Good morning. My name is Marcella, and I will be your conference operator today. I'd like to welcome everyone to the Cullen/Frost Third Quarter Earnings Conference Call. [Operator Instructions] Mr. Greg Parker, you may begin your conference.

Thank you, Marcella. 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 third quarter 2017 results for Cullen/Frost, and our Chief Financial Officer, Jerry Salinas, will also provide additional comments before we open it up for your questions. In the third quarter, Cullen/Frost recorded $1.41 per diluted common share and that compared to $1.24 in the same quarter last year and $1.29 in second quarter of this year. This is very good quarter for Frost. Besides the excellent earnings, our return on average assets exceeded 1.19%, which is the highest level since the first quarter of 2012. And we also reversed the trend of declining money market deposits and showed strong growth in loans. During the quarter, average loans were $12.6 billion, and this represents an increase of approximately 10% over the third quarter of last year and on a linked quarter annualized basis. Our provision for loan losses was just under $11 million in the third quarter, and it was up from $8.4 million in the second quarter. Although the impact of the Gulf Coast storms through our third quarter results has been pretty nominal, we believe it's prudent to recognize the possibility of lingering impacts in the future. Non-performing assets totaled $150 million in the third quarter. It was an increase from the total of $90.2 million in the second quarter. While our energy portfolio continues to improve significantly, some of these credits are still moving through the snake, as I've said before towards their final resolution. And we can talk more about them in your questions. Net charge-offs in the third quarter of 2017 were $6.2 million, and that compared with $11.9 million in the previous quarter -- excuse me, it was $5 million in the third quarter of 2016. Annualized net charge-offs represent just 20…

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. Regarding the economy, despite the impact from Hurricane Harvey in the third quarter, the Texas economy continues to expand with consistent growth and historically low unemployment. The Dallas Fed estimates the short-term job loss in the Gulf Coast in the range of 55,000 to 75,000 jobs with a quick bounce back this quarter. Rebuilding efforts are expected to create jobs and boost infrastructure spending. Year-to-date, Texas employment is up an annualized 2.2%. The Texas unemployment rate in September was 4%, the lowest in nearly 17 years, and down sharply from 5% at the end of the first quarter, and 4.6% at the end of the second quarter. Texas unemployment at 4% is now below the national unemployment rate of 4.2%. Despite Hurricane Harvey, the Dallas Fed still maintains its 2.6% job growth projection for Texas in 2017. Looking at individual markets. The Dallas/Fort Worth economy strengthened in September. According to the Dallas Fed, the DFW job -- DFW jobs grew an annualized 4.7% last month, and 2.6% in the third quarter. The Dallas Fed reports that Metroplex job growth was broad based across major sectors with construction and mining leading the way. The Metroplex labor market remains tight. September unemployment in Dallas fell to 3.5%, while the Fort Worth unemployment rate declined to 4.2%. The Austin economy expanded rapidly in September. According to the Dallas Fed, jobs in Austin grew 3% annualized in the third quarter. Growth was broad based with construction, financial activities, healthcare, wholesale trade -- and wholesale trade accelerating significantly compared to the first half of the year. Austin's unemployment rate was 2.7% in September, the lowest in nearly 17 years,…

Thank you, Jerry. We'll now open up the call for questions.

[Operator Instructions] Your first question comes from the line of Michael Rose.

At the outset, you mentioned that the momentum in deposits had continued. Can you talk about specifically, maybe where some of that growth is coming from? And are you starting to see some inflows in deposits in the hurricane-impacted markets?

I'll let Jerry speak to some of the deposits, but I can tell you that we really haven't seen the Hurricane Harvey -- any Hurricane Harvey deposit money coming at this point.

Yes, Michael, just looking -- if we look at a late quarter basis on a period end, we've -- deposits increased 3.1% or 12.3% annualized. A lot of that growth is coming from the high-yield MMAs, where we talked about increasing those rates, but we're also seeing good increase in our checking account in DDA and IOC.

Okay, that's helpful. And then, just wanted to talk about the loan growth. Was that impacted at all by the hurricane? And you mentioned that the commitments were up pretty substantially year-over-year. And you previously guided to kind of a high single digits growth rate. Does that still hold? And then, kind of where are you seeing, maybe by geography, the strongest growth?

We really haven't seen anything that significant regarding the hurricane. I think there were $3.3 million of sort of disaster loans -- through disaster loan program that we put in place that we have decisioned at this point. So that's very minimal. No, I don't think the hurricane's impacting our loan volumes at all. And we're seeing good growth really throughout all the regions. A little bit of weakness in the far south Texas market, but those aren't large markets for us. So loan growth just continues to be positive. It continues to be diversified, and it's across a broad base. We'll have to see how -- what impact the hurricane might have on specific markets, like the ones in the affected areas. We're not seeing any tremendous increase right now but you could see some slowing there. So we're going to keep an eye on our pipeline. I think really what we're seeing in the pipeline this quarter, which is -- it's down a little bit on a linked quarter basis. But in talking with all our people, I think that's more us just being successful on our number of deals and just in the process of reloading there.

Okay. And then finally, good to see that the new stock buybacks. Given where the stock is trading now relative to where it was last quarter, I mean, how aggressive would you expect to be. I mean capital levels are still pretty strong here?

Thank you. Well, the program that we put in place, that the board approved yesterday, isn't really to be aggressive per se. It's really just -- it's good corporate housekeeping. And you need a program like that in our view for whenever opportunities arise, either you can't use the capital or you think that there is a -- I really believe was the case in this last quarter. There was sort of a dislocation between what management believed about our situation was, and what some of the market believed about what our situation was. And we say in Texas, that's what makes horse races. And so we decided to bet on a company to the tune of about $100 million. So that was more aggressive than we would typically be. But the program that we put in place now, as Jerry said, is a two-year program. And as we see opportunity, use it. If it's prudent to use it, we'll use it.

Your next question comes from the line of Dave Rochester from Deutsche Bank.

You mentioned the sale of treasuries the quarter-end. Have you guys used the proceeds to purchase other securities in 4Q? I know you mentioned the muni purchases in 3Q. But any additional ones that we should think about? And what were the yields on those?

So, Dave, our plan is to invest about $400 million of that amount. So our plan would be to try to purchase those as quickly as we can, a lot of it's going to be, of course, determined by what's available in the market. That's the current plan.

And the $400 million, will that primarily go into monies [ph] as well or other things?

Yes, right now, it's primarily, we're thinking that the $400 million would go into monies [ph]. The $350 million, we're talking about keeping in balances at the Fed, gives us more flexibility in this rising rate environment and helps us from an asset sensitivity standpoint. So that's the current thought.

Yes, okay. And then, can you just talk about the increase in the nonaccrual loans this quarter. Maybe just some details around product types impacted, reserve coverage that kind of thing?

Yes, the increase in the nonperformers really is not indicative of the overall portfolio's continued improvement. If you look in the quarter, resolutions exceeded downgrades in the portfolio by more than 2:1. If you look at the quarterly additions that we had, say last year, to what -- to problem loans which are again these risk grade 10 and higher, just our term full, they average $380 million. This year, it's averaged $153 million. In the third quarter, it's only $100 million. So things are going very well there, and it's going well in the energy portfolio as well. Because I've said, for the last several quarters, we still have some credits that as -- as I say are moving through the snake, and these are credits that had property sets that weren't in favor, like you've seen some of the activity in the Permian basin for example that may be have higher cost structures, things like that. And they're just going to have to work them -- their way through. They didn't have the opportunity to deleverage like some of our other customers did. The biggest one of these was a $43 million credit, which was a potential problem before. It had been servicing its debt -- it let the bank group know in the last quarter that it would stop doing that, and that it needed a plan to move forward. So what we did, we -- and they're great group of people, so don't get the wrong idea. But we took a specific allocation, which would move this credit down to its liquidation value if we chose to do that. And so that's in place right now. So it's neutralized as far as any meaningful financial effect where we are right now. But I think the good news about that particular credit is that the nature of that -- their business is enhancing existing production, and so if they are provided with additional capital, they can pretty efficiently increase the amount of production associated with investing net capital in terms of what they do. And you know what they do is, again, it's enhancing existing production. So they could pretty efficiently increase their production against the loan balance that would be outstanding. It's just a question of, do they and how they go about getting that additional capital to do that. So even though it's a big number, I feel we've neutralized the impact in terms of where it is right now versus market value. And we still -- let's just say we've still got an opportunity to make this work.

So was most of this migration related to energy or credits in energy heavy areas?

Say that one more time?

What was most of the migration you saw, the NPA, either energy credits or credits that are located within energy-dominated areas?

Yes, they were. I mean, there was another credit that was about $13 million credit that were non-performer. But it actually recently is demonstrating positive cash flow and I feel good about the prospects with that one. And then the other one was within, as you say, in an area that was -- that's dependent or heavily related to energy, but it's more in the maritime business and it has some issues with regard to the competition and over capacity. That's really just a banking business issue, those things come up every now and then. They're just having to work through some issues, and we'll see how that goes. That one wasn't really one of these credits moving through the snake that I talk about.

All right. Okay, I appreciate the color there. And then just one quick one on expenses. The other expense line was down a lot this quarter. Can you just talk about the drivers there? And then your outlook overall on expenses for 4Q?

Yes, they were low. I think what I would say is, typically the third quarter is lighter on some things like advertising, for example. So we'll see some pickup there in the fourth quarter. Also the fourth quarter will be higher a lot of times on the incentive pay areas. We'll kind of finalize those in Q4. So typically sellers are higher there. Yes, I'd think the way I'd look at it is that the third quarter would need to be adjusted up on a more fourth quarter normalized basis. I'd go back and look at our historical trends, you could kind of see an uptick there.

Your next question comes from the line of Steven Alexopoulos from JP Morgan.

I wanted to start on the $43 million nonperformer that you saw this quarter. I assume that was E&P, is that correct?

Yes.

Was that a shared national credit also?

Yes.

Okay. And I just want to understand, I'd think there will be less pressure on E&P at this stage, given oil's over $50. What would cause a loan that size to trip into nonperformer at this stage?

Well, the fact is that they informed the group that they were not going to be making interest payments.

Okay. And then what were the thoughts, I know you sold pretty significant chunk of treasury securities in the quarter, $750 million, when you took that $3 million loss. What was the thought behind that? I want to fully understand that.

Well, sure. If you think about it, we were only earning 1.3, just 5 basis points than what we would earn at the Fed. They just thought there was an opportunity to utilize some of those proceeds in this higher rate environment.

And also, as Jerry, I think, mentioned before too, it's really reinvesting a part of it.

Right, $400 million.

Yes, we're letting some of that ride in liquidity. I mean, that -- it will help our asset sensitivity and that's just sort of our orientation in terms of what we see, we believe is happening with rates, and so we're keeping some dry powder in that.

Okay. And then, I appreciate the commentary on the expenses and the pickup. If we look, you'd some movement too in the fee revenue this quarter, looked a little bit high. How do you think about a run rate of fee revenue from where we came out in the third quarter?

Give me just a second. Yes, I think that -- looking at the fees, I think that I would expect that it's fairly good run rate, typically in the fourth quarter. If you go back and look at some of our historical performance, insurance revenues were typically up in that fourth quarter. So I expect, we probably see that sort of trend. But other than that, I think it's a fairly good trend, of course, ignoring the loss on the securities transactions.

Okay. And just one final one. With all the deposit growth you guys are seeing in the money market account now that you've raised rates there, how do we think about margin here in the fourth quarter? Is that going to continue to pressure margin?

The way I tend to look at it is kind of flattish with what -- the adjusted 3.7% that I mentioned for the -- we took this 3.73% for the actual, adjust out the adjustment, we're at 3.70%. And so I tend to look at it as staying pretty flattish. The challenge there, of course is going to be the timing of the purchases of the municipal securities that we talked about, the $400 million. And as you mentioned, of course, also the deposit level. So there may be some -- a little bit of pressure on the percentage itself. It may be more optics than anything else where you see with -- we're in favor of getting it. We love to get more deposits. So we could potentially see a little bit of pressure on the percentage, but an increase in net interest income dollars.

Your next question comes from the line of John Pancari from Evercore ISI.

So regarding the energy book, again, with that credit, can you just remind me the size of the reserves still around 4.5% of the energy book?

No, that has gone down as it has improved.

Yes, we're down. We were -- at last quarter, we were at 3.85% and we're down to 3.74% this quarter.

Okay, all right. And at that 3.74% level still comfortable that it's adequate to absorb the remaining items that can move through the snake here? I mean, these are somewhat lumpy in terms of the size of these credit. So if we've got a few more, you're going to be hitting that reserve by a fair amount. So I was just curious, how it stands?

Well, first of all, the answer of your question is yes. And the -- this is for what hits the reserves is going to depend upon, obviously, whatever happens, whatever they're able to do. But I want to keep in mind that the overall portfolio in the energy sector has really being improving. We've got a dichotomy here of these firms that weren't able to deleverage, if you will. And so I would tell you other thing, we haven't identified any new credits in the energy side this year. So again, like I said, that makes horse races, right? That's what makes it -- that we feel like we're doing a good job of recognizing where we are in these credits. And when we see issues or see something get worse, we're aggressive and market it to where it needs to be. So I'm not worried about the remaining credits in the snake. They -- it'll be what they are, but I frankly moved on from that.

Okay, all right. And then, back to the margin. On the deposit side, could you just talk to us about the -- remind us of the beta, the deposit beta that you assumed in terms of the cycle? And where you stand currently?

Our assumption for us, we do have an assumption for a Fed hike in December, but it's not having a material impact of course on our numbers. Our beta, I guess, the way we look at them is that we kind of setup when we made those deposit increases in July, we kind of looked back over the -- the Fed had raised by that point rates by 100 basis points. And so we probably took a beta at that point of, say, about 30%. We would expect as rates go up, we'll just need to look at the competition, we kind of feel like we're in a good place, to be quite honest with you, compared to some of the competitors out there who haven't raised rates. So our betas may not need to be as aggressive going forward, but we'll just have to see how it plays out.

Okay, so it may not be as high, the incremental beta may not be as high as 30%?

Correct. But we'll just have to see what's happening in the market.

Yes, John, I think we did heavy lifting last quarter. And so now what we're doing is, we're just going to keep an eye on the market. We're going to -- we want deposits to grow. We want to make sure our value proposition is good enough to attract customers. And so it's going to be more -- I think it'll be a little bit more fine tuning than it was with the heavy lifting we had to do last quarter.

Okay. Thanks, Phil. And then lastly, back to the capital discussion regarding the buyback. Just trying to gauge your -- how you're thinking about the magnitude? I mean, is there -- what's the likelihood that you remain somewhat aggressive with this program and potentially followed up with another one. I mean, your capital levels are still relatively solid. I know that this was already asked about, your appetite from here. But is there a rationale, when you look at your growth outlook right now? Is there any type of rationale where you can stay somewhat aggressive in terms of buying back here, and just given that how solid your capital levels are?

John, I'd say that the -- it's going to depend on growth prospects, all right? We're highly rated company. We've sort of managed now to increase our loans in a sustainable way, and a lot of that is related to again this focus on the core part of the portfolio. So it's really well diversified. Like to use capital in that regard, and I would like to have a strong capital position. That said, we'll use the buyback in an opportunistic way if we feel it's warranted. And you know, when you look at the buybacks historically, I think the $100 million that we've sort of authorized, have been fairly close to what I would call the leakages in terms of the stock it goes out based upon stock plans that the company has and that kind of thing. So this will really represent sort of that level, plus a little extra. So it's a little bit bigger than what we had before. I wouldn't read too much into strategy with that program. It's really just give management the ability to take advantage of situations and favor shareholders as we see it. But again, I hope growth is what uses this capital up. We're committed to sustainable organic growth. But if it doesn't and we have excess capital just like we've done over time, we'll continue to use buyback in the board meets every quarter.

Your next question comes from the line of Ebrahim Poonawala from Bank of America.

I'm sorry if I missed this. Did you say what the money market rate was this quarter? And whether that reflected the full impact of the upward pricing on those deposits?

Maybe the best way that I could answer that is, looking at our deposit cost on interest-bearing deposits, so they went up from 6 basis points in the second quarter to 15 basis points in the third quarter. And if you recall that rate hike went in, I guess, about the 24th of July, so we still have a little bit of an impact in the fourth quarter.

And is that at a point, I know you mentioned that the money market high-yield growth was strong, is it at a point where you believe it's okay that even if we get a December rate hike, we don't need to further increase that rate? Or how do you sort of look at the competitive pressures in the market? And do you expect that we might be in a situation where you need to raise that again if the Fed moves in December?

Ebrahim, we'll just look at it at that time. Like I said, I think we'll fine tune it. I think we'll increase it. If the Fed increases, I think we'll increase. I don't think we'll increase the same level. I think our high yield ratio is at 35 basis points on the high end, which is great rate. CDs were...

75.

Yes, 75 to 80 -- it was probably less. CDs really not that bigger deal in terms of their dollar impact on our balance sheet and the marginal effect. I think -- but just since you asked, I think, probably the pressure on -- if I can use that word on betas for CDs is less than MMA, I think you've going to have to make sure that your MMA continues to be a relevant rate. So I think we'll see an increase, don't think we'll see anywhere near the 35 basis points or moving to the 35 basis points so that you saw last time. But Jerry has got that in his projections that he just talked about too.

Understood. And I'm sorry if I missed it, you mentioned there was a spread between the 3.73% and the 3.70% margin. What was the 3 basis points?

We mentioned in my comments that we did have a correction on some loans that were misclassified as taxable rather than tax exempt. So we tried to take that impact out of the -- that was related to 2017 out of the margin, just to give a more normalized rate, which would have been that 3.70%.

Understood. And just one last question, Phil. In terms of when you think about balance sheet growth, I think it was earlier asked, did you see any dampening impact in this quarter from the hurricanes? And if not, do you expect the kind of quarter we saw about 1.5% to 2% sequential loan growth. Is that sustainable, as we think about '18?

Yes, I would like to see similar loan growth. And we said high single digits is what we like to shoot for, and we're going to have a goal to do that. We really haven't seen much impact from the hurricane with regard to deposits or loans. But we're going to have to keep an eye on it, right? Because you just don't know, we hadn't been through it. And so we're going to have to see the impact it might be in the fourth quarter or early first. But I'm optimistic about it. We want to be careful and prudent about it. But I'm optimistic about how we're able to grow and what our people really have been able to do.

Your next question comes from the line of Jennifer Demba from SunTrust.

Is there any way to quantify the fees you lost during the quarter from the waivers related to the storms?

We'll say, yes, there is. Mainly it has been done, it's mainly about remembering it.

Yes. Yes, I think at the high end, Phil. I really don't remember it. It wasn't -- I thought it was $200,000.

So something in that range, Jennifer.

[Operator Instructions] Your next question comes from the line of Brandy Gailey from KBW.

It's Brady, so one more person on fee income. If you look at one of the big drivers for increased fee income on a linked quarter basis, it was also in that other category, went from about $7 million to roughly $11 million, a little under $11 million. What were some of the components that pushed up other fees?

Sure. One of the things there in that other income category was we did get $1.2 million related to a recovery. This was an asset that Western National Bank at our acquisition that we did in 2014, they'd written it off, and so on our books it had a 0 value. And we got $1.2 million related to that in the third quarter. We also had a real strong quarter on derivative activity. They were up about $900,000 compared to the third quarter last year. And then if you recall, we sold this Frost Bank Tower in downtown San Antonio and recognized a gain, and where we deferred a portion of that gain because we're still in the building and so that gets amortized into income of $700,000 a quarter and we didn't have that in the third quarter last year, that building sale occurred late in the fourth quarter last year.

And how that $700,000 a quarter, how long will that last?

That should go on until mid-2019.

All right. And just to be clear, back to Harvey, it sounds like you'll did not take a Harvey-specific provision. Is that the right way to think about it?

Yes, it is. I mean, just the way the reserve works and how it is calculated in improvements and other parts of the portfolio, and just our ability to look on a macro basis. There was no specific allocation -- or specific provision for Harvey. But we really feel good about the general allocations that we have, which would recognize that along with lots of other things that are out there in the environment. So we feel good about our -- of where we stand with regards to having a reserve against what might happen there.

All right. And then lastly for me, if you look over the last three years or so, I think you might have even said it in your comments, Phil, but your energy has gone from over 16% of loans to a little under 11% of loans. Now since we've seen some stability with oil over $50, do you think now is the time right to think about starting to increase that percentage? And could that be additive to loan growth for you guys over the next couple of years?

Brady, I wouldn't increase the percentage just strictly to add the loan growth. What I expect from the business is for it to continue to grow, and to grow in line with what the rest of our loan portfolio and our loan business does. You know if you look at what's going on in the markets today, based upon what we're hearing from our people, it's slowed a little bit on energy. And that may be because CapEx budgets near the end of the year fill up. There has been a little bit of slowing on this big acreage deals that have been pretty public out there. I think on a long-term basis, the independent producers and important customers to us, they may not be coming back until it gets to $60 in any great degree. So I don't think it's really a robust market right now; energy is steady, but with a little bit of slowing in the pipeline. So I would not look for that part of the portfolio to sort of make our dreams come true in anyway. I mean, it'll be a part of that, but I look to it more being in line with what our growth. So we may be more in line with sort of where we are right now. Its percentage could move up a little bit on a quarter or go down occasionally. In the Permian, even though the independents may take say [indiscernible] works well in the Permian and in the scoop, but beyond that it can be problematic.

Your next question comes from the line of Ebrahim Poonawala from Bank of America.

Just a quick question. Did you say what you expect the effect of tax rate to be going forward and into '18?

We don't give any guidance yet on '18. If I was looking at the fourth quarter, I'd probably say, we're going to -- our expectations would be that we'd be somewhere in that 13% to 14% range.

And I appreciate that you don't want to give the '18 guidance. Would the delta from the '13 to '14 versus into '18 would be just the level of muni purchases? Or are there other things that would impact the tax rate?

No, of course, the strength of our earnings because from that marginal level, and that corporate rate is still 35%. So yes, it could be affected by lot of issues associated with that.

Your next question comes from the line of Matt Olney from Stephens Inc.

Just want to ask on the update for the shared national credit portfolio. Do you guys have the updated balance of that portfolio? And were there any great changes from the recent national exam for that [ph] recently?

Yes, the size of the portfolio -- just give me a second, period-end was $795 million. And there was no change as a result of that last exam.

There are no further questions at this time. I turn the call over to Phil Green.

Okay, everyone, we thank you for your participation on the call. We'll be adjourned.

This concludes today's conference call. You may now disconnect.