Cullen/Frost Bankers Inc (CFR) 2009 Q2 法說會逐字稿

Good morning. My name is Jennifer and I will be your conference operator today. At this time, I would like to welcome everyone to the Cullen/Frost Banker second quarter earnings call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. (Operator Instructions). I would now like to turn the call over to Mr. Greg Parker, Executive Vice President, Director of Investor Relations. Sir, you may begin.

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 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 Dick.

Thank you, Greg, and good morning, and thank you for joining us. I'm pleased to review our earnings for the second quarter 2009. I'll provide a brief recap of the results and then I'll ask our Chief Financial Officer, Phil Green, to offer some more details behind the numbers. And afterwards, Phil and I will be happy to take your questions.

I would characterize our results for the quarter as a blend of factors affecting Cullen/Frost in several ways, both good and bad. We continue to have solid growth in our deposits, net interest income increased year-over-year, which we feel especially good about given the rates have been pushed to near zero during this period. And although loans were up versus last year, they trended down compared to the first quarter. Those things that are within our controls such as aggressive efforts to boost new customer relationships have yielded positive results. That's good, and it is underscored by recent research that shows Frost leads the industry in several key customer satisfaction metrics, both for individuals and businesses.

However, the weakened economy nationwide and in Texas have pressured our results in ways that we cannot control, which include such things as industry-wide FDIC special assessment. I believe our performance reflects the economic environment we're operating in today. However, we believe the economy is showing signs of bottoming out. Of course, how long we stay at the bottom is the big question, but I'm very comfortable with Cullen/Frost's position and optimistic about our overall direction.

Now, let's take a look at some of the results. Cullen/Frost net income was $37.9 million for the second quarter of 2009 versus $52.5 million reported last year for the second quarter. On a per share basis, earnings were $0.63 per diluted common share compared to $0.89 per diluted common share a year earlier. Earnings impact was driven primarily by meeting certain obligations to the FDIC and by our decision to increase the provision for loan losses. With respect to the FDIC, the industry-wide special assessment affected our earnings by $7.3 million, or $0.08 per share on an after-tax basis.

In addition, our FDIC insurance rose an additional $3.7 million, representing previous increases over last year. Average loans for the second quarter of '09 were up 7.3% versus last year. However, we've seen a leveling off of loan demand this quarter. Loans are basically flat compared to the first quarter of '09. Our net interest margin was 4.28% versus the second quarter of last year at 4.68% and last year of -- excuse me. Our net interest margin was 4.28% for the second quarter of '09 compared to 4.68% last year, and 4.33% this past quarter. Net interest income on a taxable equivalent basis rose 5.9% to $144 million compared to $136 million.

Our capital levels continue to remain strong compared to all regulatory and industry ratios. We've seen an increase in our nonperforming loans this quarter. They still remain at manageable levels. Net charge-offs were up compared to last quarter, but are also considered manageable, at 38 basis points of average loans on an annual -- on an annualized basis. This second quarter of '09, the provision for possible loan losses was $16.6 million compared to charge-offs of $8.3 million. The allowance for loan losses as a percentage of total loans was 1.42% for June 30, 2009 compared to 1.13% for June 30 of '08, and 1.30% for the end of last quarter. We believe the higher reserve coverage is appropriate in this financial climate.

Non-interest income was $68 million for the second quarter of '09 versus $70.6 million a year earlier. Looking at the components, trust fees decreased $2.1 million to $16.9 million. This was due to lower investment fees and lower oil and gas management fees. Service charges on deposits were $25.2 million, up $16.3 million. The increase was $3 million and was primarily in commercial accounts resulting from higher treasury management fees due to lower earnings credit rate. Other service charges and fees were $6.3 million compared to $9.5 million. Last year, we recognized a $1.4 million fee in investment banking. Other income was $12.5 million compared to $13.5 million last year. The decrease was primarily the result of a $1 million decrease in the gain on sale of student loans.

On the expense side, our non-interest expenses for the quarter were up $16.2 million, or 13.5% to $136.3 million. Second quarter of last year, again, most of this increase is attributable to our FDI expenses already discussed. Salaries and wages increased $2 million to 3.7%. Employee benefits were up 15.7%, primarily due to the increase in retirement plans and 401-K and profit share plans. Our furniture and fixtures increased $1.5 million from the same quarter of last year, mainly due to new locations and upgrades in our Retail Banking technology and teller systems. Let's spend a minute now on credit quality.

As we saw in the first quarter, nonperforming assets did increase. However, they migrated from the bank's problem loan list and therefore did not come as a surprise. Non-performers at quarter end totaled $190 million. There has been -- since the quarter end, a $10 million improvement, as we have seen some of these credits be favorably resolved and we are cautiously optimistic about further improvement by year end. During the quarter, the increase came primarily from one energy credit of $18 million that I previously discussed with you, a manufacturing concern that was relying on a faulty audit that added $9 million, and approximately $9.5 million to home building related borrowers and commercial loans extended to Mexico entities that are operating in Mexico added $3.2 million.

Now, let me further address a couple of these increases starting with Mexico. The Mexico situation is primarily the result of the peso devaluation and slower Mexican economy. We identified $36 million of problem loans. Of this, $5 million are backed by XM insurance. $24 million as private insurance. And $7 million secured by commercial real estate in Monterey. We have contained the situation and set aside appropriate reserves and we feel that the impact to financial statements should be minimal going forward.

The level of troubled home builders has been flat for nine months. These credits that moved to nonperforming during the quarter were identified as problems and adequately reserved in prior quarters. While not a part of the nonperforming additions, it's worth noting that extensions of credit secured by retail centers have not experienced measurable deterioration. Another measure of credit quality, charge-offs saw some deterioration compared to the prior quarter. Specifically net charge-offs for the second quarter '09 rose to $8.3 million, up from $5.7 million in the first quarter. Annualized in this quarter's numbers equates to 38 basis points. I would expect to be in the neighborhood of 38 basis points when we close the year, barring any big unknown surprise.

Loan delinquencies 30 days or more stood at $102 million, or 1.18% of total loans. The first quarter, they sat at 1.22% and year end, 1.38%. Past due levels are reasonable and are expected to remain so. While deterioration in the credit quality was recognized in the second quarter, it was not unexpected and did not emerge from unfamiliar areas and occurred at a manageable rate.

Also, the inflow of new problems has slowed. Good measurement of this is the level of potential problem loans, which set at $27 million. The last time we saw this low level was in the first quarter of '08 at $24 million and prior to that, it was the third quarter of '07. Finally, it is important to recognize that the allowance for loan losses did increase in the quarter to $122.5 million. When you look at this coverage, it has a coverage to total loans of 1.42% and to charge-offs of approximately 4.5 times based on annualized year to date net charge-offs.

Turning now to the consumer side, the second quarter produced solid growth, net new customers and deposit balances, which were up 11.4% year-over-year. Same-store sales and deposits were up for the second quarter of '09 versus '08. And on a linked quarter basis. We're also pleased with the new customer growth in our de novo branches and consumer loans are up for the second quarter of '09 versus '08, but they are flat on a linked quarter basis.

Turning to the business side, with respect to new relationships, we turned in an outstanding quarter. Year to date, we have acquired 141% more new relationships than the same period last year. These new relationships have excellent breadth and depth. On an average, each of these new relationships includes 3.5 individual customers and over 60% of them have chosen to use all three of our major banking product groups, loans, deposits, and fee services. This means we are servicing the needs of both the business and the individuals who own and run these businesses. More important is this increased potential, these relationships will provide when the economy recovers. This is very strong, especially considering the customers are hesitant to move in such uncertain times. This speaks to our discipline in targeting and pursuing new customers and to the reputation we enjoy as a safe haven.

On the other hand, the commercial loan market continues to be difficult. As you might expect, with flat or falling revenues, companies are less likely to need financing for capital expenditures or increases in their working capital lines. Recognizing this dramatic reduction and loan request, we are stepping up our calling efforts and have made 35% more calls this year compared to last year, but even with this increased effort, loan requests have declined 22% compared to last year with customers requests down 38%. Year to date, our customers have had $1 billion less in loan requests than last year.

Still, there's some good news. In the second quarter, we were up 16% compared to the first quarter, with customer requests holding steady. New loan commitments booked in the second quarter are also up 16% compared to the first quarter.

Well, let me say a few words about the economic environment we face as I close these remarks and turn it over to Phil. First, there's no avoiding or debating the fact that Texas economy is slowing right now. Cullen/Frost's business is tied very closely to Texas and we feel some of the pain as well, given the state's strong pro business climate, Texas was perhaps the last place to enter the recession. Our hope is that we will be among the first to exit as well. There's some very modest indications that things are leveling off. As we look at job losses, for example, last quarter's prediction was that Texas would lose 370,000 jobs or a negative 3.5% for the year. Now, it looks more like Texas will lose some 264,000 jobs or a negative 2.5%. So the rate of loss is improving.

Otherwise, we expect the recession here will continue through the balance of the year, but it should moderate, especially compared with other regions of the country. I believe the biggest challenge we have in this country and certainly in this state is for consumers and businesses to regain the confidence they need to invest again. And we're doing all we can to be ready when this happens. For example, we continue to open new financial centers, four new locations coming online this year. We continue to provide the kind of industry-leading service that brings new customers to the door and keeps them around for a long time. And we are focused on providing the best products possible.

In June, six of our mutual funds received the five-star overall rating from Morningstar, which is a terrific accomplishment. Finally, we continue to earn and enjoy a very strong reputation for providing terrific service and great value. This is important, because as Greenwich Research recently said, reputation is critical. Among the research of Greenwich, two-thirds of mid-market executives say bank reputation and image is as important as pricing is today. This is good for us, because research has shown us that consumer customers rank us higher than customers of just about every other bank in key customer service and satisfaction metrics.

Also, Frost has consistently received the highest retention rate in the nation for consumer customers. And research shows us that our business customers rank Frost higher than every other bank in excellent client satisfaction and financial stability and number one nationally in treasury management satisfaction. Cullen/Frost is executing well and that's a testament to all our employees here and I would like to thank them again for doing an outstanding job under these tougher times. Now, I would like to turn the call over to Phil Green.

Thanks, Dick. I'll just make a few more comments and I will open it up for questions. On the margin side, our margin for the quarter dropped five basis points from the first quarter. However, there's a lot going on under the water to get to that number. Our average deposits were up by $725 million for the quarter and that represented an annualized growth of 25%. At the same time, loans were flat. So this created significant excess deposits for us which by itself would have put a fair amount of pressure on the margin. However, we were able to offset most of this through investment purchases and a modest reduction in deposit rates from first quarter levels.

Looking at our balance sheet overall, expanded by about $2 billion for the second quarter, or from the second quarter of last year and that's about 15%, with none of that coming from acquisitions. 90% of that growth was from deposits with the rest coming from higher capital. Loans only used about 30% of this increase, so our issue has really been what to do with the excess. And as we said in the past, we haven't generally liked what the securities markets may have offered in part because we believe the government's participation in the markets is overpriced a lot of what we historically bought, including agency mortgage backed securities.

Additionally, we've also been great believers in maintaining strong levels of liquidity and we feel it's especially important today, since no one can be sure just how much of this record deposit growth will stick once the economy turns or rates begin to increase, or how much will be needed to fund loan growth as customer and consumer confidence returns. That being said, in this unusual time, with the fed funds targeted at only 0.25% and with the average cost of our deposits during the quarter at about 0.5%, there's a very real cost to us of holding it.

What we've done over the last year is to put about 44% of our balance sheet growth into investment securities and that represented purchases of about $1.6 billion. And of this, a little over $900 million has been in municipal securities, primarily Texas, PSF insured triple-A securities, and our average tax equivalent yield over this period has been about 7%, which we feel compensates us for what we're taking on in duration and given up in liquidity.

More recently, we've also been buying a laddering of one and two-year treasuries, which although they combine to yield a pitiful 70-plus basis points, add almost 50 basis points above what we would earn in day money, with minimal interest rate exposure and excellent liquidity flexibility. And we'll most likely continue this investment strategy for the next few months.

Looking at our growth in average loans versus last year, of the $600 million increase, half was in C&I. 40% was commercial real estate mortgages, with the rest of the growth spread over consumer real estate, including helix and commercial construction. Declines occurred mainly in raw land and student loans. Compared to the previous quarter, both C&I and real estate loans declined a little over 1% annualized. An area where we're making a concerted effort with good success is in the area of loan pricing, where we're charging a fairer price for the risk we take on. And this is an area I believe everyone felt had gotten way out of line over the past few years. Our most recent month showed pricing on new and renewed commercial loans to be 147 basis points over prime. If you look back a year ago, that was only 17 basis points over prime. And in addition, we're greatly reducing the amount of loans that we make, which float with LIBOR in favor of making prime floating loans.

Now, looking at deposits, our growth has been extremely strong compared to both last year and the previous quarter. Demand deposits have increased and annualized 17% for both periods. Time deposits also increased 17% from a year ago and on a link quarter basis, were up an annualized 30% in the second quarter. I want to make a -- I want to point out a couple of specific items that are helping drive this unusual time deposit growth in the third quarter.

One, is given the low rate environment, we're actually seeing some downstream correspondent banks keep money in our corporate money market deposit account rather than selling the funds to us or keeping them in their fed account, because they can get about 15 basis points additional yield. We saw an increase of about $127 million in these deposits during the second quarter.

Additionally, we offer customers the opportunity to receive greatly enhanced FDIC coverage for high dollar certificates of deposit through the use of the certificate of deposit registry service. That's commonly known as CDRS softened by financial. It is fairly well know. And the customer accepts a slighty lower rate on these deposits, but is afforded additional security. During the first half of the year, we saw some customers bring in money from various sources in order to take advantage of the program and during the quarter, we saw an increase of $188 million from these deposits. Although, I understand it more recently is markets have somewhat settled that this product is in somewhat less demand.

And finally, the Frost momentum account, an innovative hybrid checking account or really checking and savings account offered only online and introduced just under a year ago increased $68 million to end the quarter at $136 million. Additionally, with regard to deposit growth, the first half of this year has seen record growth in the number of new checking accounts open for both commercial and consumer customers. And we focus on opening checking accounts as a key ingredient of a customer's relationship, is what Dick calls a funnel account. We're proud of this vote of confidence from depositors in these uncertain times.

And finally, I want to remind us all that in a recession, several things happen that have to be dealt with and some are common and some are specific to this particular environment. And some examples. Obviously, credit quality weakens, as customers come under pressure. Customers borrow less money. Assets values drop, putting pressure on money management and oil and gas management fees, as well as on pension costs. Brokerage revenues are pressured as investors sit on the sidelines and money markets funds can no longer afford to pay distribution fees in the low rate environment.

Short-term interest rates have dropped to near zero, while bank core deposit pricing is now at levels well in excess of the general market rates, putting pressure on the value of new deposits raised and the net interest margin. And finally, costs for FDIC insurance are up 1,700%. However, as we deal with these issues, we feel there are a number of positives that we are accomplishing right now that will help set the foundation for profitable growth as the economy begins to turn and we see the above factors reversed. Some examples of these include our business development efforts are mature and our numbers of new relationships are at historically high levels. Our deposit growth is at an all-time high. We have industry-leading customer retention. Our loan pricing has improved significantly. Liquidity is extremely strong, giving us the opportunity to meet future loan demand as it develops and take advantage of investment opportunities. Tangible common equity is very strong. The Frost investment performance for the RIA is resulting in six five-star funds at our new Business-to-Business loss ratio and the trust area is currently three to one. And finally, we have just implemented new and core retail and customer service systems, which were just installed.

Finally, regarding our current outlook for the year and through the end of the year, it's a little hard to gauge because of how the various analysts are accounting for the special assessments from the FDIC. In light of that, I think it's best to just say that our current outlook for reported earnings excluding any future FDIC assessments with picking up the one we just had would be in the range of $2.90 to $3.00 a share. And with that, I'll turn it back over to Dick for questions.

Thank you, Phil. We're ready to entertain your questions.

(Operator Instructions). Your first question comes from the line of Ken Zerbe.

Thanks.

Good morning.

Could you talk about the quality of loans that you're writing right now. I understand you're getting wider spreads on that, but I guess I'm just wondering, how are you balancing the sharp reduction in loan demand with either being more picky or having stronger terms on the loans that you are writing? Seems like that's a trade-off that needs to be balanced very well, as demand has fallen.

It's a great question. As we look at it, quite frankly, the risk grades of the loans that we are putting on the books are down. So that would say to us that we're putting better quality on. At the same time, I think the -- I think our underwriting standards -- I don't think. They are very consistent and we stay strong.

As you know from past discussions, we talked a lot about the pipeline that we lose and year to date we've lost $473 million either to structure or pricing. And I will tell you it's 50/50, about half structure and half pricing. So that's 35% less than last year. Just the whole water line has gone down. There's a lot less volume. But we feel good about our quality as best you can. We're being very careful. You know, the government keeps saying that, you know, you need to grow loans. We need to grow loans out of this. Quite frankly, that's how we got into this mess. Not our mess, by lowering quality. So we never have been a believer of that. And so we're trying to find that balance and I think we are. I think we're putting a little bit better quality.

The other thing you got to remember, when you compare the quality of the new loans to the existing portfolio, you got to remember you've washed through a lot of things and there's a lot of maturity in the current. So you got to be -- I have to be a little careful with that comparison.

Ken, it's a good question. This is Phil. And I think, you know, I think underlying the question, well, look, it's good your pricing loans better, but you probably got two questions.

One, you're not dipping down in quality to get these better prices, are you? And the answer to that is definitely not.

And secondly, I think the implied question is are you out of the market, is that why your loan volume is down? And I think the thing that Dick said about how the amount that we've lost relative to price has been about 50% compared to structure, and that's been very consistent with what we've seen over the last quarters. If we were seeing a significant pickup in terms of deals lost to price. You would be more of a flag that our pricing is more out of the market than it is what we're seeing more generally in the market. Where I think most banks are recognizing they need to get more for credit in these times.

So I think at this point, we feel good with it. It's really more the demand overall from customers that we're seeing changes as opposed to we're just pricing too high in the market as far as what we're seeing. We'll be very close to that if we see any kind of change, and it looks like we're exclusively losing deals with regard to price. Obviously, we'll have to adjust to market. But right now, we feel what we've done is just done a better job of getting where we need to be.

Let me just add on to what Phil's saying. We are a relationship bank. And that means we know our customer. So we're real close to this issue. So it's not a numbers game with us like happens in the large banks and where you're getting a lack of response just because you're looking at the statistics. But rather our staff is very close to it. We're all close to it. And we're aggressively out trying to make good loans.

I just told you that we've increased our relationships 141%. And in every case, if we can make a loan, we want to make a loan. But we want to make a good loan.

You know, Ken, an interesting side note of this better loan pricing is that you'll recall that hedge that we have in place, that 1.2 billion, which pays us $52 million a year, $1 million a week, is based upon three different pools of loans. One's a prime-based pool. One's a prime-plus a half pool and one is a prime-plus one pool and our challenge given the great pricing we're getting is maintaining enough loans within those pools at those pricing levels to maintain effectiveness on that hedge and that's something that we're working on as well during this period of time as we are pricing loans.

Now, is that hedge the reason why you're switching more of your loans to prime-based as opposed to LIBOR-based?

Part of it is. But I tell you the other thing is, I think LIBOR, we think LIBOR has been an area that was pretty much disconnected from what funding really is for regional banks and what is a real number to our customers, to our middle market customers and it's really kind of a way of pricing loans too low frankly.

I think the other thing, when you look at 13 banks in Europe, set the rate for 31 trillion, whatever it is, whatever it is in this country of loans, you know, it's ridiculous. Secondly, as you and I both know, the Central Banks have been driving that rate down because of the mortgage pools and to try to help the economy.

The mortgage pools don't relate to us and so there's a lot of things happening to that rate, the LIBOR rate, that we think are inappropriate for our organization.

And so we are adjusting -- there will be a lot of loans, such as in our energy portfolio, that will stay with some type of LIBOR spread. I'm happy that in most all of those cases, they are increasing the spread over LIBOR.

Perfect. Thank you very much.

Your next question comes from the line of John Pancari.

Good morning.

Good morning, Don.

In terms of your relationships that moved on to nonperformers, can you just give us an idea of the granularity or the number of credits there was.

I know you listed the manufacturing and the home building, as well as the energy credit and the Mexican piece, but if you could just go through the, you know, give us an idea of the granularity, the number of relationships actually included in the increase.

There's really about seven credits that represent 90% of the increase. The Mexico, which was $13.2 million increase is represented really by one credit. You've got -- you know, there is a hot spot. There's one petroleum credit that I've talked to you about before that's moved over. It's the company that I told you was -- spent most of last year focused on the, on selling the company and therefore they didn't increase their reserves. And so -- and the banking group should have done a better job of watching the half life payout. But we are where we are and that will have some resolution. We are -- you've got a building loan. You've got the one real estate. So it's not dominated by real estate. We've got that loan that had a bad audit, which is really interesting. The accounting firm quite frankly misstated the inventory of this Company by $5 million. And so that gets into all the things of, you know, what responsibilities do they have. We got one airplane and that was some guys that bought a plane and thought they could lease it. And you know what's happening with airplanes. So it's kind of all over the board. Is that what you were looking for?

Yes, it is. I guess what I'm just trying to get at is are you seeing, you know, a general progression in terms of the buckets or the classifications of loans that are starting to see some of the pressure in terms of past dues and what's moving on to MPAs. Either it's real estate-related or CNI now.

It's really two things, if you really want to -- it's too much leverage and it's bad management, but as I said, in my opening remarks, we're pleased that we haven't seen much change in the last really couple of quarters of this year of the real estate changes in retail centers and as I was looking at the decrease in loans from the first quarter to now, you've got CNI loans that are paid down $131 million and we look at that, and that's really the usage being down.

In fact, we're down from about 54% advanced to 53%. 1% doesn't sound like a lot, but take 1% of $6.5 billion, it gets to be real money. The other thing is commercial real estate loans are paid down permanently about 75 million.

That to me is a good sign in the fact that the loans are -- they got a place to go. Now, there's a lot that don't in this environment. Now, that's the good part of the portfolio, just kind of relating to it.

Back to what's kind of happening. Mexico, you know, what happened with Mexico, we depended too much on XM and private insurance. We've been doing business in Mexico for 90 years and you shouldn't ever do that, whether it's an SBA guarantee or whatever you got to underwrite the credits properly related to the underlying business. And so that created, you know, some of those problems and Mexico's, you know, got some real challenges today. So you really can't find it. I've looked.

I've talked to you a lot about the energy portfolio and you look at energy and our price decks, you know, at $45 and $50 in '10 and $55 in '11 and gas at 3.50 in '09 and going to 5.00 and 550. You remember we take a sensitivity number and that is 37.50 for oil. We ought to be able to liquidate 3.75 gas. I still believe gas is going to be weaker in the next couple of months. I told you that I thought it would be 2.50 in August. It might have been a little earlier.

I think our underwriting standards are very good. We try to capture 100% of the loans. 100% of the loans to be paid in the half life of the properties. We also have experience that our, probably we are very conservative on our volume of in the ground of production. So it's, you know, hedges are still an important factor and, you know, we're about 50% hedged for '09. Our customers are. And they are about 25% hedged in '10 and $65 and 650. You look at the curve, the hedges are strong. I think we'll go through a pretty big dip. Obviously, time is the big factor. You know, how long will they stay? If they stay real low for 12 or 18 months, sure, there will be other problems. But right now I'm comfortable with that portfolio.

One to four family. I think we got way ahead of the curve last year early. You know, we've gone down from one to four family from 443 million this time last year to 260 million in commitments and our outstandings have gone from 252 to 167 and our classifieds have held level, as I mentioned. We're sitting at a little under 60 million. Foreclosed in one to four family did go from 4.8 million to 8.4. We're selling this fast. For us, this is good news. You want to work through this stuff, deal with it, and obviously we had a bunch of it in the second quarter, but I think we're dealing with the right things.

Okay, and then one last question, your charge-off expectations, I believe you mentioned 30 basis points for the year. Is that where you're going to end the year, fourth quarter, or full year?

Full year.

Okay.

I think we'll be in that neighborhood. And obviously that's pretty aggressive for me to say a number when there's so many unknowns. But that's what I believe today. And I think our -- as I said earlier, I think our nonperformers, you know, we may be at a peak and they are already starting to come, you know, $10 million off of 190 isn't a lot, but it's better than continuing to go up. And I think, we've got some things working and I think we can continue to work it down.

And the only -- the other factor is, if this economy is getting better and we think maybe we're at the bottom, at the same time, I don't think we're going to have roaring growth. I think we're going to come off the bottom.

We might get out of the recession early next year and then I think we're just going to plug along. I think there's some big changes in our economy. And the biggest thing, and I can't overemphasize it, is I will tell you the business person is not doing anything except building cash and paying loans down. They are pretty much scared to death to do anything. And we've got to get confidence built back into the business person.

Okay. Thank you.

Thank you.

Your next question comes from the line of Bob Patten.

All my questions have been asked. Thank you.

Thank you, Bob.

Your next question comes from the line of Jennifer Demba.

Thank you. Good morning.

Good morning, Jennifer.

Dick, just wondered what your interest level is in either FDIC transactions or possibly other companies divesting assets or deposits in Texas over the next several months.

We're always interested and we obviously, you know us well enough to know we want to make sure it works good, both with the human side and the financial side.

I think one of the things that's extremely important today is that I have just a tremendous amount of confidence in the processes that we have. And I will tell you that we have capacity to take on some other banks and we just got to make sure that they are right for us. But we have the capacity. We have the fundamentals are good. We -- as I tell people, you know, we know what we want to do. We have a lot of clarity in the kind of bank that we want to be, and that we are and what we work on is just being better at it each and every day.

And so if we can make some acquisitions either from FDIC or selling off parts of other companies in this great state of Texas, we would be interested.

All right. Thank you.

Your next question comes from the line of Ken Usdin.

Thanks, good morning.

Good morning.

I think you said that you're expecting full year earnings $2.90 to $3.00. Just want to make sure that that's based on the 76 and the 63 you earned in the first half.

Yes, it is.

And so if that's the case, then it implies that even if you back out the FDIC costs from this quarter, that you're expecting a nice improvement to $0.75 to $0.80 a quarter, you know, in the back half of the year.

And if that math is right, I just want to understand what you think the positive deltas are going to be as we move forward with regards to, you know, have we seen the peak in provision, is margin going to start going back up, just wonder what you believe you'll start seeing as your actual earnings drivers given the background you've laid out in today's call.

Okay. Well, you know, basically we feel like the provision for this quarter was higher than normal. I mean we definitely built the reserve a significant level of about $8 million and it wasn't related to any one specific thing. So we are hopeful we won't need that same amount on a quarterly basis. So I think that's a positive to look forward to.

We've got a number of investments that we've made in municipals in this quarter. We've got some that we are continuing to make and as we utilize some of this liquidity that we have. I think last I looked, I think it was selling over $1 billion in fed funds. And actually we don't sell fed funds very much, just keep it in the fed account because fed funds is less than the 25 basis points the fed pays.

So there's opportunity to enhance liquidity as far as that goes, and then we're just trying to continue to move the business forward while we're watching expenses and try to keep those at levels more in line with revenues. So I mean that, that's more of what we're seeing.

All right. So provision's probably the biggest potential delta, right, given that that was probably the most -- the biggest kind of negative this quarter?

You know, it's one of the bigger ones. I wouldn't say it's the only one, but it's certainly -- I think it's an important one definitely.

Then my second question would just be around talking about obviously the economy's tough, slowing to an extent. You seem to be seeing some light out there or hope out there for the turn. So as far as the expectation for charge-offs to be in kind of the upper 30s, which is higher than what you guys had indicated last quarter. I guess what are the concerns -- I know these are small numbers, but what gives you the confidence that you are seeing kind of that peaking out of losses and, you know, why we can not expect the loss race to continue to move higher, given the sizable jump we did see in nonperformers this quarter.

The answer to your question is really just because of our understanding of the detail of the nonperformers and what we see happening.

Obviously, when you start talking about the crystal ball, nobody's is perfect, but we have a closer eye on it than anybody else and we spend a lot of time with the details of it and that's the reason we feel comfortable in making that statement. You know, I don't know for sure. I certainly don't, but everything I do know today, I'm comfortable in saying that to you.

Okay. Got it. Thanks a lot.

Your next question comes from the line of Brett Rabakin.

Good morning. Wanted to ask on the asset quality discussion, you obviously mentioned the $10 million improvement since the end of the quarter on NPAs. And the potential problem of 27 million.

Want to make sure I understood it correctly that you're basically expecting nonperformers to probably be in a similar range going forward to maybe potentially lower. Is that a fair assessment?

Yes, what I said was I would expect them to move down now between now and the end of the year.

And want to make sure I understood. Is that more a function of resolution of nonperformers, your optimism that the economy's at a bottom, or just your confidence that new loans moving in will be minimal, or is that--

It's a combination of all of that. But I think the biggest factor is just understanding the nonperformers and that we have worked with for sometime and that we are optimistic about some resolution.

Now, any time you get into this, you think it can happen this quarter and it never happens till next quarter and, you know, all those kinds of things.

But we push pretty hard to move towards resolution and quite frankly, I'm not in love with bankruptcy, but a company filing bankruptcy often gives you that opportunity to move forward and new capital comes in and you may have to take a little charge-off compared to the total loan. But you move the nonperformer out. So it's just blocking and tackling hard work.

And then I'm curious, I know your credit quality is much better than many banks, but I'm just curious if you guys added any workout staff this past quarter or two or kind of what you've done with your credit staff to this year.

We have a great workout staff. As you know, all of us have been around and went through this in the '80s.

Yes.

So they just try to keep me out of the way. We got a great staff that can work with it and, no, we haven't. You know, I mean, we really haven't increased it.

One thing we've done to take advantage of the opportunity is to let some of our younger people actually spend time in the workout area because you learn a lot more in problems than you do just seeing good times.

Obviously they are new and they are inexperienced, but they can help with the resolution process and it also is a chance to give them really invaluable opportunity to see how things work in good times and bad times.

Phil has really hit an important factor. All of us really grew up in the '80s, a whole bunch, more than we ever dreamed we could. And what we see is this is a tremendous opportunity to really train the next generation in our Company by letting them spend some time there.

Okay, great. Thanks for the color.

You're welcome.

(Operator Instructions) There are no further questions at this time.

Well, thank you again for joining us on this call, and we appreciate your support and your interest in Cullen/Frost. We stand adjourned.

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