Cullen/Frost Bankers Inc (CFR) 2010 Q4 法說會逐字稿

Good afternoon, my name is Farrah and I will be your conference operator today. At this time, I would like to welcome everyone to the Cullen/Frost Bankers fourth quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After these speakers' remarks, there will be a question-and-answer session. (Operator Instructions)Thank you. Mr. Greg Parker, Executive Vice President, director of investor relations, 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 department at 210-220-5632.

At this time I'll turn the call over to Dick Evans.

Thank you, Greg. Good morning and thanks for joining us today. It is my pleasure today to review Cullen/Frost fourth quarter 2010 results. Our Chief Financial Officer, Phil Green, will then offer additional details behind the numbers and after that, we'll both be happy to answer your questions. During our quarterly call last October, we said that business owners and investors were essentially paralyzed by the persistent uncertainty about the future. Factors causing that uncertainty included concerns about taxes, the upcoming midterm election and the impact of healthcare and financial reform legislation. We also counted our blessings for being in Texas, because even though Texas economy had its challenges, it was still weathering the recession better than almost anywhere else in the nation. Finally, we said that Cullen/Frost was well-positioned for these uncertain days and that we were working hard to expand our relationships and find new ways to grow our business amid the challenges surrounding the economic and our industry.

Today, I'm pleased to report reasons for cautious optimism about our economy and Cullen/Frost. First and foremost, there is more clarity in the 2011 than we had late last year. The midterm elections are behind us and we now know new composition of Congress and the Texas legislature. The tax package passed in late December by Congress, providing two more years of clarity concerning taxes, which is especially important to small businesses and families. We're starting to see some clarity in the interpretation of the financial reform legislation, such as the feds ruling on interchange fees. That doesn't mean that we're necessarily like the changes but the first step is to develop a strategic game plan is to know the rules of the game. As new legislations are announced and clarified, our financial institution will respond accordingly by adopting our business models to these changes. Of course, there's still a lot we don't know about the financial regulations. Healthcare and our economy, so we see 2011 as a transition year for our industry and for Cullen/Frost.

In addition to more clarity in the market, a second reason for cautious optimism is that our business is in Texas. We know that Texas, like most states, faces a large budget shortfall and debates on how best to balance the budget will determine the Texas legislative session. Unlike the Federal Government, our State Constitution does not allow Texas to operate with deficit financing and the governor has committed to balance the budget without raising taxes. Our unemployment rate in Texas of 8.2% should remain lower than the national average, which is now 9.8%, while our job growth will continue to outpace the nation by at least 1% as it has for many years.

There are probably multiple reasons to explain the relatively -- relative strength of Texas but it really boils down to this. The top economic sectors in the US are technology and energy, which just happens to be the real sweet spot for Texas. But Texas also has great diversity of industries so that we're not solely reliant on the strength of any partic -- one particular sector. As a Texas-based Company, Cullen/Frost is in the right place at the right time.

The third reason for cautious optimism is the culture of our Company. At Cullen/Frost we have clearly defined our value proposition and great people who have executed strategically, prudently and efficiently during the economic downturn. We've seen good growth and have continued to raise our dividend through the market cycle. Our brand is outstanding. Our reputation has never been better. We have tremendous capacity. Our liquidity and capital are much higher than the national average. Simply stated, we have money to lend. Because of our steady and consistent performance, we're well-positioned to adapt to the coming industry changes required by financial reform legislation and regulators. Our continued focus on building new relationships and expanding our existing relationships into new growth areas will pay off as the economy continues to improve.

Now, let's take a look at our results for the fourth quarter and the year. Our net income for the fourth quarter was $53.1 million, up from the $51.5 million reported in the fourth quarter of 2009. On a per share basis, our earnings were $0.87 per diluted common share, compared to $0.86 per diluted common share for a year ago. Remember, the fourth quarter of 2009 included the $18 million one-time gain on the federal home loan bank swap termination. Returns on average assets and equity were 1.18% and 9.96% respectively compared to 1.25% and 10.70% for the same period of 2009.

I'm pleased to tell you that Cullen/Frost reported annual earnings of $208.8 million in 2010, a 16.6% increase over 2009 of the $179 million. On a per share basis, 2010 earnings were $3.44 per diluted common share, an increase of 14.7% compared to the $3 per diluted common share reported in 2009. For the year, our return on average assets and equity were 1.21% and 10.30% respectively compared to 1.14% and 9.78% in 2009. This level of profitability during a down economy speaks volumes about our outstanding people. I appreciate their commitment to our culture and to taking great care of our customers.

For the fourth quarter of 2010, our net interest margin grew to $155.2 million on a taxable, equivalent basis, compared to $150.7 million reported for the fourth quarter of 2009. This increase primarily resulted from an increase in the average volume of earning assets and partly offset by decrease in the net interest margin, which was 3.93% compared to 4.20% for the year-earlier period and 4.04% for the third quarter of 2010. Deposits continue to rise, although at a slower pace as customers respond to our valued proposition. Average deposits for 2010 rose to $14 billion, up 13.1% or $1.6 billion over the $12.4 billion reported in 2009. For the year-ended December 31, 2010, average total loans were $8.1 billion, compared to $8.7 billion for the previous year.

For the fourth quarter, was our best quarter for new loan commitments in two years. It was 22% better than last year and 18% better than the third quarter of 2010. This improvement was across the board, with all regions reporting double-digit growth compared to the fourth quarter of last year. 2010 was a turnaround year for loan requests. During the year, we booked 12% more new commitments than the previous year and ended 2010 with a pipeline that is about 20% higher than this time in 2009. In addition, we saw fundings under our commitments increase slightly in the fourth quarter. While the increase was not large, it was the second consecutive quarter that we saw increased usage of our lines of credit.

As we have discussed in the past, this increased usage is an indicator that customers are using their lines to support their growth. Another positive indicator has been the increase in demand from our customers. On a year-over-year basis, requests from customers were up 6%. While this is not robust, it is a big improvement compared to the 33% decline that we saw between 2008 and 2009 and it indicates that customers are being comfortable taking on additional debt.

We are beginning to see the results of our disciplined calling effort. Our prospecting calls resulted in a 19% increase in loan requests from prospects compared to 2009. This is the result of a 14% increase in calls on prospects in 2010, which produced a record number of new relationships last year. And it's not just quantity. In 2010, the quality of the request also improved as we booked a higher percentage of those requests. This improved booking percentage was realized in all regions and side segments for both customers and prospects. While the trend and the quality of loan requests continues to be positive, the volume is still below pre-crash levels. We believe we're well-positioned to meet the needs of our markets and hope to see continued increase as the economy improves.

Turning to credit quality, it was encouraging to see another decline in non-performing loans this quarter from both the same period a year ago and the previous quarter. And current activity reinforces that the favorable credit quality trends during 2010 should persist. I'm pleased that credit quality continues to be at manageable levels. For the year the provision dropped nearly $22 million from more than $65 million in 2009. We continue to work successfully through problem loans. Rather than charging them off, we're getting resolutions through credit quality improvement of individual credits, refinancing loans elsewhere, loan payments and pay downs, and orderly collateral liquidation.

Problem outflow exceeds inflow for the fourth consecutive quarter. It is worth noting that the allowance is most sensitive to this activity. Total collections of problem loans, not including charge-offs, during 2010 was approximately $260 million. Non-performing assets decreased during the quarter. Net charge-offs improved significantly from $20.1 million in the fourth quarter of 2009. Delinquencies ended the quarter at $82 million, or 1.01% of total loans. The quarter-end total is the lowest in at least the last eight quarters. The allowance for loan and lease loss dollars levels remains comparable to what was reported in each quarter and in 2010. We expect these trends to continue. In particular, the outflow of problem loans. If problem loans continue to be reduced, as expected, and the economy stabilizes, we may have the opportunity to begin releasing reserves.

Non-interest income for the fourth quarter of 2010 was $70.3 million, down $16.1 million from $86.3 million a year earlier. Other income was $14.2 million, down from the $29.4 million reported in the fourth quarter of 2009 when the Company realized a one-time $17.7 million gain from the termination of an interest rate swaps related to home loan bank advances. Service charges on deposits decreased from $26 million in the fourth quarter 2009 to $24.1 million in the fourth quarter of 2010, primarily due to a new rule issued by the Federal Reserve board related to consumer overdraft, insufficient fund charges and a decrease in commercial billable services. Moving now to our consumer banking activity, the fourth quarter produced growth in the number of checking accounts and deposit balances. Checking accounts grew 5.2% from the fourth quarter of 2009 to the fourth quarter of 2010 while balances grew 7% over the same period.

Before I turn the call over to Phil, let me leave you with some thoughts on the coming year. As I said earlier, we believe that 2011 will be a transition year for our industry and for Cullen/Frost. We're still waiting to see some interpretations of the new financial reform legislation but we know this much for sure. The regulation will reduce our revenues and increase our costs. When the outside factors adversely affect business models, businesses adjust. Much of the industry has responded by raising prices or charging for things that used to be free. This is the dreaded unintended consequences of new legislation. At Cullen/Frost we want to be careful to avoid a knee-jerk reaction that would violate our value proposition. We want to make sure we're getting a fair price for the excellent service we consistently provide. At the same time, we also want to assure that we empower the customers to structure his or her relationship with us in a way that works best for each of them while recognizing the length and depth of those relationships.

An approach like that takes a little more time, but we believe it meets with the best long-term success. At Cullen/Frost, we will be ready and we will respond with our well-known focus on delivering value to our customers who recognize and appreciate the Frost difference. We're always gratified by our customers' response. A recent example of positive customer feedback is found in the 2010 Greenwich Associates survey of 24,000 small and middle-market businesses. In these interviews of companies across the country with sales between $1 million and $500 million in revenues, Frost earned 17 excellent awards for distinguishing itself from more than 750 banks evaluated. We also set ourselves apart by turning down TARP bailout funds and getting out of the residential mortgage lending business in 2000, when the industry had become commoditized and not a relationship product, delivering steady and consistent performance quarter after quarter and paying dividends to our shareholders throughout the recent cycle and even increasing the dividend and the recession.

One of our biggest challenges, however, has been to make sure people know about us and our distinguishing characteristics. We often hear from new customers that if they had only known about us, they would have banked with us sooner. In 2011, we plan to invest in our future by increasing our marketing efforts. We want to make sure that more people know about our great culture, clearly defined value proposition and our great people when they make their decision about their banking relationship. While 2011 is a year in which many monumental changes to our industry must be dealt with, we remain solidly optimistic at Cullen/Frost about the long-term future and success of our Company.

With that, I'll turn the call over to Phil Green.

Thanks, Dick. I'm going to make a few additional comments about our operations, including some balance sheet activities and net interest margin, I'm going to discuss the impact of regulatory change on our Company and then discuss our outlook for 2011. First, I want to outline a change in our derivatives position whereby we sold the remaining $800 million prime-based hedge in the fourth quarter. The reason for this decision was two-fold. The first and most important dealt with the impact of a law change, mainly Dodd Frank, while the second was market related. Regarding the law change, Dodd Frank repeals REG Q effective mid 2011, which allows the payment of interest on demand deposits. Without going into all the reasons why I believe this is bad policy, suffice it to say that this has eliminated the largest fixed rate liability from the vast majority of banks' balance sheets, including ours. The impact of this was to move us, and I might add many others, at mid 2011 from an asset-sensitive position to a liability-sensitive position. It also does so at the historical low point in the rate cycle. This was not a place we wanted to be.

Regarding the second market-related reason, in mid-fourth quarter 2010, the market reacted strongly to the prospect of the feds QE2 policy by driving the yield curve sharply lower in advance of the actual event. You may recall our comments in the last conference call when we said we were prepared to sit out of the bond market rather than investing in what we felt were bubble prices. However, these same factors drove up the value of our remaining swap position so as to make the on-going costs of giving up the position the lowest it had been in the time we had held it. The math of this is that any time you give up an in-the-money derivatives position it will cost you the current cash flow of that position. However, the gain on that position must be amortized through the remaining term of the original contract, which can help offset the lost cash flow.

Specifically, in our case, at the current prime rate, the annual cash flow of the remaining position was about $34.5 million per year. The sale resulted in realizing a gain of $111 million, which will amortize at a little over $28.5 million per year through October of 2014. Obviously this results in a negative annual impact of a little over $6 million per year at current rates, which we expect to carry through 2011. However, we also expect rates to ultimately rise, which will reduce this impact and increase the -- which will reduce this impact with each increase and the prime rate. And to put that in perspective, an increase in the prime of about three-quarters of a percent will move that $6 million negative carry to breakeven.

So to summarize, the sale of the position into the over-valued November market had little immediate impact on our operations, but it served to move us back to a slightly asset-sensitive position even after the impact of Dodd Frank. It did so at a manageable annual cost of $6 million at current rates, a virtue of amortizing the $111 million gain. In the current rate environment, which has since corrected from November's highs, we estimate the value of that position today would be in the, say, mid -- $90 million range. Now that it's gone -- to recap the position -- over it's three-year life it resulted in $105 million in positive cash flow into interest income and $157 million in realized gains, currently being amortized, for a total benefit of just over a quarter of a billion dollars.

Taking a look at our net interest margin, we did see a drop of 11-basis points in the third quarter. 80% of this drop stems from the $344 million increase in deposits, which went into the fed or lower yielding securities, and most of the rest of this resulted from a slightly-lower loan yield which was the result of a partial quarter of the $6 million negative impact I mentioned earlier in connection with the derivative sale.

Dick mentioned we're beginning to see some clarity in the interpretation of the new finance reform legislation and I'd like to make a few comments regarding potential impacts of Dodd Frank, as we have increasing visibility on issues surrounding it. First, Dick mentioned that we're not happy with the feds first proposal concerning the interchange and for good reason. We estimate it could result in at least 75% revenue loss in this area, or in round numbers, about an annualized $20 million beginning mid 2011. Also in 2011, the impact of Reg E and all current plan changes to our overdraft program is estimated at an additional cost of $5 million over the impact of 2010.

Regarding Reg Q, the impact of the payment of interest on demand deposits remains to be seen and will depend to a large extent on the competitive environment. However, we estimate in the neighborhood of $3.5 billion of deposits may be impacted. And on a brighter note, we estimate that the current FDIC assessment plan using assets instead of deposits would lower our premiums in the range of $6 million. Given all of these factors, including the additional marketing investment Dick mentioned, I think you can see what he means when he refers to a year of transition.

Finally, regarding our outlook for 2011, we're anticipating a year of flat rates and modest strengthening in the economy. This backdrop, along with the factors we just reviewed, would lead us to be more comfortable with a level of earnings a little below the current consensus of estimates for the year. That said, I agree with Dick that the fundamental outlook for our Company does remain strong. And with that, I'll turn it back over to Dick for questions.

Thank you, Phil. We'd now be happy to entertain your questions.

(Operator Instructions) Your first question comes from the line of John Pancari with Evercore Partners.

Good morning.

Good morning, John.

Can you -- in light of the impact of the derivative sale can you give us a little bit more color on expectations for the margin near term, how that could impact on a full-quarter basis and what your outlook would be given some expectation for return in loan growth?

I think that when we talk about the margin, we always need to do two things. One, we need to think about the impact of increased liquidity that may go into the Fed account at 25-basis points and the arithmetic of that will always put pressure on the margin number, per se, while it won't really effect the dollar number. I think from a business point of view two things were happening, which we think could add to a slight improvement in the margin at this point. One is the loan growth that you mentioned. Two is that we have been able to make some investments, given the return to some normalcy in the rate environment. After the Fed actually began implementing the QE2 policy they saw rates move up fairly sharply.

So, we've been able to take advantage of some investments in the periods since that's happened, mainly in the area of a few additional investments in municipals, some Jennie Mae ARMs and a few Jennie Mae fixed. So those, to the extent they're coming out of liquidity, could help us with our margin. So I'd say those factors, not withstanding the -- what I'll call an optical change whenever you see liquidity increase, should result in some increase -- modest increase we expect in the net interest margin.

Okay, and that'll be more on a near-term basis, that increase in the margin?

I would say, yes, over this -- we were talking about 2011. I should point out one other thing, and you did bring it up, is we did have a sale of the derivative, I think it was mid November last year, so we do have a full quarter that we've got to fade beginning in the first quarter. So that will tend to put a little bit of pressure, but not a tremendous amount of pressure, on a quarterly basis on the margin. I think that the factors that we talked about, the ability to invest on an opportunistic way and the return in -- expected return in loan growth should help us to see some modest improvement in margin.

Okay. And then that loan growth pickup, can you talk about to the magnitude that you expect you can see lifting growth and it's largely coming from CNI, I assume?

As you -- it's -- first of all, as I said throughout my comments, we're encouraged -- well, I also use words that it is not robust but it's certainly encouraging after coming through a year where loans were down several hundred million dollars. You got to remember, too, we moved $260 million of problem loans out of the bank or resolved them or they paid off or whatever, so, we see that the problem's starting to ease, while ours hasn't been near like the industry but they're starting to ease. You're starting to see a little line usage and this is where the art of it is pretty tough to project, but we're optimistic -- cautiously optimistic about that you're starting to see some trends.

I don't think the economy is just going to start booming but I do see the activity picking up. And if you start to see line usage of customers -- if I remember the number we're around 46% line usage -- and that really starts to -- if you just move a percentage point in that regard, you really start to get some lift and we've been experiencing through the recession just the opposite. And so that starts to lift. Obviously, we've been extremely aggressive in our prospecting and doing a good job to build the base, so you start to see those customers. And so to say what the number's going to be I have no idea, but I certainly see the trends are beginning to be positive in almost every area of how you grow loans. And so this -- on a late quarter basis we were up $64 million. Doesn't sound like a lot of money but after being down over the year of $250 million, it's sure encouraging.

Okay, then one last one, Dick. Can you talk about the M&A environment in Texas and your view of the opportunities and the pricing, particularly on the heels of the Comerica-Sterling deal?

Well, they -- I guess you would agree that, that was quite a price for the Sterling deal and I think that -- but that's what makes horse races, everybody has their own opinion. For us, we're going to continue to do what we've done for years and years and that is look for the right opportunities but make sure that the finances work. I think that one of the things that's happening in this environment, not only in Texas but everywhere, it's not fun going through a recession and it's tough to grow loan growth and then you stack on top all of this regulation changes of taking income out and raising expenses, sometimes you just look for another way to make it work. I think you -- for Cullen/Frost we will be very careful to make sure that in any analysis or opportunities that we might -- might come our way in an acquisition that a great deal of due diligence is required and a great deal of analysis to make sure -- those same things that are happening to us about losing fee income, and as Phil went through, are happening to everybody, so it's not unique. And so we'll continue to be aggressive lookers and conservative buyers.

Okay. Thanks for taking my questions.

Your next question comes from the line of Jon Arfstrom with RBC Capital Markets.

Thanks, good morning, guys.

Good morning.

Good morning, Jon.

Just a question on the Reg Q changes, Dick. How might you approach that and what is your opinion in terms of what the competitors might do? Does this just result in pricing pressure on two sides of the relationship or what do you think is the right way to look at it?

I'll let Phil talk about it in a minute then I'll make a few comments.

The -- I guess I mentioned in my comments the fact is we don't know. There's -- and there's no guessing what some competitors might do. I mean, you see that in acquisition pricing, you see that in loan pricing, you see that at times in deposit pricing and I think you'll see that in the demand deposit-related Reg Q pricing. I think it's going to be important for people in the marketplace to be able to differentiate their value propositions to other -- to the customers and not just compete on price.

I think it's ironic that they took what was probably the most relational base deposit and are going to introduce a price component into it and to the industry. But regardless, that's what we have and what we'll try to do is to be fair with the price we're going to pay, still providing the excellent service. And I know that's not giving an answer but the fact is we don't know what it is. I think it's pretty easy math to see the financial leverage that it has when you're talking about $3.5 billion of deposits, in our case, and a little number goes a long way there, so we just don't know.

I just -- I have to repeat the don't know. Phil said it three or four times, but I will tell you this. In a low-rate environment, which we're in what I call a zero-rate environment, you're not going to have -- you shouldn't have that much pressure on that. I think the real challenge that the industry has, and we have, is going out beyond when you start to see higher rates, and whenever that is, and what effect it will have. And so I think a lot of our thought is out in that realm.

Yes, I think the thing, Jon, also to remember -- excuse me -- is that we are asset sensitive, or at least we're not liability sensitive anymore [since] we got rid of the swaps, so that's going to be -- the impact of a higher rate on those deposits it's got to be factored in with all of the other rate changes in our balance sheet, both from liability side and asset side. And as it stands right now, we are not liability sensitive.

Then just one balance sheet question, if I may. How do you view the relationship between the size of your loan balances and the size of your securities portfolio, particularly when it sounds like you might have a bit of an increase in loan balances? Is this something where you might see the security balances come down as loans grow, or is that the wrong way to think about it?

Well, I think the first thing we have to do is eat through about just under $2.5 billion worth of liquidity that we currently maintain at the Fed and that will take us awhile to get through. If we were to get, say, a 80% loan-to-deposit ratio, where we were a couple of years ago, we would need to dip into the securities portfolio to do that. One thing about our portfolio today that we didn't have two or three years ago was we have almost $1 billion worth of US treasury securities which -- many of which are fairly short term so it won't be that difficult to eke some liquidity out of that portfolio. So I think we will see some reduction in the portfolio, if our balance sheet stayed flat, let's say, but that would happen after we got through the liquidity position at the Fed.

Thanks.

Let's not forget that would be a good thing. We would like to have that opportunity to have good quality loan growth and yes, we're very comfortable with the liquidity that we have.

Okay, thank you.

Your next question comes from the line of Bob Patten with Morgan Keegan.

Good morning, Phil and Dick, you guys call it like it is. Why haven't more banks joined in with Bill Cooper to -- this lawsuit about the Durbin amendment, we're all talking about how upset we are about it but what are the banks doing to get to the Congressmen and the Senators and so forth?

I think there's a little complication in regard to the first part of your question related to the exact lawsuit Bill Cooper, and we certainly admire him and what he's done and his particular situation. I think in regard that you're seeing more of the industry come together from the very largest to the very smallest and addressing this issue. And I think it will be addressed over the next weeks and months as, again, probably for the first time in the history of the industry really addressing this problem. There's different -- like anything, it is a little complicated by the $10 billion and under but even then, the community banks know that there's not going to be a two tier. When you go to Target or Walmart or wherever -- and incidentally, I guess, what we really saw is $10 billion move out of the financial industry to the retail industry and the consumer gets no benefit.

And yes, there's questions of constitutional law and all of those things, but what's going to bring the smaller banks under $10 billion, they realize that while they talk about a two tier, it is not going to work. And so -- and then you take the rest of the industry, they certainly see what's happening to them, just as we showed you what's happening to us. It's everywhere. So, I'm optimistic and participating in discussions that this will be addressed. I think it was a terrible judgment and ruling on the part of the Fed and I think it'll play out to -- for politicians to understand exactly what it is, certainly the comment letters to the Fed and third, is the legal aspect. So, there's three fronts. They're all complex and different ways, but even with the complexity you're seeing more and more of a unified effort. And I think you will see it as we go forward.

Great commentary, Dick. Just one last question, are there any areas that Cullen could ramp up, whether it's specialty leasing or asset-based lending or any other specialty businesses that you maybe have been thinking about?

Again, the way we think of the business, as you hear us over and over, is in relationships. The good news about having an asset-based lending, a factoring company, a great leasing business, making loans, all of those aspects, we're going to continue to team sell. We're going to go across the board and we've got -- obviously I'm partial, but an outstanding financial service company that can do all aspects of the different kinds of financing. And so what we will continue to do is go and build a total relationship, broadening deep in the relationship with our customers and let the customer have the choice of what is best for their business. If they want a lease, we can do it. If they want a factor, we can do it. If they want to make a loan, we can do it. And so it's about the customer choice but understand that this Company has the ability to do that broad range.

Thank you very much, guys.

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

Good morning.

Morning.

Could you talk to us maybe a little bit about whether you're emphasizing any new business lines or new product sets that could help offset some of the regulatory drags? And then maybe just generally how do you think the industry offsets these regulatory drags that you guys have been talking about? Thanks.

Well, one of the things that I talked about -- you heard me talk about -- is that there's a lot ha -- there's a lot of knee-jerk reactions, and you can do that. You can -- we've seen prices increase and changing things.We understand what's happening in that regard. We think it's particularly important to not knee-jerk but to really understand what the customer -- if you look deeply at the research that's being done, there's still a lot of frustrations on the part of the customers about the different services and so we're spending a lot of time looking at that and matching up what we will offer in regard to an offering that still has a fair price for excellent service, which our service we'll put up against anybody in the United States.

So I think just from the industry point of view, and I think it affects us, as well, Dick's talked about some of the deposit pricing changes that have happened but really, I think from a bank business point of view, price of credit has got to be better than it was pre-Lehman. That's really where the operating leverage is in the industry and I think the effect of a lot of these changes will be, has been and will continue to be a higher price that's got to be [extracted] for credit than what was in the past. So, I think that's a big factor. We've seen spreads -- I think in our case -- and I've said this many times before -- but our pre-Lehman spread to prime on new and renewed business was about 38-basis points for the year pre-Lehman. I think last year was about 121-basis points or so. We're seeing competition -- continue to see competition. I think that'll come down some, but I don't expect it to go back to where it was before. And so I think that's a big factor.

If you look at our specific case, that just being Cullen/Frost -- I'm not sure the industry's in this situation -- but our loan-to-deposit ratio today is roughly 55%, a little over that maybe, but not much, so let's say 55%. As I mentioned earlier, a couple of years ago, that percentage was 80%, so the efficiency, if you will, of our balance sheet is not nearly what it was. But the operating leverage of moving that to, say that 80% level again, is tremendous and it's one of the reasons that we have on our longer-term basis a high level of optimism about what we're doing. So, those are two things I think are important, in addition to the deposit product pricing that Dick has mentioned.

I just -- just to add, Phil's really hit what's really important and we've been -- he gave you the exact number of working on that for some time and the industry needs to be realistic about the cost of money. And certainly, we're looking at all of the areas but I think you should think in the terms of tweaking different types of areas. There's not -- the big money's going to come in what Phil described. And the other thing I'd say to you is there are no silver bullets.

If there were, we'd have shot them already. We're trying to operate the Company as effectively as we can and so if we thought there was a business line that we could do better in -- and there have been some -- new things to focus on and new thrusts, we would do them and we have been doing them.

As we talk about team selling, we're talking about coming together as one and trying to help all of the business lines be better and have higher volumes and priced properly.

All right. That's helpful. Thank you very much.

(Operator Instructions)Your next question comes from the line of Tom Alonso with Macquarie.

Good morning, gentlemen.

Good morning.

Just real quickly, as you're talking about moving that liquidity into loans as you see the loan demand increase, do you expect to see a commensurate drag down on deposits, maybe not commensurate on dollar for dollar but as the borrowers, rather than looking to take loans, use the liquidity they've built up, and will some of that excess liquidity to have go to deal with potential deposit outflows?

Well, it's certainly there for that, as well. I think that -- I said before that when you look back on the previous time the Fed jammed rates down extremely low, which was when they went down to 1% after the post-2001, we saw a tremendous build up, particularly in demand deposits and we actually wondered if we'd see a drop in those deposits after we saw the economy pick up. In fact, what happened was it was more of a flattening. And I said also that I believe that the amount of inflow we've had at this time has been more dramatic, so I think will probably see some reduction but that's an other things equal reduction.

I think the other thing that we've got going for us is, that we've had really good growth, I believe, in all aspects of our deposits and we feel our value proposition and our positioning in the market's resonating very well in the state. So, I would like to believe that we won't just stand pat, we'll actually have some growth underneath that to help what will be -- I agree with you -- some utilization of those deposits by businesses whenever the economy picks up. But the 2.5 -- just under $2.5 billion or so that we have is there for liquidity and liquidity is there for making loans and it's there for covering deposit outflows.

Okay. Fair enough. And then just real quick, the other income line this quarter, was there anything special in there? It was up a little over $2 million link-quarter.

We had -- I think there was a recovery of some interest -- charged off interest of a previous year, which was the largest thing on a link-quarter basis. That was about $885,000. But other than that, it was -- we had some good activity in our public finance underwriting, which is a business that's a little bit newer for us. Done a nice job there. Mineral interest income was up. Both of those combined were up about $600,000, so it was a lot of different things.

Okay. Fair enough. Thanks for answering my questions.

Your next question comes from the line of John Helfst with Schroder.

Hey, guys. You guys get a gold star on the timing and usage of your swap. Appreciate that.

Thanks.

I have a question just on the business DDA. Isn't there an earnings credit rate that you can play around with a little bit to offset maybe some competitors using rate? So, there's a lot of moving parts or am I not correct in thinking about that?

You are correct.

Yes, you're right. The earnings credit rate is a factor, it's a factor there today. When I mentioned the $3.5 billion, those represent demand deposits that are not a part of that account analysis system subject to the ECR.

Okay.

Because our total amount of demand deposit is over $5 billion or something like that, so the $3 billion, $3.5 billion is just an estimate that we have that would be excess balances that might be available or for balances that are not subject to that system.

Even if you took the rate higher, like a minimum balance?

I think --

Well, yes, you could -- there are a lot of different ways. For example, the ECR, the earnings credit rate that you mentioned, is actually a tiered rate in our case. We might implement a tiered rate on the terms of what we pay. It is complicated and we're going to have -- the industry's going to have to see it work itself out. The reason I didn't say what we pay is because we don't know, but I did -- what I'd do is I'd give you the balance that I thought might possibly be affected.

Okay.

I guess one of the things I'd add to it, there seems to be consis -- I've heard investors talk about that they can all be covered in the pricing of one example that you've given. What we -- I'm not sure that, that's realistic. Certainly, there can be tweaking in the pricing to pay for services and those kinds of things, but I think it's only realistic that there's not enough money there to cover it all by a long shot.

Okay, appreciate the up-frontness. Thanks.

You're welcome.

Your next question comes from the line of Scott Valentin with FBR Capital Markets.

Good morning and thanks for taking my question. Just with regard you mentioned loan strength, I think you pointed out it was CNI, is there any particular category you're seeing the strength in?

Not really. It is pretty much across the board and, quite frankly, there's some opportunity in commercial real estate. I don't want you to throw the phone down and jump but remember, this is a quality market and it's not robust by any means. But having lived through the '80s, which was really a depression in Texas, we never cut the spigot off or opened it all the way.

And we're continuing to see -- if you look at a patch art of our loans, one of the things we watch that I think' s important is that we're not jumping off in some new area to save the whole thing. You're going to see that we're -- what you see when you look at the detail is we're growing in all of those segments. Obviously energy's about 9.5% of our loans. Energy's doing well. Medical, despite the new healthcare bill, is continuing to expand. And so it is really across the board. We have, and have for years, had a specialty in finance and insurance companies and it's continued to grow.

And so it's -- there's no one thing. Again, it comes back to the way we think about lending. We lend to people and then we measure how many -- the kind of collateral or the kind of industry we're thinking. But we start with quality, still judging character, which is -- seems to be kind of an old thought but we think it's a consistent thought you should keep in building a true relationship with the customer. And that's what makes consistent earnings over long periods of times and going through down cycles like we just experienced.

This is a follow up on the commercial real estate side. Is it fair to say that maybe there's slightly less competition in commercial real estate today because many of the smaller banks, maybe potentially were irrational competitors in the past, have gorged on commercial real estate, have their limit of commercial real estate, now, therefore, you're seeing less competition, or is that less appropriate for Texas because, to your point you didn't see the downturn similar to the rest of the US?

I wouldn't get too locked into that. That could be a small factor but not a large one.

Okay. And in terms of the growth rate, you mentioned it picked up, I think, towards -- (inaudible) more toward the end of the quarter. Is the pipeline continuing to show continued loan demand, loan growth?

Well, the pipeline continues to look good. I want to -- cautiously optimistic. Remember what I'm saying, cautious. But it is -- there are positive signs in really all of the categories and a lot of that's because our people have done such a great job of prospecting and taking care of customers and being -- we knew -- we learned a lesson in the '80s and it's kind of apples and oranges but we were so beat up that all we tried to do was solve problems. In this downturn cycle we have been extremely aggressive of -- what we said to you over and over of building new relationships. In many cases, those are deposits that we've brought in and -- but it is building a relationship that the business, or the individual is already in-house and so when those opportunities start to see, it's not like going out and bringing them in. You start to expand the business off of that base you have.

Okay. Thanks very much.

At this time, there are no further questions. Presenters, do you have any closing remarks?

We appreciate your interest in our Company and the support of Cullen/Frost. We stand adjourned.

This concludes today's conference call, you may now disconnect.