Cullen/Frost Bankers Inc (CFR) 2009 Q1 法說會逐字稿

Good morning, I will be your conference operator today. At this time, I would like to welcome everyone to the Cullen/Frost Bank first quarter earnings conference call. (Operator Instructions) Thank you.

Mr. Parker, you may begin your conference.

Thank you. This morning's conference call will be led by Dick Evans, Chairman and CEO; and Phil Green, Group Executive Vice President and CFO. Before I turn the call over to Dick and Phil, 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 at area code 210-220-5632. At this time, I will turn the call over to Dick Evans.

Thank you, Greg. And good morning and thank you for joining our call. I am pleased to provide a broad overview of the first quarter results today. Following that, Phil Green, our Chief Financial Officer, will provide some additional details into the numbers. And as always, we will be glad to take your questions at the end.

Cullen/Frost net income was $45 million for the first quarter of 2009 versus $52.8 million reported for the first quarter of '08. On a per share basis, earnings were $0.76 per diluted common share, compared to $0.89 per diluted common share reported a year earlier. Our return on assets for the first quarter of '09 was 1.23%, and return on equity was 10.33%. Our revenue growth was impacted by the Fed's unprecedented reduction of interest rates to near 0 at the end of 2008. In addition, our expense growth was affected by a $4.1 million increase in FDIC premiums.

Even with these challenges, I feel confident in our ability to do well in this environment. Frost's business philosophy of conservative management, and a relentless focus on customer service and relationship banking has always guided us and will this time. Thanks to the commitment of our employees who really are the best in the business. We have a very seasoned management team that has been here before, and which is providing steady leadership now. So I feel good about where we are, and where we're headed.

Now, let's take a look at the first quarter. Average loans for the first quarter of 2009 were up 11.3% from the first quarter of '08. However, we've seen demand level off this quarter with loans basically flat compared to the fourth quarter of 2008. For the second quarter in a row, average deposits showed double digit growth over the linked quarters, as commercial customers build up cash reserves, and individuals increase their deposits. They're bringing their deposits to us, recognizing Cullen/Frost as a safe haven, resulting in significant deposit growth.

Net interest income on a taxable equivalent basis rose 2.2%, to $138 million, compared to $135 million reported a year earlier. Our net interest margin was 4.33%, for the first quarter of '09, compared to 4.67% reported for the first quarter last year. Keep in mind that the Federal Reserve had cut rates totaling 200 basis points since the end of the first quarter of 2008. Including 75 basis points cut in mid December of 2008. Cullen/Frost capital levels continue to remain strong. In fact, they are even higher than they were when we declined to apply for funding under the TARP last year. Noninterest income was $69.9 million for the first quarter of '09, compared to $70.2 million reported a year earlier.

Let's look at some of the components. Trust fees decreased $2.3 million to $16 million. That was due to lower investment fees and lower oil and gas management fees. Service charges on deposits were $24.9 million, up 27%, primarily because of the lower earnings credit rate. Insurance commissions and fees were $10.8 million, compared to $11.2 million, reported in the same quarter a year ago. Mainly due to softening market in the property and casualty area. And other income decreased $2.8 million to $11.5 million compared to $14.3 million reported in the first quarter of '08. The decrease was primarily the result of a $1.9 million gain reported last year from the partial redemption of the Company's Visa shares related to Visa IPO. Also impacting the decrease was a $743,000 decrease in gains on sale of student loans. You will recall that we exited the student loan business last year.

On the expense side, noninterest expenses for the quarter were up $9.5 million or 7.9%, to $129 million for the first quarter of last year. Deposit insurance increased $4.1 million, primarily due to an increase in FDIC assessment rate. Without this increased premium, the percentage of the expense growth would have been a more normalized 4.5%.

Now, let's turn to credit quality. While nonperforming assets did increase, there were not any surprises. They did migrate from the Bank's problem loan list, and were already being managed by our special asset group. Loss potential has been accounted for in the allocations methodology. We do not anticipate the need for any significant additional reserves for this increase. Nonperformers at quarter end totaled $128 million.

On December the 31st, they stood at $78 million, during the second half of 2008, and through the first quarter of '09, loans to home builders were the largest contributor to the movement of nonperformers. A note about these loans to home builders as a part of nonperformers. At $18 million, the amount was smaller than we saw in the fourth quarter. Of perhaps greater importance is that the level of troubled home builders has been flat for the past six months.

In addition to home builders, nonperformers were affected by a $19 million loan extended to a restaurant franchise which I have spoken about during prior conference calls. And another $5 million secured by a retail center also previously mentioned. These two credits were reported in past periods as potential problems. Other measures of credit quality, charge-offs and delinquencies were essentially flat, with what was reported at year-end. Net charge-offs for the quarter totaled $5.7 million, and represented an annualized 26 basis points of average loans. This first quarter charge-offs are comparable to what we've experienced in the last half of 2008. We expect charge-offs to remain at reasonable and respected levels, and to continue to be measurably better than the industry average. Loan delinquencies 30 days or more aggregated to $107 million or 1.22% of period end loans. At year-end, these triggers were 122 million, or 1.38% respectively. Past due levels are reasonable and are expected to remain so. While some deterioration in credit quality was recognized in the first quarter, it was moderate and it occurred at a manageable rate.

Well, let's turn now to the consumer segment. Where as in the past quarters, the numbers of consumer checking accounts continue to grow in the mid single digits. Consumer transaction account balances grew 17.2%, year-over-year. On a linked quarter basis, the trends were even stronger demonstrating our Company's strong reputation as a safe haven. Compared to the same quarter last year, consumer loans outstandings grew by 5.3%. On a linked quarter basis, we are seeing a flattening in growth and a slowing in the application flow.

On the business side, the commercial loan market is challenged by the economy as customers and prospects are reluctant to take on risk of new projects or expand their businesses. Also, in more normal times, our loan growth would be generated 75 to 85% by existing customers and 15 to 20% by new prospects. By the fourth quarter, our discipline of analyzing market direction changes showed it was taking 12 in person calls versus nine calls in the third quarter to produce a new loan pipeline. Being aware of these changes in the market, we corrected our course by escalating the number of calls being made by our officers with a pronounced concentration on prospects. Our end prospect calls were up 65% over the previous year. Due to this change, we have turned around our growth pipeline and increased the total by 26% over link quarters.

These prospect pipelines require additional focused plan, due to the fear of business owners changing banks, and adding a new bank relationship in this turbulent time. Increasing our efforts is significant, as we believe loans are the best investment and the best place for us to deploy capital both now and for the long term. Nevertheless, we have proven our ability by increasing our new business relationships by an additional 50% over the previous year. This success has been in the majority of our regions. As I have said before, these relationships and what they mean is that we have obtained the primary operating account, or what I call the funnel account. Many of these businesses are deposit-only customers. We believe increases demonstrate the market's appreciation of our strength and our relationship approach to banking. More important, and that increased potential of these relationships will provide for increasing loans and fee services when the economy recovers.

Now, let's take a look at the Texas economy. While economic activity in the state has softened, the state's economy remains stronger than that of the nation. We have especially seen a slowdown in labor markets, rig counts and in export markets which of course are affected by the economic problems in Mexico. On the bright side, housing seems to be stable. Unlike much of the US, we have not seen much erosion in housing prices. One factor in Texas pricing edge has been a relatively healthy level of existing home inventories. Currently, about seven months of supply in the major Texas metro areas, compared to 10 months for the nation. I believe we will not feel the impact of the recession as much here as elsewhere in the country for several reasons.

First, Texas has a long-fostered pro-business environment, that attracts companies, generates jobs, and creates growth. We also avoided the wild swings in housing prices, which is at the root of the nation's economic crisis. Although our home building has been slowed. That is a quick snapshot of our first quarter performance, which I believe is very positive, considering the environment. Again, I feel very good about our business model, our strategic goals, and our ability to execute against them. Our business fundamentals are sound. I am very confident that we can manage our way through this downturn in Texas. What I don't know, of course, is how long the recession will last, or what our economy will look at, look like when it is over.

My sense is that businesses and consumers alike are deleveraging and adjusting to a new reality as they try to find a new level from which to operate. Whatever form that takes, Cullen/Frost will be there to help businesses grow and help people meet their financial goals. And now, I would like to turn the call over to Phil Green, and after that we will be glad to entertain your questions. Phil?

Thanks, Dick. I'm going to make a few comments about our link quarter performance, I'm going to look at some of the specific changes in our outlook since our last conference call and then I want to update our current earnings guidance for 2009, and then as Dick said, I will turn it back over to him for Q&A.

As Dick reported, our earnings for the first quarter were $0.76, and even though this represented an ROA of 1.23%, they were down $0.13 from the fourth quarter of last year. And those of you who follow our Company will remember that the first quarter is typically by far our weakest quarter of the year, due to seasonal factors, including fewer number of days to earn spread income, and the seasonal increase in benefits expenses that relate to higher payroll taxes, as well as payroll taxes and 401K matches, related to incentive compensation, which is typically paid in the first quarter of the year. And those factors were once again in the first quarter of 2009. The fewer number of days impacted our net interest income by $3.1 million. And the benefit costs increased $4.7 million, from the fourth quarter, for an increase of 45%. However, our net interest income for the first quarter was also impacted by the Fed taking interest rates to essentially 0 in December.

This impact from rates lowered our sequential net interest income by $7.8 million, and it offset the $4.9 million improvement we experienced from additional balance sheet volumes during the quarter. As an example of this effect, the average prime rate dropped 82 basis points for the fourth quarter. But in addition to this, average LIBOR rates dropped about double that amount. Impacting the $1.9 billion in LIBOR priced loans we still maintain. In fact, the hedge adjusted impact of the lower LIBOR was 2.25 times the hedge adjusted impact of more prime on a linked quarter basis.

Our net interest margin declined 27 basis points for the quarter primarily due to the loan yield decrease relative to the drop in deposit costs. Also negatively affecting us during the first quarter was a $2.6 million increase in FDIC premiums, as they more than doubled from the fourth quarter level. And we also had an 8.7% drop in trust fees which is two-thirds related to lower management fees on oil and gas properties, and the remaining third was mostly related to lower state fees, from unusually high levels in the fourth quarter.

On the positive side, we did see some unprecedented deposit increases with average deposits increasing an annualized 20% on a link quarter basis, as the bank continues to be a safe haven. Also, deposit service charges grew a nonannualized 5.1%, versus the fourth quarter, from increased treasury management fees. Also, we had credit costs that were in line with our previous expectations. We had good expense control, adjusting for the seasonal and FDIC anomalies. We were also improving our loan pricing. In addition, it was encouraging that our trust investment management fees were flat versus the fourth quarter, even with the severe drops in the financial markets during that time, due to our relatively strong investment performance in stocks and fixed income, and our continued account growth.

Looking forward, I wanted to mention a couple of items that have impacted our current outlook. Given the continued weakness in energy prices, and the absence of any meaningful leasing and drilling activity on our managed oil and gas trust assets, and also given the weakness in equity market valuations, we are currently expecting lower full-year trust revenues than we were three months ago. In addition, relating back to what Dick's discussion was, concerning how customers more and more seem to be holding off on expansion, we now expect somewhat lower loan volume, more in the mid single digit growth, versus the high single digit growth we anticipated earlier in the year. And finally, I will say because of the uncertainty currently surrounding the amount of any one-time special FDIC assessment, we have not included that potential special expense in our outlook at this time.

So in light of these factors, we're now currently seeing our full-year performance and excluding any one-time special FDIC assessment as somewhere closer to the current range of consensus estimates for our Company. With that, I will turn it back over to Dick for questions.

Thank you, Phil. We will be happy to entertain your questions.

(Operator Instructions) And your first question comes from the line of Ken Zerbe with Morgan Stanley.

In talking about your methodology of when you recognize losses on nonperforming loans, I guess I would have expected to see charge-offs or even provisions, or the reserve increase a little bit more than we did, given the sharp increase in nonperforming loans this quarter.

Well, I think oftentimes, that is true. However, we have spent a lot of time looking at the reserve in great detail, and we're very comfortable that the reserve is where it should be, and the nonperformers, in fact, if you look back, our reserve covers our charge-offs 5 times on an historical basis. So there is a lot of ways to look at it, and I hope that another factor is that we're identifying problems earlier and catching them when we can reduce the potential loss. We learned that in the 80s. That is a major factor. And as I told you in the previous conference call, when we saw nonperformers increasing, and the charge-off level has -- I don't like any charge-offs, but when you take everything into consideration, I think it has been very well managed.

Ken, this is Phil. I would say also, as we said in the past, I think our reserve formula is probably most responsive to increase in classified loans. I mean it includes other factors, but it is probably as sensitive to increases in classifieds as anything. And those credits were previously identified as really through the process as they moved through the classified line, I think two of the biggest ones were potential problem loans included in our last quarter numbers. So these were not new credits. Had they been just complete surprises and these were large loans that were not classified and had gone suddenly into nonperformers, I think you would have seen the impact that you're talking about, but the fact that we were familiar with them and sort of seen them go through the process meant that the provisions related to these were already taken in previous quarters.

Ken, just to give you a little detail in that regard, as we've already -- as I said earlier, the biggest factor has been the one to four family construction, and when we saw this downturn, when we first started talking about this, we had a year ago, we had one to four family commitments of $480 million. And today, we have $294 million in commitments. And we had outstanding loans, one to four family a year ago, 255, today we have 192. And what I meant by that statement, when I was talking about credit quality, that we had seen for six months, this start to level off. The classified or criticized assets have stayed right at $60 million. I mean it is just right there, 59.9, 60.2, and today, 61.4.

Now, when you look at the foreclosed factor, also, we've been staying around 5 million, I think what will happen is that will probably move up not all at once, as we go along, but it could be -- it could double, so 5 million would move out of the 61, and the 10 million -- or the 5 million foreclosed could go to 10. But the main thing is it is not increasing. And I think we've got -- we're managing it well. We got into it early. And then as I said to you, let's not forget that home prices are holding in Texas, inventory is relatively low, seven months is a lot bigger than it was a couple of years ago, obviously, but we just got to work through it. And that's the biggest factor in the nonaccruals.

Okay. And that makes sense. And then just -- I know Texas is still holding up very, very well, at least relative to the economy, but, the national economy, but it is weakening. If unemployment in Texas continues to rise, which loan categories do you think you would be most worried about?

I worry about all of them. And I guess one of the things that we have had -- I guess you could take two categories, and I talked about them last time in some detail, I talked about retail centers, and looking at those numbers, since we talked about it, and I went through quite a bit of detail last time, they haven't changed much, they're down about $10 million, in overall commitments, I talked about, if you would look at the retail centers, we've got one loan, a nonaccrual, and a retail center, and that's the $5 million, I talked about it a couple of quarters, and so we've got to work through that. We've got -- and one classified. One sub-standard loan out of all of the retail centers.

So we have taken a good deep dive at that category, and the main thing, if you will remember, I talked to you about last time, was looking at the tenants, and we take a close look at our tenant, versus the information that is public about who is weak and those kinds of things, and our tenants are really doing in good shape, and as I said before, we've got, as ever, I guess, retail center wants, is a Starbucks and they're kind of overdone, but they don't take much space, and we've got about four Starbucks in our whole portfolio. So there's -- that is one factor. I think we would all say that, in any economy, starts to turn down, and we think ours is well managed.

I think the other thing, our energy. If you look at energy prices, they've moved down, particularly gas. Gas, natural gas, the supply is high, projections are we're going to have a cool summer. The rigs are stacking, nationally, we've gone from 2,000 to a little less than 1,000, and the projections are another 20% will probably drop off so maybe we will be at 800 rigs out of 2,000 at the peak. And so the other thing, the energy companies are doing is just halting their activities. They're only drilling those wells that are necessary to hold on to good leases, and where they can shut in production, they're doing it.

The other thing that we have done is I've talked about our sensitivity price deck. You remember our price decks, we look at the current price, and currently -- and then we take 75% of that number. We have kind of taken a stress test and looked at -- looking at oil at $33.75, and gas at $2.50, a lot of talk today about gas could get to $2.50 at the end of the summer, and we have run these sensitivities in anticipation of possible lower natural gas prices, and we continue to feel comfortable with our exposure. As reported last quarter, many of our customers have hedges. Those hedges in '09 have gas hedged at $7.75, and oil at 75 to $80, which obviously is the reason I can say to you that as gas prices are weak today, and possibly could continue to weaken, why I feel comfortable.

I think the other thing that as you look at 2010, gas at trading levels of $6 and $6.50 in 2011, our customers are starting to also look at that closely, and evaluate positioning themselves in a hedge, in '10 and '11 possibly. So those are things -- and overall, our bank, we've had -- we've been very proactive in managing our exposure in the E&P sector, and this -- we've got -- our customers have really a very low advance rate. And I guess fifth, I would say to you that drilling costs, as you might expect, has come down. All in, you can probably use a number about 30%. Some rigs are down 50%. And when you take it all in, about -- drilling costs down about 30%. On the other hand, financing cost is up. And so overall, I feel comfortable with our management of the energy portfolio.

So to answer your question, I think by the detail and the deep dive we've done in those two sectors, and then of course I have addressed the one to four family, I think you know what I worry about.

That's great. That was a very thorough answer, I appreciate it. Thank you.

And your next question comes from the line of [Maclovia Pena].

Kind of a follow-up on the credit quality. You did mention a little bit of what happened with nonaccruals but I'm curious to know, in terms of this quarter's charge-offs, what is the composition of those in general terms, please?

A large portion of it would follow the one to four family, is primarily what it is made up of. I think that trend pretty well goes, as I already talked about in detail, all of the sectors.

I think if you are asking on a net basis, the commercial was about -- this is of our 5.6 million, the commercial was about 2.4 million, commercial real estate was 1.7, consumer real estate was 300,000, and consumer-related was 1.2 million.

Okay. Great. And next, do you have any guidance in the sustainability of your dividends with what you're seeing now?

We look at that on a quarterly basis and we have a Board meeting tomorrow and we will address that subject.

Okay. Great. Thank you.

And your next question comes from Jon Arfstrom with RBC Capital Markets.

Thanks. Good morning, guys.

Good morning.

Hey, Jon.

You talked a little bit about the deposit flow that you saw during the quarter. Curious if you ran any promotions on it, and whether or not you did, are you seeing that type of flow continue in the second quarter?

We did not run any abnormal promotions, just the normal advertising that we do. It's -- as I think about it, and I will let Phil, see if he has any additional comments, the -- first of all, as I emphasized, it is no surprise to us of us being a safe haven. For 141 years and going through the cycles of the great depression, or the '80s here, we've seen -- this Company has a very valuable reputation as being a safe haven. I think the other thing that we have to recognize is that at 0 interest rates, which in my 40 years of being in this business, I have not experienced, you've got corporate treasurers, who, it is just not worth their time to try to invest in overnight, and so you've got an -- they can leave it in their checking accounts, all insured, and not worry about it. That's a lot of what is happening with both the business person and the individual, is finding a place where they don't have to worry. And so they -- the business Chief Financial Officers have been building up their deposits. And because of -- and individuals have been putting money in the organization. I was pleased that when you look at the mix of the growth of the $1 billion for the last six months, 35% are in DDA of that increase, and 65% are in time. So you got a strong DDA increase.

Now, as you sit there and see this money come in in that regard, the thing we're focused on is when the recession is over, and to make sure that we have continued to build the core of this business and that is the reason why we are so focused on new relationships. In a simple example, if we bring in a customer who today has $100,000 on deposit, maybe their normal balance is $50,000. I want to make sure that we've got that new customer, because then we will know that we've got a new level of $50,000. Phil, do you have any other comments you would like to make?

I might just mention a couple of things. Jon, we're not really a promotion bank, so you're not seeing that kind of thing. We're not advertising rates on CDs or anything. It is an unusual time, though. I think there are some unusual things that you see occasionally. They're not huge but just might give you anecdotally a little feel for it.

One thing we've seen is we've seen some smaller correspondent banks downstream, actually not sell us Fed funds but put their money in corporate money market accounts that currently have a yield of let's say 45 basis points but it is a lot better than Fed funds at 15 to 25 and that is pretty unusual. And that money would have been on our balance sheet still, but it is just in a different category. I think we might have seen -- I think the highest number I saw there at one point was $80 million. But it moves around a lot. So it is not a huge number.

Another thing that is a little bit interesting, a little different from us, is that we've had some success offering a product on the Internet called our Momentum Account, which is a hybrid account, it is a spending and savings account, it is really neat product that has been well-received, and we've seen some -- it started from a really -- it started from the base of 0, I guess, in August, and we averaged this quarter, it is not a lot, in terms of average, but we averaged $55 million, and that is -- it is a higher rate than we pay in our traditional bank deposit, it is available only on the web, and so that is -- I think that is probably our highest cost in terms of just interest rate money or I wouldn't call it promotional. It is just different. I might run through maybe it would be helpful to run through sort of the categories of deposits on a link quarter basis, and give you the annualized growth rate.

Demand deposits were up 18%, these are all annualized link quarter, on the first quarter, our savings accounts were up 14%, and our interest on checking accounts, or some people call it NOW accounts are up 14% annualized. The Momentum account that I told you would have had a huge growth rate because it started from a small number. We saw our high yield MMA account up 7.6% annualized. We saw jumbo CDs up 51% annualized. We saw consumer CDs up 21% annualized. I think that gives you a feel, kind of what is happening. It is very broad-based. And we feel very good about the kind of volumes we're seeing.

But I think one thing Dick mentioned that is worth repeating. We have had incredible deposit growth, but we want to be careful not to just take the view that, well, let's take all of this money that has gone in, let's take the highest yield we can get on the money, whether it is a long duration or whatever, and let's just employ that and hope it stays. We don't think that is a prudent thing to do with our balance sheet. You are going to see us keep more liquidity on our balance sheet as we've see this run up in deposits because we want to make sure that what we're doing is we're getting the relationships that Dick talked about and there is probably an amount of money that is going to flow out when things settle down and we just want to be prepared to have plenty of liquidity to manage that and be effectively employing the core part of it.

That is helpful. And then just a quick follow-up on that, Phil. When I think through it, with loan demand leveling off, and it looks like your securities portfolio was up pretty materially in the quarter, just maybe touch a little bit more on how you plan to management the liquidity, and if you feel like all of them -- obviously some other cross-currents like higher spreads on new loans, offsetting some pressure from loan yields coming down, so maybe give us some thoughts on how you manage the balance sheet, and what you expect the margins to look like as you go through the year?

Okay. Well, I think that you are right, we did have some increases in securities during the quarter. We actually averaged, if you just look at total securities, $3.3 billion in the fourth quarter, we averaged $3.7 billion in the first quarter, and the things we've been buying, that we like to buy, primarily, is municipal securities, because that is where you've seen actually real value, and pretty much all we've bought has been PSF insured, Texas school bonds, and I talked about PSF before and if anyone has any questions on what that is, just ask, but that is truly a guilt edge insured by the state of Texas, security -- with underlying security ratings of A, so this is great credit, and we're buying a lot of them from hedge funds that want to get rid of them and can't hold them, so we're seeing yields there, I think in the quarter, we saw yields average just below 7% on those, between 6 and 7%, on those bonds. That's what we like to buy.

We also bought some mortgage-backed securities. But you're looking at yields there of probably 3 and [3.25]% for a similar duration instrument. I will tell you that we are getting less and less enamored with buying what we feel are overpriced mortgage-backed securities where the Fed, for example, may be in the market, and they're commendably trying to lower mortgage rates but the effect for buyers of those papers is that you end up with a security overpriced and if the Fed moves out at some point, it affects the value of your security. As a result, and because of the risk/reward we see there, we are planning probably on maintaining more in terms of maybe even treasury securities, short-term, short-term treasury securities for us or Fed funds sold. I know that is an opportunity cost associated with just diving in and let's say buying the current mortgage-backed security for 3.50 or 3.75.

But I think for now, given what we've seen in the markets, and given the dislocations we're seeing with the deposit flows, we don't want to -- we just want to be careful about what we're seeing and we want to make sure we're getting good value for the money that we're investing and not going to get our head handed to us once the government steps out of these securities markets.

And then just how much of the re-pricing do you feel is in the margin already?

With regard to loans?

Yes.

We still have a lot of work to do on re-pricing. I think it has helped but I don't think it has been nearly fully re-priced in.

Just to give you an example, one thing, on energy loans, we think we're about halfway there. We will probably get another quarter in the next 60 days, and so, you got to just work through it. And that is just an example. Every sector then is a little bit different, but we certainly have a very specific plan to widen those spreads, and when I say widen them, we're not taking advantage of the customer. You just got to -- these things have just come down so much, and so low, that you got to get back to getting paid for the risk.

And Jon, I think maybe the bottom line of what you're asking is what do I see happening with the margin. And I don't see it changing a lot. A lot of weird things happen so I can't give you guarantees, but I think what we're seeing with the benefit on loan pricing that we're seeing, it might be offset by what we're seeing on the pre-payments, on mortgage-backed securities, again, you are seeing speeds there really pick up, and again, we're not going back into mortgage-backs today, and even if we were, we would be going back in at lower yields, so that is sort of a negative impact, so let's say those two items, not that they're the only two items but let's say those two items work against each other and maybe work towards more of a -- more for the next couple of quarters more of a stable margin but we will have to see on that.

I will just repeat again what Phil said earlier, that we are going to be careful this time, and we talked to you about deposits and we're really proud of the increase, and it is good core customers that are increasing, and getting some new customers, we want to be ready, too. We always want to protect our liquidity. Obviously, we want to grow loans. We want to have the ability to do that. And we want to be ready if somebody decides they would like to take it out of their -- lower their deposits, and invest in the stock market, or whatever might come along, so I think we got to just go through this 0 interest rate environment which is -- I think we're doing a good job of managing it, we introduced a pricing metric last fall, and we're gaining some traction there, and so it is just -- it is hard work. Because you want to be fair with your customers and at the same time be realistic about what is happening in the market. It is hard for everybody to get used to 0.

Right. Thanks for the color, guys.

You're welcome.

Your next question comes from the line of [Fred Romentine] with Sterne Agee.

Hi, good morning. I wanted to ask, are you seeing weakness particularly in one part of the state, or another, or is it -- or is the weakness pretty broad-based just based on the overall economic environment of the Mexican economy having its impact and energy and kind of just the overall softness? Basically, is Houston weaker than Dallas or can you compare some of the larger markets?

If you look overall, looking at the statistics of payroll, employment annual growth rates, the state as a whole is a negative 4.36%. You got to be careful with three months, because these numbers are all adjusted but it is the best I got. But I think it will address you. Interestingly enough, Dallas is worse than Houston. Dallas is at a 5.17 and Houston is a 3.16 and Austin is at a 0.77. And I think the thing -- so the answer to your question is pretty broad-based. And let's don't get too tied up in one point greater in one market than the other. As these energy prices come down, and the service companies have to lower their pricing, I think you will see a little more weakness in Houston, and what is happening in Dallas, remember Dallas is big telecom, and also the airlines, you got American, you got Southwest there, you got a lot of high-tech in Austin, and there is more technology that affects Texas than I think people realize. They close in on energy.

There is no doubt energy is important, but also technology, and as we've seen the technology industry weaken, that is going to affect -- so I think these numbers will get a little weaker. I don't think we're going to be worse than the nation. The nation is at a little over 6, negative 6 versus our 4.36, so it is pretty broad spread. San Antonio and Fort Worth are more stable. You got a little more manufacturing in the Fort Worth area that has an effect on it. And so the most stable market out of all of them is San Antonio.

Right. And then just a quick follow-up, maybe Phil, do you have the numbers for -- you've been talking about the customer growth, do you have the comparisons, either link quarter or year-over-year, for both the consumer and business clients, have you got it on the deposit side?

In terms of the numbers of customers?

Correct. Or however you want to measure there, the growth.

Well, if you look at transaction accounts, let's see if I have something here. On the total deposit side, it looks like I show year-over-year growth in transaction accounts up 7% for total. I'm sorry, that's for total deposits. It looks like transaction accounts year-over-year are up 17%.

Okay. Great. Thanks for the color.

Terry McEvoy with Oppenheimer.

Good morning.

Good morning.

Just getting back to I believe it was Ken's question on the calculation of the quarterly provision, is it safe to assume then that the $40 million increase in nonperforming assets in the first quarter, a large majority of that had been classified as criticized in the fourth quarter, and then kind of a second piece, if the amount of criticized assets in both the home builder portfolio and the retail portfolio were relatively flat, what was the other part of your loan portfolio that did trigger some building of the reserve in this -- in the first quarter?

Well, first of all, let's go back to what you said first and what Phil said earlier. The methodology is really driven by our classifications. So yes, we had, in previous quarter, not just first, but all through the second half of last year, as things start to address, that's when the methodology allows us to start providing as classifications increase. Today we will be providing for that, and did some, obviously, in the first quarter. You are always doing it.

And Dick, I think on the last call, in January, you talked about your outlook for net charge-offs in '09, being relatively consistent with 2008. Would you reiterate that same statement today?

Yes, I would. I think what I said, you kind of got them jumped around in 2008, you had 4 million in the first quarter, and then 6 million and then 19 and then 8.5, and now we're at -- I'm looking at provision, I'm sorry. The charge-offs we said would--.

I think we said we would be about 29 basis points, indicate 29, 30 basis points last conference call, and I don't think we've seen any change.

We're sitting at 26 today, so we're comfortable at those levels.

Based on what we know right now.

Yes. The world changes every day.

And then just looking at the second quarter expected insurance and commission fees, they were down year-over-year in the first quarter. Do you expect any sort of recovery in the second quarter? Or do you think we will see a decline on a year-over-year basis?

Let me just first say that you've got some seasonality in our insurance commission. You've got in the first quarter where you got -- you get a little bit higher point because of -- what's the word I'm thinking of, retainages, bonuses and those sort of things come in the first quarter. The third quarter, we do a lot of school business, so you've got, in the third quarter, that always happens, so it is a little harder to look at that.

First of all, Dick's right. Seasonally you are going to see a decline in the second quarter on insurance commissions but if you look back to the same quarter a year ago, current expectations for us -- are for us to be up slightly, but the market has been softening. We will just have to see what happens. What we have been seeing is PNC has been soft and benefits have been growing. We will just have to see how those two relate. We expect to see some growth overall versus the same quarter a year ago, and we will just have to see if that plays out.

Thanks a lot.

You're welcome.

And your next question comes from the line of Michael Rose with Raymond James.

Thanks for taking my question. Any special consideration being given to the [SNICK] portfolio at this point? Are you seeing any further weakness there?

We really are not. It continues to be strong. We saw -- in fact, it was up a little bit, it was up from 500 -- the balance is, the outstanding from 534 million to 542 million. And the increase really came from an insurance company and an old AG manufacturing company, so no, we -- that portfolio, you remember, it's about 62% energy, and I've talked in great detail about energy, and so we feel good about where it is.

Great. Thank you.

And your next question comes from the line of Jennifer Demba with SunTrust Robinson.

Thank. My questions have been answered.

Okay. Thank you, Jennifer.

Hello, Jennifer?

Her question has been answered.

I'm sorry. I should comment the consumer numbers that I gave you were based on balance, not numbers of accounts.

And just one last thought that hit me in regard to the question about the reserve, we also -- don't forget that as we saw the economy begin to weaken, really in the fourth quarter, we began to build a reserve as a result of that. So that is a factor built in there, also. We would be happy to entertain any other questions.

The question comes from Steven Alexopoulos with JPMorgan.

Alexopoulos from JPMorgan. Just to follow-up first on the shared national credit question, was even of the $50 million increase in nonaccrual loans related to share national credits this quarter?

No. And there is only one classified loan in the whole portfolio.

Okay. And just one--?

And there are no nonaccruals.

Okay. Why was the tax rate so low this quarter, and is 30% a better expectation over the next couple of quarters?

The reason it is a lot lower is because we have been successful buying municipal securities that we talked about earlier and we've seen an increase in that, I think it will be fairly -- it will be lower now since we have that same level of tax-free income.

So run rate closer to what we saw this quarter?

I think so.

Okay. Thanks, guys.

You're welcome.

(Operator Instructions) And your next question comes from the line of Tom Alonso with Fox-Pitt Kelton.

Good morning, gentlemen. I had a quick question on the NPS, if yields are so low and if they are, as you say potentially overvalued here as you're -- as the government is in buying, any thought for you? I would assume there is an unrealized gain in that portfolio any thought to maybe recognize some of those gains as an offset to potential FDIC charges the one time charge coming down the road? Just your thoughts on that.

Well, given the way that -- I kind of like to evaluate your intentions on available for sale, I'm not allowed to think about that.

Okay then. That's all I had. Thank you.

Okay. Thank you.

(Operator Instructions) And your next question comes from the line of Kevin Reynolds with [Wonderly].

Good morning, gentlemen.

Good morning.

I got a couple of question, and I guess less focused on the very, very short term and more just going back to your unique experience, sort of in the '80s and I actually got a couple of them here. First is, based on that '80s experience in Texas, do you think that this credit environment or the banking environment today is better or worse than that, than what occurred within Texas back then? And then second, maybe sort of looking into the future, not so much applying -- I'm not seeking guidance from you, as much as I just want to know how you feel like this is transpiring and projected to transpire over the next several quarters and maybe couple of years?

First of all, I think the '80s versus today are apples and oranges to a large extent. The '80s was energy-related, followed by energy and energy was even more impacted by the change in the tax laws, and there was very much of a focus of those problems on Texas alone, more than the rest of the United States, and certainly not the world. Today, I believe we have a world problem, a world recession, and as you know, and all of you know, the markets have been majorly affected. We went through a time, I think -- I think today's can be really characterized by it's leverage, stupid. We saw the leverage on individuals in the residential mortgage. We saw the leverage on the investment bank, 30 and 40%, writing them up. We saw that in the conduits and all of those things have affected the markets. And what I believe that the Fed has worked hard to do is get the markets opened again, and there are times that the government should step in and interject itself to help capitalism begin to operate. I think the important thing is that they not forget that the capitalism is what is so important today.

Our business customers are primarily hard-working individuals, who have started with nothing and built their businesses up, and they are sitting and waiting to see how this is going to play out. And I guess that moves me to the next thing, that as far as the future goes, I'm an optimist. I think we will work through this. And I'm a great believer, if you will let the free markets take their course, accept your loss, when you have losses, and put them behind you, and build forward, I think there's a great deal of focus on financial capital, and not enough on human capital, and it takes humans to solve these things, and they can be solved and worked out, so I think we've got a -- I don't know, 12, 18 months to get through this, and then we will start with a new start.

As I said in my closing remarks, I think we're going through a period of time of deleveraging, and I also think that the way to get out of it is once people find their new level and the new level of sales for business, and the right level for each individual, then they will start going forward, and we can start growing this economy again.

I will just echo what Dick said, I mean being apples and oranges, I mean this is not the '80s. Not even close. And well, knock on wood but the '80s, a perfect storm in Texas, that this is nothing like it. Our earnings are down a little bit this quarter but we're still -- I mean we're almost double as profitable we are, we are almost double the profitability that we had going into the 80s before today, our Company, our capitalization level is up, I bet it is double, probably more. So you lock at the -- the environment is totally different. I mean recessions happen. It is a part of banking. That's what we're dealing with and we're going to be dealing with in the state going forward. It is nothing unusual. It's going to happen all the time. And you just got to manage through it. The time to deal with the recessions is not when you're in it so much as before it and getting prepared so you're not hurt so bad going into it. And we think we tried to do our job there and we will just work through this. But I don't see this anything like the '80s.

I would also say that our state is nothing like the '80s. We were in the bottom of the trash can in the '80s. And now, we're kind of hanging around the rim at the top. We're fortunate, this housing thing that was kind of the roots of the problem, because we have a good infrastructure, lots of land, we were able to hold housing costs down. Our state was growing. We're the number one fortune 500 -- has more fortune 500 companies than any other state. And so we're not -- what we are is we've got real companies who are making things, and servicing companies, and so there is a real good business environment for us to build off of, and that's the reason, quite frankly, we believe this is a great opportunity for Cullen/Frost. It has taken a lot of work. The customers are resistant to making changes because they, like the economy is kind of frozen. But we are going t make those 12 calls versus 9 calls to be sure we can pull them across the line, and build a core of this Company. This is an opportunity, you can pick up those businesses that you can never do in the hey days. And so is it going to happen overnight? No. Is it going to take a lot of hard work? You bet you.

And I guess a couple of other little questions here. One is in talking about your margin, and again, not trying to pin you down to a specific number, or on a quarterly basis, because I know there are a lot of moving parts, but as we sit here today, conceptually, I mean interest rates are near zero on the short end of the curve, is it safe to say that your net interest margin is at or near a bottom, again, sort of stepping back from 30,000 feet, and maybe another way of asking it is, is your balance sheet still positioned to benefit meaningfully over the next couple of years from both the volume increases and NIM expansion if the economy recovers over the next few years?

Well, I would say that -- there are kind of a lot of moving parts in what you said. First of all, let's take it a piece at a time. Other things equal, the better loan pricing could help margins. If that is the only thing. That is true. Secondly, we have begun to be somewhat more asset-sensitive. Even with the hedge that we've got in place, we were much more neutral than we used to be. We've begun to be somewhat more asset-sensitive as we've seen liquidity build up a lot from where it was. So we can see higher rates begin to help us there. That could be some margin expansion as well.

On the other side of the coin, just arithmetic of the margin, as you well know is if you are going to grow liquidity a lot, even though you may not get -- lose any money on it, compared to what you're funding it with, that is going to tend to dilute the margin per se even though it won't cost you any net interest income. You know what I mean. And then you've got these security yields that we still have done a good job buying securities over the years, and we've got rates in our portfolio that are above what you can get today, so that is a factor as well that you got to take off on the other side. So all of those things kind of go together. And so I won't argue that there could be some room for margin expansion, as things normalize, but we also got to recognize that over the next few quarters that there are a lot of moving parts and we will just have to see what happens.

Okay. And I guess one last question, and to frame all of this and kind of keep it in context, what we've seen from you today and the big picture, I think I saw just a little bit earlier that sources were speculating that the results of the stress test out there, I know you're not subject to, but that the treasury would like to see, minimum 3% tangible common equity ratios on the banks and their worst case scenario. Would you remind us where you are and what it would take to put you in a situation that would put you anywhere close to that?

I think our tangible common number today is around an 840 or so. 830, 840. And you're right, we're not subject to the stress test because we didn't take any bailout money. But we looked at -- we considered the stress of our income statement when we decided not to take TARP and we felt like we would be in good shape. So I don't foresee that being a problem.

Okay. Thank you.

And your next question comes from the line of [Kelsey Johnson] with [Lambardia Capital].

Hi, thanks for taking the question. Just wanted to get an update on the potential problem loan portfolio, so as of December 31, I think it came in at around $50 million, and it sounds like most of those moves into your NPA classification for this quarter, you can talk about where that portfolio sort of stands right now, and if you just give us an update there?

It is down from $50 million to $39 million, and about 28% is -- it is pretty diversified, and a couple of metal fabricators, 27% of it is one collection agency that we've talked about in previous calls, and it continues to pay down. And then about 22% is in real estate lot developers and single family construction. And so it is a little bit of everything, and then you got a music store retailer and a printer and a computer sales, and an airplane, and no big dollars in those last few I talked about, and so it is -- it is very manageable. There's some good things happening with some of them that we hope happen, and then you could see maybe some of the builders and one of the builders on the lots, which is a little less than $1 million could move over and we already talked about all of that, so it has moved down, and I think it is doing what it is supposed to do, helping us focus on those items and hopefully help them do something, move them out, or sell a company, or whatever, and -- but some of them will go into the nonaccruals. Does that kind of help you?

Yes, that's great. Thank you.

(Operator Instructions) And at this time, there are no further audio questions.

Well, again, we appreciate your interest in our Company and I can commit to you that we will continue to work hard, and we stand adjourned.

Thank you. This concludes today's conference. You may now disconnect.