hard to call. I think one thing that happens when rates are this low is you get multiples really high on a business. And a person takes a look at the prices that those things generate and they go ahead and hit the bid.

And so you'll see people getting liquidity in that regard. You'll see people financing deals out and maybe selling real estate deals because of low cap rates.

And I think if we get a little bit of increase in rates, you might see a little bit of a slowdown in that. So I think -- it's hard to tell if it will be the same level as this year, but I hope it will be. I hope it will be better.

And then the energy loan-loss reserve, I think last quarter it was a little over $66 million. Did that change much in 3Q?

Could you repeat your question, Brady?

Yes. The energy loan-loss reserve. Last quarter, it was a little over $66 million. I was just wondering if that changed much in third quarter.

Brady, that's down to $62 million.

$62 million, okay. And then Jerry --

(multiple speakers) 4.5%.

Okay. And then you mentioned the kind of one-time impact on the tax rate. If you adjust for that, it's 13.6%. Is that a pretty good forward run rate for taxes?

Brady, what I would do is -- that tax effect on a year to date for the quarter was $1.5 million. On a year-to-date basis, it was $1.6 million. So if you pull out that discrete item out of the year-to-date tax rate, you'd come to -- back to about 12%. And I think that's probably more reasonable for the fourth quarter. That's kind of what I would go with.

Okay. Great. Thank you, guys.

Brett Rabatin, Piper Jaffray.

I joined a few minutes late, but just was hoping for some color on the margin outlook from here. And what you guys are doing in the securities portfolio -- I mean, what you did during 3Q as well.

What I said last quarter on the net interest margin that we were looking at flat to down a little bit. We are actually down 4 basis points this quarter. What I said during my comments was that a lot of it was related to higher balances at the Fed proportionately.

So what I guess I would say for the fourth quarter is really kind of consistent. We are still looking at that flat to down. A lot of it will depend on what happens with deposit balances and what we do at the Fed -- keep our balances at the Fed. That's what I would look at if I were modeling something.

And as far as what we did during the quarter, we actually had purchases in the quarter of $324 million of the investment portfolio and it was all in municipal securities. They had a TE yield, an average TE yield of 453. They had about a 19-year average life with 10-year calls.

Okay, that's helpful. And then just thinking about the outlook as we go into 2017, obviously energy prices are better. And I know there's probably everyone's got one or two credits that they have to deal with that may not be currently sort of through the snake yet.

But as we think about 2017, can you guys give any color on how you think about provisioning? The reserve obviously has come down a little bit on the energy book. Can you give us any color on that?

Directionally, the portfolio and particularly regarding energy is stable and improving. And you are exactly right. There are some credits that are still moving through the snake -- I like the term that you use. We'll just have to see how those turn out. I'm not particularly worried about that situation.

But we've got a lot more credits where the momentum is to improve. And our reserve has always been most sensitive to classified levels. And we've got some credits that -- many more credits, if you look at the energy portfolio, are directionally improving than others that are moving through the snake.

So I think that the trend there is for improvement. Once you begin seeing improvements in a cycle, they don't come fast, but they tend to gain momentum over time. And I think that's what we are seeing.

And another thing to keep in mind is the improvement that we are seeing in the energy portfolio, you can tend to think it's -- well, it's price movements. Prices are going up, and so that's great. But what happens if those prices move around?

But most of the improvement recently I think has been because of deleveraging as opposed to just price movement. And that deleveraging is hard work. And as I said last time, you see these properties sell, you see these transactions happen, and the tendency is to think, okay, well, prices are up and so now we can do deals.

But these are things that have been worked on for a long time. And we've been staying close to our customer. And so when the opportunity happens in the markets, you are able to take advantage of it. And so I'm proud, really proud of the work our people have done.

And I'd like -- given what's happening with acreage sales and prices you are seeing there, I'd like to believe that we'll continue to see improvements and opportunities for people to deleverage going forward. So I would expect that the outlook provision wise, particularly compared to this year, is better as we see it today.

Okay, great. Appreciate all the color.

(Operator Instructions) Brenden Stoner, Stoner Equities.

So I just wanted to ask a couple questions here. I got on the line a little bit late, so I apologize if the question was already asked.

But could you just talk about how you guys think about the low interest rate environment? I know the loan growth was a little tepid and I applaud you guys for not being so -- in such a hurry to lock up capital at such low rates. So could you just discuss a little bit about how you think about allocating capital moving forward into the next few years and where you guys see rates going.

Okay. First of all, as it relates to the low rates, I'm against them. In fact, the -- I think that -- the thing to keep in mind about our Company is we continue to be stodily (sic) asset sensitive. And so we are -- we want to maintain that position.

We're going to have to make some investments in securities as we move along just because we expect we'll have a loan demand to deal with all the funds we are producing. But we will have to do some investing.

But while we do those, we will continue to maintain ourselves in a position that's going to take advantage of higher rates. Because we believe that's what's going to happen in the short term. Not by a lot, but by some. It doesn't have to happen -- doesn't have to be a lot of rate increase to be really beneficial to us. I'd say that's sort of our view.

And I guess the other thing I would say is when you look at our Company's balance sheet, we've got maybe one of the lowest cost of funds in the country. Not because we're not paying fair rates; we pay right in the median in rates. But it's because we are -- we have a relational deposit base and those kind of deposit bases cost less.

So we know that we've got the opportunity to compete on price as it relates to asset pricing on loans. And if it's in the interest of growing long-term relationships, and so we'll be allocating capital that way and feel good about it.

I appreciate the comments. One more question for you guys. I definitely realize that you have a nice balance between your deposit base there. Could you touch on a little bit of the energy loans? Again, apologies if I got on the call late and this was already discussed.

I know in your last annual report you kind of mentioned most of those energy loans maturing within 12 months or so. Is that still the case? Do you have any figures on most of the maturities for those energy loans as they roll off and are prepaid, whatnot?

We actually don't at hand. But it's -- just think of it like a traditional commercial portfolio. They are evolving facilities. They are for different things and they are structured and priced different ways depending on what it is.

But just like a commercial portfolio would be, I don't think there's anything in my view that is dramatically different about that portfolio that you should -- that should influence you one way or the other. The main thing they are is relationships. And we work with those customers to take care of their needs depending upon what's going on in their business going forward.

That may be a short-term deal. That may be a longer-term deal. Depending on just what they are doing. But that's not on my radar right now.

Okay I appreciate that. And congratulations on the quarter and thank you for all your hard work.

John Moran, Macquarie.

I've got a couple of housekeeping questions around the securities book and then one just circling back on credit. And I guess I'll hit credit first.

The one on the SNC, I think, Phil, you said it was leverage-driven. Was that sort of the EBITDA lookback that's kind of the new bright-line test in the OCC guidelines? Is that what drove that?

The increases in classifieds related to the SNC exam are definitely related to that. In fact, I don't remember any of them having -- of those new classifications having a reserve deficiency. In fact, most of them can pay off the deal in the economic half-life. That's what we've used to underwrite energy loans for generations.

But what's happened is the regulators are using a bright-line test. And if it's a 3.5 times EBITDA, cash flow versus cash flow, you're going to get a special mention credit. And it's 4 times or more, you are going to get a substandard credit.

And it doesn't take into account the life or the half-life of the property. It will include all debt, even non-secured debt positions, even if you are in a first lien position. And it's very different than the industry's been underwritten for years and years and it's reduced liquidity in the industry.

But that's the way the regulators are looking at it, and so you've got to play by their rules. So that's what drove the increase is really to the SNC exam.

Understood. And then I think you said --

Excuse me. That wasn't just in the non-performer increase. That was in the increases related to classifications as well.

Got you, got you. And you said that the credit, the one larger one that slipped was gassy, right? And gas has obviously had a nice recovery and I think some folks are sort of thinking that that's sustainable. So I guess that the follow-up question would be, you know, if that's the case and the EBITDA improves kind of quickly, that could come back in.

Well, the problem is that they are using the EBITDA from trailing 12 months. And so they are not looking forward. So you don't get -- so they are using periods -- and a lot of these were June 30.

And so you are using that period, the first part of this year, which is horrible, and then the first -- and the last half of last year, which was not good either. And so what you're using, you can't use today with the current prices and current projections of prices. So you won't really see that work its way through until you get some calendar behind you. You know what I'm saying?

Understood, yes. So it could take a whole year. Okay, okay, got you. That's really helpful. And then the housekeeping item is just around the securities book.

Yields -- I think you guys said were down 3 basis points linked quarter. Do you have handy if prem am ticked up and caused some of that? And then the muni yields were down 11 basis points, if I got you right. Just a little bit more color on that.

Yes. So the purchasing that we made in the fourth quarter on the muni book were at -- I said on average a TE yield of 453. And that for most of -- year to date, if you look at the purchases, that yield is about 455. So obviously if we -- our current yield is 553, the current-year purchases that we've had have had an impact on that -- on the TE yield.

Okay, got you. And then prem am?

Say that one more time? I'm sorry.

I'm sorry. The premium amortization. If any of you have that number handy, what it was 3Q versus 3Q.

Hold on, I've got it. You are looking for premium amortization on the muni portfolio?

On the whole book.

On the whole book. Give me a second. It should be $13.1 million.

Okay. $13.1 million this quarter. And was that up or reasonably flat from 2Q?

That was -- let me see -- it was -- if it's third quarter, it was -- it was up on the third quarter -- or the second quarter, excuse me. The second quarter I guess we were at $11.5 million.

Okay, perfect. Thanks very much.

And there are no further questions at this time. I pass the call back to Phil for closing remarks.

Thank you very much for your interest and support and this will conclude our call. Thank you.

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