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Cullen/Frost Bankers, Inc. (NYSE:CFR) Q1 2024 Earnings Call Transcript

Cullen/Frost Bankers, Inc. (NYSE:CFR) Q1 2024 Earnings Call Transcript April 25, 2024

Cullen/Frost Bankers, Inc. misses on earnings expectations. Reported EPS is $2.06 EPS, expectations were $2.12. Cullen/Frost Bankers, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Greetings. Welcome to Cullen/Frost Bankers Inc. First Quarter 2024 Earnings Conference Call. [Operator Instructions] Please note, this conference is being recorded. I will now turn the conference over to A.B. Mendez, Senior Vice President and Director of Investor Relations. Thank you. You may begin.

A.B. Mendez: Thanks, Jerry. This afternoon'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 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.

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Phil Green: Thanks, A.B., and good afternoon, everyone. Thanks for joining us. Today, I'll review the first quarter results for Cullen/Frost and our Chief Financial Officer, Jerry Salinas, will provide additional comments before we open it up to your questions. In the first quarter, Cullen/Frost earned $134 million or $2.06 per share compared with earnings of $176 million or $2.70 a share reported in the same quarter last year. The first quarter results were affected by an additional FDIC insurance surcharge accrual of $7.7 million or $0.09 a share associated with the bank failures that happened in early 2023. Our return on average assets and average common equity in the first quarter of 1.09% and 15.22%, respectively, and that compared with 1.39% 22.59% for the same period last year.

Solid earnings from the first quarter demonstrate the success of our organic growth strategy and the hard work of our bankers. Our strength and stability, combined with our core values and strong corporate culture allow us to continue providing world-class service to our customers which results in sustained long-term growth. Our balance sheet and our liquidity levels remain consistently strong. Also, as was the case in previous quarters, Cullen/Frost did not take on any Federal Home Loan Bank advances, participate in any special liquidity facility or government borrowing access any broker deposits or utilizing reciprocal deposit arrangements to build uninsured deposit percentages. And additionally, our available-for-sale securities, representing more than 80% of our portfolio at year-end - at quarter end.

Average deposits in the first quarter were $40.7 billion, down 4.8% from the $42.8 billion in the first quarter of last year. Average loans grew 10.4% and $19.1 billion in the first quarter compared with $17.3 billion in the quarter a year ago. We continue to see excellent results in our organic growth program. For example, we combined our Houston locations and the expansion, they stand at 104% deposit goal, 164% of loan goal and 122% of our new household goal. For the Dallas market expansion, we stand at 174% of deposit goal, 212% of loan goal and 185% of our new household goal. Just after the first quarter closed, we opened the second new location on our 17-site Austin expansion project. Our next new Austin region location will open just after the Memorial Day.

At the end of the first quarter, our overall expansion efforts had generated $2 billion in deposits, $1.5 billion in loans and added over 46,000 new households. And it helps me to put this in perspective, when I remember that the largest acquisition in our history was a company with $1.4 billion in deposits. Our consumer banking business continues to build momentum from the 2023s record net new household growth, and we added 6,600 net new checking accounts for households to the quarter, and we had an annual growth rate there of 6.5%, which we believe continues to put us among the top growing banks in the country. Average consumer loans saw steady growth in the first quarter, increasing an annualized 13% on a linked-quarter basis and hit a milestone of $3 billion in average balances outstanding.

And we remain excited about the prospects for our new mortgage product, which is approaching 200 loans with about half coming in the first quarter. Looking at our commercial business. On a linked-quarter basis, average loan balances increased an annualized 10.5% for C&I and 13.4% increase CRE. Our new commitments booked in the first quarter were 24% less than the level booked in the first quarter of 2023. Our new commercial relationships were up 10% year-over-year and at 825 represented our highest level of first quarter relationships ever. This coincided with us achieving our highest level ever for calling activity in the first quarter. New loan opportunities in our pipeline were up 15% year-over-year and were second only to the last year's spike after SBD's failure.

Our weighted average pipeline stood at $1.46 billion, up by 24% from the fourth quarter and by 17.5% from the first quarter last year. And regarding those 825 new relationships in the first quarter that I mentioned, about half of those continue to come from the two big failed banks. We continue to use discretion as we look at our new loan opportunities. And as an example, I'd point out that in the first quarter, our deals lost were up by 24% year-over-year and 82% of those deals lost were due to structure. Credit quality is good by historical standards with net charge-offs and debt and new nonaccrual loans at healthy levels. We're seeing some normalization in credit risk ratings. And as we come off the historic lows and problems experienced in the years immediately following the pandemic.

And looking at some of the details. Net charge-offs for the first quarter were $7.4 million compared to $10.9 million last quarter and $8.8 million a year ago. Annualized net charge-offs for the first quarter represented 15 basis points of period end loans. Nonperforming assets totaled $72 million at the end of the first quarter compared to $62 million last quarter and $39 million a year ago. The quarter end figure represents a 37 basis points of period in loans and 15 basis points of total assets. Problem loans, which we define as risk grade 10 or OAEM, totaled $809 million at the end of the first quarter. And that's up from $571 million at the end of the fourth quarter and $347 million at the same time last year. 3/4 of the increase was due to company's specific C&I loans with the remainder being CRE credits of various types.

And this growth in first quarter was fairly evenly split between loans and the OAEM or risk grade 10 and classified a risk grade 11 categories and was mainly attributable to a few larger credits, some of which we expect relatively quick resolution for. Less than 20% of our problem loans overall are tied to investor commercial real estate. About 50% are related to C&I credits with most of the balance in owner-occupied real estate, which are closely related to C&I loans. Regarding commercial real estate lending, our overall portfolio remains stable with steady operating performance across all asset types and acceptable debt service coverage ratios and loan to values. Within this portfolio, what we consider to be the major categories of investor CRE, office, multifamily, retail and industrial, for example, totaled about $4 billion or 46% of total CRE loans outstanding.

Our investor CRE portfolio has held up well with the average performance metrics stable quarter-over-quarter exhibiting an overall average loan to value and underwriting of about 53% and average weighted debt service coverage ratio of about $1.47. The investor office portfolio, specifically had a balance of $983 million at quarter end, and that portfolio exhibited an average loan-to-value of 53% and healthy occupancy levels and the average debt service coverage ratio of 1.53, which has slightly improved for the second consecutive quarter. Our comfort level with the office portfolio continues to be based on the character and experience of our borrowers and sponsors and the predominantly Class A nature of our office building projects. In our last conference call, I mentioned that we had just introduced the new Frost Bank marketing campaign and brand refresh designed to emphasize our great customer experiences.

A customer tapping their debit card at an ATM, making a secure transaction.
A customer tapping their debit card at an ATM, making a secure transaction.

We saw the proof points of that in the first quarter when Frost achieved the highest scores nationwide and the Greenwich Excellence Award for the eighth consecutive year and the highest ranking for banking customer satisfaction in Texas in J.D. Power's retail banking satisfaction study for the 15th consecutive year. These are unprecedented achievements. No other bank can say those things. And I hope no other bank ever will. But when you think about it, that level of service is why our customers have come to expect from Frost. That's what we deliver on a daily basis, and it's what we mean when we talk in the new campaign about real-life examples of extraordinary customer service with the description, exactly what you unexpected. And none of this is possible without the dedication of our employees across Texas, their commitment to our culture and their optimistic experience, make all of our success as possible and I'm proud of everything that our Frost teams are accomplishing across all our communities.

And now I'll turn the call over to our Chief Financial Officer, Jerry Salinas, for some additional comments.

Jerry Salinas: Thank you, Phil. Let me start off by giving some additional color on our overall expansion results. As Phil mentioned, we continue to be very pleased with the volumes we've been able to achieve. Looking at the first quarter, growth in both average loans and deposits was approximately 9% when compared to the previous quarter. And for the first quarter, the profitability of the Houston expansion offset the costs associated with the additional expansion efforts in Dallas and Austin. Now moving to our net interest margin. Our net interest margin percentage for the first quarter was 3.48%, up 7 basis points from the 3.41% reported last quarter. Some positives for the quarter include higher volumes of both loans and balances at the Fed and higher yields on loans and investment securities.

These positives were partially offset by higher cost of interest-bearing deposits compared to the fourth quarter. Looking at our investment portfolio. The total investment portfolio averaged $19.3 billion during the first quarter, down $510 million from the fourth quarter. During the first quarter, investment purchases totaled $187 million with $112 million of that being Agency MBS securities and $75 million in municipals. The net unrealized loss on the available for sale portfolio at the end of the quarter was $1.59 billion, an increase of $199 million from the $1.39 billion reported at the end of the fourth quarter. The taxable equivalent yield on the total investment portfolio in the first quarter was 3.32%, but up 8 basis points from the fourth quarter.

The taxable portfolio, which averaged $12.5 billion down approximately $582 million from the prior quarter had a yield of 2.83%, up 8 basis points from the prior quarter. Our tax-exempt municipal portfolio averaged about $6.8 billion during the first quarter, up about $73 million from the fourth quarter and had a taxable equivalent yield of 4.27%, up 1 basis point from the prior quarter. At the end of the first quarter, approximately 70% of the municipal portfolio was pre-refunded or PSF insured. The duration of the investment portfolio at the end of the first quarter was 5.5 years up from five years at the end of the fourth quarter. Looking at deposits. On a linked-quarter basis, average total deposits of $40.7 billion were down $459 million or 1.1% from the previous quarter.

We did continue to see a shift -- a mix shift during the first quarter as average non-interest-bearing demand deposits decreased $720 million or 4.9%, while interest-bearing deposits increased $261 million or 1% when compared to the previous quarter. Based on first quarter average balances, non-interest-bearing deposits as a percentage of total deposits were 34.3% compared to 35.7% in the fourth quarter. The cost of interest-bearing deposits in the first quarter was 2.34% up 7 basis points from 2.27% in the fourth quarter. Looking at April month-to-date averages for total deposits through yesterday, they are up about $134 million from our first quarter average of $40.7 billion with interest-bearing up $332 million and non-interest-bearing down $198 million month-to-date.

Customer repos for the first quarter averaged $3.8 billion, basically flat with the fourth quarter. The cost of customer repos for the quarter was 3.76%, up 1 basis point from the fourth quarter. The month-to-date April average balance for customer repos was down approximately $42 million from the first quarter average. Looking at non-interest income expense on a linked quarter basis. I'll point out a couple of items. Trust and investment management fees were down $1.1 million or 2.7% impacted by lower estate fees down $1.5 million. A state fees can be lumpy as they are based on the value and number of estates settled. Insurance commissions and fees were up $5.6 million or 44%. Property and casualty and benefit company bonuses, which are typically received in the first quarter contributed $3.4 million to the increase.

Benefit commissions were up $2.1 million as the first quarter is typically the strongest quarter for those commissions. As a reminder, the second quarter is typically the weakest quarter for insurance commissions and fees, given our typical yearly renewal cycle. The other non-interest income category was down $6.9 million primarily related to $4.4 million in card-related incentives, as those incentives are received in the fourth quarter each year and a $3.5 million fourth quarter recovery of a previous loss accrual. Salaries and wages were up $1.4 million as increased salaries and higher incentive accruals were mostly offset by stock compensation expense, which was lower by $8.2 million. As a reminder, our stock awards are granted in October of each year and some awards by their nature, require immediate expense recognition.

Benefits expense was up $7.9 million, impacted by higher payroll taxes and 401(k) expenses related to annual bonuses paid during the first quarter and impacted by the normal trend for FICA taxes and 401(k) limits reset at the beginning of the year. Other non-interest expense was down $6.4 million or 9.6%. The decrease was driven primarily by donations expense which was down $3.5 million and professional services down $2.9 million. Regarding our guidance for full year of 2024. Our current projections include two 25 basis point cuts for the Fed funds rate over the remainder of 2024 with one cut in September and another one in November. This is down from five cuts in our January guidance. For the full year of '24, we currently expect full year average loan growth in the high single digits.

That's up from our previous guidance of growth in the mid- to high single digits. Full year average deposit growth in the range of flat to 2%, that's down from our previous guidance of growth in the range of 1% to 3%. Net interest income growth in the range of 2% to 4%, that has not changed from our previous guidance, with the net interest margin percentage expected to trend slightly upward each quarter for the remainder of the year. Non-interest income could be flat to up 1%, impacted by the pressure facing the industry on interchange revenues and OD fees, and also impacted by our high level of sundry income in 2023. That represents a slight improvement from our previous guidance of basically flat. Non-interest expense growth in the range of 6% to 8% on a reported basis, this has not changed from our previous guidance.

Regarding net charge-offs, we still expect those to go up to a more normalized historical level of 25 to 30 basis points of average loans. Regarding taxes, our effective tax rate for the full year of '23, was 16.1%, and we currently expect a comparable effective rate in 2024. No change to this guidance. With that, I'll now turn the call back over to Phil for questions.

Phil Green: Thanks, Jerry. We'll now open up the call for questions.

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