Will small regionals copy Cullen/Frost's expansion plan?

Forget the third-quarter results — Cullen/Frost Bankers’ new expansion plans in the Houston market took center stage instead during its quarterly conference call Thursday.

Among the questions analysts had for Chairman and CEO Phil Green: Why Houston and not Dallas-Fort Worth, where it has 50% more deposits? How fast will these 25 branches it's opening break even? And how much of this is driven by intensifying competition for deposits in a rising-rate market?

Green and his team outlined several key details about their plans, including their approach to hiring and deposit-gathering. But Green kept coming back to one central message: The San Antonio company’s Frost Bank unit already has strong name recognition in the rapidly growing Houston market, and it would be foolish not to use that as a launching pad for future growth.

“It really is opportunity that we’ve left on the table, and we haven’t made the investments to grow that,” Green said. “We’ve got the chops, in my view, to get this done.”

Several large banks and big regionals have made splashy announcements recently about expansion into new markets that include opening hundreds of branches, but Cullen/Frost’s move to nearly double its presence in Houston goes against the grain for smaller regionals.

It is clear that big banks see physical branches as crucial to deposit growth. JPMorgan Chase recently announced plans to build 400 new branches over the next five years in cities like Boston, Philadelphia and Washington, where it had had none. Likewise, Bank of America will add 500 new branches over the next five years.

And Fifth Third Bancorp in Cincinnati intends to resume a Southeast expansion plan it began before the financial crisis, with plans to add 100 to 125 branches in markets like Nashville, Tenn., Charlotte, N.C., and Atlanta.

Smaller regional banks have largely moved in the opposite direction, trimming branches in a broader effort to keep costs down and appease investors, although a handful have selectively expanded.

The $18.2 billion-asset FirstBank in Denver, Colo., has said it plans to add around 100 new employees this year and expand in the Phoenix market. Signature Bank in New York plans to open an office in San Francisco. And Flagstar Bancorp in Troy, Mich., recently bought 52 branches from Wells Fargo.

But smaller banks have still struggled to fend off competition for deposits from their larger competitors and the online banks that are increasingly scooping up market share. The online-only Ally Bank, for example, added 57,000 retail deposit customers during the third quarter and reported that deposits rose 12.5% to $101 billion from a year earlier.

Cullen/Frost plans to nearly double its branch count in the Houston market, ultimately adding 25 locations at a pace of about one per month through 2019 and 2020. It will also hire about 200 employees, adding to the 32 branches and 600 employees it already has in the market. Frost Bank had $4.5 billion in deposits and 1.83% market share in Houston as of June 30, according to the Federal Deposit Insurance Corp.

The quest for deposits is one significant reason, but not the only one, behind the expansion.

Green said his team found that 60% of new digital accounts opened in the Houston market are within a five-mile drive of a branch.

“Even though digital’s important, physical locations are as well,” he said. “What we’re doing is giving both alternatives to the customer.”

But Frost Bank expects that its Houston expansion will follow largely the same strategy that has been working for it already. Its deposit base is roughly 55% commercial and 45% consumer, and its loans are about 85% commercial and 15% consumer.

“Those are the kind of metrics we're going to continue to expect,” Green
said.

Third-quarter profits at Cullen/Frost increased 27% to $115.8 million. Loan growth of 8.7% and noninterest income growth of 7.4% were two of the main reasons.

At $1.78, earnings per share came in 6 cents higher than the mean estimate of analysts surveyed by FactSet Research Systems.

The company anticipates that the costs associated with the Houston expansion plan will reduce next year’s earnings per share by about 19 cents.

Green said that based on prior experience, he expects each new branch to post a net loss of roughly $1.5 million until it breaks even, usually about 27 months after opening.

But why Houston and not another area where Cullen/Frost has branches, an analyst asked, like say, Dallas-Fort Worth?

It’s not that Cullen/Frost is planning to neglect the Dallas-Fort Worth market, where it has $6.8 billion in deposits and a 2.48% market share. In fact, Green said, the company has “a number of locations on the board” for that market, as well.

But Houston represents a significant growth opportunity, where the company can grow to a share closer to what it has in San Antonio, where Frost boasts the No. 2 deposit market share of 7.46%.

“Right now, we felt like the best place for us to allocate our energy and capital and resources was in the Houston market,” he said.