Cullen/Frost Bankers - Earnings Call - Q4 2016
January 25, 2017
Transcript
Speaker 0
Good morning, and welcome to the CullenFos Bank's Fourth Quarter and Year End twenty sixteen Conference Call. I would now like to turn today's call over to Mr. Greg Parker, Executive President and Director of Investor Relations. Mr. Parker, you may begin.
Speaker 1
Thank you, Amy. 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 Gerry, 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 by the in the Private Securities Litigation Reform Act of 1995 as amended. We intend such statements to be covered by the safe harbor provisions of 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 fourth quarter and full year twenty sixteen results for CullenFrost, and our Chief Financial Officer, Cherry Salinas, will also provide additional comments before we open it up to your questions. In the fourth quarter, CullenFrost earned $1.28 per diluted common share, which is up from $0.90 in the same quarter last year and up from $1.24 reported in the third quarter of this year. For the full year of 2016, CullenFrost earned $4.7 per diluted common share, which is up from $4.28 in 2015.
The fourth quarter represented a strong finish to 2016, and it gives us some good momentum going into 2017. Our average loan balance during the fourth quarter was $11,700,000,000 about 3.1% higher than the 2015. However, without energy loans, they were up 8.2%. Additionally, on a period end basis, fourth quarter annualized loan growth was 13.6% versus the linked quarter as loans grew to just under $12,000,000,000 This gives us some great momentum going into 2017. Net charge offs in the 2016 stayed low at $5,700,000 up slightly from $5,000,000 in the previous quarter, but down from $8,500,000 in the 2015.
Energy related net charge offs were zero in the fourth quarter. And that compared to less than $1,000,000 in the third quarter. Our provision for loan losses was just under $9,000,000 far lower than the provision of $34,000,000 in the 2015. Nonperforming assets totaled $102,600,000 virtually flat when compared with the third quarter. Our allowance for loan loss was 1.28 of period end loans in the fourth quarter.
Annualized net charge offs represented 19 basis points for the fourth quarter. Total problem loans defined as risk grade 10 and higher were down about 8% in the fourth quarter when compared to the third quarter. Energy related problem loans decreased by about 19% to $453,000,000 in the fourth quarter from $556,000,000 in the third quarter as the sector continued to recover. Energy related borrowers that are on nonaccrual totaled $57,600,000 at the end of the fourth quarter compared to $51,400,000 at the end of the third quarter. The specific loss allocation for these energy credits totaled $3,750,000 in the fourth quarter.
Finally, outstanding energy loans at the end of the fourth quarter totaled $1,390,000,000 or 11.6% of total loans. That compares with the peak at over 16% in early twenty fifteen. Now I'd like to mention several items about the fourth quarter and 2016 overall that have given us some momentum going into the new year. 2016 was the best year Frost has seen for new loan commitments with new loan commitments up by 7% compared to last year. New non energy C and I commitments grew by 14% for full year 2016 compared to 2015, and they represented 39% of total new commitments.
New real estate commitments rose by 18% over 2015 and represented 41% of the new commitments. Consumer commitments rose by 12% over 2015 and represented 12% of the new commitments. New relationships for 2016 rose by 13% compared to 2015. Customer calls for 2016 increased 1% and prospect calls were up by 2%. In the 2016, consumer loans grew by 7.7% compared with the 2015.
This is another area where we believe Frost can build a strong foundation for future growth. With a strong product mix and exceptional asset quality, Frost is positioned well in Texas. We're maintaining our credit disciplines, which has served us well. And we're pleased to see good growth in our current weighted pipeline. The growth was split between C and I, commercial real estate and public finance.
One particular item I'd like to mention is that in the fourth quarter, we completed the sale of $57,600,000 in Downtown San Antonio real estate, including our office tower and other properties. This resulted in a net gain of $10,300,000 that was reflected in other income. However, this net gain is largely offset by write downs from properties we intend to dispose of this year as continue our program of upgrading, consolidating and expanding our financial centers across the state. The remainder of the gain was contributed to the Frost Charitable Foundation. As mentioned, these items essentially offset the large real estate gains.
Overall, despite the headwinds in 2016 from low energy prices, Frost continued to move forward. We continued to post solid positive financial results. We increased our dividend for the twenty third consecutive year. We grew our loan portfolio at all levels. And most important, we continued enhancing the customer experience contact and through the latest technologies.
No matter how our customers choose to be served, Frost keeps winning awards for helping to make people's lives better. We're a company that's going to turn 150 years old next year, and we've never been more optimistic about the future than we are today. And that can only happen at an organization with a strong culture and with people who are dedicated to keeping the culture vibrant. So in closing, I'd like to thank everyone at Frost for all their hard work and dedication through this past year. They work with our customers to nurture the long term relationships that have been part of the Frost customer experience, and they are the force that will keep Frost going as we embark upon our next one hundred and fifty years of service.
Now I'll turn the call over to our chief financial officer, Jerry Salinas, for some additional details.
Speaker 3
Thank you, Phil. I'm going to make some comments about the economy, then I'll give some additional information about our financial performance before giving 2017 guidance. I'll then turn the call back over to Phil for questions. The diverse and resilient Texas economy expanded 1.6% in 2016, and the Dallas Fed expects even stronger growth in 2017. Despite lingering low oil prices in the 2016, the Texas economy grew faster than the national average and all other energy states.
The service sector and the I-thirty 5 Corridor remained strong throughout the downturn. According to the Texas Workforce Commission, Texas added 210,000 jobs last year. The unemployment rate in December was 4.6%. Texas employers continue to express concerns about finding skilled and qualified workers to meet the ongoing labor demand. This is particular concern in major cities along the I-thirty 5 Corridor, where unemployment rates are even lower.
The Dallas Fed expects the Texas economy to grow about 1.9% in 2017 with resurgent optimism in the energy sector. Looking at the individual markets. Dallas Fort Worth led the state in job growth in 2016. DFW employment grew 3.2% for the year. Growth was broad based across sectors.
The Metroplex construction boom continues with major corporate relocations from other states and population influx. Home prices in DFW increased more than 10% last year. Unemployment rate in the Metroplex declined to 3.7%. San Antonio employment grew 1.8 in 2016, the second fastest among large Texas metro areas. Aside from a notable decline in construction, San Antonio jobs have been steady or increasing in all major industries.
San Antonio's unemployment rate fell to 3.7% despite a recent surge in its labor force. Austin employment growth slowed to 1.5% in 2016. Even so, its unemployment rate declined to 3.2%. That's the lowest of any major city in the state. Despite the strong dollar, the value of exports from Austin increased 15.2% in 2016.
In Houston, total employment is growing modestly. Higher oil prices and rig counts indicate an increasingly positive outlook, that energy jobs have yet to follow. While many sectors improved in the 2016, the construction and manufacturing sectors continue to lose jobs. For the year, Houston employment grew 0.2%. Unemployment stands at point 9%.
For Texas overall, the Dallas Fed expects 1.9% growth and 233,000 new jobs in 2017. Looking at our financial performance. Our net interest margin for the fourth quarter was 3.55%, up two basis points from the 3.53% reported last quarter. We had some positives and some negatives affecting the net interest margin percentage this quarter as compared to the third quarter. On the positive side, we had higher yields and volumes in investments and loans.
Partially offsetting these positives was the negative effect of keeping a higher proportion of balances at the Fed as compared to the third quarter. The taxable equivalent loan yield for the quarter was 4.04%, up two basis points from the third quarter. Average loans for the fourth quarter were $11,730,000,000 up $269,000,000 or 9.4% on an annualized basis from the $11,460,000,000 last quarter. The taxable equivalent yield on the investment portfolio was also 4.04, up seven basis points from 3.97% for the previous quarter and was impacted by a higher proportion of the portfolio being in higher yielding municipal securities compared to the third quarter. The duration of the investment portfolio at the end of the fourth quarter was four point eight years, the same as the previous quarter.
The total investment portfolio averaged $12,510,000,000 during the fourth quarter, up about $132,000,000 from the third quarter average of $12,380,000,000 Our municipal portfolio at the end of the fourth quarter was up $171,000,000 from September to $7,350,000,000 During the fourth quarter, we purchased approximately $559,000,000 in municipal securities, yielding 4.7% with an average life of seventeen years. At the end of the fourth quarter, about 70% of the municipal portfolio was pre refunded or PSF insured. Regarding income taxes, as I mentioned last quarter, during the third quarter, we chose to early adopt an accounting standard, which became effective in 2017 related to the recognition of income tax effects associated with the 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 effects at settlement go through income tax expense.
The exercise of stock options during the fourth quarter had a favorable impact on income tax expense for the quarter of approximately $3,500,000 Our effective tax rate for the fourth quarter was 9.24%. Without the tax benefit from the stock option exercises, our effective tax rate for the quarter would have been 13%. Our capital levels remain strong with our common equity Tier one ratio at 12.52% at the December. Regarding full year 2017 earnings, we currently believe that the current full year mean of analyst estimates of $5.1 is reasonable. I'll now turn the call back over to Phil for questions.
Speaker 2
Thank you, Jerry. We'll now open up the call for questions.
Speaker 0
Your first question today comes from the line of Brett Rabatin of Piper Jaffray. Your line is open.
Speaker 4
Hey, guys. Good morning. Good morning. Wanted to first just ask about the loan pipeline and thinking about this year, obviously, lot better growth in the fourth quarter, assume that was maybe partially a function of lower payoffs. But could you maybe give a little more color on the growth in the quarter?
And then just thinking about 2017, are you hopeful you could get closer to double digit? Or how do you think about the year as you look at it today?
Speaker 5
Yes.
Speaker 2
Well, I would say that it's mainly activity as opposed to anything really significantly changing in payoffs. I mean we still have payoffs. But the most interesting thing to me is just the level of activity has improved. As I've gone around the state visiting all our locations during the month of December, one thing that was a consistent message was how many customers, particularly, I'll say mid and small customers are moving forward with plans that they had delayed, right? So somebody had a piece of equipment they wanted to put in.
They've been waiting for six months. After they got the clarity from the political situation, the word was, let's move forward. Let's move forward now. So I think we're definitely seeing just general optimism in the market moving forward. I think our people are doing a great job being responsive to those opportunities.
We're trying to do a better job of getting decision making authority closer to the customer and working closely with our concurrence and credit people and doing that in a faster way. And I think that we're giving a better customer experience. So just things like that.
Speaker 4
Okay. Does your crystal ball tell you that maybe you can grow double digit in the loan portfolio this year?
Speaker 2
I don't think we're projecting a number. I think we're seeing momentum increase and I would expect loan growth to be better than 2016 for sure.
Speaker 4
Okay. And then quite a few things to ask, but I guess the other thing I really wanted to touch on was the expense base and thinking about, obviously noise in 4Q, but is 183,000,000 $184,000,000 kind of a good run rate to base things off of starting for this quarter?
Speaker 3
Yes. Think other than the item that Phil mentioned, I think it's a good run rate to go forward with.
Speaker 2
But that included
Speaker 3
$10,000,000 Yes, excluding the $10,000,000 I think he said that. Yes.
Speaker 4
Right. Okay, great. Thanks for the color.
Speaker 2
Thank you.
Speaker 0
Your next question comes from the line of Dave Rochester of Deutsche Bank. Your line is open.
Speaker 5
Hey, good morning, guys.
Speaker 3
Good morning. Good morning.
Speaker 5
Hey, I think you guys had mentioned previously in calls last year that you were going to revert to a more normalized level of muni purchases. It looked like that level was a little bit elevated this quarter, around $550,000,000 I think was the number you said. Is this sort of the level we should expect going forward? Or should we see these taper?
Speaker 3
No, you should see them taper. Part of what we were doing is we expect to have some municipal calls during 2017 and we really were doing some purchases in anticipation of that. So going forward, wouldn't expect that we'd see that sort of level going forward.
Speaker 5
Okay, great. And just outside of liquidity changes,
Speaker 3
how are you
Speaker 5
guys thinking about the NIM trend heading into at least the first quarter? I would imagine you've got the full quarter impact of the LIBOR increase flowing through that should support and then you've got full quarter impact of these muni purchases. I was just wondering if you could kind of frame it for us.
Speaker 3
Sure. I guess I'd say a couple of things as we look at the NIM for 2017. First of all, let me just say that we are projecting just one rate increase, and we're projecting that in November. In addition, we are projecting that we're going to have increases in deposit rates during the year. Now we didn't see any in all of 'sixteen, but we are projecting deposit increases in 'seventeen related with the Fed increase that we just saw in December.
And then as I mentioned, we are projecting to have about $670,000,000 in muni cash flow during the year. And as I mentioned, some of that we purchased early in the fourth quarter, but some of the yields that are dropping off are probably north 6.5% on a TE basis. And so we'll be replacing those with TE yields around 4.5%. So we do have a few a bit of a headwind going forward. So as I looked at $20.17 NIM compared to the fourth quarter, I'm thinking it's going to be relatively flat given those two headwinds of our assumptions on deposit rates and then our the impact of the munis that are being called.
Speaker 5
That's great color. I appreciate that. Have you actually seen any evidence? I know you didn't see any last year in terms of deposit repricing upward. Have you seen any of that in January so far?
Speaker 3
We have not. We hear some conversations going on, but we've not seen any.
Speaker 5
Okay. Great. And then just one last one on the tax rate. Was just wondering how you think about that in 2017 now with the accounting change and you've got potentially some more options exercises coming.
Speaker 3
Right. I think the fourth quarter was pretty heavy there on option exercises. You know, 10 that 13%, you know, that excluded that. You know, go if you look at what I said about earnings going forward, we are obviously projecting earnings growth. So the way I'd look at it is I kind of tend to take that 13% kind of as a run rate going forward.
It's going to be affected, by option exercises, but that's the run rate I assume.
Speaker 5
Okay. Great. And just one last one quickly on the runoff of the intermediate portfolio. What's the timing of that during the year?
Speaker 3
It's about two thirds in the first quarter and the remaining third in early third quarter.
Speaker 5
Your
Speaker 0
next question comes from the line of Brad Gailey of KBW. Your line is open.
Speaker 6
Hey, good morning, guys. It's Brady.
Speaker 3
Hey, Brady.
Speaker 6
You think about the tax rate, a lot of people are talking about what might happen with the reduction in corporate tax rates. I know you guys wouldn't be as big of a beneficiary just because of the size of your muni book. But have you all looked at the sensitivity to what your earnings could do with the lower tax rate?
Speaker 3
I guess what I'll answer back to you, Brady, is that we did look at it. And certainly, when you're looking at an effective tax rate of 13% compared to peers at 35%, if rates went down to 15%, if you will, we'd still have our effective tax rate doesn't have a whole lot of room to go down. It would go down. We'd be talking probably in the 5% or 6% range. So we'll still see a benefit.
But obviously, we've used up some of that benefit, if you will, through the years with this with the large media portfolio and a lower effective tax rate that we've
Speaker 6
had. Okay. All right. And then looking at loan balances, how much loans were purchased, SNCs in the fourth quarter? I think last quarter, it was around $796,000,000 Did that number change much in 4Q?
Speaker 3
No. It's at the period end, I think the SNCs were $772,000,000 That's down from $796,000,000 last quarter.
Speaker 6
Okay. And then lastly, as we start to think about higher deposit costs with higher rates, I mean, you guys have a very nice inexpensive funding base. So I would expect your deposit beta to be less than some of your peers. But how are you all thinking about deposit betas as we start to see rates head higher?
Speaker 3
Well, way we look at deposits is is, first, I guess, I'll say we're not going to lose deposits to pricing. So we we tend to price at the median of the big banks. And so, you know, we and our assumptions for '17, we're pretty conservative. We assume that we're not going to lose deposits. We assume that rates are going go up, deposit rates are going to go up.
But we'll be providing a fair market price when we compare ourselves to the big banks is our pricing philosophy.
Speaker 6
All right, great. Thanks guys.
Speaker 2
Thanks Brady.
Speaker 0
Your next question comes from the line of Ebrahim Poonawala of Bank of America. Your line is open.
Speaker 7
Good morning, guys. My question was actually just asked and answered, but I had one follow-up question regarding what you mentioned on tax rate and the fact that it will go to 5% to 6%. I'm assuming that assumes that you expect under that scenario that the muni tax credit holds. In the event where the elimination or the tax benefit tied to muni securities were to go away, could we have a scenario where you don't really pick up any benefit from a reduction in the statutory federal tax rate or you would still benefit?
Speaker 3
I think we would still benefit. And really, when we talk about the yields that we're earning and looking at our investment philosophy, the munis are still, even on a non TE basis, are really still better than anything else we could invest in. I don't see us changing philosophically too much right now based on what we know.
Speaker 7
Understood. And just one other question in terms of would you say if rates stay where they are today, the move in the rates and the impact on the AOCI was fully captured at the end of the fourth quarter? Or could we see more incremental impact, which might have flown through into 1Q on your TCE?
Speaker 3
I would assume that, again, we'll make additional purchases, but we'll have some so we've made some additional purchases. In the fourth quarter, we'll make some in the first. So there could be some additional movement, but I sure don't expect a whole lot more from where we're at.
Speaker 7
Got it. And is there a targeted sort of capital ratio that you look at? Is TCE about 7% something that you'd like to maintain on an ongoing basis? Or are you looking more at the regulatory ratios?
Speaker 2
We look primarily at the regulatory ratios and we want to make sure they're strong and we think we've got great growth prospects. And so we're trying to keep some dry powder there. We do have a buyback in place today that's not fully utilized. There's that tool as well if we needed it.
Speaker 7
Understood. Thanks for taking my questions.
Speaker 3
Thanks.
Speaker 0
Your next question comes from the line of Steven Alexopoulos of JPMorgan. Your line is open.
Speaker 8
Hey, everyone. This is actually Ben Lauria on for Steve. Most of my questions have been asked and answered, but I guess just turning back to expenses. So even if we took out the $5,900,000 write down and $4,400,000 contribution, it still seems like that other line was kind of elevated. Is there anything else in there that was maybe one time or just unusual that drove that higher?
Thanks.
Speaker 3
If you're looking at the comparison, say, to a year ago fourth quarter, I think that's what you're talking about. We did have guess the only thing I'd say that our Visa Check Card expenses were higher by about $900,000 and most of that was associated with our EMV card issuance. So that would be a onetime expense that was included in the fourth quarter. Other than that, I don't see anything really too different than a normal run rate.
Speaker 8
Okay. Got it. And then, I guess, can you just update us on where the reserve on energy loan stands? I think it was $62,000,000 or something last quarter?
Speaker 2
It's $60,000,653 so $60,000,653 that's a 4.38% number.
Speaker 0
Your next question comes from the line of Jon Arfstrom of RBC Capital Markets. Your line is open.
Speaker 9
Hey, thanks. Good morning, guys.
Speaker 3
Hey, Jon. Hey, Jon.
Speaker 9
Hey. Not much to pick on here, but maybe a couple of things to ask about that haven't been covered. Phil, you talked about customer calls and prospect calls, I think you said they were up 12%. That's lower than it's historically been. And I remember times when you guys were growing those numbers in the teens and not seeing the loan growth.
And now you're seeing the loan growth, and that number seems to be down a little bit. Maybe help us understand what's happening there.
Speaker 2
Yes. Don't think it's any particular program. It's just I think it's just timing and the numbers. We're still very active. And the thing I really like about it, I think we're really being effective with the calls that we're undertaking.
And you can see that through the numbers that we're seeing growing.
Speaker 9
Yes. Clearly showing up. Okay. And then one of the other comments, Gerry, I think you made it when you were talking about some of the unemployment rates, but you talked about the lack of skilled and qualified workers is an issue for some of your customers. How prevalent is that and how often do you hear that from your borrowers?
Speaker 3
Yes. I mean, I think that the conversations that we're hearing is, yes, it's a challenge. I think it's a challenge along that I-thirty 5 corridor in Dallas and in Austin. And yes, it's something that all the cities are dealing with.
Speaker 9
Okay. And then I guess the last question I have is on Houston. Do you guys feel like the Houston economy has really bottomed and we're just kind of flat lining here? Do you feel like we'll see some growth in Houston? Maybe give us a little more detail on that.
Speaker 2
Yes. I think we feel pretty good about Houston. Houston grew jobs, as Jerry mentioned, in 2016, which I think a lot of people were surprised at. There are parts of market that are soft, construction soft. You need to be careful with multifamily there.
We're not really doing any multifamily in Houston. We're doing it in some other markets. And I think the attitude is pretty good. We talk to our people there. We ask them what the attitude is, what people are feeling.
I think it's been very consistent. I think we'll still see some more employment shakeout from the integrated firms and energy firms, but the rate on that has slowed. And so we feel good about it. And we've seen some good momentum in Houston over the last quarter when you look at the loan growth and deposit growth. So I don't really see Houston as being different in terms of what it's able to do and produce compared to our other markets right now.
Speaker 0
Your next question comes from the line of Scott Buck of Macquarie. Your line is open.
Speaker 3
Hi. Yes, it's Scott on for John Moran. Just real quick circling back on credit. The energy reserve at north of 4% and then the overall reserve is still looking pretty healthy. You guys are running kind of 20 basis points on charge offs.
Could you give us some help in terms of how to think about provision into 2017?
Speaker 2
It's going to continue to be formula based. And there'll be two factors that I hope that we'll continue to see. One is we're going to continue to see upgrades. We had some really nice upgrades during the first I mean, during this last quarter, about $100,000,000 worth of improvement in what we call problem loans, risk grade 10 and higher. And what we're seeing is credits that are moving to pass that might have been, say, risk grade 10 primarily.
And a lot of this are production loans that got caught up in the new OCC standard, the EBITDA standard on debt to EBITDA, if you recall. And you got to correct that by improving your 12 trailing cash flow sufficient so that you can move that ratio down below the 3.5x cut line. And we're beginning to see that as we move through these quarters. So we're seeing some improvement there. That will help the reserve.
Remember, we do have a few credits that are still moving through the snake, as someone mentioned last time, and we'll just continue to work through those and their impact on reserves and what they require. We'll just see what that is. It's nothing I'm worried about. And then in terms of it's a high class problem, but if you have good loan growth, we're going to want to make sure that are keeping up with that with regard to the reserve and our formula is going to require us to do that. So I certainly don't expect the provisions in 2017 that we had in 2016.
And we'll just see how those factors, the ones that use up reserve and the ones that give it back are going to be impacting us.
Speaker 0
And I would now like to turn the call back over to Mr. Phil Green for closing remarks.
Speaker 2
Okay, great. Well, we appreciate everyone's interest in the call today. And with that, we will be adjourned.
Speaker 0
And this concludes today's conference call. You may now