Cullen/Frost Bankers Inc
NYSE:CFR
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Cullen/Frost Bankers Inc
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Good morning and welcome to the Cullen/Frost Bank, Second Quarter Earnings Conference Call. My name is Amy and I will be facilitating the audio portion of today’s interactive broadcast. (Operator Instructions).
At this time I would like to turn the show over to Mr. A.B. Mendez, Senior Vice President and Director of Investor Relations. Mr. Mendez, you may begin.
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 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 for such statements to be covered by the Safe Harbor provisions or 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 welcome to the investor relations team, and I'd also like to thank Greg Parker
who's been managing investor relations for Frost for about the past 20 years. Greg has done an outstanding job for us. So Greg, thank you and congratulations on your new role in Operational Risk.
Good morning everyone. Thanks for joining us. Today I’ll review second quarter 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 second quarter Cullen/Frost earned $109.3 million or $1.68 per diluted common share, which represents a 30% increase compared with the same quarter last year. Our solid second quarter earnings were the result of Frost bankers executing the strategy that we discussed over the past several quarters, focusing on sustainable, above average, organic growth.
Along with the excellent earnings, our return on average assets reached 1.43% in the second quarter, the highest quarterly total in nine years. Now I’d like to offer some details about the elements that go into this growth.
We continue to build our loan portfolio while maintaining our quality standards. During the second quarter, average loans were $13.5 billion. This represents an increase of more than $1.2 billion or just over 10% versus the second quarter last year.
C&I loans grew 10% and commercial real estate loans grew 11%. Our provision for loan losses was $8.3 million in the second quarter and that compared to $6.9 million in the first and $8.4 million in the second quarter of 2017.
Non-performing assets totaled $122.8 million in the second quarter. This was down 10% from the $136.6 million in the first quarter. Potential problem loans totaled $50 million at the end of the second quarter. That’s our lowest level in more than three years and it matches levels prior to the energy downturn.
Net charge-offs in the second quarter of 2018 were $7.9 million, compared with $12.4 million in the first quarter and $11.9 million in the second quarter of last year. The lower total represents continued improvement in credit quality and maintaining higher loan standards. As expected, second quarter annualized net charge-offs dropped to a level of 23 basis points of our average loans.
Overall delinquencies for accruing loans at the end of the second quarter were $67 million or 49 basis points of period-end loans. That a number well within our standards and comparable to what we've experienced in the past two and a half years. Total problem loans, which we define as risk grade 10 and higher decreased by more than 6% compared to the first quarter and were down about 25% from the year ago.
Outstanding energy loans at the end of the second quarter represented just over 11% of total loans. The energy industry activity is increasing in markets where we do business, but the percentage of energy loans in our portfolio remains well below our peak of more than 16% in 2015.
Other industries in Texas we continue to do well. In generally, our customers tell us they are optimistic about their prospects for future growth and Frost is well positioned to serve them with a competitive product mix and strong value proposition. Average total deposits in the second quarter were $26.1 billion compared with $25.7 billion in the second quarter of last year.
In consumer banking, our value proposition and award winning service continued to attract customers. On a linked quarter basis same store sales growth for new account origination is up 4.5% unannualized in the second quarter. Almost 9% of our account openings came from our online channel, which includes our Frost Bank mobile app; that’s nearly 65% higher than last year.
The consumer loan portfolio averaged $1.620 billion in the second quarter increasing by 8.3% or a $125 million compared to the second quarter of 2017. On the commercial side, new loan opportunities are up by 2% year-to-date compared with last year. However, this is impacted by new energy opportunities which were down 27% from the year ago and public finance opportunities which were down 26%. However, regular commercial new opportunities were up by 7%, while commercial real-estate opportunities increased 4%.
Looking now at new loan commitments booked in the second quarter, overall the decline from the year ago was 6%, however the regular C&I component was up 7%. Both energy and commercial real-estate and new commitments were down 17%. As we mentioned last quarter, early 2017 was an extremely strong period for commercial real-estate.
However on a link quarter comparison of new loan commitments booked shows solid growth from the first quarter with all portfolio segments increasing. Remember that the first quarter is typically seasonally weaker. With regard to the current active loan pipeline, I’m glad to see the second quarter was up from the previous year by 7%.
Finally, our strategy of building our core loan portfolio wad redefined as loan relationships under $10 million in size and continues to help provide steady sustainable organic growth. For the second quarter new commitments under $10 million accounted for 50% of commitments booked, up from 44% in the second quarter last year.
Let me say that I’m extremely pleased with what our people at Frost were able to achieve this year and in this quarter particularly. It's not often you are able to report a 30% increase in earnings. They do it by taking care of our customers, by offering them top quality service and excellence at a fair price. They provide a safe sound place to do business and most of all, they provide great customer experiences and make people's lives better. We've been doing that for 150 years now and that experience has shown us the value of having a positive, optimistic attitude towards growth.
Our hardworking Frost banker's build long term relationships with our customers that benefit everyone in good times and bad and I want to thank them for that.
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, enclosed with our guidance for full year 2018. The Texas economy continues to expand amid a tight labor market and historically low unemployment. According to the Federal Reserve’s Dallas branch, Texas employment has expanded 3.6% year-to-date. The Texas unemployment rate in June decrease to 4%; that near a four decade low and the same as the U.S. national average.
Tight labor markets are challenging Texas businesses to find qualified workers. The Dallas Fed projects 2018 Texas job growth at 3%. Based on that forecast, Texas should add more than 370,000 new jobs in 2018.
Looking at individual markets, Huston’s economy expanded 6.1% in June, the fastest among the major metro areas. Year-to-date Huston employment is up 4.8%. The biggest gains are in professional services and manufacturing. Energy jobs are also increasing. Houston’s unemployment rate fell to 4.4% in June, the lowest in more than three years. According to The Dallas fed, employment in the Dallas-Fort Worth Metroplex grew 3.2% annualized year-to-date.
Growth through the first six months is 3.6% in Dallas and 2.4% in Fort Worth. Job expansion is widespread across all sectors. Payrolls in the goods producing sector, that’s manufacturing, construction and mining, were up an annualized 9.3% this year in Dallas. June unemployment was 3.5% in Dallas and 3.6% in Fort Worth.
The Austin labor force is at 3.8% annualized this year. Growth is mixed across industries; leisure and hospitality grew 14% from March to May, while healthcare and professional business services have the largest declines.
Austin’s unemployment rate in June was 3%. The San Antonio economy is steady with low unemployment. Goods producing industries are growing at a robust pace. Energy sector and manufacturing jobs expanded briskly in the previous three months, although leisure and hospitality jobs continue to decline. San Antonio’s June unemployment rate fell to 3.3%.
The Permian Basin economy is growing rapidly with surging employment and record low unemployment. Midland-Odessa employment has added jobs at an annualized rate of about 10% for four consecutive months. Employment in the Permian Basin in now higher than during its than during its pre-bust fee. Midland-Odessa's unemployment rate fell to a new low of 2.5% in June, the lowest in the state. For Texas as a whole the Dallas Fed projects 3% job growth in 2018.
Now moving to our financial performance, our net interest margin percentage for the second quarter was 3.64%, up 12 basis points from the 3.52% reported last quarter. Driving the increase was a favorable effect of higher yields on earning assets, primarily loans and balances at the Fed and higher loan volumes. In addition, a lower proportion of earning assets invested in balance at the Fed during the second quarter had a positive effect on the net interest margin percentage.
These favorable variances were partly offset by the higher deposit cost during the second quarter. The taxable equivalent long yield for the second quarter was 4.90% up 25 basis points from the 4.65% reported in the first quarter, driven by the higher rate environment.
Looking at our investment portfolio, the total investment portfolio averaged $11.9 billion during the second quarter, up about $90 million from the first quarter average of $11.8 billion. The taxable equivalent yield on the investment portfolio was 3.36% in the second quarter, flat with the first quarter.
Our municipal bond portfolio averaged about $7.7 billion during the second quarter, up about $59 million from the first quarter. During the second quarter we purchased about $230 million in municipal securities with the taxable equivalent yields of about 4%.
The municipal portfolio had a taxable equivalent yield for the second quarter of 4.1% down 2 basis points from the previous quarter. At the end of the second quarter about 68% of the municipal portfolio was pre-refunded or PSF-insured.
Regarding the income taxes, our effective tax rate for the quarter was 11.1% up from the 9.5% reported last quarter, impacted by higher net income and a lower benefit from stock option settlements during the second quarter as compared to the first. On a year-to-date basis our effective tax rate was 10.3%.
Regarding the outlook for 2018. Estimates for the full year 2018 regarding the estimates for full year 2018 earnings, we currently believe that the mean of analyst estimates for the year of $6.74 is reasonable, given our current assumption of another rate hike in September.
With that, I'll now turn the call back over to Phil for questions.
Thanks Jerry, and with that we’ll open the call for questions.
(Operator Instructions). Our first question today comes from the line of Ebrahim Poonawala of Bank of America Merrill Lynch. Your line open.
Good morning guys.
Good morning.
So I guess if you can first, just wanted to touch upon in terms of deposits. I mean, we saw a pretty sharp decline on a period end basis. Average balances were a little better. If Phil or Jerry you can talk about the dynamics on the deposit front, where the growth – whether you expect those to grow in the back half of the year and the change that we've seen in the cost of deposits quarter-over-quarter?
Sure, but one thing Ebrahim, if you a period end its really kind of soft rock, because those balances fluctuate so much period end to period end from one day to the next, so we certainly tend to focus more on the averages.
So if you're looking, I guess if I look at the year-over-year average for example, you know we're showing a 1.6% of quarter-over-quarter growth compared to the second quarter last year and what we saw was really our demand deposits which for us were about $10.7 billion or about 40% of our deposits. They were actually down about 0.6%. So that's really where we're seeing the decrease and is in those commercial balances.
Our interest bearing accounts were actually up 3.2% compared to the second quarter last year, and really what we're saying is with the alternatives available to customers, we are seeing some dollars moving into some suite accounts for example. The customers are using their balances to grow the business, but there is going to be pressure in deposits as we look through the rest of the year.
For us, we really see a pickup typically seasonally starting in the third and fourth quarter, and right now that's really what our projections show. We're assuming that we’ll have that same sort of trend going up for the latter part of the year.
Understood, and if you could provide a change in the cost of interest bearing deposit for the quarter.
Sure. So the total cost went from – for the first quarter was 16 basis points, going up to 27.
Understood. And just moving to sort of the outlook when we think about the margin and 364, based on sort of the expectation on the deposit front. If we don't get a rate hike, like what’s your expectation for the margin. It should continue to trend higher without the hike and with the hike what's that adding to the margin?
Well, you know what I'd say is again on the net interest margin as we discussed, you know some of that benefit is dependent on what happens with deposits. Our projections right now assume that those will continue to trend up. The interest margin will trend up through this latter part of the year. Really either way with or without the September increase, because again the impact of the June increase isn't completely in our numbers, but obviously better if we get the rate hiked in September, but percentage wise it'll be dependent on the deposit volume.
Got it, and just last question, moving to expenses, we’re running like sub 2% year-over-year in terms of expense growth. Do we still expect expenses to end the year in that 4% ranger or is 2% the right way to think about expense growth for 2018?
No, what I would say, I think you know the guidance I've given is what I'm still comfortable with. What we said, and I think we need to be careful with last year, because remember the network costs are in last year's expenses and this year they made it again. So if you were just out ‘17 expenses, they are like at $747 million, if you're just out the $12 million in network costs, and the guidance I’ve given is that we projected we'd be up about 4.5% from that and that's still a good number.
Got it. Thank you for taking my questions.
Your next question comes from a line of Jennifer Demba of SunTrust. Your line is open.
I was just wondering if you could talk about the loan competition dynamics you saw during the quarter. Where the most opportunities were and where you were seeing maybe the most pricing and structure competition? Thanks.
On the competition side it continues to be – you know it continues to be tough. It's been that way for a long, long time and it shows no signs of abating. I think that the – it's my sense that probably the biggest level of competition you see on price right is probably the fixed rate loans on the smaller side, because you think you get a lot of community banks in that area, which tend to price particularly aggressively, so that's where I would see that.
As far as where our growth is coming from, it's been really well balanced. The biggest part of the growth that we've seen has been in C&I loans and you know that's good, because that's really our wheel house. I mean, we do great with consumer CRE. Obviously we're a good energy lender, but you know this big part of the portfolio that's been growing the most has been C&I and that’s – I think that's partly because of focus and that's partly because of our focus on core loans and those tend to be more in the C&I area and then our – you’ve heard us talk about final authority.
We give some authority to execute transactions on an expedited basis to our people and I think those tend to be C&I as well. And when they are not C&I, I think they tend to be owner occupied CRE for the most part.
Thank you.
Thanks.
Your next question comes from the line of Dave Rochester of Deutsche Bank. Your line is open.
Hey, good morning guys.
Good morning Dave.
I was just curious, next year for 2019, how much in the way of expense savings are you expecting to get for the roll off of the FDIC surcharge?
Dave, we're projecting that number in the $8 million to $9 million range, with tax obviously yeah.
Great! And then the data security expense that was in this quarter, are you expecting that to drop out as we head into the back half of the year?
You know there's a lot of communication that happened early. So I mean as it relates to that part of it, yeah I would think that that would lighten up some, but like anytime you get into the data intrusion issues, you know it's a process, whether its regulatory, legal or whatever. And so you know there will be some ancillary costs. I'm sure that we'll see as we go through that process, but the biggest amount of activity was in that previous quarter.
Yeah okay, and just switching back to the NIM, I know you guys had raised rates on deposits a few times this quarter. I was just curious if you have noted that those increases have had a positive impact already on flows and then if you could just talk about you know maybe where average deposits have trended so far this quarter, just to give an early look on that trend, so it sounds like your positive on that this quarter.
I’ll just make a couple of comments and Jerry can feel in. Yeah, I think definitely they've had a – they are great changes. We’ve had a positive impact. I think year-over-year curious if we're up like around 3.5% or so in time deposit growth and I really believe that would have been a negative number had we not taken the action we did on increasing interest rates.
And then on the average balances so far this quarter, are you seeing that growth there so far?
Let me grab some information here Dave real quick. You know what I’d say is that, you know we are seeing now – you know basically right now I will tell you that we’re probably about flat, maybe up a little bit on average.
Okay, okay great and then just one last one. You know you guys have some great loan growth this quarter and I was just curious how the pipeline heading into 3Q looks verses the pipeline heading into 2Q. It sounded like you were saying it was up from a year ago. I was just curious quarter-over-quarter how that looks.
If you look at the pipeline, your current active pipeline on a linked quarter basis, it was up by, on a gross basis up by 5%. So that’s quarter-over-quarter, weighted basis three [ph]. To me, the park parkland still looks good and I think our outlook for loans still looks good. It hasn't changed from what we've been over the last few quarters and an expecting for this year.
And then just one last one back on the NIM. It sounded like you were saying that you think the NIM can still expand the next quarter, whether you get another rate hike or not in September, I guess expands through the end of this year, whether you get that September rate hike or not and is that just because you were saying you did not benefit the full amount from the June rate hike or you're not expecting to – I guess you had some of the impact in the second quarter and even though you're going to see the rest of it in 3Q, you think that's enough to having them expanding to the end of this year.
Yeah, all I said really Dave was that its trending up. You know I think that obviously if we get to September rate hike, things will look better, but with the June rate hike, its just it was so late in June that we need to factor it really in all the numbers.
Yeah, and that incorporates all the increases that you've made on the calls to deposit side, obviously, yeah. Okay, great, thanks guys.
(Operator Instructions) Your next question comes from the line of Steven Alexopoulos of JPMorgan. Your line is open.
Good morning guys. This is Alex on for Steve. I just want to touch on a question from before on deposit costs. You mentioned 16 to 27 basis points, that's on the total cost of deposits, right?
Right, from 16 to 27 yes.
Got it, okay. It helps. And then just touching on expenses, were there any one timers in the quarter and can you just touch on that for a bit?
Yeah, I think that we tried to identify in the quarter kind of the things that were unique. We did have like $900,000 related to the IT incident that I mentioned. Then we had another $900,000 in settlements during the quarter, settlement costs, and then we had a $500,000 contribution to our charitable foundation, so we’re kind of unique.
Got it, and that’s on a year-over-year basis?
Yes. They would be unique if you will, but the comparison numbers are yes, against the – actually those are distinct numbers in the second quarter. So regardless of the comparison they are distinct numbers, discreet numbers.
Okay, got it.
Did you get that?
Yeah, helpful. And then just given what some of the banks have been saying about the commercial real estate market in a more competitive and even irrational, can you touch on what you're seeing in the CRE space?
Well, obviously the competition is always strong. The thing to focus on and remember about us is we’re not banking things, we’re not doing transactions, we’re banking people, and we’ve got some great relationships as it relates to commercial real estate. And you know it's – again, competition is strong, but you know we see strong equity and projects. You know the economy is good, so. We're being careful, but we've got plenty of opportunity and we’re continuing to see that.
I also said we were down a little bit from last year, because that was such a strong period last year, but I still think the pipeline is good and we’ve got opportunity to really support great customers as they see good projects. Obviously, you got to be careful in what you're doing and things are changing, retail is changing in terms of how we see that underwritten and what good developers are looking for.
But even, you know we’re being careful with multi-family although there are some good opportunities that are that are out there for some great customers, and you know the industrial side, I think it continues to be very strong in Texas, and residential as well. So we got to be careful, but – you know to describe it as irrational from our point of view, I don't think would be accurate, particularly as you relate to the work we do with great customers.
Great. Thanks for taking my question.
Your next question comes from a line of Brady Gailey with KBW. Your line is open.
Yeah, thank you. Good morning guys.
Hey Brady.
Hey Brady.
So just another question on deposit costs. When you look at the total cost of deposits, they are up 11 basis points linked quarter. That’s more of an increase than you’ve all seen in the past, which you know totally makes sense, that's where everybody is headed. But you know just looking at it forward, I just want to get your take on where you think deposit betas will be? I mean if you look at the 11 basis points, that’s about 45% deposit beta. We’re seeing you know some of your peers closer to 80% to 90% deposit pay and do you think that Frost will get up to that level over time?
We were lighthearted on that earlier. If you go back to July last year, I think one reason that we're not at those levels is because we did our heavy lifting you know a year ago, which is why you know we've been able to show some growth.
I think we’ve got some flexibility frankly Brady in terms of the betas that we’re bringing to the table for future increases and we'll see you know. We’ll just keep an eye on the market, take a look at deposit flows and I don’t know Jerry, any comments you have on it?
No, I think I agree with you 100%. I think that’s the way we’re looking at it, is if we do have more flexibility and be able to move accordingly.
Alright and then, real fast, I’m sorry Brady, but as Phil said, I don't think we feel the same amount of pressure today as some of the peers, because it seems that we did a lot of the heavy lifting you know a year ago, so we're not in the same place as they are.
Yeah, and then some of your deposit balances were down a little bit this quarter, you know it sounds like from commercial demand deposits. You know I know you never like to see down deposits, but at the same time your loan-to-deposit ratio is only 53%. So I mean would you be fine seeing a little more deposit shrinkage if that helped keep deposit costs at bay?
Honestly, no. I mean we're really trying to grow organically and make sure our value proposition is working and I think it is. I think what we’re seeing and Jerry mentioned is, you know if you are a commercial business and you have opportunities now, the opportunity costs to leave that in cash is just higher and plus the activity here in Texas is strong, so we're seeing people use money and so that's really the area that I think is going to be most interesting to see.
You know consumer checking accounts are up, you know any interest bearing account categories are up you know and we've done as we’ve said, the lifting to keep that value proposition strong and so I think if it's a deposit – not a deposit, if it’s a funding source that's low cost and somewhat transactional and it's in the commercial area, that's the thing that’s going to be interesting to see.
You know if you look at the growth we've had in commercial, over 100% of the growth we've had in the commercial sector has been from new customers. So you've seen diminishment from our current customer base. That's different than in the consumer side; its roughly 50/50 new customer growth and augmentation on the consumer side.
So it really revolves around this commercial funding base and what we're going to see as rates go up you know, and then I think we'll reach some kind of dynamic equilibrium at some point and then go from there. But while we’re seeing some diminishment in customer balances, I am really happy with the work that our people have done in growing new relationships, again which account for really all the growth in the commercial area. That's really the job that we have had and we’ll continue to have. We've just got to continue to grow long term relationships and we're pretty good at it and we got to stick at it.
Well, and then finally for me, just the duration of the bond book last quarter was 4.8 years. It sounds like that didn't change much in 2Q.
Yeah, I think that's right. I think that it was maybe down to 4.7, so that’s really why I didn’t say anything, yes.
Great, thanks guys.
Sure.
Your next question comes from the line of Jon Arfstrom of RBC Capital Markets. Your line is open.
Thanks, good morning guys.
Good morning Jon.
Hey, just a few follow ups on some of the numbers that seems a little bit outsized. Phil, I think you said on consumer you talked about new account origination up 4.5% unannualized. Is that – did I hear that correctly?
That same store sales, right, stores that have been open for a year or more.
Can you talk a little bit about that? It seems like that's a strong number, if it's unannualized.
Yeah, it is a strong number. Probably we got some seasonality in that, because you know it wouldn’t surprise me that the first quarter is a little bit weak. But you know if you were to look at – let’s say you looked at year-over-year growth, which really isn't the best one to use in this quarter, because the real Grande Valley was down a lot, and that was because, largely because Capital One got out of that market and you know so we had a really big increase as they exited.
So if you look – took the Rio Grande Valley out and you looked at year-over-year growth and same store sales, it would have been 6.8%. And so you know – I mean it's not like annualizing the first quarter, but that's still really good same store sales growth and if you look at you know major markets we were in, you know Dallas was up 14.8%; the Permian Basin was up over 15%; Tarrant County was up over 15%; you know Houston was up over 5%, so those are just some examples. I think you know our value proposition is good and we’re working hard on that, so.
Okay, good, that helps. Two other things here, one other number that seemed outsized. You talked about new energy opportunities down 27% from the year ago quarter. Is that your risk tolerance or is there something else happening that you’d want to call out on that number?
I think it's mainly us pruning the portfolio, just making sure that we’re – you know the things that we’re doing are ones that we really want to do. It really is a good opportunity for us, so it's really our call. We could do a lot more if we wanted to in that line of business.
Okay, last question I have. You talked about the, I think you called it the core loan portfolio of under $10 million and that’s 50% of your commitments. Would you have any idea what your market share would be where you have geographic presence in that under $10 million market?
You know I've seen numbers that we’ve come up with and let me just give you a general feel for it. If you look at companies with sales size, say under $100 million and if you kind of look at it sometimes under 10 and then you look at it under 100, so your just looking under 100, I mean our market share is not that far off from the from the big 3, too big to fail.
And Chase is opened at 100 and under for us on the sell side. We’re probably twice our size, between you know Chase is 100 times our size, sort of more as a company and we're looking at the other two of the big 3. I mean we’re sort of not that far off this year that they have in that segment. Of course they’re usually a lot bigger than we are and the really big companies in Texas, we’d only play in that area, but that’s the numbers that are actually for us and I think we’ve been doing a good job, frankly taking some share there.
Okay. Alright, thank you.
And there are no further questions in queue at this time. I’ll turn the call back to Mr. Green for any closing remarks.
Well, we thank you for your support and that is the end of our call. We appreciate you joining us today.
This concludes today’s conference call. You may now disconnect.