Cullen/Frost Bankers - Earnings Call - Q1 2017

Transcript

Speaker 0

Good morning, ladies and gentlemen, and welcome to the CullenFrost Bank First Quarter Earnings Conference Call. 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.

Speaker 1

Thank you. This morning's call 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 at our website or by calling the Investor Relations department at (210) 220-5632. At this time, I'll turn the call over to Phil.

Speaker 2

Thank you, Greg. Good morning, and thanks for joining us. Today, I'll review first quarter twenty seventeen results for Cullen Frost, and our chief financial officer, Jerry Salinas, will also provide additional comments before we open it up to your questions. In the first quarter, Cullen Frost earned a dollar 28 per diluted common share compared with a dollar 7 in the same quarter last year and a dollar 28 in the fourth quarter of last year. Our first quarter results represent a strong start to 2017, and we're building on the momentum from the 2016.

During the first quarter, average loans were $12,100,000,000 up more than 5% from the first quarter of last year. And on a linked quarter annualized basis, first quarter average loans were up over 12%. Our provision for loan losses were $8,000,000 in the first quarter, down sharply from $28,500,000 reported in the 2016. And nonperforming assets totaled $118,000,000 in the first quarter, which was up by 15,600,000.0 from the fourth quarter, but were down by 34% from the 2016. The increase from year end was primarily related to one energy related credit, which is included previously in potential problem loans.

Net charge offs in the 2017 were $7,900,000 compared with $5,700,000 in the previous quarter and $2,500,000 in the 2016. Annualized net charge offs represent 27 basis points of average loans for the first quarter. Overall, delinquencies for accruing loans at the end of the first quarter were only 36 basis points of period end loans, an extremely low number. Total problem loans defined as risk grade 10 and higher fell by about 5% in the first quarter when compared to the fourth quarter. This is primarily the result of favorable resolutions like upgrades, paydowns and payoffs.

Energy related nonaccruals increased to $78,700,000 at the end of the first quarter compared to $57,600,000 at the end of the fourth quarter, driven by a single energy related credit mentioned earlier. The specific loan loss allocation for these nonaccrual energy credits was $850,000 which was down from $3,750,000 in the fourth quarter. The reserve for energy loans at the end of the first quarter was approximately 4.5%. Based on all traditional measures, the number of problem energy borrowers peaked a year ago, and we continue to manage these levels down further. Finally, outstanding energy loans at the end of the fourth quarter totaled $1,360,000,000 or 11.2 percent of total loans.

That compares with 11.6% at the 2016 and over 16% at its peak in 2015. So I believe we've moved from a period of energy related headwinds to a period of growth, momentum and optimism. The economy is doing well in Texas, and our customers are responding. Average total deposits in the first quarter rose to $25,800,000,000 up by almost 8% from just under $24,000,000,000 in the first quarter of last year. On the consumer side, we continue to see good growth in accounts, customers and balances.

Same store sales growth for new account origination is up by 22% compared to the 2016 with growth at or near double digits in all regions. There are several reasons for this growth. First, our value proposition is increasingly attractive versus our competitors in the market. Prospects can now open accounts and become customers using the Frost Bank mobile app wherever they are. Third, we've opened 10 new financial centers since the beginning of 2016, strengthening our presence in our markets.

And finally, I should say that our bankers remain committed to building relationships with customers who come to us digitally or through our locations. Regarding consumer lending, in the 2017, total average consumer loans grew by 8.2% compared to the 2016. And this is an area where we're making a conscious effort to develop this segment of our customer base. On the commercial side, the year started out much stronger than 2016, and new loan opportunities are up by 44% compared with last year. We've seen an increase in the volume of both smaller and larger commitments.

New commitments under $10,000,000 were up by 31% in the first quarter compared to last year, while new commitments at or above $10,000,000 were 41% higher than last year. Overall, new loan commitments are up by 36% from last year. We've been focusing on delivering sustainable, above average organic growth through great customer experiences that make people's lives better. And I believe that our financial results and the recognition that we get from third parties like J. D.

Power, Greenwich and Consumer Reports demonstrate we're making progress toward that end. But let me say, it's our great staff that makes all this happen. As I've said before, without them, we're nothing more than empty buildings and lease obligations. Our people are the ones who work with our customers to nurture the long term relationships that make Frost unique. So I'd like to thank everyone at Frost for all their hard work and dedication through everything we've been through and into the opportunities to come.

Now I'll turn the call over to our chief financial officer, Jerry Salinas, for some additional comments.

Speaker 3

Thank you, Phil. I'm going to make some comments about the economy, and I'll give some additional information about our financial performance for the quarter before updating our 2017 guidance. I'll then turn the call back over to Phil for questions. The Texas economy is accelerating across industry sectors and metro areas. Texas employment expanded at an annualized 2.4% in the 2017.

The Dallas Fed notes more hiring optimism in in Texas than in recent years. Although Texas rig counts are rising, employment growth in the energy sector is a bit slower due to both increased efficiency and automation. For the first time in many years, the Texas unemployment rate is higher than the national average due to a sharp increase in the state's workforce. The March unemployment rate in Texas is now 5% compared to the national average of 4.5%. Looking at individual markets.

Dallas Fort Worth remains strong with 2,017 employment growth above 4%. The increase is mostly broad based across sectors. The professional and business services sector is adding jobs rapidly from ongoing relocations and expansions in the Metroplex. The March unemployment rate was 4.1% in Dallas and 4.8% in Fort Worth. Austin continues to expand but at a slower pace.

Austin jobs grew at a 2.6% annualized pace from the previous three months. Austin job expansion is diversified across most industries, especially in construction and manufacturing. Boston's unemployment rate in March was 3.6%. San Antonio employment increased only point 7% during the first quarter, indicating slower than expected growth in the 2017. Health services jobs rose sharply over the past three months, while jobs in scientific and technical services declined.

San Antonio's unemployment rate was 4% in March. With the oil and gas sector improving, the outlook for Greater Houston is modestly positive. February nonfarm employment grew at an annualized 2.5% or nearly 19,000 jobs. The largest gains in Houston came from manufacturing and professional and business services. Houston's unemployment rate in March was 5.6%.

For Texas overall, the Dallas Fed projects 2.4% job growth in 02/2017. Looking at our financial performance. Our net interest margin for the first quarter was 3.64%, up nine basis points from the 3.55% reported last quarter. We had some positives and some negatives affecting the net interest margin percentage this quarter as compared to the fourth quarter. On the positive side, we had higher rates that affected our yields on loans and balances kept at the Fed.

A lower proportion of earning assets being held in balances at the Fed as compared to the fourth quarter also had a positive impact on our net interest margin percentage. Partially offsetting these favorable variances was the lower yields on our investment portfolio as compared to last quarter. The taxable equivalent loan yield for the quarter was 4.15%, up 11 basis points from the fourth quarter. Average loans for the first quarter were 12,090,000,000.00, up 364,000,000 or 12.4% on an annualized basis from the 11,730,000,000.00 last quarter. The taxable equivalent yield on the investment portfolio was 3.99%, down five basis points from 404% for the previous quarter and was impacted primarily by a lower yield on our municipal portfolio.

The taxable equivalent yield on our municipal portfolio was 5.44%, down eight basis points from the fourth quarter last year. The duration of the investment portfolio at the end of the fourth quarter was five point zero years excuse me. At the end of the first quarter was five point zero years, up slightly from four point eight years for the previous quarter. The total investment portfolio averaged 12,550,000,000.00 during the first quarter, up about 39,000,000 from the fourth quarter average of 12,510,000,000.00. Our municipal portfolio at the end of the first quarter was down approximately a 100,000,000 December to 7,250,000,000.00.

During the first quarter, we purchased approximately 291,000,000 in municipal securities yielding 4.76 with an average life of twenty years. As we expected, during the first quarter, about 400,000,000 in municipal securities were called. These securities came off our books at a taxable equivalent yield of over 7%, which had a negative impact on the municipal portfolio yield for the quarter as mentioned previously. At the end of the fourth quarter, about 67% of the municipal portfolio was prefunded or PSF insured. Regarding income taxes, the exercise of stock options during the first quarter had a favorable impact on income tax expense for the quarter of approximately 3,500,000.0.

Under the new accounting standard, which we adopted in the third quarter last year, the tax effects of settlement of share based payments go through income tax effect expense. Our effective tax rate for the first quarter was 11.83%. Without the tax benefit from the stock option exercises, our effective tax rate for the quarter would have been about 15.5%. Our capital levels remain strong with our common equity tier one ratio at 12.71% at the March. Regarding full year 2,017 earnings, we currently believe that the current full year mean of analyst estimates of $5.13 is low.

An estimate closer to the average of the low estimate of $5 and the high estimate of $5.45 would be more reasonable. I'll now turn the call back over to Phil for questions.

Speaker 2

Thanks, Jerry. We'll now turn the call over for questions.

Speaker 0

First question comes from line of Dave Rochester of Deutsche Bank. Just

Speaker 4

real quickly, housekeeping on the tax rate. You mentioned a 15% core rate ex the tax benefit. How do you think that trends going forward?

Speaker 3

Well, you know, for the a lot of it will be dependent on, the stock option exercises, which, of course, is gonna be dependent on stock prices and in people's exercising of stock options. So I guess what I'd tell you is that 15.5%, all things being equal, would be our core rate and would be adjusted accordingly for any changes in projected earnings or or any exercises that had a tax benefit. That makes sense?

Speaker 4

Okay. Yep. That's great. Thank you. And just switching to the fee income side.

Was just wondering what the driver was for the weaker insurance income year over year and how you're thinking about growth in that line item going forward?

Speaker 3

Sure. In the first quarter, what we typically receive is our bonus payments, the contingent payments, that we receive on our policies. And, the payments that we we receive are based on how those policies how the business grows in the prior year and how those policies perform individually. And, so for the quarter, we were actually down compared to the first quarter last year. Those contingent fees were down 2,600,000.0.

So they were the bulk of the the reason for the decrease. Offsetting some of that was about a million 3 in favorable commissions, which are the ongoing, sort of type fees result resulting in the, unfavorable variance of 1,600,000.0. So the contingent, you know, we we would have liked to have them, but, they're not, they're not part of the core business. So we feel good about the the growth that we're seeing in the in the commission business.

Speaker 4

Okay. So year over year, are you thinking that you could actually still be up on this on the insurance line versus last year in terms for the for the full year 2017?

Speaker 3

Are you talking about including those contingents or are you pulling them out or how are you treating those?

Speaker 4

Keeping them in. I'm just wondering if this line item for 2017, do you think it's going to be down or it going to be relatively flat?

Speaker 3

It's going to be relatively flat, which we're hoping is that we'll see increases in commissions offsetting those reduced contingent fees. So pretty flat.

Speaker 4

Sounds good. And then just real quick on expenses. Those came in a bit below expectations this quarter. How are you thinking about the trend there going into 2Q and then your thoughts for the full year? I know you mentioned growing financial centers a decent amount over the last year.

Maybe if you could just comment on your plans for the next year as a part of that, that'd be great.

Speaker 3

I'd say that, looking at expenses, what I'd say is the the first quarter had a pretty good run rate associated with it. What I, you know, I think that, we'd expect some bumps, some small bumps throughout the the year, but, I think with a fairly fairly stable, running rate. I don't think there was anything unusual there. And you're right. We will continue to open financial centers into 02/2017, maybe at a little bit slower pace than the 10 Phil mentioned for 02/2016, but we'll continue to open some.

Speaker 4

Okay. Great. Thanks, guys.

Speaker 2

Thank you.

Speaker 0

And your next question comes from the line of John Pancari of Evercore ISI. Your line is open.

Speaker 5

Yes, this is Rahul Patil on behalf of John. Just a question on loan growth, which came in better this quarter, better than what we were expecting, better than looks like overall industry trends. Could you provide some color on where you're getting incremental loan growth, the main drivers of loan growth in coming quarters?

Speaker 2

Yes. I think the growth is good overall. As I said, consumer is up 8%. We're seeing strong commercial real estate growth. There's a lot of activity there.

We're being real careful and selective as far as that goes. And we're seeing good C and I growth. I would say it's a very broad based growth in the portfolio overall. So it's just indicative of better activity.

Speaker 5

Okay. And then just shifting to deposits. Could you talk about trends in deposit flows, especially post recent Fed hikes? If you're seeing any notable shift in behavior? And then just as a follow-up, what sort of deposit betas are you seeing on your commercial deposit?

Speaker 3

Well, on the deposit side, yeah, we've seen a really good growth in the quarter. It's been pretty broad based, leaning a little bit more on the commercial side than on the on the consumer side. We do have a look back or we look at deposit growth over the last twelve months rolling, and, we're really seeing that about half of our growth is coming from existing customers and half is coming from new customers. You know? And we did see a good good nice increase in energy deposits also.

So overall, feeling good pretty good about where where deposits are and the growth potential there.

Speaker 5

Okay. And just lastly, just one small question. Do you have the the portion of the demand deposits that are related to commercial clients?

Speaker 3

I think the numbers that we have that's not associated with balances where, they're used to paying services were about $3,600,000,000 I think was the last number I heard, something in that range.

Speaker 5

Okay. Perfect. Thank you.

Speaker 0

Your next question comes from the line of Brad Pitt Galley of KBW. Your line is open.

Speaker 6

It's Brady. Good morning, guys.

Speaker 3

Hey, Brady.

Speaker 6

So it sounds like cash balances went down a little bit linked quarter. Can you just update us on as we're seeing higher long rates, you guys still have a lot of cash on the balance sheet. What's your interest in putting that cash to work in the bond book longer term?

Speaker 2

As we've kind of said it before, our goal is to really create the sustainability of inorganic growth. And to do that, we've got to grow the loan portfolio consistently in all our regions. And that's what we've been doing and plan on doing. And I've really been pleased with the results that we've been seeing. Brady, we're going to try not to buy many more securities.

You look at, say, the second half of this year. If we we'll do a limited amount, and I mean less than $100,000,000 would be my guess in municipals just to fill out some of what our plans were and to recognize some payoffs that we're having in that portfolio. But we're not really expecting much in the way of securities purchases in the second half of this year and not very much in the second quarter. And that's a good thing.

Speaker 6

Yes. Okay. Great. And then I don't think you'll have much health care exposure, but we're seeing increased focus on that this quarter. Can you quantify how much healthcare exposure you have, if any?

Speaker 2

It can, but it may take me just a second to do it. It's in the top five categories of our C and I portfolio. Hang on just a second.

Speaker 6

And are you all seeing any weakness in health care right now?

Speaker 2

No. Yes. It's probably Brady, we'll have to look forward just a second. We'll get back to you on it.

Speaker 6

Yes. That's fine. Thanks for the color, guys.

Speaker 2

You bet.

Speaker 0

There are no further questions in this queue. At this time, I'd to turn the call back to Mr. Phil Green for his closing remarks.

Speaker 2

Okay. Well, first of all, before we leave, Brady, we were able to locate the Medical Services number. In 2016, it was 4.6% of our portfolio. So it's a good sector and it's performed very well. Okay.

Well, if we have no more questions, then we'll bring the call to an end. Thank you for your participation today. It will be adjourned.

Speaker 0

And this concludes today's conference call. You may now disconnect.