Earnings Call: Q4 2018

Jan 31, 2019

Good day, ladies and gentlemen, and welcome to the CullenFrost Q4 and Full Year 2018 Call. As a reminder, this conference is being recorded. I would now like to introduce your host for today's call, Mr. A. B. Mendez. Mr. Mendez, you may begin. Thank you, Sherry. 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 that such statements should 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 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 210-220-5234. At this time, I'll turn the call over to Phil. Thanks, A. B, and good morning, everyone. Thanks for joining us. Today, I'll review the 4th quarter results for CullenFrost and our Chief Financial Officer, Jerry Salinas, will also provide additional comments and then we'll open it up to your questions. In the Q4, CullenFrost earned $117,200,000 or $1.82 per share, which represented a 19% increase compared with the $1.53 per share reported in the same quarter last year. For the full year of 2018, CullenFrost earned $6.90 a share, which is up more than 25% from 2017. Our solid 4th quarter and full year earnings result from our continued execution of our plan to pursue consistent above average organic growth across our enterprise. Our return on average assets reached 1.48% in the 4th quarter compared to 1.2 6% in the Q4 last year. For full year 2018, return on average assets was 1.44% compared to 1.17% in 2017. During the Q4, total average loans were 13,900,000,000 dollars This represents an increase of $1,100,000,000 or slightly over 8% versus the Q4 of last year and growth was broadly based across all categories. Our provision for loan losses was $3,800,000 for the 4th quarter compared to $2,700,000 the 3rd $8,100,000 in the 4th quarter of 2017. And non performing assets totaled $74,900,000 in the 4th quarter and they were down 13% from the Q3. Additions during the 4th quarter totaled only $2,000,000 which was the lowest quarterly add in several years. Net charge offs in the 4th quarter were $9,200,000 compared with $15,300,000 in the 3rd $7,000,000 in the 4th of last year. 4th quarter charge offs mostly have been identified as problems and had allowance dollars allocated to them in previous quarters. 4th quarter annualized net charge offs were only 26 basis points of average loans. Overall delinquencies for accruing loans at the end of the 4th quarter were $80,000,000 that was 57 basis points of period end loans. Those numbers are slight improvements from the 3rd quarter and are well within our standards and comparable to what we've experienced over the last 3 years. Total problem loans, which we define as risk grade 10 and higher, decreased by $26,800,000 or a little over 5% compared to the 3rd quarter. They were down from 35% they were down about 35% from a year ago. Problem energy loans were down 17% from the 3rd quarter. During the Q4, energy commodity prices saw increased volatility, but that didn't impact our energy customers significantly. Remember that at Frost, we don't bank industries, we bank people in industries and our energy energy customers know that volatility is inherent in the business and they've been prudent with their operating models and balance sheets. Energy related problem loans totaled $115,000,000 at the end of the 4th quarter compared to $139,000,000 for the 3rd quarter, $249,000,000 at the end of 2017. And it was pointed out to me earlier today by our Chief Credit Officer that that number was down from $600,000,000 at the high. Percentage of energy loans in our portfolio remains well below our peak of more than 16% 2015. Jerry is going to give you a brief Texas economic update, but I'd like to say that after talking to our bankers and our customers, there's still a great deal of optimism about opportunities in the state. Average total deposits in the Q4 were $26,500,000,000 up slightly from the Q4 last year. We saw steady growth in our money market accounts and CDs as our interest rate increases over the last 18 months continued to see good traction. In Consumer Banking, our value proposition and award winning service coupled with our drive to increase deposits, market share in Houston and Dallas continue to attract customers. We opened the first of 25 centers over the next 2 years in the Houston area just before the end of the 4th quarter. And overall, net new customer growth for the 4th quarter is up by 46% compared with a year ago. Same store sales increased by 4.9% compared to 12 months ago. Excluding the Rio Grande Valley, same store sales increased by 8% year over year. About 23% of our account openings came from our online channel, which includes Frost Bank mobile app, and that's nearly 40% higher than last year. The consumer loan portfolio averaged 1.6 $7,000,000,000 in the 4th quarter, increasing by 8% compared to the Q4 of 2017. On the commercial side, our focus is on consistent balanced loan growth, including the core loan component, while maintaining our credit quality standards during this period. I'm pleased at the level of new commitments booked from both core and large relationships continues to be evenly split. Looking at new loan commitments during 2018, overall they declined by 9% from 2017, but that was due to lower energy and commercial real estate commitments. We saw very good growth in community banking, commercial and industrial commitments, which rose by 12% compared to last year. With regard to our current active loan pipeline, the 4th quarter was up from the previous year by 2%. Finally, during the 4th quarter, we took the opportunity to utilize some of the $150,000,000 stock buyback authorization, buying $100,000,000 in CFR shares. Let me say I'm extremely pleased with what our people at Frost have been able to achieve over a very eventful 2018, the year that we celebrate our 150th anniversary of our company's founding. I've said many times, you don't get to be 150 years old without outstanding employees who take great care of their customers. As we begin 2019, we're happy to learn from 3rd party services in our own market research that our company's net promoter score, which measures how likely it is that people would recommend Frost to a friend or colleague is up significantly. We've also seen healthy increases in our brand awareness in key markets. We continue to discuss our opt for optimism initiative, which is resulting in consideration of Frost as a thought leader. Our sponsorship agreements with the San Antonio Spurs and Houston Rockets of the NBA providing great exposure of our brand. Later this year, we'll move into our new San Antonio headquarters building, which already has a fan base on social media. And of course, we'll continue to expand our presence, not only with our special initiative in Houston, but also with normal expansion in our other markets. Having a positive optimistic attitude toward opportunities along with award winning customer service and an attractive value proposition has allowed us to build the kind of long term relationships that have sustained Frost for more than 150 years and that remains true today. Now I'll turn the call over to our Chief Financial Officer, Jerry Salinas for some additional comments. Thank you, Phil. I'll make a few general comments about the Texas economy before I provide some additional information about our financial performance for the quarter, and I'll close with our guidance for full year 2019. Regarding the economy, the Texas economy continued to grow in the 4th quarter, but at a slightly slower pace than in previous quarters. While employment growth has begun to plateau due to labor market constraints, unemployment continued to decrease to record lows. According to the Federal Reserve's Dallas branch, Texas employment had expanded by 2.4% year to date toward the end of 2018. The energy, manufacturing and financial sectors led growth during the Q4, while the trade, transportation and utility sector and the construction industry also added jobs at a strong pace. The Texas unemployment rate fell to 3.7% in November, the most recent month that statistics are available. That's the lowest level in 4 decades. Now moving to our financial performance, looking at our net interest margin. Our net interest margin percentage for the 4th quarter was 3.72%, up 6 basis points from the 3.66% reported last quarter. Driving the increase was the favorable effect of higher yields on loans and balances kept at the Fed and higher loan volumes. These favorable variances were partly offset by higher funding costs on both deposits and customer repos during the Q4. The taxable equivalent loan yield for the 4th quarter was 5.20 percent, up 16 basis points from the 5 0 4 percent reported in the Q3, driven primarily by the increase in interest rates. Looking at our investment portfolio. The total investment portfolio averaged $12,400,000,000 during the 4th quarter, up about $380,000,000 from the 3rd quarter average of $12,100,000,000 The taxable equivalent yield on the investment portfolio was 3.39% in the 4th quarter, down 2 basis points from the 3rd quarter. Our municipal portfolio averaged about $8,100,000,000 during the 4th quarter, up about $180,000,000 from the 3rd quarter. The municipal portfolio had a taxable equivalent yield for the 4th quarter of 4.08 percent, down 7 basis points from the previous quarter. At the end of the 4th quarter, about 2 thirds of the municipal portfolio was pre refunded or PSF insured. The duration of the investment portfolio at the end of the quarter was 4.5 years, down slightly from 4.7 years the previous quarter. Looking at our funding sources, the cost of total deposits for the 4th quarter was 37 basis points, up 3 basis points from the 3rd quarter. The cost of combined Fed funds purchased in repurchase agreements, which consist primarily of customer repos, increased to 1.5 6% for the Q4 from 90 basis points in the previous quarter. We instituted a tiered rate for our customer repos during the Q3, but we continue seeing quite a bit of exception pricing in this product. Those balances averaged about $1,100,000,000 during the 4th quarter of about $127,000,000 from the previous quarter. Regarding estimates for full year 2019 earnings, we currently believe that the mean of analyst estimates of $7.11 is reasonable. With that, I'll now turn the call back over to Phil for questions. Thank you, Jerry. We'll now open the call up for questions. Thank Our first question comes from Bradley Gailey with KBW. Hey, it's Brady. Good morning, guys. Hey, Brady. Good morning, Brady. Maybe just start with the buyback. Phil, I heard you say $100,000,000 in the 4th quarter. What was the average price that you repurchased that at? And just as you look forward, your TCE is kind of around the 8% level. How do you think about additional buybacks from here? Brady, our average price was $97.34 And just to remind you, we do have $150,000,000 buyback program currently outstanding. We did purchase $100,000,000 so we do have $50,000,000 still authorized. All right. And then thoughts going forward, can we expect Frost to continue to be active on the buyback front? I think we will as we see opportunity. We are we don't have a specific schedule, but we've always said we want to be opportunistic and we'll continue do that. Okay. And then you have one of your new locations open in Houston. I know last quarter we talked about the financial impact of that being around a $0.19 per share burden to earnings. Is that as you all have gotten into it, have any of those metrics changed? Or is that still the way to think about the Houston expansion? Yes, Brady, I think at this point, it's still so early on that I think the guidance we gave is what I continue to depend on. Okay. All right. And then just bigger picture, I mean credit just continues to improve for you guys and it's very clean. Is there anything out there that is giving you pause or concern on the credit front at this point? Well, you always got to be concerned, right? I mean, we're Frost Bankers and we worry about everything. You're just seeing a lot of competition today. I think we are if you look at what we've lost in pricing structure, I think we've moved up this last quarter to 60% structure versus 40% price. You're seeing longer terms, no prepayment penalties, lower collateral levels, longer amortizations. So you're seeing a lot of competition in that regard and so we just got to maintain our disciplines there. We've had the volatility that I mentioned in my comments in the energy markets. I felt really good about how the portfolio performed, but it's a commodity based business. And so that's you have to watch that. I feel really good about what we've been putting on and the structures of that. But it's you always have to watch that and that's the nature of that business. I'd say the economy is strong as Jerry pointed out. You've got to watch supply in some markets. I think it's good, but you've got some slowing in certain segments. For example, housing in some markets are slowing a bit, not bad, but slowing. Just general things, there's not any one particular thing that I'm worried about, just making sure that we maintain our credit underwriting principles and stay close to our customers. All right, great. Thanks for the color, guys. Thank you. Our next question comes from Jennifer Demba with SunTrust. Hi, Jennifer. Good morning. Question for Jerry on the net interest margin. Jerry, what's the outlook this year in a variety of rates scenarios, 0 rate hikes or maybe 1 or 2? Jennifer, in all those scenarios that you mentioned, we do project an increasing net interest margin percentage. Obviously, the rate hike that we got in the Q4 of last year helps push us forward. So in that 1 or 2 rate hike scenario, of course, that would be a positive for us. But even in a flat scenario, given the wind behind us, we're still projecting increasing trends in that net interest margin percentage. Can you talk about the deposit competition you're seeing right now, changes you've seen maybe in the last 3, 6 months, if any? I think that from a pricing competitors locally and nationally. And I still feel good about where we are. I think that's what we've been saying. So yes, we continue to perform well there. I think the pressure continues to be on the DDA accounts. I think that's what we've talked about the last couple of quarters. We're seeing more diminishment on the commercial side. And that kind of goes back to what we've seen in previous scenarios when rates started to move up. I think what we've said is we believe there may be some stabilization once rates start increasing or excuse me, stop increasing. We're just having a lot of the CFOs, I think, looking at interest rates and trying to find some better rates on those commercial deposits. So not any real big changes in my mind from this quarter compared to last. Thanks, Jeff. I feel good about the like I said, the traction that we're getting on those areas where we increased rates, it's going back to gosh, this is July 2017 now. And I think we've seen good traction on MMAs and CDs. So I feel good about what we're paying. I think we're giving our customers a square deal, and I think we're going to get known for a place that does that. And I think we're seeing some benefit from it. Thank you. Thank you. Our next question comes from Peter Winter with Wedbush Securities. Good morning. I was just curious, was there anything non recurring in the other non interest expense? And I'm just curious what the outlook is for expense growth next year with the build out of the branches? Let me try to see if there's anything unusual you're talking about in the Q4 this year? Yes. It was a big jump. Yes. Well, I think dollars Yes. I think that if you so you're talking about from the linked quarter standpoint? That's right. We did have about 1,500,000 dollars related to some write offs on some assets, also about $700,000 higher in advertising and direct mail. So those are probably the big things there compared to the linked quarter. As far as outlook for expenses, we're not going to give any sort of explicit expense growth guidance. What I will say is that as we continue to grow our business and we continue to provide excellent customer service, we'll continue to see increases in expenses. And in addition, we've noted our Houston expansion, where we're excited about that opportunity, but where expenses are going to be front end loaded, given the nature of that build out. And Phil also talked about sponsorships and marketing expenses that we're putting in place to increase brand awareness. So I think all of those things will push the growth rate higher in 2019. Okay. Thank you. And just on credit, obviously, it's outstanding. And you mentioned that no big concerns. I'm just wondering, given where the reserve to loan ratio is, and I know it's formula driven, but would you expect to start adding to reserves in 2019? I think you said it and it's formula driven and it just depends on what happens with classifications and risk rates, I think is the primary thing. I mean, you can see, like we've always said, we still got some energy credits moving through the snake. So it depends on what happens with some of those. But I don't think we're tied to any one particular number. Jerry, any comments? No. I guess what I would say is, as you noted, there really the provision levels during 2018 were unusually low. I mean, we had excellent credit quality. We had a lot of improvement on the energy side. So risk rating improvements, improvements on historical loss factors. So a lot of positive momentum there that resulted in not having to provide as much as we had charged off given that we had reserves associated with those credits already allocated to those credits. So from a provision standpoint, if you're just talking about provision levels 2018 versus 2019, I certainly expect that provision levels would be higher given the great credit quality in 2018 and the improvement in 2018. And some of that's going to be that as we grow the portfolio, there's going to be normal provisions that go on with that as well. And we've been doing a nice job of consistent growth. Got it. Thanks. Appreciate it. Thank you. Our next question comes from Ebrahim Poonawala with Bank of America Merrill Lynch. Good morning, guys. Good morning. Just a question. So I hear you that I appreciate that you don't want to give specific guidance on expenses. But if you put together kind of how you talked about the margin and expenses, how do you think about the efficiency ratio? Like do you see that staying around the 55% to 56% or do you still expect positive operating leverage even while you invest for this Houston expansion? Any thought process around that would be helpful. Yes. I think with the Houston expansion, there's certainly going to be some pressure on that efficiency ratio based on where we ended up the year. It's kind of guess what I would say. I think that I don't envision that it will change significantly, but I think it's going to be under pressure as we put those additional Houston branches on the books. Yes, I would agree with Jerry. One of the things, Ebrahim, that we've talked about early on as we started to talk about this whole initiative in Houston was one of the decisions that we were making was how much of our improving operating leverage are we spending on growing the core business. And so we'll continue to have a business that can grow organically and above average rate. So I think the nature of that kind of investment does spend some operating leverage, but I don't think it's something that changes the momentum or direction of our company has continued to be positive. And just because obviously the market has been all over the place between now and when you first discussed this in October, what's the I know you think very, very long term like is there a point where if the macro backdrop deteriorates, you pull back from the strategy a little bit to kind of manage expenses better? Or would things need to go and get materially worse for that to happen or that cannot happen? I would not I don't expect that to happen. That strategy is long term. And as I've said, Texas, let's say we have a downturn. I mean Texas tends to operate at higher levels in the nation. So the Houston market is a great one. It's growing. I mean it grew through the really bad you could argue that the really bad downturn in the energy business over the last few years. So I would not expect us to materially alter that if we had some turbulence in the economy. And that is a long term strategy that we want to continue to prosecute. That's helpful. And just one last question on Jerry on the margin. So it sounds like the margin should go higher with or without rate hikes. Is there a tipping point where the margin starts feeling pressure or there's just so much repricing and you feel good about the deposit costs where even without the Fed doing anything and big changes in the yield curve that it should continue to drift higher? Yes. I do feel good about it. I think that one thing you'll see in our 10 ks, which we would expect to file late next week, is we do have over $2,000,000,000 in treasuries that are set to mature next year at a rate of 155. So the redeployment of those proceeds on their own, there is obviously it will affect duration as we move forward, but obviously it will help the yield compared to this year. Understood. Thanks for taking my questions. Thank you. Our next question comes from Brett Rabatin with Piper Jaffray. Hey guys, good morning. Hey Brett. Wanted to, I guess first, 2 housekeeping issues. Would you happen to have average interest bearing funds for the quarter and then ending period securities? And then maybe just talk about what you did in the securities book this quarter, if you can? Sure. Hold on just a second. So our investment portfolio at the end of December looks like it's about pretty close to 12,500,000,000 dollars And then not too much activity during the quarter. Let me grab it here in front of me. I think we purchased municipal of about here about $65,000,000 in municipals during the quarter at a TE rate of about 4.39 and we also bought $100,000,000 in agencies, had a yield of 3.91 percent. Okay. And then Jerry, would you happen to have the average interest bearing funds? Sure. For the quarter, average interest bearing deposits were 15,767. Okay. And then just wanted to circle back around about expenses. And I know last year you had talked some, Phil, about AI and doing some things to further the growth of the franchise besides the Houston investment. Is that a part of the plan in 2019? And does that also impact expenses? And maybe just a little more color around if we're doing other things besides the Houston build out in 2019 that might be impactful? Yes. Brett, our conversations around that really, I think if I'm remembering the conversation, it has to do with there were decisions this company made that a generation ago, like 22 years ago with data warehouse technology and 20 years ago with hosting our own website and web development that really have benefited us as we move forward since that time and have allowed us to punch above our weight class as far as customer service and projecting our brand. Those were great decisions, but my point on all that is that we and I think this is true for the industry. We've got to make decisions today. We've got that as we go forward in the future, future bankers will look back on and say the same thing about those decisions as I just said about the 2 I just mentioned. And the thing that's a little more complicated today, I think, is because there are a lot more swim lanes and types of technology and technological waves than there were back 20 years ago when we made those decisions. And AI is an example of whether it's cryptocurrency or whether it's we can just go down the line on the various different kinds of technologies that are coming to market. And so we have to make the right decisions on where to invest on those. I personally believe that AI is one that I think is going to help the industry. And then as I look at the landscape and I think what has the probability of being one of those technologies that will really help us and we can look back at how it did help our business. I think that's one of them. We do have some opportunities to utilize that on the margin in the business, but that's not something that is a large investment for us right now. What I think we're doing is we're trying to understand how it might impact us in position ourselves to take advantage of that as we move forward. It's not something that will be affecting us in any material way in 2019. Okay. And then maybe just one last one. Trust and insurance were bright spots in 2018, but fee income was a little slower in aggregate relative to 2017. Are you guys thinking about opportunities in fee income and what would they be? Well, I think those are 2 good businesses for us. And I think we had the market didn't help in the Q4. Now if anybody, you're in that business, so you know. But I think up until that point, we'd had really a pretty good year without those headwinds. I feel good about the business long term. I feel good about what they plan on doing this year. I think our insurance business is doing well. It's they managed a 20% pretax profit margin last year, which I think is great for that business. And so they've had some good momentum. So I think they'll both be contributors. Okay. I appreciate all the color. You bet. Thank you. Our next question comes from Steven Alexopoulos with JPMorgan. Hey, guys. This is Anthony Elian on for Steve. My first question is another one on expenses. How much of the increase in expenses during the quarter was driven by the one branch that opened as well as the upcoming openings, particularly in the salaries line? I don't think they had a Steven, I don't think they had or excuse me, Anthony, I don't think they had a significant impact on the Q4. Okay, got it. And then turning to non interest bearing deposits, it's good to see another small increase for the 2nd straight quarter. Can you comment on any migration you're seeing out of non interest bearing into interest bearing accounts? I think that really what we're seeing primarily on the we do see some of it, obviously, but I think the bigger change is really the big large commercial accounts going to sweep accounts. So I think that's kind of really what we're seeing more of here recently. Okay, got it. And then my last question just on loan growth. Is the high single digit pay still a good growth rate to expect for 2019? And then do you expect this growth to be broad based or any particular segments to outperform? Our expectations will continue to be consistent with our growth. And so yes, I think that's our target. And yes, we expect it to be broadly based. Got it. Thank you. Thank you. And we do have a question from Jon Arfstrom with RBC Capital Markets. Hey, thanks. Good morning. Hey, John. Good morning. Hey, I think all the numbers have been handled. But just early assessment on how it's going in Houston. I'm curious when the branch opened and how it's gone so far and maybe an update in terms of any more or less optimistic on it on the outlook? Well, it's early. I kind of laugh. John, you sound like us. I think the 1st week it opened and we have a weekly meeting with our team that's our implementation team. I think it had been open 6 days and they reported that and one of us said, well, how's it going? It's very early. Look, these are long term strategies. We're not planting corn, we're planting trees. And the important thing is, are we hiring the right people to be picked the right markets? And I think everything we know about these markets, we feel really good about it. I feel good about how we've been able to hire people because we've got 260 plus people I think that we want to hire in that market as we expand. And I think we've hired almost 70% of the posted positions that we have, that we put out so far. And just anecdotally, the response that we're getting from people has been really good. A response that I've heard from our folks is that they'll hear someone say, I wasn't planning on looking at anything, but when I heard it was frost, I decided to answer the call. And I think that's gratifying and I hope it represents that people understand we have great culture and great place to work and we're a growing company in a growing market. So I hope we're creating a little bit of momentum there and I feel really good about the hiring so far. And when I look at the relationship managers that we've been able to bring on, they've been experienced. And so I'm encouraged. Okay. And the brand awareness spending, is that targeted or maybe allocated a bit more to Houston at this point? There's some. The Rockets sponsorship that we did is we wanted to increase our brand in Houston, but I think we were also motivated by our moving forward in that market. So I think it was an opportunity for us to leverage the Rockets. I mean, they're a great franchise and a lot of excitement around them in the Houston market. So we're more visible there. And so that was one I would say is related to that. But we'll also increase our market spend in the Houston market because we want to develop that market. Yes. Okay. All right. Thank you. You bet. Ladies and gentlemen, thank you for participating in the question and answer session. I would now like to turn the call back over to management for any closing remarks. Well, thank you. We appreciate your participation in the call. And with that, we'll be adjourned. Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect and have a wonderful day.