Good morning. My name is Nicole and I will be your conference operator today. At this time, I would like to welcome everyone to the Cullen/Frost Bank’s Second Quarter Earnings Conference Call. [Operator Instructions] I would now like to turn today’s call over to Mr. Greg Parker, Executive Vice President and Director of Investor Relations. Mr. Parker, you may begin.

Thank you, Nicole. 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 will turn the call over to Phil.

Thank you, Greg. Good morning and thanks for joining us. Today, I will review second quarter 2016 results for Cullen/Frost. 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 $1.11 per diluted common share, which is flat with the same quarter last year and up from $1.07 a share reported in the previous quarter. Looking overall at the second quarter, credit quality was stable and showed signs of improvement over the first quarter. Our provision for loan losses was $9.2 million compared to $28.5 million in the first quarter. Non-performing assets dropped by more than half from $180 million in the first quarter to $89.5 million in the second. Net charge-offs in the second quarter totaled $21.4 million, the vast majority of which were specifically reserved for in prior periods. We are seeing other signs of growth compared with the first quarter. While energy loans continue to drop, total loans outside the energy sector grew at an annualized rate of 7.9% between the first and second quarters. The first quarter of this year included one-time events like the net gain of $15 million from the sale of securities that reduced our concentrations in oil-dependent economies. It also included a more stringent regulatory debt to EBITDA standard, which we apply to our energy portfolio. The second quarter has been more towards a return to business as usual. Looking deeper at credit quality, regarding the reduction in nonperforming assets, I mentioned earlier, nearly the entire reduction was a result of payoffs on three credits: two payoffs were energy credits totaling $62.8 million; the other was a payoff on a real estate credit of $22.6 million. As a part of these payoffs, we charged off $11.3 million…

Thank you, Phil. I am going to make some comments about the Texas economy then I will give some additional color on our financial performance before giving an update on 2016 guidance. I will then turn the call back over to Phil for questions. The Texas economy continues to grow, thanks to market and industry diversity, population growth and a business friendly environment. According to the Dallas Fed, the state’s economy grew 1.2% in the second quarter of 2016 compared to 1.3% decline in the first quarter of this year. The Dallas Fed now expects 1.1% expansion in the second half of 2016 for a total annual job growth of 0.5% in Texas this year. The state unemployment is 4.5% compared to 4.9% nationally. According to the Texas Comptroller’s office, the state unemployment rate has been at or below the national unemployment rate for more than 9 years. Oil price increases in the first quarter and price stability in the second quarter provide reasons for optimism. Texas manufacturing activity improved in July, although the rise in the dollar continues to challenge manufacturers. Looking at individual markets, Austin, Dallas, Fort Worth and San Antonio remain strong with very low unemployment rates. Annualized job growth in Austin is 2.1%, with an unemployment rate of only 3%. Growth is broad based with notable expansions in retail trade, healthcare and construction. Dallas, Fort Worth is growing at an annualized rate of 2.7% or twice as fast as the national economy. The top three growth areas in DFW are financial services, education and health services and trade transportation and utilities. The housing market remains red hot. Dallas, Fort Worth is now the top U.S. market in annual new home starts. Thanks in part to a number of prominent corporate relocations from other states. The unemployment…

Thank you, Jerry. We will now open up the call for your questions.

[Operator Instructions] Your first question comes from the line of Steven Alexopoulos from JPMorgan. Your line is open.

Hi, good morning everybody.

Good morning.

Good morning.

Can we start – just one question on energy, I think you said special mention were flat, but could you give us the actual balance of special mention and classified and criticized as well?

Yes. Are you talking about for the energy selection?

Yes. Just for energy.

Okay. I would say, the total of risk rate 10, which is going to be our criticize is $296 million, let’s say at the end of second quarter. Risk rate 11 would be – sub-standard would be $228 million. And then, 12s and 13s would be about $42 million combined.

Okay, that’s helpful. At $45 oil, how do you guys see this playing out from here, should we expect to see potential problem loans start to decline or is it just too early?

At $45 oil, our portfolio is stable. As it relates to the oil piece of the portfolio, we are actually seeing some customers who are increasing drilling. We are seeing rig counts increase particularly in the Permian Basin at $45. I think our portfolio is probably stable at $40, say $40 to $45 as it relates to oil. Given the technology that’s happened and the improvements in technology, improvements in efficiencies and drilling, $40, $45 you can make the decent return if you are in the good plays. Another thing we have seen at these price levels is we have begun to see sales of properties. Just some of our customers, just anecdotally one of them had $400 million sale of public company. Once – some things that are working right now, either have been done or pending, once got a $50 million sale. Now this has got $125 million sale, once it got an $80 million sale and what they are selling in most of these cases is acreage, it’s really not production. And so what you see also these are public companies typically at this point that we are seeing doing these deals. So, it looks like people are trying to take advantage of what’s happened with technology and efficiency to take advantage of some of this good properties and good acreage out there and we are seeing to make good prices.

That’s helpful. Maybe just one follow-up, are you seeing again with oil given that it’s recovered, increased competence for commercial borrowers as well. I think you said the pipeline was up, but are you seeing confidence levels improve there? Thanks.

It depends on the market that you are in. I think you have seen increasing confidence in some markets, that be in, let’s say, cost and for example, North Texas. Houston I would say is fairly consistent, not a lot of greater confidence, but they have been – they have had a fair amount of confidence through this whole period of time. I think the weakest area is going to be out in heavily oil-related economies like the Permian Basin and say Corpus Christi, but when all got to be in the $40s, yes, it definitely let a lot more air in the room.

Okay, thanks for all the color.

Thank you.

Your next question comes from the line of Emlen Harmon from Jefferies. Your line is open.

Good morning.

Good morning.

Good morning.

Clearly, you guys with the non-accrual booked on quite a bit this quarter, could you talk about kind of what it was that brought those balances down, whether you mentioned some asset sales earlier, whether borrowers were able to kind of prove their financial condition, if it was something where you had to work out some credits or sell assets? Just be kind of curious how you are able to affect that decline and whether you would anticipate being able to do some more of that?

Well, the biggest factors were three credits and little bit different situation in each one of them. The one non-energy credit was commercial real estate. It was a hospital that has some problems. It was in bankruptcy foreclosure and it was sold. We recovered all of our balances, all our principal and interest, all our expenses, attorney fees, etcetera. It was sold for much more than what we had looked for or the – it was sold for a great price. The other two were energy credits. One was a company that sold properties and was able to pay down debt and so we were the beneficiaries of that. And then the third one was one where we saw a credit that we had written down significantly. And when we saw what third-party prices were being paid for that credit, we decided to hit the bid. We actually freed up about $4.5 million in reserves related to that problem asset sale. And on the one where I have said we had a company that sold energy properties, we freed up about $5.2 million in reserve on that one. So, when you look at the two energy credits, one which paid down because they sold properties and one which was a payoff because we sold the credit, we freed up about $10 million in reserve for both of those combined.

Got it. Thanks. And then if we just look at the total energy portfolio, it looks like it was down a couple of hundred million quarter-over-quarter. Would you expect the continued kind of diversifying out of that portfolio over the next few quarters just trying to get the size of that down?

I think you are likely to see a decline overall in the energy component, but that doesn’t mean we are not looking at good deals. And the deals that we are seeing, they are very heavily capitalized and they are in producing properties. And so there are people that are taking advantage of it, but we are continuing to work out on the weaker – the credits, the ones maybe where the relationship is not as strong as it should be or we would like it to be. And just from the hedges we set for years to get the – let the good stuff grow and trim the stuff off the bottom that it doesn’t make sense for us to be in.

Okay, thanks. I will step back.

Your next question comes from the line of Brady Gailey from KBW. Your line is open.

Hey, good morning guys.

Good morning.

Good morning.

Maybe just a follow-up on that last point, so it sounds like energy balances could head lower. So, do you think we will see the same magnitude or shrinkage over the next quarter or two that we saw in the second quarter or maybe to ask it differently, energy is $1.5 billion where would you expect that portfolio at a bottom? I am just trying to get a sense on that you haven’t grown total loans, much at all in the first half of the year driven by the shrinkage of this energy book?

Brady, I don’t expect it to have the same kind of decline that you seemed to have over the last 6 to 12 months. It could decline some more, I think the rate of decline as we have seen has reduced. And again, we are beginning to see some deals that make a lot of sense based upon the way they were structured. So, as we see really good opportunities, we can take advantage of them. I don’t really have a projection of what energy will be going forward. It’s just going to depend upon what we see and our appetite for it. I will tell you that a number of people who used to be in this business apparently are not anymore. And so their field is there to take advantage of what’s out there in the market. So, as I have said before we are going to continue to be in this business. It’s important to the country. It’s important to Texas. And we are going to be in it for the long-term. But we are just – we are not going to see a lot of growth in the business for a little while.

Okay. And then you talked about Houston slowing, but it’s still kind of hanging in there fine. What’s your update at Houston’s CRE exposure? I think last quarter it was around $760 million. Did that change much in 2Q?

No, I don’t think we have seen a lot of change. And I think the – we are just looking at CRE overall, but we feel really good about the portfolio, only about 3.8%, let’s say, less than 4% of the CRE portfolio is classified 10 or higher, which would be criticized or as we say, the problem loans. If you look at some of the markets, Houston has about – these are round numbers. Houston has got about 20% of our CRE portfolio. It’s got about $47 million in loans classified as problems or like I say, 10 or greater. Only about $19.6 million of that relates to energy and the majority of those are owner-occupied warehouses. The largest energy-related CRE credit that has an issue in Houston is only $3.5 million. We don’t have any multifamily problems in Houston, no tenant and office building problems, no developer problems. If you look at San Antonio, which we have about, let’s say, 25% of our CRE portfolio, no energy issues there. Only $14.5 million are recognized as problems, so very clean there. If you look at Fort Worth, we have got about 20% of our CREs in Fort Worth, only about $16 million of problems noted there. $2 million of that are energy-related and that’s an owner-occupied deal. Take a look at Dallas, for example, where we have got say, 15% round numbers of the portfolio, about $36 million recognized as problems, they have $8.3 million related to energy. Oddly enough, that’s a hotel in Midland. And so the rest of the portfolio, I think is about well, you got Austin at 10%, no issues there. Austin is a great market as everyone knows. And then you got about 10% leftover for all the rest and really not much in terms of problems. I would say overall if you look at energy problems in our commercial real estate portfolio, in total, it’s about $36 million, the largest of that being that $8 million hotel in the Permian Basin that’s – that’s just taken – its ramp up is just little behind schedule.

Right. That’s helpful. And then last for me, the tax rate keeps ticking down here at 10.5%, I think it was a little over 12% last quarter, what’s the good forward run-rate on the tax rate?

Brady, I would probably tend to go more towards that first quarter rate.

The 12%?

Yes.

Okay, thanks guys.

Thank you.

Your next question comes from the line of David Rochester from Deutsche Bank. Your line is open.

Hey, good morning guys.

Good morning.

Can you just talk about the securities purchases you made in the quarter and what those yields were? It sounded like you brought on a lot more munis. And can you also just talk about what your appetite there is in the back half of the year?

Well, just as a remainder, we had sold $444 million, if I remember correctly in the first quarter of the muni book, so some of that we were making up. But during the quarter, we purchased about $648 million in municipal securities with the TE yield of about 460.

And then how are you thinking about those purchases in the back half?

Yes. You will continue to see purchases during this latter part of the year. It won’t be as accelerated or there won’t be as much as we had in the first half of the year. But we will still continue to make purchases.

And then, how large can that portfolio actually get as a – either a percentage of securities or as a percentage of assets, do you guys have any like internal limits on that kind of thing or just – I was curious how you thought about that?

I would say that the – maybe you keep in mind in municipals over time is that that’s not something that you can continue to do indefinitely, because you have got an amount of effective tax rate that you can apply to it and that’s a limited resource. You also want to make sure your durations in line and you are not getting out over your skis on that. And then, you want to make sure your liquidity is good and strong, because municipals aren’t as liquid as other assets, it’s a different ballgame as it relates to that. We keep our eye closely on all three of those things. And as Jerry said, we have got room to do some additional and then we will do some an additional – we will do some in the second half of the year, although not at the same extent as the first half. And as we said, we don’t have to make up for the ones that we sold in the oil patch. So we recognized that, that’s not a forever strategy and that’s why we are working so hard and our people are doing a good job, making calls and putting in pipeline and growing the portfolio, up and down the segment, so whether they will be large deals, middle market deals or small deals.

And then just given the, I guess the deposit growth was a little bit slower than we had saw this quarter, how did you end up funding the purchases, was it just like overnight borrowings that will be replaced later?

Some of it was with just – we have got excess balances at the Fed. I think at the end of the quarter, we were still at $3 billion, so we used up some of that, but we did have some deposit growth in funded portions of it.

Got it. And then just overall, how are you guys thinking about the NIM trend in the back half of the year, I guess bringing on these securities will certainly help it in 3Q, but how should we look at that?

I think what I have said last quarter and I am going to stick by it. Last quarter, I said that I would project that it would be in the flat to down. And I think we are still with that. I mean there is still some pricing pressure, obviously that we are dealing with. So I think at this point, that’s the way we look at it.

Great, alright. Thanks guys.

Sure. Thank you.

[Operator Instructions] Your next question comes from the line of Stephen Moss from Evercore ISI. Your line is open.

Stephen.

Sorry about that. Good morning. I just wanted to start off with – back to the energy book here, historically Cullen/Frost’s energy borrowers had very little in terms of hedging, wondering if that still remains the case, today?

Yes, it does. We are seeing some hedging pickup and we saw prices go up and it has been a wholesale change.

Okay. So still I can – if I recall correctly, low single-digits or mid single-digits as a percentage of 2016, 2017 production?

That’s not an unreasonable number.

Okay. And also you mentioned with regard to energy that as long as oil prices remain stable, there would not be any incremental – the provisioning would return more to normal levels. Just wondering at what price point do you believe you would have to start adding to energy reserves if prices were to just declining further?

I don’t know the exact price point. I would say that the portfolio though has been – is continuing to improve. You have got – we did stress it before with oil prices down to $30 a barrel. And so we recognize that part of it. The energy customers that we have remember, been working through problems and we are beginning to see as I mentioned earlier, deals get done, lot of capital go into the business. And the fact that this has happened isn’t just a recent phenomenon, our customers have been working on these plans for the last year. And we have been working right alongside with them and talking to them and working with them through the entire period. So it kind of looks like it’s all happened just at once, but people have really been working hard on this. So I believe, our portfolio continues to improve. And as we said, we stressed $30 before and now I like to believe that our consumers are in better shape to withstand it if it does get softer as we move forward. And I wouldn’t be surprised if prices got a little bit softer with the glide in gasoline and refineries slowing down somewhat, we could see prices move down a little bit further here, but that’s not a great concern to us now.

Okay, got it. And then in terms of loan growth, I hear you in terms of the energy headwind here declining but just excluding the energy, kind of what do you think would be the growth rate for the remainder of the book, high single-digits for a loan growth or...?

I think that Phil mentioned that in the – without energy our loan growth was in the 7% range and I think we have said in the first quarter ex-energy on the linked quarter, we were up maybe 6%. So I guess I wouldn’t – I am not sure I would go any different in something like that in that range.

Okay, thank you very much.

Your next question comes from the line of Emlen Harmon from Jefferies. Your line is open.

Hey guys. I have just a couple of other follow-ups, if you don’t mind. The insurance fees this quarter, the decline there looked like it was bigger than we would typically see seasonally, was there anything unique that happened this quarter?

Yes. We took it on the chin a little bit. We were impacted by some loss business is what you are seeing there during the quarter.

Okay. So we should think about – as we think about it on a year-over-year basis, it should potentially be a little lower going forward?

Well, I think that – well, I guess the full year, yes it would be.

Okay. And then you noticed that consensus EPS looked a little bit low, I don’t know how deep you get into it, but does it – from your perspective, does it feel like that provision was the major delta of the difference there?

We really don’t spend a whole lot of time with the individual analyst estimates to be quite honest with you. If I had to just make a wild guess, I would try to say that the differences are probably provisioned, that would be my guess. We don’t spend a lot of time with them.

Okay, alright. Thank you.

There are no further questions at this time. I would like to turn your call back over to Phil. Thank you.

Well, great. We appreciate all your interest and thank you for your questions. This will end our call.