Good morning, and welcome to the Cullen/Frost Bankers fourth quarter and year-end earnings conference call. My name is Kristen, and I will be facilitating the audio portion of today's interactive broadcast. All lines have been placed on mute to prevent any background noise. For those of you listening on the stream, please take note of the options available in your event console. At this time, I would like to turn the call over to Mr. Greg Parker, Executive Vice President and Director of Investor Relations. Mr. Parker, you may begin.
Thank you, Kristen. 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 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.
Thank you, Greg. Good morning, and thanks for joining us. Today, I'll review fourth quarter and full year 2017 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 fourth quarter, Cullen/Frost earned $1.53 for diluted common share, compared with $1.28 in the same quarter last year and $1.41 in the third quarter of this year. For the full year 2017, Cullen/Frost earned $5.51 per diluted common share, which is up from $4.70 in 2016. Fourth quarter and full year 2017 results include the benefit on a net basis of $4 million or $0.06 a share to adjust deferred taxes as a result of the Tax Cuts and Jobs Act. As you can see, a strong fourth quarter capped a very good year overall in 2017.
Besides the excellent earnings, our return on average assets reached 117 for the full year and was 126 in the fourth quarter. One area of focus in 2017 was balanced quality loan growth, we had good results. During the fourth quarter, average loans were $12.9 billion. This represents an increase of more than $1.15 billion over the fourth quarter last year. Our provision for loan losses fell to $8.1 million in the fourth quarter, compared to $11 million in the third quarter. Non-performing assets totaled $157.3 million in the fourth quarter, a slight increase from the total of $150 million in the third quarter. The increase was basically attributable to one credit, a long-time customer that has ceased operations. Net charge-offs in the fourth quarter were $7 million, compared with $6.2 million the previous quarter and $5.7 million in the fourth quarter of 2016.
For the past six quarters, we've experienced near normal levels of charge-offs, and we expect this trend to continue. Fourth quarter annualized net charge-offs represent just 22 basis points of average loans. Overall delinquencies for accruing loans at the end of the fourth quarter were only 82 basis points of period-end loans, a number well within our standards and one of the lowest totals in more than two years. Total problem loans, defined as risk grade 10 and higher, were flat compared to the third quarter. Finally, outstanding energy loans at the end of the fourth quarter totaled $1.5 billion, or 11.4% of total loans. The increase is split between increased customer activity in the energy sector and some quality customer acquisitions. Our current level compares to our peak of 16% in 2015.
As we've discussed in previous quarters, Frost is building on momentum in the markets that we serve, we're seeing increased optimism among our customers. In responding to this optimism, we are focused on steady and sustainable organic growth through a competitive product mix and a strong value proposition. Average total deposits in the fourth quarter rose to $26.4 billion. That was up by 4% from $25.4 billion in the fourth quarter of last year. Throughout 2017, we saw broad-based growth in our deposit portfolio. In consumer banking, we continue to gain momentum from the investments we've made in our value proposition, including things like 24/7 customer service, one of the largest ATM networks in Texas, an outstanding mobile app, an expanded branch footprint, and competitive deposit rates. Net consumer customer growth for the year was 2.7% due to high customer acquisition and strong retention of existing customers.
Same-store sales growth for new account origination is up by 7.4% compared to the fourth quarter of 2016, with strong growth in all regions. 22.1% of our account openings came from our online channel, which includes our Frost Bank mobile app. That maintains our pace of more than double the level of the same quarter a year ago. The consumer loan portfolio reached $1.6 billion by the end of 2017. To put this in perspective, this is larger than our energy portfolio. Total period-end consumer loans grew by 11%, or $155 million, compared to the same timeframe in 2016. About 56% of this growth came from consumer real estate, such as home equity lines of credit, home improvement loans, HELOC, and home equity loans closed in, with the rest driven by general consumer and consumer lines of credit, particularly private banking.
Our multifaceted, concentrated effort to effectively grow the consumer loan portfolio included streamlining processes to increase efficiencies in our loan center in hiring additional key lenders. We continue to make progress with our mobile and web-based account openings, which have opened new channels for customers to build a relationship with Frost. These digital account openings have helped us grow while still applying the same Frost standards that we have in place for traditional account openings. On the commercial side, new loan opportunities are up 28% compared with last year. Our strategy of building our core loan portfolio, which we define as loan relationships under $10 million in size, continues to help provide steady, sustainable, organic growth. For 2017, new commitments under $10 million accounted for 47% of the total volume for the full year. The efforts that our bankers have been putting into this are paying off extremely well.
For our larger customers, new commitments at above $10 million accounted for 53% of commitment growth. We continue to be successful developing larger relationships. Overall, new loan commitments are up by 17% from last year. In 2017, we had a 27% increase in opportunities from customers. That indicates that customers have an increased need for new financing to support their growth, which is a reflection of a stronger economy. This kind of sustainable organic growth is only possible by building long-term relationships with our customers. As you may have seen in the press release, Frost is celebrating the 150th anniversary of its founding this year. Banks, especially Texas banks, don't get to be 150 years old unless they succeed in helping their customers succeed and by making people's lives better in the areas where they do business.
Those positive customer experiences are reflected in the recognition we receive from third parties like J.D. Power and the American Banker/Reputation Institute survey. We continue to build on that success. During the fourth quarter, Frost was named to Money magazine's list of the best banks in America, which included the designation as best bank in Texas. Global Finance magazine named Frost the best private bank in the Southwest. A bank also can't get to be 150 years old without great bankers. As we roll out our 150th anniversary celebrations this year, we plan to do at least 150 volunteer projects and community improvement efforts throughout Texas. The spirit of Frost employees and their dedication to their communities, their customers, and each other is truly inspiring.
I'd like to thank everyone at Frost for all their hard work and dedication as we celebrate this milestone and look ahead to future accomplishments. 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 close with our guidance for 2018. Regarding the economy, the Texas economy continues to expand with steady growth and historically low unemployment. According to the Dallas Fed, Texas employment in 2017 grew 2.4%, twice the rate of 2016 and faster than the U.S. growth rate despite the impact of Hurricane Harvey. Energy sector employment grew 9%, and manufacturing employment grew 2.8% after two previous years of contraction in both sectors. The Dallas Fed's Texas Business Outlook Surveys suggest continued growth in the state's manufacturing and service sectors. The Texas unemployment rate in December was 3.9%, up slightly from November, but still one of the lowest levels on record.
Tightening labor markets could make it more challenging for Texas businesses to find qualified workers in 2018. Because of the labor tightness, the Dallas Fed reports that Texas wages began rising in 2017 for the first time in three years. Recent gains in the Texas Leading Index suggest that the positive momentum from the second half of the year should carry forward into 2018. The Dallas Fed projects 2.8% job growth in Texas in 2018. Based on that forecast, about 350,000 new jobs would be added in Texas this year. Looking at individual markets, the Interstate 35 corridor markets continue to lead the state. The Austin economy is the fastest-growing major metro area with extremely low unemployment. According to the Dallas Fed, Austin's 3.6% job growth in 2017 was the best among the state's major metro areas. Austin jobs grew 5.1% in the fourth quarter.
The top growing sectors in the fourth quarter were leisure and hospitality, professional and business services. Austin's December unemployment rate held steady at 2.8%, the lowest of all major Texas metro areas and a near 17-year low. The San Antonio economy is accelerating rapidly. For 2017, San Antonio employment grew 3.4%, the fastest among all the large state metro areas. The construction and leisure and hospitality sectors were the main drivers of job growth. According to the Dallas Fed, post-Hurricane Harvey reconstruction drove both sectors as many displaced coastal residents stayed in San Antonio while their homes were rebuilt. San Antonio's December unemployment rate declined to 3.8%. Regarding Dallas-Fort Worth, according to the Dallas Fed, Metroplex employment expanded 2.3% for all of 2017. Job gains generally were broad-based and strongest in the second half of the year. The Metroplex labor market remains tight.
December unemployment was 3.5% in Dallas and 4.4% in Fort Worth. Houston's economic outlook continues to improve. Employment totals have surpassed pre-Hurricane Harvey levels, while energy-related jobs are increasing. Financial activities and trade, transportation, and utilities are the strongest sectors. For 2017, Houston employment grew 1.3%, and Houston's unemployment rate was 4.9% in December. The 2018 outlook for Houston remains positive. For Texas as a whole, the Dallas Fed projects 2.8% job growth in 2018. Now moving to our financial performance. Looking at our net interest margin, our net interest margin for the fourth quarter was 3.7%, down three basis points from the 3.73% reported last quarter. As a reminder, last quarter, we had an adjustment to our tax-exempt loan balances, which had a three basis point positive improvement on our net interest margin percentage.
If you adjust out the impact from the correction of the tax-exempt income issue, the net interest margin is flat with last quarter's adjusted net interest margin percentage of 3.70%. We had some positive effects offsetting some negative effects. I would summarize by saying the favorable effect of higher yields on earning assets and higher loan volumes were offset by higher deposit costs and higher balances at the Fed. Our TE net interest margin percentage for the fourth quarter, as I said, was 3.70%. Had the 21% statutory tax rate been in effect, our net interest margin percentage for the quarter would've been 3.39%. The taxable equivalent loan yield for the quarter was flat at 4.46% with the prior quarter. However, excluding the third quarter tax-exempt loan correction that I mentioned earlier, the yield would've been up four basis points.
Looking at our investment portfolio, the total investment portfolio averaged $11.7 billion during the fourth quarter, down about $600 million from the third quarter average of $12.3 billion. The decrease was impacted by the sale of $750 million in treasury securities that occurred late in the third quarter. The taxable equivalent yield on the investment portfolio was 4.09%, up 15 basis points from 3.94% for the previous quarter and was impacted by the sale of the treasury securities last quarter that had a yield of 1.3%. Also, during the quarter, we purchased about $300 million in municipal securities with a TE yield of about 4.5% or 2.93 non-TE yield with a 20-year average maturity. Our municipal portfolio averaged about $7.48 billion during the fourth quarter, up about $122 million from the previous quarter.
The municipal portfolio had a yield for the quarter of 5.30%, down four basis points from the previous quarter. At the end of the fourth quarter, about 68% of the municipal portfolio was pre-refunded or PSF insured. The duration of the investment portfolio at the end of the quarter was 4.7 years, down slightly from 4.8 years for the previous quarter. Regarding the outlook for 2018, our projections include a rate hike in June and one in December, with of course the December hike having minimal impact on our projections. With respect to the impact of the Tax Cuts and Jobs Act on our forward-looking effective tax rate, we currently project an effective tax rate in 2018 of about 10%. Regarding estimates for full year 2018 earnings, we currently believe that the current mean of analyst estimates of $6.12 is too low.
With that, I'll turn the call back over to Phil for questions.
Thank you, Jerry Salinas. With that, we'll open up the call for questions.
If you would like to ask a question over the phone today, please press star followed by the number one on your telephone keypad. Our first question today comes from Ebrahim Poonawala from Bank of America. Please go ahead.
Good morning, guys.
Good morning.
Good morning.
I was wondering, first if we could start with just the outlook on loan growth. It was a strong quarter, and when we look at about 10% year-over-year, Phil, just based on some of the numbers you guys shared in the prepared remarks, do you expect loan growth to get stronger relative to what we saw this year? Just in terms of the makeup of loan growth that you expect into 2018.
Ebrahim, I think we expect consistency with what we've been doing. I'm extremely pleased about how we've executed. I'm very optimistic about future execution, I don't want to change what we're doing. What we're doing is we've got balanced growth, as we talked about, we're growing larger deals, which we're going to do. But we've shown over the last 18, 24 months, the continuing momentum and focus on growing what we call around here the core loans. These are relationships under $10 million. They're very valuable because they grow organically as the businesses grow, they're very amenable to a lot of the services we're offering, that we offer because they're smaller customers. It doesn't sound very sexy, to put it frankly, but it's really important. We've got our focus on balanced growth in that area.
We've got our focus on the consumer side, which really is just expanding relationships. 45% of the relationships that we have of our deposit base is consumer related. Those are great relationships, we feel like we've left some money on the table, that we have the ability with the correct products to scale that business in a quality way, we've been doing it. I love what we did in this year in terms of the growth and the level of growth, I'm optimistic about being consistent with that and continuing that growth for this year.
Understood. Is it fair to say that means you funded entire loan growth this year with deposits? Should we expect the same to continue in 2018?
Excuse me. Yeah, I think our projections would stay about the same. Yes.
Got it. Switching to expenses, I think if I back out some of the one-off type items you called out, about $192 million in expenses implies about 4%-5% year-over-year expense growth. As we think about 2018, should we expect that 5% rate to remain consistent again, or is there anything else going on from an investment standpoint that you guys are sort of thinking about?
Excuse me. Phil talked about some of the things that we're doing to grow the business, the people that we're hiring. We've talked about technology that we're going to have to spend, that we have spent on infrastructure and on product development. We're good stewards of expenses, but to grow the business, it takes expenses. I think your higher-end year-over-year sort of growth based on the reported number, I would say is probably closer to kind of what our expectations are.
Got it. Closer to 5% on the full sort of reported expense number. Understood. Perfect. Thank you very much, and congrats on the 150th anniversary.
Thank you.
Our next question comes from Brady Gailey from KBW. Please go ahead.
Hey, good morning, guys.
Good morning, Brady.
I know last quarter, you all had margin guidance of around the 370 level, which is exactly where you came in the fourth quarter. Do you think that will hold as we go into 2018? I realize with the tax adjustment, optically the margin will look closer to 340, but do you think kind of a stable 340 margin is the right way to think about 2018?
Brady, what I'd say is that it's a good starting point. Our projections would show some improvement, some improving trend as we go through 2018.
Okay. You guys did a good job of breaking out some of the asset yields and what happened last quarter. Can you maybe give us an update on any fluctuations in your funding costs in the fourth quarter?
Yeah, sure. Excuse me. Let me get that for you.
Like what happened to non-interest-bearing deposits. I'm sorry, interest-bearing deposits.
Sure. Hold on. Let me grab my average balance sheet here. If you looked at the third quarter to the fourth quarter, our cost of total interest-bearing deposits went from 15 basis points to 19, and our total deposit cost went from nine basis points to 11.
Okay. Despite you all putting out some higher rates like you did earlier in 20
2017, there wasn't a ton of movement. Do you think that there will be more movement in funding costs as we progress through 2018?
Brady, with the December rate hike, we did have additional increases in deposit costs. We went ahead and increased some of our rates, given what we were seeing with alternative products that the customers could go into. Our deposit beta's probably on the high end, like we've talked about before, our high yield money market account, which was at 35 basis points for balances over $250,000. We had a 40% beta on that product as an example.
Okay, great. Thanks for the color.
Thanks, Brady.
Our next question comes the line of Jennifer Demba from SunTrust. Your line is open.
Hey, Jennifer.
Good morning. Phil, it looks like you guys really hit a home run with focusing on the sub $10 billion, $10 million loans rather, in 2017. Are there any new initiatives for 2018, or will you just continue to focus on that particular goal as one of your top priorities?
Jennifer, we're going to continue to focus on the goals that we had in 2017 and just continuing to execute. I wouldn't say we hit a home run so much as we hit a bunch of singles and doubles, and we want to continue to do that. I think that's a way to rack up runs in the long term.
Thanks so much.
Thank you.
Our next question comes the line of John Pancari from Evercore ISI. Your line is open.
Morning, guys.
Morning, John.
On the tax reform benefit, can you just talk to us a little bit about how you're thinking about how much of that falls to the bottom line, how much of that stays there? Do you think there's going to be any intentional reinvestment into the business in terms of the infrastructure and personnel and everything, also, how do you think about the potential for it to be competed away by the industry and some of your competitors? Thanks.
There's a couple of things there. First of all, with regard to reinvesting in the business, yes, we're doing that. We've been increasing our value proposition to our employees over the last few months, and we'll continue to do that. It's a competitive business, but I think the change in the tax law makes it easier for us to invest in the business, and we are, and we will. I think that'll be manifested a lot in technology, making sure that we're keeping up with competition and our value proposition. Those are big dollar expenditures, and we get some air cover with the tax law change to do that and have some earning capacity to reinvest. Yeah, I think that we will do that. We've been, like I say, investing in our employees. We'll be investing and have been, and will continue to invest in technology.
We've been investing in our value proposition. One of the things has been making sure our rates are competitive for the long term, so that'll help in that area as well. It was good to get to see that change in tax law. We're just running a business here, and just as business people, a change like that helps us and makes it easier to invest in that business. That's what I believe we're also seeing and hearing from a lot of our customers.
The potential for that to get competed away, the remainder of the benefit, how do you feel about that?
Well, we compete every day. Every day. I don't know. I expect competitors to be irrational every day, and they probably expect the same of me. I don't expect anything specifically about that. If besides, I feel like we're in a really good spot. As Jerry Salinas said, even with their increases in rates, what's our deposit cost, Jerry Salinas?
Our total deposit costs for the quarter were 11 basis points.
11 basis points. I'll compete with anybody with that. I'll compete with anybody.
Yep. Got it. Back to that first answer you gave in terms of you have been reinvesting. Do you care to put a number around it? What % of that tax relief do you think gets put back to the business?
No, we're not ready to say that.
Okay. All right, good. Thank you.
Thank you, John.
Our next question comes from the line of Peter Winter from Wedbush Securities. Your line is open.
Good morning.
Good morning.
Just curious, with tax reform, does that have any impact on your strategy of holding such a high level of muni securities?
Peter, certainly, it's a different outlook, but really right now, based on what we're seeing and what we're doing, until the long end of the curve moves up, we're going to continue to see value in the municipals as one of our more attractive investments. At this point, don't really see any change in our strategy. The guys in our investment area keep an eye on that every day, but as far as any sort of huge structural change for us in that investment portfolio, no, you shouldn't expect anything like that.
Okay. One follow-up. Other fee income, it was elevated in the third quarter. The fourth quarter came in a little bit higher. I'm just wondering what drove the increase. Is a more normal run rate what we saw in the first half of 2017?
I think in the fourth quarter, I guess of this year, I'm looking at included, I guess we had about a $2 million gain on the sale of a property. If you recall-
I was taking that out.
Yeah. You're taking that out and you're still seeing the change you're saying?
Yeah. In other words, if I take that out, fourth quarter was about $10 million, $9.6 million in the third on a core basis, which you said was somewhat elevated, and it's around $7 million in the first half.
Yeah, I'm not really seeing, other than those gains from the sale of property. It's kind of lumpy anyway because anything that's unusual flows through there, the businesses that make up that business, we're really not seeing any significant changes there. That's where we have our public finance underwriting. That was a little bit softer, maybe if you did a third to fourth sort of view. We certainly expect that business to pick up. That's really the only thing that I'm seeing that I would call as unusual in that business line.
Okay. Thank you.
Once again, if you would like to ask a question today, please press star and then the number 1 on your telephone keypad. Once again, if you would like to ask a question today, please press star and then the number 1 on your telephone keypad. Our next question comes to the line of Brett Rabatin from Piper Jaffray. Your line is open.
Hey, good morning.
Good morning.
Wanted to ask, you've had a [inaudible] bit balance sheet the past years and a fairly low loan to deposit ratio. I'm curious, Phil, just thinking about this year, I know you're trying to execute on a lot of the things you were doing last year and growing relationships in commercial and consumer. Is there an underlying goal maybe to increase the loan proportion to assets on the balance sheet, or are there things with the balance sheet that you're trying to accomplish this year?
That's really not driving the efforts. I think there's an underlying realization that being successful in a broad-based way, in a balanced way, in the loan portfolio, in great markets, you got to remember that, is going to result in other things equal, some increase in the loan-to-deposit ratio. Remember, we're focused on the relationships overall, and so we're growing deposit relationships as well. As we do that, we create feedstock for future years, and the cost of holding that feedstock, it continues to go down as interest rates have gone up, and you've seen, let's say, the Fed numbers increase. Just the spread you're getting on these relationships that we're bringing in now are much more valuable than they were at almost zero interest rates.
In a sense, continuing to focus on the relationships creates what we've always called around here a high-class problem, where you're growing deposits. When you do that, and the relational aspect of it gives you the kind of deposit cost Jerry just mentioned, that 11 basis points, which is not because we're paying under market, as everyone knows, we're aggressive and in the market with our rates. It's really because we've got so many transactional accounts and quarter accounts in that way. As all that moves forward, that's what we're really doing, is just focused on the relationship, the loan relationships, the deposit relationships, and just being true to what we are.
Okay. Fair enough. The other thing I was curious about was, prior to the last cycle, you guys did the brilliant move of putting on the swaps that received fixed pay floating. Are you considering doing anything like that as the Fed moves rates higher?
Well, if I was, I wouldn't say it here. I think that we're always looking at all kinds of alternatives. The people that do that for us regularly propose a lot of different things, and our team regularly vets it. You got the same people basically sitting on the ALCO committee that have been there for years. We understand this balance sheet and how it works. Who knows? The thing is, those things are great, and sometimes it's better to be lucky than good on that swap. It was fantastic. The thing I'm most excited about is not hitting home runs because we make a great decision on interest rate swap directionally. It's that we've got great people. I'm not just saying that. We have great people. I thought about why we have such great people. It's because we have a great culture.
When you have a great culture like that, over time, it draws people to you end up with great people. When you add to that a great value proposition, you add to that We're in tremendous markets. I dare someone to find a better place to do business than Texas today. You add to that our bankers understand what they're supposed to be doing. You add to that they're doing it. That's what I'm most excited about. It's that simple in one sense, but in another sense, it's that hard because you can't put that together without a focus and commitment over a long period of time. We couldn't sit here and come up with a plan for next year that says, "Let's do all this. Okay, let's put this in place." You couldn't do it.
We've got it in place. People are doing it. We're in great markets doing it. That's the thing I'm most excited about. I am very, very positive about it.
Okay. Great. Appreciate all the color, Phil.
All right. Thank you.
Our next question comes from the line of Dave Rochester from Deutsche Bank. Your line is open.
Hey, sorry, guys. This is actually [Meng] on for Dave. Most of my questions, all my questions actually have been answered, so thank you.
Thank you.
Thank you.
Our next question now comes to the line of Steve Alexopoulos from JP Morgan. Your line is open.
Hi, this is actually Jason Oetting on for Steve today. I'm just curious, how do you guys think about potential capital deployment from here with 2018 effective tax rate being lower and the possibility for regulatory relief coming up? Any color on the topic of capital deployment would be appreciated.
I think we've been doing a nice job with it really relates to three key areas. We've got a great dividend, right? We've increased it for 24, however many years. It's an important thing to us. We want to continue to maintain that in place and increase it as our prospects increase. We'll focus on that. Secondly, we've utilized stock buybacks in the third quarter. We had a dislocation in price. After the rate increase that we did, bought back 100 million shares there in that program, then added right after that $150 million program for a couple years. We've got that in place to use, and we will use it if we feel like it's in the company's best interest. We occasionally, but I would say rarely, do an acquisition. That's not the key focus of what we're doing right now.
The key focus of what we're doing is putting in organic growth. As you're growing loans in high single digits, and our deposit growth has been, say, mid-single digits, you're going to end up spending your regulatory risk-based capital faster than you're spending your leverage ratio, if you will. We're using it to grow the business. That's what I love to do. I'd love for us to take capital, plow it back in the business, and continue to see it grow. We've really got, I think, the three legs of the stool that we have utilized, and we'll continue to be utilizing those.
Okay. That's helpful. Thank you.
Thank you.
Once again, if you would like to ask a question today, please press star and then the number 1 on your telephone keypad. Once again, if you would like to ask a question today, please press star and then the number 1 on your telephone keypad. We have no further phone questions at this time.
Great. Well, we appreciate your interest in our company, and we will be adjourned. Thank you.
Thank you for your participation. This does conclude today's call. You may now disconnect your line.