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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning and welcome to the Cullen/Frost Bank 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. [Operator Instructions]
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 2018 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 per 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 shares which is up from $4.70 in 2016. Fourth quarter and full-year 2017 results include the benefit or 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 kept a very good year overall in 2017. Besides the excellent earnings, our return on average assets reached 1.17% for the full-year and it was 1.26% in the fourth quarter. One area of focus in 2017 was balanced quality loan growth and 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 of 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 to longtime customer that it seems to operations.
Net charge-offs in the fourth quarter was $7 million compared with $6.2 million in 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 and we are 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 the $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, and outstanding mobile app, and expanded branch footprint, and competitive deposit rates.
Net consumer customer growth for the year was 2.7% due to high customer acquisition in 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 coming from consumer real estate such as home equity lines of credit, on improvement loans HELOC and home equity loans closed in with that just driven by general consumer and consumer lines of credit, particularly private banking.
Our multi-faceted concentrated effort to effectively grow the consumer loan portfolio included streamlining processes to increase efficiencies in our loan center and hiring additional key lenders. We continue to make progress with our mobile and web based account openings, which you can open new channels for customers to build a relationship with Frost. These digital account openings that help us grow while still applying the same Frost standards that we have in place were 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 defined 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 or paying off extremely well.
For our larger customers, new commitments had above $10 million accounted to 53% of commitment growth. We continue to be successful developing larger relationships. Overall, new loan commitments are about 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 time the sustainable organic growth is only possible by building the 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 to succeed, and by making people's lives better in the areas where they do business. Those positive customer experiences are reflected and the recognition we received from third parties like J.D. Power and the American Banker/Reputation Institute Survey and we continue to build on that success.
During the fourth quarter, Frost has been named in money magazine's list of the best banks in America, which included the designation as the best bank in Texas. And Global Finance magazine named Frost, the best private bank in the Southwest. Bank also can get to be 150 years old without great bankers. As we roll out our 150 anniversary celebrations this year, we plan to do at least 150 volunteer projects and community improvement efforts throughout Texas.
The spirit for Frost employees and their dedication to their communities, their customers, and each other is truly inspiring. I would like to thank everyone at Frost for all their hard work and dedication as we celebrate this milestone and move 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%; flat 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 Texas business outlook surveys suggest continued growth in the state manufacturing and service sectors. The sectors 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 begin 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 leave the state. The Austin economy is the fastest growing major metro area with extremely low unemployment. According to the Dallas Fed, Austin 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 rates 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 unemployment 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 resident's state 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 total has surpassed pre-Hurricane Harvey levels, while energy related jobs are increasing. Financial activities and trade and 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 and looking at our net interest margin. Our net interest margin for the fourth quarter was 3.7%, down 3 basis points from the 3.73% reported last quarter, but as a reminder, last quarter we had an adjustment to our tax exempt loan balances, which had a 3 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 quarters adjusted net interest margin percentage of 3.70%. We had some positive effects offsetting some negative effects, but 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% and 21% statutory tax rate been in effect, our net interest margin percentage for the quarter would have 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 have been up 4 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 security 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 of about $122 million from the previous quarter.
The municipal portfolio had a yield for the quarter of 5.30% down 4 basis points from the previous quarter. And at the end of the fourth quarter about 68% of 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 need of analyst estimate of $6.12 is too low.
With that, I'll turn the call back over to Phil for questions.
Thank you, Jerry. And with that, we'll open up the call for questions.
[Operator Instructions] And 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 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 and just in terms of the make-up of loan growth that you expect in 2018?
Ebrahim, I think we expect consistency of what we've been doing. I am extremely pleased about how we've executed. I'm very optimistic about future execution and I don't want to change what we're doing. And what we're doing as we've got balanced growth, and as we talked about. We are growing larger deals which we renew that we've shown over the last 18 months, 24 months, the continuing momentum and focus on growing, what we call around here the core loans; these are relationships under $10 million.
And you're very valuable because they grow organically as the businesses grow and they're very amenable to a lot of new services we're offering and we offer because your smaller customers. It doesn't sound very sexy, if you put it frankly. But it's really important and so we 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 basis consumer related, and those are great relationships.
And we feel like we've left some money on the table and that we have the ability with the correct products to scale that business in a quality way and we've been doing it. So I'll love what we did and this year in terms of the growth and the level of growth and I'm optimistic about being consistent with that and continuing that growth for this year.
Understood. And it is fair to say that I mean you funded entire loan growth this year with deposits, should we expect the same continuing in 2018?
Yes, I think our projections would say about the same, yes.
Got it, and then 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% to 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?
Phil talked about some of the things that we're going to grow the business. The people that we're hiring and 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. So 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 put our expectations are.
Got it. So closer to 5% on the full sort of reporter 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 3.70% level, which is exactly where you came in the fourth quarter. Do you think that will hold up as we go into 2018? I realize with the tax adjustment off to be the marginal will look closer to 3.40%. But if you think kind of a stable 3.40% margin is the right way to think about 2018?
Brady, what I say is that it's a good starting point, but our projections which show some improvements - some improving trend as we go through 2018.
Okay, and then you guys did a good job of breaking out some of the asset yield, somewhat happened linked quarter. Phil, can you maybe give us an update on any fluctuations in your funding costs in the fourth quarter?
Yes, sure. Let me get that for you.
Like what happened to non-interest bearing deposits –interest bearing deposits?
Sure. Hold on let me get my average balance here. So if you looked that, the third quarter to the fourth quarter, so our total interest bearing deposits went cost of - total interest bearing deposits went from 15 basis points to 19 basis points and our total deposit costs went from 9 basis points to 11 basis points.
Okay. So that mean despite you all putting out, some higher rates like you did earlier in 2017, I mean 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, we did. So with the December rate hike, we did have additional increases in deposit costs. So we're going ahead and increase some of our rates, given what we were saying with alternative products that the customers could go into. So our deposit beta is probably on the high end like in our - we've talked about before, our high yield money market account, which was at 35 basis points for balances over 250,000. We had 40% beta on that product as an example.
Okay, great. Thanks for the color.
And our next question comes from the line of Jennifer Demba from SunTrust. Your line is open.
Hi, Jennifer.
Good morning. It looks like you guys really hit a home run with focusing on the sub $10 million loans rather in 2017, are there any new initiatives for 2018 or you - will you just continue to focus on that particular goal as one of your top priority?
Jennifer, we will continue to focus on the goals that we had in 2017 and just continuing to execute. I'd say, I think we didn't - I wouldn't say we hit a home run as much as we hit a bunch of singles and doubles, and we want to continue to do that. And I think that's the way to rack up runs in the long-term.
Thanks so much.
Our next question comes from the line of John Pancari from Evercore ISI. Your line is open.
Good morning, guys.
Good 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 and how much of that stays there? And do you think there's going to be any intentional reinvestment into the business in terms of the infrastructure and personnel and everything, but also how do you think about the potential for it to be computed away by the industry and some of your competitors? Thanks.
I think that - there's a couple things here. First of all, with regard to reinvesting in the business, yes, we are doing that. I mean 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 will 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 that - with the tax law change to do that and have some earning capacity to reinvest.
So yes, I think that we will do that. We've been obviously investing in our employees. We will be investing and have been, and we will continue to invest in technology, and we've been investing in our value proposition. And one of the things has been - you are making sure rates are competitive for the long-term.
So that will help in that area as well. So it is 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, and that's what I believe we're also seeing and hearing from a lot of our customers.
And then the potential for that to get competed away the remainder of the benefit? I mean how do you feel about that?
Well, we competed every day and some people have - so I don't know. I expect some competitors to be irrational every day. But probably expect the same on me, but I don't expect anything specifically about that. And if besides, I feel like we're in really good spot. I mean as just Jerry said, there is increases in rates. What's our deposit cost Jerry?
Our total deposit costs for the quarter were 11 basis points.
11 basis points. I will compete with anybody with that. I will compete with anybody.
Yes. Got it. And then back to that first answer you gave in terms of yours have been reinvesting or if you care to put a number around it, what percentage 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. 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 more attractive investments. So at this point don't really see any change in our strategy, but 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. And then one follow-up, other fee income it was elevated in the third quarter and then the fourth quarter came in a little bit higher. I'm just wondering what drove the increase and is a more normal run rate what we saw in the first half of 2017?
I think in the - the fourth quarter I guess of this year, I'm looking at - included, I guess that we had about a $2 million gain on the sale of the property. And then if you recall…
And I was taking that out.
Yes, and so you're taking that out and you're still seeing a change or sign?
Yes, so in other words, if I take that out fourth quarter was about $10 million, $9.6 million in the third on a core basis what you said was somewhat elevated and that's around $7 million in the first half?
Yes, I'm not really seeing other than those gains from the sale of property. I mean you know it's kind of lumpy anyway because anything that's unusual flows through there, but the businesses that make-up that business really not seeing any significant changes there. That's where we have our public finance underwriting. And that was a little bit softer maybe if you did a third to fourth sort of view, but we certainly expect that business to pick up. And that's really the only thing that I'm seeing that I would call is unusual in that business lines.
Okay. Thank you.
[Operator Instructions] Our next question comes from the line of Brett Rabatin from Piper Jaffray. Your line is open.
Hi, good morning.
Good morning.
Good morning.
I wanted to ask, you've always had a pre-approved balance sheet in 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 are doing last year and growing relationships in commercial and consumer. Is there 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 reutilization that being successful in a broad-based way, in a balanced way, in the loan portfolio in great markets, remember that, is going to result in other things equal to some increase in loan to deposit ratio. But remember we're focused on relationships overall. And so we're growing deposit relationships as well.
So as we do that we create feedstock for future years and the cost of holding that feedstocks and it continues to go down as interest rates have gone up and you see, let's say the Fed numbers increase. So just the spread you're getting on these relationships that will bringing it now or much more valuable than they have were almost real interest. And so incense continued to focus on relationships, creates what once call it around high class problem, your growing deposits.
But when you do that and the relational aspect of it gives you the kind of deposit cost. You just mentioned at 11 basis points, which is not because we're paying under market is everyone knows, we're aggressive and in the market with our relationship really because we got so many transactional accounts quarter - accounts in that way. So you know it's all that news forward and that's what we're really doing is just focused on relationships. The loan relationships to deposit relationships and just intruded what we are.
Okay, fair enough. And then 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?
I wouldn't say it here. I think that we're always looking at all kinds of alternatives. So the people that do that for us regularly propose a lot of different things and then in our team regularly that's it. You got the same people basically sitting on that HELCO committee that have been there for years.
We understand this balance sheet and how it works, who knows. But the thing is - those things are great and sometimes it's better to be lucky than good on that spot, it seems fantastic. But I think I'm most excited about is, is not hidden home loans because we make a great decision on interest rates 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 those great people. It's because we have a great culture.
And when you have a great culture like that over time, it draws me between and end up with great people and so when you add to that, a great value proposition and you add to that we're in tremendous markets. There is someone to find a better place to do business in Texas today.
And we add that to our Banners understand of what they're supposed to be doing. And then you add to that that we're doing it. That's why 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 in commitment over a long period of time. We couldn't sit here you come up with a plan from next year that says let's do all this, okay. Let's put this in place. You can do it, but we've got it in place, people are doing it. Great, markets doing it. That's the thing I'm most excited about.
Okay, great. I appreciate all the color Phil.
Thank you.
And our next question comes from the line of Dave Rochester from Deutsche Bank. Your line is open.
Hey. 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.
And our next question now comes from the line of Steve Alexopoulos from JPMorgan. Your line is open.
Hi. This is actually Jason Oetting on for Steve today. I'm just curious how do you guys think about the 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 are doing a nice job with it. And it really relates to three key areas. We got great dividend, right. We've increased through 24, whatever have been in the years. It's an important thing to us. We want to continue to maintain that in place and increase it as our prospects increase, so we'll focus on that.
Secondly, we utilized stock buybacks in the third quarter. We have had dislocation in price after the rate increase that we did, bought back 100 million shares in that program and then added right after that $150 million program for a couple years, so we've got that in place using. We will use it if we feel like it's in the Company's best interest.
We have occasionally, but I would say rarely, do an acquisition. That's not the key focus of what we are doing right now. Key focus of what we are doing is in organic growth. As you're growing loans in high single-digits and our deposit growth has been, say mid single-digit. You are going to end up spending your regulatory risk-based capital faster than you're spending your leverage ratio if you will.
So we're using it to grow the business and that's what I'd love to do. I mean I love for us to pay capital and brought back in the business and continuously grow. So we've really got to - I think the three legs in stool and we have utilized and we will continue to be utilized in those.
Okay. That's helpful. Thank you.
[Operator Instructions] And we have no further phone questions at this time.
Great. 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.