Cullen/Frost Bankers, Inc. (NYSE:CFR) Q4 2023 Earnings Call Transcript

Cullen/Frost Bankers, Inc. (NYSE:CFR) Q4 2023 Earnings Call Transcript January 25, 2024

Cullen/Frost Bankers, Inc. misses on earnings expectations. Reported EPS is $1.55 EPS, expectations were $2.01. 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. Fourth Quarter and Full Year 2023 Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [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, Sherry. 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.

Phil Green: Thank you, A.B. Good afternoon, everybody, and thanks for joining us. Today, I’ll review fourth quarter results for Cullen/Frost and our Chief Financial Officer, Jerry Salinas will provide additional comments before we open it up for your questions. In the fourth quarter, Cullen/Frost earned $100.9 million or $1.55 per share compared with earnings of $189.5 million or $2.91 a share reported in the same quarter last year. Now these results were affected by a $51.5 million one-time FDIC insurance surcharge associated with the bank failures that happened early in 2023. Our return on assets and common equity for the fourth quarter were 82 basis points and 13.51% respectively, and that compares with 1.44% and 27.16% for the same quarter – same period last year.

For full year 2023, the company’s annual net income available to common shareholders was $591.3 million. That’s an increase of 3.3% compared to 2022 earnings available to common shareholders of $572.5 million. On a per share basis, 2023 full year earnings were $9.10 a share compared to $8.81 a share reported in 2022. As we mentioned in this morning’s press release, just for the one-time FDIC insurance surcharge, our yearly earnings would have been up by approximately 10% over 2022. This solid fourth quarter and full year performance is due to the continued strong execution of our organic growth strategy by Frost Bankers who provide our customers with top quality service and experiences that make people’s lives better. Our balance sheet and our liquidity levels remain consistently strong.

Frost remains very well capitalized and has a 45% loan-to-deposit ratio. Also, as was the case in previous quarters, Cullen/Frost did not take on any home loan advances, participate in any special liquidity facility or government borrowing, access any broker deposits or utilize any reciprocal deposit arrangements to build insured deposit percentages. And additionally, our available-for-sale securities portfolio represented more than 80% of our portfolio total at quarter end. Our average deposits grew in the fourth quarter to $41.2 billion, up an annualized 3.5% from the $40.8 billion in the previous quarter. Average loans also grew in the fourth quarter to $18.6 billion compared with $18 billion in the third quarter. That was an annualized increase of 14.3%.

We continue to see excellent results from our organic growth program. For example, our original Houston expansion locations stand at 103% of original deposit goal, 155% loan goal and 122% of our new household goal. For what we call our Houston 2.0 locations the last of which will open this year, we stand at 297% of deposit goal, 351% of loan goal and 185% of new household goal. As of quarter end, expansion loans and deposits represented approximately 24% and 19%, respectively, of our total Houston market presence. For the Dallas market expansion, we stand at 217% of deposit goal, 269% of loan goal and 198% of our new household goal. While still relatively early in this effort, expansion loans represent approximately 12% and deposits represented approximately 10% and of Dallas market totals.

We’ve opened up almost two-thirds of our planned locations in the Dallas market, and we look forward to their growth as these locations mature past the start-up phase. And we’re also excited about our new Austin expansion effort, where we plan to open 17 locations to double our presence in that market, as we’ve mentioned before, and the first of those opened in 2023 and the next is scheduled to open in April. Keep in mind that we’ve been successful generating core stable grassroots business and our expansions, and that will generate significant value over the long-term. At year-end, our overall expansion efforts have generated $1.9 billion in deposits and $1.4 billion in loans even though many of these locations are still early in their development.

Looking at our Consumer Banking business, we continue to see outstanding organic growth, and we ended 2023 with a record net new household growth of 28,632 households. Again, that’s net growth and it’s 12% higher than last year’s net household growth. In the past three years, we’ve added 81,000 net new consumer checking households. That’s 2.6 times more than the three years before that. And that shows that our organic growth strategy combined with our customer experience and reputation is key to our success. We have the right products and services and relationships to help customers in our markets. Also, as we’ve noted, we’re excited about the prospects for our new mortgage product, we completed the product rollout in December to the last of our regions, which was the Houston region.

And in the fourth quarter, we approached the milestone of originating our first 100 mortgages and we expect faster growth in 2024. Looking at our commercial business, our weighted pipeline is at $1.175 billion and that was down from the record that we set of $1.918 billion in the third quarter. In the fourth quarter, we brought in 960 new relationships. That’s the third highest quarterly amount ever, up an unannualized 8.7% over the third quarter and up 21% over the fourth quarter last year. This shows me that our success in growing our business organically includes not only a consumer, but also commercial business as well. For the full year, new commercial relationships added $806 million in new loan balances and $800 million in new deposits.

Credit quality continues to be good by historical standards, with non-accrual loans down from the previous quarter and net charge-offs at healthy levels. Problem loans, which we define as risk-grade 10 or higher, totaled $571 million at the end of the fourth quarter. That was up from the $513 million at the end of the second quarter and $320 million this time last year. This growth in the fourth quarter was evenly split between loans in the OAEM and classified categories, another way of saying risk-grade 10 and risk-grade 11 categories. Non-performing assets total $62 million at the end of the fourth quarter compared with $68 million last quarter and $39 million a year ago. The year-end figure represents just 32 basis points of period in loans and 12 basis points of total assets.

Net charge-offs for the fourth quarter were $10.9 million compared to $5.2 million last quarter and $3.8 million a year ago. Annualized net charge-offs for the fourth quarter represent 23 basis points of average loans and full year charge-offs were 18 basis points of loans. Regarding commercial real estate lending, our overall portfolio remain stable with steady operating performance across all asset types and acceptable debt service coverage ratios and loan to values. Within this portfolio, what we would consider to be the major categories of investor CRE, that is office, multifamily, retail and industrial as examples totaled $3.9 billion or 44% of total CRE loans outstanding. Our investor CRE portfolio has held up well with the average performance metrics slightly improved quarter-over-quarter, exhibiting an overall average loan to value of about 53% and weighted average debt service coverage ratio of about 1.44.

The investor office portfolio in particular had a balance of $891 million at quarter end, which was down from $959 million the prior quarter. That portfolio exhibited an average loan to value of 49% and an average debt service coverage ratio of 1.54 and healthy occupancy levels, all of which improved from the prior quarter. Our comfort level with our office portfolio continues to be based on the character and expertise and experience of our borrowers and sponsors, as well as with the predominantly Class A nature of our office building projects. And again, we’re glad to be operating in Texas. More than 90% of our office portfolio projects are in Frost markets, which are Texas’s major metropolitan areas. We continue to see good economic growth and strong levels of immigration of both people and businesses.

I also wanted to note that from September 30 to December 31, total investor office outstandings decreased 7% from the linked quarter and total commitments decreased by 9%. Finally, I’ll point out that we’ve just rolled out a new Frost marketing campaign and brand refresh designed to emphasize the great customer experiences we provide in order to differentiate our voice in a crowded banking marketplace. We’ve been talking for some time about the need to invest in marketing capabilities to complement the organic success we’ve been achieving, and we’re optimistic about the impact this will make in customer acquisition. So in closing, we remain optimistic for what lies ahead. We’re capitalizing on opportunities, we’re enhancing and expanding our brand, and I’m proud of everything that our Frost teams are accomplishing across 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 Houston 1.0 expansion results. As Phil mentioned, we’ve been very pleased with the volumes we’ve been able to achieve. Looking at the fourth quarter, linked quarter growth in average loans and deposits were $52 million and $78 million, respectively, each representing approximately 24% annualized growth. And for the fourth quarter, Houston 1.0 contributed $0.07 to our quarterly earnings per share. Now, moving to our net interest margin. Our net interest margin percentage for the fourth quarter was 3.41%, down three basis points from the 3.44% reported last quarter. Some positives for the quarter included higher yields and volumes of both loans and balances at the Fed.

These positives were primarily offset by higher costs and volumes of deposits and customer repos compared to the third quarter. Looking at our investment portfolio, the total investment portfolio averaged $19.8 billion during the fourth quarter, down $723 million from the third quarter. During the quarter, we did not make any material investment purchases. The net unrealized loss on the available for sale portfolio at the end of the quarter was $1.39 billion, a decrease of $825 million from the $2.2 billion reported at the end of the third quarter. The taxable equivalent yield on the total investment portfolio in the fourth quarter was 3.24% flat with the third quarter. The taxable portfolio, which averaged $13.1 billion, down approximately $471 million from the prior quarter, had a yield of 2.75%, down one basis point from the prior quarter.

Our tax-exempt municipal portfolio averaged about $6.7 billion during the fourth quarter, down about $252 million from the third quarter, and had a taxable equivalent yield of 4.26%, flat with the prior quarter. At the end of the fourth quarter, approximately 71% of the municipal portfolio was pre-refunded or PSF insured. The duration of the investment portfolio at the end of the fourth quarter was 5.0 years down from 5.7 years at the end of the third quarter. Looking at deposits. On a linked-quarter basis, average deposits of $41.2 billion were up $356 million or 3.5% on an annualized basis from the previous quarter. We did continue to see a mix shift during the quarter as average non-interest bearing demand deposits decreased $126 million or 0.9%, while interest-bearing deposits increased $482 million or 1.9% when compared to the previous quarter.

Based on the fourth quarter average balances, non-interest-bearing deposits as a percentage of total deposits were 35.7% compared to 36.3% in the third quarter. Looking at January month-to-date averages for total deposits through yesterday, they’re basically flat with our fourth quarter average of $41.2 billion. For January month-to-date through yesterday, the average non-interest-bearing deposit balance was $14.39 billion, down $309 million from the fourth quarter average affected by seasonality, as those deposits tend to peak in the fourth quarter and soften in the first half of the year. For January month-to-date average, interest-bearing deposits through yesterday were $26.8 billion, up $309 million from our fourth quarter average. In the January month-to-date average, we do continue to see a shift in the mix in interest-bearing deposits to higher cost CDs from lower-cost products.

The cost of interest-bearing deposits in the fourth quarter was 2.27%, up 15 basis points from 2.12% in the third quarter. Customer repos for the fourth quarter averaged $3.8 billion, up $225 million from the $3.5 billion average in the third quarter. The cost of customer repos for the quarter was 3.75%, up eight basis points from the third quarter. The month-to-date January average for customer repos was basically flat with the fourth quarter. Looking at non-interest income and expense on a linked-quarter basis, I’ll just point out a couple of items. The other non-interest income category included a $3.5 million recovery of a fraud-related loss accrual that we recognized in the fourth quarter last year. Salaries and wages included approximately $8.8 million in higher stock compensation compared to the third quarter.

As a reminder, our stock awards are granted in October of each year, and some awards by their nature require immediate expense recognition. The other non-interest expense category included a donation to our Frost Charitable Foundation of $3.5 million. Regarding estimates for full year 2024, our current projections include five – 25 [ph] basis point cuts for the Fed funds rate over the course of 2024. For the full year of 2024, we currently expect full year average loan growth in the mid to high single digits. Full year average deposit growth in the range of 1% to 3%. Net interest income growth in the range of 2% to 4% with the net interest margin percentage expected to be slightly higher for full year 2024 than the 3.45% we reported for 2023.

Non-interest income could be relatively flat given the pressure facing the industry on interchange revenues and OD, NSF fees. Non-interest expense growth in the range of 6% to 8% on a reported basis. Regarding net charge-offs, we do expect those to go up in 2024 to a more normalized historical level of 25 basis points to 30 basis points of average loans, given the unusually low level we’ve seen in the last few years. Regarding taxes, our effective tax rate for the full year of 2023 was 16.1%, and we currently expect a comparable effective tax rate in 2024. Going forward, given, the wide range of analyst estimates and the results and impact on the mean of estimates, we do not plan to comment on consensus EPS as we have in the past and will instead provide our outlook for the major building blocks of our profitability.

With that, I’ll now turn the call back over to Phil for questions.

Phil Green: Thank you, Jerry. Now, we’ll open up the call for questions.

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Q&A Session

Operator: [Operator Instructions] Our first question is from Ebrahim Poonawala from Bank of America. Please proceed.

Ebrahim Poonawala: Good afternoon.

Phil Green: Hey, Ebrahim.

Ebrahim Poonawala: I guess maybe first question for Jerry, your outlook with the five rate cuts for NII growth. You mentioned about 2% to 4%. Just give us a sense of the sensitivity, my understanding is the balance sheet is still asset sensitive. So first, whether that’s right or wrong. And then as the year progresses, do you expect NII to drift lower? Or do we build from fourth quarter levels? And are you just outrunning rate cut impact because of balance sheet growth and fixed rate asset repricing?

Jerry Salinas: That’s a lot. Let me first say that, yes, we still are asset sensitive. I think we’ve talked about this in the past, and I’ll just kind of go through some of the pieces of it and fill in as I can remember your question. But one of the upsides that we talked about was that we’ve got projected about $3 million in proceeds from our investment portfolio. And about $1.45 billion [ph] if I remember correctly, is in the first quarter. So a big chunk of it comes in. And the yields that, that portfolio has – I think we’ve talked in the past about some specific treasury securities that we had purchased. I think $750 million of that is going to mature here this month, and the yield on that portfolio was a little 102 [ph], I think it was.

So some of what we’re seeing is a pickup that we’re going to get just from the – even if we don’t reinvest in investment securities, even in that rate environment that we’ve discussed, it would still be favorable to our net interest margin percentage. We’ve also seen some improvements, I was noting in our fourth quarter loan spreads that we booked, not huge, but there are some improvements during the quarter. I think that’s going to be a positive to us as well. So no, I mean, I think overall, we’re feeling good about net interest income and net interest margin based on where we’re at. I mentioned that we continue to see a mix change, but the changes that we’re seeing at this point, in my mind, aren’t really material. I think especially in a rate environment where we’ve been for a while now, and even if you said it was flat, I think the bulk of the rate competition for the most part is gone.

We still continue to see especially smaller banks, smaller local and regional banks be, what I think is really putting out some unrealistic deposit rates that we’re not going to match. I think we’ve always said to the community that we don’t intend to be the highest rate in the market, but we do want to be competitive. In a rate environment, as we portrayed, I think we find ourselves being able to be more competitive on money market funds because our betas typically have been – of a range, we’ll take a money market, have been like 60%. In that the rate environment that we’re talking about, some of those shorter duration investments that those funds would be making. They have 100% beta, if you will. So I think we’ll find ourselves in a much more competitive situation.

You heard me say we’re not projecting a huge growth in deposits. I think that we feel really excited about the level of loans and deposits that are coming from our expansion branches. I think we’re really excited about that. We’ve also talked about continually about the nice growth that we’ve had in commercial relationships. As we’ve said in the past, those relationships take a little bit longer to get all the accounts moved over and signature cards done, et cetera. So I think overall, we’re not too aggressive on deposits. I think there – it’s still to be seen. We saw a little bit of a downtick, as I said in January, on the commercial DDA. But as we look at our trends, that’s really pretty normal for us. So I think we’re still feeling good about all that and still feel like we’ve got some room to improve on the NIM percentage and net interest income.

We’re not talking on net interest income. As I gave guidance on 2% to 4%, and that’s given the rate environment that we’re talking about. If you were – if we were talking about a flat environment, just to give you some perspective, I’d probably be talking about increasing those percentages, say, 1.5%. We feel a little bit nicer improvement in our NIM in that situation.

Ebrahim Poonawala: That was good color. So thanks for your patience there, Jerry. And maybe a question just on loan growth. When I look at the period-end balance it would equate to about 5% growth starting out for the year. So it suggests that you don’t expect as much momentum on loan growth looking forward. So maybe Phil, give us some perspective around customer sentiment and whether you are seeing that slowdown play out? And given that we’re going – entering sort of an election cycle, do you expect loan growth to be weighed down by that as well?

Phil Green: It’s a good question, Ebrahim. I think that – with regard to sentiment, I believe that things are slowing some with regard to that. And I think some of it is what you mentioned that typically happens with an election year. People are wanting to know what the regulatory environment is going to look like. So I think there’s some of that. I think there’s just a general slowdown and some other things in interest-sensitive areas, say, like obviously, real estate, commercial real estate deals, some interest-sensitive areas, I would say, used cars, for example, if you’re looking at a specific segment. So there is some of that. And I looked at our pipelines also. Our new loan commitments were up about 9% linked quarter annualized.

So recent activity has been good, but if I want to look at our opportunities, they are down a little bit from where they were last year. They’re down about 7%. On a linked-quarter basis, they’re down about 17, depending on whether you’re looking at a customer or prospects, prospects are down about 26%. So that just shows what’s kind of going into the hopper, if you will, says to me that we’re slowing in terms of what’s available and what we’re seeing. I should point out that if you did look at our core loans, which are those loan relationships under $10 million, that if you look versus last year, those are actually up 28%. So we’ve seen most of the slowdown year-over-year to be in larger deals. And I think that represents that expansion strategy.